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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-27525
DSL.NET, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1510312
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
545 Long Wharf Drive
New Haven, Connecticut 06511
(Address of principal executive offices) (Zip Code)
(203) 772-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [_] No [X]
As of August 11, 2003 the registrant had 65,521,540 shares of Common Stock
outstanding.
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DSL.NET, INC.
INDEX
Page
Number
------
Part I - Financial Information
Item 1. Consolidated Financial Statements ..................................2
Consolidated Balance Sheets (unaudited) at December 31,
2002 and June 30, 2003 ....................................2
Consolidated Statements of Operations (unaudited) for the
three and six months ended June 30, 2002 and 2003 .........3
Consolidated Statements of Cash Flows (unaudited) for the
three and six months ended June 30, 2002 and 2003 .........4
Notes to Consolidated Financial Statements ....................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................20
Item 3. Quantitative and Qualitative Disclosures about Market Risk ........37
Item 4. Controls and Procedures ...........................................37
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K ..................................37
Signature ..................................................................39
Exhibit Index ..............................................................40
1
Part I - Financial Information
Item 1. Consolidated Financial Statements
DSL.net, Inc.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
(unaudited)
December 31, June 30,
2002 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 11,318 $ 3,582
Restricted cash 1 22
Accounts receivable (net of allowances of $606 and $1,013
at December 31, 2002 and June 30, 2003, respectively) 4,358 7,791
Inventory 707 551
Deferred costs 615 809
Prepaid expenses and other current assets 726 1,056
--------- ---------
Total current assets 17,725 13,811
Fixed assets, net 23,066 30,170
Goodwill and other intangible assets 10,656 10,082
Other assets 2,049 7,596
--------- ---------
Total assets $ 53,496 $ 61,659
========= =========
LIABILITIES, MANDATORILY REDEEMABLE, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,621 $ 3,410
Accrued salaries 1,225 1,460
Accrued liabilities 4,621 11,939
Deferred revenue 3,591 5,844
Current portion of capital leases payable 2,676 3,224
--------- ---------
Total current liabilities 16,734 25,877
Capital leases payable 1,889 544
Notes payable (Note 5) -- 5,000
Credit facility (Note 7) -- 6,100
--------- ---------
Total liabilities 18,623 37,521
--------- ---------
Commitments and contingencies (Note 8)
Preferred stock: 20,000,000 preferred shares authorized (Note 9)
20,000 shares designated as Series X, mandatorily redeemable, convertible
preferred stock, $.001 par value; 20,000 shares issued and outstanding
as of December 31, 2002 and June 30, 2003 (liquidation preference
$22,315 and $23,515 as of December 31, 2002 and June 30, 2003, respectively) 8,741 13,287
15,000 shares designated as Series Y, mandatorily redeemable, convertible
preferred stock, $.001 par value; 15,000 shares issued and outstanding
as of December 31, 2002 and June 30, 2003, (liquidation preference
$16,380 and $17,280 as of December 31, 2002 and June 30, 2003, respectively) 5,381 8,956
Stockholders' equity
Common stock, $.0005 par value; 400,000,000 and 400,000,000 shares authorized;
64,929,899 and 65,306,999 shares issued and outstanding 32 33
Additional paid-in capital 305,647 304,296
Deferred compensation (437) --
Accumulated deficit (284,491) (302,434)
--------- ---------
Total stockholders' equity 20,751 1,895
--------- ---------
Total liabilities, preferred stock and stockholders' equity $ 53,496 $ 61,659
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
2
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
Revenue $ 11,596 $ 18,097 $ 22,977 $ 34,862
------------ ------------ ------------ ------------
Operating expenses:
Network (excluding $8, $3, $15 and $11
of stock compensation, respectively) 8,625 13,406 17,337 25,643
Operations (excluding $14, $3, $29 and $10
of stock compensation, respectively) 1,856 2,818 3,847 5,574
General and administrative (excluding $57, $17, $168 and $69
of stock compensation, respectively) 3,373 3,216 6,776 6,273
Sales and marketing (excluding $217, $137, $430 and $348
of stock compensation, respectively) 1,577 1,889 2,774 4,122
Stock compensation 296 160 642 438
Depreciation and amortization 5,274 4,498 10,388 9,335
------------ ------------ ------------ ------------
Total operating expenses $ 21,001 $ 25,987 $ 41,764 $ 51,385
------------ ------------ ------------ ------------
Operating loss $ (9,405) $ (7,890) $ (18,787) $ (16,523)
Interest income (expense), net 8 (847) (236) (1,411)
Other income (expense), net 3 37 175 (9)
------------ ------------ ------------ ------------
Net loss $ (9,394) $ (8,700) $ (18,848) $ (17,943)
============ ============ ============ ============
Net loss applicable to common stockholders:
Net loss (9,394) (8,700) (18,848) (17,943)
Dividends on preferred stock (879) (1,050) (1,473) (2,100)
Accretion of preferred stock, net of issuance costs (2,461) (3,011) (4,057) (6,021)
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $ (12,734) $ (12,761) $ (24,378) $ (26,064)
============ ============ ============ ============
Net loss per share, basic and diluted $ (0.20) $ (0.20) $ (0.38) $ (0.40)
============ ============ ============ ============
Shares used in computing net loss per share, basic and diluted 64,868,362 65,030,504 64,806,104 64,981,319
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
3
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, except per share data)
(unaudited)
Six Months ended
June 30,
----------------------
2002 2003
-------- --------
Cash flows from operating activities:
Net loss $(18,848) $(17,943)
Reconciliation of net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 10,388 9,335
Bad debt expense 1,285 1,335
Sales credits and allowances 869 241
Amortization of deferred debt issuance costs 9 816
Stock compensation expense 642 438
Loss on sale/write-off of fixed assets 52 117
Net changes in assets and liabilities:
(Increase) in accounts receivable (2,382) (5,009)
Decrease / (increase) in prepaid and other current assets 313 (369)
(Increase) / decrease in other assets (385) 293
(Decrease) in accounts payable (328) (1,211)
Increase in accrued salaries 24 235
(Decrease) / increase in accrued expenses (2,738) 6,568
Increase in deferred revenue 285 1,170
-------- --------
Net cash used in operating activities (10,814) (3,984)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (880) (1,231)
Proceeds from sales of property and equipment 85 --
Acquisitions of businesses and customer lines (750) (7,917)
Decrease / (Increase) in restricted cash 40 (21)
-------- --------
Net cash used in investing activities (1,505) (9,169)
-------- --------
Cash flows from financing activities:
Proceeds from credit facility -- 6,100
Proceeds from common stock issuance 10 114
Proceeds from preferred stock issuance 15,000 --
Principal payments under notes and capital lease obligations (1,484) (797)
-------- --------
Net cash provided by financing activities 13,526 5,417
-------- --------
Net increase / (decrease) in cash and cash equivalents 1,207 (7,736)
Cash and cash equivalents at beginning of period 19,285 11,318
-------- --------
Cash and cash equivalents at end of period $ 20,492 $ 3,582
======== ========
Supplemental disclosure of non-cash investing activities:
On January 10, 2003, the Company purchased the network assets and associated
subscriber lines of Network Access Solutions Corporation (Note 5)
The fair value of the assets acquired was $14,750
The accompanying notes are an integral part of these consolidated financial statements.
4
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. Summary of Significant Accounting Policies
A. Basis of Presentation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements. Actual
results may differ from those estimates. Certain prior period amounts have been
reclassified to conform to the 2003 presentation. The consolidated financial
statements ("financial statements") at June 30, 2003 and for the three and six
months ended June 30, 2002 and 2003 are unaudited, but in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) that DSL.net, Inc. ("DSL.net" or the "Company") considers necessary
for a fair presentation of its financial position and operating results.
Operating results for the three and six months ended June 30, 2003 are not
necessarily indicative of results that may be expected for any future periods.
The accompanying unaudited interim financial statements have been prepared
with the assumption that users of the interim financial information have either
read or have access to the Company's financial statements for the year ended
December 31, 2002. Accordingly, footnote disclosures that would substantially
duplicate the disclosures contained in the Company's December 31, 2002 audited
financial statements have been omitted from these unaudited interim financial
statements. These financial statements have been prepared in accordance with the
instructions to Form 10-Q and the rules and regulations of the Securities and
Exchange Commission ("SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. While management believes the disclosures
presented are adequate to make these financial statements not misleading, these
financial statements should be read in conjunction with the Company's audited
financial statements and related notes included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002, which has been filed with the
SEC.
B. Revenue Recognition
The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin ("SAB") No. 101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS", which
requires that four basic criteria be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) are based on
management's judgments regarding the fixed nature of the fee charged for
services rendered and products delivered and the collectibility of those fees.
C. Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing income or loss
applicable to common shareholders by the weighted average number of shares of
the Company's common stock outstanding during the period, after giving
consideration to shares subject to repurchase.
5
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Diluted earnings per share is determined in the same manner as basic
earnings per share except that the number of shares is increased assuming
exercise of dilutive stock options and warrants using the treasury stock method
and dilutive conversion of the Company's outstanding preferred stock. The
diluted earnings per share amount is the same as the basic earnings per share
amount because the Company had a net loss during each period presented and the
impact of the assumed exercise of the stock options and warrants and the assumed
conversion of preferred stock would have been anti-dilutive.
2. Liquidity
As reflected in the Company's audited financial statements and related
notes included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002, the Company incurred operating losses of approximately
$35,821 and negative operating cash flows of approximately $17,706 during the
year ended December 31, 2002. During the six months ended June 30, 2003, the
Company incurred operating losses of approximately $16,523 and negative
operating cash flows of approximately $3,984. These operating losses and
negative operating cash flows have been financed primarily by proceeds from
equity issuances. The Company had accumulated deficits of approximately $284,491
at December 31, 2002 and approximately $302,434 at June 30, 2003.
The Company expects its operating losses, net operating cash outflows and
capital expenditures to continue through 2003 and into 2004. The Company
successfully completed rounds of private equity and bridge loan financings
totaling approximately $35,000 as follows: approximately $20,000 in the fourth
quarter of 2001, $10,000 in March 2002 and $8,531 in May 2002 (which, after
cancellation of the bridge loans, yielded net proceeds of approximately $5,000)
(Note 9). In addition, on July 18, 2003, the Company successfully raised
approximately $30,000 in additional financing (Note 13). The Company believes
that its existing cash and cash equivalents, cash expected to be generated from
operations and proceeds from this recent financing will be sufficient to fund
its operating losses, capital expenditures, lease payments and working capital
requirements through at least the end of 2004, based on its current business
plans and projections. The Company intends to use these cash resources to
finance its capital expenditures and for working capital and other general
corporate purposes. The Company may also use a portion of these cash resources
to acquire complementary businesses, subscriber lines or other assets. The
amounts actually expended for these purposes will vary significantly depending
on a number of factors, including market acceptance of the Company's services,
revenue growth, planned capital expenditures, cash generated from operations,
improvements in operating productivity, the extent and timing of entry into new
markets, and availability and prices paid for acquisitions. Failure to generate
sufficient revenues, contain certain discretionary spending or achieve certain
other business plan objectives could have a material adverse affect on the
Company's results of operations and financial position.
3. Stockholders' Equity
During the second quarter of 2003, the Company's remaining unamortized
deferred compensation balance relating to stock options and restricted stock
held by employees and directors became fully amortized. Consequently, there was
no remaining unamortized deferred compensation balance as of June 30, 2003.
6
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. Restructuring
The Company's restructuring reserve balance at June 30, 2003, of
approximately $865, which related to various restructuring charges recorded in
2000 and 2001, was included in the Company's accrued liabilities and represented
approximately $550 of real estate charges for anticipated costs pertaining to
its vacated facilities and approximately $315 for anticipated costs pertaining
to its closed central offices.
5. Acquisitions
During the quarter ended March 31, 2002, the Company entered into an Asset
Purchase Agreement, dated as of January 1, 2002, with Broadslate Networks, Inc.
("Broadslate") for the purchase of business broadband customer accounts and
certain other assets, including certain accounts receivable related to the
customer accounts. The initial purchase price of $800 was subject to certain
adjustments which resulted in a $50 reduction in the purchase price. The
Broadslate customer line acquisitions were accounted for under the purchase
method of accounting and, accordingly, the adjusted purchase price of
approximately $750 was allocated to the assets acquired based on their estimated
fair values at the date of acquisition as follows: approximately $28 to net
accounts receivable acquired and approximately $722 to approximately 520
subscriber lines acquired, which amount is being amortized on a straight-line
basis over two years from the date of purchase.
In December of 2002, the U.S. Bankruptcy Court for the District of
Delaware approved the Company's bid to purchase network assets and associated
subscriber lines of Network Access Solutions Corporation ("NAS") for $14,000,
consisting of $9,000 in cash and $5,000 in a note payable to NAS. The Company
closed the transaction on January 10, 2003, whereby it acquired NAS's operations
and network assets, associated equipment in approximately 300 central offices
and approximately 11,500 associated subscriber lines. Additionally, on January
10, 2003, the Company hired approximately 78 employees formerly employed by NAS.
No pre-closing liabilities were assumed in connection with the NAS transaction.
The cash portion of the consideration was paid from the Company's existing cash.
In accordance with the Asset Purchase Agreement, DSL.net negotiated a $1,083
reduction in the cash paid at the closing, representing DSL.net's portion of
January revenue which was billed and collected by NAS, bringing the net cash
paid for the NAS network assets and associated subscriber lines to $7,917. The
NAS note has a term of 5 years, bears interest at 12% per annum and is
collateralized by the network equipment acquired from NAS. Interest is payable
monthly in arrears on the unpaid principal balance. The note requires
interest-only payments for the first 21 months after which principal payments
will commence monthly and be paid in 39 equal monthly installments together with
interest on the unpaid principal balance.
NAS provided high-speed Internet and Virtual Private Network services to
business customers using Digital Subscriber Line, frame relay and T-1 technology
via its own network facilities in the Northeast and Mid-Atlantic markets. The
NAS acquisition significantly increased the Company's subscriber base and its
facilities-based footprint in one of the largest business markets in the United
States, providing it with increased opportunities to sell more higher-margin
facilities-based services.
The acquisition has been accounted for under the purchase method of
accounting in accordance with SFAS No. 141. The results of NAS's operations have
been included in the consolidated financial statements since January 10, 2003
(the acquisition date). The allocated estimated fair values of the acquired
assets at the date of acquisition exceeded the purchase price and, accordingly,
7
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
have been written down on a pro-rata basis by asset group to the purchase price
of approximately $14,750 ($14,000 plus associated direct acquisition costs of
approximately $750) as follows: (i) intangible assets pertaining to
approximately 11,500 acquired subscriber lines of $1,476, and (ii) property and
equipment of $13,274. The Company is still in the process of finalizing certain
estimates of certain property and equipment and, thus, the allocation of the
purchase price is subject to further adjustment.
In connection with the integration of the NAS business, on January 17,
2003, the Company had a reduction in force of approximately 35 employees at its
headquarters facility in New Haven, Connecticut. The Company paid approximately
$62 in severance to the terminated employees. Subsequent to this reduction in
force, the Company's headcount was approximately 230 employees.
With the acquisition of the NAS assets on January 10, 2003, the Company
acquired a number of subscribers, some of whom it serves indirectly through
various Internet service providers ("ISP's"). The Company sells its services to
such ISP's who then resell such services to the end-user subscriber.
Accordingly, the Company has some increased exposure and concentration of credit
risk pertaining to such ISP's during 2003. However, no individual customer
accounted for more than 5% of revenue for the first 6 months of 2003.
On April 8, 2003, the Company entered into an asset purchase agreement
with TalkingNets, Inc. and TalkingNets Holdings, LLC, (collectively,
"TalkingNets") pursuant to which the Company agreed to acquire assets and
subscribers of TalkingNets for $726 in cash (the "TalkingNets Asset Purchase
Agreement"). As TalkingNets filed a voluntary petition for Chapter 11
reorganization in February 2003, the TalkingNets Asset Purchase Agreement was
subject to the approval of the U.S. Bankruptcy Court for the Eastern District of
Virginia. On April 9, 2003, the TalkingNets Asset Purchase Agreement and the
transactions contemplated thereby were approved by the Bankruptcy Court. If all
closing conditions are satisfied, the Company expects that this transaction will
be completed during the third quarter of 2003. On April 11, 2003, the Company
paid the full purchase price of $726 into escrow. In accordance with the terms
of the TalkingNets Asset Purchase Agreement, the Company will have a transition
period of up to 150 days to integrate TalkingNets' operations into its own
operations and obtain all requisite approvals prior to final closing of the
transaction. During the transition period, the Company will be entitled to the
cash collections from the proposed acquired customers and be obligated to pay
for certain of the related operating costs of TalkingNets' operations. During
this transition period, the Company has included the net effect of cash
collections from the proposed acquired customers less certain related operating
costs of TalkingNets' operations in its statements of operations. This net
effect for the three and six months ended June 30, 2003, was approximately $235
in expense.
8
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth the unaudited pro forma consolidated
financial information of the Company, giving effect to the acquisition of the
Broadslate customers and the acquisition of network assets and associated
subscriber lines of NAS, as if the transactions occurred at the beginning of the
periods presented. Inclusion of TalkingNets results would not materially change
the reported unaudited pro forma results.
PRO FORMA
SIX MONTHS ENDED JUNE 30,
-----------------------------------
2002 2003
------------ ------------
Pro forma revenue $ 35,088 $ 35,620
Pro forma operating loss $ (19,897) $ (16,496)
Pro forma net loss $ (21,118) $ (17,962)
Pro forma net loss applicable to common stockholders $ (26,648) $ (26,083)
Pro forma net loss per share, basic and diluted $ (0.41) $ (0.40)
Shares used in computing pro forma net loss per share 64,806,104 64,981,319
The pro forma results are not necessarily indicative of the actual results
of operations that would have been obtained had the acquisitions taken place at
the beginning of the respective periods or the results that may occur in the
future.
The actual revenue attributable to customer lines acquired during the
period was approximately $784 and $12,111 for the six months ended June 30, 2002
and 2003, respectively.
6. Goodwill and Other Intangible Assets
In accordance with SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS",
which became effective January 1, 2002, the Company has ceased to amortize
approximately $8,482 of goodwill. In lieu of amortization, the Company made an
initial impairment review of its goodwill in January of 2002 and another
impairment review in December of 2002. The Company did not record any goodwill
impairment adjustments resulting from its impairment reviews. The Company will
continue to perform annual impairment reviews, unless a change in circumstances
requires a review in the interim.
Amortization expense of other intangible assets for the three and six
months ended June 30, 2002 was approximately $1,352 and $2,694, respectively.
For the three and six months ended June 30, 2003, amortization expense was
approximately $870 and $2,050, respectively.
7. Debt
In December 2001, in conjunction with the Company's sale of shares of
mandatorily redeemable convertible Series Y Preferred Stock (the "Series Y
Preferred Stock"), the Company issued short-term promissory notes (the
"Promissory Notes") for proceeds of $3,531 to the holders of the Series Y
Preferred Stock. The Promissory Notes provided for an annual interest rate of
12%. In May 2002, in accordance with the terms of the Series Y Preferred Stock
Purchase Agreement (the "Series Y Purchase Agreement"), the Company sold an
additional 8,531 shares of Series Y Preferred Stock
9
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
for $5,000 in cash and delivery of the Promissory Notes for cancellation. All
accrued interest on the Promissory Notes, of approximately $145, was forgiven
(Note 9).
The Company entered into a Revolving Credit and Term Loan Agreement, dated
as of December 13, 2002 (the "Credit Agreement"), with a commercial bank
providing for a revolving line of credit of up to $15,000 (the "Commitment").
Borrowings under the Credit Agreement could be made in minimum $500 increments
from time to time up to the Commitment and repayments could be made in minimum
$100 increments, in each case until the revolving credit maturity date of
December 12, 2004, at which time all amounts outstanding would convert into a
term loan payable in 12 quarterly installments commencing on December 31, 2004
(the "Term Loan"). The Company could pre-pay amounts due under the Term Loan in
increments of $1,000 without penalty. Interest was payable on all amounts
outstanding under the Credit Agreement in arrears at the end of each calendar
quarter at a variable interest rate equal to the higher of the bank's prime rate
equivalent or 0.5% percent above the Federal Funds Effective rate. As of June
30, 2003, amounts outstanding under this Credit Agreement bore interest at an
annual rate of 4.0%. The amount not drawn upon under the Commitment (subject to
certain adjustments) was subject to a commitment fee, payable in arrears at the
end of each calendar quarter, equal to an annualized rate of 0.25%. The Credit
Agreement also required the Company and its subsidiaries, except for Vector
Internet Services, Inc., to maintain all of its bank deposit and investment
accounts with the bank. The Company's ability to borrow amounts available under
the Credit Agreement was subject to the bank's receipt of a like amount of
guarantees from certain of the Company's investors and/or other guarantors
acceptable to the bank and to certain other conditions set forth in the Credit
Agreement. As of June 30, 2003, the Company's investors had guaranteed $9,100
under the Credit Agreement. On February 3, 2003, the Company borrowed $6,100
under the Credit Agreement. As of June 30, 2003, the Company's outstanding
balance under the Credit Agreement was $6,100. On July 18, 2003, the Company
repaid the $6,100 outstanding balance plus accrued interest, and terminated the
Credit Agreement (Note 13).
The Company entered into a Reimbursement Agreement, dated as of December
27, 2002, with several private investment funds affiliated with VantagePoint
Venture Partners ("VantagePoint"), Columbia Capital Equity Partners
("Columbia"), The Lafayette Investment Fund, L.P. and Charles River Partnership,
L.P. (collectively the "Guarantors") and VantagePoint Venture Partners III (Q),
L.P., as administrative agent (the "Agent"). The Guarantors are all holders of
or affiliates of holders of the Company's Series X and Series Y Preferred Stock.
Pursuant to the terms of the Reimbursement Agreement, on December 27, 2002,
VantagePoint and Columbia issued guarantees in an aggregate amount of $6,100 to
support certain obligations of the Company under the Credit Agreement. The
Reimbursement Agreement obligated the Company to reimburse the Guarantors for
any payments they may be required to make in accordance with their guarantees.
The Company's obligations under the Reimbursement Agreement were guaranteed by
certain of the Company's wholly-owned subsidiaries and collateralized by a
Security Agreement signed by the Company and certain of its wholly-owned
subsidiaries which pledged a significant portion of the Company's consolidated
assets as collateral. On July 18, 2003, in connection with the termination of
the Credit Agreement, the guarantees, Reimbursement Agreement and related
Security Agreement were terminated (Note 13).
Pursuant to the terms of the Reimbursement Agreement, on December 27,
2002, the Company issued warrants to purchase 12,013,893 shares of its common
stock to VantagePoint and to Columbia, in consideration for their guarantees
aggregating $6,100. All such warrants have a ten year life and an exercise price
of $0.50 per share. On March 26, 2003, the Company, issued additional warrants,
exercisable for ten years, to purchase a total of 936,107 shares its common
10
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
stock at $0.50 per share to VantagePoint and Columbia, bringing the total number
of warrants issued in connection with the Reimbursement Agreement to 12,950,000.
Pursuant to the terms of the Reimbursement Agreement, in the event that the
Company did not borrow any amounts under the Credit Agreement on or before March
31, 2003, then the Credit Agreement and all Guarantees issued under the
Reimbursement Agreement would have been terminated and any warrants issued to
Guarantors in connection with the transactions contemplated would have been
deemed terminated. Since the Company borrowed amounts under the Credit Agreement
on February 3, 2003, the Guarantors' guarantees of the subject loan became
effective on February 3, 2003 and the contingency related to the validation of
the warrants was eliminated.
On February 3, 2003, the Company valued the 12,950,000 warrants at $0.514
each with a total value of approximately $6,656. The valuation was performed
using a Black Scholes valuation model with the following assumptions: (i) a risk
free interest rate of 4.01% (ten-year Treasury rate), (ii) a zero dividend
yield, (iii) a ten year expected life, (iv) an expected volatility of 153%, (v)
an option exercise price of $0.50 and (vi) a current market price of $0.52 (the
closing price of the Company's common stock on February 3, 2003). Since the
warrants were issued in consideration for loan guarantees, which enabled the
Company to secure financing at below market interest rates, the Company recorded
their value as a deferred debt financing cost which will be amortized to
interest expense over the term of the loan (approximately 57 months) using the
"Interest Method" of amortization. For the three and six months ended June 30,
2003, interest expense relating to amortized deferred financing costs
approximated $501 and $816, respectively.
On March 3, 2003, the Company and certain of the Guarantors entered into
Amendment No. 1 to the Reimbursement Agreement, pursuant to which VantagePoint
increased its guarantee by $3,000, bringing the aggregate guarantees by all
Guarantors under the Reimbursement Agreement, as amended, to $9,100. As
consideration for VantagePoint's increased guarantee, if the Company closed an
equity financing on or before December 3, 2003, it was authorized to issue
VantagePoint additional warrants to purchase the type of equity securities
issued by it in such equity financing. The number of such additional warrants
would be determined by dividing $1,000 by the per share price of such equity
securities. Accordingly, since the Company closed a financing on July 18, 2003,
the Company intends, subject to stockholder approval at its 2003 annual meeting
of stockholders, to issue to VantagePoint additional warrants to purchase
2,260,909 shares of its common stock at a per share price of $0.4423 (Note 13).
8. Commitments and Contingencies
In certain markets where the Company has not deployed its own local
broadband equipment, the Company utilizes local facilities of wholesale
providers, including Covad Communications, Inc. ("Covad"), in order to provide
service to its end-user customers. These wholesale providers may terminate their
service with little or no notice. The failure of Covad or any of the Company's
other wholesale providers to provide acceptable service on acceptable terms
could have a material adverse effect on the Company's operations. There can be
no assurance that Covad or other wholesale providers will be successful in
managing their operations and business plans.
The Company transmits data across its network via transmission facilities
that are leased from certain carriers, including AT&T and MCI (formerly known as
WorldCom). The failure of any of the Company's data transport carriers to
provide acceptable service on acceptable terms could have a material adverse
effect on the Company's operations. MCI has filed a voluntary petition to
reorganize under Chapter 11 of the U.S. Bankruptcy Code. While MCI has announced
that it expects to continue with its current operations without adverse impact
on its customers, it may not
11
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
be able to do so. The Company believes that it could transition the data
transport services currently supplied by MCI to alternative suppliers in thirty
to sixty days, should MCI announce discontinuance of such services. However, if
MCI was to discontinue such services without providing sufficient advance notice
(at least sixty days), the Company might not be able to transition such services
in a timely manner, which could disrupt service provided by the Company to
certain of its customers. This could result in the loss of revenue, loss of
customers, claims brought against the Company by its customers, or could
otherwise have a material adverse effect on the Company. Even if MCI was to
provide adequate notice of any such discontinuation of service, there can be no
assurance that the Company would be able to transition such service without a
material adverse impact on the Company or its customers, if at all.
Effective May 1, 2003, the Company entered into a 35 month lease for
office space in Herndon, Virginia, with minimum lease payments of approximately
$164 in 2003, $256 in 2004, $268 in 2005 and $68 in 2006.
Under the Company's facility operating leases, minimum office facility
operating lease payments are approximately $1,638 in 2003, $2,000 in 2004, $766
in 2005, $233 in 2006, $169 in 2007 and $28 in 2008. The Company also has
long-term purchase commitments with MCI, AT&T, Sprint and other vendors for data
transport and other services with minimum payments due even if its usage does
not reach the minimum amounts. Minimum payments under our long-term purchase
commitments are approximately $3,668 in 2003, $2,396 in 2004 and $57 in 2005.
9. Mandatorily Redeemable Convertible Preferred Stock
As more fully described in the Company's audited financial statements and
related notes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002, the Company entered into a Series X Preferred Stock
Purchase Agreement (the "Series X Purchase Agreement") with VantagePoint on
November 14, 2001, relating to the sale and purchase of up to an aggregate of
20,000 shares of Series X Preferred Stock at a purchase price of $1,000 per
share. On December 24, 2001, the Company entered into a Series Y Preferred Stock
Purchase Agreement (the "Series Y Purchase Agreement") with the Columbia Capital
Equity Partners III, L.P., Columbia Capital Equity Partners II, L.P., The
Lafayette Investment Fund, L.P., Charles River Partnership X, a Limited
Partnership and N.I.G. Broadslate (collectively with their assigns, the "Series
Y Investors"), relating to the sale and purchase of up to an aggregate of 15,000
shares of Series Y Preferred Stock at a purchase price of $1,000 per share.
Pursuant to the Series X Purchase Agreement, in November and December
2001, the Company sold an aggregate of 10,000 shares of Series X Preferred Stock
to VantagePoint for total proceeds of $10,000, before direct issuance costs of
approximately $189. Pursuant to the Series X Purchase Agreement, on March 1,
2002, the Company sold an additional 10,000 shares of Series X Preferred Stock
to VantagePoint for total proceeds of $10,000.
Pursuant to the Series Y Purchase Agreement, in December 2001, the Company
sold an aggregate of 6,469 shares of Series Y Preferred Stock to the Series Y
Investors for an aggregate purchase price of $6,469, before direct issuance
costs of approximately $300, which costs pertain to all funding transactions
under the Series Y Purchase Agreement.
In addition, in December 2001, the Company issued the Promissory Notes to
the Series Y Investors in the aggregate principal amount of $3,531 in exchange
for proceeds of $3,531. The Promissory Notes provided for an annual interest
rate of 12%. In May 2002, in accordance with the
12
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
terms of the Series Y Purchase Agreement, the Company sold 8,531 additional
shares of Series Y Preferred Stock for $5,000 in cash and delivery of the
Promissory Notes for cancellation. All accrued interest on the Promissory Notes,
of approximately $145, was forgiven (Note 7).
The Series X and Series Y Preferred Stock activity during the six months
ended June 30, 2002 is summarized as follows:
MANDATORILY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
----------------------------------------------------------
SERIES X SERIES Y
------------------------- ------------------------
SHARES AMOUNT SHARES AMOUNT
-------- -------- -------- --------
Balance December 31, 2001 10,000 $ 436 6,469 $ 34
Issuance of shares 10,000 10,000 8,531 8,531
Discount on Series X and Y Preferred Stock resulting
from a beneficial conversion feature (10,000) (8,531)
Accrued dividends on Series X and Y Preferred Stock 1,000 473
Accretion of beneficial conversion feature of Series X
and Y Preferred Stock 2,758 1,299
-------- -------- -------- --------
Balance June 30, 2002 20,000 $ 4,914 15,000 $ 1,806
======== ======== ======== ========
The Series X and Series Y Preferred Stock activity during the six months
ended June 30, 2003 is summarized as follows:
MANDATORILY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
----------------------------------------------------------
SERIES X SERIES Y
------------------------- ------------------------
SHARES AMOUNT SHARES AMOUNT
-------- -------- -------- --------
Balance December 31, 2002 20,000 $ 8,741 15,000 $ 5,381
Accrued dividends on Series X and Y Preferred Stock 1,200 900
Accretion of beneficial conversion feature of Series X
and Y Preferred Stock 3,346 2,675
-------- -------- -------- --------
Balance June 30, 2003 20,000 $ 13,287 15,000 $ 8,956
======== ======== ======== ========
As part of the agreements negotiated in conjunction with the Company's
$30,000 financing on July 18, 2003 (Note 13), the Company and holders of a
majority of the Series X and Series Y Preferred Stock agreed to extend the
redemption dates of the Series X and Series Y Preferred Stock from January 1,
2005 to July 18, 2006. Also, as a result of the financing transaction, in
accordance with the terms of the Series Y Preferred Stock, the Series Y
conversion price was adjusted from $0.50 (each Series Y Preferred Share is
convertible into 2,000 shares of common stock) to $0.4423 (each Series Y
Preferred Share is convertible into approximately 2,260.9 shares of common
stock).
13
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. Related Party Transactions
In accordance with the Series X Purchase Agreement, a group of private
investment funds affiliated with VantagePoint purchased an additional 10,000
shares of the Company's mandatorily redeemable convertible Series X Preferred
Stock in a closing that occurred on March 1, 2002 (Note 9). Prior to the sale of
the additional 10,000 shares of Series X Preferred Stock, VantagePoint
beneficially owned approximately 21,956,063 shares, or approximately 34%, of the
Company's total outstanding common stock and 10,000 shares of Series X Preferred
Stock. The 20,000 shares of Series X Preferred Stock owned by VantagePoint are
convertible into approximately 111,111,111 shares of common stock. As a result,
VantagePoint beneficially owned the equivalent of 133,067,174 shares of common
stock. Two affiliates of VantagePoint are members of the Company's Board of
Directors.
In accordance with the Series Y Purchase Agreement (Note 9), in December
2001, the Company sold to the Series Y Investors 6,469 shares of its Series Y
Preferred Stock for an aggregate purchase price of $6,469. In addition, in
December 2001, the Company issued the Promissory Notes to the Series Y Investors
in the aggregate principal amount of $3,531 in exchange for proceeds of $3,531
(Note 7). In May 2002, the Company sold to the Series Y Investors 8,531 shares
of Series Y Preferred Stock for total proceeds of $8,531, which resulted in net
proceeds of approximately $5,000, after the cancellation of the Promissory Notes
issued to the Series Y Investors in December 2001. An affiliate of Columbia was
a member of the Company's Board of Directors until August 5, 2003.
The Company entered into a Reimbursement Agreement, dated as of December
27, 2002, with the Guarantors and the Agent. The Guarantors are all holders of
or affiliates of holders of the Company's Series X and Series Y Preferred Stock.
Pursuant to the terms of the Reimbursement Agreement, on December 27, 2002, the
Company issued warrants to purchase 10,379,420 shares of its common stock to
VantagePoint and warrants to purchase 1,634,473 shares of its common stock to
Columbia, in consideration for their guarantees aggregating $6,100. The Company
issued additional warrants to purchase 767,301 shares of its common stock to
VantagePoint and 168,806 shares of its common stock to Columbia during the first
quarter of 2003, bringing the total number of warrants issued to 12,950,000. All
such warrants are exercisable for ten years at an exercise price of $0.50 per
share (Note 7). On March 3, 2003, the Company and certain of the Guarantors
entered into Amendment No. 1 to the Reimbursement Agreement, pursuant to which
VantagePoint increased its guarantee by $3,000, bringing the aggregate
guarantees by all Guarantors under the Reimbursement Agreement, as amended, to
$9,100. As consideration for VantagePoint's increased guarantee, and as a result
of the financing on July 18, 2003, the Company intends, subject to the receipt
of stockholder approval at its next annual stockholders' meeting, to issue to
VantagePoint, additional warrants to purchase 2,260,909 shares of its common
stock (Notes 7 and 13). Prior to the execution of the Reimbursement Agreement,
VantagePoint beneficially owned 21,956,063 shares of the Company's common stock
and 20,000 shares of the Company's Series X Preferred Stock, which are
convertible into 111,111,111 shares of the Company's common stock, and Columbia
owned 15,000 shares of the Company's Series Y Preferred Stock, which are
convertible into 30,000,000 shares of the Company's common stock. Two affiliates
of VantagePoint are members of the Company's Board of Directors. An affiliate of
Columbia was a member of the Company's Board of Directors until August 5, 2003.
14
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. Incentive Stock Award Plans
As of June 30, 2003, the Company has four stock-based employee
compensation plans, which are described more fully in the Company's audited
financial statements and related notes included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002. The Company accounts for
Stock-based compensation under the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). Accordingly, compensation expense is not recognized when
options are granted at the fair market value on the date of grant.
The Company has elected to continue following APB 25 to account for its
stock-based compensation plans. The following table presents the effect on the
Company's net loss and net loss per share as if the Company had applied the fair
value method of accounting for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"):
Three Months Ended June 30, Six Months Ended June 30,
------------------------- -------------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net loss, as reported ($ 9,394) ($ 8,700) ($18,848) ($17,943)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (1,220) (1,285) (2,522) (2,800)
-------- -------- -------- --------
Pro forma under FAS 123 ($10,614) ($ 9,985) ($21,370) ($20,743)
Net loss applicable to common stockholders:
As reported ($12,734) ($12,761) ($24,378) ($26,064)
Pro forma under FAS 123 ($13,954) ($14,046) ($26,900) ($28,864)
Basic and diluted net loss per common share:
As reported ($ 0.20) ($ 0.20) ($ 0.38) ($ 0.40)
Pro forma under FAS 123 ($ 0.22) ($ 0.22) ($ 0.42) ($ 0.44)
15
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The estimated fair value at date of grant for options granted during the
three and six months ended June 30, 2002 ranged from $0.55 to $1.51 per share.
The estimated fair value at date of grant for options granted during the three
and six months ended June 30, 2003 ranged from $0.43 to $0.45 per share. The
minimum value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Three Months Ended Six Months Ended
------------------------ -------------------------
June 30, June 30,
2002 2003 2002 2003
---- ---- ---- ----
Risk free interest rate 3.79-4.42% 2.15% 3.73-4.42% 2.15-2.70%
Expected dividend yield None None None None
Expected life of option 4 Years 4 Years 4 Years 4 Years
Expected volatility 138% 152% 138% 152%
As additional options are expected to be granted in future periods, and
the options vest over several years, the above pro forma results are not
necessarily indicative of future pro forma results.
12. Recently Issued Accounting Pronouncements
In July 2001, Statement of Financial Accounting Standards ("SFAS") No. 142
"GOODWILL AND OTHER INTANGIBLE ASSETS" was issued. SFAS No. 142 requires that
goodwill and intangible assets with indefinite lives no longer be amortized but
instead be measured for impairment at least annually, or when events indicate
that there may be an impairment. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. With the implementation of SFAS No. 142, the
Company has discontinued amortizing approximately $8,482 of goodwill associated
with acquired businesses.
In June 2001, SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS"
was issued. SFAS No. 143 addresses financial accounting and reporting for legal
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs that result from the acquisition, construction, or
development and normal operation of a long-lived asset. Upon initial recognition
of a liability for an asset retirement obligation, SFAS No. 143 requires an
increase in the carrying amount of the related long-lived asset. The asset
retirement cost is subsequently allocated to expense using a systematic and
rational method over the asset's useful life. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. The adoption of this statement did
not have and is not expected to have a material affect on the Company's
financial position or results of operations.
In August 2001, SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL
OF LONG-LIVED ASSETS" was issued. SFAS 144 supersedes SFAS No. 121, "ACCOUNTING
FOR THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF" and supercedes and
amends certain other accounting pronouncements. SFAS No. 144 retains the
fundamental provisions of SFAS No. 121 for recognizing and measuring impairment
losses on long-lived assets held for use and long-lived assets to be disposed of
by sale, while resolving significant implementation issues associated with SFAS
No. 121. Among other things, SFAS No. 144 provides guidance on how long-lived
assets used as part of a group should be evaluated for impairment, establishes
criteria for when long-lived assets are held for sale, and prescribes the
accounting for long-lived assets that will be disposed of other
16
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
than by sale. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 144 has not had a material impact on
the Company's financial position and results of operations.
In June 2002, SFAS No. 146, "ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES"
was issued. SFAS No. 146 addresses the accounting for costs to terminate a
contract that is not a capital lease, costs to consolidate facilities and
relocate employees, and involuntary termination benefits under one-time benefit
arrangements that are not an ongoing benefit program or an individual deferred
compensation contract. The provisions of the statement will be effective for
disposal activities initiated after December 31, 2002. The adoption of this
statement did not have and is not expected to have a material affect on our
financial position or results of operations.
In December 2002, SFAS No. 148 "ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE - AN AMENDMENT OF SFAS NO. 123" was issued. SFAS No.
148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", to provide
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results (Note 11).
In November 2002, the FASB issued Interpretation No. 45, "GUARANTOR'S
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS," ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees.
FIN 45 requires an entity to recognize an initial liability for the fair value
of an obligation assumed by issuing a guarantee. The disclosure requirements of
FIN 45 are effective for all financial statements issued after December 15,
2002. The provision for initial recognition and measurement of the liability
will be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have and is not expected to
have a material adverse impact on the Company's financial position, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. The changes are intended to result in a more complete
depiction of an entity's liabilities and equity and will, thereby, assist
investors and creditors in assessing the amount, timing, and likelihood of
potential future cash outflows and equity share issuances. This statement also
requires that certain obligations that could be settled by issuance of an
entity's equity but lack other characteristics of equity be reported as
liabilities even though the obligation does not meet the definition of a
liability. The requirements of SFAS 150 became effective for the Company for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. FAS 150 is to be implemented by reporting the cumulative effect of a
change in an accounting principle for financial instruments created before the
issuance date of the statement and still existing at the beginning of the
interim period of adoption. The Company did not enter into or modify any
financial instruments having characteristics of both liabilities and equity
during June 2003. The Company has evaluated the impact of SFAS 150 to determine
the effect it may have on its consolidated results of operations, financial
position or cash flows and has concluded that the adoption of this statement is
not expected to have a material affect on the Company's financial position or
results of operations.
17
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
13. Subsequent Events
On July 18, 2003, the Company entered into a Note and Warrant Purchase
Agreement (the "Note and Warrant Purchase Agreement") with Deutsche Bank AG
London, acting through DB Advisors LLC as Investment Agent ("Deutsche Bank"),
VantagePoint Venture Partners III (Q), L.P., VantagePoint Venture Partners III,
L.P., VantagePoint Communications Partners, L.P. and VantagePoint Venture
Partners 1996, L.P. (collectively, the "Investors") relating to the sale of an
aggregate of (i) $30,000 in senior secured promissory notes (the "Notes") and
(ii) warrants to purchase an aggregate of 157,894,737 shares of the Company's
common stock for a period of three years at an exercise price of $0.38 per share
(the "Warrants"). The aggregate purchase price for the Notes and Warrants was
$30,000.
Subject to the terms and conditions of the Note and Warrant Purchase
Agreement, the Company issued an aggregate of $30,000 in principal amount of
Notes to the Investors on July 18, 2003. Principal on the Notes is payable in a
single payment on July 18, 2006. The Notes provide for an annual interest rate
of 1.23%, payable in cash quarterly in arrears commencing on October 18, 2003,
unless the Company elects to defer payment of such interest and pay it together
with the principal amount of the Notes at maturity on July 18, 2006. Pursuant to
the terms of an Agency, Guaranty and Security Agreement (the "Security
Agreement") by and among the Company, certain of the Company's subsidiaries,
Deutsche Bank Trust Company Americas, as administrative agent, and the
Investors, the Company's obligations under the Notes are secured by a security
interest in a majority of the personal property and assets of the Company and
certain of its subsidiaries.
Subject to the terms and conditions of the Note and Warrant Purchase
Agreement, the Company issued a warrant (the "Initial Warrant") to purchase
12,950,000 shares of its common stock to Deutsche Bank. Deutsche Bank may not
exercise or transfer the Initial Warrant until the issuance of the Additional
Warrants (as defined below), except in certain circumstances set forth in the
Note and Warrant Purchase Agreement.
The Company will issue to the Investors (or their assignees) the remaining
Warrants (the "Additional Warrants") to purchase an aggregate of 144,944,737
shares of its common stock after the following conditions have been met:
o Stockholder approval of (i) amendments to the Company's certificate
of incorporation to, among other things, increase the authorized
number of shares of the Company's common stock, and (ii) the issuance
of the Warrants (collectively, the "Required Stockholder Approvals");
and
o Receipt of regulatory approvals from certain state public utility
commissions.
In connection with the Note and Warrant Purchase Agreement, certain
holders of the Company's Series X Preferred Stock and Series Y Preferred Stock
entered into a voting agreement which obligates them to vote in favor of the
Required Stockholder Approvals. The Company believes that the stock subject to
such voting agreement is sufficient to obtain the Required Stockholder Approvals
and that the Required Stockholder Approvals will, therefore, be obtained at the
Company's 2003 annual meeting of stockholders.
The proceeds from the sale of the Notes and Warrants will be used by the
Company for general corporate purposes, including acquisitions, the expansion of
the Company's sales and marketing
18
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
activities and repayment of debt and lease obligations. The Company has paid, or
paid into escrow, approximately $10,200 for the complete repayment of
approximately $14,600 of its debt and lease obligations (including repayment of
all of its obligations under its bank credit facility, certain capital leases
and (if approved by the bankruptcy court overseeing the noteholder's estate), a
note issued by the Company to Network Access Solutions Corporation in connection
with an acquisition).
On July 18, 2003, in connection with the Note and Warrant Purchase
Agreement, the Company, the Investors and certain of the stockholders of the
Company entered an Amended and Restated Stockholders Agreement (the
"Stockholders Agreement"), which provides for rights relating to election of
directors, the registration of the Company's common stock and certain protective
provisions.
On March 3, 2003, the Company and certain of the Guarantors entered into
Amendment No. 1 to the Reimbursement Agreement, pursuant to which VantagePoint
increased its guarantee by $3,000, bringing the aggregate guarantees by all
Guarantors under the Reimbursement Agreement, as amended, to $9,100. As
consideration for VantagePoint's increased guarantee, if the Company closed an
equity financing on or before December 3, 2003, it was authorized to issue
VantagePoint additional warrants to purchase the type of equity securities
issued by it in such equity financing. The number of such additional warrants
would be determined by dividing $1,000 by the per share price of such equity
securities. Accordingly, since the Company closed the above mentioned financing
on July 18, 2003, the Company intends, subject to the receipt of stockholder
approval at its next annual meeting of stockholders, to issue to VantagePoint
additional warrants to purchase 2,260,909 shares of its common stock at a per
share price of $0.4423 (Note 7).
19
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the financial condition and results of
operations of DSL.net should be read in conjunction with the financial
statements and the related notes thereto included elsewhere in this Form 10-Q
and the audited financial statements and notes thereto and Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in our Annual Report on Form 10-K for the year ended December 31, 2002,
which has been filed with the Securities and Exchange Commission.
OVERVIEW
We provide high-speed data communications, Internet access, and related
services to small and medium-sized businesses throughout the United States,
primarily using digital subscriber line, or DSL, technology. We have primarily
targeted select second and third tier cities, as well as some first tier cities,
for the deployment of our own local communications equipment. In certain markets
where we have not deployed our own equipment, we utilize the local facilities of
other carriers to provide service.
In December of 2002, the U.S. Bankruptcy Court for the District of
Delaware approved our bid to purchase network assets and associated subscriber
lines of Network Access Solutions Corporation ("NAS") for $14,000, consisting of
$9,000 in cash and $5,000 in a note payable to NAS. We closed the transaction on
January 10, 2003, whereby we acquired the majority of NAS's operations and
network assets, associated equipment in approximately 300 central offices and
approximately 11,500 associated subscriber lines. The cash portion of the
purchase price was paid from our existing cash. In accordance with the Asset
Purchase Agreement, we negotiated a $1,083 reduction in the cash paid at the
closing, representing our portion of January revenue which was billed and
collected by NAS, bringing the net cash paid for the NAS network assets and
associated subscriber lines to $7,917. In connection with the closing of the NAS
transaction, on January 10, 2003, we hired approximately 78 former NAS
employees. No pre-closing liabilities were assumed in connection with the NAS
transaction.
NAS provided high-speed Internet and Virtual Private Network services to
business customers using DSL, frame relay and T-1 technology via its own network
facilities in the Northeast and Mid-Atlantic markets. The acquisition
significantly increased our subscriber base and our facilities-based footprint
in one of the largest business markets in the United States, providing us with
increased opportunities to sell more higher-margin facilities-based services.
The acquisition has been accounted for under the purchase method of
accounting in accordance with SFAS No. 141. The results of NAS's operations have
been included in our consolidated financial statements since January 10, 2003
(the acquisition date). The allocated estimated fair values of the acquired
assets at the date of acquisition exceeded the purchase price and, accordingly,
have been written down on a pro-rata basis by asset group to the purchase price
of approximately $14,750 ($14,000 plus associated direct acquisition costs of
approximately $750) as follows: (i) intangible assets pertaining to
approximately 11,500 acquired subscriber lines of $1,476, and (ii) property and
equipment of $13,274. We are still in the process of finalizing estimates of
certain property and equipment and, thus, the allocation of the purchase price
is subject to further adjustment.
On February 3, 2003, we borrowed $6,100 under our Revolving Credit and
Term Loan Agreement (discussed below). The loan bore interest, payable monthly
in arrears at the bank's "base rate" and any unpaid principal balance would
automatically convert to a term loan on
20
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 12, 2004, after which principal payments (together with accrued
interest on the unpaid principal balance) would be made in 12 equal installments
payable at the end of each calendar quarter commencing on December 31, 2004.
Amounts borrowed under the bank credit line were guaranteed by the principal
holders of our Series X and Series Y Preferred Stock, with whom we had signed a
Reimbursement Agreement (discussed below). On July 18, 2003, we repaid the
$6,100 outstanding balance plus accrued interest, and the bank Credit Agreement
was terminated.
On April 8, 2003, we entered into an asset purchase agreement with
TalkingNets, Inc. and TalkingNets Holdings, LLC, (collectively, "TalkingNets")
pursuant to which we agreed to acquire assets and subscribers of TalkingNets for
$726 in cash (the "TalkingNets Asset Purchase Agreement"). As TalkingNets filed
a voluntary petition for Chapter 11 reorganization in February 2003, the
TalkingNets Asset Purchase Agreement was subject to the approval of the U.S.
Bankruptcy Court for the Eastern District of Virginia. On April 9, 2003, the
TalkingNets Asset Purchase Agreement and the transactions contemplated thereby
were approved by the Bankruptcy Court. If all closing conditions are satisfied,
we expect that this transaction will be completed during the third quarter of
2003. On April 11, 2003, we paid the full purchase price of $726 into escrow. In
accordance with the terms of the TalkingNets Asset Purchase Agreement, we will
have a transition period of up to 150 days to integrate TalkingNets' operations
into our own operations and obtain all requisite approvals prior to final
closing of the transaction. During the transition period, we will be entitled to
the cash collected from the proposed acquired customers and be obligated to pay
for certain of the related operating costs of TalkingNets' operations. During
the quarter ended June 30, 2003, we incurred approximately $235 in expense, net
of customer collections, related to TalkingNets' operations.
As reflected in our audited financial statements and related notes
included in our Annual Report on Form 10-K for the year ended December 31, 2002,
we incurred operating losses of approximately $35,821 and negative operating
cash flows of approximately $17,706 during the year ended December 31, 2002.
During the six months ended June 30, 2003, we incurred operating losses of
approximately $16,523 and negative operating cash flows of approximately $3,984.
These operating losses and negative operating cash flows have been financed
primarily by proceeds from equity issuances. We had accumulated deficits of
approximately $284,491 at December 31, 2002 and $302,434 at June 30, 2003.
We expect our operating losses, net operating cash outflows and capital
expenditures to continue through 2003 and into 2004. We successfully completed
rounds of private equity and bridge loan financings totaling approximately
$35,000 as follows: approximately $20,000 in the fourth quarter of 2001, $10,000
in March 2002, and $8,531 in May 2002 (which, after cancellation of the bridge
loans, yielded net proceeds of approximately $5,000). In addition, on July 18,
2003, we raised approximately $30,000 in additional financing. We believe that
our existing cash and cash equivalents, cash expected to be generated from
operations, and proceeds from this recent financing will be sufficient to fund
our operating losses, capital expenditures, lease payments and working capital
requirements into at least the end of 2004, based on our current business plans
and projections. We intend to use these cash resources to finance our capital
expenditures and for our working capital and other general corporate purposes.
We may also use a portion of these cash resources to acquire complementary
businesses, subscriber lines and other assets. The amounts actually expended for
these purposes will vary significantly depending on a number of factors,
including market acceptance of our services, revenue growth, planned capital
expenditures, cash generated from operations, improvements in operating
productivity, the extent and timing of entry into new markets, and availability
and prices paid for acquisitions. Failure to generate sufficient revenues,
contain certain discretionary spending or achieve certain other business plan
objectives could have a material adverse affect on our results of operations and
financial position.
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DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60, which was released in December 2001 by
the Securities and Exchange Commission (the "SEC"), requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statements. We have identified the accounting
principles critical to our business and results of operations. Note 2 to our
audited financial statements included in our Annual Report on Form 10-K for the
year ended December 31, 2002, which has been filed with the SEC, includes a
complete summary of the significant accounting policies and methods used in the
preparation of our financial statements. The following is a brief discussion of
the more significant accounting policies and methods used by us.
In addition, Financial Reporting Release No. 61, which was released in
December 2001 by the SEC, requires all companies to include a discussion to
address, among other things, liquidity, off-balance sheet arrangements,
contractual obligations and commercial commitments.
Management's discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, including the
recoverability of tangible and intangible assets, disclosure of contingent
assets and liabilities as of the date of the financial statements, and the
reported amounts of revenues and expenses during the reported period. The
markets for our services are characterized by intense competition, rapid
technological development, regulatory and legislative changes, and frequent new
product introductions, all of which could impact the future value of our assets
and liabilities.
We evaluate our estimates on an on-going basis. The most significant
estimates relate to revenue recognition, goodwill and other long-lived assets,
the allowance for doubtful accounts, income taxes, contingencies and litigation.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ materially from those estimates.
Management believes the following critical accounting policies affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements:
REVENUE RECOGNITION
We recognize revenue in accordance with SEC Staff Accounting Bulletin No.
101 (SAB N0. 101), "REVENUE RECOGNITION IN FINANCIAL STATEMENTS", which requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) are based on
management's judgments regarding the fixed nature of the fee charged for
services rendered and products delivered and the collectibility of those fees.
Revenue is recognized pursuant to the terms of each contract on a monthly
service fee basis, which varies based on the speed of the customer's Internet
connection and the services ordered by the customer. The monthly fee includes
phone line charges, Internet access charges, the cost of the equipment installed
at the customer's site and the other services we provide, as applicable. Revenue
that is billed in advance of the services provided is deferred until the
services are rendered. Revenue related to installation charges is also deferred
and amortized to revenue over 18 months. Related direct costs incurred (up to
the amount of deferred revenue) are also deferred and amortized to expense over
18 months.
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DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Any excess direct costs over installation charges are charged to expense as
incurred. In certain instances, we negotiate credits and allowances for service
related matters. We establish a reserve for such credits based on historical
experience.
We seek to price our services competitively. The market for high-speed
data communications services and Internet access is rapidly evolving and
intensely competitive. While many of our competitors and potential competitors
enjoy competitive advantages over us, we are pursuing a significant market that,
we believe, is currently under-served. Although pricing is an important part of
our strategy, we believe that direct relationships with our customers and
consistent, high quality service and customer support will be key to generating
customer loyalty. During the past several years, market prices for many
telecommunications services and equipment have been declining, a trend that
might continue.
GOODWILL AND OTHER LONG-LIVED ASSETS
We account for our long-lived assets in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, "ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF", which
requires that long-lived assets and certain intangible assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. If undiscounted expected future cash
flows are less than the carrying value of the assets, an impairment loss is to
be recognized based on the fair value of the assets.
Effective January 1, 2002, we adopted SFAS No. 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS". This statement requires that the amortization of goodwill be
discontinued and instead an impairment approach be applied. The impairment tests
were performed during January and December of 2002 and will be performed
annually hereafter (or more often if adverse events occur) and are based upon a
fair value approach rather than an evaluation of the undiscounted cash flows. If
impairment exists, under SFAS No. 142, the resulting charge is determined by the
recalculation of goodwill through a hypothetical purchase price allocation of
the fair value and reducing the current carrying value to the extent it exceeds
the recalculated goodwill. We did not record any goodwill impairment adjustments
resulting from our impairment reviews during 2002.
Other long-lived assets, such as identifiable intangible assets and fixed
assets, are amortized or depreciated over their estimated useful lives. These
assets are reviewed for impairment whenever events or circumstances provide
evidence that suggests that the carrying amount of the assets may not be
recoverable, with impairment being based upon an evaluation of the identifiable
undiscounted cash flow. If impaired, the resulting charge reflects the excess of
the asset's carrying cost over its fair value.
If market conditions become less favorable, future cash flows (the key
variable in assessing the impairment of these assets) may decrease and as a
result we may be required to recognize impairment charges.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
generally sell our services directly to end users mainly consisting of small to
medium sized businesses, as opposed to selling to Internet service providers who
then resell such services. We believe that we do not have significant exposure
or concentrations of credit risk with respect to any given customer. However, if
the country or any region we service experiences an economic downturn, the
financial condition of our customers
23
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
could be adversely affected, which could result in their inability to make
payments to us. This could require additional provisions for allowances. In
addition, a negative impact on revenue related to those customers may occur.
With the acquisition of the NAS assets on January 10, 2003, we acquired a
number of subscribers, some of whom we serve indirectly through various Internet
service providers ("ISP's"). We sell our services to such ISP's who then resell
such services to the end-user subscriber. We have some increased exposure and
concentration of credit risk pertaining to such ISP's. However, no individual
customer accounted for more than 5% of revenue for the first six months of 2003.
INCOME TAX
We use the liability method of accounting for income taxes, as set forth
in Statement of Financial Accounting Standards No. 109, "ACCOUNTING FOR INCOME
TAXES". Under this method, deferred tax assets and liabilities are recognized
for the expected future tax consequences of temporary differences between the
carrying amounts and the tax basis of assets and liabilities and net operating
loss carryforwards, all calculated using presently enacted tax rates.
We have not generated any taxable income to date and, therefore, have not
paid any federal income taxes since inception. Our state and federal net
operating loss carryforwards begin to expire in 2004 and 2019, respectively. Use
of our net operating loss carryforwards may be subject to significant annual
limitations resulting from a change in control due to our sales of Series X and
Series Y Preferred Stock. We are currently assessing the potential impact
resulting from these transactions. We have provided a valuation allowance for
the full amount of the net deferred tax asset since management has not
determined that these future benefits will more likely than not be realized.
LITIGATION
From time to time, we may be involved in litigation concerning claims
arising in the ordinary course of our business, including claims brought by
former employees and claims related to acquisitions. We record liabilities when
a loss is probable and can be reasonably estimated. These estimates are based on
analyses made by internal and external legal counsel who consider information
known at the time. We believe we have made reasonable estimates in the past,
however, court decisions could cause liabilities to be incurred in excess of
estimates.
RESULTS OF OPERATIONS
REVENUE. Revenue is recognized pursuant to the terms of each contract on a
monthly service fee basis, which varies based on the speed of the customer's
connection and the services ordered by the customer. The monthly fee includes
all phone line charges, Internet access charges, the cost of the equipment
installed at the customer's site and the other services we provide, as
applicable. Revenue that is billed in advance of the services provided is
deferred until the services are rendered. Revenue related to installation
charges is deferred and amortized to revenue over 18 months. Related direct
costs incurred (up to the amount of deferred revenue) are also deferred and
amortized to expense over 18 months. Any excess direct costs over installation
charges are charged to expense as incurred. In certain instances, we negotiate
credits and allowances for service related matters. We establish a reserve for
such credits based on historical experience.
Revenue for the three months ended June 30, 2003 increased by 56% to
approximately $18,097, from approximately $11,596 for the three months ended
June 30, 2002. Revenue for the six months ended June 30, 2003 increased by 52%
to approximately $34,862, from approximately $22,977 for the six months ended
June 30, 2002. The increase in revenue in 2003 was primarily due to an
24
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
increase in subscriber lines resulting from our acquisition of the NAS assets.
The actual revenue attributable to customer lines acquired for the three months
ended June 30, 2002 and 2003, was approximately $382 and $6,237, respectively.
For the six months ended June 30, 2002 and 2003, actual revenue attributable to
customer lines acquired was approximately $784 and $12,111, respectively. We
expect revenue to continue to increase in 2003 as compared to 2002 as a result
of our acquisition of the NAS assets and associated subscriber lines, and as we
continue our sales and marketing efforts, introduce additional services and,
possibly, acquire additional businesses and/or subscriber lines.
NETWORK EXPENSES. Our network expenses include costs related to network
engineering and network operations personnel, costs for telecommunications lines
between customers, central offices, network service providers and our network,
costs for rent and power at our central offices, costs to connect to the
Internet, costs of customer line installations and the costs of customer premise
equipment when sold to our customers. We lease high-speed lines and other
network capacity to connect our central office equipment and our network. Costs
incurred to connect to the Internet are expected to increase as the volume of
data communications traffic generated by our customers increases.
Network expenses for the three months ended June 30, 2003 increased
approximately 55%, to approximately $13,406, compared to approximately $8,625
for the three months ended June 30, 2002. This increase of approximately $4,781
was primarily attributable to increased telecommunications expenses of
approximately $4,146 and increased network engineering and field operations
personnel expenses of approximately $239 resulting from our acquisition of the
NAS assets, increased subcontract labor of approximately $264 related to the
integration of certain central offices, and increased other expenses of
approximately $132. For the six months ended June 30, 2003, network expenses
increased approximately 48%, to approximately $25,643, compared to approximately
$17,337 for the six months ended June 30, 2002. This increase of approximately
$8,306 was primarily attributable to increased telecommunications expenses of
approximately $7,574 and increased network engineering and field operations
personnel expenses of approximately $546 resulting from our acquisition of the
NAS assets. The increase was also attributable to increased subcontract labor of
approximately $278 related to the integration of certain central offices, and
was partially offset by net decreases in miscellaneous other expenses of
approximately $92. We expect our network expenses, including costs for
subscriber lines, to increase in 2003, as compared to 2002, as a result of our
acquisition of the NAS assets and associated subscriber lines, and as we add
customers.
OPERATIONS EXPENSES. Our operations expenses include costs related to
customer care, customer provisioning, customer billing, customer technical
assistance, purchasing, headquarters facilities operations, operating systems
maintenance and support and other related overhead expenses.
Operations expenses for the three months ended June 30, 2003 were
approximately $2,818, compared to operations expenses for the three months ended
June 30, 2002 of approximately $1,856. This 52% increase of approximately $962
was primarily due to increases in operations personnel expenses of approximately
$539, other outside services of approximately $299 and other miscellaneous
expenses of approximately $124. Operations expenses for the six months ended
June 30, 2003 were approximately $5,574, compared to operations expenses for the
six months ended June 30, 2002 of approximately $3,847. This 45% increase of
approximately $1,727 was primarily due to increases in operations personnel
expenses of approximately $1,134, other outside services of approximately $356
and other miscellaneous expenses of approximately $237. We expect our operations
expenses to increase in future periods, as compared to 2002, as a result of the
NAS acquisition.
25
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses
consist primarily of costs relating to human resources, finance, executive,
administrative services, recruiting, insurance, legal and auditing services,
leased office facilities rent and bad debt expenses.
General and administrative expenses were approximately $3,216 for the
three months ended June 30, 2003, compared to general and administrative
expenses for the three months ended June 30, 2002 of approximately $3,373. This
5% reduction of approximately $157 was primarily due to decreases in personnel
expenses of approximately $68 and decreases in miscellaneous expenses of
approximately $283, partially offset by increases in professional and consulting
services of approximately $129 and increases in bad debt expense of
approximately $65. For the six months ended June 30, 2003, general and
administrative expenses were approximately $6,273, compared to general and
administrative expenses for the six months ended June 30, 2002 of approximately
$6,776. This 7% reduction of approximately $503 was primarily due to decreases
in executive bonus expense of approximately $280, decreases in insurance expense
of approximately $200, decreases in bad debt related expenses of approximately
$68, decreases in property and corporate related taxes of approximately $176,
and decreases in other expenses of $295, partially offset by increases in
professional and consulting services of approximately $448 and miscellaneous
expenses of approximately $68.
SALES AND MARKETING. Our sales and marketing expenses consist primarily of
expenses for personnel, the development of our brand name, promotional
materials, direct mail advertising and sales commissions and incentives.
Sales and marketing expenses for the three months ended June 30, 2003 were
approximately $1,889, compared to sales and marketing expenses for the three
months ended June 30, 2002 of approximately $1,577, representing a 20% increase
of approximately $312. The increase in sales and marketing expenses was
primarily attributable to increased salaries, benefits and commissions
approximating $373 resulting from the NAS acquisition, partially offset by
decreased advertising, direct mail marketing and referrals fees of approximately
$71. Sales and marketing expenses for the six months ended June 30, 2003 were
approximately $4,122, compared to sales and marketing expenses for the six
months ended June 30, 2002 of approximately $2,774, representing a 49% increase
of approximately $1,348. The increase in sales and marketing expenses was
primarily attributable to increased salaries, benefits and commissions
approximating $1,045 resulting from the NAS acquisition, increased advertising,
direct mail marketing and referral fees of approximately $257, and increased
miscellaneous expenses of approximately $46. We expect our sales and marketing
expenses to increase in future periods, as compared to 2002, primarily as a
result of the NAS acquisition and increased sales and marketing activities.
STOCK COMPENSATION. We incurred non-cash stock compensation expenses as a
result of the granting of stock and stock options to employees, directors and
members of our former board of advisors with exercise prices per share
subsequently determined to be below the fair values per share of our common
stock for financial reporting purposes at the dates of grant. The stock
compensation, if vested, was charged immediately to expense, while non-vested
compensation is being amortized over the vesting period of the applicable
options or stock, which is generally 48 months. Unvested options for terminated
employees are cancelled and the value of such options are recorded as a
reduction of deferred compensation with an offset to additional paid-in-capital.
Non-cash stock compensation expense was approximately $160 and $296 for
the three months ended June 30, 2003 and 2002, respectively. For the six months
ended June 30, 2003 and 2002, non-cash stock compensation expense was
approximately $438 and $642, respectively. These expenses consisted of charges
and amortization related to stock options and restricted stock granted to our
employees and directors and became fully amortized during the second quarter of
2003. The
26
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
unamortized balances as of December 31, 2002 and June 30, 2003 were
approximately $437 and zero, respectively.
As of December 31, 2002 and June 30, 2003, options to purchase 23,877,004
and 23,275,784 shares of common stock, respectively, were outstanding, which
were exercisable at weighted average exercise prices of $0.98 and $0.94 per
share, respectively.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization is primarily
attributable to the following: (i) depreciation of network and operations
equipment and Company-owned modems and routers installed at customer sites, (ii)
depreciation of information systems and computer hardware and software, (iii)
amortization and depreciation of the costs of obtaining, designing and building
our collocation space and corporate facilities and (iv) amortization of
intangible capitalized costs pertaining to acquired businesses and customer line
acquisitions.
Depreciation and amortization expenses were approximately $4,498 for the
three months ended June 30, 2003, compared to depreciation and amortization
expenses of approximately $5,274 for the three months ended June 30, 2002. The
15% decrease in depreciation and amortization expenses of approximately $776 was
primarily attributable to certain intangible and fixed assets becoming fully
depreciated during 2002 and 2003, resulting in a net decline in depreciation and
amortization expense of approximately $1,654, which was partially offset by
increased depreciation and amortization expenses relating to the acquisition of
NAS assets and associated subscriber lines of approximately $878. Depreciation
and amortization expenses were approximately $9,335 for the six months ended
June 30, 2003, compared to depreciation and amortization expenses of
approximately $10,388 for the six months ended June 30, 2002. The 10% decrease
in depreciation and amortization expenses of approximately $1,053 was primarily
attributable to certain intangible and fixed assets becoming fully depreciated
during 2002 and 2003, resulting in a net decline in depreciation and
amortization expense of approximately $2,724, which was partially offset by
increased depreciation and amortization expenses relating to the acquisition of
NAS assets and associated subscriber lines of approximately $1,671.
Depreciation expenses pertaining to assets related to network expenses and
operations expenses were approximately $3,285 and $3,713 for the three months
ended June 30, 2003 and 2002, respectively, and approximately $6,613 and $7,130
for the six months ended June 30, 2003 and 2002, respectively. Depreciation and
amortization expenses pertaining to assets related to general and administrative
expenses were approximately $1,213 and $1,561 for the three months ended June
30, 2003 and 2002, respectively, and approximately $2,722 and $3,258 for the six
months ended June 30, 2003 and 2002, respectively.
Also, in accordance with SFAS No. 142 (see Recently Issued Accounting
Pronouncements, discussed below), we discontinued amortization of goodwill
beginning January 1, 2002, and completed an impairment review during January and
December of 2002. We did not record any impairment adjustments resulting from
these impairment reviews and will continue to make annual reviews, unless a
change in circumstances requires a review in the interim.
INTEREST EXPENSE (INCOME) NET. Net interest expense of approximately $847
for the three months ended June 30, 2003 included approximately $860 of interest
expense, which was partially offset by approximately $13 in interest income. Net
interest income of approximately $8 for the three months ended June 30, 2002
included approximately $83 of interest income, which was partially offset by
approximately $75 of interest expense. The increase in net interest expense of
approximately $855 was primarily attributed to the amortization of deferred
non-cash financing costs of approximately $501 which related to the warrants
issued in consideration for loan guarantees under our Reimbursement Agreement
(discussed below), increased interest expense of approximately $215 pertaining
to the note payable to NAS and borrowings under the Credit Agreement (discussed
27
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
below), the reversal of $145, in May 2002, of previously accrued interest
expense pertaining to interest forgiven on $3,531 of short-term promissory
notes, which were cancelled in May 2002 upon the issuance of additional Series Y
Preferred Stock, in accordance with the terms of the Series Y Preferred Stock
Purchase Agreement and decreased interest income of approximately $70 due to
lower cash balances. These were partially offset by decreases in other interest
expenses of approximately $76.
Net interest expense of approximately $1,411 for the six months ended June
30, 2003 included approximately $1,449 of interest expense, which was partially
offset by approximately $38 in interest income. Net interest expense of
approximately $236 for the six months ended June 30, 2002 included approximately
$406 of interest expense, which was partially offset by approximately $170 of
interest income. The increase in net interest expense of approximately $1,175
was primarily attributed to the amortization of deferred non-cash financing
costs of approximately $816 which related to the warrants issued in
consideration for loan guarantees under our Reimbursement Agreement (discussed
below), increased interest expense of approximately $355 pertaining to the note
payable to NAS and borrowings under the Credit Agreement (discussed below) and
decreased interest income of approximately $132 due to lower cash balances.
These were partially offset by decreases in other interest expenses of
approximately $128.
NET LOSS. Net loss was approximately $8,700 and $9,394 for the three
months ended June 30, 2003 and 2002, respectively, and approximately $17,943 and
$18,848 for the six months ended June 30, 2003 and 2002, respectively.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our capital expenditures and operations primarily with
the proceeds from the sale of stock and from borrowings, including equipment
lease financings. As of June 30, 2003, we had cash and cash equivalents of
approximately $3,582 and negative working capital of approximately $12,066.
Net cash provided by financing activities for the six months ended June
30, 2003 was approximately $5,417, primarily related to borrowings under our
bank credit facility. Net cash provided by financing activities for the six
months ended June 30, 2002 of approximately $13,526 resulted from the sale of
our preferred stock. We have used, and intend to continue using, proceeds from
our financings for general corporate purposes. We have used, and may in the
future use, a portion of such proceeds to acquire complementary businesses or
assets.
In March 1999, we entered into a 36-month lease facility to finance the
purchase of up to an aggregate of $2,000 of equipment. Amounts financed under
this lease facility bear an interest rate of 8% or 9%, depending on the type of
equipment, and are secured by the financed equipment. In July 2000, we entered
into a 48-month lease agreement with an equipment vendor to finance the purchase
of network equipment. We have leased approximately $8,900 under this agreement.
Amounts financed under this agreement bear an interest rate of 12% per annum and
are secured by the financed equipment. In addition, during 1999 and 2000, we
purchased and assumed through acquisition certain equipment and computer
software under other capital leases, which are being repaid over periods ranging
from 24 months to 60 months at annual interest rates ranging from 7.5% to 15%.
In the aggregate, there was approximately $4,565 and $3,768, outstanding under
capital leases at December 31, 2002 and June 30, 2003, respectively. On July 18,
2003, we prepaid a significant portion of our outstanding capital lease
obligations leaving a balance of approximately $235.
28
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In November and December of 2001 and March of 2002, we received proceeds
of $6,000, $4,000 and $10,000, respectively, from the sale of 6,000, 4,000 and
10,000 shares, respectively, of Series X Preferred Stock, before direct issuance
costs of approximately $189.
In December 2001, in conjunction with our sale of shares of mandatorily
redeemable convertible Series Y Preferred Stock (the "Series Y Preferred
Stock"), we issued short-term promissory notes (the "Promissory Notes") for
proceeds of $3,531 to the Series Y Preferred Stockholders. The Promissory Notes
provided for an annual interest rate of 12%. In May 2002, in accordance with the
terms of the Series Y Purchase Agreement, we sold an additional 8,531 shares of
Series Y Preferred Stock for $5,000 in cash and delivery of the Promissory Notes
for cancellation. All accrued interest on the Promissory Notes, of approximately
$145, was forgiven.
We entered into a Revolving Credit and Term Loan Agreement, dated as of
December 13, 2002 (the "Credit Agreement"), with a commercial bank providing for
a revolving line of credit of up to $15,000 (the "Commitment"). Borrowings under
the Credit Agreement could be made in minimum increments of $500 from time to
time up to the Commitment and repayments could be made in minimum increments of
$100, in each case until the revolving credit maturity date of December 12,
2004, at which time all amounts outstanding would convert into a term loan
payable in 12 quarterly installments commencing on December 31, 2004 (the "Term
Loan"). We could pre-pay amounts due under the Term Loan in increments of $1,000
without penalty. Interest was payable on all amounts outstanding under the
Credit Agreement in arrears at the end of each calendar quarter at a variable
interest rate equal to the higher of the bank's prime rate equivalent or 0.5%
percent above the Federal Funds Effective Rate. As of June 30, 2003, amounts
outstanding under this Credit Agreement bore interest at an annual rate of 4.0%.
The amount not drawn upon under the Commitment (subject to certain adjustments)
was subject to a commitment fee, payable in arrears at the end of each calendar
quarter, equal to an annualized rate of 0.25%. The Credit Agreement also
required us and our subsidiaries, except for Vector Internet Services, Inc., to
maintain all of our bank deposit and investment accounts with the bank. Our
ability to borrow amounts available under the Credit Agreement was subject to
the bank's receipt of a like amount of guarantees from certain of our investors
or other guarantors acceptable to the bank and to certain other conditions set
forth in the Credit Agreement. As of March 31, 2003, our investors had provided
guarantees of $9,100 under the Credit Agreement. On February 3, 2003, we
borrowed $6,100 under the Credit Agreement. As of June 30, 2003, our outstanding
balance was $6,100. On July 18, 2003, we repaid our outstanding loan obligation
and terminated the Credit Agreement.
We entered into a Reimbursement Agreement, dated as of December 27, 2002,
with several private investment funds affiliated with VantagePoint Venture
Partners ("VantagePoint"), Columbia Capital Equity Partners ("Columbia"), The
Lafayette Investment Fund, L.P. and Charles River Partnership, L.P.
(collectively the "Guarantors") and VantagePoint Venture Partners III (Q), L.P.,
as administrative agent . The Guarantors are all holders of or affiliates of
holders of our Series X and Series Y Preferred stock. Pursuant to the terms of
the Reimbursement Agreement, on December 27, 2002, VantagePoint and Columbia
issued guarantees in an aggregate amount of $6,100 to support certain of our
obligations under the Credit Agreement. The Reimbursement Agreement obligated
the Company to reimburse the Guarantors for any payments they may be required to
make in accordance with their guarantees. Our obligations under the
Reimbursement Agreement were also guaranteed by certain of our wholly-owned
subsidiaries and collateralized by a Security Agreement signed by us and certain
of our wholly-owned subsidiaries which pledged a significant portion of our
consolidated assets as collateral.
Pursuant to the terms of the Reimbursement Agreement, on December 27,
2002, we issued warrants to purchase 12,013,893 shares of our common stock to
VantagePoint and Columbia, in consideration for their guarantees aggregating
$6,100. All such warrants have a ten year life and an exercise price of $0.50
per share. On March 26, 2003, we issued additional warrants, exercisable
29
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
for ten years, to purchase a total of 936,107 shares of our common stock at
$0.50 per share, to VantagePoint and Columbia, bringing the total number of
warrants issued in connection with the Reimbursement Agreement to 12,950,000.
Pursuant to the terms of the Reimbursement Agreement, in the event that we did
not borrow any loans under the Credit Agreement on or before March 31, 2003,
then the Credit Agreement and all Guarantees issued under the Reimbursement
Agreement would have terminated and any warrants issued to Guarantors in
connection with the transactions contemplated would have been terminated. Since
we borrowed amounts under the Credit Agreement on February 3, 2003, the
Guarantors' guarantees of the subject loan became effective on February 3, 2003
and the contingency related to the validation of the warrants was eliminated.
On February 3, 2003, we valued the 12,950,000 warrants at $0.514 each with
a total value of $6,656. The valuation was performed using a Black Scholes
valuation model with the following assumptions: (i) a risk free interest rate of
4.01% (ten-year Treasury rate), (ii) a zero dividend yield, (iii) a ten year
expected life, (iv) an expected volatility of 153%, (v) an option exercise price
of $0.50 and (vi) a current market price of $0.52 (the closing price of our
common stock on February 3, 2003). Since the warrants were issued in
consideration for loan guarantees, which enabled us to secure financing at below
market interest rates, we recorded their value as a deferred financing cost
(guarantee fee) which will be amortized to interest expense over the term of the
loan (approximately 57 months) using the "Interest Method" of amortization. For
the three and six months ended June 30, 2003, amortized interest expense
relating to deferred financing costs approximated $501 and $816, respectively.
On March 3, 2003, we and certain of our Guarantors entered into Amendment
No. 1 to the Reimbursement Agreement, pursuant to which VantagePoint increased
its guarantee by $3,000, bringing the aggregate guarantees by all Guarantors
under the Reimbursement Agreement, as amended, to $9,100. As consideration for
VantagePoint's increased guarantee, if we closed an equity financing on or
before December 3, 2003, we were authorized to issue VantagePoint additional
warrants to purchase the type of equity securities issued by us in such equity
financing. The number of such additional warrants would be determined by
dividing $1,000 by the per share price of such equity securities. Accordingly,
since we closed a financing on July 18, 2003 (discussed below), we intend,
subject to the receipt of stockholder approval at our 2003 annual meeting of
stockholders, to issue to VantagePoint additional warrants to purchase 2,260,909
shares of our common stock at a per share price of $0.4423.
On July 18, 2003, we entered into a Note and Warrant Purchase Agreement
(the "Note and Warrant Purchase Agreement") with Deutsche Bank AG London, acting
through DB Advisors LLC as Investment Agent ("Deutsche Bank"), VantagePoint
Venture Partners III (Q), L.P., VantagePoint Venture Partners III, L.P.,
VantagePoint Communications Partners, L.P. and VantagePoint Venture Partners
1996, L.P. (collectively, the "Investors") relating to the sale and purchase of
an aggregate of (i) $30,000 in senior secured promissory notes (the "Notes") and
(ii) warrants to purchase 157,894,737 shares of our common stock for a period of
three years at an exercise price of $0.38 per share (the "Warrants"). The
aggregate purchase price for the Notes and Warrants was $30,000.
Subject to the terms and conditions of the Note and Warrant Purchase
Agreement, we issued an aggregate of $30,000 in principal amount of Notes to the
Investors on July 18, 2003. Principal on the Notes is payable in a single
payment on July 18, 2006. The Notes provide for an annual interest rate of
1.23%, payable in cash quarterly in arrears commencing on October 18, 2003,
unless we elect to capitalize such interest and pay it together with the
principal amount of the Notes at maturity on July 18, 2006. Pursuant to the
terms of an Agency, Guaranty and Security Agreement (the "Security Agreement")
by and among us, certain of our subsidiaries, Deutsche Bank Trust Company
Americas, as administrative agent, and the Investors, our obligations under the
Notes are secured by a security interest in a majority of our personal property
and assets and certain of our subsidiaries.
30
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Subject to the terms and conditions of the Note and Warrant Purchase
Agreement, we issued a warrant (the "Initial Warrant") to purchase 12,950,000
shares of our common stock to Deutsche Bank. Deutsche Bank may not exercise or
transfer the Initial Warrant until the issuance of the Additional Warrants (as
defined below), except in certain circumstances set forth in the Note and
Warrant Purchase Agreement.
We will issue to the Investors (or their assignees) the remaining Warrants
(the "Additional Warrants") to purchase an aggregate of 144,944,737 shares of
our common stock after the following conditions have been met:
o Stockholder approval of (i) amendments to our certificate of
incorporation to, among other things, increase the authorized number
of shares of our common stock, and (ii) the issuance of the Warrants
(collectively, the "Required Stockholder Approvals"); and
o Receipt of regulatory approvals from certain state public utility
commissions.
In connection with the Note and Warrant Purchase Agreement, certain
holders of our Series X Preferred Stock and Series Y Preferred Stock entered
into a voting agreement which obligates them to vote in favor of the Required
Stockholder Approvals. We believe that the stock subject to such voting
agreement is sufficient to obtain the Required Stockholder Approvals and that
the Required Stockholder Approvals will, therefore, be obtained at our 2003
annual meeting of stockholders.
The proceeds from the sale of the Notes and Warrants will be used by us
for general corporate purposes, including acquisitions, the expansion of our
sales and marketing activities and repayment of debt and lease obligations. We
have paid, or paid into escrow, approximately $10,200 for the complete repayment
of approximately $14,600 of our debt and lease obligations (including repayment
of all of our obligations under the Credit Agreement, certain capital leases and
(if approved by the bankruptcy court overseeing the noteholder's estate) a note
issued by us to NAS in connection with an acquisition).
On July 18, 2003, in connection with the termination of the Credit
Agreement, the related guarantees by our Series X and Y Preferred Stockholders
were terminated, along with the related Reimbursement Agreement and Security
Agreement.
On July 18, 2003, in connection with the Note and Warrant Purchase
Agreement, we, the Investors and certain of our stockholders entered an Amended
and Restated Stockholders Agreement (the "Stockholders Agreement"), which
provides for rights relating to election of directors, the registration of our
common stock and certain protective provisions.
As part of the agreements negotiated in conjunction with the Company's
$30,000 financing on July 18, 2003, we and holders of a majority of the Series X
and Series Y Preferred Stock agreed to extend the redemption dates of the Series
X and Series Y Preferred Stock from January 1, 2005 to July 18, 2006. Also, as a
result of the financing transaction, in accordance with the terms of the Series
Y Preferred Stock, the Series Y conversion price was adjusted from $0.50 (each
Series Y Preferred Share is convertible into 2,000 shares of common stock) to
$0.4423 (each Series Y Preferred Share is convertible into approximately 2,260.9
shares of common stock).
As a result of the development of our operating infrastructure and
acquisitions, we have entered into certain long-term agreements providing for
fixed payments. Under our facility operating leases, minimum office facility
operating lease payments are approximately $1,638 in 2003, $2,000 in 2004, $766
in 2005, $233 in 2006, $169 in 2007 and $28 in 2008. We also have long-term
purchase commitments with MCI (formerly known as WorldCom), AT&T, Sprint and
other vendors for data
31
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
transport and other services with minimum payments due even if our usage does
not reach the minimum amounts. Minimum payments under our long-term purchase
commitments are approximately $3,668 in 2003, $2,396 in 2004 and $57 in 2005.
We transmit data across our network via transmission facilities that are
leased from certain carriers, including AT&T and MCI (as described above). The
failure of any of our data transport carriers to provide acceptable service on
acceptable terms could have a material adverse effect on our operations. MCI has
filed a voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy
Code. While MCI has continued with its current operations since filing its
voluntary petition to reorganize in June of 2001, and has announced that it
expects to continue with its current operations without adverse impact on its
customers, it may not be able to do so. We believe that we could transition the
data transport services currently supplied by MCI to alternative suppliers in
thirty to sixty days, should MCI announce discontinuance of such services.
However, were MCI to discontinue such services without providing sufficient
advance notice (at least sixty days), we might not be able to transition such
services in a timely manner, which could disrupt service provided by us to
certain of our customers. This could result in the loss of revenue, loss of
customers, claims brought against us by our customers, or could otherwise have a
material adverse effect on us. Even were MCI to provide adequate notice of any
such discontinuation of service, there can be no assurance that we would be able
to transition such service without a material adverse impact on us or our
customers, if at all, or that such discontinuation of service would not
otherwise have a material adverse effect on us.
For the six months ended June 30, 2003, the net cash used in our operating
activities was approximately $3,984. This cash was used for a variety of
operating expenses, including salaries, network operations, sales, marketing and
promotional activities, consulting and legal expenses, and overhead expenses.
Net cash used in investing activities for the six months ended June 30,
2003 was approximately $9,169. Of this amount, approximately $7,917 was used for
the acquisition of NAS assets and associated subscriber lines, approximately
$1,231 was used for the purchase of equipment, and approximately $21 related to
the increase in restricted cash.
The development and expansion of our business has required significant
capital expenditures. Capital expenditures, including collocation fees but
excluding acquisitions, were approximately $1,231 and $880 for the six months
ended June 30, 2003 and 2002, respectively, and customer assets and line
acquisitions were approximately $7,917 and $750 for the six months ended June
30, 2003 and 2002, respectively. The actual amounts and timing of our future
capital expenditures will vary depending on the speed at which we expand and
implement our network and implement service for our customers. Our planned
capital expenditures for 2003 are currently expected to be primarily for the
upgrade of our network to support our integrated voice and data service
offering. We currently anticipate spending approximately $3,000 to $3,500 for
capital expenditures, excluding acquisitions, during the year ending December
31, 2003. The actual amounts and timing of our capital expenditures could differ
materially both in amount and timing from our current plans.
On July 18, 2003, we raised approximately $30,000 in additional financing.
We believe that our existing cash and cash equivalents, cash expected to be
generated from operations, and proceeds from this recent financing will be
sufficient to fund our operating losses, capital expenditures, lease payments
and working capital requirements at least until the end of 2004, based on our
current business plans and projections. We intend to use these cash resources to
finance our capital expenditures and for our working capital and other general
corporate purposes. We may also use a portion of these cash resources to acquire
complementary businesses, subscriber lines and other assets. The amounts
actually expended for these purposes will vary significantly depending on a
number of factors, including market acceptance of our services, revenue growth,
planned capital
32
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
expenditures, cash generated from operations, improvements in operating
productivity, the extent and timing of entry into new markets, and availability
and prices paid for acquisitions. Failure to generate sufficient revenues,
contain certain discretionary spending or achieve certain other business plan
objectives could have a material adverse affect on our results of operations and
financial position.
On July 22, 2002, The Nasdaq Stock Market, Inc. ("Nasdaq") transferred the
listing of our common stock from the Nasdaq National Market to the Nasdaq
SmallCap Market. We applied for such transfer as a result of our non-compliance
with Nasdaq's Marketplace Rule 4450(a)(5), which required us to maintain a bid
price of $1.00 per share for at least 10 consecutive trading days during the
last ninety day period prior to July 17, 2002 in order to remain qualified for
listing on the Nasdaq National Market. On October 16, 2002, Nasdaq notified us
that, while we had not regained compliance by October 15, 2002 with the $1.00
bid price per share requirement generally required for continued listing on the
Nasdaq SmallCap Market, we did continue to meet the initial listing requirements
for the Nasdaq SmallCap Market under Rule 4310(c)(2)(A). As a result, we had an
additional 180 calendar days, or until April 14, 2003, to comply with the
minimum bid price of $1.00 per share for 10 consecutive trading days, or such
greater number of trading days as Nasdaq may determine, in order to remain
listed on the Nasdaq SmallCap Market. On March 11, 2003, Nasdaq amended its
rules to provide that a company that satisfies the initial listing requirements
for the Nasdaq SmallCap Market under Rule 4310(c)(2)(A) would have an additional
90 days (over the 180 days already contemplated by the Nasdaq SmallCap Market
rules) to comply with the minimum bid price of $1.00 per share. On April 15,
2003, Nasdaq notified us that, while we had not regained compliance by April 14,
2003 with the $1.00 bid price per share requirement generally required for
continued listing on the Nasdaq SmallCap Market, we did continue to meet the
initial listing requirements for the Nasdaq SmallCap Market under Rule
4310(c)(2)(A). As a result, we had an additional 90 calendar days, or until July
14, 2003, to comply with the minimum bid price of $1.00 per share for 10
consecutive trading days, or such greater number of trading days as Nasdaq may
determine, in order to remain listed on the Nasdaq SmallCap Market. On July 15,
2003, we received notification from the Nasdaq staff indicating that our common
stock failed to comply with the $1.00 closing bid price per-share requirement
for 10 consecutive trading days as set forth in the Nasdaq's Marketplace Rule
4310(c)(4) and as such our common stock is subject to delisting from the Nasdaq
SmallCap Market. We have appealed this determination to a Listings
Qualifications Panel and requested a hearing. The hearing is scheduled for
August 21, 2003. Under the Nasdaq's rules, the delisting process is stayed
pending the hearing and the Panel's decision. There can be no assurance that we
will be able to continue to remain on the Nasdaq SmallCap Market, if at all, or
that we will continue to satisfy the other listing requirements of the Nasdaq
SmallCap Market.
Nasdaq has submitted proposed rules changes to the SEC which would, among
other things, further extend the number of days during which a company that
satisfies the initial listing requirements of the Nasdaq SmallCap Market may
continue to be listed on such market without complying with the $1.00 minimum
bid price requirement. There can be no assurance that the SEC will approve this
proposed rule change, if at all, in time to delay the possible delisting of our
common stock from the Nasdaq SmallCap Market or that, if the SEC does approve
this rule change, that we will be prospectively granted an extension to meet the
$1.00 minimum bid price requirement. In addition, there can be no assurance that
we will continue to satisfy the initial listing requirements of the Nasdaq
SmallCap Market.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, Statement of Financial Accounting Standards ("SFAS") No. 142
"GOODWILL AND OTHER INTANGIBLE ASSETS" was issued. SFAS No. 142 requires that
goodwill and intangible assets with indefinite lives no longer be amortized but
instead be measured for impairment at least annually, or when events indicate
that there may be an impairment. SFAS No. 142 is effective for
33
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
fiscal years beginning after December 15, 2001. With the implementation of SFAS
No. 142, we have discontinued amortizing approximately $8,482 of goodwill
associated with acquired businesses.
In June 2001, SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS"
was issued. SFAS No. 143 addresses financial accounting and reporting for legal
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs that result from the acquisition, construction, or
development and normal operation of a long-lived asset. Upon initial recognition
of a liability for an asset retirement obligation, SFAS No. 143 requires an
increase in the carrying amount of the related long-lived asset. The asset
retirement cost is subsequently allocated to expense using a systematic and
rational method over the asset's useful life. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. The adoption of this statement did
not have and is not expected to have a material affect on our financial position
or results of operations.
In August 2001, SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL
OF LONG-LIVED ASSETS" was issued. SFAS 144 supersedes SFAS No. 121, "ACCOUNTING
FOR THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF" and supercedes and
amends certain other accounting pronouncements. SFAS No. 144 retains the
fundamental provisions of SFAS No. 121 for recognizing and measuring impairment
losses on long-lived assets held for use and long-lived assets to be disposed of
by sale, while resolving significant implementation issues associated with SFAS
No. 121. Among other things, SFAS No. 144 provides guidance on how long-lived
assets used as part of a group should be evaluated for impairment, establishes
criteria for when long-lived assets are held for sale, and prescribes the
accounting for long-lived assets that will be disposed of other than by sale.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.
The adoption of SFAS No. 144 has not had a material impact on our financial
position and results of operations.
In June 2002, SFAS No. 146, "ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES"
was issued. SFAS No. 146 addresses the accounting for costs to terminate a
contract that is not a capital lease, costs to consolidate facilities and
relocate employees, and involuntary termination benefits under one-time benefit
arrangements that are not an ongoing benefit program or an individual deferred
compensation contract. The provisions of the statement will be effective for
disposal activities initiated after December 31, 2002. The adoption of this
statement did not have and is not expected to have a material affect on our
financial position or results of operations.
In December 2002, SFAS No. 148 "ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE - AN AMENDMENT OF SFAS NO. 123" was issued. SFAS No.
148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", to provide
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We have adopted these amended
disclosure requirements in Note 11 to our financial statements included in this
Form 10-Q under the heading "Incentive Stock Award Plans".
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS," ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees.
FIN 45 requires an entity to recognize an initial liability for the fair value
of an obligation assumed by issuing a guarantee. The disclosure requirements of
FIN 45 are effective for all financial statements issued after December 15,
2002. The provision for initial recognition and measurement of the liability
will be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have and is not
34
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
expected to have a material adverse impact on our financial position, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. The changes are intended to result in a more complete
depiction of an entity's liabilities and equity and will, thereby, assist
investors and creditors in assessing the amount, timing, and likelihood of
potential future cash outflows and equity share issuances. This statement also
requires that certain obligations that could be settled by issuance of an
entity's equity but lack other characteristics of equity be reported as
liabilities even though the obligation does not meet the definition of a
liability. The requirements of SFAS 150 became effective for us for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. FAS 150 is to be implemented by reporting the cumulative effect of a
change in an accounting principle for financial instruments created before the
issuance date of the statement and still existing at the beginning of the
interim period of adoption. We did not enter into or modify any financial
instruments having characteristics of both liabilities and equity during June
2003. We have evaluated the impact of SFAS 150 to determine the effect it may
have on our consolidated results of operations, financial position or cash flows
and have concluded that the adoption of this statement is not expected to have a
material affect on our financial position or results of operations.
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The statements contained in this
report, which are not historical facts, may be deemed to contain forward-looking
statements. These statements relate to future events or our future financial or
business performance, and are identified by terminology such as "may," "might,"
"will," "should," "expect," "scheduled," "plan," "intend," "anticipate,"
"believe," "estimate," "potential," or "continue" or the negative of such terms
or other comparable terminology. These statements are subject to a variety of
risks and uncertainties, many of which are beyond our control, which could cause
actual results to differ materially from those contemplated in these
forward-looking statements. In particular, the risks and uncertainties include,
among other things, those described under "Risk Factors" in our Annual Report on
Form 10-K for the year ended December 31, 2002, which has been filed with the
SEC, and (i) fluctuations in our quarterly operating results, which could
adversely effect the price of our common stock; (ii) our unproven business
model, which may not be successful; (iii) our ability to execute our business
plan in a timely manner to generate the forecasted financial and operating
results, which may not be achieved if our sales force is not able to generate
sufficient sales to customers or if we are not able to install and commence
service for customers in a timely manner; (iv) failure to generate sufficient
revenue, contain certain discretionary spending or achieve certain other
business plan objectives could have a material adverse affect on our results of
operations and financial position; (v) risks associated with the possible
removal of our common stock from the Nasdaq SmallCap Market, which removal could
adversely impact the pricing and trading of our common stock; (vi) risks
associated with acquisitions, including difficulties in identifying and
completing acquisitions, integrating acquired businesses or assets and realizing
the revenue, earnings or synergies anticipated from any acquisitions; (vii)
risks associated with the completion of the acquisition of assets and subscriber
lines from TalkingNets; (viii) regulatory, legislative, and judicial
developments, which could adversely affect the way we operate our business; (ix)
the risk that our stockholders do not approve the matters required for the
issuance of the remaining Warrants to the Investors under the Note and Warrant
Purchase Agreement or that other conditions to the issuance of such Warrants are
not satisfied or waived on or before January 14, 2004 in which case we may then
be obligated to repay
35
DSL.NET, INC.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
the Notes; (x) risks associated with our reliance on certain carriers, including
MCI, to transmit data across our network; (xi) the challenges relating to the
timely installation of service for customers, including our dependence on
traditional telephone companies to provide acceptable telephone lines in a
timely manner; (xii) our dependence on wholesale providers to provide us with
local broadband facilities in areas where we have not deployed our own
equipment; (xiii) the need for us to achieve sustained market acceptance of our
services at desired pricing levels; (xiv) competition; (xv) our limited
operating history, which makes it difficult to evaluate our business and
prospects; (xvi) the difficulty of predicting the new and rapidly evolving
high-speed data communications industry; (xvii) our ability to negotiate, enter
into and renew interconnection and collocation agreements with traditional
telephone companies; and (xviii) our ability to recruit and retain qualified
personnel, establish the necessary infrastructure to support our business, and
manage the growth of our operations. Existing and prospective investors are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. We undertake no obligation, and disclaim any
obligation, to update or revise the information contained in this report,
whether as a result of new information, future events or circumstances or
otherwise.
36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no derivative financial instruments in our cash and cash
equivalents. We invest our cash and cash equivalents in investment-grade, highly
liquid investments, consisting of commercial paper, bank money markets and
certificates of deposit and corporate bonds.
ITEM 4. CONTROLS AND PROCEDURES
a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the disclosure controls and procedures (as defined in the
Securities Exchange Act of 1934, as amended (the "Exchange Act") Rules
13a-15(e)) as of the end of the period covered by this quarterly report on Form
10-Q. Based on this evaluation, the principal executive officer and principal
financial officer concluded that our disclosure controls and procedures were, as
of the end of the period covered by this report, effective to provide reasonable
assurances that information required to be disclosed in our filings and
submissions under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms.
b) CHANGES IN INTERNAL CONTROLS
There were no significant changes in our internal controls over financial
reporting that occurred during the last fiscal quarter that materially affected,
or are reasonably likely to materially affect, our internal controls over
financial reporting.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
- ------------ -----------------------------------------------------------------
Exhibit No. Exhibit
- ------------ -----------------------------------------------------------------
4.01 Form of Senior Secured Promissory Note dated July 18, 2003.
- ------------ -----------------------------------------------------------------
4.02 Form of Warrant to Purchase Shares of Common Stock issuable
pursuant to the Note and Warrant Purchase Agreement dated as of
July 18, 2003, by and among DSL.net, Inc. and the investors named
therein.
- ------------ -----------------------------------------------------------------
10.01 Note and Warrant Purchase Agreement dated as of July 18, 2003, by
and among DSL.net, Inc. and the investors named therein.
- ------------ -----------------------------------------------------------------
10.02 Agency, Guaranty and Security Agreement dated as of July 18,
2003, by and among DSL.net, Inc., certain of DSL.net's
subsidiaries, Deutsche Bank Trust Company Americas, as
administrative agent, and the investors named therein.
- ------------ -----------------------------------------------------------------
10.03 Voting Agreement dated as of July 18, 2003, by and between
DSL.net, Inc., the stockholders named therein and the investors
named therein.
- ------------ -----------------------------------------------------------------
10.04 Amended and Restated Stockholders Agreement dated as of July 18,
2003, by and among DSL.net, Inc., the stockholders named therein
and the investors named therein.
- ------------ -----------------------------------------------------------------
37
- ------------ -----------------------------------------------------------------
11.01 Statements of Computation of Basic and Diluted Net Loss Per
Share.
- ------------ -----------------------------------------------------------------
31.1 Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
- ------------ -----------------------------------------------------------------
31.2 Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
- ------------ -----------------------------------------------------------------
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ------------ -----------------------------------------------------------------
32.2 Certification 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.
The Company filed a Current Report on Form 8-K on May 13, 2003, reporting
on Items 7 and 9, relating to a press release issued by the Company on May 13,
2003, relating to the Company's financial results for the quarter ended March
31, 2003.
The Company filed a Current Report on Form 8-K on May 14, 2003, reporting
on Item 9, relating to the certifications of its Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, in connection with the
Company's quarterly report on Form 10-Q for the quarter ended March 31, 2003.
The certifications were submitted to the Securities and Exchange Commission on
May 14, 2003.
38
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DSL.NET, INC.
By: /s/ Robert J. DeSantis
----------------------------
Robert J. DeSantis
Chief Financial Officer
Date: August 13, 2003
39
EXHIBIT INDEX
-------------
- ------------ -----------------------------------------------------------------
Exhibit No. Exhibit
- ------------ -----------------------------------------------------------------
4.01 Form of Senior Secured Promissory Note dated July 18, 2003.
- ------------ -----------------------------------------------------------------
4.02 Form of Warrant to Purchase Shares of Common Stock issuable
pursuant to the Note and Warrant Purchase Agreement dated as of
July 18, 2003, by and among DSL.net, Inc. and the investors named
therein.
- ------------ -----------------------------------------------------------------
10.01 Note and Warrant Purchase Agreement dated as of July 18, 2003, by
and among DSL.net, Inc. and the investors named therein.
- ------------ -----------------------------------------------------------------
10.02 Agency, Guaranty and Security Agreement dated as of July 18,
2003, by and among DSL.net, Inc., certain of DSL.net's
subsidiaries, Deutsche Bank Trust Company Americas, as
administrative agent, and the investors named therein.
- ------------ -----------------------------------------------------------------
10.03 Voting Agreement dated as of July 18, 2003, by and between
DSL.net, Inc., the stockholders named therein and the investors
named therein.
- ------------ -----------------------------------------------------------------
10.04 Amended and Restated Stockholders Agreement dated as of July 18,
2003, by and among DSL.net, Inc., the stockholders named therein
and the investors named therein.
- ------------ -----------------------------------------------------------------
11.01 Statements of Computation of Basic and Diluted Net Loss Per
Share.
- ------------ -----------------------------------------------------------------
31.1 Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
- ------------ -----------------------------------------------------------------
31.2 Certification Pursuant to Rule 13a-14(a) of the Exchange Act, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
- ------------ -----------------------------------------------------------------
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ------------ -----------------------------------------------------------------
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ------------ -----------------------------------------------------------------
40