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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____________ to ____________
COMMISSION FILE NUMBER: 0-29255
FASTNET CORPORATION
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-2767197
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3864 COURTNEY STREET
TWO COURTNEY PLACE, SUITE 130
BETHLEHEM, PA 18017
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(610) 266-6700
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
---
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF
CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's Common stock outstanding as of
May 15, 2002 was 25,571,323.
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FASTNET CORPORATION
FORM 10-Q
MARCH 31, 2002
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - March 31, 2002 (unaudited) and December 31, 2001......3
Consolidated Statements of Operations - Three Months Ended
March 31, 2002 and 2001 ...........................................................4
Consolidated Statements of Cash Flows - Three Months Ended
March 31, 2002 and 2001 ...........................................................5
Notes to Unaudited Consolidated Financial Statements ...............................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations .............................................................13
Item 3. Qualitative and Quantitative Disclosures About Market Risk ........................18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .................................................................18
Item 2. Changes in Securities and Use of Proceeds .........................................18
Item 3. Defaults Upon Senior Securities ...................................................18
Item 4. Submission of Matters to a Vote of Security Holders ...............................18
Item 5. Other Information .................................................................18
Item 6. Exhibits and Reports on Form 8-K ..................................................26
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2002 2001
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(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................................. $ 5,690,488 $ 10,271,755
Marketable securities .................................................. 3,097,427 2,300,100
Accounts receivable, net of allowance of $1,101,159 and $1,135,398 .... 2,902,408 2,663,800
Other current assets ................................................... 1,271,306 500,795
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Total current assets ...................................... 12,961,629 15,736,450
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PROPERTY AND EQUIPMENT, net ................................................. 15,001,084 16,397,900
INTANGIBLES, net of accumulated amortization of $4,037,334 and $3,799,001 ... 8,321,569 6,766,044
OTHER ASSETS ................................................................ 318,508 295,451
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$ 36,602,790 $ 39,195,845
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt ...................................... $ 1,168,358 $ 1,160,205
Current portion of capital lease obligations ........................... 322,115 366,741
Capital lease buyout ................................................... -- 1,600,000
Accounts payable ....................................................... 3,186,129 2,819,073
Accrued expenses ....................................................... 2,328,458 2,696,348
Deferred revenues ...................................................... 3,688,663 3,446,854
Accrued restructuring .................................................. 1,582,849 1,772,117
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Total current liabilities ................................. 12,276,572 13,861,338
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LONG-TERM DEBT .............................................................. 1,852,366 2,123,923
CAPITAL LEASE OBLIGATIONS ................................................... 34,103 32,520
OTHER LIABILITIES ........................................................... 143,685 141,213
SHAREHOLDERS' EQUITY:
Preferred stock (10,000,000 shares authorized;
3,406,293 shares issued and outstanding) ........................... 1,636,606 1,266,247
Common stock (50,000,000 shares authorized, 21,528,201 shares
outstanding; 20,390,947 shares outstanding) .......................... 71,976,280 71,194,396
Deferred compensation .................................................. (63,479) (357,937)
Note receivable ........................................................ (470,313) (463,750)
Accumulated other comprehensive income ................................. (2,904) --
Accumulated deficit .................................................... (49,780,126) (47,602,105)
Less - Treasury stock, at cost ......................................... (1,000,000) (1,000,000)
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Total shareholders' equity ................................ 22,296,064 23,036,851
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$ 36,602,790 $ 39,195,845
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
3
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
2002 2001
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REVENUES .......................................................... $ 4,319,812 $ 3,660,311
OPERATING EXPENSES:
Cost of revenues (excluding depreciation) .................... 1,924,856 3,151,183
Selling, general and administrative (excluding depreciation).. 2,277,377 2,761,604
Depreciation and amortization ................................ 1,898,547 1,761,951
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6,100,780 7,674,738
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Operating loss ............................................... (1,780,968) (4,014,427)
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OTHER INCOME (EXPENSE):
Interest income .............................................. 42,031 306,967
Interest expense ............................................. (63,422) (257,536)
Other ........................................................ (5,303) (310)
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(26,694) 49,121
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NET LOSS .......................................................... (1,807,662) (3,965,306)
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Deemed Dividend - Beneficial Conversion Feature ................... (370,359) --
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS ........................ $ (2,178,021) $ (3,965,306)
============= =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE ....................... $ (0.11) $ (0.25)
============= =============
SHARES USED IN COMPUTING BASIC AND DILUTED
NET LOSS PER COMMON SHARE ......................................... 20,684,713 15,682,613
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
4
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
2002 2001
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OPERATING ACTIVITIES:
Net loss ......................................................... $ (1,807,662) $ (3,965,306)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................................ 1,898,547 1,761,951
Amortization of debt discount ................................ 2,788 --
Amortization of deferred compensation ........................ 6,297 45,177
Stock-based compensation expense ............................. 6,315 --
Provision for doubtful accounts .............................. 21,000 --
Interest income from note .................................... (6,563) --
Changes in operating assets and liabilities:
Increase in assets:
Accounts receivable ................................. (208,630) (43,222)
Other assets ........................................ (789,188) (257,640)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses ............... (392,901) (898,158)
Deferred revenues ................................... 164,806 (144,250)
Accrued restructuring ............................... (189,268) (1,380,801)
Other liabilities ................................... 2,472 7,322
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Net cash used in operating activities ............... (1,291,987) (4,874,927)
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INVESTING ACTIVITIES:
Purchases of property and equipment .............................. (163,251) (534,675)
Cash acquired in (paid for) business acquisition, net ............ (380,269) 208,821
(Purchases) sales of marketable securities, net .................. (800,231) 7,454,466
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Net cash provided by (used in) investing activities.. (1,343,751) 7,128,612
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FINANCING ACTIVITIES:
Repayments of debt ............................................... (288,862) (252,969)
Repayments of capital lease obligations .......................... (1,656,667) (726,875)
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Net cash used in financing activities ............... (1,945,529) (979,844)
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................. (4,581,267) 1,273,841
CASH AND CASH EQUIVALENTS, beginning of period ........................ 10,271,755 5,051,901
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CASH AND CASH EQUIVALENTS, end of period .............................. $ 5,690,488 $ 6,325,742
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
5
FASTNET CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BACKGROUND
FASTNET Corporation and its subsidiaries ("FASTNET" or the "Company")
have been providing Internet access and enhanced products and services to its
customers since 1994. The Company is an Internet services provider to businesses
in selected secondary markets. The Company complements its Internet access
services by delivering a wide range of enhanced products and services that are
designed to meet the needs of its target customer base.
LIQUIDITY AND GOING CONCERN
The Company's business plan has required substantial capital to fund
operations, capital expenditures, expansion of sales and marketing capabilities,
and acquisitions. The Company modified its business strategy in October 2000, to
reduce the Company's cash consumption and maintain operations without any
additional funding in the foreseeable future. Simultaneous with the modification
of its strategic plan, the Company recorded a charge primarily related to
network and telecommunication optimization and cost reduction, facility exit
costs, realigned marketing strategy, and involuntary employee terminations.
These actions have reduced the Company's cash consumption. In December 2001, the
Company recorded an additional charge related to excess data center facilities
and office space that the Company cannot use, sublet or terminate.
The Company has incurred losses since inception and expects to continue
to incur losses in 2002. As of March 31, 2002, the Company's accumulated deficit
was $49,780,126. As of March 31, 2002, cash and cash equivalents and marketable
securities were $8,787,915. The Company believes that its existing cash and cash
equivalents, and marketable securities will be sufficient to meet its working
capital and capital expenditure requirements through December 31, 2002. However,
the Company may be required or desire to seek additional sources of financing.
If additional funds are raised through the issuance of equity securities,
existing shareholders may experience significant dilution. Furthermore,
additional financing may not be available when needed or, if available, such
financing may not be on terms favorable to the Company. If such sources of
financing are insufficient or unavailable, or if the Company experiences
shortfalls in anticipated revenue or increases in anticipated expenses, the
Company may need to idle additional markets and make further reductions in head
count. Any of these events could harm the Company's business, financial
condition or results of operations.
The Company is subject to those risks associated with companies in the
telecommunications industry. The Company's future results of operations involve
a number of risks and uncertainties. Factors that could affect the Company's
future operating results and cause actual results to vary materially from
expectations include, but are not limited to, risks from competition, new
products and technological change, price and margin pressures, capital
availability and dependence on key personnel. See Part II, Item 5 of this form
10-Q for a description of additional factors that may affect the Company's
future operating results.
QUARTERLY FINANCIAL INFORMATION AND RESULTS OF OPERATIONS
The accompanying unaudited financial information as of March 31, 2002
and for the three months ended March 31, 2002 and 2001 has been prepared in
accordance with accounting principles generally accepted in the United States.
In the opinion of management, all significant adjustments, consisting of only
normal and recurring adjustments, have been included in the accompanying
unaudited financial statements. Operating results for the three months ended
March 31, 2002 are not necessarily indicative of the results that may be
expected for the full year. While the Company believes that the disclosures
presented are adequate to make the information not misleading, these
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and the notes included in the Company's latest
annual report on Form 10-K.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of FASTNET and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
6
MANAGEMENT'S USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States require management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME
The Company follows SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 requires companies to classify items of other comprehensive income
by their nature in a financial statement and display the accumulated balance of
other comprehensive income separately from the shareholders' equity section of
the balance sheet. For the three months ended March 31, 2002 and 2001,
comprehensive loss was as follows:
THREE MONTHS ENDED
MARCH 31, MARCH 31,
2002 2001
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Net loss ........................................ $(1,807,662) $(3,965,306)
Unrealized gain (loss) on marketable securities.. (2,904) 10,517
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Comprehensive loss .............................. $(1,810,566) $(3,954,789)
============ ============
REVENUE RECOGNITION
Revenues include one-time and ongoing charges to customers for
accessing the Internet. One-time charges primarily relate to the initial
connection fees and are recognized as revenue over the life of the customer
contract. The Company recognizes access revenue over the period the services are
provided. The Company offers contracts for Internet access that are generally
billed in advance of providing service. These advance billings are recorded as
deferred revenues and recognized to revenue ratably over the service period.
Revenues are also derived from the resale of products, including
hardware and software, and web hosting services. The Company sells its web
hosting and related services for contractual periods ranging from one to twelve
months. These contacts generally are cancelable by either party without penalty.
Revenues from these contracts are recognized ratably over the contractual period
as services are provided. Incremental fees for excess bandwidth usage and data
storage are billed and recognized as revenue in the period in which customers
utilize such services.
Revenues also include professional services and web design related
projects. Revenues from professional services are generally recognized as the
services are provided. The Company generally recognizes project revenue using
the percentage-of-completion method. The percentage-of-completion method is used
over a period of time that commences with an execution of the project agreement
and ends when the project is complete. Any anticipated losses on contracts are
recorded to earnings when identified. Amounts received or billed in excess of
revenue recognized to date are classified as deferred revenues, whereas revenue
recognized in excess of amounts billed are classified as unbilled accounts
receivable and are included in accounts receivable in the accompanying
consolidated balance sheets.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period to conform
to the current period presentation.
(2) ACQUISITIONS
On March 14, 2001, the Company acquired all the assets and assumed
substantially all the liabilities of Cybertech Wireless, Inc., ("Cybertech") a
provider of fixed wireless Internet services headquartered in Rochester, New
York, for 2,000,000 shares of Common stock valued at $1,875,000. The results of
operations from Cybertech have been included in the consolidated financial
statements from the date of acquisition. The Company recorded the acquisition
using the purchase method of accounting pursuant to APB Opinion No. 16,
"Business Combinations." The excess of the purchase price over the fair value of
net assets acquired was determined to be $1,298,690. Based on a valuation by an
independent valuation consultant, $600,000 of the excess purchase price was
allocated to developed
7
technology and the remaining $698,690 was allocated to goodwill, which is not
expected to be deductible for tax purposes. The developed technology is being
amortized on a straight-line basis over a five-year period. The goodwill was
being amortized over a five-year period in 2001, however, in accordance with
SFAS No. 142, the goodwill is no longer amortized beginning January 1, 2002.
Amortization expense for the three months ended March 31, 2002, was $30,000. The
pro forma information is not presented, as information for Cybertech is
immaterial.
On January 31, 2002, the Company acquired all the assets and
substantially all of the liabilities of SuperNet, Inc. ("SuperNet"), an ISP
headquartered in East Brunswick, New Jersey. SuperNet provides Internet access
to businesses and residential customers, as well as web hosting and colocation
services to customers located in the central New Jersey region. The Company
recorded the acquisition using the purchase method of accounting pursuant to APB
Opinion No. 16. The total purchase price was $1,593,000, including transaction
costs. The purchase price consisted of 1,096,907 shares of the Company's Common
stock valued at $1,064,000, or $0.97 per share, the fair market value at the
date of acquisition. The excess of the purchase price over the fair value of net
assets acquired was determined to be $1,790,945. Based on a valuation by an
independent valuation consultant, $500,000 of the excess purchase price was
allocated to customer relationships and the remaining $1,290,945 was allocated
to goodwill, none of which is deductible for tax purposes. The customer
relationships is being amortized on a straight-line basis over a five-year
period. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
the goodwill will not be amortized. The pro forma information is not presented,
as information for SuperNet is immaterial.
The following table lists noncash assets that were acquired and
liabilities that were assumed as part of the above acquisitions:
SuperNet Cybertech
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Noncash assets:
Accounts receivable .................. $ 50,978 $ 76,827
Other current assets ................. 4,380 101,638
Property and equipment ............... 64,124 1,953,682
Intangibles .......................... 1,790,945 1,298,690
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$ 1,910,427 $ 3,430,837
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Assumed liabilities:
Accounts payable ..................... $ 207,569 $ 1,013,626
Accrued expenses ..................... 181,586 306,135
Deferred revenues .................... 77,003 181,083
Debt ................................. -- 250,000
Other liabilities .................... -- 13,814
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466,158 1,764,658
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Net noncash assets acquired...... 1,444,269 1,665,179
Purchase price paid in stock .............. (1,064,000) (1,875,000)
------------ ------------
Cash paid (acquired)....................... $ 380,269 $ (208,821)
============ ============
On November 1, 2001 the Company acquired all the assets, and assumed
substantially all the liabilities of NetReach, Inc., ("NetReach") an internet
access, web hosting, web design and web application development company
headquartered in Ambler, Pennsylvania for 2,400,000 shares of Common stock
valued at $2,232,000. The selling shareholders may receive up to an additional
690,900 shares of Common stock of the Company contingent upon the achievement of
certain revenues and margin targets, as defined, for each of the five
consecutive calendar quarters beginning October 1, 2001. The targets related to
the contingent consideration were not met in the quarters ended December 31,
2001 and March 31, 2002.
8
On April 4, 2002, the Company acquired all the outstanding capital
stock of Netaxs, Inc. ("Netaxs"), an Internet access, web hosting and colocation
provider located in the greater Philadelphia, Pennsylvania area. The aggregate
consideration paid was $984,690 in cash, the issuance of promissory notes to
certain shareholders of Netaxs having an aggregate principal amount of
$2,514,898, and 4,040,187 shares of unregistered Common stock valued at
$4,080,589, $1.01 per share, the fair value of the Company's Common stock at the
date of acquisition The principal due under the notes will accrue interest at a
rate of 7.09% per annum, and the notes are payable in monthly installments
through October 2005.
(3) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid debt investments purchased with
an original maturity of ninety days or less to be cash equivalents.
Management determines the appropriate classification of its investments
in debt and equity securities at the time of purchase and reevaluates such
determinations at each balance sheet date. As of March 31, 2002, all of the
Company's investments are classified as available for sale and are included in
marketable securities in the accompanying consolidated balance sheets.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
as well as interest are included in interest income. Realized gains and losses
are included in other income in the accompanying consolidated statements of
operations. The cost of securities sold is based on the specific identification
method.
The Company's investments in debt and equity securities are diversified
among high-credit quality securities in accordance with the Company's investment
policy.
(4) PROPERTY AND EQUIPMENT
As of March 31, 2002 and in the year ended December 31, 2001, property
and equipment consists of the following:
MARCH 31, 2002 DECEMBER 31, 2001
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Equipment ................... $ 19,998,924 $ 19,837,983
Computer equipment .......... 2,212,288 2,182,562
Computer software ........... 1,834,223 1,761,833
Furniture and fixtures ...... 669,732 670,620
Leasehold improvements ...... 3,206,761 3,205,532
--------------- -----------------
27,921,928 27,658,530
Less-Accumulated depreciation
and amortization .......... (12,920,844) (11,260,630)
--------------- -----------------
$ 15,001,084 $ 16,397,900
=============== =================
Depreciation expense for the three months ended March 31, 2002 and 2001
was $1,660,214 and $1,371,789, respectively. The net carrying value of property
and equipment under capital leases was $985,544 and $1,035,501 at March 31, 2002
and December 31, 2001, respectively.
9
(5) INTANGIBLE ASSETS
Intangible assets as of March 31, 2002 are as follows:
AMORTIZING NON-AMORTIZING
--------------------------------------- --------------------------
GROSS GROSS
USEFUL CARRYING ACCUMULATED CARRYING ACCUMULATED
LIFE AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------- ------------ ------------ ------------ ------------
Customer relationships...... 3-5 years $ 3,000,000 $(1,836,121) $ -- $--
Developed technology ....... 5 years 600,000 (125,344) -- --
Goodwill ................... n/a -- -- 8,758,903 (2,075,869)
------------ ------------ ------------ ------------
Total ...................... $ 3,600,000 $(1,961,465) $ 8,758,903 $(2,075,869)
============ ============ ============ ============
The carrying value of goodwill and other intangible assets are
evaluated periodically based on fair values or undiscounted operating cash flow
whenever significant events or changes occur which might impair recovery of
recorded costs. The Company believes that no impairment of goodwill or other
intangible assets exists at March 31, 2002. Amortization of goodwill was $0 and
$223,496 for the three months ended March 31, 2002 and 2001, respectively.
Amortization of other intangibles was $238,333 and $166,667 for the three
months ended March 31, 2002 and 2001, respectively.
(6) RESTRUCTURING CHARGE
On October 10, 2000, the Company announced a restructuring to its
business operations and this restructuring plan provided for the suspension of
selling and marketing efforts in 12 of the 20 markets that were operational as
of September 30, 2000 (the "Restructuring Plan"). Selling and marketing efforts
are now focused on targeted markets located in Pennsylvania, New Jersey and New
York. The Restructuring Plan includes redesigning the network architecture
intended to achieve an overall reduction in telecommunication expenses. In
conjunction with the Restructuring Plan, the Company terminated 44 employees.
The Company has ceased all sales and marketing activities in the 12
closed markets and is negotiating the exit of the facilities, where practicable.
Telecommunication exit and termination costs relate to contractual obligations
the Company is unable to cancel for network and related cost in the markets
being closed. These costs consist of Internet backbone connectivity cost, as
well as network and access costs, for services are no longer required in the
closed markets. Leasehold termination payments include carrying costs and rent
expense for leased facilities located in non-operational markets. The Company is
actively pursuing both sublease opportunities as well as full lease terminations
(see discussion below regarding additional restructuring charge recorded in
December 2001).
During the fourth quarter of 2000, the Company recorded a charge for
$5,159,503. The restructuring charges were determined based on formal plans
approved by the Company's management and Board of Directors using the
information available at the time. In addition in the fourth quarter of 2000,
the Company recorded a $3,233,753 asset impairment charge as a result of the
Restructuring Plan.
Throughout 2001, the Company continually reviewed the reserves that
were established in October 2000 as part of its Restructuring Plan. In the
fourth quarter of 2001, the Company recorded an additional charge of $1,335,790
related to its excess and idle data centers and administrative offices. The
amount of the charge was determined using assumptions regarding the Company's
ability to sublet or dispose of these facilities. This decision was made in the
fourth quarter of 2001 as the Company experienced significant difficulties in
attempting to dispose of or sublet these facilities due to an overall slowdown
in the economy and, in particular, the commercial real estate market. The
Company is continuing its efforts to dispose of or sublet these facilities. As
of March 31, 2002, the total amount of lease payments relating to these excess
or idle facilities is approximately $4,600,000 through 2010. Actual results
could differ materially from these estimates. Management believes this provision
will be adequate to cover any future costs incurred relating to the
restructuring.
The activity in the restructuring charge accrual during the three
months ended March 31, 2002 is summarized in the table below:
10
CASH PAYMENTS
ACCRUED DURING THE ACCRUED
RESTRUCTURING THREE MONTHS RESTRUCTURING
AS OF ENDED AS OF
DECEMBER 31, MARCH 31, MARCH 31,
2001 2002 2002
------------ ------------ ------------
Telecommunications exit and termination fees.. $ 233,980 $ -- $ 233,980
Leasehold termination costs .................. 115,543 (115,543) --
Sales and marketing contract terminations .... 52,321 -- 52,321
Facility exit costs .......................... 1,370,273 (73,725) 1,296,548
------------ ------------ ------------
$ 1,772,117 $ (189,268) $ 1,582,849
============ ============ ============
(7) DEBT
TERM NOTE
In December 2001, the Company entered into a loan agreement with a bank
and issued a $2,300,000 promissory note to the bank (the "Bank Note"). The
proceeds from the Bank Note will be used for general corporate purposes. The
Bank Note bears interest at LIBOR plus 1.5%, per annum. The Bank Note is payable
in consecutive monthly payments of $95,833 principal and interest with all
principal and interest due in December 2003. The Bank Note is secured by
substantially all of the assets of the Company. There are certain restrictive
financial and non-financial covenants related to the Bank Note including the
maintenance of a cash balance of at least $5,000,000. Interest expense related
to the Bank Note for the three months ended March 31, 2002 was $12,915. Future
maturities on the Bank Note as of March 31, 2002 are $1,150,000 through March
31, 2003 and $86,250 through December 2003.
NOTES PAYABLE
In conjunction with the NetReach acquisition, the Company acquired
various notes payable in the aggregate of $760,000 (the "NetReach Notes"). Of
the $760,000 total notes payable, $525,000 are convertible notes that convert
into the Company's Common stock at a conversion price of $2.00 per share.
Additionally, if the closing price of the Company's Common stock is at least
$3.00 per share for any consecutive 30 calendar days, the Company shall have the
right to convert all of the outstanding principal and interest due under the
convertible notes into unregistered shares of the Company's Common stock at a
conversion price equal to $2.00 per share. The convertible notes bear interest
at 8.0% and prime plus 4.0% and mature at various dates in 2003 and 2004.
Additionally, several of the convertible notes were issued with warrants to
purchase a total of 52,140 shares of the Company's Common stock at exercise
prices ranging from $1.89 to $7.57. The warrants expire from February 9, 2008
through October 17, 2008. The Company valued the warrants using the
Black-Scholes option pricing model and recorded a debt discount of $29,581
related to the warrants. The discount is being expensed over the terms of the
convertible notes.
The remaining balance of $235,000 of the NetReach Notes are term notes.
The term notes bear interest at 8.0% and mature in 2004. Interest expense
related to these term notes for the three months ended March 31, 2002 was
$6,600. Future maturities on these term notes as of March 31, 2002 are $26,400
through March 31, 2003 and $16,000 through 2004.
In conjunction with the Netaxs acquisition in April 2002, the Company
issued promissory notes to certain shareholders of Netaxs having an aggregate
principal amount of $2,514,898. The principal due under these notes will accrue
interest at a rate of 7.09% per annum and are payable in monthly installments
through October 2005.
(8) DEFERRED COMPENSATION
As a result of stock option termination, $288,161 of the unamortized
balance of deferred compensation was reversed in the quarter ended March 31,
2002.
11
(9) PREFERRED STOCK
As of March 31, 2002 and December 31, 2001 the Company had authorized
10,000,000 shares of no par value Preferred stock. In August 1999, the Company
designated and issued 808,629 shares as Series A Convertible Preferred stock
("1999 Series A Preferred"). The 1999 Series A Preferred was convertible at any
time into Common stock of the Company at a one-for-one conversion ratio. The
holders of the 1999 Series A Preferred had a liquidation preference of $7.13 per
share. In August 1999, the Company sold 666,198 shares of 1999 Series A
Preferred to certain investors at $7.13 per share. The net proceeds from the
sale of the 1999 Series A Preferred were $4,445,108. The 1999 Series A Preferred
converted into Common Stock immediately prior to the consummation of the
Company's initial public offering.
In August 2001, the Company authorized the issuance of up to 5,494,505
shares of a newly designated Series A Convertible Preferred stock ("2001 Series
A Preferred").
On September 5, 2001, the Company sold 2,506,421 shares of 2001 Series
A Preferred, no par value, at a purchase price of $0.91 per share to several
investors for gross proceeds of $2,287,109 ("First Closing"). In conjunction
with the sale of the 2001 Series A Preferred at the First Closing, the Company
issued warrants to purchase 626,605 shares of Common stock at an exercise price
of $1.27 per share. The warrants expire in five years. Additionally, a founder
of the Company sold 456,169 shares of Common stock to one of the 2001 Series A
Preferred investors for $0.50 per share for proceeds to the founder of $228,085.
On November 12, 2001, the Company sold an additional 790,283 shares of
2001 Series A Preferred at a purchase price of $0.91 per share for gross
proceeds of $712,891 and issued additional warrants to purchase 197,571 shares
of Common stock at an exercise price of $1.27 per share to the same investors
involved in the First Closing ("Second Closing"). The same founder noted above
sold an additional 143,831 shares of Common stock to the same 2001 Series A
Preferred investors for $0.50 per share for proceeds to the founder of $71,916.
Additionally, the Company issued 109,589 shares of 2001 Series A Preferred to a
law firm utilized by the Company in exchange for $100,000 of professional
services rendered, the fair value of the equity issued.
Each share of 2001 Series A Preferred is convertible into the Company's
Common stock any time after the earlier of September 4, 2002 or a mandatory
conversion event, as defined. In the event a mandatory conversion does not
occur, the 2001 Series A Preferred is convertible at the option of the holder
any time on or after August 30, 2002. The holders of the 2001 Series A Preferred
are entitled to receive dividends at the same rate as dividends are paid with
respect to Common stock shares. In the event of any liquidation, dissolution or
winding-up of the Company, the holders of 2001 Series A Preferred are entitled
to the greater of (i) $0.91 per share (subject to adjustment for stock splits,
stock dividends, recapitalizations and similar events) plus all dividends
declared but unpaid or (ii) such amount per share as would have been payable had
each share been converted to Common stock immediately prior the event. As of
March 31, 2002, the 2001 Series A Preferred had a liquidation preference of
$3,956,045.
The 2001 Series A Preferred stockholders vote together with all other
classes and series of stock as a single class. The 2001 Series A Preferred
stockholders are entitled to the number of votes, except that the 2001 Series A
Preferred stockholders are entitled to a separate class vote with respect to
certain matters affecting the 2001 Series A Preferred and certain other
fundamental transactions, such as a liquidation, dissolution or winding up of
the Company, issuances of certain additional securities and the merger,
consolidation with or into, or sale of substantially all of the assets of the
Company to another entity equal to the number of whole shares of Common stock
into which the shares of 2001 Series A Preferred are convertible. The 2001
Series A Preferred stockholders, as a separate series, are entitled to elect two
directors of the Company.
The Company allocated the proceeds from the First Closing to the 2001
Series A Preferred, warrants to purchase Common stock, and Common stock sold by
a founder based on the relative fair values of each instrument. The fair value
of the warrants issued in the First Closing was determined based on the
Black-Scholes option-pricing model using a life of five years, a volatility of
100% and a risk-free interest rate of 4.529%. Accordingly, approximately
$1,802,000 of the 2001 Series A Preferred proceeds was allocated to the 2001
Series A Preferred, $338,000 was allocated to the warrants and $148,000 was
allocated to the shares of Common stock sold by the founder. The fair values of
the warrants and the Common stock have been recorded as Common stock on the
accompanying consolidated balance sheets. After considering the allocation of
the proceeds based on the relative fair values, it was determined that the 2001
Series A Preferred has a beneficial conversion feature ("BCF") in accordance
with Emerging Issues Task Force ("EITF") Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios." The Company recorded the BCF related to the First
Closing of approximately $980,000 as a discount to the 2001 Series A Preferred
in the year ended December 31, 2001. The value of the BCF will be recorded in a
manner similar to a deemed dividend over the period from the date of issuance to
the earliest known date of conversion, September 4, 2002. The Company allocated
the proceeds from the Second Closing in the same manner as discussed above. The
fair value of the warrants issued in the Second Closing was determined based on
the Black-Scholes option pricing model using a life of five years, a volatility
of 100% and a risk free interest rate of 3.957%. Approximately, $517,000 of the
2001 Series A Preferred proceeds from the Second Closing was allocated to the
2001 Series A Preferred, $264,000 was allocated to the warrants and $41,000 was
allocated to the shares of Common stock sold by the founder. The Company
recorded a BCF related to the Second Closing of approximately $397,000 as a
12
discount to the 2001 Series A Preferred in the year ended December 31, 2001. The
value of the BCF will be recorded in a manner similar to a deemed dividend over
the period from the dates of issuance to the earliest date of conversion,
September 4, 2002. The Company recorded a deemed dividend - BCF of $370,359 and
$389,405 in the three months ended March 31, 2002 and the year ended December
31, 2001, respectively.
(10) NET LOSS PER COMMON SHARE
The Company has presented net loss per common share pursuant to SFAS
No. 128, "Earnings Per Share." Basic net loss per Common share was computed by
dividing net loss by the weighted average number of shares of Common stock
outstanding during the period. Diluted net loss per Common share reflects the
potential dilution from the exercise or conversion of securities into Common
stock, such as stock options. Outstanding Common stock options and warrants are
excluded from the diluted net loss per Common share calculations as the impact
on the net loss per Common share using the treasury stock method is antidilutive
due to the Company's losses. The number of shares excluded from this calculation
was 1,422,500 as of March 31, 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH OUR FINANCIAL STATEMENTS AND THE RELATED NOTES TO THE FINANCIAL STATEMENTS
APPEARING ELSEWHERE IN THIS FORM 10-Q. THE FOLLOWING INCLUDES A NUMBER OF
FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT VIEWS WITH RESPECT TO FUTURE
EVENTS AND FINANCIAL PERFORMANCE. WE USE WORDS SUCH AS ANTICIPATES, BELIEVES,
EXPECTS, FUTURE, AND INTENDS, AND SIMILAR EXPRESSIONS TO IDENTIFY
FORWARD-LOOKING STATEMENTS. YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD- LOOKING STATEMENTS, WHICH APPLY ONLY AS OF THE DATE OF THIS QUARTERLY
REPORT ON FORM 10-Q. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR OUR PREDICTIONS, INCLUDING, WITHOUT LIMITATION, THOSE
FACTORS SET FORTH IN ITEM 5 OF PART II OF THIS FORM 10-Q. THE FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES INCLUDING, BUT NOT
LIMITED TO, OUR ABILITY TO: SUCCESSFULLY ADJUST OUR OPERATIONS UNDER OUR
MODIFIED BUSINESS PLAN; OFFER OUR CUSTOMERS IN THE REGIONS, SERVED BY COMPANIES
THAT WE HAVE RECENTLY ACQUIRED A FULL SUITE OF PRODUCTS AND SERVICES THAT WE
OFFER OUR OTHER CUSTOMERS; INCREASE OUR ACCESS AND ENHANCED REVENUES AS A
PERCENTAGE OF OUR TOTAL REVENUES; EXPAND OUR CUSTOMER BASE; MIGRATE CUSTOMERS
13
FROM OUR COMPETITORS IF THE INDUSTRY CONTINUES TO CONSOLIDATE AND GROW OUR
REVENUES; DECREASE SOHO REVENUES AS A PERCENTAGE OF TOTAL REVENUES; REDUCE OUR
COST OF REVENUES; CHANGE OUR INTEREST INCOME AND INTEREST EXPENSE THROUGH
REVISED OPERATIONS; AND EFFECITVELY INTEGRATE OPERATIONS OF COMPANIES THAT WE
HAVE RECENTLY ACQUIRED. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS
DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE INFORMATION CONTAINED HEREIN IS
CURRENT ONLY AS OF THE DATE OF THIS FILING AND WE UNDERTAKE NO OBLIGATION TO
UPDATE THE INFORMATION IN THIS FORM 10-Q IN THE FUTURE.
OVERVIEW
We are an Internet solutions provider offering broadband data
communication services and enhanced products and services to businesses in the
Northeastern United States. Our services included high-speed data and Internet
services, data center services, including managed and unmanaged colocation
services, web hosting, small office home office (SOHO) Internet access,
wholesale ISP services, and various professional services including e-Solutions,
web design and development. We focus our sales and marketing efforts on
businesses in the markets we serve using the value proposition of leveraging our
technical expertise with dedicated customer care. We approach our customers from
an access independent position, providing connectivity over a variety of
available technologies. These include classic Telco provided point-to-point,
ISDN, SMDS, ATM, and DSL. We also offer FASTNET controlled last mile Internet
access utilizing wireless transport.
As of March 31, 2002, we provided Internet access and enhanced services
to approximately 2,164 enterprise customers, 26,276 SOHO customers, and 7,014
customers using our shared and dedicated web hosting, and colocation services.
OUR HISTORY OF OPERATING LOSSES
We have incurred operating losses in each year since our inception and
expect our losses to continue through December 31, 2002 as we seek to execute
our revised business plan. Our operating losses were $14,135,638, $32,044,023
and $5,242,373 for the years ended December 31, 2001, 2000 and 1999,
respectively, and $1,780,968 for the three months ended March 31, 2002.
MODIFICATION OF OUR STRATEGIC PLAN
On October 10, 2000, we modified our business plan. This modified plan
called for the suspension of selling and marketing efforts in 12 of the 20
markets that were operational as of September 30, 2000. Our selling and
marketing strategy is now focused on markets located in Pennsylvania, New Jersey
and New York.
Simultaneous with the modification of our business plan, we recorded a
restructuring charge of $5,159,503 primarily related to network and
telecommunication optimization and cost reduction, facility exit costs,
realigned marketing strategy, and involuntary employee terminations.
Throughout 2001, the Company continually reviewed the reserves that
were established in October 2000 as part of its 2000 restructuring plan. In the
fourth quarter of 2001, the Company recorded an additional approximately $1.3
million restructuring charge related to its excess and idle data centers and
administrative offices. This charge makes certain assumptions regarding the
Company's ability to sublet or dispose of these facilities. This decision was
made in the fourth quarter of 2001 as we experienced significant difficulties in
attempting to dispose of or sublet these facilities due to an overall slowdown
in the economy and, in particular, the commercial real estate market. We are
continuing our efforts to dispose of or sublet these facilities. As of March
2002, the total amount of lease payments relating to these excess or idle
facilities is approximately $4,600,000 through 2010. Actual results could differ
materially from this estimate.
The activity in the restructuring charge accrual during the three
months ended March 31, 2002 is summarized in the table below:
14
CASH PAYMENTS
ACCRUED DURING THE ACCRUED
RESTRUCTURING THREE MONTHS RESTRUCTURING
AS OF ENDED AS OF
DECEMBER 31, MARCH 31, MARCH 31,
2001 2002 2002
------------ ------------ ------------
Telecommunications exit and termination fees.. $ 233,980 $ -- $ 233,980
Leasehold termination costs .................. 115,543 (115,543) --
Sales and marketing contract terminations .... 52,321 -- 52,321
Facility exit costs .......................... 1,370,273 (73,725) 1,296,548
------------ ------------ ------------
$ 1,772,117 $ (189,268) $ 1,582,849
============ ============ ============
RESULTS OF OPERATIONS
REVENUES
We classify our revenue into these major categories: revenues from the
sale of enterprise level Internet access and enhanced products and services,
SOHO Internet access which includes revenues from the sale of Internet access to
SOHOs and includes revenue from the sale of wholesale dialup access to customers
that use our Dialplex Virtual Private Network (VPN or wholesale Internet access
services) to provide service to their subscribers, revenue from hosting services
which includes shared web hosting services, dedicated hosting services and
colocation services and revenues from e-Solutions, web design and development
services. We target our Internet access and enhanced services toward businesses
located within our active markets. FASTNET offers a broad range of dedicated
access solutions including T-1, T-3, Frame Relay, SMDS, enterprise class DSL
services and fixed broadband wireless. Our enhanced services are complementary
to dedicated Internet access and include Total Managed Security and the sale of
third party hardware and software. Our business plan focuses on the core service
offering of Internet access coupled with add-on sales of enhanced products and
services as our customer's Internet needs expand. Internet access and enhanced
product revenues are recognized as services are provided.
The market for data and related services is becoming increasingly
competitive. We seek to continue to expand our customer base by both increasing
market penetration in our existing markets and by increasing average revenue per
customer by selling additional enhanced products and services. We have had a
historically low churn rate with our dedicated Internet customers. We believe as
the industry consolidates that we will have opportunities to migrate customers
from our competitors as their customers become dissatisfied with the level of
service provided by the consolidated organizations. In addition, the recent
economic challenges have caused other providers to either cease operations or
terminate certain product offerings. We seek to grow our revenues by capturing
market share from other providers.
Our SOHO revenues consist of dial-up Internet access to both
residential and small office business customers, and revenue from the sale of
wholesale dialup access to customers that use VPN to provide service to their
subscribers, SOHO DSL Internet access, and ISDN Internet access. Customers using
our SOHO services generally sign service contracts for one to two years. We
typically bill these services in advance of providing services. As a result,
revenues are deferred until such time as services are rendered. In the future as
we execute our business plan, we expect SOHO revenues to decrease as a
percentage of total revenues. We have reduced selling and marketing efforts
targeted to this customer base in response to increased competition from both
free Internet service providers and other providers.
We also offer our customers VPN solutions. VPN's allow business
customers secure, remote access to their internal networks through a connection
to FASTNET's network. The cost of these services varies with the scope of the
services provided.
COST OF REVENUES
Our cost of revenues primarily consists of our Internet connectivity
charges and network charges. These are our costs of directly connecting to
multiple Internet backbones and maintaining our network. Cost of revenues also
includes engineering payroll, creative and programming staff payrolls and the
cost of third party hardware and software that we sell to our customers,
facility rental expense for in-market network infrastructure, and rental expense
on network equipment financed under operating leases.
The following table sets forth statement of operations data as a
percentage of revenues for the periods indicated:
15
THREE MONTHS ENDED
MARCH 31,
2002 2001
-------- --------
Revenues .......................................................... 100.0% 100.0%
Operating expenses:
Cost of revenues (excluding depreciation) .................... 44.6 86.1
Selling, general and administrative (excluding depreciation).. 52.7 75.4
Depreciation and amortization ................................ 43.9 48.1
-------- --------
Operating loss .................................................... (41.2) (109.6)
Other expense, net ................................................ (0.6) (1.3)
-------- --------
Net loss .......................................................... (41.8)% (108.3)%
======== ========
THE THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THE THREE MONTHS ENDED MARCH
31, 2001
REVENUES. Revenues increased by $660,000 or 18% to approximately $4.3
million for the three months ended March 31, 2002, from approximately $3.7
million for the three months ended March 31, 2001. This increase in revenues is
primarily a result of an increase in the number of business customers using our
dedicated Internet access services. Our dedicated Internet access customer base
grew by 130% from 940 as of March 31, 2001 to 2,164 as of March 31, 2002 as a
result of the acquisition of the customer bases of NetReach, which we acquired
on November 1, 2001, and SuperNet, which we acquired on January 31, 2002. These
acquisitions contributed to the increase in revenues through the addition of
dedicated Internet access, dial-up, web hosting, colocation and e-Solutions
customers to FASTNET's existing customer base, and the growth of our sales of
colocation and dedicated hosting services grew by 127% from the first quarter of
2001 compared to the first quarter of 2002. Partially off-setting the growth
from these revenue streams was a 15% decrease in the number of shared service
web hosting customers from 8,250 as of March 31, 2001, to 6,715 as of March 31,
2002. Also partially offsetting our revenue growth rate was the loss of revenue
as a result of the termination of our wholesale dialup service contract with
Mircosoft's WebTV. There was no revenue from WebTV in the first quarter of 2002,
while revenue from WebTV for the first quarter of 2001 was $558,000 or 15% of
our revenues.
COST OF REVENUE. Cost of revenues decreased by approximately $1.2
million, or 39%, from $3.2 million for the three months ended March 31, 2001 to
$1.9 million for the three months ended March 31, 2002. Gross margin improved
from 14% for the three months ended March 31, 2001 to 55% for the three months
ended March 31, 2002. The decrease in cost of revenues and the improvement in
gross margin were primarily due to the reduction in the size and improvement in
efficiency of our network and price renegotiations with our network and Internet
bandwidth providers. The decision to discontinue service to Microsoft's WebTV
also contributed to the reduction in cost of revenues and the increase in gross
margin. Offsetting the decrease in cost of revenues is the additional cost of
revenues associated with acquisitions made subsequent to March 31, 2001.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general and
administrative expenses decreased by $484,000, or 18% from $2.8 million for the
three months ended March 31, 2001 to $2.3 million for the three months ended
March 31, 2002. Contributing to this decrease was a reduction in head count from
122 at March 31, 2001 to 115 at March 31, 2002. Also contributing to this
decline in selling, general and administrative expense was a reduction in those
expenses that are directly related to head count such as taxes, benefits and
insurances.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
by $137,000 or 8%, from approximately $1.8 million for the three months ended
March 31, 2001 to $1.9 million for the three months ended March 31, 2002. The
change is a result of an increase in deprecation expense of $288,000 related to
the additional assets acquired from NetReach and SuperNet off-set by a $151,000
decrease in amortization expense of goodwill. The decrease in amortization
expense is in accordance with SFAS No. 142, which states that goodwill is no
longer amortized as of January 1, 2002, which was $238,333 for the three months
ended March 31, 2002 and $390,163 for the three months ended March 31, 2002.
16
OTHER INCOME/EXPENSE. Interest income decreased by $265,000, or 86%
from $307,000 for the three months ended March 31, 2001 to $42,000 for the three
months ended March 31, 2002. This decrease in interest income resulted from the
lower amount of interest being earned on marketable securities as a result of
drawing down the invested proceeds from our initial public offering in February
2000 to fund operating losses and as a result of a decline in return on
investments. Interest expense decreased by $194,000 from $258,000 for three
months ended March 31, 2001 to $63,000 for the three months ended March 31,
2002. The decrease in interest expense is primarily the result of the debt
cancellation of capital leases with two vendors and the reduction in investment
in equipment financed using capital lease facilities.
CASH FLOWS ANALYSIS
The following table sets forth cash flows data for the periods indicated:
THREE MONTHS ENDED
MARCH 31,
2002 2001
------------ ------------
Other Financial Data:
Cash flows used in operating activities ............... $(1,291,987) $(4,874,927)
Cash flows provided by (used in) investing activities.. (1,343,751) 7,128,612
Cash flows used in financing activities ............... (1,945,529) (979,844)
------------ ------------
Net increase (decrease) in cash and cash equivalents... $(4,581,267) $ 1,273,841
============ ============
Cash used by operating activities decreased by approximately $3.6
million from cash used of approximately $4.9 million for the three months ended
March 31, 2001 to cash used of approximately $1.3 million for the three months
ended March 31, 2002. This decrease in cash used in operations is primarily the
result of improved gross margin, and the overall reduction in selling, general
and administrative expenses.
Cash flows from investing activities decreased by approximately $8.5
million from cash provided of approximately $7.1 million for the three months
ended March 31, 2001 to cash used of approximately $1.3 million for the three
months ended March 31, 2002. This decrease resulted from the liquidation of
marketable securities required to fund our operating losses in 2001.
Cash flows used by financing activities increased by approximately $1.0
million from cash used of approximately $1.0 million for the three months ended
March 31, 2001 to cash used of approximately $1.9 million for the three months
ended March 31, 2002. The increase in cash used in financing activities is
primarily the result of an approximately $1.6 million payment made to settle a
capital lease obligation in the first quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company's future liquidity and capital requirements will depend on
numerous factors including, but not limited to, risks from competition, new
products and technological changes, price and margin pressures and dependence on
key personnel. If additional financing is needed, the Company may seek to raise
funds through the sale of securities, bank borrowings or otherwise. There can be
no assurance that financing will be available to the Company, if at all. The
Company believes that its existing cash, cash equivalents and short-term
investments will be sufficient to meet its working capital and capital
expenditure requirements into 2003.
The business plan we executed at the time of our initial public
offering required substantial capital to fund operations, capital expenditures,
expansion of sales and marketing capabilities, and acquisitions. We modified our
business strategy in October 2000. Simultaneous with the modification of our
business plan, we recorded a charge primarily related to network and
telecommunication optimization and cost reduction, facility exit costs,
realigned marketing strategy, and involuntary employee terminations. These
actions have and we believe will continue to reduce our cash consumption rate
currently and in the future. As of March 31, 2002, we had approximately $8.8
million in cash, cash equivalents and marketable securities.
During the fourth quarter of 2000, we recorded a charge for $5,159,503
in connection with our modified business plan, and during the fourth quarter of
2001, we recorded an additional charge for $1,335,790. Of these restructuring
charges, $1,582,849 has not been paid as of March 31, 2002 and is, accordingly,
classified as accrued restructuring. The Company anticipates that the entire
amount accrued will be paid in 2002 and 2003. The restructuring charges were
determined based on formal plans approved by the Company's management and Board
of Directors using the information available at the time. Management of the
Company believes this provision will be adequate to cover any future costs
incurred relating to the restructuring.
17
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
Our financial instruments primarily consist of debt. All of our debt
instruments bear interest at fixed rates. Therefore, a change in interest rates
would not affect the interest incurred or cash flows related to our debt. A
change in interest rates would, however, affect the fair value of the debt. The
following sensitivity analysis assumes an instantaneous 100 basis point move in
interest rates from levels at March 31, 2002 with all other factors held
constant. A 100 basis point increase or decrease in market interest rates would
result in a change in the value of our debt of less than $50,000 at March 31,
2002. Because our debt is neither publicly traded nor redeemable at our option,
it is unlikely that such a change would impact our financial statements or
results of operations.
All of our transactions are conducted using the United States dollar.
Therefore, we are not exposed to any significant market risk relating to
currency rates.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not involved currently in any legal proceedings that, either
individually or taken as a whole, are likely to have a material adverse effect
on our business, financial condition and results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) On January 31, 2002, we issued 1,064,000 shares of our Common
stock to shareholders of SuperNet in connection with our
acquisition of the assets, and substantially all of the
liabilities of SuperNet. This sale was made under the
exemption from registration provided under Section 4(2) of the
Securities Act.
On April 4, 2002, we issued 4,040,187 shares of our Common
stock to shareholders of Netaxs in connection with our
acquisition of the assets, and substantially all of the
liabilities of Netaxs. This sale was made under the exemption
from registration provided under Section 4(2) of the
Securities Act. In conjunction with the Netaxs acquisition in
April 2002, the Company issued promissory notes to certain
shareholders of Netaxs having an aggregate principal amount of
$2,514,898. The principal due under these notes will accrue
interest at a rate of 7.09% per annum and are payable in
monthly installments through October 2005. Ths sale was made
under the exemption from registration provided under Section
4(2) of the Securities Act.
(d) None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
FACTORS AFFECTING FUTURE OPERATING RESULTS
WE ONLY BEGAN TO IMPLEMENT OUR REVISED STRATEGIC BUSINESS PLAN IN OCTOBER 2000.
AS A RESULT, YOU MAY NOT BE ABLE TO EVALUATE OUR BUSINESS PROSPECTS BASED ON OUR
HISTORICAL RESULTS.
In October 2000, we announced our revised business plan and strategy in
response to changes in market conditions, the low probability of obtaining
additional financing for the existing business plan, and competitive factors.
Consequently, the evaluation of our future business prospects is difficult
because our historical results for the time that we were implementing our
revised strategy is limited to 18 months. Our success will depend upon:
18
o our continued ability to attract and sell additional products and
services to our target customers;
o our continued ability to enter into selected product or service
partnerships; and
o our continued ability to open new markets through the acquisition
of ISPs within these new markets.
Our ability to successfully implement our business strategy, and the
expected benefits to be obtained from our strategy, may be adversely affected by
a number of factors, such as unforeseen costs and expenses, technological
change, economic downturns, changes in capital markets, competitive factors or
other events beyond our control.
IF WE ARE UNABLE TO SUSTAIN THE COST SAVINGS AND REDUCTION IN CASH CONSUMPTION
UNDER OUR REVISED BUSINESS PLAN THROUGHOUT 2002, WE MAY HAVE TO FURTHER MODIFY
OUR BUSINESS PLAN AND OUR BUSINESS COULD BE HARMED.
If we do not continue to achieve the cost savings and reduction in cash
consumption under this plan throughout 2002, then we may need to seek additional
capital from public or private equity or debt sources to fund our business plan.
Given the existing capital market conditions, it may be difficult or impossible
to raise additional capital in the public market in the future. In addition, we
cannot be certain that we will be able to raise additional capital through debt
or private financing at all or on terms acceptable to us. Raising additional
equity capital and issuing shares of Common stock for acquisitions likely will
dilute current shareholders. If alternative sources of financing are
insufficient or unavailable, we may be required to further modify our growth and
operating plans in accordance with the extent of available financing.
IF WE ARE UNABLE TO INTEGRATE THE OPERATIONS WE HAVE ACQUIRED WITH FASTNET, WE
MAY NOT REALIZE OUR PLANNED COST SAVINGS.
A key element of our business strategy is to grow through acquisitions,
and we must be able to integrate the networks of FASTNET and these acquired
operations to gain the efficiencies we hope to achieve. We also must be able to
retain and manage key personnel, integrate the back-office operations of these
acquired operations into the back-office operations of FASTNET, and expand our
consolidated company product portfolio across our increased customer base from
these acquired operations or we may not be able to achieve the operating
efficiencies we anticipate.
To integrate our newly acquired operations successfully, we must:
o install and standardize adequate operational and control systems;
o deploy standard equipment and telecommunications facilities;
o employ qualified personnel to provide technical and marketing support in new
as well as existing locations;
o eliminate redundancies in overlapping network systems and personnel;
o incorporate acquired technology and products into our existing service
offerings;
o implement and maintain uniform standards, procedures and policies;
o standardize marketing and sales efforts under the common FASTNET brand, and,
where applicable, maintain the brand name integrity of products and services
that continue to be marketed and sold under the brand names utilized by the
acquired operations; and
o continue the expansion of our managerial, operational, technical and
financial resources.
The process of consolidating and integrating acquired operations takes
a significant period of time, places a significant strain on our managerial,
operating and financial resources, and could prove to be even more expensive and
time-consuming than we have predicted. We may increase expenditures in order to
accelerate the integration and consolidation process with the goal of achieving
longer-term cost savings and improved profitability.
The key integration challenges we face in connection with our acquisitions
include:
o acquired operations, facilities, equipment, service offerings, networks,
technologies, brand names and sales, marketing and service development
efforts may not be effectively integrated with our existing operations;
o anticipated cost savings and operational benefits may not be realized;
o in the course of integrating an acquired operation, we may discover facts or
circumstances that we did not know at the time of the acquisition that
adversely impact our business or operations, or make the integration more
difficult or expensive;
o integration efforts may divert our resources from our existing business;
19
o standards, controls, procedures and policies may not be maintained;
o employees who are key to the acquired operations may choose to leave; and we
may experience unforeseen delays and expenses.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS.
We expect to continue our targeted acquisition and expansion strategy.
Future acquisitions could materially adversely affect our operating results as a
result of dilutive issuances of equity securities and the incurrence of
additional debt. In addition to the equity securities that we have issued to
date in connection with our completed acquisitions, we may also be obligated to
issue additional equity securities based on earn-out provisions set forth in the
acquisition agreements. In addition, the purchase price for many of these
acquired businesses likely will significantly exceed the current fair value of
the net identifiable assets of the acquired businesses. As a result, material
goodwill and other intangible assets would be required to be recorded which
would result in significant amortization or other charges in future periods.
These charges, in addition to the financial impact of such acquisitions, could
have a material adverse effect on our business, financial condition and results
of operations. We recorded all business acquisitions under the purchase method
of accounting. Effective January 1, 2002 the Company no longer amortizes
goodwill and certain intangibles pursuant to Statement of Financial Accounting
Standards No.142 "Goodwill and Other Intangible Assets". We cannot assure you of
the number, timing or size of future acquisitions, or the effect that any such
acquisitions might have on our operating or financial results.
THE FINANCIAL INFORMATION CONCERNING BUSINESSES WE ACQUIRE MAY BE INACCURATE.
A number of the Internet businesses we have acquired did not have
audited financial statements, and this may be true for subsequent acquisitions
as well. These companies often have varying degrees of internal controls and
detailed financial information, and the financial information we are able to
provide for recently completed acquisitions may not be audited. Our subsequent
audits of those acquired companies may reveal significant issues with respect to
revenues, expenses and liabilities, contingent or otherwise.
WE ARE SUBJECT TO RESTRICTIVE COVENANTS THAT LIMIT OUR FLEXIBILITY.
Our loan agreement with First Union National Bank contains customary
covenants limiting our flexibility, including covenants limiting our ability to
incur additional debt, make liens, make investments, consolidate, merge or
acquire other businesses and sell assets, pay dividends and other distributions,
make capital expenditures and enter into transactions with affiliates. Failure
to comply with the terms of the loan would entitle the bank to foreclose on
certain of our assets, including the capital stock of our subsidiaries. The bank
would be repaid from the proceeds of the liquidation of those assets before the
assets would be available for distribution to other creditors and, lastly, to
the holders of FASTNET's capital stock.
In addition, the terms and agreements relating to the sale of our
Series A Convertible A Preferred stock contain customary covenants limiting our
flexibility, including covenants limiting our ability to incur additional debt,
create or issue any shares of capital stock with rights senior to the holders of
the Series A Convertible Preferred stock, make distributions or declare
dividends, consolidate, merge or acquire other businesses and sell assets, pay
dividends and other distributions, effect stock splits, and issue additional
equity securities. Such covenants may make it difficult for us to pursue our
business strategies.
Such restrictive covenants may make it difficult for us to pursue our
business strategies without the consent of parties to these agreements, which we
may not be able to obtain. Our ability to satisfy the financial and other
restrictive covenants may be affected by events beyond our control.
WE HAVE A HISTORY OF LOSSES AND ARE UNABLE AT THIS TIME TO PREDICT WHEN WE WILL
BE ABLE TO TURN PROFITABLE.
We have incurred net losses since our inception. For the three months
ended March 31, 2002 and for the years ended December 31, 2001, 2000 and 1999,
we had net losses of approximately $1.8 million, $8.5 million, $31.1 million,
and $5.6 million, respectively.
In order to achieve profitability, we must develop and market products
and services that gain broad commercial acceptance by our target customers in
our target markets. We cannot give any assurances that our products and services
will ever achieve broad commercial acceptance among our customers. Although our
revenues have increased each year since we began operations, we cannot give any
assurances that this growth in annual revenues will continue or lead to our
profitability in the future. Moreover, our revised business plan may not enable
20
us to reduce expenses or increase revenues sufficiently to permit us to turn
profitable. Therefore, we cannot predict with certainty whether we will be able
to obtain or sustain positive operating cash flow or that our revised business
plan will allow us to generate positive cash flow into the future.
IT IS UNLIKELY THAT INVESTORS WILL RECEIVE A RETURN ON OUR COMMON STOCK THROUGH
THE PAYMENT OF CASH DIVIDENDS.
We have never declared or paid cash dividends on our Common stock and
have no intention of doing so in the foreseeable future. We have had a history
of losses and expect to operate at a net loss for the next several years. These
net losses will reduce our stockholders' equity. For the three months March 31,
2002, we had a net loss to Common stockholders of approximately $2.2 million. We
cannot predict what the value of our assets or the amount of our liabilities
will be in the future.
OUR OPERATING RESULTS FLUCTUATE DUE TO A VARIETY OF FACTORS AND ARE NOT A
MEANINGFUL INDICATOR OF FUTURE PERFORMANCE.
Our operating results have fluctuated in the past and may fluctuate
significantly in the future, depending upon a variety of factors, including:
o the timing of the introduction of new products and services;
o changes in pricing policies and product offerings by us or our
competitors;
o fluctuations in demand for Internet access and enhanced products
and services; and
o potential customers perception of the financial soundness of the
Company.
Therefore, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful and cannot be relied upon as
indicators of future performance. If our operating results in any future period
fall below the expectations of analysts and investors, the market price of our
Common stock would likely decline.
THE MARKET PRICE AND TRADING VOLUME OF OUR COMMON STOCK ARE VOLATILE.
The market price of our Common stock has fluctuated significantly in
the past, and is likely to continue to be highly volatile. In addition, the
trading volume in our Common stock has fluctuated, and significant price
variations can occur as a result. We cannot assure you that the market price of
our Common stock will not fluctuate or continue to decline significantly in the
future. In addition, the U.S. equity markets have from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the stocks of technology and telecommunications companies.
These broad market fluctuations may materially adversely affect the market price
of our Common stock in the future. Such variations may be the result of changes
in our business, operations or prospects, announcements of technological
innovations and new products by competitors, new contractual relationships with
strategic partners by us or our competitors, proposed acquisitions by us or our
competitors, financial results that fail to meet public market analyst
expectations, regulatory considerations and domestic and international market
and economic conditions.
WE MAY BE UNABLE TO MAINTAIN THE STANDARDS FOR LISTING ON THE NASDAQ NATIONAL
MARKET, WHICH COULD MAKE IT MORE DIFFICULT FOR INVESTORS TO DISPOSE OF OUR
COMMON STOCK AND COULD SUBJECT OUR COMMON STOCK TO THE "PENNY STOCK" RULES.
Our Common stock is listed on the Nasdaq National Market. Nasdaq
requires listed companies to maintain standards for continued listing, including
either a minimum bid price for shares of a company's stock or a minimum tangible
net worth. For example, Nasdaq requires listed companies to maintain a minimum
bid price of at least $1.00. Since February 7, 2000, the date of our Initial
Public Offering, our stock price has risen and fallen and has traded below a
$1.00 for varying lengths of time. We cannot provide assurances that we will be
able to continue to meet these continued listing requirements. If we are unable
to maintain these standards, our Common stock could be delisted from the Nasdaq
National Market, where our Common stock currently trades. Trading in our stock
would then be conducted on the Nasdaq SmallCap Market unless we are unable to
meet the requirements for inclusion. If we were unable to meet the requirements
for inclusion in the SmallCap Market, our Common stock would be traded on an
electronic bulletin board established for securities that do not meet the Nasdaq
listing requirements or in quotations published by the National Quotation
Bureau, Inc. that are commonly referred to as the "pink sheets". As a result, it
could be more difficult to sell, or obtain an accurate quotation as to the price
of our Common stock.
21
In addition, if our Common stock were delisted, it would be subject to
the so-called penny stock rules. The SEC has adopted regulations that define a
"penny stock" to be any equity security that has a market price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the rules impose additional sales practice
requirements on broker-dealers subject to certain exceptions.
For transactions covered by the penny stock rules, a broker-dealer must
make a special suitability determination for the purchaser and must have
received the purchaser's written consent to the transaction prior to the sale.
The penny stock rules also require broker-dealers to deliver monthly statements
to penny stock investors disclosing recent price information for the penny stock
held in the account and information on the limited market in penny stocks. Prior
to the transaction, a broker-dealer must provide a disclosure schedule relating
to the penny stock market. In addition, the broker-dealer must disclose the
following:
o commissions payable to the broker-dealer and the registered
representative; and
o current quotations for the security as mandated by the applicable
regulations.
If our Common stock were delisted and determined to be a "penny stock,"
a broker-dealer may find it to be more difficult to trade our Common stock, and
an investor may find it more difficult to acquire or dispose of our Common stock
in the secondary market.
FUTURE SALES OF OUR COMMON STOCK COULD REDUCE THE PRICE OF OUR STOCK AND OUR
ABILITY TO RAISE CASH IN FUTURE EQUITY OFFERINGS.
No prediction can be made as to the effect, if any, that future sales
of shares of Common stock or the availability for future sale of shares of
Common stock or securities convertible into or exercisable for our Common stock
will have on the market price of our Common stock. Sale, or the availability for
sale, of substantial amounts of Common stock by existing shareholders under Rule
144, through the exercise of registration rights or the issuance of shares of
Common stock upon the exercise of stock options or warrants, or the perception
that such sales or issuances could occur, could adversely affect prevailing
market prices for our Common stock and could materially impair our future
ability to raise capital through an offering of equity securities.
IN THE FUTURE, WE MAY BE UNABLE TO EXPAND OUR SALES, TECHNICAL SUPPORT AND
CUSTOMER SUPPORT INFRASTRUCTURE, WHICH MAY HINDER OUR ABILITY TO GROW AND MEET
CUSTOMER DEMANDS.
On October 10, 2000, we terminated 44 employees across all departments
of the Company. This involuntary termination may make it more difficult to
attract and retain employees. If, in the future, we are unable to expand our
sales force and our technical support and customer support staff, our business
could be harmed since this more limited staff could limit our ability to obtain
new customers, sell products and services and provide existing customers with a
high level of technical support.
WE FACE SIGNIFICANT AND INCREASING COMPETITION IN OUR INDUSTRY, WHICH COULD
CAUSE US TO LOWER PRICES RESULTING IN REDUCED REVENUES.
The growth of the Internet access and related services market and the
absence of substantial barriers to entry have attracted many start-ups as well
as existing businesses from the telecommunications, cable, and technology
industries. As a result, the market for Internet access and related services is
very competitive. We anticipate that competition will continue to intensify as
the use of the Internet grows. Current and prospective competitors include:
o national Internet service providers and regional and local
Internet service providers, including any remaining viable
providers of free dial-up Internet access;
o national and regional long distance and local telecommunications
carriers;
o cable operators and their affiliates;
o providers of web hosting, colocation and other Internet-based
business services;
22
o computer hardware and other technology companies that bundle
Internet connections with their products; and
o terrestrial wireless and satellite Internet service providers.
We believe that the number of competitors we face is significant and is
constantly changing. As a result, it is extremely difficult for us to accurately
identify and quantify our competitors. In addition, because of the constantly
evolving competitive environment, it is extremely difficult for us to determine
our relative competitive position at any given time.
As a result of vertical and horizontal integration in the industry, we
currently face and expect to continue to face significant pricing pressure and
other competition in the future. Advances in technology and changes in the
marketplace and the regulatory environment will continue, and we cannot predict
the effect that ongoing or future developments may have on us or the pricing of
our products and services.
Many of our competitors have significantly greater market presence,
brand-name recognition, and financial resources than we do. In addition, all of
the major long distance telephone companies, also known as interexchange
carriers, offer Internet access services. The recent reforms in the federal
regulation of the telecommunications industry have created greater opportunities
for local exchange carriers, including incumbent local exchange carriers and
competitive local exchange carriers, to enter the Internet access market. In
order to address the Internet access requirements of the current business
customers of long distance and local carriers, many carriers are integrating
horizontally through acquisitions of or joint ventures with Internet service
providers, or by wholesale purchase of Internet access from Internet service
providers. In addition, many of the major cable companies and other alternative
service providers, such as those companies utilizing wireless and satellite-
based service technologies, have announced their plans to offer Internet access
and related services. Accordingly, we may experience increased competition from
traditional and emerging telecommunications providers. Many of these companies,
in addition to their substantially greater network coverage, market presence,
and financial, technical and personnel resources, also already provide
telecommunications and other services to many of our target customers.
Furthermore, they may have the ability to bundle Internet access with basic
local and long distance telecommunications services, which we do not currently
offer. This bundling of services may harm our ability to compete effectively
with them and may result in pricing pressure on us that would reduce our
earnings.
OUR GROWTH DEPENDS ON THE CONTINUED ACCEPTANCE BY OUR TARGET CUSTOMERS OF THE
INTERNET FOR COMMERCE AND COMMUNICATION.
If the use of the Internet by businesses and enterprises for commerce
and communication does not continue to grow, our business and results of
operations will be harmed. Our products and services are designed primarily for
the rapidly growing number of business users of the Internet. Commercial use of
the Internet by small and medium sized enterprises is still in its early stages.
Despite growing interest in the commercial uses of the Internet, many businesses
have not purchased Internet access and related services for several reasons,
including:
o lack of inexpensive, high-speed connection options;
o a limited number of reliable local access points for business
users;
o lack of affordable electronic commerce solutions;
o limited internal resources and technical expertise;
o inconsistent quality of service; and
o difficulty in integrating hardware and software related to
Internet based business applications.
In addition, we believe that many Internet users lack confidence in the
security of transmitting their data over the Internet, which has hindered
commercial use of the Internet. Technologies that adequately address these
security concerns may not be developed.
The adoption of the Internet for commerce and communication
applications, particularly by those enterprises that have historically relied
upon alternative means, generally requires the understanding and acceptance of a
new way of conducting business and exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
conducting commerce and exchanging information may be reluctant or slow to adopt
a new strategy that may make their existing personnel and infrastructure
obsolete.
23
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT OF INTERNET INFRASTRUCTURE.
The recent growth in the use of the Internet has caused periods of
performance degradation, requiring the upgrade by providers and other
organizations with links to the Internet of routers and switches,
telecommunications links and other components forming the infrastructure of the
Internet. We believe that capacity constraints caused by rapid growth in the use
of the Internet may impede further development of the Internet to the extent
that users experience increased delays in transmission or reception of data or
transmission errors that may corrupt data. Any degradation in the performance of
the Internet as a whole could impair the quality of our products and services.
As a consequence, our future success will be dependent upon the reliability and
continued expansion of the Internet.
WE RELY ON A LIMITED NUMBER OF VENDORS AND SERVICE PROVIDERS, SOME OF WHICH ARE
OUR COMPETITORS. THIS MAY ADVERSELY AFFECT THE FUTURE TERMS OF OUR
RELATIONSHIPS.
We rely on other companies to supply key components of our network
infrastructure, which are available only from limited sources. For example, we
currently rely on routers, switches and remote access devices from Lucent
Technologies, Inc., Cisco Systems, Inc. and Nortel Networks Corporation. We
could be adversely affected if any of these products were no longer available on
commercially reasonable terms, or at all. From time to time, we experience
delays in the delivery and installation of these products and services, which
can lead to the loss of existing or potential customers. We do not know that we
will be able to obtain such products in the future cost-effectively and in a
timely manner. Moreover, we depend upon a limited number of companies as our
primary backbone providers. These companies also sell products and services that
compete with ours. Our agreements with our primary backbone providers are fixed
price contracts with terms ranging from one to three years. Our backbone
providers operate national or international networks that provide data and
Internet connectivity and enable our customers to transmit and receive data over
the Internet. Our relationship with these backbone providers could be adversely
affected as a result of our direct competition with them. Failure to renew these
relationships when they expire or enter into new relationships for such services
on commercially reasonable terms or at all could harm our business, financial
condition and results of operations.
WE NEED TO RECRUIT AND RETAIN QUALIFIED PERSONNEL OR OUR BUSINESS COULD BE
HARMED.
Competition for highly qualified employees in the Internet service
industry is intense because there are a limited number of people with an
adequate knowledge of and significant experience in our industry. Our success
depends largely upon our ability to attract, train and retain highly skilled
management, technical, marketing and sales personnel and upon the continued
contributions of such people. Since it is difficult and time consuming to
identify and hire highly qualified employees, we cannot assure you of our
ability to do so. Our failure to attract additional highly qualified personnel
could impair our ability to grow our operations and services to our customers.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH COULD RESULT
IN THE LOSS OF OUR CUSTOMERS OR LIABILITY TO OUR CUSTOMERS.
The continued operation of our network infrastructure depends upon our
ability to protect against:
o downtime due to malfunction or failure of hardware or software;
o overload conditions;
o power loss or telecommunications failures;
o human error;
o natural disasters; and
o sabotage or other intentional acts of vandalism.
Any of these occurrences could result in interruptions in the services
we provide to our customers and require us to spend substantial amounts of money
24
repairing and replacing equipment. In addition, we have finite capacity to
provide service to our customers under our current infrastructure. Because
utilization of our network is constantly changing depending upon customer use at
any given time, we maintain a level of capacity that we believe to be adequate
to support our current customer base. If we obtain additional customers in the
future, we will need to increase our capacity to maintain the quality of service
that we currently provide our customers. If customer usage exceeds our capacity
and we are unable to increase our capacity in a timely manner, our customers may
experience interruptions in or decreases in quality of the services we provide.
As a result, we may lose current customers or incur significant liability to our
customers for any damages they suffer due to any system downtime as well as the
possible loss of customers.
OUR NETWORK MAY EXPERIENCE SECURITY BREACHES, WHICH COULD DISRUPT OUR SERVICES.
Our network infrastructure may be vulnerable to computer viruses,
break-ins and similar disruptive problems caused by our customers or other
Internet users. Computer viruses, break-ins or other problems caused by third
parties could lead to interruptions, delays or cessation in service to our
customers. There currently is no existing technology that provides absolute
security, and the cost of minimizing these security breaches could be
prohibitively expensive. We may face liability to customers for such security
breaches. Furthermore, such incidents could deter potential customers and
adversely affect existing customer relationships.
WE FACE POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR NETWORK.
It is possible that claims could be made against Internet service
providers in connection with the nature and content of the materials
disseminated through their networks. The law relating to the liability of
Internet service providers due to information carried or disseminated through
their networks is not completely settled. While the U.S. Supreme Court has held
that content transmitted over the Internet is entitled to the highest level of
protection under the U.S. Constitution, there are federal and state laws
regarding the distribution of obscene, indecent, or otherwise illegal material,
as well as material that violates intellectual property rights which may subject
us to liability. Several private lawsuits have been brought in the past and are
currently pending against other entities which seek to impose liability upon
Internet service providers as a result of the nature and content of materials
disseminated over the Internet. If any of these actions succeed, we might be
required to respond by investing substantial resources or discontinuing some of
our service or product offerings, which could harm our business.
NEW LAWS AND REGULATIONS GOVERNING OUR INDUSTRY COULD HARM OUR BUSINESS.
We are subject to a variety of risks that could materially affect our
business due to the rapidly changing legal and regulatory landscape governing
Internet access providers. For example, the Federal Communications Commission
currently exempts Internet access providers from having to pay per-minute access
charges that long-distance telecommunications providers pay local telephone
companies for the use of the local telephone network. In addition, Internet
access providers are currently exempt from having to pay a percentage of their
gross revenues as a contribution to the federal universal service fund. Should
the Federal Communications Commission eliminate these exemptions and impose such
charges on Internet access providers, this would increase our costs of providing
dial-up Internet access service and could have a material adverse effect on our
business, financial condition and results of operations.
We face risks due to possible changes in the way our suppliers are
regulated which could have an adverse effect on our business. For example, most
states require local exchange carriers to pay reciprocal compensation to
competing local exchange carriers for the transport and termination of Internet
traffic. However, the Federal Communications Commission has concluded that at
least a substantial portion of dial-up Internet traffic is jurisdictionally
interstate, and has adopted plans for gradually eliminating the reciprocal
compensation payment requirement for Internet traffic. If the FCC completes its
planned elimination of reciprocal compensation payments, telephone carriers
might no longer be entitled to receive payment from the originating carrier to
terminate traffic delivered to us. The Federal Communications Commission has
launched an inquiry to determine an alternative mechanism for covering the costs
of terminating calls to Internet service providers. In the interim, state
commissions will determine whether carriers will receive compensation for such
calls. If the new compensation mechanism adopted by the Federal Communications
Commission increases the costs to our telephone carriers for terminating traffic
to us, or if states eliminate reciprocal compensation payments, our telephone
carriers may increase the price of service to us in order to recover such costs.
This could have a material adverse effect on our business, financial condition
and results of operations.
Although the U.S. Supreme Court has held that content transmitted over
the Internet is entitled to the highest level of protection under the U.S.
Constitution, a recently-adopted Pennsylvania statute subjects Internet service
providers to fines and potential imprisonment and felony charges for failing to
25
disable access to child pornography within five days of notification by the
state Attorney General's office. We could be subject to this law after it goes
into effect on April 20, 2002. Although it is not possible for us to predict the
outcome, it is possible that this law could be ruled unconstitutional.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
On April 19, 2002, the Company filed a report on Form 8-K
relating to the Company's acquisition of Netaxs, Inc.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FASTNET Corporation:
Date: May 15, 2002 /s/ Stephen A. Hurly
------------------------------------
Stephen A. Hurly
Chief Executive Officer
Date: May 15, 2002 /s/ Stanley F. Bielicki
------------------------------------
Stanley F. Bielicki
Chief Financial Officer
(Principal Financial & Accounting
Officer)
27