DSL.net, Inc.
Filed 4/2/01
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2000
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-27525
DSL.NET, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 06-1510312
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
545 LONG WHARF DRIVE, NEW HAVEN, CONNECTICUT 06511
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (203) 772-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.0005 PAR VALUE
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 report(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the Registrant, as of March 21, 2001, was
approximately $34,272,439 (based on the closing price of the Registrant's Common Stock on March 21, 2001, of $1.00 per
share).
The number of shares outstanding of the Registrant's $.0005 par value Common Stock as of March 21, 2001 was 64,779,468.
DOCUMENT INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to Regulation 14A within 120 days of the end of the fiscal year
ended December 31, 2000. Portions of such proxy statement are incorporated by reference into Part III of this Form 10-K.
DSL.net, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
Page No.
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Part I
Item 1. Business......................................................................................3
Item 2. Properties...................................................................................15
Item 3. Legal Proceedings............................................................................15
Item 4. Submission of Matters to a Vote of Security Holders..........................................16
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................17
Item 6. Selected Consolidated Financial Data.........................................................17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........19
Item 7A. Quantitative and Qualitative Disclosure About Market Risk....................................40
Item 8. Financial Statements and Supplementary Data..................................................41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.........68
Part III
Item 10. Directors and Executive Officers of the Registrant...........................................68
Item 11. Executive Compensation.......................................................................68
Item 12. Security Ownership of Certain Beneficial Owners and Management...............................68
Item 13. Certain Relationships and Related Transactions...............................................68
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................69
SIGNATURES...............................................................................................72
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PART I
ITEM 1. BUSINESS
THIS BUSINESS SECTION AND OTHER PARTS OF THIS ANNUAL REPORT ON FORM 10-K CONTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE,
BUT ARE NOT LIMITED TO, THOSE SET FORTH IN "ITEM 7 - MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN THIS
ANNUAL REPORT ON FORM 10-K. EXISTING AND PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF
THE DATE HEREOF. WE UNDERTAKE NO OBLIGATION, AND DISCLAIM ANY OBLIGATION, TO UPDATE
OR REVISE THE INFORMATION CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS OR CIRCUMSTANCES OR OTHERWISE.
GENERAL
DSL.net, Inc. ("DSL.net" or the "Company") (Nasdaq: DSLN) provides high-speed data communications, Internet access, and
related services to small and medium sized businesses, primarily using digital subscriber line, or DSL, technology. We primarily
target select second and third tier cities for the deployment of our own local DSL equipment. As of March 15, 2001, we had
installed equipment in over 375 cities. In first tier cities, and certain other markets where we have not deployed our own
equipment, we utilize the local DSL facilities of other carriers to provide service. Our networks enable data transport over
existing copper telephone lines at speeds of up to 1.5 megabits per second. Our services offer customers high-speed digital
connections and related services at prices that are attractive compared to the cost and performance of alternative data
communications services.
THE DSL.NET SOLUTION
Our services provide small and medium sized businesses, as well as branch offices of large businesses, with high-speed Internet
access and data services using DSL technology. Key elements of our solution are:
HIGH-SPEED CONNECTIONS. We offer Internet access at speeds of up to 1.5 megabits per second. Our network is
designed to provide data transmission at the same speed to and from the customer, known as symmetric data transmission, and
is also capable of providing service at different rates, known as asymmetrical data transmission. We believe that symmetric data
transmission is best suited for business applications, because business users require fast connections both to send and receive
information.
COMPLETE BUSINESS SOLUTION. We offer our customers a single point of contact for a complete solution that includes
all of the necessary equipment and services to establish and maintain digital data communications. Our primary services include
Internet access, e-mail, domain name or Internet address registration for our customers, firewalls, hosting our customers' Web
sites, and virtual private networks that connect customers' various offices. Our network is designed to enable us to individually
configure each customer's service remotely.
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ALWAYS-ON CONNECTIONS. With our service, customers can access the Internet continuously without having to dial into
the network for each use. These "always-on" connections provide customers with the ability to readily access the Internet and
transfer information. We charge our customers a flat fee per month rather than billing them based on usage.
ATTRACTIVE VALUE PROPOSITION. Our DSL services offer customers high-speed digital connections at prices that are
attractive compared to the cost and performance of alternative data communications services, such as dial-up, T1, ISDN or
frame relay lines. We believe that our services also increase the productivity of network users by decreasing the time they spend
connecting to the Internet and waiting for information downloads and transfers.
CUSTOMER SUPPORT. We provide customer support 24 hours a day, seven days a week. This support is important to
many of our small and medium sized business customers because they do not typically have dedicated internal support staff.
With our remote monitoring and troubleshooting capabilities, we continuously monitor our network. This enables us to identify
and enhance network quality, service and performance and address network problems promptly.
OUR SERVICES
We utilize DSL technology to provide reliable and cost-effective service to our customers. As part of our service offerings, we
function as our customers' Internet service provider and deliver a range of Internet-based, value-added solutions.
Our services currently include all necessary equipment, software and lines required to establish and maintain a digital Internet
connection. Our primary services include Internet access, e-mail, domain name or Internet address registration for our
customers, firewalls, hosting our customers' Web sites, and virtual private networks that connect customers' various offices. Our
Services also include collocation of customer equipment and limited alternative access solutions, including T1, ISDN and
dial-up. Our network is designed to enable us to individually configure each customer's service remotely.
Customers typically pay an installation charge and a monthly fee for the service. The monthly fee includes the cost of our
standard equipment installed at the customer's site, all phone line charges, and general Internet access services, including e-mail,
assistance in obtaining Internet addresses and services related to the registration of these addresses with various administrative
bodies. Generally, customers subscribe to our services for at least one year and are billed for services on a monthly basis.
CUSTOMERS
Our target customers are primarily small and medium sized businesses. We sell to these customers primarily on a direct basis. In
particular, we believe the following are especially attractive prospective customers:
o businesses currently using other high-speed data communications services, such as T1, ISDN and frame relay services, or
low-speed dial-up Internet access;
o professional or service-based firms that have multiple Internet service provider accounts and phone lines;
o branch office locations that require transmission of large files between locations; and
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o businesses that use data-intensive applications, such as financial services, technology, and publishing.
None of our customers accounted for more than 5% of our total revenues during the period from inception (March 3, 1998)
through December 31, 1998, or during the years ended December 31, 1999 and 2000.
SALES AND MARKETING
Our marketing professionals have developed a methodology to identify the businesses that would benefit from our services.
Once we identify businesses in a target market, we employ a targeted local marketing strategy utilizing a variety of mediums,
including print and radio, but primarily focused on direct mail. Through inbound and outbound telesales campaigns, we utilize
both internal and external sales professionals to sell our services to prospective customers. We also partner with local
information technology professionals to assist in the sale of our services.
CUSTOMER SUPPORT AND OPERATIONS
Our customer support professionals work to minimize the complexity and inconvenience of data communications and Internet
access for our customers. They provide our customers with a single point of contact for implementation, maintenance and
operations support.
IMPLEMENTATION. We manage the implementation of our service for each customer. In areas where we have installed our
own local DSL facilities, we lease the copper telephone lines from the local telephone company. These lines run from our
equipment located in the telephone company's central office to our customer. We test these lines to determine whether they
meet our specifications and work with the local telephone company to correct any problems identified by our testing. In other
areas, we utilize the local DSL facilities of other carriers, and work with these carriers to provide the DSL service. In both
cases, field service technicians install the modem and any necessary wiring inside our customers' offices and test the modem and
connection over our network.
MAINTENANCE. Our network operations center provides network surveillance for all equipment in our network. We are
able to detect and correct many of our customers' maintenance problems remotely, often before our customer is aware of the
problem. Customer-initiated maintenance and repair requests are managed and resolved primarily through our help desk. Our
information management system, which generates reports for tracking maintenance problems, allows us to communicate
maintenance problems from the customer service center to our network operations center 24 hours a day, seven days a week.
OPERATIONS SUPPORT SYSTEMS. Our operations support systems are intended to improve many of our business
processes, including customer billing, service activation, inventory control, customer care reports and maintenance reports. They
have been designed to provide us with accurate, up-to-date information in these areas. Additional enhancements and integration
of these systems will continue during 2001. We believe that our operations support systems will provide us with the flexibility to
add additional services for our customers as well as to meet our expansion goals.
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OUR NETWORK
Our network delivers high-speed Internet access and data communication services. It offers scalability, reliability, security and
high performance.
NETWORK DESIGN. The key design principles of our network are:
o INTELLIGENT END-TO-END NETWORK MANAGEMENT. Our network is designed to allow us to monitor network
components and customer traffic from a central location. We can perform network diagnostics and equipment surveillance
continuously. From our network operations center, we have visibility across our entire network, allowing us to identify and
address network problems quickly and to provide quality service and performance.
o CONSISTENT PERFORMANCE WITH THE ABILITY TO EXPAND. We have designed our network to leverage the
economics of DSL technology, to grow with our business and to provide consistent performance. We also use asynchronous
transfer mode equipment in our network, which implements high-speed, high volume transmission of data.
o SECURITY. Our network is designed to reduce the possibility of unauthorized access and to allow our customers to safely
transmit and receive sensitive information and applications. The modems we install on our customers' premises are designed to
work in conjunction with installed security systems and network servers in an effort to provide safe connections to the Internet
and a secure operating environment.
NETWORK COMPONENTS. The primary components of our network are:
o DSL MODEMS AND ON-SITE CONNECTIONS. We purchase DSL modems and provide them to our customers as
part of the service contract. We configure the DSL modem and arrange for the installation of the modem and on-site wiring
needed to connect the modem to the copper telephone line. In areas where we have deployed our own local DSL facilities, we
contract with independent field service organizations to perform these services, in addition to using a small internal staff. In areas
where we utilize the local DSL facilities of other carriers, these other carriers provide these installation services.
o COPPER TELEPHONE LINES. In areas where we have deployed our own local DSL facilities, we lease a copper
telephone line running to each customer from our equipment in the local telephone company's central office under terms
specified in our interconnection agreements with these companies. In areas where we utilize the local DSL facilities of other
carriers, the carrier leases the telephone line from the local telephone company. If we, or the other DSL carriers with whom we
work, are unable to lease, or experience delays in leasing, a sufficient number of acceptable telephone lines on acceptable
terms, our business will be harmed.
o CENTRAL OFFICE COLLOCATION. Through our interconnection agreements, we secure space to locate our equipment
in certain central offices of traditional local telephone companies and offer our services from these locations. These collocation
spaces are designed to offer the same high reliability and availability standards as the telephone companies' other central office
spaces. We install the equipment necessary to provide high-speed DSL signals to our customers in these spaces. We have
continuous access to these spaces to install and maintain our equipment located in these central offices. In first tier cities and
certain other markets where we have not deployed our own DSL
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equipment, we utilize the local DSL facilities installed in central offices by other carriers to provide high-speed DSL connections
to our customers.
o CONNECTION TO THE INTERNET. Network traffic gathered at each of our central offices is routed to one of our
regional hubs and then to the Internet. In certain areas where we offer service from more than one central office, network traffic
is routed from each central office in that area to a local hub which aggregates its traffic and the traffic from the other central
offices located in that area and routes this traffic to a regional hub. At our regional hubs, we also connect to other carriers'
networks via high speed connections. Our hubs contain extra equipment and backup power to provide backup facilities in the
event of an equipment failure and are actively monitored from our network operations center. We lease space for our hubs in
facilities designed to host network equipment. Our hubs are connected to one another via high speed data communications lines.
We have agreements with WorldCom and AT&T to provide this service. Internet connectivity is provided by a combination of
public and private peering and transit arrangements. We have presence at eight of the largest and newest national "network
access points" to facilitate this high-performance high-volume external connectivity.
o NETWORK OPERATIONS CENTER. Our network is managed from our network operations center located in New
Haven, Connecticut. We provide end-to-end network management 24 hours a day, seven days a week. This enhances our
ability to address performance and service issues before they affect the customer. From the network operations center, we can
monitor individual customer lines and the equipment and circuits in our network.
COMPETITION
We face competition from many companies with significantly greater financial resources, well-established brand names and large
installed customer bases. We expect that the level of competition in our markets may intensify in the future. We expect
competition from:
OTHER DSL PROVIDERS. Certain competitive carriers, including Covad Communications and Rhythms NetConnections,
offer DSL-based services. The 1996 Telecommunications Act specifically grants competitive telecommunications companies,
including other DSL providers, the right to negotiate interconnection agreements with traditional telephone companies, including
interconnection agreements which may be identical in all respects to, or more favorable than, our agreements. Several of the
large telecommunications companies and computer companies, such as Microsoft and Qwest, have made investments in DSL
service providers.
INTERNET SERVICE PROVIDERS. Several national and regional Internet service providers, including UUNET, Cais,
EarthLink, Verio, and America Online, offer high-speed access capabilities, along with other products and services. These
companies generally provide Internet access to residential and business customers through a host of methods, including DSL.
TRADITIONAL LOCAL TELEPHONE COMPANIES. Many of the traditional local telephone companies, including
BellSouth, SBC Communications, Qwest and Verizon, are rapidly deploying DSL-based services, either directly or through
affiliated companies. These companies have established brand names and reputations for high quality in their service areas,
possess sufficient capital to deploy DSL equipment rapidly, have their own copper telephone lines and can bundle digital data
services with their existing voice services to achieve a competitive advantage in serving customers. In addition, these companies
also offer high-speed data communications services that use other technologies. We depend on these traditional local telephone
companies to enter into agreements for interconnection and to provide us access
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to individual elements of their networks. Although the traditional local telephone companies are required to negotiate in good
faith in connection with these agreements, future interconnection agreements may contain less favorable terms and result in a
competitive advantage to the traditional local telephone companies.
NATIONAL LONG DISTANCE CARRIERS. National long distance carriers, such as AT&T, Qwest, Sprint, Williams and
WorldCom, have deployed large-scale data networks, sell connectivity to businesses and residential customers, and have high
brand recognition. They also have interconnection agreements with many of the traditional telephone companies, and many offer
competitive DSL services.
OTHER FIBER-BASED CARRIERS. Companies such as Allegiance, Choice One and Intermedia have extensive fiber
networks in many metropolitan areas, primarily providing high-speed data and voice circuits to small and large corporations.
They also have interconnection agreements with the traditional telephone companies under which they have acquired collocation
space in many large markets, which could position them to offer DSL service in those markets.
CABLE MODEM SERVICE PROVIDERS. Cable modem service providers, such as At Home and its cable partners,
RoadRunner and High Speed Access, offer high-speed Internet access over cable networks to consumers. @Work, a division
of At Home, has positioned itself to do the same for businesses. Where deployed, these networks provide high-speed local
access services, in some cases at speeds higher than DSL service. They typically offer these services at lower prices than our
services, in part by sharing the capacity available on their cable networks among multiple end users.
WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Several companies, including Motorola Satellite Systems,
Hughes Communications, Teligent and WinStar Communications, are emerging as wireless and satellite-based data service
providers. These companies use a variety of new and emerging technologies to provide high-speed data services.
The most significant competitive factors include: transmission speed, service reliability, breadth of product offerings,
price/performance, network security, ease of access and use, content and service bundling, customer support, brand
recognition, operating experience, capital availability and exclusive contracts with customers, including Internet service providers
and businesses with multiple offices. We believe our services compete favorably within our service markets with respect to
transmission speed, price/performance, ease of access and use and customer support. Many of our competitors enjoy
competitive advantages over us based on their brand recognotion, breadth of product offerings, financial resources, customer
bases, operating experience and exclusive contracts with customers.
INTERCONNECTION AGREEMENTS WITH TRADITIONAL LOCAL TELEPHONE COMPANIES
We are required to enter into and implement interconnection agreements with the traditional local telephone company in each
market in which we deploy our own local DSL equipment . These agreements govern, among other things:
o the price and other terms under which we locate our equipment in the telephone company's central offices,
o the price we pay to lease copper telephone lines,
o the special conditioning of these copper lines that the traditional telephone company provides to enable the transmission of
DSL signals,
o the price we pay to access the telephone company's transmission facilities, and
o certain other terms and conditions of our relationship with the telephone company.
Under the 1996 Telecommunications Act, the traditional local telephone companies have a statutory duty to negotiate in good
faith with us for agreements for interconnection and access to certain individual elements of their networks. This interconnection
process is subject to review and approval by the state
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regulatory commissions. We have signed interconnection agreements with BellSouth, Cincinnati Bell, Frontier, SBC
Communications, Qwest, Sprint, and Verizon or their subsidiaries, which govern our relationships in 48 states and the District of
Columbia. In addition, we are negotiating certain replacement agreements with these carriers as the current agreements' terms
expire and are also negotiating amendments to existing agreements. Future interconnection agreements may contain terms and
conditions less favorable to us than those in our current agreements and could increase our costs of operations.
During these interconnection negotiations, either the telephone company or we may submit disputes to the state regulatory
commissions for mediation and, after the expiration of the statutory negotiation period set forth in the 1996 Telecommunications
Act, we may submit outstanding disputes to the states for arbitration, as well as ask the state regulatory commissions to arbitrate
a new agreement or particulars thereof.
Under the 1996 Telecommunications Act, states have begun and, in a number of cases, completed regulatory proceedings to
determine the pricing of individual elements of their networks and services, and the results of these proceedings will determine
the price we pay for, and whether it is economically attractive for us to use, these elements and services.
Our interconnection agreements generally have terms of one or two years. Therefore, we have had to renegotiate our existing
agreements when they have expired and will have to renegotiate other existing agreements when they expire. Although we
expect to renew our interconnection agreements and believe the 1996 Telecommunications Act limits the ability of traditional
telephone companies not to renew these agreements, we may not succeed in extending or renegotiating our interconnection
agreements on favorable terms. In addition, disputes have arisen and will likely arise in the future as a result of differences in
interpretations of the interconnection agreements. These disputes have, in the past, delayed the deployment of our networks.
Finally, the interconnection agreements are subject to state regulatory commission, FCC and judicial oversight. These
government authorities may modify the terms of the interconnection agreements in ways that hurt our business.
GOVERNMENT REGULATIONS
A significant portion of the services that we offer are subject to regulation at the federal and/or state levels. The Federal
Communications Commission, or FCC, and state public utility commissions regulate telecommunications common carriers,
which are companies that offer telecommunications services to the public or to all prospective users on standardized rates and
terms. Our DSL data transport services are common carrier services.
While we serve many of our customers using transport facilities that we own or lease, in some areas where we do not have the
necessary facilities we provide our Internet access and other services using the local DSL facilities of another carrier. The FCC
has determined that Internet service providers, such as us, who are using another carrier's DSL transport facilities, are not acting
as carriers. In those markets where we have not deployed our own local DSL transport facilities, our DSL services are
therefore not subject to common carrier regulation. Our ability to provide such services, however, is affected by regulations
imposed upon the carriers whose DSL facilities we utilize.
The FCC exercises jurisdiction over common carriers, and their facilities and services, to the extent they are providing interstate
or international communications. The various state utility commissions retain jurisdiction over telecommunications carriers, and
their facilities and services, to the extent they are used to provide communications that originate and terminate within the same
state. The degree of regulation varies from state to state.
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In recent years, the regulation of the telecommunications industry has been in a state of flux as the United States Congress and
various state legislatures have passed laws seeking to foster greater competition in telecommunications markets. The FCC and
state regulatory commissions have adopted many new rules to implement those new laws and to encourage competition. These
changes, which are still incomplete, have created new opportunities and challenges for us and our competitors. Certain of these
and other existing federal and state regulations are currently the subject of judicial proceedings, legislative hearings and
administrative proposals which could change, in varying degrees, the manner in which this industry operates. Neither the
outcome of these proceedings nor their impact upon the telecommunications industry or us can be predicted at this time. Indeed,
future federal or state regulations and legislation may be less favorable to us than current regulations and legislation and therefore
have a material and adverse impact on our business and financial prospects by undermining our ability to provide DSL services
at competitive prices. In addition, we may expend significant financial and managerial resources to participate in proceedings
setting rules at either the federal or state level, without achieving favorable results.
FEDERAL REGULATION AND LEGISLATION
We must comply with the requirements of a common carrier under the Communications Act of 1934, as amended, to the extent
we provide regulated interstate services. These requirements include an obligation that our charges, terms and conditions for
communications services must be "just and reasonable" and that we may not make any "unjust or unreasonable discrimination" in
our charges or terms and conditions. The FCC also has jurisdiction to act upon complaints against common carriers for failure
to comply with their statutory obligations. We are not currently subject to price cap or rate of return regulation at the federal
level and are not currently required to obtain FCC authorization for the installation, acquisition or operation of our facilities.
The FCC has established different levels of regulation for dominant and non-dominant carriers. Of domestic carriers, only the
traditional local telephone companies are classified as dominant carriers and all other providers of domestic common carrier
service, including us, are classified as non-dominant carriers. As a non-dominant carrier, we are subject to less FCC regulation
than are dominant carriers.
In October 1998, the FCC ruled that DSL and other advanced data services provided as dedicated access services in
connection with interstate services such as Internet access are interstate services subject to the FCC's jurisdiction. Accordingly,
we could offer DSL services without state regulatory authority, so long as we do not also provide local or intrastate
telecommunications services via our network. This decision allows us to provide our DSL services in a manner that potentially
reduces state regulatory obligations. However, the regulatory parameters used to define DSL service are, directly and indirectly,
subject to many pending FCC and judicial proceedings and could change in the future.
Comprehensive changes to the Communications Act of 1934 were made by the 1996 Telecommunications Act, enacted on
February 8, 1996. It represents a significant milestone in telecommunications policy by establishing competition in local
telephone service markets as a national policy. The 1996 Telecommunications Act removes many state regulatory barriers to
competition and forecloses state and local governments from creating laws preempting or effectively preempting competition in
the local telephone service market.
The 1996 Telecommunications Act places substantial interconnection requirements on the traditional local telephone companies.
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o Traditional local telephone companies are required to provide physical collocation, which allows companies such as us and
other interconnectors to install and maintain their own network termination equipment in the central offices of traditional local
telephone companies, and virtual collocation only if requested or if physical collocation is demonstrated to be technically
infeasible. This requirement is intended to enable us and other competitive carriers to deploy our equipment on a relatively
convenient and economical basis.
o Traditional local telephone companies are required to unbundle components of their local service networks so that other
providers of local service can compete for a wide range of local service customers. This requirement is designed to provide us
flexibility to purchase only the equipment we require to deliver our services.
o Traditional local telephone companies are required to establish "wholesale" rates for their services to promote resale by
competitive local exchange carriers and other competitors.
o Traditional local telephone companies are required to establish number portability, which allows a customer to retain its
existing phone number if it switches from the traditional local telephone companies to a competitive local service provider.
o Traditional local telephone companies are required to establish dialing parity, which ensures that customers will not detect a
quality difference in dialing telephone numbers or accessing operators or emergency services of competitive local service
providers.
o Traditional local telephone companies are required to provide nondiscriminatory access to telephone poles, ducts, conduits
and rights-of-way. In addition, the 1996 Telecommunications Act requires traditional local telephone companies to compensate
competitive carriers for traffic originated by them and terminated on the competitive carrier's network.
The 1996 Telecommunications Act in some sections is self-executing. The FCC issues regulations interpreting the 1996
Telecommunications Act that impose specific requirements upon which we and our competitors rely. The outcome of various
ongoing FCC rulemaking proceedings or judicial appeals of such proceedings could materially affect our business and financial
prospects by increasing the cost or decreasing our flexibility in providing DSL services.
The FCC prescribes rules applicable to interstate communications, including rules implementing the 1996 Telecommunications
Act, a responsibility it shares in certain respects with the state regulatory commissions. As part of its effort to implement the
1996 Telecommunications Act, the FCC issued an order governing interconnection, the unbundling of network elements, and
many other aspects of the relationships between new and traditional telephone companies in August 1996. The United States
Court of Appeals for the Eighth Circuit vacated many of these rules, and, in January 1999, the United States Supreme Court
reversed elements of the Eighth Circuit's ruling, finding that the FCC has broad authority to interpret the 1996
Telecommunications Act and issue rules for its implementation. Following the Supreme Court's decision, in November, 1999,
the FCC issued a modified list of the network elements that must be offered on an unbundled basis by traditional local telephone
companies, including the local copper telephone lines leased by DSL.net. This decision is currently subject to reconsideration
and to appeal.
Although the Supreme Court affirmed the FCC's authority to develop pricing guidelines in its January 25, 1999 decision, the
Supreme Court did not evaluate the specific pricing methodology adopted by the FCC for unbundled network elements.
Instead, the Supreme Court remanded the case to the Eighth Circuit for further consideration of the FCC's rules regarding its
forward-looking pricing methodology for unbundled network elements. On July 18, 2000, the Eighth Circuit, among other
findings, vacated a portion of the FCC's pricing methodology
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that likely had the effect of lowering the costs that we pay to the traditional local telephone companies for unbundled network
elements that we use to provision DSL service. The Eighth Circuit's decision has been stayed pending an appeal to the Supreme
Court, which agreed in January 2001 to hear the case. We cannot predict the possible impact of these proceedings on our
ability to provide DSL services to the public at competitive prices, if at all.
In March 1998, several traditional local telephone companies petitioned the FCC for relief from certain regulations applicable to
the DSL and other advanced data services that they provide, including their obligations to provide copper telephone lines and
resold DSL services to competitive carriers. In August 1998, the FCC concluded that DSL services are telecommunications
services and, therefore, the traditional local telephone companies are required to allow interconnection of their facilities and
equipment used to provide data transport functionality, unbundle local telecommunications lines and offer for resale DSL
services. After some of the traditional local telephone companies appealed this decision, the U.S. Court of Appeals for the
District of Columbia remanded the proceeding to the FCC for further consideration. In December 1999, the FCC reaffirmed its
conclusion on remand that traditional telephone companies are required to offer to competitive data transmission companies the
ability to interconnect and the necessary unbundled network elements to provide advanced data transmission services. This
remand order is now pending on appeal before the U.S. Court of Appeals. Any change in the August 1998 and December
1999 orders that would affect our ability to interconnect with and obtain facilities from the traditional local telephone companies
could affect our ability to provide DSL services to the public.
The traditional local telephone companies continue to urge the elimination of their unbundling obligations with respect to
advanced services in various FCC proceedings and through legislation. Recent changes in federal Congressional and executive
leadership could increase the possibility of changes in the law that could alter our relationship with these companies, and thereby
affect our ability to provide DSL services to the public.
At least two traditional telephone companies, SBC Communications and Verizon, have taken the position in state and federal
regulatory proceedings that they are not obligated to unbundle portions of their network where they construct modified or new
digital loop carrier facilities that would enable them to offer DSL services to customers who are located too far from the
traditional local telephone companies' central offices to be reached by existing DSL technologies. DSL.net and other
competitive carriers have urged state and federal regulators to require these companies to provide access to these facilities on
an unbundled basis and to hold that carriers such as us may invoke the good-faith negotiation and arbitration procedures of the
Telecommunications Act of 1996 to establish rates, terms and conditions for such access. We cannot predict the outcome of
these proceedings. If SBC and Verizon are not required to provide access on an unbundled basis, there is no guarantee that we
will be able to provide DSL service in these areas, or that we will be able to secure favorable rates, terms and conditions from
the traditional local telephone companies for access. For example, while SBC and Verizon are developing "voluntary" wholesale
DSL products for competitive local telephone companies that would utilize their respective digital loop carrier facilities, these
products would support only asymmetric DSL, and not the symmetric DSL that we primarily offer today.
In August 1998 , the FCC issued a notice of proposed rulemaking seeking comments on its tentative conclusion that traditional
local telephone companies should be permitted to create separate affiliates to provide DSL services. Under the separate affiliate
proposal, traditional local telephone companies would be required to provide wholesale service to other DSL carriers at the
same rates, terms and conditions that it provided to its separate affiliate. The outcome of this proceeding remains uncertain. In
connection with its approval of mergers, however, the FCC subsequently required two traditional local telephone companies,
SBC Communications and Verizon, to create separate affiliates to provide DSL services, as
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conditions of their mergers with Ameritech and GTE, respectively. In January 2001, the United States Court of Appeals for the
District of Columbia held that SBC may not avoid its obligations under the 1996 Telecommunications Act through the creation
of a separate advanced services affiliate. Under the terms of the FCC's conditions on the SBC-Ameritech merger, SBC may be
able to fold its separate affiliate back into the parent company as early as later this year. It remains unclear how this court
decision will affect the existing SBC and Verizon affiliates and the pending FCC proceedings. Any outcome that alters our
relationship with the traditional local telephone companies could adversely affect our ability to provide DSL services at a
competitive price.
In March 1999, the FCC strengthened its regulations that require the traditional local telephone companies to permit other
carriers to collocate all equipment necessary for interconnection. This requirement covers equipment that we use to provide
DSL data services. The FCC adopted limits on the construction standards and other conditions for collocation that may be
imposed by traditional local telephone companies. These new rules would reduce our collocation costs and expedite our ability
to provide service to new areas. In March 2000, however, the U.S. Court of Appeals for the District of Columbia vacated
some of these rules, and reconsideration of the collocation rules remains pending before the FCC. There can be no assurance
that this proceeding will produce favorable collocation rules.
In November 1999, the FCC issued an order reaffirming its prior conclusion that DSL services must be offered for resale at a
discount by traditional local telephone companies to the extent such services are offered at retail to residential and business
customers. The FCC determined, however, that advanced services provided to Internet service providers would not be subject
to resale at a discount. Accordingly, traditional telephone companies may enter into volume and term discounts for the
provisioning of DSL services with internet service providers, arguably including its own internet affiliates, without having to make
such arrangements available to other requesting competitive carriers at discounted rates. There is no guarantee that these resale
rates will compare favorably to those offered to internet service providers.
In December 1999, the FCC issued an order that requires the traditional local telephone companies to provide "line sharing" of
unbundled copper telephone lines to DSL companies. Line sharing allows a DSL company to lease the high frequency portion
of a loop over which some types of DSL data traffic is transmitted without having to lease the low frequency portion of the loop
which carries voice traffic. Line sharing is not currently available using symmetric DSL technology, which transmits data at the
same speed to and from the customer and is the technology that we primarily use in providing our service.
Also in December 1999, the FCC granted Verizon (formerly Bell Atlantic) authority to provide long distance interexchange
service in New York, a service it and the other traditional local telephone companies created by AT&T's divestiture of its local
telephone service business had previously been barred from offering. Subsequently, the FCC has authorized Southwestern Bell,
a subsidiary of SBC Communications, to provide long distance service in Texas, Kansas and Oklahoma, and numerous
additional applications are expected over the next one to two years. While we do not presently provide long distance
interexchange service, this ruling and any future similar rulings could negatively impact our business. First, Verizon and
Southwestern Bell are able to offer potentially attractive packages of local, long distance and data services. Second, the
prospect of long distance authority has served as a powerful incentive for the traditional local telephone companies to comply
with their obligations under the 1996 Telecommunications Act, including the provision of unbundled network elements and
collocation services to competitors such as us. The traditional local telephone companies may not extend to us the same level of
cooperation once they receive approval to provide long distance interexchange service.
The 1996 Telecommunications Act also directs the FCC, in cooperation with state regulators, to establish a universal service
fund that will provide subsidies to carriers that provide service to individuals that live in rural, insular, and high-cost areas. A
portion of carriers' contributions to the universal service
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fund also will be used to provide telecommunications related facilities for schools, libraries and certain rural health care
providers. The FCC released its initial order in this context in June 1997, which requires all telecommunications carriers to
contribute to the universal service fund. The FCC's implementation of universal service requirements remains subject to judicial
and additional FCC review. Additional changes to the universal service regime, which could increase our costs, could have an
adverse affect on us.
DSL.net is authorized to provide interstate telecommunications services pursuant to its access tariff filed with the FCC in April
1999. Although not required for our existing DSL data service offering, on August 6, 1999 we obtained authority from the FCC
to provide international telecommunications services originating from the United States.
STATE REGULATION
In October 1998, the FCC deemed data transmission to the Internet to be interstate services subject only to federal jurisdiction.
However, this decision is currently subject to reconsideration and appeal. Also, some of our services that are not limited to
interstate access potentially may be classified as intrastate services subject to state regulation. All of the states where we
operate, or intend to operate, require some degree of state regulatory commission approval to provide certain intrastate services
and maintain ongoing regulatory supervision. In most states, intrastate tariffs are also required for various intrastate services,
although our services are not subject to price or rate of return regulation. Actions by state public utility commissions could cause
us to incur substantial legal and administrative expenses and adversely affect our business.
We have obtained authorizations to provide local exchange and long-distance telecommunications services in all 50 states, the
District of Columbia, and Puerto Rico.
LOCAL GOVERNMENT REGULATION
In certain instances, we may be required to obtain various permits and authorizations from municipalities, such as for use of
rights-of-way, in which we operate our own local distribution facilities. Whether various actions of local governments over the
activities of telecommunications carriers such as ours, including requiring payment of franchise fees or other surcharges, pose
barriers to entry for competitive local exchange carriers which violate the 1996 Telecommunications Act or may be preempted
by the FCC is the subject of litigation. While we are not a party to this litigation, we may be affected by the outcome. If
municipal governments impose conditions on granting permits or other authorizations or if they fail to act in granting such permits
or other authorizations, the cost of providing DSL services may increase or it may negatively impact our ability to expand our
network on a timely basis and adversely affect our business.
INTELLECTUAL PROPERTY
We regard our products, services and technology as proprietary and attempt to protect them with copyrights, trademarks, trade
secret laws, restrictions on disclosure and other methods. For example, we own a federal supplemental registration and claim
rights in the name DSL.net. There can be no assurance these methods will be sufficient to protect our technology and intellectual
property. We also generally enter into confidentiality agreements with our employees and consultants, and generally control
access to and distribution of our documentation and other proprietary information. Despite these precautions, it may be possible
for a third party to copy or otherwise obtain and use our proprietary information without authorization, or to develop similar
information independently. Effective patent, copyright, trademark and trade secret protection may be unavailable or limited in
certain foreign countries, and the global nature
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of the Internet makes it virtually impossible to control the ultimate destination of our technology or proprietary information.
There can be no assurance that the steps we have taken will prevent misappropriation or infringement of our technology or
proprietary information. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse effect on our business, operating results and
financial condition. In addition, some of our information, including our competitive carrier status in individual states and our
interconnection agreements, is a matter of public record and can be readily obtained by our competitors and potential
competitors, possibly to our detriment.
EMPLOYEES
As of December 31, 2000, we had 380 employees. We believe that our future success will depend in part on our continued
ability to attract, hire and retain qualified personnel. Competition for such personnel is intense, and we may be unable to identify,
attract and retain such personnel in the future. None of our employees are represented by a labor union or are the subject of a
collective bargaining agreement. We have never experienced a work stoppage and believe that our employee relations are
good.
ITEM 2. PROPERTIES
Our headquarters consists of approximately 56,200 square feet in an office building in New Haven, Connecticut. We also lease
other offices in Milford and New Haven, Connecticut; Santa Cruz, California; Minneapolis, Minnesota; Marietta, Georgia and
Chantilly, Virginia. We have vacated the offices in Milford, Connecticut and Chantilly, Virginia, as well as certain office space in
New Haven, Connecticut, and are currently looking to sublease those premises. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations". In addition, we lease space for network equipment installations in a number of
other locations. With respect to our arrangements to use space in traditional telephone companies' central offices, please see
"BUSINESS - Interconnection Agreements with Traditional Local Telephone Companies."
ITEM 3. LEGAL PROCEEDINGS
A lawsuit for wrongful termination of employment was filed against us in the Superior Court in New Haven, Connecticut on July
29, 1999 by Frank W. Pereira, a former officer who was employed by us for less than two months. Plaintiff's claims are based
chiefly on his allegation that we terminated his employment because he allegedly voiced concerns to senior management about
the feasibility of our second and third tier city business strategy. He further alleges that our senior management knew of these
alleged flaws in the strategy. The plaintiff is principally seeking compensatory damages for wages and unvested stock options.
We deny these allegations and believe that the plaintiff's claims are without merit. We plan to defend the case vigorously.
We are also a party to legal proceedings related to regulatory approvals. We are subject to state commission, FCC and court
decisions as they relate to the interpretation and implementation of the 1996 Telecommunications Act, the interpretation of
competitive carrier interconnection agreements in general and our interconnection agreements in particular. In some cases, we
may be deemed to be bound by the results of ongoing proceedings of these bodies. We therefore may participate in
proceedings before these regulatory agencies or judicial bodies that affect, and allow us to advance, our business plans.
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From time to time, we may be involved in other litigation concerning claims arising in the ordinary course of our business,
including claims brought by former employees and claims related to acquisitions. We do not currently believe that any of the
legal claims or proceedings will result in a material adverse effect on our business, financial position, results of operations or cash
flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended December 31, 2000 we did not submit any matters to the vote of our security holders.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of March 21, 2001, there were approximately 589 holders of record of our common stock. Our common stock is listed for
quotation on the Nasdaq National Market under the symbol "DSLN".
The range of high and low sales prices per share of DSL.net's common stock as reported on the Nasdaq National Market since
DSL.net's initial public offering are shown below.
QUARTER ENDED HIGH LOW
December 31, 1999 (from October 6, 1999) $25.625 $7.469
March 31, 2000 $32.563 $14.000
June 30, 2000 $22.250 $6.125
September 30, 2000 $10.375 $2.406
December 31, 2000 $3.500 $0.469
RECENT SALES OF UNREGISTERED SECURITIES
In May 2000, 102,737 shares of common stock were issued upon the cashless exercise of an outstanding warrant pursuant to
its terms. These shares of common stock were issued pursuant to an exemption from registration provided under Sections
3(a)(9) or 4(2) of the Securities Act of 1933.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock and currently intend to retain any future earnings for
the future operation and expansion of our business. In addition, our credit agreement with our bank prohibits the payment of
cash dividends. Accordingly, we do not anticipate that any cash dividends will be declared or paid on our common stock in the
foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
We were incorporated on March 3, 1998 and commenced operations on March 28, 1998. The following historical data for the
period from inception (March 3, 1998) through December 31, 1998 and the years ended December 31, 1999 and December
31, 2000, except for "Other Data," has been derived from our financial statements audited by PricewaterhouseCoopers LLP,
independent accountants. Our balance sheets at December 31, 1999 and 2000 and the related statements of operations,
changes in stockholders' equity and cash flows for the period from inception (March 3, 1998) to December 31, 1998 and the
years ended December 31, 1999 and December 31, 2000 and notes thereto appear elsewhere in this annual report on Form
10-K.
You should refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the more
complete financial information included elsewhere in this annual report on Form 10-K.
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Period From
Inception (March 3,
1998) Through Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
---- ---- ----
STATEMENT OF OPERATIONS DATA:
Revenue ......................................... $ 31,533 $ 1,312,546 $ 17,789,410
Operating expenses:
Network and operations .................... 127,054 9,604,200 78,242,544
General and administrative ................ 2,653,544 8,036,547 25,793,932
Sales and marketing ....................... 35,961 7,543,191 26,236,619
Total operating expenses ................ 2,816,559 25,183,938 130,273,095
Operating loss .................................. (2,785,026) (23,871,392) (112,483,685)
Interest expense (income), net .................. 4,611 (1,889,312) (6,729,657)
Other expense ................................... -- 6,233 9,120
Net loss ........................................ $ (2,789,637) $ (21,988,313) $(105,763,148)
NET LOSS PER COMMON SHARE DATA:
Net Loss per common share, basic and diluted .... $ (0.55) $ (2.05) $ (1.75)
Shares used in computing net loss per share ..... 5,118,342 16,549,535 60,593,437
CASH FLOW DATA:
Used in operating activities .................... $ (153,505) $ (6,342,720) $ (74,985,739)
Used in investing activities .................... (290,082) (48,660,812) (56,717,213)
Provided by financing activities ................ 483,066 121,142,314 141,959,673
OTHER DATA:
EBITDA (A) ...................................... $ (356,010) $ (17,917,617) $ (88,137,915)
Capital expenditures ............................ 290,082 33,811,121 55,942,721
December 31,
---------------------------------------------------
1998 1999 2000
---- ---- ----
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities $ 39,479 $ 79,452,444 $ 76,434,982
Total assets .................................... 369,980 117,631,772 194,805,921
Long-term obligations (including current portion) 433,161 3,055,625 14,114,457
Total stockholders' equity (deficit) ............ (315,865) 100,732,886 149,417,439
(A) EBITDA, shown above under "Other Data," consists of net loss excluding net interest, taxes, depreciation of capital assets,
amortization of intangibles and non-cash stock compensation expense. Other companies, however, may calculate it differently
from us. We have provided EBITDA because it is a measure of financial performance commonly used for comparing
companies in the telecommunications industry in terms of operating performance, leverage, and ability to incur and service debt.
EBITDA is not a measure determined under generally accepted accounting principles. EBITDA should not be considered in
isolation from, and you should not construe it as a substitute for:
o operating loss as an indicator of our operating performance,
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o cash flows from operating activities as a measure of liquidity,
o other consolidated statement of operations or cash flows data presented in accordance with generally accepted accounting
principles, or
o as a measure of profitability or liquidity.
The above financial data includes the operating results of acquisitions from their acquisition date and consequently will effect the
comparability of such financial data from year to year.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH "ITEM 6 - SELECTED
CONSOLIDATED FINANCIAL DATA" AND "ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA" THAT APPEAR ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K. THIS DISCUSSION AND
ANALYSIS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES.
OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT
ARE NOT LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS ANNUAL
REPORT ON FORM 10-K. EXISTING AND PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE
HEREOF. WE UNDERTAKE NO OBLIGATION, AND DISCLAIM ANY OBLIGATION, TO UPDATE OR REVISE
THE INFORMATION CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K, WHETHER AS A RESULT OF
NEW INFORMATION, FUTURE EVENTS OR CIRCUMSTANCES OR OTHERWISE.
OVERVIEW
We provide high-speed data communications, Internet access, and related services to small and medium sized businesses,
primarily using digital subscriber line, or DSL, technology. We primarily target select second and third tier cities for the
deployment of our own local DSL equipment. We began offering commercial service in May 1998 and, as of March 15, 2001,
we had installed equipment in over 375 cities. In first tier cities, and certain other markets where we have not deployed our own
equipment, we utilize the local DSL facilities of other carriers to provide service.
We have incurred operating losses and net losses for each month since our formation. For the periods ended December 31,
1998, 1999 and 2000, we experienced net cash outflows from operating and investing activities. As of December 31, 1998,
1999 and 2000, we had accumulated deficits of approximately, $2,789,600, $27,180,000 and $132,943,100, respectively.
In an effort to increase revenue from our installed network and conserve capital, in the fourth quarter of 2000, we decided to
suspend the build-out of additional central offices and focus our efforts on increasing revenue through targeted marketing to
increase penetration in our existing service areas and by introducing more services. In addition, we decided to suspend network
connections to certain central offices, consolidate operating facilities, significantly reduce staff and curtail overall operating
expenses. As a result, in 2001, we currently expect a significant reduction in our capital expenditures and a reduction
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in the size of our operating losses, net losses and net operating cash outflows. We currently believe these actions will reduce our
monthly net cash outlay during 2001.
Our financial performance will vary, and whether and when we achieve profitability will depend on a number of factors,
including:
o development of the high-speed data communications industry and our ability to compete effectively;
o our ability to obtain additional financing to continue the implementation of our business plan;
o amount, timing and pricing of customer revenue;
o commercial acceptance of our service and attaining expected penetration within our target markets;
o our ability to recruit and retain qualified personnel;
o up front sales and marketing expenses;
o cost and utilization of our network components which we lease from other telecommunications providers, including other
competitive carriers;
o our ability to establish and maintain relationships with marketing partners;
o successful implementation and management of financial, information management and operations support systems to efficiently
and cost-effectively manage our growth; and
o favorable outcome of federal and state regulatory proceedings and related judicial proceedings, including proceedings relating
to the 1996 Telecommunications Act.
FACTORS AFFECTING FUTURE OPERATIONS
REVENUE. We derive our revenue from monthly fees and installation costs paid by customers for our services, which vary
based on the speed of the connection and the services ordered. The current monthly fee includes all phone line charges, Internet
access charges, the cost of the modem installed at the customer's site and the other services we provide.
During fiscal 2000, we implemented the Securities and Exchange Commission's Staff Accounting Bulletin ("SAB") No. 101
"REVENUE RECOGNITION IN FINANCIAL STATEMENTS." As a result, installation revenue and installation costs are
now deferred and amortized to revenue and expense, respectively, over eighteen months, the estimated life of the customer
relationship. Any excess of installation cost over revenue is expensed when incurred. In certain situations we waive
non-recurring installation charges in order to obtain a customer and expense the related direct installation cost as incurred.
Management believes that implementation of SAB No. 101 will not have a significant impact on future revenue or future
operating results because installation revenue represents a small percentage of our total revenue and because the deferred
revenue is offset by the deferral of an equal amount of installation cost.
We seek to price our services competitively. The market for high-speed data communications services and Internet access is
rapidly evolving and intensely competitive. While many of our competitors and potential competitors enjoy competitive
advantages over us, we are pursuing a significant market that, we
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believe, is currently under-served. Although pricing will be an important part of our strategy, we believe that direct relationships
with our customers and consistent, high quality service and customer support will be key to generating customer loyalty. During
the past several years, market prices for many telecommunications services and equipment have been declining, a trend that we
believe will likely continue.
NETWORK AND OPERATIONS. Our network and operations expenses include costs related to personnel, monthly fees for
telecommunications lines between customers, central offices, network service providers and our network, customer line
installation, Internet access, certain depreciation and amortization expenses and other costs. Our costs for customer lines will
increase as we add customers. We lease high-speed lines and other network capacity to connect our central office equipment
and our network. Additional costs are incurred to connect to the Internet. Because of significant expansion and growth of our
business during 2000, our results include various network and operations expenses, particularly depreciation and amortization
expenses, for a portion of the year. As a result, we expect to see increases in such expenses during 2001 as such expenses are
included for the full year. We also expect these costs to increase as the volume of data communications traffic generated by our
customers' increases.
The majority of our capital expenditures relate to building our network and delivering service to customers. Accordingly, the
majority of our depreciation and amortization expense, excluding amortization of goodwill and intangibles resulting from
acquisitions, is included in our network and operations expense. This expense includes:
o Depreciation of network and operations equipment and DSL modems and routers installed at customer sites;
o Depreciation of information systems, and computer hardware and software; and
o Amortization and depreciation of the costs of obtaining, designing and building our collocation space and corporate facilities.
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses consist primarily of costs relating to human
resources, finance, billing, administrative services, recruiting, insurance, legal services, operating facilities rent, depreciation and
amortization of goodwill and intangibles resulting from acquisitions.
SALES AND MARKETING. Our sales and marketing expenses consist primarily of expenses for personnel, the development
of our brand name, promotional materials, advertising and sales commissions and incentives.
STOCK COMPENSATION. We incurred non-cash stock compensation expenses as a result of the granting of stock and
stock options to employees and others with exercise prices per share subsequently determined to be below the fair values per
share of our common stock for financial reporting purposes at the dates of grant. The stock compensation, if vested, was
charged immediately to expense, while non-vested compensation is being amortized over the vesting period of the applicable
options or stock, which is generally 48 months. In addition, in fiscal 2000, we recorded $870,000 of non-cash compensation
expense relating to the vesting of stock options held by members of our former advisory board.
TAXATION. We have not generated any taxable income to date and, therefore, have not paid any federal income taxes since
inception. Use of our net operating loss carryforwards, which will begin to expire in 2003, may be subject to limitations. We
have recorded a full valuation allowance on a deferred tax asset,
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consisting primarily of net operating loss carryforwards, because of uncertainty regarding their future recoverability.
RESULTS OF OPERATIONS
REVENUE. Revenue increased from approximately $32,000 for the period from March 3, 1998 (inception) to December 31,
1998 to approximately $1,313,000 for the year ended December 31, 1999 and to approximately $17,789,000 for the year
ended December 31, 2000. Revenue increased primarily due to the expansion of our network, the increased number of
customers subscribing for our services and contributions from acquired businesses, primarily Vector Internet Services, Inc. and
Tycho Networks. We currently expect revenue to increase in future periods as we increase our sales and marketing efforts in
our existing service areas and introduce additional services.
NETWORK AND OPERATIONS. Network and operations expenses increased from approximately $127,000 for the period
from March 3, 1998 (inception) to December 31, 1998 to approximately $9,604,000 for the year ended December 31, 1999
and approximately $78,243,000 for the year ended December 31, 2000. The increase in network and operations expenses
between the 1998 and 1999 periods was primarily due to the increased number of customers subscribing for our services and
other increased costs resulting from the addition of personnel, the expansion of our network and legal costs incurred in
connection with our applications for regulatory approvals in various states. The increases in these expenses between the 1999
and 2000 periods was primarily attributable to increased telecommunication costs and central office facilities costs, increases in
personnel and professional services and increased depreciation expense. These increases resulted primarily from the expansion
of our network and the increased number of customers subscribing for our services.
Network and operations expenses included depreciation expense of approximately $5,744, $1,621,000 and $15,119,000 for
the period from March 3, 1998 (inception) to December 31, 1998 and the years ended December 31, 1999 and 2000,
respectively. This expense increased as we incurred further capital expenditures in connection with our expansion and more of
our network facilities became operational.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased from approximately $2,653,000 for
the period from March 3, 1998 (inception) to December 31, 1998 to $8,037,000 for year ended December 31, 1999 and
approximately $25,794,000 for the year ended December 31, 2000. The increase in general and administrative expenses
between the 1998 and 1999 periods was principally the result of increases in the number of employees. The increases in these
expenses between the 1999 and 2000 periods were principally the result of increases in personnel and professional services,
increases in office facility rents resulting from the development of our operating infrastructure and amortization of goodwill and
other intangible assets related to acquisitions.
SALES AND MARKETING. Sales and marketing expenses increased from approximately $36,000 for the period from
March 3, 1998 (inception) to December 31, 1998 to approximately $7,543,000 for the year ended December 31, 1999 and
approximately $26,237,000 for the year ended December 31, 2000. These expenses increased primarily as a result of
increased marketing and promotional activities, including direct mail, and increases in sales and marketing personnel.
STOCK COMPENSATION. Non-cash stock compensation expenses were approximately $2,423,000 for the period from
March 3, 1998 (inception) to December 31, 1998, compared to $4,123,000 for the year ended December 31, 1999 and
$3,192,000 for the year ended December 31, 2000. These expenses
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consisted of charges and amortization related to stock options and restricted stock granted to our employees, directors and
advisors.
The unamortized balance of approximately $13,362,000 as of December 31, 1999 and $3,931,000 as of December 31, 2000,
will be amortized over the remaining vesting period of each grant. As of December 31, 1999 and 2000 options to purchase
5,874,302 and 7,318,612 shares of common stock, respectively, were outstanding, which were exercisable at weighted
average exercise prices of $2.32 and $4.07 per share, respectively.
INTEREST EXPENSE (INCOME), NET. Net interest expense of approximately $5,000 for the period from March 3, 1998
(inception) to December 31, 1998 did not include any interest income. For the year ended December 31, 1999, net interest
income of approximately $1,889,000 included $2,077,000 of interest income partially offset by $188,000 of interest expense.
Net interest income of approximately $6,730,000 for the year ended December 31, 2000 included $8,538,000 of interest
income partially offset by $1,808,000 of interest expense. The increases in interest income in 1999 and 2000 were primarily
due to an increase in our cash and investment balances resulting from the sale of preferred stock and common stock in 1999
and the sale of common stock in 2000. The increases in interest expense were related to increased debt, primarily attributable
to new capital lease obligations and other financing arrangements.
RESTRUCTURING. In the fourth quarter of 2000, we incurred approximately $3,542,000 in non-recurring charges related to
a corporate restructuring. Of that amount, approximately $448,000 related to severance costs incurred as a result of a reduction
in our workforce of approximately 140 employees. These severance costs are included in network and operations, general and
administrative and sales and marketing expenses. A charge of approximately $1,078,000 was included in general and
administrative expense for the estimated costs resulting from the consolidation of our office facilities by vacating office space
located in Milford, Connecticut, and Chantilly, Virginia and for unused office space in Santa Cruz, California. Lastly, a reserve
of approximately $2,016,000 was included in network and operations expenses for the estimated costs resulting from our
decision to not accept certain central offices' previously applied for, and to forego the completion of our build-out of certain
other central offices.
At December 31, 2000, approximately $362,000 of severance costs and approximately $1,416,000 of capitalized collocation
application fees had been charged against the restructuring reserves.
NET LOSS. Net loss of $2,790,000 for the period from March 3, 1998 (inception) to December 31, 1998 increased to
approximately $21,988,000 for the year ended December 31, 1999 and approximately $105,763,000 for the year ended
December 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our capital expenditures and operations primarily with the proceeds from the sale of stock and from
borrowings, including equipment lease financings. As of December 31, 2000, we had cash and cash equivalents of
approximately $76,435,000 and working capital of approximately $46,762,000.
Net cash provided by financing activities in the periods ended 1998, 1999 and 2000 was approximately $483,000,
$121,142,000 and $141,960,000, respectively. This cash primarily resulted from the sale of our capital stock. We have used,
and intend to continue using, the proceeds from these financings primarily to implement our business plan and for working
capital and general corporate purposes. We have also used, and may in the future use, a portion of these proceeds to acquire
complementary businesses or assets.
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In August 1998, we issued a $100,000 demand note, which bore interest at the annual rate of 5.56%. As of December 31,
1998, $66,667 of principal of this note remained outstanding. This note was repaid in full in January 1999.
In November 1998, we received $350,000 from a short-term bridge note and warrant financing. These notes had an aggregate
principal amount of $350,000 and bore interest at annual rates of 5.56% or 6%. These notes were exchanged for shares of our
Series A preferred stock in January 1999.
During 1998, we also received $50,500 from the sale of capital stock to our founders.
In January 1999, we received net proceeds of approximately $3,302,000 from the sale of shares of Series A preferred stock
and certain warrants. In April 1999, we received net proceeds of approximately $9,940,000 from the sale of shares of Series C
preferred stock to our principal stockholders and others. In May 1999, we received net proceeds of approximately
$29,961,000 from the sale of shares of Series D preferred stock to our principal stockholders and others. In addition, we
received approximately $1,007,000 in connection with repayment of a note, including interest at 6.0%, from an officer in
connection with the purchase of Series D preferred stock in June 1999. In July 1999, we received net proceeds of
approximately $18,458,000 from the sale of shares of Series E preferred stock to two strategic marketing partners. In October
and November 1999, we received net proceeds of approximately $55,722,000 from the sale of shares of common stock in our
initial public offering. Upon the closing of the initial public offering of our common stock on October 12, 1999, all outstanding
shares of our preferred stock converted automatically into shares of common stock. In March 2000, we received net proceeds
of approximately $141,273,000 from the sale of 5,750,000 shares of our common stock in a public offering.
In May 2000, our $5 million bank line of credit expired and the amounts outstanding converted to a 36-month term loan.
Amounts borrowed under this term loan generally bear interest at the sum of 1% plus the higher of the bank's prime rate of
interest and the federal funds rate plus 0.5%, and are secured by a lien on certain of our equipment. As of December 31, 2000,
the $3,545,000 outstanding under the term loan bore interest at the annual rate of 10.5%. The term loan contains certain
restrictive covenants, including covenants requiring us to maintain certain financial ratios and limitations relating to, among other
things, new indebtedness, the creation of liens, types of investments, mergers, consolidations and the transfer of all or
substantially all of our assets.
In March 1999, we entered into a 36-month lease facility to finance the purchase of up to an aggregate of $2,000,000 of
equipment. Amounts financed under this lease facility bear an interest rate of 8% or 9%, depending on the type of equipment,
and are secured by the financed equipment. In July 2000, we entered into a 48-month lease agreement with an equipment
vendor to finance the purchase of network equipment. We have leased approximately $8,900,000 under this agreement.
Amounts financed under this agreement bear an interest rate of 12% and are secured by the financed equipment. In addition,
during 1999 and 2000, we purchased and assumed through acquisition certain equipment and computer software under other
capital leases, which are being repaid over periods ranging from 24 months to 60 months at rates ranging from 7.5% to 15%. In
the aggregate, there was approximately $10,477,000 outstanding under capital leases at December 31, 2000.
As a result of the development of our operating infrastructure and recent acquisitions, we have entered into certain long-term
agreements providing for fixed payments. Under our facility operating leases, minimum office facility operating lease payments
are approximately $3,514,000 in 2001, $3,542,000 in 2002, $2,556,000 in 2003, $1,450,000 in 2004 and $389,000 in
2005. In addition, under agreements with two long distance carriers providing for data transmission services, minimum payments
are approximately $8,295,000 in 2001, $10,024,000 in 2002, $9,281,000 in 2003, $4,800,000 in 2004 and
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$1,600,000 in 2005. As part of our restructuring in December 2000, we vacated certain office space in Milford, Connecticut
and Chantilly, Virginia and did not occupy certain increased space in Santa Cruz, California. We are currently seeking to
sublease these spaces. If we are successful, the fixed payments associated with facility operating leases described above will
decrease. We may not be able to sublease these facilities for lease rates that will cover our lease payments, or at all.
On December 1, 1999, we acquired Tycho Networks, which is based in Santa Cruz, California. Tycho Networks provides
Internet access, web hosting and related services throughout central coastal California. The approximate net purchase price of
$3.3 million, excluding transaction costs associated with the acquisition, consisted of cash payments at closing of $1.6 million
(including notes paid at closing of approximately $0.8 million), amounts due to the selling stockholders and others after the
closing of approximately $0.8 million, net liabilities assumed of approximately $0.5 million and other costs of approximately
$0.4 million. All amounts due to Tycho Networks selling stockholders have been paid.
On April 3, 2000, we acquired certain assets and liabilities of Trusted Net Media Holdings, LLC. This acquisition was
accounted for under the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets
acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The approximate net purchase
price of $2,500,000, excluding transaction costs, consisted of cash payments at closing of approximately $2,097,000; amounts
due to Trusted Net after the closing of approximately $350,000; and net liabilities assumed of approximately $53,000. In
addition, we incurred transaction costs associated with the acquisition of approximately $150,000.
On May 26, 2000, we acquired Vector Internet Services, Inc.("VISI"), an Internet solution provider based in Minneapolis,
Minnesota. This acquisition was accounted for under the purchase method of accounting and, accordingly, the purchase price
has been allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition.
The approximate net purchase price of $19,969,000, excluding transaction costs, consisted of cash payments at closing of
approximately $8,800,000; amounts due to selling stockholders after the closing of approximately $2,200,000; common stock
valued at $2,315,000; and the assumption of VISI employee stock options, which were valued at $6,654,000. In addition, we
incurred transaction costs associated with the acquisition of approximately $425,000.
On December 1, 2000, we acquired certain assets of Exario Networks. This acquisition was accounted for under the purchase
method of accounting and, accordingly, the purchase price has been allocated to the assets acquired based on their estimated
fair values at the date of acquisition. The approximate net purchase price of $4,463,000, excluding transaction costs, consisted
of cash payments at closing of approximately $2,902,000 and amounts due to Exario after the closing of approximately
$1,561,100. In addition, we incurred transaction costs associated with the acquisition of approximately $100,000.
In 1998, 1999 and 2000, net cash used in our operating activities was approximately $154,000, $6,343,000 and $74,986,000,
respectively. This cash was used for a variety of operating expenses, including salaries, consulting and legal expenses, network
operations and overhead expenses.
Net cash used in investing activities in 1998, 1999 and 2000 was approximately $290,000 $48,661,000 and $56,717,000,
respectively. For the year ended December 31, 1999 approximately $33,811,000 was used for purchases of equipment and
payment of collocation costs, approximately $13,274,000 was used for the purchase of marketable securities and
approximately $1,576,000 was used to acquire Tycho Networks. For the year ended December 31, 2000, approximately
$55,943,000 was used primarily for the purchase of equipment and payment of collocation costs and approximately
$14,049,000
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was used for acquisitions and investments, excluding approximately $4,034,000 which is payable by us to selling stockholders
at future dates. These expenditures were partially offset by proceeds from the sale of marketable securities of approximately
$13,274,000.
The development and expansion of our business has required significant capital expenditures. Capital expenditures, including
collocation fees, were approximately $55,493,000 for the year ended December 31, 2000. The actual amounts and timing of
our future capital expenditures will vary depending on the speed at which we expand and implement our network and implement
service for our customers. As a result of our decision to delay further deployment of our network, our planned capital
expenditures for 2001 are currently expected to be primarily for the purchase and installation at our customers' sites of the
equipment necessary for us to provide our services, as well as for the continued development of our network and operational
support systems. We currently anticipate spending approximately $15,000,000 to $20,000,000 for capital expenditures during
the year ending December 31, 2001. The actual amounts and timing of our capital expenditures could differ materially both in
amount and timing from our current plans.
We expect our operating losses, net operating cash outflows and capital expenditures to continue during 2001. Our independent
accountants have noted in their report that our sustained operating losses raise substantial doubt about our ability to continue as
a going concern. We believe that our existing cash and short-term investments and cash generated from operations will be
sufficient to fund our operating losses, capital expenditures, lease payments and working capital requirements into the fourth
quarter of 2001. We intend to use these cash resources to finance our capital expenditures and for working capital and other
general corporate purposes. We may also use a portion of these cash resources to acquire complementary businesses or other
assets. The amounts actually expended for these purposes will vary significantly depending on a number of factors, including the
rate of market acceptance of our services and revenue growth, planned capital expenditures, cash generated from operations,
improvements in operating productivity, and the extent and timing of our entry into new markets.
Additional financing will be required during 2001. We do not believe that our operations will generate sufficient cash to finance
our requirements. As a result, we need to raise financing through some combination of borrowings, leasing, vendor financing and
the sale of equity or debt securities. Our capital requirements may vary based upon the timing and the success of implementation
of our business plan and as a result of regulatory, technological and competitive developments or if:
o demand for our services or our cash flow from operations is less than or more than expected;
o our development plans or projections change or prove to be inaccurate;
o we make acquisitions; or
o we accelerate or delay deployment of our network or otherwise alter the schedule or targets of our business plan
implementation.
We cannot assure you that we will be able to raise sufficient debt or equity capital on terms that we consider acceptable, if at
all. If we are unable to obtain adequate funds, we may not be able to deploy and operate our network, respond to competitive
pressures or fund our operations. Ultimately, we may be required to significantly reduce or discontinue our operations. Our
financial statements included herein do not include any adjustments that might result from this uncertainty.
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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 1999, the staff of the Securities and Exchange Commission issued its Staff Accounting Bulletin ("SAB") No. 101,
"REVENUE RECOGNITION IN FINANCIAL STATEMENTS." SAB No. 101 provides guidance on the measurement and
timing of revenue recognition in financial statements of public companies. Changes in accounting policies to apply the guidance
of SAB No. 101, as amended by SAB No. 101B, must be adopted by recording the cumulative effect of the change back to
January 1, 2000.
We have adopted the revenue recognition guidelines of SAB No. 101, which changed the manner in which we recognize
installation revenue (see "REVENUE RECOGNITION IN FINANCIAL STATEMENTS" above). The cumulative effect of
adoption of SAB No. 101 resulted in deferral of installation revenues and related direct costs of approximately $176,000 at
January 1, 2000. The effect of the adoption for the year ended December 31, 2000, resulted in a deferral of installation revenue
and related direct costs of approximately $735,000.
In March 2000, The Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44 ("FIN 44"),
"ACCOUNTING FOR CERTAIN TRANSACTIONS
INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF ACCOUNTING PRINCIPLES BOARD
("APB") OPINION NO. 25." FIN 44 clarifies the following: the definition of an employee for purposes of applying APB
Opinion No. 25; the criteria for determining whether a plan qualifies as a noncompensatory plan; the accounting consequence of
various modifications to the terms of previously fixed stock options or awards; and the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 became effective on July 1, 2000, but certain conclusions in FIN 44
cover specific events that occurred after either December 15, 1998 or January 12, 2000. The initial adoption of FIN 44 did not
have a material impact on our financial position or results of operations.
In June 1999, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 137, "ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE OF FASB
STATEMENT NO.133." In June 2000, the FASB issued SFAS 138, "ACCOUNTING FOR CERTAIN DERIVATIVE
INSTRUMENTS AND CERTAIN HEDGING AGREEMENTS - AN AMENDMENT TO FASB STATEMENT NO.
133." SFAS 133 established new standards of accounting and reporting for derivative instruments and hedging activities, and
required that all derivatives, including foreign currency exchange contracts, be recognized on the balance sheet at fair value. We
will adopt SFAS 133, as amended by SFAS 137 and SFAS 138, in the first quarter of 2001 and do not expect the adoption to
have a material effect on our financial condition or results of operations.
RISK FACTORS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND CERTAIN OTHER
INFORMATION
Some of the statements under "Risk Factors", "Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business" and elsewhere in this Annual Report on Form 10-K constitute forward-looking statements. DSL.net
makes such forward-looking statements under the provisions of the "Safe Harbor" section of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. These statements relate to
future events or our future financial or business performance and are identified by terminology such as "may", "might", "will",
"should", "expect", "scheduled", "plan", "intend", "anticipate", "believe", "estimate", "potential", or "continue" or the negative of
such terms or other comparable terminology. These statements are subject to a variety of risks and uncertainties, many of which
are beyond our control, which could cause actual results to differ materially from those contemplated in these forward-looking
statements. In evaluating these statements, you should specifically consider various factors, including the
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risks outlined under "Risk Factors". Existing and prospective investors are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. We undertake no obligation, and disclaim any obligation,
to update or revise the information contained in this Annual Report on Form 10-K, whether as a result of new information,
future events or circumstances or otherwise.
RISKS RELATING TO OUR BUSINESS
OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND
PROSPECTS
We commenced operations in March 1998 and began offering commercial service in Stamford, Connecticut in May 1998.
Accordingly, you have limited information about our company with which to evaluate our business, strategies and performance
and an investment in our common stock.
WE HAVE INCURRED LOSSES AND HAVE EXPERIENCED NEGATIVE OPERATING CASH FLOW TO
DATE AND EXPECT OUR LOSSES AND NEGATIVE OPERATING CASH FLOW TO CONTINUE
We have incurred significant losses and experienced negative operating cash flow for each month since our formation. We
expect to continue to incur significant losses and negative operating cash flow for the foreseeable future. If our revenue does not
grow as expected or capital and operating expenditures exceed our plans, our business, prospects, financial condition and
results of operations will be materially adversely affected. As of December 31, 2000, we had an accumulated deficit of
approximately $132,900,000. We cannot be certain if or when we will be profitable or if or when we will generate positive
operating cash flow. We expect our operating expenditures, particularly network and operations and sales and marketing
expenditures, to continue to increase as we implement our business plan. In addition, we expect to continue to make additional
capital expenditures in 2001 and in subsequent years. Our revenue, however, may not increase despite this increased spending.
Our independent accountants have noted in their report that our sustained operating losses raise substantial doubt about our
ability to continue as a going concern.
WE MUST OBTAIN ADDITIONAL FINANCING IN 2001 IF WE ARE TO CONTINUE OPERATING OUR
BUSINESS
Additional financing will be required during 2001. We expect our operating losses, net operating cash outflows and capital
expenditures to continue during 2001. Our independent accountants have noted in their report that our sustained operating
losses raise substantial doubt about our ability to continue as a going concern. We believe that our existing cash and short-term
investments and cash generated from operations will be sufficient to fund our operating losses, capital expenditures, lease
payments and working capital requirements into the fourth quarter of 2001. We do not believe that our operations alone will
generate sufficient cash to finance our requirements. As a result, we need to raise financing through some combination of
borrowings, leasing, vendor financing and the sale of equity or debt securities. Our capital requirements may vary based upon
the timing and the success of implementation of our business plan and as a result of regulatory, technological and competitive
developments or if:
o demand for our services or our cash flow from operations is less than or more than expected;
o our development plans or projections change or prove to be inaccurate;
o we make acquisitions; or
o we accelerate or delay deployment of our network or otherwise alter the schedule or targets of our business plan
implementation.
We cannot assure you that we will be able to raise sufficient debt or equity capital on terms that we consider acceptable, if at
all. If we are unable to obtain adequate funds, we may not be able to deploy and operate our network, respond to competitive
pressures or fund our operations. Ultimately, we may be required to significantly reduce or discontinue our operations.
OUR INDEPENDENT ACCOUNTANTS HAVE RAISED QUESTIONS ABOUT OUR ABILITY TO CONTINUE AS
A GOING CONCERN IN THEIR REPORT ON OUR AUDITED FINANCIAL STATEMENTS, WHICH MAY HAVE
AN ADVERSE IMPACT ON OUR ABILITY TO RAISE ADDITIONAL CAPITAL AND ON OUR STOCK PRICE
Our independent accountants have included in their report an explanatory paragraph relating to our ability to continue as a going
concern. This explanatory paragraph includes the following language: "The accompanying financial statements have been
prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the
Company has experienced sustained operating losses that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty." The inclusion of this explanatory paragraph in the report of
our independent accountants may have an adverse impact on our ability to raise additional capital and on our stock price. We
cannot assure you that we will be able to continue as a going concern.
BECAUSE THE HIGH-SPEED DATA COMMUNICATIONS INDUSTRY IS NEW AND RAPIDLY
EVOLVING, WE CANNOT PREDICT ITS FUTURE GROWTH OR ULTIMATE SIZE
The high-speed data communications industry is in the early stages of development and is subject to rapid and significant
technological change. Since this industry is new and because the technologies available for high-speed data communications
services are rapidly evolving, we cannot accurately predict the rate at which the market for our services will grow, if at all, or
whether emerging technologies will render our services less competitive or obsolete. If the market for our services fails to
develop or grows more slowly than anticipated, our business, prospects, financial condition and results of operations could be
materially adversely affected. Many providers of high-speed data communication services are testing products from numerous
suppliers for various applications. In addition, certain industry groups are in the process of trying to establish standards which
could limit the types or speeds of the technologies we could use. Certain critical issues concerning commercial use of DSL
technology for Internet access, including security, reliability, ease and cost of access and quality of service, remain unresolved
and may impact the growth of these services.
OUR BUSINESS MODEL IS UNPROVEN, AND MAY NOT BE SUCCESSFUL
We do not know whether our business model and strategy will be successful. If the assumptions underlying our business model
are not valid or we are unable to implement our business plan, achieve the predicted level of market penetration or obtain the
desired level of pricing of our services for sustained periods, our business, prospects, financial condition and results of
operations could be materially adversely affected. We have adopted a different strategy than certain other broadband ISPs and
DSL providers. We focus on selling directly to small and medium sized businesses. Our unproven business model makes it
difficult to predict the extent to which our services will achieve market acceptance. To be successful, we must deploy our
services in a significant number of our selected markets and convince our target customers to utilize our service. In December
2000, we decided to suspend the further build-out of our
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network into new target markets and to focus our efforts on penetrating the markets in which we currently can provide service
and on adding services. It is possible that these efforts will not result in significant market penetration, favorable operating results
or profitability.
IF OUR SERVICES FAIL TO ACHIEVE OR SUSTAIN MARKET ACCEPTANCE AT DESIRED PRICING LEVELS,
OUR ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW WOULD BE IMPAIRED
Prices for digital communication services have fallen historically, a trend we expect will continue. Accordingly, we cannot
predict to what extent we may need to reduce our prices to remain competitive or whether we will be able to sustain future
pricing levels as our competitors introduce competing services or similar services at lower prices. If our services fail to achieve
or sustain market acceptance at desired pricing levels, our ability to achieve profitability or positive cash flow would be
impaired, which would have a material adverse effect on our business, prospects, financial condition and results of operations.
WE DEPEND ON WHOLESALE DSL PROVIDERS, SOME OF WHOM ARE COMPETITORS, TO PROVIDE US
WITH LOCAL DSL FACILITES IN AREAS WHERE WE HAVE NOT DEPLOYED OUR OWN DSL EQUIPMENT
In markets where we have not deployed our own local DSL equipment, we utilize local DSL facilities from wholesale providers,
including Covad Communications and NorthPoint Communications, in order to provide service to our end-user customers. In
these cases, we are dependent upon these wholesale carriers to provide, or arrange the provision of, the equipment and on-site
wiring required to provide local DSL services to our end-user customers, as well as to provide and maintain the local DSL line.
In general, these carriers may terminate the service they provide to us with little or no notice. These carriers may not continue to
provide us with acceptable local DSL services for our customers on the scale, at the price levels and within the time frames we
require, or at all. If we are unable to obtain acceptable DSL services from these wholesale carriers or they terminate the service
they provide us, we may be required to install our own equipment in a central office and provide and install new equipment for
our customers, or arrange for another wholesale carrier to do so. Obtaining space and provisioning equipment in a new central
office is a lengthy and costly process. We cannot assure you that we, or another carrier with whom we work, would be able to
obtain the space required in a central office on a cost effective basis, if at all, or that we could provide DSL services to such
customers on a timely basis. Our failure to install and provide services to customers on a timely basis, or the disruption in the
services provided to our customers, would likely result in the loss of many, if not all, of the customers in the affected locations,
and could result in claims brought by these customers against us. This could have a material adverse effect on our competitive
position, business, results of operations, financial position and prospects.
Certain wholesale DSL providers with whom we work offer services that compete with ours, or have other customers whose
services compete with ours. Such competing interests may affect the ability or willingness of these providers to provide us with
acceptable services on acceptable terms. In addition, certain of these providers are relatively young companies that are facing
substantial operational and financial challenges. The operational success and abilities of these carriers to operate and expand
their businesses could materially affect our business. The failure of any of these companies could cause us to lose customers and
revenue, expose us to claims and otherwise have a material adverse effect on our competitive position, business, results of
operations, financial position and prospects.
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THERE IS SUBSTANTIAL UNCERTAINTY ABOUT OUR ABILITY TO CONTINUE PROVIDING SERVICE
TO CUSTOMERS WHOSE LOCAL DSL FACILITES ARE PROVIDED BY NORTHPOINT
COMMUNICATIONS
We utilize local DSL facilities provided by NorthPoint Communications in order to provide service to certain of our end-user
customers. NorthPoint Communications is currently in bankruptcy and has notified its customers, including us, that the cessation
of its services is imminent. NorthPoint has already discontinued providing local DSL service for a number of our end-user
customers, and we believe that it will discontinue this service for the remainder of our customers who are served using its
facilities. We are working to establish interim and long-term alternatives for our affected customers. Some of these customers
are located in areas where neither we nor any of our existing wholesaler DSL providers other than NorthPoint have installed
DSL equipment. We may need to offer incentives and concessions to these customers. We may not be able to transition all of
our customers who currently obtain service through us via local DSL facilities provided by NorthPoint on a timely basis, if at all.
Any disruption in service may result in a loss of many, if not all, of these customers, and could result in claims brought by these
customers against us. This could have a material adverse effect on our competitive position, business, results of operations,
financial position and prospects.
IF WE FAIL TO RECRUIT QUALIFIED PERSONNEL IN A TIMELY MANNER AND RETAIN OUR EMPLOYEES,
WE WILL NOT BE ABLE TO EXECUTE OUR BUSINESS PLAN AND OUR BUSINESS WILL BE HARMED
To execute our business plan, we need to hire and retain a substantial number of qualified personnel, particularly sales and
marketing, engineering and other technical personnel. If we are unable to recruit qualified personnel in a timely manner or to
retain our employees, we will not be able to execute our business plan. In particular, if we are unable to recruit and retain a
sufficient number of qualified personnel, our revenue growth may be lower than we expect and our business may be harmed.
Our industry is characterized by intense competition for, and aggressive recruiting of, skilled personnel, as well as a high level of
employee mobility. Our recent reduction in workforce, together with our need for additional financing during 2001 and the
competitive nature of our industry may make it difficult to hire qualified personnel on a timely basis and to retain our employees.
OUR MANAGEMENT TEAM IS CRITICAL AND THE LOSS OF KEY PERSONNEL COULD ADVERSELY
AFFECT OUR BUSINESS
We depend on a small number of executive officers and other members of senior management to work effectively as a team, to
execute our business strategy and business plan, and to manage employees located in several offices across the United States.
The loss of key managers or their failure to work effectively as a team could have a material adverse effect on our business and
prospects. We do not have employment agreements with any of our executive officers, so any of these individuals may terminate
employment at any time.
OUR FAILURE TO ESTABLISH AND MAINTAIN THE NECESSARY INFRASTRUCTURE TO SUPPORT OUR
BUSINESS AND TO MANAGE OUR GROWTH COULD STRAIN OUR RESOURCES AND ADVERSELY AFFECT
OUR BUSINESS AND FINANCIAL PERFORMANCE
We have had significant growth in the number of markets in which we provide service, the number of customers subscribing for
our service and in the number of employees in geographically-dispersed areas. This growth has placed a significant strain on our
management, financial controls, operations, personnel
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and other resources. We have deployed operations support systems to help manage customer service, bill customers, process
customer orders and coordinate with vendors and contractors. The subsequent integration and enhancement of these systems
could be delayed or cause disruptions in service or billing. To efficiently and cost-effectively manage our
geographically-dispersed business, we must continue to successfully implement these systems on a timely basis, and continually
expand and upgrade these systems as our operations expand.
DISAPPOINTING QUARTERLY REVENUE, OPERATING RESULTS OR OPERATING STATISTICS COULD
CAUSE THE PRICE OF OUR COMMON STOCK TO FALL
Our quarterly revenue, operating results and operating statistics are difficult to predict and may fluctuate significantly from
quarter to quarter. If our quarterly revenue, operating results or operating statistics fall below the expectations of investors or
security analysts, the price of our common stock could fall substantially. Our quarterly revenue, operating results and operating
statistics may fluctuate as a result of a variety of factors, many of which are outside our control, including:
o the amount and timing of expenditures relating to the rollout of our infrastructure and services;
o regulatory developments;
o the rate at which we are able to attract customers within our target markets and our ability to retain these customers at
sufficient aggregate revenue levels;
o our ability to deploy our network on a timely basis;
o the availability of financing to continue our operations and expansion;
o technical difficulties or network service interruptions; and
o the introduction of new services or technologies by our competitors and resulting pressures on the pricing of our service.
THE FAILURE OF OUR CUSTOMERS TO PAY THEIR BILLS ON A TIMELY BASIS COULD ADVERSELY
AFFECT OUR CASH FLOW
Our target customers consist of small and medium sized businesses. We bill and collect numerous relatively small customer
accounts. We may experience difficulty in collecting amounts due on a timely basis. Our failure to collect accounts receivable
owed to us by our customers on a timely basis could have a material adverse effect on our business, financial condition and cash
flow.
OUR FAILURE TO DEVELOP AND MAINTAIN GOOD RELATIONSHIPS WITH MARKETING PARTNERS IN A
LOCAL SERVICE MARKET COULD ADVERSELY AFFECT OUR ABILITY TO OBTAIN AND RETAIN
CUSTOMERS IN THAT MARKET
In addition to marketing through our direct sales force, we rely on relationships with local marketing partners, such as integrators
of computer systems and networks and consultants. These partners recommend our services to their clients, provide us with
referrals and help us build a local presence in each
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market. We may not be able to identify, and maintain good relationships with quality marketing partners and we cannot assure
you that they will recommend our services rather than our competitors' services to their customers. Our failure to identify and
maintain good relationships with quality marketing partners could have a material adverse effect on our ability to obtain and
retain customers in a market and, as a result, our business would suffer.
OUR SUCCESS DEPENDS ON NEGOTIATING AND ENTERING INTO INTERCONNECTION
AGREEMENTS WITH TRADITIONAL TELEPHONE COMPANIES
We must enter into and renew interconnection agreements with traditional local telephone companies in each market in which
we deploy our own DSL equipment. These agreements govern, among other things, the price and other terms regarding our
location of equipment in the offices of traditional local telephone companies which house telecommunications equipment and
from which local telephone service is provided, known as central offices, and our lease of copper telephone lines that connect
those central offices to our customers. We have entered into agreements with BellSouth, Cincinnati Bell, SBC Communications,
Qwest, Sprint, Verizon or their subsidiaries, which govern our relationships in 48 states and the District of Columbia. Delays in
obtaining or renewing interconnection agreements would delay our entrance into target markets and could have a material
adverse effect on our business and prospects. In addition, disputes have arisen, and will likely arise in the future, regarding the
interpretation of these interconnection agreements. These disputes have, in the past, delayed the deployment of our network.
Our interconnection agreements generally have limited terms of one to two years and we cannot assure you that new
agreements will be negotiated on a timely basis, if at all, or that existing agreements will be extended on terms favorable to us.
Interconnection agreements must be approved by state regulators and are also subject to oversight by the FCC and the courts.
These governmental authorities may modify the terms or prices of our interconnection agreements in ways that could adversely
affect our ability to deliver service and our business and results of operations.
FAILURE TO NEGOTIATE INTERCONNECTION AGREEMENTS WITH THE TRADITIONAL LOCAL
TELEPHONE COMPANIES COULD LEAD TO COSTLY AND LENGTHY ARBITRATION WHICH MAY NOT BE
RESOLVED IN OUR FAVOR
Under federal law, traditional local telephone companies have an obligation to negotiate with us in good faith to enter into
interconnection agreements. If no agreement can be reached, either side may petition the applicable state telecommunications
regulators to arbitrate remaining disagreements. Arbitration is a costly and lengthy process that could delay our entry into
markets and could harm our ability to compete. Interconnection agreements resulting from arbitration must be approved by state
regulators. We cannot assure you that a state regulatory authority would resolve disputes in our favor.
FAILURE TO OBTAIN ADDITIONAL SPACE FOR OUR DSL EQUIPMENT IN THE LOCAL TELEPHONE
COMPANIES' CENTRAL OFFICES IN OUR TARGET MARKETS COULD ADVERSELY AFFECT OUR BUSINESS
In December 2000, we began to focus our efforts on increasing our penetration of those markets in which we can currently
provide service and providing more services. As our penetration of a target market increases, we may be required to install
additional equipment in central offices, known as collocation space. We may not be able to secure additional collocation space
in the central offices of our choice on a timely basis or on acceptable terms.
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OUR SUCCESS DEPENDS ON TRADITIONAL TELEPHONE COMPANIES PROVIDING ACCEPTABLE
TRANSMISSION FACILITIES AND COPPER TELEPHONE LINES
We interconnect with and use the networks of traditional telephone companies to provide services to our customers in the
markets where we have deployed our own DSL equipment. In markets where we utilize the local DSL facilities of other carriers
to provide our service, those carriers must interconnect with and use the networks of traditional local telephone companies to
provide this service. We cannot assure you that these networks will be able to meet the telecommunications needs of our
customers or maintain our service standards. We also depend on the traditional telephone companies to provide and maintain
their transmission facilities and the copper telephone lines between our network and our customers' premises. Our d