HIGH SPEED ACCESS CORP (HSAC)
Quarterly Report (SEC form 10-Q)
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company. Such statements are only predictions, involve risks and uncertainties, and actual events or results may differ materially from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include those discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors" as well as those discussed in other filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. The Company is not soliciting the vote of any of its stockholders with respect to the approval of the proposed sale of substantially all of its assets to Charter pursuant to this Quarterly Report on Form 10-Q. The Company intends to provide to stockholders, as soon as reasonably practicable, a definitive proxy statement relating to a special meeting of stockholders at which, among other things, the sale of substantially all of the Company's assets to Charter will be considered.
OVERVIEW
We provide high speed Internet access to residential and commercial customers primarily via cable modems. As of September 30, 2001, we had deployed our services in systems covering approximately 3,850,000 homes passed and had approximately 200,000 high speed residential end users. Approximately 3,675,000 of our 3,850,000 homes passed are deployed to business and residential customers of Charter. Subsequent to September 30, 2001, we have successfully negotiated out of all non-Charter distribution agreements.
On September 28, 2001, we entered into an asset purchase agreement with Charter, pursuant to which we will sell to Charter substantially all of the assets and operations associated with our provision of high speed Internet access to residential and commercial customers of Charter and its affiliates via cable modems. We have also agreed to continue these operations until the closing of the asset sale.
We are presently winding down our operations other than those subject to the asset purchase agreement. We intend to either fulfill or negotiate an early termination to our existing contractual obligations to KNRW in Germany. At this time, we cannot predict whether our KNRW contract, pursuant to which we provide ISP infrastructure services, will terminate upon fulfillment in August 2002, or be mutually terminated on some earlier date.
If the closing of the asset purchase agreement does not occur, we will likely file for bankruptcy.
OUR BUSINESS PRIOR TO THE CLOSING
Until the closing of the asset purchase agreement, we will provide high speed Internet access via cable modems to residential and commercial customers of Charter. At the closing, we will transfer to Charter essentially all of the assets related to these operations in accordance with the terms of the asset purchase agreement. In the event that the closing does not occur, we will likely file for bankruptcy.
We provide services to residential and commercial customers of Charter, primarily in exurban markets. Pursuant to our existing operating agreements with Charter, we provide a suite of services on a comprehensive "turnkey" basis as well as on an unbundled or "network services" basis. These services enable Charter's customers to receive high speed Internet access. Previously, we had similar relationships with cable system operators other than Charter. However, we have exited from these relationships.
In our turnkey solution, we generate revenue primarily from the monthly fees we receive from end users for our cable modem-based Internet access services. In our turnkey solution, we generally bill the end user directly and pay our cable partners a portion of the monthly fee we receive. In these instances, we report our revenues net of the percentage split we pay to our cable partners. For promotional purposes, we often provide new end users with 30 days of free Internet access when they subscribe to our services. As a result, our revenue does not reflect new end users until the end of the promotional period. We also receive revenues from renting cable modems to end users.
In a Network Services solution, we deliver fewer services and incur lower costs than in a turnkey solution but will also earn a smaller percentage of the subscription revenue or a fixed fee on a per subscriber basis. Charter bills the end user and remits to us our percentage of the revenue or the fixed fee. Network Services solutions have become a significant part of our business mix.
In connection with the asset purchase agreement, we have entered into a management agreement with Charter relating to the management of these operations prior to the closing. Under the management agreement, Charter will assume responsibility for the purchase and installation of cable modems and will share marketing responsibilities with us.
Our revenue also includes international ISP infrastructure services to KNRW in Germany. During 2001, international revenue has become an increasingly significant part of our business mix.
OUR BUSINESS AFTER THE CLOSING
We have not yet determined what our strategic direction will be following the consummation of the asset sale and are considering at least three possible alternatives. Currently, we anticipate pursuing one of the following three options.
o Option 1 - Make No Distribution; Retain the Proceeds and Reinvent the Business. We may elect to:
(i) make no distribution to stockholders:
(ii) proceed, as expeditiously and prudently as possible, with the sale of all of our remaining assets except those required to fulfill our existing contractual obligations with respect to our international operations or new strategic initiatives; and
(iii) use all of the proceeds from the asset sale to pursue select domestic business opportunities as they arise, including the possible acquisition of an existing business or the development of one or more new businesses.
o Option 2 Make a Partial Distribution; Retain Part of the Proceeds and Reinvent the Business. We may elect to:
(i) make a portion of the proceeds from the asset sale available to our stockholders through a direct distribution, a stock redemption or stock repurchase program;
(ii) proceed, as expeditiously and prudently as possible, with the sale of all of our remaining assets except those required to fulfill our existing contractual obligations with respect to our international operations or new strategic initiatives; and
(iii) use the remaining proceeds from the asset sale to pursue select domestic business opportunities as they arise, including the possible acquisition of an existing business or the development of one or more new businesses.
o Option 3 Distribute All of the Proceeds: Wind Down the Business and Dissolve. We may decide to cease all of our operations and seek stockholder approval of a plan of liquidation and dissolution so that we may liquidate all of our remaining assets, pay our known liabilities, distribute our remaining cash on hand (subject to the set aside of adequate reserves to cover known, unknown and contingent liabilities that we reasonably expect to be incurred) and dissolve.
At this time, we cannot predict which option we will pursue. We currently do not know whether we will make any distributions, or, if we do, the number, amount or timing of such distributions. Additionally, we may not be successful in identifying, developing and executing a new business strategy and could eventually use all, or a substantial portion, of our remaining cash on hand in connection with any such new business efforts.
In the event we decide to pursue option 1 or option 2, we anticipate that our operations would consist of the businesses described below. There may be additional risks that we do not currently know of or that we currently deem immaterial because of the information available to us. All of these risks may impair our business operations and could decrease the value of your investment.
INTERNATIONAL BUSINESS
We provide professional services relating to the design, testing and implementation of broadband Internet access infrastructure services to KNRW in Germany. Revenues from the service agreement are recognized as services are provided. For the three and nine months ended September 30, 2001, we recognized revenues from the service agreement of $2.6 million and $4.7 million, respectively. Although we believe our international business will be profitable in the current year and beyond, we cannot assure you that it will be profitable.
Although the term of our current master contract with KNRW expires in February 2004, our present engagement is scheduled to terminate in August 2002. We are discussing with KNRW the possibility of mutually terminating our engagement prior to that, but we cannot predict exactly when that might occur, if it occurs at all. In any event, KNRW has the right to terminate our contract with them after the 18-month anniversary of the execution of the contract (August 2002) or in the event we engage in a transaction constituting a "change of control" of High Speed Access International, the subsidiary through which we operate our international business. Even if we do not negotiate an early termination to the contract, we cannot assure you that KNRW will not terminate our contract in August 2002 or attempt to do so following the consummation of the asset sale.
OTHER BUSINESS OPPORTUNITIES; POSSIBLE DISSOLUTION
We also may decide to explore opportunities to acquire, invest in or develop new lines of business. To date, the board has not proposed a new strategic direction for the Company. Accordingly, we cannot predict what businesses we may enter or strategies we may adopt; and thus can offer no indication of what risks and opportunities might arise in the context of such a new direction.
RECENT DEVELOPMENTS
Since July 2001, we have taken the following actions to reduce our operating costs:
o Exit from One-Way Cable TV Markets. We have completed our previously announced exit from one-way cable TV markets. In the second quarter of 2001, we recorded a $1.7 million asset impairment charge for the write-down of equipment used in one-way markets and a $1.1 million charge for other operating costs, primarily non-cancelable lease obligations.
o Exit from Most Two-Way Cable TV Markets. We have exited all of our two-way cable system agreements except for those with Charter. As of September 30, 2001, we were in the process of terminating service in 40 systems covering approximately 500,000 homes passed and serving 23,000 high speed residential customers. We will not recognize any revenue from these subscribers subsequent to October 1, 2001, although we may continue to provide certain services, including e-mail, personal web pages and assistance in transitioning services to new providers, through November 30, 2001. During the quarter ended September 30, 2001 we recorded an asset impairment charge of $17.5 million for the write-down of the equipment used in these markets, additional excess inventory used in the cable modem business, furniture and fixtures and equipment located in our Denver corporate headquarters and call center and other regional offices, and the write off of the remaining goodwill associated with the acquisition of CATV and HSAN.
o Wind Down of Digital, No Earnout Payment. During the quarter ended September 30, 2001, we recorded an asset impairment charge of $2.2 million for the write-down of the Digital assets, including the write-off of the remaining goodwill associated with the acquisition of Digital.
In June 2000, we entered into an agreement to acquire Digital, a Florida-based web hosting and systems integration company. In August 2000, we issued 3,000,000 shares of common stock in connection with this transaction in exchange for all for the outstanding shares of Digital. The purchase agreement requires us to issue up to $25.0 million of our common stock to Digital's former shareholders if Digital met certain revenue performance targets during 2000 and 2001. On September 29, 2001, we issued to the Digital former shareholders' representative a report indicating that Digital had not met the revenue performance targets established for 2000 and 2001. On October 31, 2001 we sold substantially all of the operating assets of Digital, including its hosted customer websites.
o Abandon DSL Effort. We have discontinued our efforts to enter the DSL market and are attempting to sell our DSL equipment. For the quarter ended September 30, 2001, we recorded an asset impairment charge relating to the DSL assets of $3.2 million. In connection with the purchase of certain DSL assets, we entered into a $1.9 million debt financing agreement with Lucent Technologies Inc. ("Lucent") in July 2001. The debt obligation was paid in full on September 28, 2001 at a discount of $250,000. This transaction, along with prior purchases, has fulfilled our $5.0 million purchase obligation with Lucent.
o Write Off Unnecessary Information Systems. We recorded an asset impairment charge of $4.6 million during the quarter ended September 30, 2001 for information systems which are not being acquired by Charter and are not required for our continued operations.
o Exit Unnecessary Leased Space. We recorded a charge of $3.9 million during the quarter ended September 30, 2001 for non-cancelable lease obligations for office space which we currently intend to vacate.
o Prepay Certain Obligations. We expect to pay certain debt and lease obligations immediately prior to the closing of the asset sale. We expect to pay approximately $9.5 million related to these obligations and record a charge of approximately $1.1 million related to the early termination of these obligations assuming closing of the asset sale occurs on or prior to December 31, 2001.
o Terminate AOL/TimeWarner Agreement. In September 2001, our agreement with Time Warner Cable, a unit of AOL/Time Warner, covering the provision of high speed Internet access services over AOL/Time Warner's cable systems terminated in accordance with its terms. We had entered into this agreement in May 2001.
o Reduce Workforce. We have reduced our workforce to include only those employees that Charter has agreed to hire on the closing date, those necessary to operate any assets to be operated as a going concern after the closing and those necessary to effect the orderly wind-down and/or restructuring of our remaining assets. Excluding our international operating personnel (21 employees as of October 15, 2001), we expect to reduce our staff to 12 to 15 full time employees on or about January 1, 2002, after the consummation of the asset sale. During the quarter ended September 30, 2001, we incurred approximately $3.2 million in severance and related costs relating to these workforce reductions. We do not expect that we will incur additional costs related to workforce reductions or severance in the fourth quarter of 2001.
At the present time, with the exception of the continuing Charter operations and the wind-down of our non-Charter turnkey business, the only assets we are operating are those directly related to the fulfillment of our KNRW contract in Germany.
We will continue to monitor the size of our workforce and the levels of our other operating costs and cash commitments with a view to conserving cash, thereby enhancing our ability to pursue alternative business strategies and/or maximize a potential distribution to our stockholders.
Our expenses consist of the following:
o Operating costs, which consist primarily of salaries and related personnel expenses for customer care, field technical support, network operations center, international, and content and web hosting employees; telecommunications expenses, including charges for Internet backbone and telecommunications circuitry; allocated cost of facilities; costs of installing cable modems for our end users; and depreciation and maintenance of equipment. Many of our operating costs are relatively fixed in the short term.
o Engineering expenses, which consist primarily of salaries and related personnel expenses for the development and support of our information systems; network design and installation of the telecommunications and data network hardware and software; system testing and project management expenses; allocated cost of facilities; and depreciation and maintenance on the equipment used in our engineering processes.
o Sales and marketing expenses, which consist primarily of salaries and related personnel expenses, commissions, costs associated with the development and distribution of sales and marketing materials, the preparation of database market analytics, and direct mail and telemarketing expenses.
o Non-cash compensation expense from stock options, warrants and restricted stock consists of the fair market value of our stock at the time of grant over the exercise price of the stock options granted to employees and directors amortized over the vesting period and the fair market value of non-distribution agreement warrants and restricted stock issued to employees amortized over the vesting period.
o Amortization of distribution agreement costs, which relates to warrants issued to cable and strategic partners in connection with distribution agreements. We measure the cost of warrants issued to cable and strategic partners based on the fair values of the warrants when earned by those partners. Because the fair value of the warrant is dependent to a large extent on the price of our common stock, the cost of warrants earned in the future may vary significantly. Costs of warrants granted in connection with distribution agreements are amortized over the term of the underlying agreement. For markets in which service was terminated during the second quarter of 2001, the remaining value of the associated warrants was fully amortized.
o Asset impairment charges, which consists of the write-down of non-Charter fixed assets. These assets include equipment used in exited two-way markets and other excess inventory used in the cable modem and DSL businesses, furniture, fixtures and equipment located in our Denver corporate headquarters and call center, regional offices and Digital facility, information systems not being purchased by Charter, and the goodwill related to the purchase of CATV, HSAN and Digital.
o Other general and administrative expenses, which consist primarily of salaries for our executive, administrative and finance personnel; allocated cost of facilities; severance and related costs; amortization of goodwill; and fees for professional services.
Our operating results have varied on a quarterly basis during our short operating history and may fluctuate significantly in the future due to a variety of factors, many of which are outside our control. In addition, the results of any quarter do not indicate the results to be expected for a full fiscal year. The factors that may contribute to fluctuations in our operations are set forth generally under the caption "Management's Discussion and Analysis of Financial Conditions and Results of Operations - Risk Factors" and particularly in that section under the heading "Our Quarterly Operating Results Are Likely To Fluctuate Significantly And May Not Meet Our Expectations Or The Expectations Of Analysts And Investors". As a result of such factors, our annual or quarterly results of operations may be below the expectations of public market analysts or investors, in which case the market price of the common stock could be materially and adversely affected.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
COMPARED WITH THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
REVENUES
Net revenue consists of net monthly subscription fees for cable modem-based and traditional dial-up Internet services, cable modem rental income, international infrastructure services, monthly fees for web hosting services and overall strategic consulting. Total net revenue for the three months ended September 30, 2001 and 2000 was $11.4 million and $4.3 million, respectively, an increase of $7.1 million. Total net revenue for the nine months ended September 30, 2001 and 2000 was $27.7 million and $9.0 million, respectively, an increase of $18.7 million.
In February 2001, the Company began providing internet infrastructure services to KNRW in Germany. Revenues from the service agreement are recognized as services are provided. For the three and nine months ended September 30, 2001, the Company recognized revenues of $2.6 million and $4.7 million, respectively. This agreement is terminable by KNRW in the event of a change of control of the Company.
Revenue by product offering as a percentage of total net revenue is as follows:
% OF REVENUE
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------- ------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Cable modem-based subscription fees - Turnkey 28% 37% 31% 42%
Cable modem-based subscription fees - Network Services 30% 11% 27% 8%
Traditional dial-up service fees 2% 10% 4% 14%
Cable modem rental fees 14% 19% 16% 21%
International infrastructure services 23% -- 17% --
Web hosting 2% 3% 3% 1%
Other revenue 1% 20% 2% 14%
--- --- --- ---
100% 100% 100% 100%
=== === === ===
COSTS AND EXPENSES
OPERATING. Operating costs for the three months ended September 30, 2001 and 2000 were $17.8 million and $18.1 million, respectively, a decrease of $0.3 million. The decrease in operating costs for the quarter resulted primarily from cost savings associated with exiting certain non-Charter one-way cable TV markets, scaling back operations of Digital and cost reduction efforts for the remaining cable modem business. These cost reductions were partially offset by increases in personnel and personnel related costs for additional staff in our customer care and international operations. Operating costs for the nine months ended September 30, 2001 and 2000 were $62.3 million and $48.9 million, respectively, an increase of $13.4 million. The increase in operating costs during 2001 resulted primarily from an increase in personnel and personnel related costs for additional staff in our customer care and network operation centers, international operations and additional personnel costs associated with the purchase of Digital, our larger subscriber base, additional depreciation of capital equipment from the expansion of our network during the first half of the year and the installation of cable modems for additional subscribers. In addition, operating costs for the nine months ended September 30, 2001 include lease termination and other one-way system charges of $1.1 million.
ENGINEERING. Engineering expenses for the three months ended September 30, 2001 and 2000 were $4.6 million and $6.0 million, respectively, a decrease of $1.4 million. The decrease in engineering expenses for the quarter resulted primarily from a reduction in expenses for the development of our information systems and the curtailment of developing new service and product offerings. Engineering expenses for the nine months ended September 30, 2001 and 2000 were $17.5 million and $16.4 million, respectively, an increase of $1.1 million. The increase in engineering expenses for the nine month period resulted from the development and support of information systems, an increase in personnel and personnel-related costs for additional technical staff to support cable modem services during the first half of the year, continued network design and system testing during the first half of the year and additional depreciation on capital equipment. These increases were partially offset by a reduction in expenses for the development of our billing system.
SALES AND MARKETING. Sales and marketing expenses for the three months ended September 30, 2001 and 2000 were $1.2 million and $5.9 million, respectively, a decrease of $4.7 million. Sales and marketing expenses for the nine months ended September 30, 2001 and 2000 were $8.6 million and $18.4 million, respectively, a decrease of $9.8 million. The decrease in sales and marketing expenses resulted primarily from lower direct advertising costs, and reduced sales and marketing efforts due to exiting certain non-Charter markets.
NON-CASH COMPENSATION EXPENSE FROM STOCK OPTIONS, WARRANTS AND RESTRICTED
STOCK. Non-cash compensation expense from stock options, warrants and restricted stock for the three months ended September 30, 2001 and 2000 was $0.2 million and $0.1 million, respectively, an increase of $0.1 million. Non-cash compensation expense from stock options, warrants and restricted stock for the nine months ended September 30, 2001 and 2000 was $0.5 million and $0.1 million, respectively, an increase of $0.4 million. These expenses represent the excess of the fair market value of our common stock over the exercise price of the stock options granted to employees and directors amortized over the vesting period, the amortization of common stock purchase warrants issued to contractors and the fair value of restricted stock amortized over the restriction period. The increase in 2001 resulted from the issuance of 1.5 million shares of restricted stock to key members of management.
AMORTIZATION OF DISTRIBUTION AGREEMENT COSTS. Amortization of distribution agreement costs for the three months ended September 30, 2001 and 2000 was $0.6 million and $0.8 million, respectively, a decrease of $0.2 million. Amortization of distribution agreement costs for the nine months ended September 30, 2001 and 2000 was $5.3 million and $1.9 million, respectively, an increase of $3.4 million. The costs consist of the amortization of the value of warrants earned under distribution agreements for commitments of homes passed. During the second quarter of 2001, amortization of distribution agreements costs included $2.8 million for the amortization of warrants issued in one-way markets where service was terminated during this period. The Company had issued 2,826,714 and 1,658,464 warrants in connection with distribution agreements at September 30, 2001 and 2000, respectively.
In May 2000, the Company and Charter entered into an amended and restated warrant to purchase up to 12,000,000 shares of our common stock at an exercise price of $3.23 per share. The restated warrant becomes exercisable at the rate of 1.55 shares for each home passed committed to us by Charter under the distribution agreement entered into by Charter and us in November 1998. The warrant also becomes exercisable at the rate of .775 shares for each home passed committed to us by Charter under the second distribution agreement entered into in May 2000 up to 5,000,000 homes passed and at a rate of 1.55 shares for each home passed in excess of 5,000,000. Charter also has the opportunity to earn additional warrants to purchase shares of our common stock upon any renewal of the May 2000 agreement. Such a renewal warrant will have an exercise price of $10 per share and will be exercisable to purchase one-half of a share for each home passed in the systems for which the May 2000 agreement is renewed. If the asset sale is consummated, these warrants and the May 2000 agreement will terminate.
ASSET IMPAIRMENT CHARGES. Asset impairment charges for the three and nine months ended September 30, 2001 were $27.5 million and $29.1 million, respectively. During the third quarter of 2001, the Company recorded an asset impairment charge of $27.5 million for the write-down of non-Charter fixed assets. These assets include equipment used in two-way markets in which we ceased operations and other excess inventory used in the cable modem and DSL businesses, furniture, fixtures and equipment located in our Denver corporate headquarters and call center, regional offices and Digital facility, information systems not being purchased by Charter, and the goodwill related to the purchase of CATV, HSAN and Digital. During the second quarter of 2001, the Company recorded an asset impairment charge of $1.6 million related to the assets located in terminated non-Charter one-way systems.
OTHER GENERAL AND ADMINISTRATIVE. Other general and administrative expenses for the three months ended September 30, 2001 and 2000 were $10.7 million and $6.5 million, respectively, an increase of $4.2 million. Other general and administrative expenses for the nine months ended September 30, 2001 and 2000 were $24.1 million and $15.7 million, respectively, an increase of $8.4 million. The increase in other general and administrative expenses resulted from severance costs associated with the termination of certain employees, additional personnel and personnel related costs to administer the procurement, accounting and finance functions during the first half of the year, lease termination costs, additional depreciation on capital equipment and the amortization of intangible assets associated with the purchase of Digital.
NET INVESTMENT EXPENSE / INCOME. Net investment expense for the three months ended September 30, 2001 was $15,000 compared to net investment income of $1.0 million for the three months ended September 30, 2000. Net investment income for the nine months ended September 30, 2001 and 2000 was $1.1 million and $4.0 million, respectively. The decrease in net investment income for the three and nine months ended September 30, 2001, is the result of lower investment balances. Net investment income represents interest earned on cash, cash equivalents, short-term investments and restricted cash.
INCOME TAXES. At December 31, 2000, we accumulated net operating loss carryforwards for federal and state tax purposes of approximately $182.1 million, which will expire beginning in 2018. At December 31, 2000, we had net deferred tax assets of $77.6 million relating principally to our accumulated net operating losses. Our ability to realize the value of our deferred tax assets depends on our future earnings, if any, the timing and amount of which are uncertain. We have recorded a valuation allowance for the entire
net deferred tax asset as a result of those uncertainties. Accordingly, we did not record any income tax benefit for net losses incurred for the three and nine months ended September 30, 2001 and 2000.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, we had approximately $36.9 million in cash and cash equivalents, short-term investments and restricted cash. To preserve cash, the Company has implemented a series of significant cost reduction measures. Among the actions being taken by the Company are:
o the completion of its previously announced exit from certain one-way cable TV markets;
o the commencement of negotiations to exit all of its turnkey contracts with cable operators other than Charter (covering approximately 23,000 subscribers);
o the scaling back of the operations of Digital, including reducing its workforce and eliminating all service offerings other than web site hosting and the subsequent sale of certain operating assets, including hosted customer websites, on October 31, 2001;
o ceasing entry into the DSL market and ceasing development of any other new service and product offerings other than those that are expected to be cash flow positive in the short term;
o material reductions in workforce; and
o entering into a management agreement with Charter, pursuant to which Charter is responsible for the purchase and installation of cable modems and related equipment while sharing responsibility for product marketing. In addition, Charter has the option to undertake additional management responsibilities with respect to the business related to the assets it seeks to acquire.
After these changes are completed, the Company's operations will consist of its Internet access cable business with Charter and our existing international ISP infrastructure services business. The Company expects these reductions in its operations to result in future operating cost reductions, the amounts of which cannot yet be determined. However, even with these changes, the Company will continue to experience substantial negative cash flow from its remaining operations. Although the Company will continue to monitor the size of its workforce and the levels of its other operating costs and cash commitments with a view to conserving cash, the Company will not be able to reduce costs significantly enough to continue as a going concern without additional financing.
The Company believes that it will not be able to secure additional financing in the current economic environment being faced by the telecommunications industry before its cash reserves are depleted in early 2002. In light of the difficult current financing environment, the Company has entered into the asset purchase agreement with Charter. If the asset sale to Charter is not consummated, the Company will likely file for bankruptcy.
At September 30, 2001, we had cash and cash equivalents of $12.1 million and short-term investments of $22.4 million, compared with $114.8 million of cash and cash equivalents and $13.2 million of short-term investments at December 31, 2000. We had significant negative cash flow from operating activities for the nine months ended September 30, 2001. Cash used in operating activities for the nine months ended September 30, 2001 was $72.7 million, caused primarily by a net loss of $118.7 million, an increase in current and non-current assets of $7.5 million, a net decrease in accounts payable, accrued expenses and other current liabilities of $7.3 million, offset by non-cash expenses of $60.8 million.
Cash used in investing activities for the nine months ended September 30, 2001 was $22.2 million, due to the purchase of short-term investments totaling $40.7 million and capital expenditures of $12.9 million, partially offset by sales and maturities of short-term investments of $31.4 million. The principal capital expenditures incurred during this period were for the purchase of cable modems, data center equipment, and DSL equipment.
Cash used by financing activities for the nine months ended September 30, 2001 was $7.8 million, comprised of net payments on capital lease obligations and long-term debt.
If the asset sale is not consummated, we expect to experience substantial negative cash flow from operating activities and negative cash flow from investing activities and would likely be unable to attract the funding we need to continue as a going concern. Under such circumstances, our future cash requirements will depend on a number of factors, including the success of our cost reduction measures and changes in our operating expenses, such as our personnel expense.
We expect to incur $15.0 million of capital expenditures in 2001 principally related to the purchase of cable modems, the upgrade of our data center infrastructure and the purchase of $3.4 million of DSL assets. For the nine month period ended September 30, 2001, we have incurred $12.9 million of capital expenditures.
INVESTMENT PORTFOLIO. Cash equivalents are highly-liquid investments with insignificant interest rate risk and original maturities of 90 days or less and are stated at amounts that approximate fair value based on quoted market prices. Cash equivalents consist principally of investments in interest-bearing money market accounts with financial institutions and highly-liquid investment-grade debt securities of the U.S. Government.
Short-term investments are classified as available-for-sale and, as a result, are stated at fair value. Short-term investments are principally comprised of highly-liquid debt securities of corporations and the U.S. Government. We record changes in the fair market value of securities held for short-term investment as an equal adjustment to the carrying value of the security and stockholders' equity.
Restricted cash is comprised of certificates of deposit collateralizing letters of credit backing certain leases.
LOAN FACILITIES. The Company has $2.9 million outstanding under various loan facilities at September 30, 2001 with interest rates on draws on the facilities ranging from 14.63% to 15.52%. No draws were made on loan facilities for the nine months ended September 30, 2001.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), which provides that all business combinations should be accounted for using the purchase method of accounting and establishes criteria for the initial recognition and measurement of goodwill and other intangible assets recorded in connection with a business combination. The provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001 and to all business combinations accounted for by the purchase method that are completed after June 30, 2001, or later. The Company will apply the provisions of SFAS 141 to any future business combinations.
In addition, the FASB issued Statements of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes the accounting for goodwill and other intangible assets following their recognition. SFAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. SFAS 142 provides that goodwill should not be amortized but should be tested for impairment annually using a fair-value based approach. In addition, SFAS 142 provides that other intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 142 is effective for the Company beginning on January 1, 2002. The Company has no intangible assets or goodwill at September 30, 2001, and therefore expects that the adoption of SFAS 142 on January 1, 2002 will have no impact on the financial condition or results of operations of the Company.
In October 2001, the FASB issued Statements of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121. SFAS 144 applies to all long-lived assets and consequently amends Accounting Principles Board Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of Disposal of a Segment of a Business" ("APB 30"). SFAS 144 develops one accounting model (based on the model in SFAS 121) for long-lived assets that are to be disposed of by sale, as well as addresses the principal implementation issues. SFAS 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value, less cost to sell. That requirement eliminates APB 30's requirement that discontinued operations be measured at net realizable value or that entities include under "discontinued operations" in the financial statements amounts for operating losses that have not yet occurred. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company beginning on January 1, 2002.
RISK FACTORS
You should carefully consider the following factors and other information in this Form 10-Q and other filings we make with the Securities and Exchange Commission before trading in our common stock. If any of the following risks actually occur, our business and financial results could be materially and adversely affected. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS PRIOR TO THE CHARTER ASSET PURCHASE AND OUR CONTINUING BUSINESS IF THE ASSET PURCHASE FAILS TO CLOSE WE NEED SUBSTANTIAL ADDITIONAL CAPITAL IF WE ARE TO CONTINUE OUR OPERATIONS BEYOND EARLY 2002.
The Company believes that it will not be able to secure additional financing in the current economic environment being faced by the telecommunications industry before its cash reserves are depleted in early 2002. In light of the difficult current financing environment, the Company has entered into the asset purchase agreement with Charter. If the asset sale to Charter is not consummated, the Company will likely file for bankruptcy. Consequently, there is substantial doubt as to the Company's ability to continue as a going concern unless it completes the sale of assets to Charter.
WE HAVE NOT BEEN PROFITABLE AND EXPECT FUTURE LOSSES.
We have a limited operating history and have recognized only limited revenues since our inception, April 3, 1998. Our senior management team and other employees have worked together at our Company for only a relatively short period of time. Since our founding, we have not been profitable, and have incurred substantial losses to create and introduce our broadband Internet access services, to operate these services, and to grow our business. Our limited operating history, the dynamic and immature nature of our industry, and changes in our business model make predicting our operating results, including operating expenses, difficult. We also expect to continue to incur substantial losses and experience substantial negative cash flow from operations for the foreseeable future.
OUR QUARTERLY OPERATING RESULTS FLUCTUATE SIGNIFICANTLY AND MAY NOT MEET OUR EXPECTATIONS OR THE EXPECTATIONS OF ANALYSTS AND INVESTORS.
Our revenues and expenses, and in particular our quarterly revenues and operating results have varied in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. These factors include:
o Our ability to close the Charter asset purchase in a timely manner;
o Changes in our operating expenses including, in particular, personnel expenses;
o The success of our cost control measures; and
o Economic conditions specific to the Internet and cable industries, as well as general economic and market conditions.
In addition, our operating expenses are based on our expectations of the future demand for our services and are relatively fixed in the short term. We may be unable to adjust spending quickly enough to offset any unexpected demand surge or shortfall in demand. A shortfall in revenues in relation to our expenses could have a material and adverse effect on our business and financial results.
The quarter-to-quarter comparisons of our results of operations should not be relied upon as an indication of future performance. It is possible that in some future periods our results of operations may be below our expectations and the expectations of public market analysts and investors. In that event, the price of our common stock is likely to fall.
OUR LARGEST CABLE PARTNER CAN TERMINATE ITS CONTRACT WITH US.
Our only remaining cable partner is Charter, to whom we have agreed to sell the majority of our assets and operations. Charter is an affiliate of Vulcan, an affiliate of Microsoft co-founder Paul Allen, who may be deemed to beneficially own 48.5% of our outstanding common stock as of September 30, 2001, assuming 100% conversion of the Company's convertible preferred stock and the exercise of 2,650,659 warrants owned by Charter.
We have entered into several agreements with Charter, including several distribution agreements. The first distribution agreement was entered into in November 1998 and the second in May 2000. Under both agreements, we provide various Network Services related to the delivery of Internet access to homes passed in some of Charter's cable systems. Under the May 2000 agreement, we will provide Network Services, including call center support for cable modem customers as well as network monitoring, troubleshooting and security services. The agreement has an initial term of five years and may be renewed at Charter's option for additional successive five-year terms. In a Network Services solution, we deliver fewer services and incur lower costs than in turnkey solutions, but will also earn a smaller percentage of the subscription revenue based on a fixed fee per subscriber. Under the November 1998 agreement, we provide comprehensive turnkey services.
Charter may, for various reasons or no reason as set forth in the distribution agreements, terminate our rights. If Charter were to terminate either agreement, in whole or for any material system, regardless of any termination fee we may receive, we would lose end users and thus revenue.
BECAUSE OF OUR RELATIONSHIP WITH VULCAN VENTURES, NEW INVESTORS WILL HAVE LITTLE INFLUENCE OVER MANAGEMENT DECISIONS.
Vulcan and Charter currently own 35.6% and 12.9%, respectively, of our outstanding stock assuming 100% conversion of the Company's convertible preferred stock and the exercise of 2,650,659 warrants owned by Charter. Charter also has warrants to purchase up to 12,000,000 shares of our common stock at an exercise price of $3.23 per share. Paul Allen is the controlling stockholder of Charter and Vulcan and as a result Mr. Allen's beneficial ownership of our outstanding stock is 48.5%. Accordingly, Mr. Allen will be able to significantly influence and possibly exercise control over most matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in control. In addition, conflicts of interest may arise as a consequence of Mr. Allen's control relationship with us, including:
o Conflicts between Vulcan, Charter and other affiliates of Mr. Allen and our other stockholders, whose interests may differ with respect to, among other things, our strategic direction or significant corporate transactions;
o Conflicts related to corporate opportunities that could be pursued by us, on the one hand, or by Vulcan, Charter or other affiliates of Mr. Allen, on the other hand; or
o Conflicts related to existing or new contractual relationships between us, on the one hand, and Mr. Allen and his affiliates, such as Vulcan and Charter, on the other hand.
If the asset purchase transaction with Charter and the stock repurchase transaction with Vulcan are consummated, all shares of preferred stock held by Charter and Vulcan would be cancelled. See Note 7, "Business Developments" and Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations Recent Developments" for a description of the transactions.
WE DEPEND ON THIRD PARTIES AND OUR BUSINESS IS SUBJECT TO DISRUPTION BY EVENTS OUTSIDE OUR CONTROL.
Our operations depend upon the capacity, reliability and security of the infrastructure used to carry data between our end users and the Internet. A significant portion of that infrastructure, including the cable infrastructure, is owned by third parties. Accordingly, we have no control over its quality and maintenance. We also rely on other third parties to provide a connection from the cable infrastructure to the Internet and to provide fulfillment services to us. Currently, we have transit agreements with MCI WorldCom and its affiliate, UUNet, and others to support the exchange of traffic between our data servers, the cable infrastructure and the Internet. We also have agreements with various vendors to manage and oversee our customer installation process, including installation, customer education, dispatch service, quality control, recruitment and training. The failure of these third parties to maintain this infrastructure and otherwise fulfill their obligations under these agreements could have a material adverse effect on our business and financial results.
Our operations also depend on our ability to avoid damages from fires, earthquakes, floods, power losses, telecommunications failures, network software flaws, transmission cable cuts, and similar events. The occurrence of any of these events could interrupt our services. The failure of the Internet backbone, our servers, or any other link in the delivery chain, whether from operational disruption, natural disaster or otherwise, resulting in an interruption in our operations could have a material adverse effect on our business and financial results.
WE ARE SUBJECT TO RISKS OF INTERNATIONAL OPERATIONS.
We provide ISP infrastructure consulting services to KNRW in Germany. We believe that our existing contractual obligations to KNRW will be fulfilled by mid-2002. Consequently, we are subject to the risks of conducting business internationally, including:
o Foreign currency fluctuations, which could result in increased operating expenses;
o The burdens of complying with a variety of foreign laws and trade standards;
o Tariffs and trade barriers;
o Difficulty in accounts receivable collection;
o Foreign taxes;
o Unexpected changes in regulatory requirements, including the regulation of Internet access; and
o Uncertainty regarding liability for information retrieved and replicated in foreign countries.
We are not actively seeking other international expansion opportunities. In the unlikely event that we do expand internationally, in addition to those risks listed above, we will also be subject to general geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships. Our international operations could harm our revenues and ability to achieve profitability.
OUR CONVERTIBLE PREFERRED STOCK CONTAINS ANTI-DILUTION PROVISIONS AND OTHER RESTRICTIONS ON OUR FUTURE ACTIVITIES.
Vulcan and Charter own 38,000 and 37,000 convertible preferred shares, respectively. Paul Allen controls Vulcan and Charter. The shares of convertible preferred stock were initially convertible at a conversion price of $5.01875 per share into 14,943,960 shares of common stock. The conversion price is subject to an anti-dilution adjustment which increases the number of shares that will be issued to Vulcan and Charter upon conversion of the convertible preferred stock if we issue common stock (or are deemed to issue common stock) at below the conversion price. The conversion price at September 30, 2001 was $5.01575.
The terms of the convertible preferred stock also place significant restrictions on our activities in the future. Among other things, these constraints will require us to:
o Obtain the approval of Vulcan and Charter before declaring a dividend, entering into a merger, acquisition, consolidation, business combination, or other similar transaction, or issuing any debt or equity securities;
o Provide Vulcan and Charter with a right of first refusal to purchase shares of stock, common or otherwise, that we may offer in the future; and
o Offer and make available to Vulcan, Charter and their affiliates, licensing and business arrangements relating to our technologies, products and services, of any combination thereof, on terms and conditions at least as favorable as those agreed to with any third party at substantially the same level of purchase or other financial commitment.
Because the convertible preferred stock has voting rights, its issuance has a dilutive effect on the relative voting power of our common stockholders. You should also be aware that conversion of the convertible preferred stock into shares of common stock will have a dilutive effect on earnings per share of our common stockholders. In addition, you should note that we may issue additional shares of common stock in connection with the payment of dividends or conversion price adjustments on the convertible preferred stock, which may increase the number of shares of common stock issued in connection with the transaction.
RISKS RELATED TO THE CHARTER ASSET PURCHASE AND OUR BUSINESS AFTER THE CLOSING OF THE CHARTER ASSET PURCHASE
WE MIGHT FAIL TO SATISFY A CLOSING CONDITION OR OTHERWISE FAIL TO CLOSE THE ASSET PURCHASE AGREEMENT WITH CHARTER.
The consummation of the asset purchase agreement is subject to a number of conditions, including conditions related to:
o The representations and warranties contained in the asset purchase agreement;
o The performance of all obligations contained in the asset purchase agreement;
o Required consents;
o The absence of any developments having a material adverse effect; and
o The delivery of required opinions and certificates.
In addition, as a condition to the closing of the asset sale, the asset purchase agreement requires the approval of a majority of the votes actually cast at a Special Meeting (in person or by proxy) by holders of our common stock other than Charter, Vulcan, their respective affiliates and certain of our executive officers. The satisfaction of this condition does not depend on any minimum number of votes to be present or cast at the Special Meeting and there will not be a separate vote or ballot for the purposes of satisfying this condition. Rather, this condition will be satisfied by the approval of a simple majority of those votes actually cast. Accordingly, for the purposes of satisfying this condition in the asset purchase agreement, broker non-votes and abstentions will have no effect, whereas votes actually cast for or against the asset sale will have an effect.
If we violate any of these provisions and fail to cure or obtain a waiver of such conditions, the Company will continue to exist as a publicly owned entity, however we will not have sufficient capital to fund our operations and it is likely that we will file for bankruptcy. If the asset sale is not consummated, our preferred stock will remain outstanding. Therefore, if we subsequently liquidate and dissolve, Charter Communications Ventures, LLC and Vulcan, as the holders of our preferred stock, will have a liquidation preference over holders of our common stock with respect to any liquidating distribution of our assets. Accordingly, if the asset sale is not approved or otherwise not consummated, your stock would likely be rendered worthless.
Additionally, if Charter Communications Ventures, LLC and Vulcan were to continue to hold our preferred stock, we would be unable to sell substantially all of our assets or merge into or otherwise be acquired by another company without the consent of Charter Communications Ventures, LLC and Vulcan.
WE ARE SUBJECT TO RISKS INHERENT IN PURSUING OTHER BUSINESS
OPPORTUNITIES SHOULD WE ELECT TO REMAIN IN BUSINESS.
The Company may decide to explore opportunities to acquire, invest in or develop new lines of business. To date, our board has not proposed a new strategic direction for the Company. Accordingly, we cannot predict what businesses we may enter or strategies we may adopt; and thus can offer no indication of what risks and opportunities might arise in the context of such a new direction.
Similarly, any new strategic direction we choose could likely involve the acquisition or development of other businesses. Any
decision we make with respect to any new strategic direction will likely involve risks, including the following:
o We have no specific plan as to what businesses or products we may seek to acquire or develop, and therefore may have no operating history or experience in such businesses upon which you may base an evaluation of any strategic business plan and determine our prospects. Any business we might develop will likely involve all of the risks, uncertainties, expenses and difficulties frequently encountered by development stage companies.
o Our future success depends, in significant part, on our ability to attract, hire and retain directors, management and other personnel with the managerial, marketing and technical skills that may be required by any business or businesses that we acquire in the future. As part of our recent cost-cutting measures, we have substantially reduced the Company's workforce (except for those employees who will be hired by Charter). Competition for personnel is intense, and there may be a limited number of persons with knowledge of, and experience in, any industry we might seek to enter. If we fail to timely identify, recruit and hire qualified personnel, we may be unable to compete effectively.
o To be successful in any planned acquisition, we will need to identify applications, technologies and businesses that are complementary, and we may need to integrate disparate technologies and corporate cultures and potentially manage a geographically dispersed company. Each subsequent acquisition may divert our attention from our existing business concerns and expose us to unforeseen liabilities or risks associated with entering new markets. Integrating newly acquired organizations and technologies into our company could be expensive, time consuming and may strain our resources. We anticipate that we will face intense competition for acquisitions, and that many of these competitors will be larger, better-funded organizations. If we fail to execute our acquisition strategy successfully for any reason, our business may be adversely affected. We do not have a tested business model and we cannot be sure that any business model we develop will yield positive results.
o We may pay for some of our acquisitions by issuing additional common stock and this could dilute our stockholders. We may also use cash to buy companies or technologies in the future. If we do use cash, we may need to incur debt to pay for these acquisitions as well as to fund any operating losses. Acquisition financing may not be available on favorable terms or at all. In addition, we may be required to amortize significant amounts of goodwill and other intangible assets in connection with future acquisitions, which would have an adverse affect on our results of operations.
We intend to identify potential acquisition candidates through contacts with persons and entities including investment banks, accountants, consultants, and other professionals. Affiliates of ours, including their officers and directors who are instrumental in identifying or closing future acquisitions, may be compensated by payment of fees or in amounts which are in addition to the amount of salary, bonus or directors fees which we customarily pay such individuals. Any such additional compensation will be determined on a case by case basis by the board of directors prior to or at the time of the acquisition. As of this date we are not a party to any agreement regarding the provision of such services or payments of such fees or amounts.
We may not be successful in identifying, developing and executing a new business strategy and could eventually use all, or a substantial portion, of our remaining cash on hand in connection with any such new business efforts.
WE MAY CONTINUE TO BE SUBJECT TO RISKS IN OUR INTERNATIONAL BUSINESS.
As discussed above, we intend to either fulfill or negotiate an early termination to our existing contractual obligations to provide professional services relating to the design testing and implementation of broadband Internet access infrastructure services to KNRW in Germany.
Although the term of our current master contract with KNRW expires in February 2004, our present engagement is scheduled to terminate in August 2002. We are discussing with KNRW the possibility of mutually terminating our engagement prior to that, but we cannot predict exactly when that might occur, if it occurs at all. In any event, KNRW has the right to terminate our contract with them after the 18-month anniversary of the execution of the contract (August 2002) or in the event we engage in a transaction constituting a "change of control" of High Speed Access International, the subsidiary through which we operate our international business. Even if we do not negotiate an early termination to the contract, we cannot assure you that KNRW will not terminate our contract with them in
August 2002 or attempt to do so following the consummation of the asset sale.
MISCELLANEOUS RISKS
OUR STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.
The stock market has experienced extreme price and volume fluctuations. In particular, the market prices of the securities of Internet-related companies have been especially volatile. In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. If we were the object of securities class action litigation, it could result in substantial costs and a diversion of our management's attention and resources.
WE MAY BE DELISTED BY NASDAQ.
On September 10, 2001, we received formal notice from the Nasdaq Stock Market that we were not in compliance with the continuing listing requirements because the market price of our common stock was below $1.00 per share. However, on September 27, 2001, in response to the extraordinary market conditions following the terrorist attacks on September 11, Nasdaq announced that it had implemented an across-the-board moratorium on the minimum bid and public float requirements for continued listing until January 2, 2002. On October 9, 2001, we received notification from Nasdaq that the previously announced moratorium would apply to us. Nevertheless, we currently believe that we will not be in compliance with these requirements after the moratorium is lifted. We anticipate that the market price of our common stock will remain below $1.00 per share and may decline further if, among other things, we make distributions to our stockholders. We also expect that our market capitalization will fall below the minimum required for continued listing by Nasdaq. Accordingly, we do not expect our common stock to remain eligible for listing and we expect that it will be de-listed in 2002. If our common stock is de-listed, trading of our common stock would be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities in what are commonly referred to as the "pink sheets."
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION.
Our business has two main components. First, we supply information and entertainment to customers primarily over the cable systems of our cable system partners. This information and entertainment includes materials that we obtain from third parties (including Vulcan and its affiliates) as well as information generally available on the Internet that our customers will reach by means of our service. Second, we install and maintain the equipment needed to transmit that information to customers over the cable systems of our cable partners in a form that can be understood by customers' personal computers. There are certain risks associated with both aspects of this business.
With regard to supplying information, we are subject to the same types of risks that apply to all businesses that publish, broadcast or distribute information. These include potential liability for defamation, libel, invasion of privacy and similar claims, as well as potential liability for copyright or trademark infringement and similar claims. In addition, the law relating to the liability of Internet and online service providers for information carried on or disseminated through their networks is unsettled. There are also some specific federal laws regarding the distribution of obscene or indecent content by means of communications facilities (including distribution of such content to minors) under which we are subject to potential liability. These risks are mitigated to some extent by a federal law passed in 1996 that immunizes Internet service providers from legal liability for defamation and similar claims in connection with information that the Internet service provider did not itself create. The law regarding these issues is controversial, and could be changed in ways that would expose us to greater liability. Also, the Digital Millennium Copyright Act, passed in 1998, creates a "safe harbor" from copyright infringement liability for Internet service providers who meet its requirements, which we intend to do. Finally, if we expand our operations to other countries with less extensive legal protections for publishers and speakers, our potential liability for our activities in those countries could be much greater than in the United States.
The other main aspect of our business installing and maintaining the equipment needed to permit cable systems to transmit information in a computer-accessible format is not currently regulated by state or federal governments. Even so, the business of our cable partners is subject to regulation by the federal government and by local governments (which issue franchises to cable systems) in accordance with federal law. There are four main ways that these regulations could change that might severally and negatively affect our business.
First, our service is generally classified by cable operators as a "cable service." This means that our cable partners may offer our service over their cable systems under their present franchise rights. If our service is not a cable service, then some franchising authorities (usually cities or countries) might claim that our cable partners need separate authorization to offer it. This separate authorization may not be obtainable on reasonable terms, or at all. In the alternative, even if the service is treated as cable service, local franchising authorities may seek to impose "non-discrimination" or "open access" obligations on our cable partners as a condition of franchise transfer or renewal.
Second, if our service is not a "cable service," it could be reclassified as a "telecommunications service." This could subject our cable partners (and possibly us) to regulation as "telecommunications carriers" at the state and federal level. For example, if we or our cable partners were either classified as telecommunications common carriers, or otherwise subject to common carrier-like access and non-discrimination requirements in the provision of our Internet over cable service, we or they could potentially be subject to government-regulated terms, conditions and prices for Internet connection services, as well as become obligated to make contributions to the universal service support fund. We may also provide Internet telephony services over cable plant, and this service may be regulated in the future as a common carrier telecommunications service. It is not clear what impact compliance with those regulations would have on our business, but the impact could be severe. Moreover, we or our cable partners might then have to get a "telecommunications franchise" from some localities. This franchise might not be available on reasonable terms, or at all. The regulatory climate affecting our existing business is uncertain. Historically, the Company and its cable partners believed that for regulatory purposes our services would be considered a form of cable service, or an unregulated information service. Some federal courts have reached decisions consistent with these views. However, in June 2000, the federal appeals court for the 9th Circuit concluded that a cable operator's provision of transmission facilities in some instances is a telecommunications service under the Communications Act. This classification could subject our cable partners, and possibly us, to federal and state regulation as "telecommunications carriers." If we or our cable partners were classified as telecommunications common carriers, or otherwise subject to common carrier-like access and non-discrimination requirements in the provision of our Internet over cable service, the Company or Charter could be subject to burdensome governmental regulations. In particular, the government might seek to regulate us and our cable partners with respect to the terms, conditions and prices for Internet connection services and interconnections with the public switched telephone network, and require that we make contributions to the universal service support fund. The law in this area thus remains unsettled. Moreover, some local franchising authorities might claim that our cable partners need a separate franchise to offer our service. This franchise may not be obtainable on reasonable terms, or at all.
THE FUTURE SALE OF SHARES MAY HURT OUR MARKET PRICE.
A substantial number of shares of our common stock are available for resale. If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. These sales also might make it more difficult for us to sell equity securities in the future at times and prices that we deem appropriate. If we are successful in closing the Charter asset purchase and Vulcan stock repurchase, the number our outstanding common shares will decrease from approximately 60 million to 40 million.
WE HAVE ANTI-TAKEOVER PROVISIONS.
Certain provisions of our certificate of incorporation, our bylaws and Delaware law, in addition to the concentration of ownership by Mr. Paul Allen, makes it difficult for a third party to acquire us, even if doing so might be beneficial to our other stockholders.
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