<PAGE>
As filed with the Securities and Exchange Commission on February 4, 1999
Registration No. 333-71235
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------
AMENDMENT NO. 1
TO
FORM S-3
REGISTRATION STATEMENT
Under
The Securities Act of 1933
----------------
CONCENTRIC NETWORK CORPORATION
(Exact name of Registrant as specified in its charter)
----------------
Delaware 4813 65-0257497
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Identification Number)
incorporation or Classification Code
organization) Number)
1400 Parkmoor Avenue
San Jose, California 95126-3429
(408) 817-2800
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
----------------
Henry R. Nothhaft
President, Chief Executive Officer and
Chairman of the Board
CONCENTRIC NETWORK CORPORATION
1400 Parkmoor Avenue
San Jose, California 95126-3429
(408) 817-2800
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
----------------
Copies to:
David J. Segre Nora L. Gibson
N. Anthony Jeffries Randall M. Lake
Paul B. Shinn Gautam Anand
Elizabeth C. Hewitt Brobeck, Phleger & Harrison LLP
Wilson Sonsini Goodrich & Rosati One Market
Professional Corporation Spear Street Tower
650 Page Mill Road San Francisco, California 94015
Palo Alto, California 94304-1050 (415) 442-0900
(650) 493-9300 Fax: (415) 442-1010
Fax: (650) 493-6811
----------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
----------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
----------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. We may not sell these securities until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+preliminary prospectus is not an offer to sell these securities and it is not +
+soliciting an offer to buy these securities in any jurisdiction where the +
+offer of sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED FEBRUARY 4, 1999
PROSPECTUS
2,500,000 Shares
[LOGO OF CONCENTRIC NETWORK APPEARS HERE]
Common Stock
------------
This is a public offering of 2,500,000 shares of common stock of Concentric
Network Corporation. We are selling all of the 2,500,000 shares of common stock
offered under this prospectus.
Our common stock is traded on the Nasdaq National Market under the symbol
"CNCX." On January 29, 1999, the last reported sale price for our common stock
on Nasdaq National Market was $43.50 per share.
See "Risk Factors" beginning on page 7 to read about certain risks that you
should consider before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal
offense.
------------
<TABLE>
<CAPTION>
Per
Share Total
----- -----
<S> <C> <C>
Public offering price............................................... $ $
Underwriting discounts and commissions.............................. $ $
Proceeds, before expenses, to us.................................... $ $
</TABLE>
------------
The underwriters may, under certain circumstances, purchase up to an additional
375,000 shares of common stock from us at the initial public offering price
less the underwriting discount.
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares against payment in New York, New York
on February , 1999.
------------
Bear, Stearns & Co. Inc.
BancBoston Robertson Stephens
CIBC Oppenheimer
First Union Capital Markets Corp.
C.E. Unterberg, Towbin
Warburg Dillon Read LLC
The date of this Prospectus is , 1999.
<PAGE>
The
Concentric
Network
[CONCENTRIC NETWORK MAP APPEARS HERE]
The Concentric network uses an advanced, geographically dispersed ATM
backbone. In the United States and Canada, Concentric employs SuperPOPs in 19
major metropolitan areas and 143 secondary and tertiary POPs in other cities,
allowing local dial-up access to the network for most customers. Through a
partnership agreement with Telecom Italia, the network has expanded to include
over 100 cities in 46 countries. Concentric provides analog dial-up, frame
relay, DSL, fractional T-1, T-1 and DS3 access to the network. The Concentric
network is designed, through software intelligence, to enable a broad range
of applications requiring high throughput, low latency and security. The high
performance characteristics of our network enable us to offer quality of
service guarantees to our customers. Concentric believes that the combination
of our high performance, scalable network and international coverage positions
us extremely well in the enterprise market for IP-based network services.
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and notes to those statements appearing
elsewhere in this prospectus. Some of the technical terms used in this
prospectus are defined in the Glossary of Terms beginning on page G-1.
Concentric Network Corporation
We provide tailored, value-added Internet Protocol ("IP") based network
services for enterprises and consumers using our low/fixed latency, high-
throughput network. Our service offerings for enterprises include virtual
private networks, dedicated access facilities, digital subscriber line
services, remote access services and Web hosting services. These services
enable enterprises to use standard Internet tools such as browsers and high-
performance servers to customize data communications within an enterprise and
between an enterprise and its suppliers, partners and customers. Our services
combine the cost advantages, nationwide access and standard protocols of public
networks with the customization, high performance, reliability and security of
private networks. Among our current enterprise customers are Intuit, Inc., SBC
Communications Inc., Teligent, Inc., and WebTV Networks, Inc., a subsidiary of
Microsoft Corporation. Our service offerings for consumers and small
office/home office customers include local Internet dial-up access, digital
subscriber line services and applications hosting.
Our network employs an advanced, geographically dispersed ATM and frame
relay backbone, SuperPOPs in 19 major metropolitan areas and 143 secondary and
tertiary POPs in other cities. Our architecture allows most customers in the
U.S. and Canada to access our network through a local telephone call. In
addition to dial-up access, we provide frame relay, digital subscriber lines,
fractional T-1, T-1 and DS3 access to the network. Our network is engineered
and managed to provide superior quality of service, balancing several key
performance criteria. We provide guaranteed levels of service for dedicated
access facilities to enterprise customers, and target performance benchmarks
for connection success rates, latency levels and throughput for all of our
service offerings.
Industry analysts expect the market size for both value-added IP data
networking services and Internet access to grow rapidly as businesses and
consumers increase their use of the Internet, intranets and privately managed
IP networks. According to industry analyst Forrester Research, Inc., the total
market for these services is projected to grow from $6.2 billion in 1997 to
approximately $49.7 billion in the year 2002, with approximately $27.9 billion
in the enterprise market segment and $21.8 billion in the consumer market
segment.
Our objective is to become the leading supplier of value-added, IP-based
network services worldwide. In order to achieve this goal, our business
strategy focuses on the following key principles:
. Capitalizing on our expertise in developing tailored virtual private
networks to establish a leadership position in rapidly developing,
deploying and maintaining a range of value-added network services to
meet the specific needs of our customers.
. Increasing total network utilization and optimizing this utilization by
targeting both daytime business and evening-intensive consumer users to
balance the network's usage throughout a 24-hour period.
. Identifying and acquiring assets, technologies and businesses
complementary to our value-added enterprise network service strategy.
Such acquisition efforts are targeted at businesses that offer the
potential to expand our revenue base, increase the scalability of our
network infrastructure and value-added service offerings, as well as
optimize the utilization of our network.
3
<PAGE>
. Forming alliances with certain software developers and
telecommunications service and equipment suppliers that have
substantially greater marketing, distribution and sales resources than
we do and that have a large installed customer base.
. Launching a variety of initiatives to address the increasing demands of
our enterprise customers for global network services.
Recent Strategic Developments
In October 1998, SBC Communications Inc. agreed to acquire 906,679 shares of
our common stock either on the open market or from us. In December 1998, SBC
purchased 100,000 shares of our common stock in two open market purchases. The
remaining 806,679 shares were purchased from us in January 1999 for an
aggregate purchase price of approximately $19.5 million. We also issued SBC a
warrant in January 1999 to purchase 906,679 shares of our common stock at an
exercise price of $21.00 per share. In connection with this agreement, SBC
agreed to integrate our Internet-based business data services and related
technology into its portfolio of data products and services for its business
customers. In addition, in January 1999 we entered into a strategic
relationship with Covad Communications Group, Inc. to combine our value-added
IP services with Covad's high speed DSL local loop services. As part of this
relationship, we purchased 555,556 shares of Covad common stock for
approximately $10.0 million.
----------------
"Concentric" and the "Company" refer in this prospectus to Concentric
Network Corporation. Our principal executive offices are at 1400 Parkmoor
Avenue, San Jose, California 95126-3429, and our telephone number at that
address is (408) 817-2800.
Concentric Network Corporation, The Concentric Network, Concentric
RemoteLink, ConcentricView, ConcentricHost, ConcentricHost Server Solutions,
Concentric CustomLink, FlexChannel, FullChannel, Powered by Concentric Network,
RemoteHands and PremierConnect are among the trademarks of the Company. This
prospectus contains other product names, trade names and trademarks that belong
to us or to other organizations.
THE OFFERING
<TABLE>
<C> <S>
Common stock offered by us.......................... 2,500,000 shares
Common stock outstanding after the offering (1)(2).. 18,450,989 shares
Use of proceeds..................................... For general corporate
purposes, working capital
and approximately $30.0
million of capital
expenditures in 1999. See
"How We Intend to Use the
Proceeds From the
Offering."
Nasdaq National Market Symbol....................... CNCX
</TABLE>
- ----------
(1) Excludes (A) options and warrants to purchase approximately 5,770,835
shares of common stock outstanding as of December 31, 1998, having a
weighted average exercise price of $13.98 per share, (B) a warrant to
purchase 906,679 shares of common stock at an exercise price of $21.00 per
share that we issued to SBC in January 1999, and (C) options to purchase
598,975 shares of common stock issued in January 1999, having a weighted
average exercise price of $33.69 per share.
(2) Includes 806,679 shares of common stock issued to SBC in January 1999 at
$24.15 per share for net proceeds of approximately $19.5 million.
4
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1994 1995 1996 1997 1998(1)
------- -------- -------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenue...................... $ 442 $ 2,483 $ 15,648 $ 45,457 $ 82,807
Cost of revenue.............. 2,891 16,168 47,945 61,439 85,352
Network equipment write-
off(2)...................... -- -- 8,321 -- --
Development, marketing and
sales and general and
administrative operating
expenses.................... 1,784 7,602 22,503 34,262 57,925
Amortization of goodwill and
other intangible assets..... -- -- -- -- 3,842
Acquisition-related charges.. -- -- -- -- 1,291
Write-off of in-process
technology.................. -- -- -- -- 5,200
------- -------- -------- -------- --------
Total costs and expenses..... 4,675 23,770 78,769 95,701 153,610
------- -------- -------- -------- --------
Loss from operations......... (4,233) (21,287) (63,121) (50,244) (70,803)
Other income (expense)....... -- -- -- 1,233 (750)
Net interest expense......... (57) (721) (3,260) (6,571) (13,595)
------- -------- -------- -------- --------
Loss before extraordinary
item........................ (4,290) (22,008) (66,381) (55,582) (85,148)
Extraordinary gain on early
retirement of debt.......... -- -- -- -- 3,042
------- -------- -------- -------- --------
Net loss..................... $(4,290) $(22,008) $(66,381) $(55,582) $(82,106)
------- -------- -------- -------- --------
Preferred stock dividends and
accretion................... -- -- -- -- (11,958)
------- -------- -------- -------- --------
Net loss attributable to
common stockholders......... $(4,290) $(22,008) $(66,381) $(55,582) $(94,064)
======= ======== ======== ======== ========
Net loss per share
attributable to common
stockholders(3)............. $ (13.46) $ (5.63) $ (6.47)
======== ======== ========
Shares used in computing net
loss per share attributable
to common stockholders(3)... 4,937 9,872 14,547
======== ======== ========
Other Consolidated Financial
Data:
Depreciation and
amortization................ $ 169 $ 2,196 $ 9,470 $ 19,230 $ 33,418
EBITDA(4).................... (4,064) (19,091) (53,651) (31,014) (30,894)
Capital expenditures(5)...... 718 17,176 39,093 22,798 30,137
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1998
------------------------
Actual As Adjusted(6)
-------- --------------
(In thousands)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents............................ $ 98,988 $221,032
Short term investments............................... 52,226 52,226
Restricted cash(7)................................... 36,238 36,238
Property and equipment, net.......................... 64,268 64,268
Total assets......................................... 298,257 420,301
Notes payable and capital lease obligations, net of
current portion..................................... 156,455 156,455
Redeemable exchangeable preferred stock.............. 156,105 156,105
Total stockholders' equity (deficit)................. (56,875) 65,169
</TABLE>
Footnotes appear on the next page.
5
<PAGE>
(1) During 1998, we acquired InterNex Information Services, Inc., Delta
Internet Services, Inc. and AnaServe, Inc., the effects of which have been
included in the 1998 financial results. See Note 13 of Notes to
Consolidated Financial Statements.
(2) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 3 of Notes to Consolidated Financial
Statements.
(3) Net loss per share and shares used in computing net loss per share
attributable to common stockholders are presented on a pro forma basis for
the years ended December 31, 1996 and 1997 and on an historical basis for
the year ended December 31, 1998. See Note 1 of Notes to Consolidated
Financial Statements.
(4) EBITDA is loss from operations before interest, taxes, depreciation and
amortization and also excludes the write off of in-process technology and
acquisition-related charges. EBITDA is included in this table because our
management believes that investors find it to be a useful tool for
approximating the Company's cash flow. However, EBITDA does not represent
cash flow from operations, as defined by generally accepted accounting
principles, should not be considered as a substitute for net loss as an
indicator of our operating performance or cash flow as a measure of
liquidity, and should be examined in conjunction with our Consolidated
Financial Statements and Notes thereto beginning on page F-1 of this
prospectus.
(5) Capital expenditures includes assets acquired through capital lease
financing and other debt.
(6) The as adjusted data gives effect to the offering, after deduction of
estimated offering expenses and the estimated discount to the underwriters
and to the issuance of 806,679 shares of common stock to SBC at $24.15 per
share in January 1999 for net proceeds of approximately $19.5 million. The
as adjusted data assumes an offering price of $43.50. See "How We Intend to
Use the Proceeds From the Offering" and "Capitalization."
(7) Restricted cash of $36.2 million consists of funds held in escrow to pay
interest relating to our 12 3/4% Senior Notes due 2007. See Note 5 of Notes
to Consolidated Financial Statements.
6
<PAGE>
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial may also impair our
operations.
If any of the following risks actually occur, our business, financial
condition or results of operations could be materially adversely affected. In
such case, the trading price of our common stock could decline, and you may
lose all or part of your investment.
This prospectus also contains forward-looking statements that involve risks
and uncertainties. We use words such as "anticipates," "believes," "plans,"
"expects," "future," "intends," and similar expressions to identify forward-
looking statements. Our actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors,
including the risks described below and elsewhere in this prospectus.
We Have a Limited Operating History and Expect Continuing Operating Losses.
We were incorporated in 1991, commenced network operations in 1994 and
completed initial deployment of our current network architecture and use of an
advanced ATM backbone network in late 1996. Accordingly, we have a limited
operating history upon which an evaluation of our prospects can be based. Our
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in new and rapidly evolving markets. To
address these risks, we must, among other things:
. respond to competitive developments;
. continue to attract, retain and motivate qualified personnel; and
. continue to upgrade our technologies and commercialize network
services incorporating such technologies.
We cannot assure you that we will be successful in addressing the risks we
face. The failure to do so could have a material adverse effect on our
business, financial condition and results of operations.
We have incurred net losses and experienced negative cash flow from
operations since inception. We expect to continue to operate at a net loss and
experience negative cash flow at least through 1999. Our ability to achieve
profitability and positive cash flow from operations is dependent upon our
ability to substantially grow our revenue base and achieve other operating
efficiencies. We experienced net losses attributable to common stockholders of
approximately $66.4 million for the year ended December 31, 1996, $55.6 million
for the year ended December 31, 1997 and $94.1 million for the year ended
December 31, 1998. At December 31, 1998, we had an accumulated deficit of
approximately $246.1 million. We cannot assure you that we will be able to
achieve or sustain revenue growth, profitability or positive cash flow on
either a quarterly or an annual basis.
Our estimates of the periods of time in which we expect to continue to
operate at a net loss, experience negative cash flow and not generate taxable
income are forward-looking statements that involve risks and uncertainties.
Actual results could vary materially as a result of a number of factors,
including those set forth in this Risk Factors section.
Our Operating Results Fluctuate and Could Decline.
Our operating results have fluctuated in the past and may fluctuate
significantly in the future. Our operating results fluctuate due to a variety
of factors, including the following:
. timely deployment and expansion of our network and new network
architectures;
7
<PAGE>
. the incurrence of capital costs related to network expansion;
. variability and length of the sales cycle associated with our
product and service offerings;
. the receipt of new value-added network services and consumer
services subscriptions;
. the introduction of new services by us and our competitors;
. the pricing and mix of services offered by us;
. our customer retention rate;
. market acceptance of new and enhanced versions of our services;
. changes in pricing policies by our competitors;
. our ability to obtain sufficient supplies of sole- or limited-source
components;
. user demand for network and Internet access services;
. balancing of network usage over a 24-hour period;
. the ability to manage potential growth and expansion;
. the ability to identify, acquire and successfully integrate suitable
acquisition candidates; and
. charges related to acquisitions.
Variations in the timing and amounts of revenues due to these actions could
have a material adverse effect on our quarterly operating results. Due to the
foregoing factors, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful. Such comparisons cannot be
relied upon as indicators of future performance. If our operating results in
any future period fall below the expectations of securities analysts and
investors, the market price of our securities would likely decline.
The Loss of Any of Our Major Customers Could Severely Impact Our Business.
We currently derive a substantial portion of our total revenue from WebTV.
Revenue from WebTV accounted for 10.1% of our revenue for the year ended
December 31, 1996, 33.4% of our revenue for the year ended December 31, 1997
and 26.8% of our revenue for the year ended December 31, 1998.
WebTV may terminate our current agreement at will after October 31, 2000.
While we expect revenue from WebTV to decrease as a percentage of revenue in
future periods, we believe that revenue derived from a limited number of
customers may continue to represent a significant portion of our revenue. As a
result, the loss of one or more of our major customers could have a material
adverse effect on our business, financial condition and results of operations.
In addition, we cannot assure you that revenue from customers that have
accounted for significant revenue in past periods, individually or as a group,
will continue, or will reach or exceed historical levels in any future period.
Our Growth and Expansion May Strain Our Resources.
Our business and service offerings have grown rapidly since our inception.
The growth and expansion of our business and our service offerings have placed,
and are expected to continue to place, a significant strain on our management,
operational and financial resources. In addition, we recently expanded and
upgraded our network to use an ATM backbone. We plan to continue to
substantially expand our network in 1999 and future periods. To manage our
growth, we must, among other things:
. continue to implement and improve our operational, financial and
management information systems, including our billing, accounts
receivable and payable tracking, fixed assets and other financial
management systems;
. hire, train and retain qualified personnel; and
. continue to expand and upgrade our network infrastructure.
8
<PAGE>
We are currently in the process of replacing and updating our operational,
financial and management information systems. The systems being replaced and
updated include our billing, provisioning and other financial management
systems. We began to replace our information systems facilities in the fourth
quarter of 1998 and these efforts will continue throughout 1999. We also
consolidated our Silicon Valley operations in a new, larger facility in the
fourth quarter of 1998 and will transfer our remaining Silicon Valley data
centers to this facility during the first two quarters of 1999. Management of
the transition of our information systems and of the personnel and operational
equipment to the new facility is expected to place additional strain on our
resources. We cannot assure you that this transition will be completed
successfully or on a timely basis.
We cannot assure you that we will be able to expand our network or add
services at the rate or according to the schedule presently planned by us. We
had 96 employees and 47 independent contractors as of December 31, 1996, and
have grown to 508 employees and 61 independent contractors as of December 31,
1998. We cannot assure you that we will be able to effectively manage this
growth in personnel. Additionally, we cannot assure you that we will be able to
hire, train and retain sufficient numbers of qualified personnel to meet our
requirements.
Our expanding customer base demands the rapid growth of our network
infrastructure and technical support resources. We may in the future experience
difficulties meeting the demand for our access services and technical support.
We cannot assure you that our technical support or other resources will be
sufficient to facilitate our growth. We are striving to increase total network
utilization and to optimize this utilization by targeting both business and
consumer users to balance the network's usage throughout a 24-hour period.
There will be additional demands on our customer support, sales and marketing
resources as we pursue this utilization strategy. If we fail to manage our
growth effectively, our business, financial condition and results of operations
could be materially adversely affected.
Our Acquisition Strategy Poses Several Risks.
We have completed three acquisitions to date and may seek to acquire
additional assets, technologies and businesses complementary to our operations.
The completed acquisitions are and any subsequent acquisitions would be
accompanied by the risks commonly encountered in such transactions. Such risks
include, among other things:
. difficulties integrating the operations and personnel of acquired
companies;
. the additional financial resources that may be needed to fund the
operations of acquired companies;
. the potential disruption of our business;
. our management's ability to maximize our financial and strategic
position by the incorporation of acquired technology or businesses
into our service offerings;
. the difficulty of maintaining uniform standards, controls,
procedures and policies;
. the potential loss of key employees of acquired companies;
. the impairment of relationships with employees and customers as a
result of changes in management; and
. the incurrence of significant expenses in consummating acquisitions.
Any of the above risks could prevent us from realizing significant benefits
from our acquisitions. In addition, the issuance of our common stock in
acquisitions will dilute our stockholder interests in our company, while the
use of cash will deplete our cash reserves. Finally, if we are unable to
account for our acquisitions under the "pooling of interests" method of
accounting, we may incur significant, one-time write-offs and amortization
charges. These write-offs and charges could decrease our future earnings or
increase our future losses.
9
<PAGE>
Our Future Success Depends Upon Third-Party Distribution and Engineering
Relationships.
An important element of our strategy is to develop relationships with
leading companies to enhance our distribution and engineering efforts. We have
agreements with Netscape and Microsoft pursuant to which we distribute and
modify their browsers. Our customization of browsers is an integral part of our
current tailored VPN offerings. The Netscape agreement may be terminated at any
time upon 60 days notice and the Microsoft agreement expires in March 1999. We
are currently discussing with Microsoft an extension of the term of our
agreement, but we cannot assure you that these discussions will be successful.
We have an agreement with Intuit for the development, operation and maintenance
of a VPN that is the integrated access, dial-up network and infrastructure used
by purchasers of Quicken, Turbo Tax and other Intuit software products. Intuit
customers use this VPN to access the Quicken Financial Network Website and the
Internet. The Intuit contract may be terminated at the election of Intuit upon
six months prior notice of an election to terminate. We have also recently
entered into strategic agreements with SBC and Teligent for the delivery of
private-labeled services to their customers. We rely on these relationships for
the acquisition of enterprise and consumer customers. Our inability to
capitalize on these agreements, the termination of or failure to renew any of
these agreements or our inability to enter into similar relationships with
others could have a material adverse effect on our business, financial
condition and results of operation.
We have an outsourcing agreement with Williams Technology Solutions, a
subsidiary of Williams Communications Group, Inc., that enables us to use
Williams employees for the operational support of our network. Our use of
Williams employees and Williams engineering expertise was integral to the
development of our network and continue to be integral to the ongoing operation
of our network operations center. Pursuant to the agreement with Williams, all
of the Williams employees currently working for us will become our employees
when the agreement terminates in December 2000. Termination of any of these
agreements or our failure to renew any of the agreements upon termination on
terms acceptable to us could have a material adverse effect on our business,
financial condition and results of operations.
We Depend Upon New and Uncertain Markets.
We offer tailored, value-added network services for enterprises and
consumers, including Internet access. These markets are in the early stages of
development. It is difficult to predict the rate at which the market will grow,
if at all, because these markets are relatively new and current and future
competitors are likely to introduce competing services or products. New or
increased competition may result in market saturation. Certain critical issues
concerning commercial use of tailored, value-added services and Internet
services, remain unresolved and may impact the growth of such services. These
issues include, among others, security, reliability, ease and cost of access,
and quality of service. Our business, financial condition and results of
operations would be materially adversely affected if the markets for our
services, including Internet access:
. fail to grow;
. grow more slowly than anticipated; or
. become saturated with competitors.
We Depend Upon New and Enhanced Services.
We have recently introduced new enterprise service offerings, including the
introduction of value-added, IP-based communication services to enterprises and
a new line of DSL services in limited areas. The failure of these services to
gain market acceptance in a timely manner or at all, or the failure of the DSL
service in particular, to achieve significant market coverage could have a
material adverse effect on our business, financial condition and results of
operations. If we introduce new or enhanced services with reliability, quality
or compatibility problems, then market acceptance of such services could be
significantly delayed or hindered. Such problems or delays could adversely
affect our ability to attract new customers and subscribers.
10
<PAGE>
Our New or Enhanced Services May Have Errors or Defects.
Our services may contain undetected errors or defects when new services or
enhancements are first introduced. We cannot assure you that, despite testing
by us or our customers, errors will not be found in new services or
enhancements after commencement of commercial deployment. Such errors could
result in:
. additional development costs;
. loss of, or delays in, market acceptance;
. diversion of technical and other resources from our other
development efforts; and
. the loss of customers and subscribers.
Any of these consequences could have a material adverse effect on our
business, financial condition and results of operations.
We Need to Balance Network Use to Provide Quality Service.
If we do not achieve balanced network utilization over a 24-hour period, our
network could become overburdened at certain periods during the day, which
could adversely affect our quality of service. Conversely, due to the high
fixed cost nature of our infrastructure, under-utilization of our network
during certain periods of the day could adversely affect our ability to provide
cost-efficient services at other times. Any failure to achieve balanced network
utilization could have a material adverse effect on our business, financial
condition and results of operations.
We Depend Upon Our Suppliers and Have Sole- and Limited-Sources of Supply for
Certain Products and Services.
We rely on other companies to supply certain key components of our network
infrastructure. These components include critical telecommunications services
and networking equipment, which, in the quantities and quality demanded by us,
are available only from sole- or limited-sources. AT&T Corp., MCI WorldCom,
Inc., PacWest Telecomm, Inc. and Williams are our primary providers of data
communications facilities and capacity. AT&T is currently the sole provider of
the frame relay backbone of our network. MCI WorldCom and Williams are
currently the providers of the ATM backbone of our network. We are also
dependent upon LECs to provide telecommunications services to us and our
customers. We experience delays from time to time in receiving
telecommunications services from these suppliers. We cannot assure you that we
will be able to obtain such services on the scale and within the time frames
required by us at an affordable cost, or at all. Any failure to obtain such
services on a sufficient scale, on a timely basis or at an affordable cost
would have a material adverse effect on our business, financial condition and
results of operations.
We purchase our Nortel/Bay, Cisco Systems, Netopia, Lucent Technologies, Sun
Microsystems and other vendor equipment either directly from the manufacturer
or via systems integrators including Milgo Solutions, Inc. and Williams. Some
of these vendors are sole-source suppliers. We purchase these components
pursuant to purchase orders placed from time to time with our suppliers. We do
not carry significant inventories of these components and have no guaranteed
supply arrangements for such components. Our suppliers also sell products to
our competitors and may in the future themselves become our competitors. We
cannot assure you that our suppliers will not enter into exclusive arrangements
with our competitors or stop selling their products or components to us at
commercially reasonable prices, or at all.
The expansion of our network infrastructure is placing, and will continue to
place, a significant demand on our suppliers. Some of these suppliers have
limited resources and production capacity. In addition, some of our suppliers
rely on sole-or limited-sources of supply for components included in their
products. Failure of our suppliers to meet increasing demand may prevent them
from continuing to supply components and products in the quantities and quality
and at the times required by us, or at all. Our inability to obtain sufficient
quantities of sole- or limited-source components or to develop alternative
sources, if required, could result in delays and
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increased costs in expanding, and overburdening of, our network infrastructure.
Any such delay, increased costs or overburdening would have a material adverse
effect on our business, financial condition and results of operations.
We also depend on our suppliers' ability to provide necessary products and
components that comply with various Internet and telecommunications standards.
These products and components must also interoperate with products and
components from other vendors. Any failure of our suppliers to provide products
or components that comply with Internet standards or that interoperate with
other products or components used by us in our network infrastructure could
have a material adverse effect on our business, financial condition and results
of operations.
Some of our suppliers, including the RBOCs and other LECs, currently are
subject to tariff controls and other price constraints that in the future may
be changed. In addition, regulatory proposals are pending that may affect what
the RBOCs and other LECs charge us. Any such regulatory changes could result in
increased prices of products and services, which could have a material adverse
effect on our business, financial condition and results of operations.
We Depend Upon Our Network Infrastructure.
Our success depends upon the capacity, reliability and security of our
network infrastructure. We currently derive a significant portion of our
revenue from customer subscriptions. We expect that a substantial portion of
our future revenue will be derived from the provision of tailored, value-added
network services to our enterprise customers. We must continue to expand and
adapt our network infrastructure as the number of users and the amount of
information they wish to transfer increase and as customer requirements change.
We currently project our network utilization will require rapid expansion of
the network capacity to avoid capacity constraints that would adversely affect
system performance. The expansion and adaptation of our network infrastructure
will require substantial financial, operational and management resources in
1999 and future periods. We cannot assure you that we will be able to expand or
adapt our network infrastructure to meet additional demand or our customers'
changing requirements on a timely basis, at a commercially reasonable cost, or
at all. In addition, if demand for network usage were to increase faster than
projected or were to exceed our current forecasts, the network could experience
capacity constraints, which would adversely affect the performance of the
system. Our business, financial condition and results of operations could be
materially adversely affected if, for any reason, we fail to:
. expand our network infrastructure on a timely basis;
. adapt our network infrastructure to changing customer requirements
or evolving industry trends; or
. alleviate capacity constraints experienced by our network
infrastructure.
Currently, we have transit agreements with MCI WorldCom, Sprint and UUNet
and we have peering agreements with America Online, PSINet and other network
providers to support the exchange of traffic between our network and the
Internet. We also have public peering arrangements with multiple smaller
Internet service providers. These public peering arrangements also support the
exchange of traffic between our network and the Internet. The failure of the
networks with which we have public peering, private peering or private transit,
or the failure of any of our data centers, or any other link in the delivery
chain, or any inability to successfully integrate new network resources into
our existing infrastructure, and resulting interruption of our operations would
have a material adverse effect on our business, financial condition and results
of operations.
Our Market Is Extremely Competitive.
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry in this market, and we
expect that competition will intensify in the future. We believe that our
ability to compete successfully depends upon a number of factors, including:
. market presence;
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. the capacity, reliability, low latency and security of our network
infrastructure;
. technical expertise and functionality, performance and quality of
services;
. customization;
. ease of access to and navigation of the Internet;
. the pricing policies of our competitors and suppliers;
. the variety of services;
. the timing of introductions of new services by us and our
competitors;
. customer support;
. our ability to support industry standards; and
. industry and general economic trends.
Our competitors generally may be divided into four groups:
telecommunications companies, online service providers, Internet service
providers and Web hosting providers. Many of our competitors have greater
market presence, engineering and marketing capabilities, and financial,
technological and personnel resources than those available to us. As a result,
they may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging
technologies and changes in customer requirements, take advantage of
acquisition and other opportunities more readily, and devote greater resources
to the marketing and sale of their products and services than we can. In
addition to the competitors discussed above, various organizations have entered
into or are forming joint ventures or consortiums to provide services similar
to those of our company.
We believe that new competitors will enter the value-added network services
market. Such new competitors could include large computer hardware, software,
media and other technology and telecommunications companies. Certain
telecommunications companies and online services providers are currently
offering or have announced plans to offer Internet or online services or to
expand their network services. Certain companies, including America Online,
BBN, PSINet and Verio, have also obtained or expanded their Internet access
products and services as a result of acquisitions. Such acquisitions may permit
our competitors to devote greater resources to the development and marketing of
new competitive products and services and the marketing of existing competitive
products and services. In addition, the ability of some of our competitors to
bundle other services and products with virtual private network services or
Internet access services could place us at a competitive disadvantage. Certain
companies are also exploring the possibility of providing or are currently
providing high-speed data services using alternative delivery methods such as
over the cable television infrastructure, through direct broadcast satellites
and over wireless cable.
As a result of increased competition and vertical and horizontal integration
in the industry, we could encounter significant pricing pressure. This pricing
pressure could result in significant reductions in the average selling price of
our services. For example, telecommunications companies that compete with us
may be able to provide customers with reduced communications costs in
connection with their Internet access services or private network services,
reducing the overall cost of their solutions and significantly increasing price
pressures on us. We cannot assure you that we will be able to offset the
effects of any such price reductions with an increase in the number of our
customers, higher revenue from enhanced services, cost reductions or otherwise.
In addition, we believe that the Internet access and online services businesses
are likely to encounter consolidation in the near future. Consolidation could
result in increased price and other competition in these industries and,
potentially, the virtual private networks industry. Increased price or other
competition could result in erosion of our market share and could have a
material adverse effect on our business, financial condition and results of
operations. We cannot assure you that we will have the financial resources,
technical expertise or marketing and support capabilities to continue to
compete successfully.
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We Must Keep Up With Rapid Technological Change and Evolving Industry
Standards.
The markets for our services are characterized by rapidly changing
technology, evolving industry standards, changes in customer needs, emerging
competition and frequent new product and service introductions. Our future
success will depend, in part, on our ability to:
. effectively use leading technologies;
. continue to develop our technical expertise;
. enhance our current networking services;
. develop new services that meet changing customer needs;
. advertise and market our services; and
. influence and respond to emerging industry standards and other
technological changes.
All this must be accomplished in a timely and cost-effective manner. We
cannot assure you that we will be successful in effectively using new
technologies, developing new services or enhancing our existing services on a
timely basis. We cannot assure you that such new technologies or enhancements
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense. We cannot assure you that we will
succeed in adapting our network service business to alternate access devices
and conduits as they emerge.
We believe that our ability to compete successfully is also dependent upon
the continued compatibility and interoperability of our services with products
and architectures offered by various vendors. Although we intend to support
emerging standards in the market for Internet access, we cannot assure you that
industry standards will be established. If industry standards are established,
we cannot assure you that we will be able to conform to these new standards in
a timely fashion and maintain a competitive position in the market.
Specifically, our services rely on the continued widespread commercial use of
TCP/IP. Alternative open protocol and proprietary protocol standards have been
or are being developed. If any of these alternative protocols become widely
adopted, there may be a reduction in the use of TCP/IP, which could render our
services obsolete and unmarketable. In addition, we cannot assure you that
services or technologies developed by others will not render our services or
technology uncompetitive or obsolete.
An integral part of our strategy is to design our network to meet the
requirements of emerging standards such as 56.6 Kbps modems and applications
such as IP-based interactive video and voice conferencing communications. Our
initial deployment of 56.6 Kbps modem technology was difficult for some of our
customers, including WebTV, due to compatibility problems between the software
and their modems. We had to remove the software from the network and modems to
fix the problem. We are currently testing a modified version of the software
and we expect to redeploy it into the network in the first quarter of 1999.
However, we cannot assure you that we will successfully redeploy the software.
If we fail, for technological or other reasons, to develop and introduce the
56.6 Kbps modem technology or other new or enhanced services that are
compatible with industry standards and that satisfy customer requirements, then
our business, financial condition and results of operations would be materially
adversely affected. See "Business--The Concentric Network."
We face the risk of fundamental changes in the way Internet access is
delivered. Internet services are currently accessed primarily by computers
connected by telephone lines. Several companies have announced the development
and planned sale of cable television modems, wireless modems and satellite
modems to provide Internet access. Cable television, satellite and wireless
modems can transmit data at substantially faster speeds than the modems we and
our subscribers currently use. In addition, wireless modems have the potential
to reduce the cost of network services. As the Internet becomes accessible
through these cable television, wireless and satellite modems and by screen-
based telephones, televisions or other consumer electronic devices,
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or subscriber requirements change the way Internet access is provided, we will
have to develop new technology or modify our existing technology to accommodate
new developments such as:
. Internet access through cable television, satellite and wireless
modems;
. Internet access through screen-based telephones, televisions or
other consumer electronic devices; or
. subscriber requirements that change the way Internet access is
provided.
Our pursuit of these technological advances may require substantial time and
expense. We cannot assure you that we will succeed in adapting our Internet
access business to alternate access devices and conduits.
Our Network System Could Fail.
Network expansion and growth in usage will place increased stress upon our
network hardware and traffic management systems. Our network has been designed
with redundant backbone circuits to allow traffic re-routing. We cannot assure
you, however, that we will not experience failures relating to individual
network POPs or even catastrophic failure of the entire network. Moreover, our
operations are dependent upon our ability to protect our network infrastructure
against damage from power loss, telecommunications failures and similar events.
A significant portion of our computer equipment, including critical equipment
dedicated to our Internet access services, is located at our facilities in
Chicago, Illinois, and Cupertino, California. In addition, our modems and
routers that serve large areas of the United States are located in these
cities. Our network operations center, which manages the entire network, is in
St. Louis, Missouri. Despite our precautions, a natural disaster, such as an
earthquake, or other unanticipated problem at the network operations center, at
one of our hubs (sites at which we have located routers, switches and other
computer equipment that make up the backbone of our network infrastructure) or
at a number of our POPs has from time to time in the past caused, and in the
future could cause, interruptions in our services. In addition, our services
could be interrupted if our telecommunications providers fail to provide the
data communications capacity in the time frame required by us as a result of a
natural disaster or for some other reason. Any damage or failure that causes
interruptions in our operations could have a material adverse effect on our
business, financial condition and results of operations.
Our System May Experience Security Breaches.
Despite the implementation of network security measures, the core of our
network infrastructure is vulnerable to computer viruses, break-ins and similar
disruptive problems caused by our customers or Internet users. Computer
viruses, break-ins or other problems caused by third parties could lead to
interruptions, delays or cessation in service to our customers and subscribers.
Furthermore, inappropriate use of the network by third parties could also
potentially jeopardize the security of confidential information stored in our
computer systems and our customer's computer systems. We may face liability and
may lose potential subscribers as a result. Although we intend to continue to
implement industry-standard security measures, such measures occasionally have
been circumvented in the past. We cannot assure you that our security
enclosures will not be circumvented in the future. The costs and resources
required to eliminate computer viruses and alleviate other security problems
may result in interruptions, delays or cessation of service to our customers
that could have a material adverse effect our business, financial condition and
results of operations.
We Depend Upon Key Personnel and May be Unable to Timely Hire and Retain
Sufficient Numbers of Qualified Personnel.
Our success depends to a significant degree upon the continued contributions
of our executive management team, including Henry R. Nothhaft, the Company's
Chairman, President and Chief Executive Officer, and John K. Peters, the
Company's Executive Vice President and General Manager, Network Services
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Applications Division. The loss of the services of Mr. Nothhaft or Mr. Peters
could have a material adverse effect on us. We do not have employment
agreements with any of our senior officers, including Mr. Nothhaft or Mr.
Peters. Nor do we carry key man life insurance on the life of any such persons.
Our success will also depend upon the continued service of the other members of
our senior management team and technical, marketing and sales personnel.
Competition for qualified employees is intense. Our employees may voluntarily
terminate their employment with us at any time. Our success also depends upon
our ability to attract and retain additional highly qualified management,
technical, sales and marketing and customer support personnel. Locating
personnel with the combination of skills and attributes required to carry out
our strategy is often a lengthy process. The loss of key personnel, or the
inability to attract additional, qualified personnel, could have a material
adverse effect upon our results of operations, development efforts and ability
to complete the expansion of our network infrastructure. Any such event could
have a material adverse effect on our business, financial condition and results
of operations.
We Have Incurred Substantial Indebtedness and May Not Be Able to Service Our
Debt.
We are and will continue to have a significant amount of outstanding
indebtedness. We have significant debt service requirements as a result of this
indebtedness. At December 31, 1998, our total debt (including current portion)
was $163.0 million and stockholders' deficit was $56.9 million. Interest on
such indebtedness totals approximately $19.1 million per year. We also issued
150,000 shares of preferred stock in June 1998. Dividends accrue on the
preferred stock at the rate of 13 1/2% per year. At December 31, 1998,
dividends and accretion on the preferred stock totaled approximately $12.0
million. Dividends and accretion will total approximately $23.0 million in 1999
and are expected to grow in each successive year. To date, we have chosen to
pay such dividends in shares of preferred stock, rather than in cash. We must
also redeem the preferred stock in 2010. As a result of these and other
features, the preferred stock is substantially equivalent to debt. Our debt,
including the preferred stock, has important consequences for our company and
for you, including the following:
. our ability to obtain additional financing in the future, whether
for working capital, capital expenditures, acquisitions or other
purposes, may be impaired;
. a substantial portion of our cash flow from operations is dedicated
to the payment of interest on our debt, which reduces the funds
available to us for other purposes;
. our flexibility in planning for or reacting to changes in market
conditions may be limited; and
. we may be more vulnerable in the event of a downturn in our
business.
Our ability to meet our debt service and preferred stock dividend
obligations will depend on our future operating performance and financial
results. This ability will be subject in part to factors beyond our control.
Although we believe that our cash flow will be adequate to meet our interest
and dividend payments, we cannot assure you that we will continue to generate
sufficient cash flow in the future to meet our debt service and preferred stock
requirements. If we are unable to generate cash flow in the future sufficient
to cover our fixed charges and are unable to borrow sufficient funds from other
sources, then we may be required to:
. refinance all or a portion of our existing debt; or
. sell all or a portion of our assets.
We cannot assure you that a refinancing would be possible. We cannot assure
you that any asset sales would be timely or that the proceeds which we could
realize from such asset sales would be sufficient to meet our debt service
requirements. In addition, the terms of our debt and preferred stock restrict
our ability to sell our assets and our use of the proceeds from any such asset
sale.
We May Need Additional Capital in the Future and Such Additional Financing May
Not Be Available.
We currently anticipate that our available cash resources, combined with the
net proceeds from this offering and financing available under a network
equipment lease agreement (that currently has no maximum
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borrowing limit), will be sufficient to meet our anticipated working capital
and capital expenditure requirements through 1999. However, we cannot assure
you that such resources will be sufficient for anticipated or unanticipated
working capital and capital expenditure requirements. We may need to raise
additional funds through public or private debt or equity financings in order
to:
. take advantage of unanticipated opportunities, including more rapid
international expansion or acquisitions of complementary businesses
or technologies;
. develop new products or services; or
. respond to unanticipated competitive pressures.
We may also raise additional funds through public or private debt or equity
financings if such financings become available on favorable terms. We cannot
assure you that any additional financing we may need will be available on terms
favorable to us, or at all. If adequate funds are not available or are not
available on acceptable terms, we may not be able to take advantage of
unanticipated opportunities, develop new products or services or otherwise
respond to unanticipated competitive pressures. In such case, our business,
results of operations and financial condition could be materially adversely
affected. Our forecast of the period of time through which our financial
resources will be adequate to support our operations is a forward looking
statement that involves risks and uncertainties, and actual results could vary
materially as a result of a number of factors, including those set forth above.
We Face Risks Associated with International Expansion.
A key component of our strategy is to expand into international markets. The
following risks are inherent in doing business on an international level:
. unexpected changes in regulatory requirements;
. export restrictions;
. export controls relating to encryption technology;
. tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations;
. longer payment cycles;
. problems in collecting accounts receivable;
. political instability;
. fluctuations in currency exchange rates;
. seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
. potentially adverse tax consequences that could adversely impact the
success of our international operations.
We cannot assure you that one or more of such factors will not have a
material adverse effect on our future international operations and,
consequently, on our business, financial condition and results of operations.
We have an agreement with TMI Telemedia International, Ltd., a subsidiary of
the leading Italian telecommunications company, Telecom Italia, SpA, to
establish an international network based on our network technology and
expertise and TMI's existing telecommunications infrastructure. In exchange, we
granted TMI certain exclusive rights in critical markets, including Europe.
While the goal of this effort is to deliver a range of compatible network
services worldwide, to date we have had only limited deployment of services
under this agreement. Our experience in working with TMI to develop versions of
our products and to market and
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distribute our products internationally is limited. Our international strategy
has not developed as rapidly as anticipated and may be further delayed if:
. we cannot successfully deploy our technology over TMI's
infrastructure;
. we cannot transfer our knowledge to TMI's employees; or
. TMI does not devote sufficient management, technological or
marketing resources to this project.
Our business, results of operation or financial condition could be
materially adversely affected if delays in our international strategy continue
or worsen.
We have entered into roaming agreements with third parties to allow our
customers to access their Internet accounts from Japan and certain other
foreign countries. We provide Web hosting and extranet services for GX
Networks' United Kingdom customers pursuant to an agreement signed in August
1998. We also acquired Web hosting facilities in Stockholm, Sweden, Tokyo,
Japan and Hong Kong in February 1998 as a result of our acquisition of
Internex. We cannot assure you that we will be able to successfully market,
sell and deliver our products in these markets.
Our Business May Be Impacted By The Year 2000 Issue.
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in system failures or miscalculations causing
disruptions of normal business activities. We are currently in the process of
reviewing our products and services, as well as our internal management
information systems in order to identify and modify those products, services
and systems that are not year 2000 compliant.
Based on our assessment to date, we have determined that our internally
developed software, including much of our operational, financial and management
information systems software, is year 2000 compliant. Our operational,
financial and management information systems software which have not been
internally developed have been certified as year 2000 compliant by the third
party vendors who have supplied the software. To the extent that our systems
are not year 2000 compliant, we are modifying such systems to make them
compliant. We expect such modifications will be made on a timely basis and do
not believe that the cost of such modifications will have a material effect on
our operating results. Additionally, we are continuing to assess the year 2000
compliance of our products and services. To date, most of our newly introduced
products and services do not contain material year 2000 deficiencies, however
some of our customers are running earlier product versions that are not year
2000 compliant. We have been encouraging such customers to migrate to current
product versions. We estimate that the capital and other costs associated with
the upgrade and conversion of our existing products, services and systems
relating to the year 2000 issue will not be material. We do not have and are
not developing a contingency plan in the event our systems fail due to year
2000 related problems.
Our products, services and systems operate in complex network environments
and directly and indirectly interact with a number of other hardware and
software systems. We face risks to the extent that suppliers of products,
services and systems purchased by us and others with whom we transact business
on a worldwide basis, including those which form significant portions of our
network and may be sole- or limited-source suppliers, do not have business
systems or products that comply with year 2000 requirements. We have not
received any significant assurances from our suppliers that their networks are
year 2000 compliant. If these networks fail, our business will be significantly
impacted.
Our expectation that we will be able to upgrade our products, services and
systems to address the year 2000 issue and our expectation regarding the costs
associated with these upgrades are forward-looking statements subject to a
number of risks and uncertainties. Actual results may vary materially as a
result of a number of factors. We cannot assure you that we will be able to
timely and successfully modify such products,
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services and systems to comply with year 2000 requirements. Any failure to do
so could have a material adverse effect on our operating results. Furthermore,
despite testing by us and our vendors, our products, services and systems may
contain undetected errors or defects associated with year 2000 date functions.
In the event any material errors or defects are not detected and fixed or third
parties cannot timely provide us with products, services or systems that meet
the year 2000 requirements, our operating results could be materially adversely
affected. Known or unknown errors or defects that affect the operation of our
products, services or systems could result in delay or loss of revenue,
interruption of network services, cancellation of customer contracts, diversion
of development resources, damage to our reputation, and litigation costs. We
cannot assure you that these or other factors relating to year 2000 compliance
issues will not have a material adverse effect on our business, operating
results or financial condition.
We Could Face Government Regulation.
The Federal Communications Commission ("FCC") currently does not regulate
value-added network software or computer equipment related services that
transport data or IP-based voice messages over telecommunication facilities as
telecommunications services. We provide value-added IP-based network services,
in part, through data transmissions over public telephone lines. Operators of
these types of value-added networks that provide access to regulated
transmission facilities only as part of a data services package are classified
for regulatory purposes as providers of "information services" and are
currently excluded from regulations that apply to "telecommunications
carriers." As such, we are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, future changes in law or regulation could result
in some aspects of our current operations becoming subject to regulation by the
FCC or another regulatory agency.
The FCC currently is reviewing its regulatory positions on data
transmissions over telecommunications networks and could seek to impose some
form of telecommunications carrier regulation on the network transport and
telecommunications functions of an enhanced or information services package.
Further, the FCC could conclude that our protocol conversions, computer
processing and interaction with customer-supplied information are insufficient
to afford us with the benefits of the enhanced or information service
regulatory classification. If the FCC reaches such conclusions, it may seek to
regulate some segments of our activities as telecommunications services.
State public utility commissions generally have declined to regulate
enhanced or information services. Some states, however, have continued to
regulate particular aspects of enhanced services in limited circumstances, such
as where they are provided by incumbent LECs that operate telecommunications
networks. Moreover, the public service commissions of some states continue to
review potential regulation of such services. We cannot assure you that
regulatory authorities of states where we provide Internet access, intranet and
VPN services will not seek to regulate aspects of these activities as
telecommunications services. The prices at which we may sell our services could
be affected by regulatory changes:
. in the Internet connectivity market;
. that indirectly or directly affect telecommunications costs; or
. that increase the likelihood or scope of competition from the RBOCs.
We cannot predict the impact, if any, that future regulation or regulatory
changes may have on our business and we cannot assure you that future
regulation or regulatory changes will not have a material adverse effect on our
business, results of operations or financial condition.
We Depend On Our Proprietary Technology and Technological Expertise.
Our success and ability to compete is dependent in part upon our technology.
In this regard, we believe our success is more dependent upon our technical
expertise than our proprietary rights. We rely upon a
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combination of copyright, trademark and trade secret laws and contractual
restrictions to protect our proprietary technology. It may be possible for a
third party to copy or otherwise obtain and use our products or technology
without authorization or to develop similar technology independently. We cannot
assure you that such measures have been, or will be, adequate to protect our
proprietary technology. Our competitors may also independently develop
technologies that are substantially equivalent or superior to our technology.
We operate a material portion of our business over the Internet. The
Internet is subject to a variety of risks. Such risks include but are not
limited to the substantial uncertainties that exist regarding the system for
assigning domain names and the status of private rules for resolution of
disputes regarding rights to domain names. We cannot assure you that we will
continue to be able to employ our current domain names in the future or that
the loss of rights to one or more domain names will not have a material adverse
effect on our business and results of operations.
Third Parties May Claim We Infringe Their Proprietary Rights.
Although we do not believe we infringe the proprietary rights of any third
parties, we cannot assure you that third parties will not assert such claims
against us in the future or that such claims will not be successful. We could
incur substantial costs and diversion of management resources to defend any
claims relating to proprietary rights, which could have a material adverse
effect on our business, financial condition and results of operations.
Furthermore, parties making such claims could secure a judgment awarding
substantial damages, as well as injunctive or other equitable relief that could
effectively block our ability to license our products in the United States or
abroad. Such a judgment would have a material adverse effect on our business,
financial condition and results of operations. In addition, we are obligated
under certain agreements to indemnify the other party for claims that we
infringe on the proprietary rights of third parties. If we are required to
indemnify parties under these agreements, our business, financial condition and
results of operations could be materially adversely affected. If someone
asserts a claim relating to proprietary technology or information against us,
we may seek licenses to such intellectual property. We cannot assure you,
however, that we could obtain licenses on commercially reasonable terms, if at
all. The failure to obtain the necessary licenses or other rights could have a
material adverse effect on our business, financial condition and results of
operations.
We Could Face Liability for Information Disseminated Through Our Network.
The law relating to the liability of online service providers, private
network operators and Internet service providers for information carried on or
disseminated through the facilities of their networks is continuing to evolve
and remains unsettled. In the past, at least one court has ruled that Internet
service providers could be found liable for copyright infringement as a result
of information disseminated through their networks. Such claims have been
asserted against us in the past and we cannot assure you that similar claims
will not be asserted in the future. Federal laws have been enacted, however,
which, under certain circumstances, provide Internet service providers with
immunity from liability for information that is disseminated through their
networks when they are acting as mere conduits of information. A Federal Court
of Appeals has recently held that the Telecommunications Act of 1996 creates
immunity from liability on the part of Internet service providers for libel
claims arising out of information disseminated over their services by third
party content providers. In addition, the Digital Millennium Copyright Act,
which was enacted in 1998, creates a safe-harbor from copyright infringement
liability for Internet service providers that meet certain requirements. These
requirements include certain technical measures and registering with the
Copyright Office the identity of the provider's Designated Infringement Agent
who is to receive notice of any claims of copyright infringement. We cannot
assure you, however, that the Digital Millennium Copyright Act or any other
legislation will protect us from copyright infringement liability.
The Child Online Protection Act of 1998 prohibits and imposes criminal
penalties and civil liability on anyone engaged in the business of selling or
transferring, by means of the World Wide Web, material that is
20
<PAGE>
harmful to minors without restricting access to such material by persons under
seventeen years of age. Numerous states have adopted or are currently
considering similar types of legislation. The imposition upon us, Internet
service providers or Web server hosts of potential liability for such materials
carried on or disseminated through our systems could require us to implement
measures to reduce our exposure to such liability. Such measures may require
the expenditure of substantial resources or the discontinuation of certain
product or service offerings. Further, the costs of defending against any such
claims and potential adverse outcomes of such claims could have a material
adverse effect on our business, financial condition and results of operations.
The Child Online Protection Act of 1998 has been challenged by civil rights
organizations in part on the grounds that it violates the First Amendment. A
similar statute was held unconstitutional by the United States Supreme Court in
1997. A United States District Court has temporarily enjoined enforcement of
the law until February 1, 1999, and it is possible that additional injunctions
prohibiting enforcement of the statute will be entered pending final resolution
of the case.
We Have Discretionary Authority Over the Use of Net Proceeds.
We have no specific allocations for the net proceeds of this offering.
Consequently, management will retain a significant amount of discretion over
the application of such proceeds. Because of the number and variability of
factors that determine our use of the net proceeds of the offering, we cannot
assure you that such applications will not vary substantially from our current
intentions. Pending such uses, we intend to invest the net proceeds of the
offering in short term U.S. investment grade and government securities.
Our Stock Price Has Been and May Continue to Be Volatile.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to
a variety of factors, including the following:
. actual or anticipated variations in quarterly operating results;
. announcements of technological innovations;
. new products or services offered by us or our competitors;
. changes in financial estimates by securities analysts;
. conditions or trends in the network services market;
. our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
. additions or departures of key personnel;
. sales of common stock; and
. other events or factors that may be beyond our control.
In addition, the stock markets in general, and the Nasdaq National Market
and the market for network services and technology companies in particular,
have experienced extreme price and volume fluctuations recently. These
fluctuations often have been unrelated or disproportionate to the operating
performance of these companies. The trading prices of many technology
companies' stocks are at or near historical highs and these trading prices and
multiples are substantially above historical levels. These trading prices and
multiples may not be sustained. These broad market and industry factors may
materially adversely affect the market price of our common stock, regardless of
our actual operating performance. In the past, following periods of volatility
in the market price of a company's securities, securities class action
litigation often has been instituted against that company. Litigation like
this, if instituted, could result in substantial costs and a diversion of
management's attention and resources.
21
<PAGE>
HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING
Our net proceeds from the sale of the 2,500,000 shares of common stock we
are offering are estimated to be $102.6 million at an assumed public offering
price of $43.50 per share, after deducting the underwriting discount and
estimated offering expenses we will pay.
We expect to use the net proceeds from this offering for general corporate
purposes, working capital and anticipated capital expenditures of approximately
$30.0 million in 1999. In addition, we may use a portion of the net proceeds to
acquire complementary assets, technologies and businesses. We currently have no
commitments or agreements and are not involved in any negotiations with respect
to any such transactions. Pending use of the net proceeds of this offering, we
intend to invest the net proceeds in short term U.S. investment grade and
government securities.
PRICE RANGE OF OUR COMMON STOCK
Our common stock has been traded on the Nasdaq National Market under the
symbol "CNCX" since our initial public offering on August 1, 1997. The
following table sets forth, for the periods indicated, the high and low sale
prices for our common stock as reported by the Nasdaq National Market:
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
Fiscal Year Ended December 31, 1997:
Third Quarter (from August 1, 1997)........................... $16 $11 3/8
Fourth Quarter................................................ 15 7 7/8
Fiscal Year Ended December 31, 1998:
First Quarter................................................. $20 3/8 $ 8 7/8
Second Quarter................................................ 31 1/2 18 5/8
Third Quarter................................................. 41 14 1/4
Fourth Quarter................................................ 37 1/4 14 1/2
Fiscal Year Ending December 31, 1999:
First Quarter (through January 29, 1999)...................... $47 1/2 $31 7/8
</TABLE>
On January 29, 1999, the last reported sale price for our common stock on
the Nasdaq National Market was $43.50 per share. As of January 20, 1999, we
estimate that there were approximately 271 holders of record and over 4,388
beneficial owners of the common stock.
DIVIDEND POLICY
We have not paid and do not anticipate paying any cash dividends on our
common stock in the foreseeable future. We intend to retain our earnings, if
any, for use in our growth and ongoing operations. In addition, the terms of
our preferred stock restrict our ability to pay dividends on our common stock.
22
<PAGE>
CAPITALIZATION
The following table sets forth (i) our actual cash and cash equivalents and
capitalization derived from financial statements as of December 31, 1998, and
(ii) such amounts, as adjusted to reflect our sale of an aggregate of 2,500,000
shares of common stock having net proceeds of $102.6 million after deducting
the estimated discount and offering expenses from the offering and to reflect
our sale of 806,679 shares of common stock to SBC at $24.15 per share for net
proceeds of approximately $19.5 million which occurred in January 1999. The
capitalization information set forth in the table below is qualified by the
more detailed Consolidated Financial Statements and Notes thereto beginning on
page F-1 of this prospectus. The table should be read in conjunction with such
Consolidated Financial Statements and Notes.
<TABLE>
<CAPTION>
December 31, 1998
----------------------
Actual As Adjusted
--------- -----------
(In thousands)
<S> <C> <C>
Cash and cash equivalents(1)............................ $ 98,988 $ 221,032
--------- ---------
Short term investments.................................. 52,226 52,226
--------- ---------
Restricted cash......................................... 36,238 36,238
--------- ---------
Long term debt:
Capital lease obligations, net of current portion(2).. 10,434 10,434
12 3/4% Senior Notes due 2007(3)...................... 146,021 146,021
--------- ---------
Total long-term debt, net of current portion........ 156,455 156,455
13 1/2% Senior Redeemable Exchangeable Preferred Stock
due 2010............................................... 156,105 156,105
Stockholders' equity (deficit):
Common Stock, $0.001 par value; 100,000,000 shares
authorized; 15,144,310 shares outstanding(4)......... 190,076 312,120
Accumulated deficit................................... (246,055) (246,055)
Deferred compensation................................. (896) (896)
--------- ---------
Total stockholders' equity (deficit)................ (56,875) 65,169
--------- ---------
Total capitalization.................................... $ 255,685 $ 377,729
========= =========
</TABLE>
- ----------
(1) Excludes restricted cash of $36.2 million held in an escrow account in
connection with our 12 3/4% Senior Notes. See Note 5 of Notes to
Consolidated Financial Statements.
(2) See Note 4 of Notes to Consolidated Financial Statements.
(3) Includes the unamortized discount of $4.0 million relating to warrants
which were issued in connection with our 12 3/4% Senior Notes. See Note 5
of Notes to Consolidated Financial Statements.
(4) Excludes (A) options and warrants to purchase approximately 5,770,835
shares of common stock outstanding as of December 31, 1998, having a
weighted average exercise price of $13.98 per share, (B) a warrant to
purchase 906,679 shares of common stock at an exercise price of $21.00 per
share that we issued to SBC in January 1999, and (C) options to purchase
598,975 shares of common stock issued in January 1999, having a weighted
average exercise price of $33.69 per share.
23
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Consolidated Financial Statements and Notes thereto beginning on page F-1 of
this prospectus and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" beginning on page 25 of this prospectus.
The consolidated statement of operations data for each of the three years ended
December 31, 1998 and consolidated balance sheet data as of December 31, 1997
and 1998 are derived from financial statements of the Company which have been
audited by Ernst & Young LLP, independent auditors, and are included elsewhere
herein. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1994 1995 1996 1997 1998(1)
------- -------- -------- -------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenue..................... $ 442 $ 2,483 $ 15,648 $ 45,457 $ 82,807
Cost of revenue............. 2,891 16,168 47,945 61,439 85,352
Network equipment write-
off(2)..................... -- -- 8,321 -- --
Development................. 534 837 2,449 4,850 7,734
Marketing and sales......... 639 3,899 16,609 24,622 39,793
General and administrative.. 611 2,866 3,445 4,790 10,398
Amortization of goodwill and
other intangible assets.... -- -- -- -- 3,842
Acquisition-related
charges.................... -- -- -- -- 1,291
Write-off of in-process
technology................. -- -- -- -- 5,200
------- -------- -------- -------- ---------
Total costs and expenses.... 4,675 23,770 78,769 95,701 153,610
------- -------- -------- -------- ---------
Loss from operations........ (4,233) (21,287) (63,121) (50,244) (70,803)
Other income (expense)...... -- -- -- 1,233 (750)
Net interest expense........ (57) (721) (3,260) (6,571) (13,595)
------- -------- -------- -------- ---------
Loss before extraordinary
item....................... (4,290) (22,008) (66,381) (55,582) (85,148)
Extraordinary gain on early
retirement of debt......... -- -- -- -- 3,042
------- -------- -------- -------- ---------
Net loss.................... (4,290) (22,008) (66,381) (55,582) (82,106)
------- -------- -------- -------- ---------
Preferred stock dividends
and accretion.............. -- -- -- -- (11,958)
------- -------- -------- -------- ---------
Net loss attributable to
common stockholders........ $(4,290) $(22,008) $(66,381) $(55,582) $ (94,064)
======= ======== ======== ======== =========
Net loss per share
attributable to common
stockholders(3)............ $ (13.46) $ (5.63) $ (6.47)
======== ======== =========
Shares used in computing net
loss per share attributable
to common stockholders(3).. 4,937 9,872 14,547
======== ======== =========
Other Consolidated Financial
Data:
Depreciation and
amortization............... $ 169 $ 2,196 $ 9,470 $ 19,230 $ 33,418
EBITDA(4)................... (4,064) (19,091) (53,651) (31,014) (30,894)
Capital expenditures(5)..... 718 17,176 39,093 22,798 30,137
<CAPTION>
As of December 31,
------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet
Data:
Cash and cash equivalents... $ 63 $ 19,054 $ 17,657 $119,959 $ 98,988
Short term investments...... -- -- -- -- 52,226
Restricted cash(6).......... -- -- -- 52,525 36,238
Property and equipment,
net........................ 1,303 16,289 47,927 53,710 64,268
Total assets................ 1,798 37,235 70,722 244,489 298,257
Notes payable and capital
lease obligations, net of
current portion............ 1,648 11,047 30,551 179,172 156,455
Redeemable exchangeable
preferred stock............ -- -- -- -- 156,105
Total stockholders' equity
(deficit).................. (4,202) 9,763 2,925 31,918 (56,875)
</TABLE>
(Footnotes appear on the next page.)
24
<PAGE>
- ----------
(1) During 1998, the Company acquired InterNex, DeltaNet and AnaServe, the
effects of which have been included in the 1998 financial results. See Note
13 of Notes to Consolidated Financial Statements.
(2) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 3 of Notes to Consolidated Financial
Statements.
(3) Net loss per share and shares used in computing net loss per share
attributable to common stockholders are presented on a pro forma basis for
the years ended December 31, 1996 and 1997 and on an historical basis for
the year ended December 31, 1998. See Note 1 of Notes to Consolidated
Financial Statements.
(4) EBITDA is loss from operations before interest, taxes, depreciation and
amortization and also excludes the write-off of in-process technology and
acquisition-related charges. EBITDA is included in this table because
management believes that certain investors find it to be a useful tool for
approximating the Company's cash flow. However, EBITDA does not represent
cash flow from operations, as defined by generally accepted accounting
principles, should not be considered as a substitute for net loss as an
indicator of the Company's operating performance or cash flow as a measure
of liquidity, and should be examined in conjunction with the Consolidated
Financial Statements and Notes thereto of the Company included elsewhere in
this prospectus.
(5) Capital expenditures includes assets acquired through capital lease
financing and other debt.
(6) Restricted cash of $36.2 million consists of funds held in escrow to pay
interest relating to the Company's 12 3/4% Senior Notes. See Note 5 of
Notes to Consolidated Financial Statements.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with financial
statements and related notes included elsewhere in this prospectus. The results
shown in this prospectus are not necessarily indicative of the results to be
expected in any future periods. This discussion contains forward-looking
statements based on current expectations which involve risks and uncertainties.
Actual results and the timing of certain events may differ significantly from
those projected in such forward-looking statements due to a number of factors,
including those set forth in the section entitled "Risk Factors" and elsewhere
in this prospectus.
Overview
The Company was founded in 1991. From 1991 to mid-1993, the Company
conducted development and network services planning activities and realized no
revenues. Initially, the Company was focused on providing consumers with direct
dial-up connectivity to bulletin board services. Online gaming and
entertainment services for consumers were commenced in July 1993 through the
utilization of a third party network infrastructure. The Company commenced
operation of its own network in late 1994. In May 1995, new management led by
Henry R. Nothhaft redefined and broadened the Company's strategy to provide a
range of Internet and tailored, value-added Internet Protocol-based network
services to consumers and businesses.
The Company's revenue prior to 1996 was primarily generated from providing
Internet access to consumers. The Company's current focus is on developing and
deploying VPNs and providing dedicated network access and Web hosting services
for enterprise customers. Contracts with enterprise customers typically have a
term ranging from one to three years. The Company expects enterprise-related
revenue to represent an increasing portion of total revenue in future periods.
The foregoing expectation is a forward-looking statement that involves risks
and uncertainties, and actual results could vary as a result of a number of
factors including the Company's operating results, the results and timing of
the Company's launch of new products and services, governmental or regulatory
changes, the ability of the Company to meet product and project demands, the
success of the Company's marketing efforts, competition and acquisitions of
complementary businesses, technologies or products.
In February 1998, the Company acquired InterNex, a provider of network
services, collocation services and Web hosting facilities to enterprise
customers. This acquisition was accounted for using the purchase method of
accounting. Accordingly, the Company's historical financial statements do not
include results of operations, financial position or cash flows of InterNex
prior to its acquisition in February 1998. In addition, as a result of the
acquisition, the Company incurred a charge of $5.2 million relating to acquired
in-process technology and recorded an aggregate of $12.6 million of goodwill
and other intangible assets, which will be amortized on a straight-line basis
over their estimated useful lives ranging from two to five years.
In May 1998, the Company acquired DeltaNet, a provider of dial-up and
dedicated access services, Web hosting services and Web application development
and design. This transaction was accounted for as a pooling of interests.
Results of DeltaNet's operations for the period beginning April 1, 1998 through
December 31, 1998 are included in the consolidated results of operations. In
addition, as a result of the acquisition, the Company has incurred charges of
approximately $1.3 million in transaction costs consisting primarily of
severance costs, redundant facilities and assets and professional fees related
to the acquisition.
In August 1998, the Company acquired AnaServe, a provider of Web hosting
services. This acquisition was accounted for using the purchase method of
accounting. The Company's historical financial statements do not include
results of operations, financial position or cash flows of AnaServe prior to
its acquisition. As a result of the acquisition, the Company has recorded an
aggregate of $12.0 million of goodwill and other intangible assets, which will
be amortized on a straight-line basis over their useful lives ranging from one
to five years.
26
<PAGE>
The Company may acquire other complementary products, technology and
businesses. If the Company were to incur additional charges for acquired in-
process technology, amortization of goodwill and acquisition costs with respect
to any future acquisitions, the Company's business, operating results and
financial condition could be materially and adversely affected. See "Risk
Factors--Our Acquisition Strategy Poses Several Risks" and "--Liquidity and
Capital Resources."
The Company has incurred net losses and experienced negative cash flow from
operations since inception and expects to continue to operate at a net loss and
experience negative cash flow at least through the remainder of 1999. The
Company's ability to achieve profitability and positive cash flow from
operations is dependent upon the Company's ability to substantially grow its
revenue base and achieve other operating efficiencies. The Company experienced
net losses attributable to common stockholders of approximately $66.4 million,
$55.6 million and $94.1 million for the years ended December 31, 1996, 1997,
and 1998, respectively. We cannot assure you that the Company will be able to
achieve or sustain revenue growth, profitability or positive cash flow on
either a quarterly or an annual basis. At December 31, 1998, the Company had
approximately $90.0 million of gross deferred tax assets comprised primarily of
net operating loss carry-forwards. The Company believes that, based on a number
of factors, the available objective evidence creates sufficient uncertainty
regarding the realizability of the deferred tax assets such that a full
valuation allowance has been recorded. These factors include the Company's
history of net losses since its inception and the fact that the market in which
the Company competes is intensely competitive and characterized by rapidly
changing technology. The Company believes that, based on the current available
evidence, it is more likely than not that the Company will not generate taxable
income through 1999, and possibly beyond, and accordingly will not realize the
Company's deferred tax assets through 1999, and possibly beyond. The Company
will continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of
net operating losses before utilization. See "Risk Factors--We Have a Limited
Operating History and Expect Continuing Operating Losses."
The Company expects to focus in the near term on building and increasing its
revenue base, which will require it to significantly increase its expenses for
personnel, marketing, network infrastructure and the development of new
services, and may adversely impact short term operating results. As a result,
the Company believes that it will incur losses in the near term and we cannot
assure you that the Company will be profitable in the future.
The Company's operating results have fluctuated in the past and may in the
future fluctuate significantly, depending upon a variety of factors, including
the timely deployment and expansion of the Concentric network and new network
architectures, the incurrence of related capital costs, variability and length
of the sales cycle associated with the Company's product and service offerings,
the receipt of new value-added network services and consumer services
subscriptions and the introduction of new services by the Company and its
competitors. Additional factors that may contribute to variability of operating
results include: the pricing and mix of services offered by the Company;
customer retention rate; market acceptance of new and enhanced versions of the
Company's services; changes in pricing policies by the Company's competitors;
the Company's ability to obtain sufficient supplies of sole- or limited-source
components; user demand for network and Internet access services; balancing of
network usage over a 24-hour period; the ability to manage potential growth and
expansion; the ability to identify, acquire and integrate successfully suitable
acquisition candidates; and charges related to acquisitions. In response to
competitive pressures, the Company may take certain pricing or marketing
actions that could have a material adverse affect on the Company's business. As
a result, variations in the timing and amounts of revenues could have a
material adverse affect on the Company's quarterly operating results. Due to
the foregoing factors, the Company believes that period-to-period comparisons
of its operating results are not necessarily meaningful and that such
comparisons cannot be relied upon as indicators of future performance. In the
event that the Company's operating results in any future period fall below the
expectations of securities analysts and investors, the trading price of the
Company's common stock would likely decline.
27
<PAGE>
Results of Operations
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997.
Revenue. Revenue totaled approximately $82.8 million for the year ended
December 31, 1998, a $37.3 million increase over revenue of approximately $45.5
million for the year ended December 31, 1997. This increase reflects growth in
revenue from:
. the Company's broadened product offerings to its enterprise customers;
. the Company's marketing arrangements with its strategic partners;
. continued growth in revenue derived from Internet access customers;
. revenue generated from network, colocation and Web hosting services
provided by the Company's wholly-owned subsidiary, InterNex, which was
acquired in February 1998; and
. revenues from DeltaNet and AnaServe which were acquired in May and
August 1998, respectively.
The Company expects revenue growth from Internet access customers to flatten
over time as it de-emphasizes this sector of its business. Revenue from WebTV
declined to 26.8% of the Company's net revenue for the year ended December 31,
1998 compared to 33.4% for the year ended December 31, 1997. The Company
expects revenue from WebTV to decrease as a percentage of revenue. The
foregoing expectation is a forward looking statement that involves risks and
uncertainties and the actual results could vary materially as a result of a
number of factors including those set forth under the caption "Risk Factors--
The Loss of Any of Our Major Customers Could Severely Impact Our Business."
Cost of Revenue. Cost of revenue consists primarily of personnel costs to
maintain and operate the Company's network, access charges from local exchange
carriers, backbone and Internet access costs, depreciation of network equipment
and amortization of related assets. Cost of revenue for the year ended December
31, 1998 was approximately $85.4 million, an increase of $24.0 million from
cost of revenue of $61.4 million for the year ended December 31, 1997. This
increase is attributable to the overall growth in the size of the network and
costs associated with acquired operations. As a percentage of revenue, such
costs declined to 103.1% of revenue in the year ended December 31, 1998, down
from 135.2% of revenue in the prior year, due to increased network utilization
associated with the Company's revenue growth and lower per port costs of the
Company's network architecture. The Company expects its cost of revenue to
continue to increase in dollar amount, while declining as a percentage of
revenue as the Company expands its customer base. The foregoing expectation is
a forward looking statement that involves risks and uncertainties and the
actual results could vary materially as a result of a number of factors,
including those set forth under the captions "Risk Factors--We Have a Limited
Operating History and Expect Continuing Operating Losses," "Risk Factors--Our
Growth and Expansion May Strain Our Resources" and "Risk Factors--We Depend
Upon New and Uncertain Markets."
Development Expense. Development expense consists primarily of personnel and
equipment related expenses associated with the development of products and
services of the Company. Development expense was approximately $7.7 million and
$4.9 million for the years ended December 31, 1998 and 1997, respectively. This
higher level of development expense reflects an overall increase in personnel
to develop new product offerings, to manage the overall growth in the network
and from acquired operations. Development expense as a percentage of revenue
declined to 9.3% for the year ended December 31, 1998 from 10.7% for the year
ended December 31, 1997 as a result of the Company's increased revenue. The
Company expects its development spending to continue to increase in dollar
amount, but to decline as a percentage of revenue. The foregoing expectation is
a forward looking statement that involves risks and uncertainties and the
actual results could vary materially as a result of a number of factors,
including those set forth below under the captions "Risk Factors--We Have a
Limited Operating History and Expect Continuing Operating Losses" and "Risk
Factors--We Depend Upon New and Enhanced Services."
28
<PAGE>
Marketing and Sales Expense. Marketing and sales expense consists primarily
of personnel expenses, including salary and commissions, costs of marketing
programs and the cost of 800 number circuits utilized by the Company for
customer support functions. Marketing and sales expense was approximately $39.8
million for the year ended December 31, 1998 and $24.6 million for the year
ended December 31, 1997. The $15.2 million increase in 1998 reflects a
substantial investment in the customer support, marketing and sales
organizations necessary to support the Company's expanded customer base. This
increase also reflects a growth in subscriber acquisition costs, related to
both increased direct marketing efforts as well as commissions paid to
distribution partners. Marketing and sales expense as a percentage of revenue
declined to 48.1% for the year ended December 31, 1998 from 54.2% in the year
earlier period as a result of the Company's increased revenue. The Company
expects marketing and sales expenditures to continue to increase in dollar
amount, but to decline as a percentage of revenue. The foregoing expectation is
a forward looking statement that involves risks and uncertainties and the
actual results could vary materially as a result of a number of factors
including those set forth under the captions "Risk Factors--We Depend on New
and Uncertain Markets" and "Risk Factors--Our Growth and Expansion May Strain
Our Resources."
General and Administrative Expense. General and administrative expense
consists primarily of personnel expense and professional fees. General and
administrative expense was approximately $10.4 million for the year ended
December 31, 1998 and $4.8 million for the year ended December 31, 1997. This
higher level of expense reflects an increase in personnel and professional fees
necessary to manage the financial, legal and administrative aspects of the
business. General and administrative expense as a percentage of revenue
increased to 12.6% for the year ended December 31, 1998 from 10.5% in the prior
year as a result of the Company's increased facilities costs and expenses
related to updating the Company's information systems. The Company expects
general and administrative expense to increase in dollar amount, reflecting its
growth in operations, but to decline as a percentage of revenue. The foregoing
expectation is a forward looking statement that involves risks and
uncertainties and the actual results could vary materially as a result of a
number of factors including those set forth under the captions "Risk Factors--
We Depend on New and Uncertain Markets" and "Risk Factors--Our Growth and
Expansion May Strain Our Resources."
Amortization of Goodwill and Other Intangible Assets. For the year ended
December 31, 1998, the Company recorded amortization of goodwill and other
intangible assets of $3.8 million resulting from the acquisition of InterNex in
February 1998 and AnaServe in August 1998.
Acquisition-Related Charges. For the year ended December 31, 1998 the
Company charged to operations one-time acquisition costs of $1.3 million
related to the DeltaNet acquisition. Those costs principally related to
professional fees, reserves for redundant assets and facilities and employee
severance packages.
Write-off of In-Process Technology. For the year ended December 31, 1998,
the Company wrote-off $5.2 million of in-process technology related to the
acquisition of InterNex. This acquisition provided technology and expertise
that the Company is using to enhance and expand the breadth of its product and
service offerings to its customers.
Other Income (Expense). During the year ended December 31, 1998, the Company
recorded $750,000 of other expense in connection with the settlement of certain
litigation with the shareholders of Diana Corporation. During the year ended
December 31, 1997, upon settlement of the Sattel litigation, the Company
recorded $970,000 of other income related to the reversal of previously
established reserves. Additionally, the Company recorded $425,000 of other
income related to the re-negotiation of a third party services agreement.
Net Interest Expense. Net interest expense was approximately $13.6 million
and $6.6 million for the years ended December 31, 1998 and 1997, respectively.
The increase is primarily due to interest related to $150.0 million principal
amount of 12 3/4% Senior Notes issued in December 1997.
Extraordinary Gain. For the year ended December 31, 1998, the Company
realized an extraordinary gain of $3.0 million related to the early retirement
of debt in the form of capital lease obligations.
29
<PAGE>
Preferred Stock Dividends and Accretions. For the year ended December 31,
1998, the Company recorded dividend and stock accretion of $12.0 million
related to the preferred stock issued in June 1998.
Net Loss Attributable to Common Stockholders. The Company's net loss
attributable to common stockholders increased to approximately $94.1 million
for the year ended December 31, 1998 as compared to approximately $55.6 million
for the year ended December 31, 1997. For comparative purposes, the net loss
attributable to common stockholders for the year ended December 31, 1998
included expenses related to financing and acquisition charges of $1.3 million
resulting from the acquisition of DeltaNet, $12.0 million of dividends and
accretion related to the preferred stock issued in June 1998, $19.9 million of
interest expense and amortization of debt issuance costs related to the 12 3/4%
Senior Notes and warrants, $5.2 million write-off of in-process technology and
$3.8 million of amortization of goodwill and other intangibles relating to the
acquisitions of InterNex and AnaServe. These losses were partially offset by an
extraordinary gain of $3.0 million on early retirement of debt.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996.
Revenue. Revenue for the year ended December 31, 1997 totaled approximately
$45.5 million, an increase of $29.9 million over revenue of $15.6 million for
the year ended December 31, 1996. This increased revenue reflects growth in
revenue from the Company's broadened product offerings to its enterprise
customers and through the Company's leveraged marketing arrangements with its
strategic partners, as well as continued growth in revenue derived from
Internet access customers. WebTV accounted for approximately 33.4% of total
revenue for the year ended December 31, 1997.
Cost of Revenue. Cost of revenue for the year ended December 31, 1997
totaled approximately $61.4 million compared with $47.9 million for the year
ended December 31, 1996. This increase is attributable to the overall growth in
the size of the network. As a percentage of revenue, costs declined to 135.2%
of revenue in the year ended December 31, 1997 from 306.4% of revenue in the
prior year due to increased network utilization associated with the Company's
revenue growth and lower per port costs of the Company's SuperPOP network
architecture deployed in the second half of 1996.
Development Expense. Development expense for the years ended December 31,
1997 and 1996 was approximately $4.9 million and $2.4 million, respectively.
This higher level of development expense reflects an overall increase in
personnel to develop new product offerings and to manage the overall growth in
the network. As a percent of revenue, development expense declined to 10.7% for
the year ended December 31, 1997 from 15.7% for the year ended December 31,
1996, as a result of the Company's increased revenue.
Marketing and Sales Expense. For the years ended December 31, 1997 and 1996,
marketing and sales expense was approximately $24.6 million and $16.6 million,
respectively. The $8.0 million increase in 1997 reflects a substantial
investment in the customer support, marketing and sales organizations necessary
to support the Company's expanded customer base. This increase also reflects a
growth in subscriber acquisition costs, related to both increased direct
marketing efforts as well as commissions paid to distribution partners.
Additionally, the increase reflects the ramp-up of marketing efforts related to
the introduction of enterprise products and services. Marketing and sales
expense as a percentage of revenue declined to 54.2% for the year ended
December 31, 1997 from 106.1% in the year earlier period as a result of the
Company's increased revenue.
General and Administrative Expense. For the years ended December 31, 1997
and 1996, general and administrative expenses were approximately $4.8 million
and $3.4 million, respectively. This higher level of expense reflects an
increase in personnel and professional fees necessary to manage the financial,
legal and administrative aspects of the business. For the year ended December
31, 1997, general and administrative expense declined to 10.5% from 22.0% for
the year ended December 31, 1996 as a result of the Company's increased
revenue.
Other Income (Expense). During the year ended December 31, 1997, upon
settlement of the Sattel litigation, the Company recorded $970,000 of other
income related to the reversal of previously established
30
<PAGE>
reserves. Additionally, the Company recorded $425,000 of other income related
to the re-negotiation of a third party services agreement. The Company recorded
no other income or expense during the year ended December 31, 1996.
Net Interest Expense. Net interest expense was approximately $6.6 million
and $3.3 million for the years ended December 31, 1997 and 1996, respectively.
The increase for the year ended December 31, 1997 was primarily due to a cost
of financing charge of $930,000 associated with the value of warrants issued in
connection with $5.0 million of bridge loans received in June 1997 and $744,000
associated with the issuance of the 12 3/4% Senior Notes. Additionally, the
principal amount of capitalized lease obligations increased $7.0 million from
December 31, 1996 to December 31, 1997. The year ended December 31, 1996
included approximately $330,000 associated with the value of warrants issued in
connection with bridge loan financing.
Net Loss. For the year ended December 31, 1997 the net loss totaled $55.6
million as compared to $66.4 million for the year ended December 31, 1996.
Quarterly Results of Operations
The Company's quarterly operating results can fluctuate from period-to-
period depending upon factors such as the success of the Company's efforts to
expand its subscriber and third party partnership base, changes in, and the
timing of, expenses relating to development and sales and marketing and changes
in pricing policies by the Company or its competitors. Management believes that
period-to-period comparisons of its financial results should not be relied upon
as an indication of future performance. The Company may experience significant
period-to-period fluctuations in operating results.
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<PAGE>
The following tables set forth the statement of operations data for each of
the last eight quarters through December 31, 1998, as well as the percentage of
the Company's revenue. This information has been derived from the Company's
unaudited financial statements. In the opinion of management, the unaudited
information set forth below has been prepared on the same basis as the audited
financial statements contained herein and includes all adjustments, consisting
only of normal recurring adjustments necessary to present fairly the
information set forth herein. The operating results for any quarter are not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- -------- --------- -------- --------- -------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue................. $ 9,154 $ 10,814 $ 11,824 $ 13,665 $ 16,484 $ 19,662 $ 21,579 $ 25,082
Costs and expenses:
Cost of revenue........ 15,744 14,913 14,838 15,944 17,724 20,204 22,906 24,518
Development............ 1,025 1,200 1,313 1,312 1,507 1,798 2,100 2,329
Marketing and sales.... 4,936 6,094 6,459 7,133 8,494 9,291 11,494 10,514
General and
administrative........ 1,060 1,127 1,182 1,421 1,852 2,412 2,547 3,587
Amortization of
goodwill and other
intangible assets..... -- -- -- -- 506 843 1,100 1,393
Acquisition-related
charges............... -- -- -- -- -- 1,291 -- --
Write-off of in-process
technology............ -- -- -- -- 5,200 -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total costs and
expenses.............. 22,765 23,334 23,792 25,810 35,283 35,839 40,147 42,341
-------- -------- -------- -------- -------- -------- -------- --------
Loss from operations.... (13,611) (12,520) (11,968) (12,145) (18,799) (16,177) (18,568) (17,259)
Other income (expense).. -- 1,395 (162) -- -- -- -- (750)
Net interest expense.... (1,070) (1,779) (2,088) (1,634) (4,470) (4,025) (2,390) (2,710)
-------- -------- -------- -------- -------- -------- -------- --------
Loss before
extraordinary item..... (14,681) (12,904) (14,218) (13,779) (23,269) (20,202) (20,958) (20,719)
Extraordinary gain on
early retirement
of debt................ -- -- -- -- 3,042 -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Net loss................ (14,681) (12,904) (14,218) (13,779) (20,227) (20,202) (20,958) (20,719)
-------- -------- -------- -------- -------- -------- -------- --------
Preferred stock
dividends and
accretion.............. -- -- -- -- -- (1,277) (5,279) (5,402)
-------- -------- -------- -------- -------- -------- -------- --------
Net loss attributable to
common stockholders.... $(14,681) $(12,904) $(14,218) $(13,779) $(20,227) $(21,479) $(26,237) $(26,121)
======== ======== ======== ======== ======== ======== ======== ========
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- -------- --------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue........ 172.0 137.9 125.5 116.7 107.5 102.8 106.1 97.7
Development............ 11.2 11.1 11.1 9.6 9.1 9.1 9.7 9.3
Marketing and sales.... 53.9 56.4 54.6 52.2 51.5 47.2 53.3 41.9
General and
administrative........ 11.6 10.4 10.0 10.4 11.2 12.3 11.8 14.3
Amortization of
goodwill and other
intangible assets..... -- -- -- -- 3.1 4.3 5.1 5.6
Acquisition-related
charges............... -- -- -- -- -- 6.6 -- --
Write-off of in-process
technology............ -- -- -- -- 31.6 -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total costs and
expenses.............. 248.7 215.8 201.2 188.9 214.0 182.3 186.0 168.8
-------- -------- -------- -------- -------- -------- -------- --------
Loss from operations.... (148.7) (115.8) (101.2) (88.9) (114.0) (82.3) (86.0) (68.8)
Other income (expense),
net.................... -- 12.9 (1.4) -- -- -- -- (3.0)
Net interest expense.... (11.7) (16.4) (17.7) (11.9) (27.1) (20.5) (11.1) (10.8)
-------- -------- -------- -------- -------- -------- -------- --------
Loss before
extraordinary item..... (160.4) (119.3) (120.3) (100.8) (141.1) (102.8) (97.1) (82.6)
Extraordinary gain on
early retirement
of debt................ -- -- -- -- 18.4 -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Net loss................ (160.4) (119.3) (120.3) (100.8) (122.7) (102.8) (97.1) (82.6)
-------- -------- -------- -------- -------- -------- -------- --------
Preferred stock
dividends and
accretion.............. -- -- -- -- -- (6.4) (24.5) (21.5)
-------- -------- -------- -------- -------- -------- -------- --------
Net loss attributable to
common stockholders.... (160.4)% (119.3)% (120.3)% (100.8)% (122.7)% (109.2)% (121.6)% (104.1)%
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
32
<PAGE>
In view of the significant growth of the Company's operations, the Company
believes that period-to-period comparisons of its financial results should not
be relied upon as an indication of future performance and that the Company may
experience in the future significant period-to-period fluctuations in operating
results. The Company expects to focus in the near term on building and
increasing its revenue base, which will require it to significantly increase
its expenses for personnel, marketing, network infrastructure and the
development of new services, and may adversely impact short term operating
results. As a result, we cannot assure you that the Company will be profitable
on a quarterly basis in the future and the Company believes that it will incur
losses in the near term. See "Risk Factors--Our Operating Results Fluctuate and
Could Decline."
Liquidity and Capital Resources
To date, the Company has satisfied its cash requirements primarily through
capitalized lease financings, the sale of capital stock and debt financings.
The Company's principal uses of cash are to fund working capital requirements
and capital expenditures, to service its capital lease and debt financing
obligations, to finance and fund acquisitions and to provide for the early
retirement of debt. Net cash used in operating activities for the years ended
December 31, 1998 and 1997 was approximately $46.6 million and $45.9 million,
respectively. Included in the amount for the year ended December 31, 1997 is
$4.4 million of cash paid in settlement of a dispute with an equipment
provider. Cash used in operating activities in both periods was primarily
affected by the net losses, caused by increased costs related to the expansion
of the Company's network and organizational infrastructure.
Net cash used in investing activities for the years ended December 31, 1998
and 1997 was approximately $101.9 million and $6.5 million, respectively. Net
cash used in investing activities for the year ended December 31, 1998
consisted primarily of $52.2 million used to purchase short term investments,
$23.5 million used for purchases of capital equipment to support the Company's
expanded network infrastructure and $25.1 million of cash used to acquire
InterNex and AnaServe. For the year ended December 31, 1997, net cash used in
investing activities was primarily for purchases of capital equipment.
For the year ended December 31, 1998, net cash of $127.6 million was
provided from financing activities, reflecting $144.1 million of net proceeds
from the issuance of preferred stock in June 1998 less $24.8 million used for
the early retirement of capital lease obligations, $10.2 million used for
repayment of other capital lease obligations and restricted cash of $16.3
million used to pay interest on the 12 3/4% Senior Notes. For the year ended
December 31, 1997 net cash of approximately $154.7 million was generated from
financing activities, of which $74.0 million, net of issuance costs, was
derived from the issuance of stocks and warrants and $145.0 million, net of
issuance costs, was derived from the issuances of the 12 3/4% Senior Notes, net
of $52.5 million investment in U.S. Government treasury strips held as
restricted cash. The Company also received $5.0 million in debt financing in
June 1997, of which $2.0 million was repaid and $3.0 million was converted into
common stock, respectively, upon closing of the Company's initial public
offering in August 1997. Concurrent with the closing of the initial public
offering, the Company repurchased $2.2 million of common stock from certain
stockholders. The remainder of financing activities for the year ended
December 31, 1997 is comprised of $11.6 million used for repayment of capital
lease obligations. The net cash decrease for the year ended December 31, 1998
was $21.0 million as compared to a net cash increase for the year ended
December 31, 1997 of $102.3 million.
At December 31, 1998, the Company had cash and cash equivalents of
approximately $99.0 million, short term investments of $52.2 million,
restricted cash of $36.2 million and working capital of $144.5 million. The
Company expects to incur additional operating losses and will rely primarily on
its available cash resources, the net proceeds from the issuance of the common
stock and financing available under a network equipment lease agreement (that
currently has no maximum borrowing limit) to meet its anticipated cash needs
for working capital and for the acquisition of capital equipment through at
least the end of 1999. However, we cannot assure you that the Company will not
require additional financing within this time frame. The Company's forecast of
the period of time through which its financial resources will be adequate to
support its operations is a forward-looking statement that involves risks and
uncertainties, and actual results could vary materially as a result of a number
of factors, including those set forth on under the caption "Risk Factors--We
May Need Additional Capital in the Future and Such Additional Financing May Not
Be Available." The Company may
33
<PAGE>
be required to raise additional funds through public or private financing,
strategic relationships or other arrangements. We cannot assure you that such
additional funding, if needed, will be available on terms attractive to the
Company, or at all.
In January 1999, the Company used approximately $10.0 million in cash to
purchase 555,556 shares of Covad's common stock. The investment was made as
part of a broader strategic relationship with Covad. The shares of common stock
were purchased at Covad's initial public offering price of $18.00 per share.
Additionally, SBC purchased approximately $19.5 million of common stock from
the Company in January 1999.
Disclosures About Market Risk
The following discusses the Company's exposure to market risk related to
changes in interest rates, equity prices and foreign currency exchange rates.
This discussion contains forward-looking statements that are subject to risks
and uncertainties. Actual results could vary materially as a result of a number
of factors including those set forth under the captions "Risk Factors--We Have
Incurred Substantial Indebtedness and May Not Be Able to Service Our Debt" and
"Risk Factors--We May Need Additional Capital in the Future and Such Additional
Financing May Not Be Available."
Interest Rate Sensitivity.
Short-Term Investments Owned By the Company. As of December 31, 1998, the
Company had short term investments of $52.2 million. These short-term
investments consist of highly liquid investments with original maturities at
the date of purchase of between three and twelve months. These investments are
subject to interest rate risk and will fall in value if market interest rates
increase. A hypothetical increase in market interest rates by 10 percent from
levels at December 31, 1998 would cause the fair value of these short-term
investments to decline by an immaterial amount. The Company has the ability to
hold these investments until maturity, and therefore the Company would not
expect the value of these investments to be affected to any significant degree
by the effect of a sudden change in market interest rates. Declines in interest
rates over time will, however, reduce the Company's interest income.
Outstanding Debt of the Company. As of December 31, 1998, the Company had
outstanding long term debt of approximately $150.0 million at a fixed interest
rate of 12 3/4% and $150.0 million of preferred stock outstanding with a
dividend rate of 13 1/2%. In certain circumstances, the Company may redeem this
preferred stock or exchange long-term debt for this preferred stock. Because
the interest and dividend rates on these instruments are fixed, a hypothetical
10 percent decrease in interest rates would not have a material impact on the
Company. Increases in interest rates could, however, increase the interest
expense associated with future borrowings by the Company, if any. The Company
does not hedge against interest rate increases.
Equity Price Risk.
The Company owns 555,556 shares of the common stock of Covad. The Company
purchased these shares at the time of Covad's initial public offering in
January 1999 at a price of $18.00 per share. On January 25, 1999, the closing
price of Covad's common stock was $51.88 per share. The Company values this
investment using the lower of cost or market method, and thus continues to
value this investment at its cost of $10.0 million. If the price of Covad
common stock were to decline below $18.00 per share and such decline was
considered to be other than temporary, the Company would be required to write-
down the value of this investment. The Company is generally restricted from
selling these shares for at least one year from the date of their purchase. The
Company does not hedge against equity price changes.
Foreign Currency Exchange Rate Risk.
All of the Company's revenues are realized in dollars and substantially all
of the Company's revenues are from customers in the United States. Therefore,
the Company does not believe it has any significant direct foreign currency
exchange rate risk. The Company does not hedge against foreign currency
exchange rate changes.
34
<PAGE>
Impact of The Year 2000 Issue
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in system failures or miscalculations causing
disruptions of normal business activities. The Company is currently in the
process of reviewing its products and services, as well as its internal
management information systems in order to identify and modify those products,
services and systems that are not year 2000 compliant.
Based on the Company's assessment to date, the Company has determined that
its internally developed software, including much of its operational, financial
and management information systems software is year 2000 compliant. The
Company's operational, financial and management information systems software
which have not been internally developed have been certified as year 2000
compliant by the third party vendors who have supplied the software. The
equipment and software that runs the Company's data centers are supplied by
Microsoft, Nortel/Bay Networks and Sun Microsystems. The Company has
implemented software patches supplied by Microsoft so that the Microsoft
software in these data centers no longer contains any material year 2000
deficiencies. The Company implemented similar patches for the software supplied
by Sun Microsystems at the end of 1998 and expects to replace the Bay Networks
equipment and software by the end of March 1999 with versions which do not
contain any material year 2000 deficiencies. The Company expects such
modifications will be made on a timely basis and does not believe that the cost
of such modifications will have a material effect on the Company's operating
results. Additionally, the Company is continuing to assess the year 2000
compliance of its products and services. To date, most newly introduced
products and services of the Company do not contain material year 2000
deficiencies, however some of the Company's customers are running earlier
product versions that are not year 2000 compliant. The Company has been
encouraging such customers to migrate to current product versions. The Company
estimates that the capital and other costs associated with the upgrade and
conversion of its existing products, services and systems relating to the year
2000 issue will not be material. The Company does not separately track internal
costs incurred to assess and remedy deficiencies related to the year 2000
problem, however, such costs are principally the payroll costs for its
information systems group. The Company does not have and is not developing a
contingency plan in the event its systems fail as a result of year 2000 related
problems.
The Company's products, services and systems operate in complex network
environments and directly and indirectly interact with a number of other
hardware and software systems. The Company faces risks to the extent that
suppliers of products, services and systems purchased by the Company and others
with whom the Company transacts business on a worldwide basis, including those
which form significant portions of the Company's network and may be sole- or
limited-source suppliers, do not have business systems or products that comply
with year 2000 requirements. The Company has not received significant
assurances from its suppliers that their networks are year 2000 compliant. If
these networks fail, the Company's business will be significantly impacted.
The Company's expectation that it will be able to upgrade its products,
services and systems to address the year 2000 issue and its expectation
regarding the costs associated with these upgrades are forward-looking
statements subject to a number of risks and uncertainties. Actual results may
vary materially as a result of a number of factors. There can be no assurance
that the Company will be able to timely and successfully modify such products,
services and systems to comply with year 2000 requirements. Any failure to do
so could have a material adverse effect on the Company's operating results.
Furthermore, despite testing by the Company and its vendors, the Company's
products, services and systems may contain undetected errors or defects
associated with year 2000 date functions. In the event any material errors or
defects are not detected and fixed or third parties cannot timely provide the
Company with products, services or systems that meet the year 2000
requirements, the Company's operating results could be materially adversely
affected. Known or unknown errors or defects that affect the operation of the
Company's products, services or systems could result in delay or loss of
revenue, interruption of network services, cancellation of customer contracts,
diversion of development resources, damage to the Company's reputation, and
litigation costs. There can be no assurance that these or other factors
relating to year 2000 compliance issues will not have a material adverse effect
on the Company's business, operating results or financial condition.
35
<PAGE>
BUSINESS
Concentric provides tailored, value-added IP-based network services for
enterprises and consumers. To provide these services, the Company utilizes its
low/fixed latency, high-throughput network, employing its advanced network
architecture and the Internet. Concentric's service offerings for enterprises
include VPNs, DAFs, DSL, remote access and Web hosting. These services enable
enterprises to take advantage of standard Internet tools such as browsers and
high-performance servers for customized data communications within an
enterprise and between an enterprise and its suppliers, partners and customers.
These services combine the cost advantages, nationwide access and standard
protocols of public networks with the customization, high performance,
reliability and security of private networks. Among the current enterprise
customers are Intuit, SBC, Teligent and WebTV. Concentric's service offerings
for consumers and small office/home office customers include local Internet
dial-up access, DSL and applications hosting.
Industry Background
Development of Private Networks
Historically, the data communications services offered by public carriers
had limited security features, were expensive and did not adequately ensure
accurate and reliable transmission. As a result, many corporations established
and maintained their own private WANs to provide network-based services, such
as transaction processing, to their customers and to coordinate operations
between employees, suppliers and business partners. Such private WANs were
frequently customized to specific applications, business practices and user
communities. As a result, these private WANs had the capability of providing
organizations and users with tailored performance and features, security,
reliability and private-label branding.
The demand for WANs has grown as a result of today's competitive business
environment. Factors stimulating the higher demand include the need to provide
broader and more responsive customer service, to operate faster and more
effectively between operating units, suppliers and other business partners, and
the need to take advantage of new business opportunities for network-based
offerings in a timely fashion. In addition, as businesses become more global in
nature, the ability to access business information across the enterprise has
become a competitive necessity.
Despite the attractive capabilities of private networks, limitations of many
private WANs have impeded or reduced the effectiveness of their use. These
networks, which traditionally have required the use of leased telephone lines
with bandwidth dedicated solely to this purpose and the purchase of vendor-
specific networking equipment, are inherently expensive to set up, operate and
maintain. Private WANs often require the development and maintenance of
proprietary software and lack cost-effective access. These aspects of
developing, deploying and maintaining such private WANs have conflicted with
the increased focus of many businesses on their core competencies, which has
prompted the outsourcing of many non-core functions. The Company believes that
many businesses have viewed as unacceptable the costs of maintaining a private
WAN infrastructure and the risks of investing in new technologies in the
absence of a single technological standard.
Emergence of the Internet
The emergence of the Internet and the widespread adoption of IP as a data
transmission standard in the 1990s, combined with deregulation of the
telecommunications industry and advances in telecommunications technology have
significantly increased the attractiveness of providing data communication
applications and services over public networks. At the same time, growth in
client/server computing, multimedia personal computers and online computing
services and the proliferation of networking technologies have resulted in a
large and growing group of people who are accustomed to using networked
computers for a variety of purposes, including email, electronic file
transfers, online computing and electronic financial transactions. These trends
have led businesses increasingly to explore opportunities to provide IP-based
applications and services within their organization, and to customers and
business partners outside the enterprise.
36
<PAGE>
Need for IP-Based Private Networks
The ubiquitous nature and relatively low cost of the Internet have resulted
in its widespread usage for certain applications, most notably Web access and
email. However, usage of the Internet for mission-critical business
applications has been impeded by the limited security and unreliable
performance inherent in the structure and management of the Internet. On the
Internet, latency is frequently relatively high and variable, making it sub-
optimal for these emerging applications. Although private networks are capable
of offering lower and more stable latency levels, providers of these emerging
applications also desire a network that will offer their customers full access
to the Internet. As a result, these businesses and applications providers
require a network that combines the best features of the Internet, such as
openness, ease of access and low cost made possible by the IP standard, with
the advantages of a private network, such as high security, low/fixed latency
and customized features.
Industry analysts expect the market size for both value-added IP data
networking services and Internet access to grow rapidly as businesses and
consumers increase their use of the Internet, intranets and privately managed
IP networks. According to industry analyst Forrester Research, Inc., the total
market for these services is projected to grow from $6.2 billion in 1997 to
approximately $49.7 billion in the year 2002, with approximately $27.9 billion
in the enterprise market segment and $21.8 billion in the consumer market
segment.
The Concentric Solution
Concentric provides tailored, value-added IP-based network services for
businesses and consumers using a low/fixed latency, high-throughput network.
Concentric allows enterprises to create virtual private networks providing
tailored network access, content and services to enterprise-defined end users
with higher reliability and more security than is available over the Internet.
Concentric's VPN solutions also provide the ease of access and flexibility of
public networks at a lower cost than private WANs without sacrificing
reliability or security.
The Concentric network employs an advanced, geographically dispersed ATM and
frame relay backbone, SuperPOPs in 19 major metropolitan areas and 143
secondary and tertiary POPs in other cities. The Company's architecture allows
most customers in the U.S. and Canada to access its network through a local
telephone call. In addition to dial-up access, the Company provides frame
relay, DSL, fractional T-1, T-1 and DS3 access to the network. The Concentric
network is engineered and managed to provide superior quality of service,
balancing several key performance criteria. The Company provides guaranteed
levels of service for dedicated access facilities to enterprise customers, and
targets performance benchmarks for connection success rates, latency levels and
throughput for all of its service offerings.
Business Strategy
The Company's objective is to become the leading supplier of value-added,
IP-based network services worldwide. In order to achieve this goal, the Company
is implementing a business strategy focused on the following key principles:
Rapidly Provide Cost-Effective, Tailored Network Solutions. The Company
intends to capitalize on its expertise in developing tailored VPNs to establish
a leadership position in rapidly developing, deploying and maintaining a range
of value-added network services to meet the specific needs of its customers.
The Company utilizes a set of software and hardware technology modules as
"building blocks" to offer a variety of tailored network services on an IP-
based network architecture with minimal additional investment in engineering
and rapid time to market for businesses and consumers. These building blocks
include modules for client and system software, dedicated and remote network
connectivity, tracking and billing, Web hosting, customer support and security.
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Optimize Network Utilization. Given the fixed cost nature of Concentric's
network infrastructure, the Company strives to increase total network
utilization and to optimize this utilization by targeting both daytime business
and evening-intensive consumer users to balance the network's usage throughout
a 24-hour period. Accordingly, while the Company's current strategic focus is
on providing value-added IP-based communications services to enterprises, the
Company intends to continue partnering with multi-channel distributors to
acquire and maintain a base of consumer subscribers who access the Concentric
network predominantly during non-business hours.
Acquire Complementary Assets, Technologies and Businesses. The Company is
actively seeking to identify and acquire assets, technologies and businesses
complementary to the Company's value-added enterprise network service strategy.
Such acquisition efforts are targeted at businesses that offer the potential to
expand the Company's revenue base, increase the scalability of the Company's
network infrastructure and value-added service offerings, as well as optimize
the utilization of the Company's network. As part of this strategy, the Company
completed three acquisitions in 1998. The Company acquired InterNex, a Tier 1
provider of network services, colocation service and Web-hosting facilities to
enterprise customers, in February 1998. The Company acquired Deltanet, a
provider of network services, colocation and managed dedicated hosting
services, in May 1998. The Company acquired AnaServe, a provider of shared
hosting and managed dedicated hosting services, in August 1998.
Employ Leveraged Marketing Through Strategic Partners. The Company actively
seeks to form alliances with certain software developers and telecommunications
service and equipment suppliers that have substantially greater marketing,
distribution and sales resources than does the Company and that have a large
installed customer base. These alliances facilitate the cost-effective
acquisition of consumer and business customers and increase Concentric's
network utilization. These marketing relationships are developed and enhanced
through the bundling of Concentric's IP-based network services with the
products and services offered by the strategic partners. These relationships
may involve customized browsers, registration services and specialized pricing,
commissions and billing programs. To date, Concentric has established such
strategic relationships with a number of companies, including WebTV, SBC,
Williams, Covad, Teligent, Intuit, Nortel/Bay Networks, Inc. and TMI.
Deploy Network Services Internationally. The Company believes that its
enterprise customers increasingly will require their network solutions
providers to offer network services on a global basis. To date, the Company has
launched the following initiatives to provide global solutions to its
customers:
Mondonet. Pursuant to an agreement with TMI, entered into in August
1996, the Company is working to establish an international network based on
Concentric's network technology and expertise and TMI's existing
telecommunications infrastructure. The goal is to deliver a range of
compatible network services worldwide. TMI currently has a
telecommunications network deployed in 40 countries worldwide. In April
1998, the Company and TMI launched Mondonet, the first international
network designed and built expressly to support VPN services with coverage
in more than 30 cities in 24 countries.
Roaming Services in Japan. The Company entered into a roaming services
agreement in June 1997 with NTT PC, a leading provider of IP services in
Japan. The roaming services agreement allows Concentric customers to use
the NTT PC network to access their Internet accounts in Japan and allows
members of the NTT PC network to access their Internet accounts in the
United States and Canada.
GRIC Roaming Alliance. The Company executed a roaming services agreement
with GRIC International in October 1998. GRIC International is an alliance
of 400 ISPs and telecommunication companies that together form a worldwide
network of 2,700 POPs. The GRIC International alliance allows the Company's
customers to access the Internet through these worldwide POPs while
traveling outside of the United States.
Hosting Services in the United Kingdom. The Company entered into a
strategic agreement with GX Networks, one of the largest ISPs located in
the United Kingdom, in August 1998. The agreement allows
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GX Networks and the Company to expand Web hosting and extranet services for
each other's customers. Through this agreement, the Company can serve the
networking needs of its domestic United States customers based in the
United Kingdom.
Global Web Hosting Facilities. The Company acquired Web hosting
facilities in Stockholm, Sweden, Tokyo, Japan and Hong Kong in February
1998 as part of the acquisition of InterNex.
While the Company does not expect to generate significant revenue from
deployment of international network services until at least the year 2000, the
Company believes that the ability to deliver network solutions globally will be
a key competitive factor in its industry. The foregoing expectation is a
forward-looking statement that involves risks and uncertainties and the actual
results could vary materially as a result of a number of factors including
those set forth in "Risk Factors--We Face Risks Associated with International
Expansion."
Services
Concentric provides tailored, value-added IP-based network services for
businesses and consumers. To provide these services, the Company employs a
low/fixed latency high-throughput network based on an advanced, geographically
dispersed ATM and frame relay backbone and the Internet.
Enterprise Solutions
The Company has developed a set of enterprise services including VPNs,
dedicated access facilities, digital subscriber line services, wireless access
services and applications hosting services. These services are marketed to
Concentric's enterprise customers.
Virtual Private Network Services. Concentric's custom VPN solutions enable
its customers to deploy tailored, IP-based mission-critical business
applications for internal enterprise, business-to-business and business-to-
customer data communications on the Concentric network while also affording
high-speed access to the Internet. Concentric offers its customers a secure
network on which to communicate and access information between an
organization's geographically dispersed locations; collaborate with external
groups or individuals, including customers, suppliers, and other business
partners and use the Web to access information on the Internet and communicate
with other Web users.
The Company's VPN solutions allow the enterprise customer to tailor the type
of access, services and information that various users of the VPN are afforded
according to the specific needs of the enterprise. Key benefits include rapid
implementation time, lower operating and maintenance costs, minimal capital
investment, higher quality of service overall and 24-hour network and customer
support. For example, starting in October 1995 the Company created and now
maintains the VPN used by Intuit customers using a customized version of the
Netscape Navigator browser bundled with Quicken for Windows and Macintosh,
Quickbooks, ProTax and TurboTax/MacInTax. The bundled software allows a Quicken
customer to click on an icon that launches Netscape, and takes the user
directly to Quicken Financial Network Website. On the Web page Quicken
customers will find useful financial advice, information from Intuit's bank and
financial institution partners, answers to commonly asked technical questions
and tips on how to tap the full potential of Intuit's financial products.
In addition to the custom VPNs that Concentric has developed and delivered,
the following three distinct VPN products are now offered by the Company:
Concentric CustomLink. Concentric CustomLink provides a complete,
private-labeled dial-up VPN service for customers. In addition, CustomLink
permits the customer to segment its users, and apply various levels of
services, such as Web access, email, and file transfer protocol to each
customer group. CustomLink includes dial-up network access, customized and
customer-branded client software, and private labeled help desk services.
The dial-up network access offerings include local access, toll-free
access, and a unique connection service, PremierConnect, which provides
such subscribers with connectivity to the VPN, even if local access numbers
are busy.
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Enterprise VPN. The Company's Enterprise VPN service includes security
hardware and software, high speed network access, network connectivity,
customer premise routing equipment and customer support services. The
Enterprise VPN service is targeted at customers seeking to create a secure,
outsourced WAN for intranet and extranet applications. Installation support
for the customer premise located routing and security equipment is also
provided. Concentric can also provide management services for firewall and
packet encryption equipment if desired by the customer.
Concentric RemoteLink. The Company's remote access service is targeted
at businesses that have employees in remote locations. RemoteLink offers
customers the potential to significantly reduce the high costs of
telecommunications charges and user support associated with building,
deploying, and maintaining an internal remote access infrastructure.
RemoteLink enables an enterprise's salespeople and other mobile employees,
telecommuters and business partners to dial into an enterprise's corporate
network resources and use them as if they were connected locally, thus
increasing potential productivity and allowing for information to be
available on a real-time basis across the enterprise. Concentric's
RemoteLink is designed to be highly customizable and provides the ability
to interface with existing company network infrastructure.
Concentric performs around-the-clock monitoring of network performance.
Concentric also enables its customers to monitor their network through the
Company's proprietary ConcentricView software. ConcentricView is a Web-based
network management tool which allows a customer to monitor usage on a call-by-
call basis and performance of that portion of the Concentric network bandwidth
supporting the customer's applications.
Dedicated Access Facilities. In January 1997, the Company began offering
DAFs as a stand-alone product targeted at businesses that desire single or
multipoint high-speed, dial-up and/or dedicated connections to distributed
locations such as regional offices, warehouses, manufacturing facilities and/or
to the Internet. DAF products are primarily targeted at providing intranet
connectivity among distributed enterprise locations with the additional benefit
of Internet access if desired by the customer. The Company provides a full
range of connectivity options, allowing the customer to order the appropriate
amount of bandwidth to meet its networking requirements. In addition,
Concentric offers its DAF customers a guarantee on the quality of service and
performance of these facilities. Furthermore, Concentric believes it is the
only network service provider to bill customers based on average usage levels
rather than peak usage levels.
Concentric has six offerings in its dedicated access product line:
FullChannel T-1, FullChannel T-1 Protected, FlexChannel and LECFrame Relay, as
well as FullChannel and FlexChannel offerings at DS3 bandwidth options which
support up to 45 Mbps. The Company has begun working with key customers to
support even higher speeds up to OC3 (155 Mbps).
FullChannel T-1 and DS3 pricing is based on a one time set-up fee and
average utilization pricing. The customer's usage is measured at five-minute
intervals throughout the month, and the average of all of those measurements is
used to determine the customer's bill at the end of the month. The one time
set-up fee for FullChannel T-1 service is $3,000 and the monthly fee ranges
from $1,095 to $2,695 depending on usage. The one time set-up fee for
FullChannel DS3 service is $5,000 and the monthly fee ranges from $6,000 to
$40,500 depending on usage. FullChannel T-1 and DS3 pricing is the appropriate
choice for those customers who have fluctuating and/or uncertain bandwidth
consumption patterns.
FullChannel T-1 Protected gives a customer a fixed price for a full 1.5
megabits of bandwidth. The one time set-up fee is $3,000 and the monthly fee is
set at $2,095. This is an economical choice for those customers who recognize
in advance that their bandwidth throughput requirements will equal T-1 levels.
FlexChannel gives a customer the opportunity to purchase a fractional
portion of a T-1 or DS3 for a fixed monthly fee. The set up fee is the same as
for FullChannel pricing but the monthly fee ranges from $895 to $1,895 for
FlexChannel T-1 service and from $5,900 to $40,500 for FlexChannel DS3 pricing.
FlexChannel T-1 and DS3 pricing is the appropriate choice for the customers who
know that their bandwidth requirements are going to be consistently less than a
full T-1 or DS3.
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LECFrame Relay is based on various LECs' Frame Relay facilities. Although
Concentric does not offer service level guarantees over LECFrame Relay,
Concentric does guarantee the committed information rate. This offering gives a
lower cost, lower performance network service for those customers for whom
performance is less imperative. Concentric charges a one time set-up fee of
$2,000 LECFrame Relay services and monthly fees ranging from $395 to $1,195
depending on usage.
Digital Subscriber Lines. In December 1997, Concentric began offering
Internet and intranet connectivity using DSL technology. DSL and its variants
are a new dedicated access technology being deployed by telephone companies
that allow high speed digital service over regular telephone lines. To expand
its DSL service area, the Company has formed relationships with a number of
CLECs, including Covad Communications Group, Inc. and NorthPoint
Communications, Inc., as well as SBC's California subsidiary, Pacific Bell.
Concentric's DSL service offerings are currently available in the following
geographical markets: the San Francisco Bay Area, Los Angeles, San Diego,
Boston, New York, Washington, D.C., and Chicago. Several additional markets are
planned during 1999. The Company's DSL service offerings include a wide range
of dedicated access speeds, from 144 Kbps to 1.5 Mbps symmetric DSL, as well as
1.5 Mbps/384 Kbps asymmetric DSL.
Concentric DSL services are targeted at the small-to-medium sized business,
telecommuter and consumer markets. The "dedicated access feature" of DSL
services combined with its high speed and low flat rate pricing are designed to
appeal to the large installed base of ISDN users. Pricing for the service is
low relative to traditional dedicated access services, making it attractive to
medium sized businesses, while at the same time broadening the market to reach
small businesses who previously could not justify the expense of dedicated
Internet service.
Pricing is based on the bandwidth of the DSL circuit, and is a flat rate
monthly fee ranging from $149 to $499 depending on the service speed.
Concentric provides complete installation services including all the customer
premise equipment necessary to provide the DSL service at fees ranging from
$325 to $725.
Wireless Access Services. In October 1998, the Company introduced
ConcentricWireless as an alternative to traditional access lines, particularly
in areas where DSL is not yet available. ConcentricWireless has a unique
distribution system that provides sustained speeds up to 1.5 Mbps and is priced
competitively with ISDN and DSL services and significantly lower than T-1
services. At speeds ranging from 512 Kbps to 1.5 Mbps, ConcentricWireless
provides high-speed personal Internet connectivity for the small business,
small office/home office or telecommuting consumer. ConcentricWireless is
currently available in the greater San Francisco Bay Area at prices ranging
from $150 per month for 384 Kbps symmetric to $450 per month for 1.5 Mbps/152
Kbps.
Applications Hosting Services. The Company offers a range of high-
performance applications hosting services, including Concentric Server
Solutions, a suite of sophisticated high-end hosting and Web site traffic
management solutions for Internet-centric businesses, and ConcentricHost, a
suite of Web hosting, e-commerce, and streamed media services designed for
small to medium-sized businesses. The Company's other applications hosting
services include a private-label version of ConcentricHost and a Windows NT-
based hosting solution. The high performance of the Company's applications
hosting services is enabled by Concentric's network architecture and its
combination of public and private peering arrangements.
Together, these applications hosting services manage a company's Web-based
infrastructure and operational needs allowing customers to focus on their Web-
based content. By outsourcing its Web hosting to Concentric, an enterprise can
increase the reliability and performance of its Web applications and reduce its
costs by taking advantage of Concentric's high quality data centers with back-
up power, multiple high bandwidth network connections and Tier 1 Internet
peering arrangements. In addition to state-of-the-art hosting facilities,
Concentric provides server management tools and services to completely manage
customers' servers for them.
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For reliable, high performance flow of traffic between customer's Web
servers and worldwide networks, Concentric has combined public peering and
private peering arrangements to provide improved performance to users.
Concentric currently operates data centers in Santa Clara, Cupertino, and Los
Angeles, California, Chicago, Illinois and Washington, DC. A new 10,000 square
foot data center in San Jose is scheduled to open in February 1999. Each
Concentric data center is connected via multiple DS3 (45 Mbps) or OC3 (155
Mbps) high-speed links to geographically dispersed points in its private ATM
backbone as well as to key public and private Internet exchange points. This
architecture provides diversity and redundancy and high performance to
customers while minimizing user costs. See"--The Concentric Network."
Concentric Server Solutions. In February 1998, Concentric announced the
---------------------------
availability of Concentric Server Solutions, a line of Web hosting services
designed for companies who require outsourced maintenance, management,
bandwidth and housing for their Internet or extranet Web servers. Unlike
colocation services that simply provide rack space in a data center and
bandwidth, Concentric Server Solutions provide high-performance Internet access
from state-of-the-art data centers, skilled technicians and systems
administrators, maintenance programs that monitor servers 24 hours a day, seven
days a week, and scalability to address the needs of companies as their
businesses become increasingly reliant on the Web. The Company recently
announced the following two enhancements to Concentric Server Solutions:
Distributed Server Environment. In September 1998, Concentric launched
the Distributed Server Environment ("DSE") platform designed to manage
distributed applications for content, media and Web-centric businesses.
These businesses typically require high availability, fault tolerance and
scalability for distributed hosted sites. DSE offers local and global load
balancing and fail-over services. Load balancing allows for the intelligent
distribution of user requests over multiple server resources to avoid
transmission congestion and bottlenecks among Web servers.
Concentric Peak Protection. In December 1998, the Company introduced
Concentric Peak Protection which offers "capacity on demand" or "peak
insurance" for customers who need data center and network diversity and the
ability to add Web site bandwidth capacity on-demand. Content providers,
for example, can use Concentric Peak Protection to prepare for rapid growth
and spikes in Web site traffic without making large up-front hardware and
bandwidth investments ahead of demand. Concentric Peak Protection manages
Web-site traffic spokes by seamlessly dividing traffic between Concentric
hosting centers and other server locations. Concentric Peak Protection is
ideal for companies that do not want to rely exclusively on a single
hosting provider, ISP or their own data center for hosting and data center
services.
Concentric Server Solutions, including Distributed Server Environment and
Concentric Peak Protection range in price from $550 to $10,000 per month,
depending upon the volume of traffic and number of customer servers required.
ConcentricHost. ConcentricHost is a suite of Web-hosting products and
--------------
services designed to provide comprehensive solutions to the Internet needs of a
small to medium-sized business in one account. Packages, which include Web
hosting, multiple email IDs and dial-up Internet access range from $29.95 to
$199.95 per month depending on the number of email accounts and the amount of
disk space and bandwidth provided to the customer. These packages also offer
shared security for e-commerce and are managed from a user-friendly Web
interface. Other features include access to 24 hours a day, seven days a week
toll free telephone and email based customer support and built-in self
administration tools that allow the customer to buy more features online in
real time as well as to analyze Web activity online in near real time. The
system automatically notifies customers when they are approaching the
allocation limits of their account encouraging them to upgrade online.
In June 1998, Concentric enhanced ConcentricHost with the introduction of
the Virtual Development Environment ("VDE"), which provides Web developers high
level security and performance on the ConcentricHost shared server hosting
platform. At the same time, VDE offers maximum freedom to Web
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developers by providing them with their own virtually dedicated operating and
file systems. These virtually dedicated systems provide Web developers the
freedom to create complex CGI scripts without security and stability risks and
without requiring them to be reviewed and approved prior to installation.
ConcentricHost Private Label. In November 1998, Concentric launched a
----------------------------
private label hosting solution targeted at companies looking to quickly and
cost-effectively add fully featured Web hosting to their small business service
portfolio. The ConcentricHost Private Label solution allows service providers,
small business retailers, and other resellers to leverage Concentric's proven
technology in applications hosting with their own resources. This approach
allows customers to avoid much of the time, equipment expense, and information
services resources required to internally develop a Web hosting service.
Windows NT Hosting. The Company also has a line of Windows NT-based hosting
------------------
and e-commerce services targeted at small to medium sized businesses.
Concentric also offers Windows NT-based hosting services with its Concentric
Small Business Server Internet Suite service which includes Web hosting,
Internet email exchange and Internet access services designed to be used with
Microsoft's Small Business Server.
Consumer Services
Concentric provides its individual and small office/home office customers
with a broad range of Internet access options and Web hosting email, chat, file
transfer protocol, Gopher and online shareware services. Users can choose from
local and long distance direct dial 800-number and telnet services. Concentric
offers the Microsoft Internet Explorer to its users when they sign up for dial-
up or 800-number service.
Internet Access Pricing
<TABLE>
<CAPTION>
Plan Monthly Fee Additional Time
---- ----------- ---------------
<S> <C> <C>
Starter Plan.......... $ 7.95 $1.95/hour after 5 hours
Standard Plan......... $19.95 No charges for additional time. Unlimited
active access for one monthly fee.
800-number Plan....... $10.00 $5/hour after 2 hours
Inbound Internet
Plan................. $10.00 No charges for additional time. Unlimited
active access for one monthly fee.
</TABLE>
The Company also offers consumers value-added services, including a
collection of premium products targeted to vertical segments such as the family
and small office/home office market. This includes the upselling of discounted
products and services in such areas as retail products, software, hardware,
telephony services with such partners as Amazon.com, Inc., QuadraCom, LLC,
TuneUp.com, Connected OnLine Backup and Excite. Such arrangements not only
provide an additional monthly revenue stream but also increase customer
satisfaction and retention. Additional value-added products and services being
reviewed by the Company for potential introduction include premium service,
customer support, education research, virus protection, and faxing services.
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Customers
The following is a representative list of the Company's customers during the
last 12 months, each of which accounted for more than $10,000 in revenues.
Acer America Corporation Olin Corporation
Allegiance Telecom, Inc. OnCommand Corporation
Amdahl Corp. OzeMail Interline Pty, Ltd.
American Greetings Corporation Peapod L.P.
Ameritech Corporation Philips Mobile Computing
Andersen Consulting PictureTel Corporation
AT&T Corp. Pierce Leahy Corp.
Bay Networks, Inc. PointCast Incorporated
Bloomberg, L.P. Qwest Communications Corporation
Citizens Communications, L.P. Redback Networks, Inc.
Corel Corporation Rockwell International Corporation
Electric SchoolHouse LLC SBC Communications Inc.
First USA, Inc. Sega of America, Incorporated
Graybar Electric Company, Inc. Teligent, Inc.
Hitachi Metals America, Ltd. The Vanguard Group, Inc.
Intuit Inc. 3Com Corporation
Iomega Corporation TMI Telemedia International, Ltd.
Juno Online Services, L.P. U.S. Office Products Company
Kleiner, Perkins Caufield, & Byers USWeb Corporation
MCI WorldCom Inc. Wawa Inc.
Microsoft Corporation WebTV Networks, Inc.
Netpulse Communications, Inc. Williams Communications Inc.
Netscape Communications Corporation You Bet! On-Line Entertainment
Network Associates Inc. Ziff-Davis Publishing Co.
NTT PC Communications, Inc.
Revenue from WebTV accounted for 26.8% of the Company's revenue during the
year ended December 31, 1998 and 33.4% of the Company's revenue during the year
ended December 31, 1997.
Strategic Business Alliances
The Company aggressively pursues strategic business alliances with a variety
of companies. Through these partners, the Company seeks to expand its
enterprise and consumer customer base and increase the 24 hour utilization of
the Concentric network. The following is a summary of selected strategic
relationships:
WebTV Networks Inc. WebTV provides the world's first high-quality Internet
solution for television. In the fall of 1996, WebTV's licensees, Sony
Electronics, Inc. and Philips Electronics introduced a plug-and-play set-top
box that enables Internet browsing from a television. As part of the WebTV
service, Concentric and WebTV jointly designed and implemented a national
virtual private dial-up network solution to connect WebTV NetworkTM users to
the Internet, utilizing Concentric's network. The WebTV Internet terminal,
combined with the virtual private network, allows anyone to browse the Internet
from the comfort of their living room.
SBC Communications Inc. In October 1998, SBC and the Company agreed to
integrate Concentric's Internet-based business data services and technology
into SBC's portfolio of data products and services for business customers.
Concentric and SBC plan to deploy a complete suite of packet-switched, IP-based
services such as VPNs, Web hosting, shared software and electronic commerce for
business customers. SBC is working with Concentric to design and offer a new
product called Online Office. Targeted at medium and small businesses, Online
Office is being designed to offer turnkey data solutions for businesses that
want the benefits
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of data networking enjoyed by larger companies but lack the skill, time and
resources to handle it themselves. Online Office is being designed to provide
customers with local area network equipment, installation and network
management services and network-hosted business applications. Applications
include desktop office applications, email, calendaring and e-commerce. Online
Office will also support more experienced businesses as they expand their data
networking capabilities to include features like Web hosting, intranet and
extranet services, electronic commerce and remote access. SBC and Concentric
will host the services and software on remote servers and deliver the
capabilities directly to the customers' desktops. SBC's Southwestern Bell and
Pacific Bell units will provide the local telecommunications link between a
customer's location and Concentric's network POP customers and Concentric will
provide interLATA long distance transport. SBC and Concentric have introduced
these new services on a trial basis in San Francisco, California and Austin,
Texas. Widespread deployment of portions of Online Office is planned for the
second quarter of 1999. The entire Online Office package is targeted for
release in the third quarter of 1999.
As part of this relationship, SBC agreed in October 1998 to acquire 906,679
shares of Concentric's common stock either on the open market or from the
Company. In December 1998, SBC purchased 100,000 shares of common stock in two
open market purchases. The remaining 806,679 shares were purchased from the
Company in January 1999 for an aggregate purchase price of approximately $19.5
million. We also issued SBC a warrant to purchase 906,679 shares of Concentric
common stock at an exercise price of $21.00 per share.
Williams Communications Group, Inc. Concurrent with the closing of the
Company's initial public offering of common stock in August 1997, the Company
entered into a strategic relationship with Williams Communications Group, Inc.,
a subsidiary of the Williams Companies, Inc. (together, "Williams"). Williams
provides a full range of enterprise network solutions, communications services
and advanced applications to businesses, including equipment and services for
data, voice and video, international satellite and fiber-optic transmission
services, telemarketing services, and multipoint video- and audio-conferencing.
As part of the strategic business relationship, Williams has made available,
and the Company has agreed to purchase from Williams, a total of $21.2 million
in telecommunications equipment and services through the five year period
ending in 2002. At the election of Williams, $2.0 million of the minimum
purchase commitment may be paid by the issuance of Common Stock by the Company
at the then-current fair market value. Additionally, Williams and the Company
have entered into a reseller agreement and an agency agreement through which
Williams is able to sell the Company's products and services for an initial
term of two years. The agreements with Williams provide that, in the event of a
change of control of the Company, Williams will have a right to purchase a
nonexclusive, perpetual license to use, distribute and modify all of the
intellectual property of the Company, including any copyright, patent, license,
trademark or trade secret which the Company has or obtains the right to
transfer.
The relationship with Williams includes an equity investment in the Company
by Williams of approximately $15.0 million which closed in August 1997.
Covad. In January 1999, the Company entered into a strategic relationship
with Covad to combine Concentric's value-added IP services with Covad's high
speed DSL local loop services. This strategic relationship allows Concentric to
resell Covad's DSL local loop services to Concentric's customers. The companies
also will co-market DSL in approximately 20 major metropolitan areas in the
United States and jointly fund product development efforts in 1999 and 2000.
Additionally, Concentric invested approximately $10.0 million in Covad,
purchasing 555,556 shares of Covad's common stock at the initial public
offering price of $18.00 per share.
Teligent. Concentric signed an agreement with Teligent, a wireless CLEC, in
February 1998 to provide nationwide backbone data network services.
Concentric's services enable Teligent to offer a full range of high quality,
high-bandwidth communication services to small and medium-sized businesses.
Teligent's digital wireless networks interconnect with Concentric's ATM
backbone to deliver high speed, Internet-based services in several dozen
metropolitan markets throughout the United States. These services were launched
in July 1998. Teligent plans to ultimately offer services in 74 major markets
across the country and to interconnect
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with Concentric for data services in each of these markets. In addition, the
agreement enables Teligent to re-sell Concentric's VPN and Web hosting services
through its nationwide sales team. Teligent's sales force began reselling
selected Concentric products and services in August 1998.
Intuit. Intuit, a financial software and Web-based services company, is a
market leader in personal and small business financial software. Intuit views
its Websites as a key channel for communicating with its customers, and as a
vehicle to provide personal finance, investment and tax related financial
information. Concentric and Intuit partnered in October 1995 to launch
integrated Internet access to the Quicken Financial Network and the Internet.
The Internet access capability included both a virtual private network service
designed to provide Intuit customers subsidized access to select Intuit Web
sites and the ability to upgrade to full access to the Internet. Intuit has
bundled tailored versions of the Netscape Navigator browser in its fiscal year
1998 and 1999 releases and the Microsoft Explorer browser in its 1998 and 1999
releases of Quicken, TurboTax, ProTax and Quickbooks. Concentric designed and
implemented tailored registration and network access software to provide Intuit
customers with seamless, subsidized access to select Intuit Web sites.
Concentric provides an easy, Web-based upgrade process for customers desiring
full Internet access and email services. Customers are billed for network time
through Concentric's billing systems. In addition, Concentric provides private-
labeled customer service to Intuit customers with full network access on a
twenty-four hour a day, seven day a week basis. Intuit uses Concentric's high
performance network primarily to enable customers to send electronic tax
filings and software product registration.
Nortel/Bay Networks. In October 1997, Concentric began providing RemoteLink
dial-up access service to Nortel/Bay Network's entire U.S.-based mobile
workforce. Nortel/Bay Network's RemoteLink users dial into Concentric Network's
high-performance network and are then "tunneled" through one of two secure T-1
connections to access their corporate intranet, never touching the Internet. A
component of the service is that Nortel/Bay Networks controls authentication of
the users permitted to access its corporate intranet. In addition, Nortel/Bay
Networks uses Concentric's customer service center to provide round-the-clock
user support. This outsourced solution has allowed Nortel/Bay Networks to
realize considerable cost savings over traditional toll-free remote access and
in-house help desk support services.
TMI. In August 1996, the Company entered into an agreement with TMI to
establish an international network based on Concentric's network technology and
expertise and TMI's existing telecommunications infrastructure. TMI currently
has a telecommunications network deployed in 40 countries worldwide. In April
1998, the Company and TMI launched Mondonet, the first international network
designed and built expressly to support VPN services with coverage in more than
30 cities in 24 countries. As part of the agreement with TMI, the Company
granted TMI certain exclusive rights in certain critical markets, including
Europe. While the goal of this effort is to deliver a range of compatible
network services worldwide, only limited deployment of services has occurred
under this agreement to date. The Company's experience in working with TMI to
develop versions of its products and to market and distribute its products
internationally is limited. See "Risk Factors--We Face Risks Associated with
International Expansion."
The Concentric Network
The Concentric network employs an advanced, geographically dispersed ATM and
frame relay backbone, SuperPOPs in 19 major metropolitan areas plus a total of
143 secondary and tertiary POPs in other cities, allowing local dial-up access
to the network to users in the U.S. and Canada. In addition, the Company can
provide analog dial-up, frame relay, fractional T-1, T-1 and DS3 access to the
network. Concentric is in the process of deploying 56.6 Kbps modems throughout
its network and expects this deployment to be completed in the first quarter of
1999. This planned deployment is a forward looking statement and is subject to
a number of risks and uncertainties and the actual results could differ
materially as a result of a number of factors including those set forth under
the caption "Risk Factors--We Depend Upon New and Enhanced Services" and "Risk
Factors--We Depend Upon Our Network Infrastructure."
46
<PAGE>
The Concentric network is managed via a centralized network control center
in St. Louis, Missouri. Two data centers (located in Chicago, Illinois and
Cupertino, California) house the servers that support log on/authentication,
billing, email, Internet access, Web services and other network services. The
Cupertino data center will be consolidated into the new San Jose, California
headquarters building in mid-1999. In February 1998, the Company acquired
InterNex, a provider of network services, colocation services and Web-hosting
facilities to enterprise customers. With the acquisition of InterNex, the
Company expanded its Internet connectivity strategy to include not only private
transit with MCI, Sprint and UUNet, but also private peering with other network
providers as well as public peering with multiple smaller Internet service
providers. The Company's new hybrid private/public Internet connectivity
strategy is designed to allow Concentric to offer superior Internet
connectivity performance by avoiding congestion (packet loss) that may occur
when connecting to certain network providers at many public peering points.
The Concentric SuperPOPs are designed to support both dial-up and dedicated
access services within a broad geographic region. Typically, a SuperPOP will
utilize one or more CLECs and LECs to aggregate dial traffic within a 50-200
mile radius of the SuperPOP and terminate it at the SuperPOP. This strategy
allows Concentric to offer users local call coverage within the SuperPOP region
without having to deploy individual POPs in each local calling area. All the
calls are terminated at the modem equipment at the regional SuperPOP. This
results in broader call coverage, lower costs due to the typically lower rates
from CLECs and economies of scale from larger modem installations, lower
maintenance costs, and easier capacity upgrades since equipment is located in a
single location within a region.
DAFs and DSLs from customer locations in a region are terminated in the
SuperPOP as well. Typically, Fractional T-1, T-1, and DS3 circuits are
terminated directly into SuperPOP router equipment or via a channelized DS3
connected to a competitive access provider. Frame access is terminated via
aggregated LEC Frame Access circuit(s). DSL is terminated via a multiplexed DS3
connection to a CLEC metropolitan area DSL network. Both dial-up and dedicated
traffic is then aggregated by the routers/switches in the SuperPOP and directed
to the Concentric ATM backbone via one or more DS3 ATM links.
The Concentric network also offers its customers the security, reliability
and management features that companies require in their own private networks.
Varying layers of security and encryption are supported and tailored to
specific customer requirements. The network design includes a standard security
layer and is compatible with most types of custom security applications.
Further, security is provided at both the edge of the network and internally
based on embedded firewall and encryption techniques. The Concentric network
features colocation of network access and switching equipment in "hardened"
facilities, direct connections to carrier facilities, a resilient ATM/frame
relay backbone, dual data processing centers, and redundancy within data
centers to substantially enhance its uptime performance.
Network managers, customer service and technical support staff require near
real-time access to information about the performance and quality of their
networks. In traditional private networks, this information is provided by
network management, trouble reporting/tracking, and management information
systems. Customers usually sacrifice a great deal of control and have access to
less information when using a public network instead of a private network. It
has been difficult for public network providers to provide their major
customers with information regarding network performance that relates to that
customer's usage without either compromising other customers' proprietary
information or compromising the integrity of the network itself. Concentric has
developed a set of non-intrusive software tools and reporting mechanisms,
distributed to enterprise customers to allow a customer's network manager to
monitor network performance and quality and to adequately support inquiries for
help from their users. Web browsers and file transfer tools are used to provide
access to much of this information. In some cases, custom integration of
Concentric's network management and trouble tracking/reporting systems will be
provided to customers.
Sales and Marketing
The Company focuses on marketing its services to two distinct market
segments: enterprises (primarily small and medium size businesses) and
consumers. By attracting enterprise customers who use the network
47
<PAGE>
primarily during the daytime, and consumer customers who use the network
primarily at night, the Company is able to utilize its network infrastructure
more cost effectively. The Company pursues these customers through a multi-
tiered sales strategy consisting of leveraged third party distribution
channels, inbound and outbound telesales, value-added resellers, original
equipment manufacturers and a direct sales force. As of December 31, 1998, the
Company employed 168 persons in sales and marketing.
Leveraged Third Party Distribution. The Company has positioned itself as a
key network services provider for companies that bundle network access in their
products or services. For example, the Company's network service is bundled
with Intuit's Quicken, TurboTax and Quickbooks products, Microsoft Office 98
and with WebTV's Internet access devices. Additionally, the Company is one of
the Internet services providers listed on the Netscape Navigator and Microsoft
Internet Explorer browser registration servers.
Telesales. The Company employs separate telesales groups to generate inbound
leads in three market sectors. The consumer telesales group sells Internet
connectivity and shared hosting to the consumer market. The Company's AnaServe
sales group is focused on both shared and dedicated hosting and electronic
commerce solutions for the small business sector. The inside enterprise sales
group offers business solutions including T-1, DSL and wireless connectivity
products as well as shared and dedicated hosting products to enterprise
customers. In addition, an outbound group is dedicated to generating leads for
field sales and resellers, as well as managing the customer installed base in
the pursuit of upgrades and contract renewals.
Value-Added Resellers. The Company has established sales channels and
significant market coverage through value-added resellers without incurring the
commensurate costs of a large direct sales force. These resellers are
categorized into four groups, national and regional network integrators and
colocation and shared hosting resellers. In the enterprise market, these
companies sell both network equipment and full service network/Internet
solutions, including design, installation and maintenance. Williams
Communications Solutions is a national network integrator with over 300 trained
sales and support professionals who are compensated for selling Concentric's
enterprise connectivity, VPN and dedicated hosting solutions. Concentric
solicits shared hosting developers and resellers through a combination of on
line advertising and direct telesales, and currently has over 500 resellers in
this market. In addition, the Company has launched a trial program with
Microsoft for the sale of the Microsoft Small Business Server bundled with
Concentric DSL for sale through the Microsoft Value Added Provider channel.
OEM Sales. Concentric recently adopted an OEM, i.e. private-label, strategy
that enables national telecommunications infrastructure providers to offer a
full suite of private labeled IP-based consumer and enterprise network
services. Concentric's OEM partners, such as Teligent and SBC, sell
Concentric's services through their large sales forces into established
customer bases.
Direct Sales Force. The Company employs 29 field sales people located in San
Jose, Orange County and Los Angeles, California, Dallas, Texas, Washington,
D.C., the New York metropolitan area, Atlanta, Georgia, Chicago, Illinois and
Boston, Massachusetts for support of complex custom enterprise VPN solutions
and to acquire, support, train and retain distribution channel partners. The
Company's field sales force is supported by inside sales/account managers,
project and program managers and systems engineers.
Concentric markets its enterprise services to marketing and information
service professionals, enabling companies to take full advantage of IP-based
WAN, intranet and extranet applications. The Company uses print advertising in
targeted industry publications, end-user seminars and media spot advertisements
specifically to build awareness and acquire leads for its VARs and its direct
sales team.
In the consumer market, the Company focuses on direct mail to targeted
audiences; establishment of customer referral programs; and co-marketing such
as packaging literature with MasterCard mailers and Intuit software. In
addition, the Company has implemented online customer retention programs, such
as a Website "home" where they can learn how to use the service, how to use the
Internet, and how to find information quickly. Additionally, the Company is
generating advertising revenue on its Website from direct ad banner placements
as well as from shared revenue relationships with content partners such as
Excite, Inc. and Lycos, Inc.
48
<PAGE>
The Company employs in-house public relations personnel and contracts with
an outside public relations agency to provide broad coverage in network
computer and vertical industry publications. The Company also participates in
industry trade shows with and without its strategic marketing partners and
conducts numerous seminar "road shows" for market awareness and lead
generation.
Customer Service
Concentric believes that a high level of customer support is critical to
attracting and retaining its enterprise and consumer customers. The Company's
customer support strategy is based on the following principles:
. our technical expertise in devising cost-effective network solutions for
customers;
. rapid development time and flexibility in meeting customer applications
requirements; and
. responsive customer support and effective account management.
The Company maintains a customer support call center at its Saginaw,
Michigan facility. Concentric offers several levels of customer support all of
which are available 24 hours per day, seven days per week. The basic level of
customer support includes support for customers on installing and using their
software, customer communications and customer training. Premier level service
programs guarantee an exceptional performance standard, offer supplemental
support training, and provide monthly reports on operations. Private label
support gives businesses a premier level of support provided by their own
customer service team who answer calls with that customer's company name.
Customer support is provided by email, telephone, Website and online chat. As
of December 31, 1998, the Company employed 171 persons in customer support.
Competition
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. The Company believes
that its ability to compete successfully depends upon a number of factors,
including market presence; the capacity, reliability, low latency and security
of network infrastructure; technical expertise and functionality, performance
and quality of services; customization; ease of access to and navigation of the
Internet; the pricing policies of its competitors; the variety of services; the
timing of introductions of new services by the Company and its competitors;
customer support; the Company's ability to support industry standards; and
industry and general economic trends.
The Company's current and prospective competitors generally may be divided
into four groups. These groups and examples of key competitors in each group
are listed below:
. telecommunications companies AT&T
MCI WorldCom
Sprint
Qwest
Level 3 Communications, Inc.
the RBOCs and other LECs
various cable companies
. online service providers America Online, Inc.
CompuServe Corporation
MSN, the Microsoft Network
Prodigy Communications Corporation
. Internet service providers BBN Corporation, a subsidiary of GTE
EarthLink Network, Inc.
MindSpring Enterprises, Inc.
PSINet Inc.
Verio Inc.
other national and regional providers
49
<PAGE>
. Web hosting providers AboveNet Communications
Exodus Communications
Many of these competitors have greater market presence, engineering and
marketing capabilities, and financial, technological and personnel resources
than those available to the Company. As a result, they may be able to develop
and expand their communications and network infrastructures more quickly, adapt
more swiftly to new or emerging technologies and changes in customer
requirements, take advantage of acquisition and other opportunities more
readily, and devote greater resources to the marketing and sale of their
products than can the Company. In addition, various organizations, including
certain of those identified above, have entered into or are forming joint
ventures or consortiums to provide services similar to those of the Company.
The Company believes that new competitors, including large computer
hardware, software, media and other technology and telecommunications companies
will enter the value added network services markets, resulting in even greater
competition for the Company. Certain of such telecommunications companies and
online services providers are currently offering or have announced plans to
offer Internet or online services or to expand their Internet access services.
Certain companies, including America Online, MindSpring, PSINet and Verio have
also obtained or expanded their Internet access products and services as a
result of acquisitions. Such acquisitions may permit the Company's competitors
to devote greater resources to the development and marketing of new competitive
products and services and the marketing of existing competitive products and
services. In addition, the ability of some of the Company's competitors to
bundle other services and products with VPN and consumer network services could
place the Company at a competitive disadvantage. Certain companies are also
exploring the possibility of providing high-speed data services using
alternative delivery methods such as over the cable television infrastructure,
through direct broadcast satellite technology and by wireless cable. There can
be no assurance that the Company will have the financial resources, technical
expertise or marketing and support capabilities to continue to compete
successfully. See "Risk Factors--Our Market Is Extremely Competitive."
Proprietary Rights
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The Company
principally relies upon a combination of copyright, trademark and trade secret
laws and contractual restrictions to protect its proprietary technology. It may
be possible for a third party to copy or otherwise obtain and use the Company's
products or technology without authorization or to develop similar technology
independently, and there can be no assurance that protective measures have
been, or will be, adequate to protect the Company's proprietary technology or
that the Company's competitors will not independently develop technologies that
are substantially equivalent or superior to the Company's technology. The
Company operates a material portion of its business over the Internet, which is
subject to a variety of risks. Such risks include but are not limited to the
substantial uncertainties that exist regarding the system for assigning domain
names and the status of private rules for resolution of disputes regarding
rights to domain names. There can be no assurance that the Company will
continue to be able to employ its current domain names in the future or that
the loss of rights to one or more domain names will not have a material adverse
effect on the Company's business and results of operations.
Although the Company does not believe that it infringes the proprietary
rights of any third parties, we cannot assure you that third parties will not
assert such claims against the Company in the future or that such claims will
not be successful. See "Risk Factors--Third Parties May Claim We Infringe Their
Proprietary Rights."
Employees
As of December 31, 1998, Concentric had 508 employees and 61 independent
contractors, including 168 persons in sales and marketing, 171 persons in
network operations and development, 171 in customer support
50
<PAGE>
and 59 in finance and administrative functions. The Company believes that its
future success will depend in part on its continued ability to attract, hire
and retain qualified personnel. Competition for such personnel is intense, and
We cannot assure you that the Company will be able to identify, attract, and
retain such personnel in the future. None of the Company's employees is
represented by a labor union, and management believes its employee relations
are good.
Legal Proceedings
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana, the parent corporation of Sattel, alleging
securities fraud related to plaintiffs' purchase of shares of Diana Common
Stock in reliance upon allegedly misleading statements made by defendants,
Diana, Sattel and certain of their respective affiliates, officers and
directors. Concentric was named as a defendant in the complaint in connection
with certain statements made by Diana and officers of Diana related to
Concentric's purchase of network switching equipment from Diana's Sattel
subsidiary. The plaintiffs sought unspecified compensatory damages. A motion by
the Company to dismiss the complaint was denied, and the court has allowed the
action to proceed against the Company. The parties have agreed in principal to
settle the case and expect to enter the settlement agreement with the court in
February 1999.
51
<PAGE>
MANAGEMENT
Executive Officers, Directors and Senior Management
The following table sets forth certain information as of December 31, 1998,
with respect to the executive officers and directors of the Company, as well as
certain members of its senior management.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Henry R. Nothhaft.................... 54 Chairman, President, Chief Executive
Officer and Director
John K. Peters....................... 50 Executive Vice President and General
Manager, Network Services Applications
Division
Michael F. Anthofer.................. 46 Senior Vice President and Chief
Financial Officer
Mark W. Fisher....................... 38 Senior Vice President of Corporate
Marketing, General Manager, Network
Services Division
William C. Etheredge................. 52 Senior Vice President of Sales
Eileen A. Curtis..................... 50 Vice President of Customer Relations
James L. Isaacs...................... 38 Vice President of Business Development
Vinod Khosla(2)...................... 44 Director
S. Miller Williams(1)................ 47 Director
Franco Regis(1)...................... 42 Director
Gary E. Rieschel(2).................. 42 Director
</TABLE>
- ----------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Henry R. Nothhaft joined the Company as President and Chief Executive
Officer in May 1995 and was appointed a Director of the Company in August 1995
and Chairman of the Board in January 1998. From 1989 to August 1994, Mr.
Nothhaft was President, Chief Executive Officer and a Director of David
Systems, Inc., a networking company. From 1983 to 1989, Mr. Nothhaft held
various positions with DSC Communications Corporation, including President of
the Business Network Systems Group, President of the Digital Switch Corporation
subsidiary, Senior Vice President of Marketing and a Corporate Director of DSC.
From 1979 to 1983, Mr. Nothhaft was Vice President of Domestic Marketing and
Vice President of Sales for GTE Telenet Communications Corporation (now
Sprint). Mr. Nothhaft has an M.B.A. in Information Systems Technology from
George Washington University and a B.S. from the U.S. Naval Academy, and is a
former officer in the U.S. Marine Corps.
John K. Peters was named Executive Vice President and General Manager,
Network Services Division in June 1995. In June 1998, Mr. Peters assumed a new
position as Executive Vice President and General Manager, Network Services
Applications Division. From 1993 to August 1995, Mr. Peters served as President
of Venture Development Consulting, a consulting firm specializing in new
communications and information services. From 1988 to 1993, Mr. Peters was Vice
President and Chief Operating Officer of Pacific Bell Information Services,
Inc. Prior to that, Mr. Peters spent three years as Vice President of
Application Services for Telestream Corporation. In 1981, Mr. Peters co-founded
Integrated Office Systems, Inc., a communications and information systems
company. From 1976 to 1980, Mr. Peters was Vice President of Advanced Network
Services for GTE Telenet Communications Corporation. Mr. Peters has an M.B.A.
from Stanford Graduate School of Business and a B.S. in Statistics from
Stanford University.
Michael F. Anthofer joined the Company in January 1996 as Vice President and
Chief Financial Officer and became a Senior Vice President in November 1996.
From January 1991 to December 1995, Mr. Anthofer served as an Executive Vice
President and Chief Financial Officer, as well as a member of the Board of
Directors, of Shared Resource Exchange, Inc., a privately held digital
switching platform and PBX supplier. Prior to 1991, Mr. Anthofer held various
executive positions at DSC Communications Corporation including Vice President,
Corporate Business Planning, Vice President, Business Network Group and Vice
President, Network Products Group. Mr. Anthofer has an M.B.A. and a B.S. from
the University of California, Berkeley.
52
<PAGE>
Mark W. Fisher joined the Company in June 1997 as Vice President of
Corporate Marketing and was promoted to Senior Vice President and General
Manager, Network Services Division in July 1998. From July 1996 to June 1997,
Mr. Fisher was General Manager and Vice President, Marketing of Pacific Bell
Internet Services, a wholly owned subsidiary of Pacific Bell. From June 1995 to
August 1996, Mr. Fisher was Vice President, Marketing of Pacific Bell Internet
Services. From 1989 to May 1995, Mr. Fisher held various data product marketing
and data center operations positions at Pacific Bell. Mr. Fisher has an M.B.A.
from the University of California, Berkeley and a B.S. in mechanical
engineering from the U.S. Naval Academy.
William C. Etheredge joined the Company in March 1997 as the Senior Vice
President of Sales. From May 1991 to March 1997, Mr. Etheredge served first as
Vice President of Sales and Marketing and then as Vice President of Sales for
Meridian Data, Inc., a provider of networked CD-ROM database creation and
retrieval software and network servers. From July 1990 to May 1991, he served
as Vice President of Strategic Accounts for Maxtor Corporation. From June 1985
to June 1990, he served first as Vice President US Sales and Marketing and then
Vice President Western Region for Memorex-Telex Corporation. Mr. Etheredge has
an M.B.A. from Bowling Green University and a B.A. from Westminster College.
Eileen A. Curtis became Customer Relations Manager in January 1995, Director
of Customer Relations in September 1995 and Vice President, Customer Relations
in November 1996. From August 1987 to July 1993, Ms. Curtis was employed by Cox
Communications Saginaw, Inc. and served in various positions including
Marketing and Public Relations Manager, Administrative Manager and Customer
Service Manager. Ms. Curtis has an MBA and a B.S. from Central Michigan
University.
James L. Isaacs joined the Company in October 1995 as the Director of
Product Management. In March 1997, he became Vice President of Product
Management and in November 1997 he was appointed Vice President of Business
Development. From July 1988 to October 1995, Mr. Isaacs held various positions
at Apple Computer, including Group Manager Product Marketing, Apple On Line
Services Division and Business Development Manager of Apple On Line Services
Division. Mr. Isaacs has an M.B.A. from the University of California, Berkeley
and an A.B. from Stanford University.
Vinod Khosla has been a Director of the Company since April 1995. Mr. Khosla
has been a General Partner with the venture capital firm of Kleiner Perkins
Caufield & Byers from February 1986 to the present. Mr. Khosla was a co-founder
of Daisy Systems and the founding Chief Executive Officer of Sun Microsystems,
Inc. Mr. Khosla also serves on the boards of Excite, Inc., PictureTel, The 3DO
Company, and Spectrum Holobyte. He has a B.S.E. from the Indian Institute of
Technology in New Delhi, an M.S.E. from Carnegie Mellon University, and an
M.B.A. from the Stanford Graduate School of Business.
S. Miller Williams has been a Director of the Company since September 1998.
Mr. Williams is Vice President of Corporate Development for Williams
Communications Group, Inc., a subsidiary of Williams Companies, Inc., a
position he has held since 1992. Mr. Williams has a B.S. in Business
Administration from the University of North Carolina and an M.B.A. from the
University of Tulsa.
Franco Regis has been a Director of the Company since October 1996. Since
1994, Mr. Regis has been a Director of Business Development and Strategic
Planning at Telecom Italia, SpA, the telephone operating company of Italy. From
1992 to 1994, Mr. Regis was a Director of Budget and Control for the business
division of Telecom Italia. Mr. Regis has an engineering degree from the Rome
State University.
Gary E. Rieschel has been a Director of the Company since October 1996. Mr.
Rieschel is Executive Managing Partner at SOFTBANK Technology Ventures, having
joined that company in January 1996. Mr. Rieschel was Vice President for N-Cube
Corporation from August 1994 through December 1995. He was Sales Director at
Cisco Systems, Inc. from July 1993 through October 1994. Prior to this, Mr.
Rieschel was a General Manager and Sales Director at Sequent Computer for over
nine years. Mr. Rieschel has an M.B.A. from Harvard Graduate School of Business
and a B.A. in biology from Reed College.
53
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of our common stock as of December 31, 1998, by: (i) each
person who we know owns beneficially more than 5% of the common stock; (ii)
each of our director, our Chief Executive Officer and our four most highly
compensated officers in 1998; and (iii) all of our directors and executive
officers as a group. Except as otherwise noted, the persons named in the table
have sole voting and investment power with respect to all shares of common
stock shown as beneficially owned by them, subject to community property laws
where applicable.
<TABLE>
<CAPTION>
Percent Beneficially
Owned(1)
Shares ------------------------
Beneficially Before After
Names and Addresses Owned Offering Offering
- ------------------- ------------ ---------- ----------
<S> <C> <C> <C>
Williams Communications, Inc.(2)..... 2,671,876 17.2% 14.8%
One Williams Center
Tulsa, OK 74172
TMI Telemedia International,
Ltd.(3)............................. 1,580,966 10.2 8.8
Viale del Campo, Boario, 56D
00153 Rome, Italy
Henry R. Nothhaft(4)................. 182,775 1.2 1.0
John K. Peters(5).................... 153,404 1.0 *
Michael F. Anthofer(6)............... 55,473 * *
William C. Etheridge(7).............. 31,635 * *
Vinod Khosla(8)...................... 246,675 1.6 1.4
S. Miller Williams(9)................ -- -- --
Franco Regis(10)..................... 1,580,966 10.2 8.8
Gary E. Rieschel(11)................. -- -- --
All current executive officers and
directors as a group
(11 persons)(12).................... 2,285,802 14.5 12.5
</TABLE>
- ----------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, based on factors including voting and
investment power with respect to shares, subject to the applicable
community property laws. Percentage of beneficial ownership is based on
15,144,310 shares of common stock outstanding as of December 31, 1998.
Shares of common stock subject to options or warrants currently
exercisable, or exercisable by March 1, 1999, are deemed outstanding for
the purpose of computing the percentage ownership of the person holding
such options or warrants, but are not deemed outstanding for computing the
percentage ownership of any other person. The number of shares outstanding
does not include 806,679 shares of common stock and a warrant to purchase
906,679 shares of common stock that the Company issued to SBC in January
1999.
(2) Includes warrants to purchase 355,018 shares of common stock.
(3) Includes warrants to purchase 341,001 shares of common stock.
(4) Includes 20,197 shares of common stock issuable upon exercise of
outstanding stock options and warrants.
(5) Includes 91,093 shares of common stock issuable upon exercise of
outstanding stock options and warrants.
(6) Includes 24,961 shares of common stock issuable upon exercise of
outstanding stock options.
(7) Includes 16,949 shares of common stock issuable upon exercise of
outstanding stock options.
54
<PAGE>
(8) Includes 161,913 shares and warrants to purchase 83,333 shares of common
stock. Represents shares beneficially owned by Kleiner Perkins Caufield &
Byers VII and KPCB Information Sciences Zaibatsu Fund II. Mr. Khosla is an
affiliate of such entities. Mr. Khosla disclaims beneficial ownership of
such shares, except to the extent of his pecuniary interest therein.
(9) Excludes 2,316,858 shares and warrants to purchase 355,018 shares of
common stock held by Williams Communications, Inc. Mr. Williams, a
Director of the Company, is a vice president of Williams Communications
Group, Inc., an affiliate of Williams Communications, Inc. Mr. Williams
disclaims beneficial ownership of such shares.
(10) Includes 1,239,965 shares and warrants to purchase 341,001 shares of
common stock held by TMI Telemedia International, Ltd. Mr. Regis is the
Director of Business Development and Strategic Planning of Telecom Italia,
S.p.A., the parent of TMI Telemedia International, Ltd. See note (3). Mr.
Regis disclaims beneficial ownership of such shares.
(11) Excludes 752,279 shares held by SOFTBANK Ventures Inc. Mr. Rieschel, a
director of the Company, is the Senior Vice President at SOFTBANK Holdings
Inc., an affiliate of SOFTBANK Ventures Inc. Mr. Rieschel disclaims
beneficial ownership of such shares.
(12) Includes shares of Common Stock issuable upon exercise of outstanding
options and warrants, and shares beneficially owned by entities associated
with Messrs. Regis and Khosla, as to which they disclaim beneficial
ownership. See Notes (4)-(11).
55
<PAGE>
UNDERWRITING
Concentric and the underwriters for the offering (the "Underwriters") named
below, for whom Bear, Stearns & Co. Inc., BancBoston Robertson Stephens Inc.,
CIBC Oppenheimer Corp., First Union Capital Markets Corp., C.E. Unterberg,
Towbin and Warburg Dillon Read LLC are acting as representatives (collectively,
the "Representatives"), have entered into an underwriting agreement with
respect to the shares being offered. Subject to certain conditions, each
Underwriter has severally agreed to purchase the number of shares indicated in
the following table.
<TABLE>
<CAPTION>
Underwriters Number of Shares
------------ ----------------
<S> <C>
Bear, Stearns & Co. Inc. ...................................
BancBoston Robertson Stephens Inc...........................
CIBC Oppenheimer Corp.......................................
First Union Capital Markets Corp............................
C.E. Unterberg, Towbin......................................
Warburg Dillon Read LLC.....................................
---------
Total..................................................... 2,500,000
=========
</TABLE>
If the Underwriters sell more than the total number set forth in the table
above, the Underwriters have an option to buy up to an additional 375,000
shares from Concentric to cover such sales. They may exercise that option for
30 days. If any shares are purchased pursuant to this option, the Underwriters
will severally purchase shares in approximately the same proportion as set
forth in the table above.
The following table shows the per share and total underwriting discounts and
commissions to be paid to the Underwriters by Concentric. Such amounts are
shown assuming both no exercise and full exercise of the Underwriters' option
to purchase additional shares.
<TABLE>
<CAPTION>
Paid by Concentric
Network Corporation
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ $
Total.............................................. $ $
</TABLE>
Shares sold by the Underwriters to the public will initially be offered at
the public offering price set forth on the cover of this prospectus. Any shares
sold by the Underwriters to securities dealers may be sold at a discount of up
to $ per share from the public offering price. Any such securities dealers
may resell any shares purchased from the Underwriters to certain other brokers
or dealers at a discount of up to $ per share from the public offering
price. If all the shares are not sold at the offering price, the
Representatives may change the offering price and the other selling terms.
Concentric, and its directors and executive officers, have agreed with the
Underwriters not to dispose of or hedge any of their common stock or securities
convertible into or exchangeable for shares of common stock during the period
from the date of this prospectus continuing through the date 90 days after the
date of this prospectus, except with the prior written consent of the
Representatives. This agreement does not apply to issuances or sales by
Concentric pursuant to any existing employee benefit plans or upon conversion
or exchange of any currently outstanding convertible or exchangeable
securities.
In connection with the offering, the Underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the Underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock while the offering is in progress.
56
<PAGE>
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the Representatives have repurchased shares
sold by or for the account of such Underwriter in stabilizing or short covering
transactions. These activities by the Underwriters may stabilize, maintain or
otherwise affect the market price of the common stock. As a result, the price
of the common stock may be higher than the price that otherwise might exist in
the open market. If these activities are commenced, they may be discontinued by
the Underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
In connection with this offering, certain Underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in the common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended, during the business day prior to
the pricing of the offering before the commencement of offers or sales of the
common stock. Passive market makers must comply with applicable volume and
price limitations and must be identified as such. In general, a passive market
maker must display its bid at a price not in excess of the highest independent
bid of such security; if all independent bids are lowered below the passive
market makers' bid, however, such bid must then be lowered when certain
purchase limits are exceeded.
The Company estimates that its share of the total expenses of the offering,
excluding underwriting discounts and commissions, will be approximately
$750,000.
The Company has agreed to indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's Web site at http://www.sec.gov. You may also read and
copy any document we file with the SEC at its Public Reference Room at 450
Fifth Street, N.W., Washington, D.C. 20549. You can also obtain copies of the
documents at prescribed rates by writing to the Public Reference Section of the
SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330 for further information on the operation of its Public Reference
Room.
The SEC allows us to "incorporate by reference" into the prospectus the
information we have filed with them. The information incorporated by reference
is an important part of this prospectus and the information that we file
subsequently with the SEC will automatically update this prospectus. The
information incorporated by reference is considered to be part of this
prospectus. We incorporate by reference the documents listed below and any
filings we make with the SEC under Sections 13(a), 13(c), 14, or 15(d) of the
Securities Exchange Act of 1934, as amended, after the initial filing of this
registration statement that contains this prospectus and prior to the time that
we sell all the securities offered by this prospectus:
. the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997;
. the Company's Quarterly Report on Form 10-Q for the quarter ended March
31, 1998;
. the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1998;
. the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998;
. the Company's Definitive Proxy Statement dated April 23, 1998, filed in
connection with the Company's 1998 Annual Meeting of Stockholders held
on May 20, 1998; and
. the description of the Company's Common Stock contained in the Company's
Registration Statement on Form 8-A filed on July 25, 1997 under Section
12 of the Exchange Act, including any amendment or report updating such
description.
57
<PAGE>
You may request a copy of these filings, at no cost, by writing or
telephoning the Company at the following address:
Concentric Network Corporation
Attention: Peter Bergeron
1400 Parkmoor Avenue
San Jose, California 95126-3429
(408) 817-2800
LEGAL MATTERS
The validity of the common stock offered by this prospectus will be passed
upon for the Company by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, Palo Alto, California. Certain legal matters relating to this
offering will be passed upon for the Underwriters by Brobeck, Phleger &
Harrison LLP, San Francisco, California, counsel for the Underwriters.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements included in this prospectus and Registration Statement for
the years ended December 31, 1997 and 1998 and for each of the three years in
the period ended December 31, 1998 as set forth in their report. Our
consolidated financial statements are included in reliance on their report,
given on their authority as experts in accounting and auditing.
58
<PAGE>
CONCENTRIC NETWORK CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Operations.................................... F-4
Consolidated Statements of Common Stock Subject to Rescission and
Stockholders' Equity (Deficit).......................................... F-5
Consolidated Statements of Cash Flows.................................... F-7
Notes to Consolidated Financial Statements............................... F-9
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Concentric Network Corporation
We have audited the accompanying consolidated balance sheets of Concentric
Network Corporation as of December 31, 1997 and 1998, and the related
consolidated statements of operations, common stock subject to rescission and
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule included in Item 16(b) These financial statements and
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Concentric Network Corporation at December 31, 1997 and 1998, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the financial information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
January 25, 1999, except for Note 15, as to which the date is February 1, 1999
F-2
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 119,959 $ 98,988
Short term investments................................. -- 52,226
Current portion of restricted cash..................... 19,125 19,125
Accounts receivable, net of allowances of $80 in 1997
and $690 in 1998...................................... 4,549 13,714
Prepaid expenses and other current assets.............. 3,871 3,058
--------- ---------
Total current assets................................. 147,504 187,111
Property and equipment:
Computer and telecommunications equipment.............. 71,942 89,668
Software............................................... 1,519 5,427
Furniture and fixtures and leasehold improvements...... 2,984 11,357
--------- ---------
76,445 106,452
Accumulated depreciation and amortization.............. 22,735 42,184
--------- ---------
53,710 64,268
Restricted cash, net of current portion................. 33,400 17,113
Goodwill and other intangible assets, net of current
portion................................................ -- 20,364
Other assets............................................ 9,875 9,401
--------- ---------
Total assets....................................... $ 244,489 $ 298,257
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................... $ 10,144 $ 26,342
Accrued compensation and other employee benefits....... 1,577 2,024
Other current liabilities.............................. 4,917 4,559
Current portion of capital lease obligations,
including $13,600 in 1997 to a related party.......... 15,326 6,543
Deferred revenue....................................... 1,435 3,104
--------- ---------
Total current liabilities............................ 33,399 42,572
Capital lease obligations, including $32,373 in 1997 to
a related party, net of current portion................ 33,595 10,434
Notes payable........................................... 145,577 146,021
Commitments and contingencies
Redeemable exchangeable preferred stock................. -- 156,105
Stockholders' equity (deficit):
Preferred stock, $0.001 par value; issuable in series:
Authorized shares--10,000 in 1997 and 1998
Issued and outstanding shares--none in 1997 and
1998................................................ -- --
Common stock, $0.001 par value; issuable in classes:
Authorized shares--100,000 in 1997 and 1998
Issued and outstanding shares--14,139 in 1997 and
15,144 in 1998....................................... 182,721 190,076
Accumulated deficit..................................... (149,534) (246,055)
Deferred compensation................................... (1,269) (896)
--------- ---------
Total stockholders' equity (deficit)................. 31,918 (56,875)
--------- ---------
Total liabilities and stockholders' equity
(deficit)......................................... $ 244,489 $ 298,257
========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Revenue.......................................... $ 15,648 $ 45,457 $ 82,807
Costs and expenses:
Cost of revenue................................ 47,945 61,439 85,352
Network equipment write-off.................... 8,321 -- --
Development.................................... 2,449 4,850 7,734
Marketing and sales, including $2,448, $2,600
and $1,085 to a related party for the years
ended December 31, 1996, 1997 and 1998,
respectively.................................. 16,609 24,622 39,793
General and administrative..................... 3,445 4,790 10,398
Amortization of goodwill and other intangible
assets........................................ -- -- 3,842
Acquisition-related charges.................... -- -- 1,291
Write-off of in-process technology............. -- -- 5,200
-------- -------- --------
Total costs and expenses..................... 78,769 95,701 153,610
-------- -------- --------
Loss from operations............................. (63,121) (50,244) (70,803)
Other income (expense)........................... -- 1,233 (750)
Interest income.................................. 614 1,217 9,975
Interest expense, including $3,065, $6,197 and
$1,272 to related parties for the years ended
December 31, 1996, 1997 and 1998, respectively.. (3,874) (7,788) (23,570)
-------- -------- --------
Loss before extraordinary item................... (66,381) (55,582) (85,148)
Extraordinary gain on early retirement of debt... -- -- 3,042
-------- -------- --------
Net loss......................................... (66,381) (55,582) (82,106)
Preferred stock dividends and accretion.......... -- -- (11,958)
-------- -------- --------
Net loss attributable to common stockholders..... $(66,381) $(55,582) $(94,064)
======== ======== ========
Net loss per share (pro-forma 1996 and 1997,
historical 1998)
Loss before extraordinary item................. $ (13.46) $ (5.63) $ (5.86)
Extraordinary gain............................. -- -- .21
-------- -------- --------
Net loss......................................... (13.46) (5.63) (5.65)
Preferred stock dividends and accretion.......... -- -- (.82)
-------- -------- --------
Net loss per share attributable to common
stockholders.................................... $ (13.46) $ (5.63) $ (6.47)
======== ======== ========
Shares used in computing net loss and net loss
attributable to common stockholders per share
(pro-forma 1996 and 1997, historical 1998)...... 4,937 9,872 14,547
======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
<TABLE>
<CAPTION>
Stockholders' Equity (Deficit)
--------------------------------------------------------------------------
Common Stock
Subject to Total
Rescission Preferred Stock Common Stock Stockholders'
-------------- ---------------- ---------------- Accumulated Deferred Equity
Shares Amount Shares Amount Shares Amount Deficit Compensation (Deficit)
------ ------- ------ -------- ------ -------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... 445 $ 5,080 2,078 $ 35,695 1,388 $ 1,639 $ (27,571) $ -- $ 9,763
Issuance of Class A
common stock.......... -- -- -- -- -- 1 -- -- 1
Conversion of
debentures to Class A
common stock.......... 10 70 -- -- -- -- -- -- --
Exercise of options.... -- -- -- -- 5 22 -- -- 22
Conversion of note to
Series C preferred
stock (net of issuance
costs)................ -- -- 123 2,960 -- -- -- -- 2,960
Issuance of Series D
preferred stock (net
of issuance costs).... -- -- 2,451 48,533 -- -- -- -- 48,533
Conversion of note to
Series D preferred
stock................. -- -- 249 5,072 -- -- -- -- 5,072
Warrants issued to
purchase Series D
preferred stock....... -- -- -- 2,955 -- -- -- -- 2,955
Deferred compensation
resulting from grant
of options............ -- -- -- -- -- 188 -- (188) --
Net loss............... -- -- -- -- -- -- (66,381) -- (66,381)
---- ------- ------ -------- ------ -------- --------- ------- --------
Balance at December 31,
1996................... 455 5,150 4,901 95,215 1,393 1,850 (93,952) (188) 2,925
Issuance of Class A
common stock for
services.............. -- -- -- -- 5 17 -- -- 17
Conversion of Class B
common to Series A
preferred stock....... -- -- 7 -- (7) -- -- -- --
Conversion of Series A,
B, C and D preferred
to Class A common
stock................. -- -- (5,693) (99,604) 5,693 99,604 -- -- --
Shares issued upon the
initial public
offering (net of
issuance costs)....... -- -- -- -- 4,945 52,757 -- -- 52,757
Shares issued in a
private placement..... -- -- -- -- 1,246 14,950 -- -- 14,950
Conversion of note to
Class A common stock.. -- -- -- -- 253 3,041 -- -- 3,041
Repurchase of Class A
common stock in
connection with the
initial public
offering.............. -- -- -- -- (185) (2,217) -- -- (2,217)
Shares issued subject
to dilution ratios.... -- -- 484 -- -- -- -- -- --
Exercise of options to
purchase stock........ -- -- -- -- 65 243 -- -- 243
Exercise of warrants to
purchase stock........ -- -- 301 3,281 309 1,201 -- -- 4,482
Warrants issued to
purchase stock........ -- -- -- 1,108 -- 5,370 -- -- 6,478
Deferred compensation
resulting from grant
of options............ -- -- -- -- -- 1,303 -- (1,303) --
Amortization of
deferred
compensation.......... -- -- -- -- -- -- -- 222 222
Expiration of statutes
of limitations on
common stock subject
to rescission......... (422) (4,602) -- -- 422 4,602 -- -- 4,602
Repurchase of shares
for cancellation in
connection with
Rescission Offer...... (33) (548) -- -- -- -- -- -- --
Net loss............... -- -- -- -- -- -- (55,582) -- (55,582)
---- ------- ------ -------- ------ -------- --------- ------- --------
Balance at December 31,
1997................... -- $ -- -- $ -- 14,139 $182,721 $(149,534) $(1,269) $ 31,918
</TABLE>
See accompanying notes.
F-5
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Common Stock
Subject to
Rescission
-------------
Shares Amount
------ ------
<S> <C> <C>
Amortization of deferred
compensation....................... -- $ --
Common stock issued under stock
purchase plan...................... -- --
Common stock issued in acquisition
of DeltaNet Services, Inc.......... -- --
Exercise of options to purchase
common stock....................... -- --
Exercise of warrants for no cash
consideration...................... -- --
Warrants issued to purchase stock... -- --
Net loss............................ -- --
Preferred stock dividends and
accretion.......................... -- --
--- -----
Balance at December 31, 1998......... -- $ --
- --------------------------------------------------
=== =====
<CAPTION>
Stockholders' Equity (Deficit)
--------------------------------------------------------------------
Preferred Total
Stock Common Stock Stockholders'
------------- --------------- Accumulated Deferred Equity
Shares Amount Shares Amount Deficit Compensation (Deficit)
------ ------ ------ -------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Amortization of deferred
compensation....................... -- $ -- -- $ -- $ -- $ 373 $ 373
Common stock issued under stock
purchase plan...................... -- -- 74 781 -- -- 781
Common stock issued in acquisition
of DeltaNet Services, Inc.......... -- -- 226 1,147 (2,457) -- (1,310)
Exercise of options to purchase
common stock....................... -- -- 612 3,527 -- -- 3,527
Exercise of warrants for no cash
consideration...................... -- -- 93 -- -- -- --
Warrants issued to purchase stock... -- -- -- 1,900 -- -- 1,900
Net loss............................ -- -- -- -- (82,106) -- (82,106)
Preferred stock dividends and
accretion.......................... -- -- -- -- (11,958) -- (11,958)
------ ------ ------ -------- ----------- ------------ -------------
Balance at December 31, 1998......... -- $ -- 15,144 $190,076 $(246,055) $(896) $(56,875)
- --------------------------------------------------
====== ====== ====== ======== =========== ============ =============
</TABLE>
See accompanying notes.
F-6
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1996 1997 1998
-------- -------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ...................................... $(66,381) $(55,582) $ (82,106)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................ 7,528 16,852 24,442
Amortization of deferred interest, cost of
revenue and marketing and sales related to
issuance of warrants........................ 1,942 1,720 1,210
Amortization of goodwill and other intangible
assets...................................... -- -- 3,842
Amortization of deferred financing costs
related to 12 3/4% Senior Notes............. -- -- 526
Amortization of other deferred assets........ -- -- 3,025
Amortization of deferred compensation........ -- 658 373
Gain on early retirement of debt............. -- -- (3,042)
Write-off of in-process technology........... -- -- 5,200
Loss on disposal of equipment................ -- 162 --
Network equipment write-off.................. 8,321 -- --
Changes in current assets and liabilities:
Prepaid expenses and other current assets... (57) (3,581) 1,009
Accounts receivable......................... (1,734) (2,700) (7,140)
Accounts payable............................ 5,129 (7,287) 7,408
Accrued compensation and other employee
benefits................................... 484 863 (315)
Deferred revenue............................ 1,097 197 509
Other current liabilities................... 1,546 2,795 (1,575)
-------- -------- ---------
Net cash used in operating activities.......... (42,125) (45,903) (46,634)
INVESTING ACTIVITIES
Additions of property and equipment............ (6,889) (6,130) (23,489)
Increase in refundable deposits................ (442) -- (1,200)
Decrease (increase) in note receivable......... -- (370) 100
Purchase of short term investments............. -- -- (52,226)
Acquisition of InterNex Information Services,
Inc., net of cash acquired.................... -- -- (15,452)
Acquisition of AnaServe, Inc., net of cash
acquired...................................... -- -- (9,625)
-------- -------- ---------
Net cash used in investing activities.......... (7,331) (6,500) (101,892)
FINANCING ACTIVITIES
Proceeds from notes payable.................... 6,300 155,000 --
Change in restricted cash...................... -- (52,525) 16,287
Repayment of lease obligations to a related
party......................................... (4,561) (10,039) (3,079)
Repayment of lease obligations to a related
party--early retirement of debt............... -- -- (24,750)
Repayment of lease obligations................. (886) (1,517) (7,079)
Repayment of notes payable..................... (1,300) (2,000) (1,960)
Repurchase of common stock..................... -- (2,765) --
Deferred financing costs....................... -- (5,006) (320)
Proceeds from issuance of redeemable
exchangeable preferred stock, net of issuance
costs......................................... -- -- 144,148
Proceeds from issuances of stock and warrants.. 48,506 73,557 4,308
-------- -------- ---------
Net cash provided by financing activities...... 48,059 154,705 127,555
-------- -------- ---------
Increase (decrease) in cash and cash
equivalents................................... (1,397) 102,302 (20,971)
Cash and cash equivalents at beginning of
period........................................ 19,054 17,657 119,959
-------- -------- ---------
Cash and cash equivalents at end of period..... $ 17,657 $119,959 $ 98,988
======== ======== =========
</TABLE>
See accompanying notes.
F-7
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Years Ended December
31,
-----------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Stock exchanged for notes payable, including accrued
interest............................................. $ 8,082 $ 3,041 $ --
Capital lease obligations incurred with a related
party................................................ 30,945 23,042 1,285
Capital lease obligations incurred.................... 2,136 -- 5,363
Reduction of accounts payable through capital lease
obligations incurred................................. -- 2,000 --
Convertible debentures exchanged for stock............ 70 -- --
Issuance of warrants.................................. 2,955 5,370 1,900
Purchase of property and equipment through accounts
payable.............................................. 6,344 -- --
Accretion of dividends and financing costs related to
Redeemable Exchangeable Preferred Stock.............. -- -- 11,958
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid......................................... $ 2,807 $ 5,728 $22,609
</TABLE>
See accompanying notes.
F-8
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
The Company
Concentric Network Corporation (the Company or Concentric) was incorporated
in the state of Florida in 1991 and reincorporated into Delaware in 1997. The
Company operates primarily in one business segment in the United States.
Concentric provides tailored, value-added Internet Protocol (IP) based network
services for businesses and consumers. To provide these services, the Company
utilizes its low/fixed latency, high-throughput network, employing its advanced
network architecture and the Internet. Concentric's service offerings for
enterprises include virtual private networks (VPNs), dedicated access
facilities (DAFs), digital subscriber line services (DSL), remote access and
Web hosting. These services enable enterprises to take advantage of standard
Internet tools such as browsers and high-performance servers for customized
data communications within an enterprise and between an enterprise and its
suppliers, partners and customers. These services combine the cost advantages,
nationwide access and standard protocols of public networks with the
customization, high performance, reliability and security of private networks.
Basis Of Presentation And Preparation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates
The preparation of these consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in these
consolidated financial statements and accompanying notes. Actual results could
differ materially from those estimates.
Cash, Cash Equivalents and Short Term Investments
The Company considers all highly liquid investments with an original
maturity (at date of purchase) of three months or less to be the equivalent of
cash for the purpose of balance sheet and statement of cash flows presentation.
Investments with maturities between three and twelve months are considered to
be short term investments. Management determines the appropriate classification
of its investments in debt securities at the time of purchase and reevaluates
such designation as of each balance sheet date. The Company's debt securities
have been classified and accounted for as available-for-sale. These securities
are carried at fair value and unrealized gains and losses have not been
material to date. Comprehensive net loss per share is not materially different
from net loss for all years presented. Realized gains and losses and declines
in value judged to be other than temporary on available-for-sale securities are
included in interest income and have not been material to date. Cash and cash
equivalents are held primarily with three financial institutions.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
provided using the straight-line method over the estimated useful lives of the
related assets as follows: computer and telecommunications equipment: three to
five years; purchased software: three to five years; furniture and fixtures:
eight to ten years; and leasehold improvements: the shorter of the remaining
term of the related leases or the estimated economic useful lives of the
improvements. Equipment under capital leases is amortized over the shorter of
the expected useful life or the related lease term (see Note 4).
F-9
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue and Customer Receivables
Revenue is recognized over the period in which services are provided,
generally monthly. Payments received in advance of services being provided are
included in deferred revenue. Substantially all end-user subscribers pay for
services with major credit cards for which the Company receives daily
remittances from the credit card carriers.
Commissions and other obligations to strategic partners through marketing
and distribution arrangements are expensed as incurred, at the time the
associated revenue is recognized.
Concentration of Credit Risk
The Company typically offers its enterprise customers credit terms. The
Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. Credit losses have
historically been insignificant.
Advertising Costs
The Company expenses the costs of advertising as incurred except for direct-
response advertising costs meeting certain specific criteria. To date, no
direct-response advertising costs have been capitalized.
Income Taxes
The Company accounts for income taxes using the liability method in
accordance with Financial Accounting Standards Board Statement No. 109,
"Accounting for Income Taxes" (FAS 109).
Basic and Diluted Net Loss Per Share
Basic and diluted net loss per share have been computed in accordance with
the Financial Accounting Standards Board issued Statement No. 128, "Earnings
Per Share."
Except as noted below, net loss per share is computed using the weighted
average number of shares of common stock outstanding excluding common stock
subject to rescission. Common stock equivalent shares from convertible
preferred stock and from stock options and warrants are not included as the
effect is antidilutive. Pursuant to the Securities and Exchange Commission
Staff Accounting Bulletin No. 98 (SAB No. 98) which was issued in February
1998, common and common equivalent shares issued by the Company for nominal
consideration during any of the periods for which a statement of operations was
presented in the Company's initial public offering registration statement have
been included in the calculation of basic and diluted net loss per share for
all such periods in a manner similar to a stock split.
F-10
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma net loss per share gives effect, even if antidilutive, to common
equivalent shares from convertible preferred shares that were automatically
converted to common shares upon the closing of the Company's initial public
offering (using the as-if-converted method). The following table sets forth the
computation of basic and diluted loss per share, on a historical and pro forma
basis.
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
----------------------------
1996 1997 1998
-------- -------- --------
(In thousands, except per
share data)
<S> <C> <C> <C>
NUMERATOR:
Net loss before extraordinary item.............. $(66,381) $(55,582) $(85,148)
Extraordinary gain on early retirement of debt.. -- -- 3,042
-------- -------- --------
Net loss........................................ (66,381) (55,582) (82,106)
======== ======== ========
Preferred stock dividends and accretion......... -- -- (11,958)
-------- -------- --------
Numerator for basic and diluted loss per share.. $(66,381) $(55,582) $(94,064)
======== ======== ========
DENOMINATOR:
Denominator for basic and diluted earnings per
share--weighted average shares (historical).... 1,391 6,665 14,547
======== ======== ========
Adjustments to reflect the effect of the assumed
conversion of convertible preferred stock from
the date of issuance........................... 3,546 3,207
======== ========
Denominator for basic and diluted earnings per
share--weighted average shares (pro forma)..... 4,937 9,872
======== ========
Basic and diluted net loss per share
(historical):
Loss before extraordinary item................ $ (47.72) $ (8.34) $ (5.86)
-------- -------- --------
Extraordinary gain............................ -- -- .21
-------- -------- --------
Net loss...................................... (47.72) (8.34) (5.65)
======== ======== ========
Preferred stock dividends and accretion....... -- -- (.82)
-------- -------- --------
Net loss attributable to common stockholders.. $ (47.72) $ (8.34) $ (6.47)
======== ======== ========
Basic and diluted net loss per share (pro
forma)......................................... $ (13.46) $ (5.63)
======== ========
</TABLE>
Stock-Based Compensation
The Company accounts for employee stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25), and has adopted the "disclosure only"
alternative described in Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123).
Long-Lived Assets
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," the Company continually reviews long-lived assets to assess
recoverability based upon undiscounted cash flow analysis. Impairments, if any,
are recognized in operating results in the period in which a permanent
diminution in value is determined (see Note 3).
F-11
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Customer Concentrations
The Company currently derives a substantial portion of its total revenue
from a single customer. For the years ended December 31, 1996, 1997 and 1998,
revenue from WebTV Networks, Inc. represented approximately 10.1%, 33.4% and
26.8%, respectively, of the Company's total revenue.
Sole or Limited Sources of Supply
The Company relies on other companies to supply certain key components of
their network infrastructure. These components include critical
telecommunications services and networking equipment, which, in the quantities
and quality demanded by us, are available only from sole- or limited-sources.
Four companies provide the data communications facilities and capacity for the
Company. The Company is also dependent upon local exchange carriers to provide
telecommunications services to the Company and its customers. The Company has
experienced delays from time to time in receiving telecommunications services
from these suppliers. There can be no assurance that such services on the scale
and within the time frames required by the Company at an affordable cost will
be attainable. Any failure to obtain such services on a sufficient scale, on a
timely basis and at an affordable cost would have a material adverse effect on
the business, financial condition and results of operations of the Company.
The Company purchases its network equipment primarily from five vendors. Two
companies also act as systems integrators. One company is the sole supplier of
the servers primarily used in the Company's network infrastructure. The Company
purchases these components pursuant to purchase orders placed from time to time
with these suppliers. The Company does not carry significant inventories of
these components and has no guaranteed supply arrangements for such components.
The Company's suppliers also sell products to competitors and may in the future
themselves become competitors. There can be no assurance that suppliers will
not enter into exclusive arrangements with competitors or stop selling their
products or components to the Company at commercially reasonable prices, or at
all.
2. Cash, Cash Equivalents and Short-Term Investments
The following table summarizes the Company's available-for-sale securities
at amortized cost, which approximates fair value, as of December 31, 1998 (in
thousands):
<TABLE>
<S> <C>
U.S. Corporate securities........................................ $25,132
-------
Total included in cash and cash equivalents..................... $25,132
=======
U.S. Treasury securities......................................... 17,424
U.S. Corporate securities........................................ 34,802
-------
Total included in short-term investments........................ $52,226
=======
</TABLE>
As of December 31, 1998, there are no investments with maturities greater
than 12 months. The Company's U.S. Corporate securities include commercial
paper. The Company's cash equivalents and short term investments have generally
been held until maturity. The Company's cash and cash equivalents at December
31, 1997 consisted primarily of money market funds and U.S. Corporate
Securities.
F-12
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Network Equipment Write-off
In December 1996, the Company wrote off approximately $8,321,000
representing the net book value and future commitments for certain network
equipment purchased from Sattel Communications LLC (Sattel), a stockholder of
the Company. The Company decided not to deploy the equipment in the network
because of concerns that the equipment would not provide the functionality and
reliability required by the Company and concerns that the equipment provider
would be unable to provide timely maintenance and support (see Note 12).
4. Commitments
Operating Leases
The Company has an agreement with a related party through which such related
party makes available the premises at which the Company's POP sites throughout
the United States are located. POP sites are locations where certain
telecommunications switching and related equipment are installed. This
agreement expires in December 2000, and the amount of the payments is based,
among other things, on the number of POP sites maintained by the Company,
subject to certain minimums. Costs of approximately $1,622,000, $1,326,000 and
$1,267,000 were incurred during the years ended December 31, 1996, 1997 and
1998, respectively, for these facilities. Additionally, the Company has
agreements with three telecommunications companies to locate POP sites and
certain of such equipment at their facilities. Costs of approximately
$1,246,000 were incurred during the year ended December 31, 1998 for these
facilities. The expiration dates associated with these agreements range from
December 1998 to January 2000.
The Company leases its facilities and certain office equipment under non-
cancelable operating leases which expire at various dates through January 2006.
Total rent expense for all operating leases was approximately $2,060,000,
$2,418,000 and $4,743,000 for the years ended December 31, 1996, 1997 and 1998,
respectively.
Future minimum lease commitments for all noncancelable operating leases with
initial terms of one year or more consists of the following at December 31,
1998 are (in thousands):
<TABLE>
<S> <C>
1999.............................................................. $ 4,257
2000.............................................................. 4,030
2001.............................................................. 3,248
2002.............................................................. 2,533
2003.............................................................. 2,513
Thereafter........................................................ 5,164
-------
Total............................................................. $21,745
=======
</TABLE>
Capital Leases
In August 1994, the Company entered into a master lease agreement under
which a related party began installing networking equipment at the Company's
POP sites and data center. This agreement became effective upon installation
and acceptance by the Company on March 31, 1995. The lease provides for monthly
payments for terms of 48 or 60 months, depending upon the type of equipment.
The Company has continued to install equipment under the terms of this
agreement, resulting in a monthly payment of approximately $896,000, $1,443,000
and $536,000 at December 31, 1996, 1997 and 1998, respectively. In March 1998,
the Company retired a portion of the capital lease obligations to the related
party. The Company paid $24,750,000
F-13
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for the extinguishment of the debt. The Company recognized an extraordinary
gain of $3,042,000 in connection with this transaction. Subsequent to March
1998, the related party sold its stockholdings in the Company and is no longer
considered a related party.
In September 1995, the Company entered into a master lease agreement with a
third party for an equipment lease line. The term of the lease is 36 months and
provides for monthly payments of approximately $114,000 as of December 31,
1998.
Assets capitalized under capital leases totaled approximately $61,927,000
and $28,068,000 at December 31, 1997 and 1998, respectively, and are included
in computer and telecommunications equipment. Accumulated amortization for
assets capitalized under capital leases totaled approximately $18,542,000 and
$8,356,000 at December 31, 1997 and 1998, respectively. Amortization of leased
assets is included in depreciation and amortization expense. The Company has
granted a security interest in all equipment under capital lease agreements.
Future minimum lease payments under capital lease obligations at December 31,
1998 are as follows (in thousands):
<TABLE>
<S> <C>
1999............................................................. $ 7,285
2000............................................................. 6,257
2001............................................................. 4,312
2002............................................................. 1,956
Thereafter....................................................... 504
-------
Total minimum lease payments..................................... 20,314
Less amount representing interest................................ 3,337
-------
Present value of net minimum lease payments...................... 16,977
Less current portion of capital leases........................... 6,543
-------
Long-term portion of capital leases.............................. $10,434
=======
</TABLE>
Other
The Company has a noncancelable service agreement with AT&T for the
utilization of its frame relay telecommunications network. The agreement
provides for minimum payments to AT&T of approximately $300,000 per month over
its three-year term, expiring in June 1999.
The Company has a noncancelable service agreement with MCI for the
utilization of its ATM telecommunications network. The agreement provides for
minimum payments to MCI of approximately $1,200,000 per year over its term,
expiring three years after the end of an initial ramp up period but no later
than June 2000. The Company also has a noncancelable telecommunications service
agreement with MCI for other services, including dedicated access and 800
service, that provides for minimum payments of approximately $8,500,000 over
the term of the agreement, which expired in June 1998. The Company had incurred
expenses, through the life of the agreement, of approximately $3,700,000,
$8,100,000 and $4,143,000 for the years ended December 31, 1996, 1997 and 1998,
respectively, related to these other services. The agreement was renewed in
August 1998 and provides for minimum payments of $6,000,000 per year over its
term, expiring July 2000. The Company incurred expenses of approximately
$3,042,000 related to the new agreement for the five month period ended
December 31, 1998.
In November 1995, the Company entered into a two-year service agreement
under which a third party provided substantially all of the network analysis
and deployment and maintenance of POP sites. In 1997, the third party was
purchased by Williams Communication, Group Inc. (Williams), a stockholder of
the
F-14
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company that also has a seat on the Board of Directors of the Company, and the
agreement was extended to December 31, 2000. The Company will reimburse
Williams for its employee compensation and direct costs for services provided.
Related party payments to Williams for these services were approximately
$1,884,000 and $4,848,000 for the years ended December 31, 1997 and 1998,
respectively. At the end of the agreement, Williams is obligated to transfer to
the Company those personnel, resources, and facilities used to support the
Company's network analysis, POP site deployment, and maintenance.
In August 1997, the Company entered into a five-year service and equipment
agreement under which Williams, a related party, will provide telecommunication
services and equipment. The agreement provides for minimum payments as follows:
$1.2 million in 1998, $2.5 million in 1999, $7.0 million in 2000, $6.5 million
in 2001 and $4.0 million in 2002. At the election of Williams, $2.0 million of
the minimum payments may be paid by the issuance of common stock of the Company
at the then-current fair market value. The Company made payments totaling
$4,843,000 for the year ended December 31, 1998 related to this agreement, of
which $4,311,000 relates to the purchase of equipment from Williams.
5. Convertible Debentures and Notes Payable
Bridge Loans
At December 31, 1995, convertible debentures in the amount of $70,000,
representing 9,802 shares of common stock, were outstanding. The conversion of
these debentures into shares of common stock subject to rescission was
completed in March 1996.
In 1995, the Company issued convertible notes totaling $7,000,000 to
shareholders of which $4,000,000, plus accrued interest, was converted into
Series B convertible preferred stock in December 1995. The remaining $3,000,000
outstanding at December 31, 1995 was converted into Series C convertible
preferred stock in February 1996.
In June 1997, the Company borrowed $3 million from a related party in the
form of a 10% convertible secured promissory note (the Secured Note). The
Secured Note automatically converted into 253,403 shares of common stock upon
the closing of the Public Offering at a per share conversion price equal to the
Public Offering price of $12.00. In connection with the Secured Note, the
Company issued a warrant to purchase 63,351 shares of common stock at an
exercise price of $6.00 per share (see Note 8).
Notes Payable
In December 1997, the Company issued 150,000 units (collectively, the
Units), each consisting of $1,000 principal amount of 12 3/4% Senior Notes (the
12 3/4% Senior Notes) due 2007 and one warrant (a Warrant), each Warrant
entitling the holder thereof to purchase 6.34 shares of common stock at $10.86
per share and such Warrants expire on December 15, 2007 (see Note 8) for
aggregate cash proceeds of $150,000,000. Approximately $52,525,000 of the cash
proceeds was placed in a escrow account to fund the first six interest payments
in accordance with the Senior Note agreement which is classified as restricted
cash. As of December 31, 1998, the Company had $36,238,000 remaining in the
escrow account restricted for future interest payments.
The Warrants resulted in the right of the holders to purchase 951,108 shares
of the Company's common stock. The Company deemed the fair value of the
warrants, using the Black-Scholes method, to be approximately $4,440,000 which
was recorded as a discount on the 12 3/4% Senior Notes. The discount is being
amortized as interest expense over the term of the 12 3/4% Senior Notes.
Amortization expense was $17,000 and $444,000 for the years ended December 31,
1997 and 1998, respectively.
F-15
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The 12 3/4% Senior Notes will be redeemable at the option of the Company, in
whole or in part, at any time on or after December 15, 2002, at the redemption
rates (expressed as a percentage of the principal amount) commencing with
106.375% on December 15, 2002 and declining to 100% on December 15, 2005, plus
accrued interest to the date of redemption. In addition, on or prior to
December 15, 2000, the Company may redeem up to 35% of the original aggregate
principal amount of the 12 3/4% Senior Notes at a redemption price of 112.75%
of the principal amount, together with accrued and unpaid interest to the date
of redemption with the net cash proceeds of one or more public equity offerings
or the sale of common stock to a strategic investor, provided that at least 65%
of the original aggregate principal amount of the 12 3/4% Senior Notes remain
outstanding.
In connection with the issuance of the 12 3/4% Senior Notes, the Company
incurred approximately $5,300,000 of debt issuance costs which are classified
as other assets. These costs are being amortized as interest expense over the
term of the 12 3/4% Senior Notes. Amortization expense was $526,000 for the
year ended December 31, 1998.
6. Common Stock Subject to Rescission
In August 1993, the Company commenced sales of convertible debentures and
certain additional shares of its common stock. Through March 31, 1995, sales of
convertible debentures aggregated $4,260,000, and issuance of common stock
aggregated $890,000. The sale of common stock and sale of and/or conversion of
debentures into common stock was not made pursuant to a registration statement
filed under the Securities Act of 1933 (the Act) or any filings pursuant to the
laws of any of the states in which such sales occurred (State Blue Sky Laws).
Although at the time the Company believed the sale and conversion, if
applicable, of these securities was exempt from the provisions of the Act and
applicable State Blue Sky Laws, it appears that the appropriate exemptions may
not have been available. As a result, on September 30, 1997, the Company made
rescission offers (the "Rescission Offer") to certain purchasers of these
securities who are entitled to a return of the consideration paid for their
stock or debentures. As such, these shares have been classified as common stock
subject to rescission in the accompanying financial statements. Additionally,
options issued pursuant to the Company's 1995 Stock Incentive Plan to Employees
and Consultants and non-plan options were issued in various states for which
the Company may not have had an available exemption under state laws. Such
options are potentially subject to rescission and the Company has included them
in the Rescission Offer. As of December 31, 1997, statutes of limitations under
federal and state securities laws applicable to the shares which may have been
issued without securities laws exemptions have lapsed and the Rescission Offer
had expired. Pursuant to the Rescission Offer, the Company offered to rescind
the issuance of shares and options as to which the applicable statute of
limitations had not run. There can be no assurances that the Company will not
otherwise be subject to additional liabilities with respect to such issuances.
The Company repurchased 32,423 shares of Common Stock subject to the Rescission
Offer for $548,000 and paid related interest charges of $125,000. Based upon
the above, the Company has reclassified the remaining rescission liability and
shares into stockholders' equity.
7. Stockholders' Equity
Initial Public Offering and Direct Placements
Effective July 30, 1997, the Company reincorporated under the laws of the
state of Delaware. In addition, the Company authorized 100,000,000 shares of
its common stock. Upon closing of the initial public offering (the Public
Offering), all outstanding shares of Series A, B, C, and D convertible
preferred stock and Class B common stock were converted into common stock.
F-16
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On August 1, 1997, the Company effected its Public Offering of common stock.
The offering consisted of 4,300,000 shares of common stock issued to the public
at $12.00 per share. Concurrent with the closing of the Public Offering,
certain strategic investors, including Williams, purchased directly from the
Company 1,499,236 shares of common stock having an aggregate purchase price of
approximately $18 million (including the cancellation of approximately $3
million in indebtedness). Such shares are unregistered shares and were
purchased at the Public Offering price of $12.00 per share.
In connection with the direct purchase, the Company issued warrants to one
of the strategic investors to purchase 291,667 shares of the Company's common
stock at $6.00 per share (see Note 8). In September, the underwriters exercised
an option to purchase an additional 645,000 shares of common stock at the
Public Offering price of $12.00 per share to cover over-allotments in
connection with the Public Offering.
Redeemable Exchangeable Preferred Stock
In June 1998, the Company completed a $150 million private placement of 13
1/2% Series A Senior Redeemable Exchangeable Preferred Stock due 2010 (Series A
Preferred). In September 1998, the Company issued 154,657 shares of its 13 1/2%
Series B Senior Redeemable Exchangeable Preferred Stock due 2010 (Series B
Preferred) in exchange for all outstanding shares of the Series A Preferred
pursuant to a registered exchange offer. Each share of Series B Preferred has a
liquidation preference of $1,000 per share. Dividends on the Series B Preferred
accrue at a rate of 13 1/2% per annum of the liquidation preference thereof and
are payable quarterly in arrears commencing on September 1, 1998. Dividends are
payable in cash, except that on each dividend payment date occurring on or
prior to June 1, 2003, dividends may be paid, at the Company's option, by the
issuance of additional shares of Series B Preferred having an aggregate
liquidation preference equal to the amount of such dividends. For the year
ended December 31, 1998, the Company issued a total of 9,865 shares of Series B
Preferred Stock as payment of the quarterly dividends. Series B Preferred Stock
has no voting rights.
The Series B Preferred is redeemable at the option of the Company, in whole
or in part, at any time on or after June 1, 2003, at redemption rates
(expressed as a percentage of the liquidation preference) commencing with
106.75% on June 1, 2003 and declining to 100% on June 1, 2008, plus accumulated
and unpaid dividends to the date of redemption. In addition, prior to June 1,
2001, the Company may, at its option, redeem up to a maximum of 35% of the
initially issued Series B Preferred from the net proceeds of one or more public
equity offerings or the sale of common stock to a strategic investor. The
Series B Preferred is subject to mandatory redemption at its liquidation
preference, plus accumulated and unpaid dividends on June 1, 2010.
On any scheduled dividend payment date, the Company may, at its option,
exchange in whole but not in part the then outstanding shares of Series B
Preferred for 13 1/2% Senior Subordinated Debentures due 2010 (Exchange
Debentures) with a principal amount equal to the aggregate liquidation
preference of the Preferred Stock. If the Exchange Debentures were issued, they
would mature on June 1, 2010. Interest on the Exchange Debentures would be
payable semi-annually in arrears. Interest payable on or prior to June 1, 2003
may be paid in the form of additional Exchange Debentures valued at the
principal amount thereof.
The Company is accreting the Series B Preferred to its liquidation
preference through the due date of the Series B Preferred. The accretion for
the year ended December 31, 1998 was approximately $11,676,000. In connection
with the issuance of Series A Preferred and Series B Preferred, the Company
incurred approximately $5,852,000 of issuance costs. These costs are being
accreted over 12 years which amounted to $282,000 for the year ended December
31, 1998.
F-17
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plans
1995 Stock Incentive Plan for Employees and Consultants. The Company's 1995
Stock Incentive Plan for Employees and Consultants (the 1995 Plan) provided for
the granting to employees of incentive stock options and for the granting to
employees and consultants of nonstatutory stock options, stock appreciation
rights (SARs) and restricted stock awards (RSAs). No SARs or RSAs have been
granted under the 1995 Plan. The 1995 Plan was terminated effective October 4,
1996. As of December 31, 1998, options to purchase 162,157 shares of common
stock at a weighted exercise price of $3.75 per share were outstanding under
the 1995 plan of which 102,910 options were vested.
Amended and Restated 1996 Stock Plan. The Company's Amended and Restated
1996 Stock Plan (the Restated 1996 Plan) provides for the granting to employees
of incentive stock options and for the granting to employees, directors and
consultants of nonstatutory stock options and stock purchase rights (Rights).
The Restated 1996 Plan has been terminated. As of December 31, 1998, options to
purchase 678,846 shares of common stock at a weighted average exercise price of
$6.40 per share were outstanding of which 246,460 were vested.
The Restated 1996 Plan provides that in the event of a merger of the Company
with or into another corporation, a sale of substantially all of the Company's
assets or a like transaction involving the Company, each option shall be
assumed or an equivalent option substituted by the successor corporation. If
the outstanding options are not assumed or substituted as described in the
preceding sentence, the Restated 1996 Plan provides the optionee or Right
holder to have the right to exercise the option or Right as to all of the
optioned stock, including shares as to which it would not otherwise be
exercisable.
1997 Stock Plan. The Company's 1997 Stock Plan (the 1997 Plan) provides for
the granting to employees of incentive stock options and for the granting to
employees, directors and consultants of nonstatutory stock options and stock
purchase rights (Rights). The 1997 Plan was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. An amendment
increasing the number of shares thereunder from 1,500,000 to 2,250,000 was
approved by the Board of Directors on April 10, 1998, 1998 and the Stockholders
on May 20, 1998. Unless terminated sooner, the 1997 Plan will terminate
automatically in 2007. Options granted under the 1997 Plan must generally be
exercised within three months of the end of optionee's status as an employee,
director or consultant of the Company, or within twelve months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option's term. The exercise price of all incentive stock
options granted under the 1997 Plan must be at least equal to the fair market
value of the common stock on the date of grant. The exercise price of
nonstatutory stock options and Rights granted under the 1997 Plan is determined
by the 1997 Plan's Compensation Committee, but with respect to nonstatutory
stock options intended to qualify as "performance-based compensation," the
exercise price must at least be equal to the fair market value of the common
stock on the date of grant. With respect to any participant who owns stock
possessing more than 10% of the voting power of all classes of the Company's
outstanding capital stock, the exercise price of any incentive stock option
granted must equal at least 110% of the fair market value on the grant date and
the term of such incentive stock option must not exceed five years. The term of
other incentive stock options granted under the 1997 Plan may not exceed ten
years. A total of 2,250,000 shares of common stock are currently reserved for
issuance pursuant to the 1997 Plan. As of December 31, 1998, options to
purchase 2,113,929 shares of common stock at a weighted average exercise price
of $18.21 per share were outstanding of which 111,909 were vested, and 96,582
shares of common stock remained available for future grants under the 1997
Plan.
The 1997 Plan provides that in the event of a merger of the Company with or
into another corporation, a sale of substantially all of the Company's assets
or a like transaction involving the Company, each option shall be assumed or an
equivalent option substituted by the successor corporation. If the outstanding
options are not
F-18
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
assumed or substituted as described in the preceding sentence, the 1997 Plan
provides for the optionee or Right holder to have the right to exercise the
option or Right as to all of the optioned stock, including shares as to which
it would not otherwise be exercisable.
1997 Employee Stock Purchase Plan. The Company's 1997 Employee Stock
Purchase Plan (the 1997 Purchase Plan) was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. A total of 500,000
shares of common stock has been reserved for issuance under the 1997 Purchase
Plan. The 1997 Purchase Plan, which is intended to qualify under Section 423 of
the Internal Revenue Code, consists of 24-month offering periods beginning on
the first trading day on or after February 15 and August 15 of each year,
except for the first such offering period, which commenced on August 4, 1997
and ended on February 13, 1998. Each offering period contains four six-month
purchase periods. Employees are eligible to participate if they are customarily
employed by the Company or any designated subsidiary for at least 20 hours per
week and more than five months in any calendar year. The 1997 Purchase Plan
permits eligible employees to purchase common stock through payroll deductions
of up to 10% of an employee's compensation (excluding overtime, shift premium,
and other bonuses and incentive compensation), up to a maximum of $25,000 for
all offering periods ending within the same calendar year. No employee may
purchase more than 25,000 shares in any purchase period. The price of stock
purchased under the 1997 Purchase Plan is 85% of the lower of the fair market
value of the common stock at the beginning of the offering period or at the end
of the current purchase period. Employees may end their participation at any
time during an offering period, and they will be paid their payroll deductions
to date. Participation ends automatically upon termination of employment with
the Company. During the year ended December 31, 1998, 74,142 shares were
purchased under the 1997 Purchase Plan at a weighted average price of $10.54
per share.
The 1997 Purchase Plan provides that, in the event of a merger of the
Company with or into another corporation or a sale of substantially all of the
Company's assets, each outstanding option shall be assumed or an equivalent
option shall be substituted for it, or the Board of Directors or its committee
shall shorten the purchase and offering periods then in progress (so that
employees' rights to purchase stock under the Plan are exercised prior to the
merger or sale of assets). The 1997 Purchase Plan will terminate in 2007.
The Company issued options to purchase 179,300 shares of common stock in
December 1996, 40,267 shares of common stock in January 1997, 216,733 shares of
common stock in June 1997, and repriced 181,473 options in July 1997. The
Company recorded deferred compensation, for financial reporting purposes, of
approximately $188,000 in 1996 and $1,303,000 for the year ended December 31,
1997, with respect to such option grants to reflect the difference between the
exercise price and the deemed fair value for financial reporting purposes of
these shares. Amortization of this deferred compensation was $0, $222,000 and
$373,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
The amortization of this deferred compensation will continue over the four year
vesting period of the associated stock options.
1999 Nonstatutory Stock Option Plan. The Company's 1999 Nonstatutory Stock
Option Plan (the "1999 Plan") provides for the granting to employees, directors
and consultants of nonstatutory stock options. The 1999 Plan was approved by
the Board of Directors in January 1999. Unless terminated sooner, the 1999 Plan
will terminate automatically in 2009. A total of 550,000 shares of Common Stock
are currently reserved for issuance pursuant to the 1999 Plan, options to
purchase all of which were granted in January 1999.
The 1999 Plan may be administered by the Board of Directors or a committee
of the Board (as applicable, the "Administrator"). The Administrator has the
power to determine the terms of the options, including the exercise price, the
number of shares subject to each option, the exercisability thereof, and the
form of consideration payable upon such exercise. In addition, the
Administrator has the authority to amend, suspend or
F-19
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
terminate the 1999 Plan, provided that no such action may affect any share of
Common Stock previously issued and sold or any option previously granted under
the 1999 Plan.
Options granted under the 1999 Plan are not generally transferable by the
optionee, and each option is exercisable during the lifetime of the optionee
only by such optionee. Options granted under the 1999 Plan must generally be
exercised within three months of the end of the optionee's status as an
employee or consultant of the Company, or within twelve months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option's term. The exercise price of nonstatutory stock
options granted under the 1999 Plan is determined by the Administrator.
The 1999 Plan provides that in the event of a merger of the Company with or
into another corporation, a sale of substantially all of the Company's assets,
each option shall be assumed or an equivalent option substituted by the
successor corporation. If the outstanding options are not assumed or
substituted, the Administrator shall provide for the Optionee to have the right
to exercise the option as to all of the optioned stock, including shares as to
which it would not otherwise be exercisable for a period of fifteen (15) days
from the date of such notice, and the option will terminate upon the expiration
of such period.
The following table summarizes stock option activity under all of the Plans:
<TABLE>
<CAPTION>
Number of
Shares Price Per Share
--------- ---------------
<S> <C> <C>
Balance at December 31, 1995........................ 807,083 $ 3.75--$ 33.00
Granted........................................... 421,620 $3.75
Exercised......................................... (4,483) $ 3.75--$ 9.00
Canceled.......................................... (95,218) $ 3.75--$ 30.00
---------
Balance at December 31, 1996........................ 1,129,002 $ 3.75--$ 33.00
Granted........................................... 1,472,338 $ 3.75--$ 11.25
Exercised......................................... (64,544) $3.75
Canceled.......................................... (244,630) $ 3.75--$ 11.25
---------
Balance at December 31, 1997........................ 2,292,166 $ 3.75--$ 30.00
Granted........................................... 1,883,958 $ 9.88--$ 75.89
Exercised......................................... (611,694) $ 3.75--$ 20.87
Canceled.......................................... (247,831) $ 3.75--$ 75.89
---------
Balance at December 31, 1998........................ 3,316,599 $ 3.75--$ 75.89
=========
</TABLE>
The weighted average fair value of options granted during 1996, 1997 and
1998 was $0.87, $1.87 and $12.67, respectively.
F-20
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information concerning currently outstanding
and exercisable options as of December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Number Average
Number Contractual Exercise Exercisable Exercise
Exercise Prices Outstanding Life Price and Vested Price
--------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$3.75..................... 565,168 7.31 $ 3.75 374,715 $ 3.75
$6.00..................... 311,828 8.04 $ 6.00 131,443 $ 6.00
$8.85--$9.30.............. 218,564 8.47 $ 9.13 78,058 $ 9.15
$9.88--$11.25............. 515,066 8.86 $11.04 111,409 $11.21
$12.45--$30.00............ 1,693,688 9.38 $20.26 72,812 $14.47
$37.95--$75.89............ 12,285 8.46 $60.07 6,539 $60.30
--------- -------
Total..................... 3,316,599 774,976
========= =======
</TABLE>
Stock-Based Compensation
Pro forma information regarding results of operations and loss per share is
required by FAS 123 for awards granted after December 31, 1994 as if the
Company had accounted for its stock-based awards to employees under a valuation
method permitted by FAS 123. The value of the Company's stock-based awards to
employees in 1995 and 1996 was estimated using the minimum value method.
Options granted after the Public Offering have been valued using the Black-
Scholes option pricing model. Among other things, the Black-Scholes model
considers the expected volatility of the Company's stock price, determined in
accordance with FAS 123, in arriving at an option valuation. The minimum value
method does not consider stock price volatility. Further, certain other
assumptions necessary to apply the Black-Scholes model may differ significantly
from assumptions used in calculating the value of options granted in 1995 and
1996 under the minimum value method.
The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Expected volatility........................................ N/A .250 .935
Expected life of options in years.......................... 4.0 3.3 3.49
Risk-free interest rate.................................... 6.3% 6.0% 5.0%
Expected dividend yield.................................... 0.00% 0.00% 0.00%
</TABLE>
F-21
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For pro forma purposes, the estimated minimum value of the Company's stock-
based awards to employees is amortized over the options' vesting period. If the
Company had elected to recognize compensation cost based on the fair value of
the options granted at grant date as prescribed by FAS 123, net loss and net
loss per share would have increased to the pro forma amounts indicated in the
table below (in thousands except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1996 1997 1998
-------- -------- ---------
<S> <C> <C> <C>
Net loss attributable to common stockholders
as reported................................ $(66,381) $(55,582) $ (94,064)
Net loss attributable to common
stockholders--pro forma.................... $(66,605) $(56,224) $(100,030)
Net loss per share attributable to common
stockholders--as reported.................. $ (13.46) $ (5.63) $ (6.47)
Net loss per share attributable to common
stockholders--pro forma.................... $ (13.49) $ (5.70) $ (6.88)
</TABLE>
8. Warrants to Purchase Common Stock
In connection with the Company's Public Offering, all of the outstanding
warrants to purchase preferred stock were converted to warrants to purchase
common stock. The following warrants to purchase shares of the Company's common
stock were outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Warrants Outstanding
----------------------------------
Number Weighted Average Year
Exercise Prices of Shares Exercise Price Expires
--------------- --------- ---------------- -------
<S> <C> <C> <C>
$19.49.................................... 877,718 $19.49 1999
$3.75-$26.87.............................. 185,742 $20.42 2000
$6.00-$68.30.............................. 439,668 $ 6.19 2002
$10.86.................................... 951,108 $10.86 2007
---------
2,454,236
=========
</TABLE>
The Company is obligated to issue a warrant to purchase 906,679 shares to
SBC Communications Inc. in connection with an agreement signed in October 1998.
The warrant will be issued upon the closing of the SBC Financing Agreement (See
Note 14).
The above warrants were issued at various times over the last several years
in connection with a service agreements, a capital lease agreement, several
debt and equity financings and a reseller agreement The Company has deemed the
fair market value of such warrants, using the Black-Scholes method, to be
$822,000, $61,000, $5,700,000, $2,623,000 and $1,900,000, respectively. The
Company is amortizing the value of the warrants over the term of the related
agreements which range from one to ten years. Amortization expense for the
years ended December 31, 1996, 1997 and 1998 was $1,942,000, $1,720,000 and
$767,000, respectively. The Company has reserved the amount of shares necessary
to meet the exercise of these warrants.
9. Employee Benefit Plans
Retirement Savings Plan
The Company maintains a contributory 401(k) plan that covers substantially
all employees. The Company contributes $0.30 for every $1.00 contributed by the
participant up to a maximum of 1.5% of the participants' compensation. The
Company contributed $45,000, $158,000 and $266,000 to the plan during the years
ended December 31, 1996, 1997 and 1998, respectively.
F-22
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Income Taxes
As of December 31, 1998, the Company had federal and state net operating
loss carryforwards of approximately $208,000,000 and $138,000,000,
respectively. The net operating loss carryforwards will expire at various
dates beginning in the years 2003 through 2018, if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes of December 31, 1997 and 1998 are as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 55,000 $ 85,000
Write-off of network equipment......................... 4,000 4,000
Other, net............................................. 1,000 3,000
-------- --------
Total deferred tax assets................................ 60,000 92,000
-------- --------
Deferred tax liabilities:
Other, net............................................. 2,000 2,000
-------- --------
Net deferred tax assets.................................. 58,000 90,000
Valuation allowance...................................... (58,000) (90,000)
-------- --------
$ -- $ --
======== ========
</TABLE>
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax assets such that a full valuation allowance has been
recorded. These factors include the Company's history of net losses since
inception and the fact that the market in which the Company competes is
intensely competitive and characterized by rapidly changing technology. The
Company believes that, based on the currently available evidence, it is more
likely than not that the Company will not generate taxable income through
1999, and possibly beyond, and accordingly will not realize the Company's
deferred tax assets through 1999 and possibly beyond. The Company will
continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration
of net operating losses before utilization.
The net valuation allowance increased by approximately $21,000,000 in 1997
and $32,000,000 in 1998.
11. Related Party Transactions--Other
A former officer of the Company is a majority shareholder of a vendor of
the Company. The Company incurred marketing fees to the vendor totaling
$2,448,000, $2,600,000 and $1,085,000 in the years ended December 31, 1996,
1997, and 1998, respectively.
12. Contingencies
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana Corporation (Diana), the parent corporation of
Sattel Communications LLC (Sattel), alleging securities fraud related to
plaintiffs' purchase of shares of Diana Common Stock in reliance upon
allegedly misleading statements made by defendants, Diana, Sattel and certain
of their respective affiliates, officers and directors (Diana Suit). The
Company was named as a defendant in the complaint in connection with certain
statements made by Diana and officers of Diana related
F-23
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
to the Company's purchase of network switching equipment from Diana's Sattel
subsidiary. The plaintiffs seek unspecified compensatory damages (See Note 15).
While the ultimate outcome of such litigation is uncertain, the Company
believes it has meritorious defenses to the claims and intends to conduct a
vigorous defense. An unfavorable outcome in this matters could have a material
adverse effect on the Company's financial condition. In addition, even if the
ultimate outcomes is resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either or which could have a material adverse effect on the
Company's results of operations.
Sattel Settlement
On April 22, 1997, a complaint was filed in the Los Angeles County,
California Superior Court against the Company and other unnamed defendants by
Sattel Communications LLC (Sattel). Sattel's complaint alleged that the Company
was in breach of an agreement to pay for up to $4.3 million of DSS Switches
from Sattel for use in the Company's network and also sought unspecified
consequential and punitive damages. On July 11, 1997, the Company settled the
complaint with Sattel in the amount of $4.4 million. The Company also purchased
32,986 shares of the Company's common stock held by Sattel on the day after the
closing of the offering at the Public Offering price. In August, 1997 the
Company made cash payments to Sattel totaling approximately $4.8 million, to
satisfy its obligations pursuant to the settlement agreement and the repurchase
of common stock. Upon the settlement of the Sattel complaint, the Company
recorded $970,000 of other income related to the reversal of previously
established reserves.
13. Business Combinations
On February 5, 1998, the Company acquired all of the outstanding stock of
InterNex Information Services, Inc. (InterNex). The transaction was accounted
for using the purchase method of accounting. The total purchase price of
approximately $23.9 million consisted of a $15.5 million cash payment upon
closing and the assumption of approximately $8.4 million of InterNex's
liabilities (including acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<S> <C>
Current and other assets............................................ $ 1,348
Computer and telecommunications equipment........................... 4,784
Goodwill............................................................ 9,496
Other intangible assets............................................. 3,080
Write-off of in process technology.................................. 5,200
-------
Total purchase price allocation................................... $23,908
=======
</TABLE>
Goodwill arising from the acquisition is being amortized on a straight-line
basis over 5 years. Other intangible assets include developed technology,
assembled workforce and customer lists and are being amortized over their
useful lives ranging from two to four years.
In May 1998, the Company acquired Delta Internet Services, Inc. ("DeltaNet")
in a transaction that was accounted for as a pooling of interests. The Company
issued approximately 226,000 shares of its common stock to DeltaNet
shareholders in exchange for all outstanding DeltaNet shares. The Company also
assumed outstanding DeltaNet options and warrants which were converted to
options and warrants to purchase approximately 98,000 and 7,000 shares,
respectively, of the Company's common stock. The results of operations of
DeltaNet for the period from April 1, 1998 through December 31, 1998 are
included in the
F-24
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
consolidated results of operations. The Company's historical consolidated
financial statements prior to the combination have not been restated to reflect
the financial results of DeltaNet as these results are not material. The
consolidated results of operations for the year ended December 31, 1998 include
an acquisition related charge of $1.3 million primarily related to severance
costs, reserves for redundant facilities and assets and professional fees.
In August 1998, the Company acquired all of the outstanding stock of
AnaServe, Inc. ("AnaServe"). The transaction was accounted for using the
purchase method of accounting. The total purchase price of approximately $13.0
million consisted of a $9.6 million cash payment upon closing and the
assumption of approximately $3.4 million of AnaServe's liabilities (including
acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<S> <C>
Current and other assets........................................... $ 467
Computer and telecommunications equipment.......................... 497
Goodwill........................................................... 11,630
Other intangible assets............................................ 416
-------
Total purchase price allocation.................................. $13,010
=======
</TABLE>
Goodwill is being amortized over five years. Other intangible assets include
developed technology, assembled workforce and customer lists and are being
amortized over their useful lives ranging from one to four years.
The following unaudited pro forma information represents the combined
results of operations as if the acquisitions of InterNex, DeltaNet and AnaServe
had occurred as of the beginning of the periods presented and does not purport
to be indicative of what would have occurred had the acquisitions been made as
of that date or the results which may occur in the future.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
(In thousands,
except per share data)
<S> <C> <C> <C>
Pro forma net revenues....................... $ 25,958 $ 61,424 $ 89,435
Pro forma net loss attributable to common
stockholders................................ (78,769) (71,351) (92,967)
Pro forma net loss per share attributable to
common stockholders......................... (15.26) (7.07) (6.37)
</TABLE>
The pro forma results include the historical operations of the Company and
the historical operations of the acquired businesses adjusted to reflect
certain pro forma adjustments, including the amortization of intangible assets,
totaling $5.6 million during the years ended December 31, 1996 and 1997, and
$1,724,000 during the year ended December 31, 1998. The pro forma results do
not include the write-off of purchased research and development of $5.2 million
since it is considered a non-recurring adjustment.
14. Strategic Relationship
In October 1998, the Company entered into a strategic business arrangement
(Commitment Agreement) with SBC Communications Inc. (SBC) to integrate
Concentric's Internet-based business data services and technology into SBC's
"Online Office" portfolio of data products and services for business customers.
In connection with this arrangement, SBC agreed to acquire 906,679 shares of
Concentric common stock either on the open market or from the Company at a
price of $24.15 per share (SBC Financing Agreement). In December 1998, SBC
purchased 100,000 shares of the Company's common stock in two open market
purchases. The
F-25
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company also agreed to issue a warrant to SBC to purchase an additional 906,679
shares. The warrant expires three years from the date of issuance and will be
exercisable at $21 per share. The Company used the Black-Scholes method to
determine the fair market value of the warrant and allocated $1,900,000 of the
warrant value to the Commitment Agreement which will be amortized over the life
of the Commitment Agreement.
15. Subsequent Event
Public Offering
On January 15, 1999, the Board of Directors authorized the Company to
proceed with a public offering of the Company's common stock.
Litigation
On January 24, 1999, the Company agreed in principle to settle the Diana
Suit for $750,000. The settlement is contingent upon court approval and certain
other conditions.
Equity Investment
On January 22, 1999, the Company purchased approximately $10.0 million of
common stock from Covad Communications in a private placement.
SBC Financing Agreement
On January 29, 1999, SBC purchased 806,679 shares of common stock from the
Company in connection with the SBC Financing Agreement for net proceeds of
approximately $19,500,000 and issued SBC a warrant to purchase 906,679 shares
of the Company's common stock at an exercise price of $21.00 per share.
F-26
<PAGE>
GLOSSARY OF TERMS
56.6 Kbps.................. Equivalent to a single high-speed telephone
service line; capable of transmitting one voice
call or 56.6 Kbps of data. Currently in
widespread use by medium and large businesses
primarily for entry level high-speed data and
very low-speed video applications.
ATM........................ Asynchronous Transfer Mode. A low latency, fixed
delay information transfer standard for routing
traffic. The ATM format can be used by many
different information systems, including LANs, to
deliver traffic at varying rates, permitting a
mix of data, voice and video.
Backbone................... A centralized high-speed network that
interconnects smaller, independent networks.
Bandwidth.................. The number of bits of information that can move
through a communications medium in given amount
of time; the capacity of a telecommunications
circuit/network to carry voice, data and video
information. Typically measured in Kbps and Mbps.
Bandwidth from public networks is typically
available to business and residential end-users
in increments from 56.6 Kbps to DS3.
CGI script................. A CGI script is a program written in a scripting
language and used within a Web page. CGI scripts
are useful for adding text processing or other
small tasks to a Web site. CGI scripts are also
used to perform calculations, process user input,
and to display data.
CLEC....................... Competitive Local Exchange Carrier. A category of
telecommunications service provider that offers
services similar to LECs. A CLEC may also provide
other types of services such as long distance,
Internet access and entertainment.
DSL........................ Digital subscriber line, a high-speed data
delivery technology that uses standard copper
phone wires. DSL is the main broadband
alternative to cable modems.
DS3........................ A data communications circuit capable of
transmitting data at 45 Mbps.
Email...................... An application that allows a user to send or
receive text messages to or from any other user
with an Internet address, commonly termed an
email address.
Firewall................... A system placed between networks that filters
data passing through it and removes unauthorized
traffic, thereby enhancing the security of the
network.
Frame relay................ A variable delay information transfer standard
for relaying traffic. Frame relay can be an
economical means to backhaul traffic to an ATM
network.
FTP........................ File Transfer Protocol. A protocol that allows
file transfer between a host and a remote
computer.
Internet................... A global collection of interconnected computer
networks which use TCP/IP, a common
communications protocol.
ISDN....................... Integrated Services Digital Network. An
information transfer standard for transmitting
digital voice and data over telephone lines at
speeds up to 128 Kbps.
G-1
<PAGE>
Kbps....................... Kilobits per second. A transmission rate. One
kilobit equals 1,024 bits of information.
LAN........................ Local Area Network. A data communications network
designed to interconnect personal computers,
workstations, minicomputers, file servers and
other communications and computing devices within
a localized environment.
Latency.................... The time that elapses between the moment when a
command is sent to the time that a response is
received. On a network, latency is due to delays
in routers or switches, congestion delays on a
crowded backbone, and the time required for
electrons to travel a great distance between
nodes on a network.
Leased line................ Telecommunications line dedicated to a particular
customer along a predetermined route.
LEC........................ Local Exchange Carrier. A telecommunications
company that provides telecommunications services
in a geographic area in which calls generally are
transmitted without toll charges.
Mbps....................... Megabits per second.
Modem...................... A device for transmitting digital information
over an analog telephone line.
NAP........................ Network Access Point. A location at which ISPs
exchange each other's traffic.
Online services............ Commercial information services that offer a
computer user access to a specified slate of
information, entertainment and communications
menus on what appears to be a single system.
Peering.................... The commercial practice under which nationwide
ISPs exchange each other's traffic without the
payment of settlement charges.
POPs....................... Points-of-presence. Geographic areas within which
the Company provides local access. For purposes
of this Memorandum, POPs include both physical
points of presence as well as VLA.
RBOC....................... Regional Bell Operating Company. LECs created by
AT&T's divestiture of its local exchange
business.
Router..................... A system placed between networks that relays data
to those networks based upon a destination
address contained in the data packets being
routed.
Server..................... Software that allows a computer to offer a
service to another computer. Other computers
contact the server program by means of matching
client software. In addition, such term means the
computer on which server software runs.
SuperPOP................... A SuperPOP is a Concentric POP that is directly
connected to the Concentric ATM backbone.
SuperPOPs typically support dial access
G-2
<PAGE>
from the region surrounding the SuperPOP
(typically within 200 miles of the SuperPOP)
using the services of a CLEC. SuperPOPs also
support dedicated access connections to customer
locations using Local Exchange Carrier and/or
Competitive Access Provider facilities to connect
the customer to the Concentric SuperPOP.
TCP/IP..................... Transmission Control Protocol/Internet Protocol.
A suite of network protocols that allow computers
with different architectures and operating system
software to communicate with other computers on
the Internet.
T-1........................ A data communications circuit capable of
transmitting data at 1.5 Mbps.
UNIX....................... A computer operating system frequently found on
workstations and PCs and noted for its
portability and communications functionality.
VPN........................
Virtual Private Network. A network capable of
providing the tailored services of a private
network (i.e., low latency, high throughput,
security and customization) while maintaining the
benefits of a public network (i.e., ubiquity and
economies of scale).
WAN........................ Wide Area Network. A data communications network
designed to interconnect personal computers,
workstations, minicomputers, file servers and
other communications and computing devices across
multiple locations within an enterprise.
World Wide Web or Web...... A system that supports easy access to documents
that have been linked across the Internet. The
documents contain links to each other, hence the
term "Web." Users do not have to know the
locations of particular documents and work
through a user friendly interface.
Webserver.................. A server connected to the Internet from which
Internet users can obtain information.
G-3
<PAGE>
Concentric Network
Value-Added
IP Network Services
Virtual Private Networks (VPNs): Concentric Enterprise VPN/TM/ (EVPN) is a
business-critical wide-area networking solution that enables an organization
to securely and reliably communicate with its offices, business partners,
vendors, customers and employees (both local and remote). EVPN customers take
advantage of turnkey security solutions. Concentric CustomLink/TM/ is a unique
VPN offering that gives an organization a direct, individualized online
connection in the form of an intranet or extranet for their organization.
Concentric RemoteLink/TM/ enables mobile employees, telecommuters and business
partners to securely and cost-effectively dial into their enterprise network
and use network resources as if they were locally connected.
Application Hosting an E-Commerce: Concentric provides a complete line of
shared and dedicated application hosting services that provide reliable,
high-performance and scalable solutions. The service offerings range from the
ConcentricHost bundled Web hosting, email and dial-up Internet packages for
small to medium-sized businesses to managed Web server and colocation services
for media and Internet-centric companies. Concentric's family of NT-based
electronic commerce solutions provide a full suite of tools to securely
conduct commerce over the Internet. With the Distributed Server Environment
platform, large businesses, Internet media and content providers and software
distributors have the ability to load balance between local or global servers
and can benefit from fail-over services. Concentric Peak Protection service is
ideal for companies that do not want to rely on a single hosting provider,
Internet Service Provider, or their own data center for hosting and data
center services. The service seamlessly divides traffic between Concentric
hosting centers and other server locations.
Access Services: Concentric offers a full-range of high-speed dedicated access
services to connect multiple, dispersed network sites, providing Internet,
intranet and LAN access across a VPN. Most of these services have latency and
throughput guarantees and are priced based on average usage. Options include
FullChannel T1/TM/ and DS3, FlexChannel T1/TM/ and DS3, LECFrame Relay,
Digital Subscriber Line (DSL), and wireless services. Concentric offers DSL
services with access speeds ranging from 144 Kbps to 1.5 Mbps.
[CONCENTRIC NETWORK LOGO APPEARS HERE]
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Prospective investors may rely only on the information contained in this Pro-
spectus. Neither Concentric Network Corporation nor any underwriter has autho-
rized anyone to provide prospective investors with different or additional in-
formation. This Prospectus is not an offer to sell nor is it seeking an offer
to buy these securities in any jurisdiction where the offer or sale is not
permitted. The information contained in this Prospectus is correct only as of
the date of this Prospectus, regardless of the time of the delivery of this
Prospectus or any sale of these securities.
--------------------
TABLE OF CONTENTS
--------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
How We Intend to Use the Proceeds From the Offering...................... 22
Price Range of Our Common Stock.......................................... 22
Dividend Policy.......................................................... 22
Capitalization........................................................... 23
Selected Historical Consolidated Financial Data.......................... 24
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 26
Business................................................................. 36
Management............................................................... 52
Principal Stockholders................................................... 54
Underwriting............................................................. 56
Where You Can Find More Information...................................... 57
Legal Matters............................................................ 58
Experts.................................................................. 58
Index to Financial Statements............................................ F-1
Glossary of Terms........................................................ G-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
[LOGO OF CONCENTRIC NETWORK CORPORATION APPEARS HERE]
2,500,000 Shares
Common Stock
------------
PROSPECTUS
------------
Bear, Stearns & Co. Inc.
BancBoston Robertson Stephens
CIBC Oppenheimer
First Union Capital Markets Corp.
C.E. Unterberg, Towbin
Warburg Dillon Read LLC
, 1999
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses other than
underwriting discounts and commissions, payable by the Company in connection
with the sale of Common Stock being registered. All amounts are estimates
except the Registration Fee, the NASD Filing Fee and the Nasdaq Listing of
Additional Shares Fee.
<TABLE>
<CAPTION>
Amount To Be
Paid By the
Company
------------
<S> <C>
SEC Registration Fee............................................ $ 26,775
NASD Filing Fee................................................. 10,133
Nasdaq Listing of Additional Shares Fee......................... 17,500
Printing........................................................ 150,000
Legal Fees and Expenses......................................... 250,000
Accounting Fees and Expenses.................................... 150,000
Blue Sky Fees and Expenses...................................... 3,000
Transfer and Custody Agent Fees................................. 10,000
Miscellaneous................................................... 132,592
--------
Total......................................................... $750,000
========
</TABLE>
Item 15. Indemnification of Directors and Officers
In May 1997, the Registrant entered into indemnification agreements with its
directors and officers providing for limitations on a director's and officer's
liability for judgments, settlements, penalties, fines and expenses of defense
(including attorneys' fees, bonds and costs of investigation) arising out of or
in any way related to acts or omissions as a director or an officer, or in any
other capacity in which services are rendered to the Registrant. The Registrant
believes its indemnification agreements will assist it in attracting and
retaining qualified individuals to serve as directors and officers. The
agreements provide that a director or officer is not entitled to
indemnification under such agreements (i) if the director or officer is not
relieved of liability under applicable law, (ii) for violations of certain
securities laws, or (iii) for certain claims initiated by the officer or
director. Due to the lack of applicable case law, it is not clear whether
indemnification is available in case of a breach of securities laws of the U.S.
As permitted by Section 145 of the Delaware General Corporation Law, the
Registrant's Second Amended and Restated Certificate of Incorporation includes
a provision that eliminates the personal liability of its directors for
monetary damages for breach or alleged breach of their duty of care. In
addition, as permitted by Section 145 of the Delaware General Corporation Law
the Bylaws, as amended, of the Registrant provide that: the Registrant is
required to indemnify its directors and officers and persons serving in such
capacities in other business enterprises (including, for example, subsidiaries
of the Registrant) at the Registrant's request, to the fullest extent permitted
by Delaware law, including in those circumstances in which indemnification
would otherwise be discretionary; (ii) the Registrant may, in its discretion,
indemnify employees and agents in those circumstances where indemnification is
not required by law; (iii) the Registrant is required to advance expenses, as
incurred, to its directors and officers in connection with defending a
proceeding (except that it is not required to advance expenses to a person
against whom the Registrant brings a claim for breach of the duty of loyalty,
failure to act in good faith, intentional misconduct, knowing violation of law
or deriving an improper personal benefit); (iv) the rights conferred in the
Bylaws, as amended, are not exclusive, and the Registrant is authorized to
enter into indemnification agreements with its directors, officers and
employees; and (v) the Registrant may not retroactively amend the Bylaw
provisions in a way that is adverse to such directors, officers and employees.
II-1
<PAGE>
The Registrant's policy is to enter into indemnification agreements with
each of its directors and officers that provide the maximum indemnity allowed
to directors and officers by Section 145 of the Delaware General Corporation
Law and the Bylaws, as amended, as well as certain additional procedural
protections.
The indemnification provisions in the Bylaws, as amended, and the agreements
entered into between the Registrant and its directors and officers may be
sufficiently broad to permit indemnification of the Registrant's directors and
officers for liabilities arising under the Securities Act.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
Registrant pursuant to the foregoing provisions, the Registrant has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
Item 16. Exhibits and Financial Statement Schedules
<TABLE>
<CAPTION>
Exhibits
--------
<C> <S>
1.1+ Form of Underwriting Agreement.
3.1*+ Form of Amended and Restated Certificate of Incorporation of
Registrant.
3.2*+ Amended and Restated Bylaws of Registrant.
3.3**+ Certificate of Designation of Voting Power, Designation Preferences
and Relative, Participating, Optional and Other Special Rights and
Qualifications, Limitations and Restrictions of 13 1/2%
Series A and Series B Senior Redeemable Exchangeable Preferred Stock,
due 2010 of the Registrant.
5.1+ Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation.
10.1++ Amendment Number Four to Virtual Private Services Agreement between
the Registrant and WebTV, Inc., dated November 19, 1998.
10.2 Form of 1999 Non-Statutory Stock Option Plan.
21.1+ List of Subsidiaries.
23.1+ Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation
(included in Exhibit 5.1).
23.2 Consent of Ernst & Young, LLP, Independent Auditors.
24.1+ Power of Attorney.
27.1+ Financial Data Schedule.
</TABLE>
- ----------
* Incorporated by reference from Registrant's Registration Statement on Form
S-1 (File No. 333-27241), as amended, declared effective by the Securities
and Exchange Commission on July 31, 1997.
** Incorporated by reference from Registrant's Registration Statement on Form
S-4 (File No. 333-58641), as amended, as filed with the Securities and
Exchange Commission July 7, 1998.
+ Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request.
+ Previously filed.
(b) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions Deductions Balance
Balance Charge to Uncollectable at End
at Beginning Costs & Accounts of
Description of Period Expenses Written Off Period
----------- ------------ ---------- ------------- --------
<S> <C> <C> <C> <C>
For the period ended
December 31, 1998......... $80,049 $1,155,356 $545,051 $690,354
---------------------------
For the period ended
December 31, 1997......... 56,000 40,000 15,951 80,049
---------------------------
For the Period ended
December 31, 1996......... 0 56,000 0 56,000
---------------------------
</TABLE>
II-2
<PAGE>
Item 17. Undertakings
The undersigned Registrant hereby undertakes that:
(1) The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of
the registrant's annual report pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide
offering thereof.
(2) The undersigned registrant hereby undertakes to deliver or cause to
be delivered with the prospectus, to each person to whom the prospectus is
sent or given, the latest annual report, to security holders that is
incorporated by reference in the prospectus and furnished pursuant to and
meeting the requirements of Rule 14a-3 or Rule 14c-3 under the Securities
Exchange Act of 1934; and, where interim financial information required to
be presented by Article 3 of Regulation S-X is not set forth in the
prospectus, to deliver, or cause to be delivered to each person to whom the
prospectus is sent or given, the latest quarterly report that is
specifically incorporated by reference in the prospectus to provide such
interim financial information.
(3) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the registrant pursuant to the provisions described
in Item 15 or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of
expenses incurred or paid by a director, officer, or controlling person of
the registrant in the successful defense of any action, suit, or
proceeding) is asserted by such director, officer, or controlling person in
connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
(4) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed be part of this
registration statement as of the time it was declared effective.
(5) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form S-3 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of San Jose, State of California, on the 4th day
of February, 1999.
Concentric Network Corporation
/s/ Henry R. Nothhaft
By: _________________________________
Henry R. Nothhaft,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Henry R. Nothhaft President and Chief February 4, 1999
______________________________________ Executive Officer
Henry R. Nothhaft (Principal Executive
Officer), Director,
Chairman of the Board
* Chief Financial Officer February 4, 1999
______________________________________ (Principal Financial and
Michael F. Anthofer Accounting Officer)
* Director February 4, 1999
______________________________________
Vinod Khosla
* Director February 4, 1999
______________________________________
Franco Regis
* Director February 4, 1999
______________________________________
Gary E. Rieschel
* Director February 4, 1999
______________________________________
S. Miller Williams
/s/ Henry R. Nothhaft February 4, 1999
*By: _________________________________
Henry R. Nothhaft
</TABLE>
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
--------
<C> <S>
1.1+ Form of Underwriting Agreement.
3.1*+ Form of Amended and Restated Certificate of Incorporation of
Registrant.
3.2*+ Amended and Restated Bylaws of Registrant.
3.3**+ Certificate of Designation of Voting Power, Designation Preferences
and Relative, Participating, Optional and Other Special Rights and
Qualifications, Limitations and Restrictions of 13 1/2%
Series A and Series B Senior Redeemable Exchangeable Preferred Stock,
due 2010 of the Registrant.
5.1+ Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation.
10.1++ Amendment Number Four to Virtual Private Services Agreement between
the Registrant and WebTV, Inc., dated November 19, 1998.
10.2 Form of 1999 Non-Statutory Stock Option Plan.
21.1+ List of Subsidiaries.
23.1+ Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation
(included in Exhibit 5.1).
23.2 Consent of Ernst & Young, LLP, Independent Auditors.
24.1+ Power of Attorney.
27.1+ Financial Data Schedule.
</TABLE>
- ----------
* Incorporated by reference from Registrant's Registration Statement on Form
S-1 (File No. 333-27241), as amended, declared effective by the Securities
and Exchange Commission on July 31, 1997.
** Incorporated by reference from Registrant's Registration Statement on Form
S-4 (File No. 333-58641), as amended, as filed with the Securities and
Exchange Commission July 7, 1998.
+ Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request.
+ Previously filed.
<PAGE>
EXHIBIT 10.2
CONCENTRIC NETWORK CORPORATION
1999 NONSTATUTORY STOCK OPTION PLAN
1. Purposes of the Plan. The purposes of this Nonstatutory Stock
--------------------
Option Plan are:
. to attract and retain the best available personnel for positions of
substantial responsibility,
. to provide additional incentive to Employees, Directors and
Consultants, and
. to promote the success of the Company's business.
Options granted under the Plan will be Nonstatutory Stock Options.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" means the Board or any of its Committees as
-------------
shall be administering the Plan, in accordance with Section 4 of the Plan.
(b) "Applicable Laws" means the requirements relating to the
---------------
administration of stock option plans under U.S. state corporate laws, U.S.
federal and state securities laws, the Code, any stock exchange or quotation
system on which the Common Stock is listed or quoted and the applicable laws of
any foreign country or jurisdiction where Options are, or will be, granted under
the Plan.
(c) "Board" means the Board of Directors of the Company.
-----
(d) "Code" means the Internal Revenue Code of 1986, as amended.
----
(e) "Committee" means a committee of Directors appointed by the Board
---------
in accordance with Section 4 of the Plan.
(f) "Common Stock" means the Common Stock of the Company.
------------
(g) "Company" means Concentric Network Corporation, a Delaware
-------
corporation.
(h) "Consultant" means any person, including an advisor, engaged by
----------
the Company or a Parent or Subsidiary to render services to such entity.
(i) "Director" means a member of the Board.
--------
(j) "Disability" means total and permanent disability as defined in
----------
Section 22(e)(3) of the Code.
<PAGE>
(k) "Employee" means any person, including Officers, employed by the
--------
Company or any Parent or Subsidiary of the Company. A Service Provider shall not
cease to be an Employee in the case of (i) any leave of absence approved by the
Company or (ii) transfers between locations of the Company or between the
Company, its Parent, any Subsidiary, or any successor. Neither service as a
Director nor payment of a director's fee by the Company shall be sufficient to
constitute "employment" by the Company.
(l) "Exchange Act" means the Securities Exchange Act of 1934, as
------------
amended.
(m) "Fair Market Value" means, as of any date, the value of Common
-----------------
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system, including without limitation the Nasdaq
National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its
Fair Market Value shall be the closing sales price for such stock (or the
closing bid, if no sales were reported) as quoted on such exchange or system for
the last market trading day prior to the time of determination, as reported in
The Wall Street Journal or such other source as the Administrator deems
reliable;
(ii) If the Common Stock is regularly quoted by a recognized
securities dealer but selling prices are not reported, the Fair Market Value of
a Share of Common Stock shall be the mean between the high bid and low asked
prices for the Common Stock on the last market trading day prior to the day of
determination, as reported in The Wall Street Journal or such other source as
the Administrator deems reliable;
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value shall be determined in good faith by the
Administrator.
(n) "Notice of Grant" means a written or electronic notice evidencing
---------------
certain terms and conditions of an individual Option grant. The Notice of Grant
is part of the Option Agreement.
(o) "Officer" means a person who is an officer of the Company within
-------
the meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.
(p) "Option" means a nonstatutory stock option granted pursuant to
------
the Plan, that is not intended to qualify as an incentive stock option within
the meaning of Section 422 of the Code and the regulations promulgated
thereunder.
(q) "Option Agreement" means an agreement between the Company and an
----------------
Optionee evidencing the terms and conditions of an individual Option grant. The
Option Agreement is subject to the terms and conditions of the Plan.
(r) "Option Exchange Program" means a program whereby outstanding
-----------------------
options are surrendered in exchange for options with a lower exercise price.
-2-
<PAGE>
(s) "Optioned Stock" means the Common Stock subject to an Option.
--------------
(t) "Optionee" means the holder of an outstanding Option granted
--------
under the Plan.
(u) "Parent" means a "parent corporation," whether now or hereafter
------
existing, as defined in Section 424(e) of the Code.
(v) "Plan" means this 1999 Nonstatutory Stock Option Plan.
----
(w) "Service Provider" means an Employee including an Officer,
----------------
Consultant or Director.
(x) "Share" means a share of the Common Stock, as adjusted in
-----
accordance with Section 12 of the Plan.
(y) "Subsidiary" means a "subsidiary corporation," whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 12 of
-------------------------
the Plan, the maximum aggregate number of Shares which may be optioned and sold
under the Plan is five hundred fifty thousand (550,000) Shares. The Shares may
be authorized, but unissued, or reacquired Common Stock.
If an Option expires or becomes unexercisable without having been
exercised in full, or is surrendered pursuant to an Option Exchange Program, the
unpurchased Shares which were subject thereto shall become available for future
grant or sale under the Plan (unless the Plan has terminated).
4. Administration of the Plan.
--------------------------
(a) Administration. The Plan shall be administered by (i) the Board
--------------
or (ii) a Committee, which committee shall be constituted to satisfy Applicable
Laws.
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan, and in the case of a Committee, subject to the specific duties delegated
by the Board to such Committee, the Administrator shall have the authority, in
its discretion:
(i) to determine the Fair Market Value of the Common Stock;
(ii) to select the Service Providers to whom Options may be
granted hereunder;
(iii) to determine whether and to what extent Options are
granted hereunder;
-3-
<PAGE>
(iv) to determine the number of shares of Common Stock to be
covered by each Option granted hereunder;
(v) to approve forms of agreement for use under the Plan;
(vi) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any award granted hereunder. Such terms and
conditions include, but are not limited to, the exercise price, the time or
times when Options may be exercised (which may be based on performance
criteria), any vesting acceleration or waiver of forfeiture restrictions, and
any restriction or limitation regarding any Option or the shares of Common Stock
relating thereto, based in each case on such factors as the Administrator, in
its sole discretion, shall determine;
(vii) to reduce the exercise price of any Option to the then
current Fair Market Value if the Fair Market Value of the Common Stock covered
by such Option shall have declined since the date the Option was granted;
(viii) to institute an Option Exchange Program;
(ix) to construe and interpret the terms of the Plan and awards
granted pursuant to the Plan;
(x) to prescribe, amend and rescind rules and regulations
relating to the Plan, including rules and regulations relating to sub-plans
established for the purpose of qualifying for preferred tax treatment under
foreign tax laws;
(xi) to modify or amend each Option (subject to Section 14(b)
of the Plan), including the discretionary authority to extend the post-
termination exercisability period of Options longer than is otherwise provided
for in the Plan;
(xii) to authorize any person to execute on behalf of the
Company any instrument required to effect the grant of an Option previously
granted by the Administrator;
(xiii) to determine the terms and restrictions applicable to
Options;
(xiv) to allow Optionees to satisfy withholding tax obligations
by electing to have the Company withhold from the Shares to be issued upon
exercise of an Option that number of Shares having a Fair Market Value equal to
the amount required to be withheld. The Fair Market Value of the Shares to be
withheld shall be determined on the date that the amount of tax to be withheld
is to be determined. All elections by an Optionee to have Shares withheld for
this purpose shall be made in such form and under such conditions as the
Administrator may deem necessary or advisable; and
(xv) to make all other determinations deemed necessary or
advisable for administering the Plan.
-4-
<PAGE>
(c) Effect of Administrator's Decision. The Administrator's
----------------------------------
decisions, determinations and interpretations shall be final and binding on all
Optionees and any other holders of Options.
5. Eligibility. Options may be granted to Service Providers.
-----------
6. Limitation. Neither the Plan nor any Option shall confer upon an
----------
Optionee any right with respect to continuing the Optionee's relationship as a
Service Provider with the Company, nor shall they interfere in any way with the
Optionee's right or the Company's right to terminate such relationship at any
time, with or without cause.
7. Term of Plan. The Plan shall become effective upon its adoption by the
------------
Board. It shall continue in effect for ten (10) years, unless sooner terminated
under Section 14 of the Plan.
8. Term of Option. The term of each Option shall be stated in the Option
--------------
Agreement.
9. Option Exercise Price and Consideration.
---------------------------------------
(a) Exercise Price. The per share exercise price for the Shares to
--------------
be issued pursuant to exercise of an Option shall be determined by the
Administrator.
(b) Waiting Period and Exercise Dates. At the time an Option is
---------------------------------
granted, the Administrator shall fix the period within which the Option may be
exercised and shall determine any conditions which must be satisfied before the
Option may be exercised.
(c) Form of Consideration. The Administrator shall determine the
---------------------
acceptable form of consideration for exercising an Option, including the method
of payment. Such consideration may consist entirely of:
(i) cash;
(ii) check;
(iii) promissory note;
(iv) other Shares which (A) in the case of Shares acquired upon
exercise of an option, have been owned by the Optionee for more than six months
on the date of surrender, and (B) have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to which said
Option shall be exercised;
(v) consideration received by the Company under a cashless
exercise program implemented by the Company in connection with the Plan;
-5-
<PAGE>
(vi) a reduction in the amount of any Company liability to the
Optionee, including any liability attributable to the Optionee's participation
in any Company-sponsored deferred compensation program or arrangement;
(vii) such other consideration and method of payment for the
issuance of Shares to the extent permitted by Applicable Laws; or
(viii) any combination of the foregoing methods of payment.
10. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
-----------------------------------------------
granted hereunder shall be exercisable according to the terms of the Plan and at
such times and under such conditions as determined by the Administrator and set
forth in the Option Agreement. An Option may not be exercised for a fraction of
a Share.
An Option shall be deemed exercised when the Company receives:
(i) written or electronic notice of exercise (in accordance with the Option
Agreement) from the person entitled to exercise the Option, and (ii) full
payment for the Shares with respect to which the Option is exercised. Full
payment may consist of any consideration and method of payment authorized by the
Administrator and permitted by the Option Agreement and the Plan. Shares issued
upon exercise of an Option shall be issued in the name of the Optionee or, if
requested by the Optionee, in the name of the Optionee and his or her spouse.
Until the Shares are issued (as evidenced by the appropriate entry on the books
of the Company or of a duly authorized transfer agent of the Company), no right
to vote or receive dividends or any other rights as a shareholder shall exist
with respect to the Optioned Stock, notwithstanding the exercise of the Option.
The Company shall issue (or cause to be issued) such Shares promptly after the
Option is exercised. No adjustment will be made for a dividend or other right
for which the record date is prior to the date the Shares are issued, except as
provided in Section 12 of the Plan.
Exercising an Option in any manner shall decrease the number of
Shares thereafter available, both for purposes of the Plan and for sale under
the Option, by the number of Shares as to which the Option is exercised.
(b) Termination of Relationship as a Service Provider. If an
-------------------------------------------------
Optionee ceases to be a Service Provider, other than upon the Optionee's death
or Disability, the Optionee may exercise his or her Option, but only within such
period of time as is specified in the Option Agreement, and only to the extent
that the Option is vested on the date of termination (but in no event later than
the expiration of the term of such Option as set forth in the Option Agreement).
In the absence of a specified time in the Option Agreement, the Option shall
remain exercisable for three (3) months following the Optionee's termination.
If, on the date of termination, the Optionee is not vested as to his or her
entire Option, the Shares covered by the unvested portion of the Option shall
revert to the Plan. If, after termination, the Optionee does not exercise his or
her Option within the time specified by the Administrator, the Option shall
terminate, and the Shares covered by such Option shall revert to the Plan.
-6-
<PAGE>
(c) Disability of Optionee. If an Optionee ceases to be a Service
----------------------
Provider as a result of the Optionee's Disability, the Optionee may exercise his
or her Option within such period of time as is specified in the Option
Agreement, to the extent the Option is vested on the date of termination (but in
no event later than the expiration of the term of such Option as set forth in
the Option Agreement). In the absence of a specified time in the Option
Agreement, the Option shall remain exercisable for twelve (12) months following
the Optionee's termination. If, on the date of termination, the Optionee is not
vested as to his or her entire Option, the Shares covered by the unvested
portion of the Option shall revert to the Plan. If, after termination, the
Optionee does not exercise his or her Option within the time specified herein,
the Option shall terminate, and the Shares covered by such Option shall revert
to the Plan.
(d) Death of Optionee. If an Optionee dies while a Service
-----------------
Provider, the Option may be exercised within such period of time as is specified
in the Option Agreement (but in no event later than the expiration of the term
of such Option as set forth in the Notice of Grant), by the Optionee's estate or
by a person who acquires the right to exercise the Option by bequest or
inheritance, but only to the extent that the Option is vested on the date of
death. In the absence of a specified time in the Option Agreement, the Option
shall remain exercisable for twelve (12) months following the Optionee's
termination. If, at the time of death, the Optionee is not vested as to his or
her entire Option, the Shares covered by the unvested portion of the Option
shall immediately revert to the Plan. The Option may be exercised by the
executor or administrator of the Optionee's estate or, if none, by the person(s)
entitled to exercise the Option under the Optionee's will or the laws of descent
or distribution. If the Option is not so exercised within the time specified
herein, the Option shall terminate, and the Shares covered by such Option shall
revert to the Plan.
(e) Buyout Provisions. The Administrator may at any time offer to
-----------------
buy out for a payment in cash or Shares, an Option previously granted based on
such terms and conditions as the Administrator shall establish and communicate
to the Optionee at the time that such offer is made.
11. Non-Transferability of Options. Unless determined otherwise by the
------------------------------
Administrator, an Option may not be sold, pledged, assigned, hypothecated,
transferred, or disposed of in any manner other than by will or by the laws of
descent or distribution and may be exercised, during the lifetime of the
Optionee, only by the Optionee. If the Administrator makes an Option
transferable, such Option shall contain such additional terms and conditions as
the Administrator deems appropriate.
12. Adjustments Upon Changes in Capitalization, Dissolution, Merger or
------------------------------------------------------------------
Asset Sale.
- ----------
(a) Changes in Capitalization. Subject to any required action by the
-------------------------
shareholders of the Company, the number of shares of Common Stock covered by
each outstanding Option, and the number of shares of Common Stock which have
been authorized for issuance under the Plan but as to which no Options have yet
been granted or which have been returned to the Plan upon cancellation or
expiration of an Option, as well as the price per share of Common Stock covered
by each such outstanding Option, shall be proportionately adjusted for any
increase or decrease in the number of issued shares of Common Stock resulting
from a stock split, reverse stock split, stock
-7-
<PAGE>
dividend, combination or reclassification of the Common Stock, or any other
increase or decrease in the number of issued shares of Common Stock effected
without receipt of consideration by the Company; provided, however, that
conversion of any convertible securities of the Company shall not be deemed to
have been "effected without receipt of consideration." Such adjustment shall be
made by the Board, whose determination in that respect shall be final, binding
and conclusive. Except as expressly provided herein, no issuance by the Company
of shares of stock of any class, or securities convertible into shares of stock
of any class, shall affect, and no adjustment by reason thereof shall be made
with respect to, the number or price of shares of Common Stock subject to an
Option.
(b) Dissolution or Liquidation. In the event of the proposed
--------------------------
dissolution or liquidation of the Company, the Administrator shall notify each
Optionee as soon as practicable prior to the effective date of such proposed
transaction. The Administrator in its discretion may provide for an Optionee to
have the right to exercise his or her Option until ten (10) days prior to such
transaction as to all of the Optioned Stock covered thereby, including Shares as
to which the Option would not otherwise be exercisable. In addition, the
Administrator may provide that any Company repurchase option applicable to any
Shares purchased upon exercise of an Option shall lapse as to all such Shares,
provided the proposed dissolution or liquidation takes place at the time and in
the manner contemplated. To the extent it has not been previously exercised, an
Option will terminate immediately prior to the consummation of such proposed
action.
(c) Merger or Asset Sale. In the event of a merger of the Company
--------------------
with or into another corporation, or the sale of substantially all of the assets
of the Company, each outstanding Option shall be assumed or an equivalent option
or right substituted by the successor corporation or a Parent or Subsidiary of
the successor corporation. In the event that the successor corporation refuses
to assume or substitute for the Option, the Optionee shall fully vest in and
have the right to exercise the Option as to all of the Optioned Stock, including
Shares as to which it would not otherwise be vested or exercisable. If an Option
becomes fully vested and exercisable in lieu of assumption or substitution in
the event of a merger or sale of assets, the Administrator shall notify the
Optionee in writing or electronically that the Option shall be fully vested and
exercisable for a period of fifteen (15) days from the date of such notice, and
the Option shall terminate upon the expiration of such period. For the purposes
of this paragraph, the Option shall be considered assumed if, following the
merger or sale of assets, the option or right confers the right to purchase or
receive, for each Share of Optioned Stock, immediately prior to the merger or
sale of assets, the consideration (whether stock, cash, or other securities or
property) received in the merger or sale of assets by holders of Common Stock
for each Share held on the effective date of the transaction (and if holders
were offered a choice of consideration, the type of consideration chosen by the
holders of a majority of the outstanding Shares); provided, however, that if
such consideration received in the merger or sale of assets is not solely common
stock of the successor corporation or its Parent, the Administrator may, with
the consent of the successor corporation, provide for the consideration to be
received upon the exercise of the Option, for each Share of Optioned Stock to be
solely common stock of the successor corporation or its Parent equal in fair
market value to the per share consideration received by holders of Common Stock
in the merger or sale of assets.
-8-
<PAGE>
13. Date of Grant. The date of grant of an Option shall be, for all
-------------
purposes, the date on which the Administrator makes the determination granting
such Option, or such other later date as is determined by the Administrator.
Notice of the determination shall be provided to each Optionee within a
reasonable time after the date of such grant.
14. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may at any time amend,
-------------------------
alter, suspend or terminate the Plan.
(b) Effect of Amendment or Termination. No amendment, alteration,
----------------------------------
suspension or termination of the Plan shall impair the rights of any Optionee,
unless mutually agreed otherwise between the Optionee and the Administrator,
which agreement must be in writing and signed by the Optionee and the Company.
Termination of the Plan shall not affect the Administrator's ability to exercise
the powers granted to it hereunder with respect to options granted under the
Plan prior to the date of such termination.
15. Conditions Upon Issuance of Shares.
----------------------------------
(a) Legal Compliance. Shares shall not be issued pursuant to the
----------------
exercise of an Option unless the exercise of such Option and the issuance and
delivery of such Shares shall comply with Applicable Laws and shall be further
subject to the approval of counsel for the Company with respect to such
compliance.
(b) Investment Representations. As a condition to the exercise of
--------------------------
an Option the Company may require the person exercising such Option to represent
and warrant at the time of any such exercise that the Shares are being purchased
only for investment and without any present intention to sell or distribute such
Shares if, in the opinion of counsel for the Company, such a representation is
required.
16. Inability to Obtain Authority. The inability of the Company to obtain
-----------------------------
authority from any regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the lawful issuance and sale
of any Shares hereunder, shall relieve the Company of any liability in respect
of the failure to issue or sell such Shares as to which such requisite authority
shall not have been obtained.
17. Reservation of Shares. The Company, during the term of this Plan,
---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.
-9-
<PAGE>
CONCENTRIC NETWORK CORPORATION
1999 NONSTATUTORY STOCK OPTION PLAN
STOCK OPTION AGREEMENT
Unless otherwise defined herein, the terms defined in the Plan shall have
the same defined meanings in this Option Agreement.
I. NOTICE OF STOCK OPTION GRANT
----------------------------
[Optionee's Name and Address]
You have been granted an option to purchase Common Stock of the Company,
subject to the terms and conditions of the Plan and this Option Agreement, as
follows:
Grant Number ____________________________
Date of Grant ____________________________
Vesting Commencement Date ____________________________
Exercise Price per Share $___________________________
Total Number of Shares Granted ____________________________
Total Exercise Price $___________________________
Type of Option: Nonstatutory Stock Option
Term/Expiration Date: ____________________________
Vesting Schedule:
----------------
Subject to the Optionee continuing to be a Service Provider on such dates,
this Option shall vest and become exercisable in accordance with the following
schedule:
[25% of the Shares subject to the Option shall vest twelve months after the
Vesting Commencement Date, and 1/48th of the Shares subject to the Option shall
vest upon the last day of each month thereafter.]
Termination Period:
------------------
This Option may be exercised for _____ [days/months] after Optionee ceases
to be a Service Provider. Upon the death or Disability of the Optionee, this
Option may be exercised for such longer period as provided in the Plan. In no
event shall this Option be exercised later than the Term/Expiration Date as
provided above.
<PAGE>
II. AGREEMENT
---------
1. Grant of Option. The Plan Administrator of the Company hereby grants
---------------
to the Optionee named in the Notice of Grant attached as Part I of this
Agreement (the "Optionee") an option (the "Option") to purchase the number of
Shares, as set forth in the Notice of Grant, at the exercise price per share set
forth in the Notice of Grant (the "Exercise Price"), subject to the terms and
conditions of the Plan, which is incorporated herein by reference. In the event
of a conflict between the terms and conditions of the Plan and the terms and
conditions of this Option Agreement, the terms and conditions of the Plan shall
prevail.
2. Exercise of Option.
------------------
(a) Right to Exercise. This Option is exercisable during its term in
-----------------
accordance with the Vesting Schedule set out in the Notice of Grant and the
applicable provisions of the Plan and this Option Agreement.
(b) Method of Exercise. This Option is exercisable by delivery of an
------------------
exercise notice, in the form attached as Exhibit A (the "Exercise Notice"),
which shall state the election to exercise the Option, the number of Shares in
respect of which the Option is being exercised (the "Exercised Shares"), and
such other representations and agreements as may be required by the Company
pursuant to the provisions of the Plan. The Exercise Notice shall be completed
by the Optionee and delivered to [Title]. The Exercise Notice shall be
accompanied by payment of the aggregate Exercise Price as to all Exercised
Shares. This Option shall be deemed to be exercised upon receipt by the Company
of such fully executed Exercise Notice accompanied by such aggregate Exercise
Price.
No Shares shall be issued pursuant to the exercise of this Option
unless such issuance and exercise complies with Applicable Laws. Assuming such
compliance, for income tax purposes the Exercised Shares shall be considered
transferred to the Optionee on the date the Option is exercised with respect to
such Exercised Shares.
3. Method of Payment. Payment of the aggregate Exercise Price shall be
-----------------
by any of the following, or a combination thereof, at the election of the
Optionee:
(a) cash;
(b) check;
(c) consideration received by the Company under a cashless exercise
program implemented by the Company in connection with the Plan; or
(d) surrender of other Shares which (i) in the case of Shares acquired
upon exercise of an option, have been owned by the Optionee for more than six
(6) months on the date of surrender, and (ii) have a Fair Market Value on the
date of surrender equal to the aggregate Exercise Price of the Exercised Shares.
-2-
<PAGE>
4. Non-Transferability of Option. This Option may not be transferred in
-----------------------------
any manner otherwise than by will or by the laws of descent or distribution and
may be exercised during the lifetime of Optionee only by the Optionee. The terms
of the Plan and this Option Agreement shall be binding upon the executors,
administrators, heirs, successors and assigns of the Optionee.
5. Term of Option. This Option may be exercised only within the term set
--------------
out in the Notice of Grant, and may be exercised during such term only in
accordance with the Plan and the terms of this Option Agreement.
6. Tax Consequences. Some of the federal tax consequences relating to this
----------------
Option, as of the date of this Option, are set forth below. THIS SUMMARY IS
NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE.
THE OPTIONEE SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THIS OPTION OR
DISPOSING OF THE SHARES.
(a) Exercising the Option. The Optionee may incur regular federal
---------------------
income tax liability upon exercise of an NSO. The Optionee will be treated as
having received compensation income (taxable at ordinary income tax rates) equal
to the excess, if any, of the Fair Market Value of the Exercised Shares on the
date of exercise over their aggregate Exercise Price. If the Optionee is an
Employee or a former Employee, the Company will be required to withhold from his
or her compensation or collect from Optionee and pay to the applicable taxing
authorities an amount in cash equal to a percentage of this compensation income
at the time of exercise, and may refuse to honor the exercise and refuse to
deliver Shares if such withholding amounts are not delivered at the time of
exercise.
(b) Disposition of Shares. If the Optionee holds NSO Shares for at
---------------------
least one year, any gain realized on disposition of the Shares will be treated
as long-term capital gain for federal income tax purposes.
7. Entire Agreement; Governing Law. The Plan is incorporated herein by
-------------------------------
reference. The Plan and this Option Agreement constitute the entire agreement
of the parties with respect to the subject matter hereof and supersede in their
entirety all prior undertakings and agreements of the Company and Optionee with
respect to the subject matter hereof, and may not be modified adversely to the
Optionee's interest except by means of a writing signed by the Company and
Optionee. This agreement is governed by the internal substantive laws, but not
the choice of law rules, of California.
8. NO GUARANTEE OF CONTINUED SERVICE. OPTIONEE ACKNOWLEDGES AND AGREES
---------------------------------
THAT THE VESTING OF SHARES PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED
ONLY BY CONTINUING AS A SERVICE PROVIDER AT THE WILL OF THE COMPANY (AND NOT
THROUGH THE ACT OF BEING HIRED, BEING GRANTED AN OPTION OR PURCHASING SHARES
HEREUNDER). OPTIONEE FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE
TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO
NOT CONSTITUTE AN EXPRESS OR IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A
SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL,
-3-
<PAGE>
AND SHALL NOT INTERFERE WITH OPTIONEE'S RIGHT OR THE COMPANY'S RIGHT TO
TERMINATE OPTIONEE'S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR
WITHOUT CAUSE.
By your signature and the signature of the Company's representative below,
you and the Company agree that this Option is granted under and governed by the
terms and conditions of the Plan and this Option Agreement. Optionee has
reviewed the Plan and this Option Agreement in their entirety, has had an
opportunity to obtain the advice of counsel prior to executing this Option
Agreement and fully understands all provisions of the Plan and Option Agreement.
Optionee hereby agrees to accept as binding, conclusive and final all decisions
or interpretations of the Administrator upon any questions relating to the Plan
and Option Agreement. Optionee further agrees to notify the Company upon any
change in the residence address indicated below.
OPTIONEE CONCENTRIC NETWORK CORPORATION
- -------------------------------- -----------------------------------
Signature By
- -------------------------------- -----------------------------------
Print Name Title
- --------------------------------
Residence Address
- --------------------------------
-4-
<PAGE>
EXHIBIT A
---------
CONCENTRIC NETWORK CORPORATION
1999 NONSTATUTORY STOCK OPTION PLAN
EXERCISE NOTICE
Concentric Network Corporation
[address]
Attention: [Title]
1. Exercise of Option. Effective as of today, ________________, _____,
------------------
the undersigned ("Purchaser") hereby elects to purchase ______________ shares
(the "Shares") of the Common Stock of Concentric Network Corporation (the
"Company") under and pursuant to the 1999 Nonstatutory Stock Option Plan (the
"Plan") and the Stock Option Agreement dated ______, ___ (the "Option
Agreement"). The purchase price for the Shares shall be $_______, as required
by the Option Agreement.
2. Delivery of Payment. Purchaser herewith delivers to the Company the
-------------------
full purchase price for the Shares.
3. Representations of Purchaser. Purchaser acknowledges that Purchaser has
----------------------------
received, read and understood the Plan and the Option Agreement and agrees to
abide by and be bound by their terms and conditions.
4. Rights as Shareholder. Until the issuance (as evidenced by the
---------------------
appropriate entry on the books of the Company or of a duly authorized transfer
agent of the Company) of the Shares, no right to vote or receive dividends or
any other rights as a shareholder shall exist with respect to the Optioned
Stock, notwithstanding the exercise of the Option. The Shares so acquired shall
be issued to the Optionee as soon as practicable after exercise of the Option.
No adjustment will be made for a dividend or other right for which the record
date is prior to the date of issuance, except as provided in Section 12 of the
Plan.
5. Tax Consultation. Purchaser understands that Purchaser may suffer
----------------
adverse tax consequences as a result of Purchaser's purchase or disposition of
the Shares. Purchaser represents that Purchaser has consulted with any tax
consultants Purchaser deems advisable in connection with
<PAGE>
the purchase or disposition of the Shares and that Purchaser is not relying on
the Company for any tax advice.
6. Entire Agreement; Governing Law. The Plan and Option Agreement are
-------------------------------
incorporated herein by reference. This Agreement, the Plan and the Option
Agreement constitute the entire agreement of the parties with respect to the
subject matter hereof and supersede in their entirety all prior undertakings and
agreements of the Company and Purchaser with respect to the subject matter
hereof, and may not be modified adversely to the Purchaser's interest except by
means of a writing signed by the Company and Purchaser. This agreement is
governed by the internal substantive laws, but not the choice of law rules, of
California.
Submitted by: Accepted by:
PURCHASER CONCENTRIC NETWORK CORPORATION
- -------------------------------- -----------------------------------
Signature By
- -------------------------------- -----------------------------------
Print Name Title
-----------------------------------
Date Received
Address: _______________________ Address: __________________________
- ------- -------
_______________________ __________________________
_______________________ __________________________
-2-
<PAGE>
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the references to our firm under the caption "Experts" and
"Selected Historical Consolidated Financial Data" and to the use of our report
dated January 25, 1999 (except for Note 15, as to which the date is February 1,
1999) in the Registration Statement (Form S-3) and the related Prospectus of
Concentric Network Corporation for the registration of 2,875,000 shares of its
common stock.
/s/ Ernst & Young LLP
San Jose, California
February 1, 1999
