<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 000-22575
----------
CONCENTRIC NETWORK CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 65-0257497
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
</TABLE>
1400 Parkmoor Avenue
San Jose, California 95126
(Address of principal executive offices, including zip code)
(408) 817-2800
(Registrant's telephone number, including area code)
----------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days. Yes [X] No [ ]
The number of issued and outstanding shares of the Registrant's Common Stock,
$0.001 par value, as of September 30, 1999, was 42,119,597.
================================================================================
<PAGE>
CONCENTRIC NETWORK CORPORATION
PART I--FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
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Item 1. Financial Statements:
<S> <C> <C>
Condensed Consolidated Balance Sheets at September 30, 1999 and December 31, 1998....................... 3
Condensed Consolidated Statements of Operations for the three and nine month periods ended
September 30, 1999 and 1998............................................................................. 4
Condensed Consolidated Statements of Cash Flows for the nine month periods ended
September 30, 1999 and 1998............................................................................. 5
Notes to Unaudited Condensed Consolidated Financial Statements.......................................... 7-10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................... 11-30
PART II--OTHER INFORMATION
Item 1. Legal Proceedings....................................................................................... 31
Item 2. Changes in Securities and Use of Proceeds............................................................... 31
Item 3. Defaults Upon Senior Securities......................................................................... 31
Item 4. Submission of Matters to a Vote of Security Holders..................................................... 31
Item 5. Other Information....................................................................................... 31
Item 6. Exhibits and Reports on Form 8-K........................................................................ 31
Signatures.............................................................................................. 32
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---------------- ------------------
(Unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents.............................................................. $ 82,982 $ 98,988
Short term investments................................................................. 70,396 52,226
Current portion of restricted cash..................................................... 142,809 19,125
Accounts receivable, net............................................................... 19,689 13,714
Other current assets................................................................... 8,562 3,058
--------- ---------
Total current assets................................................................ 324,438 187,111
Property and equipment, net............................................................ 73,927 64,268
Restricted cash, net of current portion................................................ 8,881 17,113
Goodwill and other intangible assets................................................... 16,190 20,364
Long term investments.................................................................. 22,206 --
Other assets........................................................................... 11,087 9,401
--------- ---------
Total assets........................................................................ $ 456,729 $ 298,257
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................................................... $ 27,419 $ 26,342
Accrued compensation and other employee benefits....................................... 3,269 2,024
Other current liabilities.............................................................. 10,915 4,559
Current portion of capital lease obligations........................................... 6,377 6,543
Deferred revenue....................................................................... 4,828 3,104
--------- ---------
Total current liabilities........................................................... 52,808 42,572
Capital lease obligations, net of current portion........................................ 6,788 10,434
Notes payable............................................................................ 146,354 146,021
Other long term liabilities.............................................................. 98 --
Commitments
Redeemable exchangeable preferred stock.................................................. 173,372 156,105
Convertible redeemable preferred stock................................................... 39,223 --
Stockholders' equity (deficit):
Common stock........................................................................... 363,684 190,076
Accumulated deficit.................................................................... (324,981) (246,055)
Deferred compensation.................................................................. (617) (896)
--------- ---------
Total stockholders' equity (deficit)..................................................... 38,086 (56,875)
--------- ---------
Total liabilities and stockholders' equity (deficit)..................................... $ 456,729 $ 298,257
========= =========
</TABLE>
See accompanying notes.
3
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CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenue..................................................... $ 38,082 $ 21,579 $101,175 $ 57,725
Costs and expenses:
Cost of revenue........................................... 34,711 22,906 93,894 60,834
Development............................................... 2,596 2,100 7,953 5,405
Marketing and sales....................................... 13,734 11,494 37,308 29,279
General and administrative................................ 3,822 2,547 10,566 6,811
Amortization of goodwill and other intangible assets...... 1,392 1,100 4,175 2,449
Acquisition related charges............................... -- -- -- 1,291
Write off of in-process technology........................ -- -- -- 5,200
-------- -------- -------- --------
Total costs and expenses.................................... 56,255 40,147 153,896 111,269
-------- -------- -------- --------
Loss from operations........................................ (18,173) (18,568) (52,721) (53,544)
Net interest expense and other.............................. (1,920) (2,390) (7,775) (10,885)
-------- -------- -------- --------
Loss before extraordinary item.............................. (20,093) (20,958) (60,496) (64,429)
Extraordinary gain on early retirement of debt.............. -- -- -- 3,042
-------- -------- -------- --------
Net loss.................................................... (20,093) (20,958) (60,496) (61,387)
Preferred stock dividends and accretion..................... (7,115) (5,279) (18,430) (6,556)
-------- -------- -------- --------
Net loss attributable to common stockholders................ $(27,208) $(26,237) $(78,926) $(67,943)
======== ======== ======== ========
Net loss per share:
Loss before extraordinary item............................ $ (0.48) $ (0.71) $ (1.56) $ (2.23)
Extraordinary gain........................................ -- -- -- 0.11
-------- -------- -------- --------
Net loss.................................................. (0.48) (0.71) (1.56) (2.12)
Preferred stock dividends and accretion................... (0.17) (0.18) (0.47) (0.23)
-------- -------- -------- --------
Net loss attributable to common stockholders.............. $ (0.65) $ (0.89) $ (2.03) $ (2.35)
======== ======== ======== ========
Shares used in computing net loss per share attributable to
common stockholders......................................... 41,789 29,388 38,920 28,858
======== ======== ======== ========
</TABLE>
See accompanying notes.
4
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating Activities
Net loss................................................................................................... $ (78,926) $(67,943)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation............................................................................................ 20,207 17,618
Amortization of deferred interest, cost of revenue and marketing and sales related to issuance of
warrants............................................................................................ 1,163 912
Amortization of goodwill and other intangible assets.................................................... 4,174 2,450
Amortization of financing costs......................................................................... 473 392
Amortization of other deferred assets................................................................... 1,554 2,538
Amortization of deferred compensation................................................................... 280 280
Preferred stock dividends and accretion................................................................. 18,429 6,556
Gain on early retirement of debt........................................................................ -- (3,042)
Write-off of in-process technology...................................................................... -- 5,200
Changes in current assets and liabilities:
Accounts receivable..................................................................................... (6,718) (3,679)
Other current assets.................................................................................... (420) 629
Prepaid expenses........................................................................................ (4,256) (333)
Accounts payable........................................................................................ 1,077 2,222
Accrued compensation and other employee benefits........................................................ 1,245 (791)
Deferred revenue........................................................................................ 1,723 175
Other current liabilities............................................................................... 6,705 3,616
--------- --------
Net cash used in operating activities...................................................................... (33,290) (33,200)
Investing Activities
Net change in restricted cash.............................................................................. (123,684) --
Additions of property and equipment........................................................................ (28,919) (11,288)
Proceeds from sale of property and equipment............................................................... 135 --
Net change in notes receivable............................................................................. (830) --
Net change in short term investments....................................................................... (18,170) (17,251)
Net change in long term investments........................................................................ (22,206) --
Cash investment in network services businesses, net of cash acquired....................................... -- (25,077)
--------- --------
Net cash used in investing activities...................................................................... (193,674) (53,616)
Financing Activities
Net change in restricted cash.............................................................................. 8,232 7,313
Repayment of notes payable................................................................................. -- (1,960)
Repayment of lease obligations to a related party.......................................................... -- (3,079)
Repayment of lease obligations to a related party-early retirement of debt................................. -- (24,750)
Repayment of lease obligations............................................................................. (5,144) (5,015)
Proceeds from issuances of stock and warrants.............................................................. 161,668 2,528
Proceeds from issuances of redeemable exchangeable preferred stock......................................... -- 144,250
Proceeds from issuances of convertible redeemable preferred stock.......................................... 50,000 --
Deferred financing costs................................................................................... (3,798) (320)
--------- --------
Net cash provided by financing activities.................................................................. 210,958 118,967
--------- --------
Net change in cash and cash equivalents.................................................................... (16,006) 32,151
Cash and cash equivalents at beginning of period........................................................... 98,988 119,959
--------- --------
Cash and cash equivalents at end of period................................................................. $ 82,982 $152,110
========= ========
Supplemental Disclosures of Noncash Investing and Financing Activities:
Capital lease obligations incurred with a related party.................................................... $ -- $ 1,285
Capital lease obligations incurred......................................................................... $ 1,294 $ 4,485
</TABLE>
5
<PAGE>
<TABLE>
<S> <C> <C>
Supplemental Disclosures of Cash Flow Information
Interest paid.............................................................................................. $ 10,950 $ 12,499
</TABLE>
6
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
These unaudited condensed consolidated financial statements and the related
footnote information have been prepared pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of the Company's
management, the accompanying unaudited interim condensed financial statements
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information for the periods presented.
The results for the interim period ended September 30, 1999 are not necessarily
indicative of results to be expected for the entire year ending December 31,
1999 or future operating periods.
All share and per share information presented herein, except as noted, and in
the Company's condensed consolidated financial statements has been retroactively
restated to reflect a two-for-one stock split of the Company's common stock on
May 21, 1999, paid in the form of a stock dividend, to holders of record on
April 30, 1999.
2. 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. 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 four financial institutions.
3. 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". Net loss per share is computed using the weighted average number of
shares of common stock outstanding. Common stock equivalent shares from stock
options and warrants are not included as the effect is antidilutive.
4. Stockholders' Equity
In January 1999 SBC Communications Inc. purchased, prior to the stock split,
806,679 shares of common stock for an aggregate purchase price of approximately
$19.5 million pursuant to an agreement reached between the two companies in
October 1998. In connection with the agreement, the Company has issued to SBC a
warrant to purchase an additional pre-split 906,679 shares. The warrant expires
three years from the date of issuance and is exercisable at the pre-split price
of $21.00 per share. The Company deemed the fair market value of the warrant,
using the Black-Scholes method, to be $1.9 million which is being amortized as a
marketing cost over the life of the agreement.
In February 1999 the Company effected a public offering of its common stock
pursuant to a Registration Statement on Form S-3 filed with the Securities and
Exchange Commission. The Company issued and sold 2,830,500 shares prior to the
split at $44.50 per share for net proceeds of approximately $119.4 million.
Certain selling stockholders exercised warrants to purchase directly from the
Company 800,000 shares of pre split common stock having an aggregate purchase
price of approximately $10.2 million, which shares were also registered and sold
in the public offering by such stockholders.
7
<PAGE>
In June 1999 the Company issued a warrant to Microsoft Corporation
("Microsoft"), in conjunction with Microsoft's $50 million purchase of preferred
stock (see Note 8), to purchase 500,000 shares of its common stock. The warrant
expires four years from the date of issuance and is exercisable at $33.27 per
share. In connection with the issuance of the Series C Preferred the Company
issued a warrant to purchase 500,000 shares of its common stock. The Company
deemed the fair market value of the warrants, using the Black-Scholes model, to
be approximately $11.9 million and is accreting this value over four years.
In June 1999 the Company amended an agreement with TMI Telemedia
International, Ltd. ("TMI") and in connection with the agreement, the Company
issued a warrant to purchase 50,000 shares of its common stock. The warrant
expires in January 2001 and is exercisable at $25.1875 per share. The Company
deemed the fair market value of the warrant, using the Black-Scholes method, to
be $504,000, which was written off as other expense in June 1999.
5. Equity Investments
In January 1999 the Company purchased approximately $10.0 million of common
stock from Covad Communications, Inc. ("Covad") and certain Covad stockholders
at Covad's initial public offering price. In April 1999 the Company purchased
approximately $5.0 million of Class B Common Stock from NorthPoint
Communications Group, Inc. ("NorthPoint"). In July 1999 the Company purchased
approximately $5.0 million of Series A Convertible Preferred Stock from
Register.com, Inc. ("Register.com"). In August 1999 the Company purchased
approximately $2.0 million of Series B Preferred Stock from Asia Online, Ltd.
("Asia Online").
6. Acquisitions
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):
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
=======
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 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 452,000 pre-split 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 196,000 and 14,000 pre-split
shares, respectively, of the Company's common stock. The consolidated results
of operations for the three and nine months ended September 30, 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):
8
<PAGE>
Current and other assets..................................... $ 467
Computer and telecommunications equipment.................... 497
Goodwill..................................................... 11,630
Other intangible assets...................................... 416
-------
Total purchase price allocation........................... $13,010
=======
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.
7. Early Retirement of Debt
On March 31, 1998, the Company retired a portion of debt in the form of
capital lease obligations to a related party. The Company paid $24.8 million for
extinguishment of debt. The Company recognized an extraordinary gain of $3.0
million in connection with this transaction.
8. Convertible Redeemable Preferred Stock
In June 1999, the Company issued 50,000 shares of Series C 7% Convertible
Redeemable Preferred Stock due 2010 ("Series C Preferred") to Microsoft for $50
million. Each share of Series C Preferred has a liquidation preference of
$1,000 per share. Dividends on the Series C Preferred accrue at the rate of 7%
per annum of the liquidation preference thereof and are payable quarterly in
arrears commencing on September 1, 1999. Dividends are payable in cash, except
that on each dividend payment date dividends may be paid, at the Company's
option, by the issuance of additional shares of Series C Preferred having an
aggregate liquidation preference equal to the amount of such dividends.
The Series C 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 commencing
with 105.125% declining to 100% on June 1, 2010. The Series C Preferred is
subject to mandatory redemption at its liquidation preference, plus accumulated
and unpaid dividends on September 1, 2010. The holder of any Series C Preferred
has the right, at its option, to convert at any time any shares of Series C
Preferred into shares of common stock at the conversion price of $39.924.
The Company is accreting the Series C Preferred to its liquidation preference
through the due date of the Series C Preferred. The accretion for the quarter
and year-to-date period ended September 30, 1999 was approximately $888,000.
9. Consent Agreements
In July 1999, the Company solicited and received consents of more than a
majority of the Company's outstanding 12 3/4% Senior Notes due 2007 ("12 3/4%
Senior Notes") and the outstanding 13 1/2% Series B Redeemable Exchangeable
Preferred Stock due 2010 ("Series B Preferred"). The consents allow the Company
to increase its permitted investments under the Indenture relating to the 12
3/4% Senior Notes and the Certificate of Designation relating to the Series B
Preferred. In August, the Company paid consent fees of approximately $3.8
million to the holders who delivered consents prior to the expiration date of
such consents.
10. 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"). No provision for income taxes is expected for 1999
as the Company expects to incur a net loss for the year and does not meet the
criteria for recognizing an income tax benefit under the provisions of FAS 109.
11. Commitments
In May 1999, the Company signed an agreement to lease space in Irvine,
California for an office and data center. The lease expires in June 2004. The
average annual rent over the term of the lease is approximately $411,000.
9
<PAGE>
In June 1999, the Company signed an agreement through which Microsoft will
provide services to certain of the Company's customers and the Company will
purchase $7.5 million worth of advertising during the term of the three year
agreement.
In September 1999, the Company announced that it had reached an agreement to
acquire Internet Technology Group plc, a provider of Internet access for
consumers and dedicated access and hosting for businesses in the UK and Europe.
The transaction is valued at approximately $217.0 million, consisting of 50%
cash and 50% Concentric stock. The Company has placed $123.7 million into
restricted cash pending completion of this transaction.
In November 1999, the Company signed an agreement to sublease office space in
San Jose, California from November 1999 through March 2002 for approximately
$1.2 million per year.
11. Subsequent Events
In October 1999 the Company acquired substantially all of the assets of 9 Net
Avenue, Inc., a provider of web hosting services, for approximately $51.8
million in stock and cash and assumed approximately $9.9 million in liabilities.
In October 1999 the Company purchased approximately $5.0 million of Series C
Preferred stock from Corio, Inc.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section and other parts of this Report contain forward-looking statements
that involve risks and uncertainties. The Company's actual results may differ
significantly from the results discussed in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in the subsection entitled "Factors Affecting Operating
Results". The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Financial
Statements and the Notes thereto included elsewhere in this Report.
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 virtual private networks or VPNs and providing dedicated network
access, digital subscriber line (DSL) 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. 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. 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. 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.
In October 1999 the Company acquired 9Net Avenue, Inc. and has signed an
agreement to acquire ITG. Both of these transactions will result in additional
charges for goodwill. Additionally, the Company may acquire other complementary
products or technology and 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
"Factors Affecting Operating Results--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 2001. The Company's ability to
11
<PAGE>
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 and
$78.9 million for the nine months ended September 30, 1999. 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.
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.
Results of Operations
Revenue. Revenue totaled approximately $38.1 million for the three month
period ended September 30, 1999, a $16.5 million increase over revenue of
approximately $21.6 million for the three month period ended September 30, 1998.
Revenue for the nine month period ended September 30, 1999 was approximately
$101.2 million, a $43.5 million increase over revenue of approximately $57.7
million for the nine month period ended September 30, 1998. 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; and
. revenues from acquired operations.
The Company expects revenue growth from Internet access customers to flatten
over time. Revenue from WebTV decreased to 24.0% of the Company's net revenue
for the three month period ended September 30, 1999 compared to 25.9% for the
three month period ended September 30, 1998. WebTV accounted for approximately
26.5% of net revenue for the nine months ended September 30, 1999 as compared to
27.0% for the comparable period in 1998. 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 "Factors Affecting Operating Results--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
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equipment and amortization of related assets. Cost of revenue for the three
month period ended September 30, 1999 was approximately $34.7 million, an
increase of $11.8 million from cost of revenue of $22.9 million for the three
month period ended September 30, 1998. 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 91.1% of revenue
in the three month period ended September 30, 1999, down from 106.1% of revenue
in the year earlier period, due to increased network utilization associated with
the Company's revenue growth and lower per port costs of the Company's network.
Cost of revenue for the nine months ended September 30, 1999 was approximately
$93.9 million compared to $60.8 million for the nine months ended September 30,
1998. As a percentage of revenue, costs declined to 92.8% of revenue in the nine
months ended September 30, 1999 from 105.4% of revenue in the year earlier
period. 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
"Factors Affecting Operating Results--We Have a Limited Operating History and
Expect Continuing Operating Losses," "Factors Affecting Operating Results--Our
Growth and Expansion May Strain Our Resources" and "Factors Affecting
Operating Results--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 $2.6 million and
$2.1 million for the three month periods ended September 30, 1999 and 1998,
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 6.8% for the three month period ended
September 30, 1999 from 9.7% for the three month period ended September 30, 1998
as a result of the Company's increased revenue. Development expense for the nine
month periods ending September 30, 1999 and 1998 was approximately $8.0 million
and $5.4 million, respectively. As a percentage of revenue, development expense
declined to 7.9% for the nine months ended September 30, 1999 from 9.4% for the
nine months ended September 30, 1998. 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 "Factors Affecting Operating Results--We Have a Limited
Operating History and Expect Continuing Operating Losses" and "Factors
Affecting Operating Results--We Depend Upon New and Enhanced Services."
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 $13.7
million for the three month period ended September 30, 1999 and $11.5 million
for the three month period ended September 30, 1998. The $2.2 million increase
in 1999 reflects an expansion of 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
36.1% for the three month period ended September 30, 1999 from 53.3% in the year
earlier period as a result of the Company's increased revenue. For the nine
months ended September 30, 1999 and 1998, marketing and sales expense was
approximately $37.3 million and $29.3 million, respectively, and was 36.9% and
50.7% of revenue, respectively. 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 "Factors Affecting Operating Results--We Depend on New and
Uncertain Markets" and "Factors Affecting Operating Results--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 $3.8 million for the three month period
ended September 30, 1999 and $2.5 million for the three month period ended
September 30, 1998. 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 declined to 10.0% for the three month period ended
September 30, 1999 from 11.8% in the year earlier period as a result of the
Company's increased revenue. For the nine months ended September 30, 1999 and
1998, general and administrative expense was approximately $10.6 million and
$6.8 million, respectively. General and administrative expense as a percentage
of revenue declined to 10.4% in the nine months ended September 30, 1999 from
11.8% for the comparable period in 1998. The Company expects general and
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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 "Factors Affecting Operating
Results--We Depend on New and Uncertain Markets" and "Factors Affecting
Operating Results--Our Growth and Expansion May Strain Our Resources."
Amortization of Goodwill and Other Intangible Assets. For the three month
periods ended September 30, 1999 and September 30, 1998, respectively, the
Company recorded amortization of goodwill and other intangible assets of $1.4
million and $1.1 million. Amortization of goodwill and other intangible assets
for the nine month period ended September 30, 1999 was $4.2 million as compared
to $2.4 million for the comparable period in 1998. The increase is primarily
the result of the acquisition of AnaServe in August 1998.
Acquisition-Related Charges. For the nine month period ended September 30,
1998, the Company charged to operations one-time acquisition costs of $1.3
million related to the DeltaNet acquisition.
Write-off of In-Process Technology. In the nine month period ended September
30, 1998, the Company wrote-off $5.2 million of in-process technology related to
the acquisition of InterNex.
Net Interest Expense and Other Expense. Net interest expense and other
expense was approximately $1.9 million and $2.4 million for the three month
periods ended September 30, 1999 and 1998, respectively. For the nine months
ended September 30, 1999 and 1998, net interest expense and other expense was
$7.8 million and $10.9 million, respectively. The decrease is primarily due to
the early retirement of debt in the form of capital lease obligations in March
1998 and higher levels of cash, cash equivalents and short term investments in
the three and nine months ended September 30, 1999. During the nine month
period ended September 30, 1999, the Company wrote off $504,000 related to the
issuance of a warrant to TMI.
Extraordinary Gain. For the nine month period ended September 30, 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.
Preferred Stock Dividends and Accretions. For the three month periods ended
September 30, 1999 and 1998, the Company recorded dividend and stock accretion
of $7.1 million and $5.3 million, respectively, related to the Series A 13 1/2%
Redeemable Exchangeable Preferred Stock due 2010 ("Series A Preferred") issued
in June 1998, the Series B 13 1/2% Redeemable Exchangeable Preferred Stock due
2010 ("Series B Preferred") issued in September 1998 in exchange for all
outstanding shares of Series A Preferred and the Series C 7% Convertible
Redeemable Preferred Stock due 2010 ("Series C Preferred"). Dividend and stock
accretion for the nine months ended September 30, 1999 and 1998, was $18.4
million and $6.6 million, respectively.
Net Loss Attributable to Common Stockholders. The Company's net loss
attributable to common stockholders increased to approximately $78.9 million for
the nine month period ended September 30, 1999 as compared to approximately
$67.9 million for the nine month period ended September 30, 1998. For
comparative purposes, the net loss attributable to common stockholders for the
nine month period ended September 30, 1999 included $18.4 million of dividends
and accretion related to the preferred stock issued in June 1998, an increase of
$11.8 million over the prior year comparable period. The net loss attributable
to common stockholders for the nine month period ended September 30, 1998
included a $5.2 million write-off of in-process technology partially offset by
an extraordinary gain of $3.0 million on early retirement of debt.
Liquidity and Capital Resources
To date, the Company has satisfied its cash requirements primarily through the
sale of capital stock, debt financings and capitalized lease 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, to provide for the early
retirement of debt and to finance equity investments in strategic partners. Net
cash used in operating activities for the nine month periods ended September 30,
1999 and 1998 was approximately $33.3 million and $33.2 million, respectively.
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.
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Net cash used in investing activities for the nine month periods ended
September 30, 1999 and 1998 was approximately $193.7 million and $53.6 million,
respectively. Net cash used in investing activities for the nine month period
ended September 30, 1999 consisted of equity investments of $10.0 million in
Covad Communications, Inc., $5.0 million in NorthPoint Communications, Group,
Inc., $5.0 million in Register.com, Inc. and $2.0 million in Asia Online, Ltd.
Restricted cash of $123.7 million was placed in escrow for the pending Internet
Technology Group acquisition, $28.9 million was used to purchase capital
equipment to support the Company's expanded network infrastructure, and $18.2
million was used to purchase short term investments. For the nine month period
ended September 30, 1998, net cash used in investing activities consisted
primarily of $25.1 million for the acquisitions of InterNex, DeltaNet and
AnaServe and $11.3 million for purchases of capital equipment.
For the nine month period ended September 30, 1999, net cash of approximately
$211.0 million was provided from financing activities. Net proceeds from the
public stock offering in February 1999 was $119.0 million, net proceeds from the
issuance of Series C Preferred was approximately $50.0 million, net proceeds
from the sale of stock to SBC was $19.5 million and net proceeds from other
stock issuances, including the sale of stock to stockholders exercising
warrants, was $23.2 million. For the nine month period ended September 30,
1998, net cash of approximately $119.0 million was provided by financing
activities, of which $144.3 million was the net proceeds from the issuance of
Series A Preferred and $24.7 million was used for the early retirement of
capital lease obligations.
For the nine month period ended September 30, 1999 net cash decreased $16.0
million as compared to a net cash increase for the nine month period ended
September 30, 1998 of $32.2 million.
At September 30, 1999, the Company had cash and cash equivalents of
approximately $83.0 million, short term investments of $70.4 million, restricted
cash of $151.7 million and working capital of $271.6 million. The Company
expects to incur additional operating losses and will rely primarily on its
available cash resources to meet its anticipated cash needs for working capital
and for the acquisition of capital equipment through September 2000. However,
the Company may 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 under the caption
"Factors Affecting Operating Results--We May Need Additional Capital in the
Future and Such Additional Financing May Not Be Available." The Company may 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.
Disclosures About Market Risk
The following discusses the Company's exposure to market risk related to
changes in equity prices. 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 caption "Factors Affecting Operating Results--We May Need Additional
Capital in the Future and Such Additional Financing May Not Be Available."
Equity Price Risk
The Company owns 833,334 shares of the common stock of Covad, purchased in
January 1999 at a split adjusted price of $12.00 per share, 277,840 shares of
Class B Common Stock of NorthPoint purchased in April 1999 at $18.00 per share,
416,667 shares of Series A Convertible Preferred Stock of Register.com purchased
in July 1999 at $12.00 per share and 629,660 shares of Series B Preferred Stock
of Asia Online purchased in August 1999 at $3.176 per share. The Company values
these investments using the lower of cost or market method, and thus continues
to value them at their respective costs of $10.0 million, $5.0 million, $5.0
million and $2.0 million. If the price per share of these stocks were to
decline below the cost per share and such decline was considered to be other
than temporary, the Company would be required to write-down the value of these
investments. The Company is generally restricted from selling these shares for
at least one year from the date of purchase. The Company does not hedge against
equity price changes.
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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 Bay Networks equipment and software during 1999 with versions which do not
contain any material year 2000 deficiencies. 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.
Factors Affecting Operating Results
As described by the following factors, past financial performance should not
be considered a reliable indicator of future performance and investors should
not use historical trends to anticipate results or trends in future periods.
We Have a Limited Operating History and Expect Continuing Operating Losses
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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 2001. 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, $94.1 million for the year ended December 31, 1998 and
$78.9 million for the nine month period ended September 30, 1999. At September
30, 1999, we had an accumulated deficit of approximately $325.0 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 Factors Affecting Operating Results 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;
. 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;
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. 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,
26.8% of our revenue for the year ended December 31, 1998 and 26.5% of our
revenue for the nine month period ended September 30, 1999.
WebTV may terminate our current agreement at will after December 31, 2002.
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.
We are currently in the process of replacing or updating our operational,
financial and management information systems. The systems being replaced or
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 will be
consolidating two facilities in Southern California into one by the end 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 these transitions 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 608 employees and 96 independent contractors as of September 30,
1999. 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.
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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 four acquisitions to date, and have announced another
acquisition which is subject to certain closing conditions, 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.
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 2000. 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
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employees and Williams engineering expertise was integral to the development of
our network and continues 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
DSL services in limited areas. Our failure to introduce new enterprise service
offerings or the failure of these services to gain market acceptance in a timely
manner or at all, or the failure 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.
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
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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., Covad 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 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
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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;
. 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
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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.
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
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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. A modified version of the software was deployed in the network
in the first quarter of 1999. 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, 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 San Jose and Irvine, 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
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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 of Corporate Strategy and Business
Development. The loss of the services of Mr. Nothhaft or Mr. Peters could have a
material adverse effect on us. We have Executive Continuity Agreements with six
senior officers, including Mr. Nothhaft and Mr. Peters. These agreements provide
for compensation, certain expense reimbursement and continued option vesting for
these officers in the event of involuntary termination without cause or
constructive termination without cause within 18 months of a change of control.
We do not 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 September 30, 1999, our total debt (including current portion)
was $159.5 million, and stockholders' equity was $38.1 million. Interest on such
indebtedness totals approximately $19.1 million per year. We also issued 150,000
shares of preferred stock in June 1998 with dividends which accrue at the rate
of 13 1/2 % per year and 50,000 shares of preferred stock in June 1999 with
dividends which accrue at the rate of 7% per year. At September 30, 1999,
cumulative dividends and accretion on the preferred stock totaled approximately
$29.5 million. Dividends and accretion will total approximately $24.7 million in
1999 and are expected to grow in each successive year. To date, we have paid
such dividends in shares of preferred stock, rather than in cash. We must also
redeem both issuances of 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.
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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 will be sufficient
to meet our anticipated working capital and capital expenditure requirements
through September 2000. 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;
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. 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,
establishing 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. In
June 1999 we amended the agreement to release TMI's exclusive rights in all
territories but Italy, Spain and Austria. 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
developing versions of our products and marketing and distributing our products
internationally is limited. Our international strategy has not developed as
rapidly as anticipated and may be further delayed if:
. we cannot successfully develop satisfactory relationships with other
partners;
. we cannot successfully deploy our technology over our partners'
infrastructure;
. we cannot transfer our knowledge to our partners' employees; or
. our partners do 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. In September 1999 we reached an agreement to acquire ITG which
currently provides network services in the UK and Holland. We cannot assure you
that we will be able to successfully market, sell and deliver our products in
these markets.
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 one or more forms
of telecommunication regulation by the FCC or other regulatory agencies.
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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. One significant
example of the type of regulation some incumbent LECs would like to have the FCC
impose on IP-based services is typified by a recent Petition for Expedited
Declaratory Ruling filed by US West seeking an FCC ruling that IP-based
Telephony services provided over interexchange carrier networks not be
considered information services, but telecommunications services subject to
incumbent LEC-imposed interstate access charges. While the FCC has not taken
action to date on the US West Petition, its filing indicates that there are
telecommunications carriers anxious to reclassify exempt information services to
be regulated 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 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
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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 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. On February 1, 1999
a United States District Court preliminarily enjoined enforcement of the law
pending final resolution of the case.
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;
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. 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.
30
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
27.1 Financial data schedule
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K dated October 22, 1999 to
report under Item 5 the acquisition of substantially all of the assets of
9 Net Avenue, Inc. for approximately $51.8 million and the assumption of
approximately $9.9 million of liabilities.
31
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 15, 1999
CONCENTRIC NETWORK CORPORATION
By: /s/ Henry R. Nothhaft
------------------------------------------
Henry R. Nothhaft,
President, Chief Executive
Officer and Director
By: /s/ Michael F. Anthofer
------------------------------------------
Michael F. Anthofer,
Senior Vice President and
Chief Financial Officer
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 225,791 225,791
<SECURITIES> 70,396 70,396
<RECEIVABLES> 20,553 20,553
<ALLOWANCES> 864 864
<INVENTORY> 0 0
<CURRENT-ASSETS> 324,438 324,438
<PP&E> 134,452 134,452
<DEPRECIATION> 60,525 60,525
<TOTAL-ASSETS> 456,728 456,728
<CURRENT-LIABILITIES> 52,808 52,808
<BONDS> 0 0
212,595 212,595
0 0
<COMMON> 363,684 363,684
<OTHER-SE> (324,981) (324,981)
<TOTAL-LIABILITY-AND-EQUITY> 456,728 456,728
<SALES> 38,082 101,175
<TOTAL-REVENUES> 38,082 101,175
<CGS> 34,711 93,894
<TOTAL-COSTS> 56,255 153,896
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,920 7,775
<INCOME-PRETAX> (27,208) (78,926)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (27,208) (78,926)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (27,208) (78,926)
<EPS-BASIC> (.65) (2.03)
<EPS-DILUTED> (.65) (2.03)
</TABLE>
