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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 MARCH 31, 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)
DELAWARE 65-0257497
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
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 March 31, 1999, was 20,109,319.
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CONCENTRIC NETWORK CORPORATION
PART I-FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
- ----------- ------------------------------------------------------------------------------------------------ -------
Item 1. Financial Statements:
<S> <C> <C>
Condensed Consolidated Balance Sheets at March 31, 1999 and December 31, 1998................... 3
Condensed Consolidated Statements of Operations for the three month periods ended
March 31, 1999 and 1998......................................................................... 4
Condensed Consolidated Statements of Cash Flows for the three month periods ended
March 31, 1999 and 1998......................................................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements.................................. 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 8-27
PART II-OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 28
Item 2. Changes in Securities and Use of Proceeds....................................................... 28
Item 3. Defaults Upon Senior Securities................................................................. 28
Item 4. Submission of Matters to a Vote of Security Holders............................................. 28
Item 5. Other Information............................................................................... 28
Item 6. Exhibits and Reports on Form 8-K................................................................ 29
Signatures. 30
</TABLE>
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PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
(Unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents........................................................ $ 225,661 $ 98,988
Short term investments........................................................... 48,272 52,226
Current portion of restricted cash............................................... 19,125 19,125
Accounts receivable, net......................................................... 12,369 13,714
Other current assets............................................................. 4,178 3,058
--------- ---------
Total current assets........................................................... 309,605 187,111
Property and equipment, net....................................................... 69,209 64,268
Restricted cash, net of current portion........................................... 17,610 17,113
Goodwill and other intangible assets.............................................. 18,973 20,364
Other assets...................................................................... 18,942 9,401
--------- ---------
Total assets...................................................................... $ 434,339 $ 298,257
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................................................. $ 23,950 $ 26,342
Accrued compensation and other employee benefits................................. 2,208 2,024
Other current liabilities........................................................ 10,014 4,559
Current portion of capital lease obligations..................................... 6,256 6,543
Deferred revenue................................................................. 3,441 3,104
--------- ---------
Total current liabilities...................................................... 45,869 42,572
Capital lease obligations, net of current portion................................. 9,546 10,434
Notes payable..................................................................... 146,132 146,021
Commitments
Redeemable exchangeable preferred stock........................................... 161,658 156,105
Stockholders' equity (deficit):
Common stock..................................................................... 343,492 190,076
Accumulated deficit.............................................................. (271,555) (246,055)
Deferred compensation............................................................ (803) (896)
--------- ---------
Total stockholders' equity (deficit).............................................. 71,134 (56,875)
--------- ---------
Total liabilities and stockholders' equity (deficit).............................. $ 434,339 $ 298,257
========= =========
</TABLE>
See accompanying notes.
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CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
Revenue.............................................................................. $ 30,066 $ 16,484
Costs and expenses:
Cost of revenue..................................................................... 28,263 17,724
Development......................................................................... 2,645 1,507
Marketing and sales................................................................. 11,173 8,494
General and administrative.......................................................... 3,321 1,852
Amortization of goodwill and other intangible assets................................ 1,391 506
Write off of in-process technology.................................................. - 5,200
-------- --------
Total costs and expenses............................................................. 46,793 35,283
-------- --------
Loss from operations................................................................. (16,727) (18,799)
Net interest expense and other....................................................... 3,220 4,470
-------- --------
Loss before extraordinary item....................................................... (19,947) (23,269)
Extraordinary gain on early retirement of debt....................................... - 3,042
-------- --------
Net loss............................................................................. (19,947) (20,227)
Preferred stock dividends and accretion.............................................. (5,553) -
-------- --------
Net loss attributable to common stockholders......................................... $(25,500) $(20,227)
======== ========
Net loss per share:
Loss before extraordinary item...................................................... $ (1.17) $ (1.64)
Extraordinary gain.................................................................. - 0.21
-------- --------
Net loss............................................................................ (1.17) (1.43)
Preferred stock dividends and accretion............................................. (.32) -
-------- --------
Net loss per share attributable to common stockholders.............................. $ (1.49) $ (1.43)
======== ========
Shares used in computing net loss and net loss per share attributable to common 17,091 14,157
stockholders........................................................................ ======== ========
</TABLE>
See accompanying notes.
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CONCENTRIC NETWORK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating Activities
Net loss................................................................................................ $(25,500) $(20,227)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation........................................................................................... 6,266 5,282
Amortization of deferred interest, cost of revenue and marketing and sales related to issuance
of warrants........................................................................................... 424 304
Amortization of goodwill and other intangible assets................................................... 1,391 506
Amortization of deferred interest related to Senior Notes.............................................. 134 127
Amortization of other deferred assets.................................................................. 488 451
Amortization of deferred compensation.................................................................. 93 93
Preferred stock dividends and accretion................................................................ 5,553 -
Gain on retirement of debt............................................................................. - (3,042)
Write-off of in-process technology..................................................................... - 5,200
Changes in current assets and liabilities:
Accounts receivable.................................................................................... 1,345 (475)
Other current assets................................................................................... (335) (81)
Prepaid expenses....................................................................................... (1,055) (16)
Accounts payable....................................................................................... (2,392) 93
Accrued compensation and other employee benefits....................................................... 184 (559)
Deferred revenue....................................................................................... 337 (66)
Other current liabilities.............................................................................. 5,454 3,995
-------- --------
Net cash used in operating activities................................................................... (7,613) (8,415)
Investing Activities
Additions of property and equipment..................................................................... (10,832) (1,543)
Net change in short term investments.................................................................... 3,954 -
Net change in long term investments..................................................................... (10,205) -
Cash investment in InterNex Information Services, Inc., net of cash acquired............................ - (15,452)
-------- --------
Net cash used in investing activities................................................................... (17,083) (16,995)
Financing Activities
Net change in restricted cash........................................................................... (497) (748)
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.......................................................................... (1,550) (504)
Proceeds from issuances of stock and warrants........................................................... 153,416 362
Deferred financing costs................................................................................ - (163)
-------- --------
Net cash provided by (used in) financing activities..................................................... 151,369 (30,842)
-------- --------
Increase (decrease) in cash and cash equivalents........................................................ 126,673 (56,252)
Cash and cash equivalents at beginning of period........................................................ 98,988 119,959
-------- --------
Cash and cash equivalents at end of period.............................................................. $225,661 $ 63,707
======== ========
Supplemental Disclosures Of Noncash Investing And Financing Activities
Capital lease obligations incurred with a related party................................................. $ -- $ 1,285
Capital lease obligations incurred...................................................................... $ 587 $ 19
Supplemental Disclosures Of Cash Flow Information
Interest paid........................................................................................... $ 365 $ 1,397
</TABLE>
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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 March 31, 1999 are not necessarily
indicative of results to be expected for the entire year ending December 31,
1999 or future operating periods.
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 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 906,679 shares. The warrant expires three years from the
date of issuance and is exercisable at $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 will be 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 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 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.
5. Equity Investment
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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.
6. Acquisition
On February 5, 1998, the Company acquired all of the outstanding stock
of InterNex Information Services, Inc. (InterNex). The transaction was accounted
for using the purchase method of accounting. The total purchase price of
approximately $23.9 million consisted of a $15.5 million cash payment upon
closing and the assumption of approximately $8.4 million of InterNex's
liabilities (including acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<S> <C>
Current and other assets.............................................................................................. $ 1,348
Computer and telecommunications equipment............................................................................. 4,784
Goodwill.............................................................................................................. 9,496
Other intangible assets............................................................................................... 3,080
Write-off of in process technology.................................................................................... 5,200
-------
Total purchase price allocation.................................................................................... $23,908
=======
</TABLE>
Goodwill 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.
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. 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.
9. Subsequent Events
Equity Investment.
In April 1999, the Company purchased approximately $5.0 million of
Series D-1 Preferred Stock from NorthPoint Communications Group, Inc.
Stock Split.
In March 1999, the Company announced that its Board of Directors had
approved a two-for-one stock split of its common stock. Stockholders will
receive one additional share for every share of Concentric common stock held on
the record date of April 30, 1999. These shares are expected to be payable after
market close on May 21, 1999, and accordingly, share and per share information
will not be retroactively restated until such date.
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<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" commencing on page 14. 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 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.
The Company may acquire other complementary products, 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 the first quarter of 2000.
The Company's ability to achieve profitability and positive cash flow from
operations is dependent upon the Company's ability to substantially grow its
revenue base and achieve other operating efficiencies. The
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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 $25.5 million for the three
months ended March 31, 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 $30.1 million for the three
month period ended March 31, 1999, a $13.6 million increase over revenue of
approximately $16.5 million for the three month period ended March 31, 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;
. continued growth in revenue derived from Internet access customers;
and
. revenues from InterNex, DeltaNet and AnaServe which were acquired in
1998.
The Company expects revenue growth from Internet access customers to
flatten over time. Revenue from WebTV declined to 30.1% of the Company's net
revenue for the three month period ended March 31, 1999 compared to 30.8% for
the three month period ended March 31, 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
equipment and amortization of related assets. Cost of revenue for the three
month period ended March 31, 1999 was approximately $28.3 million, an increase
of $10.6 million from cost of revenue of $17.7 million for the three month
period ended March 31, 1998. This increase is attributable to the overall growth
in the size of the network and costs
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associated with acquired operations. As a percentage of revenue, such costs
declined to 94.0% of revenue in the three month period ended March 31, 1999,
down from 107.5% 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 architecture. The Company expects its cost of
revenue to continue to increase in dollar amount, while declining as a
percentage of revenue as the Company expands its customer base. The foregoing
expectation is a forward looking statement that involves risks and uncertainties
and the actual results could vary materially as a result of a number of factors,
including those set forth under the captions "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 $1.5 million for the three month periods ended March 31, 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 8.8% for the three month period ended March
31, 1999 from 9.1% for the three month period ended March 31, 1998 as a result
of the Company's increased revenue. The Company expects its development spending
to continue to increase in dollar amount, but to decline as a percentage of
revenue. The foregoing expectation is a forward looking statement that involves
risks and uncertainties and the actual results could vary materially as a result
of a number of factors, including those set forth below under the captions
"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
$11.2 million for the three month period ended March 31, 1999 and $8.5 million
for the three month period ended March 31, 1998. The $2.7 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
37.2% for the three month period ended March 31, 1999 from 51.5% in the year
earlier period as a result of the Company's increased revenue. The Company
expects marketing and sales expenditures to continue to increase in dollar
amount, but to decline as a percentage of revenue. The foregoing expectation is
a forward looking statement that involves risks and uncertainties and the actual
results could vary materially as a result of a number of factors including those
set forth under the captions "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 $3.3 million for the three month period
ended March 31, 1999 and $1.9 million for the three month period ended March 31,
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 11.0% for the three month period ended March 31, 1999 from
11.2% in the year earlier period as a result of the Company's increased revenue.
The Company expects general and administrative expense to increase in dollar
amount, reflecting its growth in operations, but to decline as a percentage of
revenue. The foregoing expectation is a forward looking statement that involves
risks and uncertainties and the actual results could vary materially as a result
of a number of factors including those set forth under the captions "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 March 31, 1999 and March 31, 1998, respectively, the Company
recorded amortization of goodwill and other intangible assets of $1.4 million
and $500,000. The increase is primarily the result of the acquisition of
AnaServe in August 1998.
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Write-off of In-Process Technology. For the three month period ended
March 31, 1998, the Company wrote-off $5.2 million of in-process technology
related to the acquisition of InterNex.
Net Interest Expense. Net interest expense was approximately $3.2
million and $4.5 million for the three month periods ended March 31, 1999 and
1998, 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 months ended
March 31, 1999.
Extraordinary Gain. For the three month period ended March 31, 1998,
the Company realized an extraordinary gain of $3.0 million related to the early
retirement of debt in the form of capital lease obligations.
Preferred Stock Dividends and Accretions. For the three month period
ended March 31, 1999, the Company recorded dividend and stock accretion of $5.6
million related to the preferred stock issued in June 1998.
Net Loss Attributable to Common Stockholders. The Company's net loss
attributable to common stockholders increased to approximately $25.5 million for
the three month period ended March 31, 1999 as compared to approximately $20.2
million for the three month period ended March 31, 1998. For comparative
purposes, the net loss attributable to common stockholders for the three month
period ended March 31, 1999 included $5.6 million of dividends and accretion
related to the preferred stock issued in June 1998. The net loss attributable to
common stockholders for the three month period ended March 31, 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 three month periods
ended March 31, 1999 and 1998 was approximately $7.6 million and $8.4 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.
Net cash used in investing activities for the three month periods ended
March 31, 1999 and 1998 was approximately $17.1 million and $17.0 million,
respectively. Net cash used in investing activities for the three month period
ended March 31, 1999 consisted primarily of $10.0 million used for an equity
investment in Covad Communications, Inc. and $10.8 million used for purchases of
capital equipment to support the Company's expanded network infrastructure. In
the same period, approximately $4.0 million was received from the sale of short
term investments. For the three month period ended March 31, 1998, net cash used
in investing activities was primarily used for the InterNex acquisition of $15.5
million and $1.5 million for purchases of capital equipment.
For the three month period ended March 31, 1999, net cash of $151.4
million was provided from financing activities. Net proceeds from the public
stock offering in February 1999 was $119.4 million, $19.5 million was received
from the sale of stock to SBC and $14.5 million was from other stock issuances,
including the sale of stock to stockholders exercising warrants. For the three
month period ended March 31, 1998, net cash of approximately $30.8 million was
used in financing activities, of which $24.8 million was used for the early
retirement of capital lease obligations.
The net cash increase for the three month period ended March 31, 1999
was $126.7 million as compared to a net cash decrease for the three month period
ended March 31, 1998 of $56.3 million.
At March 31, 1999, the Company had cash and cash equivalents of
approximately $225.7 million, short term investments of $48.3 million,
restricted cash of $36.7 million and working capital of $263.7 million. The
Company expects to incur additional operating losses and will rely primarily on
its available cash resources to meet its anticipated
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cash needs for working capital and for the acquisition of capital equipment
through at least the end of 1999. However, we cannot assure you that the Company
will not require additional financing within this time frame. The Company's
forecast of the period of time through which its financial resources will be
adequate to support its operations is a forward-looking statement that involves
risks and uncertainties, and actual results could vary materially as a result of
a number of factors, including those set forth on under the caption "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.
In April 1999, the Company used approximately $5.0 million in cash to
purchase 340,908 shares of NorthPoint Communications Group Inc. Series D-1
Preferred Stock.
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 555,556 shares of the common stock of Covad. The
Company purchased these shares at the time of Covad's initial public offering in
January 1999 at a price of $18.00 per share. On May 11, 1999, the closing price
of Covad's common stock was $83.13 per share. The Company values this investment
using the lower of cost or market method, and thus continues to value this
investment at its cost of $10.0 million. If the price of Covad common stock were
to decline below $18.00 per share and such decline was considered to be other
than temporary, the Company would be required to write-down the value of this
investment. The Company is generally restricted from selling these shares for
at least one year from the date of 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 expects to complete the replacement of Bay Networks equipment
and software by the end of June 1999 with versions which do not contain any
material year 2000 deficiencies. The Company expects such modifications will be
made on a timely basis and does not believe that the cost of such modifications
will have a material effect on the Company's operating results. Additionally,
the Company is continuing to assess the year 2000 compliance of its products and
services. To date, most newly introduced products and services of the Company do
not contain material year 2000 deficiencies, however some of the Company's
customers are running earlier product versions that are not year 2000 compliant.
The Company has been encouraging such customers to migrate to current product
versions. The Company estimates that the capital and other costs associated with
the upgrade and conversion of its existing products, services and systems
relating to the year 2000 issue will not be material. The Company does not
separately track internal costs incurred to assess and remedy deficiencies
related to the year 2000 problem, however, such costs are principally the
payroll costs for its information systems group. The Company does not have and
is not developing a contingency plan in the event its systems fail as a result
of year 2000 related problems.
The Company's products, services and systems operate in complex network
environments and directly and indirectly interact with a number of other
hardware and software systems. The Company faces risks to the extent that
suppliers of products, services and systems purchased by the Company and others
with whom the Company transacts business on a worldwide basis, including those
which form significant portions of the Company's network and may be sole- or
limited-source suppliers, do not have business systems or products that comply
with year 2000 requirements. The Company has not received significant assurances
from its suppliers that their networks are year 2000 compliant. If these
networks fail, the Company's business will be significantly impacted.
The Company's expectation that it will be able to upgrade its products,
services and systems to address the year 2000 issue and its expectation
regarding the costs associated with these upgrades are forward-looking
statements subject to a number of risks and uncertainties. Actual results may
vary materially as a result of a number of factors. There can be no assurance
that the Company will be able to timely and successfully modify such products,
services and systems to comply with year 2000 requirements. Any failure to do so
could have a material adverse effect on the Company's operating results.
Furthermore, despite testing by the Company and its vendors, the Company's
products, services and systems may contain undetected errors or defects
associated with year 2000 date functions. In the event any material errors or
defects are not detected and fixed or third parties cannot timely provide the
Company with products, services or systems that meet the year 2000 requirements,
the Company's operating results could be
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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.
We were incorporated in 1991, commenced network operations in 1994 and
completed initial deployment of our current network architecture and use of an
advanced ATM backbone network in late 1996. Accordingly, we have a limited
operating history upon which an evaluation of our prospects can be based. Our
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in new and rapidly evolving markets. To
address these risks, we must, among other things:
. respond to competitive developments;
. continue to attract, retain and motivate qualified personnel;
and
. continue to upgrade our technologies and commercialize network
services incorporating such technologies.
We cannot assure you that we will be successful in addressing the risks
we face. The failure to do so could have a material adverse effect on our
business, financial condition and results of operations.
We have incurred net losses and experienced negative cash flow from
operations since inception. We expect to continue to operate at a net loss and
experience negative cash flow at least through 1999. Our ability to achieve
profitability and positive cash flow from operations is dependent upon our
ability to substantially grow our revenue base and achieve other operating
efficiencies. We experienced net losses attributable to common stockholders of
approximately $66.4 million for the year ended December 31, 1996, $55.6 million
for the year ended December 31, 1997, $94.1 million for the year ended December
31, 1998 and $25.5 million for the three month period ended March 31, 1999. At
March 31, 1999, we had an accumulated deficit of approximately $271.6 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;
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. the receipt of new value-added network services and consumer
services subscriptions;
. the introduction of new services by us and our competitors;
. the pricing and mix of services offered by us;
. our customer retention rate;
. market acceptance of new and enhanced versions of our services;
. changes in pricing policies by our competitors;
. our ability to obtain sufficient supplies of sole- or limited-
source components;
. user demand for network and Internet access services;
. balancing of network usage over a 24-hour period;
. the ability to manage potential growth and expansion;
. the ability to identify, acquire and successfully integrate
suitable acquisition candidates; and
. charges related to acquisitions.
Variations in the timing and amounts of revenues due to these actions
could have a material adverse effect on our quarterly operating results. Due to
the foregoing factors, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful. Such comparisons cannot be
relied upon as indicators of future performance. If our operating results in any
future period fall below the expectations of securities analysts and investors,
the market price of our securities would likely decline.
The Loss of Any of Our Major Customers Could Severely Impact Our Business.
We currently derive a substantial portion of our total revenue from
WebTV. Revenue from WebTV accounted for 10.1% of our revenue for the year ended
December 31, 1996, 33.4% of our revenue for the year ended December 31, 1997,
26.8% of our revenue for the year ended December 31, 1998 and 30.1% of our
revenue for the three month period ended March 31, 1999.
WebTV may terminate our current agreement at will after October 31,
2000. While we expect revenue from WebTV to decrease as a percentage of revenue
in future periods, we believe that revenue derived from a limited number of
customers may continue to represent a significant portion of our revenue. As a
result, the loss of one or more of our major customers could have a material
adverse effect on our business, financial condition and results of operations.
In addition, we cannot assure you that revenue from customers that have
accounted for significant revenue in past periods, individually or as a group,
will continue, or will reach or exceed historical levels in any future period.
Our Growth and Expansion May Strain Our Resources.
Our business and service offerings have grown rapidly since our
inception. The growth and expansion of our business and our service offerings
have placed, and are expected to continue to place, a significant strain on our
management, operational and financial resources. In addition, we recently
expanded and upgraded our network to use an ATM backbone. We plan to continue to
substantially expand our network in 1999 and future periods. To manage our
growth, we must, among other things:
. continue to implement and improve our operational, financial and
management information systems, including our billing, accounts
receivable and payable tracking, fixed assets and other
financial management systems;
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. 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
also consolidated our Silicon Valley operations in a new, larger facility in the
fourth quarter of 1998 and will transfer our remaining Silicon Valley data
centers to this facility during the first two quarters of 1999. Management of
the transition of our information systems and of the personnel and operational
equipment to the new facility is expected to place additional strain on our
resources. We cannot assure you that this transition will be completed
successfully or on a timely basis.
We cannot assure you that we will be able to expand our network or add
services at the rate or according to the schedule presently planned by us. We
had 96 employees and 47 independent contractors as of December 31, 1996, and
have grown to 516 employees and 67 independent contractors as of March 31, 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.
Our expanding customer base demands the rapid growth of our network
infrastructure and technical support resources. We may in the future experience
difficulties meeting the demand for our access services and technical support.
We cannot assure you that our technical support or other resources will be
sufficient to facilitate our growth. We are striving to increase total network
utilization and to optimize this utilization by targeting both business and
consumer users to balance the network's usage throughout a 24-hour period. There
will be additional demands on our customer support, sales and marketing
resources as we pursue this utilization strategy. If we fail to manage our
growth effectively, our business, financial condition and results of operations
could be materially adversely affected.
Our Acquisition Strategy Poses Several Risks.
We have completed three acquisitions to date and may seek to acquire
additional assets, technologies and businesses complementary to our operations.
The completed acquisitions are and any subsequent acquisitions would be
accompanied by the risks commonly encountered in such transactions. Such risks
include, among other things:
. difficulties integrating the operations and personnel of
acquired companies;
. the additional financial resources that may be needed to fund
the operations of acquired companies;
. the potential disruption of our business;
. our management's ability to maximize our financial and strategic
position by the incorporation of acquired technology or
businesses into our service offerings;
. the difficulty of maintaining uniform standards, controls,
procedures and policies;
. the potential loss of key employees of acquired companies;
. the impairment of relationships with employees and customers as
a result of changes in management; and
. the incurrence of significant expenses in consummating
acquisitions.
Any of the above risks could prevent us from realizing significant
benefits from our acquisitions. In addition, the issuance of our common stock in
acquisitions will dilute our stockholder interests in our company, while the use
of cash will deplete our cash reserves. Finally, if we are unable to account for
our acquisitions under the "pooling of interests" method of accounting, we may
incur significant, one-time write-offs and amortization charges. These write-
offs and charges could decrease our future earnings or increase our future
losses.
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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 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 a new line of DSL services in limited areas. The failure of these services
to gain market acceptance in a timely manner or at all, or the failure of the
DSL service in particular, to achieve significant market coverage could have a
material adverse effect on our business, financial condition and results of
operations. If we introduce new or enhanced services with reliability, quality
or compatibility problems, then market acceptance of such services could be
significantly delayed or hindered. Such problems or delays could adversely
affect our ability to attract new customers and subscribers.
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Our New or Enhanced Services May Have Errors or Defects.
Our services may contain undetected errors or defects when new services
or enhancements are first introduced. We cannot assure you that, despite testing
by us or our customers, errors will not be found in new services or enhancements
after commencement of commercial deployment. Such errors could result in:
. additional development costs;
. loss of, or delays in, market acceptance;
. diversion of technical and other resources from our other
development efforts; and
. the loss of customers and subscribers.
Any of these consequences could have a material adverse effect on our
business, financial condition and results of operations.
We Need to Balance Network Use to Provide Quality Service.
If we do not achieve balanced network utilization over a 24-hour period,
our network could become overburdened at certain periods during the day, which
could adversely affect our quality of service. Conversely, due to the high fixed
cost nature of our infrastructure, under-utilization of our network during
certain periods of the day could adversely affect our ability to provide cost-
efficient services at other times. Any failure to achieve balanced network
utilization could have a material adverse effect on our business, financial
condition and results of operations.
We Depend Upon Our Suppliers and Have Sole- and Limited-Sources of Supply
for Certain Products and Services.
We rely on other companies to supply certain key components of our
network infrastructure. These components include critical telecommunications
services and networking equipment, which, in the quantities and quality demanded
by us, are available only from sole- or limited-sources. AT&T Corp., MCI
WorldCom, Inc., PacWest Telecomm, Inc. and Williams are our primary providers of
data communications facilities and capacity. AT&T is currently the sole provider
of the frame relay backbone of our network. MCI WorldCom and Williams are
currently the providers of the ATM backbone of our network. We are also
dependent upon LECs to provide telecommunications services to us and our
customers. We experience delays from time to time in receiving
telecommunications services from these suppliers. We cannot assure you that we
will be able to obtain such services on the scale and within the time frames
required by us at an affordable cost, or at all. Any failure to obtain such
services on a sufficient scale, on a timely basis or at an affordable cost would
have a material adverse effect on our business, financial condition and results
of operations.
We purchase our Nortel/Bay, Cisco Systems, Netopia, Lucent Technologies,
Sun Microsystems and other vendor equipment either directly from the
manufacturer or via systems integrators including Milgo Solutions, Inc. and
Williams. Some of these vendors are sole-source suppliers. We purchase these
components pursuant to purchase orders placed from time to time with our
suppliers. We do not carry significant inventories of these components and have
no guaranteed supply arrangements for such components. Our suppliers also sell
products to our competitors and may in the future themselves become our
competitors. We cannot assure you that our suppliers will not enter into
exclusive arrangements with our competitors or stop selling their products or
components to us at commercially reasonable prices, or at all.
The expansion of our network infrastructure is placing, and will
continue to place, a significant demand on our suppliers. Some of these
suppliers have limited resources and production capacity. In addition, some of
our suppliers rely on sole-or limited-sources of supply for components included
in their products. Failure of our suppliers to meet increasing demand may
prevent them from continuing to supply components and products in the quantities
and quality and at the times required by us, or at all. Our inability to obtain
sufficient quantities of sole- or limited-source components or to develop
alternative sources, if required, could result in delays and increased costs in
expanding, and
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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 operatio ns.
Some of our suppliers, including the RBOCs and other LECs, currently are
subject to tariff controls and other price constraints that in the future may be
changed. In addition, regulatory proposals are pending that may affect what the
RBOCs and other LECs charge us. Any such regulatory changes could result in
increased prices of products and services, which could have a material adverse
effect on our business, financial condition and results of operations.
We Depend Upon Our Network Infrastructure.
Our success depends upon the capacity, reliability and security of our
network infrastructure. We currently derive a significant portion of our revenue
from customer subscriptions. We expect that a substantial portion of our future
revenue will be derived from the provision of tailored, value-added network
services to our enterprise customers. We must continue to expand and adapt our
network infrastructure as the number of users and the amount of information they
wish to transfer increase and as customer requirements change. We currently
project our network utilization will require rapid expansion of the network
capacity to avoid capacity constraints that would adversely affect system
performance. The expansion and adaptation of our network infrastructure will
require substantial financial, operational and management resources in 1999 and
future periods. We cannot assure you that we will be able to expand or adapt our
network infrastructure to meet additional demand or our customers' changing
requirements on a timely basis, at a commercially reasonable cost, or at all. In
addition, if demand for network usage were to increase faster than projected or
were to exceed our current forecasts, the network could experience capacity
constraints, which would adversely affect the performance of the system. Our
business, financial condition and results of operations could be materially
adversely affected if, for any reason, we fail to:
. expand our network infrastructure on a timely basis;
. adapt our network infrastructure to changing customer
requirements or evolving industry trends; or
. alleviate capacity constraints experienced by our network
infrastructure.
Currently, we have transit agreements with MCI WorldCom, Sprint and
UUNet and we have peering agreements with America Online, PSINet and other
network providers to support the exchange of traffic between our network and the
Internet. We also have public peering arrangements with multiple smaller
Internet service providers. These public peering arrangements also support the
exchange of traffic between our network and the Internet. The failure of the
networks with which we have public peering, private peering or private transit,
or the failure of any of our data centers, or any other link in the delivery
chain, or any inability to successfully integrate new network resources into our
existing infrastructure, and resulting interruption of our operations would have
a material adverse effect on our business, financial condition and results of
operations.
Our Market Is Extremely Competitive.
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry in this market, and we
expect that competition will intensify in the future. We believe that our
ability to compete successfully depends upon a number of factors, including:
. market presence;
. the capacity, reliability, low latency and security of our
network infrastructure;
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. technical expertise and functionality, performance and quality
of services;
. customization;
. ease of access to and navigation of the Internet;
. the pricing policies of our competitors and suppliers;
. the variety of services;
. the timing of introductions of new services by us and our
competitors;
. customer support;
. our ability to support industry standards; and
. industry and general economic trends.
Our competitors generally may be divided into four groups:
telecommunications companies, online service providers, Internet service
providers and Web hosting providers. Many of our competitors have greater market
presence, engineering and marketing capabilities, and financial, technological
and personnel resources than those available to us. As a result, they may be
able to develop and expand their communications and network infrastructures more
quickly, adapt more swiftly to new or emerging technologies and changes in
customer requirements, take advantage of acquisition and other opportunities
more readily, and devote greater resources to the marketing and sale of their
products and services than we can. In addition to the competitors discussed
above, various organizations have entered into or are forming joint ventures or
consortiums to provide services similar to those of our company.
We believe that new competitors will enter the value-added network
services market. Such new competitors could include large computer hardware,
software, media and other technology and telecommunications companies. Certain
telecommunications companies and online services providers are currently
offering or have announced plans to offer Internet or online services or to
expand their network services. Certain companies, including America Online, BBN,
PSINet and Verio, have also obtained or expanded their Internet access products
and services as a result of acquisitions. Such acquisitions may permit our
competitors to devote greater resources to the development and marketing of new
competitive products and services and the marketing of existing competitive
products and services. In addition, the ability of some of our competitors to
bundle other services and products with virtual private network services or
Internet access services could place us at a competitive disadvantage. Certain
companies are also exploring the possibility of providing or are currently
providing high-speed data services using alternative delivery methods such as
over the cable television infrastructure, through direct broadcast satellites
and over wireless cable.
As a result of increased competition and vertical and horizontal
integration in the industry, we could encounter significant pricing pressure.
This pricing pressure could result in significant reductions in the average
selling price of our services. For example, telecommunications companies that
compete with us may be able to provide customers with reduced communications
costs in connection with their Internet access services or private network
services, reducing the overall cost of their solutions and significantly
increasing price pressures on us. We cannot assure you that we will be able to
offset the effects of any such price reductions with an increase in the number
of our customers, higher revenue from enhanced services, cost reductions or
otherwise. In addition, we believe that the Internet access and online services
businesses are likely to encounter consolidation in the near future.
Consolidation could result in increased price and other competition in these
industries and, potentially, the virtual private networks industry. Increased
price or other competition could result in erosion of our market share and could
have a material adverse effect on our business, financial condition and results
of operations. We cannot assure you that we will have the financial resources,
technical expertise or marketing and support capabilities to continue to compete
successfully.
We Must Keep Up With Rapid Technological Change and Evolving Industry
Standards.
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The markets for our services are characterized by rapidly changing
technology, evolving industry standards, changes in customer needs, emerging
competition and frequent new product and service introductions. Our future
success will depend, in part, on our ability to:
. effectively use leading technologies;
. continue to develop our technical expertise;
. enhance our current networking services;
. develop new services that meet changing customer needs;
. advertise and market our services; and
. influence and respond to emerging industry standards and other
technological changes.
All this must be accomplished in a timely and cost-effective manner. We
cannot assure you that we will be successful in effectively using new
technologies, developing new services or enhancing our existing services on a
timely basis. We cannot assure you that such new technologies or enhancements
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense. We cannot assure you that we will
succeed in adapting our network service business to alternate access devices and
conduits as they emerge.
We believe that our ability to compete successfully is also dependent
upon the continued compatibility and interoperability of our services with
products and architectures offered by various vendors. Although we intend to
support emerging standards in the market for Internet access, we cannot assure
you that industry standards will be established. If industry standards are
established, we cannot assure you that we will be able to conform to these new
standards in a timely fashion and maintain a competitive position in the market.
Specifically, our services rely on the continued widespread commercial use of
TCP/IP. Alternative open protocol and proprietary protocol standards have been
or are being developed. If any of these alternative protocols become widely
adopted, there may be a reduction in the use of TCP/IP, which could render our
services obsolete and unmarketable. In addition, we cannot assure you that
services or technologies developed by others will not render our services or
technology uncompetitive or obsolete.
An integral part of our strategy is to design our network to meet the
requirements of emerging standards such as 56.6 Kbps modems and applications
such as IP-based interactive video and voice conferencing communications. Our
initial deployment of 56.6 Kbps modem technology was difficult for some of our
customers, including WebTV, due to compatibility problems between the software
and their modems. We had to remove the software from the network and modems to
fix the problem. 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
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<PAGE>
. 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, California. In addition, our modems and routers
that serve large areas of the United States are located in these cities. Our
network operations center, which manages the entire network, is in St. Louis,
Missouri. Despite our precautions, a natural disaster, such as an earthquake, or
other unanticipated problem at the network operations center, at one of our hubs
(sites at which we have located routers, switches and other computer equipment
that make up the backbone of our network infrastructure) or at a number of our
POPs has from time to time in the past caused, and in the future could cause,
interruptions in our services. In addition, our services could be interrupted if
our telecommunications providers fail to provide the data communications
capacity in the time frame required by us as a result of a natural disaster or
for some other reason. Any damage or failure that causes interruptions in our
operations could have a material adverse effect on our business, financial
condition and results of operations.
Our System May Experience Security Breaches.
Despite the implementation of network security measures, the core of our
network infrastructure is vulnerable to computer viruses, break-ins and similar
disruptive problems caused by our customers or Internet users. Computer viruses,
break-ins or other problems caused by third parties could lead to interruptions,
delays or cessation in service to our customers and subscribers. Furthermore,
inappropriate use of the network by third parties could also potentially
jeopardize the security of confidential information stored in our computer
systems and our customer's computer systems. We may face liability and may lose
potential subscribers as a result. Although we intend to continue to implement
industry-standard security measures, such measures occasionally have been
circumvented in the past. We cannot assure you that our security enclosures will
not be circumvented in the future. The costs and resources required to eliminate
computer viruses and alleviate other security problems may result in
interruptions, delays or cessation of service to our customers that could have a
material adverse effect our business, financial condition and results of
operations.
We Depend Upon Key Personnel and May be Unable to Timely Hire and Retain
Sufficient Numbers of Qualified Personnel.
Our success depends to a significant degree upon the continued
contributions of our executive management team, including Henry R. Nothhaft, the
Company's Chairman, President and Chief Executive Officer, and John K. Peters,
the Company's Executive Vice President and General Manager, Network Services
Applications Division. 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 five 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
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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 March 31, 1999, our total debt (including current portion) was
$161.9 million, and stockholders' equity was $71.1 million. Interest on such
indebtedness totals approximately $19.1 million per year. We also issued 150,000
shares of preferred stock in June 1998. Dividends accrue on the preferred stock
at the rate of 13/1//2% per year. At March 31, 1999, cumulative dividends and
accretion on the preferred stock totaled approximately $17.0 million. Dividends
and accretion will total approximately $23.0 million in 1999 and are expected to
grow in each successive year. To date, we have paid such dividends in shares of
preferred stock, rather than in cash. We must also redeem the preferred stock in
2010. As a result of these and other features, the preferred stock is
substantially equivalent to debt. Our debt, including the preferred stock, has
important consequences for our company and for you, including the following:
. our ability to obtain additional financing in the future,
whether for working capital, capital expenditures, acquisitions
or other purposes, may be impaired;
. a substantial portion of our cash flow from operations is
dedicated to the payment of interest on our debt, which reduces
the funds available to us for other purposes;
. our flexibility in planning for or reacting to changes in market
conditions may be limited; and
. we may be more vulnerable in the event of a downturn in our
business.
Our ability to meet our debt service and preferred stock dividend
obligations will depend on our future operating performance and financial
results. This ability will be subject in part to factors beyond our control.
Although we believe that our cash flow will be adequate to meet our interest and
dividend payments, we cannot assure you that we will continue to generate
sufficient cash flow in the future to meet our debt service and preferred stock
requirements. If we are unable to generate cash flow in the future sufficient to
cover our fixed charges and are unable to borrow sufficient funds from other
sources, then we may be required to:
. refinance all or a portion of our existing debt; or
. sell all or a portion of our assets.
We cannot assure you that a refinancing would be possible. We cannot
assure you that any asset sales would be timely or that the proceeds which we
could realize from such asset sales would be sufficient to meet our debt service
requirements. In addition, the terms of our debt and preferred stock restrict
our ability to sell our assets and our use of the proceeds from any such asset
sale.
We May Need Additional Capital in the Future and Such Additional
Financing May Not Be Available.
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated working capital and capital expenditure
requirements through 1999. However, we cannot assure you that such resources
will be sufficient for anticipated or unanticipated working capital and capital
expenditure requirements. We may need to raise additional funds through public
or private debt or equity financings in order to:
. take advantage of unanticipated opportunities, including more
rapid international expansion or acquisitions of complementary
businesses or technologies;
. develop new products or services; or
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<PAGE>
. respond to unanticipated competitive pressures.
We may also raise additional funds through public or private debt or
equity financings if such financings become available on favorable terms. We
cannot assure you that any additional financing we may need will be available on
terms favorable to us, or at all. If adequate funds are not available or are not
available on acceptable terms, we may not be able to take advantage of
unanticipated opportunities, develop new products or services or otherwise
respond to unanticipated competitive pressures. In such case, our business,
results of operations and financial condition could be materially adversely
affected. Our forecast of the period of time through which our financial
resources will be adequate to support our operations is a forward looking
statement that involves risks and uncertainties, and actual results could vary
materially as a result of a number of factors, including those set forth above.
We Face Risks Associated with International Expansion.
A key component of our strategy is to expand into international markets.
The following risks are inherent in doing business on an international level:
. unexpected changes in regulatory requirements;
. export restrictions;
. export controls relating to encryption technology;
. tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations;
. longer payment cycles;
. problems in collecting accounts receivable;
. political instability;
. fluctuations in currency exchange rates;
. seasonal reductions in business activity during the summer
months in Europe and certain other parts of the world; and
. potentially adverse tax consequences that could adversely impact
the success of our international operations.
We cannot assure you that one or more of such factors will not have a
material adverse effect on our future international operations and,
consequently, on our business, financial condition and results of operations.
We have an agreement with TMI Telemedia International, Ltd., a
subsidiary of the leading Italian telecommunications company, Telecom Italia,
SpA, to establish an international network based on our network technology and
expertise and TMI's existing telecommunications infrastructure. In exchange, we
granted TMI certain exclusive rights in critical markets, including Europe.
While the goal of this effort is to deliver a range of compatible network
services worldwide, to date we have had only limited deployment of services
under this agreement. Our experience in working with TMI to develop versions of
our products and to market and distribute our products internationally is
limited. Our international strategy has not developed as rapidly as anticipated
and may be further delayed if:
. we cannot successfully deploy our technology over TMI's
infrastructure;
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<PAGE>
. we cannot transfer our knowledge to TMI's employees; or
. TMI does not devote sufficient management, technological or
marketing resources to this project.
Our business, results of operation or financial condition could be
materially adversely affected if delays in our international strategy continue
or worsen.
We have entered into roaming agreements with third parties to allow our
customers to access their Internet accounts from Japan and certain other foreign
countries. We provide Web hosting and extranet services for GX Networks' United
Kingdom customers pursuant to an agreement signed in August 1998. We also
acquired Web hosting facilities in Stockholm, Sweden, Tokyo, Japan and Hong Kong
in February 1998 as a result of our acquisition of Internex. We cannot assure
you that we will be able to successfully market, sell and deliver our products
in these markets.
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.
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.
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<PAGE>
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 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
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<PAGE>
implement measures to reduce our exposure to such liability. Such measures may
require the expenditure of substantial resources or the discontinuation of
certain product or service offerings. Further, the costs of defending against
any such claims and potential adverse outcomes of such claims could have a
material adverse effect on our business, financial condition and results of
operations. The Child Online Protection Act of 1998 has been challenged by civil
rights organizations in part on the grounds that it violates the First
Amendment. A similar statute was held unconstitutional by the United States
Supreme Court in 1997. A United States District Court has temporarily enjoined
enforcement of the law until February 1, 1999 xxxxxxx , and it is possible that
additional injunctions prohibiting enforcement of the statute will be entered
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;
. 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.
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The shares of common stock and warrants issued to SBC Communications,
Inc. were issued in reliance on the exemption from registration under Section
4(2) the Securities Act of 1933, as amended (the "Act").
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In January 1999 SBC Communications Inc. purchased 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 906,679 shares. The warrant expires three years from the
date of issuance and is exercisable at $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 will be amortized as a marketing cost over the life of the
agreement.
In February 1999 the Company issued and sold its common stock in a
public offering 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
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 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. The shares of common stock issued upon
exercise of such warrants were issued in reliance on the exemption from
registration under section 4(2) of the Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on May 5, 1999 at which the
following matters were submitted to a vote of the stockholders:
1. An election was held with Gary E. Rieschel being elected to the
Board of Directors as a Class I director with 16,486,376 shares voting in favor
and 91,276 shares withheld. Vinod Khosla was elected to the Board of Directors
as a Class II director with 16,542,622 shares voting in favor and 35,032 shares
withheld.
2. A proposal to amend the Company's 1997 Stock Plan to increase the
number of shares available for issuance thereunder by 1,000,000 shares to an
aggregate of 3,250,000 shares was approved with 9,531,135 shares voting for,
4,509,952 shares voting against, 7,478 shares abstaining and 2,529,089 broker
non-votes.
3. A proposal to amend the Company's 1997 Stock Plan to provide for an
annual increase in the number of shares reserved for issuance thereunder equal
to the lesser of (i) 1,000,000 shares, (ii) 4% of the outstanding shares of
common stock of the Company or (iii) a number of shares determined by the Board
of Directors was approved with 9,057,306 shares voting in favor, 4,979,878
shares voting against, 11,381 shares abstaining and 2,529,089 broker non-votes.
4. A proposal to ratify the appointment of Ernst & Young LLP as
independent auditors for the Company for the fiscal year ending December 31,
1999 was approved with 16,521,043 shares voting in favor, 52,786 shares voting
against and 3,825 shares abstaining.
ITEM 5. OTHER INFORMATION
In the Company's Proxy Statement for the Annual Meeting of Stockholders
held on May 5, 1999, the Company incorrectly stated the date by which
stockholders must submit proposals for the Company's Annual Meeting of
Stockholders in 2000. Proposals for stockholders intended to be presented at
the next Annual Meeting of Stockholders of the Company (i) must be received by
the Company at 1400 Parkmoor Avenue, San Jose, California 95126 not later than
December 7, 1999 and (ii) must satisfy the conditions established by the
Securities and Exchange Commission for stockholder proposals to be included in
the Company's Proxy Statement for that meeting. If a stockholder intends to
submit a proposal at the Company's 2000 annual Meeting of Stockholders which is
not submitted in time to be eligible for inclusion in the Proxy Statement
relating to that meeting, the stockholder must give notice to the Company not
less than 60 days nor more than 90 days prior to the meeting in accordance with
the requirements set forth in the Securities Exchange Act of 1934, as amended,
(the "Exchange Act") and the Company's bylaws. If such a stockholder fails to
comply with the foregoing notice provisions, the proposal may not be brought
before the meeting.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 27.1 Financial data schedule.
(b) Reports on Form 8-K.
Not applicable.
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<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: May 17, 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
-30-
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