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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended: December 31, 1998
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: 0-22575
CONCENTRIC NETWORK CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 65-0257497
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1400 Parkmoor Avenue, San Jose, CA 95126-3429
(Address of principal executive (zip code)
office)
Registrant's telephone number, including area code: (408) 817-2800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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 filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on
January 25, 1999 as reported on the National Market of The Nasdaq Stock
Market, was approximately $324,049,633.50. Shares of Common Stock held by each
officer and director and by each person who owns 5% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. As of January 25, 1999,
registrant had outstanding 15,144,310 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form 10-
K portions of its Proxy Statement for Registrant's Annual Meeting of
Stockholders to be held May 19, 1999.
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The Business 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 section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Factors Affecting Operating Results" commencing on page 32.
PART I
Item 1. Business
BUSINESS
Concentric provides tailored, value-added IP-based network services for
enterprises and consumers. To provide these services, the Company utilizes its
low/fixed latency, high-throughput network, employing its advanced network
architecture and the Internet. Concentric's service offerings for enterprises
include VPNs, DAFs, DSL, remote access and Web hosting. These services enable
enterprises to take advantage of standard Internet tools such as browsers and
high-performance servers for customized data communications within an
enterprise and between an enterprise and its suppliers, partners and
customers. These services combine the cost advantages, nationwide access and
standard protocols of public networks with the customization, high
performance, reliability and security of private networks. Among the current
enterprise customers are Intuit, SBC, Teligent and WebTV. Concentric's service
offerings for consumers and small office/home office customers include local
Internet dial-up access, DSL and applications hosting.
The Company was incorporated in Florida in 1991 under the name Engineered
Video Concepts, Inc., changed its name to Concentric Research Corporation in
1992 and commenced network operations in 1994. In 1995, the Company changed
its name to Concentric Network Corporation and reincorporated into Delaware in
1997.
Industry Background
Development of Private Networks
Historically, the data communications services offered by public carriers
had limited security features, were expensive and did not adequately ensure
accurate and reliable transmission. As a result, many corporations established
and maintained their own private WANs to provide network-based services, such
as transaction processing, to their customers and to coordinate operations
between employees, suppliers and business partners. Such private WANs were
frequently customized to specific applications, business practices and user
communities. As a result, these private WANs had the capability of providing
organizations and users with tailored performance and features, security,
reliability and private-label branding.
The demand for WANs has grown as a result of today's competitive business
environment. Factors stimulating the higher demand include the need to provide
broader and more responsive customer service, to operate faster and more
effectively between operating units, suppliers and other business partners,
and the need to take advantage of new business opportunities for network-based
offerings in a timely fashion. In addition, as businesses become more global
in nature, the ability to access business information across the enterprise
has become a competitive necessity.
Despite the attractive capabilities of private networks, limitations of
many private WANs have impeded or reduced the effectiveness of their use.
These networks, which traditionally have required the use of leased telephone
lines with bandwidth dedicated solely to this purpose and the purchase of
vendor-specific networking equipment, are inherently expensive to set up,
operate and maintain. Private WANs often require the development and
maintenance of proprietary software and lack cost-effective access. These
aspects of developing, deploying and maintaining such private WANs have
conflicted with the increased focus of many businesses on their core
competencies, which has prompted the outsourcing of many non-core functions.
The Company believes that many businesses have viewed as unacceptable the
costs of maintaining a private WAN infrastructure and the risks of investing
in new technologies in the absence of a single technological standard.
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Emergence of the Internet
The emergence of the Internet and the widespread adoption of IP as a data
transmission standard in the 1990s, combined with deregulation of the
telecommunications industry and advances in telecommunications technology have
significantly increased the attractiveness of providing data communication
applications and services over public networks. At the same time, growth in
client/server computing, multimedia personal computers and online computing
services and the proliferation of networking technologies have resulted in a
large and growing group of people who are accustomed to using networked
computers for a variety of purposes, including email, electronic file
transfers, online computing and electronic financial transactions. These
trends have led businesses increasingly to explore opportunities to provide
IP-based applications and services within their organization, and to customers
and business partners outside the enterprise.
Need for IP-Based Private Networks
The ubiquitous nature and relatively low cost of the Internet have resulted
in its widespread usage for certain applications, most notably Web access and
email. However, usage of the Internet for mission-critical business
applications has been impeded by the limited security and unreliable
performance inherent in the structure and management of the Internet. On the
Internet, latency is frequently relatively high and variable, making it sub-
optimal for these emerging applications. Although private networks are capable
of offering lower and more stable latency levels, providers of these emerging
applications also desire a network that will offer their customers full access
to the Internet. As a result, these businesses and applications providers
require a network that combines the best features of the Internet, such as
openness, ease of access and low cost made possible by the IP standard, with
the advantages of a private network, such as high security, low/fixed latency
and customized features.
Industry analysts expect the market size for both value-added IP data
networking services and Internet access to grow rapidly as businesses and
consumers increase their use of the Internet, intranets and privately managed
IP networks. According to industry analyst Forrester Research, Inc., the total
market for these services is projected to grow from $6.2 billion in 1997 to
approximately $49.7 billion in the year 2002, with approximately $27.9 billion
in the enterprise market segment and $21.8 billion in the consumer market
segment.
The Concentric Solution
Concentric provides tailored, value-added IP-based network services for
businesses and consumers using a low/fixed latency, high-throughput network.
Concentric allows enterprises to create virtual private networks providing
tailored network access, content and services to enterprise-defined end users
with higher reliability and more security than is available over the Internet.
Concentric's VPN solutions also provide the ease of access and flexibility of
public networks at a lower cost than private WANs without sacrificing
reliability or security.
The Concentric network employs an advanced, geographically dispersed ATM
and frame relay backbone, SuperPOPs in 19 major metropolitan areas and 143
secondary and tertiary POPs in other cities. The Company's architecture allows
most customers in the U.S. and Canada to access its network through a local
telephone call. In addition to dial-up access, the Company provides frame
relay, DSL, fractional T-1, T-1 and DS3 access to the network. The Concentric
network is engineered and managed to provide superior quality of service,
balancing several key performance criteria. The Company provides guaranteed
levels of service for dedicated access facilities to enterprise customers, and
targets performance benchmarks for connection success rates, latency levels
and throughput for all of its service offerings.
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Business Strategy
The Company's objective is to become the leading supplier of value-added,
IP-based network services worldwide. In order to achieve this goal, the
Company is implementing a business strategy focused on the following key
principles:
Rapidly Provide Cost-Effective, Tailored Network Solutions. The Company
intends to capitalize on its expertise in developing tailored VPNs to
establish a leadership position in rapidly developing, deploying and
maintaining a range of value-added network services to meet the specific needs
of its customers. The Company utilizes a set of software and hardware
technology modules as "building blocks" to offer a variety of tailored network
services on an IP-based network architecture with minimal additional
investment in engineering and rapid time to market for businesses and
consumers. These building blocks include modules for client and system
software, dedicated and remote network connectivity, tracking and billing, Web
hosting, customer support and security.
Optimize Network Utilization. Given the fixed cost nature of Concentric's
network infrastructure, the Company strives to increase total network
utilization and to optimize this utilization by targeting both daytime
business and evening-intensive consumer users to balance the network's usage
throughout a 24-hour period. Accordingly, while the Company's current
strategic focus is on providing value-added IP-based communications services
to enterprises, the Company intends to continue partnering with multi-channel
distributors to acquire and maintain a base of consumer subscribers who access
the Concentric network predominantly during non-business hours.
Acquire Complementary Assets, Technologies and Businesses. The Company is
actively seeking to identify and acquire assets, technologies and businesses
complementary to the Company's value-added enterprise network service
strategy. Such acquisition efforts are targeted at businesses that offer the
potential to expand the Company's revenue base, increase the scalability of
the Company's network infrastructure and value-added service offerings, as
well as optimize the utilization of the Company's network. As part of this
strategy, the Company completed three acquisitions in 1998. The Company
acquired InterNex, a Tier 1 provider of network services, colocation service
and Web-hosting facilities to enterprise customers, in February 1998. The
Company acquired Deltanet, a provider of network services, colocation and
managed dedicated hosting services, in May 1998. The Company acquired
AnaServe, a provider of shared hosting and managed dedicated hosting services,
in August 1998.
Employ Leveraged Marketing Through Strategic Partners. The Company actively
seeks to form alliances with certain software developers and
telecommunications service and equipment suppliers that have substantially
greater marketing, distribution and sales resources than does the Company and
that have a large installed customer base. These alliances facilitate the
cost-effective acquisition of consumer and business customers and increase
Concentric's network utilization. These marketing relationships are developed
and enhanced through the bundling of Concentric's IP-based network services
with the products and services offered by the strategic partners. These
relationships may involve customized browsers, registration services and
specialized pricing, commissions and billing programs. To date, Concentric has
established such strategic relationships with a number of companies, including
WebTV, SBC, Williams, Covad, Teligent, Intuit, Nortel/Bay Networks, Inc. and
TMI.
Deploy Network Services Internationally. The Company believes that its
enterprise customers increasingly will require their network solutions
providers to offer network services on a global basis. To date, the Company
has launched the following initiatives to provide global solutions to its
customers:
Mondonet. Pursuant to an agreement with TMI, entered into in August
1996, the Company is working to establish an international network based on
Concentric's network technology and expertise and TMI's existing
telecommunications infrastructure. The goal is to deliver a range of
compatible network services worldwide. TMI currently has a
telecommunications network deployed in 40 countries worldwide. In April
1998, the Company and TMI launched Mondonet, the first international
network designed and built expressly to support VPN services with coverage
in more than 30 cities in 24 countries.
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Roaming Services in Japan. The Company entered into a roaming services
agreement in June 1997 with NTT PC, a leading provider of IP services in
Japan. The roaming services agreement allows Concentric customers to use
the NTT PC network to access their Internet accounts in Japan and allows
members of the NTT PC network to access their Internet accounts in the
United States and Canada.
GRIC Roaming Alliance. The Company executed a roaming services agreement
with GRIC International in October 1998. GRIC International is an alliance
of 400 ISPs and telecommunication companies that together form a worldwide
network of 2,700 POPs. The GRIC International alliance allows the Company's
customers to access the Internet through these worldwide POPs while
traveling outside of the United States.
Hosting Services in the United Kingdom. The Company entered into a
strategic agreement with GX Networks, one of the largest ISPs located in
the United Kingdom, in August 1998. The agreement allows GX Networks and
the Company to expand Web hosting and extranet services for each other's
customers. Through this agreement, the Company can serve the networking
needs of its domestic United States customers based in the United Kingdom.
Global Web Hosting Facilities. The Company acquired Web hosting
facilities in Stockholm, Sweden, Tokyo, Japan and Hong Kong in February
1998 as part of the acquisition of InterNex.
While the Company does not expect to generate significant revenue from
deployment of international network services until at least the year 2000, the
Company believes that the ability to deliver network solutions globally will
be a key competitive factor in its industry. The foregoing expectation is a
forward-looking statement that involves risks and uncertainties and the actual
results could vary materially as a result of a number of factors including
those set forth in "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Operating Results--We
Face Risks Associated with International Expansion."
Services
Concentric provides tailored, value-added IP-based network services for
businesses and consumers. To provide these services, the Company employs a
low/fixed latency high-throughput network based on an advanced, geographically
dispersed ATM and frame relay backbone and the Internet.
Enterprise Solutions
The Company has developed a set of enterprise services including VPNs,
dedicated access facilities, digital subscriber line services, wireless access
services and applications hosting services. These services are marketed to
Concentric's enterprise customers.
Virtual Private Network Services. Concentric's custom VPN solutions enable
its customers to deploy tailored, IP-based mission-critical business
applications for internal enterprise, business-to-business and business-to-
customer data communications on the Concentric network while also affording
high-speed access to the Internet. Concentric offers its customers a secure
network on which to communicate and access information between an
organization's geographically dispersed locations; collaborate with external
groups or individuals, including customers, suppliers, and other business
partners and use the Web to access information on the Internet and communicate
with other Web users.
The Company's VPN solutions allow the enterprise customer to tailor the
type of access, services and information that various users of the VPN are
afforded according to the specific needs of the enterprise. Key benefits
include rapid implementation time, lower operating and maintenance costs,
minimal capital investment, higher quality of service overall and 24-hour
network and customer support. For example, starting in October 1995 the
Company created and now maintains the VPN used by Intuit customers using a
customized version of the Netscape Navigator browser bundled with Quicken for
Windows and Macintosh, Quickbooks, ProTax and TurboTax/MacInTax. The bundled
software allows a Quicken customer to click on an icon that launches Netscape,
and takes the user directly to Quicken Financial Network Website. On the Web
page Quicken customers will find useful financial advice, information from
Intuit's bank and financial institution partners, answers to commonly asked
technical questions and tips on how to tap the full potential of Intuit's
financial products.
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In addition to the custom VPNs that Concentric has developed and delivered,
the following three distinct VPN products are now offered by the Company:
Concentric CustomLink. Concentric CustomLink provides a complete,
private-labeled dial-up VPN service for customers. In addition, CustomLink
permits the customer to segment its users, and apply various levels of
services, such as Web access, email, and file transfer protocol to each
customer group. CustomLink includes dial-up network access, customized and
customer-branded client software, and private labeled help desk services.
The dial-up network access offerings include local access, toll-free
access, and a unique connection service, PremierConnect, which provides
such subscribers with connectivity to the VPN, even if local access numbers
are busy.
Enterprise VPN. The Company's Enterprise VPN service includes security
hardware and software, high speed network access, network connectivity,
customer premise routing equipment and customer support services. The
Enterprise VPN service is targeted at customers seeking to create a secure,
outsourced WAN for intranet and extranet applications. Installation support
for the customer premise located routing and security equipment is also
provided. Concentric can also provide management services for firewall and
packet encryption equipment if desired by the customer.
Concentric RemoteLink. The Company's remote access service is targeted
at businesses that have employees in remote locations. RemoteLink offers
customers the potential to significantly reduce the high costs of
telecommunications charges and user support associated with building,
deploying, and maintaining an internal remote access infrastructure.
RemoteLink enables an enterprise's salespeople and other mobile employees,
telecommuters and business partners to dial into an enterprise's corporate
network resources and use them as if they were connected locally, thus
increasing potential productivity and allowing for information to be
available on a real-time basis across the enterprise. Concentric's
RemoteLink is designed to be highly customizable and provides the ability
to interface with existing company network infrastructure.
Concentric performs around-the-clock monitoring of network performance.
Concentric also enables its customers to monitor their network through the
Company's proprietary ConcentricView software. ConcentricView is a Web-based
network management tool which allows a customer to monitor usage on a call-by-
call basis and performance of that portion of the Concentric network bandwidth
supporting the customer's applications.
Dedicated Access Facilities. In January 1997, the Company began offering
DAFs as a stand-alone product targeted at businesses that desire single or
multipoint high-speed, dial-up and/or dedicated connections to distributed
locations such as regional offices, warehouses, manufacturing facilities
and/or to the Internet. DAF products are primarily targeted at providing
intranet connectivity among distributed enterprise locations with the
additional benefit of Internet access if desired by the customer. The Company
provides a full range of connectivity options, allowing the customer to order
the appropriate amount of bandwidth to meet its networking requirements. In
addition, Concentric offers its DAF customers a guarantee on the quality of
service and performance of these facilities. Furthermore, Concentric believes
it is the only network service provider to bill customers based on average
usage levels rather than peak usage levels.
Concentric has six offerings in its dedicated access product line:
FullChannel T-1, FullChannel T-1 Protected, FlexChannel and LECFrame Relay, as
well as FullChannel and FlexChannel offerings at DS3 bandwidth options which
support up to 45 Mbps. The Company has begun working with key customers to
support even higher speeds up to OC3 (155 Mbps).
FullChannel T-1 and DS3 pricing is based on a one time set-up fee and
average utilization pricing. The customer's usage is measured at five-minute
intervals throughout the month, and the average of all of those measurements
is used to determine the customer's bill at the end of the month. The one time
set-up fee for FullChannel T-1 service is $3,000 and the monthly fee ranges
from $1,095 to $2,695 depending on usage. The one time set-up fee for
FullChannel DS3 service is $5,000 and the monthly fee ranges from $6,000 to
$40,500 depending on usage. FullChannel T-1 and DS3 pricing is the appropriate
choice for those customers who have fluctuating and/or uncertain bandwidth
consumption patterns.
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FullChannel T-1 Protected gives a customer a fixed price for a full 1.5
megabits of bandwidth. The one time set-up fee is $3,000 and the monthly fee
is set at $2,095. This is an economical choice for those customers who
recognize in advance that their bandwidth throughput requirements will equal
T-1 levels.
FlexChannel gives a customer the opportunity to purchase a fractional
portion of a T-1 or DS3 for a fixed monthly fee. The set up fee is the same as
for FullChannel pricing but the monthly fee ranges from $895 to $1,895 for
FlexChannel T-1 service and from $5,900 to $40,500 for FlexChannel DS3
pricing. FlexChannel T-1 and DS3 pricing is the appropriate choice for the
customers who know that their bandwidth requirements are going to be
consistently less than a full T-1 or DS3.
LECFrame Relay is based on various LECs' Frame Relay facilities. Although
Concentric does not offer service level guarantees over LECFrame Relay,
Concentric does guarantee the committed information rate. This offering gives
a lower cost, lower performance network service for those customers for whom
performance is less imperative. Concentric charges a one time set-up fee of
$2,000 LECFrame Relay services and monthly fees ranging from $395 to $1,195
depending on usage.
Digital Subscriber Lines. In December 1997, Concentric began offering
Internet and intranet connectivity using DSL technology. DSL and its variants
are a new dedicated access technology being deployed by telephone companies
that allow high speed digital service over regular telephone lines. To expand
its DSL service area, the Company has formed relationships with a number of
CLECs, including Covad Communications Group, Inc. and NorthPoint
Communications, Inc., as well as SBC's California subsidiary, Pacific Bell.
Concentric's DSL service offerings are currently available in the following
geographical markets: the San Francisco Bay Area, Los Angeles, San Diego,
Boston, New York, Washington, D.C., and Chicago. Several additional markets
are planned during 1999. The Company's DSL service offerings include a wide
range of dedicated access speeds, from 144 Kbps to 1.5 Mbps symmetric DSL, as
well as 1.5 Mbps/384 Kbps asymmetric DSL.
Concentric DSL services are targeted at the small-to-medium sized business,
telecommuter and consumer markets. The "dedicated access feature" of DSL
services combined with its high speed and low flat rate pricing are designed
to appeal to the large installed base of ISDN users. Pricing for the service
is low relative to traditional dedicated access services, making it attractive
to medium sized businesses, while at the same time broadening the market to
reach small businesses who previously could not justify the expense of
dedicated Internet service.
Pricing is based on the bandwidth of the DSL circuit, and is a flat rate
monthly fee ranging from $149 to $499 depending on the service speed.
Concentric provides complete installation services including all the customer
premise equipment necessary to provide the DSL service at fees ranging from
$325 to $725.
Wireless Access Services. In October 1998, the Company introduced
ConcentricWireless as an alternative to traditional access lines, particularly
in areas where DSL is not yet available. ConcentricWireless has a unique
distribution system that provides sustained speeds up to 1.5 Mbps and is
priced competitively with ISDN and DSL services and significantly lower than
T-1 services. At speeds ranging from 512 Kbps to 1.5 Mbps, ConcentricWireless
provides high-speed personal Internet connectivity for the small business,
small office/home office or telecommuting consumer. ConcentricWireless is
currently available in the greater San Francisco Bay Area at prices ranging
from $150 per month for 384 Kbps symmetric to $450 per month for 1.5 Mbps/152
Kbps.
Applications Hosting Services. The Company offers a range of high-
performance applications hosting services, including Concentric Server
Solutions, a suite of sophisticated high-end hosting and Web site traffic
management solutions for Internet-centric businesses, and ConcentricHost, a
suite of Web hosting, e-commerce, and streamed media services designed for
small to medium-sized businesses. The Company's other applications hosting
services include a private-label version of ConcentricHost and a Windows NT-
based hosting solution. The high performance of the Company's applications
hosting services is enabled by Concentric's network architecture and its
combination of public and private peering arrangements.
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Together, these applications hosting services manage a company's Web-based
infrastructure and operational needs allowing customers to focus on their Web-
based content. By outsourcing its Web hosting to Concentric, an enterprise can
increase the reliability and performance of its Web applications and reduce
its costs by taking advantage of Concentric's high quality data centers with
back-up power, multiple high bandwidth network connections and Tier 1 Internet
peering arrangements. In addition to state-of-the-art hosting facilities,
Concentric provides server management tools and services to completely manage
customers' servers for them.
For reliable, high performance flow of traffic between customer's Web
servers and worldwide networks, Concentric has combined public peering and
private peering arrangements to provide improved performance to users.
Concentric currently operates data centers in Santa Clara, Cupertino, and Los
Angeles, California, Chicago, Illinois and Washington, DC. A new 10,000 square
foot data center in San Jose is scheduled to open in February 1999. Each
Concentric data center is connected via multiple DS3 (45 Mbps) or OC3 (155
Mbps) high-speed links to geographically dispersed points in its private ATM
backbone as well as to key public and private Internet exchange points. This
architecture provides diversity and redundancy and high performance to
customers while minimizing user costs. See"--The Concentric Network."
Concentric Server Solutions. In February 1998, Concentric announced the
availability of Concentric Server Solutions, a line of Web hosting services
designed for companies who require outsourced maintenance, management,
bandwidth and housing for their Internet or extranet Web servers. Unlike
colocation services that simply provide rack space in a data center and
bandwidth, Concentric Server Solutions provide high-performance Internet
access from state-of-the-art data centers, skilled technicians and systems
administrators, maintenance programs that monitor servers 24 hours a day,
seven days a week, and scalability to address the needs of companies as their
businesses become increasingly reliant on the Web. The Company recently
announced the following two enhancements to Concentric Server Solutions:
Distributed Server Environment. In September 1998, Concentric launched
the Distributed Server Environment ("DSE") platform designed to manage
distributed applications for content, media and Web-centric businesses.
These businesses typically require high availability, fault tolerance and
scalability for distributed hosted sites. DSE offers local and global load
balancing and fail-over services. Load balancing allows for the intelligent
distribution of user requests over multiple server resources to avoid
transmission congestion and bottlenecks among Web servers.
Concentric Peak Protection. In December 1998, the Company introduced
Concentric Peak Protection which offers "capacity on demand" or "peak
insurance" for customers who need data center and network diversity and the
ability to add Web site bandwidth capacity on-demand. Content providers,
for example, can use Concentric Peak Protection to prepare for rapid growth
and spikes in Web site traffic without making large up-front hardware and
bandwidth investments ahead of demand. Concentric Peak Protection manages
Web-site traffic spokes by seamlessly dividing traffic between Concentric
hosting centers and other server locations. Concentric Peak Protection is
ideal for companies that do not want to rely exclusively on a single
hosting provider, ISP or their own data center for hosting and data center
services.
Concentric Server Solutions, including Distributed Server Environment and
Concentric Peak Protection range in price from $550 to $10,000 per month,
depending upon the volume of traffic and number of customer servers required.
ConcentricHost. ConcentricHost is a suite of Web-hosting products and
services designed to provide comprehensive solutions to the Internet needs of
a small to medium-sized business in one account. Packages, which include Web
hosting, multiple email IDs and dial-up Internet access range from $29.95 to
$199.95 per month depending on the number of email accounts and the amount of
disk space and bandwidth provided to the customer. These packages also offer
shared security for e-commerce and are managed from a user-friendly Web
interface. Other features include access to 24 hours a day, seven days a week
toll free telephone and email based customer support and built-in self
administration tools that allow the customer to buy more features online in
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real time as well as to analyze Web activity online in near real time. The
system automatically notifies customers when they are approaching the
allocation limits of their account encouraging them to upgrade online.
In June 1998, Concentric enhanced ConcentricHost with the introduction of
the Virtual Development Environment ("VDE"), which provides Web developers
high level security and performance on the ConcentricHost shared server
hosting platform. At the same time, VDE offers maximum freedom to Web
developers by providing them with their own virtually dedicated operating and
file systems. These virtually dedicated systems provide Web developers the
freedom to create complex CGI scripts without security and stability risks and
without requiring them to be reviewed and approved prior to installation.
ConcentricHost Private Label. In November 1998, Concentric launched a
private label hosting solution targeted at companies looking to quickly and
cost-effectively add fully featured Web hosting to their small business
service portfolio. The ConcentricHost Private Label solution allows service
providers, small business retailers, and other resellers to leverage
Concentric's proven technology in applications hosting with their own
resources. This approach allows customers to avoid much of the time, equipment
expense, and information services resources required to internally develop a
Web hosting service.
Windows NT Hosting. The Company also has a line of Windows NT-based hosting
and e-commerce services targeted at small to medium sized businesses.
Concentric also offers Windows NT-based hosting services with its Concentric
Small Business Server Internet Suite service which includes Web hosting,
Internet email exchange and Internet access services designed to be used with
Microsoft's Small Business Server.
Consumer Services
Concentric provides its individual and small office/home office customers
with a broad range of Internet access options and Web hosting email, chat,
file transfer protocol, Gopher and online shareware services. Users can choose
from local and long distance direct dial 800-number and telnet services.
Concentric offers the Microsoft Internet Explorer to its users when they sign
up for dial-up or 800-number service.
Internet Access Pricing
<TABLE>
<CAPTION>
Plan Monthly Fee Additional Time
---- ----------- ---------------
<S> <C> <C>
Starter Plan.......... $ 7.95 $1.95/hour after 5 hours
Standard Plan......... $19.95 No charges for additional time. Unlimited
active access for one monthly fee.
800-number Plan....... $10.00 $5/hour after 2 hours
Inbound Internet $10.00 No charges for additional time. Unlimited
Plan................. active access for one monthly fee.
</TABLE>
The Company also offers consumers value-added services, including a
collection of premium products targeted to vertical segments such as the
family and small office/home office market. This includes the upselling of
discounted products and services in such areas as retail products, software,
hardware, telephony services with such partners as Amazon.com, Inc.,
QuadraCom, LLC, TuneUp.com, Connected OnLine Backup and Excite. Such
arrangements not only provide an additional monthly revenue stream but also
increase customer satisfaction and retention. Additional value-added products
and services being reviewed by the Company for potential introduction include
premium service, customer support, education research, virus protection, and
faxing services.
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Customers
The following is a representative list of the Company's customers during
the last 12 months, each of which accounted for more than $10,000 in revenues.
Acer America Corporation Olin Corporation
Allegiance Telecom, Inc. OnCommand Corporation
Amdahl Corp. OzeMail Interline Pty, Ltd.
American Greetings Corporation Peapod L.P.
Ameritech Corporation Philips Mobile Computing
Andersen Consulting PictureTel Corporation
AT&T Corp. Pierce Leahy Corp.
Bay Networks, Inc. PointCast Incorporated
Bloomberg, L.P. Qwest Communications Corporation
Citizens Communications, L.P. Redback Networks, Inc.
Corel Corporation Rockwell International Corporation
Electric SchoolHouse LLC SBC Communications Inc.
First USA, Inc. Sega of America, Incorporated
Graybar Electric Company, Inc. Teligent, Inc.
Hitachi Metals America, Ltd. The Vanguard Group, Inc.
Intuit Inc. 3Com Corporation
Iomega Corporation TMI Telemedia International, Ltd.
Juno Online Services, L.P. U.S. Office Products Company
Kleiner, Perkins Caufield, & Byers USWeb Corporation
MCI WorldCom Inc. Wawa Inc.
Microsoft Corporation WebTV Networks, Inc.
Netpulse Communications, Inc. Williams Communications Inc.
Netscape Communications Corporation You Bet! On-Line Entertainment
Network Associates Inc. Ziff-Davis Publishing Co.
NTT PC Communications, Inc.
Revenue from WebTV accounted for 26.8% of the Company's revenue during the
year ended December 31, 1998 and 33.4% of the Company's revenue during the
year ended December 31, 1997.
Strategic Business Alliances
The Company aggressively pursues strategic business alliances with a
variety of companies. Through these partners, the Company seeks to expand its
enterprise and consumer customer base and increase the 24 hour utilization of
the Concentric network. The following is a summary of selected strategic
relationships:
WebTV Networks Inc. WebTV provides the world's first high-quality Internet
solution for television. In the fall of 1996, WebTV's licensees, Sony
Electronics, Inc. and Philips Electronics introduced a plug-and-play set-top
box that enables Internet browsing from a television. As part of the WebTV
service, Concentric and WebTV jointly designed and implemented a national
virtual private dial-up network solution to connect WebTV NetworkTM users to
the Internet, utilizing Concentric's network. The WebTV Internet terminal,
combined with the virtual private network, allows anyone to browse the
Internet from the comfort of their living room.
SBC Communications Inc. In October 1998, SBC and the Company agreed to
integrate Concentric's Internet-based business data services and technology
into SBC's portfolio of data products and services for business customers.
Concentric and SBC plan to deploy a complete suite of packet-switched, IP-
based services such as VPNs, Web hosting, shared software and electronic
commerce for business customers. SBC is working with Concentric to design and
offer a new product called Online Office. Targeted at medium and small
businesses, Online Office is being designed to offer turnkey data solutions
for businesses that want the benefits
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of data networking enjoyed by larger companies but lack the skill, time and
resources to handle it themselves. Online Office is being designed to provide
customers with local area network equipment, installation and network
management services and network-hosted business applications. Applications
include desktop office applications, email, calendaring and e-commerce. Online
Office will also support more experienced businesses as they expand their data
networking capabilities to include features like Web hosting, intranet and
extranet services, electronic commerce and remote access. SBC and Concentric
will host the services and software on remote servers and deliver the
capabilities directly to the customers' desktops. SBC's Southwestern Bell and
Pacific Bell units will provide the local telecommunications link between a
customer's location and Concentric's network POP customers and Concentric will
provide interLATA long distance transport. SBC and Concentric have introduced
these new services on a trial basis in San Francisco, California and Austin,
Texas. Widespread deployment of portions of Online Office is planned for the
second quarter of 1999. The entire Online Office package is targeted for
release in the third quarter of 1999.
As part of this relationship, SBC agreed in October 1998 to acquire 906,679
shares of Concentric's common stock either on the open market or from the
Company. In December 1998, SBC purchased 100,000 shares of common stock in two
open market purchases. The Company expects SBC to purchase the remaining
806,679 shares from the Company in February 1999 for an aggregate purchase
price of approximately $19.5 million. SBC will also acquire a warrant to
purchase 906,679 shares of Concentric common stock at a price of $21.00 per
share.
Williams Communications Group, Inc. Concurrent with the closing of the
Company's initial public offering of common stock in August 1997, the Company
entered into a strategic relationship with Williams Communications Group,
Inc., a subsidiary of the Williams Companies, Inc. (together, "Williams").
Williams provides a full range of enterprise network solutions, communications
services and advanced applications to businesses, including equipment and
services for data, voice and video, international satellite and fiber-optic
transmission services, telemarketing services, and multipoint video- and
audio-conferencing. As part of the strategic business relationship, Williams
has made available, and the Company has agreed to purchase from Williams, a
total of $21.2 million in telecommunications equipment and services through
the five year period ending in 2002. At the election of Williams, $2.0 million
of the minimum purchase commitment may be paid by the issuance of Common Stock
by the Company at the then-current fair market value. Additionally, Williams
and the Company have entered into a reseller agreement and an agency agreement
through which Williams is able to sell the Company's products and services for
an initial term of two years. The agreements with Williams provide that, in
the event of a change of control of the Company, Williams will have a right to
purchase a nonexclusive, perpetual license to use, distribute and modify all
of the intellectual property of the Company, including any copyright, patent,
license, trademark or trade secret which the Company has or obtains the right
to transfer.
The relationship with Williams includes an equity investment in the Company
by Williams of approximately $15.0 million which closed in August 1997.
Covad. In January 1999, the Company entered into a strategic relationship
with Covad to combine Concentric's value-added IP services with Covad's high
speed DSL local loop services. This strategic relationship allows Concentric
to resell Covad's DSL local loop services to Concentric's customers. The
companies also will co-market DSL in approximately 20 major metropolitan areas
in the United States and jointly fund product development efforts in 1999 and
2000. Additionally, Concentric invested approximately $10.0 million in Covad,
purchasing 555,556 shares of Covad's common stock at the initial public
offering price of $18.00 per share.
Teligent. Concentric signed an agreement with Teligent, a wireless CLEC, in
February 1998 to provide nationwide backbone data network services.
Concentric's services enable Teligent to offer a full range of high quality,
high-bandwidth communication services to small and medium-sized businesses.
Teligent's digital wireless networks interconnect with Concentric's ATM
backbone to deliver high speed, Internet-based services in several dozen
metropolitan markets throughout the United States. These services were
launched in July 1998. Teligent plans to ultimately offer services in 74 major
markets across the country and to interconnect
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<PAGE>
with Concentric for data services in each of these markets. In addition, the
agreement enables Teligent to re-sell Concentric's VPN and Web hosting
services through its nationwide sales team. Teligent's sales force began
reselling selected Concentric products and services in August 1998.
Intuit. Intuit, a financial software and Web-based services company, is a
market leader in personal and small business financial software. Intuit views
its Websites as a key channel for communicating with its customers, and as a
vehicle to provide personal finance, investment and tax related financial
information. Concentric and Intuit partnered in October 1995 to launch
integrated Internet access to the Quicken Financial Network and the Internet.
The Internet access capability included both a virtual private network service
designed to provide Intuit customers subsidized access to select Intuit Web
sites and the ability to upgrade to full access to the Internet. Intuit has
bundled tailored versions of the Netscape Navigator browser in its fiscal year
1998 and 1999 releases and the Microsoft Explorer browser in its 1998 and 1999
releases of Quicken, TurboTax, ProTax and Quickbooks. Concentric designed and
implemented tailored registration and network access software to provide
Intuit customers with seamless, subsidized access to select Intuit Web sites.
Concentric provides an easy, Web-based upgrade process for customers desiring
full Internet access and email services. Customers are billed for network time
through Concentric's billing systems. In addition, Concentric provides
private-labeled customer service to Intuit customers with full network access
on a twenty-four hour a day, seven day a week basis. Intuit uses Concentric's
high performance network primarily to enable customers to send electronic tax
filings and software product registration.
Nortel/Bay Networks. In October 1997, Concentric began providing RemoteLink
dial-up access service to Nortel/Bay Network's entire U.S.-based mobile
workforce. Nortel/Bay Network's RemoteLink users dial into Concentric
Network's high-performance network and are then "tunneled" through one of two
secure T-1 connections to access their corporate intranet, never touching the
Internet. A component of the service is that Nortel/Bay Networks controls
authentication of the users permitted to access its corporate intranet. In
addition, Nortel/Bay Networks uses Concentric's customer service center to
provide round-the-clock user support. This outsourced solution has allowed
Nortel/Bay Networks to realize considerable cost savings over traditional
toll-free remote access and in-house help desk support services.
TMI. In August 1996, the Company entered into an agreement with TMI to
establish an international network based on Concentric's network technology
and expertise and TMI's existing telecommunications infrastructure. TMI
currently has a telecommunications network deployed in 40 countries worldwide.
In April 1998, the Company and TMI launched Mondonet, the first international
network designed and built expressly to support VPN services with coverage in
more than 30 cities in 24 countries. As part of the agreement with TMI, the
Company granted TMI certain exclusive rights in certain critical markets,
including Europe. While the goal of this effort is to deliver a range of
compatible network services worldwide, only limited deployment of services has
occurred under this agreement to date. The Company's experience in working
with TMI to develop versions of its products and to market and distribute its
products internationally is limited. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Factors Affecting Operating
Results--We Face Risks Associated with International Expansion."
The Concentric Network
The Concentric network employs an advanced, geographically dispersed ATM
and frame relay backbone, SuperPOPs in 19 major metropolitan areas plus a
total of 143 secondary and tertiary POPs in other cities, allowing local dial-
up access to the network to users in the U.S. and Canada. In addition, the
Company can provide analog dial-up, frame relay, fractional T-1, T-1 and DS3
access to the network. Concentric is in the process of deploying 56.6 Kbps
modems throughout its network and expects this deployment to be completed in
the first quarter of 1999. This planned deployment is a forward looking
statement and is subject to a number of risks and uncertainties and the actual
results could differ materially as a result of a number of factors including
those set forth under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors Affecting Operating
Results--We Depend Upon New and Enhanced Services" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Factors Affecting Operating Results--We Depend Upon Our Network
Infrastructure."
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The Concentric network is managed via a centralized network control center
in St. Louis, Missouri. Two data centers (located in Chicago, Illinois and
Cupertino, California) house the servers that support log on/authentication,
billing, email, Internet access, Web services and other network services. The
Cupertino data center will be consolidated into the new San Jose, California
headquarters building in mid-1999. In February 1998, the Company acquired
InterNex, a provider of network services, colocation services and Web-hosting
facilities to enterprise customers. With the acquisition of InterNex, the
Company expanded its Internet connectivity strategy to include not only
private transit with MCI, Sprint and UUNet, but also private peering with
other network providers as well as public peering with multiple smaller
Internet service providers. The Company's new hybrid private/public Internet
connectivity strategy is designed to allow Concentric to offer superior
Internet connectivity performance by avoiding congestion (packet loss) that
may occur when connecting to certain network providers at many public peering
points.
The Concentric SuperPOPs are designed to support both dial-up and dedicated
access services within a broad geographic region. Typically, a SuperPOP will
utilize one or more CLECs and LECs to aggregate dial traffic within a 50-200
mile radius of the SuperPOP and terminate it at the SuperPOP. This strategy
allows Concentric to offer users local call coverage within the SuperPOP
region without having to deploy individual POPs in each local calling area.
All the calls are terminated at the modem equipment at the regional SuperPOP.
This results in broader call coverage, lower costs due to the typically lower
rates from CLECs and economies of scale from larger modem installations, lower
maintenance costs, and easier capacity upgrades since equipment is located in
a single location within a region.
DAFs and DSLs from customer locations in a region are terminated in the
SuperPOP as well. Typically, Fractional T-1, T-1, and DS3 circuits are
terminated directly into SuperPOP router equipment or via a channelized DS3
connected to a competitive access provider. Frame access is terminated via
aggregated LEC Frame Access circuit(s). DSL is terminated via a multiplexed
DS3 connection to a CLEC metropolitan area DSL network. Both dial-up and
dedicated traffic is then aggregated by the routers/switches in the SuperPOP
and directed to the Concentric ATM backbone via one or more DS3 ATM links.
The Concentric network also offers its customers the security, reliability
and management features that companies require in their own private networks.
Varying layers of security and encryption are supported and tailored to
specific customer requirements. The network design includes a standard
security layer and is compatible with most types of custom security
applications. Further, security is provided at both the edge of the network
and internally based on embedded firewall and encryption techniques. The
Concentric network features colocation of network access and switching
equipment in "hardened" facilities, direct connections to carrier facilities,
a resilient ATM/frame relay backbone, dual data processing centers, and
redundancy within data centers to substantially enhance its uptime
performance.
Network managers, customer service and technical support staff require near
real-time access to information about the performance and quality of their
networks. In traditional private networks, this information is provided by
network management, trouble reporting/tracking, and management information
systems. Customers usually sacrifice a great deal of control and have access
to less information when using a public network instead of a private network.
It has been difficult for public network providers to provide their major
customers with information regarding network performance that relates to that
customer's usage without either compromising other customers' proprietary
information or compromising the integrity of the network itself. Concentric
has developed a set of non-intrusive software tools and reporting mechanisms,
distributed to enterprise customers to allow a customer's network manager to
monitor network performance and quality and to adequately support inquiries
for help from their users. Web browsers and file transfer tools are used to
provide access to much of this information. In some cases, custom integration
of Concentric's network management and trouble tracking/reporting systems will
be provided to customers.
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Sales and Marketing
The Company focuses on marketing its services to two distinct market
segments: enterprises (primarily small and medium size businesses) and
consumers. By attracting enterprise customers who use the network primarily
during the daytime, and consumer customers who use the network primarily at
night, the Company is able to utilize its network infrastructure more cost
effectively. The Company pursues these customers through a multi-tiered sales
strategy consisting of leveraged third party distribution channels, inbound
and outbound telesales, value-added resellers, original equipment
manufacturers and a direct sales force. As of December 31, 1998, the Company
employed 168 persons in sales and marketing.
Leveraged Third Party Distribution. The Company has positioned itself as a
key network services provider for companies that bundle network access in
their products or services. For example, the Company's network service is
bundled with Intuit's Quicken, TurboTax and Quickbooks products, Microsoft
Office 98 and with WebTV's Internet access devices. Additionally, the Company
is one of the Internet services providers listed on the Netscape Navigator and
Microsoft Internet Explorer browser registration servers.
Telesales. The Company employs separate telesales groups to generate
inbound leads in three market sectors. The consumer telesales group sells
Internet connectivity and shared hosting to the consumer market. The Company's
AnaServe sales group is focused on both shared and dedicated hosting and
electronic commerce solutions for the small business sector. The inside
enterprise sales group offers business solutions including T-1, DSL and
wireless connectivity products as well as shared and dedicated hosting
products to enterprise customers. In addition, an outbound group is dedicated
to generating leads for field sales and resellers, as well as managing the
customer installed base in the pursuit of upgrades and contract renewals.
Value-Added Resellers. The Company has established sales channels and
significant market coverage through value-added resellers without incurring
the commensurate costs of a large direct sales force. These resellers are
categorized into four groups, national and regional network integrators and
colocation and shared hosting resellers. In the enterprise market, these
companies sell both network equipment and full service network/Internet
solutions, including design, installation and maintenance. Williams
Communications Solutions is a national network integrator with over 300
trained sales and support professionals who are compensated for selling
Concentric's enterprise connectivity, VPN and dedicated hosting solutions.
Concentric solicits shared hosting developers and resellers through a
combination of on line advertising and direct telesales, and currently has
over 500 resellers in this market. In addition, the Company has launched a
trial program with Microsoft for the sale of the Microsoft Small Business
Server bundled with Concentric DSL for sale through the Microsoft Value Added
Provider channel.
OEM Sales. Concentric recently adopted an OEM, i.e. private-label, strategy
that enables national telecommunications infrastructure providers to offer a
full suite of private labeled IP-based consumer and enterprise network
services. Concentric's OEM partners, such as Teligent and SBC, sell
Concentric's services through their large sales forces into established
customer bases.
Direct Sales Force. The Company employs 29 field sales people located in
San Jose, Orange County and Los Angeles, California, Dallas, Texas,
Washington, D.C., the New York metropolitan area, Atlanta, Georgia, Chicago,
Illinois and Boston, Massachusetts for support of complex custom enterprise
VPN solutions and to acquire, support, train and retain distribution channel
partners. The Company's field sales force is supported by inside sales/account
managers, project and program managers and systems engineers.
Concentric markets its enterprise services to marketing and information
service professionals, enabling companies to take full advantage of IP-based
WAN, intranet and extranet applications. The Company uses print advertising in
targeted industry publications, end-user seminars and media spot
advertisements specifically to build awareness and acquire leads for its VARs
and its direct sales team.
In the consumer market, the Company focuses on direct mail to targeted
audiences; establishment of customer referral programs; and co-marketing such
as packaging literature with MasterCard mailers and Intuit
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software. In addition, the Company has implemented online customer retention
programs, such as a Website "home" where they can learn how to use the
service, how to use the Internet, and how to find information quickly.
Additionally, the Company is generating advertising revenue on its Website
from direct ad banner placements as well as from shared revenue relationships
with content partners such as Excite, Inc. and Lycos, Inc.
The Company employs in-house public relations personnel and contracts with
an outside public relations agency to provide broad coverage in network
computer and vertical industry publications. The Company also participates in
industry trade shows with and without its strategic marketing partners and
conducts numerous seminar "road shows" for market awareness and lead
generation.
Customer Service
Concentric believes that a high level of customer support is critical to
attracting and retaining its enterprise and consumer customers. The Company's
customer support strategy is based on the following principles:
. our technical expertise in devising cost-effective network solutions for
customers;
. rapid development time and flexibility in meeting customer applications
requirements; and
. responsive customer support and effective account management.
The Company maintains a customer support call center at its Saginaw,
Michigan facility. Concentric offers several levels of customer support all of
which are available 24 hours per day, seven days per week. The basic level of
customer support includes support for customers on installing and using their
software, customer communications and customer training. Premier level service
programs guarantee an exceptional performance standard, offer supplemental
support training, and provide monthly reports on operations. Private label
support gives businesses a premier level of support provided by their own
customer service team who answer calls with that customer's company name.
Customer support is provided by email, telephone, Website and online chat. As
of December 31, 1998, the Company employed 171 persons in customer support.
Competition
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. The Company believes
that its ability to compete successfully depends upon a number of factors,
including market presence; the capacity, reliability, low latency and security
of network infrastructure; technical expertise and functionality, performance
and quality of services; customization; ease of access to and navigation of
the Internet; the pricing policies of its competitors; the variety of
services; the timing of introductions of new services by the Company and its
competitors; customer support; the Company's ability to support industry
standards; and industry and general economic trends.
The Company's current and prospective competitors generally may be divided
into four groups. These groups and examples of key competitors in each group
are listed below:
. telecommunications companies AT&T
MCI WorldCom
Sprint
Qwest
Level 3 Communications, Inc.
the RBOCs and other LECs
various cable companies
. online service providers America Online, Inc.
CompuServe Corporation
MSN, the Microsoft Network
Prodigy Communications Corporation
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. Internet service providers
BBN Corporation, a subsidiary of GTE
EarthLink Network, Inc.
MindSpring Enterprises, Inc.
PSINet Inc.
Verio Inc.
other national and regional providers
. Web hosting providers AboveNet Communications
Exodus Communications
Many of these competitors have greater market presence, engineering and
marketing capabilities, and financial, technological and personnel resources
than those available to the Company. As a result, they may be able to develop
and expand their communications and network infrastructures more quickly,
adapt more swiftly to new or emerging technologies and changes in customer
requirements, take advantage of acquisition and other opportunities more
readily, and devote greater resources to the marketing and sale of their
products than can the Company. In addition, various organizations, including
certain of those identified above, have entered into or are forming joint
ventures or consortiums to provide services similar to those of the Company.
The Company believes that new competitors, including large computer
hardware, software, media and other technology and telecommunications
companies will enter the value added network services markets, resulting in
even greater competition for the Company. Certain of such telecommunications
companies and online services providers are currently offering or have
announced plans to offer Internet or online services or to expand their
Internet access services. Certain companies, including America Online,
MindSpring, PSINet and Verio have also obtained or expanded their Internet
access products and services as a result of acquisitions. Such acquisitions
may permit the Company's competitors to devote greater resources to the
development and marketing of new competitive products and services and the
marketing of existing competitive products and services. In addition, the
ability of some of the Company's competitors to bundle other services and
products with VPN and consumer network services could place the Company at a
competitive disadvantage. Certain companies are also exploring the possibility
of providing high-speed data services using alternative delivery methods such
as over the cable television infrastructure, through direct broadcast
satellite technology and by wireless cable. There can be no assurance that the
Company will have the financial resources, technical expertise or marketing
and support capabilities to continue to compete successfully. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting Operating Results--Our Market Is Extremely
Competitive."
Proprietary Rights
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The Company
principally relies upon a combination of copyright, trademark and trade secret
laws and contractual restrictions to protect its proprietary technology. It
may be possible for a third party to copy or otherwise obtain and use the
Company's products or technology without authorization or to develop similar
technology independently, and there can be no assurance that protective
measures have been, or will be, adequate to protect the Company's proprietary
technology or that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technology. The Company operates a material portion of its business over the
Internet, which is subject to a variety of risks. Such risks include but are
not limited to the substantial uncertainties that exist regarding the system
for assigning domain names and the status of private rules for resolution of
disputes regarding rights to domain names. There can be no assurance that the
Company will continue to be able to employ its current domain names in the
future or that the loss of rights to one or more domain names will not have a
material adverse effect on the Company's business and results of operations.
Although the Company does not believe that it infringes the proprietary
rights of any third parties, we cannot assure you that third parties will not
assert such claims against the Company in the future or that such claims will
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not be successful. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Operating Results--
Third Parties May Claim We Infringe Their Proprietary Rights."
Employees
As of December 31, 1998, Concentric had 508 employees and 61 independent
contractors, including 168 persons in sales and marketing, 171 persons in
network operations and development, 171 in customer support and 59 in finance
and administrative functions. The Company believes that its future success
will depend in part on its continued ability to attract, hire and retain
qualified personnel. Competition for such personnel is intense, and We cannot
assure you that the Company will be able to identify, attract, and retain such
personnel in the future. None of the Company's employees is represented by a
labor union, and management believes its employee relations are good.
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EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
Executive Officers, Directors and Senior Management
The following table sets forth certain information as of December 31, 1998,
with respect to the executive officers and directors of the Company, as well
as certain members of its senior management.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Henry R. Nothhaft.................... 54 Chairman, President, Chief Executive
Officer and Director
John K. Peters....................... 50 Executive Vice President and General
Manager, Network Services Applications
Division
Michael F. Anthofer.................. 46 Senior Vice President and Chief
Financial Officer
Mark W. Fisher....................... 38 Senior Vice President of Corporate
Marketing, General Manager, Network
Services Division
William C. Etheredge................. 52 Senior Vice President of Sales
Eileen A. Curtis..................... 50 Vice President of Customer Relations
James L. Isaacs...................... 38 Vice President of Business Development
Vinod Khosla(2)...................... 44 Director
S. Miller Williams(1)................ 47 Director
Franco Regis(1)...................... 42 Director
Gary E. Rieschel(2).................. 42 Director
</TABLE>
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Henry R. Nothhaft joined the Company as President and Chief Executive
Officer in May 1995 and was appointed a Director of the Company in August 1995
and Chairman of the Board in January 1998. From 1989 to August 1994, Mr.
Nothhaft was President, Chief Executive Officer and a Director of David
Systems, Inc., a networking company. From 1983 to 1989, Mr. Nothhaft held
various positions with DSC Communications Corporation, including President of
the Business Network Systems Group, President of the Digital Switch
Corporation subsidiary, Senior Vice President of Marketing and a Corporate
Director of DSC. From 1979 to 1983, Mr. Nothhaft was Vice President of
Domestic Marketing and Vice President of Sales for GTE Telenet Communications
Corporation (now Sprint). Mr. Nothhaft has an M.B.A. in Information Systems
Technology from George Washington University and a B.S. from the U.S. Naval
Academy, and is a former officer in the U.S. Marine Corps.
John K. Peters was named Executive Vice President and General Manager,
Network Services Applications Division in June 1995. From 1993 to August 1995,
Mr. Peters served as President of Venture Development Consulting, a consulting
firm specializing in new communications and information services. From 1988 to
1993, Mr. Peters was Vice President and Chief Operating Officer of Pacific
Bell Information Services, Inc. Prior to that, Mr. Peters spent three years as
Vice President of Application Services for Telestream Corporation. In 1981,
Mr. Peters co-founded Integrated Office Systems, Inc., a communications and
information systems company. From 1976 to 1980, Mr. Peters was Vice President
of Advanced Network Services for GTE Telenet Communications Corporation. Mr.
Peters has an M.B.A. from Stanford Graduate School of Business and a B.S. in
Statistics from Stanford University.
Michael F. Anthofer joined the Company in January 1996 as Vice President
and Chief Financial Officer and became a Senior Vice President in November
1996. From January 1991 to December 1995, Mr. Anthofer served as an Executive
Vice President and Chief Financial Officer, as well as a member of the Board
of Directors, of Shared Resource Exchange, Inc., a privately held digital
switching platform and PBX supplier. Prior
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to 1991, Mr. Anthofer held various executive positions at DSC Communications
Corporation including Vice President, Corporate Business Planning, Vice
President, Business Network Group and Vice President, Network Products Group.
Mr. Anthofer has an M.B.A. and a B.S. from the University of California,
Berkeley.
Mark W. Fisher joined the Company in June 1997 as Vice President of
Corporate Marketing and General Manager, Network Services Division. From July
1996 to June 1997, Mr. Fisher was General Manager and Vice President,
Marketing of Pacific Bell Internet Services, a wholly owned subsidiary of
Pacific Bell. From June 1995 to August 1996, Mr. Fisher was Vice President,
Marketing of Pacific Bell Internet Services. From 1989 to May 1995, Mr. Fisher
held various data product marketing and data center operations positions at
Pacific Bell. Mr. Fisher has an M.B.A. from the University of California,
Berkeley and a B.S. in mechanical engineering from the U.S. Naval Academy.
William C. Etheredge joined the Company in March 1997 as the Senior Vice
President of Sales. From May 1991 to March 1997, Mr. Etheredge served first as
Vice President of Sales and Marketing and then as Vice President of Sales for
Meridian Data, Inc., a provider of networked CD-ROM database creation and
retrieval software and network servers. From July 1990 to May 1991, he served
as Vice President of Strategic Accounts for Maxtor Corporation. From June 1985
to June 1990, he served first as Vice President US Sales and Marketing and
then Vice President Western Region for Memorex-Telex Corporation. Mr.
Etheredge has an M.B.A. from Bowling Green University and a B.A. from
Westminster College.
Eileen A. Curtis became Customer Relations Manager in January 1995,
Director of Customer Relations in September 1995 and Vice President, Customer
Relations in November 1996. From August 1987 to July 1993, Ms. Curtis was
employed by Cox Communications Saginaw, Inc. and served in various positions
including Marketing and Public Relations Manager, Administrative Manager and
Customer Service Manager. Ms. Curtis has an MBA and a B.S. from Central
Michigan University.
James L. Isaacs joined the Company in October 1995 as the Director of
Product Management. In March 1997, he became Vice President of Product
Management and in November 1997 he was appointed Vice President of Business
Development. From July 1988 to October 1995, Mr. Isaacs held various positions
at Apple Computer, including Group Manager Product Marketing, Apple On Line
Services Division and Business Development Manager of Apple On Line Services
Division. Mr. Isaacs has an M.B.A. from the University of California, Berkeley
and an A.B. from Stanford University.
Vinod Khosla has been a Director of the Company since April 1995. Mr.
Khosla has been a General Partner with the venture capital firm of Kleiner
Perkins Caufield & Byers from February 1986 to the present. Mr. Khosla was a
co-founder of Daisy Systems and the founding Chief Executive Officer of Sun
Microsystems, Inc. Mr. Khosla also serves on the boards of Excite, Inc.,
PictureTel, The 3DO Company, and Spectrum Holobyte. He has a B.S.E. from the
Indian Institute of Technology in New Delhi, an M.S.E. from Carnegie Mellon
University, and an M.B.A. from the Stanford Graduate School of Business.
S. Miller Williams has been a Director of the Company since September 1998.
Mr. Williams is Vice President of Corporate Development for Williams
Communications Group, Inc., a subsidiary of Williams Companies, Inc., a
position he has held since 1992. Mr. Williams has a B.S. in Business
Administration from the University of North Carolina and an M.B.A. from the
University of Tulsa.
Franco Regis has been a Director of the Company since October 1996. Since
1994, Mr. Regis has been a Director of Business Development and Strategic
Planning at Telecom Italia, SpA, the telephone operating company of Italy.
From 1992 to 1994, Mr. Regis was a Director of Budget and Control for the
business division of Telecom Italia. Mr. Regis has an engineering degree from
the Rome State University.
Gary E. Rieschel has been a Director of the Company since October 1996. Mr.
Rieschel is Executive Managing Partner at SOFTBANK Technology Ventures, having
joined that company in January 1996. Mr. Rieschel was Vice President for N-
Cube Corporation from August 1994 through December 1995. He was Sales
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Director at Cisco Systems, Inc. from July 1993 through October 1994. Prior to
this, Mr. Rieschel was a General Manager and Sales Director at Sequent
Computer for over nine years. Mr. Rieschel has an M.B.A. from Harvard Graduate
School of Business and a B.A. in biology from Reed College.
Classified Board of Directors
The Company's Certificate of Incorporation provides that, so long as the
Board of Directors consists of more than two directors, the Board of Directors
will be divided into three classes of directors serving staggered three-year
terms. As a result, one-third of the Company's Board of Directors will be
elected each year.
Director Compensation
Directors are reimbursed for certain reasonable expenses incurred in
attending Board or committee meetings. Officers of the Company are elected
annually by the Board of Directors and serve at its discretion. The Company
has entered into indemnification agreements with each member of the Board of
Directors and certain of its officers providing for the indemnification of
such person to the fullest extent authorized, permitted or allowed by law.
Compensation Committee
The Company's Board of Directors currently has a Compensation Committee
that reviews and approves the compensation and benefits to be provided to the
officers, directors, employees, and consultants of the Company, administers
the Company's 1993 Incentive Stock Option Plan, 1995 Stock Incentive Plan for
Employees and Consultants, and Amended and Restated 1996 Stock Plan, and the
1997 Stock Plan and 1997 Employee Stock Purchase Plan. The Compensation
Committee currently consists of Messrs. Khosla and Rieschel.
Audit Committee
The Company's Board of Directors currently has an Audit Committee that
monitors the corporate financial reporting and the external audits of the
Company, reviews and approves material accounting policy changes, monitors
internal accounting controls, recommends engagement of independent auditors,
reviews related-party transactions and performs other duties as prescribed by
the Board of Directors. The Audit Committee currently consists of Messrs.
Bender and Regis.
Item 2. Properties
The Company's executive offices are located in San Jose, California, under
a lease expiring on February 1, 2006. The Company also leases network
operations facilities in Bay City, Michigan, under a lease expiring on
December 31, 1999, data centers in Chicago, Illinois, under a lease expiring
on June 30, 2008, in Santa Clara, California, under a lease expiring on May
31, 2000, in Newport Beach, California, under a lease expiring on June 30,
1999, and in Anaheim, California, under a lease expiring on June 30, 1999, and
a customer support facility in Saginaw, Michigan under a lease expiring in
December 2001.
Item 3. Legal Proceedings
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana, the parent corporation of Sattel, alleging
securities fraud related to plaintiffs' purchase of shares of Diana Common
Stock in reliance upon allegedly misleading statements made by defendants,
Diana, Sattel and certain of their respective affiliates, officers and
directors. Concentric was named as a defendant in the complaint in connection
with certain statements made by Diana and officers of Diana related to
Concentric's purchase of network switching equipment from Diana's Sattel
subsidiary. The plaintiffs sought unspecified compensatory damages. A motion
by the Company to dismiss the
20
<PAGE>
complaint was denied, and the court has allowed the action to proceed against
the Company. The parties have agreed in principal to settle the case and
expect to enter the settlement agreement with the court in February 1999.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock has been traded on the Nasdaq National Market under the
symbol "CNCX" since our initial public offering on August 1, 1997. The
following table sets forth, for the periods indicated, the high and low sale
prices for our common stock as reported by the Nasdaq National Market:
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
Fiscal Year Ended December 31, 1997:
Third Quarter (from August 1, 1997)........................... $16 $11 3/8
Fourth Quarter................................................ 15 7 7/8
Fiscal Year Ended December 31, 1998:
First Quarter................................................. $20 3/8 $ 8 7/8
Second Quarter................................................ 31 1/2 18 5/8
Third Quarter................................................. 41 14 1/4
Fourth Quarter................................................ 37 1/4 14 1/2
Fiscal Year Ending December 31, 1999:
First Quarter (through January 25, 1999)...................... $42 1/8 $31 7/8
</TABLE>
On January 25, 1999, the last reported sale price for our common stock on
the Nasdaq National Market was $34.50 per share. As of January 20, 1999, we
estimate that there were approximately 271 holders of record and over 4,388
beneficial owners of the common stock.
The Company currently intends to retain any earnings for use in its
business and does not anticipate paying any cash dividends in the foreseeable
future.
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<PAGE>
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
commencing on page 24.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1994 1995 1996 1997 1998(1)
------- -------- -------- -------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenue..................... $ 442 $ 2,483 $ 15,648 $ 45,457 $ 82,807
Cost of revenue............. 2,891 16,168 47,945 61,439 85,352
Network equipment write-
off(2)..................... -- -- 8,321 -- --
Development................. 534 837 2,449 4,850 7,734
Marketing and sales......... 639 3,899 16,609 24,622 39,793
General and administrative.. 611 2,866 3,445 4,790 10,398
Amortization of goodwill and
other intangible assets.... -- -- -- -- 3,842
Acquisition-related
charges.................... -- -- -- -- 1,291
Write-off of in-process
technology................. -- -- -- -- 5,200
------- -------- -------- -------- ---------
Total costs and expenses.... 4,675 23,770 78,769 95,701 153,610
------- -------- -------- -------- ---------
Loss from operations........ (4,233) (21,287) (63,121) (50,244) (70,803)
Other income (expense)...... -- -- -- 1,233 (750)
Net interest expense........ (57) (721) (3,260) (6,571) (13,595)
------- -------- -------- -------- ---------
Loss before extraordinary
item....................... (4,290) (22,008) (66,381) (55,582) (85,148)
Extraordinary gain on early
retirement of debt......... -- -- -- -- 3,042
------- -------- -------- -------- ---------
Net loss.................... (4,290) (22,008) (66,381) (55,582) (82,106)
------- -------- -------- -------- ---------
Preferred stock dividends
and accretion.............. -- -- -- -- (11,958)
------- -------- -------- -------- ---------
Net loss attributable to
common stockholders........ $(4,290) $(22,008) $(66,381) $(55,582) $ (94,064)
======= ======== ======== ======== =========
Net loss per share
attributable to common
stockholders(3)............ $ (13.46) $ (5.63) $ (6.47)
======== ======== =========
Shares used in computing net
loss per share attributable
to common stockholders(3).. 4,937 9,872 14,547
======== ======== =========
<CAPTION>
As of December 31,
------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet
Data:
Cash and cash equivalents... $ 63 $ 19,054 $ 17,657 $119,959 $ 98,988
Short term investments...... -- -- -- -- 52,226
Restricted cash(4).......... -- -- -- 52,525 36,238
Property and equipment,
net........................ 1,303 16,289 47,927 53,710 64,268
Total assets................ 1,798 37,235 70,722 244,489 298,257
Notes payable and capital
lease obligations, net of
current portion............ 1,648 11,047 30,551 179,172 156,455
Redeemable exchangeable
preferred stock............ -- -- -- -- 156,105
Total stockholders' equity
(deficit).................. (4,202) 9,763 2,925 31,918 (56,875)
</TABLE>
(Footnotes appear on the next page.)
22
<PAGE>
- --------
(1) During 1998, the Company acquired InterNex, DeltaNet and AnaServe, the
effects of which have been included in the 1998 financial results. See
Note 13 of Notes to Consolidated Financial Statements.
(2) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 3 of Notes to Consolidated Financial
Statements.
(3) Net loss per share and shares used in computing net loss per share
attributable to common stockholders are presented on a pro forma basis for
the years ended December 31, 1996 and 1997 and on an historical basis for
the year ended December 31, 1998. See Note 1 of Notes to Consolidated
Financial Statements.
(4) Restricted cash of $36.2 million consists of funds held in escrow to pay
interest relating to the Company's 12 3/4% Senior Notes. See Note 5 of
Notes to Consolidated Financial Statements.
23
<PAGE>
Item 7. 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 32. 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 VPNs and providing dedicated network access and Web hosting services
for enterprise customers. Contracts with enterprise customers typically have a
term ranging from one to three years. The Company expects enterprise-related
revenue to represent an increasing portion of total revenue in future periods.
The foregoing expectation is a forward-looking statement that involves risks
and uncertainties, and actual results could vary as a result of a number of
factors including the Company's operating results, the results and timing of
the Company's launch of new products and services, governmental or regulatory
changes, the ability of the Company to meet product and project demands, the
success of the Company's marketing efforts, competition and acquisitions of
complementary businesses, technologies or products.
In February 1998, the Company acquired InterNex, a provider of network
services, collocation services and Web hosting facilities to enterprise
customers. This acquisition was accounted for using the purchase method of
accounting. Accordingly, the Company's historical financial statements do not
include results of operations, financial position or cash flows of InterNex
prior to its acquisition in February 1998. In addition, as a result of the
acquisition, the Company incurred a charge of $5.2 million relating to
acquired in-process technology and recorded an aggregate of $12.6 million of
goodwill and other intangible assets, which will be amortized on a straight-
line basis over their estimated useful lives ranging from two to five years.
In May 1998, the Company acquired DeltaNet, a provider of dial-up and
dedicated access services, Web hosting services and Web application
development and design. This transaction was accounted for as a pooling of
interests. Results of DeltaNet's operations for the period beginning April 1,
1998 through December 31, 1998 are included in the consolidated results of
operations. In addition, as a result of the acquisition, the Company has
incurred charges of approximately $1.3 million in transaction costs consisting
primarily of severance costs, redundant facilities and assets and professional
fees related to the acquisition.
In August 1998, the Company acquired AnaServe, a provider of Web hosting
services. This acquisition was accounted for using the purchase method of
accounting. The Company's historical financial statements do not include
results of operations, financial position or cash flows of AnaServe prior to
its acquisition. As a result of the acquisition, the Company has recorded an
aggregate of $12.0 million of goodwill and other intangible assets, which will
be amortized on a straight-line basis over their useful lives ranging from one
to five years.
The Company may acquire other complementary products, technology and
businesses. If the Company were to incur additional charges for acquired in-
process technology, amortization of goodwill and acquisition costs
24
<PAGE>
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 remainder of 1999. The
Company's ability to achieve profitability and positive cash flow from
operations is dependent upon the Company's ability to substantially grow its
revenue base and achieve other operating efficiencies. The Company experienced
net losses attributable to common stockholders of approximately $66.4 million,
$55.6 million and $94.1 million for the years ended December 31, 1996, 1997,
and 1998, respectively. We cannot assure you that the Company will be able to
achieve or sustain revenue growth, profitability or positive cash flow on
either a quarterly or an annual basis. At December 31, 1998, the Company had
approximately $90.0 million of gross deferred tax assets comprised primarily
of net operating loss carry-forwards. The Company believes that, based on a
number of factors, the available objective evidence creates sufficient
uncertainty regarding the realizability of the deferred tax assets such that a
full valuation allowance has been recorded. These factors include the
Company's history of net losses since its inception and the fact that the
market in which the Company competes is intensely competitive and
characterized by rapidly changing technology. The Company believes that, based
on the current available evidence, it is more likely than not that the Company
will not generate taxable income through 1999, and possibly beyond, and
accordingly will not realize the Company's deferred tax assets through 1999,
and possibly beyond. The Company will continue to assess the realizability of
the deferred tax assets based on actual and forecasted operating results. In
addition, the utilization of net operating losses may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses before
utilization. See "Factors Affecting Operating Results--We Have a Limited
Operating History and Expect Continuing Operating Losses."
The Company expects to focus in the near term on building and increasing
its revenue base, which will require it to significantly increase its expenses
for personnel, marketing, network infrastructure and the development of new
services, and may adversely impact short term operating results. As a result,
the Company believes that it will incur losses in the near term and we cannot
assure you that the Company will be profitable in the future.
The Company's operating results have fluctuated in the past and may in the
future fluctuate significantly, depending upon a variety of factors, including
the timely deployment and expansion of the Concentric network and new network
architectures, the incurrence of related capital costs, variability and length
of the sales cycle associated with the Company's product and service
offerings, the receipt of new value-added network services and consumer
services subscriptions and the introduction of new services by the Company and
its competitors. Additional factors that may contribute to variability of
operating results include: the pricing and mix of services offered by the
Company; customer retention rate; market acceptance of new and enhanced
versions of the Company's services; changes in pricing policies by the
Company's competitors; the Company's ability to obtain sufficient supplies of
sole- or limited-source components; user demand for network and Internet
access services; balancing of network usage over a 24-hour period; the ability
to manage potential growth and expansion; the ability to identify, acquire and
integrate successfully suitable acquisition candidates; and charges related to
acquisitions. In response to competitive pressures, the Company may take
certain pricing or marketing actions that could have a material adverse affect
on the Company's business. As a result, variations in the timing and amounts
of revenues could have a material adverse affect on the Company's quarterly
operating results. Due to the foregoing factors, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and that such comparisons cannot be relied upon as indicators of
future performance. In the event that the Company's operating results in any
future period fall below the expectations of securities analysts and
investors, the trading price of the Company's common stock would likely
decline.
25
<PAGE>
Results of Operations
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997.
Revenue. Revenue totaled approximately $82.8 million for the year ended
December 31, 1998, a $37.3 million increase over revenue of approximately
$45.5 million for the year ended December 31, 1997. This increase reflects
growth in revenue from:
. the Company's broadened product offerings to its enterprise customers;
. the Company's marketing arrangements with its strategic partners;
. continued growth in revenue derived from Internet access customers;
. revenue generated from network, colocation and Web hosting services
provided by the Company's wholly-owned subsidiary, InterNex, which was
acquired in February 1998; and
. revenues from DeltaNet and AnaServe which were acquired in May and
August 1998, respectively.
The Company expects revenue growth from Internet access customers to
flatten over time as it de-emphasizes this sector of its business. Revenue
from WebTV declined to 26.8% of the Company's net revenue for the year ended
December 31, 1998 compared to 33.4% for the year ended December 31, 1997. The
Company expects revenue from WebTV to decrease as a percentage of revenue. The
foregoing expectation is a forward looking statement that involves risks and
uncertainties and the actual results could vary materially as a result of a
number of factors including those set forth under the caption "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 year
ended December 31, 1998 was approximately $85.4 million, an increase of $24.0
million from cost of revenue of $61.4 million for the year ended December 31,
1997. This increase is attributable to the overall growth in the size of the
network and costs associated with acquired operations. As a percentage of
revenue, such costs declined to 103.1% of revenue in the year ended December
31, 1998, down from 135.2% of revenue in the prior year, due to increased
network utilization associated with the Company's revenue growth and lower per
port costs of the Company's network architecture. The Company expects its cost
of revenue to continue to increase in dollar amount, while declining as a
percentage of revenue as the Company expands its customer base. The foregoing
expectation is a forward looking statement that involves risks and
uncertainties and the actual results could vary materially as a result of a
number of factors, including those set forth under the captions "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 $7.7 million
and $4.9 million for the years ended December 31, 1998 and 1997, respectively.
This higher level of development expense reflects an overall increase in
personnel to develop new product offerings, to manage the overall growth in
the network and from acquired operations. Development expense as a percentage
of revenue declined to 9.3% for the year ended December 31, 1998 from 10.7%
for the year ended December 31, 1997 as a result of the Company's increased
revenue. The Company expects its development spending to continue to increase
in dollar amount, but to decline as a percentage of revenue. The foregoing
expectation is a forward looking statement that involves risks and
uncertainties and the actual results could vary materially as a result of a
number of factors, including those set forth below under the captions "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."
26
<PAGE>
Marketing and Sales Expense. Marketing and sales expense consists primarily
of personnel expenses, including salary and commissions, costs of marketing
programs and the cost of 800 number circuits utilized by
the Company for customer support functions. Marketing and sales expense was
approximately $39.8 million for the year ended December 31, 1998 and $24.6
million for the year ended December 31, 1997. The $15.2 million increase in
1998 reflects a substantial investment in the customer support, marketing and
sales organizations necessary to support the Company's expanded customer base.
This increase also reflects a growth in subscriber acquisition costs, related
to both increased direct marketing efforts as well as commissions paid to
distribution partners. Marketing and sales expense as a percentage of revenue
declined to 48.1% for the year ended December 31, 1998 from 54.2% in the year
earlier period as a result of the Company's increased revenue. The Company
expects marketing and sales expenditures to continue to increase in dollar
amount, but to decline as a percentage of revenue. The foregoing expectation
is a forward looking statement that involves risks and uncertainties and the
actual results could vary materially as a result of a number of factors
including those set forth under the captions "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 $10.4 million for the year ended
December 31, 1998 and $4.8 million for the year ended December 31, 1997. This
higher level of expense reflects an increase in personnel and professional
fees necessary to manage the financial, legal and administrative aspects of
the business. General and administrative expense as a percentage of revenue
increased to 12.6% for the year ended December 31, 1998 from 10.5% in the
prior year as a result of the Company's increased facilities costs and
expenses related to updating the Company's information systems. The Company
expects general and administrative expense to increase in dollar amount,
reflecting its growth in operations, but to decline as a percentage of
revenue. The foregoing expectation is a forward looking statement that
involves risks and uncertainties and the actual results could vary materially
as a result of a number of factors including those set forth under the
captions "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 year ended
December 31, 1998, the Company recorded amortization of goodwill and other
intangible assets of $3.8 million resulting from the acquisition of InterNex
in February 1998 and AnaServe in August 1998.
Acquisition-Related Charges. For the year ended December 31, 1998 the
Company charged to operations one-time acquisition costs of $1.3 million
related to the DeltaNet acquisition. Those costs principally related to
professional fees, reserves for redundant assets and facilities and employee
severance packages.
Write-off of In-Process Technology. For the year ended December 31, 1998,
the Company wrote-off $5.2 million of in-process technology related to the
acquisition of InterNex. This acquisition provided technology and expertise
that the Company is using to enhance and expand the breadth of its product and
service offerings to its customers.
Other Income (Expense). During the year ended December 31, 1998, the
Company recorded $750,000 of other expense in connection with the settlement
of certain litigation with the shareholders of Diana Corporation. During the
year ended December 31, 1997, upon settlement of the Sattel litigation, the
Company recorded $970,000 of other income related to the reversal of
previously established reserves. Additionally, the Company recorded $425,000
of other income related to the re-negotiation of a third party services
agreement.
Net Interest Expense. Net interest expense was approximately $13.6 million
and $6.6 million for the years ended December 31, 1998 and 1997, respectively.
The increase is primarily due to interest related to $150.0 million principal
amount of 12 3/4% Senior Notes issued in December 1997.
Extraordinary Gain. For the year ended December 31, 1998, the Company
realized an extraordinary gain of $3.0 million related to the early retirement
of debt in the form of capital lease obligations.
27
<PAGE>
Preferred Stock Dividends and Accretions. For the year ended December 31,
1998, the Company recorded dividend and stock accretion of $12.0 million
related to the preferred stock issued in June 1998.
Net Loss Attributable to Common Stockholders. The Company's net loss
attributable to common stockholders increased to approximately $94.1 million
for the year ended December 31, 1998 as compared to approximately $55.6
million for the year ended December 31, 1997. For comparative purposes, the
net loss attributable to common stockholders for the year ended December 31,
1998 included expenses related to financing and acquisition charges of $1.3
million resulting from the acquisition of DeltaNet, $12.0 million of dividends
and accretion related to the preferred stock issued in June 1998, $19.9
million of interest expense and amortization of debt issuance costs related to
the 12 3/4% Senior Notes and warrants, $5.2 million write-off of in-process
technology and $3.8 million of amortization of goodwill and other intangibles
relating to the acquisitions of InterNex and AnaServe. These losses were
partially offset by an extraordinary gain of $3.0 million on early retirement
of debt.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996.
Revenue. Revenue for the year ended December 31, 1997 totaled approximately
$45.5 million, an increase of $29.9 million over revenue of $15.6 million for
the year ended December 31, 1996. This increased revenue reflects growth in
revenue from the Company's broadened product offerings to its enterprise
customers and through the Company's leveraged marketing arrangements with its
strategic partners, as well as continued growth in revenue derived from
Internet access customers. WebTV accounted for approximately 33.4% of total
revenue for the year ended December 31, 1997.
Cost of Revenue. Cost of revenue for the year ended December 31, 1997
totaled approximately $61.4 million compared with $47.9 million for the year
ended December 31, 1996. This increase is attributable to the overall growth
in the size of the network. As a percentage of revenue, costs declined to
135.2% of revenue in the year ended December 31, 1997 from 306.4% of revenue
in the prior year due to increased network utilization associated with the
Company's revenue growth and lower per port costs of the Company's SuperPOP
network architecture deployed in the second half of 1996.
Development Expense. Development expense for the years ended December 31,
1997 and 1996 was approximately $4.9 million and $2.4 million, respectively.
This higher level of development expense reflects an overall increase in
personnel to develop new product offerings and to manage the overall growth in
the network. As a percent of revenue, development expense declined to 10.7%
for the year ended December 31, 1997 from 15.7% for the year ended December
31, 1996, as a result of the Company's increased revenue.
Marketing and Sales Expense. For the years ended December 31, 1997 and
1996, marketing and sales expense was approximately $24.6 million and $16.6
million, respectively. The $8.0 million increase in 1997 reflects a
substantial investment in the customer support, marketing and sales
organizations necessary to support the Company's expanded customer base. This
increase also reflects a growth in subscriber acquisition costs, related to
both increased direct marketing efforts as well as commissions paid to
distribution partners. Additionally, the increase reflects the ramp-up of
marketing efforts related to the introduction of enterprise products and
services. Marketing and sales expense as a percentage of revenue declined to
54.2% for the year ended December 31, 1997 from 106.1% in the year earlier
period as a result of the Company's increased revenue.
General and Administrative Expense. For the years ended December 31, 1997
and 1996, general and administrative expenses were approximately $4.8 million
and $3.4 million, respectively. This higher level of expense reflects an
increase in personnel and professional fees necessary to manage the financial,
legal and administrative aspects of the business. For the year ended December
31, 1997, general and administrative expense declined to 10.5% from 22.0% for
the year ended December 31, 1996 as a result of the Company's increased
revenue.
Other Income (Expense). During the year ended December 31, 1997, upon
settlement of the Sattel litigation, the Company recorded $970,000 of other
income related to the reversal of previously established
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reserves. Additionally, the Company recorded $425,000 of other income related
to the re-negotiation of a third party services agreement. The Company
recorded no other income or expense during the year ended December 31, 1996.
Net Interest Expense. Net interest expense was approximately $6.6 million
and $3.3 million for the years ended December 31, 1997 and 1996, respectively.
The increase for the year ended December 31, 1997 was primarily due to a cost
of financing charge of $930,000 associated with the value of warrants issued
in connection with $5.0 million of bridge loans received in June 1997 and
$744,000 associated with the issuance of the 12 3/4% Senior Notes.
Additionally, the principal amount of capitalized lease obligations increased
$7.0 million from December 31, 1996 to December 31, 1997. The year ended
December 31, 1996 included approximately $330,000 associated with the value of
warrants issued in connection with bridge loan financing.
Net Loss. For the year ended December 31, 1997 the net loss totaled $55.6
million as compared to $66.4 million for the year ended December 31, 1996.
Liquidity and Capital Resources
To date, the Company has satisfied its cash requirements primarily through
capitalized lease financings, the sale of capital stock and debt financings.
The Company's principal uses of cash are to fund working capital requirements
and capital expenditures, to service its capital lease and debt financing
obligations, to finance and fund acquisitions and to provide for the early
retirement of debt. Net cash used in operating activities for the years ended
December 31, 1998 and 1997 was approximately $46.6 million and $45.9 million,
respectively. Included in the amount for the year ended December 31, 1997 is
$4.4 million of cash paid in settlement of a dispute with an equipment
provider. Cash used in operating activities in both periods was primarily
affected by the net losses, caused by increased costs related to the expansion
of the Company's network and organizational infrastructure.
Net cash used in investing activities for the years ended December 31, 1998
and 1997 was approximately $101.9 million and $6.5 million, respectively. Net
cash used in investing activities for the year ended December 31, 1998
consisted primarily of $52.2 million used to purchase short term investments,
$23.5 million used for purchases of capital equipment to support the Company's
expanded network infrastructure and $25.1 million of cash used to acquire
InterNex and AnaServe. For the year ended December 31, 1997, net cash used in
investing activities was primarily for purchases of capital equipment.
For the year ended December 31, 1998, net cash of $127.6 million was
provided from financing activities, reflecting $144.1 million of net proceeds
from the issuance of preferred stock in June 1998 less $24.8 million used for
the early retirement of capital lease obligations, $10.2 million used for
repayment of other capital lease obligations and restricted cash of $16.3
million used to pay interest on the 12 3/4% Senior Notes. For the year ended
December 31, 1997 net cash of approximately $154.7 million was generated from
financing activities, of which $74.0 million, net of issuance costs, was
derived from the issuance of stocks and warrants and $145.0 million, net of
issuance costs, was derived from the issuances of the 12 3/4% Senior Notes,
net of $52.5 million investment in U.S. Government treasury strips held as
restricted cash. The Company also received $5.0 million in debt financing in
June 1997, of which $2.0 million was repaid and $3.0 million was converted
into common stock, respectively, upon closing of the Company's initial public
offering in August 1997. Concurrent with the closing of the initial public
offering, the Company repurchased $2.2 million of common stock from certain
stockholders. The remainder of financing activities for the year ended
December 31, 1997 is comprised of $11.6 million used for repayment of capital
lease obligations. The net cash decrease for the year ended December 31, 1998
was $21.0 million as compared to a net cash increase for the year ended
December 31, 1997 of $102.3 million.
At December 31, 1998, the Company had cash and cash equivalents of
approximately $99.0 million, short term investments of $52.2 million,
restricted cash of $36.2 million and working capital of $144.5 million. The
Company expects to incur additional operating losses and will rely primarily
on its available cash resources, the
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net proceeds from the issuance of the common stock and financing available
under a network equipment lease agreement (that currently has no maximum
borrowing limit) to meet its anticipated cash needs for working capital and
for the acquisition of capital equipment through at least the end of 1999.
However, we cannot assure you that the Company will not require additional
financing within this time frame. The Company's forecast of the period of time
through which its financial resources will be adequate to support its
operations is a forward-looking statement that involves risks and
uncertainties, and actual results could vary materially as a result of a
number of factors, including those set forth on under the caption "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 January 1999, the Company used approximately $10.0 million in cash to
purchase 555,556 shares of Covad's common stock. The investment was made as
part of a broader strategic relationship with Covad. The shares of common
stock were purchased at Covad's initial public offering price of $18.00 per
share. Additionally, SBC has agreed to purchase approximately $19.5 million of
common stock from the Company. This investment by SBC is expected to close in
early February 1999.
In January 1999, the Company filed a registration statement with the
Securities and Exchange Commission for a proposed public offering of up to
2,875,000 shares of common stock. The proceeds of the offering will be used
for general corporate purposes.
Disclosures About Market Risk
The following discusses the Company's exposure to market risk related to
changes in interest rates, equity prices and foreign currency exchange rates.
This discussion contains forward-looking statements that are subject to risks
and uncertainties. Actual results could vary materially as a result of a
number of factors including those set forth under the captions "Factors
Affecting Operating Results--We Have Incurred Substantial Indebtedness and May
Not Be Able to Service Our Debt" and "Factors Affecting Operating Results--We
May Need Additional Capital in the Future and Such Additional Financing May
Not Be Available."
Interest Rate Sensitivity.
Short-Term Investments Owned By the Company. As of December 31, 1998, the
Company had short term investments of $52.2 million. These short-term
investments consist of highly liquid investments with original maturities at
the date of purchase of between three and twelve months. These investments are
subject to interest rate risk and will fall in value if market interest rates
increase. A hypothetical increase in market interest rates by 10 percent from
levels at December 31, 1998 would cause the fair value of these short-term
investments to decline by an immaterial amount. The Company has the ability to
hold these investments until maturity, and therefore the Company would not
expect the value of these investments to be affected to any significant degree
by the effect of a sudden change in market interest rates. Declines in
interest rates over time will, however, reduce the Company's interest income.
Outstanding Debt of the Company. As of December 31, 1998, the Company had
outstanding long term debt of approximately $150.0 million at a fixed interest
rate of 12 3/4% and $150.0 million of preferred stock outstanding with a
dividend rate of 13 1/2%. In certain circumstances, the Company may redeem
this preferred stock or exchange long-term debt for this preferred stock.
Because the interest and dividend rates on these instruments are fixed, a
hypothetical 10 percent decrease in interest rates would not have a material
impact on the Company. Increases in interest rates could, however, increase
the interest expense associated with future borrowings by the Company, if any.
The Company does not hedge against interest rate increases.
Equity Price Risk.
The Company owns 555,556 shares of the common stock of Covad. The Company
purchased these shares at the time of Covad's initial public offering in
January 1999 at a price of $18.00 per share. On January 25,
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1999, the closing price of Covad's common stock was $51.88 per share. The
Company values this investment using the lower of cost or market method, and
thus continues to value this investment at its cost of $10.0 million. If the
price of Covad common stock were to decline below $18.00 per share and such
decline was considered to be other than temporary, the Company would be
required to write-down the value of this investment. The Company is generally
restricted from selling these shares for at least one year from the date of
their purchase. The Company does not hedge against equity price changes.
Foreign Currency Exchange Rate Risk.
All of the Company's revenues are realized in dollars and substantially all
of the Company's revenues are from customers in the United States. Therefore,
the Company does not believe it has any significant direct foreign currency
exchange rate risk. The Company does not hedge against foreign currency
exchange rate changes.
Impact of The Year 2000 Issue
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, date-
sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of normal business activities. The Company is currently in
the process of reviewing its products and services, as well as its internal
management information systems in order to identify and modify those products,
services and systems that are not year 2000 compliant.
Based on the Company's assessment to date, the Company has determined that
its internally developed software, including much of its operational,
financial and management information systems software is year 2000 compliant.
The Company's operational, financial and management information systems
software which have not been internally developed have been certified as year
2000 compliant by the third party vendors who have supplied the software. The
equipment and software that runs the Company's data centers are supplied by
Microsoft, Nortel/Bay Networks and Sun Microsystems. The Company has
implemented software patches supplied by Microsoft so that the Microsoft
software in these data centers no longer contains any material year 2000
deficiencies. The Company implemented similar patches for the software
supplied by Sun Microsystems at the end of 1998 and expects to replace the Bay
Networks equipment and software by the end of March 1999 with versions which
do not contain any material year 2000 deficiencies. The Company expects such
modifications will be made on a timely basis and does not believe that the
cost of such modifications will have a material effect on the Company's
operating results. Additionally, the Company is continuing to assess the year
2000 compliance of its products and services. To date, most newly introduced
products and services of the Company do not contain material year 2000
deficiencies, however some of the Company's customers are running earlier
product versions that are not year 2000 compliant. The Company has been
encouraging such customers to migrate to current product versions. The Company
estimates that the capital and other costs associated with the upgrade and
conversion of its existing products, services and systems relating to the year
2000 issue will not be material. The Company does not separately track
internal costs incurred to assess and remedy deficiencies related to the year
2000 problem, however, such costs are principally the payroll costs for its
information systems group. The Company does not have and is not developing a
contingency plan in the event its systems fail as a result of year 2000
related problems.
The Company's products, services and systems operate in complex network
environments and directly and indirectly interact with a number of other
hardware and software systems. The Company faces risks to the extent that
suppliers of products, services and systems purchased by the Company and
others with whom the Company transacts business on a worldwide basis,
including those which form significant portions of the Company's network and
may be sole- or limited-source suppliers, do not have business systems or
products that comply with year 2000 requirements. The Company has not received
significant assurances from its suppliers that their networks are year 2000
compliant. If these networks fail, the Company's business will be
significantly impacted.
The Company's expectation that it will be able to upgrade its products,
services and systems to address the year 2000 issue and its expectation
regarding the costs associated with these upgrades are forward-looking
statements subject to a number of risks and uncertainties. Actual results may
vary materially as a result of a
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number of factors. There can be no assurance that the Company will be able to
timely and successfully modify such products, services and systems to comply
with year 2000 requirements. Any failure to do so could have a material
adverse effect on the Company's operating results. Furthermore, despite
testing by the Company and its vendors, the Company's products, services and
systems may contain undetected errors or defects associated with year 2000
date functions. In the event any material errors or defects are not detected
and fixed or third parties cannot timely provide the Company with products,
services or systems that meet the year 2000 requirements, the Company's
operating results could be materially adversely affected. Known or unknown
errors or defects that affect the operation of the Company's products,
services or systems could result in delay or loss of revenue, interruption of
network services, cancellation of customer contracts, diversion of development
resources, damage to the Company's reputation, and litigation costs. There can
be no assurance that these or other factors relating to year 2000 compliance
issues will not have a material adverse effect on the Company's business,
operating results or financial condition.
Factors Affecting Operating Results
As described by the following factors, past financial performance should
not be considered a reliable indicator of future performance and investors
should not use historical trends to anticipate results or trends in future
periods.
We Have a Limited Operating History and Expect Continuing Operating Losses.
We were incorporated in 1991, commenced network operations in 1994 and
completed initial deployment of our current network architecture and use of an
advanced ATM backbone network in late 1996. Accordingly, we have a limited
operating history upon which an evaluation of our prospects can be based. Our
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in new and rapidly evolving markets. To
address these risks, we must, among other things:
. respond to competitive developments;
. continue to attract, retain and motivate qualified personnel; and
. continue to upgrade our technologies and commercialize network
services incorporating such technologies.
We cannot assure you that we will be successful in addressing the risks we
face. The failure to do so could have a material adverse effect on our
business, financial condition and results of operations.
We have incurred net losses and experienced negative cash flow from
operations since inception. We expect to continue to operate at a net loss and
experience negative cash flow at least through 1999. Our ability to achieve
profitability and positive cash flow from operations is dependent upon our
ability to substantially grow our revenue base and achieve other operating
efficiencies. We experienced net losses attributable to common stockholders of
approximately $66.4 million for the year ended December 31, 1996, $55.6
million for the year ended December 31, 1997 and $94.1 million for the year
ended December 31, 1998. At December 31, 1998, we had an accumulated deficit
of approximately $246.1 million. We cannot assure you that we will be able to
achieve or sustain revenue growth, profitability or positive cash flow on
either a quarterly or an annual basis.
Our estimates of the periods of time in which we expect to continue to
operate at a net loss, experience negative cash flow and not generate taxable
income are forward-looking statements that involve risks and uncertainties.
Actual results could vary materially as a result of a number of factors,
including those set forth in this 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;
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. the incurrence of capital costs related to network expansion;
. variability and length of the sales cycle associated with our
product and service offerings;
. the receipt of new value-added network services and consumer
services subscriptions;
. the introduction of new services by us and our competitors;
. the pricing and mix of services offered by us;
. our customer retention rate;
. market acceptance of new and enhanced versions of our services;
. changes in pricing policies by our competitors;
. our ability to obtain sufficient supplies of sole- or limited-source
components;
. user demand for network and Internet access services;
. balancing of network usage over a 24-hour period;
. the ability to manage potential growth and expansion;
. the ability to identify, acquire and successfully integrate suitable
acquisition candidates; and
. charges related to acquisitions.
Variations in the timing and amounts of revenues due to these actions could
have a material adverse effect on our quarterly operating results. Due to the
foregoing factors, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful. Such comparisons cannot be
relied upon as indicators of future performance. If our operating results in
any future period fall below the expectations of securities analysts and
investors, the market price of our securities would likely decline.
The Loss of Any of Our Major Customers Could Severely Impact Our Business.
We currently derive a substantial portion of our total revenue from WebTV.
Revenue from WebTV accounted for 10.1% of our revenue for the year ended
December 31, 1996, 33.4% of our revenue for the year ended December 31, 1997
and 26.8% of our revenue for the year ended December 31, 1998.
WebTV may terminate our current agreement at will after October 31, 2000.
While we expect revenue from WebTV to decrease as a percentage of revenue in
future periods, we believe that revenue derived from a limited number of
customers may continue to represent a significant portion of our revenue. As a
result, the loss of one or more of our major customers could have a material
adverse effect on our business, financial condition and results of operations.
In addition, we cannot assure you that revenue from customers that have
accounted for significant revenue in past periods, individually or as a group,
will continue, or will reach or exceed historical levels in any future period.
Our Growth and Expansion May Strain Our Resources.
Our business and service offerings have grown rapidly since our inception.
The growth and expansion of our business and our service offerings have
placed, and are expected to continue to place, a significant strain on our
management, operational and financial resources. In addition, we recently
expanded and upgraded our network to use an ATM backbone. We plan to continue
to substantially expand our network in 1999 and future periods. To manage our
growth, we must, among other things:
. continue to implement and improve our operational, financial and
management information systems, including our billing, accounts
receivable and payable tracking, fixed assets and other financial
management systems;
. hire, train and retain qualified personnel; and
. continue to expand and upgrade our network infrastructure.
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We are currently in the process of replacing and updating our operational,
financial and management information systems. The systems being replaced and
updated include our billing, provisioning and other financial management
systems. We began to replace our information systems facilities in the fourth
quarter of 1998 and these efforts will continue throughout 1999. We also
consolidated our Silicon Valley operations in a new, larger facility in the
fourth quarter of 1998 and will transfer our remaining Silicon Valley data
centers to this facility during the first two quarters of 1999. Management of
the transition of our information systems and of the personnel and operational
equipment to the new facility is expected to place additional strain on our
resources. We cannot assure you that this transition will be completed
successfully or on a timely basis.
We cannot assure you that we will be able to expand our network or add
services at the rate or according to the schedule presently planned by us. We
had 96 employees and 47 independent contractors as of December 31, 1996, and
have grown to 508 employees and 61 independent contractors as of December 31,
1998. We cannot assure you that we will be able to effectively manage this
growth in personnel. Additionally, we cannot assure you that we will be able
to hire, train and retain sufficient numbers of qualified personnel to meet
our requirements.
Our expanding customer base demands the rapid growth of our network
infrastructure and technical support resources. We may in the future
experience difficulties meeting the demand for our access services and
technical support. We cannot assure you that our technical support or other
resources will be sufficient to facilitate our growth. We are striving to
increase total network utilization and to optimize this utilization by
targeting both business and consumer users to balance the network's usage
throughout a 24-hour period. There will be additional demands on our customer
support, sales and marketing resources as we pursue this utilization strategy.
If we fail to manage our growth effectively, our business, financial condition
and results of operations could be materially adversely affected.
Our Acquisition Strategy Poses Several Risks.
We have completed three acquisitions to date and may seek to acquire
additional assets, technologies and businesses complementary to our
operations. The completed acquisitions are and any subsequent acquisitions
would be accompanied by the risks commonly encountered in such transactions.
Such risks include, among other things:
. difficulties integrating the operations and personnel of acquired
companies;
. the additional financial resources that may be needed to fund the
operations of acquired companies;
. the potential disruption of our business;
. our management's ability to maximize our financial and strategic
position by the incorporation of acquired technology or businesses
into our service offerings;
. the difficulty of maintaining uniform standards, controls,
procedures and policies;
. the potential loss of key employees of acquired companies;
. the impairment of relationships with employees and customers as a
result of changes in management; and
. the incurrence of significant expenses in consummating acquisitions.
Any of the above risks could prevent us from realizing significant benefits
from our acquisitions. In addition, the issuance of our common stock in
acquisitions will dilute our stockholder interests in our company, while the
use of cash will deplete our cash reserves. Finally, if we are unable to
account for our acquisitions under the "pooling of interests" method of
accounting, we may incur significant, one-time write-offs and amortization
charges. These write-offs and charges could decrease our future earnings or
increase our future losses.
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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
1999. We are currently discussing with Microsoft an extension of the term of
our agreement, but we cannot assure you that these discussions will be
successful. We have an agreement with Intuit for the development, operation
and maintenance of a VPN that is the integrated access, dial-up network and
infrastructure used by purchasers of Quicken, Turbo Tax and other Intuit
software products. Intuit customers use this VPN to access the Quicken
Financial Network Website and the Internet. The Intuit contract may be
terminated at the election of Intuit upon six months prior notice of an
election to terminate. We have also recently entered into strategic agreements
with SBC and Teligent for the delivery of private-labeled services to their
customers. We rely on these relationships for the acquisition of enterprise
and consumer customers. Our inability to capitalize on these agreements, the
termination of or failure to renew any of these agreements or our inability to
enter into similar relationships with others could have a material adverse
effect on our business, financial condition and results of operation.
We have an outsourcing agreement with Williams Technology Solutions, a
subsidiary of Williams Communications Group, Inc., that enables us to use
Williams employees for the operational support of our network. Our use of
Williams employees and Williams engineering expertise was integral to the
development of our network and continue to be integral to the ongoing
operation of our network operations center. Pursuant to the agreement with
Williams, all of the Williams employees currently working for us will become
our employees when the agreement terminates in December 2000. Termination of
any of these agreements or our failure to renew any of the agreements upon
termination on terms acceptable to us could have a material adverse effect on
our business, financial condition and results of operations.
We Depend Upon New and Uncertain Markets.
We offer tailored, value-added network services for enterprises and
consumers, including Internet access. These markets are in the early stages of
development. It is difficult to predict the rate at which the market will
grow, if at all, because these markets are relatively new and current and
future competitors are likely to introduce competing services or products. New
or increased competition may result in market saturation. Certain critical
issues concerning commercial use of tailored, value-added services and
Internet services, remain unresolved and may impact the growth of such
services. These issues include, among others, security, reliability, ease and
cost of access, and quality of service. Our business, financial condition and
results of operations would be materially adversely affected if the markets
for our services, including Internet access:
. fail to grow;
. grow more slowly than anticipated; or
. become saturated with competitors.
We Depend Upon New and Enhanced Services.
We have recently introduced new enterprise service offerings, including the
introduction of value-added, IP-based communication services to enterprises
and a new line of DSL services in limited areas. The failure of these services
to gain market acceptance in a timely manner or at all, or the failure of the
DSL service in particular, to achieve significant market coverage could have a
material adverse effect on our business, financial condition and results of
operations. If we introduce new or enhanced services with reliability, quality
or compatibility problems, then market acceptance of such services could be
significantly delayed or hindered. Such problems or delays could adversely
affect our ability to attract new customers and subscribers.
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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
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sole- or limited-source components or to develop alternative sources, if
required, could result in delays and increased costs in expanding, and
overburdening of, our network infrastructure. Any such delay, increased costs
or overburdening would have a material adverse effect on our business,
financial condition and results of operations.
We also depend on our suppliers' ability to provide necessary products and
components that comply with various Internet and telecommunications standards.
These products and components must also interoperate with products and
components from other vendors. Any failure of our suppliers to provide
products or components that comply with Internet standards or that
interoperate with other products or components used by us in our network
infrastructure could have a material adverse effect on our business, financial
condition and results of operations.
Some of our suppliers, including the RBOCs and other LECs, currently are
subject to tariff controls and other price constraints that in the future may
be changed. In addition, regulatory proposals are pending that may affect what
the RBOCs and other LECs charge us. Any such regulatory changes could result
in increased prices of products and services, which could have a material
adverse effect on our business, financial condition and results of operations.
We Depend Upon Our Network Infrastructure.
Our success depends upon the capacity, reliability and security of our
network infrastructure. We currently derive a significant portion of our
revenue from customer subscriptions. We expect that a substantial portion of
our future revenue will be derived from the provision of tailored, value-added
network services to our enterprise customers. We must continue to expand and
adapt our network infrastructure as the number of users and the amount of
information they wish to transfer increase and as customer requirements
change. We currently project our network utilization will require rapid
expansion of the network capacity to avoid capacity constraints that would
adversely affect system performance. The expansion and adaptation of our
network infrastructure will require substantial financial, operational and
management resources in 1999 and future periods. We cannot assure you that we
will be able to expand or adapt our network infrastructure to meet additional
demand or our customers' changing requirements on a timely basis, at a
commercially reasonable cost, or at all. In addition, if demand for network
usage were to increase faster than projected or were to exceed our current
forecasts, the network could experience capacity constraints, which would
adversely affect the performance of the system. Our business, financial
condition and results of operations could be materially adversely affected if,
for any reason, we fail to:
. expand our network infrastructure on a timely basis;
. adapt our network infrastructure to changing customer requirements
or evolving industry trends; or
. alleviate capacity constraints experienced by our network
infrastructure.
Currently, we have transit agreements with MCI WorldCom, Sprint and UUNet
and we have peering agreements with America Online, PSINet and other network
providers to support the exchange of traffic between our network and the
Internet. We also have public peering arrangements with multiple smaller
Internet service providers. These public peering arrangements also support the
exchange of traffic between our network and the Internet. The failure of the
networks with which we have public peering, private peering or private
transit, or the failure of any of our data centers, or any other link in the
delivery chain, or any inability to successfully integrate new network
resources into our existing infrastructure, and resulting interruption of our
operations would have a material adverse effect on our business, financial
condition and results of operations.
Our Market Is Extremely Competitive.
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry in this market, and we
expect that competition will intensify in the future. We believe that our
ability to compete successfully depends upon a number of factors, including:
. market presence;
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. the capacity, reliability, low latency and security of our network
infrastructure;
. technical expertise and functionality, performance and quality of
services;
. customization;
. ease of access to and navigation of the Internet;
. the pricing policies of our competitors and suppliers;
. the variety of services;
. the timing of introductions of new services by us and our
competitors;
. customer support;
. our ability to support industry standards; and
. industry and general economic trends.
Our competitors generally may be divided into four groups:
telecommunications companies, online service providers, Internet service
providers and Web hosting providers. Many of our competitors have greater
market presence, engineering and marketing capabilities, and financial,
technological and personnel resources than those available to us. As a result,
they may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging
technologies and changes in customer requirements, take advantage of
acquisition and other opportunities more readily, and devote greater resources
to the marketing and sale of their products and services than we can. In
addition to the competitors discussed above, various organizations have
entered into or are forming joint ventures or consortiums to provide services
similar to those of our company.
We believe that new competitors will enter the value-added network services
market. Such new competitors could include large computer hardware, software,
media and other technology and telecommunications companies. Certain
telecommunications companies and online services providers are currently
offering or have announced plans to offer Internet or online services or to
expand their network services. Certain companies, including America Online,
BBN, PSINet and Verio, have also obtained or expanded their Internet access
products and services as a result of acquisitions. Such acquisitions may
permit our competitors to devote greater resources to the development and
marketing of new competitive products and services and the marketing of
existing competitive products and services. In addition, the ability of some
of our competitors to bundle other services and products with virtual private
network services or Internet access services could place us at a competitive
disadvantage. Certain companies are also exploring the possibility of
providing or are currently providing high-speed data services using
alternative delivery methods such as over the cable television infrastructure,
through direct broadcast satellites and over wireless cable.
As a result of increased competition and vertical and horizontal
integration in the industry, we could encounter significant pricing pressure.
This pricing pressure could result in significant reductions in the average
selling price of our services. For example, telecommunications companies that
compete with us may be able to provide customers with reduced communications
costs in connection with their Internet access services or private network
services, reducing the overall cost of their solutions and significantly
increasing price pressures on us. We cannot assure you that we will be able to
offset the effects of any such price reductions with an increase in the number
of our customers, higher revenue from enhanced services, cost reductions or
otherwise. In addition, we believe that the Internet access and online
services businesses are likely to encounter consolidation in the near future.
Consolidation could result in increased price and other competition in these
industries and, potentially, the virtual private networks industry. Increased
price or other competition could result in erosion of our market share and
could have a material adverse effect on our business, financial condition and
results of operations. We cannot assure you that we will have the financial
resources, technical expertise or marketing and support capabilities to
continue to compete successfully.
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We Must Keep Up With Rapid Technological Change and Evolving Industry
Standards.
The markets for our services are characterized by rapidly changing
technology, evolving industry standards, changes in customer needs, emerging
competition and frequent new product and service introductions. Our future
success will depend, in part, on our ability to:
. effectively use leading technologies;
. continue to develop our technical expertise;
. enhance our current networking services;
. develop new services that meet changing customer needs;
. advertise and market our services; and
. influence and respond to emerging industry standards and other
technological changes.
All this must be accomplished in a timely and cost-effective manner. We
cannot assure you that we will be successful in effectively using new
technologies, developing new services or enhancing our existing services on a
timely basis. We cannot assure you that such new technologies or enhancements
will achieve market acceptance. Our pursuit of necessary technological
advances may require substantial time and expense. We cannot assure you that
we will succeed in adapting our network service business to alternate access
devices and conduits as they emerge.
We believe that our ability to compete successfully is also dependent upon
the continued compatibility and interoperability of our services with products
and architectures offered by various vendors. Although we intend to support
emerging standards in the market for Internet access, we cannot assure you
that industry standards will be established. If industry standards are
established, we cannot assure you that we will be able to conform to these new
standards in a timely fashion and maintain a competitive position in the
market. Specifically, our services rely on the continued widespread commercial
use of TCP/IP. Alternative open protocol and proprietary protocol standards
have been or are being developed. If any of these alternative protocols become
widely adopted, there may be a reduction in the use of TCP/IP, which could
render our services obsolete and unmarketable. In addition, we cannot assure
you that services or technologies developed by others will not render our
services or technology uncompetitive or obsolete.
An integral part of our strategy is to design our network to meet the
requirements of emerging standards such as 56.6 Kbps modems and applications
such as IP-based interactive video and voice conferencing communications. Our
initial deployment of 56.6 Kbps modem technology was difficult for some of our
customers, including WebTV, due to compatibility problems between the software
and their modems. We had to remove the software from the network and modems to
fix the problem. We are currently testing a modified version of the software
and we expect to redeploy it into the network in the first quarter of 1999.
However, we cannot assure you that we will successfully redeploy the software.
If we fail, for technological or other reasons, to develop and introduce the
56.6 Kbps modem technology or other new or enhanced services that are
compatible with industry standards and that satisfy customer requirements,
then our business, financial condition and results of operations would be
materially adversely affected. See "Business--The Concentric Network."
We face the risk of fundamental changes in the way Internet access is
delivered. Internet services are currently accessed primarily by computers
connected by telephone lines. Several companies have announced the development
and planned sale of cable television modems, wireless modems and satellite
modems to provide Internet access. Cable television, satellite and wireless
modems can transmit data at substantially faster speeds than the modems we and
our subscribers currently use. In addition, wireless modems have the potential
to reduce the cost of network services. As the Internet becomes accessible
through these cable television, wireless and satellite modems and by screen-
based telephones, televisions or other consumer electronic devices, 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;
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. Internet access through screen-based telephones, televisions or
other consumer electronic devices; or
. subscriber requirements that change the way Internet access is
provided.
Our pursuit of these technological advances may require substantial time and
expense. We cannot assure you that we will succeed in adapting our Internet
access business to alternate access devices and conduits.
Our Network System Could Fail.
Network expansion and growth in usage will place increased stress upon our
network hardware and traffic management systems. Our network has been designed
with redundant backbone circuits to allow traffic re-routing. We cannot assure
you, however, that we will not experience failures relating to individual
network POPs or even catastrophic failure of the entire network. Moreover, our
operations are dependent upon our ability to protect our network infrastructure
against damage from power loss, telecommunications failures and similar events.
A significant portion of our computer equipment, including critical equipment
dedicated to our Internet access services, is located at our facilities in
Chicago, Illinois, and Cupertino, California. In addition, our modems and
routers that serve large areas of the United States are located in these
cities. Our network operations center, which manages the entire network, is in
St. Louis, Missouri. Despite our precautions, a natural disaster, such as an
earthquake, or other unanticipated problem at the network operations center, at
one of our hubs (sites at which we have located routers, switches and other
computer equipment that make up the backbone of our network infrastructure) or
at a number of our POPs has from time to time in the past caused, and in the
future could cause, interruptions in our services. In addition, our services
could be interrupted if our telecommunications providers fail to provide the
data communications capacity in the time frame required by us as a result of a
natural disaster or for some other reason. Any damage or failure that causes
interruptions in our operations could have a material adverse effect on our
business, financial condition and results of operations.
Our System May Experience Security Breaches.
Despite the implementation of network security measures, the core of our
network infrastructure is vulnerable to computer viruses, break-ins and similar
disruptive problems caused by our customers or Internet users. Computer
viruses, break-ins or other problems caused by third parties could lead to
interruptions, delays or cessation in service to our customers and subscribers.
Furthermore, inappropriate use of the network by third parties could also
potentially jeopardize the security of confidential information stored in our
computer systems and our customer's computer systems. We may face liability and
may lose potential subscribers as a result. Although we intend to continue to
implement industry-standard security measures, such measures occasionally have
been circumvented in the past. We cannot assure you that our security
enclosures will not be circumvented in the future. The costs and resources
required to eliminate computer viruses and alleviate other security problems
may result in interruptions, delays or cessation of service to our customers
that could have a material adverse effect our business, financial condition and
results of operations.
We Depend Upon Key Personnel and May be Unable to Timely Hire and Retain
Sufficient Numbers of Qualified Personnel.
Our success depends to a significant degree upon the continued contributions
of our executive management team, including Henry R. Nothhaft, the Company's
Chairman, President and Chief Executive Officer, and John K. Peters, the
Company's Executive Vice President and General Manager, Network Services
Applications Division. The loss of the services of Mr. Nothhaft or Mr. Peters
could have a material adverse effect on us. We do not have employment
agreements with any of our senior officers, including Mr. Nothhaft or Mr.
Peters. Nor do we carry key man life insurance on the life of any such persons.
Our success will also depend upon the continued service of the other members of
our senior management team and technical, marketing and sales personnel.
Competition for qualified employees is intense. Our employees may voluntarily
terminate their employment with us at any time. Our success also depends upon
our ability to attract and retain additional highly qualified management,
technical, sales and marketing and customer support personnel. Locating
personnel with
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the combination of skills and attributes required to carry out our strategy is
often a lengthy process. The loss of key personnel, or the inability to
attract additional, qualified personnel, could have a material adverse effect
upon our results of operations, development efforts and ability to complete
the expansion of our network infrastructure. Any such event could have a
material adverse effect on our business, financial condition and results of
operations.
We Have Incurred Substantial Indebtedness and May Not Be Able to Service Our
Debt.
We are and will continue to have a significant amount of outstanding
indebtedness. We have significant debt service requirements as a result of
this indebtedness. At December 31, 1998, our total debt (including current
portion) was $163.0 million and stockholders' deficit was $56.9 million.
Interest on such indebtedness totals approximately $19.1 million per year. We
also issued 150,000 shares of preferred stock in June 1998. Dividends accrue
on the preferred stock at the rate of 13 1/2% per year. At December 31, 1998,
dividends and accretion on the preferred stock totaled approximately $12.0
million. Dividends and accretion will total approximately $23.0 million in
1999 and are expected to grow in each successive year. To date, we have chosen
to pay such dividends in shares of preferred stock, rather than in cash. We
must also redeem the preferred stock in 2010. As a result of these and other
features, the preferred stock is substantially equivalent to debt. Our debt,
including the preferred stock, has important consequences for our company and
for you, including the following:
. our ability to obtain additional financing in the future, whether
for working capital, capital expenditures, acquisitions or other
purposes, may be impaired;
. a substantial portion of our cash flow from operations is dedicated
to the payment of interest on our debt, which reduces the funds
available to us for other purposes;
. our flexibility in planning for or reacting to changes in market
conditions may be limited; and
. we may be more vulnerable in the event of a downturn in our
business.
Our ability to meet our debt service and preferred stock dividend
obligations will depend on our future operating performance and financial
results. This ability will be subject in part to factors beyond our control.
Although we believe that our cash flow will be adequate to meet our interest
and dividend payments, we cannot assure you that we will continue to generate
sufficient cash flow in the future to meet our debt service and preferred
stock requirements. If we are unable to generate cash flow in the future
sufficient to cover our fixed charges and are unable to borrow sufficient
funds from other sources, then we may be required to:
. refinance all or a portion of our existing debt; or
. sell all or a portion of our assets.
We cannot assure you that a refinancing would be possible. We cannot assure
you that any asset sales would be timely or that the proceeds which we could
realize from such asset sales would be sufficient to meet our debt service
requirements. In addition, the terms of our debt and preferred stock restrict
our ability to sell our assets and our use of the proceeds from any such asset
sale.
We May Need Additional Capital in the Future and Such Additional Financing
May Not Be Available.
We currently anticipate that our available cash resources, combined with
the net proceeds from this offering and financing available under a network
equipment lease agreement (that currently has no maximum borrowing limit),
will be sufficient to meet our anticipated working capital and capital
expenditure requirements through 1999. However, we cannot assure you that such
resources will be sufficient for anticipated or unanticipated working capital
and capital expenditure requirements. We may need to raise additional funds
through public or private debt or equity financings in order to:
. take advantage of unanticipated opportunities, including more rapid
international expansion or acquisitions of complementary businesses
or technologies;
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. develop new products or services; or
. respond to unanticipated competitive pressures.
We may also raise additional funds through public or private debt or equity
financings if such financings become available on favorable terms. We cannot
assure you that any additional financing we may need will be available on
terms favorable to us, or at all. If adequate funds are not available or are
not available on acceptable terms, we may not be able to take advantage of
unanticipated opportunities, develop new products or services or otherwise
respond to unanticipated competitive pressures. In such case, our business,
results of operations and financial condition could be materially adversely
affected. Our forecast of the period of time through which our financial
resources will be adequate to support our operations is a forward looking
statement that involves risks and uncertainties, and actual results could vary
materially as a result of a number of factors, including those set forth
above.
We Face Risks Associated with International Expansion.
A key component of our strategy is to expand into international markets.
The following risks are inherent in doing business on an international level:
. unexpected changes in regulatory requirements;
. export restrictions;
. export controls relating to encryption technology;
. tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations;
. longer payment cycles;
. problems in collecting accounts receivable;
. political instability;
. fluctuations in currency exchange rates;
. seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
. potentially adverse tax consequences that could adversely impact the
success of our international operations.
We cannot assure you that one or more of such factors will not have a
material adverse effect on our future international operations and,
consequently, on our business, financial condition and results of operations.
We have an agreement with TMI Telemedia International, Ltd., a subsidiary
of the leading Italian telecommunications company, Telecom Italia, SpA, to
establish an international network based on our network technology and
expertise and TMI's existing telecommunications infrastructure. In exchange,
we granted TMI certain exclusive rights in critical markets, including Europe.
While the goal of this effort is to deliver a range of compatible network
services worldwide, to date we have had only limited deployment of services
under this agreement. Our experience in working with TMI to develop versions
of our products and to market and distribute our products internationally is
limited. Our international strategy has not developed as rapidly as
anticipated and may be further delayed if:
. we cannot successfully deploy our technology over TMI's
infrastructure;
. we cannot transfer our knowledge to TMI's employees; or
. TMI does not devote sufficient management, technological or
marketing resources to this project.
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Our business, results of operation or financial condition could be
materially adversely affected if delays in our international strategy continue
or worsen.
We have entered into roaming agreements with third parties to allow our
customers to access their Internet accounts from Japan and certain other
foreign countries. We provide Web hosting and extranet services for GX
Networks' United Kingdom customers pursuant to an agreement signed in August
1998. We also acquired Web hosting facilities in Stockholm, Sweden, Tokyo,
Japan and Hong Kong in February 1998 as a result of our acquisition of
Internex. We cannot assure you that we will be able to successfully market,
sell and deliver our products in these markets.
Our Business May Be Impacted By The Year 2000 Issue.
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, date-
sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of normal business activities. We are currently in the
process of reviewing our products and services, as well as our internal
management information systems in order to identify and modify those products,
services and systems that are not year 2000 compliant.
Based on our assessment to date, we have determined that our internally
developed software, including much of our operational, financial and
management information systems software, is year 2000 compliant. Our
operational, financial and management information systems software which have
not been internally developed have been certified as year 2000 compliant by
the third party vendors who have supplied the software. To the extent that our
systems are not year 2000 compliant, we are modifying such systems to make
them compliant. We expect such modifications will be made on a timely basis
and do not believe that the cost of such modifications will have a material
effect on our operating results. Additionally, we are continuing to assess the
year 2000 compliance of our products and services. To date, most of our newly
introduced products and services do not contain material year 2000
deficiencies, however some of our customers are running earlier product
versions that are not year 2000 compliant. We have been encouraging such
customers to migrate to current product versions. We estimate that the capital
and other costs associated with the upgrade and conversion of our existing
products, services and systems relating to the year 2000 issue will not be
material. We do not have and are not developing a contingency plan in the
event our systems fail due to year 2000 related problems.
Our products, services and systems operate in complex network environments
and directly and indirectly interact with a number of other hardware and
software systems. We face risks to the extent that suppliers of products,
services and systems purchased by us and others with whom we transact business
on a worldwide basis, including those which form significant portions of our
network and may be sole- or limited-source suppliers, do not have business
systems or products that comply with year 2000 requirements. We have not
received any significant assurances from our suppliers that their networks are
year 2000 compliant. If these networks fail, our business will be
significantly impacted.
Our expectation that we will be able to upgrade our products, services and
systems to address the year 2000 issue and our expectation regarding the costs
associated with these upgrades are forward-looking statements subject to a
number of risks and uncertainties. Actual results may vary materially as a
result of a number of factors. We cannot assure you that we will be able to
timely and successfully modify such products, services and systems to comply
with year 2000 requirements. Any failure to do so could have a material
adverse effect on our operating results. Furthermore, despite testing by us
and our vendors, our products, services and systems may contain undetected
errors or defects associated with year 2000 date functions. In the event any
material errors or defects are not detected and fixed or third parties cannot
timely provide us with products, services or systems that meet the year 2000
requirements, our operating results could be materially adversely affected.
Known or unknown errors or defects that affect the operation of our products,
services or systems could result in delay or loss of revenue, interruption of
network services, cancellation of customer contracts, diversion of
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development resources, damage to our reputation, and litigation costs. We
cannot assure you that these or other factors relating to year 2000 compliance
issues will not have a material adverse effect on our business, operating
results or financial condition.
We Could Face Government Regulation.
The Federal Communications Commission ("FCC") currently does not regulate
value-added network software or computer equipment related services that
transport data or IP-based voice messages over telecommunication facilities as
telecommunications services. We provide value-added IP-based network services,
in part, through data transmissions over public telephone lines. Operators of
these types of value-added networks that provide access to regulated
transmission facilities only as part of a data services package are classified
for regulatory purposes as providers of "information services" and are
currently excluded from regulations that apply to "telecommunications
carriers." As such, we are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, future changes in law or regulation could
result in some aspects of our current operations becoming subject to
regulation by the FCC or another regulatory agency.
The FCC currently is reviewing its regulatory positions on data
transmissions over telecommunications networks and could seek to impose some
form of telecommunications carrier regulation on the network transport and
telecommunications functions of an enhanced or information services package.
Further, the FCC could conclude that our protocol conversions, computer
processing and interaction with customer-supplied information are insufficient
to afford us with the benefits of the enhanced or information service
regulatory classification. If the FCC reaches such conclusions, it may seek to
regulate some segments of our activities as telecommunications services.
State public utility commissions generally have declined to regulate
enhanced or information services. Some states, however, have continued to
regulate particular aspects of enhanced services in limited circumstances,
such as where they are provided by incumbent LECs that operate
telecommunications networks. Moreover, the public service commissions of some
states continue to review potential regulation of such services. We cannot
assure you that regulatory authorities of states where we provide Internet
access, intranet and VPN services will not seek to regulate aspects of these
activities as telecommunications services. The prices at which we may sell our
services could be affected by regulatory changes:
. in the Internet connectivity market;
. that indirectly or directly affect telecommunications costs; or
. that increase the likelihood or scope of competition from the RBOCs.
We cannot predict the impact, if any, that future regulation or regulatory
changes may have on our business and we cannot assure you that future
regulation or regulatory changes will not have a material adverse effect on
our business, results of operations or financial condition.
We Depend On Our Proprietary Technology and Technological Expertise.
Our success and ability to compete is dependent in part upon our
technology. In this regard, we believe our success is more dependent upon our
technical expertise than our proprietary rights. We rely upon a 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
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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 implement
measures to reduce our exposure to such liability. Such measures may require
the expenditure of substantial resources or the discontinuation of certain
product or service offerings. Further, the costs of defending against any such
claims and potential adverse outcomes of such claims could have a material
adverse effect on our business, financial condition and results of operations.
The Child Online Protection Act of 1998 has been challenged by civil rights
organizations in part on the grounds that it violates the First Amendment. A
similar statute was held unconstitutional by the United States Supreme Court
in 1997. A United States District Court has temporarily enjoined enforcement
of the law until February 1, 1999, and it is possible that additional
injunctions prohibiting enforcement of the statute will be entered pending
final resolution of the case.
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We Have Discretionary Authority Over the Use of Net Proceeds.
We have no specific allocations for the net proceeds of this offering.
Consequently, management will retain a significant amount of discretion over
the application of such proceeds. Because of the number and variability of
factors that determine our use of the net proceeds of the offering, we cannot
assure you that such applications will not vary substantially from our current
intentions. Pending such uses, we intend to invest the net proceeds of the
offering in short term U.S. investment grade and government securities.
Our Stock Price Has Been and May Continue to Be Volatile.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to
a variety of factors, including the following:
. actual or anticipated variations in quarterly operating results;
. announcements of technological innovations;
. new products or services offered by us or our competitors;
. changes in financial estimates by securities analysts;
. conditions or trends in the network services market;
. our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
. additions or departures of key personnel;
. sales of common stock; and
. other events or factors that may be beyond our control.
In addition, the stock markets in general, and the Nasdaq National Market
and the market for network services and technology companies in particular,
have experienced extreme price and volume fluctuations recently. These
fluctuations often have been unrelated or disproportionate to the operating
performance of these companies. The trading prices of many technology
companies' stocks are at or near historical highs and these trading prices and
multiples are substantially above historical levels. These trading prices and
multiples may not be sustained. These broad market and industry factors may
materially adversely affect the market price of our common stock, regardless
of our actual operating performance. In the past, following periods of
volatility in the market price of a company's securities, securities class
action litigation often has been instituted against that company. Litigation
like this, if instituted, could result in substantial costs and a diversion of
management's attention and resources.
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Item 8. Financial Statements and Supplementary Data
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Concentric Network Corporation
We have audited the accompanying consolidated balance sheets of Concentric
Network Corporation as of December 31, 1997 and 1998, and the related
consolidated statements of operations, common stock subject to rescission and
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule included in Item 14. These financial statements and
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Concentric Network Corporation at December 31, 1997 and 1998, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the financial information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
January 25, 1999
47
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 119,959 $ 98,988
Short term investments................................. -- 52,226
Current portion of restricted cash..................... 19,125 19,125
Accounts receivable, net of allowances of $80 in 1997
and $690 in 1998...................................... 4,549 13,714
Prepaid expenses and other current assets.............. 3,871 3,058
--------- ---------
Total current assets................................. 147,504 187,111
Property and equipment:
Computer and telecommunications equipment.............. 71,942 89,668
Software............................................... 1,519 5,427
Furniture and fixtures and leasehold improvements...... 2,984 11,357
--------- ---------
76,445 106,452
Accumulated depreciation and amortization.............. 22,735 42,184
--------- ---------
53,710 64,268
Restricted cash, net of current portion................. 33,400 17,113
Goodwill and other intangible assets, net of current
portion................................................ -- 20,364
Other assets............................................ 9,875 9,401
--------- ---------
Total assets....................................... $ 244,489 $ 298,257
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................... $ 10,144 $ 26,342
Accrued compensation and other employee benefits....... 1,577 2,024
Other current liabilities.............................. 4,917 4,559
Current portion of capital lease obligations,
including $13,600 in 1997 to a related party.......... 15,326 6,543
Deferred revenue....................................... 1,435 3,104
--------- ---------
Total current liabilities............................ 33,399 42,572
Capital lease obligations, including $32,373 in 1997 to
a related party, net of current portion................ 33,595 10,434
Notes payable........................................... 145,577 146,021
Commitments and contingencies
Redeemable exchangeable preferred stock................. -- 156,105
Stockholders' equity (deficit):
Preferred stock, $0.001 par value; issuable in series:
Authorized shares--10,000 in 1997 and 1998
Issued and outstanding shares--none in 1997 and
1998................................................ -- --
Common stock, $0.001 par value; issuable in classes:
Authorized shares--100,000 in 1997 and 1998
Issued and outstanding shares--14,139 in 1997 and
15,144 in 1998....................................... 182,721 190,076
Accumulated deficit..................................... (149,534) (246,055)
Deferred compensation................................... (1,269) (896)
--------- ---------
Total stockholders' equity (deficit)................. 31,918 (56,875)
--------- ---------
Total liabilities and stockholders' equity
(deficit)......................................... $ 244,489 $ 298,257
========= =========
</TABLE>
See accompanying notes.
48
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Revenue.......................................... $ 15,648 $ 45,457 $ 82,807
Costs and expenses:
Cost of revenue................................ 47,945 61,439 85,352
Network equipment write-off.................... 8,321 -- --
Development.................................... 2,449 4,850 7,734
Marketing and sales, including $2,448, $2,600
and $1,085 to a related party for the years
ended December 31, 1996, 1997 and 1998,
respectively.................................. 16,609 24,622 39,793
General and administrative..................... 3,445 4,790 10,398
Amortization of goodwill and other intangible
assets........................................ -- -- 3,842
Acquisition-related charges.................... -- -- 1,291
Write-off of in-process technology............. -- -- 5,200
-------- -------- --------
Total costs and expenses..................... 78,769 95,701 153,610
-------- -------- --------
Loss from operations............................. (63,121) (50,244) (70,803)
Other income (expense)........................... -- 1,233 (750)
Interest income.................................. 614 1,217 9,975
Interest expense, including $3,065, $6,197 and
$1,272 to related parties for the years ended
December 31, 1996, 1997 and 1998, respectively.. (3,874) (7,788) (23,570)
-------- -------- --------
Loss before extraordinary item................... (66,381) (55,582) (85,148)
Extraordinary gain on early retirement of debt... -- -- 3,042
-------- -------- --------
Net loss......................................... (66,381) (55,582) (82,106)
Preferred stock dividends and accretion.......... -- -- (11,958)
-------- -------- --------
Net loss attributable to common stockholders..... $(66,381) $(55,582) $(94,064)
======== ======== ========
Net loss per share (pro-forma 1996 and 1997,
historical 1998)
Loss before extraordinary item................. $ (13.46) $ (5.63) $ (5.86)
Extraordinary gain............................. -- -- .21
-------- -------- --------
Net loss......................................... (13.46) (5.63) (5.65)
Preferred stock dividends and accretion.......... -- -- (.82)
-------- -------- --------
Net loss per share attributable to common
stockholders.................................... $ (13.46) $ (5.63) $ (6.47)
======== ======== ========
Shares used in computing net loss and net loss
attributable to common stockholders per share
(pro-forma 1996 and 1997, historical 1998)...... 4,937 9,872 14,547
======== ======== ========
</TABLE>
See accompanying notes.
49
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
<TABLE>
<CAPTION>
Stockholders' Equity (Deficit)
--------------------------------------------------------------------------
Common Stock
Subject to Total
Rescission Preferred Stock Common Stock Stockholders'
-------------- ---------------- ---------------- Accumulated Deferred Equity
Shares Amount Shares Amount Shares Amount Deficit Compensation (Deficit)
------ ------- ------ -------- ------ -------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... 445 $ 5,080 2,078 $ 35,695 1,388 $ 1,639 $ (27,571) $ -- $ 9,763
Issuance of Class A
common stock.......... -- -- -- -- -- 1 -- -- 1
Conversion of
debentures to Class A
common stock.......... 10 70 -- -- -- -- -- -- --
Exercise of options.... -- -- -- -- 5 22 -- -- 22
Conversion of note to
Series C preferred
stock (net of issuance
costs)................ -- -- 123 2,960 -- -- -- -- 2,960
Issuance of Series D
preferred stock (net
of issuance costs).... -- -- 2,451 48,533 -- -- -- -- 48,533
Conversion of note to
Series D preferred
stock................. -- -- 249 5,072 -- -- -- -- 5,072
Warrants issued to
purchase Series D
preferred stock....... -- -- -- 2,955 -- -- -- -- 2,955
Deferred compensation
resulting from grant
of options............ -- -- -- -- -- 188 -- (188) --
Net loss............... -- -- -- -- -- -- (66,381) -- (66,381)
---- ------- ------ -------- ------ -------- --------- ------- --------
Balance at December 31,
1996................... 455 5,150 4,901 95,215 1,393 1,850 (93,952) (188) 2,925
Issuance of Class A
common stock for
services.............. -- -- -- -- 5 17 -- -- 17
Conversion of Class B
common to Series A
preferred stock....... -- -- 7 -- (7) -- -- -- --
Conversion of Series A,
B, C and D preferred
to Class A common
stock................. -- -- (5,693) (99,604) 5,693 99,604 -- -- --
Shares issued upon the
initial public
offering (net of
issuance costs)....... -- -- -- -- 4,945 52,757 -- -- 52,757
Shares issued in a
private placement..... -- -- -- -- 1,246 14,950 -- -- 14,950
Conversion of note to
Class A common stock.. -- -- -- -- 253 3,041 -- -- 3,041
Repurchase of Class A
common stock in
connection with the
initial public
offering.............. -- -- -- -- (185) (2,217) -- -- (2,217)
Shares issued subject
to dilution ratios.... -- -- 484 -- -- -- -- -- --
Exercise of options to
purchase stock........ -- -- -- -- 65 243 -- -- 243
Exercise of warrants to
purchase stock........ -- -- 301 3,281 309 1,201 -- -- 4,482
Warrants issued to
purchase stock........ -- -- -- 1,108 -- 5,370 -- -- 6,478
Deferred compensation
resulting from grant
of options............ -- -- -- -- -- 1,303 -- (1,303) --
Amortization of
deferred
compensation.......... -- -- -- -- -- -- -- 222 222
Expiration of statutes
of limitations on
common stock subject
to rescission......... (422) (4,602) -- -- 422 4,602 -- -- 4,602
Repurchase of shares
for cancellation in
connection with
Rescission Offer...... (33) (548) -- -- -- -- -- -- --
Net loss............... -- -- -- -- -- -- (55,582) -- (55,582)
---- ------- ------ -------- ------ -------- --------- ------- --------
Balance at December 31,
1997................... -- $ -- -- $ -- 14,139 $182,721 $(149,534) $(1,269) $ 31,918
</TABLE>
See accompanying notes.
50
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Common Stock
Subject to
Rescission
-------------
Shares Amount
------ ------
<S> <C> <C>
Amortization of deferred
compensation....................... -- $ --
Common stock issued under stock
purchase plan...................... -- --
Common stock issued in acquisition
of DeltaNet Services, Inc.......... -- --
Exercise of options to purchase
common stock....................... -- --
Exercise of warrants for no cash
consideration...................... -- --
Warrants issued to purchase stock... -- --
Net loss............................ -- --
Preferred stock dividends and
accretion.......................... -- --
--- -----
Balance at December 31, 1998......... -- $ --
- --------------------------------------------------
=== =====
<CAPTION>
Stockholders' Equity (Deficit)
--------------------------------------------------------------------
Preferred Total
Stock Common Stock Stockholders'
------------- --------------- Accumulated Deferred Equity
Shares Amount Shares Amount Deficit Compensation (Deficit)
------ ------ ------ -------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Amortization of deferred
compensation....................... -- $ -- -- $ -- $ -- $ 373 $ 373
Common stock issued under stock
purchase plan...................... -- -- 74 781 -- -- 781
Common stock issued in acquisition
of DeltaNet Services, Inc.......... -- -- 226 1,147 (2,457) -- (1,310)
Exercise of options to purchase
common stock....................... -- -- 612 3,527 -- -- 3,527
Exercise of warrants for no cash
consideration...................... -- -- 93 -- -- -- --
Warrants issued to purchase stock... -- -- -- 1,900 -- -- 1,900
Net loss............................ -- -- -- -- (82,106) -- (82,106)
Preferred stock dividends and
accretion.......................... -- -- -- -- (11,958) -- (11,958)
------ ------ ------ -------- ----------- ------------ -------------
Balance at December 31, 1998......... -- $ -- 15,144 $190,076 $(246,055) $(896) $(56,875)
- --------------------------------------------------
====== ====== ====== ======== =========== ============ =============
</TABLE>
See accompanying notes.
51
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1996 1997 1998
-------- -------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ...................................... $(66,381) $(55,582) $ (82,106)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................ 7,528 16,852 24,442
Amortization of deferred interest, cost of
revenue and marketing and sales related to
issuance of warrants........................ 1,942 1,720 1,210
Amortization of goodwill and other intangible
assets...................................... -- -- 3,842
Amortization of deferred financing costs
related to 12 3/4% Senior Notes............. -- -- 526
Amortization of other deferred assets........ -- -- 3,025
Amortization of deferred compensation........ -- 658 373
Gain on early retirement of debt............. -- -- (3,042)
Write-off of in-process technology........... -- -- 5,200
Loss on disposal of equipment................ -- 162 --
Network equipment write-off.................. 8,321 -- --
Changes in current assets and liabilities:
Prepaid expenses and other current assets... (57) (3,581) 1,009
Accounts receivable......................... (1,734) (2,700) (7,140)
Accounts payable............................ 5,129 (7,287) 7,408
Accrued compensation and other employee
benefits................................... 484 863 (315)
Deferred revenue............................ 1,097 197 509
Other current liabilities................... 1,546 2,795 (1,575)
-------- -------- ---------
Net cash used in operating activities.......... (42,125) (45,903) (46,634)
INVESTING ACTIVITIES
Additions of property and equipment............ (6,889) (6,130) (23,489)
Increase in refundable deposits................ (442) -- (1,200)
Decrease (increase) in note receivable......... -- (370) 100
Purchase of short term investments............. -- -- (52,226)
Acquisition of InterNex Information Services,
Inc., net of cash acquired.................... -- -- (15,452)
Acquisition of AnaServe, Inc., net of cash
acquired...................................... -- -- (9,625)
-------- -------- ---------
Net cash used in investing activities.......... (7,331) (6,500) (101,892)
FINANCING ACTIVITIES
Proceeds from notes payable.................... 6,300 155,000 --
Change in restricted cash...................... -- (52,525) 16,287
Repayment of lease obligations to a related
party......................................... (4,561) (10,039) (3,079)
Repayment of lease obligations to a related
party--early retirement of debt............... -- -- (24,750)
Repayment of lease obligations................. (886) (1,517) (7,079)
Repayment of notes payable..................... (1,300) (2,000) (1,960)
Repurchase of common stock..................... -- (2,765) --
Deferred financing costs....................... -- (5,006) (320)
Proceeds from issuance of redeemable
exchangeable preferred stock, net of issuance
costs......................................... -- -- 144,148
Proceeds from issuances of stock and warrants.. 48,506 73,557 4,308
-------- -------- ---------
Net cash provided by financing activities...... 48,059 154,705 127,555
-------- -------- ---------
Increase (decrease) in cash and cash
equivalents................................... (1,397) 102,302 (20,971)
Cash and cash equivalents at beginning of
period........................................ 19,054 17,657 119,959
-------- -------- ---------
Cash and cash equivalents at end of period..... $ 17,657 $119,959 $ 98,988
======== ======== =========
</TABLE>
See accompanying notes.
52
<PAGE>
CONCENTRIC NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Years Ended December
31,
-----------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Stock exchanged for notes payable, including accrued
interest............................................. $ 8,082 $ 3,041 $ --
Capital lease obligations incurred with a related
party................................................ 30,945 23,042 1,285
Capital lease obligations incurred.................... 2,136 -- 5,363
Reduction of accounts payable through capital lease
obligations incurred................................. -- 2,000 --
Convertible debentures exchanged for stock............ 70 -- --
Issuance of warrants.................................. 2,955 5,370 1,900
Purchase of property and equipment through accounts
payable.............................................. 6,344 -- --
Accretion of dividends and financing costs related to
Redeemable Exchangeable Preferred Stock.............. -- -- 11,958
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid......................................... $ 2,807 $ 5,728 $22,609
</TABLE>
See accompanying notes.
53
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
The Company
Concentric Network Corporation (the Company or Concentric) was incorporated
in the state of Florida in 1991 and reincorporated into Delaware in 1997. The
Company operates primarily in one business segment in the United States.
Concentric provides tailored, value-added Internet Protocol (IP) based network
services for businesses and consumers. To provide these services, the Company
utilizes its low/fixed latency, high-throughput network, employing its
advanced network architecture and the Internet. Concentric's service offerings
for enterprises include virtual private networks (VPNs), dedicated access
facilities (DAFs), digital subscriber line services (DSL), remote access and
Web hosting. These services enable enterprises to take advantage of standard
Internet tools such as browsers and high-performance servers for customized
data communications within an enterprise and between an enterprise and its
suppliers, partners and customers. These services combine the cost advantages,
nationwide access and standard protocols of public networks with the
customization, high performance, reliability and security of private networks.
Basis Of Presentation And Preparation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates
The preparation of these consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in these
consolidated financial statements and accompanying notes. Actual results could
differ materially from those estimates.
Cash, Cash Equivalents and Short Term Investments
The Company considers all highly liquid investments with an original
maturity (at date of purchase) of three months or less to be the equivalent of
cash for the purpose of balance sheet and statement of cash flows
presentation. Investments with maturities between three and twelve months are
considered to be short term investments. Management determines the appropriate
classification of its investments in debt securities at the time of purchase
and reevaluates such designation as of each balance sheet date. The Company's
debt securities have been classified and accounted for as available-for-sale.
These securities are carried at fair value and unrealized gains and losses
have not been material to date. Comprehensive net loss per share is not
materially different from net loss for all years presented. Realized gains and
losses and declines in value judged to be other than temporary on available-
for-sale securities are included in interest income and have not been material
to date. Cash and cash equivalents are held primarily with three financial
institutions.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
the related assets as follows: computer and telecommunications equipment:
three to five years; purchased software: three to five years; furniture and
fixtures: eight to ten years; and leasehold improvements: the shorter of the
remaining term of the related leases or the estimated economic useful lives of
the improvements. Equipment under capital leases is amortized over the shorter
of the expected useful life or the related lease term (see Note 4).
54
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue and Customer Receivables
Revenue is recognized over the period in which services are provided,
generally monthly. Payments received in advance of services being provided are
included in deferred revenue. Substantially all end-user subscribers pay for
services with major credit cards for which the Company receives daily
remittances from the credit card carriers.
Commissions and other obligations to strategic partners through marketing
and distribution arrangements are expensed as incurred, at the time the
associated revenue is recognized.
Concentration of Credit Risk
The Company typically offers its enterprise customers credit terms. The
Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. Credit losses have
historically been insignificant.
Advertising Costs
The Company expenses the costs of advertising as incurred except for
direct-response advertising costs meeting certain specific criteria. To date,
no direct-response advertising costs have been capitalized.
Income Taxes
The Company accounts for income taxes using the liability method in
accordance with Financial Accounting Standards Board Statement No. 109,
"Accounting for Income Taxes" (FAS 109).
Basic and Diluted Net Loss Per Share
Basic and diluted net loss per share have been computed in accordance with
the Financial Accounting Standards Board issued Statement No. 128, "Earnings
Per Share."
Except as noted below, net loss per share is computed using the weighted
average number of shares of common stock outstanding excluding common stock
subject to rescission. Common stock equivalent shares from convertible
preferred stock and from stock options and warrants are not included as the
effect is antidilutive. Pursuant to the Securities and Exchange Commission
Staff Accounting Bulletin No. 98 (SAB No. 98) which was issued in February
1998, common and common equivalent shares issued by the Company for nominal
consideration during any of the periods for which a statement of operations
was presented in the Company's initial public offering registration statement
have been included in the calculation of basic and diluted net loss per share
for all such periods in a manner similar to a stock split.
55
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma net loss per share gives effect, even if antidilutive, to common
equivalent shares from convertible preferred shares that were automatically
converted to common shares upon the closing of the Company's initial public
offering (using the as-if-converted method). The following table sets forth
the computation of basic and diluted loss per share, on a historical and pro
forma basis.
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
----------------------------
1996 1997 1998
-------- -------- --------
(In thousands, except per
share data)
<S> <C> <C> <C>
NUMERATOR:
Net loss before extraordinary item.............. $(66,381) $(55,582) $(85,148)
Extraordinary gain on early retirement of debt.. -- -- 3,042
-------- -------- --------
Net loss........................................ (66,381) (55,582) (82,106)
======== ======== ========
Preferred stock dividends and accretion......... -- -- (11,958)
-------- -------- --------
Numerator for basic and diluted loss per share.. $(66,381) $(55,582) $(94,064)
======== ======== ========
DENOMINATOR:
Denominator for basic and diluted earnings per
share--weighted average shares (historical).... 1,391 6,665 14,547
======== ======== ========
Adjustments to reflect the effect of the assumed
conversion of convertible preferred stock from
the date of issuance........................... 3,546 3,207
======== ========
Denominator for basic and diluted earnings per
share--weighted average shares (pro forma)..... 4,937 9,872
======== ========
Basic and diluted net loss per share
(historical):
Loss before extraordinary item................ $ (47.72) $ (8.34) $ (5.86)
-------- -------- --------
Extraordinary gain............................ -- -- .21
-------- -------- --------
Net loss...................................... (47.72) (8.34) (5.65)
======== ======== ========
Preferred stock dividends and accretion....... -- -- (.82)
-------- -------- --------
Net loss attributable to common stockholders.. $ (47.72) $ (8.34) $ (6.47)
======== ======== ========
Basic and diluted net loss per share (pro
forma)......................................... $ (13.46) $ (5.63)
======== ========
</TABLE>
Stock-Based Compensation
The Company accounts for employee stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25), and has adopted the "disclosure only"
alternative described in Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123).
Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of," the Company continually reviews long-lived assets to
assess recoverability based upon undiscounted cash flow analysis. Impairments,
if any, are recognized in operating results in the period in which a permanent
diminution in value is determined (see Note 3).
56
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Customer Concentrations
The Company currently derives a substantial portion of its total revenue
from a single customer. For the years ended December 31, 1996, 1997 and 1998,
revenue from WebTV Networks, Inc. represented approximately 10.1%, 33.4% and
26.8%, respectively, of the Company's total revenue.
Sole or Limited Sources of Supply
The Company relies on other companies to supply certain key components of
their network infrastructure. These components include critical
telecommunications services and networking equipment, which, in the quantities
and quality demanded by us, are available only from sole- or limited-sources.
Four companies provide the data communications facilities and capacity for the
Company. The Company is also dependent upon local exchange carriers to provide
telecommunications services to the Company and its customers. The Company has
experienced delays from time to time in receiving telecommunications services
from these suppliers. There can be no assurance that such services on the
scale and within the time frames required by the Company at an affordable cost
will be attainable. Any failure to obtain such services on a sufficient scale,
on a timely basis and at an affordable cost would have a material adverse
effect on the business, financial condition and results of operations of the
Company.
The Company purchases its network equipment primarily from five vendors.
Two companies also act as systems integrators. One company is the sole
supplier of the servers primarily used in the Company's network
infrastructure. The Company purchases these components pursuant to purchase
orders placed from time to time with these suppliers. The Company does not
carry significant inventories of these components and has no guaranteed supply
arrangements for such components. The Company's suppliers also sell products
to competitors and may in the future themselves become competitors. There can
be no assurance that suppliers will not enter into exclusive arrangements with
competitors or stop selling their products or components to the Company at
commercially reasonable prices, or at all.
2. Cash, Cash Equivalents and Short-Term Investments
The following table summarizes the Company's available-for-sale securities
at amortized cost, which approximates fair value, as of December 31, 1998 (in
thousands):
<TABLE>
<S> <C>
U.S. Corporate securities........................................ $25,132
-------
Total included in cash and cash equivalents..................... 25,132
=======
U.S. Treasury securities......................................... $17,424
U.S. Corporate securities........................................ 34,802
-------
Total included in short-term investments........................ $52,226
=======
</TABLE>
As of December 31, 1998, there are no investments with maturities greater
than 12 months. The Company's U.S. Corporate securities include commercial
paper. The Company's cash equivalents and short term investments have
generally been held until maturity. The Company's cash and cash equivalents at
December 31, 1997 consisted primarily of money market funds and U.S. Corporate
Securities.
57
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Network Equipment Write-off
In December 1996, the Company wrote off approximately $8,321,000
representing the net book value and future commitments for certain network
equipment purchased from Sattel Communications LLC (Sattel), a stockholder of
the Company. The Company decided not to deploy the equipment in the network
because of concerns that the equipment would not provide the functionality and
reliability required by the Company and concerns that the equipment provider
would be unable to provide timely maintenance and support (see Note 12).
4. Commitments
Operating Leases
The Company has an agreement with a related party through which such
related party makes available the premises at which the Company's POP sites
throughout the United States are located. POP sites are locations where
certain telecommunications switching and related equipment are installed. This
agreement expires in December 2000, and the amount of the payments is based,
among other things, on the number of POP sites maintained by the Company,
subject to certain minimums. Costs of approximately $1,622,000, $1,326,000 and
$1,267,000 were incurred during the years ended December 31, 1996, 1997 and
1998, respectively, for these facilities. Additionally, the Company has
agreements with three telecommunications companies to locate POP sites and
certain of such equipment at their facilities. Costs of approximately
$1,246,000 were incurred during the year ended December 31, 1998 for these
facilities. The expiration dates associated with these agreements range from
December 1998 to January 2000.
The Company leases its facilities and certain office equipment under non-
cancelable operating leases which expire at various dates through January
2006. Total rent expense for all operating leases was approximately
$2,060,000, $2,418,000 and $4,743,000 for the years ended December 31, 1996,
1997 and 1998, respectively.
Future minimum lease commitments for all noncancelable operating leases
with initial terms of one year or more consists of the following at December
31, 1998 are (in thousands):
<TABLE>
<S> <C>
1999.............................................................. $ 4,257
2000.............................................................. 4,030
2001.............................................................. 3,248
2002.............................................................. 2,533
2003.............................................................. 2,513
Thereafter........................................................ 5,164
-------
Total............................................................. $21,745
=======
</TABLE>
Capital Leases
In August 1994, the Company entered into a master lease agreement under
which a related party began installing networking equipment at the Company's
POP sites and data center. This agreement became effective upon installation
and acceptance by the Company on March 31, 1995. The lease provides for
monthly payments for terms of 48 or 60 months, depending upon the type of
equipment. The Company has continued to install equipment under the terms of
this agreement, resulting in a monthly payment of approximately $896,000,
$1,443,000 and $536,000 at December 31, 1996, 1997 and 1998, respectively. In
March 1998, the Company retired a portion of the capital lease obligations to
the related party. The Company paid $24,750,000
58
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for the extinguishment of the debt. The Company recognized an extraordinary
gain of $3,042,000 in connection with this transaction. Subsequent to March
1998, the related party sold its stockholdings in the Company and is no longer
considered a related party.
In September 1995, the Company entered into a master lease agreement with a
third party for an equipment lease line. The term of the lease is 36 months
and provides for monthly payments of approximately $114,000 as of December 31,
1998.
Assets capitalized under capital leases totaled approximately $61,927,000
and $28,068,000 at December 31, 1997 and 1998, respectively, and are included
in computer and telecommunications equipment. Accumulated amortization for
assets capitalized under capital leases totaled approximately $18,542,000 and
$8,356,000 at December 31, 1997 and 1998, respectively. Amortization of leased
assets is included in depreciation and amortization expense. The Company has
granted a security interest in all equipment under capital lease agreements.
Future minimum lease payments under capital lease obligations at December 31,
1998 are as follows (in thousands):
<TABLE>
<S> <C>
1999............................................................. $ 7,285
2000............................................................. 6,257
2001............................................................. 4,312
2002............................................................. 1,956
Thereafter....................................................... 504
-------
Total minimum lease payments..................................... 20,314
Less amount representing interest................................ 3,337
-------
Present value of net minimum lease payments...................... 16,977
Less current portion of capital leases........................... 6,543
-------
Long-term portion of capital leases.............................. $10,434
=======
</TABLE>
Other
The Company has a noncancelable service agreement with AT&T for the
utilization of its frame relay telecommunications network. The agreement
provides for minimum payments to AT&T of approximately $300,000 per month over
its three-year term, expiring in June 1999.
The Company has a noncancelable service agreement with MCI for the
utilization of its ATM telecommunications network. The agreement provides for
minimum payments to MCI of approximately $1,200,000 per year over its term,
expiring three years after the end of an initial ramp up period but no later
than June 2000. The Company also has a noncancelable telecommunications
service agreement with MCI for other services, including dedicated access and
800 service, that provides for minimum payments of approximately $8,500,000
over the term of the agreement, which expired in June 1998. The Company had
incurred expenses, through the life of the agreement, of approximately
$3,700,000, $8,100,000 and $4,143,000 for the years ended December 31, 1996,
1997 and 1998, respectively, related to these other services. The agreement
was renewed in August 1998 and provides for minimum payments of $6,000,000 per
year over its term, expiring July 2000. The Company incurred expenses of
approximately $3,042,000 related to the new agreement for the five month
period ended December 31, 1998.
In November 1995, the Company entered into a two-year service agreement
under which a third party provided substantially all of the network analysis
and deployment and maintenance of POP sites. In 1997, the third party was
purchased by Williams Communication, Group Inc. (Williams), a stockholder of
the
59
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company that also has a seat on the Board of Directors of the Company, and the
agreement was extended to December 31, 2000. The Company will reimburse
Williams for its employee compensation and direct costs for services provided.
Related party payments to Williams for these services were approximately
$1,884,000 and $4,848,000 for the years ended December 31, 1997 and 1998,
respectively. At the end of the agreement, Williams is obligated to transfer
to the Company those personnel, resources, and facilities used to support the
Company's network analysis, POP site deployment, and maintenance.
In August 1997, the Company entered into a five-year service and equipment
agreement under which Williams, a related party, will provide
telecommunication services and equipment. The agreement provides for minimum
payments as follows: $1.2 million in 1998, $2.5 million in 1999, $7.0 million
in 2000, $6.5 million in 2001 and $4.0 million in 2002. At the election of
Williams, $2.0 million of the minimum payments may be paid by the issuance of
common stock of the Company at the then-current fair market value. The Company
made payments totaling $4,843,000 for the year ended December 31, 1998 related
to this agreement, of which $4,311,000 relates to the purchase of equipment
from Williams.
5. Convertible Debentures and Notes Payable
Bridge Loans
At December 31, 1995, convertible debentures in the amount of $70,000,
representing 9,802 shares of common stock, were outstanding. The conversion of
these debentures into shares of common stock subject to rescission was
completed in March 1996.
In 1995, the Company issued convertible notes totaling $7,000,000 to
shareholders of which $4,000,000, plus accrued interest, was converted into
Series B convertible preferred stock in December 1995. The remaining
$3,000,000 outstanding at December 31, 1995 was converted into Series C
convertible preferred stock in February 1996.
In June 1997, the Company borrowed $3 million from a related party in the
form of a 10% convertible secured promissory note (the Secured Note). The
Secured Note automatically converted into 253,403 shares of common stock upon
the closing of the Public Offering at a per share conversion price equal to
the Public Offering price of $12.00. In connection with the Secured Note, the
Company issued a warrant to purchase 63,351 shares of common stock at an
exercise price of $6.00 per share (see Note 8).
Notes Payable
In December 1997, the Company issued 150,000 units (collectively, the
Units), each consisting of $1,000 principal amount of 12 3/4% Senior Notes
(the 12 3/4% Senior Notes) due 2007 and one warrant (a Warrant), each Warrant
entitling the holder thereof to purchase 6.34 shares of common stock at $10.86
per share and such Warrants expire on December 15, 2007 (see Note 8) for
aggregate cash proceeds of $150,000,000. Approximately $52,525,000 of the cash
proceeds was placed in a escrow account to fund the first six interest
payments in accordance with the Senior Note agreement which is classified as
restricted cash. As of December 31, 1998, the Company had $36,238,000
remaining in the escrow account restricted for future interest payments.
The Warrants resulted in the right of the holders to purchase 951,108
shares of the Company's common stock. The Company deemed the fair value of the
warrants, using the Black-Scholes method, to be approximately $4,440,000 which
was recorded as a discount on the 12 3/4% Senior Notes. The discount is being
amortized as interest expense over the term of the 12 3/4% Senior Notes.
Amortization expense was $17,000 and $444,000 for the years ended December 31,
1997 and 1998, respectively.
60
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The 12 3/4% Senior Notes will be redeemable at the option of the Company,
in whole or in part, at any time on or after December 15, 2002, at the
redemption rates (expressed as a percentage of the principal amount)
commencing with 106.375% on December 15, 2002 and declining to 100% on
December 15, 2005, plus accrued interest to the date of redemption. In
addition, on or prior to December 15, 2000, the Company may redeem up to 35%
of the original aggregate principal amount of the 12 3/4% Senior Notes at a
redemption price of 112.75% of the principal amount, together with accrued and
unpaid interest to the date of redemption with the net cash proceeds of one or
more public equity offerings or the sale of common stock to a strategic
investor, provided that at least 65% of the original aggregate principal
amount of the 12 3/4% Senior Notes remain outstanding.
In connection with the issuance of the 12 3/4% Senior Notes, the Company
incurred approximately $5,300,000 of debt issuance costs which are classified
as other assets. These costs are being amortized as interest expense over the
term of the 12 3/4% Senior Notes. Amortization expense was $526,000 for the
year ended December 31, 1998.
6. Common Stock Subject to Rescission
In August 1993, the Company commenced sales of convertible debentures and
certain additional shares of its common stock. Through March 31, 1995, sales
of convertible debentures aggregated $4,260,000, and issuance of common stock
aggregated $890,000. The sale of common stock and sale of and/or conversion of
debentures into common stock was not made pursuant to a registration statement
filed under the Securities Act of 1933 (the Act) or any filings pursuant to
the laws of any of the states in which such sales occurred (State Blue Sky
Laws). Although at the time the Company believed the sale and conversion, if
applicable, of these securities was exempt from the provisions of the Act and
applicable State Blue Sky Laws, it appears that the appropriate exemptions may
not have been available. As a result, on September 30, 1997, the Company made
rescission offers (the "Rescission Offer") to certain purchasers of these
securities who are entitled to a return of the consideration paid for their
stock or debentures. As such, these shares have been classified as common
stock subject to rescission in the accompanying financial statements.
Additionally, options issued pursuant to the Company's 1995 Stock Incentive
Plan to Employees and Consultants and non-plan options were issued in various
states for which the Company may not have had an available exemption under
state laws. Such options are potentially subject to rescission and the Company
has included them in the Rescission Offer. As of December 31, 1997, statutes
of limitations under federal and state securities laws applicable to the
shares which may have been issued without securities laws exemptions have
lapsed and the Rescission Offer had expired. Pursuant to the Rescission Offer,
the Company offered to rescind the issuance of shares and options as to which
the applicable statute of limitations had not run. There can be no assurances
that the Company will not otherwise be subject to additional liabilities with
respect to such issuances. The Company repurchased 32,423 shares of Common
Stock subject to the Rescission Offer for $548,000 and paid related interest
charges of $125,000. Based upon the above, the Company has reclassified the
remaining rescission liability and shares into stockholders' equity.
7. Stockholders' Equity
Initial Public Offering and Direct Placements
Effective July 30, 1997, the Company reincorporated under the laws of the
state of Delaware. In addition, the Company authorized 100,000,000 shares of
its common stock. Upon closing of the initial public offering (the Public
Offering), all outstanding shares of Series A, B, C, and D convertible
preferred stock and Class B common stock were converted into common stock.
On August 1, 1997, the Company effected its Public Offering of common
stock. The offering consisted of 4,300,000 shares of common stock issued to
the public at $12.00 per share. Concurrent with the closing of the
61
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Public Offering, certain strategic investors, including Williams, purchased
directly from the Company 1,499,236 shares of common stock having an aggregate
purchase price of approximately $18 million (including the cancellation of
approximately $3 million in indebtedness). Such shares are unregistered shares
and were purchased at the Public Offering price of $12.00 per share.
In connection with the direct purchase, the Company issued warrants to one
of the strategic investors to purchase 291,667 shares of the Company's common
stock at $6.00 per share (see Note 8). In September, the underwriters
exercised an option to purchase an additional 645,000 shares of common stock
at the Public Offering price of $12.00 per share to cover over-allotments in
connection with the Public Offering.
Redeemable Exchangeable Preferred Stock
In June 1998, the Company completed a $150 million private placement of 13
1/2% Series A Senior Redeemable Exchangeable Preferred Stock due 2010 (Series
A Preferred). In September 1998, the Company issued 154,657 shares of its 13
1/2% Series B Senior Redeemable Exchangeable Preferred Stock due 2010 (Series
B Preferred) in exchange for all outstanding shares of the Series A Preferred
pursuant to a registered exchange offer. Each share of Series B Preferred has
a liquidation preference of $1,000 per share. Dividends on the Series B
Preferred accrue at a rate of 13 1/2% per annum of the liquidation preference
thereof and are payable quarterly in arrears commencing on September 1, 1998.
Dividends are payable in cash, except that on each dividend payment date
occurring on or prior to June 1, 2003, dividends may be paid, at the Company's
option, by the issuance of additional shares of Series B Preferred having an
aggregate liquidation preference equal to the amount of such dividends. For
the year ended December 31, 1998, the Company issued a total of 9,865 shares
of Series B Preferred Stock as payment of the quarterly dividends. Series B
Preferred Stock has no voting rights.
The Series B Preferred is redeemable at the option of the Company, in whole
or in part, at any time on or after June 1, 2003, at redemption rates
(expressed as a percentage of the liquidation preference) commencing with
106.75% on June 1, 2003 and declining to 100% on June 1, 2008, plus
accumulated and unpaid dividends to the date of redemption. In addition, prior
to June 1, 2001, the Company may, at its option, redeem up to a maximum of 35%
of the initially issued Series B Preferred from the net proceeds of one or
more public equity offerings or the sale of common stock to a strategic
investor. The Series B Preferred is subject to mandatory redemption at its
liquidation preference, plus accumulated and unpaid dividends on June 1, 2010.
On any scheduled dividend payment date, the Company may, at its option,
exchange in whole but not in part the then outstanding shares of Series B
Preferred for 13 1/2% Senior Subordinated Debentures due 2010 (Exchange
Debentures) with a principal amount equal to the aggregate liquidation
preference of the Preferred Stock. If the Exchange Debentures were issued,
they would mature on June 1, 2010. Interest on the Exchange Debentures would
be payable semi-annually in arrears. Interest payable on or prior to June 1,
2003 may be paid in the form of additional Exchange Debentures valued at the
principal amount thereof.
The Company is accreting the Series B Preferred to its liquidation
preference through the due date of the Series B Preferred. The accretion for
the year ended December 31, 1998 was approximately $11,676,000. In connection
with the issuance of Series A Preferred and Series B Preferred, the Company
incurred approximately $5,852,000 of issuance costs. These costs are being
accreted over 12 years which amounted to $282,000 for the year ended December
31, 1998.
Stock Option Plans
1995 Stock Incentive Plan for Employees and Consultants. The Company's 1995
Stock Incentive Plan for Employees and Consultants (the 1995 Plan) provided
for the granting to employees of incentive stock options
62
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and for the granting to employees and consultants of nonstatutory stock
options, stock appreciation rights (SARs) and restricted stock awards (RSAs).
No SARs or RSAs have been granted under the 1995 Plan. The 1995 Plan was
terminated effective October 4, 1996. As of December 31, 1998, options to
purchase 162,157 shares of common stock at a weighted exercise price of $3.75
per share were outstanding under the 1995 plan of which 102,910 options were
vested.
Amended and Restated 1996 Stock Plan. The Company's Amended and Restated
1996 Stock Plan (the Restated 1996 Plan) provides for the granting to
employees of incentive stock options and for the granting to employees,
directors and consultants of nonstatutory stock options and stock purchase
rights (Rights). The Restated 1996 Plan has been terminated. As of December
31, 1998, options to purchase 678,846 shares of common stock at a weighted
average exercise price of $6.40 per share were outstanding of which 246,460
were vested.
The Restated 1996 Plan provides that in the event of a merger of the
Company with or into another corporation, a sale of substantially all of the
Company's assets or a like transaction involving the Company, each option
shall be assumed or an equivalent option substituted by the successor
corporation. If the outstanding options are not assumed or substituted as
described in the preceding sentence, the Restated 1996 Plan provides the
optionee or Right holder to have the right to exercise the option or Right as
to all of the optioned stock, including shares as to which it would not
otherwise be exercisable.
1997 Stock Plan. The Company's 1997 Stock Plan (the 1997 Plan) provides for
the granting to employees of incentive stock options and for the granting to
employees, directors and consultants of nonstatutory stock options and stock
purchase rights (Rights). The 1997 Plan was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. An amendment
increasing the number of shares thereunder from 1,500,000 to 2,250,000 was
approved by the Board of Directors on April 10, 1998, 1998 and the
Stockholders on May 20, 1998. Unless terminated sooner, the 1997 Plan will
terminate automatically in 2007. Options granted under the 1997 Plan must
generally be exercised within three months of the end of optionee's status as
an employee, director or consultant of the Company, or within twelve months
after such optionee's termination by death or disability, but in no event
later than the expiration of the option's term. The exercise price of all
incentive stock options granted under the 1997 Plan must be at least equal to
the fair market value of the common stock on the date of grant. The exercise
price of nonstatutory stock options and Rights granted under the 1997 Plan is
determined by the 1997 Plan's Compensation Committee, but with respect to
nonstatutory stock options intended to qualify as "performance-based
compensation," the exercise price must at least be equal to the fair market
value of the common stock on the date of grant. With respect to any
participant who owns stock possessing more than 10% of the voting power of all
classes of the Company's outstanding capital stock, the exercise price of any
incentive stock option granted must equal at least 110% of the fair market
value on the grant date and the term of such incentive stock option must not
exceed five years. The term of other incentive stock options granted under the
1997 Plan may not exceed ten years. A total of 2,250,000 shares of common
stock are currently reserved for issuance pursuant to the 1997 Plan. As of
December 31, 1998, options to purchase 2,113,929 shares of common stock at a
weighted average exercise price of $18.21 per share were outstanding of which
111,909 were vested, and 96,582 shares of common stock remained available for
future grants under the 1997 Plan.
The 1997 Plan provides that in the event of a merger of the Company with or
into another corporation, a sale of substantially all of the Company's assets
or a like transaction involving the Company, each option shall be assumed or
an equivalent option substituted by the successor corporation. If the
outstanding options are not assumed or substituted as described in the
preceding sentence, the 1997 Plan provides for the optionee or Right holder to
have the right to exercise the option or Right as to all of the optioned
stock, including shares as to which it would not otherwise be exercisable.
63
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1997 Employee Stock Purchase Plan. The Company's 1997 Employee Stock
Purchase Plan (the 1997 Purchase Plan) was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. A total of 500,000
shares of common stock has been reserved for issuance under the 1997 Purchase
Plan. The 1997 Purchase Plan, which is intended to qualify under Section 423
of the Internal Revenue Code, consists of 24-month offering periods beginning
on the first trading day on or after February 15 and August 15 of each year,
except for the first such offering period, which commenced on August 4, 1997
and ended on February 13, 1998. Each offering period contains four six-month
purchase periods. Employees are eligible to participate if they are
customarily employed by the Company or any designated subsidiary for at least
20 hours per week and more than five months in any calendar year. The 1997
Purchase Plan permits eligible employees to purchase common stock through
payroll deductions of up to 10% of an employee's compensation (excluding
overtime, shift premium, and other bonuses and incentive compensation), up to
a maximum of $25,000 for all offering periods ending within the same calendar
year. No employee may purchase more than 25,000 shares in any purchase period.
The price of stock purchased under the 1997 Purchase Plan is 85% of the lower
of the fair market value of the common stock at the beginning of the offering
period or at the end of the current purchase period. Employees may end their
participation at any time during an offering period, and they will be paid
their payroll deductions to date. Participation ends automatically upon
termination of employment with the Company. During the year ended December 31,
1998, 74,142 shares were purchased under the 1997 Purchase Plan at a weighted
average price of $10.54 per share.
The 1997 Purchase Plan provides that, in the event of a merger of the
Company with or into another corporation or a sale of substantially all of the
Company's assets, each outstanding option shall be assumed or an equivalent
option shall be substituted for it, or the Board of Directors or its committee
shall shorten the purchase and offering periods then in progress (so that
employees' rights to purchase stock under the Plan are exercised prior to the
merger or sale of assets). The 1997 Purchase Plan will terminate in 2007.
The Company issued options to purchase 179,300 shares of common stock in
December 1996, 40,267 shares of common stock in January 1997, 216,733 shares
of common stock in June 1997, and repriced 181,473 options in July 1997. The
Company recorded deferred compensation, for financial reporting purposes, of
approximately $188,000 in 1996 and $1,303,000 for the year ended December 31,
1997, with respect to such option grants to reflect the difference between the
exercise price and the deemed fair value for financial reporting purposes of
these shares. Amortization of this deferred compensation was $0, $222,000 and
$373,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
The amortization of this deferred compensation will continue over the four
year vesting period of the associated stock options.
64
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes stock option activity under all of the
Plans:
<TABLE>
<CAPTION>
Number of
Shares Price Per Share
--------- ---------------
<S> <C> <C>
Balance at December 31, 1995........................ 807,083 $ 3.75--$ 33.00
Granted........................................... 421,620 $3.75
Exercised......................................... (4,483) $ 3.75--$ 9.00
Canceled.......................................... (95,218) $ 3.75--$ 30.00
---------
Balance at December 31, 1996........................ 1,129,002 $ 3.75--$ 33.00
Granted........................................... 1,472,338 $ 3.75--$ 11.25
Exercised......................................... (64,544) $3.75
Canceled.......................................... (244,630) $ 3.75--$ 11.25
---------
Balance at December 31, 1997........................ 2,292,166 $ 3.75--$ 30.00
Granted........................................... 1,883,958 $ 9.88--$ 75.89
Exercised......................................... (611,694) $ 3.75--$ 20.87
Canceled.......................................... (247,831) $ 3.75--$ 75.89
---------
Balance at December 31, 1998........................ 3,316,599 $ 3.75--$ 75.89
=========
</TABLE>
The weighted average fair value of options granted during 1996, 1997 and
1998 was $0.87, $1.87 and $12.67, respectively.
The following table summarizes information concerning currently outstanding
and exercisable options as of December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Number Average
Number Contractual Exercise Exercisable Exercise
Exercise Prices Outstanding Life Price and Vested Price
--------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$3.75..................... 565,168 7.31 $ 3.75 374,715 $ 3.75
$6.00..................... 311,828 8.04 $ 6.00 131,443 $ 6.00
$8.85--$9.30.............. 218,564 8.47 $ 9.13 78,058 $ 9.15
$9.88--$11.25............. 515,066 8.86 $11.04 111,409 $11.21
$12.45--$30.00............ 1,693,688 9.38 $20.26 72,812 $14.47
$37.95--$75.89............ 12,285 8.46 $60.07 6,539 $60.30
--------- -------
Total..................... 3,316,599 774,976
========= =======
</TABLE>
Stock-Based Compensation
Pro forma information regarding results of operations and loss per share is
required by FAS 123 for awards granted after December 31, 1994 as if the
Company had accounted for its stock-based awards to employees under a
valuation method permitted by FAS 123. The value of the Company's stock-based
awards to employees in 1995 and 1996 was estimated using the minimum value
method. Options granted after the Public Offering have been valued using the
Black-Scholes option pricing model. Among other things, the Black-Scholes
model considers the expected volatility of the Company's stock price,
determined in accordance with FAS 123, in
65
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
arriving at an option valuation. The minimum value method does not consider
stock price volatility. Further, certain other assumptions necessary to apply
the Black-Scholes model may differ significantly from assumptions used in
calculating the value of options granted in 1995 and 1996 under the minimum
value method.
The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Expected volatility........................................ N/A .250 .935
Expected life of options in years.......................... 4.0 3.3 3.49
Risk-free interest rate.................................... 6.3% 6.0% 5.0%
Expected dividend yield.................................... 0.00% 0.00% 0.00%
</TABLE>
For pro forma purposes, the estimated minimum value of the Company's stock-
based awards to employees is amortized over the options' vesting period. If
the Company had elected to recognize compensation cost based on the fair value
of the options granted at grant date as prescribed by FAS 123, net loss and
net loss per share would have increased to the pro forma amounts indicated in
the table below (in thousands except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1996 1997 1998
-------- -------- ---------
<S> <C> <C> <C>
Net loss attributable to common stockholders
as reported................................ $(66,381) $(55,582) $ (94,064)
Net loss attributable to common
stockholders--pro forma.................... $(66,605) $(56,224) $(100,030)
Net loss per share attributable to common
stockholders--as reported.................. $ (13.46) $ (5.63) $ (6.47)
Net loss per share attributable to common
stockholders--pro forma.................... $ (13.49) $ (5.70) $ (6.88)
</TABLE>
8. Warrants to Purchase Common Stock
In connection with the Company's Public Offering, all of the outstanding
warrants to purchase preferred stock were converted to warrants to purchase
common stock. The following warrants to purchase shares of the Company's
common stock were outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Warrants Outstanding
----------------------------------
Number Weighted Average Year
Exercise Prices of Shares Exercise Price Expires
--------------- --------- ---------------- -------
<S> <C> <C> <C>
$19.49.................................... 877,718 $19.49 1999
$3.75-$26.87.............................. 185,742 $20.42 2000
$6.00-$68.30.............................. 439,668 $ 6.19 2002
$10.86.................................... 951,108 $10.86 2007
---------
2,454,236
=========
</TABLE>
The Company is obligated to issue a warrant to purchase 906,679 shares to
SBC Communications Inc. in connection with an agreement signed in October
1998. The warrant will be issued upon the closing of the SBC Financing
Agreement (See Note 14).
The above warrants were issued at various times over the last several years
in connection with a service agreements, a capital lease agreement, several
debt and equity financings and a reseller agreement The Company
66
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
has deemed the fair market value of such warrants, using the Black-Scholes
method, to be $822,000, $61,000, $5,700,000, $2,623,000 and $1,900,000,
respectively. The Company is amortizing the value of the warrants over the
term of the related agreements which range from one to ten years. Amortization
expense for the years ended December 31, 1996, 1997 and 1998 was $1,942,000,
$1,720,000 and $767,000, respectively. The Company has reserved the amount of
shares necessary to meet the exercise of these warrants.
9. Employee Benefit Plans
Retirement Savings Plan
The Company maintains a contributory 401(k) plan that covers substantially
all employees. The Company contributes $0.30 for every $1.00 contributed by
the participant up to a maximum of 1.5% of the participants' compensation. The
Company contributed $45,000, $158,000 and $266,000 to the plan during the
years ended December 31, 1996, 1997 and 1998, respectively.
10. Income Taxes
As of December 31, 1998, the Company had federal and state net operating
loss carryforwards of approximately $208,000,000 and $138,000,000,
respectively. The net operating loss carryforwards will expire at various
dates beginning in the years 2003 through 2018, if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes of December 31, 1997 and 1998 are as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 55,000 $ 85,000
Write-off of network equipment......................... 4,000 4,000
Other, net............................................. 1,000 3,000
-------- --------
Total deferred tax assets................................ 60,000 92,000
-------- --------
Deferred tax liabilities:
Other, net............................................. 2,000 2,000
-------- --------
Net deferred tax assets.................................. 58,000 90,000
Valuation allowance...................................... (58,000) (90,000)
-------- --------
$ -- $ --
======== ========
</TABLE>
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax assets such that a full valuation allowance has been
recorded. These factors include the Company's history of net losses since
inception and the fact that the market in which the Company competes is
intensely competitive and characterized by rapidly changing technology. The
Company believes that, based on the currently available evidence, it is more
likely than not that the Company will not generate taxable income through
1999, and possibly beyond, and accordingly will not realize the Company's
deferred tax assets through 1999 and possibly beyond. The Company will
continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration
of net operating losses before utilization.
The net valuation allowance increased by approximately $21,000,000 in 1997
and $32,000,000 in 1998.
67
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Related Party Transactions--Other
A former officer of the Company is a majority shareholder of a vendor of
the Company. The Company incurred marketing fees to the vendor totaling
$2,448,000, $2,600,000 and $1,085,000 in the years ended December 31, 1996,
1997, and 1998, respectively.
12. Contingencies
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana Corporation (Diana), the parent corporation of
Sattel Communications LLC (Sattel), alleging securities fraud related to
plaintiffs' purchase of shares of Diana Common Stock in reliance upon
allegedly misleading statements made by defendants, Diana, Sattel and certain
of their respective affiliates, officers and directors (Diana Suit). The
Company was named as a defendant in the complaint in connection with certain
statements made by Diana and officers of Diana related to the Company's
purchase of network switching equipment from Diana's Sattel subsidiary. The
plaintiffs seek unspecified compensatory damages (See Note 15).
While the ultimate outcome of such litigation is uncertain, the Company
believes it has meritorious defenses to the claims and intends to conduct a
vigorous defense. An unfavorable outcome in this matters could have a material
adverse effect on the Company's financial condition. In addition, even if the
ultimate outcomes is resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either or which could have a material adverse effect on the
Company's results of operations.
Sattel Settlement
On April 22, 1997, a complaint was filed in the Los Angeles County,
California Superior Court against the Company and other unnamed defendants by
Sattel Communications LLC (Sattel). Sattel's complaint alleged that the
Company was in breach of an agreement to pay for up to $4.3 million of DSS
Switches from Sattel for use in the Company's network and also sought
unspecified consequential and punitive damages. On July 11, 1997, the Company
settled the complaint with Sattel in the amount of $4.4 million. The Company
also purchased 32,986 shares of the Company's common stock held by Sattel on
the day after the closing of the offering at the Public Offering price. In
August, 1997 the Company made cash payments to Sattel totaling approximately
$4.8 million, to satisfy its obligations pursuant to the settlement agreement
and the repurchase of common stock. Upon the settlement of the Sattel
complaint, the Company recorded $970,000 of other income related to the
reversal of previously established reserves.
13. Business Combinations
On February 5, 1998, the Company acquired all of the outstanding stock of
InterNex Information Services, Inc. (InterNex). The transaction was accounted
for using the purchase method of accounting. The total purchase price of
approximately $23.9 million consisted of a $15.5 million cash payment upon
closing and the assumption of approximately $8.4 million of InterNex's
liabilities (including acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<S> <C>
Current and other assets............................................ $ 1,348
Computer and telecommunications equipment........................... 4,784
Goodwill............................................................ 9,496
Other intangible assets............................................. 3,080
Write-off of in process technology.................................. 5,200
-------
Total purchase price allocation................................... $23,908
=======
</TABLE>
68
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Goodwill arising from the acquisition is being amortized on a straight-line
basis over 5 years. Other intangible assets include developed technology,
assembled workforce and customer lists and are being amortized over their
useful lives ranging from two to four years.
In May 1998, the Company acquired Delta Internet Services, Inc.
("DeltaNet") in a transaction that was accounted for as a pooling of
interests. The Company issued approximately 226,000 shares of its common stock
to DeltaNet shareholders in exchange for all outstanding DeltaNet shares. The
Company also assumed outstanding DeltaNet options and warrants which were
converted to options and warrants to purchase approximately 98,000 and 7,000
shares, respectively, of the Company's common stock. The results of operations
of DeltaNet for the period from April 1, 1998 through December 31, 1998 are
included in the consolidated results of operations. The Company's historical
consolidated financial statements prior to the combination have not been
restated to reflect the financial results of DeltaNet as these results are not
material. The consolidated results of operations for the year ended December
31, 1998 include an acquisition related charge of $1.3 million primarily
related to severance costs, reserves for redundant facilities and assets and
professional fees.
In August 1998, the Company acquired all of the outstanding stock of
AnaServe, Inc. ("AnaServe"). The transaction was accounted for using the
purchase method of accounting. The total purchase price of approximately $13.0
million consisted of a $9.6 million cash payment upon closing and the
assumption of approximately $3.4 million of AnaServe's liabilities (including
acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<S> <C>
Current and other assets........................................... $ 467
Computer and telecommunications equipment.......................... 497
Goodwill........................................................... 11,630
Other intangible assets............................................ 416
-------
Total purchase price allocation.................................. $13,010
=======
</TABLE>
Goodwill is being amortized over five years. Other intangible assets
include developed technology, assembled workforce and customer lists and are
being amortized over their useful lives ranging from one to four years.
The following unaudited pro forma information represents the combined
results of operations as if the acquisitions of InterNex, DeltaNet and
AnaServe had occurred as of the beginning of the periods presented and does
not purport to be indicative of what would have occurred had the acquisitions
been made as of that date or the results which may occur in the future.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
(In thousands,
except per share data)
<S> <C> <C> <C>
Pro forma net revenues....................... $ 25,958 $ 61,424 $ 89,435
Pro forma net loss attributable to common
stockholders................................ (78,769) (71,351) (92,967)
Pro forma net loss per share attributable to
common stockholders......................... (15.26) (7.07) (6.37)
</TABLE>
The pro forma results include the historical operations of the Company and
the historical operations of the acquired businesses adjusted to reflect
certain pro forma adjustments, including the amortization of intangible
assets, totaling $5.6 million during the years ended December 31, 1996 and
1997, and $1,724,000 during the year ended December 31, 1998. The pro forma
results do not include the write-off of purchased research and development of
$5.2 million since it is considered a non-recurring adjustment.
69
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Strategic Relationship
In October 1998, the Company entered into a strategic business arrangement
(Commitment Agreement) with SBC Communications Inc. (SBC) to integrate
Concentric's Internet-based business data services and technology into SBC's
"Online Office" portfolio of data products and services for business
customers. In connection with this arrangement, SBC agreed to acquire 906,679
shares of Concentric common stock either on the open market or from the
Company at a price of $24.15 per share (SBC Financing Agreement). In December
1998, SBC purchased 100,000 shares of the Company's common stock in two open
market purchases. The Company also agreed to issue a warrant to SBC to
purchase an additional 906,679 shares. The warrant expires three years from
the date of issuance and will be exercisable at $21 per share. The Company
used the Black-Scholes method to determine the fair market value of the
warrant and allocated $1,900,000 of the warrant value to the Commitment
Agreement which will be amortized over the life of the Commitment Agreement.
15. Subsequent Event
Public Offering
On January 15, 1999, the Board of Directors authorized the Company to
proceed with a public offering of the Company's common stock.
Litigation
On January 24, 1999, the Company agreed in principle to settle the Diana
Suit for $750,000. The settlement is contingent upon court approval and
certain other conditions.
Equity Investment
On January 22, 1999, the Company purchased approximately $10.0 million of
common stock from Covad Communications in a private placement.
70
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Certain information required by Part III is omitted from this Report in
that the registrant will file a definitive Proxy Statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end
of the fiscal year covered by this Report, and certain information included
therein is incorporated herein by reference.
Item 10. Directors and Officers of the Company
Certain information regarding the directors and officers of the Company is
contained herein under Item 1, "Executive Officers and Directors of the
Company."
Information regarding directors appearing under the caption "Election of
Directors--Directors and Nominees for Director" in the Proxy Statement is
hereby incorporated by reference.
Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, is hereby incorporated herein by reference
from the section entitled "Election of Directors--Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement.
Item 11. Executive Compensation
The information required by Item 11 is set forth under the caption,
"Executive Compensation" in the Company's Proxy Statement, which information
is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is set forth under the caption
"Security Ownership" in the Company's Proxy Statement, which information is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is set forth under the captions
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions" in the Company's Proxy Statement, which information is
incorporated herein by reference.
71
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K
(a) 1. Financial Statements.
See Item 8 above.
2. Financial Statement Schedule.
See Item 14(d) below.
3. Exhibits.
The following exhibits are filed with this Report:
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Title
------- -------------
<C> <S>
3.1 Form of Amended and Restated Certificate of Incorporation of
Registrant. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the Securities and Exchange Commission ("SEC")
on July 31, 1997).
3.2 Amended and Restated Bylaws of Registrant. (Incorporated by
reference from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July
31, 1997).
3.3 Certificate of Designation of Voting Power, Designation Preferences
and Relative, Participating, Optional and Other Special Rights and
Qualifications, Limitations and Restrictions of 13 1/2% Series A and
Series B Senior Redeemable Exchangeable Preferred Stock, due 2010 of
the Registrant. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
4.1 Form of $150,000,000 12 3/4% Senior Notes due 2007. (Incorporated by
reference from Registrant's Registration Statement on Form S-4 (File
No. 333-45055), as amended, declared effective by the SEC on March
24, 1998).
4.2 Form of Warrant to purchase common stock. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
58641), as declared effective by the SEC on August 11, 1998).
10.1 Amended and Restated Registration Rights Agreement, as amended and
restated as of August 21, 1996, by and among the Registrant, GS
Capital Partners, L.P., Kleiner Perkins Caufield & Byers VII,
Comdisco, Inc., Intuit, Inc., certain listed holders of Series C
Convertible Preferred Stock, certain listed holders of Common Stock,
certain listed holders of Series D Convertible Preferred Stock, and
Racal-Datacom, Inc. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.2 Preferred Stock and Warrant Purchase Agreement, dated as of April
20, 1995, by and among the Registrant, GS Capital Partners, L.P.,
and Kleiner Perkins Caufield & Byers VII and KPCB Information
Sciences Zaibatsu Fund 11, as amended. (Incorporated by reference
from Registrant's Registration Statement on Form S-1 (File No. 333-
27241), as amended, declared effective by the SEC on July 31, 1997).
10.3 Form of Director and Officer Indemnification Agreement.
(Incorporated by reference from Registrant's Registration Statement
on Form S-1 (File No. 333-27241), as amended, declared effective by
the SEC on July 31, 1997).
</TABLE>
72
<PAGE>
<TABLE>
<C> <S>
10.4 1995 Stock Incentive Plan for Employees and Consultants, as amended
February 21, 1996. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.5 Amended and Restated 1996 Stock Plan. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.6 1997 Stock Plan. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.7 1997 Employee Stock Purchase Plan. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.8* Amended and Restated Employee Services and Staffing Agreement, dated
June 19, 1997, between the Registrant and Critical Technologies,
Inc., as amended on September 30, 1996, and October 23, 1996,
including Colocation Services Agreement, dated as of November 1,
1994, between the Registrant and Critical Technologies, Inc. and
amendments thereto. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.9* Internet-Sign Up Wizard Referral and Microsoft Internet Explorer
License and Distribution Agreement, dated March 28, 1997, between the
Registrant and Microsoft Corporation. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.10* OEM License Agreement dated July 27, 1995, between the Registrant and
Netscape Communications Corporation, as amended by First Amendment,
dated January 2, 1996, Second Amendment, effective January 2, 1996,
and Third Amendment, dated May 21, 1996. (Incorporated by reference
from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July 31,
1997).
10.11* "Dial up Client" Agreement, dated August 21, 1995, between the
Registrant and Netscape Communications Corporation. (Incorporated by
reference from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July 31,
1997).
10.12* "Internet Account Server" Participation Agreement, dated as of
January 14, 1997, between the Registrant and Netscape Communications
Corporation. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.13* Special Customer Arrangement, dated May 17, 1996, between MCI
Telecommunications Corporation and Sattel Communications LLC, as
amended by First Amendment, dated July 2, 1996; assigned to
Registrant by Assignment and Novation Agreement #2, dated as of
August 7, 1996. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.14* Master Agreement for MCI Enhanced Services, effective November 1,
1996, between the Registrant and MCI Telecommunications Corporation.
(Incorporated by reference from Registrant's Registration Statement
on Form S-1 (File No. 333-27241), as amended, declared effective by
the SEC on July 31, 1997).
10.15* Amended and Restated Employee Services and Staffing Agreement.
(Incorporated by reference from Registrant's Registration Statement
on Form S-1 (File No. 333-27241), as amended, declared effective by
the SEC on July 31, 1997).
10.16* Amendment No. 3 to Internet Access Services Agreement, dated August
23, 1996, between the Registrant and Intuit Inc. (Incorporated by
reference from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July 31,
1997).
</TABLE>
73
<PAGE>
<TABLE>
<C> <S>
10.17* Contract for Services, dated June 17, 1996, by and between the
Registrant and MFS Telephone, Inc. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.18* AT&T Contract Tariff Order, dated June 17, 1996, and Addendum of even
date therewith. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.19* Master Lease Agreement Number CON01C Between Concentric Research
Corporation and Racal-Datacom, Inc. ("Racal"), dated August 4, 1994,
as Supplemented by Letter Agreement, dated March 30, 1995, Between
the Corporation and Racal. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.20* Lease Agreement Number CON04C between Concentric Network Corporation
and Racal- Datacom, Inc., dated June 26, 1996. (Incorporated by
reference from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July 31,
1997).
10.21* Master On-site Maintenance Plan Agreement Number CON02C Between
Concentric Research Corporation and Racal-Datacom, Inc., dated August
24, 1994. (Incorporated by reference from Registrant's Registration
Statement on Form S-1 (File No. 333-27241), as amended, declared
effective by the SEC on July 31, 1997).
10.22 Lease Agreement, dated November 1, 1996, effective March 11, 1996, by
and between the Registrant and Saginaw Video Associates, d.b.a.
Saginaw Conference Center. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.23 Amended and Restated Lease Agreement, dated as of October 7, 1996,
between the Registrant and Larry Shackley. (Incorporated by reference
from Registrant's Registration Statement on Form S-1 (File No. 333-
27241), as amended, declared effective by the SEC on July 31, 1997).
10.24* Internet Access Service Agreement, dated December 11, 1995, effective
as of August 1, 1995, between the Registrant and Intuit, Inc., as
amended. (Incorporated by reference from Registrant's Registration
Statement on Form S-1 (File No. 333-27241), as amended, declared
effective by the SEC on July 31, 1997).
10.25* Virtual Private Network Services, dated August 16, 1996, between the
Registrant and WebTV Networks, Inc. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.26* Support Services Agreement, dated March 31, 1997, by and between the
Registrant and MCI Telecommunications Corporation. (Incorporated by
reference from Registrant's Registration Statement on Form S-1 (File
No. 333-27241), as amended, declared effective by the SEC on July 31,
1997).
10.27 Note and Warrant Purchase Agreement, dated June 19, 1997, by and
between the Registrant and Williams Communications Group, Inc.
("WCG"). (Incorporated by reference from Registrant's Registration
Statement on Form S-1 (File No. 333-27241), as amended, declared
effective by the SEC on July 31, 1997).
10.28 Service Credits Letter Agreement, dated June 19, 1997, by and between
the Registrant and WCG. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.29 $1,100,000 Obligation Letter Agreement, dated June 19, 1997, between
the Registrant and WCG. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
</TABLE>
74
<PAGE>
<TABLE>
<C> <S>
10.30 Agency Agreement and Distribution Agreement, dated June 19, 1997,
between the Registrant and WCG. (Incorporated by reference from
Registrant's Registration Statement on Form S-1 (File No. 333-27241),
as amended, declared effective by the SEC on July 31, 1997).
10.31* Co-Marketing Service Agreement, dated June 23, 1997 between the
Registrant and Netscape Communications, Inc. ("Netscape").
(Incorporated by reference from Registrant's Registration Statement
on Form S-1 (File No. 333-27241), as amended, declared effective by
the SEC on July 31, 1997).
10.32* Trademark License Agreement, dated June 23, 1997, between the
Registrant and Netscape. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.33* Software License Order Form, dated June 23, 1997, between the
Registrant and Netscape. (Incorporated by reference from Registrant's
Registration Statement on Form S-1 (File No. 333-27241), as amended,
declared effective by the SEC on July 31, 1997).
10.34 Note and Warrant Purchase Agreement, dated June 23, 1997, between the
Registrant, Kleiner Perkins, Caufield & Byers VII and KPCB
Information Science Zaibatsu Fund VII. (Incorporated by reference
from Registrant's Registration Statement on Form S-1 (File No. 333-
27241), as amended, declared effective by the SEC on July 31, 1997).
10.35* Amendment to Virtual Private Network Services Agreement between the
Registrant and WebTV Networks, Inc., dated November 1, 1997.
(Incorporated by reference from Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, filed with the SEC on
November 14, 1997).
10.36 Registration Rights Agreement, dated as of December 18, 1997 between
the Registrant and UBS Securities LLC, Bear Stearns & Co., Inc., and
Wheat First Securities, Inc. (the "Initial Purchasers").
(Incorporated by reference from Registrant's Registration Statement
on Form S-4 (File No. 333-45055), as amended, declared effective by
the SEC on March 24, 1998).
10.37 Purchase Agreement, dated as of December 15, 1997 between the
Registrant and the Initial Purchasers. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
45055), as amended, declared effective by the SEC on March 24, 1998).
10.38 Warrant Agreement, dated as of December 18, 1997, between the
Registrant and Chase Manhattan Bank and Trust Company, National
Association, as warrant agent. (Incorporated by reference from
Registrant's Registration Statement on Form S-4 (File No. 333-45055),
as amended, declared effective by the SEC on March 24, 1998).
10.39 Warrant Registration Rights Agreement, dated as of December 18, 1997,
between the Registrant and the Initial Purchasers. (Incorporated by
reference from Registrant's Registration Statement on Form S-4 (File
No. 333-45055), as amended, declared effective by the SEC on March
24, 1998).
10.40 Escrow Agreement, dated December 18, 1997, between the Registrant and
Chase Manhattan Bank and Trust Company, National Association.
(Incorporated by reference from Registrant's Registration Statement
on Form S-4 (File No. 333-45055), as amended, declared effective by
the SEC on March 24, 1998).
10.41 Standard Industrial Lease, dated as of February 17, 1995, by and
between Tiara Computer Systems, Inc. and InterNex Information
Services, Inc. (Incorporated by reference from Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997).
10.42 Standard Industrial Lease, dated as of July 25, 1996, by and between
San Tomas Investors II and InterNex Information Service, Inc.
(Incorporated by reference from Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1997).
10.43 Form of Warrant to purchase common stock. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
58641), as declared effective by the SEC on August 11, 1998).
</TABLE>
75
<PAGE>
<TABLE>
<C> <S>
10.44 Purchase Agreement, dated as of June 3, 1998, by and among the
Registrant and the Initial Purchasers. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
58641), as declared effective by the SEC on August 11, 1998).
10.45 Registration Rights Agreement, dated as of June 8, 1998, by and among
the Registrant and the Initial Purchasers. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
58641), as declared effective by the SEC on August 11, 1998).
10.46 Form of Indenture for Exchange Debentures. (Incorporated by reference
from Registrant's Registration Statement on Form S-4 (File No. 333-
58641), as declared effective by the SEC on August 11, 1998).
10.47* Carrier Agreement by and between the Registrant and MCI
Telecommunications Corporation, dated August 12, 1998. (Incorporated
by reference from Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, filed with the SEC on November 16,
1998).
10.48 Stock Purchase Agreement by and between the Registrant and
Southwestern Bell Internet Services, Inc., dated October 19, 1998.
(Incorporated by reference from Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998, filed with the SEC on
November 16, 1998).
21.1 List of Subsidiaries.
23.1 Consent of Ernst & Young, LLP, Independent Auditors.
24.1 Power of Attorney (see signature page).
27.1 Financial Data Schedule. (Incorporated by reference to Registrant's
Registration Statement on Form S-3 (File No. 333-71235) filed with
the SEC January 20, 1999).
</TABLE>
- --------
* Certain information in this exhibit was omitted and filed separately with
the SEC pursuant to a confidential treatment request.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of the
period covered by this report.
(c) Exhibits.
See item 14(a)(3) above.
(d) Financial Statement Schedules.
Schedule II--Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions Deductions Balance
Balance Charge to Uncollectable at End
at Beginning Costs & Accounts of
Description of Period Expenses Written Off Period
----------- ------------ ---------- ------------- --------
<S> <C> <C> <C> <C>
For the period ended
December 31, 1998......... $80,049 $1,155,356 $545,051 $690,354
---------------------------
For the period ended
December 31, 1997......... 56,000 40,000 15,951 80,049
---------------------------
For the Period ended
December 31, 1996......... 0 56,000 0 56,000
---------------------------
</TABLE>
All other schedules have been omitted because the required information is
not present in amounts sufficient to require submission of the schedule or
because the information required is included in the financial statements
including the notes thereto.
76
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: January 29, 1999 CONCENTRIC NETWORK CORPORATION
By: /s/ Henry R. Nothhaft
------------------------------
Henry R. Nothhaft
President and Chief Executive
Officer
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Henry R. Nothhaft and Michael F.
Anthofer, jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to
this Annual Report on Form 10-K, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-
in-fact, or his substitute or substitutes, may do or cause to be done by
virtue thereof.
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Henry R. Nothhaft President and Chief January 29, 1999
- -------------------------------- Executive Officer
Henry R. Nothhaft (Principal Executive
Officer), Director,
Chairman of the Board
/s/ Michael F. Anthofer Chief Financial Officer January 29, 1999
- -------------------------------- (Principal Financial and
Michael F. Anthofer Accounting Officer)
/s/ Vinod Khosla Director January 29, 1999
- --------------------------------
Vinod Khosla
/s/ Franco Regis Director January 29, 1999
- ---------------------------------
Franco Regis
/s/ Gary E. Rieschel Director January 29, 1999
- ---------------------------------
Gary E. Rieschel
/s/ S. Miller Williams Director January 29, 1999
- ---------------------------------
S. Miller Williams
</TABLE>
<PAGE>
EXHIBIT 21.1
LIST OF MATERIAL SUBSIDIARIES
The following companies are wholly-owned subsidiaries of Concentric Network
Corporation:
AnaServe, Inc., a California corporation;
Delta Internet Services, Inc., a California corporation; and
InterNex Information Services, Inc., a California corporation.
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8) pertaining to the Incentive Stock Option Plan, 1995 Stock Incentive
Plan for Employees and Consultants Option Agreements, Amended and Restated 1996
Stock Plan, 1997 Stock Plan and 1997 Employee Stock Purchase Plan and in the
Registration Statement (Form S-8) pertaining to the 1996 Stock Option Plan,
Stock Option Agreement and Warrant Agreement of Delta Internet Services, Inc.
and in the related Prospectuses, of Concentric Network Corporation of our
report dated January 25, 1999, with respect to the consolidated financial
statements and financial statement schedule of Concentric Network Corporation
included in this annual report (Form 10-K) for the year ended December 31,
1998.
/s/ Ernst & Young LLP
San Jose, California
January 25, 1999
