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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
----------------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 000-23795
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EXODUS COMMUNICATIONS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 77-0403076
----------------------------------- ----------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2831 Mission College Boulevard, Santa Clara, CA 95054
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(Address of principal executive offices)
(Zip Code)
(408) 346-2200
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No___
---
The number of shares outstanding of the issuer's common stock, par value $0.001,
as of August 4, 2000 was 416,705,656 shares.
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1
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EXODUS COMMUNICATIONS, INC.
INDEX
-----
<TABLE>
PART I. Financial Information Page No.
--------------------- --------
<S> <C>
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30, 2000 and
December 31, 1999 3
Condensed Consolidated Statements of Operations - Three
and Six Month Periods ended June 30, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows -
Six Month Periods ended June 30, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. Other Information
-----------------
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 29
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXODUS COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
-------------------- -------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 520,170 $1,015,960
Accounts receivable, net 108,293 61,916
Prepaid expenses and other current assets 27,067 15,331
-------------------- -------------------
Total current assets 655,530 1,093,207
Property and equipment, net 762,883 368,239
Restricted cash equivalents 51,160 35,390
Goodwill and other intangible assets 191,702 156,002
Marketable equity securities 58,968 --
Investments 391,597 --
Other assets 107,928 90,052
-------------------- -------------------
$2,219,768 $1,742,890
==================== ===================
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of equipment loans and line of credit facilities $ 8,305 $ 6,897
Current portion of capital lease obligations 30,948 17,162
Accounts payable 130,600 60,203
Accrued expenses 65,696 42,457
Accrued interest payable 32,805 23,829
-------------------- -------------------
Total current liabilities 268,354 150,548
Equipment loans and line of credit facilities, less current portion 3,849 8,353
Capital lease obligations, less current portion 49,368 40,343
Convertible subordinated notes 572,237 749,800
Senior notes 769,267 776,231
-------------------- -------------------
Total liabilities 1,663,075 1,725,275
-------------------- -------------------
Stockholders' equity:
Common stock 415 356
Additional paid-in capital 842,057 247,805
Deferred stock compensation (1,914) (2,894)
Accumulated deficit (337,860) (228,216)
Accumulated other comprehensive income 53,995 564
-------------------- -------------------
Total stockholders' equity 556,693 17,615
-------------------- -------------------
$2,219,768 $1,742,890
==================== ===================
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
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EXODUS COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------- ------------------------------
2000 1999 2000 1999
--------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues $ 179,553 $ 42,616 $ 313,695 $ 72,726
Cost of revenues 124,862 34,918 219,523 63,186
--------------- ------------- ------------- --------------
Gross profit 54,691 7,698 94,172 9,540
--------------- ------------- ------------- --------------
Operating expenses:
Marketing and sales 44,281 12,890 75,162 23,637
General and administrative 29,978 8,351 56,590 15,028
Product development 3,562 1,843 7,413 3,386
Amortization of goodwill and intangible assets 8,793 819 16,562 1,432
--------------- ------------- ------------- --------------
Total operating expenses 86,614 23,903 155,727 43,483
--------------- ------------- ------------- --------------
Operating loss (31,923) (16,205) (61,555) (33,943)
Interest and other income (expense):
Interest and other income 11,253 4,118 24,397 6,977
Interest and other expense (30,624) (10,552) (72,486) (18,905)
--------------- ------------- ------------- --------------
Total interest and other expense, net (19,371) (6,434) (48,089) (11,928)
--------------- ------------- ------------- --------------
Net loss $ (51,294) $ (22,639) $ (109,644) $ (45,871)
=============== ============= ============= ==============
Basic and diluted net loss per share $ (0.12) $ (0.07) $ (0.28) $ (0.14)
=============== ============= ============= ==============
Shares used in computing basic and diluted net loss per share 410,904 331,526 388,471 329,013
=============== ============= ============= ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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EXODUS COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------------
2000 1999
---------- -----------
<S> <C> <C>
Cash flows from operating activities
Net loss $ (109,644) $ (45,871)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization 70,855 12,807
Loss on disposal of property and equipment 730 --
Remeasurement gain on Euro denominated senior notes (466) --
Amortization of deferred stock compensation 1,045 375
Amortization of debt issuance costs 957 425
Interest accretion on restricted cash equivalents (281) (1,139)
Changes in operating assets and liabilities:
Accounts receivable (44,549) (12,816)
Prepaid expenses and other assets (12,131) (6,767)
Accounts payable 69,865 13,406
Accrued expenses 22,181 11,215
Accrued interest payable 8,976 4,317
---------- -----------
Net cash provided by (used for) operating activities 7,538 (24,048)
---------- -----------
Cash flows from investing activities
Capital expenditures (409,767) (81,958)
Business acquired, net of cash received (3,745) (20,009)
Release of restricted cash equivalents and investments 23,687 3,325
Increase in restricted cash equivalents and investments (38,578) --
Purchases of available-for-sale securities (5,500) --
Investments (81,540) --
Other assets (23,797) (8,131)
---------- -----------
Net cash used for investing activities (539,240) (106,773)
---------- -----------
Cash flows from financing activities
Proceeds from issuance of common stock, net 56,549 9,577
Payments on capital lease obligations (10,419) (3,971)
Proceeds from equipment loans and line of credit facilities 705 --
Payments on equipment loans and line of credit facilities (4,130) (12,280)
Proceeds from convertible notes, net of offering costs -- 242,250
Proceeds from senior notes, net -- 73,425
---------- -----------
Net cash provided by financing activities 42,705 309,001
---------- -----------
Net increase (decrease) in cash and cash equivalents (488,997) 178,180
Effects of exchange rates on cash and cash equivalents (6,793) --
Cash and cash equivalents at beginning of period 1,015,960 156,015
---------- -----------
Cash and cash equivalents at end of period 520,170 $ 334,195
========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 29,776 $ 14,423
========== ===========
Non-cash investing and financing activities:
Assets recorded under capital leases $ 33,205 $ 28,105
========== ===========
Deferred compensation on grants of stock options $ 901 $ --
========== ===========
Conversion of convertible subordinated notes into common stock $ 177,563 $ --
========== ===========
Issuance of common stock and assumption of stock options in connection
with acquisition $ 50,077 $ --
========== ===========
Issuance of common stock in connection with strategic investments $ 310,057 $ --
========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
EXODUS COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information, the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements include all adjustments, consisting
only of normal recurring adjustments, necessary for the fair presentation of the
Company's financial position as of June 30, 2000 and the results of its
operations for the three and six month periods ended June 30, 2000 and 1999 and
cash flows for the six-month periods ended June 30, 2000 and 1999. These
financial statements should be read in conjunction with the Company's audited
consolidated financial statements as of December 31, 1999 and 1998 and for each
of the years in the three-year period ended December 31, 1999, including notes
thereto, included in the Company's 1999 Annual Report on Form 10-K. Operating
results for the six-month period ended June 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. Certain prior period amounts have been reclassified to conform to the
current period presentation.
NOTE 2 - NET LOSS PER SHARE
Basic and diluted net loss per share has been computed by dividing the net
loss by the weighted-average number of shares of common stock outstanding during
the period. Diluted net loss per share does not include the effect of the
following common shares outstanding as the effect of their inclusion is
antidilutive as of the following dates (in thousands):
<TABLE>
<CAPTION>
June 30,
------------------------
2000 1999
------- ------
<S> <C> <C>
Shares issuable under stock options 101,442 88,290
Shares issuable pursuant to warrants to
purchase common and redeemable convertible
preferred stock 987 1,066
Shares of redeemable convertible preferred
stock and convertible preferred stock on
an "as if converted basis" basis -- 7,428
Convertible subordinated notes on an "as if
converted" basis 26,855 --
</TABLE>
The weighted-average exercise price of stock options was $15.83 and $2.49
for options outstanding as of June 30, 2000 and 1999, respectively. The
weighted-average exercise price of warrants to purchase common and reedemable
convertible preferred stock as of June 30, 2000 and 1999, was $0.93 and $0.90,
respectively. As of June 30, 2000, $72.2 million and $500.0 million of
convertible notes are convertible into the common stock at a conversion rate
of 175.1408 shares and 28.4068 shares, respectively, per $1,000 principal
amount of convertible notes, subject to adjustment, in certain events and at
each holder's option.
NOTE 3 - REVENUE RECOGNITION
The Company's revenues consist of (i) monthly fees from customer use of
Internet Data Center sites, network services, managed services, and professional
services and use of equipment and software provided by the Company, (ii)
revenues from sales or rentals of third-party equipment to customers and (iii)
fees for installation and certain professional services. Currently,
substantially all of the Company's revenue is derived from services. Revenues
(other than installation fees, equipment sales to customers and certain
professional services) are generally billed and recognized ratably over the term
of the contract, which is generally one year. Installation fees are typically
recognized at the time the installation occurs and equipment sales revenues are
typically recognized when the equipment is delivered to the customer or placed
into service at an Internet Data Center. The Company sells third-party equipment
to its customers as an accommodation to facilitate their purchase of services.
Sales of third party equipment account for less than 10% of total revenues for
all periods presented. One-time professional service fees are typically
recognized when services are rendered.
6
<PAGE>
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30, 2000 December 31,
1999
------------- -------------
<S> <C> <C>
Data centers and related equipment $652,513 $ 332,092
Furniture, fixtures, computer equipment and other 69,787 55,790
Construction in progress 146,804 35,663
-------- ---------
869,104 423,545
Less accumulated depreciation and amortization 106,221 55,306
-------- ---------
$762,883 $ 368,239
======== =========
</TABLE>
Computer and other equipment and certain data center infrastructure are
recorded under capital leases that aggregated $104,158,000 and $70,953,000 as of
June 30, 2000 and December 31, 1999, respectively. Accumulated amortization on
the assets recorded under capital leases aggregated $35,332,000 and $23,853,000
as of June 30, 2000 and December 31, 1999, respectively.
NOTE 5 - ACQUISITIONS AND INVESTMENTS
On July 27, 1999, the Company completed its acquisition of Cohesive
Technology Solutions, Inc. ("Cohesive"). Pursuant to the exchange ratios applied
in the acquisition, the Company issued 3,201,592 shares of Exodus common stock
and paid approximately $50,000,000 in cash and assumed options to purchase a
total of 817,424 shares of Exodus common stock for a total purchase price of
approximately $112,000,000. The acquisition was accounted for as a purchase with
the results of Cohesive's operations included from the acquisition date.
On December 17, 1999, the Company acquired 85% of the common stock of
Global Online Japan Co., Ltd. ("GOL") of Tokyo, Japan. The Company issued
830,592 shares of Exodus common stock and paid approximately $12,000,000 in cash
for a total purchase price of approximately $36,000,000. As the Company has a
majority share of 85% in GOL, the Company has consolidated GOL's results of
operation with its results of operations. The acquisition was accounted for as a
purchase with the results of GOL's operations included from the acquisition
date. The minority interest related to GOL is not material.
On February 11, 2000, the Company completed its acquisition of KeyLabs,
Inc. ("KeyLabs"), a provider of e-business testing services based in Utah. The
Company issued approximately 786,000 shares of Exodus common stock in exchange
for all outstanding shares of KeyLabs' common stock and reserved approximately
202,000 shares of common stock for issuance upon the exercise of KeyLabs'
options the Company assumed pursuant to the agreement, for total consideration
valued at approximately $50,000,000. The transaction was accounted for as a
purchase with the results of KeyLabs' operations included from the acquisition
date. The excess of the purchase price over the fair value of tangible net
assets acquired amounted to approximately $48,210,000 and was attributed
primarily to goodwill ($46,140,000), customer lists ($1,450,000) and assembled
workforce ($620,000). These amounts are being amortized on a straight-line basis
over periods ranging from 3 to 5 years.
The summary table below, prepared on an unaudited pro forma basis, reflects
the condensed consolidated results of operations for the three and six month
periods ended June 30, 2000 and 1999, assuming Cohesive, GOL and KeyLabs had
been acquired as of January 1, 1999 (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
--------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues $ 179,553 $ 60,464 $ 314,844 $ 105,984
Net loss $ (51,294) $ (34,557) $ (110,785) $ (68,079)
Basic and diluted net loss per share $ (0.12) $ (0.10) $ (0.28) $ (0.20)
Shares used in pro forma per share
computation 410,904 336,344 388,817 333,831
</TABLE>
7
<PAGE>
The pro forma results are not necessarily indicative of what would have
occurred if the acquisitions had been in effect for the periods presented. In
addition, they are not intended to be a projection of future results and do not
reflect any synergies that might be achieved from combined operations.
In April 2000, the Company closed its investment in the common stock of
Mirror Image Internet, Inc. ("Mirror Image"), a privately held company and a
provider of content distribution services. $75.0 million of the investment was
paid in cash, with the balance of the consideration consisting of 7,516,536
shares of the Company's common stock. The total value of the investment on the
closing date was approximately $385.1 million, plus certain professional fees
associated with the investment. The Company holds less than 20% ownership and
does not exert significant influence over operations. The investment is
accounted for under the cost method.
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consisted of the following (in thousands):
June 30, 2000 December 31,
1999
------------- -------------
Goodwill $168,105 $ 117,950
Customer lists 38,492 37,007
Workforce in place 11,246 10,624
------------- -------------
217,843 165,581
Less accumulated amortization 26,141 9,579
------------- -------------
$191,702 $ 156,002
============= =============
Goodwill and other intangible assets are being amortized on a straight-
line basis over periods generally ranging from 2 to 8 years.
NOTE 7 - CONVERTIBLE SUBORDINATED NOTES AND LINE OF CREDIT FACILITIES
In March 2000, holders of an aggregate principal amount of approximately
$160.0 million of the Company's 5% Convertible Subordinated Notes due March 15,
2006 converted the notes into approximately 28,000,000 shares of the Company's
common stock. The Company made aggregate payments of approximately $3,200,000 to
the holders in connection with these conversions, which is included in interest
expense for the six month period ended June 30, 2000, in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 84, Induced Conversion
of Convertible Debt. Also, holders of an additional approximately $18.0 million
principal amount of the Company's 5% Convertible Subordinated Notes due March
15, 2006 converted the notes into approximately 3,200,000 shares of the
Company's common stock. The Company did not make any payments in connection with
these conversions.
In April 2000, the Company entered into an agreement to increase its
existing $20,000,000 line of credit facility with a financial institution to
$30,000,000. This line of credit will expire in December 2000 and is to be used
solely for letters of credit.
NOTE 8 - COMPREHENSIVE LOSS
The components of comprehensive loss are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------- -------------------------------
2000 1999 2000 1999
-------------- -------------- -------------- ------------
<S> <C> <C> <C> <C>
Net loss $ (51,294) $ (22,639) $ (109,644) $ (45,871)
Unrealized gain on available-for-sale securities 48,363 -- 53,468 --
Foreign currency translation loss -- -- (37) --
-------------- -------------- -------------- ------------
Comprehensive loss $ (2,931) $ (22,639) $ (56,213) $ (45,871)
============== ============== ============== ============
</TABLE>
Accumulated other comprehensive income consists of unrealized gains or
losses on available-for-sale securities, which are included in marketable equity
securities on the condensed consolidated balance sheets, and cumulative
translation adjustments. There was no significant tax effect on the components
of comprehensive loss for the three-month and six-month periods ended June 30,
2000 and 1999.
8
<PAGE>
NOTE 9 - SEGMENT INFORMATION
The Company operates a number of Internet Data Centers throughout North
America and internationally. The Company establishes these Internet Data Centers
using a consistent investment and operating model. As a result, the expected
long-term economic characteristics and financial performance are similar. In
particular, each Internet Data Center provides the same Internet related
services to a similar type of customer who may locate its servers in multiple
Internet Data Centers. As a result, the Company believes these Internet Data
Centers represent one reportable segment under the aggregation criteria of SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information.
Internet Data Center operations primarily include services such as server
infrastructure support, Internet connectivity and managed services.
With the acquisition of Cohesive on July 27, 1999, the chief operating
decision maker began reviewing financial information and business performance
and allocating resources based on both Internet Data Center operations and
professional services, given Cohesive's expertise in networking, Internet-based
applications and technology solutions. As a result, the Company identified
professional services as an additional reportable segment. Professional services
primarily include services such as network design and development, Internet-
based and application development, and information technology strategy.
Financial information for the Company's reportable segments is presented
below:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- --------------------------------
2000 1999 2000 1999
-------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Internet Data Centers $150,584 $38,740 $260,470 $67,249
Professional services 28,969 3,876 53,225 5,477
------------- ------------ ------------- -------------
Total revenues $179,553 $42,616 $313,695 $72,726
============= ============ ============= =============
Operating profit (loss):
Internet Data Centers $41,554 $8,770 $59,121 $12,820
Professional services 4,742 270 7,771 (299)
Corporate areas (78,219) (25,245) (128,447) (46,464)
------------- ------------ ------------- -------------
Total operating loss $(31,923) $(16,205) $(61,555) $(33,943)
============= ============ ============= =============
</TABLE>
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
----------------- ---------------------
<S> <C> <C>
Total assets:
Internet Data Centers $690,038 $ 314,452
Professional services 3,949 3,068
Corporate assets 1,525,781 1,425,370
----------------- ---------------------
Total assets $2,219,768 $ 1,742,890
================= =====================
</TABLE>
NOTE 10 - STOCK SPLIT
On June 20, 2000, the Company completed a two-for-one stock split
effected in the form of a stock dividend. Share and per share amounts in the
accompanying condensed consolidated financial statements reflect this two-for-
one stock split retroactively.
NOTE 11 - SUBSEQUENT EVENT
In July 2000, the Company issued $1,000,000,000 of 11 5/8% Senior Notes
due 2010 and Euro 200,000,000 of 11 3/8% Senior Notes due 2008 for aggregate net
proceeds of approximately $1.155 billion (net of offering expenses). Interest is
payable semiannually on January 15 and July 15 of each year.
In July 2000, the Company entered into an agreement to extend the
expiration date of its existing $30,000,000 line of credit facility with a
financial institution from December 31, 2000 to March 31, 2001.
9
<PAGE>
In July 2000, the Company filed a registration statement with the
Securities and Exchange Commission to register the offer and sale of up to $2.0
billion of debt and equity securities in on or more public offerings over the
next two years.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-Q contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934 and Section 27A of the
Securities Act of 1933. Forward-looking statements are identified by words such
as "believes," "anticipates," "expects," "estimates," "intends," "will," "may,"
and other similar expressions. In addition, any statements which refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. In addition, the section labeled
"Factors Affecting Future Results" consists primarily of forward-looking
statements. We undertake no obligation to revise forward-looking statements.
Readers are urged to review and consider carefully the various disclosures made
by us in this report and in our other reports filed with the Securities and
Exchange Commission, including our 1999 Annual Report on Form 10-K, that advise
interested parties of risks and uncertainties that may affect our business.
These risks and uncertainties include: difficulties in achieving timely
expansion of our network and opening of additional Internet Data Centers;
difficulties in executing our current business plan, including the integration
of acquired companies; retaining customers and attracting new customers; and
difficulties in developing and deploying new services. Our actual results may
differ materially from any forward-looking statements due to such risks and
uncertainties.
Overview
As the leading provider of services for companies with complex Internet
businesses, Exodus offers a wide range of capabilities, from sophisticated
managed and professional services to state-of-the-art facilities to one of the
most technologically advanced global networks in the world.
We are the successor to a Maryland corporation that was formed in August
1992 to provide computer-consulting services. We began offering server hosting
and Internet connectivity services in late 1995, opened our first dedicated
Internet Data Center in August 1996 and introduced managed services in 1997 and
professional services in 1998. We have derived most of our revenues from
customers for whom we provide these services. Many of our Internet Data Center
customers initially purchase a subset of our service offerings to address
specific departmental or enterprise Internet computing needs, and many of these
customers purchase additional services as the scale and complexity of their
Internet operations increase. We sell our services under contracts that
typically have minimum terms of one year. Customers pay monthly fees for the
services utilized, as well as one-time fees for installation, certain
professional services and for equipment they purchase from us.
We opened our first Internet Data Center in the Silicon Valley
metropolitan area in August 1996. Since that time, we have opened additional
North American Internet Data Centers in the metropolitan areas of New York
(March 1997 and September 1999), Silicon Valley (August 1997, June 1998, June
1999 and June 2000), Seattle (September 1997 and June 1999), Los Angeles
(October 1997 and September 1999), Washington, D.C. (December 1997 and May
1999), Boston (July 1998 and December 1999), Chicago (April 1999), Austin, Texas
(November 1999), Atlanta (December 1999) and Toronto, Canada (April 2000). In
addition, we opened our first Internet Data Center outside of the United States
in London in June 1999. In December 1999, we acquired Global OnLine Japan Co.,
Ltd. of Tokyo, Japan, which has an Internet Data Center located in Tokyo. We
relocated this Internet Data Center to a new facility in Tokyo in March 2000. In
April 2000, we opened an Internet Data Center in Frankfurt, Germany. The
building of Internet Data Centers has required us to obtain substantial equity
and debt financing. See "Factors Affecting Future Results--Our substantial
leverage and debt service obligations adversely affect our cash flow" and "--
Liquidity and Capital Resources" below.
On March 3, 1999, we issued $250.0 million of 5% Convertible Subordinated
Notes due March 15, 2006 for aggregate net proceeds of approximately $242.1
million (net of offering expenses). The convertible notes are convertible into
our common stock at a conversion rate of 175.1408 shares per $1,000 principal
amount of convertible notes, subject to adjustment in certain events and at each
holder's option. Interest on the convertible notes is payable on March 15 and
September 15 of each year. On December 8, 1999, we issued $500.0 million of 4
3/4% Convertible Subordinated Notes due July 15, 2008 for aggregate net proceeds
of approximately $485.0 million (net of offering expenses). These convertible
notes are convertible into our common stock at a conversion rate of 28.4068
shares per $1,000 principal amount of the notes, subject to adjustment in
certain circumstances. Interest is payable on January 15 and July 15 of each
year.
On June 22, 1999, we issued an additional $75.0 million of 11 1/4% Senior
Notes due 2008 at 100.50% plus accrued interest, if any, from June 22, 1999, for
aggregate net proceeds of approximately $73.2 million (net of offering
expenses). Interest is payable
10
<PAGE>
semi-annually on January 1 and July 1 of each year. On December 8, 1999, we
issued $375.0 million and Euro 125.0 million of 10 3/4% Senior Notes due 2009
for aggregate net proceeds of approximately $486.0 million (net of offering
expenses). Interest is payable semiannually on June 15 and December 15 of each
year.
We completed our merger with Service Metrics, Inc. ("SMI") on November
23, 1999. The merger was accounted for as a pooling of interests. Accordingly,
the consolidated financial statements have been restated for all periods
presented as if we and SMI had always been combined. In connection with the
merger, we incurred one-time expenses of approximately $4.1 million, which are
included in merger costs in the consolidated statement of operations for the
year ended December 31, 1999. SMI is a leading provider of Internet monitoring
applications and services that measure the consistency, availability and
performance of Web sites. Under the terms of the agreement, the former
shareholders and option holders of SMI common stock received shares and options
of Exodus common stock at the rate of approximately 0.504 shares of Exodus
common stock for each share of SMI common stock. We issued a total of
approximately 12,600,000 shares of Exodus common stock in exchange for all
outstanding shares of SMI common stock and reserved approximately 1,500,000
shares of common stock for issuance upon the exercise of SMI options we assumed
pursuant to the agreement.
On February 11, 2000, we acquired KeyLabs, a provider of e-business
testing services based in Utah. We issued approximately 786,000 shares of Exodus
common stock in exchange for all outstanding shares of KeyLabs' common stock and
reserved approximately 202,000 shares of common stock for issuance upon the
exercise of KeyLabs' options we assumed pursuant to the agreement, for total
consideration valued at approximately $50.0 million. The transaction was
accounted for as a purchase with the results of KeyLabs' operations included
from the acquisition date. The excess of the purchase price over the fair value
of tangible net assets acquired amounted to approximately $48.2 million and was
attributed primarily to goodwill ($46.1 million), customer lists ($1.5 million)
and assembled workforce ($620,000). These amounts are being amortized on a
straight-line basis over periods ranging from 3 to 5 years.
In April 2000, we closed on an investment in the common stock of Mirror
Image Internet, Inc. ("Mirror Image"), a privately held company and a provider
of content distribution services. $75.0 million of the investment was paid in
cash, with the balance of the consideration consisting of 7,516,536 shares of
our common stock. Those shares were registered for resale in May 2000. The total
value of the investment on the closing date was approximately $385.1 million,
plus certain profesional fees associated with the investment. We hold less than
20% ownership and do not exert significant influence over operations. The
investment is accounted for under the cost method. We also entered into a
commercial agreement to offer Mirror Image's content distribution services and
to deploy Mirror Image Content Access Point architecture throughout our
Internet Data Center network.
In July 2000, we issued $1.0 billion of 11 5/8% Senior Notes due 2010 and
Euro 200.0 million of 11 3/8% Senior Notes due 2008, for aggregate net proceeds
of approximately $1.155 billion (net of offering expenses). Interest is payable
semiannually on January 15 and July 15 of each year.
We intend to expand domestically and internationally. Prior to building
an Internet Data Center in a new geographic region, we employ various means to
evaluate the market opportunity in a given location, including market research
on Internet usage statistics, the pre-selling of services into the proposed
market and analysis of specific financial criteria. We typically require at
least six months to select the appropriate location for an Internet Data Center,
construct the necessary facilities, install equipment and telecommunications
infrastructure, and hire the operations and sales personnel needed to conduct
business at that site. Expenditures related to an Internet Data Center commence
well before the Internet Data Center opens, and it takes an extended period to
approach break-even capacity utilization at each site. As a result, we expect
that individual Internet Data Centers will experience losses for in excess of
one year from the time they are opened. We experience further losses from sales
personnel hired to test market our services in markets where there is no, and
may never be, an Internet Data Center. In addition, we intend to make services
an increasingly significant portion of our offerings. As a result, we expect to
make investments in expanding our business rapidly into new geographic regions
which, while potentially increasing our revenues in the long term, will lead to
significant losses for the foreseeable future. See "Factors Affecting Future
Results--Our rapid expansion produces a significant strain on our business and
requires us to expend substantial resources".
Since we began to offer server hosting and Internet connectivity services
in 1995, we have experienced operating losses and negative cash flows from
operations in each fiscal quarter and year. As of June 30, 2000, we had an
accumulated deficit of approximately $337.9 million. The revenue and income
potential of our business and market is unproven, and our limited operating
history makes an evaluation of our business operations, our prospects and us
difficult. We intend to invest in new Internet Data Centers and other sites,
product development and sales and marketing programs. We therefore believe that
we will continue to experience net losses on a quarterly and annual basis for
the foreseeable future. As a company in the new and rapidly evolving market for
Internet system and network management solutions, we encounter risks, expenses
and difficulties that affect our business and prospects. There can be no
assurance that we will achieve profitability on a quarterly or an annual basis
or that we will sustain profitability. See "Factors Affecting Future Results--
Our short operating history and heavy losses make our business difficult to
evaluate."
11
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Results of Operations
The following table sets forth certain statement of operations data as a
percentage of total revenues for the three and six month periods ended June 30,
2000 and 1999. This information has been derived from our unaudited condensed
consolidated financial statements which, in management's opinion, have been
prepared on substantially the same basis as the audited financial statements
included in our 1999 Annual Report on Form 10-K and include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the financial information for the quarters presented. This
information should be read in conjunction with the unaudited condensed
consolidated financial statements and accompanying notes included in this Form
10-Q. These operating results are not indicative of the results to be expected
for any future period.
EXODUS COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------- ---------------------------------
2000 1999 2000 1999
---------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Revenues 100% 100% 100% 100%
Cost of Revenues 70% 82% 70% 87%
---------------- -------------- -------------- ---------------
Gross Profit 30% 18% 30% 13%
---------------- -------------- -------------- ---------------
Operating expenses:
Marketing and sales 24% 30% 24% 32%
General and administrative 17% 20% 18% 21%
Product development 2% 4% 3% 5%
Amortization of goodwill and intangible assets 5% 2% 5% 2%
---------------- -------------- -------------- ---------------
Total operating expenses 48% 56% 50% 60%
---------------- -------------- -------------- ---------------
Operating loss (18%) (38%) (20%) (47%)
Interest and other income (expense):
Interest and other income 6% 10% 8% 10%
Interest and other expense (17%) (25%) (23%) (26%)
---------------- -------------- -------------- ---------------
Total interest and other expense, net (11%) (15%) (15%) (16%)
---------------- -------------- -------------- ---------------
Net loss (29%) (53%) (35%) (63%)
================ ============== ============== ===============
</TABLE>
Revenues
Our revenues consist of (1) monthly fees for customer use of Internet Data
Center sites, network services, managed services and professional services, and
use of equipment and software provided by us, (2) revenues from sales or rentals
of third-party equipment to customers and (3) fees for installation and certain
professional services. Currently, substantially all of our revenues are derived
from services. Revenues, other than installation fees, equipment sales to
customers and certain professional services, are generally billed and recognized
ratably over the term of the contract, which is generally one year. Installation
fees are typically recognized at the time the installation occurs and equipment
sales revenues are typically recognized when the equipment is delivered to the
customer or placed into service at an Internet Data Center. We sell third-party
equipment to our customers as an accommodation to facilitate their purchase of
services. Sales of third-party equipment account for less than 10% of total
revenues for all periods presented. One-time professional service fees are
typically recognized when the services are rendered.
Our revenues increased 321% and 331% to $179.6 million and $313.7
million, respectively, for the three-month and six-month periods ended June 30,
2000 from $42.6 million and $72.7 million in the same periods of the prior year.
Revenues generated by Internet Data Centers increased to $150.6 million and
$260.5 million, respectively, for the three-month and six-month periods ended
June 30, 2000 from $38.7 million and $67.2 million in the same periods of the
prior year. This growth in revenues was primarily the result of opening new
Internet Data Centers, expanding existing Internet Data Centers, increases in
the number of new customers and increases in revenues from existing customers.
In addition, revenues generated by professional services increased to $29.0
million and $53.2 million for the three-month and six-month periods ended June
30, 2000 from $3.9
12
<PAGE>
million and $5.5 million in the same periods of the prior year which was
primarily due to increases in revenues arising from increases in the number of
customers and revenues generated from the acquisition of Cohesive in July 1999.
Cost of Revenues
Our cost of revenues is comprised of the costs for salaries and benefits
for our customer service and operations personnel (customer service personnel,
network engineers and professional services personnel), depreciation and
amortization, costs of network and local telecommunications circuits,
interconnections to other networks, rent, consultants' fees, repairs and
utilities related to our Internet Data Centers and other sites, and costs of
third-party equipment sold or rented to customers.
Cost of revenues increased 258% and 247% to $124.9 million and $219.5
million, respectively, for the three-month and six-month periods ended June 30,
2000 from $34.9 million and $63.2 million in the same periods of the prior year.
Our cost of revenues as a percentage of revenues decreased to 70% for each of
the three-month and six-month periods ended June 30, 2000 from 82% and 87% for
the same periods of the prior year. The increase in cost of revenues in absolute
dollars from the six-month period ended June 30, 1999 to the six-month period
ended June 30, 2000 was primarily the result of higher costs associated with
hiring additional employees and consultants, including professional services
employees hired in connection with our business combinations, increased
depreciation due to capital expenditures related to the buildout and expansion
of Internet Data Centers and increased traffic on our network and to other
networks, which in aggregate represented more than 70% of the increase. Cost of
revenues also increased in absolute dollars due to increased rent, increased
utilities and other costs related to the opening and expanding of Internet Data
Centers. The decrease in cost of revenues as a percentage of revenues primarily
resulted from revenues from new and existing Internet Data Centers increasing
faster than related costs of revenues as we have realized economies of scale
from our investments. We expect that cost of revenues will continue to increase
in absolute dollars.
Marketing and Sales
Our marketing and sales expenses are comprised of salaries, commissions and
benefits for our marketing and sales personnel, printing and advertising costs,
public relations costs, consultants' fees and travel and entertainment expenses.
Our marketing and sales expenses increased 244% and 218% to $44.3 million
and $75.2 million, respectively, for the three-month and six-month periods ended
June 30, 2000 from $12.9 million and $23.6 million in the same periods of the
prior year. Our marketing and sales expenses as a percentage of revenues
decreased to 24% and 24%, respectively, for the three-month and six-month
periods ended June 30, 2000 from 30% to 32% for the same periods of the prior
year. The increase in marketing and sales expenses in absolute dollars from the
six-month period ended June 30, 1999 to the six-month period ended June 30, 2000
was primarily the result of increased compensation and related expenses
associated with hiring additional marketing and sales personnel, including
employees hired in connection with our business combinations and increased
travel expenses, which in aggregate represented more than 80% of the
increase. Marketing and Sales expenses also increased in absolute dollars due to
increased marketing program expenses and increased rent. The decrease in
marketing and sales expenses as a percentage of revenues was primarily due to
revenues growing faster than marketing and sales expenses over that time period
and reflects the emergence of economies of scale as a result of our investment.
We expect that marketing and sales expenses will continue to increase in
absolute dollars.
General and Administrative
Our general and administrative expenses are primarily comprised of salaries
and benefits for our administrative and management information systems security
personnel, consulting fees, recruiting fees, depreciation on IT equipment and
travel expenses.
Our general and administrative expenses increased 259% and 277% to $30.0
million and $56.6 million, respectively, for the three-month and six-month
periods ended June 30, 2000 from $8.4 million and $15.0 million in the same
periods of the prior year. Our general and administrative expenses as a
percentage of revenues decreased to 17% and 18%, respectively, for the three-
month and six-month periods ended June 30, 2000 from 20% and 21% for the same
periods of the prior year. The increase in general and administrative expenses
in absolute dollars from the six-month period ended June 30, 1999 to the six-
month period ended June 30, 2000 was primarily the result of increased
compensation expenses associated with additional hiring of general and
administrative personnel, including employees hired in connection with our
business combinations, bad debt expenses, costs for consultants and professional
services providers and higher depreciation expenses, which in aggregate
represents more than 70% of the increase. General and administrative expenses
also increased in absolute dollars due to increased recruiting expenses,
increased freight expenses and increased rent. The decrease in general and
administrative expenses as a percentage of revenues was primarily due to
revenues growing faster than general and administrative expenses and reflects
the emergence of economies of scale as a result of our investments. We expect
that general and administrative expense will continue to increase in absolute
dollars.
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<PAGE>
Product Development
Our product development expenses consist primarily of salaries and benefits
for our product development personnel and fees paid to consultants.
Our product development expenses increased 93% and 119% to $3.6 million and
$7.4 million, respectively, for the three-month and six-month periods ended June
30, 2000 from $1.8 million and $3.4 million in the same periods of the prior
year. Our product development expenses as a percentage of revenues decreased to
2% and 3%, respectively, for the three-month and six-month periods ended June
30, 2000 from 4% and 5% for the same periods of the prior year. The increase in
product development expenses in absolute dollars from the six-month period ended
June 30, 1999 to the six-month period ended June 30, 2000 was primarily the
result of increased compensation expenses associated with the hiring of
additional product development personnel to develop our expanded service
offerings, which represented more than 80% of the increase. The decrease in
product development expenses as a percentage of revenues resulted from revenues
growing faster than product development expenses and reflects the emergence of
economies of scale as a result of our investments. We expect that product
development expenses will continue to increase in absolute dollars.
Amortization of Goodwill and Intangible Assets
As part of our strategy to grow through acquisitions of complementary
businesses, we acquired the assets of Arca Systems, Inc. in October 1998,
American Information Systems, Inc. ("AIS") in February 1999, Cohesive in July
1999, GOL in December 1999 and KeyLabs in February 2000. In connection with
those acquisitions, we have recorded intangible assets related to goodwill,
customer lists and workforce in place. Amortization related to those intangibles
was approximately $8.8 million and $819,000 for the three month periods ended
June 30, 2000 and 1999, respectively, and $16.6 million and $1.4 million for the
six month periods ended June 30, 2000 and 1999, respectively. These intangibles
are being amortized on a straight-line basis over periods generally ranging from
2 to 8 years. We expect amortization related to goodwill and other intangible
assets will continue to increase in absolute dollars.
Interest and other expense, net
Our net interest and other expense increased to $19.4 million and $48.1
million for the three-month and six-month periods ended June 30, 2000 from $6.4
million and $11.9 million for the same periods of the prior year. The increase
in interest and other expense was primarily due to our increasing additional
indebtedness, primarily $250.0 million of 5% convertible subordinated notes
issued March 3, 1999, $75.0 million 11 1/4% senior notes issued June 22, 1999,
$375.0 million and Euro 125.0 million 10 3/4% senior note financing and the $500
million 4 3/4% convertible note financing which occurred on December 8, 1999,
and secondarily increased borrowings as we entered into equipment loans and
lease agreements to finance the construction of our Internet Data Centers. In
March 2000, holders of an aggregate principal amount of approximately $160.0
million of the Company's 5% Convertible Subordinated Notes due March 15, 2006
converted the notes into approximately 28,000,000 shares of the Company's common
stock. The Company made aggregate payments of approximately $3.2 million to the
holders in connection with these conversions which is included in interest
expense for the six month period ended June 30, 2000, in accordance with SFAS
84. The increase in interest expense was partially offset by increased interest
and other income as a result of cash raised in our sales of senior notes and
convertible notes. We expect that net interest and other expense will continue
to increase as we enter into additional equipment leases and loans, obtain
additional borrowings and long term debt and experience reduced interest income
as a result of the decline in our cash reserves to fund working capital and
other uses. For example, we expect to enter into a secured bank credit facility
in the amount of up to $600.0 million which will cause borrowing expenses to
increase each year the facility can be fully utilized.
EBITDA
Our earnings before net interest and other expense, income taxes,
depreciation, amortization (including amortization of deferred stock
compensation) and other noncash charges, including fixed asset write-offs,
("EBITDA") were $8.6 million and $10.3 million for the three-month and six-month
periods ended June 30, 2000 compared to an EBITDA loss of $8.7 million and $20.5
million for the same periods of the prior year. The increase in the level of
EBITDA was primarily due to increased revenues from new and existing customers,
as well as increases in revenues from our managed services and professional
service offerings. The increase in revenue was partially offset by related
increases in the costs of those revenues as well as increased operating
expenses.
Although EBITDA should not be used as an alternative to operating loss or
net cash provided by (used for) operating activities, investing activities or
financing activities, each as measured under generally accepted accounting
principles, our management believes that EBITDA is an additional meaningful
measure of performance.
14
<PAGE>
Liquidity and Capital Resources
From inception through June 30, 2000, we have financed our operations
primarily through private sales of preferred stock, our initial public offering
of common stock in March 1998, our senior notes offerings in July 1998, June
1999 and December 1999, our convertible subordinated notes offerings in March
1999 and December 1999, and through various types of equipment loans and lease
lines and working capital lines of credit. At June 30, 2000, our principal
source of liquidity was approximately $520.2 million in cash and cash
equivalents. In addition, in July 2000, we issued $1.0 billion of our 11 5/8%
Senior Notes and Euro 200.0 million of our 11 3/8% Senior Notes. We also have
the right to issue up to $100.0 million of additional 10 3/4% Senior Notes on or
prior to December 8, 2000, up to $100.0 million of additional 11 5/8% Senior
Notes prior to the maturity date of those notes and Euro 100.0 million of
additional 11 3/8% Senior Notes prior to the maturity of those notes. As of June
30, 2000, our outstanding bank borrowings, equipment loans and lines of credit
facilities, capital lease obligations and senior and convertible notes were
approximately $1.4 billion. Furthermore, we expect to enter into secured credit
facilities, under which we will be permitted to borrow up to $600.0 million.
However, there can be no assurance as to whether, or on what terms, we will
obtain the credit facilities. In addition, existing financing arrangements
require us to maintain compliance with certain covenants including minimum cash
balance and other profitability based measurements. As of June 30, 2000, we were
in compliance with all such covenants.
Net cash provided by operating activities for the six-month period ended
June 30, 2000 was $7.5 million, primarily due to depreciation and amortization
and increases in accounts payable and accrued expenses, offset by net losses and
increases in accounts receivable and prepaid expenses. This compares to net cash
used for operating activities for the six-month period ended June 30, 1999 of
$24.0 million which was primarily due to net losses, an increase in accounts
receivable and prepaid expenses and other assets, offset in part by depreciation
and amortization and an increase in accounts payable, accrued expenses and
accrued interest payable.
Net cash used for investing activities for the six-months ended June 30,
2000 was $539.2 million primarily due to capital expenditures for the continued
construction of Internet Data Centers, our investment in Mirror Image, an
increase in restricted cash equivalents and investments and increase in other
assets, offset in part by a release of restricted cash equivalents and
investments. This compares to net cash used for investing activities for the
six-months ended June 30, 1999 of $106.8 million which was due to capital
expenditures for the construction of Internet Data Centers, the acquisition of
AIS and expenditures related to a telecommunication agreement in which we
entered.
Net cash provided by financing activities for the six-month period ended
June 30, 2000 was approximately $42.7 million, primarily due to the proceeds
from our issuance of common stock and exercise of employee stock options, offset
in part by payments on capital lease obligations, equipment loans and line of
credit facilities. This compares to net cash provided by financing activities
for the six-month period ended June 30, 1999 of $309.0 million which was
primarily due to the proceeds from our issuance of $250 million of convertible
subordinated notes and our $75.0 million offering of senior notes, offset in
part by payments on capital lease obligations, equipment loans and line of
credit facilities.
As of June 30, 2000, we had commitments under capital leases and under
noncancellable operating leases of $80.3 million and $639.4 million,
respectively, through 2016. In addition, in August 1999 we entered into capacity
purchase agreements with Global Crossing USA, Inc. The agreements provide for a
total potential outlay of approximately $105.0 million for fiber capacity and
related maintenance covering approximately 25 years; as of June 30, 2000, we had
expended $43.5 million for this purpose.
We intend to make significant expenditures during the next 12 months
primarily for property and equipment, in particular equipment and construction
needed for existing and future Internet Data Centers, as well as office
equipment, computers and telephones. We have a $30.0 million line of credit
facility with a financial institution that is used for letters of credit
required to obtain facilities for operating activities. We expect to finance
capital expenditures primarily through the net proceeds from our 11 5/8% and 11
3/8% Senior Notes issued in July 2000 and the remaining net proceeds from our 10
3/4% senior notes and 4 3/4% convertible subordinated notes issued in December
1999, borrowings under the anticipated secured credit facilities, existing and
future equipment loans and lease lines of credit, and issuances of additional
debt and other financing activities. We believe our currently estimated working
capital and capital expenditure requirements over the next 12 months can be met
with existing cash and cash equivalents and investments, cash from sales of
services and proceeds from existing and future debt financings and existing and
future equipment financing lines of credit. We may enter into additional
equipment loans and capital leases. We may also seek to raise additional funds
through public or private financings, strategic relationships or other
arrangements. There can be no assurance that we will be successful in generating
sufficient cash flows from operations or raising capital in sufficient amounts
on terms acceptable to us. See "Factors Affecting Future Results--Our rapid
expansion produces a significant strain on our business and requires us to
expend substantial resources."
15
<PAGE>
Recent Accounting Pronouncements
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 establishes methods for accounting for derivative financial instruments and
hedging activities related to those instruments, as well as other hedging
activities. In June 2000, we entered into a foreign currency exchange contract
in order to reduce the impact of currency fluctuations related to our Euro
denominated senior notes. We will be required to adopt SFAS No. 133 for the year
ending December 31, 2001. We expect that the adoption of SFAS No. 133 will not
have a material impact on our financial position, results of operations or cash
flows.
Revenue Recognition
In December 1999, the Securities and Exchange Commission (SEC) released
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements, as amended by SAB No. 101B, which provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. SAB 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. Although we do not expect the adoption of SAB 101 to have
a material effect on our consolidated financial position or results of
operations,implementation guidance is expected to be released by the SEC in the
near term.
In March 2000, the Emerging Issues Task Force ("EITF") published their
consensus on EITF Issue No. 00-3, Application of AICPA Statement of Position 97-
2, Software Revenue Recognition, to Arrangements That Include the Right to Use
Software Stored on Another Entity's Hardware. EITF Issue No. 00-3 outlines the
accounting criteria for hosting arrangements. We do not expect the adoption of
EITF Issue No. 00-3 to have a material effect on our consolidated financial
position or results of operations.
Stock-Based Compensation
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. This interpretation clarifies the application of Opinion 25 for
certain issues including: (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. In general, this interpretation is effective July 1, 2000. The
adoption of Interpretation No. 44 did not have a material effect on our
consolidated financial position or results of operations.
Factors Affecting Future Results
Our short operating history and heavy losses make our business difficult to
evaluate
Our limited operating history makes evaluating our business operations and
our prospects difficult. We began offering server hosting and Internet
connectivity services in 1995, opened our first dedicated Internet Data Center
in August 1996 and introduced Managed Services in 1997 and Professional Services
in 1998. Due to our short operating history, our business model is still
evolving. We have incurred operating losses and negative cash flows each fiscal
quarter and year since 1995. Our accumulated deficit was approximately $337.9
million at June 30, 2000. We anticipate continuing to make significant
investments in new Internet Data Centers and network infrastructure, product
development, sales and marketing programs and personnel. We believe that we will
continue to experience net losses on a quarterly and annual basis for the
foreseeable future. We may also use significant amounts of cash and/or equity to
acquire complementary businesses, products, services or technologies. Although
we have experienced significant growth in revenues in recent periods, this
growth rate is not necessarily indicative of future operating results. It is
possible that we may never achieve profitability on a quarterly or an annual
basis.
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<PAGE>
Our operating results have fluctuated widely and we expect this to continue
We have experienced significant fluctuations in our results of operations
on a quarterly and an annual basis. We expect to continue to experience
significant fluctuations due to a variety of factors, many of which are outside
of our control, including:
. demand for and market acceptance of our services;
. the timing and magnitude of capital expenditures, including
construction costs relating to the expansion of operations;
. the timing of expansion of existing Internet Data Centers and
completion of new Internet Data Centers, including obtaining necessary
permits and adequate public utility power;
. costs related to the acquisition of network capacity and arrangements
for interconnections with third-party networks;
. customer retention and satisfaction;
. capacity utilization of our Internet Data Centers;
. the timing, magnitude and integration of acquisitions of complementary
businesses and assets;
. the timing of customer installations;
. customer discounts and credits;
. the mix of services we sell;
. the timing and success of marketing efforts and service introductions
by us and our competitors;
. the introduction by third parties of new Internet and networking
technologies;
. changes in our pricing policies and our competitors, pricing policies;
. fluctuations in bandwidth used by customers; and
. delays in obtaining licenses and permits required to construct
facilities, deploy networking infrastructure or operate in the United
States and foreign countries.
In addition, a relatively large portion of our expenses are fixed in the
short term, particularly with respect to telecommunications, depreciation,
substantial interest expenses, real estate and personnel. Therefore, our results
of operations are particularly sensitive to fluctuations in revenues.
Furthermore, if we were to be unable to continue leveraging third-party products
in our services offerings, our product development costs could increase
significantly. Finally, many of our customers are emerging growth companies with
negative cash flows, and there is the possibility that we will not be able to
collect receivables on a timely basis.
Our rapid expansion produces a significant strain on our business and
requires us to expend substantial resources
The expansion of our network through the opening of additional Internet
Data Centers in geographically diverse locations is one of our key strategies.
We currently have 22 Internet Data Centers located in the following metropolitan
areas: Atlanta, Austin, Boston, Chicago, Frankfurt, London, Los Angeles, New
York, Seattle, Silicon Valley, Tokyo, Toronto and Washington, D.C. To expand
successfully, we must be able to assess markets, locate and secure new Internet
Data Center sites, install telecommunications circuits and equipment and
Internet Data Center facilities, and establish additional interconnections with
Internet service providers. To manage this expansion effectively, we must
continue to improve our operational and financial systems and expand, train and
manage our employee base. Our inability to establish additional Internet Data
Centers or effectively manage our expansion would have a material adverse effect
upon our business.
We expect to expend substantial resources for leases or the purchases of
real estate, significant improvements of facilities, purchase of complementary
businesses, assets and equipment, implementation of multiple telecommunications
connections and
17
<PAGE>
hiring of network, administrative, customer support and sales and marketing
personnel with the establishment of each new Internet Data Center. Moreover, we
expect to make additional significant investments in sales and marketing and the
development of new services as part of our expansion strategy. If we fail to
generate sufficient cash flows or to raise sufficient funds, we may be required
to delay or abandon development and expansion plans or otherwise forego market
opportunities, making it difficult for us to generate additional revenue and to
respond to competitive pressures.
In general, it takes us at least six months to select the appropriate
location for a new Internet Data Center, construct the necessary facilities,
install equipment and telecommunications infrastructure and hire operations and
sales personnel. Expenditures commence well before the Internet Data Center
opens, and it takes an extended period for us to approach break-even capacity
utilization. As a result, we expect that individual Internet Data Centers will
experience losses for in excess of one year from the time they are opened. We
incur further expenses from sales personnel hired to test market our services in
markets where there is no Internet Data Center. Growth in the number of our
Internet Data Centers is likely to increase the amount and duration of losses.
In addition, if we do not attract customers to new Internet Data Centers in a
timely manner, or at all, our business would be materially adversely affected.
Because we compete with much larger companies and there are few barriers to
entry of new competitors, we are always at risk that we will lose business
to existing and new competitors
Our market is intensely competitive. There are few barriers to entry, and
we expect to face additional competition from existing competitors and new
market entrants. Many companies have already announced that they intend to begin
to provide services or they will expand their service offerings in ways that are
competitive with our services. The principal competitive factors in our market
include:
. the ability to deliver services when requested by the customer;
. Internet system engineering and other expertise;
. customer service;
. network capability, reliability, quality of service and scalability;
. variety of services offered;
. access to network resources, including circuits, equipment and
interconnection capacity to other networks;
. broad geographic presence;
. price;
. the ability to maintain and expand distribution channels;
. brand name;
. the timing of introductions of new services;
. network security; and
. financial resources.
There can be no assurance that we will have the resources or expertise to
compete successfully in the future. Our current and potential competitors in the
market include:
. providers of server hosting services;
. national, foreign and regional internet service providers;
. global, regional and local telecommunications companies and Regional
Bell Operating Companies; and
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. Information technology outsourcing firms.
Many of our competitors have substantially greater resources, more
customers, longer operating histories, greater name recognition and more
established relationships in the industry. As a result, they may be able to
develop and expand their network infrastructures and service offerings more
quickly, devote greater resources to the marketing and sale of their products
and adopt more aggressive pricing policies. In addition, some of these
competitors have entered into and are likely to continue to enter into, business
relationships to provide additional services competitive with those we provide.
Some of our competitors may be able to provide their customers with
additional benefits in connection with their Internet system and network
management solutions, including reduced communications costs, which could reduce
the overall costs of their services relative to ours. We may not be able to
offset the effects of any price reductions. In addition, we believe our market
is likely to consolidate in the near future, which could result in increased
competition, including price competition.
Our market is new and our services may not be generally accepted by
enterprises looking to outsource their mission-critical Internet operations,
which could harm our operating results
The market for Internet system and network management solutions has only
recently begun to develop, is evolving rapidly and is characterized by an
increasing number of market entrants. This market may not prove to be viable or,
if it becomes viable, may not continue to grow. We currently incur costs greater
than our revenues. If we cannot retain or grow our customer base, we will not be
able to increase our sales and revenues or create economies of scale to offset
our costs. Our future growth depends on the willingness of enterprises to
outsource the system and network management of their mission-critical Internet
operations and our ability to market our services in a cost- effective manner to
a sufficiently large number of customers. If this market fails to develop, or
develops more slowly than expected, or if our services do not achieve market
acceptance, our business will be adversely affected. In addition, in order to be
successful we must be able to differentiate ourselves from our competition
through our service offerings and delivery.
Our substantial leverage and debt service obligations adversely affect our
cash flow
We have substantial amounts of outstanding indebtedness, primarily from
our 11 5/8% Senior Notes, 11 3/8% Senior Notes, 10 3/4% Senior Notes, 4 3/4%
Convertible Subordinated Notes, 11 1/4% Senior Notes, and our 5% Convertible
Subordinated Notes. There is the possibility that we may be unable to generate
cash sufficient to pay the principal of, interest on and other amounts due in
respect of the notes and our other debt when due. As of June 30, 2000, we had
debt of approximately $1.4 billion, which does not include the issuance of our
11 5/8% Senior Notes and our 11 3/8% Senior Notes in July 2000. We also have the
right to issue $100.0 million of additional 10 3/4% Senior Notes on or prior to
December 8, 2000, $100.0 million of additional 11 5/8% Senior Notes before the
maturity date of those notes and Euro 100.0 million of additional 11 3/8% Senior
Notes before the maturity date of those notes. Furthermore, we expect to enter
into secured credit facilities for up to $600.0 million, and the notes would be
effectively subordinated to any borrowings under the credit facilities. In
addition, we expect to add additional equipment loans and lease lines to finance
capital expenditures for our Internet Data Centers and to obtain additional
long-term debt, working capital lines of credit and lease lines. We cannot be
certain that any financing arrangements will be available.
Our substantial leverage could have significant negative consequences,
including:
. increasing our vulnerability to general adverse economic and industry
conditions;
. limiting our ability to obtain additional financing;
. requiring the dedication of a substantial portion of our expected cash
flow from operations to service our indebtedness, thereby reducing the
amount of our expected cash flow available for other purposes,
including capital expenditures;
. limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we compete; and
. placing us at a possible competitive disadvantage compared to
competitors with less leverage or competitors that have better access
to capital resources.
We are subject to restrictive covenants in our note indentures that limit
our flexibility in managing our business
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Our senior notes and convertible subordinated notes contain various
restrictions on our ability to incur debt, pay dividends or make other
restricted payments, sell assets, enter into affiliate transactions and take
other actions. Our anticipated secured bank credit facility is likely to have
more restrictive covenants. Furthermore, our existing financing arrangements
are, and future financing arrangements are likely to be, secured by
substantially all of our assets. The existing financing arrangements require,
and future financing arrangements are likely to require, that we maintain
specific financial ratios and comply with covenants restricting our ability to
incur debt, pay dividends or make other restricted payments, sell assets, enter
into affiliate transactions or take other actions.
In addition, a number of instruments evidencing our debt restrict the
manner in which the funds raised in our debt financings and debt incurred in the
future may be used.
We must manage growth effectively by expanding operating and financial
procedures, controls and systems or our business will be harmed
We are experiencing, and we expect to continue to experience, rapid
growth with respect to the building of our Internet Data Centers and network
infrastructure, acquisitions of assets and companies, expansion of our service
offerings, geographic expansion, expansion of our customer base and increases in
the number of employees. This growth has placed, and we expect it to continue to
place, a significant strain on our financial, management, operational and other
resources, including our ability to ensure customer satisfaction. This expansion
also requires significant time commitment from our senior management and places
a significant strain on their ability to manage the existing business. In
addition, we are required to manage multiple relationships with a growing number
of third parties as we seek to complement our service offerings. Our ability to
manage our growth effectively will require us to continue to expand operating
and financial procedures and controls, to replace or upgrade our operational,
financial and management information systems and to attract, train, motivate and
retain key employees. We have recently hired many key employees and officers,
and as a result, our entire management team has worked together for only a brief
time. In addition, we intend to hire additional senior management personnel to
support our growth and expansion of our business. If our executives are unable
to manage growth effectively, our business could be materially adversely
affected.
We may experience difficulty in integrating our recent acquisitions, which
could harm our operating results
We believe that our future growth depends, in part, upon the acquisition
of complementary businesses, products, services or technologies. After
purchasing a company, we could have difficulty in assimilating its technology,
personnel and operations. In addition, the key personnel of the acquired company
may decide not to work for us. These difficulties could disrupt our ongoing
business, distract our management and employees and increase our expenses. In
addition, future acquisitions by us may require us to issue stock that could
dilute the ownership of our then existing stockholders, incur additional debt or
assume liabilities, result in large one-time write-offs or create goodwill or
other intangible assets that could result in amortization expenses.
System failures could lead to significant costs
We must protect our network infrastructure, our equipment, and customers'
equipment against damage from human error, physical or electronic security
breaches, power loss and other facility failures, fire, earthquake, flood,
telecommunications failure, sabotage, vandalism and similar events. Despite
precautions we have taken, a natural disaster or other unanticipated problems at
one or more of our Internet Data Centers could result in interruptions in our
services or significant damage to customer equipment. In addition, failure of
any of our telecommunications providers, such as MCI WorldCom, Qwest
Communications Corporation or Global Crossing, to provide consistent data
communications capacity, and local exchange carriers to provide interconnection
agreements, could result in interruptions in our services. Any damage to or
failure of our systems or service providers could result in reductions in, or
terminations of, services supplied to our customers, which could have a material
adverse effect on our business. In the past, we have experienced interruptions
in specific circuits within our network resulting from events outside our
control, temporary loss of power, and failure of networking equipment, all of
which led to short-term degradation in the level of performance of our network
or temporary unavailability of our services. We attempt to limit exposure to
system downtime by contract by giving customers a credit of free service for a
short period of time for disruptions. However, customers may demand additional
remedies. If we incur significant service level commitment obligations in
connection with system downtime, our liability insurance may not be adequate to
cover those expenses.
Customer satisfaction with our services is critical to our success
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Our customers demand a very high level of service and services are an
increasingly significant portion of our offerings. Our customer contracts
generally provide a limited service level commitment related to the continuous
availability of service on a 24 hours per day, seven-days-per-week basis. This
commitment is generally limited to a credit consisting of free service for a
short period of time for disruptions in Internet transmission services. If we
incur significant service level commitment obligations in connection with system
downtime, our liability insurance may not be adequate to cover these expenses.
As customers outsource more mission-critical operations to us, we are subject to
increased liability claims and customer dissatisfaction if our systems fail or
our customers otherwise become unsatisfied.
Our ability to expand our network is unproven and will require substantial
financial, operational and management resources
To satisfy customer requirements, we must continue to expand and adapt
our network infrastructure. We are dependent on MCI WorldCom, Qwest, Global
Crossing and other telecommunications providers for our network capacity. The
expansion and adaptation of our telecommunications infrastructure will require
substantial financial, operational and management resources as we negotiate
telecommunications capacity with network infrastructure suppliers. Due to the
limited deployment of our services to date, our ability to connect and manage a
substantially larger number of customers at high transmission speeds is unknown.
We have yet to prove our network's ability to be scaled up to higher customer
levels while maintaining superior performance. Furthermore, it may be difficult
for us to increase quickly our network capacity in light of current necessary
lead times within the industry to purchase circuits and other critical items. If
we fail to achieve or maintain high capacity data transmission circuits,
customer demand could diminish because of possible degradation of service. In
addition, as we upgrade our telecommunications infrastructure to increase
bandwidth available to our customers, we expect to encounter equipment or
software incompatibility which may cause delays in implementation.
We depend on network interconnections provided by third parties who may
raise their fees or deny access
We rely on a number of public and private network interconnections to
allow our customers to connect to other networks. If the networks with which we
interconnect were to discontinue their interconnections, our ability to exchange
traffic would be significantly constrained. Furthermore, our business will be
harmed if these networks do not add more bandwidth to accommodate increased
traffic. Many of the companies with which we maintain interconnections are our
competitors. Some of these networks require that we pay them fees for the right
to maintain interconnections. There is nothing to prevent any networks, many of
which are significantly larger than we are, from increasing fees or denying
access. In early 2000, one network with whom we previously maintained
interconnections unilaterally terminated the interconnections. In the future,
other networks could refuse to continue to interconnect directly with us, might
impose significant costs on us or limit our customers' access to their networks.
In this event, we may not be able, on a cost-effective basis, to access
alternative networks to exchange our customers' traffic. In addition, we may not
be able to pass through to our customers any additional costs of utilizing these
networks. In these cases, our business could be harmed.
Difficulties presented by international economic, political, legal,
accounting and business factors could harm our business in international
markets
A component of our strategy is to expand into international markets. We
opened our first Internet Data Center outside of the United States in the London
metropolitan area in June 1999 and acquired an Internet Data Center in Tokyo
through our acquisition of GOL in December 1999. In April 2000, we opened two
additional Internet Data Centers in Frankfurt and Toronto. Furthermore, we plan
to open additional international Internet Data Centers by the end of 2000. In
order to expand our international operations, we may enter into joint ventures
or outsourcing agreements with third parties, acquire rights to high-bandwidth
transmission capability, acquire complementary businesses or operations, or
establish and maintain new operations outside of the United States. Thus, we may
depend on third parties to be successful in our international operations. In
addition, the rate of development and adoption of the Internet has been slower
outside of the United States, and the cost of bandwidth has been higher, which
may adversely affect our ability to expand operations and may increase our cost
of operations internationally. The risks inherent in conducting business
internationally include:
. unexpected changes in regulatory requirements, export restrictions,
tariffs and other trade barriers;
. challenges in staffing and managing foreign operations;
. differences in technology standards;
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. employment laws and practices in foreign countries;
. longer payment cycles and problems in collecting accounts receivable;
. political instability;
. fluctuations in currency exchange rates and imposition of currency
exchange controls; and
. potentially adverse tax consequences.
We might not be successful in our attempts to keep up with rapid
technological change and evolving industry standards
Our future success will depend on our ability to offer services that
incorporate leading technology and address the increasingly sophisticated and
varied needs of our current and prospective customers. Our market is
characterized by rapidly changing and unproven technology, evolving industry
standards, changes in customer needs, emerging competition and frequent new
service introductions. Future advances in technology may not be beneficial to,
or compatible with, our business. In addition, we may not be able to incorporate
advances on a cost-effective and timely basis. Moreover, technological advances
may have the effect of encouraging our current or future customers to rely on
in-house personnel and equipment to furnish the services we currently provide.
In addition, keeping pace with technological advances may require substantial
expenditures and lead time.
We believe that our ability to compete successfully is also dependent
upon the continued compatibility and interoperability of our services with
products, services and architectures offered by various vendors. Although we
work with various vendors in testing newly developed products, these products
may not be compatible with our infrastructure or adequate to address changing
customer needs. Any incompatibility would require us to make significant
investments to achieve compatibility. Although we intend to support emerging
standards, industry standards may not be established or we may not be able to
conform timely to new standards. Our failure to conform to a prevailing
standard, or the failure of a common standard to emerge, could have a material
adverse effect on our business.
System security risks could disrupt our services
The ability to provide secure transmissions of confidential information
over networks accessible to the public is a significant barrier to electronic
commerce and communications. A portion of our services rely on encryption and
authentication technology licensed from third parties. Despite a variety of
network security measures we have taken, we cannot assure that unauthorized
access, computer viruses, accidental or intentional actions and other
disruptions will not occur. Our Internet Data Centers have experienced, and in
the future may experience delays or interruptions in service as a result of the
accidental or intentional actions of Internet users, current and former
employees of Exodus or others. Furthermore, inappropriate use of the network by
third parties could also jeopardize the security of confidential information,
such as customer and Exodus passwords as well as credit card and bank account
numbers, stored in our computer systems or those of our customers. As a result,
we could become liable to others and lose existing or potential customers. The
costs required to eliminate computer viruses and alleviate other security
problems could be prohibitively expensive. In addition, the efforts to address
these problems could result in interruptions, delays or cessation of service to
our customers.
We depend on third-party equipment and software suppliers
We depend on vendors to supply key components of our telecommunications
infrastructure and system and network management solutions. Some of the
telecommunications services and networking equipment is available only from sole
or limited sources. For instance, the routers, switches and modems we use are
currently supplied primarily by Cisco Systems, Inc. We typically purchase or
lease all of our components under purchase orders placed from time to time. We
do not carry significant inventories of components and have no guaranteed supply
arrangements with vendors. If we are unable to obtain required products or
services on a timely basis and at an acceptable cost, our business would be
harmed. In addition, if our sole or limited source suppliers do not provide
products or components that comply with evolving Internet and telecommunications
standards or that interoperate with other products or components we use, our
business would be harmed. For example, we have experienced performance problems
with routers and switches, including previously unknown software and firmware
bugs, that have caused temporary disruptions in and impairment of network
performance.
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Government regulation and legal uncertainties may harm our business
Laws and regulations directly applicable to communications and commerce
over the Internet are becoming more prevalent. The United States Congress has
considered enacting Internet laws regarding children's privacy, copyrights,
taxation and the transmission of sexually explicit material. The European Union
also enacted its own privacy regulations. The law of the Internet, however,
remains largely unsettled, even in areas where there has been some legislative
action. It may take years to determine whether and how existing laws such as
those governing intellectual property, privacy, libel and taxation apply to the
Internet. In addition, the growth and development of the market for online
commerce may prompt calls for more stringent consumer protection laws, both in
the United States and abroad, that may impose additional burdens on companies
conducting business online. The adoption or modification of laws or regulations
relating to the Internet could adversely affect our business. We provide
services over the Internet in many states in the United States and in many
foreign countries, and we facilitate the activities of our customers in these
jurisdictions. As a result we may be required to qualify to do business, or be
subject to taxation, or be subject to other laws and regulations, in these
jurisdictions even if we do not have a physical presence or employees or
property in these jurisdictions. The application of these multiple sets of laws
and regulations is uncertain, but we could find that Exodus is subject to
regulation, taxation, enforcement or other liability in unexpected ways, which
could materially adversely affect our business.
We could be held liable for the information disseminated through our network
The law relating to the liability of online services companies and
Internet access providers for information and commerce carried on or
disseminated through their networks is currently unsettled. The Child Online
Protection Act of 1998 imposes criminal penalties and civil liability on anyone
engaged in the business of selling or transferring material that is harmful to
minors, by means of the World Wide Web, without restricting access to this type
of material by underage persons. Numerous states have adopted or are currently
considering similar types of legislation. The imposition upon us and other
Internet network providers of potential liability for information carried on or
disseminated through our systems could require us to implement measures to
reduce exposure to liability, which may require the expenditure of substantial
resources, or to discontinue various service or product offerings. Further, the
costs of defending against any claims and potential adverse outcomes of these
claims could have a material adverse effect on our business. While we carry
professional liability insurance, it may not be adequate to compensate or may
not cover us in the event we become liable for information carried on or
disseminated through our networks.
Some businesses, organizations and individuals have in the past sent
unsolicited commercial e-mail messages through our network or advertising sites
hosted at our facilities to a massive number of people. This practice, known as
"spamming," has led to some complaints against us. In addition, some ISPs and
other online services companies could deny network access to us if we allow
undesired content or spamming to be transmitted through our networks. Although
we prohibit customers by contract from spamming, we cannot be sure that
customers will not engage in this practice, which could have a material adverse
effect on our business.
Our future success depends on our key personnel
Our success depends in significant part upon the continued services of
our key technical, sales and senior management personnel. Any officer or
employee can terminate his or her relationship at any time. If we lose the
services of one or more of our key employees or are unable to attract additional
qualified personnel, our business would be adversely affected. We do not carry
key-person life insurance for any of our employees.
If the Internet and Internet infrastructure development do not continue to
grow, our business will be harmed
Our success depends in large part on continued growth in the use of the
Internet. Critical issues concerning the commercial use of the Internet,
including security, reliability, cost, ease of access, quality of service and
necessary increases in bandwidth availability, remain unresolved and are likely
to affect the development of the market for our services. In addition, the rate
of development and adoption of the Internet has been slower outside of the
United States and the cost of bandwidth has been higher. The recent growth in
the use of the Internet has caused frequent periods of performance degradation,
requiring the upgrade of routers and switches, telecommunications links and
other components forming the infrastructure of the Internet by ISPs and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a whole could undermine the benefits of our
services. Consequently, the emergence and growth of the market for our services
is dependent on improvements being made to the entire Internet infrastructure to
alleviate overloading and congestion.
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We face risks associated with protection and enforcement of intellectual
property rights
We rely on a combination of copyright, patent, trademark, service mark
and trade secret laws and contractual restrictions to establish and protect
proprietary rights in our products and services. We have very little patented
technology that would preclude or inhibit competitors from entering our market.
Although we have entered into confidentiality agreements with our employees,
contractors, suppliers, distributors and appropriate customers to limit access
to and disclosure of our proprietary information, these may prove insufficient
to prevent misappropriation of our technology or to deter independent third-
party development of similar technologies. In addition, the laws of various
foreign countries may not protect our products, services or intellectual
property rights to the same extent as do the laws of the United States.
In addition to licensing technologies from third parties, we are
developing and acquiring additional proprietary intellectual property. Third
parties may try to claim that our products or services infringe their
intellectual property. We expect that participants in our markets will be
increasingly subject to infringement claims. Any claim, whether meritorious or
not, could be time-consuming, result in costly litigation, cause product
installation delays or require us to enter into royalty or licensing agreements.
These royalty or licensing agreements might not be available on terms acceptable
to us or at all.
Potential risks related to the Year 2000 problem might harm our business
In many of our recent filings with the Commission, we discussed the
nature and progress of our plans to become year 2000 compliant. In late 1999, we
completed our remediation and testing of systems. As a result of those planning
and implementation efforts, we experienced no significant disruptions in mission
critical information technology systems and other internal operating systems.
Costs directly associated with our year 2000 compliance efforts were not
material, amounting to less than $1.0 million. We are not aware of any material
problems with our products or services or internal operating systems resulting
from year 2000 issues, and we have not received notice of any material year 2000
compliance issues from our external vendors. However, it remains possible that
year 2000 problems associated with our systems or our vendors' products may
still arise or that we could receive notice of year 2000 problems that have
arisen with our vendors' products.
Our stock price has been volatile in the past and is likely to continue to
be volatile
The market price of our common stock has been volatile in the past and is
likely to continue to be volatile. In addition, the securities markets in
general, and Internet stocks in particular, have experienced significant price
volatility and accordingly the trading price of our common stock has been and is
likely to continue to be affected by this activity.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio which principally consists of money market
funds with original maturities of 90 days or less. Current yields on these
instruments, categorized as cash equivalents, range from approximately 5.50% to
6.50%. We do not use derivative financial instruments in our investment
portfolio. The fair value of our investment portfolio would not be significantly
impacted by a 10% increase or decrease in interest rates due mainly to the
short-term nature of the major portion of our investment portfolio. We place our
investments with high quality issuers, and, by policy, limit the amount of risk
by investing primarily in money market funds, debt instruments of the U.S.
government and its agencies, and certificates of deposits. An increase or
decrease in interest rates would not significantly increase or decrease interest
expense on debt obligations due to the fixed nature of our debt obligations.
Investment Risk
We invest in equity instruments of privately-held companies for business
and strategic purposes. These investments are accounted for under the cost
method when ownership is less than 20% and we do not have the ability to
exercise significant influence over operations. For these investments in
privately-held companies, our policy is to regularly review the assumptions
underlying the operating performance and cash flow forecasts in assessing the
carrying values. We identify and record impairment losses on long-lived assets
when events and circumstances indicate that such assets might be impaired. To
date, no such impairment has been recorded. Since our initial investment, one of
these investments in a privately-held company has become a marketable equity
security upon the investee completing an initial public offering and one of
these
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investments in a privately-held company has become a marketable equity security
upon an acquisition by a public company. Such investments are subject to
significant fluctuations in fair market value due to the volatility of the stock
market, and are included in marketable equity securities.
Foreign Currency Risk
Our international business is subject to risks typical of an
international business, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility. Accordingly,
our future results could be materially adversely impacted by changes in these or
other factors.
We are exposed to foreign exchange rate fluctuations on the financial
results of foreign subsidiaries that are translated into U.S. dollars upon
consolidation and on our Euro 125.0 million of 10 3/4% Senior Notes due 2009 and
Euro 200.0 million of 11 3/8% Senior Notes due 2008, which have periodic
interest payments due in Euros on June 15 and December 15, and January 15 and
July 15, of each year, respectively, commencing on June 15, 2000 and January 15,
2001, respectively. Furthermore, exchange rate volatility may negatively impact
our financial results.
We entered into a foreign currency exchange contract in order to reduce
the impact of currency fluctuations related to our Euro denominated senior
notes. Net gains or losses are included in other income and expense in the
Condensed Consolidated Statements of Operations. We recognized net gains from
the foreign currency exchange contracts of $258,000 for the three months ended
June 30, 2000. We had an outstanding forward foreign exchange contract at June
30, 2000 to buy $27.8 million for Euro 29.0 million under a foreign currency
exchange facility with a bank in the United States.
A sensitivity analysis was performed on our hedging portfolio as of
June 30, 2000. This sensitivity analysis was based on a modeling technique that
measures the hypothetical market value resulting from a 10% shift in the value
of exchange rates relative to the U.S. dollar. The increase in the value of the
U.S. dollar (and a corresponding decrease in the value of the hedged foreign
currency asset) would lead to an increase in the fair value of our financial
hedging instrument by approximately $2.7 million. Conversely, the decrease in
the value of the U.S. dollar would result in a decrease in the fair value of
this financial instrument by approximately $2.9 million.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Sales of Unregistered Securities
On April 21, 2000, we completed our equity investment in Mirror Image Internet,
Inc., (`MII") a provider of Internet content distribution services. We receiived
32,725,872 shares of MII common stock in exchange for $75.0 million in cash and
7,516,536 shares of our common stock. Of the 7,516,536 shares of our common
stock transferrd in the transaction, 1,469,900 was acquired by MII and 6,046,636
was acquired by Xcelera.com Inc., a majority stockholder of MII. The sales and
issuance of our common stock was exempt from registration as a transaction not
involving any public offering, in compliance with Regulation D of Securities Act
of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Stockholders June 6, 2000. Following are
descriptions of the matters voted on and the results of such meeting (share
numbers do not reflect the two-for-one stock split effected on June 20, 2000):
<TABLE>
<CAPTION>
Votes For Votes Against Votes Votes Broker Non-
Abstained Withheld votes
<S> <C> <C> <C> <C> <C>
1. Election of Directors:
John R. Dougery 168,723,988 --- --- 515,383 ---
Mark Dubovoy 142,599,889 --- --- 26,639,482 ---
Ellen M. Hancock 168,774,619 --- --- 464,752 ---
Max D. Hopper 168,775,696 --- --- 463,675 ---
L. William Krause 167,926,654 --- --- 1,312,717 ---
Daniel C. Lynch 168,779,814 --- --- 459,557 ---
Thadeus J. Mocarski 168,770,858 --- --- 468,513 ---
Naomi O. Seligman 167,937,310 --- --- 1,302,061 ---
Dirk A. Stuurop 167,942,999 --- --- 1,296,372 ---
2. Amendment of Restated Certificate of 165,381,247 3,693,527 164,247 --- ---
Incorporation to increase the authorized
number of shares of common stock from
300,000,000 to 1,500,000,000 shares
3. Amendment of the Company's 1998 Equity 73,412,028 47,472,856 387,855 --- 47,966,632
Incentive Plan to increase the number
of shares of common stock reserved for
issuance from 40,000,000 to 58,000,000
shares
4. Amendment to the Company's 1998 93,603,965 27,240,370 482,689 --- 47,912,347
Directors Stock Option Planto change
the vesting schedule for grants under
the plan
5. Amendment to the Company's 1998 116,553,767 4,349,158 424,099 --- 47,912,347
Employee Stock Purchase Plan to
increase the number of shares of
common stock reserved for issuance
</TABLE>
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<TABLE>
<S> <C> <C> <C> <C> <C>
under the plan from 9,600,000 to
13,200,000 shares, and to provide
that the number of shares of common
stock reserved for issuance will
automatically be increased each year
by an amount equal to 1% of the total
number of shares of common stock
outstanding.
6. Proposal to ratify the appointment of 168,105,652 950,565 182,804 --- 350
KPMG LLP as the Company's independent
auditors for the fiscal year ending
December 31, 2000
</TABLE>
ITEM 5. OTHER INFORMATION
On June 7, 2000, we named Don Casey President and Chief Operating
Officer and Sam S. Mohamad President of Worldwide Sales and International
Field Operations. We also announced that L. William Krause, Dirk A. Stuurop
and Laura D'Andrea Tyson have joined our board of directors. Ellen M. Hancock
has been appointed chairman of the board. In April, 2000, Morris Taradalsky
joined us as Executive Vice President, Engineering.
On July 18, 2000, we filed a shelf registration statement on Form S-3
with the Securities and Exchange Commission under which we may register the
offer and sell up to $2.0 billion of our debt and equity securities in one or
more public offerings over the next two years.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit Number Exhibit Title
------------- -------------
2.01 Common Stock Purchase Agreement dated as of
March 22, 2000 among Registrant, Mirror Image
Internet, Inc. and Xcelera.com Inc.
(Incorporated by reference from Exhibit 2.01 to
the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange
Commission in April 7, 2000).
2.02 Common Stock Purchase Agreement dated as of
March 22, 2000 between Registrant and
Xcelera.com Inc. (Incorporated by reference
from Exhibit 2.02 to the Registrant's Current
Report on Form 8-K filed with the Securities
and Exchange Commission on April 7, 2000).
3.01 Registrant's Restated Certificate of
Incorporation. (Incorporated by reference from
Exhibit 4.01 to the Registrant's Registration
Statement on Form S-8 filed with the Securities
and Exchange Commission on June 9, 2000).
3.02 Certificate of Designations specifying the
terms of the Series A Junior Participating
Preferred Stock of the Registrant, as filed
with the Delaware Secretary of State on January
28, 1999. (Incorporated herein by reference to
Exhibit 3.02 of the Registrant's Registration
Statement on Form 8-A filed with the Security
and Exchange Commission on January 29, 1999).
3.03 Registrant's Bylaws. (Incorporated herein by
reference to Exhibit 3.06 if the Registrant's
Registration Statement on Form S-1,
Registration No. 333-44469, declared effective
by the Security and Exchange Commission on
March 18, 1998).
4.01 Registration Rights Agreement dated April 21,
2000 between Registrant and Xcelera.com, Inc.
(Incorporated by reference from Exhibit 4.01 to
the Registrant's Registration Statement on Form
S-3 filed with the Securities and Exchange
Commission on May 5, 2000).
4.02 Exodus Communications, Inc. 1998 Equity
Incentive Plan, as amended. (Incorporated by
reference from Exhibit 4.04 to the Registrant's
Registration Statement on Form S-8 filed with
the Securities and Exchange Commission on June
9, 2000).
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4.03 Exodus Communications, Inc. 1998 Employee Stock
Purchase Plan, as amended. (Incorporated by
reference from Exhibit 4.05 to the Registrant's
Registration Statement on Form S-8 filed with
the Securities and Exchange Commission on
June 9, 2000).
4.04 Indenture between Registrant, as Issuer, and
Chase Manhattan Bank and Trust Company,
National Association, as trustee, dated July 6,
2000 related to the Registrant's 11 5/8% Senior
Notes due 2010. (Incorporated by reference from
Exhibit 4.17 to the Registrant's Registration
Statement on Form S-4 filed with the Securities
and Exchange Commission on August 10, 2000).
4.05 Indenture between Registrant, as Issuer, and
Chase Manhattan Bank and Trust Company,
National Association, as trustee, dated July 6,
2000 related to the Registrant's 11 3/8% Senior
Notes due 2008. (Incorporated by reference from
Exhibit 4.18 to the Registrant's Registration
Statement on Form S-4 filed with the Securities
and Exchange Commission on August 10, 2000).
10.01 Purchase Agreement among Registrant, Goldman,
Sachs & Co., Merrill Lynch, Pierce, Fenner &
Smith Incorporated, Morgan Stanley & Co.
Incorporated, Chase Securities Inc., Donaldson,
Lufkin & Jenrette Securities Corporation,
FleetBoston Robertson Stephens Inc. and Thomas
Weisel Partners LLC, dated June 28, 2000
related to the Registrant's 11 5/8% Senior
Notes due 2010 and 11 3/8% Senior Notes due
2008. (Incorporated by reference from Exhibit
10.75 to the Registrant's Registration
Statement on Form S-4 filed with the Securities
and Exchange Commission on August 10, 2000).
10.02 Exchange and Registration Rights Agreement
among Registrant, Goldman Sachs & Co., Merrill
Lynch, Pierce, Fenner & Smith Incorporated,
Morgan Stanley & Co. Incorporated, Chase
Securities Inc., Donaldson, Lufkin & Jenrette
Securities Corporation, FleetBoston Robertson
Stephens Inc. and Thomas Weisel Partners LLC,
dated July 6, 2000 related to the Registrant's
11 5/8% Senior Notes due 2010. (Incorporated by
reference from Exhibit 10.76 to the
Registrant's Registration Statement on Form S-4
filed with the Securities and Exchange
Commission in August 10, 2000).
10.03 Exchange and Registration Rights Agreement
among Registrant, Goldman Sachs & Co., Merrill
Lynch, Pierce, Fenner & Smith Incorporated,
Morgan Stanley & Co. Incorporated, Chase
Securities Inc., Donaldson, Lufkin & Jenrette
Securities Corporation, FleetBoston Robertson
Stephens Inc. and Thomas Weisel Partners LLC,
dated July 6, 2000 related to the Registrant's
11 3/8% Senior Notes due 2008. (Incorporated by
reference from Exhibit 10.77 to the
Registrant's Registration Statement on Form S-4
filed with the Securities and Exchange
Commission in August 10, 2000).
27.01 Financial Data Schedule
b. Reports on Form 8-K
On April 7, 2000, we filed a report on Form 8-K announcing the common
stock purchase agreements with Mirror Image Internet, Inc. and Xcelera.com, Inc.
on March 22, 2000.
On June 21, 2000, we filed a report on Form 8-K announcing our
intention to raise a total of $600 million gross proceeds through a private
offering of senior notes on June 20, 2000.
On June 30, 2000, we filed a report on Form 8-K announcing an agreement
that we entered into on June 28, 2000, to sell approximately $1.155 billion
aggregate principal amount of senior notes in a private offering consisting of
$1.0 billion aggregate principal amount of 11 5/8% Senior Notes due 2010 and
Euro 200.0 million aggregate principal amount of 11 3/8% Senior Notes due 2008.
28
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Exodus Communications, Inc.
By: /s/ Ellen M. Hancock August 10, 2000
Ellen M. Hancock
Chairman and Chief Executive Officer
By: /s/ R. Marshall Case August 10, 2000
R. Marshall Case
Executive Vice President, Finance and Chief Financial Officer
29
