<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of The
Securities Exchange Act of 1934
Date of Report (date of earliest event reported): June 21, 1999
ABOVENET COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 0-25864 77-0424796
- ---------------------------- ------------ -------------------
(State or other jurisdiction (Commission (I.R.S. Employer
of incorporation) File Number) Identification No.)
</TABLE>
50 W. San Fernando Street, Suite 1010, San Jose, California, 95113
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 367-6666
<PAGE> 2
Item 7. Financial Statements and Exhibits
On its Current Report on Form 8-K dated July 2, 1999, AboveNet
Communications Inc., a Delaware corporation ("AboveNet") announced its
acquisition of the Palo Alto Internet Exchange ("PAIX"). AboveNet is filing this
Current Report on Form 8-K/A solely for the purpose of filing audited financial
statements relating to the PAIX acquisition.
(a) Financial Statements of Business Acquired
(b) Pro Forma Financial Statements
<PAGE> 3
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 hereunto duly authorized.
AboveNet Communications Inc.
Date: September 3, 1999 /s/ David F. Larson
----------------------------
David F. Larson
Senior Vice President and
Chief Financial Officer
<PAGE> 4
ABOVENET
UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information illustrates the
effect of the acquisition by AboveNet of assets and assumed obligations related
to the Palo Alto Internet Exchange (PAIX) from Compaq Computer Corporation
(Compaq) on June 21, 1999. The consideration included $70.0 million in cash and
an obligation to provide various services to Compaq, with a value currently
estimated to be approximately $5.0 million, and AboveNet incurred costs of $1.5
million, resulting in a total purchase cost of $76.5 million.
The unaudited pro forma financial information presented herein is based on
the historical financial statements of AboveNet and PAIX. The historical
financial statements of PAIX include (i) a combined statement of assets to be
acquired and liabilities to be assumed (which includes only the assets to be
acquired and liabilities to be assumed by AboveNet in accordance with the asset
purchase agreement entered into with Compaq), and (ii) a combined statement of
revenues and direct expenses (which includes only those revenues and expenses
directly related to the PAIX business).
The unaudited pro forma condensed combining statements of operations for
the nine months ended March 31, 1999 and for the year ended June 30, 1998 give
effect to the acquisition of PAIX as if it had been consummated on July 1,
1997. The unaudited pro forma condensed combining balance sheet as of March 31,
1999 gives effect to the acquisition of PAIX as if it had been consummated on
March 31, 1999. This method of combining companies is only for the presentation
of pro forma financial information. Actual statements of operations will
include the results of PAIX from the date of acquisition, with no retroactive
restatement.
The pro forma adjustments are based on available information and
assumptions that AboveNet believes are reasonable at the time made. The
unaudited pro forma condensed combining financial statements do not purport to
present AboveNet's financial position or results of operations had the
acquisition of PAIX occurred on the dates specified, nor are they necessarily
indicative of the financial position or results of operations that may be
achieved in the future. The unaudited pro forma condensed combining statements
of operations do not reflect any adjustments for synergies that might be
realized upon consummation of the acquisition of PAIX. No assurances can be made
as to the amount of cost savings or revenue enhancements, if any, that may be
realized.
The unaudited pro forma condensed combining financial statements should be
read in conjunction with the historical financial statements of AboveNet and
PAIX.
AboveNet plans to account for the acquisition of PAIX using the purchase
method of accounting. Accordingly, the assets acquired and liabilities assumed
have been recorded at their estimated fair values, which are subject to further
adjustment based on future events and further analysis.
79
<PAGE> 5
ABOVENET COMMUNICATIONS INC.
PRO FORMA CONDENSED COMBINING BALANCE SHEET
MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ABOVENET PAIX ADJUSTMENTS COMBINED
----------- ----------- ---------------- -----------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and equivalents ..................... $44,947,700 $ -- $(44,000,000)(1) $ 947,700
Short-term investments ................... 11,744,200 -- (11,744,200)(1) --
Accounts receivable, net ................. 1,851,000 102,000 -- 1,953,000
Prepaid expenses and other current
assets ................................ 1,301,200 29,000 -- 1,330,200
----------- ----------- ------------ ------------
Total current assets ..................... 59,844,100 131,000 (55,744,200) 4,230,900
Property and equipment, net ................. 24,393,800 3,405,000 -- 27,798,800
Rights to use fiber optic capacity .......... 9,080,000 -- -- 9,080,000
Restricted cash ............................. 1,220,000 -- -- 1,220,000
Other assets ................................ 1,644,800 -- -- 1,644,800
Intangible assets ........................... -- 32,864,000 (32,864.000)(4) 73,130,000
73,130,000 (3)
----------- ----------- ------------ ------------
Total .................................... $96,182,700 $36,400,000 $(15,478,200) $117,104,500
=========== =========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................... $ 8,521,000 $ -- $ -- $ 8,521,000
Remaining obligation for rights to
use fiber optic capacity .............. 800,000 -- -- 800,000
Accrued liabilities ...................... 1,315,800 -- -- 1,315,800
Customer deposits ........................ 971,300 166,000 -- 1,137,300
Current portion of long-term
obligations ........................... 3,511,200 -- 250,000 (2) 19,517,000
15,755,800 (1)
----------- ----------- ------------ ------------
Total current liabilities ................ 15,119,300 166,000 16,005,800 31,291,100
Other long-term obligations ................. 9,972,500 -- 4,750,000 (2) 14,722,500
----------- ----------- ------------ ------------
Total stockholders' equity .................. 71,090,900 36,234,000 (36,234,000)(5) 71,090,900
----------- ----------- ------------ ------------
Total .................................... $96,182,700 $36,400,000 $(15,478,200) $117,104,500
=========== =========== ============ ============
</TABLE>
See accompanying notes to unaudited pro forma condensed
combining financial statements
80
<PAGE> 6
ABOVENET COMMUNICATIONS INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
TWELVE MONTHS ENDED JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ABOVENET PAIX ADJUSTMENTS COMBINED
----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues............................... $ 3,436,400 $3,164,000 $ -- $ 6,600,400
Costs and expenses:
Cost of revenues..................... -- 2,896,000 -- 2,896,000
Data communications and
telecommunications................. 2,199,800 -- -- 2,199,800
Network operations................... 1,571,800 35,000 -- 1,606,800
Sales, general and administrative.... 3,240,200 686,000 -- 3,926,200
Depreciation and amortization........ 475,500 -- -- 475,500
Amortization of intangibles.......... -- 188,000 (188,000)(4) 7,313,000
-- -- 7,313,000 (6) --
Stock-based compensation expense..... 1,276,400 -- -- 1,276,400
----------- ---------- ------------ ------------
Total costs and expenses........... 8,763,700 3,805,000 7,125,000 19,693,700
Loss from operations................... (5,327,300) (641,000) (7,125,000) (13,093,300)
Interest expense....................... (160,800) -- (10,650,000)(7) (10,810,800)
Interest and other income.............. 63,100 -- -- 63,100
----------- ---------- ------------ ------------
Net loss............................... $(5,425,000) $ (641,000) $(17,775,000) $(23,841,000)
=========== ========== ============ ============
Basic and diluted loss per share....... $ (10.34) $ (45.45)
Shares used in basic and diluted
loss per share....................... 524,608 524,608
</TABLE>
See accompanying notes to unaudited pro forma condensed
combining financial statements
81
<PAGE> 7
ABOVENET COMMUNICATIONS INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
NINE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ABOVENET PAIX ADJUSTMENTS COMBINED
------------ ----------- ------------ -------------
<S> <C> <C> <C> <C>
Revenues.................................. $ 8,297,400 $ 4,067,000 $ 12,364,400
Costs and expenses:
Cost of revenues........................ -- 2,050,000 2,050,000
Data communications and
telecommunications.................... 5,705,100 -- 5,705,100
Network operations...................... 3,720,600 9,000 3,729,600
Sales, general and administrative....... 10,043,700 317,000 10,360,700
Depreciation and amortization........... 2,005,100 2,005,100
Amortization of intangibles............. -- 2,678,000 $ (2,678,000)(4) 5,484,700
5,484,700 (6)
Stock-based compensation expense........ 1,282,800 -- 1,282,800
------------ ----------- ------------ ------------
Total costs and expenses.............. 22,757,300 5,054,000 2,806,700 30,618,000
------------ ----------- ------------ ------------
Loss from operations...................... (14,459,900) (987,000) (2,806,700) (18,253,600)
Interest expense.......................... (916,400) (9,185,600)(7) (10,102,000)
Interest and other income................. 976,800 976,800
------------ ----------- ------------ ------------
Net loss.................................. $(14,399,500) $ (987,000) $(11,992,300) $(27,378,800)
============ =========== ============ ============
Basic and diluted loss per share.......... $ (1.25) $ (2.38)
Shares used in basic and diluted loss per
share................................... 11,484,816 11,484,816
</TABLE>
See accompanying notes to unaudited pro forma condensed
combining financial statements
<PAGE> 8
ABOVENET COMMUNICATIONS INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINING FINANCIAL STATEMENTS
The following pro forma adjustments have been made to the pro forma
combining financial statements:
(1) Reflects funds used for the acquisition of PAIX of approximately $71.5
million, including acquisition costs. Funds for the purchase were assumed
to be derived from the following sources:
Cash and equivalents......................... $44,000,000
Short-term investments....................... 11,744,200
Assumed borrowings........................... 15,755,800
-----------
Total........................................ $71,500,000
-----------
(2) Reflects an obligation to provide various services to Compaq, with a value
currently estimated to be approximately $5 million.
(3) Reflects the excess of cost over net tangible assets acquired.
(4) Reflects the elimination of PAIX historical intangibles and related
amortization.
(5) Reflects the elimination of PAIX stockholders' equity.
(6) Reflects amortization of the excess of cost over net assets acquired by
use of the straight-line method over 10 years.
(7) Reflects interest expense on assumed borrowings of $71,500,000, which were
assumed to be necessary to complete the acquisition of PAIX on July 1,
1997, at AboveNet's assumed incremental borrowing rate of 15%, compounded
annually. At July 1, 1997, AboveNet had limited cash resources available,
and accordingly it was assumed that the entire $71,500,000 was financed
with debt.
83
<PAGE> 9
BUSINESS OF METROMEDIA
Metromedia is a facilities-based provider of technologically advanced,
high-bandwidth, fiber optic communications infrastructure to carrier and
corporate/government customers in the Untied States and Europe. Metromedia has
installed and intends to install local intracity networks that will consist of
in excess of 1.2 million fiber miles which is equal to the number of strands of
fiber in a length of fiber optic cable multiplied by the length of the cable in
miles, covering approximately 9,250 route miles which is equal to the number of
miles spanned by fiber optic cable calculated without including physically
overlapping segments of cable, in 17 metropolitan markets in the United States
and Europe.
Metromedia focuses on leasing or otherwise making available for use its
broadband communications infrastructure to two main customer groups:
communications carriers and corporate/government customers located in selected
top 15 cities in the United States based on population.
Metromedia was founded in 1993 and is a Delaware corporation and its
executive offices are located at One North Lexington Avenue, White Plains, NY
10601.
BUSINESS OF ABOVENET
You should read the following description of AboveNet's business
together with the information included elsewhere in this document. This
description contains certain forward-looking statements based upon current
expectations that involve risks and uncertainties. Any statements contained
herein that are not statements of historical fact may be deemed to be
forward-looking statements. You can identify these statements by words such as
"may," "will," "should," "estimates," "predicts," "potential," "continue,"
"strategy," "believes," "anticipates," "plans," "expects," "intends" and similar
expressions. AboveNet's actual results and the timing of certain events may
differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a discrepancy include those discussed
in "Risk Factors" and elsewhere in this document.
RECENT DEVELOPMENT--ACQUISITION OF THE PALO ALTO INTERNET EXCHANGE
On June 21, 1999, AboveNet completed its acquisition of assets and
assumed obligations related to the Palo Alto Internet Exchange, or PAIX, a
network exchange facility for managing traffic over the Internet. PAIX was
acquired from Compaq Computer Corporation and its subsidiary Digital Equipment
Corporation for a purchase price of $70 million in cash and an obligation to
provide various services. PAIX, which began operations in July 1996, offers
Internet interconnection and related services to telecommunications carriers,
Internet service providers, Internet content providers and business customers.
AboveNet believes that PAIX is the only major commercial Internet exchange that
is not owned by a telecommunications company. PAIX will be managed as a separate
entity, with its own management, board of directors and advisory board to ensure
its neutrality, but will remain a wholly owned subsidiary of AboveNet. AboveNet
has agreed, among other things, to make available to Compaq and Digital
communications capacity on an OC-3 circuit and up to 155 Mbps bandwidth of
Internet access, and to not relocate PAIX.
GENERAL
AboveNet is a leading provider of facilities-based, managed services for
customer-owned Web servers and related equipment, known as co-location, and high
performance Internet connectivity solutions for electronic commerce and other
business critical Internet operations. AboveNet has developed a network
architecture based upon strategically located, fault-tolerant facilities known
as Internet service exchanges, or ISXs, AboveNet's ISXs combine co-location
services for Internet content providers with direct access to Internet service
providers, or ISPs. As of March 31, 1999, AboveNet had 257 direct public and
private data exchange connections, known as peering arrangements, including
relationships with most major network providers. AboveNet's network architecture
and extensive peering relationships are designed to reduce the number of network
connections or "hops" for data
84
<PAGE> 10
PALO ALTO INTERNET EXCHANGE
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Accountants' Reports........................................................ F-24
Combined Statements of Assets to be Acquired and Liabilities to be Assumed as of
March 27, 1999 (unaudited), December 26, 1998 and December 27, 1997................... F-26
Combined Statement of Revenues and Direct Expenses for the Quarters Ended
March 27, 1999 and March 28, 1998 (unaudited), period from June 12, 1998
through December 26, 1998, period from December 28, 1997 through June 11, 1998
and the Fiscal Years Ended December 27, 1997 and December 29, 1996.................... F-27
Notes to Combined Statements of Assets to be Acquired and Liabilities to be
Assumed and Combined Statements of Revenues and Direct Expenses....................... F-28
</TABLE>
F-23
<PAGE> 11
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Compaq Computer Corporation
We have audited the accompanying Combined Statement of Assets to be
Acquired and Liabilities to be Assumed of Palo Alto Internet Exchange (the
"Business") as of December 26, 1998 and the related Combined Statement of
Revenues and Direct Expenses for the period June 12, 1998 through December 26,
1998. These statements are the responsibility of the Business' and Compaq
Computer Corporation's management. Our responsibility is to express an opinion
on these statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the statements. We believe that
our audit provides a reasonable basis for our opinion.
The accompanying statements were prepared for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission (for
inclusion in the Current Report on Form 8-K of AboveNet Communications Inc.) as
described in Note 2 and are not intended to be a complete presentation of the
Business' financial position or results of operations.
In our opinion, the statements referred to above present fairly, in all
material respects, the assets to be acquired and liabilities to be assumed as
of December 26, 1998 and the revenues and direct expenses described in Note 2
of the Business for the period June 12, 1998 through December 26, 1998, in
conformity with generally accepted accounting principles.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
June 15, 1999
F-24
<PAGE> 12
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Compaq Computer Corporation
We have audited the accompanying Combined Statement of Assets to be Acquired
and Liabilities to be Assumed of Palo Alto Internet Exchange (the "Business")
as of December 27, 1997 and the related Combined Statement of Revenues and
Direct Expenses for the period December 28, 1997 through June 11, 1998 and the
fiscal years ended December 27, 1997 and December 29, 1996. These statements
are the responsibility of the Business' and Compaq Computer Corporation's
management. Our responsibility is to express an opinion on these statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the statements. We believe that
our audits provide a reasonable basis for our opinion.
The accompanying statements were prepared for the purpose of complying with the
rules and regulations of the Securities and Exchange Commission (for inclusion
in the Current Report on Form 8-K of AboveNet Communications Inc.) as described
in Note 2 and are not intended to be a complete presentation of the Business'
financial position or results of operations.
In our opinion, the statements referred to above present fairly, in all material
respects, the assets to be acquired and liabilities to be assumed as of December
27, 1997 and the revenues and direct expenses described in Note 2 of the
Business for the period December 28, 1997 through June 11, 1998 and the fiscal
years ended December 27, 1997 and December 29, 1996, in conformity with
generally accepted accounting principles.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
June 15, 1999
F-25
<PAGE> 13
PALO ALTO INTERNET EXCHANGE
COMBINED STATEMENT OF ASSETS TO BE ACQUIRED AND LIABILITIES TO BE ASSUMED
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 27,
1999 DECEMBER 26, DECEMBER 27,
(UNAUDITED) 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
ASSETS TO BE ACQUIRED:
Unbilled accounts receivable............. $ 102 $ 18 $ 14
Prepaid expenses......................... 29 2 1
Property and equipment, net.............. 3,405 3,088 2,750
Intangible assets, net................... 32,863 33,756 --
------- ------- ------
Total assets to be acquired............ $36,399 $36,864 $2,765
======= ======= ======
LIABILITIES TO BE ASSUMED:
Unearned service revenue................. 166 200 106
------- ------- ------
Total liabilities to be assumed........ 166 200 106
------- ------- ------
Net assets to be acquired............ $36,233 $36,664 $2,659
======= ======= ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE> 14
PALO ALTO INTERNET EXCHANGE
COMBINED STATEMENT OF REVENUES AND DIRECT EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
QUARTER QUARTER JUNE 12, 1998 PERIOD FROM FISCAL FISCAL
ENDED ENDED THROUGH DECEMBER 28, YEAR ENDED YEAR ENDED
MARCH 27, MARCH 26, DECEMBER 26, 1997 THROUGH DECEMBER 27, DECEMBER 29,
1999 1998 1998 JUNE 11, 1998 1997 1996
--------- ---------- ------------- ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Service revenues..................... $1,534 $ 892 $ 2,630 $1,732 $ 1,895 $ 155
------ ----- ------- ------ ------- -------
Direct expenses:
Cost of revenues................... 616 817 1,548 1,440 2,579 537
Research and development........... - 4 9 8 54 599
Selling, general and
administrative expenses........... 131 83 191 242 700 121
Amortization of intangible assets... 893 - 1,944 - - -
------ ----- ------- ------- ------- -------
Total direct expenses........... 1,640 904 3,692 1,690 3,333 1,257
------ ----- ------- ------- ------- -------
Excess (shortfall) of revenues
over direct expenses......... $ (106) $ (12) $(1,062) $ 42 $(1,438) $(1,102)
====== ===== ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE> 15
PALO ALTO INTERNET EXCHANGE
NOTES TO COMBINED STATEMENTS OF ASSETS TO BE ACQUIRED
AND LIABILITIES TO BE ASSUMED AND
COMBINED STATEMENTS OF REVENUES AND DIRECT EXPENSES
(AMOUNTS IN THOUSANDS)
1. DESCRIPTION OF BUSINESS:
The Palo Alto Internet Exchange ("PAIX" or the "Business") is a business
within the Technology & Corporate Development and Operations Management
Services business units of Compaq Computer Corporation ("Compaq," formerly
Digital Equipment Corporation, "Digital," collectively the "Company"). The
Business is a high-level switching and peering point for global and regional
Internet Service Providers ("ISP") and content providers. The Business features
a data center to provide global services to PAIX customers for transmission of
data in high-volume over the worldwide Internet network. The Business utilizes
a highly redundant fiber-based infrastructure owned by multiple data carriers,
including the 30-mile fiber ring owned by the City of Palo Alto. The Business
was started in 1993 as a research project within the Company and commenced
meaningful operations during fiscal year 1996. The Business is engaged
primarily in providing Internet interconnectivity solutions and related
services in support of mission critical Internet operations of its customers.
2. BASIS OF PRESENTATION:
The accompanying Combined Statement of Assets to be Acquired and
Liabilities to be Assumed and Combined Statement of Revenues and Direct
Expenses ("the financial statements") have been prepared for the purpose of
complying with the rules and regulations of the Securities and Exchange
Commission for inclusion in the Current Report on Form 8-K of AboveNet
Communications, Inc. ("AboveNet"). The Combined Statement of Assets to be
Acquired and Liabilities to be Assumed includes the Business' assets to be sold
to and liabilities to be assumed by AboveNet, in accordance with the Asset
Purchase Agreement dated May 21, 1999 (the "Agreement"). Compaq and AboveNet
also entered into certain service contracts and other arrangements that are
described in the Agreement. These arrangements include, but are not limited to,
access to the Internet, favorable pricing terms on such future services, and
non-relocation and non-compete arrangements. The terms of such contracts and
other arrangements range from one to 20 years. The assets to be acquired and
liabilities to be assumed include unbilled accounts receivable, prepaid
expenses, property and equipment, intangibles and unearned service revenue. The
Combined Statement of Revenues and Direct Expenses includes only those revenues
and expenses directly related to the Business to be sold. The financial
statements exclude any other activity and related expense that are not directly
attributable to the Business, such as corporate general and administrative
costs, income taxes and interest expense.
The financial statements of the Business are derived from the historic
books and records of Digital through June 11, 1998. As a result of the
acquisition of Digital by Compaq on June 11, 1998, the financial statements of
the Business after the acquisition date are derived from the historic books and
records of Compaq.
As mentioned above, indirect costs allocated to the Business from the
Company, such as certain corporate general and administrative costs, have been
excluded from the financial statements on the basis that such costs are not
direct costs of the Business. However, in determining the Business' direct
expenses, certain allocations were made for expenses incurred by the Company,
as appropriate, that are directly attributed to the services provided to the
Business. These allocations relate primarily to engineering support in
connection with the delivery of services, facility and other occupancy costs,
and other general and administrative functions performed directly on behalf and
for the benefit of the
<PAGE> 16
PALO ALTO INTERNET EXCHANGE
NOTES TO COMBINED STATEMENTS OF ASSETS TO BE ACQUIRED
AND LIABILITIES TO BE ASSUMED AND
COMBINED STATEMENTS OF REVENUES AND DIRECT EXPENSES (CONTINUED)
(AMOUNTS IN THOUSANDS)
2. BASIS OF PRESENTATION: (CONTINUED)
Business. Costs for such services have been reflected in the financial
statements on the basis of activity or utilization, estimated support provided
to the Business, or other methods management believe to be reasonable.
Cost of revenues primarily consists of costs relating to facility rent,
data communications and telecommunication expenses, service delivery and
engineering support personnel and depreciation expense.
The financial statements have been prepared in accordance with the
Company's accounting policies and generally accepted accounting principles.
However, these statements do not purport to represent the costs and expenses
which may be incurred by an unaffiliated company to achieve similar results. In
addition, the financial statements do not purport to represent the financial
position of the Business.
FISCAL YEAR
For purposes of these financial statements the fiscal year of PAIX is a
fifty-two week period ending the Saturday nearest the last day of December.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
direct expenses, and related disclosure of contingent assets and liabilities.
Actual results could differ from those estimates.
PROPERTY AND EQUIPMENT
Building improvements, computer, telecommunications, and office equipment
and construction-in-progress are stated at cost less depreciation, which is
computed using the straight-line method. Expenditures for improvements which
substantially extend the useful life or increase the capacity of an asset are
capitalized. Ordinary repairs and maintenance are expensed as incurred.
Estimated useful lives for purposes of computing depreciation expense range
from two to 10 years.
INTANGIBLE ASSETS
Intangible assets, which consist of goodwill and customer lists related to
the acquisition of Digital by Compaq, are amortized on a straight-line basis
over 10 years.
REVENUE
Service revenue relating to Internet and colocation service contracts are
recognized over the contract period the services are provided. The Business
recognizes installation and certain other service fees as revenue on a per event
basis. Unearned service revenue represents the unearned portion of prepaid
service from Internet and colocation service contracts with customers. Such
amounts are amortized to revenue over the contract period, which ranges from one
year to three years. The
F-29
<PAGE> 17
PALO ALTO INTERNET EXCHANGE
NOTES TO COMBINED STATEMENTS OF ASSETS TO BE ACQUIRED
AND LIABILITIES TO BE ASSUMED AND
COMBINED STATEMENTS OF REVENUES AND DIRECT EXPENSES (CONTINUED)
(AMOUNTS IN THOUSANDS)
2. BASIS OF PRESENTATION: (CONTINUED)
Business provides for estimated future losses on Internet and colocation
service contracts, to the extent such losses are probable and estimable.
RESEARCH AND DEVELOPMENT
Research and development costs of the Business are charged to expense in
the period incurred.
LONG-LIVED ASSETS
The Business reviews for the impairment of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. An impairment loss would be recognized when
estimated future cash flows expected to result from the use of the asset and
its eventual disposition is less than its carrying amount.
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Business sells to customers primarily in the Internet and
Telecommunications industries and customers are primarily located in the United
States. The Company performs ongoing credit evaluations of its customers'
financial condition and maintains adequate provisions for uncollectible amounts
when necessary.
For the periods in the fiscal year ended December 26, 1998, and for the
years ended December 27, 1997 and December 29, 1996, PAIX generated more than
10% of its total revenue from the following customers:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
UUNet................................ 12% 19% 35%
BBN/GTE Internetworking.............. -- -- 14%
Epoch................................ -- -- 31%
Genuity.............................. -- -- 11%
</TABLE>
As of December 26, 1998 and December 27, 1997, customers which comprised
10% or more of accounts receivable were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
UUNet................................ 23% 25%
Epoch................................ -- 20%
</TABLE>
UNAUDITED INTERIM FINANCIAL INFORMATION
The interim financial information for the quarters ended March 27, 1999
and March 26, 1998 is unaudited and has been prepared on the same basis as the
audited financial statements. In the opinion of management, such unaudited
information includes all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the interim information.
Results for the
F-30
<PAGE> 18
PALO ALTO INTERNET EXCHANGE
NOTES TO COMBINED STATEMENTS OF ASSETS TO BE ACQUIRED
AND LIABILITIES TO BE ASSUMED AND
COMBINED STATEMENTS OF REVENUES AND DIRECT EXPENSES (CONTINUED)
(AMOUNTS IN THOUSANDS)
2. BASIS OF PRESENTATION: (CONTINUED)
three months ended March 27, 1999 are not necessarily indicative of results to
be expected for the year ending December 31, 1999.
3. PROPERTY AND EQUIPMENT:
Major classifications of property and equipment consisted of the following:
<TABLE>
<CAPTION>
ESTIMATED DECEMBER 26, DECEMBER 27,
USEFUL LIVES 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
Building improvements................. 10 years $2,479 $2,450
Computer equipment.................... 2-3 years 52 87
Office equipment...................... 10 years 6 --
Electrical and telecommunications
equipment........................... 3 years 251 388
Construction in progress.............. -- 521 112
------ ------
Less: accumulated depreciation........ (221) (287)
------ ------
$3,088 $2,750
====== ======
</TABLE>
Depreciation expense was approximately $221, $184, $286 and $1 for the
period June 12, 1998 through December 26, 1998, the period December 28, 1997
through June 11, 1998, and the fiscal years ended December 27, 1997 and December
29, 1996, respectively.
4. INTANGIBLE ASSETS:
Intangible assets consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 26, JUNE 11,
1998 1998
------------ --------
<S> <C> <C>
Goodwill ............................. $27,400 $27,400
Customer lists ....................... 8,300 8,300
Less: accumulated amortization ....... (1,944) --
------- -------
$33,756 $35,700
======= =======
</TABLE>
On June 11, 1998, Compaq consummated its acquisition of Digital and
allocated its purchase price to the assets acquired and liabilities assumed
based on Compaq's estimates of fair value. The fair value assigned to
intangible assets acquired was based on a valuation prepared by an independent
third-party appraisal company and included goodwill and customer lists related
to the Business.
5. COMMITMENTS AND CONTINGENCIES:
The Company, on behalf of the Business, has entered into service contracts
with customers and telecommunications vendors to provide services.
F-31
<PAGE> 19
PALO ALTO INTERNET EXCHANGE
NOTES TO COMBINED STATEMENTS OF ASSETS TO BE ACQUIRED
AND LIABILITIES TO BE ASSUMED AND
COMBINED STATEMENTS OF REVENUES AND DIRECT EXPENSES (CONTINUED)
(AMOUNTS IN THOUSANDS)
5. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
In some instances, the Company provides limited warranties to customers in
connection with Internet and colocation service contracts. To date, costs
incurred in connection with such warranties have been immaterial.
6. LEGAL MATTERS:
The Company is involved in lawsuits, claims, investigations, and
proceedings which are being handled and defended in the ordinary course of
business. There are no such matters pending that the Company and its General
Counsel expect to be material in relation to the Business and no amounts have
been accrued in the financial statements for such matters.
7. RELATED PARTY TRANSACTIONS:
As described in Note 2, the Company incurred expenses for services
performed directly on behalf and for the benefit of the Business. Costs for such
services have been reflected in the accompanying Statement of Revenues and
Direct Expenses on the basis of activity or utilization, estimated support
provided to the Business, or other methods management believe to be reasonable.
The cost of such services is presented as cost of revenue, research and
development and general and administrative.
The Business has no external borrowings and there have been no allocation
of the Company's consolidated borrowings and related interest expenses in the
financial statements.
The Business recognized revenue from AboveNet of $66, $36, $22 and $10 for
the period June 12, 1998 through December 26, 1998, the period December 8, 1997
through June 11, 1998, and the fiscal years ended December 27, 1997 and December
29, 1996, respectively. Accounts receivable from AboveNet are $11 and $4 at
December 26, 1998 and December 27, 1997, respectively.
