<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration Statement No. 333-75795
4,000,000 SHARES
LOGO
ABOVENET COMMUNICATIONS INC.
COMMON STOCK
$85.00 PER SHARE
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AboveNet Communications Inc. is offering 2,825,178 shares and the selling
stockholders identified in this prospectus are offering 1,174,822 shares with
this prospectus. AboveNet will not receive any proceeds from the sale of shares
by the selling stockholders. This is a firm commitment underwriting.
The common stock is listed on the Nasdaq National Market under the symbol
"ABOV." On April 29, 1999, the last reported sale price of the common stock on
the Nasdaq National Market was $93.00 per share.
INVESTING IN THE COMMON STOCK INVOLVES CERTAIN RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 7.
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<CAPTION>
PER SHARE TOTAL
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Price to the public........................ $85.00 $340,000,000
Underwriting discount...................... 4.88 19,516,000
Proceeds to AboveNet....................... 80.12 226,356,087
Proceeds to the selling stockholders....... 80.12 94,127,913
</TABLE>
AboveNet has granted an over-allotment option to the underwriters. Under this
option, the underwriters may elect to purchase a maximum of 600,000 additional
shares from AboveNet within 30 days following the date of this prospectus to
cover over-allotments.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
CIBC WORLD MARKETS
LEHMAN BROTHERS
PAINEWEBBER INCORPORATED
VOLPE BROWN WHELAN & COMPANY
The date of this Prospectus is April 30, 1999
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary.......................................... 4
Risk Factors................................................ 7
Special Note Regarding Forward-Looking Statements........... 20
Use of Proceeds............................................. 21
Dividend Policy............................................. 21
Price Range of Common Stock................................. 21
Capitalization.............................................. 22
Dilution.................................................... 23
Selected Financial and Operating Data....................... 24
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 26
Business.................................................... 37
Management.................................................. 54
Certain Transactions........................................ 66
Principal and Selling Stockholders.......................... 68
Description of Capital Stock................................ 70
Shares Eligible for Future Sale............................. 73
Underwriting................................................ 75
Legal Matters............................................... 77
Experts..................................................... 77
Change in Accountants....................................... 77
Additional Information...................................... 77
Index to Financial Statements............................... F-1
</TABLE>
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As used in this prospectus, the terms "we," "us," "our" and AboveNet mean
AboveNet Communications Inc. and the term "common stock" means our common stock,
par value $0.001 per share.
Our principal executive offices are located at 50 W. San Fernando Street, Suite
#1010, San Jose, California 95113. Our telephone number is (408) 367-6666.
Unless otherwise stated herein, all information contained in this prospectus
assumes no exercise of the over-allotment option granted to the underwriters.
On March 30, 1999, we announced a 2 for 1 stock split of our common stock. The
stock split will be effected through the issuance of a stock dividend and will
entitle each stockholder of record on April 14, 1999, to receive one share for
every outstanding share of common stock held by them on that date. The dividend
is expected to be distributed to stockholders on May 7, 1999. All common stock
numbers in this prospectus do not reflect the stock split.
The underwriters are offering the shares subject to various conditions and may
reject all or part of any order. The shares should be ready for delivery on or
about May 5, 1999 against payment in immediately available funds.
EtherValve is our registered trademark. Cabriolet and MRTG are our trademarks.
We have applied for federal trademark registration of the following trademarks:
AboveNet, APS, ASAP, As-Ur-Here and Internet Service Exchange. All other
trademarks, servicemarks or tradenames referred to in this prospectus are the
property of their respective owners.
3
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PROSPECTUS SUMMARY
The summary highlights information contained in other parts of this prospectus,
including "Risk Factors." It is not complete and may not contain all of the
information that you should consider before investing in the shares. You should
read the entire prospectus carefully.
OUR COMPANY
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. We have developed a network architecture
based upon strategically located facilities. These facilities, known as Internet
service exchanges, allow Internet content providers direct access to Internet
service providers. We are establishing two campuses, one located on the West
Coast and one located on the East Coast. Our West Coast campus is comprised of
our two San Jose, California Internet service exchange facilities, one of which
is under development. Our East Coast campus is comprised of our existing Vienna,
Virginia Internet service exchange facility and our planned facilities in New
York, New York and the Washington D.C. area. On March 31, 1999, we had 257
public and private data exchange connections, known as peering arrangements,
including relationships with most major network providers. Our network
architecture and extensive peering relationships are designed to reduce the
number of network connections or "hops" for data traveling across the Internet.
By having both Internet content providers and Internet service providers
co-located at our Internet service exchange facilities we enable our Internet
service provider customers to offer their users "one hop" connectivity, through
our local area network, to the sites of the Internet content providers that are
co-located at our facilities. As of March 31, 1999, we had 449 customers,
including Internet content providers, Web hosting companies and Internet service
providers.
The Internet has experienced tremendous growth and is emerging as a global
medium for communications and commerce. Internet-based businesses and other
enterprises need non-stop, high performance Internet operations that can handle
the growth in their businesses and allow them to communicate and transact
business globally over the Internet. However, many businesses that are seeking
to establish these operations lack the resources and expertise to
cost-effectively develop, maintain and enhance the necessary facilities and
network systems. As a result, many businesses are seeking to outsource these
functions to third party service providers to enhance their Web site reliability
and performance, provide continuous operation of their Internet solutions,
reduce related operating expenses and focus on their core businesses.
We design our solutions to be very flexible and to allow our customers to easily
expand their use of our services as their Internet operations grow. We charge
our customers based on how much space and bandwidth they use. This provides our
customers with a flexible, cost-effective method to increase their Internet
operations.
We design our services to enhance performance through a high speed network and
we provide our customers with monitoring, notification and diagnostic services
twenty-four hours a day, seven days a week. Our internally developed software
monitors all of our direct and indirect network connections for delays in
delivery of data packets and loss of data packets. This monitoring software
allows our network engineers to enhance performance by rerouting data traffic as
problems occur to avoid congested points. We also provide our customers with
sophisticated monitoring, reporting and management tools that can be accessed by
customers remotely from their own facilities to control their Internet
operations. By providing a means to reduce the number of "hops" in the
transmission of data, we believe that our network design can provide significant
benefits to Internet service providers and their users as they seek to gain
fast, reliable access to the sites of Internet content providers.
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Our objective is to become the leading global provider of co-location and high
performance Internet connectivity for Internet content providers, Web hosting
companies and Internet service providers that require high bandwidth, business
critical Internet operations. To achieve this objective, we intend to do the
following:
- Increase awareness of the AboveNet name on a global basis.
- Expand our customer base through increased sales and marketing efforts and
establish relationships with channel partners.
- Expand our global Internet service exchange network by connecting
centralized facilities in key domestic and international locations. As part
of this strategy, in March 1999, we entered into strategic agreements to
establish regional Internet service exchange facilities in Austria, Germany
and the United Kingdom.
- Leverage our Internet service exchange model to increase our customer base
and to generate additional recurring monthly revenues.
- Address the emerging requirements of Internet technologies such as audio and
video streaming and voice over the Internet.
Our customers include CNET Download.com, e-Media, LLC, Got.Net, IntelliChoice,
Inc., iXL, Inc., KDD America, Netscape Communications Corporation (acquired by
America Online, Inc.), RealNetworks, Inc., RemarQ Communities, Inc. (formerly
named Supernews, Inc.), WebMD, Inc. and The Web Zone, Inc. Our customer base
increased from 221 at March 31, 1998, to 278 at June 30, 1998, to 316 at
September 30, 1998, to 382 at December 31, 1998, to 449 at March 31, 1999.
THE OFFERING
Common stock offered by AboveNet........ 2,825,178 shares
Common stock offered by the selling
stockholders............................ 1,174,822 shares
Common stock to be outstanding after the
offering................................ 16,491,168 shares
Use of proceeds......................... For capital expenditures related to
the build out of Internet service
exchange facilities and increasing
network capacity, potential
acquisitions and strategic
investments, working capital and
general corporate purposes. See
"Use of Proceeds."
Nasdaq National Market symbol........... ABOV
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The number of shares outstanding is based on shares outstanding as of March 31,
1999 and, excludes:
- 2,021,179 shares of common stock issuable upon exercise of options
outstanding at a weighted average exercise price of $9.70 per share and
1,227,100 shares of common stock reserved for issuance under our stock plans;
- 170,158 shares of common stock issuable upon exercise of outstanding warrants
at a weighted average exercise price of $9.06 per share; and
- 156,250 shares of common stock reserved for issuance under our 1998 Employee
Stock Purchase Plan.
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SUMMARY FINANCIAL AND OPERATING DATA
(In thousands, except per share and customer data)
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<CAPTION>
PERIOD FROM NINE MONTHS ENDED
MARCH 8, 1996 YEAR ENDED JUNE 30, MARCH 31,
(INCEPTION) TO ------------------- ------------------
JUNE 30, 1996 1997 1998 1998 1999
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STATEMENT OF OPERATIONS DATA:
Revenues......................... $ 79 $ 552 $ 3,436 $ 2,069 $ 8,297
Loss from operations............. (78) (1,804) (5,327) (2,732) (14,460)
Net loss......................... $ (78) $(1,803) $(5,425) $(2,829) $(14,400)
====== ======= ======= ======= ========
Basic and diluted loss per
share.......................... $(0.62) $ (9.17) $(20.68) $(11.85) $ (2.51)
====== ======= ======= ======= ========
Shares used in basic and diluted
loss per share................. 125 197 262 239 5,742
Pro forma basic and diluted loss
per share reflecting 2 for 1
stock split.................... $(0.31) $ (4.58) $(10.34) $ (5.92) $ (1.25)
Shares used in pro forma basic
and diluted loss per share..... 250 393 525 478 11,485
OTHER OPERATING DATA:
Capital expenditures............. $ 101 $ 850 $ 4,145 $ 659 $ 30,243
Number of customers at period
end............................ 10 110 278 221 449
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MARCH 31, 1999
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ACTUAL AS ADJUSTED
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BALANCE SHEET DATA:
Cash, cash equivalants and short-term investments........... $56,692 $282,148
Working capital............................................. 44,725 270,181
Total assets................................................ 96,183 321,639
Long-term obligations, net of current portion............... 9,973 9,973
Total stockholders' equity.................................. 71,091 296,547
</TABLE>
The "as adjusted" numbers in the table above give effect to our receipt of the
net proceeds from the sale of 2,825,178 shares of common stock by us at the
public offering price of $85.00 per share, after deducting the underwriting
discount and estimated offering expenses payable by us. Capital expenditures in
the table above represent purchases of property and equipment, including
non-cash transactions such as the acquisition of equipment under capital leases
and the acquisition of rights to use fiber optic cable capacity. On March 30,
1999, the Company announced a 2 for 1 stock split to be effected as a stock
dividend. The dividend for each outstanding share of common stock is expected to
be distributed on or about May 7, 1999. Pro forma basic and diluted per share
reflects, on a pro forma basis, the 2 for 1 stock split, which has been declared
but is undistributed. No other share or per share amounts in the financial
statements have been adjusted to give effect to this stock split. See Notes 1
and 9 of Notes to Financial Statements for an explanation of the method used to
determine the number of shares used to compute basic and diluted loss per share
and pro forma basic and diluted loss per share to reflect our 2 for 1 stock
split.
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RISK FACTORS
You should carefully consider the following factors and other information in
this prospectus before deciding to invest in the shares. The risks and
uncertainties described below may not be the only ones we face. If any of the
following risks actually occur, our business, financial condition or results of
operations could be materially and adversely affected. In this event, the
trading price of our common stock could decline, and you may lose all or part of
your investment. Please see the "Special Note Regarding Forward-Looking
Statements" on page 19 of this prospectus.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, OUR BUSINESS IS DIFFICULT TO
EVALUATE
We were incorporated in March 1996 and began offering our co-location and
Internet connectivity services to content providers through our first facility
in July 1996. We introduced our co-location and Internet connectivity services
to Internet service providers in August 1997 and began operating our second
Internet service exchange facility in Vienna, Virginia, in July 1998.
Accordingly, we have a limited operating history, and we face all of the risks
and uncertainties encountered by early-stage companies. Also, because we have a
limited operating history, our past results may not be meaningful and you should
not rely on them as indicators of our future performance. In addition, our
prospects must be considered in light of the risks, expenses and difficulties
associated with the new and rapidly evolving market for co-location and Internet
connectivity services. In sum, because of our limited history and the youth and
inherent risks of our industry, predictions of our future performance are very
difficult.
WE HAVE INCURRED SUBSTANTIAL LOSSES AND ANTICIPATE CONTINUING AND INCREASING
LOSSES
Since our inception we have incurred substantial losses. We expect our losses to
significantly increase as we make further investments. We experienced net losses
of $1.8 million, $5.4 million and $14.4 million in fiscal years 1997 and 1998,
and for the nine months ended March 31, 1999. As of March 31, 1999, we had an
accumulated deficit of $21.7 million. Our losses are expected to increase as we
intend to:
- substantially increase our sales and marketing activities;
- establish additional Internet service exchange facilities in San Jose,
California, New York, New York, and the Washington D.C. area;
- purchase additional rights to use capacity on fiber optic cable systems;
- establish joint ventures with foreign entities developing international
Internet service exchange facilities; and
- expand our global network through purchases of long-term capacity and
related equipment.
We face significant challenges before we can become profitable. These challenges
include our ability to:
- increase our customer base and maintain existing customer relationships;
- expand domestically and internationally;
- provide scalable, reliable and cost-effective services;
- develop our infrastructure to accommodate expanded and new facilities,
additional customers and the increase of our network capacity;
- expand our channels of distribution;
- effectively establish our brand name;
- retain and motivate qualified personnel; and
- continue to respond to competitive developments.
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Although we have experienced significant growth in revenues in recent periods,
we do not believe that this growth rate is necessarily a good indication of
future operating results. We might not ever achieve or sustain profitability.
Please see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for more detailed information concerning our losses and
other operating results.
OUR BUSINESS WILL SUFFER IF WE DO NOT EXPAND AND MAINTAIN OUR CUSTOMER BASE
Our success depends on the continued growth of our customer base and the
retention of our customers. Our ability to attract new customers depends on a
variety of factors, including:
- the willingness of businesses to outsource their Internet operations;
- the reliability and cost-effectiveness of our services; and
- our ability to effectively market such services.
To attract new customers we intend to significantly increase our sales and
marketing expenditures. However, our efforts might not result in more sales as a
result of the following factors:
- we may be unsuccessful in implementing our marketing strategies;
- we may be unsuccessful in hiring a sufficient number of qualified sales and
marketing personnel; and
- any implemented strategies might not result in increased sales.
Our marketing efforts include developing relationships with hardware providers,
system integrators, value added resellers and Web hosting companies. We may
limit our ability to increase revenues if we fail to develop these
relationships.
In the past, we have lost customers to other service providers for various
reasons, including lower prices and other incentives offered by competitors that
we do not match. Our customers might terminate or decide not to renew their
commitments to use our services. A majority of our customer contracts are
cancelable on 30 days notice.
WE EXPECT OUR OPERATING RESULTS TO FLUCTUATE
We have experienced significant fluctuations in our operating results from
quarter to quarter. As a result of these fluctuations, period to period
comparison of our operating results is not necessarily meaningful and should not
be relied upon as an indicator of future performance. We expect our future
operating results to fluctuate. Factors that are likely to cause these
fluctuations include:
- demand for and market acceptance of our services;
- capacity utilization of our Internet service exchange facilities;
- fluctuations in data communications and telecommunications costs;
- customer retention;
- the timing and magnitude of capital expenditures;
- costs relating to the expansion of operations;
- expansion of existing facilities and completion of new facilities;
- fluctuations in bandwidth used by customers;
- introductions of new services or enhancements by us and our competitors;
- the timing of customer installations and related payments;
- the ability to maintain or increase peering relationships;
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- provisions for customer discounts and credits;
- changes in our pricing policies and those of our competitors;
- changes in regulatory laws and policies;
- economic conditions, particularly those related to the Internet industry;
- difficulties in collecting accounts receivable, particularly because many of
our customers are in an emerging stage;
- compensation costs related to certain option grants and warrants; and
- decreased revenues during the summer months and other seasonal effects on
sales.
In addition, a relatively large portion of our expenses are fixed in the
short-term, particularly with respect to data communications and
telecommunications costs, depreciation, real estate and personnel. Our future
operating results will be particularly sensitive to fluctuations in revenues
because of these and other short-term fixed costs.
Our operating results in the future may fall below the expectations of
securities analysts and investors. In this event, the trading price of our
common stock will likely decrease significantly. Please see "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for a
more detailed analysis of our period to period results.
WE MAY FACE PROBLEMS IN CONNECTION WITH OUR EXPANSION PLANS
We are currently expanding our West Coast campus by developing an additional
Internet service exchange facility in San Jose, California. In addition, we are
planning to expand our East Coast campus by developing additional Internet
service exchange facilities in New York, New York and in the Washington D.C.
area. The successful expansion of these campuses will involve significant
planning and resources. We may face problems in connection with our expansion
plans and, as a result, these expansion plans may be delayed or never completed.
We have not yet entered into a facility lease for our planned facility in the
Washington D.C. area. Please see "Business -- Facilities" for a more detailed
description of our planned Internet service exchange facilities.
Our expansion plans will face many obstacles. In order to carry out our
expansion plans, we must:
- obtain the necessary permits and approvals;
- enter into leases for proposed facilities;
- pass the required inspections; and
- hire the necessary contractors, builders, electricians, architects and
designers.
Our expansion plans are subject to risks, such as:
- construction delay;
- cost estimation errors or overruns;
- equipment and material delays or shortages;
- inability to obtain necessary permits on a timely basis;
- strain on management and diversion of our attention from day-to-day
operations;
- failure to timely hire the necessary employees, including management and
sales personnel; and
- failure to predict customer demand for new facilities.
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In addition, our costs will increase as we expand. These increased costs
include:
- expenses associated with hiring;
- training and managing new employees;
- purchasing new equipment;
- implementing power and redundancy systems;
- implementing multiple data communications and telecommunications
connections; and
- leasing additional real estate and depreciation.
For a discussion of the risks associated with our needs for additional funding,
please see the Risk Factor entitled "Additional funding may not be available if
we need it."
WE HAVE A LONG SALES CYCLE
A customer's decision to purchase our services involves a significant commitment
of resources. As a result, we have a long sales cycle. We also need to educate
customers regarding the benefits of co-location and Internet connectivity
services. We generally incur significant expenses in sales and marketing prior
to getting customer commitments for our services. As a result, our inability to
get customer commitments or delays due to the lengthy sales cycles could
significantly harm our operating results.
WE DEPEND ON THIRD PARTIES TO ESTABLISH AND OPERATE INTERNATIONAL INTERNET
SERVICE EXCHANGES
As part of our strategy, we plan to continue to make investments in joint
ventures and foreign companies that are expected to develop regional Internet
service exchange facilities in Europe and Asia and to license our trademarks and
technology to these entities. We do not expect to control or manage any of these
foreign entities. As a result, we will be required to depend on the management
of these foreign entities to successfully establish and operate these regional
Internet service exchange facilities.
The ability of these foreign entities to successfully establish and operate
Internet service exchange facilities is subject to a number of risks over which
we will have little or no control. These risks include:
- the inability to set up a data communications and telecommunications
infrastructure in a cost-effective manner;
- the inability to compete effectively in international markets; and
- a potentially more rigorous set of laws within each foreign country.
These foreign entities are expected to operate under the AboveNet name. If these
foreign entities are not successful, they could significantly damage our
reputation and brand equity. Also, we have granted exclusive licenses in
Austria, Germany and the United Kingdom and expect to do the same in other
countries. Under the terms of the license agreements, the foreign companies have
at least one year in which to meet their performance targets before they risk
losing exclusivity in their territories. Because of these restrictions, if the
foreign companies are not successful, we will not be able to enter those markets
on our own or with other third parties for a significant period of time. For a
description of our international Internet service exchange facilities, please
see "Business -- International Internet Service Exchanges."
While our international sales are typically denominated in U.S. dollars,
fluctuations in currency exchange rates could cause our services to become
relatively more expensive to customers in a particular country, potentially
leading to a reduction in sales to local customers.
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WE FACE INTENSE COMPETITION FROM OTHER COMPANIES
Our business is intensely competitive. We expect to face additional competition
from existing competitors and new market entrants in the future as there are few
substantial barriers to entering the co-location service business. We must
distinguish ourselves through the quality of our network performance, service
offerings and brand name recognition. We may be unsuccessful in doing this. In
addition, our business model of establishing centralized Internet service
exchange facilities may not be widely adopted over the model established by
other outsource providers who have developed and are continuing to develop
numerous geographically dispersed facilities. We cannot be certain that we will
have the resources or expertise to compete successfully in the future.
Some of our competitors have certain advantages over us. These advantages
include:
- substantially greater financial, technical and marketing resources;
- larger customer bases;
- longer operating histories;
- greater name recognition; and
- more established relationships in the industry.
Our competitors may be able to utilize these advantages to:
- expand their offerings more quickly;
- adapt to new or emerging technologies and changes in customer requirements
more quickly;
- take advantage of acquisitions and other opportunities more readily;
- devote greater resources to the marketing and sale of their services; and
- adopt more aggressive pricing and incentive policies.
In addition, some of our competitors have offered co-location services at prices
lower than ours. Furthermore, some competitors offer incentives we do not match.
These incentives include free start-up and domain name registration, periods of
free service and low-priced Internet access. This and future price competition
may have a material adverse effect on our business and operating results.
In addition, some competitors have entered into joint ventures, consortiums or
consolidations to provide services competitive with our services. As a result,
these competitors may be able to provide customers with additional benefits,
including reduced communications costs, which could reduce the overall costs of
their services relative to our services. We might not be able to offset the
effects of those price reductions. We also believe that companies seeking
co-location and Internet connectivity for their business critical Internet
operations may use more than one company to provide this service. As a result,
these customers would be able to shift the amount of service and bandwidth usage
from one provider to another more easily. We may also face competition from our
suppliers.
WE MAY NOT BE ABLE TO MANAGE OUR GROWTH EFFECTIVELY
Our operating results and financial condition could suffer if we do not
effectively manage any growth that may occur. We have recently experienced a
period of rapid growth with respect to the expansion of our Internet service
exchange facilities and our customer base. To manage our growth effectively, we
must continue to:
- expand our operating and financial procedures and controls;
- replace or upgrade our operational, financial and management information
systems;
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- attract, train, motivate, manage and retain key employees; and
- increase substantially the size of our sales and marketing organization.
WE MAY NOT BE ABLE TO HIRE OR RETAIN THE KEY EMPLOYEES WE NEED
The market for highly qualified personnel is very competitive. Particularly, we
are dependent on our ability to increase significantly the size of our sales and
marketing organization. If we are unable to hire the key personnel we need, we
may provide poor service and have difficulty signing up new customers.
In addition, we depend on the ability of a new management team to effectively
execute our strategies. We recently hired many of our key employees. Between
August and December 1998, we hired our Senior Vice President and Chief Financial
Officer, our Vice President of Construction and Real Estate and our Vice
President of Marketing. In December 1998, we promoted an employee to Vice
President of Sales. Our Vice President of Engineering joined us in February
1999. Because many members of our management team have worked together only for
a short period of time, we need to integrate these officers into our operations.
We may lose some of our key personnel and any loss may have an adverse effect on
our business. It is important that we retain our Chief Executive Officer,
Sherman Tuan, President and Chief Operating Officer, Warren J. Kaplan, Chief
Technical Officer, David Rand, and Senior Vice President of Sales and Marketing,
David Dembitz. Any of our officers or employees can quit at any time. We
maintain a key man insurance policy in the amount of approximately $1.1 million
on the life of Mr. Tuan, but no policy on any other executive officers. Also,
all options to purchase common stock held by Mr. Kaplan vested upon our initial
public offering.
WE MUST MAINTAIN AND INCREASE PEERING RELATIONSHIPS
The Internet is comprised of network providers who operate their own networks
and interconnect their networks at various public and private points. These
interconnections are called peering arrangements. Our establishment and
maintenance of peering relationships is necessary in order to effectively
exchange traffic with Internet service providers without having to pay the
higher costs of transit services and in order to maintain high network
performance levels. These arrangements are not subject to regulation and are
subject to changes in terms, conditions or costs. We may not be able to provide
our customers with affordable services if we are unable to maintain and increase
peering relationships with Internet service providers.
In addition, any increase in the costs associated with access to the Internet
that we are unable to pass to our customers may affect our financial condition
and operating results. We may have to pay increasing amounts to maintain our
relationships with Internet service providers to the point where it becomes
necessary to find alternatives. These Internet service providers may increase
their prices. In turn, we may be required to identify alternative methods to
distribute our customers' content. These alternatives may not exist.
WE DEPEND ON THIRD PARTY SUPPLIERS
We depend on third parties to maintain and provide us key components for our
network infrastructure. Our financial condition may suffer if the third parties
we depend on to provide our network infrastructure either increase their cost to
us or fail to maintain the operational integrity of their networks. We, and our
customers, depend upon data communications and telecommunications providers,
such as MCI WorldCom, Sprint, Pacific Bell, Teleport Communications Group, a
subsidiary of AT&T, and WinStar Communications, Inc., to provide the data
communications and telecommunications capacity we require. As a result, the
service we provide our customers may be interrupted if our data communications
and telecommunications providers' systems fail or if they stop providing us the
data communications and
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telecommunications capacity that we need. If the systems of our providers fail,
our reputation could be harmed or our customers could leave. We currently are in
a dispute with WinStar Communications, Inc. over currently invoiced amounts and
credits available to apply against amounts invoiced in the future. We believe we
are entitled to net credits under our agreements with WinStar Communications.
WinStar Communications has stated that unless the dispute is resolved to its
satisfaction, it will discontinue providing us telecommunications capacity.
WinStar Communications is one of our major suppliers of this service. While the
Company is in the process of accelerating the acquisition of additional capacity
to help offset the potential impact of any termination of such service,
termination of the telecommunications capacity that WinStar Communications
provides to us could result in a significant disruption of our services to our
customers and cause a significant adverse effect on our business and operating
results. Since the additional capacity is not yet installed, we cannot guarantee
that it will be available when and if needed. Furthermore, because we intend to
accelerate our purchase of additional capacity as a result of this dispute, we
expect to incur additional expenses in the quarter ending June 30, 1999. If
settlement is not reached, this dispute might result in litigation. Litigation
could be costly and could have a significant adverse effect on our operating
results, regardless of the outcome. See "Business -- Legal Proceedings." In
addition, MCI WorldCom is a current competitor of ours. Other data
communications providers are potential competitors of ours.
Furthermore, some equipment we depend on is available only from limited sources
because of the quantities and quality we demand. Currently, we order all of our
routers from Cisco Systems, Inc. We believe we could find alternative sources to
supply routers in the event routers from Cisco Systems were unavailable.
However, we would need to train our personnel in the use of these alternative
routers. This training could cause delay or interruption of our services.
We have purchased fiber optic cable capacity between the U.S. and the United
Kingdom from affiliates of Global Crossing Ltd. In March 1999, we entered into
an agreement with Global Crossing to purchase fiber optic cable capacity between
the U.S. and the Netherlands. This agreement is subject to us entering into an
additional agreement with Global Crossing for fiber optic cable capacity
connecting certain European cities. If the contemplated agreement is entered
into, we will be dependent on Global Crossing for fiber optic cable connectivity
to and within Europe. Global Crossing Holding Ltd., the parent of Global
Crossing, Ltd., is acquiring Frontier Global, Inc., a competitor of ours.
OUR SYSTEMS OR OTHER SYSTEMS ON WHICH WE DEPEND MAY FAIL
Our customers depend on our ability to provide continuous service. As a result,
if our service is interrupted, our reputation will be harmed and our customers
may leave. Our systems and our customers' systems risk damage from numerous
forces, including:
- human error;
- fire;
- earthquakes;
- floods;
- power loss;
- telecommunications failures; or
- sabotage or vandalism.
In addition, our operations may be disrupted due to unannounced or unexpected
changes in transmission protocols or other technology.
We may be subject to legal claims and be liable for losses suffered by our
customers for disruption of service or damage to customer equipment. Our
contracts with our customers attempt to eliminate our liability for
consequential or punitive damages and for damage to customer equipment not
caused by our gross negligence or willful acts. However, those provisions may
not protect us from being held liable for those damages.
13
<PAGE> 13
THE MARKET FOR CO-LOCATION AND INTERNET CONNECTIVITY SERVICES IS NEW AND MAY NOT
GROW
The market for co-location and Internet connectivity services is new and
evolving. As a result, our financial condition will be harmed if the market
fails to develop, or develops more slowly than we expect. The growth of the
market depends on several uncertain events or occurrences. These events or
occurrences include:
- the growth of the Internet as a global communication and commerce medium;
- the willingness of businesses to co-locate their Internet operations; and
- our ability to successfully and cost-effectively market our services to a
sufficiently large number of customers.
Our business may also suffer if our services do not achieve widespread
acceptance in this new market.
WE MUST BE ABLE TO EXPAND AND ADAPT OUR NETWORK INFRASTRUCTURE
We must continue to expand and adapt our network as the number of its users
grow, as its users place increasing demands on it, and as requirements change.
If we are unable to expand and adapt our network infrastructure, we may lose
customers. We have had limited deployment of our services. Accordingly, it is
difficult to determine if our network will be able to handle, connect and manage
large numbers of users at high transmission speeds. We may not be able to
provide our customers with the increasing levels of data transmission capacity
that they may require for a number of reasons, such as our possible inability to
raise the funds needed to develop the network infrastructure to maintain
adequate data transmission speeds and the lack of additional network capacity
from third-party suppliers. In addition, any future attempts we make to bolster
our network may be delayed or cause further complications. We may encounter
equipment or software incompatibility, among other things, if we upgrade our
network to increase its capacity. This may cause delays in our attempts to
expand or improve our services. For more detailed information regarding our
network, please see "Business -- Network Architecture."
WE MAY FACE RISKS AND COSTS ASSOCIATED WITH POTENTIAL FUTURE ACQUISITIONS
The costs and risks we may face if we consummate acquisitions of key
technologies or companies in the future may have an adverse impact on us. An
acquisition may result in the use of significant amounts of cash, potentially
dilutive issuances of equity securities, incurrence of debt or amortization
expenses related to goodwill and other intangible assets. Any acquisitions we
may engage in may involve numerous risks. These risks include:
- difficulties in the assimilation of the operations, technologies, products
and personnel of the acquired company;
- the diversion of management's attention from other business concerns;
- risks related to entering markets in which we have no or limited direct
prior experience; and
- potential loss of key employees of the acquired company.
Our financial condition and operating results may be adversely affected if any
acquisitions occur.
WE DEPEND ON THE GROWTH AND PERFORMANCE OF THE INTERNET
Our success will depend in large part on growth in the use of the Internet. The
growth of the Internet is highly uncertain and depends on a variety of factors.
These factors include security, reliability, cost, ease of access, quality of
service and necessary increases in bandwidth availability. In addition, broad
adoption of
14
<PAGE> 14
the Internet for most business applications will require the acceptance of a new
medium of conducting business and exchanging information.
The recent growth in the use of the Internet has placed strain on the Internet.
This increased use has required the upgrade of routers and switches,
telecommunications links and other components forming the infrastructure of the
Internet by Internet service providers and other organizations with links to the
Internet. Any perceived weakening in the performance of the Internet could
undermine the benefits of our services. The benefits of our services are
ultimately dependent upon the speed and reliability of the networks operated by
third parties. Consequently, the emergence and growth of our market is dependent
on improvements being made to the entire Internet infrastructure to alleviate
overloading and congestion.
WE MAY NOT BE ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES OR EMERGING
INDUSTRY STANDARDS
Our services will become relatively less useful to our customers if we are
unable to respond to technological advances. Our future success depends, in
part, on our ability to address the increasingly sophisticated and varied needs
of our current and prospective customers. Keeping pace with technological
advances in our industry may require substantial expenditures and lead time.
In addition, future advances in technology may harm our business. We may not be
able to incorporate technological advances on a cost-effective or timely basis
into our business. Future technological advances may also make our services
unnecessary or less cost-effective for our customers. Also technological
advances may encourage businesses to rely on in-house personnel and equipment to
furnish the services we currently provide.
We currently intend to support emerging standards if they become established and
our failure to conform to prevailing standards or the failure of a common
standard to emerge could hurt our business.
WE FACE RISKS ASSOCIATED WITH THE SECURITY OF OUR SYSTEMS
Despite our design and implementation of a variety of network security measures,
unauthorized access, computer viruses, accidental or intentional action and
other disruptions could occur. In addition, we may incur significant costs to
prevent breaches in security or to alleviate problems caused by such breaches.
Any breaches that may occur could result in liability to us, loss of existing
customers and the deterrence of future customers. We have been sued by a
customer alleging that we negligently allowed the customer's consultant access
to the customer's servers co-located at our San Jose facility. Please see
"Business -- Legal Proceedings" for a more detailed description of this lawsuit.
WE OPERATE IN AN UNCERTAIN LEGAL LANDSCAPE
The adoption and interpretation of any future or currently existing regulations
might have a negative impact on our business. The Internet and our market are
relatively new. Many of the laws and regulations that govern us have yet to be
interpreted or enforced. It is likely that in the future many new laws will take
effect that will regulate the Internet and our industry. The applicability to
the Internet of existing laws governing issues such as property ownership,
copyrights and other intellectual property issues, taxation, libel, obscenity
and personal privacy is uncertain. Current and future laws and regulations may:
- decrease the growth of the Internet;
- decrease demand for our services; and
- impose taxes or other costly technical requirements or otherwise increase
the cost of doing business.
We operate over the Internet in multiple states and foreign countries. In
addition, we facilitate sales by our customers to end users located in many
states and foreign jurisdictions. As a result, we are potentially subject to the
laws and regulations of jurisdictions in which we are not qualified to do
business. These jurisdictions may claim that we are required to qualify to do
business as a foreign corporation in each such state or foreign country,
potentially subjecting us to additional taxes and lawsuits in these
jurisdictions.
15
<PAGE> 15
WE MAY FACE LIABILITY AND OTHER RISKS AS A RESULT OF INFORMATION DISSEMINATED
THROUGH OUR NETWORK
The liability we may face as a result of information disseminated through our
network could have a negative impact on our financial condition. The law
relating to the liability of online services companies and Internet access
providers for information carried on or disseminated through their networks is
currently unsettled. It is possible that claims could be made against online
services companies, co-location companies and Internet access providers under
both United States and foreign law for defamation, negligence, copyright or
trademark infringement or under other legal theories. Content distributed by
some of our current or future customers may be regulated or banned. We may lose
some of our customers if their content is regulated. We have received letters
from recipients of information transmitted by our customers objecting to the
nature and content of the information. Several private lawsuits seeking to
impose liability on online services companies and Internet access providers are
currently pending. In addition, legislation has been recently passed and
continues to be proposed that imposes liability for or prohibits the
transmission over the Internet of certain types of information.
We may need to implement measures to reduce our exposure to this potential
liability. These measures may require the expenditure of substantial resources.
We also may need to discontinue certain service offerings. The increased
attention focused upon liability issues as a result of these lawsuits, new laws
and legislative proposals could impact the growth of Internet use. We carry
general liability insurance, but 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.
In addition, some of our customers have sent unsolicited commercial e-mails from
servers co-located at our facilities to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead to
complaints against service providers that enable such activities, particularly
where recipients view the materials received as offensive. Internet service
providers and other online services companies might deny network access to us if
undesired content or spamming were to be transmitted from servers co-located by
us. In addition, legislation that prohibits "spamming" has recently been passed,
and continues to be proposed. The loss of these services could adversely affect
our business and operating results.
THE PROTECTION OF OUR PROPRIETARY INFORMATION IS LIMITED
We have no patented technology. We rely on a combination of copyright,
trademark, service mark and trade secret laws and contractual restrictions to
establish and protect certain proprietary rights in our technology. The steps we
have taken to protect our intellectual property may be insufficient. Our
technology may be misappropriated or a third party may independently develop
similar technologies. The laws of certain foreign countries may not protect our
intellectual property rights to the same extent as do the laws of the U.S.
WE MAY BE ACCUSED OF INFRINGING THE PROPRIETARY RIGHTS OF OTHERS
Our business may be adversely affected by a claim that we are infringing the
proprietary rights of others. We have not been notified that we infringe the
proprietary rights of third parties. However, we might face claims of
infringement in the future. Any claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause service delays or require us
to enter into royalty or licensing agreements. Any royalty or licensing
agreements required might not be available at all or on terms acceptable to us.
ADDITIONAL FUNDING MAY NOT BE AVAILABLE IF WE NEED IT
Our business may suffer if we require additional funding and are not able to
obtain it. We expect to incur significant expenditures as part of our expansion
plans. In March 1999, we entered into a commitment to pay $7.5 million for
additional fiber optic capacity. This $7.5 million commitment is subject to us
entering into an additional commitment to purchase fiber optic capacity
connecting certain European cities, which
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<PAGE> 16
commitment is expected to be approximately $11.0 million. We might not enter
into the commitment to purchase fiber optic cable capacity connecting certain
European cities on reasonable terms or at all. We intend to enter into
additional arrangements to secure fiber optic capacity for Europe, Asia and the
Pacific Rim. These agreements may require us to make substantial up front
payments for long-term capacity that could require us to seek additional debt or
equity financing. In addition, we have investment commitments and plan to
continue to make future investments in joint ventures and foreign companies to
develop international Internet service exchange facilities. We believe that,
following this offering, our cash reserves and available borrowings will be
adequate to fund our operations for at least the next 12 months. However, we may
require additional funds either during or after such 12 month period. Please see
"Use of Proceeds."
We are currently seeking to enter into an equipment financing arrangement for up
to $10.0 million. This financing and any future financing may not be available
if required or may only be available on terms that are not favorable to us. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of our stockholders could be significantly diluted. Any new
equity securities may have rights, preferences or privileges senior to those of
our stockholders. For a more detailed description of our capital commitments and
resources, please see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Notes 3, 4, 6 and 11 of Notes to
Financial Statements.
WE FACE RISKS ASSOCIATED WITH THE YEAR 2000 COMPUTER PROBLEM
Although we have taken precautions, we may still encounter problems attributable
to the Year 2000 issue. Many currently installed computer systems and software
products are coded to accept only two digit dates. These systems will need to
distinguish 21st century dates from 20th century dates. Any inability to do so
could result in system failures or miscalculations causing disruptions of
operations, including a temporary inability to process transactions, send
invoices or engage in similar normal business activities. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.
We are in the process of establishing procedures for evaluating and managing the
risks and costs associated with this problem. We believe our computer systems on
a stand-alone basis are currently Year 2000 compliant. However, we cannot assure
you that our computer systems are Year 2000 compliant.
We may face losses due to the failure of our customers or suppliers to ensure
that their systems are Year 2000 compliant. Many of our customers' and
suppliers' Internet operations may be impacted by Year 2000 complications. This
impact may result in decreased Internet usage or the delay or inability to
obtain necessary data communications and telecommunications capacity. These
delays may have a direct effect on our operations.
WE ARE SUBJECT TO INFLUENCE FROM PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND
DIRECTORS
Some of our stockholders own a large enough stake in us to have an influence on
matters presented to the stockholders. Our executive officers, directors and
greater than 5% stockholders (and their affiliates) will, in the aggregate, own
approximately 25% of our outstanding common stock after this offering. If these
parties acted in concert they could influence, among other things, the election
and removal of directors and any merger, consolidation or sale of all or
substantially all of our assets. This concentration of ownership may delay or
prevent a change in control, merger, consolidation, takeover or other business
combination involving us. This may discourage a potential acquirer from making a
tender offer or otherwise attempting to obtain control of us. As a result, this
concentration of ownership may have an adverse effect on our value.
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<PAGE> 17
OUR STOCK PRICE IS VOLATILE
The market price of our stock has and is likely to experience extreme
fluctuations in response to a number of factors. These factors include:
- actual or anticipated variations in our results of operations;
- announcements of technological innovations;
- new services introduced by us or our competitors;
- changes in financial estimates by security analysts;
- conditions and trends in the Internet industry;
- general market conditions; and
- potential volatility due to the increase in the number of publicly traded
shares in connection with this offering.
The Nasdaq National Market has experienced extreme price and volume
fluctuations, as have other stock markets. For example, from December 10, 1998,
the date of the initial public offering of our common stock, through April 29,
1999, our stock price has fluctuated from $13.00 per share to $150.27 and has on
many days fluctuated more than 10%. Similar market fluctuations have affected
the market prices of equity securities of many technology companies. The effects
on the stock prices of these companies have often been unrelated or
disproportionate to the operating performance of these companies. The trading
prices of many technology companies' stocks are at or near historical highs and
reflect valuations substantially above historical levels. These trading prices
and valuations may fall significantly. In addition, these broad market factors
may adversely affect the market price of our common stock. Our stock price may
also be adversely affected by general economic, political and market conditions
such as recession, interest rate changes or international currency fluctuations.
Class action litigation has often been instituted following periods of
volatility in the market price of a company's securities. We would be adversely
affected if such litigation were brought against us.
THIS OFFERING WILL BENEFIT SOME OF OUR EXISTING STOCKHOLDERS
The selling stockholders will receive substantial proceeds from selling their
shares of common stock in this offering. We will pay the expenses of the selling
stockholders related to this offering other than the underwriting discount. At
the public offering price of $85.00 per share, the net proceeds to the selling
stockholders, most of whom are our affiliates, will be approximately $94.1
million.
In addition, as a result of this offering, the pro forma net tangible book value
per share to existing stockholders will immediately increase and the net
tangible book value per share to new investors will immediately be diluted.
WE HAVE BROAD DISCRETION AS TO USE OF PROCEEDS
The net proceeds of this public offering will be approximately $225.5 million.
We expect to use the net proceeds for capital expenditures related to the
build-out of our facilities, increasing network capacity, potential strategic
investments, working capital and general corporate purposes. However, we may
change the allocation of these proceeds in response to economic or industry
developments or changes. Our management can spend the proceeds from this
offering in ways with which the stockholders may not agree. We cannot be certain
that such proceeds will be invested to yield a favorable return. See "Use of
Proceeds."
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<PAGE> 18
WE HAVE ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND THERE ARE
PROVISIONS OF DELAWARE LAW THAT COULD PREVENT OR DELAY A CHANGE IN CONTROL OF
OUR COMPANY
Our certificate of incorporation, our bylaws and Delaware law contain provisions
that could make it more difficult for a third party to acquire us, even if doing
so would be beneficial to our stockholders. Such provisions include:
- authorizing the issuance of up to 5,000,000 shares of "blank check"
preferred stock;
- providing for a classified board of directors with staggered, three year
terms; and
- prohibiting certain stockholder action by written consent.
We are currently considering other anti-takeover measures, including a
stockholders' rights plan. Please see "Description of Capital Stock" for a more
complete discussion of these matters.
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE NET TANGIBLE BOOK
VALUE OF THE STOCK YOU PURCHASE
The public offering price is substantially higher than the net tangible book
value per outstanding share of common stock. Purchasers of our common stock will
incur immediate and substantial dilution of $67.02 per share in the net tangible
book value of our common stock from the public offering price of $85.00.
Additional dilution will occur upon the exercise of outstanding options.
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<PAGE> 19
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this prospectus are forward-looking statements that
involve risks and uncertainties. These forward-looking statements include
statements about our plans, objectives, expectations, intentions and assumptions
and other statements contained in this prospectus that are not statements of
historical fact. 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. We cannot guarantee future results, levels of activity, performance
or achievements. Our 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 prospectus.
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<PAGE> 20
USE OF PROCEEDS
The net proceeds from the sale of the 2,825,178 shares of common stock offered
by us will be approximately $225.5 million at the public offering price of
$85.00 per share and after deducting the underwriting discount and estimated
offering expenses payable by us. We will not receive any proceeds from the sale
of shares by the selling stockholders.
We currently expect to use between $56.0 million to $72.0 million of the net
proceeds of this offering for capital expenditures associated with our planned
expansion of our West and East Coast campuses. We also expect to use a
significant amount of the net proceeds for the purchase of fiber optic cable
capacity and related equipment. In addition, we intend to use a portion of the
net proceeds for strategic investments in companies developing Internet service
exchange facilities in Europe and Asia.
The balance of the net proceeds of this offering will be used for working
capital and general corporate purposes. We have discussions on an ongoing basis
regarding possible acquisitions of or investments in businesses or technologies
that are complementary to our business. Although we may use a portion of the net
proceeds for these kinds of possible acquisitions, there are no current
agreements or commitments in this regard. We may, however, change the allocation
of these proceeds in response to developments or changes that affect our
business and/or our industry. Our management may spend the proceeds from this
offering in ways with which the stockholders may not deem desirable. Pending use
of the net proceeds for the above purposes, we plan to invest such funds in
short-term, investment grade, interest-bearing securities. We cannot predict
that the proceeds will be invested to yield a favorable return.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We currently
expect to retain future earnings, if any, for use in the operation and expansion
of our business and do not anticipate paying any cash dividends in the
foreseeable future. Our debt facilities contain restrictive covenants that limit
our ability to pay cash dividends without the prior written consent of the
lender.
PRICE RANGE OF COMMON STOCK
Our common stock began trading publicly on the Nasdaq National Market on
December 10, 1998 and is traded under the symbol "ABOV." The following table
shows the high and low per share closing prices of our common stock, as reported
by the Nasdaq National Market for the periods indicated.
<TABLE>
<CAPTION>
HIGH LOW
-------- -------
<S> <C> <C>
1998
Second Fiscal Quarter (beginning December 10, 1998)....... $ 25.75 $ 12.13
1999
Third Fiscal Quarter...................................... $131.88 $ 19.44
Fourth Fiscal Quarter (through April 29, 1999)............ $150.27 $ 93.00
</TABLE>
On April 29, 1999, the closing price of our common stock on the Nasdaq National
Market was $93.00 per share, and on March 31, 1999 there were approximately 150
holders of record of the common stock.
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<PAGE> 21
CAPITALIZATION
The following table sets forth the following information as of March 31, 1999:
- our cash, cash equivalents and short-term investments;
- our actual capitalization; and
- our "as adjusted" capitalization that gives effect to the sale of 2,825,178
shares of common stock at the public offering price of $85.00 per share in
this offering, less the underwriting discount and our estimated offering
expenses.
<TABLE>
<CAPTION>
MARCH 31, 1999
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(In thousands)
<S> <C> <C>
Cash, cash equivalents and short-term investments........... $ 56,692 $282,148
======== ========
Long term obligations, less current portion................. $ 9,973 $ 9,973
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000 shares
authorized; no shares issued and outstanding, actual
and as adjusted........................................ -- --
Common stock, $0.001 par value; 60,000,000 shares
authorized, 13,665,990 shares issued and outstanding,
actual; 16,491,168 shares issued and outstanding, as
adjusted............................................... 89,292 314,748
Common stock options...................................... 3,561 3,561
Deferred stock compensation............................... (57) (57)
Accumulated deficit....................................... (21,705) (21,705)
-------- --------
Total stockholders' equity........................ 71,091 296,547
-------- --------
Total capitalization.............................. $ 81,064 $306,520
======== ========
</TABLE>
The number of outstanding shares of common stock excludes:
- 2,021,179 shares of common stock issuable upon exercise of options
outstanding at a weighted average price of $9.70 per share;
- 170,158 shares of common stock issuable upon exercise of outstanding
warrants at a weighted average exercise price of $9.06 per share;
- 1,227,100 shares of common stock reserved for future issuance under our
stock option plans; and
- 156,250 shares of common stock reserved for future issuance under our 1998
Employee Stock Purchase Plan.
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<PAGE> 22
DILUTION
The net tangible book value of our common stock as of March 31, 1999, was $71.1
million, or approximately $5.20 per share. "Net tangible book value" per share
represents the amount of total tangible assets less total liabilities, divided
by the number of shares of common stock outstanding. Dilution in the net
tangible book value per share represents the difference between the amount per
share paid by purchasers of shares of our common stock in this offering and the
net tangible book value per share of common stock immediately afterwards. After
giving effect to the sale of 2,825,178 shares of common stock offered by this
prospectus and after deducting the underwriting discount and our estimated
offering expenses, our net tangible book value would have been $296.5 million,
or approximately $17.98 per share. This represents an immediate increase in net
tangible book value of $12.78 per share to existing stockholders and an
immediate dilution in net tangible book value of $67.02 per share to new
investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................. $85.00
Net tangible book value per share as of March 31, 1999.... $ 5.20
Increase in net tangible book value per share attributable
to the offering........................................ 12.78
Net tangible book value per share after giving effect to the
offering.................................................. 17.98
------
Net tangible book value dilution per share to new investors
in the offering........................................... $67.02
======
</TABLE>
This table excludes all options and warrants that were outstanding as of March
31, 1999. See Note 8 of Notes to Financial Statements. The exercise of the
outstanding options and warrants having an exercise price less than the offering
price would increase the dilutive effect to new investors.
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<PAGE> 23
SELECTED FINANCIAL AND OPERATING DATA
This section presents historical financial data of AboveNet Communications Inc.
You should read carefully the financial statements included in this prospectus,
including the notes to the financial statements. The selected data in this
section is not intended to replace the financial statements.
We derived the statement of operations data for the period from March 8, 1996
(inception) to June 30, 1996, for the years ended June 30, 1997 and 1998, and
for the nine months ended March 31, 1999, and the balance sheet data as of June
30, 1997 and 1998 and March 31, 1999 from the audited financial statements
included in this prospectus. Those financial statements were audited by Deloitte
& Touche LLP, our independent auditors. We derived the balance sheet data as of
June 30, 1996 from unaudited financial statements that are not included in this
prospectus. We derived the statement of operations data for the nine months
ended March 31, 1998 from the unaudited financial statements included in this
prospectus. We believe that the unaudited financial statements contain all
adjustments needed to present fairly the information included in those
statements, and that the adjustments made consist only of recurring adjustments.
<TABLE>
<CAPTION>
NINE MONTHS
PERIOD FROM ENDED
MARCH 8, 1996 YEAR ENDED JUNE 30, MARCH 31,
(INCEPTION) TO -------------------- -------------------
JUNE 30, 1996 1997 1998 1998 1999
-------------- -------- -------- ------- --------
(In thousands, except per share and customer data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 79 $ 552 $ 3,436 $ 2,069 $ 8,297
------ ------- ------- ------- --------
Costs and expenses:
Data communications and
telecommunications...................... -- 559 2,200 1,268 5,705
Network operations........................ 20 417 1,572 857 3,721
Sales and marketing....................... 19 382 1,618 908 6,348
General and administrative................ 66 434 1,621 960 3,695
Depreciation and amortization............. 52 133 476 299 2,005
Stock-based compensation expense.......... -- -- 1,276 509 1,283
Joint venture termination fee............. -- 431 -- -- --
------ ------- ------- ------- --------
Total costs and expenses.................... 157 2,356 8,763 4,801 22,757
------ ------- ------- ------- --------
Loss from operations........................ (78) (1,804) (5,327) (2,732) (14,460)
Interest expense............................ -- (7) (161) (128) (916)
Interest income............................. -- 8 63 31 976
------ ------- ------- ------- --------
Net loss.................................... $ (78) $(1,803) $(5,425) $(2,829) $(14,400)
====== ======= ======= ======= ========
Basic and diluted loss per share............ $(0.62) $ (9.17) $(20.68) $(11.85) $ (2.51)
====== ======= ======= ======= ========
Shares used in basic and diluted loss per
share..................................... 125 197 262 239 5,742
Pro forma basic and diluted loss per share
reflecting 2 for 1 stock split............ $(0.31) $ (4.58) $(10.34) $ (5.92) $ (1.25)
Shares used in pro forma basic and diluted
loss per share............................ 250 393 525 478 11,485
OTHER OPERATING DATA:
Capital expenditures........................ $ 101 $ 850 $ 4,145 $ 659 $ 30,243
Number of customers at period end........... 10 110 278 221 449
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
----------------------------- MARCH 31,
1996 1997 1998 1999
------- ------- ------- ------------
(In thousands)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..... $ 89 $ 331 $ 8,141 $56,692
Working capital (deficit)............................. 88 (946) 5,061 44,725
Total assets.......................................... 151 1,171 13,693 96,183
Long-term obligations, net of current portion......... 210 116 9,325 9,973
Total stockholders' equity (deficiency)............... (73) (262) 661 71,091
</TABLE>
24
<PAGE> 24
On March 30, 1999, the Company announced a 2 for 1 stock split to be effected as
a stock dividend. The dividend for each outstanding share of common stock is
expected to be distributed on or about May 7, 1999. Pro forma basic and diluted
per share reflects, on a pro forma basis, the 2 for 1 stock split, which has
been declared but is undistributed. No other share or per share amounts in the
financial statements have been adjusted to give effect to this stock split. See
Notes 1 and 9 of Notes to Financial Statements for an explanation of the method
used to determine the number of shares used in computing basic and diluted loss
per share and pro forma basic and diluted loss per share. Capital expenditures
in the table above represent purchases of property and equipment, including
non-cash transactions such as the acquisition of equipment under capital lease
and the acquisition of rights to use fiber optic cable capacity.
25
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read this together with the financial statements and other financial
information included in this prospectus. This prospectus contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from those indicated in the forward-looking
statements. Please see the "Special Note Regarding Forward-Looking Statements"
elsewhere in this prospectus. Our fiscal year ends on June 30.
OVERVIEW
We are a leading provider of high performance, managed co-location and Internet
connectivity solutions for electronic commerce and other business critical
Internet operations. We were founded in March 1996 and, in July 1996, began
providing co-location and Internet connectivity services to content providers at
our San Jose, California facility. In August 1997, we expanded our service
offerings to provide co-location and Internet connectivity services to Internet
service providers, enabling the development of our Internet service exchange
model. In July 1998, we opened our second Internet service exchange facility,
located in Vienna, Virginia, and completed an expansion of our San Jose Internet
service exchange facility. The San Jose facility currently has approximately
6,800 square feet of co-location space and the Vienna facility has approximately
12,000 square feet of co-location space.
We derive most of our revenues from bandwidth charges, with additional revenues
generated from charges related to space requirements and one-time installation
fees. Bandwidth and space requirement charges are billed on a monthly basis.
Space requirement charges include access to our network, proprietary tools and
management services. In most instances, we charge our customers for a set amount
of bandwidth availability and charge incremental fees if the customer uses
additional bandwidth. Our contracts range from month-to-month to multiple year
commitments, a majority of which are cancelable on 30 days notice. Revenues
relating to bandwidth usage and space requirement charges are generally
recognized in the period in which the services are performed. Installation fees
are recognized in the period of installation.
A significant component of our expenses relates to data communications and
telecommunications costs. Data communications costs consist primarily of
payments to network providers, such as MCI WorldCom, Sprint, Pacific Bell,
Teleport Communications Group, a subsidiary of AT&T, and WinStar Communications,
Inc. Telecommunications charges generally consist of one time fees for circuit
installation and variable recurring circuit charges. Monthly circuit charges
vary based upon circuit type, the distance the circuit spans and/or the circuit
usage, as well as the term of the contract.
We intend to create a global Internet service exchange network by connecting
centralized facilities in key domestic and international locations. As part of
this strategy, we have made and intend to continue to make strategic investments
in joint ventures and foreign companies to develop Internet service exchanges in
Europe and Asia. In March 1999, we made an aggregate investment of approximately
$600,000 in foreign entities in Austria, Germany and the United Kingdom. These
entities will establish regional Internet service exchange facilities in those
markets. Under our agreements with these entities, we are required to invest an
additional $1.9 million in the quarter ending June 30, 1999. We have committed
to invest up to an additional $6.5 million in the aggregate in the German and
United Kingdom entities. We will account for these investments under the equity
method of accounting, which requires us to recognize our proportionate share of
the net income or loss of these entities.
To further our global strategy, we entered into a series of agreements in
December 1998 with Global Crossing Ltd. for the acquisition of a right to use
capacity on a fiber optic cable system between the U.S. and the United Kingdom.
As of March 31, 1999, we have paid $7.5 million and are obligated to pay an
additional $800,000 under these agreements, which have 25 year terms. The
capacity became available in March 1999. In the short term, we plan to resell
all or a portion of the additional capacity. In March 1999, we entered into
another agreement with Global Crossing for the acquisition of a right to use
capacity
26
<PAGE> 26
on a fiber optic cable system between the U.S. and the Netherlands. The
agreement commits us to pay $7.5 million in a series of installments through
December 30, 1999. Any outstanding amounts will bear interest at the rate of
10.5% per year. Our commitment to pay the $7.5 million to Global Crossing is
conditioned on us entering into another agreement with Global Crossing for the
right to use capacity on a fiber optic cable system connecting certain European
cities. If we enter into this contemplated agreement for the right to use fiber
optic cable capacity connecting certain European cities, we expect to pay up to
approximately $11.0 million for this capacity. We might not enter into the
contemplated agreement on reasonable terms, or at all. We intend to enter into
agreements for additional rights to use capacity on fiber optic cable systems or
other types of arrangements to secure capacity for Europe, Asia and the Pacific
Rim. These agreements may require us to make substantial up front payments for
long-term capacity which could be a significant use of the proceeds of this
offering. See Note 3 of Notes to Financial Statements.
We are establishing a West Coast campus by developing a second San Jose,
California Internet service exchange facility of approximately 124,000 square
feet, including approximately 61,000 square feet of co-location space. In March
1999, we opened this new facility with 4,500 square feet of co-location space
and we intend to build out an additional 6,800 square feet of co-location space
by the fall of 1999. Afterwards, we intend to build out approximately 13,000
square feet of additional co-location space by the spring of 2000. The build-out
of the additional co-location space will occur incrementally over time based on
customer demand. In addition, we are establishing an East Coast campus. We have
entered into a lease in New York, New York and intend to develop a smaller
Internet service exchange facility there. We intend to connect the New York
facility to our Vienna, Virginia facility by a high speed, high capacity fiber
optic cable connection. The New York facility is expected to be approximately
27,000 square feet, including approximately 11,000 square feet of co-location
space. The new facility is targeted to open in the fall of 1999. We intend to
complete the initial build-out of approximately 5,500 square feet of co-location
space and the build-out of additional co-location space incrementally over time
based on customer demand. We also plan to expand our East Coast campus by
developing a second Internet service exchange facility in the Washington D.C.
area. We target opening the facility in the second half of calendar year 2000.
We have not yet signed a lease for this facility. The development and equipping
of these facilities will significantly increase our fixed and operating
expenses, including expenses associated with hiring, training and managing new
employees, purchasing new equipment, implementing power and redundancy systems,
implementing multiple data communications and telecommunications connections,
leasing additional real estate and depreciation.
In connection with our international Internet service exchange investments and
our expansion plans, we expect our data communications and telecommunications
costs to significantly increase in order to expand our network capacity. We
expect this increase in costs to begin in the quarter ending June 30, 1999.
We currently are in a dispute with WinStar Communications, Inc. over currently
invoiced amounts and credits available to apply against amounts invoiced in the
future. We believe we are entitled to net credits under our agreements with
WinStar Communications. WinStar Communications has stated that unless the
dispute is resolved to its satisfaction, it will discontinue providing us
telecommunications capacity. WinStar Communications is one our major suppliers
of this service. While the Company is in the process of accelerating the
acquisition of additional capacity to offset the potential impact of any
termination of such service, termination of the telecommunications capacity that
WinStar Communications provides to us could result in a significant disruption
of our services to our customers and cause a significant adverse effect on our
business and operating results. Since the additional capacity is not yet
installed, we cannot guarantee that it will be available when and if needed.
Furthermore, because we intend to accelerate our purchase of additional capacity
as a result of this dispute, we expect to incur additional expenses in the
quarter ending June 30, 1999. If settlement is not reached, this dispute might
result in litigation. Litigation could be costly and could have a significant
adverse effect on our operating results regardless of the outcome. See "Risk
Factors -- We depend on third party suppliers."
A key aspect of our strategy is to significantly increase our sales and
marketing activities through the expansion of our sales force, increased focus
on developing reseller channels and increased marketing
27
<PAGE> 27
efforts to build the AboveNet brand. We expect sales and marketing expenses to
increase substantially in future periods.
28
<PAGE> 28
We recently hired many of our key employees and officers. Our President and
Chief Operating Officer joined us in November 1997. Our Senior Vice President of
Sales and Marketing joined us in April 1998. Our Vice President of Construction
and Real Estate and Vice President of International -- Europe each joined us in
August 1998. Our Chief Financial Officer joined us in November 1998 and, in
December 1998, we hired a Vice President of Marketing and promoted an existing
employee to serve as the new Vice President of Sales. Our Vice President of
Engineering joined us in February 1999.
During late fiscal 1997 and 1998, we granted stock options and warrants to
strategic business partners and non-employees. Additionally, during fiscal 1998
and the first quarter of fiscal 1999, we granted a key executive stock options
at an exercise price below market. As a result, we recognized stock-based
compensation expense of approximately $1.3 million and $1.3 million in fiscal
1998 and the first nine months of fiscal 1999, respectively. At March 31, 1999,
we had $57,000 of deferred stock compensation which will be amortized through
fiscal 2000.
In connection with our investments in entities developing international Internet
service exchange facilities in March 1999, we agreed that we will grant options
to purchase up to 300,000 shares of common stock to employees of those entities
upon meeting certain annual performance criteria over the next four years. We
will recognize compensation expense for these options as the performance
criteria are being achieved. In addition, we granted 42,500 options to purchase
shares of common stock to three non-employees, two of whom are members of our
board of directors. These options vest over three years and have a three-year
term. We will begin to recognize compensation expense for these service options
in the quarter ending June 30, 1999. While the ultimate amount of compensation
expense for these arrangements is unknown, the amount could be substantial as it
will be measured based on the value of the options when the options vest.
Since our inception in March 1996, we have experienced operating losses and
negative cash flows from operations in each quarterly and annual period. As of
March 31, 1999, we had an accumulated deficit of $21.7 million. The revenue and
income potential of our business and market is unproven, and our limited
operating history makes an evaluation of us and our prospects difficult. In
addition, although we have experienced significant growth in revenues in recent
periods, we do not believe that this growth rate is necessarily indicative of
future operating results. We may never achieve profitability or, if we achieve
profitability, we might not sustain profitability.
29
<PAGE> 29
RESULTS OF OPERATIONS
The following table sets forth certain statements of operations data as a
percentage of revenues for the period from March 8, 1996 (inception) to June 30,
1996, for the years ended June 30, 1997 and 1998 and for the nine months ended
March 31, 1998 and 1999. This information should be read in conjunction with the
Financial Statements and Notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
PERIOD FROM YEAR ENDED ENDED
MARCH 8, 1996 JUNE 30, MARCH 31,
(INCEPTION) TO --------------- ---------------
JUNE 30, 1996 1997 1998 1998 1999
-------------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Revenues.............................. 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Data communications and
telecommunications............... -- 101.3 64.0 61.2 68.8
Network operations.................. 24.7 75.5 45.7 41.4 44.8
Sales and marketing................. 24.3 69.4 47.1 43.9 76.5
General and administrative.......... 84.1 78.6 47.2 46.4 44.5
Depreciation and amortization....... 65.6 24.1 13.8 14.5 24.2
Stock-based compensation expense.... -- -- 37.2 24.6 15.5
Joint venture termination fee....... -- 78.1 -- -- --
----- ------ ------ ------ ------
Total costs and expenses......... 198.7 427.0 255.0 232.0 274.3
----- ------ ------ ------ ------
Loss from operations.................. (98.7) (327.0) (155.0) (132.0) (174.3)
Interest expense...................... -- (1.3) (4.7) (6.2) (11.0)
Interest and other income............. -- 1.5 1.8 1.5 11.8
----- ------ ------ ------ ------
Net loss.............................. (98.7)% (326.8)% (157.9)% (136.7)% (173.5)%
===== ====== ====== ====== ======
</TABLE>
COMPARISON OF THE NINE MONTHS ENDED MARCH 31, 1998 AND 1999
Revenues. We derive most of our revenues from monthly bandwidth charges, with
additional revenues from space requirement charges and one-time installation
fees. Our revenues increased 301% from $2.1 million for the nine months ended
March 31, 1998, to $8.3 million for the nine months ended March 31, 1999. This
growth in revenues resulted primarily from an increase in the number of
customers, from 221 customers at March 31, 1998, to 449 customers at March 31,
1999. One customer, RemarQ Communities, Inc. (formerly named Supernews, Inc.),
accounted for 13.3% of revenues for the nine months ended March 31, 1998 and
8.5% of revenues for the nine months ended March 31, 1999. Our agreement with
RemarQ Communities, Inc. has a term of one year, which expires July 1999, and
does not contain any minimum bandwidth usage requirements.
Data Communications and Telecommunications. Data communications costs consist
primarily of payments to network providers. Telecommunications charges consist
of one-time fees for circuit installation and variable recurring circuit
charges. Our data communications and telecommunications expenses increased 350%
from $1.3 million for the nine months ended March 31, 1998, to $5.7 million for
the nine months ended March 31, 1999. The increase is primarily due to the
growth in our customer base and usage of additional bandwidth. We expect that
data communications and telecommunications costs will continue to increase in
absolute dollars as we continue to expand our network infrastructure.
Network Operations. Network operations expenses are comprised primarily of
salaries, benefits and related expenses for our operations and engineering
personnel, as well as facility rent and expenses associated with maintaining our
co-location facilities. Our network operations expenses increased 334% from
$856,000 for the nine months ended March 31, 1998, to $3.7 million for the nine
months ended March 31, 1999. The increase is primarily due to the hiring of
additional operations and engineering personnel and associated
30
<PAGE> 30
costs. Most recently, a significant factor in the increase has been due to the
increased staffing at the Vienna, Virginia Internet service exchange facility.
We expect that network operations expenses will continue to increase in absolute
dollars as we hire additional personnel to expand our operations.
Sales and Marketing. Our sales and marketing expenses are primarily comprised of
salaries, commissions and benefits related to our sales and marketing personnel,
the cost of our marketing and promotional efforts, including advertising,
printing and trade show costs, as well as related consultants' fees and travel
and entertainment expenses. Sales and marketing expenses increased 599% from
$908,000 for the nine months ended March 31, 1998, to $6.3 million for the nine
months ended March 31, 1999. This increase was due primarily to increased
compensation and related expenses resulting from the hiring of additional sales
and marketing personnel and increases in trade show, advertising and marketing
program costs. We expect that sales and marketing expenses will increase
substantially in future periods as we continue to expand our sales force and our
brand-building activities.
General and Administrative. Our general and administrative expenses are
comprised primarily of salaries and benefits for our management and
administrative personnel, as well as fees paid for professional services and
corporate overhead. General and administrative expenses increased 285% from
$960,000 for the nine months ended March 31, 1998, to $3.7 million for the nine
months ended March 31, 1999. This increase was primarily due to increased
compensation and related benefits associated with additional personnel,
increased professional services fees and the costs associated with supporting
our expansion. We expect that general and administrative expenses will continue
to increase in absolute dollars as we expand our operations and incur the higher
costs associated with being a publicly-traded company.
Depreciation and Amortization. Depreciation and amortization expenses relate
primarily to our facility improvement and construction efforts as well as
telecommunications equipment. Our depreciation and amortization expenses
increased 570% from $299,000 for the nine months ended March 31, 1998 to $2.0
million for the nine months ended March 31, 1999. The increase is primarily due
to capital expenditures incurred during the second half of fiscal 1998 and the
first three quarters of fiscal 1999 related to facility improvement and
construction costs in San Jose, California, the construction of our Internet
service exchange facility in Vienna, Virginia, and additional telecommunications
equipment. We expect to incur increased depreciation and amortization expenses
related to our planned Internet service exchange facilities, as well as the
amortization of the rights to use capacity on fiber optic cable systems.
Stock-based Compensation. During fiscal 1998 and 1999, we granted stock options
to a key executive at an exercise price below market prices on the dates of the
grants. Additionally, during late fiscal 1997 and fiscal 1998 and 1999, we
granted stock options and warrants to strategic business partners and non-
employees. Stock options and warrants result in stock-based compensation
charges, a portion of which is deferred and expensed over the vesting period. On
December 10, 1998, we completed our initial public offering, at which time the
vesting of a significant number of these options accelerated. Consequently, the
remaining deferred compensation costs related to those options were recognized.
For the nine months ended March 31, 1998 and March 31, 1999, stock-based
compensation expenses were $509,000 and $1.3 million, respectively.
Interest Income (Expense), Net. Interest income (expense), net was $(97,000) for
the nine months ended March 31, 1998 compared to $60,000 for the nine months
ended March 31, 1999. Interest income for the nine months ended March 31, 1999
related primarily to our higher cash balances as a result of our recent initial
public offering partially offset by interest expense incurred related to
borrowings to finance equipment purchases and improvements to our Internet
service exchange facilities in San Jose, California and Vienna, Virginia.
Interest expense for the nine months ended March 31, 1998, was primarily related
to the issuance of warrants associated with our issuance of convertible debt. We
expect that interest expense will continue to increase in absolute dollars as we
enter into additional equipment leases and borrowing facilities to finance
expansion, including the development of our planned Internet service exchange
facilities.
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<PAGE> 31
COMPARISON OF FISCAL YEARS ENDED JUNE 30, 1997 AND 1998
Revenues. Our revenues increased 523% from $552,000 in fiscal 1997 to $3.4
million in fiscal 1998. This growth in revenues resulted primarily from an
increase in the number of customers, from 110 customers at June 30, 1997 to 278
customers at June 30, 1998. One customer, RemarQ Communities, Inc. (formerly
named Supernews, Inc.), accounted for 12% of revenues in fiscal 1997 and 14% of
revenues in fiscal 1998.
Data Communications and Telecommunications. Our data communications and
telecommunications expenses increased 294% from $559,000 in fiscal 1997 to $2.2
million in fiscal 1998. This increase is primarily due to the growth in our
customer base and usage of additional bandwidth.
Network Operations. Our network operations expenses increased 277% from $417,000
in fiscal 1997 to $1.6 million in fiscal 1998. The increase is primarily due to
the hiring of additional operations and engineering personnel and the costs
associated therewith.
Sales and Marketing. Sales and marketing expenses increased 323% from $383,000
in fiscal 1997 to $1.6 million in fiscal 1998. Sales and marketing expenses as a
percentage of total revenues decreased from 69% in fiscal 1997 to 47% in fiscal
1998. Of this increase, approximately $700,000 was due to increased compensation
and related expenses as the result of the hiring of additional sales and
marketing personnel. The increase was also attributable to increased marketing
program, trade show and advertising expenses. The decrease as a percentage of
revenue in fiscal 1998 was primarily due to increased revenues associated with
higher bandwidth utilization among the existing customer base, which had lower
associated sales and marketing expenses.
General and Administrative. General and administrative expenses increased 274%
from $434,000 in fiscal 1997 to $1.6 million in fiscal 1998. General and
administrative expenses as a percentage of revenues decreased from 79% in fiscal
1997 to 47% in fiscal 1998 due to the increase in revenues. Of this increase,
approximately $500,000 was due to increased compensation and related benefits
associated with additional personnel in management, finance and administration,
while the remaining increase was primarily attributable to the costs associated
with supporting our expansion.
Depreciation and Amortization. Our depreciation and amortization expenses
increased 258% from $133,000 in fiscal 1997 to $476,000 in fiscal 1998. The
increase is due to additional capital expenditures incurred during fiscal 1998,
primarily for telecommunications equipment.
Stock-Based Compensation. Stock-based compensation expense during fiscal 1997
and fiscal 1998 was zero and $1.3 million, respectively. Stock-based
compensation in fiscal 1998 related to services rendered during fiscal 1998 and
the acceleration of the vesting during the fourth quarter of 1998 of certain
non-employee stock option and warrant grants.
Joint Venture Termination Fee. In fiscal 1996, we entered into a joint venture
agreement with DSK, Inc. to cooperatively market and develop our services. We
paid $33,700 to DSK during the year ended June 30, 1997 related to this
agreement. In the fourth quarter of fiscal 1997, we terminated this agreement
and hired the majority shareholders of DSK as employees or consultants by
issuing 500,000 fully vested shares of Series B preferred stock with a fair
market value of $1.20 per share, or $600,000, for the outstanding shares of
common stock of DSK. We recorded the transaction by allocating the value of the
shares issued to property and equipment (at DSK's net book value of $169,000,
which approximated fair market value), with the balance of $431,000 reflected as
a joint venture termination fee.
Interest Income (Expense), Net. Interest income (expense), net decreased from
$1,000 in fiscal 1997 to $(98,000) in fiscal 1998. The decrease was primarily
the result of higher interest expense related to the issuance of stock purchase
warrants in conjunction with the issuance of our convertible debt during the
first half of fiscal 1998 as well as increased borrowings to finance equipment
purchases and improvements to our San Jose, California Internet service exchange
facility and construction of our Vienna, Virginia Internet service exchange
facility.
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<PAGE> 32
INCEPTION THROUGH JUNE 30, 1996
We generated $79,000 in revenues in the period from inception to June 30, 1996,
primarily as a result of consulting services provided as we were developing our
tools and preparing to commence our current co-location and Internet
connectivity operations. Our costs and expenses during this period consisted
primarily of salaries, depreciation and amortization expenses and consulting
services. Given the stage of our business and the shortness of the period, we do
not believe that the results of operations for this period are comparable to
fiscal 1997.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited statement of operations data
for the seven quarters ended March 31, 1999, as well as the percentage of our
revenues represented by each item. This data has been derived from unaudited
interim financial statements prepared on the same basis as the audited Financial
Statements contained herein and, in the opinion of management, include all
adjustments consisting only of normal recurring adjustments, that we consider
necessary for a fair presentation of such information when read in conjunction
with the Financial Statements and Notes thereto appearing elsewhere in this
prospectus. The operating results for any quarter should not be considered
indicative of results of any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
SEP. 30, DEC. 31, MAR. 31, JUNE 30, SEP. 30, DEC. 31, MAR. 31,
1997 1997 1998 1998 1998 1998 1999
-------- -------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................................. $ 430.9 $ 674.6 $ 963.3 $ 1,367.6 $ 1,793.1 $ 2,653.1 $ 3,851.2
-------- -------- --------- --------- --------- --------- ---------
Costs and expenses:
Data communications and
telecommunications................... 256.0 372.8 639.1 931.9 1,079.9 1,749.8 2,875.4
Network operations..................... 221.8 222.8 411.8 715.4 772.8 1,250.0 1,697.8
Sales and marketing.................... 258.6 216.4 433.4 710.3 1,355.8 2,137.0 2,855.5
General and administrative............. 198.9 276.9 483.8 661.9 812.7 1,248.1 1,634.6
Depreciation and amortization.......... 86.4 95.4 117.6 176.1 659.8 543.5 801.8
Stock-based compensation expense....... 14.3 35.1 459.6 767.4 436.2 733.4 113.2
-------- -------- --------- --------- --------- --------- ---------
Total costs and expenses............. 1,036.0 1,219.4 2,545.3 3,963.0 5,117.2 7,661.8 9,978.3
-------- -------- --------- --------- --------- --------- ---------
Loss from operations..................... (605.1) (544.8) (1,582.0) (2,595.4) (3,324.1) (5,008.7) (6,127.1)
Interest expense......................... (58.8) (67.0) (2.6) (32.4) (147.6) (345.9) (422.9)
Interest and other income................ 1.9 7.4 22.0 31.8 120.8 162.4 693.6
-------- -------- --------- --------- --------- --------- ---------
Net loss................................. $ (662.0) $(604.4) $(1,562.6) $(2,596.0) $(3,350.9) $(5,192.2) $(5,856.4)
======== ======== ========= ========= ========= ========= =========
</TABLE>
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<PAGE> 33
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
SEP. 30, DEC. 31, MAR. 31, JUNE 30, SEP. 30, DEC. 31, MAR. 31,
1997 1997 1998 1998 1998 1998 1999
-------- -------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
-------- -------- --------- --------- --------- --------- ---------
Costs and expenses:
Data communications and
telecommunications................... 59.4 55.3 66.3 68.2 60.2 66.1 74.7
Network operations..................... 51.5 33.0 42.8 52.3 43.1 47.1 44.1
Sales and marketing.................... 60.0 32.1 45.0 51.9 75.6 80.5 74.2
General and administrative............. 46.2 41.1 50.2 48.4 45.3 47.0 42.4
Depreciation and amortization.......... 20.0 14.1 12.2 12.9 36.8 20.5 20.8
Stock-based compensation expense....... 3.3 5.2 47.7 56.1 24.4 27.6 2.9
-------- -------- --------- --------- --------- --------- ---------
Total costs and expenses............. 240.4 180.8 264.2 289.8 285.4 288.8 259.1
-------- -------- --------- --------- --------- --------- ---------
Loss from operations..................... (140.4) (80.8) (164.2) (189.8) (185.4) (188.8) (159.1)
Interest expense......................... (13.6) (9.9) (0.3) (2.3) (8.2) (13.0) (11.0)
Interest and other income................ 0.4 1.1 2.3 2.3 6.7 6.1 18.0
-------- -------- --------- --------- --------- --------- ---------
Net loss................................. (153.6)% (89.6)% (162.2)% (189.8)% (186.9)% (195.7)% (152.1)%
======== ======== ========= ========= ========= ========= =========
</TABLE>
FACTORS AFFECTING OPERATING RESULTS
We have experienced significant fluctuations in our results of operations from
quarter to quarter. As a result of these fluctuations, period-to-period
comparison of our operating results is not necessarily meaningful and should not
be relied upon as an indicator of future performance. We expect our future
operating results to fluctuate. Factors that are likely to cause these
fluctuations include:
- demand for and market acceptance of our services;
- capacity utilization of our Internet service exchange facilities;
- fluctuations in data communications and telecommunications costs;
- customer retention;
- the timing and magnitude of capital expenditures;
- costs relating to the expansion of operations;
- expansion of existing facilities and completion of new facilities;
- fluctuations in bandwidth used by customers;
- introductions of new services or enhancements by us and our competitors;
- the timing of customer installations and related payments;
- the ability to maintain or increase peering relationships;
- provisions for customer discounts and credits;
- changes in our pricing policies and those of our competitors;
- changes in regulatory laws and policies;
- economic conditions, particularly those related to the Internet industry;
- difficulties in collecting accounts receivable as many of our customers are
in an emerging stage;
- compensation costs related to certain option grants and warrants; and
- decreased revenues during the summer months and other seasonal effects on
sales.
In addition, a relatively large portion of our expenses are fixed in the
short-term, particularly with respect to data communications and
telecommunications costs, depreciation, real estate and personnel. Our future
results of operations will be particularly sensitive to fluctuations in revenues
because of these and other short-term fixed costs.
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<PAGE> 34
As a result of these and other factors, our future operating results may fall
below the expectations of securities analysts and investors. In this event, the
price of our common stock will likely decrease significantly.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to distinguish 21st century dates from 20th century dates. This could
result in system failures or miscalculations causing disruptions of operations
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements.
We have begun the first phase of our Year 2000 readiness review. The review will
include assessment, implementation, testing and contingency planning. To date,
we have evaluated our internally developed software and believe that this
software is Year 2000 compliant. However, we utilize software and hardware
developed by third parties both for our network and internal information
systems. We have not done any testing of such third party software to determine
if such software is Year 2000 compliant. We have sought assurances from some of
our vendors, and intend to continue to seek assurances from others, that such
vendors products are or will be Year 2000 compliant.
We expect to continue assessing and testing our internal information technology
and non-information technology systems into 1999. We are not currently aware of
any material operations issues or costs associated with preparing our internal
information technology and non-information technology systems for the Year 2000.
However, we may experience material unanticipated problems and costs caused by
undetected errors or defects in the technology used in our internal information
technology and non-information technology systems.
Based upon the public filings and press releases of our primary equipment,
telecommunications and data communications providers, we are aware that all such
providers are in the process of reviewing and implementing their own Year 2000
compliance programs. Since we do not believe that we will be afforded the
opportunity to test the systems of these providers, we will seek assurances from
them that they are Year 2000 compliant. If our primary vendors experience
business interruptions as a result of the failure to achieve Year 2000
compliance, our ability to provide Internet connectivity could be impaired,
which could have a material adverse effect on our business, results of
operations and financial condition.
We do not currently have any information regarding the Year 2000 status of our
customers, most of whom are private companies. However, we are in the process of
developing a plan to survey all of our customers regarding their Year 2000
compliance. As is the case with similarly situated companies, if our customers
experience Year 2000 problems, which result in business interruptions or
otherwise impact their operations, we could experience a decrease in the demand
for our services, which could have a material adverse impact on our business,
results of operations and financial condition.
We have not incurred any significant expenses to date associated with our Year
2000 plan and are not aware of any material costs associated with our
anticipated Year 2000 efforts. We believe that a material loss of revenues would
arise if our major customers or providers fail to achieve Year 2000 readiness.
We have not yet developed a comprehensive contingency plan to address the issues
which could result from such failure.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to fluctuations in interest rates and market values of our
investments. Our exposure to fluctuations in interest rates and market values of
our investments relates primarily to our short-term investment portfolio, which
is included in cash and cash equivalents and short-term investments. We have not
used derivative financial instruments in our investment portfolio. We invest our
excess cash in debt
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instruments of the U.S. Government, and, by policy, we limit the amount of
credit exposure to any one issuer. Due to the short-term nature of our
investments, the impact of interest rate changes would not be expected to have a
significant impact on the value of these investments. The effect of interest
rate and investment risk on us has not been significant.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted due to a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, our future investment income may fall short of
expectations due to changes in interest rates or we may suffer losses in
principal if we are forced to sell securities which have declined in market
value due to changes in interest rates.
We are also exposed to interest rate risk on our fixed rate debt obligations. At
June 30, 1998 and March 31, 1999, fixed rate debt obligations totaled $1.2
million and $11.9 million, respectively. The fixed rate debt obligations bear
interest at annual rates ranging from 13.3% to 15.1% and are payable in 42
monthly installments. While generally an increase in market interest rates will
decrease the value of this debt, and decreases in rates will have the opposite
effect, we are unable to estimate the impact that interest rate changes will
have on the value of the substantial majority of this debt as there is no active
public market for the debt and we are unable to determine the market interest
rate at which alternate financing would have been available.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations principally from the private and public sale of
equity securities and, to a lesser extent, lease financing. We had cash and cash
equivalents of approximately $44.9 million as of March 31, 1999.
Net cash used in operating activities was $2.1 million and $6.8 million for the
nine months ended March 31, 1998 and 1999, respectively, and $744,000 and $1.7
million in fiscal years 1997 and 1998, respectively. Net cash used in operating
activities is primarily attributable to our net losses. These losses were
partially offset by depreciation and amortization, stock-based compensation
expense and increases in accounts payable and accrued liabilities.
Net cash used by investing activities was $833,000 and $29.8 million for the
nine months ended March 31, 1998 and 1999, respectively, and $507,000 and $3.8
million in fiscal years 1997 and 1998, respectively. Net cash used by investing
activities consists primarily of purchases of property and equipment, including
costs associated with the establishment of our Internet service exchange
facility in Vienna, Virginia and the expansion of our Internet service exchange
facility in San Jose, California. In addition, for the nine months ended March
31, 1999, we used cash to pay $8.3 million toward the purchase of rights to use
fiber optic cable capacity.
Net cash provided by financing activities was $4.1 million and $73.3 million for
the nine months ended March 31, 1998 and 1999, respectively, and $1.5 million
and $13.3 million in fiscal years 1997 and 1998, respectively. Net cash provided
by financing activities for the nine months ended March 31, 1998, and in fiscal
1998 resulted primarily from the sale of notes and advances, partially offset by
debt and capital lease repayments. Net cash provided by financing activities for
the nine months ended March 31, 1999 resulted primarily from the proceeds of our
initial public offering and, to a lesser extent, the issuance of convertible
preferred stock and utilization of our equipment financing facility, partially
offset by debt and capital lease repayments.
We have a $15 million equipment financing arrangement. Borrowings under this
arrangement are payable in 42 monthly installments. Borrowings incurred bear
interest ranging from 13.3% to 15.1%. As of March 31, 1999, approximately $1.2
million remained available for borrowings under this arrangement. We expect to
utilize the available credit for the development of the planned second Internet
service exchange facility in San Jose, California. We also have a $2.5 million
equipment lease facility, of which $920,000
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was available for future use at March 31, 1999. We intend to enter into an
additional equipment financing arrangement for up to $10 million. We might not
be able to enter into this arrangement on reasonable terms or at all.
We have a $750,000 line of credit facility with a bank, none of which was
outstanding at March 31, 1999. Borrowings under the line of credit facility bear
interest at the bank's prime rate plus 1% and the line of credit facility
expires in May 1999.
We currently expect to utilize approximately $56 million to $72 million for
capital expenditures in connection with the development of additional Internet
service exchange facilities in San Jose, California, New York, New York and in
the Washington, D.C. area.
In connection with a December 1998 agreement for the purchase of the right to
use fiber optic cable capacity between the U.S. and the United Kingdom, we have
a remaining commitment to pay $800,000 as of March 31, 1999. In March 1999, we
entered into an agreement for the purchase of the right to use capacity on a
fiber optic cable system between the U.S. and the Netherlands which commits us
to pay $7.5 million in a series of installments through calendar year 1999. Any
outstanding amounts payable will bear interest at an annual rate of 10.5%. Our
commitment to pay the $7.5 million is conditioned on us entering into an
additional agreement to purchase fiber optic cable capacity connecting certain
European cities. If we enter into the contemplated agreement to purchase fiber
optic cable capacity to connect certain European cities, we expect to pay up to
approximately $11.0 million for the right to use this capacity. We might not be
able to enter into this agreement on reasonable terms or at all. We may enter
into agreements for the right to use fiber capacity or other types of
arrangements to secure capacity for Europe, Asia and the Pacific Rim. These
agreements may require us to make substantial up front payments for long-term
capacity.
We believe that the net proceeds from this offering, together with existing cash
balances and financing arrangements, will provide us with sufficient funds to
finance our operations and planned capital expenditures for at least the next 12
months. We may require additional funds during or after this period to support
our working capital requirements or for other uses, including potential
acquisitions and investments, and may seek to raise additional funds through
public or private equity or debt financings or other sources. Additional
financing might not be available at all or on favorable terms.
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BUSINESS
You should read the following description of our business together with the
information included elsewhere in this prospectus. 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. Our 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 prospectus.
GENERAL
AboveNet is a leading provider of high performance, managed co-location and
Internet connectivity solutions for electronic commerce and other business
critical Internet operations. We have developed a network architecture based
upon strategically located, fault-tolerant facilities that combine co-location
services for Internet content providers with direct access to Internet service
providers, or ISPs, to create Internet service exchanges, or ISXs. As of March
31, 1999, we had 257 direct public and private data exchange connections, known
as peering arrangements, including relationships with most major network
providers. Our network architecture and extensive peering relationships are
designed to reduce the number of network connections or "hops" for data
traveling across the Internet. By having both Internet content providers and
ISPs at our ISXs we enable our ISP customers to provide their users with "one
hop" connectivity, through our local area network, to the Web sites of the
Internet content providers that are co-located at the same facility. As of March
31, 1999, we had 449 customers, including a wide range of Internet content
providers, Web hosting companies and ISPs.
INDUSTRY BACKGROUND
The Growth of the Internet
The Internet has experienced tremendous growth and is emerging as a global
medium for communications and commerce. According to International Data
Corporation, or IDC, the number of Internet users worldwide will grow from 69
million at the end of 1997 to 320 million by 2002. Of the total number of
worldwide Internet users, IDC estimates that the number in Asia/Asia Pacific,
excluding Japan, will grow from 6.6 million in 1997 to 34.2 million in 2002 and
the number in Western Europe will grow from 16.8 million to 82.0 million in the
same period. In addition, according to Forrester Research, Inc., or Forrester,
the number of Internet sites worldwide is expected to grow from less than
500,000 in 1997 to approximately 4.0 million in 2002. The growth of the Internet
is being driven by a number of factors, including the large and growing
installed base of personal computers, improvements in network architectures,
increasing numbers of network-enabled applications, the emergence of compelling
content and commerce-enabling technologies, and easier, faster and cheaper
Internet access. The future growth in Internet usage is also projected to be
fueled by increased use of high speed access devices, such as cable, ADSL and
other high speed access devices as these become more widely available and
affordable. Forrester projects that the penetration of broadband Internet access
through cable, ADSL and other high speed access devices will grow from
approximately 200,000 households in 1997 to approximately 5.5 million households
in 2000 and approximately 17.6 million households in 2002. The increase in the
availability of high-speed access devices is also expected to increase the
demand for emerging high bandwidth technologies such as audio and video
streaming and voice over the Internet.
IDC estimates are based upon their Internet Commerce Market Model. This model
uses both supply and demand-side research based on responses from 40,000
interviews per year. Other data components include Web usage figures,
penetration rates, quarterly trend research, lead user research and device base
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information. The estimates are subject to the following assumptions: no
catastrophic failure of the Internet will occur; regional economies will
continue their current expansion without upheaval; and security on the Internet,
as well as consumer confidence, will continue to improve slowly. The projected
amounts in this report may not be achieved.
Forrester estimates are based upon interviews with more than 41,000 households
as part of Forrester's "Technographics '98" survey. In addition, Forrester's
report stated that 81 ISPs were asked to provide detailed unit sales, prices and
projections for 1996 through 1998. The ISP data was extrapolated to provide a
total market size and direction. Finally, Forrester contacted 22 vendors of
hosting services and related organizations. Actual results may differ
significantly.
The Expansion of Electronic Commerce
The functionality and accessibility of the Internet and commercial online
services have created an increasingly attractive commercial medium by providing
features that historically have been unavailable through traditional channels.
In the last several years, many enterprises that focus solely on delivering
services over the Internet have emerged and many businesses have implemented Web
sites and electronic commerce applications. Internet-based businesses have
developed Internet products and services in areas such as finance, banking,
entertainment, education and advertising, while other businesses are using the
Internet for an expanding variety of applications, ranging from corporate
publicity and advertising to sales, customer service, employee training and
communication with business partners. The ability to offer these kinds of
products and services requires high bandwidth Internet sites and operations. In
addition, due to advances in on-line security and payment mechanisms, the number
of businesses establishing commerce-enabled Web sites is expected to increase
dramatically. IDC estimates that the number of consumers buying goods and
services on the Internet will grow from 17.6 million in 1997 to 128.4 million in
2002, and that the total value of goods and services purchased over the Internet
will increase from approximately $12 billion in 1997 to approximately $425
billion by 2002.
The Internet Infrastructure
The Internet is a worldwide network of private and public computer networks that
link businesses, individuals, government agencies, universities and other users
having disparate computer systems and networks. A multi-tiered system of local,
regional and national ISPs has evolved to provide connectivity among Internet
users. Data traveling across the Internet is broken down into multiple packets.
ISPs exchange these packets of data generated by their users through either
direct or indirect connections with other ISPs. Large ISPs often have multiple
direct data exchange connections with other ISPs, known as peering
relationships, either through private line connections between their routers or
through a public peering arrangement where multiple ISPs can be connected
through a single interface. However, significant peering relationships are
generally unavailable to many small and mid-sized ISPs and, even if available,
the associated telecommunications costs could be prohibitive. As a result, these
ISPs typically need to purchase indirect connection services, known as
"transit," from a third party ISP.
To address the needs of ISPs to exchange data at centralized points, a series of
Internet exchanges were established by Internet backbone providers. Although
there are numerous exchanges, the Company believes the two principal exchanges
in the United States, based upon traffic volume, are MAE West in San Jose,
California, and MAE East in Vienna, Virginia. Despite the relatively centralized
nature of these exchange points, data traveling across the dispersed Internet
architecture often must make multiple connections or "hops" through a variety of
local, regional and national ISPs, as data moves from the originating site to
the Internet backbone and back to the destination site.
The Trend Toward Outsourcing of Internet Operations
Internet operations are increasingly becoming critical to an enterprise's
commercial and communication operations. Internet-based businesses and other
enterprises need non-stop, non-congested, fault-tolerant and
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scalable Internet operations to allow them to perform sophisticated digital
communications and commerce transactions globally over the Internet. However,
many businesses that are seeking to establish these sophisticated Internet
operations lack the resources and expertise to cost-effectively develop,
maintain and continually enhance the necessary facilities and network systems.
In addition, individuals with the expertise to establish and maintain a
sophisticated Internet service are scarce and their services are costly.
Furthermore, businesses often find it difficult to keep up with new technology
introductions and to integrate new technologies into their own information
technology infrastructure. Finally, many businesses are currently being forced
to deploy their limited information technology resources to address the
impending Year 2000 issues. As a result of these and other factors, many
enterprises are seeking outsourcing arrangements to enhance Web site reliability
and performance, provide continuous operation of their Internet solutions,
reduce related operating expenses and focus on their core business. By
outsourcing these services, businesses, particularly non Internet-centric
enterprises, can focus on their core business rather than using their resources
to support their Internet operations. Forrester estimates that by 2002,
approximately 40% of Internet Web sites will be outsourced and that Internet
hosting revenues for complex sites will increase from approximately $200 million
in 1997 to almost $8 billion by 2002.
The Emergence of Co-Location Services
A variety of companies including Web hosting companies and ISPs have begun to
focus on providing Internet co-location services. These co-location companies
typically build networks of numerous geographically dispersed data centers in
order to be physically close to their customers. As a result of this dispersed
geographic network, data moving from one customer to another is subject to
increased risks of latency and data loss, as data travels across multiple
network connections or "hops." These problems are compounded by the lack of
available tools to monitor all of the various connection points on the Internet
in order to identify and avoid the congested links which can cause latency and
data loss. While these problems existed to some extent with early, less data
intensive applications, such as e-mail, they are becoming increasingly acute
with the growth of bandwidth intensive applications such as audio and video
streaming. In addition, many co-location providers do not have the flexibility
or capacity to quickly scale their services to meet the sharp growth and high
bandwidth requirements of business critical Internet operations.
Internet co-location companies also typically fail to address the increasing
need of local and regional ISPs to provide enhanced connectivity to compelling
content for their customers. Without the ability to maintain extensive peering
relationships with large ISPs, the cost of providing redundant, reliable and
scalable connectivity is often prohibitive for these local and regional ISPs. As
a result, they face increasing congestion as emerging applications consume more
bandwidth. International ISPs are also seeking a means to obtain fast, reliable
access to the large concentration of U.S.-based content. While many of these
problems could be addressed if these ISPs co-located their facilities with
content providers, many of the Web hosting and co-location companies also
compete with ISPs for sales of Internet access and, therefore, ISPs are often
reluctant to co-locate in their facilities.
THE ABOVENET SOLUTION
AboveNet provides high performance, managed co-location and Internet
connectivity services to a wide range of Internet content providers, Web hosting
companies and ISPs. Our ISX facilities provide high performance, reliable and
scalable solutions for electronic commerce and other business critical
applications. We currently operate two ISX campuses, located near MAE West and
MAE East, using our suite of sophisticated network management and remote
monitoring tools. We believe that our centralized network architecture provides
enhanced connectivity while eliminating the need to build numerous
geographically dispersed data centers. Our ISX model offers customers the
benefits of combining co-location services with direct ISP access. The
convergence of content providers and ISPs at our ISXs enables ISPs to provide
their users with "one hop" connectivity, through our local area network, to the
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co-located content site. This direct connectivity minimizes the risk of delays
and data loss often encountered in the transmission of data over the public
Internet infrastructure.
Our solution provides the following key advantages to our customers:
Scalability and Flexibility. Our services are designed to be highly scalable and
flexible in order to meet the needs of our customers as their Internet
operations expand. Our network is designed to enable us to quickly scale
bandwidth to meet our customers' needs. In addition, since we charge our
customers based on the amount of space and bandwidth they use, customers are
afforded a flexible, cost-effective path to increasing their Internet
operations. We also provide flexibility for our customers by supporting most
leading Internet hardware and software systems vendor platforms.
High Performance and Enhanced Connectivity. Our services are designed to enhance
Internet performance through redundant and high speed network design and we
provide monitoring, notification and diagnostic services twenty-four hours a
day, seven days a week. We are able to address the high bandwidth needs and
rapid growth of our customers' business critical operations by maintaining an
extensive number of direct public and private network peering interconnections,
including peering relationships with major network providers. In order to
provide our customers with available and uncongested bandwidth during network
traffic spikes, we are committed to maintaining excess network capacity. The
amount of excess bandwidth at any given time depends upon many factors including
the timing of the addition of new circuits, the timing of customer additions and
increases in usage by existing customers.
Enhanced Access for ISPs. By connecting within our ISX, ISPs have "one hop"
connectivity to content providers co-located in the same facility. We believe
that by providing a means to reduce the number of "hops" in the transmission of
data, our network design offers significant benefits to international ISPs as
they seek to gain fast, reliable access to U.S.-based content. In addition, ISPs
that participate in our Internet service exchanges are able to take advantage of
peering relationships generally available only to major network providers.
Sophisticated Network Management Services and Tools. By leveraging the knowledge
gained from supporting many leading-edge Internet operations, we provide
sophisticated network management and monitoring services on twenty-four hours a
day, seven days a week basis. Our proprietary ASAP software monitors all of our
direct and indirect network connections for latency and packet loss, allowing
our network engineers to dynamically reroute traffic to avoid congested points.
By utilizing ASAP, we are able to identify and resolve many potential problems
before they impact an Internet site's availability or performance.
Remote Management Capabilities. We provide our customers with sophisticated
monitoring, reporting and management tools that can be accessed by customers
remotely to control their Internet hardware, software and application
environments. Our monitoring system probes each customer's equipment every five
minutes and provides the customer with notice of potential problems. We believe
that these tools, combined with our trained twenty-four hours a day, seven days
a week support staff, provide customers with a highly effective means of
monitoring, responding to and resolving problems, significantly reducing
customers' needs for on-site access to their equipment.
Fault-Tolerant Facilities. We have built fault-tolerant facilities designed to
enable the uninterrupted operations necessary for business critical Internet
operations. Each of our facilities is equipped with an uninterruptible DC and AC
power supply and back-up generators for power redundancy, multi-tiered fire
suppression systems, seismically braced racks, separate and redundant cooling
zones and security systems.
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STRATEGY
Our objective is to become the leading global Internet service exchange network
for business enterprises and ISPs that require high bandwidth and business
critical Internet operations. To achieve this objective, our strategy includes
the following key elements:
Build Brand Name. We intend to increase awareness of the AboveNet brand name
among Internet content providers, Web hosting companies and ISPs on a global
basis. We believe that associating the AboveNet brand with high quality and
technologically advanced network and services for outsourcing business critical
Internet operations is key to the expansion of our customer base. We have
recently begun to aggressively invest in building the AboveNet brand through
integrated marketing, including traditional and online advertising in business
and trade publications, trade show participations and public relations
campaigns. We also intend to continue to conduct seminars to increase awareness
of our services among potential customers.
Expand Customer Base. We intend to expand our customer base, which numbered 449
as of March 31, 1999, by significantly increasing our sales and marketing
efforts. Our direct sales force has grown to 35 persons as of March 31, 1999.
Our direct sales force is organized into groups to target leading Internet
content providers, Web hosting companies and ISPs. In addition, we have
personnel responsible for addressing the development of customers in the Asian
and European markets. Our sales force is supported in their sales efforts by
sales engineers and, in many instances, by our senior management. We intend to
significantly expand our direct sales force and sales engineers, as well as hire
experienced channel managers. We seek to establish and expand relationships with
potential channel partners including hardware vendors, value added resellers,
system integrators and Web hosting companies in order to leverage their sales
organizations.
Extend Internet Service Exchange Network Globally. We seek to create a global
ISX network by connecting centralized facilities in key domestic and
international locations. Domestically, we currently have ISXs in San Jose,
California (near MAE West) and Vienna, Virginia (near MAE East) and are
developing a second ISX facility in San Jose, California and a facility in New
York, New York. Additionally, we are planning to develop an ISX facility in the
Washington D.C. area. Internationally, we have formed joint ventures in Austria,
Germany and the United Kingdom with experienced Internet management teams and
strategic partners to develop regional ISXs. We intend to continue to expand our
European network, primarily through strategic investments in additional joint
ventures and foreign companies in major business centers and countries with high
levels of Internet traffic. We also intend to make similar investments in Asian
markets.
Leverage Internet Service Exchange Model. We intend to leverage our ISX model to
increase our customer base and generate recurring revenue. We believe that as
our customer base expands, the benefits to both content providers and ISPs of
our "one hop" solution will increase, creating greater incentives for new
customers to use our services. Since we charge these customers monthly based
upon space and bandwidth usage, we are generally able to increase revenue as our
customers' Internet usage grows. In addition, since our service fees are based
upon bandwidth usage, we believe that we are well positioned to capitalize on
the requirements of high bandwidth applications.
Address Emerging Internet Technology Markets. We believe that our centralized
ISX network will enable us to address the needs of emerging Internet
technologies such as audio and video streaming and voice over the Internet.
Since these applications require a solution that provides low latency and packet
loss, we believe that our high bandwidth, centralized network and enhanced
connectivity capabilities will enable us to offer significant advantages to
customers utilizing these emerging technologies.
THE ABOVENET INTERNET SERVICE EXCHANGE
Our ISXs provide co-location services, Internet connectivity services and
network management services and tools. Our ISXs are designed to provide
customers with the high performance, scalability, connectivity,
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security, reliability and expertise they need to enhance their business critical
Internet applications. We create solutions for our customers based on their
specific business and technical requirements, modifying the services as each
customer's needs evolve. Our services are primarily delivered through
centralized campuses located near MAE West and MAE East. Our planned New York
facility will be connected to our facility located near MAE East by high speed,
high capacity fiber optic cable. This planned facility is intended to facilitate
access to European Internet traffic. Our management services and tools enable us
and our customers to continuously manage customers' Internet operations jointly,
proactively and remotely.
Co-Location Services
We provide co-location services designed to meet the demands of sophisticated,
multi-vendor business critical Internet operations. We support most leading
Internet hardware and software system vendor platforms, including those from
Ascend Communications, Inc., Nortel Networks, Cisco Systems, Inc., Compaq
Computer Corporation, Dell Computer Corporation, EMC Corporation,
Hewlett-Packard Company, International Business Machines Corporation, Lucent
Technologies Inc., Microsoft Corporation, Apple Computer, Inc., Network
Appliance, Inc., Silicon Graphics Inc., Sun Microsystems Inc. and 3Com
Corporation. This multi-vendor compatibility enables our customers to retain
control over their choice of technical solution and to integrate their Internet
operations into our existing information technology architecture. Because
business critical Internet operations are dynamic and often require timely
hardware and software upgrades to maintain targeted service levels, customers
have twenty-four hours a day, seven days a week physical and remote access to
the ISX facilities. Additional space and electrical power can be added as needed
in order to provide our customers with access to additional server co-location
services. Customers install and manage their own hardware and software at our
facilities and we do not provide any Web hosting services.
Our co-location facilities include dedicated electrical power circuits to ensure
that each customer's electrical power requirements are met. Each ISX facility is
constructed to address the requirements of business critical network operations
with an uninterruptible DC and AC power supply and back-up generators, FM-200
Fire Suppression with pre-action backup, HVAC, separate cooling zones,
seismically braced racks, twenty-four hours a day, seven days a week operations,
and high levels of physical security. Any damage to or failure of the systems of
our service providers could result in reductions in, or terminations of,
services supplied to our customers, which could have a significant adverse
effect on our business and operating results. See "Risk Factors -- Our systems
or other systems on which we depend may fail."
Customers can select from shared rack facilities, secure cabinets or enclosed
cage facilities, based upon their business and technical requirements. These
facilities have the following features:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
TYPE OF SPACE SIZE FEATURES
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Open Rack Single shelf, 1/4, 1/2, or full 9(#) or Entry-level service providing a
6(#) racks cost-effective solution for our
customers who do not need dedicated
environments. Secured environment that
is shared by multiple customers.
- ---------------------------------------------------------------------------------------------------------
Cabriolet 9(#) or 6(#) stainless steel enclosed, secure Dedicated, locked cabinet. Provides a
cabinet, 1/4, 1/2, or full rack single rack with the security of a
dedicated environment.
- ---------------------------------------------------------------------------------------------------------
Cage 8(#) x 6(#), 8(#) x 8(#) or customized to Dedicated, locked cage. Provides
order flexibility in designing and configuring
Internet servers, including space for
multiple racks and other equipment.
- ---------------------------------------------------------------------------------------------------------
</TABLE>
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Internet Connectivity
Our Internet connectivity services are designed to meet the requirements of high
bandwidth, business critical Internet operations by providing highly reliable,
scalable, non-stop and uncongested operations. On March 31, 1999, we had peering
relationships with 257 network providers, including 78 private peering
relationships. Any failure by us to maintain and increase peering relationships
would have a material adverse effect on our business, results of operations and
financial condition. See "Risk Factors -- We must maintain and increase peering
relationships."
Our network is designed to minimize the likelihood of service interruptions.
Each ISX has multiple physical fiber paths into the facility. We maintain
multiple network links from multiple vendors and regularly check that our
network traffic traverses physically separated paths. This network architecture
enhances the availability of a customer's site, even in the event of a link
failure. In addition, since our customers' Internet operations often experience
network traffic spikes due to promotions or events, we have a policy of
maintaining significant excess capacity. We might not be able to expand or adapt
our telecommunications infrastructure to meet additional demand or our
customers' changing requirements on a timely basis and at a commercially
reasonable cost, or at all. See "Risk Factors -- We must be able to expand and
adapt our network infrastructure."
Our Internet connectivity services are also designed to reduce latency and to
enhance network performance. Our engineering personnel continuously monitor
traffic patterns and congestion points throughout the Internet and dynamically
reroute traffic flows to improve end-user response times. We also enhance
network performance by maintaining what we believe is among the largest number
of direct public and private network peering interconnections in the industry.
For customers seeking a direct communications link to the site of another
customer that is located at the same ISX, we offer highly secure, fast and
efficient cross-connections.
Our connectivity services utilize our proprietary ASAP technology to enhance
Internet connectivity by monitoring all of our direct and indirect network
connections for congestion.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
TOOL DESCRIPTION BENEFITS
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASAP -- ASAP automatically monitors all of our major If packet loss and congestion is
Asymmetric providers' and peers' direct and indirect detected on any of the links that
Allocation of connections on a real-time 24-hour basis to directly affect customers' performance,
Packets identify congestion. our network engineers are able to
dynamically reroute traffic temporarily
away from the problem link. This
functionality is particularly important
for emerging applications such as audio
and video streaming and voice over the
Internet.
- ---------------------------------------------------------------------------------------------------------
</TABLE>
Management Services and Tools
Our management services and tools support business critical Internet operations
by providing the customer with detailed monitoring, reporting and management
tools to control their hardware, network, software and application environments.
Through our network management services and tools, customers are able to
remotely manage their business critical Internet operations housed at our ISX
facilities. We believe that this provides an important advantage to enterprises
that seek to outsource a portion of their Internet operations and to link the
management of the outsourced operations with in-house operations. Our proactive
management services and tools enable us to identify and resolve hardware,
software, network and application problems, often before the customer is aware
that a problem exists.
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Customers may access their co-located equipment by visiting the ISX facility or
by using our software tools and services for remote access. Using our remote
access tools, customers can perform emergency tasks, control power functions and
monitor their own system usage. These remote access tools alleviate the need for
us to build numerous, geographically dispersed ISX facilities. In the event of a
system problem, we notify our customer who can then attempt to resolve the issue
remotely. We intend to continue to enhance our software tools in order to meet
the needs of customers with business critical Internet operations. Our space
requirement charges include access to all of our management services and tools.
See "Risk Factors -- We may not be able to keep pace with rapid technological
changes or emerging industry standards."
We offer the tools and services summarized below:
<TABLE>
<S> <C> <C>
- -----------------------------------------------------------------------------------------------
TOOLS/SERVICES DESCRIPTION BENEFITS
- -----------------------------------------------------------------------------------------------
MRTG MRTG is a widely used tool licensed by MRTG shows customers the amount of
us that provides real-time monitoring bandwidth being used and, therefore,
and management of bandwidth. Currently the actual cost of that business
used by most major backbone providers, expense. Through a graphical
MRTG generates HTML pages containing interface, users can view, in
GIF images which provide a real-time real-time, the actual amount of
visual representation of this traffic. bandwidth flowing through their
MRTG can also be used to display servers and/or networking equipment.
historical statistical data in graphic MRTG also allows us and our customers
form. to view our connections and bandwidth
usage with each of our backbone
providers.
- -----------------------------------------------------------------------------------------------
EtherValve EtherValve is a tool licensed by us EtherValve allows us to provide each
that regulates the actual flow of customer a clear channel of the
bandwidth from a customer's server bandwidth purchased. This assures
through a 10 Mbps or 100 Mbps Ethernet customers that they will have the
segment. bandwidth they have purchased
available to them at any given time.
EtherValve also allows the customer's
bandwidth to be scaled up immediately,
in increments as small as 8 bps (0.008
Kbps).
- -----------------------------------------------------------------------------------------------
APS -- APS is a suite of proprietary tools APS provides real-time information
Automatic developed to continually monitor the about a customer's remote equipment.
Pro-Active performance of customer equipment. APS automatically notifies the
Services Three levels of predetermined customer and our technical personnel
escalation procedures include of system malfunctions. Predetermined
automatic notification by e-mail, escalation procedures customized for
notification by pager and automatic each customer are then carried out by
power cycle. our personnel. Automatic rebooting and
other predetermined procedures often
serve to correct problems before the
customer is aware of the problem.
- -----------------------------------------------------------------------------------------------
As-Ur-Here As-Ur-Here provides various service As-Ur-Here allows customers to
Service aspects including automatic remote maintain access and control over their
power cycle and remote services equipment and perform effective
terminal server access. equipment maintenance and problem
solving while they outsource their
servers and/or networking equipment.
- -----------------------------------------------------------------------------------------------
</TABLE>
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CUSTOMERS
We have established a diversified base of customers including Internet content
providers, Web hosting companies and ISPs. As of March 31, 1999, we had
approximately 449 customers. One customer, RemarQ Communities, Inc., (formerly
named Supernews, Inc.) accounted for 12% and 14% of our revenues in fiscal 1997
and 1998, respectively. No other customer accounted for more than 10% of
revenues in either fiscal 1997 or 1998. Our success is substantially dependent
on the continued growth of our customer base and the retention of our customers.
Our customer base increased from 278 at June 30, 1998 to 382 at December 31,
1998 to 449 at March 31, 1999. We had a monthly customer retention rate of 97%
or greater in each of the nine months ended March 31, 1999. See "Risk Factors --
We must grow and retain our customer base."
The following is a representative list of customers as of March 31, 1999:
<TABLE>
- ----------------------------------------------------------------------------------------------------------
INTERNET CONTENT PROVIDERS WEB HOSTING COMPANIES ISPS
<S> <C> <C>
- ----------------------------------------------------------------------------------------------------------
e-Media, LLC Bay Area Gold Direct Network Access, Ltd.
Imagine Radio, Inc. (acquired by MTV) CNET Download.com Flashcom
IntelliChoice, Inc. FRNK Technology Group Got.Net Corporation
Netscape Communications Corporation Floating Point Software Hinet, a wholly-owned
(acquired by America Online, Inc.) iXL, Inc. subsidiary
RealNetworks, Inc. Lars Mapstead of Chung Hwa Telecom
RemarQ Communities, Inc. PulseWeb Ventures Hurricane Electric
Visual Dynamics LLC The Web Zone, Inc. Innetix
WebMD, Inc. VirtuaLynx Internet, LLC KDD America
Westech ExpoCorp. WebAsyst Corporation Linkage Online Limited
PH Communications
Singapore Telecommunications
- ----------------------------------------------------------------------------------------------------------
</TABLE>
The following examples illustrate how our customers use our services:
Internet Content Providers
- - RealNetworks, Inc. RealNetworks is a leading developer of software products
and services designed to enable users of personal computers and other consumer
electronic devices to send and receive audio, video and other multimedia
services using the World Wide Web. RealNetworks uses our facilities to host
its Web site for users to download its client and server software.
RealNetworks selected us because of the speed and high performance of our
network (enabling fast, reliable downloading of their products), our ability
to rapidly scale the amount of bandwidth and our extensive peering
relationships. Since becoming a customer in February 1998, RealNetworks has
co-located an increasing portion of their downloading operations with us.
- - e-Media, LLC. e-Media's core focus is the production and broadcast of live
events over the Internet. The viewers of these streaming events are sensitive
to the visual degradation that occurs as a result of the Internet's packet
loss and latency. e-Media moved to our facilities over six months ago to solve
this degradation problem and meet the stringent demands of their Internet
viewers. e-Media chose AboveNet because of our ability to scale to support the
large and unpredictable number of online viewers for their live events.
- - RemarQ Communities, Inc. RemarQ, formerly named Supernews, Inc. is a leading
Internet discussion service for corporate, ISP and individual clients. RemarQ
serves hundreds of thousands of users through corporations, ISPs and direct
subscriptions. RemarQ supports over 30,000 newsgroups and an average of 30
gigabytes of data daily. As its business grew, RemarQ realized it had to
outsource its Internet connectivity and the computers that served the Internet
discussion groups. We reliably handle RemarQ's
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traffic which can reach 300 Mbps. The cost savings realized by co-locating
provided RemarQ the ability to focus on its core business.
- - WebMD. WebMD is an Internet-based healthcare network that connects physicians,
hospitals, third-party payers and consumers to a virtual world of medical
information, tools, and services. WebMD needed to be able to send and receive
their medical content quickly and securely. We provide WebMD with a secure,
highly reliable co-location solution for the critical medical records located
on WebMD's servers. Additionally, because WebMD's users come to the WebMD site
from numerous ISPs, WebMD chose us because of our substantial public and
private peering relationships. WebMD is co-locating at our San Jose,
California and Vienna, Virginia ISXs.
Web Hosting Companies
- - CNET Download.com. CNET is an Internet media company that operates a network
of sites on the Web. Download.com, a division of CNET, is a leading site for
downloading software titles. CNET Download.com selected us to provide
co-location and connectivity services for its servers due to the high
performance of our network and peering relationships with major ISPs and other
large companies, including America Online, Inc. Our scalable bandwidth also
allows CNET Download.com the flexibility necessary to accommodate traffic
surges accompanying new software releases.
- - The Web Zone, Inc. The Web Zone, Inc. is a full service Internet and
networking solutions company. Web Zone relies on us to offer its customers
reliable, high performance Internet connection and secure facilities. Our
connectivity and co-location services enable Web Zone to offer a full set of
services including Web hosting to its customers who want to focus on their
core businesses and not the cost and problems associated with maintaining
their own Web sites, servers and Internet connections.
ISPs
- - PH Communications. PH Communications is a San Francisco Bay Area ISP that
provides its customers access, Web hosting, e-mail and support services. PH
Communications chose us to provide highly reliable and high performance
co-location and Internet connectivity services. PH Communications uses our
management tools, including APS and MRTG, to enable it to remotely manage its
equipment and bandwidth utilization on a twenty-four hours a day, seven days a
week basis. PH Communications has relied on the scalability and extensive
peering relationships of our solution to support the growth of its business
over the last two years.
- - KDD America. KDD America is a subsidiary of Japan's largest international
telecommunications carrier, KDD Corporation. KDD America is a leading provider
of global telecommunications services. KDD America selected AboveNet's San
Jose, California facility as one of its primary U.S. Internet access points
because of our scalable facility management and high performance network, our
ability to rapidly scale the amount of available bandwidth and our extensive
peering relationships.
INTERNATIONAL INTERNET SERVICE EXCHANGES
We are seeking to create a global network by investing in joint ventures and
foreign companies that can develop regional ISXs in Europe and Asia. In March
1999, we entered into agreements with local partners to establish regional ISXs
in Austria, Germany and the United Kingdom. We intend to continue to expand our
European network through additional investments in joint ventures in other major
business centers and countries with high levels of Internet traffic. These
regional service exchanges will be based on our business model and facility
design and will offer co-location and Internet connectivity services to both
Internet content providers and ISPs in their markets.
Austria. We founded AboveNet Austria GmbH (AboveNet Austria) in partnership with
Raiffeisen Rechenzentrum RRZ, an affiliate of the Raiffeisen group. We acquired
a 50% ownership interest in AboveNet Austria in consideration of a cash
investment and the grant of a royalty-free license to our tools
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and trademarks. The Austrian ISX expects to be operational by the second half of
calendar year 1999. However, the development of this ISX might encounter
unanticipated delays.
Germany. We founded AboveNet Germany GmbH (AboveNet Germany) in partnership with
three German nationals. The German partners include founders of EUNet Germany, a
large German ISP which was subsequently acquired by UUNet, and managing
directors of the German Internet exchange point DE-CIX. We acquired a 50%
ownership interest in AboveNet Germany for a cash investment and the grant of a
royalty-free license to our tools and trademarks. The German ISX is currently
expected to be operational by the first quarter of calendar year 2000. However,
the development of this ISX might encounter unanticipated delays.
United Kingdom. We founded AboveNet UK Limited (AboveNet UK) in partnership with
two Scottish nationals who were the founders of Teledata Holdings, a call center
and Internet services company which was acquired by Scottish Telecom in 1995.
Subject to an additional cash investment, we will have a 40% ownership interest
in AboveNet UK for a cash investment and the grant of a royalty-free license for
our tools and trademarks. The UK ISX is currently expected to be operational in
the fourth quarter of calendar year 1999. However, the development of this ISX
might encounter unanticipated delays.
As of March 31, 1999, we had committed up to an aggregate of approximately $8.4
million in additional financing to the joint ventures and have the right to
participate in future financings to maintain our percentage of interest. We also
have a right of first refusal to purchase the shares of our foreign partners if
they seek to transfer them to a third party. In addition, in Germany and the
United Kingdom, we have an option to purchase the shares of our partners in
years three through five at a price determined through an independent appraisal
mechanism.
The investment in these regional ISXs subjects us to a number of risks. See
"Risk Factors --We depend on third parties to establish and operate
international Internet service exchanges."
SALES AND MARKETING
Our sales and marketing objective is to achieve broad market penetration and
increase brand name recognition among Internet content providers, Web hosting
companies and ISPs on a global basis through investments in the expansion of our
sales organization and extensive marketing activities. As of March 31, 1999, we
employed 46 persons in sales and marketing. We have developed a two-tiered sales
strategy to target leading Internet content providers, Web hosting companies and
ISPs through direct sales and channel relationships. See "Risk Factors -- We may
not be able to hire and retain the key employees we need."
Direct Sales Force
We maintain a direct sales force of highly trained individuals in San Jose,
California, and Vienna, Virginia. As of March 31, 1999, we had 35 persons in
direct sales targeting Internet content providers, Web hosting companies and
ISPs. We also have personnel responsible for addressing the development of
customers in Asia and Europe. We are actively seeking to expand our direct sales
force and sales engineers. Substantially all of our sales are currently
generated by our direct sales force. Our sales force is supported in their sales
efforts by our sales engineers and, in many instances, by our senior management.
We believe that the integration of our sales engineers with our sales account
managers assists in both the establishment of customer relationships as well as
the migration of customers to increased use of our services. We have developed
programs to attract and retain high quality, motivated sales representatives
that have the necessary technical skills, consultative sales experience and
knowledge of their local markets. These programs include technical and sales
process training and instruction in consultative selling techniques. We have
also developed sales compensation plans which provide for significant incentives
for exceeding performance targets.
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<PAGE> 48
Under the terms of license, connectivity and marketing agreements entered into
between us and the joint venture entities, we have granted those entities the
exclusive right to use our tools and trademarks in their respective countries,
subject to meeting certain minimum performance targets. In return, the joint
ventures have agreed that, so long as they maintain their exclusivity under the
license, connectivity and marketing agreements, we will be their exclusive
provider of connectivity services.
Develop Channel Relationships
We are seeking to develop relationships with potential channel partners
including hardware vendors, value added resellers, system integrators,
application hosting and Web hosting companies in order to leverage their sales
organizations. We believe that by leveraging the sales forces of these
companies, we can attract customers for our services in a cost-effective manner,
as well as provide co-branded Internet service offerings for our channel
partners. For example, some of our Web hosting customers market our service as
part of their overall bundled offering and we have been involved in joint
marketing and sales efforts with those customers. We are actively seeking to
hire experienced channel managers to focus exclusively on developing these
relationships. We also plan to develop seminar programs and other cooperative
sales programs to further develop these relationships.
Marketing
Our strategy is to significantly expand our marketing efforts to stimulate
increased demand for our services and build the AboveNet brand. We plan to
aggressively invest in building the AboveNet brand through integrated marketing
campaigns, including traditional and online advertising in business and trade
publications, trade show participations, direct mail and public relations
campaigns to increase customer awareness and demand. We have also established a
client advisory council to strengthen our relationship with our customers.
NETWORK ARCHITECTURE
Our high performance network is designed to provide enhanced connectivity to our
customers. Our two Internet service exchange campuses are connected to one
another with high speed SONET circuits, and connected to the Internet through
public and private peering arrangements.
Our Internet service exchange campuses are located near MAE West and MAE East
and are connected to local Internet exchange points by multiple high-speed
backbone connections, provided by MCI WorldCom, Sprint, Pacific Bell, Teleport
Communications Group, a subsidiary of AT&T, and WinStar Communications. These
links to the local exchange points, combined with private exchanges with ISPs,
connect our customers' traffic to the Internet. We have engineered our peering
using a geographically diverse fiber path to provide high reliability, even in
the event of a link failure. We have developed dynamic rerouting and load
balancing technologies to enhance the performance of our customers' connections
Internet operations.
We have determined that as voice, video and other services are carried across
the Internet, the need for ATM in network infrastructures is reduced. We have
built our network using DS-3 and OC-3 clear channel circuits. By using clear
channel circuits, we are able to make highly efficient use of these connections,
lowering infrastructure costs and providing high performance connectivity.
Inside of each ISX facility, we have multiple local area networks, each
connected to the outside network through redundant routers and network
connections. These routers are configured such that in case of failure of a
single connection, or piece of equipment, alternative equipment or network paths
are automatically utilized, without human intervention, or performance
degradation. See "Risk Factors -- We depend on third party suppliers."
We utilize a combination of public and private peering in order to provide a
high level of network performance. On March 31, 1999, we had peering
relationships with 257 network providers including 78 private peering
relationships. Our ISXs are connected to all of the major U.S. Internet exchange
points.
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The combination of public and private peering sessions allows us to provide high
levels of performance and reliability to their customers. To ensure that this
connectivity is not degraded, we have a policy of providing significant excess
capacity on all local area network, wide area network and Internet exchange
point connections in our network. Any failure to maintain and increase peering
relationships would have a material adverse effect on our business, results of
operations and financial condition. See "Risk Factors -- We must maintain and
increase peering relationships."
Our operations are dependent upon our ability to protect our network
infrastructure and customers' equipment against damage from human error, fire,
earthquakes, floods, power loss, telecommunications failures, sabotage,
intentional acts of vandalism and similar events. Despite precautions taken by,
and planned to be taken by us, the occurrence of a natural disaster or other
unanticipated problem at one or more of our Internet service exchange facilities
could result in interruptions in the services provided by us. Such an event
could significantly impact the ability of suppliers to provide the data
communications capacity required by us and could result in interruptions in our
services. See "Risk Factors -- Our systems or other systems on which we depend
on may fail" and "-- We face risks associated with the security of our systems."
CUSTOMER SERVICE AND QUALITY ASSURANCE
We offer a high level of customer service and quality assurance by understanding
the technical requirements and business objectives of our customers and
addressing their needs proactively on an individual basis. By working closely
with our customers, we are able to enhance the performance of our customers'
Internet operations, avoid downtime, resolve quickly any problems that may arise
and make appropriate adjustments in services as customer needs change over time.
We work with our customers to ensure that we are offering the appropriate types
and quality of service. We use advanced software tools to aid in our customer
monitoring and service efforts. We received our ISO 9002 certification in March
1998. As of March 31, 1999, we had 44 employees dedicated to customer service
and quality assurance.
Customer service begins before a sale, when we provide technical support for
complex orders. During the installation phase, we assign a transition team and a
project manager, who also retains responsibility for the account after
installation, to assist the new customer with the installation process. After
installation, the customer's equipment is overviewed by our network operation
center in San Jose, California, which is operated twenty-four hours a day, seven
days a week by engineers who answer customer calls, monitor site and network
operations and activate teams to solve problems that arise. Our customer service
personnel are also available to assist customers whose operations require
specialized procedures.
We believe that our quality assurance programs are key to building our brand
name. The objectives of our quality assurance system are to comply with ISO
9002: 1994 quality administration systems; to achieve and maintain a level of
quality that enhances our reputation with our customers; to ensure compliance
with relevant safety and environmental requirements; and to endeavor to deliver
high quality services to customers in an environment centered on adherence to
high legal and ethical standards.
COMPETITION
Our business is intensely competitive. There are few substantial barriers to
entering the co-location service business, and we expect that we will face
additional competition from existing competitors and new market entrants in the
future. We believe that participants in this market must grow rapidly and
achieve a significant presence in the market in order to compete effectively. We
believe that the principal competitive factors in our market are uncongested
connectivity, quality of facilities, level of customer service, price, the
financial stability and credibility of the provider, brand name and the
availability of network management tools. We might not have the resources or
expertise to compete successfully in the future. Our current and potential
competitors in the market include: (i) providers of co-location services, such
as Exodus Communications, Inc., Frontier GlobalCenter, Inc., which is being
acquired by Global Crossing Holdings, Ltd., Hiway Technologies, Inc., which was
acquired by Verio Inc. and Globix
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Corporation; (ii) national and regional ISPs, such as Concentric Network
Corporation, PSINet, Inc., MCI WorldCom and certain subsidiaries of GTE
Corporation; (iii) global, regional and local telecommunications companies, such
as Sprint, MCI WorldCom and regional bell operating companies, some of whom
supply capacity to us; and (iv) large information technology outsourcing firms,
such as International Business Machines Corporation and Electronic Data Systems.
Some of these companies operate in one or more of these markets. In addition,
many of our current and potential competitors have substantially greater
financial, technical and marketing resources, larger customer bases, longer
operating histories, greater name recognition and more established relationships
in the industry than we do. As a result, some of these competitors may be able
to develop and expand their network infrastructures and service offerings more
quickly, adapt to new or emerging technologies and changes in customer
requirements more quickly, take advantage of acquisitions and other
opportunities more readily, devote greater resources to the marketing and sale
of their services and adopt more aggressive pricing policies than we can. In an
effort to gain market share, some of our competitors have offered co-location
services similar to ours at lower prices or with incentives not matched by us,
including free start-up and domain name registration, periods of free service
and low-priced Internet access. As a result of these policies, we may encounter
increasing pricing pressure which could have a significant adverse effect on our
business and operating results.
In addition, these competitors have entered and will likely continue to enter
into joint ventures, consortiums or consolidations to provide additional
services competitive with those provided by us. As a result, such competitors
may be able to provide customers with additional benefits in connection with
their co-location and network management solutions, including reduced
communications costs, which could reduce the overall costs of their services
relative to our services. We might not be able to offset the effects of any such
price reductions. In addition, we expect competition to intensify as our current
and potential competitors incorporate a broader range of bandwidth, connectivity
and Internet networking services and tools into their service offerings. We
believe that companies seeking co-location and Internet connectivity providers
for their business critical Internet operations may use more than one company to
provide this service. As a result, these customers would be able to shift the
amount of service and bandwidth usage from one provider to another. We may also
face competition from our suppliers. Our agreements with our suppliers and other
partners do not limit or restrict those parties from offering similar services
to our customers, thereby enabling such parties to compete against us.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of copyright, trademark, service mark and trade secret
laws and contractual restrictions to establish and protect certain proprietary
rights in our software. We have no patented technology that would preclude or
inhibit competitors from entering our market. We have generally entered into
confidentiality and invention assignment agreements with our employees in order
to limit access to and disclosure of certain of our proprietary information. We
cannot be certain that these contractual arrangements or the other steps taken
by us to protect our intellectual property will prove sufficient to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies. The laws of certain foreign countries may
not protect our services or intellectual property rights to the same extent as
do the laws of the U.S. We also rely on certain technologies that we license
from third parties. Two key technologies offered by us, MRTG and EtherValve, are
licensed from David Rand, our Chief Technical Officer. We have perpetual,
irrevocable, royalty-free worldwide licenses to both technologies. The license
to MRTG is non-exclusive and the license to EtherValve is exclusive subject to
one previously granted license. We do not license any other technology which is
not generally available. To date, we have not been notified that we infringe the
proprietary rights of third parties, but we cannot be certain that third parties
will not claim infringement by us. We expect that participants in our markets
will be increasingly subject to infringement claims as the number of
technologies and competitors in our industry segment grows. Any such claim,
whether meritorious or not, could be time-consuming, result in costly
litigation, cause service delays or require us to enter into royalty or
licensing agreements. Such royalty or licensing agreements might not be
available on terms acceptable to us or at all. As a
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result, any such claim could have a material adverse effect upon our business,
results of operations and financial condition.
GOVERNMENT REGULATION
There is currently a small but growing body of laws and regulations directly
applicable to access to or commerce on the Internet. Due to the increasing
popularity and use of the Internet, it is likely that a growing number of laws
and regulations will be adopted at the international, federal, state and local
levels with respect to the Internet, covering issues such as user privacy,
freedom of expression, pricing, characteristics and quality of products and
services, taxation, advertising, intellectual property rights, information
security and the convergence of traditional telecommunications services with
Internet communications. Moreover, a number of laws and regulations have been
proposed and are currently being considered by federal, state and foreign
legislatures with respect to such issues. The nature of any new laws and
regulations and the manner in which existing and new laws and regulations may be
interpreted and enforced cannot be fully determined. For example, although
sections of the Communications Decency Act of 1996 (the "CDA") that, among other
things, proposed to impose criminal penalties on anyone distributing "indecent"
material to minors over the Internet, were held to be unconstitutional by the
U.S. Supreme Court, there can be no assurance that similar laws will not be
proposed and adopted. Legislation similar to the CDA could subject us and/or our
customers to potential liability, which in turn could have an adverse effect on
our business, operating results and financial condition. In addition,
legislation that prohibits or limits sending unsolicited commercial e-mails has
recently been passed, and continue to be proposed which could subject us and our
customers to potential liability. The adoption of any future laws or regulations
might decrease the growth of the Internet, decrease demand for our services,
impose taxes or other costly technical requirements or otherwise increase the
cost of doing business or in some other manner have a significant adverse effect
on us or our customers, which, in turn, could have a significant adverse effect
on our business and operating results. In addition, applying existing laws
governing issues such as property ownership, copyrights and other intellectual
property issues, taxation, libel, obscenity and personal privacy to the Internet
is uncertain. The vast majority of these laws were adopted prior to the advent
of the Internet and related technologies and, as a result, do not contemplate or
address the unique issues of the Internet and related technologies. Changes to
these laws intended to address these issues, including some recently proposed
changes, could create uncertainty in the marketplace which could reduce demand
for our services or increase the cost of doing business as a result of costs of
litigation or increased service delivery costs, or could in some other manner
have a significant adverse effect on our business and operating results. In
addition, as our services are available over the Internet in multiple states and
foreign countries, and as we facilitate sales by our customers to end users
located in these states and foreign countries, these jurisdictions may claim
that we are required to qualify to do business as a foreign corporation in each
of these states or foreign countries. Any new legislation or regulation, or the
application of laws or regulations from jurisdictions whose laws may not
currently apply to our business, could have a significant adverse effect on our
business and operating results.
EMPLOYEES
As of March 31, 1999, we had 130 employees, including 46 people in sales and
marketing, 62 people in customer service, network and backbone engineering and
product development and 22 people in general and administration. We believe that
our future success will depend in part on our continued ability to attract, hire
and retain qualified personnel. The competition for these personnel is intense,
and we might not be able to hire or retain these personnel. See "Risk
Factors -- We may not be able to manage our growth effectively," and "We may not
be able to hire or retain the key employees we need."
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FACILITIES
Our principal executive and administrative offices are located in San Jose,
California and consist of approximately 20,000 square feet that are leased until
2008, with an option by us to expand to 2018. We lease our ISX facilities in San
Jose, California and Vienna, Virginia (in the Washington, D.C. area). The San
Jose, California facility consists of approximately 10,000 square feet,
including 6,800 square feet of co-location space and is leased until 2008, with
an option for us to extend to 2018. The Vienna, Virginia facility, which
consists of approximately 17,000 square feet, including 12,000 square feet of
co-location space is leased until 2007, with an option for us to extend to 2012.
We are establishing a West Coast campus by developing a second ISX facility of
approximately 124,000 square feet, including approximately 61,000 square feet of
co-location space, near our San Jose, California facility. We opened this
facility with an initial build-out of 4,200 square feet of co-location space in
March 1999 and we intend to build out an additional 6,800 square feet of
co-location space by the fall of 1999. Afterwards, we intend to build out
approximately 13,000 additional square feet of co-location space by the spring
of 2000. The build-out of additional co-location space will occur incrementally
over time based on customer demand. The lease for this planned facility is a
twenty year lease commencing on the earlier of such time when any portion of the
facility can be occupied or one year following the earlier of the date on which
construction on the planned facility commences or should have commenced.
In addition, we are establishing an East Coast campus with plans to develop
another ISX in New York, New York which will be connected by fiber optic cable
to our Vienna, Virginia facility. This facility is expected to be about 27,000
square feet, including approximately 11,000 square feet of co-location space. We
intend to initially complete the build-out of approximately 5,500 square feet of
co-location space and continue to add co-location space over time based on
customer demand. The lease for this planned facility has a fifteen year term.
We are also planning to develop an additional ISX in the Washington D.C. area to
be a part of our East Coast campus. The target for opening the facility is the
second half of calendar year 2000. However, we have not entered into a lease for
this planned facility. Any of the ISXs planned for development might not be
completed in a timely manner, or at all. See "Risk Factors -- We may face
problems in connection with out expansion plans."
LEGAL PROCEEDINGS
We have a dispute with one of our customers, Pathway Communications, Inc.,
involving one of Pathway's consultants. The consultant misrepresented his
identity to us to gain access to Pathway's servers in order to delete files. On
September 3, 1998, Pathway Communications filed a complaint against us for
negligence, breach of contract, conversion, and intentional and negligent
interference with prospective economic advantage in the Superior Court of the
State of California, County of Santa Clara. The lawsuit seeks general, special
and punitive damages upon proof, as well as costs and reasonable attorneys'
fees. We obtained an order requiring that the dispute be submitted to
arbitration. We intend to vigorously defend against such action. However, we
might not prevail in this litigation and this litigation might have a
significant adverse effect on our business or operating results.
We currently are in a dispute with WinStar Communications, Inc. over currently
invoiced amounts and credits available to apply against amounts invoiced in the
future. We believe we are entitled to net credits under our agreements with
WinStar Communications. WinStar Communications has stated that unless the
dispute is resolved to its satisfaction, it will discontinue providing us
telecommunications capacity. WinStar Communications in one of our major
suppliers of this service. While the Company is in the process of accelerating
the acquisition of additional capacity to offset the potential impact of any
termination of such service, termination of the telecommunications capacity that
WinStar Communications provides to us could result in a significant disruption
of our services to our customers and cause a significant adverse
53
<PAGE> 53
effect on our business and operating results. Since the additional capacity is
not yet installed, we cannot guarantee that it will be available when and if
needed. Furthermore, because we intend to accelerate our purchase of additional
capacity as a result of this dispute, we expect to incur additional expenses in
the quarter ending June 30, 1999. If a settlement is not reached, this dispute
might result in litigation. Litigation could be costly and could have a
significant adverse effect on our operating results, regardless of the outcome.
See "Risk Factors -- We depend on third party suppliers."
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<PAGE> 54
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The executive officers, directors and key employees of AboveNet are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Sherman Tuan............................... 45 Chairman of the Board and Chief Executive
Officer
Peter C. Chen, Ph.D.(2).................... 59 Vice Chairman of the Board
Warren J. Kaplan........................... 56 President, Chief Operating Officer and
Director
David Rand................................. 36 Chief Technology Officer
Stephen P. Belomy.......................... 40 Executive Vice President and Secretary
David Dembitz.............................. 45 Senior Vice President of Sales and
Marketing
David F. Larson............................ 51 Senior Vice President and Chief Financial
Officer
Jerry Chen................................. 34 Vice President of International -- Asia
Avi Freedman............................... 29 Vice President of Engineering
Kevin Hourigan............................. 34 Vice President of Finance and Controller
Van D. Jepson.............................. 45 Vice President of Marketing
Mark Kaleem................................ 52 Vice President of Sales
Jeffrey Monroe............................. 32 Vice President of Construction and Real
Estate
Wayne Sanders.............................. 56 Vice President of Corporate Development
Paul Steiner, Ph.D......................... 42 Vice President of International -- Europe
Robert A. Burgelman, Ph.D.(1).............. 53 Director
Frank R. Kline(2).......................... 48 Director
James Sha(1)............................... 48 Director
Tom Shao, Ph.D.(2)......................... 64 Director
Kimball W. Small(2)........................ 63 Director
Fred A. Vierra(1).......................... 67 Director
</TABLE>
- -------------------------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Mr. Tuan, the founder of AboveNet, has served as Chief Executive Officer and a
Director since 1996, and President until January 1998. Mr. Tuan has served as
Chairman of the Board since August 1998. Mr. Tuan was President of InterNex
Information Services, Inc., an Internet infrastructure provider, from November
1994 to October 1995 and from February 1994 to November 1995 was President of
Tiara Computer, Inc., a network equipment manufacturer, which merged with
InterNex Information Services, Inc. in November 1994. From January 1992 to June
1993, Mr. Tuan was Vice President of Worldwide Sales and Marketing of Primus
Technologies, Inc., a provider of problem resolution and knowledge management
software, and President of Celerite Graphics, Inc., a manufacturer of video
chips. Mr. Tuan received an Electrical Engineering degree from Feng-Chia
University in Taiwan.
Dr. Chen has served as Vice Chairman of the Board since August 1998. Dr. Chen
served as Chairman from December 1996 to August 1998, and has been our Director
since March 1996. Dr. Chen is the Founder and Chairman of Crosslink Technology
Partners, an investment firm specializing in funding and developing early stage
semiconductor, healthcare and Internet related technology ventures, where he has
been employed since August 1992. From September 1983 to May 1992, Dr. Chen was
Founder, General Manager and Chief Executive Officer of Mosel Corporation, a
semiconductor manufacturer in Taiwan.
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<PAGE> 55
Dr. Chen received a B.S. in Engineering from National Taiwan University and a
Ph.D. in Engineering from Cornell University.
Mr. Kaplan has served as President, Chief Operating Officer and a Director since
January 1998, and as Acting President and Chief Operating Officer from November
1997 to January 1998. From March 1996 to November 1997, Mr. Kaplan was an
investor and consultant to various Internet software start-up companies. Mr.
Kaplan served as Chief Executive Officer and a director of Simply Interactive,
Inc., a software company, from June 1996 to December 1996, and was President
from April 1996 to June 1996. Until February 1996, Mr. Kaplan served (i) as a
Managing Director -- International at NETCOM On-Line Communication Services,
Inc., an ISP and Web hosting company, from August 1995, (ii) as Executive Vice
President from February 1994, (iii) as Secretary from October 1994, and (iv) as
a Director since April 1994. Mr. Kaplan also served as NETCOM's Chief Financial
Officer from February 1994 through September 1995. From September 1989 to
December 1993, Mr. Kaplan was Vice President of Operations of Gefinor (USA)
Inc., a merchant banking business, and also served as Senior Vice President and
Chief Financial Officer and Interim Chief Executive Officer of its
majority-owned subsidiary, Sheaffer Pen Company, from September 1989 to August
1991 and September 1989 to August 1990, respectively. Mr. Kaplan received a B.S.
in Accounting from New York University and an M.B.A. in Taxation from Long
Island University.
Mr. Rand has served as Chief Technology Officer since March 1996, initially as a
consultant, and since May 1998 as an employee. Mr. Rand has served as a member
of the Internet Engineering Task Force for the past seven years. Mr. Rand
authored rfc 1962 and rfc 1663, developed the EtherValve technology and
developed ASAP and APS, as well as co-developed MRTG. From September 1995 to May
1998, Mr. Rand was an engineer at Cisco Systems, Inc., a router manufacturer.
From February 1994 to August 1995, Mr. Rand was an engineer at Innovative
Systems and Technologies, a video compression company. From October 1993 to
February 1994, Mr. Rand was a software engineer at Novell, Inc., a network
server company.
Mr. Belomy has served as Executive Vice President since January 1998. Mr. Belomy
also served as AboveNet's Chief Financial Officer from January 1998 to November
1998, and as AboveNet's Director of Operations from January 1997 to January
1998. From August 1985 to December 1996, Mr. Belomy served as Vice President of
Kimball Small Properties, a commercial real estate developer in San Jose,
California. Mr. Belomy has a B.S. in Engineering from the University of
California at Los Angeles.
Mr. Dembitz has served as Senior Vice President of Sales and Marketing since
April 1998. From February 1996 to April 1997, Mr. Dembitz was Vice President of
Sales and Marketing of ISDNet, a start-up company that provided remote access
solutions, which was acquired in 1997. From June 1993 to December 1995, Mr.
Dembitz was an independent consultant providing networking consulting services.
From January 1990 to June 1993, Mr. Dembitz held various sales positions,
including Senior Manager of Major Account Programs and Channel Programs, as well
as the Senior Manager of Sales Operations for SynOptics Communications, which
was acquired by Bay Networks, a provider of routers, switches and hubs. Mr.
Dembitz received a B.S. in Management and a B.S. in Economics, as well as an
M.B.A. with a minor in Marketing, from the University of Utah.
Mr. Larson has served as Senior Vice President and Chief Financial Officer since
November 1998. From December 1997 to November 1998, Mr. Larson served as Vice
President and Treasurer of Silicon Valley Group, Inc., which designs,
manufactures and markets semiconductor processing equipment. From August 1993 to
December 1997, Mr. Larson served as Silicon Valley Group's Director of Planning
and from July 1991 to August 1993, Mr. Larson served as Silicon Valley Group's
Corporate Controller. Mr. Larson received a B.S. with honors (with a
concentration in Accounting) from California Polytechnic State University, San
Luis Obispo. Mr. Larson is a Certified Public Accountant.
Mr. Chen has served as Vice President of International -- Asia since October
1998. Previously, Mr. Chen served as Sales and Marketing Manager from January to
December 1996, as Senior Customer Service Manager from January to December 1997,
as San Jose Operations Director from January 1998 to June 1998 and as a Director
of Asia Pacific from July 1998 to October 1998. Prior to joining AboveNet,
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<PAGE> 56
Mr. Chen was a Director of Postable Systems for Everex Systems, Inc., a computer
manufacturer, from January 1995 to January 1996 and the Co-founder and Vice
President of Intelligent Notebook Systems, a computer reseller, from May 1994 to
January 1996. From July 1991 to May 1994, Mr. Chen was a sales manager for
Santron Inc., a computer reseller. Mr. Chen received a B.S. in Electrical
Engineering from Feng-Chia University in Taiwan, and an M.B.A. from the
University of Hartford.
Mr. Freedman has served as Vice President of Engineering since February 1999.
From August 1992 until he joined AboveNet, Mr. Freedman was the founder and
served as the Chief Executive Officer, Chief Financial Officer and Chief
Technology Officer of Net Access, an Internet service provider. Mr. Freedman has
served as a board member of the Internet Service Provider Consortium since 1996.
Mr. Freedman has completed studies towards a B.S. in Computer Science at Temple
University in Philadelphia, Pennsylvania, as well as Ph.D. courses at the State
University of New York in Stony Brook, New York.
Mr. Hourigan was promoted to Vice President of Finance in August 1998, and has
served as Controller since February 1998. Mr. Hourigan served as a consulting
associate with Deloitte & Touche LLP from October 1997 to February 1998. From
August 1993 to April 1997, Mr. Hourigan worked for NETCOM, serving in the
positions of Controller and Director of Internal Audit, Budgeting and Analysis.
From August 1991 to August 1993, Mr. Hourigan served as Financial Analyst for
Hewlett-Packard Company, a computer manufacturer. Mr. Hourigan received a B.A.
in Business Economics and a B.A. in Law & Society from University of California,
Santa Barbara and an M.B.A. from Santa Clara University.
Mr. Jepson has served as Vice President of Marketing since December 1998. From
1997 until he joined AboveNet, Mr. Jepson served as the Director of Worldwide
Field Marketing and, prior to that, the Business Development Manager for
Marimba, Inc. From 1990 to 1997, Mr. Jepson worked for Sun Microsystems, Inc.,
serving in the positions of Director of Worldwide Industry Marketing, Director
of Worldwide Manufacturing Industry Marketing and Director of Worldwide Higher
Education Marketing. Mr. Jepson received his B.S. in Electrical Engineering from
the University of California at Davis.
Mr. Kaleem has served as Vice President of Sales since January 1999. From
September 1998 to December 1998, Mr. Kaleem served as Managing Director of
National Accounts. From December 1997 to August 1998, Mr. Kaleem was the
proprietor of Unetix International. From June 1996 to October 1997, Mr. Kaleem
was the Vice President, Corporate Development and Strategic Planning of
InfoSpace, Inc. and, from 1992 to November 1995, he was the President of
ComTrade, Inc.
Mr. Monroe has served as Vice President of Construction and Real Estate since
August 1998. Mr. Monroe was a Project Manager for Cupertino Electric, an
electrical contractor, from February 1998 to August 1998. Prior to that, Mr.
Monroe was a Project Manager from April 1992 to January 1998, an Assistant
Manager from 1990 to 1992 and an Estimator from 1989 to 1990 for Truland Systems
Corporation, an electrical engineering and contracting company. Mr. Monroe
completed a four year IBEN Electrical apprenticeship program and is a licensed
electrician in the State of Virginia and Washington, D.C.
Mr. Sanders has served as Vice President of Corporate Development since August
1998. Mr. Sanders served as AboveNet's Director of Sales from May 1996 to August
1998. From April 1994 to April 1996, Mr. Sanders was the Director of Sales for
InterNex Communications, Inc., an Internet infrastructure provider. Prior
thereto, Mr. Sanders was the Founder of InterSell, a computer peripheral
manufacturer and distribution company, which subsequently was split into three
companies, from July 1976 to January 1993. The three companies were: Integrated
Marketing, a manufacturing representative firm where he held the position of
Chief Executive Officer and President; Paragon Sales, a distributor of computer
peripherals where he held the position of Chief Executive Officer; and Intek
Manufacturing, a manufacturer of intelligent printers and smart switch boxes
where he held the position of Chief Executive Officer. Mr. Sanders attended
Olympic College in Bremerton, Washington.
Dr. Steiner has served as Vice President of International -- Europe since August
1998. From August 1995 until August 1998, Dr. Steiner was the Managing Director
of Europe, Africa, Middle East and India, and from February 1995 until August
1995, Dr. Steiner was a consultant for NETCOM. From January 1994 to January
1995, Dr. Steiner was an independent consultant in Palo Alto, California. From
April 1986 to
57
<PAGE> 57
December 1993, Dr. Steiner served as a Managing Director and Partner for HOT
Engineering Ltd., a petroleum engineering software and consulting company in
Leoben, Austria. Dr. Steiner received a B.S. and M.S. in Petroleum Engineering,
and a Ph.D. in Reservoir Engineering from Leoben Mining University in Leoben,
Austria, and an M.B.A. from the University of Michigan.
Dr. Burgelman has served as a Director since November 1998. Dr. Burgelman is
currently the Edmond W. Littlefield Professor of Management and Director of the
Stanford Executive Program at Stanford Business School and has been a professor
at Stanford Business School since August 1981. From 1991 to 1992, Dr. Burgelman
also served as Chair of the Division of Business Policy and Strategy of the
Academy of Management and was a Marvin Bower Fellow at Harvard Business School.
From 1996 to 1997 and 1988 to 1989, Dr. Burgelman was a GSB Trust Faculty Fellow
and a BP America Faculty Fellow at Stanford Business School. Dr. Burgelman
earned a Licenciate degree in Applied Economics from Antwerp University in
Belgium, an M.A. in Sociology and a Ph.D. in Management of Organizations from
Columbia University.
Mr. Kline has served as a Director since August 1998. Mr. Kline has served as a
Managing Partner of Kline Hawkes California, L.P./Kline Hawkes California SBIC,
L.P., a private equity firm, since 1994. From June 1984 to June 1994, Mr. Kline
served as a private equity manager of Lambda Fund Management, Inc., a venture
capital firm. Mr. Kline currently serves as a director of four companies:
CampusLink Communications Systems, Inc., EOS Corporation, SuperShuttle
International, Inc. and TranSoft Networks, Inc. Mr. Kline also serves on the
Board of Governors of the National Association of Small Business Investment
Companies. Mr. Kline received a B.S. in Commerce from Rider College and an M.S.
from the University of Massachusetts at Amherst.
Mr. Sha has served as a Director since August 1998. Since January 1998, Mr. Sha
has served as Senior Vice President, Commerce Solutions at Netscape
Communications, a provider of software and Internet services for businesses.
From April 1996 to December 1997, Mr. Sha was the President and Chief Executive
Officer of Actra Business Systems, a developer of high-end Internet commerce
applications. Actra, a joint venture between Netscape and GE Information
Services, was acquired by Netscape in December 1997. Mr. Sha served as Vice
President and General Manager of integrated application at Netscape from August
1994 to April 1996. From June 1990 to August 1994, Mr. Sha was the Vice
President of the Unix Product Division at Oracle Corporation, a software
company. Mr. Sha received an M.S. Electrical Engineering from the University of
California at Berkeley, an M.B.A. from Santa Clara University and a B.S. in
Electrical Engineering from Taiwan University.
Dr. Shao has served as Director since January 1998. Since September 1997, Dr.
Shao has served as Managing Director of Technology Associates Management Co.,
Ltd., a venture fund manager. Dr. Shao served as a senior consultant for
Technology Associates Corporation of Taiwan, a venture investment firm, from
September 1995 to September 1997. From September 1985 to September 1995, Dr.
Shao served as Senior Vice President of DynaTech Development Corporation, a
management consulting and venture investment firm. Since August 1992, Dr. Shao
has served as President of TSS Enterprises, a privately held high technology
management consulting, investing and trading company. Dr. Shao received a Ph.D.
in Applied Mathematics/Computer Science, a M.S. in Engineering from the
University of Illinois, and a B.S. in Engineering from National Taiwan
University.
Mr. Small has served as Director since March 1997. Mr. Small is the Founder and
President of Kimball Small Properties, a San Jose, California commercial real
estate development company incorporated in 1978. Mr. Small received a B.S. from
the University of California at Los Angeles.
Mr. Vierra has served as Director since October 1998. Mr. Vierra is the Vice
Chairman of the Board of Directors and a consultant to Tele-Communications
International, Inc. (TINTA), a cable television and telecommunications company.
Prior to his current position with TINTA, Mr. Vierra served as the Chief
Executive Officer from June 1995 to January 1998 and as Executive Vice President
from December 1991 to June 1995. Prior to joining TINTA, Mr. Vierra was
President and Chief Operating Officer of the United Artists Entertainment
Company, a cable television and motion picture theatre company, from 1989 to
1991. Mr. Vierra received a B.S. in Business Administration from the University
of Tulsa.
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<PAGE> 58
Classified Board
Our certificate of incorporation provides for a classified board of directors
consisting of three classes of directors, each serving staggered three-year
terms. As a result, a portion of our board of directors is elected each year. To
implement the classified structure, prior to the consummation of the offering,
two of the nominees to the board of directors were elected to one-year terms,
two were elected to two-year terms, and three were elected to three-year terms.
Thereafter, directors will be elected for three-year terms. Robert A. Burgelman,
Frank R. Kline and Tom Shao have been designated Class I directors whose term
expires at the 1999 annual meeting of stockholders. Peter C. Chen, Warren J.
Kaplan and Fred A. Vierra have been designated Class II directors whose term
expires at the 2000 annual meeting of stockholders. James Sha, Kimball W. Small
and Sherman Tuan have been designated Class III directors whose term expires at
the 2001 annual meeting of stockholders. See "Description of Capital
Stock -- Antitakeover Effects of Provisions of Certificate of Incorporation,
Bylaws and Delaware Law."
Executive officers are appointed by the board of directors on an annual basis
and serve until their successors have been duly elected and qualified.
BOARD COMMITTEES
Our board of directors has a compensation committee and an audit committee.
Compensation Committee
The compensation committee of the board reviews and makes recommendations to our
board regarding all forms of compensation provided to our executive officers and
directors including stock compensation and loans. In addition, the compensation
committee reviews and makes recommendations on bonus and stock compensation
arrangements for all our employees. The compensation committee also administers
our 1996 and 1997 Stock Option Plans, 1998 Stock Incentive Plan and 1998
Employee Stock Purchase Plan. The current members of the compensation committee
are Messrs. Burgelman, Sha and Vierra.
Audit Committee
The audit committee reviews and monitors the corporate financial reporting and
our internal and external audits, including, among other things, our internal
audit and control functions, the results and scope of the annual audit and other
services provided by our independent auditors and our compliance with legal
matters that have a significant impact on our financial reports. The audit
committee also consults with our management and our independent auditors prior
to the presentation of financial statements to stockholders and, as appropriate,
initiates inquiries into aspects of our financial affairs. In addition, the
audit committee has the responsibility to consider and recommend the appointment
of, and to review fee arrangements with, our independent auditors. The current
members of the audit committee are Messrs. Chen, Kline, Shao and Small.
DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS
Our directors who are not employees receive cash payments of $2,000 per board
meeting and committee meeting. From time to time, certain directors who are
non-employees have received grants of options to purchase shares of our common
stock. Directors receive automatic option grants under our 1998 Stock Incentive
Plan. See "-- Stock Incentive Plan."
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<PAGE> 59
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee currently consists of Messrs. Burgelman, Sha and
Vierra. No interlocking relationship exists between any member of our board or
our compensation committee and any member of the board of directors or
compensation committee of any other company, and no such interlocking
relationship has existed in the past.
ADVISORY BOARD
We have an advisory board whose members advise our management with respect to
strategic issues and other business matters. Our advisory board currently
consists of the following persons:
Robert Berger is President of Internet Bandwidth Development, an Internet
infrastructure and service consultancy. Mr. Berger founded InterNex Information
Services, Inc. in 1993 and held various executive management positions through
1996 and served as a board member until the company was sold to Concentric
Network in March 1997.
Dr. Gregg Carse is the founder and Chief Executive Officer of CWA Communications
Products Inc., a designer of systems for telecommunications products both
domestically and internationally for over 20 years.
Adam Cioth is the Managing Partner of Rolling Hills Capital, a private equity
investment and strategic advisory firm. Prior to that he served as a Managing
Director of Volpe Brown Whelan & Company.
Michael Conley is Director of Asian Operations for Nuance Communications, a
provider of speech recognition technologies for telecommunication and enterprise
applications. Mr. Conley had previous Asia-related positions with Spyglass Inc.,
a leading Internet software provider, and NetFRAME Systems where he worked as
Vice President, Asia Pacific.
Daniel Gatti has been President and Chief Executive Officer of Mayan Networks, a
multiservice carrier class access switch company, since June 1998. Prior to
joining Mayan Networks, Mr. Gatti served as Vice President and General Manager
of 3Com Corporation's Network Service Provider Division.
Glenn Kohner is President of ISO-Online Inc. Prior to 1996, Mr. Kohner was a
consultant and business owner.
James Lee is Director of Strategy at the Singapore National Information
Technology Research Institute, Kent Ridge Digital Labs.
Frank McGrath retired on March 1, 1999. Prior to that time he served as Vice
President of MCI WorldCom, Inc. since 1988. From 1980 to 1988, Mr. McGrath was
Vice President of ITT World Communications.
Richard Steranka has held several positions at Cisco Systems, Inc. since 1992.
Mr. Steranka is presently Director, Small-Medium Business Channel Marketing.
Bruce Weber has been President of QMS Quality Management Systems, Inc. since
1995 and a Managing Director of Boca Corporate Resources, a successor of Martin,
Randolph and Barnes since 1992, a firm specializing in corporate acquisitions,
restructuring and leveraged buyouts.
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EXECUTIVE COMPENSATION
The following table sets forth the compensation earned during the fiscal year
ended June 30, 1998, by our Chief Executive Officer and our three other most
highly compensated executive officers for services rendered in all capacities
for that fiscal year.
SUMMARY COMPENSATION TABLE FOR LAST FISCAL YEAR
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
-------------------
ANNUAL COMPENSATION SECURITIES
----------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) OPTIONS(#)
--------------------------- --------- -------- -------------------
<S> <C> <C> <C>
Sherman Tuan
Chief Executive Officer.................. 132,500(1) --(2) 67,500(3)
Warren J. Kaplan
President, Chief Operating Officer....... 71,635(4) --(5) 202,500(6)
Stephen P. Belomy
Executive Vice President................. 112,500(7) -- 42,500(8)
David Rand
Chief Technology Officer................. 103,333(9)(10) -- 30,000(11)
</TABLE>
- -------------------------
(1) Mr. Tuan's annual base salary is currently $225,000 with a minimum annual
increase of 10% each year. See "-- Employment Agreements."
(2) Mr. Tuan will receive a minimum annual bonus of $50,000 per year with a
minimum bonus increase of 10% each year. However, this bonus will not
exceed the amount of Mr. Tuan's then current salary. See "-- Employment
Agreements."
(3) On August 18, 1998, Mr. Tuan received an option to purchase 131,500 shares
of common stock at an exercise price of $12.00 per share. This option will
vest in equal installments over 48 months. On December 1, 1998, our board
of directors approved an amendment to reduce the exercise price of the
option to $10.00 per share. On April 6, our board of directors approved a
correction to change the vesting schedule as follows: 20% of the option
shares are fully vested and the balance becomes vested over the next 36
months of service measured from August 18, 1998. See "Certain
Transactions." On December 18, 1998 Mr. Tuan received an option to purchase
2,500 shares at an exercise price of $12.125 per share. The option shares
were fully vested on the date of grant.
(4) Mr. Kaplan's annual base salary is currently $225,000 with a minimum annual
increase of 10% each year. See "-- Employment Agreements."
(5) Mr. Kaplan will receive a minimum annual bonus of $50,000 per year with a
minimum annual bonus increase of 10% each year. However, this bonus will
not exceed the amount of Mr. Kaplan's then current salary. See "--
Employment Agreements."
(6) On December 18, 1998 Mr. Kaplan received an option to purchase 2,500 shares
at an exercise price of $12.125 per share. The option shares were fully
vested on the date of grant.
(7) Mr. Belomy's annual base salary is currently $160,000.
(8) On December 18, 1998 Mr. Belomy received an option to purchase 2,500 shares
at an exercise price of $12.125 per share. The option shares were fully
vested on the date of grant.
(9) Mr. Rand's employment started on May 1, 1998 at an annual salary of
$140,000. Mr. Rand's annual base salary is currently $190,000.
(10) Includes $80,000 earned as a consultant.
(11) On August 18, 1998, Mr. Rand received an option to purchase 101,250 shares
of common stock at an exercise price of $12.00 per share. On December 1,
1998, our board of directors approved an amendment to reduce the exercise
price of the option to $10.00 per share. On April 6, our board of directors
approved a correction to change the vesting schedule as follows: 20% of the
option shares are fully vested and the balance becomes vested over the next
36 months of service measured from August 18, 1998. See "Certain
Transactions." On December 18, 1998 Mr. Rand received an option to purchase
2,500 shares at an exercise price of $12.125 per share. The option shares
were fully vested on the date of grant. On March 21, 1999, Mr. Rand
received an option to purchase an additional 25,000 shares of common stock.
The option shares were fully vested on the date of grant. On March 21, 1999
Mr. Rand received an option to purchase 25,000 shares of common stock. This
option will vest in equal installments over 36 months.
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<PAGE> 61
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options during the fiscal
year ended June 30, 1998 to our Chief Executive Officer and our three other most
highly compensated executive officers. No stock appreciation rights were granted
during the last fiscal year.
The assumed 5% and 10% rates of stock price appreciation are provided in
accordance with rules of the Securities and Exchange Commission and do not
represent our estimate or projection of our common stock price. Actual gains, if
any, on stock option exercises are dependent on the future performance of our
common stock, overall market conditions and the option holders' continued
employment through the vesting period. Unless the market price of our common
stock appreciates over the option term, no value will be realized from the
option grants made to these executive officers. The potential realizable values
shown in the table are calculated by assuming that the estimated fair market
value of our common stock on the date of grant increases by 5% and 10%,
respectively, during each year of the option term. See footnote 7 for
information on how the fair market value was estimated.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT
----------------------------------------------------------- ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK PRICE
SECURITIES TOTAL APPRECIATION FOR
UNDERLYING OPTIONS GRANTED EXERCISE OR OPTION TERM($)
OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION ---------------------
NAME GRANTED(#) FISCAL YEAR(6) ($/SHARE)(7) DATE(8) 5% 10%
---- ---------- --------------- ------------ ---------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Sherman Tuan......... 62,500(1) 11.18 0.40 12/09/07 15,722 39,844
5,000(2) * 1.20 1/26/08 3,773 9,562
Warren J. Kaplan..... 27,500(3) 4.92 0.20 11/09/07 3,459 8,766
175,000(4) 31.30 0.40 11/09/07 44,023 111,562
Stephen P. Belomy.... 37,500(5) 6.71 0.40 12/09/07 9,433 23,906
5,000(2) * 1.20 1/26/08 3,773 9,562
David Rand........... 25,000(5) 4.47 0.40 12/09/07 6,289 15,937
5,000(2) * 1.20 1/26/08 3,773 9,562
</TABLE>
- -------------------------
* Less than one percent.
(1) 6.25% of the shares vest every 3 months after the vesting commencement date
until the first anniversary of the vesting commencement date. 1/36 of the
remaining shares vest each month thereafter. Under the terms of Mr. Tuan's
employment agreement, all of the shares subject to this option will
accelerate and become fully vested if either Mr. Tuan's employment with us
is terminated without cause or there is a material breach by us of his
employment agreement. See "-- Employment Agreements."
(2) Each of the options granted to Messrs. Tuan, Belomy and Rand on January 27,
1998 were fully vested at the time of grant.
(3) 1/3 of the shares vested on December 10, 1997, 1/3 of the shares vested on
January 10, 1998 and 1/3 of the shares vested on February 9, 1998. 9,166 of
the option shares were cancelled when Mr. Kaplan joined us as President and
Chief Operating Officer.
(4) 1/5 of the shares were immediately exercisable on the date of grant and
1/36 of the remaining shares became exercisable each month thereafter. All
unvested options accelerated upon the closing of our initial public offering
on December 10, 1998.
(5) 6.25% of the shares vest every 3 months after the vesting commencement date
until the first anniversary of the vesting commencement date. 1/36 of the
remaining shares vest each month thereafter.
(6) Based on an aggregate of 559,125 options granted to our employees under our
1997 Stock Option Plan and the option granted to Mr. Kaplan on November 10,
1997 with an exercise price of $0.40 per share. See "-- Employment
Agreements."
(7) The exercise price is equal to the deemed fair market value of our common
stock as estimated by our board of directors on the date of grant. However,
the exercise price of the option granted to Mr. Kaplan on November 10, 1997
to purchase 175,000 shares of common stock at an exercise price of $0.40 per
share was deemed to be above the fair market value on the date of grant. The
fair market value of our common stock was estimated by our board of
directors on the basis of the purchase price paid by investors for shares of
our preferred stock, taking into account the liquidation preferences and
other rights, privileges and preferences associated with such preferred
stock, and an evaluation by our board of directors of our revenues,
operating history and prospects.
(8) Each of the options has a ten-year term. However, the options will terminate
earlier if the optionee ceases service with us.
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<PAGE> 62
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information concerning the options exercised by
our Chief Executive Officer and our three other most highly compensated
executive officers in fiscal year 1998 and the year-end number and value of
unexercised options with respect to each of these executive officers. No stock
appreciation rights were exercised by these executive officers in fiscal year
1998 or were outstanding at the end of that year.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES AT FISCAL YEAR-END(#) AT FISCAL YEAR-END($)(3)
ACQUIRED ON VALUE ------------------------------ ---------------------------
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE(2) UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------------- -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Sherman Tuan........... -- -- 155,000 87,500 771,500 451,500
Warren J. Kaplan....... 65,833 64,833 14,721 112,777 70,661 541,330
Stephen P. Belomy...... 7,551 37,708 55,781 -- 268,124 --
David Rand............. -- -- 86,250 62,500 427,250 317,500
</TABLE>
- -------------------------
(1) Based on the fair market value of our common stock on the date of exercise,
less the exercise price payable for such shares.
(2) Certain of the options are then immediately exercisable for all the option
shares as of the date of grant but any shares purchased are subject to
repurchase by us at the original exercise price paid per share if the
optionee ceases service with us before vesting in such shares.
(3) Based on the fair market value of our common stock at fiscal year end of
$5.20 per share less the exercise price payable for such shares. The fair
market value of our common stock at the end of fiscal year 1998 was
estimated by our board of directors on the basis of the purchase price paid
by investors for shares of our preferred stock, taking into account the
liquidation preferences and other rights, privileges and preferences
associated with such preferred stock, and an evaluation by our board of
directors of our revenues, operating history and prospects.
STOCK INCENTIVE PLAN
In August 1998, our board of directors adopted our 1998 Stock Incentive Plan. It
replaces our 1996 Stock Option Plan and our 1997 Stock Plan. The 1996 Stock
Option Plan and 1997 Stock Plan terminated when we adopted the 1998 Stock
Incentive Plan. No further grants will be made under the 1996 Stock Option Plan
and 1997 Stock Plan, although they will continue to govern all outstanding
awards made under their terms. All awards will be made under the 1998 Stock
Incentive Plan.
We reserved 1,562,500 shares of common stock for issuance under the 1998 Stock
Incentive Plan. If we forfeit or terminate any options granted under the 1998
Stock Incentive Plan for any reason without the grants having been exercised in
full, then the unpurchased shares subject to those options will become available
for additional grants of stock options or shares under the 1998 Stock Incentive
Plan. If we forfeit any shares granted or purchased under the 1998 Stock
Incentive Plan, then those shares will also become available for additional
grants under the 1998 Stock Incentive Plan. The number of shares reserved for
issuance under the 1998 Stock Incentive Plan will increase automatically on July
1 of each year by a number equal to the lesser of (1) 312,500 shares or (2) 4%
of the shares of common stock outstanding at that time. Options granted to any
optionee in a single fiscal year shall not cover more than 312,500 shares.
However, options granted to a new employee in the fiscal year in which his or
her service as an employee first commences shall not cover more than 625,000
shares.
Under the 1998 Stock Incentive Plan, directors, employees, and consultants and
advisors to us, or a subsidiary or affiliate of us, are eligible to purchase
shares of common stock and to receive awards of shares or grants of nonstatutory
options. Employees are also eligible to receive grants of incentive stock
options intended to qualify under Section 422 of the Internal Revenue Code of
1986, as amended. Collectively, these grants are known as awards. Our
compensation committee of our board of directors administers the 1998 Stock
Incentive Plan and selects the persons to whom shares will be sold or awarded or
options will be granted, determines the type, number, vesting requirements and
other features and conditions of each sale, award or grant, interprets this plan
and makes all other decisions relating to the operation of the plan.
The exercise price under any nonstatutory stock options generally must be at
least 85% of the fair market value of the common stock on the date of grant, and
the exercise price may vary in accordance with a
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<PAGE> 63
predetermined formula while the nonstatutory stock option is outstanding. The
exercise price under incentive stock options cannot be lower than 100% of fair
market value of the common stock on the date of grant and, in the case of
incentive stock options granted to holders of more than 10% of our voting power,
not less than 110% of such fair market value. The term of an incentive stock
option cannot exceed 10 years, and the term of an incentive stock option granted
to a holder of more than 10% of our voting power cannot exceed five years.
The exercise price of common stock issued upon exercise of options is payable in
cash equivalents at the time when such shares are purchased. However, the stock
option agreement for an incentive stock option, and with respect to nonstatutory
stock option, the compensation committee at any time, may specify that payment
may be made in any of the following forms: (1) by surrendering, or attesting to
the ownership of, shares of common stock that are already owned by the optionee;
(2) by delivering an irrevocable direction to a securities broker approved by us
to sell all or part of the shares being purchased under the 1998 Stock Incentive
Plan and to deliver all or part of the sales proceeds to us; (3) by delivering
an irrevocable direction to pledge all or part of the shares being purchased
under the 1998 Stock Incentive Plan to a securities broker or lender approved by
us, as security for a loan, and to deliver all or part of the loan proceeds to
us; (4) by delivering a full-recourse promissory note; or (5) any other form
that is consistent with applicable laws, regulations and rules. The par value of
the shares being purchased under the 1998 Stock Incentive Plan, if newly issued,
must be paid in cash or cash equivalents.
Each new non-employee director who is elected to our board of directors will
automatically be granted as of the date of election a nonstatutory stock option
to purchase 9,375 shares of common stock at an exercise price equal to the fair
market value of the common stock on the date of grant. The shares subject to
these options will vest in 36 equal installments at monthly intervals over the
three-year period commencing on the date of grant. In addition, each
non-employee director who will continue to serve following any annual meeting of
stockholders will automatically be granted an option as of the date of such
meeting to purchase 3,125 shares of common stock at an exercise price equal to
the fair market value of the common stock on the date of grant. These options
will vest on the first anniversary of grant. These options will expire on the
earliest of (1) the 10th anniversary of grant, (2) 3 months after termination of
service for any reason other than death or total and permanent disability or (3)
12 months after termination of service due to death or disability. No director
will receive the 9,375-share grant and a 3,125-share grant in the same fiscal
year.
Our compensation committee may permit or require an optionee to have shares that
otherwise would be delivered to such optionee as a result of the exercise of an
option converted into amounts credited to a deferred compensation account
established for such optionee as an entry on our books. In addition to options,
shares may be sold or awarded under the 1998 Stock Incentive Plan for such
consideration as the compensation committee may determine, including, without
limitation, cash, cash equivalents, full-recourse promissory notes, past
services and future services. To the extent that an award consists of newly
issued shares, the recipient must furnish consideration with a value not less
than the par value of such shares in the form of cash, cash equivalents or past
services rendered to us or a parent or subsidiary, as the compensation committee
may determine. The holders of shares awarded under the 1998 Stock Incentive Plan
shall have the same voting, dividend and other rights as our other stockholders
except that the award agreement may require that the holders of shares invest
any cash dividends received in additional shares. These additional shares are
subject to the same conditions and restrictions as the award with respect to
which the dividends were paid.
Immediately before the effective date of a change in control, an award will
become fully exercisable as to all shares subject to this award, except that (1)
in the case of an incentive stock plan, the acceleration of exercisability shall
not occur without the optionee's written consent; and (2) if we and the other
party to the transaction constituting a change in control agree that such
transaction is to be treated as a "pooling of interest" for financial reporting
purposes, and if such transaction in fact is so treated, then the acceleration
of exercisability shall not occur to the extent that our independent accountants
and the other party's independent accountants separately determine in good faith
that such acceleration would preclude the use of "pooling of interest"
accounting. In addition, all options granted to non-employee directors will
become fully exercisable if the director's service terminates because of death,
total and permanent disability or retirement at or after age 70.
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<PAGE> 64
Our board of directors may amend or terminate the 1998 Stock Incentive Plan at
any time. The 1998 Stock Incentive Plan shall remain in effect until it is
terminated except that no incentive stock options shall be granted on or after
the 10th anniversary of the later of (1) the date when our board of directors
adopted the 1998 Stock Incentive Plan or (2) the date when the board adopted the
most recent increase in the number of shares of common stock available under the
1998 Stock Incentive Plan which was approved by our stockholders. Amendments may
be subject to stockholder approval to the extent required by applicable laws.
EMPLOYEE STOCK PURCHASE PLAN
In August 1998, our board of directors adopted our Employee Stock Purchase Plan
to provide our employees with an opportunity to purchase common stock through
payroll deductions. Under the Employee Stock Purchase Plan, 156,250 shares of
common stock have been reserved for issuance. As of July 1 of each year, the
number of shares reserved for issuance under the Employee Stock Purchase Plan
will increase automatically by the number of shares necessary to cause the
number of shares then available for purchase to be restored to 156,250. The
Employee Stock Purchase Plan became effective at the time of our initial public
offering. All employees whose customary employment is for more than five months
per calendar year and for more than 20 hours per week are eligible to
participate in the Employee Stock Purchase Plan.
Eligible employees may contribute up to 15% of their total cash compensation to
the Employee Stock Purchase Plan. Amounts withheld are applied at the end of
every six-month accumulation period to purchase shares of common stock, but not
more than 3,125 shares per accumulation period. The value of the common stock
(determined as of the beginning of the offering period) that may be purchased by
any participant in a calendar year is limited to $25,000. Participants may
withdraw their contributions at any time before stock is purchased.
The purchase price is equal to 85% of the lower of (1) the market price of
common stock immediately before the beginning of the applicable offering period
or (2) the market price of common stock at the time of the purchase. In general,
each offering period is 24 months long, but a new offering period begins every
six months. Thus, up to four overlapping offering periods may be in effect at
the same time. An offering period continues to apply to a participant for the
full 24 months, unless the market price of common stock is lower when a
subsequent offering period begins. In that event, the subsequent offering period
automatically becomes the applicable period for purposes of determining the
purchase price. The first accumulation and offering periods commenced on
December 10, 1998 and will end on April 30, 1999, and October 31, 2000,
respectively.
EMPLOYMENT AGREEMENTS
We entered into an employment agreement with Sherman Tuan dated as of February
1, 1998. Under this employment agreement, Mr. Tuan receives certain compensation
and benefits including, but not limited to, an annual base salary of $225,000,
bonus, and stock options. Mr. Tuan's current bonus amount is at a minimum
$50,000. The bonus cannot exceed the amount of Mr. Tuan's then current salary.
In addition, Mr. Tuan is guaranteed a minimum annual salary and bonus increase
of 10% each year. Mr. Tuan receives his base salary for twelve months and fully
vests in his option shares following either a termination without cause or a
material breach of his employment agreement by us before December 31, 1999. For
the purposes of this agreement, "cause" means (1) Mr. Tuan's conviction of,
guilty or "no contest" plea to or confession of guilt of a felony, (2) a willful
act by Mr. Tuan which constitutes gross misconduct and which is materially
injurious to us or (3) violation by Mr. Tuan of our proprietary information and
inventions agreement without our prior written consent. "Material Breach" means
(a) the failure of us to pay base salary or additional compensation in
accordance with his employment agreement, (b) the assignment to Mr. Tuan without
Mr. Tuan's consent of duties substantially inconsistent with his duties as set
forth in his employment agreement, (c) the relocation of our principal offices
to a geographic location other than Northern California, or (d) a failure to
reelect Mr. Tuan as a member of the board.
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<PAGE> 65
We have entered into an employment agreement with Warren J. Kaplan dated as of
November 10, 1997. Under his employment agreement, Mr. Kaplan receives certain
compensation and benefits including, but not limited to an annual base salary of
$225,000, a bonus of at least $50,000 which does not exceed his then current
salary, and stock options. We shall continue to pay Mr. Kaplan his base salary
for twelve months following a termination without cause during the term of his
employment agreement. In addition, Mr. Kaplan is guaranteed a minimum annual
salary and bonus increase of 10% each year.
Under the terms of his employment agreement, Mr. Kaplan received an option to
purchase shares of our common stock. This option was initially for 175,000
shares. However, the option contained an anti-dilution clause which guaranteed
that, prior to any underwritten initial public offering of our securities, the
number of option shares granted to Mr. Kaplan would always be equal to 5% of our
outstanding common stock less 18,333 option shares. Under the terms of this
anti-dilution clause, Mr. Kaplan received an additional 264,862 option shares on
July 31, 1998, an additional 30,110 option shares on September 4, 1998 and an
additional 22,240 option shares on December 1, 1998. This option is immediately
exercisable with respect to 20% of the option shares and the balance became
exercisable in equal monthly installments over the next 36 months of employment
with us measured from November 10, 1997, the date of Mr. Kaplan's employment
agreement. All outstanding options are fully vested upon the completion of our
initial public offering. The exercise price is $0.40 per share which was above
the fair market value of our common stock on November 10, 1997.
We have entered into an employment agreement with David Rand effective as of May
1, 1998. Under his employment agreement, Mr. Rand was appointed our Chief
Technology Officer. Mr. Rand's base salary is currently $190,000. Mr. Rand
receives six months' severance if he is terminated without cause.
See "Risk Factors -- We may not be able to hire or retain the key employees we
need."
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
Our Restated Certificate of Incorporation limits the liability of directors to
the maximum extent not prohibited by Delaware law. Delaware law provides that a
corporation's certificate of incorporation may contain a provision eliminating
or limiting the personal liability of a director for monetary damages for breach
of their fiduciary duties as directors, except for liability for any of the
following:
- for any breach of their duty of loyalty to the corporation or our
stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- for unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General Corporation
Law; or
- for any transaction from which the director derived an improper personal
benefit.
Our bylaws provide that we shall indemnify our directors, officers and employee
benefit plan fiduciaries, and may indemnify our employees and agents to the
fullest extent permitted by law. We believe that indemnification under our
bylaws covers at least negligence and gross negligence on the part of
indemnified parties. Our bylaws also permit us to advance expenses incurred by
an indemnified director or officer in connection with the defense of any action
or proceeding arising out of the director's or officer's status or service as
our director or officer upon any undertaking by the director or officer to repay
any advances if it is ultimately determined that such director or officer is not
entitled to such indemnification.
We have also entered into agreements to indemnify our directors and officers.
These agreements, among other things, indemnify our directors and officers for
certain expenses (including attorneys' fees and associated legal expenses),
judgments, fines and amounts paid in settlement amounts if this settlement is
approved in advance by us, which approval shall not be unreasonably withheld,
actually and reasonably incurred by any person in any action, suit, proceeding
or alternative dispute resolution mechanism arising out of that person's
services as our director or officer, any subsidiary of us or any other company
or enterprise to which the person provides services at our request. We believe
that those provisions and agreements are necessary to attract and retain
qualified directors and officers.
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<PAGE> 66
CERTAIN TRANSACTIONS
Since our inception in March 1996, there has not been any transaction or series
of similar transactions to which we were or are a party in which the amount
involved exceeded or exceeds $60,000 and in which any director, executive
officer, holder of more than 5% of any class of our voting securities or any
member of the immediate family of any of the foregoing persons had or will have
a direct or indirect material interest, other than the transactions described
below.
EQUITY FINANCINGS
From inception to our initial public offering in December, 1998, we financed our
growth primarily through the sale of preferred stock, resulting in the issuance
of an aggregate of 1,025,000 shares of series A preferred stock at purchase
price of $0.40 per share; 1,631,896 shares of series B preferred stock at a
weighted-average purchase price of $1.35 per share; 2,003,000 shares of series C
preferred stock at a weighted-average purchase price of $1.93 per share;
2,115,378 shares of series D preferred stock at a purchase price of $5.20 per
share; and 408,775 shares of series E preferred stock at a purchase price of
$10.00 per share. The purchasers of our series A preferred stock, series B
preferred stock, series C preferred stock, series D preferred stock and series E
preferred stock include the following directors, executive officers and 5% or
greater stockholders:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF PREFERRED STOCK
----------------------------------------------------
NAME SERIES A SERIES B SERIES C SERIES D SERIES E
---- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Hui-Tzu Hu(1)............................ -- 150,013 500,000 192,307 --
Kline Hawkes California SBIC,
L.P.(1)(2)............................. -- -- -- 769,230 40,000
Techgains Corp. and Technology Associates
Management Co., Ltd.(1)(3)............. -- -- 552,500 192,307 --
Primus Technology Fund(1)................ -- -- -- 384,615 112,000
Peter C. Chen(1)(4)...................... 275,000 171,078 -- -- --
Warren J. Kaplan(5)...................... -- -- 12,500 -- 2,500
Kimball Small(6)......................... -- 325,000 -- -- --
Spring Creek Investments(7).............. -- -- -- 96,153 --
Jerry Chen(8)............................ -- 33,750 -- -- --
</TABLE>
- -------------------------
(1) Holds 5% or more of our outstanding capital stock. Includes all shares held
by affiliated entities.
(2) Frank R. Kline, a director, is a private equity manager of Kline Hawkes
California SBIC, L.P.
(3) Tom Shao, a director, is a Managing Director of Technology Associates
Management Co., Ltd.
(4) Peter C. Chen is a director.
(5) Includes shares held by Mr. Kaplan and his wife. Warren J. Kaplan is
President, Chief Operating Officer and a director.
(6) Kimball Small is a director.
(7) James Sha, a director, is a principal of Spring Creek Investments.
(8) Jerry Chen is an executive officer.
CONSULTING WARRANTS
We issued a warrant to Primus Technology Fund, a holder of more than 5% of our
capital stock, to purchase 8,750 shares of our common stock at a per share
exercise price of $5.20 in connection with services provided by Primus in
assisting us in establishing operations in Asia.
In December 1996, we granted options to purchase an aggregate of 104,166 shares
of our common stock at an exercise price of $0.12 per share to Stephen Belomy,
our Executive Vice President and Secretary, and Kimball Small, a member of our
board of directors, in consideration of their real estate consulting services.
In June 1998, our Board fully accelerated the vesting of these options.
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<PAGE> 67
REAL PROPERTY AGREEMENTS
Kimball Small Properties co-manages the building in which our San Jose,
California office and Internet service exchange facility is located, and has an
ownership interest in the building. Kimball Small, President of Kimball Small
Properties, holds more than 5% of our capital stock and is a director.
We entered into a lease for an approximately 110,000 square foot Internet
service exchange facility in San Jose, California. Kimball Small Properties
co-manages the building in which the new facility is being developed and has an
ownership interest in the building. See "Risk Factors -- We may face problems in
connection with our expansion plans."
WARRANTS
In connection with the exchange of outstanding notes and warrants for our series
B preferred stock, we issued a warrant to the Peter and Pat Chen Living Trust,
owned as community property by Peter C. Chen, a holder of more than 5% of our
capital stock and Vice Chairman of the Board of Directors, to purchase 26,972
shares of our common stock at a per share exercise price of $2.00.
In connection with the exchange of outstanding notes and warrants for our series
B preferred stock, we issued a warrant to Hui-Tzu Hu, a holder of more than 5%
of our capital stock, to purchase 29,375 shares of our common stock at a per
share exercise price of $2.00.
TECHNOLOGY AGREEMENT
David Rand, our Chief Technology Officer, has granted to us perpetual,
non-royalty bearing worldwide licenses to the EtherValve and MRTG technologies
and assigned the APS and ASAP technology to us pursuant to a technology
agreement dated August 18, 1998. In consideration for entering into the
agreement, Mr. Rand received options to purchase 101,250 shares of our common
stock at an exercise price of $12.00 per share. On December 1, 1998, the Board
approved an amendment to reduce the exercise price of the option to $10.00 per
share. See "-- Option Repricing." The options vest over four years.
SERVICE OPTIONS
On March 27, 1999, the board of directors granted options to each of Kimball
Small and Frank R. Kline, both of whom are our directors, for 12,500 and 15,000
shares of our common stock. The options have an exercise price of $85.06 per
share and vest in three equal annual installments and terminate in 3 years.
OPTION REPRICING
On December 1, 1998, the board of directors approved the amendment of all
outstanding stock options under our 1997 Stock Plan with an exercise price in
excess of $10.00 per share. As a result, all options granted in August 1998,
September 1998 and October 1998 were repriced at $10.00 per share, including the
options granted to Sherman Tuan, our Chief Executive Officer and Chairman of our
Board of Directors, on August 18, 1998 for 131,500 shares, the option granted to
David Rand, our Chief Technology Officer, on August 18, 1998 for 101,250 shares
and options granted to each of Fred A. Vierra and Robert A. Burgelman, both of
whom are directors, on October 14, 1998 and October 28, 1998, respectively, for
9,375 shares.
We believe that all of the transactions set forth above were made on terms no
less favorable to us than could have been obtained from unaffiliated third
parties. All future transactions, including loans between us and our officers,
directors, principal stockholders and their affiliates, will be approved by a
majority of our board, including a majority of the independent and disinterested
outside directors on the board of directors, and will continue to be on terms no
less favorable to us than could be obtained from unaffiliated third parties.
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<PAGE> 68
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information regarding the beneficial ownership of
common stock as of March 31, 1999, and as adjusted to reflect the sale by us of
2,825,178 shares of common stock and the sale of 1,174,822 shares of common
stock by the following individuals or groups:
- each person or entity who is known by us to own beneficially more than 5% of
our common stock;
- each director;
- each of the Named Executive Officers;
- all of our executive officers and directors as a group; and
- all other selling stockholders.
Unless otherwise indicated, the address for each five percent stockholder listed
in the following table is c/o AboveNet Communications Inc, 50 W. San Fernando
Street, Suite #1010, San Jose, California 95113. Except as otherwise indicated,
and subject to applicable community property laws, the persons named in the
table have sole voting and investment power with respect to all shares of common
stock held by them.
Applicable percentage ownership in the following table is based on 13,665,990
shares of common stock outstanding as of March 31, 1999.
To the extent that any shares are issued upon exercise of options, warrants or
other rights to acquire capital stock that are presently outstanding or granted
in the future or reserved for future issuance under stock plans, there will be
further dilution to new public investors.
The numbers shown in the table below assume no exercise by the underwriters of
their over-allotment option. AboveNet has granted the underwriters an option to
purchase up to 600,000 shares, to cover over-allotments, if any.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO OFFERING AFTER OFFERING
-------------------- SHARES --------------------
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS NUMBER PERCENT OFFERED NUMBER PERCENT
--------------------------------------- --------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
Kline Hawkes California SBIC, L.P.(1)..... 910,063 6.7 -- 910,063 5.5
11726 San Vicente Blvd
Suite 300
Los Angeles, California 90049
Hui-Tzu Hu................................ 867,175 6.3 150,000 717,175 4.3
c/o D-Link Corporation
2F No. 233-2 Pro-Chino Road
Tsin-Tren
Taipei, Taiwan R.O.C
Techgains Corp. and Technology
Associates.............................. 744,807 5.5 148,961 595,846 3.6
Management Co., Ltd.(2)
2378 W. 239th Street
Torrance, California 90501
Robert A. Burgelman, Ph.D.(3)............. 9,375 * -- 9,375 *
Peter C. Chen, Ph.D.(4)................... 468,900 3.4 100,000 368,900 2.2
Warren J. Kaplan(5)....................... 524,007 3.7 77,000 447,007 2.6
Frank R. Kline(6)......................... 910,063 6.7 -- 910,063 5.5
James Sha(7).............................. 96,153 * -- 96,153 *
Tom Shao, Ph.D.(8)........................ 744,807 5.5 148,961 595,846 3.6
Kimball Small(9).......................... 409,027 3.0 70,000 339,027 2.0
Sherman Tuan(10).......................... 427,125 3.1 20,000 407,125 2.4
Fred A. Vierra(11)........................ 9,375 * -- 9,375 *
Stephen P. Belomy(12)..................... 108,333 * 20,000 88,333 *
David Rand(13)............................ 228,888 1.6 40,000 188,888 1.1
All directors and officers as a group (21
persons)(14)............................ 4,106,423 27.8 513,437 3,592,986 20.4
</TABLE>
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<PAGE> 69
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO OFFERING AFTER OFFERING
-------------------- SHARES --------------------
OTHER SELLING STOCKHOLDERS NUMBER PERCENT OFFERED NUMBER PERCENT
-------------------------- --------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
En-Lei Tuan............................... 375,000 2.7 200,000 175,000 1.1
North American
Venture Fund L.P........................ 242,307 1.8 121,154 121,153 *
Synergy (formerly Prosperity.............. 250,000 1.8 50,000 200,000 1.2
Capital)
Ching-Jung Chen........................... 208,000 1.5 45,000 163,000 1.0
Jerry Chen(15)............................ 157,185 1.1 20,000 137,185 *
Other Selling Stockholders................ 530,144 3.9 112,707 417,437 2.5
each holding less than one percent of
the common stock prior to the offering,
as a group (13 persons or entities)
</TABLE>
- -------------------------
* Each stockholder represents less than 1 percent.
(1) The General Partner of Kline Hawkes California SBIC, a California limited
partnership, is Kline Hawkes California SBIC GP, a limited partnership. The
General Partner of Kline Hawkes California SBIC GPLP is Kline Hawkes
Management SBIC, Inc. The controlling shareholder of Kline Hawkes
Management SBIC, Inc. is Frank R. Kline, Jr.
(2) Includes all shares held by TAMC. Mr. Shao is a Managing Director of TAMC.
Mr. Shao, a director of AboveNet, disclaims beneficial ownership of such
shares except to the extent of his pecuniary interest therein.
(3) Includes 9,375 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Burgelman is a director
of AboveNet.
(4) Includes all shares owned as community property with Pat Chen and all
shares owned by the Peter Cheng-Yu and Pat Te-Hui Living Trust. Mr. Chen is
a director of AboveNet.
(5) Includes 424,424 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999 (all of which are currently
vested). Includes for purposes of calculations under Rule 13d-3 of the
Securities Exchange Act of 1934, as amended, 15,000 shares of common stock
owned by Judith A. Kaplan, Mr. Kaplan's wife. However, Judith A. Kaplan's
shares are held as separate property. Excludes shares of common stock owned
by Mr. Kaplan's adult children. Mr. Kaplan is a director and an officer of
AboveNet. In December 1998, Mr. Kaplan bought 2,000 shares of our common
stock on the open market. In connection with this offering, Mr. Kaplan will
disgorge his profits on the sale of 2,000 shares of common stock to us
pursuant to Section 16(b) of the Exchange Act of 1934, as amended.
(6) Includes 909,230 shares held by Kline Hawkes California SBIC, L.P. and our
affiliates. Includes 833 shares of common stock issuable to Mr. Kline
pursuant to options exercisable within 60 days of March 31, 1999. Mr.
Kline, a director of AboveNet and a private equity manager of Kline Hawkes
California L.P./Kline Hawkes California SBIC, L.P., disclaims beneficial
ownership of such shares except to the extent of his pecuniary interest.
(7) Includes 96,153 shares held by Spring Creek Investments. Mr. Sha, a
director of AboveNet, is a principal of Spring Creek Investments.
(8) Includes 744,807 shares held by Techgains Corp. and Technology Associates
Management Co., Ltd. (collectively, "TAMC"). Mr. Shao is a Managing
Director of TAMC. Mr. Shao, a director of AboveNet, disclaims beneficial
ownership of such shares except to the extent of his pecuniary interest
therein.
(9) Includes 84,027 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Includes all shares held in
community property with Martha Small. Mr. Small is a director of AboveNet.
(10) Includes 245,250 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Tuan is a director and an
officer of AboveNet.
(11) Includes 9,375 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Vierra is a director of
AboveNet.
(12) Includes 33,281 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Belomy is an officer of
AboveNet.
(13) Includes 210,138 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Rand is an officer of
AboveNet.
(14) Includes 1,121,312 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. See also footnotes 4, 6 and
8.
(15) Includes 27,499 shares of common stock issuable pursuant to options
exercisable within 60 days of March 31, 1999. Mr. Chen is an officer of
AboveNet.
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<PAGE> 70
DESCRIPTION OF CAPITAL STOCK
GENERAL
We are authorized to issue 60,000,000 shares of common stock, $0.001 par value,
and 5,000,000 shares of undesignated preferred stock, $0.001 par value. The
following description of our capital stock and certain provisions of our
certificate of incorporation and bylaws is not complete and is subject to and
qualified in its entirety by our certificate of incorporation and bylaws, which
are included as exhibits to the registration statement of which this prospectus
forms a part, and by applicable provisions of Delaware law.
COMMON STOCK
As of March 31, 1999, there were 13,665,990 shares of common stock outstanding
that were held of record by approximately 150 stockholders. There will be
16,491,168 shares of common stock outstanding (assuming no exercise of options
and warrants outstanding as of March 31, 1999 or granted thereafter) after
giving effect to the sale of common stock offered to the public hereby. The
holders of common stock are entitled to one vote per share held of record in all
matters submitted to a vote of stockholders. Holders of common stock do not have
cumulative voting rights, and, therefore, holders of a majority of the shares
voting for the election of directors can elect all of the directors. In such
event, the holders of the remaining shares will not be able to elect any
directors.
Holders of the common stock are entitled to receive such dividends as may be
declared from time to time by the board of directors out of funds legally
available therefor, subject to the terms of any existing or future agreements
between us and our debtholders. We have never declared or paid cash dividends on
our capital stock, expect to retain future earnings, if any, for use in the
operation and expansion of our business, and do not anticipate paying cash
dividends in the foreseeable future. In the event of our liquidation,
dissolution or winding up, the holders of common stock are entitled to share
ratably in all assets legally available for distribution after payment of all
debts and other liabilities and subject to the prior rights of holders of
preferred stock then outstanding, if any. See -- "Dividend Policy."
PREFERRED STOCK
Our board of directors has the authority to issue the preferred stock in one or
more series and to fix the price, rights, preferences, privileges and
restrictions thereof, including dividend rights, dividend rates, conversion
rights, voting rights, terms of redemption, redemption prices, liquidation
preferences and the number of shares constituting a series or the designation of
such series, without any further vote or action by our stockholders. The
issuance of preferred stock, while providing desirable flexibility in connection
with possible acquisitions and other corporate purposes, could have the effect
of delaying, deferring or preventing a change in control of us without further
action by the stockholders and may adversely affect the market price of, and the
voting and other rights of, the holders of common stock. The issuance of
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of common stock, including the loss of voting
control to others. We have no current plans to issue any shares of preferred
stock.
ANTITAKEOVER EFFECTS OF PROVISIONS OF CERTIFICATE OF INCORPORATION, BYLAWS AND
DELAWARE LAW
Our certificate of incorporation provides that all stockholder actions must be
effected at a duly called annual or special meeting and may not be effected by
written consent. In addition, we have a classified board of directors such that
approximately one-third of the members of our board of directors are elected at
each annual meeting of the stockholders. Our bylaws provide that, except as
otherwise required by law, special meetings of the stockholders can only be
called pursuant to a resolution adopted by a majority of the board of directors,
or by our president, or by the chairman of the board or at the request of
71
<PAGE> 71
stockholders holding at least a majority of our outstanding stock. In addition,
the bylaws establish an advance notice procedure for stockholder proposals to be
brought before an annual meeting of stockholders, including proposed nominations
of persons for election to the board. Stockholders at an annual meeting may only
consider proposals or nominations specified in the notice of meeting or brought
before the meeting by or at the direction of the board of directors or by a
stockholder who was a stockholder of record on the record date for the meeting,
who is entitled to vote at the meeting and who has delivered timely written
notice in proper form to our Secretary of the stockholder's intention to bring
such business before the meeting. Our certificate of incorporation provides that
the affirmative vote of holders of at least a majority of the total votes
eligible to be cast in the election of directors is required to amend, alter,
change or appeal certain of its provisions. Our bylaws provide that the
affirmative vote of the holders of at least 80 percent of the voting stock is
required to amend, alter or repeal any of its provisions.
The foregoing provisions of our certificate of incorporation and bylaws are
intended to enhance the likelihood of continuity and stability in the
composition of the board of directors and in the policies formulated by the
board of directors and to discourage certain types of transactions which may
involve an actual or threatened change of control of us. These provisions are
designed to reduce the vulnerability of us to an unsolicited acquisition
proposal and, accordingly, could discourage potential acquisition proposals and
could delay or prevent a change in control of us. These provisions are also
intended to discourage certain tactics that may be used in proxy fights but
could, however, have the effect of discouraging others from making tender offers
for our shares and, consequently, may also inhibit fluctuations in the market
price of our shares that could result from actual or rumored takeover attempts.
These provisions may also have the effect of preventing changes in our
management. We are currently considering other anti-takeover measures, including
the adoption of a stockholder rights plan. See "Risk Factors -- We have
antitakeover provisions in our charter documents and there are provisions of
Delaware law that could prevent or delay a change of control of our company."
EFFECT OF DELAWARE ANTITAKEOVER STATUTE
We are subject to Section 203 of the Delaware General Corporation Law ("Section
203") which, subject to certain exceptions, prohibits a Delaware corporation
from engaging in any business combination with any interested stockholder for a
period of three years following the date that such stockholder became an
interested stockholder, unless:
- prior to such date, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder;
- upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned (1) by persons who are directors and
also officers and (2) by the employee stock plans in which employee
participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange
offer; or
- on or subsequent to such date, the business combination is approved by the
board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock which is not owned by the
interested stockholder.
Section 203 defines a business combination to include:
- any merger or consolidation involving the corporation and an interested
stockholder;
- any sale, lease, exchange, mortgage, transfer, pledge or other disposition
of 10% or more of the assets or stock of the corporation involving an
interested stockholder;
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<PAGE> 72
- subject to certain exceptions, any transaction which results in the issuance
or transfer by the corporation of any stock of the corporation to an
interested stockholder;
- any transaction involving the corporation which has the effect of increasing
the proportionate share of the stock of any class or series, or convertible
into the stock of any class or series, of the corporation which is owned by
an interested stockholder; or
- the receipt by an interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation. In general, Section 203 defines an interested
stockholder as any entity or person beneficially owning 15% or more of the
outstanding voting stock of the corporation or any entity or person
affiliated with or controlling or controlled by such entity or person. See
"Risk Factors -- We have antitakeover provisions in our charter documents
and there are provisions of Delaware law that could prevent or delay a
change of control of our company."
REGISTRATION RIGHTS OF CERTAIN HOLDERS
The holders of approximately 6,261,267 shares of common stock are entitled to
certain rights with respect to the registration of those shares under the
Securities Act. Under the terms of the agreement between us and the holders of
these registrable securities, if we propose to register any of our securities
under the Securities Act, either for our own account or for the account of other
securities holders exercising registration rights, these holders are entitled to
notice of such registration and are entitled to include their shares therein.
Holders of registration rights may also require us to file a registration
statement under the Securities Act at our expense with respect to their shares
of common stock, and we are required to use our best efforts to effect such
registration. Further, holders may require us to file registration statements on
Form S-3 at our expense when that form becomes available for use by us. All such
registration rights are subject to certain conditions and limitations, including
the right of the underwriters of an offering to limit the number of shares to be
included in such registration.
WARRANTS
As of March 31, 1999, there were outstanding warrants to purchase 170,158 shares
of our common stock.
TRANSFER AGENT
The transfer agent and registrar for our common stock is Boston EquiServe L.P.
Its address is 150 Royall Street, Canton, Massachusetts, and its telephone
number at this location is (781) 575-3010.
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<PAGE> 73
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, based on shares outstanding as of March 31,
1999, we will have 16,491,168 shares of common stock outstanding, assuming no
exercise of the underwriters' over-allotment option. Of this amount, the
4,000,000 shares sold in this offering, assuming no exercise of the
underwriters' over-allotment option, will be freely tradeable without
restriction or further registration under the Securities Act of 1933, as
amended, unless the shares are purchased by our "affiliates" as that term in
Rule 144 under the Securities Act. In addition, the 5,750,000 shares sold in our
December 1998 initial public offering are currently eligible to be resold
immediately in the public market without restriction unless the shares were
purchased by affiliates. Of the remaining shares, approximately (1) 106,182
shares will be available for immediate sale in the public market as of the date
of this prospectus, (2) 2,327,055 shares will be available for sale on June 10,
1999, the expiration date of the contractual lock-up agreements entered into in
connection with our initial public offering, (3) 96,153 shares will be available
for sale at various times during the period beginning June 10, 1999 and ending
90 days after the date of this prospectus (4) 3,803,003 shares will be eligible
90 days after the date of this prospectus following the expiration of 90-day
lockup agreements entered into with the underwriters, in some cases subject to
the volume limitations described below and (5) 408,775 shares will be eligible
for sale thereafter. Shares issuable upon exercise of outstanding options after
March 31, 1999 are not included in this analysis.
<TABLE>
<CAPTION>
DAYS AFTER DATE APPROXIMATE SHARES
OF THIS PROSPECTUS ELIGIBLE FOR FUTURE SALE COMMENT
------------------ ------------------------ -------
<S> <C> <C>
Upon Effectiveness................... 9,856,182 Freely tradable shares sold in our
initial public offering, this
offering and shares saleable under
Rules 144(k) or 701 that are not
subject to additional 90 day
contractual lockup restrictions
June 10, 1999........................ 2,327,055 Initial public offering lockup
released; shares saleable under
Rule 144, 144(k) or 701 that are
not subject to additional 90 day
lockup restrictions
Period between June 10, 1999 and 90 96,153 Initial public offering lockup
days after prospectus.............. released; shares saleable under
Rule 144, 144(k) or 701 that are
not subject to additional 90 day
lockup restrictions
90 days after prospectus............. 3,803,003 90-day lockup in connection with
this offering released; shares
saleable under Rule 144 or 701
Thereafter........................... 408,775 Restricted securities held for one
year or less
</TABLE>
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated) who has beneficially owned shares for at least one year
is entitled to sell within any three-month period a number of shares that does
not exceed the greater of (1) 1% of the then outstanding shares of common stock
(approximately 164,912 shares immediately after this offering) or (2) the
average weekly trading volume during the four calendar weeks preceding such
sale, subject to the filing of a Form 144 with respect to such sale. A person
(or persons whose shares are aggregated) who is not deemed to have been our
affiliate at any time during the 90 days immediately preceding the sale who has
beneficially owned his or her shares for at least two years is entitled to sell
those shares pursuant to Rule 144(k) without regard to the limitations described
above. Persons deemed to be affiliates must always sell pursuant to Rule 144,
even after the applicable holding periods have been satisfied.
AboveNet, our directors, executive officers, the selling stockholders and
certain other stockholders have agreed pursuant to the underwriting agreement
and other agreements that they will not sell any common stock without the prior
consent of CIBC Oppenheimer Corp. for a period of 90 days from the date of this
prospectus, except that we may, without such consent, grant options and sell
shares pursuant to our stock
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<PAGE> 74
plans. We have agreed with the underwriters that we will not release any shares
subject to lock-up agreements with us without the prior consent of CIBC
Oppenheimer Corp.
We are unable to estimate the number of shares that will be sold under Rule 144,
since this will depend on the market price for our common stock, the personal
circumstances of the sellers and other factors. Any sale of substantial amounts
of the common stock in the open market may adversely affect the price of the
common stock offered hereby.
In addition, the holders of approximately 6,261,267 shares of common stock
entitled to certain rights with respect to registration of those shares under
the Securities Act. Registration of those shares under the Securities Act would
result in those shares becoming freely tradable without restriction under the
Securities Act (except for shares purchased by our affiliates) immediately upon
the effectiveness of that registration. See "Description of Capital
Stock -- Registration Rights of Certain Holders."
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<PAGE> 75
UNDERWRITING
AboveNet and the selling stockholders have entered into an underwriting
agreement with the underwriters named below. CIBC Oppenheimer Corp., Lehman
Brothers Inc., PaineWebber Incorporated and Volpe Brown Whelan & Company, LLC
are acting as representatives of the underwriters.
The underwriting agreement provides for the purchase of a specific number of
shares of common stock by each of the underwriters. The underwriters'
obligations are several, which means that each underwriter is required to
purchase a specified number of shares, but is not responsible for the commitment
of any other underwriter to purchase shares. Subject to the terms and conditions
of the underwriting agreement, each underwriter has severally agreed to purchase
the number of common stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------ ----------
<S> <C>
CIBC Oppenheimer Corp. ..................................... 1,300,000
Lehman Brothers Inc. ....................................... 800,000
PaineWebber Incorporated.................................... 570,000
Volpe Brown Whelan & Company, LLC........................... 570,000
BT Alex. Brown Incorporated................................. 80,000
Bear, Stearns & Co. Inc. ................................... 80,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 80,000
Goldman, Sachs & Co. ....................................... 80,000
Salomon Smith Barney Inc. .................................. 80,000
Wasserstein Perella Securities, Inc. ....................... 80,000
Corinthian Partners......................................... 35,000
Dain Rauscher Wessels....................................... 35,000
First Analysis Securities Corporation....................... 35,000
Gerard Klauer Mattison & Co., Inc. ......................... 35,000
Kaufman Bros., L.P. ........................................ 35,000
Scott & Stringfellow, Inc. ................................. 35,000
Stephens Inc. .............................................. 35,000
Wit Capital Corporation..................................... 35,000
----------
Total............................................. 4,000,000
==========
</TABLE>
This is a firm commitment underwriting. This means that the underwriters have
agreed to purchase all of the shares offered by this prospectus (other than
those covered by the over-allotment option described below) if any are
purchased. Under the underwriting agreement, if an underwriter defaults in its
commitment to purchase shares, the commitments of non-defaulting underwriters
may be increased or the underwriting agreement may be terminated, depending on
the circumstances.
The representatives have advised AboveNet and the selling stockholders that the
underwriters propose to offer the shares directly to the public at the public
offering price that appears on the cover page of this prospectus. In addition,
the representatives may offer some of the shares to certain securities dealers
at such price less a concession of $2.90 per share. The underwriters may also
allow, and such dealers may reallow, a concession not in excess of $0.10 per
share to certain other dealers. After the shares are released for sale to the
public, the representatives may change the offering price and other selling
terms at various times.
AboveNet has granted the underwriters an over-allotment option. This option,
which is exercisable for up to 30 days after the date of this prospectus,
permits the underwriters to purchase a maximum of 600,000 additional shares from
AboveNet to cover over-allotments. If the underwriters exercise all or part of
this
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<PAGE> 76
option, they will purchase shares covered by the option at the public offering
price that appears on the cover page of this prospectus, less the underwriting
discount. If this option is exercised in full, the total price to public will be
$391.0 million, and the total proceeds to AboveNet will be approximately $274.4
million. The underwriters have severally agreed that, to the extent the
over-allotment option is exercised, they will each purchase a number of
additional shares proportionate to the underwriter's initial amount reflected in
the foregoing table.
The following table provides information regarding the amount of the discount to
be given to the underwriters by AboveNet and the selling stockholders.
<TABLE>
<CAPTION>
TOTAL WITH FULL
TOTAL WITHOUT EXERCISE EXERCISE OF
PER SHARE OF OVER-ALLOTMENT OVER-ALLOTMENT
--------- ---------------------- ---------------
<S> <C> <C> <C>
AboveNet.............................. $4.88 $13,781,120.00 $16,704,520.00
Selling stockholders.................. 4.88 $ 5,738,880.00 $ 5,738,880.00
----- -------------- --------------
Total............................ $19,520,000.00 $22,443,400.00
</TABLE>
AboveNet will pay all of the expenses of the offering, excluding the
underwriting discount, which we estimate to be approximately $900,000.
AboveNet and the selling stockholders have agreed to indemnify the underwriters
against certain liabilities, including liabilities under the Securities Act of
1933.
AboveNet, its officers and directors and certain other stockholders have agreed
to a 90-day "lock up" with respect to approximately 3,803,003 shares of common
stock and certain other AboveNet securities that they beneficially own,
including securities that are convertible into shares of common stock and
securities that are exchangeable or exercisable for shares of common stock. This
means that, subject to certain exceptions, for a period of 90 days following the
date of this prospectus, AboveNet and such persons may not offer, sell, pledge
or otherwise dispose of the AboveNet securities without the prior written
consent of CIBC Oppenheimer Corp.
Rules of the Securities and Exchange Commission may limit the ability of the
underwriters to bid for or purchase shares before the distribution of the shares
is completed. However, the underwriters may engage in the following activities
in accordance with the rules:
- Stabilizing transactions -- The representatives may make bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares,
so long as stabilizing bids do not exceed a specified maximum.
- Over-allotments and syndicate covering transactions -- The underwriters may
create a short position in the shares by selling more shares than are set
forth on the cover page of this prospectus. If a short position is created
in connection with the offering, the representatives may engage in syndicate
covering transactions by purchasing shares in the open market. The
representatives may also elect to reduce any short position by exercising
all or part of the over-allotment option.
- Penalty bids -- If the representatives purchase shares in the open market in
a stabilizing transaction or syndicate covering transaction, they may
reclaim a selling concession from the underwriters and selling group members
who sold those shares as part of this offering.
- Passive market making -- Market makers in the shares who are underwriters or
prospective underwriters may make bids for or purchases of shares, subject
to certain limitations, until the time, if ever, at which a stabilizing bid
is made.
Stabilization and syndicate covering transactions may cause the price of the
shares to be higher than it would be in the absence of such transactions. The
imposition of a penalty bid might also have an effect on the price of the shares
if it discourages resales of the shares.
Neither AboveNet nor the underwriters make any representation or prediction as
to the effect that the transactions described above may have on the price of the
shares. These transactions may occur on the Nasdaq National Market or otherwise.
If these transactions are commenced, they may be discontinued without notice at
any time.
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<PAGE> 77
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for AboveNet
and the selling stockholders by Gunderson Dettmer Stough Villeneuve Franklin &
Hachigian, LLP, Menlo Park, California. An investment partnership comprised of
members of that firm beneficially owns a warrant to purchase 2,500 shares of our
common stock at an exercise price of $5.20 per share. Certain legal matters in
connection with this offering will be passed upon for the Underwriters by
Pillsbury Madison & Sutro LLP, Palo Alto, California. Pillsbury Madison & Sutro
LLP has acted and continues to act as counsel to us in connection with certain
legal matters.
EXPERTS
Our financial statements as of June 30, 1997 and 1998 and March 31, 1999 and for
the period from March 8, 1996 (inception) to June 30, 1996, each of the years in
the two-year period ended June 30, 1998 and for the nine months ended March 31,
1999 included in this Prospectus and the related financial statement schedule
included elsewhere in the Registration Statement have been audited by Deloitte &
Touche LLP, independent auditors, as stated in their reports appearing herein
and elsewhere in the Registration Statement, and have been so included in
reliance upon the reports of such firm given upon their authority as experts in
accounting and auditing.
CHANGE IN ACCOUNTANTS
In April 1998, we appointed Deloitte & Touche LLP to replace our former
accountants as our principal accountants. There were no disagreements with our
former accountants during the period from inception to April 30, 1998 or during
any subsequent interim period preceding their replacement on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedures, which disagreements, if not resolved to the former
accountants' satisfaction, would have caused them to make reference to the
subject matter of the disagreement in connection with their reports. Our former
accountants issued an unqualified opinion on the financial statements as of and
for the year ended June 30, 1997 and the period from inception to June 30, 1997.
We did not consult with Deloitte & Touche LLP on any accounting or financial
reporting matters in the periods prior to their appointment. The change in
accountants was approved by our board of directors.
ADDITIONAL INFORMATION
AboveNet has filed a registration statement on Form S-1 with the Securities and
Exchange Commission in connection with this offering. We are subject to the
informational requirements of the Exchange Act and file annual, quarterly and
current reports, proxy statements and other information with the SEC. You may
read and copy the registration statement and any other documents we filed at the
SEC's Public Reference Room at the principal office of the SEC, 450 Fifth
Street, N.W., Washington, D.C. 20549 or at the Regional Offices of the SEC:
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511, and Seven World Trade Center, New York, New York 10048. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information
on the Public Reference Room. Our SEC filings are also available to the public
at the SEC's Internet site at "http://www.sec.gov."
This prospectus is a part of the registration statement and does not contain all
of the information included in the registration statement. Whenever a reference
is made in this prospectus to any contract or other document, the reference may
not be complete and you should refer to the exhibits that are part of the
registration statement for a copy of the contract or document.
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<PAGE> 78
ABOVENET COMMUNICATIONS INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Balance Sheets as of June 30, 1997 and 1998 and March 31,
1999...................................................... F-3
Statements of Operations for the Period from March 8, 1996
(Inception) to June 30, 1996, the Years Ended June 30,
1997 and 1998 and the Nine Months Ended March 31, 1998
(unaudited) and 1999...................................... F-4
Statements of Stockholders' Equity (Deficiency) for the
Period from March 8, 1996 (Inception) to June 30, 1996,
the Years Ended June 30, 1997 and 1998 and the Nine Months
Ended March 31, 1999...................................... F-5
Statements of Cash Flows for the Period from March 8, 1996
(Inception) to June 30, 1996, the Years Ended June 30,
1997 and 1998 and the Nine Months Ended March 31, 1998
(unaudited) and 1999...................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 79
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
AboveNet Communications Inc.:
We have audited the accompanying balance sheets of AboveNet Communications Inc.
as of June 30, 1997 and 1998 and March 31, 1999 and the related statements of
operations, stockholders' equity (deficiency) and cash flows for the period from
March 8, 1996 (inception) to June 30, 1996, for each of the two years in the
period ended June 30, 1998 and for the nine months ended March 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial 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 financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of AboveNet Communications Inc. as of June 30,
1997, and 1998 and March 31, 1999 and the results of their operations and their
cash flows for the period from March 8, 1996 (inception) to June 30, 1996, for
each of the two years in the period ended June 30, 1998 and for the nine months
ended March 31, 1999 in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
San Jose, California
April 22, 1999
F-2
<PAGE> 80
ABOVENET COMMUNICATIONS INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
-------------------------- MARCH 31,
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and equivalents............................. $ 331,100 $ 8,141,200 $ 44,947,700
Short-term investments........................... -- -- 11,744,200
Accounts receivable, net of reserve for doubtful
accounts of $15,000, $60,000 and $477,100,
respectively.................................. 41,100 357,000 1,851,000
Prepaid expenses and other current assets........ -- 269,600 1,301,200
----------- ----------- ------------
Total current assets..................... 372,200 8,767,800 59,844,100
Property and equipment, net........................ 766,400 4,436,100 24,393,800
Rights to use fiber optic capacity................. -- -- 9,080,000
Restricted cash.................................... -- 300,000 1,220,000
Deposits and other assets.......................... 32,700 189,400 1,644,800
----------- ----------- ------------
Total.................................... $ 1,171,300 $13,693,300 $ 96,182,700
=========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable................................. $ 312,000 $ 2,301,300 $ 8,521,000
Remaining obligation for rights to use fiber
optic capacity................................ -- -- 800,000
Accrued liabilities.............................. 109,700 619,900 1,315,800
Customer deposits................................ 85,000 309,400 971,300
Advances......................................... 739,900 -- --
Current portion of long-term obligations......... 71,500 476,000 3,511,200
----------- ----------- ------------
Total current liabilities................ 1,318,100 3,706,600 15,119,300
----------- ----------- ------------
Convertible notes payable and advances............. -- 8,000,000 --
----------- ----------- ------------
Other long-term obligations........................ 115,500 1,325,300 9,972,500
----------- ----------- ------------
Commitments and contingencies (Notes 3, 4 and 11)
Stockholders' equity (deficiency):
Preferred stock, $0.001 par value, 5,000,000
shares authorized; shares issued and
outstanding -- none...........................
Convertible preferred stock, $0.001 par value: -- -- --
Series A; shares issued and
outstanding -- 1,025,000, 1,025,000 and
none, respectively.......................... 410,000 410,000 --
Series B; shares issued and
outstanding -- 1,000,000, 1,631,896 and
none, respectively.......................... 1,200,000 2,323,100 --
Series C; shares issued and
outstanding -- none, 2,003,000 and none,
respectively................................ -- 3,873,400 --
Series D; no shares issued and outstanding.... -- -- --
Series E; no shares issued and outstanding.... -- -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized; shares issued and
outstanding -- 203,125, 364,348 and
13,665,990, respectively...................... 8,100 38,900 89,292,200
Common stock options............................. -- 1,861,500 3,561,100
Deferred stock compensation...................... -- (540,100) (57,500)
Accumulated deficit.............................. (1,880,400) (7,305,400) (21,704,900)
----------- ----------- ------------
Total stockholders' equity
(deficiency)........................... (262,300) 661,400 71,090,900
----------- ----------- ------------
Total.................................... $ 1,171,300 $13,693,300 $ 96,182,700
=========== =========== ============
</TABLE>
See notes to financial statements.
F-3
<PAGE> 81
ABOVENET COMMUNICATIONS INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
MARCH 8, 1996 NINE MONTHS ENDED
(INCEPTION) YEAR ENDED JUNE 30, MARCH 31,
TO ------------------------- --------------------------
JUNE 30, 1996 1997 1998 1998 1999
------------- ----------- ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues....................... $ 78,600 $ 551,600 $ 3,436,400 $ 2,068,800 $ 8,297,400
-------- ----------- ----------- ----------- ------------
Costs and expenses:
Data communications and
telecommunications........ -- 558,600 2,199,800 1,267,900 5,705,100
Network operations........... 19,400 416,700 1,571,800 856,400 3,720,600
Sales and marketing.......... 19,100 382,600 1,618,700 908,400 6,348,300
General and administrative... 66,100 433,700 1,621,500 959,600 3,695,400
Depreciation and
amortization.............. 51,600 132,700 475,500 299,400 2,005,100
Stock-based compensation
expense................... -- -- 1,276,400 509,000 1,282,800
Joint venture termination
fee....................... -- 431,100 -- -- --
-------- ----------- ----------- ----------- ------------
Total costs and
expenses........... 156,200 2,355,400 8,763,700 4,800,700 22,757,300
-------- ----------- ----------- ----------- ------------
Loss from operations........... (77,600) (1,803,800) (5,327,300) (2,731,900) (14,459,900)
Interest expense............... -- (7,400) (160,800) (128,400) (916,400)
Interest and other income...... -- 8,400 63,100 31,300 976,800
-------- ----------- ----------- ----------- ------------
Net loss....................... $(77,600) $(1,802,800) $(5,425,000) $(2,829,000) $(14,399,500)
======== =========== =========== =========== ============
Basic and diluted loss per
share........................ $ (0.62) $ (9.17) $ (20.68) $ (11.85) $ (2.51)
======== =========== =========== =========== ============
Shares used in basic and
diluted loss per share....... 125,000 196,618 262,304 238,810 5,742,408
======== =========== =========== =========== ============
Pro forma basic and diluted
loss per share reflecting
stock split (see Note 8)..... $ (0.31) $ (4.58) $ (10.34) $ (5.92) $ (1.25)
======== =========== =========== =========== ============
Shares used in pro forma basic
and diluted loss per share... 250,000 393,236 524,608 477,620 11,484,816
======== =========== =========== =========== ============
</TABLE>
See notes to financial statements.
F-4
<PAGE> 82
ABOVENET COMMUNICATIONS INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK COMMON DEFERRED
------------------------- ------------------------ STOCK STOCK ACCUMULATED
SHARES AMOUNT SHARES AMOUNT OPTIONS COMPENSATION DEFICIT
---------- ------------ ---------- ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, March 8, 1996
(inception)..................... -- $ -- -- $ -- $ -- $ -- $ --
Issuance of common stock.......... -- -- 125,000 5,000 -- -- --
Net loss.......................... -- -- -- -- -- -- (77,600)
---------- ------------ ---------- ----------- ---------- ----------- ------------
Balances, June 30, 1996........... -- -- 125,000 5,000 -- -- (77,600)
Issuance of common stock.......... -- -- 62,500 2,500 -- -- --
Issuance of Series A convertible
preferred stock................. 1,025,000 410,000 -- -- -- -- --
Exercise of common stock
options......................... -- -- 15,625 600 -- -- --
Issuance of Series B convertible
preferred stock................. 500,000 600,000 -- -- -- -- --
Issuance of Series B convertible
preferred stock in conjunction
with acquisition of DSK, Inc.
(Note 8)........................ 500,000 600,000 -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- (1,802,800)
---------- ------------ ---------- ----------- ---------- ----------- ------------
Balances, June 30, 1997........... 2,025,000 1,610,000 203,125 8,100 -- -- (1,880,400)
Exercise of common stock
options......................... -- -- 161,223 30,800 -- -- --
Issuance of warrants in connection
with issuance of debt........... -- 112,000 -- -- 45,000 -- --
Issuance of Series B convertible
preferred stock................. 631,896 1,011,100 -- -- -- -- --
Issuance of Series C convertible
preferred stock................. 2,003,000 3,873,400 -- -- -- -- --
Compensatory stock arrangements... -- -- -- -- 1,816,500 (1,816,500) --
Amortization of deferred stock
compensation.................... -- -- -- -- -- 1,276,400 --
Net loss.......................... -- -- -- -- -- -- (5,425,000)
---------- ------------ ---------- ----------- ---------- ----------- ------------
Balances, June 30, 1998........... 4,659,896 6,606,500 364,348 38,900 1,861,500 (540,100) (7,305,400)
Issuance of Series D convertible
preferred stock................. 2,115,378 10,771,000 -- -- -- -- --
Issuance of Series E convertible
preferred stock................. 408,775 3,846,400 -- -- -- -- --
Exercise of Series B warrants..... 104,700 -- -- -- -- -- --
Conversion of convertible
preferred stock to common
stock........................... (7,288,749) (21,223,900) 7,288,749 21,223,900 -- -- --
Issuance of common stock upon
initial public offering......... -- -- 5,750,000 67,822,000 -- -- --
Exercise of common stock options
and warrants.................... -- -- 262,893 207,400 -- -- --
Issuance of warrants in connection
with issuance of debt and
leases.......................... -- -- -- -- 899,400 -- --
Compensatory stock arrangements... -- -- -- -- 800,200 (800,200) --
Amortization of deferred stock
compensation.................... -- -- -- -- -- 1,282,800 --
Net loss.......................... -- -- -- -- -- -- (14,399,500)
---------- ------------ ---------- ----------- ---------- ----------- ------------
Balances, March 31, 1999.......... -- $ -- 13,665,990 $89,292,200 $3,561,100 $ (57,500) $(21,704,900)
========== ============ ========== =========== ========== =========== ============
<CAPTION>
STOCKHOLDERS'
EQUITY
(DEFICIENCY)
-------------
<S> <C>
Balances, March 8, 1996
(inception)..................... $ --
Issuance of common stock.......... 5,000
Net loss.......................... (77,600)
------------
Balances, June 30, 1996........... (72,600)
Issuance of common stock.......... 2,500
Issuance of Series A convertible
preferred stock................. 410,000
Exercise of common stock
options......................... 600
Issuance of Series B convertible
preferred stock................. 600,000
Issuance of Series B convertible
preferred stock in conjunction
with acquisition of DSK, Inc.
(Note 8)........................ 600,000
Net loss.......................... (1,802,800)
------------
Balances, June 30, 1997........... (262,300)
Exercise of common stock
options......................... 30,800
Issuance of warrants in connection
with issuance of debt........... 157,000
Issuance of Series B convertible
preferred stock................. 1,011,100
Issuance of Series C convertible
preferred stock................. 3,873,400
Compensatory stock arrangements... --
Amortization of deferred stock
compensation.................... 1,276,400
Net loss.......................... (5,425,000)
------------
Balances, June 30, 1998........... 661,400
Issuance of Series D convertible
preferred stock................. 10,771,000
Issuance of Series E convertible
preferred stock................. 3,846,400
Exercise of Series B warrants..... --
Conversion of convertible
preferred stock to common
stock........................... --
Issuance of common stock upon
initial public offering......... 67,822,000
Exercise of common stock options
and warrants.................... 207,400
Issuance of warrants in connection
with issuance of debt and
leases.......................... 899,400
Compensatory stock arrangements... --
Amortization of deferred stock
compensation.................... 1,282,800
Net loss.......................... (14,399,500)
------------
Balances, March 31, 1999.......... $ 71,090,900
============
</TABLE>
See notes to financial statements.
F-5
<PAGE> 83
ABOVENET COMMUNICATIONS INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
MARCH 8, 1996 NINE MONTHS ENDED
(INCEPTION) YEAR ENDED JUNE 30, MARCH 31,
TO ------------------------- --------------------------
JUNE 30, 1996 1997 1998 1998 1999
------------- ----------- ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.............................. $ (77,600) $(1,802,800) $(5,425,000) $(2,829,000) $(14,399,500)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation and amortization....... 51,600 132,700 475,500 299,400 2,005,100
Stock-based compensation expense.... -- --......... 1,276,400 509,000 1,282,800
Noncash interest expense............ -- -- 133,200 112,000 84,300
Joint venture termination fee....... -- 431,100 --
Changes in assets and liabilities:
Accounts receivable............... (12,000) (29,100) (315,900) (196,300) (1,494,000)
Prepaid expenses and other current
assets......................... -- -- (269,600) (258,200) (1,031,600)
Restricted cash................... -- --......... (300,000) (300,000) (920,000)
Accounts payable.................. 13,100 298,900 1,989,300 261,100 6,219,700
Accrued liabilities............... -- 109,700 510,200 183,800 695,900
Customer deposits................. -- 85,000 224,400 140,600 661,900
Deferred rent..................... --.......... 30,400 18,200 13,700 119,500
----------- ----------- ----------- ----------- ------------
Net cash used in operating
activities................... (24,900) (744,100) (1,683,300) (2,063,900) (6,775,900)
----------- ----------- ----------- ----------- ------------
Cash flows from investing activities:
Cash paid for rights to use fiber
optic capacity...................... -- -- -- -- (8,280,000)
Purchase of property and equipment.... (101,100) (474,500) (3,666,000) (659,200) (20,858,700)
Increase in deposits and other
assets.............................. -- (32,700) (111,700) (173,900) (640,300)
----------- ----------- ----------- ----------- ------------
Net cash used in investing
activities................... (101,100) (507,200) (3,777,700) (833,100) (29,779,000)
----------- ----------- ----------- ----------- ------------
Cash flows from financing activities:
Purchase of short-term investments.... -- -- -- -- (11,744,200)
Proceeds from notes payable and
advances............................ 210,000 739,900 13,395,000 4,144,600 12,543,300
Debt repayments....................... -- -- (70,000) -- (1,823,500)
Capital lease repayments.............. --.......... (49,600) (84,700) (48,700) (261,000)
Proceeds from issuance of common
stock............................... 5,000 3,100 30,800 20,800 68,029,400
Proceeds from issuance of convertible
preferred stock..................... -- 800,000 -- -- 6,617,400
----------- ----------- ----------- ----------- ------------
Net cash provided by financing
activities................... 215,000 1,493,400 13,271,100 4,116,700 73,361,400
----------- ----------- ----------- ----------- ------------
Net increase in cash and equivalents.... 89,000 242,100 7,810,100 1,219,700 36,806,500
Cash and equivalents, beginning of
period................................ -- 89,000 331,100 331,100 8,141,200
----------- ----------- ----------- ----------- ------------
Cash and equivalents, end of period..... $ 89,000 $ 331,100 $ 8,141,200 $ 1,550,800 $ 44,947,700
=========== =========== =========== =========== ============
Supplemental cash flow
information -- Cash paid for
interest.............................. $ -- $ 7,400 $ 27,600 $ 16,400 $ 832,100
=========== =========== =========== =========== ============
Noncash investing and financing
activities:
Remaining obligation for rights to use
fiber optic capacity................ $ -- $ -- $ -- $ -- $ 800,000
=========== =========== =========== =========== ============
Acquisition of equipment under capital
lease............................... $ -- $ 206,200 $ 479,200 $ -- $ 1,104,100
=========== =========== =========== =========== ============
Acquisition of leasehold improvements
in conjunction with DSK, Inc.
acquisition......................... $ -- $ 168,900 $ -- $ -- $ --
=========== =========== =========== =========== ============
Exchange of notes, advances, accrued
interest and warrants for
convertible preferred stock......... $ -- $ 210,000 $ 4,884,500 $ 1,011,100 $ 8,000,000
=========== =========== =========== =========== ============
Conversion of preferred stock into
common stock........................ $ -- $ -- $ -- $ -- $ 21,223,900
=========== =========== =========== =========== ============
Issuance of warrants in connection
with issuance of debt and leases.... $ -- $ -- $ 45,000 $ -- $ 899,400
=========== =========== =========== =========== ============
</TABLE>
See notes to financial statements.
F-6
<PAGE> 84
ABOVENET COMMUNICATIONS INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM MARCH 8, 1996 (INCEPTION) TO JUNE 30, 1996,
THE YEARS ENDED JUNE 30, 1997 AND 1998,
AND THE NINE MONTHS ENDED MARCH 31, 1998 (UNAUDITED) AND 1999
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION -- AboveNet Communications Inc. (the "Company"), was formed on
March 8, 1996 (inception). The Company provides 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.
USE OF ESTIMATES -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK -- Financial instruments that potentially subject
the Company to concentration of credit risk consist of trade receivables.
However, the Company's credit risk is mitigated by its credit evaluation process
and the reasonably short collection terms. The Company does not require
collateral or other security to support accounts receivable and maintains
reserves for potential credit losses.
CASH AND EQUIVALENTS -- The Company considers all highly liquid investments with
an original maturity of ninety days or less to be cash equivalents.
SHORT-TERM INVESTMENTS -- Short term investments consist of treasury bills with
a maturity date greater than 90 days but less than twelve months. The Company's
short-term investments are classified as available-for-sale. The investments are
carried at cost, which approximated fair value at March 31, 1999. Material
unrealized gains or losses would be reported as a separate component of
stockholders' equity. No investments were sold in the periods presented.
PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of three to five years. Leasehold improvements and assets acquired
under capital lease are amortized over the shorter of the lease term or the
useful lives of the improvement.
RIGHTS TO USE FIBER OPTIC CAPACITY -- Indefeasible rights to use (IRU) capacity
on fiber optic cable systems are stated at cost. Amortization will be recognized
over the shorter of the term of the IRU or its useful life when such capacity
becomes available to the Company.
RESTRICTED CASH -- Restricted cash consists of certificates of deposit which are
restricted from use pursuant to certain lease agreements.
REVENUE RECOGNITION -- Revenue consists primarily of service revenue which is
recognized in the period in which the services are provided. The services
primarily include bandwidth and space requirement charges which are recognized
monthly as well as installation fees which are recognized as revenue in the
period of installation. Advance customer deposits received are deferred until
the period in which the services are rendered.
INCOME TAXES -- Deferred tax liabilities are recognized for future taxable
amounts, and deferred tax assets are recognized for future deductions, net of a
valuation allowance to reduce net deferred tax assets to amounts that are more
likely than not to be realized.
F-7
<PAGE> 85
STOCK-BASED COMPENSATION -- The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees."
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF -- The
Company evaluates its long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets or intangibles may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
NET INCOME (LOSS) PER SHARE -- Basic income (loss) per share excludes dilution
and is computed by dividing net income (loss) by the weighted-average number of
common shares outstanding, less shares subject to repurchase by the Company, for
the period. Diluted income (loss) per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. Common share equivalents are excluded
from the computation in loss periods as their effect would be antidilutive.
On March 30, 1999, the Company announced a 2 for 1 stock split to be effected as
a stock dividend. The dividend for each outstanding share of common stock is
expected to be distributed on or about May 7, 1999. Pro forma basic and diluted
per share reflects, on a pro forma basis, the 2 for 1 stock split, which has
been declared but is undistributed. No other share or per share amounts in the
financial statements have been adjusted to give effect to this stock split.
UNAUDITED INTERIM FINANCIAL INFORMATION -- The interim financial information for
the nine months ended March 31, 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 nine months ended March 31, 1999 are not
necessarily indicative of results to be expected for the year ending June 30,
1999.
RECLASSIFICATIONS -- Certain prior period amounts have been reclassified to
conform to the current period presentation. Such reclassifications had no effect
on stockholders' equity (deficiency) or net loss.
RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 1997, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 130, "Reporting Comprehensive Income", which requires an enterprise to
report, by major components and as a single total, the change in the Company's
net assets during the period from nonowner sources. The Company adopted SFAS No.
130 in fiscal 1999. For all periods presented, comprehensive loss was equal to
the Company's net loss.
Additionally, in June 1997, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information", which establishes annual and
interim reporting standards for an enterprise's business segments and related
disclosures about the enterprise's products, services, geographic areas and
major customers. The Company adopted this statement in fiscal 1999. The Company
has determined that it operates in one reporting segment.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides guidance for an enterprise on accounting for the costs of computer
software developed or obtained for internal use. SOP 98-1 is effective for the
Company in fiscal 2000. The Company anticipates that accounting for transactions
under SOP 98-1 will not have a material impact on its financial position or
results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which defines derivatives, requires that
all derivatives be carried at fair value, and provides for hedge accounting when
certain conditions are met. SFAS No. 133 is effective for the Company in fiscal
2000.
F-8
<PAGE> 86
Although the Company has not fully assessed the implications of SFAS No. 133,
the Company does not believe adoption of this statement will have a material
impact on its financial position or results of operations.
2. PROPERTY AND EQUIPMENT, NET
Property and equipment are comprised of the following:
<TABLE>
<CAPTION>
JUNE 30,
----------------------- MARCH 31,
1997 1998 1999
--------- ---------- -----------
<S> <C> <C> <C>
Property and equipment, at cost:
Telecommunication equipment................. $ 774,300 $2,295,300 $ 7,615,100
Leasehold improvements (primarily
co-location facilities).................. 168,900 224,700 12,383,500
Office equipment............................ 7,500 186,500 840,700
Construction in progress.................... -- 2,389,400 5,893,700
--------- ---------- -----------
Total............................... 950,700 5,095,900 26,733,000
Less accumulated depreciation and
amortization................................ (184,300) (659,800) (2,339,200)
--------- ---------- -----------
Property and equipment, net................... $ 766,400 $4,436,100 $24,393,800
========= ========== ===========
</TABLE>
Construction in progress primarily relates to costs incurred during the
expansion of the Company's facilities.
3. INDEFEASIBLE RIGHTS TO USE FIBER OPTIC CAPACITY
During fiscal 1999, the Company entered into a series of agreements providing
for the acquisition of an indefeasible right to use capacity on a fiber optic
cable system between the U.S. and the United Kingdom for $8.3 million, $7.5
million of which has been paid as of March 31, 1999. The terms of these
agreements are 25 years.
In addition, in fiscal 1999, the Company entered into an agreement whereby the
Company committed to acquire an indefeasible right to use capacity on a fiber
optic cable system between the U.S. and the Netherlands for $7.5 million. The
agreement is conditioned upon the Company entering into another indefeasible
right to use capacity on a fiber optic cable system connecting certain European
cities.
In fiscal 1999, the Company entered into a series of agreements to lease fiber
optical cable systems between Washington D.C. and New York City. The leases will
require annual payments of $630,000 for 20 years from the initiation of the
leases which, is anticipated to be in the fourth quarter of fiscal 1999. The
leases will be accounted for as capital leases upon initiation of the lease.
4. JOINT VENTURES
In March 1999, as part of its international expansion strategy, the Company
entered into agreements to form joint ventures in Austria, Germany, and the
United Kingdom to provide managed co-location and Internet connectivity
solutions for mission critical Internet operations. The Company invested a total
of $581,400 in March 1999, which is included in deposits and other assets at
March 31, 1999. The Company is required to invest an additional $1.9 million in
the quarter ending June 30, 1999, for up to a 50% ownership in each of these
joint ventures. In addition, the Company has agreed to provide up to $2 million
of additional financing to certain of these joint ventures, if required, and to
arrange or provide for an additional $4.5 million contingent upon the joint
ventures raising an equivalent amount from third parties. These joint ventures
will be accounted for under the equity method of accounting.
5. CONVERTIBLE NOTES PAYABLE AND ADVANCES
In June 1997, the Company received $739,900 in cash advances from certain
individuals, including stockholders and employees. In July and August 1997, the
Company received an additional $250,000 in cash advances. In August 1997, the
advances were converted into notes payable of $989,900 and warrants to
F-9
<PAGE> 87
acquire 494,953 shares of Series B convertible preferred stock at $2.00 per
share. The notes generally bore an annual interest rate of 10%. The related
warrants were valued at $112,000, or $0.23 per share, and were recorded as
noncash interest expense in fiscal 1998.
On December 31, 1997, the Company entered into exchange agreements with the note
holders. Pursuant to the exchange agreements, the above notes, accrued interest
of $21,200 and the related warrants were exchanged for (i) 631,896 shares of
Series B convertible preferred stock and (ii) warrants to acquire 123,736 shares
of Series B convertible preferred stock at $2.00 per share.
During fiscal 1998, the Company received $3,873,400 of cash advances from
certain potential investors. In May 1998, these advances were converted into
2,003,000 shares of Series C convertible preferred stock.
On June 30, 1998, in anticipation of the Company's pending sale of preferred
stock, the Company received $8 million in cash, of which $1 million represented
a noninterest bearing cash advance and $7 million represented convertible notes
payable. The notes bore interest at 6%, were due on July 15, 1998 and were
convertible into Series D convertible preferred stock at $5.20 per share. On
July 15, 1998, the convertible notes and advance were converted into Series D
convertible preferred stock (see Note 8).
6. OTHER LONG-TERM OBLIGATIONS
Long-term obligations consist of:
<TABLE>
<CAPTION>
JUNE 30,
---------------------- MARCH 31,
1997 1998 1999
-------- ---------- -----------
<S> <C> <C> <C>
Credit facility................................ $ -- $1,201,600 $11,921,400
Capital lease facility......................... 156,600 551,100 1,394,200
Deferred rent.................................. 30,400 48,600 168,100
-------- ---------- -----------
Total obligations.................... 187,000 1,801,300 13,483,700
Current portion of long-term obligations....... (71,500) (476,000) (3,511,200)
-------- ---------- -----------
Long-term obligations.......................... $115,500 $1,325,300 $ 9,972,500
======== ========== ===========
</TABLE>
Credit Facility
At March 31, 1999, the Company had a $15 million credit facility (the "Credit
Facility"), $1.2 million of which is available for future borrowings. Proceeds
from borrowings on the Credit Facility may be used solely for the purpose of
acquiring network operating center equipment, office equipment and leasehold
improvements. Borrowings outstanding under the Credit Facility are payable in 42
monthly installments, bear interest at rates ranging from 13.3% to 15.1% and are
collateralized by the equipment and improvements purchased with the proceeds of
the borrowing. The ability to borrow on the Credit Facility expires October 31,
1999. At March 31, 1999, the outstanding borrowings on the Credit Facility are
due as follows: remainder of fiscal 1999, $719,500; fiscal 2000, $3,146,100;
fiscal 2001, $3,623,800; fiscal 2002, $3,836,400; and fiscal 2003, $595,600.
Capital Lease Facility
At March 31, 1999, the Company had $920,000 available on a $2.5 million facility
under which the Company leases certain equipment under capital leases. Leases
outstanding at March 31, 1999 expire on various dates through fiscal 2002 (see
Note 11).
Line of Credit
The Company has a revolving line of credit from a bank which provides for
borrowings up to $750,000 through May 1999. Borrowings under the line bear
interest at the bank's prime rate (7.75% at March 31, 1999) plus 1% per annum
and are collateralized by substantially all of the Company's assets. As of March
31, 1999, the Company had no borrowings outstanding on the line of credit. The
line of credit agreement limits the Company's ability to pay cash dividends
without the bank's consent and requires, among other things, that the Company
satisfy certain financial covenants. As of March 31, 1999 the Company was in
compliance with all
F-10
<PAGE> 88
covenants. In June 1998, the Company issued to the bank a warrant to purchase
1,250 shares of Series D preferred stock at $4.00 per share (See Note 8). The
warrant had an estimated fair value of $1,900 or $1.52 per share.
7. INCOME TAXES
The Company's deferred income tax assets are comprised of the following:
<TABLE>
<CAPTION>
JUNE 30,
------------------------ MARCH 31,
1997 1998 1999
--------- ----------- ------------
<S> <C> <C> <C>
Net deferred tax assets:
Net operating loss carryforwards.......... $ 489,700 $ 1,871,700 $ 6,426,600
Stock compensation expense on nonqualified
stock options.......................... -- 485,300 913,200
Accruals deductible in different
periods................................ 54,000 114,700 824,800
Depreciation and amortization............. (14,000) (65,200) (156,600)
--------- ----------- ------------
529,700 2,406,500 8,008,000
Valuation allowance......................... (529,700) (2,406,500) (8,008,000)
--------- ----------- ------------
Total............................. $ -- $ -- $ --
========= =========== ============
</TABLE>
The Company's effective rate differs from the federal statutory tax rate as
follows:
<TABLE>
<CAPTION>
MARCH 8, 1996 YEAR ENDED NINE MONTHS
(INCEPTION) JUNE 30, ENDED
TO JUNE 30, -------------- MARCH 31,
1996 1997 1998 1999
------------- ----- ----- -----------
<S> <C> <C> <C> <C>
Federal statutory tax rate................... 35.0% 35.0% 35.0% 35.0%
State taxes, net of federal benefit.......... 3.0 3.0 3.0 2.9
Joint venture termination fee................ -- (9.1) -- --
Other........................................ (25.4) (0.1) (0.3) (0.1)
Valuation allowance.......................... (12.6) (28.8) (37.7) (37.8)
----- ----- ----- -----
Effective tax rate........................... --% --% --% --%
===== ===== ===== =====
</TABLE>
The Company has no income tax provision due to its history of operating losses.
Due to the uncertainty surrounding the realization of the benefits of its
favorable tax attributes in future tax returns, the Company has fully reserved
its net deferred tax assets as of June 30, 1997 and 1998 and March 31, 1999.
At March 31, 1999, the Company had net operating loss carryforwards of
approximately $16.8 million for federal and $8.4 million for state income tax
purposes. These carryforwards begin to expire in 2003 for state and 2010 for
federal purposes. Additionally, Section 382 of the Internal Revenue Code and the
applicable California law impose annual limitations on the use of net operating
loss carryforwards if there is a change in ownership, as defined, within any
three-year period. The utilization of certain net operating loss carryforwards
may be limited due to the Company's capital stock transactions.
8. STOCKHOLDERS' EQUITY (DEFICIENCY)
Stock Splits
During November 1998, the Company reincorporated in the State of Delaware and
effected a stock exchange of one share of common stock and preferred stock for
every two and one-half shares of common stock and preferred stock, respectively,
of its California predecessor entity. The Company also effected another reverse
stock split during November 1998 whereby one share of common and preferred stock
was issued for every 1.6 shares of common stock and preferred stock. All share
and per share amounts in these financial statements have been adjusted to give
effect to these reverse stock splits.
F-11
<PAGE> 89
Initial Public Offering
On December 10, 1998, the Company sold 5,000,000 shares of common stock in an
underwritten public offering and on December 30, 1998 sold an additional 750,000
shares through the exercise of the underwriters' over-allotment option for net
proceeds of approximately $67,822,000.
Convertible Preferred Stock and Warrants
In fiscal 1997, the Company issued 1,025,000 shares of Series A convertible
preferred stock for cash of $200,000 and the conversion of advances of $210,000.
Also in fiscal 1997, the Company issued 500,000 shares of Series B convertible
preferred stock in connection with the acquisition of DSK, Inc. (see Note 10)
and issued 500,000 shares of Series B convertible preferred stock for cash of
$600,000. In fiscal 1998, the Company issued 631,896 shares of Series B
convertible preferred stock and 2,003,000 shares of Series C convertible
preferred stock upon conversions of notes, advances, and accrued interest of
$1,011,100 and $3,873,400, respectively (see Note 5). During the nine months
ended March 31, 1999, the Company issued 2,115,378 shares of Series D
convertible preferred stock for cash of $2,771,000 (net of costs of $229,000)
and the conversion of notes and advances of $8,000,000. During the same period,
the Company issued 408,775 shares of Series E convertible preferred stock for
cash of $3,846,400 (net of costs of $223,600).
As discussed in Note 5, pursuant to certain exchange agreements entered into on
December 31, 1997, the Company issued warrants to acquire 123,736 shares of
Series B convertible preferred stock at $2.00 per share. Also, as discussed in
Note 6, during fiscal 1998, the Company issued a warrant to purchase 1,250
shares of Series D convertible preferred stock at an exercise price of $4.00 per
share.
Simultaneously with the closing of the initial public offering, all 7,184,049
shares of the Company's preferred stock were converted into common stock on a
share for share basis. Additionally, all of the holders of warrants to purchase
123,736 shares of Series B convertible preferred stock exercised such warrants
through a net issuance provision and were issued 104,700 shares of common stock.
Also in connection with the initial public offering, the warrant to acquire
1,250 shares of Series D convertible preferred stock was converted into a
warrant to purchase an equivalent number of common shares at an exercise price
of $4.00 per share.
Common Stock Reserved for Future Issuance
At March 31, 1999, the Company has reserved the following shares of common stock
for issuance in connection with:
<TABLE>
<S> <C>
Warrants issued and outstanding................... 170,158
Options issued and outstanding.................... 2,021,179
Options available under stock option plans........ 1,227,100
Shares available under 1998 Purchase Plan......... 156,250
---------
Total................................... 3,574,687
=========
</TABLE>
Common Stock Subject to Repurchase
Upon the exercise of certain unvested employee stock options, the Company issued
to the employees common stock which is subject to repurchase by the Company at
the original exercise price of the stock option. This right lapses over the
original four year vesting period. At March 31, 1999, 34,645 shares were subject
to repurchase.
Stock Option Plans
Under the Company's stock option plans (collectively, the "Plans) a total of
2,828,356 nonstatutory and incentive common stock options are authorized for
issuance. Nonstatutory stock options may be granted to employees, outside
directors and consultants, and incentive stock options may only be granted to
employees. The Plans provide for the granting of incentive stock options at not
less than 100% of the fair market value of the underlying stock at the grant
date. Nonstatutory stock options may be granted at not less than 85% of the
F-12
<PAGE> 90
fair market value of the underlying stock at the date of grant. Options granted
to employees generally vest over four years and expire ten years from the date
of the grant. In addition, upon change in control, all options granted under
certain plans shall immediately vest.
The plans provide that each nonemployee director who is elected to the Company's
board of directors will automatically be granted a nonstatutory stock option to
purchase 9,375 shares of common stock at an exercise price equal to the fair
value of the common stock on the grant date. These grants vest ratably over
three years. An additional option to purchase 3,125 shares of common stock will
be granted to the nonemployee director each year thereafter with an exercise
price equal to the fair market value of the common stock on that date. These
grants vest after one year of service.
Employee Stock Purchase Plan
On December 10, 1998, the Company adopted the 1998 Employee Stock Purchase Plan
(the "1998 Purchase Plan"). Under the 1998 Purchase Plan, eligible employees are
allowed to have salary withholdings of up to 10% of their base compensation to
purchase shares of common stock at a price equal to 85% of the lower of the
market value of the stock at the beginning or end of defined purchase periods.
The initial purchase period commenced on December 10, 1998. The Company has
reserved 156,250 shares of common stock for issuance under this plan. As of
March 31, 1999, no shares have been issued under the 1998 Purchase Plan.
Nonplan Option Grant
In connection with its hiring of the Company's President and Chief Operating
Officer in November 1997, the Company granted to this officer options to
purchase 175,000 shares of common stock with an exercise price of $0.40 per
share. The option was immediately exercisable with respect to 20% of the option
shares with the balance exercisable in equal monthly installments over the next
36 months of employment with the Company. However, vesting accelerated upon the
closing of the Company's underwritten public offering. In addition, the option
grant contained an antidilution clause which guaranteed that, prior to any
underwritten initial public offering of the Company's common stock, the number
of shares under the option grant would always be equal to 5% of its outstanding
common stock on a fully diluted basis less 18,333 shares. As a result of various
sales of equity securities and option grants since the initial grant in November
1997, the officer was issued options to purchase an additional 319,425 shares of
common stock at an exercise price of $0.40 per share during the nine months
ended March 31, 1999. In connection with this award, the Company recognized
$362,100 and $1,087,200 in stock-based compensation expense during fiscal 1998
and the nine months ended March 31, 1999, respectively.
Options and Warrants Granted to Nonemployees
The Company has granted options and warrants to nonemployees for services
performed and to be performed after the date of grant. In connection with these
awards, the Company recognized $310,100 and $195,600 in stock-based compensation
expense during fiscal 1998 and the nine months ended March 31, 1999,
respectively. At March 31, 1999, options to purchase 42,500 shares of common
stock at an exercise price of $85.06 were unearned by certain nonemployees.
These options vest over three years and have a term of three years. At March 31,
1999, all services relating to all other awards have been rendered and the
related options and warrants were fully exercisable.
In connection with the Company's formation of its European joint ventures in
March 1999, the Company agreed that it will grant options to purchase up to
300,000 shares of common stock to employees of the joint ventures upon the joint
ventures meeting certain performance criteria of over the next four years. The
exercise price for these options would be based on the fair market value of the
Company's common stock at the date of grant.
In connection with the Credit Facility (see Note 6), in fiscal 1998, the Company
issued warrants to purchase 22,500 shares of common stock at a weighted-average
exercise price of $4.61 per share. The fair value of these warrants is being
recognized as interest expense through June 30, 1999. During the nine months
ended March 31, 1999, in connection with an amendment to the Credit Facility,
the Company issued warrants to
F-13
<PAGE> 91
purchase 25,000 shares of common stock which have a weighted-average exercise
price of $10.20 per share and a term of five years. The estimated fair value of
these warrants of $335,300 is included in deposits and other assets at March 31,
1999 and is being amortized to interest expense over the repayment period.
In connection with the signing of a new facility lease (See Note 11) in fiscal
1999, the Company issued the lessor a warrant to purchase 100,000 shares of its
common stock at $10.00 per share. The estimated fair value of this warrant of
$609,100 is included in deposits and other assets at March 31, 1999 and will be
amortized to expense over the lease period.
At June 30, 1998, warrants to purchase 32,343 shares of common stock at a
weighted-average exercise price of $4.19 per share were outstanding; such
warrants expire in 2003. All of these warrants were issued during the year ended
June 30, 1998 (none issued in fiscal 1996 or 1997) and had an estimated
weighted-average fair value of $2.46 per share at the date of grant. During the
nine months ended March 31, 1999, warrants to purchase 142,815 shares of common
stock at a weighted-average exercise price of $9.93 were issued and had an
estimated weighted-average fair value of $6.53 per share at date of grant. At
March 31, 1999 warrants to purchase 170,158 shares of common stock at a
weighted-average exercise price of $9.06 per share were outstanding.
Option Repricing
On December 1, 1998, the Company repriced 464,425 options previously granted at
$12.00 to $16.00 per share to fair value at that date of $10.00 per share.
Stock option activity is summarized as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
----------------------------
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Balance, March 8, 1996 (inception)......................... -- $ --
Granted.................................................... 570,000 0.04
---------
Balance, June 30, 1996 (68,750 shares vested at a weighted
average exercise price of $0.04 per share)............... 570,000 0.04
Granted.................................................... 225,000 0.13
Exercised.................................................. (15,625) 0.04
Canceled................................................... (194,375) 0.04
---------
Balance, June 30, 1997 (109,687 shares vested at a weighted
average exercise price of $0.04 per share)............... 585,000 0.06
Granted.................................................... 571,306 1.17
Exercised.................................................. (161,223) 0.19
Canceled................................................... (16,167) 0.62
---------
Balance, June 30, 1998 (367,135 shares vested at a weighted
average exercise price of $0.37 per share)............... 978,916 0.67
Granted.................................................... 1,845,175 13.98
Exercised.................................................. (256,648) 0.74
Canceled................................................... (546,264) 12.19
---------
Balance, March 31, 1999.................................... 2,021,179 $ 9.70
=========
</TABLE>
F-14
<PAGE> 92
The following table summarizes information as of March 31, 1999 concerning
currently outstanding and vested options:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------- OPTIONS VESTED
WEIGHTED ---------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OF CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES SHARES LIFE (YEARS) PRICE OF SHARES PRICE
- --------------- ---------- ------------ -------- --------- --------
<S> <C> <C> <C> <C> <C>
$ 0.04 - $ 1.20 946,414 8.5 $ 0.34 794,441 $ 0.38
4.00 - 5.20 147,188 9.2 4.57 264 4.00
10.00 - 13.00 695,427 9.7 10.34 124,804 10.12
24.50 - 33.25 82,150 9.8 26.79 -- --
52.19 107,500 9.9 52.19 40,000 52.19
85.06 42,500 10.0 85.06 -- --
---------- -------
$ 0.04 - $85.06 2,021,179 9.1 $ 9.70 959,509 $ 3.81
========== =======
</TABLE>
At March 31, 1999, 1,227,100 shares remained available for future grant.
Additional Stock Plan Information
As discussed in Note 1, the Company accounts for its stock-based awards to
employees using the intrinsic value method in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees," and its related interpretations.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the disclosure
of pro forma net income (loss) and net income (loss) per share had the Company
adopted the fair value method since the Company's inception. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values.
The Company's calculations for employee grants were made using the minimum value
method for grants prior to September 8, 1998 and the fair value method for
grants after that date with the following weighted average assumptions: expected
life, one year following vesting; risk free interest rate of 6%; and no
dividends during the expected term. In addition, volatility of 70% was used for
grants valued under the fair value method. The Company's calculations are based
on a multiple award valuation approach and forfeitures are recognized as they
occur. If the computed values of the Company's stock-based awards to employees
had been amortized to expense over the vesting period of the awards as specified
under SFAS No. 123, net loss would have been $78,000 ($0.62 per basic and
diluted share), $1,803,800 ($9.17 per basic and diluted share), $5,111,000
($19.49 per basic and diluted share), and $14,520,730 ($2.53 per basic and
diluted share) for the period from inception to June 30, 1996, for the years
ended June 30, 1997 and 1998, and for the nine months ended March 31, 1999,
respectively.
F-15
<PAGE> 93
The number and estimated weighted-average value per option for employee and
nonemployee awards, granted are as follows:
<TABLE>
<CAPTION>
INCEPTION TO YEAR ENDED JUNE 30, NINE MONTHS ENDED
JUNE 30, -------------------- MARCH 31,
1996 1997 1998 1999
------------ -------- -------- -----------------
<S> <C> <C> <C> <C>
Employee Options:
Number of shares.................. 551,250 -- 501,625 1,796,425
Estimate weighted-average value... $ 0.01 $ -- $ 0.20 $ 5.47
Nonemployee Options:
Number of shares.................. 18,750 225,000 69,681 48,700
Estimated weighted-average
value.......................... $ 0.01 $ 0.03 $ 0.15 $ 40.77
</TABLE>
9. NET LOSS PER SHARE
The following is a reconciliation of the numerators and denominators used in
computing basic and diluted net loss per share.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
INCEPTION YEAR ENDED JUNE 30, MARCH 31,
TO JUNE 30, ------------------------- --------------------------
1996 1997 1998 1997 1999
----------- ----------- ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net loss (numerator), basic and
diluted........................ $(77,600) $(1,802,800) $(5,425,000) $(2,829,000) $(14,399,500)
======== =========== =========== =========== ============
Shares (denominator):
Weighted average common shares
outstanding................. 125,000 196,618 265,112 238,810 5,754,139
Weighted average common shares
outstanding subject to
repurchase.................. -- -- (2,808) -- (11,731)
-------- ----------- ----------- ----------- ------------
Shares used in computation, basic
and diluted.................... 125,000 196,618 262,304 238,810 5,742,408
-------- ----------- ----------- ----------- ------------
Net loss per share, basic and
diluted........................ $ (0.62) $ (9.17) $ (20.68) $ (11.85) $ (2.51)
======== =========== =========== =========== ============
</TABLE>
For the above mentioned periods, the Company had securities outstanding which
could potentially dilute basic net income per share in the future, but were
excluded in the computation of diluted net loss per share in the periods
presented, as their effect would have been antidilutive. At March 31, 1999,
outstanding potentially dilutive securities consist of 34,645 outstanding shares
of common stock subject to repurchase, and options and warrants to purchase
2,191,337 shares of common stock.
10. JOINT VENTURE TERMINATION FEE
In fiscal 1996, the Company entered into a joint venture agreement (the
"Agreement") with DSK, Inc. ("DSK") to cooperatively market and develop the
Company's services. The Company paid $33,700 to DSK during the year ended June
30, 1997 related to the Agreement.
In April 1997, the Company terminated the Agreement and hired the majority
stockholders of DSK as either employees or consultants by issuing 500,000 fully
vested shares of the Series B preferred stock with a fair value of $1.20 per
share, or $600,000, for the outstanding shares of common stock of DSK. The
Company recorded the transaction by allocating the value of the shares issued to
property and equipment (at DSK's net book value of $168,900, which approximated
fair value), with the balance of $431,100 reflected as a joint venture
termination fee.
Additionally, in April 1997, the Company granted to certain of the former owners
of DSK options to purchase a total of 125,000 shares of its common stock at
$0.12 per share for real estate consulting services to be performed. In June
1998, the Company accelerated the vesting of all the DSK options awarded. In
F-16
<PAGE> 94
conjunction with this award, the Company recognized $604,200 of stock-based
compensation expense during fiscal 1998.
11. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its facilities under noncancelable operating leases. These
leases expire on various dates through fiscal 2002. Minimum future lease
payments under noncancelable operating and capital leases as of March 31, 1999
are summarized as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
FISCAL YEARS ENDING JUNE 30, LEASES LEASES
---------------------------- ---------- -----------
<S> <C> <C>
Remainder of fiscal 1999........................... $ 161,200 $ 328,200
2000............................................... 650,500 2,167,500
2001............................................... 612,000 2,220,800
2002............................................... 262,500 2,271,300
2003............................................... -- 2,401,700
2004............................................... -- 2,449,800
Thereafter......................................... -- 16,195,000
---------- -----------
Total minimum lease payments....................... 1,686,200 $28,034,300
===========
Less amount representing interest at rates ranging
from 13.253% to 14.68%........................... (292,000)
----------
Present value of minimum lease payments............ 1,394,200
Less current portion............................... (474,800)
----------
Long term portion.................................. $ 919,400
==========
</TABLE>
Rent expense under operating leases for the period from March 8, 1996
(inception) to June 30, 1996, for the years ended June 30, 1997 and 1998 and for
the nine months ended March 31, 1999 was none, $61,500, $444,900, and $917,000,
respectively.
Effective in fiscal 2000, the Company has committed to lease additional
facilities. The lease is for a minimum term of 20 years with annual rental
payments increasing from approximately $3 million to $4 million over the lease
term.
See Note 3 regarding the Company's agreements to lease fiber optic cable
systems.
Purchase Commitments
The Company has entered into noncancelable commitments to purchase property and
equipment related to the expansion of its operations facilities. As of March 31,
1999, approximately $32 million was committed for purchases under these
agreements through fiscal 2000.
Telecommunications and Peering Arrangements
The Company has guaranteed to pay certain monthly usage levels or fees with
various communications or interconnect providers. Minimum payments under these
agreements at March 31, 1999 are approximately $950,000 for the remainder of
fiscal 1999 $4,900,000 in fiscal 2000; $5,800,000 in fiscal 2001; $3,300,000 in
fiscal 2002; $1,000,000 in fiscal 2003; and $1,000,000 in fiscal 2004.
The Company is a party to numerous peering agreements with other internet
providers to allow for the exchange of internet traffic. These agreements do not
have fee commitments and generally have a one year term with automatic renewals.
The Company does not record any revenue or expense associated with these
non-cash transactions as such transactions do not represent the culmination of
the earnings process and the fair value of such transactions are not reasonably
determinable.
F-17
<PAGE> 95
Legal Matters
The Company is involved in various claims and legal actions arising out of the
normal course of business. Management does not expect that the outcome of these
cases will have a material effect on the Company's financial position or results
of operations.
12. RELATED PARTY TRANSACTIONS
A member of the Board of Directors is the president of an entity which is the
co-manager of the Company's primary facilities. Rent expense in fiscal 1996,
1997 and 1998 and for the nine months ended March 31, 1999 for these facilities
was none, $16,400, $265,200, and $736,200 respectively. The Company believes
that its lease arrangements were on an arm's length basis.
During the nine months ended March 31, 1999, the same entity was granted a
warrant to purchase 100,000 shares of common stock in connection with the
signing of a new facility lease (see Note 8) . The estimated fair value of the
warrant is $609,100.
13. MAJOR CUSTOMERS
Two customers accounted for 32% and 25% of revenues in fiscal 1996, while
another customer accounted for 12% and 14% of revenues in fiscal 1997 and 1998,
respectively. For the nine months ended March 31, 1999, no one customer
accounted for more than 10% of revenues.
At June 30, 1997, four customers accounted for 13%, 13%, 11% and 10% of trade
receivables. At June 30, 1998, two customers accounted for approximately 22% and
13% of trade receivables. At March 31, 1999, one customer accounted for
approximately 10% of trade receivables.
14. GEOGRAPHIC DATA
During the nine months ended March 31, 1999, the Company generated approximately
14% of its revenues from customers domiciled in countries other than the United
States, primarily in Asia. For the period from March 8, 1996 (inception) to June
30, 1996 and the years ended June 30, 1997 and 1998, substantially all of the
Company's revenues were derived from domestic customers.
15. 401(K) PLAN
In May 1998, the Company began a 401(k) plan (the Plan) that covers all
employees who meet the Plan's eligibility requirements of one year of employment
and attainment of age 21. Eligible employees can contribute up to 15% of their
salary, subject to certain IRS limitations. The Company's contributions in
fiscal 1998 and the nine months ended March 31, 1999 were zero and $103,500,
respectively.
F-18
<PAGE> 96
Narrative Description of Inside Front Cover
Inside Front Cover
Top Center -- [AboveNet logo -- depicting the Company's name inserted through a
spherical circle]
Caption beneath logo and centered to page: "Global Internet Service Exchange
Strategy"
A world map with North and South America in the center. The United States is
clearly defined by being shaded in blue. To the left is the Asian continent and
Australia. To the right is the European continent. Across the United States map
are two curved lines connecting two ISX facilities, one located on the East and
one located on the West coast of the United States. From the facility on the
West Coast is a series of lines connected to locations in the Asian continent
and Australia. From the facility on the East Coast are three lines connected to
locations in three European countries.
Below the world map is a box captioned "Existing Customer Connections In:" and
listed below the caption are: Australia, France, Hong Kong, Japan, Korea,
Philippines, Singapore, Taiwan and United Kingdom.
To the right of the boxes is the following text: "Our objective is to become the
leading global Internet Service Exchange network for Internet content providers,
Web hosting companies and Internet Service Providers that require reliable and
scalable Internet connectivity and co-location services to support their
business critical Internet operations."
<PAGE> 97
Narrative Description of Inside Back Cover
The Inside of the Back Cover shows a series of photographs. The top photograph
is of a room with a series of monitors and computers with a person standing
behind a counter talking to another person in front of the counter. Underneath
the picture is the caption "Internet Service Exchange facility professionally
staffed 24 hours a day, 7 days a week." To the right is a picture that shows
network switching and router units housed in racks. That picture is captioned
"Telecom and Datacom Connectivity." Below is a series of three pictures
captioned "Co-Location Offerings." The left picture shows a person working on a
computer server which is housed in one of the Company's cabinets. The picture is
captioned "Cabriolet Cabinet." The middle picture shows a series of network
servers placed on racks with a person typing on a keyboard housed on one of the
racks. The picture is captioned "Open Rack." To the right is a picture showing a
corridor with cages along the right side. The picture is captioned "Cage." Below
the three pictures is a picture showing a series of power generators with an
individual standing in front of the generators. The picture is captioned
"Redundant Power Systems."
To the right of the bottom picture is the following text: "AboveNet has
developed a network architecture based upon two strategically located, campuses
that combine content co-location services for Internet Content Providers with
direct access to Internet Service Providers to create Internet Service
Exchanges."
2
<PAGE> 98
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LOGO
ABOVENET
COMMUNICATIONS INC.
4,000,000 SHARES
COMMON STOCK
---------------------------
PROSPECTUS
---------------------------
April 30, 1999
CIBC WORLD MARKETS
LEHMAN BROTHERS
PAINEWEBBER INCORPORATED
VOLPE BROWN WHELAN
& COMPANY
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO DEALER,
SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE INFORMATION THAT IS NOT
CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT
SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR
SALE IS NOT PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT
ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY
OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES.
