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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 000-25333
PRODIGY COMMUNICATIONS
CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-3323363
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
44 SOUTH BROADWAY 10601
WHITE PLAINS, NEW YORK 10601
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (914) 448-8000
_______________________________________________________________________
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [_] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Annual Report on Form 10-K or any
amendment to this Form 10-K. [X]
The approximate aggregate market value of the Common Stock held by non-
affiliates of the registrant was $609,470,238 based on the last reported sale
price of the registrant's Common Stock on the Nasdaq National Market as of the
close of business on February 28, 1999. There were 60,804,243 shares of Common
Stock outstanding as of February 28, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE
None
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes," "anticipates," "plans," "expects" and similar expressions are
intended to identify forward-looking statements. The important factors discussed
below under the caption "Certain Factors That May Affect Future Operating
Results," among others, could cause actual results to differ materially from
those indicated by forward-looking statements made herein and presented
elsewhere by management. Such forward-looking statements represent management's
current expectations and are inherently uncertain. Investors are warned that
actual results may differ from management's expectations.
Prodigy(R), the Prodigy logo, Prodigy Internet(TM), It's a tool for
living(TM), Prodigy Classic(TM) and Prodigy MailLink(TM) are trademarks of the
Company. All other trademarks referred to herein are the property of their
respective owners.
Unless the context otherwise requires, the terms "Prodigy" and the
"Company" refer to Prodigy Communications Corporation and its predecessors, in
each case together with their subsidiaries.
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INDEX
ITEM DESCRIPTION PAGE
---- ----------- ----
PART I
Item 1 Business 4
Item 2 Properties 19
Item 3 Legal Proceedings 19
Item 4 Submission of Matters to a Vote of Security-Holders 21
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 22
Item 6 Selected Financial Data 23
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 26
Item 7A Quantitative and Qualitative Disclosures About Market Risk 43
Item 8 Financial Statements and Supplementary Data 44
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 73
PART III
Item 10 Directors and Executive Officers of the Registrant 73
Item 11 Executive Compensation 75
Item 12 Security Ownership of Certain Beneficial Owners and
Management 80
Item 13 Certain Relationship and Related Transactions 82
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on
Form 8-K 90
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PART I.
ITEM 1. BUSINESS
Prodigy Communications Corporation ("Prodigy" or the "Company") is a
leading nationwide Internet Service Provider ("ISP") that provides fast and
reliable Internet access and related value-added services. Prodigy has
nationwide brand recognition and customer acquisition channels not available to
regional and local ISPs, and utilizes a nationwide network covering over 700
cities in all 50 states allowing approximately 83% of the United States
population to access Prodigy's services with a local telephone call. Combining
these strengths with Prodigy's scalable technology has enabled the Prodigy
Internet service to achieve one of the fastest subscriber growth rates among
U.S. ISPs, with the number of billable subscribers to Prodigy Internet
(including migration from Prodigy's original online service, now called Prodigy
Classic) increasing from 221,000 at December 31, 1997 to 505,000 at December 31,
1998. The total number of billable subscribers to Prodigy Internet and Prodigy
Classic increased from 613,000 at December 31, 1997 to 671,000 at December 31,
1998. Prodigy Internet enables the Internet to be used as a productivity tool by
allowing subscribers to obtain and communicate desired information quickly and
efficiently in an easy and personalized manner. Prodigy Internet users receive
fast and reliable access to the Internet, Prodigy-branded content powered by
Excite and other Prodigy member services. Prodigy is in the process of expanding
its Web hosting and electronic commerce activities for business customers, and
believes that its extensive experience in operating a large data center with
electronic commerce applications positions it well for growth in these areas.
Prodigy also recently introduced the co-branded marketing of paging and is in
the process of evaluating and introducing other consumer value-added services,
such as long-distance and cellular telephone services, Internet-based telephony
and fax services and online bill presentment.
Prodigy has been an online pioneer since its inception in 1984. Prodigy's
original online service was launched as the world's first consumer-focused
online service in 1988 and achieved national distribution in 1990. Prodigy
Classic featured custom content, e-mail and chat capabilities and was based on
proprietary technologies. In October 1996, the Company launched Prodigy
Internet, an open standards-based Internet access service. Since the autumn of
1997, the Company has focused on expanding Prodigy Internet's subscriber base
and introducing additional value-added services. The Company has also made
strategic decisions to outsource its network, minimize its development of custom
content and use multiple vendors for outsourced customer service functions. As a
result of these initiatives, the Company has substantially reduced its fixed
operating costs and headcount and now has a business and operating model that it
believes can accommodate sustained subscriber growth on a cost-effective basis
without significant capital expenditures.
INDUSTRY BACKGROUND
Growth of the Internet and Electronic Commerce
The Internet is a collection of computer networks that links millions of
public and private computers to form the largest computer network in the world.
It has become an important global medium enabling millions of people to obtain
and share information and conduct business electronically, and a critical tool
for information and communications for many users. The Internet has grown
rapidly in recent years both in terms of the number of Web users and the number
of Web sites. International Data Corporation ("IDC") estimates that at the end
of 1997 there were over 38 million Web users in the United States and over 68
million worldwide, and projects that by the end of 2002 the number of Web users
will increase to over 135 million in the United States and over 319 million
worldwide. The growth in the number of Web users and the number of Web sites is
being driven by a number of factors, including the large and growing installed
base of personal computers, advances in the performance and speed of personal
computers and modems, improvements in network infrastructure, easier access to
the Internet and the increasing importance of the Internet as a communications
medium, an information resource and a sales and distribution channel.
For many businesses, the Internet has created a new communications and
sales channel enabling large numbers of geographically dispersed organizations
and consumers to be reached quickly and cost-effectively. IDC estimates that the
number of consumers buying goods and services on the Internet will grow from
17.6 million in
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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 $426 billion by 2002.
Evolution of the Internet Services Market
Today, the Internet services market consists primarily of Internet access.
Access services include dial-up access for individuals and small businesses and
high-speed dedicated access primarily for larger organizations. Forrester
Research, Inc. ("Forrester") projects that revenues from Internet access
services in the United States will grow from $5.8 billion in 1997 to $38.1
billion in 2002. The rapid development and growth of the Internet has resulted
in a highly fragmented industry, consisting of more than 5,000 ISPs in the
United States, most of which operate as small, local businesses. The Internet
services industry is expected to undergo substantial consolidation, especially
among mid-sized ISPs, over the next few years. ISPs vary widely in geographic
coverage, customer focus and the nature and quality of services provided to
subscribers. Relatively few ISPs offer nationwide coverage, have a brand name
with nationwide recognition or have the ability to grow significantly without
additional investment in infrastructure. ISPs may concentrate on specific types
of customers that differ from the target markets of other ISPs. Services offered
by ISPs can range from simple dial-up access to highly organized, personalized
access coupled with value-added services. The Company believes that consumers
are generally focused on speed and reliability of access, ease of use, customer
service and price as they evaluate an ISP. In addition to speed and reliability
of access, the Company believes many business customers want all their Internet-
based requirements, such as access, Web hosting and electronic commerce
applications, met by a single provider.
Internet operations, including Web hosting and electronic commerce, are
increasingly becoming mission-critical to an enterprise's commercial and
communications operations. However, many businesses lack the resources and
expertise to develop, maintain and enhance, on a cost-effective basis, the
facilities and network systems necessary for successful Internet operations. As
a result, businesses increasingly seek outsourcing arrangements to enhance Web
site reliability and performance, provide continuous operation of their Internet
solutions and reduce related operating expenses. By outsourcing these services,
companies can focus on their core competencies rather than utilizing their
resources to support Internet operations. Forrester projects that Internet
hosting revenues will increase from approximately $400 million in 1997 to $10.5
billion in 2002.
As a result, there is increasing demand for ISPs to offer "turnkey"
electronic commerce services. An increasing number of ISPs are beginning to
supplement their basic Internet access services with a variety of commercial
services that facilitate electronic commerce, such as Web hosting, bill
presentment, co-location and other value-added services. Such services expand an
ISP's potential revenue streams from basic monthly access fees to other fees
such as set-up and maintenance charges. In addition to services that enable
electronic commerce, some larger and more sophisticated ISPs are beginning to
market other value-added services, such as paging, long-distance and cellular
telephone services, to both consumers and business customers nationwide.
THE PRODIGY SOLUTION
The Company currently provides fast and reliable Internet access and
certain value-added services. The Company intends to meet the rapidly changing
needs of its customers by offering new products and additional value-added
services as demand arises. The Company believes the following competitive
strengths will position Prodigy to meet this goal:
Nationwide Brand Name Recognition. Since the introduction of its original
service in 1988, Prodigy has established substantial nationwide brand
recognition that the Company believes offers a significant competitive advantage
in attracting new subscribers to its services. The Company uses a variety of
advertising, promotional and distribution channels to leverage the equity of its
brand name, one of the oldest and best-known in the Internet industry. The
Company launched the Prodigy Internet service in October 1996 as a productivity
tool dedicated to the Internet and designed to make a user's experience simpler
and more rewarding. The Company believes the strength of the Prodigy brand has
enhanced the market positioning of Prodigy Internet and facilitated the rapid
growth in the number of Prodigy Internet subscribers.
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Nationwide Customer Acquisition Channels. The Company has in place a
variety of nationwide customer acquisition channels, including: bundling with
PCs shipped by leading PC manufacturers; the Microsoft relationship described
below; Web-based marketing; retail channels; direct mail and telemarketing;
television and radio advertising; and migration of subscribers from Prodigy
Classic to Prodigy Internet. Many of Prodigy's customer acquisition channels are
not available to regional and local ISPs who lack the required nationwide
presence and marketing flexibility. The Prodigy Internet software is pre-loaded
on the hard drives of selected PC models shipped by many leading PC
manufacturers and is included in the online services folder of every copy of the
Windows 98 and Windows 95 (OSR 2.5 release) operating systems shipped by
Microsoft for sale in retail channels or for loading on new PCs. The Prodigy
Internet service is also included in Microsoft's ISP Internet Referral Service
Program. See"--Customer Acquisition and Marketing".
Scalable Business Model. Since the autumn of 1997, Prodigy has created a
business and operating model that it believes can accommodate sustained
subscriber growth on a cost-effective basis without significant capital
expenditures. Prodigy has outsourced the major capital and labor intensive
functions to organizations that can provide scalable and dependable network
coverage, customer service and organized content. Prodigy's outsourcing
arrangements enable it to rely on the resources of other organizations while
drawing on its own past experience to manage these services. As a result, the
principal costs of servicing new subscribers, network usage and telephone
customer service, are variable and generally increase only as the subscriber
base increases. In addition, Prodigy's e-mail and customer authentication
systems have been developed in-house to support a large number of customers, and
Prodigy's existing data hosting facilities have the capacity to support millions
of additional subscribers.
Fast and Reliable Service. The Prodigy Internet service offers fast and
reliable Internet connections. Prodigy Internet subscribers have direct Internet
access at speeds of up to 56 kbps (kilobits per second). Inverse Network
Technology Inc. ("Inverse") is an independent Internet testing group that
measures and reports eight parameters of ISP network performance. Since
completion of the network used by the Company in May 1998, Inverse has given
Prodigy Internet ratings of A+ or A for 24-hour call failure rate for each of
the months of May 1998 through February 1999, which ratings exceeded or equaled
the comparable overall industry rating given by Inverse based on 13 major
providers of Internet access services, except that Prodigy Internet received a B
rating compared to an overall industry rating of A for October 1998. The Company
believes call failure rate is the most important network measure in terms of
customer satisfaction. Overall, Prodigy Internet exceeded or equaled the
comparable industry rating given by Inverse in at least six of the eight
parameters for each of the months of May 1998 through October 1998 and at least
seven of the nine parameters for each of the months of November 1998 through
February 1999. For a fuller discussion of network performance and the Inverse
reports, see "--Network and Related Infrastructure--Reliability and
Availability". In October 1998, J.D. Power and Associates, an independent
market research firm, announced that Prodigy Internet had been ranked third in
overall customer satisfaction based on a nationwide survey of users of the five
largest national ISPs, representing approximately 52% of the U.S.
Internet/online access market.
Nationwide Network Coverage. The network used to offer the Prodigy
Internet service covers over 700 cities in all 50 states. The network is able to
provide dial-up access, with a local telephone call, to approximately 83% of the
households in the United States. Prodigy also offers network access via an 800
telephone number for $.10 per minute without an additional enrollment charge.
See "--Network and Related Infrastructure".
Superior Customer Experience. In addition to offering an easy-to-use
interface and extensive personalization, the Company believes Prodigy Internet
offers a productive and rewarding customer experience. The Company's customer
services include toll-free telephone support, various online support options and
an online "members helping members" program. The Company distributes its
customer service calls over multiple outsourcing partners to reduce call waiting
times. The Company has developed proprietary filters to limit unsolicited
commercial e-mail, or "spam", sent by or addressed to subscribers. The Company
accepts banner advertisements and sponsorships but does not generate pop-up
advertisements and intercept screens so that the revenue opportunity from
advertising is balanced against an enhanced customer experience. The Company
also offers the Personal Value Center, which rewards subscribers for their
loyalty. See "--Products and Services".
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BUSINESS STRATEGY
Prodigy's objectives are to strengthen its position as a leading nationwide
ISP and to expand the range of services it offers and markets it serves. See
"Certain Factors That May Affect Future Operating Results--Risks of New Services
and Markets; Failure to Implement Business Strategy" under Item 7 below. Key
elements to the Company's business strategy include:
Leverage Strong Brand Name. The Company intends to increase its brand
equity by promoting the recognition and positive perceptions of the Prodigy
brand, partly through increased marketing and advertising activities, including
the "There Is A Choice" campaign. The Company is leveraging the Prodigy brand
name to encourage Prodigy Classic subscribers to migrate to Prodigy Internet,
expand its other customer acquisition activities, offer new services and enter
new markets.
Introduce New Services. The Company is seeking to expand its Web hosting
business and introduce additional value-added services. The Company's strategy
is to introduce value-added services for business customers that will also be
attractive to consumers. For example, in September 1998 the Company launched co-
branded paging services in partnership with SkyTel Communications, Inc.
("SkyTel"). The Company is also pursuing a variety of other value-added
services, such as the co-branded marketing of long-distance and cellular
telephone services, Internet-based telephony and fax services and online bill
presentment. In January 1999, Prodigy entered into a non-binding letter of
intent with Frontier Communications Services Inc. ("Frontier") to market and
promote Frontier's long-distance and other mutually agreed telecommunications
services to Prodigy's members. The Company is enhancing its data mining
capabilities to enable targeted sales and marketing of value-added services to
existing subscribers. In addition, the Company plans to expand its electronic
commerce activities and introduce broadband services. Prodigy already provides
the fundamental elements of electronic commerce, and Prodigy's strategy is to
provide turnkey solutions for electronic commerce. Prodigy's broadband strategy
is designed to provide business customers with a suite of Internet access and
value-added services. See "--Products and Services".
Enter New Markets. The Company intends to leverage its brand recognition
to expand beyond its existing consumer market to include small and medium sized
businesses. The first services offered in this area will be targeted to small-
office/home-office ("SOHO") customers and will include dial-up Internet
access, Web hosting, communications provisioning and related services. See "--
Business Services". On January 25, 1999, Prodigy and Telefonos de Mexico, S.A.
de C.V. ("Telmex") executed an agreement pursuant to which Prodigy will provide
Telmex with advice and assistance with respect to Telmex's Internet Directo
Personal ("IDP") subscribers in exchange for a management fee. See "--Products
and Services--Spanish-Speaking and Hispanic Market". Telmex, which made a
significant equity investment in the Company in August 1998, is the leading
provider of local and long-distance telephone services in Mexico and the largest
ISP in Mexico. See "Item 12. Security Ownership of Certain Beneficial Owners and
Management." The Company is also seeking a partner with whom to offer a Spanish
language portal to the Internet, which the Company believes will be attractive
to Spanish-speaking and Hispanic Internet users. See "--Products and Services--
Spanish-Speaking and Hispanic Market".
Evaluate Acquisition Opportunities. The Company evaluates acquisition
opportunities on an ongoing basis and at any given time may be, and at the
present time is, engaged in discussions with respect to possible acquisitions or
other business combinations. The Company may seek strategic acquisitions that
can complement the Company's current or planned business activities,
particularly the expansion of value-added services such as Web hosting. The
Internet services industry is expected to undergo substantial consolidation over
the next few years, and the Company may also seek to acquire other ISPs as an
additional means of customer acquisition or entry into new markets.
PRODUCTS AND SERVICES
Prodigy Internet
Prodigy Internet is an open standards-based Internet access service. The
Prodigy Internet service combines the depth and breadth of the Internet with the
ease of use and organization of a traditional online service. Prodigy
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Internet users receive fast and reliable access to the Internet, Prodigy-branded
content powered by Excite and other Prodigy member services. See "--Principal
Outsourcing Arrangements--Excite".
As of December 31, 1998, there were 505,000 billable subscribers to the
Prodigy Internet service. The Company includes as Prodigy Internet subscribers
all subscribers who are enrolled in a Prodigy Internet/Prodigy Classic
combination plan (134,000 at December 31, 1998). See "Certain Factors That May
Affect Future Operating Results--Impact of Planned Termination of Prodigy
Classic Service" under Item 7 below.
The Prodigy Internet service provides subscribers with direct, high-speed
Internet access, an electronic mailbox enabling subscribers to send and receive
an unlimited number of text, graphics and multimedia messages, and disk space on
Prodigy's servers to host a personal Web page. Prodigy Internet also offers for
most Prodigy Internet subscribers: (i) Prodigy-branded Web content, as selected,
organized and edited by Excite into a series of 16 "channels" covering topics
such as Autos, Business & Investing, Travel and Shopping; (ii) a personalized
homepage for each subscriber which includes personalized news services, stock
portfolios, weather, local TV listings and sports scores; (iii) customer service
and online member support, including help files, tutorials and other online
educational tools; (iv) content generated by community members using
communication tools such as chat, message boards, newsgroups, bulletin boards
and personal Web pages; and (v) access to online transactions on the Web.
The Prodigy Internet service is compatible with Internet standards and
protocols. Standardization of both Prodigy Internet content and network permits
use of industry-standard client/server software. Unlike some online services
that use proprietary protocols, Prodigy Internet merges seamlessly with Web
content and can be regularly updated to incorporate advances in Internet
technologies, such as new browsers, RealAudio and security devices for
electronic commerce. Prodigy Internet is compatible with Microsoft Internet
Explorer and Netscape Navigator on the Windows 98, Windows 95 and Windows 3.1
operating systems and on Macintosh computers. Microsoft Internet Explorer is the
primary browser shipped on disks that contain the Prodigy Internet software.
The price plans for the Prodigy Internet service vary among acquisition
channels and target market segments and are subject to change. Prodigy
Internet's principal price plans currently are (i) $19.95 per month for
unlimited usage with a 30-day money back guarantee, (ii) a discounted prepaid
annual plan of $189 for one year of unlimited usage (equivalent to $15.75 per
month), (iii) $9.95 per month for three months of unlimited usage, then $19.95
per month thereafter, and (iv) a free trial (for 30 to 60 days) with unlimited
usage and $19.95 per month thereafter.
Prodigy Classic
The Prodigy Classic service, launched in 1988 as the world's first
consumer-focused online service, is based on a proprietary architecture and
technologies. Prodigy Classic offers most basic Internet capabilities, including
e-mail exchange, newsgroup support and Web browsing, as well as proprietary
content developed by or with third-party content providers such as Dow Jones and
Associated Press. Prodigy Classic's implementations of these Internet functions
predate current Internet standards and are not readily upgradable, and the
Company has determined not to make Prodigy Classic Year 2000 compliant. The
Company intends to discontinue Prodigy Classic in the fourth quarter of 1999.
See "Certain Factors That May Affect Future Operating Results--Impact of
Planned Termination of Prodigy Classic Service" under Item 7 below. Prodigy
Classic is no longer marketed actively, although new enrollments continue to
occur as a result of residual marketing efforts. The Company encourages
migration with targeted pricing offers, special hardware upgrade promotions and
the introduction of features and functions that have contributed to the
retention of Prodigy Classic subscribers. See "--Customer Acquisition and
Marketing--Migration from Prodigy Classic". As of December 31, 1998, there were
166,000 billable subscribers to the Prodigy Classic service.
Prodigy Classic's principal price plans currently are $19.95 per month for
unlimited usage or $9.95 per month for five hours of usage with additional time
billed at $2.95 per hour. In order to encourage existing Prodigy Classic
subscribers to trial and convert to the Prodigy Internet service, Prodigy also
offers a plan that provides unlimited usage of both Prodigy Classic and Prodigy
Internet for a monthly fee of $9.95 for the first three months and $19.95
thereafter or under a discounted prepaid annual plan of $189 for one year of
unlimited usage.
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Consumer Value-Added Services
The Marketplace on Prodigy Internet currently provides links to over 150
Web-based stores and retailers, including Amazon.com, Reel.com, PC Flowers and
Gifts, Godiva Chocolate, eToys, Outpost.com and Omaha Steaks. In January 1999,
the Company agreed to create a co-branded Internet service with Value America,
Inc., that will provide exclusive discounts and online shopping opportunities to
subscribers, and to include the Value America online stores in Prodigy
Internet's Marketplace area. In September 1998, the Company launched co-branded
paging services in partnership with SkyTel. Over the next six to nine months,
the Company plans to roll out additional consumer value-added services, such as
the co-branded marketing of long-distance and cellular telephone services,
Internet-based faxing, online billing services, the online procurement of
additional goods and services and premium services. In January 1999, Prodigy
entered into a non-binding letter of intent with Frontier to market and promote
Frontier's long-distance and other mutually agreed telecommunications services
to Prodigy's members. In November 1998, the Company entered into an agreement
with JFAX Communications, Inc. to provide Prodigy subscribers with integrated
fax, voice mail and e-mail messaging solutions. In February 1999, the Company
entered into a strategic alliance with Blockbuster Video for the design,
development and hosting of co-branded Internet service for Blockbuster. In
February 1999, the Company announced the launch of Prodigy MailLink, a new Web-
based e-mail program that allows Prodigy Internet members to access their
Prodigy e-mail from any PC connected to the Web and has enrolled over 55,000
members in this service within the first month of availability. To enable
targeted sales and marketing of value-added services to existing subscribers,
the Company is enhancing its data mining capabilities. There can be no assurance
Prodigy will be successful in offering additional consumer value-added services.
See "Certain Factors That May Affect Future Operating Results--Risks of New
Services and Markets; Failure to Implement Business Strategy" under Item 7
below.
Business Services
Prodigy has formed a business services division, called the Prodigy
Business Solutions Group, to develop and market Internet-based services to
commercial and business entities. These services are planned to include Internet
access, basic and enhanced hosting services and broadband services. The Company
also plans to extend its Web hosting activities to include hosting of intranets
and extranets for businesses and electronic commerce. Prodigy initially plans to
target its business services to the SOHO market in specific regions of the
United States. Although Prodigy does not currently provide any business
services, other than Web hosting to a limited number of customers, the Company
has recently entered into several agreements to enable Prodigy to begin to offer
additional business services. In November 1998, the Company entered into an
agreement permitting the Company to resell co-branded intranet services provided
by HotOffice. In December 1998, Prodigy became a channel partner in Hewlett-
Packard's Covision program, which integrates Internet-based business
applications, Hewlett-Packard computer technology and services from systems
integrators and ISPs, and began to market these services to its business
customers. In addition, the Company has appointed various Web site design and
development companies as authorized resellers of Prodigy's Web hosting services.
There can be no assurance Prodigy will be successful in offering business
services. See "Certain Factors That May Affect Future Operating Results--Risks
of New Services and Markets; Failure to Implement Business Strategy" under Item
7 below.
Prodigy was a pioneer in electronic commerce through its establishment of
standards and creation of applications that facilitated online shopping and
transacting, such as online banking and securities trading. Prodigy currently
has the capability to provide the fundamental elements of electronic commerce--
Web hosting, hosting of intranets/extranets and high-speed dial access.
Prodigy's strategy is to provide turnkey solutions for electronic commerce.
Electronic commerce applications that Prodigy plans to roll out during 1999
include electronic "shopping carts", order processing and tracking, online
bill presentation and payment processing, co-location hosting and, in
conjunction with partners, consulting and integration services for complex and
large electronic commerce sites.
Prodigy's broadband strategy is designed to provide business customers with
a suite of Internet access and value-added services in conjunction with selected
technology and marketing partners. Commencing in 1999, the Company plans to
introduce fractional T1, T1, DS-3 frame relay and ATM (Asynchronous Transfer
Mode) services. Commencing in 1999, Prodigy also plans to market VPN (Virtual
Private Networks) capability and Internet-based
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voice and fax services for businesses. Splitrock Services, Inc. ("Splitrock"),
the Company's network provider, does not currently support the broadband
applications the Company plans to offer. The Company is in discussions with
Splitrock and others to support various broadband applications, but there can be
no assurance the Company will reach agreement with Splitrock or any other party
regarding additional broadband services. See "--Network and Related
Infrastructure".
Spanish-Speaking and Hispanic Market
Prodigy plans to market Internet services to Spanish-speaking and Hispanic
customers in the United States. According to United States census data, there
are approximately 17 million persons in the United States age 5 or older who
speak Spanish at home, and a total of approximately 28 million U.S. residents
are identified as Hispanic. Prodigy believes this market is not currently being
targeted by any other nationwide ISP. In addition, the Company is seeking a
partner with whom to offer a Spanish language portal to the Internet. Although
the Company has not yet identified or reached agreement with a partner, the
Company believes that a Spanish language portal, once offered, will be
attractive to Spanish-speaking and Hispanic Internet users.
Telmex is the largest ISP in Mexico and had approximately 110,000 billable
subscribers to its IDP online service at December 31, 1998. Telmex has advised
the Company that IDP subscribers currently generate average monthly revenue of
approximately 200 pesos per subscriber (approximately $20 per subscriber based
on the current peso/dollar exchange rate). On January 25, 1999, Prodigy and
Telmex executed an agreement under which: (i) Prodigy will assist Telmex in the
negotiation of agreements with service providers for Telmex's IDP service in
Mexico pertaining to network/Internet access, Web hosting, customer service,
content hosting, billing, marketing, sales and data collection services; (ii)
Prodigy will advise Telmex on customer service, administrative functions and
technical operations, including marketing, Internet connection and other network
services, content, customer support, pricing and service composition, billing
and collection, inbound telemarketing and other aspects of the ISP business;
(iii) the parties will discuss the potential migration of certain IDP
infrastructure functions, including email, subscriber management and
authentication systems, for Telmex's IDP subscribers to the Prodigy
infrastructure platform, and the advisability of offering a co-branded
IDP/Prodigy service in Mexico; and (iv) the parties will pursue additional
opportunities, such as providing services to one another and the joint
acquisitions of subscribers. In exchange for Prodigy's services, Telmex will pay
Prodigy a management fee, on a monthly basis, equal to 15% of the net subscriber
revenue (defined as the invoiced sales price less discounts, excise taxes and
credits for returns) on the first 200,000 IDP subscribers and 10% of the net
subscriber revenue (as defined above) on additional IDP subscribers. The
agreement has a term of five years and may be terminated by Telmex if Prodigy
undergoes a change of control.
Telmex is the leading provider of local and long-distance telephone
services in Mexico and is the principal full-service telecommunications provider
in Mexico. Telmex owns the nationwide network of local telephone lines and the
principal public long-distance telephone transmission facilities in Mexico, and
has built a nationwide data transmission network. Based on total assets at
December 31, 1998, Telmex was the second-largest company in Mexico and the
largest company listed on the Mexican Stock Exchange. Telmex was the state-owned
monopoly telephone company in Mexico until 1990, when it was privatized and sold
to an investor group led by Grupo Carso, S.A. de C.V. (which subsequently spun-
off its interest to Carso Global Telecom, S.A. de C.V. ("Carso Global Telecom"),
a significant stockholder of the Company), Southwestern Bell Corporation
(currently known as SBC Communications Inc.) and France Telecom, the French
state-owned telecommunications company. Telmex is currently controlled by Carso
Global Telecom. Carso Global Telecom and Telmex collectively own 61.9% of the
Company's outstanding Common Stock as of February 28, 1999. See "Item 12.
Security Ownership of Certain Beneficial Owners and Management."
CUSTOMER ACQUISITION AND MARKETING
Prodigy utilizes a variety of customer acquisition channels and focuses on
the lowest-cost and most efficient channels, such as PC bundling. The Company
believes that the strong brand recognition of the Prodigy name among consumers
and the nationwide reach of the network utilized by the Company provide the
Company with access to customer acquisition channels not available to local and
regional ISPs.
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The Prodigy Internet service is marketed through a variety of media
vehicles, including television and radio advertising. See "Use of Proceeds".
The target audiences for Prodigy Internet are: (i) purchasers of new desktop
consumer PCs, (ii) existing subscribers to online services who may be interested
in moving to an ISP and (iii) existing ISP subscribers who are dissatisfied with
their current service or attracted to the performance and features of Prodigy
Internet. The Company believes that the first target segment listed gives
Prodigy effective access to both first-time Internet users, who may be attracted
by Prodigy Internet's ease-of-use, customer service and online assistance, and
existing Internet access subscribers who, in conjunction with the purchase of a
new PC, may be willing to switch to Prodigy Internet. The Company believes that
consumers in the second and third target segments listed above are less likely
to switch back from Prodigy Internet to another ISP, are less price sensitive
and are more receptive to value-added services.
Prodigy's marketing efforts position the Prodigy Internet service as the
right Internet choice and as a productivity tool to help users obtain and
communicate desired information quickly and efficiently. Marketing themes
emphasize that the Prodigy Internet service is superior in terms of connectivity
(availability and reliability), speed (up to 56 kbps), technology (digital
switched ATM in most major markets) and navigation and personalization (via the
co-branded Prodigy/Excite content services). See "--Products and Services" and
"--Network and Related Infrastructure".
PC Bundling. The Prodigy Internet service is bundled with PCs under
arrangements where the Company pays a negotiated fee to the PC manufacturer only
if a subscriber enrolls from the PC distributed by the manufacturer and
continues as a service customer beyond an introductory period. PC bundling is an
attractive acquisition channel because the supplier bears the distribution cost
and it reaches many more potential subscribers than could be reached through
most other acquisition channels. The Prodigy Internet software is pre-loaded on
the hard drives of selected PC models shipped by Packard Bell/NEC, TalkAmerica,
Hewlett-Packard, IBM, Gateway 2000, Sony and Acer. See "Certain Factors That
May Affect Future Operating Results--Dependence on PC Bundling and Microsoft
Relationship" under Item 7 below.
Microsoft Relationship. Microsoft includes the Prodigy Internet service
in the online services folder of every copy of the Windows 98 and Windows 95
(OSR 2.5 release) operating systems shipped by Microsoft for sale in retail
channels or for loading on new PCs. Prodigy Internet, Microsoft Network, America
Online, CompuServe and AT&T WorldNet are the only services in the online
services folders of Windows 98 and Windows 95 (OSR 2.5 release). The Prodigy
Internet service is also included in Microsoft's ISP Internet Referral Service
Program. The Company believes that these arrangements enhance Prodigy's
nationwide brand presence. See "Certain Factors That May Affect Future
Operating Results--Dependence on PC Bundling and Microsoft Relationship" under
Item 7 below.
Web-Based. Prodigy maintains a Web site (www.prodigy.com) that provides
Internet users with the opportunity to learn about and enroll in the Prodigy
Internet service. In addition, as part of its Excite arrangements, approximately
nine million Prodigy banner ad impressions appear each month throughout Excite's
Web site to promote Prodigy Internet to non-subscribers. The Company believes
these banner advertising and other programs help target the "switcher"
audience.
Retail. Prodigy has relationships with major retailers in the computer,
software and consumer electronics areas, including Best Buy, Blockbuster Video,
Circuit City, Electronics Boutique, Micro Center and Staples. The Prodigy
Internet software is currently available at approximately 6,000 retail outlets
nationwide, and is the first Internet service marketed to Staples customers in
all 900 Staples retail stores nationwide. These relationships typically entitle
Prodigy to establish displays containing software, along with incentive
applications such as free software in prime locations next to cash registers or
end caps. Prodigy supports these relationships through the use of bounty
programs, cooperative advertising, joint promotional events and manufacturer
development funds. Prodigy also maintains a Prodigy Pro Program that provides
training, information, incentives and access to the Prodigy Internet service to
over 4,000 retail sales people in partner stores. Prodigy is currently exploring
expanded distribution through additional retailers, including music stores,
video rental chains, book stores and online retailers. Lycos provides the search
engine and portal for subscribers to Prodigy Internet who enroll through
Blockbuster Video as the result of a separate agreement between Blockbuster
Video and Lycos.
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Direct. Prodigy pursues highly targeted and prequalified audiences in its
direct mailing and telemarketing efforts. Prodigy's direct mail is targeted to
highly-qualified prospects, such as known Internet users and new PC purchasers.
Prodigy's inbound telemarketing program fulfills customer orders, 24 hours a
day, 7 days a week, 365 days a year, via toll-free telephone numbers (1-800-
PRODIGY and 1-888-PRODIGY) which are widely promoted. Prodigy's outbound
telemarketing programs focus on the reacquisition of recently disconnected
members and qualified leads. Prodigy's telemarketing services, inbound and
outbound, are outsourced. Prodigy maintains an online, member-assisted referral
program in which existing subscribers receive cash payments for signing up new
members.
Migration from Prodigy Classic. Prodigy acquires additional subscribers
to the Prodigy Internet service who migrate from Prodigy Classic. Prodigy
encourages migration with targeted pricing offers, special hardware upgrade
promotions and the introduction of features and functions, including enhanced
chat and bulletin boards, special pricing for additional mailboxes and a special
alternative homepage for Prodigy Classic members, which have contributed to the
retention of Prodigy Classic subscribers, while emphasizing that the Prodigy
Internet service provides direct and reliable Internet access. Because a
substantial portion of the remaining Prodigy Classic subscribers lack the
minimum hardware requirements for the Prodigy Internet service, in the fourth
quarter of 1997 Prodigy initiated special hardware discounts in conjunction with
PC and modem suppliers to encourage migration to the Prodigy Internet service.
As of December 31, 1998, 144,000 of the Prodigy Internet billable subscribers
had migrated from Prodigy Classic (most of whom are enrolled in a Prodigy
Internet/Prodigy Classic combination plan), and there were 166,000 remaining
billable subscribers to Prodigy Classic. The Company intends to discontinue
Prodigy Classic in the fourth quarter of 1999. See "Certain Factors That May
Affect Future Operating Results--Impact of Planned Termination of Prodigy
Classic Service" under Item 7 below.
Retention Programs. Prodigy also develops programs to encourage conversion
from trial to paying status and improve customer retention. Typical conversion
promotions are designed to induce usage because usage is a primary determinant
of conversion. For example, in February 1998, Prodigy launched an e-mail
promotion that featured prizes such as Palm Pilots and software titles. The
promotion was entered by approximately 10,000 trialers whose average usage
doubled during their trial period. In June 1998, Prodigy introduced the Personal
Value Center, a member loyalty program designed to increase knowledge and usage
of the Web for transactions and other services. Through the Personal Value
Center, Prodigy members can earn "points" based on usage and redeem such
points for gift certificates at selected retail stores. Prodigy plans to extend
the Personal Value Center to travel services and other merchandise. The Company
also uses incentives to retain subscribers who might otherwise terminate
service.
CUSTOMER SERVICE
Prodigy's customer service programs are designed to contribute to member
satisfaction and retention, while controlling costs, by combining selective
outsourcing with in-house services. Prodigy believes that its customer service
programs, coupled with new release management which is both member-sensitive and
market responsive, have positioned Prodigy to provide customer support services
that are efficient and scalable for future growth.
Telephone Support. Prodigy outsources its first contact, toll-free
telephone support to various vendors that provide support 365 days per year.
Customer technical support is available twenty-four hours per day, and
administrative and billing support is available 20 hours per day (support is not
available from 3:00 a.m. to 7:00 a.m., Eastern time). Customers are assisted
with Prodigy software installation, enrollment questions, account management
concerns, service access problems and disconnect requests. By using multiple
vendors, Prodigy is able to direct customer traffic flow volumes on short
notice, which Prodigy believes creates a competitive environment and results in
enhanced quality, performance and pricing. Geographic distribution of call
centers allows for uninterrupted service to Prodigy's member base in the event
of regional disasters. The Company currently outsources its telephone support
services to Ron Weber and Associates, EnvisioNet, Softbank Services Group, SPS
Payment Systems and Stream.
In-House Customer Support and Systems. Prodigy maintains an online member
services content area that provides a variety of support options to all members,
including real-time chat, instant messaging, newsgroups,
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message boards, e-mail, and fax back. Prodigy has integrated comprehensive help,
tutorials, advisories, frequently asked questions and tips online. Prodigy also
has an online "members helping members" program, in which selected subscribers
receive nominal monthly compensation in exchange for providing personalized
responses to members posting inquiries on newsgroups, message boards and chat.
Prodigy's customer service organization monitors customer service vendor
performance with quantitative metrics (including average wait time, first call
resolution rate and abandon rate) and qualitative controls (including call
monitoring). Prodigy also has technically-trained customer service
representatives to call subscribers with unresolved problems.
Prodigy maintains detailed customer records and documents each customer
request in a problem tracking system. This system allows recurring problems to
be identified and communicated to the appropriate internal Prodigy function for
resolution. Prodigy maintains a Web-based database that is accessible by all
vendor and employee customer service representatives on a real-time basis to
help ensure delivery of customer service in a consistent manner regardless of
where the contact is handled.
Billing. Prodigy's customer billing system and services are outsourced to
CSG Systems, Inc. ("CSG"). CSG's billing system is highly customized and
flexible and supports prompt pricing changes. CSG provides credit card and paper
billing, transaction processing and check handling. A substantial majority of
Prodigy's current subscribers are billed through pre-authorized credit card
charges, while the remainder are issued invoices. See "--Principal Outsourcing
Arrangements--CSG".
TECHNOLOGY
Prodigy has been a technology pioneer in the online industry since its
formation in 1984 and introduced many concepts that would later be adopted for
the Web. Continuing this pioneering heritage in the Internet industry, the
Prodigy Internet service utilizes a standards-based, proprietary service
provider platform and mail server developed by the Company.
Service Provider Platform. The service provider platform is a suite of
functions which creates the infrastructure of a large-scale ISP. Capabilities
include customer profile management, access control, authentication, billing and
customer care interfaces and other functions necessary to offer large-scale
Internet services. The service provider platform is highly scalable (up to
millions of subscribers) and is compatible with industry standard products, such
as Netscape Web servers, Oracle databases, Net.Commerce (IBM's electronic
commerce solution) and Lotus Domino (an interface between Lotus Notes and the
Web). The service provider platform also interfaces effectively with Prodigy's
mail server, and is built to open standards to enable the utilization of
applications from other suppliers.
Mail Server. The Prodigy Internet service uses a scalable, reliable
Internet mail server. The mail server draws on the fault-tolerance and
scalability provided by the underlying Oracle database to offer flexibility,
ease of operation and scalability. Prodigy's mail server supports standard
Internet protocols, such as SMTP (Simple Mail Transfer Protocol), POP3 (Post
Office Protocol) and MIME (Multi-Purpose Internet Mail Extensions). The mail
system also provides:
Tools for Administrators. Welcome messages, bulk mailers, quota
controls (by realm, domain, household, small business or individual account),
tools to manage spam and operational scripts and tools.
Tools for Users. User configured filters for prioritization and spam
removal. Messages can contain any number of MIME attachments (up to a size
limitation of 10 megabytes per mailbox) and are delivered without any
promotional tag lines.
Features for Business Customers. Support for multiple domains which
enable Prodigy Internet to operate multiple Internet services under different
brands on the same system base, and which enable an off-site administrator to
control enterprise mailboxes.
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Configuration and Provisioning Interfaces. The system supports a
standard administrative interface that provides configuration and control of
the mail system from external systems or via an HTML (Hypertext Markup
Language) screen. Standard APIs (Application Programming Interfaces) interface
the system to external databases for user authentication and mailbox
provisioning.
Scaling Ability. The system is designed to scale to millions of
mailboxes with an architecture that supports hardware and data redundancy.
NETWORK AND RELATED INFRASTRUCTURE
Subscribers access Prodigy's services by connecting to a network with their
PCs using local, toll-free or long distance telephone service. The network
connects subscribers' PCs to the Internet as well as to Prodigy's hosting
servers, which store some of the data accessed during subscriber sessions.
Network connections are made through communications hardware, such as telephone
lines, routers, switches and modems, which serve to direct data and enable
communication among a variety of computer operating systems. The network used
for the Prodigy Internet service is built to Internet standards, including
TCP/IP (Transmission Control Protocol/Internet Protocol) transmission and PPP
(Point-to-Point Protocol) access. The Prodigy Classic service operates on
certain proprietary standards which are used only for Prodigy Classic. The
Company outsources its network functions to Splitrock. See "--Principal
Outsourcing Arrangements--Splitrock".
Network Architecture
The network infrastructure utilized by Prodigy Internet consists of three
primary tiers: local points of presence ("POPs"); a middle tier, which
connects the POPs to regional hubs; and a backbone tier, which connects the
regional hubs to the Internet or Prodigy's data hosting center. The network
currently includes over 700 POPs nationwide and has the capability to provide
dial-up access, with a local telephone call, to approximately 83% of the
households in the United States. Prodigy also offers access to the Splitrock
network via an 800 telephone number for $.10 per minute without an additional
enrollment charge.
Over 700 POPs currently provide 56 kbps access to Prodigy Internet
subscribers having modems of that speed. All of the POPs which provide 56 kbps
access are V.90 supported. The backbone implemented by Splitrock utilizes the
WorldCom network. Twenty-one fully-meshed core nodes in major cities are
connected via high-speed links using digital ATM technology in all major
metropolitan markets. To optimize data transmission and facilitate the addition
of POPs as necessary, Splitrock employs an "ATM-to-the-edge" architecture,
placing ATM switches in all physical sites rather than only at major
transmission nodes on the backbone. Eight connections from the backbone to the
Internet provide data transmission to and from servers on the Internet, and
Splitrock is building additional connections to other major networks with which
it has peering arrangements.
Data Hosting Center
Prodigy's data hosting center, located in Yorktown Heights, New York,
houses approximately 400 high-capacity servers to store content and other data.
The data center contains a mainframe complex which supports business support
systems such as subscriber session accounting and reporting, customer service
support systems and business accounting. Prodigy's data center hosts a variety
of applications that are scalable to millions of users. The use of standard
interfaces allows integration of products offered by a broad spectrum of
vendors, including IBM, Microsoft and Netscape. Supported operating system
platforms include UNIX/AIX, Windows(R) NT, OS/390 and TPF, and installed
database products include Oracle and DB2.
Prodigy's data hosting center is equipped with triple redundant power
systems and is housed in a climate and humidity controlled environment. Both
battery and diesel power backup systems are installed to preclude outages that
might otherwise result from interruption of utility power to the building. All
production host systems have backup processors and peripherals, and all critical
data is backed up to tape daily. Facilities and data are physically secured by
incrementally restrictive card key locks, and logical data security is provided
by built-in operating system security features. Firewall technology is
implemented to protect critical systems, and servers that
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are open directly to the Internet are installed on a network separate from those
that are not. In addition, anti-hacking measures are in place.
Reliability and Availability
Reliability and availability are key objectives of Prodigy's network and
hosting configurations. Splitrock has designed and is rolling out its network to
meet specified service level objectives, including the P.01 grade of service (no
more than one busy signal in 100 dial-up attempts during the busiest hour of the
day on the busiest day of the week), and specified objectives for site and
overall system availability and backbone transit delay. Splitrock accumulates
and analyzes statistics on each access line, and lines exhibiting quality
problems are removed from service and referred for repair. In addition, Prodigy
has integrated Inverse's Access Ramp product into the Prodigy Internet software
to gather data on the actual connection experiences of subscribers who have
agreed to have their connection experiences measured. Prodigy reports problem
sites to Splitrock for action.
At Prodigy's data hosting center, Prodigy operates a 24x7 operations
control center and Splitrock operates a 24x7 network operations center. Where
feasible, the access lines are distributed among multiple modem subsystems and
access servers to provide diversity. The hosting center is connected to the
backbone via redundant DS3 lines. Splitrock's fully-meshed core node
architecture provides multiple transmission routes across the backbone for
optimal speed and reliability.
Inverse measures and reports eight parameters of ISP network performance
(24-hour call failure rate, evening-hour call failure rate, business-hour call
failure rate, initial modem connect speed, average time to login, average DNS
(Domain Name System) lookup time, average Web throughput and average total Web
failures/timeouts). Since completion of Splitrock's network in May 1998, Inverse
has given Prodigy Internet ratings of A+ or A for 24-hour call failure rate for
each of the months of May 1988 through February 1999, which ratings exceeded or
equaled the comparable overall industry rating given by Inverse based on 13
major providers of Internet access services, except that Prodigy Internet
received a B rating compared to an overall industry rating of A for October
1998. The Company believes call failure rate is the most important network
measure in terms of customer satisfaction. Overall, Prodigy Internet exceeded or
equaled the comparable industry rating given by Inverse in at least six of the
eight parameters for each of the months of May 1988 through October 1998 and at
least seven of the nine parameters for each of the months of November 1998
through February 1999. Investors should not place undue reliance on Inverse's
reports as a measure of network performance because such reports do not measure
and report on all factors that may affect the quality of the Company's services.
For example, Inverse's reports are based on tests conducted on selected days at
a random sampling of only 42 of Splitrock's POPs, and Inverse's reports cited
above cover only a ten month period. There can be no assurance Splitrock's
network will be able to sustain the level of performance indicated by Inverse's
reports. See "Certain Factors That May Affect Future Operating Results--Network
Risks" under Item 7 below.
PRINCIPAL OUTSOURCING ARRANGEMENTS
The Company follows a "best of breed" outsourcing philosophy in which it
selects from among competing suppliers in order to enhance service quality,
control costs and enable the Company to focus on its core strengths.
Splitrock
Prodigy owned and operated its own network in the United States until July
1, 1997. Effective July 1, 1997, Prodigy conveyed its network assets to
Splitrock in exchange for Splitrock's agreement to build and operate the
Splitrock network described above, hire all Prodigy employees engaged in
Prodigy's network operations and assume certain POPs leases and other
liabilities. The Company believes its Splitrock network arrangements present a
number of significant advantages to Prodigy. In addition to shifting to
Splitrock the capital costs of network expansion and enhancement as well as
network operating and personnel expenses, the Company believes these
arrangements have reduced Prodigy's network costs and made such costs more
predictable. Prodigy also believes the variety and sophistication of data
services available to it will increase due to anticipated network enhancements
and upgrades. See "Certain Factors That May Affect Future Operating Results--
Network Risks" under Item 7 below.
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The Splitrock network arrangements cover only the United States, and Prodigy
would need to make other network arrangements in order to offer services in
foreign countries.
Splitrock is required to provide dial-up network access in all locations in
which Prodigy provided dial-up service as of June 30, 1997. Prodigy may require
additional sites to be added if certain coverage and usage parameters are met.
Splitrock may also provide access to the network to other customers. Splitrock
is required to provide a backbone network based on ATM technology and is
required to support transmission via SLIP (Serial Line Internet Protocol), PPP
and TCP/IP. Splitrock is also required to support the proprietary standard
utilized by Prodigy Classic through December 31, 1999, and the Company intends
to discontinue Prodigy Classic in the fourth quarter of 1999. See "Certain
Factors That May Affect Future Operating Results--Impact of Planned Termination
of Prodigy Classic Service" under Item 7 below.
Splitrock is required to meet specified service level objectives, including
the P.01 grade of service and specified objectives for site and overall system
availability and backbone transit delay. Splitrock's failure to meet the
specified service level objectives will result in financial penalties. If
Splitrock fails to meet specified service level objectives for an extended
period of time, Prodigy may terminate the agreement. In addition, if there is a
system-wide failure, or Splitrock breaches specified financial covenants,
Prodigy will have the right to terminate the agreement or assume responsibility
for operating the network at Splitrock's expense.
Splitrock charges Prodigy a monthly fee per subscriber for usage by
Prodigy's subscribers. If the average hourly usage by Prodigy's subscribers in
any month exceeds a specified threshold, Prodigy must pay Splitrock an
additional amount per hour in excess of such threshold for such month. The
agreement includes minimum monthly charges and is terminable by Prodigy upon
payment of a specified early termination charge. During the years ended December
31, 1997 and December 31, 1998, the Company incurred network charges to
Splitrock of $22.7 million and $64.1 million, respectively. See "Certain
Factors That May Affect Future Operating Results--Control of the Company and
Potential Conflicts of Interest" under Item 7 below.
The agreement has an initial term of four years through June 30, 2001 and
is subject to automatic renewal for successive one-year terms unless terminated
by either party upon 12 months' notice. Until termination of the agreement,
Prodigy has agreed that Splitrock will be Prodigy's primary provider of network
services. During this period, Prodigy must give Splitrock advance notice of, and
the opportunity to discuss with Prodigy, any forms of service access (other than
network access) that Prodigy wishes to pursue in the United States.
Excite
In January 1998, Prodigy entered into an agreement with Excite, Inc.
("Excite") under which Excite, commencing in April 1998, provides the majority
of subscribers to the Prodigy Internet service with Prodigy-branded Excite
content using Excite's "My Channel" technology. This arrangement enables
Prodigy to offer Excite's extensive editorialized content and content
personalization and communication features under the Prodigy brand without
incurring the time or expense to develop similar capabilities internally.
Prodigy's agreement with Excite (i) has an initial term of three years and
automatically renews for successive one-year terms unless Excite elects not to
renew it, (ii) is terminable by Prodigy upon 60 days' notice, (iii) makes Excite
Search the exclusive search engine, Excite NewsTracker the exclusive
personalized Internet news clipping service and Excite Shopping Search the
exclusive Internet shopping search tool on Web pages provided to subscribers to
the Prodigy Internet service, (iv) does not prohibit Prodigy from entering into
similar agreements with other content providers (except as provided in the
preceding clause (iii)) or prohibit Excite from entering into similar agreements
with other ISPs, (v) provides for a sharing of all revenue derived from the
advertising banners on the co-branded Prodigy/Excite Internet service, and (vi)
gives Prodigy free advertising banner impressions throughout Excite's Web site
to promote the Prodigy Internet service.
In January 1999, At Home Corporation, a provider of broadband Internet
access, announced that it had agreed to acquire Excite. The Company's agreement
with Excite will not be terminated as a result of At Home's acquisition of
Excite, but At Home's ownership of Excite could affect the likelihood of the
agreement being
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renewed upon its scheduled expiration in January 2001 or the terms of any such
renewal. See "Certain Factors That May Affect Future Operating Results--
Reliance on Third-Party Providers" under Item 7 below.
CSG
Prodigy outsources its customer billing to CSG. CSG is a leading provider
of customer care and billing solutions for various telecommunications providers,
including many of the largest cable television and direct broadcast satellite
providers. Prodigy and CSG have agreed that CSG is Prodigy's exclusive provider
of billing services for the Prodigy Internet and Prodigy Classic services but
not for premium services or other billing services. CSG charges Prodigy a
monthly fee based on the number of subscribers, subject to a specified minimum
charge, as well as a monthly minimum fee for ongoing development and support.
The agreement between Prodigy and CSG expires June 30, 2001.
COMPETITION
The industry in which the Company competes is intensely competitive and
includes a number of significant participants, including ISPs, proprietary
online service providers and major international telecommunications companies,
as well as Internet-search services and various other telecommunications
companies. There are more than 5,000 ISPs in the United States, most of which
operate small, local businesses. Additional regional telephone operating
companies, long-distance carriers and cable companies may also elect to compete
with Prodigy. Various partnering arrangements have been established between
Internet-search service companies and major telecommunications companies, which
could result in increased competition for Prodigy. Moreover, the Company faces
competition from companies that provide broadband connections to households,
including local and long-distance telephone companies, cable television
companies and electric utility companies. Broadband technologies offer
significantly faster Internet access than conventional modems, and such
companies could include Internet access in their basic service packages, could
offer access for a nominal additional charge or could prevent the Company from
delivering Internet access through the cable or wire connections that such
companies own. See "Certain Factors That May Affect Future Operating Results--
Intense Competition" under Item 7 below.
Among the larger providers of ISP services are EarthLink Network, Inc.
(which has a strategic relationship with Sprint Corporation), MindSpring
Enterprises, Inc., Microsoft Network, AT&T WorldNet, MCI Internet, IBM Internet
Connection, PSINet Inc., GTE Internetworking (which includes the former ISP
business of BBN Corporation), Netcom On-Line Communications Services, Inc. and
Concentric Network Corporation. In January 1999, ICG Communications, Inc., the
owner of Netcom On-Line Communications Services, Inc., announced that it had
agreed to sell Netcom's dial-up, dedicated and Web hosting accounts in the
United States to MindSpring Enterprises, Inc. but will retain Netcom's network
backbone. In December 1998, AT&T announced that it had agreed to acquire IBM's
data networking business, including its ISP business. In addition, AT&T has
agreed to acquire Tele-Communications, Inc., the second largest cable television
operator in the United States, which is the majority stockholder of At Home
Corporation. Microsoft's ownership of the dominant PC operating system and the
Microsoft Internet Explorer browser may give Microsoft Network certain
competitive advantages, including distribution and marketing synergies.
Prodigy also competes with America Online, which offers the America Online
and CompuServe proprietary online services over closed networks, as well as
Internet access. America Online has recently announced several transactions that
could result in additional competition for the Company. In November 1998,
America Online announced that it had agreed to acquire Netscape Communications
Corporation, owner of the Netscape Navigator browser and other Internet software
applications. In November 1998, America Online also announced that it had
entered into strategic development and marketing agreements with Sun
Microsystems, Inc. to develop electronic commerce and next-generation Internet
devices. In December 1998, America Online announced that it had formed a joint
venture with the Cisneros Group, a leading Latin American media and
telecommunications conglomerate, to provide online services in Latin America,
with an initial focus on Mexico, Argentina and Brazil. In January 1999, America
Online and Bell Atlantic announced a strategic alliance to provide high speed
DSL access to the America Online service. In addition, CompuServe is currently
providing the content for MCI WorldCom's homepage.
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Prodigy believes that the principal competitive factors in the ISP industry
are speed and reliability of access, ease of use, brand name recognition,
network coverage, customer service and price. Prodigy believes that its services
compete effectively on the basis of all of these factors.
GOVERNMENT REGULATION
Internet access and online services are not subject to direct regulation in
the United States, but changes in the regulatory environment relating to the
telecommunications and media industry could have an effect on Prodigy's
business. For example, Federal Communications Commission regulatory review and
rulemaking could result in regulation of the Internet and online services
industry which could result in increased telecommunications costs for
participants in the Internet industry, including Prodigy. The Company cannot
predict whether, or to what extent, any such new rulemaking will occur, or what
effect any such rulemaking would have on Prodigy.
The Communications Decency Act of 1996, which was held unconstitutional by
the United States Supreme Court in June 1997, had generally made it illegal,
subject to certain defenses, for persons to knowingly use an interactive
computer service to send or display "indecent" communications to minors. The
federal Children's Online Protection Act ("COPA"), enacted in October 1998,
creates criminal penalties for content on the Internet which may be deemed
"harmful to minors" (as defined in various court decisions). The Company has
not changed any of its plans or policies as a result of the enactment of COPA,
and does not believe its current plans or policies violate this statute. In
February 1999, enforcement of COPA was enjoined by a federal judge. The Company
cannot predict whether additional federal or similar state legislation will be
enacted in the future, whether any such future legislation would be upheld, how
courts would interpret any such future legislation or what effect, if any, such
legislation would have on the Company. There also are laws that make it illegal
to traffic in obscene or child pornographic materials, including by a computer,
and accordingly Prodigy's servers do not host certain newsgroups which it
believes traffic in child pornography. While the Company does not believe that
its activities will violate any of these laws, it cannot predict how a court
would interpret these laws in the Internet context or whether a court would hold
that Prodigy Internet has a duty to monitor material being transmitted or, if
notified that illegal material is being transmitted, to attempt to stop or
restrict such transmissions. See "Certain Factors That May Affect Future
Operating Results--Government Regulation" under Item 7 below.
In addition, the applicability to Prodigy of existing laws governing issues
such as intellectual property ownership, defamation and personal privacy is
uncertain. Courts have indicated that, under certain circumstances, online
service providers and ISPs could be held responsible for the publication of
defamatory material or for failure to prevent the distribution of material that
infringes copyrights owned by others. The Company does not edit or otherwise
monitor the content accessed by subscribers to Prodigy Internet, although the
Company does filter certain words on Prodigy Classic. In addition, the Company
blocks access to newsgroups that meet certain criteria indicating they carry
child pornography. Future interpretations by the courts of online defamation,
privacy, copyright infringement and other legal issues is also uncertain.
In March 1997, Prodigy entered into a Consent Order with the Federal Trade
Commission (which became effective in March 1998) regarding use of the word
"free" and similar words in advertising, disclosure of the financial terms and
conditions of services, including method of cancellation, practices with respect
to electronic funds transfers and certain related matters. The Consent Order has
a duration of twenty years and imposes various recordkeeping requirements. The
Company believes that it is in compliance with the Consent Order and that its
continuing compliance with the Consent Order will not have a material adverse
affect on Prodigy's business. America Online is subject to a similar Consent
Order which governs its marketing of services under both the American Online and
CompuServe brands.
PROPRIETARY RIGHTS
The Company owns a variety of trademarks, including "Prodigy(R)", the
Prodigy logo, "Prodigy Internet", "It's a tool for living", "Prodigy
Classic", "Prodigy MailLink" and others, many of which are the subject of
existing or pending registrations in the United States and various foreign
countries. The Company also owns other intellectual property rights, including
proprietary software used in its business. See "Technology." The Company
18
<PAGE>
protects its proprietary technology through copyright and trade secrets laws,
employee and third-party confidentiality agreements and other methods. See
"Certain Factors That May Affect Future Operating Results--Protection of
Proprietary Technology" under Item 7 below.
Prodigy and IBM have entered into patent cross-license agreements for their
entire patent portfolios existing as of June 17, 1996 and all additional patents
issued with respect to patent applications filed prior to June 1, 1999. Until
June 17, 2001, the Company is required to grant IBM "most favored nation"
status with respect to Prodigy's software that it makes generally available to
the public. See "Corporate History and Certain Transactions--Acquisition of
Prodigy Services Company" under Item 13 below.
EMPLOYEES
At December 31, 1998, the Company had 313 full-time employees, of whom 52
were in sales and marketing, 86 were in technology and product development, 28
were in customer service, 93 were in technical services and 54 were in
management, finance and administration. As necessary, the Company supplements
its regular employees with temporary and contract personnel, which totaled 81
persons at December 31, 1998.
None of the Company's employees is represented by a labor union. The
Company believes that its employee relations are good.
ITEM 2. PROPERTIES
Prodigy leases 97,000 square feet of office space in White Plains, New
York. The lease expires December 31, 2004 and Prodigy has a right of first offer
upon expiration. The current annual base rent is $2,275,000 and Prodigy is
required to pay an allocated portion of taxes and operating expenses. Prodigy
has established a letter of credit in the initial amount of $3,930,000
(declining ratably over the lease term) to secure the rent payments.
Prodigy also leases 80,000 square feet in Yorktown Heights. The lease
expires February 28, 2001 with two five-year renewal options in Prodigy's favor.
The current annual base rent is $687,000 and Prodigy is required to pay
associated taxes and operating expenses. Prodigy uses approximately 57,500
square feet of its Yorktown Heights facility for its data hosting center and
subleases the balance to Splitrock. See "Item 1. Business--Network and Related
Infrastructure--Data Hosting Center".
The Company leases approximately 16,000 square feet of office space in
Medford, Massachusetts under a lease expiring on August 1, 2001. Prodigy vacated
this facility, which formerly housed the headquarters for Prodigy's
international operations, in June 1998 and is seeking to sublease it.
For additional information regarding the Company's leased facilities and
its aggregate rental expenses, see Note 13 to the Company's Consolidated
Financial Statements.
The Company believes that its existing facilities are adequate for its
current needs and that suitable additional space will be available as needed.
ITEM 3. LEGAL PROCEEDINGS
After the Company filed the Registration Statement for its initial public
offering (the "IPO"), two former executives of the Company, Edward A. Bennett
and William J. Lansing, contacted the Company and asserted through legal counsel
that their options to acquire an aggregate of 275,000 shares of Common Stock at
$12.00 per share had not expired and would remain exercisable until 270 days
after the IPO. The Company has denied this assertion and believes that such
options have expired. If Messrs. Bennett and Lansing file a lawsuit against the
Company, the Company will defend it vigorously. The Company believes that the
resolution of this matter will not have a material adverse effect on the
Company.
19
<PAGE>
In September 1998, the Company received a letter from the Office of the
Attorney General of New York notifying the Company that the "advertising and
certain other practices" of Prodigy and other unnamed ISPs were being
investigated by the Attorneys General of New York and 19 other states. The
letter stated that the inquiry was a follow-up to the settlement between America
Online and many states in May 1998 concerning the following issues: disclosures
for free offers, representations concerning pricing, disclosures concerning
premium areas, disclosures for communications charges, advertising to minors,
cancellation procedures, unauthorized charges to credit cards or bank accounts
and changes to the service agreement. The letter requested that the Company
voluntarily supply various documents and other information relating to the
marketing and provision of its services. The Company is cooperating with the
inquiry and believes that its outcome will not have a material adverse effect on
the Company.
On November 27, 1996, Malcolm Haynes and Lightwave, Ltd., a Cayman Islands
corporation ("Lightwave"), filed a lawsuit in the District Court of Clark
County, Nevada, against the Company, International Wireless Incorporated (the
Company's predecessor) ("IW"), Comstar Cellular Network, Inc. ("Comstar"), Greg
C. Carr, Terrance P. Dillon, Duncan E. Wine and Blaize Kaduru. Mr. Carr is the
former Chairman of the Board of the Company and a former principal stockholder
of the Company, and was a director and principal stockholder of IW. Mr. Dillon
was a director and principal stockholder of the Company, was a director, officer
and principal stockholder of IW and was a director and technical advisor to
Comstar. Mr. Wine is a former principal stockholder of the Company and IW. Mr.
Kaduru is a former principal stockholder of the Company and IW, was an officer
of IW and was a director and officer of Comstar. Mr. Haynes was co-founder,
President and a director of Comstar and claims that he and Mr. Wine each hold a
30% interest in Lightwave. In connection with IW's acquisition of the assets and
liabilities of Comstar in August 1994, IW issued to Comstar all then outstanding
common stock of IW, which Comstar then distributed as a liquidating dividend to
the holders of certificates for common stock of Comstar. Each holder of a
certificate for common stock of Comstar was required to acknowledge and accept
the terms of the Comstar acquisition and release Comstar and IW from all claims
which such holder may have had against either Comstar or IW. See "Corporate
History and Certain Transactions--Prior Corporate History" under Item 13 below.
Pursuant to the foregoing, Comstar offered 1,200,000 shares of IW's common stock
to Mr. Haynes, but Mr. Haynes refused to participate and therefore received no
shares. The lawsuit filed by Mr. Haynes and Lightwave alleges, among other
things, that Messrs. Dillon, Wine and Kaduru breached their fiduciary duties to
the plaintiffs, that Mr. Wine defrauded or made misrepresentations to the
plaintiffs, that Mr. Wine misappropriated a corporate opportunity belonging to
Lightwave, that all defendants are liable for conversion of plaintiffs' shares
of common stock, and that IW and Mr. Carr aided and abetted the wrongful conduct
of Messrs. Dillon, Wine and Kaduru. The lawsuit seeks to compel the defendants
to provide to the plaintiffs 4,500,000 shares of Common Stock of the Company or
the fair market value thereof, to impose a constructive trust on the shares of
Common Stock received by Messrs. Dillon, Wine and Kaduru in the Comstar
acquisition, and other monetary damages and declaratory and equitable relief.
The Company is defending and indemnifying Mr. Carr in this lawsuit. On February
25, 1998, the Court granted the motion of the Company and Mr. Carr to dismiss
the lawsuit against them for lack of personal jurisdiction in Nevada, and the
lawsuit is continuing against the other defendants. Unless this decision is
overturned on appeal, the plaintiffs
20
<PAGE>
cannot pursue this lawsuit against the Company and Mr. Carr in Nevada, although
the plaintiffs could pursue these claims in a new lawsuit filed in any state or
states where personal jurisdiction over the Company and Mr. Carr could be
established and where the applicable statute of limitations has not expired. If
a new lawsuit is filed, the Company intends to defend it vigorously, but there
can be no assurance that its outcome would not have a material adverse effect on
the Company's business, financial condition, results of operations or prospects
or result in substantial dilution to the Company's stockholders.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
21
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET FOR THE COMPANY'S COMMON STOCK
The Company's Common Stock has traded on the Nasdaq National Market under
the symbol "PRGY" since the Company's initial public offering on February 11,
1999. The following table sets forth for the fiscal periods indicated the high
and low sale prices per share of Common Stock as reported on the Nasdaq National
Market.
HIGH LOW
-----------------
1999
First Quarter (from February 11, 1999 through February
28, 1999, inclusive) $50.62 $20.00
There were 486 stockholders of record of the Company's Common Stock as of
February 28, 1999. This number does not include stockholders who hold the stock
in "street name" through brokers or nominees.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying any cash dividends in the foreseeable
future. The Company's current policy is to retain earnings, if any, to provide
funds for the operation and expansion of its business. Payment of future
dividends, if any, will be at the discretion of the Company's Board of Directors
after taking into account various factors, including the Company's financial
condition, operating results, current and anticipated cash needs and growth
plans.
SALES OF UNREGISTERED SECURITIES
The following is a description of the unregistered securities sold by the
Company during 1998:
1. In April 1998, the Company issued 3,250,000 shares of Common
Stock to Carso Global Telecom upon the exercise of a warrant at a purchase price
of $4.00 per share for aggregate cash proceeds of $13,000,000.
2. In May 1998, the Company issued 500,000 shares of Common Stock to
an investor upon exercise of a warrant at a purchase price of $4.00 per share
for aggregate cash proceeds of $2,000,000.
3. In July 1998, the Company issued 1,375,000 shares of Common Stock
to Carso Global Telecom for a purchase price of $8.00 per share for aggregate
cash proceeds of $11,000,000, and in August 1998 the Company issued 6,125,000
shares of Common Stock to Telmex for a purchase price of $8.00 per share for
aggregate cash proceeds of $49,000,000. Wit Capital Corporation acted as
financial advisor in this private placement and was paid a cash fee of $50,000.
4. In November 1998, the Company granted a person (i) a warrant to
purchase 1,960 shares of Common Stock for $10.00 per share, exercisable at any
time prior to March 1, 2001, for his assistance in identifying investors in a
private placement in 1995, and (ii) a warrant to purchase 11,095 shares of
Common Stock for $12.00 per share, exercisable at any time prior to March 1,
2001, for his assistance in identifying investors in a private placement in
1995-1996.
22
<PAGE>
During 1998, the Company granted stock options to employees and consultants
to purchase an aggregate of 1,440,780 shares of Common Stock with exercise
prices ranging from $4.00 to $8.60 per share. During this same period, the
Company issued an aggregate of 2,637 shares of Common Stock for aggregate cash
proceeds of $30,227 pursuant to the exercise of stock options.
The securities issued in the foregoing transactions were either (i) offered
and sold in reliance upon exemptions from registration set forth in Sections
3(b) and 4(2) of the Securities Act, or regulations promulgated thereunder,
relating to sales by an issuer not involving any public offering, (ii) in the
case of certain sales to non-United States persons, pursuant to Regulation S
promulgated under the Securities Act, or (iii) in the case of certain options to
purchase shares of Common Stock and shares of Common Stock issued upon the
exercise of such options, such offers and sales were made in reliance upon an
exemption from registration under Rule 701 of the Securities Act. Except as
noted above, no underwriters or placement agents were involved in the foregoing
sales of securities.
The foregoing information reflects the one-for-four reverse stock split of
the Company's Common Stock effected on February 4, 1999.
USE OF PROCEEDS FROM REGISTERED SECURITIES
The effective date of the Company's first registration statement, filed on
Form S-1 under the Securities Act of 1933 (No. 333-64233), relating to the
Company's initial public offering of its Common Stock and simultaneous sale of
shares to Telmex and registering 11,200,000 shares, was February 10, 1999. A
total of 9,200,000 shares of Company's Common Stock (including 1,200,000 shares
pursuant to the exercise of the underwriters' over-allotment option) were sold
to an underwriting syndicate, and 2,000,000 shares were simultaneously sold to
Telmex. The IPO was lead-managed by Bear, Stearns & Co. Inc. and BancBoston
Robertson Stephens Inc. and co-managed by ING Baring Furman Selz LLC and Volpe
Brown Whelan & Company, LLC. The IPO commenced and was completed on February
11, 1999 at a price of $15.00 per share. The IPO resulted in gross proceeds of
$136,000,000, $9,315,000 of which was applied toward the underwriting discount.
The sale to Telmex resulted in gross proceeds of $30 million. Expenses related
to the IPO totaled approximately $1,500,000. The amount of net proceeds to the
Company from the IPO was approximately $157,185,000.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected consolidated financial information
and other data for the Company and Prodigy Services Company ("PSC"). The
selected consolidated financial data for the Company for the period from May 23,
1994 (date of inception) to December 31, 1994 and for the year ended December
31, 1995 has been derived from the Company's unaudited Consolidated Financial
Statements for the year ended December 31, 1995. The selected consolidated
financial data for the Company for the years ended December 31, 1996, 1997 and
1998 has been derived from the Company's Consolidated Financial Statements that
appear elsewhere in this Annual Report on Form 10-K, which have been audited by
PricewaterhouseCoopers LLP, independent public accountants.
The selected consolidated financial data should be read in conjunction with
the Consolidated Financial Statements, and the notes thereto, of the Company and
PSC appearing elsewhere in this Annual Report on Form 10-K and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations".
23
<PAGE>
Prodigy Communications Corporation
<TABLE>
<CAPTION>
PERIOD FROM
-------------
MAY 23, 1994
--------------
(DATE OF
----------
INCEPTION) TO
-------------
DECEMBER 31, YEAR ENDED DECEMBER 31,
------------ ---------------------------------
1994(1) 1995(1) 1996 1997 1998
-------- ------- ---- ---- ----
(In millions, except number of billable
subscribers and per share information)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Internet and online service revenues:
Prodigy Internet -- -- $ .1 $ 29.5 $ 80.7
Prodigy Classic -- -- 90.6 98.8 48.2
----- ----- ------ ------- ------
-- -- 90.7 128.3 128.9
Other -- -- 8.2 5.9 7.2
----- ----- ------ ------- ------
Total revenues -- -- 98.9 134.2 136.1
----- ----- ------ ------- ------
Operating costs and expenses:
Costs of revenue...................................................... -- $ .1 70.2 100.2 99.2
Marketing............................................................. -- -- 21.3 60.5 41.8
Product development................................................... -- -- 9.0 16.8 12.9
General and administrative............................................ $ 1.0 3.0 53.4 63.2 52.7
Acquired incomplete technology........................................ -- -- 20.9 -- --
Restructuring and other special costs................................. -- -- 3.1 9.9 --
Write-down of assets held for sale.................................... -- -- -- 2.4 --
Loss on sale of cellular assets....................................... -- -- -- .8 --
----- ----- ----- ------- ------
Total operating costs and expenses........................................ 1.0 3.1 177.9 253.8 206.6
----- ----- ------ ------- ------
Operating loss............................................................ (1.0) (3.1) (79.0) (119.6) (70.5)
Loss on equity investment in joint venture................................ -- -- .5 12.1 --
(Gain) on sale of assets.................................................. -- -- -- -- (5.2)
Write-down (recovery) of equity investments............................... -- -- 9.1 (.3) --
Interest expense (income), net............................................ -- -- 2.2 1.4 (.2)
----- ----- ------ ------- ------
Net loss.................................................................. $(1.0) $(3.1) $(90.8) $(132.8) $(65.1)
====== ===== ====== ======= ======
Net loss per common share:
Basic and diluted....................................................... $(.16) $(.37) $(8.76) $ (7.66) $(1.60)
====== ===== ====== ======= ======
Weighted average number of common and common equivalent shares
outstanding:
Basic and diluted....................................................... 6.2 8.4 10.4 17.3 40.7
====== ===== ===== ======= ======
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
PERIOD FROM
-----------
MAY 23, 1994 YEAR ENDED
------------ ----------
(DATE OF DECEMBER 31,
-------- ------------
INCEPTION) TO
-------------
DECEMBER 31,
-------------
1994(1) 1995(1) 1996 1997 1998
-------------- --------- ---------- --------- --------
(IN MILLIONS, EXCEPT NUMBER OF BILLABLE
SUBSCRIBERS AND PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C>
OTHER DATA:
Prodigy Internet billable subscribers at period end... -- -- 7,000 221,000 505,000
Prodigy Classic billable subscribers at period end.... -- -- 780,000 392,000 166,000
------- ------- -------- -------- --------
Total billable subscribers at period end.............. -- -- 787,000 613,000 671,000
======= ======= ======== ======== ========
EBITDA (2)............................................ $(1.0) $(3.1) $ (76.2) $ (110.0) $ (49.7)
OTHER CASH FLOW DATA:
Net cash used in operating activities................. $(1.0) $(2.4) $ (35.3) $ (114.0) $ (68.0)
Net cash from (used) in investing activities.......... $ (.1) $(1.4) $ (47.9) $ (15.3) $ 2.6
Net cash provided by financing activities............. $ 1.4 $ 4.0 $ 104.1 $ 120.4 $ (65.2)
</TABLE>
<TABLE>
<CAPTION>
December 31, DECEMBER 31, 1998
-------------------------------------- ---------------------------
1994(1) 1995(1) 1996 1997 ACTUAL AS ADJUSTED (3)(4)
-------- -------- -------- -------- ------- ------------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit)...................................... $ .1 $ (.3) $(54.8) (48.5) $(33.6) $123.6
Total assets................................................... .4 2.5 126.6 93.5 78.3 235.5
Long-term debt................................................. .4 1.6 56.0 10.0 -- --
Contingent convertible notes (included in stockholders' equity
(deficit))..................................................... -- -- 30.5 30.5 30.5 --
Stockholders' equity (deficit)................................. (.2) -- (11.5) 17.7 29.8 187.0
===== ===== ====== ====== ====== ======
</TABLE>
______________
(1) IW was incorporated in May 1994 to evaluate and develop cellular telephone
systems and Internet access and online services in Africa. See "Corporate
History and Certain Transactions--Prior Corporate History" under Item 13
below. In June 1996, the Company was formed under the name Prodigy, Inc. as
a new holding company to acquire PSC and to hold IW and the other
communications interests of IW. On June 17, 1996, the Company consummated
the acquisition of PSC. The acquisition was accounted for under the
purchase method of accounting. Accordingly, the results of operations of
PSC are included in the Company's consolidated results of operations from
the date of acquisition. See Notes 1 and 4 to the Company's Consolidated
Financial Statements. In January 1997, the Company sold its cellular
telephone assets and operations. Subsequently, the Company decided to sell
and wind-down its remaining international operations in Africa and China.
See "Corporate History and Certain Transactions" under Item 13 below and
Note 5 to the Company's Consolidated Financial Statements.
(2) EBITDA is a commonly used measure for operating performance of ISPs, and
also provides additional information to assist investors in determining the
Company's liquidity. EBITDA is not an accounting measure under U.S.
generally accepted accounting principals ("GAAP"), is not necessarily
indicative of operating income or cash flows from operations as determined
under GAAP and may not be comparable to similarly titled measures reported
by other companies.
(3) Reflects the conversion upon the closing of the IPO of the Contingent Notes
(as defined below) held by IBM and Sears into an aggregate of 4,255,266
shares of Common Stock. See "Corporate History and Certain Transactions--
Acquisition of Prodigy Services Company" and "--Prior Equity Financing" and
Note 9 to the Company's Consolidated Financial Statements.
25
<PAGE>
(4) Adjusted to give effect to the sale by the Company of 11,200,000 shares of
Common Stock in the IPO and simultaneous sale to Telmex, and after
deducting the underwriting discounts relating to the IPO and estimated
offering expenses payable by the Company. See "Use of Proceeds".
PRODIGY SERVICES COMPANY
<TABLE>
<CAPTION>
PERIOD
------
FROM
----
YEAR ENDED DECEMBER 31, JANUARY 1,
---------------------------- ---------
1996
---------
TO JUNE
--------
16,
---
1994 1995 1996
---------------- ---------- -----
(IN MILLIONS)
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Online service revenues........................ $179.6 $230.6 $ 98.2
Other.......................................... 31.4 12.8 8.9
------ ------ ------
Total revenues................................. 211.0 243.4 107.1
------ ------ ------
Net loss....................................... $(52.0) $(34.6) $(62.9)
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit)...................... $(38.9) $(36.4)
Total assets................................... 80.1 84.7
Long-term debt................................. 18.4 16.4
Partners' capital (deficit).................... (4.3) 9.8
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with "Item 6.
Selected Financial Data" and the Consolidated Financial Statements and Notes
thereto contained herein under Item 8.
OVERVIEW
The Company is a leading national ISP. In October 1996, the Company
launched Prodigy Internet, an open standards-based Internet access service.
Since the autumn of 1997, the Company has focused on expanding the Prodigy
Internet subscriber base and introducing additional value-added services. The
Company has also made strategic decisions to outsource its network, discontinue
its development of custom content and use multiple vendors for outsourced
customer service functions. As a result of these initiatives, the Company has
substantially reduced its fixed operating costs and headcount.
In conjunction with the launch of Prodigy Internet in October 1996, the
Company began offering a plan allowing subscribers unlimited usage of Prodigy
Internet for a flat monthly fee without hourly usage charges. In December 1996,
the Company introduced a similar plan for Prodigy Classic. Since the
introduction of the Company's unlimited usage plans, the portion of revenues
generated from hourly usage charges has decreased substantially.
The results of operations of ISPs, including those of the Company, are
significantly affected by subscriber cancellations. Subscriber acquisition
expenses and the administrative expenses of enrolling and assisting new
subscribers are substantial, and in the past the Company typically offered free
service for one or two months to new subscribers. In selected distribution
channels, the Company is replacing free trial programs with money-back
26
<PAGE>
guarantees in order to attract enrollees who are less likely to terminate
service. The failure to attract and retain subscribers to the Company's
services, or an increase in the rate of subscriber cancellations, would have a
material adverse effect on the Company. See "--Certain Factors That May Affect
Future Operating Results--Subscriber Turnover". The Company historically has
experienced better retention for subscribers under prepaid term plans than
subscribers under month-to-month plans. Under prepaid term plans, subscribers
choose to prepay for longer terms at reduced monthly rates. The Company ceased
offering prepaid term plans in 1995 but reinstated such term plans in January
1997.
The Company historically has experienced seasonality in its business, with
higher expenses during the last and first fiscal quarters, corresponding to the
Christmas and post-Christmas selling season, and lower timed usage revenues
(revenues from hourly usage charges) during its second and third fiscal quarters
resulting from reduced usage of its services during the summer months. The
Company believes that the seasonal reductions in timed usage revenues
historically experienced by the Company will be mitigated by the movement from
timed usage plans to unlimited usage plans as well as growth in the Company's
subscriber base, although the Company expects to continue to have higher
expenses during its first and fourth quarters. As a result of the seasonality of
its business, as well as other factors, the Company experiences quarterly
fluctuations in its operating results. See "--Certain Factors That May Affect
Future Operating Results--Quarterly Fluctuations in Operating Results".
On June 17, 1996, the Company acquired PSC from IBM and Sears for an
aggregate purchase price of $78.1 million, consisting of a cash payment of $40.8
million, the issuance of the Contingent Notes valued by an independent appraiser
at $30.5 million and direct acquisition related expenses of $6.8 million (the
"Prodigy Acquisition"). See "Item 13. Certain Relationships and Related
Transactions--Acquisition of Prodigy Services Company". The Prodigy Acquisition
was accounted for as a purchase. Accordingly, the assets purchased and
liabilities assumed and related results of operations of PSC are included in the
consolidated financial statements of the Company from the date of acquisition.
The purchase price was allocated among tangible and intangible assets acquired
based on their respective fair market values. As a result of this allocation,
the Company recorded as intangible assets, with ten-year lives, tradename of
$35.7 million and goodwill of $15.5 million. In addition, $27.2 million was
allocated to property and equipment and assigned a three-year life. As part of
this process, the acquired technology was extensively evaluated, including the
state of the technology and needed developments, the inherent difficulties and
uncertainties in completing the development and thereby achieving technological
feasibility, and the risks related to the viability and potential changes to
target markets. Because the Internet technology acquired in the Prodigy
Acquisition was incomplete and substantial additional development effort by the
Company was required before a viable consumer product could be launched, the
Company recognized a charge for the purchase of incomplete technology in June
1996 in the amount of $20.9 million. See "--Incomplete Technology" and Note 4
to the Company's Consolidated Financial Statements.
RESULTS OF OPERATIONS
The Company's total revenues has two components: Internet revenues,
consisting of subscription revenues from subscribers to Prodigy Internet and
Prodigy Classic, and other revenues, consisting primarily of advertising and
transaction fees and revenues from the Company's former international
operations. Subscription revenues include revenues from hourly usage charges
("timed usage revenues"). The Company defines "billable" subscribers as
subscribers who remain enrolled beyond completion of the applicable trial period
or who enroll in a money-back guarantee program.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Subscription revenues from Prodigy Internet increased $51.2 million, or
174%, from $29.5 million in 1997 to $80.7 million in 1998. The number of Prodigy
Internet billable subscribers increased 284,000, or 129%, from 221,000 at
December 31, 1997 to 505,000 billable subscribers at December 31, 1998,
representing 36% and 75% of total billable subscribers at December 31, 1997 and
December 31, 1998, respectively. Prodigy Internet subscribers accounted for 44%
and 80%, respectively, of total network usage during 1997 and 1998. Subscription
revenues from Prodigy Classic decreased $50.6 million, or 51%, from $98.8
million in 1997 to $48.2 million in 1998 as the number of Prodigy Classic
billable subscribers decreased from 392,000 at December 31, 1997 to 166,000 at
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December 31, 1998. The Company intends to discontinue Prodigy Classic in the
fourth quarter of 1999. Total billable subscribers increased by 58,000, or 9%,
from 613,000 at December 31, 1997 to 671,000 at December 31, 1998. Timed usage
revenues decreased $7.8 million, or 65%, from $12.0 million in 1997 to $4.2
million in 1998. The decrease in revenues attributable to decreases in the total
number of billable subscribers and in timed usage revenues associated with
Prodigy Classic was offset, in part, by an increase in average revenue per
billable subscriber primarily due to the higher-priced plans for unlimited usage
associated with Prodigy Internet. Other revenues increased by $1.3 million, or
22%, from $5.9 million in 1997 to $7.2 million in 1998 primarily due to
increased sales by the Company's African Internet operations which were sold on
October 1, 1998. For the years 1997 and 1998, the other revenues derived from
the Company's former international operations consisted primarily of fees for
Internet access and online services provided primarily to businesses in Africa
and China. As a result of the foregoing factors, total revenues increased by
$1.9 million from $134.2 million in 1997 to $136.1 million in 1998.
Cost of revenues includes network and content expenses. Content expenses
consist of the cost of developing, or obtaining from third parties, content for
inclusion in the Company's service offerings. Cost of revenues decreased from
$100.2 million in 1997 to $99.2 million in 1998. This decrease was primarily
attributable to content expense, which declined as a result of the renegotiation
and/or termination of content contracts associated with Prodigy Classic and the
Company's content outsourcing agreement with Excite which substantially
eliminated content associated with Prodigy Internet beginning in April 1998. The
reduction in content expense was offset, in part, by increased network charges
incurred by the Company in 1998. Network usage increased 74% in 1998 compared to
1997 primarily due to the shift of the subscriber base from timed usage to
unlimited usage plans, but network charges increased only 40% because of a
monthly "cap" (based on average hourly usage by subscribers) contained in the
network agreement between the Company and Splitrock.
Marketing expense includes the costs to acquire and retain subscribers,
advertising and other general sales and marketing costs. Marketing expense
decreased from $60.5 million in 1997 to $41.8 million in 1998, a decrease of
$18.7 million, or 31%. The 1997 period reflected spending related to the launch
of Prodigy Internet in October 1996, which continued through the post-Christmas
selling season. In addition, in early 1998, the Company temporarily deferred
certain of its sales and marketing programs in response to network performance
issues encountered during the transition period accompanying the initial
roll-out of the new Splitrock network.
Product development expense includes research and development costs and
other product development costs. Product development expense decreased from
$16.8 million in 1997 to $12.9 million in 1998, a decrease of $3.9 million, or
23%. During 1997, product development efforts were primarily focused on
stabilization and enhancement of Prodigy Internet and on migration of Prodigy
Classic content to the Prodigy Internet platform. As a result of the completion
of these activities in 1997, product development activities and spending were
subsequently reduced. In 1998, product development activities centered on
integration and stabilization of the Splitrock network, transition to the co-
branded Prodigy/Excite content platform for Prodigy Internet, and development of
certain commercial application and value-added services.
General and administrative expense decreased from $63.2 million in 1997 to
$52.7 million in 1998, a decrease of $10.5 million, or 17%. The decrease in
general and administrative expense was attributable to significantly lower
personnel costs resulting from a decrease in average headcount and lower
incentive compensation expense combined with lower occupancy expense due to the
relocation to a new headquarters facility in White Plains, New York as of
January 1, 1998. As a result of the grant of employee stock options with
exercise prices deemed to be below fair market value, the Company recorded
compensation expense of $.7 million in 1998 and expects to record compensation
expense of approximately $1.3 million, $1.3 million and $.6 million in the years
ending December 31, 1999, 2000 and 2001, respectively.
Interest income/expense, net improved from an expense of $1.4 million in
1997 to income of $.2 million in 1998. This improvement was due to higher cash
balances and reduced levels of borrowing during 1998.
In 1997, the Company recorded a loss of $12.1 million on an equity
investment in a joint venture, restructuring and other special costs of $9.9
million, a $2.4 million write-down of its investment in its African Internet
operations to the net realizable value, and an $.8 million loss on the sale of
its African cellular telephone
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operations. In 1998, the Company recognized gains of $2.9 million and $2.3
million, respectively, from the sale of its African Internet operations and
internally developed customer service and content applications.
As a result of the foregoing factors, the Company's operating loss
decreased from $119.6 million in 1997 to $70.5 million in 1998, and its net loss
decreased from $132.8 million in 1997 to $65.1 million in 1998.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Prior to the Prodigy Acquisition on June 17, 1996, the Company was a start-
up company engaged in the evaluation and development of cellular telephone
systems and Internet access and online services in Africa. Due to the
significant changes that occurred in the Company's business and operations as a
result of the Prodigy Acquisition, the subsequent sale and wind-down of the
Company's former international operations and other changes in the Company's
business since the Prodigy Acquisition, the Company believes that its historical
financial statements for the years ended December 31, 1996 and 1997 are not
directly comparable. WHEN READING THE FOLLOWING COMPARISON OF THE YEARS ENDED
DECEMBER 31, 1996 AND 1997, INVESTORS ARE CAUTIONED THAT THE OPERATING RESULTS
OF PSC'S BUSINESS ARE INCLUDED ONLY FOR SIX AND ONE-HALF MONTHS OF 1996 BUT ARE
INCLUDED FOR ALL OF 1997.
Total revenues increased from $98.9 million in 1996 to $134.2 million in
1997, primarily due to the Prodigy Acquisition on June 17, 1996 and the
inclusion of the operating results of PSC's business for only six and one-half
months in 1996 but all of 1997. The Prodigy Internet service was launched in
October 1996 but did not generate any significant revenues during 1996. During
1997, Prodigy Internet grew from 7,000 billable subscribers at December 31, 1996
to 221,000 billable subscribers at December 31, 1997, and generated revenues of
$29.5 million. Prodigy Classic revenues increased from $90.6 million in 1996 to
$98.8 million in 1997. The number of Prodigy Classic billable subscribers
decreased from 780,000 at December 31, 1996 to 392,000 at December 31, 1997, but
Prodigy Classic revenues increased by $8.2 million from 1996 to 1997 because the
operating results of PSC's business were included for only six and one-half
months in 1996 but all of 1997. In conjunction with the launch of Prodigy
Internet in October 1996, there commenced a shift in subscriber composition from
timed usage plans to higher-priced unlimited usage plans. Timed usage revenues
decreased from $19.9 million in 1996 to $12.0 million in 1997, and other
revenues decreased from $8.2 million in 1996 to $5.9 million in 1997. The
decrease in other revenues also reflected decreases in subscribers which, in
turn, resulted in fewer advertisers and reduced advertising display fees for
Prodigy Classic.
Cost of revenue increased from $70.2 million in 1996 to $100.2 million in
1997, primarily due to the Prodigy Acquisition on June 17, 1996 and the
inclusion of the operating results of PSC's business for only six and one-half
months in 1996 but all of 1997. The effects of the Prodigy Acquisition on the
Company's cost of revenue in 1997 were offset, in part, by network rate
reductions resulting from the Company's network arrangements with Splitrock
which commenced in July 1997, lower subscriber levels, headcount reductions
throughout the Company, reductions in royalty-based content in 1997 and the
renegotiation and/or termination of certain Prodigy Classic content contracts in
1997.
Marketing expense increased from $21.3 million in 1996 to $60.5 million in
1997, primarily due to the Prodigy Acquisition on June 17, 1996 and the
inclusion of the operating results of PSC's business for only six and one-half
months in 1996 but all of 1997. In 1996, marketing expense reflected advertising
campaigns instituted in late 1996 to support the launch of Prodigy Internet.
Prodigy Internet launch advertising continued into 1997.
Product development expense increased from $9.0 million in 1996 to $16.8
million in 1997, primarily due to the Prodigy Acquisition on June 17, 1996 and
the inclusion of the operating results of PSC's business for only six and one-
half months in 1996 but all of 1997. The Company's product development efforts
during 1996 were focused on the design and development of Prodigy Internet,
which was essentially completed by the end of 1996. During 1997, product
development efforts primarily related to the stabilization and maintenance of
Prodigy Internet, and integration and stabilization of the Splitrock network.
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General and administrative expense increased from $53.4 million in 1996 to
$63.2 million in 1997, primarily due to the Prodigy Acquisition on June 17, 1996
and the inclusion of the operating results of PSC's business for only six and
one-half months in 1996 but all of 1997. The effects of the Prodigy Acquisition
on the Company's general and administrative expense in 1997 were offset, in
part, by lower personnel costs resulting from decreased headcount and incentive
compensation expense, a reduction in occupancy expense and a cost containment
program initiated in the customer service area.
Interest expense, net decreased from $2.2 million in 1996 to $1.4 million
in 1997. This decrease resulted from reduced levels of borrowing.
In 1996, the Company recorded a charge of $20.9 million relating to the
purchase of incomplete technology acquired in the Prodigy Acquisition, a $9.1
million write-down of its investment in Global Enterprise Services, Inc.
("GES") to an estimated net realizable value of zero, restructuring and other
special costs of $3.1 million and a loss of $.5 million on an equity investment
in a joint venture. In 1997, the Company recorded a loss of $12.1 million on an
equity investment in a joint venture, restructuring and other special costs of
$9.9 million, a $2.4 million write-down of its investment in its African
Internet operations to the estimated net realizable value and a $.8 million loss
on the sale of its African cellular telephone operations. See "--Restructuring
Charges", "--Incomplete Technology" and "--Dispositions of Former
International Operations".
As a result of the foregoing factors, the Company's operating loss
increased from $79.0 million in 1996 to $119.6 million in 1997, and its net loss
increased from $90.8 million in 1996 to $132.8 million in 1997.
RESTRUCTURING CHARGES
In response to changes in its business environment and to decrease cash
outflows and more efficiently manage its business, the Company has incurred
restructuring and other special costs. The table below presents restructuring
and other special costs incurred and/or expended by the Company from June 17,
1996 through December 31, 1998:
<TABLE>
<CAPTION>
YEAR ENDED
-----------
DECEMBER 31,
-----------
1996 1997 1998
------------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
Balance at beginning of period:........................ $10.7(1) $ 11.5 $ 7.9
Network termination costs(2)........................... -- 4.7 --
Reductions-in-force(3)................................. .7 2.9 --
Content production(4).................................. -- .6 --
Facility closing(5).................................... -- 1.6 --
Headquarters lease termination(1)...................... -- -- --
Idle leased space at former headquarters' location(6).. 2.5 -- --
----- ------ -----
Subtotal, period accruals.............................. 3.2 9.8 --
----- ------ -----
Restructuring expenditures:
Network termination costs.............................. -- -- (.8)
Reductions-in-force.................................... (1.6) (3.1) (1.0)
Content production..................................... -- -- (.6)
Facility closing....................................... -- -- (.8)
Headquarters lease termination......................... (.8) (7.8) --
Idle leased space at former headquarters' location..... -- (2.5) --
----- ------ -----
Subtotal, period expenditures.......................... (2.4) (13.4) (3.2)
----- ------ -----
Accrued restructuring costs at period end.............. $11.5 $ 7.9 $ 4.7
===== ====== =====
</TABLE>
____________________
(1) Opening balance represents the remaining balance of prior restructuring
charges recorded by PSC and assumed by the Company at the time of the
Prodigy Acquisition. Restructuring charges of $14.6 million
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<PAGE>
were recorded by PSC in 1996 prior to the time of the Prodigy Acquisition.
These restructuring charges included lease termination penalties and write-
down of leasehold improvements at PSC's former headquarters' location as
well as severance pay, early retirements and outplacement services in a
reduction-in-force which affected 120 employees.
(2) In connection with the sale of its network, the Company incurred
liabilities related primarily to early termination payments and other
contractual obligations for certain non-cancelable network related
agreements.
(3) The Company implemented restructuring plans in 1996 and 1997 intended to
reduce costs through a reduction-in-force. Approximately 120 employees and
80 employees throughout the Company were terminated, respectively, in 1996
and 1997.
(4) The Company decided to discontinue the production of its own content and as
a result recorded a charge of $.6 million to account for the employee
termination costs and the costs to settle content related contractual
obligations. Approximately 25 employees were terminated.
(5) The Company's offices in Massachusetts were closed and a charge of $1.6
million was recorded to account for the costs of employee terminations and
lease cancellation. The terminated employees were involved with the
Company's international operations and/or former headquarters management.
Approximately 20 employees were terminated.
(6) Beginning in late 1996, the Company vacated 29% of its leased space at its
former headquarters location. The cost of the lease attributed to the idle
leased facility amounted to $2.5 million. The Company terminated its lease
at this location and moved to a new facility effective January 1, 1998.
INCOMPLETE TECHNOLOGY
The Prodigy Acquisition was accounted for as a purchase. Accordingly, the
purchase price was allocated among tangible and intangible assets based on their
respective fair market values. The fair value of intangible assets was
determined using a risk adjusted discounted cash flow approach. Acquired
incomplete technology was valued using a stage-of-completion approach.
Specifically, the Internet technology acquired was evaluated through extensive
interviews and analysis of data concerning the state of the technology and
required development work. The evaluation assumed an average growth in the
Company's Internet revenues of 49% per year, based on industry expectations at
that time, a gross margin on Internet services ranging from 8% to 49% and sales
and general and administrative expenses ranging from 10% to 27% of revenues. The
assumptions used for purposes of the evaluation should not be construed as
forecasts of the Company's future operating results. A discount rate of 35% was
used in the evaluation, reflecting the difficulties and uncertainties in
completing the development effort, the risks related to the viability and
potential changes to target markets and the inherent uncertainty of predicting
cash flows in the Internet industry. The Company estimated its stage-of-
completion at the date of the Prodigy Acquisition to be 30%, based on costs
incurred of $7.9 million and estimated costs to complete of $18.3 million.
Actual operating expenses incurred subsequent to the Prodigy Acquisition,
excluding costs of development, were lower than expected, although these cost
savings were more than offset by lower than anticipated revenue from the Prodigy
Internet service. Actual costs through December 31, 1998 were $315.6 million
compared to projected costs of $742.5 million. Actual revenues through
December 31, 1998 were $110.4 million compared to projected revenues of $608.2
million. Accordingly, actual costs through December 31, 1998 were $ 426.9
million less than projected costs for such period, and actual revenues through
December 31, 1998 were $497.8 million less than projected revenues for such
period. The net result of these variances has had an adverse impact on the
expected return on investment. The technology had no alternative future use to
the Company, inasmuch as the Company could not commercialize the technology in
its existing form. The Company also had no other product, line of business or
research and development in which the technology could be utilized. Therefore,
the Company recognized a $20.9 million charge in June 1996 for the purchase of
incomplete technology.
The purchased technology was incomplete because the majority of the coding,
integration and testing of the product was incomplete. At the date of the
Prodigy Acquisition (June 17, 1996), there were over 50 components that needed
further development and integration before the Prodigy Internet service could
reach technological feasibility. These components included applications for
parental access control, browsing, searching, e-mail, the message board, menus,
the navigational bar, the tool bar, code update mechanisms, authentication,
registration,
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<PAGE>
service access control and subscriber billing. The ability of the Company's
Prodigy Internet development team to integrate these components into the Prodigy
Internet platform was a crucial factor in reaching technological feasibility,
and the ability to complete this integration had not been established as of the
acquisition date. The Company has now successfully completed the further
development necessary to complete and integrate the acquired technology. The
cost of completing the development effort was approximately $6.8 million and
involved approximately 470 person-months of work. The Internet technology is now
being used within the Prodigy Internet service, which was launched in October
1996.
FORMER INTERNATIONAL OPERATIONS
The historical results discussed above include the operating results of the
Company's Africa and China operations, which began in late-1995 and mid-1996,
respectively. The revenue and net loss from the Company's Africa and China
operations were $7.0 thousand and $89.0 thousand, respectively, for the year
ended December 31, 1995, $1.0 million and $2.7 million, respectively, for the
year ended December 31, 1996, $3.2 million and $8.5 million, respectively, for
the year ended December 31, 1997 and $4.4 million and $.2 million, respectively,
for the year ended December 31, 1998. The Company sold its African cellular
telephone operations in January 1997, determined to terminate its Chinese
operations in December 1997, terminated its Chinese operations in March 1998 and
sold its African Internet operations in October 1998. In 1997, the Company
recorded a $.8 million loss on the sale of its African cellular telephone
operations and a $2.4 million write-down of its investment in its African
Internet operations to the estimated net realizable value. See "Item 13. Certain
Relationships and Related Transactions--Prior Corporate History--Dispositions of
Former International Operations".
LIQUIDITY AND CAPITAL RESOURCES
Since formation, the Company has relied on private sales of equity
securities (totaling $294.1 million through December 31, 1998), borrowings and
the IPO in February 1999 (with net proceeds of $157.2 million) to fund its
operations. See "Item 13. Certain Relationships and Related Transactions--Prior
Equity Financings". The Company has incurred significant losses since inception
and, at December 31, 1998, had an accumulated deficit of $292.8 million, a
working capital deficit of $33.6 million, current liabilities of $48.5 million
and current assets of $14.9 million. For the years ended December 31, 1996, 1997
and 1998, respectively, the Company incurred negative cash flow from operations
of $35.3 million, $114.0 million and $68.0 million. Prior to its acquisition by
the Company, PSC sustained losses and negative cash flow from operations which
required continued funding by PSC's former owners, IBM and Sears, aggregating
$1.3 billion as of June 16, 1996 (the day before the Prodigy Acquisition). See
"--Certain Factors That May Affect Future Operating Results--History of Losses".
To fund operations, the Company borrowed $16.4 million from Banco Inbursa,
S.A. ("Banco Inbursa"), an affiliate of Carso Global Telecom, in February 1998
and $5.7 million from Banco Inbursa in July 1998. The Banco Inbursa loans bore
9% interest and were due December 31, 1999. In July 1998, the Company borrowed
$30.0 million from Bank of America National Trust and Savings Association
("Bank of America") and used the proceeds to repay $30.0 million of the $32.1
million then owed to Banco Inbursa. The Bank of America loan bore 6.5% interest,
was guaranteed by Carso Global Telecom and was due August 14, 1998. The Bank of
America loan was repaid with interest with a portion of the proceeds from the
sales of Common Stock described in the following paragraph.
In February 1999, the Company sold 11,200,000 shares of Common Stock in its
IPO, including 2,000,000 shares of Common Stock sold to Telmex, for aggregate
net proceeds of $157.2 million.
In August 1998, Telmex purchased 6,125,000 shares of Common Stock from the
Company for gross proceeds of $49.0 million, and in July 1998 Carso Global
Telecom purchased 1,375,000 shares of Common Stock from the Company for gross
proceeds of $11.0 million. The Company used a portion of the proceeds to repay
amounts owed to Banco Inbursa and Bank of America in the aggregate amount of
$32.1 million. See "Item 13. Certain Relationships and Related Transactions"
and "Item 12. Security Ownership of Certain Beneficial Owners and Management."
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<PAGE>
In August 1998, Carso Global Telecom agreed to provide the Company with a
$35.6 million committed revolving line of credit entitling the Company to
borrow, repay and reborrow amounts in minimum increments of $1.0 million prior
to maturity on December 31, 1999. Advances are due 90 days after borrowing, but
the Company is permitted to roll over advances into new advances at its
election. Advances are unsecured and bear interest at the LIBOR rate plus
between one and five percentage points (as negotiated on a case-by-case basis).
As of December 31, 1998, no amounts were outstanding under the revolving line of
credit. Carso Global Telecom is the Company's principal stockholder. See "Item
12. Security Ownership of Certain Beneficial Owners and Management."
As a result of the Company's outsourcing arrangements, the Company has
significantly reduced the level of capital expenditures needed in its
operations. The Company's July 1997 network agreement with Splitrock eliminated
the need for the Company to maintain and upgrade its own network. The Company's
portal content agreement with Excite eliminated the need, beginning in April
1998, for internal development of content and Prodigy Internet customization and
other programming projects. See "Item 1. Business--Principal Outsourcing
Arrangements". The Company's capital expenditures for the year ended December
31, 1998 were $2.6 million, primarily for the purchase of data processing
equipment, compared to $8.8 million and $8.6 million, respectively, for the
years ended December 31, 1996 and 1997. The Company currently anticipates that
its capital expenditures for the year ending December 31, 1999 will be
approximately $11.0 million, principally for the purchase and implementation of
a new member management system with enhanced customer care, data mining and
marketing program management capabilities, the purchase and implementation of a
new accounting and financial reporting system and the purchase of new equipment
for Prodigy Internet.
At February 28, 1999, the Company had available cash of $167.2 million. The
Company is currently experiencing substantial negative cash flow each month and
expects to continue to experience negative cash flow through at least the end of
1999. The Company's future financing requirements will depend on a number of
factors, including the Company's operating performance and increases in
operating expenses associated with growth in the Company's business. Based on
its current operating plan, the Company believes that the net proceeds from the
IPO, together with its existing cash and available financing under its revolving
credit facility with Carso Global Telecom, will be sufficient to meet its
anticipated cash requirements for at least the next twelve months. The Company
has made no arrangements to obtain additional financing, other than pursuant to
the Carso Global Telecom credit facility, and there can be no assurance that
adequate additional financing on acceptable terms will be available when needed,
if at all. The unavailability of sufficient financing when needed would have a
material adverse effect on the Company. See "--Certain Factors That May Affect
Future Operating Results--Need for Additional Financing".
YEAR 2000 COMPLIANCE
The Year 2000 issue is the result of computer programs being written using
two digits (rather than four) to define the applicable year. Computer programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices or engage in other
normal business activities. The Company maintains various internal computer
systems and equipment and contracts with third-party vendors for the provision
of computerized customer billing, network operation, Prodigy Internet service
content and certain other information technology and other services.
The Company is currently incurring costs to resolve the potential impact of
the year 2000 on the processing of date-sensitive information by the Company's
internal computer systems and equipment and the computer systems and equipment
of the third-party vendors on which the Company's business relies. The Company
has established a Year 2000 project office staffed by Company personnel and
assisted by a consulting firm.
The Company has completed an inventory of substantially all of its internal
systems and programs related to both the delivery of the Prodigy Internet
service and the daily operations of the business. Based on its preliminary
analysis, the Company estimates that it will spend approximately $9.5 million
through the end of 1999 to remediate potential Year 2000 problems with its
internal systems and to purchase and implement a new member management system
with enhanced customer care, data mining and marketing program management
capabilities that will replace a system that is not Year 2000 compliant. Prodigy
Classic is not Year 2000 compliant and the Company intends to
33
<PAGE>
discontinue Prodigy Classic in the fourth quarter of 1999. See "--Certain
Factors That May Affect Future Operating Results--Impact of Planned Termination
of Prodigy Classic Service".
The Company is developing contingency plans in the event that any critical
service component or business process fails due to a Year 2000 problem. The
Company expects to complete contingency planning by mid-1999. With respect to
critical third-party vendor systems, (i) Splitrock has publicly reported that
substantially all of its information and non-information technology systems are
Year 2000 compliant (and that upgrades are available for those software systems
that are not Year 2000 compliant that will enable Splitrock to be Year 2000
compliant by mid-1999), (ii) Excite has publicly reported that it has not yet
fully evaluated the Year 2000 compliance status of its proprietary systems or
services, or the third-party equipment and software it utilizes or of its
vendors, joint venture partners and content partners, and (iii) Prodigy's
billing provider has committed to making its billing system Year 2000 compliant.
There can be no assurance that the Company will be able to address, in a timely
fashion, all potential Year 2000 problems, or that the systems of the third-
party vendors upon which the Company's business relies (and the maintenance and
operation of which are not within the control of the Company) will be Year 2000
compliant or will become Year 2000 compliant in a timely manner. Any Year 2000
problems could impact the provision of products or services to the Company's
customers and could subject the Company to the risk of litigation, lost revenues
and loss of current or future customers.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position No. 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), which provides
guidance on applying generally accepted accounting principles in addressing
whether and under what condition the costs of internal-use software should be
capitalized. SOP 98-1 is effective for transactions entered into in fiscal years
beginning after December 15, 1998, but earlier adoption is encouraged. The
Company adopted the guidelines of SOP 98-1 as of January 1, 1998. Adoption of
SOP 98-1 did not have a material impact on the Company's consolidated financial
statements.
In April 1998, the AcSEC issued Statement of Position No. 98-5, "Reporting
on the Costs of Start-Up Activities" ("SOP 98-5"), effective for fiscal years
beginning after December 15, 1998. SOP 98-5 provides guidance on the financial
reporting of start-up costs and organization costs. SOP 98-5 requires that costs
of start-up activities and organization costs be expensed as incurred. Initial
application of SOP 98-5 should be reported as the cumulative effect of a change
in accounting principles, as described in Accounting Principles Board (APB)
Opinion No. 20, "Accounting Changes". When adopting SOP 98-5, entities are not
required to report the pro forma effects of retroactive application. The Company
does not believe implementation of SOP 98-5 will have a material impact on its
consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities" ("SFAS No. 133"), which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Company does not expect the adoption
of the statement to have a significant impact on the Company's results of
operations, financial position or cash flows.
CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
This Annual Report on Form 10-K contains "forward-looking statements"
relating to, without limitation, future economic performance, plans and
objectives of the Company for future operations and projections of revenue and
other financial items, that are based on the beliefs of, assumptions made by and
information currently available
34
<PAGE>
to the Company. The words "expect", "estimate", "anticipate", "believe",
"intend", "plan" and similar expressions and variations thereof are intended to
identify forward-looking statements. The cautionary statements set forth in this
"Certain Factors that May Affect Future Operating Results" section and elsewhere
in this Annual Report on Form 10-K identify important factors with respect to
such forward-looking statements, including certain risks and uncertainties, that
could cause actual results to differ materially from those expressed in or
implied by such forward-looking statements.
History of Losses
Since inception, the Company has incurred significant losses. During the
years ended December 31, 1998 and 1997, the Company incurred net losses of $65.1
million and $132.8 million, respectively, on revenues of $136.1 million and
$134.2 million, respectively. At December 31, 1998, the Company had an
accumulated deficit of $292.8 million, a working capital deficit of $33.6
million, current liabilities of $48.5 million and current assets of $14.9
million. During the years ended December 31, 1996 and 1997, the Company incurred
net losses of $90.8 million and $132.8 million, respectively, on revenues of
$98.9 million and $134.2 million, respectively. Since formation, the Company has
not generated cash flow from operations and has relied on private sales of
equity securities and borrowings to fund its operations. For the years ended
December 31, 1996, 1997 and 1998, respectively, the Company incurred negative
cash flow from operations of $35.3 million, $114.0 million and $68.0 million.
Prior to its acquisition by the Company on June 17, 1996, PSC incurred net
losses of $60.0 million, $52.0 million, $34.6 million and $62.9 million in the
years ended December 31, 1993, 1994 and 1995 and the five and one-half months
ended June 16, 1996, respectively, and sustained negative cash flow from
operations which required continued funding by PSC's former owners, IBM and
Sears, aggregating $1.3 billion as of June 16, 1996. There can be no assurance
that the Company will be able to achieve or sustain profitability. See "Item 6.
Selected Financial Data", the other sections of this Item 7 and the Consolidated
Financial Statements and Notes thereto contained herein under Item 8.
Intense Competition
The industry in which the Company competes is intensely competitive and
includes a number of significant participants, including ISPs, proprietary
online service providers and major international telecommunications companies,
as well as Internet-search services and various other telecommunications
companies. Moreover, the Company faces competition from companies that provide
broadband connections to households, including local and long-distance telephone
companies, cable television companies and electric utility companies. Broadband
technologies offer significantly faster Internet access than conventional
modems, and such companies could include Internet access in their basic service
packages, could offer access for a nominal additional charge or could prevent
the Company from delivering Internet access through the cable or wire
connections that such companies own. The Telecommunications Act of 1996 (the
"Telecommunications Act") contains certain provisions that remove, or establish
procedures for removing, restrictions on the regional Bell operating companies
and others that may permit them to engage directly in the Internet access
business. The Telecommunications Act also makes it easier for national long-
distance carriers, such as AT&T, to offer local telephone service, which would
permit such carriers to offer direct local Internet access. Competition from
these companies could have a material adverse effect on the Company. The Company
cannot predict the extent to which the Telecommunications Act, or strategic
alliances or consolidation among ISPs, may result in additional competitive
pressures on the Company.
Among the larger providers of ISP services are EarthLink Network, Inc.
(which has a strategic relationship with Sprint Corporation), MindSpring
Enterprises, Inc., Microsoft Network, AT&T WorldNet, MCI Internet, IBM Internet
Connection, PSINet Inc., GTE Internetworking (which includes the former ISP
business of BBN Corporation), Netcom On-Line Communications Services, Inc. and
Concentric Network Corporation. In January 1999, ICG Communications, Inc., the
owner of Netcom On-Line Communications Services, Inc., announced that it had
agreed to sell Netcom's dial-up, dedicated and Web hosting accounts in the
United States to MindSpring Enterprises, Inc. but will retain Netcom's network
backbone. In December 1998, AT&T announced that it had agreed to acquire IBM's
data networking business, including its ISP business. In addition, AT&T has
agreed to acquire Tele-Communications, Inc., the second largest cable television
operator in the United States, which is the majority stockholder of At Home
Corporation, a provider of broadband Internet access. Microsoft's ownership of
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the dominant PC operating system and the Microsoft Internet Explorer browser may
give Microsoft Network certain competitive advantages, including distribution
and marketing synergies.
Prodigy also competes with America Online, which offers the America Online
and CompuServe proprietary online services over closed networks, as well as
Internet access. America Online has recently announced several transactions that
could result in additional competition for the Company. In November 1998,
America Online announced that it had agreed to acquire Netscape Communications
Corporation, owner of the Netscape Navigator browser and other Internet software
applications. In November 1998, America Online also announced that it had
entered into strategic development and marketing agreements with Sun
Microsystems, Inc. to develop electronic commerce and next-generation Internet
devices. In December 1998, America Online announced that it had formed a joint
venture with the Cisneros Group, a leading Latin American media and
telecommunications conglomerate, to provide online services in Latin America,
with an initial focus on Mexico, Argentina and Brazil. In January 1999, America
Online and Bell Atlantic announced a strategic alliance to provide high speed
DSL (Digital Subscriber Line) access to the America Online service. In addition,
CompuServe is currently providing the content for MCI WorldCom's homepage.
The market for Internet and online services is presently characterized by
low operating margins and minimal profitability, and the Company historically
has experienced low operating margins and incurred operating losses. See "--
History of Losses". The introduction of unlimited usage plans and the
elimination of most hourly access charges throughout the industry has placed
further pressure on the Company's revenues and profit margins. Many of the
Company's current and future competitors have substantially greater financial,
marketing and technical resources than the Company. The Company believes that
competition will increase and that increased competition could lead to lower
pricing to customers and greater spending on marketing. Increased competition
could also adversely affect the Company's ability to develop new service
offerings and interfere with the Company's efforts to maintain or grow its
subscriber base. Any of the foregoing factors could have a material adverse
effect on the Company. There can be no assurance the Company will be able to
compete effectively or that price competition will not have a material adverse
effect on the Company's business, financial condition, results of operations or
prospects. See "Item 1. Business--Competition".
Subscriber Turnover
The results of operations of ISPs, including the Company, are materially
adversely affected by subscriber cancellations. Customer acquisition expenses
and the administrative expenses of enrolling and assisting new subscribers are
substantial. The failure to attract and retain subscribers to the Company's
services, or an increase in, or a failure to slow, the rate of subscriber
cancellations, would have a material adverse effect on the Company. Since launch
in October 1996, the Prodigy Internet service has grown to 505,000 billable
subscribers at December 31, 1998, including migration from Prodigy Classic. The
total number of billable subscribers (including billable subscribers to Prodigy
Internet and Prodigy Classic) declined from 1,129,000 at December 31, 1995 to
787,000 at December 31, 1996 and to 613,000 at December 31, 1997, but increased
to 671,000 at December 31, 1998. See "Item 1. Business," the other sections of
this Item 7 and the Consolidated Financial Statements and Notes thereto
contained herein under Item 8.
Network Risks
Effective July 1, 1997, Prodigy conveyed its network assets to Splitrock in
exchange for Splitrock's agreement to build and operate a network to carry
Prodigy's traffic between subscribers and Prodigy's data hosting center.
Splitrock is required to meet specified service level objectives relating to
grade of service, site and overall system availability and average transit
delays, and to comply with certain financial covenants. In certain
circumstances, Prodigy has the right to assume responsibility for operating the
network at Splitrock's expense. Although the Company believes these network
arrangements present a number of significant advantages to Prodigy, there are
associated risks. Splitrock was formed in 1997 and has a limited operating
history, and Prodigy currently is its only significant customer. See "--
Potential Conflicts of Interest". The failure by Splitrock for any reason to
provide network services as required, or any significant disruption in such
services, whether for technical, operational or financial reasons, would have a
material adverse effect on the Company. The Splitrock arrangements
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cover only the United States, and the Company will need to make other network
arrangements in order to offer services in foreign countries. See "--Rapidly
Changing Markets and Technology" and "Item 1. Business--Principal Outsourcing
Arrangements".
Security problems represent an ongoing threat to public and private data
networks and related telecommunications infrastructures. Splitrock's network and
the Company's data hosting center are potentially vulnerable to computer
viruses, break-ins and similar disruptions caused by others which could lead to
service interruptions to the Company's customers. Inappropriate use of the
Internet by third parties could potentially jeopardize the confidentiality of
information stored or transmitted by the Company's customers. The security
measures employed by Splitrock and the Company cannot assure complete protection
from computer viruses, break-ins and other disruptions. The occurrence of such
problems may result in claims against or liability on the part of the Company
and could adversely affect the Company or its ability to attract and retain
customers.
The Company's operations are also dependent on the protection of
Splitrock's network and the Company's data hosting center against damage from
fire, power loss, telecommunications failures and similar events. The Company's
host configuration for Prodigy Classic and Prodigy Internet is unique and, for
cost reasons, has not been replicated off site. The occurrence of a natural
disaster, other catastrophe or other unanticipated problems in Splitrock's
network or the Company's data hosting center, or the failure of
telecommunications providers to provide required data communications capacity as
a result of a natural disaster, operational disruption or for any other reason,
could cause interruptions in the services provided by the Company, and such
service interruptions could have a material adverse effect on the Company.
In addition to technical problems and network failures that occur from time
to time in the ordinary course of operating a telecommunications network, in
connection with the migration of the Company's subscribers to the Splitrock
network, Prodigy experienced significant service interruptions and failures, the
most prolonged and serious of which occurred in February, March and April of
1998. The Company believes Splitrock and Splitrock's modem vendor have addressed
the causes of these service interruptions and failures, but there can be no
assurance these or similar problems will not recur in the future. See "Item 1.
Business--Network and Related Infrastructure".
Reliance on Third-Party Providers
In addition to its network arrangements with Splitrock, the Company has
outsourced its content to Excite and aspects of its customer service and billing
functions to several providers. Although the Company believes its outsourcing
strategy permits it to control costs, enhance service quality and focus on its
core strengths, outsourcing also makes the Company reliant on third-party
providers for certain critical functions. The failure of these providers to
provide services as required, or any significant disruption of or deterioration
in services, would have a material adverse effect on the Company. In January
1999, At Home Corporation announced that it had agreed to acquire Excite. The
Company's agreement with Excite will not be terminated as a result of At Home's
acquisition of Excite, but At Home's ownership of Excite could affect the
likelihood of the agreement being renewed upon its scheduled expiration in
January 2001 or the terms of any such renewal. The Company also relies on local
telephone companies and other companies to provide data communications capacity
via local telecommunications lines and leased long-distance lines. The
Telecommunications Act generally is expected to lead to increased competition in
the provision of local and other telephone service, but the Company cannot
predict the timing or extent of any such developments or the effect thereof on
pricing or supply. The Company's suppliers and telecommunications carriers also
sell or lease products and services to the Company's competitors and may be, or
in the future may become, competitors of the Company. There can be no assurance
that the Company's suppliers and telecommunications carriers will not enter into
exclusive arrangements with the Company's competitors or stop selling or leasing
their products or services to the Company at commercially reasonable prices or
at all. See "Item 1. Business--Products and Services", "Item 1. Business--
Customer Service" and "Item 1. Business--Principal Outsourcing Arrangements".
Control of the Company and Potential Conflicts of Interest
As of February 28, 1999, Carso Global Telecom, the Company's principal
stockholder, owned 29,396,911 shares of Common Stock, representing 44.6% of the
outstanding Common Stock, and Telmex owned 11,412,500
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shares of Common Stock, representing 17.3% of the outstanding Common Stock. Mr.
Carlos Slim Helu, a Mexican citizen, and certain members of his immediate
family, beneficially own a majority of the outstanding voting equity securities
of Carso Global Telecom. Carso Global Telecom may be deemed to control Telmex
through the regular-voting shares of Telmex that it owns directly and its
interest in a trust which owns a majority of Telmex's outstanding regular-voting
shares. Thus, Mr. Slim and members of his immediate family may be deemed to
control Carso Global Telecom, Telmex and the Company. Mr. Slim is Chairman of
the Board of Carso Global Telecom and Telmex. In addition, IBM and Sears have
agreed to vote their shares of Common Stock received upon conversion of the
Contingent Notes (as defined below) or exercise of the Contingent Warrants (as
defined below) held by them in accordance with the voting recommendations of the
Company's Board of Directors. As a result, Carso Global Telecom is able to
determine the outcome of all matters submitted to a vote of the stockholders,
including the election of all members of the Company's Board of Directors, and
control the management and affairs of the Company. Circumstances may arise in
which the interests of Carso Global Telecom and/or Telmex, as stockholders of
the Company, could conflict with the interests of the other stockholders of the
Company. The voting control of Carso Global Telecom could be used as a means or
have the effect of delaying or preventing a change in control or acquisition of
the Company.
Carso Global Telecom and its affiliates have engaged in numerous
transactions with the Company in the past, which transactions were not
necessarily a result of arms'-length negotiations. For example, Carso Global
Telecom currently provides the Company with a $35.6 million revolving line of
credit. See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources". The Company has
outsourced its network operations to Splitrock, an affiliate that is 30.2% owned
by Carso Global Telecom. See "Item 1. Business--Network and Related
Infrastructure". Carso Global Telecom and its affiliates may engage in
additional related-party transactions with the Company in the future, and there
can be no assurance such transactions will be on arms'-length terms. Samer F.
Salameh, the Company's Chairman of the Board and Chief Executive Officer, serves
on Splitrock's Board of Directors and holds stock options to purchase 80,000
shares of Splitrock's common stock (approximately 0.1% of the outstanding
shares) at $1.10 per share vesting over four years. Mr. Salameh also serves as
an Advisor to the Chief Executive Officer of Telmex. In addition, four of the
Company's current six directors are affiliated with Carso Global Telecom or
Telmex. Mr. Salameh is married to Mr. Slim's niece and Arturo Elias, a director
of the Company, is married to Mr. Slim's daughter. Any decision made by the
Company's directors is required by law to be made in accordance with their
fiduciary duties and in the best interests of the Company and its stockholders.
Messrs. Salameh, Elias, Nakfoor and Sanchez, directors of the Company, owe
similar duties to the other companies for which they serve as directors or
officers or with which they are otherwise affiliated. Due to the nature of the
potential conflicts of interest presented on an ongoing basis by these
arrangements, and potential future arrangements, there can be no assurance that
the directors involved have acted or will act in the best interests of the
Company and its stockholders. See "Item 10. Directors and Executive Officers of
the Registrant," "Item 12. Security Ownership of Certain Beneficial Owners and
Management" and "Corporate History and Certain Transactions" under Item 13.
Need for Additional Financing
At February 28, 1999, the Company had available cash of $167.2 million.
Since formation, the Company has sustained negative cash flow from operations,
and the Company's available cash at February 28, 1999 was attributable to the
proceeds of the sales of equity securities in July and August 1998 to Carso
Global Telecom and Telmex and the sale of Common Stock in the IPO and
simultaneous sale of Common Stock to Telmex in February 1999. See"--History of
Losses" and "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources". The Company is
currently experiencing substantial negative cash flow each month and expects to
continue to experience negative cash flow through at least the end of 1999. The
Company's future financing requirements will depend on a number of factors,
including the Company's operating performance and increases in operating
expenses associated with growth in the Company's business. Based on its current
operating plan, the Company believes that the net proceeds from the IPO,
together with its existing cash and available financing under its revolving
credit facility with Carso Global Telecom, will be sufficient to meet its
anticipated cash requirements for at least the next twelve months. The Company
has made no arrangements to obtain additional financing, other than pursuant to
the Carso Global Telecom credit facility, and there can be no assurance that
adequate additional financing on acceptable terms will be available when needed,
if at
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all. The unavailability of sufficient financing when needed would have a
material adverse effect on the Company. Any additional equity financing may
cause investors to experience dilution and any additional debt financing may
result in restrictions on Prodigy's operations or its ability to pay dividends
in the future. See the other sections of "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations", "Item 1. Business",
"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters"
and the Consolidated Financial Statements and Notes thereto contained herein
under Item 8.
Dependence on PC Bundling and Microsoft Relationship
A majority of the Company's Prodigy Internet enrollments arise from its
bundling arrangements with PC manufacturers and its relationship with Microsoft.
During the years ended December 31, 1997 and 1998, approximately 31% and 44%,
respectively, of total Prodigy Internet enrollments resulted from PC bundling.
Prodigy's bundling relationship with Packard Bell/NEC accounted for
approximately 27% and 32%, respectively, of total Prodigy Internet enrollments
during such periods. During the years ended December 31, 1997 and 1998,
approximately 7% and 20%, respectively, of total Prodigy Internet enrollments
resulted from Prodigy's relationship with Microsoft. The loss of the Company's
relationships with Packard Bell/NEC or Microsoft or any significant reduction in
enrollments from these channels would have a material adverse effect on the
Company. The Company's bundling agreement with Packard Bell/NEC automatically
renews from year to year but is terminable by either party upon 30 days' written
notice. The Company's agreements with Microsoft for inclusion of Prodigy
Internet in the online services folder of Microsoft's Windows 98 and Windows 95
(OSR 2.5 release) operating systems expire in June 1999. In addition, Microsoft
offers a service, Microsoft Network, which competes with the Company's Prodigy
Internet and Prodigy Classic services, which could affect the willingness of
Microsoft to extend its agreements with the Company upon expiration or the terms
on which extensions could be obtained. See "Item 1. Business--Customer
Acquisition and Marketing" and "--Competition".
Several recent developments are likely to have an adverse effect on future
enrollments to Prodigy Internet from the Packard Bell/NEC bundling arrangement.
The Company now requires new enrollees through Packard Bell/NEC to supply credit
card information for billing rather than relying on subsequent paper billing.
The Company believes this change may result in a lower level of new subscriber
enrollments through the Packard Bell/NEC channel but that the resultant
enrollees will be less likely to terminate service upon completion of the
applicable trial period. The Prodigy Internet software is pre-loaded on the hard
drives of selected PC models shipped by Packard Bell/NEC but Prodigy Internet is
no longer automatically selected as the customer's Internet service if no other
selection is made. The Company is unable to predict the terms or nature of its
future bundling arrangements with Packard Bell/NEC or the level of future
Prodigy Internet enrollments from Packard Bell/NEC.
Impact of Planned Termination of Prodigy Classic Service
On January 22, 1999, the Company announced that it intends to discontinue
Prodigy Classic in the fourth quarter of 1999, because the Company has shifted
its business focus to Internet-based products and services and because the
Company has determined not to make the significant investment required to make
Prodigy Classic Year 2000 compliant. Prodigy Classic has been a significant
source of the Company's revenues and subscribers to Prodigy Internet. During the
years ended December 31, 1996, 1997 and 1998, approximately 92%, 73% and 35%,
respectively, of the Company's total revenues were attributable to Prodigy
Classic. As of December 31, 1998, 144,000 of the Prodigy Internet billable
subscribers had migrated from Prodigy Classic (most of whom are enrolled in a
Prodigy Internet/Prodigy Classic combination plan), and there were 166,000
remaining billable subscribers to Prodigy Classic. Although the Company plans to
continue to encourage Prodigy Classic subscribers to migrate to the Prodigy
Internet service, the Company has experienced difficulty in generating migration
from Prodigy Classic to Prodigy Internet, and a substantial portion of the
remaining Prodigy Classic subscribers lack the minimum hardware requirements for
the Prodigy Internet service. For example, in the three months ended December
31, 1998, there was a net reduction of 42,000 billable subscribers to Prodigy
Classic and a net reduction of 1,000 in the number of billable subscribers who
had migrated from Prodigy Classic to Prodigy Internet. No assurance can be given
as to the number of remaining Prodigy Classic subscribers who will migrate to
Prodigy Internet. In addition, a substantial number of the billable subscribers
enrolled in a Prodigy Internet/Prodigy Classic combination plan (60,000 of
134,000 at December 31, 1998) use both services and some combination plan
subscribers (12,000 of
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134,000 at December 31, 1998) do not use Prodigy Internet at all. Accordingly,
some combination plan subscribers may be unwilling or unable to migrate to
Prodigy Internet upon termination of Prodigy Classic. The termination of Prodigy
Classic could adversely affect the Company's business, financial condition,
results of operations or prospects. See the other sections of "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Item 1. Business" and the Consolidated Financial Statements and
Notes thereto contained herein under Item 8.
Dependence on the Internet
Substantially all of the Company's revenues are dependent on the continued
use and expansion of the Internet. Only recently has the commercial sector begun
significant use of the Internet and, more recently still, have consumers begun
using the Internet. Use of the Internet has grown dramatically, but no assurance
can be given of the continued use and expansion of the Internet as a medium of
communications and commerce. A decrease in the demand for Internet services or a
reduction in the currently anticipated growth for such services could have a
material adverse effect on the Company's business, financial condition, results
of operations or prospects. This Annual Report on Form 10-K contains various
data and projections related to the number of Internet users, revenues from
Internet access services, Internet hosting revenues and the size of Internet
commerce. These data and projections have been included in studies prepared by
IDC and Forrester, independent market research firms, and the projections are
based on a number of significant assumptions. If the assumptions turn out to be
incorrect, the projections may be materially different than actual results or
circumstances, which could have a material adverse effect on the Company's
business, financial condition, results of operations or prospects. Although the
Company believes that such data and projections are generally indicative of the
matters reflected therein, such data and projections are inherently imprecise
and investors are cautioned not to place undue reliance on them. See "Item 1.
Business--Industry Background".
Uncertain Legal Standards
The law relating to the liability of ISPs and online services companies for
information available through their services is uncertain. As the law and
judicial decisions in this area develop, the potential imposition of liability
upon the Company for information available through its services could require
the Company to implement measures to reduce its exposure to such liability. The
implementation of such measures could require the expenditure of substantial
resources or the discontinuation of certain service offerings. Any costs that
are incurred as a result of such expenditures, contesting any such asserted
claims or the imposition of liability could have a material adverse effect on
the Company's business, financial condition, results of operations or prospects.
In addition, due to the increasing use of the Internet, it is possible that
additional laws and regulations may be adopted with respect to the Internet
covering issues such as content, user privacy, pricing, libel, intellectual
property protection and infringement and technology export and other controls.
Changes in the regulatory environment relating to the Internet services
industry, including regulatory changes that directly or indirectly affect
telecommunication costs or increase the likelihood or scope of competition,
could have a material adverse effect on the Company. "Item 1. Business--
Government Regulation".
Rapidly Changing Markets and Technology
The industry in which the Company competes is characterized by rapid
technological change resulting in dynamic customer demands and frequent new
product and service introductions. As a result, the Company's markets can change
rapidly and the Company's future results will depend in part on its ability to
make timely and cost-effective enhancements and additions to its services and
introduce new services that meet customer demands. For example, certain ISPs
have introduced, or announced plans to introduce, high-speed Internet access
utilizing broadband applications such as cable modems, ISDN (Integrated Services
Digital Network) telephone service and xDSL (Digital Subscriber Line) telephone
service. The Company does not currently provide any residential or business
broadband access services. The Company is in discussions with Splitrock and
others to support various broadband applications, but there can be no assurance
the Company and Splitrock or any other party will reach agreement. See "Item 1.
Business--Products and Services--Business Services". There also can be no
assurance that the Company will have sufficient resources to introduce new
services that meet customer demands on a timely basis
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or that its new service introductions will achieve acceptance in the
marketplace. The Company believes that its ability to compete successfully is
also dependent upon the continued compatibility and interoperability of its
services with products and architectures offered by various vendors. Although
the Company intends to support emerging standards in the market for Internet
access, there can be no assurance that the Company will be able to conform to
new standards in a timely fashion and maintain a competitive position in its
markets. In addition, there can be no assurance that services or technologies
developed by others will not render the Company's services or technology
uncompetitive or obsolete. See "Item 1. Business".
Risks of New Services and Markets; Failure to Implement Business Strategy
The Company's business strategy includes the introduction of numerous new
services and entry into various new markets. For example, the Company is
expanding its Web hosting activities and other value-added services, plans to
expand beyond its existing consumer market to include small and medium sized
businesses, and plans to provide Internet services to Spanish-speaking and
Hispanic customers in the United States. See "Item 1. Business--Business
Strategy" and "Item 1. Business--Products and Services". The Company
historically has focused on the consumer market and has relatively little
experience in developing and marketing services to business customers. In
addition, the Company has not previously focused on Spanish-speaking or Hispanic
customers, and the Company's success in penetrating this market will depend in
large part on the Company's ability to establish a strategic partnership with a
company with experience in selling products or services to this market.
Furthermore, to the extent the Company elects to introduce services in
international markets, foreign operations present certain risks and
uncertainties not generally encountered in the United States, such as compliance
with regulatory requirements, export and trade controls, difficulties in
staffing and managing international operations, longer payment cycles, problems
in collecting accounts receivable, foreign exchange fluctuations and controls,
potentially adverse tax consequences and inadequate protection of intellectual
property rights. See "Item 1. Business--Products and Services--Spanish-Speaking
and Hispanic Market". In addition, the Splitrock arrangements cover only the
United States, and the Company would need to make other network arrangements in
order to offer services in foreign countries. See " -- Network Risks". There can
be no assurance that the Company will be successful in offering new services and
entering new markets as planned or that any such services, if introduced, will
achieve acceptance in the marketplace.
The Company may decide to alter or discontinue certain aspects of its
business strategy described herein and may adopt alternative or additional
strategies. The Company's ability to successfully implement its business
strategy, and the expected benefits to be obtained from the Company's strategy,
may be adversely impacted by factors not currently foreseen, such as unforeseen
costs and expenses, or events beyond its control, such as technological change
or an economic downturn. In addition, competitive factors may require the
Company to alter or reduce its business strategies or reduce the expected
benefits to be obtained therefrom.
Quarterly Fluctuations in Operating Results
The Company experiences quarterly fluctuations in its operating results due
to a number of factors, including the seasonality of its business, changes in
the level of consumer spending during business cycles, the timing of
introduction of new and enhanced services by the Company, pricing changes and
competitive factors. The Company historically has experienced seasonality in its
business, with higher expenses during the last and first fiscal quarters,
corresponding to the Christmas and post-Christmas selling season, and lower
timed usage revenues (revenues from hourly usage charges) typically occurring
during its second and third fiscal quarters resulting from reduced usage of its
services during the summer months. The Company believes that the seasonal
reductions in timed usage revenues historically experienced by the Company will
be mitigated by the movement from timed usage plans to unlimited usage plans as
well as growth in the Company's subscriber base, although the Company expects to
continue to have higher expenses during the first and fourth quarters.
Accordingly, the Company believes that quarter-to-quarter comparisons of the
Company's operating results may not be meaningful or indicative of future
results. Although the Company's outsourcing strategy enables it to tie many
variable costs to variable revenue sources, the Company's fixed expenses are
based, in part, on its expectations as to future revenues. To the extent that
revenues are below expectations and the Company is unable to reduce fixed costs
proportionately, the Company's operating results would be adversely affected.
See the other sections of "Item 7. Management's
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Discussion and Analysis of Financial Condition and Results of Operations", "Item
1. Business" and the Consolidated Financial Statements and Notes thereto
contained herein under Item 8.
Protection of Proprietary Technology
The Company protects its proprietary technology through copyright and trade
secrets laws, employee and third-party confidentiality agreements and other
methods. Customers are granted a license to use Prodigy's services under
agreements that contain terms and conditions prohibiting unauthorized
reproduction. Despite these precautions, unauthorized third parties may be able
to copy certain portions of Prodigy's services or reverse engineer or obtain and
use information Prodigy regards as proprietary. Although the Company does not
believe that its products infringe the proprietary rights of any third parties,
there can be no assurance that third parties will not assert infringement claims
against the Company or that such claims will not be successful. The Company
could incur substantial costs and diversion of management resources with respect
to any claims relating to proprietary rights, whether or not successful, which
could materially adversely affect the Company's business, financial condition,
results of operations or prospects. See "Item 1. Business--Technology" and "--
Proprietary Rights".
Management of Growth and Dependence on Key Personnel
The Company's ability to exploit the market for its products and services
and increase its subscriber base requires an effective planning and management
process. The Company's ability to plan and manage effectively will require it to
continue to implement and improve its operational, financial and management
information systems and to attract and retain skilled managers and other
personnel, including its current executive officers. Competition for such
personnel is intense, and there can be no assurance that the Company will be
successful in attracting and retaining necessary personnel. The Company does not
maintain insurance on the lives of any of its officers or directors. Although
the Company has entered into non-competition agreements with certain executive
officers, no assurance can be given that such agreements are or will be
enforceable by the Company. Most of the Company's executive officers have joined
the Company since the autumn of 1997, including Samer F. Salameh, Chairman of
the Board and Chief Executive Officer, David C. Trachtenberg, President and
Chief Operating Officer, David R. Henkel, Executive Vice President, Finance and
Chief Financial Officer, James P. Dougherty, Executive Vice President, Business
Services and Andrea S. Hirsch, Executive Vice President, Business Development
and General Counsel. See "Item 10. Directors and Executive Officers of the
Registrant".
Government Regulation
Internet access and online services are not subject to direct regulation in
the United States, but changes in the regulatory environment relating to the
telecommunications and media industry could have an effect on Prodigy's
business, financial condition, results of operations or prospects. For example,
Federal Communications Commission regulatory review and rulemaking could result
in regulation of the Internet and online services industry which could result in
increased telecommunications costs for participants in the Internet industry,
including Prodigy. The Company cannot predict whether, or to what extent, any
such new rulemaking will occur, or what effect any such rulemaking would have on
Prodigy. There can be no assurance the Company will not be adversely affected by
any such matters. See "Item 1. Business--Government Regulation".
Possible Acquisitions
The Internet services industry is highly fragmented, consisting of more
than 5,000 ISPs in the United States, and is expected to undergo substantial
consolidation over the next few years. See "--Intense Competition". The Company
evaluates acquisition opportunities on an ongoing basis and at any given time
may be, and at the present time is, engaged in discussions with respect to
possible acquisitions or other business combinations. The Company may seek
strategic acquisitions that can complement the Company's current or planned
business activities, particularly the expansion of value-added services such as
Web hosting. The Company may also seek to acquire other ISPs as an additional
means of customer acquisition or entry into new markets. Such acquisitions may
not be available at the times or on terms acceptable to the Company, or may not
be available at all. In addition, any acquisitions that the Company makes may
involve risks, including the successful integration and management of
42
<PAGE>
acquired operations and personnel. The integration of acquired businesses may
also lead to the diversion of management attention from other business matters.
No assurance can be given that suitable acquisitions can be identified, financed
and completed on acceptable terms or that any acquisitions by the Company will
be successful. See "Item 1. Business--Business Strategy".
No Public Market; Possible Volatility of Stock Price
Prior to the IPO, there was no public market for the Common Stock, and
there can be no assurance that an active trading market will be sustained or
that the market price of the Common Stock will not decline below the IPO price.
Market prices for securities of ISPs and other participants in the Internet
industry have been and may continue to be highly volatile. Such volatility may
be caused by factors outside of the Company's control and may be unrelated or
disproportionate to the Company's operating results.
No Dividends
The Company has never declared or paid cash dividends on its capital stock
and does not anticipate paying any cash dividends in the foreseeable future. The
Company's current policy is to retain earnings, if any, to provide funds for the
operation and expansion of its business. See "Item 5. Market for Registrant's
Common Equity and Related Stockholder Matters".
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
43
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Prodigy Communications Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of
Prodigy Communications Corporation and its subsidiaries (the "Company") at
December 31, 1997 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
New York, New York
March 10, 1999
44
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
December 31,
-----------------------------
ASSETS: 1997 1998
------------ -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 12,363 $ 12,180
Trade accounts receivable, net of allowances for doubtful accounts
of $685 and $367 at December 31, 1997 and 1998, respectively 1,740 966
Other receivables 674 -
Prepaid expenses 1,379 1,691
Other current assets 1,108 106
------------ ----------
Total current assets 17,264 14,943
Restricted cash 4,148 5,420
Property and equipment, net 18,327 12,998
Tradename, net 30,246 26,579
Goodwill, net 13,138 11,587
Deferred network costs, net 8,167 5,939
Notes receivable, net of deferred gain of $16,148
at December 31, 1997 and 1998 - -
Assets held for sale 1,650 -
Other assets 510 866
------------ ----------
Total assets $ 93,450 $ 78,332
============ ==========
LIABILITIES and STOCKHOLDERS' EQUITY:
Current liabilities:
Notes payable $ 2,000 $ 2,000
Accounts payable 15,650 6,184
Accrued compensation 2,348 3,000
Accrued restructuring and other special costs 7,875 4,705
Other accrued expenses 33,344 22,451
Unearned revenue 4,552 10,200
------------ ----------
Total current liabilities 65,769 48,540
Notes payable-related parties 10,000 -
------------ ----------
Total liabilities 75,769 48,540
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized;
none issued or outstanding - -
Contingent convertible notes 30,500 30,500
Common stock, $.01 par value; 280,000,000 and 280,000,000 shares
authorized; 33,803,894 and 45,034,297 shares issued and
outstanding out at December 31, 1997 and 1998, respectively 338 450
Additional paid-in capital 218,736 294,296
Accumulated deficit (227,704) (292,787)
Accumulated other comprehensive loss (189) -
Note receivable from stockholder (4,000) (2,667)
------------ ----------
Total stockholders' equity 17,681 29,792
------------ ----------
Total liabilities and stockholders' equity $ 93,450 $ 78,332
============ ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
45
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1997 1998
-------- ------- ------
<S> <C> <C> <C>
Revenues:
Internet and online service revenues:
Prodigy Internet $ 113 $ 29,459 $ 80,696
Prodigy Classic 90,600 98,793 48,212
------ ------- -------
90,713 128,252 128,908
Other 8,201 5,940 7,232
------ ------- -------
Total revenues 98,914 134,192 136,140
------ ------- -------
Operating costs and expenses:
Costs of revenue 70,204 100,174 99,213
Marketing 21,253 60,461 41,830
Product development 8,921 16,822 12,917
General and administrative 53,474 63,270 52,665
Acquired incomplete technology 20,874 - -
Restructuring and other special costs 3,147 9,854 -
Write-down of assets held for sale - 2,400 -
Loss on sale of cellular assets - 848 -
-------- -------- --------
Total operating costs and expenses 177,873 253,829 206,625
-------- -------- --------
Operating loss (78,959) (119,637) (70,485)
(Gain) on sale of assets - - (5,176)
Loss on equity investment in joint venture 539 12,101 -
Write-down (recovery) of equity investment 9,053 (250) -
Interest income (392) (272) (1,541)
Interest expense 2,643 1,559 1,315
-------- -------- --------
Net loss $(90,802)$(132,775) $(65,083)
======== ======== ========
Basic and diluted loss per share $(8.76) $(7.66) $ (1.60)
======== ======== ========
Weighted average number of common shares outstanding -
used in computing basic and diluted net loss per share 10,361 17,337 40,746
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
46
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
CONTINGENT COMMON STOCK ADDITIONAL
CONVERTIBLE ------------------- PAID-IN ACCUMULATED
NOTES SHARES AMOUNT CAPITAL DEFICIT
-------------- -------- ------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 8,632 $ 86 $ 4,084 $ (4,127)
Issuance of common stock for cash 3,208 32 43,164
Issuance of common stock for services 8 90
Issuance of common stock to purchase minority
interest in subsidiary 87 1 1,049
Conversion of credit facility 375 4 4,496
Issuance of contingent convertible notes $ 30,500
Comprehensive loss:
Net loss (90,802)
Other comprehensive losses:
Translation adjustment
Comprehensive loss
------------ ------- ------ --------- ----------
Balance at December 31, 1996 30,500 12,310 123 52,883 (94,929)
------------ ------- ------ --------- ----------
Issuance of common stock for cash 14,913 149 71,890
Issuance of common stock on conversion
of advances from stockholders 8,547 86 102,565
Acquisition and retirement of treasury shares (1,966) (20) (8,602)
Comprehensive loss:
Net loss (132,775)
Other comprehensive losses:
Translation adjustment
Comprehensive loss
------------ ------- ------ --------- -----------
Balance at December 31, 1997 30,500 33,804 338 218,736 (227,704)
------------ ------- ------ --------- -----------
Issuance of common stock for cash 11,254 112 74,926
Issuance of common stock on conversion of
advances from stockholders
Options granted at below fair value 730
Acquisition and retirement of treasury shares (24) (96)
Comprehensive loss:
Net loss (65,083)
Other comprehensive income:
Translation adjustment
Comprehensive loss
------------ ------- ------ --------- -----------
Balance at December 31, 1998 $ 30,500 45,034 $ 450 $ 294,296 $ (292,787)
============ ======= ====== ========= ===========
<CAPTION>
ACCUMULATED
OTHER NOTE
COMPREHENSIVE RECEIVABLE
(LOSS) FROM COMPREHENSIVE
PROFIT STOCKHOLDER LOSS TOTAL
--------------- ------------- --------------- ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 $ (4) $ 39
Issuance of common stock for cash 43,196
Issuance of common stock for services 90
Issuance of common stock to purchase minority
interest in subsidiary 1,050
Conversion of credit facility 4,500
Issuance of contingent convertible notes 30,500
Comprehensive loss:
Net loss $ (90,802) (90,802)
Other comprehensive losses:
Translation adjustment (26) (26) (26)
-----------
Comprehensive loss $ (90,828)
-------------- ---------- ============ -----------
Balance at December 31, 1996 (30) $ (11,453)
-------------- ---------- ----------
Issuance of common stock for cash $ (4,000) 68,039
Issuance of common stock on conversion of
advances from stockholders 102,651
Acquisition and retirement of treasury shares (8,622)
Comprehensive loss:
Net loss $ (132,775) (132,775)
Other comprehensive losses:
Translation adjustment (159) (159) (159)
------------
Comprehensive loss $ (132,934)
-------------- ---------- ============ ----------
Balance at December 31, 1997 (189) (4,000) $ 17,681
-------------- ---------- ----------
Issuance of common stock for cash 75,038
Issuance of common stock on conversion 1,333 1,333
of advances from stockholders - -
Options granted at below fair market value 730
Acquisition and retirement of treasury shares (96)
Comprehensive loss:
Net loss $ (65,083) (65,083)
Other comprehensive losses:
Translation adjustment 189 189 189
-------------
Comprehensive loss $ (64,894)
-------------- -------- ============= ----------
Balance at December 31, 1998 $ - $ (2,667) $ 29,792
============== ======== ==========
</TABLE>
See footnote 16 - Subsequent Events (UNAUDITED) for a description of the
one-for-four reverse stock split.
The accompanying notes are an integral part of the consolidated financial
statements.
47
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
Consolidated Statements of Cash Flows
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------
1996 1997 1998
------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (90,802) $ (132,775) $ (65,083)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on equity investment in joint venture 539 12,101 -
Write-down (recovery) of equity investments 9,053 (250) -
Acquired incomplete technology 20,874 - -
Services settled by issuance of common stock 90 - -
Gain on sale of assets - - (5,176)
Option grants at below fair value - - 730
Loss on sale of cellular assets - 848 -
Depreciation and amortization of property and equipment 7,108 11,997 7,896
Amortization of goodwill 840 1,551 1,551
Amortization of tradename 1,915 3,455 3,667
Amortization of deferred network costs - 1,335 2,228
Write-down of assets held for sale - 2,400 -
Amortization of deferred software development costs 1,047 1,159 -
Write-down of deferred software development costs to net realizable value 1,399 1,946 -
Provision for doubtful accounts 930 (245) (318)
Change in operating assets and liabilities, net of effects
of acquisitions and disposals:
Trade accounts receivable 690 1,838 1,092
Other receivable - (674) 674
Prepaid expenses 436 1,340 (312)
Other assets (257) (1,016) 646
Assets held for sale (10,334) (5,325) 1,650
Accounts payable 21,279 (9,314) (9,466)
Accrued compensation 3,438 (1,089) 652
Accrued restructuring and other special costs 730 (2,178) (3,170)
Other accrued expenses - (2,336) (10,893)
Unearned revenue (4,269) 1,193 5,648
------------ ----------- -----------
Net cash used in operating activities (35,294) (114,039) (67,984)
------------ ----------- -----------
Cash flows from investing activities:
Cash paid for Prodigy Services Company, net of cash acquired (21,088) - -
Equity investments (9,053) - -
Acquisition of property and equipment (8,820) (8,556) (2,567)
Deferred software development costs (3,575) - -
Investment in joint venture (5,700) (7,006) -
Increase in other assets 323 308 -
Proceeds from sale of assets - - 5,176
------------ ----------- -----------
Net cash used in investing activities (47,913) (15,254) 2,609
------------ ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 43,196 68,039 74,942
Repayment of notes payable to related parties - (46,000) (32,100)
Proceeds from notes payable to related parties 58,900 - 22,100
Repayment of borrowings - - (30,000)
Proceeds from borrowings 2,000 102,651 30,000
Payment of note receivable from stockholder - - 1,333
Increase in restricted cash - (4,148) (1,272)
Other (26) (161) 189
------------ ----------- -----------
Net cash provided by financing activities 104,070 120,381 65,192
------------ ----------- -----------
Net increase (decrease) in cash and cash equivalents 20,863 (8,912) (183)
------------ ----------- -----------
Cash and cash equivalents, beginning of period 412 21,275 12,363
------------ ----------- -----------
Cash and cash equivalents, end of period $ 21,275 $ 12,363 $ 12,180
============ =========== ===========
Years Ended December 31,
------------------------------------------------
1996 1997 1998
------------------------------------------------
<S> <C> <C> <C>
Cash paid for interest $ 2,428 $ 1,177 $ 1,164
========== ========== ==========
Noncash investing and financing activities:
Conversion of advances from stockholder to common stock $ 4,500 $ 102,651
Contingent convertible notes and contingent warrants
issued in exchange for contingent convertible note - 30,500 -
Sale of network assets in exchange for service agreement - 9,502 -
Acquisition of minority interest in "Comstar Cote d'Ivoire,"
in exchange for 350,000 shares of common stock $ 1,050 $ - $ -
========== ========== ==========
Acquisition of business, net of cash acquired:
Fair value of assets acquired $ 136,095 $ - $ -
Cash paid for assets, including direct costs (47,616) - -
Issuance or contingent convertible notes (30,500) - -
---------- ---------- ----------
Liabilities assumed $ 57,979 $ - $ -
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
48
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION
Prodigy Communications Corporation (the "Company") is a leading nationwide
Internet Service Provider ("ISP"). The Company is controlled by Carso
Global Telecom, S.A. de C.V. ("Carso Global Telecom") through a majority
voting equity interest in the Company's common stock. The Company was
formed in June 1996, under the name Prodigy, Inc., to acquire Prodigy
Services Company ("PSC") and to hold International Wireless Incorporated
("IW") and other communications interests. All outstanding common stock of
IW was converted into common stock of the Company on a one-for-one basis in
June 1996. The assets and liabilities of IW were carried over to the
Company at historical cost as the respective shareholders maintained their
relative ownership percentages existing immediately prior to the
conversion. Accordingly, the financial statements prior to the acquisition
of Prodigy Services on June 17, 1996, consist solely of IW. IW was
incorporated on May 23, 1994, to develop and operate cellular telephone
systems in Africa. IW's other communications interests consisted of Africa
Online, Inc. (see Note 5-Dispositions), a wholly-owned subsidiary engaged
in Internet access and online services in Africa, an equity investment in
Global Enterprise Services, Inc. (see Note 4-Acquisitions) and an equity
investment in a start-up joint venture in China (see Note 5-Dispositions).
Since the acquisition of PSC, the Company has been in the midst of a major
transformation, both domestically and internationally. In the United
States, the Company launched its open standards based Internet access
service ("Prodigy Internet") in October 1996. The Company's cellular
telephone assets and operations were sold in January 1997. In 1997, the
Company determined that its primary focus will be as an ISP and decided to
discontinue the production of its own content for Prodigy Internet. The
Company sold its African operations and negotiated a settlement of its
liabilities in connection with the closing of its Asian operations (see
Note 5-Dispositions).
The acquisition of PSC was accounted for as a purchase. Accordingly, the
results of operations of PSC since the date of acquisition, June 17, 1996,
are included in the accompanying consolidated statements of operations for
the year ended December 31, 1996. The Company's accounts as of the date of
the acquisition reflect the fair value of the assets acquired and
liabilities assumed (see Note 4-Acquisitions).
The Company's ability to meet its obligations in the ordinary course of
business is dependent upon its ability to establish profitable operations
through public financings (see Note 16 Subsequent Events (Unaudited)),
collaborative or other arrangements with corporate sources, or other
sources of financing to fund operations. During 1998 the Company has
received additional financing of approximately $75 million through the
issuance of common stock. Management believes that the additional funding
through the sources mentioned above will be sufficient to enable the
Company to meet its planned expenditures through at least December 31,
1999.
49
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
ESTIMATES AND ASSUMPTIONS
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 revenue and expenses
during the reporting periods. Actual results could differ from those
estimates. Significant estimates made by the Company include the useful
lives of fixed assets and the recovery of fixed assets, capitalized
software, goodwill, tradename, deferred network asset and deferred tax
assets.
FOREIGN CURRENCY TRANSLATION
The functional currencies of the Company's foreign subsidiaries are the
local currencies. Accordingly, assets and liabilities of foreign
subsidiaries are translated to U.S. dollars at period-end exchange rates
and revenues and expenses are translated using the average rates during the
period. The effects of foreign currency translation adjustments have been
accumulated and are included as a separate component of stockholders'
equity. Foreign currency transaction gains and losses, arising from
exchange rate fluctuations on transactions denominated in currencies other
than the functional currencies, were immaterial for all periods presented.
REVENUE RECOGNITION
Internet and on-line service revenues encompass subscription and usage fees
and are earned over the period services are provided. Other revenues,
consisting principally of marketing services and transaction fees from the
sale of merchandise, are recognized as services are provided or fees are
earned. Unearned revenue consists primarily of subscription fees billed in
advance.
50
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
SUBSCRIBER ACQUISITION COSTS
Direct response advertising costs which result in subscriber registrations
without further effort required by the Company are capitalized and
amortized over their estimated useful life subject to recoverability
limitations. No such subscriber acquisition costs have been capitalized
due to the uncertainty of recovery. General marketing costs, as well as
all other costs related to the acquisition of subscribers, are expensed as
incurred.
ADVERTISING COSTS
Advertising costs are included in marketing expenses and are expensed as
incurred.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities at date of purchase of three months or less to be cash
equivalents. Cash and cash equivalents are stated at cost, which
approximates fair value because of the short maturity of these instruments.
RESTRICTED CASH
Restricted cash represents collateral for outstanding letters of credit,
the escrow portion of proceeds relates to the Company's sale of a
subsidiary and collateral for a surety bond filed with a state government.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the assets.
Expenditures for major renewals and betterments that extend the useful
lives of property and equipment are capitalized. Expenditures for
maintenance and repairs are charged to expense as incurred. When assets
are sold or otherwise disposed of, the cost and related accumulated
depreciation are relieved and any resulting gain or loss is recognized.
PRODUCT DEVELOPMENT COSTS
Software development costs are expensed as incurred until technological
feasibility has been established. The Company determines technological
feasibility upon the completion of a working model. Once technological
feasibility has been established, such costs are capitalized until the
software is available for general release to customers. Amortization is
calculated on a product-by-product basis, using the greater of the
straight-line basis over the estimated economic lives of the related
products, two years, or the ratio of current gross revenue to total current
and expected future gross revenue for the related products, also over two
years. The straight-line basis has produced a greater charge and,
accordingly, has been used exclusively to date. The amortization and
write-down of deferred software development costs is included in "Costs of
Revenue."
Amortization of deferred software development costs totaled $1,047,
$1,159 and $0 in 1996, 1997 and 1998, respectively.
51
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
INVESTMENT IN JOINT VENTURE
The Company had an investment in a foreign joint venture operating in China
which was accounted for under the equity method of accounting, as the
Company did not have a controlling interest. As of December 31, 1997, the
Company's investment was written down to its net realizable value of zero
(see Note 5 - Dispositions).
The assets and revenues of the joint venture were immaterial for all
periods presented.
TRADENAME
The "Prodigy" tradename was recorded at fair value as of June 17, 1996,
upon the acquisition of PSC. The tradename is amortized on a straight-line
basis over 10 years.
GOODWILL
Goodwill relates to the excess of cost over the fair value of the net
assets purchased upon the acquisition of PSC as of June 17, 1996. Goodwill
is amortized on a straight-line basis over 10 years.
LONG-LIVED ASSETS
The Company periodically evaluates the net realizable value of long-lived
assets, including the Prodigy tradename, goodwill and property and
equipment, relying on a number of factors including operating results,
business plans, economic projections and anticipated future cash flows. An
impairment in the carrying value of an asset is recognized when the
expected future operating cash flows derived from the asset are less than
its carrying value. In addition, the Company's evaluation considers
nonfinancial data such as market trends, product and development cycles,
and changes in management's market emphasis.
INCOME TAXES
Deferred tax liabilities and assets are recognized based on temporary
differences between the financial statement and tax bases of assets and
liabilities using current statutory rates. A valuation allowance is
applied against net deferred tax assets if, based on the weighted available
evidence, it is more likely than not that some or all of the deferred tax
assets will not be realized.
CONTINGENT CONVERTIBLE NOTES
The contingent convertible notes issued in connection with the acquisition
of PSC are classified in Stockholders' Equity. In 1997, the Company
exchanged the contingent convertible notes for contingent convertible notes
and contingent warrants (see Note 9 - Contingent Convertible Notes and
Warrants).
52
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company adopted Statement of Financial Accounting Standards No. 123
(SFAS No. 123), "Accounting for Stock-Based Compensation," in 1996. As
permitted by SFAS No. 123, the Company has elected to continue to apply the
intrinsic value methodology provisions of Accounting Principles Board
Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," for
the grants or awards of equity instruments to employees. In accordance with
APB 25 no expense was recorded during 1996 and 1997. During 1998
approximately $730 of compensation expense was recorded. As required by
SFAS No. 123, the Company has disclosed the pro forma effect on net loss of
using a fair value approach to measure compensation for grants or awards of
equity instruments in 1996, 1997 and 1998 (see Note 12-Stock Options and
Warrants.
NET LOSS PER SHARE
The Company computes basic and diluted earnings per share in accordance
with Statement of Financial Accounting Standards No. 128 ("SFAS 128"),
"Earnings per Share." SFAS 128 requires the Company to report both basic
earnings per share, which is based on the weighted average number of common
shares outstanding, and diluted earnings per share, which is based on the
weighted average number of common shares outstanding and all dilutive
potential common shares outstanding. As the Company incurred losses for
all periods presented, there is no difference between basic and diluted
earnings per share.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and trade
receivables. Concentration of credit risk with respect to cash is limited
as the Company invests its cash in deposits with several financial
institutions. Concentration of credit risk with respect to trade
receivables is limited as the outstanding total represents a large number
of customers with individually small balances. The Company does not
require collateral or other security against trade receivable balances;
however, it does maintain reserves for potential credit losses and such
losses have been within management's expectations.
RECLASSIFICATIONS
Certain amounts from the prior year have been reclassified to conform with
the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1").
SOP 98-1 is effective for financial statements for years beginning after
December 15, 1998. SOP 98-1 provides guidance over accounting for computer
software developed or obtained for internal use including the requirement
to capitalize specified costs and amortization of such costs. The Company
does not expect the adoption of this standard to have a material effect on
the Company's capitalization policy.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5, which is
effective for fiscal years beginning after December 15, 1998, provides
guidance on the financial reporting of start-up costs and organization
costs. It requires costs of start up activities and organization costs to
be expensed as incurred. As the Company has expensed these costs
historically, the adoption of this standard is not expected to have a
significant impact on the Company's results of operations, financial
position or cash flows.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information", which establishes standards for the
way that a public enterprise reports information about operating segments
in annual financial statements, and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997. In the initial year of application, comparative
information for earlier years must be restated. The Company has determined
that it does not have any separately reportable business segments.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities. SFAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company does not expect the adoption of this statement to have a
significant impact on the Company's results of operations, financial
position or cash flows.
53
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
3. RESTRUCTURING AND OTHER SPECIAL COSTS
FISCAL YEAR 1996 RESTRUCTURINGS AND OTHER SPECIAL COSTS
The components of the Company's restructuring provision at December 31,
1996 are detailed below:
<TABLE>
<CAPTION>
<S> <C>
(A) Prodigy services $ 8,321
(B) Cost reduction plan 3,147
-------
$ 11,468
=======
</TABLE>
(A) In connection with the acquisition of PSC as of June 17, 1996, the
Company assumed non-recurring liabilities classed as "Accrued
Restructuring and Other Special Costs" of $10,738, of which $8,321
remained outstanding as of December 31, 1996, and payable in 1997.
These non-recurring liabilities related to restructuring plans which
occurred prior to the acquisition date in connection with (i) a lease
cancellation penalty for PSC's lease of its White Plains, NY
facilities, of which $7,826 was outstanding as of December 31, 1996,
and (ii) salary continuance and related liabilities resulting from job
eliminations and early retirements of certain executives, of which
$495 was outstanding as of December 31, 1996.
(B) In 1996, subsequent to the PSC acquisition, the Company approved
another restructuring plan to reduce costs through additional job
eliminations and a reduction in the use of leased office space, and as
a result, recorded a restructuring charge of $3,147. Approximately 20
employees were terminated in January 1997 and the related severance
cost of $659 was included in "Accrued Restructuring and Other Special
Costs" at December 31, 1996. Beginning in November 1996, the Company
vacated 29% of its leased space in White Plains, N.Y. The cost of the
lease attributed to the idle leased facility amounted to $2,488 and
was included in "Accrued Restructuring and Other Special Costs" as of
December 31, 1996.
During 1997, the Company paid the balance of the 1996 accrued restructuring
and other special costs.
54
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
FISCAL YEAR 1997 RESTRUCTURINGS AND OTHER SPECIAL COSTS
In an effort to decrease cash outflows and more efficiently manage its
business, the Company decided to restructure its operations and outsource
its network and content production functions. The Company's provisions,
expenditures and remaining balances to be paid are detailed below:
<TABLE>
<CAPTION>
ACCRUED ACCRUED
COSTS AT COSTS AT
1997 1997 DECEMBER 31, 1998 DECEMBER 31,
COST EXPENDITURES 1997 EXPENDITURES 1998
--------- ---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
(A) Network termination costs $ 4,740 $ 4,740 $ 849 $ 3,891
(B) Employee severance 2,900 $ 1,979 921 921 0
(C) Discontinuance of content production 585 585 585 0
(D) Medford, MA Facility Closing 1,629 1,629 815 814
--------- ---------------- --------------- ---------------- ---------------
$ 9,854 $ 1,979 $ 7,875 $ 3,170 $ 4,705
========= ================ =============== ================ ===============
</TABLE>
(A) In connection with the sale of its network (see Note 5 - Dispositions,
Sale of Network), the Company incurred liabilities related primarily
to early termination payments and other contractual obligations for
certain non-cancelable network related agreements. Management expects
to use this reserve in full by the year ending December 31, 2001.
(B) The Company implemented a restructuring plan to reduce costs through
job elimination and as a result recorded a charge of $2,900.
Approximately 80 employees throughout the Company were terminated. The
entire reserve was used in 1997 and 1998 to make severance payments to
employees identified as part of the original plan.
(C) The Company decided to discontinue the production of its own content
and as a result recorded a charge of $585 to account for the employee
termination costs and the costs to settle content related contractual
obligations. Approximately 25 employees were terminated. The entire
reserve was used in 1997 and 1998 to make severance payments to
employees identified as part of the original plan.
(D) The Company's Medford, Massachusetts location has been closed and a
charge of $1,629 was recorded to account for the costs of employee
terminations and lease cancellation. Management expects to use this
reserve in full by the year ending December 31, 2001. The terminated
employees were involved with the Company's international operations
and/or former headquarters management. Approximately 20 employees were
terminated.
55
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
4. ACQUISITIONS
ACQUISITION OF MINORITY INTEREST IN SUBSIDIARY
In January 1996, the Company purchased 90 shares of common stock of Comstar
Cellular S.A. Cote d'Ivoire ("Comstar Cote d'Ivoire") from a minority
shareholder and employee in exchange for $300 in cash and 87,500 shares of
common stock of the Company with a value of $12.00 per share. As a result
of this transaction, the Company's equity interest in Comstar Cote d'Ivoire
increased from 91% to 100%.
The acquisition was accounted for as a purchase and the excess of the
purchase price over the fair value of the assets acquired and liabilities
assumed, representing goodwill, amounted to $1,350 and was included with
assets held for sale in connection with the sale of International Wireless,
which included the cellular operations of Comstar Cote d'Ivoire.
INVESTMENT IN GLOBAL ENTERPRISE SERVICES, INC. ("GES")
During the period from January 1996 to March 1996, the Company acquired a
48% voting interest in GES, represented by 4,800,000 shares of convertible
preferred stock, for $9,000. The preferred stock had voting rights and was
convertible into common stock. In 1996, the Company recorded a charge of
$9,053 to reduce the carrying value of its investment in GES to an
estimated net realizable value of zero.
In January 1997, pursuant to a redemption agreement, the Company disposed
of its 48% interest in GES for $250.
ACQUISITION OF PRODIGY SERVICES
On June 17, 1996, the Company acquired all of the partnership interests of
International Business Machines Corporation ("IBM") and Sears Roebuck and
Co. ("Sears") in PSC. The Company acquired the assets and assumed the
liabilities of PSC, with the exception of certain patents and all
obligations and liabilities related to employee retirement and other
postretirement benefit plans. The assets purchased and liabilities
assumed, and related results of operations, are included in the
consolidated financial statements of the Company from the date of
acquisition. The aggregate purchase price of $78,116 consisted of a cash
payment of $40,800, the issuance of Contingent Convertible Notes (see Note
9 - Contingent Convertible Notes and Warrants) valued at $30,500, and
direct acquisition related expenses of $6,816.
56
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
The acquisition was accounted for as a purchase. The purchase price,
including direct costs of $6,816, was allocated based on fair values, as
follows:
<TABLE>
<S> <C>
Purchase price $ 78,116
Add: fair value of net liabilities assumed 23,009
-------------
Excess to allocate 101,125
Less: excess allocated:
Tradename 35,668
Property and equipment 27,154
Completed technology-Prodigy Classic 1,900
Incomplete technology-Prodigy Internet 20,874
Goodwill 15,529
</TABLE>
The fair value of intangible assets was determined using a risk adjusted
discounted cash flows approach. Specifically, the Prodigy Internet
technology acquired was evaluated through extensive interviews and analysis
of data concerning the state of the technology and needed developments.
The evaluation of the underlying technology acquired considered the
inherent difficulties and uncertainties in completing the development, and
thereby achieving technological feasibility, and the risks related to the
viability and potential changes to target markets. Incomplete technology
had no alternative future use. Therefore, the Company recognized a charge
of $20,874 for the purchase of incomplete technology in 1996.
In connection with the acquisition, the Company entered into a Funding
Agreement (the "Funding Agreement"), as described in Note 8 - Notes
Payable, with Carso Global Telecom and another stockholder of the Company
(the "Stockholder"). The Funding Agreement was amended in October 1996 and
March 1997.
5. DISPOSITIONS
SALE OF INTERNATIONAL WIRELESS
Effective January 1997, the Company sold all issued outstanding capital
stock of IW to a company (the "Buyer") formed by a former executive and
shareholder of the Company (the "Executive"). The Executive was a former
director of the Company and a former director and officer of IW. Effective
as of October 21, 1996, the Executive resigned as a director of, and from
all other positions with, the Company and IW. Immediately prior to the
sale of IW, the Executive owned 1.0% of the Company's outstanding shares,
and the management team of the Buyer (including the Executive) held an
aggregate of 3.3% of the Company's outstanding shares. The management team
including minority investors held greater than
57
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
10.0% of the Company's outstanding shares immediately prior to the sale of
IW. The executive has no continuing involvement in the Company either as an
employee or stockholder. The assets of IW at the time of the sale consisted
of cellular communications licenses and license applications in certain
African countries, and the associated rights and assets used in the
Company's cellular telephone activities. Africa Online, Inc., formerly a
wholly-owned subsidiary of IW, had been transferred to another subsidiary
of the Company (see Exit of International Operations, below). The Company
also retained the joint venture investment in China previously held by IW
(see Exit of International Operations, below). The selling price consisted
of (i) the surrender of 1,392,857 shares of common stock of the Company,
(ii) a Promissory Note (the "Note") in the amount of $21,500 due in full on
July 27, 1997, including $1,500 in reimbursement of capital expenditures
made by the Company for the benefit of IW, secured by a pledge of 67% of
the shares of IW purchased from the Company, and bearing interest at 9%
until April 27, 1997 and 12% thereafter, and (iii) the termination of the
Executive's fully vested options to purchase 125,000 shares of common stock
for $1.00 per share and 125,000 shares of common stock for $8.00 per share.
In October 1997, the Company and the Buyer modified the Note as follows:
(i) the due date was extended to January 31, 1999, (ii) the Note is
unsecured, (iii) the interest rate was reduced to 8%, (iv) the Note is
subject to mandatory repayment out of the net proceeds from an acquisition
of IW, (v) the Note is also subject to mandatory repayment to the extent of
10% of the first $5,000 in net financing proceeds received by IW (with
certain exceptions), 20% of the next $5,000 in proceeds and 40% of all
proceeds in excess of $10,000, and (vi) the Company is allowed to convert
the Note upon maturity into equity securities of IW at a 20% discount from
the price at which IW has sold equity securities to investors. The Buyer
also surrendered an additional 573,580 shares of common stock of the
Company in exchange for a reduction in IW's unpaid obligations at October
31, 1997 to $16,148.
As a result of the restructuring of the Note and the revaluation of the
Company's stock from $12.00 to $4.00 per share, a loss on the sale of IW of
$848 was recorded in 1997. The Note has been valued at zero. Any future
cash collected against the Note will be accounted for as a gain in "Other
Income."
SALE OF NETWORK
Prodigy owned and operated its own network in the United States until July
1, 1997. Effective July 1, 1997, the Company sold to Splitrock Services,
Inc. ("Splitrock") certain of its network assets. Splitrock agreed to: (i)
assume equipment leases, maintenance and license liabilities related to
network assets, and (ii) enter into a Full Service Agreement whereby
Splitrock will provide certain network services to the Company including
commitments to meet certain capacity and performance requirements. Carso
Global Telecom owns a minority interest in Splitrock.
58
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
The Company also entered into a Sublease Agreement pursuant to which
Splitrock subleases a portion of the Company's leased space in Yorktown
Heights, New York, effective July 1, 1997 through February 28, 2001.
Pursuant to the Full Service Agreement, effective July 1, 1997, Splitrock
provides to the Company network services consisting primarily of end-to-end
connection services from subscriber dial-up lines to the Company's data
center. Splitrock charges Prodigy at a fixed rate per subscriber, subject
to a monthly maximum usage limit, after which an incremental hourly rate is
charged, and certain minimum charges (see Note 13-Commitments and
Contingencies). The Company incurred network charges to Splitrock of
approximately $22,700 and $64,100 for the years ended December 31, 1997
and December 31, 1998, respectively.
Additionally, the Company's accounts payable to Splitrock for the years
ended December 31, 1997 and December 31, 1998 was $0 and approximately
$2,500, respectively.
Under a transition services agreement, Prodigy agreed to pay for certain of
Splitrock's operating expenses and to provide temporary network-related
services to Splitrock, including accounting, human resources and purchasing
functions. Splitrock agreed to reimburse Prodigy for expenses incurred and
the cost of providing these support services (excluding termination
penalties under existing network contracts). The total of the reimbursed
expenses and service costs in 1997 was $27,532. The reimbursed amounts have
been offset against the corresponding expenses and costs in the statements
of operations. The transition services agreement terminated on December 31,
1997, although the Company continued to provide certain incidental services
and make payments on behalf of Splitrock through June 30, 1998. The net
amount due from Splitrock under the Full Service Agreement and the
transition services agreement as of December 31, 1997 was $674. This amount
is recorded under the heading "Other Receivable" on the balance sheet.
Splitrock has notified Prodigy of the Prodigy Local Site ("PLS") leases,
which it wishes to assume, and Prodigy remains liable for all PLS leases
not assumed by Splitrock. Prodigy also remains liable for all obligations
and termination penalties under its existing agreements with IBM Global
Network Services and other third-party providers of Points of Presence
("POPs"). The costs associated with the PLS leases retained by the Company
and the termination penalties have been accrued as part of network
termination costs as of December 31, 1997 (see Note 3 - Restructuring and
Other Special Costs).
Upon termination of the transition services agreement, a Full Services
Agreement became effective, and Splitrock hired all Prodigy employees
engaged in Prodigy's network operations. Splitrock is required to provide
dial-up network access in all locations in which Prodigy provided dial-up
services as of July 1, 1997. Commencing December 31, 1999, Splitrock will
not be required to support the proprietary standards on which the Prodigy
Classic service operates.
Under the Full Service Agreement, Splitrock is required to meet specified
service level objectives. Splitrock's failure to meet the service level
objectives results in financial penalties. If Splitrock fails to meet the
service level objectives for an extended period of
59
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENT, CONTINUED
(in thousands except share and per share amounts)
time, Prodigy may terminate the Full Service Agreement. In addition, if
there is a system-wide failure, or Splitrock breaches specified financial
covenants, Prodigy has the right to terminate the Full Service Agreement or
assume responsibility for operating the network at Splitrock's expense.
As a result of the sale of the network effective July 1, 1997, the Company
sold property and equipment with a net book value of approximately $9,500
and did not record any gain or loss upon the sale of these assets. The net
book value of the equipment was removed from property and equipment on the
balance sheet and classified in "Other Intangible Assets, Net" and is being
amortized over the four year term of the Splitrock contract on a straight-
line basis.
EXIT OF INTERNATIONAL OPERATIONS
In December 1997, management decided to exit its international operations
in order to focus on its domestic internet service business. During 1996
and 1997, the Company incurred losses of $539 and $12,101, respectively, in
relation to its joint venture operation in China.
The assets of Africa Online, Inc., a wholly-owned subsidiary, are carried
as assets held for sale at their estimated fair value of $1,650, as of
December 31, 1997. Africa Online, Inc. was originally part of IW. The
Company recorded a charge of $2,400 in 1997 to reduce the carrying value of
Africa Online, Inc. long lived assets, including goodwill, to their
estimated net realizable value.
On October 1, 1998, Africa Online, Inc. was sold for gross cash proceeds of
$2,815, of which $750 was placed in escrow to secure certain
indemnification obligations of the Company for a six month period. The sale
resulted in an estimated gain to the Company of $2,900, subject to full
release of the escrowed funds.
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
USEFUL LIFE 1997 1998
------------- ------- -------
<S> <C> <C> <C>
Computer equipment 3-5 years $ 25,453 $ 26,837
Leasehold improvements 3-5 years 4,177 4,778
Furniture and equipment 5-8 years 1,008 1,590
--------- --------
30,638 33,205
Less accumulated depreciation and amortization 12,311 20,207
--------- --------
$ 18,327 $ 12,998
========= ========
</TABLE>
Depreciation and amortization of fixed assets was approximately $7,108,
$11,997 and $7,896 for the years ended December 31, 1996, 1997 and 1998,
respectively.
60
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
7. TRADENAME, GOODWILL, AND DEFERRED NETWORK COSTS
The cost and accumulated amortization of the Tradename, Goodwill and
Deferred Network Costs was as follows at December 31:
<TABLE>
<CAPTION>
1997 1998
------------ -------------
<S> <C> <C>
Tradename:
Cost $ 35,668 $ 35,668
Less: accumulated amortization 5,422 9,089
------------ -------------
$ 30,246 $ 26,579
============ =============
Goodwill:
Cost $ 15,529 $ 15,529
Less: accumulated amortization 2,391 3,942
------------ -------------
$ 13,138 $ 11,587
============ =============
Deferred network costs:
Cost $ 9,502 $ 9,502
Less accumulated amortization 1,335 3,563
------------ -------------
$ 8,167 $ 5,939
============ =============
</TABLE>
Amortization expense in 1997 for Tradename, Goodwill and Deferred Network
Costs was $3,455, $1,551 and $1,335 respectively. Amortization expense
during 1998 for Tradename, Goodwill and Deferred Network Costs was $3,667,
$1,551 and $2,228 respectively.
8. NOTES PAYABLE
Notes payable consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
------------- -------------
<S> <C> <C>
Loan from Banco Inbursa $ 10,000 $ 0
------------- -------------
Notes payable to related parties $ 10,000 $ 0
============= =============
Loan from corporate lender $ 2,000 $ 2,000
============= =============
</TABLE>
In June 1996, the Company entered into a loan agreement with Banco Inbursa
("Inbursa"), an affiliate of Carso Global Telecom, whereby Inbursa agreed
to provide a credit facility to the Company of up to $50,000 with an
original maturity date in June 1997, at an interest rate of prime plus
1/2%. Borrowings under this credit facility are collateralized by a pledge
of 4,250,000 shares of the Company's common stock of which 1,750,000 shares
were pledged by Carso Global Telecom and 2,500,000 shares are pledged by
the stockholder. As a result of an extension of the credit facility from
Inbursa, the maturity date for outstanding borrowings of $10,000 was
extended from June 17, 1997 to December 31, 1999. The Stockholder had
agreed to continue to make available for pledge, until June 13, 1998,
2,500,000 shares of common stock to secure a new line of credit from a U.S.
bank or other debt financing to replace or extend the line of credit from
Inbursa. During 1998, all loans were repaid and stock pledges terminated.
61
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
Pursuant to an amendment to the Company's original Funding Agreement
effective March 18, 1997, the Company exercised a Put option to issue
common stock to the Stockholder for $15,000 and to Carso Global Telecom for
$65,000, of which $40,000 was used to partially repay the $50,000 loan from
Inbursa. The remaining Put of $45,000 was allocated $39,000 to Carso Global
Telecom and $6,000 to the Stockholder. The aggregate proceeds of $80,000
from the exercise of the Put, as well as proceeds from subsequent Put
exercises of $9,000, were raised through the issuance of 7,416,667 shares
of common stock at $12.00 per share. All amounts available under the Put
have been exercised.
In October 1997, Carso Global Telecom and the Stockholder arranged interim
financing for the Company. Carso Global Telecom agreed to (i) establish a
$4,000 letter of credit required as part of the revised Contingent
Convertible Notes and Warrants (see Note 9-Contingent Convertible Notes and
Warrants), (ii) arrange for Inbursa to lend $13,750 to the Company, of
which $3,750 is secured by the Stockholder's pledge of 1,875,000 shares of
common stock, and (iii) indicate its intention to purchase, under a rights
offering, its maximum allocation of 12,385,955 shares of common stock. In
payment for its 12,385,955 shares, Carso Global Telecom will (i) be
credited with $4,000 for the issuance of the $4,000 letter of credit, (ii)
pay $13,750 directly to Inbursa on the Company's behalf, and (iii) pay to
the Company the remainder of the purchase price of $31,794 less any other
funds advanced to the Company prior to the closing of the rights offering.
Subsequent to the issuance of the $4,000 letter of credit, on a quarterly
basis, Carso Global Telecom will contribute $333, less any draws on the
letter of credit, until the $4,000 has been paid to the Company. The
Stockholder agreed to (i) lend the Company up to $2,250 without interest,
(ii) pledge 1,875,000 shares of common stock to secure advances of $3,750
from Inbursa until the earlier of the closing of the rights offering (see
Note 11 - Stockholders' Equity) or December 15, 1997, and (iii) convert its
advances to the Company into common stock upon the closing of the rights
offering. As of December 31, 1997, interim financing of $27,100 had been
re-paid in connection with the rights offering.
In March 1996, the Company borrowed $2,000 from a network company (the
"Corporate Lender") pursuant to an 8.25% convertible note. Principal and
interest were due on March 31, 1997. The note has not been formally
extended. The Corporate Lender had the right within 30 days after the
completion of a private placement and prior to March 31, 1997 to convert
the principal and interest into common stock at the price per share at
which the Company's common stock is issued in the private placement. (See
Note 16-Subsequent Events (Unaudited)).
In February 1998, the Company entered into an additional loan agreement
with Inbursa in the amount of $16,400, payable December 31, 1999 at an
interest rate of 9%. In July 1998, a further $5,700 was borrowed from
Inbursa, payable December 31, 1999 at an interest rate of
62
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
9%. Also in July 1998, the Company borrowed $30,000 from Bank of America
National Trust and Savings Association ("Bank of America"), payable on
August 14, 1998 at an interest rate of approximately 6.5%. This loan was
guaranteed by Carso Global Telecom. The proceeds from this loan were used
to pay down the Inbursa notes payable. During 1998, the Bank of America
loan was repaid in full.
In August 1998, the Company secured a $35,600 line of credit commitment
from Carso Global Telecom. This credit facility expires on December 31,
1999 and bears interest at the LIBOR rate plus between one and five
percentage points (as negotiated on a case-by-case basis).
9. CONTINGENT CONVERTIBLE NOTES AND WARRANTS
The Contingent Convertible Notes ("Contingent Notes") issued in connection
with the acquisition of PSC (see Note 4 - Acquisitions), would have accrued
interest at a rate of 8% annually commencing on December 17, 1997.
The Contingent Notes were automatically convertible into shares
constituting 15% of the Company's then outstanding common stock on a fully
diluted basis, limited to the number of shares equal to a value of $200,000
plus contingent interest, upon the earlier of (i) an initial public
offering by the Company resulting in gross proceeds of at least $25,000,
(ii) an acquisition of the Company, (iii) following an initial public
offering with gross proceeds of less than $25,000, the first date on which
the Company's market value exceeds $200,000, or (iv) June 17, 2006. In lieu
of conversion upon an initial public offering or June 17, 2006, the Company
had the option, but under no circumstances the obligation, to redeem the
Contingent Notes. The Contingent Notes were non-voting and the holders had
no redemption rights.
In November 1997, IBM and Sears exchanged the Contingent Notes for (i)
contingent notes in the face amount of $200,000 and (ii) contingent
warrants to acquire up to 15% of the Company. Subject to a maximum
aggregate value of $200,000, plus contingent interest, the contingent notes
are automatically convertible into shares constituting 15% of the value of
the Company's common stock in excess of a market value of $250,000, upon
the earlier of (i) an initial public offering by the Company resulting in
gross proceeds of at least $25,000, (ii) an acquisition of the Company,
(iii) following an initial public offering with gross proceeds of less than
$25,000, the first date on which the Company's market value exceeds
$200,000, or (iv) June 17, 2006. In lieu of conversion upon an initial
public offering or June 17, 2006, the Company had the option, but under no
circumstances the obligation, to redeem the Contingent Notes. The warrants
allow IBM and Sears to purchase up to 15% of the Company at 130% of the
fair market value at the date of conversion of the contingent notes. The
63
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
warrants are exercisable at any time prior to the third anniversary of the
conversion of the contingent notes. As a condition to these arrangements,
Carso Global Telecom prepaid (as an advance to the Company) the balance due
on the White Plains lease of $5,831. Carso Global Telecom also established
a $4,000 letter of credit, declining quarterly over three years, to secure
other payment obligations of the Company under contracts for which IBM and
Sears retained liability. After conversion of the contingent notes or
exercise of the contingent warrants, IBM and Sears have agreed to vote
their shares of common stock in accordance with the voting recommendations
of the Company's Board of Directors. The contingent notes are non-voting
and the holders have no redemption rights. (See Note 16 - Subsequent Events
(UNAUDITED))
10. INCOME TAXES
The Company had no income tax expense for the years ended December 31, 1997
and 1998 as a result of net losses. As of December 31, 1997 and 1998, the
Company's deferred tax assets were as follows:
<TABLE>
<CAPTION>
1997 1998
------------- -------------
<S> <C> <C>
Domestic net operating loss carryforwards $ 46,000 $ 84,991
Foreign net operating loss carryforwards 8,840 -
Intangible assets 4,698 6,382
Restructuring and other nonrecurring reserves 5,357 3,838
Other 4,045 979
Valuation allowance (68,940) (96,190)
------------- -------------
Net deferred tax asset $ - $ -
============= =============
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $207,000 which may be used to
offset future taxable income, beginning to expire in 2010. The utilization
of the federal income tax loss carryforwards is subject to limitation as a
result of a change of ownership.
Management of the Company has evaluated the positive and negative evidence
bearing upon the realizability of its deferred tax assets, which are
comprised principally of net operating loss carryforwards. Under the
applicable accounting standards, management has considered the Company's
history of losses and concluded that it is more likely than not that the
Company will not realize these favorable tax attributes. Accordingly, the
deferred tax assets
64
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
have been fully reserved. Management revaluates the positive and negative
evidence periodically.
11. STOCKHOLDERS' EQUITY
AUTHORIZED SHARES OF COMMON STOCK
In 1997, the Board of Directors and the stockholders approved an increase
in the authorized shares of common stock to 280,000,000 shares.
PRIVATE PLACEMENT
In October 1996, the Company offered up to 2,000,000 shares of its common
stock in a private placement, resulting in net proceeds to the Company from
investors (other than Carso Global Telecom and the Stockholder) of
approximately $1,843. In February 1997, the Company increased the size of
the offering from 2,000,000 shares to 4,000,000 shares of common stock and
reduced the offering price to $12.00 per share from $28.00 per share. As a
result of the reduction in the offering price, the Company offered to each
investor the choice of either (i) receiving additional shares to reduce
their average purchase price to $12.00 or (ii) rescinding their
subscriptions and receiving refunds without interest upon the closing. The
Company received aggregate gross proceeds of $88,843 and issued 7,403,603
shares of common stock.
In November 1997, the Company made a Rights Offering whereby each eligible
stockholder was entitled to purchase at a price of $4.00 per share, one
share of the Company's common stock for each share held. The Company issued
12,640,478 additional shares and received $46,554 in cash and a $4,000 note
receivable from Carso Global Telecom for the issuance of the IBM/Sears
letter of credit (see Note 9 - Contingent Convertible Notes and Warrants).
On a quarterly basis, Carso Global Telecom will contribute $333 less any
draws on the letter of credit until the $4,000 has been paid to the
Company.
In August 1998, the Company sold 6,125,000 shares of common stock at a
price of $8.00 per share to Telefonos de Mexico, S.A. de C.V. ("Telmex"),
an affiliate of Carso Global Telecom, resulting in proceeds of $49,000 to
the Company. At the same time Carso Global Telecom purchased an additional
1,375,000 shares of common stock at a price of $8.00 per share, resulting
in proceeds of $11,000 to the Company. These proceeds were used to repay
the $30,000 note payable to Bank of America and a remaining $2,100 in notes
payable to Inbursa, with the balance to be used for general corporate
purposes.
65
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
12. STOCK OPTIONS AND WARRANTS
In 1996, the Board of Directors and the stockholders approved a Stock
Option Plan (the "Plan"). Under the Plan, options to purchase up to
2,375,000 shares of common stock may be granted to employees, directors,
consultants and advisors of the Company. Options granted may be either
"incentive stock options" or "nonqualified options." All options issued
under the Plan are exercisable over periods determined by the Board of
Directors, not to exceed 10 years from the date of grant. Options generally
vest over periods ranging from 3-5 years. In September 1997, the Board of
Directors and the stockholders approved an increase of 750,000 to the
number of shares of common stock available for future grants. These options
have the same terms and conditions as the shares initially authorized under
the 1996 Plan.
Stock option plan activity for the years ended December 31, 1996, 1997 and
1998 follows (in thousands):
<TABLE>
<CAPTION>
1996 1997 1998
----------- --------- -----------
<S> <C> <C> <C>
Outstanding at January 1 1,197 2,286 2,299
Options granted 1,703 828 1,441
Options exercised (3)
Options canceled (614) (815) (1,367)
----------- --------- ---------
Outstanding at December 31 2,286 2,299 2,370
=========== ========= =========
Exercisable at December 31 469 867 691
=========== ========= =========
Available for grant at December 31 89 825 752
=========== ========= =========
</TABLE>
Weighted average option exercise price information for the years ended
December 31, 1996, 1997 and 1998 follows:
<TABLE>
<CAPTION>
1996 1997 1998
--------- ------------ -------------
<S> <C> <C> <C>
Outstanding at January 1 8.60 $ 12.48 $ 10.72
Options granted 12.00 $ 10.04 $ 5.84
Options exercised 0 0 11.46
Options canceled 10.92 $ 9.32 $ 10.64
Outstanding at December 31 12.48 $ 10.72 $ 5.83
========= ============ =============
Exercisable at December 31 7.88 $ 10.96 $ 6.87
========= ============ =============
</TABLE>
66
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------------------------- -------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES (IN THOUSANDS) LIFE PRICE (IN THOUSANDS) PRICE
--------------- ------------- ----------- ---------- --------------- ------------
<S> <C> <C> <C> <C> <C>
$1.00 6 6.2 years $1.00 6 $1.00
$4.00 1,509 8.6 years $4.00 388 $4.00
$8.00 552 9.0 years $8.00 52 $8.00
$8.60 31 10.0 years $8.60 0 $0.00
$10.00 83 5.0 years $10.00 83 $10.00
$12.00 189 6.6 years $12.00 162 $12.00
------------- --------- ---------- ------------- -----------
$1.00 to 12.00 2,370 8.4 years $5.83 691 $6.87
============== ============= ========= ========== ============= ===========
</TABLE>
Had compensation cost for the Company been determined based upon the fair
value at the grant date for awards under the plan consistent with the
methodology prescribed under SFAS No. 123, the Company's net losses for the
years ended December 31, 1996, 1997, and 1998 would have been approximately
$93,207, $136,921 and $65,872, respectively, and basic and diluted net loss
per share would have been approximately $9.0, $7.9 and $1.62,
respectively. The effects of this pro forma disclosure are not indicative
of future amounts. Additional awards are anticipated in future years. The
weighted average fair value of the options granted during the years ended
December 31, 1996, 1997, and 1998 was estimated at $6.76, $1.12, and
4.15 per share, respectively, on the date of grant using the Black-Scholes
option-pricing model. The following assumptions were used for 1996 and 1997
no dividend yield, volatility of 55% for, risk-free rate of 6.16% for 1996
and 5.99% for 1997, and an expected option life of 4.6 years from date of
vesting. The following assumptions were used for 1998: no dividend yield,
volatility of 60%, risk free rate of 5.4% and expected option life of
approximately 3 years from the date vesting.
In determining the fair value of the common stock at the date of grant
under the Plan, the Board considered a broad range of factors including the
liquid nature of an investment in the Company's common stock, transactions
in the Company's common stock, the Company's historical financial
performance relative to that of comparable companies and its future
prospects.
REPRICING OF STOCK OPTIONS
In June 1997, the Board approved a repricing plan to reprice employee stock
options under the Plan to restore the long-term employee retention and
performance incentives of the stock options outstanding. In accordance with
the repricing plan, all stock options held by current, active full-time
employees, with exercise prices above $12.00 per share, were canceled and
replaced by the same number of options exercisable at $12.00 per share, the
fair value of the Company's common stock as determined by the Board on the
date of the repricing.
67
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
In May 1998, the Board approved a repricing plan to reprice employee stock
options under the Plan to restore the long-term employee retention and
performance incentives of the stock options outstanding. In accordance with
the repricing plan, all stock options held by current, active full-time
employees, with exercise prices above $4.00 per share, were canceled and
replaced by the same number of options exercisable at $4.00 per share. The
Company records compensation expense for these repriced options over the
vesting periods based upon a fair value of $7.00 per share. The deferred
compensation expense amounted to $3,123 at December 31, 1998.
The exercise and vesting periods of the outstanding options were not
altered by the repricings.
In making the determinations of the fair value of the Company's common
stock, the Board considered a broad range of factors including the illiquid
nature of an investment in the Company's common stock, transactions of the
Company's common stock, the Company's historical financial performance
relative to that of comparable companies and its future prospects.
STOCK WARRANTS
In October 1996, the Stockholder exercised his warrant to purchase 67,500
shares of common stock at a price of $12.00 per share, less a discount
resulting in proceeds of $792 to the Company. The discount was approved by
the Company's Board of Directors and was agreed upon to reflect the fact
that the Stockholder exercised the warrant prior to its expiration date of
December 31, 1996. In December 1996, Carso Global Telecom exercised its
warrant to purchase 675,000 shares of common stock at a price of $12.00 per
share, resulting in proceeds of $8,100 to the Company. These warrants were
granted in consideration of the commitments described in the Funding
Agreement (see Note 4-Acquisition of Prodigy Services).
The warrant to purchase 250,000 shares issued to Carso Global Telecom in
1996 was canceled in March 1997, at which time the Company granted Carso
Global Telecom and the Stockholder warrants to purchase 3,250,000 shares
and 500,000 shares, respectively, of common stock for $12.00 per share,
exercisable prior to or on November 12, 1997. In October 1997, in
consideration of the interim financing (see Note 8-Notes Payable), the
exercise price was reduced from $12.00 per share to $4.00 per share.
At December 31, 1997, the Company had warrants outstanding with various
shareholders, including Carso Global Telecom, to purchase 3,859,347 shares
of the Company's common stock at an average price of $4.20 per share. At
December 31, 1998, the Company had warrants outstanding with various
shareholders to purchase 489,609 shares of the Company's common stock at an
average price of $2.77 per share. All the outstanding warrants are
exercisable as of December 31, 1998.
68
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
In April 1998, 3,250,000 warrants were exercised at $4.00 per share. In May
1998, 500,000 warrants were exercised at $4.00 per share.
13. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
At December 31, 1997, the Company's minimum rental commitments under
noncancelable operating leases with initial or remaining terms of more than
one year were as follows:
Year ended December 31,
1999 $ 3,154
2000 3,347
2001 2,707
2002 2,609
2003 and thereafter 5,218
-----------
$ 17,035
===========
The Company's rent expense in the years ended December 31, 1996, 1997, and
1998 was approximately $5,800, $9,192 and $2,302, respectively.
In December 1993, PSC entered into a noncancelable agreement with a
telephone company to provide certain services at the Company's White
Plains, NY and Yorktown, NY facilities. The agreement has a term ("service
period") of ten years. The agreement calls for line charges totaling $510
per year. The Company has the right to terminate the agreement for certain
services at any time at a cost of 80% of the line charges over the
remaining services period.
The Company is party to a contract for a subscription management system
through June 2001. This contract requires minimum annual payment of
processing fees of $900. For the years ended 1996, 1997 and 1998, the
Company paid $5,055, $3,628 and $3,039, respectively.
The Company is party to a number of other agreements with information
providers which require payment of fees based upon the number of
subscribers or subscriber usage of providers' data.
Under the Company's four-year agreement with Splitrock, the Company is
obligated to minimum annual payments of $45,000 in 1999, $51,000 in 2000
and $27,000 in 2001 and maximum monthly charges based on the number of the
Company's subscribers for the month. The agreement provides for early
69
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
termination charges of $7,000 in the first year, declining thereafter of an
annual basis. The agreement is automatically successive 12-month periods
unless terminated by either party upon 12-months notice.
In September 1997, the Company entered into a 22-month agreement with a
vendor to provide network licensing and technical support. This agreement
requires an annual payment of $429 in 1999. Upon 30-day prior written
notice, the Company can terminate the agreement without penalty. The
agreement can be extended for an additional 12 months.
As of December 31, 1997, the Company was contractually obligated to pay IBM
a network termination penalty of $7,500 resulting from the sale of the
Company's network. The Company has negotiated with IBM to settle this
liability through a defined purchasing plan, whereby the Company will be
obliged to purchase services from IBM through December 31, 2000, up to
$7,500 in value, with any shortfall being paid as a penalty. The Company
has accrued $3,600 as of December 31, 1997, representing management's best
estimate of the amount of the purchase commitment that will not be used as
of December 31, 2000. This amount is included in the Company's accrued
network termination cost (see Note 3-Restructuring and Other Special
Costs).
The Company has accrued an additional $3,115 as of December 31, 1998,
representing management's change in estimate relating to the anticipated
unfullfilled purchase commitment to IBM. This amount is included in the
Company's other accrued expenses.
In February 1998 the Company contracted with a vendor to provide various
data communications services. The contract has a term of 36 months and
requires minimum annual payments to the vendor of $7,300. If the minimum
annual payment is not reached, the Company is subject to an
underutilization charge equal to 50% of the difference between the minimum
annual payment and the actual usage. The Company can terminate the
agreement upon written notice to the vendor and the payment of a penalty
equal to 50% of the minimum annual payment due for the remaining term.
In May 1998 the Company contracted with a vendor to provide customer
service and technical support to its members. The contract is for 12 months
expiring April 1999. In March 1999 the Company extended this contract for
an additional 12 months through April 2000. The agreement requires minimum
monthly payments to the vendor of $100,000.
CONTINGENCIES
In June 1998, Lycos, Inc. ("Lycos") filed a complaint and motion for
preliminary injunction in the Superior Court of Middlesex County,
Massachusetts against the Company. The lawsuit alleges, among other things,
that the Company breached a license agreement with Lycos by entering into a
portal outsourcing agreement with Excite in January 1998 and by terminating
the license agreement between Lycos and the Company. The lawsuit seeks
specific performance of the license agreement between Lycos and the
Company, a preliminary and permanent injunction enjoining the Company from
terminating the license agreement between Lycos and the Company and from
performing under its agreement with Excite, money damages and attorneys'
fees. A hearing on Lycos' motion for preliminary injunction has been
adjourned because the parties are in negotiations to settle the lawsuit.
However, there can be no assurance the lawsuit will be settled. If the
lawsuit is not settled, the Company intends to defend it vigorously. It is
not currently possible to estimate the effect of an unfavorable outcome to
this lawsuit; however, it is possible that such an outcome could have a
material adverse impact on the Company's operations. See the third
paragraph of Note 16 for subsequent event.
70
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(in thousands except share and per share amounts)
14. DEFINED CONTRIBUTION PLAN
On June 17, 1996, as part of the Company's acquisition of PSC (see Note 4 -
Acquisitions), the Company took on responsibility for the administration
and sponsorship of the Prodigy Services Corporation Capital Accumulation
Plan (the "Plan").
The Plan is a defined contribution plan covering all employees of the
Company. Employees can participate in the Plan from their first day of
employment.
Each year, active participants may contribute up to 12 percent of their
pre-tax base salaries, up to the maximum amount allowed by the Plan. The
Company contributes a matching contribution equal to 100 percent of an
employee's pre-tax contributions, limited to a maximum of 3 percent of a
participant's compensation. The Plan also has an after-tax savings feature
that permits employees to contribute from 1 percent to 10 percent of their
base salaries subject to Internal Revenue Code limitations.
The Company's contributions were $596 and $469 in 1997 and 1998,
respectively.
15. VALUATION AND QUALIFYING ACCOUNTS
The following table sets forth activity in the Company's reserve accounts:
<TABLE>
<CAPTION>
ACCOUNTS RECEIVABLE
BALANCE AT BALANCE AT
BEGINNING CHARGES TO END OF
OF PERIOD OPERATIONS DEDUCTIONS PERIOD
------------ ------------- ------------- -----------
<S> <C> <C> <C> <C>
Year ended:
December 31, 1996 $ $ 4,002 $ 3,072 $ 930
December 31, 1997 930 4,749 4,994 685
December 31, 1998 685 2,585 2,903 367
</TABLE>
16. SUBSEQUENT EVENTS (UNAUDITED)
Telmex Agreement
Telmex is the largest ISP in Mexico and had approximately 110,000 billable
subscribers to its Internet Directory Personal ("IDP") online service at
December 31, 1998. Telmex has advised the Company that IDP subscribers
currently generate average monthly revenue of approximately 200 pesos per
subscriber (approximately $20 per subscriber based on the current
peso/dollar exchange rate). On January 25, 1999, Prodigy and Telmex
executed an agreement under which: (i) Prodigy will assist Telmex in the
negotiation of agreements with service providers for Telmex's IDP service
in Mexico pertaining to network/Internet access, Web hosting, customer
service, content hosting, billing, marketing, sales and data collection
services; (ii) Prodigy will advise Telmex on customer service,
administrative functions and technical operations, including marketing,
Internet connection and other network services, content, customer support,
pricing and service composition, billing and collection, inbound
telemarketing and other aspects of the ISP business; (iii) the parties will
discuss the potential migration of certain IDP infrastructure functions,
including email, subscriber management and authentication systems, for
Telmex's IDP subscribers to the Prodigy infrastructure platform, and the
advisability of offering a co-branded IDP/Prodigy service in Mexico; and
(iv) the parties will pursue additional opportunities, such as providing
services to one another and the joint acquisitions of subscribers. In
exchange for Prodigy's services, Telmex will pay Prodigy a management fee,
on a monthly basis, equal to 15% of the net subscriber revenue (defined as
the invoiced sales price less discounts, excise taxes and credits for
returns) on the first 200,000 IDP subscribers and 10% of the net subscriber
revenue (as defined above) on additional IDP subscribers. The agreement has
a term of five years and may be terminated by Telmex if Prodigy undergoes a
change of control.
In January 1999, the Company paid the Corporate Lender (see Note 8 - Notes
Payable) $750 in full settlement of its 8 1/4% convertible note in the
principal amount of $2,000.
In January 1999, the Company settled its dispute with Lycos (see Note
13 - Commitments and Contingencies) at no net cost to the Company.
Reverse Stock Split
On January 25, 1999 the Board effected a one-for-four reverse common stock
split. The share information in the accompanying consolidated financial
statements has been retroactively restated to reflect the effect of the
reverse stock split.
Reduction in Authorized Shares
On January 25, 1999 the Company effected a reduction in the number of
authorized shares from 280,000,000 to 150,000,000.
Initial Public Offering
On February 11, 1999, the Company completed on initial public offering
("IPO") under the Securities Act of 1933 ("The Act"). This resulted in the
sale of 11.2 million shares of common stock for approximately $168 million
and net proceeds of approximately $158.7 million.
IBM and Sears Conversion of Contingent Notes
Upon the completion of the Company's offering under the Act both IBM and
Sears acquired 7.5% of the Company's outstanding common stock in accordance
with the Contingent Notes Conversion feature (see Note 9-Contingent and
Convertible Notes and Warrants). IBM and Sears each received approximately
2,127,500 shares for a combined total of approximately 4,255,000 or 15% of
the Company.
Additionally, IBM and Sears each received warrants which allow them to
purchase up to 15% of the Company at 130% of the fair market value at the
date of conversion of the Contingent Notes. Those warrants are exercisable
for three years from the conversion date. IBM and Sears each received
approximately 2,409,000 of warrants or approximately 4,818,000 in total.
71
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
72
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company, their respective ages and
their positions with the Company are as follows:
<TABLE>
<CAPTION>
NAME Age POSITION
- - --------------------------- --- -----------------------------------------------------------------------
<S> <C> <C>
Samer F. Salameh........... 34 Chairman of the Board and Chief Executive Officer
Alfredo Sanchez............ 43 Vice Chairman of the Board
David C. Trachtenberg...... 36 President and Chief Operating Officer
David R. Henkel............ 47 Executive Vice President, Finance, Chief Financial Officer and Director
Andrea S. Hirsch........... 41 Executive Vice President, Business Development and General Counsel
James P. Dougherty......... 42 Executive Vice President, Business Services
Arturo Elias(1)............ 32 Director
James M. Nakfoor(1)........ 35 Director
Russell I. Pillar.......... 33 Director
</TABLE>
_____________
(1) Member of the Compensation Committee
Mr. Salameh has served as Chief Executive Officer and a director of the
Company since September 1997, as Chairman of the Board since August 1998, and
served as President from September 1997 to December 1998. From July 1994 until
joining the Company, Mr. Salameh served as Director, Long Distance Division of
SBC Communications (formerly Southwestern Bell), responsible for marketing,
strategy, positioning, product management and product development with respect
to Telmex. Mr. Salameh was employed by MCI Telecommunications as a Product
Manager in 1994 and as a Strategic Marketing Manager from 1991 to 1993. During
1993, Mr. Salameh was employed as Vice President of Finance by Merl Industries,
a start-up management consulting firm. Mr. Salameh holds a Master's degree from
the Fletcher School of Law and Diplomacy, a B.S. degree in Management and
Technology Transfer from Polytechnic University of New York and a Baccalaureate
degree with a concentration in Math and Physics from Lycee Fenelon in Paris. He
is also a director of Splitrock and serves as an Advisor to the Chief Executive
Officer of Telmex. See "Certain Factors That May Affect Future Operating
Results--Control of the Company and Potential Conflicts of Interest" under Item
7 below and "Item 1. Business--Principal Outsourcing Arrangements".
Mr. Sanchez joined the Company's Board of Directors in June 1996 and became
Vice Chairman in August 1998. Mr. Sanchez has served as President of Uninet,
S.A. de C.V., a wholly-owned subsidiary of Telmex through which Telmex provides
data transmission services and Internet access to customers, since January 1996.
He has also served as President of Consorcio Red Uno, S.A. de C.V., a network
company founded by Mr. Sanchez and now owned by Telmex, since March 1991. See
"Certain Factors That May Affect Future Operating Results--Control of the
Company and Potential Conflicts of Interest". From 1985 to March 1991, he was
President of Onyx Systems, a Unix microcomputer manufacturer with operations in
the United States, Europe and Mexico. Mr. Sanchez previously held various
communications and transportation positions in the Mexican government. Mr.
Sanchez holds a degree in Electronics Engineering from the Metropolitan
Autonomous University of Mexico.
73
<PAGE>
Mr. Trachtenberg joined the Company as President and Chief Operating
Officer in December 1998. Prior to joining the Company, Mr. Trachtenberg was
employed for more than eight years by MCI Communications Corporation and then
MCI WorldCom, Inc. From September 1997 to December 1998, Mr. Trachtenberg was
Executive Director of Online Marketing, responsible for residential and small
business Internet operations, and from January 1997 to September 1997, he served
as Executive Director of Brand Marketing, responsible for the MCI One brand
portfolio, including domestic and international long distance products, calling
card services and advanced services for the consumer and small business
segments. Between March 1990 and January 1997, he held various other marketing
and business development positions, including director of Customer Marketing and
director of International Marketing. Prior to joining MCI, Mr. Trachtenberg was
employed for four years by Bain & Company, an international consulting firm. Mr.
Trachtenberg received a B.A. degree, summa cum laude, from Tufts University, and
received an MBA degree from the Wharton School of Business at the University of
Pennsylvania, where he also received a Masters in International Affairs and was
a Fellow at the Lauder Institute.
Mr. Henkel joined Prodigy in August 1998 as Executive Vice President,
Finance, Chief Financial Officer and a director. In 1997, Mr. Henkel founded AFX
TraTech, Inc., a wireless data company, and served as its Chief Financial
Officer until joining Prodigy. From 1993 to 1997, Mr. Henkel served in a number
of positions with 7th Level, Inc., a developer of interactive games and
educational products, including Chief Operating Officer from 1995 to 1997 and
Chief Financial Officer from 1994 to 1995. In 1993, Mr. Henkel served as Chief
Financial Officer of Value Added Communications Corporation, a
telecommunications reseller, from 1991 to 1993 he served as Chief Financial
Officer and a director of Micrografx, Inc., a software company, and from 1987 to
1991 he was a partner with Arthur Andersen LLP. Mr. Henkel holds a B.A. degree
from Rice University and an M.B.A. degree from Harvard Business School.
Ms. Hirsch joined Prodigy in September 1998 as Executive Vice President,
Business Development and General Counsel. Prior to joining the Company, Ms.
Hirsch served as Vice President, Corporate Development Counsel for Simon &
Schuster, Inc., a publishing company, from March 1994 to September 1998, and as
Assistant General Counsel for Macmillan, Inc., a publishing company, from June
1991 to January 1994. Ms. Hirsch holds a B.A. degree from Queens College and a
J.D. degree from Washington College of Law at American University.
Mr. Dougherty joined Prodigy's former software development division as
Senior Vice President of Marketing and Sales in November 1997, became its Chief
Operating Officer in April 1998 and became its Chief Executive Officer in May
1998. He became the Company's Executive Vice President, Business Services in
August 1998. From May 1996 through September 1997, Mr. Dougherty worked for and
consulted with a number of Internet startup companies. From November 1987
through May 1996, Mr. Dougherty held various executive positions at Lotus
Development Corporation, including general manager of the Electronic
Applications division, which built and marketed Internet applications to global
businesses, and director in the technology consulting practice. Mr. Dougherty
holds a B.A. degree from Framingham State College, a graduate degree
(Certificate of Special Studies) from Harvard University in finance and
administration and a Master's degree from Columbia University in international
economics.
Mr. Elias joined the Company's Board of Directors in September 1997. He
served as Consulting Advisor to the President of Telmex from September 1996 to
May 1998 and has since served as Head of Commercial New Technologies and
Regulation for Telmex. Since 1994, he has also been a private investor in
Mexican real estate, textile and retail businesses. Mr. Elias is also a director
of Carso Global Telecom, Telmex, Sears Roebuck de Mexico and several privately-
held companies. See "Certain Factors That May Affect Future Operating Results--
Control of the Company and Potential Conflicts of Interest" under Item 7 below.
Mr. Elias studied Business Administration at Anahuac University and received a
Master in Business Management degree from the Instituto Panamericano de Alta
Direccion de Empresa (IPADE).
Mr. Nakfoor joined the Company's Board of Directors in September 1997.
Since 1991, Mr. Nakfoor has served as Vice President of Securities Trading for
Inversora Bursatil, S.A. de C.V., a wholly-owned subsidiary of Grupo Financiero
Inbursa, S.A. de C.V. ("Grupo Financiero"), which is engaged in the securities
brokerage, investment banking and money management businesses in Mexico. Grupo
Financiero, which is affiliated with Carso Global Telecom, is a Mexican
financial group whose businesses include banking, brokerage, insurance, leasing,
74
<PAGE>
factoring and other financial services. See "Certain Factors That May Affect
Future Operating Results--Control of the Company and Potential Conflicts of
Interest" under Item 7 below. Mr. Nakfoor holds a B.A. degree in Economics and
an M.B.A. degree from the University of Texas at Austin.
Mr. Pillar joined the Company's Board of Directors in October 1996 and
served as President and Chief Executive Officer of the Company's Prodigy
Internet division from September 1997 until August 1998. In November 1998, Mr.
Pillar was appointed President and Chief Executive Officer of Virgin
Entertainment Group, Inc., a subsidiary of Britain's Virgin Group that operates
the Virgin Megastores chain of retail music stores throughout North America.
Since October 1991, he also has served as Managing Partner of Critical Mass, a
company that creates new software solution-based businesses seeking to
capitalize on the migration of communications traffic from circuit-switched to
packet-switched networks. From December 1993 through October 1996, he served as
President, Chief Executive Officer and a director of Precision Systems, Inc., a
publicly traded international telecommunications software provider. Mr. Pillar
is also a director of Telescan, Inc., which develops, markets and operates
online networks and Internet sites. He graduated Phi Beta Kappa, cum laude, with
an A.B. degree in East Asian Studies from Brown University.
Officers of the Company serve at the discretion of the Board of Directors
and hold office until their successors are duly elected and qualified or until
their earlier resignation or removal.
Mr. Pillar qualifies as an "independent" director under Nasdaq rules. The
Company intends to appoint one additional independent director on or before May
12, 1999.
Mr. Carlos Slim Helu, a Mexican citizen, and certain members of his
immediate family, beneficially own a majority of the outstanding voting equity
securities of Carso Global Telecom. Carso Global Telecom may be deemed to
control Telmex through the regular-voting shares of Telmex that it owns directly
and its interest in a trust which owns a majority of Telmex's outstanding
regular-voting shares. Thus, Mr. Slim and members of his immediate family may be
deemed to control Carso Global Telecom, Telmex and the Company. Mr. Salameh is
married to Mr. Slim's niece and Mr. Elias is married to Mr. Slim's daughter.
There are no other family relationships among the Company's directors, executive
officers and principal stockholders and their affiliates. See "Certain Factors
That May Affect Future Operating Results--Control of the Company and Potential
Conflicts of Interest" under Item 7 above and "Item 12. Security Ownership of
Certain Beneficial Owners and Management."
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth the total compensation earned in the year
ended December 31, 1998 for the Company's Chief Executive Officer, its four
other most highly compensated executive officers in 1998 who were serving as
executive officers on December 31, 1998, one former executive officer who was
not serving as an executive officer on December 31, 1998 and the Company's other
current executive officers. Such current and former executive officers are
hereinafter referred to as the "Named Executive Officers". For additional
information concerning the terms of employment of the Named Executive Officers,
see "--Employment Agreements".
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.
Not applicable.
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SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION ------------
NAME AND PRINCIPAL POSITION ------------------------------------- SECURITIES
- - --------------------------- OTHER ANNUAL UNDERLYING ALL OTHER
SALARY BONUS COMPENSATION OPTIONS(1) COMPENSATION (2)
--------- -------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Current Executive Officers:
Samer F. Salameh.................................. $200,000 $ 15,000 $ 50,084(3) -- $6,000
Chairman and Chief Executive Officer
David C. Trachtenberg(4).......................... $ 11,056 -- -- 125,000 --
President and Chief Operating Officer
David R. Henkel(5)................................ $ 79,167 -- -- 187,500 $2,375
Executive Vice President, Finance and
Chief Financial Officer
Andrea S. Hirsch(6)............................... $ 56,878 $180,000 -- 93,750 --
Executive Vice President, Business
Development and General Counsel
James P. Dougherty................................ $171,138 $ 44,904 -- -- $4,404
Executive Vice President, Business Services
Former Executive Officers:
Inder S. Gopal(7)................................. $ 84,675 $ 33,870 $230,891(8) -- $2,540
Former President and General Manager of
Prodigy software and development division
James L'Heureux(9)................................ $190,000 $ 11,756 -- 43,750 --
Former Executive Vice President,
Consumer Services
Carena M. Pooth(10)............................... $181,250 $ 26,250 -- 68,750 $4,313
Former Executive Vice President, Technology
</TABLE>
_______________
(1) Represents the number of shares covered by options to purchase shares of
the Company's Common Stock granted during the year ended December 31, 1998.
The Company has never granted any stock appreciation rights.
(2) Represents Company matching contributions under its 401(k) plan.
(3) Represents housing and car allowances.
(4) Commenced employment with the Company in December 1998.
(5) Commenced employment with the Company in August 1998.
(6) Commenced employment with the Company in September 1998.
(7) Ceased employment with the Company during 1998.
(8) Represents severance payments.
(9) Ceased employment with the Company in January 1999.
(10) Ceased employment with the Company in February 1999.
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OPTION GRANTS DURING 1998
The following table sets forth grants of stock options to each of the Named
Executive Officers during the year ended December 31, 1998.
OPTION GRANTS IN FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM(2)
-------------------------------------------------- ---------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO EXERCISE
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION
NAME GRANTED FISCAL YEAR SHARE(1) DATE 5% 10%
- - ------------------------------ ------- ----------- -------- ---- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Current Executive Officers:
Samer F. Salameh.............. -- -- -- -- -- --
David C. Trachtenberg......... 93,750 6.51% $4.00 12/14/08 $938,296 $1,716,205
David C. Trachtenberg......... 31,250 2.17% $8.60 12/14/08 $169,015 $ 428,318
David R. Henkel............... 187,500 13.01% $8.00 8/3/08 $943,342 $2,390,614
Andrea S. Hirsch.............. 93,750 6.51% $8.00 11/16/08 $471,671 $1,195,307
James P. Dougherty............ -- -- -- -- -- --
Former Executive Officers:
Inder S. Gopal(3)............. -- -- -- -- -- --
James L'Heureux............... 43,750 3.04% $4.00 1/26/08 $323,849 $ 619,334
Carena M. Pooth............... 68,750 4.77% $4.00 1/26/08 $508,906 $ 973,239
</TABLE>
_______________
(1) Reflects a repricing in May 1998 of the options held by Ms. Pooth and Mr.
L'Heureux from $12.00 per share to $4.00 per share. In addition, options
granted to Messrs. Salameh, Dougherty and Gopal prior to 1998 were repriced
to $4.00 per share in May 1998.
(2) Amounts reported in these columns represent amounts that may be realized
upon exercise of the options immediately prior to the expiration of their
term assuming the specified compound rates of appreciation (5% and 10%) on
the market value of the Common Stock on the date of option grant over the
term of the options. These numbers are calculated based on rules promulgated
by the Securities and Exchange Commission and do not reflect the Company's
estimate of future stock price growth. Actual gains, if any, on stock option
exercises and Common Stock holdings are dependent on the timing of such
exercise and the future performance of the Common Stock. There can be no
assurance that the rates of appreciation assumed in this table can be
achieved or that the amounts reflected will be received by the individuals.
(3) Upon termination of Mr. Gopal's employment with the Company, all of his
options were cancelled.
YEAR-END OPTION VALUES
The following table sets forth certain information concerning the number
and value of unexercised options held by each of the Named Executive Officers on
December 31, 1998. No Named Executive Officer exercised a stock option during
1998.
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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END(1)
--------------------------------- --------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Current Executive Officers:
Samer F. Salameh............... 68,750(2) 87,500 $316,250 $402,500
David C. Trachtenberg.......... -- 125,000 -- $431,250
David R. Henkel................ -- 187,500 -- $112,500
Andrea S. Hirsch............... -- 93,750 -- $ 56,250
James P. Dougherty............. 43,750 50,000 $201,250 $230,000
Former Executive Officers:
Inder S. Gopal................. -- -- -- --
James L'Heureux................ 12,500 81,250 $ 57,500 $373,750
Carena M. Pooth................ 11,100 82,650 $ 51,060 $380,190
</TABLE>
______________________
(1) Represents the difference between the fair market value of the Common Stock
at fiscal year end as determined by the Board of Directors of the Company
($8.60 per share) and the option exercise price.
(2) Excludes 18,750 of Mr. Salameh's options which became exercisable upon the
closing of the IPO.
EMPLOYMENT AGREEMENTS
Current Executive Officers
Mr. Salameh is employed under an Employment Agreement that expires on
December 31, 2000 under which he currently receives an annual base salary of
$200,000. Mr. Salameh received a sign-on bonus of $90,000 and is eligible to
receive an annual performance bonus of up to 50% of his base salary, contingent
upon the successful completion of personal and corporate goals as mutually
established. Mr. Salameh is also eligible to participate in all of the Company's
fringe benefit programs. The Company has agreed to provide Mr. Salameh with a
monthly housing allowance of $4,000, a monthly car allowance of $1,050 and
monthly roundtrip airfare between New York and Mexico City. Mr. Salameh was also
entitled to certain accelerated vesting of stock options as a result of the
closing of the IPO. In the event the Company terminates Mr. Salameh's employment
other than for cause, or does not offer by November 1, 2000 to renew his
Employment Agreement for at least one year, Mr. Salameh will (with certain
exceptions) continue to receive his base salary and fringe benefits for a period
of 12 months and will receive a severance payment equal to one week's base
salary for each six months of completed service with the Company. If Mr. Salameh
is terminated for any reason, the Company is required to pay up to $40,000 of
Mr. Salameh's expenses to relocate out of the New York City area.
Mr. Trachtenberg is employed under an Employment Agreement that expires on
December 31, 2001 under which he currently receives an annual base salary of
$224,000. Mr. Trachtenberg received a sign-on bonus of $74,000 and is eligible
to receive an annual performance bonus of up to 50% of his base salary,
contingent upon the successful completion of personal and corporate goals as
mutually established. Mr. Trachtenberg is also eligible to participate in all of
the Company's fringe benefit programs. The Company has agreed to provide Mr.
Trachtenberg with a monthly car allowance of $2,166 and up to $5,000 to
terminate his current car lease. For the first six months of employment, the
Company has agreed to reimburse his reasonable temporary housing expenses and
weekly commuting expenses between New York and Washington, D.C., and thereafter
the Company will reimburse his relocation expenses and provide a monthly housing
allowance of $3,500. The Company has also agreed to reimburse Mr. Trachtenberg's
reasonable legal fees for review of his Employment Agreement. In the event the
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Company terminates Mr. Trachtenberg's employment other than for cause, he will
continue to receive his base salary for a length of time based on his length of
service and will receive certain accelerated vesting of options.
Mr. Henkel is employed pursuant to an Employment Agreement under which he
currently receives an annual base salary of $190,000. Mr. Henkel is eligible to
receive an annual performance bonus of up to 50% of his base salary, contingent
upon the successful completion of personal and corporate goals as mutually
established. The Company has agreed to provide Mr. Henkel with a monthly housing
allowance of $3,000, certain allowances for airfare between New York City and
Dallas for Mr. Henkel and members of his family for up to one year, and
relocation expenses of up to $3,000. Mr. Henkel is also eligible to participate
in all of the Company's fringe benefit programs. In the event the Company
terminates Mr. Henkel's employment other than for cause after his third month of
service with the Company, he will continue to receive his base salary for a
length of time based on his length of service. Mr. Henkel is also entitled to
certain accelerated vesting of stock options upon a change in control of the
Company.
Ms. Hirsch is employed under an Employment Agreement that expires on
September 13, 2001 and under which she currently receives an annual base salary
of $190,000. Prodigy paid Ms. Hirsch a sign-on bonus of $180,000. Ms. Hirsch is
eligible to receive an annual performance bonus of up to 50% of her base salary,
contingent upon the successful completion of personal and corporate goals as
mutually established. Ms. Hirsch is also eligible to participate in all of the
Company's fringe benefit programs. In the event the Company terminates Ms.
Hirsch's employment other than for cause after Ms. Hirsch's third month of
service with the Company, Ms. Hirsch will continue to receive her base salary
and fringe benefits for six months and will be entitled to certain accelerated
vesting of stock options. In the event that Prodigy has not offered to renew her
Employment Agreement prior to its expiration, Ms. Hirsch will continue to
receive her base salary and fringe benefits for six months and will be entitled
to receive a performance bonus for such six-month period.
Mr. Dougherty is employed under an Employment Agreement that expires on
November 24, 2001 and under which he currently receives an annual base salary of
$190,000. Mr. Dougherty received a sign-on bonus of $20,000 and is eligible to
receive an annual performance bonus of up to 50% of his base salary, contingent
upon the successful completion of personal and corporate goals as mutually
established. Mr. Dougherty is also eligible to participate in all of the
Company's fringe benefit programs. In the event the Company terminates Mr.
Dougherty's employment other than for cause, Mr. Dougherty will continue to
receive his base salary and fringe benefits for nine months if termination
occurs prior to November 24, 1999 (six months if termination occurs on or after
November 24, 1999).
Former Executive Officers
Mr. Gopal was employed under an Employment Agreement scheduled to expire on
September 1, 2000 providing for an initial annual base salary of $210,000
subject to annual review and increase, a sign-on bonus of $90,000, an annual
performance bonus of up to 30% of his base salary (with a guaranteed bonus of
$46,000 for 1996), customary fringe benefits and other customary provisions.
Effective May 15, 1998, Mr. Gopal resigned, and the Company agreed to pay him
severance consisting of continued salary and fringe benefits through May 15,
1999, which Mr. Gopal agreed to take in a lump sum payment on May 30, 1998. The
Company also agreed that 70,000 of Mr. Gopal's options would vest upon
termination of employment.
Mr. L'Heureux was employed under an Employment Agreement scheduled to
expire on May 31, 2000 providing for an annual base salary of $190,000 subject
to annual review and increase, a sign-on bonus of $40,000, an annual performance
bonus of up to 50% of his base salary, customary fringe benefits and other
customary provisions. Effective January 13, 1999, Mr. L'Heureux resigned, and
the Company agreed to pay him a performance bonus of $60,000 for 1998 and
severance consisting of a lump sum payment of $11,000 and continued salary and
fringe benefits for nine months. The Company also agreed that 27,083 of Mr.
L'Heureux's options would remain vested and exercisable through September 30,
1999.
Ms. Pooth was employed under an Employment Agreement scheduled to expire on
May 31, 2000 providing for an annual base salary of $190,000. Ms. Pooth was
eligible to receive an annual performance bonus of
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up to 50% of her base salary, contingent upon the successful completion of
personal and corporate goals as mutually established. Ms. Pooth was eligible to
participate in all of the Company's fringe benefit programs, and was entitled to
certain accelerated vesting of stock options upon a change in control of the
Company. Effective February 28, 1999, Ms. Pooth resigned from the Company, and
pursuant to her employment agreement, she is entitled to salary continuation for
nine months and all of her options accelerated and will remain exercisable
through December 31, 1999.
DIRECTOR COMPENSATION
All directors are reimbursed for their expenses in attending Board and
Committee meetings in accordance with the Company's expense reimbursement
policies. Directors who are also employees of the Company do not receive
additional compensation for serving as directors.
In January 1999, the Company's Board of Directors and stockholders adopted
the Company's 1999 Outside Director Stock Option Plan (the "Director Plan"). The
Director Plan permits the issuance of up to 250,000 shares of Common Stock upon
the exercise of options granted under the Director Plan. All options granted
under the Director Plan are non-statutory stock options. Pursuant to the
Director Plan, each director of the Company who was not then employed by the
Company (each, an "outside director") received upon the closing of the IPO an
option to purchase 30,000 shares of Common Stock at an exercise price equal to
the price per share at which shares are sold in the IPO ($15.00). Messrs.
Sanchez, Elias, Nakfoor and Pillar received such options upon the closing of the
IPO. Thereafter, each additional outside director will receive, upon his or her
initial election to the Board of Directors, an option to purchase 30,000 shares
of Common Stock at an exercise price equal to the fair market value of the
Common Stock on the date of grant. All options granted under the Director Option
Plan vest in four equal annual installments, based on continued service as a
director, and expire three months after termination of service as a director. In
the event of an acquisition of the Company, 50% of all then unvested options
will accelerate and become exercisable.
The Company entered into a one-year Consulting Agreement with Mr. Pillar on
July 31, 1998. Under his Consulting Agreement, Mr. Pillar received an annual
base fee of $250,000 and was eligible to receive either (i) a performance bonus
of $125,000 in the event that the Company closed an initial public offering or
(ii) a discretionary performance bonus payable in February 1999. Mr. Pillar's
consulting services were provided on a part-time basis and Mr. Pillar was
permitted to accept other employment (including full-time employment) during the
term of the Consulting Agreement. In January 1999, the Company and Mr. Pillar
terminated his Consulting Agreement and the Company paid Mr. Pillar a lump sum
of $252,000 in lieu of consulting fees and bonuses otherwise payable under the
Consulting Agreement. The Company is required to pay all reasonable relocation
expenses incurred by Mr. Pillar upon Mr. Pillar's relocation out of the New York
City area, and Mr. Pillar was entitled to certain accelerated vesting of stock
options upon the closing of the IPO. From November 1, 1996 through June 30,
1997, the Company also had retained Mr. Pillar as a consultant and paid him a
consulting fee of $50,700.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock of the Company as of February 28, 1999 by (i) each
person or entity known to the Company to own beneficially more than 5% of the
Company's Common Stock, (ii) each of the directors of the Company, (iii) each of
the Named Executive Officers and (iv) all current executive officers and
directors as a group.
<TABLE>
<CAPTION>
SHARES TO BE BENEFICIALLY
OWNED (1)
------------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE
- - -------------------------------------------------------------- --------------- -------------
<S> <C> <C>
Current Directors, Executive Officers and 5% Stockholders:
</TABLE>
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<TABLE>
<S> <C> <C>
Carso Global Telecom(2)....................................... 29,396,911 44.6%
Telmex(3)..................................................... 11,412,500 17.3
Samer F. Salameh(4)(5)........................................ 87,500 *
Alfredo Sanchez(5)............................................ -- --
Arturo Elias(5)............................................... -- --
James M. Nakfoor(5)........................................... 9,375 *
Russell I. Pillar(6).......................................... 140,000 *
David C. Trachtenberg......................................... -- --
David R. Henkel............................................... -- --
Andrea S. Hirsch.............................................. -- --
James P. Dougherty(7)......................................... 43,750 *
All current executive officers and directors as a group.......
(9 persons)(5)(8)............................................ 280,625 *
Other 5% Stockholders:
IBM(9)........................................................ 4,536,778 6.9
Sears(10)..................................................... 4,536,778 6.9
Former Executive Officers:
Inder S. Gopal................................................ -- --
James L'Heureux............................................... -- --
Carena M. Pooth(11)........................................... 34,016 *
</TABLE>
_____________
* Denotes ownership of less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and is not necessarily indicative of
beneficial ownership for any other purpose. Under such rules, beneficial
ownership includes any shares as to which the individual or entity has sole
or shared voting power or investment power and any shares as to which the
individual or entity has the right to acquire within 60 days after February
28, 1999 through the exercise of any stock option, warrant or other right
(but such shares are not deemed outstanding for purposes of calculating the
percentage ownership of any other person). The inclusion herein of any such
shares, however, does not constitute an admission that the named stockholder
is a direct or indirect beneficial owner of such shares. Unless otherwise
indicated, each person or entity named in the table has sole voting power
and investment power (or, in the case of individuals, shares such power with
his or her spouse) with respect to all shares of capital stock listed as
owned by such person or entity.
(2) Excludes the listed shares held by Telmex. Carso Global Telecom may be
deemed to control Telmex through the regular-voting shares of Telmex that it
owns directly and its interest in a trust which owns a majority of Telmex's
outstanding regular-voting shares. In June 1996, Carso Global Telecom was
spun-off from Grupo Carso, a Mexican holding company with interests in the
tobacco, mining, metallurgical and paper industries, in the operation of
restaurants and department, stores and in the production of copper, copper
alloys, copper cable, aluminum wire and tires. Mr. Carlos Slim Helu, a
Mexican citizen, and certain members of his immediate family, beneficially
own a majority of the outstanding voting equity securities of Carso Global
Telecom. Thus, Mr. Slim and members of his immediate family may be deemed to
control Carso Global Telecom, Telmex and the Company. See "Certain Factors
That May Affect Future Operating Results--Control of the Company and
Potential Conflicts of Interest" under Item 7 above. As used herein with
respect to the Company, all references to Carso Global Telecom mean and
include Grupo Carso prior to the date Carso Global Telecom was spun-off from
Grupo Carso. The business address of Carso Global Telecom and Mr. Slim is
Paseo de las Palmas, #736, Col. Lomas de Chapultepec, Mexico City, Mexico
11000.
(3) Telmex's business address is Parque Via 190, Oficina 1016, Colonia
Cuauhtemoc, Mexico City, Mexico 06599. See footnote (3).
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(4) Consists of shares of Common Stock subject to outstanding stock options
that are exercisable within 60 days after February 28, 1999.
(5) Excludes the listed shares held by Carso Global Telecom and Telmex. See
"Item 10. Executive Officers and Directors of the Registrant".
(6) Includes 87,500 shares of Common Stock subject to outstanding stock options
that are exercisable within 60 days after February 28, 1999.
(7) Consists of shares of Common Stock subject to outstanding stock options
that are exercisable within 60 days after February 28, 1999.
(8) Includes an aggregate of 218,750 shares of Common Stock subject to
outstanding stock options that are exercisable within 60 days after
February 28, 1999.
(9) Consists of (i) 2,127,633 shares issued to IBM pursuant to the conversion
of the Contingent Note held by IBM and (ii) 2,409,145 shares of Common
Stock issuable to IBM upon exercise of the Contingent Warrant held by it
with an exercise price of $19.50 per share. See "Acquisition of Prodigy
Services Company" under Item 13 below. IBM's business address is New
Orchard Road, Armonk, New York 10504.
(10) Consists of (i) 2,127,633 shares issued to Sears pursuant to the conversion
of the Contingent Note held by Sears and (ii) 2,409,145 shares of Common
Stock issuable to Sears upon exercise of the Contingent Warrant held by it
with an exercise price of $19.50 per share. See "Corporate History and
Certain Transactions--Acquisition of Prodigy Services Company" under Item
13 below. Sears' business address is 3333 Beverly Road, Hoffman Estates,
Illinois 60179.
(11) Consists of shares of Common Stock subject to outstanding stock options
that are exercisable within 60 days after February 28, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ACQUISITION OF PRODIGY SERVICES COMPANY
Acquisition Terms
On June 17, 1996, the Company acquired PSC from its owners, IBM and Sears,
for $46,950,000 in cash (including $6,150,000 paid to financial advisors) plus
the issuance of 8% Contingent Convertible Promissory Notes (the "Contingent
Notes") valued at $30,500,000 by an independent appraiser. The Contingent Notes
entitled IBM and Sears to receive in the aggregate (i) in the event of a
qualifying initial public offering, 15% of the Company's Common Stock on a
fully-diluted basis, or (ii) in the event the Company is acquired, 15% of the
consideration received, provided that the value of the consideration payable to
IBM and Sears in either case was limited to $200,000,000 plus accrued interest.
IBM and Sears assumed PSC's four existing retirement plans and all obligations
thereunder. Effective as of the closing, IBM received sole ownership of six
patents jointly-owned with PSC, the Company received sole ownership of two other
jointly-owned patents, and IBM and the Company entered into the patent cross-
license agreements described under "Item 1. Business--Proprietary Rights". The
Company is obligated to indemnify IBM and Sears for claims and liabilities
arising out of PSC's business, whether arising before or after the closing of
the Prodigy Acquisition, except with respect to the retirement plans assumed by
IBM and Sears.
In November 1997, IBM and Sears (i) agreed that the consideration
receivable upon conversion of the Contingent Notes would be based on the
valuation of the Company in excess of $250,000,000 (with the aggregate
consideration payable to IBM and Sears still limited to $200,000,000 plus
interest from June 17, 1996) and (ii) were granted Contingent Stock Purchase
Warrants (the "Contingent Warrants") to purchase shares of Common Stock of the
Company at 130% of the fair market value thereof at the time of conversion of
the Contingent Notes. The aggregate number of shares of Common Stock issuable to
IBM and Sears upon conversion of the Contingent Notes and exercise of the
Contingent Warrants cannot exceed 15% of the number of shares outstanding upon
completion of the IPO. As a condition to these arrangements, Carso Global
Telecom prepaid (on behalf of and as an advance to the Company) the balance due
on the Company's former White Plains lease ($5,831,000) and established a
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$4,000,000 letter of credit, declining quarterly over three years, to secure
certain payment obligations of the Company under PSC contracts for which IBM and
Sears remain liable. See Notes 1, 4 and 9 to the Company's Consolidated
Financial Statements.
Upon the closing of the IPO, IBM and Sears each (i) received 2,127,633
shares of Common Stock pursuant to the conversion of its Contingent Note and
(ii) hold a Contingent Warrant to purchase 2,409,145 shares of Common Stock at
an exercise price of $19.50 per share (subject to customary anti-dilution
adjustments) at any time prior to the third anniversary of the IPO. IBM and
Sears have customary piggyback and demand registration rights, at the Company's
expense, with respect to the Common Stock issuable upon conversion of the
Contingent Notes or exercise of the Contingent Warrants, including customary
indemnification and other provisions. After conversion of the Contingent Notes
or exercise of the Contingent Warrants, IBM and Sears have agreed to vote their
shares of Common Stock in accordance with the voting recommendations of the
Company's Board of Directors.
Reorganization
In connection with the Prodigy Acquisition, the Company was formed to
acquire PSC and to hold all of the outstanding stock of IW, and IW retained its
existing cellular telephone assets and conveyed its other assets to other
subsidiaries of the Company. The new holding-company structure was created to
effect the Prodigy Acquisition and to consolidate the Company's cellular
telephone assets within IW in order to position IW for separate sale or
financing. As a result of this reorganization, all outstanding Common Stock of
IW was automatically converted into Common Stock of the Company on a one-for-one
basis. See "--Prior Corporate History".
OTHER ARRANGEMENTS WITH IBM AND SEARS
In October 1998, the Company sold to IBM a version of Prodigy's service
provider platform software enabling an ISP to manage subscriber data. IBM paid
the Company $2,000,000, and the Company retained a perpetual, royalty-free
license to use and upgrade the software for its own use. The Company does not
use such software to manage its own subscriber data. See "Item 1. Business--
Technology".
Between the closing of the Prodigy Acquisition and October 1997, IBM and
Sears paid the State of New York $3.4 million for sales and use taxes assessed
against PSC for certain periods ended prior to the Prodigy Acquisition. In
October 1997, the Company, IBM and Sears agreed that each of them would be
liable for one-third of all sales and use taxes assessed against PSC for periods
ended prior to the Prodigy Acquisition, and Carso Global Telecom paid (as an
advance to the Company) $567,000 to each of IBM and Sears in light of prior
payments of such taxes by IBM and Sears.
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Prior to outsourcing its network to Splitrock, Prodigy utilized a network
backbone and certain POPs provided by Advantis (a joint venture of IBM and
Sears) and subsequently by IBM Global Services after IBM acquired Sears'
interest in Advantis during 1997. Splitrock continues to use certain POPs
provided by IBM Global Services. The Company also purchases computer equipment
from IBM on normal commercial terms. During the period June 17, 1996 through
December 31, 1996, the year ended December 31, 1997 and the year ended December
31, 1998, respectively, the Company paid IBM/Advantis an aggregate of
$15,091,000, $33,244,000 and $8,742,000 for network services and equipment
purchases.
At the time of outsourcing its network to Splitrock, Prodigy had certain
non-cancellable commitments to purchase network services from Advantis/IBM
Global Services. In December 1998, in settlement of such commitments, the
Company agreed to purchase from IBM, on normal commercial terms, certain
maintenance and voice-related network services in the aggregate amount of
$7,500,000 prior to December 31, 2000. If the aggregate amount of such purchases
does not equal $7,500,000 by December 31, 2000, the Company must pay the balance
in cash on or before December 31, 2000.
Prior to the Prodigy Acquisition, PSC utilized a network backbone and
certain POPs provided by Advantis and purchased computer equipment from IBM.
During the year ended December 31, 1995 and the period January 1, 1996 through
June 16, 1996, PSC paid Advantis $3,347,000 and $4,355,000, respectively, for
network services and paid IBM $13,686,000 and $4,893,000, respectively, for
computer equipment. See Note 4 to the Consolidated Financial Statements of
Prodigy Services Company for a description of certain other transactions among
PSC, IBM and Sears.
CERTAIN TRANSACTIONS INVOLVING CARSO GLOBAL TELECOM, TELMEX AND GREG C. CARR
Funding Agreement
Set forth below is a summary of the Funding Agreement entered into by the
Company, Carso Global Telecom and Greg C. Carr on May 12, 1996 in connection
with the Prodigy Acquisition (the "Funding Agreement"). All obligations under
the Funding Agreement have been performed and the Funding Agreement has no
further effect.
Pursuant to the Funding Agreement, Carso Global Telecom and Mr. Carr
granted the Company stock puts giving the Company the right to require Carso
Global Telecom and Mr. Carr to purchase shares of Common Stock with an aggregate
purchase price of up to $125,000,000 and $12,500,000, respectively, subject to
reduction in certain circumstances. The stock puts originally were exercisable
at a price of $24.00 per share until the earlier of November 12, 1997 or the
closing of the Company's initial public offering with gross proceeds of at least
$25,000,000. The Funding Agreement also contained a commitment from Carso Global
Telecom and Mr. Carr to invest $5,000,000 and $2,000,000, respectively, in the
Company's next private placement. The Company also granted Carso Global Telecom
an option, which was not exercised, to purchase the Company's cellular telephone
licenses and assets in the Ivory Coast and Guinea for $69,000,000 prior to July
26, 1996. On October 31, 1996, the Funding Agreement was amended to reduce the
exercise price of the stock puts to $12.00 per share and the investment
commitments of Carso Global Telecom and Mr. Carr in the Company's next private
placement were changed to $3,500,000 each. On March 18, 1997, the Funding
Agreement was further amended as follows: (i) the amount of Carso Global
Telecom's stock put was reduced by $8,444,762, (ii) the amount of Mr. Carr's
stock put was increased by $8,500,000, (iii) Carso Global Telecom and Mr. Carr
agreed to the exercise of $65,000,000 and $15,000,000 of the stock puts,
respectively, and (iv) the expiration of the remaining stock puts was extended
to May 12, 1998. The proceeds of the foregoing $65,000,000 and $15,000,000 of
stock puts, together with the proceeds of their additional financing commitments
of $3,500,000 each, were paid to the Company in connection with the October 1996
Placement described below under "--Prior Equity Financings". The final amount of
the stock puts, after giving effect to certain reductions contained in the
Funding Agreement and the changes made by the March 18, 1997 amendment to the
Funding Agreement, was $103,938,467 for Carso Global Telecom and $20,990,533 for
Mr. Carr. By October 1, 1997, the stock puts had been fully exercised for
8,661,539 shares and 1,749,211 shares, respectively.
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Pending expiration of the waiting period under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended (the "HSR Act"), applicable to
certain of the stock put exercises, (i) Carso Global Telecom loaned $71,500,000
to the Company on an interest-free basis (subsequently converted into 5,958,333
shares), (ii) Carso Global Telecom caused Banco Inbursa, an affiliate of Carso
Global Telecom, to loan $13,650,000 to the Company at 9% interest (subsequently
repaid in full), (iii) Mr. Carr loaned $16,000,000 to the Company on an
interest-free basis (subsequently converted into 1,333,333 shares) and (iv) Mr.
Carr loaned $1,500,000 to the Company at 9% interest (subsequently converted
into 125,000 shares). All such loans were unsecured, and the proceeds were used
to finance the Company's operations, except that $40,000,000 of the proceeds was
used to repay indebtedness owed to Banco Inbursa under its prior revolving line
of credit. See "--Loans from Banco Inbursa".
Warrants
Set forth below is a summary of certain stock purchase warrants previously
granted by the Company to Carso Global Telecom and Mr. Carr. All such warrants
have been exercised or cancelled.
In consideration of their commitments under the Funding Agreement, the
Company granted Carso Global Telecom and Mr. Carr (i) warrants to purchase
675,000 shares and 67,500 shares, respectively, of Common Stock for $12.00 per
share (the "Initial Warrants"), exercisable until December 31, 1996, and (ii)
warrants to purchase 500,000 shares and 250,000 shares, respectively, of Common
Stock for $36.00 per share (the "Additional Warrants"), exercisable until the
earlier of (a) the closing of the Company's initial public offering or (b)
November 12, 1997. On October 2, 1996, Mr. Carr exercised his Initial Warrant at
the Company's request for $11.72 per share, reflecting a discount (based on the
interest rate paid under the Company's bank debt) from the original exercise
price in order to induce early exercise. On December 27, 1996, Carso Global
Telecom exercised its Initial Warrant for $12.00 per share. In connection with
the October 31, 1996 amendment of the Funding Agreement, Mr. Carr's Additional
Warrant was cancelled and the number of shares subject to Carso Global Telecom's
Additional Warrant was reduced from 500,000 to 250,000 and its exercise price
was reduced to $28.00 per share. In consideration of the increased financing
commitments under the March 18, 1997 amendment to the Funding Agreement, the
Company granted Carso Global Telecom and Mr. Carr warrants (the "March 1997
Warrants") to purchase 3,250,000 shares and 500,000 shares, respectively, of
Common Stock for $12.00 per share, exercisable prior to the expiration of the
stock puts, and Carso Global Telecom's Additional Warrant was cancelled. In
consideration of certain interim financing commitments made by Carso Global
Telecom and Mr. Carr in October 1997, the exercise price of the March 1997
Warrants was reduced from $12.00 per share to $4.00 per share. Carso Global
Telecom exercised its March 1997 Warrant in April 1998. Mr. Carr subsequently
transferred his March 1997 Warrant to a third party, who exercised such March
1997 Warrant in May 1998.
Board Arrangements
Mr. Carr was Chairman of the Board and a director of the Company from its
formation in June 1996 until his resignation in July 1998 and was also a
director of IW from March 1995 until January 1997. The Company paid Mr. Carr an
annual fee of $135,000 from May 1996 until his resignation in recognition of the
fact that Mr. Carr's duties as Chairman of the Board were significantly greater
than the duties ordinarily assumed by a Chairman of the Board.
In connection with the March 18, 1997 amendment of the Funding Agreement,
Carso Global Telecom and Mr. Carr agreed that, until the earlier of March 18,
2007 or one year after the Company's initial public offering with gross proceeds
of at least $25,000,000, (i) Carso Global Telecom would have the right to
designate 60% of the Company's directors, (ii) Mr. Carr would have the right to
designate 40% of the Company's directors, (iii) Mr. Carr would vote all shares
over which he (or any affiliate of Mr. Carr) exercised voting control in favor
of the election of the directors designated by Carso Global Telecom and (iv)
Carso Global Telecom would vote all shares over which it (or any affiliate of
Carso Global Telecom) exercised voting control in favor of the election of the
directors designated by Mr. Carr. In connection with Telmex's purchase of
3,250,000 shares from Mr. Carr in August 1998, Carso Global Telecom and Mr. Carr
agreed to terminate the foregoing voting agreement, and Carso Global Telecom
agreed to continue, until the earlier of July 24, 1999 or Mr. Carr's resignation
as a director, to vote all shares over which it (or any of its affiliates)
exercised voting control in favor of the election of Mr. Carr as a director. On
July
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24, 1998, Mr. Carr resigned as Chairman of the Board and, on July 31, 1998, Mr.
Carr resigned as a director of the Company. See "--Certain Stock Purchases by
Telmex".
Certain Stock Purchases by Telmex
In August 1998, Telmex purchased 3,250,000 shares of Common Stock from Mr.
Carr for $8.00 per share for an aggregate purchase price of $26,000,000. Mr.
Carr concurrently purchased 288,656 shares at the same price from family members
and certain other stockholders. Pending the termination of the waiting period
under the HSR Act applicable to Telmex's purchase from Mr. Carr, Telmex loaned
$26,000,000 to Mr. Carr. Such loan did not bear interest and was secured by Mr.
Carr's pledge to Telmex of 3,250,000 shares. Telmex and Carso Global Telecom
also granted Mr. Carr certain co-sale rights to participate in subsequent sales
by Telmex or Carso Global Telecom, which rights expired upon the closing of the
IPO.
In August 1998, Telmex purchased 37,500 shares of Common Stock from Paul W.
DeLacey for $8.00 per share for an aggregate purchase price of $300,000. Mr.
DeLacey served as President and Chief Executive Officer of the Company from June
1996 until September 1997 and as a director of the Company from June 1996 until
July 1998. Mr. DeLacey concurrently purchased 6,250 shares at the same price
from family members. Pending the termination of the waiting period under the HSR
Act applicable to Telmex's purchase from Mr. DeLacey, Telmex loaned $300,000 to
Mr. DeLacey. Such loan did not bear interest and was secured by Mr. DeLacey's
pledge to Telmex of 37,500 shares. In connection with this transaction, Mr.
DeLacey resigned as a director of the Company on July 24, 1998.
As a result of Telmex's purchases of an aggregate of 3,287,500 shares from
Messrs. Carr and DeLacey as described above, its purchase of 6,125,000 shares
from the Company as described below under "--Prior Equity Financings" and its
purchase of 2,000,000 shares from the Company simultaneously with the IPO at a
purchase price of $15.00 per share, Telmex owns 19.3% of the Company's
outstanding Common Stock as of February 28, 1999. See "Item 12. Security
Ownership of Certain Beneficial Owners and Management".
Loans from Banco Inbursa
Set forth below is a summary of certain loans previously made to the
Company by Banco Inbursa. All such loans have been repaid (with interest as
applicable) in cash.
In June 1996, Banco Inbursa agreed to provide the Company with a
$50,000,000 revolving line of credit with an original maturity of June 13, 1997.
In June 1996, the Company borrowed $48,000,000 in order to pay the cash portion
of the purchase price for the Prodigy Acquisition and related expenses and
subsequently borrowed the remaining $2,000,000. In March 1997, the Company
repaid $40,000,000 to Banco Inbursa. See "--Funding Agreement". In June 1997,
Banco Inbursa agreed to extend the line of credit for $10,000,000 until January
31, 1998. Advances under the line of credit bore interest at the prime rate plus
one-half percentage point. Between February 1998 and July 1998, Banco Inbursa
made additional advances to the Company in the aggregate amount of $22,100,000
to fund operations; such loans bore 9% interest and were due December 31, 1999.
In late July 1998, the Company repaid all $32,100,000 then owed to Banco
Inbursa. Banco Inbursa also made interim loans to the Company pending the
closing of certain equity financings, all of which loans have been repaid. See
"--Prior Equity Financings".
In June 1996, Carso Global Telecom and Mr. Carr pledged 1,750,000 shares
and 2,500,000 shares of Common Stock, respectively, owned by them to secure
amounts outstanding under the Banco Inbursa line of credit. In connection with
the October 31, 1996 amendment of the Funding Agreement, Mr. Carr agreed to
continue his stock pledge until June 13, 1998 to secure a new line of credit
from a United States bank or other debt financing to replace the Banco Inbursa
line of credit. In October 1997, Mr. Carr agreed to pledge 1,875,000 shares of
Common Stock to secure advances of $3,750,000 from Banco Inbursa to the Company
until the closing of the Company's rights offering in December 1997. All stock
pledges of Carso Global Telecom and Mr. Carr were released in July 1998.
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Loans from Greg C. Carr
Set forth below is a summary of certain loans previously made to the
Company by Mr. Carr. All such loans have been repaid (with interest as
applicable) in cash or through conversion into Common Stock of the Company.
In November and December 1996, Mr. Carr loaned $6,000,000 to the Company.
Such loans bore interest at the prime rate plus 1 1/4 percentage points and
were repaid with interest on January 2, 1997.
From March 31, 1995 to May 15, 1995, Mr. Carr provided a revolving line of
credit of $1,250,000 to the Company. See "--Prior Corporate History--ACI
Merger". As of May 15, 1995, Mr. Carr converted the advances and accrued
interest then outstanding ($730,000 in total) into Common Stock at $10.00 per
share. From November 15, 1995 to June 12, 1996, Mr. Carr provided a revolving
line of credit of $4,500,000 to the Company. Effective as of March 31, 1996, Mr.
Carr converted $3,000,000 in advances into 250,000 shares of Common Stock at
$12.00 per share in connection with the November 1995 Placement described below
under "--Prior Equity Financings". Effective as of June 12, 1996, Mr. Carr
converted the remaining $1,500,000 in advances into 125,000 shares of Common
Stock at $12.00 per share. Advances under both facilities were secured by all of
the Company's assets, bore interest at a floating interest rate based on the
prime rate and were used to finance the Company's operations. Upon establishment
of the $4,500,000 facility, the Company paid Mr. Carr a commitment fee equal to
1% of the total facility ($45,000) through the issuance of 3,750 shares of
Common Stock valued at $12.00 per share.
PRIOR EQUITY FINANCINGS
In August 1998, Telmex purchased 6,125,000 shares of Common Stock from the
Company for $8.00 per share for aggregate gross proceeds of $49,000,000, and in
July 1998 Carso Global Telecom purchased 1,375,000 shares of Common Stock from
the Company for $8.00 per share for aggregate gross proceeds of $11,000,000.
Pending the termination of the applicable waiting period under the HSR Act,
Telmex's investment in the Company was represented by an unsecured, interest-
free loan to the Company.
In November 1997, the Company made a rights offering in which each
stockholder of the Company was entitled to purchase one share of Common Stock at
a price of $4.00 per share for each one share held as of October 10, 1997. The
offering price was determined by the Company's Board of Directors to equal the
fair market value of the Common Stock at that time upon consideration of certain
analyses undertaken by a financial advisor as to the range within which the
purchase price would be fair to the Company from a financial point of view and
after consideration of other factors. On December 19, 1997, the Company closed
the rights offering by issuing an aggregate of 12,640,478 shares to 36
stockholders of the Company, including 12,385,955 shares to Carso Global Telecom
and 125,000 shares to Mr. Carr. Mr. Carr paid the purchase price for his shares
through the conversion of $500,000 of prior advances to the Company without
interest. In payment for its 12,385,955 shares, Carso Global Telecom (i) was
credited with $4,000,000 by reason of the issuance of the IBM/Sears LC, (ii)
paid $13,750,000 directly to Banco Inbursa on the Company's behalf in repayment
of $13,750,000 of indebtedness owed by the Company to Banco Inbursa (see "--
Loans from Banco Inbursa") and (iii) paid the remaining $31,793,822 to the
Company. Each calendar quarter, Carso Global Telecom is required to pay the
Company an amount equal to $333,333 less any draws on the IBM/Sears LC during
such quarter until the entire $4,000,000 has been paid to the Company or drawn
under the IBM/Sears LC. As of January 25, 1999, Carso Global Telecom had paid
$1,333,333 pursuant to such commitment and the IBM/Sears LC had been reduced to
$2,666,667.
Between October 1996 and May 1997, the Company received aggregate gross
proceeds of $88,843,235 from the private placement (the "October 1996
Placement") of 7,403,603 shares of Common Stock for $12.00 per share. In the
October 1996 Placement, Carso Global Telecom and Mr. Carr invested $68,500,000
and $18,500,000, respectively, through exercises of the stock puts and the
financing commitments contained in the Funding Agreement, and Mr. Pillar
invested $30,000. See "--Funding Agreement". The Company granted a warrant to
purchase 17,014 shares of Common Stock for $12.00 per share, exercisable at any
time prior to December 13, 2001, to a placement agent in the October 1996
Placement, and paid a financial advisor cash fees totalling $150,000.
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Pursuant to an agreement dated April 11, 1996, Carso Global Telecom
purchased 1,750,000 shares of Common Stock from the Company for $12.00 per share
(for aggregate gross proceeds of $21,000,000) on various dates between March
1996 and September 1996.
Between November 1995 and March 1996, the Company received aggregate gross
proceeds of $7,376,508 from the private placement (the "November 1995
Placement") of 614,709 shares of Common Stock for $12.00 per share. Mr. Carr
purchased 250,000 shares in the November 1995 Placement for $3,000,000 upon the
conversion of advances made by him to the Company under a line of credit. See "-
- - -Loans from Greg C. Carr". The Company paid a placement agent in the November
1995 Placement a cash fee of $50,000 and granted other placement agents (i) a
warrant to purchase 33,333 shares of Common Stock for $12.00 per share,
exercisable at any time prior to August 15, 2005, and (ii) a warrant to purchase
11,095 shares of Common Stock for $12.00 per share, exercisable at any time
prior to March 1, 2001. The foregoing warrants are currently outstanding.
Between May 1995 and November 1995, the Company received aggregate gross
proceeds of $3,081,250 from the private placement (the "May 1995 Placement") of
308,125 shares of Common Stock for $10.00 per share. Mr. Carr purchased 100,000
shares in the May 1995 Placement for $1,000,000. The Company paid a placement
agent in the May 1995 Placement a cash fee of $77,438 and granted other
placement agents (i) a warrant to purchase 4,000 shares of Common Stock for
$10.00 per share, exercisable at any time prior to August 15, 2005, and (ii) a
warrant to purchase 1,960 shares of Common Stock for $10.00 per share,
exercisable at any time prior to March 1, 2001. The foregoing warrants are
currently outstanding.
Between October 1994 and February 1995, the Company received aggregate
gross proceeds of $907,456 from the private placement (the "October 1994
Placement") of 453,728 shares of Series A Convertible Preferred Stock ("Series A
Stock") for $2.00 per share. Each share of Series A Stock was convertible into
.25 share of Common Stock for an effective purchase price of $8.00 per share of
Common Stock. On March 31, 1995, each share of Series A Stock was reclassified
and changed into .3125 share of Common Stock (for an aggregate of 141,790 shares
of Common Stock), resulting in an effective purchase price for the investors in
the October 1994 Placement of $6.40 per share of Common Stock. The rate at which
Series A Stock was exchanged for Common Stock was intended to compensate the
holders of Series A Stock for the value of the liquidation preference they
relinquished upon the reclassification of their shares into Common Stock.
As a result of their purchases from the Company as described above, and
certain purchases from other stockholders of the Company, Carso Global Telecom
and Telmex own 49.8% and 19.3%, respectively, of the Company's outstanding
Common Stock of February 28, 1999. Mr. Carr currently owns less than 5% of the
Company's outstanding Common Stock. See "--Certain Stock Purchases by Telmex".
PRIOR CORPORATE HISTORY
Comstar Transaction
The Company's predecessor, IW, was formed in Delaware in May 1994 to
develop and operate cellular telephone systems in Africa. On August 10, 1994, IW
acquired all of the assets of Comstar Cellular Network, Inc. and assumed
Comstar's outstanding accounts payable. At the time of the acquisition,
Comstar's corporate records were incomplete and there had been an overissuance
of Comstar's common stock. Comstar also required an immediate cash infusion in
order to complete the activities required to convert the two provisional
communications licenses it held in Africa into definitive licenses. In exchange
for Comstar's assets, IW issued to Comstar all then outstanding common stock of
IW, which Comstar then distributed as a liquidating dividend to the holders of
certificates for common stock of Comstar. Each holder of a certificate for
common stock of Comstar was required to acknowledge and accept the terms of the
Comstar acquisition and release Comstar and IW from all claims which such holder
may have had against either Comstar or IW. The terms of the Comstar acquisition
were accepted by the holders of 98% of the certificates for common stock of
Comstar (representing 78% of the number of shares covered by outstanding
certificates for common stock of Comstar), and an aggregate of 5,409,213 shares
of IW common stock were issued to the former holders of Comstar certificates.
Three persons chose not to participate in the Comstar acquisition and received
no IW shares. See "Item 3. Legal Proceedings". In March 1995, Comstar was
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dissolved under Nevada law. The Company believes that the Comstar acquisition
provided the holders of certificates for common stock of Comstar with the
opportunity to acquire equity participation, without further investment, in a
properly constituted corporation without the corporate irregularities or claims
of creditors faced by Comstar and in substantially the same proportions as they
would have had in Comstar had their certificates been validly issued.
ACI Merger
On March 31, 1995, African Communications Incorporated ("ACI") was merged
with and into IW (the "ACI Merger"). Prior to the ACI Merger, IW and ACI had
jointly evaluated certain African markets and established IW's initial foreign
subsidiaries. ACI had no material assets or liabilities other than its equity
interests in the initial foreign subsidiaries and loans of approximately
$450,000 to IW and certain of its foreign subsidiaries. Immediately prior to the
ACI Merger, ACI assigned these loans to Mr. Carr (who was then ACI's sole
stockholder), and Mr. Carr agreed to make approximately $800,000 in additional
loans available to IW. See "--Loans from Greg C. Carr". In the ACI Merger, Mr.
Carr received 2,790,564 shares of common stock of IW, representing 33.8% of the
outstanding common stock immediately after the ACI Merger and 32.3% of the then
outstanding common stock on a fully-diluted basis. The terms of the ACI Merger
were negotiated to reflect the fact that the initial foreign subsidiaries were
owned by IW and ACI in a two-to-one ratio.
Dispositions of Former International Operations
On January 27, 1997, the Company sold IW to an acquisition corporation (the
"Cellular Buyer") formed by Terrance P. Dillon, a former director and principal
stockholder of the Company and IW. At the time of the sale, IW's assets
consisted of cellular communications licenses and license applications in
certain African countries and the associated rights and assets used in the
Company's cellular telephone operations. The original purchase price consisted
of (i) the surrender of 1,392,857 shares of Common Stock of the Company (valued
by the parties at $27.00 per share), (ii) a Promissory Note (the "Cellular
Note") in the original principal amount of $21,500,000 (including $1,500,000 in
reimbursement of capital expenditures made by the Company for the benefit of IW)
and (iii) the cancellation of options to purchase 125,000 shares of Common Stock
of the Company. In October 1997, the Cellular Buyer surrendered an additional
573,580 shares of Common Stock of the Company held by the Cellular Buyer (valued
by the parties at $12.00 per share) to reduce its unpaid obligations under the
Cellular Note and to satisfy unpaid indemnification obligations owed to the
Company. As of December 31, 1998, $17,655,000 in principal amount and accrued
interest was outstanding under the Cellular Note. Due to uncertainties
associated with the efforts of the Cellular Buyer to obtain financing, the
Cellular Note has been recorded in the Company's accounts at a book value of
zero.
On October 1, 1998, the Company sold Africa Online, Inc. ("AFOL"), an ISP
operating in various African countries, for $2,815,000 in cash, of which
$750,000 was placed in escrow for six months to secure the Company's
indemnification obligations to the buyer. In connection with the sale of AFOL,
24,230 shares of Common Stock of the Company were surrendered to the Company (of
which 17,180 shares were surrendered by a former employee and 7,050 were
returned to the Company out of the escrow established when the Company acquired
AFOL in November 1995).
The Company formerly participated in several joint ventures which offered
Internet, online, voice messaging and fax messaging services in China. In March
1998, the Company terminated its Chinese joint ventures and operations. See Note
5 to the Company's Consolidated Financial Statements.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Compensation Committee of the Board of Directors
are Messrs. Elias and Nakfoor. No executive officer of the Company has served as
a director or member of the compensation committee (or other committee serving
an equivalent function) of any other entity, whose executive officers served as
a director of or member of the Compensation Committee of the Board of Directors.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this Form 10-K:
1. Financial Statements. See Index to Financial Statements and
Schedules in Part II, Item 8 of this Form 10-K.
2. Financial Statement Schedules. Schedules for which provision is
made in the applicable accounting regulations of the Commission are either not
required under the related instructions, are inapplicable or not material, or
the information called for thereby is otherwise included in the financial
statements and therefore has been omitted.
3. Exhibits. The Exhibits listed in the Exhibit Index immediately
preceding such Exhibits are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
See Exhibit Index.
(d) Financial Statement Schedules
Schedules for which provision is made in the applicable
accounting regulations of the Commission are either not required under
the related instructions, are inapplicable or not material, or the
information called for thereby is otherwise included in the financial
statements and therefore has been omitted.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRODIGY COMMUNICATIONS CORPORATION
By: /s/ Samer F. Salameh
-----------------------------------
Samer F. Salameh
Chairman of the Board and Chief Executive
Officer
Date: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE Title Date
<S> <C> <C>
Chairman of the Board and Chief Executive March 29, 1999
Officer (Principal Executive Officer)
/s/ Samer F. Salameh
- - ----------------------------------------
Samer F. Salameh
Executive Vice President, Finance Chief
Financial Officer and Director March 29, 1999
/s/ David R. Henkel (Principal Financial and Accounting Officer)
- - ----------------------------------------
David R. Henkel
/s/ Alfredo Sanchez Vice Chairman of the Board March 29, 1999
- - ----------------------------------------
Alfredo Sanchez
/s/ Arturo Elias Director March 29, 1999
- - ----------------------------------------
Arturo Elias
/s/ James M. Nakfoor Director March 29, 1999
- - ----------------------------------------
James M. Nakfoor
/s/ Russell I. Pillar Director March 29, 1999
- - ----------------------------------------
Russell I. Pillar
</TABLE>
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- - ----------- -------------------------------------------------------------
3.1(1) Certificate of Incorporation of the Registrant, as amended.
3.2(1) By-laws of the Registrant, as amended.
4.1(1) Specimen certificate for shares of Common Stock.
10.1(1) Agreement and Plan of Corporate Reorganization, dated July 8,
1994, among International Wireless Incorporated, Comstar
Cellular Network, Inc., Terrance Dillon, Duncan Wine, Blaize
Kaduru and Herbert Orji.
10.2(1) Partnership Purchase Agreement, dated May 12, 1996, among
International Wireless Incorporated, Prodigy Services Company,
International Business Machines Corporation and Sears, Roebuck
and Co., as amended by Amendment dated June 3, 1996.
10.3(1) Note Exchange Agreement, dated October 20, 1997, among the
Registrant, Prodigy Services Corporation, International
Business Machines Corporation and Sears, Roebuck and Co., as
amended by Amendment to Note Exchange Agreement dated October
31, 1997.
10.4(1) Letter agreement, dated October 20, 1997, between the
Registrant and Carso Global Telecom, S.A. de C.V., relating to
the Note Exchange Agreement.
10.5(1) Form of 8% Contingent Convertible Promissory Note issued by
Prodigy Services Corporation to IBM and Sears.
10.6(1) Form of Contingent Common Stock Purchase Warrant issued by
Prodigy Services Corporation to IBM and Sears.
10.7(1) Letter agreement, dated April 11, 1996, between International
Wireless Incorporated and Grupo Carso, S.A. de C.V.
10.8(1) Funding Agreement, dated May 12, 1996, among International
Wireless Incorporated, Grupo Carso, S.A. de C.V. and Greg C.
Carr.
10.9(1) Amendment to Funding Agreement, dated October 31, 1996, among
the Registrant, Carso Global Telecom, S.A. de C.V. and Greg C.
Carr.
10.10(1) Amendment No. 2 to Funding Agreement, dated March 18, 1997,
among the Registrant, Carso Global Telecom, S.A. de C.V. and
Greg C. Carr.
10.11(1) Put Exercise Agreement, dated May 6, 1997, among the
Registrant, Carso Global Telecom, S.A. de C.V. and Greg C.
Carr.
10.12(1) Interim Financing Agreement, dated October 30, 1997, among the
Registrant, Greg C. Carr and Carso Global Telecom, S.A. de C.V.
10.13(1) Stock Purchase Agreement, dated July 24, 1998, between the
Registrant and Telefonos de Mexico, S.A. de C.V.
10.14(1) Stock Purchase Agreement, dated July 24, 1998, between the
Registrant and Carso Global Telecom, S.A. de C.V.
<PAGE>
10.15(1) Stock Purchase Agreement, dated July 24, 1998, among the
Registrant, Telefonos de Mexico, S.A. de C.V., Greg C. Carr and
Carso Global Telecom, S.A. de C.V.
10.16(1)* 1999 Outside Director Stock Option Plan of the Registrant.
10.17(1)+ Software License and Services Agreement, dated April 16, 1997,
between Prodigy Services Corporation and ORACLE Worldwide Tech
Support.
10.18(1) Understanding Agreement, dated August 5, 1998, for line of
credit granted by Carso Global Telecom, S.A. de C.V. to the
Registrant.
10.19(1)+ Splitrock Full Service Agreement, dated June 24, 1997, between
Splitrock Services, Inc. and Prodigy Services Corporation.
10.20(1) Agreement of Sublease, dated June 24, 1997, between Splitrock
Services, Inc. and Prodigy Services Corporation.
10.21(1)* Employment Agreement, dated September 1, 1998, between the
Registrant and Samer F. Salameh.
10.22(1)* Consulting Agreement, dated July 31, 1998, between the
Registrant and Russell I. Pillar, as amended January 5, 1999.
10.23(1)* Employment Agreement, dated July 21, 1998, between the
Registrant and David R. Henkel.
10.24(1)* Employment Agreement, dated November 24, 1997, between the
Registrant and James P. Dougherty.
10.25(1)* Employment Agreement, dated September 14, 1998, between the
Registrant and Andrea S. Hirsch.
10.26(1)* Employment Agreement, dated December 14, 1998 between the
Registrant and David C. Trachtenberg.
10.27(1)* Employment Agreement, dated June 1, 1998, between the
Registrant and Carena M. Pooth.
10.28(1)* 1996 Stock Option Plan of the Registrant, as amended.
10.29(1)* 1999 Employee Stock Purchase Plan of the Registrant.
10.30(1) Lease, dated August 14, 1997, between Prodigy Services
Corporation and Westchester One LLC, as amended.
10.31(1)+ Promotion & Distribution Agreement, effective October 7, 1996,
between Microsoft Corporation and Prodigy Services Corporation,
as amended.
10.32(1)+ Distribution and Licensing Agreement, effective October 1,
1996, between Packard Bell NEC, Inc. and Prodigy Services
Corporation.
10.33(1)+ Excite Services Distribution and Co-Branded Area Agreement,
dated January 20, 1998, between Excite, Inc. and Prodigy
Services Corporation.
10.34(1) Lease Agreement, dated June 6, 1988, between Prodigy Services
Company and Crow-Kelly#1, as amended.
<PAGE>
10.35@ Microsoft Windows 98 "Get Connected" Co-Marketing Agreement,
dated July 2, 1998, between Prodigy Services Corporation and
Microsoft Corporation.
10.36(1)+ Software Development and Processing Services Agreement, dated
January 1, 1992, between Prodigy Services Company and CSG
Systems, Inc., as amended.
10.37(1) Form of Prodigy Service Member Agreement.
10.38(1) Agreement, dated January 25, 1999, among the Registrant,
Telfonos de Mexico, S.A. de C.V. and others.
10.39 Microsoft Internet Explorer Logo License Agreement, dated
July 2, 1998, by and between Prodigy Services Corporation and
Microsoft Corporation.
10.40 Microsoft Internet Explorer License and Distribution Agreement,
dated July 2, 1998, by and between Prodigy Services Corporation
and Microsoft Corporation.
23.1 Consent of PriceWaterhouseCoopers LLP.
27.1 Financial Data Schedule.
___________
(1) Incorporated by reference from the registrant's Registration Statement on
Form S-1 (File No. 333-64233).
* Management contract or compensation plan or arrangement filed in response
to Item 14(a)(3) of the instructions to Annual Report on Form 10-K.
+ Confidential treatment granted as to certain portions, which portions have
been omitted and filed separately with the Securities and Exchange
Commission.
@ Confidential treatment requested as to certain portions.
<PAGE>
Exhibit 10.35
- - ------------------------------------------------------------------------------
Confidential Materials omitted and filed separately with the Securities and
- - ------------------------------------------------------------------------------
Exchange Commission.
- - ------------------------------------------------------------------------------
Asterisks denote omissions.
- - ------------------------------------------------------------------------------
MICROSOFT WINDOWS 98 "GET CONNECTED" CO-MARKETING AGREEMENT
Document Version 4.1. April 14, 1998
This Microsoft Windows 98 "Get Connected" Co-Marketing Agreement ("Agreement")
is made and entered into this 22 day of July, 1998("Effective Date") by and
between MICROSOFT CORPORATION, a Washington corporation, One Microsoft Way,
Redmond, WA 98052-6399 ("MS"), and Prodigy Services Corporation, a Delaware
corporation, including its majority owned subsidiaries and affiliates
(collectively, "COMPANY"). MS and Company each defined as a "party," and
collectively defined as the "parties".
INTRODUCTION
MS has developed the "Internet Connection Wizard" as a means of facilitating
easy Internet sign-up by users of Microsoft Windows 98 software;
MS intends that the "Internet Connection Wizard" provide highest quality
Internet experiences, from sign-up through day-to-day access, by users of
Microsoft Windows 98 software;
In order to achieve the goals described above, MS desires to make the "Internet
Connection Wizard" available to highest quality providers of Internet access
services;
MS believes that COMPANY meets the standards of a leading Internet Service
Provider, as evidenced in part by both subscriber popularity and objective
quality measures;
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<PAGE>
COMPANY is willing to commit to provide technically satisfactory Internet
experiences for subscribers who use the Internet Connection Wizard to access
COMPANY'S web-based services, and to pay MS a referral fee for each subscriber
acquired by means of the Internet Connection Wizard;
The parties agree as follows:
1. DEFINITIONS.
The following terms, whenever initially capitalized, shall have the following
meanings for purposes of this Agreement:
1.1 "Access" means telecommunications facilities and services that enable a
computer user to access and use internet sites and content by means of a
TCP/IP connection.
1.2 "Browsing Software" means software (whether part of an operating system or
available as a separate product) designed to view, render, browse or
otherwise interact with the Internet, the Web and/or other public networks
now existing or hereafter created.
1.3 "COMPANY Information" means information regarding or relating to the ISP
Service such as order processing information, fees, service plans, etc.,
and other information that is reasonably necessary to describe and solicit
orders of the ISP Service to the ISP Subscriber and/or such other
information that has been mutually agreed to by the parties.
1.4 "Email Client" means software which is used to compose, transmit, retrieve,
and read electronic messages using peer-to-peer, store and forward, or
similar email communication methods, whether part of an operating system
(e.g., Outlook Express) or available as a separate product (e.g., Hotmail).
1.5 "IE Agreement" means an agreement (Internet Explorer License and
Distribution Agreement document version 4.0 or later) between MS and
COMPANY by which COMPANY has acquired rights to customize and distribute
software that upgrades Windows 95 or Windows 98 to the Internet Explorer,
version 4.x or higher level of functionality.
1.6 "Internet Connection Wizard" or "ICW" means an electronic referral
mechanism to promote the ISP services for various ISP's, including COMPANY,
and which ordering mechanism shall enable the end user to order ISP Service
via a link to COMPANY's Sign-up Server or other method mutually agreed to
by the parties. The Internet Connection Wizard shall prompt the ISP
Subscriber to enter various Locator Information. MS may, in its sole
discretion, include the Internet Connection Wizard in other MS products.
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<PAGE>
1.7 "Internet Product" means any COMPANY product or service which provides
access to or information about the Internet. An Internet Product may not
be a personal computer. For purposes of this Agreement, "ISP Service"
(defined below) shall be a type of Internet Product.
1.8 "Internal Referral Server Starter Kit" or "IRSS Kit" means the package of
technical information related to participation in the Referral Service,
including the Microsoft Internet Referral Service Program, "Internet
Service Provider's Guide," as such tool may be amended from time to time.
1.9 "ISP(s)" means an Internet Service Provider.
1.10 "ISP Information" means information regarding or relating to Internet
access services (including the ISP Service) such as order processing
information, fees, service plans, etc., and other information that is (a)
reasonably necessary to describe Internet access services to, and solicit
orders for Internet access services from, an Internet access service
subscriber; and/or (b) such other information as may be mutually agreed to
by MS and an Internet service provider (including COMPANY).
1.11 "ISP Information Page" means a HTML based page which includes ISP
Information, to be maintained by COMPANY and hosted on the Referral Server.
The ISP Information Page shall be downloaded to the prospective ISP
Subscriber as part of the ordering and referral process.
1.12 "ISP Phone Book(s)" means a listing of names of ISPs and their associated
telephone numbers and other ISP Information, including COMPANY Information.
There may be one or more ISP Phone Books specific to a given telephone area
code, geographic region or Service Area. The ISP Phone Book(s) shall be
hosted on one or more Referral Server(s). MS shall solely determine the
placement, presentation and content of COMPANY Information in the ISP Phone
Book(s).
1.13 "ISP Referral Fee" means the per ISP Subscriber payment amount set forth in
Section 4.
1.14 "ISP Service" means a COMPANY service, described in Exhibit A, which
---------
provides an Internet protocol (IP) access service to the Internet as
contemplated by this Agreement. The parties acknowledge that COMPANY may
provide access to the Internet via other Internet Product(s) not listed in
Exhibit A.
---------
1.15 "ISP Subscriber" means any individual or legal entity who subscribes to the
ISP Service through or as a result of the Internet Connection Wizard.
1.16 "Locator Information" means an ISP Subscriber's name, email and
conventional mailing addresses, telephone and facsimile numbers, credit
card number, and any other data about
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<PAGE>
such ISP Subscriber that enables the possessor of such information to
personally identify such ISP Subscriber.
1.17 "Promote" or "Promotion" means communicate or advertise, to existing or
potential customers of COMPANY's ISP Services, by any means, media or
channel whatsoever (including, for example but without limitation, direct
mailings or print, online, television radio or telephone communications,
solicitations, advertisements, or the like).
1.18 "Quarter" means a calendar quarter. The first Quarter shall commence on
January 1, April 1, July 1 or October 1, whichever date most closely
precedes the Effective Date.
1.19 "Referral Server" means a server maintained by MS which shall provide an
ISP Subscriber with one or more ISP Phone Books, and which shall enable the
ISP Subscriber to transmit ordering information, via the Internet
Connection Wizard to the Sign-up Server.
1.20 "Service Area" means the area in which COMPANY currently provides or will
provide Access, as of the Effective Date, as set forth in Exhibit B.
---------
1.21 "Sign-up Server" means a server maintained by COMPANY which shall enable
the ISP Subscriber to order ISP Service from COMPANY and shall further
enable COMPANY to configure the ISP Subscriber's copy of the Licensed
Software (hosted on the ISP Subscriber's computer), all via on-line
transmission. COMPANY shall use the Sign-up Server to configure the ISP
Subscriber's copy of Licensed Software in accordance with instructions in
the IRSS Kit.
1.22 "Start Page" means the beginning web page from which an ISP Subscriber
launches the ISP Service.
1.23 "Windows 98" means the MS personal computer operating system software
licensed by MS under that name.
2. MICROSOFT OBLIGATIONS
---------------------
2.1 ISP Phone Book(s). Provided that COMPANY complies with its obligations
-----------------
under this Agreement, MS shall include COMPANY's name, telephone number and
other mutually agreed upon COMPANY Information in one or more ISP Phone
Books. Unless otherwise provided in Exhibit B, MS may determine, in MS'
sole discretion, the order and placement of COMPANY Information within any
ISP Phone Book(s).
2.2 Internet Connection Wizard. MS shall distribute the Internet Connection
--------------------------
Wizard as part of Windows 98. MS may, in its sole discretion, include the
ICW in other MS software. COMPANY acknowledges and agrees that inclusion
of companies in referral servers for
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<PAGE>
the ICW incorporated in any other MS software shall be pursuant to separate
agreements related to those MS products.
2.3 Referral Server. MS shall develop and maintain the Referral Server(s),
---------------
which shall be operational on a 7X24 basis.
2.4 Internet Referral Service Starter Kit. MS shall provide an lRSS Kit,
-------------------------------------
including the Internet Referral Service Provider's Guide, to COMPANY.
3. COMPANY OBLIGATIONS
-------------------
In partial consideration for inclusion in the Internet Referral Server and
this "Get Connected" co-marketing program, COMPANY shall perform the
following obligations:
3.1 A condition precedent to COMPANY's execution of this Agreement is that
COMPANY shall have executed an IE Agreement. During the term of this
Agreement, COMPANY shall maintain in force and comply with all material
provisions of its IE Agreement. Further, COMPANY shall support any
successor versions of IE released during the term of this Agreement.
3.2 COMPANY shall offer the ISP Service(s). Recognizing the importance of
convenient and high-quality service in order to meet the objectives of this
Agreement, the parties agree that COMPANY's ISP Service(s) shall use
commercially reasonable efforts to maintain parity with the convenience and
quality of other participants in this ICW program. COMPANY recognizes and
agrees that failure to substantially comply with the requirements of this
Section 3.2 shall constitute a material default under this Agreement.
3.3 COMPANY shall develop and maintain a Sign-up Server. The Sign-up Server
shall be operational on a 7X24 basis. Recognizing the importance of
convenient and high-quality service in order to meet the objectives of this
Agreement, the parties agree that COMPANY shall use commercially reasonable
efforts to ensure that COMPANY's Sign-up Server shall maintain parity with
the convenience and quality of other participants in this ICW program.
COMPANY recognizes and agrees that failure to substantially
Confidential Materials omitted and filed separately with the Securities and
Exchange Commission.
Asterisks denote omissions.
comply with the requirements of this Section 3.3 shall constitute a
material default under this Agreement.
-5-
<PAGE>
3.4 COMPANY shall comply with all technical specifications set forth in IRSS
Kit. Amendments to the IRSS Kit, including the Internet Service Provider's
Guide, shall be binding on COMPANY upon ninety (90) days' written notice.
3.5 COMPANY shall provide Microsoft with information and access as reasonably
requested by Microsoft from time to time to allow Microsoft to ensure
COMPANY's ongoing compliance with all specifications set forth in IRSS Kit.
3.6 COMPANY shall establish a toll free telephone number, or any other
communication medium mutually agreed to by the parties or the processing of
orders for ISP Subscribers. COMPANY shall notify Microsoft in writing by a
mutually agreed upon date of such specific communication medium or other
relevant means of order entry secured by COMPANY for the ISP Service and
any other COMPANY Information. COMPANY shall use unique numbers,
extensions or addresses so as to ensure that all ISP Subscribers (e.g.
those directed to the Sign-up Server by the Internet Connection Wizard) can
be easily segregated from other orders received by COMPANY that do not
Originate from the Internet Connection Wizard for revenue reporting
purposes.
3.7 COMPANY shall test and certify technical and design compatibility with (a)
the ICW and Windows 98, (b) other industry standard protocols, and (c)
other specifications and standards specified by Microsoft from time to time
in accordance with the procedures, and using the testing tools specified by
Microsoft from time to time, including, without limitation, the
specification, and acceptance testing procedures set forth in the IRSS Kit.
The foregoing shall be a prerequisite to listing COMPANY in any ISP Phone
Book(s).
3.8 COMPANY shall maintain in force a valid license to use the "Microsoft
Internet Explorer" logo. COMPANY shall include the logo (or any successor
thereto) in Promotion of ISP Services made available to ISP Subscribers.
3.9 COMPANY shall maintain [**]: If COMPANY [**] in connection with ISP
Services made available to ISP Subscribers, COMPANY shall [**] the Licensed
Software [**].
-6-
<PAGE>
Confidential Materials omitted and filed separately with the Securities and
Exchange Commission.
Asterisks denote omissions.
3.10 COMPANY shall maintain [**]: If in connection with ISP Services made
available to ISP Subscribers COMPANY [**] COMPANY shall maintain [**], the
Licensed Software.
3.11 COMPANY shall permit Microsoft to use COMPANY's name in a commercially
reasonable and non-disparaging way in any press release or other Microsoft
advertising or promotion regarding the Internet Connection Wizard or
execution of any "Get Connected" Co-Marketing agreement(s), provided that
any such use of COMPANY's name shall be limited to factual statements
relating to COMPANY's participation in the ICW (e.g., "COMPANY is included
in the ICW" or "COMPANY has executed a Get Connected Co-Marketing
Agreement") but shall not state or imply any contractual terms or
conditions regarding use of, offer or subscription to COMPANY's Internet
Product.
4. PAYMENT AND REPORTING
---------------------
4.1 In consideration of each ISP Subscriber, COMPANY shall pay MS an ISP
Referral Fee in the amount of [**], for each subscription for ISP Service
ordered by an ISP Subscriber.
4.2 COMPANY shall implement the "real-time" reporting system established by MS
and documented in the IRSS Kit for electronic reporting of lead referrals
and sign-ups (see "Internet Service Provider's Guide, version 3.0, chapter
three, "Notifying the Referral Server during the Sign-Up Process"), as
amended from time to time.
4.3 Within forty five (45) days after the end of each Quarter, COMPANY shall
furnish MS a statement together with payment for any amount shown thereby
to be due to MS. The referral fee statement shall be based upon ISP
Referral Fees for the Quarter then ended, and shall be in the form of the
sample report set forth below as Exhibit C.
---------
4.4 All amounts due hereunder are exclusive of any taxes, duties, fees, excises
or tariffs imposed on any of COMPANY's activities in connection with this
Agreement. Such charges, if any, shall be paid by COMPANY.
4.5 Late payment(s), including receipts for foreign taxes withheld, if
applicable, shall bear interest at the rate of one and one-half percent
(1.5%) per month or the maximum rate allowable by applicable law, from the
date such payment is due until the date it is actually paid.
4.6 Payments and reports shall be sent to the address set forth in Exhibit D.
---------
-7-
<PAGE>
4.7 All referral fee statements and electronic reports shall be maintained in
confidence by MS and shall not be disclosed to any third part except to its
immediate legal and financial consultants as may be required in the
ordinary course of MS' business.
5. ACCEPTANCE, DISCLAIMER OF WARRANTY AND LIMITATION OF LIABILITY
--------------------------------------------------------------
5.1 Neither the COMPANY nor any of its employees shall have any right to in
make any representation, warranty, or promise on behalf of MS.
5.2 THE INTERNET CONNECTION WIZARD SOFTWARE, REFERRAL SERVER IMPLEMENTATION,
AND ANY OTHER TECHNOLOGY OR SOFTWARE (COLLECTIVELY, "TECHNOLOGIES")
PROVIDED TO COMPANY UNDER THIS AGREEMENT ARE PROVIDED "AS IS" WITHOUT
WARRANTY OF ANY KIND. THE ENTIRE RISK AS TO THE RESULTS AND PERFORMANCE OF
THE TECHNOLOGIES ARE ASSUMED BY COMPANY AND THE END-USER CUSTOMER.MS
DISCLAIMS ALL WARRANTIES, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT
LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR
PURPOSE AND NON-INFRINGEMENT.
5.3 IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR ANY DIRECT (EXCEPT AS TO
AMOUNTS OWED HEREUNDER), CONSEQUENTIAL, INDIRECT, INCIDENTAL, OR SPECIAL
DAMAGES WHATSOEVER, INCLUDING WITHOUT LIMITATION, DAMAGES FOR LOSS OF
BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS INFORMATION, AND
THE LIKE, ARISING OUT OF THIS AGREEMENT, EVEN IF THE OTHER PARTY HAS BEEN
ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
6. TERM OF AGREEMENT
-----------------
The term of this Agreement shall commence as of the Effective Date and
shall continue in force for twelve (12) months.
7. DEFAULT AND TERMINATION
-----------------------
7.1 COMPANY may terminate this Agreement for any reason upon ninety (90) days'
prior written notice.
7.2 This Agreement may terminate earlier if any of the following events of
default occur: (a) if either Party materially fails to perform or comply
with this Agreement or any provision hereof; (b) if either Party fails to
strictly comply with the provisions of Section 9; (c) if COMPANY makes or
attempts to make an assignment in violation of Section 12.5; (d) if either
Party becomes insolvent or admits in writing its inability to pay its debts
as they
-8-
<PAGE>
mature, or makes an assignment for the benefit of creditors; (e) if a
petition under any foreign, state, or United States bankruptcy act,
receivership statute, or the like, as they now exist, or as they may be
amended, is filed by either Party; or (f) if such a petition is filed by
any third party, or an application for a receiver of either Party is made
by anyone and such petition or application is not resolved favorably to
that Party within sixty (60) days.
7.3 Termination under Section 7.1 shall be effective ninety (90) days after
notice of termination is given. Termination under Section 7.2(b) shall be
effective as of the date notice is given by the non-defaulting Party. In
all other cases, termination shall be effective sixty (60) days after
notice of termination to COMPANY if COMPANY's defaults have not been cured.
The rights and remedies of MS provided in this Section shall not be
exclusive and are in addition to any other rights and remedies provided by
law or this Agreement.
7.4 Upon termination of this Agreement, COMPANY's Information shall be
immediately removed from the ISP Phone Book(s).
7.5 Sections 1, 4, 5, 6, 7, 9, 10 11 and 12 shall survive termination of this
Agreement.
8. SUPPORT
-------
8.1 COMPANY shall have the sole responsibility and expense for providing all
support for the Sign- up Server and all support needed by ISP Subscribers
for the ISP Service.
8.2 MS will, directly or through contract(s) with third party(ies), provide
COMPANY and ISP Subscribers support for the Internet Connection Wizard,
from initiation of the ICW by subscriber up through subscriber dial-up to
COMPANY's Sign-Up Server. Except for such support, this Agreement does not
include technical support from MS to COMPANY or ISP Subscribers.
Confidential Materials omitted and filed separately with the Securities and
Exchange Commission.
Asterisks denote omissions.
Technical support may be available from MS or an MS subsidiary pursuant to
a separate agreement.
8.3 COMPANY shall offer end user support for all versions of the Licensed
Software (as defined in the applicable IE Agreement) released by Microsoft
during the Term. COMPANY shall provide support [**].
9. NONDISCLOSURE AGREEMENT
-----------------------
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<PAGE>
COMPANY shall keep confidential the terms and conditions of this Agreement,
and other non-public information and know-how disclosed to COMPANY by MS.
However, COMPANY may disclose the terms and conditions of this Agreement in
confidence to its immediate legal and financial consultants as required in
the ordinary course of COMPANY's business. The Parties rights and
obligations with respect to other non-public information and know-how shall
be governed by that certain reciprocal Nondisclosure Agreement between the
Parties dated March 20, 1997.
10. NOTICES AND REQUESTS
All notices, authorizations, and requests in connection with this Agreement
shall be deemed given on the day they are (i) deposited in the U.S. mails,
postage prepaid, certified or registered, return receipt requested; or (ii)
sent by overnight courier, charges prepaid, with a confirming fax; and
addressed as follows:
NOTICES TO COMPANY:
- - ------------------
Prodigy Services Corporation
44 S Broadway
White Plains, NY 10601
Attn: General Counsel
Telephone: (914) 448-8000
Fax: (914) 448-8223
NOTICES TO MS:
- - --------------
MICROSOFT CORPORATION
One Microsoft Way
Redmond, WA 98052-6399
Attn: General Manager, Internet Customer Unit
Copy to: Law & Corporate Affairs, US Legal
Fax: (206) 936-7209
or to such other address as the party to receive the notice or request so
designates by written notice to the other.
-10-
<PAGE>
11. AUDITS
------
11.1 During the term of this Agreement, COMPANY agrees to keep all usual and
proper records and books of account and all usual and proper entries
relating to COMPANY's ISP Subscriptions sufficient to substantiate the
number of ISP Subscribers. COMPANY shall maintain on COMPANY premises such
records for itself and for each subsidiary which exercises rights under
this Agreement.
11.2 In order to verify statements issued by COMPANY and COMPANY's compliance
with the terms of this Agreement, MS may cause an audit to be made of
COMPANY's applicable books and records. Any audit shall be conducted
during COMPANY's regular business hours at COMPANY's facilities upon thirty
(30) days advance written notice. Any audit shall be conducted by an
independent certified public accountant of national stature selected by MS
(other than on a contingent fee basis).
11.3 COMPANY agrees to provide MS' designated audit team access to the relevant
COMPANY's records and facilities.
11.4 Prompt adjustment shall be made to compensate for any errors or omissions
disclosed by such audit. Any such audit shall be paid for by MS unless
material discrepancies are disclosed. "Material" shall mean the under
reporting of five percent (5%) of the amount due. If material
discrepancies are disclosed, COMPANY agrees to pay MS for the costs
associated with the audit in addition to the amount of any discrepancy.
12. GENERAL
-------
12.1 This Agreement shall be construed and controlled by the laws of the State
of Washington, and COMPANY consents to jurisdiction and venue in the state
and federal courts sitting in the State of Washington. Process may be
served on either party in the manner provided in Section 11 above, or by
such other method as is authorized by law.
12.2 Neither this Agreement, nor any terms and conditions contained herein,
shall be construed as creating a partnership, joint venture, agency
relationship or as granting a franchise.
12.3 This Agreement constitutes the entire agreement between the parties with
respect to the subject matter hereof and supersedes all prior and
contemporaneous agreements or communications with regard to the Parties co-
marketing of the ICW with Windows 98. This Agreement shall not be modified
except by a written agreement dated subsequent to the date of this
Agreement and signed on behalf of COMPANY and MS by their respective duly
authorized representatives. No waiver of any breach of any provision of
this Agreement shall constitute a waiver of any prior, concurrent or
subsequent breach of
-11-
<PAGE>
the same or any other provisions hereof, and no waiver shall be effective
unless made in writing and signed by an authorized representative of the
waiving party.
12.4 If any provision of this Agreement shall be held by a court of competent
jurisdiction to be illegal, invalid or unenforceable, the remaining
provisions shall remain in full force and effect.
12.5 The rights and obligations hereunder shall inure to the benefit of the
successors of the parties hereto, provided any rights or obligations
hereunder shall not be assigned by COMPANY without the prior written
approval of MS. COMPANY hereby agrees that it will remain responsible for
and guarantee the compliance of each majority owned subsidiary or affiliate
which exercises rights under this Agreement.
12.6 Each Party shall, at its own expense, obtain and arrange for the
maintenance in full force and effect of all governmental approvals,
consents, licenses, authorizations, declarations, filings, and
registrations as may be necessary for it to perform in accordance with all
of the terms and conditions of the Agreement including, but not limited to,
foreign exchange approvals, import and offer agent licenses, fair trade
approvals and all approvals which may be required to realize the purposes
of the Agreement.
12.7 In the event income taxes are required to be withheld by any non-U.S.A
government on payments required hereunder, COMPANY may deduct such taxes
from the amount owed MS and pay them to the appropriate tax authority.
COMPANY shall promptly deliver to MS an official receipt for any such taxes
withheld or other documents necessary to enable MS to claim a U.S.A.
Foreign Tax Credit. COMPANY will make certain that any taxes withhold are
minimized to the extent permitted by the applicable law.
12.8 If either MS or COMPANY employs attorneys to enforce any rights arising out
of or relating to this Agreement, the prevailing party shall be entitled to
recover reasonable attorneys' fees and costs.
12.9 The following Exhibits are part of this Agreement:
Exhibit A COMPANY ISP Service(s)
Exhibit B COMPANY Service Area
Exhibit C Referral Fee Report
Exhibit D Addresses For Payments/Reports
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<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date set
forth above. All signed copies of this Agreement shall be deemed originals.
MICROSOFT CORPORATION Prodigy Services Corp
---------------------
(COMPANY)
/s/J. Dossett /s/Marc Jacobson
- - ----------------------- ----------------------------
By (sign) By (sign)
Jeffrey J. Dossett Marc Jacobson
- - ----------------------- ----------------------------
Name: (Print) Name: (Print)
General Manager
Internet Customer Unit Acting CFO & General Counsel
- - ----------------------- ----------------------------
Title Title
8/18/98 7/2/98
- - ----------------------- ----------------------------
Date Date
-13-
<PAGE>
EXHIBIT A
---------
COMPANY'S ISP SERVICE(S)
Inclusion of COMPANY Information in ISP Phone Book(s) will be determined in
Microsoft's sole discretion. To assist Microsoft in its deliberations regarding
content of ISP Phone Books, COMPANY provides the following information, which
COMPANY may amend from time to time:
Description of ISP Services, specifying as applicable (1) area where the ISP
Service is offered, (2) target market (business, consumer, etc.), (3) brand
name, (4) marketing:
[For example:
"Acme Online Service" marketed to end-user and business customers under the
ACME Online Brand name in the United States.
"Acme.Com" service for end users of Acme OEM, Inc. PCs in the United
States, as exclusively marketed by Acme OEM, Inc.]
Prodigy Internet is marketed to the consumer end-user market and business
customers under the Prodigy Internet brand name in the United States of America.
-14-
<PAGE>
EXHIBIT B
---------
COMPANY SERVICE AREA
Inclusion of COMPANY Information in ISP Phone Book(s) will be determined in
Microsoft's sole discretion. To assist Microsoft in its deliberations regarding
content of ISP Phone Books, COMPANY provides the following information, which
COMPANY may amend from time to time.
1. Core Service Area(s) (Local POPs):
---------------------------------
[For example: All of California, Nevada, and Arizona
or
All of U.S. Area Codes 425, 206, and 253]
AK 907 ANCHORAGE CA 408 SAN JOSE
AL 205 ANNISTON CA 408 SANTA CRUZ
AL 205 BIRMINGHAM CA 415 SAN FRANCISCO
AL 205 FLORENCE CA 415 SAN RAFAEL
AL 205 GADSDEN CA 510 OAKLAND
AL 205 HUNTSVILLE CA 530 CHICO
AL 205 TUSCALOOSA CA 530 MARYSVILLE
AL 334 DOTHAN CA 530 REDDING
AL 334 MOBILE CA 530 SO. LAKE TAHOE
AL 334 MONTGOMERY CA 562 LOS ALAMITOS
AL 334 OPELIKA CA 562 WHITTIER
AR 501 FAYETTEVILLE CA 619 LA MESA
AR 501 FT. SMITH CA 619 RANCHO BERNARDO
AR 501 HOT SPRINGS CA 619 SAN DIEGO
AR 501 LITTLE ROCK CA 626 PASADENA
AR 870 JONESBORO CA 650 PALO ALTO
AR 870 PINE BLUFF CA 650 SAN MATEO
AZ 520 FLAGSTAFF CA 707 EUREKA
AZ 520 TUCSON CA 707 FAIRFIELD
AZ 520 YUMA CA 707 NAPA
AZ 602 PHOENIX CA 707 SANTA ROSA
CA 209 FRESNO CA 707 VALLEJO
CA 209 MERCED CA 714 IRVINE
CA 209 MODESTO CA 714 PLACENTIA
CA 209 STOCKTON CA 714 SADDLEBACK VALLEY
CA 209 VISALIA CA 714 SILVERADO
CA 213 LOS ANGELES CA 760 EL CENTRO
CA 213 LOS ANGELES CA 760 PALM SPRINGS
CA 310 EL SEGUNDO CA 760 VICTORVILLE
CA 310 INGLEWOOD CA 760 VISTA
CA 310 TORRANCE CA 805 BAKERSFIELD
CA 408 MONTEREY CA 805 LANCASTER
CA 408 SALINAS CA 805 MOORPARK
-15-
<PAGE>
CA 805 NEWHALL CA 805 OXNARD
CA 805 SAN LUIS OBISPO FL 561 VERO BEACH
CA 805 SANTA BARBARA FL 561 WEST PALM BEACH
CA 805 SANTA MARIA FL 813 CLEARWATER
CA 818 AGOURA FL 813 TAMPA
CA 818 BURBANK FL 850 DESTIN
CA 818 CANOGA PARK FL 850 PANAMA CITY
CA 818 NORTHRIDGE FL 850 PENSACOLA
CA 818 VAN NUYS FL 850 TALLAHASSEE
CA 909 CHINO FL 904 DAYTONA BEACH
CA 909 ONTARIO FL 904 JACKSONVILLE
CA 909 REDLANDS FL 941 FT. MYERS
CA 909 RIVERSIDE FL 941 LAKELAND
CA 916 FAIR OAKS FL 941 NAPLES
CA 916 SACRAMENTO FL 941 SARASOTA
CA 925 ANTIOCH FL 954 FT. LAUDERDALE
CA 925 PLEASANTON GA 404 ATLANTA
CA 925 WALNUT CREEK GA 706 ATHENS
CO 303 BOULDER GA 706 AUGUSTA
CO 719 COLORADO SPRINGS GA 706 CALHOUN
CO 719 PUEBLO GA 706 COLUMBUS
CO 970 FT. COLLINS GA 912 ALBANY
CO 970 GRAND JUNCTION GA 912 MACON
CO 970 GREELEY GA 912 PERRY
CT 203 BRIDGEPORT GA 912 SAVANNAH
CT 203 DANBURY HI 808 KAKAAKO (HONOLULU)
CT 203 NEW HAVEN HI 808 KEAUHOU
CT 203 NORWALK HI 808 MAUI (WAILAKU)
CT 203 OLD GREENWICH IA 319 CEDAR RAPIDS
CT 203 WATERBURY IA 319 DUBUQUE
CT 860 BLOOMFIELD IA 319 IOWA CITY
CT 860 MIDDLETOWN IA 319 WATERLOO
CT 860 NORWICH IA 515 AMES
CT 860 PUTNMA IA 515 DES MOINES
CT 860 SOUTHINGTON IA 515 MARSHALLTOWN
DE 302 DOVER IA 515 OTTUMWA
DE 302 GEORGETOWN IA 712 SIOUX CITY
DE 302 NEWARK ID 208 BOISE
DE 302 WILMINGTOM ID 208 COEUR D'ALENE
FL 305 MIAMI ID 208 IDAHO FALLS
FL 305 SUGARLOAF ID 208 POCATELLO
FL 352 GAINESVILLE ID 208 TWIN FALLS
FL 352 LEESBURG IL 217 CHAMPAIGN/URBANA
FL 352 OCALA IL 217 DANVILLE
FL 407 COCOA IL 217 DECATUR
FL 407 KISSIMMEE IL 217 QUINCY
FL 407 WINTER PARK IL 217 SPRINGFIELD
FL 561 BOCA RATON IL 309 BLOOMINGTON
FL 561 PORT ST. LUCIE IL 309 PEORIA
FL 561 STUART IL 309 ROCK ISLAND
-16-
<PAGE>
IL 312 CHICAGO DOWNTOWN IL 618 BELLEVILLE
IL 618 CARBONDALE KS 913 SALINA
IL 630 AURORA KS 502 TOPEKA
IL 630 BIG ROCK KS 502 LEAVENWORTH
IL 630 DOWNERS GROVE KY 502 BOWLING GREEN
IL 630 ELMHURST KY 502 FRANKFORT
IL 630 GENEVA KY 502 LOUISVILLE
IL 708 BEECHER KY 502 OWENSBORO
IL 708 CALUMET CITY KY 502 PADUCAH
IL 708 CHICAGO HGTS KY 606 LEXINGTON
IL 708 OAKLAWN LA 318 ALEXANDRIA
IL 708 TINELY PARK LA 318 LAFAYETTE
IL 773 CHICAGO SOUTH LA 318 LAKE CHARLES
IL 815 FREEPORT LA 318 MONROE
IL 815 GARDNER LA 318 SHREVEPORT
IL 815 JOLIET LA 504 BATON ROUGE
IL 815 KANKAKEE LA 504 NEW ORLEANS
IL 815 MOHENRY LA 504 SLIDELL
IL 815 MORRIS MA 413 HOLYOKE
IL 815 OTTAWA MA 413 PITTSFIELD
IL 815 PLAINFIELD MA 508 CATAUMET
IL 815 ROCKFORD MA 508 CHARLTON
IL 815 UTICA MA 508 CHATHAM
IL 815 WOODSTOCK MA 508 DENNIS
IL 847 ALGONQUIN MA 508 E BRIDGEWATER
IL 847 ANTIOCH MA 508 EASTON
IL 847 ELGIN MA 508 FALL RIVER
IL 847 ELK GROVE MA 508 FOXBORO
IL 847 EVANSTON MA 508 FRANKLIN
IL 847 LAKE FOREST MA 508 HOLDEN
IL 847 LIBERTYVILLE MA 508 HOLISTON
IL 847 NORTHBROOK MA 508 MARION
IL 847 PARK RIDGE MA 508 NORTHBORO
IN 219 ELKHART MA 508 SOUTHGATE
IN 219 FORT WAYNE MA 508 WELLFLEET
IN 219 MERRILVILLE MA 508 WHITTINSVILLE
IN 317 SOUTH BEND MA 617 CAMBRIDGE
IN 765 VALPARAISO MA 617 EAST BOSTON
IN 765 INDIANAPOLIS MA 617 ROXBURY
IN 765 KOKOMO MA 781 BRAINTREE
IN 765 LAFAYETTE MA 781 DEDHAM
IN 812 MARION MA 781 HINGHAM
IN 812 MUNCIE MA 781 KINGSTON
IN 812 BLOOMINGTON MA 781 LYNN
IN 316 EVANSVILLE MA 781 LYNNFIELD
IN 316 TERRA HAUTE MA 781 MALDEN
KS 785 HUTCHINSON MA 781 WALTHAM
KS 785 WICHITA MA 781 WOBURN
KS 785 LAWRENCE MA 978 AYER
KS 785 MANHATTAN MA 978 GARDNER
-17-
<PAGE>
MA 978 GLOUCESTER MA 978 LOWELL
MA 978 MAYNARD MI 906 ISHPEMING
MA 978 PETERSCHAM MN 218 DULUTH
MA 978 SALEM MN 218 HIBBING
MA 978 TOPSFIELD MN 320 ST. CLOUD
MA 978 TOWNSEND MN 507 MANKATO
MA 978 W NEWBURY MN 507 ROCHESTER
MD 301 CUMBERLAND MN 612 MINNEAPOLIS
MD 301 FREDERICK MO 314 CHESTERFIELD
MD 301 HAGERSTOWN MO 314 MANCHESTER
MD 301 HYATTSVILLE MO 314 ST. LOUIS
MD 301 LAUREL MO 417 JOPLIN
MD 301 SILVER SPRING MO 417 SPRINGFIELD
MD 410 ABERDEEN MO 573 CAPE GIRARDEAU
MD 410 BROOKLYN PARK MO 573 COLUMBIA
MD 410 COCKEYSVILLE MO 573 JEFFERSON CITY
MD 410 ELLICOTT CITY MO 573 ROLLA
MD 410 SALISBURY MO 816 KANSAS CITY
ME 207 AUGUSTA MO 816 ST. JOSEPH
ME 207 BANGOR MS 228 GULFPORT
ME 207 ELIOT MS 228 PASCAGOULA
ME 207 LEWISTON MS 601 HATTIESBURG
ME 207 PORTLAND MS 601 JACKSON
ME 207 PRESQUE ISLE MS 601 MERIDIAN
MI 248 HOLLY MS 601 TUPELO
MI 248 PONTIAC MS 601 VICKSBURG
MI 248 ROYAL OAK MT 406 BILLINGS
MI 248 SOUTH LYON MT 406 BOZEMAN
MI 248 SOUTHFIELD MT 406 BUTTE
MI 313 DETROIT MT 406 GREAT FALLS
MI 517 BAY CITY MT 406 HELENA
MI 517 HOWELL MT 406 MISSOULA
MI 517 JACKSON NC 704 ASHEVILLE
MI 517 LANSING NC 704 CHARLOTTE
MI 517 MIDLAND NC 704 GASTONIA
MI 517 SAGINAW NC 704 KANNAPOLIS
MI 616 BATTLE CREEK NC 910 FAYETTEVILLE
MI 616 BENTON HARBOR NC 910 GREESNBORO
MI 616 CADILLAC NC 910 HIGH POINT
MI 616 GRAND RAPIDS NC 910 WILMINGTON
MI 616 KALAMAZOO NC 910 WINSTON-SALEM
MI 616 MUSKEGON NC 919 DURHAM
MI 616 TRAVERSE CITY NC 919 GREENVILLE
MI 734 CHELSEA (ANN ARBOR) NC 919 RALEIGH
MI 734 YPSILANTI NC 919 ROCKY MOUNT
MI 810 FLINT ND 701 BISMARCK
MI 810 LAPEER ND 701 FARGO
MI 810 MT CLEMENS ND 701 GRAND FORKS
MI 810 PORT HURON ND 701 MINOT
MI 810 ST CLAIR NE 308 GRAND ISLAND
-18-
<PAGE>
NE 402 LINCOLN NE 402 OMAHA
NH 603 HANOVER NY 607 ELMIRA
NH 603 MANCHESTER NY 607 ENDICOTT
NH 603 NASHUA NY 607 ITHACA
NH 603 PETERBOROUGH NY 716 BUFFALO
NJ 201 HACKENSACK NY 716 JAMESTOWN
NJ 201 JERSEY CITY NY 716 PENDLETON
NJ 201 ORADELL NY 716 ROCHESTER
NJ 609 BORDEWNTOWN NY 718 BROOKLYN
NJ 609 CRANBURY NY 914 CARMEL
NJ 609 HADDONFIELD NY 914 CONGERS
NJ 609 MERCHANTVILLE NY 914 KINGSTON
NJ 609 MOUNT HOLLY NY 914 POUGHKEEPSIE
NJ 609 PITMAN NY 914 YONKERS
NJ 609 PLEASANTVILLE OH 216 CLEVELAND
NJ 609 PRINCETON OH 330 AKRON
NJ 609 VINELAND OH 330 CANTON
NJ 609 WILLIAMSTOWN OH 330 WARREN
NJ 732 HOLMDEL OH 330 YOUNGSTOWN
NJ 732 LAKEWOOD OH 419 FINDLEY
NJ 732 METUCHEN OH 419 LIMA
NJ 732 RAHWAY OH 419 MANSFIELD
NJ 732 RED BANK OH 419 TOLEDO
NJ 908 PEAPACK OH 440 ELYRIA
NJ 908 SOMERVILLE OH 513 CINCINNATI
NJ 973 BOONTON OH 614 COLUMBUS
NJ 973 ERSKINE LAKES OH 614 STEUBENVILLE
NJ 973 HOPATCONG OH 740 NEWARK
NJ 973 MADISON OH 740 ZANESVILLE
NJ 973 MOUNTAINVIEW OH 937 DAYTON
NJ 973 NEWARK OH 937 SPRINGFIELD
NJ 973 PATERSON OK 405 ARDMORE
NM 505 ALBUQUERQUE OK 405 ENID
NM 505 LAS CRUCES OK 405 LAWTON
NM 505 ROSWELL OK 405 OKLAHOMA CITY
NM 505 SANTA FE OK 918 TULSA
NV 702 CARSON CITY OR 503 PORTLAND
NV 702 LAS VEGAS OR 503 SALEM
NV 702 RENO OR 541 BEND
NY 212 NEW YORK CITY OR 541 CORVALLIS
NY 315 SYRACUSE OR 541 EUGENE
NY 315 UTICA OR 541 MEDFORD
NY 315 WATERTOWN PA 215 AMBLER
NY 516 BABYLON PA 215 DOYLESTOWN
NY 516 EASTPORT PA 215 PHILADELPHIA
NY 516 GARDEN CITY PA 215 WARRINGTON
NY 518 ALBANY PA 412 PITTSBURGH
NY 518 COLONIE PA 610 ALLENTOWN
NY 607 BINGHAMTON PA 610 BRYN MAWR
NY 607 CORNING PA 610 CHESTER
-19-
<PAGE>
PA 610 DOWNINGTON PA 610 EXTON
PA 610 KENNETT SQ TX 281 TOMBALL
PA 610 POTTSTOWN TX 409 BRYAN
PA 610 READING TX 409 NDRLAND/PORT NECHE
PA 610 SCHWENKSVILLE TX 409 TEXAS CITY
PA 610 SWARTHMORE TX 512 AUSTIN
PA 610 VALLEY FORGE TX 512 CORPUS CHRISTI
PA 717 HARRISBURG TX 512 VICTORIA
PA 717 HERSHEY TX 713 HOUSTON
PA 717 LANCASTER TX 806 AMARILLO
PA 717 SCRANTON TX 806 LUBBOCK
PA 717 WILKES-BARRE TX 817 FT. WORTH
PA 717 WILLIAMSPORT TX 903 LONGVIEW
PA 717 YORK TX 903 SHERMAN
PA 724 BUTLER TX 903 TEXARKANA
PA 724 GREESNBURG TX 903 TYLOR
PA 724 NEW CASTLE TX 915 ABILENE
PA 814 ALTOONA TX 915 EL PASO
PA 814 EERIE TX 915 MIDLAND
PA 814 JOHNSTOWN TX 915 ODESSA
PA 814 STATE COLLEGE TX 915 SAN ANGELO
RI 401 NEWPORT TX 940 DENTON
RI 401 PROVIDENCE TX 940 WICHITA FALLS
RI 401 WOONSOCKET TX 956 BROWNSVILLE
SC 803 AIKEN TX 956 HARLINGEN
SC 803 COLUMBIA TX 956 LAREDO
SC 803 FLORENCE TX 956 MCALLEN
SC 803 MYRTLE BEACH TX 972 MCKINNEY
SC 843 CHARLESTON UT 801 PROVO
SC 864 GREENVILLE UT 801 SALT LAKE CITY
SC 864 SPARTANBURG VA 540 HARRISONBURG
SD 605 PIERRE VA 540 ROANOKE
SD 605 RAPID CITY VA 703 FAIRFAX
SD 605 SIOUX CITY VA 703 MANASSAS
TN 423 BLOUNTVILLE VA 757 NEWPORT NEWS
TN 423 CHATTANOOGA VA 757 NORFOLK
TN 423 JOHNSON CITY VA 804 CHARLOTTESVILLE
TN 423 KNOXVILLE VA 804 LYNCHBURG
TN 615 NASHVILLE VA 804 PETERSBURG
TN 901 JACKSON VA 804 RICHMOND
TN 901 MEMPHIS VT 802 BURLINGTON
TN 931 CLARKSVILLE VT 802 MONTPELIER
TX 210 SAN ANTONIO WA 206 SEATTLE
TX 214 DALLAS WA 253 TACOMA
TX 254 KILLEEN WA 360 BELLINGHAM
TX 254 TEMPLE WA 360 BLACK DIAMOND
TX 254 WACO WA 360 LONGVIEW
TX 281 BAYTOWN WA 360 OLYMPIA
TX 281 DICKINSON WA 360 PORT ANGELES
TX 281 HOUSTON/BAMMEL WA 360 SILVERDALE
-20-
<PAGE>
WA 360 VANCOUVER WA 425 EVERETT
WA 509 KENNEWICK WI 920 GREEN BAY
WA 509 PULLMAN WI 920 OSHKOSH
WA 509 SPOKANE WI 920 SHEBOYGAN
WA 509 YAKIMA WV 304 BLUEWELL
WI 414 KENOSHA WV 304 CHARLESTON
WI 414 RACINE WV 304 CLARKSBURG
WI 414 WAUKESHA WV 304 HUNTINGTON
WI 414 WEST BEND WV 304 MORGANTOWN
WI 608 BELOIT WV 304 PARKERSBURG
WI 608 LA CROSSE WV 304 WHEELING
WI 608 MADISON WY 307 CASPER
WI 715 EAU CLAIRE WY 307 CHEYENNE
WI 715 WAUSAU WY 307 LARAMIE
WI 920 APPLETON
2. Extended Service Area(s) (Long Distance or toll-free access). Toll-Free
------------------------------------------------------------
access in the United States.
-21-
<PAGE>
Confidential Materials omitted and filed separately with the Securities and
Exchange Commission.
Asterisks denote omissions.
EXHIBIT C
---------
QUARTERLY REFERRAL FEE REPORT
Report for ________________________________
Reporting Period: ____________________, 199_ to __________________, 199_
Microsoft License # _____________________
Referral Fee Calculation:
A. Total new ISP Subscribers for the Quarter _______ x [**] = _______
B. Previously reported ISP Subscriber accounts
lasting (90) days which terminated during
the Quarter _______ x [**] = _______
C. Total fees due (Line A - Line B) = _________
D. Total number of copies of Licensed Software
distributed through all channels = ____________
The undersigned hereby certifies that he/she is an officer or director of
COMPANY and that this report is complete and correct.
_______________________________ (Signature)
__________________________________ (Print)
__________________________________ (Title)
__________________________________ (Date)
Telephone Number: ( )
-------------------------------
-22-
<PAGE>
EXHIBIT D
---------
ADDRESSES FOR PAYMENTS/REPORTS:
-------------------------------
Payments Made by Check and Associated Reports to:
- - -------------------------------------------------
MICROSOFT CORPORATION
Microsoft North America Collections
P.O. Box 844505
Dallas, TX 75284-4505
For Overnight Delivery to:
- - --------------------------
MICROSOFT CORPORATION
Microsoft North American Collections
Lockbox #844505
1401 Elm Street
5th Floor
Dallas, TX 75202
Invoice No:___________________
Payments made by wire transfer to:
- - ----------------------------------
MICROSOFT CORPORATION
c/o NationsBank
Microsoft North American Collections #844505
Account #3750771767
ABA #1110000-2
NationsBank of Texas, N.A.
Regarding:
Microsoft ICU Collections
or to such other bank, address or account as MS may specify from time to time by
written notice to COMPANY. COMPANY agrees to ensure that the regarding line
stated above, the MS license agreement number for the Agreement, and the MS
invoice number, if any, are specified on each payment made pursuant to the
Agreement. One day prior to making any wire transfer, COMPANY shall send to MS
a fax containing all remittance information with a cover sheet listing the
COMPANY's name, the date of the wire transfer, the amount of the wire transfer,
and the number of pages being faxed to the attention of:
ICU Accounts Receivable
Microsoft Corporation
1-425-936-5140
-23-
<PAGE>
Exhibit 10.39
MICROSOFT(R) INTERNET EXPLORER
LOGO LICENSE AGREEMENT
This Microsoft(R) Internet Explorer Logo License Agreement is made and entered
into this 2nd day of July, 1998 ("Effective Date") by and between MICROSOFT
CORPORATION, a Washington corporation located at One Microsoft Way, Redmond, WA
98052-6399 ("Microsoft"), and PRODIGY SERVICES CORPORATION, a Delaware
corporation located at 44 S Broadway, White Plains, NY 10601 ("Company").
1. DEFINITIONS
-----------
(a) "Internet Explorer" or "IE" shall mean the Microsoft software that
upgrades Windows 95 or Windows 98 to the Internet Explorer, version 4.x
or higher level of functionality.
(b) "IE Agreement" shall mean the Microsoft Internet Explorer License and
Distribution Agreement currently in effect between the parties.
(c) "IEAK Agreement" shall mean, if applicable, the IEAK Customization Rights
Exhibit to the IE Agreement.
(d) "Referral Server Agreement", shall mean, if applicable, the Microsoft
Windows 98 and/or any other "Get Connected" Co-Marketing Agreement(s)
and/or other referral server agreement(s) executed by the parties.
(e) "Logo" shall mean the Microsoft(R) Internet Explorer logo(s) depicted in
the "Guidelines", or such additional or replacement Microsoft Internet
Explorer logos as MS may provide from time to time under this Agreement.
(f) "Guidelines" shall mean the web page entitled "Microsoft Internet
Explorer logos available for your use", which is currently located at
http://ieak.microsoft.com/logo/asp#elogo, or any successor thereto.
------------------------------------------------------------------
(g) "Product" shall mean the COMPANY product(s) described on the registration
form and identified as "Internet Product" in the IE Agreement and/or the
Referral Server Agreement(s), and which are distributed or provided to
customers together with Microsoft Internet Explorer, in accordance with
the IE, IEAK, and/or Referral Server Agreement(s).
-1-
<PAGE>
(h) "Territory" subject to 2(b), shall be as defined in the IE and/or
Referral Server Agreement(s).
2. LICENSE GRANT
-------------
(a) Subject to and expressly conditioned upon compliance with the terms and
conditions of this Agreement, MS hereby grants to COMPANY a worldwide (except as
provided in Section 2(b)), nonexclusive, nontransferable, royalty-free, personal
right to use the Logo solely in conjunction with Product in the manner described
in the Guidelines, and as may be prescribed by MS from time to time.
(b) The license right set forth in Section 2(a) shall not extend to the
Republic of China ("Taiwan"). South Korea ("Korea"), or the People's Republic
of China ("PRC"), unless and until COMPANY provides MS with written notice of
COMPANY's intent to distribute Product in these countries. COMPANY agrees not
to use the Logo in such countries and shall not be licensed pursuant to this
Agreement to do so until COMPANY has provided MS with such written notice.
(c) COMPANY may not use or reproduce the Logo in any manner whatsoever other
than as expressly described in the Guidelines.
(d) COMPANY agrees and acknowledges that MS retains all right, title and
interest in and to the Logo. Except as expressly granted in this Agreement,
COMPANY shall have no rights in the Logo. Under no circumstances will anything
in this Agreement be construed as granting, by implication, estoppel or
otherwise, a license to any MS technology or propriety right other than the
permitted use of the Logo pursuant to Section 2(a).
(e) COMPANY represents and warrants that it will use the Logo solely as
provided in this Agreement and will not use the Logo for promotional goods or
for Product which, in MS' reasonable judgment, will diminish or otherwise damage
MS' goodwill in the Logo, including but not limited to uses which could be
deemed to be obscene, pornographic, excessively violent or otherwise in poor
taste or unlawful, or which purpose or objective is to encourage unlawful
activities.
3. NO FURTHER CONVEYANCES
----------------------
The license grant in Section 2(a) is personal to COMPANY, and COMPANY shall
not assign, transfer or sublicense this Agreement (or any right granted herein)
in any manner without the prior written consent of MS.
-2-
<PAGE>
4. QUALITY, INSPECTION, AND APPROVAL
---------------------------------
(a) COMPANY agrees to maintain the quality of Product used in conjunction
with the Logo at a level that meets or exceeds industry standards and is
at least commensurate with the quality of Product previously distributed
by COMPANY.
(b) COMPANY shall supply MS with suitable specimens of Product and COMPANY's
use of the Logo in connection with Product at any time upon reasonable
notice from MS. COMPANY shall cooperate fully with MS to facilitate
periodic review of COMPANY's use of the Logo and of COMPANY's compliance
with the quality standards described in this Agreement.
(c) COMPANY shall fully correct and remedy any deficiencies in its use of the
Logo and/or the quality of Product used in conjunction with the Logo,
upon reasonable notice from MS.
(d) COMPANY represents and warrants that Product shall be distributed to
customers with Microsoft Internet Explorer in accordance with the IE,
IEAK, and/or Referral Server Agreement(s), and meets all requirements and
specifications in the IE, IEAK, and/or Referral Server Agreement(s).
(e) COMPANY warrants and represents that it will comply with all applicable
laws, rules, and regulations regarding promotion and sale of Product with
the Logo, and will not violate or infringe any right of any third party.
(f) COMPANY agrees to indemnify and defend MS from and against any and all
claims, damages, costs, and expenses (including reasonable attorneys'
fees) and pay the amount of any adverse final judgment (or settlement to
which both parties consent) arising out of or related to the Product in
any manner, including user claims regarding Product's incompatibility
with Internet Explorer; provided COMPANY is notified promptly in writing
of any claim, COMPANY has sole control over its defense or settlement,
and MS provides reasonable assistance in the defense of the same.
5. IDENTIFICATION AND USE
----------------------
(a) COMPANY shall mark every use of the Logo with the trademark designations
set forth in the Guidelines and shall comply with MS' trademark use
guidelines as amended from time to time.
(b) COMPANY acknowledges MS' ownership of the Logo and the "Microsoft"
trademark. COMPANY shall employ best efforts to use the Logo in a manner
that does not derogate from MS' rights in the Logo and will take no
action that will interfere with or diminish MS' rights in the Logo,
either during the term of this Agreement or afterwards. COMPANY agrees
not to adopt, use or register any
-3-
<PAGE>
corporate name, tradename, trademark, domain name, service mark or
certification mark, or other designation similar to, or containing in
whole or in part, the Logo. COMPANY agrees that all use of the Logo by
COMPANY will inure to the benefit of MS. COMPANY may not use the Logo in
any way as an endorsement or sponsorship of Product by MS.
6. DEFENSE OF INFRINGEMENT CLAIM
-----------------------------
(a) MS agrees to indemnify and defend COMPANY from and against any and all
claims, damages, costs, and expenses (including reasonable attorneys'
fees), and pay the amount of any adverse final judgment (or settlement to
which both parties consent) resulting from, third party claim(s)
(hereinafter "Indemnified Claims") that the Logo infringes any trademark
rights of such third party in the Territory; provided MS is notified
promptly in writing of the Indemnified Claim and has sole control over
its defense or settlement, and COMPANY provides reasonable assistance in
the defense of the same.
(b) In the event MS receives information concerning an intellectual property
infringement claim (including an Indemnified Claim) related to the Logo,
MS may at its expense, without obligation to do so, either (i) procure
for COMPANY the right to continue to distribute the alleged infringing
Logo, or (ii) replace or modify the Logo to make it non-infringing, and
in which case, COMPANY shall thereupon cease distribution of the alleged
infringing Logo.
(c) MS shall have no liability for any intellectual property infringement
claim (including an Indemnified Claim) based on COMPANY's manufacture,
distribution, or use of the Logo after MS' notice that COMPANY should
cease use of such Logo due to such a claim. For all claims described in
this Section 6(c), COMPANY agrees to indemnify and defend MS from and
against all damages, costs and expenses, including reasonable attorneys'
fees.
(d) MS MAKES NO WARRANTIES EITHER EXPRESS, IMPLIED, STATUTORY OR OTHERWISE
WITH RESPECT TO THE LOGO, INCLUDING ANY WARRANTY OF NON-INFRINGEMENT,
IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR
PURPOSE.
-4-
<PAGE>
7. CONSEQUENTIAL ET. AL. DAMAGES
-----------------------------
EXCEPT AS PART OF A THIRD PARTY DAMAGE CLAIM FOR WHICH ONE OF THE PARTIES IS
OBLIGATED TO INDEMNIFY THE OTHER, NEITHER PARTY SHALL BE LIABLE FOR ANY
CONSEQUENTIAL INCIDENTAL, INDIRECT, PUNITIVE OR SPECIAL DAMAGES (INCLUDING LOSS
OF BUSINESS PROFITS) ARISING FROM OR RELATED TO COMPANY'S MARKETING,
DISTRIBUTION OR ANY USE OF THE LOGO, REGARDLESS OF WHETHER SUCH LIABILITY IS
BASED ON BREACH OF CONTRACT, TORT, STRICT LIABILITY, BREACH OF WARRANTIES,
INFRINGEMENT OF INTELLECTUAL PROPERTY, FAILURE OF ESSENTIAL PURPOSE OR
OTHERWISE, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. IN NO EVENT
SHALL MS BE LIABLE FOR ANY DAMAGES FOR COMPANY'S USE OF THE LOGO IN VIOLATION OF
THE TERMS AND CONDITIONS OF THIS AGREEMENT
8. INFRINGEMENT
------------
COMPANY shall promptly notify MS of any suspected infringement of or
challenge to the Logo or any of its constituent elements.
9. TERM OF AGREEMENT
-----------------
(a) The term of this Agreement shall run from the Effective Date until the
earlier of (i) the date on which COMPANY ceases licensing and distributing any
Products to third parties pursuant to the terms of the IE, IEAK, and/or Referral
Server Agreement(s) or (ii) the date of expiration or termination of the IE,
IEAK, and/or Referral Server Agreement(s); provided however, that MS shall have
the right to terminate this Agreement with or without cause upon thirty (30)
days prior written notice.
(b) From and after termination or expiration of this Agreement, COMPANY shall
cease and desist from all use of the Logo. However, unless the Agreement is
terminated for breach, COMPANY may distribute then-existing units of Product and
advertising materials containing the Logo for a period of ninety (90) days from
the termination date provided use of the Logo in connection with such inventory
is in compliance with the terms and conditions of this Agreement.
10. NOTICES
-------
All notices and other communications under this Agreement shall be in writing
and shall be deemed given if delivered personally, mailed by registered or
certified mail, return receipt requested, or sent by telecopy with a receipt
confirmed by telephone, to the parties at the following addresses or to such
other addresses as a party may from time to time notify the other parties.
-5-
<PAGE>
MS: MICROSOFT CORPORATION
One Microsoft Way
Redmond, WA 98052-6399
USA
Attention: Microsoft Internet Explorer
Logo Department
Fax: (425) 936-7329
With Copy
To: MICROSOFT CORPORATION
One Microsoft Way
Redmond, WA 98052-6399
USA
Attention: Law & Corporate Affairs, Trademarks
Fax: (425) 869-1327
COMPANY: Information listed in the registration form.
11. ENTIRE AGREEMENT; AMENDMENT
---------------------------
MS' providing this Agreement to COMPANY does not constitute an offer by MS.
Upon COMPANY's acceptance of the terms herein by submitting the registration
form below, this Agreement, including all Exhibits, contains the entire
agreement of the parties with respect to the subject matter hereof, and shall
supersede and merge all prior and contemporaneous communications. It shall not
be amended except by a written agreement subsequent to the Effective Date and
signed on behalf of the parties by their respective authorized representatives.
12. GOVERNING LAW; ATTORNEYS' FEES; EQUITABLE RELIEF
------------------------------------------------
(a) This Agreement shall be governed by and construed in accordance with the
laws of the State of Washington. COMPANY hereby consents to jurisdiction and
venue in the state and federal courts sitting in the State of Washington. The
parties agree to accept service of process by U.S. certified or registered mail,
return receipt requested, or by any other method authorized by applicable law.
(b) If either party employs attorneys to enforce any rights arising out of or
related to this Agreement, the prevailing party shall be entitled to recover its
reasonable attorneys' fees, costs, and other expenses.
-6-
<PAGE>
(c) COMPANY acknowledges that a breach by it of this Agreement may cause MS
irreparable damage that cannot be remedied in monetary damages in an action law,
and may also constitute infringement of the Logo. In the event of any breach
that could cause irreparable harm to MS, or cause some impairment or dilution of
its reputation or Logo, MS shall be entitled to an immediate injunction, in
addition to any other legal or equitable remedies.
13. HEADINGS
--------
Section headings are used in this Agreement for convenience of reference only
and shall not affect the meaning of any provision of this Agreement.
14. NO WAIVER
---------
No waiver of any breach of any provision of this Agreement shall constitute a
waiver of any prior, concurrent or subsequent breach of the same or any other
provision hereof, and no waiver shall be effective unless made in writing and
signed by an authorized representative of the waiving party.
15. SEVERABILITY
------------
If any provision of this Agreement (or any other agreements incorporated
herein) shall be held by a court of competent jurisdiction to be illegal,
invalid or unenforceable, the remaining provisions shall remain in full force
and effect.
16. RELATIONSHIP
------------
Neither this Agreement, nor any terms and conditions contained herein, shall
be construed as creating a partnership, joint venture or agency relationship or
as granting a franchise.
17. SURVIVAL
--------
The provisions of Sections 2(d), 5(b) and 7, as well as Section 4(f) with
respect to Product(s) distributed during the term of this Agreement and 6(a) for
claims based on use of the Logo permitted herein, shall survive expiration or
termination of this Agreement.
-7-
<PAGE>
IN WITNESS WHEREOF, the parties have entered into this Agreement as of the
Effective Date written above.
MICROSOFT CORPORATION COMPANY Prodigy Services Corp
/s/J. Dossett /s/Marc Jacobson
- - ------------------------- --------------------------
By (sign) By (sign)
Jeffrey J. Dossett Marc Jacobson
- - ------------------------- --------------------------
Name: (Print) Name: (Print)
General Manager
Internet Customer Unit Acting CFO & General Counsel
- - ------------------------- --------------------------
Title Title
8/18/98 7/2/98
- - ------------------------- --------------------------
Date Date
-8-
<PAGE>
Exhibit 10.40
MICROSOFT INTERNET EXPLORER
LICENSE AND DISTRIBUTION AGREEMENT
Document Version 4.0, April 10, 1998
This Internet Explorer License and Distribution Agreement ("Agreement") is made
and entered into this 2nd day of July, 1998 ("Effective Date") by and between
MICROSOFT CORPORATION, a Washington corporation located at One Microsoft Way,
Redmond, WA 98052-6399 ("Microsoft"), and PRODIGY SERVICES CORPORATION, a
Delaware corporation located at 44 S. Broadway, White Plains, NY 10601
("Company").
1. DEFINITIONS
(1) "Browsing Software" means software (whether part of an operating system
or available as a separate product) designed to view, render, browse or
otherwise interact with the Internet, the Web, and/or other public
networks now existing or hereafter created;
(2) "Email Client" means software which is used to compose, transmit,
retrieve, and read electronic messages using peer-to-peer, store and
forward, or similar email communication methods, whether part of an
operating system (e.g., Outlook Express in Windows 98) or available as a
separate product (e.g., Hotmail).
(3) "Internet Site" means Company's Web site(s).
(4) "Internet Product" means the Company-labeled product(s) and services
which provided (i) access to the Internet, (ii) printed or online
information about the Internet, and/or (iii) Content which is used or
viewed in conjunction with the Internet; provided, however, that
"Internet Product" does not include a personal computer.
(5) "Logo" means the "Microsoft(R) Internet Explorer" logo(s) (or any
successor(s) thereof) to be licensed to Company by separate agreement.
(6) "Licensed Software" means, in object code form only for Platforms in all
available languages requested by Company, the Microsoft software
identified in Exhibit A, as may be amended from time to time.
(7) "Platforms" means Windows 3.x (including Windows for Workgroups 3.x),
Windows 95, Windows 98, Windows NT, Apple Macintosh, and UNIX.
-1-
<PAGE>
2. LICENSE GRANTS, CONDITIONS & RESTRICTIONS
(1) Licensed Software. Microsoft grants to Company a nonexclusive, limited,
-----------------
worldwide, royalty-free license to use, reproduce and distribute
(directly and indirectly through Company's distributors) through
Company's distribution channels (including, but not limited to,
distribution via the Web) the Licensed Software solely as part of or for
use in conjunction with Company's Internet Product to Company's end user
customers and prospective end user customers. The foregoing license is
expressly subject to the following conditions:
(1) No Standalone Distribution. The Licensed Software may only be
distributed as part of or for use with Company's Internet Product,
and not as a "standalone" product; provided, however, that Company or
Company's sublicensees may distribute updates of the Licensed
Software separately for purposes of updating an existing end user
customer of an Internet Product.
(2) No Distribution Apart from Web Browsing Software and Email Client. No
component part(s) of the Licensed Software (e.g., NetShow,
NetMeeting) may be distributed separate from the Internet Explorer
and Outlook Express operating system updates or technologies.
(3) New Releases. If Microsoft makes a new release of Licensed Software
available, then: (i) Company shall use reasonable efforts to cease
reproduction and distribution of the older version of the Licensed
Software component and shall promptly commence reproduction and
distribution of the new release of the Licensed Software component
with Company's Internet Product, provided that Company may deplete is
existing inventory of Company's Internet Product containing a prior
version of the Licensed Software, (ii) Company shall make the new
release of Licensed Software available to its end user customers, and
(iii) Company shall use reasonable efforts to notify its end users
that a new release of the Licensed Software may be available from
Company (with indication of appropriate URL) or from Microsoft by at
lease including substantially the following notice on Company's main
public web site for the Internet Product: "A new version of the
Licensed Software (or component thereof) may be available. Please go
to [applicable Company URL] to update your software."
(4) End Users and Distributors. Company's sublicenses will not be
materially inconsistent with the terms and conditions of this
Agreement regarding rights granted by and obligations imposed upon
Company by Microsoft.
-2-
<PAGE>
(5) License Restrictions. The following restrictions apply to the
license grant in this Section 2: (i) Company may not reverse
engineer, decompile or disassemble the Licensed Software; (ii)
Company may not authorize further redistribution of the Licensed
Software by end users of Company's Internet Product; and (iii)
Company shall maintain and not alter or remove any copyright,
trademark, and other protective notices contained in the Licensed
Software, including the end user license agreement ("EULA") which is
included in the setup installation of the Licensed Software. Company
shall also comply with the Guidelines.
3. COMPANY OBLIGATIONS
In partial consideration for the royalty-free license grants set forth in
Article 2 above, Company shall perform the following obligations:
(1) As a condition precedent to exercise of any rights under this Agreement,
Company shall accept the terms of the Microsoft Internet Explorer Logo
License Agreement ("Logo Agreement") located at
ieak.microsoft.com/logo.asp#elogo.
---------------------------------
(2) Company shall provide Microsoft with a quarterly volume distribution
summary detailing the number of copies of the Licensed Software it has
distributed the quarter within forty-five (45) days following the end of
each calendar quarter. Such summary shall specify separately each
component, component version(s), and Platform(s) distributed and the
means of distribution (Web download or CDROM) and shall be submitted to
https://ieak.microsoft.com/secure/addReport.asp. In the event Company
-----------------------------------------------
distributed no copies of the Licensed Software, Company shall indicate
this on the volume distribution summary. Microsoft shall maintain all
distribution summary reports in confidence and may only disclose such
reports to its immediate legal and financial consultants as may be
required in the ordinary course of Microsoft's business.
(3) Company shall maintain the quality of the Internet Product at a level
that meets or exceeds industry standards and that is at least
commensurate with the quality of products distributed by Company on or
before the Effective Date.
(4) Company shall participate in the following co-marketing activities:
(1) Authorize Microsoft to use Company's name in press releases or other
Microsoft advertising or promotions, and to identify Company as a
licensee of the Licensed Software;
(2) Make the Licensed Software available for use internally under
Company's customary information services policies and procedures.
-3-
<PAGE>
4. OWNERSHIP
Except as expressly licensed to Company in Section 2, Microsoft retains all
right, title and interest in and to the Licensed Software. All rights not
expressly granted herein are reserved by Microsoft.
5. ACCEPTANCE AND DISCLAIMER OR WARRANTY
(1) The Licensed Software is deemed accepted by Company.
(2) Neither the Company nor any of its distributors or employees shall have
any right to make any representation, warranty, or promise on behalf of
Microsoft.
(3) THE LICENSED SOFTWARE ARE PROVIDED TO COMPANY AS IS WITHOUT WARRANTY OF
ANY KIND. THE ENTIRE RISK AS TO THE RESULTS AND PERFORMANCE OF THE
LICENSED SOFTWARE ARE ASSUMED BY COMPANY AND THE END-USER CUSTOMER.
MICROSOFT DISCLAIMS ALL WARRANTIES, EITHER EXPRESS OR IMPLIED, INCLUDING
BUT NOT LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A
PARTICULAR PURPOSE, TITLE AND NON-INFRINGEMENT.
6. LIMITATION OF LIABILITY
IN NO EVENT SHALL MICROSOFT BE LIABLE FOR ANY DIRECT, CONSEQUENTIAL, INDIRECT,
INCIDENTAL, OR SPECIAL DAMAGES WHATSOEVER, INCLUDING WITHOUT LIMITATION, DAMAGES
FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS
INFORMATION, AND THE LIKE, ARISING OUT OF THE USE OF OR INABILITY TO USE THE
LICENSED SOFTWARE, EVEN IF MICROSOFT HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH
DAMAGES.
7. TERM
The term of this Agreement shall commence as of the Effective Date and shall
continue for a period of one (1) year. Thereafter, this Agreement shall
automatically renew for successive one year periods unless either party gives
the other party not fewer than sixty (60) days' notice of its intent not to
renew, unless earlier terminated as provided in Section 8.
8. DEFAULT AND TERMINATION
(1) Either party may terminate this Agreement for any reason upon sixty (60)
days prior written notice.
-4-
<PAGE>
(2) Either party may suspend performance and/or terminate this Agreement
immediately upon written notice at any time if the other party is in
material breach of any material warranty, term, condition or covenant of
this Agreement, and fails to cure that breach within sixty (60) days
after the written notice thereof.
(3) Upon termination of this Agreement for any reason, Company's rights under
Section 2 immediately terminate, and Company shall return to Microsoft or
destroy all full or partial copies of the Licensed Software in Company's
possession or under its control within ten (10) days following the
termination date.
(4) End-user sublicenses validly granted prior to expiration or termination
of this Agreement shall survive termination or expiration of this
Agreement; sublicenses granted to Marketing Affiliates shall be
coterminous with Company's licenses.
(5) Sections 1, 4, 5, 6, 8, 9, 10 and 11 shall survive termination of this
Agreement.
9. SUPPORT
COMPANY shall be responsible for providing support for end users of any versions
of the Licensed Software and COMPANY's Internet Product distributed by COMPANY.
10. NOTICES AND REQUESTS
Except as otherwise provided on Exhibit A, all notices, authorizations, and
requests in connection with this Agreement shall be deemed given on the day they
are (i) transmitted via electronic mail with a copy deposited in the mail,
postage prepaid, certified or registered, return receipt requested; or (ii) sent
by overnight courier, charges prepared, with a confirming fax; and addressed as
follows:
NOTICES TO Company:
------------------
Prodigy Services Corporation
44 S. Broadway
White Plains, NY 10601
Attn: General Council
Telephone: (914) 448-8000
Fax: (914) 448-8223
Email Address:_________________
NOTICES TO Microsoft:
--------------------
Notices: MICROSOFT CORPORATION
One Microsoft Way
-5-
<PAGE>
Redmond, WA 98052-6399
Attn: General Manager, Internet Customer Unit
Email Address: ____________________
Copy to: Law & Corporate Affairs, US Legal
Fax: (206) 936-7209
Distribution summaries: choose the "Report" option at:
https://ieak.microsoft.com/secure/addReport.asp
-----------------------------------------------
or to such other address as the party to receive the notice or request so
designates by written notice to the other.
11. GENERAL
(1) This Agreement shall be governed by the laws of the State of Washington,
USA, as though entered into between Washington residents and to be
performed entirely within the State of Washington, and Company consents
to jurisdiction and venue in the state and federal courts sitting in the
State of Washington.
(2) Neither this Agreement, nor any terms and conditions contained herein,
shall be construed as creating a partnership, joint venture, agency
relationship or as granting a franchise.
(3) No waiver of any breach of any provision of this Agreement shall
constitute a waiver of any prior, concurrent or subsequent breach of the
same or any other provisions hereof, and no waiver shall be effective
unless made in writing and signed by an authorized representation of the
waiving party.
(4) If any provision of this Agreement shall be held by a court of competent
jurisdiction to be illegal, invalid or unenforceable, the remaining
provisions shall remain in full force and effect.
(5) The rights and obligations hereunder shall inure to the benefit of the
successors of the parties hereto, provided any rights or obligations
hereunder shall not be assigned by Company without the prior written
approval of Microsoft, such approval shall not be unreasonably withheld.
(6) Any Licensed Software which Company distributes or licenses to or on
behalf of the United States of America, its agencies and/or
instrumentalities (the "Government"), shall be provided with RESTRICTED
RIGHTS in accordance with DFARS 252.227-7013(c)1(ii), or as set forth in
the particular department or agency regulations or rules, or particular
contract which provide Microsoft equivalent or greater protection.
-6-
<PAGE>
(7) Company acknowledges that the Licensed Software is subject to the export
control laws and regulations of the US, and any amendments thereof.
Company confirms that with respect to the Licensed Software, it will not
export or re-export it, directly or indirectly, either to (i) any
countries that are subject to US export restrictions (currently
including, but not necessarily limited to, Cuba, Iran, Iraq, Libya, North
Korea, Sudan, and Syria); (ii) any end user who Company knows or has
reason to know will utilize them in the design, development or production
of nuclear, chemical or biological weapons; or (iii) any end user who has
been prohibited from participating in the US export transactions by any
federal agency of the US government. Company further acknowledges that
the Licensed Software may include technical data subject to export and
re-export restrictions imposed by US law.
(8) Company shall, at its own expense, promptly obtain and arrange for the
maintenance of all non-U.S.A. government approvals, if any, and comply
with all applicable local laws and regulations as may be necessary for
Company's performance under this Agreement.
(9) Company shall pay, and be responsible for any and all sales taxes, use
taxes and any other taxes imposed by any jurisdiction as a result of (i)
the entry into this Agreement; (ii) the performance of any of the
provisions of this Agreement; or (iii) the transfer of any property,
rights or any other grant hererunder.
(10) If either Microsoft or Company employs attorneys to enforce any rights
arising out of or relating to this Agreement, the prevailing party shall
be entitled to recover reasonable attorneys' fees and costs.
(11) This Agreement constitutes the entire agreement between the parties with
respect to the subject matter hereof and supersedes all prior and
contemporaneous agreements or communications. It shall not be modified
except by a written agreement dated subsequent to the date of this
Agreement and signed on behalf of Company and Microsoft by their
respective duly authorized representatives.
IN WITNESS WHEREOF, the parties have entered into this Agreement as of the
Effective Date written above.
MICROSOFT CORPORATION COMPANY Prodigy Services Corp
/s/J. Dossett /s/Marc Jacobson
- - ----------------------- --------------------------
By (sign) By (sign)
Jeffrey J. Dossett Marc Jacobson
- - ----------------------- --------------------------
Name: (Print) Name: (Print)
General Manager
Internet Customer Unit Acting CFO & General Counsel
- - ----------------------- ---------------------------
Title Title
8/18/98 7/2/98
- - ----------------------- ----------------------------
Date Date
-7-
<PAGE>
EXHIBIT A
LICENSED SOFTWARE
<TABLE>
<CAPTION>
Technology Name Technology Version Language Version
- - ---------------------------------------------------------------------------------
<S> <C> <C>
- - ---------------------------------------------------------------------------------
Internet Explorer* 3.x, 4.x All publicly released
- - ---------------------------------------------------------------------------------
Outlook Express* 4.x All publicly released
- - ---------------------------------------------------------------------------------
Comic Chat All publicly released final versions All publicly released
- - ---------------------------------------------------------------------------------
NetShow All publicly released final versions All publicly released
- - ---------------------------------------------------------------------------------
FrontPage Express All publicly released final versions All publicly released
- - ---------------------------------------------------------------------------------
NetMeeting 1x, 2x All publicly released
- - ---------------------------------------------------------------------------------
</TABLE>
Special Notice Regarding Technology Upgrades and Amendments
All Licensed Software includes the indicated Technology Version only. Microsoft
reserves the right to amend this Agreement in the event of public release of new
versions any of the Licensed Software (for example, release of IE 5.x). In the
event that Microsoft elects to amend any of the terms and conditions of this
Agreement, upon release of a new Technology Version Microsoft will make
available through its http:/ieak.microsoft.com Web site (or any successor
------------------------
thereto):
(1) Identification of the new Technology Version;
(2) An amendment to this Agreement ("Amendment"), setting forth the new terms
and conditions that shall govern this Agreement;
(3) Means for Company to "click accept" that Amendment.
Microsoft's notice regarding the Amendment will include notice (pursuant to
section 7 of the Agreement) that Microsoft will not renew the Agreement, absent
---
such Amendment, beyond its then current term.
* Although Internet Explorer and Outlook Express comprise part of the operating
system of Windows 95, Windows 98 and Windows NT, certain versions of the
Technology are available as standalone software for the Windows 3.1, Macintosh
and Unix operating systems.
-8-
<PAGE>
EXHIBIT B
MICROSOFT INTERNET EXPLORER LICENSE AND DISTRIBUTION AGREEMENT
Document Version 4.0, April 9, 1998
IE Version 4.0 and IEAK Version 4.0 CUSTOMIZATION RIGHTS
ADDITIONAL DEFINITIONS:
(a) "Active Desktop" means the Channel Client feature of Microsoft's Internet
Explorer version 4.0 software which supports "webcast," "push" or
"broadcasts" of Content via the World Wide Web (the "Web").
(b) "Channel" means an aggregation of Content and advertising (if any) that is
displayed or played, or available to be selected by an end user for display
and/or play, by means of a Channel Client, and which may be further divided
into sub-Channels.
(c) "Channel Client" means software that enables an End User to select and
receive Channels in one or more display and/or audio elements, including
software that is: (i) an interactive application (such as a Web browser)
that displays and/or plays Content within an application (or similar) window
or directly upon a operating system desktop; and/or (ii) and animated and
network-interactive screen saver application.
(d) "Channel Icon" means an icon or button which has an identifying logo and/or
trademark and an integrated pointer/URL which may be pre-configured in the
Internet Explorer Active Desktop user interface such that an end user, upon
first starting up or using Active Desktop, will (if already connected to the
Web) be able to link to an associated Channel.
(e) "Content" means data, text, audio, video, graphics, photographs, artwork and
other technology and materials provided for use on Channels or Web sites.
(f) "IEAK" means a collection of tools that enable Company to perform limited
customizations to the Licensed Software, such customizations being made in
accordance with the on-line instructions provided in the IEAK application
("Instructions"), as amended from time to time.
(g) "License Key" means to 10-digit alpha numeric code provided by Microsoft
that enables company to use the customization features of the IEAK.
(h) "Marketing affiliate" means a third party company which has contracted with
COMPANY to produce a co-branded or "private labeled" Browsing Software or
Email Client.
LICENSE GRANT:
Limited License Grant. Subject to Company's continued compliance with all
- - ---------------------
material terms of the Agreement and the terms of this Exhibit B, Microsoft
grants to Company a nonexclusive,
-9-
<PAGE>
limited worldwide, royalty-free license to customize the Licensed Software using
the IEAK in accordance with the IEAK Instructions. Company acknowledges and
agrees that its use of the IEAK to customize the Licensed Software requires the
rightful receipt from Microsoft of the "Standard Redistribution" license key
allocated to Company. Company agrees that it shall only use the IEAK and license
key in accordance with the Instructions. In the event the capabilities and/or
Instructions of the IEAK provide either more or fewer capabilities than the
customization rights granted in this Exhibit B, the customization rights set
forth in this Exhibit B shall govern.
1. Additional Customization Rights/Active Setup
Permitted Customizations/Active Setup. For versions 4.x of Internet Explorer
- - -------------------------------------
which support Active Setup, Company may use the IEAK to perform the any or all
of the following additional customizations:
(a) Customize Browser title bar (says "Microsoft Internet Explorer" by
default) only to add "provided by Company" at the end of the title.
(b) Customize tool bar background bit map (watermark) that is used when not
in high color mode.
(c) Change default search page (default is home.microsoft.com/access/
--------------------------
allionone.asp).
-------------
(d) Change default start page (default is home.microsoft.com).
------------------
(e) Change help "online support" page (defaults to point to microsoft.com).
-------------
(f) Add an unlimited number of pre-configured "favorites" entries (default is
none).
(g) Change Favorites hierarchy (with exception of "special folders" like
"Channels")
(h) Rename and/or customize Links (Todays' Links, Best of the Web, Today's
News, etc.)
(i) Disable and/or customize first time boot welcome page (after
installation).
(j) Customize Outlook Express info pane.
3. Additional Customization Rights/ISP Customization
Permitted Customizations/ISP Customization. For versions 4.x of Internet
- - ------------------------------------------
Explorer which support ISP Customization Company may use the IEAK to perform the
any or all of the following additional customizations:
-10-
<PAGE>
(a) Import Profile created by separately purchased Internet Connection
Manager Administration Kit.
(b) Change bitmap in Connection Manager dialog.
(c) Pre-set the Proxy Server address.
(d) Choose signup method (Internet Signup Server or Serverless Local) and
customize required connection information.
(e) For Outlook Express, set:
. Incoming and outgoing mail servers
. News server
. Add custom LDAP servers
(f) Add custom ILS server for NetMeeting if applicable.
4. Additional customization Rights/Channels
(a) Mandatory Customization/Selection of Pre-Configured Channels to Match Local
---------------------------------------------------------------------------
Language and Region. For versions 4.x of Internet Explorer which support
-------------------
Channels, Company shall use the IEAK to select the pre-configured Channels
for the specific territory for which each and every Company-customized
version of IE is targeted for distribution. For example, if Company
customizes separate versions of IE for distribution into territories A and
B, Company shall use the IEAK to select the pre-configured default Channels
for territory A for the version of IE Company creates for territory A, and
shall use the IEAK to select the pre-configured default Channels for
territory B for the version of IE Company creates for territory B. If
Company distributes a single version of IE into multiple territories,
Company shall use the IEAK to select the pre-configured default Channels
that are targeted to the single largest population in the combined
territories in which Company distributes IE. For the purpose of this
paragraph, "territory" shall mean a language/country combination, such as
German/Switzerland or French/Canada.
-11-
<PAGE>
(b) Permitted Customizations/ISP Customization of Channels. For versions 4.x of
------------------------------------------------------
Internet Explorer which support Channels, Company may use the IEAK to
perform the any or all of the following additional customizations with
respect to Channels (as further illustrated in Attachment B-1):
(1) Add a single Company Channel Icom to the topmost navigation level of the
Internet Explorer Active Desktop Channel bar in the position below the
Microsoft Channel Guide Icon. Said Icon may link either to Company or
third party Channel available through Internet Explorer, provided that
any trade names, trademarks, logos or brands displayed on the Channel
Icon added by Company shall be limited to Company's mark or Company's
Internet Product marks.
(2) Add multiple "sub-channels" grouped underneath (at the second navigation
level) the Company Channel Icon on the Internet Explorer Active Desktop
channel bar, where each such sub-channel may be linked to Company or
third-party Content accessible through Internet Explorer, and where each
such sub-channel may use any branding selected by Company. In the case
where sub-channels are grouped underneath a Company Channel Icon, the
Company Channel is the only Channel which is individually recognized by
IE; the sub-channels do not operate as separate standalone Channels by
themselves (and cannot be subscribed directly using the IE 4.0 user
interface without first accessing the Company Channel Icon).
(3) configure the Company Channel added by Company to be "subscribed" by
default, such that Company Channel Content and schedule information
downloads to the end user's computer system hard disk automatically when
the end user connects to the Internet and selects the "update" option.
(4) Delete from the Internet Explorer Active Desktop channel bar any pre-
configured Channel Icons that are developed or distributed by companies
which compete directly with Company or Company's Marketing Affiliate(S),
where such deleted Channels are to include only: (i) pre-configured
Channels from other Internet access providers, (ii) pre-configured
Channels which are produced by, or exclusively distributed by, direct
competitors of Company or Company's Marketing Affiliates. Company may not
delete a pre-configured Channel Icon that offers Content which is not
directly competitive with Company or Company's Content but that may
nonetheless compete for the end user's attention or interest with Content
offered by Company.
-12-
<PAGE>
(c) Development and Maintenance of advanced Internet Explorer Features in
---------------------------------------------------------------------
Channels. Company recognizes that customization of Channels is a
--------
supplemental right granted to Company pursuant to the Agreement. In
consideration for this supplemental right, Company agrees that for any
Channel added pursuant to the Agreement. In consideration for this
supplemental right, company agrees that for any Channel added pursuant to
this Exhibit B, Section 4, Company shall use reasonable commercial efforts
to develop and maintain the customized Channel such that it demonstrates the
advanced W3C-standard HTML features supported by Internet Explorer (such as
Dynamic HTML) meets end user expectations of performance and frequency of
update, and compares favorably, in Company's reasonable judgment, to
Channels offered by other companies in Company's line of business.
5. CO-MARKETING ACTIVITIES
Company shall participate in the following co-marketing activities:
(a) Use the Logo in Company's packaging, advertising and promotional
materials in accordance with the terms and guidelines in the Logo
Agreement and as may be provided by Microsoft from time to time;
(b) Display the "Get Microsoft Internet Explorer" link logo, separately
licensed from Microsoft, on the home page for Company's Internet Product
along with a hot link to www.microsoft.com/ie in accordance with the
--------------------
guidelines set forth at ieak.microsoft.com/logo.asp#elogo, or any
---------------------------------
successor thereof;
6. ACCEPTANCE AND DISCLAIMER OF WARRANTY
(a) The IEAK is deemed accepted by Company
(b) Neither the Company nor any of its distributors or employees shall have any
right to make any representation, warranty, or promise on behalf of
Microsoft.
(c) THE IEAK IS PROVIDED TO COMPANY AS IS WITHOUT WARRANTY OF ANY KIND. THE
ENTIRE RISK AS TO THE RESULTS AND PERFORMANCE OF THE IEAK ARE ASSUMED BY
COMPANY AND THE END-USER CUSTOMER. MICROSOFT DISCLAIMS ALL WARRANTIES,
EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO, IMPLIED WARRANTIES
OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, TITLE AND NON-
INFRINGEMENT
-13-
<PAGE>
7. LIMITATION OF LIABILITY
IN NO EVENT SHALL MICROSOFT BE LIABLE FOR ANY DIRECT, CONSEQUENTIAL, INDIRECT,
INCIDENTAL, OR SPECIAL DAMAGES WHATSOEVER, INCLUDING WITHOUT LIMITATION, DAMAGES
FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS
INFORMATION, AND THE LIKE, ARISING OUT OF THE USE OF INABILITY TO USE THE IEAK,
EVEN IF MICROSOFT HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
8. EXPORT CONTROLS
Company acknowledges that the IEAK is subject to the export control laws and
regulations of the US, and any amendments thereof. Company confirms that with
respect to the IEAK, it will not export or re-export it, directly or indirectly,
either to (i) any countries that are subject to US export restrictions
(currently including, but not necessarily limited to, Cuba, Iran, Iraq, Libya,
North Korea, Sudan, and Syria); (ii) any end user who Company knows or has
reason to know will utilize them in the design, development or production of
nuclear, chemical or biological weapons; or (iii) any end user who has been
prohibited from participating in the US export transactions by any federal
agency of the US government. Company further acknowledge that the IEAK may
include technical data subject to export and re-export restrictions imposed by
US law.
9. TERMINATION
Upon termination of the Agreement or this Exhibit B for any reason, Company's
rights under this Exhibit B immediately terminate, and Company shall return to
Microsoft or destroy all full or partial copies of the IEAK in Company's
possession or under its control within ten (10) days following the termination
date.
-14-
<PAGE>
ATTACHMENT B-1
Illustration of Channel Bar Navigation Hierarchy & Channel Placement
1. Channel Bar Topmost Navigation Level (visible on Active Desktop) sample
configuration:
Channel
Guide
- - -----------
Company
Channel
- - -----------
MSN
- - -----------
MSNBC
- - -----------
Disney
- - -----------
PointCast
- - -----------
(others)
- - -----------
1. The Channel Guide always occupies the first position (at the top of the
Channel Bar). Company Channel may be inserted in the second position
(thereby shifting other Channels down one position). The Company Channel
Icon is visible by default when Active Desktop is first installed. With the
exception of adding the Company Channel, all pre-configured Channels must
remain on the Channel Bar in the order shipped in the IEAK for each target
territory (or country/language combination). End users are able to add,
rearrange, and/or delete any Channels they wish after installing IE.
2. Channel Bar "sub-Channels" may be configured "under" a topmost level Category
such that when a topmost level Category is clicked, the sub-Channel(s) are
displayed. Sub-Channels are not visible until the Category containing them
is clicked.
-15-
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements
of Prodigy Communications Corporation (formerly Prodigy, Inc.) on Forms S-8
(File Nos. 333-72179, 333-72181, 333-72183) of our report, dated March 10, 1999,
on our audits of the consolidated financial statements of Prodigy Communications
Corporation at December 31, 1998 and 1997 and for the years ended December 31,
1998, 1997 and 1996, which report is included in this Annual Report on Form
10-K.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 31, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 12,180
<SECURITIES> 0
<RECEIVABLES> 1,333
<ALLOWANCES> 367
<INVENTORY> 0
<CURRENT-ASSETS> 14,943
<PP&E> 33,205
<DEPRECIATION> 20,207
<TOTAL-ASSETS> 78,332
<CURRENT-LIABILITIES> 48,540
<BONDS> 0
0
0
<COMMON> 450
<OTHER-SE> 29,342
<TOTAL-LIABILITY-AND-EQUITY> 78,332
<SALES> 128,908
<TOTAL-REVENUES> 136,140
<CGS> 99,213
<TOTAL-COSTS> 206,625
<OTHER-EXPENSES> (6,717)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,315
<INCOME-PRETAX> (65,083)
<INCOME-TAX> 0
<INCOME-CONTINUING> (65,083)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (65,083)
<EPS-PRIMARY> ($1.60)
<EPS-DILUTED> ($1.60)
</TABLE>
