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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER 0-25812
PSINET INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 16-1353600
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
510 HUNTMAR PARK DRIVE, HERNDON, VA 22070
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(703) 904-4100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT DATE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
COMMON STOCK, $.01 PAR VALUE -- 39,057,336 SHARES AS OF MAY 1, 1996
(INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE)
The Index of Exhibits filed with this Report begins at page 16.
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PSINET INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of December 31, 1995 and
March 31, 1996. . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations for the three months
ended March 31, 1995 and March 31, 1996 . . . . . . . . . 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1995 and March 31, 1996 . . . . . . . . . 5
Notes to Consolidated Financial Statements. . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . 13
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, 1995 MARCH 31, 1996
----------------- --------------
(AUDITED) (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $102,710 $ 68,352
Short-term investments and
marketable securities - 14,844
Accounts receivable, net 6,231 8,318
Inventories 1,149 1,211
Prepaid expenses 2,071 2,857
Other current assets 4,194 4,846
-------- --------
Total current assets 116,355 100,428
Property and equipment, net 51,355 70,837
Goodwill and other intangibles, net 25,398 23,538
Software costs, net 6,133 5,691
Other assets and deferred charges 2,589 2,778
-------- --------
$201,830 $203,272
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 3,012 $ 209
Current portion of long-term debt 13,631 17,857
Trade accounts payable 10,002 12,551
Accrued payroll and related expenses 2,184 2,269
Other accounts payable and accrued liabilities 654 1,054
Deferred revenue 3,245 4,472
-------- --------
Total current liabilities 32,728 38,412
Long-term debt 24,130 34,442
Deferred taxes 635 595
Other liabilities 1,107 730
-------- --------
Total liabilities 58,600 74,179
-------- --------
Shareholders' equity:
Preferred stock - -
Common stock 379 391
Capital in excess of par value 206,035 206,190
Retained deficit (61,539) (76,427)
Treasury stock, at cost (2,054) (2,005)
Net unrealized gain on investments 813 1,229
Cumulative foreign currency translation
adjustment (404) (285)
-------- --------
Total shareholders' equity 143,230 129,093
-------- --------
$201,830 $203,272
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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PSINET INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------------------
1995 1996
---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Revenue:
Internet access $ 5,887 $ 15,618
Software - 1,563
-------- --------
Total revenue 5,887 17,181
-------- --------
Operating costs and expenses:
Data communications and operations 4,303 13,115
Software operations - 827
Sales and marketing 1,840 7,844
General and administrative 1,181 5,475
Depreciation and amortization 1,666 6,182
-------- --------
Total operating costs and expenses 8,990 33,443
-------- --------
Loss from operations (3,103) (16,262)
Interest expense (254) (857)
Interest income 89 1,224
Other income - 1,068
Equity in loss of affiliate (12) (100)
-------- --------
Loss before income taxes (3,280) (14,927)
Income taxes 65 39
-------- --------
Net loss $ (3,215) $(14,888)
-------- --------
-------- --------
Loss per share (pro forma in 1995) $ (0.12) $ (0.39)
-------- --------
-------- --------
Shares used in computing
loss per share 26,857 38,178
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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PSINET INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------------------
1995 1996
---------------------------------
(IN THOUSANDS)
<S> <C> <C>
Net cash used in operating activities $ (110) $(10,818)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment, net (4,508) (4,369)
Purchases of short-term investments and
marketable securities - (12,215)
Capitalized software costs (9) (269)
Investment in subsidiary, net of cash acquired 322 -
Loan to affiliate - (169)
Investments in certain businesses (39) -
-------- --------
Net cash used in investing activities (4,234) (17,022)
-------- --------
Cash flows from financing activities:
Net payments on line of credit (800) (2,803)
Proceeds from issuance of notes payable 1,784 2,010
Repayments of notes payable (107) (876)
Principal payments under capital lease obligations (513) (5,133)
Proceeds from issuance of Series E redeemable
preferred stock 12,238 -
Proceeds from issuance of common stock 52 -
Proceeds from exercise of common stock options - 313
Other - (29)
-------- --------
Net cash provided by (used in) financing
activities 12,654 (6,518)
-------- --------
Net increase (decrease) in cash and cash equivalents 8,310 (34,358)
Cash and cash equivalents, beginning of year 3,358 102,710
-------- --------
Cash and cash equivalents, end of period $ 11,668 $ 68,352
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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PSINET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note l - Basis of Presentation
These consolidated financial statements for the three months ended March 31,
1996 and the related footnote information are unaudited and have been prepared
on a basis substantially consistent with the audited consolidated financial
statements of PSINet Inc. ("PSINet") and subsidiaries (collectively, the
"Company") as of December 31, 1995 incorporated by reference in the Company's
Annual Report on Form 10-K as filed with the Securities and Exchange Commission
(the "Annual Report"). These financial statements should be read in conjunction
with the audited consolidated financial statements and the related notes to
consolidated financial statements of the Company as of December 31, 1995
incorporated by reference in the Company's Annual Report. In the opinion of
management, the accompanying unaudited financial statements contain all
adjustments (consisting of normal recurring adjustments) which management
considers necessary to present fairly the consolidated financial position of the
Company at March 31, 1996 and the results of operations and cash flows for the
three month periods ended March 31, 1995 and 1996. The results of operations for
the three month period ended March 31, 1996 may not be indicative of the results
expected for any succeeding quarter or for the entire year ending December 31,
1996.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements. Actual results may
differ from those estimates.
Note 2 - Loss per Share and Pro Forma Loss per Share
Loss per share is computed using the weighted average number of shares of
common stock, adjusted for the dilutive effect of common stock equivalent shares
of common stock options and warrants. Common stock equivalent shares are
calculated using the treasury stock method.
Pro forma loss per share is computed using the weighted average number of
shares of common stock, adjusted for the dilutive effect of common stock
equivalent shares of common stock options and warrants and assuming the
conversion of redeemable preferred and common stock as of the beginning of the
period presented. Pursuant to Securities and Exchange Commission Staff
Accounting Bulletin No. 83, common stock and common stock equivalent shares
issued by the Company at prices below its initial public offering price during
the twelve month period prior to the initial public offering date (using the
treasury stock method and an offering price of $12.00 per share) have been
included in the calculation of pro forma loss per share for the three months
ended March 31, 1995, as if they were outstanding for all of the period
regardless of whether they are dilutive.
Note 3 - Short-term Investments and Marketable Securities
The Company classifies its investment holdings in debt and equity securities
as either held-to-maturity securities, trading securities or available-for-sale
securities and reports the investments at amortized cost, fair value with
unrealized gains and losses included in earnings and fair value with unrealized
gains and losses included in shareholders' equity, respectively.
At March 31, 1996, short-term investments and marketable securities included
debt securities classified as held-to-maturity with original maturities of
greater than 90 days of approximately $9.1 million and equity securities
classified as available-for-sale of approximately $5.7 million.
At March 31, 1996, shareholders' equity included a credit of $1.2 million
related to the net unrealized gain on the securities classified as available-
for-sale. Additionally, other income for the three months ended March 31, 1996
consists of approximately $1.1 million of realized gains on equity securities
held by the Company.
6
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PSINET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LONG-TERM DEBT
During the three months ended March 31, 1996, the Company incurred capital
lease obligations of approximately $18.5 million upon the execution of leases
for new data communications equipment and other fixed assets.
At March 31, 1996, the aggregate unused portion under the company's various
financing arrangements for purchases of data communications equipment and other
fixed assets was $6.5 million.
Additionally, the Company has a secured revolving credit agreement with a
bank under which the Company may borrow up to a maximum principal amount of the
lesser of $5.0 million or 75% of qualified accounts receivable which secure the
loan less 20% of aggregate principal of certain term credit advances
(approximately $4.3 million at March 31, 1996). There were no amounts advanced
under this credit agreement at March 31, 1996.
NOTE 5 - STRATEGIC ALLIANCE
In August 1995, the company entered into an agreement to form a joint venture
with Hansol Paper Co. Ltd. ("Hansol Paper"), of Seoul, Korea for the purpose of
extending the psinet network to provide internet services in Korea. In March
1996, pursuant to these arrangements, the company acquired a 10% interest in
Hansol Telecom Co., Ltd. ("Hansol"), an affiliate of Hansol Paper, for
approximately $3.1 million. This investment is classified as available-for-sale
and is reflected in short-term investments and marketable securities at March
31, 1996. Pursuant to its agreement with Hansol, the Company has the right, for
up to three years, to require Hansol Paper to purchase its hansol shares at the
higher of market value at the date of sale or the price at which the company
purchased its hansol shares plus interest at the rate of prime plus 1% per annum
from the time of its purchase through the date of sale. In connection with this
transaction, the company licensed intellectual property to Hansol for a one-time
license fee of approximately $1.7 million, which was included in internet access
revenue for the three months ended March 31, 1996.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING
CONSOLIDATED FINANCIAL STATEMENTS AND ASSOCIATED NOTES THERETO AND THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS, THE NOTES THERETO AND MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY AS
OF DECEMBER 31, 1995 INCORPORATED BY REFERENCE TO THE COMPANY'S ANNUAL REPORT ON
FORM 10-K. THIS DISCUSSION INCLUDES CERTAIN FORWARD-LOOKING STATEMENTS. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS AS A RESULT
OF A NUMBER OF FACTORS, INCLUDING ACTIONS OF ACTUAL AND PROSPECTIVE COMPETITORS
AND OTHER COMPETITIVE FACTORS, RISKS ASSOCIATED WITH THE COMPANY'S GROWTH AND
DOMESTIC AND INTERNATIONAL EXPANSION AND THE DEVELOPMENT OF THE INTERNET MARKET,
RISKS ASSOCIATED WITH ACQUISITIONS, RISKS ASSOCIATED WITH THE MARKET FOR
INDIVIDUAL CUSTOMERS, RISKS ASSOCIATED WITH SYSTEM DESIGN AND OPERATION,
REGULATORY RISKS AND THE COMPANY'S DEPENDENCE UPON SOLE AND LIMITED SOURCE
SUPPLIERS. FOR A DISCUSSION OF SUCH FACTORS AND OTHER FACTORS THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, SEE
"RISK FACTORS" IN ITEM 1 TO THE COMPANY'S ANNUAL REPORT ON FORM 10-K, THE RISK
FACTORS SET FORTH IN EXHIBIT 99.1 FILED HEREWITH AND THE COMPANY'S OTHER FILINGS
WITH THE SECURITIES AND EXCHANGE COMMISSION.
GENERAL
The Company provides Internet access, services and products to both businesses
and individuals throughout the United States and internationally. The Company
offers a broad spectrum of Internet access services ranging from dial-up
services to continuous access services using dedicated high-speed telephone
circuits. In addition, the Company offers Web site design and hosting services,
training and consulting services, Internet access security services and client
software products. At March 31, 1996, the Company had approximately 10,300
business subscribers and 116,000 individual subscribers, consisting of
approximately 36,000 professional and 80,000 consumer subscribers, serviced
through more than 300 network local access points called Points-of-Presence or
"POPs."
Since the commencement of the Company's operations in 1989, the Company has
undertaken a program of developing and expanding its network. In connection with
this development and expansion, the Company made significant investments in
telecommunications circuits and equipment. These investments generally are made
significantly in advance of anticipated subscriber growth and resulting revenue.
The Company also increased its sales and marketing, customer support, network
operations and field services commitments in anticipation of the expansion of
its subscriber base. These expansion efforts have caused the Company to
experience increases in expenses from time to time, both in absolute terms and
as a percentage of revenue, in anticipation of potential future growth in the
Company's subscriber base. The nature and amount of these expenses may
fluctuate over time as the Company shifts its focus from network expansion
efforts to enhancement of its existing network.
The Company's operating results have fluctuated in the past and they may
continue to fluctuate significantly in the future as a result of a variety of
factors, some of which are beyond the Company's control. As of March 31, 1996,
the Company had an accumulated deficit of $76.4 million. The Company believes
that it will incur losses throughout 1996, and there can be no assurance that
the Company will achieve profitability in the future.
STRATEGIC ALLIANCE
In August 1995, the Company entered into an agreement to form a joint venture
with Hansol Paper Co. Ltd. ("Hansol Paper"), of Seoul, Korea for the purpose of
extending the PSINet network to provide Internet services in Korea. In March
1996, pursuant to these arrangements, the Company acquired a 10% interest in
Hansol Telecom Co., Ltd. ("Hansol"), an affiliate of Hansol Paper, for
approximately $3.1 million.
8
<PAGE>
THREE MONTHS ENDED MARCH 31, 1996 AS COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 1995
RESULTS OF OPERATIONS
REVENUE. Revenue is derived from the sale of Internet access and related
services to businesses and individuals and, as a result of the acquisitions of
InterCon and Software Ventures in 1995, from the sale of connectivity software
products. Revenue increased by 191.8% from approximately $5.9 million for the
three months ended March 31, 1995 to approximately $17.2 million for the three
months ended March 31, 1996. The increase in Internet access revenue over the
same three month period in 1995 resulted principally from greater sales of
Internet services to businesses and individuals. The Company believes these
increases were facilitated by a number of factors including: an increase in the
number of subscribers driven by an increase during 1995 in the number of POPs in
operation; an expansion of the Company s sales force during 1995; the Company's
acquisition of Pipeline during February 1995; and greater public awareness and
acceptance of the Internet. Included in Internet access revenue for the three
months ended March 31, 1996, are one-time license fees of approximately $1.7
million for the licensing of intellectual property to Hansol. The Company's
business subscriber base increased by 132.0% from approximately 4,440 business
subscribers at March 31, 1995 to approximately 10,300 business subscribers at
March 31, 1996 and its individual subscriber base increased from approximately
19,440 individual subscribers at March 31, 1995 to approximately 116,000
individual subscribers at March 31, 1996. The Company's network infrastructure
increased from 114 POPs at March 31, 1995 to more than 300 POPs at March 31,
1996. Prior to the Company's acquisitions of InterCon and Software Ventures in
1995, the Company did not recognize any material revenues from the sale of
connectivity software products. Revenues attributable to the sale of software
were $1.6 million, or 9.1% of total revenues for the three months ended March
31, 1996.
As a result of increased competition in the industry, the Company expects to
continue to encounter significant pricing pressure for its business Internet
access services, which in turn could result in reductions in the average selling
price of the Company's services. For example, certain of the Company's
competitors which are telecommunications companies may be able to provide
customers with reduced communications costs in connection with their Internet
access services or to offer Internet access as a standard component of their
overall service package, thereby significantly increasing price pressure on
PSINet. The Company has in the past reduced prices on certain of its Internet
access options and other services and products and may continue to do so in the
future. There can be no assurance that the Company will be able to offset the
effects of any such price reductions with an increase in the number of its
customers, higher revenue from enhanced services, cost reductions or otherwise.
Additionally, in the consumer market, the Company expects to continue to
encounter significant competition as evidenced by AT&T Corp's and MCI
Communications Corp's announcements that they will offer five hours of free
Internet access per month and fixed monthly charges for the balance of their
subscribers' monthly usage of standard Internet access services. In the future,
the Company plans to focus its efforts in the individual Internet service market
on the more sophisticated Internet user and has announced its intention to
introduce an enhanced consumer Internet service designed to meet the needs of
these more technical Internet-savvy users. The Company also anticipates that it
will adjust its pricing for these enhanced services. There can be no assurance
that the Company will be able to offset the effects of any future price changes
with respect to this new consumer Internet service focus with an increase in the
number of its customers, higher revenue from enhanced services, cost reductions
or otherwise. While the Company plans to continue to support both the low-end
and high-end individual subscribers, it anticipates that its focus may result in
a decreased number of individual subscribers, which, in turn, could adversely
impact revenues in the near term.
DATA COMMUNICATIONS AND OPERATIONS. Data communications and operations costs
and expenses consist primarily of leased long distance circuit costs, local loop
costs, and expenses associated with network operations, customer support and
field service functions. Data communications and operations costs and expenses
were approximately $4.3 million (73.1% of revenue) and approximately $13.1
million (76.3% of revenue) during the three months ended March 31, 1995 and
9
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1996, respectively. The $8.8 million increase in data communications and
operations expenses during the three months ended March 31, 1996 compared to the
same period in 1995 related principally to increases in (i) personnel costs
resulting from the expansion of the Company's network operations, customer
support and field service staff from 120 persons at March 31, 1995 to 311
persons at March 31, 1996, (ii) costs associated with providing dedicated
circuits to the Company's InterFrame and InterMan subscribers and (iii) circuit
costs relating to the Company's new POPs deployed throughout 1995 and 1996.
Circuit costs relating to the Company's new POPs generally are incurred by the
Company significantly in advance of anticipated expansion in the Company's
customer base. The Company expects that data communications and operations
costs and expenses will continue to increase as the Company's customer base
continues to grow.
SOFTWARE OPERATIONS. Software operations costs and expenses consist primarily
of materials, fulfillment and distribution costs and other personnel costs
related to the research and development of Internet software applications.
Software expenses were $0.8 million (4.8% of total revenue) for the three months
ended March 31, 1996. The Company began to recognize software operations costs
and expenses as a result of the Company's acquisitions of InterCon and Software
Ventures during 1995; therefore, there are no comparative numbers for the three
months ended March 31, 1995. The Company expects that software operations costs
and expenses will increase as the Company attempts to promote and develop its
software business.
SALES AND MARKETING. Sales and marketing expenses consist primarily of sales
and marketing personnel costs, advertising costs, fulfillment and distribution
costs and related occupancy costs. Sales and marketing expenses increased from
approximately $1.8 million (31.3% of revenue) during the three months ended
March 31, 1995 to approximately $7.8 million (45.7% of revenue) during the
three months ended March 31, 1996. The $6.0 million increase in these expenses
resulted principally from the increase in the Company's sales and marketing
staff from 54 at March 31, 1995 to 184 persons at March 31, 1996 and a
significant increase in advertising costs. With respect to advertising, all
such costs have been expensed in the period incurred. The Company expects that,
as a result of its refocused efforts on the more sophisticated Internet user,
its sales and marketing expenses with respect to the individual Internet service
market will decrease over time.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and occupancy costs for administrative, executive,
accounting and finance personnel. General and administrative expenses were
approximately $1.2 million (20.1% of revenue) during the three months ended
March 31, 1995 and approximately $5.5 million (31.9% of revenue) during the
three months ended March 31, 1996. The increase in these costs resulted
primarily from an increase in the Company's general and administrative staff
from 59 at March 31, 1995 to 120 persons at March 31, 1996. The Company may from
time to time increase its general and administrative function in response to
current business developments.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense consists
principally of expense associated with the costs of hardware and buildout that
support expansion and upgrade of the Company's POPs as well as the costs of
other fixed assets, software costs and other intangible assets. Depreciation and
amortization costs were approximately $1.7 million (28.3% of revenue) during the
three months ended March 31, 1995 and approximately $6.2 million (36.0% of
revenue) during the three months ended March 31, 1996. A significant portion of
these amounts (approximately $0.7 million for the three months ended March 31,
1995 as compared to $2.6 million for the three months ended March 31, 1996)
relates to the amortization of certain intangible assets recorded in connection
with certain acquisitions completed in 1995. Additionally, POP expansion and
existing POP equipment upgrades as well as facility expansion required as a
result of additional hiring in sales, marketing and administration contributed
to this increase. The Company anticipates that its depreciation and amortization
expense, although it may vary as a percentage of revenue, will increase as the
Company continues to incur capital expenditures associated with network
infrastructure enhancements and as the Company completes acquisitions and other
business combinations, if any.
INTEREST EXPENSE. Interest expense increased from approximately $0.3 million
for the three months ended March 31, 1995 to approximately $0.9 million for the
three months ended March 31,
10
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1996. The increase in interest expense was principally due to increased
borrowings and capital lease obligations incurred by the Company to finance
network expansion, related sales and marketing, customer support, network
operations and field service staff expansion and to fund working capital
requirements. Although the Company expects that it will incur increased
borrowings and capital lease obligations in the near term in connection with its
network enhancements, the amount of the Company's interest expense will
fluctuate from time to time as a result of the Company entering into new
financing arrangements at varying rates.
INTEREST INCOME. Interest income increased from approximately $90,000 for the
three months ended March 31, 1995 to approximately $1.2 million for the three
months ended March 31, 1996. The increase in interest income was principally due
to the investment of proceeds from the Company's public offering in December
1995. These proceeds are currently invested in short-term, investment grade,
interest bearing securities.
OTHER INCOME. Other income of approximately $1.1 million for the three
months ended March 31, 1996 relates to the recognition of a realized gain on
equity securities held by the Company.
NET LOSS. Net loss was approximately $3.2 million and $14.9 million for the
three months ended March 31, 1995 and 1996, respectively. These losses reflect
PSINet's strategy of early investment in expanding the PSINet network and the
administrative and operational infrastructure designed to position the Company
to compete in the Internet market domestically and internationally.
LIQUIDITY AND CAPITAL RESOURCES
The Company historically has satisfied its cash requirements through cash from
operations, through borrowings and capital lease financings from financial
institutions and other third parties and through the issuance of equity
securities.
Cash flow used in operating activities was approximately $0.1 million and $10.8
million for the three months ended March 31, 1995 and 1996, respectively. Cash
flow used in operating activities can vary significantly from period to period
depending upon the timing of operating cash receipts and payments, especially
accounts receivable, prepaid expenses and other assets, and accounts payable and
accrued liabilities.
Cash flow used in investing activities for the three months ended March 31, 1995
and 1996 was approximately $4.2 million and $17.0 million, respectively. The
expansion of the Company s network resulted in capital expenditures of
approximately $8.2 million and $22.9 million for the three months ended March
31, 1995 and 1996, respectively (which included capital expenditures financed
under equipment financing agreements aggregating approximately $3.7 million and
$18.5 million for the three months ended March 31, 1995 and 1996, respectively).
Additionally, the Company invested approximately $3.1 million in Hansol and
approximately $9.1 million in debt securities with original maturities of
greater than 90 days.
Cash flow provided by financing activities for the three months ended March 31,
1995 was approximately $12.7 million while the cash flow used in financing
activities for the three months ended March 31, 1996 was approximately $6.5
million. The Company raised approximately $12.2 million of equity, net of
expenses in the three months ended March 31, 1995. During the three months
ended March 31, 1996, the Company made repayments of $2.8 million, $0.9 million
and $5.1 million on lines of credit, notes payable and capital lease
obligations, respectively.
As of March 31, 1996, the Company had approximately $68.4 million of cash and
cash equivalents, approximately $14.8 million of short-term investments and
marketable securities and approximately $6.5 million available under financing
facilities for the future financing of data communications equipment and other
fixed assets, and a $5.0 million working capital facility, subject to
availability under a borrowing base formula (at March 31, 1996 a maximum of
approximately $4.3 million was available under the facility), under which no
borrowings were outstanding as of March 31, 1996. The Company's financing
arrangements, which are secured by substantially all of the Company's assets,
require the Company to satisfy certain financial covenants and restrict the
payment of dividends.
11
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As of March 31, 1996, the Company had commitments to certain telecommunications
vendors totaling approximately $10.2 million. The commitments require minimum
monthly usage levels of data and voice communications over the next five years.
Additionally, the Company has various agreements to lease office space and
facilities, and as of March 31, 1996, the Company was obligated to make future
minimum lease payments of approximately $14.9 million on leases expiring in
various years through 2005. In addition, with respect to its obligation to
purchase an additional 10% interest in World Online, the Company may be required
to pay cash (not to exceed $5.0 million) and/or contribute shares of PSINet
common stock at the end of 1996.
Based upon its present business plan, the Company believes that working capital,
funds from operations, existing credit facilities and additional capital or
borrowings which the Company expects to be able to obtain when needed will be
sufficient to meet its presently anticipated working capital and capital
expenditure requirements of its existing operations.
12
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 2 Shareholder Agreement dated February 28, 1996 between
the Company and Hansol Telecom Co., Ltd.
Exhibit 3.1 Certificate of Incorporation, as amended
Exhibit 3.2 Certificate of Amendment of Certificate of
Incorporation dated April 25, 1995
Exhibit 3.3 Certificate of Amendment of Certificate of
Incorporation dated May 5, 1995
Exhibit 3.4 Certificate of Amendment of Certificate of
Incorporation dated November 11, 1995
Exhibit 3.5 Amended and Restated By-laws of the Company
Exhibit 4.1 Form of Common Stock Certificate
Exhibit 4.2 Form of Common Stock Certificate (name change)
Exhibit 4.3 Articles Fourth, Fifth, Sixth, Ninth and Tenth of the
Certificate of Incorporation of the Company, as amended
(see Exhibits 3.2, 3.3 and 3.4)
Exhibit 4.4 Article I of the Amended and Restated By-laws of the
Company, as amended
Exhibit 10.1 Employment Separation Agreement dated January 25, 1996
between the Company and Martin L. Schoffstall
Exhibit 10.2 Employment Agreement dated February 13, 1996 between
the Company and Mitchell Levinn
Exhibit 10.3 Employment Agreement dated February 21, 1996 between
the Company and Daniel P. Cunningham
Exhibit 10.4 Employment Agreement dated February 21, 1996 between
the Company and Stephen A. Schoffstall
Exhibit 10.5 Employment Agreement dated February 9, 1996 between
the Company and Mary-Ann Carolan
Exhibit 10.6 Employment Agreement dated January 2, 1996 between the
Company and David Mann
Exhibit 10.7 Amendment to Master Lease Agreement No. 1753 dated
January 26, 1996 between the Company and Technology
Credit Corporation
Exhibit 10.8 Security Agreement dated as of March 20, 1996 between
the Company and USL Capital Corporation
13
<PAGE>
(a) Exhibits (continued)
Exhibit 10.9 Intellectual Property License Agreement dated March
1996 between the Company and Hansol Telecom Co., Ltd.
Exhibit 11.1 Calculation of Pro Forma Loss per Share and Weighted
Average Shares Used in Calculation for the Three Months
Ended March 31, 1995
Exhibit 11.2 Calculation of Loss per Share and Weighted Average
Shares Used in Calculation for the Three Months Ended
March 31, 1996
Exhibit 27 Financial Data Schedule **
Exhibit 99.1 Risk Factors
** Not deemed filed for purposes of Section 11 of the Securities
Act of 1933, Section 18 of the Securities Exchange Act of 1934
and Section 323 of the Trust Indenture Act of 1939 or otherwise
subject to the liabilities of such sections and not deemed part
of any registration statement to which such exhibit relates.
(b) Reports on Form 8-K
On February 15, 1996, the Company filed a Current Report on Form 8-K
with the Securities and Exchange Commission dated February 13, 1996
stating, among other things, that the Company intended to merge its
two wholly-owned software subsidiaries, InterCon Systems Corporation
and Software Ventures Corporation.
On April 1, 1996, the Company filed a Current Report on Form 8-K with
the Securities and Exchange Commission dated March 26, 1996 stating
that it had determined not to proceed with its proposed acquisition of
33% of the outstanding common stock of NetVision Ltd. ("NetVision")
from the existing NetVision shareholders.
14
<PAGE>
PSINET INC.
FORM 10-Q
MARCH 31, 1996
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PSINET INC.
May 15, 1996 By: /s/ William L. Schrader
- - ------------- ----------------------------------
Date William L. Schrader
Chairman of the Board, President,
Chief Executive Officer and Director
(Principal Executive Officer)
May 15, 1996 By: /s/ Harold S. Wills
- - ------------- ----------------------------------
Date Harold S. Wills
Executive Vice President, Chief Operating
Officer, Acting Chief Financial Officer and
Director
(Principal Financial and Accounting Officer)
15
<PAGE>
EXHIBIT INDEX
Item 6(a) Exhibits:
Exhibit Exhibit Name Location
- - ------- ------------ --------
2 Shareholder Agreement dated February 28,
1996 between the Company and Hansol Telecom
Co., Ltd.. . . . . . . . . .. . . . . . . . Incorporated by reference
from Exhibit 2.8 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
3.1 Certificate of Incorporation, as amended. . Incorporated by
referencefrom Exhibit 3.1
to the Company's
Registration Statement on
Form S-1 declared
effective on May 1, 1995
located under Securities
Exchange Commission File
No. 33-90154 ("May 1995
Registration Statement").
3.2 Certificate of Amendment of Certificate
of Incorporation dated April 25, 1995.. . . Incorporated by reference
from Exhibit 3.1 to the
Company's Quarterly
Report on Form 10-Q for
the quarter ended June
30, 1995 located under
Securities Exchange
Commission File No.
0-25812 ("June 10-Q").
3.3 Certificate of Amendment of Certificate
of Incorporation dated May 5, 1995. . . . . Incorporated by reference
from Exhibit 3.2 to the
June 10-Q.
3.4 Certificate of Amendment of Certificate
of Incorporation dated November 11, 1995. . Incorporated by reference
from Exhibit 3.1 to the
Company's Quarterly
Report on Form 10-Q for
the quarter ended
September 30, 1995
located under Securities
Exchange Commission File
No. 0-25812.
16
<PAGE>
Exhibit Exhibit Name Location
- - ------- ------------ --------
4.1 Form of Common Stock Certificate. . . . . . Incorporated by reference
from Exhibit 4.1 to the
May 1995 Registration
Statement.
4.2 Form of Common Stock Certificate
(name change) . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 4.1A to the
Company's Registration
Statement on Form S-1
declared effective on
December 14, 1995 located
under Securities Exchange
Commission File No.
33-99610 ("December 1995
Registration Statement")
4.3 Articles Fourth, Fifth, Sixth, Ninth and
Tenth of the Certificate of Incorporation
of the Company, as amended (see Exhibits
3.2, 3.3 and 3.4) . . . . . . . . . . . . . Incorporated by reference
from Exhibit 4.2 to the
December 1995 Registra-
tion Statement.
4.4 Article I of the Amended and Restated
By-laws of the Company, as amended. . . . . Incorporated by
referencefrom Exhibit 4.3
to the December 1995
Registration Statement.
10.1 Employment Separation Agreement dated
January 25, 1996 between the Company and
Martin L. Schoffstall . . . . . . . . . . . Incorporated by reference
from Exhibit 10.35 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.2 Employment Agreement dated February 13,
1996 between the Company and Mitchell
Levinn. . . . . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 10.36 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
17
<PAGE>
Exhibit Exhibit Name Location
- - ------- ------------ --------
10.3 Employment Agreement dated February 21,
1996 between the Company and Daniel P.
Cunningham. . . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 10.37 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.4 Employment Agreement dated February 21,
1996 between the Company and Stephen A.
Schoffstall . . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 10.41 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.5 Employment Agreement dated February 9,
1996 between the Company and Mary-Ann
Carolan . . . . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 10.42 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.6 Employment Agreement dated January 2,
1996 between the Company and David Mann . . Incorporated by reference
from Exhibit 10.43 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.7 Amendment to Master Lease Agreement No.
1753 dated January 26, 1996 between the
Company and Technology Credit Corporation . Incorporated by reference
from Exhibit 10.77 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
18
<PAGE>
Exhibit Exhibit Name Location
- - ------- ------------ --------
10.8 Security Agreement dated as of March 20,
1996 between the Company and USL Capital
Corporation . . . . . . . . . . . . . . . . Incorporated by reference
from Exhibit 10.79 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
10.9 Intellectual Property License Agreement
dated March 1996 between the Company and
Hansol Telecom Co., Ltd.. . . . . . . . . . Incorporated by reference
from Exhibit 10.93 to the
Company's Annual Report
on Form 10-K for the
fiscal year ended
December 31, 1995 located
under Securities and
Exchange Commission File
No. 0-25812.
11.1 Calculation of Pro Forma Loss per Share
and Weighted Average Shares Used in
Calculation for the Three Months Ended
March 31, 1995. . . . . . . . . . . . . . . 20
11.2 Calculation of Loss per Share and Weighted
Average Shares Used in Calculation for the
Three Months Ended March 31, 1996 . . . . . 21
27 Financial Data Schedule . . . . . . . . . . 22
99.1 Risk Factors. . . . . . . . . . . . . . . . 23
19
<PAGE>
EXHIBIT 11.1
PSINET INC.
AND SUBSIDIARIES
CALCULATION OF PRO FORMA LOSS PER SHARE (UNAUDITED) (1)
PRO FORMA
MARCH 31, 1995
--------------
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of year ................. 13,041,266
Shares issued to employees under revenue bonus plan ..... 18,750
Shares issued for the acquisition of Pipeline ........... 2,690,218
Shares issued for the conversion of certain
Pipeline employee stock options ......................... 98,255
Shares from conversion of redeemable preferred stock,
assuming conversion as of beginning of year ............. 10,042,680
Common stock equivalents:
Options and warrants to purchase 1,325,570 shares of
common stock granted from March 8, 1994 through
March 31, 1995, subject to SAB 83 using the treasury
stock method ............................................ 966,242
-------------
26,857,411
-------------
-------------
Net Loss ........................................................ $ (3,215,000)
-------------
-------------
Pro forma loss per share (unaudited)............................. $ (0.12)
-------------
-------------
- - --------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------
(1) For a description of pro forma loss per share, see Note 2 of the Notes to
the Consolidated Financial Statements.
20
<PAGE>
EXHIBIT 11.2
PSINET INC.
AND SUBSIDIARIES
CALCULATION OF LOSS PER SHARE (UNAUDITED)
MARCH 31, 1996
--------------
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of year ................. 37,914,932
Weighted average shares issued during the three months
ended March 31, 1996 (1,074,527 shares) ................. 262,968
----------
38,177,900
----------
----------
Net Loss ........................................................$ (14,888,000)
--------------
--------------
Loss per share (unaudited) ...................................... $ (0.39)
-------------
-------------
- - --------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------
(1) For a description of loss per share, see Note 2 of the Notes to the
Consolidated Financial Statements.
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1996
AND THE CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1996 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 68,352
<SECURITIES> 14,844
<RECEIVABLES> 9,241
<ALLOWANCES> 923
<INVENTORY> 1,211
<CURRENT-ASSETS> 100,428
<PP&E> 88,639
<DEPRECIATION> 17,802
<TOTAL-ASSETS> 203,272
<CURRENT-LIABILITIES> 38,412
<BONDS> 34,442
0
0
<COMMON> 391
<OTHER-SE> 128,702
<TOTAL-LIABILITY-AND-EQUITY> 203,272
<SALES> 17,181
<TOTAL-REVENUES> 17,181
<CGS> 13,942
<TOTAL-COSTS> 13,942
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 857
<INCOME-PRETAX> (14,927)
<INCOME-TAX> (39)
<INCOME-CONTINUING> (14,888)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,888)
<EPS-PRIMARY> (0.39)
<EPS-DILUTED> (0.39)
</TABLE>
<PAGE>
EXHIBIT 99.1
RISK FACTORS
THE FOLLOWING RISK FACTORS ARE SUBSTITUTED FOR THOSE SET FORTH UNDER LIKE
HEADINGS IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K ("FORM 10-K") FOR THE
FISCAL YEAR ENDED DECEMBER 31, 1995 AND SHOULD BE CONSIDERED IN ADDITION TO THE
OTHER RISK FACTORS IN THE FORM 10-K IN EVALUATING THE COMPANY AND ITS BUSINESS.
LIMITED HISTORY OF OPERATIONS; OPERATING DEFICIT; CONTINUING LOSSES;
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
The Company began offering its services in 1990. Although the Company has
experienced revenue growth on an annual basis, it has incurred losses and
experienced negative cash flow from operations during each of its last three
fiscal years including a loss of $53.2 million and negative cash flow from
operations of $30.1 million for 1995 and a loss of $14.9 million and negative
cash flow from operations of $10.8 million for the three months ended March 31,
1996. At March 31, 1996, the Company had a retained deficit of $76.4 million.
There can be no assurance that revenue growth will continue or that the Company
will achieve profitability or positive cash flow from operations in the future.
The Company expects to focus in the near term on continuing to increase its
corporate subscriber base and its high-end individual subscriber base, which
will require it to continue to incur its expenses for marketing, network
infrastructure, personnel and the development of new services and software, and
thereby will likely adversely impact cash flow and operating performance. The
Company also plans to continue to enhance the PSINet network and the
administrative and operational infrastructure necessary to support its Internet
access service domestically and internationally. As a result, the Company
believes that it will continue to incur losses throughout 1996, and there can be
no assurance that the Company will achieve profitability in the future.
Amortization charges in connection with the Company's acquisitions were first
incurred in 1995 and are expected to adversely affect the Company's results of
operations through the third quarter of 2000.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside of the Company's control, including general economic
conditions, specific economic conditions in the Internet access industry, user
demand for the Internet, capital expenditures and other costs relating to the
expansion of operations, the timing of customer subscriptions, the introduction
of new services by the Company or its competitors, the mix of services sold and
the mix of channels through which those services are sold, pricing changes and
new product introductions by the Company and its competitors and delays in
obtaining sole or limited source equipment. As a strategic response to a
changing competitive environment, the Company may elect from time to time to
make certain pricing, service or marketing decisions or acquisitions that could
have a material adverse effect on the Company's business, results of operations
and cash flow. In addition, due to changing market conditions, substantial
amortization expenses may be accelerated in accordance with generally accepted
accounting principles to recognize changes in the expected life of acquisitions
and related long-lived assets.
COMPETITION
The market for data communications services, including Internet access and
on-line services, is highly competitive. The industry has relatively
insignificant barriers to entry, numerous entities competing for the same
customers and a high average churn rate as individual customers frequently
change Internet access providers in response to the offering of lower rates or
promotional incentives by competitors. PSINet expects that competition will
continue to intensify. The Company believes that the primary competitive factors
for the provision of Internet services are price, quality of service,
reliability, technical expertise, ease of use, variety of value-added services,
quality and availability of customer support, experience of the supplier,
geographic coverage and name recognition. PSINet's success in this market will
depend heavily upon its ability to provide high quality Internet connectivity
and value-added Internet services at competitive prices.
23
<PAGE>
The Company's current and prospective competitors generally may be divided
into the following four groups: (1) other Internet access providers, such as
NETCOM On-Line Communications Services, Inc. ("NETCOM"), UUNET Technologies,
Inc. ("UUNET"), Bolt, Beranek & Newman Inc., and other national and regional
providers; (2) telecommunications companies, such as AT&T Corp. ("AT&T"), MCI
Communications Corporation ("MCI"), MFS Communications Co., Inc. ("MFS"),
Sprint, Inc., regional Bell operating companies ("RBOCs") and various cable
television companies; (3) on-line services providers, such as America Online,
Inc. ("America Online"), CompuServe Incorporated (a division of H&R Block, Inc.,
"CompuServe"), Delphi Internet Services (a division of News Corp.), GEnie (a
division of General Electric Information Services), the Microsoft Network
("MSN"), a service of Microsoft Corp. ("Microsoft"), and Prodigy (a joint
venture of International Business Machines Corporation ("IBM") and Sears,
Roebuck and Co.); and (4) Internet software providers, such as Netscape
Communications Corp. ("Netscape"), Spyglass, Inc. ("Spyglass"), NetManage, Inc.
("NetManage"), FTP Software, Inc. ("FTP") and others. Many of these competitors
have greater market presence, engineering and marketing capabilities, and
financial, technological and personnel resources than those available to PSINet.
As a result, they may be able to develop and expand their communications and
network infrastructures more quickly, adapt more swiftly to new or emerging
technologies and changes in customer requirements, take advantage of acquisition
and other opportunities more readily, and devote greater resources to the
marketing and sale of their products than can PSINet. In addition, the ability
of some of the Company's competitors to bundle other services and products with
Internet access services could place PSINet at a competitive disadvantage.
PSINet believes that competition will intensify as new competitors,
including large computer hardware, software, media and other technology and
telecommunications companies, enter the Internet services market and as existing
competitors form alliances with or acquire other companies. Recently, for
example, MFS and UUNET announced a merger of their companies creating the
possibility for network expense reductions which could result in a competitive
advantage for the combined entity. Additionally, AT&T and MCI each recently
have announced plans to offer Internet access to their customers. Such
acquisitions, alliances and expanded service offerings may permit the Company's
competitors to devote greater resources to the development and marketing of new
competitive products and services and the marketing of existing competitive
products and services.
In licensing its software products, the Company currently competes with
connectivity and networking companies, other Internet access providers, on-line
service companies and operating system vendors. The Company competes most
frequently with connectivity and networking software vendors including Netscape,
Spyglass, FTP, NetManage, Frontier, Firefox, Novell and others. In addition,
certain on-line service companies and Internet access providers such as NETCOM,
Prodigy, America Online, UUNET and CompuServe have developed or acquired Web
browsers to include with their services. The Company also competes with
operating system vendors such as Novell, IBM and Microsoft, that incorporate Web
browsing capabilities within their products.
As PSINet expands its operations outside the United States, it will
encounter new competitors and competitive environments. In some cases, the
Company will be forced to compete with and buy services from government owned or
subsidized telecommunications providers, some of which may enjoy a monopoly on
telecommunications services essential to the Company's business. There can be no
assurance that the Company will be able to purchase such services at a
reasonable price or at all. In addition to the risks associated with the
Company's previously described competitors, foreign competitors may possess a
better understanding of their local markets and better working relationships
with local infrastructure providers. There can be no assurance that the Company
can obtain similar levels of local knowledge, and failure to obtain that
knowledge could place the Company at a significant competitive disadvantage.
As a result of increased competition in the industry, the Company expects
to encounter significant pricing pressure, which in turn could result in
significant reductions in the average selling price of the Company's services.
For example, certain of the Company's competitors which are telecommunications
companies, including AT&T and MCI, may be able to provide customers with
24
<PAGE>
reduced or free communications costs in connection with their Internet access
services or offer Internet access as a standard component of their overall
service package, thereby significantly increasing price pressure on PSINet. The
Company has in the past reduced prices on certain of its Internet access options
and may continue to do so in the future. There can be no assurance that the
Company will be able to offset the effects of any such price reductions with an
increase in the number of its customers, higher revenue from enhanced services,
cost reductions or otherwise. In addition, as is exemplified by the recent
merger announcement by MFS and UUNET, PSINet believes that the data
communications business, and in particular Internet access and on-line services
businesses, are likely to encounter consolidation in the near future, which
could result in increased price and other competition in the industry. Increased
price or other competition could result in erosion of the Company's market share
and could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will have the financial resources, technical expertise or marketing and support
capabilities to continue to compete successfully.
RISKS OF GROWTH AND EXPANSION
The Company had expanded its network to more than 300 POPs as of March 31,
1996 and plans to continue to add additional POPs and expand the capacity of
existing POPs during 1996. There can be no assurance that the Company will be
able to add service in new cities or expand existing capacity at the rate
presently planned by the Company. The Company's rapid growth has placed, and in
the future may continue to place, a significant strain on the Company's
administrative, operational and financial resources and increased demands on its
systems and controls. The Company anticipates that its continued growth will
require it to recruit and hire, from time to time, new managerial, technical and
sales and marketing personnel. The Company also believes that it will need,
both in the short term and the long term, to promote and hire qualified
administrative and management personnel in the accounting and financial area to
manage its financial control systems. Competition for qualified personnel in the
internetworking industry is intense and there are a limited number of persons
with knowledge of and experience in the Internet service industry. The process
of locating, training and successfully integrating qualified personnel into the
Company's operations is often lengthy and expensive. There can be no assurance
that the Company will be successful in attracting, integrating and retaining
such personnel. In addition, there can be no assurance that the Company's
operating and financial control systems and infrastructure will be adequate to
maintain and effectively monitor future growth. The inability to continue to
upgrade the networking systems or the operating and financial control systems,
the inability to recruit and hire necessary personnel, the inability to
successfully integrate new personnel into the Company's operations, the
inability to manage its growth effectively or the emergence of unexpected
expansion difficulties could adversely affect the Company's business, results of
operations and financial condition.
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
The Company expects to continue to enhance its network in order to maintain
its competitive position and continue to meet the increasing demands for service
quality, availability and competitive pricing. As of March 31, 1996, the
Company's network was comprised of more than 300 POPs. Based upon its present
business plan, the Company believes that working capital, funds from operations,
existing credit facilities and additional capital or borrowings which the
Company expects to be able to obtain when needed will be sufficient to meet its
presently anticipated working capital and capital expenditure requirements of
its existing operations. The Company may seek to raise additional funds in
order to take advantage of unanticipated opportunities, including more rapid
international expansion or acquisitions of complementary businesses or
technologies, or to develop new products or otherwise respond to unanticipated
competitive pressures. There can be no assurance that the Company will be able
to raise such capital on favorable terms or at all. In the event that the
Company is unable to obtain such additional capital or is unable to obtain such
additional capital on acceptable terms, the Company may determine not to enter
into various expansion opportunities.
25
<PAGE>
RISKS ASSOCIATED WITH INDUSTRY CONSOLIDATION
The Company expects significant consolidation among Internet service
providers to occur in the near future. As part of its business strategy, the
Company may acquire additional Internet service providers and, perhaps,
complementary businesses and technologies in 1996 and 1997. If the Company is
unable to acquire additional Internet service providers on favorable terms, or
at all, or if a competitor of the Company acquires one or more of such
businesses, the Company could be at a competitive disadvantage and its business,
financial condition and results of operations could be materially adversely
affected. See "Competition."
Although the Company currently anticipates that its available working
capital, funds from operations, existing credit facilities and additional
capital or borrowings which the Company expects to be able to obtain when needed
will be sufficient to meet its presently anticipated working capital and capital
expenditure requirements of its existing operations, the Company may seek to
raise additional funds through public or private debt or equity financings in
order to accelerate domestic and international expansion, acquire other Internet
service providers or complementary businesses or technologies, develop new
products or otherwise respond to unanticipated competitive pressures. There can
be no assurance that additional financing will be available on terms favorable
to the Company, or at all. If adequate funds are not available on acceptable
terms, or at all, the Company may determine not to undertake various expansion
opportunities.
LIMITED EXPERIENCE IN COMPETITIVE MARKET FOR INDIVIDUAL CUSTOMERS
Historically, the Company provided its Internet access services
primarily to organizations. The Company began offering Internet access services
developed for sophisticated individual users with the introduction of its
InterRamp service in June 1994, and expanded its service offerings for
individual users with its acquisition of Pipeline in February 1995. Prior to
the introduction of InterRamp, the Company had limited experience in marketing
its services to individual customers. The market for individual customers is
intensely competitive and any failure on the part of the Company to develop
effective business strategies for this market could inhibit the growth of the
Company's customer base and have a material adverse effect on its business,
operating results and financial condition. In response to competitive
considerations, the Company has determined to focus its efforts in the
individual customer market on the high-end user and, in that regard, has
announced its intention to introduce an enhanced consumer Internet service
designed to meet the needs of such users. The Company also expects that it will
adjust its pricing for these enhanced services. There can be no assurance that
the Company will be successful in marketing to individual subscribers or that
the Company will be able to offset the effects of any future price changes with
respect to this new consumer Internet service focus with an increase in the
number of its customers, higher revenue from enhanced services, cost reductions
or otherwise.
26
