================================================================================
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, 1997
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 20170
(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 -- 40,186,459 shares as of May 1, 1997
(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 appears on page 14.
================================================================================
<PAGE>
PSINET INC.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of December 31, 1996 and March 31, 1997.......................3
Consolidated Statements of Operations for the three months ended
March 31, 1996 and March 31, 1997.........................................................4
Consolidated Statements of Cash Flows for the three months ended
March 31, 1996 and March 31, 1997.........................................................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 ...........................................................12
Signatures ............................................................................................13
Exhibit Index ............................................................................................14
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
ASSETS
December 31, 1996 March 31, 1997
----------------- --------------
(Audited) (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 52,695 $ 55,154
Short-term investments and
marketable securities 4,649 4,649
Accounts receivable, net 17,421 17,579
Inventories 643 693
Prepaid expenses 1,963 1,494
Other current assets 4,940 3,551
--------------- ----------------
Total current assets 82,311 83,120
Property and equipment, net 72,061 75,781
Goodwill and other intangibles, net 13,589 2,385
Software costs, net 3,084 -
Other assets and deferred charges 6,067 6,052
--------------- ----------------
Total assets $177,112 $167,338
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit $ 2,000 $ 2,000
Current portion of long-term debt 24,915 26,850
Trade accounts payable 19,868 18,993
Accrued payroll and related expenses 3,098 2,123
Other accounts payable and accrued liabilities 3,632 3,699
Deferred revenue 5,612 5,001
--------------- ----------------
Total current liabilities 59,125 58,666
Long-term debt 26,938 27,295
Deferred income taxes 476 -
Other liabilities 790 837
---------------- ----------------
Total liabilities 87,329 86,798
---------------- ----------------
Shareholders' equity:
Preferred stock - -
Common stock 402 403
Capital in excess of par value 208,000 208,092
Retained deficit (116,636) (125,905)
Treasury stock, at cost (2,005) (2,005)
Cumulative foreign currency translation
adjustment 22 (45)
---------------- ----------------
Total shareholders' equity 89,783 80,540
---------------- ----------------
Total liabilities and shareholders' equity $177,112 $167,338
================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE>
PSINET INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------------------
1996 1997
----------------- ----------------
(in thousands, except per share amounts)
<S> <C> <C>
Revenue $ 17,181 $ 25,639
Operating costs and expenses:
Data communications and operations 13,942 20,968
Sales and marketing 7,844 6,002
General and administrative 5,475 5,481
Depreciation and amortization 6,182 8,034
----------------- ----------------
Total operating costs and expenses 33,443 40,485
----------------- ----------------
Loss from operations (16,262) (14,846)
Interest expense (857) (1,350)
Interest income 1,224 775
Other income (expense) 1,068 (25)
Gain on sale of subsidiary - 5,701
Equity in loss of affiliate (100) -
----------------- ----------------
Loss before income taxes (14,927) (9,745)
Income tax benefit 39 476
----------------- ----------------
Net loss $ (14,888) $ (9,269)
================ ================
Loss per share $ (0.39) $ (0.23)
================= ================
Shares used in computing
loss per share 38,178 40,158
================= ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
PSINET INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------------
1996 1997
--------- -----------
(in thousands)
<S> <C> <C>
Net cash used in operating activities $ (10,818) $ (9,495)
--------- -----------
Cash flows from investing activities:
Purchases of property and equipment, net (4,369) (2,678)
Purchases of short-term investments and
marketable securities (12,215) -
Net proceeds from sale of subsidiary - 20,353
Payments received on note receivable from
MindSpring - 93
Capitalized software costs (269) -
Loan to affiliate (169) -
Other - (74)
--------- -----------
Net cash (used in) provided by investing activities (17,022) 17,694
--------- -----------
Cash flows from financing activities:
Net payments on lines of credit (2,803) -
Proceeds from issuance of notes payable 2,010 -
Repayments of notes payable (876) (1,591)
Principal payments under capital lease obligations (5,133) (4,241)
Proceeds from exercise of common stock warrants - 4
Proceeds from exercise of common stock options 313 88
Other (29) -
--------- -----------
Net cash used in financing activities (6,518) (5,740)
--------- -----------
Net (decrease) increase in cash and cash equivalents (34,358) 2,459
Cash and cash equivalents, beginning of year 102,710 52,695
--------- -----------
Cash and cash equivalents, end of period $ 68,352 $ 55,154
========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
PSINET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note l - Basis of Presentation
These consolidated financial statements for the three months ended March
31, 1997 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. and subsidiaries (collectively, "PSINet" or
the "Company") as of December 31, 1996 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,
1996 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, 1997 and the results of operations and cash flows for the
three month periods ended March 31, 1996 and 1997. The results of operations for
the three month period ended March 31, 1997 may not be indicative of the results
expected for any succeeding quarter or for the entire year ending December 31,
1997.
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
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.
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," (EPS) which is effective for the Company's December 31, 1997 financial
statements, requires disclosure of Basic EPS and Diluted EPS. Basic EPS excludes
the dilutive effects of common stock equivalents. Diluted EPS reflects the
potential dilution that could occur if common stock equivalents or other
contracts to issue common stock were exercised or converted into common stock.
The Company anticipates that the adoption of SFAS No. 128 will not have a
material effect on the Company's loss per share data.
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, 1997, short-term investments and marketable securities
included debt securities classified as held-to-maturity with original maturities
of greater than 90 days of approximately $1.5 million.
6
<PAGE>
PSINET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Short-term Investments and Marketable Securities (continued)
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 building an Internet network and providing Internet-related 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 reflected in
short-term investments and marketable securities.
Other income for the three months ended March 31, 1996 consists of
approximately $1.1 million of realized gains on equity securities sold by the
Company.
Note 4 - Long-term Debt
During the three months ended March 31, 1997, the Company incurred capital
lease obligations of approximately $8.1 million upon the execution of leases for
new data communications equipment and other fixed assets.
At March 31, 1997, the aggregate unused portion under the Company's various
financing arrangements for purchases of data communications equipment and other
fixed assets was $11.1 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 the aggregate principal amount of certain term credit advances
(approximately $4.1 million at March 31, 1997). There was $2.0 million advanced
under this credit agreement at March 31, 1997. Interest is payable monthly at an
annual rate of prime plus 1.5% (9.75% at March 31, 1997).
Note 5 - Sale of Software Subsidiary
Effective as of February 1, 1997, the Company sold all of the issued and
outstanding capital stock of its wholly-owned subsidiary, InterCon Systems
Corporation ("InterCon"), to Ascend Communications, Inc. ("Ascend") in exchange
for $12 million in cash pursuant to a Stock Acquisition Agreement between the
Company and Ascend. In addition, in connection with the sale, the Company
received $8.5 million in cash from Ascend as repayment of intercompany debt owed
by InterCon to the Company. The Company recognized a gain of approximately $5.7
million in connection with the sale of InterCon in the three months ended March
31, 1997.
7
<PAGE>
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
unaudited 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, 1996 incorporated by reference to the Company's
Annual Report on Form 10-K, as filed with the Securities and Exchange
Commission. 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. For a discussion of the risk factors that could cause
actual results to differ materially from the forward-looking statements, see
"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 is a leading provider of Internet access, services and products. The
Company offers, throughout the United States and internationally, a broad
spectrum of Internet access services to corporate customers ranging from
low-cost dial-up services to high performance continuous access services using
dedicated high-speed telephone circuits, intranet networking services, Web site
design and hosting services, Electronic Commerce, training and consulting
services and Internet access security services. Pursuant to network access
agreements with consumer-oriented Internet service providers ("ISPs"), the
Company also provides Internet connection services which allow the subscribers
of the ISPs to connect to the Internet through PSINet's network local access
points called Points-of-Presence or "POPs" for specified fees payable by the
ISPs. At March 31, 1997, the Company served approximately 20,900 corporate
customers, including 33 consumer-oriented ISPs, through approximately 350 POPs.
To further refine the Company's focus on corporate Internet services, in
February 1997 the Company sold its software subsidiary, InterCon Systems
Corporation ("InterCon"), to Ascend Communications, Inc. ("Ascend") for cash
consideration of $12 million. The Company also was paid $8.5 million in cash by
Ascend as repayment of intercompany debt owed by InterCon to the Company.
Revenue and expenses of its software subsidiary included in the Company's
consolidated statements of operations were $1.6 million and $4.1 million,
respectively, for the three months ended March 31, 1996 and $0.3 million and
$1.1 million, respectively, for the three months ended March 31, 1997.
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 has made significant investments in
telecommunications circuits and equipment. These investments generally are made
in advance of anticipated customer growth and resulting revenue. The Company
also has increased its sales and marketing, customer support, network operations
and field services commitments in anticipation of the expansion of its customer
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 customer
base. The nature and amount of these expenses may fluctuate over time as the
Company shifts its focus from expanding its network to refining and enhancing
its existing network.
8
<PAGE>
Three Months Ended March 31, 1997 as Compared to the Three Months Ended March
31, 1996
Results of Operations
Revenue. Revenue is derived from the sale of Internet access and related
services to businesses. Revenue increased by 49.2% from approximately $17.2
million for the three months ended March 31, 1996 to approximately $25.6 million
for the three months ended March 31, 1997. The increase in revenue over the same
three month period in 1996 resulted principally from greater sales of Internet
services to businesses offset by a decrease in revenue relating to the strategy,
which was implemented in mid-1996, of providing wholesale network services to
consumer-oriented providers of Internet access services rather than providing
the consumer access services directly. More specifically, the Company believes
the greater sales were attributable to a number of factors including: an
increase in the number of customers facilitated by an increase in the number of
POPs in operation; an expansion of the Company's sales force; and greater public
awareness and acceptance of the Internet. The Company's corporate customer base
increased by approximately 102.9% from approximately 10,300 corporate customers
at March 31, 1996 to approximately 20,900 corporate customers, including 33
consumer-oriented ISPs, at March 31, 1997. The Company's network infrastructure
increased from approximately 300 POPs at March 31, 1996 to approximately 350
POPs at March 31, 1997.
Data Communications and Operations. Data communications and operations
expenses consist primarily of leased long distance circuit costs, local loop
costs and expenses associated with network operations, customer support and
field service. Data communications and operations expenses were approximately
$13.9 million (81.2% of revenue) and approximately $21.0 million (81.8% of
revenue) for the three months ended March 31, 1996 and 1997, respectively. The
$7.1 million increase in data communications and operations expenses during the
three months ended March 31, 1997 as compared to the same period in 1996 related
principally to increases in (i) costs associated with providing dedicated
circuits to the Company's InterFrame and InterMan customers and (ii) circuit
costs relating to the Company's new POPs deployed in early 1996 and network
infrastructure enhancements. Circuit costs relating to the Company's new and
expanded POPs generally are incurred by the Company in advance of anticipated
growth in the Company's customer base. Although the Company expects that data
communications and operations expenses will continue to increase as the
Company's customer base continues to grow, it anticipates that such expenses
will decrease as a percentage of revenue.
Sales and Marketing. Sales and marketing expenses consist primarily of
sales and marketing personnel costs, advertising costs, distribution costs and
related occupancy costs. Sales and marketing expenses decreased from
approximately $7.8 million (45.7% of revenue) during the three months ended
March 31, 1996 to approximately $6.0 million (23.4% of revenue) during the three
months ended March 31, 1997. The $1.8 million decrease during the three months
ended March 31, 1997 as compared to the same period in 1996 resulted principally
from an aggregate reduction in sales and marketing expenses of approximately
$2.9 million which resulted principally from the implementation of the Company's
wholesale network services strategy and the sale of InterCon. These decreased
expenses were offset, in part, by an increase of approximately $1.5 million in
sales and marketing expenses relating to the expansion of the Company's
operations in Canada, Japan and the United Kingdom. All advertising and
marketing costs are expensed in the period incurred. The Company expects that,
as a result of the implementation of its wholesale network services strategy and
its continued efforts to focus on increasing its corporate customer base, its
sales and marketing expenses will decrease as a percentage of revenue over time.
General and Administrative. General and administrative expenses consist
primarily of salaries and occupancy costs for executive, financial, legal and
administrative personnel. General and administrative expenses were approximately
$5.5 million (31.9% of revenue) during the three months ended March 31,
9
<PAGE>
1996 and approximately $5.5 million (21.4% of revenue) during the three months
ended March 31, 1997. Although the Company experienced decreased expenses
primarily due to the implementation of the Company's wholesale network services
strategy (approximately $0.5 million) and the sale of InterCon (approximately
$0.4 million) in June 1996 and February 1997, respectively, overall general and
administrative expenses remained fairly constant due to offsetting increases of
approximately $1.4 million relating to the Company's corporate Internet access
business. The Company may from time to time adjust its general and
administrative function in response to current business developments.
Depreciation and Amortization. Depreciation and amortization costs were
approximately $6.2 million (36.0% of revenue) during the three months ended
March 31, 1996 and approximately $8.0 million (31.3% of revenue) during the
three months ended March 31, 1997. This increase was principally the result of
one-time charges relating to the acceleration of amortization of certain
intangible assets of the Company totaling approximately $2.0 million. The
Company anticipates that, based upon its present business plan for its existing
operations, the net effect of the decreases in depreciation and amortization due
to the transfer of certain tangible and intangible assets, in connection with
the implementation of the Company's wholesale network services strategy in the
second and third quarters of 1996 and the sale of its software operations in the
first quarter of 1997 and the increases due to anticipated capital expenditures
associated with network infrastructure enhancements will likely result in no
material changes in the level of depreciation and amortization when compared to
1996.
Interest Expense. Interest expense increased from approximately $0.9
million during the three months ended March 31, 1996 to approximately $1.4
million during the three months ended March 31, 1997. The approximately $0.5
million increase in interest expense during the three months ended March 31,
1997 as compared to the same period in 1996 was principally due to increased
borrowings and capital lease obligations incurred by the Company to finance
network expansion and to fund working capital requirements. The Company may
incur increased borrowings and capital lease obligations in the near term in
connection with its network enhancements which will further impact the amount of
the Company's interest expense.
Interest Income. Interest income decreased from approximately $1.2 million
during the three months ended March 31, 1996 to approximately $0.8 million
during the three months ended March 31, 1997. The $0.4 million decrease in
interest income during the three months ended March 31, 1997 as compared to the
same period in 1996 was principally due to a decrease in the amount of proceeds
remaining from the Company's public offerings in 1995. All remaining proceeds
are currently invested in short-term, investment grade, interest bearing
securities.
Other income. Other income of approximately $1.1 million during the three
months ended March 31, 1996 relates to the recognition of realized gains on
equity securities which were sold by the Company.
Gain on sale of subsidiary. The gain on the sale of subsidiary of
approximately $5.7 million relates to the sale of the Company's software
subsidiary, InterCon, to Ascend for cash consideration of $12.0 million. In
connection with the sale, the Company also was paid $8.5 million in cash by
Ascend as repayment of intercompany debt owed by InterCon to the Company.
Net loss and loss per share. As a result of the factors discussed above,
the Company's net loss was $14.9 million or $0.39 per share during the three
months ended March 31, 1996, compared with a net loss of $9.3 million or $0.23
per share during the three months ended March 31, 1997.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," (EPS) which
is effective for the Company's December 31, 1997 financial statements. The
Company anticipates that the adoption of SFAS No. 128 will not have a material
effect on the Company's reported loss per share data.
10
<PAGE>
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 $10.8 million and $9.5
million for the three months ended March 31, 1996 and 1997, 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, 1996
was approximately $17.0 million and cash flow provided by investing activities
for the three months ended March 31, 1997 was approximately $17.7 million. The
expansion of the Company's network resulted in capital expenditures of
approximately $22.9 million and $10.8 million for the three months ended March
31, 1996 and 1997, respectively (which included capital expenditures financed
under equipment financing agreements aggregating approximately $18.5 million and
$8.1 million for the three months ended March 31, 1996 and 1997, respectively).
Additionally, during the three months ended March 31, 1996, the Company invested
approximately $12.2 million in equity and debt securities with original
maturities of greater than 90 days. In February 1997, the Company sold its
software subsidiary, InterCon to Ascend for cash consideration of $12.0 million.
The Company also was paid $8.5 million by Ascend as repayment of intercompany
debt owed by InterCon to the Company.
Cash flow used in financing activities was approximately $6.5 million and $5.7
million for the three months ended March 31, 1996 and 1997, respectively. During
the three months ended March 31, 1996 and 1997, the Company made repayments
aggregating $8.8 million and $5.8 million, respectively, on its financing
facilities. Additionally, during the three months ended March 31, 1996, the
Company received proceeds from the issuance of $2.0 million of notes payable.
As of March 31, 1997, the Company had approximately $55.2 million of cash and
cash equivalents, approximately $4.6 million of short-term investments and
marketable securities and approximately $11.1 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, 1997 a maximum
availability of approximately $4.1 million), under which $2.0 million was
outstanding. 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.
As of March 31, 1997, the Company had commitments to certain telecommunications
vendors totaling approximately $13.2 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, 1997, the Company was obligated to make future
minimum lease payments of approximately $11.3 million on non-cancellable
operating leases expiring in various years through 2005.
Based upon its present business plan, the Company believes that working capital,
funds from operations, existing credit facilities and additional borrowings
which the Company expects to be able to obtain when needed, will be sufficient
to meet the presently anticipated working capital and capital expenditure
requirements of its existing operations.
11
<PAGE>
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following Exhibits are filed herewith:
Exhibit 11.1 Calculation of Loss per Share and Weighted
Average Shares Used in Calculation for the
Three Months Ended March 31, 1997
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 March 3, 1997, the Company filed a Current Report on Form 8-K,
dated February 14, 1997, relating to the sale of all of the issued
and outstanding capital stock of its wholly-owned subsidiary,
InterCon Systems Corporation, to Ascend Communications, Inc.
12
<PAGE>
PSINET INC.
FORM 10-Q
MARCH 31, 1997
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, 1997 By: /s/ William L. Schrader
- ------------ ---------------------------
Date William L. Schrader
Chairman, President, Chief
Executive Officer and Director
May 15, 1997 By: /s/ Edward D. Postal
- ------------ ---------------------------
Date Edward D. Postal
Vice President and Chief Financial Officer
(Principal Financial and Chief Accounting
Officer)
13
<PAGE>
EXHIBIT INDEX
Item 6 (a) Exhibits:
Exhibit Exhibit Name Location
- ------- ---------------- --------
11.1 Calculation of Loss per Share and Weighted
Average Shares Used in Calculation for the Three Months
Ended March 31, 1997.........................................15
27 Financial Data Schedule......................................16
99.1 Risk Factors.................................................17
14
Exhibit 11.1
PSINet Inc.
and Subsidiaries
Calculation of Loss per Share (Unaudited) (1)
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1997
--------------
<S> <C>
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of period..................................................... 40,113,234
Weighted average shares issued during the three months ended March 31, 1997
(60,268 shares) .............................................................................. 44,847
---------------
40,158,081
==============
Net loss ............................................................................................ $ (9,269,000)
==============
Loss per share (unaudited) .......................................................................... $ (0.23)
==============
=========================================================================================================================
</TABLE>
(1) For a discussion of loss per share, see Note 2 of the Notes to the
Consolidated Financial Statements.
15
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary information extracted from the Consolidated
Statement of Operations for the three months ended March 31, 1997 and the
Consolidated Balance Sheet as of March 31, 1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 55,154
<SECURITIES> 4,649
<RECEIVABLES> 20,316
<ALLOWANCES> 2,737
<INVENTORY> 693
<CURRENT-ASSETS> 83,120
<PP&E> 109,845
<DEPRECIATION> 34,064
<TOTAL-ASSETS> 167,338
<CURRENT-LIABILITIES> 58,666
<BONDS> 27,295
0
0
<COMMON> 403
<OTHER-SE> 80,137
<TOTAL-LIABILITY-AND-EQUITY> 167,338
<SALES> 25,639
<TOTAL-REVENUES> 25,639
<CGS> 20,968
<TOTAL-COSTS> 20,968
<OTHER-EXPENSES> 19,517
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,350
<INCOME-PRETAX> (9,745)
<INCOME-TAX> 476
<INCOME-CONTINUING> (9,269)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,269)
<EPS-PRIMARY> (0.23)
<EPS-DILUTED> (0.23)
</TABLE>
Exhibit 99.1
RISK FACTORS
From time to time, in both written reports and in oral statements by PSINet
senior management, expectations and other statements are expressed regarding
future performance of the Company. These forward-looking statements are
inherently uncertain and investors must recognize that events could turn out to
be different than such expectations and statements. Key factors impacting
current and future performance are discussed in the Company's Annual Report on
Form 10-K and other filings with the Securities and Exchange Commission. In
addition, the following Risk Factors as well as the other information in this
Quarterly Report should be considered 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 with revenue increasing from
$15.2 million in 1994 to $38.7 million in 1995 to $84.4 million in 1996, it has
incurred losses and experienced negative earnings before interest, taxes,
depreciation and amortization (EBITDA) during each of its last three fiscal
years. The Company has incurred net losses of approximately $5.3 million, $53.2
million and $55.1 million and has incurred negative EBITDA of approximately $1.5
million, $27.9 million and $28.0 million for each of the years ended December
31, 1994, 1995 and 1996, respectively, and has incurred a net loss of
approximately $9.3 million and negative EBITDA of approximately $6.8 million for
the three months ended March 31, 1997. At March 31, 1997, the Company had a
retained deficit of $125.9 million. Although the Company presently projects that
it will achieve positive EBITDA sometime during the second quarter of 1997 and
will be profitable by the first quarter of 1998 or prior thereto, there can be
no assurance that revenue growth will continue or that the Company will achieve
profitability or positive EBITDA in the future. The Company expects to focus in
the near term on continuing to increase its corporate customer base and
expanding its wholesale network services strategy which will require it to
continue to incur expenses for marketing, network infrastructure, personnel and
the development of new services and software. Such continued expenses may
adversely impact cash flow and operating performance. The Company also plans to
continue to enhance PSINet's network and the administrative and operational
infrastructure necessary to support its Internet access service domestically and
internationally.
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 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 that could have a material adverse effect on the Company's
business, results of operations and cash flow.
Competition
The market for data communications services, including Internet access
services, is highly competitive. The industry has relatively insignificant
barriers to entry and numerous entities competing for the same customers. PSINet
expects that competition will continue to intensify. The Company
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believes that the primary competitive factors for the provision of Internet
services are quality of service, reliability, price, 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.
The Company's current and prospective competitors generally may be
divided into the following two groups: (1) other Internet access providers, such
as Bolt, Beranek & Newman Inc. ("BBN"), NETCOM On-Line Communications Services,
Inc. ("NETCOM") and other national and regional providers; and (2)
telecommunications companies, such as AT&T Corp. ("AT&T"), GTE Corp. (if its
recently announced plan to acquire BBN is consummated), MCI Communications
Corporation ("MCI"), WorldCom, Inc. (through its mergers with MFS Communications
Co., Inc. ("MFS") and UUNET Technologies, Inc. ("UUNET")), Sprint, Inc.,
regional Bell operating companies ("RBOCs") and various cable television
companies. 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
marketing or competitive disadvantage.
Recent Federal Communications Commission ("FCC") regulations may
increase competitive activity by RBOCs and other companies in the Internet
access business. The 1996 Federal telecommunications legislation also contains
certain provisions which allow the RBOCs to provide electronic publishing of
information and databases. In addition, this legislation makes it easier for
national long distance carriers such as AT&T to offer local telephone service.
These regulations and legislation may result in additional competitive pressures
on the Company or have a material adverse effect on the Company's business,
results of operations and financial condition.
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. For example, the
1996 mergers of UUNET with MFS and of MFS with WorldCom, Inc., as well as GTE
Corp.'s recently announced plan to acquire BBN, may create the potential for
network expense reductions which could result in a competitive advantage for the
combined entity. 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.
As PSINet continues to expand 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 and others. 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.
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As a result of industry competition, the Company expects to encounter
pricing pressure, 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, including AT&T and MCI, may
be able to provide customers with 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 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. PSINet is not able presently to
predict the impact which future growth in the Internet access and on-line
services businesses will have upon 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.
Entry Into Wholesale Network Services Business
In response to competitive considerations in the market for consumer
dial-up Internet access customers, the Company altered its strategy in mid-1996
to include providing wholesale network services to consumer-oriented Internet
service providers ("ISPs") in the United States, rather than providing the
consumer access services directly. The wholesale network services business
supplements, but does not directly affect, the Company's core business. At March
31, 1997, the Company provided wholesale network services to approximately 33
consumer-oriented ISPs. The consumer-oriented ISPs are subject to a number of
business risks, including, without limitation, those arising from the intense
competition in their market, which could impact the Company's wholesale network
services business. There can be no assurance that the Company's new strategy
will provide significant revenue in the future.
Risks of Growth and Expansion
The Company had expanded its network to approximately 350 POPs as of
March 31, 1997 and plans to continue to expand the capacity of existing POPs as
customer-driven demand dictates throughout 1997. 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 has increased
demands on its systems and controls. The Company anticipates that its wholesale
network service, as well as other business growth, may require continued
enhancements to and expansion of its network. 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 existing 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.
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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, 1997,
the Company's network comprised approximately 350 POPs. Based upon its present
business plan, the Company believes that working capital, funds from operations,
existing credit facilities and additional borrowings which the Company expects
to be able to obtain when needed, will be sufficient to meet 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, more rapid international expansion or
acquisitions of complementary businesses, 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 funds on favorable terms.
In the event that the Company is unable to obtain such additional funds on
acceptable terms, the Company may determine not to enter into various expansion
opportunities.
Risks Associated with International Expansion
A component of the Company's strategy is its planned expansion into
international markets. To date, the Company has only limited experience in
providing international Internet service. There can be no assurance that the
Company will be able to obtain the permits and operating licenses required for
it to operate, to hire and train employees or to market, sell and deliver high
quality services in these markets. In addition to the uncertainty as to the
Company's ability to expand its international presence, there are certain risks
inherent to doing business on an international level, such as unexpected changes
in regulatory requirements, tariffs, customs, duties and other trade barriers,
difficulties in staffing and managing foreign operations, longer payment cycles,
problems in collecting accounts receivable, political instability,
expropriation, nationalization, war, insurrection and other political risks,
fluctuations in currency exchange rates, foreign exchange controls which
restrict or prohibit repatriation of funds, technology export and import
restrictions or prohibitions, delays from customs brokers or government
agencies, seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world and potentially adverse tax
consequences, which could adversely impact the success of the Company's
international operations. The Company may need to enter into additional joint
ventures or other strategic relationships with one or more third parties in
order to successfully conduct its foreign operations. There can be no assurance
that such factors will not have an adverse effect on the Company's future
international operations and, consequently, on the Company's business, financial
condition and results of operations. In addition, there can be no assurance that
laws or administrative practice relating to taxation, foreign exchange or other
matters of countries within which the Company operates will not change. Any such
change could have a material adverse effect on the Company's business, financial
condition and results of operations.
Risks Associated With Acquisitions and Strategic Alliances
As part of its business strategy, the Company expects to seek to
develop strategic alliances both domestically and internationally and/or to
acquire assets and businesses principally relating to or complementary to its
current operations. Any such future strategic alliances or acquisitions would be
accompanied by the risks commonly encountered in strategic alliances with or
acquisitions of companies. Such risks include, among other things, the
difficulty of assimilating the operations and personnel of the companies, the
potential disruption of the Company's ongoing business, the inability of
management to maximize the financial and strategic position of the Company by
the successful incorporation of licensed or acquired technology and rights into
the Company's service offerings, the maintenance of uniform standards, controls,
procedures and policies and the impairment of relationships with employees and
customers as a result of changes in management. There can be no assurance that
the Company would be
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successful in overcoming these risks or any other problems encountered in
connection with such strategic alliances or acquisitions.
In addition, if the Company were to proceed with one or more
significant acquisitions in which the consideration consists of cash, a
substantial portion of the Company's available cash could be used to consummate
the acquisitions. If the Company were to consummate one or more significant
acquisitions or strategic alliances in which the consideration consists of
stock, shareholders of the Company could suffer a significant dilution of their
interests in the Company. Many of the businesses that might become attractive
acquisition candidates for the Company may have significant goodwill and
intangible assets, and acquisition of these businesses, if accounted for as a
purchase, would typically result in increases in the Company's amortization
expenses and the length of time over which they are reported. In connection with
acquisitions, the Company could incur substantial expenses, including the
expenses of integrating the business of the acquired company or the strategic
alliance with the Company's business. Such expenses, in addition to the
financial impact of such acquisitions, could have a material adverse effect on
the Company's business, financial condition and results of operations and could
cause substantial fluctuations in the Company's quarterly and yearly operating
results.
Dependence on Key Personnel
The Company's success depends to a significant degree upon the
continued contributions of its senior management team and technical, marketing
and sales personnel. The Company's employees may voluntarily terminate their
employment with the Company at any time. Competition for qualified employees and
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 Company's success also will depend on its ability to attract and
retain qualified management, marketing, technical and sales executives and
personnel. The process of locating such personnel with the combination of skills
and attributes required to carry out the Company's strategies is often lengthy.
The loss of the services of key personnel, or the inability to attract
additional qualified personnel, could have a material adverse effect on the
Company's results of operations, product development efforts and ability to
expand its network infrastructure. There can be no assurance that the Company
will be successful in attracting and retaining such executives and personnel.
Any such event could have a material adverse effect on the Company's business,
financial condition and results of operations.
Potential Liability for Information Disseminated through Network; Pending and
Threatened Litigation
The law relating to the liability of on-line services companies and
Internet access providers for information carried on or disseminated through
their systems is currently unsettled in the United States. Several private
lawsuits seeking to impose such liability upon on-line services companies and
Internet access providers are currently pending. In addition, recently enacted
Federal legislation prohibits and imposed liability for the transmission on the
Internet of certain types of information and content. In one case brought
against an Internet access provider, Religious Technology Center v. Netcom
On-Line Communications Services, Inc., a Federal district court ruled that under
certain circumstances Internet access providers could be held liable for
copyright infringement. The imposition upon the Company and other Internet
access providers or Web hosting sites of potential liability for information
carried on or disseminated through their systems could require the Company to
implement measures to reduce its exposure to such liability, which may require
the expenditure of substantial capital and other resources, or to discontinue
certain product or service offerings. The increased attention focused upon
liability issues as a result of these lawsuits and legislative proposals could
impact the growth of the Internet.
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The Company carries errors and omissions insurance with a basic policy
limitation of $2.0 million, subject to deductibles, exclusions and
self-insurance retention amounts. Such coverage may not be adequate or available
to compensate the Company for all liability that may be imposed. The imposition
of liability in excess of, or the unavailability of, such coverage could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The law relating to the regulation and liability of on-line services
and Internet access providers in relation to information carried or disseminated
also is undergoing a process of development in other countries. Decisions, laws,
regulations and other activities regarding regulation and content liability may
significantly affect the development and profitability of companies offering
on-line and Internet access services, including the Company.
Risks Associated with Financing Arrangements
The Company's financing arrangements are secured by substantially all
of the Company's assets and stock of certain subsidiaries of the Company and
require the Company to satisfy certain financial covenants and restrict the
payment of dividends. The Company's secured lenders would be entitled to
foreclose upon those assets in the event of a default under the financing
arrangements and to be repaid from the proceeds of the liquidation of those
assets before the assets would be available for distribution to the Company's
shareholders in the event that the Company is liquidated. In addition, the
collateral security arrangements under the Company's existing financing
arrangements may adversely affect the Company's ability to obtain additional
borrowings.
Government Regulatory Risks
The 1996 Federal telecommunications legislation imposes criminal
liability on persons sending or displaying in a manner available to minors
indecent material on an interactive computer service such as the Internet. The
1996 Federal telecommunications legislation also imposes criminal liability on
an entity knowingly permitting facilities under its control to be used for such
activities. Entities solely providing access to facilities not under their
control (including transmission, downloading, intermediate storage, access
software and other incidental capabilities) are exempted from liability, as are
service providers that take good faith, reasonable, effective and appropriate
actions to restrict access by minors to the prohibited communications. The
constitutionality of these provisions is being challenged in the U.S. Supreme
Court, and the interpretation and enforcement of them is uncertain. This
legislation may decrease demand for Internet access, chill the development of
Internet content, or have other adverse effects on Internet access providers
such as the Company. In addition, in light of the uncertainty attached to
interpretation and application of this law, there can be no assurance that the
Company would not have to modify its operations to comply with the statute,
including prohibiting users from maintaining home pages on the World Wide Web.
Recent FCC regulations may increase competitive activity by RBOCs and
other companies in the Internet access business. The 1996 Federal
telecommunications legislation also contains certain provisions which allow the
RBOCs to provide electronic publishing of information and databases. In
addition, this legislation makes it easier for national long distance carriers
such as AT&T to offer local telephone service. These regulations and legislation
may result in additional competitive pressures on the Company or have a material
adverse effect on the Company's business, results of operations and financial
condition.
The Company provides Internet access, in part, through transmissions
over public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for communications. Although the Company
has a subsidiary which is a certified international
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telecommunications carrier, the Company presently is considered an enhanced
services provider in respect of its domestic operations and, therefore, is not
currently subject to direct regulation or access charges imposed by the FCC or
any other agency for such operations, other than regulations applicable to
businesses generally. The Company could become subject in the future to access
charges and FCC regulation and/or regulation by other regulatory commissions as
a provider of basic telecommunications services. The FCC recently issued a
Notice of Inquiry in which it seeks comment on whether it should distinguish
between different categories of enhanced services, and announced that it will
address issues about the continued viability of its current regulatory division
between basic and enhanced services in a future proceeding. If the FCC
determines that such a distinction is appropriate, this could result in
increased costs being imposed upon the Company.
Risk of System Failure or Shutdown
The success of the Company is dependent upon its ability to deliver
reliable, high-speed access to the Internet. The Company's network, as is also
the case with other networks providing similar service, is vulnerable to damage
or cessation of operations from fire, earthquakes, severe storms, power loss,
telecommunications failures and similar events, particularly if such events
occur within a high traffic location of the network. The Company is also
dependent upon the ability of its telecommunications providers to deliver
reliable, high-speed telecommunications service through their networks. While
the Company's network has been designed with redundant circuits among POPs to
allow traffic rerouting, lab and field testing is performed before integrating
new and emerging technology into the network, and the Company engages in
capacity planning, there can be no assurance that the Company will not
experience failures or shutdowns relating to individual POPs or even
catastrophic failure of the entire network. The Company carries property, POP
equipment and business interruption insurance with basic policy limitations of
$4.0 million, $5.0 million and $5.0 million, respectively, subject to
deductibles, exclusions and self-insurance retention amounts. Such coverage may
not be adequate or available to compensate the Company for all losses that may
occur. In addition, the Company attempts to limit its liability to customers
arising out of network failures through contractual provisions disclaiming all
such liability and, in respect of certain services, limiting liability to a
usage credit based upon the amount of time that the system was not operational.
There can be no assurance that such limitations will be enforceable. In any
event, significant or prolonged system failures or shutdowns could damage the
reputation of the Company and result in the loss of customers.
New and Uncertain Market
Substantially all of the Company's revenue to date has been, and for
the foreseeable future will be, derived from the sale of its Internet access,
services and products. The Company's success will depend upon the development
and expansion of the market for Internet access services and products and the
networks which comprise the Internet. The market for Internet services has only
recently developed and has been accompanied by increased press coverage
concerning the scope and nature of the information and services available on,
and potential uses of, the Internet. Certain critical issues presently
surrounding commercial use of the Internet, including security, reliability,
ease and cost of access, and quality of service, remain unresolved and may
adversely impact the growth of Internet use. If the Internet access market fails
to grow, grows more slowly than anticipated or becomes saturated with
competitors, the Company's business, financial condition and results of
operations would be materially adversely affected.
Network Security Risks; Risks Associated with Providing Security Services
Despite the implementation of network security measures by the Company,
such as limiting physical and network access to its routers, its infrastructure
is potentially vulnerable to computer viruses,
23
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break-ins and similar disruptive problems caused by its customers or other
Internet users. Computer viruses, break-ins or other problems caused by third
parties could lead to interruptions, delays or cessation in service to the
Company's customers. Furthermore, such inappropriate use of the Internet by
third parties could also potentially jeopardize the security of confidential
information stored in the computer systems of the Company's customers, which may
deter potential customers and adversely affect existing customer relationships.
Persistent security problems continue to plague public and private data
networks. Break-ins have reportedly reached computers connected to the Internet
at General Electric Co., Sprint and IBM as well as the computer systems of
NETCOM, Netscape and the San Diego Supercomputer Center. Addressing problems
caused by computer viruses, break-ins or other problems caused by third parties
could have a material adverse effect on the Company.
The security services offered by the Company for use in connection with
its customers' networks also cannot assure complete protection from computer
viruses, break-ins and other disruptive problems. Although the Company attempts
to limit contractually its liability in such instances, the occurrence of such
problems may result in claims against or liability on the part of the Company.
Such claims, regardless of their ultimate outcome, could result in costly
litigation and could have a material adverse effect on the Company's business or
reputation or on its ability to attract and retain customers for its products.
Moreover, until more consumer reliance is placed on security technologies
available, the security and privacy concerns of existing and potential customers
may inhibit the growth of the Internet service industry and the Company's
customer base and revenues.
Dependence on Suppliers
The Company has few long-term contracts with its suppliers. The Company
is dependent on third party suppliers for its leased-line connections, or
bandwidth. Certain of these suppliers are or may become competitors of the
Company, and such suppliers are not subject to any restrictions upon their
ability to compete with the Company. To the extent that these suppliers change
their pricing structures, the Company may be adversely affected. Moreover, the
Company is dependent on certain third party suppliers of hardware components.
Although the Company attempts to maintain a minimum of two vendors for each
required product, certain components used by the Company in providing its
networking services are currently acquired or available from only one source.
The Company has from time to time experienced delays in the receipt of
certain hardware components. A failure by a supplier to deliver quality products
on a timely basis, or the inability to develop alternative sources if and as
required, could result in delays which could materially adversely affect the
Company. The Company's remedies against suppliers who fail to deliver products
on a timely basis are limited by contractual liability limitations contained in
supply agreements and purchase orders and, in many cases, by practical
considerations relating to the Company's desire to maintain good relationships
with the suppliers. As the Company's suppliers revise and upgrade their
equipment technology, the Company may encounter difficulties in integrating the
new technology into the Company's network.
Certain of the vendors from whom the Company purchases
telecommunications bandwidth, including the RBOCs and other local exchange
carriers ("LECs"), currently are subject to tariff controls and other price
constraints which in the future may be changed. In addition, newly enacted
legislation will produce changes in the market for telecommunications services.
These changes may affect the prices charged by the RBOCs and other LECs to the
Company, which could have a material adverse effect on the Company's business,
financial condition and results of operations. Moreover, the Company is subject
to the effects of other potential regulatory actions which, if taken, could
increase the cost of the Company's telecommunications bandwidth through, for
example, the imposition of access charges.
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Risks of Technology Trends and Evolving Industry Standards
PSINet's success will depend upon its ability to develop new products
and provide new services that meet customers' changing requirements. The market
for Internet access is characterized by rapidly changing technology, evolving
industry standards, emerging competition, changes in customer needs and frequent
new service and product introductions. The Company's future success will depend,
in part, on its ability to effectively use leading technologies, to continue to
develop its technical expertise, to enhance its current services, to develop new
services that meet changing customer needs, and to influence and respond to
emerging industry standards and other technological changes on a timely and
cost-effective basis. There can be no assurance that the Company will be
successful in effectively using new technologies, developing new services or
enhancing its existing services on a timely basis or that such new technologies
or enhancements will achieve market acceptance. 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. There can be no assurance that the
Company will be able to effectively address the compatibility and
interoperability issues raised by technological changes or new industry
standards. 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.
Dependence on Technology; Proprietary Rights
The Company's success and ability to compete is dependent in part upon
its technology and proprietary rights, although the Company believes that its
success is more dependent upon its technical expertise than its proprietary
rights. The Company relies on a combination of copyright, trademark and trade
secret laws and contractual restrictions to establish and protect its
technology. Nevertheless, it may be possible for a third party to copy or
otherwise obtain and use PSINet's products or technology without authorization
or to develop similar technology independently, and there can be no assurance
that such measures are adequate to protect PSINet's proprietary technology. In
addition, PSINet's products may be licensed or otherwise utilized in foreign
countries where laws may not protect PSINet's proprietary rights to the same
extent as do laws in the United States. It is the Company's policy to require
employees and consultants and, when obtainable, suppliers to execute
confidentiality agreements upon the commencement of their relationships with the
Company. There can be no assurance that the steps taken by the Company will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. The Company is also subject
to the risk of adverse claims and litigation alleging infringement of the
intellectual property rights of others. From time to time the Company has
received claims of infringement of other parties' proprietary rights. While the
Company does not believe that it has infringed the proprietary rights of other
parties, there can be no assurance that third parties will not assert
infringement claims in the future with respect to the Company's current or
future products or that any such claims will not require the Company to enter
into license arrangements or result in protracted and costly litigation,
regardless of the merits of such claims. No assurance can be given that any
necessary licenses will be available or that, if available, such licenses can be
obtained on commercially reasonable terms.
Potential Volatility of Stock Price
The market price and trading volume of the Company's Common Stock has
been and may continue to be highly volatile. Factors such as variations in the
Company's revenue, earnings and cash flow and announcements of new service
offerings, technological innovations or price reductions by the Company, its
competitors or providers of alternative services could cause the market price of
the Common Stock to fluctuate substantially. In addition, the stock markets
recently have experienced
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significant price and volume fluctuations that particularly have affected
technology based companies and resulted in changes in the market prices of the
stocks of many companies that have not been directly related to the operating
performance of those companies. Such broad market fluctuations have adversely
affected and may continue to adversely affect the market price of the Common
Stock.
26
