<PAGE>
================================================================================
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 SEPTEMBER 30, 1999 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)
----------------
<TABLE>
<S> <C>
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)
</TABLE>
--------------
(703) 904-4100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
--------------
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 - 65,003,738 SHARES AS OF NOVEMBER 1,
1999 (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 35
================================================================================
<PAGE>
PSINET INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998....................3
Consolidated Statements of Operations for the three and nine months ended
September 30, 1999 and 1998...............................................................4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 1998.......................................................5
Notes to Consolidated Financial Statements....................................................6
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................. 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk................................. 29
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders....................................... 31
Item 6. Exhibits and Reports on Form 8-K.......................................................... 32
Signatures ............................................................................................ 34
Exhibit Index ......................................................................................... 35
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN THOUSANDS OF U.S. DOLLARS)
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 494,143 $ 56,842
Restricted cash and short-term investments 137,450 162,469
Short-term investments and marketable securities 1,079,210 265,666
Accounts receivable, net 65,460 50,211
Prepaid expenses 14,490 10,998
Other current assets 39,706 19,077
----------- -----------
Total current assets 1,830,459 565,263
Property, plant and equipment, net 790,423 389,476
Goodwill and other intangibles, net 544,806 282,781
Other assets and deferred charges 133,767 46,711
----------- -----------
Total assets $ 3,299,455 $ 1,284,231
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of debt $ 89,467 $ 59,968
Trade accounts payable 85,744 89,973
Accrued payroll and related expenses 21,108 8,501
Other accounts payable and accrued liabilities 72,070 82,760
Accrued interest payable 49,953 28,988
Deferred revenue 22,605 19,427
----------- -----------
Total current liabilities 340,947 289,617
Long-term debt 2,402,841 1,064,633
Deferred income taxes 2,928 6,123
Other liabilities 64,857 44,032
----------- -----------
Total liabilities 2,811,573 1,404,405
----------- -----------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred Stock
Preferred stock, Series A -- --
Convertible preferred stock, Series B -- 28,802
Convertible preferred stock, Series C 368,838 --
Common stock 651 522
Capital in excess of par value 825,848 401,990
Accumulated deficit (636,537) (427,597)
Treasury stock (2,005) (2,005)
Accumulated other comprehensive income 53,959 36,664
Bandwidth asset/IRU agreement (122,872) (158,550)
----------- -----------
Total shareholders' equity (deficit) 487,882 (120,174)
----------- -----------
Total liabilities and shareholders' equity (deficit) $ 3,299,455 $ 1,284,231
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
PSINET INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------- -------------------------------------
1999 1998 1999 1998
------------------ ----------------- ----------------- ---------------
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue $ 140,600 $ 67,550 $ 369,268 $ 165,732
Operating costs and expenses:
Data communications and operations 97,531 51,908 259,873 130,517
Sales and marketing 27,527 14,701 68,032 37,919
General and administrative 14,850 11,566 47,318 29,439
Depreciation and amortization 41,586 14,658 102,796 37,011
Charge for acquired in-process
research and development - 13,400 - 40,400
------------------ ----------------- ----------------- ---------------
Total operating costs and expenses 181,494 106,233 478,019 275,286
------------------ ----------------- ----------------- ---------------
Loss from operations (40,894) (38,683) (108,751) (109,554)
Interest expense (59,364) (18,722) (120,850) (38,193)
Interest income 19,743 4,747 32,541 11,391
Other income (expense), net (1,058) (301) (796) 703
Gain (loss) on sale of investments (12) 5,647 (632) 5,647
------------------ ----------------- ----------------- ---------------
Loss before income taxes (81,585) (47,312) (198,488) (130,006)
Income tax benefit (expense) 300 (36) 750 (65)
------------------ ----------------- ----------------- ---------------
Net loss (81,285) (47,348) (197,738) (130,071)
Return to preferred shareholders (6,404) (768) (11,202) (2,313)
------------------ ----------------- ----------------- ---------------
Net loss available to common shareholders $ (87,689) $ (48,116) $ (208,940) $ (132,384)
================== ================= ================= ===============
Basic and diluted loss per share $ (1.35) $ (0.93) $ (3.48) $ (2.70)
================== ================= ================= ===============
Shares used in computing basic and diluted loss
per share 64,844 51,659 60,105 49,120
================== ================= ================= ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
PSINET INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------
1999 1998
------------------ ----------------
(IN THOUSANDS OF U.S. DOLLARS)
(UNAUDITED)
<S> <C> <C>
Net cash used in operating activities $(203,521) $ (76,931)
------------------ ----------------
Cash flows from investing activities:
Purchases of property and equipment (217,220) (48,635)
Purchases of short term investments (1,073,784) (247,223)
Proceeds from maturity or sale of short term investments 262,588 200,044
Investments in certain businesses, net of cash acquired (238,484) (123,797)
Restricted cash and short-term investments 25,019 (106,212)
Other, net 740 (205)
------------------ ----------------
Net cash used in investing activities (1,241,141) (326,028)
------------------ ----------------
Cash flows from financing activities:
Payments on lines of credit - (5,603)
Proceeds from issuance of notes payable, net 1,278,405 718,575
Repayments of debt (107,132) (37,313)
Payments under capital lease obligations (45,573) (24,205)
Proceeds from equity offerings, net 742,041 -
Proceeds from exercise of common stock options 11,232 4,645
Payments of dividends on preferred stock (452) (2,140)
Other, net - 269
------------------ ----------------
Net cash provided by financing activities 1,878,521 654,228
------------------ ----------------
Effect of exchange rate changes on cash 3,442 (2,005)
------------------ ----------------
Net increase in cash and cash equivalents 437,301 249,264
Cash and cash equivalents, beginning of period 56,842 33,322
------------------ ----------------
Cash and cash equivalents, end of period $ 494,143 $ 282,586
================== ================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
PSINET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
These consolidated financial statements for the three and nine month periods
ended September 30, 1999 and 1998 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 its subsidiaries
(collectively, "PSINet" or the "Company") as of and for the year ended December
31, 1998 included 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 and for the year ended December 31, 1998 included in the Annual
Report and the unaudited quarterly consolidated financial statements and related
notes to unaudited consolidated financial statements of the Company for the
three month period ended March 31, 1999 and the three and six month periods
ended June 30, 1999 included in the Company's Form 10-Q for each of the quarters
then ended, as filed with the Securities and Exchange Commission. In the opinion
of management, the accompanying unaudited consolidated 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 September 30, 1999, the results of its operations for
the three and nine month periods ended September 30, 1999 and 1998, and its cash
flows for the nine months ended September 30, 1999 and 1998. The results of
operations for the three and nine month periods ended September 30, 1999 may not
be indicative of the results expected for any succeeding quarter or for the
entire year ending December 31, 1999.
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 - ACCOUNTING POLICIES
LOSS PER SHARE - Basic loss per share is computed using the weighted average
number of shares of common stock outstanding during the period. Diluted 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 from common
stock options and warrants and convertible preferred stock. Common stock
equivalent shares are calculated using the treasury stock method and include
stock options, warrants and common stock shares issuable upon conversion of
convertible preferred stock. All common stock equivalents, totaling 16.2 million
shares and 4.8 million shares at September 30, 1999 and 1998, respectively, have
been excluded from the computation of diluted loss per share as their effect
would be antidilutive and, accordingly, there is no reconciliation between basic
and diluted loss per share for each of the periods presented.
FOREIGN CURRENCY - Gains and losses on translation of the accounts of the
Company's non-U.S. operations are accumulated and reported as a component of
accumulated other comprehensive income in shareholders' equity. Transaction
gains and losses and translation of non-functional currency denominated
assets and liabilities are recorded in the consolidated statement of
operations.
6
<PAGE>
NOTE 3 - ACQUISITIONS OF CERTAIN BUSINESSES
CONSUMMATED TRANSACTIONS
During the nine months ended September 30, 1999, the Company acquired a 100%
ownership interest in the following businesses:
<TABLE>
<CAPTION>
BUSINESS NAME LOCATION ACQUISITION DATE
- ------------- -------- ----------------
<S> <C> <C>
Planete.net France 2/99
Satelnet France 2/99
Tele Linx United Kingdom 2/99
Horizontes Brazil 4/99
Openlink Brazil 4/99
Sao Paulo Online Brazil 5/99
Internet de Mexico Mexico 5/99
DataNet Mexico 5/99
The Internet Company Switzerland 5/99
Caribbean Internet U.S. (Puerto Rico) 6/99
The Internet Access Company (TIAC) U.S. 6/99
Argentina On-Line Argentina 6/99
CSO.net Austria 6/99
Intercomputer Spain 7/99
Abaforum Spain 7/99
Netwing Austria 7/99
Global Link Hong Kong 7/99
Sinfonet Panama 8/99
Domain Brazil 8/99
Netsystem Argentina 8/99
Netline Chile 8/99
Vision Network Hong Kong 9/99
ServNet Brazil 9/99
Elender Hungary 9/99
Infase and Ciberia Spain 9/99
Internet Network Technologies U.S. 9/99
Site Internet LTDA Brazil 9/99
TotalNet Canada 9/99
Terzomillennio Italy 9/99
OrbiNet Panama 9/99
</TABLE>
Subsequent to September 30, 1999, the Company acquired a 100% ownership interest
in the following businesses:
<TABLE>
<CAPTION>
BUSINESS NAME LOCATION ACQUISITION DATE
- ------------- -------- ----------------
<S> <C> <C>
ZebraNet U.S. 10/99
</TABLE>
7
<PAGE>
<TABLE>
<S> <C> <C>
SPIN Switzerland 10/99
Zircon Australia 10/99
Mlink Canada 10/99
Netup Chile 11/99
</TABLE>
Generally, the businesses acquired are ISPs that serve both consumer and
business customers with dedicated and dial-up connectivity, Web hosting services
and systems integration services. TeleLinx operates a data center facility in
the U.K. and Intercomputer operates an e-banking business in Spain.
Each of the acquisitions was accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations of the
acquired companies have been included in the Company's consolidated financial
statements since the acquisition dates. The purchase prices of the 1999
acquisitions have been preliminarily allocated to assets acquired, including
intangible assets, and liabilities assumed, based on their respective fair
values at the acquisition dates. As part of the allocation process, the
Company evaluates each acquisition for acquired in-process research and
development technologies. Based on the Company's preliminary allocations, no
in-process research and development technologies were identified for its 1999
acquisitions to date. The Company is in the process of finalizing valuations
for 1999 acquisitions and the allocation of the purchase price for such
acquisitions is preliminary. The Company expects that final allocations for
material acquisitions will be completed before the 1999 results are
finalized. The Company does not expect any change in the current allocation,
including any charge for acquired in-process research and development, to
have a material impact on its results of operations.
In connection with the acquisitions made during the nine months ended September
30, 1999, liabilities assumed were as follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
CASH PAID
FAIR VALUE OF FOR THE LIABILITIES
ASSETS ACQUIRED CAPITAL STOCK ASSUMED
--------------- ------------- -------
<S> <C> <C> <C>
Tele Linx $ 88,220 $ (33,195) $ 55,025
TIAC 27,484 (18,595) 8,889
TotalNet 27,508 (23,100) 4,408
Intercomputer 35,589 (32,718) 2,871
Elender 36,941 (35,273) 1,668
All Others 135,675 (119,188) 16,487
------- --------- ------
$ 351,417 $ (262,069) $ 89,348
========= =========== ========
</TABLE>
For certain acquisitions made in 1999 and 1998, the Company has retained a
portion of the purchase price under holdback provisions of the purchase
agreements to secure performance by the sellers of indemnification or other
contractual obligations. These holdback amounts are generally payable up to 24
months after the date of closing of the related acquisitions. Acquisition
holdback amounts totaled $71.4 million at September 30, 1999, the majority of
which is reported in other liabilities.
The following represents the unaudited pro forma results of operations of the
Company for the nine months ended September 30, 1999 and 1998 as if the
acquisitions which closed prior to September 30, 1999 had been consummated at
January 1, 1998. The unaudited pro forma results of operations include certain
pro forma adjustments, including the amortization of intangible assets relating
to the acquisitions. The unaudited pro forma results of operations are prepared
for comparative purposes only and do not necessarily reflect the results that
would have occurred had the acquisitions actually been consummated at January 1,
1998 or the results that may occur in the future.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------ ------------------
(IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNT)
<S> <C> <C>
Revenue....................................................... $ 416.1 $ 225.3
Net loss available to common shareholders..................... $(224.1) $(151.5)
Basic and diluted loss per share.............................. $ (3.73) $ (3.08)
</TABLE>
8
<PAGE>
Total amortization expense of goodwill and other intangibles was $11.7 million
and $2.9 million for the three months ended September 30, 1999 and 1998,
respectively, and $29.3 million and $5.1 million for the nine months ended
September 30, 1999 and 1998, respectively.
PENDING TRANSACTION
On August 22, 1999, the Company entered into a definitive agreement, as
amended on October 14, 1999, to acquire Transaction Network Services, Inc.
(NYSE: TNI). Under the terms of the merger agreement, the aggregate
consideration to be paid to TNI shareholders consists of up to $351.2 million
in cash and up to 7.8 million shares (assuming the exercise of all of the
currently exercisable TNI stock options, which was approximately 1.4
million at September 30, 1999) of PSINet common stock, which represents an
aggregate value of up to approximately $708.0 million, assuming a price per
share of PSINet common stock of $45.719. Additionally, obligations
outstanding under TNI's Revolving Credit Facility, which was $62.0 million at
September 30, 1999, will be repaid as a condition to closing. TNI
shareholders may elect to receive cash, PSINet stock, or both cash and stock,
subject to certain adjustments. The amount of cash paid and shares of PSINet
stock issued in the TNI merger are contingent upon the ultimate number of
outstanding TNI stock options exercised prior to closing. Completion of the
TNI merger is expected in late November 1999 and is subject to a number of
conditions, including receipt of TNI shareholder approval and regulatory
approvals.
TNI operates a communications network focused on the network services needs of
the POS (point-of-sale/ point-of-service) transaction processing industry
through its POS division. TNI currently operates four divisions: (1) the POS
Division, (2) the Telecom Services Division, (3) the Financial Services
Division, and (4) the International Systems Division.
The Company has recently engaged an independent third party to determine the
allocation of the total purchase price of our pending acquisition of TNI and
other completed 1999 acquisitions. The preliminary evaluation for TNI
indicates there are the following intangible assets present: existing
technology including software, patents, unpatented technology and know-how,
tradenames, customer contracts and relationships, existing workforce and
goodwill, with useful lives from five to 20 years, and approximately $35.0
million of purchased in-process research and development. To the extent that
a different portion of the purchase price is allocated to in-process research
and development, a different charge against operating results would be
recognized in the fourth quarter of 1999, the period in which the TNI merger
is expected to be completed. Such difference could be material.
NOTE 4 - SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
Short-term investments and marketable securities consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
U.S. government obligations $ 812,827 $ 235,105
Commercial paper 326,101 112,290
Certificates of deposit 571 25,000
Other 4,287 --
--------- --------
1,143,786 372,395
Less restricted amounts (64,576) (106,729)
--------- --------
Short-term investments and marketable securities, net $ 1,079,210 $ 265,666
========= ========
</TABLE>
9
<PAGE>
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net, consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
Telecommunications bandwidth $ 320,506 $148,429
Data communications equipment 460,484 275,402
Leasehold improvements 39,440 29,267
Software 28,816 17,724
Office and other equipment 26,816 18,799
Land and buildings 86,859 3,290
Other 4,437 -
--------- ---------
967,358 492,911
Less accumulated depreciation and amortization (176,935) (103,435)
--------- ---------
Property, plant and equipment, net $790,423 $389,476
======= =======
</TABLE>
Total depreciation and leasehold amortization expense was $29.8 million and
$11.8 million for the three months ended September 30, 1999 and 1998,
respectively, and $73.5 million and $31.9 million for the nine months ended
September 30, 1999 and 1998, respectively.
NOTE 6 - DEBT
Debt consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
10% Senior notes $ 600,000 $ 600,000
11% Senior notes (Euro 150,000) 160,260 -
11% Senior notes 1,050,000 -
11.5% Senior notes 350,000 350,000
Capital lease obligations at interest rates ranging from 3.5% to 15.2% 290,527 120,670
Notes payable at interest rates ranging from 1.8% to 11.5%. 38,796 50,981
--------- -----------
2,489,583 1,121,651
Plus unamortized premium 2,725 2,950
--------- -----------
2,492,308 1,124,601
Less current portion (89,467) (59,968)
--------- -----------
Long-term portion $ 2,402,841 $ 1,064,633
========= ===========
</TABLE>
The Company has deposited in an escrow account restricted cash and short-term
investments of $66.7 million at September 30, 1999 to fund, when due, the
next two semi-annual interest payments on the 10% senior notes. During the
quarter ended September 30, 1999, the Company issued $1.05 billion aggregate
principal amount and Euro 150 million aggregate principal amount of 11%
senior notes due 2009. Each of the indentures governing the Company's senior
notes contains financial and other covenants that, among other things, will
restrict the Company's ability to incur further indebtedness, make certain
payments (including payments of dividends) and investments, and sell assets.
10
<PAGE>
The Company has various financing arrangements accounted for as capital leases
for the acquisition of equipment, telecommunications bandwidth, a building and
other fixed assets. During the nine months ended September 30, 1999 and 1998,
the Company incurred capital lease obligations under these arrangements and from
the acquisitions of businesses of $127.9 million and $ 54.9 million,
respectively. At September 30, 1999, the aggregate unused portion under these
arrangements totaled $293.5 million after designating $27.0 million of payables
for various equipment purchases which will be financed under capital lease
facilities. These financing arrangements contain provisions which, among other
things, require the maintenance of certain financial ratios and restrict the
payment of dividends.
The Company has a senior secured credit facility ("Credit Facility") with a
maximum principal amount of $110.0 million; amounts drawn are payable in
September 2001. At September 30, 1999, no amounts were outstanding, $9.7 million
was being utilized for letters of credit, and $100.3 million was available to
draw. Interest on the Credit Facility is based on a spread over the London
interbank offered rate or the higher of the bank's prime rate or the Federal
funds effective rate, at the Company's option (9.5% at September 30, 1999). The
Credit Facility requires, among other things, the satisfaction of certain
financial covenants, including a minimum annual consolidated revenue test, a
minimum EBITDA test and requires the reduction in the maximum amount of
availability and prepayments equal to the net proceeds received from certain
asset sales and certain casualty events. The Company is required to pay an
annual commitment fee ranging from 0.50% to 0.875% of the unused amounts under
the Credit Facility.
The Company was in compliance with the covenants under each of its financing
arrangements at September 30, 1999.
NOTE 7 - CAPITAL STOCK
TERMINATION OF CONTINGENT PAYMENT OBLIGATION TO IXC
In January 1999, the Company's contingent payment obligation to IXC Internet
Services, Inc. ("IXC") under an agreement relating to the purchase of OC-48
bandwidth from IXC was terminated without the payment of any additional amounts
or issuance of additional shares of common stock to IXC. This occurred when the
fair market value of the shares of common stock originally issued to IXC
exceeded the $240.0 million threshold in accordance with the terms of the
agreement.
ISSUANCE OF COMMON STOCK
In May 1999, the Company completed a public offering of 8,000,000 shares of its
common stock at $50.50 per share for net proceeds of approximately $383.8
million after underwriting discounts and commissions and other offering
expenses.
During the nine months ended September 30, 1999, options with respect to
1,890,234 shares of common stock were exercised for aggregate net proceeds of
approximately $11.2 million.
CONVERSION OF CONVERTIBLE PREFERRED STOCK
During the first quarter of 1999, all 600,000 shares of the Company's Series B
8% convertible preferred stock were converted into an aggregate of 3,000,000
shares of the Company's common stock in accordance with the original terms of
the convertible preferred stock.
11
<PAGE>
ISSUANCE OF CONVERTIBLE PREFERRED STOCK
In May 1999, the Company completed a public offering of 9,200,000 shares of its
6 3/4% Series C cumulative convertible preferred stock ("Series C Preferred
Stock") for net proceeds of approximately $358.2 million after underwriting
discounts and commissions and other offering expenses. The Series C Preferred
Stock has a liquidation preference of $50 per share.
At closing, the purchasers of the Series C Preferred Stock deposited
approximately $85.8 million into an account established with a deposit agent
("Deposit Account"). The Deposit Account is not an asset of the Company.
Funds in the Deposit Account will be paid to the holders of the Series C
Preferred Stock each quarter in the amount of $0.84375 per share in cash or
may be used, at the Company's option, to purchase shares of common stock at 95%
of the market price of the common stock on that date for delivery to holders
of Series C Preferred Stock in lieu of cash payments. Holders of Series C
Preferred Stock received a quarterly interest payment from the deposit
account of approximately $7.8 million on August 15, 1999. The funds placed in
the Deposit Account by the purchasers of the Series C Preferred Stock will,
together with the earnings on those funds, be sufficient to make payments, in
cash or stock, through May 15, 2002. Until the expiration of the Deposit
Account, the Company will accrete a return to preferred shareholders each
quarter from the date of issuance at an annual rate of approximately 6 3/4%
of the liquidation preference per share. Such amount will be recorded as a
deduction from net income to determine net income available to common
shareholders. Upon the expiration of the Deposit Account, which is expected
to occur on May 15, 2002 unless earlier terminated, the Series C Preferred
Stock will begin to accrue dividends at an annual rate of 6 3/4% of the
liquidation preference payable in cash or, at our option, in shares of our
common stock at 95% of the market price of the common stock on that date.
Under certain circumstances, the Company can elect to terminate the Deposit
Account prior to May 15, 2002, at which time the remaining funds in the
Deposit Account would be distributed to the Company and the Series C Preferred
Stock would begin to accrue dividends.
NOTE 8 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) for the three and nine months ended September 30,
1999 and 1998 was as follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $ (81,285) $ (47,348) $ (197,738) $ (130,071)
----------- --------- ---------- ----------
Other comprehensive income:
Unrealized holding gains (losses) 2,240 (4,955) 2,676 -
Foreign currency translation adjustment 34,047 343 14,619 (530)
----------- --------- ---------- ----------
36,287 (4,612) 17,295 (530)
----------- --------- ---------- ----------
Comprehensive income (loss) $ (44,998) $ (51,960) $ (180,443) $ (130,601)
=========== ========= ========== ==========
</TABLE>
During the three and nine months ended September 30, 1999, significant
fluctuations in the Japanese Yen resulted in the majority of the change in the
foreign currency translation adjustment.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
On March 23, 1999, an arbitrator awarded The Chatterjee Management Company
("Chatterjee") compensatory damages, including interest and legal expenses,
from the Company. In conjunction with this arbitration decision, the Company
recorded a charge of $49.0 million during its fiscal year ended December 31,
1998, which was included in other accounts payable and accrued liabilities in
its consolidated balance sheets at December 31, 1998 and was paid in April
1999. After accounting for other expenses, the resolution of the previously
established accrual resulted in a non-recurring gain during the second
quarter of 1999 of $0.7 million.
As of September 30, 1999, the Company had commitments to certain
telecommunications vendors under operating lease agreements totaling $152.8
million payable in various years through 2011. Additionally, the Company has
various agreements to lease office space, facilities and equipment and, as of
September 30, 1999, the Company was obligated to make future minimum lease
payments of $53.5 million under such non-cancelable operating leases expiring
in various years through 2009.
In connection with the Company's previously announced naming rights and
sponsorship agreements with the Baltimore Ravens of the National Football
League, the Company will make payments over the next 19 years totaling
approximately $81.7 million.
Under the terms of the merger agreement, the aggregate consideration to be paid
to TNI shareholders consists of up to $351.2 million in cash and up to 7.8
million shares (assuming the exercise of all of the currently exercisable TNI
stock options, which was approximately 1.4 million at September 30, 1999) of
PSINet common stock, which represents an aggregate value of up to approximately
$708.0 million, assuming a price per share of PSINet common stock of $45.719.
Additionally, obligations outstanding under TNI's Revolving Credit Facility,
which was $62.0 million at September 30, 1999, will be repaid as a condition to
closing.
At September 30, 1999, we were obligated to make future cash payments that
total $240.5 million for acquisitions of global fiber-based and satellite
telecommunications bandwidth, including IRUs or other rights. We also expect
that there will be additional costs, such as connectivity and equipment
charges, in connection with taking full advantage of such acquired bandwidth
and IRUs. Certain of this fiber-based and satellite telecommunications
bandwidth may require the acquisition and installation of equipment necessary
to access and light the bandwidth in order to make it operational. At
September 30, 1999, we were obligated to make capital expenditures for such
equipment of $242.0 million. In addition, currently we are obligated to make
expenditures in connection with our build-out of new eCommerce Web hosting
centers in key financial and business centers throughout the world of
approximately $61.8 million. As a result of the foregoing, we currently
believe that our capital expenditures in 1999 will be substantially greater
than those in 1998 and that, as a result of the completion of our recent debt
and equity offerings, our capital expenditure program will be accelerated.
This may occur as we continue to execute our expansion strategy in the 20
largest global telecommunications markets and beyond.
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<PAGE>
The Company is subject to certain other claims and legal proceedings that arise
in the ordinary course of its business activities. Each of these matters is
subject to various uncertainties, and it is possible that some of these matters
may be decided unfavorably to the Company. Management believes that any
liability that may ultimately result from the resolution of these matters will
not have a material adverse effect on the financial condition or results of
operations or cash flows of the Company.
NOTE 10 - INDUSTRY SEGMENT AND GEOGRAPHIC REPORTING
The Company's operations are organized into four geographic operating segments -
U.S./Canada, Latin America, Europe and Asia/Pacific. The Company evaluates the
performance of its segments and allocates resources to them based on revenue and
EBITDA, which the Company defines as losses before interest expense and interest
income, taxes, depreciation and amortization, other non-operating income and
expense, and charge for acquired in-process research and development.
Operations of the Company's U.S./Canada segment include shared network costs and
corporate functions which the Company does not allocate to its other geographic
segments for management reporting purposes. Capital expenditures include both
assets acquired for cash and financed through capital leases and seller-financed
arrangements.
Financial information for the Company's geographic operating segments is
presented below (in millions of U.S. dollars):
<TABLE>
<CAPTION>
U.S./CANADA LATIN AMERICA EUROPE ASIA/PACIFIC ELIMINATIONS TOTAL
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
Revenue $ 75.1 $ 7.3 $ 23.7 $ 34.5 $ --- $ 140.6
EBITDA (5.2) 1.1 (0.1) 4.9 --- 0.7
Assets 2,479.5 112.4 339.1 368.4 --- 3,299.4
Capital expenditures 124.0 1.5 26.6 14.1 * 166.2
THREE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue $ 49.1 $ --- $ 11.4 $ 7.1 $ --- $ 67.6
EBITDA (6.4) --- (1.4) (2.8) --- (10.6)
Assets 632.3 --- 57.3 189.0 --- 878.6
Capital expenditures 47.5 --- 4.3 1.4 --- 53.2
NINE MONTHS ENDED
SEPTEMBER 30, 1999
Revenue $ 204.3 $ 10.5 $ 58.3 $ 96.2 $ --- $ 369.3
EBITDA (16.6) 1.9 (2.7) 11.4 --- (6.0)
Assets 2,479.5 112.4 339.1 368.4 --- 3,299.4
Capital expenditures 287.1 1.8 64.3 27.6 --- 380.8
NINE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue $ 130.1 $ --- $ 25.4 $ 10.5 $ (0.3) $ 165.7
EBITDA (25.2) --- (4.2) (2.7) --- (32.1)
Assets 632.3 --- 57.3 189.0 --- 878.6
Capital expenditures 120.3 --- 8.8 1.8 --- 130.9
</TABLE>
EBITDA for all reportable segments differs from consolidated loss before income
taxes reported in the Company's consolidated statements of operations as follows
(in thousands of U.S. dollars):
13
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
EBITDA $ 692 $ (10,625) $ (5,955) $ (32,143)
Reconciling items:
Depreciation and amortization (41,586) (14,658) (102,796) (37,011)
Charge for acquired IPR&D - (13,400) - (40,400)
Interest expense (59,364) (18,722) (120,850) (38,193)
Interest income 19,743 4,747 32,541 11,391
Other income (expense), net (1,058) (301) (796) 703
Gain (loss) on sale of investments (12) 5,647 (632) 5,647
----------- --------- ----------- -----------
Loss before income taxes $ (81,585) $ (47,312) $ (198,488) $ (130,006)
=========== =========== =========== ===========
</TABLE>
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH (1) OUR
ACCOMPANYING UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO, (2)
OUR AUDITED CONSOLIDATED FINANCIAL STATEMENTS, NOTES THERETO AND MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AS OF
AND FOR THE YEAR ENDED DECEMBER 31, 1998 INCLUDED IN OUR ANNUAL REPORT ON FORM
10-K FOR SUCH PERIOD, AND (3) OUR UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1999 AND
FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1999 INCLUDED IN OUR FORM
10-Q FOR EACH OF THE QUARTERS THEN ENDED, AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION. THE RESULTS SHOWN HEREIN ARE NOT NECESSARILY INDICATIVE OF
THE RESULTS TO BE EXPECTED IN ANY FUTURE PERIODS. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS AND THE TIMING OF EVENTS 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, YOU SHOULD READ "RISK FACTORS"
INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-Q AND OUR OTHER PERIODIC REPORTS AND
DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
GENERAL
We are the leading independent global provider of Internet and eCommerce
solutions to businesses. As an Internet Super Carrier, or ISC, we offer
global distribution of PSINet services through wholly-owned subsidiaries,
supported by local language customer service and a worldwide fiber optic
network capable of speeds of over three terabits. We define the elements of
an ISC to include:
o Multiple eCommerce Web hosting centers - We currently have or are building
eCommerce Web hosting centers in key financial and business centers around
the world, including Atlanta, Frankfurt, Hong Kong, London, Los Angeles,
New York, Paris, Sao Paulo, Toronto, Tokyo and Washington, D.C.;
o Extensive global distribution - We have over 1,000 sales personnel and over
2,500 value added resellers, or VARs, systems integrators and Web design
professionals in 22 countries throughout the world;
o Global brand name recognition - Our brand name is increasingly recognized
throughout the world for Internet-protocol services and applications that
meet the needs of business customers, supported by local language sales,
provisioning and service; and
o Worldwide fiber network and related optronic equipment - We operate one of
the largest global data communications networks that enables or in the
future is expected to enable our customers to connect to the Internet and
access their corporate networks and systems resources from most of the
world's major business and population centers.
We offer a suite of value-added products and services that are designed to
enable our customers to maximize utilization of the Internet to communicate more
efficiently with their customers, suppliers, business partners and remote office
locations. We conduct our business through operations organized into four
geographic operating segments--U.S./Canada, Latin America, Europe and
Asia/Pacific. Our services and products include access services that offer
dedicated, dial-up, wireless and digital subscriber line, or DSL, connections,
Web hosting services, intranets, virtual private networks, or VPNs, electronic
commerce, or eCommerce, voice-over-Internet protocol, email and managed security
services. We also provide wholesale and private label network connectivity and
related services to other Internet service providers, known as ISPs, and
telecommunications carriers to further utilize our network capacity.
15
<PAGE>
We provide Internet connectivity and Web hosting services to customers in 90 of
the 100 largest metropolitan statistical areas in the U.S. and in 17 of the 20
largest global telecommunications markets and are currently operating in 22
countries. We have operations in four separate geographic segments, structured
as follows: (1) U.S./Canada; (2) Latin America (Argentina, Brazil, Chile,
Mexico, and Panama); (3) Europe (Austria, Belgium, France, Germany, Hungary,
Italy, Luxembourg, the Netherlands, Spain, Switzerland, and the United Kingdom);
and (4) Asia/Pacific (Australia, Hong Kong, Japan and the Republic of Korea). We
typically enter a new market through the acquisition of an existing company
within the particular market, and then further expand through a combination of
organic growth supplemented by further acquisitions. Revenue from non-U.S.
operations as a percentage of consolidated results comprised 53% of revenue in
the third quarter of 1999, which is consistent with the 51% of revenue generated
by non-U.S. operations in the second quarter of 1999. By comparison, non-U.S.
operations comprised 40% of revenue for all of 1998.
We operate one of the largest global commercial data communications networks.
Our Internet-optimized network extends around the globe and is connected to
over 700 sites, called points of presence or POPs, situated throughout our
geographic operating regions that enable our customers to connect to the
Internet. Our network reach allows our customers to access their corporate
network and systems resources through local calls in over 150 countries. We
further expand the reach of our network by connecting with other large ISPs
at 163 points through 67 contractual arrangements, called peering agreements
that permit the exchange of information between our network and the networks
of our peering partners. As part of our ISC strategy, we have opened four
global Internet hosting facilities in the U.S., Switzerland, Canada and the
United Kingdom containing a total of approximately 125,000 square feet. Most
recently, we opened a second Internet hosting facility in the U.S. in New
York in October 1999 and currently anticipate opening an additional Internet
hosting facility in Los Angeles in November 1999, which contain an aggregate
total for both hosting facilities of approximately 55,000 square feet. We
have two network operating centers that monitor and manage network traffic
24-hours per day, seven-days per week.
Since the commencement of our operations, we have undertaken a program of
developing and expanding our data communications network. In connection with
this program, we have made significant investments in telecommunications
circuits and equipment to produce a geographically-dispersed, Asynchronous
Transfer Mode (ATM), Integrated Service Digital Network (ISDN) and Switched
Multimegabit Data Service (SMDS) compatible frame relay network specially
designed to optimize Internet traffic. ATM, ISDN and SMDS are among the most
widely used switching standards. These investments generally are made in advance
of obtaining customers and resulting revenue.
As part of our ongoing efforts to further expand and enhance our network, we
have acquired or agreed to acquire significant amounts of global
telecommunications bandwidth in order to build a worldwide fiber optic
network capable of speeds of over three terabits. These include long-term
rights, typically for ten years or more called indefeasible rights of use, or
IRUs, or other rights, in dark fiber, lit fiber, and satellite transponder
capacity. The acquisition of these telecommunications bandwidth assets has
increased our network capacity by a substantial magnitude while reducing
significantly our data communications and operations costs per equivalent
mile. The increased network capacity should enable us to expand our offering
of higher-speed or more bandwidth intensive Internet and Internet-related
services to a larger customer base.
We provide our customers with different types of connectivity products to the
Internet based upon their needs and demands. Some of our customers are served
through DSL technology, which is an alternative technology for local loop
access using existing copper infrastructure. DSL is a single connectivity
solution, of which there are many, that our customers may choose. We will
provide DSL technology, along with wireless and other new technologies that
provide competitive advantages to our
16
<PAGE>
customers in meeting their existing and evolving service requirements. The
continued migration of customers to DSL as a solution could impact our
revenue mix, but in the aggregate we expect greater customer growth, and
therefore greater revenue growth, to be generated from our offering of DSL
connectivity services, although we cannot assure you that our DSL services
will gain market acceptance or that such growth will occur.
ISSUANCE OF 11% SENIOR NOTES
In July 1999, we completed a private placement of $1.2 billion aggregate
principal amount of our 11% senior notes due 2009, consisting of $1.05 billion
aggregate principal amount of 11% senior notes due 2009 and Euro 150 million
aggregate principal amount of 11% senior notes due 2009, for aggregate net
proceeds of approximately $1.17 billion after giving effect to discounts and
commissions and other offering expenses.
PENDING ACQUISITION OF TRANSACTION NETWORK SERVICES, INC.
On August 22, 1999, we entered into a definitive agreement, as amended on
October 14, 1999, to acquire Transaction Network Services, Inc. (NYSE: TNI).
Under the terms of the merger agreement, the aggregate consideration to be
paid to TNI shareholders consists of up to $351.2 million in cash and up to
7.8 million shares (assuming the exercise of all of the currently exercisable
TNI stock options, which was approximately 1.4 million at September 30, 1999)
of PSINet common stock, which represents an aggregate value of up to
approximately $708.0 million, assuming a price per share of PSINet common
stock of $45.719. Additionally, the obligations outstanding under TNI's
Revolving Credit Facility, which was $62.0 million at September 30, 1999,
will be repaid as a condition to closing. TNI shareholders may elect to
receive cash, PSINet stock, or both cash and shares, subject to adjustments.
The amount of cash paid and shares of PSINet stock issued in the TNI merger
are contingent upon the ultimate number of outstanding TNI stock options
exercised prior to closing. Completion of the TNI merger is expected in late
November 1999 and is subject to a number of conditions, including receipt of
TNI shareholder approval and regulatory approvals.
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AS COMPARED TO THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 1998
RESULTS OF OPERATIONS
REVENUE. We generate revenue primarily from the sale of Internet access,
eCommerce and related services to businesses. Revenue was $140.6 million for
the three months ended September 30, 1999, an increase of $73.0 million, or
108%, from $67.6 million for the three months ended September 30, 1998 and an
increase of $16.8 million, or 14%, over the $123.8 million for the three
months ended June 30, 1999. Revenue was $369.3 million for the nine months
ended September 30, 1999, an increase of $203.6 million, or 123%, from $165.7
million for the nine months ended September 30, 1998. Revenue growth of 14%
from the second quarter of 1999 consisted of organic (internally generated)
growth of 10% and growth from acquisitions of 4%. Our internally generated
revenue growth is attributable to a number of factors, including an increase
in the number of business customer and ISP accounts and an increase in the
average annual revenue realized per new business customer account, which are
offset by a decrease in hardware sales to customers. While most revenue is
recurring in nature, from time to time we generate non-recurring revenue from
consulting and other arrangements that may or may not continue in the future.
To date, such amounts have not been material to revenue.
Our business customer account base increased by 71% to 79,900 business accounts
at September 30, 1999 from 46,700 business accounts at September 30, 1998. By
comparison, at June 30, 1999, we had 73,400 accounts. Of the total business
account growth from September 30, 1998, 20,085 accounts were
17
<PAGE>
attributable to the existing customer base of the companies we acquired.
Accounts outside the U.S. represented 60% of our customer account base at
September 30, 1999, compared to 51% at September 30, 1998. The total number
of our Carrier and ISP customers grew to 644 at September 30, 1999, and,
together with our small office/home office ("SOHO") and consumer customers,
provided service to 1.2 million customers. This compares with 141 Carrier and
ISP customers and 665,000 SOHO and consumer customers at September 30, 1998.
Average annual new contract value for business accounts increased to $6,700
for the three months ended September 30, 1999 from $5,900 for the three
months ended September 30, 1998 and $6,000 for the full year 1998, which we
believe reflects an increasing demand for value-added services and higher
levels of bandwidth. The average annual new contract value for the current
quarter represents a decrease in comparison to the $7,300 average annual
value for the quarter ended June 30, 1999, due to the effect of non-U.S.
acquisitions in some less mature business markets. Our business account
retention rate remained strong for the third straight quarter in a row at 80%
for the three months ended September 30, 1999 and compared with a full-year
retention rate in 1998 of 79%.
DATA COMMUNICATIONS AND OPERATIONS. Data communications and operations expenses
consist primarily of leased long distance and local circuit costs as well as
personnel and related operating expenses associated with network operations,
customer support and field service. Data communications and operations expenses
were $97.5 million (69.4% of revenue) for the three months ended September 30,
1999, an increase of $45.6 million, or 87.9%, from $51.9 million (76.8% of
revenue) for the three months ended September 30, 1998. Data communications and
operations expenses were $259.9 million (70.4% of revenue) for the nine months
ended September 30, 1999, an increase of $129.4 million, or 99.1%, from $130.5
million (78.8% of revenue) for the nine months ended September 30, 1998. The
increase in expenses related principally to increases in:
o the number of leased backbone, dedicated customer and dial-up circuits;
o expenditures for additional primary rate interface, or PRI, circuits to
support the growth of our Carrier and ISP customer business;
o personnel costs resulting from the expansion of our network operations,
customer support and field service staff, including through acquisitions;
and
o operating and maintenance charges on telecommunications bandwidth.
Our dedicated access customer account base grew to 21,400 at September 30,
1999 from 11,400 at September 30, 1998, an increase of 87.7%. Comparing the
third quarter of 1999 to the third quarter of 1998, backbone circuit costs
increased $10.6 million, or 84.3%, dedicated customer circuit costs increased
$7.5 million, or 69.3%, PRI expense increased $8.9 million, or 96.5%,
personnel and related operating expenses associated with network operations,
customer support and field service increased $10.3 million, or 84.4% and
operating and maintenance charges on our bandwidth increased $1.4 million, or
208%. Circuit costs relating to our new and expanded POPs and PRIs generally
are incurred by us in advance of obtaining customers and resulting revenue.
Historically, the organic growth of our Carrier and ISP customer business is
highest beginning late in the fourth quarter due to seasonal impacts from
holiday sales of computers. In order to prepare for this demand, in addition
to improving service to existing customers, we have expended a considerable
amount of effort during the past six months in building an inventory of PRIs.
As a result, our monthly direct costs in the U.S. for PRIs has increased from
approximately $3.0 million in the month of March 1999 to approximately $5.0
million in the month of September 1999. Based on current capacity and
customer usage rates, we believe that we are now able to service
approximately twice as many dial-up customers in the U.S. than we currently
service with these PRIs.
Although we expect that data communications and operations expenses will
continue to increase as our customer base grows, we anticipate that such
expenses will continue to decrease over time as a percentage of revenue as we
acquire network bandwidth under IRU or capital lease agreements due to decreases
in unit costs as a result of continued increases in network utilization. Network
bandwidth
18
<PAGE>
acquired under IRU or capital lease agreements is recorded as an asset and
amortized over its useful life. This will, in turn, result in an increase in the
operations and maintenance expense component of data communications costs,
increases in costs for other leased circuits connected to the bandwidth, as well
as increases in depreciation and amortization expense over the useful life of
the bandwidth, typically 10 to 20 years.
SALES AND MARKETING. Sales and marketing expenses consist primarily of personnel
costs, advertising costs, distribution costs and related occupancy costs. Sales
and marketing expenses were $27.5 million (19.5% of revenue) for the three
months ended September 30, 1999, an increase of $12.8 million, or 87.2%, from
$14.7 million (21.8% of revenue) for the three months ended September 30, 1998.
Sales and marketing expenses were $68.0 million (18.4% of revenue) for the nine
months ended September 30, 1999, an increase of $30.1 million, or 79.4%, from
$37.9 million (22.9% of revenue) for the nine months ended September 30, 1998.
The increase is principally attributable to costs associated with the expansion
of our sales force internationally in conjunction with our growth and
acquisitions, implementation of our newly regionalized sales and marketing
organization in the U.S. and to advertising costs, including costs associated
with our naming rights and sponsorship agreements for PSINet Stadium with the
Baltimore Ravens of the National Football League and the launch of our NFL
television advertising campaign.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and occupancy costs for executive, financial, legal and
administrative personnel and provision for uncollectible accounts receivable.
General and administrative expenses were $14.8 million (10.6% of revenue) for
the three months ended September 30, 1999, an increase of $3.2 million, or
27.6%, from $11.6 million (17.1% of revenue) for the three months ended
September 30, 1998 which resulted from approximately $4.4 million increase
relating to general and administrative expenses of companies acquired after
September 30, 1998, a decrease of organic expenses of approximately $0.5
million and a decrease of approximately $0.7 million relating to the
reversal of certain acquisition related liabilities.
General and administrative expenses were $47.3 million (12.8% of revenue) for
the nine months ended September 30, 1999, an increase of $17.9 million, or
60.7%, from $29.4 million (17.8% of revenue) for the nine months ended
September 30, 1998. The increase resulted from an approximately $11.7 million
increase relating to general and administrative expenses of companies
acquired after September 30, 1998 and an increase of expenses relating to our
organic growth of approximately $6.9 million due to the addition of
management staff and other related operating expenses across our
organization. We are finalizing plans to consolidate most of our Virginia
locations into one facility. As a result, various costs associated with the
termination of various facility leases and the relocation of employees are
likely to be incurred over the next two quarters.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs were $41.6
million (29.6% of revenue) for the three months ended September 30, 1999, an
increase of $26.9 million, or 184%, from $14.7 million (21.7% of revenue) for
the three months ended September 30, 1998. Depreciation and amortization costs
were $102.8 million (27.8% of revenue) for the nine months ended September 30,
1999, an increase of $65.8 million, or 178%, from $37.0 million (22.3% of
revenue) for the nine months ended September 30, 1998.
Depreciation and amortization costs have increased as a result of capital
expenditures associated with network infrastructure enhancements, including
telecommunications bandwidth acquisitions, and depreciation and amortization of
tangible and intangible assets related to business acquisitions. We anticipate
that our depreciation and amortization expenses will continue to increase
significantly as we acquire network bandwidth under IRU or capital lease
agreements, and as we record depreciation and
19
<PAGE>
amortization on tangible and intangible assets related to business
combinations and expansion of our operations. In connection with finalizing
our plans to consolidate most of our Virginia locations into one facility,
the useful lives of certain of our assets may be shortened over the next two
quarters.
Our rapid growth over the past year through acquisitions and through the
expansion of our global data communications network has led to a significant
increase in the carrying value of our tangible and intangible assets. In
conjunction with the process of integrating these assets into our business,
we may identify opportunities where we can streamline our operations and
improve network quality through the elimination of redundant or
underperforming assets. Our ongoing integration actions and other steps aimed
at reducing our cost structure may lead to charges or to adjustments to the
depreciable lives of our assets in the future.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. The results for the nine months
ended September 30, 1999 include no charges for acquired in-process research and
development related to acquisitions completed during the period. The results for
the nine months ended September 30, 1998 include a $40.4 million charge (24.4%
of revenue) for acquired in-process research and development. The charges in
1998 were based on independent valuations and reflect technologies acquired
prior to technological feasibility and for which there was no alternative future
use. We are in the process of finalizing valuations for 1999 acquisitions and
the allocation of the purchase price for such acquisitions is preliminary. We
expect that final allocations for material acquisitions will be completed before
the 1999 results are finalized. We do not expect any change in the current
allocation, including any charge for acquired in-process research and
development, to have a material impact on our results of operations.
We have recently engaged an independent third party to determine the
allocation of the total purchase price of our pending acquisition of TNI and
other 1999 completed acquisitions. The preliminary evaluation for TNI
indicates there are the following intangible assets present: existing
technology including software, patents, unpatented technology and know-how,
tradenames, customer contracts and relationships, existing workforce and
goodwill, with useful lives from five to 20 years, and approximately $35.0
million of purchased in-process research and development. To the extent that
a different portion of the purchase price is allocated to in-process research
and development, a different charge against operating results would be
recognized in the fourth quarter of 1999, the period in which the TNI merger
is expected to be completed. Such charge may be material.
INTEREST EXPENSE. Interest expense was $59.4 million (42.2% of revenue) for the
three months ended September 30, 1999, an increase of $40.6 million, or 217%,
from $18.7 million (27.7% of revenue) for the three months ended September 30,
1998. Interest expense was $120.9 million (32.7% or revenue) for the nine months
ended September 30, 1999, an increase of $82.7 million, or 216%, from $38.2
million (23.0% of revenue) for the nine months ended September 30, 1998. The
increase was due to interest related to our 10% senior notes issued in April
1998, 11 1/2% senior notes issued in November 1998 and 11% senior notes issued
in July 1999, as well as to increased borrowings and capital lease obligations
incurred to finance our network expansion and to fund our working capital
requirements.
INTEREST INCOME. Interest income was $19.7 million (14.0% of revenue) for the
three months ended September 30, 1999, an increase of $15.0 million, or 316%,
from $4.7 million (7.0% of revenue) for the three months ended September 30,
1998. Interest income was $32.5 million (8.8% of revenue) for the nine months
ended September 30, 1999, an increase of $21.2 million, or 186%, from $11.4
million (6.9% of revenue) for the nine months ended September 30, 1998. The
increase was due to interest received on the net proceeds of our various
financing activities during 1998 and 1999, which we invest in short-term
investment grade and government securities until such time as we use them for
other purposes.
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NET LOSS AVAILABLE TO COMMON SHAREHOLDERS AND LOSS PER SHARE. Our net loss
available to common shareholders for the three months ended September 30, 1999
was $87.7 million, or $1.35 basic and diluted loss per share, an increase of
$39.6 million, or 82.2%, from a net loss available to common shareholders for
the three months ended September 30, 1998 of $48.1 million, or $0.93 basic and
diluted loss per share. Our net loss available to common shareholders was $208.9
million, or $3.48 basic and diluted loss per share, for the nine months ended
September 30, 1999, an increase of $76.6 million, or 57.8%, from $132.4 million,
or $2.70 basic and diluted loss per share, for the nine months ended September
30, 1998.
The primary reasons for the increase were:
o operating losses from certain acquired businesses;
o an increase in interest expense due to the issuance of our senior notes;
o acquisitions of fiber-based and satellite telecommunications bandwidth,
leading to an increase in depreciation, personnel and other operating costs
to manage the bandwidth;
o an increase in depreciation and amortization related to acquisitions,
offset by the reduction in charges for acquired in-process research and
development; and
o an increase in expenditures for dial-up circuits (e.g., PRIs).
The return to preferred shareholders is subtracted from net loss in determining
the net loss available to common shareholders. Because inclusion of common stock
equivalents is antidilutive, basic and diluted loss per share are the same for
each period presented.
SEGMENT INFORMATION
Our operations are organized into four geographic operating segments -
U.S./Canada, Latin America, Europe and Asia/Pacific. Latin America became a
new segment in 1999 as a result of acquisitions.
We evaluate the performance of our operating segments and allocate resources
to them based on revenue and EBITDA, which we define as earnings (losses)
before interest expense and interest income, taxes, depreciation and
amortization, other non-operating income and expense, and charge for acquired
in-process research and development. Since acquisitions are such an integral
part of the growth of our business over the last year, the following table
highlights the components of our revenue growth by breaking it into organic
and acquisitive growth.
Key changes in the metrics we report in our segment disclosure footnote are
as follows:
<TABLE>
<CAPTION>
U.S./CANADA LATIN AMERICA EUROPE ASIA/PACIFIC TOTAL
----------- ------------- ------ ------------ -----
<S> <C> <C> <C> <C> <C>
Revenue growth - 3Q98 to 3Q99 53% ** 108% 386% 108%
Revenue growth - YTD98 to YTD99 57% ** 130% 816% 123%
EBITDA as % of Revenue - 3Q99 (7)% 15% -% 14% 1%
EBITDA as % of Revenue - 3Q98 (13)% ** (12)% (39)% (16)%
EBITDA as % of Revenue - YTD99 (8)% 18% (5)% 12% (2)%
EBITDA as % of Revenue - YTD98 (19)% ** (17)% (26)% (19)%
Asset growth - 9/30/98 to 9/30/99 292% ** 491% 95% 276%
Capital expenditure growth -- 3Q98 to 3Q99 161% ** 519% 907% 212%
Capital expenditure growth -- YTD98 to YTD99 139% ** 631% 1433% 191%
</TABLE>
** Latin America is new in 1999 as a result of acquisitions.
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All of our operating segments have experienced significant changes in
revenue, EBITDA, assets and capital expenditures during 1999 as compared with
1998 due to organic growth, to significant acquisitions primarily outside of
the U.S. and to investments in our network as described elsewhere in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Our loss from operations differs from EBITDA only by depreciation and
amortization and the charge for acquired in-process research and development;
therefore, loss from operations in each segment reflects the same underlying
trends as those impacting EBITDA as a percentage of revenue.
LIQUIDITY AND CAPITAL RESOURCES
We historically have had losses from operations, which have been funded
primarily through borrowings and capital lease financings from vendors,
financial institutions and other third parties, and through the issuance of debt
and equity securities. In 1999, we have to date received net proceeds of
approximately $1.9 billion from debt and equity financings. At September 30,
1999, we had $1.7 billion of cash, cash equivalents, short-term investments and
marketable securities, including restricted amounts.
CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Cash flows used in operating activities were $203.5 million and $76.9 million
for the nine months ended September 30, 1999 and 1998, respectively. Cash
flows from operating activities can vary significantly from period to period
depending upon the timing of operating cash receipts and payments and other
working capital changes, especially accounts receivable, prepaid expenses and
other assets, and accounts payable and accrued liabilities. In both of these
nine-month periods, our net losses were the primary component of cash used in
operating activities, offset by significant non-cash depreciation and
amortization expenses relating to our network and intangible assets.
Operating cash flows in 1999 also include the $48.0 million arbitration award
payment.
Cash flows used in investing activities were $1.2 billion and $326.0 million
for the nine months ended September 30, 1999 and 1998, respectively.
Investments in certain businesses resulted in the use of $238.5 million of
cash for the
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nine months ended September 30, 1999, net of cash acquired. Investments in
our network and facilities during the first nine months of 1999 resulted in
total additions to fixed assets of $380.8 million. Of this amount, $127.9
million was financed under vendor or other financing arrangements, $35.7
million of non-cash additions related to the OC-48 bandwidth acquired from
IXC Internet Services, Inc. ("IXC"), and $217.2 million was expended in cash.
For the nine months ended September 30, 1998, total additions were $130.9
million, of which $54.9 million was financed under equipment financing
agreements, $27.4 million of non-cash additions related to the OC-48
bandwidth acquired from IXC and $48.6 million was expended in cash. Purchases
of short-term investments during the first nine months of 1999 were an
aggregate of $1.07 billion, offset by proceeds from the sale and maturity of
short-term investments of $262.6 million. Purchases of short-term investments
during the nine months of 1998 were an aggregate of $247.2 million offset by
proceeds from the sale and maturity of short-term investments of $200.0
million. Investing cash flows in the first nine months of 1999 and 1998 were
increased by $25.0 million and decreased by $106.2 million, respectively,
from changes in restricted cash and short-term investments related to various
financing and acquisition activities.
Cash flows provided by financing activities were $1.88 billion and $654.2
million for the nine months ended September 30, 1999 and 1998, respectively.
In the first nine months of 1999, we received $1.28 billion from the issuance
of notes payable and $742.0 million from equity offerings. In the first nine
months of 1998, we received net proceeds from the issuance of notes payable
of $718.6 million. We made repayments aggregating $152.7 million and $67.1
million for the nine months ended September 30, 1999 and 1998, respectively,
on our lines of credit, capital lease obligations and notes payable. During
the nine months ended September 30, 1999 and 1998, we received proceeds from
the exercise of stock options of $11.2 million and $4.6 million, respectively.
CAPITAL STRUCTURE
Our capital structure at September 30, 1999 consisted of a revolving credit
facility, other lines of credit, capital lease obligations, senior notes,
convertible preferred stock and common stock.
Total borrowings at September 30, 1999 were $2.5 billion, which included $0.1
billion in current obligations and $ 2.4 billion in long-term debt, capital
lease obligations and notes payable.
We have a senior secured revolving credit facility that expires on September 29,
2001 and has an aggregate principal amount of $110.0 million. At September 30,
1999, no amounts were outstanding, $9.7 million was being utilized for letters
of credit, and $100.3 million was available to draw under the credit facility.
In addition, as of September 30, 1999, $293.5 million was available for
purchases of equipment and other fixed assets under various other financing
arrangements, after designating $27.0 million of payables for various equipment
purchases that we intend to finance under these agreements.
Our bank financing arrangements, which are secured by substantially all of our
assets, require us to satisfy many financial covenants such as those relating to
consolidated revenue, leverage, liquidity and EBITDA (as defined therein), and
prohibit us from paying cash dividends and repurchasing our capital stock
without the lender's consent. In particular, we are prohibited from permitting:
o consolidated revenue for the period of four consecutive fiscal quarters to
be less than $285.0 million during the six month period beginning June 30,
1999, $350.0 million during the six month period beginning December 31,
1999, $425.0 million during the six month period beginning June 30, 2000,
and $500.0 million on December 31, 2000 and thereafter;
o the ratio of consolidated debt minus cash, excluding cash escrowed with
respect to the payment of obligations, to annualized consolidated revenue
for the most recent fiscal quarter for which financial
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statements have been delivered, as adjusted to give pro forma effect to any
acquisitions completed during or after such fiscal quarter, to exceed 2.5
to 1 at any time;
o the sum of cash (excluding cash escrowed with respect to the payment of
obligations) and available borrowing capacity under our credit facility at
any time to be less than $100.0 million; and
o EBITDA (as defined therein) to be less than ($15.0) million, $0, $15.0
million, $25.0 million, $40.0 million and $50.0 million for the period of
four consecutive fiscal quarters ending on each of September 30, 1999,
December 31, 1999, March 31, 2000, June 30, 2000, September 30, 2000 and
December 31, 2000, respectively.
At September 30, 1999, we were in compliance with all such covenants.
At September 30, 1999, we had outstanding $600.0 million aggregate principal
amount of 10% senior notes due 2005, $350.0 million aggregate principal
amount of 11 1/2 % senior notes due 2008 and $1.05 billion aggregate
principal amount and Euro 150 million aggregate principal amount of 11%
senior notes due 2009. We have on deposit in an escrow account restricted
cash and short-term investments of $66.7 million to fund, when due, the next
two semi-annual interest payments on the 10% senior notes.
The indentures governing each of the senior notes contain many covenants with
which we must comply relating to, among other things, the following matters:
o a limitation on our payment of cash dividends, repurchase of capital stock,
payment of principal on subordinated indebtedness and making of certain
investments, unless after giving effect to each such payment, repurchase or
investment, certain operating cash flow coverage tests are met, excluding
permitted payments and investments;
o a limitation on our incurrence and our subsidiaries' incurrence of
additional indebtedness, unless at the time of such incurrence, our ratio
of debt to annualized operating cash flow would be less than or equal to
6.0 to 1.0 prior to April 1, 2001 and less than or equal to 5.5 to 1.0 on
or after April 1, 2001, excluding permitted incurrences of debt;
o a limitation on our incurrence and our subsidiaries' incurrence of liens,
unless the 10% senior notes, the 11 1/2% senior notes and the 11% senior
notes are secured equally and ratably with the obligation or liability
secured by such lien, excluding permitted liens;
o a limitation on the ability of any of our subsidiaries to create or
otherwise cause to exist any encumbrance or restriction on the payment of
dividends or other distributions on their capital stock, payment of
indebtedness owed to us or to any of our other subsidiaries, making of
investments in us or in any of our other subsidiaries, or transfer of any
of their properties or assets to us or any of our other subsidiaries,
excluding certain permitted encumbrances and restrictions;
o a limitation on certain mergers, consolidations and sales of assets by us
or our subsidiaries;
o a limitation on transactions with our affiliates;
o a limitation on the ability of any of our subsidiaries to guarantee or
otherwise become liable with respect to any of our indebtedness unless such
subsidiary provides for a guarantee of the 10% senior notes, the 11 1/2%
senior notes and the 11% senior notes on the same terms as the guarantee of
such indebtedness;
o a limitation on sale and leaseback transactions by us or our subsidiaries;
o a limitation on issuances and sales of capital stock of our subsidiaries;
and
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o a limitation on the ability of us or our subsidiaries to engage in any
business not substantially related to a telecommunications business.
At September 30, 1999, we were in compliance with all such covenants.
In May 1999, we completed a public offering of 8,000,000 shares of our common
stock at $50.50 per share for net proceeds of approximately $383.8 million,
after underwriting discounts and commissions and other offering expenses.
In May 1999, we completed a public offering of 9,200,000 shares of our 6 3/4%
Series C Cumulative Convertible Preferred Stock ("Series C Preferred Stock")
for net proceeds of approximately $358.2 million after underwriting discounts
and commissions and other offering expenses. The Series C Preferred Stock has
a liquidation preference of $50 per share.
At closing, the purchasers of the Series C Preferred Stock deposited
approximately $85.8 million into an account established with a deposit agent
("Deposit Account"). The Deposit Account is not an asset of ours. Funds in
the Deposit Account will be paid to the holders of the Series C Preferred
Stock each quarter in the amount of $0.84375 per share in cash or may be
used, at our option, to purchase shares of common stock at 95% of the market
price of the common stock on that date for delivery to holders of Series C
Preferred Stock in lieu of cash payments. Holders of Series C preferred stock
received a quarterly interest payment from the Deposit Account of
approximately $7.8 million on August 15, 1999. The funds placed in the
Deposit Account by the purchasers of the Series C Preferred Stock will,
together with the earnings on those funds, be sufficient to make payments, in
cash or stock, through May 15, 2002. Until the expiration of the Deposit
Account, we will accrete a return to preferred shareholders each quarter from
the date of issuance at an annual rate of approximately 6 3/4% of the
liquidation preference per share. Such amount will be recorded as a deduction
from net income to determine net income available to common shareholders.
Upon the expiration of the Deposit Account, which is expected to occur on May
15, 2002 unless earlier terminated, the Series C Preferred Stock will begin
to accrue dividends at an annual rate of 6 3/4% of the liquidation preference
payable in cash or, at our option, in shares of our common stock at 95% of
the market price of the common stock on that date. Under certain
circumstances, we can elect to terminate the Deposit Account prior to May 15,
2002, at which time the remaining funds in the Deposit Account would be
distributed to us and the Series C Preferred Stock would begin to accrue
dividends.
Each share of Series C Preferred Stock is convertible at any time at the
option of the holders thereof into 0.8017 shares of our common stock, equal
to at an initial conversion price of $62.3675 per share, subject to
adjustment upon the occurrence of specified events. The Series C Preferred
Stock is redeemable, at our option, at a redemption premium of 101.929% of
the liquidation preference (plus accumulated and unpaid dividends) on or
after November 15, 2000 and prior to May 15, 2002 if the trading price for
the Series C Preferred Stock exceeds $124.74 per share for a specified
trading period. Additional payments will also be made from the Deposit
Account or by us to the holders of the Series C Preferred Stock if we redeem
Series C Preferred Stock under the foregoing circumstances. Except in the
foregoing circumstances, we may not redeem the Series C Preferred Stock prior
to May 15, 2002. Beginning on May 15, 2002, we may redeem shares of Series C
Preferred Stock at an initial redemption premium of 103.857% of the
liquidation preference, declining to 100.00% on May 15, 2006 and thereafter,
plus in each case all accumulated and unpaid dividends to the redemption
date. We may effect any redemption, in whole or in part, at our option, in
cash by delivery of fully paid and nonassessable shares of our common stock
or a combination thereof (subject to applicable law), by delivering notice to
the holders of the Series C Preferred Stock.
In the event of a change of control of PSINet (as defined in the charter
amendment designating the Series C Preferred Stock), holders of Series C
Preferred Stock will, if the market value of our common stock at such time is
less than the conversion price for the Series C Preferred Stock, have a one
time option to convert all of their outstanding shares of Series C Preferred
Stock into shares of our
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common stock at an adjusted conversion price equal to the greater of (1) the
market value of our common stock as of the date of the change in control and
(2) $38.73. In lieu of issuing shares of common stock issuable upon
conversion in the event of a change of control, we may, at our option, make a
cash payment equal to the market value of the common stock otherwise issuable.
COMMITMENTS, CAPITAL EXPENDITURES AND FUTURE FINANCING REQUIREMENTS
As of September 30, 1999, we had commitments to certain telecommunications
vendors under operating lease agreements totaling $152.8 million payable in
various years through 2011. Additionally, we have various agreements to lease
office space, facilities and equipment and, as of September 30, 1999, we were
obligated to make future minimum lease payments of $53.5 million under such
non-cancelable operating leases expiring in various years through 2009.
Under the terms of the merger agreement, the aggregate consideration to be
paid to TNI shareholders consists of up to $351.2 million in cash and up to
7.8 million shares (assuming the exercise of all of the currently exercisable
TNI stock operations, which was approximately 1.4 million at September 30,
1999) of PSINet common stock, which represents an aggregate value of up to
approximately $708.0 million, assuming a price per share of PSINet common
stock of $45.719. Additionally, obligations outstanding under TNI's Revolving
Credit Facility, which was $62.0 million at September 30, 1999, will be
repaid as a condition to closing.
For most of our acquisitions, we have retained a portion of the purchase
price under holdback provisions of the purchase agreements to secure
performance by certain sellers of indemnification or other contractual
obligations of the sellers. These holdback amounts are generally payable up
to 24 months after the date of closing of the related acquisitions.
Acquisition holdback amounts totaled $71.4 million at September 30, 1999, the
majority of which is reported in other liabilities.
In connection with our previously announced naming rights and sponsorship
agreements with the Baltimore Ravens of the National Football League, we will
make payments over the next 19 years totaling approximately $81.7 million.
In order to maintain our competitive position, enhance our capabilities as an
Internet Super Carrier and continue to meet the increasing demands for
service quality, availability and competitive pricing, we expect to make
significant capital expenditures. At September 30, 1999, we were obligated to
make future cash payments that total $240.5 million for acquisitions of
global fiber-based and satellite telecommunications bandwidth, including IRUs
or other rights. We also expect that there will be additional costs, such as
connectivity and equipment charges, in connection with taking full advantage
of such acquired bandwidth and IRUs. Certain of this fiber-based and
satellite telecommunications bandwidth may require the acquisition and
installation of equipment necessary to access and light the bandwidth in order
to make it operational. At September 30, 1999, we were obligated to make
capital expenditures for such equipment of $242.0 million. In addition, we
currently are obligated to make expenditures in connection with our
build-out of new eCommerce Web hosting centers in key financial and business
centers throughout the world of approximately $61.8 million. As a result of
the foregoing, we currently believe that our capital expenditures in 1999
will be substantially greater than those in 1998 and that, as a result of the
completion of our recent debt and equity offerings, our capital expenditure
program will be accelerated. This may occur as we continue to execute our
expansion strategy in the 20 largest global telecommunications markets and
beyond.
We presently believe, based on the flexibility we expect to have in the
timing of orders of bandwidth, in outfitting our POPs with appropriate
telecommunications and computer equipment, and in controlling the pace and
scope of our anticipated buildout of our international data communications
network and eCommerce Web hosting centers, that we will have a reasonable
degree of flexibility to adjust the amount and timing of such capital
expenditures in response to our then existing financing capabilities, market
conditions, competition and other factors. Accordingly, we believe that
working capital generated from the use of acquired bandwidth, together with
other working capital, working capital from existing credit facilities, from
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capital lease financings, from the proceeds of our recent debt and equity
offerings and from future equity or debt financings, which we presently
expect to be able to obtain when needed, will be sufficient to meet the
currently anticipated working capital and capital expenditure requirements of
our operations. We cannot assure you, however, that we will have access to
sufficient additional capital and/or financing on satisfactory terms to
enable us to meet our capital expenditure and working capital requirements.
We regularly review our capital commitments and needs and the availability of
financing through institutional sources and the capital markets. We expect to
pursue opportunities to raise additional capital from time to time as we
determine to be advisable based upon our capital needs, financing
capabilities and market conditions.
OTHER POSSIBLE STRATEGIC RELATIONSHIPS AND ACQUISITIONS
We anticipate that we will continue to seek to develop relationships with
strategic partners, both domestically and internationally, and to acquire
assets, including, without limitation, additional telecommunications bandwidth,
and businesses and make investments (including venture capital investments)
principally relating to or complementary to our existing businesses. Certain of
these strategic relationships may involve other telecommunications companies
that desire to enter into joint marketing and services arrangements with us
pursuant to which we would provide Internet and Internet-related services to
such companies. Such transactions, if deemed appropriate by us, may also be
effected in conjunction with an equity or debt investment by such companies in
us. Such relationships and acquisitions may require additional financing and may
be subject to the consent of our lenders and other third parties.
DERIVATIVES AND FOREIGN CURRENCY EXPOSURE
We have not entered into any material financial instruments to serve as hedges
against certain financial and currency risks or for trading. However, as a
result of the recent increase in our foreign operations and the issuance of our
Euro-denominated 11% senior notes, we may begin to use various financial
instruments, including derivative financial instruments, in the ordinary course
of business, for purposes other than trading. These instruments could include
letters of credit, guarantees of debt, interest rate swap agreements and foreign
currency exchange contracts relating to intercompany payables of foreign
subsidiaries. We do not intend to use derivative financial instruments for
speculative purposes. Foreign currency exchange contracts would be used to
mitigate foreign currency exposure and with the intent of protecting the U.S.
dollar value of certain currency positions and future foreign currency
transactions. Interest rate swap agreements would be used to reduce our exposure
to risks associated with interest rate fluctuations. By their nature, all such
instruments would involve risk, including the risk of nonperformance by
counterparties. We would attempt to control our exposure to counterparty credit
risk through monitoring procedures and by entering into multiple contracts.
RISKS ASSOCIATED WITH YEAR 2000
The commonly referred to Year 2000 or Y2K problem results from the fact that
many existing computer programs and systems use only two digits to identify the
year in the date field. These programs were designed and developed without
considering the impact of a change in the century designation. If not corrected,
computer applications that use a two-digit format could fail or create erroneous
results in any computer calculation or other processing involving the Year 2000
or a later date. We have identified two main areas of Y2K risk:
o Internal computer systems or embedded chips could be disrupted or fail,
causing an interruption or decrease in productivity in our operations; and
o Computer systems or embedded chips of third parties including, without
limitation, financial institutions, suppliers, vendors, landlords,
customers, international suppliers of telecommunications services and
others, could be disrupted or fail, causing an interruption or decrease in
our ability to continue our operations.
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We developed detailed plans for implementing, testing and completing any
necessary modifications to our key computer systems and equipment with
embedded chips to ensure that they are Y2K compliant. A third party
consultant performed an assessment of our U.S. internal systems (e.g.,
accounting, billing, customer support and network operations) to determine
the status of their Y2K compliance. The assessment recommended that some
minor changes were necessary. We believe that no material changes or
modifications to our internal systems are required to achieve Y2K compliance.
We have developed a test bed of our U.S. internal systems to implement and
complete testing of the requisite minor changes. We believe that our U.S.
internal systems are presently Y2K ready. We have completed an inventory of
our internal systems that we use outside of the United States to determine
the status of their Y2K compliance. For our international operations, we have
plans to upgrade or, if necessary, replace components of our internal systems
to ensure they are Y2K compliant. We anticipate that our international
operations, excluding businesses acquired in the fourth quarter, will be Y2K
compliant during the fourth quarter of 1999. To help ensure that our network
operations and services to our customers are not interrupted due to the Y2K
problem, we have established a network operations team. This team of
operational staff have completed inventories of our network equipment
(software and hardware) and have found no material Y2K compliance issues. We
believe that all equipment currently being purchased for use in the PSINet
network is Y2K compliant. Any existing equipment that is not Y2K compliant is
in the process of being made Y2K compliant through minor changes to the
software or hardware or, in limited instances, replacement of the equipment.
We believe that our network is presently Y2K compliant. In addition to
administering the implementation of necessary upgrades for Y2K compliance,
our network team has developed a contingency plan to address potential
problems that may occur with our network as we enter the year 2000. We
believe that, as a result of our detailed assessment and completed
modifications, the Y2K issue will not pose significant operational problems
for us. However, if the requisite modifications and conversions are not made,
or not completed in a timely fashion, it is possible that the Y2K problem
could have a material impact on our operations.
We have, and will continue to require, Y2K disclosures from all companies
that we acquire in the fourth quarter of 1999. We believe that, as a result
of due diligence performed and information gathered, the effect of the Y2K
issues on the companies we acquire will not in the aggregate have a material
impact on our operations. However, if such Y2K disclosures are not complete
or required remediator actions are not taken by the acquired companies in a
timely manner, it is possible that the Y2K problem could have a material
impact.
Our cost of addressing Y2K issues has been minor to date, less than 5% of our
information technology and network operations budgets, but this amount may
increase if additional outside consultants or personnel resources are required
or if important operational equipment must be remediated or replaced. Our
estimated total costs related to Y2K issues for 1999 is not expected to exceed
$2.0 million. These costs include equipment, consulting fees, software and
hardware upgrades, testing, remediation and, in limited instances, replacement
of equipment. The risk that Y2K issues could present to us include, without
limitation, disruption, delay or cessation of operations, including operations
that are subject to regulatory compliance. In each case, the correction of the
problem could result in substantial expense and disruption or delay of our
operations. The total cost of Y2K assessments and remediation is funded through
cash on hand and available from other sources and we are expensing these costs,
as appropriate. The financial impact of making all required systems changes or
other remediation efforts cannot be known precisely, but it is not expected to
be material to our financial position, results of operations, or cash flows. We
have not canceled any principal information technology projects as a result of
our Y2K effort, although we have rescheduled some internal tasks to accommodate
this effort.
In addition, we have identified, prioritized and are communicating with our
suppliers, vendors, customers, lenders and other material third parties to
determine their Y2K status and any probable impact on us. To date, our inquiries
have not revealed any significant Y2K noncompliance issue affecting our material
third parties. We will continue to monitor and evaluate our long-term
relationships with our material third parties based on their responses to our
inquiries and on information learned from other
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sources. If any of our material third parties are not Y2K ready and their
non-compliance causes a material disruption to any of their respective
businesses, our business could be materially adversely affected. Disruptions
could include, among other things:
o the failure of a material third party's business;
o a financial institution's inability to take and transfer funds;
o an interruption in delivery of supplies from vendors;
o a loss of voice and data connections;
o a loss of power to our facilities; and
o other interruptions in the normal course of our operations, the nature and
extent of which we cannot foresee.
We will continue to evaluate the nature of these risks, but at this time we are
unable to determine the probability that any such risk will occur, or if it does
occur, what the nature, length or other effects, if any, of such a risk may have
on us. If any of our material third parties experience significant failures in
their computer systems or operations due to Y2K non-compliance, it could affect
our ability to process transactions or otherwise engage in similar normal
business activities. For example, while we expect our internal systems, U.S. and
non-U.S., to be Y2K ready in stages during 1999, we and our customers who
communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a material adverse effect on our revenues and business and that
of our customers. While many of these risks are outside our control, we have
identified and contacted our critical third party vendors and suppliers and are
establishing contingency plans to remedy any potential interruption to our
operations.
While we believe that we are adequately addressing the Y2K issue, we cannot
assure you that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue will
not materially adversely impact our business, prospects, revenues or financial
position. We are uncertain as to our most reasonably likely worst case Y2K
scenario and, although we have completed a contingency plan to handle reasonably
foreseeable interruptions resulting from the Y2K problem, we cannot assure you
that our contingency plan will be capable of adequately addressing every
potential interruption that may occur.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 1999, we had other financial instruments consisting of cash,
fixed and variable rate debt and short-term investments which are held for
purposes other than trading. The substantial majority of our debt obligations
have fixed interest rates and are denominated in U.S. dollars, which is our
reporting currency. However, as described elsewhere in this report, we
recently issued fixed rate Euro 150.0 million aggregate principal amount of
11% senior notes which are subject to foreign currency exchange risk. The
proceeds from the Euro senior notes are currently invested in Euro
denominated cash and cash equivalents. A 10% change in the exchange rate for
the Euro would impact quarterly interest expense by approximately $0.5
million and the carrying value of the Euro denominated notes and cash and
cash equivalents would each change by approximately $16.0 million. We had no
amounts outstanding under our credit facility at September 30, 1999. Annual
maturities of our debt obligations at September 30, 1999, excluding capital
lease obligations and our credit facility, were as follows: $1.7 million in
1999, $6.9 million in 2000, $4.1 million in 2001, $2.8 million in 2002, $1.2
million in 2003 and $2,166.6 million thereafter. At September 30, 1999, the
carrying value of our debt obligations, excluding capital lease obligations,
was $2,183.3 million and the fair value was $2,159.6 million. The
weighted-average interest rate of our debt obligations, excluding capital
lease obligations, at September 30, 1999 was
29
<PAGE>
10.8%. Our investments are generally fixed rate short-term investment grade and
government securities denominated in U.S. dollars. At September 30, 1999, all of
our investments in debt securities are due to mature within twelve months and
the carrying value of all of our investments approximates fair value. At
September 30, 1999, $137.5 million of our cash and short-term investments were
restricted in accordance with the terms of our financing arrangements and
certain acquisition holdback agreements. We actively monitor the capital and
investing markets in analyzing our capital raising and investing decisions.
30
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) A Special Meeting of Shareholders of the Company was held on September 28,
1999.
(b) Proxies representing 55,308,991 shares were received (total shares
outstanding as of the Record Date were 64,963,700). The matters voted upon at
the Special Meeting and the results of the voting as to each such matter are set
forth below:
(i) The approval of the proposed 1999 Employee Stock
Purchase Plan and related 1999 International Employee
Stock Purchase Plan.
Votes for 42,298,331
Votes against 654,754
(ii) The approval of a proposal to allow shares of the
Company's common stock to be issued as a dividend on
the Company's 6 3/4% Series C cumulative convertible
preferred stock.
Votes for 41,740,203
Votes against 1,185,283
(iii) The approval of an amendment to the Company's
Certificate of Incorporation allowing the Company to
issue shares of one class or series of its stock as a
distribution to holders of another class or series of
its stock.
Votes for 41,281,609
Votes against 1,642,631
(iv) The approval of an amendment to the Company's
Certificate of Incorporation to increase the number
of authorized shares of capital stock from 280
million shares to 530 million shares, of which 500
million shares will be shares of common stock and 30
million will be shares of preferred stock.
Votes for 50,536,857
Votes against 4,683,967
(v) The approval of amendments to the Company's Executive
Stock Incentive Plan to increase the number of shares
of common stock available for awards under the
Executive Stock Incentive Plan from 11,800,000 shares
to 15,800,000 shares.
Votes for 33,169,411
Votes against 9,756,810
(vi) The approval of amendments to the Company's Strategic
Stock Incentive Plan to increase the number of shares
of common stock available for awards under the
Strategic Stock Incentive Plan from 4,500,000 shares
to 8,000,000 shares.
Votes for 28,411,178
Votes against 14,511,158
31
<PAGE>
There were 12,276,737 broker non-votes in respect of each of the foregoing
matters, with the exception of matter (iv) for which there were no broker
non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following Exhibits are filed herewith:
<TABLE>
<S> <C>
Exhibit 2.1 Agreement and Plan of Merger, dated August 22, 1999, among PSINet,
PSINet Shelf I Inc. and Transaction Network Services, Inc.
Exhibit 2.2 Amendment No. 1, dated October 14, 1999, to Agreement and Plan of
Merger dated August 22, 1999 among PSINet, PSINet Shelf I Inc. and
Transaction Network Services, Inc.
Exhibit 4.1 Amendment No. 3, dated as of November 5, 1999, to Rights Agreement,
dated as of May 8, 1996, between PSINet and First Chicago Trust
Company of New York, as Rights Agent
Exhibit 10.1** Employment Agreement dated as of October 1, 1999 between PSINet and
William L. Schrader
Exhibit 10.2** Employment Agreement dated as of October 1, 1999 between PSINet and
Harold S. Wills
Exhibit 10.3** Employment Agreement dated as of October 1, 1999 between PSINet and
Edward D. Postal
Exhibit 11.1 Calculation of Basic and Diluted Loss per Share and Weighted
Average Shares Used in Calculation for the
</TABLE>
32
<PAGE>
<TABLE>
<S> <C>
Three Months Ended September 30, 1999
Exhibit 11.2 Calculation of Basic and Diluted Loss per Share and Weighted
Average Shares Used in Calculation for the Nine Months Ended
September 30, 1999
Exhibit 27* Financial Data Schedule
Exhibit 99.1 Risk Factors
</TABLE>
* 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
of which such exhibit relates.
** Indicates a management contract or compensatory plan or
arrangement required to be filed as an Exhibit pursuant to
Item 14(a)(3).
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K dated July 6, 1999 under which
we filed a press release relating to an amendment of our senior
secured revolving credit facility.
We filed a Current Report on Form 8-K dated July 16, 1999 under
which we filed a press release relating to our offering of $1.05
billion aggregate principal amount and Euro 150 million aggregate
principal amount of 11% senior notes due 2009.
We filed a Current Report on Form 8-K dated August 22, 1999 under
which we filed a press release relating to our announcement of our
pending acquisition of TNI.
We filed a Current Report on Form 8-K dated August 22, 1999 under
which we filed unaudited pro forma financial information relating to
our pending acquisition of TNI and historical financial statements of
TNI.
We filed a Current Report on Form 8-K dated November 5, 1999 under
which we filed a press release announcing an amendment to our
Shareholder Rights Agreement.
33
<PAGE>
PSINET INC.
FORM 10-Q
SEPTEMBER 30, 1999
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.
<TABLE>
<S> <C>
November 15, 1999 By: /s/ William L. Schrader
- ------------------- -----------------------
Date William L. Schrader
Chairman, Chief Executive Officer
and Director
November 15, 1999 By: /s/ Edward D. Postal
- ------------------ -----------------------
Date Edward D. Postal
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
</TABLE>
34
<PAGE>
EXHIBIT INDEX
The following Exhibits are filed herewith:
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit Location
------ ---------------------- --------
<S> <C> <C>
2.1 Agreement and Plan of Merger, dated August 22, Incorporated by reference to Exhibit 2.1 to
1999, among PSINet, PSINet Shelf I Inc. and PSINet's Current Report on Form 8-K dated
Transaction Network Services, Inc. August 22, 1999 located under Securities and
Exchange Commission File No. 0-25812
2.2 Amendment No. 1, dated October 14, 1999, to Incorporated by reference to Exhibit 2.2 to
Agreement and Plan of Merger dated August 22, PSINet's Registration Statement on Form S-4
1999, among PSINet, PSINet Shelf I Inc. and declared effective on October 20, 1999
Transaction Network Services, Inc. located under Securities and Exchange
Commission File No. 33-88325
4.1 Amendment No. 3, dated as of November 5, 1999, Incorporated by reference to Exhibit 4 to
to Rights Agreement, dated as of May 8, 1996, PSINet's Registration Statement on Form 8-A/A
between PSINet and First Chicago Trust Company dated November 5, 1999 located under
of New York, as Rights Agent Securities and Exchange Commission File No.
0-25812
10.1** Employment Agreement dated as of October 1, 1999 Filed herewith
between PSINet and William L. Schrader
10.2** Employment Agreement dated as of October 1, 1999 Filed herewith
between PSINet and Harold S. Wills
10.3** Employment Agreement dated as of October 1, 1999 Filed herewith
between PSINet and Edward D. Postal
</TABLE>
35
<PAGE>
<TABLE>
<S> <C> <C>
11.1 Calculation of Basic and Diluted Loss per Share and Weighted Filed herewith
Average Shares Used in Calculation for the Three Months Ended
September 30, 1999
11.2 Calculation of Basic and Diluted Loss per Share and Weighted Filed herewith
Average Shares Used in Calculation for the Nine Months Ended
September 30, 1999
27* Financial Data Schedule Filed herewith
99.1 Risk Factors Filed herewith
</TABLE>
* 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
of which such exhibit relates.
** Indicates a management contract or compensatory plan or
arrangement required to be filed as an Exhibit pursuant to
Item 14(a)(3).
36
<PAGE>
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT made and entered into as of the 1st day of
October, 1999 by and between PSINet Inc. (the "Company"), a New York corporation
with its principal offices at 510 Huntmar Park Drive, Herndon, Virginia, and
William L. Schrader (the "Executive").
WHEREAS, the Executive is currently serving as Chairman of the Board of
Directors and Chief Executive Officer of the Company, and the Company desires to
secure the continued employment of the Executive in these positions, as his
services are deemed essential to the Company's continued success; and
WHEREAS, the Company wishes to continue to employ the Executive and the
Executive is willing to continue to be employed by the Company, all on the terms
and conditions set forth in this Agreement.
NOW, THEREFORE, in consideration of the mutual promises, covenants and
agreements set forth below, and for other good and valuable consideration, the
receipt and adequacy of which are hereby acknowledged, the parties, intending to
be legally bound, hereby agree as follows:
1. EMPLOYMENT POSITION.
a) POSITION AND DUTIES. The Company hereby employs the Executive as the Chairman
of the Board of Directors and Chief Executive Officer of the Company. This is a
corporate officer position and as an officer of the Company the Executive must
stand for election by the Company's Board of Directors (the "Board") each year
of the Term (as defined in Section 2 hereof). The Executive shall have such
powers, duties, authority and responsibilities as are (i) consistent with such
positions, (ii) assigned to such offices in the Company's By-laws, and (iii)
reasonably assigned to the Executive by the Board. The Executive accepts such
employment and agrees to remain in the employ of the Company, and, except during
vacations or periods of illness, to provide management services to the Company,
as determined by and under the direction of the Board.
b) BOARD SEAT. The Executive shall be a member of the Board, and the Company
will cause the Executive to be included in the management slate for election,
and will use its best efforts to cause the Executive to be elected, as a
Director throughout the Term.
c) LOCATION OF EMPLOYMENT. In connection with the Executive's employment by the
Company, the Executive's principal place of employment shall be the greater
Washington, D.C. area and he shall not, during the Term, be required permanently
to relocate to a principal place of business outside of the greater Washington,
D.C. area.
d) FULL TIME BASIS. During the Term, the Executive will, except during
vacations, periods of illness, and other absences beyond his reasonable control,
devote his best efforts, skill
<PAGE>
and attention to the performance of his duties on behalf of the Company.
Notwithstanding the foregoing, the Executive may serve on corporate,
industry, civic or charitable boards or committees (subject to the provisions
of Section 6 hereof).
2. TERM OF EMPLOYMENT. The term of the employment under this Agreement shall
commence on October 1, 1999, and shall continue for a period of four (4) years
(the "Initial Term"); provided, however, that this Agreement shall automatically
be extended for additional one-year periods (each, a "Renewal Term"), unless (i)
the Company, with the prior approval of the Board, or (ii) the Executive, shall
have given notice to the other at least six (6) months prior to the end of the
Initial Term or any Renewal Term, as applicable, that this Agreement shall not
be extended (the "Non-Renewal Notice"). The Initial Term together with any
Renewal Term are referred to herein collectively as the "Term."
3. COMPENSATION.
a) BASE SALARY. The Company shall pay the Executive a base salary at the rate of
$750,000 per annum beginning October 1, 1999. Beginning on January 1, 2001 and
on January 1st of each succeeding calendar year during the Term, the Executive's
base salary shall be increased at a minimum by an amount equal to five percent
(5%) of the Executive's then current base salary. The Executive's base salary
shall be subject to additional increases at the discretion of the Compensation
Committee of the Board (the "Compensation Committee"). The Executive's base
salary shall be payable in such installments as the Company regularly pays its
other salaried employees, subject to such deductions and withholdings as may be
required by law or by further agreement with the Executive.
b) PERFORMANCE BONUS. The Company will pay the Executive a bonus subject to the
successful completion of the objectives established for the Executive's
performance for each calendar year during the Term. The performance criteria
will be issued separately by the Compensation Committee with respect to each
calendar year during the Term, and may be changed, as may be mutually agreed
upon by the Executive and the Compensation Committee, from time to time, as
situations develop. Promptly after signing this Agreement, the Company will pay
to the Executive $150,000, which represents 75% of the Executive's target
performance bonus for calendar year 1999. The target performance bonus for the
balance of calendar year 1999 (pro-rated as required) and for subsequent
calendar years during the Term will be $450,000 or such greater amount as may be
determined by the Compensation Committee.
c) INCENTIVE STOCK OPTIONS. On October 1, 1999, the Company shall grant the
Executive options to purchase 50,000 shares of the Company's common stock
(the "Options") pursuant to the Company's Executive Stock Incentive Plan (the
"Plan"). Such Options shall be evidenced by an option agreement in such form
as is required by the Plan. Among other terms and provisions prescribed by
the Plan, the option agreement shall provide, subject to the terms of this
Agreement, that (i) the exercise price of the Options shall be the price per
share of the Company's common stock as reported by the NASDAQ Stock Market at
the close of business on the date of grant (October 1, 1999), (ii) the
Options shall not be exercisable after the expiration of ten (10) years from
the date such Options are granted, and (iii) the Options shall vest ratably,
monthly, over forty-eight (48) months, provided that, for each month's
vesting purposes, the
2
<PAGE>
Executive continues to be employed full time by the Company or one of its
subsidiaries during such month (other than in the case of a Termination Event
as defined in Section 5(d) hereof).
In addition, on October 1 of each subsequent year of the Term, the Company
shall grant the Executive options to purchase an additional 50,000 shares of
the Company's common stock pursuant to the Plan or another option plan of the
Company, such grant being subject to the terms of this Agreement and (A) the
achievement of the performance criteria to be established by the Compensation
Committee, (B) the Executive's continued employment at the time of grant
(other than in the case of a Termination Event, and (C) the options having an
exercise price equal to the closing price per share (as reported by the
NASDAQ Stock Market) of the Company's common stock on the date of grant.
d) VESTING OF STOCK OPTIONS. In the event of (i) a Change in Control (as
defined in Section 3(e) hereof), (ii) termination of the Executive's
employment by the Company or its successor for any reason other than for
Cause (as defined in Section 5(b) hereof), (iii) the Company's exercise of
its right of non-renewal as provided for in Section 2 hereof, (iv) the
Executive's termination of employment for Good Reason (as defined in Section
5(c) hereof), or (v) upon the occasion of the Executive's death or disability
during the Term (in all cases, while the Executive is in compliance with the
terms of this Agreement), the Company shall (A) immediately vest all of the
unvested stock options the Executive has received prior to the Date of
Termination (as defined in Section 5(h) hereof), (B) immediately grant and
vest all future grants of options to be made pursuant to Section 3(c) hereof
(the "Future Options"); and (C) immediately grant and vest any and all
options available to the Executive pursuant to the Two-Year Option Payout (as
defined in Section 5(d)(7) hereof). Such action shall be taken by the Company
as of the date of the Change in Control event, the Date of Termination or the
date on which the Company delivered its Non-Renewal Notice (the "Non-Renewal
Notice Date"), as applicable. In each case, the options granted pursuant to
clauses (B) and (C) above will have an exercise price equal to the closing
price per share (as reported by the NASDAQ Stock Market) of the Company's
common stock on the date of grant. In the event that the foregoing takes
place, subject to shareholder approval, if required, the Company shall
provide a loan to the Executive sufficient to allow him (or, in the case of
his death or disability, his estate, heirs or legal representatives) to
exercise all vested stock options and pay any required taxes to which the
Executive may be subjected as a result, with the terms of the loan to be no
less favorable than installment free for the duration, interest charged at
the applicable rate provided in Section 1274(d) of the Internal Revenue Code
of 1986, as amended, with a five (5) year balloon payment for interest and
principal.
e) CHANGE IN CONTROL. As used in this Agreement, "Change in Control" shall mean:
(i) the shareholders of the Company approve an agreement for the sale of all or
substantially all of the assets of the Company; or (ii) the shareholders of the
Company approve a merger or consolidation of the Company with any other
corporation (and the Company implements it), other than (A) a merger or
consolidation which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent more than eighty
percent (80%) of the combined voting power of the voting securities of the
Company, or such surviving entity, outstanding immediately after such merger or
consolidation, or (B) a merger or consolidation effected to implement a
recapitalization of the Company (or similar transaction) in
3
<PAGE>
which no "person" (as defined below) acquires more than thirty percent (30%)
of the combined voting power of the Company's then-outstanding securities; or
(iii) any "person," as such term is used in Sections 13(d) and 14(d) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") (other than
(1) the Company or (2) any corporation owned, directly or indirectly, by the
Company or the shareholders of the Company in substantially the same
proportions as their ownership of stock of the Company), is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of securities of the Company representing thirty
percent (30%) or more of the combined voting power of the Company's then
outstanding securities.
4. EMPLOYEE BENEFITS. The Executive shall be provided employee benefits,
including (without limitation) 401(k) and related plans, revenue bonus plan
participation, four weeks' paid vacation which can accumulate to a maximum of
eight (8) weeks, and life, health, accident and disability insurance under the
Company's standard plans, policies and programs available to employees in
accordance with the provisions of such plans, policies, and programs.
5. TERMINATION.
a) BASIS FOR TERMINATION OTHER THAN FOR GOOD REASON. The Executive's employment
with the Company may be terminated by the Company at any time for Cause. In
the event of a termination for Cause, all salary and benefits otherwise
payable to the Executive shall cease immediately upon such termination.
Termination by the Company or its successors in interest for any reason other
than Cause shall constitute a breach of this Agreement and, notwithstanding
any such breach or any dispute concerning Cause, the Company shall make the
Termination Payments to the Executive pursuant to Section 5(d) hereof. In
addition, the Executive may terminate his employment at any time without Good
Reason, provided that the Executive shall have given the Company at least
thirty (30) days' (but not more than ninety (90) days') prior written notice
of such termination. In the event of termination by the Executive without Good
Reason, the Executive's salary and benefits shall continue during the notice
period specified by the Executive and shall cease thereafter. The Executive or
the Company may exercise their right of non-renewal by delivering a
Non-Renewal Notice. In the event the Executive delivers a Non-Renewal Notice,
the Executive's salary and benefits shall continue until the expiration of the
Term. In the event the Company delivers a Non-Renewal Notice, the Company
shall make the Termination Payments to the Executive pursuant to Section 5(d)
hereof.
b) DEFINITION OF CAUSE. The Company shall have Cause for termination of the
Executive's employment by reason of (i) any breach by the Executive of his
agreement not to compete pursuant to Section 6 hereof, (ii) the Executive
committing an act in contravention of action taken by the Board which materially
and adversely affects the Company and which constitutes willful misconduct on
his part, (iii) the Executive's conviction of the commission of a felony which,
at the time of commission, has a material adverse effect on the Company, (iv)
the Executive's voluntary resignation without Good Reason and without having
given the Company at least thirty (30) days' prior written notice, or (v) any
material breach by the Executive of this Agreement which is not cured within
thirty (30) days after notice is given to the Executive in accordance with this
Agreement.
4
<PAGE>
c) DEFINITION OF GOOD REASON TERMINATION. The Executive may terminate his
employment at any time for Good Reason. For purposes of this Agreement, Good
Reason shall mean any of the following taking place during the Term:
(i) the diminution or change, without the Executive's written consent,
of his positions, authority, duties or responsibilities as indicated in
Section 1(a) hereof;
(ii) the Executive not being elected to, or being removed from, the
Board or, without his consent, any committee thereof;
(iii) the Company requiring the Executive, without his written consent,
to be based at any office or location or to relocate to any location
other than the Company's headquarters which shall be located in the
Washington, D.C. area;
(iv) any Change in Control where, regardless of whether the Company is
the surviving entity, the Executive is not elected as, or chooses not
to serve as (in his sole and absolute discretion), the Chief Executive
Officer of such surviving entity; or
(v) any material breach by the Company of this Agreement which is not
cured within thirty (30) days after notice is given to the Company in
accordance with this Agreement.
d) TERMINATION PAYMENTS. In the event (i) the Company exercises its right of
non-renewal as provided in Section 2 hereof, or (ii) the Executive's employment
is terminated (A) by the Executive for Good Reason, (B) by the Company for any
reason other than for Cause or (C) due to the Executive's death or disability
(each of the circumstances in (i) and (ii) of this Section 5(d) being known as a
"Termination Event"), the Company shall pay and give to the Executive (or, in
the case of his death, his estate, heirs or legal representatives) the following
(collectively, the "Termination Payments"), to be paid or given, with respect to
all items other than the items in clause (3) below, within thirty (30) days of
the Date of Termination (except with respect to items 6 and 7 below which will
be granted and given in accordance with Section 3(d) hereof):
(1) a lump sum representing the Executive's base salary as provided in
Section 3(a) hereof, giving effect to all annual increases thereto
provided for in Section 3(a) hereof, for the longer of (y) the
remainder of the Term or (z) two (2) years after the Date of
Termination (and assuming for purposes of this clause that such
two (2) year period, if applicable, is included in the
definition of "Term" for purposes of calculating any amounts
due hereunder (the "Two-Year Application")), plus all other
accrued and unpaid amounts due to the Executive as of the Date
of Termination (including, without limitation, accrued vacation
pay and reimbursement of business expenses);
(2) all annual bonus amounts, as provided for in Section 3(b) hereof,
calculated on the assumption that all performance criteria
objectives would have been exceeded, such that the Executive would
receive the maximum bonus established by the Compensation
Committee to which the Executive would have been entitled had he
5
<PAGE>
remained employed by the Company for the longer of (y) the
remainder of the Term or (z) two (2) years after the Date of
Termination (assuming for purposes of this clause the Two-Year
Application);
(3) continuation of all life insurance and health benefits, disability
insurance and benefits and reimbursement theretofore being
provided to the Executive and/or his family, or such other more
favorable benefits applicable to any senior executive officer of
the Company, to which the Executive would have been entitled had
he remained employed by the Company for the longer of (y) the
remainder of the Term or (z) two (2) years after the Date of
Termination (assuming for purposes of this clause the Two-Year
Application);
(4) to the extent the continuation of any such benefit under clause
(3) is not possible under applicable law, and for all other fringe
benefits theretofore being provided to the Executive and/or his
family not included in clause (3), or other more favorable
fringe benefits applicable to any senior executive officer of
the Company, a lump sum equal to the cost to the Executive of
replacing all such benefits to which he would have been
entitled had he remained employed by the Company for the longer
of (y) the remainder of the Term or (z) two (2) years after the
Date of Termination (assuming for purposes of this clause the
Two-Year Application);
(5) Company contributions, to the extent permitted by applicable law,
to a SEP-IRA, Keogh or other retirement mechanism reasonably
selected by the Executive sufficient to provide the same level of
retirement benefits the Executive would have received if he had
remained employed by the Company for the longer of (y) the
remainder of the Term or (z) two (2) years after the Date of
Termination (assuming for purposes of this clause the Two-Year
Application); provided, however, that the Company shall make up
the difference in cash payments directly to the Executive to the
extent that applicable law would not permit it to make such
contributions;
(6) the vested options provided in Section 3(d) (including without
limitation all Future Options);
(7) in the event the Date of Termination is after October 1, 2001, an
immediate, vested grant of options pursuant to the Plan or another
option plan of the Company (the "Two-Year Option Payout") to
purchase (y) 100,000 shares of the Company's common stock less (z)
any shares issuable upon exercise of any previously ungranted
options that would otherwise be required to be accelerated under
the provisions of Section 3(d)(B) hereof; and
(8) the Company will vest, no later than the Date of Termination, all
other equity-based awards the Executive has or would have received
during the Term (assuming for purposes of this clause the Two-Year
Application).
e) TAX PROVISIONS. In the event that any payments under this Agreement or any
other compensation, benefit or other amount from the Company for the benefit of
the Executive are
6
<PAGE>
subject to the tax imposed by Section 4999 of the Internal Revenue Code of
1986, as amended (the "Code") (including any applicable interest and
penalties, the "Excise Tax"), no such payment ("Parachute Payment") shall be
reduced (except for required tax withholdings) and the Company shall pay to
the Executive by the earlier of the date such Excise Tax is withheld from
payments made to the Executive or the date such Excise Tax becomes due and
payable by the Executive, an additional amount (the "Gross-Up Payment") such
that the net amount retained by the Executive (after deduction of any Excise
Tax on the Parachute Payments, taxes based upon the Tax Rate (as defined
below) upon the payment provided for by this Section 5(e) and Excise Tax upon
the payment provided for by this Section 5(e)), shall be equal to the amount
the Executive would have received if no Excise Tax had been imposed. A Tax
counsel chosen by the Company's independent auditors, provided such person is
reasonably acceptable to the Executive ("Tax Counsel"), shall determine in
good faith whether any of the Parachute Payments are subject to the Excise
Tax and the amount of any Excise Tax, and Tax Counsel shall promptly notify
the Executive of its determination. The Company and the Executive shall file
all tax returns and reports regarding such Parachute Payments in a manner
consistent with the Company's reasonable good faith determination. For
purposes of determining the amount of the Gross-Up Payment, the Executive
shall be deemed to pay taxes at the Tax Rate applicable at the time of the
Gross-Up Payment. In the event that the Excise Tax is subsequently determined
to be less than the amount taken into account hereunder at the time a
Parachute Payment is made, the Executive shall repay to the Company promptly
following the date that the amount of such reduction in Excise Tax is finally
determined the portion of the Gross-Up Payment attributable to such reduction
(without interest). In the event that the Excise Tax is determined to exceed
the amount taken into account hereunder at the time a Parachute Payment is
made (including by reason of any payment the existence or amount of which
cannot be determined at the time of the Gross-Up Payment), the Company shall
pay the Executive an additional amount with respect to the Gross-Up Payment
in respect of such excess (plus any interest or penalties payable in respect
of such excess) at the time that the amount of such excess is finally
determined. The Company shall reimburse the Executive for all reasonable
fees, expenses, and costs related to determining the reasonableness of any
Company position in connection with this paragraph and preparation of any tax
return or other filing that is affected by any matter addressed in this
paragraph, and any audit, litigation or other proceeding that is affected by
any matter addressed in this Section 5(e) and an amount equal to the tax on
such amounts at the Executive's Tax Rate. For the purposes of the foregoing,
"Tax Rate" means the Executive's effective tax rate based upon the combined
federal and state and local income, earnings, Medicare and any other tax
rates applicable to the Executive, all at the highest marginal rate of
taxation in the country and state of the Executive's residence on the date of
determination, net of the reduction in federal income taxes which could be
obtained by deduction of such state and local taxes.
f) PAYMENTS TO BE MADE DESPITE DISPUTES. The Company shall make all payments to
the Executive provided for under this Section 5 notwithstanding any dispute
which may exist between the Executive and the Company as to whether termination
of employment was for Good Reason or was with or without Cause or was with
regard to the Company's delivery of its Non-Renewal Notice; provided, however,
that Executive agrees to repay to the Company (without interest) any amounts
paid to the extent that a court of competent jurisdiction enters a final,
non-appealable order that the Executive is not entitled to any such amounts.
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(g) NOTICE OF TERMINATION. Any termination of the Executive's employment during
the Term by the Company for any reason, or by the Executive for Good Reason, or
by the Executive without Good Reason shall be communicated by Notice of
Termination to the other party hereto given in accordance with Section 15 of
this Agreement. For purposes of this Agreement, a "Notice of Termination" means
a written notice which (i) indicates the specific termination provision in this
Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable
detail the facts and circumstances claimed to provide a basis for termination of
the Executive's employment under the provision so indicated, and (iii) if
applicable, specifies a termination date (which date shall not be more than
ninety (90) days after the date of such notice). The failure by the Executive or
the Company to set forth in the Notice of Termination any fact or circumstance
which contributes to a showing of Good Reason or Cause shall not waive any right
of the Executive or the Company hereunder or preclude the Executive or the
Company, as applicable, from asserting such fact or circumstance in enforcing
the Executive's or the Company's rights hereunder. Any delivery of a Non-Renewal
Notice shall be given in accordance with Section 15 of this Agreement as well as
Section 2 of this Agreement.
(h) DATE OF TERMINATION. For purposes of this Agreement, "Date of Termination"
means (i) if the Executive's employment is terminated by reason of death, the
date of death; (ii) if the Executive's employment is terminated under any other
circumstances, the date of receipt of the Notice of Termination by the party
being so notified or any later date specified therein; provided, however, that
the specified date shall not be more than ninety (90) days after the date of
such notice; and (iii) if the Company or the Executive delivers a Non-Renewal
Notice, the date that is the end of the Term. For purposes of this Agreement,
the Executive will be deemed to be employed through the end of the calendar day
on the Date of Termination.
6. AGREEMENT NOT TO COMPETE.
a) In consideration of the Executive's employment pursuant to this Agreement and
for other good and valuable consideration, the receipt and adequacy of which is
hereby acknowledged, the Executive covenants and agrees with the Company that,
during the Term, he shall not, without the prior written consent of the Company,
either for himself or for any other person, firm or corporation, manage,
operate, control, participate in the management, operation or control of or be
employed by any other person or entity which is engaged in providing
Internet-related network or communications services competitive with the
Internet-related network or communication services offered to customers by the
Company; provided, however, that this Section 6(a) shall not prohibit the
Executive from serving on boards of directors of such other companies as may be
approved from time to time by the Board. This non-compete provision shall
terminate immediately upon the Date of Termination.
b) The Company will notify the Executive in writing if it becomes aware of any
breach or threatened breach of any of the provisions in Section 6(a) hereof, and
the Executive shall have thirty (30) days after receipt of such notice in which
to cure or prevent the breach, to the extent that he is able to do so. The
Executive and the Company acknowledge that any breach or threatened breach by
him of any of the provisions in Section 6(a) hereof cannot be remedied by the
recovery of damages, and agree that in the event of any such breach
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or threatened breach which is not cured with such thirty (30) day period, the
Company may pursue injunctive relief for any such breach or threatened breach.
7. INTELLECTUAL PROPERTY; OWNERSHIP OF WORK PRODUCT. All copyrights, patents,
trade secrets, or other intellectual property rights associated with any ideas,
concepts, techniques, inventions, processes, or works of authorship developed or
created by the Executive during the course of performing the Company's work
(collectively the "Work Product") shall belong exclusively to the Company and
shall, to the extent possible, be considered a work made for hire for the
Company within the meaning of Title 17 of the United States Code. The Executive
hereby automatically assigns, and shall assign at the time of creation of the
Work Product, without any requirement of further consideration, any right,
title, or interest he may have in such Work Product, including any copyrights or
other intellectual property rights pertaining thereto. Upon request of the
Company, the Executive shall take such further actions, including execution and
delivery of instruments of conveyance, as may be appropriate to give full and
proper effect to such assignment.
8. TRANSFERABILITY.
a) This Agreement is personal to the Executive and without the prior written
consent of the Company shall not be assignable by the Executive otherwise than
by will or the laws of descent and distribution. This Agreement shall inure to
the benefit of and be enforceable by the Executive's legal representatives.
b) This Agreement shall inure to the benefit of and be binding upon the Company,
its successors and assigns.
c) The Company shall require any successor (whether direct or indirect, by
purchase, merger, consolidation, share exchange or otherwise) to all or
substantially all of the business and/or assets of the Company to expressly
assume in writing and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform it if no such
succession had taken place. As used in this Agreement, "Company" shall mean the
Company as defined herein and any successor to its businesses and/or assets as
aforesaid that assumes and agrees to perform this Agreement by operation of law,
or otherwise. A failure of the Company to cause a successor to assume this
Agreement in any such transaction shall be a breach of this Agreement by the
Company.
9. NONEXCLUSIVITY OF RIGHTS. Nothing in this Agreement shall prevent or limit
the Executive's continuing or future participation in any benefit, plan,
program, policy or practice provided by the Company and for which the Executive
may qualify (except with respect to any benefit to which the Executive has
waived his rights in writing), nor shall anything herein limit or otherwise
affect such rights as the Executive may have under any other contract or
agreement entered into after the date of this Agreement with the Company.
Amounts which are vested benefits or which the Executive is otherwise entitled
to receive under any benefit, plan, policy, practice or program of, or any
contract or agreement entered into with, the Company shall be payable in
accordance with such benefit, plan, policy, practice or program or contract or
agreement except as explicitly modified by this Agreement.
9
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10. FULL SETTLEMENT; MITIGATION. The Company's obligation to make the payments
provided for in this Agreement and otherwise to perform its obligations
hereunder shall not be affected by any set-off, counterclaim, recoupment,
defense or other claim, right or action which the Company may have against the
Executive or others. In no event shall the Executive be obligated to seek other
employment or take any other action by way of mitigation of the amounts
(including amounts for damages for breach) payable to the Executive under any of
the provisions of this Agreement, and such amounts shall not be reduced whether
or not the Executive obtains other employment. If there occurs a dispute between
the Executive and the Company as to the interpretation, terms, validity or
enforceability of this Agreement (including any dispute about the amount of any
payment pursuant to this Agreement), the Company agrees to pay all legal fees
and expenses which the Executive may reasonably incur as a result of any such
dispute, promptly after receipt of invoices for such fees and expenses.
11. NO WAIVER. The Executive's or the Company's failure to insist upon strict
compliance with any provision of this Agreement or the failure to assert any
right the Executive or the Company may have hereunder, including, without
limitation, the right of the Executive to terminate his employment for Good
Reason pursuant to Section 5(c) hereof, or the right of the Company to terminate
the Executive's employment for Cause pursuant to Section 5(a) hereof, shall not
be deemed to be a waiver of such provision or right or any other provision or
right of this Agreement.
12. SEVERABILITY. The provisions of this Agreement will be deemed severable, and
if any part of any provision is held to be illegal, void, voidable, invalid,
nonbinding, or unenforceable in its entirety or partially or as to any party,
for any reason, such provision may be changed, consistent with the intent of the
parties hereto, to the extent reasonably necessary to make the provision, as so
changed, legal, valid, binding, and enforceable. If any provision of this
Agreement is held to be illegal, void, voidable, invalid, nonbinding, or
unenforceable in its entirety or partially or as to any party, for any reason,
and if such provision cannot be changed consistent with the intent of the
parties hereto to make it fully legal, valid, binding, and enforceable, then
such provision will be stricken from this Agreement, and the remaining
provisions of this Agreement will not in any way be affected or impaired, but
will remain in full force and effect.
13. PRIOR AGREEMENTS. This Agreement supersedes and replaces any prior or
contemporaneous agreements, negotiations, correspondence, undertakings and
communications of the Executive, the Company or any predecessor or subsidiary
thereof with respect to employment of the Executive.
14. AMENDMENTS. This Agreement may not be amended, modified, repealed, waived or
discharged except by an agreement in writing signed by the party against whom
enforcement of such amendment, modification, repeal, waiver or discharge is
sought. No person, other than pursuant to a resolution adopted by three-quarters
vote of the entire Board shall have authority on behalf of the Company to agree
to amend, modify, repeal, waive or discharge any provision of this Agreement or
anything in reference thereto. For purposes of this Section 14, the Executive
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shall not be counted for purposes of such vote, but shall be counted for
determining the number of Directors constituting the entire Board.
15. NOTICES. All notices required to be given or which may be given under this
Agreement shall be in writing delivered in accordance with one or more of the
following and shall be deemed received upon the earlier of (i) when it is
personally delivered to the party, (ii) three (3) days after having been mailed
by certified mail, postage prepaid, return receipt requested, or (iii) two (2)
days after having been sent via overnight delivery by a recognized overnight
delivery service, in each case addressed to the party intended to be notified at
the address of such party as set forth in the records of the Company or such
other address as such party may designate in writing to the other.
16. GOVERNING LAW. THIS AGREEMENT SHALL BE SUBJECT TO, GOVERNED BY AND CONSTRUED
IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT REFERENCE TO ITS
PRINCIPLES OF CONFLICTS OF LAW.
17. COUNTERPARTS. This Agreement may be executed in one or more counterparts,
each of which shall be deemed an original and all of which shall be one and the
same instrument.
* * *
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IN WITNESS WHEREOF, the Executive and, pursuant to due authorization
from its Board of Directors, the Company have caused this Agreement to be
executed as of the day and year first above written.
PSINET INC.
By: /s/ Harold S. Wills
------------------------------
Name: Harold S. Wills
Title: President and Chief Operating Officer
EXECUTIVE
/s/ William L. Schrader
- ------------------------------------
William L. Schrader
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Exhibit 10.2
October 4, 1999
Mr. Harold S. "Pete" Wills
1047 Walker Mill Road
Great Falls, VA 22124
Dear Pete:
This letter confirms our Agreement concerning your continued employment by
PSINet Inc. (the "Company"), and sets forth the terms and conditions which shall
govern such employment as outlined below. This Agreement amends and restates the
terms of your employment agreement dated April 3, 1996, as modified by the
letter agreement dated October 16, 1998.
1. EMPLOYMENT.
a) The Company hereby employs you as President and Chief Operating Officer of
the Company, although you may serve in other executive capacities within the
Company and/or its subsidiaries as the Board of Directors of the Company shall
determine is appropriate over time. This is a corporate officer position and as
an officer of the Company you must stand for election by the Board of Directors
each year. You accept the employment and agree to remain in the employ of the
Company, and, except during vacations or periods of illness, to provide
management services to the Company, as determined by and under the direction of
the Chairman of the Company.
With respect to the provisions of said services, the parties agree to observe
and to abide by the terms and conditions set forth herein.
b) In connection with your employment by the Company, your principal place of
employment shall be the greater Washington, D.C. area and you shall not be
required permanently to relocate to a principal place of business outside the
greater Washington, D.C. area during the term of your employment hereunder.
c) During your employment, you will, except during vacations, periods of
illness, and other absences beyond your reasonable control, devote your best
efforts, skill and attention to the performance of your duties on behalf of the
Company.
2. TERM OF EMPLOYMENT. The term of the employment under this Agreement shall
have commenced on October 1, 1999, and shall continue for a period of four (4)
years.
3. COMPENSATION.
a) BASE SALARY. The Company shall pay you a base salary at the rate of $600,000
per annum beginning October 1, 1999. Beginning on January 1, 2001 and on January
1st of each succeeding year during the term of this Agreement, your base salary
shall be increased at a
<PAGE>
minimum by an amount equal to five percent (5%) of your then current base
salary. Your base salary shall be subject to additional increases at the
discretion of the Compensation Committee of the Company's Board of Directors
(the "Compensation Committee"). Your base salary shall be payable in such
installments as the Company regularly pays its other salaried employees,
subject to such deductions and withholdings as may be required by law or by
further agreement with you.
b) PERFORMANCE BONUS. The Company will pay you a bonus subject to the successful
completion of the objectives established for your performance for the applicable
year. The performance criteria will be issued separately by the Compensation
Committee and may be changed, with mutual fairness, from time to time as
situations develop. Promptly after signing this Agreement, the Company will pay
you $112,500, which represents 75% of your target performance bonus for 1999.
The target performance bonus for the balance of calendar year 1999 (pro-rated as
required) and for subsequent calendar years during the term of this Agreement
will be $400,000, or such greater amount as may be determined by the
Compensation Committee, and shall be payable to you subject to the successful
completion of the objectives established for your performance by the
Compensation Committee.
c) INCENTIVE STOCK OPTIONS. On October 1, 1999, the Company shall grant you
options to purchase 35,000 shares of the Company's common stock (the "Options")
pursuant to its Executive Stock Incentive Plan (the "Plan"). Such Options shall
be evidenced by an option agreement in such form as is required by the Plan.
Among other terms and provisions prescribed by the Plan, the option agreement
shall provide that (i) the exercise price of the Options shall be the price per
share of the Company's common stock as reported by the NASDAQ Stock Market at
the close of business on the date of grant (October 1, 1999), (ii) the Options
shall not be exercisable after the expiration of ten (10) years from the date
such Options are granted, and (iii) the stock shall vest ratably, monthly, over
forty-eight (48) months, provided that, for each month's vesting purposes, you
continue to be employed full time by the Company or one of its subsidiaries
during such month (except in situations where your employment is terminated in
violation hereof), and provided that the Company's Board of Directors ratifies,
no less often than annually, that you have met the performance standards and
criteria set for you for the preceding period.
In addition, on October 1 of each subsequent year of this Agreement (i.e., each
of October 1, 2000, October 1, 2001, and October 1, 2002), the Company shall
grant you options to purchase an additional 35,000 shares of the Company's
common stock pursuant to the Plan or another option plan of the Company, such
grant being subject to the terms of this Agreement and (1) the achievement of
the performance criteria to be established by the Compensation Committee, (2)
your continued employment at the time of grant (except in situations where your
employment is terminated in violation hereof), and (3) the options having an
exercise price equal to the closing price per share (as reported by the NASDAQ
Stock Market) of the Company's common stock on the date of grant.
d) VESTING OF STOCK OPTIONS. In the event of a Change in Control, as defined in
Section 8 below, or upon the occasion of your death during the term of this
Agreement while you are in compliance with the requirements hereof, the Company
shall: (i) vest immediately all of the unvested stock options you have received
pursuant to the terms of your employment
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agreement dated April 3, 1996 as modified by the letter agreement dated
October 16, 1998, as well as any unvested stock options you may have received
during the period of your employment hereunder, (ii) in the event that your
employment is terminated or continued under conditions not substantially the
same as those called for in this Agreement, the Company shall, subject to
shareholder approval, if required, provide a loan sufficient to exercise all
vested stock options and pay any required taxes to which you may be subjected
as a result, with the terms of the loan to be no less favorable than
installment free for the duration, interest charged at the IRS minimum rate,
with a five (5) year balloon payment for interest and principal.
4. EMPLOYEE BENEFITS. You shall be provided employee benefits, including
(without limitation) 401(k) and related plans, revenue bonus plan participation,
four weeks' paid vacation which can accumulate to a maximum of eight (8) weeks,
and life, health, accident and disability insurance under the Company's standard
plans, policies and programs available to employees in accordance with the
provisions of such plans, policies, and programs.
5. TERMINATION.
a) Your employment with the Company may be terminated by the Company at any time
for "Cause" as defined in Section 5(c) hereof. In the event of a termination for
"Cause", all salary and benefits otherwise payable to you shall cease
immediately upon such termination. Upon such termination, the Company will
provide written notice whether it has elected to use the non-competition
restrictions set forth in Section 6(a) hereof. Termination by the Company or its
successors in interest for any reason other than Cause shall be deemed a breach
hereof. In addition, your employment may be terminated by you at any time for
any reason, provided you shall have given the Company at least thirty (30) days'
prior written notice of such termination. In the event of termination by you,
your salary and benefits shall continue during the thirty (30) day notice period
and shall cease thereafter, subject to the provisions of Section 5(b) hereof. By
the thirtieth (30th) day the Company must notify you in writing whether it has
elected to use the non-Competition restriction. Such decision may not be
rescinded. Failure of the Company to so notify you shall result in the
non-Competition restriction not being in place.
b) Subject to your compliance with your obligations under Section 6 hereof, in
the event that your employment terminates or is terminated by you or the Company
for any reason, and the Company has elected to use the non-Competition
restriction, you shall be entitled, for a period of twenty-four (24) months
after termination of employment, to the following (collectively, the
"Termination Payments"): (i) your then current rate of base salary as provided
in Section 3; (ii) all life insurance and health benefits, disability insurance
and benefits and reimbursement theretofore being provided to you; and (iii)
Company contributions, to the extent permitted by applicable law, to a SEP-IRA,
Keogh or other retirement mechanism selected by you sufficient to provide the
same level of retirement benefits you would have received if you had remained
employed by the Company during such twenty-four (24) month period. The Company
shall make up the difference in cash payments directly to you to the extent that
applicable law would not permit it to make such contributions.
c) The Company shall have "Cause" for termination of your employment by reason
of any breach of your agreement not to compete pursuant to Section 6 hereof,
your committing an act
3
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materially adversely affecting the Company which constitutes wanton or
willful misconduct, your conviction of a felony, your voluntary resignation
without having given the Company at least thirty (30) days' prior written
notice, or any material breach by you of this Agreement.
6. AGREEMENT NOT TO COMPETE.
a) In consideration of your employment pursuant to this Agreement and for other
good and valuable consideration, the receipt and adequacy of which is hereby
acknowledged, you covenant to and agree with the Company that, so long as you
are employed by the Company under this Agreement and for a period of twenty-four
(24) months following the termination of such employment (but only if the
Company has elected to enforce the restriction), you shall not, without the
prior written consent of the Company, either for yourself or for any other
person, firm or corporation, manage, operate, control, participate in the
management, operation or control of or be employed by any other person or entity
which is engaged in providing Internet-related network or communications
services competitive with the Internet-related network or communication services
offered to customers by the Company as of the date of termination or within six
(6) months thereafter. The foregoing shall in no event restrict you from: (i)
writing or teaching, whether on behalf of for-profit, or not-for-profit
institution(s); (ii) investing (without participating in management or
operation) in the securities of any private or publicly traded corporation or
entity; or (iii) after termination of employment, becoming employed by a
hardware, software or other vendor to the Company, provided that such vendor
does not offer network or communication services that are competitive with the
Internet-related network or communications services offered by the Company as of
the date of termination of employment or within six (6) months thereafter.
b) You may request permission from the Company's Board of Directors to engage in
activities which would otherwise be prohibited by Section 6(a). The Company
shall respond to such request within thirty (30) days after receipt. The Company
will notify you in writing if it becomes aware of any breach or threatened
breach of any of the provisions in Section 6(a), and you shall have thirty (30)
days after receipt of such notice in which to cure or prevent the breach, to the
extent that you are able to do so. You and the Company acknowledge that any
breach or threatened breach by you of any of the provisions in Section 6(a)
above cannot be remedied by the recovery of damages, and agree that in the event
of any such breach or threatened breach which is not cured with such thirty (30)
day period, the Company may pursue injunctive relief for any such breach or
threatened breach. If a court of competent jurisdiction determines that you
breached any of such provisions, you shall not be entitled to any Termination
Payments from and after date of the breach. In such event, you shall promptly
repay any Termination Payments previously made plus interest thereon from the
date of such payment(s) at twelve percent (12%) per annum. If, however, the
Company has suspended making such Termination Payments and a court of competent
jurisdiction finally determines that you did not breach such provision or
determines such provision to be unenforceable as applied to your conduct, you
shall be entitled to receive any suspended Termination Payment, plus interest
thereon from the date when due at twelve percent (12%) per annum. The Company
may elect (once) to continue paying the Termination Payments before a final
decision has been made by the court.
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7. INTELLECTUAL PROPERTY; OWNERSHIP OF WORK PRODUCT. All copyrights, patents,
trade secrets, or other intellectual property rights associated with any ideas,
concepts, techniques, inventions, processes, or works of authorship developed or
created by you during the course of performing the Company's work (collectively
the "Work Product") shall belong exclusively to the Company and shall, to the
extent possible, be considered a work made for hire for the Company within the
meaning of Title 17 of the United States Code. You hereby automatically assign,
and shall assign at the time of creation of the Work Product, without any
requirement of further consideration, any right, title, or interest you may have
in such Work Product, including any copyrights or other intellectual property
rights pertaining thereto. Upon request of the Company, you shall take such
further actions, including execution and delivery of instruments of conveyance,
as may be appropriate to give full and proper effect to such assignment.
8. TRANSFERABILITY.
a) As used in this Agreement, the term "Company" shall include any successor to
all or part of the business or assets of the Company. This Agreement shall inure
to the benefit of and be enforceable by you and your personal or legal
representatives, executors, administrators, heirs, distributees, devisees and
legatees.
b) Except as provided under paragraph (a) of this Section 8, neither this
Agreement nor any of the rights or obligations hereunder shall be assigned or
delegated by any party hereto without the prior written consent of the other
party.
c) As used in this Agreement, "Change in Control" shall mean: (i) the
shareholders of the Company approve an agreement for the sale of all or
substantially all of the assets of the Company; or (ii) the shareholders of the
Company approve a merger or consolidation of the Company with any other
corporation (and the Company implements it), other than (1) a merger or
consolidation which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent more than eighty
percent (80%) of the combined voting power of the voting securities of the
Company, or such surviving entity, outstanding immediately after such merger or
consolidation, or (2) a merger or consolidation effected to implement a
recapitalization of the Company (or similar transaction) in which no "person"
(as defined below) acquires more than thirty percent (30%) of the combined
voting power of the Company's then-outstanding securities; or (iii) any
"person," as such term is used in Sections 13(d) and 14(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act") (other than ((A)) the
Company or ((B)) any corporation owned, directly or indirectly, by the Company
or the shareholders of the Company in substantially the same proportions as
their ownership of stock of the Company), is or becomes the "beneficial owner"
(as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing thirty percent (30%) or more of the
combined voting power of the Company's then outstanding securities.
9. SEVERABILITY. The invalidity or unenforceability of any particular provision
of this Agreement shall not affect the other provisions hereof, and this
Agreement shall be construed in all respects as if such invalid or unenforceable
provision were omitted. If a court of competent
5
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jurisdiction determines that any particular provision of this Agreement is
invalid or unenforceable, the court shall restrict the provision so as to be
enforceable. However, if the provisions of Section 6 shall be restricted, a
proportional reduction shall be made in the payments under Section 5(b).
10. ENTIRE AGREEMENT; WAIVERS. This letter Agreement contains the entire
agreement of the parties concerning the subject matter hereof and supersedes and
cancels all prior agreements, negotiations, correspondence, undertakings and
communications of the parties, oral or written. No waiver or modification of any
provision of this Agreement shall be effective unless in writing and signed by
both parties.
11. NOTICES. Any notices, requests, instruction or other document to be given
hereunder shall be in writing and shall be sent certified mail, return receipt
requested, addressed to the party intended to be notified at the address of such
party as set forth at the head of this agreement or such other address as such
party may designate in writing to the other.
12. GOVERNING LAW. THIS LETTER AGREEMENT SHALL BE SUBJECT TO, GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT
REFERENCE TO ITS PRINCIPLES OF CONFLICTS OF LAW.
13. COUNTERPARTS. This letter Agreement may be executed in one or more
counterparts, each of which shall be deemed an original and all of which shall
be one and the same instrument.
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Please confirm your agreement with the forgoing by signing and
returning one copy of this letter Agreement to the undersigned, whereupon this
letter agreement shall become a binding agreement between you and the Company.
Sincerely,
PSINet Inc.
By: /s/ WILLIAM L. SCHRADER
------------------------------------------
WILLIAM L. SCHRADER, CHAIRMAN & CEO
Accepted and Agreed to as of October 4 1999:
By: /s/ Harold S. Wills
------------------------------------------
HAROLD S. WILLS
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EXHIBIT 10.3
October 4, 1999
Mr. Edward D. Postal
9329 Crimson Leaf Terrace
Potomac, MD 20854
Dear Ed:
This letter confirms our Agreement concerning your continued employment by
PSINet Inc. (the "Company"), and sets forth the terms and conditions which shall
govern such employment as outlined below. This Agreement amends and restates the
terms of your employment agreement dated October 1, 1996, as modified by the
letter agreement dated October 16, 1998.
1. EMPLOYMENT.
a) The Company hereby employs you as Executive Vice President and Chief
Financial Officer of the Company, although you may serve in other executive
capacities within the Company and/or its subsidiaries as the Board of Directors
of the Company shall determine is appropriate over time. This is a corporate
officer position and as an officer of the Company you must stand for election by
the Board of Directors each year. You accept the employment and agree to remain
in the employ of the Company, and, except during vacations or periods of
illness, to provide management services to the Company, as determined by and
under the direction of the Chairman of the Company.
With respect to the provisions of said services, the parties agree to
observe and to abide by the terms and conditions set forth herein.
b) In connection with your employment by the Company, your principal place of
employment shall be the greater Washington, D.C. area and you shall not be
required permanently to relocate to a principal place of business outside the
greater Washington, D.C. area during the term of your employment hereunder.
c) During your employment, you will, except during vacations, periods of
illness, and other absences beyond your reasonable control, devote your best
efforts, skill and attention to the performance of your duties on behalf of the
Company.
2. TERM OF EMPLOYMENT. The term of the employment under this Agreement shall
have commenced on October 1, 1999 , and shall continue for a period of four (4)
years.
3. COMPENSATION.
a) BASE SALARY. The Company shall pay you a base salary at the rate of $350,000
per annum beginning October 1, 1999. Beginning on January 1, 2001 and on January
1st of each succeeding year during the term of this Agreement, your base salary
shall be increased at a minimum by an amount equal to five percent (5%) of your
then current base salary. Your base salary shall be subject to additional
increases at the discretion of the Compensation Committee of the Company's Board
of Directors (the "Compensation Committee"). Your base salary shall be payable
in such installments as the Company regularly pays its other salaried employees,
subject to such deductions and withholdings as may be required by law or by
further agreement with you.
b) PERFORMANCE BONUS. The Company will pay you a bonus subject to the
successful completion of the objectives established for your performance for
the applicable year. The performance criteria will be issued separately by the
Compensation Committee, and may be changed, with mutual fairness, from time to
time as situations develop. Promptly after signing this Agreement, the Company
will pay you $86,250, which represents 75% of your target performance bonus for
1999. The target performance bonus for the balance of calendar year 1999
(pro-rated as required) and for subsequent calendar years during the term of
this Agreement will be $150,000,
<PAGE>
or such greater amount as may be determined by the Compensation Committee, and
shall be payable to you subject to the successful completion of the objectives
established for your performance by the Compensation Committee.
c) INCENTIVE STOCK OPTIONS. On October 1, 1999, the Company shall grant you
options to purchase 25,000 shares of the Company's common stock (the "Options")
pursuant to its Executive Stock Incentive Plan (the "Plan"). Such Options shall
be evidenced by an option agreement in such form as required by the Plan. Among
other terms and provisions prescribed by the Plan, the option agreement shall
provide that (i) the exercise price of the Options shall be the price per share
of the Company's common stock as reported by the NASDAQ Stock Market at the
close of business on the date of grant (October 1, 1999), (ii) the Options shall
not be exercisable after the expiration of ten (10) years from the date such
Options are granted, and (iii) the stock shall vest ratably, monthly, over
forty-eight (48) months, provided that, for each month's vesting purposes, you
continue to be employed full time by the Company or one of its subsidiaries
during such month (except in situations where your employment is terminated in
violation hereof), and provided that the Company's Board of Directors ratifies,
no less often than annually, that you have met the performance standards and
criteria set for you for the preceding period.
In addition, on October 1 of each subsequent year of this Agreement (i.e., each
of October 1, 2000, October 1, 2001, and October 1, 2002), the Company shall
grant you options to purchase an additional 25,000 shares of the Company's
common stock pursuant to the Plan or another option plan of the Company, such
grant being subject to the terms of this Agreement and (1) the achievement of
the performance criteria to be established by the Compensation Committee, (2)
your continued employment at the time of grant (except in situations where your
employment is terminated in violation hereof), and (3) the options having an
exercise price equal to the closing price per share (as reported by the NASDAQ
Stock Market) of the Company's common stock on the date of grant.
d) VESTING OF STOCK OPTIONS. In the event of a Change in Control, as defined in
Section 8 below, or upon the occasion of your death during the term of this
Agreement while you are in compliance with the requirements hereof, the Company
shall: (i) vest immediately all of the unvested stock options you have received
pursuant to the terms of your employment agreement dated October 1, 1996 as
modified by the letter agreement dated October 16, 1998, as well as any unvested
stock options you may have received during the period of your employment
hereunder, (ii) in the event that your employment is terminated or continued
under conditions not substantially the same as those called for in this
Agreement, the Company shall, subject to shareholder approval, if required,
provide a loan sufficient to exercise all vested stock options and pay any
required taxes to which you may be subjected as a result, with the terms of the
loan to be no less favorable than installment free for the duration, interest
charged at the IRS minimum rate, with a five (5) year balloon payment for
interest and principal.
4. EMPLOYEE BENEFITS. You shall be provided employee benefits, including
(without limitation) 401(k) and related plans, revenue bonus plan participation,
four weeks' paid vacation which can accumulate to a maximum of eight (8) weeks,
and life, health, accident and disability insurance under the Company's standard
plans, policies and programs available to employees in accordance with the
provisions of such plans, policies, and programs.
5. TERMINATION.
a) Your employment with the Company may be terminated by the Company at any
time for "Cause" as defined in Section 5(c) hereof. In the event of a
termination for "Cause", all salary and benefits otherwise payable to you shall
cease immediately upon such termination. Upon such termination, the Company will
provide written notice whether it has elected to use the non-competition
restrictions set forth in Section 6(a) hereof. Termination by the Company or its
successors in interest for any reason other than Cause shall be deemed a breach
hereof. In addition, your employment may be terminated by you at any time for
any reason, provided you shall have given the Company at least thirty (30) days'
prior written notice of such termination. In the event of termination by you,
your salary and benefits shall continue during the thirty (30) day notice period
and shall cease thereafter, subject to the provisions of Section 5(b) hereof. By
the thirtieth (30th) day the Company must notify you in writing whether it has
elected to use the non-Competition restriction. Such decision may not be
rescinded. Failure of the Company to so notify you shall result in the
non-Competition restriction not being in place.
b) Subject to your compliance with your obligations under Section 6 hereof, in
the event that your employment terminates or is terminated by you or the Company
for any reason, and the Company has elected to use the non-
2
<PAGE>
Competition restriction, you shall be entitled, for a period of twenty-four
(24) months after termination of employment, to the following (collectively, the
"Termination Payments"): (i) your then current rate of base salary as provided
in Section 3; (ii) all life insurance and health benefits, disability insurance
and benefits and reimbursement theretofore being provided to you; and (iii)
Company contributions, to the extent permitted by applicable law, to a SEP-IRA,
Keogh or other retirement mechanism selected by you sufficient to provide the
same level of retirement benefits you would have received if you had remained
employed by the Company during such twenty-four (24) month period. The Company
shall make up the difference in cash payments directly to you to the extent that
applicable law would not permit it to make such contributions.
c) The Company shall have "Cause" for termination of your employment by reason
of any breach of your agreement not to compete pursuant to Section 6 hereof,
your committing an act materially adversely affecting the Company which
constitutes wanton or willful misconduct, your conviction of a felony, your
voluntary resignation without having given the Company at least thirty (30)
days' prior written notice, or any material breach by you of this Agreement.
6. AGREEMENT NOT TO COMPETE.
a) In consideration of your employment pursuant to this Agreement and for other
good and valuable consideration, the receipt and adequacy of which is hereby
acknowledged, you covenant to and agree with the Company that, so long as you
are employed by the Company under this Agreement and for a period of twenty-four
(24) months following the termination of such employment (but only if the
Company has elected to enforce the restriction), you shall not, without the
prior written consent of the Company, either for yourself or for any other
person, firm or corporation, manage, operate, control, participate in the
management, operation or control of or be employed by any other person or entity
which is engaged in providing Internet-related network or communications
services competitive with the Internet-related network or communication services
offered to customers by the Company as of the date of termination or within six
(6) months thereafter. The foregoing shall in no event restrict you from: (i)
writing or teaching, whether on behalf of for-profit, or not-for-profit
institution(s); (ii) investing (without participating in management or
operation) in the securities of any private or publicly traded corporation or
entity; or (iii) after termination of employment, becoming employed by a
hardware, software or other vendor to the Company, provided that such vendor
does not offer network or communication services that are competitive with the
Internet-related network or communications services offered by the Company as of
the date of termination of employment or within six (6) months thereafter.
b) You may request permission from the Company's Board of Directors to engage
in activities which would otherwise be prohibited by Section 6(a). The Company
shall respond to such request within thirty (30) days after receipt. The Company
will notify you in writing if it becomes aware of any breach or threatened
breach of any of the provisions in Section 6(a), and you shall have thirty (30)
days after receipt of such notice in which to cure or prevent the breach, to the
extent that you are able to do so. You and the Company acknowledge that any
breach or threatened breach by you of any of the provisions in Section 6(a)
above cannot be remedied by the recovery of damages, and agree that in the event
of any such breach or threatened breach which is not cured with such thirty (30)
day period, the Company may pursue injunctive relief for any such breach or
threatened breach. If a court of competent jurisdiction determines that you
breached any of such provisions, you shall not be entitled to any Termination
Payments from and after date of the breach. In such event, you shall promptly
repay any Termination Payments previously made plus interest thereon from the
date of such payment(s) at twelve percent (12%) per annum. If, however, the
Company has suspended making such Termination Payments and a court of competent
jurisdiction finally determines that you did not breach such provision or
determines such provision to be unenforceable as applied to your conduct, you
shall be entitled to receive any suspended Termination Payment, plus interest
thereon from the date when due at twelve percent (12%) per annum. The Company
may elect (once) to continue paying the Termination Payments before a final
decision has been made by the court.
7. INTELLECTUAL PROPERTY; OWNERSHIP OF WORK PRODUCT. All copyrights, patents,
trade secrets, or other intellectual property rights associated with any ideas,
concepts, techniques, inventions, processes, or works of authorship developed or
created by you during the course of performing the Company's work (collectively
the "Work Product") shall belong exclusively to the Company and shall, to the
extent possible, be considered a work made for hire for the Company within the
meaning of Title 17 of the United States Code. You hereby automatically
3
<PAGE>
assign, and shall assign at the time of creation of the Work Product, without
any requirement of further consideration, any right, title, or interest you may
have in such Work Product, including any copyrights or other intellectual
property rights pertaining thereto. Upon request of the Company, you shall take
such further actions, including execution and delivery of instruments of
conveyance, as may be appropriate to give full and proper effect to such
assignment.
8. TRANSFERABILITY.
a) As used in this Agreement, the term "Company" shall include any successor to
all or part of the business or assets of the Company. This Agreement shall inure
to the benefit of and be enforceable by you and your personal or legal
representatives, executors, administrators, heirs, distributees, devisees and
legatees.
b) Except as provided under paragraph (a) of this Section 8, neither this
Agreement nor any of the rights or obligations hereunder shall be assigned or
delegated by any party hereto without the prior written consent of the other
party.
c) As used in this Agreement, "Change in Control" shall mean: (i) the
shareholders of the Company approve an agreement for the sale of all or
substantially all of the assets of the Company; or (ii) the shareholders of the
Company approve a merger or consolidation of the Company with any other
corporation (and the Company implements it), other than (1) a merger or
consolidation which would result in the voting securities of the Company
outstanding immediately prior thereto continuing to represent more than eighty
percent (80%) of the combined voting power of the voting securities of the
Company, or such surviving entity, outstanding immediately after such merger or
consolidation, or (2) a merger or consolidation effected to implement a
recapitalization of the Company (or similar transaction) in which no "person"
(as defined below) acquires more than thirty percent (30%) of the combined
voting power of the Company's then-outstanding securities; or (iii) any
"person," as such term is used in Sections 13(d) and 14(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act") (other than ((A)) the
Company or ((B)) any corporation owned, directly or indirectly, by the Company
or the shareholders of the Company in substantially the same proportions as
their ownership of stock of the Company), is or becomes the "beneficial owner"
(as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing thirty percent (30%) or more of the
combined voting power of the Company's then outstanding securities.
9. SEVERABILITY. The invalidity or unenforceability of any particular provision
of this Agreement shall not affect the other provisions hereof, and this
Agreement shall be construed in all respects as if such invalid or unenforceable
provision were omitted. If a court of competent jurisdiction determines that any
particular provision of this Agreement is invalid or unenforceable, the court
shall restrict the provision so as to be enforceable. However, if the provisions
of Section 6 shall be restricted, a proportional reduction shall be made in the
payments under Section 5(b).
10. ENTIRE AGREEMENT; WAIVERS. This letter Agreement contains the entire
agreement of the parties concerning the subject matter hereof and supersedes and
cancels all prior agreements, negotiations, correspondence, undertakings and
communications of the parties, oral or written. No waiver or modification of any
provision of this Agreement shall be effective unless in writing and signed by
both parties.
11. NOTICES. Any notices, requests, instruction or other document to be given
hereunder shall be in writing and shall be sent certified mail, return receipt
requested, addressed to the party intended to be notified at the address of such
party as set forth at the head of this agreement or such other address as such
party may designate in writing to the other.
12. GOVERNING LAW. THIS LETTER AGREEMENT SHALL BE SUBJECT TO, GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT
REFERENCE TO ITS PRINCIPLES OF CONFLICTS OF LAW.
13. COUNTERPARTS. This letter Agreement may be executed in one or more
counterparts, each of which shall be deemed an original and all of which shall
be one and the same instrument.
4
<PAGE>
Please confirm your agreement with the forgoing by signing and
returning one copy of this letter Agreement to the undersigned, whereupon this
letter agreement shall become a binding agreement between you and the Company.
Sincerely,
PSINet Inc.
By: /s/William L. Schrader
--------------------------------------------
WILLIAM L. SCHRADER, CHAIRMAN & CEO
Accepted and Agreed to as of October 4, 1999:
By: /s/Edward D. Postal
---------------------------------
EDWARD D. POSTAL
5
<PAGE>
EXHIBIT 11.1
PSINET INC.
CALCULATION OF BASIC AND DILUTED LOSS PER SHARE AND WEIGHTED AVERAGE SHARES USED
IN CALCULATION (UNAUDITED) (1)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
------------------
<S> <C>
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of period 64,677,539
Weighted average shares issued during the three months ended September 30, 1999
(296,376 shares) 166,586
------------
64,844,125
============
Net loss available to common shareholders $(87,689,000)
============
Basic and diluted loss per share $ (1.35)
============
</TABLE>
(1)For a description of basic and diluted loss per share, see Note 1 of the
Notes to Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 as filed with the
Securities and Exchange Commission.
<PAGE>
EXHIBIT 11.2
PSINET INC.
CALCULATION OF BASIC AND DILUTED LOSS PER SHARE AND WEIGHTED AVERAGE SHARES
USED IN CALCULATION (UNAUDITED) (1)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1999
------------------
<S> <C>
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of period 52,083,639
Weighted average shares issued during the nine months ended September 30, 1999
(1,890,234 shares) 8,021,219
-------------
60,104,858
=============
Net loss available to common shareholders $(208,940,000)
=============
Basic and diluted loss per share $ (3.48)
=============
</TABLE>
(1)For a description of basic and diluted loss per share, see Note 1 of the
Notes to Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 as filed with the
Securities and Exchange Commission.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Statement of Operations for the nine months ended September 30,
1999 and the Consolidated Balance Sheet as of September 30, 1999 and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 567,017
<SECURITIES> 1,143,786
<RECEIVABLES> 79,594
<ALLOWANCES> 14,134
<INVENTORY> 2,136
<CURRENT-ASSETS> 1,830,459
<PP&E> 967,358
<DEPRECIATION> 176,935
<TOTAL-ASSETS> 3,299,455
<CURRENT-LIABILITIES> 340,947
<BONDS> 2,402,841
0
368,838
<COMMON> 651
<OTHER-SE> 118,394
<TOTAL-LIABILITY-AND-EQUITY> 3,299,455
<SALES> 369,268
<TOTAL-REVENUES> 369,268
<CGS> 259,873
<TOTAL-COSTS> 259,873
<OTHER-EXPENSES> 218,146
<LOSS-PROVISION> 7,620
<INTEREST-EXPENSE> 120,850
<INCOME-PRETAX> (198,488)
<INCOME-TAX> (750)
<INCOME-CONTINUING> (197,738)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (197,738)
<EPS-BASIC> (3.48)
<EPS-DILUTED> (3.48)
</TABLE>
<PAGE>
EXHIBIT 99.1
RISK FACTORS
BEFORE YOU INVEST IN OUR SECURITIES, YOU SHOULD BE AWARE THAT THERE ARE VARIOUS
RISKS ASSOCIATED WITH US AND OUR BUSINESS, INCLUDING THE ONES LISTED BELOW. YOU
SHOULD CAREFULLY CONSIDER THESE RISK FACTORS, AS WELL AS THE OTHER INFORMATION
CONTAINED IN OUR FORM 10-Q AND OUR OTHER PERIODIC REPORTS AND DOCUMENTS FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION, IN EVALUATING PSINET AND OUR
BUSINESS.
WE HAVE SIGNIFICANT INDEBTEDNESS AND WE MAY NOT BE ABLE TO MEET OUR OBLIGATIONS
We are highly leveraged and have significant debt service requirements. As of
September 30, 1999, our total indebtedness was $2.5 billion, representing
83.6% of total capitalization. For the three and nine months ended September
30, 1999, our interest expense was $59.4 million and $120.9 million,
respectively. Our aggregate annual interest expense on our 10% senior notes,
11 1/2% senior notes and 11% senior notes is $241.5 million, assuming with
respect to the 11% senior notes an exchange rate of Euro 0.92 to U.S.$1.00,
which was the average exchange rate for the period from January 1 to
September 30, 1999. We will have additional interest expense attributable to
our revolving credit facility and equipment lease arrangements.
Our high level of indebtedness could have several important effects on our
future operations, which, in turn, could have important consequences for the
holders of our securities, including the following:
o a substantial portion of our cash flow from operations must be used to pay
interest on our indebtedness and, therefore, will not be available for
other business purposes;
o covenants contained in the agreements evidencing our debt obligations
require us to meet many financial tests, and other restrictions limit our
ability to borrow additional funds or to dispose of assets and may affect
our flexibility in planning for, and reacting to, changes in our business,
including possible acquisition activities and capital expenditures; and
o our ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, general corporate purposes or
other purposes may be impaired.
Our ability to meet our debt service obligations and to reduce our total
indebtedness depends on our future operating performance and on economic,
financial, competitive, regulatory and other factors affecting our operations.
Many of these factors are beyond our control and our future operating
performance could be adversely affected by some or all of these factors. We
historically have been unable to generate sufficient cash flow from operations
to meet our operating needs and have relied on equity, debt and capital lease
financings to fund our operations. However, based on our current level of
operations, we believe that existing working capital, existing credit
facilities, capital lease financings and proceeds of future equity or debt
financings will be adequate to meet our presently anticipated future
requirements for working capital, capital expenditures and scheduled payments of
interest on our debt. We cannot assure you, however, that our business will
generate sufficient cash flow from operations or that future working capital
borrowings will be available in an amount sufficient to enable us to service our
debt, or to make necessary capital expenditures. In addition, we cannot assure
you that we will be able to raise additional capital for any refinancing of our
debt in the future.
<PAGE>
WE HAVE EXPERIENCED CONTINUING LOSSES, NEGATIVE CASH FLOW AND FLUCTUATIONS IN
OPERATING RESULTS
Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in new and rapidly evolving
markets. To address these risks, we must, among other things, respond to
competitive developments, continue to attract and retain qualified persons,
continue to upgrade our management and financial systems, and continue to
upgrade our technologies and commercialize our network services incorporating
such technologies. We cannot assure you that we will be successful in addressing
such risks, and the failure to do so could have a material adverse effect on our
business, financial condition, results of operations and ability to pay when due
principal, interest and other amounts in respect of our debt. Although we have
experienced revenue growth on an annual basis with revenue increasing from $84.4
million in 1996 to $121.9 million in 1997 to $259.6 million in 1998 and $369.3
million for the first nine months of 1999, we have incurred losses and
experienced negative EBITDA during those periods. We may continue to operate at
a net loss and may experience negative EBITDA as we continue our acquisition
program and the expansion of our global network operations. We have incurred net
losses available to common shareholders of $55.1 million in 1996, $46.0 million
in 1997, $264.9 million in 1998 and $208.9 million for the nine months ended
September 30, 1999. We have incurred negative EBITDA of $28.0 million, $21.2
million, $42.1 million and $6.0 million for each of the years ended December 31,
1996, 1997 and 1998 and the nine months ended September 30, 1999, respectively,
and had positive EBITDA of $0.7 million for the three months ended September 30,
1999. At September 30, 1999, we had an accumulated deficit of $636.5 million. We
cannot assure you that we will be able to achieve or sustain profitability or
sustain positive EBITDA.
Our 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 our control. These factors, include, among others things:
o general economic conditions and specific economic conditions in the
Internet access industry;
o user demand for Internet services;
o capital expenditures and other costs relating to the expansion of
operations of our network;
o the introduction of new services by us or our competitors;
o the mix of services sold and the mix of channels through which those
services are sold;
o pricing changes and new product introductions by us and our competitors;
o delays in obtaining sufficient supplies of sole or limited source equipment
and telecom facilities; and
o potential adverse regulatory developments.
As a strategic response to a changing competitive environment, we may elect from
time to time to make pricing, service or marketing decisions that could have a
material adverse effect on our business, results of operations and cash flow.
WE WILL DEPEND ON THE CASH FLOWS OF OUR SUBSIDIARIES IN ORDER TO SATISFY OUR
DEBT OBLIGATIONS
We are an operating entity that also conducts a significant portion of our
business through our subsidiaries. Our operating cash flow and consequently our
ability to service our debt is therefore partially dependent upon our
subsidiaries' earnings and their distributions of those earnings to us. It may
also be dependent upon loans, advances or other payments of funds to us by those
subsidiaries. Our subsidiaries are separate legal entities and have no
obligation, contingent or otherwise, to pay any amount due pursuant to our
senior notes or to make any
<PAGE>
funds available for that purpose. Our subsidiaries' ability to make payments may
be subject to the availability of sufficient surplus funds, the terms of such
subsidiaries' indebtedness, applicable laws and other factors.
WE MAY NOT BE ABLE TO FUND THE EXPANSION WE WILL NEED TO REMAIN COMPETITIVE
In order to maintain our competitive position, enhance our capabilities as an
Internet Super Carrier and continue to meet the increasing demands for
service quality, availability and competitive pricing, we expect to make
significant capital expenditures. At September 30, 1999, we were obligated to
make future cash payments that total $240.5 million for acquisitions of
global fiber-based and satellite telecommunications bandwidth, including IRUs
or other rights. We also expect that there will be additional costs, such as
connectivity and equipment charges, in connection with taking full advantage
of such acquired bandwidth and IRUs. Certain of this fiber-based and
satellite telecommunications bandwith may require the acquisition and
installation of equipment necessary to access and light the bandwith in order
to make it operational. At September 30, 1999, we were obligated to make
capital expenditures for such equipment of $242.0 million. In addition, we
currently are obligated to make expenditures in connection with our build-out
of new eCommerce Web hosting centers in key financial and business centers
throughout the world of approximately $61.8 million. As a result of the
foregoing, we currently believe that our capital expenditures in 1999 will be
substantially greater than those in 1998 and that, as a result of the
completion of our recent debt and equity offerings, our capital expenditure
program will be accelerated. This may occur as we continue to execute our
expansion strategy in the 20 largest global telecommunications markets and
beyond.
We historically have been unable to generate sufficient cash flow from
operations to meet our operating needs and have relied on equity, debt and
capital lease financings to fund our operations. However, we believe that we
will have a reasonable degree of flexibility to adjust the amount and timing of
capital expenditures in response to market conditions, competition, our then
existing financing capabilities and other factors. We also believe that working
capital generated from the use of acquired bandwidth, together with other
existing working capital from existing credit facilities, from capital lease
financings, from the proceeds of our recent debt and equity offerings and from
proceeds of future equity or debt financings will be sufficient to meet the
presently anticipated working capital and capital expenditure requirements of
our operations. We cannot assure you, however, that we will have sufficient
additional capital and/or obtain financing on satisfactory terms to enable us to
meet our capital expenditures and working capital requirements.
We may need to raise additional funds in order to take advantage of
unanticipated opportunities, more rapid international expansion or acquisitions
of complementary businesses. In addition, we may need to raise additional funds
to develop new products or otherwise respond to changing business conditions or
unanticipated competitive pressures. We cannot assure you that we will be able
to raise such funds on favorable terms. In the event that we are unable to
obtain such additional funds on acceptable terms, we may determine not to enter
into various expansion opportunities.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS AND STRATEGIC ALLIANCES AND
INVESTMENTS RELATING TO DIFFICULTIES IN INTEGRATING COMBINED OPERATIONS,
INCURRENCE OF ADDITIONAL DEBT TO FINANCE ACQUISITIONS AND OPERATIONS OF ACQUIRED
BUSINESSES, POTENTIAL DISRUPTION OF OPERATIONS AND RELATED NEGATIVE IMPACT ON
EARNINGS, AND INCURRENCE OF SUBSTANTIAL EXPENSES THAT COULD ADVERSELY AFFECT OUR
FINANCIAL CONDITION
Growth through acquisitions represents a principal component of our business
strategy. Over the 24 months ended September 30, 1999, we acquired 47 ISPs
primarily in 16 of the 20 largest global telecommunications markets. We expect
to continue to acquire assets and businesses principally relating to or
complementary to our current operations. We may also seek to develop strategic
alliances and investments (including venture capital investments) both
domestically and internationally. Any such future acquisitions or strategic
alliances and investments would be accompanied by the risks commonly encountered
in acquisitions, strategic alliances or investments. Such risks include, among
other things:
o the difficulty of integrating the operations and personnel of the
companies, particularly in non-U.S. markets;
<PAGE>
o the potential disruption of our ongoing business;
o the inability of management to maximize our financial and strategic
position by the successful incorporation of licensed or acquired technology
and rights into our service offerings; and
o the inability to maintain uniform standards, controls, procedures and
policies and the impairment of relationships with employees and customers
as a result of changes in management.
We cannot assure you that we will be successful in overcoming these risks or any
other problems encountered in connection with such acquisitions, strategic
alliances or investments. We believe that after eliminating redundant network
architecture and administrative functions and taking other actions to integrate
the operations of acquired companies we will be able to realize cost savings.
However, we cannot assure you that our integration of acquired companies'
operations will be successfully accomplished. Our inability to improve the
operating performance of acquired companies' businesses or to integrate
successfully the operations of acquired companies could have a material adverse
effect on our business, financial condition and results of operations. In
addition, as we proceed with acquisitions in which the consideration consists of
cash, a substantial portion of our available cash will be used to consummate
such acquisitions.
As with each of our recent acquisitions, the purchase price of many of the
businesses that might become attractive acquisition candidates for us likely
will significantly exceed the fair values of the net assets of the acquired
businesses. As a result, material goodwill and other intangible assets would be
required to be recorded which would result in significant amortization charges
in future periods. In addition, an intangible asset that frequently arises in
connection with the acquisition of a technology company is "acquired in-process
research and development", which under U.S. accounting standards, as presently
in effect, must be expensed immediately upon acquisition. Such expenses, in
addition to the financial impact of such acquisitions, could have a material
adverse effect on our business, financial condition and results of operations
and could cause substantial fluctuations in our quarterly and yearly operating
results. Furthermore, in connection with acquisitions or strategic alliances, we
could incur substantial expenses, including the expenses of integrating the
business of the acquired company or the strategic alliance with our existing
business.
We expect that competition for appropriate acquisition candidates may be
significant. We may compete with other telecommunications companies with similar
acquisition strategies, many of which may be larger and have greater financial
and other resources than we have. Competition for Internet companies is based on
a number of factors including price, terms and conditions, size and access to
capital, ability to offer cash, stock or other forms of consideration and other
matters. We cannot assure you that we will be able to successfully identify and
acquire suitable companies on acceptable terms and conditions.
OUR GROWTH AND EXPANSION MAY STRAIN OUR ABILITY TO MANAGE OUR OPERATIONS AND OUR
FINANCIAL RESOURCES
Our rapid growth has placed a strain on our administrative, operational and
financial resources and has increased demands on our systems and controls. We
have over 700 points-of-presence and we plan to continue to expand the capacity
of existing points-of-presence as customer-driven demand dictates. In addition,
we have completed a number of acquisitions of companies and telecommunications
bandwidth during 1998 and 1999 and plan to continue to do so. We anticipate that
we may be required to make continued enhancements to and expand our network. The
process of consolidating the businesses and implementing the strategic
integration of these acquired businesses with our existing business may take a
significant amount of time. It may also place additional strain on our resources
and could subject us to additional expenses. We cannot assure you that we will
be able to integrate these companies successfully or in a timely manner. In
addition, we cannot assure you that our existing operating and financial control
systems and infrastructure will be adequate to maintain and effectively monitor
future growth.
<PAGE>
Our continued growth may also increase our need for qualified personnel. We
cannot assure you that we will be successful in attracting, integrating and
retaining such personnel. The following risks, associated with our growth, could
have a material adverse effect on our business, results of operations and
financial condition:
o our inability to continue to upgrade our networking systems or our
operating and financial control systems;
o our inability to recruit and hire necessary personnel or to successfully
integrate new personnel into our operations;
o our inability to successfully integrate the operations of acquired
companies or to manage our growth effectively; or
o our inability to adequately respond to the emergence of unexpected
expansion difficulties.
WE FACE RISKS ASSOCIATED WITH OUR ACQUISITIONS OF BANDWIDTH FROM NETWORK
SUPPLIERS RELATING TO OUR DEPENDENCE ON THEIR ABILITY TO SATISFY THEIR
OBLIGATIONS TO US, THE POSSIBILITY THAT WE MAY NEED TO INCUR SIGNIFICANT
EXPENSES TO UTILIZE BANDWIDTH AND THEIR ABILITY TO BUILDOUT THEIR NETWORKS UNDER
CONSTRUCTION THAT COULD ADVERSELY AFFECT OUR ABILITY TO UTILIZE ACQUIRED
BANDWIDTH
We are subject to a variety of risks relating to our recent acquisitions of
fiber-based and satellite telecommunications bandwidth from our various
global network suppliers and the delivery, operation and maintenance of such
bandwidth. Such risks include, among other things, the following:
o the risk that financial, legal, technical and/or other matters may
adversely affect such suppliers' ability to perform their respective
operation, maintenance and other services relating to such bandwidth, which
may adversely affect our use of such bandwidth;
o the risk that we will not have access to sufficient additional capital
and/or financing on satisfactory terms to enable us to make the necessary
capital expenditures to take full advantage of such bandwidth;
o the risk that such suppliers may not continue to have the necessary
financial resources to enable them to complete, or may otherwise elect not
to complete, their contemplated buildout of their respective fiber optic
telecommunications systems; and
o the risk that such buildout may be delayed or otherwise adversely affected
by presently unforeseeable legal, technical and/or other factors.
We cannot assure you that we will be successful in overcoming these risks or any
other problems encountered in connection with our acquisitions of bandwidth.
CONTINUED INTERNATIONAL EXPANSION IS A KEY COMPONENT OF OUR BUSINESS STRATEGY
AND, IF WE ARE UNABLE TO COMPLETE THIS EXPANSION, OUR FINANCIAL CONDITION MAY BE
ADVERSELY AFFECTED
A key component of our business strategy is our continued expansion into
international markets. Revenue from non-U.S. operations as a percentage of
consolidated results comprised 53% of revenue in the third quarter of 1999 which
is consistent with it being 51% of revenue in the second quarter of 1999. By
comparison, non-U.S. operations comprised 40% of revenue for all of 1998. We may
need to enter into joint ventures or other strategic relationships with one or
more third parties in order to conduct our foreign operations successfully.
However, we cannot assure you that we will be able to obtain the permits and
operating licenses required for us
<PAGE>
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 our
ability to continue to expand our international presence, there are risks
inherent in doing business on an international level. Such risks include:
o unexpected changes in or delays resulting from regulatory requirements,
tariffs, customs, duties and other trade barriers;
o difficulties in staffing and managing foreign operations;
o longer payment cycles and problems in collecting accounts receivable;
o fluctuations in currency exchange rates and foreign exchange controls which
restrict or prohibit repatriation of funds;
o technology export and import restrictions or prohibitions;
o delays from customs brokers or government agencies;
o the introduction of free ISP services for consumer customers; and
o seasonal reductions in business activity during the summer months in Europe
and other parts of the world; and potentially adverse tax consequences,
which could adversely impact the success of our international operations.
We cannot assure you that such factors will not have an adverse effect on our
future international operations and, consequently, on our business, financial
condition and results of operations. In addition, we cannot assure you that laws
or administrative practice relating to taxation, foreign exchange, foreign
ownership or other matters of countries within which we operate will not change.
Any such change could have a material adverse effect on our business, financial
condition and results of operations.
Countries in which we operate may also experience economic difficulties and
uncertainties. These economic difficulties and uncertainties could have a
material adverse effect on our business, financial condition and results of
operations.
OUR FINANCIAL RESULTS AND OUR FINANCIAL POSITION MAY BE ADVERSELY AFFECTED BY
CURRENCY AND EXCHANGE RISKS
During the year ended December 31, 1998 and the nine months ended September 30,
1999, 40% and 52%, respectively, of our revenue was derived from operations
outside the United States and at September 30, 1999, 27.4% of our assets were in
operations outside of the United States. We anticipate that a significant
percentage of our future revenue and operating expenses will continue to be
generated from operations outside the United States and we expect to continue to
invest in non-U.S. businesses. Consequently, a substantial portion of our
revenue, operating expenses, assets and liabilities will be subject to
significant foreign currency and exchange risks. Obligations of customers and of
PSINet in foreign currencies will be subject to unpredictable and indeterminate
fluctuations in the event that such currencies change in value relative to U.S.
dollars. Furthermore, those customers and PSINet may be subject to exchange
control regulations which might restrict or prohibit the conversion of such
currencies into U.S. dollars. Although we have not entered into hedging
transactions to limit our foreign currency risks, as a result of the increase in
our foreign operations and our recent issuance of Euro-denominated 11% senior
notes, we may implement such practices in the future. We cannot assure you that
the occurrence of any of these factors will not have a material adverse effect
on our business, financial position or results of operations.
<PAGE>
WE DEPEND ON KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR SERVICES
Competition for qualified employees and personnel in the Internet services
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 such
personnel with the combination of skills and attributes required to carry out
our strategies is often lengthy. Our success depends to a significant degree
upon our ability to attract and retain qualified management, technical,
marketing and sales personnel and upon the continued contributions of such
management and personnel. In particular, our success is highly dependent upon
the personal abilities of our senior executive management, including William L.
Schrader, our Chairman of the Board and Chief Executive Officer and founder of
PSINet, Harold S. "Pete" Wills, our President and Chief Operating Officer, and
Edward D. Postal, our Executive Vice President and Chief Financial Officer. We
have employment agreements with each of these senior executive officers. The
loss of the services of any one of them could have a material adverse effect on
our business, financial condition or results of operations.
WE DEPEND ON SUPPLIERS AND COULD BE AFFECTED BY CHANGES IN SUPPLIERS OR DELAYS
IN DELIVERY OF THEIR PRODUCTS AND SERVICES
We have few long-term contracts with our suppliers. We are dependent on third
party suppliers for our leased-line connections or bandwidth. Some of these
suppliers are or may become competitors of ours, and such suppliers are not
subject to any contractual restrictions upon their ability to compete with us.
If these suppliers change their pricing structures, we may be adversely
affected. Moreover, any failure or delay on the part of our network providers to
deliver bandwidth to us or to provide operations, maintenance and other services
with respect to such bandwidth in a timely or adequate fashion could adversely
affect us.
We are also dependent on third party suppliers of hardware components. Although
we attempt to maintain a minimum of two vendors for each required product, some
components used by us in providing our networking services are currently
acquired or available from only one source. We have from time to time
experienced delays in the receipt of hardware components and telecommunications
facilities, including delays in delivery of PRI telecommunications facilities,
which connect dial-up customers to our network. 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 have
a material adverse effect on us. Our 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 our desire to maintain good
relationships with the suppliers. As our suppliers revise and upgrade their
equipment technology, we may encounter difficulties in integrating the new
technology into our network.
Many of the vendors from whom we purchase telecommunications bandwidth,
including the regional Bell operating companies, competitive local exchange
carriers and other local exchange carriers, currently are subject to tariff
controls and other price constraints which in the future may be changed. In
addition, recently enacted legislation will produce changes in the market for
telecommunications services. These changes may affect the prices that we are
charged by the regional Bell operating companies and other carriers, which could
have a material adverse effect on our business, financial condition and results
of operations. Moreover, we are subject to the effects of other potential
regulatory actions which, if taken, could increase the cost of our
telecommunications bandwidth through, for example, the imposition of access
charges.
THE TERMS OF OUR FINANCING ARRANGEMENTS MAY RESTRICT OUR OPERATIONS
Our financing arrangements are secured by substantially all of our assets and
stock of some of our subsidiaries. These financing arrangements require that we
satisfy many financial covenants. Our ability to satisfy these financial
covenants may be affected by events beyond our control and, as a result, we
cannot assure you that we will be able to continue to satisfy such covenants.
These financing arrangements also currently prohibit us from paying dividends
and repurchasing our capital stock without the lender's consent. Our failure to
comply with
<PAGE>
the covenants and restrictions in these financing arrangements could lead to a
default under the terms of these agreements. In the event of a default under the
financing arrangements, our lenders would be entitled to accelerate the
indebtedness outstanding thereunder and foreclose upon the assets securing such
indebtedness. They would also be entitled to be repaid from the proceeds of the
liquidation of those assets before the assets would be available for
distribution to the holders of our securities. In addition, the collateral
security arrangements under our existing financing arrangements may adversely
affect our ability to obtain additional borrowings.
OUR FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED IF OUR SYSTEMS AND THOSE OF
OUR SUPPLIERS FAIL BECAUSE OF YEAR 2000 PROBLEMS
The commonly referred to Year 2000 or Y2K problem results from the fact that
many existing computer programs and systems use only two digits to identify the
year in the date field. These programs were designed and developed without
considering the impact of a change in the century designation. If not corrected,
computer applications that use a two-digit format could fail or create erroneous
results in any computer calculation or other processing involving the Year 2000
or a later date. We have identified two main areas of Y2K risk:
o Internal computer systems or embedded chips could be disrupted or fail,
causing an interruption or decrease in productivity in our operations; and
o Computer systems or embedded chips of third parties including, without
limitation, financial institutions, suppliers, vendors, landlords,
customers, international suppliers of telecommunications services and
others, could be disrupted or fail, causing an interruption or decrease in
our ability to continue our operations.
We developed detailed plans for implementing, testing and completing any
necessary modifications to our key computer systems and equipment with
embedded chips to ensure that they are Y2K compliant. A third party
consultant performed an assessment of our U.S. internal systems (e.g.,
accounting, billing, customer support and network operations) to determine
the status of their Y2K compliance. The assessment recommended some minor
changes were necessary. We believe that no material changes or modifications
to our internal systems are required to achieve Y2K compliance. We have
developed a test bed of our U.S. internal systems to implement and complete
testing of the requisite minor changes. We believe that our U.S. internal
systems are presently Y2K ready. We have completed an inventory of our
internal systems that we use outside of the United States to determine the
status of their Y2K compliance. For our international operations, we have
plans to upgrade or, if necessary, replace components of our internal systems
to ensure they are Y2K compliant. We anticipate that our international
operations, excluding businesses acquired in the fourth quarter, will be Y2K
compliant during the fourth quarter of 1999. To help ensure that our network
operations and services to our customers are not interrupted due to the Y2K
problem, we have established a network operations team. This team of
operational staff have completed inventories of our network equipment
(software and hardware) and have found no material Y2K compliance issues. We
believe that all equipment currently being purchased for use in the PSINet
network is Y2K compliant. Any existing equipment that is not Y2K compliant is
in the process of being made Y2K compliant through minor changes to the
software or hardware or, in limited instances, replacement of the equipment.
We believe that our network is presently Y2K compliant. In addition to
administering the implementation of necessary upgrades for Y2K compliance,
our network team has developed a contingency plan to address potential
problems that may occur with our network as we enter the year 2000. We
believe that, as a result of our detailed assessment and completed
modifications, the Y2K issue will not pose significant operational problems
for us. However, if the requisite modifications and conversions are not made,
or not completed in a timely fashion, it is possible that the Y2K problem
could have a material impact on our operations.
<PAGE>
We have, and will continue to require, Y2K disclosures from all companies
that we acquire in the fourth quarter of 1999. We believe that, as a result
of due diligence performed and information gathered, the effect of the Y2K
issues on the companies we acquire will not in the aggregate have a material
impact on our operations. However, if such Y2K disclosures are not complete
or required remediation actions are not taken by the acquired companies in a
timely manner, it is possible that the Y2K problem could have a material
impact.
Our cost of addressing Y2K issues has been minor to date, less than 5% of our
information technology and network operations budgets, but this amount may
increase if additional outside consultants or personnel resources are required
or if important operational equipment must be remediated or replaced. Our
estimated total costs related to Y2K issues for 1999 is not expected to exceed
$2.0 million. These costs include equipment, consulting fees, software and
hardware upgrades, testing, remediation and, in limited instances, replacement
of equipment. The risk that Y2K issues could present to us include, without
limitation, disruption, delay or cessation of operations, including operations
that are subject to regulatory compliance. In each case, the correction of the
problem could result in substantial expense and disruption or delay of our
operations. The total cost of Y2K assessments and remediation is funded through
cash on hand and available from other sources and we are expensing these costs,
as appropriate. The financial impact of making all required systems changes or
other remediation efforts cannot be known precisely, but it is not expected to
be material to our financial position, results of operations, or cash flows. We
have not canceled any principal information technology projects as a result of
our Y2K effort, although we have rescheduled some internal tasks to accommodate
this effort.
In addition, we have identified, prioritized and are communicating with our
suppliers, vendors, customers, lenders and other material third parties to
determine their Y2K status and any probable impact on us. To date, our inquiries
have not revealed any significant Y2K noncompliance issue affecting our material
third parties. We will continue to monitor and evaluate our long-term
relationships with our material third parties based on their responses to our
inquiries and on information learned from other sources. If any of our material
third parties are not Y2K ready and their non-compliance causes a material
disruption to any of their respective businesses, our business could be
materially adversely affected. Disruptions could include, among other things:
o the failure of a material third party's business;
o a financial institution's inability to take and transfer funds;
o an interruption in delivery of supplies from vendors;
o a loss of voice and data connections;
o a loss of power to our facilities; and
o other interruptions in the normal course of our operations, the nature and
extent of which we cannot foresee.
We will continue to evaluate the nature of these risks, but at this time we are
unable to determine the probability that any such risk will occur, or if it does
occur, what the nature, length or other effects, if any, of such a risk may have
on us. If any of our material third parties experience significant failures in
their computer systems or operations due to Y2K non-compliance, it could affect
our ability to process transactions or otherwise engage in similar normal
business activities. For example, while we expect our internal systems, U.S. and
non-U.S., to be Y2K ready in stages during 1999, we and our customers who
communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a
<PAGE>
material adverse effect on our revenues and business and that of our customers.
While many of these risks are outside our control, we have identified and
contacted our critical third party vendors and suppliers and are establishing
contingency plans to remedy any potential interruption to our operations.
While we believe that we are adequately addressing the Y2K issue, we cannot
assure you that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue will
not materially adversely impact our business, prospects, revenues or financial
position. We are uncertain as to our most reasonably likely worst case Y2K
scenario and, although we have completed a contingency plan to handle reasonably
foreseeable interruptions resulting from the Y2K problem, we cannot assure you
that our contingency plan will be capable of adequately addressing every
potential interruption that may occur.
IF WE BECOME SUBJECT TO PROVISIONS OF THE INVESTMENT COMPANY ACT, OUR BUSINESS
OPERATIONS MAY BE RESTRICTED
We have significant amounts of cash invested in short term investment grade
securities, which investments could conceivably subject us to the provisions
of the Investment Company Act of 1940. We do not propose to engage in
investment activities in a manner or to an extent which would require us to
register as an investment company under the Investment Act of 1940. The
Investment Company Act of 1940 places restrictions on the capital structure
and business activities of companies registered thereunder.
Accordingly, we will seek to limit our holding of "investment securities" (as
defined in such Act) to an amount which is less than 40% of the value of our
total assets as calculated pursuant to the Investment Company Act of 1940. The
Investment Company Act of 1940 permits a company to avoid becoming subject to
such Act for a period of up to one year despite the holding of investment
securities in excess of such amount if, among other things, its board of
directors has adopted a resolution which states that it is not the company's
intention to become an investment company. Our Board of Directors has adopted
such a resolution that would become effective in the event we are deemed to fall
within the definition of an investment company. Application of the provisions of
the Investment Company Act of 1940 would have a material adverse effect on us.
WE FACE A HIGH LEVEL OF COMPETITION IN THE INTERNET SERVICES INDUSTRY
The market for Internet connectivity and related services is extremely
competitive. We anticipate that competition will continue to intensify as the
use of the Internet grows. The tremendous growth and potential market size of
the Internet access market has attracted many new start-ups as well as
established businesses from different industries.
Our current and prospective competitors include other national, regional and
local ISPs, long distance and local exchange telecommunications companies, cable
television, direct broadcast satellite, wireless communications providers and
on-line service providers. We believe that our network, products and customer
service distinguish us from these competitors. However, some of these
competitors have significantly greater market presence, brand recognition and
financial, technical and personnel resources than we do. We compete with all of
the major long distance companies, also known as interexchange carriers,
including AT&T, MCIWorldCom, Sprint and Cable & Wireless/IMCI, which also offer
Internet access services. The recent sweeping reforms in the federal regulation
of the telecommunications industry have created greater opportunities for local
exchange carriers, including the regional Bell operating companies, to enter the
Internet connectivity market. We believe that there is a move toward horizontal
integration through acquisitions of, joint ventures with, and the wholesale
purchase of connectivity from ISPs to address the Internet connectivity
requirements of the current business customers of long distance and local
carriers. The WorldCom/MFS/UUNet consolidation, the WorldCom/MCI merger, the
ICG/NETCOM merger, Cable & Wireless' purchase of the internetMCI assets, the
Intermedia/DIGEX merger, GTE's acquisition of BBN, Global Crossing's plans to
acquire Frontier Corp. and Frontier's prior acquisition of Global Center, Qwest
Communication's plans to acquire US West, AT&T's
<PAGE>
purchase of IBM's global communications network and MCI WorldCom's recently
announced plans to merge with Sprint are indicative of this trend. Accordingly,
we expect to experience increased competition from the traditional
telecommunications carriers. Many of these telecommunications carriers may have
the ability to bundle Internet access with basic local and long distance
telecommunications services. This bundling of services may have an adverse
effect on our ability to compete effectively with the telecommunications
providers and may result in pricing pressure on us that could have a material
adverse effect on our business, financial condition and results of operations.
Many of the major cable companies have announced that they are exploring the
possibility of offering Internet connectivity, relying on the viability of cable
modems and economical upgrades to their networks. Several announcements also
have recently been made by other alternative service companies approaching the
Internet connectivity market with various wireless terrestrial and
satellite-based service technologies.
Many of the predominant on-line service providers, including America Online and
Microsoft Network, have entered the Internet access business by engineering
their current proprietary networks to include Internet access capabilities. We
compete to a lesser extent with these on-line service providers. However,
America Online's acquisition of Netscape Communications Corporation and related
strategic alliance with Sun Microsystems will enable it to offer a broader array
of Internet protocol-based services and products that could significantly
enhance its ability to appeal to the business marketplace and, as a result,
compete more directly with us.
Recently, there have been several announcements regarding the planned deployment
of broadband services for high speed Internet access by cable and telephone
companies. These services would include new technologies such as cable modems
and DSL. These providers have initially targeted the residential consumer.
However, it is likely that their target markets will expand to encompass
business customers, which is our target market. This expansion could adversely
affect the pricing of our service offerings. Moreover, there has recently been
introduced a number of free ISP services, particularly in non-U.S. markets, and
some ISPs are offering free personal computers to their subscribers. While these
services have been offered primarily to dial-up consumer customers, they could
be extended to dial-up business customers as well. These trends could have a
material adverse effect on our business, financial condition and results of
operations.
As a result of the increase in the number of competitors and the vertical and
horizontal integration in the industry, we currently encounter and expect to
continue to encounter significant pricing pressure and other competition.
Advances in technology as well as changes in the marketplace and the regulatory
environment are constantly occurring, and we cannot predict the effect that
ongoing or future developments may have on us or on the pricing of our products
and services. Increased price or other competition could result in erosion of
our market share and could have a material adverse effect on our business,
financial condition and results of operations. We cannot assure you that we will
have the financial resources, technical expertise or marketing and support
capabilities to continue to compete successfully.
As we continue to expand our operations outside the United States, we will
encounter new competitors and competitive environments. In some cases, we will
be forced to compete with and buy services from government-owned or subsidized
telecommunications providers. Some of these providers may enjoy a monopoly on
telecommunications services essential to our business. We cannot assure you that
we will be able to purchase such services at a reasonable price or at all. In
addition to the risks associated with our previously described competitors,
foreign competitors may pose an even greater risk, as they may possess a better
understanding of their local markets and better working relationships with local
infrastructure providers and others. We cannot assure you that we can obtain
similar levels of local knowledge. Failure to obtain that knowledge could place
us at a significant competitive disadvantage.
TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS COULD RESULT IN OUR
COMPETITORS DEVELOPING OR OBTAINING ACCESS TO BANDWIDTH AND TECHNOLOGIES THAT
CARRY MORE INFORMATION FASTER THAN OUR BANDWIDTH AND TECHNOLOGY AND,
CONSEQUENTLY, RENDER OUR BANDWIDTH OR TECHNOLOGY OBSOLETE
<PAGE>
Our products and services are targeted toward users of the Internet, which has
experienced rapid growth. The market for Internet access and related services is
characterized by rapidly changing technology, evolving industry standards,
changes in customer needs and frequent new product and service introductions.
Our future success will depend, in part, on our ability to effectively use and
develop leading technologies.
We cannot assure you that we will be successful in responding to changing
technology or market trends. In addition, services or technologies developed by
others may render our services or technologies uncompetitive or obsolete.
Furthermore, changes to our services in response to market demand may require
the adoption of new technologies that could likewise render many of our assets
technologically uncompetitive or obsolete. As we accept bandwidth from our
various existing global network suppliers or acquire bandwidth or equipment from
other suppliers that may better meet our needs than existing bandwidth or
equipment, many of our assets could be determined to be obsolete or excess. The
disposition of obsolete or excess assets could have a material adverse effect on
our business, financial condition and results of operations.
Even if we do respond successfully to technological advances and emerging
industry standards, the integration of new technology may require substantial
time and expense, and we cannot assure you that we will succeed in adapting our
network infrastructure in a timely and cost-effective manner.
WE MAY BE LIABLE FOR INFORMATION DISSEMINATED THROUGH OUR NETWORK
The law relating to liability of ISPs for information carried on or
disseminated through their networks is not completely settled. A number of
lawsuits have sought to impose such liability for defamatory speech,
infringement of copyrighted materials, and other claims. The U.S. Supreme
Court has let stand a lower court ruling which held that an ISP was protected
by a provision of the Communications Decency Act from liability for material
posted on its system. However, the findings in that particular case may not
be applicable in other circumstances with differing facts. Other courts have
held that online service providers and ISPs may, under some circumstances, be
subject to damages for copying or distributing copyrighted materials.
However, in an effort to protect certain qualified ISPs, the Digital
Millennium Copyright Act was signed into law in October 1998. Under certain
circumstances, this Act may provide qualified ISPs with a "safe harbor" from
liability for copyright infringement. We cannot assure you that we would be
protected by the terms, provisions and interpretations of this Act. In 1998,
the Child Online Protection Act was enacted requiring limitations on access
to pornography and other material deemed "harmful to minors." This
legislation has been attacked in court as a violation of the First Amendment.
We are unable to predict the outcome of this case at this time. The
imposition upon ISPs or web server hosts of potential liability for materials
carried on or disseminated through their systems could require us to
implement measures to reduce our exposure to such liability. Such measures
may require that we spend substantial resources or discontinue some product
or service offerings. Any of these actions could have a material adverse
effect on our business, operating results and financial condition.
We carry errors and omissions insurance with a policy limit of $5.0 million,
subject to deductibles and exclusions. Such coverage may not be adequate or
available to compensate us 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 our business, financial condition and results of
operations.
The law relating to the regulation and liability of ISPs in relation to
information carried or disseminated also is undergoing a process of development
in other countries. For example a recent court decision in England held an ISP
liable for certain allegedly defamatory content carried through its network
under factual circumstances in which the ISP had been notified by the
complainant about the offending message which the ISP had failed to delete when
asked to do so by the complainant. 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 us.
<PAGE>
One particular area of uncertainty in this regard results from the entry into
effect of European Union Directive 95/46/EC on the protection of individuals
with regard to the processing of personal data and on the free movement of such
data ("EU Directive"). That Directive imposes obligations in connection with the
protection of personal data collected or processed by third parties. Under some
circumstances, we may be regarded as subject to the EU Directive's requirements.
The United States and the European Union currently are negotiating the
application of the EU Directive to U.S. companies.
FCC REGULATIONS MAY LIMIT THE SERVICES WE CAN OFFER
Consistent with our growth and acquisition strategy, we are now engaged in, or
will soon be engaged in, activities that subject us to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications carriers to the
extent that they involve the provision, origination or termination of
jurisdictionally interstate or international communications. The state
regulatory commissions retain jurisdiction over the same facilities and services
to the extent they involve origination or termination of jurisdictionally
intrastate communications.
Our Internet operations are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, the FCC has indicated that some services offered
over the Internet, such as phone-to-phone Internet protocol telephony, may be
functionally indistinguishable from traditional telecommunications service
offerings and their non-regulated status may have to be re-examined. We are
unable to predict what regulations may be adopted in the future, or to what
extent existing laws and regulations may be found applicable, or the impact such
new or existing laws may have on our business. We cannot assure you that new
laws or regulations relating to Internet services, or existing laws found to
apply to them, will not have a material adverse effect on us. Although the FCC
has decided not to allow local telephone companies to impose per-minute access
charges on Internet service providers, and that decision has been upheld by the
reviewing court, further regulatory and legislative consideration of this issue
is likely. In addition, some telephone companies are seeking relief through
state regulatory agencies. Such rules, if adopted, would affect our costs of
serving dial-up customers and could have a material adverse effect on our
business, financial condition and results of operations.
In addition to our Internet activities, we have recently focused attention on
acquiring telecommunications assets and facilities, which is a regulated
activity. Our wholly-owned subsidiary, PSINetworks Company, has received an
international Section 214 authorization from the FCC to provide global
facilities-based and global resale telecommunications services. Our wholly-owned
subsidiary, PSINet Telecom UK Limited, has received an international facilities
license from DTI and OFTEL, the responsible telecommunications regulatory bodies
in the United Kingdom. Currently, the FCC and OFTEL do not closely regulate the
charges or practices of non-dominant carriers, such as our subsidiaries.
Nevertheless, these regulatory agencies have the power to impose more stringent
regulatory requirements on us and to change our regulatory classification, which
may adversely affect our business.
Our subsidiaries have also received competitive local exchange carrier, or CLEC,
certification in New York, Virginia, Colorado, California and Texas, and have
applied for CLEC certification in Maryland. We are considering the financial,
regulatory and operational implications of becoming a competitive local exchange
carrier in other states. As a provider of domestic basic telecommunications
services, particularly competitive local exchange services, we could become
subject to further regulation by the FCC and/or another regulatory agency,
including state and local entities.
An important issue for CLECs is the right to receive reciprocal compensation for
the transport and termination of Internet traffic. Most states have required
incumbent local exchange carriers to pay competitive local exchange carriers
reciprocal compensation. In October 1998, the FCC determined that dedicated
Digital Subscriber Line service is an interstate service and properly tariffed
at the interstate level. In February 1999, the FCC concluded that at least a
substantial portion of dial-up ISP traffic is jurisdictionally interstate. The
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FCC also concluded that its jurisdictional decision does not alter the exemption
from access charges currently enjoyed by ISPs. The FCC established a proceeding
to consider an appropriate compensation mechanism for interstate Internet
traffic. Pending the adoption of that mechanism, the FCC saw no reason to
interfere with existing interconnection agreements and reciprocal compensation
arrangements. The FCC order has been appealed and briefing was completed in
September 1999, and oral arguments are expected to begin in early 2000. In light
of the FCC's order, state commissions that previously addressed this issue and
required reciprocal compensation to be paid for ISP traffic, may reconsider and
may modify their prior rulings. Several incumbent local exchange carriers are
seeking to overturn prior orders, or seek refunds of, or authority to escrow,
payments that they claim are inconsistent with the FCCs' February 1999 order. In
response to these and other challenges, some state commissions have opened
inquiries as to the appropriate compensation mechanisms in the context of ISP
traffic. Of the state commissions that have considered the issue since the FCC's
February 1999 order, the majority of these states have upheld the requirement to
pay reciprocal compensation for ISP traffic. We cannot assure you that any
future court, state regulatory or FCC decision on this matter will favor our
position. An unfavorable result may have an adverse impact on our potential
future revenues as a CLEC, as well as increasing our costs for PRIs generally.
IF WE EXPERIENCE SYSTEM FAILURE OR SHUTDOWN, WE MAY NOT BE ABLE TO DELIVER
SERVICES
Our success depends upon our ability to deliver reliable, high-speed access to
the Internet and upon the ability and willingness of our telecommunications
providers to deliver reliable, high-speed telecommunications service through
their networks. Our network, and other networks providing services to us, are
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. We have
designed our network to minimize the risk of such system failure, for instance,
with redundant circuits among POPs to allow traffic rerouting. In addition, we
perform lab and field testing before integrating new and emerging technology
into the network, and we engage in capacity planning. Nonetheless, we cannot
assure you that we will not experience failures or shutdowns relating to
individual POPs or even catastrophic failure of the entire network.
We carry business personal property insurance at both scheduled locations and
unscheduled locations to protect us against losses due to property damage and
business interruption. Such coverage, however, may not be adequate or available
to compensate us for all losses that may occur. In addition, we generally
attempt to limit our liability to customers arising out of network failures by
contractually disclaiming all such liability. In respect of many services, we
have also contractually limited liability to a usage credit based upon the
amount of time that the system was not operational. We cannot assure you,
however, that such limitations will be enforceable. In any event, significant or
prolonged system failures or shutdowns could damage our reputation and result in
the loss of customers.
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ALTHOUGH WE HAVE IMPLEMENTED NETWORK SECURITY MEASURES, OUR NETWORK MAY BE
SUSCEPTIBLE TO VIRUSES, BREAK-INS OR DISRUPTIONS
We have implemented many network security measures, such as limiting physical
and network access to our routers. Nonetheless, our network's infrastructure is
potentially vulnerable to computer viruses, break-ins and similar disruptive
problems caused by our 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 our 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 our
customers. This could, in turn, deter potential customers and adversely affect
our existing customer relationships. Security problems represent an ongoing
threat to public and private data networks. Attacks upon the security of
Internet sites and infrastructure continue to be reported to organizations such
as the CERT Coordination Center at Carnegie Mellon University, which facilitates
responses of the Internet community to computer security events. Addressing
problems caused by computer viruses, break-ins or other problems caused by third
parties could have a material adverse effect on us.
The security services that we offer in connection with our customers' networks
cannot assure complete protection from computer viruses, break-ins and other
disruptive problems. Although we attempt to limit contractually our liability in
such instances, the occurrence of such problems may result in claims against us
or liability on our part. Such claims, regardless of their ultimate outcome,
could result in costly litigation and could have a material adverse effect on
our business or reputation or on our ability to attract and retain customers for
our 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
our customer base and revenues.
RISK ASSOCIATED WITH DEPENDENCE ON TECHNOLOGY AND WITH PROPRIETARY RIGHTS
Our success and ability to compete is dependent in part upon our technology and
technical expertise and, to a lesser degree, on our proprietary rights. In order
to establish and protect our technology, we rely on a combination of copyright,
trademark and trade secret laws and contractual restrictions. Nevertheless, we
cannot assure you that such measures are adequate to protect our proprietary
technology. It may be possible for a third party to copy or otherwise obtain and
use our products or technology without authorization or to develop similar
technology independently. In addition, our products may be licensed or otherwise
utilized in foreign countries where laws may not protect our proprietary rights
to the same extent as do laws in the United States. It is our policy to require
employees and consultants and, when obtainable, suppliers to execute
confidentiality agreements upon the commencement of their relationships with us.
Nonetheless, we cannot assure you that these precautions will be adequate to
prevent misappropriation of our technology or that our competitors will not
independently develop technologies that are substantially equivalent or superior
to our technology.
In addition, we are also subject to the risk of adverse claims and litigation
alleging infringement by us of the intellectual property rights of others. From
time to time, we have received claims that we have infringed other parties'
proprietary rights. While we do not believe that we have infringed the
proprietary rights of other parties, we cannot assure you that third parties
will not assert infringement claims in the future with respect to our current or
future products. Such claims may require that we enter into license arrangements
or may result in protracted and costly litigation, regardless of the merits of
such claims. We cannot assure you that any necessary licenses will be available
or that, if available, such licenses can be obtained on commercially reasonable
terms.
We have recently introduced new enterprise service offerings, including
value-added, Internet protocol-based enterprise communication services and
DSL-based Internet access services. The failure of these services to gain market
acceptance in a timely manner or at all, or the failure of DSL-based services,
in particular, to achieve significant market coverage could have a material
adverse effect on our business, financial condition
<PAGE>
and results of operations. If we introduce new or enhanced services with
reliability, quality or compatibility problems, it could significantly delay or
hinder market acceptance of such services, which could adversely affect our
ability to attract new customers and subscribers. Our services may contain
undetected errors or defects when first introduced or as enhancements are
introduced. Despite testing by us or our customers, we cannot assure you that
errors will not be found in new services after commencement of commercial
deployment. Such errors could result in additional development costs, loss of or
delays in market acceptance, diversion of technical and other resources from our
other development efforts and the loss of credibility with our customers and
subscribers. Any such event could have a material adverse effect on our
business, financial condition and results of operations.
Additionally, if we are unable to match our network capacity to customer demand
for our services, our network could become congested during periods of peak
customer demand. Such congestion could adversely affect the quality of service
we are able to provide. Conversely, due to the high fixed cost nature of our
infrastructure, if our network is under-utilized, it could adversely affect our
ability to provide cost-efficient services. Our failure to match network
capacity to demand could have a material adverse effect on our business,
financial condition or results of operations.
THE MARKET PRICE AND TRADING VOLUME OF OUR STOCK MAY BE VOLATILE
The market price and trading volume of our common stock and convertible
preferred stock have been and may continue to be highly volatile. Factors such
as variations in our revenue, earnings and cash flow and announcements of new
service offerings, technological innovations, strategic alliances and/or
acquisitions involving our competitors or price reductions by us, our
competitors or providers of alternative services could cause the market price of
our common stock and convertible preferred stock to fluctuate substantially. In
addition, the stock markets recently have experienced 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 our common stock and
convertible preferred stock.
WE DO NOT ANTICIPATE THAT WE WILL PAY CASH DIVIDENDS ON OUR COMMON STOCK
We have never declared or paid any cash dividends on our common stock and do not
anticipate paying cash dividends on our common stock in the foreseeable future.
In addition, our debt securities and credit facility contain limitations on our
ability to declare and pay cash dividends.
FORWARD-LOOKING STATEMENTS
Some of the information contained in the periodic report with which this Exhibit
99.1 is filed may contain forward-looking statements. Such statements can be
identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or similar words, or by
discussions of strategy that involve risks and uncertainties. These statements
may discuss our future expectations or contain projections of our results of
operations or financial condition or expected benefits to us resulting from
acquisitions or transactions. We cannot assure you that the future results
indicated, whether expressed or implied, will be achieved. The risk factors
noted in this section and other factors noted throughout the report with which
this Exhibit 99.1 is filed, including risks and uncertainties, could cause our
actual results to differ materially from those contained in any forward-looking
statement.
