<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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>
<CAPTION>
<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 - 64,513,238 SHARES AS OF MAY 4, 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 27.
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<PAGE>
PSINET INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 1999 and
December 31, 1998........................................... 3
Consolidated Statements of Operations for the three months
ended March 31, 1999 and March 31, 1998 .................... 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 1999 and March 31, 1998........ 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 25
Item 6. Exhibits and Reports on Form 8-K............................... 26
Signatures................................................................ 27
Exhibit Index ............................................................ 27
</TABLE>
-2-
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
(IN THOUSANDS OF U.S. DOLLARS)
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 25,131 $ 56,842
Restricted cash and short-term investments 132,898 162,469
Short-term investments and marketable securities 240,830 265,666
Accounts receivable, net 54,687 50,211
Prepaid expenses 23,657 10,998
Other current assets 18,042 19,077
----------- -----------
Total current assets 495,245 565,263
Property and equipment, net 503,522 389,476
Goodwill and other intangibles, net 319,960 282,781
Other assets and deferred charges 52,486 46,711
----------- -----------
Total assets $ 1,371,213 $ 1,284,231
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current portion of debt $ 166,184 $ 59,968
Trade accounts payable 64,178 89,973
Accrued payroll and related expenses 15,815 8,501
Other accounts payable and accrued liabilities 88,204 82,760
Accrued interest payable 23,804 28,988
Deferred revenue 20,521 19,427
----------- -----------
Total current liabilities 378,706 289,617
Long-term debt 1,118,801 1,064,633
Deferred income tax liabilities 6,123 6,123
Other liabilities 42,867 44,032
----------- -----------
Total liabilities 1,546,497 1,404,405
----------- -----------
Shareholders' deficit:
Preferred stock -- --
Convertible preferred stock -- 28,802
Common stock 564 522
Capital in excess of par value 437,161 401,990
Accumulated deficit (486,858) (427,597)
Treasury stock (2,005) (2,005)
Accumulated other comprehensive income 22,526 36,664
Bandwidth asset to be delivered under IXC agreement (146,672) (158,550)
----------- -----------
Total shareholders' deficit (175,284) (120,174)
----------- -----------
Total liabilities and shareholders' deficit $ 1,371,213 $ 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 MARCH 31,
----------------------------
1999 1998
--------- ---------
(IN THOUSANDS OF U.S. DOLLARS,
EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C>
Revenue $ 104,846 $ 44,469
Operating costs and expenses:
Data communications and operations 76,018 36,666
Sales and marketing 18,572 10,732
General and administrative 17,089 7,585
Depreciation and amortization 26,818 9,465
Charge for acquired in-process research and development -- 7,000
--------- ---------
Total operating costs and expenses 138,497 71,448
--------- ---------
Loss from operations (33,651) (26,979)
Interest expense (29,581) (2,579)
Interest income 4,720 585
Other expense, net (175) (99)
--------- ---------
Loss before income taxes (58,687) (29,072)
Income tax benefit -- --
--------- ---------
Net loss (58,687) (29,072)
Return to preferred shareholders (574) (782)
--------- ---------
Net loss available to common shareholders $ (59,261) $ (29,854)
--------- ---------
--------- ---------
Basic and diluted loss per share $ (1.11) $ (0.67)
--------- ---------
--------- ---------
Shares used in computing basic and diluted loss
per share (in thousands) 53,358 44,596
--------- ---------
--------- ---------
</TABLE>
-4-
<PAGE>
PSINET INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
--------- ---------
(IN THOUSANDS OF U.S. DOLLARS)
(UNAUDITED)
<S> <C> <C>
Net cash used in operating activities $ (77,264) $ (9,970)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (55,666) (6,196)
Purchases of investments (129,254) (2,205)
Proceeds from maturity or sale of investments 153,928 --
Investments in certain businesses, net of cash acquired (35,121) (15,971)
Restricted cash and short-term investments 29,571 14,255
Other, net (339) 195
--------- ---------
Net cash used in investing activities (36,881) (9,922)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of debt, net 101,258 25,000
Repayments of debt (3,365) (3,540)
Principal payments under capital lease obligations (12,271) (7,623)
Proceeds from exercise of common stock options 6,288 720
Payments of dividends on preferred stock (452) (940)
Other, net (149) --
--------- ---------
Net cash provided by financing activities 91,309 13,617
--------- ---------
Effect of exchange rate changes on cash (8,875) 96
--------- ---------
Net decrease in cash and cash equivalents (31,711) (6,179)
Cash and cash equivalents, beginning of period 56,842 33,322
--------- ---------
Cash and cash equivalents, end of period $ 25,131 $ 27,143
--------- ---------
--------- ---------
</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-month periods ended March
31, 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. In the opinion of
management, the accompanying unaudited financial statements contain all
adjustments (consisting of normal recurring adjustments) which management
considers necessary to present fairly the consolidated financial position of the
Company at March 31, 1999 and the results of its operations and cash flows for
the three-month periods ended March 31, 1999 and 1998. The results of operations
for the three-month period ended March 31, 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 - COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 1999 and 1998 was as
follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
-------- --------
<S> <C> <C>
Net loss $(58,687) $(29,072)
-------- --------
Other comprehensive income:
Unrealized holding gains (losses) (147) 3,644
Foreign currency translation adjustment (13,990) 306
-------- --------
(14,137) 3,950
-------- --------
Comprehensive income $(72,824) $(25,122)
-------- --------
-------- --------
</TABLE>
NOTE 3 - ACQUISITIONS OF CERTAIN BUSINESSES
During the three months ended March 31, 1999, the Company acquired the following
businesses:
<TABLE>
<CAPTION>
OWNERSHIP
BUSINESS NAME LOCATION ACQUISITION DATE INTEREST
------------- -------- ---------------- --------
<S> <C> <C> <C>
Planete.net S.A.R.L. France 2/99 100%
Satelnet S.A. France 2/99 100%
Tele Linx Holdings Ltd. United Kingdom 2/99 100%
</TABLE>
-6-
<PAGE>
Subsequently, during April 1999, the Company acquired the following businesses:
<TABLE>
<CAPTION>
OWNERSHIP
BUSINESS NAME LOCATION ACQUISITION DATE INTEREST
------------- -------- ---------------- --------
<S> <C> <C> <C>
Horizontes Internet Brazil 4/99 100%
Openlink Brazil 4/99 100%
</TABLE>
Planete.net, based in Montreuil, France, is an Internet service provider, or
ISP, with a mix of business and consumer customers, offering dial-up access,
leased lines, Web hosting and consulting services. Satelnet, based in Lyon,
France, is an ISP that serves the business community with connectivity, Web
hosting, wireless services and custom applications such as security and firewall
design. Tele Linx, based in London, England, operates a data center facility.
Horizontes Internet, based in Belo Horizontes, Brazil, is an ISP that has a mix
of consumer and business customers, offering dial-up access, leased lines and
Web hosting. Openlink, based in Rio de Janeiro, Brazil, is an ISP that serves
both consumer and business customers with dedicated and dial-up connectivity
as well as Web hosting capabilities.
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 price of the
acquisitions was preliminarily allocated to assets acquired, including
intangible assets, and liabilities assumed, based on their respective fair
values at the acquisition dates.
In connection with the acquisitions made during the three months ended March 31,
1999, which includes Satelnet, Planete.net and Tele Linx, 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>
$ 92,503 $ (36,372) $ 56,131
-------- --------- --------
-------- --------- --------
</TABLE>
For certain acquisitions made in 1998 and 1999, the Company has 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. These acquisition holdback liabilities are generally
payable up to 24 months after the date of closing of the respective
acquisitions.
The purchase price relating to one acquisition made in 1998 may be increased by
up to $8.0 million pursuant to an earnout provision in the event the acquired
company achieved certain levels of future operating results. Such amount will be
recorded as additional cost of the acquired company when the amount to be paid,
if any, becomes probable. At March 31, 1999, no amount has been accrued since
the final outcome of the earnout provision was not determinable.
Total amortization expense of goodwill and other intangibles was $7.4 million
and $0.5 million for the three months ended March 31, 1999 and 1998,
respectively.
-7-
<PAGE>
NOTE 4 - SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
Short-term investments and marketable securities, including restricted amounts,
consisted of the following:
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
U.S. government obligations $222,560 $235,105
Commercial paper 111,576 112,290
Certificates of deposit -- 25,000
-------- --------
$334,136 $372,395
-------- --------
-------- --------
</TABLE>
The cost of all such investments approximates fair value.
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
Telecommunications bandwidth $ 190,866 $ 148,429
Data communications equipment 344,479 275,402
Leasehold improvements 29,137 29,267
Software 20,439 17,724
Office and other equipment 19,640 18,799
Land and buildings 28,944 3,290
--------- ---------
633,505 492,911
Less accumulated depreciation and amortization (129,983) (103,435)
--------- ---------
Property, plant and equipment, net $ 503,522 $ 389,476
--------- ---------
--------- ---------
</TABLE>
Total depreciation and leasehold amortization expense was $19.4 million and $9.0
million for the three months ended March 31, 1999 and 1998, respectively.
NOTE 6 - DEBT
Debt consisted of the following:
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
(IN THOUSANDS OF U.S. DOLLARS)
<S> <C> <C>
Senior notes at interest rate of 10% $ 600,000 $ 600,000
Senior notes at interest rate of 11.5% 350,000 350,000
Capital lease obligations at interest
rates ranging from 2.1% to 17.3% 168,288 120,670
Notes payable at interest rates
ranging from 1.8% to 12.7% 63,822 50,981
Credit facility 100,000 --
----------- -----------
1,282,110 1,121,651
Plus unamortized premium 2,875 2,950
----------- -----------
1,284,985 1,124,601
Less current portion (166,184) (59,968)
----------- -----------
Long-term portion $ 1,118,801 $ 1,064,633
----------- -----------
----------- -----------
</TABLE>
At March 31, 1999, the Company has deposited in an escrow account restricted
cash and short-term investments of $93.8 million to fund, when due, the next
three semi-annual interest payments on the 10%
-8-
<PAGE>
senior notes. The indentures governing the senior notes contain certain
financial and other covenants that, among other things, will restrict the
Company's ability to incur further indebtedness and sell assets.
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 three months ended March 31, 1999 and 1998, the
Company incurred capital lease obligations under these arrangements and from the
acquisitions of businesses of $60.0 million and $30.9 million, respectively. At
March 31, 1999, the aggregate unused portion under these arrangements totaled
$31.8 million after designating $22.0 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 March 31, 1999, $100.0 million was outstanding, $5.2 million
was being utilized for letters of credit, and $4.8 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 March 31, 1999). In April
1999, the Company repaid, out of available cash, $100.0 million that it had
borrowed under the Credit Facility, thereby restoring the availability of the
Credit Facility for future borrowings to a maximum principal amount of $110.0
million. 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 a
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 March 31, 1999.
NOTE 7 - CAPITAL STOCK
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 3,000,000 shares of the
Company's common stock in accordance with the original terms of the convertible
preferred 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 was terminated without the payment of
any additional amounts or issuance of additional shares to IXC when, after the
close of trading on The Nasdaq Stock Market, the fair market value of the shares
issued to IXC exceeded the $240 million threshold in accordance with the terms
of the original agreement.
ISSUANCE OF COMMON STOCK
During the quarter ended March 31, 1999, options with respect to 1,238,327
shares of common stock were exercised for aggregate net proceeds of $6.3
million.
ISSUANCE OF COMMON STOCK
-9-
<PAGE>
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 $384.1
million after expenses.
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 $358.5 million after expenses. The
Series C Preferred Stock has a liquidation preference of $50 per share. The
Series C Preferred stock accrues dividends at an annual rate of 6 3/4%, payable
quarterly in arrears, commencing on August 15, 2002, in cash, or at the
Company's option, in shares of its common stock or a combination thereof.
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"). This 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 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. 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 $50 per share liquidation
preference payable, at the Company's option, in cash or in shares of its
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, under specified circumstances,
the remaining funds in the Deposit Account would be distributed to the
Company 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 shares of the Company's common stock at an initial
conversion ratio price of $62.3675 per share, subject to adjustment upon the
occurrence of specified events, equal to an initial conversion ratio of 0.8017
shares of the Company's common stock for each share of Series C Preferred Stock.
The Series C Preferred Stock is redeemable at a redemption premium of 101.929%
of the liquidation preference (plus accumulated and unpaid dividends) on or
after November 15, 2000 but prior to May 15, 2002 if the trading price for the
Series C Preferred Stock exceeds $124.74 per share for a specified period.
Except in the circumstances described in the preceding sentence, the Company may
not redeem the Series C Preferred Stock prior to May 15, 2002. Beginning on May
15, 2002, the Company may redeem shares of the Series C Preferred Stock
initially at a redemption premium of 103.857% and thereafter at prices declining
to 100% (plus in each case, accumulated and unpaid dividends).
In the event of a change in control of the Company and if the market price of
the Company's common stock at such time is less than the conversion price of the
Series C Preferred Stock, then the holders of the Series C Preferred Stock will
have the right to convert their shares to the Company's common stock at the
greater of (i) the market price per share ending on the date on which a change
of control event occurs, or (ii) $38.73.
-10-
<PAGE>
NOTE 8 - COMMITMENTS AND CONTINGENCIES
As previously disclosed by the Company in its annual report on Form 10-K for
our fiscal year ended December 31, 1998 and in prior filings with the
Securities and Exchange Commission, on March 23, 1999, an arbitrator awarded
The Chatterjee Management Company ("Chatterjee") compensatory damages,
including interest and legal expenses, from PSINet. In conjunction with this
arbitration decision, the Company recorded a charge of $49.0 million during
its fiscal year ended December 31, 1998, which accrual is reflected in other
accounts payable and accrued liabilities in its consolidated balance sheets
at December 31, 1998 and March 31, 1999. The Company's request that the
International Chamber of Commerce reconsider the amount of the damages award
has been denied and the Company has agreed to resolve this matter by payment
of $48.0 million to Chatterjee. The Company believes that the payment will
not have a material adverse effect on its business.
In connection with the Company's naming rights and sponsorship agreements
with the Baltimore Ravens of the National Football League it paid $11.8
million in January 1999 including a one time prepayment of $9.3 million under
the naming rights agreement. The Company will make additional payments over
the next 19 years totaling approximately $81.7 million.
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 9 - INDUSTRY SEGMENT AND GEOGRAPHIC REPORTING
The Company's operations continue to be organized into four geographic operating
segments - the U.S., Canada, Europe and Asia. The Company evaluates the
performance of its segments and allocates resources to them based on revenue and
EBITDA, which is defined 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. Financial
information for the Company's geographic segments is presented below (in
thousands of U.S. dollars):
<TABLE>
<CAPTION>
U.S. CANADA EUROPE ASIA ELIMINATIONS TOTAL
-------- ------- -------- -------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED
MARCH 31, 1999
Revenue $ 50,570 $ 8,539 $ 15,913 $ 29,900 $ (76) $ 104,846
EBITDA (8,253) 208 (1,908) 3,120 -- (6,833)
Assets 862,899 52,319 194,847 272,408 (11,260) 1,371,213
Capital expenditures 76,924 4,426 40,448 5,770 -- 127,568
THREE MONTHS ENDED
MARCH 31, 1998
Revenue $ 31,947 $ 5,036 $ 6,003 $ 1,596 $ (113) $ 44,469
EBITDA (6,240) (3,168) (1,171) 65 -- (10,514)
Assets 159,107 39,853 25,923 2,779 5,642 233,304
Capital expenditures 32,374 1,242 3,611 43 (212) 37,058
</TABLE>
-11-
<PAGE>
EBITDA for all reportable segments differs from consolidated loss before income
taxes reported in the consolidated statements of operations as follows (in
thousands of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1999 1998
-------- --------
<S> <C> <C>
EBITDA $ (6,833) $(10,514)
Reconciling items:
Depreciation and amortization (26,818) (9,465)
Charge for acquired IPR&D -- (7,000)
Interest expense (29,581) (2,579)
Interest income 4,720 585
Other expense, net (175) (99)
-------- --------
Loss before income taxes $(58,687) $(29,072)
-------- --------
-------- --------
</TABLE>
-12-
<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, AND
(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 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 WHICH 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 solutions to
businesses. We derive the majority of our revenues from providing dedicated and
dial-up Internet access services to business customers and other Internet
service providers, or ISPs, in 90 of the 100 largest metropolitan statistical
areas in the United States and in 13 of the 20 largest global telecommunications
markets. Business customers are typically signed to one-year contracts. Revenues
generated from business customers typically comprise recurring monthly fees,
installation and start-up charges and sales of related equipment and services.
Revenues from ISPs are generated pursuant to network access agreements that
typically require a minimum number of subscribers and obligate the ISPs to pay
specified monthly fees for each subscriber using the PSINet network. In addition
to Internet connectivity services, we also offer a suite of value-added products
and services, including Web hosting services, intranets, virtual private
networks or VPNs, e-commerce, voice-over-IP, e-mail and managed security
services that are designed to enable our customers to maximize utilization of
the Internet to more efficiently communicate with their customers, suppliers,
business partners and remote office locations. Revenues from value-added
services are typically in the form of monthly fees and are often bundled with
Internet access services. We conduct our business through operations organized
into four geographic operating segments - the U.S., Canada, Europe and Asia.
We operate one of the largest global commercial data communications networks.
Our Internet-optimized network has a footprint that extends around the globe and
is connected to approximately 525 sites, called points of presence or POPs,
situated throughout the U.S., Canada, Europe and Asia that enable our customers
to connect to the Internet. Our network reach allows our customers' employees to
access their corporate network and systems resources through local calls in over
150 countries.
As a key component of our growth strategy, over the 19 months ended April 30,
1999, we acquired 22 ISPs and one business that operates a data center,
primarily in ten of the 20 largest global telecommunications markets since. The
aggregate amount of the purchase prices and related payments for these
acquisitions was approximately $339.8 million, exclusive of indebtedness assumed
in connection with such acquisitions. Of such aggregate amount, we have paid
$298.5 million to the sellers as of April 30, 1999, and have retained the
balance to secure performance by certain sellers of indemnification and other
contractual obligations. In connection with these acquisitions, we acquired,
among other things, valuable technologies including some under development which
we plan to complete. We are also currently evaluating additional acquisitions as
well. However, we cannot assure that we will successfully complete any such
acquisitions currently being contemplated.
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We currently have operations in 13 of the 20 largest international
telecommunications markets. In addition to the United States, we have operations
in Belgium, Brazil, Canada, France, Germany, Hong Kong, Italy, Japan, the
Netherlands, the Republic of Korea, Switzerland and the United Kingdom. We
typically enter a new market through the acquisition of an existing company
within the particular market. Revenue from non-U.S. operations continues to
increase as a percentage of consolidated results, comprising 52% of revenue in
the first quarter of 1999. By comparison, non-U.S. operations comprised 28% of
revenue in the first quarter of 1998 and 40% for all of 1998.
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 fiber-based telecommunications bandwidth,
including long-term rights, typically for 20 years or more, called indefeasible
rights of use, or IRUs, or other rights in:
- - 10,000 equivalent route miles of OC-48 capacity across the United States,
- - transatlantic capacity in two STM-1s connecting the United States, the
United Kingdom and continental Europe,
- - ten dark fiber optic strands connecting the New York City and Washington,
D.C. metropolitan areas and major metropolitan areas in between, and four
strands each within New York and Washington, D.C.,
- - six DS-3s of transpacific capacity connecting the United States and Japan,
- - four dark fiber optic strands connecting multiple locations in the San
Francisco Bay area,
- - STM-1 network bandwidth having the capability of connecting Japan, China,
Southeast Asia, India, the Middle East, Europe and the United Kingdom,
- - STM-1 network bandwidth inter-connecting 30 European cities, and
- - 20 dark fiber optic strands connecting the Vancouver, British Columbia and
Seattle, Washington metropolitan areas.
In addition, we have entered into an agreement with other leading global
telecommunications companies to build the Japan-U.S. Cable Network.
The acquisition of these telecommunications bandwidth assets is expected to
increase our network capacity by a substantial magnitude and to reduce
significantly our future data communications and operations costs per equivalent
mile. In addition, the increased network capacity is expected to enable us to
offer a wider variety of higher-speed Internet and Internet-related services to
a larger customer base. As a result, we anticipate that our data communications
and operations costs as a percentage of revenue will decrease as we substitute
the acquired bandwidth for existing leased circuit arrangements with various
telecommunications carriers.
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THREE MONTHS ENDED MARCH 31, 1999 AS COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 1998
RESULTS OF OPERATIONS
REVENUE. We generate revenue primarily from the sale of Internet access and
related services to businesses. Revenue was $104.8 million for the three months
ended March 31, 1999, an increase of $60.3 million, or 136%, from $44.5 million
for the three months ended March 31, 1998 and an increase of 12% over the three
months ended December 31, 1998. Revenue growth from the first quarter of 1998
was a result of both acquisitions and internally generated growth, as further
described below. Revenue growth from the fourth quarter of 1998 was primarily
internally generated, with acquisitions adding only a nominal amount to the 12%
increase. Our internally generated revenue growth is attributable to a number of
factors, including an increase in the number of business customer and ISP
accounts, an increase in the average annual revenue realized per new business
customer account, and an increase in the business account retention rate.
Our business customer account base increased by 79% to 59,700 business accounts
at March 31, 1999 from 33,300 business accounts at March 31, 1998 and 54,700
accounts at the end of 1998. Of the total business account growth from the first
quarter of 1998, 42% was the result of internally generated growth and 58% was
attributable to the companies we acquired. The total number of our Carrier
customers grew to 196 at March 31, 1999, and, together with our small
office/home office ("SOHO") and consumer customers, provide service to 898,000
customers. This compares with 61 Carrier customers and 339,000 customers at
March 31, 1998. Average annual new contract value for business accounts
increased to $6,200 for the three months ended March 31, 1999 from $5,500 for
the three months ended March 31, 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. Our business account retention rate increased to 81% for
the three months ended March 31, 1999, compared with 80% for the three months
ended March 31, 1998 and 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 $76.0 million (72.5% of revenue) for the first three months of 1999, an
increase of $39.3 million from $36.7 million (82.5% of revenue) for the three
months ended March 31, 1998. The increase in expenses related principally to
increases in:
- - the number of leased long distance, dedicated customer and dial-up
circuits,
- - expenditures for additional primary rate interface, or PRI, circuits to
support the growth of our Carrier and ISP Services business,
- - personnel costs resulting from the expansion of our network operations,
customer support and field service staff, including through acquisitions,
and
- - operating and maintenance charges on telecommunications bandwidth.
Our dedicated access customer account base grew to 16,000 at March 31, 1999 from
8,300 at March 31, 1998, an increase of 93%. Comparing the quarters, backbone
circuit costs increased $12.1 million, or 139%, dedicated customer circuit costs
increased $5.3 million, or 62%, PRI expense increased $5.4 million, or 96%, and
personnel and related operating expenses associated with network operations,
customer support and field service increased $8.5 million, or 101%. Circuit
costs relating to our new and expanded POPs and PRIs generally are incurred by
us in advance of obtaining customers and resulting revenue. Although we expect
that data communications and operations expenses will continue to increase as
our customer base grows, we anticipate that such expenses will decrease over
time as a percentage of revenue due to decreases in unit costs and continued
increases in network utilization. In
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particular, we anticipate that costs for data communications and operations as a
percentage of revenue will decrease as we substitute network bandwidth purchased
or acquired under capital lease agreements for existing bandwidth currently
under operating lease agreements. Network bandwidth purchased or acquired under
capital lease agreements is recorded as an asset and amortized over its useful
life. This will, in turn, result in increases in depreciation and amortization
expense over the useful life of the bandwidth, typically 10 to 25 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 $18.6 million (17.7% of revenue) for the three
months ended March 31, 1999, an increase of $7.9 million from $10.7 million
(24.1% of revenue) for the three months ended March 31, 1998. The increase is
principally attributable to costs associated with the growth of our sales force
in conjunction with our growth and acquisitions. In conjunction with the
Company's naming rights and sponsorship agreements for PSINet Stadium with the
Baltimore Ravens of the National Football League, annual expenses under the
arrangement are expected to be approximately $4.7 million.
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 $17.1 million (16.3% of revenue) for
the three months ended March 31, 1999, an increase of $9.5 million from $7.6
million (17.1% of revenue) for the three months ended March 31, 1998. The
increase resulted from the addition of management staff and related operating
expenses across the organization, including increases in conjunction with our
growth and acquisitions.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs were $26.8
million (25.6% of revenue) for the three months ended March 31, 1999, an
increase of $17.3 million from $9.5 million (21.3% of revenue) for the three
months ended March 31, 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 substitute network
bandwidth purchased or acquired under capital lease agreements for existing
bandwidth under operating lease agreements, and as we record depreciation and
amortization on tangible and intangible assets related to business combinations
and expansion of our operations.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. The results for the three months
ended March 31, 1999 do not include any charges for acquired in-process research
and development. The results for the three months ended March 31, 1998 include a
$7.0 million charge (15.7% of revenue) for acquired in-process research and
development related to an acquisition.
INTEREST EXPENSE. Interest expense was $29.6 million (28.2% of revenue) for the
three months ended March 31, 1999, an increase of $27.0 million from $2.6
million (5.8% of revenue) for the three months ended March 31, 1998. The
increase was due to interest on our $600.0 million aggregate principal amount of
10% senior notes issued in April 1998 and our $350.0 million aggregate principal
amount of 11 1/2% senior notes issued in November 1998, 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 $4.7 million (4.5% of revenue) for the
three months ended March 31, 1999, an increase of $4.2 million from $0.5 million
(1.3% of revenue) for the three months ended March 31, 1998. The increase was
due to interest received on the net proceeds of our offerings of the 10% senior
notes and 11 1/2% senior notes, 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 March 31, 1999 was
$59.3 million, or $1.11 basic and diluted loss per share, a $29.4 million, or
98%, increase from a net loss available to common shareholders for the three
months ended March 31, 1998 of $29.9 million, or $0.67 basic and diluted loss
per share. The primary reasons for the increase were:
- - the increase in interest expense due to the issuance of the 10% senior
notes and 11 1/2% senior notes,
- - the first portions of our acquired IRUs were installed, leading to an
increase in depreciation and personnel costs to manage the IRUs,
- - increase in depreciation and amortization related to acquisitions, offset
by the absence of a charge for acquired in-process research and
development, and
- - operating losses of acquired companies.
The return to preferred shareholders, which comprises the dividends with respect
to our previously outstanding Series B 8% convertible preferred stock and
accretion of the related conversion premium, 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 continue to be organized into four geographic operating
segments - the U.S., Canada, Europe and Asia.
All our reportable segments have experienced significant revenue increases from
the first quarter of 1998 to the first quarter of 1999. Starting in late 1997
and through March 31, 1999, we acquired 20 ISPs and one business that operates a
data center, in the U.S., Canada, Europe and Asia. Revenue growth by segment for
the three months ended March 31, 1999 compared to the three months ended March
31, 1998 was as follows:
<TABLE>
<CAPTION>
TOTAL
-----
<S> <C>
United States 59%
Canada 70%
Europe 165%
Asia 1773%
All Segments 136%
</TABLE>
The Company evaluates the performance of its segments and allocates resources
to them based on revenue and EBITDA, which is defined 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. EBITDA losses as a percentage of revenue improved
in all segments from the three months ended March 31, 1998 to the three
months ended March 31, 1999, reflecting the overall development cycle of our
businesses in these areas. Improvement in EBITDA profits (losses) as a
percentage of revenue for the U.S. segment was (19.6%) to (16.3%), for the
Canadian segment was (62.9%) to 2.4%, for the European segment was (19.5%) to
(12.0%), and for the Asian segment was 4.1% to 10.4%. These improvements have
arisen primarily as a result of two factors. First, improvements have been
generated based on internally generated growth factors including high levels
of revenue growth and concentration of efforts on controlling operating
costs, and second, almost every
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company we acquired in 1998 operated at EBITDA breakeven or better, contributing
to these improvements.
Our loss from operations differs from EBITDA for the quarters 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.
With the exception of Asia, where the charges incurred for goodwill and other
intangible amortization have the most significant impact, our loss from
operations as a percentage of revenue improved across all geographic segments.
In the U.S., our loss from operations as a percentage of revenue was reduced
from (42.9%) in the first quarter of 1998 to (41.4%) in the first quarter of
1999. In Canada, it was reduced from (228.2%) to (38.9%) and in Europe from
(30.2%) to (29.9%) for those same quarters, respectively. The loss from
operations as a percentage of revenue increased in Asia from 0.2% to (16.6%).
LIQUIDITY AND CAPITAL RESOURCES
We have historically 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 1998, we received net proceeds of approximately $1.06
billion from debt financings. In May 1999, we received net proceeds of
approximately $742.6 million from equity financings.
CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Cash flows used in operating activities were $77.3 million and $10.0 million for
the three months ended March 31, 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 three-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 and, in the three months ended March 31,
1998, our charge for acquired in-process research and development.
Cash flows used in investing activities were $36.9 million and $9.9 million
for the three months ended March 31, 1999 and 1998, respectively. Acquisition
activities resulted in the use of $35.1 million of cash for the three months
ended March 31, 1999, net of cash acquired. Investments in our network and
facilities during the first three months of 1999 resulted in total additions
to fixed assets of $127.6 million, excluding assets acquired from business
acquisition. Of this amount, $60.0 million was financed under vendor or other
financing arrangements, $11.9 million of non-cash additions related to the
bandwidth acquired from IXC Internet Services, Inc., and $55.7 million was
expended in cash. For the three months ended March 31, 1998, total additions
were $37.1 million, of which $30.9 million was financed under equipment
financing agreements and $6.2 million was expended in cash. Purchases of
short-term investments during the first three months of 1999 were an
aggregate of $129.3 million, offset by proceeds from the sale and maturity of
short-term investments of $153.9 million. Investing cash flows in the first
three months of 1999 and 1998 were increased by $29.6 million and $14.3
million, respectively, from decreases in restricted cash and short-term
investments related to various financing and acquisition activities.
Cash flows provided by financing activities were $91.3 million and $13.6 million
for the three months ended March 31, 1999 and 1998, respectively. In the first
three months of 1999, we received $101.3 million from borrowings on our credit
facility and from the issuance of notes payable. In the first three months of
1998, we received net proceeds from the issuance of notes payable of $25.0
million. We made repayments aggregating $15.6 million and $11.2 million for the
three months ended March 31, 1999 and 1998, respectively, on our lines of
credit, capital lease obligations and notes payable.
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As of March 31, 1999, we had $398.9 million of cash, cash equivalents,
restricted cash, short-term investments and marketable securities.
CAPITAL STRUCTURE
Our capital structure at March 31, 1999 consisted of a revolving credit
facility, other lines of credit, capital lease obligations, 10% senior notes,
11 1/2% senior notes, and common stock.
Total borrowings at March 31, 1999 were $1.28 billion, which included $166.2
million in current obligations and $1.12 billion in long-term 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, of which $100.0
million was outstanding, $5.2 million was being utilized for letters of credit,
and $4.8 million was available to draw at March 31, 1999. In April 1999, we
repaid, out of available cash, the $100.0 million that we had borrowed under the
Credit Facility, thereby restoring the availability of the Credit Facility for
future borrowings to a maximum principal amount of $110.0 million.
In addition, as of March 31, 1999, $31.8 million was available for purchases of
equipment and other fixed assets under various other financing arrangements,
after designating $22.0 million of payables for various equipment purchases.
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:
- - consolidated revenue for the period of four consecutive fiscal quarters to
be less than $215.0 million during the six month period beginning December
31, 1998, $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;
- - 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 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;
- - 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
- - EBITDA (as defined therein), to be worse than negative $40.0 million,
negative $29.0 million, negative $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 March 31, 1999, June 30, 1999, September
30, 1999, December 31, 1999, March 31, 2000, June 30, 2000, September 30,
2000 and December 31, 2000, respectively.
At March 31, 1999, we were in compliance with all such covenants.
At March 31, 1999, we had outstanding $600.0 million aggregate principal
amount of 10% senior notes due 2005 and $350.0 million aggregate principal
amount of 11 1/2% senior notes due 2008. At that date
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we had deposited in an escrow account restricted cash and short-term investments
of $93.8 million to fund, when due, the next three semi-annual interest payments
on the 10% senior notes.
The indentures governing the 10% senior notes and the 11 1/2% senior notes
contain many covenants with which we must comply relating to, among other
things, the following matters:
- - 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;
- - 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;
- - a limitation on our incurrence and our subsidiaries' incurrence of liens,
unless the 10% senior notes and the 11 1/2% senior notes are secured
equally and ratably with the obligation or liability secured by such lien,
excluding permitted liens;
- - 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;
- - a limitation on certain mergers, consolidations and sales of assets by us
or our subsidiaries;
- - a limitation on transactions with our affiliates;
- - 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 and the 11 1/2%
senior notes on the same terms as the guarantee of such indebtedness;
- - a limitation on sale and leaseback transactions by us or our subsidiaries;
- - a limitation on issuances and sales of capital stock of our subsidiaries;
and
- - a limitation on the ability of us or our subsidiaries to engage in any
business not substantially related to a telecommunications business.
At March 31, 1999, we were in compliance with all such covenants.
In November 1997, we completed a private placement of 600,000 shares of our
Series B convertible preferred stock for gross proceeds of $30.0 million. During
the first quarter of 1999, all outstanding shares of the Series B preferred
stock, which accrued dividends at an annual rate of 8%, were converted into an
aggregate of 3,000,000 shares of our common stock. As a result of this
conversion, we are no longer required to pay the 8% annual dividends under the
terms of the Series B preferred stock, resulting in the elimination of
approximately $2.4 million in annual dividend expense.
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 $384.1 million,
after 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
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$358.5 million after expenses. The Series C Preferred Stock has a liquidation
preference of $50 per share. The Series C Preferred stock accrues dividends
at an annual rate of 6 3/4%, payable quarterly in arrears, commencing on
August 15, 2002, in cash, or at our option, in shares of our common stock or
a combination thereof.
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"). This Deposit Account is not an asset of PSINet. 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
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. 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 $50 per share liquidation preference payable, at
our option, in cash or 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,
under specified circumstances, the remaining funds in the Deposit Account
would be distributed to PSINet 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 shares of our common stock at an initial
conversion ratio price of $62.3675 per share, subject to adjustment upon the
occurrence of specified events, equal to an initial conversion ratio of
0.8017 shares of our common stock for each share of Series C Preferred Stock.
The Series C Preferred Stock is redeemable at a redemption premium of
101.929% of the liquidation preference (plus accumulated and unpaid
dividends) on or after November 15, 2000 but prior to May 15, 2002 if the
trading price for the Series C Preferred Stock exceeds $124.74 per share for
a specified period. Except in the circumstances described in the preceding
sentence, we may not redeem the Series C Preferred Stock prior to May 15,
2002. Beginning on May 15, 2002, we may redeem shares of the Series C
Preferred Stock initially at a redemption premium of 103.857% and thereafter
at prices declining to 100% (plus in each case, accumulated and unpaid
dividends).
In the event of a change in control of PSINet and if the market price of our
common stock at such time is less than the conversion price of the Series C
Preferred Stock, then the holders of the Series C Preferred Stock will have
the right to convert their shares to our common stock at the greater of (i)
the market price per share ending on the date on which a change of control
event occurs, or (ii) $38.73.
COMMITMENTS, CAPITAL EXPENDITURES AND FUTURE FINANCING REQUIREMENTS
As of March 31, 1999, we had commitments to certain telecommunications vendors
totaling $153.1 million payable in various years through 2011. Additionally, we
have various agreements to lease office space and facilities and, as of March
31, 1999, were obligated to make future minimum lease payments of $37.9 million
on non-cancelable operating leases expiring in various years through 2009.
For some of the 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 acquisition holdback liabilities are generally payable up to 24
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months after the date of closing of the respective acquisitions. Acquisition
holdback liabilities total $38.6 million at March 31, 1999. In addition, the
purchase price relating to one acquisition may be increased by up to $8.0
million pursuant to an earnout provision in the event the acquired company
achieved certain levels of operating results in the period following the
acquisition. This amount will be recorded as additional cost of the acquired
company and reflected as additional purchased goodwill if it becomes probable
that the amount will be paid. At March 31, 1999, no amounts have been accrued
since the final outcome of the earnout provision was not determinable.
In connection with our 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 connection with The Chatterjee Management Company arbitration award, we
recorded a charge of $49.0 million during our fiscal year ended December 31,
1998, which accrual is reflected in other accounts payable and accrued
liabilities in our consolidated balance sheets at December 31, 1998 and March
31, 1999. Our request that the International Chamber of Commerce reconsider the
amount of the damages award has been denied and we have agreed to resolve this
matter by payment of $48.0 million to Chatterjee.
We acquire fiber-based telecommunications bandwidth through purchases and
capital leases. Some of the purchase agreements have obligations for future cash
payments that coincide with the delivery of bandwidth. At March 31, 1999, we
were obligated to make future payments under these purchase agreements that
total $99.5 million.
We expect to continue to seek opportunities to acquire fiber-based
telecommunications bandwidth to enhance our global network capabilities. In
addition to the U.S. and Canada, we anticipate that such bandwidth acquisitions
will be in Europe and Asia and would be accompanied by capital expenditures in
the deployment of high activity POPs designed and located with the objective of
optimizing the efficient use of the bandwidth. We currently anticipate that
these expenditures in 1999 will be consistent with those in 1998 and will be
financed through a combination of capital leases, existing working capital and
other sources of financing.
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 Internet network, 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
capital lease financings, from the proceeds of our recent 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.
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 principally relating to or complementary to our existing
business. 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
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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.
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, 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 ("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:
- - Internal computer systems or embedded chips could be disrupted or fail,
causing an interruption or decrease in productivity in our operations; and
- - 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 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. We engaged a third party consultant to
perform 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 of these systems has been completed and, while some
minor changes are necessary, we believe that no material changes or
modifications to our internal systems are required to achieve Y2K compliance.
Our U.S. chief information officer has developed a test bed of our U.S. internal
systems to implement and complete testing of the requisite minor changes. We
anticipate that our U.S. internal systems will be Y2K ready by September 30,
1999. We are in the process of completing an inventory of our internal systems
that we use in Canada, United Kingdom, Europe and Asia to determine the status
of their Y2K compliance. Each international office has plans in place to test,
upgrade or, if necessary, replace components of its internal systems to ensure
they are Y2K compliant. We anticipate that our international operations 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 that meets weekly to
examine our network on a worldwide basis. This team of operational staff have
conducted inventories of our network equipment (software and
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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 planned to be
made Y2K compliant through minor changes to the software or hardware or, in
limited instances, replacement of the equipment. We anticipate that our network
will be Y2K compliant by the end of the second quarter of 1999. In addition to
administering the implementation of necessary upgrades for Y2K compliance, our
network team is developing a contingency plan to address any 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.
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:
- - the failure of a material third party's business;
- - a financial institution's inability to take and transfer funds;
- - an interruption in delivery of supplies from vendors;
- - a loss of voice and data connections;
- - a loss of power to our facilities; and
- - 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, it may have on us. If a
significant number of our material third parties experience 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
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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 can not
assure 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 have not yet completed a contingency plan to handle a worst case
scenario. We expect to have such contingency plan in place by September 30,
1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At March 31, 1999, we had other financial instruments consisting of fixed and
variable rate debt and short-term investments. The substantial majority of our
debt obligations have fixed interest rates and are denominated in U.S. dollars,
which is our reporting currency. Borrowings under our credit facility at March
31, 1999 of $100.0 million have a variable interest rate and such amounts were
repaid in April 1999. Annual maturities of our debt obligations, excluding
capital lease obligations and our credit facility, are as follows: $10.5 million
in 1999, $7.3 million in 2000, $7.1 million in 2001, $5.0 million in 2002, $3.4
million in 2003 and $967.8 million thereafter. At March 31, 1999, the carrying
value of our debt obligations excluding capital lease obligations was $1,116.7
million and the fair value was $1,184.3 million. The weighted-average interest
rate of our debt obligations at March 31, 1999 was 10.5%. Our investments are
generally fixed rate short-term investment grade and government securities
denominated in U.S. dollars. At March 31, 1999, all of our investments are due
to mature within twelve months and the carrying value of such investments
approximates fair value. At March 31, 1999, $132.9 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously disclosed by us in our annual report on Form 10-K for our
fiscal year ended December 31, 1998 and in prior filings with the Securities
and Exchange Commission, on March 23, 1999, an arbitrator awarded The
Chatterjee Management Company ("Chatterjee") compensatory damages, including
interest and legal expenses, from PSINet. In conjunction with this
arbitration award, we recorded a charge of $49.0 million during our fiscal
year ended December 31, 1998, which accrual is reflected in other accounts
payable and accrued liabilities in our consolidated balance sheets at
December 31, 1998 and March 31, 1999. Our request that the International
Chamber of Commerce reconsider the amount of the damages award has been
denied and we have agreed to resolve this matter by payment of $48.0 million
to Chatterjee. We believe that the payment will not have a material adverse
effect on our business.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following Exhibits are filed herewith:
Exhibit 10.1 Employment Agreement dated April 15, 1999 between PSINet and
Leroy M. Sloan
Exhibit 11.1 Calculation of Basic and Diluted Loss per Share and Weighted
Average Shares Used in Calculation for the Three Months
Ended March 31, 1999
Exhibit 27 Financial Data Schedule*
Exhibit 99.1 Risk Factors
* Not deemed filed for purposes of Section 11 of the Securities Act
of 1933, Section 18 of the Securities Exchange Act of 1934 and
Section 323 of the Trust Indenture Act of 1939 or otherwise
subject to the liabilities of such sections and not deemed part
of any registration statement of which such exhibit relates.
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K dated April 27, 1999 under which we
filed exhibits to our Registration Statement on Form S-3, File No.
333-75579, relating to our recent equity offerings.
We filed a Current Report on Form 8-K dated May 7, 1999 under which we
filed final forms of certain documents as exhibits to our Registration
Statement on Form S-3, File No. 333-75579, relating to our recent equity
offerings.
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PSINET INC.
FORM 10-Q
MARCH 31, 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.
May 17, 1999 By: /s/ William L. Schrader
- ------------ -----------------------------------
Date William L. Schrader
Chairman, Chief Executive Officer
and Director
May 17, 1999 By: /s/ Edward D. Postal
- ------------ -----------------------------------
Date Edward D. Postal
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
EXHIBIT INDEX
The following Exhibits are filed herewith:
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit Location
------ ---------------------- --------
<S> <C> <C>
10.1 Employment Agreement dated April 15, 1999 between Filed herewith
PSINet and Leroy M. Sloan
11.1 Calculation of Basic and Diluted Loss per Share Filed herewith
and Weighted Average Shares Used in Calculation for the
Three Months Ended March 31, 1999
27 Financial Data Schedule Filed herewith
99.1 Risk Factors Filed herewith
</TABLE>
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<PAGE>
EXHIBIT 10.1
April 15, 1999
Mr. Leroy M. Sloan
207 Emile Zola Drive
Cary, North Carolina 27511
Dear Leroy:
This letter confirms our offer to you of employment by PSINet Inc. (the
"Company"), and sets forth the terms and conditions which shall govern such
employment as outlined below. This offer is subject to satisfactory completion
of reference checks and ratification by the Company's Board of Directors, but
otherwise shall remain open until 6:00 PM on Monday, April 19, 1999.
1. EMPLOYMENT.
a) The Company agrees to employ you as Vice President of Customer
Administration, reporting to the Chief Operating Officer (COO) of the Company or
his designee. 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 begin work on or before Monday, April 26,
1999, and remain in the employ of the Company, and, except during vacation
periods and sickness, to provide during standard business hours a minimum of
forty (40) hours per week of management services to the Company, as determined
by and under the direction of the COO.
b) During our 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 shall commence on Monday,
April 26, 1999, and shall continue for a period of one (1) year.
3. COMPENSATION.
a) BASE SALARY. The Company shall pay you a base salary at the rate of
$175,000 per annum. Your base salary shall be subject to additional increases at
the discretion of the COO. 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) BONUS COMPENSATION. The Company will pay you a bonus upon the successful
completion of the objectives established for your performance, which will be
measured on or about December 31, 1999. The performance criteria will be issued
separately by the COO, and may be changed, with mutual fairness, from time to
time as situations develop. The target bonus for the period ending December 31,
1999 (start date through December 31, 1999) will be a total of up to $50,000.
Separate criteria will be established for your entitlement for the year starting
January 1, 2000.
c) NONQUALIFIED STOCK OPTIONS. Effective upon your start date as a consultant
to the Company, PSINet Inc. shall grant you options, subject to Board approval,
to purchase 50,000 shares of PSINet Inc.'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
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other terms and provisions prescribed by the Plan, the option agreement shall
provide that (a) 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, (b) the Options shall not be exercisable
after the expiration of ten (10) years from the date such Options are granted,
and (c) the stock shall vest ratably, monthly, over forty-eight (48) months,
provided that for each month's vesting purposes you continue to be retained as a
consultant or be employed full time by the Company or one of its subsidiaries
during such month, 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. You also may be eligible to
receive additional options periodically during your employment by the Company.
4. EMPLOYEE BENEFITS. You shall be provided employee benefits, including
(without limitation) 401(k), four (4) weeks' paid vacation, and life, health,
accident and disability insurance under the Company's plans, policies and
programs available to employees in accordance with the provisions of such plans,
policies, and programs.
5. RELOCATION PACKAGE. Your "target" date for completing your relocation to
the Greater Washington, D.C. area shall be Monday, September 6, 1999. Prior to
that time, but ending when you complete your relocation, the Company shall pay
for airfare for your roundtrip travel, twice per month, from North Carolina to
Washington, D.C. (business class fare rate), and will provide you with a hotel
suite/apartment in the Herndon, Virginia area. The Company will also provide you
with a relocation allowance of up to $50,000 to assist you in relocating your
residence from North Carolina to the Greater Washington, D.C. area. The
relocation allowance will include reasonable expenses of sale, moving, interim
living and resettlement into the new home. Income taxes will be withheld from
this sum. You may be eligible for a refund of some portion of the taxes withheld
upon filing your current year's US tax return. Should you voluntarily terminate
your employment with PSINet within one (1) year from the date you commence
employment at our Virginia offices, you agree to reimburse PSINet for the entire
sum of this allowance within ninety (90) days of your date of termination.
6. TERMINATION.
a) Your employment with the Company may be terminated by the Company at any
time for "Cause" as defined in Section 6(c) hereof. Upon such termination, the
Company will provide written notice whether it has elected to use the
non-competition restrictions set forth in Section 7(a) hereof. Your employment
may also be terminated by the Company at any time without Cause provided the
Company shall have given you thirty (30) days' prior written notice of such
termination. That written notice must state whether the Company has elected to
use the non-Competition restriction (which decision may not be rescinded). If
you are terminated by the Company without cause within the initial one (1) year
term of your employment, you will be paid one hundred eighty (180) days'
severance pay. 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. By the thirtieth 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 7 hereof, in
the event that your employment terminates or is terminated by you or the Company
for any reason other than for Cause, and the Company has elected to use the
non-Competition restriction, you shall be entitled, for a period of twelve (12)
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
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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 twelve (12) 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 7 hereof,
your committing an act materially adversely affecting the Company which
constitutes wanton or willful misconduct, your conviction of a felony, or any
material breach by you of this Agreement.
7. 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 twelve
(12) 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 Director's to engage
in activities which would otherwise be prohibited by Section 7(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 7(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 7(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.
8. 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
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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
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.
9. NONDISCLOSURE AGREEMENT. You agree to sign the Company's Nondisclosure
Agreement before commencing employment with PSINet Inc.
10. 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 who shall assume and
agree to perform this Agreement.
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 10, 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.
11. 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 7 shall be restricted, a proportional
reduction shall be made in the payments under Section 6.
12. ENTIRE AGREEMENT; WAIVERS. This letter Agreement, together with the
Consulting Agreement dated January 13, 1999, 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.
13. 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 for at the head of this agreement or such other address as such
party may designate in writing to the other.
14. GOVERNING LAW. THIS LETTER AGREEMENT SHALL BE SUBJECT TO, GOVERNED BY AND
CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK APPLICABLE TO
CONTRACTS TO BE PERFORMED WHOLLY WITHIN THAT STATE.
15. 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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<PAGE>
Please confirm your agreement with the foregoing 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/ Harold S. Wills
----------------------------------------
HAROLD S. WILLS
PRESIDENT AND COO
Accepted and Agreed to as of April 19 ,1999:
--------
By: /s/ Leroy M. Sloan
----------------------------------------
LEROY M. SLOAN
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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
MARCH 31, 1999
------------------
<S> <C>
Weighted average shares outstanding:
Common stock:
Shares outstanding at beginning of period ............ 52,083,639
Weighted average shares issued during the three months
ended March 31, 1999 (4,238,327 shares) ............. 1,274,755
------------
53,358,394
------------
------------
Net loss available to common shareholders .............. $(59,261,000)
------------
------------
Basic and diluted loss per share ....................... $ (1.11)
------------
------------
</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.
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<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
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CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999
AND THE CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
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<CASH> 25,131
<SECURITIES> 373,728
<RECEIVABLES> 66,959
<ALLOWANCES> 12,272
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<CURRENT-ASSETS> 495,245
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<SALES> 104,846
<TOTAL-REVENUES> 104,846
<CGS> 76,018
<TOTAL-COSTS> 76,018
<OTHER-EXPENSES> 62,479
<LOSS-PROVISION> 3,358
<INTEREST-EXPENSE> 29,581
<INCOME-PRETAX> (58,687)
<INCOME-TAX> 0
<INCOME-CONTINUING> (58,687)
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<PAGE>
EXHIBIT 99.1
RISK FACTORS
YOU SHOULD BE AWARE THAT THERE ARE VARIOUS RISKS ASSOCIATED WITH US AND OUR
BUSINESS, INCLUDING THE ONES DISCUSSED 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
March 31, 1999, our total indebtedness was $1.28 billion, representing 116% of
total capitalization, and our interest expense for the year ended December 31,
1998 and the three months ended March 31, 1999 was $63.9 million and $29.6
million, respectively.
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:
- - 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;
- - 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
- - 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, management believes 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, 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 that we will
be able to raise additional capital for any refinancing of our debt in the
future.
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, and
continue to upgrade our technologies and commercialize our network services
incorporating such technologies. We cannot assure 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
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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, we
have incurred losses and experienced negative earnings 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
("EBITDA") during each of such periods. We expect to continue to operate at a
net loss and experience negative EBITDA in the near term 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, $46.0
million and $264.9 million and have incurred negative EBITDA of $28.0 million,
$21.2 million and $42.1 million for each of the years ended December 31, 1996,
1997 and 1998, respectively. During the three months ended March 31, 1999, we
incurred net losses available to common shareholders of $59.3 million and
negative EBITDA of $6.8 million. At March 31, 1999, we had an accumulated
deficit of $486.9 million. We cannot assure that we will be able to achieve or
sustain profitability or 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:
- - general economic conditions and specific economic conditions in the
Internet access industry;
- - user demand for Internet services;
- - capital expenditures and other costs relating to the expansion of
operations of our network;
- - the introduction of new services by us or our competitors;
- - the mix of services sold and the mix of channels through which those
services are sold;
- - pricing changes and new product introductions by us and our competitors;
- - delays in obtaining sufficient supplies of sole or limited source equipment
and telecom facilities; and
- - 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 ARE PARTIALLY DEPENDENT ON OUR SUBSIDIARIES FOR REPAYMENT OF DEBT
We are an operating entity that also conducts a significant portion of our
business through our subsidiaries. Our cash flow from operations and
consequently our ability to service our debt, including our 10% senior notes and
11 1/2% senior notes, 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 have no obligation, contingent or otherwise, to
make any funds available to us for payment of the principal of or interest on
many of our debt obligations, including our 10% senior notes and 11 1/2% senior
notes. 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.
Our subsidiaries' creditors will have priority to the assets of such
subsidiaries over the claims of PSINet and the holders of our indebtedness. One
exception is that if such subsidiaries have provided guarantees of our
indebtedness and if loans made by us to our subsidiaries are recognized as
indebtedness, they will not have such priorities. In any event, our 10% senior
notes and 11 1/2% senior notes are effectively subordinated in right of payment
to all existing and future indebtedness and other liabilities of our
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subsidiaries, including trade payables. As of March 31, 1999, our subsidiaries
had approximately $181.1 million of total liabilities, including trade payables
and accrued liabilities, to which holders of our 10% senior notes and 11 1/2%
senior notes are structurally subordinated. Under the terms of agreements
evidencing our debt obligations, some of our subsidiaries are restricted in
their ability to incur debt in the future.
WE MAY NOT BE ABLE TO FUND THE EXPANSION WE WILL NEED TO REMAIN COMPETITIVE
In order to maintain our competitive position and continue to meet the
increasing demands for service quality, availability and competitive pricing, we
expect to make significant capital expenditures. At March 31, 1999, we were
obligated to make future payments that total $99.5 million for acquisitions of
global fiber-based telecommunications bandwidth, including indefeasible rights
of use 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 indefeasible rights of use. Although we are
currently unable to estimate the extent of such additional costs, we currently
anticipate that our capital expenditures in 1999 will be consistent with those
in 1998.
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
these 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, existing credit facilities, capital lease
financings and 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 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 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 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 19 months ended April 30, 1999, we acquired 22 Internet
service providers and one business that operates a data center, primarily in ten
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 both
domestically and internationally. Any such future acquisitions or strategic
alliances would be accompanied by the risks commonly encountered in acquisitions
or strategic alliances. Such risks include, among other things:
- - the difficulty of integrating the operations and personnel of the
companies;
- - the potential disruption of our ongoing business;
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- - 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
- - 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 that we will be successful in overcoming these risks or any
other problems encountered in connection with such acquisitions or strategic
alliances. 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 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 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 approximately 525 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 plan to continue to do so. We
anticipate that our Carrier and Internet Service Provider Services business
unit, as well as other business growth, may require continued enhancements to
and expansion of 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 that we will be able to integrate these companies successfully
or in a timely manner. In addition, we cannot assure that our existing operating
and financial control systems and infrastructure will be adequate to maintain
and effectively monitor future growth.
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Our continued growth may also increase our need for qualified personnel. We
cannot assure 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:
- - our inability to continue to upgrade our networking systems or our
operating and financial control systems;
- - our inability to recruit and hire necessary personnel or to successfully
integrate new personnel into our operations;
- - our inability to successfully integrate the operations of acquired
companies or to manage our growth effectively; or
- - our inability to adequately respond to the emergence of unexpected
expansion difficulties.
WE FACE RISKS ASSOCIATED WITH OUR ACQUISITIONS OF BANDWIDTH FROM NETWORK
SUPPLIERS, INCLUDING OUR STRATEGIC ALLIANCE WITH IXC COMMUNICATIONS INC.,
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 telecommunications bandwidth from our various global network
suppliers, including our strategic alliance with IXC Communications Inc., and
the delivery, operation and maintenance of such bandwidth. Such risks include,
among other things, the following:
- - 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;
- - 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;
- - 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
- - the risk that such buildout may be delayed or otherwise adversely affected
by presently unforeseeable legal, technical and/or other factors.
We cannot assure that we will be successful in overcoming these risks or any
other problems encountered in connection with our acquisitions of bandwidth.
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. 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 that we will be able
to obtain the permits and operating licenses required for us 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
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continue to expand our international presence, there are risks inherent in doing
business on an international level. Such risks include:
- - unexpected changes in or delays resulting from regulatory requirements,
tariffs, customs, duties and other trade barriers;
- - difficulties in staffing and managing foreign operations;
- - longer payment cycles and problems in collecting accounts receivable;
- - fluctuations in currency exchange rates and foreign exchange controls which
restrict or prohibit repatriation of funds;
- - technology export and import restrictions or prohibitions;
- - delays from customs brokers or government agencies;
- - seasonal reductions in business activity during the summer months in Europe
and other parts of the world; and
- - potentially adverse tax consequences, which could adversely impact the
success of our international operations.
We cannot assure 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 that laws or
administrative practice relating to taxation, foreign exchange 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.
In particular, we have made significant investments in Japan in 1998, which
continues to experience an economic recession. Other Asia-Pacific countries in
which we operate are also experiencing economic difficulties and uncertainties.
These economic difficulties and uncertainties could have a material adverse
effect on our business, financial condition and results of operations.
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 the founder
of PSINet, Harold S. Wills, our President and Chief Operating Officer, and
Edward D. Postal, our Senior Vice President and Chief Financial Officer. We have
employment agreements with Messrs. Wills and Postal. 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
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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 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, including the holders of the
notes. 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 ("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
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computer calculation or other processing involving the Year 2000 or a later
date. We have identified two main areas of Y2K risk:
1. Internal computer systems or embedded chips could be disrupted or fail,
causing an interruption or decrease in productivity in our operations; and
2. 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. We engaged a third party consultant
to perform 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 of these systems has been completed and,
while some minor changes are necessary, we believe that no material changes or
modifications to our internal systems are required to achieve Y2K compliance.
Our U.S. chief information officer has developed a test bed of our U.S. internal
systems to implement and complete testing of the requisite minor changes. We
anticipate that our U.S. internal systems will be Y2K ready by September 30,
1999. We are in the process of completing an inventory of our internal systems
that we use in Canada, United Kingdom, Europe and Asia to determine the status
of their Y2K compliance. Each international office has plans in place to test,
upgrade or, if necessary, replace components of its internal systems to ensure
they are Y2K compliant. We anticipate that our international operations 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 that meets weekly to
examine our network on a worldwide basis. This team of operational staff have
conducted 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 planned to be made Y2K compliant through
minor changes to the software or hardware or, in limited instances, replacement
of the equipment. We anticipate that our network will be Y2K compliant by the
end of the second quarter of 1999. In addition to administering the
implementation of necessary upgrades for Y2K compliance, our network team is
developing a contingency plan to address any 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.
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.
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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:
- - the failure of a material third party's business;
- - a financial institution's inability to take and transfer funds;
- - an interruption in delivery of supplies from vendors;
- - a loss of voice and data connections;
- - a loss of power to our facilities; and
- - 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, it 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 can not
assure 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 have not yet completed a contingency plan to handle a worst case
scenario. We expect to have such contingency plan in place by September 30,
1999.
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 Internet service providers, 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
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competitors have a significantly greater market presence, brand recognition and
financial, technical and personnel resources than us.
We compete with all of the major long distance companies, also known as
interexchange carriers, including AT&T, MCI WorldCom, 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
Internet service providers 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 recently
announced plans to acquire Frontier Corp. (and Frontier's acquisition of Global
Center) and AT&T's purchase of IBM's global communications network 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. Such 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.
The predominant on-line service providers, including America Online, CompuServe,
Microsoft Network and Prodigy, have all 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 recent 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 xDSL. 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.
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 in the
future. 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 that
we will have the financial resources, technical expertise or marketing and
support capabilities to continue to compete successfully.
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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 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 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
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 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 IXC and our other
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 successfully respond to technological advances and emerging
industry standards, the integration of new technology may require substantial
time and expense, and we cannot assure that we will succeed in adapting our
network infrastructure in a timely and cost-effective manner.
WE MAY BE LIABLE FOR INFORMATION DISSEMINATED THROUGH NETWORK
The law relating to liability of Internet service providers 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
and infringement of copyrighted materials. The U.S. Supreme Court has let stand
a lower court ruling which held that an Internet service provider was protected
from liability for material posted on its system by a provision of the
Communications Decency Act. However, the findings in that case may not be
applicable in other circumstances. Other courts have held that online service
providers and Internet service providers may, under some circumstances, be
subject to damages for copying or distributing copyrighted materials. Provisions
of the Communications Decency Act which imposed criminal penalties for using an
interactive computer service for transmitting obscene or indecent communications
have been found unconstitutional by the U.S. Supreme Court. However, on October
21, 1998, new federal legislation was enacted that requires 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. The imposition upon Internet
service providers 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
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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 Internet access providers in
relation to information carried or disseminated also is undergoing a process of
development in other countries. Decisions, laws, regulations and other
activities regarding regulation and content liability may significantly affect
the development and profitability of companies offering on-line and Internet
access services, including us.
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 recently 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 can not assure 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
recently 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
certification in New York, Virginia, Colorado and Texas, have applied for
competitive local exchange carrier certification in Maryland and California, and
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
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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 competitive local exchange carriers 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 Internet
service provider traffic is jurisdictionally interstate. The FCC also concluded
that its jurisdictional decision does not alter the exemption from access
charges currently enjoyed by Internet service providers. 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. There can be no
assurance 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 competitive local exchange carrier, 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 points-of-presence 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 that we will not experience failures or shutdowns relating to
individual points-of-presence 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, 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.
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.
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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 as well.
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 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 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 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 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
xDSL-based Internet access services in limited areas. The failure of these
services to gain market acceptance in a timely manner or at all, or the failure
of xDSL-based services, in particular, to achieve significant market coverage
could have a material adverse effect on our business, financial condition 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 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
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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 has 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 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.
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 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.
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