<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) January 10, 2000
----------------
PSINET INC.
(Exact Name of Registrant as Specified in its Charter)
----------------
NEW YORK 0-25812 16-1353600
(STATE OR OTHER JURISDICTION OF Commission (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) File Number IDENTIFICATION NO.)
510 HUNTMAR PARK DRIVE, HERNDON, VA 20170
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(Registrant's Telephone Number, Including Area Code) (703) 904-4100
--------------
-------------------------------------------------------------
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
Item 5. Other Events
During December 1999, we processed $1.4 million of invoices relating to
software consulting work performed by three vendors during the second and third
quarters of 1999. We are amending our financial statements to reflect these
expenses in the second and third quarters.
We believe the amounts involved ($0.4 million in the second quarter and
$1.0 million in the third quarter) are not material to any line item in the
financial statements for either quarter. These additional expenses do impact
EBITDA (earnings before interest, taxes, depreciation and amortization, other
non-operating income and expense, and charge for acquired in-process research
and development), which is one measure of our performance. Recording these
expenses in the periods in which the work was performed results in a slight
EBITDA loss in both the second and third quarters (as presented in the table
below). We believe the change has an insignificant impact on our business and
operating trends. It has no impact on compliance with our debt covenants.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
-------------------------------------------- --------------------
June 30, 1999 September 30, 1999 September 30, 1999
----------------- -------------------- --------------------
Dollars in millions (except per share amounts) As As As As As As
Reported Amended Reported Amended Reported Amended
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Data communications and operations costs and
expenses $ 86.3 $ 86.7 $ 97.5 $ 98.5 $ 259.9 $ 261.3
Loss from operations (34.2) (34.6) (40.9) (41.9) (108.8) (110.2)
EBITDA (as defined) 0.2 (0.2) 0.7 (0.3) (6.0) (7.4)
Net loss available to common shareholders (62.0) (62.4) (87.7) (88.7) (208.9) (210.4)
Basic and diluted loss per share (1.00) (1.01) (1.35) (1.37) (3.48) (3.50)
Net cash used in operating activities (62.1) (62.1) (64.2) (64.2) (203.5) (203.5)
Total liabilities 1,483.5 1,484.0 2,811.6 2,813.0
Shareholders' equity 529.9 529.5 487.9 486.5
</TABLE>
Financial statement information and related disclosures included in the exhibits
to this filing reflect, where appropriate, the resulting change. Those exhibits
are incorporated by reference into this Form 8-K.
While we have included as exhibits 99.1 and 99.3 to this filing the entire
financial statements for the second and third quarters of 1999, respectively,
readers should note that the only sections of those exhibits that actually
changed are as follows:
- - Consolidated Balance Sheets as of June 30, 1999 and September 30, 1999;
- - Consolidated Statements of Operations for the three and six months ended
June 30, 1999 and for the three and nine months ended September 30, 1999;
- - Note 1--Basis of Presentation for the six months ended June 30, 1999 and
for the nine months ended September 30, 1999;
- - Note 3--Acquisitions of Certain Business for the six months ended June 30,
1999 and for the nine months ended September 30, 1999;
- - Note 8--Comprehensive Income for the three and six months ended June 30,
1999 and for the three and nine months ended September 30, 1999; and
- - Note 10--Industry Segment and Geographic Reporting for North America
segment for the three and six months ended June 30, 1999 and for the
U.S./Canada segment for the three and nine months ended September 30, 1999.
<PAGE>
While we have also included as exhibits 99.2 and 99.4 to this filing the
entire Management's Discussion and Analysis of Financial Condition and Results
of Operations for the second and third quarters of 1999, respectively, readers
should note that the only sections of those exhibits that actually changed are:
- - Data Communications and Operations for the three and six months ended
June 30, 1999 and the three and nine months ended September 30, 1999;
- - Net Loss Available to Common Shareholders and Loss per Share for the three
and six months ended June 30, 1999 and three and nine months ended
September 30, 1999; and
- - Segment Information for the North America segment for the three months
ended June 30, 1999 and for the U.S./Canada segment for the three and nine
months ended September 30, 1999.
<PAGE>
Item 7. Exhibits
Exhibit 99.1 Item 1. Financial Statements for the quarterly period ended
June 30, 1999 (Amended)
Exhibit 99.2 Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations for the quarterly
period ended June 30, 1999 (Amended)
Exhibit 99.3 Item 1. Financial Statements for the quarterly period ended
September 30, 1999 (Amended)
Exhibit 99.4 Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations for the quarterly
period ended September 30, 1999 (Amended)
<PAGE>
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 hereunto duly authorized.
Dated: JANUARY 10, 2000 PSINET INC.
By: /s/ EDWARD D. POSTAL
--------------------------
Edward D. Postal
Executive Vice President and
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
The following Exhibits are filed herewith:
<TABLE>
<CAPTION>
- ------------------- ----------------------------------------------------------------------- ----------------
Exhibit Number Description of Exhibit Location
- ------------------- ----------------------------------------------------------------------- ----------------
<S> <C> <C>
99.1 Item 1. Financial Statements for the quarterly period ended June 30, Filed
1999 (Amended) herewith
- ------------------- ----------------------------------------------------------------------- ----------------
99.2 Item 2. Management's Discussion and Analysis of Financial Condition Filed
and Results of Operations for the quarterly period ended herewith
June 30, 1999 (Amended)
- ------------------- ----------------------------------------------------------------------- ----------------
99.3 Item 1. Financial Statements for the quarterly period ended Filed
September 30, 1999 (Amended) herewith
- ------------------- ----------------------------------------------------------------------- ------ ----------
99.4 Item 2. Management's Discussion and Analysis of Financial Condition Filed
and Results of Operations for the quarterly period ended herewith
September 30, 1999 (Amended)
- ------------------- ----------------------------------------------------------------------- ----------------
</TABLE>
<PAGE>
EXHIBIT 99.1
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(In millions of U.S. dollars)
(Unaudited, Amended) (Audited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 610.0 $ 56.8
Restricted cash and short-term investments 144.5 162.5
Short-term investments and marketable securities 106.4 265.7
Accounts receivable, net 58.6 50.2
Prepaid expenses 12.3 11.0
Other current assets 20.5 19.1
----------- -----------
Total current assets 952.3 565.3
Property, plant and equipment, net 620.7 389.4
Goodwill and other intangibles, net 373.6 282.8
Other assets and deferred charges 66.9 46.7
----------- -----------
Total assets $ 2,013.5 $ 1,284.2
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of debt $ 78.5 $ 60.0
Trade accounts payable 82.9 90.0
Accrued payroll and related expenses 18.1 8.5
Other accounts payable and accrued liabilities 54.1 82.7
Accrued interest payable 29.4 29.0
Deferred revenue 21.3 19.4
----------- -----------
Total current liabilities 284.3 289.6
Long-term debt 1,141.7 1,064.6
Deferred income taxes 4.7 6.2
Other liabilities 53.3 44.0
----------- -----------
Total liabilities 1,484.0 1,404.4
----------- -----------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred stock -- --
Convertible preferred stock, Series B -- 28.8
Convertible preferred stock, Series C 362.4 --
Common stock 0.7 0.5
Capital in excess of par value 823.6 402.0
Accumulated deficit (549.3) (427.6)
Treasury stock (2.0) (2.0)
Accumulated other comprehensive income 17.7 36.7
Bandwidth Asset/IRU Agreement (123.6) (158.6)
----------- -----------
Total shareholders' equity (deficit) 529.5 (120.2)
----------- -----------
Total liabilities and shareholders' equity (deficit) $ 2,013.5 $ 1,284.2
----------- -----------
----------- -----------
</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 JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- ----------------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(UNAUDITED; IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(AMENDED) (AMENDED)
<S> <C> <C> <C> <C>
Revenue $ 123.8 $ 53.7 $ 228.7 $ 98.2
Operating costs and expenses:
Data communications and operations 86.7 41.9 162.8 78.6
Sales and marketing 21.9 12.5 40.5 23.2
General and administrative 15.4 10.3 32.5 17.9
Depreciation and amortization 34.4 12.9 61.2 22.4
Charge for acquired in-process
research and development -- 20.0 -- 27.0
--------- -------- --------- ---------
Total operating costs and expenses 158.4 97.6 297.0 169.1
--------- -------- --------- ---------
Loss from operations (34.6) (43.9) (68.3) (70.9)
Interest expense (31.9) (16.9) (61.5) (19.4)
Interest income 8.1 6.1 12.8 6.6
Other income (expense), net (0.2) 1.1 (0.3) 1.0
--------- -------- --------- ---------
Loss before income taxes (58.6) (53.6) (117.3) (82.7)
Income tax benefit (expense) 0.4 -- 0.4 --
--------- -------- --------- ---------
Net loss (58.2) (53.6) (116.9) (82.7)
Return to preferred shareholders (4.2) (0.8) (4.8) (1.5)
--------- -------- --------- ---------
Net loss available to common shareholders $ (62.4) $ (54.4) $ (121.7) $ (84.2)
--------- -------- --------- ---------
--------- -------- --------- ---------
Basic and diluted loss per share $ (1.01) $ (1.06) $ (2.11) $ (1.76)
--------- -------- --------- ---------
--------- -------- --------- ---------
Shares used in computing basic and diluted loss
per share (in thousands) 61,956 51,111 57,657 47,854
--------- -------- --------- ---------
--------- -------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
<PAGE>
PSINET INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------
1999 1998
--------- ---------
(In millions of U.S. dollars)
(Unaudited)
<S> <C> <C>
Net cash used in operating activities $(139.3) $ (20.7)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (101.9) (25.2)
Purchases of investments (103.2) (242.3)
Proceeds from maturity or sale of investments 262.5 1.2
Investments in certain businesses, net of cash acquired (103.2) (63.3)
Restricted cash and short-term investments 18.0 (122.5)
Other, net -- 0.8
--------- ---------
Net cash used in investing activities (27.8) (451.3)
--------- ---------
Cash flows from financing activities:
Net payments on lines of credit -- (1.8)
Proceeds from issuance of notes payable, net 102.7 609.0
Repayments of debt (104.9) (29.2)
Principal payments under capital lease obligations (26.8) (15.2)
Proceeds from equity offerings, net 742.0 --
Proceeds from exercise of common stock options 9.1 2.0
Payments of dividends on preferred stock (0.4) (1.5)
Other, net -- --
--------- ---------
Net cash provided by financing activities 721.7 563.3
--------- ---------
Effect of exchange rate changes on cash (1.4) (0.1)
--------- ---------
Net increase in cash and cash equivalents 553.2 91.2
Cash and cash equivalents, beginning of period 56.8 33.3
--------- ---------
Cash and cash equivalents, end of period $ 610.0 $ 124.5
--------- ---------
--------- ---------
</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 (Amended)
These consolidated financial statements for the three and six month periods
ended June 30, 1999 and 1998 and the related footnote information are unaudited
and have been prepared on a basis substantially consistent with the audited
consolidated financial statements of PSINet Inc. and its subsidiaries
(collectively, "PSINet" or the "Company") as of and for the year ended December
31, 1998 included in the Company's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission (the "Annual Report"). These financial
statements should be read in conjunction with the audited consolidated financial
statements and the related notes to consolidated financial statements of the
Company as of and for the year ended December 31, 1998 included in the Annual
Report and the unaudited quarterly consolidated financial statements and related
notes to unaudited consolidated financial statements of the Company for the
three month period ended March 31, 1999 included in the Company's Form 10-Q for
the quarter then ended, as filed with the Securities and Exchange Commission. 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 June 30, 1999 and the results of its operations and
cash flows for the three and six month periods ended June 30, 1999 and 1998. The
results of operations for the three and six month periods ended June 30, 1999
may not be indicative of the results expected for any succeeding quarter or for
the entire year ending December 31, 1999.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements.
Actual results may differ from those estimates.
In December 1999, the Company processed certain invoices relating to expenses
for software consulting work performed in the second and third quarters of
1999. These financial statements have been amended to reflect $0.4 million of
expenses in the second quarter of 1999. Net loss available to common
shareholders for the three and six months ended June 30, 1999 has been
changed from $62.0 million and $121.2 million, respectively, to $62.4 million
and $121.7 million, respectively. Basic and diluted loss per share for the
three and six month ended June 30, 1999 has been changed from $1.00 and $2.10
loss per share, respectively, to $1.01 and $2.11 loss per share, respectively.
NOTE 2 - ACCOUNTING POLICIES
LOSS PER SHARE - Basic loss per share is computed using the weighted average
number of shares of common stock outstanding during the year. Diluted loss
per share is computed using the weighted-average number of shares of common
stock, adjusted for the dilutive effect of common stock equivalent shares
from common stock options and warrants and convertible preferred stock.
Common stock equivalent shares are calculated using the treasury stock
method. All common stock equivalents, totaling 16.3 million shares and 3.8
million shares at June 30, 1999 and 1998, respectively, have been excluded
from the computation of diluted loss per share as their effect would be
antidilutive and, accordingly, there is no reconciliation between basic and
diluted loss per share for each of the periods presented.
NOTE 3 - ACQUISITIONS OF CERTAIN BUSINESSES (Amended)
During the six months ended June 30, 1999, the Company acquired the following
businesses:
<TABLE>
<CAPTION>
OWNERSHIP
BUSINESS NAME LOCATION ACQUISITION DATE INTEREST
------------- -------- ---------------- --------
<S> <C> <C> <C>
Planete.net France 2/99 100%
Satelnet France 2/99 100%
Tele Linx United Kingdom 2/99 100%
Horizontes Brazil 4/99 100%
Openlink Brazil 4/99 100%
STI Brazil 5/99 100%
Internet de Mexico Mexico 5/99 100%
DataNet Mexico 5/99 100%
TIC Switzerland 5/99 100%
Caribbean Internet U.S. (Puerto Rico) 6/99 100%
TIAC U.S. 6/99 100%
Argentina On-Line Argentina 6/99 100%
CSO.net Austria 6/99 100%
</TABLE>
-6-
<PAGE>
Subsequently, during July 1999, the Company acquired the following businesses:
<TABLE>
<CAPTION>
OWNERSHIP
BUSINESS NAME LOCATION ACQUISITION DATE INTEREST
------------- -------- ---------------- --------
<S> <C> <C> <C>
Intercomputer Spain 7/99 100%
Abaforum Spain 7/99 100%
</TABLE>
All of the ISPs acquired generally serve both consumer and business customers
with dedicated and dial-up connectivity as well as Web hosting services. Tele
Linx operates a data center facility.
Each of the acquisitions was accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations of the
acquired companies have been included in the Company's consolidated financial
statements since the acquisition dates. The purchase prices of the 1999
acquisitions have been preliminarily allocated to assets acquired, including
intangible assets, and liabilities assumed, based on their respective fair
values at the acquisition dates. As part of the allocation process, the Company
evaluates each acquisition for acquired in-process research and development
technologies. Based on the Company's preliminary allocation, no in-process
research and development technologies were identified for its 1999 acquisitions
to date.
In connection with the acquisitions made during the six months ended June 30,
1999, liabilities assumed were as follows (in millions of U.S. dollars):
<TABLE>
<CAPTION>
CASH PAID
FAIR VALUE OF FOR THE LIABILITIES
ASSETS ACQUIRED CAPITAL STOCK ASSUMED
--------------- ------------- -------
<S> <C> <C> <C>
Tele Linx $ 88.2 $ (32.8) $ 55.4
TIAC 26.6 (16.0) 10.5
All Others 68.2 (48.6) 19.7
------- ------- ------
$ 183.0 $ (97.4) $ 85.6
------- ------- ------
------- ------- ------
</TABLE>
For certain acquisitions made in 1999 and 1998, the Company has retained a
portion of the purchase price under holdback provisions of the purchase
agreements to secure performance by the sellers of indemnification or other
contractual obligations. These holdback amounts are generally payable up to 24
months after the date of closing of the related acquisitions.
The Company recorded a $6.0 million increase to goodwill during the three months
ended June 30, 1999, reflecting final settlement and payment of an earn-out
provision in connection with an acquisition made in 1998.
The following represents the unaudited pro forma results of operations of the
Company for the six months ended June 30, 1999 and 1998 as if the acquisitions
closed prior to June 30, 1999 were consummated on January 1, 1998. The unaudited
pro forma results of operations include certain pro forma adjustments, including
the amortization of intangible assets relating to the acquisitions. The
unaudited pro forma results of operations are prepared for comparative purposes
only and do not necessarily reflect the results that would have occurred had the
acquisitions actually been consummated on January 1, 1998 or the results which
may occur in the future.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
----------------
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
(IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNT)
(Amended)
<S> <C> <C>
Revenue....................................................... $ 244.0 $ 116.4
Net loss available to common shareholders..................... $ (126.0) $ (89.9)
Basic and diluted loss per share.............................. $ (2.19) $ (1.88)
</TABLE>
Total amortization expense of goodwill and other intangibles was $9.1 million
and $1.2 million for the three months ended June 30, 1999 and 1998,
respectively, and $17.5 million and $1.8 million for the six months ended June
30, 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>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
U.S. government obligations $137.9 $235.1
Commercial paper 60.4 112.3
Certificates of deposit 0.6 25.0
Other 2.3 --
------ ------
$201.2 $372.4
------ ------
------ ------
</TABLE>
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
Telecommunications bandwidth $ 246.8 $ 148.4
Data communications equipment 396.5 275.4
Leasehold improvements 36.0 29.2
Software 23.9 17.7
Office and other equipment 29.1 18.8
Land and buildings 43.2 3.3
------- -------
775.5 492.8
Less accumulated depreciation and amortization (154.8) (103.4)
------- -------
Property, plant and equipment, net $ 620.7 $ 389.4
------- -------
------- -------
</TABLE>
Total depreciation and leasehold amortization expense was $25.3 million and
$11.7 million for the three months ended June 30, 1999 and 1998, respectively,
and $43.7 million and $20.6 million for the six months ended June 30, 1999 and
1998, respectively.
NOTE 6 - DEBT
Debt consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
Senior notes at interest rate of 10% $ 600.0 $ 600.0
Senior notes at interest rate of 11.5% 350.0 350.0
Capital lease obligations at interest rates ranging from 2.0% to 18.6% 231.3 120.7
Notes payable at interest rates ranging from 1.9% to 12.7% 36.1 51.0
----------- -----------
1,217.4 1,121.7
Plus unamortized premium 2.8 2.9
----------- -----------
1,220.2 1,124.6
Less current portion (78.5) (60.0)
----------- -----------
Long-term portion $ 1,141.7 $ 1,064.6
----------- -----------
----------- -----------
</TABLE>
The Company has deposited in an escrow account restricted cash and short-term
investments of $94.3 million at June 30, 1999 to fund, when due, the next three
semi-annual interest payments on the 10% senior notes. Each of the indentures
governing the Company's senior notes contain certain financial and other
covenants that, among other things, will restrict the Company's ability to incur
further indebtedness, make certain payments (including payments of dividends),
and 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 six months ended June 30, 1999
and 1998, the Company incurred capital lease obligations under these
arrangements and from the acquisitions of businesses of $78.6 million and
$49.1 million, respectively. At June 30, 1999, the aggregate unused portion
under these arrangements totaled $91.9 million after designating $20.4
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.
-8-
<PAGE>
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 June 30, 1999, no amounts were outstanding, $9.7 million was
being utilized for letters of credit, and $100.3 million was available to draw.
Interest on the Credit Facility is based on a spread over the London interbank
offered rate or the higher of the bank's prime rate or the Federal funds
effective rate, at the Company's option (9.0% at June 30, 1999). The Credit
Facility requires, among other things, the satisfaction of certain financial
covenants, including a minimum annual consolidated revenue test, a minimum
EBITDA test and requires the reduction in the maximum amount of availability and
prepayments equal to the net proceeds received from certain asset sales and
certain casualty events. The Company is required to pay 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 June 30, 1999.
In July 1999, the Company issued $1.2 billion aggregate principal amount of 11%
senior notes due 2009, consisting of $1.05 billion aggregate principal amount of
11% senior notes due 2009 and Euro 150 million aggregate principal amount of 11%
senior notes due 2009, pursuant to Securities and Exchange Commission Rule 144A
and Regulation S. The aggregate net proceeds of the offering of the 11% senior
notes, after giving effect to discounts and commissions and other offering
expenses, was approximately $1.17 billion.
NOTE 7 - CAPITAL STOCK
ISSUANCE OF COMMON STOCK
During the six months ended June 30, 1999, options with respect to 1,593,858
shares of common stock were exercised for aggregate net proceeds of $9.1
million.
In May 1999, the Company completed a public offering of 8,000,000 shares of its
common stock at $50.50 per share for net proceeds of approximately $383.8
million after underwriting discounts and commissions and other offering
expenses.
TERMINATION OF CONTINGENT PAYMENT OBLIGATION TO IXC
In January 1999, the Company's contingent payment obligation to IXC Internet
Services, Inc. ("IXC") under an agreement relating to the purchase of OC-48
bandwidth from IXC was terminated without the payment of any additional amounts
or issuance of additional shares of common stock to IXC. This occurred when the
fair market value of the shares of common stock originally issued to IXC
exceeded the $240 million threshold in accordance with the terms of the
agreement.
CONVERSION OF CONVERTIBLE PREFERRED STOCK
During the first quarter of 1999, all 600,000 shares of the Company's Series B
8% convertible preferred stock were converted into an aggregate of 3,000,000
shares of the Company's common stock in accordance with the original terms of
the convertible preferred stock.
ISSUANCE OF CONVERTIBLE PREFERRED STOCK
In May 1999, the Company completed a public offering of 9,200,000 shares of its
6 3/4% Series C Cumulative Convertible Preferred Stock ("Series C Preferred
Stock") for net proceeds of approximately $358.2 million after underwriting
discounts and commissions and other offering expenses. The Series C Preferred
Stock has a liquidation preference of $50 per share. 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.
-9-
<PAGE>
At closing, the purchasers of the Series C Preferred Stock deposited
approximately $85.8 million into an account established with a deposit agent
("Deposit Account"). The Deposit Account is not an asset of the Company. Funds
in the Deposit Account will be paid to the holders of the Series C Preferred
Stock each quarter in the amount of $0.84375 per share in cash or may be used,
at the Company's option, to purchase shares of common stock from the Company 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 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 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 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 the Company's option, 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% on May 15, 2006 (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, the holders of the Series C Preferred Stock will have
the right to convert their shares into 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.
NOTE 8 - COMPREHENSIVE INCOME (Amended)
Comprehensive income for the three and six months ended June 30, 1999 and 1998
was as follows (in millions of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
(Amended) (Amended)
<S> <C> <C> <C> <C>
Net loss $ (58.2) $ (53.6) $ (116.9) $ (82.7)
-------- -------- -------- --------
Other comprehensive income:
Unrealized holding gains 0.6 1.3 0.4 5.0
Foreign currency translation adjustment (5.4) (1.2) (19.4) (0.9)
-------- -------- -------- --------
(4.8) 0.1 (19.0) 4.1
-------- -------- -------- --------
Comprehensive income $ (63.0) $ (53.5) $ (135.9) $ (78.6)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
NOTE 9 - COMMITMENTS AND CONTINGENCIES
On March 23, 1999, an arbitrator awarded The Chatterjee Management Company
("Chatterjee") compensatory damages, including interest and legal expenses,
from 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 was reflected in other accounts payable and accrued
liabilities in its consolidated balance sheets at December 31, 1998. During
April 1999, the Company's request that the International Chamber of Commerce
reconsider the amount of the damages awarded was denied. The Company resolved
this matter by payment of $48.0 million to Chatterjee in April 1999; after
accounting for other expenses, the resolution of the previously established
accrual resulted in a non-recurring gain during the second quarter of 1999 of
$0.7 million.
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<PAGE>
The Company is subject to certain other claims and legal proceedings that arise
in the ordinary course of its business activities. Each of these matters is
subject to various uncertainties, and it is possible that some of these matters
may be decided unfavorably to the Company. Management believes that any
liability that may ultimately result from the resolution of these matters will
not have a material adverse effect on the financial condition or results of
operations or cash flows of the Company.
NOTE 10 - INDUSTRY SEGMENT AND GEOGRAPHIC REPORTING (Amended)
During the second quarter of 1999, the Company redefined its reporting
segments to combine its U.S. and Canadian operations into one segment called
North America; and, due to acquisitions during the quarter, added a Latin
America segment. Its operations are now organized into four geographic
operating segments - North America, Latin America, 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.
Operations of the North America segment include shared network costs and
corporate functions which the Company does not allocate to its other geographic
segments for management reporting purposes. Capital expenditures include both
assets acquired for cash and financed through capital leases and seller-financed
arrangements.
Financial information for the Company's geographic segments is presented below
(in millions of U.S. dollars):
<TABLE>
<CAPTION>
NORTH AMERICA LATIN AMERICA EUROPE ASIA ELIMINATIONS TOTAL
(Amended) (Amended)
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED
JUNE 30, 1999
Revenue $ 70.1 $ 3.2 $ 18.7 $ 31.8 $ --- $ 123.8
EBITDA (3.7) 0.8 (0.7) 3.4 --- (0.2)
Assets 1,453.5 96.1 233.9 278.0 (48.0) 2,013.5
Capital expenditures 81.6 0.4 23.3 8.6 --- 113.9
THREE MONTHS ENDED
JUNE 30, 1998
Revenue $ 44.1 $ --- $ 8.0 $ 1.8 $ (0.2) $ 53.7
EBITDA (9.4) --- (1.7) 0.1 --- (11.0)
Assets 753.1 --- 45.5 (8.7) 4.9 794.8
Capital expenditures 40.6 --- 1.3 0.3 (0.2) 42.0
SIX MONTHS ENDED
JUNE 30, 1999
Revenue $ 129.2 $ 3.3 $ 34.6 $ 61.7 $ (0.1) $ 228.7
EBITDA (11.8) 0.8 (2.6) 6.5 --- (7.1)
Assets 1,453.5 96.1 233.9 278.0 (48.0) 2,013.5
Capital expenditures 162.9 0.4 37.7 14.4 --- 215.4
SIX MONTHS ENDED
JUNE 30, 1998
Revenue $ 81.0 $ --- $ 14.0 $ 3.4 $ (0.2) $ 98.2
EBITDA (18.7) --- (2.9) 0.1 --- (21.5)
Assets 753.1 --- 45.5 (8.7) 4.9 794.8
Capital expenditures 74.2 --- 4.9 0.3 (0.4) 79.0
</TABLE>
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<PAGE>
EBITDA for all reportable segments differs from consolidated loss before income
taxes reported in the consolidated statements of operations as follows (in
millions of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
(Amended) (Amended)
<S> <C> <C> <C> <C>
EBITDA $ (0.2) $ (11.0) $ (7.1) $ (21.5)
Reconciling items:
Depreciation and amortization (34.4) (12.9) (61.2) (22.4)
Charge for acquired IPR&D -- (20.0) -- (27.0)
Interest expense (31.9) (16.9) (61.5) (19.4)
Interest income 8.1 6.1 12.8 6.6
Other income (expense), net (0.2) 1.1 (0.3) 1.0
-------- -------- -------- --------
Loss before income taxes $ (58.6) $ (53.6) $ (117.3) $ (82.7)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
<PAGE>
Exhibit 99.2
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, AND (3) OUR UNAUDITED QUARTERLY
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1999 INCLUDED
IN OUR FORM 10-Q FOR THE QUARTER THEN ENDED, AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION. THE RESULTS SHOWN HEREIN ARE NOT NECESSARILY INDICATIVE
OF THE RESULTS TO BE EXPECTED IN ANY FUTURE PERIODS. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS 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 OUR FORM 10-Q AS FILED ON AUGUST 16,
1999 AND OUR OTHER PERIODIC REPORTS AND DOCUMENTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.
GENERAL
We derive a majority of our revenues from providing Internet access services to
business customers and other Internet service providers, or ISPs. Business
customers are typically signed to contracts for one year terms. Revenues
generated from business customers are typically comprised of recurring monthly
fees, installation and start-up charges and sales of related equipment and
services. Revenues from other ISPs are generated pursuant to network access
agreements which typically require a minimum number of subscribers and obligate
the ISP customers 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, among others, Web hosting
services, intranets, virtual private networks or VPNs, e-commerce,
voice-over-Internet protocol, 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 charges and are often bundled with Internet access services. We
conduct our business through operations organized into four geographic operating
segments - North America, Latin America, Europe and Asia.
We currently have operations in 16 of the 20 largest international
telecommunications markets. We have operations in Argentina, Austria, Belgium,
Brazil, Canada, France, Germany, Hong Kong, Italy, Japan, the Republic of Korea,
Luxembourg, Mexico, the Netherlands, Spain, Switzerland, the United Kingdom and
the United States. We typically enter a new market through the acquisition of an
existing company within the particular market. Revenue from non-U.S. operations
remained consistent as a percentage of consolidated results, comprising 51% of
revenue in the second quarter of 1999. By comparison, non-U.S. operations
comprised 52% of revenue in the first quarter of 1999, 31% in the second quarter
of 1998 and 40% for all of 1998.
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 600 sites, called points of presence or POPs,
situated throughout North America, Latin America, 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.
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
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<PAGE>
significant amounts of global fiber-based telecommunications bandwidth,
including long-term rights, typically for 20 or more years, 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.
In May 1999, we completed public offerings of our common stock and 6 3/4% Series
C cumulative convertible preferred stock for aggregate gross proceeds of $864
million and aggregate net proceeds of approximately $742.0 million (excluding,
in the calculation of net proceeds, amounts paid by the purchasers of the
convertible preferred stock into the deposit account therefor).
In July 1999, we completed a private placement of $1.2 billion aggregate
principal amount of our 11% senior notes due 2009, consisting of $1.05 billion
aggregate principal amount of 11% senior notes due 2009 and Euro 150 million
aggregate principal amount of 11% senior notes due 2009, for aggregate net
proceeds of approximately $1.17 billion after giving effect to discounts and
commissions and other offering expenses.
THREE AND SIX MONTHS ENDED JUNE 30, 1999 AS COMPARED TO THE THREE AND SIX MONTHS
ENDED JUNE 30, 1998
RESULTS OF OPERATIONS
REVENUE. We generate revenue primarily from the sale of Internet access and
related services to businesses. Revenue was $123.8 million for the three months
ended June 30, 1999, an increase of $70.1 million, or 131%, from $53.7 million
for the three months ended June 30, 1998 and an increase of $19.0 million, or
18%, over the three months ended March 31, 1999. Revenue was $228.7 million for
the six months ended June 30, 1999, an increase of $130.5 million, or 133%, from
$98.2 million for the six months ended June 30, 1998. Revenue growth from the
second quarter of 1998 was a result of both acquisitions and internally
generated growth, as further described below. Revenue growth of 18% from the
first quarter of 1999 consisted of organic growth of 14% and growth from
acquisitions of 4%. Our internally generated revenue growth is attributable to a
number of factors, including an increase in the
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<PAGE>
number of business customer and ISP accounts, an increase in the average annual
revenue realized per new business customer account, and an increase in hardware
sales to customers.
Our business customer account base increased by 90% to 73,400 business accounts
at June 30, 1999 from 38,700 business accounts at June 30, 1998. By comparison,
at March 31, 1999, we had 59,700 accounts. Of the total business account growth
from June 30, 1998, 21,400 accounts were attributable to the existing customer
base of the companies we acquired. The total number of our Carrier and ISP
customers grew to 364 at June 30, 1999, and, together with our small office/home
office ("SOHO") and consumer customers, provided service to 1,041,000 customers.
This compares with 109 Carrier and ISP customers and 412,000 customers at June
30, 1998. Average annual new contract value for business accounts increased to
$7,300 for the three months ended June 30, 1999 from $5,800 for the three months
ended June 30, 1998 and $6,000 for the full year 1998, which we believe reflects
an increasing demand for value-added services and higher levels of bandwidth.
Our business account retention rate remained strong at 80% for the three months
ended June 30, 1999, compared with 83% for the three months ended June 30, 1998
and a full-year retention rate in 1998 of 79%.
DATA COMMUNICATIONS AND OPERATIONS (Amended). 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 $86.7 million (70.1% of revenue)
for the three months ended June 30, 1999, an increase of $44.8 million, or
107%, from $41.9 million (78.1% of revenue) for the three months ended June 30,
1998. Data communications and operations expenses were $162.8 million
(71.2% of revenue) for the six months ended June 30, 1999, an increase of
$84.2 million, or 107%, from $78.6 million (80.1% of revenue) for the six
months ended June 30, 1998. The increase in expenses related principally to
increases in:
- - the number of leased backbone, 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 19,300 at June 30, 1999 from
8,900 at June 30, 1998, an increase of 116%. Comparing the second quarter of
1999 to the second quarter of 1998, backbone circuit costs increased $15.1
million, or 158%, dedicated customer circuit costs increased $6.8 million, or
72%, PRI expense increased $4.9 million, or 65%, personnel and related operating
expenses associated with network operations, customer support and field service
increased $8.4 million, or 86% and operating and maintenance charges on our
bandwidth increased $2.3 million, or 2,500%. 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 continue to decrease over time as a
percentage of revenue due to decreases in unit costs and continued increases in
network utilization. In 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 an increase in the operating and maintenance expense component of data
communications costs as well as 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 $21.9 million (17.7% of revenue) for
the three months ended June 30, 1999, an increase of $9.4 million, or 76%,
from $12.5 million (23.2% of revenue) for the three months ended June 30,
1998. Sales and marketing expenses were $40.5 million (17.7% of revenue) for
the six months ended June 30, 1999, an increase of $17.3 million, or 74%,
from $23.2 million (23.6% of revenue) for the six months ended June 30, 1998.
-15-
<PAGE>
The increase is principally attributable to costs associated with the growth
of our sales force in conjunction with our growth and acquisitions and to
advertising costs, including costs associated with our naming rights and
sponsorship agreements for PSINet Stadium with the Baltimore Ravens of the
National Football League.
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 $15.4 million (12.4% of revenue) for
the three months ended June 30, 1999, an increase of $5.1 million, or 50%, from
$10.3 million (19.2% of revenue) for the three months ended June 30, 1998.
General and administrative expenses were $32.5 million (14.2% of revenue) for
the six months ended June 30, 1999, an increase of $14.6 million, or 82%, from
$17.9 million (18.2% of revenue) for the six months ended June 30, 1998. The
increase resulted from the addition of management staff and related operating
expenses across our organization, including increases in conjunction with our
growth and acquisitions
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs were $34.4
million (27.8% of revenue) for the three months ended June 30, 1999, an increase
of $21.5 million, or 167%, from $12.9 million (24.0% of revenue) for the three
months ended June 30, 1998. Depreciation and amortization costs were $61.2
million (26.8% of revenue) for the six months ended June 30, 1999, an increase
of $38.8 million, or 174%, from $22.4 million (22.8% of revenue) for the six
months ended June 30, 1998.
Depreciation and amortization costs have increased as a result of capital
expenditures associated with network infrastructure enhancements, including
telecommunications bandwidth acquisitions, and depreciation and amortization of
tangible and intangible assets related to business acquisitions. We anticipate
that our depreciation and amortization expenses will continue to increase
significantly as we 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 six months
ended June 30, 1999 include no charges for acquired in-process research and
development related to acquisitions completed during the period. The results for
the six months ended June 30, 1998 include a $27.0 million charge (27.5% of
revenue) for acquired in-process research and development. The charges in 1998
were based on independent valuations and reflect technologies acquired prior to
technological feasibility and for which there was no alternative future use. We
are in the process of finalizing valuations for 1999 acquisitions and the
allocation of the purchase price for such acquisitions is preliminary. We do not
expect any change in the allocation, including any charge for acquired
in-process research and development, to have a material impact on our results of
operations.
INTEREST EXPENSE. Interest expense was $31.9 million (25.8% of revenue) for
the three months ended June 30, 1999, an increase of $15.0 million, or 89%,
from $16.9 million (31.4% of revenue) for the three months ended June 30,
1998. Interest expense was $61.5 million (26.9% of revenue) for the six
months ended June 30, 1999, an increase of $42.1 million, or 216%, from $19.4
million (19.8% of revenue) for the six months ended June 30, 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. As a result
of the completion of our offering of the 11% senior notes, our annual
interest expense on the 10% senior notes, 11 1/2% senior notes and 11% senior
notes will be $232.6 million, assuming an exchange rate of Euro 0.98 to U.S.
$1.00, which was the exchange rate on July 16, 1999, the date on which the
offering of the 11% senior notes was priced. We will have additional interest
expense attributable to our revolving credit facility and equipment lease
arrangements.
INTEREST INCOME. Interest income was $8.1 million (6.5% of revenue) for the
three months ended June 30, 1999, an increase of $2.0 million, or 33%, from $6.1
million (11.3% of revenue) for the three months ended June 30, 1998. Interest
income was $12.8 million (5.6% of revenue) for the six months ended June 30,
1999, an increase of $6.2 million, or 93%, from $6.6 million (6.8% of revenue)
for the six months ended June 30, 1998. The increase was due to interest
received on the net proceeds of our offerings of
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<PAGE>
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.
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS AND LOSS PER SHARE (Amended). Our
net loss available to common shareholders for the three months ended June 30,
1999 was $62.4 million, or $1.01 basic and diluted loss per share, a $8.0
million, or 14.7%, increase from a net loss available to common shareholders
for the three months ended June 30, 1998 of $54.4 million, or $1.06 basic and
diluted loss per share. Our net loss available to common shareholders was
$121.7 million, or $2.11 basic and diluted loss per share, for the six months
ended June 30, 1999, an increase of $37.5 million, or 44.4%, from $84.2
million, or $1.76 basic and diluted loss per share, for the six months ended
June 30, 1998.
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,
- - our acquisitions of fiber-based telecommunications bandwidth, leading to an
increase in depreciation and personnel costs to manage the bandwidth, and
- - an increase in depreciation and amortization related to acquisitions,
offset by the absence of a charge for acquired in-process research and
development.
The return to preferred shareholders, which comprises the dividends with respect
to our convertible preferred stock, 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 (Amended)
During the second quarter of 1999, we redefined our reporting segments to
combine our U.S. and Canadian operations into one segment called North
America; and, due to acquisitions during the quarter, we added a Latin
America segment. Our operations are now organized into four geographic
operating segments - North America, Latin America, Europe and Asia.
All our reportable segments have experienced significant revenue increases from
the first six months of 1998 to the first six months of 1999. Starting in late
1997 and through June 30, 1999, we acquired 30 ISPs and one business that
operates a data center. Revenue growth by segment for the three and six months
ended June 30, 1999 compared to the three and six months ended June 30, 1998 was
as follows:
<TABLE>
<CAPTION>
REVENUE GROWTH
-----------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 JUNE 30, 1999
COMPARED TO COMPARED TO
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1998
------------------ ------------------
<S> <C> <C>
North America 59% 60%
Latin America * *
Europe 134% 147%
Asia 1,667% 1,715%
All Segments 131% 133%
</TABLE>
(*) Segment new in second quarter of 1999
The Company evaluates the performance of its segments and allocates resources to
them based on revenue and EBITDA, which is defined as earnings (losses) before
interest expense and interest income, taxes, depreciation and amortization,
other non-operating income and expense, and charge for acquired in-process
research and development. EBITDA as a percentage of revenue improved in all
segments from the three months ended June 30, 1998 to the three months ended
June 30, 1999, reflecting the
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<PAGE>
overall development cycle of our businesses in these areas. Improvement in
EBITDA losses as a percentage of revenue for the North America segment was
(21.2%) to (5.3%), for the European segment was (21.1%) to (4.0%), and for the
Asian segment was 2.4% to 10.7%. The Latin America segment, new this quarter,
generated an EBITDA profit of 25.5% of revenue. 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 concentrated efforts to control operating costs, and second, almost
every company we acquired in 1998 and 1999 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. Our
loss from operations as a percentage of revenue improved across all geographic
segments. In North America, our loss from operations as a percentage of revenue
was reduced from (68.1%) in the second quarter of 1998 to (35.6%) in the second
quarter of 1999. In Asia, it was reduced from (398.0%) to (16.2%), and in Europe
from (86.9%) to (24.1%) for those same quarters, respectively. Latin America
achieved an operating profit for the second quarter of 1999 of 8.3% of revenue.
LIQUIDITY AND CAPITAL RESOURCES
We historically have had losses from operations, which have been funded
primarily through borrowings and capital lease financings from vendors,
financial institutions and other third parties, and through the issuance of debt
and equity securities. In 1999, we have to date received net proceeds of
approximately $1.9 billion from debt and equity financings.
CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
Cash flows used in operating activities were $139.3 million and $20.7 million
for the six months ended June 30, 1999 and 1998, respectively. Cash flows from
operating activities can vary significantly from period to period depending upon
the timing of operating cash receipts and payments and other working capital
changes, especially accounts receivable, prepaid expenses and other assets, and
accounts payable and accrued liabilities. In both of these six-month periods,
our net losses were the primary component of cash used in operating activities,
offset by significant non-cash depreciation and amortization expenses relating
to our network and intangible assets. Operating cash outflows in 1999 also
include the $48.0 million arbitration award payment.
Cash flows used in investing activities were $27.8 million and $451.3 million
for the six months ended June 30, 1999 and 1998, respectively. Acquisition
activities resulted in the use of $103.2 million of cash for the six months
ended June 30, 1999, net of cash acquired. Investments in our network and
facilities during the first six months of 1999 resulted in total additions to
fixed assets of $215.4 million. Of this amount, $78.6 million was financed
under vendor or other financing arrangements, $34.9 million of non-cash
additions related to the bandwidth acquired from IXC Internet Services, Inc.,
and $101.9 million was expended in cash. For the six months ended June 30,
1998, total additions were $79.0 million, of which $49.1 million was financed
under equipment financing agreements, $4.7 million of non-cash additions
related to the bandwidth acquired from IXC and $25.2 million was expended in
cash. Purchases of short-term investments during the first six months of 1999
were an aggregate of $103.2 million, offset by proceeds from the sale and
maturity of short-term investments of $262.5 million. Purchases of short-term
investments during the six months of 1998 were an aggregate of $242.3
million. Investing cash flows in the first six months of 1999 and 1998 were
increased by $18.0 million and decreased by $122.5 million, respectively,
from changes in restricted cash and short-term investments related to various
financing and acquisition activities.
Cash flows provided by financing activities were $721.7 million and $563.3
million for the six months ended June 30, 1999 and 1998, respectively. In the
first six months of 1999, we received $102.7 million from borrowings on our
credit facility and from the issuance of notes payable and $742.0 million
from equity offerings. In the first six months of 1998, we received net
proceeds from the issuance of notes payable of $609.0 million. We made
repayments aggregating $104.9 million and $29.2 million for the six months
ended June 30, 1999 and 1998, respectively, on our lines of credit, capital
lease obligations
-18-
<PAGE>
and notes payable. During the six months ended June 30, 1999 and 1998, we
received proceeds from the exercise of stock options of $9.1 million and $2.0
million, respectively.
As of June 30, 1999, we had $860.9 million of cash, cash equivalents, restricted
cash, short-term investments and marketable securities.
CAPITAL STRUCTURE
Our capital structure at June 30, 1999 consisted of a revolving credit facility,
other lines of credit, capital lease obligations, 10% senior notes, 11 1/2%
senior notes, convertible preferred stock, and common stock.
In July 1999, we issued $1.2 billion aggregate principal amount of our 11%
senior notes due 2009, consisting of $1.05 billion aggregate principal amount of
11% senior notes due 2009 and Euro 150 million aggregate principal amount of 11%
senior notes due 2009, pursuant to Securities and Exchange Commission Rule 144A
and Regulation S. The aggregate net proceeds of the offering of the 11% senior
notes, after giving effect to discounts and commissions and other offering
expenses, was approximately $1.17 billion.
Total borrowings at June 30, 1999 were $1.22 billion, which included $78.5
million in current obligations and $1.14 billion in long-term debt, capital
lease obligations and notes payable.
We have a senior secured revolving credit facility that expires on September 29,
2001 and has an aggregate principal amount of $110.0 million. At June 30, 1999,
no amounts were outstanding, $9.7 million was being utilized for letters of
credit, and $100.3 million was available to draw under the credit facility.
In addition, as of June 30, 1999, $91.9 million was available for purchases of
equipment and other fixed assets under various other financing arrangements,
after designating $20.4 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 less than ($31.0) million, ($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 June
30, 1999, September 30, 1999, December 31, 1999, March 31, 2000, June 30,
2000, September 30, 2000 and December 31, 2000, respectively.
At June 30, 1999, we were in compliance with all such covenants.
At June 30, 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 we had deposited in an escrow account
restricted cash and short-term investments of $94.3 million to fund, when due,
the next three semi-annual interest payments on the 10% senior notes.
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<PAGE>
In July 1999, we issued $1.2 billion aggregate principal amount of 11%
senior notes due 2009, consisting of $1.05 billion aggregate principal amount of
11% senior notes due 2009 and Euro 150 million aggregate principal amount of 11%
senior notes due 2009.
The indentures governing the 10% senior notes, the 11 1/2 % senior notes and the
11% 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, the 11 1/2% senior notes and the 11% senior
notes are secured equally and ratably with the obligation or liability
secured by such lien, excluding permitted liens;
- - 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, the 11 1/2%
senior notes and the 11% senior notes on the same terms as the guarantee of
such indebtedness;
- - a limitation on sale and leaseback transactions by us or our subsidiaries;
- - 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 June 30, 1999, we were in compliance with all such covenants.
In May 1999, we completed a public offering of 8,000,000 shares of our common
stock at $50.50 per share for net proceeds of approximately $383.8 million,
after underwriting discounts and commissions and other offering expenses.
In May 1999, we completed a public offering of 9,200,000 shares of our 6 3/4%
Series C Cumulative Convertible Preferred Stock ("Series C Preferred Stock") for
net proceeds of approximately $358.2 million after underwriting discounts and
commissions and other offering expenses. The Series C Preferred Stock has a
liquidation preference of $50 per share. 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"). The Deposit Account is not an asset of ours. Funds in the
Deposit Account will be paid to the holders of the Series C Preferred Stock each
quarter in the amount of $0.84375 per share in cash or may be used, at our
option, to purchase shares of common stock at 95% of the market price of the
common stock on that date for delivery to holders of
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<PAGE>
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 liquidation preference payable in cash or, at our
option, in shares of our common stock at 95% of the market price of the common
stock on that date. Under certain circumstances, we can elect to terminate the
Deposit Account prior to May 15, 2002, at which time the remaining funds in the
Deposit Account would be distributed to us and the Series C Preferred Stock
would begin to accrue dividends.
Each share of Series C Preferred Stock is convertible at any time at the option
of the holders thereof into shares of our common stock at an initial conversion
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 our option, 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% on May 15, 2006
(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, the holders of the Series C Preferred Stock will have the right
to convert their shares into shares of 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 June 30, 1999, we had commitments to certain telecommunications vendors
totaling $162.1 million payable in various years through 2011. Additionally, we
have various agreements to lease office space and facilities and, as of June 30,
1999, were obligated to make future minimum lease payments of $43.7 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 holdback amounts are generally payable up to 24 months after the
date of closing of the related acquisitions. Acquisition holdback amounts
totaled $50.2 million at June 30, 1999.
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.
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 June 30, 1999, we were
obligated to make future payments under these purchase agreements that total
$73.9 million.
We expect to continue to seek opportunities to acquire fiber-based
telecommunications bandwidth to enhance our global network capabilities. In
addition to North America, we anticipate that such bandwidth acquisitions will
be in Latin America, 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
believe that our capital expenditures in 1999 will be greater than those in 1998
and that as a result of our completion of the offering of the 11% senior
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<PAGE>
notes and recent equity offerings, we will accelerate our capital expenditures.
This will occur as we continue to execute our expansion strategy in the 20
largest global telecommunications markets and beyond.
We presently believe, based on the flexibility we expect to have in the timing
of orders of bandwidth, in outfitting our POPs with appropriate
telecommunications and computer equipment, and in controlling the pace and scope
of our anticipated buildout of our international 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 debt and equity
offerings and from future equity or debt financings, which we presently expect
to be able to obtain when needed, will be sufficient to meet the currently
anticipated working capital and capital expenditure requirements of our
operations. We cannot assure you, however, that we will have access to
sufficient additional capital and/or financing on satisfactory terms to enable
us to meet our capital expenditure and working capital requirements.
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 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 and the issuance
of Euro-denominated 11% senior notes, we may begin to use various financial
instruments, including derivative financial instruments, in the ordinary
course of business, for purposes other than trading. These instruments could
include letters of credit, guarantees of debt, interest rate swap agreements
and foreign currency exchange contracts relating to intercompany payables of
foreign subsidiaries. We do not intend to use derivative financial
instruments for speculative purposes Foreign currency exchange contracts
would be used to mitigate foreign currency exposure and with the intent of
protecting the U.S. dollar value of certain currency positions and future
foreign currency transactions. Interest rate swap agreements would be used to
reduce our exposure to risks associated with interest rate fluctuations. By
their nature, all such instruments would involve risk, including the risk of
nonperformance by counterparties. We would attempt to control our exposure to
counterparty credit risk through monitoring procedures and by entering into
multiple contracts.
RISKS ASSOCIATED WITH YEAR 2000
The commonly referred to Year 2000 or Y2K problem results from the fact that
many existing computer programs and systems use only two digits to identify the
year in the date field. These programs were designed and developed without
considering the impact of a change in the century designation. If not corrected,
computer applications that use a two-digit format could fail or create erroneous
results in any computer calculation or other processing involving the Year 2000
or a later date. We have identified two main areas of Y2K risk:
- - 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.
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<PAGE>
We have 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 have 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 outside of the United States 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 September 30, 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;
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<PAGE>
- - 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,of such a risk may have
on us. If any of our material third parties experience significant failures in
their computer systems or operations due to Y2K non-compliance, it could affect
our ability to process transactions or otherwise engage in similar normal
business activities. For example, while we expect our internal systems, U.S. and
non-U.S., to be Y2K ready in stages during 1999, we and our customers who
communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a material adverse effect on our revenues and business and that
of our customers. While many of these risks are outside our control, we have
identified and contacted our critical third party vendors and suppliers and are
establishing contingency plans to remedy any potential interruption to our
operations.
While we believe that we are adequately addressing the Y2K issue, we can not
assure you that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue
will not materially adversely impact our business, prospects, revenues or
financial position. We are uncertain as to our most reasonably likely worst
case Y2K scenario and 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.
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<PAGE>
Exhibit 99.3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PSINET INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN MILLIONS OF U.S. DOLLARS)
(UNAUDITED, AMENDED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 494.1 $ 56.8
Restricted cash and short-term investments 137.5 162.5
Short-term investments and marketable securities 1,079.2 265.7
Accounts receivable, net 65.5 50.2
Prepaid expenses 14.5 11.0
Other current assets 39.7 19.1
-------- --------
Total current assets 1,830.5 565.3
Property, plant and equipment, net 790.4 389.4
Goodwill and other intangibles, net 544.8 282.8
Other assets and deferred charges 133.8 46.7
-------- --------
Total assets $3,299.5 $1,284.2
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of debt $ 89.5 $ 60.0
Trade accounts payable 87.1 90.0
Accrued payroll and related expenses 21.1 8.5
Other accounts payable and accrued liabilities 72.1 82.7
Accrued interest payable 50.0 29.0
Deferred revenue 22.6 19.4
-------- --------
Total current liabilities 342.4 289.6
Long-term debt 2,402.8 1,064.6
Deferred income taxes 2.9 6.2
Other liabilities 64.9 44.0
-------- --------
Total liabilities 2,813.0 1,404.4
-------- --------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred Stock
Preferred stock, Series A -- --
Convertible preferred stock, Series B -- 28.8
Convertible preferred stock, Series C 368.8 --
Common stock 0.7 0.5
Capital in excess of par value 825.9 402.0
Accumulated deficit (638.0) (427.6)
Treasury stock (2.0) (2.0)
Accumulated other comprehensive income 54.0 36.7
Bandwidth asset/IRU agreement (122.9) (158.6)
-------- --------
Total shareholders' equity (deficit) 486.5 (120.2)
-------- --------
Total liabilities and shareholders' equity (deficit) $3,299.5 $1,284.2
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
PSINET INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------- -------------------------------------
1999 1998 1999 1998
------------------ ----------------- ----------------- ---------------
(UNAUDITED, IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(AMENDED) (AMENDED)
<S> <C> <C> <C> <C>
Revenue $ 140.6 $ 67.6 $ 369.3 $ 165.7
Operating costs and expenses:
Data communications and operations 98.5 51.9 261.3 130.5
Sales and marketing 27.5 14.7 68.1 37.9
General and administrative 14.9 11.6 47.3 29.4
Depreciation and amortization 41.6 14.7 102.8 37.0
Charge for acquired in-process
research and development - 13.4 - 40.4
------------------ ----------------- ----------------- ---------------
Total operating costs and expenses 182.5 106.3 479.5 275.2
------------------ ----------------- ----------------- ---------------
Loss from operations (41.9) (38.7) (110.2) (109.5)
Interest expense (59.4) (18.7) (120.8) (38.2)
Interest income 19.8 4.8 32.5 11.4
Other income (expense), net (1.1) (0.3) (0.8) 0.7
Gain (loss) on sale of investments - 5.6 (0.6) 5.6
------------------ ----------------- ----------------- ---------------
Loss before income taxes (82.6) (47.3) (199.9) (130.0)
Income tax benefit (expense) 0.3 - 0.7 (0.1)
------------------ ----------------- ----------------- ---------------
Net loss (82.3) (47.3) (199.2) (130.1)
Return to preferred shareholders (6.4) (0.8) (11.2) (2.3)
------------------ ----------------- ----------------- ---------------
Net loss available to common shareholders $ (88.7) $ (48.1) $ (210.4) $ (132.4)
================== ================= ================= ===============
Basic and diluted loss per share $ (1.37) $ (0.93) $ (3.50) $ (2.70)
================== ================= ================= ===============
Shares used in computing basic and diluted loss
per share (in thousands) 64,844 51,659 60,105 49,120
================== ================= ================= ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
PSINET INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------
1999 1998
------------------ ----------------
(IN MILLIONS OF U.S. DOLLARS)
(UNAUDITED)
<S> <C> <C>
Net cash used in operating activities $(203.5) $ (76.9)
------------------ ----------------
Cash flows from investing activities:
Purchases of property and equipment (217.2) (48.6)
Purchases of short term investments (1,073.8) (247.2)
Proceeds from maturity or sale of short term investments 262.6 200.0
Investments in certain businesses, net of cash acquired (238.5) (123.8)
Restricted cash and short-term investments 25.0 (106.2)
Other, net 0.8 (0.2)
------------------ ----------------
Net cash used in investing activities (1,241.1) (326.0)
------------------ ----------------
Cash flows from financing activities:
Payments on lines of credit - (5.6)
Proceeds from issuance of notes payable, net 1,278.4 718.6
Repayments of debt (107.1) (37.3)
Payments under capital lease obligations (45.6) (24.2)
Proceeds from equity offerings, net 742.0 -
Proceeds from exercise of common stock options 11.2 4.6
Payments of dividends on preferred stock (0.4) (2.1)
Other, net - 0.2
------------------ ----------------
Net cash provided by financing activities 1,878.5 654.2
------------------ ----------------
Effect of exchange rate changes on cash 3.4 (2.0)
------------------ ----------------
Net increase in cash and cash equivalents 437.3 249.3
Cash and cash equivalents, beginning of period 56.8 33.3
------------------ ----------------
Cash and cash equivalents, end of period $ 494.1 $ 282.6
================== ================
</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 (Amended)
These consolidated financial statements for the three and nine month periods
ended September 30, 1999 and 1998 and the related footnote information are
unaudited and have been prepared on a basis substantially consistent with the
audited consolidated financial statements of PSINet Inc. and its subsidiaries
(collectively, "PSINet" or the "Company") as of and for the year ended December
31, 1998 included in the Company's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission (the "Annual Report"). These financial
statements should be read in conjunction with the audited consolidated financial
statements and the related notes to consolidated financial statements of the
Company as of and for the year ended December 31, 1998 included in the Annual
Report and the unaudited quarterly consolidated financial statements and related
notes to unaudited consolidated financial statements of the Company for the
three month period ended March 31, 1999 and the three and six month periods
ended June 30, 1999 included in the Company's Form 10-Q for each of the quarters
then ended, as filed with the Securities and Exchange Commission. In the opinion
of management, the accompanying unaudited consolidated financial statements
contain all adjustments (consisting of normal recurring adjustments) which
management considers necessary to present fairly the consolidated financial
position of the Company at September 30, 1999, the results of its operations for
the three and nine month periods ended September 30, 1999 and 1998, and its cash
flows for the nine months ended September 30, 1999 and 1998. The results of
operations for the three and nine month periods ended September 30, 1999 may not
be indicative of the results expected for any succeeding quarter or for the
entire year ending December 31, 1999.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements.
Actual results may differ from those estimates.
In December 1999, the Company processed certain invoices relating to expenses
for software consulting work performed in the second and third quarters of
1999. These financial statements have been amended to reflect $0.4 million
and $1.0 million of expenses in the second and third quarters of 1999,
respectively. Net loss available to common shareholders for the three and
nine months ended September 30, 1999 has been changed from $87.7 million and
$208.9 million, respectively, to $88.7 million and $210.4 million,
respectively. Basic and diluted loss per share for the three and nine months
ended September 30, 1999 has been changed from $1.35 and $3.48 loss per
share, respectively, to $1.37 and $3.50 loss per share, respectively.
NOTE 2 - ACCOUNTING POLICIES
LOSS PER SHARE - Basic loss per share is computed using the weighted average
number of shares of common stock outstanding during the period. Diluted loss per
share is computed using the weighted-average number of shares of common stock,
adjusted for the dilutive effect of common stock equivalent shares from common
stock options and warrants and convertible preferred stock. Common stock
equivalent shares are calculated using the treasury stock method and include
stock options, warrants and common stock shares issuable upon conversion of
convertible preferred stock. All common stock equivalents, totaling 16.2 million
shares and 4.8 million shares at September 30, 1999 and 1998, respectively, have
been excluded from the computation of diluted loss per share as their effect
would be antidilutive and, accordingly, there is no reconciliation between basic
and diluted loss per share for each of the periods presented.
FOREIGN CURRENCY - Gains and losses on translation of the accounts of the
Company's non-U.S. operations are accumulated and reported as a component of
accumulated other comprehensive income in shareholders' equity. Transaction
gains and losses and translation of non-functional currency denominated
assets and liabilities are recorded in the consolidated statement of
operations.
6
<PAGE>
NOTE 3 - ACQUISITIONS OF CERTAIN BUSINESSES (Amended)
CONSUMMATED TRANSACTIONS
During the nine months ended September 30, 1999, the Company acquired a 100%
ownership interest in the following businesses:
<TABLE>
<CAPTION>
BUSINESS NAME LOCATION ACQUISITION DATE
- ------------- -------- ----------------
<S> <C> <C>
Planete.net France 2/99
Satelnet France 2/99
Tele Linx United Kingdom 2/99
Horizontes Brazil 4/99
Openlink Brazil 4/99
Sao Paulo Online Brazil 5/99
Internet de Mexico Mexico 5/99
DataNet Mexico 5/99
The Internet Company Switzerland 5/99
Caribbean Internet U.S. (Puerto Rico) 6/99
The Internet Access Company (TIAC) U.S. 6/99
Argentina On-Line Argentina 6/99
CSO.net Austria 6/99
Intercomputer Spain 7/99
Abaforum Spain 7/99
Netwing Austria 7/99
Global Link Hong Kong 7/99
Sinfonet Panama 8/99
Domain Brazil 8/99
Netsystem Argentina 8/99
Netline Chile 8/99
Vision Network Hong Kong 9/99
ServNet Brazil 9/99
Elender Hungary 9/99
Infase and Ciberia Spain 9/99
Internet Network Technologies U.S. 9/99
Site Internet LTDA Brazil 9/99
TotalNet Canada 9/99
Terzomillennio Italy 9/99
OrbiNet Panama 9/99
</TABLE>
Subsequent to September 30, 1999, the Company acquired a 100% ownership interest
in the following businesses:
<TABLE>
<CAPTION>
BUSINESS NAME LOCATION ACQUISITION DATE
- ------------- -------- ----------------
<S> <C> <C>
ZebraNet U.S. 10/99
</TABLE>
7
<PAGE>
<TABLE>
<S> <C> <C>
SPIN Switzerland 10/99
Zircon Australia 10/99
Mlink Canada 10/99
Netup Chile 11/99
</TABLE>
Generally, the businesses acquired are ISPs that serve both consumer and
business customers with dedicated and dial-up connectivity, Web hosting services
and systems integration services. TeleLinx operates a data center facility in
the U.K. and Intercomputer operates an e-banking business in Spain.
Each of the acquisitions was accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations of the
acquired companies have been included in the Company's consolidated financial
statements since the acquisition dates. The purchase prices of the 1999
acquisitions have been preliminarily allocated to assets acquired, including
intangible assets, and liabilities assumed, based on their respective fair
values at the acquisition dates. As part of the allocation process, the
Company evaluates each acquisition for acquired in-process research and
development technologies. Based on the Company's preliminary allocations, no
in-process research and development technologies were identified for its 1999
acquisitions to date. The Company is in the process of finalizing valuations
for 1999 acquisitions and the allocation of the purchase price for such
acquisitions is preliminary. The Company expects that final allocations for
material acquisitions will be completed before the 1999 results are
finalized. The Company does not expect any change in the current allocation,
including any charge for acquired in-process research and development, to
have a material impact on its results of operations.
In connection with the acquisitions made during the nine months ended September
30, 1999, liabilities assumed were as follows (in millions of U.S. dollars):
<TABLE>
<CAPTION>
CASH PAID
FAIR VALUE OF FOR THE LIABILITIES
ASSETS ACQUIRED CAPITAL STOCK ASSUMED
--------------- ------------- -------
<S> <C> <C> <C>
Tele Linx $ 88.2 $ (33.2) $ 55.0
TIAC 27.5 (18.6) 8.9
TotalNet 27.5 (23.1) 4.4
Intercomputer 35.6 (32.7) 2.9
Elender 36.9 (35.3) 1.7
All Others 135.7 (119.2) 16.5
------- -------- ------
$ 351.4 $ (262.1) $ 89.4
======= ======== ======
</TABLE>
For certain acquisitions made in 1999 and 1998, the Company has retained a
portion of the purchase price under holdback provisions of the purchase
agreements to secure performance by the sellers of indemnification or other
contractual obligations. These holdback amounts are generally payable up to 24
months after the date of closing of the related acquisitions. Acquisition
holdback amounts totaled $71.4 million at September 30, 1999, the majority of
which is reported in other liabilities.
The following represents the unaudited pro forma results of operations of the
Company for the nine months ended September 30, 1999 and 1998 as if the
acquisitions which closed prior to September 30, 1999 had been consummated at
January 1, 1998. The unaudited pro forma results of operations include certain
pro forma adjustments, including the amortization of intangible assets relating
to the acquisitions. The unaudited pro forma results of operations are prepared
for comparative purposes only and do not necessarily reflect the results that
would have occurred had the acquisitions actually been consummated at January 1,
1998 or the results that may occur in the future.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------ ------------------
(IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNT)
(Amended)
<S> <C> <C>
Revenue....................................................... $ 416.1 $ 225.3
Net loss available to common shareholders..................... $(225.5) $(151.5)
Basic and diluted loss per share.............................. $ (3.75) $ (3.08)
</TABLE>
8
<PAGE>
Total amortization expense of goodwill and other intangibles was $11.7 million
and $2.9 million for the three months ended September 30, 1999 and 1998,
respectively, and $29.3 million and $5.1 million for the nine months ended
September 30, 1999 and 1998, respectively.
PENDING TRANSACTION
On August 22, 1999, the Company entered into a definitive agreement, as
amended on October 14, 1999, to acquire Transaction Network Services, Inc.
(NYSE: TNI). Under the terms of the merger agreement, the aggregate
consideration to be paid to TNI shareholders consists of up to $351.2 million
in cash and up to 7.8 million shares (assuming the exercise of all of the
currently exercisable TNI stock options, which was approximately 1.4
million at September 30, 1999) of PSINet common stock, which represents an
aggregate value of up to approximately $708.0 million, assuming a price per
share of PSINet common stock of $45.719. Additionally, obligations
outstanding under TNI's Revolving Credit Facility, which was $62.0 million at
September 30, 1999, will be repaid as a condition to closing. TNI
shareholders may elect to receive cash, PSINet stock, or both cash and stock,
subject to certain adjustments. The amount of cash paid and shares of PSINet
stock issued in the TNI merger are contingent upon the ultimate number of
outstanding TNI stock options exercised prior to closing. Completion of the
TNI merger is expected in late November 1999 and is subject to a number of
conditions, including receipt of TNI shareholder approval and regulatory
approvals.
TNI operates a communications network focused on the network services needs of
the POS (point-of-sale/ point-of-service) transaction processing industry
through its POS division. TNI currently operates four divisions: (1) the POS
Division, (2) the Telecom Services Division, (3) the Financial Services
Division, and (4) the International Systems Division.
The Company has recently engaged an independent third party to determine the
allocation of the total purchase price of our pending acquisition of TNI and
other completed 1999 acquisitions. The preliminary evaluation for TNI
indicates there are the following intangible assets present: existing
technology including software, patents, unpatented technology and know-how,
tradenames, customer contracts and relationships, existing workforce and
goodwill, with useful lives from five to 20 years, and approximately $35.0
million of purchased in-process research and development. To the extent that
a different portion of the purchase price is allocated to in-process research
and development, a different charge against operating results would be
recognized in the fourth quarter of 1999, the period in which the TNI merger
is expected to be completed. Such difference could be material.
NOTE 4 - SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
Short-term investments and marketable securities consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
U.S. government obligations $ 812.8 $ 235.1
Commercial paper 326.1 112.3
Certificates of deposit 0.6 25.0
Other 4.3 --
------- --------
1,143.8 372.4
Less restricted amounts (64.6) (106.7)
------- --------
Short-term investments and marketable securities, net $ 1,079.2 $ 265.7
========= ========
</TABLE>
9
<PAGE>
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net, consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
Telecommunications bandwidth $ 320.5 $ 148.4
Data communications equipment 460.5 275.4
Leasehold improvements 39.4 29.2
Software 28.8 17.7
Office and other equipment 26.8 18.8
Land and buildings 86.9 3.3
Other 4.4 -
------- -------
967.3 492.8
Less accumulated depreciation and amortization (176.9) (103.4)
------- -------
Property, plant and equipment, net $ 790.4 $ 389.4
======= =======
</TABLE>
Total depreciation and leasehold amortization expense was $29.8 million and
$11.8 million for the three months ended September 30, 1999 and 1998,
respectively, and $73.5 million and $31.9 million for the nine months ended
September 30, 1999 and 1998, respectively.
NOTE 6 - DEBT
Debt consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(IN MILLIONS OF U.S. DOLLARS)
<S> <C> <C>
10% Senior notes $ 600.0 $ 600.0
11% Senior notes (Euro 150,000) 160.3 -
11% Senior notes 1,050.0 -
11.5% Senior notes 350.0 350.0
Capital lease obligations at interest rates ranging from 3.5% to 15.2% 290.5 120.7
Notes payable at interest rates ranging from 1.8% to 11.5%. 38.8 51.0
------- --------
2,489.6 1,121.7
Plus unamortized premium 2.7 2.9
------- --------
2,492.3 1,124.6
Less current portion (89.5) (60.0)
------- --------
Long-term portion $2,402.8 $1,064.6
======== ========
</TABLE>
The Company has deposited in an escrow account restricted cash and short-term
investments of $66.7 million at September 30, 1999 to fund, when due, the
next two semi-annual interest payments on the 10% senior notes. During the
quarter ended September 30, 1999, the Company issued $1.05 billion aggregate
principal amount and Euro 150 million aggregate principal amount of 11%
senior notes due 2009. Each of the indentures governing the Company's senior
notes contains financial and other covenants that, among other things, will
restrict the Company's ability to incur further indebtedness, make certain
payments (including payments of dividends) and investments, and sell assets.
10
<PAGE>
The Company has various financing arrangements accounted for as capital leases
for the acquisition of equipment, telecommunications bandwidth, a building and
other fixed assets. During the nine months ended September 30, 1999 and 1998,
the Company incurred capital lease obligations under these arrangements and from
the acquisitions of businesses of $127.9 million and $ 54.9 million,
respectively. At September 30, 1999, the aggregate unused portion under these
arrangements totaled $293.5 million after designating $27.0 million of payables
for various equipment purchases which will be financed under capital lease
facilities. These financing arrangements contain provisions which, among other
things, require the maintenance of certain financial ratios and restrict the
payment of dividends.
The Company has a senior secured credit facility ("Credit Facility") with a
maximum principal amount of $110.0 million; amounts drawn are payable in
September 2001. At September 30, 1999, no amounts were outstanding, $9.7 million
was being utilized for letters of credit, and $100.3 million was available to
draw. Interest on the Credit Facility is based on a spread over the London
interbank offered rate or the higher of the bank's prime rate or the Federal
funds effective rate, at the Company's option (9.5% at September 30, 1999). The
Credit Facility requires, among other things, the satisfaction of certain
financial covenants, including a minimum annual consolidated revenue test, a
minimum EBITDA test and requires the reduction in the maximum amount of
availability and prepayments equal to the net proceeds received from certain
asset sales and certain casualty events. The Company is required to pay an
annual commitment fee ranging from 0.50% to 0.875% of the unused amounts under
the Credit Facility.
The Company was in compliance with the covenants under each of its financing
arrangements at September 30, 1999.
NOTE 7 - CAPITAL STOCK
TERMINATION OF CONTINGENT PAYMENT OBLIGATION TO IXC
In January 1999, the Company's contingent payment obligation to IXC Internet
Services, Inc. ("IXC") under an agreement relating to the purchase of OC-48
bandwidth from IXC was terminated without the payment of any additional amounts
or issuance of additional shares of common stock to IXC. This occurred when the
fair market value of the shares of common stock originally issued to IXC
exceeded the $240.0 million threshold in accordance with the terms of the
agreement.
ISSUANCE OF COMMON STOCK
In May 1999, the Company completed a public offering of 8,000,000 shares of its
common stock at $50.50 per share for net proceeds of approximately $383.8
million after underwriting discounts and commissions and other offering
expenses.
During the nine months ended September 30, 1999, options with respect to
1,890,234 shares of common stock were exercised for aggregate net proceeds of
approximately $11.2 million.
CONVERSION OF CONVERTIBLE PREFERRED STOCK
During the first quarter of 1999, all 600,000 shares of the Company's Series B
8% convertible preferred stock were converted into an aggregate of 3,000,000
shares of the Company's common stock in accordance with the original terms of
the convertible preferred stock.
11
<PAGE>
ISSUANCE OF CONVERTIBLE PREFERRED STOCK
In May 1999, the Company completed a public offering of 9,200,000 shares of its
6 3/4% Series C cumulative convertible preferred stock ("Series C Preferred
Stock") for net proceeds of approximately $358.2 million after underwriting
discounts and commissions and other offering expenses. The Series C Preferred
Stock has a liquidation preference of $50 per share.
At closing, the purchasers of the Series C Preferred Stock deposited
approximately $85.8 million into an account established with a deposit agent
("Deposit Account"). The Deposit Account is not an asset of the Company.
Funds in the Deposit Account will be paid to the holders of the Series C
Preferred Stock each quarter in the amount of $0.84375 per share in cash or
may be used, at the Company's option, to purchase shares of common stock at 95%
of the market price of the common stock on that date for delivery to holders
of Series C Preferred Stock in lieu of cash payments. Holders of Series C
Preferred Stock received a quarterly interest payment from the deposit
account of approximately $7.8 million on August 15, 1999. The funds placed in
the Deposit Account by the purchasers of the Series C Preferred Stock will,
together with the earnings on those funds, be sufficient to make payments, in
cash or stock, through May 15, 2002. Until the expiration of the Deposit
Account, the Company will accrete a return to preferred shareholders each
quarter from the date of issuance at an annual rate of approximately 6 3/4%
of the liquidation preference per share. Such amount will be recorded as a
deduction from net income to determine net income available to common
shareholders. Upon the expiration of the Deposit Account, which is expected
to occur on May 15, 2002 unless earlier terminated, the Series C Preferred
Stock will begin to accrue dividends at an annual rate of 6 3/4% of the
liquidation preference payable in cash or, at our option, in shares of our
common stock at 95% of the market price of the common stock on that date.
Under certain circumstances, the Company can elect to terminate the Deposit
Account prior to May 15, 2002, at which time the remaining funds in the
Deposit Account would be distributed to the Company and the Series C Preferred
Stock would begin to accrue dividends.
NOTE 8 - COMPREHENSIVE INCOME (LOSS) (Amended)
Comprehensive income (loss) for the three and nine months ended September 30,
1999 and 1998 was as follows (in millions of U.S. dollars):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
(Amended) (Amended)
<S> <C> <C> <C> <C>
Net loss $ (82.3) $ (47.3) $ (199.2) $ (130.1)
--------- --------- --------- --------
Other comprehensive income:
Unrealized holding gains (losses) 2.2 (5.0) 2.7 -
Foreign currency translation adjustment 34.1 0.3 14.6 (0.5)
--------- --------- --------- --------
36.3 (4.7) 17.3 (0.5)
--------- --------- --------- --------
Comprehensive income (loss) $ (46.0) $ (52.0) $ (181.9) $ (130.6)
========= ========= ========= ========
</TABLE>
During the three and nine months ended September 30, 1999, significant
fluctuations in the Japanese Yen resulted in the majority of the change in the
foreign currency translation adjustment.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
On March 23, 1999, an arbitrator awarded The Chatterjee Management Company
("Chatterjee") compensatory damages, including interest and legal expenses,
from the Company. In conjunction with this arbitration decision, the Company
recorded a charge of $49.0 million during its fiscal year ended December 31,
1998, which was included in other accounts payable and accrued liabilities in
its consolidated balance sheets at December 31, 1998 and was paid in April
1999. After accounting for other expenses, the resolution of the previously
established accrual resulted in a non-recurring gain during the second
quarter of 1999 of $0.7 million.
As of September 30, 1999, the Company had commitments to certain
telecommunications vendors under operating lease agreements totaling $152.8
million payable in various years through 2011. Additionally, the Company has
various agreements to lease office space, facilities and equipment and, as of
September 30, 1999, the Company was obligated to make future minimum lease
payments of $53.5 million under such non-cancelable operating leases expiring
in various years through 2009.
In connection with the Company's previously announced naming rights and
sponsorship agreements with the Baltimore Ravens of the National Football
League, the Company will make payments over the next 19 years totaling
approximately $81.7 million.
Under the terms of the merger agreement, the aggregate consideration to be paid
to TNI shareholders consists of up to $351.2 million in cash and up to 7.8
million shares (assuming the exercise of all of the currently exercisable TNI
stock options, which was approximately 1.4 million at September 30, 1999) of
PSINet common stock, which represents an aggregate value of up to approximately
$708.0 million, assuming a price per share of PSINet common stock of $45.719.
Additionally, obligations outstanding under TNI's Revolving Credit Facility,
which was $62.0 million at September 30, 1999, will be repaid as a condition to
closing.
At September 30, 1999, we were obligated to make future cash payments that
total $240.5 million for acquisitions of global fiber-based and satellite
telecommunications bandwidth, including IRUs or other rights. We also expect
that there will be additional costs, such as connectivity and equipment
charges, in connection with taking full advantage of such acquired bandwidth
and IRUs. Certain of this fiber-based and satellite telecommunications
bandwidth may require the acquisition and installation of equipment necessary
to access and light the bandwidth in order to make it operational. At
September 30, 1999, we were obligated to make capital expenditures for such
equipment of $242.0 million. In addition, currently we are obligated to make
expenditures in connection with our build-out of new eCommerce Web hosting
centers in key financial and business centers throughout the world of
approximately $61.8 million. As a result of the foregoing, we currently
believe that our capital expenditures in 1999 will be substantially greater
than those in 1998 and that, as a result of the completion of our recent debt
and equity offerings, our capital expenditure program will be accelerated.
This may occur as we continue to execute our expansion strategy in the 20
largest global telecommunications markets and beyond.
12
<PAGE>
The Company is subject to certain other claims and legal proceedings that arise
in the ordinary course of its business activities. Each of these matters is
subject to various uncertainties, and it is possible that some of these matters
may be decided unfavorably to the Company. Management believes that any
liability that may ultimately result from the resolution of these matters will
not have a material adverse effect on the financial condition or results of
operations or cash flows of the Company.
NOTE 10 - INDUSTRY SEGMENT AND GEOGRAPHIC REPORTING (Amended)
The Company's operations are organized into four geographic operating segments -
U.S./Canada, Latin America, Europe and Asia/Pacific. The Company evaluates the
performance of its segments and allocates resources to them based on revenue and
EBITDA, which the Company defines as losses before interest expense and interest
income, taxes, depreciation and amortization, other non-operating income and
expense, and charge for acquired in-process research and development.
Operations of the Company's U.S./Canada segment include shared network costs and
corporate functions which the Company does not allocate to its other geographic
segments for management reporting purposes. Capital expenditures include both
assets acquired for cash and financed through capital leases and seller-financed
arrangements.
Financial information for the Company's geographic operating segments is
presented below (in millions of U.S. dollars):
<TABLE>
<CAPTION>
U.S./CANADA LATIN AMERICA EUROPE ASIA/PACIFIC ELIMINATIONS TOTAL
(Amended) (Amended)
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
Revenue $ 75.1 $ 7.3 $ 23.7 $ 34.5 $ --- $ 140.6
EBITDA (6.2) 1.1 (0.1) 4.9 --- (0.3)
Assets 2,479.5 112.4 339.1 368.4 --- 3,299.4
Capital expenditures 124.0 1.5 26.6 14.1 * 166.2
THREE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue $ 49.1 $ --- $ 11.4 $ 7.1 $ --- $ 67.6
EBITDA (6.4) --- (1.4) (2.8) --- (10.6)
Assets 632.3 --- 57.3 189.0 --- 878.6
Capital expenditures 47.5 --- 4.3 1.4 --- 53.2
NINE MONTHS ENDED
SEPTEMBER 30, 1999
Revenue $ 204.3 $ 10.5 $ 58.3 $ 96.2 $ --- $ 369.3
EBITDA (18.0) 1.9 (2.7) 11.4 --- (7.4)
Assets 2,479.5 112.4 339.1 368.4 --- 3,299.4
Capital expenditures 287.1 1.8 64.3 27.6 --- 380.8
NINE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue $ 130.1 $ --- $ 25.4 $ 10.5 $ (0.3) $ 165.7
EBITDA (25.2) --- (4.2) (2.7) --- (32.1)
Assets 632.3 --- 57.3 189.0 --- 878.6
Capital expenditures 120.3 --- 8.8 1.8 --- 130.9
</TABLE>
EBITDA for all reportable segments differs from consolidated loss before income
taxes reported in the Company's consolidated statements of operations as follows
(in millions of U.S. dollars):
13
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
(Amended) (Amended)
<S> <C> <C> <C> <C>
EBITDA $ (0.3) $ (10.6) $ (7.4) $ (32.1)
Reconciling items:
Depreciation and amortization (41.6) (14.7) (102.8) (37.0)
Charge for acquired IPR&D - (13.4) - (40.4)
Interest expense (59.4) (18.7) (120.8) (38.2)
Interest income 19.8 4.8 32.5 11.4
Other income (expense), net (1.1) (0.3) (0.8) 0.7
Gain (loss) on sale of investments - 5.6 (0.6) 5.6
--------- --------- --------- ---------
Loss before income taxes $ (82.6) $ (47.3) $ (199.9) $ (130.0)
========= ========= ========= =========
</TABLE>
14
<PAGE>
Exhibit 99.4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH (1) OUR
ACCOMPANYING UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO,
(2) OUR AUDITED CONSOLIDATED FINANCIAL STATEMENTS, NOTES THERETO AND
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998 INCLUDED IN OUR
ANNUAL REPORT ON FORM 10-K FOR SUCH PERIOD, AND (3) OUR UNAUDITED QUARTERLY
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES FOR THE THREE MONTH
PERIOD ENDED MARCH 31, 1999 AND FOR THE THREE AND SIX MONTH PERIODS ENDED
JUNE 30, 1999 INCLUDED IN OUR FORM 10-Q AND IN THIS 8-K FOR EACH OF THE
QUARTERS THEN ENDED, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
THE RESULTS SHOWN HEREIN ARE NOT NECESSARILY INDICATIVE OF THE RESULTS TO BE
EXPECTED IN ANY FUTURE PERIODS. THIS DISCUSSION CONTAINS FORWARD-LOOKING
STATEMENTS BASED ON CURRENT EXPECTATIONS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS AND THE TIMING OF EVENTS COULD DIFFER
MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF
FACTORS. FOR A DISCUSSION OF THE RISK FACTORS THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS, YOU SHOULD READ
"RISK FACTORS" INCLUDED AS EXHIBIT 99.1 TO OUR FORM 10-Q AS FILED ON NOVEMBER
15, 1999 AND OUR OTHER PERIODIC REPORTS AND DOCUMENTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.
GENERAL
We are the leading independent global provider of Internet and eCommerce
solutions to businesses. As an Internet Super Carrier, or ISC, we offer
global distribution of PSINet services through wholly-owned subsidiaries,
supported by local language customer service and a worldwide fiber optic
network capable of speeds of over three terabits. We define the elements of
an ISC to include:
o Multiple eCommerce Web hosting centers - We currently have or are building
eCommerce Web hosting centers in key financial and business centers around
the world, including Atlanta, Frankfurt, Hong Kong, London, Los Angeles,
New York, Paris, Sao Paulo, Toronto, Tokyo and Washington, D.C.;
o Extensive global distribution - We have over 1,000 sales personnel and over
2,500 value added resellers, or VARs, systems integrators and Web design
professionals in 22 countries throughout the world;
o Global brand name recognition - Our brand name is increasingly recognized
throughout the world for Internet-protocol services and applications that
meet the needs of business customers, supported by local language sales,
provisioning and service; and
o Worldwide fiber network and related optronic equipment - We operate one of
the largest global data communications networks that enables or in the
future is expected to enable our customers to connect to the Internet and
access their corporate networks and systems resources from most of the
world's major business and population centers.
We offer a suite of value-added products and services that are designed to
enable our customers to maximize utilization of the Internet to communicate more
efficiently with their customers, suppliers, business partners and remote office
locations. We conduct our business through operations organized into four
geographic operating segments--U.S./Canada, Latin America, Europe and
Asia/Pacific. Our services and products include access services that offer
dedicated, dial-up, wireless and digital subscriber line, or DSL, connections,
Web hosting services, intranets, virtual private networks, or VPNs, electronic
commerce, or eCommerce, voice-over-Internet protocol, email and managed security
services. We also provide wholesale and private label network connectivity and
related services to other Internet service providers, known as ISPs, and
telecommunications carriers to further utilize our network capacity.
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We provide Internet connectivity and Web hosting services to customers in 90 of
the 100 largest metropolitan statistical areas in the U.S. and in 17 of the 20
largest global telecommunications markets and are currently operating in 22
countries. We have operations in four separate geographic segments, structured
as follows: (1) U.S./Canada; (2) Latin America (Argentina, Brazil, Chile,
Mexico, and Panama); (3) Europe (Austria, Belgium, France, Germany, Hungary,
Italy, Luxembourg, the Netherlands, Spain, Switzerland, and the United Kingdom);
and (4) Asia/Pacific (Australia, Hong Kong, Japan and the Republic of Korea). We
typically enter a new market through the acquisition of an existing company
within the particular market, and then further expand through a combination of
organic growth supplemented by further acquisitions. Revenue from non-U.S.
operations as a percentage of consolidated results comprised 53% of revenue in
the third quarter of 1999, which is consistent with the 51% of revenue generated
by non-U.S. operations in the second quarter of 1999. By comparison, non-U.S.
operations comprised 40% of revenue for all of 1998.
We operate one of the largest global commercial data communications networks.
Our Internet-optimized network extends around the globe and is connected to
over 700 sites, called points of presence or POPs, situated throughout our
geographic operating regions that enable our customers to connect to the
Internet. Our network reach allows our customers to access their corporate
network and systems resources through local calls in over 150 countries. We
further expand the reach of our network by connecting with other large ISPs
at 163 points through 67 contractual arrangements, called peering agreements
that permit the exchange of information between our network and the networks
of our peering partners. As part of our ISC strategy, we have opened four
global Internet hosting facilities in the U.S., Switzerland, Canada and the
United Kingdom containing a total of approximately 125,000 square feet. Most
recently, we opened a second Internet hosting facility in the U.S. in New
York in October 1999 and currently anticipate opening an additional Internet
hosting facility in Los Angeles in November 1999, which contain an aggregate
total for both hosting facilities of approximately 55,000 square feet. We
have two network operating centers that monitor and manage network traffic
24-hours per day, seven-days per week.
Since the commencement of our operations, we have undertaken a program of
developing and expanding our data communications network. In connection with
this program, we have made significant investments in telecommunications
circuits and equipment to produce a geographically-dispersed, Asynchronous
Transfer Mode (ATM), Integrated Service Digital Network (ISDN) and Switched
Multimegabit Data Service (SMDS) compatible frame relay network specially
designed to optimize Internet traffic. ATM, ISDN and SMDS are among the most
widely used switching standards. These investments generally are made in advance
of obtaining customers and resulting revenue.
As part of our ongoing efforts to further expand and enhance our network, we
have acquired or agreed to acquire significant amounts of global
telecommunications bandwidth in order to build a worldwide fiber optic
network capable of speeds of over three terabits. These include long-term
rights, typically for ten years or more called indefeasible rights of use, or
IRUs, or other rights, in dark fiber, lit fiber, and satellite transponder
capacity. The acquisition of these telecommunications bandwidth assets has
increased our network capacity by a substantial magnitude while reducing
significantly our data communications and operations costs per equivalent
mile. The increased network capacity should enable us to expand our offering
of higher-speed or more bandwidth intensive Internet and Internet-related
services to a larger customer base.
We provide our customers with different types of connectivity products to the
Internet based upon their needs and demands. Some of our customers are served
through DSL technology, which is an alternative technology for local loop
access using existing copper infrastructure. DSL is a single connectivity
solution, of which there are many, that our customers may choose. We will
provide DSL technology, along with wireless and other new technologies that
provide competitive advantages to our
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customers in meeting their existing and evolving service requirements. The
continued migration of customers to DSL as a solution could impact our
revenue mix, but in the aggregate we expect greater customer growth, and
therefore greater revenue growth, to be generated from our offering of DSL
connectivity services, although we cannot assure you that our DSL services
will gain market acceptance or that such growth will occur.
ISSUANCE OF 11% SENIOR NOTES
In July 1999, we completed a private placement of $1.2 billion aggregate
principal amount of our 11% senior notes due 2009, consisting of $1.05 billion
aggregate principal amount of 11% senior notes due 2009 and Euro 150 million
aggregate principal amount of 11% senior notes due 2009, for aggregate net
proceeds of approximately $1.17 billion after giving effect to discounts and
commissions and other offering expenses.
PENDING ACQUISITION OF TRANSACTION NETWORK SERVICES, INC.
On August 22, 1999, we entered into a definitive agreement, as amended on
October 14, 1999, to acquire Transaction Network Services, Inc. (NYSE: TNI).
Under the terms of the merger agreement, the aggregate consideration to be
paid to TNI shareholders consists of up to $351.2 million in cash and up to
7.8 million shares (assuming the exercise of all of the currently exercisable
TNI stock options, which was approximately 1.4 million at September 30, 1999)
of PSINet common stock, which represents an aggregate value of up to
approximately $708.0 million, assuming a price per share of PSINet common
stock of $45.719. Additionally, the obligations outstanding under TNI's
Revolving Credit Facility, which was $62.0 million at September 30, 1999,
will be repaid as a condition to closing. TNI shareholders may elect to
receive cash, PSINet stock, or both cash and shares, subject to adjustments.
The amount of cash paid and shares of PSINet stock issued in the TNI merger
are contingent upon the ultimate number of outstanding TNI stock options
exercised prior to closing. Completion of the TNI merger is expected in late
November 1999 and is subject to a number of conditions, including receipt of
TNI shareholder approval and regulatory approvals.
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AS COMPARED TO THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 1998
RESULTS OF OPERATIONS
REVENUE. We generate revenue primarily from the sale of Internet access,
eCommerce and related services to businesses. Revenue was $140.6 million for
the three months ended September 30, 1999, an increase of $73.0 million, or
108%, from $67.6 million for the three months ended September 30, 1998 and an
increase of $16.8 million, or 14%, over the $123.8 million for the three
months ended June 30, 1999. Revenue was $369.3 million for the nine months
ended September 30, 1999, an increase of $203.6 million, or 123%, from $165.7
million for the nine months ended September 30, 1998. Revenue growth of 14%
from the second quarter of 1999 consisted of organic (internally generated)
growth of 10% and growth from acquisitions of 4%. Our internally generated
revenue growth is attributable to a number of factors, including an increase
in the number of business customer and ISP accounts and an increase in the
average annual revenue realized per new business customer account, which are
offset by a decrease in hardware sales to customers. While most revenue is
recurring in nature, from time to time we generate non-recurring revenue from
consulting and other arrangements that may or may not continue in the future.
To date, such amounts have not been material to revenue.
Our business customer account base increased by 71% to 79,900 business accounts
at September 30, 1999 from 46,700 business accounts at September 30, 1998. By
comparison, at June 30, 1999, we had 73,400 accounts. Of the total business
account growth from September 30, 1998, 20,085 accounts were
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attributable to the existing customer base of the companies we acquired.
Accounts outside the U.S. represented 60% of our customer account base at
September 30, 1999, compared to 51% at September 30, 1998. The total number
of our Carrier and ISP customers grew to 644 at September 30, 1999, and,
together with our small office/home office ("SOHO") and consumer customers,
provided service to 1.2 million customers. This compares with 141 Carrier and
ISP customers and 665,000 SOHO and consumer customers at September 30, 1998.
Average annual new contract value for business accounts increased to $6,700
for the three months ended September 30, 1999 from $5,900 for the three
months ended September 30, 1998 and $6,000 for the full year 1998, which we
believe reflects an increasing demand for value-added services and higher
levels of bandwidth. The average annual new contract value for the current
quarter represents a decrease in comparison to the $7,300 average annual
value for the quarter ended June 30, 1999, due to the effect of non-U.S.
acquisitions in some less mature business markets. Our business account
retention rate remained strong for the third straight quarter in a row at 80%
for the three months ended September 30, 1999 and compared with a full-year
retention rate in 1998 of 79%.
DATA COMMUNICATIONS AND OPERATIONS (Amended). 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 $98.5 million (70.1% of revenue)
for the three months ended September 30, 1999, an increase of $46.6 million,
or 89.8%, from $51.9 million (76.8% of revenue) for the three months ended
September 30, 1998. Data communications and operations expenses were $261.3
million (70.8% of revenue) for the nine months ended September 30, 1999, an
increase of $130.8 million, or 100.2%, from $130.5 million (78.8% of revenue)
for the nine months ended September 30, 1998. The increase in expenses
related principally to increases in:
- -- the number of leased backbone, dedicated customer and dial-up circuits;
- -- expenditures for additional primary rate interface, or PRI, circuits to
support the growth of our Carrier and ISP customer 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 21,400 at September 30,
1999 from 11,400 at September 30, 1998, an increase of 87.7%. Comparing the
third quarter of 1999 to the third quarter of 1998, backbone circuit costs
increased $10.6 million, or 84.3%, dedicated customer circuit costs increased
$7.5 million, or 69.3%, PRI expense increased $8.9 million, or 96.5%,
personnel and related operating expenses associated with network operations,
customer support and field service increased $10.3 million, or 84.4% and
operating and maintenance charges on our bandwidth increased $1.4 million, or
208%. Circuit costs relating to our new and expanded POPs and PRIs generally
are incurred by us in advance of obtaining customers and resulting revenue.
Historically, the organic growth of our Carrier and ISP customer business is
highest beginning late in the fourth quarter due to seasonal impacts from
holiday sales of computers. In order to prepare for this demand, in addition
to improving service to existing customers, we have expended a considerable
amount of effort during the past six months in building an inventory of PRIs.
As a result, our monthly direct costs in the U.S. for PRIs has increased from
approximately $3.0 million in the month of March 1999 to approximately $5.0
million in the month of September 1999. Based on current capacity and
customer usage rates, we believe that we are now able to service
approximately twice as many dial-up customers in the U.S. than we currently
service with these PRIs.
Although we expect that data communications and operations expenses will
continue to increase as our customer base grows, we anticipate that such
expenses will continue to decrease over time as a percentage of revenue as we
acquire network bandwidth under IRU or capital lease agreements due to decreases
in unit costs as a result of continued increases in network utilization. Network
bandwidth
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acquired under IRU or capital lease agreements is recorded as an asset and
amortized over its useful life. This will, in turn, result in an increase in the
operations and maintenance expense component of data communications costs,
increases in costs for other leased circuits connected to the bandwidth, as well
as increases in depreciation and amortization expense over the useful life of
the bandwidth, typically 10 to 20 years.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel costs, advertising costs, distribution costs and related occupancy
costs. Sales and marketing expenses were $27.5 million (19.5% of revenue) for
the three months ended September 30, 1999, an increase of $12.8 million, or
87.2%, from $14.7 million (21.8% of revenue) for the three months ended
September 30, 1998. Sales and marketing expenses were $68.1 million (18.4% of
revenue) for the nine months ended September 30, 1999, an increase of $30.2
million, or 79.4%, from $37.9 million (22.9% of revenue) for the nine months
ended September 30, 1998. The increase is principally attributable to costs
associated with the expansion of our sales force internationally in
conjunction with our growth and acquisitions, implementation of our newly
regionalized sales and marketing organization in the U.S. and to advertising
costs, including costs associated with our naming rights and sponsorship
agreements for PSINet Stadium with the Baltimore Ravens of the National
Football League and the launch of our NFL television advertising campaign.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and occupancy costs for executive, financial, legal and
administrative personnel and provision for uncollectible accounts receivable.
General and administrative expenses were $14.9 million (10.6% of revenue) for
the three months ended September 30, 1999, an increase of $3.3 million, or
27.6%, from $11.6 million (17.1% of revenue) for the three months ended
September 30, 1998 which resulted from approximately $4.4 million increase
relating to general and administrative expenses of companies acquired after
September 30, 1998, a decrease of organic expenses of approximately $0.5
million and a decrease of approximately $0.7 million relating to the reversal
of certain acquisition related liabilities.
General and administrative expenses were $47.3 million (12.8% of revenue) for
the nine months ended September 30, 1999, an increase of $17.9 million, or
60.7%, from $29.4 million (17.8% of revenue) for the nine months ended
September 30, 1998. The increase resulted from an approximately $11.7 million
increase relating to general and administrative expenses of companies
acquired after September 30, 1998 and an increase of expenses relating to our
organic growth of approximately $6.9 million due to the addition of
management staff and other related operating expenses across our
organization. We are finalizing plans to consolidate most of our Virginia
locations into one facility. As a result, various costs associated with the
termination of various facility leases and the relocation of employees are
likely to be incurred over the next two quarters.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs were $41.6
million (29.6% of revenue) for the three months ended September 30, 1999, an
increase of $26.9 million, or 184%, from $14.7 million (21.7% of revenue) for
the three months ended September 30, 1998. Depreciation and amortization costs
were $102.8 million (27.8% of revenue) for the nine months ended September 30,
1999, an increase of $65.8 million, or 178%, from $37.0 million (22.3% of
revenue) for the nine months ended September 30, 1998.
Depreciation and amortization costs have increased as a result of capital
expenditures associated with network infrastructure enhancements, including
telecommunications bandwidth acquisitions, and depreciation and amortization of
tangible and intangible assets related to business acquisitions. We anticipate
that our depreciation and amortization expenses will continue to increase
significantly as we acquire network bandwidth under IRU or capital lease
agreements, and as we record depreciation and
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amortization on tangible and intangible assets related to business
combinations and expansion of our operations. In connection with finalizing
our plans to consolidate most of our Virginia locations into one facility,
the useful lives of certain of our assets may be shortened over the next two
quarters.
Our rapid growth over the past year through acquisitions and through the
expansion of our global data communications network has led to a significant
increase in the carrying value of our tangible and intangible assets. In
conjunction with the process of integrating these assets into our business,
we may identify opportunities where we can streamline our operations and
improve network quality through the elimination of redundant or
underperforming assets. Our ongoing integration actions and other steps aimed
at reducing our cost structure may lead to charges or to adjustments to the
depreciable lives of our assets in the future.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. The results for the nine months
ended September 30, 1999 include no charges for acquired in-process research and
development related to acquisitions completed during the period. The results for
the nine months ended September 30, 1998 include a $40.4 million charge (24.4%
of revenue) for acquired in-process research and development. The charges in
1998 were based on independent valuations and reflect technologies acquired
prior to technological feasibility and for which there was no alternative future
use. We are in the process of finalizing valuations for 1999 acquisitions and
the allocation of the purchase price for such acquisitions is preliminary. We
expect that final allocations for material acquisitions will be completed before
the 1999 results are finalized. We do not expect any change in the current
allocation, including any charge for acquired in-process research and
development, to have a material impact on our results of operations.
We have recently engaged an independent third party to determine the
allocation of the total purchase price of our pending acquisition of TNI and
other 1999 completed acquisitions. The preliminary evaluation for TNI
indicates there are the following intangible assets present: existing
technology including software, patents, unpatented technology and know-how,
tradenames, customer contracts and relationships, existing workforce and
goodwill, with useful lives from five to 20 years, and approximately $35.0
million of purchased in-process research and development. To the extent that
a different portion of the purchase price is allocated to in-process research
and development, a different charge against operating results would be
recognized in the fourth quarter of 1999, the period in which the TNI merger
is expected to be completed. Such charge may be material.
INTEREST EXPENSE. Interest expense was $59.4 million (42.2% of revenue) for
the three months ended September 30, 1999, an increase of $40.7 million, or
217%, from $18.7 million (27.7% of revenue) for the three months ended
September 30, 1998. Interest expense was $120.8 million (32.7% of revenue)
for the nine months ended September 30, 1999, an increase of $82.6 million,
or 216%, from $38.2 million (23.0% of revenue) for the nine months ended
September 30, 1998. The increase was due to interest related to our 10%
senior notes issued in April 1998, 11 1/2% senior notes issued in November
1998 and 11% senior notes issued in July 1999, as well as to increased
borrowings and capital lease obligations incurred to finance our network
expansion and to fund our working capital requirements.
INTEREST INCOME. Interest income was $19.8 million (14.0% of revenue) for the
three months ended September 30, 1999, an increase of $15.0 million, or 316%,
from $4.8 million (7.0% of revenue) for the three months ended September 30,
1998. Interest income was $32.5 million (8.8% of revenue) for the nine months
ended September 30, 1999, an increase of $21.1 million, or 186%, from $11.4
million (6.9% of revenue) for the nine months ended September 30, 1998. The
increase was due to interest received on the net proceeds of our various
financing activities during 1998 and 1999, which we invest in short-term
investment grade and government securities until such time as we use them for
other purposes.
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NET LOSS AVAILABLE TO COMMON SHAREHOLDERS AND LOSS PER SHARE (Amended). Our
net loss available to common shareholders for the three months ended
September 30, 1999 was $88.7 million, or $1.37 basic and diluted loss per
share, an increase of $40.6 million, or 84.3%, from a net loss available to
common shareholders for the three months ended September 30, 1998 of $48.1
million, or $0.93 basic and diluted loss per share. Our net loss available to
common shareholders was $210.4 million, or $3.50 basic and diluted loss per
share, for the nine months ended September 30, 1999, an increase of $78.0
million, or 58.9%, from $132.4 million, or $2.70 basic and diluted loss per
share, for the nine months ended September 30, 1998.
The primary reasons for the increase were:
- -- operating losses from certain acquired businesses;
- -- an increase in interest expense due to the issuance of our senior notes;
- -- acquisitions of fiber-based and satellite telecommunications bandwidth,
leading to an increase in depreciation, personnel and other operating costs
to manage the bandwidth;
- -- an increase in depreciation and amortization related to acquisitions,
offset by the reduction in charges for acquired in-process research and
development; and
- -- an increase in expenditures for dial-up circuits (e.g., PRIs).
The return to preferred shareholders is subtracted from net loss in determining
the net loss available to common shareholders. Because inclusion of common stock
equivalents is antidilutive, basic and diluted loss per share are the same for
each period presented.
SEGMENT INFORMATION (Amended)
Our operations are organized into four geographic operating segments -
U.S./Canada, Latin America, Europe and Asia/Pacific. Latin America became a
new segment in 1999 as a result of acquisitions.
We evaluate the performance of our operating segments and allocate resources
to them based on revenue and EBITDA, which we define as earnings (losses)
before interest expense and interest income, taxes, depreciation and
amortization, other non-operating income and expense, and charge for acquired
in-process research and development. Since acquisitions are such an integral
part of the growth of our business over the last year, the following table
highlights the components of our revenue growth by breaking it into organic
and acquisitive growth.
Key changes in the metrics we report in our segment disclosure footnote are
as follows:
<TABLE>
<CAPTION>
U.S./CANADA LATIN AMERICA EUROPE ASIA/PACIFIC TOTAL
----------- ------------- ------ ------------ ---------
(Amended) (Amended)
<S> <C> <C> <C> <C> <C>
Revenue growth - 3Q98 to 3Q99 53% ** 108% 386% 108%
Revenue growth - YTD98 to YTD99 57% ** 130% 816% 123%
EBITDA as % of Revenue - 3Q99 (8)% 15% --% 14% --%
EBITDA as % of Revenue - 3Q98 (13)% ** (12)% (39)% (16)%
EBITDA as % of Revenue - YTD99 (9)% 18% (5)% 12% (2)%
EBITDA as % of Revenue - YTD98 (19)% ** (17)% (26)% (19)%
Asset growth - 9/30/98 to 9/30/99 292% ** 491% 95% 276%
Capital expenditure growth -- 3Q98 to 3Q99 161% ** 519% 907% 212%
Capital expenditure growth -- YTD98 to YTD99 139% ** 631% 1433% 191%
</TABLE>
** Latin America is new in 1999 as a result of acquisitions.
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All of our operating segments have experienced significant changes in
revenue, EBITDA, assets and capital expenditures during 1999 as compared with
1998 due to organic growth, to significant acquisitions primarily outside of
the U.S. and to investments in our network as described elsewhere in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Our loss from operations differs from EBITDA only by depreciation and
amortization and the charge for acquired in-process research and development;
therefore, loss from operations in each segment reflects the same underlying
trends as those impacting EBITDA as a percentage of revenue.
LIQUIDITY AND CAPITAL RESOURCES
We historically have had losses from operations, which have been funded
primarily through borrowings and capital lease financings from vendors,
financial institutions and other third parties, and through the issuance of debt
and equity securities. In 1999, we have to date received net proceeds of
approximately $1.9 billion from debt and equity financings. At September 30,
1999, we had $1.7 billion of cash, cash equivalents, short-term investments and
marketable securities, including restricted amounts.
CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Cash flows used in operating activities were $203.5 million and $76.9 million
for the nine months ended September 30, 1999 and 1998, respectively. Cash
flows from operating activities can vary significantly from period to period
depending upon the timing of operating cash receipts and payments and other
working capital changes, especially accounts receivable, prepaid expenses and
other assets, and accounts payable and accrued liabilities. In both of these
nine-month periods, our net losses were the primary component of cash used in
operating activities, offset by significant non-cash depreciation and
amortization expenses relating to our network and intangible assets.
Operating cash flows in 1999 also include the $48.0 million arbitration award
payment.
Cash flows used in investing activities were $1.2 billion and $326.0 million
for the nine months ended September 30, 1999 and 1998, respectively.
Investments in certain businesses resulted in the use of $238.5 million of
cash for the
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nine months ended September 30, 1999, net of cash acquired. Investments in
our network and facilities during the first nine months of 1999 resulted in
total additions to fixed assets of $380.8 million. Of this amount, $127.9
million was financed under vendor or other financing arrangements, $35.7
million of non-cash additions related to the OC-48 bandwidth acquired from
IXC Internet Services, Inc. ("IXC"), and $217.2 million was expended in cash.
For the nine months ended September 30, 1998, total additions were $130.9
million, of which $54.9 million was financed under equipment financing
agreements, $27.4 million of non-cash additions related to the OC-48
bandwidth acquired from IXC and $48.6 million was expended in cash. Purchases
of short-term investments during the first nine months of 1999 were an
aggregate of $1.07 billion, offset by proceeds from the sale and maturity of
short-term investments of $262.6 million. Purchases of short-term investments
during the nine months of 1998 were an aggregate of $247.2 million offset by
proceeds from the sale and maturity of short-term investments of $200.0
million. Investing cash flows in the first nine months of 1999 and 1998 were
increased by $25.0 million and decreased by $106.2 million, respectively,
from changes in restricted cash and short-term investments related to various
financing and acquisition activities.
Cash flows provided by financing activities were $1.88 billion and $654.2
million for the nine months ended September 30, 1999 and 1998, respectively.
In the first nine months of 1999, we received $1.28 billion from the issuance
of notes payable and $742.0 million from equity offerings. In the first nine
months of 1998, we received net proceeds from the issuance of notes payable
of $718.6 million. We made repayments aggregating $152.7 million and $67.1
million for the nine months ended September 30, 1999 and 1998, respectively,
on our lines of credit, capital lease obligations and notes payable. During
the nine months ended September 30, 1999 and 1998, we received proceeds from
the exercise of stock options of $11.2 million and $4.6 million, respectively.
CAPITAL STRUCTURE
Our capital structure at September 30, 1999 consisted of a revolving credit
facility, other lines of credit, capital lease obligations, senior notes,
convertible preferred stock and common stock.
Total borrowings at September 30, 1999 were $2.5 billion, which included $0.1
billion in current obligations and $ 2.4 billion in long-term debt, capital
lease obligations and notes payable.
We have a senior secured revolving credit facility that expires on September 29,
2001 and has an aggregate principal amount of $110.0 million. At September 30,
1999, no amounts were outstanding, $9.7 million was being utilized for letters
of credit, and $100.3 million was available to draw under the credit facility.
In addition, as of September 30, 1999, $293.5 million was available for
purchases of equipment and other fixed assets under various other financing
arrangements, after designating $27.0 million of payables for various equipment
purchases that we intend to finance under these agreements.
Our bank financing arrangements, which are secured by substantially all of our
assets, require us to satisfy many financial covenants such as those relating to
consolidated revenue, leverage, liquidity and EBITDA (as defined therein), and
prohibit us from paying cash dividends and repurchasing our capital stock
without the lender's consent. In particular, we are prohibited from permitting:
- -- consolidated revenue for the period of four consecutive fiscal quarters to
be less than $285.0 million during the six month period beginning June 30,
1999, $350.0 million during the six month period beginning December 31,
1999, $425.0 million during the six month period beginning June 30, 2000,
and $500.0 million on December 31, 2000 and thereafter;
- -- the ratio of consolidated debt minus cash, excluding cash escrowed with
respect to the payment of obligations, to annualized consolidated revenue
for the most recent fiscal quarter for which financial
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statements have been delivered, as adjusted to give pro forma effect to any
acquisitions completed during or after such fiscal quarter, to exceed 2.5
to 1 at any time;
- -- 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 less than ($15.0) million, $0, $15.0
million, $25.0 million, $40.0 million and $50.0 million for the period of
four consecutive fiscal quarters ending on each of September 30, 1999,
December 31, 1999, March 31, 2000, June 30, 2000, September 30, 2000 and
December 31, 2000, respectively.
At September 30, 1999, we were in compliance with all such covenants.
At September 30, 1999, we had outstanding $600.0 million aggregate principal
amount of 10% senior notes due 2005, $350.0 million aggregate principal
amount of 11 1/2 % senior notes due 2008 and $1.05 billion aggregate
principal amount and Euro 150 million aggregate principal amount of 11%
senior notes due 2009. We have on deposit in an escrow account restricted
cash and short-term investments of $66.7 million to fund, when due, the next
two semi-annual interest payments on the 10% senior notes.
The indentures governing each of the senior notes contain many covenants with
which we must comply relating to, among other things, the following matters:
- -- 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, the 11 1/2% senior notes and the 11% senior
notes are secured equally and ratably with the obligation or liability
secured by such lien, excluding permitted liens;
- -- 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, the 11 1/2%
senior notes and the 11% 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
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- -- a limitation on the ability of us or our subsidiaries to engage in any
business not substantially related to a telecommunications business.
At September 30, 1999, we were in compliance with all such covenants.
In May 1999, we completed a public offering of 8,000,000 shares of our common
stock at $50.50 per share for net proceeds of approximately $383.8 million,
after underwriting discounts and commissions and other offering expenses.
In May 1999, we completed a public offering of 9,200,000 shares of our 6 3/4%
Series C Cumulative Convertible Preferred Stock ("Series C Preferred Stock")
for net proceeds of approximately $358.2 million after underwriting discounts
and commissions and other offering expenses. The Series C Preferred Stock has
a liquidation preference of $50 per share.
At closing, the purchasers of the Series C Preferred Stock deposited
approximately $85.8 million into an account established with a deposit agent
("Deposit Account"). The Deposit Account is not an asset of ours. Funds in
the Deposit Account will be paid to the holders of the Series C Preferred
Stock each quarter in the amount of $0.84375 per share in cash or may be
used, at our option, to purchase shares of common stock at 95% of the market
price of the common stock on that date for delivery to holders of Series C
Preferred Stock in lieu of cash payments. Holders of Series C preferred stock
received a quarterly interest payment from the Deposit Account of
approximately $7.8 million on August 15, 1999. The funds placed in the
Deposit Account by the purchasers of the Series C Preferred Stock will,
together with the earnings on those funds, be sufficient to make payments, in
cash or stock, through May 15, 2002. Until the expiration of the Deposit
Account, we will accrete a return to preferred shareholders each quarter from
the date of issuance at an annual rate of approximately 6 3/4% of the
liquidation preference per share. Such amount will be recorded as a deduction
from net income to determine net income available to common shareholders.
Upon the expiration of the Deposit Account, which is expected to occur on
May 15, 2002 unless earlier terminated, the Series C Preferred Stock will
begin to accrue dividends at an annual rate of 6 3/4% of the liquidation
preference payable in cash or, at our option, in shares of our common stock
at 95% of the market price of the common stock on that date. Under certain
circumstances, we can elect to terminate the Deposit Account prior to May 15,
2002, at which time the remaining funds in the Deposit Account would be
distributed to us and the Series C Preferred Stock would begin to accrue
dividends.
Each share of Series C Preferred Stock is convertible at any time at the
option of the holders thereof into 0.8017 shares of our common stock, equal
to at an initial conversion price of $62.3675 per share, subject to
adjustment upon the occurrence of specified events. The Series C Preferred
Stock is redeemable, at our option, at a redemption premium of 101.929% of
the liquidation preference (plus accumulated and unpaid dividends) on or
after November 15, 2000 and prior to May 15, 2002 if the trading price for
the Series C Preferred Stock exceeds $124.74 per share for a specified
trading period. Additional payments will also be made from the Deposit
Account or by us to the holders of the Series C Preferred Stock if we redeem
Series C Preferred Stock under the foregoing circumstances. Except in the
foregoing circumstances, we may not redeem the Series C Preferred Stock prior
to May 15, 2002. Beginning on May 15, 2002, we may redeem shares of Series C
Preferred Stock at an initial redemption premium of 103.857% of the
liquidation preference, declining to 100.00% on May 15, 2006 and thereafter,
plus in each case all accumulated and unpaid dividends to the redemption
date. We may effect any redemption, in whole or in part, at our option, in
cash by delivery of fully paid and nonassessable shares of our common stock
or a combination thereof (subject to applicable law), by delivering notice to
the holders of the Series C Preferred Stock.
In the event of a change of control of PSINet (as defined in the charter
amendment designating the Series C Preferred Stock), holders of Series C
Preferred Stock will, if the market value of our common stock at such time is
less than the conversion price for the Series C Preferred Stock, have a one
time option to convert all of their outstanding shares of Series C Preferred
Stock into shares of our
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common stock at an adjusted conversion price equal to the greater of (1) the
market value of our common stock as of the date of the change in control and
(2) $38.73. In lieu of issuing shares of common stock issuable upon
conversion in the event of a change of control, we may, at our option, make a
cash payment equal to the market value of the common stock otherwise issuable.
COMMITMENTS, CAPITAL EXPENDITURES AND FUTURE FINANCING REQUIREMENTS
As of September 30, 1999, we had commitments to certain telecommunications
vendors under operating lease agreements totaling $152.8 million payable in
various years through 2011. Additionally, we have various agreements to lease
office space, facilities and equipment and, as of September 30, 1999, we were
obligated to make future minimum lease payments of $53.5 million under such
non-cancelable operating leases expiring in various years through 2009.
Under the terms of the merger agreement, the aggregate consideration to be
paid to TNI shareholders consists of up to $351.2 million in cash and up to
7.8 million shares (assuming the exercise of all of the currently exercisable
TNI stock operations, which was approximately 1.4 million at September 30,
1999) of PSINet common stock, which represents an aggregate value of up to
approximately $708.0 million, assuming a price per share of PSINet common
stock of $45.719. Additionally, obligations outstanding under TNI's Revolving
Credit Facility, which was $62.0 million at September 30, 1999, will be
repaid as a condition to closing.
For most of our acquisitions, we have retained a portion of the purchase
price under holdback provisions of the purchase agreements to secure
performance by certain sellers of indemnification or other contractual
obligations of the sellers. These holdback amounts are generally payable up
to 24 months after the date of closing of the related acquisitions.
Acquisition holdback amounts totaled $71.4 million at September 30, 1999, the
majority of which is reported in other liabilities.
In connection with our previously announced naming rights and sponsorship
agreements with the Baltimore Ravens of the National Football League, we will
make payments over the next 19 years totaling approximately $81.7 million.
In order to maintain our competitive position, enhance our capabilities as an
Internet Super Carrier and continue to meet the increasing demands for
service quality, availability and competitive pricing, we expect to make
significant capital expenditures. At September 30, 1999, we were obligated to
make future cash payments that total $240.5 million for acquisitions of
global fiber-based and satellite telecommunications bandwidth, including IRUs
or other rights. We also expect that there will be additional costs, such as
connectivity and equipment charges, in connection with taking full advantage
of such acquired bandwidth and IRUs. Certain of this fiber-based and
satellite telecommunications bandwidth may require the acquisition and
installation of equipment necessary to access and light the bandwidth in order
to make it operational. At September 30, 1999, we were obligated to make
capital expenditures for such equipment of $242.0 million. In addition, we
currently are obligated to make expenditures in connection with our
build-out of new eCommerce Web hosting centers in key financial and business
centers throughout the world of approximately $61.8 million. As a result of
the foregoing, we currently believe that our capital expenditures in 1999
will be substantially greater than those in 1998 and that, as a result of the
completion of our recent debt and equity offerings, our capital expenditure
program will be accelerated. This may occur as we continue to execute our
expansion strategy in the 20 largest global telecommunications markets and
beyond.
We presently believe, based on the flexibility we expect to have in the
timing of orders of bandwidth, in outfitting our POPs with appropriate
telecommunications and computer equipment, and in controlling the pace and
scope of our anticipated buildout of our international data communications
network and eCommerce Web hosting centers, that we will have a reasonable
degree of flexibility to adjust the amount and timing of such capital
expenditures in response to our then existing financing capabilities, market
conditions, competition and other factors. Accordingly, we believe that
working capital generated from the use of acquired bandwidth, together with
other working capital, working capital from existing credit facilities, from
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capital lease financings, from the proceeds of our recent debt and equity
offerings and from future equity or debt financings, which we presently
expect to be able to obtain when needed, will be sufficient to meet the
currently anticipated working capital and capital expenditure requirements of
our operations. We cannot assure you, however, that we will have access to
sufficient additional capital and/or financing on satisfactory terms to
enable us to meet our capital expenditure and working capital requirements.
We regularly review our capital commitments and needs and the availability of
financing through institutional sources and the capital markets. We expect to
pursue opportunities to raise additional capital from time to time as we
determine to be advisable based upon our capital needs, financing
capabilities and market conditions.
OTHER POSSIBLE STRATEGIC RELATIONSHIPS AND ACQUISITIONS
We anticipate that we will continue to seek to develop relationships with
strategic partners, both domestically and internationally, and to acquire
assets, including, without limitation, additional telecommunications bandwidth,
and businesses and make investments (including venture capital investments)
principally relating to or complementary to our existing businesses. Certain of
these strategic relationships may involve other telecommunications companies
that desire to enter into joint marketing and services arrangements with us
pursuant to which we would provide Internet and Internet-related services to
such companies. Such transactions, if deemed appropriate by us, may also be
effected in conjunction with an equity or debt investment by such companies in
us. Such relationships and acquisitions may require additional financing and may
be subject to the consent of our lenders and other third parties.
DERIVATIVES AND FOREIGN CURRENCY EXPOSURE
We have not entered into any material financial instruments to serve as hedges
against certain financial and currency risks or for trading. However, as a
result of the recent increase in our foreign operations and the issuance of our
Euro-denominated 11% senior notes, we may begin to use various financial
instruments, including derivative financial instruments, in the ordinary course
of business, for purposes other than trading. These instruments could include
letters of credit, guarantees of debt, interest rate swap agreements and foreign
currency exchange contracts relating to intercompany payables of foreign
subsidiaries. We do not intend to use derivative financial instruments for
speculative purposes. Foreign currency exchange contracts would be used to
mitigate foreign currency exposure and with the intent of protecting the U.S.
dollar value of certain currency positions and future foreign currency
transactions. Interest rate swap agreements would be used to reduce our exposure
to risks associated with interest rate fluctuations. By their nature, all such
instruments would involve risk, including the risk of nonperformance by
counterparties. We would attempt to control our exposure to counterparty credit
risk through monitoring procedures and by entering into multiple contracts.
RISKS ASSOCIATED WITH YEAR 2000
The commonly referred to Year 2000 or Y2K problem results from the fact that
many existing computer programs and systems use only two digits to identify the
year in the date field. These programs were designed and developed without
considering the impact of a change in the century designation. If not corrected,
computer applications that use a two-digit format could fail or create erroneous
results in any computer calculation or other processing involving the Year 2000
or a later date. We have identified two main areas of Y2K risk:
- -- 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.
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We developed detailed plans for implementing, testing and completing any
necessary modifications to our key computer systems and equipment with
embedded chips to ensure that they are Y2K compliant. A third party
consultant performed an assessment of our U.S. internal systems (e.g.,
accounting, billing, customer support and network operations) to determine
the status of their Y2K compliance. The assessment recommended that some
minor changes were necessary. We believe that no material changes or
modifications to our internal systems are required to achieve Y2K compliance.
We have developed a test bed of our U.S. internal systems to implement and
complete testing of the requisite minor changes. We believe that our U.S.
internal systems are presently Y2K ready. We have completed an inventory of
our internal systems that we use outside of the United States to determine
the status of their Y2K compliance. For our international operations, we have
plans to upgrade or, if necessary, replace components of our internal systems
to ensure they are Y2K compliant. We anticipate that our international
operations, excluding businesses acquired in the fourth quarter, will be Y2K
compliant during the fourth quarter of 1999. To help ensure that our network
operations and services to our customers are not interrupted due to the Y2K
problem, we have established a network operations team. This team of
operational staff have completed inventories of our network equipment
(software and hardware) and have found no material Y2K compliance issues. We
believe that all equipment currently being purchased for use in the PSINet
network is Y2K compliant. Any existing equipment that is not Y2K compliant is
in the process of being made Y2K compliant through minor changes to the
software or hardware or, in limited instances, replacement of the equipment.
We believe that our network is presently Y2K compliant. In addition to
administering the implementation of necessary upgrades for Y2K compliance,
our network team has developed a contingency plan to address potential
problems that may occur with our network as we enter the year 2000. We
believe that, as a result of our detailed assessment and completed
modifications, the Y2K issue will not pose significant operational problems
for us. However, if the requisite modifications and conversions are not made,
or not completed in a timely fashion, it is possible that the Y2K problem
could have a material impact on our operations.
We have, and will continue to require, Y2K disclosures from all companies
that we acquire in the fourth quarter of 1999. We believe that, as a result
of due diligence performed and information gathered, the effect of the Y2K
issues on the companies we acquire will not in the aggregate have a material
impact on our operations. However, if such Y2K disclosures are not complete
or required remediator actions are not taken by the acquired companies in a
timely manner, it is possible that the Y2K problem could have a material
impact.
Our cost of addressing Y2K issues has been minor to date, less than 5% of our
information technology and network operations budgets, but this amount may
increase if additional outside consultants or personnel resources are required
or if important operational equipment must be remediated or replaced. Our
estimated total costs related to Y2K issues for 1999 is not expected to exceed
$2.0 million. These costs include equipment, consulting fees, software and
hardware upgrades, testing, remediation and, in limited instances, replacement
of equipment. The risk that Y2K issues could present to us include, without
limitation, disruption, delay or cessation of operations, including operations
that are subject to regulatory compliance. In each case, the correction of the
problem could result in substantial expense and disruption or delay of our
operations. The total cost of Y2K assessments and remediation is funded through
cash on hand and available from other sources and we are expensing these costs,
as appropriate. The financial impact of making all required systems changes or
other remediation efforts cannot be known precisely, but it is not expected to
be material to our financial position, results of operations, or cash flows. We
have not canceled any principal information technology projects as a result of
our Y2K effort, although we have rescheduled some internal tasks to accommodate
this effort.
In addition, we have identified, prioritized and are communicating with our
suppliers, vendors, customers, lenders and other material third parties to
determine their Y2K status and any probable impact on us. To date, our inquiries
have not revealed any significant Y2K noncompliance issue affecting our material
third parties. We will continue to monitor and evaluate our long-term
relationships with our material third parties based on their responses to our
inquiries and on information learned from other
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sources. If any of our material third parties are not Y2K ready and their
non-compliance causes a material disruption to any of their respective
businesses, our business could be materially adversely affected. Disruptions
could include, among other things:
- -- 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, of such a risk may have
on us. If any of our material third parties experience significant failures in
their computer systems or operations due to Y2K non-compliance, it could affect
our ability to process transactions or otherwise engage in similar normal
business activities. For example, while we expect our internal systems, U.S. and
non-U.S., to be Y2K ready in stages during 1999, we and our customers who
communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a material adverse effect on our revenues and business and that
of our customers. While many of these risks are outside our control, we have
identified and contacted our critical third party vendors and suppliers and are
establishing contingency plans to remedy any potential interruption to our
operations.
While we believe that we are adequately addressing the Y2K issue, we cannot
assure you that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue will
not materially adversely impact our business, prospects, revenues or financial
position. We are uncertain as to our most reasonably likely worst case Y2K
scenario and, although we have completed a contingency plan to handle reasonably
foreseeable interruptions resulting from the Y2K problem, we cannot assure you
that our contingency plan will be capable of adequately addressing every
potential interruption that may occur.
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