<PAGE>
 
================================================================================

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                                ______________
                                   FORM 10-K

    [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
          SECURITIES EXCHANGE ACT OF 1934
                  For the fiscal year ended December 31, 1998

                                       OR

    [_]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
          SECURITIES EXCHANGE ACT OF 1934

                        Commission File Number 0-25812
                               ________________
                                  PSINET INC.

            (Exact name of Registrant as specified in its charter)
                               ________________

              New York                                  16-1353600
       (State or other jurisdiction of                 (I.R.S. Employer
       incorporation or organization)                 Identification No.)

     510 Huntmar Park Drive, Herndon, VA                   20170
   (Address of principal executive office)              (Zip Code)

                                ______________

                                (703) 904-4100
             (Registrant's telephone number, including area code)
                             ____________________

<TABLE> 
<S>                                                             <C> 
Securities registered pursuant to Section 12(g) of the Act:      Common Stock, $.01 par value
                                                                 Preferred Stock Purchase Rights
</TABLE> 

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing  requirements for the past 90 days.  Yes  [X]  No [_]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant on March 11, 1999, based upon the closing price of The Common
Stock on The Nasdaq Stock Market for such date, was approximately
$1,343,780,000.

     The number of outstanding shares of the registrant's Common Stock as of
March 11, 1999 was approximately 55,465,000.

     Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to April 30, 1999 and to be used in connection
with the Annual Meeting of Shareholders expected to be held on May 17, 1999 are
incorporated by reference in Part III of this Form 10-K.

     The Index of Exhibits filed with this Report begins at page 81.
<PAGE>
 
================================================================================
                                  PSINET INC.

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                        Page
                                                                                                        ----
Part I
<S>             <C>                                                                                    <C>
   Item 1.      Business.............................................................................   1
 
   Item 2.      Properties...........................................................................  35
 
   Item 3.      Legal Proceedings....................................................................  36
 
   Item 4.      Submission of Matters To a Vote of Security Holders..................................  36
 
Part II
 
   Item 5.      Market For Registrant's Common Equity and Related Stockholder Matters................  37
 
   Item 6.      Selected Financial Data..............................................................  38
 
   Item 7.      Management's Discussion and Analysis of Financial Condition and Results of Operations  40
 
   Item 7A.     Quantitative and Qualitative Disclosures About Market Risk...........................  53
 
   Item 8.      Financial Statements and Supplementary Data..........................................  54
 
   Item 9.      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.  78
 
Part III
 
   Item 10.     Directors and Executive Officers of the Registrant...................................  78
 
   Item 11.     Executive Compensation...............................................................  78
 
   Item 12.     Security Ownership of Certain Beneficial Owners and Management.......................  78
 
   Item 13.     Certain Relationships and Related Transactions.......................................  78
 
Part IV
 
   Item 14.     Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....................  78
</TABLE>
Signatures

Exhibits

                                      -i-
<PAGE>
 
                                      PART I

Item 1.  Business

         Some of the information contained in this Form 10-K, including under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" set forth in Part II, Item 7 of this Form 10-K, contains forward-
looking statements.  These forward-looking statements may involve risks,
uncertainties and other factors that may cause our actual results and
performance to be materially different from the future results or performance
expressed or implied by such statements.  Cautionary statements regarding the
risks, uncertainties and other factors associated with these forward-looking
statements are discussed under "Risk Factors" beginning on page 19 of this Form
10-K.  You are urged to carefully consider these factors, as well as other
information contained in this Form 10-K and in our other periodic reports and
documents filed with the Securities and Exchange Commission.

         Technical terms used in this Form 10-K that are important to an
understanding of our business are defined in the glossary beginning on page 32
of this Form 10-K.

General

         We are a leading global provider of Internet access services and
related products to businesses. We provide dedicated and dial-up Internet
connections to businesses in 90 of the 100 largest metropolitan statistical
areas in the U.S. and in 12 of the 20 largest global telecommunications markets,
with operations organized into four geographic operating segments -- the U.S.,
Canada, Europe and Asia. We also offer, in addition to Internet connectivity
services, services and products to businesses that enable them to maximize
utilization of the Internet in their day-to-day operations in and outside of
their workplaces. Some of these value-added services include corporate
intranets, Web hosting services that permit customers to market themselves on
the Internet without having to invest significantly in technology infrastructure
and operations staff, remote user access services that permit customers to allow
their mobile personnel to access their corporate network and systems resources
in 150 countries using the Internet, multi-currency electronic commerce
services, security services and voice-over-Internet (as opposed to standard
telephone) services. We also own and operate a technologically advanced, high-
speed network that is one of the primary backbones that comprise the Internet.
In addition to being an Internet service provider ("ISP") and operating our
network, we also provide network connectivity and related services to other
telecommunications carriers and ISPs to further utilize our network capacity.

         Our mission is to build a premier Internet protocol ("IP")-based
communications company. We have grown by using multiple sales channels,
including direct sales and resellers, and by acquiring other ISPs and related
businesses in key markets.  We serve, as of December 31, 1998, approximately
54,700 business accounts, including 168 ISPs.  Our technologically advanced
network is connected to over 500 sites that enable customers to connect to the
Internet, called points-of-presence ("POPs"), in 12 countries and is connected
with other large ISPs at 27 points through contractual arrangements that permit
the exchange of data communications, called peering arrangements.

         For financial information relating to each of our U.S., Canadian,
European and Asian geographic operating segments, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Segment
Information" and Note 12 to our Consolidated Financial Statements included in
Part II, Items 7 and 8 of this Form 10-K.

         Our principal executive offices are located at 510 Huntmar Park Drive,
Herndon, Virginia 20170. Our telephone number is (703) 904-4100.

Industry Overview

         Internet access services is one of the fastest growing segments of the
global telecommunication services market place. According to International Data
Center ("IDC"), the number of Internet users worldwide reached 38 million in
1996 and is forecasted to grow to over 173 million by the year 2000. Internet
access services represent the means by which ISPs interconnect either businesses
or individual consumers to the Internet's resources or to corporate intranets
and extranets. Access services include dial-up access for individuals and small
businesses, and high-speed dedicated access used primarily by mid-sized and
larger organizations. In addition to Internet access services, business-focused
ISPs are increasingly providing a range of value-added services, including
managed access (i.e., intranets), shared and dedicated Web hosting, security
services, and advanced applications such as IP-

                                      -1-
<PAGE>
 
based voice, fax and video services. These services are being used by business
customers to enhance productivity, ensure reliability and reduce costs.

     The ISP market is segmented into large national or multinational ISPs
(''Tier 1 ISPs''), which are typically full-service providers that offer a broad
range of Internet access and value-added services to businesses, and regional
and local ISPs (''Tier 2'' and ''Tier 3 ISPs''), which typically offer a smaller
range of products and services to both individuals and business customers and
may specialize in the provision of one IP-based product or service. Tier 1 ISPs
also provide wholesale services by reselling capacity on their networks to
smaller regional and local ISPs, thereby enabling these smaller ISPs to provide
Internet services on a private label basis without building their own
facilities.  Tier 1 ISPs exchange Internet traffic at multiple public peering
points known as network access points and through private peering arrangements.
As the number of ISPs have grown, Tier 1 ISPs have increased their requirements
for peering arrangements thereby increasing the barriers to entry into the top-
tier. Tier 2 and Tier 3 ISPs generally rely on Tier 1 ISPs for Internet access
and interconnection. The ISP market is highly fragmented with over 6,700
providers estimated to be doing business in the U.S. and Canada alone. Because
of the low barriers to entry, there are many local and regional ISPs entering
the market, which has caused the level of competition to intensify. In addition,
there recently have been several acquisitions of large ISPs by multinational
telecommunications companies seeking to offer a more complete package of
telecommunications products to their customers.

     Since the commercialization of the Internet in the early 1990s, businesses
have rapidly established corporate Internet sites and connectivity as a means to
expand customer reach and improve communications efficiency. Currently, many
businesses are utilizing the Internet as a lower-cost alternative to certain
traditional telecommunications services. For example, many corporations are
connecting their remote locations using intranets to enable efficient
communications with employees, customers and suppliers worldwide, providing
remote access for a mobile workforce, reducing telecommunications costs by using
value-added services such as IP-based fax and videoconferencing, and migrating
legacy database applications to run over IP-based networks. Businesses of all
sizes are demanding advanced, highly reliable solutions designed specifically to
enhance productivity and improve efficiency. Moreover, businesses are seeking
national and global ISPs that can securely and efficiently connect multiple,
geographically-dispersed locations, provide global remote access capabilities
and offer a full range of value-added services that meet their particular
networking needs.

     We provide high quality IP-based services and products that are tailored to
meet the needs of businesses.  We believe that the business market is
particularly attractive due to its low customer churn characteristics,
relatively low penetration and early stage of development. In addition, we
believe that within the business access marketplace there is a significant
opportunity to upsell to higher service levels and provide additional value-
added services as businesses grow from establishing basic Internet connectivity
and corporate Web sites to utilizing the Internet and corporate intranets for
more advanced, mission-critical applications. Further, we believe that small and
medium sized businesses will continue to seek to outsource certain information
technology functions to large full-service ISPs to reduce costs and improve
service levels. Moreover, we believe that regional and local ISPs will continue
to seek business relationships with large, Tier 1 ISPs that enable them to sell
Internet connectivity services without making significant investments in
facilities.

The PSINet Strategy

     Our objective is to be one of the top three providers of Internet access
services and related communications services and products in each of the 20
largest global telecommunications markets. The principal elements of our
business strategy are summarized below:

     .  Pursue Internal Growth Through Multiple Sales Channels. We are pursuing
        growth opportunities through multiple channels consisting of our direct
        sales force, a reseller and referral program and strategic alliances. We
        have built a direct sales force, which, as of December 31, 1998,
        consisted of approximately 460 individuals, more than half of whom are
        employed outside of the United States. Our sales people have a strong
        Internet technical background and product knowledge, which assists them
        in effectively marketing our products and services to targeted business
        customers. We have forged an authorized reseller and referral program
        with selected telecommunications services and equipment suppliers,
        networking service companies, systems integrators and computer
        retailers. As of December 31, 1998, our reseller and referral program
        consisted of approximately 1,000 resellers and referral sources in the
        U.S. and over 700 outside of the U.S. This program enables us to utilize
        the 

                                      -2-
<PAGE>
 
        sales and marketing resources of our resellers and referral sources
        to offer PSINet Internet access services and products to a broader and
        more diverse prospect base. We also seek to establish strategic
        alliances with selected telecommunications carriers, such as we have
        with American Communications Network, Inc., ATX Telecommunications
        Services, e.Spire Communications, Inc. and Nextlink Communications Inc.,
        to offer our IP-based services and products to the carriers' customer
        base on a private label or co-branded basis as part of an integrated
        package of telecommunications and Internet services and products.

     .  Accelerate Growth Through Targeted Acquisitions. We intend to continue
        to accelerate our growth in the U.S. and expand our presence in key
        markets internationally by acquiring primarily business-focused ISPs and
        related businesses and assets. We intend to continue to acquire local or
        regional ISPs in markets where we have an established POP and can
        benefit from the increased network utilization and local sales force.
        Given an increasingly competitive environment and the large capital
        requirements required to offer a broad base of IP services and products
        and to develop access to a reliable, high-speed global network, we
        believe that undercapitalized local and regional ISPs will continue to
        benefit from combining their operations with us. In addition, we believe
        that our entrepreneurial environment is attractive to and helps us
        retain key employees of acquired ISPs. We also intend to make strategic
        acquisitions in the eight largest global telecommunications markets
        where we currently do not have a presence or in those global
        telecommunications markets where our current presence would be
        significantly enhanced. We may also seek to acquire other businesses
        relating or complementary to our existing business to broaden our market
        presence and expand our strengths in key product areas, such as
        application, Web hosting or data center companies, or data-processing
        companies with legacy networks which would benefit by migrating to IP-
        based technologies. We seek acquisition targets that, once integrated
        into our existing operations, generally will be accretive to EBITDA. We
        plan to effect future acquisitions through the use of existing cash,
        cash generated from operations and from then available credit
        facilities, and through future issuances of debt and equity securities.

     .  Capture Economies of Scale by Integrating Operations. After we have
        acquired an ISP, we typically act to generate economies of scale and
        cost savings by eliminating redundant operations and network
        architecture and migrating the acquired ISP's customers on to the PSINet
        network. Connecting an acquired ISP's customers to the PSINet network
        typically entails minimal incremental data communication costs and
        enables us to significantly reduce our transit costs. We seek to
        generate cost savings by centralizing back office operations, such as
        network monitoring, customer billing, human resources and accounting. We
        also endeavor to realize efficiencies by consolidating an acquired ISP's
        purchasing, product development and marketing and sales operations into
        our established programs. We believe this integration of operations
        improves the quality, breadth, consistency and scaleability of the
        services and products offered to customers of acquired ISPs.

     .  Increase Sales of Value-Added Services and Products. We intend to
        capitalize on the trend of companies to increasingly outsource their
        critical business applications and integrate Web-based services and
        products as part of their core data networking strategy by aggressively
        marketing value-added services and products to our existing account base
        and prospective business customers. We currently offer a number of 
        value-added services, such as corporate intranets, Web hosting and
        collocation, remote user access, multi-currency electronic commerce,
        security and voice-over IP services, that can be bundled with Internet
        access services to provide complete, turnkey solutions. In addition, the
        enhanced capacity resulting from our recent acquisitions of global
        network bandwidth will enable us to offer a wider variety of high
        quality Internet and Internet-related services and products, such as IP-
        based voice, video and other multimedia services. We believe that
        providing value-added services not only reduces customer churn by
        increasing customer switching costs but also improves profitability
        through the sale of higher margin value-added services. We believe that
        there is a significant opportunity within our existing account base to
        upgrade service levels and we are actively marketing additional services
        to these accounts. To improve upon our ability to provide these value-
        added services, we recently opened a new global Internet hosting center
        for dedicated business applications in Herndon, Virginia and an
        additional global Internet hosting center in Switzerland, and have plans
        to construct and open at least seven additional global Internet hosting
        centers.

     .  Continue to Acquire Network Facilities to Reduce Costs. We remain
        focused on reducing costs as a percentage of revenue by maintaining a
        scaleable network and increasing utilization of and controlling
        strategic assets, such as telecommunications bandwidth through long-term
        rights, typically for 20 or

                                      -3-
<PAGE>
 
        more years, called indefeasible rights of use ("IRUs") and acquisition
        of dark fiber. Our flexible network architecture utilizes advanced
        Asynchronous Transfer Mode ("ATM"), Integrated Services Digital Network
        ("ISDN") and Switched Multimegabit Data Service ("SMDS") compatible
        frame relay equipment, which allows the PSINet network to cost-
        effectively scale the number of POPs and the number of users accessing a
        POP in response to customer demand. We have enhanced our network
        significantly through several strategic acquisitions of fiber-based
        telecommunications bandwidth, including acquisitions of IRUs or other
        rights in the following:

        .  up to 10,000 equivalent route miles of OC-48 capacity across the
           United States;

        .  STM-1 transatlantic capacity 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 connecting the United States and Japan;

        .  four dark fiber optic strands connecting multiple cities 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 connecting 30 European cities;

        .  20 dark fiber optic strands connecting the Vancouver, British
           Columbia and Seattle, Washington metropolitan areas; and an

        .  agreement with other leading global telecommunications companies to
           build the Japan-U.S. Cable Network.

     These transactions represent an important strategic step in our objective
     to be a leading global facilities-based ISP. Additionally, we continue to
     evaluate alternative broadband local loop strategies, including wireless,
     xDSL and cable modem solutions.

     .  Enhance Brand Name Recognition. We were the first commercial ISP and
        have established significant brand recognition among information
        technology professionals in the United States. In 1998, we launched a
        major program to develop and enhance the PSINet brand name as a leading
        global facilities-based ISP. Our branding program includes the
        rebranding of acquired ISP operations and services under the PSINet
        name, the select use of television commercials, print ads and direct
        mailings which target key decision makers in the United States and
        abroad, and the acquisition of corporate sponsorship rights, such as our
        recent acquisition of the naming rights to the NFL Stadium of the
        Baltimore Ravens and related marketing rights. By combining this
        branding program with our multiple sales channel distribution strategy,
        we seek to expand market share, increase customer loyalty and develop
        global brand recognition in the Internet market.

     .  Build Strong Customer Loyalty. We believe that superior customer service
        is a critical element in attracting and retaining customers. We have
        made significant investments in customer service personnel and systems
        that enhance customer care and service throughout the complete customer
        life cycle from order entry and billing to selling of value-added
        services. To ensure consistency in the quality and approach to customer
        care, both domestic and international technical support associates
        attend an extensive technical training and certification program. We
        monitor and respond to customer needs by providing 24-hours per day,
        seven-days per week technical support and service from our network
        operations center (''NOC'') in Troy, New York. As part of our
        international expansion strategy, we recently opened a fully redundant
        NOC in Switzerland and anticipate adding a third NOC in Asia in 1999. By
        maintaining geographically centralized support services, we seek to
        increase operational efficiencies and enhance the quality, consistency
        and scaleability of our customer care.

PSINet Services

     We offer a broad range of reliable, high-speed Internet access options and
related services in the U.S., Canada, Europe and Asia at a variety of prices
designed to meet the requirements of commercial, educational, 

                                      -4-
<PAGE>
 
governmental and other organizations that link their computers, networks and
information servers to, or otherwise seek to benefit from the use of, the
Internet. We provide Internet solutions to help business and other organizations
reduce costs, increase productivity and access new markets. Access options range
from dial-up services to high-speed continuous access provided by dedicated
circuits. We believe that our broad range of competitively priced Internet
services and products allows us to compete effectively in the Internet access
market for corporate and other institutional customers. We have organized our
core operations into three customer-focused business units--Corporate Network
Services, which focuses on sales of Inernet access services, Applications and
Web Services, which focuses on sales of Web and value-added services, and
Carrier and ISP Services, which focuses on sales of Internet access and related
services to telecommunications carriers and consumer-based ISPs--in order to
more closely align our operations with the needs of the emerging Internet
marketplace.

     Internet Access Services.   We offer in the U.S., Canada, Europe and Asia
global connectivity services, including a variety of dial-up and dedicated
access solutions in bundled and unbundled packages, which provide high-speed
continuous access to the Internet for businesses' local area networks
(''LANs'').  We provide turnkey configuration solutions encompassing such
services as domain name registration, line ordering and installation, IP address
assignment, router configuration, installation and management, security planning
and management and technical consultation services. All of our connectivity
customers receive 24-hours per day, seven-days per week technical support.  We
also offer a full range of customer premise equipment required to connect to the
Internet, including routers, channel service units/data service units, software
and other products, as needed. Due to our business relationships with a variety
of vendors, we are able to offer competitive hardware pricing and bundled
services to our customers.

     .  Dedicated Access. We offer a broad line of high-speed dedicated
        connectivity services which provide business customers with direct
        access to a full range of Internet applications. Our flagship access
        service, InterFrame(R), provides companies with robust, full-time,
        dedicated Internet connectivity in a range of access speeds, from 56
        Kbps to 45 Mbps. InterFrame is designed to offer comprehensive network
        security and to help ensure bandwidth availability for priority business
        applications. We believe that the traffic-management advantages of the
        frame relay technology deployed in the PSINet network provide our
        customers with fully integrated Internet access and improved
        performance. For higher bandwidth needs, we provide our InterMAN(R)
        access service in major U.S. cities in connection speeds ranging from
        1.5 Mbps to 45 Mbps. InterMAN is a turnkey solution in which we provide,
        install and maintain equipment at the customers' premises. InterMAN
        affords cost advantages over competitive dedicated access services by
        utilizing high-speed SMDS and ATM data transmission technologies.

     .  Wireless Access. Our recently introduced InterSky(R) service offers
        dedicated high-speed wireless Internet access utilizing digital
        microwave technology. Speeds of up to 128Kbps are currently available
        with faster capabilities anticipated to be made available during 1999
        and 2000. Our InterSky service is currently operational in certain
        cities in Florida, with expansion to additional areas throughout the
        southeastern U.S. expected to occur later in 1999. InterSky provides an
        affordable, high-speed alternative to traditional land-based Internet
        services, commonly referred to as "local loop connections," offered by
        telecommunications carriers.

     .  Dial-up Access. Our LAN-Dial(R) dial-up services offer a cost-effective,
        entry-level Internet solution that provides access to PSINet's advanced
        network backbone via ordinary telephone lines at speeds of up to 56
        Kbps. Our LAN-ISDN service provides dial-up access through digital ISDN
        lines at speeds of up to 128 Kbps.

     Web and Value-Added Services.   We believe that business customers on a
worldwide basis will continue to increase their use of the Internet as a
business tool and will increasingly rely upon an expanding range of value-added
services to enhance productivity, reduce costs and improve service reliability.
We offer in the U.S., Canada, Europe and Asia a variety of value-added
services, including intranets, Web hosting, electronic commerce, collocation,
remote access, security services, applications, including fax and electronic
mail, and voice-over-IP designed to meet the diverse networking needs of
businesses. In addition, in order to capitalize on our technologically advanced,
high-capacity network, we intend to continue to develop new IP-based services
and products that increase customer use of the Internet, including bandwidth-
intensive multimedia services such as video conferencing over the Internet.

                                      -5-
<PAGE>
 
     .  Intranets. Our IP-optimized network allows us to create private IP
        networks, known as ''intranets'' or ''virtual private networks,'' that
        are designed to securely isolate internal network traffic from public
        Internet traffic and provide each site on the intranet access to other
        sites on the intranet as well as to the Internet. Our PSI IntraNet(R)
        service integrates an organization's multiple sites in different
        countries throughout the world by providing IP connectivity with access
        speeds ranging from 56 Kbps to 2 Mbps. By combining the security and
        control of a private network with cost-effective Internet-compatible
        connectivity, PSI IntraNet provides a turnkey solution for equipment
        management support and offers significant savings over traditional wide
        area network ("WAN") solutions.

     .  Web Hosting. We provide a line of Web hosting and multimedia streaming
        services that permit companies to market themselves and their products
        on the Internet without having to invest significantly in technology
        infrastructure and operations staff. The PSIWeb(R) services are backed
        by the industry's first 100% uptime guarantee and by our advanced
        network backbone, which provides highly reliable Internet connectivity.
        PSIWeb offers options such as complete electronic commerce solutions as
        well as ''TV on the WEB LIVE,'' a joint service offering from PSINet and
        Gardy McGrath International, which is an end-to-end solution for video
        broadcasting of live events over the Internet.

     .  Security Solutions. The proprietary nature of business Internet traffic
        demands protection from unauthorized access. We deliver a range of
        managed security services that were developed in conjunction with
        certain strategic partners and are backed by the expertise of our
        Security Planning and Response Team. Our RouteWaller(R) service provides
        cost-effective perimeter defense with sophisticated remote user
        authentication that helps to ensure that no strategic applications or
        data can be accessed until the user has proven his or her access
        clearance. SecureEnterprise(R) is our management service designed to
        protect enterprises with a full-featured, application-layer firewall.

     .  Remote Access. Today's work force increasingly operates outside the
        traditional office setting. Our InterRamp(R) Remote Access service
        enables mobile personnel to access their corporate network and systems
        resources using the Internet from over 2,400 POPs in over 150 countries
        through our strategic relationship with iPass, an international data
        communications network. In most locations where business is conducted,
        InterRamp Remote Access offers full Internet access through a local
        telephone call. As part of InterRamp Remote Access service, we provide
        our customers with a special account management system that enables
        customers' MIS administrators to control user access and monitor usage
        statistics.

     .  Multi-Currency Electronic Commerce. Our PSIWeb eCommerce/SM/ service
        provides a turnkey solution to create and manage ''Virtual Storefronts''
        and is designed to give shoppers the ability to make secure purchases in
        their local currency using the Web. PSIWeb eCommerce integrates payment
        systems engineered for security with virtual store technology, through
        alliances with CyberCash, Inc. and Mercantec, Inc., to facilitate a
        seamless shopping experience. In addition, PSIWeb Worldpay/SM/ provides
        a cost-effective electronic commerce solution for selling goods and
        services to an international audience. Developed in association with
        Worldpay Ltd., an electronic commerce transaction clearing house, and
        National Westminster Bank PLC, PSIWeb Worldpay enables customers around
        the world to make real-time purchases using the Web in over 100
        currencies.

     .  Collocation. Our PSIWeb Co-Locate /SM/ service enables companies to
        house business-critical servers in secure off-site facilities with
        improved bandwidth management and reliable connections. Collocation
        facilities are situated on the highest bandwidth portions of our
        infrastructure in order to facilitate optimal performance and high-speed
        capabilities.

     .  Faxing. Since a significant portion of telecommunications traffic
        consists of fax transmissions, companies are looking for ways to better
        manage fax costs. Our InternetPaper /SM/ service supports hard-copy
        distribution of electronic documents from desktop PCs to any fax machine
        in the world. This service offers centralized management of document
        distribution, thereby significantly reducing transmission costs.

     .  Electronic Mail. PSIMail /SM/ enables customers to outsource their e-
        mail service and its management to our highly trained systems
        administrators and support staff. For a monthly fee, we establish
        accounts, manage the servers and provide full accessibility to e-mail
        for our customers while saving them the investment in additional servers
        and staff.

                                      -6-
<PAGE>
 
     .  Voice-Over-Internet Protocol. PSIVoice /SM/ enables companies with
        multiple business locations to communicate by voice among these sites
        and with select third parties, such as business partners, customers and
        suppliers, outside their corporate intranets via low-cost IP telephony
        links. PSIVoice is a turnkey service allowing for such enhanced features
        as desktop faxing, conference calling and unified messaging services and
        includes all the hardware and network management services required for
        high quality, private-line voice connections among geographically
        dispersed offices. By providing voice and Internet traffic on the same
        circuit, customers are able to use existing bandwidth more efficiently,
        resulting in savings of 20%-50% over traditional long-distance telephone
        calling.

     Carrier and ISP Services.   In 1996, to maximize utilization of our
network, we formed our Carrier and ISP Services business unit to provide dial-up
Internet access to telecommunications carriers and consumer-based ISPs in the
U.S. and Canada, such as Earthlink Network, Inc. and MindSpring Enterprises,
Inc., whose customers typically access the network during evening hours when
business use tends to be minimal. We have recently expanded this business unit
to offer peering and transit services to telecommunications carriers and other
ISPs and to offer our connectivity and value-added services for resale, on a
private label basis, to larger telecommunications carriers and other ISPs that
require high quality business services and products to enhance their product
portfolio. Through such services, we have the opportunity to significantly
increase our distribution channel.

     .  ISP and Consumer Dial-up Access. We provide dial-up access to consumer-
        oriented ISPs enabling them to expand their geographic reach and network
        capacity by purchasing from us access to our IP-optimized network
        through over 285 POPs in the United States and Canada as of December 31,
        1998. We offer programs that provide smaller ISPs the opportunity to
        increase their user base over time and provide larger ISPs the
        opportunity to cost-effectively manage their rapid growth. In addition,
        in certain domestic and international markets, we provide dial-up access
        services directly to individual customers.

     .  Peering and Transit. In order to support the exchange of information
        between ISPs, which is critical to the effective operation of the
        Internet, we offer free private peering for all U.S.-based ISPs. Private
        peering allows other ISPs' traffic to directly reach our customers,
        which improves network performance and, we believe, thereby promotes
        customer satisfaction. Furthermore, we offer, for a fee, transit
        service, which allows an ISP to transfer traffic through the PSINet
        network to another ISP. Transit service enables ISPs to reduce their
        data communications expense by leasing network utilization from us in
        lieu of leasing point-to-point circuits from other telecommunications
        providers.

     .  Commercial Private Label Services. For companies with which we have
        strategic alliances, we provide our market-tested services on a private
        label basis. This allows these companies to market and resell PSINet
        services under their own brand while leveraging our nationwide network
        and expertise in service delivery. We assist in training the sales and
        support staffs of these companies and provide technical support to
        facilitate their resale efforts.

     .  Web Filtering. PSIChoice /SM/ enables our carrier and ISP customers to
        offer their consumers the option to protect themselves from content they
        find objectionable on the World Wide Web by restricting access to sites
        that contain undesirable information. PSIChoice is hosted on the
        technologically advanced PSINet network and utilizes content proxy
        services to screen Web content accessed by end-users. PSIChoice requires
        no software implementation on the consumer's computer and is presently
        available in the United States.

     Services and Product Development.   As part of our ongoing efforts to
develop IP-based services and products that enable businesses to take maximum
advantage of their corporate networks and the Internet, we have continually
invested in service and product development programs. Since our inception, we
have introduced to the Internet marketplace several major new services,
including the first LAN-based dial-up TCP/IP access service, the first managed
Internet security service, the first ISP electronic commerce service and the
first ISP intranet service. Major services and products currently under
development include multimedia services, such as video conferencing over the
Internet, and higher speed connectivity services.

PSINet's Network

     Overview.   We own and operate a global high capacity, IP-optimized network
which, as of December 31, 1998, was comprised of over 500 POPs, of which 250
were within the United States with the remainder located throughout Canada,
Europe and Asia.  Our network employs architecture designed to deliver superior
dedicated or 

                                      -7-
<PAGE>
 
dial-up Internet connections, reliable packet control and intelligent data
traffic routing. We have strengthened our position as a leading facilities-based
ISP through several recent acquisitions of high capacity, fiber optic
telecommunications bandwidth and other strategic network assets that have
significantly reduced our incremental data communications costs. The combination
of our technologically advanced network architecture and global network
infrastructure has positioned us to deliver the high level of IP-based services,
such as Web hosting and a broad array of multimedia Internet services,
increasingly demanded by businesses.

     Network Architecture.   We have engineered an IP-optimized network by
integrating advanced Internet routers with high-speed frame relay switching
equipment that is compatible with ATM, ISDN and SMDS transmission technologies.
We have planned for growth by ensuring that the network is scaleable, flexible,
fault tolerant, open standards-based and remotely manageable.

     .  Scaleable. Our flexible, multi-layer network architecture utilizes a
        high-speed switching fabric which enables us to grow the number of POPs
        and the number of users served in an incremental manner that matches
        investment with demand. The network's scalability extends beyond the
        currently installed base of over 500 POPs to allow for growth to 2,000
        POPs without fundamental design changes.

     .  Flexible. Our network architecture consists of an Internet routing
        infrastructure overlaid upon a fast packet switching fabric that enables
        us to provide reliable, high-speed connections and provide our customers
        the ability to manage bandwidth by type of application and to
        accommodate applications that are delay-sensitive. We are able to use
        our flexible network architecture in concert with our remote monitoring
        capability to accommodate changing customer usage patterns and patterns
        of traffic that, if left unmanaged, could otherwise degrade network
        performance.

     .  Fault Tolerant. Redundancy and adaptive technology in our network
        reduces the impact of isolated failures on the customer's experience.
        Adaptive technology incorporated into our Internet router infrastructure
        compensates automatically for circuit failures that might otherwise
        interrupt the flow of customer traffic. Key switching and router
        elements are redundantly configured to further reduce the impact of
        individual component failures. In addition, we have an uninterruptible
        power supply at each POP, limiting the impact of local power outages on
        the PSINet network.

     .  Open. The PSINet network is based on the open internetworking protocol
        standard TCP/IP and on relevant international standards relating to
        transmission and modulation technologies. We are able to install a
        variety of equipment types and capacities without impacting network
        interoperability. As a result, our network can be upgraded incrementally
        and benefit from multi-vendor supply strategies.

     .  Manageable. From our NOCs, we are able to monitor the network remotely,
        perform network diagnostics and equipment surveillance, and initialize
        customers. As a result of our network architecture and our experience in
        Internet network management, these tasks can be performed remotely
        regardless of POP location or network status. This capability allows us
        to respond quickly to network problems and to control costs associated
        with on-site network configuration and repair.

     Global Network Infrastructure.   As part of our ongoing efforts to control
strategic assets and further expand and enhance our network, we have recently
acquired or agreed to acquire IRUs and other rights in significant amounts of
fiber-based telecommunications bandwidth located throughout the world.

     .  In February 1998, we acquired from IXC Internet Services, Inc. ("IXC"),
        a subsidiary of IXC Communications, Inc., IRUs in up to 10,000
        equivalent route miles of OC-48 network bandwidth across the United
        States, including such major metropolitan areas as Atlanta, Chicago,
        Cleveland, Dallas, Houston, Los Angeles, New York, Philadelphia, Phoenix
        and Washington D.C., in exchange for approximately 20% of our common
        stock. As of January 1, 1999, approximately 6,000 route miles of OC-12
        (equivalent to approximately 1,500 route miles of OC-48) bandwidth,
        connecting New York and Los Angeles and certain major cities in between,
        have been placed into operation on the PSINet network and approximately
        6,800 additional route miles of OC-12 (equivalent to approximately 1,700
        route miles of OC-48) bandwidth, extending the network to, among other
        locations, Washington, D.C., Atlanta, Houston and San Francisco and
        certain major cities in between, are expected to be placed into
        operation early in the second quarter of 1999. We currently anticipate
        delivery of the remaining bandwidth from IXC over the next 18 to 24
        months.

                                      -8-
<PAGE>
 
     .  In March 1998, we acquired from Global Crossing Ltd. IRUs in 12,000
        route miles of STM-1 (equivalent to OC-3) network bandwidth on the
        Atlantic Crossing undersea fiber optic system connecting the United
        States, the United Kingdom and continental Europe. As of January 1,
        1999, the portion of this bandwidth linking New York City and the United
        Kingdom is operational and integrated with the OC-12 bandwidth
        previously acquired from IXC.

     .  In May 1998, we acquired from Metromedia Fiber Network 18 dark fiber
        optic strands connecting the New York City and Washington, D.C.
        metropolitan areas and major metropolitan areas in between. Using
        currently available technology, this fiber will be capable of carrying
        96 Gbps of data in the New York City to Washington, D.C. corridor, which
        currently handles approximately 35% of the telecommunications traffic in
        the United States and is a vital route connecting Internet traffic
        between Europe and the United States. We expect the 18 dark fibers to be
        placed into operation prior to the end of the second quarter of 1999.

     .  In August and September 1998, we acquired from Pacific Telecom Cable,
        Inc. in the United States and from International Digital Communications,
        Inc. and Cable & Wireless PLC in Japan bandwidth capacity equivalent to
        six DS-3s in the North Pacific Cable undersea fiber optic system
        connecting the United States and Japan through a combination of IRUs and
        long-term capital leases. As of January 1, 1999, three DS-3s connecting
        Portland, Oregon and Tokyo are operational and we expect the remainder
        of the capacity to become operational in stages during the first half of
        1999.

     .  In August 1998, we entered into an agreement with a group of leading
        telecommunications companies to build the Japan-U.S. Cable Network, an
        undersea cable system connecting the United States (through California
        and Hawaii) and Japan, on which we will own IRUs in 22 STM-1s,
        increasing to 30 STM-1s as the network is upgraded, of bandwidth. Upon
        completion, the Japan-U.S. Cable Network will initially operate at 80
        Gbps, increasing to 155 Gbps as the network is upgraded, and is
        currently anticipated to become operational in the second quarter of
        2000. Completion of the undersea cable system is subject to a number of
        risks associated with construction projects.

     .  In December 1998, we acquired from Metromedia Fiber Network IRUs in four
        dark fiber optic strands connecting multiple cities in the San Francisco
        Bay area along a circular route extending south to the Silicon Valley,
        including San Jose and Santa Clara, and east to Hayward. This market is
        an important financial and technology corridor and is expected to
        generate high demand for Internet services well into the future. We
        expect to place into operation portions of this fiber prior to the end
        of 1999, with full delivery anticipated in 2000.

     .  In January 1999, we acquired from FLAG (Fiberoptic Link Around the
        Globe) IRUs in STM-1 network bandwidth configured along an approximately
        27,300 kilometer route having the capability of connecting Japan, China,
        Southeast Asia, India, the Middle East, Europe and the United Kingdom.
        With this acquisition, the PSINet network became the first independent
        Internet network to fully circle the globe, serving customers on three
        continents. Our agreement with FLAG also enables us to purchase
        additional capacity and insert new connections along the FLAG cable
        route to accommodate future demand. We expect to place into operation
        portions of this bandwidth prior to the end of the second quarter of
        1999.

     .  In January 1999, we acquired from Hermes IRUs in STM-1 network bandwidth
        configured as multiple rings along an approximately 21,000 kilometer
        route linking 30 European cities. By the end of 1999, we expect a
        portion of this bandwidth to be connected to our existing operations in
        England, the Netherlands, Belgium, France, Germany and Switzerland. In
        2000, we anticipate that the remainder of this bandwidth will be
        extended to additional cities in Austria, Belgium, Denmark, France,
        Germany, Italy, Luxembourg, Monaco, the Netherlands, Spain and Sweden.
        The acquisition of this bandwidth will enable us to expand our presence
        into an additional three of the 20 largest global telecommunications
        markets -- Austria, Spain and Sweden -- and should be sufficient to 
        support our European operations for the next several years.

     .  In January 1999, we entered into an agreement to acquire from Starcom
        Service Corporation IRU's in 20 dark fiber optic strands connecting the
        Vancouver, British Columbia and Seattle, Washington metropolitan areas,
        a high-demand international telecommunications corridor.  We expect to 
        place into operation portions of this fiber prior to the end of the 
        second quarter of 1999.

                                      -9-
<PAGE>
 
See "Risk Factors--We face risks associated with acquisitions of bandwidth from
network suppliers and strategic alliance with IXC relating to our dependence on
their ability to satisfy their obligations to us, the possibility that we may
need to incur significant expenses to utilize bandwidth and their ability to
buildout their networks under construction that could adversely affect our
ability to utilize acquired bandwidth" in Item 1 of this Form 10-K.

         We expect to further expand our network in North America, Europe and
Asia, as well as in other select international markets, and to acquire
fiber-based IRUs and dark fiber in these regions to support demand growth and
reduce costs. We are targeting cities with a high concentration of businesses
for global expansion with the objective, over the long-term, of providing local
access to our services and products to 80% of the businesses in those cities. In
furtherance of this plan, we have entered into agreements in Germany and
Switzerland that enable us to offer local telephone call access to our services
and products throughout each of these countries. We already offer local call
access to 80% of the business markets in the United States, Canada, France, the
Netherlands, Hong Kong and Japan.

         The following table summarizes our bandwidth facilities as of February
1, 1999.

<TABLE> 
<CAPTION> 
        LOCATION                    CAPACITY                          CONNECTION POINTS                            OWNERSHIP
      --------------        -------------------------       ---------------------------------------             ---------------
<S>                       <C>                             <C>                                          <C> 
      United States         6,000 route miles of OC-12      New York--Chicago--Dallas--Los Angeles                   IRU
                            6,800 route miles of OC-12      Expanding to Washington, D.C.--Atlanta--Houston          IRU
                                                                 --San Francisco (early Q2 1999)
                            18 high capacity dark fibers    New York-Washington, DC (Q2 1999)                        IRU    
                            4 high capacity dark fibers     San Francisco Bay Area (during 1999 and 2000)            IRU     
                                       T-3                  Intercontinental                                         Leased
                      
      Trans-Atlantic        12,000 miles of STM-1 (OC-3)    New York--London--Amsterdam                              IRU
                      
      Trans-Pacific         6,000 miles of 6 DS-3s          US--Japan (3DS-3s operational; 3DS-3s in Q2 1999)  IRU/Long-term lease
                            22 STM-1s (increasing to 30)    Japan-Hawaii-US (during Q2 2000)                         IRU

      Trans-Continental     27,300 km of STM-1              Japan-China-Southeast Asia-India-Middle                  IRU
                                                            East-Europe (beginning in Q2 1999)

      Canada                20 high capacity dark fibers    Vancouver,  B.C. - Seattle,  WA (beginning in            IRU
                                                            Q2 1999)
                                      T-3                   Intercontinental                                        Leased

      Europe                21,000 km of STM-1              30 European cities (during 1999 and 2000)                IRU
                                      E-1                   Intercontinental                                        Leased
</TABLE> 

         Internet Data Centers. We have recently opened technologically
advanced, 10,000 square foot, global Internet hosting facilities in each of
Herndon, Virginia and Neuchatel, Switzerland, are currently in the process of
constructing a planned 45,000 square foot global Internet hosting facility in
London, and have plans for construction of at least six additional global
Internet hosting facilities throughout the world, including in the United
States, the Netherlands, Japan and Hong Kong. The additional facilities will
range from 10,000-50,000 square feet, will be specifically designed for
dedicated Web hosting, application hosting, collocation services and high
capacity access to the PSINet network, and will be equipped with uninterruptible
power supply and backup generators, fire suppression, raised floors, HVAC,
24-hours per day, seven-days per week operations and physical security. Our
partnership with Hewlett-Packard Company further supports our ability to provide
high-end Web services consisting of shared hosting, dedicated hosting and
collocation hosting.

         PRI Circuits. In key geographically-dispersed cities located along the
configuration of the PSINet network (e.g., Atlanta, Chicago, Dallas, Los Angeles
and Washington, D.C.), we are also investing in primary rate interface ("PRI")
circuits, which provide dial-up access to our POPs, in order to increase the
capacity available for our consumer-oriented ISP customers. Through agreements
with certain competitive local exchange carriers, we have lowered our average
cost per PRI by approximately 15-20% over the last twelve months. As of December
31, 1998, we have more than doubled our dial-up capacity from December 31, 1997
as a result of our investment in PRIs, which we believe will enhance revenue
growth in our Carrier and ISP Services business unit. As of December 31, 1998,
nearly 100% of our dial-up capacity is accessible at 56 Kbps modem speeds. We
anticipate that all newly deployed modems will support this technology.

                                      -10-
<PAGE>
 
         Peering Arrangements. We maintain peering relationships with national,
regional and local ISPs by either private peering with the ISPs or by
participation in various public peering locations, known as network access
points. As of December 31, 1998, we maintained more than 2,000 Mbps (2.0 Gbps)
of peering connectivity with 20 private agreements and seven public connections
strategically placed throughout the United States, the United Kingdom, Canada,
Japan and Europe. Recently, some companies that have previously offered peering
have cut back or eliminated peering relations and are establishing new, more
restrictive criteria for peering. We expect that, due to our offering of peering
with any of the estimated 4,000 ISPs in the United States without settlement
charges, we will substantially increase the number of ISPs with which we peer
over the next two years. We believe that by entering into direct peering
relationships with a large number of ISPs, our business customers will receive
better service and the highest quality network performance.

         Global Network Management. We believe that we offer superior network
management capabilities which enhance customer satisfaction. We have established
a 24-hours per day, seven-days per week NOC in the United States that allows for
continuous monitoring of our international network, managing of traffic, and
customer problem resolution. Back-up operating facilities manned by trained
personnel are available at our offices in Herndon, Virginia and Cambridge,
England in the event the U.S. NOC experiences service interruptions or other
difficulties. We have recently opened our European Technical Center in
Switzerland as a second NOC with global capabilities equivalent to those in the
U.S. NOC. Furthermore, we anticipate that as we expand our presence in Asia we
will construct a third NOC in that region during 1999.

SALES AND MARKETING

         We have built a multi-channel sales and marketing infrastructure
throughout the U.S., Canada, Europe and Asia in an effort to respond effectively
to the growing opportunities in the business Internet market. We seek to attract
and retain customers by offering our services and products through our direct
sales force and our authorized reseller and referral program and by seeking to
forge strategic relationships with selected telecommunications carriers. We
believe that this multi-channel approach will enable us to utilize the technical
skills and experience of our direct sales force to penetrate our targeted
customer base while utilizing the potentially greater sales and marketing
resources of the resellers, referral sources and companies with which we have
strategic alliances to offer our services and products to a broader and more
diverse potential customer base.

         Direct Sales. We have built a direct sales force, which, as of December
31, 1998, consisted of approximately 460 individuals (more than half of whom are
employed outside of the U.S.) who have a strong Internet technical background
and knowledge of potential applications of the Internet to meet the critical
needs of targeted business customers. Direct sales tactics include direct
contacts with targeted ISPs and potential significant corporate accounts by our
sales representatives and systems engineers, inbound and outbound telemarketing,
direct mail efforts, seminars and trade show participation. We have developed
programs to attract and train high quality, motivated sales representatives who,
in addition to having strong Internet technical skills and knowledge of
potential applications of the Internet, have consultative sales experience.
These programs include technical sales training, consultative selling technique
training, sales compensation plan development and sales representative
recruiting profile identification. Sales representatives from our U.S. and
international operations jointly attend training programs in order to ensure an
integrated sales approach domestically and internationally.

         Reseller and Referral Program. We have forged an authorized reseller
and referral program with selected telecommunications service companies,
equipment suppliers, networking service companies, systems integrators and
computer retailers. This program, through which we have established, as of
December 31, 1998, approximately 1,000 formal and informal arrangements in the
U.S. and over 700 outside of the U.S., affords us an indirect distribution
mechanism in our targeted markets and is designed to enable us to utilize the
potentially greater sales and marketing resources of the resellers and referral
sources to offer PSINet services and products to a broader and more diverse
potential customer base. Participants in our reseller and referral program
include Ascend Communications, Inc., a manufacturer and developer of
telecommunications equipment, CompUSA, a computer equipment and software
retailer, and Hewlett-Packard Company, a provider of computer hardware and
networking products. We provide training and ongoing support to the sales
representatives of companies with which we have reseller and referral
relationships in order to strengthen the sales representatives' knowledge of our
services and products and brand loyalty to PSINet. We believe that the reseller
and referral program has enabled us to achieve greater market reach with reduced
overhead costs and to use the reseller and referral sources to assist in the
delivery of complete solutions to meet customer needs. We have a team of 19
individuals who pursue reseller and referral arrangements for us.

                                      -11-
<PAGE>
 
         Strategic Alliances. In 1997, we launched our strategic alliance
program, pursuant to which we seek to establish strategic alliances with
selected telecommunications carriers which may afford us access to recurring
revenue from the carriers' customer base, while enabling the carriers to offer
their customers an integrated package of telecommunications and Internet
services and products. We also recently formed an alliance with the Baltimore
Ravens of the National Football League pursuant to which, among other things, we
have the right to develop a Web site and provide related Internet subscriber
services for the Baltimore Ravens. We believe that these strategic alliances may
facilitate the cost-effective acquisition of customers and increase utilization
of our network. It is anticipated that, in most cases, the companies with which
we have strategic alliances will offer our services and products on an unbranded
or co-branded basis or under only their own trademark. As with the reseller and
referral program, we provide training and ongoing support to the sales
representatives of companies with which we have strategic alliances in order to
strengthen the sales representatives' knowledge of our services and products and
brand loyalty to PSINet.

         Marketing. Our marketing program is intended to build national and
local strength and awareness of the PSINet brand. We use radio and print
advertising in targeted markets and publications to enhance awareness and
acquire leads for our direct sales team and companies with which we have resale,
referral or strategic alliance relationships. Our print advertisements are
placed in trade journals and special-interest publications. We employ public
relations personnel in-house and work with an outside public relations agency to
provide broad coverage in the Internet and computer networking fields. We also
attempt to create brand awareness by securing corporate sponsorship rights, such
as our recent acquisition of the naming rights to the NFL stadium of the
Baltimore Ravens and related sponsorship, promotion, advertising and marketing
rights, and by participating in industry trade shows such as Networld, Interop,
InterNet World and ISPCon, based on the size and vertical makeup of the trade
show audience, and relationships with industry groups and the media. We also use
direct mailings, telemarketing programs, Web marketing, co-marketing agreements
and joint promotional efforts to reach new corporate customers. We attempt to
retain our customers through active and responsive customer support as well as
by continually offering new value-added services.

CUSTOMERS

         We had, as of December 31, 1998, over 54,700 business customers,
including 168 ISP customers. Our customers include businesses in the aerospace,
finance, communications, computer data processing and related industries,
governmental agencies and educational and research institutions, as well as
other ISPs.

CUSTOMER SUPPORT

         High quality customer service and support is critical to our objective
of retaining and developing our customers. We have made significant investments
in customer service personnel and systems that enhance customer care and service
throughout the complete customer life cycle from order entry and billing to
selling of value-added services. As of December 31, 1998, our technical support
group consisted of over 570 individuals. To ensure consistency in the quality
and approach to customer care, both domestic and international associates attend
an intensive technical training and certification program at our U.S. NOC. Our
U.S. NOC monitors and responds to customer needs by providing 24-hours per day,
seven-days per week technical support and service. Our customer support group
utilizes a leading customer support trouble ticketing and workflow management
system from Remedy Corporation to track, route and report on customer service
issues. Network operations can remotely service customer connections to the
PSINet network. In addition, field service personnel are dispatched in the event
of an equipment failure that cannot be serviced remotely. As part of our
international expansion strategy, we have recently opened a fully redundant NOC
in Switzerland and anticipate adding a third in Asia in 1999. In connection with
our customer care initiatives, we seek to continuously improve systems that
increase productivity and enhance customer satisfaction. We have recently
reengineered our customer care program to address the complex needs of our
business customers and are scaling our customer care resources to keep pace with
projected increases in customer requirements. By maintaining centralized support
services, we seek to increase operational efficiencies and enhance the quality,
consistency and scalability of customer care. We are currently in the process of
implementing a new high quality, cost-effective and scaleable billing system to
replace our existing system in order to provide customers on a global basis with
uniform and easy-to-understand invoicing.

                                      -12-
<PAGE>
 
ACQUISITIONS

         As a key component of our growth strategy, over the fifteen month
period ending December 31, 1998, we have acquired 18 ISPs in eight of the 20
largest global telecommunications markets. The aggregate amount of the purchase
prices and related payments for these acquisitions was approximately $290.1
million, exclusive of indebtedness assumed in connection with such acquisitions.
Of such amount, we have paid $251.9 million as of December 31, 1998 and retained
the balance to secure performance by certain sellers of indemnification or other
contractual obligations. Most recently, in February 1999, we acquired two
additional ISPs based in France for an aggregate purchase price of approximately
$3.6 million. We are also currently evaluating additional acquisitions as well.
However, we cannot assure that we will successfully complete any such
acquisitions currently being contemplated.

         The following table summarizes basic information concerning our
acquisitions:

<TABLE> 
<CAPTION> 

                                                                                                  RANKING
         NAME OF                                                                                  AMONG 20
         ACQUIRED             DATE OF      PRINCIPAL                 BUSINESS     CONSUMER     LARGEST GLOBAL
         COMPANY            ACQUISITION    MARKET TERRITORY        ACCOUNTS       ACCOUNTS     TELECOM MARKETS
         -------            -----------    ----------------        ------------ ------------  ---------------
                                                                       (1)          (1)
                                                                       ---          --- 
<S>                       <C>             <C>                    <C>            <C>           <C> 
         CalvaCom               10/97      France                     1,500          2,300             5
         Iprolink                1/98      Switzerland                2,400          2,600            14
         ISTAR                   2/98      Canada                     2,700         47,000            10
         ITL                     4/98      Jersey, Channel Islands       --             --           N/A
         INX                     5/98      Germany                      650         15,600             3
         IoNet                   6/98      U.S.                       2,300         21,500             1
         LinkAge                 6/98      Hong Kong                  1,100             --            19
         CalvaPro                6/98      Sub-Sahara Africa            425             30           N/A
         Interlog                7/98      Canada                     2,100         41,000            10
         Rimnet                  8/98      Japan                        260         56,000             2
         TWICS                   9/98      Japan                         70          1,700             2
         HKIGS                   9/98      Hong Kong                    200             --            19
         Inet                    9/98      Korea                      1,100         13,000            12
         Tokyo Internet         10/98      Japan                      6,500         10,000             2
         IXE/USN                10/98      Netherlands                   85            --             13
         AsiaNet                11/98      Hong Kong                    180            250            19
         Spider Net             12/98      Hong Kong                     30            100            19
         Huge Net               12/98      Hong Kong                     90            --             19
         Planete.net             2/99      France                       190            780             5
         Satelnet                2/99      France                       110            --              5
                                                                     ---------  -----------
                                                          Total      21,990        211,860
                                                                     =========  ===========

</TABLE> 

-----------------------------
         (1)      As of the respective dates of acquisition.

         In October 1997, we acquired Serveur Telematique Internet S.A. (doing
business as "CalvaCom"), a leading ISP and Web hosting company in France. The
acquisition established our market presence in France with over 1,500 dedicated
and dial-up customer accounts through 24 POPs. CalvaCom also has a significant
commercial grade Web design and hosting business providing service to such
leading French companies as Total S.A. and La Chemise Lacoste S.A.

         In January 1998, we acquired Internet Prolink S.A. ("Iprolink"), the
leading commercial ISP in Switzerland. This acquisition expanded our market
presence in Switzerland by adding approximately 2,400 dedicated and dial-up
customer accounts and 18 POPs in Switzerland and France. Iprolink also has
relationships with over 170 resellers located throughout Switzerland, France and
Germany to augment its direct sales force.

                                      -13-
<PAGE>
 
         In February 1998, we acquired iSTAR internet inc. ("iSTAR"), one of the
leading Canadian providers of Internet services and solutions for business,
institutions and individuals. This acquisition established us as the largest ISP
in Canada with over 2,700 business and Web services customers as well as over
47,000 dial-up customer accounts through over 35 POPs. By eliminating redundant
network architecture and administrative functions and migrating iSTAR's
customers on to our integrated network backbone, we have realized, and believe
we will continue to realize, significant cost savings in our Canadian
operations.

         In April 1998, we acquired Interactive Telephony Limited ("ITL"), the
largest ISP based in Jersey in the Channel Islands, and a 12.5% equity interest
in WorldPay Limited, a leading provider of electronic commerce payment solutions
also based in Jersey, Channel Islands.

         In May 1998, we acquired Interactive Networx GmbH ("INX"), the largest
ISP in Berlin and nationally recognized across Germany. This acquisition
expanded our market presence in Germany by adding approximately 650 business
customers, 15,600 consumer dial-up customers and ten POPs in Germany. The
combination of INX with our existing German operations has resulted in us
becoming one of the largest ISPs in Germany, which is the fastest growing
Internet market in Europe.

         In June 1998, we acquired ioNet Internetworking Services ("ioNet"), a
provider of Internet and network systems integration services to businesses,
universities and residential customers in the south central region of the United
States. In addition, ioNet has developed a suite of vertical market Internet
services, including comprehensive banking, medical and telecommunications
Internet solutions, to enable customers to more efficiently meet their
internetworking needs. This acquisition resulted in our addition of
approximately 2,300 business and Web services accounts and 21,500 consumer
dial-up customers.

         In June 1998, we acquired LinkAge Online Limited ("LinkAge"), a Hong
Kong-based supplier of Internet solutions, including Web hosting, managed
co-location, intranets and extranets, to businesses, professionals, government
agencies and other ISPs throughout Southeast Asia. This acquisition established
our market presence in Hong Kong, the fifth largest telecommunications market in
Asia, by adding approximately 1,100 business and Web services accounts.

         In June 1998, we acquired SCII-CalvaPro ("CalvaPro"), a full service
business-to-business telecommunications company headquartered in Paris, France
that provides Internet applications and other communications services primarily
to banks and shipping and forwarding agencies in the sub-Saharan African market.
This acquisition gave us a market presence in sub-Saharan Africa by adding
approximately 425 business accounts and 30 consumer dial-up customers.

         In July 1998, we acquired INTERLOG Internet Services Inc. ("Interlog"),
one of the first Internet-only service providers in Canada. This acquisition
further solidified our market-leading presence in Canada by adding approximately
2,100 business and Web services accounts and 41,000 consumer dial-up customers.

         In August 1998, we acquired Rimnet Corporation ("Rimnet"), one of
Japan's leading providers of Internet services and solutions to businesses. This
acquisition further strengthened our market presence in Japan, one of the 20
largest global telecommunications markets, by adding approximately 260 business
and Web services accounts and 56,000 consumer dial-up customers.

         In September 1998, we acquired TWICS Co., Ltd., one of the original
ISPs in Japan, primarily serving the small-office/home-office market. This
acquisition added approximately 70 business and Web services accounts and 1,700
consumer dial-up customers to our market presence in Japan.

         In September 1998, we acquired Hong Kong Internet & Gateway Services
("HKIGS"), one of the original ISPs in Hong Kong, primarily serving the business
market. This acquisition enhanced our recently established market presence in
Hong Kong by adding approximately 200 business accounts.

         In September 1998, we acquired Inet, Inc. ("Inet"), one of Korea's
first ISPs that provides a comprehensive range of Internet access options,
applications, consulting services and education programs, including Web hosting
and content development, intranet application development and training. This
acquisition established our market presence in Korea, one of the 20 largest
global telecommunications markets, by adding approximately 1,100 business and
Web services accounts and 13,000 consumer dial-up customers.

                                      -14-
<PAGE>
 
         In October 1998, we acquired Tokyo Internet Corporation ("Tokyo
Internet"), one of the most widely used ISPs in Japan serving businesses, the
small-office/home-office market and individual Internet users. Tokyo Internet
offers a comprehensive range of Internet services, including individual and
business dial-up connection services, leased-line LAN connectivity services and
high quality collocation and Web services. In addition, Tokyo Internet has
created an IP network infrastructure that directly links 23 of Japan's largest
metropolitan areas. The combination of Tokyo Internet with our existing Japanese
operations has resulted in us becoming the second largest ISP in Japan, based on
customer domains serving business and commercial users, by adding approximately
6,500 business and Web services accounts and 10,000 consumer dial-up customers.

         In October 1998, we acquired Internet Exchange Europe B.V. ("IXE"), the
first commercial top-level ISP in Holland to maintain its own Internet backbone,
and Unix Support Netherland B.V. ("USN"), a well-known provider of Internet
services, including Web hosting and maintenance, security and other customized
solutions, to businesses. These acquisitions provided us with additional
business Internet expertise to enhance our market presence in the Netherlands
and Europe by focusing on value-added products.

         In November and December 1998, we acquired AsiaNet Limited, Huge Net
Limited and Spider Net Limited, three commercial ISPs in Hong Kong, to
supplement our acquisition of LinkAge and HKIGS. These acquisitions expanded our
market presence in Hong Kong by adding an aggregate of approximately 300
business and Web services accounts and 350 consumer dial-up customers.

         In February 1999, we acquired Planete.net and Satelnet, two commercial
ISPs based in France, to supplement our acquisition of CalvaCom. These
acquisitions expanded our market presence in France by adding an aggregate of
approximately 300 business and Web services accounts and 780 consumer dial-up
customers.

COMPETITION

         The market for Internet connectivity and related services is extremely
competitive. We anticipate that competition will continue to intensify as the
use of the Internet grows. The tremendous growth and potential market size of
the Internet access market has attracted many new start-ups as well as existing
businesses from different industries.

         We believe that a reliable international network, knowledgeable
salespeople and the quality of technical support currently are the primary
competitive factors in our targeted market and that price is usually secondary
to these factors.

         Our current and prospective competitors include, in addition to other
national, regional and local ISPs, long distance and local exchange
telecommunications companies, cable television, direct broadcast satellite,
wireless communications providers and on-line service providers. While we
believe that our network, products and customer service distinguish us from
these competitors, some of these competitors have significantly greater market
presence, brand recognition, and financial, technical and personnel resources
than us.

         ISPs. According to industry sources, there were over 6,700 ISPs in the
United States and Canada in 1998, consisting of national, regional and local
providers. Our current primary competitors include other ISPs with a significant
national presence which focus on business customers, such as UUNet Technologies,
Inc., GTE Internetworking (formerly BBN), Concentric Network and DIGEX. While we
believe that our level of customer service and support and target market focus
distinguish us from these competitors, many of these competitors have greater
market share, brand recognition, and financial, technical and personnel
resources than us. We also compete with unaffiliated regional and local ISPs in
our targeted geographic regions.

         Telecommunications Carriers. The major long distance companies, also
known as interexchange carriers, including AT&T, MCIWorldCom, Cable &
Wireless/IMCI and Sprint, offer Internet access services and compete with us.
Reforms in the federal regulation of the telecommunications industry have
created greater opportunities for incumbent local exchange carriers ("ILECs"),
including the Regional Bell Operating Companies ("RBOCs") and other competitive
local exchange carriers ("CLECs"), to enter the Internet connectivity market. In
order to address the Internet connectivity requirements of the business
customers of long distance and local carriers, we believe that there is a move
toward horizontal integration by ILECs and CLECs through acquisitions or joint
ventures with, and the wholesale purchase of, connectivity from ISPs. The
MCI/WorldCom merger (and the prior WorldCom/MFS/UUNet consolidation), GTE's
acquisition of BBN, the acquisition by ICG Communications, Inc. of 

                                      -15-
<PAGE>
 
Netcom, Global Crossing's recently announced plans to acquire Frontier Corp.
(and Frontier's prior acquisition of Global Center) and AT&T's recent purchase
of IBM's global communications network are indicative of this trend.
Accordingly, we expect that we will experience increased competition from the
traditional telecommunications carriers. Many of these telecommunications
carriers, in addition to their greater network coverage, market presence, and
financial, technical and personnel resources, also have large existing
commercial customer bases.

         Cable Companies, Direct Broadcast Satellite and Wireless Communications
Companies. Many of the major cable companies have announced that they are
exploring the possibility of offering Internet connectivity, relying on the
viability of cable modems and economical upgrades to their networks. Continental
Cablevision, Inc., Tele-Communications, Inc. ("TCI") and At Home Corporation
(@Home) have announced trials to provide Internet cable service to their
residential customers in select areas. Cable companies, however, are faced with
large-scale upgrades of their existing plant equipment and infrastructure in
order to support connections to the Internet backbone via high-speed cable
access devices. Additionally, their current subscriber base and market focus is
residential which requires that they partner with business-focused providers or
undergo massive sales and marketing and network development efforts in order to
target the business sector. Several announcements also recently have been made
by other alternative service companies approaching the Internet connectivity
market with various wireless terrestrial and satellite-based service
technologies. These include Hughes Network Systems' DirecPC product that
provides high-speed data through direct broadcast satellite technology; CAI
Wireless Systems Inc.'s announcement of an MMDS wireless cable operator
launching data services via 2.5 to 2.7 GHz and high-speed wireless modem
technology; Cellularvision's announcement that it is offering Internet access
via high-speed wireless LMDS technology; and WinStar Communications, a 38 GHz
radio company that wholesales its network capacity to other carriers and now
offers high-speed Internet access to business customers. We believe that there
is a trend toward horizontal integration involving cable companies through
acquisitions or joint ventures between cable companies and telecommunications
carriers. The acquisition of TCI by AT&T is indicative of this trend.

         On-line Service Providers. The dominant on-line service providers,
including Microsoft Network, America Online, Incorporated and Prodigy, Inc.,
have all entered the Internet access business by engineering their current
proprietary networks to include Internet access capabilities. We compete to a
lesser extent with these service providers, which currently are primarily
focused on the consumer marketplace and offer their own content, including chat
rooms, news updates, searchable reference databases, special interest groups and
shopping. However, America Online's recent acquisition of Netscape
Communications Corporation and related strategic alliance with Sun Microsystems
will enable it to offer a broader array of IP-based services and products that
could significantly enhance its ability to appeal to the business marketplace
and, as a result, compete more directly with us. While CompuServe has announced
it also will target Internet connectivity for the small to medium-sized business
market, this will require a significant transition from a consumer market focus
to a business market focus.

         We believe that our ability to attract business customers and to market
value-added services is a key to our future success. However, there can be no
assurance that our competitors will not introduce comparable services or
products at similar or more attractive prices in the future or that we will not
be required to reduce our prices to match competition. Recently, many
competitive ISPs have shifted their focus from individual customers to business
customers. Moreover, there can be no assurance that more of our competitors will
not shift their focus to attracting business customers, resulting in even more
competition for us. There can be no assurance that we will be able to offset the
effects of any such competition or resulting price reductions. Increased
competition could result in erosion of our market share and could have a
material adverse effect on our business, financial condition and results of
operations.

PROPRIETARY RIGHTS

         Our success and ability to compete is dependent in part upon our
technology and proprietary rights, although we believe that our success is more
dependent upon our technical expertise than our proprietary rights. We rely on a
combination of copyright, trademark and trade secret laws and contractual
restrictions to establish and protect our technology. There can be no assurance
that the steps taken by us will be adequate to prevent misappropriation of our
technology or that our competitors will not independently develop technologies
that are substantially equivalent or superior to our technology. We are also
subject to the risk of adverse claims and litigation alleging infringement of
the intellectual property rights of others.

                                      -16-
<PAGE>
 
REGULATORY MATTERS

         In recent years there have been a number of U.S. and foreign
legislative and other initiatives seeking to control or affect the content of
information provided over the Internet. Some of these initiatives would impose
criminal liability upon persons sending or displaying, in a manner available to
minors, indecent material or material harmful to minors. Liability would also be
imposed on an entity knowingly permitting facilities under its control to be
used for such activities. These initiatives may decrease demand for Internet
access, chill the development of Internet content, or have other adverse effects
on Internet access providers, including us.

         Both the provision of Internet access service and the provision of
underlying telecommunications services are affected by federal, state and local
regulation. The Federal Communications Commission (the "FCC") exercises
jurisdiction over all facilities of, and services offered by, telecommunications
carriers to the extent that they involve the provision, origination or
termination of jurisdictionally interstate or international communications. The
state regulatory commissions retain jurisdiction over the same facilities and
services to the extent they involve origination or termination of
jurisdictionally intrastate communications. In addition, as a result of the
passage of the Telecommunications Act of 1996 (the "1996 Act"), state and
federal regulators share responsibility for implementing and enforcing the
domestic pro-competitive policies of the 1996 Act. In particular, state
regulatory commissions have substantial oversight over the provision of
interconnection and non-discriminatory network access by ILECs. Municipal
authorities generally have some jurisdiction over access to rights of way,
franchises, zoning and other matters of local concern.

         Our Internet operations are not currently subject to direct regulation
by the FCC or any other U.S. governmental agency, other than regulations
applicable to businesses generally. However, the FCC continues to review its
regulatory position on the usage of the basic network and communications
facilities by ISPs. Although in an April 1998 Report, the FCC determined that
ISPs should not be treated as telecommunications carriers and therefore not
regulated, it is expected that future ISP regulatory status will continue to be
uncertain. Indeed, in that report, the FCC concluded that certain services
offered over the Internet, such as phone-to-phone IP telephony, may be
functionally indistinguishable from traditional telecommunications service
offerings, and their non-regulated status may have to be re-examined.

         Changes in the regulatory structure and environment affecting the
Internet access market, including regulatory changes that directly or indirectly
affect telecommunications costs or increase the likelihood of competition from
RBOCs or other telecommunications companies, could have an adverse effect on our
business. Although the FCC has decided not to allow local telephone companies to
impose per-minute access charges on ISPs, and that decision has been upheld by
the reviewing court, further regulatory and legislative consideration of this
issue is likely. In addition, some telephone companies are seeking relief
through state regulatory agencies. Such rules, if adopted, are likely to have a
greater impact on consumer-oriented Internet access providers than on
business-oriented ISPs, such as us. Nonetheless, the imposition of access
charges would affect our costs of serving dial-up customers and could have a
material adverse effect on our business, financial condition and results of
operations.

         In addition to our Internet activities, we have recently focused
attention on acquiring telecommunications assets and facilities, which is a
regulated activity. Our wholly-owned subsidiary, PSINetworks Company, has
received an international Section 214 license from the FCC to provide global
facilities-based telecommunications services, subjecting it to regulation as a
non-dominant international common carrier. In addition, our wholly-owned
subsidiary, PSINet Telecom UK Limited, has received an international facilities
license from DTI and OFTEL, the responsible telecommunications regulatory bodies
in the United Kingdom. Generally, the FCC and OFTEL have chosen not to closely
regulate the charges or practices of non-dominant carriers, such as our
subsidiaries. Nevertheless, these regulatory agencies act upon complaints
against such carriers for failure to comply with statutory obligations or with
the rules, regulations and policies of such regulatory agencies. These
regulatory agencies also have the power to impose more stringent regulatory
requirements on us and to change our regulatory classification. We believe that,
in the current regulatory environment, such regulatory agencies are unlikely to
do so. As we enter new markets, we anticipate obtaining similar licenses as
required by applicable telecommunications rules and regulations in order to
acquire and maintain telecommunications assets and facilities in such countries.

         The laws relating to the provision of telecommunications services in
other countries, and in multinational organizations such as the International
Telecommunications Union, are also undergoing a process of development. As we
continue our program of acquisition and expansion into international markets,
these laws will have an 

                                      -17-
<PAGE>
 
increasing impact on our operations. There can be no assurance that new or
existing laws or regulations will not have a material adverse effect on us.

         PSINetworks Company has also received CLEC certification in Colorado
and Texas, has applied for CLEC certification in Maryland, Virginia, California
and New York, and is considering the financial, regulatory and operational
implications of becoming a CLEC in certain other states. As a provider of
domestic basic telecommunications services, particularly competitive local
exchange services, we could become subject to further regulation by the FCC
and/or another regulatory agency, including state and local entities.

         The 1996 Act has caused fundamental changes in the markets for local
exchange services. In particular, the 1996 Act and the FCC rules issued pursuant
to it mandate competition in local markets and require that ILECs interconnect
with CLECs. Under the provisions of the 1996 Act, the FCC and state public
utility commissions share jurisdiction over the implementation of local
competition: the FCC was required to promulgate general rules and the state
commissions were required to arbitrate and approve individual agreements. The
courts have generally upheld the FCC in its promulgation of rules, including a
January 25, 1999 U.S. Supreme Court ruling which determined that the FCC has
jurisdiction to promulgate national rules in pricing for interconnection.

         An important issue for CLECs is the right to receive reciprocal
compensation for the transport and termination of Internet traffic. We believe
that, under the 1996 Act, CLECs are entitled to receive reciprocal compensation
from ILECs. However, some ILECs have disputed payment of reciprocal compensation
for Internet traffic, arguing that ISP traffic is not local traffic. Most states
have required ILECs to pay ISPs reciprocal compensation. However, in October
1998, the FCC determined that dedicated Digital Subscriber Line service is an
interstate service and properly tariffed at the interstate level. In February
1999, the FCC concluded that at least a substantial portion of dial-up ISP
traffic is jurisdictionally interstate. The FCC also concluded that its
jurisdictional decision does not alter the exemption from access charges
currently enjoyed by ISPs. The FCC established a proceeding to consider an
appropriate compensation mechanism for interstate Internet traffic. Pending the
adoption of that mechanism, the FCC saw no reason to interfere with existing
interconnection agreements and reciprocal compensation arrangements. The FCC
order has been appealed. There can be no assurance that any future court, state
regulatory or FCC decision on this matter will favor our position. An
unfavorable result may have an adverse impact on our potential future revenues
as a CLEC, as well as increasing our costs for PRIs generally.

         As we become a competitor in local exchange markets, we will become
subject to state requirements regarding provision of intrastate services. This
may include the filing of tarriffs containing rates and conditions. As a new
entrant, without market power, we expect to face a relatively flexible
regulatory environment. Nevertheless, it is possible that some states could
require us to obtain the approval of the public utilities commission for the
issuance of debt or equity or other transactions which would result in a lien on
our property used to provide intrastate services.

EMPLOYEES

         As of December 31, 1998, we had approximately 1,817 full-time
employees: 773 in the United States and 1,044 outside of the United States,
including approximately 688 in data communications and operational positions,
636 in sales and marketing, and 493 in general and administrative positions. We
believe that our relations with our employees are good. None of our employees
are represented by a labor union or covered by a collective bargaining agreement
and we have never experienced a work stoppage.

EXECUTIVE OFFICERS

         The following is a list of our executive officers as of December 31,
1998.

<TABLE> 
<CAPTION> 
          NAME                                  AGE                    TITLE
          ----                                  ---                    -----
<S>                                            <C>      <C> 
William L. Schrader.........................     47     Chairman of the Board of Directors and Chief
                                                          Executive Officer (Founder)
Harold S. Wills.............................     56     President, Chief Operating Officer and Director 
David N. Kunkel.............................     55     Executive Vice President, General Counsel and Director 
Edward D. Postal............................     43     Senior Vice President and Chief Financial Officer 
</TABLE> 

                                      -18-
<PAGE>
 
<TABLE> 
<CAPTION> 
          NAME                                  AGE                    TITLE
          ----                                  ---                    -----
<S>                                            <C>      <C> 
E.A. Davis..................................     52     Senior Vice President and President, PSINetworks  Company
Harry G. Hobbs..............................     44     Senior Vice President and President, PSINet Europe 
Chi H. Kwan.................................     47     Senior Vice President and President, PSINet Asia/Pacific 
Michael J. Malesardi........................     38     Vice President and Controller 
</TABLE> 

         Additional information regarding our executive officers is incorporated
by reference to "Executive Officers" in our Proxy Statement to be used in
connection with our 1999 Annual Meeting of Shareholders and to be filed with the
Securities and Exchange Commission on or prior to April 30, 1999.

                                 RISK FACTORS

         You should be aware that there are various risks associated with us and
our business, including the ones discussed below. You should carefully consider
these risk factors, as well as the other information contained in this Form
10-K, in evaluating us and our business.

WE HAVE SIGNIFICANT INDEBTEDNESS AND WE MAY NOT BE ABLE TO MEET OUR OBLIGATIONS

         We are highly leveraged and have significant debt service requirements.
As of December 31, 1998, our total indebtedness was $1.12 billion, representing
112% of total capitalization, and our interest expanse for the twelve months 
ended December 31, 1998 was $63.9 million.

         Our high level of indebtedness could have several important effects on
our future operations, which, in turn, could have important consequences for the
holders of our securities, including the following:

         .   a substantial portion of our cash flow from operations must be used
             to pay interest on our indebtedness and, therefore, will not be
             available for other business purposes;

         .   covenants contained in the agreements evidencing our debt
             obligations require us to meet many financial tests, and other
             restrictions limit our ability to borrow additional funds or to
             dispose of assets and may affect our flexibility in planning for,
             and reacting to, changes in our business, including possible
             acquisition activities and capital expenditures; and

         .   our ability to obtain additional financing in the future for
             working capital, capital expenditures, acquisitions, general
             corporate purposes or other purposes may be impaired.

         Our ability to meet our debt service obligations and to reduce our
total indebtedness depends on our future operating performance and on economic,
financial, competitive, regulatory and other factors affecting our operations.
Many of these factors are beyond our control and our future operating
performance could be adversely affected by some or all of these factors. We
historically have been unable to generate sufficient cash flow from operations
to meet our operating needs and have relied on equity, debt and capital lease
financings to fund our operations. However, based on our current level of
operations, management believes that existing working capital, existing credit
facilities, capital lease financings and proceeds of future equity or debt
financings will be adequate to meet our presently anticipated future
requirements for working capital, capital expenditures and scheduled payments of
interest on our debt. We cannot assure, however, that our business will generate
sufficient cash flow from operations or that future working capital borrowings
will be available in an amount sufficient to enable us to service our debt or to
make necessary capital expenditures. In addition, we cannot assure that we will
be able to raise additional capital for any refinancing of our debt in the
future.

WE HAVE EXPERIENCED CONTINUING LOSSES, NEGATIVE CASH FLOW AND FLUCTUATIONS 
IN OPERATING RESULTS

         Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in new and rapidly evolving
markets. To address these risks, we must, among other things, respond to
competitive developments, continue to attract and retain qualified persons, and
continue to upgrade our technologies and commercialize our network services
incorporating such technologies. We cannot assure that we will be successful in
addressing such risks, and the failure to do so could have a material adverse
effect on our business, financial condition, results of operations and ability
to pay when due principal, interest and other amounts in respect 

                                      -19-
<PAGE>
 
of our debt. Although we have experienced revenue growth on an annual basis with
revenue increasing from $84.4 million in 1996 to $121.9 million in 1997 to
$259.6 million in 1998, we have incurred losses and experienced negative
earnings before interest expense and interest income, taxes, depreciation and
amortization, other income and expense, and charge for acquired in-process
research and development ("EBITDA") during each of such periods. We expect to
continue to operate at a net loss and experience negative EBITDA in the near
term as we continue our acquisition program and the expansion of our global
network operations. We have incurred net losses available to common shareholders
of $55.1 million, $46.0 million and $264.9 million and have incurred negative
EBITDA of $28.0 million, $21.2 million and $42.1 million for each of the years
ended December 31, 1996, 1997 and 1998, respectively. At December 31, 1998, we
had an accumulated deficit of $427.6 million. We cannot assure that we will be
able to achieve or sustain profitability or positive EBITDA.

         Our operating results have fluctuated in the past and may fluctuate
significantly in the future as a result of a variety of factors, some of which
are outside our control. These factors, include, among others:

         .  general economic conditions and specific economic conditions in the
            Internet access industry;

         .  user demand for Internet services;

         .  capital expenditures and other costs relating to the expansion of
            operations our network;
            
         .  the introduction of new services by us or our competitors;

         .  the mix of services sold and the mix of channels through which those
            services are sold;
            
         .  pricing changes and new product introductions by us and our
            competitors;
            
         .  delays in obtaining sufficient supplies of sole or limited source
            equipment and telecom facilities; and
            
         .  potential adverse regulatory developments.

         As a strategic response to a changing competitive environment, we may
elect from time to time to make pricing, service or marketing decisions that
could have a material adverse effect on our business, results of operations and
cash flow.

WE ARE PARTIALLY DEPENDENT ON OUR SUBSIDIARIES FOR REPAYMENT OF DEBT

         We are an operating entity which also conducts a significant portion of
our business through our subsidiaries. Our cash flow from operations and
consequently our ability to service our debt, including our 10% senior notes and
11 1/2% senior notes, is therefore partially dependent upon our subsidiaries'
earnings and their distributions of those earnings to us. It may also be
dependent upon loans, advances or other payments of funds to us by those
subsidiaries. Our subsidiaries have no obligation, contingent or otherwise, to
make any funds available to us for payment of the principal of or interest on
many of our debt obligations, including our 10% senior notes and 11 1/2% senior
notes. Our subsidiaries' ability to make payments may be subject to the
availability of sufficient surplus funds, the terms of such subsidiaries'
indebtedness, applicable laws and other factors.

         Our subsidiaries' creditors and holders of preferred stock, if any, of
such subsidiaries will have priority to the assets of such subsidiaries over the
claims of PSINet and the holders of our indebtedness. One exception is that if
such subsidiaries have provided guarantees of our indebtedness and if loans made
by us to our subsidiaries are recognized as indebtedness, they will not have
such priorities. In any event, our 10% senior notes and 11 1/2% senior notes are
effectively subordinated in right of payment to all existing and future
indebtedness and other liabilities of our subsidiaries, including trade
payables. As of December 31, 1998, our subsidiaries had approximately $133.5
million of total liabilities, including trade payables and accrued liabilities,
to which holders of our 10% senior notes and 11 1/2 senior notes are
structurally subordinated. Under the terms of agreements evidencing our debt
obligations, some of our subsidiaries are restricted in their ability to incur
debt in the future.

WE MAY NOT BE ABLE TO FUND THE EXPANSION WE WILL NEED TO REMAIN COMPETITIVE

         In order to maintain our competitive position and continue to meet the
increasing demands for service quality, availability and competitive pricing, we
expect to make significant capital expenditures. At December 31, 1998, we were 
obligated to make future payments that total $103.7 million for global fiber-
based telecommunications bandwidth and related equipment, including indefeasible
rights of use or other rights. We also expect that there will
                                      -20-
<PAGE>
 
be additional costs, such as connectivity and equipment charges, in connection
with taking full advantage of such acquired bandwidth and indefeasible rights of
use.  Although we are currently unable to estimate the extent of such additional
costs, we currently anticipate that our capital expenditures in 1999 will be
consistent with those in 1998. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Commitments, Capital Expenditures
and Future Financing Requirements" in Part II, Item 7 of this Form 10-K and
"Business--PSINet's Network" in Item 1 of this Form 10-K. 

         We historically have been unable to generate sufficient cash flow from
operations to meet our operating needs and have relied on equity, debt and
capital lease financings to fund our operations. However, we believe that we
will have a reasonable degree of flexibility to adjust the amount and timing of
these capital expenditures in response to market conditions, competition, our
then-existing financing capabilities and other factors. We also believe that
working capital generated from the use of acquired bandwidth, together with
other existing working capital, existing credit facilities, capital lease
financings and proceeds of future equity or debt financings will be sufficient
to meet the presently anticipated working capital and capital expenditure
requirements of our operations.

         We may need to raise additional funds in order to take advantage of
unanticipated opportunities, more rapid international expansion or acquisitions
of complementary businesses. In addition, we may need to raise additional funds
to develop new products or otherwise respond to changing business conditions or
unanticipated competitive pressures. We cannot assure that we will be able to
raise such funds on favorable terms. In the event that we are unable to obtain
such additional funds on acceptable terms, we may determine not to enter into
various expansion opportunities.

WE FACE RISKS ASSOCIATED WITH ACQUISITIONS AND STRATEGIC ALLIANCES RELATING TO
DIFFICULTIES IN INTEGRATING COMBINED OPERATIONS, INCURRENCE OF ADDITIONAL DEBT
TO FINANCE ACQUISITIONS AND OPERATIONS OF ACQUIRED BUSINESSES, POTENTIAL
DISRUPTION OF OPERATIONS AND RELATED NEGATIVE IMPACT ON EARNINGS, AND INCURRENCE
OF SUBSTANTIAL EXPENSES THAT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION

         Growth through acquisitions represents a principal component of our
business strategy. Over the seventeen months ended February 28, 1999, we have
acquired 20 Internet service providers in eight of the 20 largest global
telecommunications markets. We expect to continue to acquire assets and
businesses principally relating to or complementary to our current operations.
We may also seek to develop strategic alliances both in the U.S. and
internationally. Any such future acquisitions or strategic alliances would be
accompanied by the risks commonly encountered in strategic alliances with or
acquisitions of companies. Such risks include, among other things:

        .  the difficulty of integrating the operations and personnel of the
           companies;
           
        .  the potential disruption of our ongoing business;

        .  the inability of management to maximize our financial and strategic
           position by the successful incorporation of licensed or acquired
           technology and rights into our service offerings; and

        .  the inability to maintain uniform standards, controls, procedures and
           policies and the impairment of relationships with employees and
           customers as a result of changes in management.

         We cannot assure that we will be successful in overcoming these risks
or any other problems encountered in connection with such acquisitions or
strategic alliances. We believe that after eliminating redundant network
architecture and administrative functions and taking other actions to integrate
the operations of acquired companies we will be able to realize cost savings.
However, we cannot assure that our integration of acquired companies' operations
will be successfully accomplished. Our inability to improve the operating
performance of acquired companies' businesses or to integrate successfully the
operations of acquired companies could have a material adverse effect on our
business, financial condition and results of operations. In addition, as we
proceed with acquisitions in which the consideration consists of cash, a
substantial portion of our available cash will be used to consummate such
acquisitions.

         As with each of our recent acquisitions, the purchase price of many of
the businesses that might become attractive acquisition candidates for us likely
will significantly exceed the fair values of the net assets of the acquired
businesses. As a result, material goodwill and other intangible assets would be
required to be recorded which would 

                                      -21-
<PAGE>
 
result in significant amortization charges in future periods. In addition, an
intangible asset that frequently arises in connection with the acquisition of a
technology company is "acquired in-process research and development," which
under U.S. accounting standards, as presently in effect, must be expensed
immediately upon acquisition. Such expenses, in addition to the financial impact
of such acquisitions, could have a material adverse effect on our business,
financial condition and results of operations and could cause substantial
fluctuations in our quarterly and yearly operating results. Furthermore, in
connection with acquisitions, we could incur substantial expenses, including the
expenses of integrating the business of the acquired company or the strategic
alliance with our existing business.

         We expect that competition for appropriate acquisition candidates may
be significant. We may compete with other telecommunications companies with
similar acquisition strategies, many of which may be larger and have greater
financial and other resources than we have. Competition for Internet companies
is based on a number of factors including price, terms and conditions, size and
access to capital, ability to offer cash, stock or other forms of consideration
and other matters. We cannot assure that we will be able to successfully
identify and acquire suitable companies on acceptable terms and conditions.

OUR GROWTH AND EXPANSION MAY STRAIN OUR ABILITY TO MANAGE OUR OPERATIONS AND OUR
FINANCIAL RESOURCES

         Our rapid growth has placed a strain on our administrative, operational
and financial resources and has increased demands on our systems and controls.
We have over 500 POPs and we plan to continue to expand the capacity of existing
POPs as customer-driven demand dictates. In addition, we have completed a number
of acquisitions of companies and telecommunications bandwidth during 1998 and
plan to continue to do so. We anticipate that our Carrier and ISP Services
business unit, as well as other business growth, may require continued
enhancements to and expansion of our network. The process of consolidating the
businesses and implementing the strategic integration of these acquired
businesses with our existing business may take a significant amount of time. It
may also place additional strain on our resources and could subject us to
additional expenses. We cannot assure that we will be able to integrate these
companies successfully or in a timely manner. In addition, we cannot assure that
our existing operating and financial control systems and infrastructure will be
adequate to maintain and effectively monitor future growth.

         Our continued growth may also increase our need for qualified
personnel. We cannot assure that we will be successful in attracting,
integrating and retaining such personnel. The following risks, associated with
our growth, could have a material adverse effect on our business, results of
operations and financial condition:

        .  our inability to continue to upgrade our networking systems or our
           operating and financial control systems;

        .  our inability to recruit and hire necessary personnel or to
           successfully integrate new personnel into our operations;

        .  our inability to successfully integrate the operations of acquired
           companies or to manage our growth effectively; or

        .  our inability to adequately respond to the emergence of unexpected
           expansion difficulties.
           
WE FACE RISKS ASSOCIATED WITH OUR ACQUISITIONS OF BANDWIDTH FROM NETWORK
SUPPLIERS AND STRATEGIC ALLIANCE WITH IXC RELATING TO OUR DEPENDENCE ON THEIR
ABILITY TO SATISFY THEIR OBLIGATIONS TO US, THE POSSIBILITY THAT WE MAY NEED TO
INCUR SIGNIFICANT EXPENSES TO UTILIZE BANDWIDTH AND THEIR ABILITY TO BUILDOUT
THEIR NETWORKS UNDER CONSTRUCTION THAT COULD ADVERSELY AFFECT OUR ABILITY TO
UTILIZE ACQUIRED BANDWIDTH

         We are subject to a variety of risks relating to our recent
acquisitions of fiber-based telecommunications bandwidth from our various global
network suppliers and the delivery, operation and maintenance of such bandwidth.
Such risks include, among other things, the following:

        .  the risk that financial, legal, technical and/or other matters may
           adversely affect such suppliers' ability to perform their respective
           operation, maintenance and other services relating to such bandwidth,
           which may adversely affect our use of such bandwidth;

        .  the risk that we will not have access to sufficient additional
           capital and/or financing on satisfactory terms to enable us to make
           the necessary capital expenditures to take full advantage of
           such bandwidth;

                                      -22-
<PAGE>
 
        .  the risk that such suppliers may not continue to have the necessary
           financial resources to enable them to complete, or may otherwise
           elect not to complete, their contemplated buildout of their
           respective fiber optic telecommunications systems; and

        .  the risk that such buildout may be delayed or otherwise adversely
           affected by presently unforeseeable legal, technical and/or other
           factors.

        In addition, we are subject to additional risks relating specifically
to our strategic alliance with IXC. Such risks include:

        .  the risk that, in the event of a material default by IXC under our
           purchase agreement with IXC at such time as IXC is in bankruptcy, our
           use of the bandwidth acquired from IXC may be materially adversely
           affected or curtailed;

        .  the risk that, in the event of a change of control or change in
           management of IXC, IXC's successor or new management, as the case may
           be, may not share IXC's commitment to the buildout of its fiber optic
           telecommunications system or may not otherwise allocate the necessary
           human, financial, technical and other resources to satisfactorily
           meet its obligations to us under our purchase agreement with IXC that
           would adversely affect our use of the bandwidth acquired from IXC;

        .  the risk that IXC, as our largest shareholder and through its ex-
           chairman's seat on our Board of Directors, could subject us to
           conflicts of interest or could influence our management in a manner
           that could adversely affect our business or the control of PSINet;
           and

        .  the risk that future sales by IXC of substantial numbers of shares of
           our common stock could adversely affect the market price of our
           common stock and make it more difficult for us to raise funds through
           equity offerings and to effect acquisitions of businesses or assets
           in consideration for issuances of our common stock.

        We cannot assure that we will be successful in overcoming these risks
or any other problems encountered in connection with our acquisitions of
bandwidth or our strategic alliance with IXC.

CONTINUED INTERNATIONAL EXPANSION IS A KEY COMPONENT OF OUR BUSINESS STRATEGY
AND, IF WE ARE UNABLE TO COMPLETE THIS EXPANSION, OUR FINANCIAL CONDITION MAY BE
ADVERSELY AFFECTED

        A key component of our business strategy is our continued expansion
into international markets. We may need to enter into joint ventures or other
strategic relationships with one or more third parties in order to conduct our
foreign operations successfully. However, we cannot assure that we will be able
to obtain the permits and operating licenses required for us to operate, to hire
and train employees or to market, sell and deliver high quality services in
these markets. In addition to the uncertainty as to our ability to continue to
expand our international presence, there are risks inherent in doing business on
an international level. Such risks include:

        .  unexpected changes in or delays resulting from regulatory
           requirements, tariffs, customs, duties and other trade barriers;

        .  difficulties in staffing and managing foreign operations;

        .  longer payment cycles and problems in collecting accounts receivable;

        .  political instability, expropriation, nationalization, war,
           insurrection and other political risks;
           
        .  fluctuations in currency exchange rates and foreign exchange controls
           which restrict or prohibit repatriation of funds;

        .  technology export and import restrictions or prohibitions;

        .  delays from customs brokers or government agencies;

        .  seasonal reductions in business activity during the summer months in
           Europe and other parts of the world; and

        .  potentially adverse tax consequences, which could adversely impact
           the success of our international operations.

                                      -23-
<PAGE>
 
         We cannot assure that such factors will not have an adverse effect on
our future international operations and, consequently, on our business,
financial condition and results of operations. In addition, we cannot assure
that laws or administrative practice relating to taxation, foreign exchange or
other matters of countries within which we operate will not change. Any such
change could have a material adverse effect on our business, financial condition
and results of operations.

         In particular, we have also recently made significant investments in
Japan, which is currently experiencing a severe economic recession. Other
Asian-Pacific countries in which we operate are also experiencing economic
difficulties and uncertainties. These economic difficulties and uncertainties
could have a material adverse effect on our business, financial condition and
results of operations.

WE DEPEND ON KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR SERVICES

         Competition for qualified employees and personnel in the Internet
services industry is intense and there are a limited number of persons with
knowledge of and experience in the Internet service industry. The process of
locating such personnel with the combination of skills and attributes required
to carry out our strategies is often lengthy. Our success depends to a
significant degree upon our ability to attract and retain qualified management,
technical, marketing and sales personnel and upon the continued contributions of
such management and personnel. In particular, our success is highly dependent
upon the personal abilities of our senior executive management, including
William L. Schrader, our Chairman of the Board and Chief Executive Officer and
the founder of PSINet, Harold S. Wills, our President and Chief Operating
Officer, David N. Kunkel, our Executive Vice President and General Counsel, and
Edward D. Postal, our Senior Vice President and Chief Financial Officer. We have
employment agreements with each of these executive officers, with the exception
of Mr. Schrader. The loss of the services of any one of them could have a
material adverse effect on our business, financial condition or results of
operations.

WE DEPEND ON SUPPLIERS AND COULD BE AFFECTED BY CHANGES IN SUPPLIERS OR DELAYS
IN DELIVERY OF THEIR PRODUCTS AND SERVICES

         We have few long-term contracts with our suppliers. We are dependent on
third party suppliers for our leased-line connections or bandwidth. Some of
these suppliers are or may become competitors of ours, and such suppliers are
not subject to any contractual restrictions upon their ability to compete with
us. If these suppliers change their pricing structures, we may be adversely
affected. Due to our recent acquisitions of telecommunications bandwidth from
IXC and other global network providers, we anticipate that our dependence upon
some of these suppliers will be decreased as we accept delivery of OC-48
bandwidth from IXC and bandwidth from our other global network providers.
Nevertheless, until the fiber optic telecommunications systems of IXC and our
other global network providers are completed, and in the case of IXC, it is not
obligated under the terms of our purchase agreement to extend its buildout of
its system beyond approximately 6,640 unique route miles of OC-48 bandwidth,
and, in some geographic areas, even after such completion, we will continue to
be dependent upon such suppliers. Moreover, any failure or delay on the part of
our network providers to deliver bandwidth to us or to provide operations,
maintenance and other services with respect to such bandwidth in a timely or
adequate fashion could adversely affect us.

         We are also dependent on third party suppliers of hardware components.
Although we attempt to maintain a minimum of two vendors for each required
product, some components used by us in providing our networking services are
currently acquired or available from only one source. We have from time to time
experienced delays in the receipt of hardware components and telecommunications
facilities, including delays in delivery of PRI telecommunications facilities,
which connect dial-up customers to our network. A failure by a supplier to
deliver quality products on a timely basis, or the inability to develop
alternative sources if and as required, could result in delays which could have
a material adverse effect on us. Our remedies against suppliers who fail to
deliver products on a timely basis are limited by contractual liability
limitations contained in supply agreements and purchase orders and, in many
cases, by practical considerations relating to our desire to maintain good
relationships with the suppliers. As our suppliers revise and upgrade their
equipment technology, we may encounter difficulties in integrating the new
technology into our network.

         Many of the vendors from whom we purchase telecommunications bandwidth,
including the Regional Bell Operating Companies, competitive local exchange
carriers and other local exchange carriers, currently are subject to tariff
controls and other price constraints which in the future may be changed. In
addition, recently enacted 

                                      -24-
<PAGE>
 
legislation will produce changes in the market for telecommunications services.
These changes may affect the prices which we are charged by the Regional Bell
Operating Companies and other carriers, which could have a material adverse
effect on our business, financial condition and results of operations. Moreover,
we are subject to the effects of other potential regulatory actions which, if
taken, could increase the cost of our telecommunications bandwidth through, for
example, the imposition of access charges.

THE TERMS OF OUR FINANCING ARRANGEMENTS MAY RESTRICT OUR OPERATIONS

         Our financing arrangements are secured by substantially all of our
assets and stock of some of our subsidiaries. These financing arrangements
require that we satisfy many financial covenants. Our ability to satisfy these
financial covenants may be affected by events beyond our control and, as a
result, we cannot assure you that we will be able to continue to satisfy such
covenants. These financing arrangements also currently prohibit us from paying
dividends and repurchasing our capital stock without the lender's consent. Our
failure to comply with the covenants and restrictions in these financing
arrangements could lead to a default under the terms of these agreements. In the
event of a default under the financing arrangements, our lenders would be
entitled to accelerate the indebtedness outstanding thereunder and foreclose
upon the assets securing such indebtedness. They would also be entitled to be
repaid from the proceeds of the liquidation of those assets before the assets
would be available for distribution to the holders of our securities, including
the holders of the notes. In addition, the collateral security arrangements
under our existing financing arrangements may adversely affect our ability to
obtain additional borrowings.

OUR FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED IF OUR SYSTEMS AND THOSE OF
OUR SUPPLIERS FAIL BECAUSE OF YEAR 2000 PROBLEMS

         The commonly referred to Year 2000 ("Y2K") problem results from the
fact that many existing computer programs and systems use only two digits to
identify the year in the date field. These programs were designed and developed
without considering the impact of a change in the century designation. If not
corrected, computer applications that use a two-digit format could fail or
create erroneous results in any computer calculation or other processing
involving the Year 2000 or a later date. We have identified two main areas of
Y2K risk:

                  1. Internal computer systems or embedded chips could be
         disrupted or fail, causing an interruption or decrease in productivity
         in our operations; and

                  2. Computer systems or embedded chips of third parties
         including, without limitation, financial institutions, suppliers,
         vendors, landlords, customers, international suppliers of
         telecommunications services and others, could be disrupted or fail,
         causing an interruption or decrease in our ability to continue our
         operations.  

         We have developed plans for implementing, testing and completing any
necessary modifications to our key computer systems and equipment with embedded
chips to ensure that they are Y2K compliant. We 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 June 30, 1999. We are in the process of completing an inventory of
our internal systems that we use in Canada, United Kingdom, Europe and Asia to
determine the status of their Y2K compliance. Each international office has
plans in place to test, upgrade or, if necessary, replace components of its
internal systems to ensure they are Y2K compliant. We anticipate that our
international operations will be Y2K compliant by the end of the third quarter
of 1999. To help ensure that our network operations and services to our
customers are not interrupted due to the Y2K problem, we have established a
network operations team that meets weekly to examine our network on a worldwide
basis. This team of operational staff have conducted inventories of our network
equipment (software and hardware) and have found no material Y2K compliance
issues. We believe that all equipment currently being purchased for use in the
PSINet network is Y2K compliant. Any existing equipment that is not Y2K
compliant is planned to be made Y2K compliant through minor changes to the
software or hardware or, in limited instances, replacement of the equipment. We
anticipate that our network will be Y2K compliant by the end of the second
quarter of 1999. In addition to administering the

                                      -25-
<PAGE>
 
implementation of necessary upgrades for Y2K compliance, our network team is
developing a contingency plan to address any potential problems that may occur
with our network as we enter the year 2000. We believe that, as a result of our
detailed assessment and completed modifications, the Y2K issue will not pose
significant operational problems for us. However, if the requisite modifications
and conversions are not made, or not completed in a timely fashion, it is
possible that the Y2K problem could have a material impact on our operations.

         Our cost of addressing Y2K issues has been minor to date, less than 5%
of our information technology and network operations budgets, but this amount
may increase if additional outside consultants or personnel resources are
required or if important operational equipment must be remediated or replaced.
Our estimated total costs related to Y2K issues for 1999 is not expected to
exceed $2.0 million. These costs include equipment, consulting fees, software
and hardware upgrades, testing, remediation and, in limited instances,
replacement of equipment. The risk that Y2K issues could present to us include,
without limitation, disruption, delay or cessation of operations, including
operations that are subject to regulatory compliance. In each case, the
correction of the problem could result in substantial expense and disruption or
delay of our operations. The total cost of Y2K assessments and remediation is
funded through cash on hand and available from other sources and we are
expensing these costs, as appropriate. The financial impact of making all
required systems changes or other remediation efforts cannot be known precisely,
but it is not expected to be material to our financial position, results of
operations, or cash flows. We have not canceled any principal information
technology projects as a result of our Y2K effort, although we have rescheduled
some internal tasks to accommodate this effort.

         In addition, we have identified, prioritized and are communicating with
our suppliers, vendors, customers, lenders and other material third parties to
determine their Y2K status and any probable impact on us. To date, our inquiries
have not revealed any significant Y2K noncompliance issue affecting our material
third parties. We will continue to monitor and evaluate our long-term
relationships with our material third parties based on their responses to our
inquiries and on information learned from other sources. If any of our material
third parties are not Y2K ready and their non-compliance causes a material
disruption to any of their respective businesses, our business could be
materially adversely affected. Disruptions could include, among other things:

         .  the failure of a material third party's business;

         .  a financial institution's inability to take and transfer funds;

         .  an interruption in delivery of supplies from vendors;

         .  a loss of voice and data connections;

         .  a loss of power to our facilities; and

         .  other interruptions in the normal course of our operations, the
            nature and extent of which we cannot foresee.

         We will continue to evaluate the nature of these risks, but at this
time we are unable to determine the probability that any such risk will occur,
or if it does occur, what the nature, length or other effects, if any, it may
have on us. If a significant number of our material third parties experience
failures in their computer systems or operations due to Y2K non-compliance, it
could affect our ability to process transactions or otherwise engage in similar
normal business activities. For example, while we expect our internal systems,
U.S. and non-U.S., to be Y2K ready in stages during 1999, we and our customers
who communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a material adverse effect on our revenues and business and that
of our customers. While many of these risks are outside our control, we have
identified and contacted our critical third party vendors and suppliers and are
establishing contingency plans to remedy any potential interruption to our
operations.

         While we believe that we are adequately addressing the Y2K issue, we
can not assure that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue will
not materially adversely impact our business, prospects, revenues or financial
position. We are uncertain as to our most reasonably likely worst case Y2K
scenario and have not yet completed a contingency plan to handle a worst case
scenario. We expect to have such contingency plan in place by September 30,
1999. See "Management's 

                                      -26-
<PAGE>
 
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000" in Part II, Item 7 of this Form 10-K.

IF WE BECOME SUBJECT TO PROVISIONS OF THE INVESTMENT COMPANY ACT, OUR BUSINESS
OPERATIONS MAY BE RESTRICTED

         Pending our utilization of all the net proceeds from the offerings of
our 10% senior notes and 11 1/2% senior notes, we have significant amounts of
cash invested in short term investment grade and government securities, which
investments could conceivably subject us to the provisions of the Investment
Company Act of 1940. We do not propose to engage in investment activities in a
manner or to an extent which would require us to register as an investment
company under the Investment Company Act of 1940. The Investment Company Act of
1940 places restrictions on the capital structure and business activities of
companies registered thereunder. Accordingly, we will seek to limit our holding
of "investment securities" (as defined in such Act) to an amount which is less
than 40% of the value of our total assets as calculated pursuant to the
Investment Company Act of 1940. The Investment Company Act of 1940 permits a
company to avoid becoming subject to such Act for a period of up to one year
despite the holding of investment securities in excess of such amount if, among
other things, its Board of Directors has adopted a resolution which states that
it is not the company's intention to become an investment company. Our Board of
Directors may adopt such a resolution. Application of the provisions of the
Investment Company Act of 1940 would have a material adverse effect on us.

WE FACE A HIGH LEVEL OF COMPETITION IN THE INTERNET SERVICES INDUSTRY

         The market for Internet connectivity and related services is extremely
competitive. We anticipate that competition will continue to intensify as the
use of the Internet grows. The tremendous growth and potential market size of
the Internet access market has attracted many new start-ups as well as
established businesses from different industries.

         Our current and prospective competitors include other national,
regional and local Internet service providers, long distance and local exchange
telecommunications companies, cable television, direct broadcast satellite,
wireless communications providers and on-line service providers. We believe that
our network, products and customer service distinguish us from these
competitors. However, some of these competitors have a significantly greater
market presence, brand recognition and financial, technical and personnel
resources than us.

         We compete with all of the major long distance companies, also known as
interexchange carriers, including AT&T, MCIWorldCom, Sprint and Cable &
Wireless/IMCI, which also offer Internet access services. The recent sweeping
reforms in the federal regulation of the telecommunications industry have
created greater opportunities for local exchange carriers, including the
Regional Bell Operating Companies, to enter the Internet connectivity market. We
believe that there is a move toward horizontal integration through acquisitions
of, joint ventures with, and the wholesale purchase of connectivity from
Internet service providers to address the Internet connectivity requirements of
the current business customers of long distance and local carriers. The
WorldCom/MFS/UUNet consolidation, the WorldCom/MCI merger, the ICG/NETCOM
merger, Cable & Wireless' purchase of the internetMCI assets, the
Intermedia/DIGEX merger, GTE's acquisition of BBN, Global Crossing's recently
announced plans to acquire Frontier Corp. (and Frontier's acquisition of Global
Center) and AT&T's purchase of IBM's global communications network are
indicative of this trend. Accordingly, we expect to experience increased
competition from the traditional telecommunications carriers. Many of these
telecommunications carriers may have the ability to bundle Internet access with
basic local and long distance telecommunications services. Such bundling of
services may have an adverse effect on our ability to compete effectively with
the telecommunications providers and may result in pricing pressure on us that
could have a material adverse effect on our business, financial condition and
results of operations.

         Many of the major cable companies have announced that they are
exploring the possibility of offering Internet connectivity, relying on the
viability of cable modems and economical upgrades to their networks. Several
announcements also have recently been made by other alternative service
companies approaching the Internet connectivity market with various wireless
terrestrial and satellite-based service technologies.

         The predominant on-line service providers, including America Online,
CompuServe, Microsoft Network and Prodigy, have all entered the Internet access
business by engineering their current proprietary networks to include Internet
access capabilities. We compete to a lesser extent with these on-line service
providers. However, America Online's recent acquisition of Netscape
Communications Corporation and related strategic alliance with 

                                      -27-
<PAGE>
 
Sun Microsystems will enable it to offer a broader array of Internet protocol-
based services and products that could significantly enhance its ability to
appeal to the business marketplace and, as a result, compete more directly with
us.

         Recently, there have been several announcements regarding the planned
deployment of broadband services for high speed Internet access by cable and
telephone companies. These services would include new technologies such as cable
modems and xDSL. These providers have initially targeted the residential
consumer. However, it is likely that their target markets will expand to
encompass business customers, which is our target market. This expansion could
adversely affect the pricing of our service offerings.

         As a result of the increase in the number of competitors and the
vertical and horizontal integration in the industry, we currently encounter and
expect to continue to encounter significant pricing pressure and other
competition in the future. Advances in technology as well as changes in the
marketplace and the regulatory environment are constantly occurring, and we
cannot predict the effect that ongoing or future developments may have on us or
on the pricing of our products and services. Increased price or other
competition could result in erosion of our market share and could have a
material adverse effect on our business, financial condition and results of
operations. We cannot assure that we will have the financial resources,
technical expertise or marketing and support capabilities to continue to compete
successfully.

         As we continue to expand our operations outside the United States, we
will encounter new competitors and competitive environments. In some cases, we
will be forced to compete with and buy services from government-owned or
subsidized telecommunications providers. Some of these providers may enjoy a
monopoly on telecommunications services essential to our business. We cannot
assure that we will be able to purchase such services at a reasonable price or
at all. In addition to the risks associated with our previously described
competitors, foreign competitors may pose an even greater risk, as they may
possess a better understanding of their local markets and better working
relationships with local infrastructure providers and others. We cannot assure
that we can obtain similar levels of local knowledge. Failure to obtain that
knowledge could place us at a significant competitive disadvantage.

TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS COULD RESULT IN OUR
COMPETITORS DEVELOPING OR OBTAINING ACCESS TO BANDWIDTH AND TECHNOLOGIES THAT
CARRY MORE INFORMATION FASTER THAN OUR BANDWIDTH AND TECHNOLOGY AND,
CONSEQUENTLY, RENDER OUR BANDWIDTH OR TECHNOLOGY OBSOLETE

         Our products and services are targeted toward users of the Internet,
which has experienced rapid growth. The market for Internet access and related
services is characterized by rapidly changing technology, evolving industry
standards, changes in customer needs and frequent new product and service
introductions. Our future success will depend, in part, on our ability to
effectively use and develop leading technologies.

         We cannot assure that we will be successful in responding to changing
technology or market trends. In addition, services or technologies developed by
others may render our services or technologies uncompetitive or obsolete.
Furthermore, changes to our services in response to market demand may require
the adoption of new technologies that could likewise render many of our assets
technologically uncompetitive or obsolete. As we accept bandwidth from IXC and
our other existing global network suppliers or acquire bandwidth or equipment
from other suppliers that may better meet our needs than existing bandwidth or
equipment, many of our assets could be determined to be obsolete or excess. The
disposition of obsolete or excess assets could have a material adverse effect on
our business, financial condition and results of operations.

         Even if we do successfully respond to technological advances and
emerging industry standards, the integration of new technology may require
substantial time and expense, and we cannot assure that we will succeed in
adapting our network infrastructure in a timely and cost-effective manner.

POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH NETWORK

         The law relating to liability of Internet service providers for
information carried on or disseminated through their networks is not completely
settled. A number of lawsuits have sought to impose such liability for
defamatory speech and infringement of copyrighted materials. The U.S. Supreme
Court has let stand a lower court ruling which held that an Internet service
provider was protected from liability for material posted on its system by a
provision of the Communications Decency Act. However, the findings in that case
may not be applicable in other circumstances. Other courts have held that online
service providers and Internet service providers may, under some circumstances,

                                      -28-
<PAGE>
 
be subject to damages for copying or distributing copyrighted materials.
Provisions of the Communications Decency Act which imposed criminal penalties
for using an interactive computer service for transmitting obscene or indecent
communications have been found unconstitutional by the U.S. Supreme Court.
However, on October 21, 1998, new federal legislation was enacted that requires
limitations on access to pornography and other material deemed "harmful to
minors." This legislation has been attacked in court as a violation of the First
Amendment. We are unable to predict the outcome of this case. The imposition
upon Internet service providers or web server hosts of potential liability for
materials carried on or disseminated through their systems could require us to
implement measures to reduce our exposure to such liability. Such measures may
require that we spend substantial resources or discontinue some product or
service offerings. Any of these actions could have a material adverse effect on
our business, operating results and financial condition.

         We carry errors and omissions insurance with a policy limit of $5.0
million, subject to deductibles and exclusions. Such coverage may not be
adequate or available to compensate us for all liability that may be imposed.
The imposition of liability in excess of, or the unavailability of, such
coverage could have a material adverse effect on our business, financial
condition and results of operations.

         The law relating to the regulation and liability of Internet access
providers in relation to information carried or disseminated also is undergoing
a process of development in other countries. Decisions, laws, regulations and
other activities regarding regulation and content liability may significantly
affect the development and profitability of companies offering on-line and
Internet access services, including us.

FCC REGULATIONS MAY LIMIT THE SERVICES WE CAN OFFER

         Consistent with our growth and acquisition strategy, we are now engaged
in, or will soon be engaged in, activities that subject us to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications carriers to the
extent that they involve the provision, origination or termination of
jurisdictionally interstate or international communications. The state
regulatory commissions retain jurisdiction over the same facilities and services
to the extent they involve origination or termination of jurisdictionally
intrastate communications.

         Our Internet operations are not currently subject to direct regulation
by the FCC or any other governmental agency, other than regulations applicable
to businesses generally. However, the FCC has recently indicated that some
services offered over the Internet, such as phone-to-phone Internet protocol
telephony, may be functionally indistinguishable from traditional
telecommunications service offerings and their non-regulated status may have to
be re-examined. We are unable to predict what regulations may be adopted in the
future, or to what extent existing laws and regulations may be found applicable,
or the impact such new or existing laws may have on our business. We can not
assure that new laws or regulations relating to Internet services, or existing
laws found to apply to them, will not have a material adverse effect on us.
Although the FCC has recently decided not to allow local telephone companies to
impose per-minute access charges on Internet service providers, and that
decision has been upheld by the reviewing court, further regulatory and
legislative consideration of this issue is likely. In addition, some telephone
companies are seeking relief through state regulatory agencies. Such rules, if
adopted, would affect our costs of serving dial-up customers and could have a
material adverse effect on our business, financial condition and results of
operations.

         In addition to our Internet activities, our wholly-owned subsidiary,
PSINetworks Company, has received a license from the FCC to provide global
facilities-based telecommunications services. Our wholly-owned subsidiary,
PSINet Telecom UK Limited, has received an international facilities license from
DTI and OFTEL, the responsible telecommunications regulatory bodies in the
United Kingdom. Currently, the FCC and OFTEL do not closely regulate the charges
or practices of non-dominant carriers, such as our subsidiaries. Nevertheless,
these regulatory agencies have the power to impose more stringent regulatory
requirements on us and to change our regulatory classification, which may
adversely affect our business.

         PSINetworks Company has also received competitive local exchange
carrier certification in Colorado and Texas, has applied for competitive local
exchange carrier certification in Maryland, Virginia, California and New York,
and is considering the financial, regulatory and operational implications of
becoming a competitive local exchange carrier in other states. As a provider of
domestic basic telecommunications services, particularly competitive local
exchange services, we could become subject to further regulation by the FCC
and/or another regulatory agency, including state and local entities.

                                      -29-
<PAGE>
 
         An important issue for competitive local exchange carriers is the right
to receive reciprocal compensation for the transport and termination of Internet
traffic. Most states have required incumbent local exchange carriers to pay
Internet service providers reciprocal compensation. In October 1998, the FCC
determined that dedicated Digital Subscriber Line service is an interstate
service and properly tariffed at the interstate level. In February 1999, the FCC
concluded that at least a substantial portion of dial-up Internet service
provider traffic is jurisdictionally interstate. The FCC also concluded that its
jurisdictional decision does not alter the exemption from access charges
currently enjoyed by Internet service providers. The FCC established a
proceeding to consider an appropriate compensation mechanism for interstate
Internet traffic. Pending the adoption of that mechanism, the FCC saw no reason
to interfere with existing interconnection agreements and reciprocal
compensation arrangements. The FCC order has been appealed. There can be no
assurance that any future court, state regulatory or FCC decision on this matter
will favor our position. An unfavorable result may have an adverse impact on our
potential future revenues as a competitive local exchange carrier, as well as
increasing our costs for PRIs generally.

IF WE EXPERIENCE SYSTEM FAILURE OR SHUTDOWN, WE MAY NOT BE ABLE TO DELIVER
SERVICES

         Our success depends upon our ability to deliver reliable, high-speed
access to the Internet and upon the ability and willingness of our
telecommunications providers to deliver reliable, high-speed telecommunications
service through their networks. Our network, and other networks providing
services to us, are vulnerable to damage or cessation of operations from fire,
earthquakes, severe storms, power loss, telecommunications failures and similar
events, particularly if such events occur within a high traffic location of the
network. We have designed our network to minimize the risk of such system
failure, for instance, with redundant circuits among points-of-presence to allow
traffic rerouting. In addition, we perform lab and field testing before
integrating new and emerging technology into the network, and we engage in
capacity planning. Nonetheless, we cannot assure that we will not experience
failures or shutdowns relating to individual points-of-presence or even
catastrophic failure of the entire network.

         We carry business personal property insurance at both scheduled
locations and unscheduled locations to protect us against losses due to property
damage and business interruption. Such coverage, however, may not be adequate or
available to compensate us for all losses that may occur. In addition, we
generally attempt to limit our liability to customers arising out of network
failures by contractually disclaiming all such liability. In respect of many
services, we have also contractually limited liability to a usage credit based
upon the amount of time that the system was not operational. We cannot assure,
however, that such limitations will be enforceable. In any event, significant or
prolonged system failures or shutdowns could damage our reputation and result in
the loss of customers.

ALTHOUGH WE HAVE IMPLEMENTED NETWORK SECURITY MEASURES, OUR NETWORK MAY BE
SUSCEPTIBLE TO VIRUSES, BREAK-INS OR DISRUPTIONS

         We have implemented many network security measures, such as limiting
physical and network access to our routers. Nonetheless, our network's
infrastructure is potentially vulnerable to computer viruses, break-ins and
similar disruptive problems caused by our customers or other Internet users.
Computer viruses, break-ins or other problems caused by third parties could lead
to interruptions, delays or cessation in service to our customers. Furthermore,
such inappropriate use of the Internet by third parties could also potentially
jeopardize the security of confidential information stored in the computer
systems of our customers. This could, in turn, deter potential customers and
adversely affect our existing customer relationships.

         Security problems represent an ongoing threat to public and private
data networks. Attacks upon the security of Internet sites and infrastructure
continue to be reported to organizations such as the CERT Coordination Center at
Carnegie Mellon University, which facilitates responses of the Internet
community to computer security events. Addressing problems caused by computer
viruses, break-ins or other problems caused by third parties could have a
material adverse effect on us.

         The security services that we offer in connection with our customers'
networks cannot assure complete protection from computer viruses, break-ins and
other disruptive problems. Although we attempt to limit contractually our
liability in such instances, the occurrence of such problems may result in
claims against us or liability on our part. Such claims, regardless of their
ultimate outcome, could result in costly litigation and could have a material
adverse effect on our business or reputation or on our ability to attract and
retain customers for our products. Moreover, until more consumer reliance is
placed on security technologies available, the security and 

                                      -30-
<PAGE>
 
privacy concerns of existing and potential customers may inhibit the growth of
the Internet service industry and our customer base and revenues.

RISK ASSOCIATED WITH DEPENDENCE ON TECHNOLOGY AND WITH PROPRIETARY RIGHTS

         Our success and ability to compete is dependent in part upon our
technology and technical expertise and, to a lesser degree, on our proprietary
rights as well. In order to establish and protect our technology, we rely on a
combination of copyright, trademark and trade secret laws and contractual
restrictions. Nevertheless, we cannot assure that such measures are adequate to
protect our proprietary technology. It may be possible for a third party to copy
or otherwise obtain and use our products or technology without authorization or
to develop similar technology independently. In addition, our products may be
licensed or otherwise utilized in foreign countries where laws may not protect
our proprietary rights to the same extent as do laws in the United States. It is
our policy to require employees and consultants and, when obtainable, suppliers
to execute confidentiality agreements upon the commencement of their
relationships with us. Nonetheless, we cannot assure that these precautions will
be adequate to prevent misappropriation of our technology or that our
competitors will not independently develop technologies that are substantially
equivalent or superior to our technology.

         In addition, we are also subject to the risk of adverse claims and
litigation alleging infringement by us of the intellectual property rights of
others. From time to time, we have received claims that we have infringed other
parties' proprietary rights. While we do not believe that we have infringed the
proprietary rights of other parties, we cannot assure that third parties will
not assert infringement claims in the future with respect to our current or
future products. Such claims may require that we enter into license arrangements
or may result in protracted and costly litigation, regardless of the merits of
such claims. We cannot assure that any necessary licenses will be available or
that, if available, such licenses can be obtained on commercially reasonable
terms.

         We have recently introduced new enterprise service offerings, including
value-added, Internet protocol-based enterprise communication services and
xDSL-based Internet access services in limited areas. The failure of these
services to gain market acceptance in a timely manner or at all, or the failure
of xDSL-based services, in particular, to achieve significant market coverage
could have a material adverse effect on our business, financial condition and
results of operations. If we introduce new or enhanced services with
reliability, quality or compatibility problems, it could significantly delay or
hinder market acceptance of such services, which could adversely affect our
ability to attract new customers and subscribers. Our services may contain
undetected errors or defects when first introduced or as enhancements are
introduced. Despite testing by us or our customers, we cannot assure that errors
will not be found in new services after commencement of commercial deployment.
Such errors could result in additional development costs, loss of or delays in
market acceptance, diversion of technical and other resources from our other
development efforts and the loss of credibility with our customers and
subscribers. Any such event could have a material adverse effect on our
business, financial condition and results of operations.

         Additionally, if we are unable to match our network capacity to
customer demand for our services, our network could become congested during
periods of peak customer demand. Such congestion could adversely affect the
quality of service we are able to provide. Conversely, due to the high fixed
cost nature of our infrastructure, if our network is under-utilized, it could
adversely affect our ability to provide cost-efficient services. Our failure to
match network capacity to demand could have a material adverse effect on our
business, financial condition or results of operations.

POTENTIAL VOLATILITY OF STOCK PRICE

         The market price and trading volume of our common stock has been and
may continue to be highly volatile. Factors such as variations in our revenue,
earnings and cash flow and announcements of new service offerings, technological
innovations, strategic alliances and/or acquisitions involving our competitors
or price reductions by us, our competitors or providers of alternative services
could cause the market price of our common stock to fluctuate substantially. In
addition, the stock markets recently have experienced significant price and
volume fluctuations that particularly have affected technology-based companies
and resulted in changes in the market prices of the stocks of many companies
that have not been directly related to the operating performance of those
companies. Such broad market fluctuations have adversely affected and may
continue to adversely affect the market price of our common stock.

                                      -31-
<PAGE>
 
FORWARD-LOOKING STATEMENTS

         Some of the information contained in this Form 10-K may contain
forward-looking statements. Such statements can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," or "anticipates" or similar words, or by discussions of strategy that
involve risks and uncertainties. These statements may discuss our future
expectations or contain projections of our results of operations or financial
condition or expected benefits to us resulting from acquisitions or
transactions. We cannot assure that the future results indicated, whether
expressed or implied, will be achieved. The risk factors noted in this section
and other factors noted throughout this Form 10-K, including risks and
uncertainties, could cause our actual results to differ materially from those
contained in any forward-looking statement.

                                   GLOSSARY

         Set forth below are definitions of some of the technical terms used in
Form 10-K.

ATM                              Asynchronous Transfer Mode. A communications
                                 standard that provides for information transfer
                                 in the form of fixed-length cells of 53 bytes
                                 each. The ATM format can be used to deliver
                                 voice, video and data traffic at varying rates.
                                
Backbone                         A centralized high-speed network that
                                 interconnects smaller, independent networks.
                                
Bandwidth                        The number of bits of information which can
                                 move over a communications medium in a given
                                 amount of time; the capacity of a
                                 telecommunications circuit/network to carry
                                 voice, data and video information. Typically
                                 measured in Kbps and Mbps. Bandwidth from
                                 public networks is typically available to
                                 business and residential end-users in
                                 increments from 56 Kbps to T-3.
                                
CLEC                             Competitive local exchange carrier. A category
                                 of telephone service provider that offers
                                 services similar to the former monopoly local
                                 telephone company. A CLEC may also provide
                                 other types of telecommunications.
                                
CSU/DSU                          Channel Service Unit/Data Service Unit. A
                                 device used in digital transmission for
                                 connecting data terminal equipment, such as a
                                 router, to a digital transmission circuit or
                                 service.
                                
Dark fiber                       Fiber which does not have connected to it
                                 the electronics required to transmit data on
                                 such fiber.
                                
Dedicated circuits               Telecommunications lines dedicated or
                                 reserved for use by particular customers along
                                 predetermined routes.
                                
Dial-up line                     Communications circuit that is established
                                 by a switched-circuit connection using the
                                 telephone network.
                                
DNS                              Domain Name System. Distributed name system
                                 used in the Internet.
                                 
Electronic mail or e-mail        An application that allows a user to send or
                                 receive text messages to or from any other user
                                 with an Internet address, commonly termed an e-
                                 mail address.

                                      -32-
<PAGE>
 
56 Kbps                          Equivalent to a single high-speed telephone
                                 service line; capable of transmitting one voice
                                 call or 56 Kbps of data. Currently in
                                 widespread use by medium and large businesses
                                 primarily for entry level high-speed data and
                                 very low-speed video applications.

Frame relay                      A communications standard that is
                                 optimized for efficient switching of variable-
                                 length data packets.

Gbps                             Gigabits per second. A measure of digital
                                 transmission rates. One gigabit equals 1,000
                                 megabits.

Host                             A computer with direct access to the Internet.

HTML                             Hypertext Markup Language used to produce Web
                                 pages. It is a method of presenting information
                                 where selected words can be "expanded" to
                                 provide other information about the word.

ILEC                             Incumbent local exchange carrier. The local
                                 exchange carrier that was the monopoly carrier,
                                 prior to the opening of local exchange services
                                 to competition.

Internet                         An open global network of interconnected
                                 commercial, educational and governmental
                                 computer networks which utilize TCP/IP, a
                                 common communications protocol.

Internetworking                  The process of communicating between and among
                                 networks.

Intranet                         A TCP/IP based network and Web site which is
                                 securely isolated from the Internet and serves
                                 the internal needs of a company or institution.

IP                               Internet protocol.

IRUs                             Indefeasible rights of use in network bandwidth
                                 capacity.
                                 
ISDN                             Integrated services digital network. A network
                                 that provides digital voice and data services
                                 through a single medium.

ISP                              Internet service provider.

Kbps                             Kilobits per second. A measure of digital
                                 information transmission rates. One kilobit
                                 equals 1,000 bits of digital information.
                                 Normally, 10 bits are used for each alpha-
                                 numeric character.

LAN                              Local area network. A data communications
                                 network designed to interconnect personal
                                 computers, workstations, minicomputers, file
                                 servers and other communications and computing
                                 devices within a localized environment.

LEC                              Local exchange carrier. A telecommunications
                                 company that provides telecommunications
                                 services in a geographic area in which calls
                                 generally are transmitted without toll charges.

Mbps                             Megabits per second. A measure of digital
                                 information transmission rates. One megabit
                                 equals 1,000 kilobits.

                                      -33-
<PAGE>
 
Modem                            A device for transmitting information over an
                                 analog communications channel such as a POTS
                                 telephone circuit.

Network                          A collection of distributed computers which
                                 share data and information through inter-
                                 connected lines of communication.

NOC                              Network operation center.

OC-3                             OC-3 SONET high capacity optical
                                 telecommunications line capable of transmitting
                                 data at 155.52 Mbps.

OC-12                            OC-12 SONET high capacity optical
                                 telecommunications line capable of transmitting
                                 data at 622.08 Mbps.

OC-48                            OC-48 SONET high capacity optical
                                 telecommunications line capable of transmitting
                                 data at 2488.32 Mbps.
                                 
OC-48 Equivalent                 One OC-48, four OC-12s, 16 OC-3s or 48 DS-3s.
                                 
OC-48 Equivalent Mile            One Route Mile of OC-48 capacity, four Route
                                 Miles of OC-12 capacity, 16 Route Miles of OC-3
                                 capacity or 48 Route Miles of DS-3 capacity.

On-line services                 Commercial information services that offer a
                                 computer user access through a modem to a
                                 specified slate of information, entertainment
                                 and communications menus. These services are
                                 generally closed systems, although many are now
                                 offering full Internet access.
                                 
Open systems                     A networking system which is based upon non-
                                 proprietary protocols (i.e., protocols which
                                 are in the public domain).
                                 
Peering                          The commercial practice under which nationwide
                                 ISPs exchange each other's traffic, in most
                                 cases, without the payment of settlement
                                 charges.
                                 
POPs                             Points-of-presence. An interlinked group of
                                 modems, routers and other computer equipment,
                                 located in a particular city or metropolitan
                                 area, that allows a nearby subscriber to access
                                 the Internet through a local telephone call or
                                 using a short-distance permanent data circuit.
                                 
POTS                             Plain old telephone service. Standard analog
                                 telephone service used by many telephone
                                 companies throughout the United States.
                                 
PRI                              Primary rate interface. ISDN interface to
                                 primary rate access.
                                 
Protocol                         A formal description of message formats and the
                                 rules two or more machines must follow in order
                                 to communicate.
                                 
RBOC                             Regional bell operating company. One of the
                                 LECs created by the divestiture of the local
                                 exchange business by AT&T. These include
                                 BellSouth, Bell Atlantic, Ameritech, US West,
                                 SBC, and PacTel.
                                 
Router                           A device that receives and transmits data
                                 packets between segments in a network or
                                 different networks.
                                 
Route Mile                       One mile of the actual geographic length of the
                                 high capacity telecommunications fiber route.

                                      -34-
<PAGE>
 
Server                           Software that allows a computer to offer a
                                 service to another computer. Other computers
                                 contact the server program by means of matching
                                 client software. The term also refers to the
                                 computer on which server software runs.
                                 
SMDS                             Switched multimegabit data service. A public
                                 packet-switching service offered by telephone
                                 companies in many major metropolitan areas.
                                 Packet-switching is a method of delivering
                                 voice and data traffic.
                                 
SONET                            Synchronous optical network.
                                 
TCP/IP                           Transmission control protocol/Internet
                                 protocol. A compilation of network and
                                 transport-level protocols that allow computers
                                 with different architectures and operating
                                 system software to communicate with other
                                 computers on the Internet.
                                 
T-3 or DS-3                      A data communications line capable of
                                 transmitting data at 45 Mbps.
                                 
UNIX                             A computer operating system for workstations
                                 and personal computers and noted for its
                                 portability and communications functionality.

VOIP                             Voice over internet protocol.

WAN                              Wide area network. A network spanning a wide
                                 geographic area.
                                 
Web or World Wide Web            A network of computer servers that uses a
                                 special communications protocol to link
                                 different servers throughout the Internet and
                                 permits communication of graphics, video and
                                 sound.

Web server                       The computer system that runs Web software,
                                 used to create custom Web sites, Web pages, and
                                 home pages.

Web sites or Web pages           A site located on the Web, written in the HTML
                                 or SGML language.

xDSL                             A term referring to a variety of new digital
                                 subscriber line technologies. Some of these
                                 varieties are asymmetric with different data
                                 rates in the downstream and upstream
                                 directions. Others are symmetric. Downstream
                                 speeds range from 384 kilobits (or "SDSL") to
                                 1.5-8 Mbps (or "ADSL").


ITEM 2.  PROPERTIES

         Our principal administrative, operational and marketing and sales
facilities total approximately 66,000 square feet and are located in an office
park in Herndon, Virginia. We occupy this space under four leases which expire
in September 2003 and include five-year renewal options. We also lease:

        .  approximately 15,000 square feet of office space in a second office
           park located in Herndon, Virginia,
           
        .  approximately 48,480 and 23,000 square feet of office space in two
           office parks located in Reston, Virginia, and

        .  approximately 23,760 square feet of office space for our network
           operations center in Troy, New York.
           
         All of our regional offices and subsidiaries also lease their
facilities, except for our European Technical Center which includes our
principal European administrative, operational, marketing and sales facilities,
which total approximately 3,900 square feet and are owned by us in Switzerland.
We also lease or are otherwise provided with the right to utilize space in
various geographic locations to provide an operational facility for certain of
our POPs. We believe that these facilities are

                               -35-
<PAGE>
 
adequate for our current needs and that suitable additional space, should it be
needed, will be available to accommodate expansion of our operations on
commercially reasonable terms.

ITEM 3.  LEGAL PROCEEDINGS

         From time to time, we have been involved in certain disputes and
threatened with or named as a defendant in lawsuits and administrative claims.
Certain of such disputes, lawsuits and threatened litigation include claims
asserting alleged breach of agreements and certain of them relate to relatively
novel or unresolved issues of law arising out of or relating to the developing
nature of the Internet and on-line services industries. See, for example, "Risk
Factors--Potential liability for information disseminated through network" in
Item 1 of this Form 10-K.

         On March 23, 1999, an arbitrator awarded Chatterjee Management Company
("Chatterjee") compensatory damages, including interest and legal expenses, from
PSINet. In conjunction with this arbitration decision, we have recorded a charge
of $49.0 million, which accrual is reflected in other accounts payable and
accrued liabilities in our consolidated balance sheet at December 31, 1998
(included in our Consolidated Financial Statements appearing in Part II, Item 8
of this Form 10-K). This award resulted from a claim by Chatterjee that we had
breached the terms of a joint venture agreement executed by the parties in
September 1996. As previously disclosed by us in various filings with the
Securities and Exchange Commission, Chatterjee had initiated the arbitration
proceeding against us in November 1997 before the International Chamber of
Commerce, Court of Arbitration, in London, England.

         On September 19, 1996, we signed an agreement with Chatterjee pursuant
to which we and an investment group led by Chatterjee would have established a
joint venture for the purpose of building an Internet network across Europe and
providing Internet-related services in Europe. Such investment group was to
invest up to $41 million in a joint venture. No monies were invested by
Chatterjee or the investment group pursuant to the joint venture agreement nor
were any other actions undertaken to implement it. Following the signing of the
agreement, the parties acknowledged structural difficulties associated with the
joint venture as originally contemplated, which prevented its implementation.
Instead, they sought for several months to negotiate a direct investment in
PSINet by Chatterjee in lieu of the initial agreement. Those negotiations were
not successful.

         In the arbitration proceeding, Chatterjee alleged that we had breached
the joint venture agreement by repudiating our obligations under the agreement
and by breaching a covenant not to compete. Chatterjee requested an arbitration
award declaring that the agreement was still valid and binding upon the parties
and that we stood in breach of the agreement, directing us to specifically
perform our obligations under the agreement or, in the alternative, awarding
Chatterjee compensatory damages in an amount not less than $25 million, awarding
Chatterjee profits that we had earned or stood to earn in Europe, and awarding
Chatterjee the costs of arbitration, including attorney's fees and interest on
the award of damages. An award of specific performance by the arbitrator could
have given Chatterjee an ongoing ownership interest in our European operations.

         We are evaluating our options and intend to pursue vigorously
appropriate legal steps to seek to modify the arbitrators order. However, due
to the nature of arbitration proceedings, our ability to obtain relief in this
matter is likely to be constrained. Any amounts payable to Chatterjee will be
made from available cash, and we believe that any such payment will not have a
material adverse effect on our business.

         In addition, from time to time we receive communications from third
parties asserting alleged infringement of patents, trademarks and service marks
of others. Although there is currently no material litigation arising out of any
alleged infringement of patents, trademarks or service marks, there can be no
assurance that litigation will not be commenced regarding these or other
matters.

         We are not involved in any other legal proceedings which we believe
would, if adversely determined, have a material adverse effect upon our
business, financial condition or results of operations. There can be no
assurance whether these matters will be determined in a manner which is
favorable to us or, if adversely determined, whether such determination would
have a material adverse effect upon our business, financial condition or results
of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

         No matters were submitted to a vote of security-holders during the
fourth quarter of the fiscal year ended December 31, 1998.

                                      -36-
<PAGE>
 
                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

                              MARKET INFORMATION

         Our common stock is traded on The Nasdaq Stock Market under the symbol
"PSIX". The following table sets forth for the periods indicated the high and
low bid prices for our common stock as reported during each quarterly period in
1997 and 1998 on The Nasdaq Stock Market . The prices do not include retail mark
ups, mark downs or commissions.

                                                1997
                                        ---------------------
                                          High         Low
                                        ---------    --------

First Quarter.........................   $ 13 3/8     $6 3/4
Second Quarter........................   $  9 1/4     $5 1/2
Third Quarter.........................   $  9 3/4     $7 3/8
Fourth Quarter........................   $  9 1/2     $4 1/4
                                         
                                                1998
                                       -----------------------
                                          High          Low
                                       -----------     -------

First Quarter........................    $17 5/16      $ 4 15/16
Second Quarter.......................    $15 3/16      $10
Third Quarter........................    $21 13/16     $10 1/8
Fourth Quarter.......................    $24 15/16     $ 8 3/8


         The last reported sale price of our common stock on The Nasdaq Stock
Market on March 11, 1999 was $40 5/8 per share. There were approximately 849
holders of record of our common stock as of March 11, 1999.

                         COMMON STOCK DIVIDEND POLICY

         We have never declared or paid cash dividends on our common stock. We
currently intend to retain all of our earnings, if any, for use in our business
and do not anticipate paying any cash dividends on our common stock in the
foreseeable future. In addition, under the terms of our existing credit
facilities, the payment of dividends is prohibited without the lender's consent,
and under the terms of the indentures governing our 10% senior notes and 11 1/2%
senior notes, our ability to pay cash dividends is limited. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Capital Structure" in Part II, Item 7 of this Form 10-K.

                    RECENT SALES OF UNRESTRICTED SECURITIES

         On November 3, 1998 and November 9, 1998, we issued $350,000,000
aggregate principal amount of our 11 1/2% Senior Notes due 2008, of which $200
million principal amount was sold at par and $150 million principal amount was
sold at 102% of par. The aggregate net proceeds of these offerings, after giving
effect to discounts, commissions, premiums and expenses, was $341.2 million.
These securities were issued and sold to Donaldson, Lufkin & Jenrette Securities
Corporation, Chase Securities Inc. and Morgan Stanley & Co. Incorporated, as
initial purchasers (the "Initial Purchasers"), in reliance on the exemption from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), provided by Section 4(2) of the Securities Act as a transaction by an
issuer not involving any public offering. In connection with this transaction,
each of the Initial Purchasers is an "accredited investor" within the meaning of
Securities and Exchange Commission Rule 501 and had adequate access to
information about PSINet, and appropriate legends regarding the restricted
nature of the securities were affixed to the certificates representing the
securities. The Initial Purchasers resold the securities to "qualified
institutional 

                                      -37-
<PAGE>
 
buyers" within the meaning of Securities and Exchange Commission Rule 144A in
reliance on the exemption from registration under the Securities Act provided by
Rule 144A. In connection with this transaction, offers and sales of the
securities were made to persons whom the Initial Purchasers reasonably believed
to be qualified institutional buyers, the offering memorandum used in connection
with the transaction met the requirements of Rule 144A(d)(4), the securities
were not of the same class as any of our securities listed on a national
securities exchange or quoted in a U.S. automated inter-dealer quotation system,
and appropriate legends regarding the restricted nature of the securities were
affixed to the certificates representing the securities.

ITEM 6.  SELECTED FINANCIAL DATA

         The following table sets forth for the periods indicated selected
consolidated financial and operating data for PSINet. The consolidated balance
sheet data and consolidated statement of operations data as of and for the years
ended December 31, 1994, 1995, 1996, 1997 and 1998 have been derived from our
Consolidated Financial Statements. In 1998, we acquired a significant number of
businesses, issued a significant amount of debt and incurred a non-recurring 
arbitration charge. In 1996 and 1997, we sold our individual subscriber accounts
and certain related assets and also sold our software subsidiary. These
transactions affect the comparability of our financial position, results of
operations and cash flows for those years. The following selected consolidated
financial and operating data are qualified by and should be read in conjunction
with our more detailed Consolidated Financial Statements and notes thereto and
the discussion under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in Part II, Items 7 and 8 of this
Form 10-K.

         EBITDA is used in the Internet services industry as one measure of a
company's operating performance and historical ability to service debt. EBITDA
is not determined in accordance with GAAP, is not indicative of cash used by
operating activities and should not be considered in isolation or as an
alternative to, or more meaningful than, measures of performance determined in
accordance with GAAP. We define EBITDA 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.
Our definition of EBITDA may not be comparable to similarly titled measures used
by other companies.

              SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
  (In thousands of U.S. dollars, except per share, ratio and operating data)

<TABLE> 
<CAPTION> 
                                                                               YEAR ENDED DECEMBER 31,
                                                              ----------------------------------------------------------
                                                                 1994         1995       1996        1997     1998    
                                                              ---------- ---------- -----------  ----------- -----------
STATEMENT OF OPERATIONS DATA:

<S>                                                         <C>          <C>        <C>         <C>         <C> 
Revenue.......................................................    $15,214   $ 38,722   $ 84,351   $121,902    $259,636 
Other income, net.............................................         --         --      5,417         --         -- 
                                                              ---------- ---------- -----------  ----------- -----------
                                                                   15,214     38,722     89,768    121,902     259,636 
Operating costs and expenses:
  Data communications and operations..........................      9,489     32,124     70,102     94,363     199,372 
  Sales and marketing.........................................      3,599     23,930     27,064     25,831      57,026 
  General and administrative..................................      3,605     10,569     20,648     22,947      45,288 
  Depreciation and amortization...............................      3,183     14,778     28,035     28,347      63,424 
  Charge for acquired in-process research and development.....        --         --         --         --       70,800 
  Intangible asset write-down.................................        --       9,938        --         --           --
                                                                 ---------- ---------- ---------------------- ----------
  Total operating costs and expenses..........................     19,876     91,339    145,849    171,488     435,910 
                                                                 ---------- ---------- ---------------------- ----------

Loss from operations..........................................     (4,662)   (52,617)   (56,081)   (49,586)   (176,274)
Interest expense..............................................       (731)    (1,964)    (5,025)    (5,362)    (63,914)
Non-recurring arbitration charge..............................        --         --         --         --      (49,000)
Loss before income taxes......................................     (5,342)   (53,160)   (55,256)   (46,078)   (262,717)
Income tax benefit............................................        --         --        (159)      (476)       (848)
                                                                 ---------- ---------- ---------------------- ----------

Net loss......................................................     (5,342)   (53,160)   (55,097)   (45,602)   (261,869)
Return to preferred shareholders..............................        --         --         --        (411)     (3,079)
                                                                 ---------- ---------- ---------------------- ----------
Net loss available to common shareholders.....................    $(5,342)  $(53,160)  $(55,097)  $(46,013)  $(264,948)
                                                                 ========== ========== ====================== ==========
Basic and diluted loss per share..............................    $ (0.42)  $  (2.01)  $  (1.40)  $  (1.14)  $   (5.32)
                                                                 ========== ========== ====================== ==========

Shares used in computing basic and diluted loss per
  share (in thousands)........................................     12,805     26,485     39,378     40,306      49,806 
                                                                 ========== ========== ====================== ==========
</TABLE> 

                                      -38-
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                    YEAR ENDED DECEMBER 31,
                                                                ----------------------------------------------------------------
                                                                    1994          1995       1996        1997         1998
                                                                ------------    ---------   -------    --------      -----------
<S>                                                           <C>              <C>        <C>          <C>       <C> 
OTHER FINANCIAL DATA:
Cash flows used in operating activities.......................    $(1,097)   $(30,093)    $(32,543)   $(15,568)   $  (87,586)
Cash flows used in investing activities.......................     (1,937)    (21,958)      (7,897)    (15,560)     (783,877)
Cash flows provided by (used in) financing activities.........      4,527     151,403      (10,529)     12,598       874,246 
EBITDA (as defined)...........................................     (1,479)    (27,901)     (28,046)    (21,239)      (42,050)
Capital expenditures..........................................      5,009      45,166       38,390      50,074       303,550 

<CAPTION> 

                                                                                        DECEMBER 31,
                                                                --------------------------------------------------------------
                                                                    1994         1995       1996        1997         1998
                                                                ------------    ---------   -------    --------      -----------
<S>                                                           <C>              <C>        <C>          <C>       <C> 
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments.............     $3,358     $102,710      $56,390     $33,322$   322,508 
Restricted cash and short-term investments....................        --            --          954      20,690    162,469 
Total assets..................................................     17,055      201,830      177,112     186,181  1,284,231 
Current portion of debt.......................................      3,369       16,643       26,915      39,633     59,968 
Long-term debt, less current portion..........................      4,397       24,130       26,938      33,820  1,064,633 
Redeemable preferred and common stock.........................     13,617           --           --          --         --
Shareholders' equity (deficit)................................     (8,283)     143,230       89,783      73,429   (120,174)

OTHER OPERATING DATA:
Number of POPs................................................         82          241          350         350        500 
Number of customer accounts...................................      4,220        8,200       17,800      26,400     54,700 
</TABLE> 

                                      -39-
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS
         
         You should read the following discussion in conjunction with our
Consolidated Financial Statements and notes thereto included in Part II, Item 8
of this Form 10-K. 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"
in Item 1 of this Form 10-K and our other periodic reports and documents filed
with the Securities and Exchange Commission.

         GENERAL

         We are a leading global provider of Internet access services and
related products to businesses. We derive the majority of our revenues from
providing dedicated and dial-up Internet access services to business customers
and other ISPs in 90 of the 100 largest metropolitan statistical areas in the
United States and in 12 of the 20 largest global telecommunications markets.
Business customers are typically signed to contracts that range from one to
three years. Revenues generated from business customers typically comprise
recurring monthly fees, installation and start-up charges and sales of related
equipment and services. Revenues from ISPs are generated pursuant to network
access agreements which typically require a minimum number of subscribers and
obligate the ISPs to pay specified monthly fees for each subscriber using the
PSINet network. We also offer, in addition to Internet connectivity services,
products and services to businesses that enable them to maximize utilization of
the Internet in their day-to-day operations in and outside of their workplaces.
Some of these value-added services include corporate intranets, web hosting
services that permit customers to market themselves on the Internet without
having to invest significantly in technology infrastructure and operations
staff, remote user access services that permit customers to allow their mobile
personnel to access their corporate network and systems resources in 150
countries using the Internet, multi-currency electronic commerce services,
security services, and other advanced IP-based applications such as
voice-over-Internet (as opposed to standard telephone services) and Internet
fax. Revenues from value-added services are typically in the form of monthly
fees and are often bundled with Internet access services.

         As a key component of our growth strategy, we acquired 18 ISPs in nine
of the 20 largest global telecommunications markets over the 15 month period
ended December 31, 1998. The aggregate amount of the purchase prices and related
payments for these acquisitions was approximately $290.1 million, exclusive of
indebtedness assumed in connection with such acquisitions. Of such aggregate
amount, we have paid $251.9 million to the sellers as of December 31, 1998, and
have retained $38.2 million to secure performance by certain sellers of
indemnification and other contractual obligations.

         We currently have operations in 12 of the 20 largest international
telecommunications markets. In addition to the United States, we have operations
in Africa, Belgium, Canada, France, Germany, Hong Kong, Italy, Japan, the
Netherlands, Republic of Korea, Switzerland and the United Kingdom. We typically
enter a new market through the acquisition of an existing company within the
particular market. Revenue from non-U.S. operations continues to increase as a
percentage of consolidated results, comprising 52% of revenue in the fourth
quarter of 1998 and 40% for all of 1998. By comparison, non-U.S. operations
comprised 18% of revenue in the fourth quarter of 1997 and 15% for all of 1997.

         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, ATM, ISDN and SMDS
compatible frame relay network specially designed to optimize Internet traffic.
These investments generally are made in advance of obtaining customers and
resulting revenue. As part of our ongoing efforts to further expand and enhance
our network, we have acquired or agreed to acquire significant amounts of global
fiber-based telecommunications bandwidth, including IRUs or other rights in:

        .  10,000 equivalent route miles of OC-48 capacity across the United
           States,
           
        .  STM-1 transatlantic capacity connecting the United States, the United
           Kingdom and continental Europe,

                                      -40-
<PAGE>
 
        .  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.

YEAR ENDED DECEMBER 31, 1998 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1997

RESULTS OF OPERATIONS

         Revenue. We generate revenue primarily from the sale of Internet access
and related services to businesses. Revenue was $259.6 million in 1998, an
increase of $137.7 million, or 113%, from $121.9 million in 1997 . The 113%
revenue growth is broken down into 58% from those operations that were in
existence at the end of 1997 and 55% from the companies we acquired in 1998. Our
organic growth is attributable to a number of factors, including an increase in
the number of business customer and ISP accounts, an increase in the average
annual revenue realized per new business customer account, and an increase in
the business account retention rate.

         Our business customer account base increased by 107% to 54,700 business
accounts at the end of 1998 from 26,400 business accounts at the end of 1997. Of
the total business account growth in 1998, 8,100 business accounts resulted from
organic growth and 20,200 business accounts were attributable to the companies
we acquired. The total number of our Carrier and ISP customers grew to 168,
serving 863,000 small office home office ("SOHO")/consumer customers at the end
of 1998, from 47 ISPs serving 264,000 SOHO/consumer customers at the end of
1997. Average annual new contract value for business accounts increased to
$6,000 in 1998 from $5,500 in 1997, which we believe reflects an increasing
demand for value-added services and higher levels of bandwidth. Our business
account retention rate improved to 79% in 1998 from 76% in 1997.

         Data Communications and Operations. Data communications and operations
expenses consist primarily of leased long distance and local circuit costs as
well as personnel and related operating expenses associated with network
operations, customer support and field service. Data communications and
operations expenses were $199.4 million (76.8% of revenue) for 1998, an increase
of $105.0 million from $94.4 million (77.4% of revenue) for 1997. The increase
in expenses related principally to increases in:

  (1) the number of leased long distance, dedicated customer and dial-up
      circuits,
 
  (2) expenditures for additional PRIs to support the growth of our Carrier
      and ISP Services business,
 
  (3) personnel costs resulting from the expansion of our network opertions, 
      customer support and field service staff, including through
      acquisitions, and  
 
  (4) operating and maintenance charges on telecommunications bandwidth.
               

                                      -41-
<PAGE>
 
         Our dedicated customer account base grew to 14,000 at December 31, 1998
from 7,500 at December 31, 1997, an increase of 87%. Comparing 1998 to 1997,
backbone circuit costs increased $30.2 million (or 141%), dedicated customer
circuit costs increased $18.4 million (or 77%), PRI expense increased $16.7
million (or 112%), and personnel and related operating expenses associated with
network operations, customer support and field service increased $23.8 million
(or 109%). Circuit costs relating to our new and expanded points-of-presence and
primary rate interfaces generally are incurred by us in advance of obtaining
customers and resulting revenue. Although we expect that data communications and
operations expenses will continue to increase as our customer base grows, we
anticipate that such expenses will decrease over time as a percentage of revenue
due to decreases in unit costs and continued increases in network utilization.
In particular, we anticipate that costs for data communications and operations
as a percentage of revenue will decrease as we substitute network bandwidth
purchased or acquired under capital lease agreements for existing bandwidth
currently under operating lease agreements. Network bandwidth purchased or
acquired under capital lease agreements is recorded as an asset and amortized
over its useful life. This will, in turn, result in increases in depreciation
and amortization expense over the useful life of the bandwidth, typically 10 to
25 years.

         Sales and Marketing. Sales and marketing expenses consist primarily of
personnel costs, advertising costs, distribution costs and related occupancy
costs. Sales and marketing expenses were $57.0 million (22.0% of revenue) for
1998, an increase of $31.2 million from $25.8 million (21.2% of revenue) for
1997. The increase is principally attributable to costs related to a branding
and advertising campaign resulting in additional advertising expense of $10.6
million and from costs associated with the growth of our sales force in
conjunction with our growth and acquisitions.

         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 $45.3 million (17.4% of revenue) for
1998, an increase of $22.4 million from $22.9 million (18.8% of revenue) for
1997. The increase resulted from the addition of management staff and related
operating expenses across the organization, including increases in conjunction
with our growth and acquisitions.

         Depreciation and Amortization. Depreciation and amortization costs were
$63.4 million (24.4% of revenue) for 1998, an increase of $35.1 million from
$28.3 million (23.3% of revenue) for 1997. 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 1998
include $70.8 million (27.3% of revenue) in charges for acquired in-process
research and development. The charges were based on independent valuations and
reflect technologies acquired prior to technological feasibility and for which
there was no alternative future use. The technologies exist at eight of the
companies we acquired, specifically iSTAR, INX, ioNET, LinkAge, Interlog,
Rimnet, iNet, and Tokyo Internet, comprising approximately 18% of the total fair
value of assets acquired. We have included a detailed description of the
specific technologies acquired, their value, cost to complete, expected
completion date and remaining tasks in the notes to our consolidated financial
statements contained in Part II, Item 8 of this Form 10-K.

         The value of the in-process projects was adjusted to reflect the
relative value and contribution of the acquired research and development. In
doing so, we gave consideration to the stage of completion, the complexity of
the work completed to date, the difficulty of completing the remaining
development, costs already incurred, and the projected cost to complete the
projects. The value assigned to purchased in-process technology was based on key
assumptions that included:

        .  Estimated revenue associated with the respective business enterprise
           valuations assuming five-year compound annual revenue growth rates of
           between 22% and 45%.

        .  Revenue growth rates for each technology considering, among other
           things, current and expected industry trends, acceptance of the
           technologies and historical growth rates for similar industry

                                      -42-
<PAGE>
 
           products. Estimated revenues from the purchased in-process technology
           projects were generally assumed to peak in the year 2003 and decline
           through 2014 or earlier as other new products are expected to be
           introduced. These revenue projections were based on management's
           estimates of market size and growth, expected trends in technology
           and the expected timing of new product introductions.

        .  Estimated net cash flows discounted back to their present value using
           a discount rate of between 17.0% and 27.5%, which represents a
           premium to our cost of capital.

        .  Estimated percentage-of-completion of the various in-process research
           and development projects ranged from 50% to 85% complete.

         If none of these projects is successfully developed, the Company's
sales and profitability may be adversely affected in future periods. However,
the failure of any particular individual project in-process would not have a
material impact on the Company's financial condition or its results of
operations. The failure of any particular individual project in-process could
impair the value of other intangible assets acquired.

         There were no comparable charges in 1997.

         Interest Expense. Interest expense was $63.9 million for 1998, an
increase of $58.5 million from $5.4 million for 1997. The increase was due to
interest on our issuance of $600.0 million aggregate principal amount of 10%
senior notes in April 1998 and our issuance of $350.0 million aggregate
principal amount of 11 1/2% senior notes in November 1998, as well as to
increased borrowings and capital lease obligations incurred to finance our
network expansion and to fund our working capital requirements.

         Interest Income. Interest income was $19.6 million for 1998, an
increase of $16.5 million from $3.1 million for 1997. The increase was due to
interest received on the net proceeds of our offerings of the 10% senior notes
and 11 1/2% senior notes, which we invest in short-term investment grade and
government securities until such time as we use them for other purposes.

         Other Income, Net. Other income, net, was $6.8 million for 1998, which
primarily relates to a $5.6 million realized gain on equity securities that we
sold during the third quarter. The total of $5.8 million in 1997 primarily
related to the sale in the first quarter of 1997 of our software subsidiary.

         Non-Recurring Arbitration Charge. The results for 1998 include a $49.0
million charge for an arbitration award and related costs associated with a
dispute between PSINet and Chatterjee Management Company. The charge relates to
a joint venture agreement executed by the parties in 1996 and there is no
ongoing relationship between the companies. There were no similar charges in
1997. See "Legal Proceedings" in Part I, Item 3 of this Form 10-K.

         Net Loss Available to Common Shareholders and Loss per Share. Our net
loss available to common shareholders for 1998 was $264.9 million, or $5.32
basic and diluted loss per share, a $218.9 million increase from a net loss
available to common shareholders for 1997 of $46.0 million, or $1.14 basic and
diluted loss per share. The primary reasons for the increase were:

        (1)  operating losses of acquired companies,
        (2)  the increase in data communications costs,
        (3)  the first portions of our acquired IRUs were installed, leading to
             an increase in depreciation and personnel costs to manage the IRUs,
        (4)  the charge for acquired in-process research and development
             relating to acquisitions in 1998,
        (5)  the increase in interest expense due to the issuance of the 10%
             senior notes and 11 1/2% senior notes, and 
        (6)  the costs of the non-recurring arbitration charge.


         The return to preferred shareholders, which comprises the dividends
with respect to our Series B 8% convertible preferred stock and accretion of the
related conversion premium, is subtracted from net loss in

                                      -43-
<PAGE>
 
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.

YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1996

RESULTS OF OPERATIONS

         Revenue. Revenue was $121.9 million in 1997, an increase of $37.5
million, or 45%, from $84.4 million in 1996. The increase was attributable to a
number of factors, including an increase in the number of business customer and
ISP accounts, an increase in the average annual revenue realized per new
business customer account and an increase in sales by our international
subsidiaries. The growth was driven by an expansion of our sales force and
greater public awareness and utilization of the Internet.

         In comparison with 1996, revenue for 1997 was affected by the sale in
1996 of our individual consumer accounts and related assets and by the sale in
1997 of our software subsidiary, which together provided $15.6 million of
revenue in 1996 but only $0.3 million in 1997. If such revenue was excluded from
1996 revenue, our growth in revenue from 1996 to 1997 would have been 77%
instead of 45%. Revenue growth in 1997 was also impacted by a drop in our
annualized business customer retention rate from 79% in 1996 to 76% in 1997,
which was attributable in part to an initiative by us to remove certain
non-performing accounts.

         Our business customer account base increased by 48% to 26,400 business
accounts at December 31, 1997, including 47 ISPs, from 17,800 business accounts,
including 22 ISPs, at December 31, 1996. Our revenue from international
operations increased by 165% to $18.0 million in 1997 from $6.8 million in 1996,
principally as a result of significant growth in our operations in the United
Kingdom, Japan and Canada.

         Other Income, Net. We did not have other income, net, in 1997, compared
with $5.4 million during 1996, consisting of the consideration received, net of
related asset costs and expenses, relating to the sale of our individual
consumer subscribers and certain related tangible and intangible assets during
the second and third quarters of 1996.

         Data Communications and Operations. Data communications and operations
expenses were $94.4 million (77.4% of revenue) during 1997, an increase of $24.3
million from $70.1 million (83.1% of revenue) during 1996.

The increase in expenses related principally to increases in:

        (1) the number of leased long distance, dedicated customer and dial-up
            circuits,
            
        (2) expenditures for additional primary rate interfaces to support the
            growth of our Carrier and ISP Services business, and

        (3) personnel costs resulting from the expansion of our network
            operations, customer support and field service staff.

         Sales and Marketing. Sales and marketing expenses were $25.8 million
(21.2% of revenue) during 1997, a decrease of $1.3 million from $27.1 million
(32.1% of revenue) during 1996. The decrease resulted principally from
reductions in costs following the sale of our individual consumer subscribers
and related infrastructure in 1996 and the sale of our software operations in
1997, which were offset in part by an increase in sales and marketing expenses
relating to the expansion of our operations.

         General and Administrative. General and administrative expenses were
$22.9 million (18.8% of revenue) during 1997, an increase of $2.3 million from
$20.6 million (24.5% of revenue) during 1996. The increase resulted from the
addition of management staff and related operating expenses across the
organization, including in conjunction with our expansion outside of the United
States, and increases in the provision for doubtful accounts receivable. These
expenses were in part offset by decreased expenses following the sale of our
individual consumer subscribers and related assets in 1996 and the sale of our
software operations in 1997.

         Depreciation and Amortization. Depreciation and amortization costs were
$28.3 million (23.3% of revenue) during 1997, an increase of $0.3 million from
$28.0 million (33.2% of revenue) during 1996. Depreciation costs increased due
to additional capital expenditures associated with network infrastructure
enhancements, which were partially offset by decreases in costs resulting from
the elimination of depreciation and amortization that had been associated with
the individual consumer subscriber assets sold in 1996 and the software assets
sold in 1997.

                                      -44-
<PAGE>
 
         Interest Expense. Interest expense was $5.4 million during 1997, an
increase of $0.4 million from $5.0 million in 1996. The increase was principally
due to increased borrowings and capital lease obligations incurred by us to
finance network expansion and to fund working capital requirements.

         Interest Income. Interest income was $3.1 million during 1997, a
decrease of $0.7 million from $3.8 million in 1996. The decrease was principally
due to a reduction in the amount of cash and short-term, interest-bearing
investments held by us.

         Other Income, Net. Other income, net, was $5.8 million for 1997, which
primarily related to the sale in the first quarter of 1997 of our software
subsidiary.

         Net Loss Available to Common Shareholders and Loss Per Share. As a
result of the factors discussed above, our net loss available to common
shareholders for 1997 was $46.0 million (37.7% of revenue), or $1.14 basic and
diluted loss per share, a $9.1 million improvement from a net loss available to
common shareholders in 1996 of $55.1 million (65.3% of revenue), or $1.40 basic
and diluted loss per share. The return to preferred shareholders, which
comprises the dividends with respect to our Series B 8% convertible preferred
stock and accretion of the related conversion premium, is subtracted from net
loss in determining the net loss available to common shareholders. Because
inclusion of common stock equivalents is antidilutive, basic and diluted loss
per share are the same for each year presented.

INCOME TAXES

         In 1998, we generated a pretax U.S. book loss of approximately $134.6
million and pretax non-U.S. book loss of approximately $128.1 million. As of
December 31, 1998, we had net operating loss carryforwards of approximately
$216.7 million for U.S. income tax purposes. The use of the U.S. net operating
loss carryforwards may be subject to limitations under the rules regarding a
change in stock ownership as determined by the Internal Revenue Code. These net
operating loss carryforwards may be carried forward in varying amounts until
2018. Additionally, at December 31, 1998, we had net operating loss
carryforwards for tax purposes in various jurisdictions outside the United
States amounting to approximately $158.6 million. The majority of non-U.S. loss
carryforwards will expire in varying amounts in 2003 to 2005. Some of the
non-U.S. loss carryforwards will never expire under local country tax rules.

         We have provided a valuation allowance against our deferred tax assets
since realization of these benefits cannot be reasonably assured. The change in
valuation allowance was an increase of $101.7 million and $18.8 million in 1998
and 1997, respectively.

         We recognized deferred income tax benefits of $0.8 million in 1998,
$0.5 million in 1997, and $0.2 million in 1996, resulting primarily from
deferred tax liabilities of companies we acquired outside of the U.S.. We did
not recognize any current income tax expense or benefit for any of those three
years.

SEGMENT INFORMATION

         We offer a broad range of Internet access services and related products
to businesses in the U.S. and throughout the world. As of December 31, 1998, we
served primary markets in 12 countries, with operations organized into four
geographic operating segments - the U.S., Canada, Europe and Asia. In measuring
performance and allocating assets, our chief operating officer reviews each
geographic operating segment as a whole and not by types of services provided.

         We evaluate the performance of our segments and allocate resources to
them based on revenue and EBITDA. We define EBITDA 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.

         All our reportable segments have experienced significant revenue
increases from 1996 to 1998. Between 1996 and 1997, our revenue growth by
segment was largely organic, with the United States growing by 33%, Canada by
823%, Europe by 114% and Asia by 205%. Starting in late 1997 and through 1998,
we acquired 18 ISPs in the U.S., Canada, Europe and Asia, and our revenue growth
between 1997 and 1998 reflects a mixture of organic and acquired revenue.
Revenue growth by segment between these years is as follows:

                                      -45-
<PAGE>
 
                              ORGANIC            ACQUIRED              TOTAL
                              -------            --------              -----
        United States             45%                  5%                50%
        Canada                   140%                725%               865%
        Europe                   144%                123%               267%
        Asia                     105%                657%               762%
        All Segments              58%                 55%               113%


         EBITDA losses as a percentage or revenue improved in all segments
except the U.S. from 1997 to 1998, reflecting the overall development cycle of
our businesses in these areas. In the U.S., our EBITDA loss as a percentage of
revenue increased from (13%) to (17%), which is reflective of increased costs
charged to the U.S. segment relating to shared network, marketing and general
and administrative costs not allocated to other reportable segments.
Improvements in EBITDA as percentage of revenue for the Canadian segment was
(144%) to (28%), for the European segment was (33%) to (16%), and for the Asian
segment was (12%) to (5%). These improvements have arisen as a result of two
primary factors. First, improvements have been generated based on organic growth
factors including high levels of revenue growth and concentration of efforts on
controlling operating costs, and second, almost every company we acquired in
1998 operated at EBITDA breakeven or better, contributing to these improvements.

         EBITDA losses as a percentage of revenue improved in all segments from
1996 to 1997. In the U.S., it went from (26%) to (13%), in Canada from (1,032%)
to (144%), in Europe from (55%) to (33%), and in Asia from (108%) to (12%). The
improvement in the U.S. reflects revenue that increased at a faster rate than
did data communications and operations, sales and marketing and general and
administrative expenses. We achieved cost reductions between 1996 and 1997 in
the U.S. due to the disposition of our software operations. Our operating
improvements outside of the U.S. primarily are the result of the development of
these operations that were largely still in a start-up mode in 1996.

         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 underlying trends as
those impacting EBITDA as a percentage of revenue. However, as a result of our
1998 acquisitions of telecommunications bandwidth and other fixed assets and
acquisitions of ISPs, we incurred charges for acquired in-process research and
development and increased depreciation and amortization expenses in each
geographic segment, which increased our loss from operations. In the U.S., our
loss from operations as a percentage of revenue went from (60%) in 1996 to (37%)
in 1997 to (47%) in 1998. In Canada, it went from (1,138%) to (176%) to (104%),
in Europe from (74%) to (51%) to (41%), and in Asia from (116%) to (17%) to
(160%) for those same three years, respectively.

QUARTERLY RESULTS

         The following tables set forth certain unaudited quarterly financial
data, and such data expressed as a percentage of revenue, for the eight quarters
ended December 31, 1998. In the opinion of management, the unaudited financial
information set forth below has been prepared on the same basis as the audited
financial information included elsewhere herein and includes all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
information set forth. The operating results for any quarter are not necessarily
indicative of results for any future period.

<TABLE> 
<CAPTION> 
                                                                    QUARTER ENDED
                                  ------------------------------------------------------------------------------------
                                                    1997                                       1998
                                  ------------------------------------------------------------------------------------
                                   MAR 31        JUN 30     SEP 30      DEC 31    MAR 31    JUN 30    SEP 30    DEC 31
                                  --------     ---------   --------    --------  --------  -------   -------    ------
                                                    (IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S>                             <C>         <C>         <C>          <C>         <C>       <C>     <C>      <C> 
Revenue                             $25.6        $29.5      $32.0        $34.8    $44.5     $53.7      $67.6     $93.9

Operating costs and expenses:

Data communications and operations   21.0         22.1       23.8         27.5     36.7     41.9        51.9      68.9
Sales and marketing                   6.0          5.9        6.2          7.8     10.7     12.5        14.7      19.1
General and administrative            5.4          6.1        5.3          6.0      7.6     10.3        11.6      15.8
Depreciation and amortization         8.0          6.1        6.6          7.7      9.5     12.9        14.7      26.4
</TABLE> 

                                      -46-
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                    QUARTER ENDED
                                  ------------------------------------------------------------------------------------
                                                    1997                                       1998
                                  ------------------------------------------------------------------------------------
                                      MAR 31    JUN 30    SEP 30    DEC 31    MAR 31    JUN 30    SEP 30    DEC 31
                                  ------------------------------------------------------------------------------------
                                                    (IN MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S>                             <C>         <C>         <C>          <C>         <C>       <C>     <C>      <C> 
Charge for acquired in-process                                                                                        
     research and development        --         --         --         --           7.0        20.0       13.4       30.4
                                  --------   --------   --------   --------    --------    --------   --------   -------- 
Total operating costs and                                
     expenses                        40.4       40.2      41 .9       49.0       71 .5        97.6      106.3      160.6
                                  --------   --------   --------   --------    --------    --------   --------   -------- 
Loss from operations                (14.8)     (10.7)      (9.9)     (14.2)      (27.0)      (43.9)     (38.7)     (66.7)
Interest expense                     (1.4)      (1.3)      (1.5)      (1.2)       (2.6)      (16.9)     (18.7)     (25.7)
Interest income                       0.8        0.7        0.5        1.1         0.5         6.0        4.8        8.2
Other income, net                     5.7       --          0.2       --          --           1.2        5.3        0.5
Non-recurring arbitration charge     --         --         --         --          --          --         --        (49.0)
                                  --------   --------   --------   --------    --------    --------   --------   -------- 
Loss before income taxes             (9.7)     (11.3)     (10.7)     (14.3)      (29.1)      (53.6)     (47.3)    (132.7)
Income tax benefit                   (0.4)      --         --         --          --          --         --         (0.9)
                                  --------   --------   --------   --------    --------    --------   --------   -------- 
Net loss                             (9.3)     (11.3)     (10.7)     (14.3)      (29.1)      (53.6)     (47.3)    (131.8)
Return to preferred shareholders     --         --         --         (0.4)       (0.8)       (0.8)      (0.8)      (0.8)
                                  --------   --------   --------   --------    --------    --------   --------   -------- 
Net loss available to common                
     shareholders                   $(9.3)    $(11.3)    $(10.7)    $(14.7)     $(29.9)     $(54.4)    $(48.1)   $(132.6)
                                  ========   ========   ========   ========    ========    ========   ========   ========  
Basic  and   diluted   loss  per                                       
     share (1)                     $(0.23)    $(0.28)    $(0.26)    $(0.36)     $(0.67)     $(1.06)    $(0.93)   $ (2.56)
                                  ========   ========   ========   ========    ========    ========   ========   ========  
Shares used in computing basic                                                                                         
     and diluted loss per share                                                                                       
     (in thousands)                40,158     40,225     40,407     40,436      44,596      51,111     51,659    51,871  
</TABLE> 

(1)   Since there are changes in the weighted average number of shares
      outstanding each quarter, the sum of the loss per share by quarter does
      not equal the loss per share for 1997 and 1998.

<TABLE> 
<CAPTION> 
                                                                    QUARTER ENDED
                                 ------------------------------------------ ------------------------------------------
                                                   1997                                       1998
                                 ------------------------------------------ ------------------------------------------
                                  JAN 30      MAR 31    SEP 30    DEC 31     MAR 31     JUN 30     SEP 30    DEC 31
                                 --------- ----------- --------- ---------- ---------- ---------- --------- ----------
<S>                             <C>       <C>          <C>      <C>       <C>         <C>       <C>        <C> 
Revenue                            100.0%    100.0%      100.0%    100.0%     100.0%     100.0%     100.0%    100.0%
Operating costs and expenses:

Data communications and  
     operations                     81.8      74.9        74.3      79.2       82.5       78.1       76.8      73.3
Sales and marketing                 23.4      19.9        19.4      22.3       24.1       23.2       21.8      20.3
General and administrative          21.4      20.8        16.7      17.2       17.1       19.2       17.1      16.9
Depreciation and amortization       31.3      20.5        20.5      22.1       21.3       24.0       21.7      28.1
Charge for acquired in-process                                                                                        
     research and development       --        --          --        --         15.7       37.2       19.8      32.4

Total operating costs and        --------  -------     -------   -------     ------      -----      -----    ------
  expenses                         157.9     136.1       130.9     140.8      160.7      181.7      157.3     171.0
                                 --------  -------     -------   -------     ------      -----      -----    ------
Loss from operations               (57.9)    (36.1)      (30.9)    (40.8)     (60.7)     (81.7)     (57.3)    (71.0)
Interest expense                    (5.2)     (4.4)       (4.7)     (3.4)      (5.8)     (31.4)     (27.7)    (27.4)
Interest income                      3.0       2.3         1.7       3.1        1.3       11.3        7.0       8.8
Other income, net                   22.1      (0.1)        0.6      (0.1)      (0.2)       2.0        7.9       0.5
Non-recurring arbitration charge    --        --          --        --         --         --         --       (52.2)
                                 --------  -------     -------   -------     ------      -----      -----    --------
Loss before income taxes           (38.0)    (38.3)      (33.3)    (41.2)     (65.4)     (99.8)     (70.1)   (141.3)
Income tax expense (benefit)        (1.8)     --          --        --         --         --          --       (0.9)
                                 --------  -------     -------   -------     ------      -----      -----    ------
Net loss                           (36.2)%   (38.3)%     (33.3)%   (41.2)%    (65.4)%    (99.8)%    (70.1)%  (140.4)%
                                 =========  =======     =======   =======     ======      =====      ======   ======
</TABLE> 

         Our quarterly operating results have fluctuated and will continue to
fluctuate from period to period depending upon such factors as:

        .  the timing of acquisitions

                                      -47-
<PAGE>
 
        .  the success of our efforts to expand our customer base, and to sell
           enhanced and value added services to existing customers,

        .  changes in and the timing of expenditures relating to the continued
           expansion of our network,
           
        .  the delivery of bandwidth from our global network providers,

        .  the development of new services, and

        .  changes in pricing policies by us or our competitors.

        In view of the significant historical growth of our operations, we
believe that period-to-period comparisons of our financial results should not be
relied upon as an indication of future performance and that we may experience
significant period-to-period fluctuations in operating results in the future. We
expect to focus in the near term on building and increasing our customer base
and increasing our network utilization both through internal growth and through
acquisitions which may require us from time to time to increase our expenditures
for personnel, marketing, network infrastructure and the development of new
services.

         LIQUIDITY AND CAPITAL RESOURCES

         We have historically had losses from operations, which have been funded
primarily through borrowings and capital lease financings from vendors,
financial institutions and other third parties, and through the issuance of debt
and equity securities. In 1998, we received net proceeds of approximately
$1,060.6 million from debt financings.

         CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

         Cash flows used in operating activities were $87.6 million in 1998,
$15.6 million in 1997 and $32.5 million in 1996. Cash flows from operating
activities can vary significantly from period to period depending upon the
timing of operating cash receipts and payments, especially accounts receivable,
prepaid expenses and other assets, and accounts payable and accrued liabilities.
In all three years, our net losses were the primary component of cash used in
operating activities, offset by significant non-cash depreciation and
amortization expenses relating to our network and intangible assets and, in
1998, our charge for acquired in-process research and development.

         Cash flows used in investing activities were $783.9 million for 1998,
$15.6 million for 1997 and $7.9 million for 1996. Acquisition activities
resulted in the use of $268.0 million of cash for 1998, net of cash acquired.
Investments in our network and facilities during 1998 resulted in total
additions to fixed assets of $303.6 million. Of this amount, $113.3 million was
financed under vendor or other financing arrangements, $27.4 million of non-cash
additions related to the bandwidth acquired from IXC, $44.9 million related to
other network facilities that remained in accounts payable at year end, and
$118.0 million was expended in cash. For 1997, total additions were $50.1
million, of which $37.5 million was financed under equipment financing
agreements and $12.6 million was expended in cash, and for 1996, additions were
$38.4 million, with $25.6 million financed and $12.8 million expended in cash.
Purchases of short-term investments with the proceeds of our 10% senior notes
and 11 1/2 % senior notes offerings during 1998 were an aggregate of $511.7
million, offset by proceeds from the sale and maturity of short-term investments
of $251.2 million. Investing cash flows in 1998 and 1997 were reduced by $141.0
million and $19.7 million, respectively, from increases in restricted cash and
short-term investments related to various financing alternatives.

         Cash flows provided by (used in) financing activities were $874.2
million for 1998, $12.6 million for 1997, and ($10.5) million for 1996. In 1998,
1997 and 1996, we received net proceeds from the issuance of notes payable of
$1,060.6 million, $10.1 million and $8.3 million, respectively. In 1997, we
completed a private placement of 600,000 shares of our Series B convertible
preferred stock for gross proceeds of $30.0 million. In 1998, 1997 and 1996, we
made repayments aggregating $189.5 million, $27.7 million, and $20.8 million,
respectively, on our capital lease obligations and notes payable.

         As of December 31, 1998, we had $485.0 million of cash, cash
equivalents, restricted cash, short-term investments and marketable securities.

                                      -48-
<PAGE>
 
         CAPITAL STRUCTURE

         Our capital structure at December 31, 1998 consisted of a revolving
credit facility, other lines of credit, capital lease obligations, 10% senior
notes, 11 1/2% senior notes, preferred stock and common stock.

         Total borrowings at December 31, 1998 were $1,124.6 million, which
included $60.0 million in current obligations and $1,064.6 million in long-term
capital lease obligations and notes payable. We also had $1.2 million of letters
of credit outstanding as of December 31, 1998. As of that date, the aggregate
unused portion under our various financing arrangements for purchases of
equipment and other fixed assets was 12.9 million, after designating $27.9
million of payables for various equipment purchases.

         Our total U.S. borrowings at December 31, 1998 were $1,070.5 million,
comprising $953.0 million of senior notes, $109.7 million of capital leases and
$7.8 million of other notes. The majority of our U.S. debt was added through the
issuance of our 10% senior notes and 11 1/2% senior notes in April and November
1998, respectively. Total non-U.S. borrowings at December 31, 1998 were $54.1
million, comprising $11.0 million of capital leases and $43.1 million of other
notes. The majority of our non-U.S. debt was added through our acquisitions
completed in 1998 and is secured by specific telecommunications assets and
letters of credit. In 1999, we expect to make interest payments on our 10% and
11 1/2% senior notes and payments on our capital leases and other notes payable
of $169.2 million in the aggregate.

         In September 1998, we entered into a new three year senior secured
revolving credit facility to replace our existing bank credit arrangements in
the United States. The revolving credit facility expires on September 29, 2001
and has an aggregate principal amount of $110.0 million, of which no amounts
were outstanding and $108.8 million was available to draw at December 31, 1998.

         Our bank financing arrangements in the U.S., which are secured by
substantially all of our assets, require us to satisfy many financial covenants
such as those relating to consolidated revenue, leverage, liquidity and EBITDA
(as defined therein), and prohibit us from paying cash dividends and
repurchasing our capital stock without the lender's consent. In particular, we
are prohibited from permitting:

        .     consolidated revenue for the period of four consecutive fiscal
              quarters to be less than $215.0 million during the six month
              period beginning December 31, 1998, $285.0 million during the six
              month period beginning June 30, 1999, $350.0 million during the
              six month period beginning December 31, 1999, $425.0 million
              during the six month period beginning June 30, 2000, and $500.0
              million on December 31, 2000 and thereafter;

        .     the ratio of consolidated debt minus cash, excluding cash escrowed
              with respect to the payment of obligations, to annualized
              consolidated revenue for the most recent fiscal quarter for which
              financial statements have been delivered, as adjusted to give pro
              forma effect to any acquisitions completed during or after such
              fiscal quarter, to exceed 2.5 to 1 at any time;

        .     the sum of cash, excluding cash escrowed with respect to the
              payment of obligations, and available borrowing capacity under our
              credit facility at any time to be less than $100.0 million; and

        .     EBITDA (as defined therein), to be worse than negative $45.0
              million, negative $40.0 million, negative $29.0 million, negative
              $15.0 million, $0, $15.0 million, $25.0 million, $40.0 million and
              $50.0 million for the period of four consecutive fiscal quarters
              ending on each of December 31, 1998, March 31, 1999, June 30,
              1999, September 30, 1999, December 31, 1999, March 31, 2000, June
              30, 2000, September 30, 2000 and December 31, 2000, respectively.

         In April 1998, we completed an offering of $600.0 million aggregate
principal amount of 10% senior notes due 2005 and in November 1998 we completed
offerings of $350.0 million aggregate principal amount of 11 1/2% senior notes
due 2008. The aggregate net proceeds of these offerings, after giving effect to
discounts, commissions, premiums and expenses and the establishment of an
initial $138.7 million escrow arrangement to fund when due the first five
interest payments on our 10% senior notes, were $785.1 million.

         The indentures governing the 10% senior notes and the 11 1/2% senior
notes contain many covenants with which we must comply relating to, among other
things, the following matters:

                                      -49-
<PAGE>
 
        .     a limitation on our payment of cash dividends, repurchase of
              capital stock, payment of principal on subordinated indebtedness
              and making of certain investments, unless after giving effect to
              each such payment, repurchase or investment, certain operating
              cash flow coverage tests are met, excluding permitted payments and
              investments;

        .     a limitation on our incurrence and our subsidiaries' incurrence of
              additional indebtedness, unless at the time of such incurrence,
              our ratio of debt to annualized operating cash flow would be less
              than or equal to 6.0 to 1.0 prior to April 1, 2001 and less than
              or equal to 5.5 to 1.0 on or after April 1, 2001, excluding
              permitted incurrences of debt;

        .     a limitation on our incurrence and our subsidiaries' incurrence of
              liens, unless the 10% senior notes and the 11 1/2% senior notes
              are secured equally and ratably with the obligation or liability
              secured by such lien, excluding permitted liens;

        .     a limitation on the ability of any of our subsidiaries to create
              or otherwise cause to exist any encumbrance or restriction on the
              payment of dividends or other distributions on their capital
              stock, payment of indebtedness owed to us or to any of our other
              subsidiaries, making of investments in us or in any of our other
              subsidiaries, or transfer of any of their properties or assets to
              us or any of our other subsidiaries, excluding certain permitted
              encumbrances and restrictions;

        .     a limitation on certain mergers, consolidations and sales of
              assets by us or our subsidiaries;

        .     a limitation on transactions with our affiliates;

        .     a limitation on the ability of any of our subsidiaries to
              guarantee or otherwise become liable with respect to any of our
              indebtedness unless such subsidiary provides for a guarantee of
              the 10% senior notes and the 11 1/2% senior notes on the same
              terms as the guarantee of such indebtedness;

        .     a limitation on sale and leaseback transactions by us or our
              subsidiaries; 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 December 31, 1998, we were in compliance with all such covenants.

         In November 1997, we completed a private placement of 600,000 shares of
our Series B convertible preferred stock for gross proceeds of $30.0 million.
During the first quarter of 1999, all outstanding shares of the Series B
preferred stock, which accrued dividends at an annual rate of 8%, were converted
into an aggregate of 3,000,000 shares of our common stock. As a result of this
conversion, we are no longer required to pay the 8% annual dividends under the
terms of the Series B preferred stock, resulting in the elimination of
approximately $2.4 million in annual dividend expense.

COMMITMENTS, CAPITAL EXPENDITURES AND FUTURE FINANCING REQUIREMENTS

         As of December 31, 1998, we had commitments to certain
telecommunications vendors totaling $95.4 million payable in various years
through 2011. Additionally, we have various agreements to lease office space and
facilities and, as of December 31, 1998, were obligated to make future minimum
lease payments of $40.4 million on non-cancellable operating leases expiring in
various years through 2009.

         For some of the acquisitions made in 1998, we have retained a portion
of the purchase price under hold-back provisions of the purchase agreements to
secure performance by certain sellers of indemnification or other contractual
obligations of the sellers. These acquisition hold-back liabilities are
generally payable up to 24 months after the date of closing of the respective
acquisitions. Acquisition hold-back liabilities total $38.2 million at December
31, 1998. In addition, the purchase price relating to one acquisition may be
increased by up to $8.0 million pursuant to an earnout provision in the event
the acquired company achieved certain levels of operating results in the period
following the acquisition. This amount will be recorded as additional cost of
the acquired company and reflected as additional purchased goodwill if it
becomes probable that the amount will be paid. At December 31, 1998, no amounts
have been accrued since the final outcome of the earnout provision was not
determinable.

                                      -50-
<PAGE>
 
         In connection with our recently announced 20-year commercial
relationship with the Baltimore Ravens of the National Football League, we
acquired, among other things, rights to name the Ravens' NFL Stadium "PSINet
Stadium" as well as rights for sponsorship and promotion of team events and
related advertising and marketing rights. In addition, we have the right to
develop a Baltimore Ravens' web site and provide related Internet services to
subscribing fan members which, along with other commercial aspects of the
transaction, are expected to bring revenues to both organizations through
service and membership fees, e-commerce and promotional ventures. In exchange
for all of these rights, we will make payments to the Baltimore Ravens over a
20-year period. We paid $11.8 million in January 1999, which includes a one-time
prepayment of $9.25 million under the stadium naming rights agreement. Annual
payments for 2000 and for the 18 years thereafter start at $2.6 million, with
successive annual increases of approximately 5%. We expect that the total
payments to be made over the 20-year period will be approximately $93.5 million.

         In connection with the non-recurring arbitration charge, we have
recorded an accrual of $49.0 million for the award and related costs, which
could be paid in 1999 from available cash.

         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 December 31,
1998, we were obligated to make future payments under these purchase agreements
that total $103.7 million, most which will be paid in 1999.

         We expect to continue to seek opportunities to acquire fiber-based
telecommunications bandwidth to enhance our global network capabilities. In
addition to the U.S. and Canada, we anticipate that such bandwidth acquisitions
will be in Europe and Asia and would be accompanied by capital expenditures in
the deployment of high activity points-of-presence designed and located with the
objective of optimizing the efficient use of the bandwidth. We currently
anticipate that these expenditures in 1999 will be consistent with those in 1998
and will be financed through a combination of capital leases, existing working
capital and other sources of financing.

         We presently believe, based on the flexibility we expect to have in the
timing of orders of bandwidth, in outfitting our points-of-presence 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 existing working capital, from existing credit
facilities, from capital lease financings, 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. There can be no assurance, 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, 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 

                                      -51-
<PAGE>
 
our exposure to risks associated with interest rate fluctuations. By their
nature, all such instruments would involve risk, including the risk of
nonperformance by counterparties. We would attempt to control our exposure to
counterparty credit risk through monitoring procedures and by entering into
multiple contracts.

RISKS ASSOCIATED WITH YEAR 2000

         The commonly referred to Year 2000 ("Y2K") problem results from the
fact that many existing computer programs and systems use only two digits to
identify the year in the date field. These programs were designed and developed
without considering the impact of a change in the century designation. If not
corrected, computer applications that use a two-digit format could fail or
create erroneous results in any computer calculation or other processing
involving the Year 2000 or a later date. We have identified two main areas of
Y2K risk:

        .     Internal computer systems or embedded chips could be disrupted or
              fail, causing an interruption or decrease in productivity in our
              operations; and

        .     Computer systems or embedded chips of third parties, including,
              without limitation, financial institutions, suppliers, vendors,
              landlords, customers, international suppliers of
              telecommunications services and others could be disrupted or fail,
              causing an interruption or decrease in our ability to continue our
              operations.

         We have developed plans for implementing, testing and completing any
necessary modifications to our key computer systems and equipment with embedded
chips to ensure that they are Y2K compliant. We 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 June 30, 1999. We are in the process of completing an inventory of
our internal systems that we use in Canada, United Kingdom, Europe and Asia to
determine the status of their Y2K compliance. Each international office has 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 by the end of the third quarter of 1999. To
help ensure that our network operations and services to our customers are not
interrupted due to the Y2K problem, we have established a network operations
team that meets weekly to examine our network on a worldwide basis. This team of
operational staff have conducted inventories of our network equipment (software
and hardware) and have found no material Y2K compliance issues. We believe that
all equipment currently being purchased for use in the PSINet network is Y2K
compliant. Any existing equipment that is not Y2K compliant is planned to be
made Y2K compliant through minor changes to the software or hardware or, in
limited instances, replacement of the equipment. We anticipate that our network
will be Y2K compliant by the end of the second quarter of 1999. In addition to
administering the implementation of necessary upgrades for Y2K compliance, our
network team is developing a contingency plan to address any potential problems
that may occur with our network as we enter the year 2000. We believe that, as a
result of our detailed assessment and completed modifications, the Y2K issue
will not pose significant operational problems for us. However, if the requisite
modifications and conversions are not made, or not completed in a timely
fashion, it is possible that the Y2K problem could have a material impact on our
operations.

         Our cost of addressing Y2K issues has been minor to date, less than 5%
of our information technology and network operations budgets, but this amount
may increase if additional outside consultants or personnel resources are
required or if important operational equipment must be remediated or replaced.
Our estimated total costs related to Y2K issues for 1999 is not expected to
exceed $2.0 million. These costs include equipment, consulting fees, software
and hardware upgrades, testing, remediation and, in limited instances,
replacement of equipment. The risk that Y2K issues could present to us include,
without limitation, disruption, delay or cessation of operations, including
operations that are subject to regulatory compliance. In each case, the
correction of the problem could result in substantial expense and disruption or
delay of our operations. The total cost of Y2K assessments and remediation is
funded through cash on hand and available from other sources and we are
expensing these costs, as appropriate. The financial impact of making all
required systems changes or other remediation efforts cannot be known precisely,
but it is not expected to be material to our financial position, results of
operations, or cash flows. 

                                      -52-
<PAGE>
 
We have not canceled any principal information technology projects as a result
of our Y2K effort, although we have rescheduled some internal tasks to
accommodate this effort.

         In addition, we have identified, prioritized and are communicating with
our suppliers, vendors, customers, lenders and other material third parties to
determine their Y2K status and any probable impact on us. To date, our inquiries
have not revealed any significant Y2K noncompliance issue affecting our material
third parties. We will continue to monitor and evaluate our long-term
relationships with our material third parties based on their responses to our
inquiries and on information learned from other sources. If any of our material
third parties are not Y2K ready and their non-compliance causes a material
disruption to any of their respective businesses, our business could be
materially adversely affected. Disruptions could include, among other things:

        .    the failure of a material third party's business;

        .    a financial institution's inability to take and transfer funds;

        .    an interruption in delivery of supplies from vendors;

        .    a loss of voice and data connections;

        .    a loss of power to our facilities; and

        .    other interruptions in the normal course of our operations, the
             nature and extent of which we cannot foresee.

        We will continue to evaluate the nature of these risks, but at this
time we are unable to determine the probability that any such risk will occur,
or if it does occur, what the nature, length or other effects, if any, it may
have on us. If a significant number of our material third parties experience
failures in their computer systems or operations due to Y2K non-compliance, it
could affect our ability to process transactions or otherwise engage in similar
normal business activities. For example, while we expect our internal systems,
U.S. and non-U.S., to be Y2K ready in stages during 1999, we and our customers
who communicate internationally will be dependent upon the Y2K-readiness of many
non-U.S. providers of telecommunication services and their vendors and
suppliers. If these providers and others are not Y2K ready, we and our customers
will not be able to send and receive data and other electronic transmissions,
which would have a material adverse effect on our revenues and business and that
of our customers. While many of these risks are outside our control, we have
identified and contacted our critical third party vendors and suppliers and are
establishing contingency plans to remedy any potential interruption to our
operations.

         While we believe that we are adequately addressing the Y2K issue, we
can not assure that our Y2K compliance effort will prevent every potential
interruption or that the cost and liabilities associated with the Y2K issue will
not materially adversely impact our business, prospects, revenues or financial
position. We are uncertain as to our most reasonably likely worst case Y2K
scenario and have not yet completed a contingency plan to handle a worst case
scenario. We expect to have such contingency plan in place by September 30,
1999.

RECENT ACCOUNTING PRONOUNCEMENTS

         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. This Statement establishes
accounting and reporting standards for derivative instruments, including some
derivative instruments embedded in other contracts, and for hedging securities.
To the extent we begin to enter into such transactions in the future, we will
adopt the Statement's disclosure requirements in the quarterly and annual
financial statements for the year ending December 31, 2000.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         At December 31, 1998, we had other financial instruments consisting of
fixed rate debt and short-term investments. The substantial majority of our debt
obligations have fixed interest rates and are denominated in U.S. dollars, which
is our reporting currency. Annual maturities of our debt obligations are as
follows: $10.5 million in 1999, $7.3 million in 2000, $7.1 million in 2001, $5.0
million in 2002, $3.4 million in 2003 and $967.8 million thereafter. At December
31, 1998, the carrying value of our debt obligations was $1,124.6 million and
the fair value was $1,009.8 million. The weighted average interest rate of our
debt obligations at December 31, 1998 was 10.5%. 

                                      -53-
<PAGE>
 
Our investments are generally fixed rate short-term investment grade and
government securities denominated in U.S. dollars. At December 31, 1998, all of
our investments are due to mature within twelve months and the carrying value of
such investments approximates fair value. At December 31, 1998, $162.5 million
of our cash and short-term investments were restricted in accordance with the
terms of our financing arrangements and certain acquisition hold-back
agreements. We actively monitor the capital and investing markets in analyzing
our capital raising and investing decisions.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE> 
<CAPTION> 
                                                                                                               Page
                                                                                                               ----
         Index to Financial Statements:

              Financial Statements:
<S>                                                                                                         <C> 
                  Report of Independent Accountants.......................................................      55

                  Consolidated Balance Sheets as of December 31, 1998 and 1997............................      56

                  Consolidated Statements of Operations for the years ended December 31, 1998,
                    1997 and 1996.........................................................................      57

                  Consolidated Statements of Changes in Shareholders' Equity (Deficit) for the years
                    ended December 31, 1998, 1997 and 1996................................................      58

                  Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997
                    and 1996..............................................................................      59

                  Notes to Consolidated Financial Statements..............................................      60

              Financial Statement Schedules:

                  II--Valuation and Qualifying Accounts for each of the three years in the period ended
                    December 31, 1998.....................................................................      77
</TABLE> 

                  All other schedules are omitted because they are not
                  applicable or the required information is shown in the
                  financial statements or notes thereto.

         The quarterly results (unaudited) for the eight quarters ended December
31, 1998 are included in "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Quarterly Results" in Part II, Item 7 of
this Form 10-K.

                                      -54-
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of PSINet Inc.

In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of PSINet
Inc. and its subsidiaries at December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.


PricewaterhouseCoopers LLP


Washington, D.C.
March 9, 1999, except as to Note 11, which is as of March 25, 1999

                                      -55-
<PAGE>
 
                                  PSINET INC.
                          CONSOLIDATED BALANCE SHEETS

<TABLE> 
<CAPTION> 
                                                                                                 DECEMBER 31,
                                                                                        ----------------------------
                                                                                          1998                 1997
                                                                                         -------             --------
                                                                                        (IN THOUSANDS OF U.S. DOLLARS,
                                                                                              EXCEPT SHARE DATA)
ASSETS
Current assets:
<S>                                                                                  <C>                   <C> 
   Cash and cash equivalents                                                             $ 56,842             $33,322 
   Restricted cash and short-term investments                                             162,469              20,690 
   Short-term investments and marketable securities                                       265,666                  -- 
   Accounts receivable, net of allowances of $11,700 and $2,101                            50,211              11,022 
   Notes receivable                                                                           318               7,224 
   Prepaid expenses                                                                        10,998               1,478 
   Other current assets                                                                    18,759               5,162
                                                                                          --------              -----
          Total current assets                                                            565,263              78,898 

Property, plant and equipment, net                                                        389,476              95,619 
Goodwill and other intangibles, net of accumulated amortization of
   $14,491 and $2,057                                                                     282,781               4,675 
Other assets and deferred charges                                                          46,711               6,989
                                                                                       ----------               -----
          Total assets                                                                 $1,284,231            $186,181
                                                                                        =========             =======

LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
---------------------------------------------
Current liabilities:

   Current portion of debt                                                                $59,968              39,633 
   Trade accounts payable                                                                  89,973              25,031 
   Accrued payroll and related expenses                                                     8,501               4,636 
   Other accounts payable and accrued liabilities                                          82,760               2,229 
   Accrued interest payable                                                                28,988                 153 
   Deferred revenue                                                                        19,427               5,944
                                                                                          -------               -----
          Total current liabilities                                                       289,617              77,626 

Long-term debt                                                                          1,064,633              33,820 
Deferred income tax liabilities                                                             6,123                  -- 
Other liabilities                                                                          44,032               1,306
                                                                                        ---------               -----
          Total liabilities                                                             1,404,405             112,752
                                                                                        ---------             -------

Commitments and contingencies (Notes 2 and 10)

Shareholders' equity (deficit):

   Preferred stock, $.01 par value; 29,324,858 shares authorized; no shares                    --                  -- 
     issued and outstanding
   Convertible preferred stock, $.01 par value; $50.00 stated value;
     675,142 shares authorized; 600,000 shares issued and outstanding                      28,802              28,135 
   Common stock, $.01 par value; 250,000,000 and 100,000,000 shares
     authorized;  52,183,195 and 40,577,342 shares issued                                     522                 406 
   Capital in excess of par value                                                         401,990             210,162 
   Accumulated deficit                                                                   (427,597)           (162,649)
   Treasury stock, 99,556 shares, at cost                                                  (2,005)             (2,005)
   Accumulated other comprehensive income (loss)                                           36,664                (620)
   Bandwidth asset to be delivered under IXC agreement                                   (158,550)                 --
                                                                                        ---------            --------
          Total shareholders' equity (deficit)                                           (120,174)             73,429
                                                                                        ---------              ------

          Total liabilities and shareholders' equity (deficit)                         $1,284,231            $186,181
                                                                                        =========             =======

</TABLE> 

              The accompanying notes are an integral part of these consolidated
financial statements.

                                      -56-
<PAGE>
 
                                  PSINET INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE> 
<CAPTION> 
                                                                                         YEAR ENDED DECEMBER 31,
                                                                               ----------------------------------------
                                                                               1998            1997                1996
                                                                               ----            ----                ----
                                                                                      (IN THOUSANDS OF U.S. DOLLARS,
                                                                                        EXCEPT PER SHARE AMOUNTS)
<S>                                                                     <C>             <C>             <C> 
Revenue                                                                     $259,636         $121,902          $ 84,351 
Other income, net                                                                --               --              5,417 
                                                                              ------           ------            ------
                                                                             259,636          121,902            89,768 

Operating costs and expenses:

   Data communications and operations                                        199,372           94,363            70,102 
   Sales and marketing                                                        57,026           25,831            27,064 
   General and administrative                                                 45,288           22,947            20,648 
   Depreciation and amortization                                              63,424           28,347            28,035 
   Charge for acquired in-process research and development                    70,800              --                --
                                                                              -------          ------           -------
          Total operating costs and expenses                                 435,910          171,488           145,849
                                                                             --------         --------          -------

Loss from operations                                                        (176,274)         (49,586)          (56,081)

Interest expense                                                             (63,914)          (5,362)           (5,025)
Interest income                                                               19,638            3,059             3,794 
Other income, net                                                              6,833            5,811             2,056 
Non-recurring arbitration charge                                             (49,000)             --                --
                                                                             --------          ------            -----

Loss before income taxes                                                    (262,717)         (46,078)          (55,256)
Income tax benefit                                                               848              476               159
                                                                             --------          ------            -----
Net loss                                                                    (261,869)         (45,602)          (55,097)

Return to preferred shareholders                                              (3,079)            (411)              --
                                                                             --------           -------          -----

Net loss available to common shareholders                                  $(264,948)        $(46,013)         $(55,097)
                                                                            =========         ========          ========

Basic and diluted loss per share                                            $ (5.32)          $(1.14)           $(1.40)
                                                                            =========         ========          ========

Shares  used in  computing  basic  and  diluted  loss  per  share  (in                                                      
thousands)                                                                    49,806           40,306            39,378
                                                                              =======          =======           ======
</TABLE> 

              The accompanying notes are an integral part of these consolidated
financial statements.

                                      -57-
<PAGE>
 
                                   PSINET INC.
       CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
                   FOR THE THREE YEARS ENDED DECEMBER 31, 1998
                 In thousands of U.S. dollars, except share data


<TABLE> 
<CAPTION> 
                                                                                                     
                                                                                                     
                                                                                                     
                                                       Preferred             Common 
                                                        Stock                Stock        Capital in                     
                                                Outstanding         Outstanding   Par     Excess of Par  Accumulated    Treasury
                                                  Shares    Amount   Shares      Value       Value          Deficit       Stock 
                                                ----------- ------- -----------  -----   --------------  ------------- -----------  
<S>                                             <C>         <C>     <C>        <C>       <C>             <C>           <C> 
Balance, December 31, 1995                           --      $--      37,914,932   $379    $206,035         $(61,539)     $(2,054)
Comprehensive income:                                                                                
  Net loss                                                                                                   (55,097)          
  Unrealized holding gains                                                                           
    (losses)                                                                                             
  Foreign currency translation                                                                       
    adjustment                                                                                       
  Total comprehensive income                                                                        
    (loss)                                                                                                                   
Retirement of treasury stock                                                                   (49)                            49  
Issuance of common stock pursuant                                                                                                  
    to exercise of stock warrants                                      1,362,604     14        (14)                                
Issuance of common stock                                                                                                           
    pursuant to exercise of stock options                                803,330      9      1,806                                 
Issuance of common stock in escrow                                                                                                 
  for acquisition of World Online                                         32,368                                                   
Repayments under employee stock                                                                                                    
  option loan program                                                                          232                                 
Interest under employee stock option                                                                                               
  loan program                                                                                 (10)                                 
                                                   --------- -------- ---------- -------- ---------       -----------    --------- 
Balance, December 31, 1996                           --        --     40,113,234    402    208,000          (116,636)      (2,005) 
                    
Comprehensive income:                                                                                
  Net loss                                                                                                   (45,602)  
  Foreign currency translation                                                                       
    adjustment                                                                                       
  Total comprehensive income                                                                         
    (loss)                                                                                             
Issuance of common stock pursuant                                                            
  to exercise of stock warrants                                          164,185      2          3       
Issuance of common stock pursuant                                                                        
  to exercise of stock options                                           283,251      3        659        
Issuance of Series B convertible                                   
  preferred stock, net of expenses                  600,000  28,064                          1,500     
Return to preferred shareholders                                 71                                             (411) 
Cancellation of common stock for                                                                
  acquisition of World Online                                            (82,884)    (1)    
                                                   --------- -------- ---------- -------- ---------       -----------    --------- 
Balance, December 31, 1997                          600,000  28,135   40,477,786    406    210,162          (162,649)      (2,005) 

Comprehensive income:                                                                                
  Net loss                                                                                                  (261,869)         
  Unrealized holding gains                                                                           
  Foreign currency translation                                                                       
   adjustment                                                                                        
  Total comprehensive income                                                                         
   (loss)                                                                                            
Issuance of common stock pursuant                                                            
  to exercise of stock warrants                                          174,274      2        277    
Issuance of common stock pursuant                                                                      
  to exercise of stock options                                         1,201,790     12      5,679     
Issuance of common stock and                                                                           
  contingent obligation to IXC                                        10,229,789    102    185,872                    
Acceptance of IXC bandwidth                                                                          
Return to preferred shareholders                                 667                                          (3,079)
                                                   --------- -------- ---------- -------- ---------       -----------    --------- 
Balance, December 31, 1998                          600,000  $28,802  52,083,639   $522   $401,990         $(427,597)     $(2,005)
                                                   ========= ======== ========== ======== =========       ===========    ========= 

</TABLE> 

<TABLE> 
<CAPTION> 
                                                 Bandwidth 
                                    Accumulated  Asset To Be
                                       Other     Delivered     Total
                                   Comprehensive   Under    Shareholders'
                                      Income        IXC        Equity
                                      (Loss)     Agreement   (Deficit)
                                   ----------- ------------ -----------    
<S>                             <C>              <C>        <C> 
Balance, December 31, 1995              $409          $--     $143,230 
Comprehensive income:                                     
  Net loss                                                   
  Unrealized holding gains             (813)              
    (losses)                                                  
  Foreign currency translation                            
    adjustment                          426               
  Total comprehensive income                                  (55,484)
   (loss)                                                 
Retirement of treasury stock                                       --  
Issuance of common stock pursuant                                  --  
  to exercise of stock warrants                           
Issuance of common stock pursuant                                                                 
  to exercise of stock options                                   1,815 
Issuance of common stock in escrow                                                                   
  for acquisition of World Online                                  --
Repayments under employee stock                                          
  option loan program                                              232 
Interest under employee stock option                                                                   
  loan program                                                     (10)
                                         --         --             --
                                                          
Balance, December 31, 1996               22         --          89,783
                                         
                                                          
Comprehensive income:                                     
  Net loss                                                   
  Foreign currency translation           
   adjustment                          (642)        
  Total comprehensive income                                   (46,244)
   (loss)                                                  
Issuance of common stock pursuant                                                                 
  to exercise of stock warrants                                      5 
Issuance of common stock pursuant                                                                 
  to exercise of stock options                                     662 
Issuance of Series B convertible                                                              
  preferred stock, net of expenses                              29,564 
Return to preferred shareholders                                  (340)
Cancellation of common stock for                                                                       
  acquisition of World Online            --        --               (1)
                                                                   ---
                                                          
Balance, December 31, 1997             (620)        --          73,429 
                                                          
Comprehensive income:                                     
                                                          
  Net loss                                                   
  Unrealized holding gains              152                
  Foreign currency translation                            
   adjustment                        37,132                  
  Total comprehensive income                                  (224,585)
    (loss)                                                 
Issuance of common stock pursuant                                                                 
  to exercise of stock warrants                                    279 
Issuance of common stock pursuant                                                                 
  to exercise of stock options                                   5,691 
Issuance of common stock and                                             
  contingent obligation to IXC                    (185,974)         --
Acceptance of IXC bandwidth                         27,424      27,424
Return to preferred shareholders                                (2,412)
                                    --------     ---------- ----------                                                           
Balance, December 31, 1998          $36,664      $(158,550) $(120,174)
                                    ========     ========== ========== 
</TABLE> 
              The accompanying notes are an integral part of these consolidated
financial statements.

                                      -58-
<PAGE>
 
                                  PSINET INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE> 
<CAPTION> 
                                                                                    YEAR ENDED DECEMBER 31,
                                                                           -------------------------------------------
                                                                           1998                1997               1996
                                                                           ----                ----               ----
                                                                                 (IN THOUSANDS OF U.S. DOLLARS)

Cash flows from operating activities:
<S>                                                                     <C>                 <C>                <C> 
     Net loss                                                            $(261,869)           $(45,602)        $(55,097)
     Adjustments  to  reconcile  net loss to net  cash  used in                                                          
      operating activities:                                                                                                       
        Depreciation and amortization                                       63,424              28,347           28,035 
        Gain on sale of investments and subsidiary                          (5,023)             (5,721)          (2,056)
        Charge for acquired in-process research and development             70,800                  --               -- 
        Amortization of debt offering costs and debt premium                 2,339                  --               -- 
        Gain on sale of other assets                                        (1,810)                 --           (5,417)
        Provision for allowances                                             5,505               5,426            3,130 
        (Increase) decrease in accounts receivable                         (27,583)                430          (14,320)
        Decrease increase in notes receivable                                4,835              (5,656)             (56)
        (Increase) decrease in prepaid expenses and other assets           (16,880)                312              311 
        Increase in other assets and deferred charges                       (3,017)               (258)            (509)
        Increase in accounts payable and accrued liabilities                78,766               6,449           11,545 
        Increase in deferred revenue                                         9,419                 635            2,367 
        Decrease in deferred income taxes                                     (848)               (476)            (159)
        (Decrease) increase in other liabilities                            (5,644)                546             (317)
                                                                        -----------         ----------------       -----
               Net cash used in operating activities                       (87,586)            (15,568)         (32,543)
                                                                         ----------            --------         --------

Cash flows from investing activities:

         Purchases of property and equipment                              (118,006)            (12,613)         (12,814)
         Purchases of investments                                         (511,738)             (3,000)         (17,167)
         Proceeds from maturity or sale of investments                     251,207               7,649           15,769 
         Proceeds from sale of assets to MindSpring                          2,077                 691            8,451 
         Proceeds from sale of InterCon, net                                    --              20,353               -- 
         Investments  in  certain   businesses,   net  of  cash                                                          
           acquired                                                       (267,979)             (8,551)             (69)
         Restricted cash and short-term investments                       (140,989)            (19,736)            (954)
         Other                                                               1,551                (353)          (1,113)
                                                                        -----------         -----------          -------
               Net cash used in investing activities                      (783,877)            (15,560)          (7,897)
                                                                          ---------            --------          -------

Cash flows from financing activities:

     Proceeds from issuance of debt                                      1,091,992              10,110            8,281 
     Cost of debt issuance                                                 (31,417)                 --               -- 
     Repayments of debt                                                   (150,977)             (5,670)          (5,666)
     Principal payments under capital lease obligations                    (38,571)            (22,071)         (15,117)
     Proceeds from issuance of Series B preferred stock                         --              29,564               -- 
     Payments of dividends on preferred stock                               (2,740)                 --               -- 
     Proceeds from exercise of common stock warrants                           279                   5               -- 
     Proceeds from exercise of common stock options                          5,691                 662            1,815 
     Other                                                                     (11)                 (2)             158
                                                                           --------            --------        --------
            Net cash  provided by (used in) financing  activities          874,246              12,598          (10,529)
                                                                           --------            --------         --------

Effect of exchange rate changes on cash                                     20,737                 111               --
                                                                          ---------          ----------       ---------

Net increase (decrease) in cash and cash equivalents                        23,520             (18,419)         (50,969)

Cash and cash equivalents, beginning of year                                33,322              51,741          102,710
                                                                          ---------            --------         -------

Cash and cash equivalents, end of year                                   $  56,842           $  33,322        $  51,741
                                                                         ==========          =========        =========
</TABLE> 

              The accompanying notes are an integral part of these consolidated
financial statements.

                                      -59-
<PAGE>
 
                                  PSINET INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         ORGANIZATION AND NATURE OF OPERATIONS - PSINet Inc. (the "Company") was
organized in October 1989 and is a leading global facilities-based Internet data
communications carrier focused on the business marketplace. The Company provides
a broad set of wireline and wireless high-speed corporate LAN/WAN Internet
connectivity services supporting managed security and guaranteed service levels
for intranet, electronic commerce, and Web and application hosting services. The
Company provides dedicated and dial-up Internet connectivity in 90 of the 100
largest metropolitan statistical areas in the U.S. and in 12 of the 20 largest
international telecommunications markets. Additionally, the Company provides
network backbone and related services to other telecommunications carriers and
Internet Service Providers ("ISPs") to further exploit its network capacity.

         The Company's operations are subject to certain risks and
uncertainties, including those associated with: significant indebtedness and the
ability to meet obligations; continuing losses, negative cash flow and
fluctuations in operating results; dependence on subsidiaries for repayment of
debt; funding expansion; acquisitions and strategic alliances, including their
integration; managing rapid growth and expansion; acquisition and utilization of
bandwidth; international expansion; dependence on key personnel; dependence on
suppliers; financing arrangement terms that may restrict operations; possible
Year 2000 issues; regulatory issues; pending litigation; competition in the
Internet services industry; technology trends and evolving industry standards;
delivering reliable service; and volatility of stock price.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         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.

         PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.

         REVENUE RECOGNITION - Revenue and related direct costs from customer
contracts are recognized ratably over the terms of the contracts, which are
generally three months to three years. Cash received in advance of revenues
earned is recorded as deferred revenue. In 1996, when the Company's offerings
included connectivity software products, revenue from the sale of software was
recognized when software products were shipped, and revenue from separate
post-contract customer support agreements was recognized over the contract
period.

         ADVERTISING AND CUSTOMER ACQUISITION COSTS - The Company expenses all
advertising and customer acquisition costs in the period incurred. Advertising
expenses (which include customer acquisition costs) were $19.8 million in 1998,
$9.2 million in 1997 and $14.3 million in 1996.

         RESEARCH AND DEVELOPMENT - Research and development costs are expensed
as incurred.

         CASH AND CASH EQUIVALENTS - All highly liquid investments with an
original maturity of three months or less at the date of acquisition are
classified as cash equivalents.

         RESTRICTED CASH AND SHORT-TERM INVESTMENTS - Restricted cash and
short-term investments represent amounts that are restricted as to their use in
accordance with financing arrangements and acquisition hold-back agreements.

         SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES - Short-term
investments and marketable securities consist of U.S. government obligations,
commercial paper and certificates of deposit with original maturities greater
than three months but less than one year. Management determines the appropriate
classification of its investments in debt and equity securities at the time of
purchase. Debt securities are classified as held to maturity when the Company
has the positive intent and ability to hold the securities to maturity. Held to
maturity securities are stated 

                                      -60-
<PAGE>
 
at amortized cost. Debt securities for which the Company does not have the
intent or ability to hold to maturity, along with any equity securities, are
classified as available-for-sale. Available-for-sale securities are carried at
fair value, with the unrealized gains and losses, net of tax, reported as a
component of accumulated other comprehensive income in shareholders' equity.
Cost of securities sold is determined on a specific identification basis.

         CONCENTRATIONS OF CREDIT RISK - Financial instruments that potentially
subject the Company to concentrations of credit risk consist principally of cash
and cash equivalents, short-term investments and marketable securities and
accounts receivable. The Company's cash and investment policies limit
investments to short-term, investment grade instruments. Concentrations of
credit risk with respect to accounts receivable are limited due to the large
number of geographic dispersion and customers comprising the Company's customer
base.

         PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is
recorded at cost less accumulated depreciation, which is provided on the
straight-line method over the estimated useful lives of the assets. Cost
includes major expenditures for improvements and replacements which extend
useful lives or increase capacity of the asset and interest costs associated
with significant capital additions. Expenditures for maintenance and repairs are
expensed as incurred. Leasehold improvements include costs associated with
telecommunications equipment installations and building improvements. In 1998,
the Company capitalized interest of approximately $0.8 million. No interest was
capitalized in 1997 or 1996.

         The Company finances most of its data communications equipment and
other fixed assets under capital lease agreements. The assets and liabilities
under capital leases are recorded at the lesser of the present value of
aggregate future minimum lease payments, including estimated bargain purchase
options, or the fair value of the assets under lease. Assets under these capital
leases are depreciated over their estimated useful lives of three to five years,
which are generally longer than the terms of the leases.

         Costs for internal use software that are incurred in the preliminary
project stage and in the post-implementation/operation stage are expensed as
incurred. Costs incurred during the application development stage are
capitalized and amortized over the estimated useful life of the software.

         Depreciation and amortization periods are as follows:

 TYPE OF ASSET:                   DEPRECIATION OR AMORTIZATION PERIOD:
 Telecommunications bandwidth     Shorter of useful life or
                                  indefeasible right of use
                                  ("IRU")/lease agreement, generally
                                  10-25 years, beginning when bandwidth
                                  is available for use

 Data communications equipment    Three to five years

 Leasehold improvements           Shorter of lease or useful life, generally 
                                  five to seven years
                                  
 Software                         Three to five years
                                  
 Office and other equipment       Three years
                                  
 Building                         50 years

         The carrying value of property, plant and equipment is assessed
annually and/or when factors indicating a possible impairment are present. If an
impairment is present, the assets are reported at the lower of carrying value or
fair value.

         GOODWILL AND OTHER INTANGIBLES - The Company continually reviews
goodwill and other intangibles and other long-lived assets to assess
recoverability based upon undiscounted cash flow analysis. Impairments, if any,
are measured based upon discounted cash flow analyses and are recognized in
operating results in the period in which an impairment in value is determined.
Goodwill is generally amortized over ten years and other intangibles are
amortized over their estimated useful lives of two to ten years.

         ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT -- The fair value of
acquired in-process research and development ("IPR&D") projects acquired in
business combinations is expensed immediately. The amount of purchase price
allocated to IPR&D is determined based on independent appraisals obtained by the
Company using appropriate valuation techniques, including
percentage-of-completion which utilizes the key milestones to estimate the stage
of development of each project at the date of acquisition, estimating cash flows
resulting from the expected revenues generated from such projects, and
discounting the net cash flows back to their present value. The discount 

                                      -61-
<PAGE>
 
rate includes a factor that takes into account the uncertainty surrounding the
successful development of the purchased in-process technology. At the respective
dates of acquisition, the IPR&D projects had not yet reached technological
feasibility and did not have alternative future uses. As discussed in Note 5,
material risks existed with each IPR&D project, however, management expects that
such projects will be completed.

         OTHER ASSETS AND DEFERRED CHARGES - Other assets and deferred charges
principally comprise debt issuance costs and investments in business in which
the Company owns less than a 20% voting equity interest. Debt issuance costs are
amortized using the effective interest method over the terms of the related debt
as additional interest expense. Investments in non-public businesses in which
the Company owns less than a 20% voting equity interest are accounted for using
the cost method. Such investments are periodically evaluated for impairment and
appropriate adjustments are recorded, if necessary.

         INCOME TAXES - The Company accounts for income taxes under the asset
and liability method which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the carrying amounts and tax basis of assets and liabilities. The
Company provides a valuation allowance on net deferred tax assets when it is
more likely than not that such assets will not be realized. In conjunction with
business acquisitions, the Company records acquired deferred tax assets and
liabilities. Future reversals of valuation allowance on acquired deferred tax
assets will first be applied against goodwill and other intangibles before
recognition of a benefit in the consolidated statements of operations.

         STOCK COMPENSATION - The Company accounts for its stock option plans
under APB Opinion No. 25, "Accounting for Stock Issued to Employees." Pro forma
information regarding net income and earnings per share, as calculated under the
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," is
disclosed herein.

         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. At December 31,
1998 and 1997, the cumulative foreign currency translation adjustment was $36.5
million and ($0.6 million), respectively. Transaction gains and losses are
recorded in the consolidated statement of operations.

         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 of
common stock options and warrants and contingently issuable shares of common
stock. Common stock equivalent shares are calculated using the treasury stock
method. All stock options and warrants outstanding 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 years presented.

         FAIR VALUE OF FINANCIAL INSTRUMENTS - For cash and cash equivalents,
short-term investments and marketable securities, the carrying amount represents
or approximates fair value. The Company estimates the fair value of borrowings
by reference to quoted market values or by discounting the future cash flows
using quoted market rates or interest rates at which similar types of borrowing
arrangements with the same maturities could be obtained by the Company.

         SEGMENT REPORTING - The Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information," during 1998. SFAS No.
131 replaces the "industry segment" approach with the "management" approach. The
management approach designates the internal organization that is used by
management for allocating resources and assessing performance as the source of
the Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas, and major customers. The adoption of
SFAS No. 131 did not affect results of operations or financial position. The
Company has provided comparable information for prior years.

         RECLASSIFICATIONS IN FINANCIAL PRESENTATION - Certain prior year
information has been reclassified to conform to the current year presentation.

         RECENT PRONOUNCEMENTS - In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
This Statement establishes accounting and reporting standards for derivative
instruments, including certain 

                                      -62-
<PAGE>
 
derivative instruments embedded in other contracts, and for hedging securities.
Currently, as the Company has no derivative instruments, the adoption of SFAS
No. 133 would have no impact on the Company's financial condition or results of
operations.

NOTE 2 - ACQUISITIONS AND DISPOSITIONS OF CERTAIN BUSINESSES

ACQUISITIONS

         During 1997 and 1998, the Company acquired the following businesses:

<TABLE> 
<CAPTION> 
                                                                                                          OWNERSHIP
     BUSINESS NAME                                  LOCATION                 ACQUISITION DATE              INTEREST
     -------------                                  --------                 ----------------              --------
<S>                                             <C>                       <C>                           <C> 
Serveur Telematique Internet S.A.                   France                   October 1997                    100%
Internet Prolink S.A.                               Switzerland              January 1998                    100%
iSTAR internet inc.                                 Canada                   February and May 1998           100%
Interactive Telephony Limited                       Channel Islands, Jersey  April 1998                      100%
Interactive Networx GmbH                            Germany                  May 1998                        100%
LinkAge Online Limited                              Hong Kong                June 1998                       100%
ioNET Internetworking Services                      United States            June 1998                       100%
SCII-CalvaPro                                       France                   June 1998                       100%
INTERLOG Internet Services, Inc.                    Canada                   July 1998                       100%
Rimnet Corporation                                  Japan                    August 1998                     100%
TWICS Co., Ltd.                                     Japan                    September 1998                  100%
Hong Kong Internet & Gateway Services               Hong Kong                September 1998                  100%
iNet, Inc.                                          Korea                    September 1998                  100%
Tokyo Internet Corporation                          Japan                    October 1998                    100%
The Unix Group B.V.                                 The Netherlands          October 1998                    100%
AsiaNet  Limited                                    Hong Kong                November 1998                   100%
Spider Net Limited                                  Hong Kong                December 1998                   100%
Huge Net Limited                                    Hong Kong                December 1998                   100%
</TABLE> 

         Each of the acquisitions was accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations of the
acquired companies have been included in the Company's consolidated financial
statements since the acquisition dates. The purchase price of the acquisitions
was allocated to assets acquired, including intangible assets, and liabilities
assumed, based on their respective fair values at the acquisition dates.

         All of the companies acquired are Internet service providers or data
transmission companies, offering a wide range of Internet-protocol based
solutions for businesses and small office/home office and consumer users.
Depending on the particular business activities of the company acquired, revenue
may also be derived from network integration, web hosting, managed co-location,
as well as vertical market Internet services, including comprehensive banking,
medical and telecommunications Internet solutions.

         For certain acquisitions, the Company has retained a portion of the
purchase price under hold-back provisions of the purchase agreements to secure
performance by certain sellers of indemnification or other contractual
obligations. These acquisition hold-back liabilities are generally payable up to
24 months after the date of closing of the respective acquisitions. Acquisition
hold-back liabilities totaling $37.0 million are included in other noncurrent
liabilities and $1.2 million are included in other accounts payable and accrued
liabilities at December 31, 1998.

         The purchase price relating to one acquisition may be increased by up
to $8.0 million pursuant to an earnout provision in the event the acquired
company achieved certain levels of future operating results. Such amount will be
recorded as additional cost of the acquired company when the amount to be paid,
if any, becomes probable. At December 31, 1998, no amount has been accrued since
the final outcome of the earnout provision was not determinable.

         In connection with these acquisitions, the Company recorded $14.2
million in other accounts payable and accrued liabilities in accordance with
planned terminations of certain contracts of acquired companies. Such

                                      -63-
<PAGE>
 
terminations are expected to occur within one year of acquisition date. Through
December 31, 1998, $1.4 million had been incurred and charged against the
liability.

         In connection with the acquisition of these companies, liabilities
assumed were as follows (in thousands of U.S. dollars):

<TABLE> 
<CAPTION> 
                                                                      CASH PAID
                                          FAIR VALUE OF                FOR THE                 LIABILITIES
   BUSINESS NAME                         ASSETS ACQUIRED            CAPITAL STOCK                  ASSUMED
   -------------                         ---------------            -------------                  -------
<S>                                     <C>                       <C>                         <C> 
Tokyo Internet                              $159,877                   $(140,457)                $  19,420
ISTAR                                         49,047                     (19,490)                   29,557
Rimnet                                        41,318                     (31,946)                    9,372
IoNET                                         26,704                     (22,215)                    4,489
LinkAge                                       18,053                     (11,800)                    6,253
INX                                           11,823                      (9,469)                    2,354
Other acquisitions                            83,338                     (54,747)                   28,591
                                              ------                     --------                   ------
                                           $ 390,160                  $ (290,124)                $ 100,036
                                             =======                    =========                  =======
</TABLE> 

         The following represents the unaudited pro forma results of operations
of the Company for 1998 and 1997 as if the acquisitions were consummated on
January 1, 1997. 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 occurred at January 1, 1997 or the
results which may occur in the future.

<TABLE> 
<CAPTION> 
                                                                                    YEAR ENDED
                                                                                    ----------
                                                                   DECEMBER 31, 1998       DECEMBER 31, 1997
                                                                   -----------------       -----------------
                                                           (IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S>                                                             <C>                       <C> 
Revenue                                                                 $ 325,252                  $ 254,654 
Net loss available to common shareholders                               $(296,140)                 $(121,216)
Basic and diluted loss per share                                        $   (5.95)                 $   (3.01)
</TABLE> 

DISPOSITIONS

         In 1997, the Company sold all of the issued and outstanding capital
stock of its software subsidiary in exchange for an aggregate of $20.5 million
in cash and recognized a gain of $5.7 million.

         In 1996, the Company transferred substantially all of its individual
subscriber accounts and related assets and rights in connection with its
consumer dial-up internet access services in the U.S. to a third party in
exchange for $12.9 million in cash and a note receivable. In addition, the
Company signed an agreement to provide continued services to the third party's
customers. The Company recognized a gain from this transaction of $5.4 million,
which is included as other income, net, a component of operating loss, because
of the continued relationship with the customers. All amounts receivable under
the note were subsequently collected in accordance with the note's terms.

NOTE 3 - SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES

         At December 31, 1998, short-term investments and marketable securities,
including restricted amounts, consist of $235.1 million of U.S. government
obligations, $112.3 million of commercial paper and $25.0 million of
certificates of deposit. The cost of all such investments approximates fair
value. The unrealized holding gain was $0.2 million and zero at December 31,
1998 and 1997, respectively.

                                      -64-
<PAGE>
 
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

<TABLE> 
<CAPTION> 
                                                                                  DECEMBER 31,
                                                                                  ------------
                                                                             1998               1997
                                                                             ----               ----
<S>                                                                     <C>                <C> 
                                                                       (IN THOUSANDS OF U.S. DOLLARS)

     Telecommunications bandwidth                                          $118,162             $ -- 
     Data communications equipment                                          103,467           32,108 
     Leasehold improvements                                                  29,267            9,204 
     Software                                                                17,724            3,920 
     Office and other equipment                                              14,826            4,451 
     Land                                                                     1,992               -- 
     Building                                                                 1,298               --
                                                                              ------       ---------
                                                                            286,736           49,683 
     Less accumulated depreciation and amortization                         (63,059)         (28,217)
                                                                            --------         --------
                                                                            223,677           21,466
                                                                           ---------        --------

     Leased data communications equipment                                   171,935           96,059 
     Leased telecommunications bandwidth                                     30,267               -- 
     Leased office and other equipment                                        3,973            3,521
                                                                              ------        --------
                                                                            206,175           99,580 
     Less accumulated amortization                                          (40,376)         (25,427)
                                                                            --------         --------
                                                                            165,799           74,153
                                                                           ---------        --------

     Property, plant and equipment, net                                    $389,476          $95,619
                                                                            =======           ======
</TABLE> 

         Total depreciation and leasehold amortization expense was $51.4 million
in 1998, $25.1 million in 1997 and $16.6 million in 1996.

NOTE 5 - GOODWILL, OTHER INTANGIBLES AND ACQUIRED IN-PROCESS RESEARCH AND
DEVELOPMENT

         Goodwill and other intangibles consisted of the following:

                                                       DECEMBER 31,
                                       
                                                1998                 1997
                                                ----                 ----
                                             (IN THOUSANDS OF U.S. DOLLARS)
                                       
     Goodwill                                 $230,362             $ 5,671 
     Tradename                                  24,081                  -- 
     Customer relationships                     25,954                  -- 
     Existing technology                         8,834                  -- 
     Workforce                                   3,887                  -- 
     Other                                       4,154               1,061
                                               --------            -------
                                               297,272               6,732 
     Less accumulated amortization             (14,491)             (2,057)
                                               --------             -------

     Goodwill and other intangibles, net       $282,781             $ 4,675
                                               ========             =======


         Total amortization expense was $11.4 million in 1998, $2.7 million in
1997 and $11.1 million in 1996.

                                      -65-
<PAGE>
 
         In connection with the acquisitions described in Note 2, the Company
recorded $70.8 million of charges in 1998 for acquired in-process research and
development. A summary of the allocated values by technology/project for
companies acquired in 1998 is as follows (in thousands of U.S. dollars):

<TABLE> 
<CAPTION> 

  ACQUIRED                                          COST TO    EXPECTED COMPLETION AT 
  COMPANY    R&D TECHNOLOGY/PROJECT       VALUE    COMPLETE    DATE OF ACQUISITION           REMAINING TASKS
  -------    ----------------------       -----    --------    -------------------           ---------------
<S>         <C>                         <C>       <C>         <C>                           <C> 
iSTAR         Corporate - DSL/ATM/Fax     $4,270     $1,930    Late   1998  or  early 1999  System verification and testing 
                on Demand/Web Hosting     
              Dial-up - Widespan           2,660      2,200    Late   1998  or  early 1999  System verification and testing
              Icommerce                       70         40    Early  1999                  System verification and testing
                                                             
INX           Access technologies          3,600      1,460    Early 1999                   System verification and testing
                                                             
ioNET         ATM and Internet services    8,500      2,210    Early 1999                   System verification and testing
                                                             
LinkAge       VPN technology               2,900        200    Early 1999                   Network architecture development
              Website tools                2,600      1,325    Early 1999                   Improve system stability
              IP Telephony                 2,400        200    Early 1999                   Transmission quality improvement
                                                             
Interlog      DSL                          2,700        320    Early 1999                   Operations support system
                                                                                              development, resolution of
                                                                                              provisioning issues
              E-commerce                     500         70    Early 1999                   Software development
              Website design                 300         50    Early 1999                   Systems verification and
                                                                                              integration
                                                             
Rimnet        Wireless local loop          2,300        135    Mid 1999                     Network interconnection and     
                                                                                              security issues 
              IP Telephony                 1,500        320    Mid 1999                     Database development, increasing system
                                                                                              scalability
              Universal Messaging            300         70    Early 1999                   Network integration and testing
                                                             
 iNet          Frame Relay                 5,000        125    Mid 1999                    Network management system software
                                                                                             development, network reconfiguration 
              Website hosting                 450        85    1999 Late 1998 or early     Software development and testing 
              E-commerce                      350        70    Early  1999                 Developement of datadase management 
                                                                                             Systems
Tokyo                                                           
Internet     ATM                           16,400       225    Early 1999                  Development of safeguards    
                                                                                            ensuring continued network
                                                                                            reliability under high reaffic loads. 
             Domain Name Service             4,300       75    Mid 1999                    Database testing and systems 
                                                                                            verification. resolution of
                                                                                            scalability issues.
             Network technologies           3,400       60     Mid 1999                    Resolution of issues related to
                                                                                            shared peering facilities,
                                                                                            reliability of content caching sysstems.
             Access technologies            3,200       60     Mid 1999                    Testing of wireless traffic
                                                                                            distribution functionality
             Performance technologies       2,800       70     Mid 1999                    Test service issues. 
             Wholesale                        300       100    Early 1999                  Testing of software verification,
                                                                                            and resolution of scalability
                                                                                            issues.
                                         ----------
Total                                     $70,800
                                         ==========
</TABLE> 

         A description of the key acquired in-process technologies for each of
the acquisitions is set forth below:

ISTAR

         iSTAR is developing four concurrent technology projects relating to
corporate Internet access, including asymmetric digital subscriber line
technology to provide high-speed Internet access, a proprietary implementation
of an Asynchronous Transfer Mode ("ATM") network to provide high-bandwidth
backbone service to customers, a data conversion project to provide fax services
over the Internet and a proprietary website hosting service that will be built
on a Windows NT platform. Additionally, iSTAR is developing a proprietary
service management interface that would allow dial-up customers to seamlessly
select and manage a wide variety of services. iSTAR is also developing several
new electronic commerce applications that will enable content providers to
charge users a nominal fee to access information and facilitate point of
terminal sales.

                                      -66-
<PAGE>
 
INX

         INX is developing proprietary implementations of wireless local loop
and digital subscriber line ("DSL") technologies to provide high-speed Internet
access in metropolitan Germany, which began in January 1997.

IONET

         ioNet is developing two concurrent technology projects, a proprietary
implementation of an ATM network for use by businesses in the Oklahoma region,
and a wholesale ISP system that will enable external service providers to use
ioNet's network, which began in January 1997.

LINKAGE

         LinkAge is developing a proprietary version of a virtual private
network ("VPN") system based around a telecommunications link from Hong Kong to
mainland China. LinkAge began its VPN technology efforts in February 1997.
Additionally, LinkAge is developing a proprietary IP telephony system for use in
overseas communications. LinkAge is also developing proprietary technology that
will enable it to provide website mirroring in multiple countries. The company
began both its IP telephony and its website mirroring efforts in February 1997.

INTERLOG

         Interlog began developing a DSL network with proprietary operations
support systems in July 1996. Additionally, Interlog is designing a proprietary
e-commerce system that will enable small businesses to manage credit-card based
transactions over the Internet, which it began in December 1996. Interlog is
also developing a new web page design system that will enable it to design
low-cost corporate websites capable of supporting its e-commerce technology,
which was initiated in December 1996.

RIMNET

         Rimnet is developing proprietary technology to allow corporate
customers to securely access wireless local loop services in the Tokyo region,
which it began in December 1997. Additionally, Rimnet is developing proprietary
software that will convert a new universal messaging system for
Japanese-language use. This system is being designed to integrate voicemail,
e-mail, and facsimile applications on one platform. Rimnet began this project in
February 1997. Rimnet is also developing a proprietary Internet Protocol ("IP")
telephony system for domestic and international service, which it began in
August 1996.

INET

         iNet is developing and integrating a frame relay network with a
proprietary network management system optimized to lower service costs for
transoceanic data traffic, which it began in August 1996. Additionally, iNet is
creating a new electronic commerce micropayment system that will enable content
providers such as Korean newspapers to charge users a nominal fee to access
information; it initiated this in July 1998. iNet is also developing a
proprietary website hosting platform that will enable it to automate the daily
operations of websites on the system, which it began in March 1998.

TOKYO INTERNET

         Tokyo Internet ("TI") is developing six technologies. In October 1996,
TI began related projects that will enable TI to support high-quality,
value-added services over its network, including IP telephony (a method of
carrying voice traffic over data networks) and IP multicasting (a method of
broadcasting data over the Internet). In July 1997, TI began related
infrastructure projects that involve the development of private peering and
content caching capabilities that will enable the company to improve its
efficiency and service quality, while serving more customers. In September 1997,
TI began developing a proprietary database and registry system to support the
new generic Top Level Domain ("gTLD") standard, which will add other domains
beyond existing ones such as ".com". This effort will enable TI to become an
authorized registrar for the new standard, so that it can offer domain
registration services to companies in Japan and internationally. In October
1997, TI began developing technologies to integrate several new methods of
accessing its network, including wireless local loop, DSL technology, and
third-

                                      -67-
<PAGE>
 
party access to ATM network resources. In March 1998, TI began a project
that will enable the company to use lower-cost ATM services in its backbone
network while maintaining its traditional emphasis on high network redundancy
and reliability and began a project that will enable the company to wholesale
its network capacity to external service providers.

KEY ASSUMPTIONS

         The value of the in-process projects was adjusted to reflect the
relative value and contribution of the acquired research and development. In
doing so, consideration was given to the stage of completion, the complexity of
the work completed to date, the difficulty of completing the remaining
development, costs already incurred, and the projected cost to complete the
projects. The value assigned to purchased in-process technology was based on key
assumptions including:

         .    The estimated revenue associated with the respective business
              enterprise valuations assumed five-year compound annual revenue
              growth rates of between 22% and 45%.
             
         .    Revenue growth rates for each technology were developed
              considering, among other things, the current and expected industry
              trends, acceptance of the technologies and historical growth rates
              for similar industry products.
             
         .    Estimated revenues from the purchased in-process technology
              projects were generally assumed to peak in the year 2003 and
              decline through 2014 or earlier as other new products are expected
              to be introduced. These revenue projections were based on
              management's estimates of market size and growth, expected trends
              in technology and the expected timing of new product
              introductions.
             
         .    The estimated net cash flows were discounted back to their present
              value using a discount rate of between 17.0% and 27.5%, which
              represents a premium to the Company's cost of capital. The
              estimated percentage-of-completion of the various in-process
              research and development projects ranged from 50% to 85% complete.

         The net cash flows from such projects were based on the Company's
estimates of revenues, cost of sales, research and development costs, selling,
general and administrative costs, and income taxes associated with such
projects.

         If none of these projects is successfully developed, the Company's
sales and profitability may be adversely affected in future periods. However,
the failure of any particular individual project in-process would not have a
material impact on the Company's financial condition or its results of
operations. The failure of any particular individual project in-process could
impair the value of other intangible assets acquired.

NOTE 6 - DEBT

         Debt consisted of the following:

<TABLE> 
<CAPTION> 
                                                                                            DECEMBER 31,
                                                                                            ------------
                                                                                       1998             1997
                                                                                       ----             ----
                                                                                   (IN THOUSANDS OF U.S. DOLLARS)
<S>                                                                                <C>               <C> 
      Senior notes at interest rate of 10%                                           $ 600,000        $    -- 
      Senior notes at interest rate of 11.5%                                           350,000             -- 
      Capital lease obligations at interest rates ranging from 2.1% to 17.3%           120,670         56,355 
      Notes payable at interest rates ranging from 1.8% to 12.7%.                       50,981         11,450 
      Lines of Credit                                                                       --          5,648
                                                                                     ---------        --------
                                                                                     1,121,651         73,453 
      Plus unamortized premium                                                           2,950             --
                                                                                     ---------        --------
                                                                                     1,124,601          73,453 
                                                                                     ---------        --------
      Less current portion                                                             (59,968)        (39,633)
                                                                                     ---------        --------
      Long-term portion                                                             $1,064,633        $ 33,820
                                                                                     =========        ========
</TABLE> 

         In April 1998, the Company completed an offering of $600.0 million
aggregate principal amount of 10% Senior Notes due 2005, at par (the "10%
Notes"). In November 1998, the Company completed offerings of

                                      -68-
<PAGE>
 
11 1/2% Senior Notes due 2008 with $200.0 million principal amount at par and
$150.0 million principal amount at 102% of par (the "11 1/2% Notes" and,
collectively with the 10% Notes, the "Notes"). The Notes are senior unsecured
obligations of the Company ranking equivalent in right of payment to all
existing and future unsecured and unsubordinated indebtedness of the Company,
and senior in right of payment to all existing and future subordinated
indebtedness of the Company. Interest is payable on the Notes semi-annually. At
December 31, 1998, the Company has deposited in an escrow account restricted
cash and short-term investments of $122.2 million to fund, when due, the next
four semi-annual interest payments on the 10% Notes. The indentures governing
the Notes contain certain financial and other covenants which, among other
things, will restrict the Company's ability to incur further indebtedness and
sell assets.

         The Company has various financing arrangements accounted for as capital
leases for the acquisition of equipment, telecommunications bandwidth, and other
fixed assets. During 1998, 1997 and 1996, the Company incurred capital lease
obligations under these arrangements of $113.3 million, $37.5 million and $25.6
million, respectively, upon the execution of leases for new data communications
equipment, telecommunications bandwidth and other fixed assets. At December 31,
1998, the aggregate unused portion under these arrangements totaled $12.9
million after designating $27.9 million of payables for various equipment
purchases which will be financed under capital lease facilities. The capital
lease obligations contain provisions which, among other things, require the
maintenance of certain financial ratios and restrict the payment of dividends.

         In September 1998, the Company entered into a new senior secured credit
facility ("Credit Facility"), to replace its then existing bank credit
arrangement in the United States. The Credit Facility has a maximum principal
amount of $110.0 million and amounts drawn are payable in September 2001. There
were no amounts outstanding at December 31, 1998 and $108.8 million was
available to draw. Interest on the Credit Facility is based on a spread over the
London interbank offered rate or the higher of the bank's prime rate or the
Federal funds effective rate, at the Company's option (8.4% at December 31,
1998).

         The Company's obligations under the Credit Facility are guaranteed by
each existing and subsequently acquired or organized significant domestic
subsidiary of the Company and are secured by a lien on substantially all of the
assets of the Company and each subsidiary guarantor and by a pledge by the
Company and each subsidiary guarantor of all capital stock and other equity
interests it owns. 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.

         Future minimum lease payments under capital leases and annual
maturities of other debt are as follows:

<TABLE> 
<CAPTION> 
                                                                         CAPITAL             OTHER
       YEAR ENDING DECEMBER 31,                                           LEASES              DEBT
       ------------------------                                           ------              ----
                                                                       (IN THOUSANDS OF U.S. DOLLARS)
<S>                                                                  <C>                    <C> 
            1999                                                        $ 58,530         $    10,463 
            2000                                                          47,394               7,253 
            2001                                                          27,782               7,078 
            2002                                                           1,830               5,033 
            2003                                                              57               3,401 
            Thereafter                                                     1,644             967,753 
                                                                        ---------         ----------
                                                                         137,237          $1,000,981 
                                                                                           =========
            Less amount representing interest                            (16,567)
                                                                       ----------
            Present value of future minimum lease payments              $120,670 
                                                                       ==========

</TABLE> 

         Cash paid for interest was $33.6 million in 1998, $5.6 million in 1997
and $5.1 million in 1996.

         At December 31, 1998 and 1997, the estimated fair value of the debt
excluding capital lease obligations was approximately $1,009.8 million and $11.4
million, respectively.

                                      -69-
<PAGE>
 
NOTE 7 - CAPITAL STOCK

PREFERRED STOCK RIGHTS PLAN

         In May 1996, the Company's Board of Directors adopted a Shareholder
Rights Plan, as thereafter amended ("Rights Plan"), pursuant to which preferred
stock purchase rights ("Rights") were granted as a dividend to shareholders of
record at the rate of one Right for each outstanding share of common stock held
of record as of the close of business on June 5, 1996. The Rights also attach to
most future issuances of common stock. Subject to exceptions, each Right, when
exercisable, will entitle the holder to buy one one-thousandth of a share of a
Series A Junior Participating Preferred Stock, par value $.01 per share, of the
Company (the "Series A Junior Preferred Stock") at an exercise price of $75 per
Right.

         Subject to exceptions, the Rights will become exercisable upon the
occurrence of specified events, including an announcement that a person or group
of affiliated or associated persons ("Acquiring Person") has acquired beneficial
ownership of 20.5% or more of the outstanding common stock of the Company. In
such event, each holder of a Right (other than Rights beneficially owned by the
Acquiring Person) will thereafter have the right, subject to exceptions, to
receive upon exercise thereof a number of shares of Series A Junior Preferred
Stock or, at the discretion of the Company's Board of Directors, a number of
additional shares of common stock of the Company, or in some circumstances,
shares of common stock of the Acquiring Person (or its parent), as set forth in
the Rights Plan.

         The Company's Board of Directors has designated 1,000,000 shares of
Series A Junior Preferred Stock, which amount may be increased or decreased by
the Board of Directors. All Rights expire on June 5, 2006, unless the Rights are
earlier redeemed or exchanged by the Company in accordance with the Rights Plan
or expire earlier upon the consummation of specified transactions as set forth
in the Rights Plan.

CONVERTIBLE PREFERRED STOCK PRIVATE PLACEMENT

         In November 1997, the Company completed a private placement of 600,000
shares of its Series B 8% Convertible Preferred Stock ("Series B Preferred
Stock") for net proceeds of $29.6 million. The Series B Preferred Stock accrues
dividends at an annual rate of 8%, payable quarterly in cash or, at the
Company's option, in Series B Preferred Stock and is non-voting. The Series B
Preferred Stock is convertible into the Company's common stock at $10 per share
and may be reset, under certain circumstances, to the stock's then current
market value. At the third anniversary date, the conversion price may be reset,
under certain circumstances, to 95% of the stock's then current market value. To
reflect the nature of the conversion rights, preferred stock was reduced at
issuance by $1.5 million with a corresponding increase to capital in excess of
par value. Such amount is being accreted as an additional return to preferred
shareholders over a period of three years. Subsequent to December 31, 1998, all
shares of the Series B Preferred Stock were converted into 3,000,000 shares of
the Company's common stock.

COMMON STOCK ISSUED TO IXC

         In February 1998, the Company closed a transaction with IXC Internet
Services, Inc. ("IXC"), an indirect subsidiary of IXC Communications, Inc., to
acquire 20-year noncancellable IRUs in up to 10,000 equivalent route miles of
fiber-based OC-48 network bandwidth (the "PSINet IRUs") in selected portions
across the IXC fiber optic telecommunications network within the United States.
The PSINet IRUs were acquired in exchange for the issuance to IXC of 10,229,789
shares of common stock of the Company (the "IXC Initial Shares") and a
contingent payment obligation. The contingent payment obligation required the
Company to pay cash or issue additional shares, at its option, to IXC if the
fair market value of the IXC Initial Shares was less than $240 million at a
future date.

         The Company accounted for the transaction in accordance with EITF
96-18, "Accounting for Equity Instruments with Variable Terms That Are Issued
for Consideration Other Than Employee Services under FASB Statement No. 123"
which required the Company to measure the fair value of the common stock and
contingent payment obligation upon issuance. The bandwidth asset to be delivered
under the IXC agreement is recorded as a reduction to shareholders' equity until
such time as the Company accepts the bandwidth from IXC.

         The fair value of the contingent payment obligation of $107.3 million
was measured utilizing a Black-Scholes valuation model using an assumed term of
four years, the closing market price per share of the common stock on the date
of the closing ($7.6875), an exercise price of $23.46 (which is the price per
share required in order 

                                      -70-
<PAGE>
 
for the calculation of the IXC Initial Shares to result in a value equal to
$240.0 million), expected volatility of 76% and an interest rate of 11%.

         In January 1999, the Company's contingent payment obligation to IXC
under the agreement was terminated without the payment of any additional amounts
or issuance of additional shares to IXC when, after the close of trading on The
Nasdaq Stock Market, the fair market value of the shares issued to IXC exceeded
this threshold.

NOTE 8 - STOCK COMPENSATION AND RETIREMENT PLANS

STOCK OPTION AND WARRANT PLANS

         The Company has four stock option plans that provide for granting of
incentive stock options, non-qualified stock options, stock appreciation rights
or restricted stock awards to employees, consultants and directors of the
Company and its subsidiaries, as appropriate. Under all of the plans, the option
exercise price is equal to fair market value at the date of grant. Options
granted under the various plans become exercisable based on a schedule
determined by the Compensation Committee at the date of grant, generally over
four years. The options have terms of seven to ten years from the date of grant.
The Company has also reserved shares for other plans.

         The number of authorized and reserved shares were as follows at
December 31, 1998:

                                            AUTHORIZED      SHARES RESERVED
                                              SHARES         FOR ISSUANCE
                                           ------------     ----------------
         Executive Stock Incentive Plan      10,000,000         9,306,427
         Strategic Stock Incentive Plan       3,500,000         3,422,789
         Executive Stock Option Plan          1,250,000           936,770
         Directors Stock Incentive Plan         100,000           100,000
         Other plans                            541,158           541,158
                                            -----------      ------------
         Total                               15,391,158        14,307,144
                                             ==========      ============


STOCK OPTION REPRICING

         In 1996, the Company's Board of Directors approved a repricing of
certain employee stock options. Accordingly, options with respect to 2,520,555
shares of the Company's common stock whose exercise price was greater than
$9.375, the closing market price of the Company's common stock on that date,
were cancelled and new options with respect to the same number of shares were
granted with an exercise price of $9.375. Other terms and conditions of the
options remained the same.

FAIR VALUE OF STOCK OPTIONS

         For disclosure purposes under SFAS No. 123, the fair value of each
stock option granted is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:

         For disclosure purposes under SFAS No. 123, the fair value of each
stock option granted is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:

                                         1998         1997         1996
                                         ----         ----         ----
         Expected life (in years)        5.0          5.0          5.0
         Risk-free interest rate         5.20%        6.36%        5.98%
         Volatility                      90.0%        76.0%        80.0%
         Dividend yield                  0%           0%           0%


         Utilizing these assumptions, the weighted-average fair value of the
stock options granted in 1998, 1997 and 1996 was $7.10, $4.88 and $4.89,
respectively.

                                      -71-
<PAGE>
 
         Under the above model, the total value of stock options granted was
$46.0 million in 1998, $23.6 million in 1997, and $28.6 million in 1996, which
would be amortized on a pro forma basis over the option vesting period. Had the
Company determined compensation cost for these plans in accordance with SFAS No.
123, the Company's pro forma results would have been as follows (in thousands of
U.S. dollars, except per share amounts):

<TABLE> 
<CAPTION> 
                                                                  YEAR ENDED DECEMBER 31,
                                                                -------------------------
                                                             1998         1997        1996
                                                             ----         ----        ----
<S>                                                        <C>          <C>         <C> 
   Pro forma net loss available to common shareholders       $(279,908)   $(53,113)   $(63,897)
   Pro forma basic and diluted loss per share                $(5.62)      $(1.32)     $(1.62)
</TABLE> 

STOCK OPTION AND WARRANT ACTIVITY

         The following table summarizes stock option and warrant activity under
all plans for the three years ended December 31, 1998:

<TABLE> 
<CAPTION> 
                                                         NUMBER OF SHARES                         WEIGHTED-
                                                          OF COMMON STOCK            PRICE         AVERAGE
                                                      OPTIONS        WARRANTS      PER SHARE   EXERCISE PRICE
                                                     --------      ----------    ------------- --------------
<S>                                             <C>                <C>           <C>          <C> 
       Balance, December 31, 1995      .            3,843,668       2,084,507    $.01 to $25.25     $3.42

           Granted                                  5,853,949             167    4.15 to 16.75      10.81
           Exercised                                 (819,256)     (1,659,000)   .01 to 9.38         2.36
           Forfeited                               (1,319,951)             --    1.60 to 25.25       8.72
           Cancelled                               (2,520,555)             --    9.56 to 25.25      13.61
                                                   -----------    ---------------
       Balance, December 31, 1996                   5,037,855         425,674    .05- to-13.50       6.24

           Granted                                  4,846,300             --     5.38 to 11.25       7.36
           Exercised                                 (288,529)       (201,400)   .05 to 8.13         1.83
           Forfeited                               (1,259,740)            --     2.00 to 13.13       8.33
                                                   -----------    ---------------
       Balance, December 31, 1997                   8,335,886         224,274    .05 to 13.50        6.81

           Granted                                  6,483,804              --    6.00 to 19.13       9.82
           Exercised                               (1,202,069)       (174,274)   .05 to 13.13        4.34
           Forfeited                               (1,171,323)              --   2.00 to 14.94       8.27
                                                   -----------    -------------

       Balance, December 31, 1998                  12,446,298          50,000    $1.60 to $19.13    $8.51
                                                   ===========         ======
                                                                                 

       Exercisable, December 31, 1996               1,584,068         425,674    $.05 to $10.01     $3.60
                                                    ==========        =======
       Exercisable, December 31, 1997               2,824,881         224,274    $.05 to $13.50     $5.76
                                                    ==========        =======
       Exercisable, December 31, 1998               4,161,506          50,000    $1.60 to $19.13    $7.27
                                                    ==========         ======
</TABLE> 

         The following table summarizes information about the outstanding and
exercisable options and warrants at December 31, 1998:

<TABLE> 
<CAPTION> 
                                            OUTSTANDING                                  EXERCISABLE
                         ---------------------------------------------------    -------------------------------
                                             WEIGHTED-                                                           
                                              AVERAGE           WEIGHTED-                                        
                                             REMAINING           AVERAGE                          WEIGHTED-
       RANGE OF                           CONTRACTUAL LIFE      EXERCISE                           AVERAGE
   EXERCISE PRICES          NUMBER            (YEARS)             PRICE           NUMBER        EXERCISE PRICE
  -----------------       ----------      ----------------    -----------      ------------    ---------------- 
<S>                     <C>             <C>                  <C>               <C>             <C> 
    $1.60 to $6.19         2,749,251            6.8              $ 4.81          1,184,631          $ 3.71
     6.25 to 7.63          3,103,259            8.3                7.13          1,119,635            7.08
     7.66 to 9.38          2,989,444            8.0                8.78          1,354,653            8.96
     9.75 to 13.19         2,579,815            9.2               11.10            486,498           10.76
    13.25 to 19.13         1,074,529            9.7               14.95             66,089           14.03
                           ---------                                              --------
    $1.60 to 19.13        12,496,298            8.2              $ 8.51          4,211,506          $ 7.27
                          ==========                                             =========
</TABLE> 

                                      -72-
<PAGE>
 
         The Company sponsors a retirement savings plan, under which
participants are eligible to receive discretionary Company matching
contributions each year of the equivalent of 100% of the first $1,000 of
employee salary deferral and 25% of amounts thereafter up to the maximum
allowable deferral under IRS regulations. All contributions to a participant's
plan account are vested after two years of service with the Company. The total
contributions made by the Company under the Plan totaled $0.9 million, $0.5
million, and $0.6 million in 1998, 1997 and 1996, respectively.

NOTE 9 - INCOME TAXES

The components of loss before income taxes are as follows (in thousands of U.S.
dollars):

<TABLE> 
<CAPTION> 
                                                              YEAR ENDED DECEMBER 31,
                                                              -----------------------
                                                          1998          1997         1996
                                                          ----          ----         ----
<S>                                                  <C>            <C>         <C> 
        U.S. operations                                $(134,639)    $(34,427)    $ (46,047)
        Non-U.S. operations                             (128,078)      (11,651)      (9,209)
                                                       ----------    ---------    ----------
                                                       $(262,717)    $(46,078)    $ (55,256)
                                                       ==========    =========    ==========
</TABLE> 

         The Company recognized deferred tax benefits of $0.8 million, $0.5
million and $0.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively, resulting primarily from deferred tax liabilities of acquired
non-U.S. companies. The Company did not recognize any current income tax expense
or benefit for 1998, 1997 or 1996, and no cash was paid for income taxes in
1998, 1997 or 1996.

         Significant components of the Company's deferred tax assets
(liabilities) consisted of the following (in thousands of U.S. dollars):

<TABLE> 
<CAPTION> 
                                           DECEMBER 31, 1998                         DECEMBER 31, 1997
                                 ---------------------------------------    -------------------------------------
                                      U.S.         NON-U.S.       TOTAL         U.S.        NON-U.S.       TOTAL
                                    -------      -----------    --------      -------      ----------     ------
Gross deferred tax assets:
<S>                             <C>             <C>            <C>          <C>           <C>           <C> 
    Net operating losses             $82,053        $63,197     $145,250      $50,470         $7,834       $58,304 
    Arbitration accrual               20,090            --        20,090          --             --            -- 
    Other                              1,998         14,120       16,118        1,515            --          1,515
                                       ------        -------      -------       ------                       -----
                                     104,141         77,317      181,458       51,985          7,834        59,819 
    Less:  Valuation allowance       (90,307)       (62,485)    (152,792)     (43,245)        (7,834)      (51,079)
                                     --------       --------    ---------     --------        -------      --------
                                      13,834         14,832       28,666        8,740            --          8,740 
                                      ------         ------     --------     --------        --------      --------

Gross deferred tax liabilities:

    Depreciation/amortization        (10,103)            --      (10,103)      (8,740)           --         (8,740)
    Acquired intangibles              (2,493)       (20,834)     (23,327)         --             --            -- 
    Other                             (1,238)          (121)      (1,359)         --             --            --
                                      -------     ----------    ---------   -----------   -----------      --------
                                     (13,834)       (20,955)     (34,789)      (8,740)           --         (8,740)
                                     --------       --------     --------      -------      --------       --------
Net deferred tax liabilities      $      --       $  (6,123)   $  (6,123)   $     --       $     --     $      --
                                    ==========      ==========   ==========   =========      =========    =========
</TABLE> 

         As of December 31, 1998, the Company had net operating loss
carryforwards of approximately $216.7 million for U.S. income tax purposes. The
use of the U.S. net operating loss carryforwards may be subject to limitation
under the rules regarding a change in stock ownership as determined by the
Internal Revenue Code. These net operating loss carryforwards may be carried
forward in varying amounts until 2018. Additionally, at December 31, 1998, the
Company had net operating loss carryforwards for tax purposes in various
jurisdictions outside the U.S. amounting to approximately $158.6 million. The
majority of non-U.S. loss carryforwards will expire in varying amounts in 2003
to 2005. Some of the non-U.S. loss carryforwards will never expire under local
country tax rules. The significant increase in net operating loss carryforwards
for tax purposes in jurisdictions outside the U.S. results mostly from the
acquisition of non-U.S. entities during 1998.

         A capital tax loss of $0.8 million resulting from the sale of one of
the Company's investments was incurred in 1997. The loss may be carried forward
until 2003.

                                      -73-
<PAGE>
 
         The Company has provided a valuation allowance against a portion of its
deferred tax assets since realization of these tax benefits cannot be reasonably
assured. The change in valuation allowance was an increase of $101.7 million and
$18.8 million in 1998 and 1997, respectively. The changes primarily relate to
additional losses in those years. The portion of the valuation allowance for
which subsequently recognized tax benefits will be first applied to reduce
goodwill or other intangibles was $32.4 million at December 31, 1998.

         Taxes computed at the U.S. statutory federal income tax rate of 34% are
reconciled to the provision for income taxes as follows:

<TABLE> 
<CAPTION> 
                                                                     YEAR ENDED DECEMBER 31,
                                                                -------------------------------
                                                                1998          1997          1996
                                                                ----          ----          ----
<S>                                                          <C>           <C>          <C> 
       U.S. federal taxes at statutory rate                     34.0%         34.0%         34.0%
       State taxes (net of federal benefit)                      7.0%          7.0%          7.0%
       Foreign rate differential                                (1.8)%        (1.5)%         --
       Change in valuation allowance                           (38.7)%       (40.7)%       (37.9)%
       Acquired intangibles                                     11.5%          --            --
       Acquired research and development write-off             (11.1)%         --            --
       Amortization of non-deductible goodwill                  (1.5)%        (0.6)%        (5.7)%
       Other                                                     0.9%          2.8%          2.9%
                                                                 ----          ----          ----
       Effective tax rate                                        0.3 %         1.0%          0.3 %
                                                                 =====         ====          =====
</TABLE> 


NOTE 10 - COMMITMENTS AND CONTINGENCIES

COMMITMENTS

         The Company has guaranteed monthly usage levels of data and voice
communications with certain of its telecommunications vendors. In addition, the
Company leases certain of its facilities under non-cancelable operating leases
expiring in various years through 2009. Total rent expense for all operating
leases amounted to $12.5 million in 1998, $5.0 million in 1997, and $3.6 million
in 1996.

         At December 31, 1998, commitments to telecommunications vendors and
future minimum lease payments under non-cancelable operating leases are as
follows:

<TABLE> 
<CAPTION> 
                   YEAR ENDING                                                        
                   -----------
                   DECEMBER 31,             TELECOMMUNICATIONS     OPERATING LEASES
                   ------------             ------------------     ----------------
                                                (IN THOUSANDS OF U.S. DOLLARS)
<S>             <C>                       <C>                     <C> 
                       1999                    $  26,151              $  9,148
                       2000                       18,398                 7,669
                       2001                       15,229                 5,956
                       2002                        8,556                 5,285
                       2003                        4,493                 4,688
                    Thereafter                    22,528                 7,671
                                               ----------             --------
                                                 $95,355              $ 40,417
                                                 =======              ========
</TABLE> 

         The Company also acquires fiber-based telecommunications bandwidth
through purchases of IRUs and capital leases. Some of the purchase agreements
have obligations for future cash payments that coincide with the delivery of
bandwidth. At December 31, 1998, the Company was obligated to make future
payments under these purchase agreements that total $103.7 million, most of
which will be paid in 1999. Under its telecommunications bandwidth agreements,
the Company is also obligated to pay operating and maintenance charges which
vary by agreement in amount.

         In January 1999, the Company entered into a 20-year commercial
relationship with the Baltimore Ravens of the National Football League pursuant
to which it acquired, among other things, the rights to name the Ravens' NFL
stadium "PSINet Stadium" as well as rights for sponsorship and promotion of team
events and related advertising and marketing rights. In addition, the Company
has the right to develop a Baltimore Ravens' web site and provide related
Internet services to subscribing fan members. In exchange for all of these
rights, the Company will make payments to the Baltimore Ravens over a 20-year
period. The Company paid $11.8 million in January 

                                      -74-
<PAGE>
 
1999, which included a one-time prepayment of $9.25 million under the stadium
naming rights agreement. Annual payments for 2000 and for the 18 years
thereafter start at $2.6 million, with successive annual increases of
approximately 5%. Total payments over the 20-year period will be approximately
$93.5 million.

CONTINGENCIES

         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 11 - NON-RECURRING ARBITRATION CHARGE

         On March 23, 1999, an arbitrator awarded Chatterjee Management Company
("Chatterjee") compensatory damages including interest and legal expenses from
the Company. In conjunction with this, the Company has recorded a charge of
$49.0 million relating to this arbitration decision and such accrual is
reflected in other accounts payable and accrued liabilities in the Company's
consolidated balance sheet at December 31, 1998. This award resulted from a
claim by Chatterjee that the Company had breached the terms of a joint venture
agreement executed by the parties in September 1996. Chatterjee had initiated
the arbitration proceedings against the Company in November 1997 before the
International Chamber of Commerce, Court of Arbitration, in London, England.

         On September 19, 1996, the Company and Chatterjee signed an agreement
pursuant to which the Company and an investment group led by Chatterjee would
have established a joint venture for the purpose of building an Internet network
across Europe and providing Internet-related services in Europe. Such investment
group was to invest up to $41 million in a joint venture. No monies were
invested by Chatterjee or the investment group pursuant to the joint venture
agreement nor were any other actions undertaken to implement it. Following the
signing of the agreement, the parties acknowledged structural difficulties
associated with the joint venture as originally contemplated, which prevented
its implementation. Instead, they sought for several months to negotiate a
direct investment in the Company by Chatterjee in lieu of the initial agreement.
Those negotiations were not successful.

         In the arbitration proceedings, Chatterjee alleged that the Company
breached the joint venture agreement by repudiating its obligations under the
agreement and by breaching a covenant not to compete. Chatterjee requested an
arbitration award declaring that the agreement was still valid and binding upon
the parties and that the Company stood in breach of the agreement, directing the
Company to specifically perform its obligations under the agreement or, in the
alternative, awarding Chatterjee compensatory damages in an amount not less than
$25 million, awarding Chatterjee profits that the Company had earned or stood to
earn in Europe, and awarding Chatterjee the costs of arbitration, including
attorney's fees and interest on the award of damages.

         The Company is evaluating its options and intends to vigorously pursue 
appropriate legal steps to seek to modify the arbitrator's order. However, due
to the nature of arbitration proceedings, the Company's ability to obtain relief
in this matter is likely to be constrained.

NOTE 12 - INDUSTRY SEGMENT AND GEOGRAPHIC REPORTING

         SFAS No. 131 establishes standards for reporting information about
operating segments in annual financial statements and requires selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Operating segments
are defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance.

         The Company offers a broad range of Internet access services and
related products to businesses in the U.S. and throughout the world. As of
December 31, 1998, the Company served primary markets in 12 countries, with
operations organized into four geographic operating segments - the U.S., Canada,
Europe and Asia. In measuring performance and allocating assets, the chief
operating decision maker reviews each geographic operating segment as a whole
and not by types of services provided.

                                      -75-
<PAGE>
 
         Each of these geographic operating segments is considered a reportable
segment, and the accounting policies of the operating segments are the same as
those described in Note 1. The Company evaluates the performance of its segments
and allocates resources to them based on revenue and EBITDA. The Company defines
EBITDA 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 U.S. 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 lease and seller-financed
arrangements.

         Revenue by reportable segment is provided on the basis of where
services are provided. The Company has no single customer representing greater
than 10% of its revenues.

         Certain financial information is presented below; amounts are in
thousands of U.S. dollars:

<TABLE> 
<CAPTION> 
                           U.S.         CANADA        EUROPE        ASIA       ELIMINATIONS     TOTAL
                         --------       ------        ------        ----       ------------     -----

1998
----
<S>                    <C>            <C>          <C>           <C>          <C>              <C> 
Revenue                    $156,431      $ 27,440     $ 40,037    $36,111         $   (383)    $259,636 
                                                                   
EBITDA                      (26,170)       (7,668)      (6,364)    (1,848)             --       (42,050)
Assets                    1,261,629        54,028       84,192    284,349         (399,967)   1,284,231
Capital expenditures        248,295        14,899       17,687     22,790             (121)     303,550 

1997
----
Revenue                     104,254         2,844       10,917      4,189             (302)     121,902 
EBITDA                      (13,091)       (4,097)      (3,556)      (515)              20      (21,239)  
                                           
Assets                      196,053        10,617       14,608      2,938          (38,035)     186,181 
Capital expenditures         47,389         1,523          473        689             --         50,074 

1996
----
Revenue                      78,132           308        5,097      1,375             (561)      84,351 
EBITDA                      (20,378)       (3,180)      (2,819)    (1,484)            (185)     (28,046)
Assets                      199,959         2,109        4,640        991          (30,587)     177,112 
Capital expenditures         35,560           438        2,130        262             --         38,390 
</TABLE> 

         EBITDA for all reportable segments differs from consolidated loss
before income taxes reported in the consolidated statements of operations as
follows (in thousands of U.S. dollars):

<TABLE> 
<CAPTION> 
                                                           YEAR ENDED DECEMBER 31,
                                                           ----------------------
                                                       1998          1997          1996
                                                       ----          ----          ----
<S>                                             <C>              <C>           <C> 
         EBITDA                                     $   (42,050)  $   (21,239)  $   (28,046)
         Reconciling items:
           Depreciation and amortization                (63,424)      (28,347)      (28,035)
           Charge for acquired IPR&D                    (70,800)          -             -
           Interest expense                             (63,914)      (5,362)        (5,025)
           Interest income                               19,638        3,059          3,794 
           Other income, net                              6,833        5,811          2,056 
           Non-recurring arbitration charge             (49,000)           -              -
         Loss before income taxes                   $  (262,717)   $ (46,078)   $   (55,256)
                                                      =========       ========      ========
</TABLE> 

                                      -76-

<PAGE>
 
                 SCHEDULE II - VALUATION ACCOUNTS AND RESERVES

<TABLE> 
<CAPTION> 
                                                                                Additions
                                                                    -----------------------------------
                                                     Balance at       Charged to        Balances of                     Balance at
                                                      beginning        costs and          acquired                        end of
                                                      of period        expenses         subsidiaries      Deductions      period
                                                     ------------   ----------------  -----------------  -------------  ------------
                                                                                      (In thousands)
<S>                                               <C>              <C>               <C>                <C>             <C> 
Year ended December 31, 1996

     Allowance for doubtful accounts and returns           875             3,130                 -            (2,096)      1,909
     Deferred tax valuation allowance                   11,375            20,948                 -                 -      32,323

Year ended December 31, 1997

     Allowance for doubtful accounts and returns         1,909             5,426                16            (5,248)      2,101
     Deferred tax valuation allowance                   32,323            18,756                 -                 -      51,079

Year ended December 31, 1998

     Allowances for doubtful accounts and returns        2,101             5,505             6,889            (2,796)     11,700
     Deferred tax valuation allowance                   51,079            69,335            32,378                 -     152,792

</TABLE> 

                                      -77-
<PAGE>
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
         
         Not applicable.

                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information required by Item 10 is incorporated by reference to our
Proxy Statement to be used in connection with our 1999 Annual Meeting of
Shareholders and to be filed with the Securities and Exchange Commission (the
"Commission") on or prior to April 30, 1999.

ITEM 11.  EXECUTIVE COMPENSATION

         The information required by Item 11 is incorporated by reference to our
Proxy Statement to be used in connection with our 1999 Annual Meeting of
Shareholders and to be filed with the Commission on or prior to April 30, 1999.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by Item 12 is incorporated by reference to our
Proxy Statement to be used in connection with our 1999 Annual Meeting of
Shareholders and to be filed with the Commission on or prior to April 30, 1999.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by Item 13 is incorporated by reference to our
Proxy Statement to be used in connection with our 1999 Annual Meeting of
Shareholders and to be filed with the Commission on or prior to April 30, 1999.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

a.       Documents filed as a part of this report.

         1.       FINANCIAL STATEMENTS

         See Index to Financial Statements on page 54.

         2.       FINANCIAL STATEMENT SCHEDULES

         See Index to Financial Statements on page 54.

         3.       EXHIBITS

         See Index to Exhibits on page 81.

b.       Reports on Form 8-K.

         On October 16, 1998, we filed a Current Report on Form 8-K relating to
the closing of a new $110.0 million senior secured credit facility to replace
our existing bank credit arrangements in the United States and our acquisition
of Tokyo Internet Corporation.

                                      -78-
<PAGE>
 
         On October 28, 1998, we filed a Current Report on Form 8-K which
included as an Exhibit a press release issued by us announcing that we would be
pursuing a placement of debt securities in accordance with Securities and
Exchange Commission Rule 144A.

         On November 10, 1998, we filed a Current Report on Form 8-K relating to
the closing of our offering of $200,000,000 principal aggregate amount of our 
11 1/2% Senior Notes due 2008.

                                      -79-
<PAGE>
 
                                  SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Dated:  March 26, 1999

                                        PSINET INC.

                                        By:  /s/ William L. Schrader
                                            -----------------------------
                                            William L. Schrader, Chairman and
                                            Chief Executive Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE> 
<CAPTION> 
                    Name                                      Title                               Date
                    ----                                      -----                               ----
<S>                                           <C>                                          <C> 

         /s/  William L. Schrader               Chairman, Chief Executive Officer                                    
        --------------------------              and Director (Principal Executive            March 26, 1999
            William L. Schrader                         Officer)

        /s/  Harold S. Wills                   President, Chief Operating Officer            March 26, 1999
     ---------------------------------                  and Director
              Harold S. Wills                             

         /s/  David N. Kunkel                   Executive Vice President, General            March 26, 1999
      -------------------------------                   Counsel and Director
              David N. Kunkel                         

         /s/  Edward D. Postal                   Senior Vice President and Chief                                     
      --------------------------------             Financial Officer (Principal              March 26, 1999
              Edward D. Postal                       Financial Officer)

        /s/  Michael J. Malesardi                 Vice President and Controller              March 26, 1999
     ---------------------------------            (Principal Accounting Officer)
            Michael J. Malesardi                 


         /s/  William H. Baumer                             Director                         March 26, 1999
      -------------------------------
             William H. Baumer

        /s/  Ian P. Sharp                                   Director                         March 26, 1999   
     ----------------------------------
                Ian P. Sharp                                


        /s/  Ralph J. Swett                                 Director                         March 26, 1999
     ----------------------------------
               Ralph J. Swett
</TABLE> 

                                      -80-
<PAGE>
 
                                 EXHIBIT INDEX

<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
      2.1        IRU and Stock Purchase Agreement dated as of          Incorporated by reference from Exhibit 2.1 to
                 July 22, 1997 between IXC Internet Services, Inc.     Amendment No. 2 to PSINet's Quarterly Report
                 and PSINet                                            on Form 10-Q for the quarter ended June 30,
                                                                       1996 located under Securities and Exchange
                                                                       Commission File No. 0-25812 ("June 1997
                                                                       10-Q/A2") 

      2.2        First Amendment to IRU and Stock Purchase             Incorporated by reference from Exhibit A to              
                 Agreement dated as of July 22, 1997 between           PSINet's Proxy Statement on Schedule 14A dated 
                 IXC Internet Services, Inc. and PSINet                December 19, 1997 located under Securities and 
                                                                       Exchange Commission File No. 0-25812 ("December
                                                                       1997 Proxy Statement")

      2.3        Second Amendment to IRU and Stock Purchase            Incorporated by reference from Exhibit A to 
                 Agreement dated as of July 22, 1997 between IXC       the December 1997 Proxy Statement 
                 Internet Services, Inc. and PSINet

      2.4        Agreement dated as of November 10, 1997 between       Incorporated by reference from Exhibit 2 to        
                 iSTAR internet inc. and PSINet                        PSINet's Quarterly Report on Form 10-Q for the    
                                                                       quarter ended September 30, 1997 located under    
                                                                       Securities and Exchange Commission File No.       
                                                                       0-25812 ("September 1997 10-Q")                    

      2.5        Pre-Acquisition Agreement between PSINet and iSTAR    Incorporated by reference from Exhibit 10.1 to 
                 internet inc., dated December 23, 1997                PSINet's Current Report on Form 8-K dated
                                                                       January 7, 1998 located under Securities and
                                                                       Exchange Commission File No. 0-25812 ("January
                                                                       7, 1998 8-K")

      2.6        Share Purchase Agreement dated as of October 1,       Incorporated by reference from Exhibit 2.1 to
                 1998 among PSINet Japan Inc., a subsidiary of         PSINet's Current Report on Form 8-K dated
                 PSINet, Tokyo Internet Corporation and Secom Co.,     October 16, 1998 located under Securities and
                 Ltd.                                                  Exchange Commission File No. 0-25812
                                                                       ("October 16, 1998 8-K")

      3.1        Certificate of Incorporation, as amended              Incorporated by reference from Exhibit 3.1 to
                                                                       PSINet's Registration Statement on Form S-1
                                                                       declared effective on May 1, 1995 located
                                                                       under Securities and Exchange Commission File
                                                                       No. 33-90154 ("May 1995 Registration
                                                                       Statement")

      3.2        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3.1 to
                 Incorporation dated April 25, 1995                    PSINet's Quarterly Report on Form 10-Q for the
                                                                       quarter ended June 30, 1995 located under
                                                                       Securities and Exchange Commission File No.
                                                                       0-25812 ("June 1995 10-Q")
</TABLE> 

                                      -81-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 

      3.3        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3.2 to
                 Incorporation Dated May 5, 1995                       the June 1995 10-Q

      3.4        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3.1 to
                 Incorporation Dated November 11, 1995                 PSINet's Quarterly Report on Form 10-Q for the
                                                                       quarter ended September 30, 1995 located under
                                                                       Securities and Exchange Commission File No.
                                                                       0-25812 ("September 1995 10-Q")

      3.5        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3 to
                 Incorporation, dated May 18, 1996                     PSINet's Quarterly Report on Form 10-Q for the
                                                                       quarter ended June 30, 1996 located under
                                                                       Securities and Exchange Commission File No.
                                                                       0-25812 ("June 1996 10-Q")

      3.6        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3.1 to
                 Incorporation dated as of November 6, 1997            the September 1997 10-Q

      3.7        Certificate of Amendment of Certificate of            Incorporated by reference from Exhibit 3.7 to
                 Incorporation dated February 5, 1998                  PSINet's Annual Report on Form 10-K for the
                                                                       fiscal year ended December 31, 1997 located under 
                                                                       Securities and Exchange Commission File No. 0-25812 
                                                                       ("1997 Form 10-K")

      3.8        Amended and Restated By-laws of PSINet                Filed herewith


      4.1        Form of Common Stock Certificate                      Incorporated by reference from Exhibit 4.1 to
                                                                       the May 1995 Registration Statement

      4.2        Form of Common Stock Certificate (name change)        Incorporated by reference from Exhibit 4.1A to
                                                                       PSINet's Registration Statement on Form S-1
                                                                       declared effective on December 14, 1995
                                                                       located under Securities and Exchange
                                                                       Commission File No. 33-99610 ("December 1995
                                                                       Registration Statement")

      4.3        Articles Fourth, Fifth, Sixth, Ninth and Tenth of     See Exhibits 3.2, 3.3, 3.4, 3.5, 3.6 and 3.7
                 the Certificate of Incorporation of PSINet, as
                 amended

      4.4        Article I of the Amended and Restated By-laws of      See Exhibit 3.8
                 PSINet, as amended

      4.5        Forms of Rights Agreement, dated as of May 8, 1996,   Incorporated by reference from Exhibit 1 to 
                 between PSINet and First Chicago Trust Company of     PSINet's Registration Statement on Form 8-A 
                 New York, as Rights Agent, which includes as          dated June 3, 1996 located under Securities 
                 Exhibit A - Certificate of Amendment; Exhibit B -     and Exchange Commission File No. 0-25812 
                 Form of Rights Certificate; and Exhibit C - Summary 
                 of Rights to Purchase Shares of Preferred Stock
</TABLE> 

                                      -82-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
      4.6        Amendment No. 1, dated as of July 21, 1997, to        Incorporated by reference from Exhibit 4.1.1
                 Rights Agreement, dated as of May 8, 1996, between    to PSINet's Current Report on Form 8-K dated
                 PSINet and First Chicago Trust Company of New York,   August 1, 1997 located under Securities and
                 as Rights Agent.                                      Exchange Commission File No. 0-25812

      4.7        Amendment No. 2, dated as of July 31, 1997, to        Incorporated by reference from Exhibit 4.1.2
                 Rights Agreement, dated as of May 8, 1996, between    to PSINet's Current Report on Form 8-K dated
                 PSINet and First Chicago Trust Company of New York,   August 20, 1997 located under Securities and
                 as Rights Agent.                                      Exchange Commission File No. 0-25812

      4.8        Form of 10% Senior Notes due 2005, Series B           Incorporated by reference from Exhibit 4.1 to
                                                                       PSINet's Current Report on Form 8-K dated
                                                                       April 22, 1998 located under Securities and
                                                                       Exchange Commission File No. 0-25812 ("April
                                                                       22, 1998 8-K")

      4.9        Indenture dated as of April 13, 1998 between PSINet   Incorporated by reference from Exhibit 4.2 to
                 and Wilmington Trust Company, as Trustee              the April 22, 1998 8-K

     4.10        Form of 11 1/2% Senior Notes due 2008, Series A       Incorporated by reference from Exhibit 4.2 to
                                                                       PSINet's Current Report on Form 8-K dated
                                                                       November 3, 1998 located under Securities and
                                                                       Exchange Commission File No. 0-25812
                                                                       ("November 10, 1998 8-K")

     4.11        Indenture dated as of November 3, 1998 between        Incorporated by reference from Exhibit 4.1 to
                 PSINet and Wilmington Trust Company, as Trustee       the November 10, 1998 8-K

     4.12        First Supplemental Indenture dated as of November     Incorporated by reference from Exhibit 4.1 to 
                 12, 1998 between PSINet and Wilmington Trust          PSINet's Quarterly Report on Form 10-Q for the
                 Company, as Trustee                                   quarter ended September 30, 1998 located
                                                                       under Securities and Exchange Commission File No.
                                                                       0-25812 ("September 1998 10-Q")

     4.13        Form of 11 1/2%  Senior Notes due 2008, Series A, as  Incorporated by reference from Exhibit 4.2 to
                 amended                                               the September 1998 10-Q

     4.14        Form of 11 1/2% Senior Notes due 2008, Series B       Incorporated by reference from PSINet's
                                                                       Registration Statement on Form S-4 declared
                                                                       effective on February 16, 1999 located under
                                                                       Securities and Exchange Commission File
                                                                       No. 333-68385

     10.1        Lease Agreement dated July 1, 1990 between PSINet     Incorporated by reference from Exhibit 10.1 to
                 and Rensselaer Polytechnic Institute, amended by      the May 1995 Registration Statement
                 Lease Renewal Agreement dated as of July 1, 1993,
                 Letter Agreement dated November 14, 1994 and Letter
                 Agreement dated February 1, 1995

     10.2        Lease Agreement dated February 8, 1995 between        Incorporated by reference from Exhibit 10.2 to
                 PSINet and Rensselaer Polytechnic Institute           the May 1995 Registration Statement
</TABLE> 

                                      -83-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.3        Amendment to Lease Agreement dated July 1, 1995       Incorporated by reference from Exhibit 10.2A 
                 between PSINet and Rensselaer Polytechnic Institute   to the December 1995 Registration Statement

     10.4        Lease Agreement dated as of April 30, 1993 by and     Incorporated by reference from Exhibit 10.3 to
                 between Vingarden Limited Partnership and PSINet      the May 1995 Registration Statement

     10.5        Lease Agreement dated April 1995 by and between       Incorporated by reference from by Exhibit 
                 Brit Limited Partnership and PSINet                   10.3A to the December 1995 Registration
                                                                       Statement

     10.6        Sublease dated September 20, 1995 by and between      Incorporated by reference from Exhibit 10.3B 
                 The Medical Sciences Research Institute and PSINet    to the December 1995 Registration Statement 
                 and Lease Agreement dated October 6, 1993 by and
                 between Vingarden Associates Limited Partnership 
                 and The Medical Sciences Research Institute

     10.7        Lease Agreement dated October 31, 1995 between        Incorporated by reference from Exhibit 10.4A 
                 Oakfern Properties Limited and PSINet                 to the December 1995 Registration Statement

     10.8        Amendment to Deed of 460 Spring Park Technology       Incorporated by reference from Exhibit 10.1 to
                 Center dated as of June 12, 1997 between JBG/         the September 1997 Form 10-Q
                 Spring Park Limited Partnership and PSINet

     10.9        Sublease Agreement dated as of June 2, 1997 between   Incorporated by reference from Exhibit 10.2 to
                 Lucas Industries, Inc. and PSINet and Office Lease    the September 1997 10-Q
                 Agreement between 3B Limited Partnership and Lucas
                 Industries Inc. dated as of September 12, 1989

     10.10       Sublease Agreement dated January 22, 1998 between     Incorporated by reference from Exhibit 10.9 to
                 PSINet and Unisys Corporation, as amended             the 1997 Form 10-K

     10.11       Lease Agreement dated February 20, 1998 between       Incorporated by reference from Exhibit 10.11 
                 PSINet and CarrAmerica Realty Corporation             to the 1997 Form 10-K

     10.12       Lease Agreement dated October 1994 between PSINet     Incorporated by reference from Exhibit 10.4 to
                 and Cascade Communications, Inc.                      the May 1995 Registration Statement

     10.13       Master Lease Agreement dated July 19, 1994 between    Incorporated by reference from Exhibit 10.5 to
                 PSINet and Technology Credit Corporation              the May 1995 Registration Statement

     10.14       Lease Agreement dated as of July 9, 1993 between      Incorporated by reference from Exhibit 10.6 to
                 Applied Telecommunications Technologies, Inc. and     the May 1995 Registration Statement
                 PSINet

     10.15       Lease Agreement dated as of February 10, 1994         Incorporated by reference from Exhibit 10.7F
                 between Applied Telecommunications Technologies,      to the December 1995 Registration Statement
                 Inc. and PSINet
</TABLE> 

                                      -84-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.16       Lease Agreement dated as of March 14, 1994 between    Incorporated by reference from Exhibit 10.7G 
                 Applied Telecommunications Technologies, Inc. and     to the December 1995 Registration
                                                                       Statement PSINet

     10.17       Lease Agreement dated as of June 9, 1994 between      Incorporated by reference from Exhibit 10.7H
                 Applied Telecommunications Technologies, Inc. and     to the December 1995 Registration Statement
                 PSINet

     10.18       Lease Agreement dated as of September 21, 1994        Incorporated by reference from Exhibit 10.7 to
                 between Applied Telecommunications Technologies,      the May 1995 Registration Statement
                 Inc. and PSINet

     10.19       Master Equipment Lease Agreement dated as of June     Incorporated by reference from Exhibit 10.1 to
                 23, 1995 between PSINet and Forsythe/McArthur         the September 1995 10-Q
                 Associates, Inc. ("FMA")

     10.20       Master Lease Line Commitment Agreement dated as of    Incorporated by reference from Exhibit 10.2 to
                 June 23, 1995 between PSINet and FMA                  the September 1995 10-Q

     10.21       Amendment Agreement dated as of August 1, 1995        Incorporated by reference from Exhibit 10.8 to 
                 between PSINet and Technology Credit Corporation      the September 1995 10-Q

     10.22       Master Equipment Lease Agreement No.                  Incorporated by reference from Exhibit 10.44A
                 620-0004602-000 dated November 1995 between PSINet    to the December 1995 Registration Statement
                 and Siemens Credit Corporation

     10.23       Amendment to Master Lease Agreement No. 1753 dated    Incorporated by reference from Exhibit 10.77 
                 January 26, 1996 between PSINet and Technology        to PSINet's Annual Report on Form 10-K for the
                 Credit Corporation                                    fiscal year ended December 31, 1995 located
                                                                       under the Securities and Exchange Commission
                                                                       File No. 0-25812 ("1995 Form 10-K")

     10.24       Master Equipment Lease Agreement dated December 15,   Incorporated by reference from Exhibit 10.78
                 1995 between PSINet and Financing for Science         to the 1995 Form 10-K
                 International, Inc.

     10.25       Security Agreement dated as of March 20, 1996         Incorporated by reference from Exhibit 10.79
                 between PSINet and USL Capital Corporation            to the 1995 Form 10-K

     10.26       Master Software/Equipment Lease Agreement dated as    Incorporated by reference from Exhibit 10.4 to 
                 of September 20, 1996 between PSINet and LPI          PSINet's Quarterly Report on Form 10-Q for the
                 Software Funding Group, Inc.                          quarter ended September 30, 1996 located under
                                                                       Securities and Exchange Commission File No.
                                                                       0-25812 ("September 1996 10-Q")

     10.27       Master Lease Agreement dated as of January 27, 1997   Incorporated by reference from Exhibit 10.77
                 between Cascade Communications Corp.                  to PSINet's Annual Report on Form 10-K for the
                 and PSINet                                            fiscal year ended December 31, 1996 located
                                                                       under Securities and Exchange Commission File
                                                                       No. O-25812 ("1996 Form 10-K")
</TABLE> 

                                      -85-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.28       Master Equipment/Software Rental Agreement dated as   Incorporated by reference from Exhibit 10.3 to
                 of September 11, 1997 between PSINet and Earthlink    the September 1997 10-Q
                 Network, Inc. and Change Order Amendment Master
                 Equipment dated as of September 22, 1997

     10.29       Equipment lease dated as of June 30, 1997 between     Incorporated by reference from Exhibit 10.4 to
                 Royal Bank of Canada and PSINet Limited               the September 1997 10-Q

     10.30       Master Lease Agreement dated as                       Incorporated by reference from Exhibit 10.4 to
                 of October 10, 1997 between Cisco Systems Capital     the September 1997 Form 10-Q
                 Corporation and PSINet

     10.31       Master Lease Agreement No. A212 dated as of October   Incorporated by reference from Exhibit 10.31
                 30, 1997 between 3Com Credit Corporation and          to the 1997 Form 10-K
                 PSINet, as amended

     10.32       Master Lease of Personal Property No. 3402, dated     Incorporated by reference from Exhibit 10.32
                 December 12, 1997 between PSINet and Charter          to the 1997 Form 10-K
                 Financial, Inc., as amended

    10.33*       Executive Stock Option Plan of PSINet                 Incorporated by reference from Exhibit 10.10
                                                                       to the May 1995 Registration Statement

    10.34*      Executive Stock Incentive Plan of PSINet,              Incorporated by reference from Exhibit 10.12 to
                as amended                                             the December 1995 Registration Statement

    10.35*      Directors Stock Incentive Plan of PSINet,              Incorporated by reference from Exhibit 10.13 to
                as amended                                             the December 1995 Registration Statement

    10.36*       Strategic Stock Incentive Plan of PSINet              Incorporated by reference from Exhibit 10 to
                                                                       the June 1995 10-Q

    10.37*       InterCon Systems Corporation 1992 Incentive Stock     Incorporated by reference from Exhibit 99.1 to
                 Plan                                                  PSINet's Registration Statement on Form S-8
                                                                       which became effective on October 18, 1995
                                                                       located under Securities  Exchange Commission
                                                                       File No. 33-98316 ("S-8 No. 16")

    10.38*       InterCon Systems Corporation 1994 Stock Option Plan   Incorporated by reference from Exhibit 99.2 to
                                                                       the S-8 No. 16

    10.39*       Software Ventures Corporation 1994 Stock Option Plan  Incorporated by reference from Exhibit 99 to
                                                                       PSINet's Registration Statement on Form S-8
                                                                       which became effective on October 18, 1995
                                                                       located under Securities and Exchange
                                                                       Commission File No. 33-98314

    10.40*       Employment Agreement dated February 9, 1996 between   Incorporated by reference from Exhibit 10.42
                 PSINet and Mary-Ann Carolan                           to the 1995 Form 10-K

    10.41*       Employment Agreement dated February 13, 1996          Incorporated by reference from Exhibit 10.19
                 between PSINet and Mitchell Levinn                    to the 1995 10-K
</TABLE> 

                                      -86-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
    10.42*       Employment Agreement dated                            Incorporated by reference from Exhibit 10.3 to
                 October 9, 1996 between PSINet and Richard R.         the September 1996 10-Q
                 Frizalone

    10.43*       Employment Agreement dated July 1, 1997 between       Incorporated by reference from Exhibit 10.5 to
                 PSINet and Michael Malesardi                          the September 1997 10-Q

    10.44*       Employment Agreement dated August 2, 1997 between     Incorporated by reference from Exhibit 10.6 to
                 PSINet and Anthony Aveta                              the September 1997 10-Q

    10.45*       Employment Agreement dated August 4, 1997 between     Incorporated by reference from Exhibit 10.7 to
                 PSINet and Harry Hobbs                                the September 1997 10-Q

    10.46*       Employment Agreement dated January 8, 1998 between    Incorporated by reference from Exhibit 10.52
                 PSINet and William Cripe                              to the 1997 Form 10-K

    10.47*       Employment Agreement dated January 18, 1998 between   Incorporated by reference from Exhibit 10.53
                 PSINet and Kathleen B. Horne                          to the 1997 Form 10-K

    10.48*       Employment Agreement dated February 16, 1998          Incorporated by reference from Exhibit 10.54
                 between PSINet and John Muleta                        to the 1997 Form 10-K

    10.49*       Employment Agreement dated June 17, 1998 between      Incorporated by reference from Exhibit 10.1 to
                 PSINet and William A. Opet                            PSINet's Quarterly Report on Form 10-Q for the
                                                                       quarter ended June 30, 1998 located under Securities and
                                                                       Exchange Commission File No. 0-25812 ("June 1998 10-Q")

    10.50*       Employment Agreement dated July 2, 1998 between       Incorporated by reference from Exhibit 10.2 to
                 PSINet and Robert D. Leahy                            the June 1998 10-Q


    10.51*       Employment Agreement dated September 1, 1998          Incorporated by reference from Exhibit 10.8 to
                 between PSINet and Chi H. Kwan                        the September 1998 10-Q

    10.52*       Employment Agreement dated September 8, 1998          Incorporated by reference from Exhibit 10.5 to
                 between PSINet and James A. Haid                      the September 1998 10-Q

    10.53*       Employment Agreement dated September 30, 1998         Incorporated by reference from Exhibit 10.3 to
                 between PSINet and Sandy L. Blaisdell                 the September 1998 10-Q

    10.54*       Amendment to Employment Agreement dated October 1,    Incorporated by reference from Exhibit 10.6 to
                 1998 between PSINet and Harry Hobbs                   the September 1998 10-Q

    10.55*       Employment Agreement dated October 12, 1998 between   Incorporated by reference from Exhibit 10.2 to
                 PSINet and Geoffrey E. Axton                          the September 1998 10-Q

    10.56*       Employment Agreement dated October 14, 1998 between   Incorporated by reference from Exhibit 10.4 to
                 PSINet and Edward Arnold Davis                        the September 1998 10-Q

    10.57*       Employment Agreement dated October 16,                Filed herewith
                 1998 between PSINet and Harold S. Wills
</TABLE> 

                                      -87-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
    10.58*       Employment Agreement dated October 16,                Filed herewith
                 1998 between PSINet and Edward D. Postal

    10.59*       Employment Agreement dated October 16,                Filed herewith
                 1998 between PSINet and David N. Kunkel

    10.60*       Employment Agreement dated November 2, 1998 between   Incorporated by reference from Exhibit 10.7 to
                 PSINet and David J. Kramer                            the September 1998 10-Q

    10.61*       Employment Agreement dated November 6, 1998 between   Incorporated by reference from Exhibit 10.9 to
                 PSINet and John Walpuck                               the September 1998 10-Q

    10.62*       Employment Agreement dated November 12, 1998          Incorporated by reference from Exhibit 10.10
                 between PSINet and Lawrence Winkler                   to the September 1998 10-Q

     10.63       Form of Indemnification Agreement                     Incorporated by reference from Exhibit 10.21
                                                                       to the May 1995 Registration Statement

     10.64       Registration Rights Agreement dated as of June 16,    Incorporated by reference from Exhibit 10.39 
                 1995 among PSINet and Stockholders of InterCon        to the December 1995 Registration Statement 
                 Systems Corporation

     10.65       Registration Rights Agreement dated as of July 11,    Incorporated by reference from Exhibit 10.40 
                 1995 among PSINet and Stockholders of Software        to the December 1995 Registration Statement 
                 Ventures Corporation

     10.66       Registration Rights Agreement made as of September    Incorporated by reference from Exhibit  10.1
                 19, 1996 by and between PSINet and The Chatterjee     to the September 1996 10-Q
                 Management Company

     10.67       Registration Rights Agreement dated as of November    Incorporated by reference from Exhibit 10.10
                 11, 1997 between PSINet and the purchasers of         to the September 1997 10-Q
                 Series B 8% Convertible Preferred Stock

     10.68       Registration Rights Agreement dated as of April 13,   Incorporated by reference from Exhibit 10.1 to
                 1998 among PSINet and Donaldson, Lufkin & Jenrette    the April 22, 1998 8-K
                 Securities Corporation, Merrill Lynch, Pierce,
                 Fenner & Smith Incorporated, and Chase Securities,
                 Inc.

     10.69       Registration Rights Agreement, dated as of November   Incorporated by reference from Exhibit 4.3 to
                 13, 1998, among PSINet and Donaldson Lufkin &         the September 1998 10-Q
                 Jenrette Securities Corporation, Chase Securities
                 Inc. and Morgan Stanley & Co. Incorporated

     10.70       Registration Rights Agreement dated as of February    Incorporated by reference from Exhibit 10.62
                 25, 1998 between PSINet and IXC Internet Services,    to the 1997 Form 10-K
                 Inc.
</TABLE> 

                                      -88-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.71       Credit Agreement dated September 29, 1998 among       Incorporated by reference from Exhibit 2.2 to
                 PSINet, the Lenders party thereto, The Chase          PSINet's October 16, 1998 8-K
                 Manhattan Bank, as Administrative Agent, Fleet
                 National Bank, as Syndication Agent, and The Bank
                 of New York as Documentation Agent

     10.72       Guarantee Agreement dated September 29, 1998 among    Incorporated by reference from Exhibit 2.3 to
                 each of the subsidiaries of PSINet party thereto      the October 16, 1998 8-K
                 and The Chase Manhattan Bank

     10.73       Pledge Agreement dated September 29, 1998 among       Incorporated by reference from Exhibit 2.4 to
                 PSINet, each subsidiary of PSINet party thereto and   the October 16, 1998 8-K
                 The Chase Manhattan Bank

     10.74       Security Agreement dated September 29, 1998 among     Incorporated by reference from Exhibit 2.5 to
                 PSINet, each subsidiary of PSINet party thereto and   the October 16, 1998 8-K
                 The Chase Manhattan Bank

     10.75       First Amendment dated as of October 27, 1998 to the   Incorporated by reference from Exhibit 10.2 to
                 Credit Agreement dated as of September 29, 1998,      the November 10, 1998 8-K
                 among PSINet, the Lenders party thereto, The Chase
                 Manhattan Bank, as Administrative Agent, Fleet
                 National Bank, as Syndication Agent, and the Bank
                 of New York, as Documentation Agent

     10.76       Warrant to purchase up to 25,000 shares of the        Incorporated by reference from Exhibit 10.39
                 Series B Preferred of PSINet, at an exercise price    to the May 1995 Registration Statement
                 of $1.60 per share, registered in the name of
                 William H. Baumer

     10.77       Warrant to purchase up to 25,000 shares of the        Incorporated by reference from Exhibit 10.40
                 Series B Preferred of PSINet, at an exercise price    to the May 1995 Registration Statement
                 of $1.60 per share, registered in the name of
                 William H. Baumer

     10.78       Joint Venture Agreement dated as of September 19,     Incorporated by reference from Exhibit 2 to 
                 1996 between PSINet and Chatterjee Management         Amendment No. 1 to PSINet's Quarterly Report 
                 Company                                               on Form 10-Q for the quarter ended
                                                                       September 30, 1996 located Securities and
                                                                       Exchange Commission File No. 0-25812

     10.79       Stock Acquisition Agreement, dated as of February     Incorporated by reference from Exhibit 2 to 
                 1, 1997, between Ascend Communications, Inc. and      PSINet's Current Report on Form 8-K dated 
                 PSINet with respect to all outstanding capital        February 14, 1997 located under Securities and 
                 stock of InterCon Systems Corporation, a Delaware     Exchange Commission File No. 0-25812
                 corporation and a wholly-owned subsidiary of PSINet

     10.80       Asset Purchase Agreement dated as of June 28, 1996    Incorporated by reference from Exhibit 2 to
                 between PSINet and MindSpring Enterprises, Inc.       the June 1996 10-Q
</TABLE> 

                                      -89-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.81       Amendment No. 1 to Asset Purchase Agreement and       Incorporated by reference from Exhibit 2 to
                 Network Services Agreement entered into as of June    the September 1996 10-Q
                 28, 1996 by and between PSINet and MindSpring
                 Enterprises, Inc.

     10.82       Amendment No. 2 to Asset Purchase Agreement entered   Incorporated by reference from Exhibit 10.8 to
                 into as of September 1, 1996 by and between PSINet    the September 1996 10-Q
                 and MindSpring Enterprises, Inc.

     10.83       Amendment No. 3 to Asset Purchase Agreement and       Incorporated by reference from Exhibit 10.74
                 Amendment No. 1 to  Convertible Note entered into     to the 1996 Form 10-K
                 as of January 24, 1997 by and between PSINet and
                 MindSpring Enterprises, Inc.

     10.84       Amendment No. 2 to Network Services Agreement         Incorporated by reference from Exhibit 10.75
                 entered in as of January 1, 1997 by and between       to the 1996 Form 10-K
                 PSINet and MindSpring Enterprises, Inc.

     10.85       IRU and Stock Purchase Agreement dated as of July     Incorporated by reference from Exhibit 2.1 to
                 22, 1997 between IXC Internet Services, Inc. and      the June 1997 10-Q/A2
                 PSINet

     10.86       First Amendment to IRU and Stock Purchase Agreement   Incorporated by reference from Exhibit A to 
                 dated as of July 22, 1997 between IXC Internet        PSINet's December 1997 Proxy Statement 
                 Services, Inc. and PSINet

     10.87       Second Amendment to IRU and Stock Purchase            Incorporated by reference from Exhibit A to 
                 Agreement dated as of July 22, 1997 between IXC       the December 1997 Proxy Statement 
                 Internet Services, Inc. and PSINet

     10.88       Joint Marketing and Services Agreement dated as of    Incorporated by reference from Exhibit 10.1 to 
                 July 22, 1997 between IXC Internet Services, Inc.     Amendment No. 1 to PSINet's Quarterly Report 
                 and PSINet                                            on Form 10-Q for the quarter ended June 30,
                                                                       1996 located under Securities and Exchange
                                                                       Commission File no. 0-25812

     10.89       Stock Purchase Agreement dated as of November 11,     Incorporated by reference from Exhibit 10.9 to
                 1997 between PSINet and the Purchasers of its         the September 1997 10-Q
                 Series B 8% Convertible Preferred Stock

     10.90       Agreement dated as of November 10, 1997 between       Incorporated by reference from Exhibit 2 to
                 iSTAR internet inc. and PSINet                        the September 1997 10-Q

     10.91       Pre-Acquisition Agreement between PSINet and iSTAR    Incorporated by reference from Exhibit 10.1 to
                 internet inc., dated December 23, 1997                the January 7, 1998 8-K

     10.92       Security Agreement and Assignment dated as of         Incorporated by reference from Exhibit 10.95
                 February 25, 1998 between PSINet and IXC Internet     to the 1997 Form 10-K
                 Services, Inc.

     10.93       Collocation and Interconnection Agreement between     Incorporated by reference from Exhibit 10.96
                 PSINet and IXC Internet Services, Inc.                to the 1997 Form 10-K
</TABLE> 

                                      -90-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     10.94       Escrow Agreement, dated as of  April 13, 1998,        Incorporated by reference from Exhibit 10.2 to
                 among Wilmington Trust Company (as escrow agent and   the April 22, 1998 8-K
                 trustee) and PSINet.

     10.95       First Amendment to Sublease dated as of March 23,     Incorporated by reference from Exhibit 10.99 
                 1998 between Unisys Corporation and PSINet            to PSINet's Registration Statement on Form S-4
                                                                       declared effective on May 7, 1998 located
                                                                       under the Securities and Exchange Commission
                                                                       File No. 333-51491 ("May 1998 Registration
                                                                       Statement")

     10.96       Share Purchase Agreement dated as of October 1,       Incorporated by reference from Exhibit 2.1 to
                 1998 among PSINet Japan Inc., a subsidiary of         the October 16, 1998 8-K
                 PSINet, Tokyo Internet Corporation and Secom Co.,
                 Ltd.

     10.97       Registration Rights Agreement dated as of November    Incorporated by reference from Exhibit 10.1 to
                 3, 1998 among PSINet and Donaldson, Lufkin and        the November 10, 1998 8-K
                 Jenrette Securities Corporation, Chase Securities,
                 Inc. and Morgan Stanley & Co. Incorporated

     10.98       Second Amendment dated as of November 9, 1998, to     Incorporated by reference from Exhibit 10.1 to
                 the Credit Agreement, dated as of September 29,       the September 1998 10-Q
                 1998, among PSINet, the Lenders party thereto, the
                 Chase Manhattan Bank, as Administrative Agent,
                 Fleet National Bank, as Syndication Agent, and The
                 Bank of New York, as Documentation Agent

     10.99       Master Lease Agreement between PSINet and             Incorporated by reference from Exhibit 10.11
                 Technology Credit Corporation No. 1788 dated June     to the September 1998 10-Q
                 20, 1998

    10.100       Master Lease Agreement between PSINet and             Incorporated by reference from Exhibit 10.12
                 Technology Credit Corporation No. 1789 dated          to the September 1998 10-Q
                 June 20, 1998

    10.101       Master Loan and Security Agreement No. 3963 between   Incorporated by reference from Exhibit 10.13
                 PSINet and Charter Financial Inc. dated               to the September 1998 10-Q
                 September 28, 1998

    10.102       Interest Escrow Agreement, dated as of April 13,      Incorporated by reference from Exhibit 10.2 to 
                 1998, among PSINet and Wilmington Trust Company, as   PSINet's quarterly Report on Form 10-Q for the 
                 escrow agent, and Wilmington Trust Company, as        quarter ended March 21, 1998 located under 
                 Trustee                                               Securities and Exchange Commission File No. 0-25812

     11.1        Calculation of Basic and Diluted Loss Per Share and   Filed herewith
                 Weighted Average Shares for the Year Ended December
                 31, 1998

     11.2        Calculation of Basic and Diluted Loss Per Share and   Filed herewith
                 Weighted Average Shares for the Year Ended December
                 31, 1997
</TABLE> 

                                      -91-
<PAGE>
 
<TABLE> 
<CAPTION> 
    EXHIBIT                                                                                                            
    NUMBER       DESCRIPTION                                           LOCATION
    ------       -----------                                           --------
<S>             <C>                                                   <C> 
     11.3        Calculation of Basic and Diluted Loss Per Share and   Filed herewith
                 Weighted Average Shares for the Year Ended December
                 31, 1996

      12         Statements re Computation of Ratios                   Filed herewith

      21         Subsidiaries of PSINet                                Filed herewith

      23         Consent of PricewaterhouseCoopers LLP                 Filed herewith

     27**        Financial Data Schedule                               Filed herewith
</TABLE> 

----------------------
  *   Indicates a management contract or compensatory plan or arrangement
      required to be filed as an Exhibit pursuant to Item 14(a)(3).

  **  Not deemed filed for purposes of Section 11 of the Securities Act of 1933,
      Section 18 of the Securities Exchange Act of 1934 and Section 323 of the
      Trust Indenture Act of 1939 or otherwise subject to the liabilities of
      such sections and not deemed part of any registration statement to which
      such exhibit relates.

                                      -92-