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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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COMMISSION FILE NUMBER 0-24219
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VERIO INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 84-1339720
(State or other jurisdiction of (I.R.S. Employer
incorporation and organization) Identification No.)
8005 SOUTH CHESTER STREET, SUITE 200, ENGLEWOOD, COLORADO 80112
(Address of principal executive offices, including zip code)
(303) 645-1900
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PER SHARE
(Title of class)
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. No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing price of the Common Stock on March 26, 1999
as reported on the Nasdaq National Market, was approximately $1,166,208,496.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded from this
computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of March 26, 1999 the Registrant had outstanding 36,928,589 shares of
Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on June 17, 1999 are incorporated by reference into
Part III of this Form 10-K Report, which Proxy Statement is to be filed
within 120 days after the end of the Registrant's fiscal year ended December
31, 1998.
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INDEX
VERIO INC.
PAGE NO.
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PART I
Item 1. BUSINESS.................................................... 1
Item 2. PROPERTIES.................................................. 30
Item 3. LEGAL PROCEEDINGS........................................... 30
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 30
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................... 31
Item 6. SELECTED FINANCIAL DATA..................................... 32
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 34
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK........................................................ 44
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 45
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................... 45
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 46
Item 11. EXECUTIVE COMPENSATION...................................... 46
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................. 46
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 46
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K......................................................... 47
SIGNATURES............................................................ 51
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE............... F-1
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PART I
ITEM 1. BUSINESS.
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K, and specifically in the sections
entitled "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," or otherwise incorporated by reference
into this Annual Report on Form 10-K are "forward-looking statements" (as such
term is defined in the Private Securities Litigation Reform Act of 1995). These
statements can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should," or "anticipates" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. The safe harbor provisions of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended, apply to forward-looking statements
made by the Registrant. These forward-looking statements involve risks and
uncertainties, including those identified within "Factors Affecting Future
Operating Results" beginning on page 17 below and elsewhere in, or incorporated
by reference into, this Annual Report on Form 10-K. The actual results that the
Registrant achieves may differ materially from any forward-looking projections
due to such risks and uncertainties. These forward-looking statements are based
on current expectations, and the Registrant assumes no obligation to update this
information. Readers are urged to carefully review and consider the various
disclosures made by the Registrant in this Annual Report on Form 10-K and in the
Registrant's other reports filed with the Securities and Exchange Commission
(the "Commission") that attempt to advise interested parties of the risks and
factors that may affect the Registrant's business. This Annual Report on Form
10-K for the year ended December 31, 1998 contains trademarks of the Registrant
and its affiliates, and may contain trademarks, trade names and service marks of
other parties. References to "Verio" or the "Registrant" are to Verio Inc. and
its subsidiaries.
OVERVIEW
Verio is a leading provider of comprehensive Internet services with an
emphasis on serving the small and medium sized business market. We provide our
customers with the telecommunications circuits that permit them to make
connections to and transmissions over the Internet. We also host their Web
sites, allowing them to make information concerning their business, operations,
products and services available broadly over the Internet to other Internet
users. Finally, we offer an expanding package of enhanced Internet tools such as
electronic commerce -- enabling our customers to conduct transactions with their
customers and vendors over the Internet -- and virtual private
networks -- permitting our customers to engage in private communications with
their employees, vendors, customers and suppliers, with whom secure Internet
communication capabilities are important.
Since our incorporation in March 1996, Verio has grown very rapidly,
establishing a global presence through the acquisition, integration and organic
growth of over 45 local, regional, national and international providers of
Internet connectivity, Web hosting and other enhanced Internet services.
Currently, Verio provides locally based sales and engineering support for our
Internet services in 41 of the top 50 metropolitan statistical areas in the U.S.
and we provide Web hosting services to customers in over 170 countries. Through
the acquisition of iServer, TABNet and Hiway, Verio has established itself as
the largest Web hosting company in the world based on the number of domain names
(such as yourcompany.com) that we host. As of December 31, 1998, including all
acquisitions we had completed as of that date, Verio served over 160,000
customer accounts, including over 80,000 hosted Web sites, with combined pro
forma revenues for the three-month period ending on that date of approximately
$39.9 million. The acquisition of Hiway, which we completed in January 1999,
increased our total customer accounts to over 260,000, the number of Web sites
hosted to over 180,000, and our combined pro forma revenues for the fourth
quarter of 1998 to approximately $50.4 million, approximately half of which is
derived from Web hosting and other enhanced services. With our large existing
customer base and strong, balanced position in both the Internet access and Web
hosting service platforms, we believe that we will be able to derive increasing
revenue from these customers and facilitate our goal of attaining profitability,
by continuing to offer them higher functionality Web sites, an expanding array
of value-added services, and the additional access bandwidth that is necessary
to support these services.
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We are continuing to integrate the operations we have acquired onto our
national network and common administrative support services in order to capture
economies of scale, derive operational efficiency and control, and improve the
quality, consistency and scalability of our services. Verio supports and manages
its operations with highly reliable and scalable national infrastructure and
systems, including a "Tier One" national network and proprietary Web site
hosting technologies and tools that differentiate our Web hosting services from
other providers. We have developed back-office support services built on high
quality systems for network monitoring and management, billing, customer service
and financial reporting and accounting. The integration of the operations we
have acquired involves:
- Redesigning acquired local networks with overlapping or non-redundant
circuits.
- Connecting those local telecommunication networks to our national
telecommunications network and eliminating unnecessary national network
capacity we acquire.
- Centralizing management functions.
- Standardizing and centralizing back-office functions such as billing and
accounting.
- Converting the brand names of the acquired operations to the Verio brand.
Our significant scale in both Internet access and Web hosting allows us to
provide robust, high-quality, and scalable service platforms which we can
continually expand and enhance in order to provide a complete and evolving range
of business Internet solutions. We intend to further enhance the value of these
platforms by developing, both internally and through strategic vendor
relationships, a further array of value-added, higher margin product and service
offerings to continue to address our ever changing customer demands.
Verio has also established a global sales and marketing engine that is
driven by:
- Direct sales through over 200 sales professionals.
- Over 4,000 resellers in the U.S. and over 170 other countries.
- Preferential marketing agreements with leading Internet on-line
companies.
- Private label and co-branded distribution relationships with major
telecommunications companies.
- In-house and outsourced telemarketing operations.
Recently, we have also undertaken significant marketing efforts to build
Verio's national brand name recognition. We have implemented a national print,
radio and television advertising campaign. Subsequent to December 31, 1998, we
commenced a joint Digital Subscriber Line (or "DSL") marketing effort with
NorthPoint Communications to rollout DSL services in 21 cities nationwide. Most
recently, in March 1999, we entered into a strategic relationship with America
Online ("AOL"), which we expect will substantially expand Verio's brand name
recognition. Under this agreement, for a three-year period, Verio will purchase
advertising promotions from AOL to promote Verio's Web hosting and related
business-focused commerce products and services on AOL's four key U.S. on-line
media properties. Verio's promotional rights with respect to its Web hosting and
designated electronic commerce products and services are exclusive during this
period on these four specified sites. AOL also will transition its approximately
7,000 PrimeHost and CompuServe BusinessWeb hosting customers to Verio, further
expanding our Web hosting customer base.
BACKGROUND OF OUR BUSINESS
Internet access and value-added Internet services, including Web hosting
and electronic commerce services, represent two of the fastest growing segments
of the telecommunications services market. The availability of Internet access,
advancements in technologies required to navigate the Internet, and the
proliferation of content and applications available over the Internet have
attracted a rapidly growing number of Internet users.
In order to capitalize on the power of the Internet, businesses must adopt
one or both of the fundamental Internet service platforms: Internet access and
an Internet Web site. Internet access provides a company with the
telecommunications circuits necessary to allow a company to connect to the
Internet, communicate with
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employees, customers and suppliers and other Internet users, transfer electronic
mail, and access the wealth of information available over the Internet. A Web
site provides a company with a corporate presence on the Internet. This
computer-based site allows a company to post information about itself that is
easily accessible to all Internet users. Businesses are increasingly adding a
variety of enhanced services and applications to their basic Internet access and
Web site platforms, in order to more fully capitalize on the power of the
Internet. These services and applications allow them to more efficiently
communicate company information, expand and enhance their distribution channels,
increase productivity through back-office automation and reduce costs. Verio
expects this trend to continue as high-bandwidth, high functionality value-added
services continue to be developed, improve and proliferate and as Internet usage
continues to expand. For example, once a company has basic Internet access, by
then connecting each of the company's office locations and providing them with
security tools, such as data encryption, the company can implement a virtual
private network -- or "VPN" -- permitting its employees, vendors, customers, and
other designated individuals to engage in secure, private communications over
the Internet. Further, by provisioning its Web site with enhanced application
tools, the company can automate business processes such as sales order entry,
shipping, inventory management and customer service from this site. When
conducting electronic commerce over a Web site, a company typically will add
security, shopping cart, and payment processing capabilities to its basic Web
site.
Industry analysts have reported that small and medium sized businesses
represent a potential market of over seven million customers in the U.S. Verio
has specifically targeted the small and medium sized business market for the
provision of our Internet services because:
- A small percentage of this market currently utilizes the Internet, but
that number is increasing rapidly and is expected to be one of the
fastest growing segments of the Internet industry.
- These businesses have rapidly expanding Internet needs, as they and their
customers look more and more to the Internet for information, as a
standard mode of communication, and to conduct business in increasingly
sophisticated and cost-effective ways.
- These companies often look to an Internet service provider to fulfill
these needs, because they typically lack the technology expertise,
information technology resources, capital, personnel, or ability to bear
the time-to-market and operational risks required to install, maintain
and monitor their own Web servers and Internet access.
- In selecting an Internet service provider, these businesses often prefer
locally based personnel who are readily available to respond in-person to
technical issues, who can assist in developing and implementing the
customer's effective use of the Internet, and with whom they can
establish a stable and long-term relationship.
- Businesses that have outsourced their Internet requirements tend to
become quite dependent on their Internet provider and tend to change
Internet providers relatively infrequently.
The Internet service provider market is segmented into large national or
multinational providers such as Verio, which typically are full service
providers, and regional and local providers which generally offer a smaller
range of services and products and lack the ability to meet all the needs of a
business customer. Full service Internet providers also typically resell
capacity on their network to regional and local providers, who rely on the
larger providers for Internet access. The largest full service providers, like
Verio, have what are referred to as "Tier One" networks, which exchange Internet
traffic cost free at multiple public peering points known as network access
points (NAPs), as well as through private peering arrangements. As the number of
Internet service providers has grown, the requirements to become a Tier One
network have increased, resulting in a higher barrier to achieving this Tier One
provider status.
OUR BUSINESS STRATEGY
Our business strategy of combining national scale with local presence was
specifically developed to serve the needs of the small and medium sized business
market. In formulating its business strategy, Verio concluded that the large,
national Internet service providers lacked the local presence to provide
customized hands-on support, while the smaller, local Internet service providers
did not have the requisite scale and
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resources to provide a full range of services at an acceptable quality and
pricing levels. We believe that Verio has a competitive advantage in serving
these business customers because we have combined the technical expertise and
hands-on support, provided through our local sales and engineering personnel,
with the quality and economic efficiency of our national network, operational
infrastructure and financial strength.
Verio's goal is to be the premier, full-service provider of Internet
services to small and medium sized businesses. The key elements of our strategy
in accomplishing this goal are:
- Build Scale, Market Presence and Service Offerings through Acquisitions
and Strategic Relationships. We have rapidly established a global
presence and expanded our customer base by acquiring established Internet
access and enhanced service providers with a business customer focus. We
intend to continue to expand our market presence, strengthen our Internet
access and Web hosting core service platforms, and add additional
value-added service capabilities, both through further acquisitions and
strategic relationships with key product and service partners. Given our
large customer base, broad distribution channels and established core
service strengths in Internet access and Web hosting, we believe that
Verio is an attractive potential acquirer or strategic partner for other
related value-added product and service companies.
- Integrate Operations and Leverage National Infrastructure to Reduce Costs
and Improve Quality. We continue to improve our efficiency, service
reliability, quality and scalability by: (1) integrating the Internet
operations we acquire onto core national service platforms for Internet
access and Web hosting; (2) focusing regional operations on sales,
distribution and customer support; and (3) leveraging a common set of
national systems and support services. We integrate the local networks we
acquire and connect them to Verio's Tier One national backbone, provide
them with network management and monitoring services from our network
operations center, consolidate point of presence (POP) facilities,
aggregate traffic on higher capacity, lower cost telecommunication
circuits, consolidate engineering and network operations staffs, increase
network redundancy and ensure consistency of network operations.
Similarly, we integrate our Web hosting operations onto common national
platforms with regional data centers connected to Verio's Tier One
national backbone and monitored by Verio's NOC. Through this integration,
we capture economies of scale, drive operational efficiency, ensure
operational control and improve the quality, consistency and scalability
of our services. We have leveraged our scale to negotiate advantageous
national volume purchasing agreements with key vendors such as Cisco,
Qwest and Raptor.
- Build Brand Recognition, Expand Distribution Channels and Leverage Local
Support to Drive Growth. We believe that brand recognition will be an
increasingly important decision factor among small and medium sized
businesses in choosing an Internet service provider. In conjunction with
the integration of our acquired providers, we have re-branded our
consolidated regional operations under the Verio name. We are building
national Verio brand recognition by aggressively marketing our full range
of services through a national advertising campaign using traditional
media, online campaigns and trade shows, strategic co-marketing
relationships, and a coordinated public relations program. Most recently,
in March 1999, we entered into a strategic relationship with AOL, which
we expect will substantially expand Verio's national brand name
recognition. Under this agreement, for a three-year period, Verio has
acquired exclusive rights to market its Web hosting and business-focused
electronic commerce services on AOL's four key on-line media properties
in the U.S.
We currently have over 200 local direct sales executives, over 300 local
engineers and customer support technicians, and over 4,000 resellers and
referral partners. We expect to continue to expand this sales and
distribution force and to increase its effectiveness through national
training, sales support, advertising and marketing programs. We also
market our services nationally through direct mail, telemarketing and
online marketing campaigns. In addition, Verio has expanded the marketing
of its services through original equipment manufacturer (OEM) type
relationships with major telecommunications carriers, such as Nippon
Telegraph and Telephone Corporation (NTT), who can offer Verio's services
on a private-label or co-branded basis to their customer base. NTT America
has recently
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launched its branded Arcstar Internet service in the U.S., and will resell
the full range of Verio services under this brand.
- Develop and Offer Value-Added Products and Services to Increase
Revenues. While basic Internet access and Web hosting constitute the
predominant services offered by Verio today, small and medium sized
businesses are increasingly looking for value-added products and services
that allow them to further leverage the power of the Internet to expand
markets, increase productivity and reduce costs. We believe that our
large existing customer base and strong, balanced position in both the
Internet access and Web hosting service platforms give us a competitive
edge in offering high-margin, value-added Internet services and bundled
packages to meet the evolving needs of our current and future customers.
As a result, we believe that we will be able to derive increasing revenue
from these customers and increase profitability by selling an expanding
array of value-added services, as well as higher functionality Web sites
and additional bandwidth to support these services. Examples of these
Web-based value-added services include electronic commerce, Web-based
faxing and email, unified messaging, office and business process
automation capabilities, audio and video applications, automated Web site
authoring tools and templates and redundant "hot" sites across multiple
national and international data centers. We currently offer broadband
"digital subscriber line" (DSL) circuits as an access option through the
relationship which we commenced with NorthPoint Communications subsequent
to December 31, 1998, and plan to offer additional alternative Internet
access options, as well as intranets and extranets incorporating both
Internet access and Web-hosting capabilities. We also offer value-added
Internet security capabilities and professional consulting services to
support a variety of Internet solutions. We expect to provide these
further value-added services through a combination of internal
development and packaging, acquisitions and new relationships with
Internet hardware, software and service companies.
THE VERIO ORGANIZATION
Verio conducts its operations with both a national and regional approach.
Initially, we pursued a regional acquisition strategy, acquiring independent,
locally based Internet service providers to establish critical mass and a
widespread market presence in the top metropolitan statistical areas across the
U.S., which we then consolidated into regional operations. In order to provide
services such as Web hosting on a national basis, we have also sought to acquire
enhanced service providers with extensive national operations. Our acquisitions
of iServer, TABNet and Hiway established Verio as the largest Web hosting
company in the world based on the number of Web sites we host, and significantly
increased our technical, marketing and operational strength.
As of December 31, 1998, we had acquired over 45 Internet service
providers, including the funding of start-up operations in the Midwest and Rocky
Mountain regions. We continue to consolidate the ownership and management of
these providers, and to integrate their network operations, customer support,
marketing efforts, financial and accounting systems, and other back-office
functions onto our national systems, in order to maximize operating synergies
and efficiencies. We are now focusing our efforts on expanding our market
presence and our strength in our Internet access and Web hosting core service
platforms, and adding value-added service capabilities. We continue to evaluate
additional potential acquisition and strategic partner candidates.
PRODUCTS AND SERVICES
Verio currently offers a comprehensive range of business Internet services,
including its core Internet access and Web hosting services, as well as a
variety of related value-added products and services that enhance these core
offerings. Verio offers a core suite of products and services nationally, with
additional specific products offered in designated markets based on factors such
as unique needs within a particular market and local telecommunications tariffs.
As its customers needs evolve, Verio intends to continue to develop a broad
range of value-added products and services independently, through acquisition,
and through strategic relationships with key vendors.
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Internet Access Services. Verio offers a variety of core Internet access
solutions, providing basic connectivity to the Internet, as well as a suite of
value-added products and services enabling our customers to expand their basic
Internet connectivity capability. For example, these additional services allow
them to send and receive e-mail, or to engage in private, secure data
transmissions between remote offices. These products are offered in bundled and
unbundled packages.
Our core Internet access services currently include:
- Basic Internet access: Our basic Internet access service currently
includes dial-up access at speeds ranging from 28.8 to 56 Kbps, ISDN
(integrated services digital network) providing 64 to 128 Kbps access,
DSL (digital subscriber line) access providing 144 Kbps to over 1 Mbps,
and frame relay and leased line connectivity at speeds ranging from 28.8
Kbps to 155 Mbps.
- Hardware products: As we provision access services, we provide necessary
hardware including routers, servers and other products as needed by the
particular customer. Our national purchasing and leasing relationships
with a variety of equipment partners provide improved hardware pricing,
lower cost leasing arrangements and bundled service offerings.
- Software products: Our software products include browsers, set up disks
and other solutions that permit customers to more effectively and easily
navigate and utilize the Internet.
- Configuration services: Our configuration solutions encompass services
such as domain name server support, supplying telecommunication circuits,
Internet protocol address space assignment, router set-up, electronic
mail configuration, router security configuration and other similar
set-up services.
Our value-added Internet access services currently include:
- E-mail: We provide e-mail services that permit customers to send and
receive electronic mail messages. These services are offered either using
the customer's domain name or though Verio's generic domain name. In
order to provide our customers with the latest developments in e-mail and
messaging services, we are in the process of converting our over 800,000
e-mail boxes to a centralized, state of the art e-mail system supported
by technology licensed to us by Netscape Communications Corporation.
- Virtual Private Networks: Many companies today have private data
communication networks to transfer data between office locations. These
are often referred to as wide area networks, and tend to be built on
expensive leased telecommunication lines. The Internet offers companies a
cost-effective alternative to wide area networks through virtual private
networks, which are meant to provide secure transmission of private
Internet protocol traffic through the Internet. Additionally, many
companies require that their employees have remote access to these
private networks from home or while traveling, which a virtual private
network can also provide. Virtual private network products are available
in hardware, software, and firewall formats. These products, often in
combination with a Web site, are also the basis for offering intranet and
extranet services. Intranets are corporate/organizational networks that
rely on Internet-based technologies to provide secure links between
corporate offices and secure access to company data. Extranets expand the
network to selected business partners through secured links on the
Internet. Increasingly, companies are finding that intranets and
extranets can enhance corporate productivity more easily and less
expensively than proprietary systems. We currently offer our customers a
number of virtual private network solutions, including Raptor's Firewall,
IRE's SafeNet(TM), and Watchguard's Firebox II(TM), and we continue to
evaluate additional products to meet our customers' needs in this area.
- Security: Security solutions are a vital component for most businesses
connected to the Internet. These solutions, which include firewalls,
packet filter and proxy servers, give the customer (1) an ability to
prevent intruders from accessing its corporate network, (2)
authentication of users attempting to gain access to the customer's local
area network or Web site, and (3) encryption services, providing secured
transmission of company data through the Internet. We currently offer a
comprehensive set of firewall products from Raptor, including the
sophisticated Eagle Firewall(TM). Additionally, we offer a "managed"
security solution that provides ongoing detection and prevention of
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intrusions. We plan to expand our security product line with new
solutions that simplify, reduce cost, or offer greater functionality as
they become commercially available.
Businesses are increasingly seeking to use the Internet for an expanding
array of telecommunication services. We plan to likewise expand our ability to
serve these more sophisticated Internet access needs by deploying additional
value-added Internet access-based services as they become commercially
available. Such products that are currently under development include Internet
protocol (IP) telephony, which permits users to make voice calls on the
Internet, Internet faxing, Internet audio and video conferencing solutions.
Additionally, we are participating in trials for the deployment of new access
technologies, such as wireless access.
Web Hosting Services. A Web site provides a company with a tangible
identity and interactive presence on the Internet. This computer-based site
allows a company to post information about itself that is easily accessible to
all Internet users. Web sites are also the basis for providing electronic
commerce, where a company can advertise and sell its products and services.
Verio offers a comprehensive range of core Web site hosting products, as well as
a growing suite of enhanced web site hosting products including electronic
commerce solutions. Generally, our customers elect to outsource to us the
hardware and software provisioning that is necessary to host a Web site, where
we can provide these services from our highly reliable data center environments.
Our Web site hosting products currently range in price from $14.95 per month to
tens of thousands of dollars per month.
Our core Web hosting services currently include:
- Shared Server Web Hosting: Verio offers a series of shared server Web
hosting plans that allow individuals and businesses to establish a
sophisticated presence on the Internet at a reasonable cost, leveraging
Verio's expertise and equipment to deploy an effective Web site. Our
basic, standardized Web hosting option offers 6,000 megabytes of data
transfer per month and 30 megabytes of disk storage on computers that are
owned and maintained by Verio in one of its data centers and monitored on
a 24X7 basis. This service level allows customers to store hyper text
markup language (the language used to create Web pages with links),
graphics, video and sound files on Verio's server. This basic shared
server plan generally satisfies customers' basic bandwidth and disk
storage requirements. A majority of our current shared server Web hosting
customers use the entry-level service. In order to allow customers to use
their Web site as an effective interface for communication, we provide
additional services bundled into our shared server hosting plans. For
example, our shared server customers are provided various Web-based
electronic mail options, support for Microsoft FrontPage(TM) extensions
and a variety of unique Web site development tools as part of the basic
Web hosting account. The higher priced shared server Web hosting
offerings, including the proprietary Virtual Server technology, provide
customers additional value-added services, functionality and resources.
Each successive pricing tier allocates the customer more disk storage and
increases the monthly data transfer limit. In addition, the more advanced
plans offer Real Audio(TM), Real Video(TM) and mSQL(TM) database support
and support for electronic commerce-enabled Web sites.
- Shared Server Support Tools: We have implemented a variety of tools to
allow our shared server customers to manage and enhance their sites more
effectively and update their Web sites remotely. Typically, the Web
hosting plans feature detailed Web statistics and access to raw log
files, giving customers the ability to track the performance and evaluate
the effectiveness of their Web sites. Higher tier plans offer customers
their own configuration files, POP server and simple mail transfer
protocol gateway. In addition, we provide a number of popular custom
gateway interface scripts that allow customers to put into use hit
counters, guest books, mail forms and other useful graphics easily, and
also support custom gateway interface scripts that enable customers to
build additional functionality into their Web sites. We offer numerous
tools which allow a customer to have increased control over managing its
Web site, allowing them to change passwords, set electronic mail
forwarding options, view Web site statistics and check account and
billing information. Additionally, all shared servers have regular
back-up procedures to protect customer files.
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- Dedicated Server Web Hosting: Verio offers dedicated server Web hosting
solutions for larger customers that prefer not to host their Web sites on
a shared server. This solution, which provides substantially more server
and network resources than those available from a shared server, gives
customers the ability to run complex applications without the additional
information technology administration costs and considerations that
customers would experience if they managed their own servers and Web
sites internally. The dedicated server Web hosting solutions provide the
customer with an NT or UNIX-based server that is owned and maintained by
Verio in one of its data centers and monitored on a 24X7 basis. We
maintain spare equipment and back up data regularly. We offer the
dedicated server service at various prices depending upon the specific
hardware configuration, level of service and data transfer rates required
by the customer.
- Co-location: Verio offers co-location services for customers that require
the resources of a dedicated server, prefer to retain physical access to
and ownership of their server, and have the expertise to maintain the Web
site and the server. Our co-location facilities offer customers a secure
location, environmental control, monitoring and a high-speed connection
to the Internet. These facilities typically are designed to provide an
uninterruptible power source, a back-up diesel generator, climate control
and 24X7 monitoring.
- Domain Name Registration: Each business or individual that desires a
personalized Web address must first reserve a domain name (such as
www.yourcompany.com). As more individuals and businesses establish a Web
presence, desirable domain names, like trade or service marks, become
more difficult to secure. We are the world leader in providing this
important service, registering more domain names (.com, .net, .org) with
Network Solutions (currently the single designated domain name registrar)
than any other company. For a one-time fee, we will register and maintain
a domain name for two years or until the customer decides to use the
domain name to host an active Web site. We believe that offering this
service provides us a marketing advantage when these domain name
registration customers then select a Web hosting provider. We actively
telemarket to new customers registering a domain name and have a high
conversion rate of these customers to our recurring revenue Web hosting
services.
The value-added Web hosting services that we currently provide include:
- Electronic Commerce Solutions: Electronic commerce provides businesses
the ability to sell products and services on the Internet. The electronic
commerce or e-commerce capability can be added to an existing Web site or
it can be the basis for a Web site, starting with the customer's product
catalog. The principle basic components of an e-commerce enabled Web site
include:
- a hosted Web site;
- a catalog of the products to be sold from the site, including prices
and inventory -- a secure means of accepting orders from customers
visiting the site;
- a secure means of accepting payment for those orders -- a means of
calculating the appropriate tax and shipping costs attributable to the
order;
- transaction reporting capability; and
- a means of reconciling these transactions with the company's
accounting records.
Verio currently offers a variety of e-commerce packages. Our entry level
"CyberStand" product is designed for a merchant with a very limited number
of products to sell that does not require real time payment clearing.
Another more advanced product is the "eVendor" product which allows a
substantially greater number of products to be offered in the catalog, but
still relies on manual payment processing. The "MarketPlace" product is
for the more sophisticated merchant who desires an unlimited number of
products to be sold and requires secure, on-line real time payment
settlement. We have relationships with numerous providers of the various
components of our e-commerce solutions, including tools for catalog and
site creation, merchant accounts, digital certificates, transaction
processing and numerous additional components that are required to build a
completely commerce
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enabled Web site. We will continue to invest in creating a greater suite
of e-commerce packages as this market develops.
- Web Site Design: Web site design is the development of the Web site
content that will be displayed on the Web site when it is being viewed on
the Internet. We rely principally on our resellers to create the Web
sites for our customers. In addition to relying on the Web design
services of our resellers, we offer Web design services to a select set
of our customers. This may entail development of a basic Web page through
to the development of a sophisticated e-commerce Web site.
We believe that more advanced Web-site based application products will
continue to expand as businesses require more sophisticated on-line commerce
capabilities. We are continually seeking to acquire technology from third
parties to incorporate with our existing solutions to provide more and more
functionality to our commerce product offerings, as well as exploring additional
Web-based services through internal development. In particular, our efforts are
focused on expanded Web-site based electronic commerce capabilities, Web-based
faxing and electronic mail, unified messaging and "virtual offices," audio and
video appliances, automated Web site authoring tools and templates, basic
automated marketing tools, and redundant "hot" sites across multiple national
and international data centers. We continue to assess potential opportunities to
extend new offerings as they become available, and to evaluate our ability to
implement these solutions in a cost-effective way while maintaining quality of
service for our customers.
MARKETING
Verio's marketing organization focuses on stimulating demand for Verio's
services and extending Verio's brands, and is responsible for advertising,
marketing communications and public relations. We rely on a combination of
traditional media and online advertising. We focus our traditional media efforts
on advertisements in major business and technical publications, television
commercials, radio spots and direct mail. Our online marketing program consists
of general rotation and keyword-specific Web banner advertisements. We became
one of the world's largest Internet domain name registrars and Web hosting
companies by pioneering domain name registration services and establishing
preferential Web-based marketing relationships with leading Internet media,
search engine and portal companies such as AOL, Netscape, Yahoo, Excite,
Infoseek, and others. Other marketing vehicles include collateral materials,
trade shows, direct response programs and management of our Web site. Public
relations focuses on cultivating industry analyst and media relationships with
the goal of securing broad media coverage and public recognition of the Verio
brand name.
We have consolidated the operations and marketing efforts of our acquired
operations under the Verio brand name, although in certain instances, where an
acquired operation has established particularly strong brand identity (such as
Hiway and its RapidSite(TM) product offering), we may continue to market
particular products and services under that name. Recently, we have focused
significant efforts in marketing campaigns and brand recognition. We have
undertaken national public relations efforts to raise the awareness and
visibility of Verio through a national print, radio and television advertising
campaign. Subsequent to December 31, 1998, we commenced a joint DSL marketing
effort with NorthPoint Communications to rollout DSL services in 21 cities
nationwide. Most recently, in March 1999, we entered into a strategic
relationship with AOL, which we expect will substantially expand Verio's
national brand name recognition. Under this agreement, for a three-year period,
Verio has acquired exclusive rights to market its Web hosting and
business-focused electronic commerce services on AOL's four key on-line media
properties (AOL Service, AOL.com, CompuServe, Digital Cities) in the U.S.
SALES AND DISTRIBUTION
Verio utilizes multiple distribution channels in order to extend its reach
and leverage the service capabilities and brand names of its channel partners.
Verio uses a combination of direct sales, online marketing, telemarketing,
value-added resellers and private label resellers.
Direct Sales. We have a direct sales force of more than 200 professionals.
These local sales representatives have a strong Internet technical background,
understand the local telco tariffs and the needs of their local business
community, and are familiar with local companies to assist in implementing
tailored solutions. Since
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these representatives are locally-based, they are able to meet face-to-face to
discuss a particular customer's Internet needs and technical requirements and
develop tailored solutions. We have developed programs at the national level to
attract and train high quality, motivated sales representatives that have the
necessary technical skills, experience and knowledge. These programs include
technical sales training, consultative selling techniques, sales compensation
plan development, and sales representative recruiting profile identification.
Through the effective use of these initiatives, we plan to continue to expand
our direct sales force. At the local level, direct marketing techniques are
being used to target customers that would achieve substantial benefit from the
business applications afforded by the Internet. Some direct marketing tactics
include direct mail, telemarketing, seminars and trade show participation. We
work with key vendors to assist in these direct marketing efforts. We co-market
with these vendors through direct mail programs, joint seminar development and
joint trade show involvement. Through the TABNet acquisition, we acquired a
centralized outbound and inbound telemarketing sales capability targeted at
offering Web hosting services.
Online Sales. We have an extensive online marketing program, consisting of
general rotation and keyword-specific Web banner advertisements, which stimulate
interest in and leads for our products and services. Much of this online
activity directs prospects to our online Web sites from which prospects may make
a product selection and order a product online. We are able to generate a
substantial amount of sales of our Web hosting products through this selling
technique as a result of the high degree of automation built into our Web site
provisioning process. Through our recently announced strategic agreement with
AOL, we expect to substantially expand Verio's national brand name recognition
through this major new on-line marketing relationship.
Resellers and Indirect Sales. We believe that indirect sales channels
contribute significantly to our growth, and have developed three primary
reseller partner programs that provide us with a formal indirect distribution
strategy. Through these programs, we have a worldwide indirect distribution
channel with over 4,000 resellers in the U.S. and over 170 other countries.
These programs include our:
- Authorized Solutions Partner (ASP) program: This program offers our
reseller the ability to share in the ongoing revenue stream of customers
they bring to Verio. ASPs include computer resellers, value-added
resellers, systems integrators and other organizations focused on
providing information technology hardware, software, and services to the
business community. They typically have an established relationship with
the prospective customer base, and a sales force capable of selling
Internet services as part of the partner's suite of services.
- Referral Partner Program: These partners include organizations such as
Web designers, advertising agencies, and telco resellers. We target
organizations that are less capable of, or interested in, selling
Internet services, or where Internet services fall outside their core
business interests.
- Private Label Partner Program: This is a wholesale program which allows
qualifying organizations to resell our services under their own brand.
The benefits that we derive from these programs including greater market
reach without fixed overhead costs, and the ability to use partners to assist in
the delivery of complete solutions to meet customer needs. In addition to local
partnerships, we are working with several national companies to expand our
indirect sales capability. We also intend to pursue additional private label
OEM-like relationships with major telecommunications carriers, similar to our
current arrangement with NTT America. NTT America recently has launched its
branded ArcStar Internet service in the U.S., and is reselling the full range of
Verio services under this brand. We also are party to this type of agreement
with a number of the regional bell operating companies and a large European
telecommunications company.
TECHNOLOGY AND NETWORK OPERATIONS
Overview. Verio owns and operates a national network, providing a high
bandwidth, highly reliable data transmission path connecting Verio's customers
to the Internet. Verio believes this network is adequate for the provision of
current and future planned access and services needs. Verio's national network
interconnects more than 29 national nodes and over 200 local POP facilities
across the United States. By aggregating the
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bandwidth and capacity requirements of our acquired operations onto one national
network, we continue to increase our operational control and efficiency, reduce
costs, and provide redundancy and higher quality service. In this way, we are
able to address some of the most significant challenges that an Internet service
provider faces in supporting its customers. Verio's national infrastructure also
incorporates several other elements critical to maintaining the highest quality
Internet service, including a high capacity and reliable national network,
peering relationships with other regional, national and international Internet
service providers, sophisticated network management tools and engineering
support services. The reliability of the national network is the result of many
factors, including redundant routers and other critical hardware, carrier class
facilities at POP locations (such as back up power, fire suppression and climate
control), and redundant telecommunications lines. With our substantial national
capacity, network support capabilities, and peering relationships, Verio has
achieved "Tier One" status as one of the largest national, full service Internet
network providers.
National Network. As of December 31, 1998, the national network carried
traffic for 37 of the acquired Internet service providers. The remaining
providers' traffic will be added as growth drives the need for additional
capacity, as private and public peering is implemented and as their current
transit contracts expire.
Currently, the national network architecture includes a presence at
selected national exchange points and redundant network nodes to link our
regional networks to the national network. As of December 31, 1998, our network
included connectivity at:
- the major public national exchange points -- MAE West, MAE East and the
NY NAP;
- the Palo Alto Internet Exchange (PAIX);
- NASA Ames; and
- other regional connecting points, including Seattle (Washington);
Portland (Oregon); Irvine, Sacramento and San Diego (California); Denver
(Colorado); Orem (Utah); New Orleans (Louisiana); Dallas and Houston
(Texas); St. Louis and Kansas City (Missouri); Chicago (Illinois); Ann
Arbor (Michigan); Atlanta (Georgia); Tampa (Florida); Harrisburg,
Philadelphia and Pittsburgh (Pennsylvania); Baltimore (Maryland);
Rochester and New York City (New York); and Boston (Massachusetts).
Each of these locations uses leading router technology. The equipment is
located in facilities leased from a variety of telco providers, including MCI
WorldCom, Sprint and others. These access points are linked, using a nationwide,
high-speed ATM and clear line network infrastructure ranging in capacity from
DS-3 to OC-12. This network capacity is leased primarily from Qwest and a
variety of other national telecommunications providers, including Sprint and MCI
WorldCom. This combination of clear channel circuits, ATM and router
architecture makes the network reliable by diversifying the path of Internet
traffic and maintaining redundant paths. Our regional networks either co-locate
at these access nodes or lease connectivity from a local service provider such
as a regional bell operating company or other local exchange carrier to connect
to our equipment.
We are continuing to add national access nodes to serve additional parts of
the Midwest, Southern California, the Southeast and the Northeast, all of which
we currently plan to put on-line during 1999. Multiple national access nodes
facilitate connection of our regional operations to our national network. We
continue to add additional private peering points and access nodes as we acquire
more Internet service providers and expand operations, and to further increase
network capacity as the need for additional bandwidth arises.
The national network is planned to allow for rapid expansion of bandwidth
through scaleable design supported by multiple local access and interexchange
carriers to provide the required bandwidth. We have begun the migration of
selected links from ATM to clear line, over 10,000 miles of which has been
leased from Qwest. We have implemented nationwide OC-3 capacity and, on some
routes, OC-12 links to handle our projected traffic requirements.
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In March 1998, we entered into a 15-year capacity and services agreement
with Qwest Communications Corporation, which we amended in December 1998. Under
this agreement, we will have access to long haul capacity and ancillary services
on Qwest's nationwide MacroCapacity(sm) Fiber Network. Initially, the agreement
required that over the first seven years we must purchase, and Qwest must
provide, not less than $100.0 million of capacity and services, at agreed upon
prices. Under the amendment, we agreed to increase that commitment by an
additional $60 million and to extend the term of our minimum commitment from 7
to 10 years. With this extended contract and higher volume of service
commitment, we received improved pricing for our capacity purchases. This
contract provides us with the flexibility to deploy circuits from DS-3 (45
megabits per second) to multiple OC-48 (2.4 gigabits per second) as our customer
needs expand. We have the right to order capacity and services in excess of the
minimum commitment at any time during the 15-year term. We also currently are a
party to a number of other long haul capacity agreements with additional telco
providers. These agreements are for various terms and at varied pricing. We
anticipate that we will satisfy a substantial portion of our capacity and
ancillary services needs under the Qwest agreement, because we believe that the
pricing levels that we are entitled to under the amended agreement will
significantly reduce the per unit costs that we otherwise would pay under our
other existing long haul capacity agreements.
We believe that the currently installed Cisco and Juniper Networks routers
will be sufficient to support our traffic routing needs up to and including OC-3
and OC-12 speeds. We are investigating and testing various options to support
higher than OC-12 speeds and bandwidth requirements. Our options include
switching, higher capacity and faster routers, or hybrid routing and switching
solutions.
Peering Relationships. Peering is the Internet practice under which
Internet service providers exchange each other's traffic without the payment of
settlement charges. The basis on which the large national providers make peering
available or impose settlement charges is evolving as the provision of Internet
access and related services has expanded and the dominance of a small group of
national providers has driven industry peering practice. Recently, companies
that have previously offered peering have cut back or eliminated peering
relationships and are establishing new, more restrictive criteria for peering.
We believe that substantial traffic volume and national scale will continue to
be the focal criteria necessary to establish and maintain peering relationships.
As a result, it has become increasingly important for companies seeking to take
advantage of peering to have significant traffic, a national network and
monitoring capability.
Verio has established public or private peering relationships with all of
the major national Internet service providers, as well as with many smaller
domestic and international networks, and continues to evaluate additional
private peering proposals. By implementing our own national network and
establishing peering relationships with other national Internet service
providers, we believe we can lower the cost of our Internet transit and increase
the performance and reliability of our network operations. With over 100 peering
partners, including all of the largest Internet service providers, Verio's
network is considered a "tier one" national network. Some large network
providers now prefer to peer at private exchange points rather than at national
exchange points. This preference represents the desire to accomplish the
exchange of high bandwidth traffic in a more efficient manner rather than to
risk congestion and equipment failure at public exchange points. We currently
anticipate that, as our traffic grows, more peering relationships can be
obtained. However, no assurance can be given that peering relationships will
continue to be made available to us. Even if these relationships are not
maintained or established, we believe that it will be more economical for Verio
to maintain an exchange point transit agreement than to pay other national
providers for transit. See "Factors Affecting Future Operating Results -- We
depend upon our network infrastructure" and "-- Our costs will increase if we
fail to maintain our peering relationships."
Web Hosting Operations. Through the iServer, TABNet and Hiway acquisitions,
we have developed high-performance, reliable, secure and scalable Web hosting
solutions, which we believe provide us with a significant competitive advantage.
These solutions consist of multiple proprietary Web hosting platforms that
incorporate automated functionality and a highly reliable network infrastructure
that includes multiple data centers monitored by our network operations center
on a 24X7 basis. Our strategy in developing our Web hosting solutions focuses on
utilizing proprietary technological innovations that we integrate with
third-party software and hardware to configure integrated solutions.
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Web Hosting Platform. We have established multiple proprietary Web hosting
platforms through our acquisitions. As a result we can efficiently host up to
two thousand Web sites on a single server. Although industry-standard Web
servers can enable Web hosting, we believe that efficiently managing large
numbers of Web sites and users on a single shared server is technically
difficult and requires significant technological innovations. Accordingly, we
have focused our technology development efforts on creating various proprietary
operating system level tools to facilitate a high-density customer to server
ratio. We also have customized or developed Web server applications designed to
improve performance in a shared server environment and resource monitoring tools
designed to report and address scarcity of shared central processing units and
memory resources. Our solution can easily allow server groups to be added
seamlessly and to be monitored centrally wherever they are located. To address
the diverse requirements of our customers, we offer Web hosting services on a
range of operating systems and computing platforms.
We also have developed proprietary software that allows us to provide our
services on an efficient and cost-effective basis by automating the following
back-end functions:
1. order-taking and processing;
2. customer billing via credit cards, check, bank transfer and
accounts receivable;
3. account provisioning and activation;
4. server management and monitoring;
5. coordination of the electronic mail subsystem to integrate
electronic mail forwarding, multiple electronic mail accounts on a
single Web site and autoresponders;
6. inherent distributor-dealer-customer hierarchy of all data; and
7. support for third-party feature "plug-ins."
In addition, we provide a front-end interface that allows a customer to set
up accounts, change account parameters, check Web site statistics quickly and
easily and verify billing information. "TQ software" was engineered to maximize
automation to achieve high levels of scalability, and the modular design allows
additional server groups to be supported easily. Language and branding
independence enables international value-added resellers and OEMs to localize
for foreign languages and customize the interface quickly and with minimal
effort.
Data Centers. We currently have data centers located in Orem, Utah; San
Francisco and Mountain View, California; Seattle, Washington; Dallas, Texas;
Boca Raton, Florida and Washington, D.C. An upgraded data center in the San
Francisco Bay Area is planned for 1999, and additional east coast data centers
as well as expansions of certain of our existing data centers also are being
planned. Primarily all of Verio's data centers include environmental controls,
back-up generators, Cisco routers and switches, and continuous monitoring
capabilities to ensure high-quality service with minimal interruptions.
National Network Management. We consider world-class network management an
essential capability for network monitoring and expansion, maintaining high
customer satisfaction and improving network quality. We have established a
network operations center to allow continuous monitoring of the network 24 hours
per day, 7 days per week. Our network operations center also provides a single
point of contact for real-time network status information and customer technical
problem resolution. The NOC is designed to provide real-time alarming, event
correlation, traffic management and forecasting, and distributed notification of
the network events and network status. We use many leading edge systems to
provide the NOC capabilities. As of December 31, 1998, we monitored the national
network and the local networks of approximately 27 of the Internet service
providers we had acquired as of such time.
Engineering Support Services. We have negotiated national level telco
contracts with local exchange carriers, such as MCI WorldCom, providing
favorable terms for local transport. We plan to expand national purchasing and
leasing benefits as well as technical planning and support to improve the
performance, reliability and economics of our regional networks. National level
purchasing benefits include both cost and
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vendor performance issues as well providing spare equipment and additional
technical support from suppliers. National level distribution agreements have
been negotiated with a number of additional national-scope suppliers.
Co-location agreements have also been established with companies such as Qwest,
Sprint, MCI WorldCom and Digital Equipment Corporation. We are pursuing
additional vendor and telco relationships in an effort to reduce the cost of
equipment and improve network quality.
Technical Planning and Support. Our engineering team provides engineering
support for routing configurations, telco management and pricing, development of
our regional and national networks and purchasing and contract negotiation. The
engineering team also works to standardize certain network elements nationally,
improve performance and reduce network costs. Support includes Internet protocol
addressing support, training and technology. This effort of sharing ideas across
our operations is intended to enhance the engineering talent available locally
and to share best practices nationally.
NATIONAL SUPPORT SERVICES
In addition to our national network and network monitoring capability,
Verio has developed and implemented three critical national support services
designed to increase operational efficiencies and enhance the quality,
consistency and scalability of Verio's services. These support services include
24X7 customer technical support and service, financial information management
through a central, standardized accounting system and a sophisticated billing
and collections system. The strategy of creating a partnership between local
support teams and Verio's established national support services enables Verio to
capture economies of scale, improve quality and responsiveness, and increase
productivity, while allowing local personnel to focus on relationships with
customers.
Customer Technical Support. Our customer care combines the responsiveness
and on-site capabilities of our local operations with the scale economies of a
national customer support center. Our NOC in Dallas, Texas, enables us to
provide 24X7 responsiveness while maintaining the ability to provide on-site
installation assistance, hands-on troubleshooting and access to local experts
who understand the customer's business. As of December 31, 1998, we were
providing customer care services to 33 of the providers we had acquired and will
offer services to all of our regional operations as the national customer
support center continues to expand throughout 1999. The support center team is
using a leading customer support trouble ticketing and workflow management
system offered by Vantive Corporation. The system enables us to track, route,
and report on customer issues. It provides significant benefit in ensuring
quality and timely care to customers. Based on information received through the
trouble ticketing system, as well as through the centralized billing and
collections system, we are able to monitor network reliability and outage
experiences. To date, this information reflects that the outages experienced by
our customers, for the most part, are minor and attributable to ordinary course
of business service interruptions, telecommunication network capacity demands,
and the customer's hardware and software functionality issues. In certain
instances, our customers experienced downtime and outages in the course of our
conversion of systems and processes associated with our integration and
consolidation efforts. While historically Verio has not, as a general matter,
provided service warranties or offered a standard service credit policy, in the
future we may as and to the extent that it becomes a necessary or desirable
commercial practice. To date, Verio has provided credits resulting from network
outages and system failures in certain circumstances, but the amount of these
credits has not been material. Certain of the entities that we have acquired
have offered and implemented various service credit policies, some of which
remain in effect with respect to customers of those acquired entities. Again,
however, credits required as a result of those policies to date have not been
material. We will continue to monitor network outage experiences, and expect to
record appropriate reserves if the level of outage credits becomes material.
Financial Information Management. We are in the process of converting all
of our acquired Internet service provider operations to the PeopleSoft(TM)
financial reporting system and the ADP payroll/human resources system, in order
to provide a central, standardized accounting system. As of December 31, 1998,
38 of our acquired operations were using the financial reporting system and 41
were using the payroll/human resources system. These systems enable us to cost
effectively increase the productivity and quality of administrative support by
standardizing operational systems such as payroll, payables, purchasing and
financial
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reporting. These enhancements are part of our initiative to implement continuous
improvement methodology and to create a learning organization.
Billing and Collections. We have implemented the Kenan Systems' EC Arbor
billing solution which offers high quality, flexibility, cost-effectiveness and
scalability. Kenan is a leading billing solutions provider to the
telecommunications industry, providing accurate, timely, and easy-to-understand
invoicing. As of December 31, 1998, this system served 27 of our acquired
Internet service operations. We are aggressively rolling out this billing
platform to all of our regional operations to centralize our billing operations.
NTT STRATEGIC RELATIONSHIP
On April 7, 1998, Verio entered into agreements establishing a strategic
relationship with NTT. Under these agreements, upon the consummation of its IPO,
NTT acquired 4,493,877 shares of Verio's common stock for approximately $100.0
million in aggregate consideration and is entitled to designate one member to
serve on Verio's board of directors.
In addition, Verio and NTT's U.S. affiliate, NTT America, Inc. ("NTT
America"), entered into a three-year outside service provider agreement, which
took effect upon the completion of NTT's investment. Pursuant to this agreement,
Verio was designated as the preferred provider of Internet access and related
services to customers of NTT America on a reseller basis. Verio and NTT also
will connect their backbones and establish a peering and transit relationship.
During the term of this agreement, NTT America will pay Verio for the services
provided by Verio at predetermined rates reflective of the strategic
relationship between the parties, under which NTT is entitled to "most favored
customer" status and pricing concessions. NTT America and Verio subsequently
executed a further agreement setting forth the details for implementation of the
specific technical and administrative aspects arising under the outside service
provider agreement. NTT America has now launched its branded Arcstar Internet
service in the U.S., and will resell the full range of Verio services under this
brand. Verio will also provide NTT America with full back-office and engineering
support.
SUBSIDIARY OWNERSHIP STRUCTURE
While Verio now typically seeks to acquire 100% of new Internet service
providers' operations, Verio's early acquisition strategy was to acquire less
than 100% of its Internet service providers. In each of these cases, it obtained
the right to buyout the remaining equity in the future. As part of its
integration strategy, Verio has effected the buyouts of all but one of the
U.S.-based companies in which it did not initially acquire 100% ownership. With
the completion of these buyouts, Verio then undertook its efforts to consolidate
the management of the acquired operations in order to minimize administrative
costs.
Verio currently holds an approximately 15% fully diluted equity interest in
VIA Internet, Inc. ("VIANet"), which was formed in 1997 to pursue a strategy
similar to that of Verio's outside of the U.S. and Canada. Verio has no
contractual right to acquire the remaining equity of VIANet, and has no present
plan to integrate the operations of VIANet with those of its own. Hiway owned
minority and majority interests in certain entities that provide Web hosting and
other enhanced Internet services in various foreign countries. Upon the
completion of the Hiway acquisition, Verio acquired the majority and minority
equity positions held by Hiway at that time. Verio has completed the acquisition
of the remaining equity in one of these entities, WWW-Service
Online-Dienstleistungen AG, a German Web hosting company. We may seek to acquire
the remaining equity of the other partially owned international entities in the
future. However, we also may decide to leave some equity in our international
subsidiaries in the hands of local owners in order to retain their continued
services and expertise in managing these distant operations.
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COMPETITION
The market for Internet access and related services is extremely
competitive. Verio anticipates 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. Current and prospective
competitors include:
- national, regional and local Internet service providers;
- global, national, and regional long distance and local exchange
telecommunications companies;
- cable television companies;
- direct broadcast satellite and wireless communications providers;
- on-line service providers; and
- Web hosting providers, and providers of other value-added Internet
services.
Verio believes that the following are the primary competitive factors in
this market:
- Maintaining a secure and reliable national network with sufficient
capacity, quality of service and scalability to support continued growth.
- Maintaining a knowledgeable and effective sales force and implementing
broad and effective distribution channels.
- Providing knowledgeable and capable technical support personnel, and
prompt and efficient customer care services.
- Maintaining Internet system engineering and other technical expertise.
- Offering competitive prices.
- Making timely introductions of new products and services.
- Having sufficient financial resources.
- Having a recognized and trusted brand name.
Many of our competitors have significantly greater market presence, brand
recognition, and financial, technical, network capacity and personnel resources
than we do. All of the major long distance companies, also known as
interexchange carriers, offer Internet access services and compete with us. 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 access
market. In order to address the Internet access requirements of the current
business customers of long distance and local carriers, there is a move toward
integrating horizontally through acquisitions of, joint ventures with, and the
wholesale purchase of Internet access from, Internet service providers by these
telecommunications companies. In addition, many of the major cable companies and
other alternative service providers -- such as those companies utilizing
wireless terrestrial and satellite-based service technologies -- have announced
their plans to offer Internet access and related services. Accordingly, we
expect that we will experience increased competition from traditional and
emerging telecommunications providers. Many of these companies, in addition to
their substantially greater network coverage, market presence, and financial,
technical and personnel resources, also have large existing commercial customer
bases. Furthermore, they may have the ability to bundle Internet access with
basic local and long distance telecommunications services. This bundling of
services may have an adverse effect on our ability to compete effectively with
them and may result in pricing pressure on us that would adversely affect our
business, financial condition and results of operations.
The recent deployment and further planned deployment of broadband services
for high speed Internet access by cable and telephone companies through new
technologies such as cable modems and various digital subscriber lines
technologies also creates further competitive pressure in Verio's business.
While these providers initially targeted the residential consumer, more recently
a number of digital subscriber lines providers also have announced their intent
to offer digital subscriber lines services to our target business market. This
may significantly affect the pricing of our Internet access service offerings.
Similar to the co-
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marketing arrangement which we entered into with NorthPoint Communications
subsequent to December 31, 1998, a number of digital subscriber lines providers
have launched their services in conjunction with Internet service providers,
allowing those providers to offer Internet access over digital subscriber lines
circuits. These digital subscriber lines circuits, which provide higher speed
and lower latency Internet connections than a standard dial-up phone connection,
compete with our dedicated connectivity offerings.
EMPLOYEES
As of December 31, 1998, Verio employed approximately 1,360 people,
including full-time and part-time employees at our corporate headquarters in
Colorado, our network operations and customer support center in Texas and at our
distributed operational offices across the country and around the world. We
consider our employee relations to be good. None of our employees are covered by
a collective bargaining agreement.
TRADEMARKS AND TRADE NAMES
Verio filed for federal trademark protection of "Verio" on November 29,
1996. On September 2, 1998, Verio filed for protection of its service mark "The
New World of Business." These applications are pending and there is no assurance
that they will be granted. Trademark protections for the Verio mark also have
been applied for in the European Economic Community, as well as in Japan.
Additionally, corporate name reservations for the name "Verio Inc." have been
filed in all fifty states. Hiway Technologies(R) and Best Internet
Communications(R) are registered trademarks of Hiway. Hiway(TM), HWAY(TM), A
Home Page(TM) and RapidSite(TM) are trademarks of Hiway. TABNET(R) is a
registered trademark of TABNet. TABNet has applied for federal trademark
protection for the following marks: 1-800-WEBSITE(TM), NETANNOUNCE(TM), NTX(TM),
TAB.NET(TM), WHOIS(TM) and WHOIS.NET(TM) .
FACTORS AFFECTING FUTURE OPERATING RESULTS
This Annual Report on Form 10-K contains forward looking statements
concerning the Registrant's future products, expenses, revenue, liquidity and
cash needs as well as the Registrant's plans and strategies. These
forward-looking statements are based on current expectations and the Registrant
assumes no obligation to update this information. Numerous factors could cause
actual results to differ significantly from the results described in these
forward-looking statements, including the following risk factors.
WE HAVE A HISTORY OF LOSSES AND LIMITED OPERATING AND FINANCIAL DATA
We have incurred net losses since our inception in March 1996. For the
period from inception to December 31, 1996, we had a loss of $(5.1) million and
for the years ended December 31, 1997 and 1998, we had losses of $(46.1) million
and $(122.0) million, respectively. Because we have been formed only recently,
there is little operating and financial data about us and this makes an
evaluation of our business operations and prospects difficult. We have
experienced revenue growth on an annual basis with revenue increasing from $2.4
million from the period of inception (March 1, 1996) to December 31, 1996 to
approximately $35.7 million in 1997, and to approximately $120.7 million in
1998. However, we have incurred losses and experienced negative earnings before
depreciation and amortization, interest income and expense, other income (loss),
income tax expense (benefit), gain on sale of investments, equity in loss of
affiliate and intangible asset write-down ("EBITDA") during each of those
periods. We expect to continue to operate at a net loss and experience negative
EBITDA in the near term as we continue to expand our business and integrate our
operations. We have incurred net losses attributable to common stockholders of
$(5.1) million, $(46.3) million and $(122.0) million and have incurred negative
EBITDA of $(5.6) million, $(29.7) million and $(51.3) million for each of the
years ended December 31, 1996, 1997 and 1998, respectively. At December 31,
1998, we had an accumulated deficit of $(173.5) million. We cannot assure you
that we will be able to achieve or sustain profitability or positive EBITDA.
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WE EXPECT CONTINUING LOSSES
We expect to incur significant additional losses and to generate negative
operating cash flow in the foreseeable future. We may also use significant
amounts of cash as we continue our acquisition and integration efforts and
continue to build out our national network operations. The extent to which we
experience negative cash flow will depend upon a number of factors, including
the following:
- the number and size of any additional acquisitions and investments;
- the expense and time required to integrate prior and future acquired
operations;
- the time and effort required to capture operating efficiencies;
- our ability to generate increased revenues and cash flow;
- the amount of our expenditures at the corporate and national level; and
- potential regulatory developments that may apply to our operations.
WE CANNOT ASSURE YOU THAT WE WILL BE PROFITABLE
In order to achieve profitability, Verio must develop and market products
and services which gain broad commercial acceptance. We cannot assure you that
we will ever achieve broad commercial acceptance or profitability. Although we
have experienced significant growth in revenues on an annual basis (see above),
we do not believe that this growth rate is necessarily indicative of future
operating results. We cannot assure that we will achieve or sustain positive
operating cash flow or generate income in the future. It is possible that we may
never achieve profitability on a quarterly or annual basis.
WE HAVE SUBSTANTIAL DEBT WHICH MAY IMPACT OUR FUTURE OPERATIONS AND AFFECT OUR
ABILITY TO MEET OUR DEBT OBLIGATIONS
We are highly leveraged and have substantial amounts of outstanding debt.
At December 31, 1998 our total long term debt was approximately $674.6 million
representing 77% of our total capitalization, and our interest expense for the
year ended December 31, 1998 was approximately $35.9 million. After giving pro
forma effect to the acquisition of Best Internet Communications, Inc. (which
does business as Hiway Technologies, Inc. and which we refer to as Hiway), our
total long term debt would be approximately $678.7 million representing 77% of
our total capitalization. In addition, we have obtained a $70.0 million
revolving credit facility from a group of lending banks. We have not drawn any
funds from this credit facility.
High levels of debt could have several important effects on our future
operations. Some of these consequences include the following:
- a substantial portion of our cash flow from operations must be used to
pay interest on our debt and will not be available for other business
purposes; and
- covenants imposed under certain of the financing agreements limit our
ability to borrow additional funds, dispose of assets and affects our
flexibility with respect to changes in our business, including possible
acquisitions and capital expenditures.
Our ability to meet our debt obligations and to reduce our total debt
depends on our future operating performance and on economic, financial,
competitive, regulatory and other factors. Many of these factors are beyond our
control. We believe that working capital from operations, existing credit
facilities, capital lease financings and proceeds of future equity or debt
financings will be adequate to meet our financial obligations. We cannot assure,
however, that our business will generate sufficient cash flow due to the various
risk factors described or that future financings will be available to provide
sufficient proceeds to meet these obligations or to service our total debt. In
particular, our cash flow may not be sufficient to pay:
- $13.5 million in annual interest (representing 38% of our total interest
expense for the year ended December 31, 1998) on the $150.0 million
principal amount of 13 1/2% senior notes due 2004 (the "1997 Notes")
beginning in June 2000 following the termination of the interest escrow
arrangement
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for the 1997 Notes, $100.0 million principal amount of which remains
outstanding after we repurchased $50.0 million of the 1997 Notes held by
Brooks Fiber Properties, Inc. in March 1998;
- $18.2 million in annual interest (representing 51% of our total interest
expense for the year ended December 31, 1998) on the $175.0 million
principal amount of 10 3/8% senior notes due 2005 (the "March 1998
Notes");
- $45.0 million in annual interest on the $400.0 million principal amount
of 11 1/4% senior notes due 2008 (the "November 1998 Notes"); or
- any debt obligations we may incur under the credit facility, if drawn
upon.
WE ARE SUBJECT TO RESTRICTIVE COVENANTS THAT LIMIT OUR FLEXIBILITY
Our $70.0 million bank credit facility may only be used if we meet certain
financial tests and prohibits us from paying dividends or repurchasing our
capital stock without the lenders' consent. Failure to comply with these terms
would entitle the secured lenders to foreclose on certain of our assets,
including the capital stock of our subsidiaries and our capacity agreement with
Qwest. The secured lenders would be repaid from the proceeds of the liquidation
of those assets before the assets would be available for distribution to the
holders of Verio's capital stock. In addition, the terms of the credit facility,
as well as the 1997 Notes, the March 1998 Notes and the November 1998 Notes,
impose limitations on our ability to incur additional debt, and therefore may
make it difficult for us to borrow in the future. The existing financial
arrangements require, and future financing arrangements are likely to require,
that we maintain certain financial ratios and comply with certain covenants
further restricting our ability to incur additional debt, pay dividends or make
other restricted payments, sell assets, enter into affiliate transactions or
take other actions. In addition, our ability to satisfy these restrictive
covenants may be affected by events beyond our control. As a result we cannot
assure you that we will be able to continue to satisfy these covenants.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN ORDER TO REMAIN COMPETITIVE
Verio depends on a number of different financing sources to fund its growth
and continued losses from operations. However, we cannot assure you that we will
be able to raise such funds on favorable terms. In the event that we are unable
to obtain such additional funds on acceptable terms, we may be unable or
determine not to take advantage of new opportunities or take other actions that
otherwise might be important to our operations.
We expect to make significant capital expenditures in order to maintain our
competitive position and continue to meet the increasing demands for service
quality, availability and competitive pricing. In addition to our continuing
acquisition efforts, we currently expect that our significant capital
expenditures will include the following:
- network equipment;
- network operating centers;
- network monitoring equipment;
- information technology systems; and
- customer support systems.
We believe that we will have a reasonable degree of flexibility to adjust
the amount and timing of these capital expenditures. However, we may need to
raise additional funds in order to take advantage of unanticipated
opportunities, such as acquisition opportunities that may arise in the U.S. and
internationally. 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 may be required to delay or abandon some
of our planned future expansion or expenditures if we fail to raise sufficient
funds.
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OUR ABILITY TO GROW DEPENDS ON OUR ABILITY TO EXPAND OUR SERVICE OFFERINGS AND
DISTRIBUTION CHANNELS
While we continue to seek to deepen and broaden our market presence in the
U.S. and internationally through acquisitions, our success is dependent on the
growth of our existing Internet access and Web hosting core service platforms.
We expect to drive this internal growth by expanding and enhancing our product
service base with additional value-added service capabilities and by
establishing further distribution capabilities. To a certain extent we may
develop these further product and distribution capabilities internally, but
expect that primarily we will look to formulate strategic relationships with
various vendors and distribution partners. Accordingly, it will be important
that we either develop these capabilities internally or identify suitable
potential product and service vendors and distributors with whom we are able to
complete agreements on acceptable terms. We expect that competition for
strategic relationships with key vendors and potential distributors could be
significant, and that we may have to compete with other companies with greater
financial and other resources to obtain these important relationships. We cannot
assure you that we will be able to identify suitable partnering candidates or be
able to complete agreements on acceptable terms with these parties.
OUR SUCCESS DEPENDS ON OUR SUCCESSFUL INTEGRATION EFFORTS
Our success depends in large part on our ability to integrate the
operations and management of the independent Internet operations we have
acquired and those we may acquire in the future. If we fail to integrate our
acquisitions successfully this may result in significant operating
inefficiencies, which in turn may adversely affect our operating results. We
have to expend substantial managerial, operating, financial and other resources
to integrate these businesses and implement our business model. In particular,
to integrate our newly acquired Internet operations successfully, we must:
- install and standardize adequate operational and control systems;
- deploy standard equipment and telecommunications facilities;
- employ qualified personnel to provide technical and marketing support in
new as well as existing locations;
- eliminate redundancies in overlapping network systems and personnel;
- incorporate acquired technology and products into our existing service
offerings;
- implement and maintain uniform standards, procedures and policies;
- standardize marketing and sales efforts under the common Verio brand; and
- continue the expansion of our managerial, operational, technical and
financial resources.
The process of consolidating and integrating acquired operations takes a
significant period of time, places a significant strain on resources, and could
prove to be more expensive and time-consuming than we have predicted. We may
increase expenditures in order to accelerate the integration and consolidation
process with the goal of achieving longer-term cost savings and improved
profitability. These expenses may include the following, among others:
eliminating redundant staffing positions; relocating personnel; canceling
overlapping Internet access contracts; closing down redundant points of presence
facilities; upgrading systems; and integrating these acquired providers' onto
our network, customer care, billing, financial and other national support
systems. For example, we recorded a one-time charge of approximately $1.9
million in 1998 relating to the elimination of 250 redundant positions. We
cannot assure you that our projected long-term cost savings and improvements in
profitability can or will be realized. We also cannot assure you that customer
support resources will be sufficient to manage the growth in our business or
that we will be successful in implementing our expansion program in whole or in
part.
In addition, future acquisitions could materially adversely affect our
operating results as a result of dilutive issuances of equity securities and the
incurrence of additional debt. In addition, the purchase price for many of these
acquired businesses likely will significantly exceed the fair values of the net
assets of the acquired businesses. As a result, material goodwill and other
intangible assets would be required to be recorded which would result in
significant amortization charges in future periods. These charges, in addition
to
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the financial impact of such acquisitions, could have a material adverse effect
on our business, financial condition and results of operations.
WE FACE CERTAIN KEY RISKS IN OUR INTEGRATION EFFORTS
We face certain key risks in successfully completing the integration of
newly acquired operations with our existing business. In particular, the
recently completed Hiway acquisition was a substantial transaction for Verio,
and difficulties we may experience associated with the integration of Hiway's
operations with our existing business may have an adverse impact on Verio. The
key integration challenges we face include:
- The acquired operations, facilities, equipment, service offerings,
networks, technologies, brand names, and sales, marketing and service
development efforts may not be effectively integrated with our existing
operations;
- anticipated cost savings may not be realized;
- integration efforts may divert our resources from our existing business;
- standards, controls, procedures and policies may not be maintained; and
- employees who are key to the acquired operations may choose to leave.
Any of these difficulties could interrupt our business and operations. We
cannot assure you that we will effectively realize any of the anticipated
benefits from the integration of our acquired operations, including from the
Hiway acquisition. Specifically with respect to Hiway, we expect to incur
significant integration expenses. Factors that could increase these costs
include: (1) unexpected employee turnover; (2) unforeseen delays in addressing
duplicate facilities and the associated costs of hiring temporary employees; and
(3) additional fees and charges to obtain consents, regulatory approvals or
permits.
Hiway was formed in May 1998 through a merger of Best Internet and Hiway.
Because the Best/Hiway Merger was accomplished fairly recently, the integration
of the operations of those two companies was not completed prior to our
acquisition of Hiway. It is likely that this integration effort will continue.
In the course of that integration effort, it is possible that facts or
circumstances may be discovered that we did not know at the time we executed the
agreement to acquire Hiway. We cannot assume that difficulties will not be
encountered in integrating Hiway, or that the specific benefits expected from
the Best/Hiway Merger will be achieved or that we will realize any of those
anticipated cost savings.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS GENERALLY
We expect to continue our acquisition and expansion strategy. Additional
acquisitions could have a material impact on the financial information we have
provided. Future acquisitions could materially adversely affect our operating
results as a result of dilutive issuances of equity securities and the
incurrence of additional debt. In addition, the purchase price for many of these
acquired businesses likely will significantly exceed the current fair values of
the net assets of the acquired businesses. As a result, material goodwill and
other intangible assets would be required to be recorded which would result in
significant amortization charges in future periods. These charges, in addition
to the financial impact of such acquisitions, could have a material adverse
effect on our business, financial condition and results of operations.
Up to now, we have recorded all business acquisitions under the purchase
method of accounting. With the acquisition of Hiway, which was completed on
January 5, 1999, we expect to record gross goodwill totaling approximately
$244.0 million, which will be amortized over a ten-year period from the
acquisition date. We cannot assure you of the number, timing or size of future
acquisitions, or the effect that any such acquisitions might have on our
operating or financial results.
THE FINANCIAL INFORMATION CONCERNING BUSINESSES WE ACQUIRE MAY BE INACCURATE
Many of the Internet service providers we have acquired did not have
audited financial statements, and this may be true for subsequent acquisitions
as well. These companies have had varying degrees of internal controls and
detailed financial information. Therefore, the financial information we are able
to provide in this
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Annual Report on Form 10-K includes financial information concerning certain
recently completed acquisitions for which audited financial statements may not
be available. Our subsequent audits of these recently acquired companies may
reveal significant issues with respect to revenues, expenses and liabilities,
contingent or otherwise, of any of these providers.
We have completed valuations of certain of our acquisitions (including
TABNet and Hiway). This process included evaluation of in-process research and
development programs. We could not allocate a meaningful value and will not be
recording any charge to operations for in-process research and development
relating to these acquisitions. We have followed the Commission's guidelines in
the valuation of in-process research and development.
OUR RAPID GROWTH MAY STRAIN OUR RESOURCES
We have been growing and expect to continue to grow rapidly. This rapid
growth has placed, and is likely to continue to place, a significant strain on
our managerial, operating, financial and other resources, including our ability
to ensure customer satisfaction. For example, as our customer base grows, and
their need for Internet bandwidth expands, we will need to acquire substantial
network capacity to support their needs. Our expansion efforts also require
significant time commitments from our senior management and places a strain on
their ability to manage our existing business. We also may be required to manage
multiple relationships with third parties as we expand our value-added service
offerings, including Web hosting. Our future performance will depend, in part,
upon our ability to manage this growth effectively. To that end, we will have to
undertake the following improvements, among others:
- implement additional management information systems capabilities;
- further develop our operating, administrative and financial and
accounting systems and controls;
- improve coordination between our engineering, accounting, finance,
marketing and operations; and
- hire and train additional personnel.
WE DEPEND UPON CHANNEL PARTNERS
We depend on third party channel partners to stimulate demand for our
products and services where we do not have a direct sales force. These channel
partners include computer and telecommunications resellers, value-added
resellers, original equipment manufacturers, systems integrators, Web designers
and advertising agencies. If we fail to gain commercial acceptance in certain
markets channel partners may discontinue their relationships with us. Conflicts
may develop between our direct sales force efforts and those of our channel
partners as well as among different channel partners. These conflicts could
affect our relationship with various channel partners. The loss of channel
partners, the failure of such parties to perform under agreements with us, or
the inability to attract other channel partners with the expertise and industry
experience required to market our products and services could adversely affect
us. Furthermore, sales through channel partners are usually at discounted rates.
Therefore, the resulting revenues and gross margins will be less than if we had
sold the same services directly.
WE FACE RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS AND EXPANSION
With our recent Web hosting acquisitions of iServer, TABNet, WWW and Hiway,
we now provide Web hosting services to customers in over 170 countries. We
expect to continue to expand in these and other international markets. The rate
of development and adoption of the Internet has been slower outside the U.S.,
and the cost of bandwidth outside the U.S. has been higher, which may adversely
affect our ability to expand operations, and increase our costs of operations
internationally. We cannot assure you that acceptance of the Internet or demand
for Internet access, Web hosting and other value-added Internet services will
increase significantly in any international markets.
We may need to enter into joint ventures or other outsourcing agreements
with third parties, acquire complementary businesses or operations, or establish
or maintain new operations outside the U.S. in order to conduct our foreign
operations successfully. However, we cannot assure you that we will be able to
obtain the
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permits and operating licenses required 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 expand our international
presence, there are certain risks inherent in doing business on an international
level. These 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;
- employment laws and practices in foreign countries;
- delays from customs brokers or government agencies;
- differences in technology standards;
- seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
- potentially adverse tax consequences.
We cannot assure you that these factors will not have an adverse effect on
our future international operations. In addition, we cannot assure you that
foreign laws or administrative practice relating to taxation, foreign exchange
or other matters will not change. Any such change could adversely affect us.
Effective January 1, 1999, 11 of the 15 member countries of the European
Union established fixed conversion rates between their existing sovereign
currencies and the euro, and adopted the euro as their common legal currency
(the "Euro Conversion"). We have not commenced any assessment of the effects or
potential impact that the Euro Conversion would have on us. Furthermore, certain
foreign governments, such as Germany, have enforced laws and regulations related
to content distributed over the Internet that are more strict than those
currently in place in the U.S. This could adversely affect our investment in
international operations such as WWW.
OUR MARKET IS EXTREMELY COMPETITIVE
The market for Internet access and related services is extremely
competitive. Verio anticipates 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. Current and prospective
competitors include:
- national, regional and local Internet service providers;
- global, national, and regional long distance and local exchange
telecommunications companies;
- cable television companies;
- direct broadcast satellite and wireless communications providers;
- on-line service providers; and
- Web hosting providers, and providers of other value-added Internet
services.
Verio believes that the following are the primary competitive factors in
this market:
- Maintaining a secure and reliable national network with sufficient
capacity, quality of service and scalability to support continued growth.
- Maintaining a knowledgeable and effective sales force and implementing
broad and effective distribution channels.
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- Providing knowledgeable and capable technical support personnel, and
prompt and efficient customer care services.
- Maintaining Internet system engineering and other technical expertise.
- Offering competitive prices.
- Making timely introductions of new products and services.
- Having sufficient financial resources.
- Having a recognized and trusted brand name.
Many of our competitors have significantly greater market presence, brand
recognition, and financial, technical, network capacity and personnel resources
than we do. All of the major long distance companies, also known as
interexchange carriers, offer Internet access services and compete with us. 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 access
market. In order to address the Internet access requirements of the current
business customers of long distance and local carriers, there is a move toward
integrating horizontally through acquisitions of, joint ventures with, and the
wholesale purchase of Internet access from, Internet service providers by these
telecommunications companies. In addition, many of the major cable companies and
other alternative service providers -- such as those companies utilizing
wireless terrestrial and satellite-based service technologies -- have announced
their plans to offer Internet access and related services. Accordingly, we
expect that we will experience increased competition from traditional and
emerging telecommunications providers. Many of these companies, in addition to
their substantially greater network coverage, market presence, and financial,
technical and personnel resources, also have large existing commercial customer
bases. Furthermore, they may have the ability to bundle Internet access with
basic local and long distance telecommunications services. This bundling of
services may have an adverse effect on our ability to compete effectively with
them and may result in pricing pressure on us that would adversely affect our
business, financial condition and results of operations.
The recent deployment and further planned deployment of broadband services
for high speed Internet access by cable and telephone companies through new
technologies such as cable modems and various digital subscriber lines
technologies also creates further competitive pressure in Verio's business.
While these providers initially targeted the residential consumer, more recently
a number of digital subscriber lines providers also have announced their intent
to offer digital subscriber lines services to our target business market. This
may significantly affect the pricing of our Internet access service offerings.
Similar to the co-marketing arrangement which we entered into with NorthPoint
Communications subsequent to December 31, 1998, a number of digital subscriber
lines providers have launched their services in conjunction with Internet
service providers, allowing those providers to offer Internet access over
digital subscriber lines circuits. These digital subscriber lines circuits,
which provide higher speed and lower latency Internet connections than a
standard dial-up phone connection, compete with our dedicated connectivity
offerings.
As we continue to expand internationally, we will encounter new
competitors. In some cases, we will be forced to compete with and buy services
from government-owned or subsidized telecommunications providers. Some of these
providers may enjoy a monopoly on telecommunications services essential to our
business. We cannot assure you that we will be able to purchase these services
at a reasonable price or at all. In addition to the risks associated with our
local competitors, foreign competitors may pose an even greater risk, as they
may possess a better understanding of their local markets and better working
relationships with local infrastructure providers and others. We cannot assure
you that we can obtain similar levels of local knowledge. Failure to obtain that
knowledge could place us at a significant competitive disadvantage.
WE DEPEND UPON OUR NETWORK INFRASTRUCTURE
Verio's success depends upon its ability to implement and expand its
national network infrastructure and support services at an acceptable cost. This
may require us to enter into additional agreements with providers of
infrastructure capacity and equipment and support services. We cannot assure you
that any of these agreements can be obtained on satisfactory terms and
conditions. We also anticipate that future expansions
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and adaptations of our network infrastructure may be necessary in order to
respond to growth in the number of customers served, increased demands to
transmit larger amounts of data and changes to our customers' product and
service requirements. This will require substantial financial, operational and
managerial resources. We cannot assure you that we will be able to expand or
adapt our network infrastructure to meet the industry's evolving standards or
our customers' growing demands and changing requirements on a timely or cost-
effective basis, or at all. Also, we may not be able to deploy successfully any
expanded and adapted network infrastructure.
OUR COSTS WILL INCREASE IF WE FAIL TO MAINTAIN OUR PEERING RELATIONSHIPS
The establishment and maintenance of peering relationships with other
Internet service providers is necessary in order to exchange traffic with other
Internet service providers without having to pay transit costs. The basis on
which the large national Internet service providers make peering available or
impose settlement charges is evolving. Recently, companies that have previously
offered peering have cut back or eliminated peering relationships and are
establishing new, more restrictive criteria for peering. If increasing
requirements associated with maintaining peering with the major national
Internet service providers develop, we may have to comply in order to maintain
our peering relationships. Failure to maintain peering relationships or
establish new ones, if necessary, would cause additional operating expenditures
which would adversely affect us.
OUR OPERATING RESULTS FLUCTUATE AND COULD DECLINE
Our operating results have fluctuated in the past and may fluctuate
significantly in the future depending upon a variety of factors, including the
incurrence of capital costs and the introduction of value-added services and new
services. Additional factors that may contribute to variability of operating
results include:
- the pricing and mix of services we offer;
- our customer retention rate;
- changes in pricing policies and product offerings by our competitors;
- growth in demand for network and Internet access services;
- one-time costs associated with acquisitions and regional consolidation;
and
- general telecommunications services' performance and availability.
We also have experienced seasonal variation in Internet use and, therefore,
revenue streams may fluctuate accordingly. In response to competitive pressures,
we may take certain pricing or marketing actions that could have a material
adverse effect on our business, financial condition and results of operations.
As a result, variations in the timing and amounts of revenues could have a
material adverse effect on our quarterly operating results. Therefore, we
believe that period-to-period comparisons of our operating results are not
necessarily meaningful and cannot be relied upon as indicators of future
performance. If our operating results in any future period fall below the
expectations of securities analysts and investors, the market price of our
securities would likely decline.
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 people with knowledge of
and experience in the Internet service industry. The process of locating
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
people. Our employees may voluntarily terminate their employment with us at any
time. We cannot assure you that we will be successful in attracting and
retaining qualified executives and personnel. The loss of the services of key
personnel, or the inability to attract additional qualified personnel, could
have a material adverse effect on its business, financial condition or results
of operations.
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OUR NETWORK SYSTEM COULD FAIL OR SHUTDOWN
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 the 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 facilities 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 point of presence facilities or even catastrophic failure
of the entire network.
Hiway historically has offered its customers a service level warranty,
under which Hiway commits that a customer's Web site will be available at least
99.9% of the time in each calendar month for as long as the customer is using
the services. If uptime falls below this level in any month, the customer is
entitled to certain service credits for that month. Verio has not implemented a
policy providing a similar service warranty to our customers generally, although
we may do so in the future based on various competitive factors. To the extent
that we provide such a service level warranty in the future, we could experience
a material decline in our revenues in connection with any significant system
downtime experienced by our customers or other material changes associated with
such warranty coverage.
We carry business personal property insurance at both scheduled locations
and unscheduled locations, with a blanket property limit of $10.0 million per
location and business interruption insurance with a blanket limit of $2.0
million per location. This insurance may not be adequate or available to
compensate us. In addition, we generally attempt to limit our liability to
customers by contractually disclaiming liability or limiting liability to a
usage credit based upon the amount of time that the system was down. We cannot
assure, however, that such limitations of liability will be enforceable. In any
event, significant or prolonged system failures or shutdowns could damage our
reputation and cause us to lose our customers.
OUR NETWORK MAY EXPERIENCE SECURITY BREACHES
The ability to provide secure transmission of information over the Internet
is a significant barrier to electronic commerce and communications. We have
implemented certain network security measures, such as limiting physical and
network access to our routers. Nonetheless, we cannot assure that our network
infrastructure will not be 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 incidents could deter potential customers and adversely affect 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, and the cost of eliminating these security
breaches could be prohibitively expensive.
WE MAY BE LIABLE TO CUSTOMERS FOR SECURITY BREACHES
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. 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. Although we attempt to limit
contractually our liability in such instances, the occurrence of these problems
may result in claims against or liability on our part. Such claims, regardless
of their ultimate outcome, could result in costly litigation and adversely
affect our business or reputation or our ability to attract and retain
customers. Moreover, until more consumer reliance is placed on security
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technologies available, the security and privacy concerns of existing and
potential customers may inhibit the growth of the Internet service industry and
our customer base and revenues.
WE DEPEND ON THE INTERNET AND INTERNET INFRASTRUCTURE DEVELOPMENT
Our products and services are targeted toward users of the Internet, which
has experienced rapid growth. Critical issues concerning the commercial use of
the Internet remain unresolved and may impact the growth of Internet use,
especially in our target business market. Despite growing interest in the many
commercial uses of the Internet, many businesses have been deterred from
purchasing Internet access services for a number of reasons, including:
- inconsistent quality of service;
- lack of availability of cost-effective, high-speed options;
- a limited number of local access points for corporate users;
- inability to integrate business applications on the Internet;
- the need to deal with multiple and frequently incompatible vendors;
- inadequate protection of the confidentiality of stored data and
information moving across the Internet; and
- a lack of tools to simplify Internet access and use.
In particular, numerous published reports have indicated that a perceived
lack of security of commercial data, such as credit card numbers, has
significantly impeded commercial use of the Internet to date. There can be no
assurance that encryption or other technologies will be developed that
satisfactorily address these security concerns. Published reports have also
indicated that capacity constraints caused by growth in the use of the Internet
may, unless resolved, impede further development of the Internet to the extent
that users experience delays, transmission errors and other difficulties. The
adoption of the Internet for commerce and communications, particularly by those
individuals and enterprises which have historically relied upon alternative
means of commerce and communication, generally requires the understanding and
acceptance of a new way of conducting business and exchanging information. In
particular, enterprises that have already invested substantial resources in
other means of conducting commerce and exchanging information may be
particularly reluctant or slow to adopt a new strategy that may make their
existing personnel and infrastructure obsolete. If the market for Internet
access services fails to develop, develops more slowly than expected, or becomes
saturated with competitors, or if the Internet access and services are not
broadly accepted, our business, operating results and financial condition will
be materially adversely affected. In addition, the rate of development and
adoption of the Internet has been slower outside of the United States and the
cost of bandwidth has been higher. The recent growth in the use of the Internet
has caused frequent periods of performance degradation, requiring the upgrade of
routers and switches, telecommunications links and other components forming the
infrastructure of the Internet by providers and other organizations with links
to the Internet. Any perceived degradation in the performance of the Internet as
a whole could undermine the benefits of our services. Consequently, the
emergence and growth of the market for our services is dependent on improvements
being made to the entire Internet infrastructure to alleviate overloading and
congestion.
WE MUST KEEP UP WITH TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS
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 leading technologies, to
continue to develop our technical expertise, to enhance our current services, to
develop new products and services that meet changing customer needs, and to
influence and respond to emerging industry standards and other technological
changes on a timely and cost-effective basis. We cannot assure that we will be
successful in accomplishing these tasks or that such new technologies or
enhancements will achieve market acceptance. We believe that our ability to
compete successfully is also dependent upon the continued compatibility and
interoperability of our services with products and architectures offered by
various vendors. We cannot assure
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that we will be able to effectively address the compatibility and
interoperability issues raised by technological changes or new industry
standards. In addition, we cannot assure that services or technologies developed
by others will not render our services or technology uncompetitive or obsolete.
For example, our services rely on the continued widespread commercial use of
Transmission Control Protocol/Internet Protocol ("TCP/IP"). Alternative open and
proprietary protocol standards that compete with TCP/IP, including proprietary
protocols developed by IBM and Novell, Inc., have been or are being developed.
The failure of the market for business-related Internet solutions to continue to
develop would adversely impact our business financial condition and result of
operations.
WE FACE 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 certain circumstances, be
subject to damages for copying or distributing copyrighted materials. Certain
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. These measures may
require that we spend substantial resources or discontinues certain product or
service offerings. Any of these actions could have a material adverse effect on
our business, operating results and financial condition.
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. For example, the European Union
recently enacted its own privacy regulations. 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.
We carry an errors and omissions insurance policy. This insurance may not
be adequate or available to compensate us for all liability that may be imposed.
WE MAY BECOME SUBJECT TO GOVERNMENT REGULATION
Although we are not currently subject to direct government regulation other
than regulations applicable to businesses generally, changes in the regulatory
environment relating to the Internet connectivity market could affect our
pricing. For example, proposed regulations at the Federal Communications
Commission would require discounted Internet connectivity rates for schools and
libraries. Due to the increasingly widespread use of the Internet, it is
possible that additional laws and regulations may be adopted. Such additional
laws could cover issues such as content, user pricing, privacy, libel,
intellectual property protection and infringement, and technology export and
other controls. We may be subject to similar or other laws and regulations in
non-U.S. jurisdictions.
Moreover, the FCC continues to review its regulatory position on the usage
of the basic network and communications facilities by Internet service
providers. Although in an April 1998 Report the FCC determined that Internet
service providers should not be treated as telecommunications carriers and
therefore not regulated, it is expected that future Internet Service Provider
regulatory status will continue to be uncertain. Indeed, in that report, the FCC
concluded that certain services offered over the Internet such as
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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.
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 regional
bell operating companies or other telecommunications companies, could adversely
affect us. Although the FCC has decided not to allow local telephone companies
to impose per-minute access charges on Internet service providers, and that
decision has been upheld by the reviewing court, further regulatory and
legislative consideration of this issue is likely. In addition, some telephone
companies are seeking relief through state regulatory agencies. Such rules, if
adopted, are likely to have a greater impact on consumer-oriented Internet
access providers than on business-oriented Internet service providers such as
Verio. 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.
WE DEPEND UPON SUPPLIERS AND LIMITED SOURCES OF SUPPLY
We rely on other companies to supply certain key components of our network
infrastructure, however, the quantity and quality of components we demand is
available only from limited sources. For example, we currently rely on Cisco
Systems to supply routers critical to our network. We could be adversely
affected if routers from Cisco were to become unavailable on commercially
reasonable terms. Qwest, Sprint, MCI and MFS, which are our competitors, are our
primary providers of data communications facilities and network capacity. We
also are dependent upon local exchange carriers, which often are our
competitors. Local exchange carriers provide telecommunications services and
lease physical space to us for routers, modems and other equipment. We have from
time to time experienced delays in our telecommunications services, which can
lead to the loss of existing or potential customers. We cannot assure that, on
an ongoing basis, we will be able to obtain such services cost-effectively and
on the scale and within the time frames we require, or at all. Failure to obtain
or to continue to make use of such services would have a material adverse effect
on its business, operating results and financial condition.
OUR BUSINESS MAY BE ADVERSELY IMPACTED BY YEAR 2000 ISSUES
We are aware of the issues associated with the programming code in existing
computer systems as the year 2000 approaches. The "Year 2000" problem is
concerned with whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate wrong data or fail. The Year 2000
problem is pervasive and complex, as virtually every company's computer
operations will potentially be affected in some way.
We are currently engaged in a phased process to evaluate our internal
status with respect to the Year 2000 issue. The first phase, systems assessment,
was completed in the fourth quarter of 1998. Phase two, risk assessment and
contingency planning, is expected to be completed during the second quarter of
1999. Phase three, testing and final verification, is expected to be completed
in the third quarter of 1999.
We hired outside consultants and used certain designated employees in our
evaluation of possible Year 2000 problems. To date, we have not discovered Year
2000 issues in the course of our assessment that would have a material adverse
effect on our business, results of operations or financial condition; however,
we cannot assure you that errors or defects would not be discovered in the
future or remain undetected.
Concurrently with the analysis of our internal systems, we have begun to
survey third-party entities with which we transact business, including critical
vendors, suppliers and financial institutions, for Year 2000 compliance. With
respect to the most critical vendors, we are in the process of evaluating the
Year 2000 preparedness of our telecommunications providers, on which we are
reliant for the network services crucial to our business. We expect to complete
this survey in the second quarter of 1999. If we, or any of our key suppliers or
vendors, fail to mitigate internal and external Year 2000 risks, we may
temporarily be unable to provide our services to our customers or engage in
normal business activities which could have a material adverse effect on our
business, financial condition and results of operations.
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STOCK PRICE VOLATILITY
The market price of our common stock has fluctuated significantly in the
past, and is likely to continue to be highly volatile. To date, the trading
volume in our stock has been relatively low and significant price fluctuations
can occur as a result. If the low trading volumes experienced to date continue,
such fluctuations could occur in the future. We cannot assure that the sales
price of our common stock will not fluctuate or decline significantly in the
future. In addition, the U.S. equity markets have from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the stocks of technology companies. These broad market
fluctuations may materially adversely affect the market price of our common
stock in future. Such fluctuations and variations may be the result of changes
in our business, operations or prospects, announcements of technological
innovations and new products by competitors, Verio or its competitors entering
into new contractual relationships with strategic partners, proposed
acquisitions by Verio or its competitors, financial results that fail to meet
public market analyst expectations of performance, regulatory considerations and
general market and economic conditions in the U.S. and throughout the world.
ITEM 2. PROPERTIES.
Verio's corporate headquarters is located in Englewood, Colorado where it
leases approximately 43,400 square feet of office space. Its lease agreement,
which commenced February 1, 1998 is for a term of five years. Verio also has
executed a lease covering approximately 20,700 square feet of space in the
InfoMart in Dallas, Texas, where it maintains its network operations center and
customer support center. That lease expires on June 30, 2002. Verio also has
executed a ten-year lease covering approximately 6,203 square feet in Vienna,
Virginia, where it maintains a data center and offices for locally-based
personnel. That lease expires on May 31, 2008. Verio also leases space,
typically less than 200 square feet, in various geographic locations to house
network infrastructure and telecommunications equipment. Certain operational
functions are also located in various regional operation offices, where Verio
typically is party to lease agreements for administrative office space
sufficient for locally based personnel, as well as smaller site leases to house
network equipment. Hiway's principal executive offices and data center was
located in Boca Raton, Florida. The lease, which covers rentable area of
approximately 78,971 square feet, commenced on February 1, 1998 and is for a
term of seven years, expiring on January 31, 2005. Verio currently uses this
space to house locally-based personnel and as a data center. Hiway also entered
into a seven year lease for approximately 15,850 square feet of office space in
Mountain View, California. This lease commenced on June 1, 1995 and expires on
May 31, 2002. Verio currently uses this space for a data center and to house
locally-based personnel.
ITEM 3. LEGAL PROCEEDINGS.
Verio is party to various legal proceedings that have arisen in the
ordinary course of business, none of which is material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The common stock of Verio has been traded on the Nasdaq National Market
(Nasdaq Symbol: VRIO) since the completion of our initial public offering on May
15, 1998. Prior to that date, there was no public market for our common stock.
The following table presents for the periods indicated the high and low bid
prices for our common stock, as reported by the Nasdaq National Market.
PRICE RANGE OF
COMMON STOCK
------------------
HIGH/ASK LOW/BID
-------- -------
Fiscal Year Ended December 31, 1998
Second Quarter (from May 15, 1998)........................ $30.00 $16.50
Third Quarter............................................. $31.875 $18.00
Fourth Quarter............................................ $28.75 $13.00
On March 26, 1998, the closing price of our common stock as reported on the
Nasdaq National Market was $45.688 per share. As of March 26, 1998, there were
approximately 425 holders of record of our common stock.
We have never declared or paid any dividends on our common stock and do not
expect to pay dividends in the foreseeable future. Verio's current policy is to
retain all of its earnings to finance future growth and acquisitions.
Furthermore, the terms of the indentures relating to each of the November 1998
Notes, the March 1998 Notes and the 1997 Notes, as well as the $70.0 million
revolving credit facility, place limitations on our ability to pay dividends.
Future dividends, if any, will be at the discretion of our board of directors
and will depend upon, among other things, our operations, capital requirements
and surplus, general financial condition, contractual restrictions and such
other factors as our board of directors may deem relevant.
Our initial public offering ("IPO") was effected through a Registration
Statement on Form S-1 (File No. 333-47099) that was declared effective by the
SEC on May 12, 1998 and pursuant to which we sold an aggregate of 5,500,000
shares of our common stock. On June 15, 1998, the managing underwriters of our
IPO partially exercised the over-allotment option selling an additional 235,000
shares of our common stock. Concurrently with the IPO we completed the sale of
4,493,877 shares of our common stock to an affiliate of NTT. Total aggregate net
proceeds were $220.8 million.
As of December 31, 1998, we had used all of the aggregate net proceeds from
our IPO and the NTT investment as follows:
General operating expenses:................................. $78.3 million
Transit and other telecommunications expense:............... $33.9 million
Acquisitions................................................ $91.4 million
Capital Equipment........................................... $17.2 million
The foregoing amounts represent our best estimate of our use of proceeds
for the period indicated. None of the net proceeds of the IPO were paid directly
or indirectly to any of our directors, officers, general partners or their
associates, persons owning 10 percent or more of any class of our equity
securities, or our affiliate.
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ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA
(In Thousands, Except Share and Per Share Data)
The selected historical consolidated financial data as of December 31,
1996, 1997 and 1998, and for the period from inception (March 1, 1996) to
December 31, 1996 and for the years ended December 31, 1997 and 1998 have been
derived from our audited Consolidated Financial Statements included elsewhere in
this Annual Report on Form 10-K.
The information contained below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Consolidated Financial Statements and the notes thereto
included elsewhere in this Annual Report on Form 10-K. Results of operations for
the period from inception to December 31, 1996 and the years ended December 31,
1997 and 1998 are not necessarily indicative of results of operations for future
periods. Our development and expansion activities, including acquisitions,
during the periods shown below may significantly affect the comparability of
this data from one period to another.
We define EBITDA as earnings (loss) from operations before interest, taxes,
depreciation, amortization and provision for loss on write-offs of investments
in Internet service providers and fixed assets and includes non-cash stock
option compensation and severance costs. The primary measure of operating
performance is net earnings (loss) and not EBITDA. Although EBITDA is a measure
commonly used in our industry, it should not be considered as an alternative to
net earnings (loss) (determined in accordance with generally accepted accounting
principles ("GAAP")) as an indicator of operating performance, or as an
alternative to cash flows from operating activities (determined in accordance
with GAAP). In addition, our definition of EBITDA may not be comparable to other
similarly titled measures of other companies.
For purposes of presenting capital expenditures, we have excluded equipment
and leasehold improvements acquired in our business acquisitions.
PERIOD FROM INCEPTION
(MARCH 1, 1996) TO YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998
--------------------- ----------------- -----------------
STATEMENT OF OPERATIONS DATA:
Total revenue..................... $ 2,365 $ 35,692 $ 120,653
Total costs and expenses.......... 8,645 75,981 211,671
-------- ---------- -----------
Loss from operations.............. $ (6,280) $ (40,289) $ (91,018)
======== ========== ===========
Loss before extraordinary item.... $ (5,122) $ (46,069) $ (111,854)
======== ========== ===========
Net loss.......................... $ (5,122) $ (46,069) $ (121,955)
======== ========== ===========
Net loss attributable to common
stockholders.................... $ (5,145) $ (46,329) $ (122,042)
======== ========== ===========
Loss per common share -- basic and
diluted:
Loss per common share before
extraordinary item........... $ (5.29) $ (40.47) $ (5.24)
======== ========== ===========
Loss per common share........... $ (5.29) $ (40.47) $ (5.71)
======== ========== ===========
Weighted average common shares
outstanding -- basic and
diluted......................... 971,748 1,144,685 21,376,322
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AS OF
-----------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
----------------- ------------ ------------
BALANCE SHEET DATA:
Cash and cash equivalents and short-term
investments............................... $66,467 $ 72,586 $ 577,387
Restricted cash and securities.............. -- 40,554 14,805
Goodwill, net............................... 8,763 83,216 236,696
Total assets................................ 82,628 246,471 933,712
Long-term debt and capital lease
obligations, net of discount.............. 106 142,321 674,618
Redeemable preferred stock.................. 76,877 97,249 --
Stockholders' equity (deficit).............. (4,055) (27,001) 202,681
PERIOD FROM
INCEPTION
(MARCH 1, 1996) YEAR ENDED YEAR ENDED
TO DECEMBER 31, DECEMBER 31,
DECEMBER 31, 1996 1997 1998
----------------- ------------ ------------
SUPPLEMENTAL FINANCIAL DATA:
EBITDA...................................... $(5,611) $ (29,665) $ (51,292)
Cash flows from operations.................. (2,326) (35,323) (64,239)
Cash flows from investing activities........ (9,123) (130,254) (284,891)
Cash flows from financing activities........ 77,916 161,772 719,892
Capital expenditures........................ 3,430 14,547 23,058
Cash dividends.............................. -- -- --
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the financial statements and related notes included elsewhere in this Form 10-K.
We account for investments in affiliates in which we acquire a minority interest
at cost. We account for investments in affiliates in which we acquire a majority
interest, through the acquisition of net assets, common stock or convertible
preferred stock, and where we exercise significant control over the operations,
using purchase accounting. As such, we consolidate the financial results of
these acquired operations with our financial results. This discussion contains
forward-looking statements based on current expectations, which involve risks
and uncertainties. Actual results and the timing of certain events could differ
materially from the forward-looking statements as a result of a number of
factors including those referred to in Factors Affecting Future Operating
Results.
OVERVIEW
Our Company was founded in March 1996. Since then, we have rapidly
established a global presence through acquiring, integrating and growing of
local Internet service providers with a business customer focus. We had,
together with our subsidiaries, total revenue of approximately $120.7 million
for the year ended December 31, 1998. Taking into account the combined revenue
of all majority owned acquired operations as of December 31, 1998, the pro forma
combined revenue for the three-month period ended December 31, 1998 was
approximately $39.9 million. The acquisition of Best Internet Communications,
Inc. (doing business as Hiway Technologies, Inc.) was completed on January 5,
1999. This acquisition would have increased our pro forma combined revenue for
the three months ended December 31, 1998 to approximately $50.4 million.
Our initial strategy was to acquire 51% to 100% of a large regional
Internet service provider, and a minority interest in smaller Internet service
providers within designated geographic regions. We have moved to a strategy of
acquiring 100% of new businesses. During the second quarter of 1998, we
completed the buyout of the remaining equity interests in all but one of the
operations in which we initially acquired less than a 100% interest. Since then,
we have undertaken to consolidate the ownership and management of the acquired
operations into five geographic operating regions. In addition, we have
integrated their network operations, customer support, marketing efforts,
financial and accounting systems, and other back-office functions onto our
national systems, in order to be more efficient. Although we have incurred
significant one-time costs in these consolidation efforts, we expect to
recognize substantial long-term cost savings as a result. We have the
contractual right to effect the buyout of the one remaining affiliate in which
we do not hold 100% ownership. In 1998 we incurred costs of approximately $52.0
million, in the aggregate, in connection with a total of 11 buyouts, and
approximately $116.1 million for acquisitions, which amounts were paid in cash,
shares of Verio stock and options to acquire stock. As a result of these
acquisitions, and the limited amount of fixed assets required to operate an
affiliate, we recorded significant amounts of goodwill in 1998, in the amount of
$171.5 million.
On July 7, 1998, we completed the acquisition of NTX, Inc. (doing business
as TABNet). We paid a purchase price of approximately $45.8 million in cash to
TABNet's shareholders. In January 1999, we closed the Hiway acquisition, for
which we paid total consideration of approximately $176.0 million in cash and
4.92 million fully diluted shares of our common stock to Hiway's shareholders,
option holders and warrant holders. In connection with the Hiway acquisition, we
expect to record additional goodwill in the amount of approximately $244.0
million which will increase goodwill significantly in 1999.
To fund our acquisitions and operations, from inception through December
31, 1998 we raised approximately $320.5 million from equity capital financings,
including approximately $120.8 million (after deducting underwriting discounts,
commissions and expenses) in our IPO. This additional capital was used to fund
our acquisitions and operations. We also raised approximately $100.0 million in
connection with the sale of our common stock to an affiliate of Nippon Telegraph
and Telephone Corporation, which occurred together with our IPO in May 1998. We
also have raised a total of $725.0 million in debt, of which $50.0 million has
been repaid. In 1997, we issued $150.0 million principal amount of 13 1/2%
senior notes due 2004 (the "1997 Notes") to a group of institutional investors
and Brooks Fiber Properties, Inc., $100.0 million of which remain outstanding
following the repurchase of $50.0 million principal amount of the 1997 Notes
previously held by
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Brooks (the "Refinancing"). On March 25, 1998, we sold $175.0 million principal
amount of 10 3/8% senior notes due 2005 (the "March 1998 Notes"), a portion of
the proceeds of which was used to effect the Refinancing. On November 25, 1998,
we sold $400 million principal amount of 11 1/4% senior notes due 2008 (the
"November 1998 Notes") resulting in net proceeds of approximately $389 million.
See " -- Liquidity and Capital Resources."
We have incurred net losses since we were formed. For the period from
inception to December 31, 1996, the year ended December 31, 1997, and the year
ended December 31, 1998, we reported net losses of ($5.1) million, ($46.3)
million, and ($122.0) million, respectively. We expect to continue to incur
significant additional losses. See "Factors Affecting Future Operating
Results -- We expect continuing losses."
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1998
The following table presents operating data, as a percentage of total
revenue, for the years ended December 31, 1997 and 1998. This information is
from our Consolidated audited financial statements included in this Form 10-K.
This information should be read in conjunction with the consolidated Financial
Statements and Notes.
YEARS ENDED
DECEMBER 31,
-------------
1997 1998
---- ----
Revenue:
Internet connectivity..................................... 66% 63%
Enhanced services and other............................... 34% 37%
---- ----
Total revenue..................................... 100% 100%
Costs and expenses:
Cost of service........................................... 45% 45%
Sales and marketing....................................... 30% 27%
General and administrative and other...................... 108% 70%
Depreciation and amortization............................. 30% 33%
---- ----
Total costs and expenses.......................... 213% 175%
---- ----
Loss from operations.............................. (113%) (75%)
---- ----
Other income (expense):
Interest income........................................... 17% 12%
Interest expense.......................................... (33%) (30%)
Equity in losses of affiliates............................ (5%) --
---- ----
Loss before minority interests and extraordinary
item............................................. (134%) (93%)
Minority interests.......................................... 5% --
---- ----
Loss before extraordinary item.................... (129%) (93%)
Extraordinary item -- loss related to debt repurchase....... -- (8%)
---- ----
Net loss.......................................... (129%) (101%)
==== ====
Revenue
The majority of revenue is received from business customers who purchase
Internet connectivity, Web hosting products, and other enhanced services. Verio
offers a broad range of connectivity options to its customers including
dedicated, Digital Subscriber Line ("DSL"), Integrated Services Digital Network
("ISDN"), frame relay and dial-up connections. Connectivity customers typically
pay fixed, recurring monthly service charges plus a one-time setup fee. These
charges vary depending on the type of service, the length of the contract, and
local market conditions. Connectivity customers typically sign a contract for
one year of service. Web hosting customers typically pay fixed, recurring
monthly service charges plus a one-time
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setup fee. These charges vary depending on the amount of disk space and transit
required by the customer. Other enhanced services include e-commerce, virtual
private networks, security services, co-location services, consulting and the
sales of equipment and customer circuits. Revenue for all products is recognized
as the service is provided. Amounts billed relating to future periods are
recorded as deferred revenue and amortized monthly as services are rendered.
In 1997 and 1998, connectivity services generated approximately two-thirds
of total revenue. In 1999 and beyond, revenue from Web hosting and other
enhanced services is expected to represent approximately 50% or more of total
revenue. The increase in revenue from Web hosting and other enhanced services is
primarily the result of recent acquisitions that have been concentrated in these
businesses. Verio has experienced some seasonality in its internal revenue
growth, with the period of higher growth being the fall and winter. Verio's
focus is on services that generate recurring revenues from small and mid sized
business customers. Revenues from business customers currently represent
approximately 90% of revenue, and approximately 80% of revenues are recurring.
No single customer represents more than 2% of revenue.
Total revenue increased 238% from $35.7 million for the year ended December
31, 1997 to $120.7 million for the year ended December 31, 1998. Acquisitions
completed after December 31, 1997 contributed significantly to this increase,
adding $41.4 million of the $85.0 million increase.
Cost of Service
Cost of service consists primarily of local telecommunications expense and
Internet access expense. Local telecommunications expense is primarily the cost
of transporting data between Verio's local Points of Presence ("POPs") and a
national POP. Internet access expense is the cost that Verio pays to lease fiber
capacity that it uses to carry its customers' data between national POPs on the
Internet. Prior to being acquired by Verio, most of Verio's businesses entered
into contracts with third parties for Internet access. Verio is in the process
of converting that traffic carried by third parties to its own network, and
expects to be substantially finished by the end of 1999. In March 1998, Verio
signed a 15 year agreement with Qwest Communications Corporation ("Qwest") (the
"Capacity Agreement") in order to fix and reduce the per-unit costs of leasing
fiber. That contract was amended in 1999 to further reduce the per-unit costs
and to increase Verio's commitment, which is now to spend a minimum of $160
million over the first 10 years of the contract. While Verio will continue to
use a variety of fiber providers for its national network, it expects to use
Qwest for the majority of its fiber requirements. Verio has the right to prepay
its minimum commitment under this contract. Such capitalized costs would be
amortized over the term of the commitment. The amount of the prepayment at
December 31, 1998 would have been approximately $84.1 million.
Cost of service increased $38.0 million, from $16.0 million for the year
ended December 31, 1997 to $54.0 million for the year ended December 31, 1998,
primarily due to acquisitions. However, as a percentage of revenue, cost of
service remained constant between the two years, at 45%. Verio expects cost of
service to increase in absolute dollars but to decrease as a percentage of total
revenue. This decrease is expected to occur as Verio's revenue mix shifts to
more high margin Web hosting and enhanced services, as traffic is shifted from
third party networks to the Verio network, and as more traffic is carried by
Qwest.
Sales and Marketing Expense
Sales and marketing expense consists primarily of salaries, commissions and
advertising. Sales and marketing expense decreased from 30% of total revenue for
the year ended December 31, 1997 to 27% for the year ended December 31, 1998,
due in part to efficiencies gained from the regionalization and nationalization
of certain sales and marketing functions. These savings were partially offset by
increased expenses related to an increase in the number of direct sales
representatives and marketing personnel, and the initiation of a national
advertising campaign.
General and Administrative Expense
General and administrative expense consists primarily of salaries and
related benefits, and includes the expenses of general management, engineering,
customer care, accounting, billing, and office space. General
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and administrative expense increased $46.0 million, from $38.6 million for the
year ended December 31, 1997 to $84.6 million for the year ended December 31,
1998, primarily due to acquisitions. However, as a percentage of revenue,
general and administrative expense decreased from 108% to 70%, which was the
result of efficiencies being realized by combining the operations of numerous
acquisitions. In 1998, Verio incurred significant one-time expenses in
connection with the operational consolidation and integration of its
acquisitions. These expenses included approximately $1.9 million primarily
related to severance costs in connection with the elimination of approximately
250 positions which are no longer necessary due to the efficiencies of the
national services. These terminations have begun and will continue through the
second quarter of 1999. The remaining liability for unpaid severance costs
totaled approximately $1.2 million at December 31, 1998.
General and administrative expenses are expected to continue to increase in
absolute dollars but to decrease as a percentage of total revenue as Verio
increases its revenues. Verio's scalable systems limit the number of additional
personnel, and the need for additional office space to support incremental
revenue. One-time integration expenses are expected to continue as the
integration of previously acquired companies is not yet complete, and due to the
cost of integrating future acquisitions.
Depreciation and Amortization
Depreciation is provided over the estimated useful lives of assets ranging
from 3 to 5 years using the straight-line method. The excess of cost over the
fair value of net assets acquired, or goodwill, is amortized using the
straight-line method over a ten-year period. Additional acquisitions and
investments are expected to cause depreciation and goodwill amortization to
increase significantly in the future.
Other Expenses
Interest expense increased from $11.9 million for the year ended December
31, 1997 to $35.9 million for the year ended December 31, 1998, primarily as a
result of the issuance of the 1997 Notes, the March 1998 Notes and the November
1998 Notes. Interest income increased from $6.1 million for the year ended
December 31, 1997 to $14.6 million for the year ended December 31, 1998 due to
increased cash balances resulting from the debt and equity offerings. See
"-- Liquidity and Capital Resources."
In 1998, an extraordinary loss of $10.1 million was recorded in connection
with the refinancing of $50.0 million of the 1997 Notes. See "-- Liquidity and
Capital Resources."
During the year ended December 31, 1997, Verio recognized equity in losses
of affiliates of $2.0 million under the equity method of accounting for
investments owned 50% or less. Such losses were not significant for the year
ended December 31, 1998. See Note 1 to the Consolidated Financial Statements of
the Company.
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PERIOD FROM INCEPTION TO DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED
DECEMBER 31, 1997
The following table presents operating data as a percentage of total
revenue for the period and year ended December 31, 1996 and 1997. This
information is from our Consolidated audited financial statements included in
this Form 10-K. This information should be read in conjunction with the
consolidated Financial Statements and Notes.
PERIOD AND
YEAR ENDED
DECEMBER 31,
-------------
1996 1997
---- ----
Revenue:
Internet connectivity..................................... 95% 66%
Enhanced services and other............................... 5% 34%
---- ----
Total revenue..................................... 100% 100%
Costs and expenses:
Cost of service........................................... 41% 45%
Sales and marketing....................................... 51% 30%
General and administrative and other...................... 246% 108%
Depreciation and amortization............................. 28% 30%
---- ----
Total costs and expenses.......................... 366% 213%
---- ----
Loss from operations.............................. (266%) (113%)
==== ====
Other income (expense):
Interest income........................................... 25% 17%
Interest expense.......................................... (5%) (33%)
Equity in losses of affiliates............................ --% (5%)
---- ----
Loss before minority interests and extraordinary
item............................................ (245%) (134%)
Minority interests.......................................... 29% 5%
---- ----
Net loss.......................................... (217%) (129%)
---- ----
Number of ISPs consolidated at end of period................ 3 22
==== ====
Number of ISPs consolidated for entire period............... 0 3
==== ====
Revenue
Total consolidated revenue was $2.4 million for the period from inception
(March 1, 1996) to December 31, 1996 (the "1996 Period"), compared to $35.7
million for the year ended December 31, 1997. Revenue attributable to
acquisitions completed in 1996 accounted for $2.4 million or 100% of total
revenue for the 1996 Period. The increase in revenue, and in the percentage of
revenue derived from enhanced services, from the 1996 Period to the year ended
December 31, 1997 was primarily due to acquisitions. Acquisitions completed
after December 31, 1996 contributed significantly to this increase, adding $22.3
million of the $33.3 million increase.
Cost of Service
Cost of service increased $15.0 million from $1.0 million for the period
ended December 31, 1996 to $16.0 million for the year ended December 31, 1997,
primarily due to acquisitions. As a percentage of revenue, cost of service
increased from 41% to 45% primarily as a result of the buildout of the national
network and the expense associated with the Internet access contracts that
existed at acquired companies, which are in the process of being canceled as the
traffic is moved onto the national network.
Sales and Marketing Expense
Sales and marketing expense consists primarily of salaries, commissions and
advertising. Sales and marketing expenses decreased from 51% of total revenue
for the year ended December 31, 1996 to 30% for the
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year ended December 31, 1998, due in part to efficiencies gained from the
regionalization and nationalization of certain sales and marketing functions.
General and Administrative Expense
General and administrative expense consists primarily of salaries and
related benefits, and includes the expenses of general management, engineering,
customer care, accounting, billing, and office space. General and administrative
expense increased $32.8 million, from $5.8 million for the period ended December
31, 1996 to $38.6 million for the year ended December 31, 1998, primarily due to
acquisitions and the development of our administrative infrastructure. As a
percentage of revenue, General and administrative expense decreased from 246% to
108% primarily due to the significant increase in revenue without a commensurate
increase in general management expenses.
Other Expenses
During the year ended December 31, 1997, the Company recognized equity in
losses of affiliates in the amount of $2.0, representing losses of those
affiliates in excess of the equity of the common shareholders of the affiliates.
Such losses were not significant in 1996. See Note 1 to the Consolidated
Financial Statements of the Company.
Interest expense increased from $0.1 million in the 1996 Period to $11.8
million for the year ended December 31, 1997 primarily as a result of the
completion of the placement of the 1997 Notes. Interest income increased from
$0.6 million for the period ended December 31, 1996 to $6.1 million for the year
ended December 31, 1997 due to increased cash balances resulting from the 1997
Notes, and the issuance of $20.0 million of Series C Preferred Stock. See
"-- Liquidity and Capital Resources."
Income Taxes
As of December 31, 1998, a net operating loss carryforward for federal
income tax purposes of approximately $133.1 million was available to offset
future federal taxable income, if any, through 2018. The utilization of a
portion of the net operating loss carryforwards may be limited under Section 382
of the Internal Revenue Code. No tax benefit for such losses has been recorded
by Verio in 1996, 1997 or 1998 due to uncertainties regarding the utilization of
the loss carryforward.
Stock-Based Compensation
We account for our stock-based compensation plans in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and Related Interpretations. Since inception, we have granted stock
options with exercise prices equal to the fair value of the underlying Common
Stock, as determined by our Board of Directors and based on our sales of stock
to third parties and based on quoted market prices subsequent to our IPO.
Accordingly, we have not recorded compensation expense related to the granting
of stock options in 1996, 1997 and through February 28, 1998. Subsequent to
February 28, 1998, and prior to the IPO, we granted options to employees with
exercise prices which were less than $22 per share, which was the low end of the
IPO filing range immediately prior to the IPO. We are recording compensation
expense totaling approximately $8.2 million representing the difference between
the strike prices of the options granted and $22 per share pro rata over the
forty-eight month vesting period of the options. Compensation expense in 1998
related to these options was $1.9 million. No compensation expense was recorded
in 1996 or 1997.
Depreciation and Amortization
Depreciation and amortization increased from December 31, 1996 to December
31, 1997 primarily due to the acquisition of affiliates and capital
expenditures.
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CASH FLOW ACTIVITY
Fiscal 1998 -- Net cash used by operating activities was $64.2 million
during the year ended December 31, 1998, which includes an increase in cash of
$4.5 million related to working capital items. Sources of cash included
approximately $120.8 million net proceeds from our IPO, $100.0 million from the
sale of common stock to an affiliate of NTT, $175.0 million from the March 1998
Notes and $400.0 million from the November 1998 Notes. Cash used during 1998 was
primarily for business combinations and capital expenditures, $151.1 million and
$23.1 million, respectively. Verio also used approximately $54.5 million of the
proceeds from the March 1998 Notes to repurchase $50.0 million principal amount
of the 1997 Notes.
Fiscal 1997 -- Net cash used by operating activities was $35.3 million
during the year ended December 31, 1997, which includes an increase in cash of
$0.1 million related to working capital items. Sources of cash included
approximately $20.0 million from the sale of 2.5 million shares of Series C
preferred stock and $150.0 million from the issuance of the 1997 Notes. Cash
used during 1997 was primarily for business combinations and capital
expenditures, $64.0 million and $14.5 million, respectively. Additionally,
approximately $46.6 million was invested in a restricted cash account to service
interest payments on the 1997 Notes.
LIQUIDITY AND CAPITAL RESOURCES
Our business strategy has required and is expected to continue to require
substantial capital for acquisitions and investments, capital expenditures, and
operating losses.
In 1996, we raised approximately $78.1 million from the sale of Series A
and B Preferred Stock and approximately $1.1 million from the sale of Common
Stock.
In 1997, we raised approximately $20.0 million from the sale of Series C
Preferred Stock, and issued 680,000 shares of Series D-1 Preferred Stock in
connection with an acquisition.
On June 24, 1997, we completed the placement of $150.0 million principal
amount of the 1997 Notes and attached warrants (the "Warrants"). One hundred and
fifty thousand units were issued, each consisting of $1,000 principal amount of
Notes and eight Warrants. The 1997 Notes mature on June 15, 2004 and interest,
at the annual rate of 13 1/2%, is payable semi-annually in arrears on June 15
and December 15 of each year. Each Warrant entitles the holder thereof to
purchase 1.76 shares of Verio's Common Stock at a price of $.01 per share, for a
total of 2,112,480 shares of Common Stock. The Warrants and the 1997 Notes were
separated on December 15, 1997. Concurrent with the completion of the sale of
the 1997 Notes, we were required to deposit funds into an escrow account in an
amount that together with interest is sufficient to fund the first five interest
payments. The 1997 Notes are redeemable at our option commencing June 15, 2002.
The 1997 Notes are senior unsecured obligations ranking equally in right of
payment with all existing and future unsecured and senior indebtedness.
In 1998, on March 25, we completed the placement of $175.0 million
principal amount of the March 1998 Notes. The March 1998 Notes are senior
unsecured obligations ranking equally in right of payment with all existing and
future unsecured and senior indebtedness, and mature on April 1, 2005. Interest
on the March 1998 Notes, at the annual rate of 10 3/8%, is payable semi-annually
in arrears on April 1 and October 1 of each year, commencing October 1, 1998.
The March 1998 Notes are redeemable at our option commencing April 1, 2002.
Verio used approximately $54.5 million of the proceeds from the March 1998 Notes
to repurchase $50.0 million principal amount of 1997 Notes from Brooks Fiber
Properties, Inc. ("Brooks") (the "Refinancing"). Upon consummation of the sale
of the March 1998 Notes and the Refinancing, $13.3 million of escrowed interest
funds were released to us.
At various times during the first four months of 1998, we issued 1,534,513
additional shares of Series D-1 Preferred stock in connection with the purchases
of substantially all the remaining unowned interests in our subsidiaries and
affiliates.
On April 6, 1998, we entered into a $57.5 million revolving credit facility
with a group of commercial lending institutions secured by the stock of our
subsidiaries and the Qwest Capacity Agreement. The credit facility was increased
to $70.0 million on September 25, 1998. The credit facility requires no payments
of
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principal until its maturity on December 31, 1999. The terms of the credit
facility provide for borrowings at a margin of 2% above the London Interbank
Offer Rate. There is a commitment fee of 1/2% per annum on the undrawn amount
of the credit facility and a one-time fee of 1/2% on any amounts drawn. The
last $3.0 million of the credit facility can only be drawn for the payment of
interest. We have made no borrowings under the credit facility.
The credit facility contains many other restrictions, including limitations
on our ability to:
- engage in businesses other than the Internet service business;
- place liens on our assets; and
- pay dividends.
Furthermore our indebtedness (less cash) may not exceed 2.35 times our
annualized pro forma revenue for the most recent quarter. We currently have the
ability to borrow the full $70.0 million commitment. We are required to pay back
any amounts borrowed under the credit facility with the proceeds of new
indebtedness, certain asset sales, free cash flow in excess of $5.0 million in
any quarter, or the net proceeds from insurance claims.
In 1998, we completed our IPO, selling an aggregate of 5,735,000 shares of
common stock (including the partial exercise of the over-allotment option by the
underwriters in the IPO) for net proceeds of approximately $120.8 million after
deducting underwriting discounts, commissions and expenses. Concurrently with
our IPO, we completed the sale of 4,493,877 shares of common stock to an
affiliate of NTT for net proceeds of approximately $100.0 million.
On November 25, 1998, we sold $400.0 million principal amount of the
November 1998 Notes, for net proceeds of approximately $389.0 million. Interest
at the annual rate of 11 1/4%, is payable semi-annually in arrears on June 1 and
December 1 of each year, commencing June 1, 1999. We have the option of
redeeming the November 1998 Notes starting from December 1, 2003.
The 1997 Notes, the March 1998 Notes and the November 1998 Notes contain
terms, other than the rate of interest, that are substantially similar. The
terms of the indentures governing these Notes impose significant limitations on
our ability to incur additional indebtedness unless we have issued additional
equity, or if our Consolidated Pro Forma Interest Coverage Ratio (as defined in
the indentures) is greater than or equal to 1.8 to 1.0 prior to June 30, 1999,
or 2.5 to 1.0 on or after that date, and if the ratio of our total debt to
earnings before interest, taxes, depreciation and amortization is not higher
than 6:1.
The indentures contain many other restrictions, including limitations on
our ability to:
- engage in businesses other than the Internet service business;
- place liens on our assets; and
- pay dividends.
If a change of control with respect to Verio occurs, we are required to
make an offer to purchase all the Notes then outstanding at a price equal to
101% of the respective principal amount of the Notes, plus accrued and unpaid
interest. We are in compliance with the provisions of all of our material debt
agreements.
Our Company is highly leveraged and has significant debt service
requirements. At December 31, 1998 our long-term debt was $674.6 million, and
the annual interest expense associated with the 1997 Notes, March 1998 Notes and
November 1998 Notes is approximately $76.7 million. The interest expense and
principal repayment obligations associated with our debt could have a
significant effect on our future operations. See "Factors Affecting future
Operating Results -- We have substantial debt which may impact our future
operations and affect our ability to meet our debt obligations."
As of December 31, 1998, we had approximately $592.2 million in cash and
cash equivalents and short-term investments (including $14.8 million of
restricted cash). Our business plan currently anticipates investments of
approximately $350.0 million over the next 12 months for capital expenditures,
acquisitions
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completed since December 31,1998, operating losses and working capital. This
includes approximately $176.0 million for the acquisition of Hiway which was
consummated in January 1999, and $17.5 million that was required as an initial
payment under our March 1999 agreement with AOL. Additional required payments to
AOL total $25.0 million, and will be paid between March 2000 and March 2001.
Cash flows used by operations increased from $(35.3) million for the year
ended December 31, 1997 to $(64.2) million for the year ended December 31, 1998.
However, cash flows used by operations as a percentage of revenue improved from
(99%) to (53%) from the year ended December 31, 1997 to the year ended December
31, 1998. We incurred $117.9 million in selling, general and administrative
expenses during the year ended December 31, 1998 as we invested in scaleable
systems, hired and trained sales personnel, and expanded our network. We expect
these investments will result in the ability to add significant additional
revenue at low incremental costs. Although we expect to continue to reduce our
operating losses as a percentage of revenue, there can be no assurance that we
will be able to do so, or that the rate of any reduction in losses will be as
rapid as is expected.
Since we achieved 100% ownership of substantially all of our subsidiaries
and affiliates in the second quarter of 1998, we have focused considerable
effort on, and incurred significant expense in connection with, the integration
of our operations and management. These expenses included approximately $1.9
million primarily related to severance costs in connection with the elimination
of approximately 250 positions that are no longer necessary due to the
efficiencies of our national services. These terminations have begun and will
continue through the second quarter of 1999. The remaining liability for unpaid
severance costs totaled approximately $1.2 million at December 31, 1998. We
expect to continue to incur integration costs related to our network, customer
care, billing and financial systems. While we anticipate that these expenses
will continue to be significant, we also expect to derive significant long-term
benefits as a result of lower incremental costs for local telecommunications
expense, Internet access expense, and general and administrative expenses as our
revenues increase.
Our anticipated expenditures are inherently uncertain and will vary widely
based on many factors including operating performance and working capital
requirements, the cost of additional acquisitions and investments, the
requirements for capital equipment to operate our business, and our ability to
raise additional funds. Accordingly, we may need significant amounts of cash in
excess of our plan, and no assurance can be given as to the actual amounts of
our future expenditures. We are constantly evaluating potential acquisition and
other investment opportunities which could significantly affect our cash needs.
We intend to use a significant portion of our cash for acquisitions, and will
have to increase revenue without a commensurate increase in costs to generate
sufficient cash to enable us to meet our debt service obligations. There can be
no assurance that we will have sufficient financial resources if operating
losses continue to increase or additional acquisition or other investment
opportunities become available.
We expect to meet our capital needs with cash on hand, proceeds from the
sale, or issuance of capital stock, the credit facility, lease financing, and
additional debt. In the near term, we intend to use our excess cash. Over the
longer term, we will be dependent on increased operating cash flow, and, to the
extent cash flow is not sufficient, the availability of additional financing, to
meet our debt service obligations. As an ongoing matter, we evaluate the
potential sources of capital that may be available to us, including public and
private sales of equity, the issuance of debt securities, bank financing, and
other sources, taking into account market conditions, available terms, the
current trading price of our stock, and other factors. Insufficient funding may
require us to delay or abandon some of our planned future expansion or
expenditures, which could have a material adverse effect on our growth and
ability to realize economies of scale. In addition, our operating flexibility
with respect to certain business activities is limited by covenants associated
with our indebtedness. There can be no assurance that such covenants will not
adversely affect our ability to finance our future operations or capital needs
or to engage in business activities that may be in our interest.
NEW ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting ("SFAS") No. 130, Reporting Comprehensive
Income (SFAS 130), No. 131, Disclosures About
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Segments of an Enterprise and Related Information (SFAS 131) and No. 132,
Employers' Disclosures about Pensions and Other Postretirement Benefits. During
1998, the FASB issued SFAS No. 134, Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise and the American Institute of Certified Public Accountants
issued Statement of Position No. 98-5, Reporting on the Costs of Start-up
Activities (SOP 97-5). The adoption of these pronouncements did not and is not
expected to have a significant effect on Verio's financial position, results of
operations or financial reporting.
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 financial statements for
the year ending December 31, 2000.
THE YEAR 2000 ISSUE
The "Year 2000" problem results from computer programs and systems using
only two digits instead of four to identify the year. Systems that do not
properly recognize such information could generate wrong data or fail. The Year
2000 problem is widespread and complex, as virtually every company's computer
operations could be affected in some way.
We rely upon computer systems, software applications, hardware and other
circuitry which may contain date-sensitive technology in our operations and
administrative support systems. Most of these technologies are
standard-purchased systems that may or may not have been customized for our own
particular applications while other technologies were internally developed. We
also rely upon various vendors and suppliers including telecommunications
providers with which we have interconnection, peering and resale agreements.
Many of our business systems are being replaced as part of our efforts to
integrate our acquisitions. As we evaluate new systems for purchase, we assess
whether they are Year 2000 compliant. We are currently engaged in a phased
process utilizing outside consultants and designated employees to evaluate our
internal status with respect to the Year 2000 issue. The costs and expenses of
these outside consultants and employees have not been material. To date, we have
not discovered any Year 2000 issues that would adversely affect us. We cannot
assure that all Year 2000 issues were discovered or that we will not discover
additional Year 2000 issues that could adversely affect us.
In our first phase, completed in the fourth quarter of 1998, we conducted
an assessment of our national systems in Denver, Colorado, Dallas, Texas and
regional networks and systems in our east operating region, including both
information technology systems and non-information technology systems such as
hardware containing embedded technology, for Year 2000 compliance. The network
systems of our operating regions have similar technology. No significant issues
have been identified. If issues are uncovered in the future, that knowledge will
be directly applied to other operating regions.
Prior to their acquisition by Verio, Hiway hired outside consultants to
evaluate their systems for Year 2000 compliance. Though issues were noted in the
internally developed provisioning systems, none were evaluated as material and
remediation activities are in progress.
We expect to complete phase two of the process during the second quarter of
1999. It will involve a more detailed and broader assessment of our systems'
degree of Year 2000 compliance, covering all operating regions and entities.
Specific risk assessments and contingency planning will be the primary focus of
this phase. We will also develop a fallback plan in the event any critical
systems remain non-compliant by January 1, 2000. As part of phase two, we will
attempt to quantify the impact, if any, of the failure to complete any necessary
corrective action. We cannot currently estimate the magnitude of such impact.
To date, the costs incurred with respect to phase two have not been
material. Future costs are difficult to estimate; however, we do not currently
anticipate that such costs will be material.
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Phase three of our Year 2000 plan will include performing end to end
testing of our supplied services under various scenarios to verify expected
performance of the network under various Year 2000 date failure modes. The
purpose of the testing will be to ensure continuity of service to customers, not
specific elemental component compliance status. This phase is expected to be
final verification of any required updates to Verio's systems and should be
completed in the third quarter of 1999.
We have begun to survey, among others, critical vendors, suppliers and
financial institutions for Year 2000 compliance. We are in the process of
evaluating the Year 2000 preparedness of our telecommunications providers, on
which we rely for the network services crucial to our business. In order to
reduce any adverse impact, we maintain diverse providers for such network
services. However, failure of any one provider may have a material impact on
Verio's operations. We expect to complete this survey in the second quarter of
1999. At this time we cannot estimate the effect, if any, that non-compliant
systems at these entities could have on us, however, it is possible that the
impact will be material.
FORWARD-LOOKING STATEMENTS
The statements included in the discussion and analysis below that are not
historical or factual are "forward-looking statements" (as such term is defined
in the Private Securities Litigation Reform Act of 1995). The safe harbor
provisions provided in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, apply to
forward-looking statements made by Verio. These statements can be identified by
the use of forward-looking terminology such as "believes," "expects," "may,"
"will," "should," or "anticipates" or the negative thereof or other variations
thereon or comparable terminology, or by discussions of strategy that involve
risks and uncertainties. Management cautions the reader that these
forward-looking statements addressing the timing, costs and scope of its
acquisition of, or investments in, existing affiliates, the revenue and
profitability levels of the affiliates in which it invests, the anticipated
reduction in operating costs resulting from the integration and optimization of
those affiliates, and other matters contained herein or therein from time to
time regarding matters that are not historical facts, are only predictions. No
assurance can be given that future results indicated, whether expressed or
implied, will be achieved. While sometimes presented with numerical specificity,
these projections and other forward-looking statements are based upon a variety
of assumptions relating to the business of Verio, which, although considered
reasonable by Verio, may not be realized. Because of the number and range of the
assumptions underlying Verio's projections and forward-looking statements, many
of which are subject to significant uncertainties and contingencies that are
beyond the reasonable control of Verio, some of the assumptions will not
materialize and unanticipated events and circumstances may occur subsequent to
the date of this report. These forward-looking statements are based on current
expectations, and Verio assumes no obligation to update this information.
Therefore, the actual experience of Verio and results achieved during the period
covered by any particular projections or forward-looking statements may differ
substantially from those projected. Consequently, the inclusion of projections
and other forward-looking statements should not be regarded as a representation
by Verio, or any other person that these estimates and projections will be
realized and actual results may vary materially. There can be no assurance that
any of these expectations will be realized or that any of the forward-looking
statements contained herein will prove to be accurate.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The following discussion relates to Verio's exposure to market risk related
to changes in interest rates, and foreign currency exchange rates. This
discussion contains forward-looking statements that are subject to risks and
uncertainties. Actual results may differ materially due to a number of factors
including those set forth under the captions "We have substantial debt which may
impact our future operations and affect our ability to meet our debt
obligations" and "We may need to raise additional capital in order to remain
competitive" in the section titled "Factors Affecting Future Operating Results."
44
47
INTEREST RATE RISK
Verio has limited exposure to financial market risks, including changes in
interest rates. At December 31, 1998, Verio had short-term investments of
approximately $592.2 million. These short-term investments consist of highly
liquid investments in debt obligations of highly rated entities with maturities
of between one and 360 days. These investments are subject to interest rate risk
and will fall in value if market interest rates increase. Verio expects to hold
these investments until maturity, and therefore expects to realize the full
value of these investments, even though changes in interest rates may affect
their value prior to maturity. If interest rates decline over time, this will
result in a reduction of our interest as our cash is reinvested at lower rates.
Verio has debt that is substantial in relation to its stockholders' equity
and cash flow. At December 31, 1998, Verio had long term debt in the aggregate
amount of $674.6 million, representing 77% of total capitalization. A change of
interest rates would not affect our obligations under these agreements.
Increases in interest rates could, however, increase the interest expense
associated with future borrowings and borrowings under our bank credit facility.
FOREIGN CURRENCY RATE RISK
Verio does not currently have any significant foreign currency exposure.
However, a portion of its revenue (less than 10%) is generated from sources
outside the United States. These payment obligations are generally denominated
in local currencies, and any currency devaluation would affect the amount of
revenues that Verio would receive from its international operations. As these
operations only represent a small portion of Verio's revenue, we do not have any
significant overall currency exposure at December 31, 1998. Verio does not hedge
against foreign currency rate changes.
On January 1, 1999, 11 of 15 member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the euro, and adopted the euro as their common legal currency (the "Euro
Conversion"). Verio has not commenced any assessment of the effects of the Euro
Conversion, and we are unsure of the potential impact of the Euro Conversion on
our international operations. Based on the size of our international
investments, these fluctuations are not expected to have a material impact.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The index to our Consolidated Financial Statements, Financial Schedules,
and the Report of the Independent Auditors appears in Part IV of this Annual
Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
45
48
PART III
ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The section labeled "Directors and Executive Officers" of the Registrant's
definitive Proxy Statement to be filed shortly hereafter for the annual meeting
of stockholders to be held on June 17, 1999 is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The section labeled "Executive Compensation and Other Information" of the
Registrant's definitive Proxy Statement to be filed shortly hereafter for the
annual meeting of stockholders to be held on June 17, 1999 is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The section labeled "Security Ownership of Certain Beneficial Owners and
Management" of the Registrant's definitive Proxy Statement to be filed shortly
hereafter for the annual meeting of stockholders to be held on June 17, 1999 is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The section labeled "Certain Relationships and Related Transactions" of the
Registrant's definitive Proxy Statement to be filed shortly hereafter for the
annual meeting of stockholders to be held on June 17, 1999 is incorporated
herein by reference.
46
49
PART IV
ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following Consolidated Financial Statements and Report of Independent
Auditors are included on pages F-1 through F-21 of this Annual Report on Form
10-K:
The consolidated balance sheets of the Registrant and its subsidiaries as
of December 31, 1997 and 1998 and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the period from
inception (March 1, 1996) to December 31, 1996 and the years ended December 31,
1997 and 1998, together with the notes thereto.
(a)(2) Financial Statement Schedule.
The following financial statement schedule is included on pages S-1 and S-2
of this Annual Report on Form 10-K. All other schedules are omitted because they
are not applicable or not required or because the required information is
included in the Consolidated Financial Statements or the notes thereto:
Schedule II -- Valuation and Qualifying Accounts
3. List of Exhibits:
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Commission. The Registrant shall furnish
copies of exhibits for a reasonable fee (covering the expense of furnishing
copies) upon request.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1** -- Restated Certificate of Incorporation of the Registrant,
as amended.
3.2** -- Certificate of Amendment of Certificate of Incorporation
of the Registrant.
3.3** -- Certificate of Designation Establishing Series D
Preferred Stock of the Registrant.
3.4** -- Bylaws of the Registrant.
4.1*** -- Form of Old 1997 Note.
4.2*** -- Form of New 1997 Note.
4.3*** -- Escrow Agreement, dated as of June 24, 1997, among First
Trust National Association (as escrow agent and trustee)
and the Registrant.
4.4** -- 1997 Indenture (See Exhibit 10.1).
4.5** -- 1997 Notes Registration Rights Agreement (See Exhibit
10.4).
4.6*** -- Purchase Agreement, dated as of June 17, 1997, by and
among Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner
& Smith Incorporated, and Lazard Freres & Co. LLC
(collectively, the "Initial 1997 Notes Purchasers"), and
the Registrant.
4.7*** -- Form of Old March 1998 Note.
4.8*** -- Form of New March 1998 Note.
4.9** -- March 1998 Indenture (See Exhibit 10.23).
4.10** -- March 1998 Notes Registration Rights Agreement (See
Exhibit 10.24).
4.11*** -- Purchase Agreement, dated as of March 19, 1998, by and
among Salomon Brothers Inc., Lazard Freres & Co. LLC,
Chase Securities, Inc., and BancBoston Securities Inc.
(collectively, the "Initial March 1998 Notes
Purchasers"), and the Registrant.
4.12+++ -- Form of Old November 1988 Note.
4.13+++ -- Form of New November 1988 Note.
4.14++ -- November 1998 Indenture (See Exhibit 10.34).
47
50
EXHIBIT
NUMBER DESCRIPTION
------- -----------
4.15++ -- November 1998 Registration Rights Agreement (See Exhibit
10.35).
4.16++ -- Purchase Agreement, dated as of November 20, 1998, by and
among Salomon Smith Barney Inc., Credit Suisse First
Boston Corporation, Donaldson, Lufkin & Jenrette
Securities Corporation and First Union Capital Markets
(collectively, the "Initial November 1998 Notes
Purchasers"), and the Registrant.
10.1** -- Indenture, dated as of June 24, 1997, by and among the
Registrant and First Trust National Association (as
trustee).
10.2** -- Warrant Agreement, dated as of June 24, 1997, by and
between First Trust National Association and the
Registrant.
10.3** -- Common Stock Registration Rights Agreement, dated as of
June 17, 1997, by and among the Registrant, Brooks Fiber
Properties, Inc., Norwest Equity Partners V, Providence
Equity Partners, Centennial Fund V, L.P., Centennial Fund
IV, L.P. (as investors), and the Initial Purchasers.
10.4** -- Registration Rights Agreement, dated as of June 17, 1997,
by and among the Registrant and the Initial Purchasers.
10.5** -- Lease Agreement, dated as of June 20, 1997, by and
between the Registrant and Highland Park Ventures, LLC,
with respect to the property in Englewood, Colorado,
including the First Amendment to Lease Agreement, dated
as of December 16, 1997.
10.6** -- Lease Agreement, dated as of May 24, 1997, by and between
the Registrant and IM Joint Venture, with respect to the
property in Dallas, Texas, as amended.
10.7** -- Form of Indemnification Agreement between the Registrant
and each of its officers and directors.
10.8** -- Amended and Restated Stockholders Agreement, dated as of
May 20, 1997, by and between the Registrant, the Series A
Purchasers, the Series B Purchasers, the Series C
Purchasers and members of the Registrant's management.
10.9** -- The Registrant's 1996 Stock Option Plan, as amended.
10.10** -- The Registrant's 1997 California Stock Option Plan, as
amended.
10.11** -- The Registrant's 1998 Employee Stock Purchase Plan, as
amended.
10.12** -- The Registrant's 1998 Stock Incentive Plan, as amended.
10.13** -- Form of Compensation Protection Agreement between the
Registrant and each of its officers.
10.14** -- Master Service Agreement, dated as of August 23, 1996, by
and between the Registrant and MFS Datanet, Inc.
10.15** -- Agreement for Terminal Facility Collocation Space, dated
August 8, 1996, by and between MFS Telecom, Inc. and the
Registrant.
10.16** -- Bilateral Peering Agreement, dated May 19, 1997, between
AT&T Corp. and the Registrant.
10.17** -- Master Lease Agreement, dated November 17, 1997, by and
between Insight Investments Corp. and the Registrant.
10.18** -- Master Lease Agreement, dated October 27, 1997, by and
between Cisco Capital Systems Corporation and the
Registrant.
10.19**+ -- Lateral Exchange Networks Interconnection Agreement,
dated as of February 3, 1997, by and between the
Registrant and Sprint Communications Company L.P.
("Sprint").
48
51
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.20**+ -- Cover Agreement, dated September 30, 1996, by and between
the Registrant and Sprint.
10.21**+ -- Amendment One to Cover Agreement, dated November 7, 1996,
by and between the Registrant and Sprint.
10.22**+ -- Amendment Two to Cover Agreement, dated March 2, 1998, by
and between the Registrant and Sprint.
10.23** -- Indenture, dated as of March 25, 1998, by and among the
Registrant and First Trust National Association (as
trustee).
10.24** -- Registration Rights Agreement, dated as of March 25,
1998, by and among the Registrant, and the Initial 1998
Notes Purchasers.
10.25**+ -- Capacity and Services Agreement, dated as of March 31,
1998, by and among the Registrant and Qwest
Communications Corporation.
10.26** -- Credit Agreement, dated as of April 6, 1998, by and among
the Registrant, The Chase Manhattan Bank (as
administrative agent) and Fleet National Bank (as
documentation agent).
10.27** -- Stock Purchase and Master Strategic Relationship
Agreement, dated as of April 7, 1998, by and among the
Registrant and Nippon Telegraph and Telephone Corporation
("NTT"), a Japanese corporation.
10.28**+ -- Investment Agreement, dated as of April 7, 1998, by and
among the Registrant and NTT.
10.29**+ -- Outside Service Provider Agreement, dated as of April 7,
1998, by and among the Registrant and NTT America, Inc.
10.30**+ -- Master Services Agreement, dated as of June 13, 1997, by
and between the Registrant and MCI Telecommunications
Corporation ("MCI").
10.31**+ -- MCI Domestic (US) Public Interconnection Agreement dated
as of June 12, 1997, by and between the Registrant and
MCI, as amended.
10.32** -- The Registrant's 1998 Non-Employee Director Stock
Incentive Plan.
10.33*+ -- Interconnection Agreement, effective as of April 1, 1998
by and between the Registrant and UUNET Technologies,
Inc.
10.34++ -- Indenture, dated as of November 25, 1998, by and among
the Registrant and U.S. Bank Trust National Association
(as trustee).
10.35++ -- Registration Rights Agreement, dated as of November 25,
1998, by and among the Registrant and the Initial
November 1998 Notes Purchasers.
21.1 -- List of Subsidiaries of the Registrant.
23.1 -- Consent of KPMG LLP.
27.1 -- Financial Data Schedule for the fiscal year ended
December 31, 1998.
- ---------------
* Incorporated by reference from the Registrant's quarterly report on Form
10-Q filed with the Commission on August 13, 1998.
** Incorporated by reference from the Registration Statement on Form S-1 of the
Registrant (Registration No. 333-47099) filed with the Commission on
February 27, 1998, as amended.
*** Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-47497) filed with the Commission on March
6, 1998, as amended.
+ Document for which confidential treatment has been requested.
49
52
++ Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-67715) filed with the Commission on
November 23, 1998, as amended.
+++ Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-70727) filed with the Commission on January
15, 1999, as amended.
(b) Reports on Form 8-K
On October 28, 1998, the Registrant filed with the Commission a report
on Form 8-K, announcing (1) its acquisition of a German Web hosting
company, WWW-Service Online-Dienstleistungen AG, and (2) its earnings for
the third quarter of 1998.
On November 18, 1998, the Registrant filed with the Commission a
report on Form 8-K, reporting under Item 5 that the Registrant had entered
into an Amended and Restated Agreement and Plan of Merger with Best
Internet Communications, Inc., a California corporation, d/b/a Hiway
Technologies ("Hiway"), pursuant to which the Registrant had agreed to
acquire Hiway, a leading Web hosting company, for an aggregate
consideration of $176 million in cash and approximately 4.92 million fully
diluted shares of the Registrant's Common Stock.
On November 20, 1998, the Registrant filed with the Commission a
report on Form 8-K, announcing that it had agreed to issue $400 million
aggregate principal amount of 11 1/4% Senior Notes due 2008 in a private
placement to a number of institutional investors in accordance with
Securities Exchange Commission Rule 144A.
50
53
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.
VERIO INC.
By: /s/ JUSTIN L. JASCHKE
----------------------------------
Justin L. Jaschke
Chief Executive Officer
(Principal Executive Officer)
Date: March 30, 1999
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ STEVEN C. HALSTEDT Chairman of the Board March 30, 1999
- -----------------------------------------------------
Steven C. Halstedt
/s/ JUSTIN L. JASCHKE Chief Executive Officer and March 30, 1999
- ----------------------------------------------------- Director (Principal
Justin L. Jaschke Executive Officer)
/s/ HERBERT R. HRIBAR President, Chief Operating March 30, 1999
- ----------------------------------------------------- Officer and Director
Herbert R. Hribar
/s/ JAMES C. ALLEN Director March 30, 1999
- -----------------------------------------------------
James C. Allen
/s/ TRYGVE E. MYHREN Director March 30, 1999
- -----------------------------------------------------
Trygve E. Myhren
/s/ PAUL J. SALEM Director March 30, 1999
- -----------------------------------------------------
Paul J. Salem
/s/ GEORGE J. STILL Director March 30, 1999
- -----------------------------------------------------
George J. Still
/s/ YUKIMASA ITO Director March 30, 1999
- -----------------------------------------------------
Yukimasa Ito
/s/ ARTHUR L. CAHOON Director March 30, 1999
- -----------------------------------------------------
Arthur L. Cahoon
/s/ PETER B. FRITZINGER Chief Financial Officer March 30, 1999
- ----------------------------------------------------- (Principal Accounting
Peter B. Fritzinger Officer)
51
54
VERIO INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
PAGE IN 1999
ANNUAL REPORT
DESCRIPTION TO STOCKHOLDERS
- ----------- ---------------
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and
1998...................................................... F-3
Consolidated Statements of Operations for the period from
inception (March 1, 1996) to December 31, 1996 and the
years ended December 31, 1997 and 1998.................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the period from inception (March 1, 1996) to December
31, 1996 and the years ended December 31, 1997 and 1998... F-5
Consolidated Statements of Cash Flows for the period from
inception (March 1, 1996) to December 31, 1996 and the
years ended December 31, 1997 and 1998.................... F-6
Notes to Consolidated Financial Statements.................. F-7
Independent Auditors' Report on Schedule.................... S-1
Schedule II: Valuation and Qualifying Accounts.............. S-2
F-1
55
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Verio Inc.:
We have audited the accompanying consolidated balance sheets of Verio Inc.
and subsidiaries as of December 31, 1997 and 1998, and the related consolidated
statements of operations, stockholders' equity (deficit), and cash flows for the
period from inception (March 1, 1996) to December 31, 1996 and the years ended
December 31, 1997 and 1998. These consolidated financial statements are the
responsibility of Verio's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Verio Inc.
and subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for the period from inception (March 1, 1996) to
December 31, 1996 and the years ended December 31, 1997 and 1998 in conformity
with generally accepted accounting principles.
/s/ KPMG LLP
Denver, Colorado
March 4, 1999
F-2
56
VERIO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
--------------------
1997 1998
-------- ---------
(AMOUNTS IN
THOUSANDS, EXCEPT
SHARE DATA)
Current assets:
Cash and cash equivalents................................. $ 62,662 $ 433,424
Securities available for sale............................. 9,924 143,963
Restricted cash and securities (note 3)................... 21,015 13,629
Receivables:
Trade, net of allowance for doubtful accounts of $1,233
and $4,763............................................. 7,565 15,084
Affiliates.............................................. 735 --
Prepaid expenses and other................................ 3,921 7,831
-------- ---------
Total current assets................................ 105,822 613,931
Restricted cash and securities (note 4)..................... 19,539 1,176
Investments in affiliates, at cost (note 2)................. 2,378 8,298
Equipment and leasehold improvements:
Internet access and computer equipment.................... 30,535 66,408
Furniture, fixtures and computer software................. 3,301 5,823
Leasehold improvements.................................... 1,596 4,887
-------- ---------
35,432 77,118
Less accumulated depreciation and amortization............ (7,219) (26,672)
-------- ---------
Net equipment and leasehold improvements................ 28,213 50,446
Other assets:
Goodwill, net of accumulated amortization of $3,595 and
$21,614 (note 2)........................................ 83,216 236,696
Debt issuance costs, net of accumulated amortization of
$330 and $1,710......................................... 4,858 18,542
Other, net................................................ 2,445 4,623
-------- ---------
Total assets........................................ $246,471 $ 933,712
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 7,389 $ 10,501
Accrued expenses.......................................... 11,401 14,228
Accrued interest payable.................................. 844 9,634
Lines of credit, notes payable and current portion of
long-term debt (note 3)................................. 2,751 3,329
Current portion of capital lease obligations (note 4)..... 1,575 5,848
Deferred revenue.......................................... 7,177 12,512
-------- ---------
Total current liabilities........................... 31,137 56,052
Long-term debt, less current portion, net of discount (note
3)........................................................ 139,376 668,177
Capital lease obligations, less current portion (note 4).... 2,945 6,441
-------- ---------
Total liabilities................................... 173,458 730,670
-------- ---------
Minority interests in subsidiaries (note 2)................. 2,765 361
Redeemable preferred stock (converted to common stock in
1998)(note 5):
Series A, convertible, $.001 par value; 6,100,000 shares
authorized; 6,033,333 shares issued and outstanding at
December 31, 1997....................................... 18,080 --
Series B, convertible, $.001 par value; 10,117,000 shares
authorized; 10,028,334 shares issued and outstanding at
December 31, 1997....................................... 59,193 --
Series C, convertible, $.001 par value; 2,500,000 shares
authorized, issued and outstanding at December 31,
1997.................................................... 19,976 --
-------- ---------
97,249 --
-------- ---------
Stockholders' equity (deficit) (note 6):
Preferred stock, Series D-1, convertible, $.001 par value;
3,000,000 shares authorized; 680,000 shares issued and
outstanding at December 31, 1997 (converted to common
stock in 1998)(note 5).................................. 10,200 --
Preferred stock, undesignated; 12,500,000 shares
authorized; no shares issued and outstanding (note 5)... -- --
Common stock, $.001 par value; 125,000,000 shares
authorized; 1,254,533 and 33,146,010 shares issued and
outstanding at December 31, 1997 and 1998............... 1 33
Additional paid-in capital................................ 14,272 376,164
Accumulated deficit....................................... (51,474) (173,516)
-------- ---------
Total stockholders' equity (deficit)................ (27,001) 202,681
-------- ---------
Commitments and contingencies (note 4)
Total liabilities and stockholders' equity
(deficit)........................................... $246,471 $ 933,712
======== =========
See accompanying notes to consolidated financial statements.
F-3
57
VERIO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM
INCEPTION YEARS ENDED
(MARCH 1, 1996) DECEMBER 31,
TO DECEMBER 31, -------------------------
1996 1997 1998
----------------- ---------- -----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Internet connectivity:
Dedicated......................................... $ 1,100 $ 16,383 $ 53,274
Dial-up........................................... 1,139 7,093 22,865
Enhanced services and other.......................... 126 12,216 44,514
------- -------- ---------
Total revenue................................ 2,365 35,692 120,653
Costs and expenses:
Cost of service...................................... 974 15,974 54,023
Sales and marketing.................................. 1,190 10,744 33,320
General and administrative and other (note 6)........ 5,812 38,639 84,602
Depreciation and amortization........................ 669 10,624 39,726
------- -------- ---------
Total costs and expenses..................... 8,645 75,981 211,671
------- -------- ---------
Loss from operations......................... (6,280) (40,289) (91,018)
Other income (expense):
Interest income...................................... 593 6,080 14,628
Interest expense..................................... (115) (11,826) (35,946)
Equity in losses of affiliates....................... -- (1,958) --
------- -------- ---------
Loss before minority interests and
extraordinary item......................... (5,802) (47,993) (112,336)
Minority interests..................................... 680 1,924 482
------- -------- ---------
Loss before extraordinary item............... (5,122) (46,069) (111,854)
Extraordinary item -- loss related to debt repurchase
(note 3)............................................. -- -- (10,101)
------- -------- ---------
Net loss..................................... (5,122) (46,069) (121,955)
Accretion of preferred stock to liquidation value...... (23) (260) (87)
------- -------- ---------
Net loss attributable to common
stockholders............................... $(5,145) $(46,329) $(122,042)
======= ======== =========
Weighted average number of common shares outstanding --
basic and diluted.................................... 972 1,145 21,376
======= ======== =========
Loss per common share -- basic and diluted:
Loss per common share before extraordinary item...... $ (5.29) $ (40.47) $ (5.24)
Extraordinary item................................... -- -- (0.47)
------- -------- ---------
Loss per common share........................ $ (5.29) $ (40.47) $ (5.71)
======= ======== =========
See accompanying notes to consolidated financial statements.
F-4
58
VERIO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK ADDITIONAL
PREFERRED ------------------- PAID-IN ACCUMULATED
STOCK SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ---------- ------ ---------- ----------- ---------
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
BALANCES AT INCEPTION........................ $ -- -- $-- $ -- $ -- $ --
Issuance of common stock for cash............ -- 1,090,000 1 1,089 -- 1,090
Accretion of redeemable preferred stock to
liquidation value.......................... -- -- -- -- (23) (23)
Net loss..................................... -- -- -- -- (5,122) (5,122)
-------- ---------- --- -------- --------- ---------
BALANCES AT DECEMBER 31, 1996................ -- 1,090,000 1 1,089 (5,145) (4,055)
Issuance of common stock for exercise of
options.................................... -- 76,200 148 -- 148
Issuance of common stock for cash............ -- 88,333 360 -- 360
Warrants issued in connection with debt
offering (note 3).......................... -- -- -- 12,675 -- 12,675
Issuance of preferred stock in business
combination (note 5)....................... 10,200 -- -- -- -- 10,200
Accretion of redeemable preferred stock to
liquidation value.......................... -- -- -- (260) (260)
Net loss..................................... -- -- -- (46,069) (46,069)
-------- ---------- --- -------- --------- ---------
BALANCES AT DECEMBER 31, 1997................ 10,200 1,254,533 1 14,272 (51,474) (27,001)
Issuance of common stock for:
Exercise of options........................ -- 157,885 -- 665 -- 665
Exercise of warrants....................... -- 656,988 1 5 -- 6
Employee purchases......................... -- 71,547 -- 988 -- 988
Issuance of common stock in initial public
offering, net of expenses (note 6)......... -- 5,735,000 6 120,812 -- 120,818
Issuance of common stock to private investor
(note 6)................................... -- 4,493,877 4 99,995 -- 99,999
Issuance of Series D-1 preferred stock in
business combinations (notes 2 and 5)...... 26,726 -- -- -- -- 26,726
Accretion of redeemable preferred stock to
liquidation value.......................... -- -- -- -- (87) (87)
Issuance of common stock pursuant to
conversion of Series D-1 preferred stock
(note 5)................................... (36,926) 2,214,513 2 36,924 -- --
Issuance of common stock pursuant to
conversion of Series A, B and C redeemable
preferred stock (note 5)................... -- 18,561,667 19 97,287 -- 97,306
Issuance of common stock options in business
combinations (note 2)...................... -- -- -- 1,937 -- 1,937
Stock option related compensation and
severance costs (note 6)................... -- -- -- 3,279 -- 3,279
Net loss..................................... (121,955) (121,955)
-------- ---------- --- -------- --------- ---------
BALANCES AT DECEMBER 31, 1998................ $ -- 33,146,010 $33 $376,164 $(173,516) $ 202,681
======== ========== === ======== ========= =========
See accompanying notes to consolidated financial statements.
F-5
59
VERIO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM
INCEPTION YEARS ENDED
(MARCH 1, 1996) DECEMBER 31,
TO DECEMBER 31, ----------------------
1996 1997 1998
--------------- --------- ---------
(AMOUNTS IN THOUSANDS)
Cash flows from operating activities:
Net loss.................................................. $(5,122) $ (46,069) $(121,955)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization........................... 669 10,624 39,726
Minority interests' share of losses..................... (680) (1,924) (482)
Stock option related compensation and severance costs... -- -- 3,279
Equity in losses of affiliates.......................... -- 1,958 --
Extraordinary item -- loss related to debt repurchase... -- -- 10,101
Changes in operating assets and liabilities, excluding
effects of business combinations:
Receivables........................................... (265) (1,561) (2,058)
Prepaid expenses and other current assets............. (284) (2,305) (1,283)
Accounts payable...................................... 1,439 (1,656) (1,766)
Accrued expenses...................................... 1,910 3,082 654
Accrued interest payable.............................. -- 844 9,674
Deferred revenue...................................... 7 1,684 (129)
------- --------- ---------
Net cash used by operating activities.............. (2,326) (35,323) (64,239)
------- --------- ---------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements..... (3,430) (14,547) (23,058)
Acquisition of net assets in business combinations and
investments in affiliates, net of cash acquired....... (5,627) (64,023) (151,119)
Change in restricted cash and securities................ (40,554) 25,750
Purchase of securities available for sale, net.......... -- (9,924) (134,039)
Other................................................... (66) (1,206) (2,425)
------- --------- ---------
Net cash used by investing activities.............. (9,123) (130,254) (284,891)
------- --------- ---------
Cash flows from financing activities:
Proceeds from lines of credit, notes payable and
long-term debt........................................ -- 145,512 559,340
Repayments of lines of credit and notes payable......... (20) (3,468) (57,885)
Repayments of capital lease obligations................. (8) (950) (4,039)
Proceeds from issuance of common and preferred stock,
net of issuance costs................................. 77,944 20,678 222,476
------- --------- ---------
Net cash provided by financing activities.......... 77,916 161,772 719,892
------- --------- ---------
Net increase (decrease) in cash and cash
equivalents...................................... 66,467 (3,805) 370,762
Cash and cash equivalents:
Beginning of period..................................... -- 66,467 62,662
------- --------- ---------
End of period........................................... $66,467 $ 62,662 $ 433,424
======= ========= =========
Supplemental disclosures of cash flow information:
Cash paid for interest.................................. $ -- $ 10,982 $ 27,156
======= ========= =========
Supplemental disclosures of non-cash investing and financing
activities:
Equipment acquired through capital lease obligations.... $ 58 $ 3,301 $ 11,027
======= ========= =========
Acquisition of net assets in business combinations
through issuance of notes payable..................... $ 6,675 $ 4,718 $ --
======= ========= =========
Acquisition of net assets in business combinations
through issuance of preferred stock and preferred
stock options......................................... $ -- $ 10,200 $ 28,663
======= ========= =========
Warrants issued in connection with debt offering........ $ -- $ 12,675 $ --
======= ========= =========
See accompanying notes to consolidated financial statements.
F-6
60
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Organization and Basis of Presentation
Verio Inc. (Verio or the Company) was incorporated on March 1, 1996 to
capitalize on the growing demand for Internet access and enhanced services by
business users through the acquisition, integration, and growth of existing
independent Internet service providers with a business customer focus in
targeted geographic regions. The goal of Verio is to be the dominant,
full-service national provider of Internet connectivity and enhanced Internet
services to small and medium sized businesses. Verio commenced operations in
April 1996 and had no activity other than the sale of common stock to founders
prior to April 1, 1996. Verio operates in one business segment and has
operations in the United States and Europe. International operations were not
significant in 1996, 1997 or 1998.
The accompanying consolidated financial statements include the accounts of
Verio and its majority owned subsidiaries, as described in Note 2. All
significant intercompany balances and transactions have been eliminated in
consolidation. The preparation of financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
(b) Cash and Cash Equivalents, Restricted Cash and Securities Available for
Sale
Verio considers all highly liquid debt instruments with original maturities
of three months or less to be cash equivalents. Included in cash equivalents as
of December 31, 1997 and 1998 are U.S. government, municipal and corporate debt
securities, money market accounts and commercial paper totaling $65,518,000
(exclusive of cash overdraft in the amount of $11,228,000) and $433,304,000,
respectively, with maturities ranging from thirty to ninety days. Verio's
short-term investments consist of readily marketable debt securities with
remaining maturities of more than 90 days at time of purchase. Verio has
classified its entire investment portfolio as available for sale. Available for
sale securities are stated at fair value with unrealized gains and losses
included in stockholders' equity. At December 31, 1997 and 1998, the amortized
cost of these securities approximated market value.
Restricted cash and securities include U.S. government securities which are
considered to be securities held to maturity and recorded at cost. At December
31, 1997 and 1998, cost approximated market value.
(c) Equipment and Leasehold Improvements
Equipment and leasehold improvements are recorded at cost. Depreciation is
provided over the estimated useful lives of the assets ranging from 3 to 5 years
using the straight-line method. Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the asset.
(d) Investments in Affiliates and Consolidation of Subsidiaries
Investments in affiliates generally represent newly issued preferred shares
of various affiliates. The preferred shares are convertible at the option of
Verio into common shares on a one-for-one basis and represent future common
stock ownership interests, upon conversion, of less than 50%. As Verio did not
acquire a common stock ownership interest, these investments are recorded at
cost until such time as the preferred shares are converted to common. In
addition, if these entities incur losses resulting in the equity of the common
shareholders being reduced to zero, Verio will utilize the equity method of
accounting for these investments and will generally recognize 100% of all losses
of the affiliates from that date, up to the amount of Verio's investment, based
on the inability of the majority common shareholders to fund additional losses.
During the year ended December 31, 1997, Verio recognized equity in losses of
affiliates of $1,958,000 under this method of accounting. Such losses were not
significant for the year ended December 31, 1998.
F-7
61
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Verio has also acquired preferred shares in certain entities which are
convertible into future common stock ownership interests of greater than 50%. In
these situations, Verio has majority representation on the Board of Directors
and majority voting rights, exercises significant control over the entities'
operations, and intends to acquire a 100% common ownership interest in the
future. As of December 31, 1998, Verio had acquired a 100% ownership interest in
all but two affiliates. Accordingly, the accounts of these investees have been
consolidated with those of Verio in the accompanying consolidated financial
statements from the dates of acquisition (see note 2).
(e) Other Assets
The excess of cost over the fair value of net assets acquired, or goodwill,
is amortized using the straight-line method over a 10-year period. Other
intangibles are amortized using the straight-line method over periods ranging
from three to seven years.
(f) Long-Lived Assets
Verio evaluates the carrying value of its long-lived assets, including
goodwill, under the provisions of Statement of Financial Accounting Standards
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of (SFAS 121). SFAS 121 requires impairment losses to be
recorded on long-lived assets used in operations when indications of impairment
are present and the undiscounted future cash flows estimated to be generated by
those assets are less than the assets' carrying amount. In addition, the
recoverability of goodwill is further evaluated under the provisions of APB
Opinion No. 17, Intangible Assets, based upon undiscounted cash flows. If such
assets are impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the estimated fair value of
the assets. Assets to be disposed of are reported at the lower of the carrying
value or fair value, less costs to sell.
(g) Revenue Recognition
Revenue related to Internet and enhanced services is recognized as the
services are provided, and deferred and amortized to operations for amounts
billed relating to future periods. Installation and customer set-up fees are
recognized upon completion of the services. Revenue from consulting services is
recognized as the services are provided. Revenue from hardware and software
sales is recognized upon shipment of the respective products.
(h) Peering Relationships
Verio does not pay any fees in connection with its peering relationships
with other companies and does not record revenue or expense in connection with
those arrangements. The nature of these relationships is that the parties share
the responsibility for communications that occur between their respective local
networks. These peering relationships are essentially exchanges of similar
productive assets rather than the culmination of an earnings process.
Accordingly, these arrangements are not reflected in the operations of Verio.
(i) Income Taxes
Verio accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109).
SFAS 109 requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the difference is expected to reverse.
F-8
62
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(j) Stock-Based Compensation
Verio accounts for its stock-based compensation plans using the intrinsic
value based method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations (APB 25).
Verio has provided pro forma disclosures of net loss and loss per share as if
the fair value based method of accounting for the plans, as prescribed by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123), had been applied. Pro forma disclosures include the
effects of employee stock options granted during the period and years ended
December 31, 1996, 1997 and 1998.
(k) Loss Per Share
Loss per share is presented in accordance with the provisions of Statement
of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Under
SFAS 128, basic EPS excludes dilution for potential common stock and is computed
by dividing income or loss available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. Basic and
diluted EPS are the same in 1996, 1997 and 1998, as all potential common stock
instruments are antidilutive.
(2) BUSINESS COMBINATIONS, INVESTMENTS IN AFFILIATES AND ASSET ACQUISITIONS
During the period from inception (March 1, 1996) to December 31, 1996,
Verio completed seven business combinations and investments for cash and notes
payable. All of the acquisitions were accounted for using the purchase method of
accounting, and represent the acquisition of stock or net assets. Outstanding
stock options of acquired businesses were included in the determination of the
purchase prices based on fair values. For those businesses acquired and
consolidated, the results of operations for the acquired businesses are included
in Verio's consolidated statement of operations from the dates of acquisition.
Summary information regarding the business combinations is as follows:
Consolidated acquisitions in 1996:
TOTAL OWNERSHIP
OWNERSHIP INTEREST AT
INTEREST DECEMBER 31, APPROXIMATE
BUSINESS NAME ACQUISITION DATE PURCHASED(A) 1996(A) PURCHASE PRICE
------------- ----------------- ------------ --------------- --------------
(AMOUNTS IN
THOUSANDS)
On-Ramp Technologies, Inc... August 1, 1996 51%
October 4, 1996 4% 55%(b) $ 8,775
RAINet, Inc................. August 2, 1996 100% 100%(c) 2,000
CCnet Inc................... December 19, 1996 100% 100%(c) 1,800
-------
$12,575
Acquisition costs.............................................................. 284
-------
$12,859
=======
The aggregate purchase price, including acquisition costs, was allocated
based upon fair value as follows:
Equipment................................................... $ 1,359
Goodwill.................................................... 9,039
Net current assets.......................................... 2,461
-------
Total purchase price.............................. $12,859
=======
F-9
63
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unconsolidated investments in 1996:
TOTAL OWNERSHIP
OWNERSHIP INTEREST AT
INTEREST DECEMBER 31, APPROXIMATE
BUSINESS NAME ACQUISITION DATE PURCHASED(A) 1996(A) PURCHASE PRICE
------------- ---------------- ------------ --------------- --------------
(AMOUNTS IN
THOUSANDS)
West Coast Online, Inc...... July 26, 1996 20% 20%(b) $ 225
National Knowledge Networks,
Inc....................... August 2, 1996 26% 26%(b) 300
Access One, Inc............. December 12, 1996 20% 20%(b) 506
Signet Partners, Inc........ December 19, 1996 25% 25%(b) 403
------
$1,434
Acquisition costs............................................................... 102
------
$1,536
======
During the year ended December 31, 1997, Verio completed 23 business
combinations and investments for cash, notes payable and preferred stock. All of
the acquisitions were accounted for using the purchase method of accounting. For
those businesses acquired and consolidated, the results of operations for the
acquired businesses are included in Verio's consolidated statement of operations
from the dates of acquisition.
F-10
64
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Seventeen subsidiaries were acquired and newly consolidated during 1997. In
addition, Verio formed two new start-up subsidiaries. Summary information
regarding these acquisitions is as follows:
Consolidated acquisitions in 1997:
TOTAL OWNERSHIP
OWNERSHIP INTEREST AT APPROXIMATE
INTEREST DECEMBER 31, PURCHASE
BUSINESS NAME ACQUISITION DATE PURCHASED(A) 1997(A) PRICE(E)
- ------------- ---------------- ------------ --------------- -----------
(AMOUNTS IN
THOUSANDS)
Global Enterprise
Services -- Network
Division.................. January 17, 1997 100% 100%(d) $ 2,350
Pioneer Global
Telecommunications,
Inc....................... February 6, 1997 100% 100%(c) 1,011
Compute Intensive Inc....... February 18, 1997 55% 55%(b) 4,900
NorthWestNet, Inc........... February 28, 1997 85% 85%(c) 9,464
RUSTnet, Inc................ March 14, 1997 100% 100%(c) 1,703
Aimnet Corporation.......... May 19, 1997 55%
September 22, 1997 45% 100%(c) 7,613
Branch Information Services,
Inc....................... September 17, 1997 100% 100%(c) 1,687
West Coast Online, Inc...... April 29, 1997 12%
September 30, 1997 68% 100%(b) 1,775
Communique, Inc............. October 2, 1997 100% 100%(c) 3,000
Clark Internet Services,
Inc....................... October 17, 1997 51% 51%(b) 3,520
ATMnet...................... November 5, 1997 100% 100%(d) 5,522
Global Internet Network
Services, Inc............. December 1, 1997 100% 100%(c) 6,000
Surf Network, Inc........... January 31, 1997 25%
December 22, 1997 75% 100%(b) 603
PREPnet..................... December 24, 1997 100% 100%(d) 1,405
Sesquinet................... December 24, 1997 100% 100%(d) 732
Service Tech, Inc........... August 1, 1997 40%
December 31, 1997 60% 100%(b) 2,055
Monumental Network Systems,
Inc....................... December 31, 1997 100% 100%(c) 3,962
Internet Servers, Inc....... December 31, 1997 100% 100%(c) 20,000
-------
$77,302
Acquisition costs............................................................... 3,396
-------
$80,698
=======
The aggregate purchase price, including acquisition costs, was allocated
based upon fair values as follows:
Equipment................................................... $12,378
Goodwill.................................................. 77,772
Net current liabilities................................... (9,452)
-------
Total purchase price.............................. $80,698
=======
F-11
65
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unconsolidated investments in 1997:
TOTAL OWNERSHIP
OWNERSHIP INTEREST AT APPROXIMATE
INTEREST DECEMBER 31, PURCHASE
BUSINESS NAME ACQUISITION DATE PURCHASE(A) 1997(A) PRICE(E)
------------- ---------------- ----------- --------------- -----------
(AMOUNTS IN
THOUSANDS)
Pacific Rim Network, Inc..... February 4, 1997 27% 27%(b) $ 150
Internet Engineering March 4, 1997 20% 20%(b) 206
Associates, Inc............
Internet Online, Inc......... March 5, 1997 35% 35%(b) 1,050
Structured Network Systems, March 6, 1997 20% 20%(b) 150
Inc........................
National Knowledge Networks, November 7, 1997 15% 41%(b) 599
Inc........................
Signet Partners, Inc......... November 20, 1997 16% 41%(b) 414
------
Acquisition costs.................................................................. $2,569
253
------
$2,822
======
During the year ended December 31, 1998, Verio purchased additional
investments in 11 of Verio's affiliates and acquired 15 new internet service
providers for a combination of cash and Series D-1 Preferred Stock. All
acquisitions were accounted for using the purchase method of accounting. For
those businesses acquired and consolidated, the results of operations for the
acquired businesses are included in Verio's
F-12
66
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
consolidated statement of operations from the dates of acquisition. Summary
information regarding the business combinations is as follows:
Consolidated acquisitions in 1998:
OWNERSHIP TOTAL OWNERSHIP APPROXIMATE
INTEREST INTEREST AT PURCHASE
BUSINESS NAME ACQUISITION DATE PURCHASE(A) DECEMBER 31, 1998(A) PRICE(E)
------------- ---------------- ----------- -------------------- -----------
(AMOUNTS IN
THOUSANDS)
Signet Partners, Inc............ January 30, 1998 14% -- --
February 26, 45% 100% $ 1,925
1998.............
Pacific Rim Network, Inc........ February 16, 1998 73% 100% 730
Clark Internet Services, Inc.... February 25, 1998 49% 100% 3,863
Internet Engineering Associates,
Inc........................... February 25, 1998 80% 100% 1,608
On-Ramp Technologies, Inc....... February 26, 1998 45% 100% 11,849
National Knowledge Networks,
Inc........................... February 27, 1998 59% 100% 2,092
Access One, Inc................. February 27, 1998 80% 100% 5,601
NSNet, Inc...................... February 27, 1998 100% 100% 3,661
NorthWestNet, Inc............... March 6, 1998 15% 100% 4,803
LI Net, Inc..................... April 9, 1998 100% 100% 6,500
STARnet, L.L.C.................. April 14, 1998 100% 100% 3,500
Computing Engineers Inc......... April 15, 1998 100% 100% 9,000
Florida Internet Corporation.... April 15, 1998 100% 100% 2,200
Structured Network Systems,
Inc........................... April 16, 1998 80% 100% 1,250
Compute Intensive Inc........... April 24, 1998 45% 100% 14,260
Matrix Online Media, Inc........ May 5, 1998 100% 100% 4,000
PacketWorks, Inc................ June 19, 1998 100% 100% 852
Internet Online, Inc............ June 30, 1998 65% 100% 4,200
NTX, Inc. (TABNet).............. July 7, 1998 100% 100% 45,800
MagicNet, Inc................... July 23, 1998 100% 100% 3,300
Smart.Connect (a division of
FiberServices, Inc.).......... August 5, 1998 100% 100% 1,009
TerraNet........................ August 7, 1998 100% 100% 4,271
Internet Now, Inc............... August 20, 1998 100% 100% 998
WWW Service AG.................. October 21, 1998 80% 80% 8,430
Tinkleman Enterprises, Inc.
(NYNet)....................... December 3, 1998 100% 100% 7,000
QualNet, Inc. (Internet Access
Group, Inc. and Great Plains
Net, Inc.).................... December 31, 1998 100% 100% 15,535
--------
168,237
Acquisition costs...................................................................... 6,255
--------
$174,492
========
The aggregate purchase price, including acquisition costs, was allocated
based upon fair values as follows:
Equipment................................................... $ 6,586
Goodwill.................................................... 171,499
Net current liabilities..................................... (3,593)
--------
Total purchase price............................... $174,492
========
F-13
67
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ---------------
(a) Represented existing ownership interest or, in the case of investments in
preferred stock, ownership upon conversion of preferred shares to common,
on a fully diluted basis.
(b) Represented ownership of preferred stock of affiliate or subsidiary.
(c) Represented ownership of common stock of affiliate or subsidiary.
(d) Represented acquisition of net assets.
(e) Purchase prices are comprised of cash, notes payable, the issuance of
shares of Series D-1 preferred stock, and the granting of an option to
purchase shares of Series D-1 preferred stock. The value of such shares,
which were converted to common stock of Verio in May 1998, as described in
note 5, was generally determined by Verio's Board of Directors based on
comparable valuations of private and public companies, methodologies based
on multiples of revenue and discounted cash flows, and arms-length
negotiated values.
The following presents the condensed unaudited pro forma results of
operations of Verio as though the above noted acquisitions had occurred at the
beginning of the respective period in which the acquisition occurred, as well as
at the beginning of the immediately preceding period:
YEAR ENDED DECEMBER 31,
---------------------------
1997 1998
----------- ------------
(AMOUNTS IN THOUSANDS,
EXCEPT FOR PER SHARE DATA)
Revenue..................................................... $106,524 $ 149,345
Loss before extraordinary item and accretion of preferred
stock..................................................... (71,525) (123,574)
Net loss.................................................... (71,525) (133,675)
Net loss attributable to common stockholders................ (71,785) (133,762)
Loss per common share -- basic and diluted.................. $ (62.69) $ (6.26)
The pro forma results do not necessarily represent results that would have
occurred if the consolidated acquisitions had occurred at the beginning of the
respective periods nor are they necessarily indicative of the results of future
operations.
Investment in affiliates at December 31, 1998 represents the Company's
investment V-I-A Internet, Inc.
Subsequent to December 31, 1998, Verio completed the acquisition of all the
outstanding common stock of Best Internet Communications, Inc. (doing business
as Hiway Technologies, Inc.) for total consideration of approximately $254.7
million, including $176.0 million in cash and 4.92 million fully diluted shares
of common stock. Verio also completed another acquisition for approximately $8.0
million in cash subsequent to December 31, 1998.
Effective March 4, 1999, Verio entered into an agreement with America
Online, Inc. (AOL). Under this agreement, for a three-year period, Verio will
purchase advertising promotions from AOL to promote Verio's Web hosting and
related business-focused commerce products and services on AOL's four key U.S.
on-line media properties. Verio's promotional rights with respect to its Web
hosting and designated electronic commerce products and services are exclusive
during this period on these four specified sites. AOL also will transition its
approximately 7,000 Prime Host and CompuServe BusinessWeb hosting customers to
Verio, further expanding Verio's Web hosting customer base. Verio agreed to make
guaranteed payments totaling $42.5 million over the first two years of the three
year term of the agreement, with AOL participating in future revenue sharing
under specified circumstances defined in the agreement.
F-14
68
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) DEBT
Lines of credit, notes payable and long-term debt as of December 31
consists of the following:
1997 1998
---------- ----------
(AMOUNTS IN THOUSANDS)
11 1/4% Senior Notes due 2008(a)............................ $ -- $400,000
10 3/8% Senior Notes due 2005(b)............................ -- 175,000
13 1/2% Senior Notes due in 2004, net of unamortized
discount of $12,130,000 and 7,296,000 as of December 31,
1997 and December 31, 1998, respectively(c)............... 137,870 92,704
Revolving lines of credit, bearing interest at .5% to 2.00%
above prime, (9.0% to 10.5% at December 31, 1997) repaid
in 1998................................................... 788 --
Unsecured notes payable bearing interest primarily at 7%,
due in 1998 and 1999...................................... 2,809 1,418
Other....................................................... 660 2,384
-------- --------
142,127 671,506
Less current portion........................................ (2,751) (3,329)
-------- --------
Long-term debt, less current portion........................ $139,376 $668,177
======== ========
- ---------------
(a) On November 25, 1998, Verio completed the private placement of $400.0
million principal amount of senior notes (the "November 1998 Notes"). The
November 1998 Notes are redeemable at the option of Verio commencing
December 1, 2003. The November 1998 Notes mature on December 1, 2008.
Interest on the November 1998 Notes, at the annual rate of 11 1/4%, is
payable semi-annually in arrears on June 1 and December 1 of each year,
commencing June 1, 1999. The November 1998 Notes are senior unsecured
obligations of Verio ranking equally in right of payment with all existing
and future unsecured and senior indebtedness. The November 1998 Notes
contain terms that are substantially similar to the March 1998 Notes and
the 1997 Notes.
(b) On March 25, 1998, Verio completed the private placement of $175.0 million
principal amount of senior notes (the "March 1998 Notes"). The March 1998
Notes are redeemable at the option of Verio commencing April 1, 2002. The
March 1998 Notes mature on April 1, 2005. Interest on the March 1998 Notes,
at the annual rate of 10 3/8%, is payable semi-annually in arrears on April
1 and October 1 of each year, commencing October 1, 1998. The March 1998
Notes are senior unsecured obligations of Verio ranking equally in right of
payment with all existing and future unsecured and senior indebtedness. The
March 1998 Notes contain terms that are substantially similar to the 1997
Notes. Verio used approximately $54.5 million of the proceeds plus accrued
interest to repurchase $50.0 million principal amount of the 1997 Notes. As
a result, Verio was refunded approximately $13.3 million from the escrow
account for the 1997 Notes, of which approximately $1.9 million was used to
pay accrued and unpaid interest. This transaction resulted in an
extraordinary loss of $10.1 million.
(c) In June 1997, Verio completed a debt offering of $150.0 million, 13 1/2%
Senior Notes due 2004 (the "1997 Notes") and warrants to purchase 2,112,480
shares of common stock at $.01 per share, expiring on June 15, 2004, which
were valued at approximately $12.7 million based on Verio's most recent
equity offering. Interest on the 1997 Notes is payable semi-annually on
June 15 and December 15 of each year. The value attributed to the warrants
was recorded as debt discount and is being amortized to interest expense
using the interest method over the term of the 1997 Notes. Upon closing,
Verio deposited U.S. Treasury securities in an escrow account in an amount
that, together with interest on the securities, will be sufficient to fund
the first five interest payments (through December 1999) on the 1997 Notes.
This restricted cash and securities balance totaled $13.1 at December 31,
1998. The 1997 Notes are redeemable on or after June 15, 2002 at 103% of
the face value, decreasing to face value at maturity. The
F-15
69
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
indenture covering the 1997 Notes includes various covenants restricting
the payment of dividends, additional indebtedness, disposition of assets,
and transactions with affiliates.
Maturities of lines of credit, notes payable and long-term debt are as
follows (in thousands):
1999........................................................ $ 3,329
2000........................................................ 473
2001........................................................ --
2002........................................................ --
2003........................................................ --
Thereafter.................................................. 667,704
--------
$671,506
========
Verio has received commitments from a group of commercial lending
institutions to provide an aggregate of up to $70.0 million pursuant to a
two-year revolving credit financing facility secured by substantially all of the
assets of Verio and expiring on December 31, 1999 with interest at 2% above the
London Interbank Offer Rate. There is a commitment fee of 1/2% per annum on the
undrawn amount of the credit facility and a one-time fee of 1/2% on any amounts
drawn. No borrowings are outstanding under this facility as of December 31,
1998.
(4) LEASES, COMMITMENTS AND CONTINGENCIES
Verio leases office space, certain facilities storing internet points of
presence and certain computer and office equipment under capital and operating
leases expiring at various dates through 2008. Future minimum annual lease
payments under these leases as of December 31, 1998 are as follows:
CAPITAL OPERATING
LEASES LEASES
------- ---------
(AMOUNTS IN
THOUSANDS)
1999........................................................ $ 6,578 $ 6,858
2000........................................................ 5,511 5,325
2001........................................................ 2,092 3,360
2002........................................................ 52 2,064
2003........................................................ 5 1,197
Thereafter.................................................. -- 3,185
------- -------
Total minimum payments............................ $14,238 $21,989
=======
Less amount representing interest and taxes................. (1,949)
-------
Present value of net minimum lease payments....... 12,289
Less current portion........................................ (5,848)
-------
$ 6,441
=======
Rent expense for the period from inception (March 31, 1996) to December 31,
1996 and the years ended December 31, 1997 and 1998 was $128,000, $1,856,000,
and $4,048,000, respectively.
In addition, Verio has entered into agreements with three
telecommunications companies to provide Verio with products and services to be
used in its operations.
On March 31, 1998, Verio entered into a 15-year Capacity and Services
Agreement with Qwest Communications Corporation ("Qwest"), under which Verio
will have access to long haul capacity and
F-16
70
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ancillary services on Qwest's nationwide MacroCapacity(sm) Fiber Network. The
Capacity and Services Agreement was amended on December 17, 1998 (as amended,
the "Capacity Agreement"). Over the first ten years of the term of the Capacity
Agreement (the "Commitment Term"), Verio must purchase, and Qwest must provide,
not less than $160.0 million, in the aggregate, of such capacity and services
(the "Commitment"), at agreed upon prices. Additionally, Verio has the right to
prepay its minimum commitment under this contract. If prepaid, such capitalized
costs would be amortized to operations over the term of the agreement. The
amount of the prepayment available at December 31, 1998 was approximately $84.1
million. The amount of capacity represented by the Commitment would satisfy less
than 50% of Verio's currently projected long haul capacity requirements over the
Commitment Term. However, Verio has the right to order capacity and services in
excess of the Commitment during the term of the Capacity Agreement, and after
the expiration of the Commitment Term, at the same prices.
Under the second agreement, Verio is obligated to spend a total of $39
million between June 16, 1997 and June 16, 2002 of which approximately $3.7
million had been paid as of December 31, 1998. Annual payments will be based on
actual usage by Verio.
Under the third agreement, Verio is obligated to spend $0.5 million during
1999.
Verio had an outstanding irrevocable letter of credit in the amount of $1.4
million as of December 31, 1998. This letter of credit, which is automatically
renewed after one year at the discretion of the bank, not to be extended beyond
January 31, 2003, is to collateralize Verio's lease obligation to a third party.
The fair value of this letter of credit approximates contract value which is
fixed over the life of the commitment. Restricted cash in the amount of
approximately $1.5 million secures the letter of credit.
The Company is subject to litigation and claims incidental to its business.
While it is not feasible to predict or determine the financial outcome of these
matters, management does not believe they should result in a materially adverse
effect on the Company's financial position, results of operations or liquidity.
(5) PREFERRED STOCK
Series A, B and C preferred shares were issued at $3, $6 and $8 per share
for total proceeds of $18,100,001, $60,170,004 and $20,000,000, respectively, in
1996 and 1997. The Series A, B, and C preferred shares were subject to mandatory
redemption and were convertible into common stock, initially on a one-for-one
basis. In December 1997, Verio also issued 680,000 shares of Series D-1
preferred stock at $15 per share in connection with an acquisition. The Series
D-1 preferred shares were not redeemable. From January 1, 1998 through April 30,
1998, Verio issued 1,534,513 additional shares of Series D-1 preferred stock
with values ranging from $15 to $22 per share in connection with business
combinations. In connection with Verio's initial public offering of common stock
discussed in note 6, all outstanding preferred shares were converted to common
stock in May 1998. At December 31, 1998, no preferred shares were issued and
outstanding. The Board of Directors have the authority to issue from time to
time up to 12,500,000 shares of undesignated preferred stock.
(6) STOCKHOLDERS' EQUITY
Common Stock Offerings
On May 15, 1998, Verio completed its initial public offering of common
stock. Verio issued 5,735,000 shares for net proceeds, after offering costs, of
approximately $120.8 million.
Concurrent with the above offering, Verio also sold an additional 4,493,877
shares to a strategic investor for total proceeds of approximately $100.0
million.
F-17
71
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation Plans
Verio has established Incentive Stock Option Plans (the Plans) whereby, at
the discretion of the Board of Directors (the Board), Verio may grant stock
options to employees of Verio and its controlled subsidiaries. As of December
31, 1998, Verio had reserved 6,601,349 shares for issuance under the Plans.
Prior to Verio's initial public offering, the option price was determined by the
Board at the time the option is granted, with such price being not less than the
fair market value of Verio's common stock at the date of grant, as determined by
the Board. Options granted subsequent to the initial public offering are granted
at fair value based on quoted prices for Verio's common stock. As of December
31, 1998 options had been granted entitling the holders to purchase 6,601,349
shares of Verio's common stock, at exercise prices ranging from $1 to $30.06 per
share. Options granted on or before December 19, 1997, vest over a five year
period, and expire ten years from the date of grant. Options granted December
20, 1997, or later, vest over a four year period, and expire eight years from
the date of grant. In certain circumstances, options vest earlier or later based
upon the fair value of Verio's common shares or upon reaching certain
performance targets, as defined, and in the case that such performance targets
are not met, such performance-based options vest seven years from the date of
grant. Performance based options granted on or before December 19, 1997, expire
ten years from the date of grant, and performance based options granted December
20, 1997, or later, expire eight years from the date of grant. Options may be
exercised prior to their scheduled vesting date, but are subject to a repurchase
by Verio at the exercise price until the scheduled vesting date.
The following table summarizes option activity for the period from
inception (March 1, 1996) through December 31, 1998:
1996 1997 1998
------------------ -------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- --------- -------- ---------- --------
Outstanding at beginning of
year.......................... -- $ -- 707,700 $2.83 2,183,850 $ 5.54
Granted......................... 707,700 2.83 1,747,550 6.54 5,738,614 18.46
Exercised....................... -- -- (76,200) 1.95 (157,885) 4.29
Canceled........................ -- -- (195,200) 6.06 (1,163,230) 11.51
------- --------- ----------
Outstanding at end of year...... 707,700 $2.83 2,183,850 $5.54 6,601,349 $15.75
======= ========= ==========
Options exercisable at year
end........................... -- -- 54,700 $5.67 607,846 $ 4.86
A summary of the range of exercise prices and the weighted-average
contractual life of outstanding stock options at December 31, 1998 is as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ----------------------------
WEIGHTED
NUMBER WEIGHTED AVERAGE WEIGHTED
OUTSTANDING AVERAGE REMAINING NUMBER AVERAGE
RANGE OF DECEMBER 31, EXERCISE CONTRACTUAL EXERCISABLE EXERCISE
EXERCISE PRICES 1998 PRICE LIFE (YEARS) DECEMBER 31, 1998 PRICE
- --------------- ------------ -------- ------------ ----------------- --------
$ 1.00-$ 6.75 1,510,266 $ 4.91 8.5 559,418 $ 4.31
8.50- 13.50 1,474,980 $ 7.46 7.9 48,428 11.19
17.00- 19.00 843,845 $18.29 8.0 -- --
20.50- 22.75 2,457,358 $21.86 8.0 -- --
24.50- 30.06 314,900 $27.25 8.0 -- --
--------- -------
$ 1.00-$30.06 6,601,349 $15.75 8.1 607,846 $ 4.86
========= =======
F-18
72
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the period and years ended December 31, 1996, 1997 and 1998, the per
share weighted-average fair value of stock options granted was $.46, $1.08 and
$11.54, respectively, on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: no
dividends, volatility of 0% in 1996 and 1997 and 95% in 1998, risk-free interest
rate of 6%, and expected life of three years. If Verio had recorded compensation
expense for the period and years ended December 31, 1996, 1997 and 1998, based
on the fair value of the options at the grant date under SFAS No. 123, net loss
attributable to common stockholders would increase to $5,210,000, $46,737,000
and $137,248,000, respectively, and basic and diluted net loss per common share
would increase to $5.36, $40.83 and $6.42, respectively.
Since inception, Verio has generally granted stock options with exercise
prices equal to the fair value of the underlying common stock, as determined by
Verio's Board of Directors and based on Verio's other equity transactions prior
to the initial public offering, and quoted prices of Verio's common stock
thereafter. Accordingly, Verio had not recorded compensation expense related to
the granting of stock options in 1996, 1997 and through February 28, 1998.
Subsequent to February 28, 1998, Verio granted options to employees with
exercise prices less than the fair value per share based upon Verio's estimated
price per share in the initial public offering. Accordingly, Verio will record
compensation expense totaling approximately $8.2 million, as adjusted for
forfeitures, pro rata over the forty-eight month vesting period of the options.
This compensation expense totaled approximately $1.9 million for the year ended
December 31, 1998. In addition, Verio incurred $1.4 million in compensation
expense during the year ended December 31, 1998 related to accelerated vesting
of options and approximately $0.6 million in compensation expense related to
options issued to Verio's new president.
(7) INCOME TAXES
Income tax benefit for the period and years ended December 31 differs from
the amounts that would result from applying the federal statutory rate of 34% as
follows (in thousands):
PERIOD OR YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1997 1998
--------- ---------- ----------
Expected tax benefit.................................. $(1,749) $(15,752) $(41,494)
State income taxes, net of federal benefit............ (180) (1,622) (4,271)
Nondeductible goodwill amortization................... 26 820 5,374
Change in valuation allowance for deferred tax assets,
exclusive of effect of acquired net operating
losses.............................................. 1,877 16,472 38,698
Nondeductible portion of loss related to debt
repurchase.......................................... -- -- 1,375
Other, net............................................ 26 82 318
------- -------- --------
Actual income tax benefit............................. $ -- $ -- $ --
======= ======== ========
F-19
73
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Temporary differences that give rise to the components of deferred tax
assets as of December 31 are as follows (in thousands):
DECEMBER 31,
-------------------
1997 1998
-------- --------
Net operating loss carryforwards, including acquisitions.... $ 18,586 $ 50,597
Receivables due to allowance for doubtful accounts for tax
purposes only............................................. -- 779
Difference in amortization period for deductible goodwill... -- 1,140
Equipment and leasehold improvements due to differences in
depreciation.............................................. -- 2,739
Compensation expense related to stock options for financial
statement purposes only................................... -- 1,474
Other, net.................................................. 163 718
-------- --------
Gross deferred tax asset.......................... 18,749 57,447
Valuation allowance......................................... (18,749) (57,447)
-------- --------
Net deferred tax asset............................ $ -- $ --
======== ========
At December 31, 1998, Verio has a net operating loss carryforward for
federal income tax purposes of approximately $133.1 million, which is available
to offset future federal taxable income, if any, through 2018. As a result of
various equity transactions during 1996, 1997 and 1998, management believes
Verio has undergone an "ownership change" as defined by section 382 of the
Internal Revenue Code. Accordingly, the utilization of a portion of the net
operating loss carryforward may be limited. Due to this limitation, and the
uncertainty regarding the ultimate utilization of the net operating loss
carryforward, no tax benefit for losses has been recorded by Verio in 1996, 1997
or 1998, and a valuation allowance has been recorded for the entire amount of
Verio's deferred tax asset.
(8) CONCENTRATION OF CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial instruments that potentially subject Verio to concentrations of
credit risk consist primarily of cash, cash equivalents and accounts receivable.
As of December 31, 1996, 1997 and 1998, Verio had no significant concentrations
of credit risk. Concentrations of credit risk with respect to trade receivables
are limited due to the large number of customers comprising Verio's customer
base and the relatively minor balances of each individual account. At December
31, 1996, 1997 and 1998, the fair values of Verio's financial instruments
approximate their carrying value, based on their terms and interest rates and
quoted market prices.
(9) EMPLOYEE BENEFIT PLAN
Verio has a 401(k) Plan (the Plan) for all full time employees of Verio.
Verio may make discretionary contributions to the Plan on behalf of employees
that meet certain contribution eligibility requirements defined under the terms
of the Plan. Verio did not make any contributions to the Plan during 1996, 1997
or 1998.
F-20
74
VERIO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) QUARTERLY FINANCIAL DATA (UNAUDITED)
Summary quarterly financial information for Verio is as follows. The second
quarter of 1996 represents the period from inception (March 1, 1996) to June 30,
1996 (in thousands except per share data):
THREE MONTHS ENDED
------------------------------------------------
1996 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
---- -------- -------- ------------ ----------- ---------
Revenue..................... $ -- $ -- $ 678 $ 1,687 $ 2,365
Loss from operations........ -- (329) (1,395) (4,556) (6,280)
Net loss attributable to
common stockholders....... -- (329) (1,442) (3,374) (5,145)
Loss per common share --
basic and diluted......... -- (0.34) (1.48) (3.47) (5.29)
THREE MONTHS ENDED
------------------------------------------------
1997 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
---- -------- -------- ------------ ----------- ---------
Revenue..................... $ 4,414 $ 8,249 $ 9,624 $ 13,405 $ 35,692
Loss from operations........ (5,592) (8,854) (10,741) (15,102) (40,289)
Net loss attributable to
common stockholders....... (4,677) (9,274) (13,250) (19,128) (46,329)
Loss per common share --
basic and diluted......... (4.29) (8.32) (11.26) (16.63) (40.47)
THREE MONTHS ENDED
------------------------------------------------
1998 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
---- -------- -------- ------------ ----------- ---------
Revenue........................ $ 21,198 $ 28,541 $ 33,804 $ 37,110 $ 120,653
Loss from operations........... (14,718) (21,327) (29,140) (25,833) (91,018)
Loss before extraordinary
item......................... (18,217) (26,294) (33,606) (33,737) (111,854)
Net loss attributable to common
stockholders................. (28,383) (26,316) (33,606) (33,737) (122,042)
Loss per common share before
extraordinary item -- basic
and diluted.................. (14.45) (1.44) (1.03) (1.02) (5.24)
Loss per common share -- basic
and diluted.................. (22.44) (1.44) (1.03) (1.02) (5.71)
F-21
75
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Verio Inc.:
Under date of March 4, 1999, we reported on the consolidated balance sheets
of Verio Inc. and subsidiaries as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the period from inception (March 1, 1996) to December 31, 1996 and the
years ended December 31, 1997 and 1998, which are included in the Company's
annual report on Form 10-K for the year ended December 31, 1998. In connection
with our audits of the aforementioned consolidated financial statements, we also
audited the related consolidated financial statement Schedule II -- Valuation
and Qualifying Accounts. This financial statement schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Denver, Colorado
March 4, 1999
S-1
76
SCHEDULE II
VERIO INC.
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO
BEGINNING OF COSTS ADDITIONS FROM BALANCE AT
DESCRIPTION PERIOD AND EXPENSES ACQUISITIONS DEDUCTIONS END OF PERIOD
----------- ------------ ------------ -------------- ---------- -------------
(IN THOUSANDS)
Period from Inception (March 1,
1996) to December 31, 1996:
Allowance for doubtful
accounts................... $ -- $ 117 $ -- $ -- $ 117
Year ended December 31, 1997:
Allowance for doubtful
accounts................... $ 117 $ 948 $ 623 $ (455) $1,233
Year ended December 31, 1998:
Allowance for doubtful
accounts................... $1,233 $3,204 $1,586 $(1,260) $4,763
See accompanying independent auditors' report.
S-2
77
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1** -- Restated Certificate of Incorporation of the Registrant,
as amended.
3.2** -- Certificate of Amendment of Certificate of Incorporation
of the Registrant.
3.3** -- Certificate of Designation Establishing Series D
Preferred Stock of the Registrant.
3.4** -- Bylaws of the Registrant.
4.1*** -- Form of Old 1997 Note.
4.2*** -- Form of New 1997 Note.
4.3*** -- Escrow Agreement, dated as of June 24, 1997, among First
Trust National Association (as escrow agent and trustee)
and the Registrant.
4.4** -- 1997 Indenture (See Exhibit 10.1).
4.5** -- 1997 Notes Registration Rights Agreement (See Exhibit
10.4).
4.6*** -- Purchase Agreement, dated as of June 17, 1997, by and
among Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner
& Smith Incorporated, and Lazard Freres & Co. LLC
(collectively, the "Initial 1997 Notes Purchasers"), and
the Registrant.
4.7*** -- Form of Old March 1998 Note.
4.8*** -- Form of New March 1998 Note.
4.9** -- March 1998 Indenture (See Exhibit 10.23).
4.10** -- March 1998 Notes Registration Rights Agreement (See
Exhibit 10.24).
4.11*** -- Purchase Agreement, dated as of March 19, 1998, by and
among Salomon Brothers Inc., Lazard Freres & Co. LLC,
Chase Securities, Inc., and BancBoston Securities Inc.
(collectively, the "Initial March 1998 Notes
Purchasers"), and the Registrant.
4.12+++ -- Form of Old November 1988 Note.
4.13+++ -- Form of New November 1988 Note.
4.14++ -- November 1998 Indenture (See Exhibit 10.34).
4.15++ -- November 1998 Registration Rights Agreement (See Exhibit
10.35).
4.16++ -- Purchase Agreement, dated as of November 20, 1998, by and
among Salomon Smith Barney Inc., Credit Suisse First
Boston Corporation, Donaldson, Lufkin & Jenrette
Securities Corporation and First Union Capital Markets
(collectively, the "Initial November 1998 Notes
Purchasers"), and the Registrant.
10.1** -- Indenture, dated as of June 24, 1997, by and among the
Registrant and First Trust National Association (as
trustee).
10.2** -- Warrant Agreement, dated as of June 24, 1997, by and
between First Trust National Association and the
Registrant.
10.3** -- Common Stock Registration Rights Agreement, dated as of
June 17, 1997, by and among the Registrant, Brooks Fiber
Properties, Inc., Norwest Equity Partners V, Providence
Equity Partners, Centennial Fund V, L.P., Centennial Fund
IV, L.P. (as investors), and the Initial Purchasers.
10.4** -- Registration Rights Agreement, dated as of June 17, 1997,
by and among the Registrant and the Initial Purchasers.
10.5** -- Lease Agreement, dated as of June 20, 1997, by and
between the Registrant and Highland Park Ventures, LLC,
with respect to the property in Englewood, Colorado,
including the First Amendment to Lease Agreement, dated
as of December 16, 1997.
78
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.6** -- Lease Agreement, dated as of May 24, 1997, by and between
the Registrant and IM Joint Venture, with respect to the
property in Dallas, Texas, as amended.
10.7** -- Form of Indemnification Agreement between the Registrant
and each of its officers and directors.
10.8** -- Amended and Restated Stockholders Agreement, dated as of
May 20, 1997, by and between the Registrant, the Series A
Purchasers, the Series B Purchasers, the Series C
Purchasers and members of the Registrant's management.
10.9** -- The Registrant's 1996 Stock Option Plan, as amended.
10.10** -- The Registrant's 1997 California Stock Option Plan, as
amended.
10.11** -- The Registrant's 1998 Employee Stock Purchase Plan, as
amended.
10.12** -- The Registrant's 1998 Stock Incentive Plan, as amended.
10.13** -- Form of Compensation Protection Agreement between the
Registrant and each of its officers.
10.14** -- Master Service Agreement, dated as of August 23, 1996, by
and between the Registrant and MFS Datanet, Inc.
10.15** -- Agreement for Terminal Facility Collocation Space, dated
August 8, 1996, by and between MFS Telecom, Inc. and the
Registrant.
10.16** -- Bilateral Peering Agreement, dated May 19, 1997, between
AT&T Corp. and the Registrant.
10.17** -- Master Lease Agreement, dated November 17, 1997, by and
between Insight Investments Corp. and the Registrant.
10.18** -- Master Lease Agreement, dated October 27, 1997, by and
between Cisco Capital Systems Corporation and the
Registrant.
10.19**+ -- Lateral Exchange Networks Interconnection Agreement,
dated as of February 3, 1997, by and between the
Registrant and Sprint Communications Company L.P.
("Sprint").
10.20**+ -- Cover Agreement, dated September 30, 1996, by and between
the Registrant and Sprint.
10.21**+ -- Amendment One to Cover Agreement, dated November 7, 1996,
by and between the Registrant and Sprint.
10.22**+ -- Amendment Two to Cover Agreement, dated March 2, 1998, by
and between the Registrant and Sprint.
10.23** -- Indenture, dated as of March 25, 1998, by and among the
Registrant and First Trust National Association (as
trustee).
10.24** -- Registration Rights Agreement, dated as of March 25,
1998, by and among the Registrant, and the Initial 1998
Notes Purchasers.
10.25**+ -- Capacity and Services Agreement, dated as of March 31,
1998, by and among the Registrant and Qwest
Communications Corporation.
10.26** -- Credit Agreement, dated as of April 6, 1998, by and among
the Registrant, The Chase Manhattan Bank (as
administrative agent) and Fleet National Bank (as
documentation agent).
10.27** -- Stock Purchase and Master Strategic Relationship
Agreement, dated as of April 7, 1998, by and among the
Registrant and Nippon Telegraph and Telephone Corporation
("NTT"), a Japanese corporation.
79
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.28**+ -- Investment Agreement, dated as of April 7, 1998, by and
among the Registrant and NTT.
10.29**+ -- Outside Service Provider Agreement, dated as of April 7,
1998, by and among the Registrant and NTT America, Inc.
10.30**+ -- Master Services Agreement, dated as of June 13, 1997, by
and between the Registrant and MCI Telecommunications
Corporation ("MCI").
10.31**+ -- MCI Domestic (US) Public Interconnection Agreement dated
as of June 12, 1997, by and between the Registrant and
MCI, as amended.
10.32** -- The Registrant's 1998 Non-Employee Director Stock
Incentive Plan.
10.33*+ -- Interconnection Agreement, effective as of April 1, 1998
by and between the Registrant and UUNET Technologies,
Inc.
10.34++ -- Indenture, dated as of November 25, 1998, by and among
the Registrant and U.S. Bank Trust National Association
(as trustee).
10.35++ -- Registration Rights Agreement, dated as of November 25,
1998, by and among the Registrant and the Initial
November 1998 Notes Purchasers.
21.1 -- List of Subsidiaries of the Registrant.
23.1 -- Consent of KPMG LLP.
27.1 -- Financial Data Schedule for the fiscal year ended
December 31, 1998.
- ---------------
* Incorporated by reference from the Registrant's quarterly report on Form
10-Q filed with the Commission on August 13, 1998.
** Incorporated by reference from the Registration Statement on Form S-1 of the
Registrant (Registration No. 333-47099) filed with the Commission on
February 27, 1998, as amended.
*** Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-47497) filed with the Commission on March
6, 1998, as amended.
+ Document for which confidential treatment has been requested.
++ Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-67715) filed with the Commission on
November 23, 1998, as amended.
+++ Incorporated by reference from the Registration Statement on Form S-4 of the
Registrant (Registration No. 333-70727) filed with the Commission on January
15, 1999, as amended.