1
================================================================================
FORM 10-Q
---------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1999
---------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---------------
COMMISSION FILE NUMBER: 000-24219
---------------
VERIO INC.
(Exact name of registrant as specified in its charter)
DELAWARE 84-1339720
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
8005 S. CHESTER STREET, SUITE 200
ENGLEWOOD, COLORADO 80112
(Address of principal executive offices)
(Zip Code)
303/645-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
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 [ ]
The number of shares of the registrant's Common Stock outstanding as of
May 5, 1999 was 37,286,531.
================================================================================
2
VERIO INC.
FORM 10-Q
MARCH 31, 1999
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets-- December 31, 1998 and March 31, 1999
(unaudited).................................................................... 2
Condensed Consolidated Statements of Operations-- Three Months Ended
March 31, 1998 and March 31, 1999 (unaudited).................................. 3
Condensed Consolidated Statement of Stockholders' Equity-- Three Months
Ended March 31, 1999 (unaudited)............................................... 4
Condensed Consolidated Statements of Cash Flows-- Three Months Ended
March 31, 1998 and March 31, 1999 (unaudited).................................. 5
Notes to Condensed Consolidated Financial Statements.............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk................. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................... 17
Item 2. Changes in Securities and Use of Proceeds................................... 17
Item 3. Defaults Upon Senior Securities............................................. 17
Item 4. Submission of Matters to a Vote of Security Holders......................... 17
Item 5. Other Information........................................................... 17
Item 6. Exhibits and Reports on Form 8-K............................................ 17
3
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, MARCH 31,
1998 1999
----------- -----------
(UNAUDITED)
Current assets:
Cash, cash equivalents and securities available for sale (note 3) .......................... $ 577,387 $ 338,598
Restricted cash and securities (note 5) .................................................... 13,629 14,078
Trade receivables, net of allowance for doubtful accounts of $4,763 and $7,352 ............. 15,084 20,304
Prepaid expenses and other ................................................................. 7,831 12,479
----------- -----------
Total current assets ................................................................. 613,931 385,459
Restricted cash and securities (note 5) ...................................................... 1,176 1,278
Investments in affiliates, at cost (note 2) .................................................. 8,298 18,887
Prepaid marketing expense (note 2) ........................................................... -- 18,500
Equipment and leasehold improvements:
Internet access and computer equipment ..................................................... 66,408 88,815
Furniture, fixtures and computer software .................................................. 5,823 7,133
Leasehold improvements ..................................................................... 4,887 10,540
----------- -----------
77,118 106,488
Less accumulated depreciation and amortization ............................................. (26,672) (34,646)
----------- -----------
Net equipment and leasehold improvements ................................................. 50,446 71,842
Other assets:
Goodwill, net of accumulated amortization of $21,614 and $35,015 (note 2) .................. 236,696 480,610
Debt issuance costs, net of accumulated amortization of $1,710 and $2,432 .................. 18,542 18,363
Other, net (note 4) ........................................................................ 4,623 30,414
----------- -----------
Total assets ......................................................................... $ 933,712 $ 1,025,353
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ........................................................................... $ 10,501 $ 7,658
Accrued expenses ........................................................................... 14,228 42,730
Accrued interest payable ................................................................... 9,634 28,873
Lines of credit, notes payable and current portion of long-term debt (note 5) .............. 3,329 957
Current portion of capital lease obligations ............................................... 5,848 7,643
Deferred revenue ........................................................................... 12,512 17,519
----------- -----------
Total current liabilities ............................................................ 56,052 105,380
Long-term debt, less current portion, net of discount (note 5) ............................... 668,177 672,431
Capital lease obligations, less current portion .............................................. 6,441 7,864
Other long-term liabilities (note 2) ......................................................... -- 10,000
----------- -----------
Total liabilities .................................................................... 730,670 795,675
----------- -----------
Minority interests in subsidiaries (note 2) .................................................. 361 --
Stockholders' equity:
Preferred stock, undesignated; 12,500,000 shares authorized; no shares issued and
outstanding .............................................................................. -- --
Common stock, $.001 par value; 125,000,000 shares authorized; 33,146,010 and 37,010,302
shares issued and outstanding at December 31, 1998 and March 31, 1999 .................... 33 37
Additional paid-in capital ................................................................. 376,164 448,269
Accumulated deficit ........................................................................ (173,516) (218,628)
----------- -----------
Total stockholders' equity ........................................................... 202,681 229,678
----------- -----------
Commitments and contingencies (note 5)
Total liabilities and stockholders' equity ........................................... $ 933,712 $ 1,025,353
=========== ===========
See accompanying notes to consolidated financial statements.
2
4
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1999
-------- --------
(UNAUDITED)
Revenue:
Internet connectivity:
Dedicated ............................................ $ 9,900 $ 21,470
Dial-up .............................................. 4,147 6,614
Enhanced services and other ............................. 7,151 27,040
-------- --------
Total revenue ................................... 21,198 55,124
Costs and expenses:
Cost of service ......................................... 9,536 19,406
Sales and marketing ..................................... 4,980 14,831
General and administrative .............................. 15,019 28,805
Depreciation and amortization ........................... 6,381 21,614
-------- --------
Total costs and expenses ........................ 35,916 84,656
-------- --------
Loss from operations ............................ (14,718) (29,532)
Other income (expense):
Interest income ......................................... 1,650 4,778
Interest expense and other .............................. (5,551) (20,358)
-------- --------
Loss before minority interests and
extraordinary item ............................ (18,619) (45,112)
Minority interests ........................................ 402 --
-------- --------
Loss before extraordinary item .................. (18,217) (45,112)
Extraordinary item-- loss related to debt repurchase
(note 5) .................................................. (10,101) --
-------- --------
Net loss ........................................ (28,318) (45,112)
Accretion of preferred stock to liquidation value ......... (65) --
-------- --------
Net loss attributable to common
stockholders .................................. $(28,383) $(45,112)
======== ========
Weighted average number of common shares
outstanding-- basic and diluted ......................... 1,265 36,448
======== ========
Loss per common share-- basic and diluted:
Loss per common share before extraordinary item ......... $ (14.45) $ (1.24)
Extraordinary item ...................................... (7.99) --
-------- --------
Loss per common share ........................... $ (22.44) $ (1.24)
======== ========
See accompanying notes to consolidated financial statements.
3
5
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK ADDITIONAL
------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- ---------- ---------- ------------ ----------
BALANCES AT DECEMBER 31, 1998 .................. 33,146,010 $ 33 $ 376,164 $ (173,516) $ 202,681
Issuance of common stock for:
Exercise of options .......................... 414,501 1 2,280 -- 2,281
Exercise of warrants ......................... 182,730 -- 2 -- 2
Exercise of warrants issued pursuant to
a non-cash exchange of notes ............... 122,215 -- 941 -- 941
Stock issued pursuant to the
acquisition .................................... 3,144,846 3 50,318 -- 50,321
of Best Internet, Inc. .....................
Issuance of common stock options and
warrants in .................................... -- -- 18,084 -- 18,084
business combinations (note 2)
Stock option related compensation and
severance costs (note 6) ..................... -- -- 480 -- 480
Net loss ....................................... -- -- -- (45,112) (45,112)
---------- ---------- ---------- ---------- ----------
BALANCES AT MARCH 31, 1999 (UNAUDITED) ......... 37,010,302 $ 37 $ 448,269 $ (218,628) $ 229,678
========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
4
6
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------------
1998 1999
--------- ---------
(unaudited)
Cash flows from operating activities:
Net loss ......................................................... $ (28,318) $ (45,112)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization .................................. 6,381 21,614
Minority interests' share of losses ............................ (402) --
Stock option related compensation and severance costs .......... -- 680
Extraordinary item-- loss related to debt repurchase ........... 10,101 --
Changes in operating assets and liabilities, excluding
effects of business combinations:
Receivables .................................................. (1,226) (1,144)
Prepaid expenses and other current assets .................... 773 (11,988)
Accounts payable ............................................. (1,607) (3,374)
Accrued expenses ............................................. (3,509) 10,489
Accrued interest payable ..................................... 3,467 19,435
Deferred revenue ............................................. (466) (321)
--------- ---------
Net cash used by operating activities ..................... (14,806) (9,721)
--------- ---------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements ............ (3,820) (9,867)
Acquisition of net assets in business combinations and
investments in affiliates, net of cash acquired .............. (18,844) (207,565)
Change in restricted cash and securities ....................... 13,341 (217)
Other .......................................................... (373) (8,975)
--------- ---------
Net cash used by investing activities ..................... (9,696) (226,624)
--------- ---------
Cash flows from financing activities:
Proceeds from lines of credit, notes payable and
long-term debt ..................................................... 169,769 --
Repayments of lines of credit and notes payable ................ (57,138) (2,631)
Repayments of capital lease obligations ........................ (450) (2,096)
Proceeds from issuance of common and preferred stock, net
of issuance costs ............................................. 131 2,283
--------- ---------
Net cash provided (used) by financing activities .......... 112,312 (2,444)
--------- ---------
Net increase (decrease) in cash and cash
equivalents ............................................. 87,810 (238,789)
Cash, cash equivalents and securities available for sale:
Beginning of period ............................................ 72,586 577,387
--------- ---------
End of period .................................................. $ 160,396 $ 338,598
========= =========
Supplemental disclosures of cash flow information:
Cash paid for interest ......................................... $ 1,875 $ 799
========= =========
Supplemental disclosures of non-cash investing and financing
activities:
Equipment acquired through capital lease obligations ............ $ 1,651 $ 4,895
========= =========
Warrants issued in connection with debt offering ................ $ 17,008 $ --
========= =========
Acquisition of net assets in business combinations through
issuance of common stock and common stock options
and warrants ....................................................... $ -- $ 68,405
========= =========
Other liabilities incurred for:
Prepaid marketing expense and acquisition of customers through AOL
agreement ..................................................... $ -- $ 25,000
========= =========
See accompanying notes to consolidated financial statements.
5
7
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 leading,
full-service 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 1998 or the
three months ended March 31, 1999.
The accompanying consolidated financial statements include the accounts of
Verio and its majority owned subsidiaries. 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. Certain reclassifications have been
made to the 1998 financial statements to conform with the 1999 financial
statement presentation.
(2) BUSINESS COMBINATIONS, INVESTMENTS IN AFFILIATES AND ASSET ACQUISITIONS
During the three months ended March 31, 1999, Verio completed two business
combinations for cash and common stock. Each of these acquisitions was accounted
for using the purchase method of accounting, and represents the acquisition of
stock. Outstanding stock options and warrants of acquired businesses were
included in the determination of the purchase prices based on fair values. The
results of operations for the two 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 1999:
OWNERSHIP
INTEREST APPROXIMATE
BUSINESS NAME ACQUISITION DATE PURCHASED PURCHASE PRICE
- ------------- ---------------- --------- --------------
(IN THOUSANDS)
Best Internet Communications, Inc. ....... January 5, 1999 100% $244,402
Web Communication, LLC ................... February 19, 1999 100% 8,000
--------
$252,402
Acquisition costs ............................................................. 3,662
--------
$256,604
========
The aggregate purchase price, including acquisition costs, was allocated based
upon fair values as follows:
Equipment ................. $ 15,458
Goodwill .................. 257,315
Net current liabilities ... (16,169)
---------
Total purchase price ..... $ 256,604
=========
6
8
In January 1999, Verio completed the acquisition of all the outstanding
common stock of Best Internet Communications, Inc. (which does business as Hiway
Technologies, Inc.) for total consideration of approximately $244.4 million,
including $176.0 million in cash and approximately 4.9 million fully diluted
shares of common stock. In February 1999, Verio also completed the acquisition
of Web Communications, LLC for approximately $8.0 million in cash.
For the three months ended March 31, 1998, on a pro forma basis, total
revenue would have increased to $30.0 million, net loss attributable to common
stockholders would have increased to $33.3 and loss per share would have
decreased to $7.50 due to the additional common stock issued pursuant to the
Hiway acquisition purchase agreement.
Investment in affiliates at March 31, 1999 represents the Company's
cost-based investments, primarily in V-I-A Internet, Inc. and NorthPoint
Communications, Inc.
Effective March 4, 1999, Verio entered into an agreement with America
Online, Inc. ("AOL"). Under this three-year agreement, 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., 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. The
first payment of $17.5 million was made in March 1999.
(3) CASH, CASH EQUIVALENTS AND SECURITIES AVAILABLE FOR SALE
Verio considers all highly liquid debt instruments with original maturities
of three months or less to be cash equivalents. Verio's securities available for
sale consist of readily market able debt securities with remaining maturities of
more than 90 days at the time of purchase. The balance of securities available
for sale are $143,963,000 and $133,623,000 at December 31, 1998 and March 31,
1999, respectively.
(4) OTHER ASSETS
Goodwill consists of the excess of cost over the fair value of net assets
acquired and is amortized using a straight-line method over a 10-year period.
Debt issuance costs are amortized over the life of the debt. Other intangibles
consist primarily of the costs associated with customer acquisitions and
non-compete agreements and are amortized over a three-year period.
(5) DEBT
On November 25, 1998, Verio completed the private placement of $400.0
million principal amount of senior notes due 2008 (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 (each as
defined below).
On March 25, 1998, Verio completed the private placement of $175.0 million
principal amount of senior notes due 2005 (the "March 1998 Notes"). The March
1998 Notes are redeemable at the option of Verio commencing
7
9
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.
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 $13.2 million at March 31, 1999. The 1997 Notes are
redeemable on or after June 15, 2002 at 103% of the face value, decreasing to
face value at maturity. The indenture covering the 1997 Notes includes various
covenants restricting the payment of dividends, additional indebtedness,
disposition of assets, and transactions with affiliates.
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 Offered 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 March 31,
1999.
(6) STOCKHOLDERS' EQUITY
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. Prior to Verio's
initial public offering ("IPO"), the option price was determined by the Board at
the time the option was 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. Typically, this determination was based on Verio's other recent equity
offerings. Options granted subsequent to the IPO are granted at fair value based
on the trading price for Verio's common stock on NASDAQ at the time of grant.
Because option grants were made at strike prices based on a current fair market
value determination, Verio had not recorded compensation expense related to the
granting of stock options in 1996, 1997 and through February 28, 1998. With
respect to certain option grants made subsequent to February 28, 1998 and before
the completion of the IPO, Verio granted options to employees with exercise
prices that subsequently were determined to be less than the fair value per
share based upon Verio's estimated price per share in the IPO. Accordingly,
Verio is recognizing 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 $0.5 million for
the three months ended March 31, 1999.
8
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
Our Company was founded in March 1996. Since then, we have rapidly
established a global presence by acquiring, integrating and growing independent
Internet service providers with a business customer focus. We had, together with
our subsidiaries, total revenue of approximately $55.1 million for the three
months ended March 31, 1999. This revenue reflects our acquisition of Best
Internet Communications, Inc. (which business as Hiway Technologies, Inc.) which
we completed on January 5, 1999.
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 now generally moved to a
strategy of acquiring 100% of new businesses, although in certain circumstances
we continue to make investments in less then wholly owned companies. 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 geographic and product
based operating units. 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.
To fund our acquisitions and operations, from inception through March 31,
1999 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 and 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
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. ("Brooks"), $100.0 million of which remain
outstanding following the repurchase of $50.0 million principal amount of the
1997 Notes previously held by 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 $400.0 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.
9
11
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THREE MONTHS ENDED
MARCH 31, 1999
The following table presents operating data, as a percentage of total
revenue, for the three months ended March 31, 1998 and 1999. This information is
from our Condensed Consolidated Financial Statements included in this Form 10-Q.
This information should be read in conjunction with the Notes to Condensed
Consolidated Financial Statements.
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1999
------- -------
Revenue:
Internet connectivity ........................................... 66% 51%
Enhanced services and other ..................................... 34% 49%
Total revenue ........................................... 100% 100%
Costs and expenses:
Cost of service ................................................. 45% 35%
Sales and marketing ............................................. 23% 27%
General and administrative ...................................... 71% 53%
Depreciation and amortization ................................... 30% 39%
Total costs and expenses ................................ 169% 154%
Loss from operations .................................... (69%) (54%)
Other income (expense):
Interest income ................................................. 8% 9%
Interest expense and other ...................................... (27%) (37%)
Loss before minority interests and extraordinary item ... (88%) (82%)
Minority interests ................................................ 2% --
Loss before extraordinary item .......................... (86%) (82%)
Extraordinary item-- loss related to debt repurchase .............. (48%) --
Net loss ................................................ (134%) (82%)
Revenue
Most of our revenue is received from business customers who purchase high
speed Internet connectivity, Web hosting products, and other enhanced value
Internet 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 sign a contract for one year of service and pay
fixed, recurring monthly service charges plus a one-time setup fee under those
agreements. These charges vary depending on the type of service, the length of
the contract, and local market conditions. Our Web hosting customers also
typically sign one year service contracts and pay fixed, recurring monthly
service charges plus a one-time 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 value
Internet 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 acquisitions we made beginning at the end of
1997 and through 1998 (including Hiway) 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 revenue from small and mid-sized
business customers. Revenue from business customers currently represents
approximately 90% of revenue, and approximately 85% of revenue is recurring. No
single customer represents more than 2% of revenue.
Total revenue increased 160% from $21.2 million for the three months ended
March 31, 1998 to $55.1 million for the three months ended March 31, 1999.
Acquisitions completed after March 31, 1998 contributed significantly to this
increase.
10
12
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. Most of the Internet businesses and operations we have acquired were
party to various local telecommunications and Internet access contracts with
third parties when we acquired them.. Verio is in the process of converting that
traffic carried by third parties to its own network as those historic agreements
expire. Currently, we expect to have substantially completed that process for
our prior acquisitions 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 we incur to lease
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, we expect to use
Qwest for the majority of our 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 March
31, 1999 would have been approximately $84.1 million.
Cost of service increased $9.9 million, from $9.5 million for the three
months ended March 31, 1998 to $19.4 million for the three months ended March
31, 1999, primarily due to acquisitions. However, as a percentage of revenue,
cost of service decreased from 45% for the three months ended March 31, 1998 to
35% for the three months ended March 31,1999. As Verio continues to grow, we
expect our cost of service likewise to continue to increase in absolute dollars.
However, we also expect cost of service to decrease as a percentage of total
revenue, as Verio's revenue mix shifts to higher margin Web hosting other and
enhanced value Internet 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 increased from 23% of total revenue for
the three months ended March 31, 1998 to 27% for the three months ended March
31, 1999, due to increases in the number of direct sales representatives,
indirect channel managers and marketing personnel, and increased national brand
advertising.
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 $13.8 million, from $15.0 million for the three months ended
March 31, 1998 to $28.8 million for the three months ended March 31, 1999,
primarily due to acquisitions. However, as a percentage of revenue, general and
administrative expense decreased from 71% to 53%, which was the result of
efficiencies being realized by combining the operations of numerous acquisitions
and lower general and administrative costs required to support enhanced
services. 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 into the fourth quarter of 1999. The
remaining liability for unpaid severance costs totaled approximately $1.0
million at March 31, 1999.
General and administrative expenses are expected to continue to increase in
absolute dollars but to decrease as a percentage of total revenue as revenue
growth continues to outpace general expenses. Verio's scalable systems limit the
number of additional personnel, and the need for additional office space to
support incremental revenue. We expect these systems 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 we expect. 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.
11
13
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. Debt issuance costs are amortized
over the life of the debt. Other intangibles consist primarily of the costs
associated with customer acquisitions and non-compete agreements and are
amortized over a three-year period.
Other Expenses
Interest expense increased from $5.6 million for the three months ended
March 31, 1998 to $20.4 million for the three months ended March 31, 1999,
primarily as a result of the issuance of the March 1998 Notes and the November
1998 Notes. Interest income increased from $1.7 million for the three months
ended March 31, 1998 to $4.8 million for the three months ended March 31, 1999
due to increased cash balances resulting from the debt and equity offerings. See
"-- Liquidity and Capital Resources."
In the three months ended March 31, 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."
CASH FLOW ACTIVITY
Three Months Ended March 31, 1999 -- Net cash used by operating activities
was $9.7 million during the three months ended March 31, 1999, which includes an
increase in cash of $13.1 million related to working capital items. Additional
cash used during the three months ended March 31, 1999 was primarily for
business combinations and capital expenditures, $207.6 million ($176.0 million
for the Hiway Acquisition) and $9.9 million, respectively. Sources of cash
included approximately $2.3 million from the exercise of options.
Three Months Ended March 31, 1998 -- Net cash used by operating activities
was $14.8 million during the three months ended March 31, 1998, which includes a
decrease in cash of $2.6 million related to working capital items. Sources of
cash included approximately $175.0 million from the March 1998 Notes of which
$54.5 million was used to repurchase $50.0 million principal amount of the 1997
Notes. Other cash used during the three months ended March 31, 1998 was
primarily for business combinations and capital expenditures, $18.8 million and
$3.8 million, respectively.
Cash flows used by operations as a percentage of revenue improved from
(70%) to (18%) from the three months ended March 31, 1998 to the three months
ended March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Our business strategy has required and is expected to continue to require
substantial capital to fund 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
12
14
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.
On March 25, 1998, 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 to effect
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 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
Offered 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 a number of other restrictions, including
limitations on our ability to:
o engage in businesses other than the Internet service business;
o place liens on our assets; and
o pay dividends.
In addition, under the credit facility, 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 May 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
13
15
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 a number of other restrictions, including, among
others, limitations on our ability to:
o engage or make investments in businesses other than the Internet
service business;
o place liens on or dispose of our assets; and
o 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.
As of March 31, 1999, we had approximately $354.0 million in cash and cash
equivalents and short-term investments (including $15.4 million of restricted
cash). Our business plan currently anticipates investments of approximately
$140.0 million over the next 12 months for capital expenditures, acquisitions
completed since December 31,1998, operating losses and working capital.
Our Company is highly leveraged and has significant debt service
requirements. At March 31, 1999 our long-term debt was $690.3 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.
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. 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 revenue increases.
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. We regularly examine financing alternatives based on prevailing
market conditions, and expect to access the capital markets from time to time
based on our current and anticipated cash needs and market opportunities. 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
14
16
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.
THE YEAR 2000 ISSUE
The "Year 2000" issue 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 material 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.
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.
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.
Prior to Verio's acquisition of Hiway, 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 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
15
17
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 above 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 our
acquisition of, or investments in, existing affiliates, the revenue and
profitability levels of the affiliates in which we invest, 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 in this report will prove to be accurate.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
No significant changes in the quantitative and qualitative disclosures
about market risk have occurred from the discussion contained in our report on
Form 10-K for the year ended December 31, 1998, which was filed with the
Commission on March 31, 1999.
16
18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Verio Inc. is party to various legal proceedings that have arisen in
the ordinary course of business, none of which are considered material.
ITEM 2. Changes in Securities and Use of Proceeds
Not Applicable
ITEM 3. Defaults Upon Senior Securities
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
See attached exhibit index.
(b) Reports on Form 8-K
On January 11, 1999, the Company filed a Current Report on Form 8-K,
dated January 5, 1999, announcing the consummation of the acquisition by the
Company of Best Internet Communications, Inc., which closed on January 5, 1999,
pursuant to the provisions of an Amended and Restated Agreement and Plan of
Merger, dated as of November 17, 1998 (the "Merger Agreement"). The Current
Report included the following exhibits: (i) Amended and Restated Agreement and
Plan of Merger, dated as of November 17, 1998; (ii) a press release issued by
the Company relating to the consummation of the Merger Agreement; (iii) Consent
of PricewaterhouseCoopers LLP; (iv) Consent of DeMeo, Young, McGrath & Company,
P.A.; and (v) Financial Statements of Best Internet Communications, Inc.
17
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERIO INC.
/s/ PETER B. FRIZINGER
Date: May 12, 1999 -------------------------------------
Peter B. Frizinger
Chief Financial Officer
/s/ CARLA HAMRE DONELSON
Date: May 12, 1999 -------------------------------------
Carla Hamre Donelson
Vice President, General Counsel and
Secretary
20
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27 - Financial Data Schedule