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FORM 10-Q
---------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
[ ] FOR THE QUARTERLY PERIOD ENDED: September 30, 1999
---------------
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: 000-24219
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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
November 12, 1999 was 77,128,419.
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VERIO INC.
FORM 10-Q
SEPTEMBER 30, 1999
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets-- December 31, 1998 and
September 30, 1999 (unaudited).................................... 3
Condensed Consolidated Statements of Operations-- Three Months Ended
September 30, 1998 and September 30, 1999 (unaudited)............. 4
Condensed Consolidated Statements of Operations-- Nine months Ended
September 30, 1998 and September 30, 1999 (unaudited)............. 5
Condensed Consolidated Statement of Stockholders' Equity-- Nine months
Ended September 30, 1999 (unaudited).............................. 6
Condensed Consolidated Statements of Cash Flows-- Nine months Ended
September 30, 1998 and September 30, 1999 (unaudited)............. 7
Notes to Condensed Consolidated Financial Statements................. 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 21
Item 2. Changes in Securities and Use of Proceeds...................... 21
Item 3. Defaults Upon Senior Securities................................ 21
Item 4. Submission of Matters to a Vote of Security Holders............ 21
Item 5. Other Information.............................................. 21
Item 6. Exhibits and Reports on Form 8-K............................... 35
2
3
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, SEPTEMBER 30,
1998 1999
---------------- ---------------
(UNAUDITED)
Current assets:
Cash, cash equivalents and securities available for sale (note 3)....... $ 577,387 $ 492,964
Restricted cash and securities (notes 6 and 8).......................... 13,629 31,485
Trade receivables, net of allowance for doubtful accounts of $4,763 and
$8,070................................................................ 15,084 30,098
Prepaid expenses and other.............................................. 7,831 15,995
---------- --------------
Total current assets.............................................. 613,931 570,542
Restricted cash and securities (note 6)................................... 1,176 1,657
Investments in affiliates and others, at cost (note 2).................... 8,298 18,912
Prepaid marketing expense (note 2)........................................ -- 17,948
Equipment and leasehold improvements (note 4) 77,118 207,448
Less accumulated depreciation and amortization............................ (26,672) (51,757)
---------- --------------
Net equipment and leasehold improvements.............................. 50,446 155,691
Other assets:
Goodwill, net of accumulated amortization of $21,614 and $63,334 (note 5) 236,696 556,543
Debt issuance costs, net of accumulated amortization of $1,710 and $3,153 18,542 17,791
Other, net (note 2)..................................................... 4,623 26,130
---------- --------------
Total assets...................................................... $ 933,712 $ 1,365,214
========== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................................ $ 10,501 $ 8,989
Accrued expenses........................................................ 14,228 50,777
Accrued interest payable................................................ 9,634 28,158
Payable for fiber capacity (note 7) .................................... -- 57,702
Lines of credit, notes payable and current portion of long-term debt
(note 6).............................................................. 3,329 917
Current portion of capital lease obligations............................ 5,848 11,327
Deferred revenue........................................................ 12,512 20,880
---------- --------------
Total current liabilities......................................... 56,052 178,750
Long-term debt, less current portion, net of discount (note 6)............ 668,177 670,840
Capital lease obligations, less current portion........................... 6,441 13,166
Other long-term liabilities (note 2)...................................... -- 10,195
---------- --------------
Total liabilities................................................. 730,670 872,951
---------- --------------
Minority interests in subsidiaries (note 2)............................... 361 --
Stockholders' equity:
Convertible preferred stock; 12,500,000 shares authorized; 7,200,000
shares of 6.75% Series A issued and outstanding - liquidation
preference of $360,000 .............................................. -- 347,601
Common stock $.001 par value; 250,000,000 shares authorized; 66,292,020
and 76,894,006 shares issued and outstanding, at December 31, 1998
and September 30, 1999 (note 8)....................................... 66 77
Additional paid-in capital.............................................. 376,131 455,638
Accumulated deficit..................................................... (173,516) (311,053)
---------- --------------
Total stockholders' equity........................................ 202,681 492,263
---------- --------------
Commitments and contingencies (note 7)
Total liabilities and stockholders' equity........................ $ 933,712 $ 1,365,214
========== ==============
See accompanying notes to consolidated financial statements.
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4
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
1998 1999
----------------- ----------------
(UNAUDITED)
Revenue:
Internet connectivity:
Dedicated................................ $ 14,380 $ 24,827
Dial-up.................................. 6,386 6,342
Enhanced services and other................. 13,038 37,157
--------- ---------
Total revenue....................... 33,804 68,326
Costs and expenses:
Cost of service............................. 15,074 18,011
Sales and marketing......................... 10,716 15,506
General and administrative.................. 25,414 32,021
Depreciation and amortization............... 11,740 29,514
--------- ---------
Total costs and expenses............ 62,944 95,052
--------- ---------
Loss from operations................ (29,140) (26,726)
Other income (expense):
Interest income............................. 4,164 5,252
Interest expense and other.................. (8,630) (20,465)
--------- ---------
Net loss............................ (33,606) (41,939)
Return on convertible preferred stock (note 8) - (4,793)
--------- ---------
Net loss attributable to common
stockholders...................... $ (33,606) $ (46,732)
========= =========
Weighted average number of common shares
outstanding-- basic and diluted ............ 65,072 76,327
========= =========
Loss per common share-- basic and diluted:.... $ (0.52) $ (0.61)
========= =========
See accompanying notes to consolidated financial statements.
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5
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1999
---------------- ----------------
(UNAUDITED)
Revenue:
Internet connectivity:
Dedicated................................ $ 36,924 $ 69,399
Dial-up.................................. 16,272 19,108
Enhanced services and other................. 30,347 96,879
-------- ---------
Total revenue....................... 83,543 185,386
Costs and expenses:
Cost of service............................. 37,928 57,556
Sales and marketing......................... 22,894 45,039
General and administrative.................. 61,087 91,866
Depreciation and amortization............... 26,818 76,254
-------- ---------
Total costs and expenses............ 148,727 270,715
-------- ---------
Loss from operations................ (65,184) (85,329)
Other income (expense):
Interest income............................. 9,381 14,262
Interest expense and other.................. (22,860) (61,677)
-------- ---------
Loss before minority interests and
Extraordinary item................ (78,663) (132,744)
Minority interests............................ 545 --
-------- ---------
Loss before extraordinary item...... (78,118) (132,744)
Extraordinary item-- loss related to debt
repurchase (note 6).......................... (10,101) --
-------- ---------
Net loss............................ (88,219) (132,744)
Accretion of preferred stock to liquidation
value and return on convertible preferred
stock (note 8)............................... (87) (4,793)
-------- ---------
Net loss attributable to common
stockholders..................... $(88,306) $(137,537)
======== =========
Weighted average number of common shares
outstanding-- basic and diluted ............ 34,924 74,720
======== =========
Loss per common share-- basic and diluted:
Loss per common share before extraordinary
item...................................... $ (2.24) $ (1.84)
Extraordinary item.......................... (0.29) --
---------- ---------
Loss per common share............... $ (2.53) $ (1.84)
========= =========
See accompanying notes to consolidated financial statements.
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6
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
CONVERTIBLE COMMON STOCK ADDITIONAL
PREFERRED ------------------- PAID-IN ACCUMULATED
STOCK SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ---------- ------ ---------- ----------- ----------
BALANCES AT DECEMBER 31, 1998 (note 8) $ -- 66,292,020 $ 66 $376,131 $(173,516) $ 202,681
Issuance of common stock for:
Exercise of options.................. -- 2,087,576 2 8,257 -- 8,259
Exercise of warrants................. -- 1,339,520 2 910 -- 912
Employee purchases................... -- 169,438 -- 1,125 -- 1,125
Exercise of warrants issued pursuant
to a non-cash exchange of notes.... -- 715,760 1 2,357 -- 2,358
Stock issued pursuant to the
acquisition of Best Internet
Communications, Inc. (note 2)........ -- 6,289,692 6 50,315 -- 50,321
Issuance of common stock options and
warrants in business combinations
(note 2)............................ -- -- -- 15,187 -- 15,187
Issuance of convertible preferred
stock, net of issuance costs......... 347,601 -- -- -- -- 347,601
Stock option related compensation and
severance costs (note 8)............. -- -- -- 1,356 -- 1,356
Return on convertible preferred stock.. (4,793) (4,793)
Net loss............................... -- -- -- -- (132,744) (132,744)
-------- ---------- ---- -------- --------- ---------
BALANCES AT SEPTEMBER 30, 1999
(unaudited)............................ $347,601 76,894,006 $ 77 $455,638 $(311,053) $ 492,263
======== ========== ==== ======== ========= =========
See accompanying notes to consolidated financial statements.
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VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1998 1999
---------------- ----------------
(UNAUDITED)
Cash flows from operating activities:
Net loss................................................... $(88,219) $ (132,744)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization............................ 26,818 76,254
Minority interests' share of losses...................... (545) --
Stock option related compensation and severance costs.... 3,040 1,356
Other ................................................... -- (377)
Extraordinary item-- loss related to debt repurchase..... 10,101 --
Changes in operating assets and liabilities, excluding
effects of Business combinations:
Receivables............................................ (1,979) (10,350)
Prepaid expenses and other current assets.............. (899) (15,613)
Accounts payable....................................... (889) (2,782)
Accrued expenses....................................... 3,720 8,268
Accrued interest payable............................... 13,040 19,182
Deferred revenue....................................... (445) 2,416
-------- ----------
Net cash used by operating activities............... (36,257) (54,390)
-------- ----------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements...... (15,327) (38,678)
Acquisition of net assets in business combinations and
investments in Affiliates and others, net of cash
acquired............................................... (121,432) (307,695)
Change in restricted cash and securities................. 19,689 (18,003)
Other.................................................... (2,242) (11,305)
--------- ----------
Net cash used by investing activities............... (119,312) (375,681)
--------- -----------
Cash flows from financing activities:
Proceeds from issuance of convertible preferred stock,
net of issuance costs.................................. -- 347,601
Proceeds from lines of credit, notes payable and
long-term debt, net of issuance costs.................. 168,827 --
Repayments of lines of credit and notes payable.......... (58,784) (4,160)
Repayments of capital lease obligations.................. (2,452) (8,089)
Proceeds from issuance of common stock, net of
issuance costs......................................... 221,304 10,296
-------- ----------
Net cash provided by financing activities........... 328,895 345,648
-------- ----------
Net increase (decrease) in cash and cash equivalents
and securities available for sale................. 173,326 (84,423)
Cash, cash equivalents and securities available for sale:
Beginning of period...................................... 72,586 577,387
-------- ----------
End of period............................................ $245,912 $ 492,964
======== ==========
Supplemental disclosures of cash flow information:
Cash paid for interest................................... $ 10,393 $ 43,152
======== ==========
Supplemental disclosures of non-cash investing and financing
activities:
Equipment acquired through capital lease obligations...... $ 7,209 $ 18,686
======== ==========
Fiber capacity asset...................................... $ -- $ 57,702
======== ==========
Acquisition of net assets in business combinations through
issuance of common stock and common stock options and
warrants................................................ $ 28,663 $ 65,508
======== ==========
Other liabilities incurred for prepaid marketing expense and
acquisition of customers through AOL agreement $ -- $ 25,000
======== ==========
See accompanying notes to consolidated financial statements.
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8
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.
Since then, Verio has rapidly established a global presence by acquiring and
growing Internet service providers with a business customer focus. Verio is the
world-wide leader in hosting domain-based Web sites and a leading provider of
high speed connectivity and enhanced services such as electronic commerce and
virtual private networks 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.
The accompanying unaudited financial information as of September 30, 1999
and for the three- and nine-month periods ended on each of September 30, 1998
and September 30, 1999 has been prepared in accordance with generally accepted
accounting principles for interim financial information. All significant
adjustments, consisting of only normal and recurring adjustments, which, in the
opinion of management, are necessary for a fair presentation of the results of
the three and nine months ended on each of September 30, 1998 and September 30,
1999 have been included. Operating results for the three- and nine-month periods
ending September 30, 1999 are not necessarily indicative of the results that may
be expected for the full year.
The accompanying consolidated financial statements include the accounts of Verio
and 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.
In particular, the financial statements reflect the effect of the two-for-one
stock split that became effective on August 20, 1999 for stockholders of record
at the close of business on August 3, 1999 (the "Stock Split") which was
effected in the form of a dividend.
(2) BUSINESS COMBINATIONS, INVESTMENTS IN AFFILIATES AND ASSET ACQUISITIONS
During the nine months ended September 30, 1999, Verio completed three
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 capital or common stock. Outstanding stock options and warrants
of the acquired businesses were included in the determination of the purchase
prices based on fair values. 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:
OWNERSHIP
INTEREST APPROXIMATE
BUSINESS NAME ACQUISITION DATE PURCHASED PURCHASE PRICE
------------- ---------------- --------- --------------
(IN THOUSANDS)
Best Internet Communications, Inc January 5, 1999 100% $ 241,505
Web Communications, LLC.......... February 19, 1999 100% 8,000
Computer Services Group, Inc.
(digitalNATION)................ July 13, 1999 100% 100,000
---------
$ 349,505
Acquisition costs...................................................... 5,276
---------
$ 354,781
=========
The aggregate purchase price, including acquisition costs, was allocated based
upon fair values as follows:
Equipment...................... $ 19,110
Goodwill....................... 349,944
Net current liabilities........ (14,273)
---------
Total purchase price........ $ 354,781
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9
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. and which we refer to as "Hiway") for total consideration of
approximately $241.5 million, including $176.0 million in cash and approximately
9.8 million shares of Verio common stock. In February 1999, Verio completed the
acquisition of Web Communications, LLC for approximately $8.0 million in cash,
and in July 1999, Verio acquired all of the outstanding stock of Computer
Services Group, Inc. (which does business as digitalNATION) for $100.0 million
in cash.
For the nine months ended September 30, 1998, on a pro forma basis, assuming
the Hiway and digitalNATION acquisitions occurred on January 1, 1998, total
revenue would have increased to $117.3 million, net loss attributable to common
stockholders would have increased to $124.9 million and loss per share would
have increased to $3.03. For the nine months ended September 30, 1999, on a pro
forma basis, assuming the digitalNATION acquisition occurred on January 1, 1998,
total revenue would have increased to $193.1 million, net loss attributable to
common stockholders would have increased to $144.6 million and loss per share
would have increased to $1.93.
Investment in affiliates at September 30, 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 Web hosting and
designated electronic commerce products and services are exclusive during this
period on these four specified sites. AOL has also conveyed its 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
agreement, with AOL participating in future revenue under specified
circumstances defined in the agreement. The first payment of $17.5 million was
made in March 1999. The payments to AOL have been allocated to subscribers and
prepaid advertising costs based on the estimated fair values of the assets
acquired.
(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 marketable debt securities with remaining maturities of
more than 90 days but less than 360 days at the time of purchase which are
carried at cost which approximates market value. The balances of securities
available for sale were $144.0 million and $127.4 million at December 31, 1998
and September 30, 1999, respectively.
(4) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consisted of the following:
December 31, September 30,
1998 1999
----------------- ----------------
Internet access and computer equipment $ 66,408 $129,267
Fiber capacity -- 57,702
Furniture, fixtures and computer software 5,823 7,861
Leasehold improvements 4,887 12,618
-------- --------
77,118 207,448
Less accumulated depreciation (26,672) (51,757)
-------- --------
Equipment and leasehold improvements, net $ 50,446 $155,691
======== ========
Total depreciation expense was $5.3 million and $11.2 million for the three
months ended September 30, 1998 and 1999, respectively, and $13.3 million and
$27.9 million for the nine months ended September 30, 1998 and 1999,
respectively.
On September 30, 1999, the Company entered into a 20-year fiber capacity
agreement ("20-year Qwest Capacity Agreement") with Qwest Communications
Corporation ("Qwest"). Under the agreement, the Company agreed to pay $57.7
million in four installment payments by December 31, 1999 for fiber capacity on
Qwest's fiber optic network. This payment will be depreciated over the life of
the agreement.
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(5) OTHER ASSETS
Goodwill consists of the excess of cost over the fair value of net assets
acquired and is generally 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.
(6) DEBT
In July 1999, Verio replaced its earlier $70.0 million revolving credit
facility with a new $100.0 million revolving credit facility. The $100.0 million
facility is secured by substantially all the capital stock of Verio's
subsidiaries and by the 15-year capacity agreement with Qwest (which was
renegotiated to a 5-year capacity agreement) and matures on June 30, 2002.
Interest on borrowings is at 2% above the London Interbank Offered Rate, and
there is a commitment fee of 1/2 of 1% per annum on the unused portion of the
facility. There are no borrowings outstanding under this facility.
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 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 4,224,960
shares at $.005 per share, expiring on June 15, 2004, which were valued at
approximately $12.7 million. 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 $6.9 million at September 30,
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 cash dividends,
additional indebtedness, disposition of assets, and transactions with
affiliates.
(7) COMMITMENTS AND CONTINGENCIES
On September 30, 1999, the Company entered into a new 20-year fiber capacity
agreement with Qwest. The Company has agreed to pay $57.7 million by December
31, 1999. This payment will be depreciated over the life of the agreement. Also
during September 1999, the Company renegotiated its earlier 15-year Capacity
Agreement with Qwest to a 5-year term, reduced the price per unit of capacity
and eliminated its previous commitment to spend $160 million so that there is no
longer any capacity commitment under the new agreement.
(8) STOCKHOLDERS' EQUITY AND LOSS PER SHARE
A two-for-one stock split, which was effective on August 20, 1999 for
shareholders of record at the close of business on August 3, 1999 (the "Stock
Split"), is reflected in the accompanying financial statements for all periods
presented.
In July 1999 Verio issued 7.2 million shares of its 6.75% Series A
Convertible Preferred Stock, with a liquidation preference of $50.00 per share,
for approximate net proceeds of $347.6 million. The shares of preferred stock
are convertible to shares of common stock at a conversion price of $48.2813 per
share. The convertible preferred stock may be redeemed, at the Company's option,
10
11
at a redemption premium of 102.0% of the liquidation preference, plus
accumulated and unpaid dividends on or after August 1, 2001, but prior to August
1, 2002, if the trading price of Verio common stock equals or exceeds $72.4219
per share for a specified period. In addition to the payments described above,
holders will receive a payment equal to the present value of the dividends that
would thereafter have been payable on the convertible preferred stock through
and including August 1, 2002. Except as described below, the Company may not
redeem the convertible preferred stock prior to August 1, 2002. Beginning on
August 1, 2002, Verio may redeem the convertible preferred stock initially at a
redemption premium of 103.8571% of the liquidation preference and thereafter at
prices declining to 100.0% on and after August 1, 2006, plus, in each case, all
accumulated and unpaid dividends. Verio may effect any redemption, in whole or
in part, by delivering cash, shares of common stock or a combination thereof. At
the closing of this offering, the initial purchasers of the convertible
preferred stock deposited approximately $24.3 million into an account from which
four, equal quarterly cash payments will be made to the preferred stockholders
of record in the form of a return of capital, or which, at Verio's election, may
be used to purchase shares of Verio common stock for delivery to holders in lieu
of cash payments. The deposit account will expire on August 1, 2000 unless it is
earlier terminated and is reflected in restricted cash on the condensed
consolidated balance sheet. Subsequent to August 1, 2000, dividends will accrue
on a cumulative basis at 6.75% per annum.
Stock-Based Compensation Plans
Verio has established Incentive Stock Option Plans (the "Plans"). At the
discretion of its 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 equity
offerings. Options granted subsequent to the IPO are granted at fair value based
on the trading price for Verio's common stock on The Nasdaq National Market
("NASDAQ") at the close of business on the last trading day immediately
preceeding the date 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 $7.5 million, as adjusted for forfeitures, pro rata over the
forty-eight month vesting period of the options. This compensation expense
totaled approximately $1.4 million for the nine months ended September 30, 1999.
There were 19.3 million shares of options and warrants outstanding at September
30, 1999 with a weighted average exercise price of $11.93 per share.
Loss per share is calculated using weighted average common shares
outstanding, which in the case of weighted average diluted shares, excluded the
effect of common stock options and warrants, and convertible preferred stock,
all of which are anti-dilutive in 1998 and 1999.
(9) Related Party Transaction
During the three months ended September 30, the Company entered into an
agreement with NTT Communications, a wholly owned subsidiary of Nippon Telegraph
and Telephone Company ("NTT") under which NTT Communications and other
affiliates of NTT will provide the Company's Web hosting products to customers
in Japan. Under this agreement, NTT Communications received a license to install
and use the Company's proprietary web hosting software and operating systems
from NTT's data center in Japan. NTT Communications paid an initial license fee
of $1.3 million upon execution of the agreement. Additional fees are payable
over the term of the agreement.
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, and growing Internet service
providers with a business customer focus. We are the world-wide leader in
hosting domain-based Web sites and a leading provider of high speed
connectivity, and enhanced services such as electronic commerce and virtual
private networks based on secure Internet communications link, to small and
medium sized businesses. As of September 30, 1999 we served approximately
290,000 customer accounts, including over 300,000 hosted Web sites, and had
total revenue of approximately $185.4 million for the nine months ended
September 30, 1999.
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Between March 1996 and May 1997, we raised private common equity and
preferred stock totaling approximately $100.0 million from a variety of sources,
primarily venture capital funds. This funding was used to invest in and acquire
Internet service providers, to fund operations and to start building a national
infrastructure including a national network, network operations center, billing,
customer care and financial reporting systems. In September 1997 and March 1998
we raised additional funds totaling $325.0 million by issuing senior notes to
institutional investors. This additional funding, together with the issuance of
preferred stock and granting of options, was used to continue our acquisition
and investment strategy, to acquire the remaining equity interests not already
owned by us in substantially all of the entities in which we made investments
prior to our initial public offering, and to repurchase $50.0 million of the
1997 Notes.
In May 1998 we completed an initial public offering of common stock for net
proceeds of approximately $120.8 million. At the same time, Nippon Telegraph and
Telephone Corporation invested approximately $100.0 million in us by purchasing
common stock. As a result of the initial public offering, all of our then
outstanding preferred stock converted to common stock. The funds we received in
the IPO and from NTT were used to continue making acquisitions and to fund
operations. In November 1998, we raised $400.0 million by issuing additional
senior notes to institutional investors. We completed our most recent capital
raising effort in July 1999, when we sold $360.0 million of our Series A
convertible preferred stock to institutional investors. We expect to continue to
use the proceeds of these offerings to further our strategic acquisition and
investment strategy and to fund our operations.
Since inception, we have completed over 50 acquisitions, all using the
purchase method of accounting. As a result, we have recorded significant amounts
of goodwill, which totaled $619.9 million, gross, at September 30, 1999. We have
undertaken to consolidate the ownership and management of the acquired
operations into nationally managed functional areas, such as sales, marketing,
customer care, network and finance. In addition, we are deploying systems for
sales force automation, operations, customer support, accounting and other
back-office functions in order to be more efficient. Although we have incurred
and continue to incur significant costs in these efforts, we expect to realize
substantial long term cost savings as a result. We have incurred net losses
since we were formed. For the period from inception to December 31, 1996, the
years ended December 31, 1997 and 1998 and the nine months ended September 30,
1999, we reported net losses of $(5.1) million, $(46.3) million, $(122.0)
million and $(137.5) million, respectively.
RESULTS OF OPERATIONS
The following table presents operating data, as a percentage of total
revenue, for the three and nine months ended September 30, 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
Financial Statements and Notes thereto:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ---------------------------
1998 1999 1998 1999
----------- ----------- ---------- -----------
Revenue:
Internet connectivity............................ 61% 45% 64% 48%
Enhanced services and other...................... 39% 55% 36% 52%
Total revenue............................ 100% 100% 100% 100%
Costs and expenses:
Cost of service.................................. 44% 26% 45% 31%
Sales and marketing.............................. 32% 23% 28% 24%
General and administrative....................... 75% 47% 73% 50%
Depreciation and amortization.................... 35% 43% 32% 41%
Total costs and expenses................. 186% 139% 178% 146%
Loss from operations..................... (86%) (39%) (78%) (46%)
Other income (expense):
Interest income.................................. 12% 8% 11% 8%
Interest expense and other....................... (25%) (30%) (27%) (33%)
Loss before extraordinary item........... (99%) (61%) (94%) (72%)
Extraordinary item--loss related to debt repurchase -- -- (12%) --
Net loss................................. (99%) (61%) (106%) (72%)
Return on convertible preferred stock ............. -- (7%) -- (2%)
Net loss attributable to common
shareholders........................... (99%) (68%) (106%) (74%)
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,
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digital subscriber line, integrated services digital network, frame relay and
dialup 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:
o e-commerce;
o virtual private networks permitting our customers to engage in private and
secure Internet communication with their employees, vendors, customers and
suppliers;
o security services;
o leased space and support services in specialized facilities for customers
that wish to place their own equipment and software in our secure,
controlled facilities;
o consulting; and,
o 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
Internet enhanced value services is expected to represent 50% or more of total
revenue. The increase in revenue from Web hosting and other enhanced value
Internet services is primarily the result of acquisitions we made beginning at
the end of 1997 and through 1999 (including Hiway and digitalNATION) that have
been concentrated in these businesses. We have experienced some seasonality in
our 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.
Three months ended September 30, 1998 compared to the three months ended
September 30, 1999
Total revenue increased 102% from $33.8 million for the three months ended
September 30, 1998 to $68.3 million for the three months ended September 30,
1999. Acquisitions completed after September 30, 1998 and internal growth both
contributed significantly to this increase.
Nine months ended September 30, 1998 compared to the nine months ended September
30, 1999
Total revenue increased 122% from $83.5 million for the nine months ended
September 30, 1998 to $185.4 million for the nine months ended September 30,
1999. Acquisitions completed after September 30, 1998 and internal growth both
contributed significantly to this 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 and a national
point of presence. Internet access expense is the cost that we pay to lease
fiber capacity that we use to carry our customers' data between national points
of presence 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. We are in the process of
converting that traffic carried by third parties to our own network. On
September 30, 1999, the Company entered into a 20-year capacity agreement with
Qwest to acquire fiber capacity on Qwest's fiber optic network for $57.7 million
to be paid by December 31, 1999. This payment will be depreciated over the life
of the agreement and will significantly reduce our future data communications
and operations costs. In March 1998, we had signed a 15 year Capacity Agreement
with Qwest Communications Corporation in order to fix and reduce the per-unit
costs we incur to lease fiber. On September 30, 1999, the Capacity Agreement was
renegotiated to a 5-year
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commitment. During the three months ended September 30, 1999 a credit relating
to the previous agreement with Qwest of approximately $2.7 million was
recognized in operations. While we will continue to use a variety of fiber
providers for our national network, we expect to use the Qwest network for the
majority of our fiber requirements.
As Verio continues to grow, we expect our cost of service 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 and other enhanced value Internet services, as traffic
is shifted from third party networks to the Verio network, and as more traffic
is carried by Qwest.
Three months ended September 30, 1998 compared to the three months ended
September 30, 1999
Cost of service increased $2.9 million, or 19%, from $15.1 million for the
three months ended September 30, 1998 to $18.0 million for the three months
ended September 30, 1999, primarily due to acquisitions. However, as a
percentage of revenue, cost of service decreased from 44% for the three months
ended September 30, 1998 to 26% for the three months ended September 30, 1999
due primarily to the advantages of carrying traffic on our own network compared
to using third party transit providers.
Nine months ended September 30, 1998 compared to the nine months ended September
30, 1999
Cost of service increased $19.6 million, or 52%, from $37.9 million for the
nine months ended September 30, 1998 to $57.6 million for the nine months ended
September 30, 1999, primarily due to acquisitions. However, as a percentage of
revenue, cost of service decreased from 45% for the nine months ended September
30, 1998 to 31% for the nine months ended September 30, 1999 due in part to the
reduction of per unit costs to acquire fiber and the Qwest credit of $2.7
million.
Sales and Marketing Expense
Sales and marketing expense consists primarily of salaries, commissions and
advertising.
Three months ended September 30, 1998 compared to the three months ended
September 30, 1999
Sales and marketing expense increased $4.8 million from $10.7 million for
the quarter ended September 30, 1998 to $15.5 million for the three months ended
September 30, 1999 due to increases in the number of sales and marketing
personnel and increased bookings. However, as a percent of revenue, sales and
marketing expense decreased from 32% for the three months ended September 30,
1998 to 23% for the three months ended September 30, 1999 due to steadily
growing revenues.
Nine months ended September 30, 1998 compared to the nine months ended September
30, 1999
Sales and marketing expense increased $22.1 million from $22.9 million for
the nine months ended September 30, 1998 to $45.0 million for the nine months
ended September 30, 1999 due to increases in the number of direct sales
representatives, indirect channel managers and marketing personnel and increased
national brand advertising. However, as a percent of revenue, sales and
marketing expense decreased from 28% for the nine months ended September 30,
1998 to 24% for the nine months ended September 30, 1999
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, rent and utilities.
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 $0.5
million at September 30, 1999 which is expected to approximate actual costs
incurred.
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
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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.
Three months ended September 30, 1998 compared to the three months ended
September 30, 1999
General and administrative expense increased $6.6 million, from $25.4
million for the three months ended September 30, 1998 to $32.0 million for the
three months ended September 30, 1999, primarily due to acquisitions. However,
as a percentage of revenue, general and administrative expense decreased from
75% to 47%, which was the result of efficiencies being realized by integrating
the operations of numerous acquisitions and lower general and administrative
costs required to support enhanced services.
Nine months ended September 30, 1998 compared to the nine months ended September
30, 1999
General and administrative expense increased $30.8 million, from $61.1
million for the nine months ended September 30, 1998 to $91.9 million for the
nine months ended September 30, 1999, primarily due to acquisitions. However, as
a percentage of revenue, general and administrative expense decreased from 73%
to 50%, which was the result of efficiencies being realized by integrating the
operations of numerous acquisitions and lower general and administrative costs
required to support enhanced services.
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 or the life of the agreement. The Qwest fiber
lease agreement will be depreciated over the life of the 20-year agreement.
Additional acquisitions and investments are expected to cause depreciation and
goodwill amortization to increase significantly in the future.
Other Expenses
Three months ended September 30, 1998 compared to the three months ended
September 30, 1999
Interest expense and other increased from $8.7 million for the three months
ended September 30, 1998 to $20.5 million for the three months ended September
30, 1999, primarily due to the issuance of the November 1998 Notes. Interest
income increased from $4.2 million for the three months ended September 30, 1998
to $5.3 million for the three months ended September 30, 1999 due to increased
cash balances resulting from the debt and equity offerings. See "-- Liquidity
and Capital Resources."
Nine months ended September 30, 1998 compared to the nine months ended September
30, 1999
Interest expense and other increased from $22.9 million for the nine months
ended September 30, 1998 to $61.7 million for the nine months ended September
30, 1999, primarily due to the issuance of the March 1998 Notes and the November
1998 Notes. Interest income increased from $9.4 million for the nine months
ended September 30, 1998 to $14.3 million for the nine months ended September
30, 1999 due to increased cash balances resulting from these debt offerings and
the equity offering relating to Verio's initial public offering and issuance of
preferred stock. See "-- Liquidity and Capital Resources."
During the nine months ended September 30, 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 ANALYSIS
Nine months Ended September 30, 1998 and 1999
Acquisitions, and the issuance of the March 1998 Notes, the November 1998
Notes and the issuance of the convertible preferred stock explain the most
significant changes in cash balances and cash flows. The acquisition of Hiway in
January 1999 and digitalNATION in July 1999 resulted in an aggregate cash
outflow of approximately $276.0 million, and also caused amortization to
increase approximately $20.2 million between the two periods. The issuance of
$175.0 million of 10-3/8% debt in March 1998, $400.0 million of 11-1/4% debt in
November 1998 and $347.6 million net proceeds from the issuance of convertible
preferred stock caused
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cash balances to increase significantly. Cash paid for interest was $43.2
million for the nine months ended September 30, 1999, compared to $10.4 million
for the nine months ended September 30, 1998. We also paid $17.5 million in cash
to AOL related to a three-year strategic marketing agreement and customer
acquisition that we entered into during the nine months ended September 30,
1999. The extraordinary charge in the nine months ended September 30, 1998
relates to the repurchase of $50.0 million of the 1997 Notes. Cash flows used by
operations as a percentage of revenue improved from (43%) to (29%) from the nine
months ended September 30, 1998 to the nine months ended September 30, 1999.
Cash provided by working capital was $12.5 million for the nine months ended
September 30, 1998 compared to $1.1 million for the nine months ended September
30, 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 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 preferred stock, and issued
1.4 million shares of 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. 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 September 15, 2004 and interest, at the
annual rate of 13-1/2%, is payable semi-annually in arrears on September 15 and
December 15 of each year. Each warrant entitles the holder thereof to purchase
3.52 shares of Verio's common stock at a price of $.005 per share, for a total
of 4,224,960 shares. 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 final
interest payment is due on December 15, 1999. The 1997 Notes are redeemable at
our option commencing September 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. Upon consummation of
the sale of the March 1998 Notes and the repurchase, $13.3 million of escrowed
interest funds were released to us.
At various times during the first four months of 1998, we issued 3.1 million
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.
In July 1999, Verio replaced its earlier $70.0 million revolving credit
facility with a new $100.0 million revolving credit facility with a group of
commercial lending institutions. This facility is secured by substantially all
of the stock of our subsidiaries and by the Qwest capacity agreement. The credit
facility requires no payments of principal until its maturity on September 30,
2002. 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 of 1%
per annum on the undrawn amount of the credit facility. 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 cash 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 $100.0 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.
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In May 1998, we completed our initial public offering, selling an aggregate
of 11,470,000 million shares of common stock, including the partial exercise of
the over-allotment option by the initial purchasers in the initial public
offering, for net proceeds of approximately $120.8 million, after deducting
underwriting discounts, commissions and expenses. Concurrently with our initial
public offering, we completed the sale of 8,987,754 million shares of common
stock to an affiliate of Nippon Telegraph and Telephone Corporation 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 September
1 and December 1 of each year, commencing September 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 September 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 cash 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 debt agreements.
In July 1999, we issued 7.2 million shares of 6.75% Series A Convertible
Preferred Stock, with a liquidation preference $50.00 per share, for approximate
net proceeds of $347.6 million. The shares of preferred stock are convertible to
shares of common stock at a conversion price of $48.2813 per share. The
convertible preferred stock may be redeemed at a redemption premium of 102.0% of
the liquidation preference, plus accumulated and unpaid dividends on or after
August 1, 2001, but prior to August 1, 2002, if the trading price of our common
stock equals or exceeds $72.4219 per share for a specified period. In addition
to the payments described above, holders will receive a payment equal to the
present value of the dividends that would thereafter have been payable on the
convertible preferred stock through and including August 1, 2002. Except as
described below, we may not redeem the convertible preferred stock prior to
August 1, 2002. Beginning on August 1, 2002, we may redeem the convertible
preferred stock initially at a redemption premium of 103.8571% of the
liquidation preference and thereafter at prices declining to 100.0% on or after
August 1, 2006, plus, in each case, all accumulated and unpaid dividends. Verio
may effect any redemption, in whole or in part, by delivering cash, shares of
our common stock or a combination thereof. At the closing of this offering, the
initial purchasers of the convertible preferred stock deposited approximately
$24.3 million into an account from which quarterly cash payments will be made,
or which may be used, at Verio's option, to purchase shares of our common stock
from us for delivery to holders in lieu of cash payments. The deposit account
will expire an August 1, 2000 unless it is earlier terminated and is reflected
in restricted cash. Subsequent to August 1, 2000, dividends will accrue on a
cumulative basis at 6.75% per annum.
As of September 30, 1999, we had approximately $526.1 million in cash and
cash equivalents and short-term investments (including $33.1 million of
restricted cash). Our business plan currently anticipates investments of
approximately $140.0 million over the next 12 months for capital expenditures,
acquisitions, operating losses and working capital.
Our Company is highly leveraged and has significant debt service
requirements. At September 30, 1999 our long-term liabilities were $694.2
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.
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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 for the next 12 months with cash on
hand, and subsequently with the 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. 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. 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.
THE YEAR 2000 ISSUE
We are aware of the issues associated with the programming code in existing
computer systems as the Year 2000 approaches. The commonly referred to Year 2000
or Y2K issue results from the fact that many computer programs and systems were
developed without considering the possible impact of a change in the century
designation that will occur on January 1, 2000. As a result, these programs and
systems use only two digits instead of four to identify the year in the date
field. Systems that do not properly recognize this date could generate wrong
data, calculate erroneous results, or fail if the issue remains uncorrected. The
Year 2000 problem is pervasive and complex, as virtually every company's
computer operations potentially could be affected in some way.
We have identified two main areas of potential Y2K risk in our business:
o Our internal systems or embedded chips could be disrupted or fail, which
could negative impact our services and productivity.
o Computer systems or embedded technology of third parties, such as our
suppliers, vendors, customers, landlords, telecommunication service
providers, outsource providers, and others could be disrupted or fail,
and thereby adversely affect our operations.
To help ensure that our network operations and services to our customers are
not interrupted due to the Y2K problem, we established a Y2K assessment team
that was responsible for overseeing the assessment of our equipment and systems
for Y2K compliance. This team meets regularly, and developed and implemented our
overall Y2K assessment and remediation plan. In the fourth quarter of 1998, we
conducted a systems assessment of our national systems in Denver, Colorado,
Dallas, Texas and regional networks, as well as systems in our eastern operating
region, including both information technology systems and non-information
technology systems such as hardware containing embedded technology, for year
2000 compliance. Because the network systems in our other operating regions
employ substantially similar technologies, we considered the outcome of this
initial assessment to be generally reflective of our entire operation. No
significant potential Y2K issues were identified in this process. With the
information gained from that initial assessment, we undertook our company-wide
year 2000 compliance program, including a complete inventory, assessment and
testing of potentially impacted systems, and the development and roll-out of
plans to implement, test and complete any necessary modifications to our key
systems and equipment to ensure that they are Y2K compliant. Prior to our
acquisition of Hiway, Hiway hired its own outside consultants to evaluate their
systems for year 2000 compliance. This evaluation disclosed some potential,
although non-material, Y2K issues in Hiway's internally developed provisioning
systems. Based on the results of this earlier evaluation, we undertook
remediation activities that were completed in the second quarter of 1999.
Additional remediated systems were implemented in the Hiway web hosting systems
during the third quarter of 1999.
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As of September 1999, Verio had assessed the compliance status of all
potentially affected systems and equipment identified from the inventory phase
of our Y2K compliance effort, throughout our operations. Compliance status was
checked against third party information sources including public statements made
by hardware and software vendors, correspondence directly with such vendors, and
compilations of compliance information published by other parties. Verio did not
independently verify compliance of such hardware and software components
utilized within our service, or independently verify the contents of the
republications. Based on compliance information found, all operating units of
Verio have completed Year 2000 upgrade plans for nearly all items in their
respective inventories of hardware and software components in the Verio network.
In conjunction with such assessment, we are implementing remedial actions,
including code level remediation, system upgrades or complete system replacement
of non-compliant items.
In connection with our efforts to integrate the operations of the various
companies we have acquired, many of the internal business operating systems that
were previously employed by those acquired entities are being replaced with new,
scalable, national systems. As we evaluate new systems for purchase, we have
assessed and confirmed their year 2000 compliance. Verio has migrated business
operations of acquired companies to national services on year 2000 compliant
systems for finance, billing, customer operations and network management. In
addition, Verio has been consolidating legacy systems in order to provide
consistent provisioning of services; and centralized domain name services, mail,
authentication and news. We have obtained Year 2000 compliance statements from
our hardware and software vendors, informing us that these systems are comprised
of the latest commercial hardware and software components and are year 2000
compliant. All of these systems are currently operational and have been
subjected to extensive operational testing within the Verio network, the
migration of customers from the historic systems to these new platforms is
currently underway. Migrations of domain name service and news are expected to
be 100% complete by the end of 1999. Migrations to mail and authentication
systems are expected to be approximately 50% complete by the end of 1999. We
continue to evaluation the historic systems that are not planned to be migrated
in 1999 for year 2000 compliance issues, but we do not expect any potential Y2K
impact of those legacy systems that remain in use at the end of 1999 to be
material.
We performed a complete end-to-end service-level test in the first week of
October to evaluate the overall Y2K compliance of our network and systems. The
goal of this test was to ensure continuity of customer services across elements
exclusively under Verio operational control. This test included a representative
sampling of all major hardware and software components that provide direct
service to our customers such as web hosting, the Verio national backbone, and
several different types of Internet connectivity including ISDN, point-to-point
and frame relay. Various routers and other network components were used to
simulate our regional networks and customer premises equipment. We also included
our national network monitoring software and hardware. The test did not include
underlying telecommunications infrastructure components over which Verio does
not exercise control. No customer-affecting Year 2000 issues were uncovered in
this test. We will continue to perform tests on all upgrades to our systems as
appropriate throughout the fourth quarter. In addition, we will continue to test
locally developed software and systems in order to verify vendor compliance
statements.
Our Y2K team is also developing contingency plans to deal with any potential
problems that may occur in our network or services as a result of the Y2K
probems. These plans will be stored centrally for use by the Verio customer
service organization to allow for a timely, well-organized response to any
unforeseen Year 2000 problems anywhere within the Verio organization. Although
we do not expect any major problems during the Year 2000 rollover period, we
will have a dedicated command center staff on duty at our Network Operations
Center to quickly respond to Year 2000 issues should any arise. We believe that,
as a result of our detailed assessment and remediation efforts, the Y2K issue
will not pose significant operational problems for us. However, if Y2K
compliance problems have not been discovered, or if requisite modifications or
remediation have not made undertaken or made, it is possible that the Y2K
problem could have a material impact on our operations. We cannot currently
estimate the magnitude of such a possible impact.
We continue to survey, among others, critical vendors, suppliers, customers
and financial institutions for Year 2000 compliance. We have evaluatied the Year
2000 preparedness of our telecommunications providers, on which we rely for the
network services crucial to our business. In order to reduce potential adverse
impacts, we maintain diverse providers for such network services. However,
failure of any one provider may have a material impact on Verio's operations.
Our survey of our third party suppliers indicates they many of them are still
working on their own Year 2000 compliance issues. We are heavily dependent upon
the veracity of their testing and statements of compliance as we cannot
replicate and independently test the services supplied to us. Though most of
these suppliers indicate that their critical systems and technology are Year
2000 ready, at this time we cannot estimate the effect, if any, that
non-compliant systems supplied by these entities could have on us. It is
possible that the impact on us could be material if one or more of these systems
are not Y2K compliant by the end of the year. We continue to work with each of
these suppliers to obtain the latest information on their compliance status to
assist us in evaluating and developing contingency plans. If any of our material
third party suppliers or vendors are not Y2K ready and their non-compliance
causes a material disruption to any of their
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respective businesses or services, our business, operations and/or services
could be materially and adversely affected.
The most significant risks that the Y2K issues could present to us
include, without limiation, disruption, delay or cessation of operations. For
example, in the event of a widespread telecommunications failure (which we
believe is our most reasonably likely worst case Y2K scenario), the entire
Internet performance could potentially be affected due to its very nature as a
collection of interconnected networks. A number of individual customers may
suffer from complete outages of services, though we believe that most Internet
services would likely continue to operate, although possibly at a reduced
performance level. Other potential adverse Y2K scenarios include the failure or
impairment of software that is provided by a third party and incorporated in one
of our service platforms as a result of a Y2K problem. In that case, the
particular service that the software supports could likewise become inoperable
or perform incorrectly. Further, in the event that third-party-supplied
equipment (including customer premise equipment) contains non-Y2K-compliant
technology, the systems, operations or services supported by that equipment also
could fail or be interrupted. Other potential disruptions could include the
failure of a material third party's business, a financial institution's
inability to transfer and receive funds, the interruption in delivery of key
supplies from vendors, a loss of power to our facilities, and other
interruptions in the normal course of our operations. In the event that a
failure does occur within one of these elements, our services could suffer
degradation or complete failure without warning or remedy, resulting in
substantial potential expense.
Our expenditures to date in our Year 2000 program efforts has been
immaterial, and is estimated to remain under $1 million in the aggregate. These
costs include equipment, consulting fees, software and hardware upgrades,
testing, and remediation in connection with our Year 2000 program office
evaluation, test, contingency planning and vendor evaluation efforts. This sum
does not include an allocated overhead amount for the work of the internal Y2K
team, as the time spent by these people is not separately tracked, but if it
were that amount likewise would not be material. It is possible that the costs
associated with our Y2K efforts could increase if it is determined that
additional resources are required or if important operational or systems
equipment must yet be remediated or replaced. The total cost of our Y2K
compliance program is funded through cash on hand and we are expecting these
costs, as appropriate. While the financial impact of making all required systems
changes or other remediation efforts cannot be known precisely, it is not
expected to be material to our financial position, results of operations, or
cash flows. We have not cancelled any principal information technology projects
as a result of our Y2K efforts, although we have rescheduled and reprioritized
some internal tasks in order to accommodate this effort.
While we believe that we are adequately addressing the Y2K issue, we cannot
assure you that our Y2K compliance effort will prevent every potential
interruption or failure, or that the cost and liabilities associated with the
Y2K issue will not materially adversely impact our business, prospects,
revenues, or financial position.
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.
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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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to various legal proceedings that have arisen in the
ordinary course of our business, none of which is material.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 17, 1999, the Company's Board of Directors authorized a two-for-one
stock split of the Company's common stock, which was effected in the form of a
stock dividend for stockholders of record at the close of business on August 3,
1999, with a dividend payment date of August 20, 1999 (the "Stock Split").
On July 20, 1999, the Company completed a Rule 144A private placement of
7,200,000 shares of its 6.75% Series A Convertible Preferred Stock (the "Series
A Preferred"), with a liquidation preference of $50.00 per share. The Series A
Preferred are senior to the Company's common stock with respect to dividends and
upon liquidation, dissolution or winding up. The shares of Series A Preferred
were sold to Salomon Smith Barney Inc., Donaldson, Lufkin & Jenrette Securities
Corporation, Credit Suisse First Boston Corporation, Deutsche Bank Securities
Inc. and First Union Capital Markets Corp., all acting as initial purchasers.
The total offering price was $360.0 million and the net proceeds of the offering
were approximately $324 million, after subtracting approximately $11.7 million
for the initial purchasers' discounts and approximately $24.3 million which the
initial purchasers deposited into a deposit account. Quarterly cash payments may
be made from the deposit account or such funds may be used to purchase shares of
common stock from the Company for delivery to holders in lieu of cash payments.
Prior to the Stock Split, shares of Series A Preferred were convertible into
shares of common stock at a conversion price of $96.5625 per share. However, as
a result of the Stock Split, the conversion price for shares of Series A
Preferred was adjusted downward such that shares of Series A Preferred are
presently convertible into shares of common stock at a conversion price of
$48.2813 per share. The Series A Preferred are subject to provisional and
optional redemption provisions. Pursuant to the provisional redemption
provision, the Series A Preferred may be redeemed at a redemption price of
102.0% of the liquidation preference, plus accumulated and unpaid dividends on
or after August 1, 2001, or earlier if the trading price of the Company's common
stock equals or exceeds $144.8438 per share for a specified period. In addition
to the payments described above, holders will receive an additional payment
equal to the present value of the dividends that would thereafter have been
payable on the Series A Preferred through and including August 1, 2002. Pursuant
to the optional redemption provision, the Company may redeem the Series A
Preferred beginning on August 1, 2002 at a redemption price of 103.8571% of the
liquidation preference, and thereafter at prices declining to 100.0% on and
after August 1, 2006, plus, in each case, all accumulated and unpaid dividends.
The Company may effect any redemption, in whole or in part, by delivering cash,
shares of its common stock or a combination thereof.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM 5. OTHER INFORMATION
Stockholders who wish to present proposals for inclusion in the
Company's proxy materials in connection with the 2000 Annual Meeting of
Stockholders must submit such proposals in writing to the Secretary of the
Company at 8005 South Chester Street, Suite 200, Englewood, Colorado 80112 not
later than February 18, 2000. In addition, any stockholder proposal submitted
with respect to the Company's 2000 Annual Meeting of Stockholders, which
proposal is submitted outside the requirements of Rule 14a-8 under the
Securities Exchange Act of 1934, will be considered untimely for purposes of
Rule 14a-4 and 14a-5 if written notice thereof is received by the Company less
than 30 or more than 60 days prior to the meeting; provided, that, to be
considered timely, in the event that less than 40 days notice or prior public
disclosure of the date of the meeting is given or made to the stockholders,
proposals must be received not later than the close of business on the tenth day
following the day on which notice of the date of the annual meeting was mailed
or publicly disclosed.
RISK FACTORS
The Company (or "Verio") is a leading provider of Internet
connectivity, Web hosting and other enhanced Internet services to small and
medium sized businesses. From time to time the Company may report through its
press releases and/or Securities and Exchange Commission filings certain matters
that would be characterized as forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 (the "Reform Act") that are
subject to risks and uncertainties that could cause actual results to differ
materially from those projected. Certain of these risks and uncertainties are
beyond management's control. This report contains statements which constitute
forward-looking statements. These statements appear in a number of places in
this report and include statements regarding the intent, belief or current
expectations of the Company, its directors or its officers primarily with
respect to the future operating performance of the Company. Readers are
cautioned that any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results may
differ materially from those in the forward-looking statements as a result of
various factors. The accompanying information contained in this report,
including the information set forth below, identifies certain important factors
that could cause such differences. The following factors supplement, and, to the
extent provided herein, amend and restate, the other business and risk factors
disclosed in the Company's annual report on Form 10-K filed with the SEC on
March 31, 1999.
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, and the nine months ended
September 30, 1999, we had losses of $(46.1) million, $(122.0) million and
$(137.5) million, respectively. Because we have a relatively short operating
history, there is little operating and financial data about us, which makes an
evaluation of our business operations and prospects more difficult. We have
experienced annual growth in revenue from approximately $2.4 million from the
period of our inception to December 31, 1996; to approximately $35.7 million in
1997; approximately $120.7 million in 1998; and approximately $185.4 million for
the nine months ended September 30, 1999.
WE EXPECT CONTINUING LOSSES AND CANNOT ASSURE YOU THAT WE WILL BECOME PROFITABLE
We expect to continue to operate at a net loss in the near term as we
continue to use significant amounts of cash for our acquisition and integration
efforts, build out our national network operations, expand and enhance our
product and service offerings, and further establish our brand name recognition.
The extent to which we experience negative cash flow will depend upon a number
of factors, including the following:
o the number and size of any additional acquisitions and
investments;
o the expense and time required to integrate prior and future
acquired operations;
o the time and effort required to capture operating efficiencies;
o our ability to generate increased revenues;
o the amount of our expenditures at the corporate and national
level; and
o potential regulatory developments that may affect our operations.
In order to achieve profitability, Verio must develop and market
products and services that gain broad commercial acceptance. We cannot assure
you that our products and services will ever achieve broad commercial acceptance
or that we will achieve profitability. Although we have experienced significant
growth in revenues on an annual basis, this growth rate is not necessarily
indicative of future operating results. We cannot assure you that we will
achieve or sustain positive operating cash flow or generate net income in the
future.
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WE HAVE SUBSTANTIAL LIABILITIES WHICH MAY IMPACT OUR FUTURE OPERATIONS AND
AFFECT OUR ABILITY TO MEET OUR DEBT OBLIGATIONS
We have substantial amounts of outstanding debt and other liabilities.
At September 30, 1999, our total long-term liabilities were approximately $694.2
million, representing 59%] of our total capitalization. In addition, we have a
$100 million revolving credit facility from a group of financial institutions.
We have not drawn any funds under this credit facility.
High levels of debt have had and could have several important effects
on our future operations. Some of these consequences include the following:
o 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. Of the $54.4 million cash flow used by
our operations for the nine months ended September 30, 1999, $43.2
million, or approximately 79%, was used to pay interest on our
debt. Of this amount, 16% was used for interest on the $100.0
million outstanding principal amount of 13 1/2% Senior Notes due
2004 -- which we refer to as the 1997 Notes; 21% was used for
interest on the $175.0 million outstanding principal amount of 10
3/8% Senior Notes due 2005 -- which we refer to as the March 1998
Notes; 54% was used for interest on the $400.0 million outstanding
principal amount of 11 1/4% Senior Notes due 2008 which we refer
to as the November 1998 Notes; and, 9% was used for interest on
capital leases and other obligations. Interest on our debt
continues to be a significant use of cash.
o Covenants imposed under certain of our financing agreements limit
our ability to pursue our business strategy, borrow additional
funds to grow our business, acquire and dispose of assets, and
make capital expenditures and may otherwise restrict our
operations and growth.
Our ability to meet our debt and other obligations and to reduce our
total debt depends on our future operating performance and on economic,
financial, competitive, regulatory and other factors. In addition, we may need
to incur additional indebtedness in the future. Many of these factors are beyond
our control. We believe that our existing current assets combined with working
capital from our operations, our existing credit facility, capital lease
financings and proceeds of future equity or debt financings will be adequate to
meet our existing financial obligations. We cannot assure you, however, that our
business will generate sufficient cash flow 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:
o $13.5 million in annual interest on the 1997 Notes (interest on
these notes is paid from an escrow account until June 2000);
o $18.2 million in annual interest on the March 1998 Notes;
o $45.0 million in annual interest on the $400.0 million outstanding
principal amount of 11 1/4% Senior Notes due 2008;
o up to $24.3 million in annual dividends we may pay on our
convertible preferred stock, plus any additional dividends owed
thereon depending on certain contingencies, beginning in November
2000; or
o any debt obligations we may incur under the credit facility, if
drawn upon.
WE ARE SUBJECT TO RESTRICTIVE COVENANTS THAT LIMIT OUR FLEXIBILITY
Our $100.0 million bank credit facility may only be used if we meet
certain financial tests. Our credit facility and other debt instruments contain
customary covenants limiting our flexibility, including covenants limiting our
ability to incur additional debt, make liens, make investments, consolidate,
merge or acquire other businesses and sell assets, pay dividends and other
distributions, make capital expenditures and enter into transactions with
affiliates. Such covenants may make it difficult for us to pursue our business
strategies. Failure to comply with the terms of the credit facility 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 other creditors
and, lastly, to the holders of Verio's capital stock. Our ability to satisfy the
financial and other restrictive covenants may be affected by events beyond our
control.
IT IS UNLIKELY THAT INVESTORS WILL RECEIVE A RETURN ON OUR COMMON STOCK THROUGH
THE PAYMENT OF CASH DIVIDENDS
We have never declared or paid cash dividends on our common stock and
have no intention of doing so in the foreseeable future. In addition, although
we have the option of paying dividends in cash, our ability to pay cash
dividends is substantially restricted under various covenants and conditions
contained in our debt instruments. In any event, under Delaware law we are
permitted to pay dividends on our capital stock only out of our surplus, or if
we have no surplus, out of our net profits for the year in
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which a dividend is declared or for the immediately preceding fiscal year.
Surplus is defined as the excess of a company's total assets over the sum of its
total liabilities and convertible preferred stock plus the par value of its
outstanding capital stock. At September 30, 1999, we had a stockholders' equity
of approximately $492.3 million. We have had a history of losses and expect to
operate at a net loss for the next several years. These net losses will reduce
our stockholders' equity. For the nine months ended September 30, 1999, we had a
net loss attributable to common stockholders of $137.5 million. We cannot
predict what the value of our assets or the amount of our liabilities will be in
the future.
OUR EARNINGS HAVE BEEN INSUFFICIENT TO PAY OUR COMBINED FIXED CHARGES AND
PREFERRED STOCK DIVIDENDS
Our earnings could not pay our combined fixed charges and preferred
stock dividends during these periods by the amounts set forth in the table
below, although our combined fixed charges and preferred stock dividends
included substantial non-cash charges for depreciation, amortization and
non-cash interest expense on some of our debt:
EARNINGS NON-CASH
DEFICIENCY CHARGES
---------- --------
(IN THOUSANDS)
Period from inception to December 31, 1996.................. $ (5,825) $ 784
Fiscal year ended December 31, 1997......................... $ (48,253) $ 11,468
Fiscal year ended December 31, 1998......................... $(112,423) $ 48,516
Nine months ended September 30, 1999........................ $(137,537) $94,779
We anticipate that earnings will be insufficient to cover our combined
fixed charges and preferred stock dividends for the next several years. In order
for us to meet our debt obligations, we will need to substantially improve our
operating results. We cannot assure you that our operating results will be of
sufficient magnitude to enable us to meet our debt and preferred stock
obligations. In the absence of such operating results, we could face substantial
liquidity problems and may be required to raise additional financing through the
issuance of debt or equity securities. We cannot assure you, however, that we
would be successful in raising such financing on acceptable terms or otherwise.
THE MARKET PRICE AND TRADING VOLUME OF OUR COMMON STOCK ARE VOLATILE
The market price of our common stock has fluctuated significantly in
the past, and is likely to continue to be highly volatile. In addition, the
trading volume in our common stock has fluctuated, and significant price
variations can occur as a result. We cannot assure you that the market 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 and telecommunications companies. These broad
market fluctuations may materially adversely affect the market price of our
common stock in future. Such variations may be the result of changes in our
business, operations or prospects, announcements of technological innovations
and new products by competitors, new contractual relationships with strategic
partners by us or our competitors, proposed acquisitions by us or our
competitors, financial results that fail to meet public market analyst
expectations, regulatory considerations and domestic and international market
and economic conditions.
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD ADVERSELY AFFECT OUR
STOCK PRICE AND OUR ABILITY TO RAISE FUNDS IN NEW EQUITY OFFERINGS
No prediction can be made as to the effect, if any, that future sales
of shares of common stock or the availability for future sale of shares of
common stock or securities convertible into or exercisable for our common stock
will have on the market price of common stock prevailing from time to time.
Sale, or the availability for sale, of substantial amounts of common stock by
existing stockholders under Rule 144, through the exercise of registration
rights or the issuance of shares of common stock upon the exercise of stock
options or warrants or the conversion of our convertible preferred stock, or the
perception that such sales or issuances could occur, could adversely affect
prevailing market prices for our common stock and could materially impair our
future ability to raise capital through an offering of equity securities.
WE ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD DELAY OR PREVENT AN
ACQUISITION AND COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK
Our certificate of incorporation and bylaws, certain provisions of
Delaware law and the certificate of designation governing the convertible
preferred stock may make it difficult in some respects to effect a change in
control of Verio and replace incumbent management. In addition, Nippon Telegraph
and Telephone Corporation has the right to designate a member of our board of
directors and is subject to certain standstill and other limitations on its
ability to make further acquisitions of our stock that could delay, defer or
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prevent a change of control. The existence of these provisions may collectively
have a negative impact on the price of the common stock, may discourage
third-party bidders from making a bid for Verio, or may reduce any premiums paid
to stockholders for their common stock. In addition, the board of directors has
the authority to fix the rights and preferences of, and to issue shares of, our
preferred stock, which may have the effect of delaying or preventing a change in
control of Verio without action by our stockholders.
WE MAY BE UNABLE TO RAISE ADDITIONAL FUNDS THAT WE WILL NEED 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 or at all. In the event
that we are unable to obtain such additional funds on acceptable terms or
otherwise, 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:
o network equipment;
o network operating and data centers;
o network monitoring equipment;
o information technology systems; and
o 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.
OUR OPERATING RESULTS FLUCTUATE DUE TO A VARIETY OF FACTORS AND ARE NOT A
MEANINGFUL INDICATOR OF FUTURE PERFORMANCE
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 new products and services.
Additional factors that may contribute to variability of operating results
include:
o the pricing and mix of services we offer;
o our customer retention rate;
o changes in pricing policies and product offerings by our
competitors;
o growth in demand for network and Internet access services;
o one-time costs associated with acquisitions and regional
consolidation; and
o general telecommunications services' performance and availability.
We also have experienced seasonal variation in Internet use.
Accordingly, our revenue streams may fluctuate. 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. 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.
OUR SUCCESS IS HIGHLY DEPENDENT ON THE GROWTH OF OUR EXISTING INTERNET ACCESS
AND WEB HOSTING CORE SERVICES, AND ON OUR ABILITY TO EXPAND OUR SERVICE
OFFERINGS AND DISTRIBUTION CHANNELS
While we continue to pursue acquisitions both in the U.S. and
internationally, our success is highly 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 enhanced value Internet service capabilities and by establishing
further distribution
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capabilities. We may develop these further product and distribution capabilities
internally, but we primarily plan to form 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. Once implemented, we
cannot assure you that any additional service capabilities that we launch will
achieve general commercial acceptance or generate significant revenue, or that
any particular distribution channels will prove to be effective.
OUR SUCCESS DEPENDS ON OUR ABILITY TO SUCCESSFULLY INTEGRATE THE OPERATIONS WE
HAVE ACQUIRED AND MAY ACQUIRE IN THE FUTURE
A key element of our business strategy is to grow through acquisitions,
and 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. To integrate our newly acquired Internet
operations successfully, we must:
o install and standardize adequate operational and control systems;
o deploy standard equipment and telecommunications facilities;
o employ qualified personnel to provide technical and marketing
support in new as well as existing locations;
o eliminate redundancies in overlapping network systems and
personnel;
o incorporate acquired technology and products into our existing
service offerings;
o implement and maintain uniform standards, procedures and policies;
o standardize marketing and sales efforts under the common Verio
brand; and
o 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 our managerial,
operating and financial resources, and could prove to be even 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.
The key integration challenges we face in connection with our
acquisitions include:
o 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;
o anticipated cost savings and operational benefits may not be
realized;
o in the course of integrating an acquired operation, we may
discover facts or circumstances that we did not know at the time
of the acquisition that adversely impact our business or
operations, or make the integration more difficult or expensive;
o integration efforts may divert our resources from our existing
business;
o standards, controls, procedures and policies may not be
maintained;
o employees who are key to the acquired operations may choose to
leave; and
o we may experience unforeseen delays and expenses.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS GENERALLY
We expect to continue our acquisition and expansion strategy. 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
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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.
We have recorded all business acquisitions under the purchase method of
accounting. With the acquisition, on January 5, 1999, of Best Internet
Communications, Inc. (d/b/a Hiway Technologies, Inc.), which we refer to as
Hiway, we recorded gross goodwill totaling approximately $240.5 million, which
is being amortized over a ten-year period from the acquisition date. On July 13,
1999, we acquired all of the outstanding stock of Computer Services Group, Inc.
(which does business as digitalNATION) for $100.0 million in cash, which is
being amortized over a 10 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 businesses 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 included in this
report or incorporated by reference 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.
OUR RAPID GROWTH PUTS A SIGNIFICANT STRAIN ON OUR RESOURCES
As a result of our acquisition strategy, we have been growing rapidly
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 the need for high
capacity Internet data transmission capability 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 place 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 enhanced
value 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:
o implement additional management information systems capabilities;
o further develop our operating, administrative and financial and
accounting systems and controls;
o improve coordination between our engineering, accounting, finance,
marketing and operations; and
o hire and train additional personnel.
WE DEPEND UPON THIRD-PARTY CHANNEL PARTNERS FOR SALES OF OUR PRODUCTS AND
SERVICES
We depend on third-party channel partners to stimulate demand for our
products and services both where we do not have a direct sales force and as an
alternative means for generating sales to customers. These channel partners
include computer and telecommunications resellers, Internet companies,
value-added resellers, original equipment manufacturers, systems integrators,
Web designers and advertising agencies. Many of our channel partner distribution
relationships involve untested or novel modes of distributing our products and
services, and not all of these channel partners have been successful in meeting
our objectives for generating additional sales of our products and services. If
we fail to gain commercial acceptance in certain markets, channel partners may
discontinue their relationships with us or we may fail to achieve a return on
our investment in certain channel partner distribution arrangements. Conflicts
may develop between our direct sales force efforts and those of our channel
partners as well as among different 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
or may require us to incur additional sales and marketing expenses. 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
We provide Web hosting services to customers in over 170 countries. For
the year ended December 31, 1998, and for the nine months ended September 30,
1999, we estimate that approximately 10% of our total revenues were from
international
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operations. 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 transmitting data over the Internet outside
the U.S. has been higher, which may adversely affect our ability to expand
operations, and may increase our costs of operations internationally. We cannot
assure you that acceptance of the Internet or demand for Internet access, Web
hosting and other enhanced value 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 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, certain risks inherent in doing business on an
international level include:
o unexpected changes in or delays resulting from regulatory
requirements, tariffs, customs, duties and other trade barriers;
o difficulties in staffing and managing foreign operations;
o longer payment cycles and problems in collecting accounts
receivable;
o political instability, expropriation, nationalization, war,
insurrection and other political risks;
o fluctuations in currency exchange rates and foreign exchange
controls which restrict or prohibit repatriation of funds;
o technology export and import restrictions or prohibitions;
o employment laws and practices in foreign countries;
o delays from customs brokers or government agencies;
o differences in technology standards;
o seasonal reductions in business activity during the summer months
in Europe and certain other parts of the world; and
o potentially adverse tax consequences.
We cannot assure you that these factors will not have an adverse effect
on our future international operations. In addition, changes in existing foreign
laws or administrative practice relating to taxation, foreign exchange,
regulatory or other matters could adversely affect us. For example, the European
Union recently enacted its own privacy regulations. Future decisions, laws,
regulations and other activities regarding regulation and content liability may
significantly affect our business. 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 -
Service Online - Dienstleistungen GmbH.
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. We have not commenced any assessment of the effects or potential
impact that the euro conversion would have on us.
WE FACE A HIGH LEVEL OF COMPETITION IN THE INTERNET SERVICES INDUSTRY
The tremendous growth and potential market size of the Internet access
market and the absence of substantial barriers to entry have attracted many new
start-ups as well as existing businesses from the telecommunications, cable and
technology industries. As a result, 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. Current and prospective
competitors include:
o national, regional and local Internet service providers;
o global, national and regional long distance and local exchange
telecommunications companies;
o cable television companies;
o direct broadcast satellite and wireless communications providers;
o on-line service providers; and
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o Web hosting providers, and providers of other enhanced value
Internet services.
Verio believes that the following are the primary competitive factors
in this market:
o a secure and reliable national network with sufficient capacity,
quality of service and scalability to support continued growth;
o a knowledgeable and effective sales force, and broad and effective
distribution channels;
o knowledgeable and capable technical support personnel, and prompt
and efficient customer care services;
o Internet system engineering and other technical expertise;
o competitive prices;
o timely introductions of new products and services;
o sufficient financial resources; and
o 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, many carriers are
integrating horizontally through acquisitions of or joint ventures with Internet
service providers, or by wholesale purchase of Internet access from Internet
service providers. 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 or high capacity data transmission capabilities by cable and telephone
companies through new technologies such as cable modems and various digital
subscriber lines also creates further competitive pressure on 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 services to our target business market. This may significantly affect
the pricing of our Internet access service offerings. Although we offer for sale
digital subscriber line services to business customers in a large number of
markets, there are numerous providers of digital subscriber lines competing with
these product offerings, and several providers have launched their services in
conjunction with Internet service providers, allowing those providers to offer
Internet access over digital subscriber lines circuits. These circuits, which
provide higher speed and lower latency Internet connections than a standard
dialup 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 and those relationships could place us at a significant competitive
disadvantage.
WE DEPEND UPON OUR NETWORK INFRASTRUCTURE
Our success depends upon our ability to implement and expand our
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
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anticipate that future expansions 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 NETWORK SYSTEM COULD FAIL, WHICH COULD NEGATIVELY IMPACT OUR REVENUES
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 fires,
earthquakes, severe storms, power losses, 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 point 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 you that we will not
experience failures or shutdowns relating to individual point of presence
facilities or even catastrophic failure of the entire network.
While historically we have not, as a general matter, offered our
customers a service-level warranty, our customers are increasingly requiring
that we provide a standard service-level warranty for our services. Many of our
competitors have begun to do so. As a result, in order to remain competitive, we
now expect to implement a standard policy under which we offer such a warranty
to our customers. 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. In addition, certain of
the companies we acquired did offer various warranties under their customer
contracts. For example, 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. By
acquiring Hiway, we inherited these warranty obligations.
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 you, 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.
ALTHOUGH WE HAVE IMPLEMENTED NETWORK SECURITY MEASURES, OUR NETWORK MAY
EXPERIENCE SECURITY BREACHES
We have implemented certain network security measures, such as limiting
physical and network access to our routers. Nonetheless, we cannot assure you
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 or 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 ensure 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 us or liability on our part.
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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, 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.
OUR COSTS WILL INCREASE IF WE FAIL TO MAINTAIN OUR PEERING RELATIONSHIPS
The establishment and maintenance of peering relationships with other
Internet service providers are necessary in order to exchange traffic with other
Internet service providers without paying transit costs. The basis on which the
large national Internet service providers make peering available or impose
settlement charges is evolving. Recently, companies that previously offered
peering have cut back or eliminated peering relationships and are establishing
new, more restrictive criteria for peering, requiring substantial data
transmission volume and broad national scale. Global network capabilities also
may become a requirement. We may have to comply with increasing peering
requirements in order to maintain our peering relationships. Failure to maintain
peering relationships or establish new ones, if necessary, will increase our
operating expenses.
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:
o inconsistent quality of service;
o lack of availability of cost-effective, high-speed options;
o a limited number of local access points for corporate users;
o inability to integrate business applications on the Internet;
o the need to deal with multiple and frequently incompatible
vendors;
o inadequate protection of the confidentiality of stored data and
information moving across the Internet; and
o 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 communication, 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 Internet access and services are not broadly
accepted, our business, financial condition and results of operations will be
materially adversely affected. In addition, the rate of development and adoption
of the Internet has been slower outside the United States, and the cost of
transmitting data over the Internet 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
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and other technological changes on a timely and cost-effective basis. We cannot
assure you 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 you 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 you 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. Alternative open and proprietary protocol standards
that compete with transmission control protocol/Internet protocol, 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
results of operations.
WE FACE POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR 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
on-line 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, federal legislation was enacted
that requires limitations on access to pornography and other material deemed
"harmful to minors" within the meaning contained in the legislation. This
legislation has been successfully attacked in the U.S. district court as a
violation of the First Amendment. We are unable to predict the outcome of this
case on appeal. In addition, other federal legislation addressing issues
relating to Internet content and liability has been proposed. 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 discontinue certain product or
service offerings. Any of these actions could have a material adverse effect on
our business, financial condition and results of operations.
The law relating to the regulation and liability of Internet access
providers in relation to information carried or disseminated also is developing
in other countries. For example, the European Union has enacted its own data
privacy regulations, and Australia has imposed new obligations on Internet
service providers to block access to certain types of content. 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, regulations at the Federal Communications Commission
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. There is pending before the Federal Trade
Commission a Notice of Proposed Rulemaking to prohibit unfair and deceptive acts
and practices in connection with the collection and use of personal information
from and about children on the Internet. As a result of this rulemaking,
additional requirements may be imposed on Web site operations relating to use,
dissemination and collection of personal information. Additional laws and
regulations 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 Federal Communications Commission 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
Federal Communications Commission 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 Federal
Communications Commission concluded that certain services offered over the
Internet, such as phone-to-phone Internet
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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 Federal Communications Commission 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 the Federal
Communications Commission and 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
dialup customers and could have a material adverse effect on our business,
financial condition and results of operations.
WE DEPEND UPON SUPPLIERS, WHO ARE OFTEN OUR COMPETITORS, AND HAVE LIMITED
SOURCES OF SUPPLY FOR CERTAIN PRODUCTS AND SERVICES
We rely on other companies to supply certain key products and services
that we resell and certain components of our network infrastructure. The
products and services that we resell, and certain components that we require for
our network, are available only from limited sources. For example, we currently
rely primarily 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 WorldCom and MFS, who sell
products and services that compete with ours, also are our primary providers of
data communications facilities and network capacity. Northpoint Communications
and Covad Communications provide us with digital subscriber line services for
resale to our customers. We also are dependent upon local exchange carriers,
which often are our competitors, to provide telecommunications services and
lease physical space to us for routers, modems and other equipment. From time to
time we experience delays in the delivery and installation of telecommunications
services, which can lead to the loss of existing or potential customers or
delays in generating revenues from sales to customers. We cannot assure you
that, on an ongoing basis, we will be able to obtain third-party products and
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
third-party products and services would have a material adverse effect on our
business, financial condition and results of operations.
WE DEPEND ON KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR SERVICES
BECAUSE OF THE LIMITED NUMBER OF QUALIFIED PEOPLE IN OUR INDUSTRY
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. We cannot assure you that we will be successful in attracting and
retaining qualified executives and personnel. In addition, our employees may
voluntarily terminate their employment with us at any time. The loss of the
services of key personnel or our failure to attract additional qualified
personnel could have a material adverse effect on our business, financial
condition and results of operations.
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 commonly referred to
Year 2000 or Y2K issue results from the fact that many computer programs and
systems were developed without considering the possible impact of a change in
the century designation that will occur on January 1, 2000. As a result, these
programs and systems use only two digits instead of four to identify the year in
the date field. Systems that do not properly recognize this date could generate
wrong data, calculate erroneous results, or fail if the issue remains
uncorrected. The Year 2000 problem is pervasive and complex, as virtually every
company's computer operations potentially could be affected in some way.
We have identified two main areas of potential Y2K risk in our
business:
o Our internal systems or embedded chips could be disrupted or fail,
which could negative impact our services and productivity.
o Computer systems or embedded technology of third parties, such as
our suppliers, vendors, customers, landlords, telecommunication
service providers, outsource providers, and others could be
disrupted or fail, and thereby adversely affect our operations.
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To help ensure that our network operations and services to our customers are
not interrupted due to the Y2K problem, we established a Y2K assessment team
that was responsible for overseeing the assessment of our equipment and systems
for Y2K compliance. This team meets regularly, and developed and implemented our
overall Y2K assessment and remediation plan. In the fourth quarter of 1998, we
conducted a systems assessment of our national systems in Denver, Colorado,
Dallas, Texas and regional networks, as well as systems in our eastern operating
region, including both information technology systems and non-information
technology systems such as hardware containing embedded technology, for year
2000 compliance. Because the network systems in our other operating regions
employ substantially similar technologies, we considered the outcome of this
initial assessment to be generally reflective of our entire operation. No
significant potential Y2K issues were identified in this process. With the
information gained from that initial assessment, we undertook our company-wide
year 2000 compliance program, including a complete inventory, assessment and
testing of potentially impacted systems, and the development and and roll-out of
plans to implement, test and complete any necessary modifications to our key
systems and equipment to ensure that they are Y2K compliant. Prior to our
acquisition of Hiway, Hiway hired its own outside consultants to evaluate their
systems for year 2000 compliance. This evaluation disclosed some potential,
although non-material, Y2K issues in Hiway's internally developed provisioning
systems. Based on the results of this earlier evaluation, we undertook
remediation activities that were completed in the second quarter of 1999.
Additional remediated systems were implemented in the Hiway web hosting systems
during the third quarter of 1999.
As of September 1999, Verio had assessed the compliance status of all
potentially affected systems and equipment identified from the inventory phase
of our Y2K compliance effort, throughout our operations. Compliance status was
checked against third party information sources including public statements made
by hardware and software vendors, correspondence directly with such vendors, and
compilations of compliance information published by other parties. Verio did not
independently verify compliance of such hardware and software components
utilized within our service, or independently verify the contents of the
republications. Based on compliance information found, all operating units of
Verio have completed Year 2000 upgrade plans for nearly all items in their
respective inventories of hardware and software components in the Verio network.
In conjunction with such assessment, we are implementing remedial actions,
including code level remediation, system upgrades or complete system replacement
of non-compliant items.
In connection with our efforts to integrate the operations of the various
companies we have acquired, many of the internal business operating systems that
were previously employed by those acquired entities are being replaced with new,
scalable, national systems. As we evaluate new systems for purchase, we have
assessed and confirmed their year 2000 compliance. Verio has migrated business
operations of acquired companies to national services on year 2000 compliant
systems for finance, billing, customer operations and network management. In
addition, Verio has been consolidating legacy systems in order to provide
consistent provisioning of services; and centralized domain name services, mail,
authentication and news. We have obtained Year 2000 compliance statements from
our hardware and software vendors, informing us that these systems are comprised
of the latest commercial hardware and software components and are year 2000
compliant. All of these systems are currently operational and have been
subjected to extensive operational testing within the Verio network, the
migration of customers from the historic systems to these new platforms is
currently underway. Migrations of domain name service and news are expected to
be 100% complete by the end of 1999. Migrations to mail and authentication
systems are expected to be approximately 50% complete by the end of 1999. We
continue to evaluation the historic systems that are not planned to be migrated
in 1999 for year 2000 compliance issues, but we do not expect any potential Y2K
impact of those legacy systems that remain in use at the end of 1999 to be
material.
We performed a complete end-to-end service-level test in the first week of
October to evaluate the overall Y2K compliance of our network and systems. The
goal of this test was to ensure continuity of customer services across elements
exclusively under Verio operational control. This test included a representative
sampling of all major hardware and software components that provide direct
service to our customers such as web hosting, the Verio national backbone, and
several different types of Internet connectivity including ISDN, point-to-point
and frame relay. Various routers and other network components were used to
simulate our regional networks and customer premises equipment. We also included
our national network monitoring software and hardware. The test did not include
underlying telecommunications infrastructure components over which Verio does
not exercise control. No customer-affecting Year 2000 issues were uncovered in
this test. We will continue to perform tests on all upgrades to our systems as
appropriate throughout the fourth quarter. In addition, we will continue to test
locally developed software and systems in order to verify vendor compliance
statements.
Our Y2K team is also developing contingency plans to deal with any potential
problems that may occur in our network or services as a result of the Y2K
probems. These plans will be stored centrally for use by the Verio customer
service organization to allow for a timely, well-organized response to any
unforeseen Year 2000 problems anywhere within the Verio organization. Although
we do not expect any major problems during the Year 2000 rollover period, we
will have a dedicated command center staff on duty at our Network Operations
Center to quickly respond to Year 2000 issues should any arise. We believe that,
as a result of our detailed
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assessment and remediation efforts, the Y2K issue will not pose significant
operational problems for us. However, if Y2K compliance problems have not been
discovered, or if requisite modifications or remediation have not made
undertaken or made, it is possible that the Y2K problem could have a material
impact on our operations. We cannot currently estimate the magnitude of such a
possible impact.
We continue to survey, among others, critical vendors, suppliers,
customers and financial institutions for Year 2000 compliance. We have
evaluatied the Year 2000 preparedness of our telecommunications providers, on
which we rely for the network services crucial to our business. In order to
reduce potential adverse impacts, we maintain diverse providers for such network
services. However, failure of any one provider may have a material impact on
Verio's operations. Our survey of our third party suppliers indicates they many
of them are still working on their own Year 2000 compliance issues. We are
heavily dependent upon the veracity of their testing and statements of
compliance as we cannot replicate and independently test the services supplied
to us. Though most of these suppliers indicate that their critical systems and
technology are Year 2000 ready, at this time we cannot estimate the effect, if
any, that non-compliant systems supplied by these entities could have on us. It
is possible that the impact on us could be material if one or more of these
systems are not Y2K compliant by the end of the year. We continue to work with
each of these suppliers to obtain the latest information on their compliance
status to assist us in evaluating and developing contingency plans. If any of
our material third party suppliers or vendors are not Y2K ready and their
non-compliance causes a material disruption to any of their respective
businesses or services, our business, operations and/or services could be
materially and adversely affected.
The most significant risks that the Y2K issues could present to us
include, without limiation, disruption, delay or cessation of operations. For
example, in the event of a widespread telecommunications failure (which we
believe is our most reasonably likely worst case Y2K scenario), the entire
Internet performance could potentially be affected due to its very nature as a
collection of interconnected networks. A number of individual customers may
suffer from complete outages of services, though we believe that most Internet
services would likely continue to operate, although possibly at a reduced
performance level. Other potential adverse Y2K scenarios include the failure or
impairment of software that is provided by a third party and incorporated in one
of our service platforms as a result of a Y2K problem. In that case, the
particular service that the software supports could likewise become inoperable
or perform incorrectly. Further, in the event that third-party-supplied
equipment (including customer premise equipment) contains non-Y2K-compliant
technology, the systems, operations or services supported by that equipment also
could fail or be interrupted. Other potential disruptions could include the
failure of a material third party's business, a financial institution's
inability to transfer and receive funds, the interruption in delivery of key
supplies from vendors, a loss of power to our facilities, and other
interruptions in the normal course of our operations. In the event that a
failure does occur within one of these elements, our services could suffer
degradation or complete failure without warning or remedy, resulting in
substantial potential expense.
Our expenditures to date in our Year 2000 program efforts has been
immaterial, and is estimated to remain under $1 million in the aggregate. These
costs include equipment, consulting fees, software and hardware upgrades,
testing, and remediation in connection with our Year 2000 program office
evaluation, test, contingency planning and vendor evaluation efforts. This sum
does not include an allocated overhead amount for the work of the internal Y2K
team, as the time spent by these people is not separately tracked, but if it
were that amount likewise would not be material. It is possible that the costs
associated with our Y2K efforts could increase if it is determined that
additional resources are required or if important operational or systems
equipment must yet be remediated or replaced. The total cost of our Y2K
compliance program is funded through cash on hand and we are expecting these
costs, as appropriate. While the financial impact of making all required systems
changes or other remediation efforts cannot be known precisely, it is not
expected to be material to our financial position, results of operations, or
cash flows. We have not cancelled any principal information technology projects
as a result of our Y2K efforts, although we have rescheduled and reprioritized
some internal tasks in order to accommodate this effort.
While we believe that we are adequately addressing the Y2K issue, we
cannot assure you that our Y2K compliance effort will prevent every potential
interruption or failure, or that the cost and liabilities associated with the
Y2K issue will not materially adversely impact our business, prospects,
revenues, or financial position. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See attached exhibit index.
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(b) Reports on Form 8-K
None.
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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.
Date: November 12, 1999 /s/ Peter B. Fritzinger
------------------------------------
Peter B. Fritzinger
Chief Financial Officer
Date: November 12, 1999 /s/ Carla Hamre Donelson
------------------------------------
Carla Hamre Donelson
Vice President, General Counsel
and Secretary
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27.1 Financial Data Schedule (for SEC use only).
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