<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
COMMISSION FILE NUMBER: 0-22575
CONCENTRIC NETWORK CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 65-0257497
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
10590 N. TANTAU AVENUE, CUPERTINO, CA 95014
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 342-2800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on February
23, 1998 as reported on the National Market of The Nasdaq Stock Market, was
approximately $129,547,838. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes. As of February 23, 1998, registrant had
outstanding 14,171,847 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for Registrant's Annual Meeting of
Stockholders to be held May 20, 1998.
<PAGE>
The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operation--Factors
Affecting Operating Results" commencing on page 29.
PART I
Item 1. Business
THE COMPANY
Concentric provides tailored, value-added Internet Protocol ("IP") based
network services for businesses and consumers. To provide these services, the
Company utilizes its low/fixed latency, high-throughput network, employing its
advanced network architecture and the Internet. Concentric's service offerings
for enterprises include virtual private networks ("VPNs"), dedicated access
facilities ("DAFs"), remote access services and Web hosting services. These
services enable enterprises to take advantage of standard Internet tools such
as browsers and high-performance servers for customized data communications
within an enterprise and between an enterprise and its suppliers, partners and
customers. These services combine the cost advantages, nationwide access and
standard protocols of public networks with the customization, high
performance, reliability and security of private networks. Among the current
enterprise customers are Acer America Corporation, Inc., Intuit, Inc.
("Intuit"), Netscape Communications Corporation ("Netscape"), Microsoft
Corporation ("Microsoft") and WebTV Networks, Inc., a subsidiary of Microsoft
("WebTV"). Concentric's service offerings for consumers and small office/home
office customers include local Internet dial-up access and applications
hosting services.
The Concentric network employs an advanced, geographically dispersed ATM and
frame relay backbone, SuperPOPs in 16 major metropolitan areas and 139
secondary and tertiary POPs in other cities, allowing dial-up network access
in the U.S. and Canada. In addition, the Company can provide analog dial-up,
frame relay, fractional T-1, T-1 and DS3 access to the network. The Concentric
network is engineered and managed to provide superior quality of service,
balancing several key performance criteria. The Company provides guaranteed
levels of service for DAFs to enterprise customers, and targets performance
benchmarks for connection success rates, latency levels and throughput for all
of its service offerings.
In addition to strong network performance capabilities, the Company believes
that several factors distinguish its ability to provide value-added network
services. These factors include: (i) excellent service quality; (ii) rapid
development time and flexibility in meeting custom applications requirements;
(iii) responsive customer support and effective account management, available
24 hours per day, seven days per week through the Company's 163 customer
service personnel; and (iv) the Company's technical expertise in devising
cost-effective network solutions for customers.
The Company was incorporated in Florida in 1991 under the name Engineered
Video Concepts, Inc., changed its name to Concentric Research Corporation in
1992 and commenced network operations in 1994. In 1995, the Company changed
its name to Concentric Network Corporation and reincorporated into Delaware in
1997. Unless the context otherwise requires, "Concentric" and the "Company"
refer to Concentric Network Corporation. The address of the Company's
principal executive offices is 10590 N. Tantau Avenue, Cupertino, CA 95014,
and its telephone number at that address is (408) 342-2800.
2
<PAGE>
INDUSTRY BACKGROUND
Development of Private Networks
Historically, the data communications services offered by public carriers
had limited security features, were expensive and did not adequately ensure
accurate and reliable transmission. As a result, many corporations established
and maintained their own private wide-area networks ("WANs") to provide
network-based services, such as transaction processing, to their customers and
to coordinate operations between employees, suppliers and business partners.
Such private WANs were frequently customized to specific applications,
business practices and user communities. As a result, these private WANs had
the capability of providing organizations and users with tailored performance
and features, security, reliability and private-label branding.
The demand for WANs has grown as a result of today's competitive business
environment. Factors stimulating the higher demand include the need to provide
broader and more responsive customer service, to operate faster and more
effectively between operating units, suppliers and other business partners,
and the need to take advantage of new business opportunities for network-based
offerings in a timely fashion. In addition, as businesses become more global
in nature, the ability to access business information across the enterprise
has become a competitive necessity.
Despite the attractive capabilities of private networks, limitations of many
private WANs have impeded or reduced the effectiveness of their use. These
networks, which traditionally have required the use of leased telephone lines
with bandwidth dedicated solely to this purpose and the purchase of vendor-
specific networking equipment, are inherently expensive to set up, operate and
maintain. Private WANs often require the development and maintenance of
proprietary software and lack cost-effective access. These aspects of
developing, deploying and maintaining such private WANs have conflicted with
the increased focus of many businesses on their core competencies, which has
prompted the outsourcing of many noncore functions. The Company believes that
many businesses have viewed as unacceptable the costs of maintaining a private
WAN infrastructure and the risks of investing in new technologies in the
absence of a single technological standard.
Emergence of the Internet
The emergence of the Internet and the widespread adoption of IP as a data
transmission standard in the 1990s, combined with deregulation of the
telecommunications industry and advances in telecommunications technology have
significantly increased the attractiveness of providing data communication
applications and services over public networks. At the same time, growth in
client/server computing, multimedia personal computers and online computing
services and the proliferation of networking technologies have resulted in a
large and growing group of people who are accustomed to using networked
computers for a variety of purposes, including e-mail, electronic file
transfers, online computing and electronic financial transactions. These
trends have led businesses increasingly to explore opportunities to provide
IP-based applications and services within their organization, and to customers
and business partners outside the enterprise.
Need for IP-Based Private Networks
The ubiquitous nature and relatively low cost of the Internet have resulted
in its widespread usage for certain applications, most notably Web access and
e-mail. However, usage of the Internet for mission-critical business
applications has been impeded by the limited security and unreliable
performance inherent in the structure and management of the Internet.
Additionally, emerging applications such as IP-based voice and video
applications, multiplayer gaming and certain multimedia applications require a
network that has high performance characteristics, including low and/or fixed
latency (response time) and high throughput, as well as the ability to
customize features for specific user requirements. On the Internet, latency is
frequently relatively high and variable, making it suboptimal for these
emerging applications. Although private networks are capable of offering lower
and more stable latency levels, providers of these emerging applications also
desire a network that will offer their customers full access to the Internet.
As a result, these businesses and applications providers require a network
that combines the best features of the Internet, such as openness, ease of
access and low cost made
3
<PAGE>
possible by the IP standard, with the advantages of a private network, such as
high security, low/fixed latency and customized features.
Industry analysts expect the market size for both value-added IP data
networking services and Internet access to grow rapidly as businesses and
consumers increase their use of the Internet, intranets and privately managed
IP networks. The total market for these services is projected to grow from
$1.2 billion in 1996 to approximately $22.7 billion in the year 2000, with
approximately $10.4 billion in the enterprise market segment and $12.3 billion
in the consumer market segment.
THE CONCENTRIC SOLUTION
Concentric provides tailored, value-added IP-based network services for
businesses and consumers. To provide these services, the Company employs a
low/fixed latency, high-throughput network based on its advanced,
geographically dispersed ATM and frame relay backbone and the Internet.
Concentric allows enterprises to create virtual private networks providing
tailored network access, content and services to enterprise-defined end users
with higher reliability and more security than is available over the Internet.
Concentric's VPN solutions also provide the ease of access and flexibility of
public networks at a lower cost than private WANs without sacrificing
reliability or security.
The Concentric network employs an advanced, geographically dispersed ATM and
frame relay backbone, SuperPOPs in 16 major metropolitan areas and 139
secondary and tertiary POPs in other cities, allowing dial-up network access
in the U.S. and Canada. In addition, the Company can provide analog dial-up,
frame relay, fractional T-1, T-1 and DS3 access to the network. The Concentric
network is engineered and managed to provide superior quality of service,
balancing several key performance criteria. The Company provides guaranteed
levels of service for dedicated access facilities to enterprise customers, and
targets performance benchmarks for connection success rates, latency levels
and throughput for all of its service offerings.
In addition to strong network performance capabilities, the Company believes
that several factors distinguish its ability to provide value-added network
services. These factors include: (i) excellent service quality; (ii) rapid
development time and flexibility in meeting custom applications requirements;
(iii) responsive customer support and effective account management, available
24 hours per day, seven days per week through the Company's 163 customer
service personnel; and (iv) the Company's technical expertise in devising
cost-effective network solutions for customers.
BUSINESS STRATEGY
The Company's objective is to become the leading supplier of value-added,
IP-based network services worldwide. In order to achieve this goal, the
Company is implementing a business strategy focused on the following key
principles:
Rapidly Provide Cost-Effective, Tailored Network Solutions. The Company
intends to capitalize on its expertise in developing tailored VPNs to
establish a leadership position in rapidly developing, deploying and
maintaining a range of value-added network services to meet the specific needs
of its customers. The Company utilizes a set of software and hardware
technology modules as "building blocks" to offer a variety of tailored network
services on an IP-based network architecture with minimal additional
investment in engineering and rapid time to market for businesses and
consumers. These building blocks include modules for client and system
software, dedicated and remote network connectivity, tracking and billing, Web
hosting, customer support and security.
Optimize Network Utilization. Given the fixed cost nature of Concentric's
network infrastructure, the Company strives to increase total network
utilization and to optimize this utilization by targeting both daytime
business and evening-intensive consumer users to balance the network's usage
throughout a 24-hour period. Accordingly, while the Company's current
strategic focus is on providing value-added IP-based communications
4
<PAGE>
services to enterprises, the Company intends to continue partnering with
multichannel distributors to acquire and maintain a base of consumer
subscribers who access the Concentric network predominantly during non-
business hours.
Acquire Complementary Assets or Businesses. The Company is actively seeking
to identify and acquire assets, technologies or businesses complementary to
the Company's value-added enterprise network service strategy. Such
acquisition efforts are targeted at businesses that offer the potential to
expand the Company's revenue base, increase the scalability of the Company's
network infrastructure and value-added service offerings, as well as optimize
the utilization of the Company's network.
Employ Leveraged Marketing Through Strategic Partners. The Company actively
seeks to form alliances with certain software developers and
telecommunications service and equipment suppliers that have substantially
greater marketing, distribution and sales resources than does the Company and
that have a large installed customer base. These alliances facilitate the
cost-effective acquisition of consumer and business customers and increase
Concentric's network utilization. These marketing relationships are developed
and enhanced through the bundling of Concentric's IP-based network services
with the products and services offered by the strategic partners. These
relationships may involve customized browsers, registration services and
specialized pricing, commissions and billing programs. To date, Concentric has
established such strategic relationships with a number of companies, including
Acer America Corporation, Bay Networks, Inc., Intuit, Microsoft, Netscape,
PictureTel Corporation, Racal Datacom, Inc. ("Racal"), TMI Telemedia
International, Ltd. ("TMI") and WebTV. See "Sales and Marketing."
Offer Next Generation Network Services. In addition to its core VPN service
offerings, the Company is continuing to expand the value-added network
services that it makes available to its customers. Towards this end, the
Company has recently introduced video conferencing and is in early stage
trials of IP-based telephony services that require the low/fixed latency
characteristics afforded by the Concentric network.
Deploy Network Services Internationally. The Company believes that its
enterprise customers increasingly will require their network solutions
providers to offer network services on a global basis. Pursuant to an
agreement with TMI, entered into in August 1996, the Company is working to
establish an international network based on Concentric's network technology
and expertise and TMI's existing telecommunications infrastructure to deliver
a range of compatible network services worldwide. TMI currently has a
telecommunications network deployed in over 40 countries worldwide.
Additionally, the Company entered into a roaming services agreement in June
1997 with NTT PC, a leading provider of IP services in Japan. The roaming
services agreement allows Concentric customers to use the NTT PC network to
access their internet accounts in Japan and allows members of the NTT PC
network to access their internet accounts in the United States and Canada.
Additionally, the Company acquired Web hosting facilities in Stockholm,
Sweden, Tokyo, Japan and Hong Kong in February 1998. While the Company does
not expect to generate significant revenue from deployment of international
network services until at least 1999, the Company believes that the ability to
deliver network solutions globally will be a key competitive factor in its
industry. The foregoing expectation is a forward-looking statement that
involves risks and uncertainties and the actual results could vary materially
as a result of a number of factors including those set forth in "Factors
Affecting Operating Results--Risks Associated with International Expansion."
SERVICES
Concentric provides tailored, value-added IP-based network services for
businesses and consumers. To provide these services, the Company employs a
low/fixed latency high-throughput network based on an advanced, geographically
dispersed ATM and frame relay backbone and the Internet.
Enterprise Solutions
For businesses, the Company has developed a set of enterprise services
including VPNs, dedicated access facilities ("DAF"), digital subscriber line
("DSL") services and Web hosting services.
5
<PAGE>
Virtual Private Network Services. Concentric's custom VPN solutions enable
its customers to deploy tailored, IP-based mission-critical business
applications for internal enterprise, business-to-business and business-to-
customer data communications on the Concentric network while also affording
high-speed access to the Internet. Concentric offers its customers a secure
network on which to communicate and access information between an
organization's geographically dispersed locations; collaborate with external
groups or individuals, including customers, suppliers, and other business
partners and use the Web to access information on the Internet and communicate
with other Web users.
The Company's VPN solutions allow the enterprise customer to tailor the type
of access, services and information that various users of the VPN are afforded
according to the specific needs of the enterprise. Key benefits include rapid
implementation time, lower operating and maintenance costs, minimal capital
investment, higher quality of service overall and 24-hour network and customer
support. For example, starting in October 1995 the Company created and now
maintains the VPN used by Intuit customers using a customized version of the
Netscape Navigator browser bundled with Quicken for Windows, Quickbooks,
ProTax and TurboTax. The bundled software allows a Quicken customer to click
on an icon that launches Netscape, and takes the user directly to Quicken
Financial Network Website. On the Web page Quicken customers will find useful
financial advice, information from Intuit's bank and financial institution
partners, answers to commonly asked technical questions and tips on how to tap
the full potential of Intuit's financial products.
In addition to the custom VPNs that Concentric has developed and delivered,
the following three distinct VPN products are now offered by the Company:
Concentric CustomLink. Concentric CustomLink provides a complete, private
labeled dial-up VPN service for customers. CustomLink includes dial-up
network access, customized and customer-branded client software, and
private labeled help desk services. The dial-up network access offerings
include local access, toll-free 800 number access, and a unique connection
service, PremierConnect, which provides important customers with
connectivity to the VPN, even if local access numbers are busy. In
addition, CustomLink permits the customer to segment their users, and apply
various levels of services, such as Web access, e-mail, and file transfer
protocol ("FTP") to each customer group. The services that access
restrictions in the form of filters can also be applied to groups of
customers.
Enterprise VPN. The Company's Enterprise VPN service includes security
hardware and software, high speed network access, network connectivity,
customer premise routing equipment and customer support services.
Installation support for the customer premise located routing and security
equipment is also provided. Concentric can also optionally provide
management services for firewall and packet encryption equipment if desired
by the customer. The Enterprise VPN service is targeted at customers
seeking to create a secure, outsourced WAN for intranet and extranet
applications.
Concentric RemoteLink. The Company's remote access service, marketed as
Concentric RemoteLink, is targeted at businesses that have employees in
remote locations. RemoteLink enables an enterprise's salespeople and other
mobile employees, telecommuters and business partners to dial into an
enterprise's corporate network resources and use them as if they were
connected locally, thus increasing potential productivity and allowing for
information to be available on a real-time basis across the enterprise.
Concentric's RemoteLink is designed to be highly customizable and provides
the ability to interface with existing company network infrastructure.
RemoteLink offers customers the potential to significantly reduce the high
costs of telecommunications charges and user support associated with
building, deploying, and maintaining an internal remote access
infrastructure.
Concentric also performs around-the-clock monitoring of network performance
and enables its customers to monitor their network as well through the
Company's proprietary ConcentricView software. ConcentricView is a Web-based
network management tool which allows a customer to monitor usage on a call-by-
call basis and performance of that portion of the Concentric network bandwidth
supporting the customer's applications.
Dedicated Access Facilities. In January 1997, the Company began offering
DAFs as a stand-alone product targeted at businesses that desire single or
multipoint high-speed, dial-up and/or dedicated connections to distributed
locations such as regional offices, warehouses, manufacturing facilities
and/or to the Internet. DAF
6
<PAGE>
products are primarily targeted at providing intranet connectivity amongst
distributed enterprise locations with the additional benefit of Internet
access if desired by the customer. The Company provides a full range of
connectivity options, allowing the customer to order the appropriate amount of
bandwidth to meet its networking requirements. In addition, Concentric offers
its DAF customers a guarantee on the quality of service and performance of
these facilities. Furthermore, Concentric believes it is the only network
service provider to bill customers based on average usage levels rather than
peak usage levels.
Concentric has six offerings in its dedicated access product line:
FullChannel T-1, FullChannel T-1 Protected, FlexChannel and LECFrame Relay, as
well as FullChannel and FlexChannel offerings at DS3 (T-3) bandwidth options
which support up to 45 Mbps.
FullChannel T-1 and DS3 (T-3) pricing is based on a one time set-up fee and
average utilization pricing. The customer's usage is measured at five-minute
intervals throughout the month, and the average of all of those measurements
is used to determine the customer's bill at the end of the month. The one time
set-up fee for FullChannel T-1 service is $3,000 and and the monthly fee
ranges from $1,095 to $2,695 depending on usage. The one time set-up fee for
FullChannel T-3 service is $5,000 and and the monthly fee ranges from $6,000
to $40,500 depending on usage. FullChannel T-1 and T-3 pricing is the
appropriate choice for those customers who have fluctuating and/or uncertain
bandwidth consumption patterns.
FullChannel T-1 Protected gives a customer a fixed price for a full 1.5
megabits of bandwidth. The one time set-up fee is $3,000 and the monthly fee
is set at $2,095. This is an economical choice for those customers who
recognize in advance that their bandwidth throughput requirements will equal
T-1 levels.
FlexChannel gives a customer the opportunity to purchase a fractional
portion of a T-1 or T-3 for a fixed monthly fee. The set up fee is the same as
for FullChannel pricing but the monthly fee ranges from $895 to $1,895 for
FlexChannel T-1 service and from $6,000 to 25,500 for FlexChannel T-3 pricing.
FlexChannel T-1 and T-3 pricing is the appropriate choice for the customers
who know that their bandwidth requirements are going to be consistently less
than a full T-1 or T-3.
LECFrame Relay is based on various LECs' Frame Relay facilities. Although
Concentric does not offer service level guarantees over LECFrame Relay,
Concentric does guarantee the committed information rate. This offering gives
a lower cost, lower performance network service for those customers for whom
performance is less imperative. Concentric charges a one time set-up fee of
$2,000 for LECFrame Relay services and monthly fees ranging from $395 to
$1,095 depending on usage.
Digital Subscriber Lines. In December 1997, Concentric began offering
Internet and intranet connectivity using DSL technology. DSL and its variants
are a new dedicated access technology being deployed by telephone companies
that allows high speed digital service over regular telephone lines. The
Company has formed relationships with PacBell and a number of Competitive
Local Exchange Carriers ("CLECs") to expand its DSL service area. Concentric's
DSL service offerings are currently available in Northern California through
such CLEC relationships. The Company's DSL service offerings include a wide
range of dedicated access speeds, from 144Kbps to 1.1Mbps symmetric DSL, as
well as 1.5Mbps/384Kbps asymmetric DSL
Concentric DSL services are targeted at the consumer, telecommuter, and
small-to-medium sized business markets. The "dedicated access feature" of DSL
services combined with its high speed and low flat rate pricing are designed
to appeal to the large installed base of ISDN users. Pricing for the service
is low relative to traditional dedicated access services, making it attractive
to medium sized businesses, while at the same time broadening the market to
reach small businesses who previously could not justify the expense of
dedicated Internet service.
Pricing is based on the bandwidth of the DSL circuit, and is a flat rate
monthly fee ranging from $149 to $399 depending on the service speed.
Concentric provides complete installation services including all the customer
premise equipment necessary to provide the DSL service at fees ranging from
$325 to $725.
7
<PAGE>
Web Hosting Services. The Company's Web hosting services were introduced in
March 1997, and are targeted at businesses that are implementing high-
performance intranet, Web, e-mail, gaming, chat or other types of services.
Concentric offers a wide range of hosting solutions structured to meet the
needs of small businesses to very large enterprises. The Company's high-end
hosting capabilities were enhanced by the acquisition of five domestic data
centers and three international hosting facilities in February 1998. By
outsourcing its Web hosting requirements to Concentric, an enterprise can
reduce costs while increasing reliability and performance of its servers.
Web hosting consists of providing and/or managing the necessary equipment to
allow companies to operate Web sites. The components of Web hosting are the
server; a workstation or PC that runs the Website; the facility to host the
server; high speed Internet access for hosted servers; server and power backup
to ensure 24 hour functionality; and maintenance to ensure ongoing operation
of the server. Concentric also bundles Web hosting software and network
services to provide businesses with complete Internet presence solutions.
In February 1998 Concentric announced the availability of ConcentricHost
Server Solutions, a line of Web hosting services designed for companies who
require outsourced maintenance, management, bandwidth and housing for their
internet or extranet Web servers. Unlike colocation services that simply
supply rack space and bandwidth, ConcentricHost Server Solutions provide high-
performance Internet access from state-of-the-art data centers, skilled
technicians and maintenance programs that monitor servers 24 hours a day,
seven days a week and scalability to address the growing networking needs of
businesses of all sizes.
For reliable, high-performance flow of traffic between customer's Web
servers and worldwide networks, Concentric has combined public peering and
private peering arrangements to provide improved performance to users.
Concentric Network currently operates data centers in Santa Clara, Cupertino,
San Francisco and Los Angeles, California, Chicago, Illinois and Washington,
D.C., along with hosting facilities in Stockholm, Sweden, Hong Kong and Tokyo,
Japan. Each Concentric Network data center is connected via multiple DS3
(45Mbps) or OC3 (155Mbps) high-speed links to geographically dispersed points
in its private ATM backbone. This network architecture provides diversity and
redundancy to user's network systems while minimizing user cost. See "--The
Concentric Network."
In addition to state-of-the-art hosting facilities, Concentric provides
industry-leading server management tools. ConcentricHost Server Solutions
offer a suite of advanced server support and management services, called
Remote Hands, to monitor performance of users business-critical applications.
Specific Remote Hands features include: power cycling equipment; running
diagnostic equipment; providing diagnostic displays; upgrading equipment; file
system back-up; and upgrading drive capacity.
ConcentricHost Server Solutions range in price from $550 to $4,400 a month,
depending on required bandwidth and rack space. Remote Hands options range in
price from basic services included at no cost with colocation service to more
advanced services ranging in price from $195 to $250 an hour. A range of
Remote Hands fixed-fee service packages, based on specific customer needs, are
also available with pricing options starting at $1,250 a month.
In February 1998, Concentric announced an extension of its ConcentricHost
line of hosting products, adding four new service packages that offer small
and mid-sized businesses flexible, tailored solutions to meet their Web
hosting needs. ConcentricHost Internet Suite(TM) is a complete, easy-to-use
service designed to cost effectively provide for all of the Internet needs of
a business in one account. Packages range from $59.95 to $199.95 a month
depending on the range of e-mail accounts, disk space and bandwidth provided
to the customer. These packages also offer the user shared security and full
domain names and are managed from a user-friendly Web interface. Other
features include 24 hours a day, seven days a week customer support and built-
in self-administration tools that allow the user to change options and analyze
activity on-line in near real time. For instance, users can increase bandwidth
allotments, create and delete e-mail accounts, and add Web space on-line. The
administration system also notifies users via e-mail of potential resource
consumption problems, such as being low on disk space or near the monthly
allocation of Internet bandwidth, allowing modifications to be made on-demand.
8
<PAGE>
In addition to the new Internet Suite packages, two existing ConcentricHost
products have received a name change to ConcentricHost Personal Web(TM). The
basic service, formerly ConcentricHost Home Office, is $29.95 per month and
includes five e-mail accounts, one dial-up account, 5 MB of disk space, 300 MB
of bandwidth and a sub-domain name. The enhanced service offering for $39.95 a
month, formerly named ConcentricHost Small Business, includes the same
features as the basic package with five additional MB of disk space and the
option for a full domain name. These services are targeted at individuals,
families and the small office/home office segment.
Netscape Virtual Office by Concentric. Pursuant to a Co-Marketing Services
Agreement, a Trademark License Agreement and a Software License Agreement
executed in June 1997 (the "Agreements"), the Company entered into a strategic
business arrangement with Netscape to design, develop and operate Netscape
Virtual Office by Concentric, to offer customers hosted private Intranet
services that can be accessed from anywhere on the Internet. The service has
been adapted from Concentric's ConcentricHost product and uses Netscape's
SuiteSpot software features. These services are designed to give an individual
or small business with an Internet connection the ability to establish a
"Virtual Office" that is accessible through Netscape's Internet site. The
Company launched the service in September 1997. The Agreements have an initial
term of two years, which may be renewed for up to two additional one year
terms. Pursuant to the Agreements, the service features hosting, both public
and private, multiple e-mail accounts and Internet dial-up service. The
Company has jointly designed the service with Netscape which has been
developed and is hosted by the Company.
Netscape Virtual Office by Concentric has been designed to give individual
professionals, small business and project groups a private on-line presence
that can be shared with co-workers or other specified users. This on-line
service serves as a user's entry point to a wide variety of on-line
information services, such as e-mail, internal and external Web sites, private
discussion groups and project collaboration without the cost of extensive
hardware, software and technical personnel. To take advantage of these
services, the user only needs an Internet access and Netscape Communicator
client software. In order to create "Virtual Office," the user signs up for
the monthly service on the Netscape Internet site. The user initially
specifies basic information, project parameters, a list of people who can
access the Virtual Office, and credit card information for payment. Once all
the information is specified, the user's Virtual Office is automatically
configured.
Consumer Services
Concentric provides its individual and small office/home office ("SOHO")
customers with a broad range of Internet access options and Web hosting, e-
mail, chat, FTP, Gopher and online shareware services. Users can choose from
local and long distance direct dial 800-number and telnet services. Concentric
offers the Microsoft Internet Explorer or the Netscape Navigator, upon
request, to its users when they sign up for dial-up or 800-number service.
INTERNET ACCESS PRICING
<TABLE>
<CAPTION>
MONTHLY
PLAN FEE ADDITIONAL TIME
---- ------- ------------------------------------------------
<S> <C> <C>
Starter Plan............ $ 7.95 $1.95/hr after 5 hours
Standard Plan........... $19.95 No charges for additional time. Unlimited active
access for one monthly fee.
800-number Plan......... $10.00 $5/hr after 2 hours
Inbound Internet Plan... $10.00 No charges for additional time. Unlimited active
access for one monthly fee.
</TABLE>
The Company also offers consumers value-added services, including a
collection of premium products targeted to vertical segments such as the
family and SOHO market. This includes the upselling of discounted products and
services in such areas as retail products, software, hardware and telephony
services with such partners as Amazon.com, Inc., QuadraCom, LLC, TuneUp.com,
Connected OnLine Backup and Classifieds 2000. Such arrangements not only
provide an additional monthly revenue stream but also increase customer
satisfaction and retention. Additional value-added products and services being
reviewed by the Company for potential introduction include premium service,
customer support, education research, virus protection, and faxing services.
9
<PAGE>
CUSTOMERS
The following is a representative list of the Company's customers during the
last 12 months.
Acer America Corporation Microsoft Corporation
Ameritech Services, Inc. Netscape Communications Corporation
AT&T Corporation On Command Corporation
Bascom Global Internet Oracle Corporation
Services, Inc. OzeMail Interline Pty, Ltd.
Bay Networks, Inc. NTT PC Communications, Inc.
Bloomberg, L.P. Peapod L.P.
Corel Corporation Philips Mobile Computing
Connected Corporation PictureTel Corporation
Electronic Data Systems PointCast, Inc.
Corporation Rosemount Inc.
Excite, Inc. SCP Communications
Fiberlane Communications, SMC Communications LLC
Inc. Scopus Technology, Inc.
Fishking Processors, Inc. Sega of America, Incorporated
First Data Corporation Tachyon Technology Corporation
Graybar Electric Company, 3Com, Inc.
Inc. Toshiba America Information Systems
Hewlett-Packard Company USWeb Corporation
Imagesoft Technologies, Inc. WebTV Networks, Inc.
Infogear Technology WorldCom, Inc.
Corporation You Bet! On-Line Entertainment
Intuit, Inc. Ziff-Davis Publishing Co.
Investools, Inc.
Iomega Corporation
Kleiner, Perkins Caufield, &
Byers
Lycos, Inc.
Network Associates Inc.
During the years ended December 31, 1996 and 1997, revenue from WebTV
accounted for 10.1% and 33.4%, respectively, of the Company's revenue. See
"Factors Affecting Operating Results--Customer Concentration."
The Company aggressively pursues business alliances with a variety of
companies. Through these partners, the Company seeks to expand its enterprise
and consumer customer base and increase the 24 hour utilization of the
Concentric network. The following is a summary of selected strategic
relationships:
Intuit. Intuit, a financial software and Web-based services company, is a
market leader in personal and small business financial software. Intuit views
its Websites as a key channel for communicating with its customers, and as a
vehicle to provide personal finance, investment and tax related financial
information. Concentric and Intuit partnered in October 1995 to launch
integrated Internet access to the Quicken Financial Network and the Internet.
The Internet access capability included both a virtual private network service
designed to provide Intuit customers subsidized access to select Intuit Web
sites and the ability to upgrade to full access to the Internet. Intuit has
bundled tailored versions of the Netscape Navigator browser in its fiscal year
1996 and 1997 releases of Quicken, TurboTax, ProTax and Quickbooks. Concentric
designed and implemented tailored registration and network access software to
provide Intuit customers with seamless, subsidized access to select Intuit Web
sites. Concentric provides an easy, Web-based upgrade process for customers
desiring full Internet access and e-mail services. Customers are billed for
network time through Concentric's billing systems. In addition, Concentric
provides private-labeled customer service to Intuit customers with full
network access on a twenty-four hour a day, seven day a week basis. Most
recently, Intuit provided subsidized full access Internet accounts in the 1998
releases of Quicken, Quickbooks, TurboTax and ProTax, along with the option
for customers to upgrade to other full Internet access plans. Intuit uses
Concentric's high performance network to enable customers to send electronic
tax filings and software product registration.
10
<PAGE>
WebTV Networks Inc. WebTV provides the world's first high-quality Internet
solution for television. In the fall of 1996, WebTV's licensees, Sony
Electronics, Inc. and Philips Electronics introduced a plug-and-play set-top
box that enables Internet browsing from a television. As part of the WebTV
service, Concentric and WebTV jointly designed and implemented a national
virtual private dial-up network solution to connect WebTV Network(TM) users to
the Internet, utilizing Concentric's network. The WebTV(TM) Internet terminal,
combined with the virtual private network, allows anyone to browse the
Internet from the comfort of their living room.
PictureTel Corporation. PictureTel, a leading provider of video conferencing
products, and Concentric have signed a joint development agreement which
specifies both parties' intent to jointly develop products and services to
enable PictureTel desktop and room video conferencing systems to communicate
over the Concentric network. Both Concentric and PictureTel currently have
trial systems installed and operating over the Concentric network. Preliminary
results demonstrate that the low/fixed latency and high throughput of the
Concentric network delivers superior quality for both desktop and room video
conferencing over IP-routed networks.
OnCommand Corp. OnCommand provides in-room TV services to guests at hotels
worldwide. OnCommand replaced its low-speed private-line network with a
Concentric Enterprise Virtual Private Network ("EVPN") that links its 12
regional offices with the San Jose, California headquarters. The EVPN allows
OnCommand to provide faster service to hotels, enabling agents to have instant
access to technical data, database information, contracts and customer
inquiries.
THE CONCENTRIC NETWORK
The Concentric network employs an advanced, geographically dispersed ATM and
frame relay backbone, 16 SuperPOPs in many major metropolitan areas plus a
total of 139 secondary and tertiary POPs in other cities, allowing local dial-
up access to the network to users in the U.S. and Canada. In addition, the
Company can provide analog dial-up, frame relay, fractional T-1, T-1 and DS3
access to the network. The Concentric network supports 28.8 Kbps (V.34) modems
and Concentric currently plans to deploy 56 Kbps modem access in the first
quarter of 1998. This planned deployment is a forward looking statement and is
subject to a number of risks and uncertainties and the actual results could
differ materially as a result of a number of factors including those set forth
under the caption "Factors Affecting Operating Results--Dependence on New an
Enhanced Services" and "--Dependence on Network Infrastructure."
The Concentric network is managed via a centralized network control center
in St. Louis, Missouri. Two data centers (located in Bay City, Michigan and
Cupertino, California) house the servers that support logon/authentication,
billing, e-mail, Internet access, Web services and other network services. In
February 1998, the Company acquired InterNex Information Services, Inc.
("InterNex"), a provider of network services, colocation services and Web-
hosting facilities to enterprise customers. With the acquisition of InterNex,
the Company has expanded its Internet connectivity strategy to include not
only private transit with MCI, Sprint and UUNet, but also private peering with
other network providers as well as public peering with multiple smaller
internet service providers. The Company's new hybrid private/public Internet
connectivity strategy is designed to allow Concentric to offer superior
Internet connectivity performance by avoiding congestion (packet loss) when
connecting to certain network providers at many public peering points. In
connection with the InterNex transaction, the Company acquired new data
centers in Santa Clara, California, San Francisco, California, Los Angeles,
California, Chicago, Illinois and Washington, D.C., and new hosting facilities
in Stockholm, Sweden, Tokyo, Japan and Hong Kong. See "Factors Affecting
Operating Results--Risks Associated With Acquisitions" and "--Dependence on
Network Infrastructure."
The Concentric SuperPOPs are designed to support both dial-up and dedicated
access services within a broad geographic region. Typically, a SuperPOP will
utilize one or more CLECs and LECs to aggregate dial traffic within a 50-200
mile radius of the SuperPOP and terminate it at the SuperPOP. This strategy
allows Concentric to offer users local call coverage within the SuperPOP
region without having to deploy individual POPs in each local calling area.
All the calls are terminated at the modem equipment at the regional SuperPOP.
This results in broader call coverage, lower costs due to the typically lower
rates from CLECs and economies of scale from larger modem installations, lower
maintenance costs, and easier capacity upgrades since equipment is located in
a single location within a region.
11
<PAGE>
DAFs and DSLs from customer locations in a region are terminated in the
SuperPOP as well. Typically, Fractional T-1, T-1, and T-3 circuits are
terminated directly into SuperPOP router equipment (via CSU/DSUs) or via a
channelized DS3 connected to a competitive access provider. Frame access is
terminated via aggregated LEC Frame Access circuit(s). DSL is terminated via a
multiplexed DS-3 connection to a LEC/CLEC metropolitan area DSL network. Both
dial-up and dedicated traffic is then aggregated by the routers/switches in
the SuperPOP and directed to the Concentric ATM backbone via one or more T-3
ATM links.
Some applications, such as Web browsing and file transfer require high
throughput, but can tolerate moderate and variable latency, while others, such
as mission-critical business applications and voice and video conferencing,
require low/fixed latency. Still others, such as transaction processing may
require high levels of security and are indifferent to latency levels.
Traditional static network access technologies and backbone architectures
cannot cost-effectively manage these varied requirements in a single network.
The Concentric network has been designed to solve this problem by
incorporating software intelligence in both its access and backbone
technologies to adapt the network's connection setup, security and data
transfer properties to the nature of the user's application requirements on a
call-by-call or service-by-service basis.
The Concentric network also offers its customers the security, reliability
and management features that companies require in their own private networks.
Varying layers of security and encryption are supported and tailored to
specific customer requirements. The network design includes a standard
security layer and is compatible with most types of custom security
applications. Further, security is provided at both the edge of the network
and internally based on embedded firewall and encryption techniques. The
Concentric network features colocation of network access and switching
equipment in "hardened" facilities, direct connections to carrier facilities,
a resilient ATM/frame relay backbone, dual data processing centers, and
redundancy within data centers to substantially enhance its uptime
performance.
Network managers, customer service, and technical support staff require near
real-time access to information about the performance and quality of their
networks. In traditional private networks, this information is provided by
network management, trouble reporting/tracking, and management information
systems. Customers usually sacrifice a great deal of control and have access
to less information when using a public network instead of a private network.
It has been difficult for public network providers to provide their major
customers with information regarding network performance that relates to that
customer's usage without either compromising other customers' proprietary
information or compromising the integrity of the network itself. Concentric
has developed a set of non-intrusive software tools and reporting mechanisms,
distributed to enterprise customers to allow a customer's network manager to
monitor network performance and quality and to adequately support inquiries
for help from their users. Web browsers and file transfer tools are used to
provide access to much of this information. In some cases, custom integration
of Concentric's network management and trouble tracking/reporting systems will
be provided to customers.
RELATIONSHIP WITH WILLIAMS COMMUNICATIONS, INC.
Concurrent with the closing of the Company's initial public offering of
common stock in August 1997 (the "IPO"), the Company entered into a strategic
relationship with Williams Communications Group, Inc., a subsidiary of the
Williams Companies, Inc. (together, "Williams"). Williams provides a full
range of enterprise network solutions, communications services and advanced
applications to businesses, including equipment and services for data, voice
and video; international satellite and fiber-optic transmission services;
telemarketing services; and, multipoint video- and audio-conferencing. The
relationship with Williams includes an equity investment in the Company by
Williams of approximately $15.0 million which closed in August 1997, and the
execution of a number of strategic business agreements. In exchange for the
approximately $15.0 million investment by Williams, the Company issued and
sold 1,249,236 shares of common stock to Williams at the initial per share
price of $12.00 in the Company's IPO.
12
<PAGE>
As part of the strategic business relationship, Williams has made available,
and the Company has agreed to purchase from Williams, a total of $21.2 million
in telecommunications equipment and services through the five year period
ending in 2002. At the election of Williams, $2.0 million of the minimum
purchase commitment may be paid by the issuance of Common Stock by the Company
at the then-current fair market value. Additionally, Williams and the Company
have entered into a reseller agreement and an agency agreement through which
Williams is able to sell the Company's products and services for an initial
term of two years. The agreements with Williams provide that, in the event of
a change of control of the Company, Williams will have a right to purchase a
nonexclusive, perpetual license to use, distribute and modify all of the
intellectual property of the Company, including any copyright, patent,
license, trademark or trade secret which the Company has or obtains the right
to transfer. Finally, the parties also agreed to amend and restate the
Employee Services and Staffing Agreement between the Company and CTI, a
wholly-owned subsidiary of Williams, and to amend the Co-location Services
Agreement between the Company and CTI, to among other things, extend the terms
of such agreements to December 31, 2000 and to forego a $1.1 million
acquisition fee to be paid by CTI to the Company as a result of the
acquisition of CTI by Williams in 1996. In exchange for the waiver of the
acquisition fee, Williams agreed to issue $1.1 million in telecommunications
services credits to the Company.
SALES AND MARKETING
The Company focuses on marketing its services to two distinct market
segments: enterprise and consumer. By attracting enterprise customers who use
the network primarily during the daytime, and consumer customers who use the
network primarily at night, the Company is able to more fully utilize its
network infrastructure by having some customers online during the day and the
others, using the same modem pools, online during the evening. The Company has
developed a multi-tiered sales strategy consisting of leveraged third party
distribution channels, inbound and outbound telesales, value-added resellers
and direct sales. As of February 23, 1998, the Company employed 111 persons in
sales and marketing.
Leveraged Third Party Distribution. The Company has positioned itself as a
key network services provider for companies that bundle network access in
their products or services. For example, the Company's network service is
bundled with Intuit's Quicken, TurboTax and Quickbooks products, Microsoft
Office 97 and with WebTV and Sega Saturn Internet access devices.
Additionally, the Company is one of the Internet services providers listed on
the Netscape Navigator and Microsoft Internet Explorer browser registration
servers.
Telesales. The Company uses an inbound telesales group to answer calls from
potential consumers/ subscribers and to sign up customers. Inbound telesales
representatives also proactively upsell premium products and services. The
Company also uses an outbound telesales group to sell DAFs and high-end
hosting products to small and medium-sized businesses. Both the inbound and
outbound telesales groups forward leads to the direct sales force when
appropriate.
Value-Added Resellers. The Company has also begun to establish sales
channels through value-added resellers. These resellers are companies that
sell equipment or other components for full-service network solutions to
medium and large businesses. Value-added resellers such as Racal, which
employs more than 500 direct sales, sales-support and network services people,
are compensated for selling Concentric's enterprise service offerings in
conjunction with their other products. These relationships enable the VARs to
provide more comprehensive solutions to their customers while affording the
Company the benefit of the VAR's large sales force without incurring the costs
of maintaining a large sales force of its own.
Direct Sales Force. For large and complex enterprise solutions and to
acquire, support and retain distribution channel partners, the Company employs
22 direct sales people located in Cupertino and Orange County, California,
Dallas, Texas, Washington, D.C., the New York metropolitan area, Atlanta,
Georgia, Chicago, Illinois and Boston, Massachusetts to provide national
direct sales coverage. The Company's direct sales force is supported by inside
sales/account managers and systems engineers.
13
<PAGE>
Concentric markets its enterprise services to information service ("IS")
professionals. In addition, the Company uses print advertising in targeted
industry publications to build awareness and acquire leads for its VARs and
its direct sales team.
In the consumer market, the Company focuses on direct mail to targeted
audiences; establishment of customer referral programs; and co-marketing such
as packaging literature with MasterCard mailers and Intuit software. In
addition, the Company has implemented on-line programs, such as a Website
"home" where they can learn how to use the service, how to use the Internet,
and how to find information quickly, designed to increase customer retention.
The Company is also implementing programs to sell additional products and
services to its consumer customers. Additionally, the Company is generating
advertising revenue on its growing Website traffic in direct ad banner
placements as well as in shared revenue relationships with content partners
such as Excite, Inc., Lycos, Inc., and Classifieds 2000, Inc.
The Company employs public relations personnel in-house and works with an
outside public relations agency to provide broad coverage in network computer
and vertical industry publications. The Company participates in industry trade
shows based on the size and vertical makeup of the trade show audience. Shows
attended in 1997 include E3 and NetWorld + InterOp. The Company also
participates in trade shows with its strategic marketing partners to promote
the sale of Concentric products and services.
CUSTOMER SUPPORT
Concentric believes that a high level of customer support is critical to
attracting and retaining its enterprise and consumer customers. The Company
maintains a customer support call center at its Saginaw, Michigan facility.
Concentric offers several levels of customer support all of which are
available 24 hours per day, seven days per week. The basic level of customer
support includes support for customers on installing and using their software,
customer communications and customer training. Premier level service programs
guarantee an exceptional performance standard, offer supplemental support
training, and provide monthly reports on operations. Private label support
gives businesses a premier level of support provided by their own customer
service team who answer calls with that customer's company name. Customer
support is provided by e-mail, telephone, Website and online chat. As of
February 23, 1998, the Company employed 163 persons in customer support.
COMPETITION
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. The Company believes
that its ability to compete successfully depends upon a number of factors,
including market presence; the capacity, reliability, low latency and security
of network infrastructure; technical expertise and functionality, performance
and quality of services; customization; ease of access to and navigation of
the Internet; the pricing policies of its competitors; the variety of
services; the timing of introductions of new services by the Company and its
competitors; customer support; the Company's ability to support industry
standards; and industry and general economic trends.
The Company's current and prospective competitors generally may be divided
into the following five groups: (i) telecommunications companies, such as
AT&T, Sprint, Inc., WorldCom, MCI, RBOCs and various cable companies; (ii)
online services providers, such as America Online, CompuServe, Microsoft's
MSN, and Prodigy; (iii) ISPs, such as BBN, which has been acquired by GTE,
NETCOM, which is being acquired by ICG Communications, Inc., PSI Net, and
other national and regional providers; (iv) nonprofit or education Internet
connectivity providers; and (v) Web server farms such as Internet Direct and
Exodus. Many of these competitors have greater market presence, engineering
and marketing capabilities, and financial, technological and personnel
resources than those available to the Company. As a result, they may be able
to develop and expand their communications and network infrastructures more
quickly, adapt more swiftly to new or emerging technologies and changes in
customer requirements, take advantage of acquisition and other opportunities
more readily, and
14
<PAGE>
devote greater resources to the marketing and sale of their products than can
the Company. In addition, various organizations, including certain of those
identified above, have entered into or are forming joint ventures or
consortiums to provide services similar to those of the Company.
The Company believes that new competitors, including large computer
hardware, software, media and other technology and telecommunications
companies will enter the value added network services markets, resulting in
even greater competition for the Company. Certain of such telecommunications
companies and online services providers are currently offering or have
announced plans to offer Internet or online services or to expand their
Internet access services. Certain companies, including America Online, BBN and
PSI, have also obtained or expanded their Internet access products and
services as a result of acquisitions. Such acquisitions may permit the
Company's competitors to devote greater resources to the development and
marketing of new competitive products and services and the marketing of
existing competitive products and services. In addition, the ability of some
of the Company's competitors to bundle other services and products with VPN
and consumer network services could place the Company at a competitive
disadvantage. Certain companies are also exploring the possibility of
providing high-speed data services using alternative delivery methods such as
over the cable television infrastructure, through direct broadcast satellite
technology and by wireless cable.
As a result of increased competition in the industry and vertical and
horizontal integration in the industry, the Company could encounter
significant pricing pressure, which in turn could result in significant
reductions in the average selling price of the Company's services. For
example, certain of the Company's competitors that are telecommunications
companies may be able to provide customers with reduced communications costs
in connection with their Internet access services or private network services,
reducing the overall cost of their solutions and significantly increasing
price pressures on the Company. There can be no assurance that the Company
will be able to offset the effects of any such price reductions with an
increase in the number of its customers, higher revenue from enhanced
services, cost reductions or otherwise. In addition, the Company believes that
the Internet access and online services businesses are likely to encounter
consolidation in the near future, which could result in increased price and
other competition in these industries and, potentially, the virtual private
networks industry. Increased price or other competition could result in
erosion of the Company's market share and could have a material adverse effect
on the Company's business, financial condition and results of operations.
There can be no assurance that the Company will have the financial resources,
technical expertise or marketing and support capabilities to continue to
compete successfully. See "Factors Affecting Operating Results--Competition,"
"--Risks of Growth and Expansion," "--Future Capital Needs; Uncertainty of
Additional Financing" and "Business--Competition."
GOVERNMENT REGULATION
The Federal Communications Commission ("FCC") currently does not regulate
value-added network software or computer equipment related services that
transport data or voice messages over telecommunication facilities. The
Company provides value-added IP-based network services, in part, through data
transmissions over public telephone lines. These transmissions are governed by
regulatory policies establishing charges and terms for wireline
communications. Operators of these types of value-added networks that provide
access to regulated transmission facilities only as part of a data services
package are currently excluded from regulations that apply to
"telecommunications carrier" and as such the Company is not currently subject
to direct regulation by the FCC or any other governmental agency, other than
regulations applicable to businesses generally. However, in the future the
Company could become subject to regulation by the FCC or another regulatory
agency as a provider of basic telecommunications services.
Currently, the FCC is reviewing its regulatory positions and could seek to
impose common carrier regulation on the network transport and communications
facilities aspects of an enhanced or information service package. Further, the
FCC could conclude that the Company's protocol conversions, computer
processing, and interaction with customer-supplied information are
insufficient to afford the Company the benefits of the enhanced or information
service classification, and thereby may seek to regulate some segments of the
Company's activities as basic telecommunications services. While state public
utility commissions generally have declined to regulate
15
<PAGE>
enhanced or information services, some states have continued to regulate
particular aspects of enhanced services in limited circumstances, such as
where they are provided by LECs. Moreover, the public service commissions of
certain states continue to review potential regulation of such services. There
can be no assurance that regulatory authorities of states within which
Concentric makes its Internet access, Intranet and VPN services available will
not seek to regulate aspects of these activities as telecommunications
services. Changes in the regulatory environment relating to the Internet
connectivity market, including regulatory changes that directly or indirectly
affect telecommunications costs or increase the likelihood or scope of
competition from the RBOCs or other telecommunications companies, could affect
the prices at which the Company may sell its services. The Company cannot
predict the impact, if any, that future regulation or regulatory changes may
have on its business and there can be no assurance that such future regulation
or regulatory changes will not have a material adverse effect on the Company's
business, results of operations and financial condition.
PROPRIETARY RIGHTS
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The Company
principally relies upon a combination of copyright, trademark and trade secret
laws and contractual restrictions to protect its proprietary technology. It
may be possible for a third party to copy or otherwise obtain and use the
Company's products or technology without authorization or to develop similar
technology independently, and there can be no assurance that such measures
have been, or will be, adequate to protect the Company's proprietary
technology or that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technology. The Company operates a material portion of its business over the
Internet, which is subject to a variety of risks. Such risks include but are
not limited to the substantial uncertainties that exist regarding the system
for assigning domain names and the status of private rules for resolution of
disputes regarding rights to domain names. There can be no assurance that the
Company will continue to be able to employ its current domain names in the
future or that the loss of rights to one or more domain names will not have a
material adverse effect on the Company's business and results of operations.
Although the Company does not believe that it infringes the proprietary
rights of any third parties, there can be no assurance that third parties will
not assert such claims against the Company in the future or that such claims
will not be successful. In addition, participants in the Company's industry
also rely upon trade secret law. The Company could incur substantial costs and
diversion of management resources with respect to the defense of any claims
relating to proprietary rights which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Furthermore, parties making such claims could secure a judgment awarding
substantial damages, as well as injunctive or other equitable relief which
could effectively block the Company's ability to license its products in the
United States or abroad. Such a judgment would have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, the Company is obligated under certain agreements to indemnify the
other party in connection with infringement by the Company of the proprietary
rights of third parties. In the event a claim relating to proprietary
technology or information is asserted against the Company, the Company may
seek licenses to such intellectual property. There can be no assurance,
however, that licenses could be obtained on commercially reasonable terms, if
at all, or that the terms of any offered licenses will be acceptable to the
Company. The failure to obtain the necessary licenses or other rights could
have a material adverse effect on the Company's business, financial condition
and results of operations.
EMPLOYEES
As of February 23, 1998, Concentric had 387 employees and 75 independent
contractors, including 111 persons in sales and marketing, 142 persons in
network operations and development, 163 in customer support and 46 in finance
and administrative functions. The Company believes that its future success
will depend in part on its continued ability to attract, hire and retain
qualified personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to identify, attract, and retain
such personnel in the future. None of the Company's employees is represented
by a labor union, and management believes its employee relations are good.
16
<PAGE>
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
EXECUTIVE OFFICERS, DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth certain information as of February 23, 1998,
with respect to the executive officers and directors of the Company, as well
as certain members of its senior management.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- ---------------------------------------------------------
<S> <C> <C>
Henry R. Nothhaft....... 53 Chairman, President, Chief Executive Officer and Director
John K. Peters.......... 50 Executive Vice President and General Manager, Network
Services Division
Michael F. Anthofer..... 45 Senior Vice President and Chief Financial Officer
Mark W. Fisher.......... 37 Vice President of Corporate Marketing
William C. Etheredge.... 51 Senior Vice President of Sales
Eileen A. Curtis........ 49 Vice President of Customer Relations
George D. Carr.......... 53 Vice President of Field Sales
James L. Isaacs......... 37 Vice President of Business Development
Warren A. Smith......... 47 Vice President of Software Engineering
Scott G. Eagle.......... 39 Vice President of Consumer Marketing
Donald C. Schutt........ 52 Vice President of International Services
Louis P. Bender, 50 Director
III(1).................
Vinod Khosla(2)......... 43 Director
Gordon Martin........... 37 Director
Franco Regis(1)......... 41 Director
Gary E. Rieschel(2)..... 41 Director
</TABLE>
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Henry R. Nothhaft joined the Company as President and Chief Executive
Officer in May 1995 and became a Director of the Company in August 1995 and
Chairman in February 1998. From 1989 to August 1994, Mr. Nothhaft was
President, Chief Executive Officer and a Director of David Systems, Inc.
("David Systems"), a networking company. From 1983 to 1989, Mr. Nothhaft held
various positions with DSC Communications Corporation ("DSC"), including
Senior Vice President of Marketing, President of the Digital Switch
Corporation subsidiary, President of the Business Network Systems Group and a
Corporate Director of DSC. From 1979 to 1983, Mr. Nothhaft was Vice President
of Domestic Marketing and Vice President of Sales for GTE Telenet
Communications Corporation (now Sprint). Mr. Nothhaft has an M.B.A. in
Information Systems Technology from George Washington University and a B.S.
degree from the U.S. Naval Academy.
John K. Peters joined the Company in May 1995 as an independent consultant.
Mr. Peters was named Executive Vice President and General Manager, Network
Services Division of the Company in June 1995. From 1993 to August 1995, Mr.
Peters served as President of Venture Development Consulting, a consulting
firm specializing in new communications, information services and software
businesses. From 1988 to 1993, Mr. Peters was Vice President and Chief
Operating Officer of Pacific Bell Information Services, Inc. Prior to that,
Mr. Peters spent three years as Vice President of Application Services for
Telestream Corporation. In 1981, Mr. Peters co-founded Integrated Office
Systems, Inc., a communications and information systems company. From 1976 to
1980, Mr. Peters was Vice President of Advanced Network Services for GTE
Telenet Communications Corporation. Mr. Peters has an M.B.A. from Stanford
Graduate School of Business and a B.S. degree in Statistics from Stanford
University.
Michael F. Anthofer joined the Company in January 1996 as Vice President and
Chief Financial Officer and became a Senior Vice President in November 1996.
From January 1991 to December 1995, Mr. Anthofer
17
<PAGE>
served as an Executive Vice President and Chief Financial Officer of Shared
Resource Exchange, Inc., a privately held digital switching platform and PBX
supplier. Prior to 1991, Mr. Anthofer held various executive positions,
including Vice President, Corporate Business Planning, Vice President,
Business Network Group and Vice President, Network Products Group, at DSC. Mr.
Anthofer has an M.B.A. and a B.S. degree from the University of California,
Berkeley.
Mark W. Fisher joined the Company in June 1997 as Vice President of
Corporate Marketing. From July 1996 to June 1997, Mr. Fisher was General
Manager and Vice President, Marketing of Pacific Bell Internet Services, a
wholly owned subsidiary of Pacific Bell. From June 1995 to August 1996, Mr.
Fisher was Vice President, Marketing of Pacific Bell Internet Services. From
1989 to May 1995, Mr. Fisher held various data product marketing and data
center operations positions at Pacific Bell. Mr. Fisher has an M.B.A. from the
University of California at Berkeley and a B.S. in mechanical engineering from
the U.S. Naval Academy.
William C. Etheredge joined the Company in March 1997 as the Senior Vice
President of Sales. From May 1991 to March 1997, Mr. Etheredge served first as
Vice President of Sales and Marketing and then as Vice President of Sales for
Meridian Data, Inc., a provider of networked CD-ROM database creation and
retrieval software and network servers. From July 1990 to May 1991, he served
as Vice President of Strategic Accounts for Maxtor Corporation. From June 1985
to June 1990, he served first as Vice President US Sales and Marketing and
then Vice President Western Region for Memorex-Telex Corporation. Mr.
Etheredge has an M.B.A. degree from Bowling Green University and a B.A. degree
from Westminster College.
Eileen A. Curtis joined the Company in November 1994 as an independent
consultant. She became Customer Relations Manager in January 1995, Director of
Customer Relations in September 1995 and Vice President, Customer Relations in
November 1996. From August 1987 to July 1993, Ms. Curtis was employed by Cox
Communications Saginaw, Inc. and served in various positions including
Marketing and Public Relations Manager, Administrative Manager and Customer
Service Manager. Ms. Curtis has a B.S. degree from Central Michigan
University.
George D. Carr joined the Company in June 1995 as an independent consultant.
In September 1995 Mr. Carr became Vice President of Sales. From June 1993 to
June 1995, Mr. Carr was Vice President of Sales and Marketing of David
Systems/ChipCom. From June 1989 to June 1993, Mr. Carr was VP of Operations
and International Sales of David Systems. From December 1983 to June 1989, Mr.
Carr was VP of Operations and Service of David Systems. Mr. Carr has a B.A.
degree from Loyola Marymount.
James L. Isaacs joined the Company in October 1995 as the Director of
Product Management. In March 1997, he became Vice President of Product
Management and in November 1997 he was appointed Vice President of Business
Development. From July 1988 to October 1995, Mr. Isaacs held various positions
at Apple Computer, including Group Manager Product Marketing, Apple On Line
Services Division and Business Development Manager of Apple On Line Services
Division. Mr. Isaacs has an M.B.A. degree from the University of California,
Berkeley and an A.B. degree from Stanford University.
Warren A. Smith joined the Company in April 1996 as Vice President, Software
Engineering. From October 1992 to April 1996, Mr. Smith was the Director of
Engineering at NetManage, Inc., a software company. From July 1987 to July
1992, Mr. Smith was the Director of Distributed Computing Technology for Sun
Microsystems, Inc. From March 1983 to July 1987, Mr. Smith was the Western
Regional Manager of SEI Information Technology an engineering consulting firm.
Mr. Smith has a B.S. degree from California State University, Sacramento.
Scott G. Eagle joined the Company in March 1996 as Vice President of
Consumer Marketing. From November 1993 to February 1996, Mr. Eagle was the
Vice President, Strategic Marketing Development for MFS Intelenet, Inc., a
start-up division of MFS Communications Company, Inc. From February 1989 to
November 1993, Mr. Eagle was the Vice President of Marketing for the
Woodbridge Group, a marketer of consumer
18
<PAGE>
package goods. Prior to February 1989, Mr. Eagle served in various marketing
management positions with The Procter & Gamble Company. Mr. Eagle has a B.S.
degree from the University of Pennsylvania, Wharton School of Business.
Donald C. Schutt joined the Company in February 1994 as Vice President of
Sales and Marketing and was appointed Chief Operations Officer later that
year. Mr. Schutt was named Vice President and General Manager, Bay City
Operations in August 1995. His title was changed to Vice President of Michigan
Operations in March 1996 and to Vice President of International Services in
November 1997. From 1964 to 1985, Mr. Schutt held various management positions
with General Motors, after which Mr. Schutt served until 1989 as Vice
President for Sales and Marketing for Gentex Corporation. From 1989 to 1993,
Mr. Schutt was President and Chief Executive Officer of AMPM, Inc., a full-
service advertising agency, and retains a 54 percent interest in such entity.
Mr. Schutt has a B.S. degree in Marketing from Ferris University.
Louis P. Bender, III has been a Director of the Company since June, 1997.
Since November 1996 he has been President, Americas Region of Racal Data
Group. Prior to such time, Mr. Bender served as Vice President, Business
Development at Bull Electronics, a business unit of Group Bull in Angers,
France. Prior to Bull Electronics, Mr. Bender held the position of Vice
President, Worldwide Sales at AVEX Electronics. Mr. Bender has bachelor's
degrees in Electrical Engineering and Business Administration from the State
University of New York and Monroe College, respectively.
Vinod Khosla has been a Director of the Company since April 1995. Mr. Khosla
has been a General Partner with the venture capital firm of Kleiner Perkins
Caufield & Byers from February 1986 to the present. Mr. Khosla was a co-
founder of Daisy Systems and the founding Chief Executive Officer of Sun
Microsystems, Inc. Mr. Khosla also serves on the boards of Excite, Inc. and
Spectrum Holobyte. He has a B.S.E. from the Indian Institute of Technology in
New Delhi, an M.S.E. from Carnegie Mellon University, and an M.B.A. from the
Stanford Graduate School of Business.
Gordon Martin has been a director of the Company since October 1997. Mr.
Martin is vice president of strategic marketing for Williams Communications
Group, Inc., a subsidiary of the Williams Companies, Inc. Mr. Martin joined
Williams Communications Group, Inc. in October 1987 as manager of
interexchange carrier sales for the network division. He was promoted to
director of product marketing in January 1993. From February 1995 to May 1995,
he served as General Manager of Digital Frontiers LLC, a division of Williams.
In June 1995, he returned to Williams as Vice President, Marketing until he
was promoted to his current position in January 1997. Mr. Martin has a
bachelor's degree in accounting and an M.B.A. from Oral Roberts University.
Franco Regis has been a Director of the Company since October 1996. Since
1994, Mr. Regis has been a Director of Business Development and Strategic
Planning at Telecom Italia, SpA, the telephone operating company of Italy.
From 1992 to 1994, Mr. Regis was a Director of Budget and Control for the
business division of Telecom Italia. Mr. Regis has an engineering degree from
the Rome State University.
Gary E. Rieschel has been a Director of the Company since October 1996. Mr.
Rieschel is a Senior Vice President at SOFTBANK Holdings, having joined that
company in January 1996. Mr. Rieschel was Vice President for N-Cube
Corporation from August 1994 through December 1995. He was Sales Director at
Cisco Systems, Inc. from July 1993 through October 1994. Prior to this, Mr.
Rieschel was a General Manager and Sales Director at Sequent Computer for over
nine years. Mr. Rieschel has an M.B.A. from Harvard Graduate School of
Business and a B.A. in biology from Reed College.
Classified Board of Directors
The Company's Certificate of Incorporation provides that, so long as the
Board of Directors consists of more than two directors, the Board of Directors
will be divided into three classes of directors serving staggered three-year
terms. As a result, one-third of the Company's Board of Directors will be
elected each year.
19
<PAGE>
Director Compensation
Directors are reimbursed for certain reasonable expenses incurred in
attending Board or committee meetings. Officers of the Company are elected
annually by the Board of Directors and serve at its discretion. The Company
has entered into indemnification agreements with each member of the Board of
Directors and certain of its officers providing for the indemnification of
such person to the fullest extent authorized, permitted or allowed by law.
Compensation Committee
The Company's Board of Directors currently has a Compensation Committee that
reviews and approves the compensation and benefits to be provided to the
officers, directors, employees, and consultants of the Company, administers
the Company's 1993 Incentive Stock Option Plan, 1995 Stock Incentive Plan for
Employees and Consultants, and Amended and Restated 1996 Stock Plan, and the
1997 Stock Plan and 1997 Employee Stock Purchase Plan. The Compensation
Committee currently consists of Messrs. Khosla and Rieschel.
Audit Committee
The Company's Board of Directors currently has an Audit Committee that
monitors the corporate financial reporting and the external audits of the
Company, reviews and approves material accounting policy changes, monitors
internal accounting controls, recommends engagement of independent auditors,
reviews related-party transactions and performs other duties as prescribed by
the Board of Directors. The Audit Committee currently consists of Messrs.
Bender and Regis.
Item 2. Properties
The Company's executive offices are located in Cupertino, California, under
a lease that expires in April 1998. The Company is currently negotiating for
an extension of the lease. The Company also leases network operations
facilities in Bay City, Michigan and Santa Clara, California under leases
expiring in December 1998 and May 2000, respectively, and a customer support
facility in Saginaw, Michigan under a lease that expires in December 2001.
Item 3. Legal Proceedings
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana Corporation ("Diana"), the parent corporation of
Sattel Communications, LLC ("Sattel"), alleging securities fraud related to
plaintiffs' purchase of shares of Diana Common Stock in reliance upon
allegedly misleading statements made by defendants, Diana, Sattel and certain
of their respective affiliates, officers and directors. Concentric was named
as a defendant in the complaint in connection with certain statements made by
Diana and officers of Diana related to Concentric's purchase of network
switching equipment from Diana's Sattel subsidiary. The plaintiffs seek
unspecified compensatory damages. A trial date has not yet been determined.
While the ultimate outcome of such litigation is uncertain, the Company
believes it has meritorious defenses to the claims and intends to conduct a
vigorous defense. An unfavorable outcome in this matter could have a material
adverse effect on the Company's financial condition. In addition, even if the
ultimate outcome is resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either of which could have a material adverse effect on the
Company's results of operations. See "Factors Affecting Operating Results--
Legal Proceedings" and Note 11 of Notes to Financial Statements.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
20
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "CNCX." The following table sets forth the range of the high and low
sale prices by quarter as reported on the Nasdaq National Market since August
1, 1997, the date the Common Stock commenced trading.
<TABLE>
<CAPTION>
QUARTER HIGH LOW
------- ---- ---
<S> <C> <C>
1997: Third Quarter (from August 1, 1997).................. 15 5/8 11 3/8
Fourth Quarter........................................... 15 7 7/8
1998: First Quarter (through February 23, 1998)............ 15 1/2 8 7/8
</TABLE>
As of February 23, 1998, the number of common stockholders of record was
435. The Company currently intends to retain any earnings for use in its
business and does not anticipate paying any cash dividends in the foreseeable
future.
The Company commenced its IPO on August 1, 1997 pursuant to a Registration
Statement on Form S-1 (File No. 333-23241) which was declared effective by the
Securities and Exchange Commission on July 31, 1997. The Company sold an
aggregate of 4,945,000 shares of Common Stock in the IPO at an initial price
to the public of $12.00 per share. The IPO has terminated and all shares have
been sold. The managing underwriters of the IPO were UBS Securities LLC,
Unterberg Harris and Wheat First Butcher Singer. Aggregate proceeds from the
IPO were $59,340,000, which includes $7,740,000 in aggregate proceeds due to
the exercise of the underwriters' option to purchase shares to cover over-
allotments.
The Company paid underwriters' discounts and commissions of $4,153,800 and
other expenses of approximately $1,100,000 in connection with the IPO. The
total expenses paid by the Company in the IPO were $5,253,800, and the net
proceeds to the Company in the IPO were $54,086,200.
From July 31, 1997, the effective date of the Registration Statement, to
December 31, 1997, the ending date of the reporting period, the approximate
amount of net offering proceeds used were $20.2 million for the purchase of
equipment, network services and related operational expenses, $1.2 million for
capital expenditures associated with expanding the Company's network and data
center operations, $8.8 million to pay certain capital lease obligations, $3.5
million to pay license fees to certain strategic partners, $2.0 million to
repay promissory notes issued to certain stockholders of the Company, $4.4
million to settle the Sattel litigation and $2.8 million to repurchase common
stock from certain stockholders of the Company. See "Management Discussion and
Analysis of Financial Condition and Results of Operations."
21
<PAGE>
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the
Financial Statements and Notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
herein.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue........................ $ 23 $ 442 $ 2,483 $ 15,648 $ 45,457
Costs and operating expenses:
Cost of revenue.............. 130 2,891 16,168 47,945 61,439
Network equipment write-
off(1)...................... -- -- -- 8,321 --
Development.................. 349 534 837 2,449 4,850
Marketing and sales.......... 131 639 3,899 16,609 24,622
General and administrative... 634 611 2,866 3,445 4,790
------- ------- -------- -------- --------
Total costs and operating
expenses.................. 1,244 4,675 23,770 78,769 95,701
------- ------- -------- -------- --------
Loss from operations........... (1,221) (4,233) (21,287) (63,121) (50,244)
Other income................... -- -- -- -- 1,233
Net interest expense........... (24) (57) (721) (3,260) (6,571)
Net loss....................... $(1,245) $(4,290) $(22,008) $(66,381) $(55,582)
======= ======= ======== ======== ========
Net loss per share............. $ (0.93) $ (3.20) $ (16.53) $ (47.72) $ (8.34)
======= ======= ======== ======== ========
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and re-
stricted cash................. $ 55 $ 63 $ 19,054 $ 17,657 $119,959
Property and equipment, net.... 675 1,303 16,289 47,927 53,710
Total assets................... 783 1,798 37,235 70,722 244,489
Long-term debt, convertible
debentures and capital lease
obligations, net of current
portion....................... 1,251 1,648 11,047 30,551 179,172
Common stock subject to
rescission.................... -- 2,812 5,080 5,150 --
Total stockholders' equity
(deficit)..................... (1,172) (4,203) 9,763 2,925 31,918
</TABLE>
- --------
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 2 of Notes to Financial Statements.
22
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the subsection entitled "Factors Affecting
Operating Results" commencing on page 29. The following discussion of the
financial condition and results of operations of the Company should be read in
conjunction with the Financial Statements and the Notes thereto included
elsewhere in this Report.
OVERVIEW
The Company was founded in 1991. From 1991 to mid-1993, the Company
conducted development and network services planning activities and realized no
revenues. Initially, the Company was focused on providing consumers with
direct dial-up connectivity to bulletin board services. On-line gaming and
entertainment services for consumers were commenced in July 1993 through the
utilization of a third party network infrastructure. The Company commenced
operation of its own network in late 1994. In May 1995, new management led by
Henry R. Nothhaft redefined and broadened the Company's strategy to provide a
range of Internet and tailored, value-added Internet Protocol-based network
services to consumers and businesses.
The Company's revenue prior to 1996 has been primarily generated from
providing Internet access to consumers. The Company's current focus is on
developing and deploying VPN's and providing dedicated access and Web hosting
services for enterprise customers. Contracts with enterprise customers
typically have a term ranging from one to three years. The Company expects
enterprise-related revenue to represent an increasing portion of total revenue
in future periods. The foregoing expectation is a forward-looking statement
that involves risks and uncertainties, and actual results could vary as a
result of a number of factors including the Company's operating results, the
results and timing of the Company's launch of new products and services,
governmental or regulatory changes, the ability of the Company to meet product
and project demands, the success of the Company's marketing efforts,
competition and acquisitions of complementary businesses, technologies or
products.
In February 1998, the company acquired InterNex Information Services, Inc.,
a California corporation ("InterNex") pursuant to a Share Acquisition
Agreement between the Company, InterNex and the sole shareholder of InterNex
(the "InterNex Acquisition"). See "--Liquidity and Capital Resources" and
"Factors Affecting Operating Results--Risks Associated with Acquisitions."
The Company has incurred net losses and experienced negative cash flow from
operations since inception and expects to continue to operate at a net loss
and experience negative cash flow at least through 1998. The Company's ability
to achieve profitability and positive cash flow from operations is dependent
upon the Company's ability to substantially grow its revenue base and achieve
other operating efficiencies. The Company experienced net losses of
approximately $22.0 million, $66.4 million and $55.6 million for the years
ended December 31, 1995, 1996 and 1997, respectively. There can be no
assurance that the Company will be able to achieve or sustain revenue growth,
profitability or positive cash flow on either a quarterly or an annual basis.
At December 31, 1997, the Company had approximately $58.0 million of gross
deferred tax assets comprised primarily of net operating loss carryforwards.
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax assets such that a full valuation allowance has been
recorded. These factors include the Company's history of net losses since its
inception and the fact that the market in which the Company competes is
intensely competitive and characterized by rapidly changing technology. The
Company believes that, based on the current available evidence, it is more
likely than not that the Company will not generate taxable income through
1999, and possibly beyond, and accordingly will not realize the Company's
deferred tax assets through 1999, and possibly beyond. The Company will
continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar
23
<PAGE>
state provisions. The annual limitation may result in the expiration of net
operating losses before utilization. See Note 9 of Notes to Financial
Statements.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996.
Revenue. Revenue for the year ended December 31, 1997 totaled approximately
$45.5 million, an increase of $29.9 million over revenue of $15.6 million for
the year ended December 31, 1996. This increased revenue reflects growth in
revenue from the Company's broadened product offerings to its enterprise
customers and through the Company's leveraged marketing arrangements with its
strategic partners, as well as continued growth in revenue derived from
Internet access customers. WebTV accounted for approximately 33.4% of total
revenue for the year ended December 31, 1997. The Company expects revenue from
WebTV to decrease as a percentage of revenue. The foregoing expectation is a
forward looking statement that involves risks and uncertainties and the actual
results could vary materially as a result of a number of factors including
those set forth under the caption "Factors Affecting Operating Results--
Customer Concentration."
Cost of Revenue. Cost of revenue consists primarily of personnel costs to
maintain and operate the Company's network, access charges from local exchange
carriers, backbone and Internet access costs, depreciation of network
equipment and amortization of related assets. Cost of revenue for the year
ended December 31, 1997 totaled approximately $61.4 million compared with
$47.9 million for the year ended December 31, 1996. This increase is
attributable to the overall growth in the size of the network. As a percentage
of revenue, costs declined to 135.2% of revenue in the year ended December 31,
1997 from 306.4% of revenue in the year earlier period due to increased
network utilization associated with the Company's revenue growth and lower per
port costs of the Company's SuperPOP network architecture deployed in the
second half of 1996. The Company expects its cost of revenue to continue to
increase in dollar amount, while declining as a percentage of revenue as the
Company expands its customer base. The foregoing expectation is a forward
looking statement that involves risks and uncertainties and the actual results
could vary materially as a result of a number of factors, including those set
forth under the caption "Factors Affecting Operating Results--Limited
Operating History; Continuing Operating Losses," "--Management of Potential
Growth and Expansion" and "--Dependence Upon Key Personnel; Ability to Hire
Additional Personnel" and "--Dependence Upon New and Uncertain Markets."
Development. Development expense consists primarily of personnel and
equipment related expenses associated with the development of products and
services of the Company. Development expense for the year ending December 31,
1997 and 1996 was approximately $4.9 million and $2.4 million, respectively.
This higher level of development expense reflects an overall increase in
personnel to develop new product offerings and to manage the overall growth in
the network. As a percent of revenue, development expense declined to 10.7%
for the year ended December 31, 1997 from 15.7% for the year ended December
31, 1996, as a result of the Company's increased revenue. The Company expects
its development spending to continue to increase in dollar amount, but to
decline as a percentage of revenue. The foregoing expectation is a forward
looking statement that involves risks and uncertainties and the actual results
could vary materially as a result of a number of factors, including those set
forth under the caption "Factors Affecting Operating Results--Limited
Operating History; Continuing Operating Losses" and "--Dependence Upon New and
Enhanced Services."
Marketing and Sales. Marketing and sales expense consists primarily of
personnel expenses, including salary and commissions, costs of marketing
programs and the cost of 800 number circuits utilized by the Company for
customer support functions. For the year ended December 31, 1997 and 1996,
marketing and sales expense was approximately $24.6 million and $16.6 million,
respectively. The $8.0 million increase in 1997 reflects a substantial
investment in the customer support, marketing and sales organizations
necessary to support the Company's expanded customer base. This increase also
reflects a growth in subscriber acquisition costs, related to both increased
direct marketing efforts as well as commissions paid to distribution partners.
24
<PAGE>
Additionally, the increase reflects the ramp-up of marketing efforts related
to the introduction of enterprise products and services. Marketing and sales
expense as a percentage of revenue declined to 54.2% for the year ended
December 31, 1997 from 106.1% in the year earlier period as a result of the
Company's increased revenue. The Company expects marketing and sales
expenditures to continue to increase in dollar amount, but to decline as a
percentage of revenue. The foregoing expectation is a forward looking
statement that involves risks and uncertainties and the actual results could
vary materially as a result of a number of factors including those set forth
under "Factors Affecting Operating Results--Dependence Upon New and Uncertain
Markets," "--Management of Potential Growth and Expansion" and "--Dependence
Upon Key Personnel; Ability to Hire Additional Personnel."
General and Administrative. General and administrative expense consists
primarily of personnel expense and professional fees. For the year ended
December 31, 1997 and 1996, general and administrative expenses were
approximately $4.8 million and $3.4 million, respectively. This higher level
of expense reflects an increase in personnel and professional fees necessary
to manage the financial, legal and administrative aspects of the business. For
the year ended December 31, 1997, general and administrative expense declined
to 10.5% from 22.0% for the year ended December 31, 1996 as a result of the
Company's increased revenue. The Company expects general and administrative
expense to increase in dollar amount, reflecting its growth in operations and
costs associated with being a publicly held entity, but to decline as a
percentage of revenue. The foregoing expectation is a forward looking
statement that involves risks and uncertainties and the actual results could
vary materially as a result of a number of factors including those set forth
under "Factors Affecting Operating Results--Dependence Upon New and Uncertain
Markets," "--Management of Potential Growth and Expansion" and "--Dependence
Upon Key Personnel; Ability to Hire Additional Personnel." The Company
believes that InterNex had significant goodwill and intangible assets at the
time of the acquisition and as a result, the InterNex Acquisition will result
in significant amortization of goodwill charges to the Company beginning in
the first quarter of 1998. See "Factors Affecting Operating Results--Risks
Associated with Acquisitions."
Net Interest Expense. Net interest expense was approximately $6.6 million
and $3.3 million for the years ended December 31, 1997 and 1996, respectively.
The increase is primarily due to a cost of financing charge of $930,000 in the
year ended December 31, 1997 associated with the value of warrants issued in
connection with $5.0 million of bridge loans received in June 1997, and
$744,000 associated with the Units Offering (as defined below). Additionally,
the principal amount of capitalized lease obligations increased $7.0 million
from December 31, 1996 to December 31, 1997. The year ended December 31, 1996
included approximately $330,000 associated with the value of warrants issued
in connection with bridge loan financing.
Other (Income) Expense. During the year ended December 31, 1997, upon
settlement of the Sattel litigation, the Company recorded $970,000 of other
income related to the reversal of previously established reserves.
Additionally, the Company recorded $425,000 of other income related to the re-
negotiation of a third party services agreement.
Net Loss. For the year ended December 31, 1997 the net loss totaled $55.6
million as compared to $66.4 million for the year ended December 31, 1996.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenue. Revenue totaled approximately $15.6 million for the year ended
December 31, 1996, an increase of $13.1 million over 1995 revenue of
approximately $2.5 million. This increase reflects continued growth in revenue
derived from Internet access customers, as well as revenue from the Company's
broadened enterprise product offerings and through the Company's leveraged
marketing arrangements with its strategic partners. The average selling prices
of the Company's offerings for consumer Internet access services decreased by
approximately 33% beginning in April 1996 due to industry-wide adoption of
flat monthly rates for unlimited Internet access.
25
<PAGE>
Cost of Revenue. Cost of revenue for the year ended December 31, 1996 was
approximately $47.9 million, an increase of $31.7 million from 1995 cost of
revenue of approximately $16.2 million. The largest component of this increase
was the cost of providing virtual local access ("VLA") service over 800
circuits. VLA service was an interim solution for providing nationwide
coverage, while the Company's SuperPOP network architecture was being
deployed. This deployment was substantially completed in December 1996. The
remainder of the increase in 1996 cost of revenue is primarily attributable to
the overall growth in the size of the network.
Network Equipment Write-off. In 1996, the Company took a charge of
approximately $8.3 million related to the cost of certain network equipment.
The Company decided not to deploy the equipment in the network because of
concerns that the equipment would not provide the functionality and
reliability required by the Company and concerns that the equipment provider
would be unable to provide timely maintenance and support. See Note 2 of Notes
to Financial Statements.
Development. Development expense for the year ended December 31, 1996 was
approximately $2.4 million, an increase of $1.6 million over 1995 expenditures
of approximately $837,000. This higher level of development expense in 1996
primarily reflects an overall increase in personnel to develop new product
offerings and to manage the overall growth in the network.
Marketing and Sales. Marketing and sales expense for 1996 was approximately
$16.6 million, an increase of $12.7 million over 1995 expenditures of
approximately $3.9 million. This increase in marketing and sales expense
reflects a substantial investment in the customer support, marketing and sales
organizations required to support the Company's expanded customer base. This
increase also reflects a growth in subscriber acquisition costs, related to
both increased direct marketing efforts as well as commissions paid to
distribution partners. Additionally, the increase reflects the ramp-up of
marketing efforts related to the introduction of enterprise products and
services.
General and Administrative. General and administrative expense for 1996 was
approximately $3.4 million, an increase of $500,000 over 1995 expenditures of
approximately $2.9 million. This increase reflects an increase in personnel
and professional fees necessary to manage the financial, legal and
administrative aspects of the business.
Net Interest Expense. Net interest expense for 1996 was approximately $3.3
million as compared to approximately $721,000 for 1995. The increase of $2.6
million is primarily due to an increase of $27.6 million in principal amount
of the capitalized lease obligations from December 31, 1995 to December 31,
1996. This increase in interest expense was partially offset by greater
interest income from higher average cash balances resulting from equity
financings completed in late 1995 and in August 1996. See Note 3 of Notes to
Financial Statements.
Net Loss. The Company's net loss increased to approximately $66.4 million in
1996 from approximately $22.0 million in 1995.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Revenue. Revenue totaled approximately $2.5 million for 1995, an increase of
$2.1 million, over 1994 revenue of approximately $400,000. The Company's
revenue in 1995 reflects its first full year of providing network services.
The Company's revenue in both of these years was derived entirely from the
sale of Internet access services to consumers.
Cost of Revenue. Cost of revenue for 1995 was approximately $16.2 million,
an increase of $13.3 million over 1994 cost of revenue of approximately $2.9
million. The increase in cost of revenue from 1994 to 1995 reflected overall
higher costs associated with deploying and managing the Company's own network
infrastructure. Prior to late 1994, the Company had leased third party network
facilities and thus had not incurred significant network deployment and
maintenance expenses.
26
<PAGE>
Development. Development expense for 1995 was approximately $837,000, an
increase of $303,000 over 1994 expenditures of approximately $534,000. This
higher level of development expense primarily reflected an overall increase in
personnel required to develop new products and support network growth.
Marketing and Sales. Marketing and sales expense for 1995 was approximately
$3.9 million, an increase of $3.3 million over 1994 expenditures of
approximately $639,000. This higher level of spending in 1995 reflected the
Company's new market focus on providing IP-based network services. In
connection with this new focus, the Company incurred increased expenses
related to direct subscriber acquisition, formation of a telesales group,
development of strategic relationships and marketing communications. With the
growth in subscribers, the Company added personnel to its customer support
organization.
General and Administrative. General and administrative expense for 1995 was
$2.9 million, an increase of $2.3 million over 1994 expenditures of
approximately $600,000. This increase generally reflects an increase in
personnel and professional fees necessary to manage the financial, legal and
administrative aspects of the business.
Net Interest Expense. Net interest expense for 1995 was approximately
$721,000 as compared with approximately $57,000 for 1994. This increase in net
interest expense resulted from the Company's deployment of network equipment
for its own network infrastructure beginning in late 1994 which equipment
purchases were primarily financed under capital leases. Capital lease
obligations at December 31, 1995 were $14.2 million, compared with no such
obligations at December 31, 1994.
Net Loss. The Company's net loss increased to approximately $22.0 million in
1995 from a net loss of $4.3 million in 1994.
LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has satisfied its cash requirements primarily through
capitalized lease financings, the sale of capital stock and the sale of the
Units (as defined below). The Company's principal uses of cash are to fund
working capital requirements and capital expenditures and to service its
capital lease financing obligations. Net cash used in operating activities for
the years ended December 31, 1997 and 1996 was approximately $45.9 million and
$42.1 million, respectively. Included in the amount for the year ended
December 31, 1997 is $4.4 million of cash paid in settlement of a dispute with
Sattel. Cash used in operating activities in both periods was primarily
affected by the net losses, caused by increased costs relating to the
expansion of the Company's network and organizational infrastructure.
Net cash used in investing activities for the years ended December 31, 1997
and 1996 was approximately $6.5 million and $7.3 million, respectively.
Investing activities were primarily comprised of $6.1 million in purchases of
capital equipment to support the growing infrastructure.
For the year ended December 31, 1997 net cash of approximately $154.7
million was generated from financing activities, of which $74.0 million, net
of issuance costs, was derived from the issuance of stocks and warrants and
$145.0 million, net of issuance costs, was derived from the issuances of the
Units, net of $52.5 million investment in U.S. Government treasury strips held
as restricted cash in accordance with the terms of the Units (as defined
below). On August 1, 1997, the Company effected its IPO. The IPO consisted of
4,300,000 shares of Common Stock issued to the public at $12.00 per share.
Concurrent with the closing of the IPO, certain strategic investors purchased
directly from the Company 1,499,236 shares of Common Stock having an aggregate
purchase price of approximately $18 million (including the cancellation of
approximately $3 million in indebtedness) (the "Direct Placements"). In
September the underwriters exercised an option to purchase an additional
645,000 shares of Common Stock at the IPO price of $12.00 per share to cover
over-allotments in connection with the IPO.
The Company also received $5.0 million in debt financing in June 1997, of
which $2.0 million was repaid and $3.0 million was converted into Common
Stock, respectively, upon closing of the Company's IPO.
27
<PAGE>
Concurrent with the closing of the IPO, the Company repurchased $2.2 million
of Common Stock from certain stockholders. The remainder of financing
activities for the year ended December 31, 1997 is comprised of $11.6 million
used for repayment of capital lease obligations. For the year ended December
31, 1996 cash of approximately $48.1 million was generated from financing
activities, which reflects receipt of $48.5 million, net of issuance costs,
for Series D Convertible Preferred Stock. Also reflected is a $5.0 million
bridge loan which was later converted into Series D Convertible Preferred
Stock. Repayment of capital lease obligations for the year ended December 31,
1996 was approximately $5.4 million.
In December 1997, the Company completed a $150.0 million debt financing (the
"Units Offering") wherein the Company issued and sold 150,000 units (the
"Units") to certain qualified investors. The Units issued by the Company in
the Units Offering consisted of 12 3/4% Notes due 2007 and warrants to
purchase an aggregate of 951,108 shares of common stock of the Company at
$10.8625 per share. See "Factors Affecting Operating Results--Substantial
Indebtedness; Ability to Service Debt." and Note 4 of Notes to Financial
Statements.
The net cash increase for the year ended December 31, 1997 was $102.3
million as compared to a net cash decrease for the year ended December 31,
1996 of $1.4 million. At December 31, 1997, the Company had cash and cash
equivalents of approximately $120.0 million, restricted cash of $52.5 million
and working capital of $115.4 million.
For the year ended December 31, 1997, the Company added approximately $23.0
million of network equipment through additional capital lease obligations
under its network equipment financing arrangement. The Company expects to make
additional capital expenditures of approximately $20.0 million in 1998. The
foregoing expectation with respect to additional capital investments is a
forward-looking statement that involves risks and uncertainties and the actual
amount of capital investment could vary materially as a result of a number of
factors. See "Factors Affecting Operating Results--Dependence on Network
Infrastructure," "--Risk Associated with International Expansion," and "--
Fluctuations in Operating Results."
The Company paid approximately $15.5 million in cash for all of the
outstanding shares of capital stock of InterNex as part of the InterNex
Acquisition in February 1998. InterNex is a provider of network services,
colocation services and web-hosting facilities to enterprise customers. See
"Factors Affecting Operating Results--Risks Associated with Acquisitions."
The Company expects to incur additional operating losses and will rely
primarily on the net proceeds from the Units Offering, the IPO and the Direct
Placements and financing available under a network equipment lease agreement
that currently has no maximum borrowing limit. The Company believes that such
financing will be sufficient to meet its anticipated cash needs for working
capital and for the acquisition of capital equipment through at least the end
of 1998. However, there can be no assurance that the Company will not require
additional financing within this time frame. The Company's forecast of the
period of time through which its financial resources will be adequate to
support its operations is a forward-looking statement that involves risks and
uncertainties, and actual results could vary materially as a result of a
number of factors, including those set forth below under the caption "Factors
Affecting Operating Results--Future Capital Needs; Uncertainty of Additional
Financing." The Company may be required to raise additional funds through
public or private financing, strategic relationships or other arrangements.
There can be no assurance that such additional funding, if needed, will be
available on terms attractive to the Company, or at all.
IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" ("FAS 128"). FAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously
28
<PAGE>
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been restated to conform to the FAS 128 requirements and the
SEC's SAB 98 related thereto.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" ("FAS 130"), and Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"). The Company is required to adopt these Statements in fiscal 1998. FAS
130 establishes new standards for reporting and displaying comprehensive
income and its components. FAS 131 requires disclosure of certain information
regarding operating segments, products and services, geographic areas of
operation and major customers. Adoption of these Statements is expected to
have no material impact on the Company's financial position, results of
operations or cash flows.
IMPACT OF THE YEAR 2000 ISSUE
Many installed computer systems and software products are coded to accept
only two digit entries in the date code field. Beginning in the year 2000,
these code fields will need to accept four digit entries to distinguish 21st
century dates from 20th century or earlier dates. As a result, in less than
two years, computer systems and/or software products used by many companies
may need to be upgraded to comply with such year 2000 requirements. The
Company believes it is currently expending sufficient resources to review its
products and services, as well as its internal management information systems
in order to identify and modify those products, services and systems that are
not year 2000 compliant. The Company expects such modifications will be made
on a timely basis and does not believe that the cost of such modifications
will have a material effect on the Company's operating results. There can be
no assurance, however, that the Company will be able to modify timely and
successfully such products, services and systems to comply with year 2000
requirements, which could have a material adverse effect on the Company's
operating results. Based on the Company's assessment to date, most newly
introduced products and services of the Company are year 2000 compliant,
however some of the Company's customers are running product versions that are
not year 2000 compliant. The Company has been encouraging such customers to
migrate to current product versions. In addition, the Company faces risks to
the extent that suppliers of products, services and systems purchased by the
Company and others with whom the Company transacts business on a worldwide
basis do not have business systems or products that comply with the year 2000
requirements. In the event any such third parties cannot timely provide the
Company with products, services or systems that meet the year 2000
requirements, the Company's operating results could be materially adversely
affected. Furthermore, there can be no assurance that these or other factors
relating to the year 2000 compliance issues, including litigation, will not
have a material adverse effect on the Company's business, operating results or
financial condition.
FACTORS AFFECTING OPERATING RESULTS
As described by the following factors, past financial performance should not
be considered a reliable indicator of future performance and investors should
not use historical trends to anticipate results or trends in future periods.
Substantial Indebtedness; Ability to Service Debt
The Company is and will continue to be highly leveraged, with significant
debt service requirements. At December 31, 1997, the Company's total debt was
$194.5 million and stockholders' equity was $31.9 million. The degree to which
the Company is leveraged has important consequences to the Company, including
the following: (i) the Company's ability to obtain additional financing in the
future, whether for working capital, capital expenditures, acquisitions or
other purposes, may be impaired; (ii) a substantial portion of the Company's
cash flow from operations is required to be dedicated to the payment of
interest on its debt, thereby reducing funds available to the Company for
other purposes; (iii) the Company's flexibility in planning for or reacting to
changes in market conditions may be limited; and (iv) the Company may be more
vulnerable in the event of a downturn in its business.
29
<PAGE>
The ability of the Company to meet its debt service obligations will depend
on the future operating performance and financial results of the Company,
which will be subject in part to factors beyond the control of the Company.
Although the Company believes that its cash flow will be adequate to meet its
interest payments, there can be no assurance that the Company will continue to
generate sufficient cash flow in the future to meet its debt service
requirements including those with respect to the Units. If the Company is
unable to generate cash flow in the future sufficient to cover its fixed
charges and is unable to borrow sufficient funds from other sources, it may be
required to refinance all or a portion of its existing debt or to sell all or
a portion of its assets. There can be no assurance that a refinancing would be
possible, nor can there be any assurance as to the timing of any asset sales
or the proceeds which the Company could realize therefrom. In addition, the
terms of certain of the Company's debt restrict its ability to sell assets and
the Company's use of the proceeds therefrom.
Limited Operating History; Continuing Operating Losses
The Company was incorporated in 1991, commenced network operations in 1994
and completed initial deployment of its current network architecture and use
of an advanced ATM backbone network in late 1996. Accordingly, the Company has
a limited operating history upon which an evaluation of the Company and its
prospects can be based. In addition, a majority of the Company's senior
management team have been working together at the Company for less than two
years. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in new and
rapidly evolving markets. To address these risks, the Company must, among
other things, respond to competitive developments, continue to attract, retain
and motivate qualified persons, and continue to upgrade its technologies and
commercialize its network services incorporating such technologies. There can
be no assurance that the Company will be successful in addressing such risks
and the failure to do so could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company has
incurred net losses and experienced negative cash flow from operations since
inception and expects to continue to operate at a net loss and experience
negative cash flow at least through 1998, although the Company's ability to
achieve profitability and positive cash flow from operations is dependent upon
the Company's ability to substantially grow its revenue base and achieve other
operating efficiencies. The Company experienced net losses of approximately
$22.0 million, $66.4 million and $55.6 million for the years ended December
31, 1995, 1996 and 1997, respectively. At December 31, 1997, the Company had
an accumulated deficit of approximately $149.5 million. There can be no
assurance that the Company will be able to achieve or sustain revenue growth,
profitability or positive cash flow on either a quarterly or an annual basis.
At December 31, 1997, the Company had approximately $58.0 million of gross
deferred tax assets comprised primarily of net operating loss carryforwards.
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax assets such that a full valuation allowance has been
recorded. These factors include the Company's history of net losses since its
inception and the fact that the market in which the Company competes is
intensely competitive and characterized by rapidly changing technology. The
Company believes that, based on the current available evidence, it is more
likely than not that the Company will not generate taxable income through
1999, and possibly beyond, and accordingly will not realize the Company's
deferred tax assets through 1999 and possibly beyond. The Company will
continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration
of net operating losses before utilization. The Company's above estimates of
the periods of time in which the Company expects to continue to operate at a
net loss, experience negative cash flow and not generate taxable income are
forward-looking statements that involves risks and uncertainties, and actual
results could vary materially as a result of a number of factors, including
those set forth above in this paragraph. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Note 9 of Notes
to Financial Statements.
30
<PAGE>
Fluctuations in Operating Results
The Company's operating results have fluctuated in the past and may in the
future fluctuate significantly depending upon a variety of factors, including
the timely deployment and implementation of expansion of the Concentric
network and new network architectures, the incurrence of related capital
costs, the receipt of new value-added network services and consumer services
subscriptions and the introduction of new services by the Company and its
competitors. Additional factors that may contribute to variability of
operating results include: the pricing and mix of services offered by the
Company; customer retention rate; market acceptance of new and enhanced
versions of the Company's services; changes in pricing policies by the
Company's competitors; the Company's ability to obtain sufficient supplies of
sole- or limited-source components; user demand for network and Internet
access services; balancing of network usage over a 24-hour period; and general
access services. In response to competitive pressures, the Company may take
certain pricing or marketing actions that could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, the Company's expense levels are relatively fixed in the short term
and are based, in part, upon the Company's estimates of growth of its
business. As a result, variations in the timing and amounts of revenues could
have a material adverse effect on the Company's quarterly operating results.
Due to the foregoing factors, the Company believes that period-to-period
comparisons of its operating results are not necessarily meaningful and that
such comparisons cannot be relied upon as indicators of future performance. In
the event that the Company's operating results in any future period fall below
the expectations of securities analysts and investors, the trading price of
the Company's Common Stock would likely be materially and adversely affected.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
Customer Concentration
The Company currently derives a substantial portion of its total revenue
from a single customer. For the years ended December 31, 1996 and 1997,
revenue from WebTV represented approximately 10.1% and 33.4%, respectively, of
the Company's revenue. The Company's current agreement to provide services to
WebTV is terminable at will after October 1, 1999. While the Company expects
revenue from WebTV to decrease as a percentage of revenue in future periods,
the Company believes that revenue derived from a limited number of current and
future customers may continue to represent a significant portion of its
revenue. As a result, the loss of one or more of the Company's major customers
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, there can be no assurance
that revenue from customers that have accounted for significant revenue in
past periods, individually or as a group, will continue, or if continued, will
reach or exceed historical levels in any future period. See Note 1 of Notes to
Financial Statements.
Management of Potential Growth and Expansion
As of December 31, 1995, the Company had 96 employees and 47 independent
contractors, as of December 31, 1996, the Company had 246 employees and 46
independent contractors, and as of February 23, 1998, the Company had 387
employees and 75 independent contractors. The growth and expansion of the
Company's business and its service offerings have placed, and are expected to
continue to place, a significant strain on the Company's management,
operational and financial resources. The Company has recently expanded and
upgraded its network to use an ATM backbone. The Company plans to continue to
substantially expand its network in the future. There can be no assurance that
the Company will be able to add services at the rate or according to the
schedule presently planned by the Company. To manage its growth, the Company
must, among other things, (i) continue to implement and improve its
operational, financial and management information systems, including its
billing, accounts receivable and payable tracking, fixed assets and other
financial management systems; (ii) hire and train additional qualified
personnel; and (iii) continue to expand and upgrade its network
infrastructure. Demands on the Company's network infrastructure and technical
support resources have grown rapidly with the Company's expanding customer
base, and the Company may in the future experience difficulties meeting the
demand for its access services and technical support. There can be no
assurance that the Company's technical support or other resources will be
sufficient to facilitate the Company's growth. As the Company strives to
31
<PAGE>
increase total network utilization and to optimize this utilization by
targeting both business and consumer users to balance the network's usage
throughout a 24-hour period, there will be additional demands on the Company's
customer support, sales and marketing resources. Any failure of the Company to
manage its growth effectively could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risks Associated With Acquisitions
The Company completed the InterNex Acquisition in February 1998 and may seek
to acquire additional assets or businesses complementary to its operations.
The InterNex Acquisition has been and any subsequent acquisitions would be
accompanied by the risks commonly encountered in acquisitions of companies.
Such risks include, among other things, the difficulty of assimilating the
operations and personnel of InterNex or such other acquired companies, the
additional financial resources that may need to be applied to fund the
operations of InterNex or such other acquired companies, the potential
disruption of the Company's business, the inability of the Company's
management to maximize the financial and strategic position of the Company by
the incorporation of acquired technology or business such as the InterNex
network into the Company's service offerings, the difficulty of maintaining
uniform standards, controls, procedures and policies, the potential loss of
key employees of acquired companies, and the impairment of relationships with
employees and customers as a result of changes in management. No assurance can
be given that InterNex will be successfully integrated in the Company's
operations. Likewise, no assurance can be given that any other acquisitions by
the Company will or will not occur, that if an acquisition does occur it will
not materially and adversely affect the Company or that any such acquisition
will be successful in enhancing the Company's business. If the Company
proceeds with additional significant acquisitions in which the consideration
consists of cash, a substantial portion of the Company's available cash could
be used to consummate the acquisitions. If the Company were to consummate one
or more acquisitions in which the consideration consisted of stock,
stockholders of the Company could suffer significant dilution of their
interests in the Company. Many business acquisitions, including the InterNex
acquisition, must be accounted for as a purchase for financial reporting
purposes. Most of the businesses that might become attractive acquisition
candidates for the Company are likely to have significant goodwill and
intangible assets, like InterNex, and acquisition of these businesses, if
accounted for as a purchase, would typically result in substantial
amortization of goodwill charges to the Company. This is the case with the
InterNex Acquisition which will result in significant amortization of goodwill
charges to the Company beginning in the first quarter of 1998. There can be no
assurance that any benefit from an acquisition will be sufficient to offset
any such charges. See "Business--The Concentric Network."
Dependence Upon New and Uncertain Markets
The markets for tailored, value-added network services for businesses and
consumers offered by the Company, including Internet access, are in the early
stages of development. Since these markets are relatively new and because
current and future competitors are likely to introduce competing services or
products, it is difficult to predict the rate at which the market will grow,
if at all, or whether new or increased competition will result in market
saturation. Certain critical issues concerning commercial use of tailored
value-added services and Internet services, including security, reliability,
ease and cost of access and quality of service, remain unresolved and may
impact the growth of such services. If the markets for the services offered by
the Company, including Internet access, fail to grow, grow more slowly than
anticipated, or become saturated with competitors, the Company's business,
financial condition and results of operations would be materially adversely
affected. See "--Competition," "--Dependence Upon New and Enhanced Services,"
and "--Risks of Technological Change and Evolving Industry Standards."
Dependence Upon New and Enhanced Services
The Company has recently introduced new enterprise service offerings,
including the introduction of value-added, IP-based communication services to
enterprises and a new line of DSL services in limited areas. The
32
<PAGE>
failure of these services to gain market acceptance in a timely manner or at
all or, the failure of the DSL Service in particular, to achieve significant
market coverage, could have a material adverse effect on the business,
financial condition and results of operations of the Company. Introduction by
the Company of new or enhanced services with reliability, quality or
compatibility problems could significantly delay or hinder market acceptance
of such services, which could adversely affect the Company's ability to
attract new customers and subscribers. The Company's services may contain
undetected errors or defects when first introduced or as enhancements are
introduced. There can be no assurance that, despite testing by the Company or
its customers, errors will not be found in new services after commencement of
commercial deployment, resulting in additional development costs, loss of, or
delays in, market acceptance, diversion of technical and other resources from
the Company's other development efforts and the loss of credibility with the
Company's customers and subscribers. Any such event could have a material
adverse effect on the Company's business, financial condition and results of
operations. Additionally, if the Company is unable to achieve balanced network
utilization over a 24-hour period, the Concentric network could become
overburdened at certain periods during the day, which could adversely affect
the quality of service provided by the Company. Conversely, due to the high
fixed cost nature of Concentric's infrastructure, under-utilization of the
Concentric network during certain periods of the day could adversely affect
the Company's ability to provide cost-efficient services at other times. The
failure of the Company to achieve balanced network utilization, because of
either over- or under-utilization could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business--Services."
Dependence Upon Suppliers; Sole and Limited Sources of Supply
The Company relies on other companies to supply certain key components of
its network infrastructure, including telecommunications services and
networking equipment, which, in the quantities and quality demanded by the
Company, are available only from sole or limited sources. AT&T Corporation
("AT&T"), WorldCom, Inc. ("WorldCom"), MCI Telecommunications, Inc. ("MCI"),
which is being acquired by WorldCom, and PacWest Telecomm, Inc. are the
primary providers to the Company of data communications facilities and
capacity. AT&T is currently the sole provider of the frame relay backbone of
the Concentric network, and MCI is currently the sole provider of the ATM
backbone of the Concentric network. The Company is also dependent upon local
exchange carriers ("LECs") to provide telecommunications services to the
Company and its customers. The Company from time to time has experienced
delays in receiving telecommunications services, and there can be no assurance
that the Company will be able to obtain such services on the scale and within
the time frames required by the Company at an affordable cost, or at all. Any
failure to obtain such services on a timely basis at an affordable cost would
have a material adverse effect on the Company's business, financial condition
and results of operations.
The routers, switches and modems the Company uses are supplied by Bay
Networks, Inc. through Racal. In addition, Racal acts as a systems integrator.
The servers primarily used in the Company's network infrastructure are
supplied solely by Sun Microsystems, Inc. The Company purchases these
components pursuant to purchase orders placed from time to time, does not
carry significant inventories of these components and has no guaranteed supply
arrangements for such components. The Company's suppliers also sell products
to the Company's competitors and may in the future themselves become
competitors of the Company. There can be no assurance that the Company's
suppliers will not enter into exclusive arrangements with the Company's
competitors or stop selling their products or components to the Company at
commercially reasonable prices or at all.
Expansion of network infrastructures by the Company and others is placing,
and will continue to place, a significant demand on the Company's suppliers,
some of which have limited resources and production capacity. In addition,
certain of the Company's suppliers, in turn, rely on sole or limited sources
of supply of components included in their products. Failure of the Company's
suppliers to adjust to meet such increasing demand may prevent them from
continuing to supply components and products in the quantities and quality and
at the times required by the Company, or at all. The Company's inability to
obtain sufficient quantities of sole- or limited-source components or to
develop alternative sources if required could result in delays and increased
costs in expanding, and overburdening of, the Company's network
infrastructure, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
33
<PAGE>
The Company also is dependent on its suppliers' ability to provide necessary
products and components that comply with various Internet and
telecommunications standards and that interoperate with products and
components from other vendors. Any failure of the Company's sole- or limited-
source suppliers to provide products or components that comply with Internet
standards or that interoperate with other products or components used by the
Company in its network infrastructure could have a material adverse effect on
the Company's business, financial condition and results of operations.
Certain of the Company's suppliers, including the regional Bell operating
companies ("RBOCs") and other LECs, currently are subject to tariff controls
and other price constraints that in the future may be changed. In addition,
regulatory proposals are pending that may affect the prices charged by the
RBOCs and other LECs to the Company. Any such regulatory changes could result
in increased prices of products and services, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "--Dependence Upon New and Enhanced Services" and "--Risks of
Technological Change and Evolving Industry Standards."
DEPENDENCE UPON NETWORK INFRASTRUCTURE
The Company's success will depend upon the capacity, reliability and
security of its network infrastructure. The Company currently derives a
significant portion of its revenue from customer subscriptions. The Company
expects that a substantial portion of its future revenues will be derived from
the provision of tailored value-added network services to its customers. The
Company must continue to expand and adapt its network infrastructure as the
number of users and the amount of information they wish to transfer increase,
and as customer requirements change. The Company's current projections of
utilization of the Concentric network require rapid expansion of the capacity
of the network to avoid capacity constraints that would adversely affect the
performance of the system. The expansion and adaptation of the Company's
network infrastructure will require substantial financial, operational and
management resources. There can be no assurance that the Company will be able
to expand or adapt its network infrastructure to meet additional demand of its
customers' changing requirements on a timely basis, at a commercially
reasonable cost, or at all. In addition, if demand for usage of the Concentric
network were to increase faster than projected or were to exceed the Company's
current forecasts, the network could experience capacity constraints, which
would adversely affect the performance of the system. Any failure of the
Company to expand its network infrastructure on a timely basis or adapt it to
either changing customer requirements or evolving industry standards, or
capacity constraints experienced by the Concentric network for any reason,
could have a material adverse effect on the Company's business, financial
condition and results of operations. Currently, the Company has a transit
agreement with network MCI, Inc. to support the exchange of traffic between
the Concentric network and the Internet. With the acquisition of InterNex, the
Company is expanding its Internet connectivity to include not only private
transit with MCI, Sprint and UUNet, but also private peering with other
network providers as well as public peering with multiple smaller internet
service providers. The Company is still in the process of integrating the
InterNex network resources, including the Sprint and UUNet private transit and
public peering arrangements, and has yet to determine if it can successfully
execute its private/public Internet connection strategy. The failure of the
networks with which Concentric has public peering, private peering or private
transit, or the failure of any of the Company's data centers, or any other
link in the delivery chain, or the inability of the Company to successfully
integrate the InterNex network resources into the Company's existing
infrastructure, and resulting interruption in the Company's operations would
have a material adverse effect on the Company's business, financial condition
and results of operations. See "--Risks Associated with Acquisition," "--Risk
of System Failure" and "Business--The Concentric Network."
Future Capital Needs; Uncertainty of Additional Financing
The Company currently anticipates that its available cash resources,
including existing lease and credit facilities, and funds from operations will
be sufficient to meet its anticipated working capital and capital expenditure
requirements through at least the end of 1998. However, there can be no
assurance that such resources will be sufficient for its anticipated working
capital and capital expenditure requirements. The
34
<PAGE>
Company may need to raise additional funds through public or private debt or
equity financings in order to take advantage of unanticipated opportunities,
including more rapid international expansion or acquisitions of complementary
businesses or technologies, or to develop new products or otherwise respond to
unanticipated competitive pressures. The Company may also raise additional
funds through public or private debt or equity financings if such financings
become available on favorable terms. If additional funds are raised, there can
be no assurance that additional financing will be available on terms favorable
to the Company, or at all. If adequate funds are not available or are not
available on acceptable terms, the Company may not be able to take advantage
of unanticipated opportunities, develop new products or otherwise respond to
unanticipated competitive pressures. Such inability could have a material
adverse effect on the Company's business, results of operations and financial
condition. The Company's forecast of the period of time through which its
financial resources will be adequate to support its operations is a forward
looking statement that involves risks and uncertainties, and actual results
could vary materially as a result of a number of factors, including those set
forth above in this paragraph. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
Competition
The market for tailored value-added network services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. The Company believes
that its ability to compete successfully depends upon a number of factors,
including market presence; the capacity, reliability, low latency and security
of its network infrastructure; technical expertise and functionality,
performance and quality of services; customization; ease of access to and
navigation of the Internet; the pricing policies of its competitors and
suppliers; the variety of services; the timing of introductions of new
services by the Company and its competitors; customer support; the Company's
ability to support industry standards; and industry and general economic
trends.
The Company's current and prospective competitors generally may be divided
into the following five groups: (i) telecommunications companies, such as
AT&T, MCI, Sprint, Inc., WorldCom, the RBOCs and other LEC's and various cable
companies; (ii) online services providers, such as America Online, Inc.
("America Online"), CompuServe Incorporated ("CompuServe"), the Microsoft
Network ("MSN") of Microsoft, and Prodigy Services Company ("Prodigy"); (iii)
Internet service providers ("ISPs"), such as BBN Corporation ("BBN"), a
subsidiary of GTE, NETCOM On-Line Communications Services, Inc. ("NETCOM"), a
subsidiary of ICG Communications, Inc., PSINet, Inc. ("PSI"), and other
national and regional providers; (iv) nonprofit or educational Internet
connectivity providers; and (v) Web server farms such as Internet Direct and
Exodus. Many of these competitors have greater market presence, engineering
and marketing capabilities, and financial, technological and personnel
resources than those available to the Company. As a result, they may be able
to develop and expand their communications and network infrastructures more
quickly, adapt more swiftly to new or emerging technologies and changes in
customer requirements, take advantage of acquisition and other opportunities
more readily, and devote greater resources to the marketing and sale of their
products and services than can the Company. In addition to the companies named
above, various organizations have entered into or are forming joint ventures
or consortiums to provide services similar to those of the Company.
The Company believes that new competitors, including large computer
hardware, software, media and other technology and telecommunications
companies, will enter the tailored value-added network services market,
resulting in even greater competition for the Company. Certain of such
telecommunications companies and online services providers are currently
offering or have announced plans to offer Internet or online services or to
expand their network services. Certain companies, including America Online,
BBN and PSI, have also obtained or expanded their Internet access products and
services as a result of acquisitions. Such acquisitions may permit the
Company's competitors to devote greater resources to the development and
marketing of new competitive products and services and the marketing of
existing competitive products and services. In addition, the ability of some
of the Company's competitors to bundle other services and products with
virtual private network services or Internet access services could place the
Company at a competitive disadvantage. Certain companies are also
35
<PAGE>
exploring the possibility of providing or are currently providing high-speed
data services using alternative delivery methods such as over the cable
television infrastructure, through direct broadcast satellites and over
wireless cable.
As a result of increased competition and vertical and horizontal integration
in the industry, the Company could encounter significant pricing pressure,
which in turn could result in significant reductions in the average selling
price of the Company's services. For example, certain of the Company's
competitors that are telecommunications companies may be able to provide
customers with reduced communications costs in connection with their Internet
access services or private network services, reducing the overall cost of
their solutions and significantly increasing price pressures on the Company.
There can be no assurance that the Company will be able to offset the effects
of any such price reductions with an increase in the number of its customers,
higher revenue from enhanced services, cost reductions or otherwise. In
addition, the Company believes that the Internet access and online services
businesses are likely to encounter consolidation in the near future, which
could result in increased price and other competition in these industries and,
potentially, the virtual private networks industry. Increased price or other
competition could result in erosion of the Company's market share and could
have a material adverse effect on the Company's business, financial condition
and results of operations. There can be no assurance that the Company will
have the financial resources, technical expertise or marketing and support
capabilities to continue to compete successfully. See "--Management of
Potential Growth and Expansion" and "Business--Competition."
Dependence Upon Third-Party Marketing, Distribution and Engineering
Relationships
An important element of the Company's strategy is to develop relationships
with leading companies to enhance Concentric's engineering, marketing and
distribution efforts. The Company has OEM agreements with Netscape and
Microsoft pursuant to which the Company is entitled to distribute and modify
these companies' browsers. The customization of browsers by the Company is an
integral part of its current tailored VPN offerings. The Netscape agreement
expires in December 1998 and the Microsoft agreement expires in March 1999.
The Company has an agreement with Intuit for the development, operation and
maintenance of a VPN that is the integrated access, dial-up network and
infrastructure used by purchasers of Quicken, Turbo Tax and other Intuit
software products to access the Quicken Financial Network Website and upgrade
to full Internet access. The Intuit contract may be terminated at the election
of Intuit upon six months prior notice of an election to terminate. The
Company relies on these relationships for acquisition of consumer customers.
The termination of or failure to renew any of these agreements or the
inability of the Company to enter into similar relationships with others could
have a material adverse effect on the Company's business, financial condition
and results of operation. The Company has an outsourcing agreement with
Critical Technologies Incorporated ("CTI"), a subsidiary of Williams
Communications Group, Inc., that enables the Company to use CTI employees for
the operational support of the Concentric network. The Company's use of CTI
employees and CTI engineering expertise were integral to its development of
the Concentric network and continue to be integral to ongoing operation of the
Company's network operations center. Pursuant to the agreement with CTI, all
of the CTI employees currently working for Concentric will become employees of
Concentric at the termination of the agreement in December 2000. Termination
of any of these agreements or the failure of the Company to renew any of the
agreements upon termination on terms acceptable to the Company could result in
a material adverse affect on the Company's business, financial condition and
results of operations. See "Business--Key Business Alliances."
Risks of Technological Change and Evolving Industry Standards
The markets for the Company's services are characterized by rapidly changing
technology, evolving industry standards, changes in customer needs, emerging
competition and frequent new product and service introductions. The Company's
future success will depend, in part, on its ability to effectively use leading
technologies; to continue to develop its technical expertise; to enhance its
current networking services; to develop new services that meet changing
customer needs; to advertise and market its services; and to influence and
respond to emerging industry standards and other technological changes in a
timely and cost-effective basis. There can be no assurance that the Company
will be successful in effectively using new technologies, developing
36
<PAGE>
new services or enhancing its existing services on a timely basis, or that
such new technologies or enhancements will achieve market acceptance. The
Company's pursuit of necessary technological advances may require substantial
time and expense, and there can be no assurance that the Company will succeed
in adapting its network service business to alternate access devices and
conduits. An integral part of the Company's strategy is to design its network
in order to meet the requirements of emerging standards such as 56.6 Kbps
modems and applications such as IP-based interactive video and voice
conferencing communications. Failure of the Company, for technological or
other reasons, to develop and introduce new or enhanced services that are
compatible with industry standards and that satisfy customer requirements
would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business--The Concentric Network."
The Company believes that its ability to compete successfully is also
dependent upon the continued compatibility and interoperability of its
services with products and architectures offered by various vendors. Although
the Company intends to support emerging standards in the market for Internet
access, there can be no assurance that industry standards will be established
or, if they become established, that the Company will be able to conform to
these new standards in a timely fashion and maintain a competitive position in
the market. Specifically, the Company's services rely on the continued
widespread commercial use of TCP/IP. Alternative open protocol and proprietary
protocol standards have been or are being developed. If any of these
alternative protocols become widely adopted, there may be a reduction in the
use of TCP/IP, which could render the Company's services obsolete and
unmarketable. Additionally, two of the leading modem manufacturers, Rockwell
and US Robotics, a subsidiary of 3Com Incorporated, have proposed different,
incompatible standards for 56.6 Kbps modems and cable modems. The Company
currently plans to accommodate both standards to the extent it can do so cost
effectively. The failure of the Company to anticipate the prevailing standard,
or the failure of a common standard to emerge could have a material adverse
effect on the Company's business and results of operations. In addition, there
can be no assurance that services or technologies developed by others will not
render the Company's services or technology uncompetitive or obsolete.
The Company faces the risk of fundamental changes in the way Internet access
is delivered. Currently, Internet services are accessed primarily by computers
connected by telephone lines. Recently, several companies announced the
development and planned sale of cable television modems, wireless modems and
satellite modems to provide access to the Internet. Cable television,
satellite and wireless modems have the ability to transmit data at
substantially faster speeds than the modems the Company and its subscribers
currently use. In addition, wireless modems have the potential to reduce the
cost of network services. As the Internet becomes accessible through these
cable television, wireless and satellite modems and by screen-based
telephones, television or other consumer electronic devices, or subscriber
requirements change the way Internet access is provided, the Company will have
to develop new technology or modify its existing technology to accommodate
these developments. The Company's pursuit of these technological advances may
require substantial time and expense, and there can be no assurance that the
Company will succeed in adapting its Internet access business to alternate
access devices and conduits.
Risk of System Failure
As the Company expands its network and usage grows, increased stress will be
placed upon network hardware and traffic management systems. While the
Company's network has been designed with redundant backbone circuits to allow
traffic re-routing, there can be no assurance that the Company will not
experience failures relating to individual network points of presence ("POPs")
or even catastrophic failure of the entire network. Moreover, the Company's
operations are dependent upon its ability to protect its network
infrastructure against damage from fire, earthquakes, floods, mudslides, power
loss, telecommunications failures and similar events. A significant portion of
the Company's computer equipment, including critical equipment dedicated to
its Internet access services, is located at its facilities in Bay City,
Michigan, and Cupertino, California. In addition, the Company's modems and
routers that serve large areas of the United States are located in such
cities. The Company's network operations center, which manages the entire
network, is in St. Louis, Missouri. Despite precautions taken by the Company,
the occurrence of a natural disaster or other unanticipated problems at the
Company's network operations center, at its hubs (sites at which the Company
has located routers, switches and
37
<PAGE>
other computer equipment that make up the backbone of the Company's network
infrastructure) or at a number of the Company's POPs has from time to time in
the past caused, and in the future could cause, interruptions in the services
provided by the Company. In addition, failure of the Company's
telecommunications providers to provide the data communications capacity in
the time frame required by the Company as a result of a natural disaster or
operational disruption or for any other reason could cause interruptions in
the services provided by the Company. Any damage or failure that causes
interruptions in the Company's operations could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Business--The Concentric Network."
System Security Risks
Despite the implementation of network security measures, the core of the
Company's network infrastructure is vulnerable to computer viruses, break-ins
and similar disruptive problems caused by its customers or Internet users.
Computer viruses, break-ins or other problems caused by third parties could
lead to interruptions, delays or cessation in service to the Company's
customers and subscribers. Furthermore, such inappropriate use of the network
by third parties could also potentially jeopardize the security of
confidential information stored in the computer systems of the Company and its
customers, which may result in liability to the Company and also may deter
potential subscribers. Although the Company intends to continue to implement
industry-standard security measures, such measures occasionally have been
circumvented in the past, and there can be no assurance that measures
implemented by the Company will not be circumvented in the future. The costs
and resources required to eliminate computer viruses and alleviate other
security problems may result in interruptions, delays or cessation of service
to the Company's customers that could have a material adverse effect on the
Company's business, financial condition and results of operations. See "--
Management of Potential Growth and Expansion," "--Dependence upon New and
Enhanced Services," "--Risks of Technological Change and Evolving Industry
Standards," "Use of Proceeds" and "Business--Services."
Dependence Upon Key Personnel; Ability to Hire Additional Qualified Personnel
The Company's success depends to a significant degree upon the continued
contributions of its executive management team, including Henry R. Nothhaft,
the Company's Chairman, President and Chief Executive Officer, and John K.
Peters, the Company's Executive Vice President and General Manager, Network
Services Division. The loss of the services of Messrs. Nothhaft or Peters
could have a material adverse effect on the Company. The Company does not have
employment agreements with any of its senior officers, including Messrs.
Nothhaft or Peters. Nor does the Company carry key man life insurance on the
life of any such persons. The Company's success will also depend upon the
continued service of the other members of its senior management team and
technical, marketing and sales personnel. The Company's employees may
voluntarily terminate their employment with the Company at any time, and
competition for qualified employees is intense. The Company's success also
depends upon its ability to attract and retain additional highly qualified
management, technical, sales and marketing and customer support personnel. The
process of locating such personnel with the combination of skills and
attributes required to carry out the Company's strategy is often lengthy. The
loss of the services of key personnel, or the inability to attract additional
qualified personnel, could have a material adverse effect upon the Company's
results of operations, development efforts and ability to complete the
expansion of its network infrastructure. Any such event could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "--Management of Potential Growth and Expansion" and
"Management."
Risks Associated with International Expansion
A key component of the Company's strategy is its planned expansion into
international markets. In particular, the Company has entered into an
agreement with TMI, to establish an international network based on
Concentric's network technology and expertise and TMI's existing
telecommunications infrastructure to deliver a range of compatible network
services worldwide. If the companies are not able to successfully deploy
Concentric's technology over TMI's infrastructure, or if Concentric is
unsuccessful in transferring its knowledge
38
<PAGE>
to TMI employees, the Company's international strategy may be delayed and the
Company's business, results of operation or financial condition could be
materially adversely affected. To date, the Company has only limited
experience in working with TMI to develop versions of its products and
marketing and distributing its products internationally. Additionally, the
Company entered into a roaming services agreement in June 1997 with NTT PC.
The roaming services agreement allows Concentric customers to use the NTT PC
network to access their internet accounts in Japan and allows members of the
NTT PC network to access their internet accounts in the United States and
Canada. Additionally, the Company acquired Web hosting facilities in
Stockholm, Sweden, Tokyo, Japan and Hong Kong in February 1998. There can be
no assurance that the Company will be able to successfully market, sell and
deliver its products in these markets. In addition to the uncertainty as to
the Company's ability to expand its international presence, there are certain
risks inherent in doing business on an international level, such as unexpected
changes in regulatory requirements, export restrictions, export controls
relating to encryption technology, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, longer payment
cycles, problems in collecting accounts receivable, political instability,
fluctuations in currency exchange rates, seasonal reductions in business
activity during the summer months in Europe and certain other parts of the
world and potentially adverse tax consequences that could adversely impact the
success of the Company's international operations. There can be no assurance
that one or more of such factors will not have a material adverse effect on
the Company's future international operations and, consequently, on the
Company's business, financial condition and results of operations.
Government Regulation
The FCC currently does not regulate value-added network software or computer
equipment related services that transport data or voice messages over
telecommunication facilities. The Company provides value-added IP-based
network services, in part, through data transmissions over public telephone
lines. These transmissions are governed by regulatory policies establishing
charges and terms for wireline communications. Operators of these types of
value-added networks that provide access to regulated transmission facilities
only as part of a data services package currently are excluded from
regulations that applies to "telecommunications carrier" and as such the
Company is not currently subject to direct regulation by the FCC or any other
governmental agency, other than regulations applicable to businesses
generally. However, in the future the Company could become subject to
regulation by the FCC or another regulatory agency as a provider of basic
telecommunications services.
Currently, the FCC is reviewing its regulatory positions and could seek to
impose common carrier regulation on the network transport and communications
facilities aspects of an enhanced or information service package. Further, the
FCC could conclude that the Company's protocol conversions, computer
processing, and interaction with customer-supplied information are
insufficient to afford the Company the benefits of the enhanced or information
service classification, and thereby may seek to regulate some segments of the
Company's activities as basic telecommunications services. While state public
utility commissions generally have declined to regulate enhanced or
information services, some states have continued to regulate particular
aspects of enhanced services in limited circumstances, such as where they are
provided by LECs. Moreover, the public service commissions of certain states
continue to review potential regulation of such services. There can be no
assurance that regulatory authorities of states within which Concentric makes
its Internet access, Intranet and VPN services available will not seek to
regulate aspects of these activities as telecommunications services. Changes
in the regulatory environment relating to the Internet connectivity market,
including regulatory changes that directly or indirectly affect
telecommunications costs or increase the likelihood or scope of competition
from the RBOCs or other telecommunications companies, could affect the prices
at which the Company may sell its services. The Company cannot predict the
impact, if any, that future regulation or regulatory changes may have on its
business and there can be no assurance that such future regulation or
regulatory changes will not have a material adverse effect on the Company's
business, results of operations and financial condition.
Dependence on Technology; Proprietary Rights
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The
39
<PAGE>
Company principally relies upon a combination of copyright, trademark and
trade secret laws and contractual restrictions to protect its proprietary
technology. It may be possible for a third party to copy or otherwise obtain
and use the Company's products or technology without authorization or to
develop similar technology independently, and there can be no assurance that
such measures have been, or will be, adequate to protect the Company's
proprietary technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or
superior to the Company's technology. The Company operates a material portion
of its business over the Internet, which is subject to a variety of risks.
Such risks include but are not limited to the substantial uncertainties that
exist regarding the system for assigning domain names and the status of
private rules for resolution of disputes regarding rights to domain names.
There can be no assurance that the Company will continue to be able to employ
its current domain names in the future or that the loss of rights to one or
more domain names will not have a material adverse effect on the Company's
business and results of operations.
Although the Company does not believe that it infringes the proprietary
rights of any third parties, there can be no assurance that third parties will
not assert such claims against the Company in the future or that such claims
will not be successful. The Company could incur substantial costs and
diversion of management resources with respect to the defense of any claims
relating to proprietary rights, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Furthermore, parties making such claims could secure a judgment awarding
substantial damages, as well as injunctive or other equitable relief that
could effectively block the Company's ability to license its products in the
United States or abroad. Such a judgment would have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, the Company is obligated under certain agreements to indemnify the
other party in connection with infringement by the Company of the proprietary
rights of third parties. In the event the Company is required to indemnify
parties under these agreements, it could have a material adverse effect on the
business, financial condition and results of operations of the Company. In the
event a claim relating to proprietary technology or information is asserted
against the Company, the Company may seek licenses to such intellectual
property. There can be no assurance, however, that licenses could be obtained
on commercially reasonable terms, if at all, or that the terms of any offered
licenses would be acceptable to the Company. The failure to obtain the
necessary licenses or other rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
Potential Liability for Information Disseminated Through Network
The law relating to the liability of online service providers, private
network operators and Internet service providers for information carried on or
disseminated through the facilities of their networks is currently unsettled.
Several lawsuits seeking a judgment of such liability are pending. In one case
brought against an Internet service provider, Religious Technology Center v.
Netcom On-Line Communication Services, Inc., the United States District Court
for the Northern District of California ruled in a preliminary phase that
under certain circumstances Internet service providers could be held liable
for copyright infringement. The case has not reached final judgment. Such
claims have been asserted against the Company in the past, and there can be no
assurance that such claims will not be asserted in the future, or if asserted,
will not be successful. The Telecommunications Act of 1996 prohibits and
imposes criminal penalties and civil liability for using an interactive
computer service for transmitting certain types of information and content,
such as obscene communications. Numerous states have adopted or are currently
considering similar types of legislation. The imposition upon the Company,
Internet service providers or Web server hosts of potential liability for
materials carried on or disseminated through their systems could require the
Company to implement measures to reduce its exposure to such liability, which
may require the expenditure of substantial resources or the discontinuation of
certain product or service offerings. Further, the costs incurred in defending
against any such claims and potential adverse outcomes of such claims could
have a material adverse effect on the Company's financial condition and
results of operations. The Company believes that it is currently unsettled
whether the Telecommunications Act of 1996 prohibits and imposes liability for
any services provided by the Company should the content of information
transmitted be subject to the statute.
40
<PAGE>
Legal Proceedings
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana, the parent corporation of Sattel, alleging
securities fraud related to plaintiffs' purchase of shares of Diana Common
Stock in reliance upon allegedly misleading statements made by defendants,
Diana, Sattel and certain of their respective affiliates, officers and
directors. Concentric was named as a defendant in the complaint in connection
with certain statements made by Diana and officers of Diana related to
Concentric's purchase of network switching equipment from Diana's Sattel
subsidiary. The plaintiffs seek unspecified compensatory damages. A motion by
the Company to dismiss the complaint was denied, and the court has allowed the
action to proceed against the Company. A trial date has not yet been
determined.
While the ultimate outcome of such litigation is uncertain, the Company
believes it has meritorious defenses to the claims and intends to conduct a
vigorous defense. An unfavorable outcome in this matter could have a material
adverse effect on the Company's financial condition. In addition, even if the
ultimate outcome is resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either of which could have a material adverse effect on the
Company's results of operations. See "Business--Legal Proceedings" and Note 11
of Notes to Financial Statements.
Item 8. Financial Statements and Supplementary Data
The information required by Item 8 is incorporated by reference herein from
Part IV Item 14(a)(1) and (2).
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
41
<PAGE>
PART III
Certain information required by Part III is omitted from this Report in that
the registrant will file a definitive Proxy Statement pursuant to Regulation
14A (the "Proxy Statement") not later than 120 days after the end of the
fiscal year covered by this Report, and certain information included therein
is incorporated herein by reference.
Item 10. Directors and Officers of the Company
Certain information regarding the directors and officers of the Company is
contained herein under Item 1, "Executive Officers and Directors of the
Company."
Information regarding directors appearing under the caption "Election of
Directors--Directors and Nominees for Director" in the Proxy Statement is
hereby incorporated by reference.
Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, is hereby incorporated herein by reference
from the section entitled "Election of Directors--Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement.
Item 11. Executive Compensation
The information required by Item 11 is set forth under the caption,
"Executive Compensation" in the Company's Proxy Statement, which information
is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is set forth under the caption "Security
Ownership" in the Company's Proxy Statement, which information is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is set forth under the captions
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions" in the Company's Proxy Statement, which information is
incorporated herein by reference.
42
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K
(a) The following documents are filed as part of this Report:
1. CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of Concentric Network
Corporation are filed as part of this Report:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Concentric Network Corporation:
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Balance Sheets........................................................... F-3
Statements of Operations................................................. F-4
Statements of Common Stock Subject to Rescission and Stockholders' Equity
(Deficit)............................................................... F-5
Statements of Cash Flows................................................. F-7
Notes to Financial Statements............................................ F-9
Internex Information Services, Inc.:
Report of Arthur Andersen LLP, Independent Accountants................... F-24
Balance Sheets........................................................... F-25
Statements of Operations................................................. F-26
Statements of Shareholders' Equity....................................... F-27
Statements of Cash Flows................................................. F-28
Notes to Financial Statements............................................ F-29
Selected Unaudited ProForma Condensed Combined Financial Information:
Introduction............................................................. F-34
Balance Sheet............................................................ F-35
Statements of Operations................................................. F-36
Notes to Selected Unaudited Pro Forma Condensed Combined Financial
Information............................................................. F-37
</TABLE>
2. CONSOLIDATED FINANCIAL STATEMENTS SCHEDULE.
Schedule II--Valuation and Qualifying Accounts
All other schedules have been omitted because the required information is
not present in amounts sufficient to require submission of the schedule or
because the information required is included in the financial statements
including the notes thereto.
43
<PAGE>
3. EXHIBITS
The exhibits listed under Item 14(c) hereof are filed as part of this
Annual Report on Form 10-K.
(b) During the fiscal quarter ended December 31, 1997, the Company filed
a Current Report on Form 8-K dated December 16, 1997 with the Commission on
December 30, 1997 reporting information under items 5 and 7.
(c) Exhibits
The following exhibits are filed with this Report:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
3.2* Amended and Restated Certificate of Incorporation of Registrant.
3.4* Amended and Restated Bylaws of Registrant.
10.1* Amended and Restated Registration Rights Agreement, as amended and
restated as of August 21, 1996, by and among the Registrant, GS
Capital Partners, L.P., Kleiner Perkins Caufield & Byers VII,
Comdisco, Inc., Intuit, Inc., certain listed holders of Series C
Convertible Preferred Stock, certain listed holders of Common
Stock, certain listed holders of Series D Convertible Preferred
Stock, and Racal-Datacom, Inc.
10.2* Preferred Stock and Warrant Purchase Agreement, dated as of April
20, 1995, by and among the Registrant, GS Capital Partners, L.P.,
and Kleiner Perkins Caufield & Byers VII and KPCB Information
Sciences Zaibatsu Fund 11, as amended.
10.3* Form of Director and Officer Indemnification Agreement.
10.4* 1995 Stock Incentive Plan for Employees and Consultants, as
amended February 21, 1996.
10.5* Amended and Restated 1996 Stock Plan.
10.6* 1997 Stock Plan.
10.7* 1997 Employee Stock Purchase Plan.
10.8* Termination of Services and Indemnification Agreement, dated as of
February 15, 1996, by and between the Registrant and Marc Collins-
Rector and Chad Shackley.
10.9* Agreement, dated as of February 15, 1996, by and between the
Registrant and Randy Maslow.
10.10* Governance Agreement, dated May 15, 1997, by and among the
Registrant, Marc Collins-Rector, Chad Shackley, GS Capital
Partners, L.P., Kleiner Perkins Caufield & Byers VII, KPCB VII
Founders Fund, KPCB Information Sciences Zaibatsu Fund II, and
Intuit, Inc.
10.11+* Amended and Restated Employee Services and Staffing Agreement,
dated June 19, 1997, between the Registrant and Critical
Technologies, Inc., as amended on September 30, 1996, and October
23, 1996, including Colocation Services Agreement, dated as of
November 1, 1994, between the Registrant and Critical
Technologies, Inc. and amendments thereto.
10.12+* Internet-Sign Up Wizard Referral and Microsoft Internet Explorer
License and Distribution Agreement, dated March 28, 1997, between
the Registrant and Microsoft Corporation.
10.13+* OEM License Agreement dated July 27, 1995, between the Registrant
and Netscape Communications Corporation, as amended by First
Amendment, dated January 2, 1996, Second Amendment, effective
January 2, 1996, and Third Amendment, dated May 21, 1996.
10.14+* "Dial up Client" Agreement, dated August 21, 1995, between the
Registrant and Netscape Communications Corporation.
10.15+* "Internet Account Server" Participation Agreement, dated as of
January 14, 1997, between the Registrant and Netscape
Communications Corporation.
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
10.16+* Special Customer Arrangement, dated May 17, 1996, between MCI
Telecommunications Corporation and Sattel Communications LLC, as
amended by First Amendment, dated July 2, 1996; assigned to
Registrant by Assignment and Novation Agreement #2, dated as of
August 7, 1996.
10.17+* Master Agreement for MCI Enhanced Services, effective November 1,
1996, between the Registrant and MCI Telecommunications
Corporation.
10.18+* Amended and Restated Employee Services and Staffing Agreement.
10.19+* Amendment No. 3 to Internet Access Services Agreement, dated
August 23, 1996, between the Registrant and Intuit Inc.
10.20+* Contract for Services, dated June 17, 1996, by and between the
Registrant and MFS Telephone, Inc.
10.21+* AT&T Contract Tariff Order, dated June 17, 1996, and Addendum of
even date therewith.
10.22+* Master Lease Agreement Number CON01C Between Concentric Research
Corporation and Racal-Datacom, Inc. ("Racal"), dated August 4,
1994, as Supplemented by Letter Agreement, dated March 30, 1995,
Between the Corporation and Racal.
10.23+* Lease Agreement Number CON04C between Concentric Network
Corporation and Racal-Datacom, Inc., dated June 26, 1996.
10.24+* Master On-site Maintenance Plan Agreement Number CON02C Between
Concentric Research Corporation and Racal-Datacom, Inc., dated
August 24, 1994.
10.25* Lease Agreement, dated November 1, 1996, effective March 11, 1996,
by and between the Registrant and Saginaw Video Associates, d.b.a.
Saginaw Conference Center.
10.26* Amended and Restated Lease Agreement, dated as of October 7, 1996,
between the Registrant and Larry Shackley.
10.27* (Master) Lease, dated January 26, 1988, between Tandem Computers
Incorporated and Spicker-French #130, Limited Partnership, as
amended by Lease Amendment No. 1, effective February 5, 1990, and
Extension Agreement, dated March 23, 1993.
10.28* Sublease, dated June 22, 1995, between the Registrant and Tandem
Computers Incorporated.
10.29* Sublease, dated April 25, 1995, between Tandem Computers
Incorporated and Passage Systems, Inc.
10.30* Assignment Agreement, dated December 6, 1996, by and between the
Registrant and Passage Systems, Inc.
10.31+* Internet Access Service Agreement, dated December 11, 1995,
effective as of August 1, 1995, between the Registrant and Intuit,
Inc., as amended.
10.32+* Virtual Private Network Services, dated August 16, 1996, between
the Registrant and WebTV Networks, Inc.
10.33+* Support Services Agreement, dated March 31, 1997, by and between
the Registrant and MCI Telecommunications Corporation.
10.34* Note and Warrant Purchase Agreement, dated June 19, 1997, by and
between the Registrant and Williams Communications Group, Inc.
("WCG")
10.35* Service Credits Letter Agreement, dated June 19, 1997, by and
between the Registrant and WCG.
10.36* $1,100,000 Obligation Letter Agreement, dated June 19, 1997,
between the Registrant and WCG.
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
10.37* Agency Agreement and Distribution Agreement, dated June 19, 1997,
between the Registrant and WCG.
10.38+* Co-Marketing Service Agreement, dated June 23, 1997 between the
Registrant and Netscape Communications, Inc. ("Netscape")
10.39+* Trademark License Agreement, dated June 23, 1997, between the
Registrant and Netscape.
10.40+* Software License Order Form, dated June 23, 1997, between the
Registrant and Netscape.
10.41* Note and Warrant Purchase Agreement, dated June 23, 1997, between
the Registrant, Kleiner Perkins, Caufield & Byers VII and KPCB
Information Science Zaibatsu Fund VII.
10.42** Amendment to Virtual Private Network Services Agreement between
the Registrant and WebTV Networks, Inc., dated November 1, 1997.
10.43*** Registration Rights Agreement, dated as of December 18, 1997
between the Registrant and UBS Securities LLC, Bear Stearns &
Co., Inc., and Wheat First Securities, Inc. (the "Initial
Purchasers")
10.44*** Purchase Agreement, dated as of December 15, 1997 between the
Registrant and the Initial Purchasers.
10.45*** Warrant Agreement, dated as of December 18, 1997, between the
Registrant and the Initial Purchasers.
10.46*** Warrant Registration Rights Agreement, dated as of December 18,
1997, between the Registrant and the Initial Purchasers.
10.47*** Escrow Agreement, dated December 18, 1997, between the Registrant
and Chase Manhattan Bank and Trust Company, National Association.
10.48*** Indenture, dated as of December 18, 1997 among the Registrant and
Chase Manhattan Bank and Trust Company, National Association, as
trustee.
10.49*** Form of $150,000,000 12 3/4% Senior Note due 2007
10.50*** Form of $150,000,000 new 12 3/4% Senior Notes due 2007.
10.51*** Form of Warrant to purchase Common Stock
10.52 Standard Industrial Lease, dated as of February 17, 1995, by and
between Tiara Computer Systems, Inc. and Internex Information
Services, Inc.
10.53 Standard Industrial Lease, dated as of July 25, 1996, by and
between San Tomas Investors II and Internex Information Service,
Inc.
11.1 Statement re computation of earnings per share.
21.1 List of Subsidiaries.
23.2 Consent of Ernst & Young, LLP, Independent Auditors
23.3 Consent of Arthur Andersen, LLP, Independent Public Accountants.
24.1 Power of Attorney (see signature page).
27.1 Financial Data Schedule
</TABLE>
- --------
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 333-27241), as amended, declared effective by the Securities
and Exchange Commission ("SEC") on July 31, 1997.
** Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997, filed with the SEC on November
14, 1997.
*** Incorporated by reference from the Company's Registration Statement on
Form S-4, filed with the SEC on January 28, 1998.
+ Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request under 17 C.F.R. (s)(5) 200.80(b)(4), 200.83 and 230.46.
46
<PAGE>
(d) Schedule II--Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
ADDITIONS DEDUCTIONS
BALANCE CHARGED TO UNCOLLECTABLE BALANCE
AT BEGINNING COSTS & ACCOUNTS AT END
DESCRIPTION OF PERIOD EXPENSES WRITTEN OFF OF PERIOD
----------- ------------ ---------- ------------- ---------
<S> <C> <C> <C> <C>
For the period ended December
31, 1997..................... $56,000 $40,000 $15,951 $80,049
For the period ended December
31, 1996..................... 0 56,000 0 56,000
For the period ended December
31, 1995..................... 0 0 0 0
</TABLE>
47
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Date: March 5, 1998 Concentric Network Corporation
/s/ Henry R. Nothhaft
By: _________________________________
Henry R. Nothhaft
Chairman, President and Chief
Executive Officer
KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Henry R. Nothhaft, and Michael Anthofer,
jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to
this Annual Report on Form 10-K, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-
in-fact, or his substitute or substitutes, may do or cause to be done by
virtue thereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS
BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE
CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE
/s/ Henry R. Nothhaft Chairman, President March 5, 1998
- ------------------------------------- and Chief Executive
HENRY R. NOTHHAFT Officer and
Director (Principal
Executive Officer)
/s/ Michael Anthofer Vice President, March 5, 1998
- ------------------------------------- Finance and Chief
MICHAEL ANTHOFER Financial Officer
(Principal
Financial and
Accounting Officer)
/s/ Vinod Khosla Director March 5, 1998
- -------------------------------------
VINOD KHOSLA
Director
- -------------------------------------
FRANCO REGIS
/s/ Gary E. Rieschel Director March 5, 1998
- -------------------------------------
GARY E. RIESCHEL
/s/ Louis P. Bender, III Director March 5, 1998
- -------------------------------------
LOUIS P. BENDER, III
/s/ Gordon Martin Director March 5, 1998
- -------------------------------------
GORDON MARTIN
<PAGE>
CONCENTRIC NETWORK CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Concentric Network Corporation:
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Balance Sheets........................................................... F-3
Statements of Operations................................................. F-4
Statements of Common Stock Subject to Rescission and Stockholders' Equity
(Deficit)............................................................... F-5
Statements of Cash Flows................................................. F-7
Notes to Financial Statements............................................ F-9
Internex Information Services, Inc.:
Report of Arthur Andersen LLP, Independent Auditors...................... F-24
Balance Sheets........................................................... F-25
Statements of Operations................................................. F-26
Statements of Shareholders' Equity....................................... F-27
Statements of Cash Flows................................................. F-28
Notes to Financial Statements............................................ F-29
Selected Unaudited ProForma Condensed Combined Financial Information:
Introduction............................................................. F-34
Balance Sheet............................................................ F-35
Statements of Operations................................................. F-36
Notes to Selected Unaudited Pro Forma Condensed Combined Financial
Information............................................................. F-37
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors Concentric Network Corporation.
We have audited the accompanying balance sheets of Concentric Network
Corporation as of December 31, 1996 and 1997, and the related statements of
operations, common stock subject to rescission and stockholders' equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 1997. Our audits also included the financial statement schedule
included in Item 14(a). These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Concentric Network
Corporation at December 31, 1996 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles. Also,
in our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly
in all material respects the financial information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
January 27, 1998, except for Note
12 as to which the date is
February 5, 1998
F-2
<PAGE>
CONCENTRIC NETWORK CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
-------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 17,657 $ 119,959
Current portion of restricted cash....................... -- 19,125
Accounts receivable, net of allowances of $56 in 1996 and
$80 in 1997............................................. 1,849 4,549
Prepaid expenses and other current assets................ 1,722 5,139
-------- ---------
Total current assets.................................... 21,228 148,772
Property and equipment:
Computer and telecommunications equipment................ 55,091 71,942
Software................................................. 583 1,519
Furniture and fixtures and leasehold improvements........ 2,130 2,984
-------- ---------
57,804 76,445
Accumulated depreciation and amortization................ 9,877 22,735
-------- ---------
47,927 53,710
Restricted cash, net of current portion................... -- 33,400
Other assets.............................................. 1,567 8,607
-------- ---------
Total assets.......................................... $ 70,722 $ 244,489
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 16,723 $ 10,144
Accrued compensation and other employee benefits......... 714 1,577
Other current liabilities................................ 2,163 4,917
Current portion of capital lease obligations, including
$10,180 in 1996 and $13,600 in 1997 to a related party.. 11,258 15,326
Deferred revenue......................................... 1,238 1,435
-------- ---------
Total current liabilities............................... 32,096 33,399
Capital lease obligations, including $29,167 in 1996 and
$32,373 in 1997 to a related party, net of current
portion.................................................. 30,551 33,595
Notes payable............................................. -- 145,577
Commitments and contingencies
Class A common stock subject to rescission, $0.001 par
value:
Issued and outstanding shares--455 in 1996 and none in
1997.................................................... 5,150 --
Stockholders' equity:
Preferred stock, $0.001 par value; issuable in series:
Authorized shares--7,333 in 1996 and 10,000 in 1997
Issued and outstanding shares--4,901 in 1996 and none in
1997................................................... 95,215 --
Common stock, $0.001 par value; issuable in classes:
Authorized shares--13,343 in 1996 and 100,000 in 1997
Issued and outstanding shares--1,393 in 1996 and 14,139
in 1997................................................ 1,850 182,721
Accumulated deficit....................................... (93,952) (149,534)
Deferred compensation..................................... (188) (1,269)
-------- ---------
Total stockholders' equity.............................. 2,925 31,918
-------- ---------
Total liabilities and stockholders' equity............ $ 70,722 $ 244,489
======== =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
CONCENTRIC NETWORK CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Revenue.......................................... $ 2,483 $ 15,648 $ 45,457
Costs and expenses:
Cost of revenue................................ 16,168 47,945 61,439
Network equipment write-off.................... -- 8,321 --
Development.................................... 837 2,449 4,850
Marketing and sales, including $920, $2,448 and
$2,600 to a related party for the years ended
December 31, 1995, 1996 and 1997,
respectively.................................. 3,899 16,609 24,622
General and administrative..................... 2,866 3,445 4,790
-------- -------- --------
Total costs and expenses..................... 23,770 78,769 95,701
-------- -------- --------
Loss from operations............................. (21,287) (63,121) (50,244)
Other income..................................... -- -- 1,233
Interest income.................................. 137 614 1,217
Interest expense, including $797, $3,065 and
$6,197 to related parties for the years ended
December 31, 1995, 1996 and 1997, respectively.. (858) (3,874) (7,788)
-------- -------- --------
Net loss......................................... $(22,008) $(66,381) $(55,582)
======== ======== ========
Pro forma net loss per share..................... $ (13.46) $ (5.63)
======== ========
Shares used in computing pro forma net loss per
share........................................... 4,937 9,872
======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
CONCENTRIC NETWORK CORPORATION
STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK STOCKHOLDERS' EQUITY (DEFICIT)
SUBJECT TO ------------------------------------------ TOTAL
RESCISSION PREFERRED STOCK COMMON STOCK ACCUMU- DEFERRED STOCKHOLDERS'
------------- ---------------- --------------- LATED COMPEN- EQUITY
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT DEFICIT SATION (DEFICIT)
------ ------ ------- -------- ------ -------- --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1994................... 248 2,812 -- -- 1,317 1,361 (5,563) -- (4,202)
Issuance of Series A
preferred stock and
common stock (net of
issuance costs)....... -- -- 906 10,147 62 117 -- -- 10,264
Issuance of Series C
preferred stock (net
of issuance costs).... -- -- 805 20,691 -- -- -- -- 20,691
Conversion of note to
Series B preferred
stock................. -- -- 367 4,035 -- -- -- -- 4,035
Warrants issued to
purchase Series B
preferred stock....... -- -- -- 822 -- -- -- -- 822
Issuance of Class A
common stock.......... 23 690 -- -- -- 1 -- -- 1
Issuance of Class A
common stock for
services.............. -- -- -- -- 2 19 -- -- 19
Conversion of officer's
note payable for Class
B common stock........ -- -- -- -- 7 80 -- -- 80
Warrants issued to
purchase Class A
common stock.......... -- -- -- -- -- 61 -- -- 61
Conversion of
debentures to Class A
common stock.......... 174 1,578 -- -- -- -- -- -- --
Net loss............... -- -- -- -- -- -- (22,008) -- (22,008)
--- ------ ------ -------- ----- -------- --------- ------- --------
Balance at December 31,
1995................... 445 5,080 2,078 35,695 1,388 1,639 (27,571) -- 9,763
Issuance of Class A
common stock.......... -- -- -- -- -- 1 -- -- 1
Conversion of
debentures to Class A
common stock.......... 10 70 -- -- -- -- -- -- --
Exercise of options.... -- -- -- -- 5 22 -- -- 22
Conversion of note to
Series C preferred
stock (net of issuance
costs)................ -- -- 123 2,960 -- -- -- -- 2,960
Issuance of Series D
preferred stock (net
of issuance costs).... -- -- 2,451 48,533 -- -- -- -- 48,533
Conversion of note to
Series D preferred
stock................. -- -- 249 5,072 -- -- -- -- 5,072
Warrants issued to
purchase Series D
preferred stock....... -- -- -- 2,955 -- -- -- -- 2,955
Deferred compensation
resulting from grant
of options............ -- -- -- -- -- 188 -- (188) --
Net loss............... -- -- -- -- -- -- (66,381) -- (66,381)
--- ------ ------ -------- ----- -------- --------- ------- --------
Balance at December 31,
1996................... 455 5,150 4,901 95,215 1,393 1,850 (93,952) (188) 2,925
</TABLE>
See accompanying notes.
F-5
<PAGE>
CONCENTRIC NETWORK CORPORATION
STATEMENTS OF COMMON STOCK SUBJECT TO RESCISSION AND
STOCKHOLDERS' EQUITY (DEFICIT)--(CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK STOCKHOLDERS' EQUITY (DEFICIT)
SUBJECT TO ----------------------------------------------
RESCISSION PREFERRED STOCK COMMON STOCK ACCUMU- DEFERRED
-------------- ----------------- ---------------- LATED COMPEN-
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT DEFICIT SATION
------ ------- ------- -------- ------ -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of Class A common stock for
services .......................... -- $ -- -- $ -- 5 $ 17 $ -- $ --
Conversion of Class B common to
Series A preferred stock .......... -- -- 7 -- (7) -- -- --
Conversion of Series A, B, C and D
preferred to Class A common stock.. -- -- (5,693) (99,604) 5,693 99,604 -- --
Shares issued upon the initial
public offering (net of issuance
costs) ............................ -- -- -- -- 4,945 52,757 -- --
Shares issued in a private
placement.......................... -- -- -- -- 1,246 14,950 -- --
Conversion of note to Class A common
stock ............................. -- -- -- -- 253 3,041 -- --
Repurchase of Class A common stock
in connection with the initial
public offering ................... -- -- -- -- (185) (2,217) -- --
Shares issued subject to dilution
ratios............................. -- -- 484 -- -- -- -- --
Exercise of options to purchase
stock ............................. -- -- -- -- 65 243 -- --
Exercise of warrants to purchase
stock ............................. -- -- 301 3,281 309 1,201 -- --
Warrants issued to purchase stock .. -- -- -- 1,108 -- 5,370 -- --
Deferred compensation resulting from
grant of options .................. -- -- -- -- -- 1,303 -- (1,303)
Amortization of deferred
compensation ...................... -- -- -- -- -- -- -- 222
Expiration of statutes of
limitations on common stock subject
to rescission...................... (422) (4,602) -- -- 422 4,602 -- --
Repurchase of shares for
cancellation in connection with
Recission Offer.................... (33) (548) -- -- -- -- -- --
Net loss ........................... -- -- -- -- -- -- (55,582) --
---- ------- ------- -------- ------ -------- --------- -------
Balance at December 31, 1997 ........ -- $ -- -- $ -- 14,139 $182,721 $(149,534) $(1,269)
==== ======= ======= ======== ====== ======== ========= =======
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
(DEFICIT)
-------------
<S> <C>
Issuance of Class A common stock for
services .......................... $ 17
Conversion of Class B common to
Series A preferred stock .......... --
Conversion of Series A, B, C and D
preferred to Class A common stock.. --
Shares issued upon the initial
public offering (net of issuance
costs) ............................ 52,757
Shares issued in a private
placement.......................... 14,950
Conversion of note to Class A common
stock ............................. 3,041
Repurchase of Class A common stock
in connection with the initial
public offering ................... (2,217)
Shares issued subject to dilution
ratios............................. --
Exercise of options to purchase
stock ............................. 243
Exercise of warrants to purchase
stock ............................. 4,482
Warrants issued to purchase stock .. 6,478
Deferred compensation resulting from
grant of options .................. --
Amortization of deferred
compensation ...................... 222
Expiration of statutes of
limitations on common stock subject
to rescission...................... 4,602
Repurchase of shares for
cancellation in connection with
Recission Offer.................... --
Net loss ........................... (55,582)
-------------
Balance at December 31, 1997 ........ $ 31,918
=============
</TABLE>
See accompanying notes.
F-6
<PAGE>
CONCENTRIC NETWORK CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss......................................... $(22,008) $(66,381) $(55,582)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................ 2,196 7,528 16,852
Amortization of deferred interest and
marketing and sales related to issuance of
warrants.................................... -- 1,942 1,720
Amortization of deferred compensation and
other....................................... -- -- 658
Loss on disposal of equipment................ 29 -- 162
Network equipment write-off.................. -- 8,321 --
Compensation related to stock and option
grants...................................... 883 -- --
Changes in current assets and liabilities:
Prepaid expenses and other current assets.. (818) (57) (3,581)
Accounts receivable........................ (14) (1,734) (2,700)
Accounts payable........................... 3,051 5,129 (7,287)
Accrued compensation and other employee
benefits.................................. 173 484 863
Deferred revenue........................... 141 1,097 197
Other current liabilities.................. 539 1,546 2,795
-------- -------- --------
Net cash used in operating activities............ (15,828) (42,125) (45,903)
INVESTING ACTIVITIES
Additions of property and equipment.............. (1,427) (6,889) (6,130)
Increase in refundable deposits.................. -- (442) --
Decrease (increase) in note receivable........... 255 -- (370)
-------- -------- --------
Net cash used in investing activities............ (1,172) (7,331) (6,500)
FINANCING ACTIVITIES
Proceeds from notes payable...................... 7,000 6,300 155,000
Increase in restricted cash...................... -- -- (52,525)
Repayment of lease obligations to a related
party........................................... (1,609) (4,561) (10,039)
Repayment of lease obligations................... -- (886) (1,517)
Repayment of notes payable....................... (218) (1,300) (2,000)
Repurchase of common stock....................... -- -- (2,765)
Deferred financing costs......................... -- -- (5,006)
Proceeds from issuances of stock................. 30,818 48,506 73,557
-------- -------- --------
Net cash provided by financing activities........ 35,991 48,059 154,705
-------- -------- --------
Increase (decrease) in cash and cash
equivalents..................................... 18,991 (1,397) 102,302
Cash and cash equivalents at beginning of
period.......................................... 63 19,054 17,657
-------- -------- --------
Cash and cash equivalents at end of period....... $ 19,054 $ 17,657 $119,959
======== ======== ========
</TABLE>
See accompanying notes.
F-7
<PAGE>
CONCENTRIC NETWORK CORPORATION
STATEMENTS OF CASH FLOWS--(CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Stock exchanged for notes payable, including
accrued interest.................................. $ 4,115 $ 8,082 $ 3,041
Capital lease obligations incurred with a related
party............................................. $ 14,578 $ 30,945 $ 23,042
Capital lease obligations incurred................. $ 1,207 $ 2,136 $ --
Reduction of accounts payable through capital lease
obligations incurred.............................. $ -- $ -- $ 2,000
Convertible debentures exchanged for stock......... $ 1,578 $ 70 $ --
Issuance of warrants............................... $ 883 $ 2,955 $ 5,370
Purchase of property and equipment through accounts
payable........................................... $ -- $ 6,344 $ --
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid...................................... $ 850 $ 2,807 $ 5,728
</TABLE>
See accompanying notes.
F-8
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Concentric Network Corporation (the Company or Concentric) was incorporated
in the state of Florida in 1991 and reincorporated into Delaware in 1997.
Concentric provides tailored, value-added Internet Protocol (IP) based network
services for businesses and consumers. To provide these services, the Company
utilizes its low/fixed latency, high-throughput network, employing its
advanced network architecture and the Internet. Concentric's service offerings
for enterprises include virtual private networks (VPNs), dedicated access
facilities (DAFs), remote access services and Web hosting services. These
services enable enterprises to take advantage of standard Internet tools such
as browsers and high-performance servers for customized data communications
within an enterprise and between an enterprise and its suppliers, partners and
customers. These services combine the cost advantages, nationwide access and
standard protocols of public networks with the customization, high
performance, reliability and security of private networks.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity (at date of purchase) of three months or less to be the equivalent of
cash for the purpose of balance sheet and statement of cash flows
presentation. Cash and cash equivalents consist primarily of money market
funds and United States Government Obligations which are carried at cost which
approximates market value. Cash and cash equivalents are held primarily with
two banks.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
provided using the straight-line method over the estimated useful lives of the
related assets as follows: computer and telecommunications equipment: three to
five years; purchased software: three to five years; furniture and fixtures:
eight to ten years; and leasehold improvements: the shorter of the remaining
term of the related leases or the estimated economic useful lives of the
improvements. Equipment under capital leases is amortized over the shorter of
the expected useful life or the related lease term (see Note 3).
Revenue and Customer Receivables
Revenue is recognized over the period in which services are provided,
generally monthly. Payments received in advance of services being provided are
included in deferred revenues. Substantially all end-user subscribers pay for
services with major credit cards for which the Company receives daily
remittances from the credit card carriers.
Commissions and other obligations to strategic partners through marketing
and distribution arrangements are expensed as incurred, at the time the
associated revenue is recognized.
Concentration of Credit Risk
The Company typically offers its enterprise customers credit terms. The
Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. Credit losses have
historically been insignificant.
Advertising Costs
The Company expenses the costs of advertising as incurred except for direct-
response advertising costs meeting certain specific criteria. To date, no
direct-response advertising costs have been capitalized.
F-9
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Income Taxes
The Company accounts for income taxes using the liability method in
accordance with Financial Accounting Standards Board Statement No. 109,
"Accounting for Income Taxes" (FAS 109).
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Basic and Diluted Net Loss Per Share (Historical)
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" (FAS 128). FAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
restated to conform to the FAS 128 requirements.
Except as noted below, net loss per share is computed using the weighted
average number of shares of common stock outstanding excluding common stock
subject to rescission. Common stock equivalent shares from convertible
preferred stock and from stock options and warrants are not included as the
effect is antidilutive. Pursuant to the Securities and Exchange Commission
Staff Accounting Bulletin No. 98 (SAB No. 98) which was issued in February
1998, common and common equivalent shares issued by the Company for nominal
consideration during any of the periods for which a statement of operations
was presented in the Company's initial public offering registration statement
have been included in the calculation of basic and diluted net loss per share
for all such periods in a manner similar to a stock split. The net loss per
share calculations have been restated for all periods presented in accordance
with SAB No. 98 which replaced SAB No. 83. The following table shows basic net
loss per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
------------------------
1995 1996 1997
------- ------- ------
<S> <C> <C> <C>
Basic Net Loss Per Share......................... $(16.53) $(47.72) $(8.34)
======= ======= ======
Shares Used in Computing Basic Net Loss Per
Share........................................... 1,331 1,391 6,665
======= ======= ======
</TABLE>
Pro Forma Net Loss Per Share
Pro forma net loss per share has been computed as described above and also
gives effect, even if antidilutive, to common equivalent shares from
convertible preferred shares that were automatically converted to common
shares upon the closing of the Company's initial public offering (using the
as-if-converted method).
Stock-Based Compensation
The Company accounts for employee stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25), and has adopted the "disclosure only"
alternative described in Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123).
F-10
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Long-Lived Assets
The Company adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of," effective January 1, 1996. The Company continually reviews
long-lived assets to assess recoverability based upon undiscounted cash flow
analysis. Impairments, if any, are recognized in operating results in the
period in which a permanent diminution in value is determined (see Note 2).
Customer Concentrations
The Company currently derives a substantial portion of its total revenue
from a single customer. For the years ended December 31, 1996 and 1997,
revenue from WebTV Networks, Inc. represented approximately 10.1% and 33.4%,
respectively, of the Company's total revenue.
Effect of New Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" (FAS 130), and Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" (FAS
131). The Company is required to adopt these Statements in fiscal 1998. FAS
130 establishes new standards for reporting and displaying comprehensive
income and its components. FAS 131 requires disclosure of certain information
regarding operating segments, products and services, geographic areas of
operation and major customers. Adoption of these Statements is expected to
have no material impact on the Company's financial position, results of
operations or cash flows.
2. NETWORK EQUIPMENT WRITE-OFF
In December 1996, the Company wrote off approximately $8,321,000
representing the net book value and future commitments for certain network
equipment purchased from Sattel Communications LLC (Sattel), a stockholder of
the Company. The Company decided not to deploy the equipment in the network
because of concerns that the equipment would not provide the functionality and
reliability required by the Company and concerns that the equipment provider
would be unable to provide timely maintenance and support. Included in
accounts payable in the accompanying balance sheet at December 31, 1996 and
1997 was $7,517,000 and $0, respectively, related to this equipment (see Note
11).
3. COMMITMENTS
Operating Leases
The Company has an agreement with a related party through which such related
party makes available the premises at which the Company's POP sites throughout
the United States are located. POP sites are locations where certain
telecommunications switching and related equipment are installed. This
agreement expires in December 2000, and the amount of the payments is based,
among other things, on the number of POP sites maintained by the Company,
subject to certain minimums. Expenses of approximately $1,155,000, $1,622,000
and $1,326,000 were incurred during the years ended December 31, 1995, 1996
and 1997, respectively, for these facilities. Additionally, the Company has
agreements with three telecommunications companies to locate POP sites and
certain of such equipment at their facilities. The expiration dates associated
with these agreements range from December 1998 to January 2000.
F-11
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company leases its facilities and certain office equipment under non-
cancelable operating leases which expires at various dates through December
2001. Total rent expense for all operating leases was approximately
$1,291,000, $2,060,000 and $2,418,000 for the years ended December 31, 1995,
1996 and 1997, respectively.
Future minimum lease commitments for all noncancelable operating leases at
December 31, 1997 are as follows (in thousands):
<TABLE>
<S> <C>
1998.................................................................. $1,710
1999.................................................................. 829
2000.................................................................. 226
2001.................................................................. 216
------
Total................................................................. $2,981
======
</TABLE>
Capital Leases
In August 1994, the Company entered into a master lease agreement under
which a related party began installing networking equipment at the Company's
POP sites and data center. This agreement became effective upon installation
and acceptance by the Company on March 31, 1995. The lease provides for
monthly payments for terms of 48 or 60 months, depending upon the type of
equipment. The Company has continued to install equipment under the terms of
this agreement, resulting in a monthly payment of approximately $896,000 and
$1,443,000 at December 31, 1996 and 1997, respectively.
In September 1995, the Company entered into a master lease agreement with a
third party for an equipment lease line against which the Company has leased
approximately $3,342,000 as of December 31, 1997. The term of the lease is 36
months and provides for monthly payments of approximately $114,000 as of
December 31, 1997. The Company has granted to the third party a security
interest in all equipment leased under this agreement.
Assets capitalized under capital leases totaled approximately $48,856,000,
and $61,927,000 at December 31, 1996 and 1997, respectively, and are included
in computer and telecommunications equipment. Accumulated amortization for
assets capitalized under capital leases totaled approximately $8,306,000 and
$18,542,000 at December 31, 1996 and 1997, respectively. Amortization of
leased assets is included in depreciation and amortization expense. Future
minimum lease payments under capital lease obligations at December 31, 1997
are as follows (in thousands):
<TABLE>
<S> <C>
1998................................................................ $20,516
1999................................................................ 16,077
2000................................................................ 12,498
2001................................................................ 8,444
Thereafter.......................................................... 1,587
-------
Total minimum lease payments........................................ 59,121
Less amount representing interest................................... 10,200
-------
Present value of net minimum lease payments......................... 48,921
Less current portion of capital leases.............................. 15,326
-------
Long-term portion of capital leases................................. $33,595
=======
</TABLE>
F-12
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Other
The Company has a noncancelable service agreement with AT&T for the
utilization of its frame relay telecommunications network. The agreement
provides for minimum payments to AT&T of approximately $300,000 per month over
its three-year term, expiring in June 1999.
The Company has a noncancelable service agreement with MCI for the
utilization of its ATM telecommunications network. The agreement provides for
minimum payments to MCI of approximately $1,200,000 per year over its term,
expiring three years after the end of an initial ramp up period but no later
than June 2000. The Company also has a noncancelable telecommunications
service agreement with MCI for other services, including dedicated access and
800 service, that provides for minimum payments of approximately $8,500,000
over the term of the agreement, expiring in June 1998. The Company had
incurred expenses of approximately $3,700,000 and $8,100,000 for the years
ended December 31, 1996 and 1997, respectively, related to these other
services.
In November 1995, the Company entered into a two-year service agreement
under which a third party provided substantially all of the network analysis
and deployment and maintenance of POP sites. In 1997, the third party was
purchased by Williams Communication, Group Inc. (Williams), a stockholder of
the Company and whom also has a seat on the Board of Directors of the Company,
and the agreement was extended to December 31, 2000. The Company will
reimburse the related party for its employee compensation and direct costs for
services provided. At the end of the agreement, Williams is obligated to
transfer to the Company those personnel, resources, and facilities used to
support the Company's network analysis, POP site deployment, and maintenance.
Additionally, as part of the agreement, the Company granted 60,000 options for
its common stock to employees of Williams at an exercise price of $3.75. At
December 31, 1997, all of these options were vested.
In August 1997, the Company entered into a five-year service and equipment
agreement under which Williams, a related party, will provide
telecommunication services and equipment. The agreement provides for minimum
payments as follows: $1.2 million in 1998, $2.5 million in 1999, $7.0 million
in 2000, $6.5 million in 2001 and $4.0 million in 2002. At the election of the
third party, $2.0 million of the minimum payments may be paid by the issuance
of common stock of the Company at the then-current fair market value.
4. CONVERTIBLE DEBENTURES AND NOTES PAYABLE
Bridge Loans
At December 31, 1995, convertible debentures in the amount of $70,000,
representing 9,802 shares of common stock, were outstanding. The conversion of
these debentures into shares of common stock subject to rescission was
completed in March 1996.
In 1995, the Company issued convertible notes totaling $7,000,000 to
shareholders of which $4,000,000, plus accrued interest, was converted into
Series B convertible preferred stock in December 1995. The remaining
$3,000,000 outstanding at December 31, 1995 was converted into Series C
convertible preferred stock in February 1996.
In June 1997, the Company borrowed $3 million from a related party in the
form of a 10% convertible secured promissory note (the Secured Note). The
Secured Note automatically converted into 253,403 shares of common stock upon
the closing of the Public Offering at a per share conversion price equal to
the Public Offering price of $12.00. In connection with the Secured Note, the
Company issued a warrant to purchase 63,351 shares of common stock at an
exercise price of $6.00 per share (see Note 7).
F-13
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In June 1997, the Company borrowed $2 million from a stockholder in the form
of a 10% unsecured promissory note (the Unsecured Note). The Unsecured Note
was repaid in August 1997. In connection with the Unsecured Note, the Company
issued a warrant to purchase 83,333 shares of common stock at an exercise
price of $6.00 per share (see Note 7).
Senior Notes
In December 1997, the Company issued 150,000 units (collectively, the
Units), each consisting of $1,000 principal amount of 12 3/4% Senior Notes
(the Senior Notes) due 2007 and one warrant (a Warrant), each Warrant
entitling the holder thereof to purchase 6.34 shares of common stock at $10.86
per share and such Warrants expire on December 15, 2007 (see Note 7) for
aggregate cash proceeds of $150.0 million. Approximately $52.5 million of the
cash proceeds was placed in a escrow account to fund the first six interest
payments in accordance with the Senior Note agreement.
The Warrants resulted in the right of the holders to purchase 951,108 shares
of the Company's common stock. The Company deemed the fair value of the
warrants, using the Black-Scholes method to be approximately $4,440,000 which
was recorded as a discount on the Senior Notes. The discount is being
amortized as interest expense over the term of the Senior Notes. Amortization
expense was nominal for the year ended December 31, 1997.
The Senior Notes will be redeemable at the option of the Company, in whole
or in part, at any time on or after December 15, 2002, at the redemption
prices set forth within the Senior Note agreement, plus accrued interest to
the date of redemption. In addition, on or prior to December 15, 2000, the
Company may redeem up to 35% of the original aggregate principal amount of
Senior Notes at a redemption price of 112.75% of the principal amount,
together with accrued and unpaid interest to the date of redemption with the
net cash proceeds of one or more public equity offerings or the sale of common
stock to a strategic investor, provided that at least 65% of the original
aggregate principal amount of the Senior Notes remain outstanding.
In connection with the issuance of Senior Notes, the Company incurred
approximately $5,000,000 of debt issuance costs which are classified as other
assets. These costs are being amortized as interest expense over the term of
the Senior Notes. Amortization expense was nominal for the year ended
December 31, 1997.
5. COMMON STOCK SUBJECT TO RESCISSION
In August 1993, the Company commenced sales of convertible debentures and
certain additional shares of its common stock. Through March 31, 1995, sales
of convertible debentures aggregated $4,260,000, and issuance of common stock
aggregated $890,000. The sale of common stock and sale of and/or conversion of
debentures into common stock was not made pursuant to a registration statement
filed under the Securities Act of 1933 (the Act) or any filings pursuant to
the laws of any of the states in which such sales occurred (State Blue Sky
Laws). Although at the time the Company believed the sale and conversion, if
applicable, of these securities was exempt from the provisions of the Act and
applicable State Blue Sky Laws, it appears that the appropriate exemptions may
not have been available. As a result, on September 30, 1997, the Company made
rescission offers (the "Rescission Offer") to certain purchasers of these
securities who are entitled to a return of the consideration paid for their
stock or debentures. As such, these shares have been classified as common
stock subject to rescission in the accompanying financial statements.
Additionally, options issued pursuant to the Company's 1995 Stock Incentive
Plan to Employees and Consultants and non-plan options were issued in various
states for which the Company may not have had an available exemption under
state laws. Such options are potentially subject to rescission and the Company
has included them in the Rescission Offer. As of December 31, 1997, statutes
of limitations under federal and state securities laws applicable to the
shares which may have been issued
F-14
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
without securities laws exemptions have lapsed and the Rescission Offer had
expired. Pursuant to the Rescission Offer, the Company offered to rescind the
issuance of shares and options as to which the applicable statute of
limitations had not run. There can be no assurances that the Company will not
otherwise be subject to additional liabilities with respect to such issuances.
The Company repurchased 32,423 shares of Common Stock subject to the
Rescission Offer for $548,000 and paid related interest charges of $125,000.
Based upon the above, the Company has reclassified the remaining rescission
liability and shares into stockholders' equity.
6. STOCKHOLDERS' EQUITY
On August 5, 1996, the Company amended its Articles of Incorporation to
increase the number of authorized shares of Class A common stock and preferred
stock to 13,333,333 and 7,333,333, respectively. Of the 7,333,333 authorized
shares of preferred stock, 1,000,000, 866,667, 933,333, and 4,533,333 are
designated as Series A, B, C, and D, respectively.
Initial Public Offering and Direct Placements
Effective July 30, 1997, the Company reincorporated under the laws of the
state of Delaware, at which time a one for 15 reverse stock split took effect.
In addition, the Company authorized 100,000,000 shares of its common stock.
Upon closing of the initial public offering (the Public Offering), all
outstanding shares of Series A, B, C, and D convertible preferred stock and
Class B common stock were converted into common stock. All share and per share
data in these financial statements have been retroactively restated to reflect
the reverse stock split.
On August 1, 1997, the Company effected its Public Offering of common stock.
The offering consisted of 4,300,000 shares of common stock issued to the
public at $12.00 per share. Concurrent with the closing of the Public
Offering, certain strategic investors, including Williams, purchased directly
from the Company 1,499,236 shares of common stock having an aggregate purchase
price of approximately $18 million (including the cancellation of
approximately $3 million in indebtedness). Such shares are unregistered shares
and were purchased at the Public Offering price of $12.00 per share.
In connection with the direct purchase, the Company issued warrants to one
of the strategic investors to purchase 291,667 shares of the Company's common
stock at $6.00 per share (see Note 7). In September, the underwriters
exercised an option to purchase an additional 645,000 shares of common stock
at the Public Offering price of $12.00 per share to cover over-allotments in
connection with the Public Offering.
Preferred Stock
Preferred stock at December 31, 1996 is as follows:
<TABLE>
<CAPTION>
SHARES
ISSUED AND PAR LIQUIDATION
AUTHORIZED OUTSTANDING VALUE AMOUNT PREFERENCE
---------- ----------- ------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Series A convertible.... 1,000,000 906,454 $0.001 $10,146,987 $10,000,000
Series B convertible.... 866,667 366,946 $0.001 4,857,130 4,035,130
Series C convertible.... 933,333 928,243 $0.001 23,651,008 20,690,804
Series D convertible.... 4,533,333 2,699,588 $0.001 56,559,871 55,071,586
--------- ----------- -----------
4,901,231 $95,214,996 $89,797,520
========= =========== ===========
</TABLE>
In connection with the Public Offering, all shares of Series A, B, C and D
preferred stock were converted into common stock of the Company.
F-15
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Common Stock
Common stock at December 31, 1996 is as follows:
<TABLE>
<CAPTION>
SHARES ISSUED PAR
AUTHORIZED AND OUTSTANDING VALUE AMOUNT
---------- --------------- ------ ----------
<S> <C> <C> <C> <C>
Class A......................... 13,333,333 1,385,790 $0.001 $1,769,819
Class B......................... 10,024 7,117 $0.001 80,065
---------- --------- ------ ----------
13,343,357 1,392,907 $1,849,884
========== ========= ==========
</TABLE>
In connection with the Public Offering, all shares of Class A and Class B
common stock were converted into common stock of the Company.
Stock Option Plans
1995 Stock Incentive Plan for Employees and Consultants. The Company's 1995
Stock Incentive Plan for Employees and Consultants (the 1995 Plan) provides
for the granting to employees of incentive stock options and for the granting
to employees and consultants of nonstatutory stock options, stock appreciation
rights (SARs) and restricted stock awards (RSAs). No SARs or RSAs have been
granted under the 1995 Plan. The 1995 Plan was approved by the Board of
Directors in September 1995 and Stockholders in September 1995, and an
amendment decreasing the number of shares thereunder from 840,000 to 762,600
was approved by the Board of Directors in February 1996. Incentive stock
options granted under the 1995 Plan must generally be exercised within three
months of the end of an optionee's status as an employee or consultant of the
Company, or within 12 months after such optionee's termination by death or
disability, but in no event later than the expiration of the option's term,
which may not exceed ten years. The exercise price of all options granted
under the 1995 Plan must be at least equal to the fair market value of the
common stock on the date of grant. With respect to any participant who owns
stock possessing more than 10% of the voting power of all classes of the
Company's outstanding capital stock, the exercise price of any option must
equal at least 110% of the fair market value on the grant date and the term of
the option must not exceed five years. The term of all other options granted
under the 1995 Plan may not exceed 10 years. The 1995 Plan was terminated
effective October 4, 1996, and no further grants are being made thereunder. A
total of 762,600 shares of common stock are reserved for issuance pursuant to
the 1995 Plan. As of December 31, 1997, options to purchase 332,130 shares of
common stock at a weighted exercise price of $3.75 per share were outstanding
under the 1995 plan.
Amended and Restated 1996 Stock Plan. The Company's Amended and Restated
1996 Stock Plan (the Restated 1996 Plan) provides for the granting to
employees of incentive stock options and for the granting to employees,
directors and consultants of nonstatutory stock options and stock purchase
rights (Rights). The 1996 Plan was initially approved by the Board of
Directors effective as of December 1996. It was amended and restated in May
1997 and approved by the Stockholders at the 1997 annual meeting. Unless
terminated sooner, the Restated 1996 Plan will terminate automatically in
December 2006. The form of option agreement currently in use provides that
options generally must be exercised within 90 days of the end of optionee's
status as an employee, director or consultant of the Company. Under the
Restated 1996 Plan, options must be exercised within twelve months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option's term. In the case of Rights, the Restricted Stock
Purchase Agreement issued in connection with the Right shall grant the Company
a repurchase option exercisable upon the voluntary or involuntary termination
of the purchaser's service with the Company. The purchase price for shares
repurchased pursuant to the Restricted Stock Purchase Agreement shall be the
original price paid by the purchaser and may be paid by cancellation of any
indebtedness of the purchaser to the Company. The repurchase option shall
F-16
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
generally lapse at a rate of 20% per year over five years. Generally, options
vest 25% after one year and 1/36 per month thereafter. The exercise price of
all incentive stock options granted under the Restated 1996 Plan must be at
least equal to the fair market value of the common stock on the date of grant.
The exercise price of nonstatutory stock options and Rights must at least be
equal to 85% of the fair market value of the common stock on the date of
grant. With respect to any participant who owns stock possessing more than 10%
of the voting power of all classes of the Company's outstanding capital stock,
the exercise price of any incentive or nonstatutory stock option granted must
equal at least 110% of the fair market value on the grant date. The term of an
incentive stock option granted to such a 10% stockholder must not exceed five
years. The term of other options granted under the Restated 1996 Plan may not
exceed ten years. A total of 1,100,000 shares of common stock are currently
reserved for issuance pursuant to the Restated 1996 Plan. As of December 31,
1997, options to purchase 914,283 shares of common stock at a weighted average
exercise price of $6.40 per share were outstanding, and 185,717 shares of
common stock remained available for future grant under the Restated 1996 Stock
Plan.
The Restated 1996 Plan provides that in the event of a merger of the Company
with or into another corporation, a sale of substantially all of the Company's
assets or a like transaction involving the Company, each option shall be
assumed or an equivalent option substituted by the successor corporation. If
the outstanding options are not assumed or substituted as described in the
preceding sentence, the Restated 1996 Plan provides the optionee or Right
holder to have the right to exercise the option or Right as to all of the
optioned stock, including shares as to which it would not otherwise be
exercisable.
1997 Stock Plan. The Company's 1997 Stock Plan (the 1997 Plan) provides for
the granting to employees of incentive stock options and for the granting to
employees, directors and consultants of nonstatutory stock options and stock
purchase rights (Rights). The 1997 Plan was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. Unless terminated
sooner, the 1997 Plan will terminate automatically in 2007. Options granted
under the 1997 Plan must generally be exercised within three months of the end
of optionee's status as an employee, director or consultant of the Company, or
within twelve months after such optionee's termination by death or disability,
but in no event later than the expiration of the option's term. The exercise
price of all incentive stock options granted under the 1997 Plan must be at
least equal to the fair market value of the common stock on the date of grant.
The exercise price of nonstatutory stock options and Rights granted under the
1997 Plan is determined by the 1997 Plan's Compensation Committee, but with
respect to nonstatutory stock options intended to qualify as "performance-
based compensation," the exercise price must at least be equal to the fair
market value of the common stock on the date of grant. With respect to any
participant who owns stock possessing more than 10% of the voting power of all
classes of the Company's outstanding capital stock, the exercise price of any
incentive stock option granted must equal at least 110% of the fair market
value on the grant date and the term of such incentive stock option must not
exceed five years. The term of other incentive stock options granted under the
1997 Plan may not exceed ten years. A total of 1,500,000 shares of common
stock are currently reserved for issuance pursuant to the 1997 Plan. As of
December 31, 1997, options to purchase 511,271 shares of common stock at a
weighted average exercise price of $11.25 per share were outstanding, and
988,729 shares of common stock remained available for future grants under the
1997 plan.
The 1997 Plan provides that in the event of a merger of the Company with or
into another corporation, a sale of substantially all of the Company's assets
or a like transaction involving the Company, each option shall be assumed or
an equivalent option substituted by the successor corporation. If the
outstanding options are not assumed or substituted as described in the
preceding sentence, the 1997 Plan provides for the optionee or Right holder to
have the right to exercise the option or Right as to all of the optioned
stock, including shares as to which it would not otherwise be exercisable.
F-17
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
1997 Employee Stock Purchase Plan. The Company's 1997 Employee Stock
Purchase Plan (the 1997 Purchase Plan) was approved by the Board of Directors
on June 6, 1997 and by the stockholders on June 30, 1997. A total of 500,000
shares of common stock has been reserved for issuance under the 1997 Purchase
Plan. The 1997 Purchase Plan, which is intended to qualify under Section 423
of the Internal Revenue Code, consists of 24-month offering periods beginning
on the first trading day on or after February 15 and August 15 of each year,
except for the first such offering period, which commenced on August 4, 1997
and ends on February 13, 1998. Each offering period contains four six-month
purchase periods. Employees are eligible to participate if they are
customarily employed by the Company or any designated subsidiary for at least
20 hours per week and more than five months in any calendar year. The 1997
Purchase Plan permits eligible employees to purchase common stock through
payroll deductions of up to 10% of an employee's compensation (excluding
overtime, shift premium, and other bonuses and incentive compensation), up to
a maximum of $25,000 for all offering periods ending within the same calendar
year. No employee may purchase more than 25,000 shares in any purchase period.
The price of stock purchased under the 1997 Purchase Plan is 85% of the lower
of the fair market value of the common stock at the beginning of the offering
period or at the end of the current purchase period. Employees may end their
participation at any time during an offering period, and they will be paid
their payroll deductions to date. Participation ends automatically upon
termination of employment with the Company.
The 1997 Purchase Plan provides that, in the event of a merger of the
Company with or into another corporation or a sale of substantially all of the
Company's assets, each outstanding option shall be assumed or an equivalent
option shall be substituted for it, or the Board of Directors or its committee
shall shorten the purchase and offering periods then in progress (so that
employees' rights to purchase stock under the Plan are exercised prior to the
merger or sale of assets). The 1997 Purchase Plan will terminate in 2007.
In April 1995, an additional 53,333 options to purchase common stock for
$30.00 per share were issued to two of the Company's executives in connection
with their employment by the Company. These options were fully vested upon
issuance and are exercisable over five years.
In October 1995 and August 1996, the exercise price of options to purchase
182,375 shares and 46,673 shares of common stock, respectively, were repriced
to $3.75 per share, the then fair value of the common stock, as determined by
the Company's Board of Directors.
The Company issued options to purchase 179,300 shares of common stock in
December 1996, 40,267 shares of common stock in January 1997, 216,733 shares
of common stock in June 1997, and repriced 181,473 options in July 1997. The
Company recorded deferred compensation, for financial reporting purposes, of
approximately $188,000 in 1996 and $1,303,000 for the year ended December 31,
1997, with respect to such option grants to reflect the difference between the
exercise price and the deemed fair value for financial reporting purposes of
these shares. Amortization of this deferred compensation was $0 in 1996 and
$222,000 in the year ended December 31, 1997. The amortization of this
deferred compensation will continue over the four year vesting period of the
associated stock options.
F-18
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes stock option activity under all of the Plans:
<TABLE>
<CAPTION>
NUMBER PRICE
OF SHARES PER SHARE
--------- --------------
<S> <C> <C>
Balance at December 31, 1994.......................... 352,456 $3.75--$33.00
Granted.............................................. 642,075 $3.75--$33.00
Exercised............................................ (133) $9.00
Canceled............................................. (187,315) $11.25--$12.45
---------
Balance at December 31, 1995.......................... 807,083 $3.75--$33.00
Granted.............................................. 421,620 $3.75
Exercised............................................ (4,483) $3.75--$ 9.00
Canceled............................................. (95,218) $3.75--$30.00
---------
Balance at December 31, 1996.......................... 1,129,002 $3.75--$33.00
Granted.............................................. 1,472,338 $3.75--$11.25
Exercised............................................ (64,544) $3.75
Canceled............................................. (244,630) $3.75--$11.25
---------
Balance at December 31, 1997.......................... 2,292,166 $3.75--$30.00
=========
</TABLE>
At December 31, 1997, vested options totaled 710,495.
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ----------------------------
WEIGHTED AVERAGE NUMBER
NUMBER REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE AND VESTED EXERCISE PRICE
--------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$3.75................... 1,029,579 8.20 $ 3.75 612,161 $ 3.75
$6.00................... 394,638 9.04 $ 6.00 43,336 $ 6.00
$8.85--$9.30............ 301,784 9.46 $ 9.11 -- --
$11.25.................. 511,171 9.83 $11.25 -- --
$12.45--$30.00.......... 54,998 6.80 $12.98 54,998 $12.98
--------- -------
Total................... 2,292,166 710,495
========= =======
</TABLE>
Stock-Based Compensation
Pro forma information regarding results of operations and loss per share is
required by FAS 123 for awards granted after December 31, 1994 as if the
Company had accounted for its stock-based awards to employees under a
valuation method permitted by FAS 123. The value of the Company's stock-based
awards to employees in 1995 and 1996 was estimated using the minimum value
method. Options granted after the Public Offering have been valued using the
Black-Scholes option pricing model. Among other things, the Black-Scholes
model considers the expected volatility of the Company's stock price,
determined in accordance with FAS 123, in arriving at an option valuation. The
minimum value method does not consider stock price volatility. Further,
certain other assumptions necessary to apply the Black-Scholes model may
differ significantly from assumptions used in calculating the value of options
granted in 1995 and 1996 under the minimum value method.
F-19
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted average
assumptions:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Expected volatility........................................ N/A N/A .250
Expected life of options in years.......................... 4.4 4.0 3.3
Risk-free interest rate.................................... 6.2% 6.3% 6.0%
Expected dividend yield.................................... 0.00% 0.00% 0.00%
</TABLE>
The weighted average minimum value of stock options granted during 1997 was
$1.87. For pro forma purposes, the estimated minimum value of the Company's
stock-based awards to employees is amortized over the options' vesting period.
The results of applying FAS 123 to the Company's option grants in 1995, 1996
and 1997 was not material to the results of operations or loss per share for
those years reported in the accompanying statements of operations. Because FAS
123 is applicable only to awards granted subsequent to December 31, 1994, its
pro forma effect will not be fully reflected until approximately 1998.
7. WARRANTS TO PURCHASE COMMON STOCK
In connection with the Company's Public Offering, all of the outstanding
warrants to purchase preferred stock were converted to warrants to purchase
common stock. The following warrants to purchase shares of the Company's
common stock were outstanding at December 31, 1997:
<TABLE>
<CAPTION>
WARRANTS OUTSTANDING
----------------------------------
NUMBER WEIGHTED AVERAGE YEAR
EXERCISE PRICES OF SHARES EXERCISE PRICE EXPIRES
--------------- --------- ---------------- -------
<S> <C> <C> <C>
$ 7.40-$15.00............................. 187,517 $11.36 1998
$19.49.................................... 692,793 $19.49 1999
$ 3.75-$26.87............................. 320,203 $22.25 2000
$ 6.00.................................... 438,351 $ 6.00 2002
$10.86.................................... 951,108 $10.86 2007
---------
2,589,972
=========
</TABLE>
The above warrants were issued at various times during the three year period
ended December 31, 1997 in connection with a service agreement, a capital
lease agreement, and several debt and equity financings. The Company has
deemed the fair market value of such warrants, using the Black-Scholes method,
to be $822,000, $61,000, $5,700,000 and $2,623,000, respectively. The Company
is amortizing the value of the warrants over the term of the related
agreements which range from one to ten years. Amortization expense for the
years ended December 31, 1995, 1996 and 1997 was $0, $1,942,000 and
$1,720,000, respectively. The Company has reserved the amount of shares
necessary to meet the exercise of these warrants.
8. EMPLOYEE BENEFIT PLANS
Retirement Savings Plan
The Company maintains a contributory 401(k) plan that covers substantially
all employees. The Company contributes $0.30 for every $1.00 contributed by
the participant up to a maximum of 1.5% of the participants' compensation. The
Company contributed $6,000, $45,000 and $158,000 to the plan during the years
ended December 31, 1995, 1996 and 1997, respectively.
F-20
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. INCOME TAXES
As of December 31, 1997, the Company had federal and state net operating
loss carryforwards of approximately $141,000,000 and $109,000,000,
respectively. The net operating loss carryforwards will expire at various
dates beginning in the years 2003 through 2012, if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes of December 31, 1996 and 1997 are as
follows:
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............... $ 32,000,000 $ 55,000,000
Write-off of network equipment 5,000,000 4,000,000
Other, net..................................... 1,000,000 1,000,000
------------ ------------
Total deferred tax assets........................ 38,000,000 60,000,000
------------ ------------
Deferred tax liabilities:
Other, net 1,000,000 2,000,000
------------ ------------
Net deferred tax assets.......................... 37,000,000 58,000,000
Valuation allowance.............................. (37,000,000) (58,000,000)
------------ ------------
$ -- $ --
============ ============
</TABLE>
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability
of the deferred tax assets such that a full valuation allowance has been
recorded. These factors include the Company's history of net losses since
inception and the fact that the market in which the Company competes is
intensely competitive and characterized by rapidly changing technology. The
Company believes that, based on the currently available evidence, it is more
likely than not that the Company will not generate taxable income through
1999, and possibly beyond, and accordingly will not realize the Company's
deferred tax assets through 1999 and possibly beyond. The Company will
continue to assess the realizability of the deferred tax assets based on
actual and forecasted operating results. In addition, the utilization of net
operating losses may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration
of net operating losses before utilization.
The net valuation allowance increased by approximately $28,000,000 in 1996
and $21,000,000 in 1997.
10. RELATED PARTY TRANSACTIONS--OTHER
An officer of the Company is a majority shareholder of a vendor of the
Company. The Company incurred marketing fees to the vendor totaling $920,000,
$2,448,000 and $2,600,000 in the years ended December 31, 1995, 1996, and
1997, respectively.
F-21
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
11. CONTINGENCIES
In late April and early May, 1997, three putative securities class action
complaints were filed in the United States District Court, Central District by
certain stockholders of Diana Corporation (Diana), the parent corporation of
Sattel Communications LLC (Sattel), alleging securities fraud related to
plaintiffs' purchase of shares of Diana Common Stock in reliance upon
allegedly misleading statements made by defendants, Diana, Sattel and certain
of their respective affiliates, officers and directors. The Company was named
as a defendant in the complaint in connection with certain statements made by
Diana and officers of Diana related to the Company's purchase of network
switching equipment from Diana's Sattel subsidiary. The plaintiffs seek
unspecified compensatory damages. A trial date has not yet been determined.
While the ultimate outcome of such litigation is uncertain, the Company
believes it has meritorious defenses to the claims and intends to conduct a
vigorous defense. An unfavorable outcome in this matters could have a material
adverse effect on the Company's financial condition. In addition, even if the
ultimate outcomes is resolved in favor of the Company, the defense of such
litigation could entail considerable cost and the diversion of efforts of
management, either or which could have a material adverse effect on the
Company's results of operations.
Sattel Settlement
On April 22, 1997, a complaint was filed in the Los Angeles County,
California Superior Court against the Company and other unnamed defendants by
Sattel Communications LLC (Sattel). Sattel's complaint alleged that the
Company was in breach of an agreement to pay for up to $4.3 million of DSS
Switches from Sattel for use in the Company's network and also sought
unspecified consequential and punitive damages. On July 11, 1997, the Company
settled the complaint with Sattel in the amount of $4.4 million. The Company
also purchased 32,986 shares of the Company's common stock held by Sattel on
the day after the closing of the offering at the Public Offering price. In
August, 1997 the Company made cash payments to Sattel totaling approximately
$4.8 million, to satisfy its obligations pursuant to the settlement agreement
and the repurchase of common stock. Upon the settlement of the Sattel
complaint, the Company recorded $970,000 of other income related to the
reversal of previously established reserves.
12. SUBSEQUENT EVENTS
On February 5, 1998, the Company acquired all of the outstanding stock of
Internex Information Services, Inc. (Internex). The transaction was accounted
for using the purchase method of accounting. The total purchase price of
approximately $23.9 million consisted of a $15.5 million cash payment upon
closing and the assumption of approximately $8.4 million of Internex's
liabilities (including acquisition costs).
A summary of the purchase price allocation is as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Current and other assets............................................ $ 1,348
Computer and telecommunications equipment........................... 4,784
Goodwill............................................................ 12,576
Write-off of in process technology.................................. 5,200
-------
Total purchase price allocation.................................... $23,908
=======
</TABLE>
F-22
<PAGE>
CONCENTRIC NETWORK CORPORATION
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The purchase price allocation has been recorded on a tentative basis, and
any adjustments to the purchase price allocation will be made within one year
of the purchase in accordance with generally accepted accounting principles.
Goodwill arising from the acquisition will be amortized on a straight-line
basis over 5 years.
The following unaudited pro forma information represents the combined
results of operations as if the acquisition of Internex had occurred as of the
beginning of the periods presented and does not purport to be indicative of
what would have occurred had the acquisitions been made as of that date or the
results which may occur in the future.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
-----------------
(IN THOUSANDS,
EXCEPT PER
SHARE AMOUNTS)
--------------
<S> <C> <C> <C>
Pro forma net revenues.................................. $ 55,411
Pro forma net loss...................................... $ (83,354)
Pro forma net loss per share............................ $ (8.44)
</TABLE>
The pro forma results include the historical operations of the Company and
the historical operations of the acquired business adjusted to reflect certain
pro forma adjustments, including the amortization of intangible assets,
totaling $2.5 million. In addition, the pro forma results reflect the interest
expense that would have been incurred had the Senior Notes been offered on
January 1, 1997. Finally, interest expense and related charges of bridge
financings have been excluded since such bridge financings would not have
occurred if the Senior Notes been offered on January 1, 1997. The pro forma
results do not include the write-off of purchased research and development of
$5.2 million since it is considered a non-recurring adjustment.
F-23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Internex Information Services, Inc.:
We have audited the accompanying balance sheet of Internex Information
Services, Inc. (a California corporation and a wholly owned subsidiary of
Internex Communications, Inc.) as of June 30, 1997 and the related statements
of operations, shareholder's equity and cash flows for the year then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Internex Information
Services, Inc. as of June 30, 1997, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company had an accumulated deficit of approximately
$11.2 million and negative working capital of approximately $2.7 million. In
addition, for the year ended June 30, 1997, the Company had a negative cash
flow from operations and incurred a significant net operating loss.
Management's current projections indicate that the cash flow from operations
will be insufficient to enable the Company to continue to meet its obligations
and fund operating expenses during fiscal 1998. These conditions, among
others, raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also
described in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ Arthur Andersen LLP
San Jose, California
January 26, 1998
F-24
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AMOUNT)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1997
-------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash................................................... $ 68 $ 11
Accounts receivable, net of allowance for doubtful
accounts of $339 and $207, respectively............... 1,002 1,403
Inventories............................................ 162 40
Other current assets................................... 113 124
-------- -------
Total current assets.................................. 1,345 1,578
-------- -------
Property And Equipment:
Network and computer equipment......................... 6,310 6,618
Furniture and office equipment......................... 557 565
Leasehold improvements................................. 773 992
-------- -------
7,640 8,175
Less--Accumulated depreciation and amortization........ (1,872) (2,877)
-------- -------
Property and equipment, net............................. 5,768 5,298
-------- -------
Other Assets........................................ 145 144
-------- -------
$ 7,258 $ 7,020
======== =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current Liabilities:
Current portion of capital lease obligations........... $ 523 $ 523
Notes payable to bank.................................. -- 1,228
Accounts payable....................................... 2,373 2,285
Accrued compensation and other employee benefits....... 165 216
Other current liabilities.............................. 994 1,052
-------- -------
Total current liabilities............................. 4,055 5,304
-------- -------
Capital lease obligations, net of current portion....... 1,115 852
-------- -------
Redeemable Convertible Preferred Stock.................. -- --
-------- -------
Commitments (Note 5)
Shareholder's Equity:
Preferred stock, no par value
Authorized--2,000,000 shares at June 30, 1997
Outstanding--None outstanding......................... -- --
Common stock, no par value
Authorized--30,000,000 shares
Issued and outstanding--7,000,000 at June 30, 1997.... 13,239 15,141
Accumulated deficit.................................... (11,151) (14,277)
-------- -------
Total shareholder's equity............................ 2,088 864
-------- -------
$ 7,258 $ 7,020
======== =======
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-25
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
YEAR ENDED ENDED DECEMBER 31,
JUNE 30, -------------------
1997 1996 1997
---------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
Revenues:
Service revenue............................... $ 8,486 $ 3,801 $4,823
Equipment revenue............................. 1,696 1,397 147
------- -------- ---------
Total revenues.............................. 10,182 5,198 4,970
------- -------- ---------
Operating Costs And Expenses:
Data communications and operations............ 7,563 3,024 4,304
Equipment cost................................ 1,415 1,170 108
Sales and marketing........................... 3,687 1,503 1,807
General and administrative.................... 2,730 1,175 1,308
Research and development...................... 569 258 504
------- -------- ---------
Total operating expenses.................... 15,964 7,130 8,031
------- -------- ---------
Loss from operations............................ (5,782) (1,932) (3,061)
Other income (expense):
Interest expense.............................. (84) (39) (110)
Other income, net............................. -- -- 45
------- -------- ---------
(84) (39) (65)
------- -------- ---------
Net loss........................................ $(5,866) $ (1,971) $ (3,126)
======= ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
STATEMENTS OF SHAREHOLDER'S EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
-------------- ACCUMULATED SHAREHOLDER'S
SHARES AMOUNT DEFICIT EQUITY
------ ------- ----------- -------------
<S> <C> <C> <C> <C>
Balance At June 30, 1996.............. 4,048 $ 6,609 $ (5,285) $ 1,324
Contributed capital received from
Internex Communications, Inc....... -- 6,330 -- 6,330
Conversion of redeemable convertible
preferred stock into common stock.. 2,952 300 -- 300
Net loss............................ -- -- (5,866) (5,866)
----- ------- -------- -------
Balance At June 30, 1997.............. 7,000 13,239 (11,151) 2,088
Contributed capital received from
Internex Communications, Inc.
(unaudited)........................ -- 1,902 -- 1,902
Net loss (unaudited)................ -- -- (3,126) (3,126)
----- ------- -------- -------
Balance At December 31, 1997
(unaudited).......................... 7,000 $15,141 $(14,277) $ 864
===== ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FOR THE SIX MONTHS
JUNE 30, ENDED DECEMBER 31,
---------- --------------------
1997 1996 1997
---------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss...................................... $(5,866) $ (1,971) $ (3,126)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization............. 1,380 506 1,005
Provision for doubtful accounts........... 563 140 --
Changes in operating assets and
liabilities:
Accounts receivable..................... (30) 304 (401)
Inventories............................. (29) (6) 122
Other assets............................ (190) (317) (10)
Accounts payable........................ 769 (217) (88)
Other current liabilities............... 385 414 109
------- --------- ---------
Net cash used in operating activities......... (3,018) (1,147) (2,389)
------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment........... (3,140) (2,819) (535)
------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash received from Internex Communications,
Inc.......................................... 6,330 3,947 1,902
Proceeds from bank line of credit............. -- -- 1,228
Principal payments on capital lease
obligations.................................. (268) (28) (263)
------- --------- ---------
Net cash provided by financing activities..... 6,062 3,919 2,867
------- --------- ---------
Net decrease in cash.......................... (96) (47) (57)
Cash, beginning of period..................... 164 164 68
------- --------- ---------
Cash, end of period........................... $ 68 $ 117 $ 11
======= ========= =========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Equipment acquired under capital leases....... $ 1,316 $ -- $ --
======= ========= =========
Conversion of preferred stock into common
stock........................................ $ 300 $ -- $ --
======= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest expense................ $ 84 $ 39 $ 110
======= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1997
1. NATURE OF OPERATIONS, ORGANIZATION AND LIQUIDITY:
Internex Information Services, Inc. ("Internex" or the "Company"), a
California corporation, is a wholly owned subsidiary of Internex
Communications, Inc., a California corporation ("Communications Inc." or the
"Parent Company"). The Company provides Internet access services and products
to both organizations and individuals throughout the United States. The
Company offers a broad spectrum of internet access services ranging from dial-
up services to continuous access services using dedicated high speed telephone
circuits. In addition, the Company offers Web hosting services, training and
consulting services.
The Company was incorporated in August 1993, and commenced commercial
operations in May 1995. On March 17, 1995, the shareholders of Internex
entered into an organization and financing agreement with Communications Inc.,
a California corporation formed for the purpose of acquiring Internex, whereby
the shareholders of Internex converted 4,048,000 shares of common stock,
2,024,000 shares of Series A preferred stock and an $83,000 debenture into
4,275,720 shares of Communications Inc. common stock (see Note 6).
The Company is subject to certain risks and uncertainties including, among
others, the need for additional financing, dependence on key personnel, actual
and prospective competition by entities with greater financial and other
resources, risks associated with the development of the Internet market, risks
associated with consolidation in the industry, acquisitions and international
expansion, limited experience in the market for individual customers and the
software industry, technology and regulatory risks and dependence upon sole
and limited suppliers.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As of June 30, 1997, the Company had
an accumulated deficit of approximately $11.2 million and negative working
capital of approximately $2.7 million. In addition, for the year ended June
30, 1997, the Company had a negative cash flow from operations and incurred a
significant net operating loss. Management's current projections indicate that
the cash flow from operations will be insufficient to enable the Company to
continue to meet its obligations and fund operating expenses during fiscal
1998. The Company has been engaged in several efforts to raise the necessary
working capital through an equity offering to enable the Company to continue
to meet its debt obligations and monthly operating expense requirements,
however, there can be no assurances that the efforts to raise the necessary
working capital will be successful. These conditions, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates in Preparation of Financial Statements
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reporting amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
Revenues from services consist primarily of fixed monthly service fees and
hourly amounts based on usage and are recognized as the service is provided.
Payments received in advance of providing services are deferred until the
period such services are provided. Deferred revenue, which was approximately
$354,000 at June 30, 1997, is included in other current liabilities in the
accompanying balance sheet. Revenues from the sale of
F-29
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
equipment, which is provided by third-party equipment manufacturers, is
recognized at the time the installation of the equipment is complete.
Significant Customer
No single customer accounted for more than 10% of the Company's total
revenues during the year ended June 30, 1997.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist principally of accounts receivable. The
Company establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of specific customers, historical trends related
to past losses and other information. As of June 30, 1997, approximately 47%
of accounts receivable were concentrated with fifteen customers.
Inventories
Inventory consists of equipment purchased from third-party equipment
manufacturers and is stated at the lower of cost or market, using the first-
in, first-out method.
Property and Equipment
Property and equipment are stated at cost. Depreciation, including
depreciation of assets acquired under capital leases, is provided using the
straight-line method over the estimated useful lives of the assets (or over
the lease term, if shorter, for capital leases and leasehold improvements),
which range from three to five years.
The Company leases certain network and computer equipment under non-
cancelable capital leasing arrangements. Total cost of equipment capitalized
under capital leases as of June 30, 1997 was approximately $1.9 million and
related accumulated depreciation was approximately $325,000.
3. RELATED PARTY TRANSACTIONS:
The Company shares its corporate facilities with Internex Communications
Inc., and Tiara Computer Systems, Inc., ("Tiara") a non-operating wholly owned
subsidiary of Internex Communications Inc. that filed Chapter 7 liquidation
bankruptcy in 1996. Reimbursement of general operating expenses from Internex
Communications Inc. and Tiara was not significant during fiscal 1997. As of
June 30, 1997, amounts due to or from either Communications Inc., or Tiara
were not significant, and the total payments received from Tiara during 1997
were not significant.
4. BANK DEBT:
On July 21, 1997, the Company entered into a $200,000 promissory note
payable agreement with a bank which bears interest at the prime rate plus 1.5%
(10% as of January 26, 1998). Principal borrowings and accrued interest under
the promissory note are due by January 31, 1998. As of January 26, 1998,
$200,000 was outstanding under the promissory note.
F-30
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
On July 26, 1997 the Company entered into a line of credit agreement (the
"Agreement") with a bank which allows for borrowings of up to $3 million.
Advances under the Agreement will be limited to 80% of eligible accounts
receivable and bears interest at the prime rate plus 2.25% (10.5% as of July
26, 1997). Borrowings outstanding under the Agreement will be secured by
substantially all of the assets of the Company. The Agreement, which expires
on July 26, 1999, requires that the Company maintain a minimum tangible net
worth, including any subordinated debt, of $1.5 million at all times. As of
January 26, 1998, approximately $1.0 million was outstanding under the
Agreement.
5. COMMITMENTS, CONTINGENCIES AND CAPITAL LEASES:
The Company leases its facilities and certain office equipment under non-
cancelable operating leases which expire at various dates through 2005. Total
rental expense for all operating leases was approximately $311,000 for the
year ended June 30, 1997. The Company also leases certain equipment under non-
cancelable capital leasing arrangements with a leasing company. The
obligations under the capital leasing arrangements are at fixed annual
interest rates at approximately 7% and 15% and are collateralized by the
related equipment.
The Company also has certain non-cancelable operating lease agreements with
several telephone companies (the "Connectivity Agreements"). Under the
Connectivity Agreements, the Company leases access to various high-speed
telephone lines and other telecommunication-related services. Total rental
expense for all Connectivity Agreements was approximately $710,000 for the
year ended June 30, 1997.
As of June 30, 1997, future minimum lease payments under all non-cancelable
operating leases, capital leases and Connectivity Agreements were as follows
(in thousands):
<TABLE>
<CAPTION>
CONNECTIVITY OPERATING CAPITAL
YEAR ENDING JUNE 30, TOTAL AGREEMENTS LEASES LEASES
-------------------- ------ ------------ --------- -------
<S> <C> <C> <C> <C>
1998................................. $1,969 $ 899 $ 360 $ 711
1999................................. 2,078 1,030 362 685
2000................................. 1,732 902 343 486
2001................................. 537 381 35 122
2002................................. 136 105 31 --
Thereafter........................... 101 -- 101 --
------ ------ ------ ------
Total minimum lease payments......... $6,553 $3,317 $1,232 2,004
====== ====== ======
Less: Amounts representing interest
on capital leases................... (366)
------
Present value of net minimum capital
lease payments...................... 1,638
Less: Current portion................ (523)
------
Long-term portion.................... $1,115
======
</TABLE>
From time to time, the Company is involved in various disputes which arise
in the ordinary course of business. Management believes that the ultimate
resolution of these disputes will not have a material adverse impact on the
Company's financial position or results of operation.
6. CONVERTIBLE PREFERRED STOCK:
As of June 30, 1996, the Company has authorized the issuance of up to
3,000,000 shares of redeemable convertible preferred stock, of which it has
designated 2,024,000 shares as Series A preferred stock, which were held by
the Parent Company. On May 12, 1997, the Parent Company converted the
outstanding 2,024,000 shares
F-31
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
of redeemable convertible Series A preferred stock it held in the Company into
2,952,000 shares of Internex common stock.
As of June 30, 1997, there were no shares of preferred stock outstanding. In
August 1997, the Company increased the number of authorized preferred shares
to 5,000,000 and designated 2,000,000 shares as Series A preferred stock.
7. COMMON STOCK:
The Company has authorized the issuance of up to 30,000,000 shares of common
stock, of which 7,000,000 are issued and held by the Parent Company as of June
30, 1997.
Stock Plans
In April 1997, the Company adopted the 1997 Stock Option Plan (the "1997
Plan"), whereby 1,500,000 shares of common stock have been reserved for future
issuance to employees, consultants and directors of the Company. As of January
26, 1998, no options have been issued under the 1997 Plan.
Effective March 17, 1995, the Parent Company adopted the 1995 Stock Option
Plan (the "1995 Plan"). Under the 1995 Plan, the Board of Directors of the
Parent Company may grant incentive and nonqualified stock options to
employees, consultants and directors of the Company to purchase common stock
of the Parent Company. The exercise price per share for an incentive stock
option cannot be less than the fair market value of a share of common stock,
as determined by the Board of Directors, on the date of grant. The exercise
price per share for nonqualified stock options cannot be less than 85% of the
fair market value, as determined by the Board of Directors of the Parent
Company, on the date of grant. Options generally expire ten years after the
date of grant and generally vest over a four-year period, not to exceed five
years.
In addition, effective March 17, 1995, the Parent Company adopted the 1995
Stock Purchase Plan (the "Purchase Plan"). Under the Purchase Plan, the Board
of Directors of the Parent Company may grant stock purchase rights to
employees and consultants of the Company to purchase common stock of the
Parent Company. The sale price per share for a stock purchase right cannot be
less than the fair market value of a share of common stock, as determined by
the Board of Directors of the Parent Company, on the date of grant. Stock
purchase rights are subject to repurchase as determined by the Board of
Directors of Communications Inc. As of June 30, 1997, rights to purchase
93,000 shares of common stock of the Parent Company have been granted to
consultants of the Company. The Company has recognized compensation expense of
approximately $25,000 related to these stock purchase rights for the years
ended June 30, 1997.
The following table summarizes option activity under the Option Plans:
<TABLE>
<CAPTION>
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- ---------
<S> <C> <C>
Outstanding at June 30, 1996......................... 3,223,500 $0.08-.60
Granted............................................ 1,547,500 0.50
Exercised.......................................... (157,708) 0.08-.60
Cancelled.......................................... (2,121,042) 0.08-.60
---------- ---------
Outstanding at June 30, 1997......................... 2,492,250 0.08-.60
Exercisable at June 30, 1996......................... 528,000 0.08-.60
========== =========
Exercisable at June 30, 1997......................... 1,046,000 $ .08-.60
========== =========
</TABLE>
F-32
<PAGE>
INTERNEX INFORMATION SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company accounts for the Option Plan and Purchase Plan (the "Plans")
under APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Accordingly, compensation expense is generally not recognized. Had
Compensation expense for the Plans been determined consistent with Statement
of Financial Accounting standards (SFAS) No. 123, "Accounting for Stock Based
Compensation," the Company's net loss would not had been materially different.
The weighted average fair values of options granted during fiscal 1997 was
$0.11 per share. The fair value of each stock option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in fiscal 1997: risk-free
interest rates of 6.2%; expected dividend yield of zero percent; expected life
of 4 years; expected volatility of zero percent.
8. INCOME TAXES:
The Parent Company accounts for income taxes pursuant to SFAS No. 109,
"Accounting for Income Taxes". This statement requires recognition of deferred
tax liabilities and assets for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Payables
and deferrals of income taxes are allocated to Internex through intercompany
accounts from the Parent Company, as the Parent Company reports income taxes
on a consolidated basis. As of June 30, 1997, the portion of the consolidated
deferred tax asset allocated to Internex was approximately $3.5 million and
consisted of net operating loss carryforwards and cumulative book to tax
temporary differences. The Company believes sufficient uncertainty exists
regarding the realizability of these items, and accordingly, a valuation
allowance for the entire amount has been established.
As of June 30, 1997, the portion of the consolidated net operating loss
carryforwards for Federal and state purposes allocated to Internex was
approximately $10.1 million and $5.5 million, respectively. The net operating
loss carryforwards expire at various dates through 2012. Under current tax
law, utilization of the net operating loss in any given year will be limited
upon the occurrence of certain events, including significant changes in
ownership interests.
9. SUBSEQUENT EVENT (UNAUDITED):
On February 5, 1998, Concentric Network Corporation ("Concentric"), a
Delaware corporation, acquired all of the outstanding capital stock of the
Company from Communications Inc., pursuant to a Share Acquisition Agreement,
dated February 1, 1998, by and among Concentric, the Company and
Communications Inc. Concentric paid approximately $15.5 million in cash to
Communications Inc. as consideration for all of the issued and outstanding
shares of capital stock of the Company. The amount of consideration for the
transaction was determined by arms-length negotiations between the parties.
F-33
<PAGE>
SELECTED UNAUDITED PRO FORMA CONDENSED COMBINED
FINANCIAL INFORMATION
The selected unaudited pro forma condensed combined financial information
for the Company set forth below gives effect to the acquisition of Internex
Information Services, Inc. ("Internex"). Under the purchase method of
accounting, the following unaudited pro forma combined financial information
presents the Unaudited Pro Forma Condensed Combined Balance Sheet as of
December 31, 1997, giving effect to the acquisition of Internex as if it had
been consummated on that date. Also presented is the Unaudited Pro Forma
Condensed Combined Statement of Operations for the fiscal year ended December
31, 1997, giving effect to the acquisition of Internex as if such acquisition
had been consummated as of the beginning of the period presented. The
Company's fiscal year ends on December 31 and Internex's fiscal year ends on
June 30. The Unaudited Pro Forma Condensed Combined Balance Sheet combines the
respective balance sheets of the Company and Internex as of December 31, 1997.
The Unaudited Pro Forma Condensed Combined Statement of Operations for the
year ended December 31, 1997 combines the results of the Company for such year
with the results of Internex for the calendar year ended December 31, 1997.
The historical financial information set forth below has been derived from,
and is qualified by reference to, the financial statements of the Company and
Internex and should be read in conjunction with those financial statements and
the notes thereto included elsewhere herein. The selected unaudited pro forma
condensed combined financial information set forth below reflects certain
adjustments, including, among others, adjustments to reflect the amortization
of the excess purchase price in connection with the acquisition of Internex
and the interest expense which would have been incurred had the debt offering
occurred on January 1, 1997.
The pro forma data is based on the historical combined statements of the
Company and Internex giving effect to the Internex acquisition under the
purchase method of accounting, and to the assumptions and adjustments (which
the Company believes to be reasonable) described in the accompanying Notes to
Unaudited Pro Forma Condensed Combined Financial Information. Under the
purchase method of accounting, assets acquired and liabilities assumed will be
recorded at their estimated fair value at the date of acquisition. The pro
forma adjustments set forth in the following unaudited pro forma combined
financial information are estimated and may differ from the actual adjustments
when they become known; however, no material differences are anticipated by
the Company.
The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Financial Statements--the Company and Internex Information
Services, Inc." The selected unaudited pro forma condensed combined financial
information set forth below does not purport to represent what the combined
results of operations or financial condition of the Company would actually
have been if the Internex acquisition and Offering had in fact occurred on
such dates or to project the future combined results of operations or
financial condition of the Company.
F-34
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED
BALANCE SHEET AS OF DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
PROFORMA
COMPANY AS OF BUSINESS
DECEMBER 31, INTERNEX AS OF COMBINATION PROFORMA
1997 DECEMBER 31, 1997 COMBINED ADJUSTMENTS(A)(1) COMBINED
------------- ----------------- -------- ----------------- --------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash
equivalents........... $ 119,959 $ 11 $119,970 $(15,490) $104,480
Current portion of
restricted cash....... 19,125 -- 19,125 -- 19,125
Accounts receivable.... 4,549 1,403 5,952 (130) 5,822
Prepaid expenses and
other current
assets................ 5,139 164 5,303 (100) 5,203
--------- ------- -------- -------- --------
Total current
assets............... 148,772 1,578 150,350 (15,720) 134,630
Property and equipment:
Computer and
telecommunications
equipment............. 71,942 6,618 78,560 (558) 78,002
Software............... 1,519 -- 1,519 -- 1,519
Furniture, fixtures, &
leasehold
improvements.......... 2,984 1,557 4,541 -- 4,541
--------- ------- -------- -------- --------
76,445 8,175 84,620 (558) 84,062
Accumulated
depreciation and
amortization.......... 22,735 2,877 25,612 -- 25,612
--------- ------- -------- -------- --------
53,710 5,298 59,008 (558) 58,450
Restricted cash, net of
current portion....... 33,400 -- 33,400 -- 33,400
Other assets........... 8,607 144 8,751 (100) 8,651
Goodwill............... -- -- -- 12,576 12,576
Customer Lists......... -- -- -- -- --
--------- ------- -------- -------- --------
Total assets......... $ 244,489 $ 7,020 $251,509 $ (3,802) $247,707
========= ======= ======== ======== ========
LIABILITIES &
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....... $ 10,144 $ 2,285 $ 12,429 $ -- $ 12,429
Accrued compensation
and other employee
benefits.............. 1,577 216 1,793 -- 1,793
Other current
liabilities........... 4,917 1,052 5,969 2,262 8,231
Notes payable to
bank.................. -- 1,228 1,228 1,228
Current portion of
capital lease
obligations........... 15,326 523 15,849 -- 15,849
Deferred revenue....... 1,435 -- 1,435 -- 1,435
--------- ------- -------- -------- --------
Total current
liabilities.......... 33,399 5,304 38,703 2,262 40,965
Capital lease
obligations........... 33,595 852 34,447 34,447
Notes payable.......... 145,577 -- 145,577 145,577
Commitments and
contingencies --
Stockholders' Equity: --
Preferred stock........ -- -- -- -- --
Common stock........... 182,721 15,141 197,862 (15,141) 182,721
Accumulated deficit.... (149,534) (14,277) (163,811) 14,277 (154,734)
(5,200)
Deferred compensation.. (1,269) -- (1,269) -- (1,269)
--------- ------- -------- -------- --------
Total stockholders'
equity............... 31,918 864 32,782 (6,064) 26,718
--------- ------- -------- -------- --------
Total liabilities and
stockholders'
equity.............. $ 244,489 $ 7,020 $251,509 $ (3,802) $247,707
========= ======= ======== ======== ========
</TABLE>
See accompanying notes.
F-35
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
INTERNEX FOR PRO FORMA
COMPANY FOR THE YEAR PRO FORMA COMBINED FOR
THE YEAR ENDED ENDED BUSINESS PRO FORMA THE YEAR ENDED
DECEMBER 31, DECEMBER 31, COMBINATION DEBT OFFERING DECEMBER 31,
1997 1997 COMBINED ADJUSTMENTS ADJUSTMENTS 1997
-------------- ------------ -------- ----------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Revenue................. $ 45,457 $9,954 $55,411 $ -- $ -- $55,411
Cost and expenses:
Cost of revenue........ 61,439 9,196 70,635 -- -- 70,635
Development............ 4,850 815 5,665 -- -- 5,665
Marketing and sales.... 24,622 3,991 28,613 -- -- 28,613
General and
administrative........ 4,790 2,863 7,653 -- -- 7,653
Amortization of
goodwill.............. -- -- -- 2,515(1) -- 2,515
-------- ------ ------- ------ ------- -------
Total cost and
expenses.............. 95,701 16,865 112,566 2,515 -- 115,081
-------- ------ ------- ------ ------- -------
Loss from operations.... (50,244) (6,911) (57,155) (2,515) -- (59,670)
Other income............ 1,233 45 1,278 -- -- 1,278
Interest income......... 1,217 -- 1,217 -- -- 1,217
Interest expense........ (7,788) (155) (7,943) -- (18,236)(2) (26,179)
-------- ------ ------- ------ ------- -------
Net Loss................ $(55,582) (7,021) (62,603) (2,515) (18,236) (83,354)
======== ====== ======= ====== ======= =======
Pro forma net loss per
share(3)............... (8.44)
=======
Shares used in computing
pro forma loss per
share.................. 9,872
=======
</TABLE>
See accompanying notes.
F-36
<PAGE>
NOTES TO THE SELECTED UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
Pro forma business combination adjustments for the balance sheet as of
December 31, 1997 are as follows:
(A) Adjustment to record the acquisition of Internex under the purchase
method of accounting as if the acquisition occurred on December 31, 1997.
The approximate purchase price of $23.9 million consists of a cash payment
$15.5 million, assumed liabilities of approximately $6.6 million and
transaction costs of approximately $1.8 million. See Note 12 of the
Concentric Network Corporation Financial Statements.
Pro forma business and Offering adjustments for the statement of operations
for the year ended December 31, 1997 are as follows:
(1) Reflects the amortization of the cost over the fair value of net
assets acquired for the Internex acquisition as follows:
<TABLE>
<CAPTION>
COST OVER
THE FAIR VALUE
OF NET AMORTIZATION
ASSETS ACQUIRED PERIOD
--------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Goodwill........................................ 12,576 5 yrs
</TABLE>
The pro forma results do not include the write-off of purchased research and
development of $5.2 million since it is considered a non-recurring adjustment.
(2) Reflects the interest expense that would have been incurred had the
Offering occurred on January 1, 1997. In addition, interest expense and
related charges of bridge financings have been excluded since such bridge
financings would not have occurred if the Offering was completed on January
1, 1997.
(3) Pro forma net loss per share is computed using the weighted average
number of shares of common stock outstanding plus common equivalent shares
from convertible preferred stock, that was converted upon the Company's
proposed initial public offering (using the if-converted method), have been
included whether dilutive or anti-dilutive pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 98. Such pro forma net
loss per share reflects the impact of the adjustments above.
F-37
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
3.2* Amended and Restated Certificate of Incorporation of Registrant.
3.4* Amended and Restated Bylaws of Registrant.
10.1* Amended and Restated Registration Rights Agreement, as amended and
restated as of August 21, 1996, by and among the Registrant, GS
Capital Partners, L.P., Kleiner Perkins Caufield & Byers VII,
Comdisco, Inc., Intuit, Inc., certain listed holders of Series C
Convertible Preferred Stock, certain listed holders of Common Stock,
certain listed holders of Series D Convertible Preferred Stock, and
Racal-Datacom, Inc.
10.2* Preferred Stock and Warrant Purchase Agreement, dated as of April
20, 1995, by and among the Registrant, GS Capital Partners, L.P.,
and Kleiner Perkins Caufield & Byers VII and KPCB Information
Sciences Zaibatsu Fund 11, as amended.
10.3* Form of Director and Officer Indemnification Agreement.
10.4* 1995 Stock Incentive Plan for Employees and Consultants, as amended
February 21, 1996.
10.5* Amended and Restated 1996 Stock Plan.
10.6* 1997 Stock Plan.
10.7* 1997 Employee Stock Purchase Plan.
10.8* Termination of Services and Indemnification Agreement, dated as of
February 15, 1996, by and between the Registrant and Marc Collins-
Rector and Chad Shackley.
10.9* Agreement, dated as of February 15, 1996, by and between the
Registrant and Randy Maslow.
10.10* Governance Agreement, dated May 15, 1997, by and among the
Registrant, Marc Collins-Rector, Chad Shackley, GS Capital Partners,
L.P., Kleiner Perkins Caufield & Byers VII, KPCB VII Founders Fund,
KPCB Information Sciences Zaibatsu Fund II, and Intuit, Inc.
10.11+* Amended and Restated Employee Services and Staffing Agreement, dated
June 19, 1997, between the Registrant and Critical Technologies,
Inc., as amended on September 30, 1996, and October 23, 1996,
including Colocation Services Agreement, dated as of November 1,
1994, between the Registrant and Critical Technologies, Inc. and
amendments thereto.
10.12+* Internet-Sign Up Wizard Referral and Microsoft Internet Explorer
License and Distribution Agreement, dated March 28, 1997, between
the Registrant and Microsoft Corporation.
10.13+* OEM License Agreement dated July 27, 1995, between the Registrant
and Netscape Communications Corporation, as amended by First
Amendment, dated January 2, 1996, Second Amendment, effective
January 2, 1996, and Third Amendment, dated May 21, 1996.
10.14+* "Dial up Client" Agreement, dated August 21, 1995, between the
Registrant and Netscape Communications Corporation.
10.15+* "Internet Account Server" Participation Agreement, dated as of
January 14, 1997, between the Registrant and Netscape Communications
Corporation.
10.16+* Special Customer Arrangement, dated May 17, 1996, between MCI
Telecommunications Corporation and Sattel Communications LLC, as
amended by First Amendment, dated July 2, 1996; assigned to
Registrant by Assignment and Novation Agreement #2, dated as of
August 7, 1996.
10.17+* Master Agreement for MCI Enhanced Services, effective November 1,
1996, between the Registrant and MCI Telecommunications Corporation.
10.18+* Amended and Restated Employee Services and Staffing Agreement.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
10.19+* Amendment No. 3 to Internet Access Services Agreement, dated August
23, 1996, between the Registrant and Intuit Inc.
10.20+* Contract for Services, dated June 17, 1996, by and between the
Registrant and MFS Telephone, Inc.
10.21+* AT&T Contract Tariff Order, dated June 17, 1996, and Addendum of
even date therewith.
10.22+* Master Lease Agreement Number CON01C Between Concentric Research
Corporation and Racal-Datacom, Inc. ("Racal"), dated August 4, 1994,
as Supplemented by Letter Agreement, dated March 30, 1995, Between
the Corporation and Racal.
10.23+* Lease Agreement Number CON04C between Concentric Network Corporation
and Racal-Datacom, Inc., dated June 26, 1996.
10.24+* Master On-site Maintenance Plan Agreement Number CON02C Between
Concentric Research Corporation and Racal-Datacom, Inc., dated
August 24, 1994.
10.25* Lease Agreement, dated November 1, 1996, effective March 11, 1996,
by and between the Registrant and Saginaw Video Associates, d.b.a.
Saginaw Conference Center.
10.26* Amended and Restated Lease Agreement, dated as of October 7, 1996,
between the Registrant and Larry Shackley.
10.27* (Master) Lease, dated January 26, 1988, between Tandem Computers
Incorporated and Spicker-French #130, Limited Partnership, as
amended by Lease Amendment No. 1, effective February 5, 1990, and
Extension Agreement, dated March 23, 1993.
10.28* Sublease, dated June 22, 1995, between the Registrant and Tandem
Computers Incorporated.
10.29* Sublease, dated April 25, 1995, between Tandem Computers
Incorporated and Passage Systems, Inc.
10.30* Assignment Agreement, dated December 6, 1996, by and between the
Registrant and Passage Systems, Inc.
10.31+* Internet Access Service Agreement, dated December 11, 1995,
effective as of August 1, 1995, between the Registrant and Intuit,
Inc., as amended.
10.32+* Virtual Private Network Services, dated August 16, 1996, between the
Registrant and WebTV Networks, Inc.
10.33+* Support Services Agreement, dated March 31, 1997, by and between the
Registrant and MCI Telecommunications Corporation.
10.34* Note and Warrant Purchase Agreement, dated June 19, 1997, by and
between the Registrant and Williams Communications Group, Inc.
("WCG")
10.35* Service Credits Letter Agreement, dated June 19, 1997, by and
between the Registrant and WCG.
10.36* $1,100,000 Obligation Letter Agreement, dated June 19, 1997, between
the Registrant and WCG.
10.37* Agency Agreement and Distribution Agreement, dated June 19, 1997,
between the Registrant and WCG.
10.38+* Co-Marketing Service Agreement, dated June 23, 1997 between the
Registrant and Netscape Communications, Inc. ("Netscape")
10.39+* Trademark License Agreement, dated June 23, 1997, between the
Registrant and Netscape.
10.40+* Software License Order Form, dated June 23, 1997, between the
Registrant and Netscape.
10.41* Note and Warrant Purchase Agreement, dated June 23, 1997, between
the Registrant, Kleiner Perkins, Caufield & Byers VII and KPCB
Information Science Zaibatsu Fund VII.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
10.42** Amendment to Virtual Private Network Services Agreement between the
Registrant and WebTV Networks, Inc., dated November 1, 1997.
10.43*** Registration Rights Agreement, dated as of December 18, 1997
between the Registrant and UBS Securities LLC, Bear Stearns & Co.,
Inc., and Wheat First Securities, Inc. (the "Initial Purchasers")
10.44*** Purchase Agreement, dated as of December 15, 1997 between the
Registrant and the Initial Purchasers.
10.45*** Warrant Agreement, dated as of December 18, 1997, between the
Registrant and the Initial Purchasers.
10.46*** Warrant Registration Rights Agreement, dated as of December 18,
1997, between the Registrant and the Initial Purchasers.
10.47*** Escrow Agreement, dated December 18, 1997, between the Registrant
and Chase Manhattan Bank and Trust Company, National Association.
10.48*** Indenture, dated as of December 18, 1997 among the Registrant and
Chase Manhattan Bank and Trust Company, National Association, as
trustee.
10.49*** Form of $150,000,000 12 3/4% Senior Note due 2007
10.50*** Form of $150,000,000 new 12 3/4% Senior Notes due 2007.
10.51*** Form of Warrant to purchase Common Stock
10.52 Standard Industrial Lease, dated as of February 17, 1995, by and
between Tiara Computer Systems, Inc. and Internex Information
Services, Inc.
10.53 Standard Industrial Lease, dated as of July 25, 1996, by and
between San Tomas Investors II and Internex Information Service,
Inc.
11.1 Statement re computation of earnings per share.
21.1 List of Subsidiaries.
23.2 Consent of Ernst & Young, LLP, Independent Auditors
23.3 Consent of Arthur Andersen, LLP, Independent Public Accountants.
24.1 Power of Attorney (see signature page).
27.1 Financial Data Schedule
</TABLE>
- --------
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 333-27241), as amended, declared effective by the Securities
and Exchange Commission ("SEC") on July 31, 1997.
** Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997, filed with the SEC on November
14, 1997.
*** Incorporated by reference from the Company's Registration Statement on
Form S-4, filed with the SEC on January 28, 1998.
+ Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request under 17 C.F.R. (s)(5) 200.80(b)(4), 200.83 and 230.46.
<PAGE>
EXHIBIT 10.52
Standard Industrial Lease
(Net)
Basic Lease Information
Effective Date: February 13, 1995
Landlord: San Tomas Investors II
Tenant: Tiara Computer Systems, Inc. and
Internex Information Services, Inc.
Lease Reference
Premises and Building
Address: 2302 Walsh Ave. Paragraph 1
Santa Clara, CA 95051
Term Commencement: June 01, 1995 Paragraph 2
Term Expiration: May 31, 2000 Paragraph 2
Base Rent: 6-1-95 to 5-31-00 $6,622.40/month Paragraph 3 (a)
First thirty six (36) months at Paragraph 3 (b)
$6,622.40/month. Last twenty four
(24) months adjusted by CPI per
attached addendum.
Tenant's Percentage Share: 5.32% Paragraphs 4 and 5
Property Taxes and Operating Expenses
Use: Engineering, administration, sales, light Paragraph 6
assembly, and warehousing.
Space plan returned to Landlord By: February 13, 1995
Paragraph 23
Work Completion Date: May 31, 1995
Paragraph 23
Security Deposit: $13,244.80
Paragraph 18
Non-refundable Cleaning Deposit: $0.00
Total amount due upon lease execution: $19,867.20
<PAGE>
Tenant's Address for Paragraph 22
Notices: 2302 Walsh Ave.
Santa Clara, CA
95051
Landlord's Address for Payments and
Notices:
c/o Commerce Communities Corp.
2316 Walsh Ave.
Santa Clara, CA 95051
Broker(s): Wayne Mascia & Associates and Paragraph 24(m)
Commerce Communities Corp.
Exhibits and Addendum:
Exhibit A - Diagram showing premises
Exhibit B - Rules and Regulations
Exhibit C - Addendum
In the event of any conflict between any Basic Lease Information and the
Lease, the latter shall control.
TENANT Tiara Computer Systems, Inc. LANDLORD San Tomas Investors II
Internex Information Services, Inc.
/s/ Sherman Tuan /s/
--------------------- -------------------------------
Sherman Tuan /s/
--------------------- -------------------------------
<PAGE>
STANDARD INDUSTRIAL LEASE
(Net)
Basic Lease Information
Table of Contents
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Premises........................................................ 1
2. Term............................................................ 1
3. Rent............................................................ 1
4. Taxes........................................................... 2
5. Operating Expenses.............................................. 2
6. Use............................................................. 3
7. Utilities....................................................... 4
8. Maintenance, Repairs............................................ 4
9. Alterations and Window Coverings................................ 4
10. Insurance and Indemnity......................................... 5
11. Damage or Destruction........................................... 6
12. Eminent Domain.................................................. 6
13. Assignment and Subletting....................................... 6
14. Rules & Regulations............................................. 8
15. Default by Tenant............................................... 8
16. Landlord's Right to Cure Defaults............................... 9
17. Default by Landlord............................................. 10
18. Security Deposit................................................ 10
19. Estoppel Certificate............................................ 10
20. Subordination................................................... 10
21. Attorney's Fees................................................. 10
22. Notices......................................................... 11
23. Landlord's Scope of Work........................................ 11
24. General Provisions.............................................. 11
25. Exhibits........................................................ 12
</TABLE>
Exhibits and Addendum
Exhibit A - Diagram of Premises
Exhibit B - Rules and Regulations
-iii-
<PAGE>
STANDARD INDUSTRIAL LEASE
(NET)
THIS LEASE is made and entered as of the Effective Date, February 17, 1995
by and between San Tomas Investors II ("Landlord") and Tiara Computer Systems,
Inc. and Internex Information Services, Inc. ("Tenant")
WITNESSETH
1. Premises.
--------
(a) Landlord hereby leases to Tenant, and Tenant hereby leases from
Landlord for the term of this Lease and at the rental and upon the conditions
set forth below, the premises described in the Basic Lease Information and
identified on the space plan attached hereto as Exhibit A. Subject to any
---------
obligations of Landlord as set forth in an exhibit to this Lease covering
initial improvement of the premises, Tenant shall accept the premises in its
"as-is" condition at the commencement of the term. Other than as expressly set
forth in this Lease, there are no implied warranties of merchantability,
habitability, fitness for a particular purpose or otherwise with respect to the
premises. The premises are located within the building commonly known as
described in the Basic Lease Information (the "Building"). Landlord further
reserves the exclusive right to the roof and exterior surface of sidewalls and
appurtenances except as provided in the Lease. Landlord reserves the right from
time to time to relocate and alter the configuration of parking and Common Area
within and adjacent to the Building. The premises, the Building and the legal
parcel(s) on which the Building and related parking areas and structures and
other appurtenances are located, are collectively, the "Property".
(b) At the expiration of the tenancy hereby created, Tenant shall
surrender the premises in the same condition as the premises were in upon
delivery of possession thereto under this Lease, reasonable wear and tear
excepted, and shall surrender all keys for the premises to Landlord at the place
then fixed for the payment of rent and shall inform Landlord of all combinations
on locks, safes and vaults, if any, in the premises. Tenant shall remove all
its trade fixture, and at Landlord's sole option, any alterations or
improvements made by Tenant before surrendering the premises as aforesaid and
shall repair any damage to the premises caused thereby. Tenant's obligations to
observe or perform this covenant shall survive the expiration or other
termination of the term of this Lease.
2. Term. The term of this Lease shall commence and, unless sooner
----
terminated as hereinafter provided, shall end on the dates respectively
specified in the Basic Lease Information. If Landlord, for any reason
whatsoever, cannot deliver possession of the premises to Tenant on the Date of
Term Commencement, this Lease shall not be void or voidable, nor shall Landlord
be liable to Tenant for any loss or damage resulting therefrom, but in that
event, subject to any contrary provisions in any agreement with Landlord
covering initial improvement of the premises, rental shall be waived for the
period between commencement of the term and the time when Landlord can deliver
possession. Any delay in delivery of possession of the premises shall not extend
the expiration date of this lease.
3. Rent.
----
(a) Tenant shall pay to Landlord as rental the amount specified in the
Basic Lease Information as the Base Rent, payable upon Tenant's execution of
this Lease and in advance on or before the first day of each and every
successive calendar month following commencement of the term during the term.
If the term commences on other than the first day of a calendar month, the first
payment of rent shall be appropriately prorated on the basis of a 30-day month.
(b) Effective as of each anniversary date of the commencement of the
term, the Base Rent shall be increased to equal the sum of (i) the Base Rent as
specified in the Basic Lease Information, plus (ii) the product obtained by
multiplying such amount by the percentage increase in the Consumer Price Index
measured from the measuring month two months preceding the commencement of the
term to the measuring month two months preceding the anniversary date in
question. As used herein, the term "Consumer Price Index" shall mean the United
States Department of Labor's Bureau of Labor Statistics" Consumer Price Index,
All Urban Consumers, All Items, San Francisco-Oakland-San Jose, California
(1982-84 equals 100), or the successor of such index. Tenant shall continue
paying the current Base Rent until the increased Base Rent has been calculated.
Upon such calculation, Landlord shall give notice to Tenant of the amount of the
new Base Rent which shall be due and payable effective as of the anniversary
date and Tenant shall upon the giving of such notice pay Landlord any shortage
in Base Rent accruing between the current anniversary date and the date of the
notice.
(c) Tenant shall pay, as additional rent, all amounts of money
required to be paid to Landlord by Tenant hereunder in addition to monthly rent,
whether or not the same be designated "additional rent." If such amounts are not
paid at the time provided in this Lease, they shall nevertheless be collectible
as additional rent with the next installment of monthly
<PAGE>
rent thereafter falling due, but nothing herein contained shall be deemed to
suspend or delay the payment of any amount of money at the time the same becomes
due and payable hereunder, or limit any other remedy of Landlord.
(d) Tenant hereby acknowledges that late payment by Tenant to Landlord
of rent and other amounts due hereunder will cause Landlord to incur costs not
contemplated by this Lease, the exact amount of which will be extremely
difficult to ascertain. Such costs include, but are not limited to, processing
and accounting charges, and late charges which may be imposed on Landlord by the
terms of any loan secured by the Building. Accordingly, if any installment of
rent or any other sums due from Tenant shall not be received by Landlord within
five days following the date due. Tenant shall pay to Landlord a late charge
equal to ten percent (10%) of such overdue amount. The parties hereby agree
that such late charge represents a fair and reasonable estimate of the costs
Landlord will incur by reason of late payment by Tenant. Acceptance of such
late charge by Landlord shall in no event constitute a waiver of Tenant's
default with respect to such overdue amount, nor prevent Landlord from
exercising any of the other rights and remedies granted hereunder.
(e) Any amount due to Landlord, if not paid when due, shall bear
interest from the date due until paid at the rate of 10% per. Provided that
interest shall not be payable on late charges incurred by Tenant to the extent
such interest would cause the total interest to be in excess of that legally
permitted.
(f) All payments due from Tenant to Landlord hereunder shall be made
to Landlord without deduction or offset in lawful money of the United States of
America at the address for payment set forth in the Basic Lease Information, or
to such other person or at such other place as Landlord may from time to time
designate by notice to Tenant.
4. Taxes.
-----
(a) Tenant shall pay before delinquency any and all taxes,
assessments, license fees, and public charges levied, assessed, or imposed, and
which become payable during the term upon Tenant's fixtures, improvements,
alterations, or additions, furniture, appliances and personal property installed
or located in the premises.
(b) Tenant shall pay upon demand during the term hereof it's
percentage share, as specified in the Basic Lease Information, of all Real
Property Taxes, gross rental receipts taxes and general or special assessments
over Base Property Taxes.
(c) The term "Real Property Taxes" shall mean all real property taxes
and personal property taxes, licenses, charges and assessments which are levied,
assessed or imposed by any governmental or quasi-governmental authority,
improvement or assessment district with respect to the Property, any other
fixtures, improvements, equipment or other property of Landlord, real or
personal, located in the project and used in connection with the operation
thereof, whether or not now customary or within the contemplation of the parties
hereto, including, without limitation, any taxes, charges or assessments for
public improvements, services or benefits, irrespective of when commenced or
completed, transit fees, parking charges or fees, housing funds, education
funds, education funds, street, highway or traffic fees, as well as any tax
which shall be levied or assessed in addition to or in lieu of such taxes, and
any costs or expenses of contesting any such taxes, licenses, charges or
assessments, but excluding any federal or state income or gift tax or any
franchise, capital stock, estate or inheritance taxes. In the event that it
shall not be lawful for Tenant to reimburse Landlord for Tenant's percentage
share of any property tax, as defined herein, the rent payable to Landlord under
this Lease shall be revised to yield to Landlord the same net rent from the
premises after imposition of any such tax upon Landlord as would have been
received by Landlord hereunder prior to the imposition of any such tax. Base
Property Taxes shall be those assessed during the Base Year set forth in the
Basic Lease Information.
5. Operating Expenses.
------------------
(a) Tenant agrees to pay upon demand during the term of the Lease and
subject to the limitation as hereinafter set forth, as further additional rent,
Tenant's Percentage Share of all Operating Expenses paid or incurred by Landlord
over and above the Base Operating Expenses.
(b) Said Percentage Share of Operating Expenses shall he paid to
Landlord, (a) upon presentation of invoice setting forth such share of Operating
Expenses and/or (b) at the option of Landlord, paid to Landlord monthly, in
advance, Tenant's share of an amount estimated by Landlord, which estimated
amount shall be reconciled at the end of each calendar Year as compared with
Landlord's actual expenditure for Operating Expenses as provided in paragraph
(d).
(c) For purposes of this Section 5. "Operating Expenses" shall mean
the total reasonable cost and reasonable expense incurred in operating and
maintaining the Property, including, without limitation: (a) all license, permit
and inspection fees, (b) premiums for any insurance maintained by Landlord with
respect to the Property including property damage, extended coverage, earthquake
and flood insurance, and such other endorsements covering hazards normally
insured by commercial property owners; (c) repairs; (d) line painting; (e)
lighting; (f) signing; (g) sanitary control; (h) supplies; (i) removal of trash,
rubbish, garbage and other refuse; (j) security services; (k) reasonable
reserves for replacements and repairs; (1) the cost of any capital improvement
made to structures or added to the common areas due to governmental requirements
amortized over a reasonable period with interest at ten percent(10%) per annum
on the unamortized cost; (m) management; (n) bookkeeping; and (o) the costs of
personnel to implement such services and to
-2-
<PAGE>
direct parking and otherwise regulate, maintain and repair the building(s) and
the common facilities;(p)utilities;(q)janitorial, heating, ventilating and air
conditioning services; (r) increased interest expense caused by rate increases
on Landlord's debt service; (s)wages, salaries, fringe benefits and payroll
burden of employees; (t)project office rent or rental value; (u) depreciation on
personal property; and (v) the cost of capital improvements to the Building or
Common Areas anticipated to reduce other Operating Expenses; and (w) gardening
and landscaping. "Common Areas" shall mean all areas, spaces, equipment and
special services provided by Landlord for common or joint use or benefit of the
occupants of the Building, their employees, agents and customers, including
without limitation, parking areas, driveways, landscaped areas, sidewalks,
restrooms, retaining walls, etc. Base Operating Expenses shall be those
Operating Expenses paid or incurred by Landlord during the Base Year.
(d) Tenant shall pay to Landlord each month at the same time and in
the same manner as monthly rent, 1/the of Landlord's estimate of Tenant's share
of Operating Expenses for the current calendar year payable by Tenant. Within
90 days after the close of each calendar year, or as soon after such 90-day
period as practicable, Landlord shall deliver to Tenant a statement of actual
Operating Expenses for such calendar year. If on the basis of such statement
Tenant owes an amount that is less than the estimated payments for such calendar
year previously made by Tenant, Landlord shall credit such excess against
Operating Expenses subsequently payable by Tenant. If on the basis of such
statement Tenant owes an amount that is more than the estimated payments for
such calendar year previously made by Tenant, Tenant shall pay the deficiency to
Landlord within 15 days after delivery of the statement. The obligations of
Landlord and Tenant under this subparagraph with respect to the reconciliation
between estimated payments and actual Operating Expenses for the last year of
the term shall survive the termination of the Lease.
6. Use.
---
(a) The premises shall be used and occupied by Tenant for the use set
forth in the Basic Lease Information and in accordance with the Rules and
Regulations attached to this Lease as Exhibit B and for no other purpose.
---------
Tenant shall, at Tenant's expense, comply promptly with all applicable statutes,
ordinances, rules, regulations, orders and requirements in effect during the
term regulating the use by Tenant of the premises including the installation of
additional facilities as required for the conduct and continuance of Tenant's
business. Tenant shall not use or permit the use of the premises or Common Area
in any manner that will tend to create waste or a nuisance, or which tends or
does unreasonably disturb other tenants of the Building or adjacent buildings,
nor shall Tenant, its employees, agents or invites damage the premises, the
Building or related improvements, nor place or maintain any signs on or visible
from the exterior of the premises without Landlord's written consent, or use any
corridors, sidewalks or other areas outside of the premises for storage or any
purpose other than access to the premises. Notwithstanding any other provision
of this Lease, Tenant shall not use, keep or permit to be used or kept on the
premises any foul or noxious gas, article or substance, nor shall Tenant do or
permit to be done anything in and about the premises, either in connection with
activities hereunder expressly permitted or otherwise, which are not permitted
would cause an increase in premiums payable under, or a cancellation of, any
policy of insurance maintained by Landlord in connection with the premises or
the Building or which would violate the terms of any covenants, conditions or
restrictions affecting the Building or the land on which it is located.
(b) Without Landlord's prior consent, which way be withheld in its
absolute discretion, Tenant shall not cause, or allow anyone else to cause, any
Hazardous Materials to be used, generated, stored, or disposed of an or about
the premises or the Building other than reasonable quantities of office and
cleaning supplies in their retail containers. Tenant shall strictly comply with
all statutes, laws, ordinances, rules, regulations, and precautions now or
hereafter mandated or advised by any federal, state, local or other governmental
agency with respect to the use, generation, storage, or disposal of hazardous,
toxic, or radioactive materials (collectively, "Hazardous Materials"). As
herein used, Hazardous Materials shall include, but not be limited to, those
materials identified in Sections 66680 through 66685 of Title 22 of the
California Code of Regulations, Division 4, Chapter 30, as amended from time to
time, and those substances defined as "hazardous substances," "hazardous
materials, "hazardous wastes," "chemicals known to cause cancer or reproductive
toxicity," "radioactive materials," or other similar designations in the
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery
Act, 42 U.S.C. Section 6901 et seq., the Hazardous Materials Transportation Act,
49 U.S.C. Section 1801 et seq., 33 U.S.C. Section 1251 et seq., 42 U.S.C.
------
Section 300(f) et seq., 42 U.S.C. 7401 et seq., California Health and Safety
Code Section 25249.5 et seq., California Water Code Section 13000 et seq.,
California Health and Safety Code Section 39000 et seq. and any other
governmental statutes, ordinances, rules, regulations, and precautions adopted
pursuant to the preceding laws or other similar laws, regulations and guidelines
now or hereafter in effect. Tenant shall defend (with counsel approved by
Landlord), indemnify and hold Landlord; its employees and agents, any entity
having a security interest in the premises or the Building, and its and their
employees and agents (collectively, "Indemnities") harmless from and against,
and shall reimburse the Indemnities for, all liabilities, claims, costs,
damages, and depreciation of property value, including all foreseeable and
unforeseeable consequential damages, directly or indirectly arising out of the
use, generation, storage, or disposal of Hazardous Materials by Tenant or any
person claiming under Tenant, including, without limitation, the cost of any
required or necessary investigation, monitoring, repair, cleanup, or
detoxification and the preparation of any closure or other required plans,
whether such action is required or necessary prior to or following the
termination of this Lease, as well as penalties, fines and claims for
contribution to the full extent that such action is attributable, directly or
indirectly, to the use, generation, storage, or disposal of Hazardous Materials
by Tenant or any person claiming under Tenant. Neither the consent by Landlord
to the use, generation, storage, or disposal of
-3-
<PAGE>
Hazardous Materials nor the strict compliance by Tenant with all statutes, laws,
ordinances, rules, regulations, and precautions pertaining to Hazardous
Materials shall excuse Tenant from Tenant's obligation of indemnification set
forth above. Tenant's obligations under this paragraph 6 shall survive
expiration or termination of this Lease.
(c) Tenant shall not place or suffer to be placed or maintained, on
any exterior door, wall or window of the premises, on any part of the real
property upon which the premises are located, any sign, awning or canopy, or
advertising matter or other thing of any kind, and will not place or maintain
any decoration, lettering or advertising matter on the glass of any window or
door of the premises without first obtaining Landlord's written approval and
consent. Tenant further agrees to maintain such sign, awning, canopy,
decoration, lettering, advertising matter or thing as way be approved, in good
condition and repair at all times. Tenant agrees, at Tenant's sole cost, to
obtain a sign in strict conformance with Landlord's sign criteria as to design,
material, color, location, size, letter style, and method of installation as
provided in Exhibit "E" hereof.
7. Utilities. Tenant shall pay for all water, sewer, gas, electricity,
---------
heat, cooling energy, telephone, refuse collection and other utility-type
services furnished to Tenant or the premises, together with any related
installation or connection charges or deposits. Whenever it is practical to do
so, such services shall be separately metered or charged to Tenant by the
provider thereof and paid for by Tenant. To the extent any of the foregoing
services are provided by Landlord, Tenant shall reimburse Landlord for all costs
incurred by Landlord in the amounts specified in the Basic Lease Information.
Landlord may bill Tenant on a monthly or other periodic basis for such services
and payment shall be made by Tenant within five (5) days after submittal of
Landlord's statement. Landlord shall not be liable in damages, consequential or
otherwise, nor shall there be any rent abatement, arising out of any curtailment
or interruption whatsoever in utility services. Subject to the immediately
preceding sentence, Landlord shall provide heat and air conditioning during
periods other than Normal Office Hours, provided Tenant shall pay Landlord as
additional rent the cost of providing such utilities to the premises during such
periods requested by Tenant.
8. Maintenance & Repairs of Leased Premises.
----------------------------------------
(a) Tenant shall, at its sole cost, keep and maintain the premises and
appurtenances and every part thereof (exception exterior surface of walls and
roof which Landlord agrees to repair at Tenant's expense under the provisions of
paragraph 5 (herein) including windows, doors and all door hardware, any store
front and the interior of the premises, including electrical, plumbing,
lighting, heating and air conditioning systems, in good and sanitary order,
condition and repair. Tenant shall, at its sole cost, keep and maintain all
utilities, fixtures and mechanical equipment used by Tenant in good order,
condition, and repair. In the case of equipment installed by Landlord for Tenant
where Tenant is responsible for maintenance of the equipment, such maintenance
will be provided by a reputable maintenance service company acceptable to
Landlord at Tenant's expense. Tenant shall deliver evidence of the execution
and continuance of such service contract will be provided to Landlord within
thirty (30) days after commencement of Lease.
(b) Tenant hereby acknowledges that the late delivery by Tenant to
Landlord of a copy of a mechanical equipment maintenance contract referred to
above will cause Landlord to incur costs not contemplated by this lease, the
exact amount of which will be extremely difficult to ascertain. Accordingly, if
such evidence of a contract required to be delivered by Tenant to Landlord
within the time prescribed above Tenant shall pay to Landlord a charge in the
sum of $300.00. The parties of this Lease hereby agree that such charge
represents a fair and reasonable estimate of the costs Landlord will incur by
reason of a late delivery by Tenant and acceptance of such charge by Landlord
shall in no event constitute a waiver of Tenant's default with respect to such
late delivery nor prevent Landlord from exercising any of the other rights and
remedies available to Landlord as a result of such default.
(c) If Tenant refuses or neglects to make repairs properly as required
hereunder and to the reasonable satisfaction of Landlord, as soon as reasonably
possible after written demand, Landlord may make such repairs without liability
to Tenant for any loss or damage that may accrue to Tenant's merchandise,
fixtures, or other property, or to Tenant's business by reason thereof, and upon
completion thereof, Tenant shall pay Landlord's costs for making such repairs
plus twenty percent (20%) per annum on said costs from the date of completion of
repairs by Landlord.
9. Alterations and Window Coverings. Tenant shall not, without
--------------------------------
Landlord's prior consent, make any alterations improvement or additions in or
about the premises. As a condition to giving such consent, Landlord may require,
among other things, reasonable changes to drawings and specifications, that
Tenant remove any such alterations, improvements or additions at the expiration
or earlier termination of the term and restore the premises to their prior
condition and that Tenant provide "as-built" drawings and specifications of the
work. In no event shall any alterations or improvements affect the structure of
the Building. Before commencing any work relating to alterations, additions or
improvements affecting the premises, Tenant shall notify Landlord of the
expected date of commencement thereof and of the anticipated cost thereof, and
shall furnish complete drawings and specifications describing such work as well
as such information as shall reasonably be requested by Landlord substantiating
Tenant's ability to pay for such work. Landlord shall then have the right at any
time and from time to time to post and maintain on the premises such notices as
Landlord reasonably deems necessary to protect the premises, the Building and
Landlord from mechanics' liens or any other liens. In any event, Tenant shall
pay when due all claims for labor or materials furnished to or for Tenant at or
for use in the premises. Tenant shall not permit any mechanics' liens to be
levied against the premises for any labor or materials furnished to Tenant or
claimed to have been furnished to
-4-
<PAGE>
Tenant or to Tenant's agents or contractors in connection with work of any
character performed or claimed to have been performed on the premises by or at
the direction of Tenant. All alterations, improvements or additions in or about
the premises performed by or on behalf of Tenant shall be done by contractors
designated or approved by Landlord, in a first-class, workmanlike manner which
does not disturb or interfere with other tenants and in compliance with all
applicable laws, ordinances, regulations and orders of any governmental
authority having jurisdiction thereover, as well as the requirements of insurers
of the premises and the Building. Prior to the commencement of any such work,
if Landlord so requests, Tenant shall furnish to Landlord performance and
payments bonds in a form and issued by a surety reasonably acceptable to
Landlord in an amount equal to the cost of such work of alteration, improvement
or addition, and evidence that any contractor(s) retained by Tenant have
adequate insurance. Notwithstanding anything in this paragraph 9 to the
contrary, upon Landlord's request, Tenant shall remove any contractor,
subcontractor or material supplier from the premises and the Building if the
work or presence of such person or entity results in labor disputes in or about
the Building or damage to the premises or the Building. Upon completion of work
performed for Tenant, at Landlord's request Tenant shall deliver to Landlord
evidence of full payment therefor and full and unconditional waivers and
releases of liens for all labor, services and/or materials used. Unless Landlord
requires their removal, as set forth above, all alterations, improvements or
additions which may be made on the premises shall become the property of
Landlord and remain upon and be surrendered with the premises at the termination
or expiration of the term; provided, however, that Tenant's machinery, equipment
and trade fixtures, other than any which may be affixed to the premises so that
they cannot be removed without material damage to the premises, shall remain the
property of Tenant and shall be removed by Tenant. Landlord shall select a
standard window covering and color, throughout the Building(s) and Tenant shall
use and maintain this standard material for any windows which shall be covered.
10. Insurance and Indemnity.
-----------------------
(a) Tenant shall obtain and maintain during the term of this Lease
commercial general liability insurance covering the premises and Common Area
with a combined single limit for personal injury and property damage in an
amount not less than $2,000,000, and employer's liability and workers'
compensation insurance as required by law. Tenant's commercial general
liability insurance policy shall be endorsed to provide (1) that it may not be
cancelled or altered in such a manner as adversely to affect the coverage
afforded thereby without 30 days' prior written notice to Landlord, (2) Landlord
is named as additional insured, (3) the insurer acknowledges acceptance of the
mutual waiver of claims by Landlord and Tenant pursuant to subparagraph (b)
below, (4) that such insurance is primary with respect to Landlord and its
property manager and that any other insurance maintained by Landlord or such
property manager is excess and noncontributing with such insurance. (5) a cross-
liability endorsement or severability of interest clause, (6) for blanket
contractual obligations coverage, broad form property damage coverage and
products and completed operations coverage (where applicable), (7) for
employee's automobile non-ownership liability, and (8) for coverage on an
occurrence, rather than claims-made basis. If, in the opinion of Landlord's
insurance adviser, based on a substantial increase in recovered liability claims
generally, the specified amounts of coverage are no longer adequate, within 30
days following Landlord's request, such coverage shall be appropriately
increased. Tenant shall also obtain and maintain insurance ("Personal Property
Insurance") covering leasehold improvements paid for by Tenant and Tenant's
personal property and fixtures from to time in, on, or at the premises, in an
amount not less than 100% of the full replacement cost, without deduction for
depreciation, providing protection against events protected under "All Risk
Coverage," as well as against sprinkler damage, vandalism, and malicious
mischief. Any proceeds from the Personal Property Insurance shall be used for
the repair or replacement of the property damaged or destroyed, unless this
Lease is terminated under an applicable provision herein. If the premises are
not repaired or restored following damage or destruction in accordance with
other provisions herein, Landlord shall receive any proceeds from the Personal
Property Insurance allocable to Tenant's leasehold improvements. Prior to the
commencement of the term, Tenant shall deliver to Landlord duplicates of such
policies or certificates thereof with endorsements, and at least 30 days prior
to the expiration of such policy or any renewal thereof, Tenant shall deliver to
Landlord replacement or renewal binders, followed by duplicate policies or
certificates within a reasonable time thereafter. Tenant hereby acknowledges
that the late delivery by Tenant to Landlord of the Insurance certificates or
policies referred to above will cause Landlord to incur costs not contemplated
by this lease, the exact amount of which will be extremely difficult to
ascertain. Such costs include, but are not limited to, processing and accounting
charges and penalties which may be imposed on Landlord by the terms of any
mortgage or trust deed covering the premises. Accordingly, if any Insurance
certificate or policy required to be delivered by Tenant above shall not be
received by Landlord at the time prescribed above, Tenant shall pay to Landlord
a charge in the sum of $300.00. The parties hereby agree that such charge
represents a fair and reasonable estimate of the costs Landlord will incur by
reason of late delivery by Tenant, and acceptance of such charge by Landlord
shall in no event constitute a waiver of Tenant's default with respect to such
late delivery, nor prevent Landlord from exercising any of the other rights and
remedies available to Landlord as a result of such default. If Tenant fails to
obtain such insurance or to furnish Landlord any such duplicate policies or
certificates as herein required, Landlord may, at its election, without notice
to Tenant and without any obligation so to do, procure and maintain such
coverage and Tenant shall reimburse Landlord on demand as additional rent for
any premium so paid by Landlord. Tenant shall have the right to provide all
insurance coverage required herein to be provided by Tenant pursuant to blanket
policies so long as such coverage is expressly afforded by such policies.
(b) Landlord hereby waives all claims against Tenant, and Tenant's
officers, directors, partners, employees, agents and representatives for loss or
damage to the extent that such loss or damage is insured against under any valid
and collectable insurance policy insuring Landlord or would have been insured
against but for any deductible amount under any such policy.
-5-
<PAGE>
and Tenant waives all claims against Landlord including Landlord's trustees,
officers, directors, partners, employees, agents and representatives for loss or
damage to the extent such loss or damage is insured against under any valid and
collectable insurance policy insuring Tenant or required to be maintained by
Tenant under this Lease, or would have been insured against but for any
deductible amount under any such policy.
(c) As insurance is available to protect it, and to the extent such
waiver does not violate public policy, Tenant hereby waives Tenant hereby waives
all claims against Landlord for damage to any property or injury to or death of
any person in, upon or about the premises or the Building arising at any time
and from any cause, and Tenant shall hold Landlord harmless from and defend
Landlord against (i) all claims for damage to any property or injury to or death
of any person arising in or from the use of the premises by Tenant, except as to
Landlord or any of its agents, employees or contractors, such as is caused by
the sole negligence or willful misconduct of Landlord, its agents, employees or
contractors otherwise entitled to indemnification, or (ii) arising from the
negligence or willful misconduct of Tenant, its employees, agents or contractors
in, upon or about those portions of the Building other than the premises. The
foregoing indemnity obligation of Tenant shall include attorneys' fees,
investigation costs and all other costs and expenses incurred by Landlord from
the first notice that any claim or demand is to be made or may be made. The
provisions of this paragraph 10 shall survive the expiration or termination of
this Lease with respect to any damage, injury or death occurring prior to such
time.
11. Damage or Destruction.
---------------------
(a) If during the term the premises are totally or partially
destroyed, or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a risk which is
wholly covered by insurance proceeds made available to Landlord for such
purpose, Landlord shall proceed with reasonable diligence to repair the damage
or destruction and this Lease shall not be terminated; provided, however, that
if in the opinion of Landlord's architect or contractor the work of repair
cannot be completed in 90 days following such damage or destruction, Landlord
may at its election terminate the Lease by notice given to Tenant within 30 days
following the event or such longer period as may reasonably be necessary to
obtain information from its architect or contractor.
(b) If during the term the premises are totally or partially
destroyed, or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a risk which is
not wholly covered by insurance proceeds made available to Landlord for repair
or reconstruction, Landlord may at its election by notice to Tenant given within
30 days following the event or such longer period as may reasonably be necessary
for Landlord to obtain information from its architect or contractor, either
restore the premises or terminate this Lease.
(c) In case of destruction or damage which materially interferes with
Tenant's use of the premises, if this Lease is not terminated as above provided,
rent shall be abated during the period required for the work of repair based
upon the degree of interference with Tenant's use of the premises. Except for
abatement of rent, Tenant shall have no claim against Landlord for any loss
suffered by Tenant due to damage or destruction of the premises or any work of
repair undertaken as herein provided. Tenant expressly waives the provisions of
Section 1932 and Section 1933(4) of the California Civil Code which are
superseded by this paragraph 11.
12. Eminent Domain. If all or any part of the premises shall be taken as
--------------
a result of the exercise of the power of eminent domain or sold by Landlord
under threat thereof, this Lease shall terminate as to the part so taken as of
the date of taking or sale and, in the case of a partial taking, either Landlord
or Tenant shall have the right to terminate this Lease as to the balance of the
premises by notice to the other within 30 days after such date if the portion of
the premises taken shall be of such extent and nature as substantially to
handicap, impede or impair Tenant's use of the balance of the premises for
Tenant's purposes. In the event of any taking or such sale, Landlord shall be
entitled to any and all compensation, damages, income, rent, awards, or any
interest therein whatsoever which may be paid or-made in connection therewith,
and Tenant shall have no claim against Landlord for the value of any unexpired
term of this Lease or otherwise. In the event of a partial taking of the
premises which does not result in a termination of this Lease, the monthly
rental thereafter to be paid shall be equitably reduced on a square footage
basis.
13. Assignment and Subletting.
-------------------------
(a) Tenant shall not assign this Lease or any interest herein or
sublet the premises or any part thereof without the prior consent of Landlord,
which consent shall not be unreasonably withheld. Tenant shall not hypothecate
this Lease or any interest herein or permit the use of the premises by any party
other than Tenant without the prior consent of Landlord, which consent may be
withheld by Landlord in its absolute discretion. This Lease shall not, nor
shall any interest herein, be assignable as to the interest of Tenant by
operation of law without the consent of Landlord. Any of the foregoing acts
without such consent shall be void and shall, at the option of Landlord,
terminate this Lease. In connection with each consent requested by Tenant,
Tenant shall submit to Landlord the terms of the proposed transaction, the
identity of the parties to the transactions, the proposed documentation for the
transaction, current financial statements of any proposed assignee or subleases
and all other information reasonably requested by Landlord concerning the
proposed transaction and the parties involved therein. As a further condition
to any consent granted by Landlord, the proposed assignee or subleases shall
agree in writing to perform for the benefit of Landlord all of the Tenant's
obligations under this Lease or so much thereof as are allocable to any portion
of the premises proposed to be sublet.
-6-
<PAGE>
(b) Without limiting the other instances in which it may be reasonable
for Landlord to withhold its consent to an assignment or subletting, Landlord
and Tenant acknowledge that it shall be reasonable for Landlord to withhold its
consent in the following instances:
(1) the proposed assignee or subtenant is a governmental agency;
(2) in Landlord's reasonable judgment, the use of the premises
would entail any alterations which would lessen the value of the leasehold
improvements in the premises, or would require increased services by
Landlord;
(3) in Landlord's reasonable judgment, the financial worth of
the proposed assignee or subtenant does not meet the credit standards
applied by Landlord for other tenants under leases with comparable terms,
or the character, reputation or business of the proposed assignee or
sublessee is not consistent with the quality of the other tenancies in the
Building;
(4) in Landlord's reasonable judgment, the proposed assignee or
subtenant does not have a good reputation as a tenant of property;
(5) Landlord has received from any prior landlord to the
proposed assignee or subtenant a negative report concerning such prior
landlord's experience with the proposed assignee or subtenant;
(6) Landlord has experienced previous defaults by or is in
litigation with the proposed assignee or subtenant;
(7) in Landlord's reasonable judgment, the premises, or the
relevant part thereof, will be used in a manner that will violate any
negative covenant as to use contained in any other lease of space in the
Building;
(8) the use of the premises by the proposed assignee or
subtenant will violate any applicable law, ordinance or regulation;
(9) the proposed assignment or sublease will create a vacancy
elsewhere in the Building;
(10) the proposed assignee or subtenant is a person with whom
Landlord in negotiating to lease space in the Building or is currently a
tenant in the Building;
(11) the proposed assignment or sublease fails to include all of
the terms and provisions required to be included therein pursuant to this
paragraph 13;
(12) Tenant is in default of any obligation of Tenant under this
Lease, or Tenant has defaulted under this lease on three or more occasions
during the 12 months preceding the date that Tenant shall request consent;
or
(13) in the case of a subletting of less than the entire
premises, if the subletting would result in the division of the premises
into more than two subparcels or would require access to be provided
through space leased or held for lease to another tenant or improvements to
be made outside of the premises.
(c) If at any time or from time to time during the term of this Lease
Tenant desires to sublet all or any part of the premises, Tenant shall give
notice to Landlord setting forth the terms of the proposed subletting and the
space so proposed to be sublet. Landlord shall have the option, exercisable by
notice given to Tenant within 20 days after Tenant's notice is given, either to
sublet from Tenant such space at the rental and other terms set forth in
Tenant's notice, or, if the proposed subletting is for the entire premises for a
sublet term ending within the last year of the term of this lease, to terminate
this Lease, in either case, effective as of the date of the proposed subletting
if Landlord so terminates this Lease, Landlord may enter into a lease with the
proposed subtenant. If Tenant proposes to assign this Lease, Landlord may, by
notice given within 20 days of Tenant's notice, elect to terminate this lease as
of the date of the proposed assignment. If Landlord so terminates this lease,
Landlord may, if it elects, enter into a new lease covering the premises or a
portion thereof with the intended assignee or subtenant on such terms as
Landlord and such person may agree, or enter into a new lease covering the
premises or a portion thereof with any other person; in such event, Tenant shall
not be entitled to any portion of the profit, if any, which Landlord may realize
on account of such termination and reletting. Landlord's exercise of its
aforesaid option shall not be construed to impose any liability upon Landlord
with respect to any real estate brokerage commission(s) or any other costs or
expenses incurred by Tenant in connection with its proposed subletting or
assignment. If Landlord does not exercise its options to terminate the Lease or
sublet the premises, Tenant shall be free to sublet such space to any third
party on the same terms set forth in the notice given to Landlord, subject to
obtaining Landlord's prior consent as hereinabove provided.
(d) As used in this Paragraph 13, the term "assign" or "assignment"
shall include, without limitation, any sale, transfer or other disposition of
all or any portion of Tenant's estate under this Lease, whether voluntary or
involuntary, and whether by operation of law or otherwise including any of the
following:
(1) If Tenant is a corporation: (i) any dissolution, merger,
consolidation or other reorganization of Tenant, or (ii) a sale of more
than 50% of the value of the assets of Tenant, or (iii) if Tenant is a
corporation with fewer than 500
-7-
<PAGE>
shareholders, sale or other transfer of a controlling percentage of the
capital stock of Tenant. The phrase "controlling percentage" means the
ownership of, and the right to vote, stock possessing at least 5O% of the
total combined voting power of all classes of Tenant's stock issued,
outstanding and permitted to vote for the election of directors;
(2) If Tenant is a trust, the transfer of more than 50% of the
beneficial interest of Tenant, or the dissolution of the trust;
(3) If Tenant is a partnership or joint venture, the withdrawal,
or the transfer of the interest of any general partner or joint venturer or
the dissolution of the partnership or joint venture; or
(4) If Tenant is composed of tenants-in-common, the transfer of
interest of any co-tenants, or the partition or dissolution of the co-
tenancy.
(e) No sublessee (other than Landlord if it exercises its option
pursuant to subparagraph (c) above) shall have a right further to sublet, and
any assignment by a sublessee of its sublease shall be subject to Landlord's
prior consent in the same manner as if Tenant were entering into a new sublease.
(f) In addition to rental otherwise payable under the lease, in the
case of an assignment, all sums or other economic consideration received by
Tenant as a result of such assignment shall be paid to Landlord after first
deducting the unamortized cost of leasehold improvements paid for by Tenant, and
the cost of any real estate commissions incurred in connection with such
assignment. In the event such consideration is received by Tenant in
installments, the portion of each installment to be paid to Landlord shall be
determined by subtracting from the installment an amount equal to the total
amount of the foregoing permitted deductions divided by the total number of
installments.
(g) In addition to rental otherwise payable under the lease, in the
case of a subletting, all sums or economic consideration received by Tenant as a
result of such subletting shall be paid to Landlord after first deducting (1)
the rental due hereunder, prorated to reflect only rental allocable to the
sublet portion of the premises, (2) the cost of leasehold improvements made to
the sublet portion of the premises at Tenant's cost, amortized over the term of
this Lease except for leasehold improvements made for the specific benefit of
the sublessee, which shall be amortized over the term of the sublease, and (3)
the cost of any real estate commissions incurred in connection with such
subletting, amortized over the term of the sublease.
(h) Regardless of Landlord's consent, no subletting or assignment
shall release Tenant of Tenant's obligations or alter the primary liability of
Tenant to pay the rental and to perform all other obligations to be performed by
Tenant hereunder. The acceptance of rental by Landlord from any other person
shall not be deemed to be a waiver by Landlord of any provision hereof. Consent
to one assignment or subletting shall not be deemed consent to any subsequent
assignment or subletting. In the event of default by any assignee of Tenant or
any successor of Tenant in the performance of any of the terms hereof, Landlord
may proceed directly against Tenant without the necessity of exhausting remedies
against such assignee or successor. Landlord may consent to subsequent
assignments or subletting of this Lease or amendments or modifications to this
Lease with assignees of Tenant, without notifying Tenant, or any successor of
Tenant, and without obtaining its or their consent thereto and such action shall
not relieve Tenant of liability under this Lease.
(i) If Tenant shall assign or sublet the premises or request the
consent of Landlord to any assignment or subletting or if Tenant shall request
the consent of Landlord for any act that Tenant proposes to do, then Tenant
shall pay Landlord's reasonable attorneys' fees incurred in connection
therewith.
14. Rules & Regulations. Tenant shall faithfully observe and comply with
-------------------
the rules and regulations attached to this Lease as Exhibit B, and, after notice
---------
thereof; all reasonable modifications thereof and additions thereto from time to
time promulgated in writing by Landlord. Landlord shall not be responsible to
Tenant for the nonperformance by any other tenant or occupant of the Building of
any of said rules and regulations, but Landlord shall use good faith efforts to
enforce the rules and regulations consistently.
15. Default by Tenant.
-----------------
(a) Any of the following events shall constitute events of default
under this Lease:
(1) a default by Tenant in the payment of any rent or other sum
payable hereunder when due;
(2) a default by Tenant in the performance of any of the other
terms, covenants, agreements or conditions contained herein and, if the
default is curable, the continuation of such default for a period of 10
days after notice by Landlord or beyond the time reasonably necessary for
cure if the default is of the nature to require more than 10 days to
remedy, provided that if Tenant has defaulted in the performance of the
same obligation more than one time in any twelve-month period and notice of
such default has been given by Landlord in such instance, no cure period
shall thereafter be applicable hereunder;
(3) the bankruptcy or insolvency of Tenant, any transfer by
Tenant in fraud of creditors, assignment by Tenant for the benefit of
creditors, or the commencement
-8-
<PAGE>
of any proceedings of any kind by or against Tenant under any provision of
the Federal Bankruptcy Act or under any other insolvency, bankruptcy or
reorganization act unless, in the event any such proceedings are
involuntary, Tenant is discharged from the same within 60 days thereafter;
the appointment of a receiver for a substantial part of the assets of
Tenant; or the levy upon this Lease or any estate of Tenant hereunder by
any attachment or execution; or
(4) the abandonment of the premises which for the purpose of this
subparagraph shall be deemed to occur when Tenant allows the premises to be
unoccupied by Tenant or its employees for a period longer than ten (10)
consecutive days during the term of this Lease.
(b) Upon the occurrence of any event of default by Tenant hereunder,
Landlord may, at its option and without any further notice or demand, in
addition to any other rights and remedies given hereunder or by law, do any of
the following:
(1) Landlord shall have the right, so long as such default
continues, to give notice of termination to Tenant, and on the date
specified in such notice this Lease shall terminate.
(2) In the event of any such termination of this Lease, Landlord
may then or at any time thereafter, re-enter the premises and remove
therefrom all persons and property and again repossess and enjoy the
premises, without prejudice to any other remedies that Landlord may have by
reason of Tenant's default or of such termination.
(3) In the event of any such termination of this Lease, and in
addition to any other rights and remedies Landlord may have, Landlord shall
have all of the rights and remedies of a landlord provided by Section
1951.2 of the California Civil Code. The amount of damages which Landlord
may recover in event of such termination shall include, without limitation,
(i) the worth at the time of award (computed by discounting such amount at
the discount rate of the Federal Reserve Bank of San Francisco at the time
of award plus one percent) of the amount by which the unpaid rent for
balance of the term after the time of award exceeds the amount of rental
loss that Tenant proves could be reasonably avoided, (ii) all legal
expenses and other related costs incurred by Landlord following Tenant's
default, (iii) all costs incurred by Landlord in restoring the premises to
good order and condition, or in remodeling, renovating or otherwise
preparing the premises for reletting, and (iv) all costs (including,
without limitation, any brokerage commissions) incurred by Landlord in
reletting the premises.
(4) For the purpose of determining the unpaid rent in the event
of a termination of this Lease, or the rent due hereunder in the event of a
reletting of the premises, the monthly rent reserved in this Lease shall be
deemed to be the sum of the rental due under paragraph 3 above and the
amounts last payable by Tenant pursuant to paragraph 4 and 5 above and any
concessions by Landlord as an inducement for Tenant to enter into this
Lease.
(5) Landlord's acceptance of payment from Tenant of less than
the amount of rent then due shall not constitute a waiver of any rights of
Landlord or Tenant including, without limitation, any right of Landlord to
recover possession of the premises.
(6) After terminating this Lease, Landlord may remove any and
all personal property located in the premises and place such property in a
public or private warehouse or elsewhere at the sole cost and expense of
Tenant.
(c) Even though Tenant has breached this Lease and abandoned the
premises, this Lease shall continue in effect for so long as Landlord does not
terminate Tenant's right to possession, and Landlord may enforce all its rights
and remedies under this Lease, including the right to recover rental as it
becomes due under this Lease. Acts of maintenance or preservation, efforts to
relet the premises, or the appointment of a receiver upon initiative of Landlord
to protect Landlord's interest under this Lease, shall not constitute a
termination of Tenant's right to possession.
(d) Tenant hereby waives all rights under California Code of Civil
Procedure Section 1179 and California Civil Code Section 3275 providing for
relief from forfeiture, and any other right now or hereafter existing to redeem
the premises or reinstate this Lease after termination pursuant to this
Paragraph 15 or by order or judgment of any court or by any legal process.
(e) Landlord and Tenant hereby waive trial by jury in any action,
proceeding or counterclaim brought by either of the parties hereby against the
other on any matters not relating to personal injury or property damage but
otherwise arising out of or in any way connected with this Lease, the
relationship of Landlord and Tenant, Tenant's use or occupancy of the premises,
and any emergency statutory or any other statutory remedy.
(f) The remedies provided for in this Lease are in addition to any
other remedies available to Landlord at law or in equity, by statute or
otherwise.
16. Landlord's Right to Cure Defaults. If Tenant shall fail to pay any
---------------------------------
sum of money, other than rental, required to be paid by it hereunder or shall
fail to perform any other act on its part to be performed hereunder and such
failure shall continue for 30 days after notice thereof by Landlord, Landlord
may, but shall not be obligated so to do, and without waiving or
-9-
<PAGE>
releasing Tenant from any obligations of Tenant, make any such payment or
perform any such other act on Tenant's part to be made or performed as in this
Lease provided. All sums so paid by Landlord and all necessary incidental costs
shall be deemed additional rent hereunder and shall be payable to Landlord on
demand, and Landlord shall have (in addition to any other right or remedy of
Landlord) the same rights and remedies in the event of the nonpayment thereof by
Tenant as in the case of default by Tenant in the payment of rental.
17. Default by Landlord. Landlord shall not be in default under this
-------------------
Lease unless Landlord fails to perform obligations required of Landlord
hereunder within a reasonable time, but in no event later than 3O days after
notice by Tenant to Landlord specifying wherein Landlord has failed to perform
such obligation; provided, however, that if the nature of Landlord's obligation
is such that more than 30 days are required for performance, then Landlord shall
not be in default if Landlord commences performance within such 30 day period
and thereafter diligently prosecutes the same to completion.
18. Security Deposit. On execution of this Lease Tenant shall deposit
----------------
with Landlord the sum specified in the Basic Lease Information (the "Deposit").
The Deposit shall be held by Landlord as security for the performance by Tenant
of all of the provisions of this Lease. Following an event of default by Tenant
under this Lease, Landlord may use, apply or retain all or any portion of the
Deposit for the payment of any rent or other charge in default, or the payment
of any other sum to which Landlord may become obligated by Tenant's default, or
to compensate Landlord for any loss or damage which Landlord may suffer thereby.
If Landlord so uses or applies all or any portion of the Deposit, then within 5
days after demand therefor Tenant shall deposit cash with Landlord in an amount
sufficient to restore the Deposit to the full amount thereof, and Tenant's
failure to do so shall be a material breach of this Lease. Landlord shall not be
required to keep the Deposit separate from its general accounts. If Tenant
performs all of Tenant's obligations hereunder, the Deposit, except that portion
designated as a non-refundable cleaning deposit or so much thereof as has not
theretofore been applied by Landlord, shall be returned, without payment of
interest for its use, to Tenant (or, at Landlord's option, to the last assignee,
if any, of Tenant's interest hereunder) at the expiration of the term hereof,
and after Tenant has vacated the premises. No trust relationship is created
herein between Landlord and Tenant with respect to the Deposit.
19. Estoppel Certificate.
--------------------
(a) Tenant shall at any time within 10 days following request from
Landlord execute, acknowledge and deliver to Landlord a statement certifying (1)
that this Lease is unmodified and in full force and effect (or, if modified,
stating the nature of such modification and certifying that this Lease, as so
modified, is in full force and effect), (2) the date to which the rent, security
deposit, and other sums payable hereunder have been paid, (3) acknowledging that
there are not, to Tenant's knowledge, any uncured defaults on the part of
Landlord hereunder, or specifying such defaults, if any, which are claimed, and
(4) such other matters as may reasonably be requested by Landlord. Any such
statement may be conclusively relied upon by any prospective purchaser or
encumbrancer of the Building and other real property of which it is a part.
(b) Tenant's failure to deliver such statement within such time shall
be conclusive upon Tenant: (1) that this Lease is in full force and effect,
without modification except as may be represented by Landlord, (2) that there
are no uncured defaults in Landlord's performance, and (3) that not more than
one month's rent has been paid in advance.
(c) If Landlord desires to finance or refinance the Building, within
10 days of Landlord's request, Tenant shall deliver to any lender designated by
Landlord such financial statements of Tenant as may be reasonably required by
such lender. All such financial statements shall be received by Landlord in
confidence and shall be used for the purposes herein set forth.
20. Subordination. This Lease, at Landlord's option, shall be subordinate
-------------
to any ground lease, mortgage, deed of trust, or any other hypothecation for
security now or hereafter placed upon the Building and to any and all advances
made on the security thereof and to all renewals, modifications, consolidations,
replacements and extensions thereof. If any mortgagee, beneficiary, trustee or
ground lessor shall elect to have this Lease prior to the lien of its mortgage,
deed of trust or ground lease, and shall give notice thereof to Tenant, this
Lease shall be deemed prior to such mortgage, deed of trust, or ground lease,
whether this Lease is dated prior to or subsequent to the date of said mortgage,
deed of trust or ground lease or the date of recording thereof. If any mortgage
or deed of trust to which this Lease is subordinate is foreclosed or a deed in
lieu of foreclosure is given to the mortgagee or beneficiary, Tenant shall
attorn to the purchaser at the foreclosure sale or to the grantee under the deed
in lieu of foreclosure; if any ground lease to which this Lease is subordinate
is terminated, Tenant shall attorn to the ground lessor. Tenant agrees to
execute any documents required to effectuate such subordination or to make this
Lease prior to the lien of any mortgage, deed of trust or ground lease, as the
case may be, or to evidence such attornment.
21. Attorneys' Fees. If either party commences an action or proceeding
---------------
against the other party arising out of or in connection with this Lease, or
institutes any proceeding in a bankruptcy or similar court which has
jurisdiction over the other party or any or all of its property or assets, the
prevailing party in such action or proceeding and in any appeal in connection
therewith shall be entitled to have and recover from the unsuccessful party
reasonable attorneys' fees, court costs, expenses and other costs of
investigation and preparation. If such prevailing party recovers a judgment in
any such action, proceeding, or appeal, such attorneys' fees, court costs and
expenses shall be included in and as a part of such judgment.
-10-
<PAGE>
22. Notices. All communications from one party to the other given
-------
pursuant to the terms of this Lease shall be in writing and shall be deemed to
have been fully given when served personally at the premises, deposited in the
United States mail postage prepaid, or delivered to a generally recognized
overnight courier service, charges prepaid, and addressed as follows: to Tenant
at the address specified in the Basic Lease Information or to such other place
as Tenant may from time to time designate in a notice to Landlord; to Landlord
at the address specified in the Basic Lease Information, or to such other place
and with such other copies as Landlord may from time to time designate in a
notice to Tenant; or, in the case of Tenant, delivered to Tenant at the
premises.
23. Landlord's Scope of Work. Attached hereto as Exhibit "A" and by this
------------------------
reference made a part hereof, is a space plan of the premises with any notations
indicating the finishing work to be performed by Landlord. Said plan is to be
approved, signed, and returned to Landlord by on or before the date specified in
the Basic Lease Information, whereupon said work shall commence and be completed
in substantial compliance with the requirements of said Exhibit and in a good
and workmanlike manner on or before the date specified in the Basic Lease
Information subject only to delays occasioned by fire, insurrection, war and
other causes beyond the control of Landlord, in which event the provisions of
Paragraph 1 of the Lease shall apply.
24. General Provisions.
------------------
(a) This Lease shall be governed by and construed in accordance with
the laws of the State of California.
(b) The invalidity of any provision of this Lease, as determined by a
court of competent jurisdiction, shall in no way affect the validity of any
other provision hereof.
(c) This Lease contains all agreements of the parties with respect to
any matter mentioned herein and supersedes any verbal and any prior written
understanding, conditions, representations, agreements or covenants, and may be
modified in writing only, signed by the parties.
(d) No waiver by Landlord of any provision hereof shall be deemed a
waiver of any other provision or of any subsequent breach by Tenant of the same
or any other provision. Landlord's consent to or approval of any act shall not
be deemed to render unnecessary the obtaining of Landlord's consent to or
approval of any subsequent act by Tenant. The acceptance of rent or any partial
payment hereunder by Landlord shall not be a waiver of any preceding breach by
Tenant of any provision hereof, other than the failure of Tenant to pay the
particular rent accepted, regardless of Landlord's knowledge of such preceding
breach at the time of acceptance of such rent.
(e) If Tenant remains in possession of the premises or any part
thereof after the expiration of the term with the consent of Landlord, such
occupancy shall be a tenancy from month to month at a rental in the amount of
one and a quarter times the last month's rental during the term plus all other
charges payable hereunder, and upon all of the terms hereof.
(f) Subject to the provisions of this Lease restricting assignment or
subletting by Tenant, this Lease shall bind the parties, their personal
representatives, successors and assigns.
(g) Landlord and Landlord's agents shall have the right to enter the
premises at reasonable times with 24 hour notice, unless an emergency for the
purpose of inspecting the same, posting notices, showing the same to prospective
purchasers or lenders, and making such alterations, repairs, improvements or
additions to the premises or to the Building as Landlord may deem necessary or
desirable. Landlord may at any time during the last 120 days of the term place
on-or about the premises any ordinary "For Lease" sign, during the last 120 days
or so of the Lease Term if Tenant does not renew Lease, Landlord at sometimes
will not be able to give a full 24 hour notice.
(h) Tenant shall not conduct any auction at the premises.
(i) The voluntary or other surrender of this Lease by Tenant, the
mutual cancellation thereof or the termination of this lease by Landlord as a
result of Tenant's default shall, at the option of Landlord, terminate all or
any existing subtenancies or may, at the option of Landlord, operate as an
assignment to Landlord of any or all of such subtenancies.
(j) If Tenant is a corporation, each individual executing this Lease
on behalf of Tenant represents and warrants that he or she is duly authorized to
execute and deliver this Lease on behalf of the corporation in accordance with a
duly adopted resolution of the Board of Directors and that this Lease is binding
upon the corporation in accordance with its terms.
(k) The term "Landlord" as used herein means the then owner of the
Building and in the event of a sale of the Building the selling owner shall be
automatically relieved of all obligations of Landlord hereunder, except for acts
or omissions of Landlord theretofore occurring.
(1) Any liability which way arise as a consequence of the execution of
this Lease by or on behalf of Landlord shall be a liability of Landlord and not
the personal liability of any trustee, partner, corporate officer or corporate
officer of a trustee or partner, nor of an employee or beneficiary of Landlord,
its trustees or partners. Notwithstanding anything to the contrary set forth in
this Lease, Tenant agrees that there shall be absolutely no personal liability
on the part of Landlord with respect to any of the obligations of Landlord under
this Lease, and Tenant shall look solely to the equity, if any, of Landlord in
the Building for the
-11-
<PAGE>
satisfaction of any liability of Landlord to Tenant. Tenant's exculpation of
personal liability of Landlord is absolute and without any exception whatsoever.
(m) Tenant warrants that it has had no dealings with any real estate
broker or agent other than the Broker(s) identified in the Basic Lease
Information in connection with the premises or this Lease. Tenant shall
indemnify Landlord and hold it harmless from and against all claims, demands,
costs or liabilities (including, without limitation, attorneys' fees) asserted
by any party other than Broker(s) based upon dealings of that party with Tenant
in connection with the premises or this Lease. Landlord shall incur no
obligation to compensate Tenant's agent or representative should this lease be
renewed or extended.
(n) Within 10 days of Landlord's request therefore, Tenant shall
execute and deliver such amendments of this Lease as shall have been required by
Landlord's lender in connection with the making of a loan to be secured by the
premises or the Building, provided such amendment does not increase the
obligations of Tenant under this Lease or materially and adversely affect
Tenant's leasehold interest.
(o) Time is of the essence of this Lease and all of its provisions.
(p) No diminution or shutting off of light, air or view by any
structure which may be erected on or adjacent to the Property shall in any way
affect this Lease or impose any liability on Landlord.
25. Exhibits. The exhibits and addendum, if any, specified in the Basic
--------
Lease Information are attached to this Lease and by this reference made a part
hereof.
-12-
<PAGE>
If this Lease has been filled in, it has been prepared for submission
to your attorney for approval. No representation or recommendation is made by
the real estate broker or its agents or employees as to the legal sufficiency,
legal effect or tax consequences of this Lease or the transaction relating
thereto. The submission of this Lease for examination does not constitute a
reservation of or option for the Leased Premises and this Lease becomes
effective as a Lease only upon execution and delivery thereof by Landlord and
Tenant.
IN WITNESS WHEREOF, the parties have executed this Lease on the
respective dates indicated below.
TENANT: LANDLORD:
Tiara Computer Systems, Inc. and SAN TOMAS INVESTORS II
Internex Information Services, Inc.
By: /s/ Sherman Tuan By: /s/
Sherman Tuan
President
By: By: /s/
Date of Execution Date of Execution
by Tenant: 2/27/95 by Landlord: 2-27/95
-13-
<PAGE>
ADDENDUM TO THAT CERTAIN LEASE DATED FEBRUARY 13, 1995 BY AND BETWEEN SAN TOMAS
INVESTORS II (LANDLORD) AND TIARA COMPUTER SYSTEMS, INC., AND INTERNEX
INFORMATION SERVICES, INC., (TENANT) FOR THE PREMISES AT 2302 WALSH AVENUE,
SANTA CLARA, CALIFORNIA:
The subject lease is modified as follows:
Paragraph 2 Term Commencement: The lease term shall commence on June 1, 1995
- -----------------------------
however, Tenant may occupy the premises immediately upon the completion of
Landlord's tenant improvement work (early occupancy). Tenant shall be obligated
to perform under all the terms and conditions of this lease during the "early
occupancy" period between the date of occupancy and June 1, 1995 except for the
payment of rent, real estate taxes, and building operating expenses.
Paragraph 3(b) Rent: Paragraph 3(b) notwithstanding, there will be no rent
- -------------------
increases for months one through thirty six. However, the rent increases which
would have been applied on the first and second anniversary dates will be added
to the rent increase for the third anniversary date to establish the rent for
months thirty seven through sixty. The increase will be calculated per paragraph
3(b) however the rent shall not increase more than five percent nor less than
two percent for any year and the total increase shall not be less than six
percent nor more than fifteen percent of the base rent.
For example, if the CPI increases 2.5% per year over the first three anniversary
dates, the cumulative CPI increase over that period of time would be 7.5% (three
years @ 2.5% per year). The original lease rate of $.80 would then be
multiplied by 1.075 to obtain the rent for the final twenty four months of the
lease.
Paragraph 13 (f) and 13 (g)Assignment and Subletting: Tenant shall be entitled
- ----------------------------------------------------
to keep one half of any economic considerations, above the rental due under this
lease, resulting from an assignment or subletting.
Paragraph 18 Security Deposit: Landlord agrees, if Tenant is not otherwise in
- -----------------------------
default in the terms and conditions of this lease, to refund $6,622.40 of the
security deposit to Tenant on June 1, 1996.
Paragraph 23 Landlord's Scope of Work: Notwithstanding anything to the contrary
- -------------------------------------
set forth in the lease, Tenant shall have a period of thirty (30) days from the
lease commencement date during which to discover and inform Landlord of any
defects in the leased premises, including, without limitation, any building
systems.
Expansion: Landlord agrees to notify Tenant of the availability of any adjacent
- ---------
space in the building prior to putting said space on the market.
Initials:
Landlord /s/
-------------------
Tenant /s/
----------------------
<PAGE>
EXHIBIT A
Landlord shall provide the following tenant improvements at Landlord's sole cost
and expense:
1. Relocate walls and doors as shown on the floor plan. Landlord may reuse
existing doors and door hardware where feasible.
2. Install three 4 foot by 8 foot interior windows at (1),(2), and (3).
Tenant to pay the labor and material cost for one (1) 4 foot by 8 foot interior
window.
3. Construct a new lunch room as shown, dimensions approximately 12 feet by 18
feet. Counter unit to be relocated from existing lunchroom area to (4).
4. New concrete walkway to main entrance of the premises.
5. Electrical outlets, HVAC supplies and returns, and ceiling tiles as
required by building code or by condition, in Landlord's judgment.
6. Touch up paint, stretch, patch, and clean carpet where needed.
7. Install existing 3 foot by 4 foot window in lobby area.
Initials:
Landlord /s/
----------------------
Tenant /s/
---------------------
<PAGE>
[MAP OF PREMISES]
<PAGE>
EXHIBIT B
---------
STANDARD INDUSTRIAL LEASE
Rules and Regulations
1. No advertisements, pictures or signs of any sort shall be displayed on or
outside the Premises without the prior written consent of Landlord. This
prohibition shall include any portable signs or vehicles placed within the
parking lot, common areas or on streets adjacent thereto for the purpose of
advertising or display. Landlord shall have the right to remove any such
unapproved item without notice and at Tenant's expense.
2. Tenant shall not park or store motor vehicles, trailers or containers
outside of the Premises after the conclusion of normal daily business
activity except in approved areas specifically designated by Landlord.
3. Tenant shall not use any method of heating or air-conditioning other than
that supplied by Landlord without the prior written consent of Landlord.
4. All window coverings and window films or coatings installed by Tenant and
visible from outside of the building require the prior written approval of
Landlord. Except for dock shelters and seals as may be expressly permitted
by Landlord, no awnings or other projections shall be attached to the
outside walls of the building.
5. Tenant shall not use, keep or permit to be used or kept any foul or noxious
gas or substance on, in or around the Premises unless approved by Landlord.
Tenant shall not use, keep or permit to be used or kept any flammable or
combustible materials without proper governmental permits and approvals.
6. Tenant shall comply with all reasonable requirements of the Landlord's
insurance underwriters, which do not conflict with its rights under the
Lease.
7. Tenant shall not use, keep or permit to be used or kept food or other
edible materials in or around the Premises in such a manner as to attract
rodents, vermin or other pests. Tenant shall not permit cooking in or
about the Premises.
8. Tenant shall not use or permit the use of the Premises for lodging or
sleeping, for public assembly, or for any illegal or immoral purpose.
9. Tenant shall not alter any lock or install any new locks or bolts on any
door at the Premises without the prior written consent of Landlord. Tenant
agrees not to make any duplicate keys without the prior consent of
Landlord.
10. Tenant shall park motor vehicles only in those general parking areas as
designated by Landlord except for active loading and containers, Tenant
shall not unreasonably interfere with traffic flow within the Industrial
Park and loading and unloading areas of other tenants.
11. Storage of forklift and propane tanks shall be in secure and protected
storage enclosures approved by the local fire department and shall be
located in areas specifically designated by Landlord. Safety equipment,
including eye wash stations and approved neutralizing agents, shall be
provided in areas used for the maintenance and charging of lead-acid
batteries. Tenant shall protect electrical panels, asphalt paving areas
and building mechanical equipment from damage from forklift trucks.
12. Tenant shall not disturb, solicit or canvas any occupant of the building or
the Property and shall cooperate to prevent same.
13. No person shall go on the roof without Landlord's permission.
14. No animals, fish or birds of any kind may be brought into or kept in or
about the Premises.
15. Machinery; equipment's and apparatus belonging to Tenant which cause noise
or vibration that may be transmitted to the structure of the Building, to
such a degree as to be objectionable to Landlord or other tenants or to
cause harm to the Building, shall be placed and maintained by Tenant, at
Tenant's expense, on vibration eliminators or other devices sufficient to
eliminate the transmission of such noise and vibration. Tenant shall cease
using any such machinery which causes objectionable noise and vibration
which cannot be sufficiently mitigated.
16. All goods, including material used to store goods, delivered to the
Premises of Tenant shall be immediately moved into the Premises and shall
not be left in parking or exterior loading areas overnight.
17. Tractor trailers which must be unhooked or parked with dolly wheels beyond
the concrete loading areas must use steel plates or wood blocks of
sufficient size to prevent damage to the asphalt paving surfaces. No
parking or storing of such trailers will be permitted in the auto parking
areas of the Property or on streets adjacent thereto.
-14-
<PAGE>
18. Forklifts which operate on asphalt paving areas shall not have solid rubber
tires and shall use only tires that do not damage the asphalt.
19. Tenant is responsible for the safe storage and removal of all pallets.
Pallets shall be stored behind screened enclosures at locations approved by
the Landlord. If Pallets are stored within the Premises, storage shall
comply with safe practices as described in Factory Mutual Loss Prevention
Data Sheet 8-24.
20. Tenant is responsible for the safe storage and removal of all trash and
refuse. All such trash and refuse shall be contained in suitable
receptacles stored behind screened enclosures at locations approved by
Landlord. Landlord reserves the right to remove, at Tenant's expense
without further notice, any trash or refuse left elsewhere outside of the
Premises or in the Industrial Park.
21. Tenant shall not store or permit the storage or placement of goods or
merchandise in or around the common areas surrounding the Premises. No
displays or sales of merchandise shall be allowed in the parking lots or
other common areas.
22. Tenant shall appoint an Emergency Coordinator who shall be responsible for
assuring notification of the local fire department in the event of an
emergency, assuring that sprinkler valves are kept open, and implementing
the Factory Mutual "Red Tag Alert" system including weekly visual
inspection of all sprinkler system valves on or within the Premises.
23. No loudspeakers, televisions, phonographs, radios or other devices shall be
used in such a manner as to be heard or seen outside of the premises
without the prior written consent of the Landlord.
24. Tenant shall use at Tenant's cost such pest extermination contractor as
Landlord may direct and at such intervals as Landlord may require.
- 15-
<PAGE>
EXHIBIT 10.53
Standard Industrial Lease
(Net)
Basic Lease Information
<TABLE>
<S> <C>
Effective Date: July 25, 1996
Landlord: San Tomas Investors II
Tenant: Internex Information Services, Inc.,
a California corporation
Lease Reference
Premises and Building
Address: 2306 Walsh Ave. Paragraph 1
Santa Clara, CA 95051
Term Commencement: August 15, 1996 Paragraph 2
Term Expiration: May 31, 2000 Paragraph 2
Base Rent: 8-15-96 through 8-14-97 $3,206.00 per month Paragraph 3 (a)
8-15-97 through 5-31-00 3,384.00 per month
Tenant's Percentage Share: 2.29% Paragraphs 4 and 5
Property Taxes and Operating Expenses
Use: Engineering, administration, sales, light Paragraph 6
assembly, and warehousing.
Utilities (Monthly) Paragraph 7
Water/Sewer: NNN
Trash: NNN
Space plan returned to Landlord By: n/a Paragraph 23
Work Completion Date: n/a Paragraph 23
Security Deposit: $3,384.00 Paragraph 18
Non-refundable Cleaning Deposit: $100.00
Total amount due upon lease execution: $3,484.00
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Tenant's Address for Paragraph 22
Notices: 2302 Walsh Ave.
Santa Clara, CA 95051
Landlord's Address for Payments and
Notices:
c/o Commerce Communities Corp.
2316 Walsh Ave.
Santa Clara, CA 95051
Broker(s): Commerce Communities Corp. Paragraph 24(m)
</TABLE>
Exhibits and Addendum:
Exhibit A - Diagram showing premises
Exhibit B - Rules and Regulations
Addendum
In the event of any conflict between any Basic Lease Information and the Lease,
the latter shall control.
<TABLE>
<CAPTION>
TENANT Internex Information Services, Inc. LANDLORD San Tomas Investors II
<S> <C>
/s/ Glen C. Wahl /s/
-------------------------- -------------------------------
7/29/96 8/2/96
-------------------------- -------------------------------
</TABLE>
<PAGE>
STANDARD INDUSTRIAL LEASE
(Net)
Table of Contents
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Premises............................................................. 1
2. Term................................................................. 1
3. Rent................................................................. 1
4. Taxes................................................................ 2
5. Operating Expenses................................................... 2
6. Use.................................................................. 3
7. Utilities............................................................ 3
8. Maintenance, Repairs................................................. 3
9. Alterations and Window Coverings..................................... 4
10. Insurance and Indemnity.............................................. 5
11. Damage or Destruction................................................ 6
12. Eminent Domain....................................................... 6
13. Assignment and Subletting............................................ 7
14. Rules & Regulations.................................................. 8
15. Default by Tenant.................................................... 8
16. Landlord's Right to Cure Defaults.................................... 9
17. Default by Landlord.................................................. 9
18. Security Deposit..................................................... 10
19. Estoppel Certificate................................................. 10
20. Subordination........................................................ 10
21. Attorneys' Fees...................................................... 10
22. Notices.............................................................. 10
23. Landlord's Scope of Work............................................. 10
24. General Provisions................................................... 10
25. Exhibits............................................................. 12
</TABLE>
Exhibits and Addendum
Exhibit A - Diagram of Premises
Exhibit B - Rules and Regulations
<PAGE>
STANDARD INDUSTRIAL LEASE
(NET)
THIS LEASE is made and entered as of the Effective Date, July 25, 1996 by
and between SAN TOMAS INVESTORS II ("Landlord") and Internex Information
Services, Inc., a California Corporation ("Tenant")
WITNESSETH
1. Premises.
--------
(a) Landlord hereby leases to Tenant, and Tenant hereby leases from
landlord for the term of this Lease and at the rental and upon the conditions
set forth below, the premises described in the Basic Lease Information and
identified on the space plan attached hereto as Exhibit A. Subject to any
---------
obligations of Landlord as set forth in an exhibit to this Lease covering
initial improvement of the premises, Tenant shall accept the premises in its
"as-is" condition at the commencement of the term. Other than as expressly set
forth in this Lease, there are no implied warranties of merchantability,
habitability, fitness for a particular purpose or otherwise with respect to the
premises. The premises are located within the building commonly known as
described in the Basic Lease information (the "Building"). Landlord further
reserves the exclusive right to the roof and exterior surface of sidewalls and
appurtenances except as provided in the Lease. Landlord reserves the right from
time to time to relocate and alter the configuration of parking and Common Area
within and adjacent to the Building. The premises, the Building and the legal
parcel(s) on which the Building and related parking areas and structures and
other appurtenances are located, are collectively, the "Property".
(b) At the expiration of the tenancy created, Tenant shall surrender
the premises in the same condition as the premises were in upon delivery of
possession thereto under this Lease, reasonable wear and tear excepted, and
shall surrender all keys for the premises to Landlord at the place then fixed
for the payment of rent and shall inform Landlord of all combinations on locks,
safes and vaults, if any, in the premises. Tenant shall remove all its trade
fixture, and at Landlord's sole option, any alterations or improvements made by
Tenant before surrendering the premises as aforesaid and shall repair any damage
to the premises caused thereby. Tenant's obligations to observe or perform this
covenant shall survive the expiration or other termination of the term of this
Lease.
2. Term. The term of this Lease shall commence and, unless sooner
----
terminated as hereinafter provided, shall end on the dates respectively
specified in the Basic Lease Information. If Landlord, for any reason
whatsoever, cannot deliver possession of the premises to Tenant on the Date of
Term Commencement, this Lease shall not be void or voidable, nor shall Landlord
be liable to Tenant for any loss or damage resulting therefrom, but in that
event, subject to any contrary provisions in any agreement with Landlord
covering initial improvement of the premises, rental shall be waived for the
period between commencement of the term and the time when Landlord can deliver
possession. Any delay in delivery of possession of the premises shall not extend
the expiration date of this lease.
3. Rent.
----
(a) Tenant shall pay to Landlord as rental the amount specified in the
Basic Lease Information as the Base Rent, payable upon Tenant's execution of
this Lease and in advance on or before the first day of each and every
successive calendar month following commencement of the term during the term. If
the term commences on other than the first day of a calendar month, the first
payment of rent shall be appropriately prorated on the basis of a 30-day month.
(b) Effective as of each anniversary date of the commencement of the
term, the Base Rent shall be increased to equal the sum of (i) the Base Rent as
specified in the Basic Lease Information, plus (ii) the product obtained by
multiplying such amount by the percentage increase in the Consumer Price Index
measured from the measuring month two months preceding the commencement of the
term to the measuring month two months preceding the anniversary date in
question. As used herein, the term "Consumer Price Index" shall mean the United
States Department of Labor's Bureau of Labor Statistics' Consumer Price Index,
All Urban Consumers, All Items, San Francisco-Oakland-San Jose, California
(1982-84 equals 100), or the successor of such Index. Tenant shall continue
paying the current Base Rate until the increased Base Rent has been calculated.
Upon such calculation, Landlord shall give notice to tenant of the amount of the
new Base Rent which shall be due and payable effective as of the anniversary
date and Tenant shall upon the giving of such notice pay Landlord any shortage
in Base Rent accruing between the current anniversary date and the date of the
notice.
(c) Tenant shall pay, as additional rent, all amounts of money
required to be paid to Landlord by Tenant hereunder in addition to monthly rent,
whether or not the same be designated "additional rent." If such amounts are not
paid at the time provided in this Lease, they shall nevertheless be collectible
as additional rent with the next installment of monthly rent thereafter falling
due, but nothing herein contained shall be deemed to suspend or delay the
payment of any amount of money at the time the same becomes due and payable
hereunder, or limit any other remedy of Landlord.
1
<PAGE>
(d) Tenant hereby acknowledges that late payment by Tenant to Landlord
of rent and other amounts due hereunder will cause Landlord to incur costs not
contemplated by this Lease, the exact amount of which will be extremely
difficult to ascertain. Such costs include, but are not limited to, processing
and accounting charges, and late charges which may be imposed on Landlord by the
terms of any loan secured by the Building. Accordingly, if any installment of
rent or any other sums due from Tenant shall not be received by Landlord within
five days following the date due, Tenant shall pay to Landlord a late charge
equal to ten percent (10%) of such overdue amount. The parties hereby agree that
such late charge represents a fair and reasonable estimate of the costs Landlord
will incur by reason of late payment by Tenant. Acceptance of such late charge
by Landlord shall in no event constitute a waiver of Tenant's default with
respect to such overdue amount, nor prevent Landlord from exercising any of the
other rights and remedies granted hereunder.
(e) Any amount due to Landlord, if not paid when due, shall bear
interest from the date due until paid at the rate of 10% per. Provided that
interest shall not be payable on late charges incurred by Tenant to the extent
such interest would cause the total interest to be in excess of that legally
permitted.
(f) All payments due from Tenant to Landlord hereunder shall be made
to Landlord without deduction or offset in lawful money of the United States of
America at the address for payment set forth in the Basic Lease Information, or
to such other person or at such other place as Landlord may from time to time
designate by notice to Tenant.
4. Taxes.
-----
(a) Tenant shall pay before delinquency any and all taxes,
assessments, license fees, and public charges levied, assessed, or imposed, and
which become payable during the term upon Tenant's fixtures, improvements,
alterations, or additions, furniture, appliances and personal property installed
or located in the premises.
(b) Tenant shall pay upon demand during the term hereof it's
percentage share, as specified in the Basic Lease Information, of all Real
Property Taxes, gross rental receipts taxes and general or special assessments
over Base Property Taxes.
(c) The term "Real Property Taxes" shall mean all real property taxes
and personal property taxes, licenses, charges and assessments which are levied,
assessed or imposed by any governmental or quasi-governmental authority,
improvement or assessment district with respect to the Property, any other
fixtures, improvements, equipment or other property of Landlord, real or
personal, located in the project and used in connection with the operation
thereof, whether or not now customary or within the contemplation of the parties
hereto, including, without limitation, any taxes, charges or assessments for
public improvements, services or benefits, irrespective of when commenced or
completed, transit fees, parking charges or fees, housing funds, education
funds, street, highway or traffic fees, as well as any tax which shall be
levied or assessed in addition to or in lieu of such taxes, any charge upon
Landlord's business of leasing of the project and any costs or expenses of
contesting any such taxes, licenses, charges or assessments, but excluding any
federal or state income or gift tax or any franchise, capital stock, estate or
inheritance taxes. In the event that it shall not be lawful for Tenant to
reimburse Landlord for Tenant's percentage share of any property tax, as
defined herein, the rent payable to Landlord under this Lease shall be revised
to yield to Landlord the same net rent from the premises after imposition of
any such tax upon landlord as would have been received by Landlord hereunder
prior to the imposition of any such tax. Base Property Taxes shall be those
assessed during the Base Year set forth in the Basic Lease Information.
5. Operating Expenses.
------------------
(a) Tenant agrees to pay upon demand during the term of the Lease and
subject to the limitation as hereinafter set forth, as further additional rent,
Tenant's Percentage Share of all Operating Expenses paid or incurred by Landlord
over and above the Base Operating Expenses.
(b) Said Percentage Share of Operating Expenses shall he paid to
Landlord, (a) upon presentation of invoice setting forth such share of Operating
Expenses and/or (b) at the option of Landlord, paid to Landlord monthly, in
advance, Tenant's share of an amount estimated by Landlord, which estimated
amount shall be reconciled at the end of each calendar year as compared with
Landlord's actual expenditure for Operating Expenses as provided in paragraph.
(d).
(c) For purposes of this Section 5. "Operating Expenses, shall mean
the total cost and expense incurred in operating and
maintaining the Property, including, without limitation: (a) all license, permit
and inspection fees, (b) premiums for any insurance maintained by Landlord with
respect to the Property including property damage, extended coverage, earthquake
and flood insurance, and such other endorsements covering hazards normally
insured by commercial property owners; (c) repairs; (d) line painting; (e)
lighting; (f) signing; (g) sanitary control; (h) supplies; (i) removal of
trash, rubbish, garbage and other refuse; (j) security services; (k) reasonable
reserves for replacements and repairs; (1) the cost of any capital improvement
made to structures or added to the common areas due to governmental requirements
amortized over a reasonable period with interest at ten percent(10%) per annum
on the unamortized cost; (m) management; (n) bookkeeping; and (o) the costs of
personnel to implement such services and to direct parking and otherwise
regulate, maintain and repair the building(s) and the common
facilities;(p)utilities;(q)janitorial, heating, ventilating and air conditioning
services; (r) increased interest expense caused by rate increases on Landlord's
debt service; (s)wages, salaries, fringe benefits and payroll burden of
employees; (t) project office rent or rental value; (u) depreciation on personal
property; and (v) the cost of capital improvements to the Building or Common
Areas anticipated to reduce other Operating Expenses; and (w) gardening and
landscaping. "Common Areas" shall mean all areas, spaces, equipment and special
services provided by Landlord for common or joint use or benefit of the
occupants of the Building, their employees, agents and customers, including
without limitation, parking areas, driveways, landscaped areas, sidewalks,
restrooms, retaining walls, etc.
(d) Tenant shall pay to Landlord each month at the same time and in
the same manner as monthly rent, 1/12th of Landlord's estimate of Tenant's share
of Operating Expenses for the current calendar year payable by Tenant. Within
90 days after the close of each calendar year, or as soon after such 90-day
period as practicable, Landlord shall deliver to Tenant a statement of actual
Operating Expenses for such calendar year. If on the basis of such statement
Tenant owes an amount that is less than the estimated payments for such calendar
year previously made by Tenant, Landlord shall credit such excess against
Operating Expenses subsequently payable by Tenant. If on the basis of such
statement Tenant owes an amount that is more than the
2
<PAGE>
estimated payments for such calendar year previously made by Tenant, Landlord
shall credit such excess against Operating Expenses subsequently payable by
Tenant. If on the basis of such statement Tenant owes an amount that is more
than the estimated payments for such calendar year previously made by Tenant,
Tenant shall pay the deficiency to Landlord within 15 days after delivery of the
statement. The obligations of Landlord and Tenant under this subparagraph with
respect to the reconciliation between estimated payments and actual Operating
Expenses for the last year of the term shall survive the termination of the
Lease.
6. Use.
---
(a) The premises shall be used and occupied by Tenant for the use set
forth in the Basic Lease Information and in accordance with the Rules and
Regulations attached to this Lease as Exhibit B and for no other purpose.
---------
Tenant shall, at Tenant's expense, comply promptly with all applicable statutes,
ordinances, rules, regulations, orders and requirements in effect during the
term regulating the use by Tenant of the premises including the installation of
additional facilities as required for the conduct and continuance of Tenant's
business. Tenant shall not use or permit the use of the premises or Common Area
in any manner that will tend to create waste or a nuisance, or which tends or
does unreasonably disturb other tenants of the Building or adjacent buildings,
nor shall Tenant, its employees, agents or invites damage the premises, the
Building or related improvements, nor place or maintain any signs on or visible
from the exterior of the premises without Landlord's written consent, or use any
corridors, sidewalks or other areas outside of the premises for storage or any
purpose other than access to the premises. Notwithstanding any other provision
of this Lease, Tenant shall not use, keep or permit to be used or kept on the
premises any foul or noxious gas, article or substance, nor shall Tenant do or
permit to be done anything in and about the premises, either in connection with
activities hereunder expressly permitted or otherwise, which are not permitted
would cause an increase in premiums payable under, or a cancellation of, any
policy of insurance maintained by Landlord in connection with the premises or
the Building or which would violate the terms of any covenants, conditions or
restrictions affecting the Building or the land on which it is located.
(b) Without Landlord's prior consent, which may be withheld in its
absolute discretion, Tenant shall not cause, or allow anyone else to cause, any
Hazardous Materials to be used, generated, stored, or disposed of on or about
the premises or the Building other than reasonable quantities of office and
cleaning supplies in their retail containers. Tenant shall strictly comply with
all statutes, laws, ordinances, rules, regulations, and precautions now or
hereafter mandated or advised by any federal, state, local or other governmental
agency with respect to the use, generation, storage, or disposal of hazardous,
toxic, or radioactive materials (collectively, "Hazardous Materials"). As
herein used, Hazardous Materials shall include, but not be limited to, those
materials identified in Sections 66680 through 66685 of Title 22 of the
California Code of Regulations, Division 4, Chapter 30, as amended from time to
time, and those substances defined as "hazardous substances," "hazardous
materials, "hazardous wastes," "chemicals known to cause cancer or reproductive
toxicity," "radioactive materials," or other similar designations in the
Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended, 42 U.S.C. Section 9601 et seq., the Resource Conservation and Recovery
Act, 42 U.S.C. Section 6901 et seq., the Hazardous Materials
Transportation Act, 49 U.S.C. Section 1801 et seq., 33 U.S.C. Section 1251 et
seq., 42 U.S.C. Section 300(f) et seq., 42 U.S.C. 7401 et seq., California
Health and Safety Code Section 25249.5 et seq., California Water Code Section
13000 et seq., California Health and Safety Code Section 39000 et seq. and any
other governmental statutes, ordinances, rules, regulations, and precautions
adopted pursuant to the preceding laws or other similar laws, regulations and
guidelines now or hereafter in effect. Tenant shall defend (with counsel
approved by Landlord), indemnify and hold Landlord, its employees and agents,
any entity having a security interest in the premises or the Building, and its
and their employees and agents (collectively, "Indemnities") harmless from and
against, and shall reimburse the Indemnities for, all liabilities, claims,
costs, damages, and depreciation of property value, including all foreseeable
and unforeseeable consequential damages, directly or indirectly arising out of
the use, generation, storage, or disposal of Hazardous Materials by Tenant or
any person claiming under Tenant, including, without limitation, the cost of any
required or necessary investigation, monitoring, repair, cleanup, or
detoxification and the preparation of any closure or other required plans,
whether such action is required or necessary prior to or following the
termination of this Lease, as well as penalties, fines and claims for
contribution to the full extent that such action is attributable, directly or
indirectly, to the use, generation, storage, or disposal of Hazardous Materials
by Tenant or any person claiming under Tenant. Neither the consent by Landlord
to the use, generation, storage, or disposal of Hazardous Materials nor the
strict compliance by Tenant with all statutes, laws, ordinances, rules,
regulations, and precautions pertaining to Hazardous Materials shall excuse
Tenant from Tenant's obligation of indemnification set forth above. Tenant's
obligations under this paragraph 6 shall survive expiration or termination of
this Lease.
(c) Tenant shall not place or suffer to be placed or maintained, on
any exterior door, wall or window of the premises, on any part of the real
property upon which the premises are located, any sign, awning or canopy, or
advertising matter or other thing of any kind, and will not place or maintain
any decoration, lettering or advertising matter on the glass of any window or
door of the premises without first obtaining Landlord's written approval and
consent. Tenant further agrees to maintain such sign, awning, canopy,
decoration, lettering, advertising matter or thing as may be approved, in good
condition and repair at all times. Tenant agrees, at Tenant's sole cost, to
obtain a sign in strict conformance with Landlord's sign criteria as to design,
material, color, location, size, letter style, and method of installation as
provided in Exhibit "E" hereof.
7. Utilities. Tenant shall pay for all water, sewer, gas, electricity,
---------
heat, cooling energy, telephone, refuse collection and other utility-type
services furnished to Tenant or the premises, together with any related
installation or connection charges or deposits. Whenever it is practical to do
so, such services shall be separately metered or charged to Tenant by the
provider thereof and paid for by Tenant. To the extent any of the foregoing
services are provided by Landlord, Tenant shall reimburse Landlord for all costs
incurred by Landlord in the amounts specified in the Basic Lease Information.
Landlord may bill Tenant on a monthly or other periodic basis for such services
and payment shall be made by Tenant within five (5) days after submittal of
Landlord's statement. Landlord shall not be liable in damages, consequential or
otherwise, nor shall there be any rent abatement, arising out of any curtailment
or interruption whatsoever in utility services.
8. Maintenance & Repairs of Leased Premises.
----------------------------------------
(a) Tenant shall, at its sole cost, keep and maintain the premises and
appurtenances and every part thereof (exception exterior surface of walls and
roof which Landlord agrees to repair at Tenant's expense under the provisions of
paragraph 5
3
<PAGE>
(herein) including windows, doors and all door hardware, any store front and the
interior of the premises, including electrical, plumbing, lighting, heating and
air conditioning systems, in good and sanitary order, condition and repair.
Tenant shall, at its sole cost, keep and maintain all utilities, fixtures and
mechanical equipment used by Tenant in good order, condition, and repair. In the
case of equipment installed by Landlord for Tenant where Tenant is responsible
for maintenance of the equipment, such maintenance will be provided by a
reputable maintenance service company acceptable to Landlord at Tenant's
expense. Tenant shall deliver evidence of the execution and continuance of such
service contract will be provided to Landlord within thirty (30) days after
commencement of Lease.
(b) Tenant hereby acknowledges that the late delivery by Tenant to
Landlord of a copy of a mechanical equipment maintenance contract referred to
above will cause Landlord to incur costs not contemplated by this lease, the
exact amount of which will be extremely difficult to ascertain. Accordingly, if
such evidence of a contract required to be delivered by Tenant to Landlord
within the time prescribed above Tenant shall pay to Landlord a charge in the
sum of $300.00. The parties of this Lease hereby agree that such charge
represents a fair and reasonable estimate of the costs Landlord will incur by
reason of a late delivery by Tenant and acceptance of such charge by Landlord
shall in no event constitute a waiver of Tenant's default with respect to such
late delivery nor prevent Landlord from exercising any of the other rights and
remedies available to Landlord as a result of such default.
(c) If Tenant refuses or neglects to make repairs properly as required
hereunder and to the reasonable satisfaction of Landlord, as soon as reasonably
possible after written demand, Landlord may make such repairs without liability
to Tenant for any loss or damage that may accrue to Tenant's merchandise,
fixtures, or other property, or to Tenant's business by reason thereof, and upon
completion thereof, Tenant shall pay Landlord's costs for making such repairs
plus twenty percent (20%) per annum on said costs from the date of completion of
repairs by Landlord.
9. Alterations and Window Coverings. Tenant shall not, without
--------------------------------
Landlord's prior consent, make any alterations, improvement or additions in or
about the premises. As a condition to giving such consent, Landlord may require,
among other things, reasonable changes to drawings and specifications, that
Tenant remove any such alterations, improvements or additions at the expiration
or earlier termination of the term and restore the premises to their prior
condition and that Tenant provide "as-built" drawings and specifications of the
work. In no event shall any alterations or improvements affect the structure of
the Building. Before commencing any work relating to alterations, additions or
improvements affecting the premises, Tenant shall notify Landlord of the
expected date of commencement thereof and of the anticipated cost thereof, and
shall furnish complete drawings and specifications describing such work as well
as such information as shall reasonably be requested by Landlord substantiating
Tenant's ability to pay for such work. Landlord shall then have the right at any
time and from time to time to post and maintain on the premises such notices as
Landlord reasonably deems necessary to protect the premises, the Building and
Landlord from mechanics' liens or any other liens. In any event, Tenant shall
pay when due all claims for labor or materials furnished to or for Tenant at or
for use in the premises. Tenant shall not permit any mechanics' liens to be
levied against the premises for any labor or materials furnished to Tenant or
claimed to have been furnished to
4
<PAGE>
Tenant or to Tenant's agents or contractors in connection with work of any
character performed or claimed to have been performed on the premises by or at
the direction of Tenant. All alterations, improvements or additions in or about
the premises performed by or on behalf of Tenant shall be done by contractors
designated or approved by Landlord, in a first-class, workmanlike manner which
does not disturb or interfere with other tenants and in compliance with all
applicable laws, ordinances, regulations and orders of any governmental
authority having jurisdiction thereover, as well as the requirements of insurers
of the premises and the Building. Prior to the commencement of any such work,
if Landlord so requests, Tenant shall furnish to Landlord performance and
payments bonds in a form and issued by a surety reasonably acceptable to
Landlord in an amount equal to the cost of such work of alteration,
improvement or addition, and evidence that any contractor(s) retained by
Tenant have adequate insurance. Notwithstanding anything in this paragraph 9
to the contrary, upon Landlord's request, Tenant shall remove any contractor,
subcontractor or material supplier from the premises and the Building if the
work or presence of such person or entity results in labor disputes in or
about the Building or damage to the premises or the Building. Upon completion
of work performed for Tenant, at Landlord's request Tenant shall deliver to
Landlord evidence of full payment therefor and full and unconditional waivers
and releases of liens for all labor, services and/or materials used. Unless
Landlord requires their removal, as set forth above, all alterations,
improvements or additions which may be made on the premises shall become the
property of Landlord and remain upon and be surrendered with the premises at
the termination or expiration of the term; provided, however, that Tenant's
machinery, equipment and trade fixtures, other than any which may be affixed
to the premises so that they cannot be removed without material damage to the
premises, shall remain the property of Tenant and shall be removed by Tenant.
Landlord shall select a standard window covering and color, throughout the
Building(s) and Tenant shall use and maintain this standard material for any
windows which shall be covered.
10. Insurance and Indemnity.
-----------------------
(a) Tenant shall obtain and maintain during the term of this Lease
commercial general liability insurance covering the premises and Common Area
with a combined single limit for personal injury and property damage in an
amount not less than $2,000,000, and employer's liability and workers'
compensation insurance as required by law. Tenant's commercial general
liability insurance policy shall be endorsed to provide (1) that it may not be
cancelled or altered in such a manner as adversely to affect the coverage
afforded thereby without 30 days' prior written notice to Landlord, (2) Landlord
is named as additional insured, (3) the insurer acknowledges acceptance of the
mutual waiver of claims by Landlord and Tenant pursuant to subparagraph (b)
below, (4) that such insurance is primary with respect to Landlord and its
property manager and that any other insurance maintained by Landlord or such
property manager is excess and noncontributing with such insurance. (5) a cross-
liability endorsement or severability of interest clause, (6) for blanket
contractual obligations coverage, broad form property damage coverage and
products and completed operations coverage (where applicable), (7) for
employee's automobile non-ownership liability, and (8) for coverage on an
occurrence, rather than claims-made basis. If, in the opinion of Landlord's
insurance adviser, based on a substantial increase in recovered liability claims
generally, the specified amounts of coverage are no longer adequate, within 30
days following Landlord's request, such coverage shall be appropriately
increased. Tenant shall also obtain and maintain insurance ("Personal Property
Insurance") covering leasehold improvements paid for by Tenant and Tenant's
personal property and fixtures from to time in, on, or at the premises, in an
amount not less than 100% of the full replacement cost, without deduction for
depreciation, providing protection against events protected under "All Risk
Coverage," as well as against sprinkler damage, vandalism, and malicious
mischief. Any proceeds from the Personal Property Insurance shall be used for
the repair or replacement of the property damaged or destroyed, unless this
Lease is terminated under an applicable provision herein. If the
5
<PAGE>
premises are not repaired or restored following damage or destruction in
accordance with other provisions herein, Landlord shall receive any proceeds
from the Personal Property Insurance allocable to Tenant's leasehold
improvements. Prior to the commencement of the term, Tenant shall deliver to
Landlord duplicates of such policies or certificates thereof with endorsements,
and at least 30 days prior to the expiration of such policy or any renewal
thereof, Tenant shall deliver to Landlord replacement or renewal binders,
followed by duplicate policies or certificates within a reasonable time
thereafter. Tenant hereby acknowledges that the late delivery by Tenant to
Landlord of the insurance certificates or policies referred to above will cause
Landlord to incur costs not contemplated by this lease, the exact amount of
which will be extremely difficult to ascertain. Such costs include, but are not
limited to, processing and accounting charges and penalties which may be imposed
on Landlord by the terms of any mortgage or trust deed covering the premises.
Accordingly, if any insurance certificate or policy required to be delivered by
Tenant above shall not be received by Landlord at the time prescribed above,
Tenant shall pay to Landlord a charge in the sum of $300.00. The parties hereby
agree that such charge represents a fair and reasonable estimate of the costs
Landlord will incur by reason of late delivery by Tenant, and acceptance of such
charge by Landlord shall in no event constitute a waiver of Tenant's default
with respect to such late delivery, nor prevent Landlord from exercising any of
the other rights and remedies available to Landlord as a result of such default.
If Tenant fails to obtain such insurance or to furnish Landlord any such
duplicate policies or certificates as herein required, Landlord may, at its
election, without notice to Tenant and without any obligation so to do, procure
and maintain such coverage and Tenant shall reimburse Landlord on demand as
additional rent for any premium so paid by Landlord. Tenant shall have the right
to provide all insurance coverage required herein to be provided by Tenant
pursuant to blanket policies so long as such coverage is expressly afforded by
such policies.
(b) Landlord hereby waives all claims against Tenant, and Tenant's
officers, directors, partners, employees, agents and representatives for loss or
damage to the extent that such loss or damage is insured against under any valid
and collectable insurance policy insuring Landlord or would have been insured
against but for any deductible amount under any such policy, and Tenant waives
all claims against Landlord including Landlord's trustees, officers, directors,
partners, employees, agents and representatives for loss or damage to the extent
such loss or damage is insured against under any valid and collectable insurance
policy insuring Tenant or required to be maintained by Tenant under this Lease,
or would have been insured against but for any deductible amount under any such
policy.
(c) As insurance is available to protect it, and to the extent such
waiver does not violate public policy, Tenant hereby waives all claims against
Landlord for damage to any property or injury to or death of any person in, upon
or about the premises or the Building arising at any time and from any cause,
and Tenant shall hold Landlord harmless from and defend Landlord against (i) all
claims for damage to any property or injury to or death of any person arising in
or from the use of the premises by Tenant, except as to Landlord or any of its
agents, employees or contractors, such as is caused by the sole negligence or
willful misconduct of Landlord, its agents, employees or contractors otherwise
entitled to indemnification, or (ii) arising from the negligence or willful
misconduct of Tenant, its employees, agents or contractors in, upon or about
those portions of the Building other than the premises. The foregoing indemnity
obligation of Tenant shall include attorneys' fees, investigation costs and all
other costs and expenses incurred by Landlord from the first notice that any
claim or demand is to be made or may be made. The provisions of this paragraph
10 shall survive the expiration or termination of this Lease with respect to any
damage, injury or death occurring prior to such time.
11. Damage or Destruction.
---------------------
(a) If during the term the premises are totally or partially
destroyed, or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a risk which is
wholly covered by insurance proceeds made available to Landlord for such
purpose, Landlord shall proceed with reasonable diligence to repair the damage
or destruction and this Lease shall not be terminated; provided, however, that
if in the opinion of Landlord's architect or contractor the work of repair
cannot be completed in 90 days following such damage or destruction, Landlord
may at its election terminate the Lease by notice given to Tenant within 30 days
following the event or such longer period as may reasonably be necessary to
obtain information from its architect or contractor.
(b) If during the term the premises are totally or partially
destroyed, or any other portion of the Building is damaged in such a way that
Tenant's use of the premises is materially interfered with, from a risk which is
not wholly covered by insurance proceeds made available to Landlord for repair
or reconstruction, Landlord may at its election by notice to Tenant given within
30 days following the event or such longer period as may reasonably be necessary
for Landlord to obtain information from its architect or contractor, either
restore the premises or terminate this Lease.
(c) In case of destruction or damage which materially interferes with
Tenant's use of the premises, if this Lease is not terminated as above provided,
rent shall be abated during the period required for the work of repair based
upon the degree of interference with Tenant's use of the premises. Except for
abatement of rent, Tenant shall have no claim against Landlord for any loss
suffered by Tenant due to damage or destruction of the premises or any work of
repair undertaken as herein provided. Tenant expressly waives the provisions of
Section 1932 and Section 1933(4) of the California Civil Code which are
superseded by this paragraph 11.
12. Eminent Domain. If all or any part of the premises shall be taken as
--------------
a result of the exercise of the power of eminent domain or sold by Landlord
under threat thereof, this Lease shall terminate as to the part so taken as of
the date of taking or sale and, in the case of a partial taking, either Landlord
or Tenant shall have the right to terminate this Lease as to the balance of the
premises by notice to the other within 30 days after such date if the portion of
the premises taken shall be of such extent and nature as substantially to
handicap, impede or impair Tenant's use of the balance of the premises for
Tenant's purposes. In the event of any taking or such sale, Landlord shall be
entitled to any and all compensation, damages, income, rent, awards, or any
interest therein whatsoever which may be paid or made in connection therewith,
and Tenant shall have no claim against Landlord for the value of any unexpired
term of this Lease or otherwise. In the event of a partial taking of the
premises which does not result in a termination of this Lease, the monthly
rental thereafter to be paid shall be equitably reduced on a square footage
basis.
6
<PAGE>
13. Assignment and Subletting.
-------------------------
(a) Tenant shall not assign this Lease or any interest herein or
sublet the premises or any part thereof without the prior consent of Landlord,
which consent shall not be unreasonably withheld. Tenant shall not hypothecate
this Lease or any interest herein or permit the use of the premises by any party
other than Tenant without the prior consent of Landlord, which consent may be
withheld by Landlord in its absolute discretion. This Lease shall not, nor
shall any interest herein, be assignable as to the interest of Tenant by
operation of law without the consent of Landlord. Any of the foregoing acts
without such consent shall be void and shall, at the option of Landlord,
terminate this Lease. In connection with each consent requested by Tenant,
Tenant shall submit to Landlord the terms of the proposed transaction, the
identity of the parties to the transaction, the proposed documentation for the
transaction, current financial statements of any proposed assignee or subleases
and all other information reasonably requested by Landlord concerning the
proposed transaction and the parties involved therein. As a further condition
to any consent granted by Landlord, the proposed assignee or subleases shall
agree in writing to perform for the benefit of Landlord all of the Tenant's
obligations under this Lease or so much thereof as are allocable to any portion
of the premises proposed to be sublet.
(b) Without limiting the other instances in which it may be reasonable
for Landlord to withhold its consent to an assignment or subletting, Landlord
and Tenant acknowledge that it shall be reasonable for Landlord to withhold its
consent in the following instances:
(1) the proposed assignee or subtenant is a governmental agency;
(2) in Landlord's reasonable judgment, the use of the premises
would entail any alterations which would lessen the value of the leasehold
improvements in the premises, or would require increased services by
Landlord;
(3) in Landlord's reasonable judgment, the financial worth of the
proposed assignee or subtenant does not meet the credit standards applied
by Landlord for other tenants under leases with comparable terms, or the
character, reputation or business of the proposed assignee or sublessee is
not consistent with the quality of the other tenancies in the Building;
(4) in Landlord's reasonable judgment, the proposed assignee or
subtenant does not have a good reputation as a tenant of property;
(5) Landlord has received from any prior landlord to the proposed
assignee or subtenant a negative report concerning such prior landlord's
experience with the proposed assignee or subtenant;
(6) Landlord has experienced previous defaults by or is in
litigation with the proposed assignee or subtenant;
(7) in Landlord's reasonable judgment, the premises, or the
relevant part thereof, will be used in a manner that will violate any
negative covenant as to use contained in any other lease of space in the
Building;
(8) the use of the premises by the proposed assignee or subtenant
will violate any applicable law, ordinance or regulation;
(9) the proposed assignment or sublease will create a vacancy
elsewhere in the Building;
(10) the proposed assignee or subtenant is a person with whom
Landlord is negotiating to lease space in the Building or is currently a
tenant in the Building;
(11) the proposed assignment or sublease fails to include all of
the terms and provisions required to be included therein pursuant to this
paragraph 13;
(12) Tenant is in default of any obligation of Tenant under this
Lease, or Tenant has defaulted under this lease on three or more occasions
during the 12 months preceding the date that Tenant shall request consent;
or
(13) in the case of a subletting of less than the entire
premises, if the subletting would result in the division of the premises
into more than two subparcels or would require access to be provided
through space leased or held for lease to another tenant or improvements to
be made outside of the premises.
(c) If at any time or from time to time during the term of this Lease
Tenant desires to sublet all or any part of the premises, Tenant shall give
notice to Landlord setting forth the terms of the proposed subletting and the
space so proposed to be sublet. Landlord shall have the option, exercisable by
notice given to Tenant within 20 days after Tenant's notice is given, either to
sublet from Tenant such space at the rental and other terms set forth in
Tenant's notice, or, if the proposed subletting is for the entire premises for a
sublet term ending within the last year of the term of this Lease, to terminate
this Lease. In either case, effective as of the date of the proposed subletting
if Landlord so terminates this Lease, Landlord may enter into a lease with the
proposed subtenant. If Tenant proposes to assign this Lease, Landlord may, by
notice given within 20 days of Tenant's notice, elect to terminate this lease as
of the date of the proposed assignment. If Landlord so terminates this lease,
Landlord may if it elects, enter into a new lease covering the premises or a
portion thereof with the intended assignee or subtenant on such terms as
Landlord and such person may agree, or enter into a new lease covering the
premises or a portion thereof with any other person; in such event, Tenant shall
not be entitled to any portion of the profit, if any, which Landlord may realize
on account of such termination and reletting. Landlord's exercise of its
aforesaid option shall not be construed to impose any liability upon Landlord
with respect to any real estate brokerage commission(s) or any other costs or
7
<PAGE>
expenses incurred by Tenant in connection with its proposed subletting or
assignment. If Landlord does not exercise its options to terminate the Lease or
sublet the premises, Tenant shall be free to sublet such space to any third
party on the same terms set forth in the notice given to Landlord, subject to
obtaining Landlord's prior consent as hereinabove provided.
(d) As used in this Paragraph 13, the term "assign" or "assignment"
shall include, without limitation, any sale, transfer or other disposition of
all or any portion of Tenant's estate under this Lease, whether voluntary or
involuntary, and whether by operation of law or otherwise including any of the
following:
(1) If Tenant is a corporation: (i) any dissolution, merger,
consolidation or other reorganization of Tenant, or (ii) a sale of more
than 50% of the value of the assets of Tenant, or (iii) if Tenant is a
corporation with fewer than 500 shareholders, sale or other transfer of a
controlling percentage of the capital stock of Tenant. The phrase
"controlling percentage" means the ownership of, and the right to vote,
stock possessing at least 5O% of the total combined voting power of all
classes of Tenant's stock issued, outstanding and permitted to vote for the
election of directors;
(2) If Tenant is a trust, the transfer of more than 50% of the
beneficial interest of Tenant, or the dissolution of the trust;
(3) If Tenant is a partnership or joint venture, the withdrawal,
or the transfer of the interest of any general partner or joint venturer or
the dissolution of the partnership or joint venture; or
(4) If Tenant is composed of tenants-in-common, the transfer of
interest of any co-tenants, or the partition or dissolution of the co-
tenancy.
(e) No sublessee (other than Landlord if it exercises its option
pursuant to subparagraph (c) above) shall have a right further to sublet, and
any assignment by a sublessee of its sublease shall be subject to Landlord's
prior consent in the same manner as if Tenant were entering into a new sublease.
(f) In the case of an assignment, all sums or other economic
consideration received by Tenant as a result of such assignment shall be paid to
Landlord after first deducting the unamortized cost of leasehold improvements
paid for by Tenant, and the cost of any real estate commissions incurred in
connection with such assignment. In the event such consideration is received by
Tenant in installments, the portion of each installment to be paid to Landlord
shall be determined by subtracting from the installment an amount equal to the
total amount of the foregoing permitted deductions divided by the total number
of installments.
(g) In the case of a subletting, all sums or economic consideration
received by Tenant as a result of such subletting shall be paid to Landlord
after first deducting (1) the rental due hereunder, prorated to reflect only
rental allocable to the sublet portion of the premises, (2) the cost of
leasehold improvements made to the sublet portion of the premises at Tenant's
cost, amortized over the term of this Lease except for leasehold improvements
made for the specific benefit of the sublessee, which shall be amortized over
the term of the sublease, and (3) the cost of any real estate commissions
incurred in connection with such subletting, amortized over the term of the
sublease.
(h) Regardless of Landlord's consent, no subletting or assignment
shall release Tenant of Tenant's obligations or alter the primary liability of
Tenant to pay the rental and to perform all other obligations to be performed by
Tenant hereunder. The acceptance of rental by Landlord from any other person
shall not be deemed to be a waiver by Landlord of any provision hereof. Consent
to one assignment or subletting shall not be deemed consent to any subsequent
assignment or subletting. In the event of default by any assignee of Tenant or
any successor of Tenant in the performance of any of the terms hereof, Landlord
may proceed directly against Tenant without the necessity of exhausting remedies
against such assignee or successor. Landlord may consent to subsequent
assignments or subletting of this Lease or amendments or modifications to this
Lease with assignees of Tenant, without notifying Tenant, or any successor of
Tenant, and without obtaining its or their consent thereto and such action shall
not relieve Tenant of liability under this Lease.
(i) If Tenant shall assign or sublet the premises or request the
consent of Landlord to any assignment or subletting or if Tenant shall request
the consent of Landlord for any act that Tenant proposes to do, then Tenant
shall pay Landlord's reasonable attorneys' fees incurred in connection
therewith.
14. Rules & Regulations. Tenant shall faithfully observe and comply with
--------------------
the rules and regulations attached to this Lease as Exhibit B, and, after notice
---------
thereof; all reasonable modifications thereof and additions thereto from time to
time promulgated in writing by Landlord. Landlord shall not be responsible to
Tenant for the nonperformance by any other tenant or occupant of the Building of
any of said rules and regulations, but Landlord shall use good faith efforts to
enforce the rules and regulations consistently.
15. Default by Tenant.
-----------------
(a) Any of the following events shall constitute events of default
under this Lease:
(1) a default by Tenant in the payment of any rent or other sum
payable hereunder when due;
(2) a default by Tenant in the performance of any of the other
terms, covenants, agreements or conditions contained herein and, if the
default is curable, the continuation of such default for a period of 10
days after notice by Landlord or beyond the time reasonably necessary for
cure if the default is of the nature to require more than 10 days to
remedy, provided that if Tenant has defaulted in the performance of the
same obligation more than one time in any twelve-month period and notice of
such default has been given by Landlord in such instance, no cure period
shall thereafter be applicable hereunder;
8
<PAGE>
(3) the bankruptcy or insolvency of Tenant, any transfer by
Tenant in fraud of creditors, assignment by Tenant for the benefit of
creditors, or the commencement of any proceedings of any kind by or against
Tenant under any provision of the Federal Bankruptcy Act or under any other
insolvency, bankruptcy or reorganization act unless, in the event any such
proceedings are involuntary, Tenant is discharged from the same within 60
days thereafter; the appointment of a receiver for a substantial part of
the assets of Tenant; or the levy upon this Lease or any estate of Tenant
hereunder by any attachment or execution; or
(4) the abandonment of the premises which for the purpose of this
sub-paragraph shall be deemed to occur when Tenant allows the premises to
be unoccupied by Tenant or its employees for a period longer than ten (10)
consecutive days during the term of this Lease.
(b) Upon the occurrence of any event of default by Tenant hereunder,
Landlord may, at its option and without any further notice or demand, in
addition to any other rights and remedies given hereunder or by law, do any
of the following:
(1) Landlord shall have the right, so long as such default
continues, to give notice of termination to Tenant, and on the date
specified in such notice this Lease shall terminate.
(2) In the event of any such termination of this Lease, Landlord
may then or at any time thereafter, re-enter the premises and remove
therefrom all persons and property and again repossess and enjoy the
premises, without prejudice to any other remedies that Landlord may have by
reason of Tenant's default or of such termination.
(3) In the event of any such termination of this Lease, and in
addition to any other rights and remedies Landlord may have, Landlord shall
have all of the rights and remedies of a landlord provided by Section
1951.2 of the California Civil Code. The amount of damages which Landlord
may recover in event of such termination shall include, without limitation,
(i) the worth at the time of award (computed by discounting such amount at
the discount rate of the Federal Reserve Bank of San Francisco at the time
of award plus one percent) of the amount by which the unpaid rent for
balance of the term after the time of award exceeds the amount of rental
loss that Tenant proves could be reasonably avoided, (ii) all legal
expenses and other related costs incurred by Landlord following Tenant's
default, (iii) all costs incurred by Landlord in restoring the premises to
good order and condition, or in remodeling, renovating or otherwise
preparing the premises for reletting, and (iv) all costs (including,
without limitation, any brokerage commissions) incurred by Landlord in
reletting the premises.
(4) For the purpose of determining the unpaid rent in the event
of a termination of this Lease, or the rent due hereunder in the event of a
reletting of the premises, the monthly rent reserved in this Lease shall be
deemed to be the sum of the rental due under paragraph 3 above and the
amounts last payable by Tenant pursuant to paragraph 4 and 5 above and any
concessions by Landlord as an inducement for Tenant to enter into this
Lease.
(5) Landlord's acceptance of payment from Tenant of less than the
amount of rent then due shall not constitute a waiver of any rights of
Landlord or Tenant including, without limitation, any right of Landlord to
recover possession of the premises.
(6) After terminating this Lease, Landlord may remove any and all
personal property located in the premises and place such property in a
public or private warehouse or elsewhere at the sole cost and expense of
Tenant.
(c) Even though Tenant has breached this Lease and abandoned the
premises, this Lease shall continue in effect for so long as Landlord does
not terminate Tenant's right to possession, and Landlord may enforce all
its rights and remedies under this Lease, including the right to recover
rental as it becomes due under this Lease. Acts of maintenance or
preservation, efforts to relet the premises, or the appointment of a
receiver upon initiative of Landlord to protect Landlord's interest under
this Lease, shall not constitute a termination of Tenant's right to
possession.
(d) Tenant hereby waives all rights under California Code of Civil
Procedure Section 1179 and California Civil Code Section 3275 providing for
relief from forfeiture, and any other right now or hereafter existing to
redeem the premises or reinstate this Lease after termination pursuant to
this Paragraph 15 or by order or judgment of any court or by any legal
process.
(e) Landlord and Tenant hereby waive trial by jury in any action,
proceeding or counterclaim brought by either of the parties hereby against
the other on any matters not relating to personal injury or property damage
but otherwise arising out of or in any way connected with this Lease, the
relationship of Landlord and Tenant, Tenant's use or occupancy of the
premises, and any emergency statutory or any other statutory remedy.
(f) The remedies provided for in this Lease are in addition to any
other remedies available to Landlord at law or in equity, by statute or
otherwise.
16. Landlord's Right to Cure Defaults. If Tenant shall fail to pay any
---------------------------------
sum of money, other than rental, required to be paid by it hereunder or shall
fail to perform any other act on its part to be performed hereunder and such
failure shall continue for 30 days after notice thereof by Landlord, Landlord
may, but shall not be obligated so to do, and without waiving or releasing
Tenant from any obligations of Tenant, make any such payment or perform any such
other act on Tenant's part to be made or performed as in this Lease provided.
All sums so paid by Landlord and all necessary incidental costs shall be deemed
additional rent hereunder and shall be payable to Landlord on demand, and
Landlord shall have (in addition to any other right or remedy of Landlord) the
same rights and remedies in the event of the nonpayment thereof by Tenant as in
the case of default by Tenant in the payment of rental.
17. Default by Landlord. Landlord shall not be in default under this
--------------------
Lease unless Landlord fails to perform obligations required of Landlord
hereunder within a reasonable time, but in no event later than 3O days after
notice by Tenant to Landlord specifying wherein Landlord has failed to perform
such obligation; provided, however, that if the nature of Landlord's obligation
is such that more
9
<PAGE>
than 30 days are required for performance, then Landlord shall not be in default
if Landlord commences performance within such 30 day period and thereafter
diligently prosecutes the same to completion.
18. Security Deposit. On execution of this Lease Tenant shall deposit
----------------
with Landlord the sum specified in the Basic Lease Information (the "Deposit") .
The Deposit shall be held by Landlord as security for the performance by Tenant
of all of the provisions of this Lease. Following an event of default by Tenant
under this Lease, Landlord may use, apply or retain all or any portion of the
Deposit for the payment of any rent or other charge in default, or the payment
of any other sum to which Landlord may become obligated by Tenant's default, or
to compensate Landlord for any loss or damage which Landlord may suffer thereby.
If Landlord so uses or applies all or any portion of the Deposit, then within 5
days after demand therefor Tenant shall deposit cash with Landlord in an amount
sufficient to restore the Deposit to the full amount thereof, and Tenant's
failure to do so shall be a material breach of this Lease. Landlord shall not be
required to keep the Deposit separate from its general accounts. If Tenant
performs all of Tenant's obligations hereunder, the Deposit, except that portion
designated as a non-refundable cleaning deposit or so much thereof as has not
theretofore been applied by Landlord, shall be returned, without payment of
interest for its use, to Tenant (or, at Landlord's option, to the last assignee,
if any, of Tenant's interest hereunder) at the expiration of the term hereof,
and after Tenant has vacated the premises. No trust relationship is created
herein between Landlord and Tenant with respect to the Deposit.
19. Estoppel Certificate.
--------------------
(a) Tenant shall at any time within 10 days following request from
Landlord execute, acknowledge and deliver to Landlord a statement certifying (1)
that this Lease is unmodified and in full force and effect (or, if modified,
stating the nature of such modification and certifying that this Lease, as so
modified, is in full force and effect), (2) the date to which the rent, security
deposit, and other sums payable hereunder have been paid, (3) acknowledging that
there are not, to Tenant's knowledge, any uncured defaults on the part of
Landlord hereunder, or specifying such defaults, if any, which are claimed, and
(4) such other matters as may reasonably be requested by Landlord. Any such
statement may be conclusively relied upon by any prospective purchaser or
encumbrancer of the Building and other real property of which it is a part.
(b) Tenant's failure to deliver such statement within such time shall
be conclusive upon Tenant: (1) that this Lease is in full force and effect,
without modification except as may be represented by Landlord, (2) that there
are no uncured defaults in Landlord's performance, and (3) that not more than
one month's rent has been paid in advance.
(c) If Landlord desires to finance or refinance the Building, within
10 days of Landlord's request, Tenant shall deliver to any lender designated by
Landlord such financial statements of Tenant as may be reasonably required by
such lender. All such financial statements shall be received by Landlord in
confidence and shall be used for the purposes herein set forth.
20. Subordination. This Lease, at Landlord's option, shall be subordinate
-------------
to any ground lease , mortgage, deed of trust, or any other hypothecation for
security now or hereafter placed upon the Building and to any and all advances
made on the security thereof and to all renewals, modifications, consolidations,
replacements and extensions thereof. If any mortgagee, beneficiary, trustee or
ground lessor shall elect to have this Lease prior to the lien of its mortgage,
deed of trust or ground lease, and shall give notice thereof to Tenant, this
Lease shall be deemed prior to such mortgage, deed of trust, or ground lease,
whether this Lease is dated prior to or subsequent to the date of said mortgage,
deed of trust or ground lease or the date of recording thereof. If any mortgage
or deed of trust to which this Lease is subordinate is foreclosed or a deed in
lieu of foreclosure is given to the mortgagee or beneficiary, Tenant shall
attorn to the purchaser at the foreclosure sale or to the grantee under the deed
in lieu of foreclosure; if any ground lease to which this Lease is subordinate
is terminated, Tenant shall attorn to the ground lessor. Tenant agrees to
execute any documents required to effectuate such subordination or to make this
Lease prior to the lien of any mortgage, deed of trust or ground lease, as the
case may be, or to evidence such attornment.
21. Attorneys' Fees. If either party commences an action or proceeding
---------------
against the other party arising out of or in connection with this Lease, or
institutes any proceeding in a bankruptcy or similar court which has
jurisdiction over the other party or any or all of its property or assets, the
prevailing party in such action or proceeding and in any appeal in connection
therewith shall be entitled to have and recover from the unsuccessful party
reasonable attorneys' fees, court costs, expenses and other costs of
investigation and preparation. If such prevailing party recovers a judgment in
any such action, proceeding, or appeal, such attorneys' fees, court costs and
expenses shall be included in and as a part of such judgment.
22. Notices. All communications from one party to the other given
-------
pursuant to the terms of this Lease shall be in writing and shall be deemed to
have been fully given when served personally at the premises, deposited in the
United States mail postage prepaid, or delivered to a generally recognized
overnight courier service, charges prepaid, and addressed as follows: to Tenant
at the address specified in the Basic Lease Information or to such other place
as Tenant may from time to time designate in a notice to Landlord; to Landlord
at the address specified in the Basic Lease Information, or to such other place
and with such other copies as Landlord may from time to time designate in a
notice to Tenant; or, in the case of Tenant, delivered to Tenant at the
premises.
23. Landlord's Scope of Work. Attached hereto as Exhibit "A" and by this
------------------------
reference made a part hereof, is a space plan of the premises with any notations
indicating the finishing work to be performed by Landlord. Said plan is to be
approved, signed, and returned to Landlord by on or before the date specified in
the Basic Lease Information whereupon said work shall commence and be completed
in substantial compliance with the requirements of said Exhibit and in a good
and workmanlike manner on or before the date specified in the Basic Lease
Information subject only to delays occasioned by fire, insurrection, war and
other causes beyond the control of Landlord, in which event the provisions of
Paragraph 1 of the Lease shall apply.
24. General Provisions.
------------------
(a) This Lease shall be governed by and construed in accordance with
the laws of the State of California.
10
<PAGE>
(b) The invalidity of any provision of this Lease, as determined by a
court of competent jurisdiction, shall in no way affect the validity of any
other provision hereof.
(c) This Lease contains all agreements of the parties with respect to
any matter mentioned herein and supersedes any verbal and any prior written
understanding, conditions, representations, agreements or covenants, and may be
modified in writing only, signed by the parties.
(d) No waiver by Landlord of any provision hereof shall be deemed a
waiver of any other provision or of any subsequent breach by Tenant of the same
or any other provision. Landlord's consent to or approval of any act shall not
be deemed to render unnecessary the obtaining of Landlord's consent to or
approval of any subsequent act by Tenant. The acceptance of rent or any partial
payment hereunder by Landlord shall not be a waiver of any preceding breach by
Tenant of any provision hereof, other than the failure of Tenant to pay the
particular rent accepted, regardless of Landlord's knowledge of such preceding
breach at the time of acceptance of such rent.
(e) If Tenant remains in possession of the premises or any part
thereof after the expiration of the term with the consent of Landlord such
occupancy shall be a tenancy from month to month at a rental in the amount of
two times the last month's rental during the term plus all other charges payable
hereunder, and upon all of the terms hereof.
(f) Subject to the provisions of this Lease restricting assignment or
subletting by Tenant, this Lease shall bind the parties, their personal
representatives, successors and assigns.
(g) Landlord and Landlord's agents shall have the right to enter the
premises at reasonable times for the purpose of inspecting the same, posting
notices, showing the same to prospective purchasers or lenders, and making such
alterations, repairs, improvements or additions to the premises or to the
Building as Landlord may deem necessary or desirable. Landlord may at any time
during the last 120 days of the term place on or about the premises any ordinary
"For Lease" sign.
(h) Tenant shall not conduct any auction at the premises.
(i) The voluntary or other surrender of this Lease by Tenant, the
mutual cancellation thereof or the termination of this lease by Landlord as a
result of Tenant's default shall, at the option of Landlord, terminate all or
any existing subtenancies or may, at the option of Landlord, operate as an
assignment to Landlord of any or all of such subtenancies.
(j) If Tenant is a corporation, each individual executing this Lease
on behalf of Tenant represents and warrants that he or she is duly authorized to
execute and deliver this Lease on behalf of the corporation in accordance with a
duly adopted resolution of the Board of Directors and that this Lease is binding
upon the corporation in accordance with its terms.
(k) The term "Landlord" as used herein means the then owner of the
Building and in the event of a sale of the Building the selling owner shall be
automatically relieved of all obligations of Landlord hereunder, except for acts
or omissions of Landlord theretofore occurring.
(1) Any liability which way arise as a consequence of the execution of
this Lease by or on behalf of Landlord shall be a liability of Landlord and not
the personal liability of any trustee, partner, corporate officer or corporate
officer of a trustee or partner, nor of an employee or beneficiary of Landlord,
its trustees or partners. Notwithstanding anything to the contrary set forth in
this Lease, Tenant agrees that there shall be absolutely no personal liability
on the part of Landlord with respect to any of the obligations of Landlord under
this Lease, and Tenant shall look solely to the equity, if any, of Landlord in
the Building for the
11
<PAGE>
satisfaction of any liability of Landlord to Tenant. Tenant's exculpation of
personal liability of Landlord is absolute and without any exception whatsoever.
(m) Tenant warrants that it has had no dealings with any real estate
broker or agent other than the Broker(s) identified in the Basic Lease
Information in connection with the premises or this Lease. Tenant shall
indemnify Landlord and hold it harmless from and against all claims, demands,
costs or liabilities (including, without limitation, attorneys' fees) asserted
by any party other than Broker(s) based upon dealings of that party with Tenant
in connection with the premises or this Lease. Landlord shall incur no
obligation to compensate Tenant's agent or representative should this lease be
renewed or extended.
(n) Within 10 days of Landlord's request therefore, Tenant shall
execute and deliver such amendments of this Lease as shall have been required by
Landlord's lender in connection with the making of a loan to be secured by the
premises or the Building, provided such amendment does not increase the
obligations of Tenant under this Lease or materially and adversely affect
Tenant's leasehold interest.
(o) Time is of the essence of this Lease and all of its provisions.
(p) No diminution or shutting off of light, air or view by any
structure which may be erected on or adjacent to the Property shall in any way
affect this tease or impose any liability on Landlord.
25. Exhibits. The exhibits and addendum, if any, specified in the Basic
--------
Lease Information are attached to this Lease and by this reference made a part
hereof.
12
<PAGE>
If this Lease has been filled in, it has been prepared for submission to
your attorney for approval. No representation or recommendation is made by the
real estate broker or its agents or employees as to the legal sufficiency, legal
effect or tax consequences of this Lease or the transaction relating thereto.
The submission of this Lease for examination does not constitute a reservation
of or option for the Leased Premises and this Lease becomes effective as a Lease
only upon execution and delivery thereof by Landlord and Tenant.
IN WITNESS WHEREOF, the parties have executed this Lease on the
respective dates indicated below.
TENANT: Internex Information Services, Inc. LANDLORD: San Tomas Investors 11
a California Corporation
By: /s/ By: /s/
By: By:
Date of Execution 7/29/96 Date of Execution
by Tenant: by Landlord: 8/2/96
13
<PAGE>
EXHIBIT "A"
Internex Information Services, Inc. INITIALS:
2306 Walsh Ave. LANDLORD: /s/
---------------------
Santa Clara, CA 95051 TENANT: /s/
----------------------
[MAP OF PREMISES APPEARS HERE]
<PAGE>
EXHIBIT B
---------
Rules and Regulations
1. No advertisements, pictures or signs of any sort shall be displayed on or
outside the Premises without the prior written consent of Landlord. This
prohibition shall include any portable signs or vehicles placed within the
parking lot, common areas or on streets adjacent thereto for the purpose of
advertising or display. Landlord shall have the right to remove any such
unapproved item without notice and at Tenant's expense.
2. Tenant shall not park or store motor vehicles, trailers or containers
outside of the Premises after the conclusion of normal daily business
activity except in approved areas specifically designated by Landlord.
3. Tenant shall not use any method of heating or air-conditioning other than
that supplied by Landlord without the prior written consent of Landlord.
4. All window coverings and window films or coatings installed by Tenant and
visible from outside of the building require the prior written approval of
Landlord. Except for dock shelters and seals as may be expressly permitted
by Landlord, no awnings or other projections shall be attached to the
outside walls of the building.
5. Tenant shall not use, keep or permit to be used or kept any foul or noxious
gas or substance on, in or around the Premises unless approved by Landlord.
Tenant shall not use, keep or permit to be used or kept any flammable or
combustible materials without proper governmental permits and approvals.
6. Tenant shall comply with all reasonable requirements of the Landlord's
insurance underwriters, which do not conflict with its rights under the
Lease.
7. Tenant shall not use, keep or permit to be used or kept food or other
edible materials in or around the Premises in such a manner as to attract
rodents, vermin or other pests. Tenant shall not permit cooking in or
about the Premises.
8. Tenant shall not use or permit the use of the Premises for lodging or
sleeping, for public assembly, or for any illegal or immoral purpose.
9. Tenant shall not alter any lock or install any new locks or bolts on any
door at the Premises without the prior written consent of Landlord.
10. Tenant shall park motor vehicles only in those general parking areas as
designated by Landlord except for active loading and containers. Tenant
shall not unreasonably interfere with traffic flow within the Industrial
Park and loading and unloading areas of other tenants.
11. Storage of forklift and propane tanks shall be in secure and protected
storage enclosures approved by the local fire department and shall be
located in areas specifically designated by Landlord. Safety equipment,
including eye wash stations and approved neutralizing agents, shall be
provided in areas used for the maintenance and charging of lead-acid
batteries. Tenant shall protect electrical panels, asphalt paving areas
and building mechanical equipment from damage from forklift trucks.
12. Tenant shall not disturb, solicit or canvas any occupant of the building or
the Property and shall cooperate to prevent same.
13. No person shall go on the roof without Landlord's permission.
14. No animals, fish or birds of any kind may be brought into or kept in or
about the Premises.
15. Machinery, equipment and apparatus belonging to Tenant which cause noise or
vibration that may be transmitted to the structure of the Building, to such
a degree as to be objectionable to Landlord or other tenants or to cause
harm to the Building, shall be placed and maintained by Tenant, at Tenants
expense, on vibration eliminators or other devices sufficient to eliminate
the transmission of such noise and vibration. Tenant shall cease using any
such machinery which causes objectionable noise and vibration which cannot
be sufficiently mitigated.
16. All goods, including material used to store goods, delivered to the
Premises of Tenant shall be immediately moved into the Premises and shall
not be left in parking or exterior loading areas overnight.
17. Tractor trailers which must be unhooked or parked with dolly wheels beyond
the concrete loading areas must use steel plates or wood blocks of
sufficient size to prevent damage to the asphalt paving surfaces. No
parking or storing of such trailers will be permitted in the auto parking
areas of the Property or on streets adjacent thereto.
18. Forklifts which operate on asphalt paving areas shall not have solid rubber
tires and shall use only tires that do not damage the asphalt.
19. Tenant is responsible for the safe storage and removal of all pallets.
Pallets shall be stored behind screened enclosures at locations approved by
the Landlord. If pallets are stored within the Premises, storage shall
comply with safe practices as described in Factory Mutual Loss Prevention
Data Sheet 8-24.
20. Tenant is responsible for the safe storage and removal of all trash and
refuse. All such trash and refuse shall be contained in suitable
receptacles stored behind screened enclosures at locations approved by
Landlord. Landlord reserves the right to remove, at Tenant's expense
without further notice, any trash or refuse left elsewhere outside of the
Premises or in the Industrial Park.
21. Tenant shall not store or permit the storage or placement of goods or
merchandise in or around the common areas surrounding the Premises. No
displays or sales of merchandise shall be allowed in the parking lots or
other common areas.
22. Tenant shall appoint an Emergency Coordinator who shall be responsible for
assuring notification of the local fire department in the event of an
emergency, assuring that sprinkler valves are kept open, and implementing
the Factory Mutual "Red Tag Alert" system including weekly visual
inspection of all sprinkler system valves on or within the Premises.
23. No loudspeakers, televisions, phonographs, radios or other devices shall be
used in such a manner as to be heard or seen outside of the premises
without the prior written consent of the Landlord.
24. Tenant shall use at Tenant's cost such pest extermination contractor as
Landlord may direct and at such intervals as Landlord may require.
25. The Tenant will protect carpeting from undue wear by providing carpet
protectors under chairs with casters, and protective covering in carpeted
areas where spillage or excessive wear may occur.
<PAGE>
ADDENDUM TO THAT CERTAIN LEASE DATED JULY 25, 1996 BY AND
BETWEEN SAN TOMAS INVESTORS II (LANDLORD) AND INTERNEX
INFORMATION SERVICES,, INC. (TENANT) FOR THE PREMISES AT 2306
WALSH AVENUE, SANTA CLARA, CALIFORNIA.
The subject lease is amended and clarified as follows:
Paragraph 3. (b) Rent: Under this paragraph the monthly rental shall be first
- ---------------------
adjusted, upward only, at the start of the third lease year (August 15, 1998) by
comparing the then current CPI, as defined in paragraph 3. (b), with the CPI
figure for the same month of 1997.
Paragraph 23 Landlord's Scope of Work: Landlord agrees to perform the following
- -------------------------------------
work on the leased premises:
1. Recarpet the office area of the Premises with building standard
carpeting.
2. Clean, patch, and paint interior walls.
Initials:
Landlord: /s/
--------------------
Tenant: /s/
--------------------
<PAGE>
EXHIBIT 11.1
CONCENTRIC NETWORK CORPORATION
STATEMENT REGARDING THE COMPUTATION OF PER SHARE LOSS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA))
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Net loss........................................ $(22,008) $(66,381) $(55,582)
======== ======== ========
Weighted average common shares outstanding used
in computing net loss per share................ 1,331 1,391 6,665
======== ======== ========
Net loss per share.............................. $ (16.53) $ (47.72) $ (8.34)
======== ======== ========
Convertible preferred stock..................... 3,546 3,207
-------- --------
Pro forma weighted average shares outstanding... 4,937 9,872
======== ========
Pro forma net loss per share.................... $ (13.46) $ (5.63)
======== ========
</TABLE>
<PAGE>
EXHIBIT 21.1
List of Material Subsidiaries
Internex Information Services, Inc., a California corporation, is a
wholly-owned subsidiary of Concentric Network Corporation.
<PAGE>
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8) pertaining to the Incentive Stock Option Plan, 1995 Stock Incentive
Plan for Employees and Consultants Option Agreements, Amended and Restated
1996 Stock Plan, 1997 Stock Plan and 1997 Employee Stock Purchase Plan and in
the related Prospectus, of Concentric Network Corporation of our report dated
January 27, 1998, except Note 12 as to which the date is February 5, 1998,
with respect to the financial statements and financial statement schedule of
Concentric Network Corporation included in this annual report (Form 10-K) for
the year ended December 31, 1997.
/s/ Ernst & Young LLP
San Jose, California
March 4, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report dated January 26, 1998 on the financial statements of Internex
Information Services, Inc. for the year ended June 30, 1997 included in this
Form 10-K. It should be noted that we have not audited any financial statements
of Internex Information Services, Inc. for any period subsequent to June 30,
1997 or performed any audit procedures subsequent to the date of our report.
/s/ ARTHUR ANDERSEN LLP
San Jose, California
March 4, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 119,959
<SECURITIES> 52,525
<RECEIVABLES> 4,549
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 148,772
<PP&E> 76,445
<DEPRECIATION> 22,735
<TOTAL-ASSETS> 244,489
<CURRENT-LIABILITIES> 33,399
<BONDS> 0
0
0
<COMMON> 182,721
<OTHER-SE> (150,803)
<TOTAL-LIABILITY-AND-EQUITY> 224,489
<SALES> 0
<TOTAL-REVENUES> 45,457
<CGS> 0
<TOTAL-COSTS> 61,439
<OTHER-EXPENSES> 34,262
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,571
<INCOME-PRETAX> (55,582)
<INCOME-TAX> 0
<INCOME-CONTINUING> (55,582)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (55,582)
<EPS-PRIMARY> (5.63)
<EPS-DILUTED> 0
</TABLE>
