<PAGE> 1
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FORM 10-Q
---------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 1998
---------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER:
VERIO INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE (State or other jurisdiction of 84-1339720 (I.R.S. Employer Identification
incorporation or organization) No.)
</TABLE>
8005 S. CHESTER STREET, SUITE 200
ENGLEWOOD, COLORADO 80112
(Address of principal executive offices)
(Zip Code)
303/645-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
The number of shares of the registrant's Common Stock outstanding as of
July 31, 1998 was 32,336,776.
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<PAGE> 2
VERIO INC.
FORM 10-Q
JUNE 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -- December 31, 1997
and June 30, 1998...................................... 2
Condensed Consolidated Statements of Operations -- Three
Months Ended June 30, 1997 and June 30, 1998........... 3
Condensed Consolidated Statements of Operations -- Six
Months Ended June 30, 1997 and June 30, 1998........... 4
Condensed Consolidated Statement of Stockholders' Equity
(Deficit) -- Six Months Ended June 30, 1998............ 5
Condensed Consolidated Statements of Cash Flows -- Six
Months Ended June 30, 1997 and June 30, 1998........... 6
Notes to Condensed Consolidated Financial Statements...... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................... 51
Item 2. Changes in Securities and Use of Proceeds........... 51
Item 3. Defaults Upon Senior Securities..................... 52
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 52
Item 5. Other Information................................... 53
Item 6. Exhibits and Reports on Form 8-K.................... 56
</TABLE>
1
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1.
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 72,586 $ 322,590
Restricted cash and securities (note 3)................... 21,015 13,759
Receivables:
Trade, net of allowance for doubtful accounts of $1,233
and $1,967, respectively............................... 7,565 12,628
Affiliates.............................................. 735 --
Prepaid expenses and other................................ 3,921 5,663
-------- ---------
Total current assets................................ 105,822 354,640
Restricted cash and securities (note 3)..................... 19,539 7,089
Investments in affiliates, at cost (note 2)................. 2,378 8,293
Equipment and leasehold improvements:
Internet access and computer equipment.................... 30,535 46,958
Furniture, fixtures and computer software................. 3,301 4,594
Leasehold improvements.................................... 1,596 3,415
-------- ---------
35,432 54,967
Less accumulated depreciation and amortization............ (7,219) (15,281)
-------- ---------
Net equipment and leasehold improvements............ 28,213 39,686
Other assets:
Goodwill, net of accumulated amortization of $3,595 and
$9,865, respectively (note 2)........................... 83,216 157,997
Debt issuance costs, net of accumulated amortization of
$330 and $764, respectively............................. 4,858 8,387
Organization costs and other, net......................... 2,445 2,673
-------- ---------
Total assets........................................ $246,471 $ 578,765
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 7,389 $ 7,734
Accrued expenses.......................................... 11,401 9,134
Accrued interest payable.................................. 844 5,195
Lines of credit, notes payable and current portion of
long-term debt (note 3)................................. 2,751 1,140
Current portion of capital lease obligations.............. 1,575 3,950
Deferred revenue.......................................... 7,177 8,121
-------- ---------
Total current liabilities........................... 31,137 35,274
Long-term debt, less current portion, net of discount (note
3)........................................................ 139,376 268,787
Capital lease obligations, less current portion............. 2,945 6,305
-------- ---------
Total liabilities................................... 173,458 310,366
-------- ---------
Minority interests in subsidiaries.......................... 2,765 --
Redeemable preferred stock (converted to common stock in
1998) (note 4):
Series A, convertible, $.001 par value. 6,100,000 shares
authorized, 6,033,333 shares issued and outstanding at
December 31, 1997. ..................................... 18,080 --
Series B, convertible, $.001 par value. 10,117,000 shares
authorized, 10,028,334 shares issued and outstanding at
December 31, 1997. ..................................... 59,193 --
Series C, convertible, $.001 par value. 2,500,000 shares
authorized, issued and outstanding at December 31,
1997. .................................................. 19,976 --
-------- ---------
97,249 --
-------- ---------
Stockholders' equity (deficit):
Preferred stock, Series D-1, convertible, $.001 par value
3,000,000 shares authorized, 680,000 and 1,684,751
shares issued and outstanding at December 31, 1997
(converted to common stock in 1998) (note 4)............ 10,200 --
Common stock, $.001 par value; 125,000,000 shares
authorized, 1,254,533 and 32,307,710 shares issued and
outstanding at December 31, 1997 and June 30, 1998,
respectively............................................ 1 32
Additional paid-in capital................................ 14,272 374,540
Accumulated deficit....................................... (51,474) (106,173)
-------- ---------
Total stockholders' equity (deficit)................ (27,001) 268,399
-------- ---------
Commitments (notes 2, 3 and 4)
Total liabilities and stockholders' equity
(deficit)........................................... $246,471 $ 578,765
======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 4
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
1997 1998
-------- --------
<S> <C> <C>
Revenue:
Internet connectivity:
Dedicated.............................................. $ 3,852 $ 12,644
Dial-up................................................ 1,564 5,739
Enhanced services and other............................... 2,833 10,158
------- --------
Total revenue..................................... 8,249 28,541
Costs and expenses:
Internet services operating costs......................... 3,433 13,318
Selling, general and administrative and other............. 11,122 25,851
Stock option related compensation and severance costs..... -- 2,001
Depreciation and amortization............................. 2,548 8,698
------- --------
Total costs and expenses.......................... 17,103 49,868
Loss from operations.............................. (8,854) (21,327)
Other income (expense):
Interest income........................................... 704 3,567
Interest expense.......................................... (471) (8,677)
Equity in losses of affiliates............................ (1,154) --
------- --------
Loss before minority interests.................... (9,775) (26,437)
Minority interests.......................................... 549 143
------- --------
Net loss.......................................... (9,226) (26,294)
Accretion of preferred stock to liquidation value........... (48) (22)
------- --------
Net loss attributable to common stockholders...... $(9,274) $(26,316)
======= ========
Weighted average number of common shares outstanding --basic
and diluted............................................... 1,115 18,243
======= ========
Loss per common share -- basic and diluted.................. $ (8.32) $ (1.44)
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 5
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
--------------------
JUNE 30, JUNE 30,
1997 1998
-------- --------
<S> <C> <C>
Revenue:
Internet connectivity:
Dedicated.............................................. $ 5,806 $ 22,544
Dial-up................................................ 2,670 9,886
Enhanced services and other............................... 4,187 17,309
-------- --------
Total revenue..................................... 12,663 49,739
Costs and expenses:
Internet services operating costs......................... 5,475 22,854
Selling, general and administrative and other............. 17,840 45,850
Stock option related compensation and severance costs..... -- 2,001
Depreciation and amortization............................. 3,794 15,079
-------- --------
Total costs and expenses.......................... 27,109 85,784
Loss from operations.............................. (14,446) (36,045)
Other income (expense):
Interest income........................................... 1,418 5,217
Interest expense.......................................... (592) (14,228)
Equity in losses of affiliates............................ (1,154) --
-------- --------
Loss before minority interests and extraordinary
item............................................ (14,774) (45,056)
Minority interests.......................................... 937 545
-------- --------
Loss before extraordinary item.................... (13,837) (44,511)
Extraordinary item -- loss related to debt repurchase....... -- (10,101)
-------- --------
Net loss.......................................... $(13,837) $(54,612)
======== ========
Accretion of preferred stock to liquidation value........... (114) (87)
-------- --------
Net loss attributable to common stockholders...... $(13,951) $(54,699)
Weighted average number of common shares
outstanding -- basic and diluted.......................... 1,133 9,801
======== ========
Loss per common share -- basic and diluted:
Loss per common share before extraordinary item........... $ (12.31) $ (4.55)
Extraordinary item........................................ -- (1.03)
-------- --------
Loss per common share..................................... $ (12.31) $ (5.58)
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 6
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
PREFERRED ------------------- PAID-IN ACCUMULATED
STOCK SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ---------- ------ ---------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997........... $ 10,200 1,254,533 $ 1 $ 14,272 $ (51,474) $(27,001)
Issuance of common stock for exercise
of options........................ -- 48,120 -- 179 -- 179
Issuance of common stock in initial
public offering, net of
expenses.......................... -- 5,735,000 6 121,945 -- 121,951
Issuance of common stock to private
investor.......................... -- 4,493,877 4 99,995 -- 99,999
Issuance of Series D-1 preferred
stock in business combinations.... 26,726 -- -- -- -- 26,726
Accretion of redeemable preferred
stock to liquidation value........ -- -- -- -- (87) (87)
Issuance of common stock pursuant to
conversion of Series D-1 preferred
stock............................. (36,926) 2,214,513 2 36,924 -- --
Issuance of common stock pursuant to
conversion of Series A, B and C
preferred stock................... -- 18,561,667 19 97,287 -- 97,306
Issuance of options in business
combinations...................... -- -- -- 1,937 -- 1,937
Stock option related compensation and
severance costs................... -- -- -- 2,001 -- 2,001
Net loss............................. (54,612) (54,612)
-------- ---------- --- -------- --------- --------
BALANCE AT JUNE 30, 1998 (UNAUDITED)... $ -- 32,307,710 $32 $374,540 $(106,173) $268,399
======== ========== === ======== ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 7
VERIO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
--------------------
JUNE 30, JUNE 30,
1997 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(13,837) $(54,612)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization.......................... 3,794 15,079
Minority interests' share of losses.................... (937) (545)
Equity in losses of affiliates......................... 1,328 --
Stock option related compensation and severance
costs................................................. -- 2,001
Extraordinary item -- loss related to the repurchase of
debt.................................................. -- 10,101
Changes in operating assets and liabilities, excluding
effects of business combinations:
Receivables.......................................... (3,316) (2,264)
Prepaid expenses and other current assets............ (698) (247)
Accounts payable..................................... (2,148) (1,885)
Accrued expenses..................................... (978) (1,626)
Accrued interest payable............................. -- 4,824
Deferred revenue..................................... 1,187 (847)
-------- --------
Net cash used by operating activities............. (15,605) (30,021)
-------- --------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements....... (7,616) (8,124)
Acquisition of net assets in business combinations and
investments in affiliates, net of cash acquired........ (21,399) (63,917)
Restricted cash and securities............................ (47,845) 19,839
Other..................................................... (773) (588)
-------- --------
Net cash used by investing activities............. (77,633) (52,790)
-------- --------
Cash flows from financing activities:
Proceeds from lines of credit, notes payable and long-term
debt................................................... 145,923 169,731
Repayments of lines of credit and notes payable........... (2,131) (57,729)
Repayments of capital lease obligations................... (387) (1,316)
Proceeds from issuance of common and preferred stock, net
of issuance costs...................................... 20,400 222,129
-------- --------
Net cash provided by financing activities......... 163,805 332,815
-------- --------
Net increase in cash and cash equivalents......... 70,567 250,004
Cash and cash equivalents:
Beginning of period....................................... 66,467 72,586
-------- --------
End of period............................................. $137,034 $322,590
======== ========
Supplemental disclosures of cash flow information:
Equipment acquired through capital lease obligations...... $ 695 $ 6,363
======== ========
Warrants issued in connection with debt offering.......... $ 12,675 $ --
======== ========
Cash paid for interest.................................... $ -- $ 9,987
======== ========
Acquisition of net assets in business combination through
issuance of preferred stock and preferred stock
options................................................ $ -- $ 17,008
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 8
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ACCOUNTING PRINCIPLES AND BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Verio Inc. and subsidiaries (the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X. All
material adjustments, consisting of only normal and recurring adjustments,
which, in the opinion of management, are necessary for a fair presentation of
the results for the interim periods have been reflected. Operating results for
the three month and six month periods ended June 30, 1998 are not necessarily
indicative of the results that may be expected for the full year. The condensed
consolidated financial statements and notes thereto should be read in
conjunction with the financial statements and notes for the period and year
ended December 31, 1996 and 1997. During 1997, the Financial Accounting
Standards Board issued Statements of Financial Accounting Standards ("SFAS") No.
130, Reporting Comprehensive Income and No. 131, Disclosures About Segments of
an Enterprise and Related Information. The adoption of SFAS 130 and 131 did not
have a significant effect on the Company's financial position or results of
operations.
NOTE 2 -- BUSINESS COMBINATIONS AND INVESTMENTS IN AFFILIATES
During the six months ended June 30, 1998, the Company purchased all of the
remaining equity interests in eleven of the Company's affiliates in which it did
not initially acquire a 100% ownership stake (each a "Buyout") and acquired 100%
of the stock of seven new Internet service providers, for a combination of cash
and shares of Series D-1 Preferred Stock (see note 4). All acquisitions were
accounted for using the purchase method of accounting. For those businesses
acquired and consolidated, the results of operations for the acquired businesses
are included in the Company's consolidated statement of operations from the
dates of acquisition. Summary information regarding the business combinations is
as follows:
Consolidated acquisitions in 1998:
<TABLE>
<CAPTION>
OWNERSHIP TOTAL OWNERSHIP APPROXIMATE
INTEREST INTEREST AT PURCHASE
BUSINESS NAME ACQUISITION DATE PURCHASED JUNE 30, 1998 PRICE
------------- ---------------- --------- --------------- -----------
(AMOUNTS IN
THOUSANDS)
<S> <C> <C> <C> <C>
Signet Partners, Inc.......... January 30, 1998 14%
February 26, 1998 45% 100% $ 1,925
Pacific Rim Network, Inc...... February 16, 1998 73% 100% 730
Clark Internet Services,
Inc......................... February 25, 1998 49% 100% 3,863
Internet Engineering
Associates, Inc............. February 25, 1998 80% 100% 1,608
On-Ramp Technologies, Inc..... February 26, 1998 45% 100% 11,849
National Knowledge Networks,
Inc......................... February 27, 1998 59% 100% 2,092
Access One, Inc............... February 27, 1998 80% 100% 5,601
NSNet, Inc.................... February 27, 1998 100% 100% 3,661
NorthWestNet, Inc............. March 6, 1998 15% 100% 4,803
LI Net, Inc................... April 9, 1998 100% 100% 6,500
STARnet, L.L.C................ April 14, 1998 100% 100% 3,500
Computing Engineers Inc....... April 15, 1998 100% 100% 9,000
Florida Internet
Corporation................. April 15, 1998 100% 100% 2,200
Structured Network Systems,
Inc. ....................... April 16, 1998 80% 100% 1,250
Compute Intensive Inc......... April 24, 1998 45% 100% 14,260
Matrix Online Media, Inc...... May 5, 1998 100% 100% 4,000
PacketWorks, Inc.............. June 19, 1998 100% 100% 852
Internet Online, Inc.......... June 30, 1998 65% 100% 4,200
-------
81,894
Acquisition costs............. 2,927
-------
$84,821
=======
</TABLE>
7
<PAGE> 9
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited condensed pro forma information presents the
unaudited results of operations of the Company as if the above consolidated
acquisitions had occurred on January 1, 1997:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
------------------------------
JUNE 30, 1997 JUNE 30, 1998
------------- -------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Revenue.................................................... $ 40,467 $ 57,439
Loss before extraordinary item and accretion of preferred
stock.................................................... (23,753) (46,694)
Net loss attributable to common stockholders............... (23,867) (56,939)
Loss per common share -- basic and diluted................. (21.06) (5.81)
</TABLE>
The pro forma results do not necessarily represent results that would have
occurred if the consolidated acquisitions had taken place as of January 1, 1997
nor are they necessarily indicative of the results of future operations.
Subsequent to June 30, 1998, the Company completed four acquisitions for
total consideration of approximately $54.0 million in cash, and contingent
consideration, based on the operating results of one of the acquired businesses
through December 31, 1998, of up to $43.2 million. In addition, the Company
entered into a definitive agreement to purchase Best Internet Communications,
Inc. d/b/a Hiway Technologies (Hiway) for total consideration of $329.0 million,
consisting of cash of $101.0 million and approximately 8.67 million fully
diluted shares of Verio Inc. Common Stock.
NOTE 3 -- DEBT
On March 25, 1998, the Company completed the private placement of $175.0
million principal amount of senior notes (the "1998 Notes"). The 1998 Notes are
redeemable at the option of the Company commencing April 1, 2002. The 1998 Notes
mature on April 1, 2005. Interest on the 1998 Notes, at the annual rate of
10 3/8%, is payable semi-annually in arrears on April 1 and October 1 of each
year, commencing October 1, 1998. The 1998 Notes are senior unsecured
obligations of the Company ranking pari passu in right of payment with all
existing and future unsecured and senior indebtedness. The 1998 Notes contain
terms that are substantially similar to the $150.0 million 13 1/2% Senior Notes
due 2004 ("1997 Notes"). The Company used approximately $54.5 million of the
proceeds plus accrued interest to repurchase $50.0 million principal amount of
the 1997 Notes. As a result, the Company was refunded approximately $13.3
million from the escrow account for the 1997 Notes, of which approximately $1.9
million was used to pay accrued and unpaid interest on the $50.0 million
principal amount of 1997 Notes repurchased from Brooks Fiber Properties, Inc.
This transaction resulted in an extraordinary loss of $10.1 million.
On April 6, 1998, the Company entered into a credit facility ("the Bank
Facility") with a group of commercial lending institutions that committed to
provide a $57.5 million revolving credit facility secured by the stock of the
affiliates that the Company owns currently or may own in the future and the
Company's long haul capacity agreement with Qwest Communications Corporation.
The Chase Manhattan Bank serves as agent for the Bank Facility. The Bank
Facility requires no payments of principal until its maturity on December 31,
1999. The terms of the Bank Facility provide for borrowings at LIBOR + 2%. There
is a commitment fee of 1/2% per annum on the undrawn amount of the Bank
Facility and a one-time fee of 1/2% on any amounts drawn. The last $3.0 million
of the Bank Facility can only be drawn for the payment of interest. No
borrowings were outstanding under the Bank Facility at June 30, 1998.
The Bank Facility sets forth covenants restricting, among other things, the
Company's ability to borrow, to guarantee the debt of others, and to make
borrowings at the subsidiary level. The Company is also limited in its ability
to enter into transactions with affiliates, create liens on its assets, and make
certain investments. In particular, Indebtedness, less cash (as defined in the
"Credit Agreement" dated as of April 6, 1998), may not exceed 2.35 times
annualized pro forma revenue for the most recent fiscal quarter. Dividends and
certain types
8
<PAGE> 10
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of investments are prohibited, as are liens incurred for borrowed money.
Borrowings under the Bank Facility are required to be paid down with the
proceeds of new Indebtedness (as defined in the Credit Agreement), certain asset
sales, Excess Cash Flow (as defined in the Credit Agreement), or the net
proceeds from insurance claims.
Subsequent to June 30, 1998, the Company initiated discussions with various
investment banks related to a possible placement of an undetermined amount of
senior notes that the Company currently expects to complete during the third or
fourth quarter of 1998.
NOTE 4 -- PREFERRED STOCK
As of April 1, 1998, the Company had outstanding an aggregate of 20,246,418
shares of Series A, B, C and D-1 Preferred Stock. On April 24, 1998, the Company
issued an additional 529,762 shares of its Series D-1 Preferred Stock in
connection with the Buyout of Compute Intensive Inc. Pursuant to the Company's
Certificate of Incorporation, upon the effectiveness of the Company's initial
public offering of shares of its Common Stock (the "IPO") on May 12, 1998 (note
5), all shares of the Company's outstanding Series A, B and C Redeemable,
Convertible Preferred Stock and Series D-1 Convertible Preferred Stock
automatically converted to an equivalent number of shares of Common Stock.
NOTE 5 -- COMMON STOCK
On May 12, 1998, the Company effected the IPO, in which 5,500,000 shares of
the Company's Common Stock were issued for net proceeds of approximately $117.0
million after deduction of the underwriting discounts, commissions and expenses
of the IPO. Concurrently with the consummation of the IPO, the Company completed
the sale of 4,493,877 shares of its Common Stock to an affiliate of Nippon
Telegraph and Telephone Corporation for proceeds of approximately $100.0
million. On June 15, 1998, the underwriters in connection with the IPO exercised
their option to purchase an additional 235,000 shares of Common Stock for
approximately $5.1 million after deducting underwriting discounts and
commissions.
NOTE 6 -- INCOME TAXES
As of June 30, 1998, the Company had a net operating loss carryforward for
federal income tax purposes of approximately $104.6 million which is available
to offset future federal taxable income, if any, through 2011. The utilization
of a portion of the net operating loss carryforwards may be limited under
Section 382 of the Internal Revenue Code. No tax benefit for such losses has
been recorded by the Company in 1997 or 1998 due to uncertainties regarding the
utilization of the loss carryforward.
NOTE 7 -- STOCK OPTION RELATED COMPENSATION AND SEVERANCE COSTS
The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and Related Interpretations. Since inception, the Company has granted
stock options with exercise prices equal to the fair value of the underlying
Common Stock, as determined by the Company's Board of Directors and based on the
Company's other equity transactions. Accordingly, the Company has not recorded
compensation expense related to the granting of stock options in 1996, 1997 and
through February 28, 1998. Subsequent to February 28, 1998 and prior to the IPO,
the Company granted options to employees with exercise prices which were less
than $22 per share, which was the low end of the IPO filing range immediately
prior to the IPO. The Company will record compensation expense totaling
approximately $10.6 million, representing the difference between the strike
prices of the options granted and $22 per share, pro rata over the forty-eight
month vesting period of the options. This compensation expense will total
approximately $2.0 million for the year ended December 31, 1998. It is the
intention of the Company to grant future stock options with exercise prices
equal to the fair value of the underlying Common Stock at the date of grant. The
compensation expense related to the six
9
<PAGE> 11
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
months ended June 30, 1998 is $630,000. Additionally, the Company incurred $1.4
million in compensation expense during the quarter ended June 30, 1998 primarily
related to the accelerated vesting of options issued to Mark Johnson, the
Company's former president who passed away in March 1998.
NOTE 8 -- SUBSEQUENT EVENTS
Subsequent to June 30, 1998, the Company completed four acquisitions for
approximately $54.0 million in cash and a contingent obligation of up to $43.2
million. Additionally, the Company entered into an agreement to acquire Hiway
for approximately $101.0 million in cash and 8.67 million shares of Verio Inc.
Common Stock. The completion of this acquisition is subject to satisfaction of a
number of closing conditions.
Also subsequent to June 30, 1998, the Company initiated discussions with
various investment banks related to a possible private placement of an
undetermined amount of senior notes that the Company currently expects to
complete during the third or fourth quarter of 1998.
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION
During the period from August 1, 1996 through June 30, 1998, the Company
completed numerous business combinations, whereby the Company acquired newly
authorized redeemable, convertible preferred stock, shares of common stock, or
certain net assets of entities operating in the Internet industry (ISPs), and
completed the Buyout of the remaining equity interests of certain ISPs in which
it initially acquired a less-than-100% equity position (collectively, the "June
30, 1998 Completed Acquisitions"). Business combinations, which are acquisitions
of a 100% ownership interest in the target business or of a majority ownership
interest (upon conversion of the preferred stock to common stock) on a fully
diluted basis, are accounted for using the purchase method of accounting.
Acquisitions of minority interests represented by preferred stock are accounted
for using the equity method of accounting. The June 30, 1998 Completed
Acquisitions are described in Note A to the accompanying pro forma condensed
combined financial statements. The Company also has completed the acquisitions
of PacketWorks, Inc., MagicNet, Inc., TerraNet, Inc. and Smart.Connect (a
division of FiberServices, Inc.) which were not considered to be significant
and, accordingly, have not been included in the accompanying pro forma financial
statements.
In addition, subsequent to June 30, 1998, the Company completed the
acquisition of the outstanding common stock of NTX, Inc. (TABNet) and entered
into a definitive agreement to acquire the common stock of Hiway (the "TABNet
and Hiway Acquisitions"). These acquisitions have been, or will be, accounted
for using the purchase method of accounting. The TABNet and Hiway Acquisitions
are also described in Note A to the pro forma condensed combined financial
statements.
While the Company now seeks to acquire 100% of new ISPs, the Company's
early acquisition strategy was to rapidly build mass and scale by acquiring less
than 100% of its ISPs. In each case where the Company acquired less than 100% of
an ISP initially, it obtained the right to Buyout the remaining equity in the
future at a price based on either agreed upon revenue multiples or the fair
market value of the ISP. As part of its integration strategy, the Company has
effected the Buyouts of all but one ISP in which it did not initially acquire a
100% interest, through the use of cash on hand and the issuance of equity. As of
August 11, 1998, Verio has consummated the Buyout of the following fifteen ISPs:
On-Ramp Technologies, Inc.; NorthWestNet, Inc.; National Knowledge Networks,
Inc.; Access One, Inc.; Signet Partners, Inc.; Surf Network, Inc.; Pacific Rim
Network, Inc.; Internet Engineering Associates, Inc.; AimNet Corporation; West
Coast Online, Inc.; ServiceTech, Inc., Clark Internet Services, Inc., Compute
Intensive Inc., Structured Network Systems, Inc. and Internet Online, Inc. With
respect to the Buyout that has not yet been completed, the Company has
contractual rights to effect this Buyout.
The unaudited pro forma condensed combined balance sheet assumes that the
TABNet and Hiway Acquisitions occurred on June 30, 1998 and includes the June
30, 1998 historical consolidated balance sheets
10
<PAGE> 12
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
of Verio, TABNet and Hiway adjusted for the pro forma effects of these
acquisitions. The assets and liabilities of the June 30, 1998 Completed
Acquisitions, adjusted for the application of the purchase method of accounting,
are included in the June 30, 1998 historical Verio consolidated balance sheet.
The unaudited pro forma condensed combined statements of operations for the year
ended December 31, 1997 and the six months ended June 30, 1998 assume that the
June 30, 1998 Completed Acquisitions and the TABNet and Hiway Acquisitions had
occurred on January 1, 1997 and include the historical or pro forma consolidated
statements of operations of Verio and the acquired businesses for the year ended
December 31, 1997 (year ended March 31, 1998 for TABNet) and the six months
ended June 30, 1998, adjusted for the pro forma effects of the acquisitions.
The unaudited pro forma condensed combined statements of operations are not
necessarily indicative of the results of operations that would actually have
occurred if the transactions had been consummated as of January 1, 1997 and are
not intended to indicate the expected results for any future period. These
statements should be read in conjunction with the historical consolidated
financial statements and related notes thereto of Verio, and certain acquired
businesses, included herein.
The Company is in the process of completing valuations of the assets
acquired and liabilities assumed in connection with certain of the Company's
more significant acquisitions. These valuations will be utilized in determining
the final purchase accounting adjustments for these acquisitions. Accordingly,
the purchase accounting adjustments reflected in the accompanying pro forma
balance sheet will be revised and such revisions may be significant.
Specifically, the Company expects to record charges to operations for in-process
research and development relating to certain of the acquisitions and these
charges, which will be recorded in the period of the acquisitions, also may be
significant. The amount of these charges are not presently determinable.
11
<PAGE> 13
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
VERIO INC.
PRO FORMA CONDENSED COMBINED BALANCE SHEET
JUNE 30, 1998 (UNAUDITED)
AMOUNTS IN THOUSANDS
ASSETS
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL PRO FORMA COMBINED- PRO FORMA PRO FORMA
------------------- ADJUSTMENTS VERIO AND HISTORICAL ADJUSTMENTS COMBINED
VERIO TABNET (NOTE C) TABNET HIWAY (NOTE C) VERIO
--------- ------- ----------- ------------ ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents.... $ 322,590 $ 91 $(45,500)(1) $277,181 $ 5,088 $(101,000)(2) $181,269
Restricted cash and
securities................ 13,759 538 -- 14,297 -- -- 14,297
Receivables, net............. 12,628 1,081 -- 13,709 3,352 -- 17,061
Prepaid expenses and other... 5,663 46 -- 5,709 1,205 -- 6,914
--------- ------- -------- -------- ------- --------- --------
Total current
assets............. 354,640 1,756 (45,500) 310,896 9,645 (101,000) 219,541
Investments in affiliates...... 8,293 -- -- 8,293 333 -- 8,626
Restricted cash and
securities................... 7,089 -- -- 7,089 -- -- 7,089
Equipment and leasehold
improvements, net............ 39,686 526 -- 40,212 13,126 -- 53,338
Other assets:
Goodwill, net................ 157,997 -- 46,170(1) 204,167 -- 317,468(2) 521,635
Other, net................... 11,060 21 -- 11,081 1,759 -- 12,840
--------- ------- -------- -------- ------- --------- --------
Total assets......... $ 578,765 $ 2,303 $ 670 $581,738 $24,863 $ 216,468 $823,069
========= ======= ======== ======== ======= ========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued
expenses.................. $ 22,063 $ 1,068 $ -- $ 23,131 $ 3,139 $ -- $ 26,270
Lines of credit, notes
payable and current
portion of long-term debt
and capital lease
obligations............... 5,090 -- -- 5,090 398 -- 5,488
Deferred revenue............. 8,121 1,905 -- 10,026 3,851 -- 13,877
--------- ------- -------- -------- ------- --------- --------
Total current
liabilities........ 35,274 2,973 -- 38,247 7,388 -- 45,635
Long-term debt and capital
lease obligations, less
current portion.............. 275,092 -- -- 275,092 5,943 -- 281,035
--------- ------- -------- -------- ------- --------- --------
Total liabilities.... 310,366 2,973 -- 313,339 13,331 -- 326,670
Minority interests in
subsidiaries................. -- -- -- -- -- -- --
Stockholders' deficit:
Common stock and additional
paid-in capital........... 361,897 3,640 (3,640)(3) 361,897 8,155 (8,155)(3) 589,897
228,000(2)
Warrants..................... 12,675 -- -- 12,675 -- -- 12,675
Retained earnings
(deficit)................. (106,173) (4,310) 4,310(3) (106,173) 3,377 (3,377)(3) (106,173)
--------- ------- -------- -------- ------- --------- --------
268,399 (670) 670 268,399 11,532 216,468 496,399
--------- ------- -------- -------- ------- --------- --------
Total liabilities and
stockholders'
equity (deficit)... $ 578,765 $ 2,303 $ 670 $581,738 $24,863 $ 216,468 $823,069
========= ======= ======== ======== ======= ========= ========
</TABLE>
12
<PAGE> 14
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
VERIO INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 (UNAUDITED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
<TABLE>
<CAPTION>
PRO FORMA
COMBINED
VERIO AND PRO FORMA
JUNE 30, 1998 PRO FORMA COMBINED- PRO FORMA PRO FORMA
COMPLETED HISTORICAL ADJUSTMENTS VERIO AND HISTORICAL ADJUSTMENTS COMBINED
ACQUISITIONS TABNET (NOTE C) TABNET HIWAY (NOTE C) VERIO
-------------- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet
connectivity........ $ 37,199 $ -- $ -- $ 37,199 $ 3,703 $ -- $ 40,902
Enhanced services and
other............... 18,564 5,106 -- 23,670 14,807 -- 38,477
----------- ------- ----------- ----------- ------- ---------- -----------
Total revenue... 55,763 5,106 -- 60,869 18,510 -- 79,379
----------- ------- ----------- ----------- ------- ---------- -----------
Costs and expenses:
Internet services
operating costs..... 24,746 985 -- 25,731 4,372 -- 30,103
Selling, general and
administrative and
other............... 49,911 4,138 -- 54,049 10,334 -- 64,383
Stock option related
compensation and
severance costs..... 2,001 3,640 -- 5,641 -- -- 5,641
Depreciation and
amortization........ 16,844 76 2,310(6) 19,230 1,139 15,873(6) 36,242
----------- ------- ----------- ----------- ------- ---------- -----------
Total costs and
expenses...... 93,502 8,839 2,310 104,651 15,845 15,873 136,369
----------- ------- ----------- ----------- ------- ---------- -----------
Loss from
operations........ (37,739) (3,733) (2,310) (43,782) 2,665 (15,873) (56,990)
Other income (expense):
Interest income....... 5,230 3 -- 5,233 -- -- 5,233
Interest expense...... (14,319) -- -- (14,319) (566) -- (14,885)
----------- ------- ----------- ----------- ------- ---------- -----------
Loss before minority
interests, income
taxes, and
extraordinary
item.............. (46,828) (3,730) (2,310) (52,868) 2,099 (15,873) (66,642)
Minority interests...... 184 -- -- 184 -- -- 184
Income taxes............ -- -- -- -- (99) 99(8) --
----------- ------- ----------- ----------- ------- ---------- -----------
Loss before
extraordinary item.... $ (46,644) $(3,730) $ (2,310) $ (52,684) $ 2,000 $ (15,774) $ (66,458)
=========== ======= =========== =========== ======= ========== ===========
Weighted average shares
outstanding -- basic
and diluted........... 11,500,769 11,500,769 8,670,000 20,170,769
=========== =========== ========== ===========
Loss per common share
before extraordinary
item -- basic and
diluted............... $ (4.06) $ (4.58) $ (3.29)
=========== =========== ===========
</TABLE>
13
<PAGE> 15
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
VERIO INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 (UNAUDITED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------- COMBINED-
JUNE 30, 1998 VERIO AND
COMPLETED PRO FORMA JUNE 30, 1998
ACQUISITIONS ADJUSTMENTS COMPLETED
VERIO (NOTE B) (NOTE C) ACQUISITIONS
--------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Revenue:
Internet connectivity............................ $ 32,430 $4,769 $ -- $ 37,199
Enhanced services and other...................... 17,309 1,397 (142)(4) 18,564
--------- ------ ----------- ------------
Total revenue............................. 49,739 6,166 (142) 55,763
--------- ------ ----------- ------------
Costs and expenses:
Internet services operating costs................ 22,854 1,974 (82)(4) 24,746
Selling, general and administrative and other.... 45,850 4,121 (60)(4) 49,911
Stock option related compensation and severance
costs.......................................... 2,001 -- -- 2,001
Depreciation and amortization.................... 15,079 302 1,463(5) 16,844
--------- ------ ----------- ------------
Total costs and expenses.................. 85,784 6,397 1,321 93,502
--------- ------ ----------- ------------
Loss from operations........................... (36,045) (231) (1,463) (37,739)
Other income (expense):
Interest income.................................. 5,217 13 -- 5,230
Interest expense................................. (14,228) (91) -- (14,319)
--------- ------ ----------- ------------
Loss before minority interests, income taxes,
and extraordinary item....................... (45,056) (309) (1,463) (46,828)
Minority interests................................. 545 -- (361)(7) 184
Income taxes....................................... -- (57) 57(8) --
--------- ------ ----------- ------------
Loss before extraordinary item................. (44,511) (366) (1,767) (46,644)
Accretion of preferred stock to liquidation
value............................................ (87) -- 87(3) --
--------- ------ ----------- ------------
Loss attributable to common stockholders before
extraordinary item............................... $ (44,598) $ (366) $ (1,680) $ (46,644)
========= ====== =========== ============
Weighted average shares outstanding -- basic and
diluted.......................................... 9,800,769 1,700,000(9) 11,500,769
========= =========== ============
Loss per common share before extraordinary
item -- basic and diluted........................ $ (4.55) $ (4.06)
========= ============
</TABLE>
14
<PAGE> 16
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
VERIO INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 (UNAUDITED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
<TABLE>
<CAPTION>
PRO FORMA
COMBINED --
VERIO AND PRO FORMA
JUNE 30, 1998 PRO FORMA COMBINED -- PRO FORMA PRO FORMA
COMPLETED HISTORICAL ADJUSTMENTS VERIO AND HISTORICAL ADJUSTMENTS COMBINED
ACQUISITION TABNET (NOTE C) TABNET HIWAY (NOTE C) VERIO
------------- ---------- ----------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet
connectivity..... $ 63,055 $ -- $ -- $ 63,055 $ 7,231 $ -- $ 70,286
Enhanced services
and other........ 25,210 4,944 -- 30,154 18,954 -- 49,108
----------- ------ ------- --------- ------- --------- ----------
Total
revenue... 88,265 4,944 -- 93,209 26,185 -- 119,394
----------- ------ ------- --------- ------- --------- ----------
Costs and expenses:
Internet services
operating
costs............ 38,145 1,006 -- 39,151 5,842 -- 44,993
Selling, general
and
administrative
and other........ 82,070 4,192 -- 86,262 14,101 -- 100,363
Depreciation and
amortization..... 25,911 86 4,617(6) 30,614 1,371 31,747(6) 63,732
----------- ------ ------- --------- ------- --------- ----------
Total costs
and
expenses... 146,126 5,284 4,617 156,027 21,314 31,747 209,088
----------- ------ ------- --------- ------- --------- ----------
Loss from
operations..... (57,861) (340) (4,617) (62,818) 4,871 (31,747) (89,694)
Other income
(expense):
Interest income.... 6,147 6 -- 6,153 67 -- 6,220
Interest expense... (12,417) -- -- (12,417) (142) -- (12,559)
----------- ------ ------- --------- ------- --------- ----------
Loss before
income taxes... (64,131) (334) (4,617) (69,082) 4,796 (31,747) (96,033)
Income taxes......... -- -- -- -- (361) 361(8) --
----------- ------ ------- --------- ------- --------- ----------
Net loss............. $ (64,131) $ (334) $(4,617) $ (69,082) $ 4,435 $ (31,386) $ (96,033)
=========== ====== ======= ========= ======= ========= ==========
Weighted average
shares
outstanding -- basic
and diluted........ 2,844,685 2,844,685 8,670,000 11,514,685
=========== ========= ========= ==========
Loss per common
share -- basic and
diluted............ $ (22.54) $ (24.28) $ (8.34)
=========== ========= ==========
</TABLE>
15
<PAGE> 17
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
VERIO INC.
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 (UNAUDITED)
AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------- COMBINED-
JUNE 30, VERIO AND
1998 JUNE 30,
COMPLETED PRO FORMA 1998
ACQUISITIONS ADJUSTMENTS COMPLETED
VERIO (NOTE B) (NOTE C) ACQUISITIONS
---------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Revenue:
Internet connectivity............................... $ 23,476 $39,677 $ (98)(4) $ 63,055
Enhanced services and other......................... 12,216 12,994 -- 25,210
---------- ------- ---------- ----------
Total revenue................................ 35,692 52,671 (98) 88,265
---------- ------- ---------- ----------
Costs and expenses:
Internet services operating costs................... 15,974 22,247 (76)(4) 38,145
Selling, general and administrative and other....... 49,383 32,687 -- 82,070
Depreciation and amortization....................... 10,624 3,257 12,030(5) 25,911
---------- ------- ---------- ----------
Total costs and expenses..................... 75,981 58,191 11,954 146,126
---------- ------- ---------- ----------
Loss from operations.............................. (40,289) (5,520) (12,052) (57,861)
Other income (expense):
Interest income..................................... 6,080 67 -- 6,147
Interest expense.................................... (11,826) (591) -- (12,417)
Equity in losses of affiliates...................... (1,958) -- 1,958(7) --
---------- ------- ---------- ----------
Loss before minority interests and income taxes... (47,993) (6,044) (10,094) (64,131)
Minority interests.................................... 1,924 -- (1,924)(7) --
Income taxes.......................................... -- (1,247) 1,247(8) --
---------- ------- ---------- ----------
Net loss..................................... (46,069) (7,291) (10,771) (64,131)
Accretion of preferred stock to liquidation value..... (260) -- 260(3) --
---------- ------- ---------- ----------
Net loss attributable to common stockholders.......... $ (46,329) $(7,291) $ (10,511) $ (64,131)
========== ======= ========== ==========
Weighted average shares outstanding -- basic and
diluted............................................. 1,144,685 1,700,000(9) 2,844,685
========== ========== ==========
Loss per common share -- basic and diluted............ $ (40.47) $ (22.54)
========== ==========
</TABLE>
16
<PAGE> 18
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(A) BASIS OF PRESENTATION
During the period from inception (March 1, 1996) to June 30, 1998, Verio
completed numerous business combinations, and completed the Buyout of the
remaining equity interests of certain ISPs in which it initially acquired a
less-than-100% equity position. In addition, subsequent to June 30, 1998, the
Company completed the acquisition of TABNet and entered into a definitive
agreement to acquire Hiway. All of the acquisitions have been or will be
accounted for using the purchase method of accounting. Summary information
regarding substantially all of the June 30, 1998 Completed Acquisitions and the
TABNet and Hiway Acquisitions is as follows:
<TABLE>
<CAPTION>
CONSIDERATION
--------------------------------
PREFERRED
JUNE 30, 1998 OWNERSHIP CASH AND OR COMMON
COMPLETED ACQUISITIONS ACQUISITION DATE(S) PERCENTAGE NOTES STOCK(B) TOTAL(C)
---------------------- ------------------- ---------- -------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
On-Ramp Technologies, Inc. ............. August 1, 1996 51%
October 4, 1996 4%
February 26, 1998 45% $ 13,639 $ 6,985 $ 20,624
National Knowledge Networks, Inc. ...... August 2, 1996 26%
November 7, 1997 15%
February 27, 1998 59% 2,991 -- 2,991
RAINet, Inc. ........................... August 2, 1996 100% 2,000 -- 2,000
Access One, Inc......................... December 12, 1996 20%
February 27, 1998 80% 6,107 -- 6,107
CCnet, Inc. ............................ December 19, 1996 100% 1,800 -- 1,800
Signet Partners, Inc. .................. December 19, 1996 25%
November 20, 1997 16%
February 26, 1998 59% 1,459 1,283 2,742
Global Enterprise Services -- Network
Division.............................. January 17, 1997 100% 2,350 -- 2,350
Surf Network, Inc. ..................... January 31, 1997 25%
December 22, 1997 75% 603 -- 603
Pacific Rim Network, Inc. .............. February 4, 1997 27%
February 16, 1998 73% 880 -- 880
Pioneer Global Telecommunications,
Inc. ................................. February 6, 1997 100% 1,011 -- 1,011
Compute Intensive Inc. ................. February 18, 1997 55%
April 24, 1998 45% 7,505 11,655 19,160
NorthWestNet, Inc. ..................... February 28, 1997 85%
March 6, 1998 15% 12,330 1,937 14,267
Internet Engineering Associates,
Inc. ................................. March 4, 1997 20%
February 25, 1998 80% 207 1,607 1,814
Internet Online, Inc. .................. March 5, 1997 36% 1,050 -- 1,050
Structured Network Systems, Inc. ....... March 6, 1997 20%
April 16, 1998 80% 1,400 -- 1,400
</TABLE>
17
<PAGE> 19
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
<TABLE>
<CAPTION>
CONSIDERATION
--------------------------------
PREFERRED
JUNE 30, 1998 OWNERSHIP CASH AND OR COMMON
COMPLETED ACQUISITIONS ACQUISITION DATE(S) PERCENTAGE NOTES STOCK(B) TOTAL(C)
---------------------- ------------------- ---------- -------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
RustNet, Inc. .......................... March 14, 1997 100% 1,703 -- 1,703
AimNet Corporation...................... May 19, 1997 55%
September 22, 1997 45% 7,613 -- 7,613
West Coast Online, Inc. ................ July 26, 1996 20%
April 29, 1997 12%
September 30, 1997 68% 2,000 -- 2,000
ServiceTech, Inc. ...................... August 1, 1997 40%
December 31, 1997 60% 2,055 -- 2,055
Branch Information Services, Inc. ...... September 17, 1997 100% 1,687 -- 1,687
Communique, Inc. ....................... October 2, 1997 100% 3,000 -- 3,000
Clark Internet Services, Inc. .......... October 17, 1997 51%
February 25, 1998 49% 3,952 3,431 7,383
ATMnet.................................. November 5, 1997 100% 5,522 -- 5,522
Global Internet Network Services,
Inc. ................................. December 1, 1997 100% 6,000 -- 6,000
Sesquinet............................... December 24, 1997 100%(a) 732 -- 732
PREPnet................................. December 24, 1997 100% 1,405 -- 1,405
Monumental Network Systems, Inc. ....... December 31, 1997 100% 3,962 -- 3,962
Internet Servers, Inc. ................. December 31, 1997 100% 9,800 10,200 20,000
NSNet, Inc. ............................ February 27, 1998 100% 1,896 1,765 3,661
LI Net, Inc. ........................... April 9, 1998 100% 6,500 -- 6,500
STARnet, L.L.C. ........................ April 14, 1998 100% 3,500 -- 3,500
Computing Engineers Inc. ............... April 15, 1998 100% 9,000 -- 9,000
Florida Internet Corporation............ April 15, 1998 100% 2,200 -- 2,200
Matrix Online Media, Inc. .............. May 5, 1998 100% 4,000 -- 4,000
--------
Total.......................... $170,722
========
TABNet.................................. July 7, 1998 100% 45,500 -- $ 45,500
========
Hiway Technologies, Inc. ............... -- 100% 101,000 228,000 $329,000
========
</TABLE>
- ---------------
18
<PAGE> 20
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
The total consideration, exclusive of acquisition costs, for the above
acquisitions has been allocated as follows:
<TABLE>
<CAPTION>
JUNE 30,
1998
COMPLETED
ACQUISITIONS TABNET HIWAY
------------ ------- --------
<S> <C> <C> <C>
Equipment.................................. $ 17,771 $ 526 $ 13,126
Goodwill................................... 154,910 46,170 317,468
Net current liabilities.................... (3,009) (1,196) (1,594)
Investment in Internet Online, Inc. ....... 1,050 -- --
-------- ------- --------
Total............................ $170,722 $45,500 $329,000
======== ======= ========
</TABLE>
(a) Assets of this entity were purchased by On-Ramp Technologies, Inc.
(b) Represents shares of Series D-1 Preferred Stock valued at $15 per share
prior to February 28, 1998 or $22 per share after February 28, 1998. For
NorthWestNet, Inc., the amount represents options to purchase Preferred
Stock at $15 per share. Such per share values were determined by the
Company's Board of Directors based on comparable valuations of private and
public companies, methodologies based on multiples of revenue and
discounted cash flows, and arms-length negotiated values.
(c) Total consideration does not include acquisition costs.
The accompanying unaudited pro forma condensed combined balance sheet as of
June 30, 1998 includes historical balances of Verio and the businesses acquired
adjusted for the pro forma effects of substantially all of the acquisitions
completed through August 11, 1998, including the acquisitions of the remaining
interests in certain consolidated subsidiaries and minority owned affiliates.
All acquisitions are assumed to have been completed for cash, debt or the
issuance of preferred or common stock of Verio. The unaudited pro forma
condensed combined statements of operations for the year ended December 31, 1997
and the six months ended June 30, 1998 include the historical results of
operations of Verio and the businesses acquired, including the acquisitions of
the remaining interests in certain consolidated subsidiaries and minority owned
affiliates, adjusted for the pro forma effects of the acquisitions.
(B) HISTORICAL CONDENSED STATEMENTS OF OPERATIONS INFORMATION -- JUNE 30, 1998
COMPLETED ACQUISITIONS
Historical condensed statement of operations information for the June 30,
1998 Completed Acquisitions for the year ended December 31, 1997 including the
periods from January 1, 1997 to the dates of consolidation is as follows:
19
<PAGE> 21
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
<TABLE>
<CAPTION>
PIONEER GLOBAL
AIMNET RUSTNET, COMPUTE NORTHWEST TELECOMMUNICATIONS, WEST COAST
YEAR ENDED DECEMBER 31, 1997 CORPORATION INC. GES INTENSIVE NET INC. ONLINE, INC.
---------------------------- ----------- -------- ----- --------- --------- ------------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet connectivity....... $1,068 $ 310 $ 112 $ 468 $ 709 $ 62 $1,192
Enhanced services and
other..................... 101 69 -- 326 351 7 457
------ ----- ----- ----- ------ ---- ------
Total revenue......... 1,169 379 112 794 1,060 69 1,649
Operating costs and expenses:
Internet services operating
costs..................... 444 147 94 301 113 33 735
Selling, general and
administrative and
other..................... 978 319 133 673 1,661 37 981
Depreciation and
amortization.............. 248 17 -- 16 136 4 77
------ ----- ----- ----- ------ ---- ------
Total costs and
expenses............ 1,670 483 227 990 1,910 74 1,793
------ ----- ----- ----- ------ ---- ------
Earnings (loss) from
operations................ (501) (104) (115) (196) (850) (5) (144)
Interest income............... 8 -- --
Interest expense.............. -- (8) -- (8) -- (2) --
------ ----- ----- ----- ------ ---- ------
Earnings (loss) before
income taxes............ (493) (112) (115) (204) (850) (7) (144)
Income taxes.................. -- -- -- -- 118 (5) --
------ ----- ----- ----- ------ ---- ------
Net earnings (loss)... $ (493) $(112) $(115) $(204) $ (732) $(12) $ (144)
====== ===== ===== ===== ====== ==== ======
<CAPTION>
BRANCH
INFORMATION
YEAR ENDED DECEMBER 31, 1997 SERVICES, INC.
---------------------------- --------------
<S> <C>
Revenue:
Internet connectivity....... $588
Enhanced services and
other..................... 84
----
Total revenue......... 672
Operating costs and expenses:
Internet services operating
costs..................... 84
Selling, general and
administrative and
other..................... 298
Depreciation and
amortization.............. 2
----
Total costs and
expenses............ 384
----
Earnings (loss) from
operations................ 288
Interest income............... --
Interest expense.............. --
----
Earnings (loss) before
income taxes............ 288
Income taxes.................. (101)
----
Net earnings (loss)... $187
====
</TABLE>
<TABLE>
<CAPTION>
GLOBAL
CLARK INTERNET
INTERNET SURF NETWORK
COMMUNIQUE, SERVICES, NETWORK, SERVICES,
INC. INC. INC. SESQUINET ATMNET INC. PREPNET
----------- --------- -------- --------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue
Internet connectivity.................... $1,454 $2,582 $ 585 $1,124 $2,754 $2,501 $2,026
Enhanced services and other.............. 764 562 190 -- 73 1,284 121
------ ------ ------ ------ ------- ------ ------
Total revenue...................... 2,218 3,144 775 1,124 2,827 3,785 2,147
Operating costs and expenses:
Internet services operating costs........ 690 1,394 431 538 2,976 2,679 793
Selling, general and administrative and
other.................................. 1,159 1,784 981 367 1,786 1,019 773
Depreciation and amortization............ 5 116 76 54 40 280 121
------ ------ ------ ------ ------- ------ ------
Total costs and expenses............... 1,854 3,294 1,488 959 4,802 3,978 1,687
------ ------ ------ ------ ------- ------ ------
Earnings (loss) from operations........ 364 (150) (713) 165 (1,975) (193) 460
Interest income............................ -- 2 -- -- -- -- --
Interest expense........................... -- (25) (33) -- (171) (8) (11)
------ ------ ------ ------ ------- ------ ------
Earnings (loss) before income taxes.... 364 (173) (746) 165 (2,146) (201) 449
Income taxes............................... (127) -- -- (58) -- -- (171)
------ ------ ------ ------ ------- ------ ------
Net earnings (loss)................ $ 237 $ (173) $ (746) $ 107 $(2,146) $ (201) $ 278
====== ====== ====== ====== ======= ====== ======
</TABLE>
20
<PAGE> 22
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
<TABLE>
<CAPTION>
INTERNET
INTERNET SERVICE PACIFIC RIM SIGNET ENGINEERING STRUCTURED
MONUMENTAL, SERVERS, TECH, NETWORK, PARTNERS, NSNET, ASSOCIATES, NETWORK
INC. INC. INC. INC. INC. INC. INC. SYSTEMS, INC.
----------- -------- ------- ------------- --------- ------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet connectivity..... $2,425 $ 704 $ 1,536 $ 472 $1,133 $1,832 $ 831 $ 859
Enhanced services and
other................... 47 3,688 627 337 518 15 303 27
------ ------ ------- ----- ------ ------ ------ -----
Total revenue......... 2,472 4,392 2,163 809 1,651 1,847 1,134 886
Operating costs and
expenses:
Internet services
operating costs......... 1,162 536 1,229 385 336 471 323 473
Selling, general and
administrative and
other................... 1,757 2,006 1,814 674 1,977 939 678 511
Depreciation and
amortization............ 172 260 197 69 10 126 63 --
------ ------ ------- ----- ------ ------ ------ -----
Total costs and
expenses........... 3,091 2,802 3,240 1,128 2,323 1,536 1,064 984
------ ------ ------- ----- ------ ------ ------ -----
Earnings (loss) from
operations............ (619) 1,590 (1,077) (319) (672) 311 70 (98)
Interest income............. -- 26 -- -- -- -- 14 --
Interest expense............ (16) -- (42) (15) (5) (6) -- (17)
------ ------ ------- ----- ------ ------ ------ -----
Earnings (loss) before
income taxes.......... (635) 1,616 (1,119) (334) (677) 305 84 (115)
Income taxes................ -- (602) 33 (15) -- (116) (29) --
------ ------ ------- ----- ------ ------ ------ -----
Net earnings (loss)... $ (635) $1,014 $(1,086) $(349) $ (677) $ 189 $ 55 $(115)
====== ====== ======= ===== ====== ====== ====== =====
</TABLE>
<TABLE>
<CAPTION>
NATIONAL
KNOWLEDGE FLORIDA COMPUTING MATRIX
ACCESSONE, NETWORKS, LI INTERNET ENGINEERS STARNET, ONLINE
INC. INC. NET, INC. CORPORATION INC. L.L.C. MEDIA, INC. TOTAL
---------- --------- --------- ----------- --------- -------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet
connectivity..... $2,484 $1,169 $1,907 $1,172 $3,322 $1,202 $1,094 $39,677
Enhanced services
and other........ 1,035 234 120 264 758 399 233 12,994
------ ------ ------ ------ ------ ------ ------ -------
Total
revenue..... 3,519 1,403 2,027 1,436 4,080 1,601 1,327 52,671
Operating costs and
expenses:
Internet services
operating
costs............ 1,510 669 792 773 1,026 717 393 22,247
Selling, general
and
administrative
and other........ 2,251 1,282 1,573 578 2,341 570 787 32,687
Depreciation and
amortization..... 245 55 135 121 329 156 127 3,257
------ ------ ------ ------ ------ ------ ------ -------
Total costs and
expenses.... 4,006 2,006 2,500 1,472 3,696 1,443 1,307 58,191
------ ------ ------ ------ ------ ------ ------ -------
Earnings (loss)
from
operations..... (487) (603) (473) (36) 384 158 20 (5,520)
Interest income...... -- 6 -- -- -- 9 2 67
Interest expense..... (26) (26) (39) (12) (96) (6) (19) (591)
------ ------ ------ ------ ------ ------ ------ -------
Earnings (loss)
before income
taxes.......... (513) (623) (512) (48) 288 161 3 (6,044)
Income taxes......... -- (3) -- -- (110) (61) -- (1,247)
------ ------ ------ ------ ------ ------ ------ -------
Net earnings
(loss)...... $ (513) $ (626) $ (512) $ (48) $ 178 $ 100 $ 3 $(7,291)
====== ====== ====== ====== ====== ====== ====== =======
</TABLE>
21
<PAGE> 23
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
Historical condensed statement of operations information for the June 30,
1998 Completed Acquisitions for the six months ended June 30, 1998 including the
periods from January 1, 1998 to the dates of consolidation is as follows:
<TABLE>
<CAPTION>
INTERNET
PACIFIC RIM SIGNET ENGINEERING STRUCTURED
NETWORK, PARTNERS, NSNET, ASSOCIATES, NETWORK ACCESSONE,
SIX MONTHS ENDED JUNE 30, 1998 INC. INC. INC. INC. SYSTEMS, INC. INC.
------------------------------ ------------- --------- ------ ----------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Internet connectivity................. $ 73 $122 $275 $152 $318 $ 643
Enhanced services and other........... 31 50 75 41 25 108
---- ---- ---- ---- ---- -----
Total revenue..................... 104 172 350 193 343 751
Operating costs and expenses:
Internet services operating costs..... 43 45 126 61 178 268
Selling, general and administrative
and other........................... 88 142 287 124 240 535
Depreciation and amortization......... 10 4 27 13 7 53
---- ---- ---- ---- ---- -----
Total costs and expenses.......... 141 191 440 198 425 856
---- ---- ---- ---- ---- -----
Earnings (loss) from operations..... (37) (19) (90) (5) (82) (105)
Interest income......................... -- -- -- 1 2 --
Interest expense........................ (2) (1) -- -- (2) (11)
---- ---- ---- ---- ---- -----
Earnings (loss) before income
taxes............................. (39) (20) (90) (4) (82) (116)
Income taxes............................ -- -- -- -- -- --
---- ---- ---- ---- ---- -----
Net earnings (loss)............... $(39) $(20) $(90) $ (4) $(82) $(116)
==== ==== ==== ==== ==== =====
</TABLE>
<TABLE>
<CAPTION>
NATIONAL
KNOWLEDGE FLORIDA COMPUTING MATRIX
NETWORKS, LI INTERNET ENGINEERS STARNET, ONLINE
INC. NET, INC. CORPORATION INC. L.L.C. MEDIA, INC. TOTAL
--------- --------- ----------- --------- -------- ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Internet connectivity........ $265 $554 $435 $ 914 $472 $546 $4,769
Enhanced services and
other...................... 68 147 180 491 26 155 1,397
---- ---- ---- ------ ---- ---- ------
Total revenue............ 333 701 615 1,405 498 701 6,166
Operating costs and expenses:
Internet services operating
costs...................... 147 299 158 373 89 187 1,974
Selling, general and
administrative and other... 246 408 415 873 326 437 4,121
Depreciation and
amortization............... 9 39 27 54 15 44 302
---- ---- ---- ------ ---- ---- ------
Total costs and
expenses.............. 402 746 600 1,300 430 668 6,397
---- ---- ---- ------ ---- ---- ------
Earnings (loss) from
operations............... (69) (45) 15 105 68 33 (231)
Interest income................ -- -- -- 9 -- 1 13
Interest expense............... -- (34) (3) (20) -- (18) (91)
---- ---- ---- ------ ---- ---- ------
Earnings (loss) before
income taxes............. (69) (79) 12 94 68 16 (309)
Income taxes................... -- -- (4) (28) (20) (5) (57)
---- ---- ---- ------ ---- ---- ------
Net earnings (loss)...... $(69) $(79) $ 8 $ 66 $ 48 $ 11 $ (366)
==== ==== ==== ====== ==== ==== ======
</TABLE>
22
<PAGE> 24
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- ADDITIONAL PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(C) PRO FORMA ADJUSTMENTS
The following pro forma adjustments have been made to the condensed
combined balance sheet as of June 30, 1998 and the condensed combined statement
of operations for the year ended December 31, 1997 and six months ended June 30,
1998. The purchase accounting adjustments relating to the June 30, 1998
Completed Acquisitions are included in the historical consolidated balance sheet
of Verio as of June 30, 1998.
(1) To reflect cash of $45,500,000 used in connection with the
acquisition of TABNet, and the allocation of the excess purchase price to
goodwill in the amount of $46,170,000. It is anticipated that the Company
will record a charge to operations for in-process research and development
in connection with the TABNet acquisition and such charge may be
significant. However, such amount is not presently determinable.
(2) To reflect cash of $101,000,000 and the issuance of 8,670,000
shares of common stock valued at approximately $228,000,000 in connection
with the acquisition of Hiway, and the allocation of the excess purchase
price to goodwill in the amount of $317,468,000. It is anticipated that the
Company will record a charge to operations for in-process research and
development in connection with the Hiway acquisition and such charge may be
material. However, such amount is not presently determinable.
(3) To eliminate the equity accounts of the acquisitions and the
accretion of preferred stock to liquidation value.
(4) To eliminate intercompany revenue, expenses, receivables and
payables.
(5) To adjust amortization expense due to increase in carrying value
of goodwill resulting from the June 30, 1998 Completed Acquisitions, using
a ten-year life and additional amortization of goodwill on 1997
acquisitions for the period from January 1, 1997 through the date of
acquisition as if the acquisitions had occurred as of January 1, 1997 and
amortization of goodwill on 1998 acquisitions for the period from January
1, 1998 through the date of acquisition as if the acquisitions had occurred
as of January 1, 1997.
(6) To adjust amortization expense due to increase in carrying value
of goodwill resulting from the TABNet and Hiway Acquisitions, using a
ten-year life, as follows (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1997 1998
------------ ----------
<S> <C> <C>
TABNet...................................................... $ 4,617 $ 2,310
======= =======
Hiway....................................................... $31,747 $15,873
======= =======
</TABLE>
(7) To eliminate minority interests share of equity and equity in
losses of affiliates upon acquisition of 100% ownership interests.
(8) To eliminate income tax expense or benefit of acquired businesses
due to consolidated net operating loss for the year ended December 31, 1997
and the six months ended June 30, 1998.
(9) To reflect the issuance of 1,700,000 shares of common stock on an
as converted basis for the June 30, 1998 Completed Acquisitions and the
issuance of 8,670,000 shares of common stock in connection with the Hiway
acquisition.
23
<PAGE> 25
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- FINANCIAL INFORMATION RELATING TO HIWAY ACQUISITION
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- JUNE 30,
1996 1997 1998
------ ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................... $1,588 $ 5,672 $ 5,088
Accounts receivable, net of allowance for doubtful accounts
of $373, $1,072 and $940, respectively.................... 1,380 2,550 3,352
Note receivable............................................. -- 160 160
Inventory -- equipment held for resale...................... 71 35 22
Prepaid expenses and other current assets................... 237 297 363
Deferred taxes.............................................. -- 342 660
------ ------- -------
Total current assets................................ 3,276 9,056 9,645
Property and equipment, net................................. 4,813 8,706 13,126
Deposits and other.......................................... 68 196 694
Investments................................................. -- 344 333
Intangible assets, net of accumulated amortization of $101,
$318 and $424, respectively............................... 1,382 1,165 1,065
------ ------- -------
Total assets........................................ $9,539 $19,467 $24,863
====== ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................ $1,165 $ 1,234 $ 1,688
Accrued payroll and related liabilities..................... 265 458 851
Other accrued liabilities................................... 201 141 600
Deferred revenue............................................ 981 2,578 3,851
Current portion of notes payable............................ 140 225 93
Current portion of capital lease obligations................ 135 251 305
------ ------- -------
Total current liabilities........................... 2,887 4,887 7,388
Deferred rent............................................... 105 119 400
Deferred taxes.............................................. -- 307 354
Notes payable, less current portion......................... 541 4,944 4,889
Capital lease obligations, less current portion............. 237 253 300
Convertible note payable.................................... 800 -- --
------ ------- -------
Total liabilities................................... 4,570 10,510 13,331
------ ------- -------
Commitments (Note 8)
STOCKHOLDERS' EQUITY:
Preferred stock, convertible and redeemable, $0.001 par
value per share: Authorized: 10,000,000 shares;
Series B: Authorized: 4,000,000 shares; Issued and
outstanding: 2,822,000, 3,462,000 and no shares,
respectively.............................................. 3,441 4,229 --
Liquidation preference: $3,528, $4,328 and $0, respectively
Common stock, $0.001 par value per share: Authorized:
60,000,000 shares; Issued and outstanding: 27,776,620,
31,120,237 and 35,757,841 shares, respectively............ 28 31 36
Additional paid-in capital.................................. 1,584 4,209 9,477
Notes receivable from stockholders.......................... -- (889) (1,358)
Retained earnings (accumulated deficit)..................... (84) 1,377 3,377
------ ------- -------
Total stockholders' equity.......................... 4,969 8,957 11,532
------ ------- -------
Total liabilities and stockholders' equity.......... $9,539 $19,467 $24,863
====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
24
<PAGE> 26
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- FINANCIAL INFORMATION RELATING TO HIWAY ACQUISITION -- (CONTINUED)
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------- -------------------------
1995 1996 1997 1997 1998
------ ------- ------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues.................................. $2,011 $12,217 $26,185 $11,535 $18,510
------ ------- ------- ------- -------
Operating costs and expenses:
Cost of revenues........................ 231 3,233 7,213 3,366 5,288
Sales and marketing..................... 154 2,555 3,589 1,382 2,761
Product development and systems
engineering.......................... 97 1,005 2,112 838 1,356
General and administrative.............. 2,068 4,641 8,400 3,393 6,440
------ ------- ------- ------- -------
Total operating costs and
expenses...................... 2,550 11,434 21,314 8,979 15,845
------ ------- ------- ------- -------
Income (loss) from operations............. (539) 783 4,871 2,556 2,665
Other income (expense).................... (7) -- 67 30 (387)
Interest expense, net..................... (4) (190) (142) (39) (179)
------ ------- ------- ------- -------
Income (loss) before provision for income
taxes................................... (550) 593 4,796 2,547 2,099
Provision for income taxes................ 1 1 361 194 99
------ ------- ------- ------- -------
Net income (loss)......................... $ (551) $ 592 $ 4,435 $ 2,353 $ 2,000
====== ======= ======= ======= =======
Basic net income (loss) per share......... $(0.03) $ 0.02 $ 0.15 $ 0.08 $ 0.06
====== ======= ======= ======= =======
Diluted net income (loss) per share....... $(0.03) $ 0.02 $ 0.13 $ 0.07 $ 0.06
====== ======= ======= ======= =======
Pro forma net income data (unaudited)
(Note 17):
Income (loss) before provision for
income taxes......................... $ (550) $ 593 $ 4,796 $ 2,547 $ 2,099
Pro forma provision for income taxes.... 1 33 1,925 1,016 843
------ ------- ------- ------- -------
Pro forma net income (loss)............... $ (551) $ 560 $ 2,871 $ 1,531 $ 1,256
====== ======= ======= ======= =======
Pro forma basic net income (loss) per
share................................... $(0.03) $ 0.02 $ 0.10 $ 0.05 $ 0.04
====== ======= ======= ======= =======
Pro forma diluted net income (loss) per
share................................... $(0.03) $ 0.02 $ 0.08 $ 0.04 $ 0.03
====== ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE> 27
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- FINANCIAL INFORMATION RELATING TO HIWAY ACQUISITION -- (CONTINUED)
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1997 AND SIX MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SERIES B NOTES RETAINED
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE EARNINGS TOTAL
-------------------- ------------------- PAID-IN FROM (ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS DEFICIT) EQUITY
---------- ------- ---------- ------ ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, JANUARY 1,
1995.................... -- $ -- -- $-- $ -- $ -- $ -- $ --
Issuance of common stock
for cash, net of
issuance costs of $7.... -- -- 22,622,141 22 990 -- -- 1,012
Issuance of common stock
for services rendered... -- -- 510,000 1 25 -- -- 26
Net loss.................. -- -- -- -- -- -- (551) (551)
---------- ------- ---------- --- ------ ------- ------- -------
BALANCES, DECEMBER 31,
1995.................... -- -- 23,132,141 23 1,015 -- (551) 487
Issuance of common stock
and exercise of stock
options for cash, net of
issuance costs of $3.... -- -- 4,509,479 5 430 -- -- 435
Issuance of common stock
for acquisitions........ -- -- 135,000 -- 67 -- -- 67
Issuance of warrants...... -- -- -- -- 72 -- -- 72
Issuance of preferred
stock for cash, net of
issuance costs
of $86.................. 2,822,000 3,441 -- -- -- -- -- 3,441
Net income................ -- -- -- -- -- -- 592 592
Distributions by Hiway
Florida (a Subchapter S
corporation)............ -- -- -- -- -- -- (125) (125)
---------- ------- ---------- --- ------ ------- ------- -------
BALANCES, DECEMBER 31,
1996.................... 2,822,000 3,441 27,776,620 28 1,584 -- (84) 4,969
Issuance of common stock
and exercise of stock
options for
cash.................... -- -- 2,279,503 2 544 -- -- 546
Issuance of common stock
and exercise of stock
options for
notes................... -- -- 1,084,114 1 608 (609) -- --
Repurchase of common
stock................... -- -- (20,000) -- (40) -- -- (40)
Issuance of warrants for
note.................... -- -- -- -- 280 (280) -- --
Issuance of warrant....... -- -- -- -- 1,233 -- -- 1,233
Issuance of preferred
stock for cash, net of
issuance costs
of $12.................. 640,000 788 -- -- -- -- -- 788
Net income................ -- -- -- -- -- -- 4,435 4,435
Distributions by Hiway
Florida (a Subchapter S
corporation)............ -- -- -- -- -- -- (2,974) (2,974)
---------- ------- ---------- --- ------ ------- ------- -------
BALANCES, DECEMBER 31,
1997.................... 3,462,000 4,229 31,120,237 31 4,209 (889) 1,377 8,957
Exercise of stock options
for cash................ -- -- 554,892 1 394 -- -- 395
Exercise of stock options
for
notes................... -- -- 620,712 1 468 (469) -- --
Conversion of preferred
stock................... (3,462,000) (4,229) 3,462,000 3 4,226 -- -- --
Contribution from
stockholders............ -- -- -- -- 180 -- -- 180
Net income................ -- -- -- -- -- -- 2,000 2,000
---------- ------- ---------- --- ------ ------- ------- -------
BALANCES, JUNE 30, 1998
(unaudited)............. -- $ -- 35,757,841 $36 $9,477 $(1,358) $ 3,377 $11,532
========== ======= ========== === ====== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
26
<PAGE> 28
VERIO INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- FINANCIAL INFORMATION RELATING TO HIWAY ACQUISITION -- (CONTINUED)
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------- -------------------------
1995 1996 1997 1997 1998
------- ------- ------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................................... $ (551) $ 592 $ 4,435 $ 2,353 $ 2,000
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization............................ 87 608 1,371 523 1,139
Amortization of intangibles.............................. -- 101 217 111 106
Services rendered in exchange for common stock........... 26 -- -- -- --
Provision for doubtful accounts.......................... 8 365 699 152 (132)
Loss (gain) on sale and trade-in of property and
equipment.............................................. -- 39 2 -- (134)
Equity in earnings of foreign resellers.................. -- -- -- -- (13)
Amortization of discount on convertible debt............. -- 72 -- -- 150
Deferred taxes........................................... -- -- (35) -- (443)
Changes in operating assets and liabilities:
Accounts receivable.................................... (92) (1,660) (1,869) (579) (671)
Inventory.............................................. (30) (41) 36 10 13
Prepaid expenses and other current assets.............. (4) (233) (60) (80) (66)
Deposits............................................... (34) (15) (128) (85) (504)
Accounts payable....................................... 360 804 69 59 453
Accrued liabilities.................................... 150 316 133 323 1,024
Deferred revenue....................................... 115 866 1,597 854 1,273
Deferred rent.......................................... 57 48 14 6 281
------- ------- ------- ------- -------
Net cash provided by operating activities.......... 92 1,862 6,481 3,647 4,476
------- ------- ------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment............... -- 47 7 -- 2
Purchases of property and equipment........................ (1,047) (3,491) (4,955) (2,003) (5,229)
Issuance of note receivable................................ -- -- (160) -- --
Purchase of investments.................................... -- -- (344) -- (26)
Acquisitions............................................... -- (1,312) -- -- --
------- ------- ------- ------- -------
Net cash used in investing activities.............. (1,047) (4,756) (5,452) (2,003) (5,253)
------- ------- ------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock..................... 1,012 422 500 500 --
Proceeds from exercise of stock options.................... -- 13 46 9 395
Proceeds from issuance of preferred stock.................. -- 3,441 788 788 --
Repurchase of common stock................................. -- -- (40) -- --
Proceeds from (repayment of) convertible notes............. -- 800 (800) (800) --
Proceeds from notes payable................................ -- 43 5,912 -- --
Principal payments on notes payable........................ -- (79) (190) (77) (285)
Proceeds from stockholder loans............................ 9 -- -- -- --
Repayment of stockholder loans............................. (8) (21) -- -- --
Loans to stockholder....................................... -- -- -- (250) --
Principal payment on capital lease obligations............. (3) (67) (187) (76) (97)
Distributions to stockholders.............................. -- (125) (2,974) (1,219) --
Contribution from stockholders............................. -- -- -- -- 180
------- ------- ------- ------- -------
Net cash provided by (used in) financing
activities....................................... 1,010 4,427 3,055 (1,125) 193
------- ------- ------- ------- -------
Net increase (decrease) in cash and cash equivalents....... 55 1,533 4,084 519 (584)
Cash and cash equivalents, beginning of period............. -- 55 1,588 1,588 5,672
------- ------- ------- ------- -------
Cash and cash equivalents, end of period................... $ 55 $ 1,588 $ 5,672 $ 2,107 $ 5,088
======= ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE> 29
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION WITH RESPECT TO JUNE 30, 1998 AND THE SIX MONTHS ENDED JUNE 30,
1997 AND 1998 IS UNAUDITED)
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
1. COMPANY BACKGROUND
Hiway Technologies, Inc. (the Company), formerly Best Internet
Communications, Inc. (Best), was incorporated in California on September 21,
1994. Activity from September 21, 1994 (date of inception) to December 31, 1994
resulted in revenues of $20 and a net loss of $46, which have been included in
the results for the year ended December 31, 1995. On May 27, 1998, Best merged
with Hiway Technologies, Inc. (Hiway Florida), a company based in Florida, and
is currently doing business as Hiway Technologies, Inc. Hiway Florida was formed
on April 6, 1995 and operated as a Subchapter S corporation.
The Company is a leading global provider of Web hosting and related
enhanced Internet services to small and medium sized businesses. The Company
focuses on delivering high-quality, reliable and flexible services that are
backed by 24 X 7 customer support.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
The Company has minority investments in certain of its foreign resellers.
The activities of these entities are not significant.
Management Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. These instruments are
stated at cost, which approximates fair value.
Fair Value of Financial Instruments:
Carrying amounts of certain financial instruments held by the Company
including cash and cash equivalents, accounts receivable, accounts payable and
other accrued liabilities approximate fair value due to their short maturities.
Based on borrowing rates currently available to the Company for loans with
similar terms, the carrying value of the notes payable and capital lease
obligations approximates fair value.
Inventory:
Inventory is stated at the lower of cost (determined on a first-in,
first-out basis) or market, and consists primarily of third party equipment for
resale.
28
<PAGE> 30
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property and Equipment:
Property and equipment is stated at cost and is depreciated on a straight
line basis over their estimated useful lives of five to seven years. Leasehold
improvements are amortized over the length of the lease or estimated useful
life, whichever is less. Major additions and betterments are capitalized, while
replacements, maintenance, and repairs that do not improve or extend the life of
the assets are charged to expense. In the period assets are retired or otherwise
disposed of, the costs and related accumulated depreciation and amortization are
removed from the accounts, and any gain or loss on disposal is included in
results of operations.
Intangible Assets:
Intangible assets consist of goodwill which arose from the acquisition of
two Internet service providers in 1996 (see Note 4) and is being amortized on a
straight-line basis over seven years. The Company reviews the carrying value of
goodwill for impairment whenever events or changes in circumstance indicate that
the carrying amount may not be recoverable.
Revenue Recognition:
Revenues consist primarily of Web hosting and Internet service fees, set-up
fees and equipment sales. The Company generally sells its Web hosting services
for contractual periods ranging from one to three months. Revenues from these
services are recognized ratably over the contractual period. Internet service
fees consist of fixed monthly amounts that are recognized as the service is
provided. Payments received in advance of providing services are deferred until
the period such services are provided. Set-up fees and equipment sales are
recognized when the set-up services are performed.
Advertising:
The Company charges advertising costs to expense as they are incurred.
Advertising expense for the years ended December 31, 1995, 1996 and 1997 was
$113, $988 and $1,353, respectively.
Product Development:
Product development expenses are charged to operations as incurred.
Income Taxes:
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income
Taxes." Under SFAS 109, deferred tax assets and liabilities are determined based
on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to affect taxable income. Valuation
allowances are established when, in management's estimate, there is uncertainty
over the recovery of deferred tax assets. The provision for income tax is
comprised of taxes payable for the current period, plus the net change in
deferred tax amounts during the period.
Income taxes are recognized in these consolidated financial statements for
the operations of Best which was a C Corporation during all periods presented.
Because Hiway Florida was a Subchapter S corporation during all periods
presented, the income taxes for Hiway Florida's operations were the
responsibility of that company's stockholders. Pro forma income tax expenses, as
though both Best and Hiway Florida reported on a combined basis as a C
corporation is disclosed in Note 17.
29
<PAGE> 31
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Unaudited Interim Financial Information:
The accompanying interim balance sheet as of June 30, 1998 and the
statements of operations and cash flows for the six months ended June 30, 1997
and 1998 together with the related notes are unaudited but include all
adjustments, consisting of only normal recurring adjustments, which the Company
considers necessary to present fairly, in all material respects, the financial
position, as of June 30, 1998 and the results of operations and cash flows for
the six months ended June 30, 1997 and 1998. Results for the six months ended
June 30, 1997 and 1998 are not necessarily indicative of results for an entire
year.
Recent Accounting Pronouncements:
In 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosure About Segments of an Enterprise and Related Information," which is
effective for the year ending December 31, 1998.
In March 1998, the AICPA issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." The Company is reviewing the impact of SOP 98-1, which will be
effective for the year ending December 31, 1999.
3. BUSINESS RISKS AND CREDIT CONCENTRATION
The Company operates in the intensely competitive Internet industry which
is characterized by rapid technological change, short product life cycles, and
heightened competition. Significant technological changes in the industry could
affect operating results adversely.
Financial instruments that potentially subject the Company to
concentrations of credit risk comprise principally cash and cash equivalents,
trade accounts receivable, and other receivables and deposits. As of December
31, 1997, the Company's cash and cash equivalents are deposited with numerous
domestic financial institutions. With respect to accounts receivable, the
Company's customer base is dispersed across many different geographic areas. The
Company monitors customers' payment history and establishes reserves for bad
debt as warranted. In addition to individual customers, the Company also
provides Web hosting services to resellers who in turn provide services to their
own customers.
4. MERGERS AND ACQUISITIONS
Merger with Hiway Florida:
On May 27, 1998, the Company merged with Hiway Florida, a provider of Web
hosting services. Under the terms of the merger agreement, each share of Hiway
Florida common stock was exchanged for 4.1374 shares of the Company's common
stock. The Company issued approximately 21.8 million shares of common stock in
exchange for all the outstanding shares of Hiway Florida. The Company also
assumed and exchanged all options and warrants to purchase Hiway Florida stock
for options and warrants to purchase approximately 3 million shares of the
Company's common stock. The transaction was accounted for as a pooling of
interest and accordingly the Company's financial statements have been restated
to include the results of Hiway Florida for all periods presented.
30
<PAGE> 32
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Separate and combined results of operations for the periods prior to the
merger are as follows:
<TABLE>
<CAPTION>
SIX
MONTHS
YEAR ENDED DECEMBER 31, ENDED
-------------------------- JUNE 30,
1995 1996 1997 1998
------ ------- ------- --------
<S> <C> <C> <C> <C>
Revenues:
Best.......................................... $1,965 $ 9,517 $15,785 $ 9,333
Hiway Florida................................. 46 2,700 10,400 9,177
------ ------- ------- -------
Combined...................................... $2,011 $12,217 $26,185 $18,510
====== ======= ======= =======
Net income (loss) -- historical:
Best.......................................... $ (566) $ (474) $ 1,662 $ 365
Hiway Florida................................. 15 1,138 2,773 1,635
------ ------- ------- -------
Combined...................................... $ (551) $ 664 $ 4,435 $ 2,000
====== ======= ======= =======
</TABLE>
Other Acquisitions:
In July 1996, the Company acquired certain assets and the ongoing
operations of two Internet service providers for a total of $2,076. The
aggregate purchase price comprised $1,312 in cash, $697 in notes payable to
sellers, and 135,000 shares of common stock valued at $67. The purchase price
was allocated to the net tangible assets acquired ($593) and to goodwill
($1,483).
5. NOTE RECEIVABLE
The note receivable is due from one of the Company's partners in a foreign
reseller. The note is uncollateralized, bears interest at the rate of 12% and is
due on demand.
6. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31,
--------------- JUNE 30,
1996 1997 1998
------ ------ --------
<S> <C> <C> <C>
Network, computer equipment and software.................. $4,661 $8,841 $11,559
Furniture and fixtures.................................... 124 471 698
Leasehold improvements.................................... 566 1,199 1,264
Construction in progress.................................. -- -- 1,972
Other..................................................... 148 252 602
------ ------ -------
5,499 10,763 16,095
Less accumulated depreciation and amortization............ 686 2,057 2,969
------ ------ -------
$4,813 $8,706 $13,126
====== ====== =======
</TABLE>
Included in network and computer equipment are $490, $776 and $799 of
equipment acquired under capital leases at December 31, 1996 and 1997 and June
30, 1998, respectively. Accumulated amortization related to such capital leases
was $40, $158 and $238 at December 31, 1996 and 1997 and June 30, 1998,
respectively. Network and computer equipment also includes $1,064 and $276 of
equipment not yet placed in service at December 31, 1997 and June 30, 1998,
respectively.
31
<PAGE> 33
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. CAPITAL LEASE OBLIGATIONS
The Company leases network equipment under several capital leases. The
agreements require the Company to maintain liability and property insurance.
Capital leases at December 31, 1997 expire at various dates through September
2000 and bear interest ranging from 5.8% to 18.5%. Future minimum lease payments
as of December 31, 1997 are as follows:
<TABLE>
<S> <C>
1998........................................................ $284
1999........................................................ 209
2000........................................................ 58
----
551
Less amount representing interest........................... 47
----
Present value of minimum lease payments..................... 504
Less current portion........................................ 251
----
$253
====
</TABLE>
8. COMMITMENTS
The Company rents office facilities and equipment under several operating
leases which expire at various times through May 2005. Rent expense charged to
operations was $155, $345 and $670 for the years ended December 31, 1995, 1996,
and 1997, respectively.
Future minimum lease payments under noncancelable operating leases as of
December 31, 1997 are as follows:
<TABLE>
<S> <C>
1998........................................................ $ 786
1999........................................................ 861
2000........................................................ 1,148
2001........................................................ 1,140
2002........................................................ 977
Thereafter.................................................. 1,818
------
Total commitments................................. $6,730
======
</TABLE>
9. NOTES PAYABLE
Notes payable comprise the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
---- ------
<S> <C> <C>
Seller notes................................................ $649 $ 475
Bank notes.................................................. 32 927
Senior unsecured notes...................................... -- 3,767
---- ------
681 5,169
Less current portion........................................ 140 225
---- ------
$541 $4,944
==== ======
</TABLE>
The seller notes bear interest at 8% per annum and are repayable in monthly
equal installments through July 2001. These notes resulted from the acquisitions
made in 1996 (see Note 4).
32
<PAGE> 34
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The bank notes bear interest at 9.75% to 10% per annum and are repayable in
equal monthly installments through October 2001. The bank notes are
collateralized by the Company's assets and require the Company to comply with
certain covenants including a minimum quick ratio, a minimum tangible net worth,
a maximum ratio of total liabilities to tangible net worth, a minimum monthly
subscriber additions to disconnections ratio, and minimum cash requirements. The
Company also has an unused line of credit with this bank in the amount of $500.
The line of credit bears interest at 1% above the bank's prime rate, and
advances are limited to 75% of eligible accounts receivable.
On December 19, 1997, the Company issued $5,000 of 5% Senior Unsecured
Notes (the Notes) with detachable warrants to purchase 1,654,952 shares of
common stock. The warrants can be exercised for $3.02 per share, at any time
after December 19, 1997. The Notes are uncollateralized and bear interest at 5%
from December 19, 1997 until January 1, 2000 and then bear interest at 9%
through maturity on December 31, 2002. Quarterly payments of interest only are
due beginning March 31, 1998 with the outstanding principal balance due on
December 31, 2002. The notes may be prepaid at the option of the Company,
subject to certain conditions, at a premium of ten percent.
In connection with the issuance of the Notes and warrants, the Company
attributed a portion of the proceeds to the warrants, which has been recorded as
additional paid in capital and as a reduction to the face amount of the Notes,
thereby increasing effective interest to 13.895% and increasing interest expense
for the year ended December 31, 1997 to $42. The value of the warrants was
determined by discounting the debt using an assumed interest rate of 12%.
Future payments of the notes payable as of December 31, 1997 are as
follows:
<TABLE>
<S> <C>
1998........................................................ $ 225
1999........................................................ 437
2000........................................................ 448
2001........................................................ 292
2002........................................................ 3,767
------
$5,169
======
</TABLE>
10. CONVERTIBLE NOTE
In January 1996, the Company issued two convertible notes in the amounts of
$200,000 and $800,000. In connection with the $200,000 note, the Company issued
a warrant to purchase 100,000 shares of common stock at $0.50 per share to the
noteholder. In connection with the $800,000 note, the Company issued warrants to
purchase 266,667 and 133,333 shares of common stock at $0.50 per share to the
noteholder and the guarantor of the note, respectively.
In July 1996, the Company repaid the $200,000 convertible note. The
$800,000 convertible note was repaid in March 1997 and the warrant issued to the
noteholder to purchase 266,667 shares of common stock was replaced by a warrant
to purchase 200,000 shares of common stock at $0.50 per share. In addition, the
warrant held by the guarantor of the note was canceled.
The Company recorded the fair value of the warrants as a discount against
the related convertible notes with a corresponding amount credited to additional
paid-in capital. Amortization of the debt discount totalled $72 in 1996 and was
insignificant in 1997.
11. NOTES RECEIVABLE FROM STOCKHOLDERS
Notes receivable from stockholders comprise loans made to stockholders in
connection with the exercise of options for the Company's common stock or to
purchase the Company's common stock. The loans are with full recourse and bear
interest at rates from 2% above prime to 8.5%. The loans are due between 1998 to
2000.
33
<PAGE> 35
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also issued a warrant to purchase 1,160,164 shares of common
stock at $2.78 per share to a stockholder in return for a promissory note in the
amount of $280. The note bears interest at prime and is due in 2000.
12. STOCKHOLDERS' EQUITY
Preferred Stock
In connection with the issuance of convertible promissory notes in 1996,
the Board of Directors designated 500,000 shares of the Serial preferred stock
as Series A preferred stock. As at December 31, 1997, the convertible promissory
notes had been repaid by the Company and there were no conversions into the
Series A preferred stock.
In 1996, the Board of Directors designated 4,000,000 shares of the Serial
preferred stock as Series B preferred stock. These shares were issued and sold
by the Company in July 1996 and March 1997 to independent third party investors.
Effective May 27, 1998, all of the outstanding shares of Series B preferred
stock were converted into 3,462,000 shares of common stock.
Warrants
In 1996 and 1997, the Company issued warrants to purchase common stock to
investors and lenders. At December 31, 1997 such warrants were as follows:
<TABLE>
<CAPTION>
SHARES OF EXERCISE EXPIRATION
COMMON STOCK PRICE DATE PURPOSE OF WARRANT
- ------------ -------- ---------- ------------------
<C> <C> <C> <S>
100,000 $0.50 January 2001 Issued in connection with $200 convertible note
200,000 $0.50 January 2001 Issued in connection with $800 convertible note
1,160,164 $2.78 December 2000 Issued to stockholder in return for $280 promissory note
1,654,952 $3.02 December 2002 Issued in connection with $5,000 senior unsecured notes
</TABLE>
13. STOCK OPTION PLANS
Under the Company's 1996 Stock Option Plan, as amended, (the Plan) the
Company could issue incentive options to employees at prices not lower than fair
market value at the date of grant, as determined by the Board of Directors.
Supplemental stock options (options that do not qualify as incentive stock
option) could be granted to employees, directors and consultants, at prices not
lower than 85% of fair market value at the date of grant, as determined by the
Board of Directors. The Board also had the authority to set the term of the
options (no longer than ten years from date of grant). Options granted generally
vest over three to four years. Unexercised options expire at least 30 days after
termination of employment with the Company.
In April 1998, the Board of Directors and the stockholders approved the
adoption of a 1998 Equity Incentive Plan (the 1998 Plan) which serves as the
successor of the 1996 Stock Option Plan. As amended through July 1998, the
Company has reserved, subject to stockholder approval, a total of 4,000,000
shares of common stock. In June 1998, the Board also adopted the 1998 Directors
Stock Option Plan and reserved a total of 600,000 shares of common stock for
issuance thereunder. The amended and restated 1998 Plan and the 1998 Directors
Stock Option Plan are subject to the stockholders' approval.
34
<PAGE> 36
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Activity under the Plans is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
--------------------------------------------------------------------
SHARES NUMBER WEIGHTED
AVAILABLE OF EXERCISE AGGREGATE AVERAGE
FOR GRANT SHARES PRICE PRICE EXERCISE PRICE
---------- ---------- ------------ ---------- --------------
<S> <C> <C> <C> <C> <C>
Options reserved at Plan
inception.................... 4,000,000 --
Options granted................ (1,156,500) 1,156,500 $ 0.05-$0.50 $ 149,564 $ 0.13
---------- ---------- ------------ ---------- ------
Balances, December 31, 1995.... 2,843,500 1,156,500 149,564 $ 0.13
Options granted................ (2,721,500) 2,721,500 $ 0.50-$0.75 1,549,955 $ 0.57
Options exercised.............. -- (178,944) $ 0.05-$0.50 (20,012) $ 0.11
Options canceled............... 592,832 (592,832) $ 0.10-$0.50 (214,015) $ 0.36
---------- ---------- ------------ ---------- ------
Balances, December 31, 1996.... 714,832 3,106,224 1,465,492 $ 0.47
Options granted................ (1,508,156) 1,508,156 $ 0.36-$3.00 1,459,085 $ 0.97
Options exercised.............. -- (1,079,986) $ 0.05-$1.25 (444,347) $ 0.41
Options canceled............... 1,419,330 (1,419,350) $ 0.50-$1.25 (727,566) $ 0.51
---------- ---------- ------------ ---------- ------
Balances, December 31, 1997.... 626,006 2,115,044 1,752,664 $ 0.83
Options reserved under new
Plan......................... 4,000,000 --
Cancellation of shares
available for grant under old
Plan......................... (578,506) --
Options granted................ (611,150) 611,150 $ 3.00-$6.00 3,496,663 $ 5.72
Options exercised.............. -- (1,175,604) $ 0.25-$2.00 (857,022) $ 0.73
Options canceled............... -- (105,764) $ 0.50-$3.00 (127,729) $ 1.21
---------- ---------- ------------ ---------- ------
Balances, June 30, 1998........ 3,436,350 1,444,826 $4,264,576 $ 2.95
========== ========== ========== ======
</TABLE>
The following table summarizes information with respect to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS CURRENTLY
-------------------------------------------------- EXERCISABLE
WEIGHTED ----------------------------
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- -------------- ----------- ---------------- ----------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$0.10........................ 140,000 7.07 $0.10 140,000 $0.10
$0.25........................ 46,000 7.50 $0.25 46,000 $0.25
$0.36........................ 206,865 9.45 $0.36 68,958 $0.36
$0.50........................ 240,116 8.62 $0.50 81,200 $0.50
$0.75........................ 1,054,318 9.04 $0.75 212,034 $0.75
$1.25........................ 108,750 9.47 $1.25 10,680 $1.25
$1.75........................ 172,495 9.84 $1.75 1,980 $1.75
$2.00........................ 128,000 9.84 $2.00 -- --
$3.00........................ 18,500 9.92 $3.00 -- --
--------- ------- -----
2,115,044 560,852 $0.48
========= ======= =====
</TABLE>
35
<PAGE> 37
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following information concerning the Company's stock option plan is
provided in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation." The Company accounts for the plan in accordance with APB No. 25
and related Interpretations.
The fair value of each option grant has been estimated on the date of grant
using the minimum value method with the following assumptions:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Risk-free interest rates.................................... 6.55% 6.25%
Expected volatility......................................... 0% 0%
Expected life............................................... 5 years 5 years
Dividends................................................... None None
</TABLE>
The weighted average fair value of the options granted in 1996 and 1997 was
$0.42 and $0.77, respectively.
The following pro forma net income (loss) information has been prepared as
if the Company had followed the provisions of SFAS No. 123:
<TABLE>
<CAPTION>
1996 1997
---- ------
<S> <C> <C>
Net income:
As reported (pro forma)................................... $560 $2,871
Pro forma................................................. $441 $2,600
</TABLE>
These pro forma amounts may not be representative of the effects on
reported net income (loss) for future years as options vest over several years
and additional awards are generally made each year.
14. INCOME TAXES
The Company's provision for income taxes for the year ended December 31,
1997 is as follows:
<TABLE>
<S> <C>
Current provision:
Federal................................................... $(314)
State..................................................... (81)
-----
(395)
-----
Deferred benefit:
Federal................................................... 33
State..................................................... 1
-----
34
-----
Provision for income taxes.................................. $(361)
=====
</TABLE>
The Company recorded a $1 tax provision for both years ended December 31,
1995 and 1996 for minimum state income tax. No other income taxes were payable
since Best incurred losses during these periods and Hiway Florida operated as a
Subchapter S corporation (see Note 17 for pro forma provision for income tax).
The Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. Since the Company underwent a change in ownership during
1996 as defined in the Internal Revenue Code, the net operating loss
carryforwards of $995 and $940 at December 31, 1996 for Federal and California
purposes, respectively, could not be fully
36
<PAGE> 38
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
utilized in 1997. At December 31, 1997 the Company had net operating loss
carryforwards of approximately $49 and $47 for Federal and California purposes,
respectively. These carryforwards expire in 2003 through 2012 if not utilized
beforehand.
The Company's deferred income taxes are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
----- -----
<S> <C> <C>
Deferred tax assets (current):
Net operating losses...................................... $ 426 $ 21
Allowance for doubtful accounts........................... 144 208
Deferred rent............................................. 45 51
Accrued liabilities....................................... 33 35
Other..................................................... 1 28
Deferred tax assets (non-current):
Amortization.............................................. 30 72
----- -----
Deferred tax assets....................................... 679 415
Deferred tax liabilities (non-current):
Depreciation.............................................. (239) (380)
Other..................................................... (30) --
----- -----
Deferred tax liabilities.................................... (269) (380)
Valuation allowance......................................... (410) --
----- -----
Net deferred tax asset............................ $ -- $ 35
===== =====
</TABLE>
The deferred tax valuation allowance decreased by $410 in 1997 as
management determined that the net deferred tax asset as of December 31, 1997
was more likely to be realized than not.
The following schedule reconciles the differences between the federal
income tax rate and the effective income tax rate for the year ended December
31, 1997:
<TABLE>
<S> <C>
Statutory rate.............................................. 34.0%
State taxes, net............................................ 1.1
Change in valuation allowance............................... (8.5)
Effect of income not subject to income taxes due to Hiway
Florida's Subchapter S status............................. (19.7)
Other....................................................... 0.6
-----
Effective tax rate.......................................... 7.5%
=====
</TABLE>
15. EMPLOYEE BENEFIT PLAN
In September 1995, the Company adopted a 401(k) Plan which qualifies under
Section 401(k) of the Internal Revenue Code of 1986. The Plan provides
retirement benefits through tax deferred salary deductions for all eligible
employees meeting certain age and service requirements. The Company may make
discretionary matching contributions on behalf of employees. All employee
contributions are 100% vested. The Company did not make any contribution to the
Plan during the years ended December 31, 1995, 1996 or 1997.
37
<PAGE> 39
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
----- ----- -------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION:
Taxes paid................................................ $ 1 $ 56 $ 283
Interest paid............................................. 4 103 122
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITY:
Note payable issued for rent deposit...................... 18 406 --
Equipment purchased under capital lease................... 36 490 286
Common stock issued in acquisitions....................... -- 67 --
Note issued in acquisitions............................... -- 697 --
Shareholders contributions of equipment in exchange for
stockholder loans payable.............................. 21 -- --
Allowances on trade in of equipment....................... -- 34 --
Exercise of stock options for notes....................... -- -- 409
Issuance of common stock for note......................... -- -- 200
Issuance of warrant for note.............................. -- -- 280
Issuance of warrant....................................... -- 72 1,233
</TABLE>
17. UNAUDITED PRO FORMA DATA
The statement of operations includes a pro forma provision for income taxes
to reflect income tax expense as if both entities in the merged company, Best
and Hiway Florida (which operated as a Subchapter S corporation), had been a C
corporation on a combined basis for all periods presented. The components of the
pro forma provision for income taxes consisted of:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
----------------------- ---------------
1995 1996 1997 1997 1998
----- ----- ------- ------- -----
<S> <C> <C> <C> <C> <C>
Current provision:
Federal...................................... $-- $ 79 $1,636 $ 863 $641
State........................................ 1 22 428 226 204
--- ---- ------ ------ ----
1 101 2,064 1,089 845
--- ---- ------ ------ ----
Deferred provision (benefit):
Federal...................................... -- (58) (138) (72) 15
State........................................ -- (10) (1) (1) (17)
--- ---- ------ ------ ----
-- (68) (139) (73) (2)
--- ---- ------ ------ ----
Pro forma provision for income taxes........... $ 1 $ 33 $1,925 $1,016 $843
=== ==== ====== ====== ====
</TABLE>
38
<PAGE> 40
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. EARNINGS PER SHARE (EPS) DISCLOSURES
In accordance with the requirements of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," a reconciliation of the numerator and
denominator of basic and diluted EPS is provided as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------- -------------------------
1995 1996 1997 1997 1998
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Numerator -- Basic EPS
Historical net income
(loss)..................... $ (551) $ 592 $ 4,435 $ 2,353 $ 2,000
=========== =========== =========== =========== ===========
Pro forma net income (loss)
(unaudited)................ $ (551) $ 560 $ 2,871 $ 1,531 $ 1,256
=========== =========== =========== =========== ===========
Denominator -- Basic EPS
Weighted average common
stock outstanding....... 16,871,100 25,877,800 30,020,460 29,782,440 32,301,080
=========== =========== =========== =========== ===========
Basic earnings (loss) per
share -- Historical........ $ (0.03) $ 0.02 $ 0.15 $ 0.08 $ 0.06
=========== =========== =========== =========== ===========
-- Pro forma......... $ (0.03) $ 0.02 $ 0.10 $ 0.05 $ 0.04
=========== =========== =========== =========== ===========
Numerator -- Diluted EPS
Historical net income
(loss)..................... $ (551) $ 592 $ 4,435 $ 2,353 $ 2,000
Interest on convertible
debt (net of related tax
effect)................. -- 28 6 -- --
----------- ----------- ----------- ----------- -----------
Historical net income
(loss)..................... $ (551) $ 620 $ 4,441 $ 2,353 $ 2,000
=========== =========== =========== =========== ===========
Pro forma net income (loss)
(unaudited)............. $ (551) $ 560 $ 2,871 $ 1,531 $ 1,256
Interest on convertible
debt (net of related tax
effect)................. -- 28 6 -- --
----------- ----------- ----------- ----------- -----------
Pro forma net income (loss)
(unaudited)................ $ (551) $ 588 $ 2,877 $ 1,531 $ 1,256
=========== =========== =========== =========== ===========
Denominator -- Diluted EPS
Denominator -- Basic EPS..... 16,871,100 25,877,800 30,020,460 29,782,440 32,301,080
Effect of Dilutive
Securities:
Common stock options....... -- 885,680 1,419,380 1,176,680 963,440
Warrants................... -- 68,460 142,100 135,000 438,640
Convertible preferred
stock................... -- 1,293,420 3,212,000 3,078,660 2,596,500
Convertible debt........... -- 383,340 83,340 -- --
----------- ----------- ----------- ----------- -----------
16,871,100 28,508,700 34,877,280 34,172,780 36,299,660
=========== =========== =========== =========== ===========
Diluted earnings (loss) per
share -- Historical........ $ (0.03) $ 0.02 $ 0.13 $ 0.07 $ 0.06
=========== =========== =========== =========== ===========
-- Pro forma......... $ (0.03) $ 0.02 $ 0.08 $ 0.04 $ 0.03
=========== =========== =========== =========== ===========
</TABLE>
For the years ended December 31, 1995, stock options, preferred stock,
convertible debt and warrants and in 1996 and 1997, convertible debt and certain
warrants were excluded from the determination of the diluted EPS since their
effect would have been antidilutive.
39
<PAGE> 41
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. SEGMENT REPORTING
The Company operates in one industry segment.
The distribution of revenues by geographic area was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
North America............................................ $2,011 $11,052 $22,507
Europe................................................... -- 593 2,194
Rest of the world........................................ -- 572 1,484
------ ------- -------
$2,011 $12,217 $26,185
====== ======= =======
</TABLE>
20. REINCORPORATION AND SUBSEQUENT EVENTS (UNAUDITED)
In June 1998, the Board of Directors approved the reincorporation of the
Company in Delaware. The reincorporation is subject to the stockholders'
approval. Under the new Certificate of Incorporation in Delaware, the Company is
authorized to issue 60,000,000 shares of common stock at $0.001 par value and
10,000,000 shares of preferred stock at $0.001 par value. The Board also adopted
the 1998 Employee Stock Purchase Plan, reserving 1,000,000 shares of common
stock for issuance thereunder.
In June 1998, the Board of Directors authorized management of the Company
to file a Registration Statement with the Securities and Exchange Commission
relating to a public offering of the Company's common stock.
In July 1998, the Company authorized a one-for-two reverse stock split that
will be effective upon the Company's reincorporation in Delaware and authorized
an increase to 4,000,000 in the number of shares of common stock reserved for
issuance under the 1998 Equity Incentive Plan.
In July 1998, the Board of Directors approved the sale of the Company to
Verio, a leading provider of Internet services. As a result of this transaction,
the one-for-two reverse stock split has not been reflected in the accompanying
financial statements. In addition, the Company suspended its public offering of
common stock.
21. UNCERTAINTY RELATING TO BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying financial statements have been restated to account for the
acquisition of Hiway Florida as a pooling of interests. In connection with the
review of the financial statements by the Securities and Exchange Commission
("the Commission"), the Commission raised certain questions concerning the
pooling of interests accounting treatment. These questions had not been resolved
when the Company suspended the registration process. In connection with
registration statements that might be filed by Verio in the future, these
financial statements may also be filed with the Commission. In the course of the
review of any of such registration statements, the Commission may raise the same
questions. In the event that Hiway does not prevail in the assertion that the
pooling of interests accounting treatment is appropriate, the Commission may
require that the financial statements be restated to account for the acquisition
as a purchase.
Under the purchase method of accounting, the fair value of the stock issued
in the transaction, plus any acquisition costs, would be allocated among the
assets and liabilities acquired. In addition, because the shareholders of Hiway
Florida became the owners of approximately 62.5% of the combined company, the
acquisition would be treated, for accounting purposes, as an acquisition of Best
by Hiway Florida. Accordingly, the historical financial statements presented
would be those of Hiway Florida and would include the results of operations of
Best only from the date of the merger (May 27, 1998).
40
<PAGE> 42
HIWAY TECHNOLOGIES, INC.
(FORMERLY BEST INTERNET COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the purchase method of accounting, the deemed purchase price of Best
by Highway Florida would have been approximately $41.0 million which would have
been allocated over the fair value of the assets and liabilities of Best
resulting in goodwill of approximately $33.0 million.
The following table reflects what the revenues and net income, and total
assets, liabilities and stockholder's equity on a historical (assuming the
merger had been accounted for as a purchase of Best by Hiway Florida) and
proforma basis in 1997 and 1998 would have been had the merger been accounted
for as a purchase. The proforma information reflects the amortization of
goodwill over 10 years as if the merger had taken place at the beginning of each
period for net income and at the balance sheet date for the December 31, 1997
balance sheet.
Actual purchase price adjustments might be adjusted based upon, among other
things, the potential recognition of charges for in-process research and
development.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
1997 JUNE 30, 1998
--------------------------- -------------------------
HISTORICAL PRO FORMA HISTORICAL* PRO FORMA
------------ ------------ ------------- ---------
<S> <C> <C> <C> <C>
Revenues........................................ 10,400 26,185 10,806 18,510
Net income...................................... 2,773 1,135 1,561 350
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1997 JUNE 30, 1998
------------ ------------ -------------
<S> <C> <C> <C> <C>
Total assets.................................... 9,293 52,467 57,588**
Total liabilities............................... 6,509 10,510 13,331**
Stockholders' equity............................ 2,784 41,957 44,257**
</TABLE>
- ---------------
* Includes Best results for June 1998.
** No pro forma balance sheet is included for June 30, 1998 as the acquisition
is reflected in the historical balance sheet.
41
<PAGE> 43
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Unless the context otherwise requires, references herein to "Verio" or the
"Company" are to Verio Inc., a Delaware corporation, and its subsidiaries.
OVERVIEW
Verio is a leading provider of Internet connectivity and enhanced Internet
services to small and medium sized businesses. Since its inception in March
1996, the Company has rapidly established a national presence through the
acquisition, integration, and growth of local Internet service providers
("ISPs") with a business customer focus. Verio believes that small and medium
sized businesses represent an attractive target market for the provision of
Internet services due to this market's low current penetration levels and
customer churn, and the expanding Internet needs of these businesses. The
Company believes it has a unique competitive advantage in serving small and
medium sized business customers through the combination of the technical
competency and hands-on support provided through its local sales and engineering
personnel with the quality and economic efficiency of Verio's national network,
operational infrastructure and financial strength. Verio has quickly built
critical mass by acquiring the stock or assets of, or making significant
investments in, over 40 ISPs that provide a comprehensive range of Internet
connectivity and enhanced products and services to over 125,000 customer
accounts providing locally based sales and engineering support in 38 of the top
50 MSAs in the country. Verio and its consolidated subsidiaries had total
revenue of approximately $28.5 million for the three-month period ended June 30,
1998. With the additional ISP operations acquired since that date, and taking
into account all of the revenue for the entire three-month period ended June 30,
1998, of all ISP operations acquired as of August 11, 1998, the pro forma
combined revenue for that three-month period would have been approximately $34.0
million. Combined revenue includes the revenue of all of the ISPs that were
owned 51% or more on or before August 11, 1998. Recently, the Company announced
that it had executed an agreement with Best Internet Communications, Inc. d/b/a
Hiway Technologies ("Hiway"), pursuant to which the Company will acquire all of
the outstanding stock of Hiway (the "Hiway Acquisition"). The completion of the
Hiway Acquisition, which the Company currently expects to complete in the fourth
quarter of 1998 (subject to the satisfaction of various closing conditions)
would bring the Company's pro forma combined revenues for the three months ended
June 30, 1998 to approximately $43.7 million.
Initially, Verio's strategy was to acquire 51% to 100% of a large regional
ISP, and a minority interest in smaller ISPs within designated geographic
regions. Verio now generally seeks to acquire 100% of new ISPs, and is
consolidating the ownership, and integrating the management teams, network
operations and marketing efforts within each particular region. While some
one-time costs are incurred in these consolidation efforts, Verio believes that
the combined organizations will be able to increase revenue faster and more cost
effectively. 100% ownership of its ISP operations facilitates the introduction
of the Verio brand name, a suite of nationwide product offerings, and the
transition of all operations onto Verio's national network and financial
systems. During the three months ended June 30, 1998, the Company completed the
acquisition of all the remaining equity ("Buyout") of three of its initially
non-wholly owned ISPs, including Structured Network Systems, Inc., Compute
Intensive Inc., and Internet Online, Inc. The Company has the contractual right
to effect the Buyout of the one remaining ISP in which it does not currently
hold 100% ownership (not including V-I-A Internet, Inc. ("VIANet") in which the
Company holds an approximately 18% equity position). From January 1, 1998
through August 11, 1998, Verio incurred costs of approximately $52.0 million, in
the aggregate, in connection with a total of 11 Buyouts, and approximately $83.7
million for acquisitions (not including any contingent purchase price payments
that may become payable in connection with the TABNet acquisition described
below), which amounts were paid with a combination of cash, shares of Verio
stock and options to acquire stock. As a result of its acquisitions, and the
limited amount of fixed assets required to operate an ISP, Verio has recorded
significant amounts of goodwill, and expects goodwill to increase significantly
during 1998.
42
<PAGE> 44
During July 1998, Verio announced its two largest acquisitions to date: The
acquisition of NTX, Inc. d/b/a TABNet ("TABNet") was consummated on July 7, 1998
(the "TABNet Acquisition"), and execution of the agreement to acquire Hiway was
announced on July 28, 1998. In the TABNet Acquisition, the Company paid an
initial purchase price of $45.5 million in cash to TABNet's shareholders, with
additional contingent payments of up to a total of $43.2 million to be paid if
TABNet's recurring revenue and EBITDA increase by agreed-to amounts through
December 1998. In the Hiway Acquisition, the Company has agreed to pay total
consideration of approximately $101.0 million in cash and 8.67 million shares of
Verio's Common Stock to Hiway's shareholders. The Company expects that the
TABNet operations will contribute positively to the Company's cash flow in 1999.
However, the Company anticipates that the costs it expects to incur for system
upgrades and integration of TABNet's operations onto Verio's network, customer
care, billing and financial systems, will offset TABNet's cash flow contribution
through the end of 1998. Similarly, Verio expects to incur expenses through
mid-1999 associated with the integration of the Hiway operations, and expects
that these expenses could be significant, although they are not determinable at
this time. The Company also expects, however, to derive significant long-term
savings as a result of synergies resulting from telco and transit cost
reductions, shared data centers, joint product development, shared
infrastructure and increased economies of scale made possible by the
consolidation of its operations with those of Hiway.
To fund its acquisitions and operations, through June 30, 1998 Verio had
raised approximately $322.1 million of equity capital, including approximately
$117.0 million (after deduction of underwriting discounts, commissions and
expenses) in connection with its initial public offering of Common Stock and
approximately $100.0 million in connection with its sale of Common Stock to an
affiliate of Nippon Telegraph and Telephone Corporation ("NTT"), both of which
occurred in May 1998. On June 15, 1998, pursuant to the partial exercise, at the
request of the managing underwriters, of the over-allotment option granted to
the underwriters in the IPO (as defined), the Company raised an additional $5.1
million (after deduction of underwriting discounts and commissions). It also
issued $150.0 million principal amount of 13 1/2% Senior Notes due 2004 ("the
1997 Notes") to a group of institutional investors and Brooks Fiber Properties,
Inc. ("Brooks"), $100.0 million of which remain outstanding following the
repurchase of $50.0 million principal amount of the 1997 Notes previously held
by Brooks (the "Refinancing"). On March 25, 1998, the Company consummated the
sale of $175.0 million principal amount of 10 3/8% Senior Notes due 2005 ("the
1998 Notes"), a portion of the proceeds of which was used to effect the
Refinancing. See "-- Liquidity and Capital Resources."
The Company has incurred net losses since its inception, and management
expects to incur significant additional losses as the Company continues its
acquisition program, the development of its national network, the implementation
of its national services and systems, and the integration of the operations it
acquires. For the period from inception to December 31, 1996, the year ended
December 31, 1997, and the six-month period ended June 30, 1998, the Company
reported net losses of $5.1 million, $46.3 million, and $54.7 million,
respectively. The extent to which the Company continues to experience negative
cash flow will depend upon a number of factors, including the number and size of
its further acquisitions, the expenses and time required to effectively
integrate acquired operations and capture operating efficiency, and the ability
to generate increasing revenues and cash flow. While the Company anticipates
that it will recognize various economies and efficiencies of scale as a result
of the integration of the operations of the ISPs it has acquired and continues
to acquire, the process of consolidating the businesses and implementing the
strategic integration of the Company and its acquired operations may take a
significant period of time, will place a significant strain on the Company's
resources, and could subject the Company to additional expenses during the
integration process. The timing and amount of expenditures related to the
Company's cost-saving initiatives and integration efforts may be difficult to
predict. The Company may increase near-term expenditures in order to accelerate
the integration and consolidation of acquired operations with the goal of
achieving longer-term cost savings and improved profitability.
RESULTS OF OPERATIONS
REVENUE
The Company derives the majority of its revenue from business customers who
purchase dedicated Internet connections and enhanced services such as Web
hosting. Verio's subsidiaries offer a broad range of
43
<PAGE> 45
connectivity options to their customers including dedicated, dial-up, Integrated
Services Digital Network ("ISDN"), frame relay and point-to-point connections.
Dedicated connection customers typically sign a contract for one to three years
of service that provides for fixed, recurring monthly service charges, and pay a
one-time setup fee. These charges vary depending on the type of service, the
length of the contract, and local market conditions. Dial-up customers also
typically pay a one-time setup fee and recurring monthly service charges. Fees
and service charges for enhanced services vary from product to product. For
example, Web hosting customers pay a one-time setup fee and fixed monthly
service charges that vary depending on the amount of disk space and bandwidth
required. In contrast, domain name registration customers pay a one-time fee.
Additional sources of revenue include e-commerce, virtual private networks,
security services, co-location services, consulting and the sales of equipment
and customer circuits. Revenue related to Internet connectivity and enhanced
services is recognized as the services are provided. Amounts billed relating to
future periods are recorded as deferred revenue and amortized monthly as
services are rendered.
Currently, connectivity services provide a majority of total revenue.
However, revenue from enhanced services, especially Web hosting, is expected to
represent an increasing percentage of total revenue in future periods. With the
TABNet Acquisition and the announced Hiway Acquisition, the Company expects that
revenue from enhanced services, including Web hosting, will exceed 50% of its
total revenue. Revenue from business customers currently represents
approximately 90% of total revenue. In addition to the growth that the Company
is achieving through acquisitions, revenue is also expected to increase due to
internal growth. In the past, the Company has experienced some seasonality in
its internal revenue growth, with the period of higher growth being the fall and
winter.
Three months ended June 30, 1997 compared to the three months ended June 30,
1998
Total consolidated revenue increased 246% from $8.2 million for the three
months ended June 30, 1997, to $28.5 million for the three months ended June 30,
1998. Internet connectivity represented 66% and 64% of total revenue for the
three months ended June 30, 1997 and the three months ended June 30, 1998,
respectively, with the balance derived from enhanced services and other, which
include Web hosting, consulting, sales of equipment and customer circuits. The
increase in enhanced services and other revenue as a percentage of total revenue
is due to acquisitions and increased sales of enhanced services, and is expected
to increase further due to the July 1998 acquisition of a Web hosting company,
TABNet, and the announced agreement to acquire Hiway. The increase in revenue
from the three months ended June 30, 1997 to the three months ended June 30,
1998 was primarily due to the acquisitions of ISPs subsequent to June 30, 1997.
Revenue attributable to acquisitions completed subsequent to June 30, 1997
accounted for $17.7 million or 62% of total revenue for the three months ended
June 30, 1998. Of these acquisitions, revenue from material acquisitions for the
three months ended June 30, 1998 were $2.7 million from Clark Internet Services,
Inc. and Monumental Network System, Inc., $1.7 million from Global Internet
Network Services Inc. and STARnet, L.L.C., and $1.6 million from Internet
Servers, Inc. ("iServer").
Six months ended June 30, 1997 compared to the six months ended June 30, 1998
Total consolidated revenue increased 293% from $12.7 million for the six
months ended June 30, 1997, to $49.7 million for the six months ended June 30,
1998. Internet connectivity represented 67% and 65% of total revenue for the six
months ended June 30, 1997 and the six months ended June 30, 1998, respectively,
with the balance derived from enhanced services and other, which include Web
hosting, consulting, sales of equipment and customer circuits. The increase in
enhanced services and other revenue as a percentage of total revenue is due to
acquisitions and increased sales of enhanced services. The increase in revenue
from the six months ended June 30, 1997 to the six months ended June 30, 1998
was primarily due to the acquisitions of ISPs subsequent to June 30, 1997.
Revenue attributable to acquisitions completed subsequent to June 30, 1997
accounted for $29.3 million or 59% of total revenue for the six months ended
June 30, 1998. Of these acquisitions, revenue from material acquisitions for the
six months ended June 30, 1998 were $5.0 million from Clark Internet Services,
Inc. and Monumental Network System, Inc., $2.6 million from Global Internet
Network Services Inc. and STARnet, L.L.C., and $3.0 million from iServer.
44
<PAGE> 46
COSTS OF SERVICE AND OPERATING EXPENSES
Internet services operating costs consist primarily of local
telecommunication expense, Internet access expense and the cost of equipment and
customer circuits sold. Local telecommunications expense represents the cost of
transporting data between the Company's Points of Presence ("POPs") and a
transit provider, or various Internet access points. Internet access expense
includes the cost incurred by the Company to transport its Internet traffic and
for its national network. In some instances the Company also will pay for the
local circuits from the customer's location to one of the POPs. As of June 30,
1998, 30 of the ISPs acquired prior thereto were utilizing the Verio national
network for their Internet access. In March 1998, the Company signed a long-term
long haul capacity agreement with Qwest Communications Corporation ("Qwest")
(the "Capacity Agreement") in order to reduce the per unit costs of such
services. There will not be a significant effect on the results for 1998 from
this agreement due to the time required to convert from existing circuits;
however, the Company expects that the pricing advantages provided by this
agreement will substantially reduce the cost of these services in future years.
Additionally, the Company has the right to prepay its minimum commitment, which
would allow the capitalization of costs (to the extent prepaid) under this
contract. Such capitalized costs would be amortized to operations over the term
of the agreement. The amount of the prepayment at June 30, 1998 would have been
approximately $60.0 million.
Selling, general and administrative and other expenses consist primarily of
salaries and related employment expenses, consulting, travel and entertainment,
rent, and utilities. Depreciation is provided over the estimated useful lives of
the assets ranging from 3 to 5 years using the straight-line method. The excess
of cost over the fair value of net assets acquired, or goodwill, is amortized
using the straight-line method over a ten-year period.
Three months ended June 30, 1997 compared to the three months ended June 30,
1998
Internet services operating costs were 42% and 47% of total revenue for the
three months ended June 30, 1997 and the three months ended June 30, 1998,
respectively. Total consolidated Internet services operating costs increased
$9.9 million or 288% from the three months ended June 30, 1997 to the three
months ended June 30, 1998 primarily due to the acquisitions of ISPs subsequent
to June 30, 1997. Internet services operating costs attributable to corporate
functions were 31% of total Internet services operating costs for the three
months ended June 30, 1997, compared to 19% of total Internet services operating
costs for the three months ended June 30, 1998. This decrease is primarily due
to recent acquisitions that have not yet converted to Verio's national network.
The Company expects Internet services operating costs to increase in absolute
dollars but to decrease as a percentage of total revenue over time as additional
ISPs acquired are integrated onto Verio's national network, as enhanced services
become a larger percentage of total revenue, and as the Capacity Agreement with
Qwest is implemented.
Selling, general and administrative and other expenses declined from 135%
to 95% of total revenue for the three months ended June 30, 1997 compared to the
three months ended June 30, 1998. Total selling, general and administrative and
other expenses increased $16.1 million or 148% from the three months ended June
30, 1997 to the three months ended June 30, 1998 primarily due to acquisitions
completed subsequent to June 30, 1997. Corporate selling, general and
administrative expenses declined from 45% of total revenue for the three months
ended June 30, 1997 to 31% for the three months ended June 30, 1998.
Consolidated sales and marketing expenses decreased from 31% of total revenue
for the three months ended June 30, 1997 to 25% for the three months ended June
30, 1998, due in part to efficiencies gained from the regionalization and
nationalization of certain sales and marketing functions.
The Company expects selling, general and administrative expenses to
continue to increase in absolute dollars but to decrease as a percentage of
total revenue as the Company acquires additional Internet businesses, allowing
it to spread its corporate overhead over a larger revenue base, as its scaleable
systems reduce the incremental costs of supporting additional revenue, as sales
force productivity increases with experience, and as indirect selling channels
are expanded. The anticipated increases in absolute dollar terms will be
primarily due to increased personnel resulting from acquisitions and additional
expenditures in sales and marketing. Depreciation and goodwill amortization are
expected to continue to increase significantly as a
45
<PAGE> 47
result of the Company's acquisition and investment strategies. Also, the Company
will continue to incur non-recurring expenses related to its strategy of
acquiring and regionalizing ISPs, and integrating those ISPs onto the Company's
national systems.
Six months ended June 30, 1997 compared to the six months ended June 30, 1998
Internet services operating costs were 43% and 46% of total revenue for the
six months ended June 30, 1997 and the six months ended June 30, 1998,
respectively. Total consolidated Internet services operating costs increased
$17.4 million from the six months ended June 30, 1997 to the six months ended
June 30, 1998 primarily due to the acquisitions of ISPs subsequent to June 30,
1997. Internet services operating costs attributable to corporate operations
were 29% of total Internet services operating costs for the six months ended
June 30, 1997, compared to 20% of total Internet services operating costs for
the six months ended June 30, 1998. This decrease is primarily due to recent
acquisitions that have not yet converted to Verio's national network. The
Company expects Internet services operating costs to increase in absolute
dollars but to decrease as a percentage of total revenue over time as additional
acquired ISPs are integrated onto Verio's national network, as enhanced services
become a larger percentage of total revenue, and as the Capacity Agreement with
Qwest is implemented.
Selling, general and administrative and other expenses declined from 141%
to 92% of total revenue from the six months ended June 30, 1997 to the six
months ended June 30, 1998. Total selling, general and administrative and other
expenses increased $28.0 million from the six months ended June 30, 1997 to the
six months ended June 30, 1998 primarily due to acquisitions completed
subsequent to June 30, 1997. Corporate selling, general and administrative
expenses declined from 52% of total revenue for the six months ended June 30,
1997 to 30% for the six months ended June 30, 1998. Consolidated sales and
marketing expenses decreased from 30% of total revenue for the six months ended
June 30, 1997 to 24% for the six months ended June 30, 1998, due in part to
efficiencies gained from the regionalization and nationalization of certain
sales and marketing functions.
The Company expects selling, general and administrative expenses to
continue to increase in absolute dollars but to decrease as a percentage of
total revenue as the Company acquires additional Internet businesses, allowing
it to spread its corporate overhead over a larger revenue base, as its scaleable
systems reduce the incremental costs supporting additional revenue, as sales
force productivity increases with experience, and as indirect selling channels
are expanded. The anticipated increases in absolute dollar terms will be
primarily due to increased personnel resulting from acquisitions and additional
expenditures in sales and marketing. Depreciation and goodwill amortization are
expected to continue to increase significantly as a result of the Company's
acquisition and investment strategies. Also, the Company will continue to incur
non-recurring expenses in connection with the integration and consolidation of
the Company's existing and newly acquired ISP operations.
OTHER EXPENSES
Interest expense increased from $0.1 million for the six months ended June
30, 1997 to $14.2 million for the six months ended June 30, 1998, primarily as a
result of the issuance of the 1997 Notes in June 1997 and the issuance of the
1998 Notes in March 1998. Interest income increased from $1.4 million for the
six months ended June 30, 1997 to $5.2 million for the six months ended June 30,
1998 due to increased the cash balance related to the debt and equity offerings.
See "-- Liquidity and Capital Resources"
The Company incurred an extraordinary expense of $10.1 million related to
the Refinancing (as defined). See "-- Liquidity and Capital Resources".
INCOME TAXES
As of June 30, 1998, the Company had a net operating loss carryforward for
federal income tax purposes of approximately $104.6 million which is available
to offset future federal taxable income, if any, through 2011. The utilization
of a portion of the net operating loss carryforwards may be limited under
Section 382 of
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the Internal Revenue Code. No tax benefit for such losses has been recorded by
the Company in fiscal 1997 or 1998 due to uncertainties regarding the
utilization of the loss carryforward.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and Related Interpretations. Since inception, the Company has granted
stock options with exercise prices equal to the fair value of the underlying
Common Stock, as determined by the Company's Board of Directors and based on the
Company's other equity transactions. Accordingly, the Company has not recorded
compensation expense related to the granting of stock options in 1996, 1997 and
through February 28, 1998. Subsequent to February 28, 1998, and prior to the
IPO, the Company granted options to employees with exercise prices which were
less than $22 per share which was the low end of the IPO filing range
immediately prior to the IPO. The Company will record compensation expense
totaling approximately $10.6 million, representing the difference between the
strike prices of the options granted and $22 per share, pro rata over the
forty-eight month vesting period of the options. This compensation expense will
total approximately $2.0 million for the year ended December 31, 1998. It is the
intention of the Company to grant future stock options with exercise prices
equal to the fair value of the underlying Common Stock at the date of grant. The
compensation expense related to the six months ended June 30, 1998 is $630,000.
Additionally, the Company incurred $1.4 million in compensation expense during
the quarter ended June 30, 1998 primarily related to the accelerated vesting of
options issued to Mark Johnson, the Company's former president who passed away
in March 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business and acquisition strategy has required and will
continue to require substantial capital for investments in Internet businesses,
capital expenditures for expansion of services, operating losses and working
capital. Net cash used by operating activities was $30.0 million during the six
months ended June 30, 1998, which includes a decrease in cash of $2.0 million
related to working capital.
Net cash used by investing activities was $52.8 million during the six
months ended June 30, 1998, primarily related to purchases of fixed assets of
$8.1 million and approximately $63.9 million for acquisitions, which was
partially offset by $19.8 million provided from the return of the restricted
cash related to the Refinancing, including $6.5 million of net interest payments
on the 1997 Notes. Net cash provided by financing activities was $332.8 million
during the six months ended June 30, 1998, primarily from the IPO, the 1998
Notes, and the NTT investment.
Until the completion of the IPO in May 1998, the Company financed its
operations primarily through the private sale of Preferred Stock, debt, and to a
lesser extent Common Stock. In 1996, the Company raised approximately $78.1
million from the sale of Series A and B Preferred Stock and approximately $1.1
million from the sale of Common Stock. In 1997, the Company sold Series C
Preferred Stock for gross proceeds of approximately $20.0 million. Upon the
effectiveness of the Company's IPO on May 12, 1998, all outstanding shares of
Series A, B, C and D-1 Preferred Stock automatically converted to an equivalent
number of shares of Common Stock.
On June 24, 1997, the Company completed the placement of $150.0 million
principal amount of the 1997 Notes and attached warrants (the "Warrants"). One
hundred fifty thousand units were issued, each consisting of $1,000 principal
amount of the 1997 Notes and eight Warrants, with each Warrant entitling the
holder thereof to purchase 1.76 shares of the Company's Common Stock at a price
of $.01 per share, for a total of 2,112,480 shares of Common Stock. The Warrants
and the 1997 Notes were separated on December 15, 1997. The 1997 Notes mature on
June 15, 2004. Interest on the 1997 Notes, at the annual rate of 13 1/2%, is
payable semi-annually in arrears on June 15 and December 15 of each year.
Concurrent with the completion of the sale of the 1997 Notes, the Company was
required to deposit funds into an escrow account in an amount that together with
interest would be sufficient to fund the first five interest payments on the
1997 Notes. Upon consummation of the sale of the 1998 Notes and the Refinancing,
that portion of the escrowed amount attributable to the principal amount of the
1997 Notes refinanced was released to the Company. The 1997
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Notes are redeemable at the option of the Company commencing June 15, 2002. The
1997 Notes are senior unsecured obligations of the Company ranking pari passu in
right of payment with all existing and future unsecured and senior indebtedness.
The 1997 Notes impose significant limitations on the Company's ability to incur
additional indebtedness unless the Company's Consolidated Pro Forma Interest
Coverage Ratio (as defined) is greater than or equal to 1.8 to 1.0 prior to June
30, 1999, or 2.5 to 1.0 on or after that date. The Company is also limited in
its ability to pay dividends or make Restricted Payments (as defined), to engage
in businesses other than the Internet service business, and to place liens on
its assets for the benefit of persons other than the noteholders, among other
restrictions. If a Change of Control (as defined in the 1997 Indenture) occurs,
the Company is required to make an offer to purchase all of the 1997 Notes then
outstanding at a price equal to 101% of the principal amount, plus accrued and
unpaid interest.
On March 25, 1998, the Company completed the placement of $175.0 million
principal amount of the 1998 Notes. The 1998 Notes are senior unsecured
obligations of the Company ranking pari passu in right of payment with all
existing and future unsecured and senior indebtedness and mature on April 1,
2005. Interest on the 1998 Notes, at the annual rate of 10 3/8%, is payable
semi-annually in arrears on April 1 and October 1 of each year, commencing
October 1, 1998. The 1998 Notes are redeemable at the option of the Company
commencing April 1, 2002. The 1998 Notes contain terms that are substantially
similar to the 1997 Notes. The Company used approximately $54.5 million of the
proceeds plus accrued interest to effect the repurchase of $50.0 million
principal amount of 1997 Notes from Brooks Fiber Properties, Inc. ("Brooks")
(the "Refinancing"). As a result of the Refinancing, the Company was refunded
approximately $13.3 million from the escrow account for the 1997 Notes, of which
approximately $1.9 million was used to pay accrued and unpaid interest on the
$50.0 million principal amount of 1997 Notes repurchased from Brooks.
On April 6, 1998, Verio entered into a credit facility ("the Bank
Facility") with a group of commercial lending institutions that committed to
provide a $57.5 million revolving credit facility secured by the stock of the
ISPs that Verio owns currently or may own in the future and the Capacity
Agreement with Qwest. The Chase Manhattan Bank serves as agent for the Bank
Facility. The Bank Facility requires no payments of principal until its maturity
on December 31, 1999. The terms of the Bank Facility provide for borrowings at
LIBOR + 2%. There is a commitment fee of 1/2% per annum on the undrawn amount
of the Bank Facility and a one-time fee of 1/2% on any amounts drawn. The last
$3.0 million of the Bank Facility can only be drawn for the payment of interest.
As of August 10, 1998, the Company had made no borrowings under the Bank
Facility.
The Bank Facility sets forth covenants restricting, among other things, the
Company's ability to borrow, to guarantee the debt of others, and to make
borrowings at the subsidiary level. The Company is also limited in its ability
to enter into transactions with affiliates, create liens on its assets, and make
certain investments. In particular, Indebtedness (less cash) as defined in the
Credit Agreement dated as of April 6, 1998 by and among the Company, The Chase
Manhattan Bank and Fleet National Bank ("the Credit Agreement"), may not exceed
2.35 times annualized pro forma revenue for the most recent fiscal quarter. The
Company's current indebtedness incurrence capacity is approximately 2.35 times
its annualized pro forma revenues. Dividends and certain types of investments
are prohibited, as are liens incurred for borrowed money. Borrowings under the
Bank Facility are required to be paid down with the proceeds of new Indebtedness
(as defined in the Credit Agreement), certain asset sales, Excess Cash Flow (as
defined in the Credit Agreement), or the net proceeds from insurance claims. As
of August 10, 1998, the Company is in compliance with the provisions of each of
the material agreements under which it has incurred indebtedness.
On May 12, 1998, the Company effected an initial public offering of
5,500,000 shares of the Company's Common Stock (the "IPO") for net proceeds of
approximately $117.0 million after deducting underwriting discounts, commissions
and expenses. Concurrently with the IPO, the Company completed the sale of
4,493,877 shares of its Common Stock to an affiliate of Nippon Telegraph and
Telephone Corporation for net proceeds of approximately $100.0 million. On June
15, 1998, pursuant to the partial exercise, at the request of the managing
underwriters, of the over-allotment option granted to the underwriters in the
IPO, the Company sold an additional 235,000 shares (the "Over-Allotment
Offering"). The net proceeds from the Over-Allotment Offering were approximately
$5.1 million after deducting underwriting discounts and commissions.
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As of June 30, 1998, the Company had approximately $322.6 million in cash
and cash equivalents (excluding restricted cash). The Company's business plan
currently anticipates investments of approximately $300.0 million over the next
12 months for capital expenditures, acquisitions, operating losses and working
capital, including an amount between $45.5 million and $88.7 million for the
acquisition of TABNet which was acquired in July 1998 and approximately $101.0
million for the acquisition of Hiway which is expected to close during the
fourth quarter of 1998. The Company's anticipated expenditures are inherently
uncertain and will vary widely based on many factors including operating
performance and working capital requirements, the cost of additional
acquisitions and investments, the requirements for capital equipment to operate
the Company's business, and the Company's ability to raise additional funds.
Accordingly, the Company may need significant amounts of cash in excess of its
plan, and no assurance can be given as to the actual amounts of the Company's
expenditures and additional capital requirements.
The Company expects to meet its capital needs with cash on hand, proceeds
from the sale, or issuance of capital stock, credit facilities (including the
Bank Facility), lease financing, and additional debt. Subsequent to June 30,
1998, the Company initiated discussions with several investment banks with
respect to the possible private placement of an undetermined amount of senior
notes. There can be no assurance that the Company will have sufficient resources
to fund its continued acquisition efforts, particularly if operating losses
continue to increase. EBITDA losses increased from $(10.7) million for the six
months ended June 30, 1997 to $(21.0) million for the six months ended June 30,
1998 despite an increase in revenue from $12.7 million for the six months ended
June 30, 1997 to $49.7 million for the six months ended June 30, 1998. EBITDA as
a percentage of revenue improved from (84%) to (42%) for the six months ended
June 30, 1997 and the six months ended June 30, 1998, respectively. The Company
incurred $45.9 million in selling, general and administrative expenses during
the six months ended June 30, 1998 as it invested in scaleable systems, hiring
and sales training, and network improvements, that it expects will result in
incremental revenue at reduced incremental costs. As a result, the Company
expects EBITDA as a percentage of revenue to improve during 1998. Although the
Company is seeking to reduce EBITDA losses as a percentage of revenue over time,
there can be no assurance that the Company will be able to do so, or that the
rate of any reduction in EBITDA losses will be as rapid as is being sought by
the Company. The Company intends to use a significant portion of its cash for
acquisitions, and will have to increase revenue without a commensurate increase
in costs to generate sufficient cash to enable it to meet its debt service
obligations as described above. In the near term, the Company intends to use its
excess cash and the Bank Facility which provides for up to $57.5 million in
credit until it matures on December 31, 1999.
Over the longer term, the Company will be dependent on increased operating
cash flows, and, to the extent cash flow is not sufficient, the availability of
additional financing, to meet its debt service obligations. There can be no
assurance that the Company will be able to service its indebtedness.
Insufficient funding may require the Company to delay or abandon some of its
planned future expansion or expenditures, which could have a material adverse
effect on the Company's growth and its ability to realize economies of scale. In
addition, the Company's operating flexibility with respect to certain business
activities is limited by covenants associated with its indebtedness. There can
be no assurance that such covenants will not adversely affect the Company's
ability to finance its future operations or capital needs or to engage in
business activities that may be in the interest of the Company.
NEW ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting No. 130, Reporting Comprehensive Income (SFAS 130) and No.
131, Disclosures About Segments of an Enterprise and Related Information (SFAS
131). During 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-5, Reporting on the Costs of Start-up Activities
(SOP 97-5). The adoption of these pronouncements did not and are not expected to
have a significant effect on the Company's financial position or results of
operations.
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FORWARD-LOOKING STATEMENTS
The statements included in the discussion and analysis below that are not
historical or factual are "forward-looking statements" (as such term is defined
in the Private Securities Litigation Reform Act of 1995). The safe harbor
provisions provided in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, apply to
forward-looking statements made by the Company. These statements can be
identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. These forward-looking statements
are subject to significant risks and uncertainties, including those identified
in the Company's Current Report on Form 8-K dated July 7, 1998. Management
cautions the reader that these forward-looking statements addressing the timing,
costs and scope of its acquisition of, or investments in, existing ISPs, the
revenue and profitability levels of the ISPs in which it invests, the
anticipated reduction in operating costs resulting from the integration and
optimization of those ISPs, and other matters contained herein or therein from
time to time regarding matters that are not historical facts, are only
predictions. No assurance can be given that future results indicated, whether
expressed or implied, will be achieved. While sometimes presented with numerical
specificity, these projections and other forward-looking statements are based
upon a variety of assumptions relating to the business of the Company, which,
although considered reasonable by the Company, may not be realized. Because of
the number and range of the assumptions underlying the Company's projections and
forward-looking statements, many of which are subject to significant
uncertainties and contingencies that are beyond the reasonable control of the
Company, some of the assumptions will not materialize and unanticipated events
and circumstances may occur subsequent to the date of this report. These
forward-looking statements are based on current expectations, and the Company
assumes no obligation to update this information. Therefore, the actual
experience of the Company and results achieved during the period covered by any
particular projections or forward-looking statements may differ substantially
from those projected. Consequently, the inclusion of projections and other
forward-looking statements should not be regarded as a representation by the
Company, or any other person, that these estimates and projections will be
realized and actual results may vary materially. There can be no assurance that
any of these expectations will be realized or that any of the forward-looking
statements contained herein will prove to be accurate.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently not party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not Applicable
(b) Not Applicable
(c) Sales of Unregistered Securities.
(1) On April 6, 1998, following the exercise of options to purchase
shares of common stock (the "Common Stock") of Verio Inc. (the "Company"),
granted under the Company's 1996 Stock Option Plan, the Company issued 33
shares of Common Stock for a purchase price of $198.00 to a former employee
of a subsidiary of the Company. The sale of Common Stock made by the
Company pursuant to the exercise of this stock option was made pursuant to
the exemption from the registration requirements of the Securities Act of
1933, as amended (the "Securities Act"), afforded by Rule 701 promulgated
under the Securities Act.
(2) On May 15, 1998, the Company issued and sold 4,493,877 shares of
Common Stock ("NTT Shares") to an affiliate of Nippon Telegraph and
Telephone Corporation ("NTT") for approximately $100.0 million concurrently
with the Company's initial public offering ("IPO"). The sale to NTT was
made pursuant to the exemption from the registration requirements of the
Securities Act afforded by Rule 506 of Regulation D under the Securities
Act.
(d) Use of Proceeds from Sales of Registered Securities. As described in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Company has completed the IPO. The following information
relates to the use of proceeds of the IPO:
(1) Effective Date of Registration Statement and Commission File
Number. The Company's Registration Statement on Form S-1, File No.
333-47099 (the "Registration Statement"), relating to the IPO, became
effective on May 11, 1998.
(2) Offering Date. The initial closing date of the IPO was May 15,
1998. A subsequent closing in connection with the partial exercise by the
underwriters in the IPO of their over-allotment option occurred on June 15,
1998.
(3) Managing Underwriters. Smith Barney Inc., Credit Suisse First
Boston Corporation and Donaldson, Lufkin & Jenrette Securities Corporation.
(4) Securities Registered and Aggregate Offering Price. The Company
registered a total of 6,325,000 shares of Common Stock. The public offering
price was $23 per share for a maximum aggregate offering price of
approximately $145.5 million.
(5) Securities Sold. A total of 5,735,000 shares were sold pursuant to
the IPO. This consisted of 5,500,000 shares sold on May 15, 1998 upon the
initial closing of the IPO (the "Initial Offering"), and 235,000 shares
sold on June 15, 1998 pursuant to the partial exercise, at the request of
the managing underwriters, of the over-allotment option granted to the
underwriters (the "Over-Allotment Offering").
(6) Aggregate Gross Proceeds, Expenses and Aggregate Net Proceeds. The
Initial Offering generated aggregate gross proceeds of $126.5 million. The
aggregate net proceeds to the Company from the Initial Offering were
approximately $117.0 million, after deducting underwriting discounts and
commissions of approximately $8.25 million and estimated expenses of
approximately $1.25 million payable by the Company. The Over-Allotment
Offering generated aggregate gross proceeds of $5.41 million. The aggregate
net proceeds to the Company from the Over-Allotment Offering were
approximately $5.1 million, after deducting underwriting discounts and
commissions of approximately $325,500 payable
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by the Company. The Company also received approximately $100.0 million from
the sale of the NTT Shares concurrently with the IPO.
(7) Use of Proceeds. As of June 30, 1998, the Company has used the
proceeds from the Initial Offering, the proceeds from the issuance of
235,000 shares of common stock pursuant to the Over-Allotment Offering, and
the proceeds of the NTT investment, for the following purposes: $14.5
million for general operating expenses, $5.7 million for transit and other
telecommunications expense, $5.0 million for acquisitions and $2.3 million
for capital equipment, for a total of $27.5 million. Total net proceeds
from the above-mentioned sales were $222.1 million. The balance of $194.6
million has been invested in short term, high quality money market
instruments. The Company expects to use the remaining net proceeds of the
IPO, together with the cash proceeds received from the sale of the NTT
Shares to further the Company's acquisition and investment strategy, to
continue the development and implementation of the national backbone,
customer care center, network operations center and billing and accounting
services and to fund the Company's general working capital requirements.
None of the net proceeds of the IPO were paid directly or indirectly to any
director, officer, general partner of the Company or their associates,
persons owning 10 percent or more of any class of equity securities of the
Company, or an affiliate of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a)-(c) Effective as of April 10, 1998, by written consent in accordance
with Section 228 of the Delaware General Corporation Law (the "DGCL") over
two-thirds of the stockholders of the Company voted in favor of the following
proposals:
(1) the amendment to the Restated Certificate of Incorporation of the
Company (a) to authorize 12,500,000 shares of so-called "blank check"
preferred stock, with rights, preferences and privileges to be designated
and established by the Board of Directors (the "Board") of the Company; (b)
to increase the authorized number of shares of Common Stock to 125,000,000
shares; and (c) to modify and insert certain provisions including, among
other things, (i) causing the Company to be subject to Section 203 of the
DGCL, (ii) providing that from and after the date on which the Company's
Registration Statement relating to the IPO is declared effective by the SEC
(the "IPO Effective Date"), the stockholders of the Company will not be
permitted to act by written consent, (iii) creating from and after the IPO
Effective Date a classified Board divided into three classes of directors
(with the classification of each then current director determined by
resolution of the Board), with each respective class serving until the
first, second or third annual meeting of stockholders of the Company
following the IPO Effective Date, and with the successors to each such
class elected for a term of three years, (iv) requiring the Company to
indemnify directors and officers, and allowing the Company, at its option,
to indemnify employees and other agents, in each case to the fullest extent
permitted by Section 145 of the DGCL, and (v) providing that a vote of at
least 80% of the then-outstanding capital stock of the Company entitled to
vote is required to amend certain provisions of the Certificate of
Incorporation;
(2) the amendment and restatement of the Company's Bylaws to modify
and insert certain provisions including, among other things, (a) fixing the
range of the number of directors to be not less than five nor more than
nine, (b) providing procedures for nomination of director candidates,
stockholder proposals and the calling of special elections and (c)
providing that a vote of at least 80% of the then-outstanding stock of the
Company entitled to vote is required to amend certain provisions of the
Bylaws.
(3) the amendment and restatement of the Company's Restated
Certificate of Incorporation, as amended, in accordance with Proposal (1)
above, following the IPO Effective Date and the conversion into Common
Stock of all outstanding shares of the Series A, Series B, Series C and
Series D-1 Preferred Stock of the Company;
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(4) the amendment of the Company's 1997 California Stock Option Plan
to increase the number of shares of Common Stock of the Company reserved
for issuance thereunder to 795,400 shares;
(5) the adoption of the Company's 1998 Stock Incentive Plan; and
(6) the adoption of the Company's 1998 Employee Stock Purchase Plan.
Stockholders holding 1,210,783 shares of Common Stock, 4,366,666 shares of
Series A Preferred Stock, 6,940,837 shares of Series B Preferred Stock and
2,001,696 shares of Series C Preferred Stock voted in favor of the above
proposals. Stockholders holding 83,483 shares of Common Stock, 1,666,667 shares
of Series A Preferred Stock, 3,087,497 shares of Series B Preferred Stock and
498,304 shares of Series C Preferred Stock withheld their votes on the above
proposals. Stockholders holding 1,329,695 shares of Series D-1 Preferred Stock
of the Company voted in favor of Proposal (1)(a), on which such holders were
entitled to vote pursuant to the DGCL, and stockholders holding 355,056 shares
of Series D-1 Preferred Stock withheld their votes on Proposal (1)(a).
Effective as of April 23, 1998, by written consent in accordance with
Section 228 of the DGCL, over two-thirds of the stockholders of the Company
voted in favor of the adoption of the Company's 1998 Non-Employee Director Stock
Incentive Plan. Stockholders holding 1,197,566 shares of Common Stock, 4,366,666
shares of Series A Preferred Stock, 7,486,668 shares of Series B Preferred Stock
and 2,001,696 shares of Series C Preferred Stock voted in favor of the above
proposals. Stockholders holding 96,700 shares of Common Stock, 1,666,667 shares
of Series A Preferred Stock, 2,541,666 shares of Series B Preferred Stock and
498,304 shares of Series C Preferred Stock withheld their votes on the above
proposals. The holders of Series D-1 Preferred Stock of the Company were not
entitled to vote on this matter.
(d) Not Applicable.
ITEM 5. OTHER INFORMATION
On July 7, 1998, the Company announced its acquisition of Napa,
California-based NTX, Inc., d/b/a TABNet, one of the world's largest domain name
registration and Web site hosting companies. With the acquisition of TABNet, the
Company now hosts more than 125,000 domain names, including over 60,000 web
sites. Pursuant to the TABNet acquisition agreement, the Company has paid $45.5
million in cash to TABNet shareholders, with additional contingent payments of
up to a total of $43.2 million if TABNet's recurring revenue and EBITDA increase
by agreed-to amounts through December 1998. TABNet recorded recurring revenues
of approximately $433,000, out of total revenues of approximately $925,000, for
the month of May 1998. In order to receive the maximum contingent purchase price
amount of $43.2 million, TABNet must achieve during the remainder of 1998
average month-over-month growth in recurring revenue of approximately 37 percent
and an average month-over-month increase in EBITDA of approximately 42 percent.
Absent an increase in recurring revenue of at least 15 percent per month, and in
EBITDA of at least 20 percent per month, on average through the end of the year,
none of the contingent purchase price amounts will be payable. At those minimum
growth rates, the contingent purchase price would total $10.8 million, with the
contingent purchase price amount increasing to the extent that TABNet's
recurring revenue or EBITDA performance exceeds those levels. While TABNet is
currently generating positive cash flow, Verio expects the costs for system
upgrades and integration of TABNet's operations onto Verio's network, customer
care, billing and financial systems to offset TABNet's cash flow contribution
through the end of 1998.
On July 28, 1998, the Company, a wholly-owned subsidiary of the Company,
and Best Internet Communications, Inc. d/b/a Hiway Technologies entered into an
Agreement and Plan of Merger (the "Merger Agreement") pursuant to which the
Company will acquire Hiway (the "Hiway Acquisition"). Hiway, a leading Web
hosting company headquartered in Boca Raton, Florida, recently acquired Best
Internet Communications, Inc. ("Best Internet") located in Mountain View,
California, one of the largest business Internet providers in the Northern
California area. Under the terms of the Merger Agreement, Hiway shareholders
will receive approximately $2.82 in cash and 0.2042 shares of Verio Common Stock
in exchange for each outstanding share of Hiway stock (subject to adjustment to
the extent that Hiway's fully diluted capitalization changes prior to closing).
Each Hiway warrant and option which remains unexercised at the
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time of closing will be assumed by the Company and become a warrant or option to
acquire approximately 0.2973 shares of Verio Common Stock. Based on these fixed
exchange ratios, the total transaction consideration will consist of $101.0
million in cash and approximately 8.67 million fully diluted shares of Verio
Common Stock. As a result, Hiway shareholders will own approximately 19% of the
pro forma combined company on a fully diluted basis. Hiway will be entitled to
designate one member to serve on the Company's Board of Directors. The Company
currently anticipates that the Hiway Acquisition will be completed in the fourth
quarter of 1998, subject to satisfaction of various closing conditions, which
include shareholder approval by both the Company's and Hiway's shareholders and
completion of requisite Hart-Scott-Rodino (as defined) filings and waiting
periods. Hiway is entitled to terminate the Merger Agreement in the event that
the Company's stockholders do not approve the transaction, in which case the
Company is required to pay a $10.0 million termination fee. Certain risk factors
relating to the Hiway Acquisition include the following:
(A) UNCERTAINTY OF PENDING TRANSACTION
The Hiway Acquisition is subject to material conditions to
consummation, including, among other things, (i) receipt of regulatory
clearance under the Hart-Scott-Rodino Anti-Trust Improvements Act of 1976,
as amended ("HSR Clearance"), (ii) absence of any material adverse change
in the business, operations, financial performance or results of operations
of Hiway, (iii) approval by the holders of a majority of the shares of the
outstanding capital stock of Hiway present and voting at a shareholders
meeting, and (iv) approval by the holders of a majority of the outstanding
capital stock of the Company present and voting at a stockholders meeting.
In connection with the execution of the Merger Agreement, holders of a
majority of the shares of outstanding capital stock of Hiway executed
irrevocable proxies in favor of the Company to vote in favor of the Hiway
Acquisition. If the Company's stockholders fail to approve the Hiway
Acquisition, Hiway may elect to terminate the Merger Agreement, in which
case the Company must pay to Hiway a termination fee of $10.0 million. The
Merger Agreement also may be terminated by mutual agreement of the Company
and Hiway. There can be no assurance that the Company's stockholders will
approve the Hiway Acquisition, that the HSR Clearance will be obtained or,
if obtained, that the Department of Justice and/or the Federal Trade
Commission will not impose conditions in connection with such HSR
Clearance. There can also be no assurance as to when, if at all, the
conditions and other contingencies with respect to the Hiway Acquisition
will be satisfied, that there will not be a material adverse change in the
business, operations, financial performance or results of operations of
Hiway, or that the parties to the Hiway Acquisition will not mutually
decide to terminate the Merger Agreement.
The Hiway Acquisition is a substantial transaction for the Company.
The Unaudited Pro Forma Condensed Combined Financial Statements included in
Part I (Item 1, Note 9) of this report reflect the pro forma impact that
the Hiway Acquisition would have had on the financial results of the
Company as if the transaction had been completed on January 1, 1997. The
Company expects that, if the Hiway Acquisition is completed, it will have a
continuing, significant impact on the Company's operating and financial
performance.
(B) RISKS ASSOCIATED WITH THE HIWAY ACQUISITION
Hiway was formed in May 1998 through a merger of Best Internet and
Hiway (the "Best/Hiway Merger"). Because the Best/Hiway Merger was
accomplished only recently, Hiway has not yet completed a full quarter of
combined operations, and is in the early stages of integrating the
operations of those two companies that previously operated independently at
different locations with separate work forces. It is likely that this
integration effort will be continuing when the Hiway Acquisition is
completed. In the course of that integration effort, it is possible that
facts or circumstances may be discovered that were not known or apparent
prior to the time that the Company executed the Merger Agreement with Hiway
or during its due diligence review of Hiway. There can be no assurance that
difficulties will not be encountered in integrating the operations of
Hiway, or that the specific benefits expected from the integration of Hiway
and Best Internet will be achieved or that any anticipated cost savings
will be realized. The acquisition of Hiway also involves a number of
special risks, including assimilation of new
54
<PAGE> 56
operations and personnel; the diversion of resources from the Company's
existing business; integration of their respective equipment, service
offerings, networks and technologies, financial and information systems and
brand names; coordination of geographically separated facilities and work
forces; management challenges associated with the integration of the
companies; coordination of their respective sales, marketing and service
development efforts, assimilation of new management personnel; and
maintenance of standards, controls, procedures and policies. The process of
integrating Hiway's operations, including its personnel, could cause
interruption of, or loss in momentum in the activities of the Company's
business and operations, including those of the business acquired. Further,
employees of Hiway who may be key to the integration effort or the
Company's ongoing operations may choose not to continue to work for the
Company following the closing of the Hiway Acquisition.
In connection with the Hiway Acquisition, the Company expects to incur
expenses through mid-1999 associated with the integration of the acquired
business with its own, including costs relating to the elimination of
duplicate systems and facilities, possible severance and employee
relocation, and other integration costs. The aggregate amount of these
expenses is not yet determinable, but could be significant. In addition,
there can be no assurance that the Company will not incur additional
charges in subsequent quarters to reflect costs associated with the Hiway
Acquisition or the integration of its operations. Factors that could
increase such costs include delays in the completion of the Hiway
Acquisition, any unexpected employee turnover, unforeseen delays in
addressing duplicate facilities once the acquisition has been completed and
the associated costs of hiring temporary employees, and any additional fees
and charges to obtain consents, regulatory approvals or permits. There can
be no assurance that the Company will realize the benefits and strategic
objectives sought through the Hiway Acquisition. Costs associated with the
Hiway Acquisition, or liabilities and expenses associated with the
operations of Hiway, that exceed the expectations of the Company, could
have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" contained in Part I (Item 2) of this report.
(C) RISKS ASSOCIATED WITH HIWAY HISTORICAL FINANCIAL INFORMATION
The Best/Hiway Merger was intended to qualify for pooling-of-interests
treatment under generally accepted accounting principles, and has been
treated accordingly in the historical financial statements of Hiway. Under
pooling-of-interests accounting, the accounts of Hiway are combined with
those of Best Internet at their historical carrying amounts and Hiway's
financial statements for all prior periods are restated to reflect the
combination of the two companies for all periods presented.
Prior to the execution of the Merger Agreement between the Company and
Hiway, Hiway had filed a registration statement on Form S-1 with the
Securities and Exchange Commission (the "Commission") with respect to its
proposed initial public offering, which registration statement contained
the historical financial statements of Hiway that are included in Part I
(Item 1, Note 10) of this report. In the course of its review of that
registration statement, the Commission raised questions concerning the
pooling-of-interests accounting treatment of the Best/Hiway Merger. These
questions had not been resolved when Hiway signed the Merger Agreement with
the Company and suspended its registration process. The Company and Hiway
believe that the accounting treatment of the Best/Hiway Merger reflected in
Hiway's historical financial statements is appropriate under generally
accepted accounting principles. The Company expects that these financial
statements will be included in additional registration statements of its
own that the Company anticipates will be filed with the Commission in the
near future, including a registration statement on Form S-4 in connection
with the Hiway Acquisition. Accordingly, the financial statements will be
subject to further review by the Commission. In the course of that review,
it is possible that the Commission will raise these same questions. In that
case, if the Company and Hiway do not prevail in their assertion that the
accounting treatment reflected in those financial statements is
appropriate, the Commission may require that those financial statements be
restated to reflect the application of the purchase method of accounting
treatment to the Best/Hiway Merger.
55
<PAGE> 57
Under the purchase accounting method, the estimated fair value of the
Best Internet common stock issued to effect the acquisition of and merger
into Hiway would be recorded as the cost of acquiring the business. It is
expected that a substantial portion of the purchase price would be
allocated to goodwill which would be amortized to operations over the
estimated life of the asset. Although purchase accounting treatment may
have a material adverse impact on the reported operating results of the
Hiway combined companies, as compared to that under pooling-of-interests
treatment, because the Hiway Acquisition must be accounted for by the
Company using purchase accounting, any such restatement of the Hiway
historical financial statements would not have a material adverse impact on
the pro forma combined operating results of the Company and Hiway.
The Company's Registration Statement on Form S-4 (the "S-4 Registration
Statement") covering exchange offers for the Company's $100.0 million principal
amount of 13 1/2% Senior Notes due 2004 that remain outstanding after the
Refinancing and $175.0 million principal amount of 10 3/8% Senior Notes due 2005
was declared effective on July 14, 1998. The Company has extended the expiration
date of such exchange offers, and intends to file a post-effective amendment to
the S-4 Registration Statement to provide additional information concerning
recent material acquisitions described above.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See attached exhibit index.
(b) Reports on Form 8-K
On June 29, 1998, the Company filed a Current Report on Form 8-K, dated
June 29, 1998, describing various risk factors applicable to the Company, its
operations and investments in the Company, and including as Exhibits press
releases issued by the Company, announcing the appointment of Herbert R. Hribar
as President and Chief Operating Officer of the Company, the appointment of
James E. Cunningham as the Company's Vice President of Sales and Marketing and
the appointment of Andrew E. Clark as the President of the Company's newly
combined Northeast and Mid-Atlantic regions.
56
<PAGE> 58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERIO INC.
<TABLE>
<S> <C>
Date: August 13, 1998 /s/ PETER B. FRITZINGER
-----------------------------------------------------
Peter B. Fritzinger
Chief Financial Officer
Date: August 13, 1998 /s/ CARLA HAMRE DONELSON
-----------------------------------------------------
Carla Hamre Donelson
Vice President, General Counsel and Secretary
</TABLE>
57
<PAGE> 59
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
10.33+ -- Interconnection Agreement, effective as of April 1, 1998
by and between the Registrant and UUNET Technologies,
Inc.
23.1 -- Consent of PricewaterhouseCoopers LLP.
23.2 -- Consent of DeMeo, Young, McGrath & Company, P.A.
27 -- Financial Data Schedule.
</TABLE>
- ---------------
+ Document for which confidential treatment has been requested.
<PAGE> 1
EXHIBIT 10.33
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
INTERCONNECTION AGREEMENT
This Interconnection Agreement (the "Agreement") is made, effective as
of April 1, 1998 (the "Effective Date"), by and between Verio, Inc., a Delaware
corporation, with its principal place of business at 8005 S. Chester Street,
Suite 200, Englewood, CO 80112 ("Company") and UUNET Technologies, Inc., a
Delaware corporation, with its principal place of business at 3060 Williams
Drive, Fairfax, VA 22031 ("UUNET").
R E C I T A L S
1. Each of Company and UUNET operates an Internet Network, as defined below;
and
2. The parties wish to provide for the interconnection of, and exchange of
traffic between, their respective Internet Networks on the terms and conditions
herein.
NOW, THEREFORE, THE PARTIES AGREE AS FOLLOWS:
1. DEFINITIONS
1.1 "Internet Network" shall mean a communications network running the
TCP/IP and other Internet protocols.
1.2 "Interconnection Point" shall mean any interconnection point at which
the parties agree to connect their respective Internet Networks under this
Agreement. A description of all Interconnection Points, together with all direct
interconnections agreed to by the parties, is set forth on the attached Schedule
1, and Schedule 1 shall be amended by the agreement of Company and UUNET in the
event of any changes.
2. EXCHANGE OF TRAFFIC
2.1 The parties agree to exchange digital communications traffic over their
respective Internet Networks at the Interconnection Points, subject to the terms
and conditions set forth in this Agreement. UUNET's obligations under this
Agreement are subject to (***).
-1-
<PAGE> 2
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
2.2 Each party shall provide, at its own expense, a connection from its
Internet Network to the Interconnection Point(s) within (***) of the date of
this Agreement. Company will send over the Interconnection Points only traffic
destined for UUNET and Verio customers. The data rates at which the parties will
connect hereunder is set forth in the attached Schedule 1.
2.3 The parties agree not to restrict the use of their respective Internet
Networks based on the subject matter of the traffic unless required to do so by
applicable law.
2.4 Except for control traffic which must be examined in order for the
parties to operate their respective Internet Networks, neither party shall
monitor or capture the contents of any data or other traffic which passes
through the Interconnection Points. Neither party shall modify the
infrastructure in any way to examine any data unless an appropriate court order
is in force. Except as otherwise agreed between the parties and with third
parties as appropriate, neither party shall provide to third parties any
statistical information itemized by service provider, by company, or by IP
address; provided, that each party may provide its customers with their own
statistical data.
2.5 Neither party will establish a route of last resort directed toward the
other party's Internet Network. Instead, the parties will fully exchange
explicit routes comprising public Internet service destinations of entities to
whom either party is contractually obligated to handle traffic.
3. TERM AND TERMINATION
This Agreement shall have an initial term of one year following the
Effective Date. Either party may terminate this Agreement upon 60 calendar days'
written notice to the other at any time after the end of the initial term. If
neither party terminates this Agreement upon expiration of the initial term,
this Agreement shall continue on its present terms and conditions, specifically
including the requirement that the parties continue their discussions and
activities under Paragraphs 4 and 5 hereof, until either party terminates it by
60 calendar days' written notice to the other.
4. TECHNICAL AND OPERATIONAL MATTERS
4.1 The parties will work together during the term of this Agreement to
establish mutually agreed performance objectives and operational procedures to
enable each party to provide the highest practical quality of service over its
Internet Network and the interconnection provided hereunder, in a cost effective
fashion. In connection therewith, the parties shall use their reasonable efforts
to achieve a minimum end-to-end one-way packet delay.
4.2 Each of the parties will use its reasonable efforts to achieve a mean
time to repair of (***) for all outages at the Interconnection
Point(s) set forth on
-2-
<PAGE> 3
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
Schedule 1. The parties will cooperate with each other in each party's efforts
under this paragraph 4.2.
4.3 Each of the parties will develop scheduled maintenance procedures that
provide for notification by one party to the other of all scheduled maintenance
that could cause end-to-end connectivity loss for any user of more than (***)
. Each party agrees to give the other three calendar days advance notice
for scheduled maintenance that is expected to result in (***) of
end-to-end connectivity loss.
4.4 Each party will, at its own expense and on a reasonable efforts basis,
provide Network Operations Center ("NOC") support in cooperation with the other
so as to maintain the smooth operation of the network service. The parties shall
develop operational procedures for the interconnection of their respective
Internet Networks, including without limitation inter-NOC problem management
information exchanges (e.g., trouble ticket tracking), and NOC escalation
procedures for addressing unscheduled outages or emergency maintenance.
4.5 Each of the parties will provide the other with certain limited access
to data for the purpose of operational monitoring and the diagnosis of
end-to-end connectivity problems. The parties will use their reasonable efforts
to develop procedures to govern the timing and other terms and conditions upon
which this access will be provided.
4.6 Each of the parties will use its reasonable efforts to collect during
the term hereof and provide to the other party traffic information with respect
to its Internet Network in order to better understand the nature of the traffic
passing through the parties' respective Internet Networks. In addition, each
party shall use its reasonable efforts to track and provide the other party with
average and peak utilization data over the interconnection facilities set forth
on Schedule 1 hereto.
5. CUSTOMER RELATIONS
Each party will be responsible for communicating with its own customers
with respect to its Internet Network. Each party will use its reasonable efforts
to notify the other promptly in writing of all trouble reports made to it by
customers of the other party. Each party shall be responsible to screen the
traffic of its own customers not desiring public Internet access from
distribution across the Interconnection Point(s). Each party will independently
establish the charges to its own customers for the services provided in
connection with this Agreement.
6. LIMITATION ON SERVICES
This Agreement shall apply only to traffic passing through the public
Internet. Virtual private data network services and services involving protocols
other than the Internet protocols are not covered by this Agreement. Neither
party shall be entitled or
-3-
<PAGE> 4
required to carry traffic hereunder if doing so would conflict with any
condition imposed by an agreement between the other party and any third party
with whom the other party connects.
7. NONEXCLUSIVITY
This Agreement shall not prohibit or restrain either party's entry into any
separate similar or dissimilar contract or agreement with one or more third
parties.
8. NO LIABILITY
NEITHER PARTY SHALL BE LIABLE TO THE OTHER FOR ANY LOSS OR DAMAGE ARISING
FROM: (I) ANY FAILURE IN OR BREAKDOWN OF ANY FACILITIES OR SERVICES HEREUNDER,
WHATSOEVER THE CAUSE AND HOWEVER LONG IT SHALL LAST; (II) ANY INTERRUPTION OF
SERVICE, WHATSOEVER THE CAUSE AND HOWEVER LONG IT SHALL LAST; (III) SUCH PARTY'S
SUBMITTING TRAFFIC TO OR ACCEPTING TRAFFIC FROM THE OTHER PARTY HEREUNDER; OR
(IV) ANY OTHER CIRCUMSTANCE RELATING TO THIS AGREEMENT.
9. INSURANCE
Each party is responsible for assessing its own need for property, casualty
and liability insurance and each shall obtain such insurance as each sees fit.
Each party shall bear the risk of loss and damage with respect to its own
equipment and agrees not to make any claims against the other, or assign any
such claims to third parties, for any property loss or damage.
10. AUTHORIZATIONS
All undertakings and obligations assumed hereunder by either party are
subject to all applicable existing and future laws, rules and regulations, and
are further subject to the issuance and continuance of all necessary
governmental licenses, waivers, consents, registrations, permissions and
approvals.
11. FORCE MAJEURE
No failure or omission by either party to carry out or observe any of the
terms and conditions of this Agreement shall give rise to any claim against the
party in question or be deemed to be a breach of this Agreement if such failure
or omission arises from any cause reasonably beyond the control of that party (a
"Force Majeure Event"). Each party shall give the other notice in the event it
experiences a failure or delay due to a Force Majeure Event. Upon such notice,
the party affected by the Force Majeure Event may delay performance hereunder
during the pendency of such Force Majeure Event, and shall have no liability for
such delay.
-4-
<PAGE> 5
12. RELATIONSHIP OF PARTIES
In their performance hereunder the parties are acting as independent
contractors, and nothing contained herein shall be construed to create a
partnership, joint venture or other agency relationship between the parties.
13. REGULATORY APPROVAL
The parties acknowledge that this Agreement, and any or all of the terms
hereof, may become subject to regulatory approval by various local, state or
federal agencies. Should such approval be required from time to time or at any
time, the parties shall cooperate, to the extent reasonable and lawful, in
providing such information as is necessary to complete any required filing.
14. ASSIGNMENT
Neither party shall transfer or assign its rights or obligations under this
Agreement or transfer by way of merger, consolidation, sale of all or
substantially all of its assets without the prior written consent of the other
party which consent shall not be unreasonably withheld; provided, that either
party may transfer its interest herein to any subsidiary or affiliate of such
party.
15. NOTICES
All notices between the parties required or permitted hereunder shall be
effective if hand delivered or sent by post or courier, postage or fees paid, or
by facsimile to the address specified below. All notices shall be effective when
sent.
If to Company: If to UUNET:
Verio Inc. UUNET Technologies, Inc.
8005 S. Chester Street, Suite 200 3060 Williams Drive
Englewood, CO 80112 Fairfax, VA 22031
ATTN: Chris Demarche ATTN: Vice-President, Systems Engineering
Chief Technical Officer Fax: 703-206-5601
with a copy to: with a copy to:
Verio UUNET Technologies, Inc.
8005 S. Chester Street 3060 Williams Drive
Suite 200 Fairfax, VA 22031
Englewood, CO 80112 ATTN: General Counsel
ATTN: General Counsel Fax: 703-206-5807
Fax: 303-792-3879
-5-
<PAGE> 6
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
16. ENTIRE AGREEMENT
This Agreement represents the entire understanding between the parties
regarding the subject matter hereof and supersedes all other prior and
contemporaneous agreements, understandings, negotiations and discussions between
the parties with respect to such subject matter. This Agreement shall be
governed by and construed in accordance with the laws of the Commonwealth of
Virginia, without regard to the conflicts of laws principles thereof.
17. SEVERABILITY
If any provision of this Agreement is held by a court of competent
jurisdiction to be contrary to law, the remaining provisions of this Agreement
will remain in full force and effect.
18. AMENDMENT
This Agreement may be modified only by a written amendment signed by both
parties. The Company may acquire interests in additional Internet service
providers ("Additional ISPs") whose networks it may wish to include within the
terms of this Agreement. Any such inclusion shall constitute an amendment to
this Agreement. In the event that such Additional ISP is a customer of UUNET, it
shall be a condition of any such amendment that (***)
.
19, NO THIRD PARTY BENEFICIARIES
Nothing contained in this Agreement shall be deemed to confer any rights in
any third party not a signatory to this Agreement.
20. CONFIDENTIALITY
All information exchanged between the parties under this Agreement or
during the negotiations preceding this Agreement and relating either to the
terms and conditions of this Agreement or any activities contemplated by this
Agreement is confidential and neither party shall disclose to any third party
any of the other party's confidential information disclosed to it. Any
announcement of this Agreement must be mutually agreed upon by both parties,
including the timing and wording of press releases and other announcements to
third parties. Should the parties not come to agreement on a press release or
other announcement of the Agreement within 60 days after execution and delivery
of the Agreement, either party may publicly acknowledge that this Agreement
exists, provided that the acknowledgment is not in the form of a press release.
Either party may disclose the existence of this Agreement
-6-
<PAGE> 7
and its terms, which may include providing a copy thereof, pursuant to any
requirement of law or regulation or pursuant to a judicial or administrative
order.
21. DISPUTES
All disputes arising out of or relating to this Agreement which are not
resolved within 30 days after notice of the dispute is given by either party to
the other shall be finally settled by arbitration conducted expeditiously in
accordance with the Commercial Arbitration Rules of the American Arbitration
Association. The arbitration shall be conducted by a single arbitrator in
Washington, D.C. The arbitration shall be governed by the United States
Arbitration Act, and judgment upon the award rendered by the arbitrator may be
entered by any court with jurisdiction. The arbitrator is not empowered to
award damages in excess of direct compensatory damages. EACH PARTY HEREBY WAIVES
ANY DAMAGES IN EXCESS OF DIRECT COMPENSATORY DAMAGES.
IN WITNESS WHEREOF, the parties have caused their respective authorized
representatives to sign this Agreement on their behalf, effective as of the date
first written above.
Verio Inc. UUNET Technologies, Inc
By: /s/ CHRIS DEMARCHE By: /s/ GEORGE P. ALBER
----------------------------- -----------------------------
Name: Chris DeMarche Name: George P. Alber
--------------------------- ---------------------------
Title: Chief Technical Officer Title: Vice President
-------------------------- --------------------------
-7-
<PAGE> 8
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
SCHEDULE 1
INTERCONNECTED POINTS
---------------------
(***)
(***)
(***)
(***)
SPEEDS
------
(***)
-8-
<PAGE> 9
THE INFORMATION BELOW MARKED (*) OR (***) HAS BEEN OMITTED PURSUANT TO A
REQUEST FOR CONFIDENTIAL TREATMENT. THE OMITTED PORTIONS HAVE BEEN SEPARATELY
FILED WITH THE COMMISSION.
<TABLE>
<CAPTION>
SCHEDULE 2
----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(***)
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Form 10-Q of our report dated May 27,
1998 on our audit of the consolidated financial statements of Hiway
Technologies, Inc.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Form 10-Q for Verio Inc. of our report dated
September 17, 1997 on our audits of the financial statements of Hiway
Technologies, Inc. as of December 31, 1996 and for the period from April 6, 1995
(date of inception) to December 31, 1995 and the year ended December 31, 1996.
DE MEO, YOUNG, MCGRATH & COMPANY, P.A.
- ------------------------------------------
/s/ De Meo, Young, McGrath & Company, P.A.
August 11, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 322,590
<SECURITIES> 0
<RECEIVABLES> 14,595
<ALLOWANCES> 1,967
<INVENTORY> 0
<CURRENT-ASSETS> 354,640
<PP&E> 54,967
<DEPRECIATION> 15,281
<TOTAL-ASSETS> 578,765
<CURRENT-LIABILITIES> 35,274
<BONDS> 268,787
0
0
<COMMON> 374,572
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 578,765
<SALES> 49,739
<TOTAL-REVENUES> 49,739
<CGS> 22,854
<TOTAL-COSTS> 85,784
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 862
<INTEREST-EXPENSE> 14,228
<INCOME-PRETAX> (44,598)
<INCOME-TAX> 0
<INCOME-CONTINUING> (44,598)
<DISCONTINUED> 0
<EXTRAORDINARY> (10,101)
<CHANGES> 0
<NET-INCOME> (54,699)
<EPS-PRIMARY> (5.58)
<EPS-DILUTED> (5.58)
</TABLE>
