<PAGE> 1
As Filed Pursuant to Rule 424(b)(4)
Registration No. 333-74403
PROSPECTUS
7,000,000 SHARES
[INTERLIANT LOGO]
COMMON STOCK
------------------------
This is Interliant's initial public offering of common stock. The U.S.
underwriters will offer 6,125,000 shares in the United States and Canada and the
international managers will offer 875,000 shares outside the United States and
Canada.
Prior to the offering, there has been no public market for the common
stock. The common stock will trade on the Nasdaq National Market under the
symbol "INIT."
INVESTING IN THE COMMON STOCK INVOLVES MATERIAL RISKS WHICH ARE DESCRIBED
IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 6 OF THIS PROSPECTUS.
------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----------
<S> <C> <C>
Public Offering Price...................................... $10.00 $70,000,000
Underwriting Discount...................................... $.70 $4,900,000
Proceeds, before expenses, to Interliant, Inc.............. $9.30 $65,100,000
</TABLE>
The U.S. underwriters may also purchase up to an additional 920,000 shares
from Interliant at the public offering price, less the underwriting discount,
within 30 days from the date of this prospectus to cover over-allotments. The
international managers may similarly purchase up to an additional 130,000 shares
from Interliant.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about July 13, 1999.
------------------------
MERRILL LYNCH & CO.
DONALDSON, LUFKIN & JENRETTE
CIBC WORLD MARKETS
------------------------
The date of this prospectus is July 7, 1999.
<PAGE> 2
[GRAPHICS]
Interliant(R) is a registered trademark of Interliant, Inc.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................................... 1
Risk Factors................................................ 6
Use of Proceeds............................................. 18
Dividend Policy............................................. 18
Capitalization.............................................. 19
Dilution.................................................... 20
Selected Consolidated Financial Data........................ 21
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 23
Business.................................................... 32
Management.................................................. 55
Related Party Transactions.................................. 65
Principal Stockholders...................................... 67
Description of Capital Stock................................ 69
Shares Eligible for Future Sale............................. 74
Underwriting................................................ 76
Legal Matters............................................... 79
Experts..................................................... 79
Available Information....................................... 80
Index to Financial Statements............................... F-1
</TABLE>
------------------------
You should rely only on the information contained in this prospectus. We
have not, and the underwriters have not, authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriters are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted.
All references to "we," "us," "our" or "Interliant" in this prospectus
means Interliant, Inc.
i
<PAGE> 4
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It is not complete and may not contain all the information that you should
consider before investing in the common stock. You should read the entire
prospectus carefully, including the "Risk Factors" section and the financial
statements and the notes to these statements. Except as otherwise indicated, the
information in this prospectus (1) assumes that the underwriters' over-allotment
option has not been exercised, (2) assumes conversion of all outstanding shares
of redeemable convertible preferred stock and (3) gives retroactive effect to a
three-for-one stock split on July 28, 1998.
OUR COMPANY
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Our hosting
services store our customers' Web sites, software applications, and data on
servers typically housed in our data centers so that others on the Internet can
access and interact with our customers' Web sites and network-based
applications. Our Web hosting services provide a variety of hosting solutions to
meet the needs of businesses of all sizes, as their Web sites develop from
low-end marketing brochures to more complex, interactive Web sites and finally
to applications integral to their businesses, or mission-critical. Our
application hosting services provide our customers remote access to
mission-critical software applications and data 24 hours a day, 7 days a week,
365 days a year or 24x7.
Since our inception in December 1997, we have grown rapidly through the
acquisition of 17 hosting and related Internet service businesses. We provide
Web hosting solutions to more than 47,000 customers, representing more than
79,000 registered Web sites that are actively maintained and used. We also host
more than 10,000 customized Lotus Notes/Domino based applications for more than
1,300 customers. Our pro forma net loss, giving effect to acquisitions completed
to date, was approximately $39.0 million for the year ended December 31, 1998
and our pro forma revenues for that same period were $41.3 million. For the year
ended December 31, 1998 and on a pro forma basis giving effect to acquisitions
completed to date:
- 28.0% of our revenues were derived from our Web hosting product
offerings;
- 51.3% of our revenues were derived from our application hosting product
offerings;
- 14.0% of our revenues were derived from consulting services; and
- 6.7% of our revenues were derived from other services.
The number of businesses using the Internet is growing rapidly. Many of
these businesses outsource the hosting of their Web sites and software
applications, rather than incur the cost of in-house operations and maintenance.
Today, the hosting market is fragmented, consisting for the most part of:
- small local and regional providers who do not have the capital, resources
or capabilities to provide quality services at competitive prices;
- large national providers who focus on Internet connectivity rather than
on hosting; and
- consulting and Web design firms for which hosting is not their core
competency.
We believe that a significant market opportunity exists for a
nationally-recognized hosting solutions provider with the scale and expertise to
offer a wide range of value-priced services to businesses of all sizes. Through
the acquisition and consolidation of hosting and enhanced Internet service
businesses, we believe we can offer a full range of hosting services that enable
businesses to deploy, use, expand and update their Web sites and applications
infrastructures more rapidly and cost-effectively than internally developed
solutions.
Our service offerings comprise three main areas: Web hosting, application
hosting and consulting.
1
<PAGE> 5
Web Hosting. Our Web hosting services include the following product offerings:
Virtual Hosting. Our virtual hosting solution provides Web site hosting on
a server that is owned, managed and housed by us for multiple customers.
This is an economical solution for customers with simple or moderately
accessed sites.
Dedicated Hosting. Our dedicated hosting solution provides Web site
hosting on a server that is managed, housed and typically owned by us for a
single customer. Dedicated server Web hosting enables a customer to host
complex Web sites and applications without the need to incur significant
infrastructure and overhead costs. This solution provides greater server
and network resources for our customers than virtual hosting and allows
them to configure their hardware to optimize site performance. Companies
with increasing levels of complexity, traffic or reliance on their Web
sites may prefer dedicated hosting.
Co-located Hosting. Our co-located hosting solution provides Web hosting
services on servers that are owned by our customers but which are managed
and housed by us. In general, the co-located servers are housed separately
from our shared and dedicated servers in our data centers which we monitor
on a 24x7 basis and to which we allow customers limited access.
Application Hosting. Our application hosting solution, through which we manage
software applications for our customers, is designed to support our customers'
Internet, intranet and extranet projects through a variety of service and
support options, with our primary platform being Lotus Notes/Domino. In
addition, through our strategic alliances with software vendors such as Lotus
and Microsoft, we host applications such as legal automation, sales automation
and distributed learning. We recently began offering ready-made, network-based
software applications that run on a remote server hosted by us, or Internet
rental applications, which allow anyone with a Web browser and an Internet
connection to use sophisticated server-based applications. Our application
hosting services consist of the following solutions:
Groupware Hosting. Groupware software applications allow people to work
more closely together while located remotely from each other. We offer a
range of groupware hosting solutions for the Lotus Notes/Domino platform
which provides our customers with the infrastructure needed to support the
following:
- e-mail and other messaging methods for internal and external
communication;
- project team collaboration and document sharing;
- business process automation and workflow; and
- document libraries.
Application Outsourcing. We offer a range of application outsourcing
services which provide our customers with the ability to capitalize on the
latest Internet-enabled technologies while outsourcing information
technology operations such as deployment strategies and maintenance and
upgrades of software to a third party. Our application outsourcing
offerings include:
- Legal Automation. Our legal automation solutions package offers our
customers a suite of collaborative applications that assist corporate
legal departments and their outside counsel in managing cases,
budgets, intellectual property and workflow in a secure, reliable
environment.
- Sales Automation. Our sales automation solutions package provides
geographically distributed sales and marketing organizations with all
the elements needed to quickly deploy a sales automation solution at a
reasonable cost.
- Distributed Learning. Our distributed learning solutions offer our
customers opportunities to deliver online training solutions.
Consulting Services. We provide consulting services to our customers for
intranet, extranet and application hosting solutions, as well as for internal
networking implementations and back-end Web development projects. Consulting
services that we provide include:
- desktop and network server support;
- network architecture and design;
2
<PAGE> 6
- strategic technology planning; and
- application development and implementation.
We have two state-of-the-art primary data centers in Atlanta, Georgia and
Houston, Texas and a recently leased facility in Vienna, Virginia. We house
co-located servers in separate limited-access rooms in our Atlanta and Virginia
data centers. In addition, we provide application hosting to our customers
primarily through our Houston data center. Our Atlanta and Houston data centers
are monitored on a 24x7 basis and include:
- sophisticated monitoring and diagnosis;
- 24x7 customer support;
- multiple and high-speed network connections to the Internet; and
- uninterruptible power supply.
We seek to become the industry leader in hosting by providing businesses
with cost-effective, innovative solutions that will allow them to capitalize on
the potential of the Internet. To achieve this objective, our strategy includes
the following key elements:
- Build the Interliant Brand. We intend to continue to build the
Interliant brand and strengthen brand recognition by marketing our full
range of services through an integrated marketing communications program
including public relations, print and online advertising campaigns and
other strategic initiatives as well as cooperative promotions with key
hardware and software vendors.
- Continue Acquisition Program. By integrating acquired companies, we
believe we can achieve substantial economies of scale and operating
efficiencies which will allow us to service customers of all sizes.
Further, we intend to capitalize on business practices of acquired
companies that we believe will best maintain our competitive advantage
and ensure ongoing delivery of high quality hosting services to our
customers.
- Expand Multiple Sales Channels. We currently use a variety of sales
channels to reach our customers including our recently launched business
partner program. We expect to increase our inbound and outbound telesales
efforts, which are targeted primarily toward virtual and dedicated
hosting customers as well as direct sales, which is targeted primarily
toward co-located hosting customers.
- Leverage the Interliant Customer Base. We intend to capitalize on the
enhanced revenue potential of the combined customer bases of our acquired
companies by leveraging the numerous cross-selling opportunities that our
expanded line of branded service offerings provides. In this regard, we
seek to coordinate the selling efforts of our Web hosting, application
hosting and consulting sales force to increase customer leads and
referrals.
- Develop Strategic Relationships. We have established and continue to
seek strategic relationships that enable us to provide complete, scalable
and reliable hosting solutions to our customers, resellers and referral
partners.
On March 10, 1999, we completed the acquisition of substantially all the
assets of Interliant, Inc. In connection with that acquisition, we changed our
name from Sage Networks, Inc. to Interliant, Inc. For purposes of this document
the acquired business of Interliant, Inc. is referred to as Interliant Texas.
Interliant Texas had revenues in 1998 of $21.2 million.
Upon completion of this offering, Web Hosting Organization LLC and members
of management will control approximately 69.5% of our common stock.
Our principal executive offices are located at Two Manhattanville Road,
Purchase, New York 10577, (914) 640-9000.
3
<PAGE> 7
THE OFFERING
Common stock offered by us:
U.S. Offering........................ 6,125,000 shares
International Offering............... 875,000 shares
Total.............................. 7,000,000 shares
Common stock outstanding after this
offering............................. 42,215,268 shares
Use of proceeds...................... We currently intend to use the net
proceeds from the offering for:
- acquisitions;
- capital expenditures, including
completing and equipping our data
centers;
- repayment of promissory notes issued or
assumed in connection with recent
acquisitions; and
- working capital and general corporate
purposes.
See "Use of Proceeds."
Nasdaq National Market Symbol........ INIT
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------------------------------------------ ----------------------------
PERIOD FROM
DECEMBER 8,
1997
(INCEPTION) THREE MONTHS THREE MONTHS THREE MONTHS
TO YEAR ENDED ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1998 1999 1998 1999
------------ --------------------- ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues.................. $ -- $ 4,905 $ 13 $ 5,434 $ 41,292 $ 10,341
--------- --------- --------- ---------- --------- ----------
Operating loss............ (158) (10,870) (553) (7,770) (38,601) (13,045)
--------- --------- --------- ---------- --------- ----------
Net loss.................. $ (158) $ (10,732) $ (539) $ (7,758) $ (39,030) $ (13,182)
========= ========= ========= ========== ========= ==========
Net loss per share --basic
and diluted............. $ (0.05) $ (1.22) $ (0.18) $ (0.31)
Weighted average shares
used in computing net
loss per share -- basic
and
diluted................. 3,000,000 8,799,432 3,000,000 24,769,890
Pro forma net loss per
share -- basic and
diluted................. $ (2.47) $ (0.46)
Shares used in computing
pro forma net loss per
share -- basic and
diluted................. 15,829,762 28,626,240
</TABLE>
4
<PAGE> 8
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
-------------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
------------ ------------ -------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 4,376 $ 9,376 $ 65,652
Working capital........................................... (5,462) (462) 63,814
Total assets.............................................. 100,897 105,897 161,597
Debt and capital lease obligations, less current
portion................................................. 914 914 914
Redeemable convertible preferred stock.................... 13,000 13,000 --
Total stockholders' equity................................ 69,528 74,528 151,228
</TABLE>
The unaudited pro forma statement of operations data gives effect to the
acquisitions completed in 1998 and 1999 as if they occurred on January 1, 1998.
The unaudited pro forma balance sheet data gives effect to the exercise in
April 1999 of warrants to purchase 749,625 shares of common stock for gross
proceeds of $5.0 million. See "Description of Capital Stock -- The SOFTBANK
Investment."
The unaudited pro forma as adjusted balance sheet data gives effect to the
conversion of all preferred stock into common stock upon completion of this
offering, see "Description of Capital Stock -- The SOFTBANK Investment," and the
sale of 7,000,000 shares of common stock offered hereby for net proceeds of
$63.7 million after deducting underwriting discounts and commissions and
estimated offering expenses.
5
<PAGE> 9
RISK FACTORS
Investing in our common stock involves risk. You should carefully consider
the risks and uncertainties described below and elsewhere in this prospectus
before making an investment decision. If any of the following risks or
uncertainties actually occur, our business could be adversely affected. In this
event, the trading price of our common stock could decline, and you could lose
all or a part of your investment.
WE HAVE A LIMITED OPERATING HISTORY AND MAY NOT SUCCESSFULLY IMPLEMENT OUR
BUSINESS PLAN.
We have a very limited operating history. We were incorporated in December
1997 and began offering Web hosting services in February 1998. We only recently
completed the acquisition of the application hosting business of Interliant
Texas. As a result, our business model is still in development. Our business and
prospects must be considered in light of the risks frequently encountered by
companies in their early stages of development, particularly companies in the
new and rapidly evolving hosting and enhanced Internet services market. Some of
these risks relate to our ability to:
- build a more comprehensive sales structure to support our business;
- provide reliable and cost-effective services to our customers;
- continue to build our operations and accounting infrastructure to
accommodate additional customers;
- respond to technological developments or service offerings by our
competitors;
- develop and offer new, successful products and services or differentiate
such products and services from those offered by our competitors;
- enter into strategic relationships with application software vendors;
- build, maintain and expand distribution channels; and
- attract and retain qualified personnel.
We may not be successful in addressing these risks, and if we are not
successful, our business could be adversely affected.
WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND THESE LOSSES MAY INCREASE IN THE
FUTURE.
Since our inception in December 1997, we have experienced operating losses
and negative cash flows for each quarterly and annual period. As of December 31,
1998 and March 31, 1999, we had an accumulated deficit of approximately $10.9
million and $18.6 million, respectively. We experienced net losses of
approximately $10.7 million in the year ended December 31, 1998 and $7.8 million
in the three months ended March 31, 1999. The revenues and income potential of
our business is unproven, and our limited operating history makes it difficult
to evaluate our prospects. We anticipate increased expenses as we expand our
sales and marketing initiatives to continue to grow the Interliant brand, fund
greater levels of product development, continue to build out our data centers,
implement centralized billing, accounting and customer service systems and
continue our acquisition program.
In addition, we have experienced growth in revenues, primarily attributable
to acquisitions, and we do not believe that this growth rate is necessarily
indicative of future operating results which will depend not only on continuing
our acquisition strategy but also on internal growth. We expect that future
acquisitions will increase our operating expenses and operating losses. As a
result, we expect to incur operating losses for the foreseeable future. We
cannot give any assurance that we will ever achieve profitability on a quarterly
or annual basis, or, if we achieve profitability, that it will be sustainable.
6
<PAGE> 10
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. AS A
RESULT, PERIOD-TO-PERIOD COMPARISONS OF OUR RESULTS OF OPERATIONS ARE NOT
NECESSARILY MEANINGFUL AND SHOULD NOT BE RELIED UPON AS INDICATIONS OF FUTURE
PERFORMANCE.
Our quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, some of which are outside of our control.
These factors include:
- the demand for and market acceptance of our hosting and enhanced Internet
services;
- our ability to identify, complete and integrate acquisitions to sustain
growth;
- downward price adjustments by our competitors on services and products
they offer which are similar to ours;
- changes in the mix of products and services sold by our competitors;
- technical difficulties or system downtime affecting the Internet
generally or our hosting operations;
- the ability to meet any increased technological demands of our customers;
- the amount and timing of our costs related to our marketing efforts and
service introductions by us or reseller or referral partners; and
- economic conditions specific to the hosting industry.
Therefore, our operating results for any particular quarter may differ
materially from our expectations or those of security analysts and may not be
indicative of future operating results which may adversely impact the price of
our common stock.
THE SUCCESS OF OUR BUSINESS PLAN DEPENDS ON OUR ABILITY TO MAKE ADDITIONAL
ACQUISITIONS.
We intend to pursue opportunities to expand our business through the
acquisition of selected companies in targeted markets. Although we expect to
finance future acquisitions, in part, with some of the proceeds from this
offering and, at a future date with the issuance of additional shares of our
common stock or other debt or equity securities, we cannot guarantee that:
- we will be able to identify appropriate acquisition candidates or
negotiate acquisitions on favorable terms;
- we will be able to obtain the financing necessary to complete future
acquisitions; or
- the issuance of our common stock or other securities in connection with
any future acquisition will not result in a substantial dilution in the
ownership interests of holders of our common stock.
THE SUCCESS OF OUR BUSINESS PLAN DEPENDS ON THE SUCCESSFUL INTEGRATION OF
ACQUISITIONS.
Since February 1998, we have acquired 17 businesses, and we are currently
pursuing additional acquisitions. Our future success will depend in large part
on our ability to integrate these businesses or any future acquired businesses
with our existing operations. To integrate these businesses, we will need to:
- consolidate their billing and accounting systems into our systems and
implement financial and other control systems;
- relocate the servers of acquired companies and other equipment to an
Interliant facility;
- migrate the operations of acquired companies onto our technology
platforms;
- integrate the customer accounts of acquired companies into our customer
service system;
- integrate the service offerings of acquired companies into the Interliant
brand; and
- identify resellers and referral partners of the services of acquired
companies and migrate them to our business partner program.
7
<PAGE> 11
The 17 businesses we acquired are in various stages of the integration
process. Our integration plan is constantly changing as a result of our business
activities as well as future acquisitions. We are not able to estimate when, if
at all, all acquired companies will be fully integrated.
THE COSTS ASSOCIATED WITH AND MANAGEMENT RESOURCES DEDICATED TO INTEGRATING
BUSINESSES WE ACQUIRE AND INTERNAL CONTROLS WITH RESPECT TO THOSE ACQUIRED
BUSINESSES MAY ADVERSELY AFFECT OUR BUSINESS.
We may not be able to successfully integrate acquired businesses with
existing operations without substantial costs, delays or other problems, if at
all. As we integrate acquired businesses:
- we may lose certain customers of acquired companies due to difficulties
during the integration process;
- we may not be able to bill customers of the acquired companies accurately
due to potential deficiencies in the internal controls of the acquired
Web hosting companies such as inadequate back-office systems of the
acquired companies and potential difficulties in migrating records onto
our own systems;
- we may experience difficulty in collecting accounts receivable of
acquired companies due to inaccurate record keeping of the acquired
companies;
- key employees of the acquired companies whom we wish to retain may
resign;
- management's attention and resources could be diverted from our ongoing
business concerns; and/or
- we may not be able to integrate newly acquired technologies with our
existing technologies.
Acquisitions also involve a number of other risks, including adverse
effects on our operating results from increases in amortization of intangible
assets, increased compensation expense associated with newly hired employees and
unforeseen liabilities. In addition, any acquired company could significantly
underperform relative to our expectations. In particular, acquired companies
have often experienced modest revenue declines immediately following the closing
of the acquisition. Because we have only recently completed many of our
acquisitions, we are currently facing all of these challenges, and we have not
established our ability to meet them over the long term. As a result of all of
the foregoing, our pursuit of an acquisition strategy could adversely affect our
business.
OUR RECENT ACQUISITION OF INTERLIANT TEXAS, OUR LARGEST ACQUISITION TO DATE, MAY
ADVERSELY AFFECT OUR BUSINESS IF WE DO NOT SUCCESSFULLY INTEGRATE INTERLIANT
TEXAS OR IF THE COSTS AND MANAGEMENT RESOURCES WE EXPEND IN CONNECTION WITH THE
INTEGRATION EXCEED OUR EXPECTATIONS.
In March 1999, we purchased, through a wholly-owned subsidiary,
substantially all the assets, and assumed certain liabilities, of Interliant
Texas, which had revenues of $21.2 million for the year ended December 31, 1998.
Our acquisition of the business of Interliant Texas has been our largest
acquisition to date, and we expect that it will have a continuing, significant
impact on our business. Although we do not currently intend to integrate all the
operations of Interliant Texas into our operations, we still expect to incur
significant integration costs. In addition, the following factors could increase
the costs of integration:
- unexpected employee turnover;
- delays in addressing duplicate operations; and
- additional fees and charges to obtain consents, regulatory approvals or
permits.
Further, we cannot guarantee that we will realize the benefits or strategic
objectives we are seeking to obtain by acquiring Interliant Texas. Costs
associated with this acquisition that exceed our expectations would have an
adverse effect on our business.
8
<PAGE> 12
A SIGNIFICANT PORTION OF OUR ASSETS CONSISTS OF INTANGIBLE ASSETS, THE
RECOVERABILITY OF WHICH IS NOT CERTAIN AND THE AMORTIZATION OF WHICH WILL
INCREASE LOSSES OR REDUCE EARNINGS IN THE FUTURE.
In connection with all of our acquisitions completed to date, $85.2 million
of the aggregate purchase price has been allocated to intangible assets such as
covenants not to compete, customer lists, trade names, assembled work force and
goodwill. Annual amortization of these intangible assets will amount to
approximately $25.4 million and will increase as we acquire additional
businesses. Our business could suffer if changes in our industry or our
inability to operate the business successfully and produce positive cash flows
from operations result in an impairment in the value of our intangible assets
and therefore necessitate a write-off of all or part of these assets.
OUR APPLICATION HOSTING SOLUTIONS DEPEND ON SOFTWARE APPLICATIONS PROVIDED TO US
UNDER AGREEMENTS WE HAVE WITH APPLICATION SOFTWARE VENDORS.
We obtain software products pursuant to agreements with Lotus and Microsoft
and package them as part of our application hosting solutions. The agreements
are typically for terms ranging from one to three years. If these agreements
were terminated or not renewed, we might have to discontinue products or
services that are central to our business strategy or delay their introduction
unless we could find, license and package equivalent technology. Our business
strategy also depends on obtaining additional application software. We cannot be
sure, however, that we will be able to obtain the new and enhanced applications
we may need to keep our solutions competitive. If we cannot obtain these
applications and as a result must discontinue, delay or reduce the availability
of our solutions or other products and services, our business may be adversely
affected.
OUR AGREEMENTS WITH APPLICATION SOFTWARE VENDORS ARE NOT EXCLUSIVE AND MAY NOT
PROVIDE US WITH ANY COMPETITIVE ADVANTAGE.
None of our third-party agreements are exclusive. Our competitors may also
license and utilize the same technology in competition with us. We cannot be
sure that the vendors of technology used in our products will continue to
support this technology in its current form. Nor can we be sure that we will be
able to adapt our own products to changes in this technology. In addition, we
cannot be sure that the financial or other difficulties of third party vendors
will not have an adverse affect on the technologies incorporated in our
products, or that, if these technologies become unavailable, we will be able to
find suitable alternatives.
WE DEPEND ON OUR RESELLER SALES CHANNEL TO MARKET AND SELL MANY OF OUR SERVICES.
We rely significantly on resellers to market and sell our services. We
estimate that as of December 31, 1998 approximately 16% of our active hosted
domains were maintained by resellers. For this purpose, we include as resellers
any entity which has three or more active domains hosted by us. Our failure to
maintain and grow our reseller sales channel may adversely affect our business.
Our agreements with resellers generally do not require that the resellers sell
any minimum level of our services and do not restrict the resellers' development
or sale of competitive services. We have very little control over whether these
resellers will dedicate resources or give priority to selling our services.
We will need to continue to deliver reliable service and keep our reseller
pricing and support programs competitive. If we succeed in increasing our sales
through resellers, we may lose brand identification and brand loyalty, since our
services may not be identified by the Interliant brand or may be marketed
differently by our resellers.
WE ONLY RECENTLY BEGAN TO OFFER MANY OF OUR PRODUCTS AND SERVICES. IF THEY ARE
NOT ACCEPTED BY THE MARKET OR HAVE RELIABILITY OR QUALITY PROBLEMS OUR BUSINESS
MAY SUFFER.
We have recently introduced new hosting solutions such as providing our
customers with integrated text, graphics, video, information and sound
capabilities on their Web sites, or multimedia hosting and providing our
customers with the ability to rent software applications instead of purchasing
them as well as
9
<PAGE> 13
enhanced Internet services such as e-commerce and consulting services. If these
and other new hosting solutions and enhanced Internet services fail to gain
market acceptance, our business could be adversely affected. In addition, if
these newly introduced hosting solutions and enhanced Internet services have
reliability, quality or compatibility problems, market acceptance of these
products could be greatly hindered and our ability to attract new customers
could be adversely affected. We cannot offer any assurance that these new
solutions and services are free from any reliability, quality or compatibility
problems.
THE EXPECTED CONTINUED GROWTH IN THE MARKET FOR OUR PRODUCTS AND SERVICES MAY
NOT MATERIALIZE.
Our market is new and rapidly evolving. Whether the market for our products
and services will continue to grow is uncertain. Our business would be adversely
affected if the hosting market does not continue to grow or if businesses prove
to be unwilling to outsource their hosting business.
Our success depends in part on continued growth in the use of the Internet.
Our business would be adversely affected if Web usage does not continue to grow.
Web usage may be inhibited for a number of reasons, such as:
- security and privacy concerns;
- uncertainty of legal and regulatory issues concerning the use of the
Internet;
- inconsistent quality of service; and
- lack of availability of cost-effective, high-speed connectivity.
OUR RAPID GROWTH AND EXPANSION HAS AND MAY CONTINUE TO SIGNIFICANTLY STRAIN OUR
RESOURCES.
We are currently experiencing rapid growth, primarily due to our
acquisition of 17 businesses since February 1998. In addition, from inception to
the date hereof we have grown to 516 employees, including 19 employees on a
contract basis. This rapid growth of our business and our product and service
offerings has placed, and is likely to continue to place, a significant strain
on our operating and financial resources. Our future performance will partly
depend on our ability to manage our growth effectively, which will require that
we further develop our operating and financial system capabilities and controls.
We have invested, and intend to continue to invest, significant amounts in
billing, accounts receivable, customer service and financial systems which we
believe, once implemented, will be able to produce timely, accurate and
consistent information as our business continues to grow. However, because we
employ a strategy that includes a high level of acquisition activity, at any
time there are likely to be one or more operating businesses that have not been
fully integrated into our core systems and continue to produce financial and
other information from their existing systems. As a result, our ability to
record, process, summarize and report financial data could be adversely
affected.
WE DEPEND ON THE GROWTH AND STABILITY OF THE INTERNET INFRASTRUCTURE.
If the use of the Internet continues to grow, its infrastructure may not be
able to support the demands placed on it by such growth and its performance or
reliability may decline. In addition, Web sites have experienced interruptions
in their service as a result of outages and other delays occurring throughout
the Internet network infrastructure. If these outages or delays occur
frequently, use of the Internet as a commercial or business medium could, in the
future, grow more slowly or decline which would adversely affect our business.
WE DEPEND ON OUR NETWORK INFRASTRUCTURE. IF WE DO NOT HAVE CONTINUED ACCESS TO A
RELIABLE NETWORK, OUR BUSINESS WILL SUFFER.
Our success partly depends upon the capacity, scalability, reliability and
security of our network infrastructure, including the capacity leased from our
telecommunications network suppliers such as UUNET Technologies, Inc. We depend
on these companies to provide uninterrupted and "bug free"
10
<PAGE> 14
service and would be adversely affected if such services were not provided. In
addition, we would be adversely affected if such companies greatly increased the
prices of their services or if the telecommunications capacity available to us
was insufficient for our business purposes and we were unable to use alternative
networks or pass along any increased costs to our customers.
OUR BUSINESS AND EXPANSION MODELS ASSUME THAT WE WILL BE ABLE TO EASILY SCALE
OUR NETWORK INFRASTRUCTURE TO SUPPORT INCREASING NUMBERS OF CUSTOMERS AND
INCREASED TRAFFIC. HOWEVER, THE SCALABILITY OF OUR NETWORK IS UNPROVEN.
We must continue to develop and expand our network infrastructure as the
number of users and the amount of information they wish to transport as well as
the number of products and services we offer increases and to meet changing
customer requirements. Our expansion and adaptation of our telecommunications
and hosting facility infrastructure will require substantial financial,
operational and management resources. If we are required to expand our network
significantly and rapidly due to increased usage, additional stress will be
placed upon our network hardware, traffic management systems and hosting
facilities. Due to the limited deployment of our services to date, the ability
of our network to connect and manage a substantially larger number of customers
at high transmission speeds while maintaining superior performance is unknown.
As our customers' bandwidth usage increases, we will need to make
additional investments in our infrastructure to maintain adequate data
transmission speeds, the availability of which may be limited and the cost of
which may be significant. Additional network capacity may not be available from
third-party suppliers as it is needed by us. As a result, our network may not be
able to achieve or maintain a sufficiently high capacity of data transmission,
especially if customers' usage increases. Any failure on our part to achieve or
maintain high-capacity data transmission could significantly reduce consumer
demand for our services and adversely affect our business.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH COULD AFFECT
OUR ABILITY TO COMPETE.
To succeed, we must be able to operate our network infrastructure on a 24x7
basis without interruption. Our operations depend upon our ability to protect
our network infrastructure, equipment and customer files against damage from:
- human error;
- various natural disasters;
- power loss or telecommunications failures; and
- sabotage or other intentional acts of vandalism.
However, even if we take precautions, the occurrence of a natural disaster
or other unanticipated problems at our data centers could result in
interruptions in the services we provide to our customers.
At this time, we do not have a formal disaster recovery plan. Although we
believe that our Atlanta and Houston data centers are state-of-the-art and have
sufficient system protections in place to ensure high quality service with
minimal interruptions, we estimate that currently only approximately 34% of our
customers are hosted in these data centers. In addition, we may not integrate
into our Network Operations Centers all the data centers of companies we
acquire. Therefore, in some instances, our network reliability may be
compromised. Although we have attempted to build redundancy into our network and
hosting facilities, our data centers are currently subject to various single
points of failure. As a result, a problem with one of our routers, switches or
fiber paths could cause an interruption in the services we provide to some of
our customers. We have experienced interruptions in service in the past. Any
future interruptions could:
- require us to spend substantial amounts of money replacing existing
equipment or adding redundant facilities;
11
<PAGE> 15
- damage our reputation for reliable service;
- cause existing end users, resellers and referral partners to cancel their
contracts;
- cause end users to seek damages for losses incurred; or
- make it more difficult for us to attract new end users, resellers and
referral partners.
Any of these occurrences could adversely affect our business.
We have entered into service level agreements with some of our customers,
and we anticipate that we will offer service level agreements to a larger group
of customers in the future. In that case, we could incur significant liability
to our customers in connection with any system downtime and those obligations
may adversely affect our business.
IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL
CHANGE, OUR BUSINESS COULD SUFFER.
The Internet industry is characterized by rapidly changing technology,
industry standards, customer needs and competition, as well as by frequent new
product and service introductions. Our future success will depend, in part, on
our ability to accomplish all of the following in a timely and cost-effective
manner, all while continuing to develop our business model and roll-out our
services on a national level:
- effectively use and integrate leading technologies;
- continue to develop our technical expertise;
- enhance our products and current networking services;
- develop new products and services that meet changing customer needs;
- advertise and market our products and services; and
- influence and respond to emerging industry standards and other changes.
We cannot assure you that we will successfully use or develop new
technologies, introduce new services or enhance our existing services on a
timely basis, or that new technologies or enhancements used or developed by us
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense.
OUR FAILURE TO DEVELOP BRAND RECOGNITION FOR THE INTERLIANT BRAND COULD HURT OUR
BUSINESS.
Upon acquiring Interliant Texas and its application hosting business, we
began the process of offering the full range of our hosting products and
enhanced Internet services under the Interliant brand. We are currently
marketing and expect to continue to market many of our products and services
under the Sage Networks brand and the brand names of acquired companies. Our
sales and marketing expenses were $2.6 million in the year ended December 31,
1998 and $1.9 million in the three months ended March 31, 1999. A key component
of our strategy is to significantly increase our sales and marketing activities.
This will include the expansion of our sales force, development of reseller and
referral partner channels and increased marketing efforts. As a result, sales
and marketing expenses will increase substantially in future periods. We expect
sales and marketing expenses for the year ending December 31, 1999 to exceed
$20.0 million. Our business could be adversely affected if the Interliant brand
is not well received by our customers, our marketing efforts are not productive
or we are otherwise unsuccessful in increasing our brand awareness.
WE OPERATE IN AN EXTREMELY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY.
Our current and prospective competitors are numerous. Many of our
competitors have substantially greater financial, technical and marketing
resources, larger customer bases, longer operating histories,
12
<PAGE> 16
greater name recognition and more established relationships in the industry than
we do. Our current and prospective competitors generally may be divided into the
following groups:
- other Web hosting and Internet services companies such as AboveNet
Communications, Inc., Exodus Communications, Inc., Frontier GlobalCenter,
Globix Corporation and local and regional hosting providers;
- national and regional Internet service providers such as Concentric
Network Corporation, MindSpring Enterprises, Inc., UUNET Technologies,
Inc., PSINet Inc. and Verio Inc.;
- global telecommunications companies including AT&T Corp., British
Telecommunications plc, Telecom Italia SpA and Nippon Telegraph and
Telephone Corp.;
- regional and local telecommunications companies, including the regional
Bell operating companies such as Bell Atlantic Corporation and US West,
Inc.;
- companies that focus on application hosting such as USinternetworking,
Inc. and IBM Global Services; and
- multimedia hosting companies such as broadcast.com.
WE DEPEND ON THE SKILLS OF KEY PERSONNEL.
We are dependent on the continued service of our key personnel, including:
- Leonard J. Fassler and Bradley A. Feld, our Co-Chairmen;
- Stephen W. Maggs, our Vice Chairman;
- James M. Lidestri, our President;
- Rajat Bhargava, our Senior Vice President, Strategic Planning and
Integration; and
- William A. Wilson, our Chief Financial Officer.
We recently entered into one-year employment agreements with Messrs.
Fassler, Maggs and Bhargava and a one-year consulting agreement with Mr. Feld
through Intensity Ventures, Inc. In addition, in connection with our acquisition
of Interliant Texas, we entered into a two-year employment agreement with Mr.
Lidestri. The loss of the services of one or more of these people could
adversely affect our business.
Our Co-Chairmen, Bradley A. Feld and Leonard J. Fassler, are each currently
active in, and serve as directors and/or executive officers of, a number of
businesses other than Interliant. Although Mr. Feld spends approximately half of
his time and Mr. Fassler spends substantially all of his time at Interliant, and
both are active in its management, neither is contractually committed to spend
any specific amount of time at Interliant. If Mr. Feld or Mr. Fassler were to
significantly reduce the time they devoted to Interliant, our business may be
adversely affected.
WE OPERATE IN AN INDUSTRY WHERE IT IS DIFFICULT TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
We expect that we will need to hire additional personnel in all areas of
our business. The competition for personnel throughout our industry is intense.
At times, we have experienced difficulty in attracting qualified new personnel.
If we do not succeed in attracting new, qualified personnel or retaining and
motivating our current personnel, our business could suffer.
WE MAY NEED ADDITIONAL FUNDS WHICH, IF AVAILABLE COULD RESULT IN AN INCREASE IN
OUR INTEREST EXPENSE OR DILUTION OF YOUR SHAREHOLDINGS. IF THESE FUNDS ARE NOT
AVAILABLE, OUR BUSINESS COULD BE HURT.
We currently anticipate that our available cash resources combined with the
net proceeds from this offering will be sufficient to fund our acquisition
program, the expansion of our sales and marketing program, completion of our
data centers and our other operating needs through the end of 1999.
13
<PAGE> 17
Thereafter, we expect to require additional financing. At this time, we do not
have any credit facility or other working capital credit line under which we may
borrow funds for working capital or other general corporate purposes. If our
plans or assumptions change or are inaccurate, we may be required to seek
additional capital or seek capital sooner than anticipated. We may need to raise
funds through public or private debt or equity financing.
If funds are raised through the issuance of equity securities, the
percentage ownership of our then current stockholders may be reduced and such
equity securities may have rights, preferences or privileges senior to those of
the holders of our common stock. If additional funds are raised through the
issuance of debt securities, such securities would have certain rights,
preferences and privileges senior to those of the holders of our common stock
and the terms of such debt could impose restrictions on our operations. If
additional funds become necessary, additional financing may not be available on
terms favorable to us, or at all. If adequate funds are not available on
acceptable terms, we may not be able to continue to fund our operations and
growth or to continue our acquisition program. Our inability to raise capital
could adversely affect our business.
CURRENCY FLUCTUATIONS AND DIFFERENT STANDARDS, REGULATIONS AND LAWS RELATING TO
OUR INTERNATIONAL OPERATIONS MAY ADVERSELY AFFECT OUR BUSINESS.
On a pro forma basis, giving effect to acquisitions completed to date,
approximately 18.5% of our dollar amount of billings for the year ended December
31, 1998 and 18.2% for the three months ended March 31, 1999 were to customers
located outside the United States, primarily in Europe, Asia and South America.
Our success may depend in part on expanding our international presence.
Because our sales overseas are denominated in U.S. dollars, currency
fluctuations may inhibit us from marketing our services to potential foreign
customers or collecting for services rendered to current foreign customers. In
addition different privacy, censorship and service provider liability standards
and regulations and different intellectual property laws in non-U.S. countries
may adversely affect our business.
DISRUPTION OF OUR SERVICES DUE TO ACCIDENTAL OR INTENTIONAL SECURITY BREACHES
MAY ADVERSELY IMPACT OUR BUSINESS.
A significant barrier to the growth of e-commerce and communications over
the Internet has been the need for secure transmission of confidential
information. Despite our design and implementation of a variety of network
security measures, unauthorized access, computer viruses, accidental or
intentional actions and other disruptions could occur. We may incur significant
costs to protect against the threat of security breaches or to alleviate
problems caused by such breaches. If a third person were able to misappropriate
our users' personal or proprietary information or credit card information, we
could be subject to claims, litigation or other potential liabilities.
NEW LAWS AND REGULATIONS WHICH IMPACT OUR INDUSTRY COULD HARM OUR BUSINESS.
We are not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, we may
become subject to regulation by the FCC or another regulatory agency. Our
business could suffer depending on the extent to which our activities are
regulated or proposed to be regulated.
WE OPERATE IN AN UNCERTAIN REGULATORY AND LEGAL ENVIRONMENT WHICH MAY MAKE IT
MORE DIFFICULT TO DEFEND OURSELVES AGAINST ANY CLAIMS BROUGHT AGAINST US.
While there are currently few laws or regulations which specifically
regulate Internet communications, laws and regulations directly applicable to
online commerce or Internet communications are becoming more prevalent. There is
much uncertainty regarding the marketplace impact of these laws. In addition,
various jurisdictions already have enacted laws covering intellectual property,
privacy, libel and taxation that could affect our business by virtue of their
impact on online commerce. Further, the growth of the
14
<PAGE> 18
Internet, coupled with publicity regarding Internet fraud, may lead to the
enactment of more stringent consumer protection laws. If we become subject to
claims that we have violated any laws, even if we successfully defend against
these claims, our business could suffer. Moreover, new laws that impose
restrictions on our ability to follow current business practices or increase our
costs of doing business could hurt our business.
IF STATES AND COUNTRIES IN WHICH WE DO NOT CURRENTLY COLLECT SALES OR OTHER
TAXES MANDATE THAT WE DO SO, OUR BUSINESS COULD SUFFER.
We currently do not collect sales or other taxes with respect to the sale
of services or products in states and countries where we believe we are not
required to do so. We do collect sales and other taxes in the states and
countries in which we have offices and are required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes for
prior periods, could have an adverse effect on our business.
WE COULD FACE LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR NETWORK.
It is possible that claims could be made against online services companies
and Internet service providers in connection with the nature and content of the
materials disseminated through their networks. Several private lawsuits are
pending against other entities which seek to impose liability upon online
services companies and Internet service providers as a result of the nature and
content of materials disseminated over the Internet. If any of these actions
succeed, we might be required to respond by investing substantial resources or
discontinuing some of our service or product offerings. The increased attention
focused upon liability issues as a result of these lawsuits and legislative
proposals could impact the growth of Internet use. Although we carry
professional liability insurance, it may not be adequate to compensate or may
not cover us in the event we become liable for information carried on or
disseminated through our networks. Any costs not covered by insurance incurred
as a result of such liability or asserted liability could adversely affect our
business.
WE DEPEND ON THE PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS.
We currently license and may in the future license certain technologies
from third parties, which may subject us to infringement actions based upon the
technologies licensed from these third parties. Any of these claims, with or
without merit, could subject us to costly litigation and divert the attention of
our technical and management personnel. These third-party technology licenses
may not continue to be available to Interliant on commercially reasonable terms.
The loss of the ability to use such technology could require Interliant to
obtain the rights to use substitute technology, which could be more expensive or
offer lower quality or performance, and therefore have a material adverse effect
on Interliant's business.
OUR COMPUTER SYSTEMS AND THOSE OF THIRD PARTIES WITH WHOM WE DO BUSINESS MAY NOT
BE YEAR 2000 COMPLIANT, WHICH MAY CAUSE SYSTEM FAILURES AND DISRUPTIONS OF
OPERATIONS.
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including
ours, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
We have made a preliminary assessment of the Year 2000 readiness of our
information technology systems. In addition, we are currently seeking assurances
from our material hardware and software vendors that their products are Year
2000 compliant. Until such process is complete, we will not be able to
completely evaluate whether our information technology systems will need to be
revised or replaced.
15
<PAGE> 19
Although we have not incurred any material expenditures in connection with
identifying or evaluating Year 2000 compliance issues to date, we do not at this
time possess the information necessary to estimate the potential costs of
revisions or replacements to our software and systems or third party software,
hardware or services that are determined not to be Year 2000 compliant. Such
expenses, if higher than anticipated, could have a material adverse effect on
our business.
Although we are not currently aware of any Year 2000 compliance problems
relating to our information technology systems that would have a material
adverse effect on our business, there is no assurance that we will not discover
any such compliance problems. Our failure to fix or replace our software,
hardware or services on a timely basis could result in lost revenues, increased
operating costs and the loss of customers and other business interruptions, any
of which could have a material adverse effect on our business. Moreover, the
failure to adequately address Year 2000 compliance issues in our information
technology systems could result in claims of mismanagement, misrepresentation or
breach of contract and related litigation, which could be costly and
time-consuming to defend.
OUR STOCK PRICE MAY BE VOLATILE.
There has not been a public market for our common stock. We cannot predict
the extent to which investor interest in Interliant will lead to the development
of a trading market or how liquid that market might become. Further, we cannot
guarantee that the price of our common stock will not decline below the initial
public offering price. Stock prices of technology companies, especially
Internet-related companies, have been highly volatile. The initial public
offering price may not be indicative of prices that will prevail in the trading
market. Various factors could cause the market price of our common stock to
fluctuate substantially. These factors may include:
- variations in our revenue, earnings and cash flow;
- announcements of new service offerings, technological innovations or
price reductions by us, or our competitors or providers of alternative
services; and
- changes in analysts' recommendations or projections and general economic
and market conditions.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted against such a company. Such litigation could result in substantial
costs and a diversion of management's attention and resources and could have a
material adverse effect on our business.
WEB HOSTING ORGANIZATION LLC AND MEMBERS OF MANAGEMENT WILL CONTROL
APPROXIMATELY 69.5% OF OUR COMMON STOCK AFTER THIS OFFERING, AND THEIR INTERESTS
MAY BE IN CONFLICT WITH THOSE OF INTERLIANT AND THE OTHER STOCKHOLDERS.
Immediately following this offering, Web Hosting Organization LLC and
members of management will control approximately 69.5% of our outstanding common
stock. Accordingly, they will be able to control any stockholder vote, including
any vote on the election of directors. The members of Web Hosting Organization
LLC are affiliates of Charterhouse Group International, Inc. and the WHO
Management LLC, of which Interliant's Co-Chairmen, Leonard J. Fassler and
Bradley A. Feld, are the member managers. Web Hosting Organization LLC's
interests could conflict with the interests of our other stockholders. See
"Description of Capital Stock -- The WEB Hosting Organization Investment" and
"Related Party Transactions."
Charterhouse Equity Partners III, L.P., which is an affiliate of
Charterhouse Group International, Inc., has the ability to control our direction
and future operations through its significant equity ownership of Web Hosting
Organization LLC. Certain decisions concerning our operations or financial
structure may present conflicts of interest between Charterhouse and our other
stockholders. In addition to its investments in us, Charterhouse or its
affiliates may in the future invest in other entities engaged in the hosting
business or other Internet-related business. As a result, Charterhouse or its
affiliates have, and may develop, relationships with businesses that are or may
be competitive with us. Conflicts may also arise in the negotiation or
enforcement of arrangements entered into by us and entities in which
Charterhouse has
16
<PAGE> 20
an interest. Such conflicts of interest could cause Charterhouse to use its
significant ownership interest to force us to act in a manner adverse to the
interests of our other stockholders.
OUR STOCK PRICE MAY BE AFFECTED BY THE AVAILABILITY OF SHARES FOR SALE IN THE
NEAR FUTURE. THE FUTURE SALE OF LARGE AMOUNTS OF OUR STOCK, OR THE PERCEPTION
THAT SUCH SALES COULD OCCUR, COULD NEGATIVELY AFFECT OUR STOCK PRICE.
The market price of the common stock could drop as a result of sales of a
large number of shares of common stock in the market after this offering. There
will be 42,215,268 shares of common stock outstanding immediately after this
offering. The 7,000,000 shares of common stock sold in this offering will be
freely tradable without restriction or further registration under the Securities
Act of 1933, as amended, unless such shares are held by "affiliates" of
Interliant, as that term is defined in Rule 144 under the Securities Act.
All of the remaining shares of common stock are subject to restrictions
under Rule 144 of the Securities Act. Holders of 32,320,790 restricted shares
have registration rights with respect to such shares. However, such shares are
subject to lock-up agreements pursuant to which the holders of these shares have
agreed, subject to certain limited exceptions, not to sell or otherwise dispose
of any of their shares for a period of 180 days after the date of this
prospectus, or exercise their registration rights, without the prior written
consent of Merrill Lynch & Co., on behalf of the several underwriters. See
"Shares Eligible for Future Sale."
As of the date of this prospectus, there are 3,086,411 shares of common
stock issuable upon exercise of options issued as compensation that will become
available for resale in the public market at prescribed times. We also intend to
register under the Securities Act the shares of common stock reserved for
issuance under our stock option plan. See "Shares Eligible for Future Sale."
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS.
This prospectus contains certain forward-looking statements, relating to,
among other things, future results of operations, growth plans, sales, gross
margin and expense trends, capital requirements and general industry and
business conditions applicable to Interliant. These forward-looking statements
are based largely on Interliant's current expectations and are subject to a
number of risks and uncertainties. When used in this prospectus, the words
"anticipate," "believe," "estimate" and similar expressions are generally
intended to identify forward-looking statements. Actual results could differ
materially from these forward-looking statements. In addition to the other risks
described elsewhere in this "Risk Factors" discussion, important factors to
consider in evaluating such forward-looking statements include changes in
external competitive market factors, changes in Interliant's business strategy
or an inability to execute its strategy due to unanticipated changes in the
hosting industry or the economy in general and various other competitive factors
that may prevent Interliant from competing successfully in existing or future
markets. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this prospectus will be in fact
realized.
17
<PAGE> 21
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the 7,000,000 shares
sold by us in this offering will be approximately $63.7 million, or
approximately $73.4 million if the underwriters' over-allotment options are
exercised in full, after deducting underwriting discounts and commissions and
estimated expenses payable by us.
We currently intend to use approximately $40.0 million of the net proceeds
of this offering for acquisitions. We are currently engaged in discussions with
respect to several acquisitions. See "Business -- Strategy" and "-- Acquisition
Program." We also expect to use the net proceeds as follows:
- approximately $9.0 million for capital expenditures including completing
and equipping our data centers;
- $8.0 million for repayment of a 9% promissory note issued in favor of
Matthew Wolf in connection with the acquisition of Interliant Texas,
which will be paid in full on the consummation of this offering; and
- $2.4 million for repayment of a promissory note, which pays interest at
the prime rate, issued in connection with the acquisition of Advanced Web
Creations, Inc., which will be paid in full on the consummation of this
offering.
See "Business -- Technology and Network Operations -- Network Operations" and
"-- Facilities."
The balance of the net proceeds of this offering will be used for working
capital and general corporate purposes. Pending use of the net proceeds for the
above purposes, we intend to invest such funds in short-term investment grade
interest-bearing securities. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
DIVIDEND POLICY
We have never paid or declared any cash dividends on our common stock. We
currently intend to retain any future earnings for our business and, therefore,
do not anticipate paying cash dividends in the foreseeable future. Future
dividends, if any, will depend on, among other things, our results of
operations, capital requirements, restrictions in loan agreements and on such
other factors as our Board of Directors may, in its discretion, consider
relevant.
18
<PAGE> 22
CAPITALIZATION
The following table sets forth at March 31, 1999 (1) our actual
capitalization, (2) capitalization on a pro forma basis to reflect (a) the
amendment of our Restated Certificate of Incorporation to provide for authorized
capital stock of 200,000,000 shares of common stock and 1,000,000 shares of
undesignated preferred stock and (b) the exercise in April 1999 of warrants to
purchase 749,625 shares of common stock for gross proceeds of $5.0 million and
(3) the pro forma capitalization adjusted to reflect (a) the conversion of
2,647,658 shares of Series A Redeemable Convertible Preferred Stock into an
equal number of shares of common stock upon the consummation of this offering
(see "Description of Capital Stock -- The SOFTBANK Investment") and (b) the net
proceeds from this offering, after deducting the underwriting discounts and
commissions and estimated offering expenses. You should read this table in
conjunction with the Selected Consolidated Financial Data, the Unaudited Pro
Forma Consolidated Financial Statements and Interliant's Consolidated Financial
Statements and Notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Notes payable, less current portion....................... $ 914 $ 914 $ 914
======== ======== ========
Series A Redeemable Convertible Preferred Stock, $0.01 par
value; 2,647,658 shares authorized and outstanding,
actual and pro forma; and 0 shares authorized and
outstanding, pro forma as adjusted...................... 13,000 13,000
Stockholders' equity:
Preferred stock, 0 shares authorized, actual; 1,000,000
shares authorized, 0 shares issued and outstanding,
pro forma and pro forma as adjusted..................
Common stock, $0.01 par value; 100,000,000 shares
authorized, 30,998,802 shares issued and outstanding,
actual; 200,000,000 shares authorized, 31,748,427
shares issued and outstanding, pro forma; 200,000,000
shares authorized, 41,396,085 shares issued and
outstanding, pro forma as adjusted(1)................ 310 317 414
Additional paid-in capital.............................. 89,067 94,060 170,663
Deferred compensation................................... (1,202) (1,202) (1,202)
Accumulated deficit..................................... (18,648) (18,648) (18,648)
-------- -------- --------
Total stockholders' equity.............................. 69,528 74,528 151,228
-------- -------- --------
Total capitalization............................ $ 83,442 $ 88,442 $152,142
======== ======== ========
</TABLE>
- ---------------
(1) Excludes 3,319,594 shares of common stock issuable upon exercise of options
outstanding under our 1998 Stock Option Plan at a weighted average exercise
price of $1.76. See "Management."
19
<PAGE> 23
DILUTION
Our pro forma negative net tangible book value as of March 31, 1999 was
$(2.9) million or $(0.09) per share of common stock. The pro forma net tangible
book value per share of common stock is determined by subtracting our total
liabilities from the total book value of our tangible assets and dividing the
difference by the number of shares of common stock deemed to be outstanding on
the date as of which such book value is determined, after giving effect to the
pro forma events listed in the introductory paragraph of "Capitalization." After
giving effect to (a) the conversion of 2,647,658 shares of Series A Redeemable
Convertible Preferred Stock into shares of common stock upon the consummation of
this offering (see "Description of Capital Stock -- The SOFTBANK Investment")
(b) receipt of the net proceeds from the sale of the 7,000,000 shares of common
stock in this offering, at an initial public offering price of $10.00 per share
and after deducting underwriting discounts and commissions and estimated
offering expenses, the pro forma net tangible book value of Interliant as of
March 31, 1999 would have been $73.8 million, or $1.78 per share. This
represents an immediate increase in net tangible book value of $1.87 per share
to existing stockholders and an immediate dilution of $8.22 per share to new
investors purchasing shares at the initial public offering price. Dilution is
defined as the reduction in the proportion of income, or earnings per share, to
which each share is entitled due to the issuance of additional shares. The
following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $10.00
Pro forma net tangible book value per share as of March
31, 1999............................................... (0.09)
Increase per share attributable to new investors.......... 1.87
-----
Pro forma net tangible book value per share after this
offering.................................................. 1.78
------
Dilution per share to new investors......................... $ 8.22
======
</TABLE>
The following table summarizes on a pro forma basis, as of March 31, 1999,
the number of shares of common stock purchased from us, the total consideration
paid to us and the average price per share paid by the existing stockholders and
by the investors purchasing shares of common stock in this offering (before
deducting the estimated underwriting discounts and commissions and estimated
offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- -------------------------
NUMBER PERCENT AMOUNT PERCENT AVERAGE PRICE PER SHARE
-------------- ------- -------------- ------- -----------------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 28,597(1) 80.3 $ 60,000(1) 46.2 $ 2.10
New investors............. 7,000 19.7 70,000 53.8 10.00
------ ----- -------- -----
Total........... 35,597 100.0 $130,000 100.0
====== ===== ======== =====
</TABLE>
The foregoing table assumes no exercise of stock options outstanding. As of
the date hereof, there are options outstanding to purchase a total of 3,086,411
shares of common stock at a weighted average per share exercise price of $2.83.
To the extent that any of these options are exercised, there will be further
dilution to new investors. See "Capitalization," "Management -- Stock Option
Plan," "Description of Capital Stock" and Note 7 of Notes to Consolidated
Financial Statements.
- ---------------
(1) Includes 2,647,658 shares of common stock issuable upon conversion of
preferred stock for total consideration of $13,000,000.
20
<PAGE> 24
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The following selected consolidated financial data should be read in
conjunction with Interliant's (formerly Sage Networks, Inc.) Consolidated
Financial Statements and Notes thereto, the Unaudited Pro Forma Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this prospectus. The
statement of operations data for the period ended December 31, 1997 and the year
ended December 31, 1998, and the balance sheet data as of December 31, 1997 and
1998, are derived from the consolidated financial statements of Interliant that
have been audited by Ernst & Young LLP, independent auditors, whose report with
respect thereto is included elsewhere in this prospectus. The statement of
operations data for the three months ended March 31, 1998 and 1999 and the
balance sheet data as of March 31, 1999 have been derived from the unaudited
financial statements included in this prospectus. We believe that the unaudited
historical financial statements contain all adjustments needed to present fairly
the information in those statements, and that the adjustments made consist only
of recurring adjustments.
The unaudited pro forma statement of operations data for the year ended
December 31, 1998 and for the three months ended March 31, 1999 assumes that the
acquisitions completed in 1998 and 1999 had occurred on January 1, 1998, and
includes the historical consolidated statements of operations of Interliant,
adjusted for the pro forma effects of such acquisitions. The unaudited pro forma
balance sheet data gives effect to the exercise in April 1999 of warrants to
purchase 749,625 shares of common stock for gross proceeds of $5.0 million. See
"Description of Capital Stock -- The SOFTBANK Investment." The unaudited pro
forma as adjusted balance sheet data gives effect to the conversion of 2,647,658
shares of Series A Redeemable Convertible Preferred Stock into shares of common
stock upon consummation of this offering (see "Description of Capital
Stock -- The SOFTBANK Investment") and the sale of 7,000,000 shares of common
stock offered hereby.
Results of operations for the period from inception to December 31, 1997
and for the year ended December 31, 1998 and for the three months ended March
31, 1999 are not necessarily indicative of results of operations for future
periods. Interliant's development and expansion activities, including
acquisitions, during the periods shown below may significantly affect the
comparability of this data from one period to another. The unaudited pro forma
statement of operations data is not necessarily indicative of the results of
operations that would actually have occurred if the transactions had been
consummated as of January 1, 1998 and is not intended to indicate the expected
results for any future period. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
----------------------------------------------------------- ---------------------------
PERIOD FROM
DECEMBER 8,
1997 THREE MONTHS THREE MONTHS THREE MONTHS
(INCEPTION) TO YEAR ENDED ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1998 1999 1998 1999
-------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................... $ -- $ 4,905 $ 13 $ 5,434 $ 41,292 $ 10,341
Costs and expenses:
Cost of revenues............ -- 3,236 54 3,251 20,291 5,976
Sales and marketing......... -- 2,555 111 1,896 9,394 3,487
General and
administrative............ 156 5,121 256 3,700 20,575 5,559
Depreciation................ 2 696 9 700 3,820 1,279
Amortization of
intangibles............... -- 2,439 2 2,594 24,085 6,021
Start-up and acquisition
integration costs......... -- 1,728 134 1,063 1,728 1,063
---------- ---------- ---------- ----------- ----------- -----------
Operating loss................ (158) (10,870) (553) (7,770) (38,601) (13,044)
Interest income and other non-
operating expense........... -- 138 14 12 (429) (138)
---------- ---------- ---------- ----------- ----------- -----------
Net loss...................... $ (158) $ (10,732) $ (539) $ (7,758) $ (39,030) $ (13,182)
========== ========== ========== =========== =========== ===========
Net loss per share -- basic
and diluted................. $ (0.05) $ (1.22) $ (0.18) $ (0.31)
Weighted average shares used
in computing net loss per
share -- basic and
diluted..................... 3,000,000 8,799,432 3,000,000 24,769,890
Pro forma net loss per
share -- basic and
diluted..................... $ (2.47) $ (0.46)
Shares used in computing pro
forma net loss per share --
basic and diluted........... 15,829,762 28,626,240
</TABLE>
21
<PAGE> 25
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
AS OF AS OF ----------------------------------
DECEMBER 31, DECEMBER 31, PRO FORMA
1997 1998 ACTUAL PRO FORMA AS ADJUSTED
------------ ------------ -------- --------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 912 $ 6,813 $ 4,376 $ 9,376 $ 65,652
Working capital.............................. 4,815 3,755 (5,462) (462) 63,814
Total assets................................. 4,953 26,197 100,897 105,897 161,597
Debt and capital lease obligations, less
current portion............................ -- -- 914 914 914
Redeemable convertible preferred stock....... -- -- 13,000 13,000
Total stockholders' equity................... 4,842 21,693 69,528 74,528 151,228
</TABLE>
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-------------------------------------------- ----------------------------
PERIOD FROM
DECEMBER 8,
1997
(INCEPTION) THREE MONTHS THREE MONTHS
TO YEAR ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1999 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
OTHER DATA:
EBITDA(1).......................... $ (156) $ (7,735) $ (4,476) $ (10,697) $ (5,744)
Net cash flows from operating
activities....................... (59) (6,001) (4,210)
Net cash flows from investing
activities....................... (29) (17,919) (21,807)
Net cash flows from financing
activities....................... 1,000 29,821 23,580
Net capital expenditures........... 29 4,322 984
</TABLE>
- ---------------
(1) EBITDA represents earnings before net interest expense, income taxes,
depreciation and amortization and other income (expense). EBITDA is
presented because it is a widely accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the basis
of operating performance and because our management believes that EBITDA is
an additional meaningful measure of performance and liquidity. EBITDA is not
intended to present cash flows for the period, nor has it been presented as
an alternative to operating income (loss) as an indicator of operating
performance and should not be considered in isolation or as a substitute for
measures of performance prepared in accordance with generally accepted
accounting principles. The items excluded from the calculation of EBITDA are
significant components in understanding and assessing our financial
performance. Our computation of EBITDA may not be comparable to the
computation of similarly titled measures of other companies. EBITDA does not
represent funds available for discretionary uses. See Interliant's (formerly
Sage Networks, Inc.) Consolidated Financial Statements and Notes thereto
appearing elsewhere in this prospectus.
22
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following description of our financial condition and
results of operations in conjunction with the Consolidated Financial Statements
and the Notes thereto and the Unaudited Pro Forma Consolidated Financial
Statements included elsewhere in this prospectus. This discussion contains
forward-looking statements based upon current expectations that involve risks
and uncertainties. Any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Our actual
results and the timing of certain events may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a discrepancy include, but are not limited to, those discussed in "Risk
Factors," "Business" and elsewhere in this prospectus.
OVERVIEW
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Our Web
hosting services provide virtual, dedicated and co-located hosting solutions to
meet the needs of businesses of all sizes, as their Web sites develop from
low-end marketing brochures to more complex, interactive Web sites and finally
to Web sites that are integral to the operating, marketing and sales and
customer support functions, or mission-critical, of a business. Our application
hosting services consist of groupware hosting and application outsourcing
solutions that can provide our customers with 24x7 remote access to
mission-critical applications and data required by their businesses.
During 1998 and 1999, our strategy has been to rapidly acquire operating
companies in the Web hosting and application hosting services businesses, to
build or acquire data centers, and to integrate the acquired operations into
those data centers. We acquired 17 operating businesses during 1998 and 1999 for
total consideration of approximately $85.2 million, including transaction costs.
We have accounted for all acquisitions using the purchase method of accounting
which has resulted in the inclusion of substantial intangible assets on our
balance sheet. Of the total consideration, we paid $7.9 million of assumed
seller debt and have or will allocate approximately $(9.7) million to tangible
net assets and $87.0 million to intangible assets which are comprised of
covenants not to compete, customer lists, assembled work force, trade names and
goodwill. In connection with acquisitions where specific intangible assets were
not stated in the purchase agreements, an allocation methodology was applied to
each acquisition to determine the value to be assigned to each type of
intangible asset where appropriate. Amounts not allocated to specific intangible
assets have been recorded as goodwill. Recoverability of our investment in
intangible assets is dependent on our ability to operate our business
successfully and generate positive cash flows from operations. Annual charges to
operations for amortization of intangible assets will be approximately $25.4
million, which will result in increased losses or reduced net income. During
1998, we charged approximately $2.4 million of amortization of the intangible
assets to operations. Additionally, during 1998 we issued stock valued at
approximately $2.6 million as compensation in connection with agreements entered
into with sellers of acquired operating businesses. During 1998, we amortized
and charged to operations approximately $0.8 million of deferred compensation.
The purchase consideration for the acquisitions was in the form of cash, stock
or a combination of cash and stock. See "Business -- Acquisition Program."
Most of the operating businesses we acquired in 1998 have been small and
entrepreneurial in nature and highly dependent on the focus and attention of the
owners. It has been our experience that during the negotiation period prior to
an acquisition, the attention of the owners has been diverted from the operation
of the business. The result of this has often been a modest revenue decline
immediately following the closing of the acquisition. In most cases, the owner
continued to have direct responsibility for the acquired business, but in some
instances, we re-assigned the owner to take advantage of unique skill sets that
have broad application within our operations. In those cases, the operating
businesses have experienced a modest decline in revenues due to loss of
customers. These factors resulted in minimal aggregate internal growth in 1998
for us and the businesses we acquired.
23
<PAGE> 27
Since our inception in December 1997, we have experienced operating losses
and negative cash flows from operating activities for each quarterly and annual
period. As of December 31, 1998, we had an accumulated deficit of approximately
$10.9 million. Had the companies acquired to date been included since January 1,
1998, our accumulated deficit would have been $39.2 million. The revenue and
income potential of our business is unproven and its limited operating history
makes an evaluation of us and our prospects difficult. We anticipate increased
operating expenses as we:
- expand our sales and marketing initiatives to continue to grow our
brands;
- fund greater levels of product development;
- continue to complete and equip our data centers;
- implement centralized billing, accounting and customer service systems;
and
- continue our acquisition program.
Although we have experienced revenue growth, primarily attributable to
acquisitions, we do not believe that this growth is necessarily indicative of
future operating results. Future acquisitions are expected to increase operating
expenses and operating losses and as a result, we expect to incur operating
losses for the foreseeable future. We cannot assure you that we will ever
achieve profitability on a quarterly or annual basis, or, if achieved, that we
will sustain profitability. See "Risk Factors -- We have a history of
significant losses and these losses may increase in the future."
RESULTS OF OPERATIONS
We derive our revenues from Web hosting, enhanced Internet services and
consulting services. In March 1999, we acquired Interliant Texas to enter the
application hosting market. Revenues for our Web hosting business consist
primarily of hosting fees and setup fees, which cover costs incurred by us to
establish a customer's Web site. We provide virtual, dedicated and co-located
hosting. We charge our Web hosting customers a fixed amount for bandwidth
availability and incremental fees if those fixed amounts are exceeded. In
addition, our virtual Web hosting customers are also charged for disk space on a
server, dedicated hosting customers are charged for use of one or more dedicated
servers and our co-located customers are charged for the amount of physical
space such co-located customers' servers occupy. We charge flat rates for our
enhanced Internet services. For application hosting, our revenues are comprised
primarily of a one-time implementation fee and monthly usage fees per number of
end users, including bandwidth fees. For our consulting services, we charge
either a fixed fee or a fee based on time and materials.
Our contracts with our Web hosting customers typically range in length from
month-to-month to one year, a large proportion of which are cancellable by
either us or our customers with 30 days notice. Our contracts with our
application hosting customers typically range in length from one year to three
years. Revenues derived from hosting are recognized ratably over the applicable
contractual period. Payments received and billings in advance of providing
services are deferred until such services are provided. Revenues from consulting
services are recognized as the services are rendered. Substantially all of our
consulting contracts call for billings on a time and materials basis. We are
aware that the Staff of the Securities and Exchange Commission is developing a
Staff Accounting Bulletin on the topic of revenue recognition. There can be no
assurance as to what revenue recognition policies will be required by the Staff
when that Bulletin is released. If that Bulletin requires revenue recognition
policies different from those we are currently using, our results of operations
may be materially affected.
Cost of revenues consists primarily of salaries and related expenses
associated with consulting and network operations personnel as well as data
communications expenses, including one-time fees for circuit installation and
variable recurring circuit payments to network providers. Monthly circuit
charges vary based upon circuit type, distance and usage, as well as the term of
the contract with the carrier.
Sales and marketing expense consists of personnel costs associated with the
direct sales force, the internal telesales group and product marketing
employees, as well as costs associated with marketing
24
<PAGE> 28
programs, product literature, external telemarketing costs and corporate
marketing activities, including public relations.
Start-up and acquisition integration costs consist primarily of salaries
for our acquisition and integration team as well as related travel expenses.
General and administrative expense includes the cost of customer service
functions including:
- finance;
- accounting;
- human resources;
- legal and executive salaries; and
- fees paid for professional services and corporate overhead.
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Revenues
Revenues were $5.4 million for the three months ended March 31, 1999
representing an increase of $5.4 million from the comparable 1998 period. The
increase in revenues was due primarily to the 15 acquisitions consummated during
the last three quarters of 1998 and the first quarter of 1999.
On a pro forma basis, giving effect to acquisitions completed to date,
revenues for the quarter ended March 31, 1999 were $10.3 million. Interliant
Texas accounted for 44.8% of such revenues. Revenues for Interliant Texas were
$4.6 million for the quarter ended March 31, 1999 compared to $4.8 million for
the quarter ended March 31, 1998. This decrease was due to lower bandwidth
charges to our customers in 1999.
For the three months ended March 31, 1999, on a pro forma basis and giving
effect to acquisitions completed to date:
- Web hosting revenues comprised 31.4% of our revenues;
- application hosting revenues comprised 44.8% of our revenues;
- consulting services revenues comprised 16.0% of our revenues; and
- each of disk space, excess bandwidth and one-time implementation fee
revenues have been de minimis.
Cost of Revenues
Cost of revenues increased by $3.2 million for the three months ended March
31, 1999. This increase was attributable to the 15 acquisitions consummated
during the last three quarters of 1998 and the first quarter of 1999. In the
future, cost of revenues may fluctuate due to capacity utilization, the timing
of investments in data centers, changes in the mix of services, fluctuations in
bandwidth costs and increased levels of staffing.
On a pro forma basis, giving effect to acquisitions completed to date, cost
of revenues for the quarter ended March 31, 1999 were $6.0 million. Interliant
Texas accounted for 46.7% of such costs of revenues. Cost of revenues for
Interliant Texas were $2.8 million for the quarter ended March 31, 1999,
approximately the same as the amount for the quarter ended March 31, 1998.
Sales and Marketing
Sales and marketing expense increased by $1.8 million for the three months
ended March 31, 1999. This increase was attributable to the 15 acquisitions
consummated during the last three quarters of 1998 and the first quarter of
1999. A key component of our strategy is to significantly increase our sales and
25
<PAGE> 29
marketing activities for application hosting and Web hosting products. This will
include the expansion of our sales force, development of reseller and referral
partner channels and increased marketing efforts to grow recognition of our
brands. As a result, sales and marketing expenses will increase substantially in
future periods. We expect sales and marketing expenses for the year ending
December 31, 1999 to exceed $20.0 million.
On a pro forma basis, giving effect to acquisitions completed to date,
sales and marketing expense for the three months ended March 31, 1999 was $3.5
million. Interliant Texas accounted for 53.2% of such sales and marketing
expense. Sales and marketing expense for Interliant Texas were $1.9 million for
the three months ended March 31, 1999 compared to $1.5 million for the three
months ended March 31, 1998. This increase was attributable to increased
personnel in the sales force and the marketing staff.
General and Administrative
General and administrative expense increased by $3.4 million for the three
months ended March 31, 1999. This increase in general and administrative expense
was attributable to the 15 acquisitions consummated during the last three
quarters of 1998 and the first quarter of 1999 and increased investments in
infrastructure and levels of staffing to implement centralized billing,
accounting and customer service systems to integrate the operations of acquired
companies. Substantial staffing increases are expected to continue in future
periods.
On a pro forma basis, giving effect to acquisitions completed to date,
general and administrative expense for the three months ended March 31, 1999 was
$5.6 million. Interliant Texas accounted for 28% of such general and
administrative expense. General and administrative expense of Interliant Texas
was $1.6 million for the three months ended March 31, 1999 compared to $1.3
million for the three months ended March 31, 1998. This increase was
attributable to higher professional fees and training expenses.
Depreciation
Depreciation expense increased by $0.7 million for the three months ended
March 31, 1999. This increase in depreciation expense was attributable to the 15
acquisitions consummated during the last three quarters of 1998 and the first
quarter of 1999 and investment in plant and equipment by us to complete our data
center in Atlanta. We expect depreciation expense to increase in the future as
we continue to invest in data centers and systems to integrate future
acquisitions and support future growth.
On a pro forma basis, giving effect to acquisitions completed to date,
depreciation expense for the three month period ended March 31, 1999 was $1.3
million. Interliant Texas accounted for 53.8% of such depreciation expense.
Depreciation expense of Interliant Texas was $0.7 million compared to $0.5
million for the three month period ended March 31, 1998. This increase was due
to an increase in investment in computer hardware, primarily servers.
Amortization
Amortization expense increased by $2.6 million for the three months ended
March 31, 1999. This increase in amortization expense was attributable to the 15
acquisitions consummated during the last three quarters of 1998 and the first
quarter of 1999. We expect amortization expense to increase in future periods as
we continue to make additional acquisitions as well as reflect amortization of
intangibles associated with acquisitions consummated to date.
On a pro forma basis, giving effect to acquisitions completed to date,
amortization expense for the three month period ended March 31, 1999 was $6.0
million. Amortization expense related to the acquisition of Interliant Texas
represented 57.1% of such amortization expense.
Start-up and Acquisition Integration Costs
Start-up and acquisition integration costs increased by $0.9 million for
the three months ended March 31, 1999. This increase was attributable to our
continuing acquisition program and our expanded
26
<PAGE> 30
acquisition integration team, including salaries and travel expenses, and the
amortization of deferred stock compensation costs.
YEAR ENDED DECEMBER 31, 1998 AND 1997
Revenues
Our revenues increased by $4.9 million for the year ended December 31,
1998. This increase in revenues was primarily attributable to the 12
acquisitions consummated during 1998.
On a pro forma basis, giving effect to acquisitions completed to date,
revenues for the year ended December 31, 1998 were $41.3 million. Interliant
Texas accounted for 51% of such revenues. Revenues for Interliant Texas were
$21.2 million for the year ended December 31, 1998 compared to $16.9 million for
the year ended December 31, 1997. This increase was primarily due to an increase
in the number of higher revenue generating customers.
For the year ended December 31, 1998, on a pro forma basis and giving
effect to acquisitions completed to date:
- Web hosting revenues comprised 28.0% of our revenues;
- application hosting revenues comprised 51.3% of our revenues;
- consulting services revenues comprised 14.0% of our revenues; and
- revenues from disk space, excess bandwidth and one-time implementation
fee have each been de minimus.
Cost of Revenues
Cost of revenues increased by $3.2 million for the year ended December 31,
1998. This increase in cost of revenues was attributable to the 12 acquisitions
consummated during 1998. In the future, cost of revenues may fluctuate due to
capacity utilization, the timing of investments in data centers, changes in the
mix of services, fluctuations in bandwidth costs and increased levels of
staffing.
On a pro forma basis, giving effect to acquisitions completed to date, cost
of revenues for the year ended December 31, 1998 were $20.3 million. Interliant
Texas accounted for 58.5% of such cost of revenues. Cost of revenues for
Interliant Texas were $11.9 million for the year ended December 31, 1998
compared to $9.4 million for the year ended December 31, 1997. This increase was
primarily due to an increase in staffing, a change in mix of staff to higher
paid employees, including technical engineers, and increased connectivity costs
associated with network upgrades.
Sales and Marketing
Sales and marketing expense increased by $2.6 million for the year ended
December 31, 1998. This increase in sales and marketing expense was attributable
to the 12 acquisitions consummated during 1998. A key component of our strategy
is to significantly increase our sales and marketing activities for application
hosting and Web hosting products. See "Business -- Strategy" and "-- Marketing."
This will include the expansion of our sales force, development of reseller and
referral partner channels and increased marketing efforts to grow recognition of
our brands. As a result, sales and marketing expenses will increase
substantially in future periods.
On a pro forma basis, giving effect to acquisitions completed to date,
sales and marketing expense for the year ended December 31, 1998 was $9.4
million. Interliant Texas accounted for 71.6% of such sales and marketing
expense. Sales and marketing expense for Interliant Texas were $6.7 million for
the year ended December 31, 1998 compared to $4.4 million for the year ended
December 31, 1997. This increase was primarily due to an increase in staffing, a
change in mix of staff to higher paid employees and increased external marketing
costs.
27
<PAGE> 31
General and Administrative
General and administrative expense increased to $5.1 million for the year
ended December 31, 1998 as compared to $0.2 million for the period from December
8, 1997 (inception) to December 31, 1997. This increase in general and
administrative expense was attributable to the 12 acquisitions consummated
during 1998 and increased investments in infrastructure and levels of staffing
to implement centralized billing, accounting and customer service systems to
integrate the operations of acquired companies. Staffing for general and
administrative functions increased substantially late in 1998 and is expected to
continue to increase during 1999 and as a result, general and administrative
expense will increase substantially in future periods.
On a pro forma basis, giving effect to acquisitions completed to date,
general and administrative expense for the year ended December 31, 1998 was
$20.6 million. Interliant Texas accounted for 20.1% of such general and
administrative expense. General and administrative expense of Interliant Texas
was $4.1 million for the year ended December 31, 1998 compared to $2.9 million
for the year ended December 31, 1997. This increase was primarily due to an
increase in staffing, a change in mix of staff to higher paid employees,
increased training costs and increased telecommunications costs.
Depreciation
Depreciation expense increased by approximately $0.7 million for 1998. This
increase was due to the acquisition of approximately $5.7 million of furniture,
fixtures and equipment. This amount includes approximately $1.4 million acquired
with operating businesses we acquired during 1998. Investments included the
construction of and acquisition of equipment for our Web hosting facilities to
ensure high levels of service to our customers and capacity for future growth
and of technology and infrastructure to implement centralized billing,
accounting and customer service systems to integrate the operations of acquired
companies. We expect depreciation expense to increase in the future as we
continue to invest in data centers and systems to integrate future acquisitions
and support future growth.
On a pro forma basis, giving effect to acquisitions completed to date,
depreciation expense for the year ended December 31, 1998 was $3.8 million.
Interliant Texas accounted for 66.1% of such depreciation expense. Depreciation
expense of Interliant Texas was $2.5 million for the year ended December 31,
1998 compared to $1.6 million for the year ended December 31, 1997. This
increase was due to an increase in investment in computer hardware, primarily
servers.
Amortization
Amortization expense increased by approximately $2.4 million in 1998. The
amortization expense was attributable to intangible assets associated with the
12 acquisitions consummated during 1998. On a pro forma basis, giving effect to
acquisitions completed to date, amortization expense for the year ended December
31, 1998 was $24.1 million. Amortization expenses related to the acquisition of
Interliant Texas represented $13.8 million of such amortization expense. We
expect amortization expense to increase in the future as we continue to acquire
businesses.
Start-up and Acquisition Integration Costs
Start-up and acquisition integration costs increased by $1.7 million for
the year ended December 31, 1998. This increase was primarily attributable to
the 12 acquisitions consummated during 1998. We expect start-up and acquisition
integration costs to remain relatively constant in future periods.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations and acquisitions primarily
from private placements of equity. Net cash used in operations for the three
months ended March 31, 1999 was $4.2 million. This reflects primarily the net
loss for the period of $7.8 million along with changes in operating assets and
liabilities. Net cash used for investing activities for the three month period
ended March 31, 1999 was
28
<PAGE> 32
$21.8 million, of which $1.0 million was for purchases of furniture, fixtures
and equipment, and $18.9 million was for acquisitions of businesses. Net cash
from financing activities for the three month period ended March 31, 1999 was
$23.6 million, reflecting $24.0 million of proceeds from issuance of common
stock and preferred stock less issuance costs and repayment of debt under
equipment financing facilities.
We had $4.4 million in cash and cash equivalents at March 31, 1999. In
April 1999 the Company received $5.0 million for the issuance of common stock
upon the exercise of a warrant by SOFTBANK.
In connection with our acquisition of Interliant Texas, we assumed a
promissory note in favor of Mathew Wolf in the amount of $8.0 million and a
promissory note in favor of Erving Wolf in the amount of $7.9 million. Upon the
closing of this acquisition, we paid in full the note in favor of Erving Wolf,
and we canceled the note in favor of Mathew Wolf and replaced it with a note
issued by us for the same principal amount (the "Wolf Note") which bears
interest at a rate of 9% per annum and is payable in full upon the completion of
this offering.
In addition to funding ongoing operations and capital expenditures
including, without limitation, $4.0 million of expenditures planned to be made
in connection with the application hosting business, our principal commitments
consist of non-cancelable operating leases and contingent payments of earnouts
to certain sellers of operating companies acquired by us. If all earnout targets
are achieved in full, total payments pursuant to all earnouts will be $1.8
million in cash and 37,481 shares of common stock in 1999 and $1.3 million in
cash and 37,481 shares of common stock in 2000.
During 1998, we constructed a data center in Atlanta into which the
majority of the operating businesses we acquired have been or are being
integrated. We believe that this facility has the capacity to service a larger
number of customers than are currently serviced there. The cost of constructing
and equipping this facility was approximately $2.0 million. We intend to invest
approximately $5.0 million to construct and equip our data centers as more
operating businesses are acquired and integrated into these facilities, and as
sales and marketing efforts generate internal growth, requiring additional
servers, routers and related equipment. We may decide to construct one or more
additional facilities in 1999, dependent upon acquisition activity. Our current
anticipated level of capital expenditures for 1999 is expected to be
approximately $15.0 million, but may vary from that amount depending upon
acquisitions and changes in operating plans. As of July 7, 1999, we have
financed $1.3 million in capital equipment under a sale/leaseback arrangement.
We may seek additional financing under this arrangement in the future.
At March 31, 1999, restricted cash totaled $1.4 million. In connection with
our acquisition of Interliant Texas, we entered into an Assignment and
Assumption Agreement, dated March 10, 1999, pursuant to which we were assigned
all right, title and interest in and to, and assumed all obligations under, the
lease for the Houston data center. In connection with receiving the landlord's
consent to assignment of the lease, we were required to issue letters of credit
in favor of the landlord totaling approximately $0.7 million to replace the
letters of credit issued by Interliant Texas. The aggregate dollar amount which
may be drawn upon by the landlord under these letters of credit shall be reduced
at specified dates in specified amounts such that by August 8, 2000 all of the
letters of credit shall have lapsed. In addition, restricted cash includes
approximately $0.5 million held in escrow in connection with one of our
acquisitions and approximately $0.2 million held to secure outstanding letters
of credit used as deposits on our facilities.
We believe that our existing cash and cash equivalents together with the
net proceeds of this offering will be adequate to meet operating needs through
the end of 1999 and will provide enough funds to continue our acquisition
program through 1999. Thereafter, we expect to require additional financing. If
our plans or assumptions change or prove to be inaccurate, we may be required to
seek additional sources of capital or seek additional capital sooner than
currently anticipated. We may also seek to raise additional capital to take
advantage of favorable conditions in the capital markets. We have no credit
facility or other working capital credit line under which we may borrow funds
for working capital or other general corporate purposes.
29
<PAGE> 33
YEAR 2000 COMPLIANCE
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including our
own, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
State of Readiness. We have made a preliminary assessment of the Year 2000
readiness of our information technology, or IT, systems, including the hardware
and software that enable us to provide and deliver our solutions, and our non-IT
systems. Our plan consists of:
- quality assurance testing of our internally developed proprietary
software and systems;
- contacting third-party suppliers, vendors and licensors of material
hardware, software and services that are both directly and indirectly
related to the delivery of our solutions to our customers;
- contacting vendors of material non-IT systems;
- assessment of repair or replacement requirements;
- repair or replacement;
- implementation; and
- creation of contingency plans in the event of Year 2000 failures.
We have been informed by vendors of material hardware and software
components of our IT systems that their products are currently Year 2000
compliant. We are currently assessing the materiality of our non-IT systems and
will seek assurances of Year 2000 compliance from providers of material non-IT
systems. Until such testing is complete and such vendors and providers are
contacted, we will not be able to completely evaluate whether our IT systems or
non-IT systems will need to be revised or replaced. We plan to complete our Year
2000 evaluation during the second half of 1999.
Costs. To date, we have not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
our expenses have related to our internal staffing costs associated with the
evaluation process and Year 2000 compliance matters generally. This trend is
expected to continue in the future. At this time, we do not possess the
information necessary to estimate the potential costs of revisions to our
software and systems should such revisions be required or the replacement of
third party software, hardware or services that are determined not to be Year
2000 compliant. Although we do not anticipate that such expenses will be
material, such expenses, if higher than anticipated, could have an adverse
effect on our business.
Risks. We are not currently aware of any Year 2000 compliance problems
relating to our IT or non-IT systems that would have a material adverse effect
on our business, results of operations and financial condition. We cannot give
you any assurance that we will not discover Year 2000 compliance problems in our
software and systems that will require substantial revisions. In addition, we
cannot give you any assurance that third party software, hardware or services
incorporated into our material IT and non-IT systems will not need to be revised
or replaced, all of which could be time consuming and expensive. Our failure to
fix or replace our software, hardware or services on a timely basis could result
in lost revenues, increased operating costs and the loss of customers and other
business interruptions, any of which could have an adverse effect on our
business. Moreover, the failure to adequately address Year 2000 compliance
issues in our IT and non-IT systems could result in claims of mismanagement,
misrepresentation or breach of contract and related litigation, which could be
costly and time-consuming to defend. In addition, we cannot give you any
assurance that governmental agencies, utility companies, telecommunication
companies, other Internet service providers, third party service providers,
hardware and software manufacturers and others outside our control will be Year
2000 compliant. The failure by such entities to be Year 2000 compliant could
result in a systemic failure beyond our control, such as a prolonged
30
<PAGE> 34
Internet, telecommunications or electrical failure, which could also prevent us
from delivering our services to our customers, decrease the use of the Internet
or prevent users from accessing the Web sites of our customers. Any of these
occurrences could have an adverse effect on our business.
Contingency Plan. As discussed above, we are engaged in an ongoing Year
2000 assessment and have not yet developed any contingency plans. The responses
received from third-party vendors and service providers will be taken into
account in determining the nature and extent of any contingency plans.
INTEREST RATE RISK
We have limited exposure to financial market risks, including changes in
interest rates. At March 31, 1999, we had short-term investments of
approximately $2.1 million. These short-term investments consist of highly
liquid investments in debt obligations of highly rated entities with maturities
of between one and 90 days. These investments are subject to interest rate risk
and will fall in value if market interest rates increase. We expect to hold
these investments until maturity, and therefore expect to realize the full value
of these investments, even though changes in interest rates may affect their
value prior to maturity. If interest rates decline over time, this will result
in a reduction of our interest as our cash is reinvested at lower rates.
31
<PAGE> 35
BUSINESS
OUR COMPANY
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Hosting
services we provide include:
- Virtual hosting, or shared server hosting, which allows customers to
store their databases, applications or Web sites on a shared server which
is owned and maintained by us;
- Dedicated hosting, which allows customers to store their databases,
applications or Web sites on a server typically owned and maintained by
us that is dedicated solely to that customer;
- Co-located hosting, which allows customers to store their databases,
applications or Web sites on servers that they own but which are
maintained by us and are located in our data centers;
- Groupware hosting, which allows customers to store groupware applications
such as email, discussion forums and document libraries on computers
which we own and manage in our data centers; and
- Application outsourcing, which combines hosting services with prepackaged
applications that can be sold directly to our customers. By doing so, our
customers can quickly deploy a software application solution without
having to purchase hardware, software or network connections.
Since our inception in December 1997, we have grown rapidly through the
acquisition of 17 hosting and related Internet service businesses. We provide
Web hosting solutions to more than 47,000 customers, representing more than
79,000 active domains. We also host more than 10,000 customized Lotus Notes/
Domino based applications for more than 1,300 customers and believe that we are
the leading provider of Lotus Notes/Domino hosting solutions. We have two
state-of-the-art primary data centers in Atlanta and Houston and a recently
leased facility in Vienna, Virginia. Our Atlanta and Houston data centers are
monitored on a 24x7 basis and include sophisticated monitoring and diagnosis,
24x7 customer support, redundant and high-speed network connectivity and
uninterruptible power supply.
INDUSTRY BACKGROUND
Growth of the Internet. The Internet is experiencing significant growth
and is emerging as a global medium for communications and commerce.
International Data Corporation or IDC estimates that the number of Web users
worldwide will increase from approximately 97.3 million at the end of 1998 to
319.8 million by the end of 2002, a 34.6% compounded annual growth rate. IDC
also estimates that the number of Web users in the United States will increase
from approximately 51.6 million at the end of 1998 to 135.9 million by the end
of 2002, a 27.4% compounded annual growth rate. During this same period, the
number of business Web sites in the United States is projected by Forrester
Research, Inc. to increase from approximately 650,000 in 1998 to approximately
2.6 million in 2002, a 41.1% compounded annual growth rate. This growth in the
number of Web users and number of Web sites is being driven by a number of
factors including:
- the large and growing installed base of personal computers;
- easier and less expensive alternatives for Internet access;
- improvements in the speed, reliability and security of the Internet;
- commerce-enabling technologies;
- higher quality and more diverse content;
- an increase in the number of networked applications; and
32
<PAGE> 36
- the proliferation of broadband technologies that promise consumers
faster, more convenient access to the Internet.
Growth in Business Use of the Internet. The dramatic growth in usage
combined with enhanced functionality and accessibility have made the Internet an
increasingly attractive medium for businesses to:
- disseminate information;
- engage in e-commerce;
- build customer relationships;
- streamline and automate data-intensive processes; and
- communicate more efficiently with dispersed employees.
In the last several years, businesses have emerged with operating models
that are exclusively dependent on the Internet, while traditional businesses of
all sizes are working quickly to establish a Web presence. Many of these
businesses establish their initial online presence with a simple, static
brochure for marketing purposes. As they become more familiar with the Internet
as a communications platform, an increasing number of businesses are
implementing more complex, mission-critical applications on the Web including
sales, customer service, customer acquisition and retention, employee
communications and e-commerce between suppliers and business partners.
Trend Toward Outsourcing. According to Forrester Research, Inc., U.S.
firms are now spending approximately 25% of their overall IT budgets on
outsourcing services. These services include packaged application software
implementation and support, customer support and network development and
maintenance. Reasons for the growth in outsourcing include:
- the desire of companies to focus on their core businesses;
- the increased costs that businesses experience in developing and
maintaining their networks and software applications;
- the fast pace of technological change that shortens time to obsolescence
and increases capital expenditures as companies attempt to capitalize on
leading-edge technologies;
- the challenges faced by companies in hiring, motivating and retaining
qualified application engineers and IT employees; and
- the desire of companies to reduce deployment time and risk.
Trend Toward Web Hosting Outsourcing. Many businesses, both small and
large, lack the resources and expertise to cost-effectively develop and
continually enhance their Web sites with evolving technologies while maintaining
a network infrastructure that remains operational in the event of a hardware or
software failure as well as supports increased bandwidth capability as their
business grows. Small- to medium-sized businesses typically lack the IT
resources, capital and scale to design their own Web sites and install, maintain
and monitor their own Web servers and Internet connectivity. Large businesses
typically require state-of-the-art facilities and networks that are monitored
and managed on a 24x7 basis by experts in Internet technology and that can be
upgraded and scaled to meet the needs of mission-critical Internet applications
that may be integral to their businesses. As a result, we believe enterprises of
all sizes are seeking outsourcing arrangements to help:
- build effective Web sites;
- improve their sites' reliability and performance;
- provide continuous monitoring of their Internet operations; and
- reduce costs.
33
<PAGE> 37
Trend Toward Application Hosting Outsourcing. Businesses increasingly face
competitive demands to automate business processes. This problem has been
exacerbated by a shortage of IT professionals. Until recently, implementation of
Internet applications required development of in-house software applications or
the customization of existing packages. This made each implementation unique and
costly. It also made implementation time frames and costs unpredictable. We
believe that businesses of all sizes have a significant need to outsource the
hosting of Internet and other software applications to improve core business
processes, reduce costs and enhance their global competitive position.
OUR OPPORTUNITY
Today the hosting market is fragmented, consisting for the most part of:
- small local and regional providers who do not have the capital, resources
or capabilities to provide quality services at competitive prices;
- large national providers who focus on Internet connectivity rather than
on hosting; and
- consulting and Web design firms for which hosting is not their core
competency.
We believe that a significant market opportunity exists for a
nationally-recognized hosting solutions provider with the scale and expertise to
offer a wide range of value-priced services to businesses of all sizes.
Interliant believes that through the acquisition and consolidation of hosting
and enhanced Internet service businesses, a hosting provider can offer a full
range of services that enable businesses to deploy, use, expand and update their
Web sites and applications infrastructures more rapidly and cost-effectively
than internally developed solutions.
Web Hosting Opportunity. The market for Web hosting services can be
segmented into virtual, dedicated and co-located hosting. Virtual hosting
primarily addresses the needs of small- to medium-sized businesses and includes
such services as disk space, shared connectivity and certain value-added
services such as e-mail hosting, e-commerce tools and other specialized
offerings. Dedicated and co-located hosting services primarily address the needs
of medium- to large-sized businesses and include:
- dedicated server equipment owned by either the hosting provider or the
customer, with an emphasis on network reliability;
- 24x7 monitoring;
- dedicated and redundant bandwidth;
- flexibility to scale rapidly; and
- high-end, value-added services such as consulting services, systems
integration and links to legacy systems.
We believe we are well positioned to take advantage of the opportunities
which exist for a nationally-recognized Web hosting solutions provider with the
scale and expertise to offer a wide range of value-priced services to businesses
of all sizes.
Application Hosting Opportunity. Traditionally, enterprises faced with the
issues of internal development and maintenance of application hosting
capabilities have sought solutions from a variety of information technology
providers including system integrators, Internet service providers, hardware and
software vendors and telecommunication companies. Thus, these companies have had
to work with at least three independent suppliers: a software applications
provider, a systems integrator and a site hosting provider, or have had to
support implementation with in-house resources. There are inherent conflicts and
difficulties with this approach, as each supplier is dedicated to providing its
own specific product or service with only limited knowledge of the bundle of
products and services required to provide the complete business solution. We
believe that these trends create a substantial market opportunity for a
single-source solution that combines software from multiple vendors, hardware,
systems integration and Internet-based communications in an integrated service
offering. Interliant believes it is well-positioned to take advantage
34
<PAGE> 38
of these opportunities as companies realize the value a single-source hosting
service provider can offer in facilitating deployment and improving management
of their corporate intranet and extranet solutions as well as mission-critical
applications.
OUR SOLUTION
We are a provider of hosting solutions that enable our customers to deploy
and manage their Web sites and network-based applications more effectively than
internally developed solutions, and to take advantage of a single-source
solution for their Internet-enabled application software needs. We offer a
unique blend of technological expertise, partnering ability and understanding of
the business and licensing models which we believe are essential to succeed in
the hosting marketplace. We believe we have developed the infrastructure,
resources, application management expertise and industry relationships required
to capitalize on this emerging market opportunity.
We provide the following advantages to our customers:
Comprehensive Hosting Solutions. We are able to provide Web hosting
services that meet our customers' needs as their Web sites evolve from low-end
marketing brochures to more complex, interactive Web sites and finally to
applications that are integral to their businesses. In addition, our application
hosting services such as groupware hosting and application outsourcing can
provide our customers with continuously available remote access to applications
and data which are mission-critical. Finally, we offer consulting services and a
broad range of enhanced Internet services such as e-commerce capabilities,
multimedia hosting and community hosting.
Performance and Reliability. Our hosting solutions help to ensure that our
customers' Web sites and networking applications are continuously online and
deliver data rapidly to users. Our state-of-the-art data centers in Atlanta and
Houston provide high-quality performance and reliability through features such
as a redundant, high-speed, secure network architecture, continuous monitoring,
alternate power sources, environmental controls, regular data back-ups and a
fault-tolerant hosting platform. Our Network Operations Centers, or NOCs,
monitor Interliant's network on a 24x7 basis and allow its staff to minimize
service interruptions.
Cost Savings. Our customers benefit from our focus on hosting and the
capital and labor investments that we have made to support hosting and enhanced
Internet services. For customers to replicate our performance and reliability,
they would be required to make significant expenditures for equipment, personnel
and dedicated bandwidth. We believe that our hosting solutions are significantly
more cost-effective and reliable than in-house solutions, both for businesses
with low-end application requirements as well as for those businesses whose
Internet operations are mission-critical and require sophisticated application
support.
Customer Service. We are dedicated to providing the highest quality
customer service. We endeavor to provide rapid and accurate responses through
customer service personnel who can answer questions over the telephone or via
e-mail. In addition, our customer service organizations in Atlanta and Houston
can address technical problems on a 24x7 basis. We have invested in advanced
customer service software and call routing technology to streamline the customer
service process. We also offer customers who are hosted in our Atlanta data
center a self-service customer support alternative which provides online access
to account and billing data and site statistics such as disk storage capacity
and bandwidth utilization.
STRATEGY
Our objective is to become the industry benchmark in the hosting services
market by providing businesses with cost-effective, innovative solutions that
will allow them to capitalize on the potential of the Internet. To achieve this
objective, our strategy includes the following key elements:
Build the Interliant Brand. We believe we have established a strong brand
identity within the application hosting industry under the Interliant brand. Our
brand will be enhanced as we begin marketing Web hosting products under the
Interliant brand and will be further enhanced as acquired companies are
35
<PAGE> 39
assimilated under our brands. We intend to continue to build name recognition
for our brand and strengthen our brand recognition by marketing our full range
of services through an integrated marketing communications program using public
relations, print and online advertising campaigns and other strategic
initiatives as well as cooperative promotions with key hardware and software
vendors.
Continue Acquisition Program. We intend to continue our acquisition
program to capitalize on consolidation opportunities in the hosting and enhanced
Internet services market in the United States and overseas. We expect that these
acquisitions will also result in substantial operating synergies, greater
internal growth and cost savings. Further, we plan to capitalize on best
practices we may identify within acquired companies to maintain our competitive
advantage and to ensure ongoing delivery of high quality hosting services to our
customers.
Expand Multiple Sales Channels. We reach our customers through multiple
sales channels including a direct sales force, indirect sales through numerous
resellers and referral partners, inbound and outbound telesales and Web
marketing programs. We intend to continue expanding these channels to further
enhance our ability to attract customers of all sizes. As an example, we
recently launched our business partner program, creating standard incentives
across our entire product line to foster growth of our business partner network.
Leverage the Interliant Customer Base. We intend to capitalize on the
enhanced revenue potential of the customer bases of our acquired companies,
leveraging the numerous cross-selling opportunities of our expanded line of
branded service offerings. We will use our multiple sales channels, including
our direct sales force, to target specific customer segments within our diverse
customer base with relevant new product offerings to realize increased revenues.
For example, we believe that we can grow our revenues by cross-selling existing
Web hosting customers with application hosting and consulting services. Further,
we believe that by coordinating the sales efforts of our combined Web hosting,
application hosting and consulting sales forces, we can increase customer leads
and referrals. Finally, we intend to assimilate the customer bases of our
acquired companies into a unified customer information management system to
facilitate sophisticated analysis and segmentation of our total customer base
and thus enable us to maximize marketing and sales opportunities.
Develop Strategic Relationships. We have established and continue to seek
strategic relationships that enhance our infrastructure and distribution
capabilities and broaden our product offerings. We believe that our strategic
alliances with companies such as IBM Corporation, Lotus Development Corporation,
Microsoft Corporation, UUNET Technologies, Inc., Equant, N.V., Allaire
Corporation, Elemental Software, Inc. and iMall, Inc. enable us to provide
complete, scalable and reliable hosting solutions to our customers, resellers
and referral partners.
SERVICES
Our service offerings comprise three main areas: Web hosting, application
hosting and consulting.
36
<PAGE> 40
WEB HOSTING SERVICES
We offer a comprehensive suite of solutions to meet the current and future
Web hosting needs of our customers. We provide virtual, dedicated and co-located
hosting services.
<TABLE>
<CAPTION>
HOSTING WEB SITE CUSTOMER
SERVICES PRICE* PROFILE KEY FEATURES BENEFITS
- -------- ------------ ---------------- ----------------- --------------
<S> <C> <C> <C> <C>
Virtual $25-$350 Static Web Shared space on Economical
per month pages, Interliant-owned
moderately server
accessed sites
Dedicated $100-$5,000 Dynamic Web Dedicated Greater server
per month content, heavily Interliant-owned resources
accessed sites server in shared requiring
rack minimal
customer
maintenance
Co-Located $500-$40,000 Mission-critical Secure cabinet Greater
per month applications for customer- customer
owned server control/access
to hardware
</TABLE>
- ---------------
* Prices are representative for products marketed under the Sage Networks and
Interliant brands and may not be representative for our products marketed
under other brand names.
All product offerings hosted in the Atlanta and Houston data centers are
designed to achieve optimal performance through features such as:
- sophisticated monitoring, notification and diagnosis;
- 24x7 customer support through the NOCs and customer service centers;
- remote access management and reporting tools;
- a high-speed network designed to continue operating in the case of any
software or hardware failure;
- uninterruptible power supply, including back-up generators capable of
sustaining server operations for more than one week;
- firewall, intrusion monitoring and site security auditing;
- full daily back-ups with off-site storage;
- air-conditioned, static and humidity controlled environment; and
- high level of physical security.
It is our intention that all product offerings marketed under our brands and
hosted at data centers other than Atlanta and Houston also have the above
features. Customers generally pay monthly, quarterly or annual fees for the
services used, as well as one-time fees for installation and any equipment
purchased by the customer.
On a pro forma basis, giving effect to acquisitions completed to date, Web
hosting revenues comprised 28.0% of our revenues in the year ended December 31,
1998 and 31.4% of our revenues for the three months ended March 31, 1999.
Although we do not account for revenues based on the virtual, dedicated and
co-located components of our Web hosting product offerings, we derive a
substantial majority of our revenues from virtual hosting as 84.0% of active
domains managed by us at March 31, 1999 are virtual hosting domains.
37
<PAGE> 41
Virtual Hosting. Our virtual hosting solution provides customers with all
the elements needed to establish a basic presence on the Web at a reasonable
cost. This entry-level service is known as virtual hosting because the
customer's home page has its own domain name, www.mycompany.com, and appears to
exist as a stand-alone server. It operates with the speed and efficiency of
Interliant's high-speed connections and its location at our facility remains
invisible to Web site visitors. Customers are able to have their own Web site
with a domain name at a fraction of the cost of maintaining it themselves. As a
result, virtual hosting is an economical solution for relatively simple or
moderately accessed Web sites. Because customers do not need to invest in costly
hardware or personnel to accommodate future growth, we believe this solution
also maximizes the customers' flexibility.
For these accounts, we host the site on a UNIX or Windows NT server that is
shared by multiple customers. Prices for virtual hosting products marketed under
the Sage Networks and Interliant brands range from $25 to $350 a month,
depending on the data transfer limit, storage capacity, number of e-mail
accounts provided and additional functionality requested such as e-commerce
capabilities, multimedia hosting and community hosting. For certain customers of
acquired businesses, the price range may be lower depending upon the
functionality of the services and reflecting a lower level of services requested
by such customers. In 1998, our average virtual hosting customer paid
approximately $20 per month.
Dedicated Hosting. As companies increase the complexity, level of traffic
or reliance on their Web sites, they may prefer to host their Web site on a
dedicated server, which is typically owned and maintained by us. A dedicated
server provides greater server and network resources to our customers than
virtual hosting and allows them to configure their hardware to optimize site
performance. Customers receive a high level of site security, maintenance, and
technical support without the prohibitive costs of setting up and maintaining
their own server and Internet connection. We support most leading Internet
hardware and software system vendor platforms, including Solaris which operates
on a Sun Microsystems, Inc. platform, Microsoft Windows NT which operates on a
Intel/PC platform and Linux which operates on a Cobalt Networks, Inc. platform.
Prices for dedicated hosting products marketed under the Sage Networks and
Interliant brands range from $100 to $5,000 a month, depending upon the hardware
configuration, bandwidth requirements and additional features that may be
requested by our customers. For certain customers of acquired businesses, the
price range may be lower. In 1998, our average dedicated hosting customer paid
$1,000 per month.
Co-located Hosting. We currently provide co-located hosting services in
our Atlanta and Washington, D.C. area data centers for customers with
sophisticated, mission-critical applications. This solution allows the customer
to own and access their servers on a 24x7 basis while delegating the day-to-day
management of their Web site to our IT specialists. In addition, co-located
servers are housed in separate, limited-access rooms in our data center. Prices
for co-located products marketed under our Sage Networks and Interliant brands
range from $500 to $40,000 a month, which incorporates fees such as bandwidth
charges and space. Bandwidth is the capacity of a telecommunications network to
carry voice, data and video information. For certain customers of acquired
businesses, the price range may be lower. In 1998, our average co-located
customer paid $750 per month.
We also provide the following enhanced Internet services to our Web hosting
customers:
E-commerce Capabilities. Through our reseller relationships, we offer a
variety of e-commerce solutions to help businesses create and maintain a
successful Web storefront. E-commerce provides businesses the ability to sell
products and services on the Internet. The e-commerce capability can be added to
an existing Web site or it can be the basis for a Web site, starting with the
customer's product catalog. Representative e-commerce offerings include:
- a full suite of Internet payment solutions offered by CyberCash, Inc.,
including payment services for credit card, micropayment and Internet
check transactions;
- ShopSite from Open Market, Inc. which allows users to build quickly a
simple catalog and begin taking orders; and
38
<PAGE> 42
- SoftCart from Mercantec which allows users to create sophisticated
e-commerce Web sites that includes order taking, credit card processing
and order fulfillment.
Multimedia Hosting. We allow our customers to include various multimedia
capabilities in their Web sites, including integrated text, graphics, video,
information and sound capabilities. With the acquisition of Telephonetics
International, Inc., we have added audio production and hosting capabilities to
the suite of Internet services available to our customers. In addition, we
provide our customers with the ability to include Real Networks and Microsoft
NetShow content within their Web sites.
Community Hosting. We allow customers of all sizes to include
community-building features such as e-mail and chat hosting. We provide POP or
Post Office Protocol e-mail boxes that can be used to send and receive e-mail
from any connection to the Internet and include unlimited aliases, forwarding
and auto-responders. We also offer chat hosting through our relationship with
eShare Technologies.
APPLICATION HOSTING SERVICES
We offer application hosting services which consist of groupware hosting
and application outsourcing solutions that provide our customers with 24x7
remote access to applications and data that are integral to their businesses.
On a pro forma basis, giving effect to acquisitions completed to date,
application hosting revenues comprised 51.3% of our revenues in the year ended
December 31, 1998 and 44.8% of our revenues for the three months ended March 31,
1999.
Groupware Hosting. We offer our customers a broad spectrum of groupware
hosting solutions for Lotus Notes/Domino, the industry-leading groupware
platform. Our groupware hosting solutions allow our customers who want to work
together collectively while located remotely from each other to store software
applications that facilitate this type of work environment on a computer that we
own and manage for them. Our groupware hosting services provide support for the
following:
- feature-rich e-mail and other types of messaging for internal and
external communication;
- workgroup and project team collaboration and document sharing;
- business process automation and workflow; and
- proprietary or custom applications built for the groupware platform.
We also can provide our customers with sophisticated, collaborative
Web-based intranets and extranet. An intranet is an Internet network which
usually belongs to a corporation and is accessible only by employees, or others
who have authorized access. An extranet is basically an intranet that provides
various levels of accessibility to outsiders who through a user name and
password can access selected parts of the extranet. We seek to provide the
following benefits to our customers hosting their groupware implementations with
us:
- reduced deployment time and risk;
- reduced day-to-day operational responsibility, allowing in-house IT
departments to focus on creating strategic value;
- lower ongoing cost;
- no capital investment in servers, facilities and other infrastructure;
- access to emerging technologies and improved responsiveness to change;
and
- 24x7 operations, high availability, rapid scalability and robust
security.
Customers generally pay monthly fees for the services offered, as well as
one-time fees for installation and deployment services. Customers typically sign
one- to three-year service contracts. Our customers have the option of using
shared or dedicated servers in one of our data centers for their groupware
hosting
39
<PAGE> 43
services, or can have their on-premise server managed by our customer-managed
server offering. Prices for our groupware hosting services range from $1,500 to
over $100,000 a month.
We provide hosting for groupware applications that are specifically
tailored for a Lotus Notes/Domino operating environment on both shared and
dedicated servers at one of our data centers or on the customer's premises. The
hosted servers support connections to:
- geographically dispersed Lotus Domino servers for messaging and
replication;
- Lotus Notes clients for remote access to e-mail and Lotus Notes
applications; and
- Web browsers for intranets and extranets.
Customers can connect to our servers using the Internet or a variety of
private network options, including frame relay, dedicated lines and local dialup
access in more than 105 countries. We provide messaging gateway services for
Lotus Domino, including:
- Internet e-mail;
- X.400 mail;
- Lotus cc:Mail;
- fax; and
- a variety of pager networks.
In addition, we and certain customers have established a Lotus
Domino/Microsoft Exchange messaging interoperability technology pilot program
which will allow users of both systems to communicate electronically, and we are
considering further expansion of this program to enhance our Microsoft Exchange
hosting offering.
As part of our groupware hosting implementation process, we start with what
we believe to be the best available system configurations and work with our
customers to modify them to the customer's specific needs. Customers may choose
from a wide variety of hardware capacity and availability options, including
RAID, or Redundant Array of Inexpensive Disks, storage and full server
clustering. Once installed, we not only monitor server hardware, operating
system and application-level system performance, but also can provide full
server administration services including adding or deleting users, database
installation, access control changes and other required server administration
tasks.
This groupware hosting service is also available for custom implementations
in conjunction with Interliant's consulting service offerings.
Application Outsourcing. Our application outsourcing offers customers an
integrated solution that combines packaged application software with managed
hosting services. We believe we are an industry leader in forging strategic
relationships with leading application developers and other key partners to
deliver these best-of-breed solutions. Through such strategic relationships, we
enable businesses of all sizes to capitalize on the latest Internet-enabled
technologies while outsourcing non-core business operations such as deployment
and migration strategies and maintenance or software upgrades to a third party.
Our branded application hosting services address the following major business
process areas:
- Legal Automation. Our legal automation solutions offer customers a suite
of collaborative applications that assist attorneys in securely and
reliably managing litigation, intellectual property matters and general
workflow within corporate legal departments and law firms. These
applications can be customized, deployed, supported and fully managed on
dedicated or shared servers at our data centers. The legal automation
suite of applications currently encompasses both Web-based and client
server applications that are priced from $100 to $300 per user per month,
as well as Internet rental applications that are priced as low as $20 per
user per month.
40
<PAGE> 44
- Sales Automation. Our sales automation services provide geographically
distributed sales and marketing organizations with all the elements
needed to quickly deploy a sales automation solution at a reasonable
cost. These solutions include modules for
- opportunity management;
- contact and account management;
- revenue forecasting reports;
- an integrated group calendar;
- automated proposal generator;
- pricing information;
- telesales campaign management; and
- correspondence and fulfillment in a shared hosting environment.
We believe that selling application outsourcing as part of a package of
hosting services rather than as a product to be installed and managed by
the customer, reduces the customer's initial capital investment, thereby
making it easier to minimize the customer's technology risk. Accordingly,
it also allows us to engage clients in long-term contracts with fixed
monthly payments. The application solution is customized, deployed, and
fully managed and supported by us, providing a single-source solution to
customers. We partner with leading packaged commercial software vendors,
hardware vendors and system integrators to deliver these solutions.
Our sales automation services can be accessed through our secure network
using a variety of dial-up or dedicated access methods on a 24x7 basis,
leading to more efficient practices and effective communications. The
solution can be easily configured to the customer's selling methodology
and can be deployed within 30 days. The solutions range in price from $100
to $200 per user per month depending upon the application features,
hardware configuration and amount of disk storage needed.
- Distributed Learning. Distributed Learning over the Web represents a
broad, horizontal market for us, with opportunities to deliver online
training in virtually all market segments. Working with leading software
technology vendors, best-of-breed content providers and business
partners, we offer comprehensive solutions for corporate, academic, and
non-profit customers. These solutions encompass:
- browser based, asynchronous or any time, any place learning
technologies;
- browser based, synchronous or same time, any place learning
technologies;
- sophisticated course and student management systems;
- online facilitation; and
- application sharing.
In addition, our distributed learning solutions leverage our core
competencies: Web hosting, multimedia technology and e-commerce, to
deliver a complete package to our customers.
Layering distributed learning know-how and functionality on top of our
existing infrastructure services allows us to quickly deliver
cost-effective solutions. Our Distributed Learning services are priced on
a "per user per course," or a "per person per year" basis, with the
typical cost of instruction per user per course in the range of $20 to
$75. Costs are driven largely by the course's duration and complexity, as
well as by the range of application level services that the customer
desires. Deployment of existing courses is very rapid, with students
typically able to access courses within a few days following registration.
- Rental Applications. We are working to create a new generation of 100%
Web-based application solutions that are designed to be delivered as
services over the Internet. No installation is required
41
<PAGE> 45
as users need only a Web browser and an Internet connection to select,
set up, configure and use a rental application. Pricing models vary based
on application usage models, but are all inclusive of the fees for
application licensing, hosting, and basic support. We establish
partnerships with software vendors to create these application services,
many of which will be based on Lotus Domino Instant!Host, a platform for
application hosting service providers co-developed by us and Lotus. We
have established a portal site, www.appsonline.com, that contains a
catalog for these Internet rental applications.
Our first Internet rental application is Lotus Instant!TEAMROOM, a
"teamware" collaboration tool available for a $14.95 monthly fee per end
user which allows distributed teams to discuss issues, share documents,
and track action items. Additional rental application services in
development include teamware for specific vertical market segments, an
application which allows companies to hold private auctions online, and
more sophisticated collaboration tools for project management,
calendaring and scheduling and document management.
CONSULTING SERVICES
We provide consulting services for Intranet, extranet and application
hosting solutions, as well as for internal networking implementations and
back-end Web development projects. In addition, we provide support for our
customers' enterprise networking needs. Our consulting services are scaled to
meet each client's needs. We address the complete spectrum of services,
including:
- desktop and network server support;
- network architecture and design;
- local area network, wide area network and virtual private network design;
- strategic technology planning;
- application development and implementation; and
- Web hosting.
On a pro forma basis, giving effect to acquisitions completed to date,
consulting services revenues comprised 14.0% of our revenues in the year ended
December 31, 1998 and 16.0% of our revenues for the three months ended March 31,
1999.
ACQUISITION PROGRAM
Since inception, we have acquired 17 companies and intend to continue our
acquisition program. Specifically, we seek to identify businesses which will
generate a positive return on investment and:
- expand our customer base;
- complement and expand our product and service offerings;
- enhance our engineering and technical capabilities;
- strengthen our reseller and referral partner relationships; and/or
- broaden our management team.
We believe that the integration of acquired companies will create economies of
scale and generate significant operating efficiencies. Because of our ongoing
acquisition strategy, we expect that at all times some portion of our acquired
companies will be in various stages of integration. We seek to identify areas in
which acquired companies outperform our competitors and adopt their best
practices. Once we acquire a company, a multi-disciplinary team begins the
four-step integration process:
Technical Integration. Technical integration begins with the physical move
of the acquired company's equipment into one of our facilities. Generally, the
customers of the acquired company are then
42
<PAGE> 46
migrated onto our hosting platforms. Migration entails duplicating the server
contents onto a new server, which runs in parallel for a test period, before
being switched over. For Web sites with real-time databases or customized
applications, the process can become significantly more complex. Our platform is
typically more robust than that of the acquired company and standardization
allows us to manage the servers more efficiently. In certain circumstances,
however, we find that it is not strategic or cost-effective to migrate customers
to our platform.
Customer Service Integration. We integrate our customer service operations
for our acquired Web hosting customers at our data center in Atlanta and for our
application hosting customers in Houston. By centralizing hosting customer
service, we believe that we can improve performance while reducing costs. In
Atlanta, we have implemented the Vantive Support system, a customer/asset
management tracking application, which enables a customer service representative
to view a customer's entire account, including past and recent interactions with
the customer. Further, the Vantive Support system provides a resolution database
that recognizes and documents support records into a central repository that can
be accessed by all customer service personnel.
Business Systems Integration. Many of the businesses we acquire do not
have adequate back-office systems or procedures. As a result, we are in the
process of transitioning acquired companies onto the PORTAL Infranet billing
system. With PORTAL Infranet, our resellers, referral partners and customers
will be able to obtain monthly statements delivered electronically which we
believe will provide them with easy access to, and accurate tracking of our
hosting expenditures. In particular, we believe that PORTAL will allow resellers
and referral partners to add new products and services, as well as pricing
discounts and incentive programs, in a timely and cost-effective manner.
Product Integration. We expect to integrate the majority of our acquired
companies into our product line, with uniform branding, pricing strategies and
distribution channels. In certain cases, however, where an acquired company's
brand is already established, we may for a period of time continue to market
certain products and services under the existing brand in order to capitalize on
the competitive advantages the acquired brand name may bring to us. Our
long-term goal, however, is to migrate most product offerings to our brand.
43
<PAGE> 47
The following chart identifies the 17 hosting and Internet-related service
companies acquired by Interliant, or from which we have acquired significant
assets.
<TABLE>
<CAPTION>
DATE NAME PRIMARY FOCUS LOCATION
- ---- ---- ------------- --------
<S> <C> <C> <C>
February 13, 1998.... Omnetrix, Inc. (dba "DirectNet") Web hosting Los Angeles, CA
April 7, 1998........ Clever Computers, Inc. Web hosting Atlanta, GA
April 30, 1998....... Server and Network connectivity Web hosting McLean, VA
assets from Knowledgelink
Interactive, Inc.
May 1, 1998.......... Tri-Star Web Creations, Inc. Web hosting New York, NY
June 10, 1998........ HostAmerica, a division of HomeCom Web hosting Atlanta, GA
Communications, Inc.
June 29, 1998........ All Information Systems, Inc. Web hosting Dallas, TX
July 1, 1998......... Software Business Technologies, Inc. Web hosting San Rafael, CA
Web Hosting Business Unit
July 1, 1998......... DevCom (division of Nextron, Inc.) Web hosting San Jose, CA
July 30, 1998........ BestWare, Inc. (dba "Maikon") Web hosting Dallas, TX
August 31, 1998...... B.N. Technologies, Inc. (dba "ICOM") Web hosting Los Angeles, CA
September 16, 1998... GEN International Inc. Web hosting St. Petersburg, FL
(Global Entrepreneur's Network, Inc.)
December 17, 1998.... Dialtone, Inc. Web hosting Pembroke Pines, FL
February 4, 1999..... Digiweb, Inc. Web hosting College Park, MD
February 4, 1999..... Telephonetics International, Inc. Multimedia Miami, FL
February 17, 1999.... Net Daemons Associates, Inc. Consulting Woburn, MA,
Burlingame, CA
and Boulder, CO
March 10, 1999....... Interliant Texas Application Houston, TX and
hosting London, England
May 4, 1999.......... Advanced Web Creations, Inc. Web hosting Fairfield, NJ
</TABLE>
CUSTOMERS
We have established a diversified customer base across our service
offerings. Our customers include a variety of business types, ranging from small
office/home office companies through Fortune 500 companies. In addition, our
customers also include resellers of our services such as Web consulting firms,
Internet service providers, network integration companies and system integrators
who sell our services to their customers. We do not believe that the loss of any
one customer would materially adversely affect us.
Our contracts with our Web hosting customers generally cover services for a
period ranging from one month to two years. We provide hosting solutions to more
than 47,000 customers, representing more than 79,000 active domains. Our
contracts with our application hosting customers generally cover services for a
period ranging from one to three years. We host more than 10,000 customized
Lotus Notes/Domino based applications for more than 1,300 customers. Our
contracts with our consulting customers generally cover services on a
project-by-project basis, with project periods typically ranging from six months
to one year.
STRATEGIC RELATIONSHIPS
Our strategic relationships and partnerships with leading technology
companies allow us to provide a wide range of services to meet our customers'
needs. The following is a list of selected companies with whom Interliant has a
strategic relationship:
IBM Corporation. We are an IBM BESTeam partner and began offering the IBM
Net.Commerce Hosting Server product in January 1999. IBM currently lists
Interliant on its Web site as one of a select group of partners that are able to
offer this product. Interliant intends to introduce Net.Commerce hosting
services to our large reseller community as a world-class end-to-end e-commerce
solution. Interliant is also
44
<PAGE> 48
hosting IBM Net.Commerce Pro solutions for dedicated server customers who
maintain large e-stores and require large scale implementations. There is no
written contract that governs this relationship with IBM and either of us can
terminate this relationship at any time. Currently, we do not have any financial
commitments to IBM as a result of this arrangement, and we do not expect this
relationship to generate any material financial commitments for us in the
future.
Lotus Development Corporation. We believe we are a leading partner of
IBM's Lotus software division and are a Lotus Net Service Provider, Lotus Net
Service Provider/Alliance Partner, as well as a Lotus Premier Business Partner.
We provide a variety of messaging and hosting services for Lotus Notes/ Domino
Internet, intranet and extranet applications. We are currently listed by Lotus
on several sections of Lotus' Web site as one of a select group of partners that
provide hosting services for Lotus Notes/Domino and other Lotus application
solutions and have twice been recognized with Lotus' highest recognition, the
Lotus Beacon Award, most recently in January 1999.
We are parties to a Joint Development Agreement with Lotus Development
Corporation, dated April 27, 1998, which is scheduled to expire on April 27,
2000, but will be automatically renewed for additional one year terms unless
terminated by either party upon prior written notice. Under this agreement,
together with Lotus we co-developed Lotus' Domino Instant! Host platform, which
enables application developers to deploy and offer Web-based collaborative
applications. Under the terms of this agreement, we share joint development
responsibilities with Lotus. Terms of this agreement include:
- We are obligated to contribute proprietary computer code owned by us, to
name one of our employees as the project liaison and to provide
non-dedicated architectural and project management assistance to Lotus.
- Lotus is obligated to contribute substantially similar type of
intellectual property and personnel resources to the project.
- Lotus is obligated to pay us a royalty equal to 25% of the net revenues
received from licensing Instant! Host. The royalty percentage may be
adjusted at the request of Lotus not more than once with respect to each
new release of Instant! Host, however, such adjustment may not reduce the
royalty percentage by more than half the percentage in effect at that
time.
- We must pay Lotus at its standard rate for all copies of Instant! Host
which we desire to license.
- If Lotus engages in product development or promotional activities which
impact its ability to generate revenues from the sale of Instant! Host,
the agreement will terminate and Lotus will be obligated to pay us up to
$250,000 in penalties depending upon the amount of royalties paid to us
through the date of termination.
Microsoft Corporation. We are a Microsoft Certified Solution Partner, or
MCSP, and are currently engaged in several strategic initiatives with Microsoft.
We have entered into a co-marketing and promotion agreement whereby Microsoft
will include our advertisements in a catalog that is inserted into every
FrontPage 2000 product box that is packaged for retail sale. Microsoft has also
agreed that it will issue a press release on its Web site highlighting our joint
involvement in the promotion of FrontPage 2000. In return, we have agreed to
feature Front Page 2000 on our Web site with greater frequency and visibility
than any competing product and have agreed to offer either free Web hosting with
a value of up to $105 or free or reduced registration and set-up fees with a
value of up to $500, in order to induce the public to host a FrontPage 2000 Web
site. This agreement remains in effect until the earlier of the initial release
of the next version of FrontPage, Microsoft ceasing to produce FrontPage, or
December 31, 2000.
We are also participating in a Microsoft initiative called the Complete
Commerce program. In conjunction with selected other MCSP's, we will incent
customers seeking to engage in e-commerce activities on the Web to enter into
this program by offering a specially priced, all inclusive storefront hosting
package integrating shipping, credit card processing and tax elements. The
service will also include consulting and development of the storefront
application Web site, back-end integration and hosting activities. Microsoft
will provide resources to help us market this program, including promotional
activities,
45
<PAGE> 49
marketing activities and participation in the customer engagement activities.
Our marketing activities for the Complete Commerce program commenced in April
1999. This relationship may be terminated at any time by either party. We
currently have no material financial commitments under either of these
agreements; and we do not expect either of these agreements to generate any
material financial commitments for us in the future.
UUNET Technologies, Inc. On February 17, 1999 we entered into an agreement
with UUNET to be our primary connectivity provider on a worldwide basis. The
agreement is scheduled to expire on February 19, 2002, but will be renewed
automatically for an additional year unless either party notifies the other of
its intent not to renew. Terms of this agreement include:
- UUNET has agreed to provide and we have agreed to purchase monthly
minimum levels of connectivity ranging from 100 Mbps to 600 Mbps of
bandwidth.
- Upon execution of this agreement we were committed to purchase 100 Mbps
of bandwidth per month.
- Our minimum monthly bandwidth purchase commitment increases to 300 Mbps
starting in December 1999 and increases further to 600 Mbps in December
2000.
- - We have agreed that, if during the second and third years of this agreement,
we obtain over 600 Mbps of bandwidth per month for our Internet traffic, we
will purchase 51% of all bandwidth in excess of 600 Mbps from UUNET. If we do
not purchase 51% of all bandwidth over 600 Mbps from UUNET, we are obligated
to pay UUNET $21.66 for each Mbps we are obligated but fail to purchase from
them.
Under the terms of the agreement, the connectivity may range in capacity
from T-1 to DS-3 to OC-12 which are the technical names of the physical
telecommunications connections or pipelines that will be used to transport data.
A larger pipeline can carry a greater volume of data at a greater speed. For
example, a T-1 can carry 1.544 megabytes per second; a DS-3 can carry 44.736
megabytes per second and an OC-12 can carry 622 megabytes per second. At our
Atlanta data center, we are currently installing four OC-3 connections, each of
which can carry 155.52 megabytes of data per second, to diverse hubs in UUNET's
network which use diverse fiber for redundancy. In addition to the connectivity
provisions, our companies have agreed to develop and implement a joint marketing
program including:
- allowing us to resell UUNET services through our network of resellers;
- cooperating on mutually beneficial hosting and co-located remarketing
agreements; and
- cooperating on an international co-location facilities agreement.
Our minimum financial commitment during each year of the agreement is as
follows: $0.7 million in year 1; $2.1 million in year 2; and $4.1 million in
year 3.
Equant, N.V. We have entered into a Network Services agreement in which
Equant, N.V. provides worldwide local dialup (X.25 and PPP) and dedicated (frame
relay) connectivity from more than 160 countries. The original agreement expired
on December 31, 1997, and since then we have continually renewed it for
successive three month terms. The current term expires on September 30, 1999.
Equant, N.V. provides significant discounts to us and competitive pricing
assurances. In addition, Equant, N.V. has entered into a distribution agreement
with us, in which Equant, N.V.'s worldwide sales force is able to offer our
groupware and application hosting services to its customers. The distribution
agreement terminates on December 19, 1999. We currently have no material
financial commitments under either of these agreements, nor do we expect either
of these agreements to generate any material financial commitments for us in the
future.
46
<PAGE> 50
Allaire Corporation. Allaire markets and distributes proprietary
commercial computer software products such as Cold Fusion Enterprise Application
Server, Cold Fusion Professional Application Server and Home Site. We have a
worldwide non-exclusive fee-bearing license to:
- reproduce exact copies of these software products onto our servers and to
allow our customers to use these products;
- reproduce exact object code copies of the products; and
- market and distribute the products as stand-alone products or bundled
with our other product offerings.
This one-year agreement commenced on February 2, 1999 and will be automatically
renewed for another year unless either party notifies the other that it elects
not to renew within sixty days of the original termination date. Upon execution
of the agreement we paid Allaire an aggregate of $66,552 covering product user
and subscription fees, distribution copies, training fees and annual support
fees. We are also obligated to purchase five additional hosted copies, products
and subscriptions during each of the last three calendar quarters of the
original term of the agreement at an aggregate price of approximately $15,000
per quarter.
In addition to the fees we pay for these licenses, we have agreed to
promote and market actively Allaire's products. We have also agreed to
participate in certain joint marketing and promotional activities.
Elemental Software, Inc. We have been granted a non-exclusive,
royalty-free license to market and resell Drumbeat(TM) 2000. By working with a
Drumbeat(TM) 2000 ISP Hosting Partner such as our company, organizations will be
able to publish data-driven Active Server Pages, or ASP, applications without
the need to set up and administer Web servers locally. As an ISP Hosting
Partner, we also provide hosting accounts for trial Drumbeat(TM) 2000 users.
Under this agreement, we are a Drumbeat(TM) 2000 reseller which means our
customers receive preferred pricing on each sale of Drumbeat(TM) 2000 generated
through the Elemental Software/Interliant e-commerce Web site. We have agreed to
undertake certain cross marketing activities to promote the launch of our
partnership, including press releases, Web advertising and a special promotion
by us of Drumbeat(TM) 2000. In addition, we have been given the opportunity to
provide an insert card to be included in the Drumbeat(TM) 2000 product packaging
promoting our services. This agreement, dated December 13, 1998, may be
terminated by either Elemental or us with thirty days prior notice to the other.
We do not have, nor do we expect to incur in the future any material financial
commitments as a result of this agreement.
iMALL, Inc. iMALL operates an Internet shopping mall and has created a
suite of e-commerce tools labeled iSTORE(TM) and Bolt-on e-commerce(TM).
Interliant and iMALL have agreed to use iMALL's experience and technical
infrastructure to create a mall where our customers can sell their products and
services online. Under the terms of the agreement, we pay iMALL for the use of
the Bolt-on e-commerce(TM) solution and iSTORE(TM) at various discounted rates
based on the number of iMALL accounts created by us. The aggregate amount of
fees payable under this agreement over the term of the agreement are not
material. Our agreement with iMALL states that it is intended to establish a
long-term relationship between us and iMALL and as such has a three-year term
which commenced on October 23, 1998.
Revenues and expenses generated by these strategic relationships are
recognized on an accrual basis. Where appropriate, revenue and expenses are
matched.
47
<PAGE> 51
SALES AND DISTRIBUTION
We sell our hosting services to our customers through a variety of sales
channels. The following schematic represents our sales approach. The prices set
forth below are for product offerings marketed under our brand.
[FLOW CHART]
<TABLE>
<S> <C> <C>
SMALL - MEDIUM MEDIUM -LARGE
TARGET BUSINESSES BUSINESSES
CUSTOMER ---------------------------------------- ----------------------------------------
MAINSTREAM RESELLERS VERY COMPLEX
WEB DEVELOPERS HOSTING SOLUTIONS
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
SERVICES WEB HOSTING & APPLICATION HOSTING &
OFFERED CONSULTING CONSULTING
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C> <C>
PRICING $25/MONTH $1,000 - 2,000/MONTH $100,000/MONTH
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C> <C>
SALES INTERNET TELESALES/ DIRECT
STRATEGY MARKETING INDIRECT SALES SALES
</TABLE>
We have historically used a variety of marketing and sales techniques,
including Internet marketing, telesales, indirect sales channels, such as
resellers and referral partners, and direct sales in order to increase our
market share. Our acquisition strategy has facilitated the integration of
different indirect and direct distribution channel models used by acquired
companies and has enabled us to customize them to fit the needs of specific
markets in which we compete.
Internet Marketing. Our Internet marketing sales program offers an
automated online sales interface to our customers that enables them to purchase
hosting services on a 24x7 basis from our Web site at www.interliant.com and
www.sagenetworks.com, or to purchase Internet rental application services at
www.appsonline.com.
Telesales. In the telesales area, we currently acquire, and plan to
develop further, our hosting accounts through inbound calls generated through
traditional media and outbound telesales to pre-qualified potential customers.
Indirect Sales. In the indirect sales channel area, our goal is to develop
the leading reseller and referral partner program in the industry through our
recently introduced business partner program. Our target partners include
reseller and referral partners, such as Web consulting firms, Internet service
providers, independent software vendors, network integration companies and
system integrators that have an established relationship with our prospective
customer base as well as a sales force capable of selling Internet services. The
benefits to us of using these indirect sales channels include greater market
reach without fixed overhead costs and the ability to use the partners to assist
in the delivery of complete
48
<PAGE> 52
solutions to meet customer needs. We offer our partners a discount from our
retail price on both products and services.
We believe that our business partner program offers its reseller and
referral partners a wide variety of benefits such as:
- financial incentives including volume discounts and/or royalties, waived
set up fees and advantageous software leasing opportunities;
- access to our hosting services and applications;
- advanced technical support;
- sales and marketing support services; and
- training and support programs.
Direct Sales. We have a sales group dedicated to selling hosting and
consulting solutions to large enterprises and other businesses whose Internet
operations are mission-critical.
As of the date hereof, we have 61 employees engaged in distribution and
sales.
MARKETING
We market our full range of hosting solutions under the Sage Networks and
Interliant brands via a marketing program that seeks to use a variety of media
and channels. We will continue to invest in building greater equity of the
Interliant brand worldwide, using a variety of marketing techniques including
print advertisements in key industry publications, broadcast advertising, direct
marketing and online advertising, such as general rotation and keyword-specific
Web banner advertisements. The focus of these branding efforts is primarily to
reinforce our position as a full service hosting provider. In addition, we will
also employ a number of other marketing tactics and communications vehicles,
such as product literature, trade shows, promotions with key hardware and
software vendors, direct response programs and our Web site to generate greater
numbers of qualified leads and to further increase awareness of our brand.
When an acquired company's brand is already well-established, we may for a
period of time continue to market certain products and services under that brand
to capitalize on the competitive advantages the acquired brand may bring to us.
Our long-term goal, however, is to migrate most of our acquired product
offerings to our brands. Our products are available from our primary Web site at
www.interliant.com as well as at www.appsonline.com.
We expect to increase our marketing expenditures in order to support our
brand marketing and lead-generation efforts. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
CUSTOMER SERVICE
We view customer service as a critical part of our business strategy. As of
the date hereof, our customer service group has 142 employees who are mainly
located in our Atlanta and Houston data centers. This group is responsible for
providing customer service to all of our customers as well as our resellers and
referral partners, including helping customers to initially set up their Web
sites, answering technical questions or helping customers use our application
hosting solutions and other enhanced offerings. Through our customer service
systems, customer service representatives can generally resolve any issues in a
timely manner via e-mail or our toll-free number.
Web Hosting Customer Service. Our Web hosting customers are primarily
serviced through our Atlanta data center. To ensure that each Web hosting
customer is connected with the customer service representative best able to
address its needs, our call center routing system, provided by Aspect
Communications, directs calls based on the phone number dialed or the menu
choice selected. In addition, the Vantive Support system, a customer/asset
management tracking application, enables a customer
49
<PAGE> 53
service representative to view a customer's entire account, including past and
recent interactions with such customer. Further, the Vantive Support system
provides a resolution database that recognizes and documents support records
into a central repository that can be accessed by all customer service
personnel. This database categorizes all reported problems so that if a
particular problem recurs, customer service representatives can view its prior
resolution and provide timely and accurate customer service. The Vantive Support
system is also linked to the Vantive Sales Force Automation module which helps
sales staff get current information on the status of accounts, recent problems
or account issues prior to calling customers to pursue new business
opportunities.
In addition to the Aspect and Vantive systems, we are in the process of
implementing the PORTAL Infranet billing system. With PORTAL Infranet, our
resellers, referral partners and customers will be able to obtain monthly
statements delivered electronically which we believe will provide them with
easily accessible and accurate tracking of their hosting expenditures. In
particular, we believe that PORTAL will allow resellers and referral partners to
add new products and services, as well as pricing discounts and incentive
programs, in a timely and cost-effective manner.
Application Hosting Customer Service. Our application hosting customers
are primarily serviced through our Houston data center. Customers serviced in
Houston can contact a Technical Support Engineer on a 24x7 basis to address
issues including registration, mail routing, connectivity or enhancements to a
customer account such as rolling out new databases and changing access control
lists. Certain customer accounts also have access to dedicated support engineers
who are familiar with each unique configuration or requirement a larger customer
may have. A focused support team handles all the application hosting support
requirements via several mechanisms including a facilitated discussion database
environment available over the Internet where customers, application developers
and support technicians can discuss pertinent issues and build a relevant
knowledge base. Customers may also access support staff through e-mail as well
as through a toll-free number.
Online Customer Service. We also provide resellers and customers who are
hosted in our Atlanta data center the opportunity to access an online control
panel which serves as a personalized, virtual customer service representative.
When fully implemented through PORTAL, this online control panel will enable
customers to find information they need such as billing histories, orders and
account profiles in a timely manner. In addition, at that time, the online
control panel will offer viewing of real-time billing statements and invoices,
the ability to order new or additional services, access to an online Web
development library, free applications and step-by-step guidance through common
Web publishing procedures. Thus, our resellers, referral partners and end users
hosted in Atlanta will have the option of accessing account and services
information themselves online or by calling the customer service centers.
TECHNOLOGY AND NETWORK OPERATIONS
We have developed a secure, reliable, high-performance, and scalable
hosting solution, which we believe provides a significant competitive advantage
in the market. This solution is comprised of multiple hosting platforms that
incorporate automated functionality and a network infrastructure that includes
multiple Internet data centers and is monitored on a 24x7 basis by our personnel
in Atlanta and Houston. Our strategy in developing our hosting solution focuses
on utilizing internally created technological innovations that we integrate with
leading software and hardware providers.
Web Hosting Platform. Although industry-standard Web servers are adequate
for basic Web hosting, we believe that efficiently managing large numbers of Web
sites and users on a single server requires significant technological
innovations. Accordingly, we have focused our technology development efforts on
creating various operating system level tools to facilitate a high customer to
server ratio. We have developed multiple Web hosting platforms that permit
efficient hosting of more than 5,000 Web sites on a Sun Microsystems, Inc.
Solaris server. We have also developed Web server applications designed to
improve performance in a virtual server environment, and we have implemented
resource monitoring tools designed to report and address scarcity of shared
computer processing units and memory resources. Our solution is scalable,
allowing servers to be added while being monitored centrally, independent of
where
50
<PAGE> 54
they are located. To address the diverse requirements of our customers, we offer
Web hosting services on a range of operating systems and computing platforms
including Solaris which operates on a Sun Microsystems, Inc. platform, Microsoft
Windows NT which operates on an Intel/PC platform and Linux which operates on a
Cobalt Networks, Inc. platform.
Application Hosting Platform. We maintain a state-of-the-art data center
in Houston from which we manage our application hosting services. This facility
features separate, redundant fiber and power connections, diesel generators,
cooling systems and uninterruptible power supplies designed to provide on site
power for up to four weeks. Quality and security are paramount concerns for our
customer base. Consequently, we employ several security measures including:
- 24x7 building guards;
- electronic surveillance;
- limited access electronic card key measures; as well as
- the physical separation of servers from administrative workstations.
The Houston facility includes high-end Compaq servers equipped with
multiple power supplies and RAID technology. Other strategic providers include
Sun Microsystems, Microsoft, and Lotus. We offer connectivity to our systems
from virtually anywhere in the world, enabling customers to deploy global
solutions. Customers can access us:
- via the Internet;
- through X.28 connections provided by Compuserve and Equant, N.V. in more
than 105 countries;
- over Frame Relay through AT&T Corp., Sprint Corporation and MCI Worldcom,
Inc.; or
- domestically via a toll-free number.
We use two DS-3 connections to the Internet provisioned directly off a
SONET ring. Internally developed management and monitoring systems provide
insight into the performance of our entire network, as well as consistency of
security measures across all of our current hosting platforms.
Network Operations. In order to provide our customers with high-quality
service, we have invested substantial resources in building our network
infrastructure. We have designed our network to minimize the effect of any
interruptions. We have also implemented security measures and monitoring systems
to ensure that our network is protected, identify potential sources of failure,
limit downtime and notify staff of any problems. Although we have attempted to
build redundancy into our network and hosting facilities, our data centers are
currently subject to various single points of failure, and a problem with one of
our routers or switches could cause an interruption in the services we provide
to some of our customers.
Our NOCs are responsible for monitoring our entire network on a 24x7 basis.
We monitor each piece of equipment, including routers, switches and servers. The
NOCs also monitor all Internet and telecommunications connections and ensure
that they are functional and properly loaded. The design of the NOCs enables
systems administrators and support staff to be promptly alerted to problems, and
we have established procedures for rapidly resolving any technical problems that
arise. The NOCs are fully integrated into our customer service facilities.
We currently have two primary data centers located in Atlanta and Houston.
These data centers are fitted with continuous monitoring capabilities, back-up
generators and environmental controls to ensure high-quality service with
minimal interruptions. The Atlanta data center is our primary Web hosting
facility and the Houston data center is our primary groupware and application
outsourcing facility. The customer service and network monitoring
infrastructures are based in Atlanta and Houston.
Our Virginia data center currently serves as a co-location facility. We
have recently entered into a ten-year lease for approximately 13,000 square feet
of space in Vienna, Virginia. We intend to use a portion of the proceeds from
this offering to complete construction of this space and create a third state-
51
<PAGE> 55
of-the-art data center for hosting and providing customer service. Once the
construction of this new space is completed, all of our Washington, D.C. area
operations will be moved into the new space. See " -- Facilities" and "Use of
Proceeds."
COMPETITION
The market served by us is highly competitive. Although barriers to entry
and continued growth are increasing, there are still few substantial barriers to
entry, particularly with respect to virtual hosting, and we expect that we will
face additional competition from existing competitors and new market entrants in
the future. The principal competitive factors in this market include:
- quality of service, including network capability, scalability,
reliability and functionality;
- customer service and support;
- variety of services and products offered;
- price;
- brand name;
- Internet system engineering and technical expertise;
- timing of introductions of additional value services and products;
- network security;
- financial resources; and
- conformity with industry standards.
We may not have the resources, expertise or other competitive factors to
compete successfully in the future.
Our current and potential competitors include:
- other Web hosting and Internet services companies such as AboveNet
Communications, Inc., Exodus Communications, Inc., Frontier GlobalCenter,
Globix Corporation and local and regional hosting providers;
- national and regional Internet service providers such as Concentric
Network Corporation, MindSpring Enterprises, Inc., UUNET Technologies,
Inc., PSINet Inc. and Verio Inc.;
- global telecommunications companies including AT&T Corp., British
Telecommunications plc, Telecom Italia SpA and Nippon Telegraph and
Telephone Corp.;
- regional and local telecommunications companies, including the regional
Bell operating companies such as Bell Atlantic Corporation and US West,
Inc.;
- companies that focus on application hosting such as USinternetworking,
Inc. and IBM Global Services; and
- audio and video content hosting companies such as broadcast.com.
Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do.
As a result, certain of these competitors may be able to develop and expand
their network infrastructures and service offerings more rapidly, adapt to new
or emerging technologies and changes in customer requirements more quickly, take
advantage of acquisition and other opportunities more readily, devote greater
resources to the marketing and sale of their services and adopt more aggressive
pricing policies than we can. In addition, these competitors have entered and
will likely continue to enter into joint ventures or consortia to provide
additional services competitive with those provided by us.
52
<PAGE> 56
In an effort to gain market share, certain of our competitors have offered
hosting services similar to ours at lower prices than ours or with incentives
not matched by us. In addition, certain of our competitors may be able to
provide customers with additional benefits, which could reduce the overall costs
of their services relative to those of us. We may not be able to reduce the
pricing of our services or offer incentives in response to the actions of our
competitors without a material adverse impact on our operating results. We also
believe that the market in which we compete is likely to encounter consolidation
in the near future, which could result in increased price and other competition
that could have an adverse effect on our business.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of copyright, trademark, service mark, trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in our services. We have no patented technology that would
preclude or inhibit competitors from entering our market. The steps taken by us
to protect our intellectual property may not prove sufficient to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies. The laws of certain foreign countries may
not protect our services or intellectual property rights to the same extent as
do the laws of the United States. We also rely on certain technologies that we
license from third parties. These third-party technology licenses may not
continue to be available to us on commercially reasonable terms. The loss of the
ability to use such technology could require us to obtain the rights to use
substitute technology, which could be more expensive or offer lower quality or
performance, and therefore have an adverse effect on our business.
To date, we have not been notified that our services infringe on the
proprietary rights of third parties, but third parties could claim infringement
by us with respect to current or future services. From time to time, we are
notified that the content of one of our customer's sites infringes on a third
party's trademark or copyright. In response, we inform the customer of such
claim and, if necessary, will terminate a customer's service. We expect that
participants in our markets will be increasingly subject to infringement claims
as the number of services and competitors in our industry segment grows. Any
such claim, whether meritorious or not, could be time-consuming, result in
costly litigation, cause service installation delays or require us to enter into
royalty or licensing agreements. Such royalty or licensing agreements might not
be available on terms acceptable to us or at all. As a result, any such claim
could have an adverse effect upon our business.
GOVERNMENT REGULATION
We are not currently subject to direct federal, state or local government
regulation, other than regulations that apply to businesses generally. Only a
small body of laws and regulations currently applies specifically to hosting and
commerce activities, or access to the Internet. Due to the increasing popularity
and use of the Internet, however, it is possible that laws and regulations with
respect to the Internet may be adopted at international, federal, state and
local levels, covering issues such as user privacy, freedom of expression,
pricing, characteristics and quality of products and services, taxation,
advertising, intellectual property rights, information security and the
convergence of traditional telecommunications services with Internet
communications. Although sections of the Communication Decency Act of 1996, the
CDA, that, among other things, proposed to impose criminal penalties on anyone
distributing "indecent" material to minors over the Internet were held to be
unconstitutional by the U.S. Supreme Court, similar laws may be proposed,
adopted and upheld. The nature of future legislation and the manner in which it
may be interpreted and enforced cannot be fully determined and, therefore,
legislation similar to the CDA could subject us and/or our customers to
potential liability, which in turn could have a material adverse effect on our
business, results of operations and financial condition. The adoption of any
such laws or regulations might decrease the growth of the Internet, which in
turn could decrease the demand for the services of us or increase the cost of
doing business or in some other manner have an adverse effect on our business.
We currently do not collect sales or other taxes with respect to the sale
of services or products in states and countries where we believe we are not
required to do so. We do collect sales and other taxes in
53
<PAGE> 57
the states we have offices and are required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes for
prior periods, could have an adverse effect on our business.
In addition, applicability to the Internet of existing laws governing
issues such as property ownership, copyright and other intellectual property
issues, taxation, libel, obscenity and personal privacy is uncertain. The vast
majority of such laws were adopted prior to the advent of the Internet and
related technologies and, as a result, do not contemplate or address the unique
issues of the Internet and related technologies. Changes to such laws intended
to address these issues could create uncertainty in the marketplace that could
reduce demand for our services or increase the cost of doing business as a
result of costs of litigation or increased service delivery costs, or could in
some other manner have an adverse effect on our business.
Any new legislation or regulation, or the application of laws or
regulations from jurisdictions whose laws do not currently apply to our
business, could have an adverse effect on our business.
EMPLOYEES
As of the date hereof, we have 516 employees, including 19 on a contract
basis, of which 93 are in sales, distribution and marketing, 175 are in
engineering and service development, 142 are in customer service and technical
support, 99 are in finance and administration and 7 are in acquisition
integration. We believe that our future success will depend in part upon our
continued ability to attract, hire and retain qualified personnel. Although we
believe we have thus far been successful in this endeavor (including a high
retention rate of key employees from acquired companies), the competition for
such personnel is intense, and we may not be able to identify, attract and
retain such personnel in the future. None of our employees are represented by a
labor union, and management believes that our employee relations are good.
FACILITIES
Our executive offices are located in Purchase, New York and consist of
approximately 12,300 square feet that are leased pursuant to agreements that
expire in June 2004. We also lease approximately 15,740 square feet in Atlanta,
Georgia under an agreement that expires in June 2003 and approximately 1,000
square feet of space in McLean, Virginia area under a lease that expires in July
2001. We also lease 59,885 square feet of space in Houston, Texas under an
agreement that expires in August 2001 and office space in London, England. In
addition, we have recently leased approximately 13,000 square feet of space in
Vienna, Virginia under a lease that expires in 2009. A portion of the proceeds
of this offering will be used by us to complete and equip this space. Once the
construction of this space is completed, all of our McLean, Virginia operations
will be moved into this space. See "Use of Proceeds" and "Business -- Technology
and Network Operations."
LEGAL PROCEEDINGS
In the ordinary course of business, we may be involved in legal proceedings
from time to time. As of the date of this prospectus, there are no material
legal proceedings pending against us.
54
<PAGE> 58
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of Interliant are as follows:
<TABLE>
<CAPTION>
NAME AGE TITLE
- ---- --- -----
<S> <C> <C>
Leonard J. Fassler......................... 67 Co-Chairman, Director
Bradley A. Feld............................ 33 Co-Chairman, Director
Stephen W. Maggs........................... 45 Vice Chairman, Treasurer and Director
James M. Lidestri.......................... 38 President
Francis J. Alfano.......................... 38 Senior Vice President, Mergers and
Acquisitions
Rajat Bhargava............................. 26 Senior Vice President, Strategic Planning
and Integration
Jesse J. Bornfreund........................ 43 Senior Vice President, Business Development
Edward A. Cavazos.......................... 30 Senior Vice President, Legal and Business
Affairs and Assistant Secretary
Paul E. Chollett........................... 39 Senior Vice President, Finance and
Administration
Bruce S. Klein............................. 39 Senior Vice President, General Counsel and
Secretary
Jennifer J. Lawton......................... 35 Senior Vice President, Consulting and
Technology
Kristian Nelson............................ 35 Senior Vice President, Service Development
and Delivery
William A. Wilson.......................... 53 Chief Financial Officer
Merril M. Halpern.......................... 64 Director
Thomas C. Dircks........................... 41 Director
Patricia A. M. Riley....................... 57 Director
Jay M. Gates............................... 34 Director
Charles R. Lax............................. 39 Director
</TABLE>
Each director holds office for a one-year term or until a successor has
been duly elected and qualifies, or until his or her earlier death, resignation
or removal. Our executive officers are appointed annually by our Board of
Directors and serve at the discretion of the Board of Directors. Mr. Lax has
been elected to the Board of Directors pursuant to a contractual arrangement.
See "Description of Capital Stock -- The SOFTBANK Investment."
Leonard J. Fassler is one of our co-founders and has been one of our
Co-Chairmen and a Director since our formation in December 1997. Mr. Fassler was
also our Secretary from December 1997 through April 1999. From 1992 to 1996, Mr.
Fassler was a Co-Chairman of AmeriData Technologies, Inc. ("AmeriData"), a New
York Stock Exchange-listed reseller of computer equipment and provider of
computer consulting and other services that was acquired by General Electric
Capital Corporation in 1996. Mr. Fassler was a co-founder of AmeriData which
grew into a company with sales in excess of two billion dollars a year and
locations in ten countries at the time that it was acquired. Mr. Fassler holds a
bachelor's degree in business administration from City College of New York and a
law degree from Fordham Law School.
Bradley A. Feld is one of our co-founders and has been one of our
Co-Chairmen and a Director since our formation in December 1997. Since 1995, Mr.
Feld has been the President of Intensity Ventures Inc., a company that helps to
establish, advise and operate software companies. From 1993 to 1995, Mr. Feld
was the chief technology officer of AmeriData. From 1985 to 1993, he was
president of Feld Technologies, Inc., a computer consulting firm founded by Mr.
Feld to develop and implement information technology solutions for a wide
variety of businesses, which was acquired by AmeriData in 1993. Mr. Feld earned
a
55
<PAGE> 59
bachelor of science degree and a master of science degree from Massachusetts
Institute of Technology. Since 1997, Mr. Feld has been a General Partner of
SOFTBANK Technology Ventures IV, L.P. and SOFTBANK Technology Advisors Fund,
L.P., venture capital funds. Mr. Feld is a director and co-chairman of Message
Media, Inc., and director of a number of privately held companies.
Stephen W. Maggs is one of our co-founders. Mr. Maggs has been our Vice
Chairman since June 1999, and our Treasurer and a Director since our formation
in December 1997. Mr. Maggs held the positions of Chief Executive Officer and
President from our formation in December 1997 until June 1999. From December
1993 to December 1996, Mr. Maggs held a variety of senior management positions
with AmeriData, including serving as an executive vice president of operations
of AmeriData and Chairman of AmeriData Canada. From February 1992 to December
1993, he was the owner of Mericom Systems Inc., a reseller of computer equipment
and provider of computer consulting and other services, which was acquired by
AmeriData in 1993. From 1984 to 1991, he held various executive positions at
Inacom Information Systems, a provider of information technology products and
services. Mr. Maggs received a bachelor of science degree from Hillsdale
College, Hillsdale, Michigan and is a Certified Public Accountant.
James M. Lidestri has been our President since June 1999. Mr. Lidestri
served as our Executive Vice President from March 1999 until June 1999. From
March 1996 to March 1999, Mr. Lidestri was the President and Chief Executive
Officer of Interliant Texas. From February 1995 to March 1996, Mr. Lidestri was
employed at IBM Corporation, a vendor of technology systems, products, services
and software and financing where he served as Group Manager of the Collaborative
Services Division. As Group Manager, Mr. Lidestri was responsible for developing
market and product strategies for network-based collaborative services, with a
primary focus on Lotus Notes. From November 1990 to February 1995, Mr. Lidestri
served in a number of executive positions at Sprint Corporation, a global
communications company, including Director of Business Operations. Mr. Lidestri
holds a bachelor of science degree in computer science from Rensselaer
Polytechnic Institute and a masters degree in business administration from New
York University.
Francis J. Alfano has served as our Senior Vice President, Mergers and
Acquisitions since December 1998. From January 1997 to November 1998, Mr. Alfano
was Vice President of Business Development at GE Capital Information Technology
Solutions, Inc., formerly AmeriData. From July 1994 to December 1996, Mr. Alfano
was Director of Taxes at GE Capital Information Technology Solutions, Inc. From
January 1991 to June 1994, Mr. Alfano was employed by Ernst & Young, an
accounting, tax and consulting firm, and was a senior manager in the tax
department at the time of his departure. From 1984 to 1990, Mr. Alfano was
employed as a Certified Public Accountant with various public accounting firms.
Mr. Alfano holds a bachelor of science degree in business administration from
the University of Arizona and is a Certified Public Accountant.
Rajat Bhargava is one of our co-founders and has been our Senior Vice
President, Strategic Planning and Integration since March 1999. He was our Chief
Operating Officer from our formation in December 1997 through March 1999. During
the period from January 1994 to June 1997, he served as Chairman, President and
Chief Executive Officer of Net.Genesis Corp., an Internet software company which
he founded. From 1991 to 1993, he worked in various engineering positions at
Intel Corporation, a manufacturer of computer networking and communications
technologies. Mr. Bhargava received a bachelor of science degree in electrical
engineering and computer science from Massachusetts Institute of Technology in
1995.
Jesse J. Bornfreund has served as our Senior Vice President, Business
Development since March 1999. From July 1996 until he joined us, Mr. Bornfreund
was Senior Vice President, Strategic Alliances of Interliant Texas. In such
position, Mr. Bornfreund was responsible for managing the strategic alliances of
Interliant Texas and the development of its business. From February 1996 through
June 1996, Mr. Bornfreund served as a Corporate Strategy Consultant at IBM
Corporation with primary responsibilities that included the development of
corporate business and technology strategies and recommendations. From February
1994 to February 1996, Mr. Bornfreund was a Program Manager for the
Collaborative Services Group of IBM Corporation. As Program Manager, Mr.
Bornfreund was responsible
56
<PAGE> 60
for strategic planning, business and market development activities and
development and management of partner relationships. Mr. Bornfreund holds a
bachelor of science degree in biology from Stockton State College.
Edward A. Cavazos has served as Senior Vice President, Legal and Business
Affairs of Interliant since March 1999. In April 1999, he became our Assistant
Secretary. From March 1997 until he joined Interliant, Mr. Cavazos was Senior
Vice President, General Counsel of Interliant Texas. From May 1994 until March
1997, Mr. Cavazos was an associate attorney at the law firm of Andrews & Kurth,
L.L.P. In addition, Mr. Cavazos served as an Adjunct Professor at the University
of Texas School of Law from January 1998 through May 1998 and as an Adjunct
Professor at the University of Houston Law Center from September 1996 through
December 1996 and September 1997 through December 1997. Mr. Cavazos holds a
bachelor of arts degree in philosophy from the University of Texas and a law
degree from the University of Texas.
Paul E. Chollett has served as Senior Vice President, Finance and
Administration of Interliant since March 1999. From July 1996 until he joined
Interliant, Mr. Chollett was Senior Vice President and Chief Financial Officer
of Interliant Texas. From July 1993 to July 1996, Mr. Chollett was the Director
of Finance and Administration in the Audit Division of the accounting firm of
Arthur Andersen, LLP. In this role, Mr. Chollett was responsible for managing
the financial, risk management and quality control aspects of the firm's audit
practice. Mr. Chollett holds a bachelor of science degree in accounting from the
University of Houston at Clear Lake City. Mr. Chollett is a Certified Public
Accountant.
Bruce S. Klein has served as our Senior Vice President, General Counsel
since December 1998. In April 1999, Mr. Klein became our Secretary. From April
1998 to November 1998, he was our General Counsel, Vice President. In addition,
from June 1998 to present, Mr. Klein has been of counsel to the law firm of
McCarthy, Fingar, Donovan, Drazen & Smith, L.L.P. From January 1996 through
March 1998, Mr. Klein was of counsel to the law firm of Spitzer & Feldman P.C.,
prior to which he was partner at the law firm of Halperin Klein & Halperin, in
each case engaged in the general practice of law, with experience in mergers and
acquisitions and general corporate and business law. Mr. Klein is admitted to
practice law in New York and Massachusetts and holds a bachelor's degree in
business administration from Rutgers University and a law degree from Western
New England College School of Law.
Jennifer J. Lawton has served as our Senior Vice President, Consulting and
Technology since February 1999. From May 1992 until she joined us, Ms. Lawton
was the Chief Executive Officer of Net Daemons Associates, Inc., a provider of
Web development and system integration activity for Internet and IT Networks
which was acquired by Interliant in February 1999. Ms. Lawton is a co-founder of
Net Daemons Associates, Inc. Ms. Lawton holds a bachelor of science degree in
applied mathematics from Union College.
Kristian Nelson has served as our Senior Vice President, Service
Development and Delivery since March 1999. From July 1997 until he joined us,
Mr. Nelson was Senior Vice President, Operations of Interliant Texas and was
responsible for the direction and control of all operational aspects of
Interliant Texas's business including product development, customer service and
application and data center services. From June 1996 through May 1997, Mr.
Nelson served as Vice President, Operations at GST Telecommunications, a
full-service telecommunications provider. In this role, Mr. Nelson was
responsible for the oversight and control of such company's Internet subsidiary,
GST Internet Inc. From June 1995 to January 1996, Mr. Nelson was a Senior
Management Consultant in the Technology Strategy Practice area at Gartner Group,
Inc., a company which provides IT advisory services and consulting where his
responsibilities included providing technical consulting services to Fortune 500
companies. From May 1986 to May 1995, Mr. Nelson was the Product Assurance
Information Technology Director at Lockheed Martin Corporation, a diversified
technology company. As such, Mr. Nelson was responsible for developing and
implementing information technology strategic planning for the Product Assurance
Group. Mr. Nelson holds a bachelor of science degree in management science from
Orlando College.
William A. Wilson has served as our Chief Financial Officer since September
1998. During the period from February 1998 to July 1998, Mr. Wilson served as
Vice President, Finance and Chief Financial Officer at XCOM Technologies, Inc.,
a competitive local exchange carrier. From October 1997 to
57
<PAGE> 61
February 1998, Mr. Wilson served as a consultant to several private companies.
From June 1997 to October 1997, Mr. Wilson served as Senior Vice President,
Finance and Chief Financial Officer of Computervision Corporation, a software
publishing and development company. Prior thereto, Mr. Wilson was Executive Vice
President and Chief Financial Officer of Arch Communications Group, Inc., a
wireless messaging company, from June 1996 to June 1997 and was Vice President,
Finance and Chief Financial Officer of Arch Communications Group, Inc. from
January 1989 to June 1996. Mr. Wilson received a bachelor of arts degree from
Luther College, a master of science degree from Northeastern University and a
masters degree in business administration from Babson College. Mr. Wilson is a
Certified Public Accountant.
Merril M. Halpern has been one of our Directors since our formation in
December 1997 and is Chairman and Chief Executive of Charterhouse Group
International, Inc. ("Charterhouse"), which he founded in 1973. Mr. Halpern is a
director of Microwave Power Devices, Inc., and United Road Services, Inc., as
well as several private companies. He received a bachelor of science degree from
Rutgers University and a masters degree in business administration from Harvard
University.
Thomas C. Dircks has been one of our Directors since our formation in
December 1997 and is a Managing Director of Charterhouse. Mr. Dircks has been
employed as an officer of Charterhouse since 1983. He was previously employed as
a Certified Public Accountant at a predecessor of PricewaterhouseCoopers LLP. He
holds a bachelor of science degree in accounting and a masters degree in
business administration from Fordham University. He is a director of a number of
privately-held companies.
Patricia A. M. Riley has been one of our Directors since our formation in
December 1997 and is a Managing Director of Charterhouse and has been an
executive officer with the firm since 1977. She is a graduate of the Advanced
Management Program at Harvard Graduate School of Business Administration and
received a bachelor of arts degree from Hunter College.
Jay M. Gates has been one of our Directors since our formation in December
1997 and is a Vice President of Charterhouse. He joined Charterhouse in 1994 as
an Analyst. Mr. Gates was previously employed as a Senior Analyst in the
Financial Consulting Advisory Group of the accounting firm of Arthur Andersen
LLP. Prior to that he was an Assistant Treasurer at Bankers Trust Corporation.
He holds a bachelor of arts degree from the State University of New York at
Binghamton and a masters degree in business administration from New York
University, Leonard N. Stern School of Business. He is also a director of a
number of privately-held companies.
Charles R. Lax has been one of our Directors since January 1999. He has
been a General Partner of SOFTBANK Technology Ventures IV, L.P. since November
1997. From March 1996 to November 1997, Mr. Lax was a Vice President of SOFTBANK
Holdings Inc. He was previously a venture partner at Vimac Partners LLC, a
venture capital firm specializing in investments in the information technology
and Internet-related industry. Mr. Lax holds a bachelor of science degree from
Boston University. He is a director of a number of privately-held companies.
Our Board of Directors has nominated John B. Landry to serve as a Director
effective upon consummation of this offering. Mr. Landry, age 51, has been
Strategic Technology Consultant to senior management of IBM Corporation since
June 1995. In addition, from October 1995 to January 1999, he was Chairman of
the Board of Narrative Communications Corporation, an Internet-based interactive
advertising company. In January 1999, Narrative was acquired by At Home
Networks. From 1990 to 1995, Mr. Landry was Senior Vice President and Chief
Technology Officer of Lotus Development Corporation, a provider of software
products and services. Mr. Landry is also a director of Skycache, Inc., MCK
Communications Corp., FlexiInternational Software, Inc., and AnyDay.COM. Mr.
Landry is currently providing consulting services to us and in connection with
his consulting arrangement has been granted options to purchase 15,000 shares of
common stock at an exercise price of $10 per share.
58
<PAGE> 62
DIRECTOR COMPENSATION
Directors receive no remuneration for serving on our Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
Our Board of Directors has standing Audit and Compensation Committees. The
Audit Committee consists of Mr. Thomas C. Dircks and Ms. Patricia A. M. Riley.
Among other functions, the Audit Committee makes recommendations to our Board of
Directors regarding the selection of independent auditors, reviews the results
and scope of the audit and other services provided by our independent auditors,
reviews our financial statements and reviews and evaluates our internal control
functions. The Compensation Committee consists of Mr. Thomas C. Dircks, Ms.
Patricia A. M. Riley and Mr. Charles R. Lax. The Compensation Committee
determines executive compensation and stock option grants and makes
recommendations to our Board of Directors concerning salaries and incentive
compensation for our employees and consultants.
EXECUTIVE COMPENSATION
Effective January 1, 1999, we entered into one-year employment agreements
with each of Messrs. Fassler, Maggs and Bhargava pursuant to which they each
will receive a salary of $180,000 for the period ending December 31, 1999.
Effective January 1, 1999, we also entered into a one-year consulting agreement
with Mr. Feld through Intensity Ventures, Inc. pursuant to which he will receive
a consulting fee of $180,000. On March 10, 1999, we entered into an employment
agreement with Mr. Lidestri for a term commencing on that date and terminating
on March 1, 2001 unless either of us exercises our rights to terminate the
agreement sooner. The agreement provides for a $150,000 signing bonus,
two-thirds of which was paid in April 1999 and the balance of which is payable
on March 10, 2000, an annual base salary of $180,000 and a performance-based
annual bonus of up to $70,000. See "-- Employment Agreements." We also have
employment agreements with certain other senior officers.
59
<PAGE> 63
The following table sets forth the total compensation for fiscal 1998 of
our Vice Chairman and each of the other four most highly compensated executive
officers whose total salary and bonus for fiscal 1998 is estimated to exceed
$100,000:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
---------------------------------- NUMBER OF
OTHER SECURITIES
ANNUAL UNDERLYING ALL OTHER
NAME OF EXECUTIVE OFFICER AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SARS COMPENSATION
- ------------------------------------------------ ---- -------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Stephen W. Maggs........................... 1998 $130,232(1)
Vice Chairman,........................... -- -- -- --
Treasurer and Director
Francis J. Alfano.......................... 1998 $ 12,500(2) -- -- -- --
Senior Vice President,
Mergers and Acquisitions
Rajat Bhargava............................. 1998 $120,152
Senior Vice President,................... -- -- -- --
Strategic Planning and Integration
Bruce S. Klein............................. 1998 $116,667(3) -- $15,635(4) -- --
Senior Vice President,
General Counsel and Secretary
William A. Wilson.......................... 1998 $ 48,894(5) -- -- -- --
Chief Financial Officer
</TABLE>
- ---------------
(1) Although Mr. Maggs commenced employment with us on December 8, 1997, he was
not put on our payroll until January 1, 1998. As a result, Mr. Maggs was
paid $10,000 in 1998 as compensation for his employment in 1997.
(2) Reflects salary received by Mr. Alfano from the commencement of his
employment with us on December 1, 1998 through December 31, 1998.
(3) Reflects salary received by Mr. Klein from the commencement of his
employment with us in April 1998 through December 31, 1998.
(4) Reflects income received by Mr. Klein in his capacity as an independent
consultant prior to becoming our employee.
(5) Reflects salary received by Mr. Wilson from the commencement of his
employment with us on September 22, 1998 through December 31, 1998.
OPTION GRANTS IN LAST FISCAL YEAR
None of the named executive officers were granted options in the last
fiscal year. On April 15, 1999, our Compensation Committee granted an aggregate
of 375,000 options to senior management, including:
- options to purchase 30,000 shares of common stock at an exercise price of
$8.00 per share to Stephen W. Maggs;
- options to purchase 30,000 shares of common stock at an exercise prices
of $8.00 per share to Rajat Bhargava;
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to Francis J. Alfano;
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to Bruce S. Klein; and
60
<PAGE> 64
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to William A. Wilson.
STOCK OPTION PLAN
Our Board of Directors has adopted and our stockholders have approved the
Interliant 1998 Stock Option Plan, under which stock options may be granted to
our officers, employees and consultants and to officers, employees and
consultants of our subsidiaries. Our stock option plan allows our Board of
Directors to award up to an aggregate of 3,800,000 options to purchase an
identical number of shares of our common stock to qualified recipients. As of
the date of this prospectus, our Board has granted a total of 3,713,994 options.
Any options which have been granted but which expire or terminate unexercised
are returned to the plan and may be granted at a later date to any qualified
recipient.
Our stock option plan is administered by the Compensation Committee of the
Board of Directors. The Committee has the authority to determine:
- the persons to whom options will be granted;
- when options will be granted;
- the number of shares subject to each option;
- the exercise price of each option;
- the time or times at which the options will become exercisable;
- the duration of the exercise period; and
- provide for the acceleration of the exercise period.
In addition, if we are involved in a merger, reorganization, stock split or
other type of corporate transaction that would diminish the value of our
outstanding options, the Compensation Committee may adjust the number of options
granted and/or the exercise price of such options in order to ensure that option
holders are treated equitably.
Our stock option plan also permits the grant of stock options that qualify
as incentive stock options ("ISOs") under Section 422 of the Internal Revenue
Code and nonqualified stock options ("NSOs"), which do not so qualify.
The exercise price of options granted under our stock option plan may not
be less than 100% of the fair market value of the common stock on the date of
grant. The maximum term of options granted under our stock option plan is 10
years from the date of grant. ISOs granted to any employee who is a 10%
shareholder of Interliant are subject to special limitations relating to the
exercise price and term of the options. The value of common stock subject to
ISOs that become exercisable by any one employee in any one year is limited by
the Internal Revenue Code to $100,000. For this purpose, the value of common
stock is determined at the time of grant. Options granted under our stock option
plan will generally become vested and exercisable over a four-year period in
equal annual installments. However, if any of the events listed below occurs and
provided that no written provision has been made, in connection with any such
event, for (1) the continuation of the stock option plan and/or the assumption
of all outstanding options by a successor corporation, or (2) the substitution
for such options of new options covering the stock of a successor corporation
then each option that was not then vested prior to such event will become fully
vested and immediately exercisable:
- An acquisition by any person or group of related individuals of
beneficial ownership of 30% or more of either the outstanding shares of
our common stock or the combined voting power of our outstanding voting
securities;
- A change in the composition of our Board of Directors during any period
of two consecutive years which results in the directors in office at the
beginning of such period plus any newly elected or nominated directors no
longer constituting at least a majority of our Board of Directors;
61
<PAGE> 65
- The approval by our stockholders of a merger, consolidation or
reorganization in which outstanding shares of our common stock are
converted into:
- shares of stock of another company, unless our stockholders end up
owning 80% or more of the voting power of such other company;
- other securities of our company or another company unless our
stockholders hold at least 80% of the voting power of our company or
such other company; or
- cash or other property;
- The approval by our stockholders of the sale or other disposition of all
or substantially all of our assets or our liquidation or dissolution; or
- The adoption by our Board of Directors of a resolution to the effect that
any person has acquired effective control of our business and affairs.
All options granted under our stock option plan may not be transferred,
except upon the death of the optionholder in accordance with his will or
applicable law. In the event of an optionee's death or permanent and total
disability, outstanding options that have become exercisable will remain
exercisable for a period of one year, and the Committee will have the discretion
to determine the extent to which any unvested options shall become vested and
exercisable in connection with such death or disability. In the case of any
other termination of employment, except for a termination for cause as described
below, outstanding options that have previously become vested will remain
exercisable for a period of 90 days. All unexercised options will be immediately
forfeited by any employee who is terminated as a result of any of the following:
- embezzlement or misappropriation of corporate funds;
- conviction for a felony;
- misconduct resulting in material injury to us;
- significant activities harmful to our reputation of the reputation or any
of our subsidiaries;
- a significant violation of our corporate policies;
- willful refusal to perform, or substantial disregard of, the duties
properly assigned to the option holder;
- a significant violation of any contractual, statutory or common law duty
of loyalty to us or any of our subsidiaries.
Under our stock option plan, the exercise price of an option is payable in
cash or, in the discretion of the Committee, in common stock or a combination of
cash and common stock. An optionee must satisfy all applicable tax withholding
requirements at the time of exercise.
Our stock option plan has a term of 10 years, and all options granted under
the Plan prior to its termination remain outstanding until they have been
exercised or are terminated in accordance with their terms. Our Board of
Directors may amend the Plan at any time.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Dircks and Ms. Riley served as members of our Compensation Committee
during fiscal year 1998. During 1998, no committee member was an officer or
employee of ours. In addition, no interlocking relationship exists between our
Board of Directors or our Compensation Committee and the board of directors or
compensation committee of any other company, nor has any such interlocking
relationship existed in the past.
62
<PAGE> 66
EMPLOYMENT AGREEMENTS
We have entered into employment agreements with Messrs. Fassler, Maggs and
Bhargava, pursuant to which each will receive annual compensation of $180,000.
The Agreements provide for a term of one year and will renew automatically for
additional one-year terms unless we or the employee deliver a notice of
non-renewal at least three months prior to termination of the term. Under the
Agreements, the employees are also entitled to participate in our employee
benefit plans which are generally available to our senior officers.
The Agreements include provisions that are effective upon the termination
of employment of the employees under certain circumstances. In general, the
employees are entitled to severance upon termination by us without "cause." The
severance shall be equal to the amount of the employee's base salary yet to be
paid for the unexpired portion of the term of the Agreement, discounted based on
a specified published interest rate. In the event of termination due to death or
disability for a specified period of time, the employee or the employee's
estate, as applicable, shall be entitled to receive one-year's base salary,
discounted based on a specified published interest rate and we shall continue to
provide the employee, his spouse and minor children, as applicable, with certain
medical and other benefits through the end of the term of the Agreement.
For our protection, the agreements prohibit Messrs. Fassler and Bhargava
during and for periods of twenty-four and twelve months, respectively after the
end of their individual employment, from:
- Soliciting any customers which are in any way related to our business;
- Competing with us in any way; or
- Disclosing or enabling anyone else to use any information he obtains
during his employment.
Each Agreement also prohibits Messrs. Fassler and Bhargava from:
- Interfering or attempting to disrupt our business relationship with
customers or suppliers; or
- Soliciting our employees.
The prohibitions contained in Mr. Maggs's contract are identical to those
contained in Mr. Fassler's contract, except Mr. Maggs is not prohibited from
engaging in Internet related business activities through Channel Reps, Inc. or
any of its subsidiaries or divisions or Channel Force, Inc.
Mr. Feld, through Intensity Ventures, Inc., has entered into a one-year
consulting agreement with us with substantially identical terms to the
agreements described above, except that Mr. Feld is not prohibited from
competing with us and is not entitled to participate in our employee benefit
plans. His annual consulting fee of $180,000 will be paid to Intensity Ventures,
Inc. on a gross basis as an independent contractor.
We have also entered into a two-year employment agreement with Mr. Lidestri
which shall automatically be extended on a month-to-month basis from the end of
the term unless we or Mr. Lidestri deliver a notice stating a desire to
terminate the agreement. The agreement provides for an annual base salary of
$180,000 and an annual bonus of up to $70,000 based upon whether Mr. Lidestri
meets or exceeds specified performance objectives. In addition, under the
agreement, we are obligated to pay Mr. Lidestri a signing bonus of $150,000 with
$100,000 of such bonus having been paid in April 1999 and the remaining $50,000
of which is payable on the first anniversary of the agreement.
Under the agreement, Mr. Lidestri is entitled to participate in our
employee benefit plans which are generally available to our employees. The
agreement states that upon termination of Mr. Lidestri's employment by us
without cause or by Mr. Lidestri as allowed under the agreement, he shall be
entitled to severance comprised of the following components:
- any remaining unpaid portion of his signing bonus; plus
63
<PAGE> 67
- the greater of (A) the unpaid portion of his annual base salary and
other compensation for the remainder of the term of the agreement,
including a pro rata portion of the performance-based bonus for the
year in which his employment is terminated, or (B) an amount equal
to six months of his annual base salary and other compensation for
the remainder of the term of the agreement plus a pro rata portion
of the performance-based bonus for the year in which his employment
is terminated.
In addition, Mr. Lidestri shall be entitled to participate in our benefit
programs for a minimum of six months from the date of termination.
If we terminate the agreement for cause, Mr. Lidestri shall be entitled to
receive only the unpaid portion of his base salary and all vested benefits under
any benefit programs, in each case, through the date of termination.
In the event of termination due to death or disability during the term of
the agreement, Mr. Lidestri or Mr. Lidestri's estate, as applicable, shall be
entitled to receive all accrued and unpaid portions of his annual base salary to
the date of his death or disability and all employee benefits accrued but unpaid
to the date of his death or disability.
Under the terms of the agreement for a period of time following termination
of Mr. Lidestri's employment with us, which shall be either one year from such
termination, one year following the expiration of the agreement or two years
following the date of the agreement depending upon the reason for termination,
Mr. Lidestri is prohibited from engaging in the following activities:
- Competing with us or any of our subsidiaries in any way, except as an
officer, director, shareholder or employee of ours or any of our
affiliates.
- Soliciting or interfering with, or attempting to hire:
- any person who was employed by us or one of our affiliates or
subsidiaries during the 12 months before the end of the agreement;
- any person who was a customer or client or requested or received a
proposal from us or one of our affiliates or subsidiaries during the
12 months before the end of the agreement; or
- Using, disclosing or publishing any confidential material related to our
business or the business of any of our subsidiaries or affiliates which
he acquired while employed with us, unless the material is publicly
available, otherwise lawfully obtained or must be disclosed by law.
64
<PAGE> 68
RELATED PARTY TRANSACTIONS
Since our inception, Web Hosting Organization LLC, SOFTBANK Technology
Ventures and SOFTBANK Technology Advisors Fund L.P. have each purchased
securities from us.
SALE OF STOCK TO THE SOFTBANK PURCHASERS
In January 1999, the SOFTBANK Purchasers purchased from us an aggregate of
2,647,658 shares of our Redeemable Convertible Preferred Stock and 749,625
warrants to purchase shares of common stock for an aggregate purchase price of
$13.0 million. In April 1999, the SOFTBANK Purchasers exercised the 749,625
warrants for an identical number of shares of common stock at an aggregate
exercise price $5.0 million.
SALE OF STOCK TO WEB HOSTING ORGANIZATION LLC
WEB owns 25,200,000 shares of our common stock which were acquired from us
in a series of six transactions in December 1997, May 1998, June 1998, September
1998, December 1998 and February 1999, in each case at a price, giving effect to
the 3-for-1 stock split effected in July 1998, of $1.67 per share.
The principal members of WEB are Charterhouse Equity Partners III, L.P.
("CEP III") and WHO Management LLC. Leonard J. Fassler and Bradley A. Feld, our
Co-Chairmen, are the member managers of WHO. Bradley A. Feld is a general
partner of the SOFTBANK Purchasers. See "Description of Capital Stock -- The WEB
Hosting Investment" and " -- The SOFTBANK Investment."
DISTRIBUTIONS BY OUR SIGNIFICANT STOCKHOLDER
Pursuant to the terms of the Limited Liability Company Agreement of WEB
dated as of November 26, 1997, as amended by Amendment No. 1, dated as of March
4, 1998, the members of WEB shall be entitled to receive a distribution of all
cash funds or other property of WEB available from any source other than the
ordinary operations of its subsidiaries, after payment of all expenses of WEB
due at the time of such distribution ("Total Proceeds"). The Total Proceeds
shall be distributed to the members of WEB in tranches with priority given to
covering members' federal tax liability, followed by return of capital and then
as necessary to achieve specified internal rates of return. Thereafter, portions
of the Total Proceeds will be distributed to WHO for the benefit of our
co-founders and the members of our senior management, other senior employees,
employees who were hired shortly after our formation and consultants as
described below.
Of the management distributions to WHO, 70% are retained by WHO for
distribution to our co-founders, who are Messrs. Fassler, Feld, Maggs and
Bhargava, and 30% are distributed to SMI Fund LLC, a New York limited liability
company, for distribution to its members.
There are a total of 18 members of SMI, all of whom are either executive
officers, senior employees, employees who were hired shortly after our formation
or consultants. Following is a list of the six senior management members who are
members of SMI. The percentage next to each of their names indicates the
percentage of amounts distributed to SMI that flow through to such person:
<TABLE>
<S> <C>
Mr. Frank Alfano...................................... 5.0%
Mr. Edward A. Cavazos................................. 3.5%
Mr. Paul E. Chollett.................................. 3.5%
Mr. Bruce S. Klein.................................... 10.0%
Mr. James M. Lidestri................................. 10.0%
Mr. William A. Wilson................................. 6.7%
</TABLE>
65
<PAGE> 69
The management distributions to WHO described above increase as the members
of WEB realize specified internal rates of return on their investment in WEB.
The following diagram depicts the flow of the distribution of Total Proceeds to
the members of WEB described above. No Total Proceeds have been distributed to
date.
[Flow Chart]
FEES PAID BY US TO OUR SIGNIFICANT STOCKHOLDERS
During 1999 and 1998, in connection with certain of our acquisitions, we
paid or accrued transaction fees of approximately $361,000 and $337,000,
respectively, to Charterhouse, which is an affiliate of CEP III. Such fees were
paid pursuant to the terms of the WEB LLC Agreement which require WEB or its
affiliates, which includes us, to pay Charterhouse two percent (2%) of the total
transaction costs of each acquisition or investment by WEB or its affiliates,
which includes us, in which Charterhouse or any of its affiliates directly or
indirectly provide all or a portion of the equity financing therefor.
Charterhouse will not receive any fees with respect to this arrangement in the
future.
CONSULTING AND EMPLOYMENTS AGREEMENTS WITH OUR CO-FOUNDERS
During 1998, we paid consulting fees of $120,000 to each of Sage Equities,
Inc. and Intensity Ventures Inc, whose principals are Messrs. Fassler and Feld,
respectively, pursuant to consulting agreements with each of them. Effective
January 1, 1999, we entered into employment agreements with Messrs. Fassler,
Maggs and Bhargava and a consulting agreement with Mr. Feld, through Intensity
Ventures, Inc., pursuant to which each will be paid annual compensation of
$180,000. See "Management -- Employment Agreements."
66
<PAGE> 70
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the common stock as of July 7, 1999 and as adjusted to reflect the
sale of the shares of common stock offered hereby by (i) each person or entity
known to us to own beneficially more than 5% of the outstanding shares of common
stock, (ii) each of our directors, (iii) each of the named executive officers
and (iv) all directors and executive officers as a group. Unless otherwise
indicated below, to our knowledge, all persons listed below have sole voting and
investment power with respect to their shares of common stock, except to the
extent authority is shared by spouses under applicable law.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE OWNED AFTER THE
OFFERING(1) OFFERING(1)
--------------------- ---------------------
BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- ---------------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Web Hosting Organization LLC(2).................. 25,200,000 77.4 25,200,000 59.7
c/o Charterhouse Group International, Inc.
535 Madison Avenue
New York, NY 10022
Charterhouse Group International, Inc.(2)........ 25,200,000 77.4 25,200,000 59.7
535 Madison Avenue
New York, NY 10022
Mathew Wolf(3)................................... 3,945,090 12.1 3,945,090 9.3
1001 Fannin Street
Suite 2000
Houston, TX 77002
SOFTBANK Technology Ventures IV, L.P.(4)......... 3,397,283 9.6 3,397,283 8.0
333 West San Carlos
Suite 1225
San Jose, CA
Leonard J. Fassler(5)............................ 25,200,000 77.4 25,200,000 59.7
Bradley A. Feld(5)(6)............................ 25,200,000 77.4 25,200,000 59.7
Stephen W. Maggs(5).............................. 25,200,000 77.4 25,200,000 59.7
Francis J. Alfano................................ -- -- -- --
Rajat Bhargava(5)................................ 25,200,000 77.4 25,200,000 59.7
Bruce S. Klein................................... -- -- -- --
William A. Wilson................................ -- -- -- --
Merril M. Halpern(8)............................. -- -- -- --
Thomas C. Dircks(8)(9)(10)....................... -- -- -- --
Patricia A.M. Riley(8)(9)(10).................... -- -- -- --
Jay M. Gates(8).................................. -- -- -- --
Charles R. Lax(7)(9)............................. 3,397,283 9.6 3,397,283 8.0
All Directors and Executive Officers as a
Group(5), (6), (7) and (8) (18 persons)........ 29,471,467 83.3 29,471,467 69.5
</TABLE>
- ---------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, based on factors including voting and
investment power with respect to shares. Shares of common stock subject to
options currently exercisable within 60 days of July 7, 1999 are deemed
outstanding for the purpose of computing the percentage of ownership of the
person holding such options, but are not deemed outstanding for computing
the percentage ownership of any other person.
(2) The principal members of WEB are CEP III, an affiliate of Charterhouse Group
International, Inc., and WHO. Their respective ownership interest in WEB are
as follows: CEP III: 95.2% and WHO 4.8%. Leonard J. Fassler and Bradley A.
Feld are the member managers of WHO and Stephen W. Maggs and Rajat Bhargava
are among the members. The general partner of CEP III is CHUSA
67
<PAGE> 71
Equity Investors III, L.P., whose general partner is Charterhouse Equity
III, Inc., a wholly-owned subsidiary of Charterhouse. As a result of the
foregoing, all of the shares of Common Stock of Interliant held by the WEB
would for purposes of Section 13(d) of the Securities Exchange Act of 1934,
as amended, be considered to be beneficially owned by Charterhouse.
(3) Includes 398,845 shares of common stock owned by the Ann Weltchek Wolf 1995
Marital Trust, 797,690 shares of common stock owned by the Mathew D. Wolf
Childrens Trust and 350,000 shares of common stock held in escrow until
March 31, 2000. Mr. Wolf disclaims beneficial ownership of all the shares of
common stock owned by both of the trusts named above.
(4) Includes 2,647,658 shares of Series A Redeemable Convertible Preferred Stock
which will be converted into an equal number of shares of common stock upon
consummation of the offering. Of these shares, 49,776 are held by SOFTBANK
Technology Advisors Fund, L.P., an affiliated entity. Also includes 14,093
shares of common stock held by SOFTBANK Technology Advisors Fund, L.P.
(5) Includes 25,200,000 shares held by WEB. Messrs. Fassler, Feld, Maggs and
Bhargava are members of WHO, which is a member of WEB. Each of Messrs.
Fassler, Feld, Maggs and Bhargava disclaim beneficial ownership of such
shares other than the shares attributable to each of them on a pro rata
basis as a result of their membership in WHO. Mr. Feld is a general partner
of Kodiak Technology Ventures II LLP. Kodiak received 5,176 shares of Common
Stock in connection with our acquisition of Net Daemons Associates, Inc. On
April 26, 1999, Kodiak distributed 2,588 shares of common stock to each of
its general partners.
(6) Excludes 3,333,414 shares held by SOFTBANK Technology Ventures IV, L.P. and
63,869 shares held by SOFTBANK Technology Advisors Fund, L.P. Mr. Feld, a
Co-chairman and Director of Interliant, is a general partner of each of
SOFTBANK Technology Ventures IV, L.P. and SOFTBANK Technology Advisors Fund,
L.P. Mr. Feld disclaims beneficial ownership of such shares.
(7) Includes 3,333,414 shares held by SOFTBANK Technology Ventures IV, L.P. and
63,869 shares held by SOFTBANK Technology Advisors Fund, L.P. Mr. Lax, a
director of Interliant, is a managing member of STV IV LLC, the general
partner of SOFTBANK Technology Ventures IV, L.P. Mr. Lax disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest therein.
(8) Excludes 25,200,000 shares held by WEB. Messrs. Halpern, Dircks, Gates and
Ms. Riley are directors and/or officers of Charterhouse. Charterhouse is an
affiliate of CEP III which is a member of WEB. Each of Messrs. Halpern,
Dircks, Gates and Ms. Riley disclaim beneficial ownership of such shares.
(9) A member of the Compensation Committee of the Board of Directors.
(10) A member of the Audit Committee of the Board of Directors.
68
<PAGE> 72
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED STOCK; ISSUED AND OUTSTANDING SHARES
Our authorized capital stock consists of 200,000,000 shares of common
stock, par value $0.01 per share, and 1,000,000 shares of undesignated preferred
stock, par value $0.01 per share.
COMMON STOCK
Immediately following the offering 42,215,268 shares of common stock will
be issued and outstanding based on the number of shares of common stock
outstanding as of the date hereof and assuming the issuance of 2,647,658 shares
of common stock upon the conversion of all outstanding Series A Redeemable
Convertible Preferred Stock (see "-- The SOFTBANK Investment"). All of the
issued and outstanding shares of common stock are, and the shares of common
stock offered hereby will upon completion of this offering be fully paid and
nonassessable.
The following summarizes the rights of holders of our common stock:
- each holder of shares of common stock is entitled to one vote per share
on all matters to be voted on by stockholders generally, including the
election of directors;
- there are no cumulative voting rights;
- the holders of our common stock are entitled to dividends which may be
paid in cash, property or shares of our capital stock and other
distributions as may be declared from time to time by the board of
directors out of funds legally available for that purpose, if any;
- upon our liquidation, dissolution or winding up, the holders of shares of
common stock will be entitled to share ratably in the distribution of all
of our assets remaining available for distribution after satisfaction of
all our debts and liabilities and the payment of the liquidation
preference of any outstanding preferred stock; and
- upon completion of this offering, the holders of common stock have no
preemptive or other subscription rights to purchase shares of our stock,
nor will holders be entitled to the benefits of any redemption or sinking
fund provisions.
As of the date hereof, there were 56 record owners of common stock.
Certain stockholders of Interliant have been given the right to nominate
persons for election as directors. See "-- The SOFTBANK Investment" and "-- The
Interliant Acquisition."
PREFERRED STOCK
Our certificate of incorporation authorizes our board of directors to
create and issue one or more series of preferred stock and determine the rights
and preferences of each series within the limits set forth in our certificate of
incorporation and applicable law. Among other rights, the board of directors may
determine, without further vote or action by our stockholders:
- the number of shares constituting the series and the distinctive
designation of the series;
- the dividend rate on the shares of the series, whether dividends will be
cumulative, and if so, from which date or dates, and the relative rights
of priority, if any, of payment of dividends on shares of the series;
- whether the series will have voting rights in addition to the voting
rights provided by law and, if so, the terms of such voting rights;
- whether the series will have conversion privileges and, if so, the terms
and conditions of conversion;
- whether or not the shares of the series will be redeemable or
exchangeable, and if so, the dates, terms and conditions of redemption or
exchange, as the case may be;
69
<PAGE> 73
- whether the series will have a sinking fund for the redemption or
purchase of shares of that series, and, if so, the terms and amount of
the sinking fund; and
- the rights of the shares of the series in the event of our voluntary or
involuntary liquidation, dissolution or winding up and the relative
rights or priority, if any, of payment of shares of the series.
Unless otherwise provided by our Board of Directors, the shares of all
series of preferred stock will rank on a parity with respect to the payment of
dividends and to the distribution of assets upon liquidation. Although we have
no present plans to issue any shares of preferred stock, any future issuance of
shares of preferred stock, or the issuance of rights to purchase preferred
shares, may have the effect of delaying, deferring or preventing a change of
control in our company or an unsolicited acquisition proposal. The issuance of
preferred stock also could decrease the amount of earnings and assets available
for distribution to the holders of common stock or could adversely affect the
rights and powers, including voting rights, of the holders of the common stock.
Accordingly, the issuance of shares of preferred stock may discourage bids for
the common stock at a premium or may otherwise adversely affect the market price
of the common stock.
Currently, excluding 2,647,658 shares of Series A Redeemable Convertible
Preferred Stock that will be converted into an equal number of shares of common
stock upon the consummation of this offering and which will then cease to exist
(see "Description of Capital Stock -- The SOFTBANK Investment"), there are no
shares of preferred stock issued or outstanding.
THE WEB HOSTING ORGANIZATION INVESTMENT
WEB owns 25,200,000 shares of our common stock, which will represent
approximately 59.7% of our outstanding common stock following consummation of
this offering. The shares were acquired for an aggregate purchase price of $42.0
million in a series of 6 transactions in December 1997, May 1998, June 1998,
September 1998, December 1998 and February 1999, in each case at a price, giving
effect to the 3-for-1 stock split effective in July 1998, of $1.67 per share.
The terms of the sale and purchase of these shares are set forth in a
subscription agreement dated December 8, 1997 between WEB and us. The principal
members of WEB are (1) CEP III, which is an affiliate of Charterhouse and (2)
WHO (collectively with CEP III, the "WEB Members"), of which Leonard J. Fassler
and Bradley A. Feld are the member managers. The WEB Members have agreed that
WEB shall be under the exclusive direction of a management committee comprised
of seven members and will vote such member's interest in WEB so that a majority
of the members of such management committee will be designees of Charterhouse.
WEB has certain demand and incidental registration rights under the terms of an
Investors Agreement dated as of January 28, 1999 and a Registration Rights
Agreement dated as of December 8, 1997. See "Description of Capital
Stock -- Registration Rights of Certain Holders."
THE SOFTBANK INVESTMENT
On January 28, 1999, the SOFTBANK Purchasers purchased from us an aggregate
of 2,647,658 shares of our Redeemable Convertible Preferred Stock and warrants
to purchase 749,625 shares of our common stock for an aggregate purchase price
of $13.0 million. On April 19, 1999, the SOFTBANK Purchasers exercised their
warrants at an aggregate exercise price of $5.0 million and now own 749,625
shares of our common stock. Upon the consummation of this offering, all of the
outstanding shares of Redeemable Convertible Preferred Stock will automatically
be converted into an equal number of shares of our common stock, and the
SOFTBANK Purchasers will own approximately 8.0% of our outstanding common stock.
Bradley A. Feld, our Co-Chairman and director, is a general partner of the
SOFTBANK Purchasers. See "Related Party Transactions." The SOFTBANK Purchasers
have certain demand and incidental registration rights under the terms of the
Investors Agreement. See "Registration Rights of Certain Holders." A majority in
interest of the SOFTBANK Purchasers also have the right, under the Investors
Agreement, to nominate one person for election to our Board of Directors and
have the Board cause that director to be a member of the Compensation Committee
and/or the Audit Committee of the
70
<PAGE> 74
Board. Such director will be subject to removal by the SOFTBANK Purchasers at
any time, with or without cause, and the SOFTBANK Purchasers will have the right
to call a special meeting of stockholders at any time for the sole purpose of
removing and replacing such director. WEB has agreed to vote its shares in a
manner consistent with these and the other terms of the Investors Agreement. Mr.
Charles R. Lax is currently serving as a director and a member of the
Compensation Committee of our Board of Directors pursuant to such provisions.
THE INTERLIANT ACQUISITION
On March 10, 1999, pursuant to an Asset Purchase Agreement with Interliant
Texas and the shareholders of Interliant Texas, we, partly through a
wholly-owned subsidiary, acquired substantially all of the assets and assumed
specified liabilities of Interliant Texas for $100,000 in cash, 4,091,642 shares
of common stock and the assumption of promissory notes in favor of Mathew Wolf
and Erving Wolf in the aggregate amount of $15.9 million. Upon the closing of
the acquisition, the $7.9 million note in favor of Erving Wolf was paid in full
and the $8.0 million note issued by Interliant Texas in favor of Mathew Wolf was
canceled and replaced by the Wolf Note. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
The 4,091,642 shares of common stock issued in connection with the
acquisition were delivered pursuant to an Agreement to Deliver Shares which
provided, among other things, for 3,608,863 shares of common stock to be
delivered at the closing of the acquisition to the shareholders of Interliant
Texas, 114,644 shares of common stock to be delivered at the closing of the
acquisition to Broadview Holdings LLP, 18,135 shares of common stock to be
delivered on the first business day following January 1, 2000 and 350,000 shares
of common stock to be placed in escrow to support the indemnification
obligations of Interliant Texas and its shareholders under the Purchase
Agreement. Unless we make a claim against the escrowed shares in accordance with
the provisions of the Purchase Agreement, the shares of common stock placed in
escrow will be distributed to Mathew Wolf, one of the shareholders of Interliant
Texas, on March 31, 2000.
In addition, under the Purchase Agreement, we issued 2,322,139 options to
purchase shares of our common stock at an exercise price of $0.13 per share. All
or a portion of such Interliant Options are fully vested and exercisable.
The shareholders have certain incidental registration rights under the
terms of the Shareholders Agreement, dated as of March 10, 1999 by and among all
of our shareholders. See "-- Registration Rights of Certain Holders."
For so long as all of the parties who received shares of common stock
pursuant to the Agreement to Deliver Shares and certain holders of our options
own in the aggregate 5% of more of the issued and outstanding common stock, such
parties shall have the right to nominate one person for election to our Board of
Directors. To date, such parties have not exercised such rights.
REGISTRATION RIGHTS OF CERTAIN HOLDERS
We have granted the holders of an aggregate of 32,320,790 shares of common
stock certain demand and incidental registration rights. The SOFTBANK Purchasers
have such registration rights under the Investors Agreement with respect to
2,647,658 shares of common stock to be received upon the consummation of this
offering from the conversion of an equal number of shares of Redeemable
Convertible Preferred Stock and 749,625 shares of common stock received on April
19, 1999 upon the exercise of warrants. WEB has such registration rights under
the terms of each of the Investors Agreement and the Registration Rights
Agreement with respect to 25,200,000 shares of common stock purchased. The
Seller Shareholders have incidental registration rights under the terms of the
Shareholders Agreement with respect to 3,608,863 shares of common stock received
as consideration for the sale of substantially all of the assets of Interliant
Texas and Broadview Holdings LLP has incidental registration rights with respect
to 114,644 shares owned by it. The Shareholders Agreement provides that it shall
be amended as
71
<PAGE> 75
necessary to include any additional shares of common stock issuable pursuant to
the provisions in the Purchase Agreement regarding adjustment of purchase price.
If we propose to file a registration statement under the Securities Act
covering our common stock or any securities exercisable or exchangeable for or
convertible into our common stock, the holders of piggyback registration rights
may require us to include a requested amount of their common stock in our
registered offering on the same terms and conditions applicable to the other
equity securities included in such registration statement. We may reduce the
number of shares to be registered if the managing underwriter determines that
the inclusion of such shares would materially and adversely affect the success
of this offering. These piggyback registration rights do not apply to the
registration of securities in connection with our employee benefit plans or
securities issuable in a merger, exchange offer or similar transaction.
Demand registration rights entitle the holder to require us to include a
requested amount of their common stock in a registration statement on Form S-1,
Form S-2 or Form S-3 and to use our best efforts to register such shares under
the Securities Act of 1933, as amended based on the advice of the managing
underwriter. A majority of the SOFTBANK Purchasers may exercise two demand
registration rights with respect to the registration of shares of common stock
on Form S-1, and twenty percent of the SOFTBANK Purchasers may exercise two
demand registration rights with respect to the registration of shares of common
stock on Form S-3 at any time we become eligible to use Form S-3. WEB may
exercise three demand registration rights with respect to the shares of common
stock that it owns. However, we are not required to register shares under demand
registration rights sooner than six months following the consummation of this
offering.
Each stockholder with the foregoing piggyback registration rights and
demand registration rights whose shares of common stock are included in a
registration statement must agree not to offer for public sale any shares of
common stock or securities exercisable or exchangeable for or convertible into
common stock, or effect any sale of securities pursuant to Rule 144 under the
Securities Act of 1933, as amended, during the ten days prior to and the 180
days after the closing date of any underwritten offering unless such shares are
covered by such registration statement or a shorter period is agreed to by the
managing underwriter. We are required to bear all related registration expenses
(excluding any underwriting discounts or commissions, if any), disbursements and
fees in connection with the exercise of Piggyback Registration Rights and Demand
Registration Rights.
In addition, in connection with the issuance to Mr. Steven C. Dabbs of
150,000 shares of common stock in connection with the acquisition of
substantially all of the assets of Clever Computers, Inc., we have agreed that
in the event we grant registration rights with respect to shares of common stock
to any other employee of Interliant or its affiliates, employed in a position
comparable or junior to Mr. Dabbs, identical registration rights shall be given
to Mr. Dabbs.
LIMITATIONS ON DIRECTOR LIABILITY
Our certificate of incorporation provides that, to the fullest extent
permitted by the Delaware General Corporation Law, none of our directors will be
personally liable to us or our stockholders for monetary damages. Section
102(b)(7) of the Delaware General Corporation Law currently provides that a
director's liability for breach of fiduciary duty to a corporation may be
eliminated, except for liability:
- for any breach of the director's duty of loyalty to the corporation or
its stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- under Section 174 of the Delaware General Corporation Law, for unlawful
dividends or unlawful stock repurchases or redemptions; and
- for any transaction from which the director derives an improper personal
benefit.
72
<PAGE> 76
Any amendment to these provisions of the Delaware General Corporation Law
will automatically be incorporated by reference into our certificate of
incorporation without any vote on the part of its stockholders unless otherwise
required, including this provision in our Amended and Restated Certificate may,
however, discourage or deter stockholders or management from bringing a lawsuit
against directors for a breach of their fiduciary duties, even though such an
action, if successful, might otherwise have benefit us and our stockholders.
The By-laws provide that we will indemnify our directors and officers to
the fullest extent permitted by Delaware law. Generally, we are required to
indemnify our directors and officers for all:
- judgments;
- fines;
- settlements;
- legal fees; and
- other expenses
incurred in connection with pending or threatened legal proceedings because of
the director's or officer's position with us.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. Under Section 203, business combinations between a Delaware
corporation whose stock generally is publicly traded or held of record by more
than 2,000 stockholders and an interested stockholder are generally prohibited
for a three-year period following the date that such a stockholder became an
interested stockholder, unless:
- the corporation has elected in its original certificate of incorporation
not to be governed by Section 203. We did not make this election;
- the business combination was approved by the board of directors of the
corporation before the other party to the business combination became an
interested stockholder;
- upon consummation of the transaction that made it an interested
stockholder, the interested stockholder owned at least 85% of the voting
stock of the corporation outstanding at the commencement of the
transaction, excluding voting stock owned by directors who are also
officers or held in employee benefit plans in which the employees do not
have a confidential right to tender or vote stock held by the plan; or
- the business combination was approved by the board of directors of the
corporation and ratified by two-thirds of the voting stock not owned by
the interested stockholder.
The three-year prohibition also does not apply to some business
combinations proposed by an interested stockholder following the announcement or
notification of an extraordinary transaction involving the corporation and a
person who had not been an interested stockholder during the previous three
years or who became an interested stockholder with the approval of the majority
of the corporation's directors.
The term "business combination" is defined generally under Section 203 to
include mergers or consolidations between a Delaware corporation and an
interested stockholder, transactions with an interested stockholder involving
the assets or stock of the corporation or its majority-owned subsidiaries and
transactions which increase an interested stockholder's percentage ownership of
stock. The term "interested stockholder" is defined generally under Section 203
as a stockholder who, together with affiliates and associates, owns or within
three years prior did own 15% or more of a Delaware corporation's voting stock.
Section 203 could prohibit or delay a merger, takeover or other change in
control of us and therefore could discourage attempts to acquire us.
73
<PAGE> 77
Our Board approved both the acquisition of common stock by WEB as part of
their approval of WEB Hosting Organization Investment and the acquisition of
preferred stock and warrants by the SOFTBANK Purchasers as part of their
approval of the SOFTBANK Investment and, accordingly, the prohibitions under
Section 203 will not apply to any business combination with either WEB or the
SOFTBANK Purchasers.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, L.L.C.
SHARES ELIGIBLE FOR FUTURE SALE
SHARES ELIGIBLE FOR FUTURE SALE
Immediately following this offering, there will be 42,215,268 shares of our
common stock issued and outstanding assuming that no option holder exercises any
outstanding stock options after the date of this prospectus. Of these shares,
the 7,000,000 shares of common stock to be sold in this offering will be
immediately eligible for sale in the public market. All of the remaining shares
will be restricted securities within the meaning of Rule 144 and may not be
publicly resold, except in compliance with the registration requirements of the
Securities Act pursuant to an exemption from registration, including that
provided by Rule 144. All of the restricted shares are subject to the 180-day
Lock-up Agreements described below.
RULE 144
In general, under Rule 144, a person, or persons whose shares are
aggregated, who has beneficially owned restricted securities for at least one
year, including a person who may be deemed an affiliate, is entitled to sell
within any three month period a number of our shares of common stock that does
not exceed the greater of:
- 1% of the then-outstanding shares of our common stock; or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the date on
which notice of sale is filed with the Securities and Exchange
Commission.
Sales under Rule 144 are subject to restrictions relating to manner of sale,
notice and the availability of current public information about us. Commencing
90 days after the date of this prospectus, 3,150,000 shares of common stock will
be eligible for resale under Rule 144. All of such shares are subject to the
180-day Lock-up Agreements described below.
A person who is not deemed an affiliate of ours at any time during the 90
days preceding a sale and who has beneficially owned shares for at least two
years would be entitled to sell shares following this offering under Rule 144(k)
without regard to the volume limitations, manner of sale provisions or notice
requirements of Rule 144.
RULE 701
Our employees, directors, officers or consultants who purchase our shares
in connection with a written compensatory plan or contract may be entitled to
rely on the resale provisions of Rule 701. Rule 701 permits non-affiliates to
sell their Rule 701 shares without having to comply with the public information,
holding period, volume limitation or notice provisions of Rule 144. Affiliates
may sell their Rule 701 shares without having to comply with Rule 144's holding
period restrictions. In each of these cases Rule 701 allows the shareholders to
sell 90 days after the date of this prospectus.
74
<PAGE> 78
OPTIONS
We intend to file one or more registration statements on Form S-8 under the
Securities Act to register all shares of Common Stock subject to outstanding
stock options and Common Stock issuable pursuant to our stock option plans.
Shares covered by these registration statements will thereupon be eligible for
sale in the public markets, subject to the 180-day Lock-up Agreements described
below, to the extent applicable.
LOCK-UP AGREEMENTS
For a period of 180 days after the date of this prospectus, we, our
executive officers, directors and substantially all of our stockholders, have
agreed not to, without approval by Merrill Lynch & Co., on behalf of the several
underwriters:
- sell, dispose of or transfer any shares of common stock or securities
convertible into common stock;
- enter into any agreement that transfers any part of the economic
consequence of ownership of the common stock; or
- seek or exercise any right to register any share of common stock or
security convertible into common stock.
Our stockholders do, however, have the right to:
- transfer the securities as a gift, if the recipient agrees to be bound by
the provisions of the Lock-up Agreement; or
- pledge their securities to us in consideration for a loan from us.
In addition, we do have the right to transfer common stock in connection
with an acquisition, if any recipient of such shares agrees to be bound by the
provisions of the Lock-up Agreement.
EFFECT OF SALES OF SHARES
No prediction can be made as to the effect, if any, that future sales of
shares of common stock or the availability of shares for future sale will have
on the prevailing market price for the common stock. Sales of substantial
amounts of common stock, or the perception that such sales could occur, could
adversely affect prevailing market prices for the common stock and could impair
our future ability to raise capital through an offering of equity securities.
75
<PAGE> 79
UNDERWRITING
GENERAL
We intend to offer our common stock in the United States and Canada through
a number of U.S. underwriters as well as elsewhere through international
managers. Merrill Lynch, Pierce, Fenner & Smith Incorporated, Donaldson, Lufkin
& Jenrette Securities Corporation and CIBC World Markets Corp. are acting as
U.S. representatives of each of the U.S. underwriters named below. Subject to
the terms and conditions set forth in a U.S. purchase agreement among us and the
U.S. underwriters, and concurrently with the sale of 875,000 shares of common
stock to the international managers, we have agreed to sell to the U.S.
underwriters, and each of the U.S. underwriters severally and not jointly has
agreed to purchase from us, the number of shares of common stock set forth
opposite its name below.
<TABLE>
<CAPTION>
NUMBER
OF SHARES
U.S. UNDERWRITER ----------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated................................... 2,450,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 1,470,000
CIBC World Markets Corp..................................... 980,000
Hambrecht & Quist LLC....................................... 150,000
ING Baring Furman Selz LLC.................................. 150,000
Lehman Brothers Inc. ....................................... 150,000
PaineWebber Incorporated.................................... 150,000
Doft & Co., Inc. ........................................... 75,000
EVEREN Securities, Inc. .................................... 75,000
Kaufman Bros., L.P. ........................................ 75,000
Ladenburg Thalmann & Co. Inc. .............................. 75,000
Monness, Crespi, Hardt & Co., Inc. ......................... 75,000
Brad Peery Inc. ............................................ 75,000
Sands Brothers & Co., Ltd. ................................. 75,000
E*OFFERING Corp. ........................................... 50,000
Wit Capital Corporation..................................... 50,000
----------
Total.......................................... 6,125,000
==========
</TABLE>
We have also entered into an international purchase agreement with certain
international managers outside the United States and Canada for whom Merrill
Lynch International, Donaldson, Lufkin & Jenrette International and CIBC World
Markets International Limited are acting as lead managers. Subject to the terms
and conditions set forth in the international purchase agreement, and
concurrently with the sale of 6,125,000 shares of common stock to the U.S.
underwriters pursuant to the U.S. purchase agreement, we have agreed to sell to
the international managers and the international managers severally have agreed
to purchase from us an aggregate of 875,000 shares of common stock. The initial
public offering price per share and the total underwriting discount per share of
common stock are identical under the U.S. purchase agreement and the
international purchase agreement.
In the U.S. purchase agreement and the international purchase agreement,
the several U.S. underwriters and the several international underwriters have
agreed, subject to the terms and conditions set forth therein, to purchase all
of the shares of common stock being sold pursuant to each such agreement if any
of the shares of common stock being sold pursuant to such agreement are
purchased. In the event of a default by an underwriter, the U.S. purchase
agreement and the international purchase agreement provide that, in certain
circumstances, the purchase commitments of the nondefaulting underwriters may be
increased or the purchase agreements may be terminated. The closings with
respect to the sale of shares of common stock to be purchased by the U.S.
underwriters and the international managers are conditioned upon one another.
76
<PAGE> 80
We have agreed to indemnify the U.S. underwriters and the international
managers against some liabilities, including some liabilities under the
Securities Act, or to contribute to payments the U.S. underwriters and the
international managers may be required to make in respect of those liabilities.
The shares of common stock are being offered by the several underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of certain legal matters by counsel for the underwriters and certain
other conditions. The underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part.
COMMISSIONS AND DISCOUNTS
The U.S. representatives have advised us that the U.S. underwriters propose
initially to offer the shares of common stock to the public at the initial
public offering price set forth on the cover page of this prospectus, and to
certain dealers at such price less a concession not in excess of $.40 per share
of common stock. The U.S. underwriters may allow, and such dealers may reallow,
a discount not in excess of $.10 per share of common stock to certain other
dealers. After the initial public offering, the public offering price,
concession and discount may change.
The following table shows the per share and total public offering price,
underwriting discount to be paid by us to the U.S. underwriters and the
international managers and the proceeds before expenses to us. This information
is presented assuming either no exercise or full exercise by the U.S.
underwriters and the international managers of their over-allotment options.
<TABLE>
<CAPTION>
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
<S> <C> <C> <C>
Public Offering Price......................... $10.00 $70,000,000 $80,500,000
Underwriting Discount......................... $.70 $4,900,000 $5,635,000
Proceeds, before expenses, to Interliant...... $9.30 $65,100,000 $74,865,000
</TABLE>
The expenses of the offerings (exclusive of the underwriting discount and
commissions) are estimated at $1.4 million and are payable by us.
INTERSYNDICATE AGREEMENT
The U.S. underwriters and the international managers have entered into an
intersyndicate agreement that provides for the coordination of their activities.
Under the terms of the intersyndicate agreement, the U.S. underwriters and the
international managers are permitted to sell shares of our common stock to each
other for purposes of resale at the initial public offering price, less an
amount not greater than the selling concession. Under the terms of the
intersyndicate agreement, the U.S. underwriters and any dealer to whom they sell
shares of our common stock will not offer to sell or sell shares of our common
stock to persons who are non-U.S. or non-Canadian persons or to persons they
believe intend to resell to persons who are non-U.S. or non-Canadian persons,
and the international managers and any dealer to whom they sell shares of common
stock will not offer to sell or sell shares of common stock to U.S. persons or
to Canadian persons or to persons they believe intend to resell to U.S. or
Canadian persons, except in the case of transactions under the terms of the
intersyndicate agreement.
OVER-ALLOTMENT OPTION
We have granted options to the U.S. underwriters, exercisable for 30 days
after the date of this prospectus, to purchase up to an aggregate of 920,000
additional shares of common stock at the public offering price set forth on the
cover page of this prospectus, less the underwriting discount. The U.S.
underwriters may exercise this option solely to cover over-allotments, if any,
made on the sale of the common stock offered hereby. To the extent that the U.S.
underwriters exercise this option, each U.S. underwriter will be obligated,
subject to certain conditions, to purchase a number of additional shares of
common stock proportionate to such U.S. underwriter's initial amount reflected
in the foregoing table.
77
<PAGE> 81
We also have granted an option to the international managers, exercisable
for 30 days after the date of this prospectus, to purchase up to an aggregate of
130,000 additional shares of common stock to cover over-allotments, if any, on
terms similar to those granted to the U.S. underwriters.
RESERVED SHARES
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 350,000 shares, or 5%, of the shares offered
hereby, to be sold to some of our directors, officers and employees and their
family members, officers and employees of SOFTBANK entities, and our resellers
and strategic partners. The number of shares of common stock available for sale
to the general public will be reduced to the extent those persons purchase such
reserved shares. Any reserved shares which are not orally confirmed for purchase
within one day of the pricing of this offering will be offered by the
underwriters to the general public on the same terms as the other shares offered
in this prospectus.
NO SALES OF SIMILAR SECURITIES
For a period of 180 days after the date of this prospectus, we, our
executive officers, directors and substantially all of our stockholders, have
agreed not to directly or indirectly, without approval by Merrill Lynch & Co.,
on behalf of the several underwriters:
- Offer, pledge, sell, dispose of or transfer any shares of common stock or
securities convertible into common stock;
- Enter into any agreement that transfers any part of the economic
consequence of ownership of the common stock; or
- Seek or exercise any right to register any share of common stock or
security convertible into common stock.
Our stockholders do, however, have the right to:
- Transfer the securities as a gift, if the recipient agrees to be bound by
the provisions of the Lock-up Agreement; or
- Pledge their securities to us in consideration for a loan from us.
In addition, we have the right to transfer common stock in connection with
an acquisition, if any recipient of such shares agrees to be bound by the
provisions of the Lock-up Agreement.
QUOTATION ON THE NASDAQ NATIONAL MARKET
Our common stock will trade on the Nasdaq National Market under the symbol
"INIT."
Before this offering, there has been no public market for our common stock.
The initial public offering price has been determined through negotiations
between us and the U.S. representatives and the lead managers. The factors
considered in determining the initial public offering price, in addition to
prevailing market conditions, were the valuation multiples of publicly-traded
companies that the U.S. representatives and the lead managers believe to be
comparable to us, certain of our financial information, the history of, and the
prospects for, our company and the industry in which we compete, and an
assessment of our management, its past and present operations, the prospects
for, and timing of, our future revenues, the present state of our development
and the above factors in relation to market values and various value measures of
other companies engaged in activities similar to ours. There can be no assurance
that an active trading market will develop for our common stock or that our
common stock will trade in the public market subsequent to this offering at or
above the initial public offering price.
The underwriters do not expect sales of the common stock to be made to any
accounts over which they exercise discretionary authority to exceed five percent
of the number of shares being offered in this offering.
78
<PAGE> 82
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters and
certain selling group members to bid for and purchase our common stock. As an
exception to these rules, the U.S. representatives are permitted to engage in
certain transactions that stabilize the price of our common stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of our common stock.
If the underwriters create a short position in our common stock in
connection with the offering contemplated hereby, i.e., if they sell more shares
of our common stock than are set forth on the cover page of this prospectus, the
U.S. representatives may reduce that short position by purchasing our common
stock in the open market. The U.S. representatives may also elect to reduce any
short position by exercising all or part of the over-allotment option described
above.
The U.S. representatives may also impose a penalty bid on our underwriters
and selling group members. This means that if the U.S. representatives purchase
shares of our common stock in the open market to reduce the underwriters' short
position or to stabilize the price of the our common stock, they may reclaim the
amount of the selling concession from the underwriters and selling group members
who sold those shares.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of our common stock to the extent that it
discourages resales of our common stock.
Neither we nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of our common stock. In addition, neither
we nor any of the underwriters makes any representation that the U.S.
representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for us by Dewey Ballantine LLP, New York, New York. Certain legal matters
in connection with the offering will be passed upon for the underwriters by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California.
EXPERTS
The consolidated financial statements of Interliant, Inc. (formerly known
as Sage Networks, Inc.) at December 31, 1997 and 1998, and for the period
December 8, 1997 (inception) to December 31, 1997 and the year ended December
31, 1998, and the financial statements of Interliant, Inc. (which is not the
registrant and which is referred to in this prospectus as Interliant Texas) at
December 31, 1997 and 1998, and for each of the three years in the period ended
December 31, 1998, appearing in this prospectus and registration statement, have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
reports thereon appearing elsewhere herein, and are included in reliance upon
the authority of such firm as experts in accounting and auditing.
The balance sheets of B.N. Technology, Inc. dba Internet Communications, as
of December 31, 1996 and 1997, and the related statements of operations and
accumulated deficit, and cash flows for the period April 15, 1996 (inception)
through December 31, 1996 and for the year ended December 31, 1997 included in
this prospectus have been so included in reliance on the report of Frankel,
Lodgen, Lacher, Golditch, Sardi & Howard, independent accountants given on the
authority of said firm as experts in auditing and accounting.
79
<PAGE> 83
The balance sheet of Clever Computers, Inc., as of December 31, 1995, 1996
and 1997 and the related statements of income, retained earnings, and cash flows
for the three years then ended included in this prospectus have been so included
in reliance on the report of BSC&E, independent accountants given on the
authority of said firm as experts in auditing and accounting.
The statements of assets and liabilities as of December 31, 1996 and 1997,
and the statements of revenue and expenses and of cash flows for each of the
three years in the period ended December 31, 1997, of HostAmerica, a division of
HomeCom Communications, Inc., included in this prospectus, have been included
herein in reliance on the report, which includes an explanatory paragraph
regarding basis of presentation, of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of that firm as experts in accounting and
auditing.
The financial statements of Net Daemons Associates, Inc., for the years
ended December 31, 1997 and 1998 included in this prospectus and in the
registration statement have been audited by Deloitte & Touche LLP, independent
accountants as stated in their report appearing herein and elsewhere in the
registration statement and is included in reliance upon the report of such firm
given upon the authority of said firm as experts in auditing and accounting.
The financial statements of Telephonetics International, Inc. and Affiliate
included in this prospectus and registration statement have been audited by BDO
Seidman, LLP, independent certified accountants to the extent and for the
periods set forth in their report appearing elsewhere herein and in this
registration statement and are included in reliance on such reports given upon
the authority of said firm as experts in auditing and accounting.
The balance sheets of Tri Star Web as of December 31, 1996 and 1997 and the
related statements of operations, and changes in retained earnings, and cash
flows for the years then ended, and the consolidated balance sheets of GEN
International Inc. and subsidiaries as of December 31, 1995, 1996 and 1997, and
the related consolidated statements of operations, changes in stockholders'
deficiency, and cash flows for the period April 4, 1995 (inception) through
December 31, 1995 and the years ended December 31, 1996 and 1997 and the balance
sheets of Digiweb, Inc. as of December 31, 1997 and 1998 and the related
statements of income, cash flows and changes in stockholders' equity for the
years then ended included in this prospectus have been so included in reliance
on the reports of Urbach Kahn & Werlin PC, independent accountants given on the
authority of said firm as experts in auditing and accounting.
AVAILABLE INFORMATION
We have filed with the Commission, Washington, D.C. 20549, a Registration
Statement on Form S-1 under the Securities Act with respect to the shares of
common stock offered hereby. This prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to us and the common
stock offered hereby, reference is made to the Registration Statement and the
exhibits and schedules filed therewith. Statements contained in this prospectus
as to the contents of any contract or any other document referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. A copy of
the Registration Statement may be inspected without charge at the offices of the
Commission in Washington, D.C. 20549, and copies of all or any part of the
Registration Statement may be obtained from the Public Reference Section of the
Commission, Washington, D.C. 20549 upon the payment of the fees prescribed by
the Commission. The Commission maintains a Web site (http://www.sec.gov) that
contains reports, proxy and information statements and other information
regarding registrants, such as Interliant, that file electronically with the
Commission.
We provide Web hosting services to a customer whose primary residence is
located in Cuba, Mr. Osvaldo Martinez. This information is correct as of the
date of this prospectus. Current information concerning business between any
person located in Cuba or the government of Cuba and Interliant may be obtained
from the Florida Department of Banking and Finance, Plaza Level, The Capitol,
Tallahassee, Florida 32399-0350, telephone number (904) 488-6311.
80
<PAGE> 84
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INTERLIANT, INC. (FORMERLY KNOWN AS SAGE NETWORKS, INC.)
Report of Independent Auditors.............................. F-4
Consolidated Balance Sheets as of December 31, 1997 and 1998
and March 31, 1999 (unaudited)............................ F-5
Consolidated Statements of Operations for the Period
December 8, 1997 (inception) to December 31, 1997 and the
Year Ended December 31, 1998 and for the three months
ended March 31, 1998 and 1999 (unaudited)................. F-6
Consolidated Statements of Stockholders' Equity for the
period December 8, 1997 (inception) to December 31, 1997
and the year ended December 31, 1998 and for the three
months ended March 31, 1999 (unaudited)................... F-7
Consolidated Statements of Cash Flows for the Period
December 8, 1997 (inception) to December 31, 1997 and the
Year Ended December 31, 1998 and for the three months
ended March 31, 1998 and 1999 (unaudited)................. F-8
Notes to Consolidated Financial Statements.................. F-9
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Pro Forma Consolidated Statement of Operations.............. F-20
Pro Forma Consolidated Statement of Operations.............. F-21
Notes to Pro Forma Consolidated Financial Statements........ F-22
ACQUIRED COMPANY (CLEVER COMPUTERS, INC.)
Independent Auditors' Report................................ F-23
Balance Sheets as of December 31, 1995, 1996 and 1997....... F-24
Statements of Income for the Years Ended December 31, 1995,
1996 and December 31, 1997 and for the three months ended
March 31, 1997 and 1998 (unaudited)....................... F-25
Statement of Retained Earnings for the Years Ended December
31, 1995, 1996 and December 31, 1997...................... F-26
Statement of Cash Flows for the Years Ended December 31,
1995, 1996 and December 31, 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-27
Notes to Financial Statements............................... F-28
ACQUIRED COMPANY (TRI STAR WEB CREATIONS, INC.)
Independent Auditor's Report................................ F-30
Balance Sheets as of December 31, 1996 and 1997............. F-31
Statements of Operations and Changes in Retained Earnings
For the Years Ended December 31, 1996 and 1997 and for the
three months ended March 31, 1997 and 1998 (unaudited).... F-32
Statements of Cash Flows for the Years Ended December 31,
1996 and 1997 and for the three months ended March 31,
1997 and 1998 (unaudited)................................. F-33
Notes to Financial Statements............................... F-34
ACQUIRED COMPANY (HOSTAMERICA DIVISION OF HOMECOM
COMMUNICATIONS, INC.)
Report of Independent Accountants........................... F-36
Statements of Assets and Liabilities as of December 31, 1996
and 1997.................................................. F-37
Statements of Revenues and Expenses for the Years ended
December 31, 1995, 1996 and 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-38
Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997 and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-39
Notes to Financial Statements............................... F-40
</TABLE>
F-1
<PAGE> 85
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ACQUIRED COMPANY (B.N. TECHNOLOGY, INC.)
Independent Auditor's Report................................ F-43
Balance Sheets as of December 31, 1996 and 1997............. F-44
Statements of Operations and Accumulated Deficit for the
Period from April 15, 1996 through December 21, 1996 and
the Year Ended December 31, 1997 and for the six months
ended June 30, 1997 and 1998 (unaudited).................. F-45
Statements of Cash Flows for the Period from April 15, 1996
through December 21, 1996 and the Year Ended December 31,
1997 and for the six months ended June 30, 1997 and 1998
(unaudited)............................................... F-46
Notes to Financial Statements............................... F-47
ACQUIRED COMPANY (GEN INTERNATIONAL, INC. AND SUBSIDIARIES)
Independent Auditor's Report................................ F-50
Balance Sheets as of December 31, 1995, 1996 and 1997....... F-51
Statements of Operations for the Period April 4, 1995
(inception) through December 31, 1995 and the Years Ended
December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998 (unaudited)........................ F-52
Statements of Cash Flows for the Period April 4, 1995
(inception) through December 31, 1995 and the Years Ended
December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998 (unaudited)........................ F-53
Statements of Changes in Stockholders' Deficiency for the
Period April 4, 1995 (inception) through December 31, 1995
and the Years Ended December 31, 1996 and 1997............ F-54
Notes to Financial Statements............................... F-55
ACQUIRED COMPANY (DIGIWEB, INC.)
Independent Auditor's Report................................ F-58
Balance Sheets as of December 31, 1997 and 1998............. F-59
Statements of Income for the Years Ended December 31, 1997
and 1998.................................................. F-60
Statements of Changes in Stockholders' Equity for the Years
Ended December 31, 1997 and 1998.......................... F-61
Statements of Cash Flows for the Years Ended December 31,
1997 and 1998............................................. F-62
Notes to Financial Statements............................... F-63
ACQUIRED COMPANY (TELEPHONETICS INTERNATIONAL, INC. AND
STATE OF THE ART, INC.)
Report of Independent Certified Public Accountants.......... F-66
Combined Balance Sheet as of December 31, 1998.............. F-67
Combined Statements of Operations for the Years Ended
December 31, 1997 and 1998................................ F-68
Combined Statements of Capital Deficit for the Years Ended
December 31, 1997 and 1998................................ F-69
Combined Statements of Cash Flows for the Years Ended
December 31, 1997 and 1998................................ F-70
Summary of Significant Accounting Policies.................. F-71
Notes to Combined Financial Statements...................... F-73
ACQUIRED COMPANY (NET DAEMONS ASSOCIATES, INC.)
Independent Auditor's Report................................ F-76
Balance Sheets as of December 31, 1997 and 1998............. F-77
Statements of Income for the Years Ended December 31, 1997
and 1998.................................................. F-78
Statements of Stockholders' Deficit for the Years Ended
December 31, 1997 and 1998................................ F-79
Statements of Cash Flows for the Years Ended December 31,
1997 and 1998............................................. F-80
Notes to Financial Statements............................... F-81
</TABLE>
F-2
<PAGE> 86
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ACQUIRED COMPANY (INTERLIANT, INC., WHICH IS NOT THE
REGISTRANT AND WHICH IS REFERRED TO IN THIS PROSPECTUS AS
INTERLIANT TEXAS)
Report of Independent Auditors.............................. F-86
Balance Sheets as of December 31, 1997 and 1998............. F-87
Statements of Operations for the Years Ended December 31,
1996, 1997 and 1998....................................... F-88
Statements of Shareholders' Deficit for the Years Ended
December 31, 1996, 1997 and 1998.......................... F-89
Statements of Cash Flows for the Years Ended December 31,
1996, 1997 and 1998....................................... F-90
Notes to Consolidated Financial Statements.................. F-91
</TABLE>
F-3
<PAGE> 87
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Interliant, Inc. (formerly known as Sage Networks, Inc.)
We have audited the accompanying consolidated balance sheets of Interliant,
Inc. (formerly known as Sage Networks, Inc.) (the Company) as of December 31,
1997 and 1998, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the period December 8, 1997 (inception)
to December 31, 1997 and the year ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Interliant, Inc. (formerly known as Sage Networks, Inc.) at December 31, 1997
and 1998, and the consolidated results of its operations and its cash flows for
the period December 8, 1997 (inception) to December 31, 1997 and the year ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
February 15, 1999, except for the second to last paragraph of Note 12,
as to which the date is March 10, 1999
F-4
<PAGE> 88
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- MARCH 31,
1997 1998 1999
---------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 912,085 $ 6,813,360 $ 4,376,478
Cash-restricted.................................. 1,392,371
Accounts receivable, net of allowance of $320,000
and $691,629 at December 31, 1998 and March
31, 1999, respectively........................ 806,322 5,097,716
Common stock subscription receivable............. 4,000,000
Prepaid expenses and other current assets........ 14,000 639,662 1,126,435
---------- ------------ ------------
Total current assets..................... 4,926,085 8,259,344 11,993,000
---------- ------------ ------------
Furniture, fixtures and equipment, net........... 27,063 5,103,123 11,467,239
Intangibles, net................................. 12,612,228 76,860,888
Other assets..................................... 222,172 575,738
---------- ------------ ------------
Total assets............................. $4,953,148 $ 26,196,867 $100,896,865
========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term
debt.......................................... $ 8,136,195
Accounts payable................................. $ 84,389 $ 787,412 2,587,650
Accrued expenses................................. 26,507 2,301,507 3,268,667
Deferred revenue................................. 1,414,969 3,462,214
---------- ------------ ------------
Total current liabilities................ 110,896 4,503,888 17,454,726
Long-term debt, less current portion............. 914,482
Series A, redeemable convertible preferred stock... 13,000,000
Stockholders' equity:
Common stock, par value $.01; 100,000,000 shares
authorized; 3,000,000, 19,217,197 and
30,998,802 shares issued and outstanding at
December 31, 1997, 1998 and March 31, 1999,
respectively.................................. 30,000 192,172 309,988
Additional paid-in capital....................... 4,970,000 34,160,334 89,067,255
Deferred compensation............................ (1,769,429) (1,201,867)
Accumulated deficit.............................. (157,748) (10,890,098) (18,647,719)
---------- ------------ ------------
Total stockholders' equity............... 4,842,252 21,692,979 69,527,657
---------- ------------ ------------
Total liabilities and stockholders'
equity................................. $4,953,148 $ 26,196,867 $100,896,865
========== ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE> 89
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD
DECEMBER 8,
1997 THREE MONTHS ENDED
(INCEPTION) TO YEAR ENDED MARCH 31,
DECEMBER 31, DECEMBER 31, ----------------------------
1997 1998 1998 1999
-------------- ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Service revenues..................... $ 4,905,027 $ 13,126 $ 5,434,162
Costs and expenses:
Cost of service revenues........... 3,236,385 53,774 3,250,703
Sales and marketing................ 2,555,035 110,882 1,896,357
General and administrative......... $ 155,898 5,120,595 256,019 3,699,847
Depreciation....................... 1,850 696,039 9,417 699,552
Amortization of intangibles........ 2,439,426 1,618 2,594,330
Start-up and acquisition
integration
costs........................... 1,727,970 134,106 1,063,458
---------- ------------ ---------- -----------
157,748 15,775,450 565,816 13,204,247
---------- ------------ ---------- -----------
Operating loss....................... (157,748) (10,870,423) (552,690) (7,770,085)
Interest income...................... 138,073 13,645 53,912
Other income (expense)............... (41,448)
---------- ------------ ---------- -----------
Net loss............................. $ (157,748) $(10,732,350) $ (539,045) $(7,757,621)
========== ============ ========== ===========
Net loss per share -- basic and
diluted............................ $ (0.05) $ (1.22) $ (0.18) $ (0.31)
========== ============ ========== ===========
Weighted average shares
outstanding........................ 3,000,000 8,799,432 3,000,000 24,769,890
========== ============ ========== ===========
</TABLE>
See accompanying notes.
F-6
<PAGE> 90
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN DEFERRED ACCUMULATED STOCKHOLDERS'
SHARES PAR VALUE CAPITAL COMPENSATION DEFICIT EQUITY
----------- --------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Sales of common stock................ 3,000,000 $ 30,000 $ 4,970,000 $ 5,000,000
Net loss............................. $ (157,748) (157,748)
----------- -------- ----------- ----------- ------------ ------------
Balance as of December 31, 1997...... 3,000,000 30,000 4,970,000 (157,748) 4,842,252
Sales of common stock.............. 15,600,000 156,000 25,884,000 26,040,000
Deferred compensation.............. 475,000 4,750 2,600,750 $(2,602,250) 3,250
Amortization of deferred
compensation..................... 832,821 832,821
Issuance of common stock in
connection with acquisitions..... 142,197 1,422 705,584 707,006
Net loss........................... (10,732,350) (10,732,350)
----------- -------- ----------- ----------- ------------ ------------
Balance as of December 31, 1998...... 19,217,197 192,172 34,160,334 (1,769,429) (10,890,098) 21,692,979
Sales of common stock (unaudited).... 6,600,000 66,000 10,934,000 11,000,000
Amortization of deferred compensation
(unaudited)........................ 567,562 567,562
Issuance of common stock in
connection with acquisitions
(unaudited)........................ 5,181,605 51,816 34,009,486 34,061,302
Issuance of stock options in
connection with acquisition
(unaudited)........................ 9,963,435 9,963,435
Net loss (unaudited)................. (7,757,621) (7,757,621)
----------- -------- ----------- ----------- ------------ ------------
Balance as of March 31, 1999
(unaudited)........................ 30,998,802 $309,988 $89,067,255 $(1,201,867) $(18,647,719) $ 69,527,657
=========== ======== =========== =========== ============ ============
</TABLE>
See accompanying notes.
F-7
<PAGE> 91
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD THREE MONTHS ENDED
DECEMBER 8, 1997 MARCH 31,
(INCEPTION) TO YEAR ENDED --------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998 1998 1999
----------------- ----------------- ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss...................................... $ (157,748) $(10,732,350) $ (539,045) $ (7,757,621)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for uncollectible accounts........ 320,000 205,182
Depreciation and amortization............... 1,850 3,135,465 11,035 3,293,882
Amortization of deferred compensation....... 832,821 567,562
Changes in operating assets and liabilities:
Accounts receivable....................... (980,391) (11,678) 56,124
Prepaid expenses and other current
assets.................................. (14,000) (602,457) (51,497) (150,354)
Accounts payable.......................... 84,389 639,607 75,831 (999,180)
Accrued expenses.......................... 26,507 1,140,135 4,914 253,940
Deferred revenue.......................... 246,502 320,560
---------- ------------ ----------- ------------
Net cash used in operating activities......... (59,002) (6,000,668) (510,440) (4,209,905)
INVESTING ACTIVITIES
Purchases of furniture, fixtures and
equipment................................... (28,913) (4,321,577) (90,392) (984,320)
Payments issued in connection with non-compete
agreements.................................. (500,000)
Transfers to restricted cash.................. (1,392,371)
Acquisitions of businesses, net of cash
acquired.................................... (13,597,558) (92,059) (18,930,098)
---------- ------------ ----------- ------------
Net cash used in investing activities......... (28,913) (17,919,135) (182,451) (21,806,789)
FINANCING ACTIVITIES
Proceeds from sale of common stock............ 1,000,000 30,043,250 4,040,000 11,000,000
Proceeds from issuance of Series A, redeemable
convertible preferred stock................. 13,000,000
Repayment of debt............................. (66,621)
Offering costs................................ (222,172) (353,567)
---------- ------------ ----------- ------------
Net cash provided by financing activities..... 1,000,000 29,821,078 4,040,000 23,579,812
---------- ------------ ----------- ------------
Net increase in cash and cash equivalents..... 912,085 5,901,275 3,347,109 (2,436,882)
Cash and cash equivalents at beginning of
period...................................... -- 912,085 912,085 6,813,360
---------- ------------ ----------- ------------
Cash and cash equivalents at end of period.... $ 912,085 $ 6,813,360 $ 4,259,194 $ 4,376,478
========== ============ =========== ============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Stock and options issued in acquisitions...... $ 707,006 $ 44,024,737
Stock issued for compensation agreements...... 2,602,250
Stock subscription receivable................. $4,000,000
</TABLE>
See accompanying notes.
F-8
<PAGE> 92
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM DECEMBER 8, 1997 (INCEPTION) TO DECEMBER 31, 1997, THE YEAR
ENDED DECEMBER 31, 1998 AND THE THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
1. BUSINESS
Interliant, Inc. (formerly known as Sage Networks, Inc.) (the Company) was
organized under the laws of the State of Delaware on December 8, 1997. Web
Hosting Organization LLC (WEB), a Delaware Limited Liability Company, is the
majority and controlling shareholder of the Company. WEB's investors are
comprised of Charterhouse Equity Partners III, L.P. and Chef Nominees Limited
(collectively, CEP Members) and WHO Management, LLC (WHO). As of December 31,
1998, CEP Members have invested $29,000,000, and WHO has invested $2,000,000 in
WEB. WEB has, in turn, invested $31,000,000 in the Company. CEP Members have
allocated an additional $11,000,000 to invest in WEB, and have funded the
remaining amount pursuant to a stock subscription agreement (see Notes 7 and
12).
Since its formation, the Company has been in the process of developing a
Web hosting business. The Company continues to build its Web hosting business
primarily through the acquisition of the Web hosting assets of Internet service
providers, system integrators and Web hosting companies. The primary sources of
revenue are from recurring fees charged to customers for hosting their Web sites
on the Company's server systems. The Company focuses on delivering high-quality,
reliable and flexible Web hosting services.
Prior to 1998, the Company was in the development stage.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Unaudited Interim Financial Information
The interim financial information as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999 is unaudited and has been prepared on the
same basis as the audited financial statements. In the opinion of management,
such unaudited information includes all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the interim
information. Operating results for the three months ended March 31, 1998 and
1999 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1999.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity (at date of purchase) of three months or less to be the
equivalent of cash for the purpose of balance sheet and statement of cash flows
presentation. Cash equivalents, which consist primarily of money market
accounts, are carried at cost, which approximates market value.
Fair Value of Financial Instruments
Carrying amounts of financial instruments held by the Company, which
include cash equivalents, accounts receivable, accounts payable and accrued
expenses, approximate fair value due to their short duration.
F-9
<PAGE> 93
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk are comprised principally of cash, cash
equivalents and accounts receivable. As of December 31, 1998, the Company's cash
and cash equivalents are deposited with various domestic financial institutions.
With respect to accounts receivable, the Company's customer base is dispersed
across many geographic areas. The Company monitors customer payment history,
generally does not require collateral and establishes reserves for uncollectible
accounts 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.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent 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.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost. 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.
Depreciation has been provided using the straight-line method over the estimated
useful lives of the assets as follows:
<TABLE>
<S> <C>
Network software and equipment............ 3 years
Furniture, fixtures and office
equipment............................... 3 years
Leasehold improvements.................... Lesser of remaining lease-term or useful
life
</TABLE>
Internally Developed Software
In 1998, the Company adopted Statement of Position 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1)
issued by the American Institute of Certified Public Accountants. SOP 98-1
permits the capitalization of certain internally developed costs related to the
development of internally used software. During 1998, the Company capitalized
approximately $650,000 of project costs related to software developed
internally.
Intangible Assets
Intangible assets consist primarily of customer lists, covenants not to
compete, other identifiable intangibles and goodwill, which arose from the
acquisitions of several Web hosting companies and are being amortized on a
straight-line basis over periods ranging from one to five years (see Note 4).
Impairment of Long-Lived Assets
The Company continually reviews amortization periods and the carrying value
of long-lived assets, including furniture, fixtures and equipment, and
intangible assets to determine whether there are any indications of reduction in
useful lives or impairment losses. If indications of impairment are present in
long-lived assets, the estimated future undiscounted cash flows associated with
the corresponding assets would be compared to its carrying amount to determine
if a change in useful life or a write-down to fair value is necessary.
F-10
<PAGE> 94
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition
Through December 31, 1998, revenues consisted of two revenue streams: Web
hosting fees and set-up fees. As a result of acquisitions in February and March
1999 (see Note 12) the Company began earning revenues from application hosting
and related one time implementation fees and from consulting services.
The Company sells its Web hosting services for contractual periods ranging
from one to twelve months. These contracts generally are cancelable by either
party without penalty. Revenues from these contracts are recognized ratably over
the contractual period as service is delivered. Payments received for billings
in advance of providing services are deferred until the period such services are
provided. Set-up fees are separately priced from hosting services and are
recognized at the time a new customer account is created. Therefore, the
customer has no expectation of any future value from set-up fees after the
account is set up and the Web site is activated. Set-up costs consist primarily
of labor by technical support personnel to activate the new Web site and are
incurred at the time of set-up. No future set-up costs are incurred. There is no
obligation of the Company to perform any future set-up services, and the set-up
fees are non-refundable. Following expiration of the initial contract period and
upon renewal of the contract by the customer, there are no additional set-up
charges and the renewal prices for Web hosting services are generally unchanged
from the original contract period. The Company does not provide any proprietary
technology or content to the customer. The Web site design and development,
including the underlying programming and content are provided by and belong to
the customer. Incremental fees for excess bandwidth usage and data storage are
billed and recognized as revenues in the period customers utilize such services.
Such fees have been de minimus.
Application hosting revenues are comprised of monthly usage fees per number
of end users, including bandwidth fees and one-time implementation fees, all of
which are recorded as revenue at the time the services are used by the customer.
One time implementation fees which cover costs incurred by the Company to
establish a customer's site and are nonrefundable, are recognized when the site
is established and the Company has no further obligation with respect to such
fees. To date such fees have been de minimus.
Revenues from consulting services are recognized as the services are
rendered, provided that no significant obligations remain and collection of the
receivable is considered probable. Generally, contracts call for billings on a
time and materials basis; however, in instances when a fixed fee contract is
signed, revenue is recognized on a percentage-of-completion basis.
The Company recognizes that the Staff of the Securities and Exchange
Commission is developing a Staff Accounting Bulletin on the topic of revenue
recognition. If that Bulletin requires revenue recognition policies different
from those the Company currently uses, the results of operations will be
affected accordingly.
Advertising Expenses
All advertising costs are expensed as incurred. Advertising expenses for
the year ended December 31, 1998 amounted to $672,000. No advertising costs were
incurred in the period December 8, 1997 (inception) through December 31, 1997.
Start-Up and Acquisition Integration Costs
In connection with acquisitions made by the Company during the year ended
December 31, 1998 (see Note 5), the Company incurred payroll, consulting and
travel costs to start-up and integrate the acquisitions into the Company.
F-11
<PAGE> 95
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
The Company accounts for income taxes using the liability method under
which 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 reverse.
Net Loss Per Share
Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic
net loss per share is computed based on the weighted average number of shares of
common stock outstanding. Diluted loss per share does not differ from basic loss
per share since potential common shares to be issued upon exercise of stock
options are anti-dilutive for the periods presented.
Stock-Based Compensation
The Company accounts for its stock-based compensation plan utilizing the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). The Company has adopted the disclosure provisions
only of Statement of Financial Accounting Standards No. 123, Accounting For
Stock-Based Compensation (SFAS 123).
Reclassifications
Certain 1997 amounts have been reclassified to conform to the 1998
presentation.
3. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- MARCH 31,
1997 1998 1999
------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Network software and equipment.................. $18,073 $5,213,879 $10,056,274
Furniture, fixtures and office equipment........ 10,840 303,742 1,241,054
Leasehold improvements.......................... 283,391 1,596,724
------- ---------- -----------
28,913 5,801,012 12,894,052
Less accumulated depreciation and
amortization............................... 1,850 697,889 1,426,813
------- ---------- -----------
$27,063 $5,103,123 $11,467,239
======= ========== ===========
</TABLE>
Depreciation expense amounted to $1,850, $696,039, and $699,552 for the
years ended 1997 and 1998, and the three months ended March 31, 1999,
respectively.
4. INTANGIBLE ASSETS
The Company has allocated the purchase price of acquired companies to
identifiable tangible assets and liabilities and intangible assets based on the
nature and the terms of the various purchase agreements and evaluation of the
acquired businesses. Covenants not to compete are amortized over periods not to
exceed the term of the respective agreement. Values are assigned to covenants
not to compete in accordance with APB 16, using values specified in the
respective agreement or, where not specified, using the Company's estimate of
fair value of the covenant. Amounts not allocated to tangible assets and
liabilities and identifiable intangible assets have been recorded as goodwill.
F-12
<PAGE> 96
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, AMORTIZATION
1998 1999 PERIOD
------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Covenants not to compete..................... $ 3,759,202 $10,880,510 1-5 Years
Customer lists............................... 3,295,369 12,129,003 3 Years
Assembled work force......................... 1,127,031 4,540,000 3 Years
Trade names.................................. 573,982 5,032,270 3 Years
Goodwill..................................... 6,296,070 49,312,861 5 Years
----------- -----------
15,051,654 81,894,644
Less accumulated amortization................ 2,439,426 5,033,756
----------- -----------
$12,612,228 $76,860,888
=========== ===========
</TABLE>
Amortization expense amounted to $2,439,426 in 1998 and $2,594,330 in the
three months ended March 31, 1999.
5. ACQUISITIONS
During the year ended December 31, 1998, the Company made the following
acquisitions, each of which was accounted for using the purchase method of
accounting. The operations of each of the acquired companies are included in the
operating results of the Company from the date of acquisition noted.
On February 13, 1998, the Company purchased certain Web hosting assets of
Omnetrix, Inc., dba DirectNet, a Web hosting provider, for cash of approximately
$78,000.
On April 7, 1998, the Company purchased the operating assets of Clever
Computers, Inc., a Web hosting company, for cash of approximately $2,500,000.
Pursuant to a three-year employment agreement, a shareholder of Clever received
150,000 shares of the Company's Common Stock, valued at $3.32 per share, which
vests and is being accounted for as compensation expense over the term of the
employment agreement.
On April 30, 1998, the Company purchased certain Web hosting assets from
KnowledgeLink Interactive, Inc. for cash of approximately $612,000.
On May 1, 1998, the Company purchased the operating assets of Tri Star Web
Creations, Inc., a Web hosting company, for cash of approximately $955,000 and
9,000 shares of the Company's Common Stock, having a valuation of $4.07 per
share.
On June 10, 1998, the Company purchased certain Web hosting assets of
HostAmerica, the Web hosting division of HomeCom Communications, Inc., for cash
of approximately $4,250,000.
On June 29, 1998, the Company purchased the operating assets of All
Information Systems, Inc., a Web hosting company, for cash of approximately
$171,000 and 115,707 shares of the Company's Common Stock, having a valuation of
$5.00 per share.
On July 1, 1998, the Company purchased certain Web hosting assets of
Software Business Technologies, Inc. for 12,000 shares of the Company's Common
Stock, having a valuation of $5.00 per share.
On July 1, 1998, the Company purchased certain Web hosting assets of
DevCom, the Web hosting division of Nextron, Inc., for cash of approximately
$600,000.
F-13
<PAGE> 97
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On July 30, 1998, the Company purchased certain Web hosting assets of
BestWare, Inc., dba Maikon, for cash of approximately $374,000 and 5,490 shares
of the Company's Common Stock, having a valuation of $5.38 per share.
On August 31, 1998, the Company purchased all of the outstanding stock of
B.N. Technology, Inc., dba ICOM, a Web hosting company, for cash of
approximately $2,000,000. The purchase agreement also provides for additional
payments of cash of up to $2,000,000 to the shareholders of ICOM if certain
earnings targets are achieved. As of December 31, 1998, the earnings targets for
periods then ended had been achieved and $1,000,000 has been accrued. This
amount has been recorded as an intangible asset and any future payments under
this agreement will be similarly recorded. Pursuant to one-year employment
agreements, two shareholders of ICOM received a total of 300,000 shares of the
Company's Common Stock valued at $6.47 per share, which vest and is being
accounted for as compensation expense over the terms of the agreements.
On September 16, 1998, the Company purchased certain Web hosting assets of
GEN International, Inc. (GEN) for cash of $455,000 and substantially all the
assets of Global Entrepreneurs Network, Inc. (a wholly-owned subsidiary of GEN)
for $295,000. Pursuant to a consulting agreement with a shareholder of GEN, the
Company issued 25,000 shares of the Company's Common Stock, having a valuation
of $6.66 per share, which vests and is being accounted for as compensation
expense over the term of the consulting agreement.
On December 17, 1998, the Company purchased certain Web hosting assets of
Dialtone, Inc. a Web hosting company for cash of $375,000.
The following unaudited condensed pro forma information presents the
unaudited results of operations of the Company as if the above acquisitions had
occurred on January 1, 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1998
----------- ------------
<S> <C> <C>
Service revenues......................................... $ 5,891,222 $ 8,893,389
Net loss................................................. (6,255,102) (11,211,583)
Net loss per share -- basic and diluted.................. $ (1.73) $ (1.23)
</TABLE>
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1997 1998 MARCH 31, 1999
------- ---------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Amounts due to former owners under contingent
consideration arrangements (see Note 5)...... $1,000,000 $ 500,000
Compensation................................... 226,641 574,740
Communications costs........................... 121,000 224,866
Other.......................................... $26,507 953,866 1,969,061
------- ---------- ----------
$26,507 $2,301,507 $3,268,667
======= ========== ==========
</TABLE>
F-14
<PAGE> 98
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCKHOLDERS' EQUITY
Common Stock
Pursuant to a Stock Subscription Agreement dated December 8, 1997 between
the Company and WEB, WEB purchased 15,600,000 shares of the Company's Common
Stock during the year ended December 31, 1998 and 3,000,000 shares during the
period December 8, 1997 (inception) to December 31, 1997, all at $1.67 per
share. WEB is entitled to purchase an additional 6,600,000 shares at $1.67
pursuant to the Stock Subscription Agreement (see Note 12). In connection with
the Stock Subscription Agreement, the Company recorded a $4,000,000 common stock
subscription receivable from WEB as of December 31, 1997. The subscription was
collected on March 12, 1998.
The Board of Directors approved a three-for-one stock split of the
Company's Common Stock on July 28, 1998. The accompanying financial statements
have been retroactively restated to give effect to the stock split.
Stock Option Plan
On February 1, 1998, the Company adopted the Sage Networks, Inc. 1998 Stock
Option Plan (the Plan), which is administered by the Board of Directors (the
Committee). Under the terms of the Plan, the Committee may grant stock options
to officers, employees and consultants of the Company. The Plan permits the
grant of incentive stock options (ISOs) and nonqualified stock options (NSOs).
As of December 31, 1998, the Company has reserved 1,500,000 shares of Common
Stock for issuance under the Plan. Stock options may not be granted at less than
100% of the fair market value of the Common Stock on the date of the grant and
may not expire more than ten years from the date of the grant. Options granted
under the Plan generally will become exercisable over a four-year period in
equal annual installments unless the Committee specifies a different vesting
schedule. In the event of a change in control of the Company, each option
becomes immediately vested and exercisable, provided that no written provision
has been made, in connection with any such event, for (1) the continuation of
the stock option plan and/or the assumption of all outstanding options by a
successor corporation or (2) the substitution for such options of new options
covering the stock of a successor corporation. The Plan has a term of ten years,
subject to earlier termination or amendment by the Committee, and all options
under the Plan prior to its termination remain outstanding until they have been
exercised or terminated.
During the year ended December 31, 1998, the Company granted 440,500
options at prices ranging from $1.67 to $6.67 per share. The weighted-average
exercise price of the options granted was $4.11. No options were exercised,
canceled or forfeited during the year ended December 31, 1998. No options are
vested at December 31, 1998.
Stock-Based Compensation
As discussed in Note 2, the Company applies APB 25 and related
interpretations in accounting for its stock option plan. Accordingly, since the
Company grants stock options with exercise prices at least equal to fair value
at the date of grant, no compensation expense has been recognized relating to
option grants in 1998.
As required under FAS 123, the following pro forma net loss and net loss
per share presentations reflect the amortization of the option grant fair value
as expense. For purposes of this disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The Company's
pro forma information follows for the year ended December 31, 1998:
<TABLE>
<S> <C>
Pro forma net loss.......................................... $(9,756,000)
Pro forma net loss per share -- basic and diluted........... $ (1.11)
</TABLE>
F-15
<PAGE> 99
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average grant date value was $0.83 for stock options issued in
1998, and the weighted-average remaining contractual life for options
outstanding as of December 31, 1998 is 9.4 years. Significant assumptions used
in determining this value include a risk free interest rate of 5.6%, expected
life of the options of four years, and a dividend rate of zero.
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures in future years as the
period presented includes only one year of option grants under the Plan.
8. INCOME TAXES
As of December 31, 1998, the Company has federal and state net operating
loss carryforwards of approximately $7,700,000. The net operating loss
carryforwards will expire at various dates beginning in the years 2003 through
2018 if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes consist of the following at December 31,
1998:
<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $3,063,000
Depreciation.............................................. (14,000)
Other, net................................................ 813,000
----------
Total deferred tax assets, net.............................. 3,862,000
Valuation allowance......................................... (3,862,000)
----------
Net deferred tax asset...................................... $ --
==========
</TABLE>
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realization of
the deferred tax assets such that a full valuation allowance has been recorded.
The Company will continue to assess the realization of the deferred tax assets
based on actual and forecasted operating results.
9. LEASES
The Company leases its data centers and certain office space under
noncancelable operating leases, which expire at various dates through June 2009.
Some of the leases contain renewal options. Total rent expense for all operating
leases was approximately $7,000 and $420,000 for the period December 8, 1997
(inception) to December 31, 1997 and the year ended December 31, 1998,
respectively. In connection with one of the leases, the Company has given the
landlord a standby letter of credit in the amount of approximately $100,000 in
lieu of a security deposit.
Future minimum lease commitments for noncancelable operating leases are as
follows at December 31, 1998:
<TABLE>
<S> <C>
1999........................................................ $ 956,764
2000........................................................ 877,488
2001........................................................ 847,484
2002........................................................ 816,334
2003........................................................ 569,958
Thereafter.................................................. 2,079,107
----------
Total minimum lease payments...................... $6,147,135
==========
</TABLE>
F-16
<PAGE> 100
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED-PARTY TRANSACTIONS
In connection with the acquisitions of certain Web hosting assets of
various entities (see Note 5), the Company paid or accrued transaction fees of
approximately $319,000 to Charterhouse Group International, Inc., a related
party of WEB. These fees are included in the respective purchase price
allocations as capitalized transaction costs.
The Company receives consulting services from Sage Equities, Inc. and
Intensity Ventures, Inc., whose principals are the co-chairmen of the Company
and members of WHO, for the purpose of identifying and executing potential
acquisitions. Sage Equities, Inc. and Intensity Ventures, Inc. are each paid
fees of $10,000 (plus expenses) per month for such services. For the period
December 8, 1997 (inception) to December 31, 1997 and the year ended December
31, 1998, the Company incurred costs under these agreements of $25,000 and
$120,000, respectively, for Sage Equities, Inc., and $17,000 and $232,000 (of
which $112,000 were expenses), respectively, for Intensity Ventures. At December
31, 1997, these entities were owed a total of $84,959 by the Company for such
consulting services, which was paid in 1998.
The Company also receives consulting services from one other member of WHO.
During the period December 8, 1997 (inception) to December 31, 1997 and the year
ended December 31, 1998, the Company incurred costs relating to these services
totaling approximately $8,000 and $44,000, respectively.
11. EMPLOYEE BENEFIT PLAN
In 1998, the Company instituted a 401k Plan for all employees who have
attained age 21 and have been employed by the Company or by an acquired business
for one month. Participating employees may make contributions to the plan up to
15% of their compensation. The Plan provides that the Company may make
discretionary contributions to the Plan on behalf of participating employees.
The Company did not make any such contributions for the year ended December 31,
1998.
12. SUBSEQUENT EVENTS
On January 28, 1999, the Company's Board of Directors and Stockholders
approved an amendment to the Company's certificate of incorporation (Charter) to
increase the number of authorized shares to 35,000,000 shares of Common Stock
and up to 2,647,658 shares of Preferred Stock, all of which is designated as
Series A Convertible Preferred Stock (Series A Preferred).
On January 28, 1999, pursuant to a Securities Purchase Agreement (the
Purchase Agreement) the Company sold to Softbank Technology Ventures IV L.P. and
one of its affiliates (the Series A Investors), 2,647,658 shares of its Series A
Preferred at a price of $4.91 per Series A Preferred share and issued 749,625
Common Stock warrants of the Company for cash of $13,000,000. The Series A
Preferred is convertible at any time, at the option of the holder, into the
Company's Common Stock, subject to anti-dilution provisions as set forth in the
Charter. In the event of a qualifying public offering (as defined in the
Charter), however, the Series A Preferred is automatically converted into Common
Stock. If the Series A Preferred is not converted before January 28, 2006, a
majority in interest of the holders thereof may request the Company to redeem
the Series A Preferred at $4.91 per share plus any accrued but unpaid dividends
on such shares. Because of the redemption features of the Series A Preferred, it
will not be reported as a component of stockholders' equity. The warrants are
immediately exercisable at a price of $6.67 per share. The warrants expire on
the earlier of three years subsequent to the consummation of the Company's
initial public offering or January 28, 2003. The Company, the Series A Investors
and WEB have entered into an Investors Agreement dated January 28, 1999, which
provides the Series A Investors to nominate a director to the Company's Board of
Directors and grants the Series A Investors preemptive rights and certain
registration rights.
F-17
<PAGE> 101
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On February 9, 1999, pursuant to its stock subscription agreement, WEB
purchased the remaining 6,600,000 shares of the Company's Common Stock for an
aggregate of $11,000,000 (see Note 7).
The Company consummated the following acquisitions in the early part of
February 1999, each of which will be accounted for using the purchase method of
accounting:
The purchase of certain assets of Telephonetics International, Inc., a
provider of customized music and messages on hold recording services to
businesses utilizing on-hold telephone equipment. The purchase price
consists of cash of $3,000,000 and 140,000 shares of the Company's Common
Stock valued at $6.67 per share.
The purchase of all of the outstanding stock of Net Daemons
Associates, Inc. (NDA), a provider of Web development and system
integration activity for Internet and IP Networks. The purchase price
consists of cash of $500,000 and 425,000 shares of the Company's Common
Stock valued at $6.67 per share. In addition, the Company has agreed to pay
certain officers of NDA $2,371,000 to induce them to enter into non-compete
agreements and to pay approximately $436,000 to cancel certain NDA stock
options. The agreement also provides for contingent purchase consideration
of $500,000 in cash and 74,963 shares of the Company's Common Stock if
specified gross revenue and gross margin targets are achieved in the
twelve-month period following the acquisition. The payment of contingent
consideration, if any, will be recorded as additional purchase price. The
shares of stock and cash to be paid for the contingent purchase
consideration have been deposited with an escrow agent.
The purchase of the Web hosting assets of Digiweb, Inc., a Web hosting
company. The purchase price consists of cash of approximately $5,000,000
and 450,000 shares of the Company's Common Stock valued at $6.67. The
agreement provides for contingent purchase consideration of $1,000,000 if
specified revenue and earnings targets are achieved in the year ending
December 31, 1999. The payment of contingent consideration, if any, will be
recorded as additional purchase price.
In March 1999, the Company's stockholders approved an amendment to the
Company's certificate of incorporation to increase the number of authorized
shares of Common Stock to 100,000,000, and, on March 10, 1999, the Company
acquired substantially all of the assets and assumed specified liabilities of
Interliant, Inc., a provider of groupware hosting and application outsourcing
services. The purchase price consisted of $100,000 in cash and 4,091,642 shares
of the Company's Common Stock valued at $6.67 per share, and options to purchase
up to 2,322,179 shares of the Company's Common Stock. In addition, the Company
paid $7,900,000 on an outstanding note payable of Interliant, Inc. at closing
and will pay the balance of the note ($8,000,000) at the earlier of the
completion of an initial public offering of the Company's Common Stock or
September 1999. The transaction will be accounted for using the purchase method
of accounting. In connection with this acquisition, the Company changed its name
to Interliant, Inc.
F-18
<PAGE> 102
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The purchase consideration for the acquisitions referred to above is as
follows:
<TABLE>
<S> <C>
Cash, including estimated transaction costs and payments of
$7,900,000 of seller's note............................... $20,287,000
Common stock (6,630,103 shares, including 1,523,461 shares
issuable upon exercise of substitute options issued in
connection with the acquisition of the net assets of
Interliant, Inc.) ........................................ 44,025,000
-----------
64,312,000
Seller debt paid............................................ 7,900,000
Allocated to intangible assets (see note 4)................. 65,967,000
-----------
Allocated to net tangible assets acquired................... $(9,555,000)
===========
</TABLE>
The following unaudited condensed pro forma information presents the
unaudited results of operations of the Company as if the acquisitions completed
in 1999 had occurred on January 1, 1998:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, 1998 MARCH 31, 1998 MARCH 31, 1999
----------------- -------------- --------------
<S> <C> <C> <C>
Service revenues.......................... $ 41,291,564 $ 9,534,050 $ 10,340,535
Net loss.................................. (39,030,493) (8,651,687) (13,182,481)
Net loss per share -- basic and diluted... $ (2.47) $ (0.84) $ (0.46)
</TABLE>
13. INFORMATION ABOUT PRODUCTS AND SERVICES
For the three months ended March 31, 1999, revenues earned from Web
hosting, application hosting, consulting and other services were 56.9%; 20.8%;
15.0%; and 7.3%, respectively of total revenues.
For the three months ended March 31, 1999, 19.8% of total revenues were
from sources outside the United States, primarily from Europe, Asia and South
America.
For the year ended December 31, 1998 all revenues were from Web hosting and
18.8% of revenues were from sources outside the United States, primarily from
Europe and Asia.
F-19
<PAGE> 103
INTERLIANT, INC.
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
During the period from inception through March 10, 1999, Interliant, Inc.
(formerly, Sage Networks, Inc.) ("Interliant" or the "Company") completed
numerous business combinations, whereby the Company acquired shares of common
stock, or certain net assets of entities operating in the Internet industry.
Business combinations are accounted for using the purchase method of accounting.
The unaudited pro forma consolidated statement of operations for the year
ended December 31, 1998 and the three months ended March 31, 1999 assumes that
the acquisitions completed in 1998 and 1999 had occurred on January 1, 1998, and
includes the historical consolidated statements of operations of Interliant,
adjusted for the pro forma effects of the acquisitions.
The unaudited pro forma consolidated statement of operations is not
necessarily indicative of the results of operations that would actually have
occurred if the transactions had been consummated as of January 1, 1998 and is
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 Interliant, and of certain
acquired businesses, included elsewhere in this prospectus.
The unaudited pro forma adjustments are based upon preliminary estimates
and certain assumptions that management of Interliant believes are reasonable in
the circumstances. The actual adjustments may be revised upon completion of the
purchase price allocations. Except for additions to intangible assets on
contingent purchase price payments based on the underlying purchase agreements,
management of Interliant does not believe that actual adjustments will be
materially different from preliminary estimates.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
ACQUISITIONS COMPLETED IN 1999(2)
--------------------------------------------------
INTERLIANT INTERLIANT PRO FORMA
HISTORICAL TELEPHONICS NET DAEMONS DIGIWEB TEXAS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- -------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service revenues................ $ 5,434,162 $331,182 $836,289 $237,300 $ 3,501,602 $ 10,340,535
Costs and expenses:
Cost of service revenues...... 3,250,703 47,387 466,929 62,003 2,149,276 5,976,298
Sales and marketing........... 1,896,357 69,711 12,122 1,508,576 3,486,766
General and administrative.... 3,699,847 201,261 285,395 82,979 1,289,018 5,558,500
Depreciation.................. 699,552 6,000 16,206 25,000 532,192 1,278,950
Amortization of intangibles... 2,594,330 $ 3,426,845(5) 6,021,175
Start up and acquisition
costs....................... 1,063,458 1,063,458
------------ -------- -------- -------- ----------- ----------- ------------
Total costs and expenses........ 13,204,247 324,359 780,652 169,982 5,479,062 3,426,845 23,385,147
------------ -------- -------- -------- ----------- ----------- ------------
Operating income (loss)......... (7,770,085) 6,823 55,637 67,318 (1,977,460) (3,426,845) (13,044,612)
Interest income (expense)....... 53,912 (1,873) (148,460) (96,421)
Other income (expense).......... (41,448) (41,448)
Income (loss) before income
tax........................... (7,757,621) 6,823 53,764 67,318 (2,125,920) (3,426,845) (13,182,481)
Provision for income tax........ (13,313) 13,313(6) --
------------ -------- -------- -------- ----------- ----------- ------------
Net income (loss)............... $ (7,757,621) $ 6,823 $ 40,451 $ 67,318 $(2,125,920) $(3,413,532) $(13,182,481)
============ ======== ======== ======== =========== =========== ============
Net loss per share -- basic and
diluted....................... $ (0.31) $ (0.46)
Number of shares................ 24,769,890 28,626,240
</TABLE>
F-20
<PAGE> 104
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
ACQUISITIONS COMPLETED IN 1999 (2)
------------------------------------------------------
INTERLIANT 1998 COMPLETED INTERLIANT PRO FORMA
HISTORICAL ACQUISITIONS(1) TELEPHONETICS NET DAEMONS DIGIWEB TEXAS ADJUSTMENTS
------------ --------------- ------------- ----------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service revenues...... $ 4,905,027 $ 3,988,362 $2,769,606 $5,770,024 $2,685,676 $21,172,869
Costs and expenses:
Cost of service
revenues.......... 3,236,385 1,266,435 823,161 3,211,532 923,310 11,880,983 $ (1,050,921)(3)
Sales and
marketing......... 2,555,035 84,858 31,577 6,722,996
General and
administrative.... 5,120,595 3,473,637 2,605,725 2,161,094 578,993 4,137,668 2,497,463(3)(4)
Depreciation........ 696,039 142,099 74,758 135,129 246,329 2,525,530
Amortization of
intangibles....... 2,439,426 21,645,276(5)
Start up and
acquisition
costs............. 1,727,970
------------ ----------- ---------- ---------- ---------- ----------- ------------
Total costs and
expenses............ 15,775,450 4,967,029 3,503,644 5,507,755 1,780,209 25,267,177 23,091,818
------------ ----------- ---------- ---------- ---------- ----------- ------------
Operating
income(loss)........ (10,870,423) (978,667) (734,038) 262,269 905,467 (4,094,308) (23,091,818)
Interest income
(expense)........... 138,073 (180,987) (7,369) (101,485) (16,829) (715,643)
Equity in loss of
joint venture....... (144,735)
Gain on litigation
settlement.......... 600,000
Income (loss) before
income tax.......... (10,732,350) (1,159,654) (741,407) 160,784 888,638 (4,354,686) (23,091,818)
Provision for income
tax................. 100,800 (100,800)(6)
------------ ----------- ---------- ---------- ---------- ----------- ------------
Net income(loss)...... $(10,732,350) $(1,159,654) $ (741,407) $ 59,984 $ 888,638 $(4,354,686) $(22,991,018)
============ =========== ========== ========== ========== =========== ============
Net loss per share --
basic and diluted... $ (1.22)
Number of shares...... 8,799,432
<CAPTION>
PRO FORMA
------------
<S> <C>
Service revenues...... $ 41,291,564
Costs and expenses:
Cost of service
revenues.......... 20,290,885
Sales and
marketing......... 9,394,466
General and
administrative.... 20,575,175
Depreciation........ 3,819,884
Amortization of
intangibles....... 24,084,702
Start up and
acquisition
costs............. 1,727,970
------------
Total costs and
expenses............ 79,893,082
------------
Operating
income(loss)........ (38,601,518)
Interest income
(expense)........... (884,240)
Equity in loss of
joint venture....... (144,735)
Gain on litigation
settlement.......... 600,000
Income (loss) before
income tax.......... (39,030,493)
Provision for income
tax................. --
------------
Net income(loss)...... $(39,030,493)
============
Net loss per share --
basic and diluted... $ (2.47)
Number of shares...... 15,829,762
</TABLE>
F-21
<PAGE> 105
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(1) Set forth below are the pre acquisition operations of acquired businesses
completed in 1998 from January 1, 1998 through the date of acquisition.
<TABLE>
<CAPTION>
HOST AMERICA,
DIVISION OF HOME-
CLEVER COMPUTERS TRISTAR WEB COME COMMUN- B.N. TECHNOLOGY, GEN INTERNATIONAL
INC. CREATIONS, INC. CATIONS, INC. DBA ICOM INC.
---------------- --------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
Service revenues......... $554,020 $256,953 $ 533,159 $ 982,376 $ 776,503
-------- -------- --------- ---------- ---------
Cost of service
revenues............... 102,197 103,232 230,435 153,919 323,518
Sales and marketing...... 52,770 32,088
General and
administrative......... 387,236 183,521 629,727 984,223 785,972
Depreciation............. 9,557 63,642 10,817 26,496
-------- -------- --------- ---------- ---------
489,433 296,310 976,574 1,148,959 1,168,074
-------- -------- --------- ---------- ---------
Operating income(loss)... 64,587 (39,357) (443,415) (166,583) (391,571)
Interest income
(expense).............. (368) (156,399) (4,051) (12,557)
-------- -------- --------- ---------- ---------
Net income(loss)......... $ 64,587 $(39,725) $(599,814) $ (170,634) $(404,128)
======== ======== ========= ========== =========
<CAPTION>
OTHER TOTAL 1998
ACQUISITIONS ACQUISITIONS
------------------ ------------
<S> <C> <C>
Service revenues......... $885,351 $ 3,988,362
-------- -----------
Cost of service
revenues............... 353,134 1,266,435
Sales and marketing...... 84,858
General and
administrative......... 502,958 3,473,637
Depreciation............. 31,587 142,099
-------- -----------
887,679 4,967,029
-------- -----------
Operating income(loss)... (2,328) (978,667)
Interest income
(expense).............. (7,612) (180,987)
-------- -----------
Net income(loss)......... $ (9,940) $(1,159,654)
======== ===========
</TABLE>
(2) Represents the results of operations for businesses acquired in 1999 for
the year ended December 31, 1998 and from January 1, 1999 through the date
of acquisition.
(3) To reclassify Interliant Texas customer service costs to conform with
Registrant's presentation.
(4) To record amortization of stock based compensation awarded to employees
and owners of acquired businesses in connection with employment and/or
consulting agreements.
(5) To record amortization of intangibles arising as a result of acquisitions
for the period from January 1, 1998 to acquisition date based on
amortization periods ranging from one to five years.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED
1998 MARCH 31, 1999
------------ --------------
<S> <C> <C>
Amortization:
1998 acquisitions from January 1, 1998 to
respective dates of acquisition,
(amortization period 1-5 years).......... $ 2,391,952 $ --
1999 acquisitions for the year ended
December 31, 1998 (amortization period 1
to 5 years).............................. 19,253,324 3,426,845
----------- ----------
$21,645,276 $3,426,845
=========== ==========
</TABLE>
(See Note 4 of Notes to Consolidated Financial Statements)
(6) To record elimination of income tax provision due to consolidated pre tax
loss.
F-22
<PAGE> 106
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholder
Clever Computers, Inc.
Atlanta, Georgia
We have audited the accompanying balance sheet of Clever Computers, Inc. as
of December 31, 1995, 1996 and 1997 and the related statements of income,
retained earnings, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Clever Computers, Inc. as of
December 31, 1995, 1996 and 1997 and the results of their operations and their
cash flows for the years then ended, in conformity with generally accepted
accounting principles.
BSC & E
Atlanta, Georgia
March 19, 1998
F-23
<PAGE> 107
CLEVER COMPUTERS, INC.
BALANCE SHEETS
DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
ASSETS
Current Assets
Cash -- operating..................................... $ 10,436 $ 72,263 $ 50,425
Cash -- payroll....................................... 12,723 50,655 42,693
Accounts receivable, net of allowance for doubtful
accounts of $16,199 in 1997........................ 1,441 25,659 91,792
Prepaid expenses...................................... 3,127 6,485
Prepaid income taxes.................................. 878
Deferred income taxes................................. 4,050
--------- --------- ---------
Total current assets.......................... 24,600 151,704 196,323
--------- --------- ---------
Property and Equipment
Furniture............................................. 1,338 1,868 2,617
Computer equipment.................................... 62,705 231,871 422,105
Computer software..................................... 13,944 30,101 34,365
--------- --------- ---------
77,987 263,840 479,087
Accumulated depreciation and amortization............. (53,601) (115,387) (231,264)
--------- --------- ---------
24,386 148,453 247,823
--------- --------- ---------
Other Assets
Other assets.......................................... 3,565 14,782 4,668
Organization costs, net of accumulated amortization of
$196, $292 and $391................................ 292 196 97
--------- --------- ---------
3,857 14,978 4,765
--------- --------- ---------
$ 52,843 $ 315,135 $ 448,911
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable...................................... $ 22,009 $ 33,941 $ 66,808
Accrued consulting fee................................ 34,000 100,000
Deferred revenues..................................... 5,000 95,536 127,324
Income taxes payable.................................. 15,906
Accrued payroll and payroll taxes..................... 11,910 42,363 35,249
Advances to stockholder............................... 10,084 22,520 2,358
--------- --------- ---------
Total current liabilities..................... 49,003 244,266 331,739
--------- --------- ---------
Stockholder's Equity
Common stock, no par value; 10,000 shares authorized;
1,000 shares issued and outstanding................ 5,000 5,000 5,000
Retained earnings..................................... (1,160) 65,869 112,172
--------- --------- ---------
3,840 70,869 117,172
--------- --------- ---------
$ 52,843 $ 315,135 $ 448,911
========= ========= =========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-24
<PAGE> 108
CLEVER COMPUTERS, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------- -------------------
1995 1996 1997 1997 1998
-------- ---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues............................. $303,443 $1,128,108 $2,156,982 $514,483 $518,320
Operating expenses................... 304,153 1,045,357 2,088,928 430,917 483,734
-------- ---------- ---------- -------- --------
Income from operations............. (710) 82,751 68,054 83,566 34,586
Other income and (expense)........... 185 (937) -- --
-------- ---------- ---------- -------- --------
Income before provision for income
taxes........................... (710) 82,936 67,117 83,566 34,586
Provision for income taxes........... 15,906 20,814 25,000 12,000
-------- ---------- ---------- -------- --------
Net income......................... $ (710) $ 67,030 $ 46,303 $ 58,566 $ 22,586
======== ========== ========== ======== ========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-25
<PAGE> 109
CLEVER COMPUTERS, INC.
STATEMENT OF RETAINED EARNINGS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<S> <C>
Balance, December 31, 1994.................................. $ (451)
Deduct net loss........................................... (710)
--------
Balance, December 31, 1995.................................. $ (1,161)
Add net income............................................ 67,030
--------
Balance, December 31, 1996.................................. 65,869
Add net income............................................ 46,303
--------
Balance, December 31, 1997.................................. $112,172
========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-26
<PAGE> 110
CLEVER COMPUTERS, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------------- --------------------
1995 1996 1997 1997 1998
-------- --------- --------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................... $ (710) $ 67,030 $ 46,303 $ 58,565 $ 22,586
Adjustments to reconcile net income to
net cash provided by operating
activities:
Deferred income taxes............... -- (4,050)
Bad debts........................... -- 16,199
Gain on sale of assets.............. -- (1,426)
Depreciation and amortization....... 25,472 61,884 117,401 30,000 30,000
Changes in operating assets and
liabilities:
Accounts receivable............... 3,723 (24,218) (82,332) 17,159 35,535
Prepaid expenses.................. -- (3,127) (3,358) (13,234) (13,248)
Prepaid income taxes.............. -- (878)
Other assets...................... (3,565) (11,217) 10,114 14,490 4,765
Accounts payable.................. 11,250 11,931 16,961 (16,389) (48,164)
Accrued consulting fees........... -- 34,000 66,000
Deferred revenues................. 5,000 90,536 31,788 10,000 54,949
Income taxes payable.............. -- 15,906 25,000 12,000
Accrued payroll and payroll
taxes.......................... 12,094 30,454 (7,115) 30,773
Advances to stockholder........... 7,109 12,436 (20,162) 3,496
Other current liabilities......... (88,429) (11,000)
-------- --------- --------- -------- ---------
Net cash provided by operating
activities................... 60,373 285,615 185,445 40,658 118,196
-------- --------- --------- -------- ---------
Cash flows from investing activities:
Acquisition of property and
equipment........................... (39,997) (185,856) (219,206) (95,564) (116,677)
Proceeds from sale of assets........... -- 3,961
-------- --------- --------- -------- ---------
Net cash used in investing
activities................... (39,997) (185,856) (215,245) (95,564) (116,677)
-------- --------- --------- -------- ---------
Cash flows from financing activities..... -- -- -- -- --
-------- --------- --------- -------- ---------
Increase (decrease) in cash.............. 20,376 99,759 (29,800) (54,906) 1,519
Cash, beginning of year.................. 2,783 23,159 122,918 122,918 93,118
-------- --------- --------- -------- ---------
Cash, end of year........................ $ 23,159 $ 122,918 $ 93,118 $ 68,012 $ 94,637
======== ========= ========= ======== =========
Cash paid during the year for:
Interest............................... $ -- $ 51 $ 2,500
Income taxes........................... -- -- 36,931
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-27
<PAGE> 111
CLEVER COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Nature of business
Clever Computers, Inc. was incorporated October 25, 1993 in the State of
Georgia. The Company is engaged in the business of Internet Web hosting.
Property and equipment
Property and equipment are recorded at cost. Depreciation is provided over
the estimated useful lives of the assets by accelerated and straight line
methods.
Statement of cash flows
The Company considers instruments with a maturity of three months or less
to be cash equivalents for purposes of the statement of cash flows.
Income taxes
Income taxes are accounted for in accordance with provisions of Statement
of Financial Accounting Standards No. 109. Deferred income taxes have been
provided for the difference in bad debt expense for income tax and financial
statement reporting purposes.
Organization costs
Organization costs are being amortized on a straight line basis over five
years.
Deferred revenues
As part of their standard service agreements with customers, the Company
bills for all services for three months in advance. As a result, a portion of
revenues collected and billed for as of year end relates to services not yet
performed. The deferred revenue associated with these services is recognized on
the balance sheet as a current liability.
Estimates
Management uses estimates and assumptions in preparing financial
statements. Those estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported revenues and expenses. Actual results could differ from those
estimates.
Unaudited information
The interim financial information for the three months ended March 31, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
NOTE 2. LEASES
The Company leases office facilities and certain equipment. Renewal options
are available on some of these leases.
F-28
<PAGE> 112
CLEVER COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments required on noncancelable operating leases
having initial or remaining terms in excess of one year as of December 31, 1997,
are as follows:
<TABLE>
<S> <C>
1998...................................................... $175,923
1999...................................................... 33,555
2000...................................................... 1,600
--------
$211,078
========
</TABLE>
Rent expense of $10,104, $40,508 and $97,655 in 1995, 1996 and 1997,
respectively, is included in operating expenses in the accompanying statements
of income.
NOTE 3. INCOME TAXES
The Company's provision for income taxes consisted of the following
amounts:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31
--------------------------
1995 1996 1997
---- ------- -------
<S> <C> <C> <C>
Current........................................... $-- $11,860 $24,864
Deferred benefit........................ -- (4,046) (4,050)
--- ------- -------
Provision for income taxes.............. $-- $15,906 $20,814
=== ======= =======
</TABLE>
NOTE 4. SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Company was approached by certain
parties regarding the potential sale of the Company. As of the report date, no
formal agreement was in place and negotiations were ongoing.
F-29
<PAGE> 113
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Sage Networks, Inc.
We have audited the accompanying balance sheets of Tri Star Web Creations,
Inc. as of December 31, 1996 and 1997, and the related statements of operations,
and changes in retained earnings, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Tri Star Web Creations, Inc.
as of December 31, 1996 and 1997, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
Urbach Kahn & Werlin PC
New York, New York
July 13, 1998
F-30
<PAGE> 114
TRI STAR WEB CREATIONS, INC.
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------ --------
<S> <C> <C>
ASSETS
Current Assets
Cash...................................................... $ 391 $ 997
Accounts receivable, net of an allowance for doubtful
accounts of $6,000 and $9,747.......................... 9,125 41,770
Prepaid expenses.......................................... -- 3,365
------ --------
Total current assets.............................. 9,516 46,132
Other assets................................................ -- 4,182
Fixed assets, net of accumulated depreciation............... -- 95,036
------ --------
Total assets...................................... $9,516 $145,350
------ --------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current Liabilities
Notes payable to related parties, current................. $ -- $ 18,510
Equipment purchase/obligations............................ -- 55,236
Accounts payable.......................................... 1,500 42,771
Deferred revenue.......................................... 2,420 26,131
------ --------
Total current liabilities......................... 3,920 142,648
------ --------
Long-term Liabilities
Note payable to related party, net of current portion..... -- 1,795
------ --------
Total liabilities................................. 3,920 144,443
------ --------
Stockholders' Equity
Capital stock, no par value; 100 shares authorized, 3
shares issued and outstanding.......................... 100 100
Retained earnings......................................... 5,496 807
------ --------
Total stockholder's equity........................ 5,596 907
------ --------
Total liabilities and stockholder's equity........ $9,516 $145,350
====== ========
</TABLE>
See Notes to Financial Statements
F-31
<PAGE> 115
TRI STAR WEB CREATIONS, INC.
STATEMENTS OF OPERATIONS AND CHANGES IN RETAINED EARNINGS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------ --------------------
1996 1997 1997 1998
---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Service revenues................................ $ 51,492 $178,251 $ 29,120 $143,256
-------- -------- -------- --------
Selling expenses................................ 7,727 25,234 18,937 19,108
General and administrative expenses............. 23,021 140,972 20,665 77,279
-------- -------- -------- --------
30,748 166,206 39,602 96,387
-------- -------- -------- --------
Operating income (loss)......................... 20,744 12,045 (10,482) 46,869
Interest expense................................ -- 1,424 147 294
-------- -------- -------- --------
Net income (loss)..................... 20,744 10,621 $(10,629) $ 46,575
======== ========
Retained earnings (accumulated deficit),
beginning of year............................. (420) 5,496
Distributions................................... (14,828) (15,310)
-------- --------
Retained earnings, end of year.................. $ 5,496 $ 807
======== ========
</TABLE>
See Notes to Financial Statements
F-32
<PAGE> 116
TRI STAR WEB CREATIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------ --------------------
1996 1997 1997 1998
---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................... $ 20,744 $ 10,621 $(10,629) $ 46,575
Adjustments to reconcile net income to net
cash provided by operating activities:
Bad debts.................................. 6,000 3,747 -- --
Depreciation............................... -- 4,337 304 9,565
Changes in:
Accounts receivable...................... (15,125) (36,392) (1,985) (42,605)
Prepaid expenses......................... -- (3,365) -- 983
Other assets............................. -- (4,182) (1,300) 1,498
Accounts payable......................... 180 41,271 16,750 2,804
Deferred revenue......................... 2,420 23,711 (2,420) 78,393
-------- -------- -------- --------
Net cash provided by operating
activities.......................... 14,219 39,748 720 97,213
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets...................... -- (37,603) (18,251) (82,301)
-------- -------- -------- --------
Net cash used in investing
activities.......................... -- (37,603) (18,251) (82,301)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from related party borrowings........ -- 25,000 18,333 --
Principal payments on related party borrowings
and equipment purchase obligations......... -- (11,229) -- (14,285)
Cash distributions paid....................... (14,828) (15,310) -- --
-------- -------- -------- --------
Net cash used in financing
activities.......................... (14,828) (1,539) 18,333 (14,285)
-------- -------- -------- --------
Net increase (decrease) in cash....... (609) 606 802 627
Cash, beginning of year......................... 1,000 391 391 997
-------- -------- -------- --------
Cash, end of year............................... $ 391 $ 997 $ 1,193 $ 1,624
======== ======== ======== ========
Supplemental disclosures of cash flow
information
Cash payments for:
Interest................................... $ -- $ 1,424 $ -- $ --
-------- -------- -------- --------
Supplemental schedule of noncash investing and
financing activities
Equipment purchase obligations incurred for
use of equipment........................... $ -- $ 61,770 $144,404 $ --
-------- -------- -------- --------
</TABLE>
See Notes to Financial Statements
F-33
<PAGE> 117
TRI STAR WEB CREATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. DESCRIPTION OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Operations: Tri Star Web Creations, Inc. (the "Company") is
primarily engaged in the business of providing web hosting services for
companies and individuals nationwide placing websites on the Internet.
Summary of Significant Accounting Policies
Revenue Recognition: The Company recognizes service revenues ratably as
hosting services are provided.
Concentrations of Credit Risk: The Company extends credit based on an
evaluation of the customer's financial condition, generally without requiring
collateral. Exposure to losses on receivables is principally dependent on each
customer's financial condition. The Company monitors its exposure for credit
losses and maintains allowances for anticipated losses.
Fixed Assets: Fixed assets are carried at cost, less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful lives of the related assets which range from five to seven
years.
Income Taxes: The Company, with the consent of its stockholders, has
elected to be taxed under sections of the federal and state income tax laws
which provide that, in lieu of corporation income taxes, the stockholder
separately accounts for the Company's items of income, deduction, losses and
credits. Therefore, no provision or liability for Federal tax is reflected in
the financial statements. A provision for state taxes is included in operating
expenses.
Use of Estimates in the Preparation of Financial Statements: 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 dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Unaudited information: The interim financial information for the three
months ended March 31, 1998 and 1997 is unaudited. However, in the opinion of
management, such information has been prepared on the same basis as the audited
financial statements and includes all adjustments, consisting solely of normal
recurring adjustments, necessary for a fair presentation of the financial
position and results of operations for the periods presented. The interim
results, however, are not necessarily indicative of results for any future
period.
NOTE 2. FIXED ASSETS
Fixed assets consist of the following at December 31:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Computers.......................................... $98,369
Furniture and fixtures............................. 1,004
-------
99,373
Less accumulated depreciation...................... 4,337
-------
$95,036
=======
</TABLE>
F-34
<PAGE> 118
TRI STAR WEB CREATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. NOTES PAYABLE, RELATED PARTIES
Loans from related parties at December 31, 1997 are represented by a
$15,305 obligation secured by substantially all assets of the Company with
interest at 8.25% and an unsecured non-interest bearing obligation of $5,000.
Notes payable, related parties at December 31, 1997 mature as follows:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Total.............................................. $20,305
Less amounts due currently......................... 18,510
-------
Amounts maturing in 1999........................... $ 1,795
=======
</TABLE>
NOTE 4. EQUIPMENT PURCHASE OBLIGATIONS
The Company finances a portion of its computer equipment under twelve month
equipment purchase obligations.
NOTE 5. OPERATING LEASE
The Company leases its office facility under an operating lease which
expires in January 2003. In addition to base rent, the leasing arrangements
obligate the Company to pay all taxes, insurance, utilities and maintenance
costs. The future minimum base rent payments under the lease are as follows:
<TABLE>
<CAPTION>
AMOUNT
--------
<S> <C>
1998.............................................. $ 21,281
1999.............................................. 22,961
2000.............................................. 23,556
2001.............................................. 24,169
2002.............................................. 25,936
--------
$117,903
========
</TABLE>
NOTE 6. SUBSEQUENT EVENT
In May 1998, the Company sold substantially all of its assets to Sage
Networks, Inc. ("Sage") for cash and assumption of certain of its liabilities
and common stock in Sage. The net consideration for this sale exceeded the
carrying amounts of the related assets at December 31, 1997.
F-35
<PAGE> 119
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
HomeCom Communications, Inc.
In our opinion, the accompanying statements of assets and liabilities and
the related statements of revenues and expenses and of cash flows present
fairly, in all material respects, the financial position of HostAmerica, a
division of HomeCom Communications, Inc., at December 31, 1996 and 1997, and the
results of its operations and its cash flows for the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been carved out of the
historical financial statements of HomeCom Communications, Inc. As such, these
financial statements represent a lesser business component and are not intended
to be a complete presentation of the financial position or the results of
operations or cash flows of the Company were it to operate on a stand-alone
basis. A description of the significant assumptions used to prepare the
carve-out financial statements is included in Note 1 to the financial
statements.
As discussed in Note 1 to the financial statements, substantially all the
assets of HostAmerica were sold to Sage Acquisition Corp. on June 9, 1998.
PricewaterhouseCoopers LLP
Atlanta, Georgia
August 18, 1998
F-36
<PAGE> 120
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF ASSETS AND LIABILITIES
AS OF DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Accounts receivable, net of allowance for
uncollectibles......................................... $ 54,306 $ 55,421
-------- --------
Total current assets.............................. 54,306 55,421
Computer equipment, net..................................... 62,610 83,662
-------- --------
Total assets...................................... $116,916 $139,083
======== ========
LIABILITIES AND BUSINESS UNIT EQUITY (DEFICIT)
Current liabilities:
Deferred revenue.......................................... $ 62,063 $173,458
-------- --------
Total current liabilities......................... 62,063 173,458
-------- --------
Commitments and contingencies
Business unit equity (deficit).............................. 54,853 (34,375)
-------- --------
Total liabilities and business unit equity
(deficit)....................................... $116,916 $139,083
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-37
<PAGE> 121
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF REVENUES AND EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------------ -----------------------
1995 1996 1997 1997 1998
-------- --------- ----------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Hosting revenues.............. $ 26,191 $ 304,399 $ 692,140 $211,617 $ 317,806
Cost of hosting revenues...... 32,298 163,767 407,785 75,207 114,780
-------- --------- ----------- -------- ---------
Gross margin.................. (6,107) 140,632 284,355 136,410 203,026
-------- --------- ----------- -------- ---------
Operating expenses:
Sales and marketing......... 7,187 99,005 407,375 21,704 37,634
General and
administrative........... 13,617 183,524 876,121 132,075 344,067
Depreciation................ 23,877 83,586 13,386 35,581
-------- --------- ----------- -------- ---------
Total operating
expenses.......... 20,804 306,406 1,367,082 167,165 417,282
-------- --------- ----------- -------- ---------
Operating loss................ (26,911) (165,774) (1,082,727) (30,755) (214,256)
Other expenses (income):
Interest expense............ 278 6,789 130,660 4,935 95,810
Other expense (income),
net...................... (868) (22,431) (210) (13,740)
-------- --------- ----------- -------- ---------
Excess of expenses over
revenues.................... $(27,189) $(171,695) $(1,190,956) ($35,480) $(296,326)
======== ========= =========== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-38
<PAGE> 122
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------- --------------------
1995 1996 1997 1997 1998
-------- --------- ----------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Excess of expenses over
revenues....................... $(27,189) $(171,695) $(1,190,956) $(35,480) $(296,326)
Adjustments to reconcile excess of
expenses over revenues to net
cash used in operating
activities:
Depreciation................... 23,877 83,586 13,386 35,582
Provision for bad debts........ 1,014 26,090 198,364 -- 7,675
Changes in assets and
liabilities:
Accounts receivables......... (6,032) (73,274) (201,583) (57,334) (26,036)
Unearned revenue............. 4,899 57,164 111,396 13,203 32,935
-------- --------- ----------- -------- ---------
Net cash used in operating
activities.............. (27,308) (137,838) (999,193) (66,225) (246,170)
-------- --------- ----------- -------- ---------
Cash flows from investing
activities:
Purchase of computer equipment.... -- (77,147) (55,589) -- (8,245)
-------- --------- ----------- -------- ---------
Net cash used in investing
activities.............. -- (77,147) (55,589) -- (8,245)
-------- --------- ----------- -------- ---------
Cash flows from financing activities
Allocated charges paid by HomeCom
Communications, Inc., net of
cash transferred............... 27,308 214,985 1,054,782 66,225 254,415
-------- --------- ----------- -------- ---------
Net cash provided by
financing activities.... 27,308 214,985 1,054,782 66,225 254,415
-------- --------- ----------- -------- ---------
Net increase (decrease) in cash..... 0 0 0 0 0
Cash and cash equivalents at
beginning of period............... 0 0 0 0 0
-------- --------- ----------- -------- ---------
Cash and cash equivalents at end of
period............................ $ 0 $ 0 $ 0 $ 0 $ 0
======== ========= =========== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-39
<PAGE> 123
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
HostAmerica is a trade name of HomeCom Communications, Inc. ("HomeCom")
under which HomeCom provides full service Internet Web site hosting services.
The Web hosting operations of HomeCom conducted under the HostAmerica trade name
are herein referred to as "HostAmerica" or "the Division".
On June 9, 1998, HomeCom sold certain assets of the Division, consisting
principally of hosting contracts, equipment and the trade name "HostAmerica" to
Sage Acquisition Corp. for $4,500,000. Pursuant to the terms of the Asset
Purchase Agreement (the "Agreement"), HomeCom retained all of the accounts
receivable of HostAmerica existing as of May 31, 1998, and retained certain
hosting contracts, and the right to perform hosting services in the future for
companies in the financial services industry. The Agreement required the deposit
of $250,000 of the proceeds to be held in escrow until May 1, 1999, for the
purpose of indemnifying Sage Acquisition Corp. for representations and
warranties made by HomeCom under the Agreement.
Basis of Presentation
Historically, financial statements were not prepared for the Division. The
accompanying financial statements have been prepared in accordance with
generally accepted accounting principles and have been "carved out" of the
financial statements of HomeCom for each of the periods, and as of each of the
dates presented. As such, these statements represent a lesser business component
and are not intended to be a complete presentation of the financial position or
the results of operations or cash flows of the Division were it to operate on a
stand-alone basis.
The accompanying financial statements exclude the assets, liabilities and
revenues related to certain premium hosting accounts referred to as Excluded
Customers in the Agreement. The statements of revenues and expenses of the
Division include all revenues and costs directly attributable to the Division
and also include allocations of corporate overhead from HomeCom. Expenses have
been allocated based on a variety of methods depending on the nature of the
expense. Such allocation methods include proportional HostAmerica revenues to
total HomeCom revenues, headcount equivalents and management estimates. The cost
of providing hosting services represents direct payroll and related costs of
those employees involved in providing hosting services and an allocation of
Internet connection services. An allocation of corporate marketing expenses and
corporate administrative functions (including data services, employee benefits,
legal, insurance, accounting and other corporate overhead) has been included in
the selling and marketing and general and administrative operating expenses in
the statements of revenues and expenses. Depreciation has been computed based
upon a computation of the direct expenses related to the assets sold under the
terms of the Agreement plus an allocation of general corporate depreciation.
Management believes these allocations are reasonable. These allocations are not
necessarily indicative of the costs and expenses that would have resulted if the
Division had been operated as a separate entity.
Accounts Receivable, Net
Accounts receivable represent amounts receivable from the class of hosting
customer subject to the Agreement and are shown net of the allowance for
doubtful accounts. The allowance was approximately $27,000 and approximately
$90,000 at December 31, 1996 and 1997, respectively.
F-40
<PAGE> 124
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Computer Equipment, Net
Computer equipment is recorded at cost less accumulated depreciation, which
is computed using the straight-line method over the estimated useful lives of
the related assets (three years). Maintenance and repairs are charged to expense
as incurred. Upon sale, retirement or other disposition of these assets, the
cost and the related accumulated depreciation are removed from the respective
accounts and any gain or loss on the disposition is included in income.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue Recognition
HostAmerica recognizes revenues ratably over the period for which the Web
site hosting services are provided. Deferred revenue, as reflected on the
accompanying statements of assets and liabilities, represents the amount of
billings recorded in advance of services being provided.
Advertising Expenses
All advertising costs are expensed when incurred. Advertising expenses
allocated to the Division were approximately $1,000, $32,000, and $384,000 for
the years ended December 31, 1995, 1996 and 1997, respectively.
Income Taxes
The Division is not a legal entity. The Division has been included in
HomeCom's consolidated federal income tax returns for all periods prior to June
9, 1998. The Division was not a party to any tax sharing agreement and,
accordingly, no benefit for income taxes has been reflected in the accompanying
statements of revenues and expenses.
Unaudited Information
The interim financial information for the three months ended March 31, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of results of operations and cash flows for
the periods presented. The interim results, however, are not necessarily
indicative of results for any future period.
F-41
<PAGE> 125
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. COMPUTER EQUIPMENT
Computer equipment, net, represents the specific assets defined in the
agreement used in the provision of hosting services and is comprised of the
following as of:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Computer equipment......................... $ 77,147 $132,736
Less: accumulated depreciation............. (14,537) (49,074)
-------- --------
$ 62,610 $ 83,662
======== ========
</TABLE>
3. COMMITMENTS AND CONTINGENCIES
The Division's software and equipment are vulnerable to computer viruses or
similar disruptive problems caused by customers or other Internet users.
Computer viruses or problems caused by third parties could lead to
interruptions, delays or cessation in service to the Division's customers.
Moreover, customers of the Division could use computer files and information
stored on or transmitted to Web server computers maintained by the Division to
engage in illegal activities that may be unknown or undetectable by the
Division, including fraud and misrepresentation, and unauthorized access to
computer systems of others. Furthermore, inappropriate use of the Internet by
third parties could also jeopardize the security of customers' confidential
information that is stored in the Division's computer systems. Any such actions
could subject the Division to liability to third parties. The Division does not
have errors and omissions, product liability or other insurance to protect
against risks caused by computer viruses or other misuse of software or
equipment by third parties. Although the Division attempts to limit its
liability to customers for these types of risks through contractual provisions,
there can be no assurance that these provisions will be enforceable.
Various legal proceedings may arise in the normal course of business.
Management does not believe that there are currently any asserted or unasserted
claims that will have a material adverse effect on the statements of assets and
liabilities, statements of revenues and expenses or cash flows of the Division.
4. CONCENTRATION OF CREDIT RISKS
Financial instruments that potentially subject the Division to significant
concentrations of credit risk consist principally of accounts receivable.
Concentration of credit risk with respect to trade receivables is monitored
by the Division through ongoing credit evaluations of its customers' financial
condition. No customer accounted for more than 10% of the revenues of the
Division during 1995, 1996 or 1997.
F-42
<PAGE> 126
INDEPENDENT AUDITOR'S REPORT
Board of Directors
B.N. Technology, Inc.
dba Internet Communications
Los Angeles, California
We have audited the accompanying balance sheets of B.N. Technology, Inc.
dba Internet Communications as of December 31, 1996 and 1997, and the related
statements of operations and accumulated deficit, and cash flows for the period
April 15, 1996 (inception) through December 31, 1996 and for the year ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amount and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material aspects, the financial position of B.N. Technology, Inc. as of
December 31, 1996 and 1997, and the results of its operations and its cash flows
for the period April 16, 1996 (inception) through December 31, 1996 and the year
ended December 31, 1997.
Encino, California
FRANKEL, LODGEN, LACHER, GOLDITCH, SARDI & HOWARD
September 11, 1998
F-43
<PAGE> 127
B.N. TECHNOLOGY, INC.
DBA INTERNET COMMUNICATIONS
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
-------- ---------
<S> <C> <C>
ASSETS
Cash........................................................ $ 6,138 $ 14,982
Property and equipment, net................................. 20,076 33,861
Deposit..................................................... 1,100 1,100
Organization costs, net..................................... 1,445 1,105
Intangible costs, net....................................... 14,000 7,000
-------- ---------
$ 42,759 $ 58,048
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred revenue............................................ $ 15,787 $ 102,417
Accounts payable and accrued expenses....................... 7,217 36,883
Accrued payroll............................................. 8,861
Contract payable............................................ 5,664 4,033
Shareholders' loans......................................... 13,051 10,551
-------- ---------
41,719 162,745
-------- ---------
Shareholders' equity (deficit):
Common stock; no par value; 100,000 shares authorized,
issued and outstanding................................. 50,100 50,100
Accumulated deficit....................................... (49,060) (154,797)
-------- ---------
1,040 (104,697)
-------- ---------
$ 42,759 $ 58,048
======== =========
</TABLE>
See accompanying notes to financial statements.
F-44
<PAGE> 128
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 15, 1996 SIX MONTHS ENDED
(INCEPTION) THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998
------------------- ------------ --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue............................... $ 47,597 $ 497,445 $ 191,759 $ 663,633
Operating expenses.................... 94,974 601,278 235,855 719,774
-------- --------- --------- ---------
Loss from operations.................. (47,377) (103,833) (44,096) (56,141)
-------- --------- --------- ---------
Interest expense...................... (883) (1,104) -- (4,051)
-------- --------- --------- ---------
Loss before provision for income
tax................................. (48,260) (104,937) (44,096) (60,192)
Income tax benefit (expense).......... (800) (800) (800) 84,600
-------- --------- --------- ---------
Net loss.............................. (49,060) (105,737) (44,896) 24,408
Accumulated deficit, beginning of
period.............................. (49,060) (49,060) (154,797)
-------- --------- --------- ---------
Accumulated deficit, end of period.... $(49,060) $(154,797) $ (93,956) $(130,389)
======== ========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-45
<PAGE> 129
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 15,
1996
(INCEPTION) SIX MONTHS ENDED
THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998
------------ ------------ -------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net income (loss)................................ $(49,060) $(105,737) $(44,896) $ 24,408
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation................................... 5,020 13,484 6,368 7,147
Amortization................................... 7,255 7,340 3,670 3,670
Provision for deferred income tax.............. (188,300)
Increase (decrease) in cash due to changes in
operating assets and liabilities:
Deposits.................................... (1,100) (6,681)
Deferred revenue............................ 15,787 86,630 26,966 224,133
Accounts payable and accrued expense........ 7,217 29,666 14,265 80,646
Accrued payroll............................. 8,861 70,536
Income tax payable.......................... 103,700
-------- --------- -------- ---------
Net cash provided (used) by operating
activities..................................... (14,881) 40,244 6,373 319,259
-------- --------- -------- ---------
Cash flows from investing activities:
Acquisition of property and equipment.......... (18,518) (27,269) (8,638) (202,931)
Shareholders and employee advances............. (17,836)
Purchase of customer list...................... (21,000)
Organizational costs........................... (1,700)
-------- --------- -------- ---------
Net cash provided (used) by investing
activities..................................... 21,933 (27,269) (8,638) (220,767)
-------- --------- -------- ---------
Cash flows from financing activities:
Repayment of contract payable.................. (914) (1,631) (1,123) (953)
Proceeds from issuance of common stock......... 50,100
Repayment of capitalized lease payable......... (1,605)
Proceeds from shareholder loan................. 13,051
Repayment of shareholder loan.................. (2,500) (10,551)
-------- --------- -------- ---------
Net cash provided (used) by financing
activities:.................................... 62,237 (4,131) (1,123) (13,109)
-------- --------- -------- ---------
Net increase in cash............................. 6,138 8,844 (3,388) 85,383
Cash, beginning of period........................ 6,138 6,138 14,982
-------- --------- -------- ---------
Cash, end of period.............................. $ 6,138 $ 14,982 $ 2,750 $ 100,365
======== ========= ======== =========
Supplemental disclosure:
Interest paid.................................. $ 883 $ 1,104 $ $ 4,051
======== ========= ======== =========
Income tax paid................................ $ $ 1,600 $ $ 0
======== ========= ======== =========
Supplemental schedule of non-cash investing and
financing activities:
During 1996, a contract payable in the amount
of $6,578 was incurred to purchase a
vehicle.
Capital lease obligation incurred for use of
equipment...................................... $ 7,655
=========
</TABLE>
See accompanying notes to financial statements.
F-46
<PAGE> 130
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies of B.N. Technology, Inc.
(the Company) is presented to assist in understanding the Company's financial
statements. The financial statements and notes are representations of the
Company's management, which is responsible for their integrity and objectivity.
These accounting policies conform to generally accepted accounting principles
and have been consistently applied in the preparation of the financial
statements.
Business activity
The Company was incorporated on April 16, 1996, and is located in Los
Angeles, California. The Company is an Internet Web hosting service provider.
Revenue recognition
Revenue consists primarily of fees for hosting Web sites. Fees received are
earned according to the subscription period sold. Subscription periods are sold
on a monthly, quarterly and annual basis.
Deferred revenue represents fees received from quarterly and annual
subscriptions which extend beyond the current balance sheet date.
Property and equipment
Property and equipment is carried at cost. The cost is depreciated over the
estimated useful lives of the related assets. Depreciation is computed on the
straight-line method for financial reporting purposes and on the accelerated
cost recovery system method for income tax purposes.
Expenditures for major renewals and betterments that extend the useful
lives of property and equipment are capitalized. Expenditures for maintenance
and repairs are charged to expense as incurred.
Advertising
Advertising costs are expensed as incurred. Advertising expense was $8,818
and $98,484 for the period ended December 31, 1996 and the year ended December
31, 1997, respectively.
Use of estimates in preparation of financial statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that directly affect the results of reported assets, liabilities,
revenue and expenses. Actual results may differ from these estimates.
Income taxes
Current income taxes are based on the taxable income for the year, as
measured by the current year's tax returns. Deferred income taxes arise
primarily due to differences between the basis of deferred revenue used for
financial statements versus cash basis used for income tax reporting purposes.
Unaudited information
The interim financial information for the six months ended June 30, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
F-47
<PAGE> 131
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. PROPERTY AND EQUIPMENT
Major classes of fixed assets are as follows:
<TABLE>
<CAPTION>
ESTIMATED
LIVES 1996 1997
--------- ------- -------
<S> <C> <C> <C>
Equipment and software........................ 5 years $10,677 $34,774
Furniture................................... 5 years 850 4,022
Automobile.................................. 5 years 13,569 13,569
------- -------
25,096 52,365
Accumulated depreciation.................... (5,020) (18,504)
------- -------
$20,076 $33,861
======= =======
</TABLE>
Depreciation expense totaled $5,020 and $13,484 for 1996 and 1997,
respectively.
3. INTANGIBLE COSTS
In 1996, the Company purchased from the majority stockholder a customer
listing and goodwill for $21,000. The cost is being amortized over a three year
period.
4. CAPITAL STOCK TRANSACTIONS
Capital stock transactions in 1996 are as follows:
<TABLE>
<CAPTION>
ISSUED
SHARES AMOUNT
------- -------
<S> <C> <C>
Sale of common stock..................................... 100,000 $50,100
======= =======
</TABLE>
5. CONTRACT PAYABLE
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
The Company has a contract payable dated May 1996, payable
in monthly installments at $222, including interest at
20.98%, commencing May 1996 through October 1999. The
contract is secured by the Company automobile. ........... $5,664 $4,033
Less current portion........................................ 1,631 2,008
------ ------
$4,033 $2,025
====== ======
</TABLE>
The following are maturities of contract payable:
<TABLE>
<CAPTION>
DECEMBER 31:
- ------------
<S> <C>
1998...................................................... $2,008
1999...................................................... 2,025
------
$4,033
======
</TABLE>
6. RELATED PARTY TRANSACTIONS
The Company has transactions with certain shareholders and officers who
receive compensation in the form of wages from the Company. Officers' salaries
aggregated $0 and $84,591 for 1996 and 1997, respectively.
F-48
<PAGE> 132
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In 1996, the Company entered into an agreement with the majority
shareholder to purchase certain equipment, goodwill, and a customer listing for
$25,000.
Shareholders' loans payable are unsecured, non-interest bearing and due on
demand.
7. COMMITMENTS
The Company leases its office and marketing sales office under an operating
lease, commencing April 16, 1996 and expiring June 15, 1998. Under the terms of
the lease agreement, the Company has the option to extend the lease for an
additional three years. The Company is responsible to pay property taxes.
The expected future minimum lease payments are as follows:
<TABLE>
<S> <C>
1998....................................................... $28,682
1999....................................................... 29,137
2000....................................................... 30,012
2001....................................................... 10,102
-------
$97,933
=======
</TABLE>
Rent expense totaled $6,295 and $15,346 for 1996 and 1997, respectively.
8. SALE OF SHAREHOLDERS' INTERESTS
On August 31, 1998, the Company's shareholders entered into an agreement to
sell their respective stock to Sage Networks, Inc.
9. INCOME TAXES
The Company has $12,538 of a net operating loss available to offset future
federal taxable income through 2012.
Valuation allowances are established to reduce deferred tax assets to the
amount expected to be realized.
Provision for income taxes are as follows:
<TABLE>
<CAPTION>
1996 1997
------- --------
<S> <C> <C>
Current................................................. $ 800 $ 800
Deferred benefit........................................ (2,368) (15,932)
Less valuation allowance................................ 2,368 15,932
------- --------
Total provision for income taxes........................ $ 800 $ 800
======= ========
</TABLE>
10. YEAR 2000 COMPLIANCE (UNAUDITED)
The Company's management believes that all information technology included
in the operating system, together with all products and services provided to its
customers or for internal use, in coordination with technology shared with
customers, suppliers or vendors, will accurately process transactions from 1999
and through the Twenty-First Century, including leap year calculations. Neither
performance nor functionality of such technology will be affected by the year
2000 issue.
F-49
<PAGE> 133
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
GEN International, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of GEN
International, Inc. and Subsidiaries (formerly Global Entrepreneurs Network,
Inc.) as of December 31, 1995, 1996 and 1997, and the related consolidated
statements of operations, changes in stockholders' deficiency, and cash flows
for the period April 4, 1995 (inception) through December 31, 1995, and the
years ended December 31, 1996 and 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of GEN International, Inc. and
Subsidiaries as of December 31, 1995, 1996 and 1997, and the results of their
operations and their cash flows for the period April 4, 1995 (inception) to
December 31, 1995, and the years ended December 31, 1996, and 1997, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 9 to
the financial statements, the Company has incurred net losses, and has a working
capital deficiency and a stockholders' deficiency as of December 31, 1997. In
March 1998, Global Entrepreneurs Network, Inc., a wholly-owned subsidiary filed
a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans with regard to these matters are
discussed in Note 9. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Urbach Kahn & Werlin PC
New York, New York September 4, 1998
F-50
<PAGE> 134
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
BALANCE SHEETS
DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
-------- --------- -----------
<S> <C> <C> <C>
ASSETS
Current Assets
Cash.................................................. $ 362 $ 888
Prepaid expenses and other current assets............. 3,080 10,471 $ 687
-------- --------- -----------
Total current assets.......................... 3,442 11,359 687
-------- --------- -----------
Equipment, net of related depreciation.................. 23,243 271,649
-------- --------- -----------
Security deposit........................................ 2,252 4,154 5,834
-------- --------- -----------
$ 5,694 $ 38,756 $ 278,170
-------- --------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities
Line of credit........................................ $ 50,000
Capital lease obligations -- current portion.......... 76,421
Accounts payable...................................... $ 45,425 147,524
Advances from stockholder............................. 12,260 82,319
Deferred revenue...................................... $ 12,624 93,185 237,378
Accrued interest -- stockholder....................... 7,611
Accrued expenses and other current liabilities........ 12,355 53,368 174,380
-------- --------- -----------
Total current liabilities..................... 24,979 204,238 775,633
-------- --------- -----------
Capital lease obligations -- non-current portion........ 112,632
-------- --------- -----------
Commitments
Stockholders' deficiency
Common stock, no par value, 25,000,000 shares......... 4,000 20,000 409,545
authorized (1,000,000 -- 1995; 5,325,000 -- 1996
and 11,816,943 -- 1997) issued and outstanding
Accumulated deficit................................... (23,285) (185,482) (1,019,640)
-------- --------- -----------
(19,285) (165,482) (610,095)
-------- --------- -----------
$ 5,694 $ 38,756 $ 278,170
======== ========= ===========
</TABLE>
See Notes to Financial Statements
F-51
<PAGE> 135
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD
APRIL 4, 1995 SIX MONTHS ENDED
(INCEPTION) THROUGH YEAR ENDED YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, DECEMBER 31, -----------------------
1995 1996 1997 1997 1998
------------------- ------------ ----------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues............. $198,503 $ 828,652 $1,130,764 $ 545,540 $ 457,170
Cost of revenues......... 68,558 345,502 914,093 519,118 298,564
-------- --------- ---------- --------- ---------
Gross profit... 129,945 483,150 216,671 26,422 158,606
-------- --------- ---------- --------- ---------
Operating expenses:
Selling, advertising
and promotion....... 76,741 301,978 425,621 183,455 22,835
General and
administrative...... 76,489 268,369 608,265 152,178 636,508
Interest expense....... -- -- 16,943 5,100 8,470
Bad debt expense....... -- 75,000 -- -- --
-------- --------- ---------- --------- ---------
153,230 645,347 1,050,829 340,733 667,813
-------- --------- ---------- --------- ---------
Net loss....... $(23,285) $(162,197) $ (834,158) $(314,311) $(509,207)
======== ========= ========== ========= =========
</TABLE>
See Notes to Financial Statements
F-52
<PAGE> 136
GEN INTERNATIONAL, AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD
APRIL 4, 1995
(INCEPTION) THROUGH YEAR ENDED YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1995 1996 1997 1997 1998
------------------- ------------ ------------ --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.............................. $(23,285) $(162,197) $(834,158) $(314,311) $(509,207)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Common stock issued for services
provided.......................... 6,000 45,834 -- --
Depreciation expense................ 1,977 33,924 8,359 54,000
Bad debt expense.................... 75,000 -- --
Changes in assets and liabilities:
Due from related parties............ (75,000) --
Prepaid expenses and other current
assets............................ (3,080) (7,391) 9,784 (8,929) (8,668)
Accounts payable.................... 45,425 102,099 222,358 270,166
Deferred revenue.................... 12,624 80,561 144,193 33,547 16,616
Accrued interest stockholder....... 7,611 3,300 (6,111)
Accrued expenses and other current
liabilities....................... 12,355 41,013 121,012 43,558 20,604
-------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities......... (1,386) 5,388 (369,701) (12,118) (162,600)
-------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Security deposit...................... (2,252) (1,902) (1,680) -- (20,030)
Purchase of equipment................. (25,220) (58,982) (33,163) (3,976)
-------- --------- --------- --------- ---------
Net cash used in investing
activities................... (2,252) (27,122) (60,662) (33,163) (24,006)
-------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings from line of credit.... 50,000 -- --
Payments on capital lease
obligations......................... (34,295) 9,364 (45,030)
Proceeds from sale of common stock.... 4,000 10,000 343,711 -- 165,472
Advances from stockholder............. 12,260 70,059 35,029 66,164
-------- --------- --------- --------- ---------
Net cash provided by financing
activities................... 4,000 22,260 429,475 44,393 186,606
-------- --------- --------- --------- ---------
Net increase (decrease) in
cash......................... 362 526 (888) (888) --
CASH
Beginning of period................... -- 362 888 888 --
-------- --------- --------- --------- ---------
End of period......................... $ 362 $ 888 $ -- $ -- $ --
======== ========= ========= ========= =========
</TABLE>
SUPPLEMENTAL CASH FLOW DISCLOSURES
In 1997, the Company entered into capital lease arrangements aggregating
$223,300 for the purchase of equipment.
Cash paid for interest was approximately $16,900 in 1997.
F-53
<PAGE> 137
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
PERIOD APRIL 4, 1995 (INCEPTION) THROUGH DECEMBER 31, 1995
AND YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
---------- -------- ----------- ---------
<S> <C> <C> <C> <C>
April 4, 1995..............................
Sale of common stock for cash to founding
stockholder.............................. 1,000,000 $ 4,000 $ 4,000
Net loss -- 1995........................... $ (23,285) (23,285)
---------- -------- ----------- ---------
Balance, December 31, 1995................. 1,000,000 4,000 (23,285) (19,285)
Sale of common stock for cash.............. 5,000 10,000 10,000
Issuance of common stock for services...... 60,000 6,000 6,000
Additional shares of common stock in
connection with stock split.............. 4,260,000
Net loss -- 1996........................... (162,197) (162,197)
---------- -------- ----------- ---------
Balance, December 31, 1996................. 5,325,000 $ 20,000 $ (185,482) $(165,482)
Exchange of Global Entrepreneurs Network,
Inc. common stock -- Note 1.............. (2,662,500)
Sale of common stock for cash.............. 586,590 242,709 242,709
Issuance of common stock for services...... 557,853 45,834 45,834
Shares issued on exercise of options....... 1,010,000 101,000 101,000
Acquisition of GEN Events, Inc., GEN
Network Operations, Inc., and GEN Europe,
Inc...................................... 7,000,000 2 2
Net loss -- 1997........................... (834,158) (834,158)
---------- -------- ----------- ---------
Balance, December 31, 1997................. 11,816,943 $409,545 $(1,019,640) $(610,095)
========== ======== =========== =========
</TABLE>
See Notes to Financial Statements
F-54
<PAGE> 138
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. ORGANIZATION, BUSINESS COMBINATIONS AND ACQUISITIONS, AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Organization: GEN International, Inc. (the "Company"), a successor entity
to Global Entrepreneurs Network, Inc. (Global), is located in St. Petersburg,
Florida and is a global network and information provider connected to the
Internet. The Company also offers storage, transfer, and Web hosting services to
its members worldwide, primarily small and medium sized businesses. The Company
was organized as a shell in June 1997. In this connection, Global, originally
incorporated in April 1995 exchanged its then outstanding common stock
(5,325,000 shares) for the common stock (2,662,500 shares) of the Company. The
Company also issued options to the former stockholders of Global. The financial
statements from inception (April 4, 1995) through the exchange in June 1997,
represent the accounts and activities of Global. In connection with this
exchange, Global became a wholly-owned subsidiary of the Company. The Company
also acquired in June 1997, the outstanding common stock of GEN Events, Inc.,
GEN Network Operations Center, Inc., and GEN Europe, Inc., shell entities with
no assets, liabilities or operations, whose shares were also substantially owned
by the principal shareholder of Global. Nominal consideration was assigned to
the 7,000,000 shares issued by the Company in this connection.
Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include
the accounts of the Company, and its wholly-owned subsidiaries as follows:
- Global Entrepreneurs Network, Inc.
- GEN Network Operations Center, Inc.
- GEN Europe, Inc.
- GEN Events, Inc.
All significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
Revenue Recognition: Recurring revenues consist primarily of monthly fees
charged to members for Web hosting services and are recognized at the beginning
of each month for which services are rendered. Other revenues generally
represent one-time set up fees and are recorded as earned. Deferred revenue
consists primarily of the unexpired portion of annual prepaid membership fees.
Property and Equipment: Property and equipment is stated at cost and
depreciated using the straight-line method over the estimated useful life of the
assets, generally three years for computers and computer related equipment and
five years for other non-computer furniture and equipment. Leasehold
improvements are amortized over the term of the lease.
Capital Leases: The Company leases certain of its phone and other computer
related equipment under capital lease agreements. The assets and liabilities
under capital leases are recorded at the lesser of the present value of future
minimum lease payments, including estimated bargain purchase options, or the
fair value of the assets under lease. Assets under capital lease are amortized
over the lesser of their estimated useful lives of three to five years or the
term of the lease.
Income Taxes: Income taxes are computed using the asset and liability
method. Under this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and
liabilities and are measured using the currently enacted tax rates and laws.
There were no deferred taxes in 1995, 1996 and 1997.
Advertising: The Company expenses advertising costs as they are incurred.
F-55
<PAGE> 139
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Use of Estimates in the Preparation of Financial Statements: 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.
Unaudited information
The interim financial information for the six months ended June 30, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1996 and
1997:
<TABLE>
<CAPTION>
1996 1997
------- --------
<S> <C> <C>
Furniture and fixtures.................................. $ 1,482 $ 2,472
Computer equipment...................................... 23,736 303,455
Leasehold improvements.................................. -- 1,623
------- --------
25,218 307,550
Less: accumulated depreciation.......................... 1,975 35,901
------- --------
$23,243 $271,649
======= ========
</TABLE>
NOTE 3. LINE OF CREDIT
The Company has a line of credit with a financial institution amounting to
$50,000. The line bears interest at 2% above the prime lending rate and is due
on demand.
NOTE 4. ADVANCES FROM STOCKHOLDER
Advances from stockholder originally due in September 1996, bear interest
at 18% per annum. Repayment of the advances was extended until such time as the
Company has sufficient resources to satisfy the obligations. Interest expense
for the year ended December 31, 1997 was $7,611. Interest in 1996 was not
material.
NOTE 5. STOCK-BASED COMPENSATION
During 1997, the Company issued options to purchase 3,715,000 shares of
common stock of the Company to certain officers, directors, stockholders and
employees at exercise prices ranging from $0.10 to $1.00. The options are
exercisable upon certain vesting requirements and/or in the event the Company
has a public offering.
During 1997, 1,010,000 options not subject to vesting requirements were
exercised for $101,000. Options to purchase 2,705,000 shares of common stock
were outstanding at December 31, 1997 at a weighted average exercise price of
approximately $1.00. All outstanding options were exercisable at December 31,
1997.
In accordance with Accounting Principles Board Statement No. 25 (APB 25),
no compensation cost has been recognized in accounting for the stock options
issued during 1997. Because the Company's stock options have characteristics
significantly different than those of traded options, compensation cost for the
F-56
<PAGE> 140
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company's 1997 grants, based upon the fair value method consistent with
Financial Accounting Statement No. 123, is not determinable.
NOTE 6. COMMITMENT
Lease: The Company had an operating lease for its corporate office, which
expired in January 1998, and was renewed through October 1998. Rent expense for
the years ending December 31, 1997 and 1996, and for the period April 4, 1995
(inception) through December 31, 1995 was $27,000, $29,445 and $5,524,
respectively.
NOTE 7. INCOME TAXES
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $1,020,000, which expire in 2010 through 2012. At December 31,
1997, the expected tax benefit from the future realization of this operating
loss carryforward of approximately $401,000 has been offset by an equivalent
valuation allowance, in view of the uncertainty as to ultimate realization.
NOTE 8. CAPITAL LEASES
During 1997, the Company entered into capital lease arrangements for
computer equipment and other office equipment. The leases, which expire in 1999
through 2000, require the Company to pay taxes, maintenance and insurance.
Annual minimum commitments under the lease arrangements are as follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -------------------------
<S> <C>
1998........................................................ $ 91,540
1999........................................................ 88,550
2000........................................................ 24,678
2001........................................................ 5,592
2002........................................................ 3,741
--------
Total minimum payments...................................... 214,101
Less amount representing interest at approximately 10%...... 25,048
Present value of future lease payments...................... 189,053
Less current portion........................................ 76,421
--------
$112,632
--------
</TABLE>
NOTE 9. GOING CONCERN
As indicated in the accompanying financial statements, the Company and its
wholly-owned subsidiaries, have incurred net operating losses, and as of
December 31, 1997, has a working capital deficiency of approximately $775,000
and a stockholders' deficiency of approximately $610,000. During March 1998,
Global Entrepreneurs Network, Inc. filed a voluntary petition for reorganization
under Chapter 11 of the Federal Bankruptcy Code, and was authorized to continue
managing and operating the business as debtor in possession subject to the
control and supervision of the Bankruptcy Court.
Management of the Company is aggressively seeking additional sources of
capital and financing, and in August, 1998, the Company entered into a contract
with Sage Networks, Inc. for the sale of certain of its assets for cash and
assumption of certain of its liabilities, which sale was subsequently
consummated in September 1998. The ability of the Company to continue as a going
concern is dependent upon obtaining additional capital and financing. The
consolidated financial statements do not include any adjustments that might be
necessary if the Company is unable to continue as a going concern.
NOTE 10. SUBSEQUENT EVENTS
In March 1998, the Company effected a 2 for 1 stock split.
F-57
<PAGE> 141
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Digiweb, Inc.
We have audited the accompanying balance sheets of Digiweb, Inc. as of
December 31, 1997 and 1998, and the related statements of income, cash flows,
and changes in stockholders' equity for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Digiweb, Inc. as of December
31, 1997 and 1998, and the results of its operations and its cash flows for the
years then ended, in conformity with generally accepted accounting principles.
Urbach Kahn & Werlin PC
New York, New York
January 24, 1999
F-58
<PAGE> 142
DIGIWEB, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
ASSETS
Current Assets
Cash...................................................... $115,643 $134,343
Accounts receivable, net of allowance for doubtful
accounts of $12,075 and $43,431........................ 36,728 50,939
Prepaid expenses and other current assets................. -- 19,365
-------- --------
Total current assets.............................. 152,371 204,647
-------- --------
Equipment, net of related depreciation...................... 505,946 653,493
-------- --------
OTHER ASSETS
Restricted cash............................................. 50,000 50,000
Security deposit............................................ 3,376 9,685
Other assets, net of amortization of $462 and $219.......... 2,220 1,977
-------- --------
Total other assets................................ 55,596 61,662
-------- --------
$713,913 $919,802
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Note payable -- current portion........................... $ 17,411 $ 41,637
Capital lease obligations -- current portion.............. 2,910 13,030
Accounts payable.......................................... 44,834 121,673
Advances from stockholder................................. 4,966 4,966
Deferred revenue.......................................... 20,239 66,381
Accrued expenses and other current liabilities............ 12,344 6,087
-------- --------
Total current liabilities......................... 102,704 253,774
-------- --------
Note payable -- non-current portion......................... 83,627 42,605
Capital lease obligations -- non-current portion............ 30,661 55,232
-------- --------
Total long-term liabilities....................... 114,288 97,837
-------- --------
Commitments
Stockholders' equity
Common stock, no par value, 1,000 shares authorized,
issued and outstanding................................. 20,000 20,000
Retained earnings......................................... 476,921 548,191
-------- --------
496,921 568,191
-------- --------
$713,913 $919,802
======== ========
</TABLE>
See Notes to Financial Statements
F-59
<PAGE> 143
DIGIWEB, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Net revenues................................................ $1,768,322 $2,685,676
Cost of revenues............................................ 729,157 1,118,913
---------- ----------
Gross profit...................................... 1,039,165 1,566,763
---------- ----------
Operating expenses:
Selling, advertising and promotion........................ 17,997 31,577
General and administrative................................ 397,691 586,288
Interest expense.......................................... 10,020 16,829
Bad debt expense.......................................... 12,075 43,431
---------- ----------
437,783 678,125
---------- ----------
Net income........................................ $ 601,382 $ 888,638
========== ==========
</TABLE>
See Notes to Financial Statements
F-60
<PAGE> 144
DIGIWEB, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
COMMON STOCK
----------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------- --------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1996........................ 1,000 $20,000 $ 39,470 $ 59,470
Stockholder distributions......................... (163,931) (163,931)
Net income -- 1997................................ 601,382 601,382
----- ------- --------- ---------
Balance, December 31, 1997........................ 1,000 $20,000 $ 476,921 $ 496,921
Stockholder distributions......................... (817,368) (817,368)
Net income -- 1998................................ 888,638 888,638
----- ------- --------- ---------
Balance, December 31, 1998........................ 1,000 $20,000 $ 548,191 $ 568,191
===== ======= ========= =========
</TABLE>
See Notes to Financial Statements
F-61
<PAGE> 145
DIGIWEB, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
--------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................ $ 601,382 $ 888,638
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization expense.................. 138,210 246,329
Bad debt expense....................................... 12,075 31,356
Changes in assets and liabilities:
Accounts receivable.................................... (9,873) (45,567)
Prepaid expenses and other current assets.............. 9,308 (19,365)
Accounts payable....................................... (44,505) 76,839
Deferred revenue....................................... (23,821) 46,142
Accrued expenses and other current liabilities......... 14,337 (6,257)
--------- ----------
Net cash provided by operating activities......... 697,113 1,218,115
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Costs paid for trademark.................................. (1,655) --
Security deposits paid.................................... (1,981) (6,309)
Deposits into cash reserve................................ (50,000) --
Purchase of equipment..................................... (302,257) (347,394)
--------- ----------
Net cash used in investing activities............. (355,893) (353,703)
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on shareholder loans................... (136,578) --
Principal payments on capital lease obligations........... (5,054) (11,548)
Principal payments on notes payable....................... (9,931) (16,796)
Shareholder distributions................................. (163,931) (817,368)
--------- ----------
Net cash used in financing activities............. (315,494) (845,712)
--------- ----------
Net increase in cash.............................. 25,726 18,700
CASH:
Beginning of period....................................... 89,917 115,643
--------- ----------
End of period............................................. $ 115,643 $ 134,343
========= ==========
Supplemental Disclosure of Cash Flow Information
Cash payments for interest................................ $ 10,020 $ 16,829
--------- ----------
Capital Lease Obligations Incurred for Purchase of
Equipment................................................. $ 39,303 $ 85,542
--------- ----------
Note Payable Incurred for Leasehold Improvements............ $ 76,444 $ --
--------- ----------
</TABLE>
F-62
<PAGE> 146
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1998
NOTE 1. ORGANIZATION, BUSINESS COMBINATIONS AND ACQUISITIONS, AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Organization: Digiweb, Inc. ("Digiweb" or the "Company") is a provider of
Web hosting and co-located services catering to small and medium sized
businesses. Based in College Park, Maryland, Digiweb offers three core services:
shared server Web hosting, dedicated server Web hosting and co-located.
Revenue Recognition: Recurring revenues consist primarily of monthly fees
charged to members for Web hosting services and are recognized ratably over the
periods for which services are rendered. Other revenues generally represent
one-time set up fees and are recorded as earned. Deferred revenue consists
primarily of the unexpired portion of annual prepaid membership fees.
Property and Equipment: Property and equipment is stated at cost and
depreciated using the straight-line method over the estimated useful life of the
assets, generally three to five years for computers and computer related
equipment and seven years for other non-computer furniture and equipment.
Leasehold improvements are amortized over the term of the lease.
Capital Leases: The Company leases certain of its autos and other computer
related equipment under capital lease agreements. The assets and liabilities
under capital leases are recorded at the lesser of the present value of future
minimum lease payments, including estimated bargain purchase options, or the
fair value of the assets under lease. Assets under capital lease are amortized
over the lesser of their estimated useful lives of three to five years or the
term of the lease.
Income Taxes: No provision for income taxes has been recorded in the
financial statements due to the Company's S Corporation status. Individual
stockholders are taxed on their respective shares of the entities' income and
receive the benefits of the entities' income tax credits.
Advertising: The Company expenses advertising costs as they are incurred.
Use of Estimates in the Preparation of Financial Statements: 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.
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1997 and
1998:
<TABLE>
<CAPTION>
1997 1998
-------- ----------
<S> <C> <C>
Leasehold improvements............................... $ 76,444 $ 76,444
Office equipment..................................... 37,318 71,053
Furniture and fixtures............................... 11,006 13,703
Computer equipment................................... 488,363 799,325
Equipment under capital leases....................... 39,303 85,542
Auto................................................. 36,262 36,262
-------- ----------
686,696 1,082,329
Less: accumulated depreciation....................... 182,750 428,836
-------- ----------
$505,946 $ 653,493
======== ==========
</TABLE>
F-63
<PAGE> 147
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. NOTE PAYABLE
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Note payable (auto) in 42 monthly payments of $615,
including interest at 11.15% and one balloon payment of
$22,142 maturing in December 1999. The loan is
collateralized by the automobile ......................... $30,753 $27,160
Note payable (leasehold improvements) in 60 monthly
installments of $1,596, including interest at 9.25%
maturing June 2002. ...................................... 70,285 57,082
------- -------
Total............................................. 101,038 84,242
Less amounts due currently........................ 17,411 41,637
------- -------
$83,627 $42,605
------- -------
</TABLE>
Future maturities of notes payable are as follows:
<TABLE>
<S> <C>
1999....................................................... $41,637
2000....................................................... 15,875
2001....................................................... 17,407
2002....................................................... 9,323
-------
$84,242
-------
</TABLE>
NOTE 4. CAPITAL LEASES
During 1996 and 1997, the Company entered into capital lease
arrangements for computer equipment and automobiles. These leases expire in
1999 through 2000. Annual minimum commitments under these arrangements are
as follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
- ------------
<S> <C>
1999........................................................ $18,528
2000........................................................ 58,503
-------
Total minimum payments...................................... 77,031
Less amount representing interest at approximately 10%...... (8,769)
-------
Present value of future lease payments...................... 68,262
Less current portion........................................ 13,030
-------
$55,232
=======
</TABLE>
NOTE 5. COMMITMENT
Lease: The Company has an operating lease for its corporate office, which
expires in May 2004. Rent expense for the years ending December 31, 1997 and
1998, was $47,395 and $69,764, respectively, including tenant charges for
building improvements in 1998.
In January 1999, the Company executed an additional lease for office
expense which expires in December 2004.
The Company also has leases with two internet line service providers,
expiring in April 2000 and January 2002. Internet line service expense for the
years ending December 31, 1997 and 1998, was $199,746 and $325,787,
respectively.
F-64
<PAGE> 148
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum rental payments under these leases are as follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31, AMOUNTS
- ------------ ----------
<S> <C>
1999..................................................... $ 301,645
2000..................................................... 216,808
2001..................................................... 191,209
2002..................................................... 139,668
2003..................................................... 143,859
Thereafter............................................... 148,174
----------
$1,141,363
==========
</TABLE>
Total rental expense was $47,395 and $69,764 for the years ending December
31, 1997 and 1998, respectively.
NOTE 6. SUBSEQUENT EVENTS
In January 1999, the Company entered into a non-binding Letter of Intent
with Sage Networks, Inc. (Sage) for the sale of certain of its assets, at
amounts in excess of their carrying values, and assumption of certain of its
liabilities, for cash and stock in Sage.
F-65
<PAGE> 149
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Telephonetics International, Inc. and
State of the Art, Inc.
Miami, Florida
We have audited the accompanying combined balance sheet of Telephonetics
International, Inc. and Affiliate as of December 31, 1998, and the related
combined statements of operations, capital deficit and cash flows for each of
the two years in the period then ended. These combined financial statements are
the responsibility of the Companies management. Our responsibility is to express
an opinion on these combined financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe our audits provide a reasonable basis for our
opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Telephonetics
International, Inc. and Affiliate as of December 31, 1998, and the results of
their operations and their cash flows for each of the two years in the period
then ended in conformity with generally accepted accounting principles.
BDO Seidman, LLP
Miami, Florida
January 15, 1999
F-66
<PAGE> 150
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
ASSETS
Current assets
Cash and cash equivalents................................. $ 106,812
Accounts receivable, net of $94,100 allowance for doubtful
accounts (Notes 2 and 5)............................... 538,845
Inventories............................................... 50,836
Prepaid expenses and other current assets................. 34,197
-----------
Total current assets.............................. 730,690
Property and equipment, net (Note 1)........................ 68,598
-----------
$ 799,288
===========
LIABILITIES AND CAPITAL DEFICIT
Current liabilities
Note payable to bank (Note 2)............................. $ 90,000
Note payable to shareholder (Note 3)...................... 50,000
Accounts payable and accrued expenses..................... 137,610
-----------
Total current liabilities......................... 277,610
Deferred income............................................. 1,583,570
-----------
Total liabilities................................. 1,861,180
-----------
Commitments and Subsequent Event (Notes 7 and 10)
CAPITAL DEFICIT (Note 9)
Common stock, $.001 par value; 15,000,000 shares
authorized; 6,000,000 shares issued and outstanding,
Telephonetics International, Inc....................... 6,000
Common stock, $1.00 par value; 1,000 shares authorized,
issued and outstanding, State of the Art, Inc.......... 1,000
Additional paid-in capital................................ 557,815
Deficit................................................... (1,626,707)
-----------
Total capital deficit............................. (1,061,892)
-----------
$ 799,288
===========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-67
<PAGE> 151
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1998
---------- ----------
<S> <C> <C>
Revenues (Note 5)........................................... $2,991,849 $2,769,606
Cost of sales............................................... 1,023,946 823,161
---------- ----------
Gross profit................................................ 1,967,903 1,946,445
Selling, general and administrative (Notes 4 and 8)......... 2,561,887 2,687,852
---------- ----------
Net loss.................................................... $ (593,984) $ (741,407)
========== ==========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-68
<PAGE> 152
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF CAPITAL DEFICIT (NOTE 9)
<TABLE>
<CAPTION>
SUBSCRIBED ADDITIONAL TOTAL
COMMON COMMON PAID-IN TREASURY CAPITAL
STOCK STOCK CAPITAL DEFICIT STOCK DEFICIT
------- ---------- ---------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996... $ 8,375 $ -- $ 92,625 $ (71,139) $(31,185) $ (1,324)
Stock subscription............. -- 100 494,900 -- -- 495,000
Dividends -- cash.............. -- -- -- (220,177) -- (220,177)
Net loss....................... -- -- -- (593,984) -- (593,984)
------- ----- -------- ----------- -------- -----------
Balance at December 31, 1997... 8,375 100 587,525 (885,300) (31,185) (320,485)
Retirement of treasury stock,
1,475,000 shares at cost..... (1,475) -- (29,710) -- 31,185 --
Issuance of common stock....... 100 (100) -- -- -- --
Net loss....................... -- -- -- (741,407) -- (741,407)
------- ----- -------- ----------- -------- -----------
Balance at December 31, 1998... $ 7,000 $ -- $557,815 $(1,626,707) $ -- $(1,061,892)
======= ===== ======== =========== ======== ===========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-69
<PAGE> 153
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------
1997 1998
--------- ---------
<S> <C> <C>
Operating Activities:
Net loss.................................................. $(593,984) $(741,407)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for losses on accounts and notes
receivable............................................ 20,850 110,000
Depreciation and amortization.......................... 31,451 74,758
(Increase) decrease in:
Accounts receivable.................................. (128,543) (135,292)
Inventories.......................................... 21,276 88,164
Prepaid expenses and other current assets............ 5,639 (24,232)
Other assets......................................... (1,840) 1,840
Increase in:
Accounts payable and accrued expenses................ 52,096 (96,962)
Deferred income...................................... 224,400 552,511
--------- ---------
Net cash used in operating activities....................... (368,655) (170,620)
--------- ---------
Investing Activities:
Proceeds from disposition of investments.................. 161,523 --
Additions to property and equipment....................... (5,960) (4,943)
Issuance of note receivable............................... (110,000) --
--------- ---------
Net cash (used in) provided by investing activities......... 45,563 (4,943)
--------- ---------
Financing Activities:
Proceeds from stock subscription.......................... 495,000 --
Proceeds from notes payable............................... 45,000 209,690
Payment of notes payable.................................. (44,889) (70,000)
Dividends................................................. (220,177) --
--------- ---------
Net cash provided by financing activities................... 274,934 139,690
--------- ---------
Net decrease in cash and cash equivalents................... (48,158) (35,873)
Cash, and cash equivalents at beginning of year............. 190,843 142,685
--------- ---------
Cash, and cash equivalents at end of year................... $ 142,685 $ 106,812
========= =========
Supplemental information:
Cash paid for:
Interest............................................... $ 2,600 $ 7,400
========= =========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-70
<PAGE> 154
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Telephonetics International, Inc. (Telephonetics) and State of the Art,
Inc. were incorporated in the State of Florida in 1982 and 1980, respectively,
for the purpose of providing customized audio programming for telephone hold
lines and other telecommunication applications. Presently such applications
include automated attendant, voice mail, integrated voice response and
computer/telephone integration applications, which collectively comprise the
Companies' sole business segment. The Companies' principle administrative,
production and sales facility is located in Miami, Florida.
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of Telephonetics
International, Inc. and its substantially inactive affiliate corporation, State
of the Art, Inc., collectively, the Companies. Telephonetics' majority
shareholder owns 85% of State of the Art, Inc.'s common stock and substantially
controls its operations. Intercompany advances and transactions have been
eliminated.
CASH AND CASH EQUIVALENTS
For the purpose of the statements of cash flows, the Companies consider all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents.
REVENUE RECOGNITION
A typical sales agreement for services entitles a customer to receive and
requires the Companies to provide upon customer request specified programming
services over a one year period. Billings to customers for such services are
rendered at the date of the agreement and recognized as revenue on a
straight-line basis over the term of the agreement. Revenue from telephone
answering devices and accessory sales are recognized upon shipment to the
customer.
INVENTORIES
Inventories are stated at the lower of cost or market using the first in,
first-out method.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation and amortization
is computed by the straight line method based on the estimated useful lives of
the related assets. Leasehold improvements are amortized over the shorter of the
life of the asset or the lease.
INCOME TAXES
The Companies, with the consent of all of their shareholders, have elected
to be taxed under the provisions of Subchapter S of the Internal Revenue Code.
Under those provisions, the Companies do not provide for or pay Federal and
certain State corporate income taxes on their taxable income. Instead, the
stockholders are liable for individual Federal and State income taxes, if any,
on their share of the Companies taxable income.
PREPARATION OF COMBINED FINANCIAL STATEMENTS
The preparation of the combined 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 at
the date of the combined financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from estimated amounts.
F-71
<PAGE> 155
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
CONCENTRATION OF CREDIT RISK
The Companies' credit risk relates to cash and cash equivalents and
accounts receivable. Cash and cash equivalents are primarily held in bank
accounts and overnight investments. These banks are insured up to $100,000 by
the FDIC. Periodically, cash balances may exceed this amount. The credit risk
associated with accounts receivable is minimal due to the Companies' customer
base and ongoing control procedures which monitor the credit worthiness of
customers.
NEW ACCOUNTING PRONOUNCEMENT
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The statement applies to
all entities and is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Companies did not engage in derivative instruments or
hedging activities in any periods presented in the financial statements.
F-72
<PAGE> 156
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
1. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL DECEMBER 31,
LIFE(YEARS) 1998
----------- ------------
<S> <C> <C>
Office and other equipment................... 7 $ 94,757
Studio and production equipment.............. 7 204,579
Furniture and fixtures....................... 7 82,120
Art work..................................... -- 5,475
---------
386,931
Less: accumulated depreciation and
amortization............................... (318,333)
---------
$ 68,598
=========
</TABLE>
2. NOTES PAYABLE
At December 31, 1998, the Companies have a financing agreement with a
financial institution which provides for a demand revolving line of credit with
maximum borrowings of $150,000. Outstanding amounts under this facility bear
annual interest at 1% over the prime rate (8.75% at December 31, 1998), payable
monthly. Amounts borrowed under this facility are collateralized by
Telephonetics International, Inc.'s accounts receivable and guaranteed by the
Company's President and principal shareholder. At December 31, 1998, amounts
outstanding under the line of credit aggregate $90,000.
The revolving line of credit agreement, requires the Companies to comply
with certain covenants, the most restrictive of which requires the Companies to
maintain tangible net worth (as defined) of at least $500,000. At December 31,
1998, the Companies were not in compliance with this covenant and accordingly,
the obligation could be called for repayment.
3. NOTE PAYABLE TO SHAREHOLDER
On May 28, 1998, the Companies' principal shareholder loaned $70,000 to the
Companies for working capital purposes. The note bears interest at 10% annually
payable in monthly principal installments of $3,000 beginning September 1998. At
December 31, 1998, outstanding amount due to the principal shareholder
aggregated $50,000.
4. RELATED PARTY TRANSACTIONS
During 1997 and 1998, the Companies paid rent to companies owned by the
Companies' principal officers in the amount of $38,500 and $104,000,
respectively.
5. SIGNIFICANT CUSTOMER
For the years ended December 31, 1997 and 1998, one customer accounted for
47% and 55% of revenues, respectively; at December 31, 1998, accounts receivable
from this customer amounted to approximately $337,600.
6. FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including certificates of
deposit, accounts receivable, accounts payable and debt approximated fair value
due to the relatively short maturity.
F-73
<PAGE> 157
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS
The Companies rent office space and warehouse under non-cancelable leases.
The minimum future rental commitment for leases in effect at December 31, 1998,
including leases to related parties, approximates the following:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------
<S> <C>
1999...................................................... $ 98,700
2000...................................................... 92,600
2001...................................................... 72,000
2002...................................................... 72,000
2003...................................................... 54,000
--------
$389,300
========
</TABLE>
Rent expense in 1997 and 1998 aggregated approximately $102,000 and
$160,000, including $38,500 and $104,000 to related parties, respectively.
The Companies are required to pay a fee for the use of custom audio
production. During 1997 and 1998, approximately $33,000 and $40,000 of royalties
were paid, respectively.
8. DEFERRED COMPENSATION PLAN
The Companies have a defined contribution plan established pursuant to
Section 401(k) of the Internal Revenue Code. Employees contribute to the plan a
percentage of their salaries, subject to certain dollar limitations and the
Companies match a portion of the employees' contributions. The Companies'
contributions to the plan for the years ended December 31, 1997 and 1998
aggregated $16,200 and $17,000, respectively.
9. CAPITAL DEFICIT
On December 15, 1997 at a special meeting of the stockholders, an action
was approved to recapitalize Telephonetics by reducing the par value of each
share of common stock from $1 per share to $.001 per share and increasing the
number of authorized shares of common stock from 100,000 shares to 15,000,000
shares. The then issued 100,000 shares of $1 par value common stock (comprised
of 80,000 outstanding shares and 20,000 shares of Treasury stock) were
subsequently exchanged (at a ratio of 73.75 to 1) for 7,375,000 shares of $.001
par value common stock, comprised of 5,900,000 outstanding shares and 1,475,000
shares of Treasury stock. All share and per share data in the accompanying
financial statements have been retroactively restated to give effect to the
recapitalization.
In July 1997, an investor subscribed for the purchase of 100,000 shares of
Telephonetics' recapitalized $.001 par value common stock for aggregate
consideration of $495,000. The shares were issued during 1998 following
consummation of the recapitalization.
During the year ended December 31, 1997, Telephonetics temporarily acquired
all of the outstanding shares of common stock of Quicklab Multimedia Centers,
Inc. in exchange for 2,950,000 shares of common stock. To facilitate the
transaction, for which the Company did not then have sufficient authorized and
unissued shares of common stock, the Company's then sole stockholder contributed
2,950,000 shares owned by him to the Company which were issued to the seller.
The acquisition was subsequently rescinded and the 2,950,000 shares of common
stock were returned to the stockholder. In connection with the rescinded
transaction, the Company loaned Quick Lab Multimedia Centers, Inc. $110,000
under the terms of an unsecured note receivable bearing interest at prime plus
1% (8.75% at
F-74
<PAGE> 158
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998). During the year ended December 31, 1998, the Company
recorded a $110,000 provision for possible losses on the note.
10. SUBSEQUENT EVENT
In January 1999, the Companies entered into a letter of intent with Sage
Networks, Inc. (Sage) for the sale of substantially all their assets and
assumption of substantially all of their liabilities in exchange for $3,000,000
in cash and 140,000 shares of Sage common stock.
11. YEAR 2000 ISSUES (UNAUDITED)
Like other companies, the Companies could be adversely affected if the
computer systems we, our suppliers or customers use do not properly process and
calculate date-related information and data from the period surrounding and
including January 1, 2000. This is commonly known as the "Year 2000" issue.
Additionally, this issue could impact non-computer systems and devices such as
production equipment, elevators, etc.
The Companies are implementing a plan to modify their business technologies
to be ready for the year 2000 and are in the process of converting critical data
processing systems. The project is expected to be substantially complete by
June, 1999 and to cost between $125,000 and $150,000. The Companies do not
expect this effort to have a significant effect on operations.
F-75
<PAGE> 159
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Net Daemons Associates, Inc.:
We have audited the accompanying balance sheets of Net Daemons Associates,
Inc. (the "Company") as of December 31, 1997 and 1998, and the related
statements of income, stockholders' deficit and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 1997 and 1998,
and the results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
Boston, Massachusetts
Deloitte & Touche LLP
February 2, 1999 (February 17, 1999 as to Note 10)
F-76
<PAGE> 160
NET DAEMONS ASSOCIATES, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and equivalents...................................... $ 47,659 $ 274,100
Accounts receivable, net of allowance of $19,400 for 1997
and $36,500 for 1998................................... 804,290 882,664
Notes receivable.......................................... 9,988 4,979
Stockholders' receivable.................................. 35,759 5,936
Prepaid expenses and other................................ 11,071 20,901
Deferred income taxes..................................... 19,700 53,000
---------- ----------
Total current assets.............................. 928,467 1,241,580
Property and Equipment, Net................................. 310,200 222,749
Deposits.................................................... 39,419 38,650
---------- ----------
Total............................................. $1,278,086 $1,502,979
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Note payable -- bank...................................... $ 150,000 $ --
Accounts payable.......................................... 129,297 263,317
Accrued salaries, wages and related benefits.............. 76,137 189,291
Accrued profit sharing.................................... 26,000 30,000
Accrued expenses.......................................... 15,590 83,612
Current portion of long-term debt......................... 20,375 38,411
Current portion of subordinated stockholder debt.......... 135,960 --
Deferred revenue.......................................... 62,910 52,127
Accrued income taxes...................................... 84,552 102,955
---------- ----------
Total current liabilities......................... 700,821 759,713
---------- ----------
Long-Term Liabilities:
Long-term debt............................................ 91,855 107,998
Subordinated stockholder debt............................. 804,040 885,214
---------- ----------
Total long-term liabilities....................... 895,895 993,212
---------- ----------
Deferred Income Taxes....................................... 12,800 21,500
---------- ----------
Total liabilities................................. 1,609,516 1,774,425
---------- ----------
Commitments (Note 8)
Stockholders' Deficit:
Preferred stock, $.01 per share par value, 21,389 shares
authorized............................................. -- --
Common stock, $.01 per share par value, 2,500,000 shares
authorized for 1997 and 2,578,611 shares authorized for
1998; 2,062,500 shares issued (Note 6)................. 20,625 20,625
Additional paid-in capital................................ 149,267 149,267
Retained earnings......................................... 438,678 498,662
Treasury stock, at cost -- 855,000 shares................. (940,000) (940,000)
---------- ----------
Total stockholders' deficit....................... (331,430) (271,446)
---------- ----------
Total............................................. $1,278,086 $1,502,979
========== ==========
</TABLE>
See notes to financial statements.
F-77
<PAGE> 161
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Revenues.................................................... $4,656,975 $5,770,024
Costs of revenues........................................... 2,457,264 3,211,532
---------- ----------
Gross profit................................................ 2,199,711 2,558,492
General and administrative expenses......................... 2,021,064 2,293,060
---------- ----------
Income from operations...................................... 178,647 265,432
Other income (expense):
Interest income........................................... 408 4,350
Loss on sale of equipment................................. (503) (3,163)
Interest expense.......................................... (31,708) (105,835)
---------- ----------
Earnings before provision for income taxes.................. 146,844 160,784
Provision for income taxes.................................. 69,510 100,800
---------- ----------
Net income.................................................. $ 77,334 $ 59,984
========== ==========
</TABLE>
See notes to financial statements.
F-78
<PAGE> 162
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED TOTAL
------------------- ADDITIONAL OTHER TREASURY STOCK STOCKHOLDERS'
PAR PAID-IN RETAINED COMPREHENSIVE -------------------- EQUITY
SHARES VALUE CAPITAL EARNINGS INCOME SHARES COST (DEFICIT)
--------- ------- ---------- -------- ------------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997..... 2,000,000 $20,000 $ 24,892 $361,344 $ -- -- $ -- $ 406,236
--------- ------- -------- -------- -------- -------- --------- ---------
Comprehensive income -- net
income................... -- -- -- 77,334 -- -- -- 77,334
Issuance of common
shares................... 62,500 625 124,375 -- -- -- -- 125,000
Purchase of common stock... -- -- -- -- -- (855,000) (940,000) (940,000)
--------- ------- -------- -------- -------- -------- --------- ---------
Balance, December 31, 1997... 2,062,500 20,625 149,267 438,678 -- (855,000) (940,000) (331,430)
Comprehensive income -- net
income................... -- -- -- 59,984 -- -- -- 59,984
--------- ------- -------- -------- -------- -------- --------- ---------
Balance, December 31, 1998... 2,062,500 $20,625 $149,267 $498,662 $ -- (855,000) $(940,000) $(271,446)
========= ======= ======== ======== ======== ======== ========= =========
</TABLE>
See notes to financial statements.
F-79
<PAGE> 163
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 77,334 $ 59,984
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 104,245 135,129
Loss on sale of equipment.............................. 503 3,163
Accrued interest on subordinated stockholder debt...... -- 81,174
Deferred income taxes.................................. (10,390) (24,600)
Changes in assets and liabilities:
Accounts receivable.................................. (63,693) (78,374)
Prepaid expenses and other........................... 2,144 (9,830)
Accounts payable..................................... 61,626 134,020
Accrued salaries, wages and related benefits......... (33,863) 113,154
Accrued profit sharing............................... (39,000) 4,000
Accrued expenses..................................... (71,382) 68,022
Deferred revenue..................................... (30,270) (10,783)
Accrued income taxes................................. (18,528) 18,403
--------- ---------
Net cash provided by (used in) operating
activities...................................... (21,274) 493,462
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment.................................... (228,985) (51,792)
Proceeds from sale of equipment........................... 6,200 951
Deposits.................................................. (39,419) 769
--------- ---------
Net cash used in investing activities............. (262,204) (50,072)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings undernote payable -- bank..... 195,108 (150,000)
Notes and stockholder receivable.......................... (13,025) 34,832
Proceeds from long-term borrowings........................ -- 54,892
Repayments of subordinated stockholder and long-term
debt................................................... (4,138) (156,673)
Proceeds from issuance of common stock.................... 100,000 --
--------- ---------
Net cash (used in) provided by financing
activities...................................... 277,945 (216,949)
--------- ---------
Increase (decrease) in cash and equivalents................. (5,533) 226,441
Cash and equivalents, beginning of year..................... 53,192 47,659
--------- ---------
Cash and equivalents, end of year........................... $ 47,659 $ 274,100
========= =========
Supplemental disclosures:
Fiscal year 1997 noncash financing activities:
Issuance of 12,500 common shares for a $25,000 note
receivable from stockholder Repurchase of 855,000
common shares from stockholder for $940,000 note
payable
Cash paid during the year for:
Interest............................................... $ 31,708 $ 22,303
========= =========
Taxes.................................................. $ 98,428 $ 108,997
========= =========
</TABLE>
See notes to financial statements.
F-80
<PAGE> 164
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1998
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Net Daemons Associates, Inc. ("NDA" or the "Company") specializes in
providing business with team-based network and system administration solutions.
NDA network and system services include outsourced network/system
administration; LAN/WAN design and implementation; network growth and transition
planning; Internet connectivity; security consulting; and customized network
solutions. In addition, NDA provides Web site development and network consulting
services.
NEW ACCOUNTING PRONOUNCEMENTS -- During the year, the Company adopted
Financial Accounting Standards Board ("FASB") Statement No. 130, "Reporting
Comprehensive Income." Statement No. 130 requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income is a more
inclusive financial reporting methodology that includes disclosure of certain
financial information that historically has not been recognized in the
calculation of net income. Comprehensive income encompasses all changes in
stockholders' equity (except those arising from transactions with stockholders).
The Company had no other components of comprehensive income. As this new
standard only requires additional information in the financial statements, it
does not affect the Company's financial position or results of operations.
USE OF ESTIMATES -- The preparation of financial statements in accordance
with generally accepted accounting principles requires the use of estimates.
These estimates include the allowance for doubtful accounts and certain accruals
and are based upon assumptions developed by management about the appropriate
carrying value of assets and liabilities. Actual results could differ from these
estimates.
REVENUE RECOGNITION -- Revenue from consulting services is recognized as
the services are rendered, provided that no significant obligations remain and
collection of the receivable is considered probable. Generally, contracts call
for billings on a time and materials basis; however, in instances when a fixed
fee contract is signed, revenue is recognized on a percentage-of-completion
basis. At December 31, 1997 and 1998, NDA had $62,910 and $52,127 of deferred
revenue recorded, respectively.
CONCENTRATION OF CREDIT RISK -- The majority of NDA's revenue is from
customers in high technology industries, who are not required to provide
collateral. NDA's customers are dispersed over a wide geographic area and are
subject to periodic review under the Company's credit policies. The Company does
not believe that it is subject to any unusual credit risks, other than the
normal level of risk attendant to operating its business.
PROPERTY AND EQUIPMENT -- Property and equipment are recorded at cost and
depreciated using the straight-line method over their estimated useful lives
(three to seven years). Leasehold improvements are amortized over the life of
the lease.
INCOME TAXES -- Deferred income taxes are provided for the tax consequences
of differences in bases between assets and liabilities for book and tax
purposes. Deferred taxes are measured using currently enacted tax rates which
are expected to be in effect when such differences reverse.
STOCK-BASED COMPENSATION -- Compensation cost associated with awards of
stock or options to employees is measured using the intrinsic-value method
prescribed by Accounting Principles Board Opinion No. 25 (see Note 6).
RECLASSIFICATIONS -- Certain amounts in the financial statements have been
reclassified to conform with the 1998 presentation.
F-81
<PAGE> 165
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. STOCKHOLDERS' RECEIVABLE
At December 31, 1998, stockholders' receivable consisted of $5,936 in notes
from NDA officers. The December 31, 1997 stockholders' receivable balance
consisted of a $25,000 note relating to the purchase of 12,500 shares of NDA's
common stock (paid on February 19, 1998) and $10,759 in notes from NDA officers.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Computer equipment and software...................... $ 329,241 $ 372,753
Furniture and fixtures............................... 50,632 54,194
Leasehold improvements............................... 13,939 13,939
Office equipment..................................... 28,405 33,124
Automobiles.......................................... 62,580 56,841
--------- ---------
Total...................................... 484,797 530,851
Less accumulated depreciation........................ (174,597) (308,102)
--------- ---------
Property and equipment, net.......................... $ 310,200 $ 222,749
========= =========
</TABLE>
4. NOTE PAYABLE -- BANK
Note payable -- bank represents the outstanding balance under a $400,000
working capital line of credit and a $100,000 line with a term conversion
feature ("the conversion line"). Interest on the lines are payable monthly based
on prime (7.75% at December 31, 1998). The lines are secured by and cross-
collateralized by substantially all assets of NDA, are personally guaranteed by
NDA's stockholders, and require the maintenance of customary financial covenants
including minimum retained earnings of $475,000. The lines are subject to
renewal annually and expires on July 1, 1999. The conversion line is to be
utilized to finance 80% of the purchase price of new equipment and converts to a
term loan in July 1999. After conversion, the loan will be payable in 48 equal
monthly installments of principal plus interest at the bank's then prime rate.
Amounts available under the lines were $500,000 at December 31, 1998.
5. LONG-TERM DEBT
EQUIPMENT LOAN -- The equipment loan requires monthly principal and
interest payments with principal payments based on a four-year straight-line
amortization schedule. Interest is based on prime (7.75% at December 31, 1998).
The equipment loan is secured by substantially all assets of NDA and is
personally guaranteed by NDA's stockholders.
TERM LOAN -- In connection with the acquisition of an automobile in June
1996, NDA entered into a term loan (the "term loan") with a bank for $23,504.
The term loan requires monthly payments of principal and interest (at 8.75%)
through May 2001.
STOCKHOLDER DEBT -- In connection with the repurchase of 855,000 shares of
common stock in December 1997, the Company entered into a $940,000 note payable
agreement (the "note payable"). This agreement calls for principal payments in
the amount of $125,333 to be made annually in 1999 through 2003 with a balloon
payment in 2004. However, NDA is only obligated to make payments, subject to
certain limitations, based on net profit as of the end of the fiscal year
preceding the relevant payment date. The note payable has an attached interest
rate of prime plus 1% (8.75% at December 31, 1998). The principal balance is
increased annually for the accrual of interest. The note payable is secured on a
pro
F-82
<PAGE> 166
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
rata basis by a security interest in the noted stock. Principal payments due
under the equipment loan, term loan and stockholder debt are as follows:
<TABLE>
<CAPTION>
EQUIPMENT STOCKHOLDER
YEAR ENDING DECEMBER 31, LOAN TERM LOAN DEBT TOTAL
- ------------------------ --------- --------- ----------- ----------
<S> <C> <C> <C> <C>
1999......................... $ 33,453 $ 4,958 $ -- $ 38,411
2000......................... 33,453 5,376 125,333 164,162
2001......................... 33,453 2,264 125,333 161,050
2002......................... 33,452 -- 125,333 158,785
2003......................... -- -- 125,333 125,333
Thereafter................... -- -- 383,882 383,882
-------- ------- -------- ----------
Total.............. $133,811 $12,598 $885,214 $1,031,623
======== ======= ======== ==========
</TABLE>
6. STOCKHOLDERS' DEFICIT
COMMON STOCK -- During fiscal year 1997, NDA issued 62,500 common shares at
a price of $2.00 per share. Of the $125,000 in proceeds due from the sale of
these shares, $100,000 had been collected, leaving an outstanding balance of
$25,000 at December 31, 1997. On February 19, 1998, the outstanding balance was
collected.
TREASURY STOCK -- In December 1997, NDA purchased 855,000 shares of common
stock. NDA's purchases of shares of common stock are recorded as "Treasury
Stock" and result in a reduction of "Stockholders' Deficit."
STOCK OPTION PLAN -- NDA's Incentive Stock Option Plan (the "Plan"),
established in December 1996, provides for grants of options to purchase up to
200,000 shares of common stock. Grants may be in the form of incentive stock
options or nonqualified options. Exercise prices and vesting periods are
determined by the Board on the date of grant. Options generally vest ratably
over a four-year period. A summary of activity in the Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- ---------
<S> <C> <C>
Outstanding at January 1, 1997.............................. 77,900 $0.20
Granted..................................................... 106,100 2.00
Cancelled................................................... (41,000) 0.20
-------
Outstanding at December 31, 1997............................ 143,000 $1.54
Granted..................................................... 116,560 3.08
Cancelled................................................... (60,300) 1.96
-------
Outstanding at December 31, 1998............................ 199,260 $2.31
=======
</TABLE>
F-83
<PAGE> 167
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth information regarding options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED-
NUMBER NUMBER AVERAGE
OF EXERCISE CURRENTLY REMAINING
OPTIONS PRICE EXERCISABLE LIFE
- ------- -------- ----------- ---------
<C> <C> <C> <S>
32,900 $0.20 23,800 8.0 years
66,160 2.00 33,784 8.6
100,200 3.20 35,600 9.5
- ------- ------
199,260 93,184
======= ======
</TABLE>
PRO FORMA DISCLOSURE -- As described in Note 1, NDA uses the
intrinsic-value method to measure compensation for equity awards to employees.
Had NDA used the fair-value method to measure compensation, reported net income
would have been $64,577 in 1997 and $9,097 in 1998.
The minimum-value method was used to measure the fair value of equity
awards in this disclosure. Key assumptions used to apply this pricing model were
average risk-free rates of 6% and expected option lives of ten years. The
estimated fair value of awards made in 1997 and 1998 were $94,710 and $190,332,
respectively.
RESERVED SHARES -- At December 31, 1997 and 1998, 200,000 shares of common
stock were reserved for issuance upon exercise of options.
7. INCOME TAXES
The provision for income taxes consisted of the following for the years
ended December 31:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Current:
Federal.............................................. $ 58,900 $112,000
State................................................ 21,000 26,500
-------- --------
Total........................................ 79,900 138,500
-------- --------
Deferred:
Federal.............................................. (9,039) (28,800)
State................................................ (1,351) (8,900)
-------- --------
Total........................................ (10,390) (37,700)
-------- --------
Provision for income taxes............................. $ 69,510 $100,800
======== ========
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
at December 31 were as follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets -- current:
Accrued vacation and benefits........................ $ 12,000 $ 38,000
Allowance for doubtful accounts...................... 7,700 15,000
-------- --------
Net deferred tax asset -- current...................... $ 19,700 $ 53,000
======== ========
Deferred tax liability -- noncurrent:
Depreciation......................................... $(12,800) $(21,500)
======== ========
</TABLE>
F-84
<PAGE> 168
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation between the statutory and effective tax rates for the
years ended December 31 were as follows:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Statutory tax rate.......................................... 34.0% 34.0%
State income taxes -- net of federal benefit................ 6.2 6.2
Nondeductible expenses...................................... 7.1 6.4
Change in prior year's tax estimate......................... -- 16.1
---- ----
47.3% 62.7%
==== ====
</TABLE>
8. COMMITMENTS
OPERATING LEASES -- The Company leases its office facilities and certain
equipment under noncancelable operating leases. Total rent expense was $169,609
and $200,098 for the years ended December 31, 1997 and 1998, respectively.
Future minimum payments under noncancelable operating leases for the years
ending December 31 are as follows:
<TABLE>
<S> <C>
1999.............................................. $222,523
2000.............................................. 44,918
2001.............................................. 13,375
</TABLE>
9. PROFIT-SHARING PLAN
NDA has a profit-sharing plan (the "plan") pursuant to Section 401(k) of
the Internal Revenue Code (the "Code"). The plan allows participants to make
pretax contributions not in excess of the maximum allowed under the Code. The
plan does not provide matching contributions by the employer. The profit-sharing
portion of the plan consists of contributions made by NDA at the discretion of
the Board. Profit-sharing expense was approximately $26,000 in 1997 and $30,000
in 1998.
10. SUBSEQUENT EVENT
On February 12, 1999 Sage Networks, Inc. ("Sage") agreed to purchase all
the outstanding stock of the Company. The purchase price consists of cash of
$500,000 and 425,000 shares of Sage common stock. In addition Sage has agreed to
pay certain officers of the Company $2,417,000 for non-compete agreements and to
pay approximately $441,000 for outstanding stock options of the Company. The
Agreement also provides for contingent consideration of $500,000 in cash and
74,963 shares of Sage common stock if certain gross revenue and gross margin
targets are met in the twelve months period following the acquisition. The
transaction closed on February 17, 1999. As a result of the acquisition, on
February 12, 1999, the Company paid all of its outstanding bank debt. In
connection with the repayment, all bank credit facilities and borrowing
availability was cancelled.
The Company had service revenue from Sage of approximately $94,000 in 1998.
* * * * * *
F-85
<PAGE> 169
REPORT OF INDEPENDENT AUDITORS
To Shareholder
Interliant, Inc. (referred to in this prospectus as Interliant Texas)
We have audited the accompanying balance sheets of Interliant, Inc.
(referred to in this prospectus as Interliant Texas) (the "Company") as of
December 31, 1997 and 1998, and the related statements of operations,
shareholder's deficit and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interliant, Inc. (referred
to in this prospectus as Interliant Texas) at December 31, 1997 and 1998, and
the results of its operations and its cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Houston, Texas
February 26, 1999,
except for Note 11, as to which the date is
March 10, 1999
F-86
<PAGE> 170
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 917,566 $ 972,467
Accounts receivable, net of allowance of $103,940 in 1997
and $150,276 in 1998................................... 1,860,152 1,775,939
Unbilled revenue.......................................... 1,758,012 1,748,234
Prepaid expenses and other................................ 168,428 391,359
----------- -----------
Total current assets........................................ 4,704,158 4,887,999
Property and equipment, net................................. 5,693,201 5,661,351
Investment in and advances to joint venture................. 72,145 149,067
----------- -----------
Total assets................................................ $10,469,504 $10,698,417
=========== ===========
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable and accrued expenses..................... $ 1,597,521 $ 1,909,514
Notes payable to shareholder and related party............ 10,825,000 15,125,000
Current portion of capital lease obligations.............. 30,083 27,919
----------- -----------
Total current liabilities................................... 12,452,604 17,062,433
Capital lease obligations................................... 136,238 110,009
Commitments and contingencies
Shareholder's deficit:
Common stock, $.01 par value; 40,000,000 shares
authorized; 10,000,000 shares issued and outstanding... 100,000 100,000
Additional paid-in capital................................ 400,000 400,000
Accumulated deficit....................................... (2,619,338) (6,974,025)
----------- -----------
Total shareholder's deficit................................. (2,119,338) (6,474,025)
----------- -----------
Total liabilities and shareholder's deficit................. $10,469,504 $10,698,417
=========== ===========
</TABLE>
See accompanying notes.
F-87
<PAGE> 171
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------
1996 1997 1998
---------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Network service fees............................... $8,401,463 $15,316,756 $18,886,503
Consulting......................................... -- 1,423,071 2,020,598
Other.............................................. 4,504 136,037 265,768
---------- ----------- -----------
8,405,967 16,875,864 21,172,869
Costs and expenses:
Cost of service revenue............................ 5,056,552 9,414,476 11,880,983
General and administrative......................... 1,523,209 2,866,509 4,137,668
Sales and marketing................................ 1,697,214 4,408,597 6,722,997
Depreciation and amortization...................... 783,208 1,642,140 2,525,530
---------- ----------- -----------
9,060,183 18,331,722 25,267,178
---------- ----------- -----------
Operating loss....................................... (654,216) (1,455,858) (4,094,309)
Other income (expense):
Equity in losses of joint venture.................. (15,767) (214,735) (144,735)
Interest expense................................... (218,394) (469,817) (715,643)
Gain on settlement of litigation................... -- 1,351,630 600,000
---------- ----------- -----------
(234,161) 667,078 (260,378)
---------- ----------- -----------
Net loss............................................. $ (888,377) $ (788,780) $(4,354,687)
========== =========== ===========
</TABLE>
See accompanying notes.
F-88
<PAGE> 172
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF SHAREHOLDER'S DEFICIT
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1995........................ 2,500,000 $ 25,000 $475,000 $ (942,181) $ (442,181)
Stock split effected as a
stock dividend........... 7,500,000 75,000 (75,000) -- --
Net loss.................... -- -- -- (888,377) (888,377)
---------- -------- -------- ----------- -----------
Balance at December 31,
1996........................ 10,000,000 100,000 400,000 (1,830,558) (1,330,558)
Net loss.................... -- -- -- (788,780) (788,780)
---------- -------- -------- ----------- -----------
Balance at December 31,
1997........................ 10,000,000 100,000 400,000 (2,619,338) (2,119,338)
Net loss.................... -- -- -- (4,354,687) (4,354,687)
---------- -------- -------- ----------- -----------
Balance at December 31,
1998........................ 10,000,000 $100,000 $400,000 $(6,974,025) $(6,474,025)
========== ======== ======== =========== ===========
</TABLE>
See accompanying notes.
F-89
<PAGE> 173
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................................ $ (888,377) $ (788,780) $(4,354,687)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation...................................... 734,331 1,403,842 1,952,629
Amortization...................................... 48,877 525,391 572,901
Loss on disposals of property and equipment....... 115,037 14,856 3,783
Provision for doubtful accounts................... 50,178 97,433 150,966
Equity in losses of joint ventures................ 15,767 214,735 144,735
Changes in operating assets and liabilities:
Accounts receivable and unbilled revenue....... (1,338,004) (1,660,351) (56,975)
Prepaid expenses and other..................... (207,233) 91,727 (222,931)
Accounts payable and accrued liabilities....... 1,378,521 (136,301) 311,993
----------- ----------- -----------
Net cash used in operating activities............... (90,903) (237,448) (1,497,586)
INVESTING ACTIVITIES
Proceeds from sale of property and equipment........ 16,889 8,281 4,000
Expenditures for property and equipment............. (4,082,093) (2,834,563) (2,501,463)
Investments in and advances to joint venture........ (55,561) (247,086) (221,657)
----------- ----------- -----------
Net cash used in investing activities............... (4,120,765) (3,073,368) (2,719,120)
FINANCING ACTIVITIES
Net proceeds from notes payable from shareholder and
related party..................................... 4,423,623 3,901,698 4,271,607
----------- ----------- -----------
Net cash provided by financing activities........... 4,423,623 3,901,698 4,271,607
----------- ----------- -----------
Increase in cash.................................... 211,955 590,882 54,901
Cash at beginning of year........................... 114,729 326,684 917,566
----------- ----------- -----------
Cash at end of year................................. $ 326,684 $ 917,566 $ 972,467
=========== =========== ===========
</TABLE>
See accompanying notes.
F-90
<PAGE> 174
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Interliant, Inc. (the "Company") was organized under the laws of the State
of Texas on July 12, 1993, under the name Wolf Communications Company. The
Company's name was changed to Interliant, Inc., effective January 20, 1997.
Interliant, Inc., is a privately owned company that provides secure
network-based hosting and messaging services on a Lotus Notes platform, enabling
worldwide continuously available remote access to business-critical applications
and data. The Company also provides vertical solutions for various markets
including distance learning, sales force automation, legal, and mortgage
banking. It is also developing hosting solutions for Microsoft Exchange and
Microsoft's Commercial Internet System, as well as a remote server management
solution.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, except notes
payable to shareholder and related party and the capital lease obligation,
approximate fair value. The fair value of notes payable to shareholder and
related party and the capital lease obligation are not determinable as the
Company's borrowings are from the shareholder and a related party and the
capital lease obligation is guaranteed by the shareholder.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company grants stock options to employees for shares with an exercise
price no less than the value of the shares at the date of grant. The company
accounts for such stock option grants in accordance with Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25").
REVENUE RECOGNITION
Revenues consist primarily of network service and related fees for
services, generally provided under contractual periods ranging from one to
twelve months. Revenues from these services are generally recognized when the
services are performed. Revenues in excess of amounts billed are accrued and
presented as unbilled revenue in the accompanying balance sheets.
ADVERTISING EXPENSES
All advertising costs are expensed as incurred. Advertising expenses were
approximately $122,000, $415,000, and $571,000 for the years ended December 31,
1996, 1997, and 1998, respectively.
COST OF SERVICE REVENUE
Cost of service revenue includes internally-funded research and development
costs, which are expensed as incurred. Research and development costs were
approximately $600,000, $1,100,000, and $1,500,000 in 1996, 1997, and 1998,
respectively.
F-91
<PAGE> 175
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets as
follows:
<TABLE>
<S> <C>
Computer equipment and software............................. 3 years
Furniture, fixtures and office equipment.................... 5 to 7 years
</TABLE>
Amortization of leasehold improvements is provided using the straight-line
method over the shorter of the remaining estimated useful lives or the lease
terms. Depreciation expense in 1997 of approximately $287,000 is presented on
the statements of operations as an offset to the gain on settlement of
litigation.
The costs of ordinary maintenance and repairs are charged to expense while
renewals and replacements are capitalized.
INCOME TAXES
The shareholder has elected S corporation status for the Company for
federal income tax purposes. Under S corporation regulations, revenues and
expenses of the Company are reportable for federal income tax purposes in the
income tax return of the shareholder. Accordingly, no provision for federal
income tax is included in the accompanying financial statements.
CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit
risk consist principally of accounts receivable. The Company provides credit, in
the normal course of business, to a number of geographically dispersed
customers, primarily within the United States. Collateral is generally not
required on these receivables. The Company maintains allowances for potential
credit losses, and customers can be denied access to services in the event of
non-payment. During 1997 and 1998, the Company's largest customer represented
approximately 10% of total revenues.
RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components. Certain items which were previously required to be reported
separately in shareholder's equity, such as unrealized gains or losses on
available-for-sale securities, minimum pension liability adjustments and foreign
currency translation adjustments, are now required to be included in other
comprehensive income. For 1996, 1997, and 1998 the Company's comprehensive
income was the same as net income, and the adoption of SFAS 130 had no impact on
the presentation of the financial statements.
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS 131"). SFAS 131 requires disclosure of
certain information regarding operating segments, products, services, geographic
areas of operation and major customers. The disclosures prescribed by SFAS 131
are effective for the year ended December 31, 1998. The Company has determined
that it does not have separately reportable segments, as defined by SFAS 131,
and thus no segment disclosures have been presented.
In March 1998, the AICPA issued Statement of Position 98-1, Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use (SOP
98-1), which is effective for the financial statements for fiscal years
beginning after December 15, 1998. SOP 98-1 will result in the capitalization of
F-92
<PAGE> 176
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
certain qualifying costs incurred in the development of software for internal
use; however, the adoption of SOP 98-1 is not expected to have a material impact
on the Company's earnings or financial position.
2. INVESTMENT IN AND ADVANCES TO JOINT VENTURE
The Company is a 50% partner in TITLELINK, L.L.C., a joint venture which
offers a network-based service to facilitate the closing of real estate
transactions within the financial community. The Company provides working
capital requirements as needed. The Company has provided an allowance against
its advances to the joint venture of approximately $30,000 and $114,000 at
December 31, 1997 and 1998, respectively, which is included in investment in and
advances to joint venture.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
---------- -----------
<S> <C> <C>
Computer equipment and software............................ $4,926,000 $ 7,298,000
Furniture, fixtures and office equipment................... 1,559,000 1,682,000
Leasehold improvements..................................... 2,659,000 2,665,000
---------- -----------
9,144,000 11,645,000
Less accumulated depreciation and amortization............. 3,451,000 5,984,000
---------- -----------
$5,693,000 $ 5,661,000
========== ===========
</TABLE>
4. NOTES PAYABLE TO SHAREHOLDER AND RELATED PARTY
Notes payable to shareholder and related party includes unsecured
borrowings from the Company's shareholder totaling $4,310,000 and $7,910,000 at
December 31, 1997 and 1998, respectively, and unsecured borrowings from a
related party totaling $6,515,000 and $7,215,000 at December 31, 1997 and 1998,
respectively. These advances have been used to fund the Company's operations.
These notes bear interest, payable monthly, at annual rates ranging from 5.5% to
6.1% in 1997, and 4.3% to 5.6% in 1998. The borrowings mature on March 31, 1999.
The Company paid interest associated with the notes payable to affiliates
of approximately $199,000, $449,000, and $696,000 in 1996, 1997, and 1998,
respectively.
5. RELATED PARTY TRANSACTIONS
The Company has an informal agreement with a related party whereby the
Company provides certain administrative services to the related party. The
related party compensates the Company for these services on a monthly basis,
which totaled $12,000, $48,000, and $48,000 in 1996, 1997, and 1998,
respectively. The amount due to the Company for these services totaled $12,000
at December 31, 1998, and there was no related amount due to the Company at
December 31, 1997.
6. EMPLOYEE BENEFIT PLAN
Substantially all of the Company's employees are participants in a
discretionary, defined contribution plan with salary deferral contributions as
provided under Section 401(k) of the Internal Revenue Code. Voluntary salary
deferral contributions are made by employees, subject to a maximum of 15% of
annual compensation and are matched 100% of the first 5% by Company
contributions. The charge to expense for
F-93
<PAGE> 177
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the Company's contributions was $109,000, $254,000, and $404,000 for the years
ended December 31, 1996, 1997, and 1998, respectively.
7. STOCK SPLIT
Effective December 16, 1996, the Board of Directors approved a four-for-one
split of the Company's common stock effected in the form of a stock dividend,
resulting in a total of 10,000,000 shares outstanding. All references in the
financial statements which relate to the number of shares of Common Stock have
been restated to reflect the stock split.
8. EMPLOYEE STOCK OPTION PLAN
In 1995, the Company's sole director (the "Director") adopted the 1995
Employee Stock Option Plan (the "Option Plan"), pursuant to which options to
purchase up to an aggregate of 4,000,000 shares of the Company's common stock
may be granted. The Option Plan is administered by the Director. Among other
things, the Director determines which employees will receive options, the number
of shares covered by any option granted, and the exercise price and other terms
and conditions of each such option.
All options granted under the Option Plan are nontransferable except by the
laws of descent and distribution. All options also expire ten years after the
date of grant or upon earlier termination of employment unless due to death,
disability, or retirement, in which case the option remains exercisable for an
additional three months in the case for Incentive Options and one year for
Non-Qualified Options. Options granted vest over periods ranging from immediate
vesting to vesting in equal increments over four years from the date of grant.
The exercise price of the options approximated the fair value of the common
stock on the date of grant, and accordingly, no compensation expense has been
recorded. The weighted-average remaining contractual life of options at December
31, 1996, 1997, and 1998 was 9.7 years, 8.8 years, and 8.0 years, respectively.
A summary of the Option Plan as of December 31, 1996, 1997, and 1998 and
changes during the years ended on those dates are as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICES
--------- ----------------
<S> <C> <C>
Options outstanding January 1, 1996...................... 340,000 $.05
Granted................................................ 2,242,000 $.05
Exercised.............................................. -- --
Surrendered............................................ -- --
--------- ----
Options outstanding December 31, 1996.................... 2,582,000 $.05
Granted................................................ 646,100 $.05
Exercised.............................................. -- --
Surrendered............................................ (214,000) $.05
--------- ----
Options outstanding December 31, 1997.................... 3,014,100 $.05
Granted................................................ 801,100 $.05
Exercised.............................................. -- --
Surrendered............................................ (173,200) $.05
--------- ----
Options outstanding December 31, 1998.................... 3,642,000 $.05
========= ====
</TABLE>
F-94
<PAGE> 178
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICES
--------- ----------------
<S> <C> <C>
Exercisable at:
December 31, 1996...................................... 2,468,000 $.05
========= ====
December 31, 1997...................................... 2,620,000 $.05
========= ====
December 31, 1998...................................... 2,847,000 $.05
========= ====
</TABLE>
At December 31, 1996, 1997, and 1998, the Company had reserved 4,000,000
shares of common stock for issuance in connection with the exercise of stock
options.
The Company has elected to follow APB 25 and related interpretations in
accounting for employee stock options. Accordingly, no compensation expense has
been recognized for these stock options. Pro forma information regarding net
income and earnings per share is required by FASB Statement No. 123, Accounting
for Stock-Based Compensation ("FAS 123"), which also requires that the
information be determined as if the Company had accounted for its employee stock
options under the fair value method of FAS 123. The fair value for these options
was estimated at the date of grant using a minimum value option pricing model
with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Risk-free interest rate................................. 6.5% 5.6% 4.8%
Dividend yield.......................................... 0.0% 0.0% 0.0%
Weighted-average expected life of options............... 5 years 5 years 5 years
</TABLE>
The minimum value method calculated the fair value of these options as
zero; therefore, pro forma net loss is the same as net loss for each year
presented.
9. COMMITMENTS AND CONTINGENCIES
The Company leases various office space and equipment under noncancelable
operating leases expiring on various dates through 2001, generally with options
to renew under terms consistent with the original leases. The gross balance of
assets recorded under capital leases which are included in property and
equipment at December 31, 1997 and 1998 was approximately $287,000 and $291,000,
respectively. Associated accumulated depreciation was approximately $95,000 and
$165,000 at December 31, 1997 and 1998, respectively. At December 31, 1998,
future lease payments are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
1999........................................................ $ 41,000 $ 983,000
2000........................................................ 41,000 898,000
2001........................................................ 41,000 524,000
2002........................................................ 35,000 --
2003........................................................ -- --
-------- ----------
Total minimum lease payments................................ 158,000 $2,405,000
==========
Less amount representing interest........................... 20,000
--------
Present value of capital lease obligations.................. 138,000
Less current portion of capital lease obligations........... 28,000
--------
Long-term capital lease obligations......................... $110,000
========
</TABLE>
F-95
<PAGE> 179
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Total rent expense for operating leases for the years ended December 31,
1996, 1997, and 1998 was $797,000, $1,700,000, and $1,449,000, respectively.
The Company has a facility with a bank for letters of credit totaling
$541,000 at December 31, 1998 relating to the Company's data center operating
lease. There were no amounts outstanding under the letter of credit facility at
December 31, 1998.
10. LITIGATION
In 1997 and 1998, the Company received proceeds of $2,500,000 and $600,000,
respectively, from the settlement of legal claims relating to a trademark
dispute. These amounts are presented in the statements of operations net of
costs related to the settlement of $1,148,000 in 1997.
The Company is involved in various lawsuits and legal proceedings which
have arisen in the normal course of business. While the ultimate results of
these matters cannot be predicted with certainty, management does not expect
them to have a material adverse effect on the financial position of the Company.
11. SUBSEQUENT EVENT
In February 1999, the shareholder reached an agreement in principle to sell
substantially all of the assets and certain liabilities of the Company. The
transaction closed on March 10, 1999. The Company has obtained approval of the
proposed transaction with the holders of outstanding borrowings. On March 10,
1999, the Company changed its name to Rancher 1 Corp.
12. YEAR 2000 ISSUE (UNAUDITED)
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including the
Company's, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
State of Readiness
The Company has made a preliminary assessment of the Year 2000 readiness of
its information technology ("IT") systems, including the hardware and software
that enable it to provide and deliver its solutions, and its non-IT systems. The
Company's plan consists of (i) quality assurance testing of its internally
developed proprietary software and systems; (ii) contacting third-party
suppliers, vendors and licensors of material hardware, software and services
that are both directly and indirectly related to the delivery of the Company's
solutions to it customers; (iii) assessment of repair or replacement
requirements; (iv) repair or replacement; (v) implementation; and (vi) creation
of contingency plans in the event of Year 2000 failures. The Company is
currently assessing the materiality of its IT and non-IT systems and will seek
assurances of Year 2000 compliance from providers of material systems. Until
such testing is complete and such vendors and providers are contacted, the
Company will not be able to completely evaluate whether its IT systems or non-IT
systems will need to be revised or replaced. The Company plans to complete its
Year 2000 evaluation during the second half of 1999.
F-96
<PAGE> 180
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Costs
To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
its expenses have related to, and are expected to continue to relate to, the
internal staffing costs associated with the evaluation process and Year 2000
compliance matters generally. At this time, the Company does not possess the
information necessary to estimate the potential costs of revisions to its
software and systems should such revisions be required or the replacement of
third party software, hardware or services that are determined not to be Year
2000 compliant. Although the Company does not anticipate that such expenses will
be material, such expenses if higher than anticipated, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Risks
The Company is not currently aware of any Year 2000 compliance problems
relating to its IT or non-IT systems that would have a material adverse effect
on the Company's business, results of operations and financial condition. There
is no assurance that the Company will not discover Year 2000 compliance problems
in its software and systems that will require substantial revisions. In
addition, there is no assurance that third party software, hardware or services
incorporated into the Company's material IT and non-IT systems will not need to
be revised or replaced, all of which could be time consuming and expensive. The
failure of the Company to fix or replace its software, hardware or services on a
timely basis could result in lost revenues, increased operating costs and the
loss of customers and other business interruptions, any of which could have a
material adverse effect on the Company's business, results of operations and
financial condition. Moreover, the failure to adequately address Year 2000
compliance issues in its IT and non-IT systems could result in claims of
mismanagement, misrepresentation or breach of contract and related litigation,
which could be costly and time-consuming to defend. In addition, there can be no
assurance that governmental agencies, utility companies, telecommunication
companies, other Internet service providers, third party service providers,
hardware and software manufacturers and others outside Interliant control will
be Year 2000 compliant. The failure by such entities to be Year 2000 compliant
could result in a systemic failure beyond the control of the Company such as a
prolonged Internet, telecommunications or electrical failure, which could also
prevent the Company from delivering its services to its customers, decrease the
use of the Internet or prevent users from accessing the Web sites of its
customers. Any of these occurrences could have a material adverse effect on the
Company's business, financial condition and results of operations.
Contingency Plan
As discussed above, the Company is engaged in an ongoing Year 2000
assessment and has not yet developed any contingency plans. The responses
received from third-party vendors and service providers will be taken into
account in determining the nature and extent of any contingency plans.
F-97
<PAGE> 181
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THROUGH AND INCLUDING AUGUST 1, 1999, ALL DEALERS EFFECTING TRANSACTIONS IN
THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
7,000,000 SHARES
[INTERLIANT LOGO]
COMMON STOCK
-----------------------
PROSPECTUS
-----------------------
MERRILL LYNCH & CO.
DONALDSON, LUFKIN & JENRETTE
CIBC WORLD MARKETS
JULY 7, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 182
PROSPECTUS
7,000,000 SHARES
[INTERLIANT LOGO]
COMMON STOCK
------------------------
This is Interliant's initial public offering of common stock. The
international managers will offer 875,000 shares outside the United States and
Canada and the U.S. underwriters will offer 6,125,000 shares in the United
States and Canada.
Prior to the offering, there has been no public market for the common
stock. The common stock will trade on the Nasdaq National Market under the
symbol "INIT."
INVESTING IN THE COMMON STOCK INVOLVES MATERIAL RISKS WHICH ARE DESCRIBED
IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 6 OF THIS PROSPECTUS.
------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----------
<S> <C> <C>
Public Offering Price...................................... $10.00 $70,000,000
Underwriting Discount...................................... $.70 $4,900,000
Proceeds, before expenses, to Interliant, Inc.............. $9.30 $65,100,000
</TABLE>
The international managers may also purchase up to an additional 130,000
shares from Interliant at the public offering price, less the underwriting
discount, within 30 days from the date of this prospectus to cover
over-allotments. The U.S. underwriters may similarly purchase up to an
additional 920,000 shares from Interliant.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about July 13, 1999.
------------------------
MERRILL LYNCH INTERNATIONAL
DONALDSON, LUFKIN & JENRETTE
CIBC WORLD MARKETS
------------------------
The date of this prospectus is July 7, 1999.
<PAGE> 183
[GRAPHICS]
Interliant(R) is a registered trademark of Interliant, Inc.
<PAGE> 184
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................................... 1
Risk Factors................................................ 6
Use of Proceeds............................................. 18
Dividend Policy............................................. 18
Capitalization.............................................. 19
Dilution.................................................... 20
Selected Consolidated Financial Data........................ 21
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 23
Business.................................................... 32
Management.................................................. 55
Related Party Transactions.................................. 65
Principal Stockholders...................................... 67
Description of Capital Stock................................ 69
Shares Eligible for Future Sale............................. 74
Underwriting................................................ 76
Legal Matters............................................... 80
Experts..................................................... 80
Available Information....................................... 81
Index to Consolidated Financial Statements.................. F-1
</TABLE>
------------------------
You should rely only on the information contained in this prospectus. We
have not, and the underwriters have not, authorized any other person to provide
you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriters are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted.
All references to "we," "us," "our" or "Interliant" in this prospectus
means Interliant, Inc.
i
<PAGE> 185
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It is not complete and may not contain all the information that you should
consider before investing in the common stock. You should read the entire
prospectus carefully, including the "Risk Factors" section and the financial
statements and the notes to these statements. Except as otherwise indicated, the
information in this prospectus (1) assumes that the underwriters' over-allotment
option has not been exercised, (2) assumes conversion of all outstanding shares
of redeemable convertible preferred stock and (3) gives retroactive effect to a
three-for-one stock split on July 28, 1998.
OUR COMPANY
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Our hosting
services store our customers' Web sites, software applications, and data on
servers typically housed in our data centers so that others on the Internet can
access and interact with our customers' Web sites and network-based
applications. Our Web hosting services provide a variety of hosting solutions to
meet the needs of businesses of all sizes, as their Web sites develop from
low-end marketing brochures to more complex, interactive Web sites and finally
to applications integral to their businesses, or mission-critical. Our
application hosting services provide our customers remote access to
mission-critical software applications and data 24 hours a day, 7 days a week,
365 days a year or 24x7.
Since our inception in December 1997, we have grown rapidly through the
acquisition of 17 hosting and related Internet service businesses. We provide
Web hosting solutions to more than 47,000 customers, representing more than
79,000 registered Web sites that are actively maintained and used. We also host
more than 10,000 customized Lotus Notes/Domino based applications for more than
1,300 customers. Our pro forma net loss, giving effect to acquisitions completed
to date, was approximately $39.0 million for the year ended December 31, 1998
and our pro forma revenues for that same period were $41.3 million. For the year
ended December 31, 1998 and on a pro forma basis giving effect to acquisitions
completed to date:
- 28.0% of our revenues were derived from our Web hosting product
offerings;
- 51.3% of our revenues were derived from our application hosting product
offerings;
- 14.0% of our revenues were derived from consulting services; and
- 6.7% of our revenues were derived from other services.
The number of businesses using the Internet is growing rapidly. Many of
these businesses outsource the hosting of their Web sites and software
applications, rather than incur the cost of in-house operations and maintenance.
Today, the hosting market is fragmented, consisting for the most part of:
- small local and regional providers who do not have the capital, resources
or capabilities to provide quality services at competitive prices;
- large national providers who focus on Internet connectivity rather than
on hosting; and
- consulting and Web design firms for which hosting is not their core
competency.
We believe that a significant market opportunity exists for a
nationally-recognized hosting solutions provider with the scale and expertise to
offer a wide range of value-priced services to businesses of all sizes. Through
the acquisition and consolidation of hosting and enhanced Internet service
businesses, we believe we can offer a full range of hosting services that enable
businesses to deploy, use, expand and update their Web sites and applications
infrastructures more rapidly and cost-effectively than internally developed
solutions.
Our service offerings comprise three main areas: Web hosting, application
hosting and consulting.
1
<PAGE> 186
Web Hosting. Our Web hosting services include the following product offerings:
Virtual Hosting. Our virtual hosting solution provides Web site hosting on
a server that is owned, managed and housed by us for multiple customers.
This is an economical solution for customers with simple or moderately
accessed sites.
Dedicated Hosting. Our dedicated hosting solution provides Web site
hosting on a server that is managed, housed and typically owned by us for a
single customer. Dedicated server Web hosting enables a customer to host
complex Web sites and applications without the need to incur significant
infrastructure and overhead costs. This solution provides greater server
and network resources for our customers than virtual hosting and allows
them to configure their hardware to optimize site performance. Companies
with increasing levels of complexity, traffic or reliance on their Web
sites may prefer dedicated hosting.
Co-located Hosting. Our co-located hosting solution provides Web hosting
services on servers that are owned by our customers but which are managed
and housed by us. In general, the co-located servers are housed separately
from our shared and dedicated servers in our data centers which we monitor
on a 24x7 basis and to which we allow customers limited access.
Application Hosting. Our application hosting solution, through which we manage
software applications for our customers, is designed to support our customers'
Internet, intranet and extranet projects through a variety of service and
support options, with our primary platform being Lotus Notes/Domino. In
addition, through our strategic alliances with software vendors such as Lotus
and Microsoft, we host applications such as legal automation, sales automation
and distributed learning. We recently began offering ready-made, network-based
software applications that run on a remote server hosted by us, or Internet
rental applications, which allow anyone with a Web browser and an Internet
connection to use sophisticated server-based applications. Our application
hosting services consist of the following solutions:
Groupware Hosting. Groupware software applications allow people to work
more closely together while located remotely from each other. We offer a
range of groupware hosting solutions for the Lotus Notes/Domino platform
which provides our customers with the infrastructure needed to support the
following:
- e-mail and other messaging methods for internal and external
communication;
- project team collaboration and document sharing;
- business process automation and workflow; and
- document libraries.
Application Outsourcing. We offer a range of application outsourcing
services which provide our customers with the ability to capitalize on the
latest Internet-enabled technologies while outsourcing information
technology operations such as deployment strategies and maintenance and
upgrades of software to a third party. Our application outsourcing
offerings include:
- Legal Automation. Our legal automation solutions package offers our
customers a suite of collaborative applications that assist corporate
legal departments and their outside counsel in managing cases,
budgets, intellectual property and workflow in a secure, reliable
environment.
- Sales Automation. Our sales automation solutions package provides
geographically distributed sales and marketing organizations with all
the elements needed to quickly deploy a sales automation solution at a
reasonable cost.
- Distributed Learning. Our distributed learning solutions offer our
customers opportunities to deliver online training solutions.
Consulting Services. We provide consulting services to our customers for
intranet, extranet and application hosting solutions, as well as for internal
networking implementations and back-end Web development projects. Consulting
services that we provide include:
- desktop and network server support;
- network architecture and design;
2
<PAGE> 187
- strategic technology planning; and
- application development and implementation.
We have two state-of-the-art primary data centers in Atlanta, Georgia and
Houston, Texas and a recently leased facility in Vienna, Virginia. We house
co-located servers in separate limited-access rooms in our Atlanta and Virginia
data centers. In addition, we provide application hosting to our customers
primarily through our Houston data center. Our Atlanta and Houston data centers
are monitored on a 24x7 basis and include:
- sophisticated monitoring and diagnosis;
- 24x7 customer support;
- multiple and high-speed network connections to the Internet; and
- uninterruptible power supply.
We seek to become the industry leader in hosting by providing businesses
with cost-effective, innovative solutions that will allow them to capitalize on
the potential of the Internet. To achieve this objective, our strategy includes
the following key elements:
- Build the Interliant Brand. We intend to continue to build the
Interliant brand and strengthen brand recognition by marketing our full
range of services through an integrated marketing communications program
including public relations, print and online advertising campaigns and
other strategic initiatives as well as cooperative promotions with key
hardware and software vendors.
- Continue Acquisition Program. By integrating acquired companies, we
believe we can achieve substantial economies of scale and operating
efficiencies which will allow us to service customers of all sizes.
Further, we intend to capitalize on business practices of acquired
companies that we believe will best maintain our competitive advantage
and ensure ongoing delivery of high quality hosting services to our
customers.
- Expand Multiple Sales Channels. We currently use a variety of sales
channels to reach our customers including our recently launched business
partner program. We expect to increase our inbound and outbound telesales
efforts, which are targeted primarily toward virtual and dedicated
hosting customers as well as direct sales, which is targeted primarily
toward co-located hosting customers.
- Leverage the Interliant Customer Base. We intend to capitalize on the
enhanced revenue potential of the combined customer bases of our acquired
companies by leveraging the numerous cross-selling opportunities that our
expanded line of branded service offerings provides. In this regard, we
seek to coordinate the selling efforts of our Web hosting, application
hosting and consulting sales force to increase customer leads and
referrals.
- Develop Strategic Relationships. We have established and continue to
seek strategic relationships that enable us to provide complete, scalable
and reliable hosting solutions to our customers, resellers and referral
partners.
On March 10, 1999, we completed the acquisition of substantially all the
assets of Interliant, Inc. In connection with that acquisition, we changed our
name from Sage Networks, Inc. to Interliant, Inc. For purposes of this document
the acquired business of Interliant, Inc. is referred to as Interliant Texas.
Interliant Texas had revenues in 1998 of $21.2 million.
Upon completion of this offering, Web Hosting Organization LLC and members
of management will control approximately 69.5% of our common stock.
Our principal executive offices are located at Two Manhattanville Road,
Purchase, New York 10577, (914) 640-9000.
3
<PAGE> 188
THE OFFERING
Common stock offered by us:
U.S. Offering........................ 6,125,000 shares
International Offering............... 875,000 shares
Total.............................. 7,000,000 shares
Common stock outstanding after this
offering............................. 42,215,268 shares
Use of proceeds...................... We currently intend to use the net
proceeds from the offering for:
- acquisitions;
- capital expenditures, including
completing and equipping our data
centers;
- repayment of promissory notes issued or
assumed in connection with recent
acquisitions; and
- working capital and general corporate
purposes.
See "Use of Proceeds."
Nasdaq National Market Symbol........ INIT
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------------------------------------------ ----------------------------
PERIOD FROM
DECEMBER 8,
1997
(INCEPTION) THREE MONTHS THREE MONTHS THREE MONTHS
TO YEAR ENDED ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1998 1999 1998 1999
------------ --------------------- ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues.................. $ -- $ 4,905 $ 13 $ 5,434 $ 41,292 $ 10,341
--------- --------- --------- ---------- --------- ----------
Operating loss............ (158) (10,870) (553) (7,770) (38,601) (13,045)
--------- --------- --------- ---------- --------- ----------
Net loss.................. $ (158) $ (10,732) $ (539) $ (7,758) $ (39,030) $ (13,182)
========= ========= ========= ========== ========= ==========
Net loss per share --basic
and diluted............. $ (0.05) $ (1.22) $ (0.18) $ (0.31)
Weighted average shares
used in computing net
loss per share -- basic
and
diluted................. 3,000,000 8,799,432 3,000,000 24,769,890
Pro forma net loss per
share -- basic and
diluted................. $ (2.47) $ (0.46)
Shares used in computing
pro forma net loss per
share -- basic and
diluted................. 15,829,762 28,626,240
</TABLE>
4
<PAGE> 189
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
-------------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
------------ ------------ -------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 4,376 $ 9,376 $ 65,652
Working capital........................................... (5,462) (462) 63,814
Total assets.............................................. 100,897 105,897 161,597
Debt and capital lease obligations, less current
portion................................................. 914 914 914
Redeemable convertible preferred stock.................... 13,000 13,000 --
Total stockholders' equity................................ 69,528 74,528 151,228
</TABLE>
The unaudited pro forma statement of operations data gives effect to the
acquisitions completed in 1998 and 1999 as if they occurred on January 1, 1998.
The unaudited pro forma balance sheet data gives effect to the exercise in
April 1999 of warrants to purchase 749,625 shares of common stock for gross
proceeds of $5.0 million. See "Description of Capital Stock -- The SOFTBANK
Investment."
The unaudited pro forma as adjusted balance sheet data gives effect to the
conversion of all preferred stock into common stock upon completion of this
offering, see "Description of Capital Stock -- The SOFTBANK Investment," and the
sale of 7,000,000 shares of common stock offered hereby for net proceeds of
$63.7 million after deducting underwriting discounts and commissions and
estimated offering expenses.
5
<PAGE> 190
RISK FACTORS
Investing in our common stock involves risk. You should carefully consider
the risks and uncertainties described below and elsewhere in this prospectus
before making an investment decision. If any of the following risks or
uncertainties actually occur, our business could be adversely affected. In this
event, the trading price of our common stock could decline, and you could lose
all or a part of your investment.
WE HAVE A LIMITED OPERATING HISTORY AND MAY NOT SUCCESSFULLY IMPLEMENT OUR
BUSINESS PLAN.
We have a very limited operating history. We were incorporated in December
1997 and began offering Web hosting services in February 1998. We only recently
completed the acquisition of the application hosting business of Interliant
Texas. As a result, our business model is still in development. Our business and
prospects must be considered in light of the risks frequently encountered by
companies in their early stages of development, particularly companies in the
new and rapidly evolving hosting and enhanced Internet services market. Some of
these risks relate to our ability to:
- build a more comprehensive sales structure to support our business;
- provide reliable and cost-effective services to our customers;
- continue to build our operations and accounting infrastructure to
accommodate additional customers;
- respond to technological developments or service offerings by our
competitors;
- develop and offer new, successful products and services or differentiate
such products and services from those offered by our competitors;
- enter into strategic relationships with application software vendors;
- build, maintain and expand distribution channels; and
- attract and retain qualified personnel.
We may not be successful in addressing these risks, and if we are not
successful, our business could be adversely affected.
WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND THESE LOSSES MAY INCREASE IN THE
FUTURE.
Since our inception in December 1997, we have experienced operating losses
and negative cash flows for each quarterly and annual period. As of December 31,
1998 and March 31, 1999, we had an accumulated deficit of approximately $10.9
million and $18.6 million, respectively. We experienced net losses of
approximately $10.7 million in the year ended December 31, 1998 and $7.8 million
in the three months ended March 31, 1999. The revenues and income potential of
our business is unproven, and our limited operating history makes it difficult
to evaluate our prospects. We anticipate increased expenses as we expand our
sales and marketing initiatives to continue to grow the Interliant brand, fund
greater levels of product development, continue to build out our data centers,
implement centralized billing, accounting and customer service systems and
continue our acquisition program.
In addition, we have experienced growth in revenues, primarily attributable
to acquisitions, and we do not believe that this growth rate is necessarily
indicative of future operating results which will depend not only on continuing
our acquisition strategy but also on internal growth. We expect that future
acquisitions will increase our operating expenses and operating losses. As a
result, we expect to incur operating losses for the foreseeable future. We
cannot give any assurance that we will ever achieve profitability on a quarterly
or annual basis, or, if we achieve profitability, that it will be sustainable.
6
<PAGE> 191
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. AS A
RESULT, PERIOD-TO-PERIOD COMPARISONS OF OUR RESULTS OF OPERATIONS ARE NOT
NECESSARILY MEANINGFUL AND SHOULD NOT BE RELIED UPON AS INDICATIONS OF FUTURE
PERFORMANCE.
Our quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, some of which are outside of our control.
These factors include:
- the demand for and market acceptance of our hosting and enhanced Internet
services;
- our ability to identify, complete and integrate acquisitions to sustain
growth;
- downward price adjustments by our competitors on services and products
they offer which are similar to ours;
- changes in the mix of products and services sold by our competitors;
- technical difficulties or system downtime affecting the Internet
generally or our hosting operations;
- the ability to meet any increased technological demands of our customers;
- the amount and timing of our costs related to our marketing efforts and
service introductions by us or reseller or referral partners; and
- economic conditions specific to the hosting industry.
Therefore, our operating results for any particular quarter may differ
materially from our expectations or those of security analysts and may not be
indicative of future operating results which may adversely impact the price of
our common stock.
THE SUCCESS OF OUR BUSINESS PLAN DEPENDS ON OUR ABILITY TO MAKE ADDITIONAL
ACQUISITIONS.
We intend to pursue opportunities to expand our business through the
acquisition of selected companies in targeted markets. Although we expect to
finance future acquisitions, in part, with some of the proceeds from this
offering and, at a future date with the issuance of additional shares of our
common stock or other debt or equity securities, we cannot guarantee that:
- we will be able to identify appropriate acquisition candidates or
negotiate acquisitions on favorable terms;
- we will be able to obtain the financing necessary to complete future
acquisitions; or
- the issuance of our common stock or other securities in connection with
any future acquisition will not result in a substantial dilution in the
ownership interests of holders of our common stock.
THE SUCCESS OF OUR BUSINESS PLAN DEPENDS ON THE SUCCESSFUL INTEGRATION OF
ACQUISITIONS.
Since February 1998, we have acquired 17 businesses, and we are currently
pursuing additional acquisitions. Our future success will depend in large part
on our ability to integrate these businesses or any future acquired businesses
with our existing operations. To integrate these businesses, we will need to:
- consolidate their billing and accounting systems into our systems and
implement financial and other control systems;
- relocate the servers of acquired companies and other equipment to an
Interliant facility;
- migrate the operations of acquired companies onto our technology
platforms;
- integrate the customer accounts of acquired companies into our customer
service system;
- integrate the service offerings of acquired companies into the Interliant
brand; and
- identify resellers and referral partners of the services of acquired
companies and migrate them to our business partner program.
7
<PAGE> 192
The 17 businesses we acquired are in various stages of the integration
process. Our integration plan is constantly changing as a result of our business
activities as well as future acquisitions. We are not able to estimate when, if
at all, all acquired companies will be fully integrated.
THE COSTS ASSOCIATED WITH AND MANAGEMENT RESOURCES DEDICATED TO INTEGRATING
BUSINESSES WE ACQUIRE AND INTERNAL CONTROLS WITH RESPECT TO THOSE ACQUIRED
BUSINESSES MAY ADVERSELY AFFECT OUR BUSINESS.
We may not be able to successfully integrate acquired businesses with
existing operations without substantial costs, delays or other problems, if at
all. As we integrate acquired businesses:
- we may lose certain customers of acquired companies due to difficulties
during the integration process;
- we may not be able to bill customers of the acquired companies accurately
due to potential deficiencies in the internal controls of the acquired
Web hosting companies such as inadequate back-office systems of the
acquired companies and potential difficulties in migrating records onto
our own systems;
- we may experience difficulty in collecting accounts receivable of
acquired companies due to inaccurate record keeping of the acquired
companies;
- key employees of the acquired companies whom we wish to retain may
resign;
- management's attention and resources could be diverted from our ongoing
business concerns; and/or
- we may not be able to integrate newly acquired technologies with our
existing technologies.
Acquisitions also involve a number of other risks, including adverse
effects on our operating results from increases in amortization of intangible
assets, increased compensation expense associated with newly hired employees and
unforeseen liabilities. In addition, any acquired company could significantly
underperform relative to our expectations. In particular, acquired companies
have often experienced modest revenue declines immediately following the closing
of the acquisition. Because we have only recently completed many of our
acquisitions, we are currently facing all of these challenges, and we have not
established our ability to meet them over the long term. As a result of all of
the foregoing, our pursuit of an acquisition strategy could adversely affect our
business.
OUR RECENT ACQUISITION OF INTERLIANT TEXAS, OUR LARGEST ACQUISITION TO DATE, MAY
ADVERSELY AFFECT OUR BUSINESS IF WE DO NOT SUCCESSFULLY INTEGRATE INTERLIANT
TEXAS OR IF THE COSTS AND MANAGEMENT RESOURCES WE EXPEND IN CONNECTION WITH THE
INTEGRATION EXCEED OUR EXPECTATIONS.
In March 1999, we purchased, through a wholly-owned subsidiary,
substantially all the assets, and assumed certain liabilities, of Interliant
Texas, which had revenues of $21.2 million for the year ended December 31, 1998.
Our acquisition of the business of Interliant Texas has been our largest
acquisition to date, and we expect that it will have a continuing, significant
impact on our business. Although we do not currently intend to integrate all the
operations of Interliant Texas into our operations, we still expect to incur
significant integration costs. In addition, the following factors could increase
the costs of integration:
- unexpected employee turnover;
- delays in addressing duplicate operations; and
- additional fees and charges to obtain consents, regulatory approvals or
permits.
Further, we cannot guarantee that we will realize the benefits or strategic
objectives we are seeking to obtain by acquiring Interliant Texas. Costs
associated with this acquisition that exceed our expectations would have an
adverse effect on our business.
8
<PAGE> 193
A SIGNIFICANT PORTION OF OUR ASSETS CONSISTS OF INTANGIBLE ASSETS, THE
RECOVERABILITY OF WHICH IS NOT CERTAIN AND THE AMORTIZATION OF WHICH WILL
INCREASE LOSSES OR REDUCE EARNINGS IN THE FUTURE.
In connection with all of our acquisitions completed to date, $85.2 million
of the aggregate purchase price has been allocated to intangible assets such as
covenants not to compete, customer lists, trade names, assembled work force and
goodwill. Annual amortization of these intangible assets will amount to
approximately $25.4 million and will increase as we acquire additional
businesses. Our business could suffer if changes in our industry or our
inability to operate the business successfully and produce positive cash flows
from operations result in an impairment in the value of our intangible assets
and therefore necessitate a write-off of all or part of these assets.
OUR APPLICATION HOSTING SOLUTIONS DEPEND ON SOFTWARE APPLICATIONS PROVIDED TO US
UNDER AGREEMENTS WE HAVE WITH APPLICATION SOFTWARE VENDORS.
We obtain software products pursuant to agreements with Lotus and Microsoft
and package them as part of our application hosting solutions. The agreements
are typically for terms ranging from one to three years. If these agreements
were terminated or not renewed, we might have to discontinue products or
services that are central to our business strategy or delay their introduction
unless we could find, license and package equivalent technology. Our business
strategy also depends on obtaining additional application software. We cannot be
sure, however, that we will be able to obtain the new and enhanced applications
we may need to keep our solutions competitive. If we cannot obtain these
applications and as a result must discontinue, delay or reduce the availability
of our solutions or other products and services, our business may be adversely
affected.
OUR AGREEMENTS WITH APPLICATION SOFTWARE VENDORS ARE NOT EXCLUSIVE AND MAY NOT
PROVIDE US WITH ANY COMPETITIVE ADVANTAGE.
None of our third-party agreements are exclusive. Our competitors may also
license and utilize the same technology in competition with us. We cannot be
sure that the vendors of technology used in our products will continue to
support this technology in its current form. Nor can we be sure that we will be
able to adapt our own products to changes in this technology. In addition, we
cannot be sure that the financial or other difficulties of third party vendors
will not have an adverse affect on the technologies incorporated in our
products, or that, if these technologies become unavailable, we will be able to
find suitable alternatives.
WE DEPEND ON OUR RESELLER SALES CHANNEL TO MARKET AND SELL MANY OF OUR SERVICES.
We rely significantly on resellers to market and sell our services. We
estimate that as of December 31, 1998 approximately 16% of our active hosted
domains were maintained by resellers. For this purpose, we include as resellers
any entity which has three or more active domains hosted by us. Our failure to
maintain and grow our reseller sales channel may adversely affect our business.
Our agreements with resellers generally do not require that the resellers sell
any minimum level of our services and do not restrict the resellers' development
or sale of competitive services. We have very little control over whether these
resellers will dedicate resources or give priority to selling our services.
We will need to continue to deliver reliable service and keep our reseller
pricing and support programs competitive. If we succeed in increasing our sales
through resellers, we may lose brand identification and brand loyalty, since our
services may not be identified by the Interliant brand or may be marketed
differently by our resellers.
WE ONLY RECENTLY BEGAN TO OFFER MANY OF OUR PRODUCTS AND SERVICES. IF THEY ARE
NOT ACCEPTED BY THE MARKET OR HAVE RELIABILITY OR QUALITY PROBLEMS OUR BUSINESS
MAY SUFFER.
We have recently introduced new hosting solutions such as providing our
customers with integrated text, graphics, video, information and sound
capabilities on their Web sites, or multimedia hosting and providing our
customers with the ability to rent software applications instead of purchasing
them as well as
9
<PAGE> 194
enhanced Internet services such as e-commerce and consulting services. If these
and other new hosting solutions and enhanced Internet services fail to gain
market acceptance, our business could be adversely affected. In addition, if
these newly introduced hosting solutions and enhanced Internet services have
reliability, quality or compatibility problems, market acceptance of these
products could be greatly hindered and our ability to attract new customers
could be adversely affected. We cannot offer any assurance that these new
solutions and services are free from any reliability, quality or compatibility
problems.
THE EXPECTED CONTINUED GROWTH IN THE MARKET FOR OUR PRODUCTS AND SERVICES MAY
NOT MATERIALIZE.
Our market is new and rapidly evolving. Whether the market for our products
and services will continue to grow is uncertain. Our business would be adversely
affected if the hosting market does not continue to grow or if businesses prove
to be unwilling to outsource their hosting business.
Our success depends in part on continued growth in the use of the Internet.
Our business would be adversely affected if Web usage does not continue to grow.
Web usage may be inhibited for a number of reasons, such as:
- security and privacy concerns;
- uncertainty of legal and regulatory issues concerning the use of the
Internet;
- inconsistent quality of service; and
- lack of availability of cost-effective, high-speed connectivity.
OUR RAPID GROWTH AND EXPANSION HAS AND MAY CONTINUE TO SIGNIFICANTLY STRAIN OUR
RESOURCES.
We are currently experiencing rapid growth, primarily due to our
acquisition of 17 businesses since February 1998. In addition, from inception to
the date hereof we have grown to 516 employees, including 19 employees on a
contract basis. This rapid growth of our business and our product and service
offerings has placed, and is likely to continue to place, a significant strain
on our operating and financial resources. Our future performance will partly
depend on our ability to manage our growth effectively, which will require that
we further develop our operating and financial system capabilities and controls.
We have invested, and intend to continue to invest, significant amounts in
billing, accounts receivable, customer service and financial systems which we
believe, once implemented, will be able to produce timely, accurate and
consistent information as our business continues to grow. However, because we
employ a strategy that includes a high level of acquisition activity, at any
time there are likely to be one or more operating businesses that have not been
fully integrated into our core systems and continue to produce financial and
other information from their existing systems. As a result, our ability to
record, process, summarize and report financial data could be adversely
affected.
WE DEPEND ON THE GROWTH AND STABILITY OF THE INTERNET INFRASTRUCTURE.
If the use of the Internet continues to grow, its infrastructure may not be
able to support the demands placed on it by such growth and its performance or
reliability may decline. In addition, Web sites have experienced interruptions
in their service as a result of outages and other delays occurring throughout
the Internet network infrastructure. If these outages or delays occur
frequently, use of the Internet as a commercial or business medium could, in the
future, grow more slowly or decline which would adversely affect our business.
WE DEPEND ON OUR NETWORK INFRASTRUCTURE. IF WE DO NOT HAVE CONTINUED ACCESS TO A
RELIABLE NETWORK, OUR BUSINESS WILL SUFFER.
Our success partly depends upon the capacity, scalability, reliability and
security of our network infrastructure, including the capacity leased from our
telecommunications network suppliers such as UUNET Technologies, Inc. We depend
on these companies to provide uninterrupted and "bug free"
10
<PAGE> 195
service and would be adversely affected if such services were not provided. In
addition, we would be adversely affected if such companies greatly increased the
prices of their services or if the telecommunications capacity available to us
was insufficient for our business purposes and we were unable to use alternative
networks or pass along any increased costs to our customers.
OUR BUSINESS AND EXPANSION MODELS ASSUME THAT WE WILL BE ABLE TO EASILY SCALE
OUR NETWORK INFRASTRUCTURE TO SUPPORT INCREASING NUMBERS OF CUSTOMERS AND
INCREASED TRAFFIC. HOWEVER, THE SCALABILITY OF OUR NETWORK IS UNPROVEN.
We must continue to develop and expand our network infrastructure as the
number of users and the amount of information they wish to transport as well as
the number of products and services we offer increases and to meet changing
customer requirements. Our expansion and adaptation of our telecommunications
and hosting facility infrastructure will require substantial financial,
operational and management resources. If we are required to expand our network
significantly and rapidly due to increased usage, additional stress will be
placed upon our network hardware, traffic management systems and hosting
facilities. Due to the limited deployment of our services to date, the ability
of our network to connect and manage a substantially larger number of customers
at high transmission speeds while maintaining superior performance is unknown.
As our customers' bandwidth usage increases, we will need to make
additional investments in our infrastructure to maintain adequate data
transmission speeds, the availability of which may be limited and the cost of
which may be significant. Additional network capacity may not be available from
third-party suppliers as it is needed by us. As a result, our network may not be
able to achieve or maintain a sufficiently high capacity of data transmission,
especially if customers' usage increases. Any failure on our part to achieve or
maintain high-capacity data transmission could significantly reduce consumer
demand for our services and adversely affect our business.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH COULD AFFECT
OUR ABILITY TO COMPETE.
To succeed, we must be able to operate our network infrastructure on a 24x7
basis without interruption. Our operations depend upon our ability to protect
our network infrastructure, equipment and customer files against damage from:
- human error;
- various natural disasters;
- power loss or telecommunications failures; and
- sabotage or other intentional acts of vandalism.
However, even if we take precautions, the occurrence of a natural disaster
or other unanticipated problems at our data centers could result in
interruptions in the services we provide to our customers.
At this time, we do not have a formal disaster recovery plan. Although we
believe that our Atlanta and Houston data centers are state-of-the-art and have
sufficient system protections in place to ensure high quality service with
minimal interruptions, we estimate that currently only approximately 34% of our
customers are hosted in these data centers. In addition, we may not integrate
into our Network Operations Centers all the data centers of companies we
acquire. Therefore, in some instances, our network reliability may be
compromised. Although we have attempted to build redundancy into our network and
hosting facilities, our data centers are currently subject to various single
points of failure. As a result, a problem with one of our routers, switches or
fiber paths could cause an interruption in the services we provide to some of
our customers. We have experienced interruptions in service in the past. Any
future interruptions could:
- require us to spend substantial amounts of money replacing existing
equipment or adding redundant facilities;
11
<PAGE> 196
- damage our reputation for reliable service;
- cause existing end users, resellers and referral partners to cancel their
contracts;
- cause end users to seek damages for losses incurred; or
- make it more difficult for us to attract new end users, resellers and
referral partners.
Any of these occurrences could adversely affect our business.
We have entered into service level agreements with some of our customers,
and we anticipate that we will offer service level agreements to a larger group
of customers in the future. In that case, we could incur significant liability
to our customers in connection with any system downtime and those obligations
may adversely affect our business.
IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL
CHANGE, OUR BUSINESS COULD SUFFER.
The Internet industry is characterized by rapidly changing technology,
industry standards, customer needs and competition, as well as by frequent new
product and service introductions. Our future success will depend, in part, on
our ability to accomplish all of the following in a timely and cost-effective
manner, all while continuing to develop our business model and roll-out our
services on a national level:
- effectively use and integrate leading technologies;
- continue to develop our technical expertise;
- enhance our products and current networking services;
- develop new products and services that meet changing customer needs;
- advertise and market our products and services; and
- influence and respond to emerging industry standards and other changes.
We cannot assure you that we will successfully use or develop new
technologies, introduce new services or enhance our existing services on a
timely basis, or that new technologies or enhancements used or developed by us
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense.
OUR FAILURE TO DEVELOP BRAND RECOGNITION FOR THE INTERLIANT BRAND COULD HURT OUR
BUSINESS.
Upon acquiring Interliant Texas and its application hosting business, we
began the process of offering the full range of our hosting products and
enhanced Internet services under the Interliant brand. We are currently
marketing and expect to continue to market many of our products and services
under the Sage Networks brand and the brand names of acquired companies. Our
sales and marketing expenses were $2.6 million in the year ended December 31,
1998 and $1.9 million in the three months ended March 31, 1999. A key component
of our strategy is to significantly increase our sales and marketing activities.
This will include the expansion of our sales force, development of reseller and
referral partner channels and increased marketing efforts. As a result, sales
and marketing expenses will increase substantially in future periods. We expect
sales and marketing expenses for the year ending December 31, 1999 to exceed
$20.0 million. Our business could be adversely affected if the Interliant brand
is not well received by our customers, our marketing efforts are not productive
or we are otherwise unsuccessful in increasing our brand awareness.
WE OPERATE IN AN EXTREMELY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY.
Our current and prospective competitors are numerous. Many of our
competitors have substantially greater financial, technical and marketing
resources, larger customer bases, longer operating histories,
12
<PAGE> 197
greater name recognition and more established relationships in the industry than
we do. Our current and prospective competitors generally may be divided into the
following groups:
- other Web hosting and Internet services companies such as AboveNet
Communications, Inc., Exodus Communications, Inc., Frontier GlobalCenter,
Globix Corporation and local and regional hosting providers;
- national and regional Internet service providers such as Concentric
Network Corporation, MindSpring Enterprises, Inc., UUNET Technologies,
Inc., PSINet Inc. and Verio Inc.;
- global telecommunications companies including AT&T Corp., British
Telecommunications plc, Telecom Italia SpA and Nippon Telegraph and
Telephone Corp.;
- regional and local telecommunications companies, including the regional
Bell operating companies such as Bell Atlantic Corporation and US West,
Inc.;
- companies that focus on application hosting such as USinternetworking,
Inc. and IBM Global Services; and
- multimedia hosting companies such as broadcast.com.
WE DEPEND ON THE SKILLS OF KEY PERSONNEL.
We are dependent on the continued service of our key personnel, including:
- Leonard J. Fassler and Bradley A. Feld, our Co-Chairmen;
- Stephen W. Maggs, our Vice Chairman;
- James M. Lidestri, our President;
- Rajat Bhargava, our Senior Vice President, Strategic Planning and
Integration; and
- William A. Wilson, our Chief Financial Officer.
We recently entered into one-year employment agreements with Messrs.
Fassler, Maggs and Bhargava and a one-year consulting agreement with Mr. Feld
through Intensity Ventures, Inc. In addition, in connection with our acquisition
of Interliant Texas, we entered into a two-year employment agreement with Mr.
Lidestri. The loss of the services of one or more of these people could
adversely affect our business.
Our Co-Chairmen, Bradley A. Feld and Leonard J. Fassler, are each currently
active in, and serve as directors and/or executive officers of, a number of
businesses other than Interliant. Although Mr. Feld spends approximately half of
his time and Mr. Fassler spends substantially all of his time at Interliant, and
both are active in its management, neither is contractually committed to spend
any specific amount of time at Interliant. If Mr. Feld or Mr. Fassler were to
significantly reduce the time they devoted to Interliant, our business may be
adversely affected.
WE OPERATE IN AN INDUSTRY WHERE IT IS DIFFICULT TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
We expect that we will need to hire additional personnel in all areas of
our business. The competition for personnel throughout our industry is intense.
At times, we have experienced difficulty in attracting qualified new personnel.
If we do not succeed in attracting new, qualified personnel or retaining and
motivating our current personnel, our business could suffer.
WE MAY NEED ADDITIONAL FUNDS WHICH, IF AVAILABLE COULD RESULT IN AN INCREASE IN
OUR INTEREST EXPENSE OR DILUTION OF YOUR SHAREHOLDINGS. IF THESE FUNDS ARE NOT
AVAILABLE, OUR BUSINESS COULD BE HURT.
We currently anticipate that our available cash resources combined with the
net proceeds from this offering will be sufficient to fund our acquisition
program, the expansion of our sales and marketing program, completion of our
data centers and our other operating needs through the end of 1999.
13
<PAGE> 198
Thereafter, we expect to require additional financing. At this time, we do not
have any credit facility or other working capital credit line under which we may
borrow funds for working capital or other general corporate purposes. If our
plans or assumptions change or are inaccurate, we may be required to seek
additional capital or seek capital sooner than anticipated. We may need to raise
funds through public or private debt or equity financing.
If funds are raised through the issuance of equity securities, the
percentage ownership of our then current stockholders may be reduced and such
equity securities may have rights, preferences or privileges senior to those of
the holders of our common stock. If additional funds are raised through the
issuance of debt securities, such securities would have certain rights,
preferences and privileges senior to those of the holders of our common stock
and the terms of such debt could impose restrictions on our operations. If
additional funds become necessary, additional financing may not be available on
terms favorable to us, or at all. If adequate funds are not available on
acceptable terms, we may not be able to continue to fund our operations and
growth or to continue our acquisition program. Our inability to raise capital
could adversely affect our business.
CURRENCY FLUCTUATIONS AND DIFFERENT STANDARDS, REGULATIONS AND LAWS RELATING TO
OUR INTERNATIONAL OPERATIONS MAY ADVERSELY AFFECT OUR BUSINESS.
On a pro forma basis, giving effect to acquisitions completed to date,
approximately 18.5% of our dollar amount of billings for the year ended December
31, 1998 and 18.2% for the three months ended March 31, 1999 were to customers
located outside the United States, primarily in Europe, Asia and South America.
Our success may depend in part on expanding our international presence.
Because our sales overseas are denominated in U.S. dollars, currency
fluctuations may inhibit us from marketing our services to potential foreign
customers or collecting for services rendered to current foreign customers. In
addition different privacy, censorship and service provider liability standards
and regulations and different intellectual property laws in non-U.S. countries
may adversely affect our business.
DISRUPTION OF OUR SERVICES DUE TO ACCIDENTAL OR INTENTIONAL SECURITY BREACHES
MAY ADVERSELY IMPACT OUR BUSINESS.
A significant barrier to the growth of e-commerce and communications over
the Internet has been the need for secure transmission of confidential
information. Despite our design and implementation of a variety of network
security measures, unauthorized access, computer viruses, accidental or
intentional actions and other disruptions could occur. We may incur significant
costs to protect against the threat of security breaches or to alleviate
problems caused by such breaches. If a third person were able to misappropriate
our users' personal or proprietary information or credit card information, we
could be subject to claims, litigation or other potential liabilities.
NEW LAWS AND REGULATIONS WHICH IMPACT OUR INDUSTRY COULD HARM OUR BUSINESS.
We are not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, we may
become subject to regulation by the FCC or another regulatory agency. Our
business could suffer depending on the extent to which our activities are
regulated or proposed to be regulated.
WE OPERATE IN AN UNCERTAIN REGULATORY AND LEGAL ENVIRONMENT WHICH MAY MAKE IT
MORE DIFFICULT TO DEFEND OURSELVES AGAINST ANY CLAIMS BROUGHT AGAINST US.
While there are currently few laws or regulations which specifically
regulate Internet communications, laws and regulations directly applicable to
online commerce or Internet communications are becoming more prevalent. There is
much uncertainty regarding the marketplace impact of these laws. In addition,
various jurisdictions already have enacted laws covering intellectual property,
privacy, libel and taxation that could affect our business by virtue of their
impact on online commerce. Further, the growth of the
14
<PAGE> 199
Internet, coupled with publicity regarding Internet fraud, may lead to the
enactment of more stringent consumer protection laws. If we become subject to
claims that we have violated any laws, even if we successfully defend against
these claims, our business could suffer. Moreover, new laws that impose
restrictions on our ability to follow current business practices or increase our
costs of doing business could hurt our business.
IF STATES AND COUNTRIES IN WHICH WE DO NOT CURRENTLY COLLECT SALES OR OTHER
TAXES MANDATE THAT WE DO SO, OUR BUSINESS COULD SUFFER.
We currently do not collect sales or other taxes with respect to the sale
of services or products in states and countries where we believe we are not
required to do so. We do collect sales and other taxes in the states and
countries in which we have offices and are required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes for
prior periods, could have an adverse effect on our business.
WE COULD FACE LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR NETWORK.
It is possible that claims could be made against online services companies
and Internet service providers in connection with the nature and content of the
materials disseminated through their networks. Several private lawsuits are
pending against other entities which seek to impose liability upon online
services companies and Internet service providers as a result of the nature and
content of materials disseminated over the Internet. If any of these actions
succeed, we might be required to respond by investing substantial resources or
discontinuing some of our service or product offerings. The increased attention
focused upon liability issues as a result of these lawsuits and legislative
proposals could impact the growth of Internet use. Although we carry
professional liability insurance, it may not be adequate to compensate or may
not cover us in the event we become liable for information carried on or
disseminated through our networks. Any costs not covered by insurance incurred
as a result of such liability or asserted liability could adversely affect our
business.
WE DEPEND ON THE PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS.
We currently license and may in the future license certain technologies
from third parties, which may subject us to infringement actions based upon the
technologies licensed from these third parties. Any of these claims, with or
without merit, could subject us to costly litigation and divert the attention of
our technical and management personnel. These third-party technology licenses
may not continue to be available to Interliant on commercially reasonable terms.
The loss of the ability to use such technology could require Interliant to
obtain the rights to use substitute technology, which could be more expensive or
offer lower quality or performance, and therefore have a material adverse effect
on Interliant's business.
OUR COMPUTER SYSTEMS AND THOSE OF THIRD PARTIES WITH WHOM WE DO BUSINESS MAY NOT
BE YEAR 2000 COMPLIANT, WHICH MAY CAUSE SYSTEM FAILURES AND DISRUPTIONS OF
OPERATIONS.
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including
ours, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
We have made a preliminary assessment of the Year 2000 readiness of our
information technology systems. In addition, we are currently seeking assurances
from our material hardware and software vendors that their products are Year
2000 compliant. Until such process is complete, we will not be able to
completely evaluate whether our information technology systems will need to be
revised or replaced.
15
<PAGE> 200
Although we have not incurred any material expenditures in connection with
identifying or evaluating Year 2000 compliance issues to date, we do not at this
time possess the information necessary to estimate the potential costs of
revisions or replacements to our software and systems or third party software,
hardware or services that are determined not to be Year 2000 compliant. Such
expenses, if higher than anticipated, could have a material adverse effect on
our business.
Although we are not currently aware of any Year 2000 compliance problems
relating to our information technology systems that would have a material
adverse effect on our business, there is no assurance that we will not discover
any such compliance problems. Our failure to fix or replace our software,
hardware or services on a timely basis could result in lost revenues, increased
operating costs and the loss of customers and other business interruptions, any
of which could have a material adverse effect on our business. Moreover, the
failure to adequately address Year 2000 compliance issues in our information
technology systems could result in claims of mismanagement, misrepresentation or
breach of contract and related litigation, which could be costly and
time-consuming to defend.
OUR STOCK PRICE MAY BE VOLATILE.
There has not been a public market for our common stock. We cannot predict
the extent to which investor interest in Interliant will lead to the development
of a trading market or how liquid that market might become. Further, we cannot
guarantee that the price of our common stock will not decline below the initial
public offering price. Stock prices of technology companies, especially
Internet-related companies, have been highly volatile. The initial public
offering price may not be indicative of prices that will prevail in the trading
market. Various factors could cause the market price of our common stock to
fluctuate substantially. These factors may include:
- variations in our revenue, earnings and cash flow;
- announcements of new service offerings, technological innovations or
price reductions by us, or our competitors or providers of alternative
services; and
- changes in analysts' recommendations or projections and general economic
and market conditions.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted against such a company. Such litigation could result in substantial
costs and a diversion of management's attention and resources and could have a
material adverse effect on our business.
WEB HOSTING ORGANIZATION LLC AND MEMBERS OF MANAGEMENT WILL CONTROL
APPROXIMATELY 69.5% OF OUR COMMON STOCK AFTER THIS OFFERING, AND THEIR INTERESTS
MAY BE IN CONFLICT WITH THOSE OF INTERLIANT AND THE OTHER STOCKHOLDERS.
Immediately following this offering, Web Hosting Organization LLC and
members of management will control approximately 69.5% of our outstanding common
stock. Accordingly, they will be able to control any stockholder vote, including
any vote on the election of directors. The members of Web Hosting Organization
LLC are affiliates of Charterhouse Group International, Inc. and the WHO
Management LLC, of which Interliant's Co-Chairmen, Leonard J. Fassler and
Bradley A. Feld, are the member managers. Web Hosting Organization LLC's
interests could conflict with the interests of our other stockholders. See
"Description of Capital Stock -- The WEB Hosting Organization Investment" and
"Related Party Transactions."
Charterhouse Equity Partners III, L.P., which is an affiliate of
Charterhouse Group International, Inc., has the ability to control our direction
and future operations through its significant equity ownership of Web Hosting
Organization LLC. Certain decisions concerning our operations or financial
structure may present conflicts of interest between Charterhouse and our other
stockholders. In addition to its investments in us, Charterhouse or its
affiliates may in the future invest in other entities engaged in the hosting
business or other Internet-related business. As a result, Charterhouse or its
affiliates have, and may develop, relationships with businesses that are or may
be competitive with us. Conflicts may also arise in the negotiation or
enforcement of arrangements entered into by us and entities in which
Charterhouse has
16
<PAGE> 201
an interest. Such conflicts of interest could cause Charterhouse to use its
significant ownership interest to force us to act in a manner adverse to the
interests of our other stockholders.
OUR STOCK PRICE MAY BE AFFECTED BY THE AVAILABILITY OF SHARES FOR SALE IN THE
NEAR FUTURE. THE FUTURE SALE OF LARGE AMOUNTS OF OUR STOCK, OR THE PERCEPTION
THAT SUCH SALES COULD OCCUR, COULD NEGATIVELY AFFECT OUR STOCK PRICE.
The market price of the common stock could drop as a result of sales of a
large number of shares of common stock in the market after this offering. There
will be 42,215,268 shares of common stock outstanding immediately after this
offering. The 7,000,000 shares of common stock sold in this offering will be
freely tradable without restriction or further registration under the Securities
Act of 1933, as amended, unless such shares are held by "affiliates" of
Interliant, as that term is defined in Rule 144 under the Securities Act.
All of the remaining shares of common stock are subject to restrictions
under Rule 144 of the Securities Act. Holders of 32,320,790 restricted shares
have registration rights with respect to such shares. However, such shares are
subject to lock-up agreements pursuant to which the holders of these shares have
agreed, subject to certain limited exceptions, not to sell or otherwise dispose
of any of their shares for a period of 180 days after the date of this
prospectus, or exercise their registration rights, without the prior written
consent of Merrill Lynch & Co., on behalf of the several underwriters. See
"Shares Eligible for Future Sale."
As of the date of this prospectus, there are 3,086,411 shares of common
stock issuable upon exercise of options issued as compensation that will become
available for resale in the public market at prescribed times. We also intend to
register under the Securities Act the shares of common stock reserved for
issuance under our stock option plan. See "Shares Eligible for Future Sale."
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS.
This prospectus contains certain forward-looking statements, relating to,
among other things, future results of operations, growth plans, sales, gross
margin and expense trends, capital requirements and general industry and
business conditions applicable to Interliant. These forward-looking statements
are based largely on Interliant's current expectations and are subject to a
number of risks and uncertainties. When used in this prospectus, the words
"anticipate," "believe," "estimate" and similar expressions are generally
intended to identify forward-looking statements. Actual results could differ
materially from these forward-looking statements. In addition to the other risks
described elsewhere in this "Risk Factors" discussion, important factors to
consider in evaluating such forward-looking statements include changes in
external competitive market factors, changes in Interliant's business strategy
or an inability to execute its strategy due to unanticipated changes in the
hosting industry or the economy in general and various other competitive factors
that may prevent Interliant from competing successfully in existing or future
markets. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this prospectus will be in fact
realized.
17
<PAGE> 202
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the 7,000,000 shares
sold by us in this offering will be approximately $63.7 million, or
approximately $73.4 million if the underwriters' over-allotment options are
exercised in full, after deducting underwriting discounts and commissions and
estimated expenses payable by us.
We currently intend to use approximately $40.0 million of the net proceeds
of this offering for acquisitions. We are currently engaged in discussions with
respect to several acquisitions. See "Business -- Strategy" and "-- Acquisition
Program." We also expect to use the net proceeds as follows:
- approximately $9.0 million for capital expenditures including completing
and equipping our data centers;
- $8.0 million for repayment of a 9% promissory note issued in favor of
Matthew Wolf in connection with the acquisition of Interliant Texas,
which will be paid in full on the consummation of this offering; and
- $2.4 million for repayment of a promissory note, which pays interest at
the prime rate, issued in connection with the acquisition of Advanced Web
Creations, Inc., which will be paid in full on the consummation of this
offering.
See "Business -- Technology and Network Operations -- Network Operations" and
"-- Facilities."
The balance of the net proceeds of this offering will be used for working
capital and general corporate purposes. Pending use of the net proceeds for the
above purposes, we intend to invest such funds in short-term investment grade
interest-bearing securities. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
DIVIDEND POLICY
We have never paid or declared any cash dividends on our common stock. We
currently intend to retain any future earnings for our business and, therefore,
do not anticipate paying cash dividends in the foreseeable future. Future
dividends, if any, will depend on, among other things, our results of
operations, capital requirements, restrictions in loan agreements and on such
other factors as our Board of Directors may, in its discretion, consider
relevant.
18
<PAGE> 203
CAPITALIZATION
The following table sets forth at March 31, 1999 (1) our actual
capitalization, (2) capitalization on a pro forma basis to reflect (a) the
amendment of our Restated Certificate of Incorporation to provide for authorized
capital stock of 200,000,000 shares of common stock and 1,000,000 shares of
undesignated preferred stock and (b) the exercise in April 1999 of warrants to
purchase 749,625 shares of common stock for gross proceeds of $5.0 million and
(3) the pro forma capitalization adjusted to reflect (a) the conversion of
2,647,658 shares of Series A Redeemable Convertible Preferred Stock into an
equal number of shares of common stock upon the consummation of this offering
(see "Description of Capital Stock -- The SOFTBANK Investment") and (b) the net
proceeds from this offering, after deducting the underwriting discounts and
commissions and estimated offering expenses. You should read this table in
conjunction with the Selected Consolidated Financial Data, the Unaudited Pro
Forma Consolidated Financial Statements and Interliant's Consolidated Financial
Statements and Notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Notes payable, less current portion....................... $ 914 $ 914 $ 914
======== ======== ========
Series A Redeemable Convertible Preferred Stock, $0.01 par
value; 2,647,658 shares authorized and outstanding,
actual and pro forma; and 0 shares authorized and
outstanding, pro forma as adjusted...................... 13,000 13,000
Stockholders' equity:
Preferred stock, 0 shares authorized, actual; 1,000,000
shares authorized, 0 shares issued and outstanding,
pro forma and pro forma as adjusted..................
Common stock, $0.01 par value; 100,000,000 shares
authorized, 30,998,802 shares issued and outstanding,
actual; 200,000,000 shares authorized, 31,748,427
shares issued and outstanding, pro forma; 200,000,000
shares authorized, 41,396,085 shares issued and
outstanding, pro forma as adjusted(1)................ 310 317 414
Additional paid-in capital.............................. 89,067 94,060 170,663
Deferred compensation................................... (1,202) (1,202) (1,202)
Accumulated deficit..................................... (18,648) (18,648) (18,648)
-------- -------- --------
Total stockholders' equity.............................. 69,528 74,528 151,228
-------- -------- --------
Total capitalization............................ $ 83,442 $ 88,442 $152,142
======== ======== ========
</TABLE>
- ---------------
(1) Excludes 3,319,594 shares of common stock issuable upon exercise of options
outstanding under our 1998 Stock Option Plan at a weighted average exercise
price of $1.76. See "Management."
19
<PAGE> 204
DILUTION
Our pro forma negative net tangible book value as of March 31, 1999 was
$(2.9) million or $(0.09) per share of common stock. The pro forma net tangible
book value per share of common stock is determined by subtracting our total
liabilities from the total book value of our tangible assets and dividing the
difference by the number of shares of common stock deemed to be outstanding on
the date as of which such book value is determined, after giving effect to the
pro forma events listed in the introductory paragraph of "Capitalization." After
giving effect to (a) the conversion of 2,647,658 shares of Series A Redeemable
Convertible Preferred Stock into shares of common stock upon the consummation of
this offering (see "Description of Capital Stock -- The SOFTBANK Investment")
(b) receipt of the net proceeds from the sale of the 7,000,000 shares of common
stock in this offering, at an initial public offering price of $10.00 per share
and after deducting underwriting discounts and commissions and estimated
offering expenses, the pro forma net tangible book value of Interliant as of
March 31, 1999 would have been $73.8 million, or $1.78 per share. This
represents an immediate increase in net tangible book value of $1.87 per share
to existing stockholders and an immediate dilution of $8.22 per share to new
investors purchasing shares at the initial public offering price. Dilution is
defined as the reduction in the proportion of income, or earnings per share, to
which each share is entitled due to the issuance of additional shares. The
following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $10.00
Pro forma net tangible book value per share as of March
31, 1999............................................... (0.09)
Increase per share attributable to new investors.......... 1.87
-----
Pro forma net tangible book value per share after this
offering.................................................. 1.78
------
Dilution per share to new investors......................... $ 8.22
======
</TABLE>
The following table summarizes on a pro forma basis, as of March 31, 1999,
the number of shares of common stock purchased from us, the total consideration
paid to us and the average price per share paid by the existing stockholders and
by the investors purchasing shares of common stock in this offering (before
deducting the estimated underwriting discounts and commissions and estimated
offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- -------------------------
NUMBER PERCENT AMOUNT PERCENT AVERAGE PRICE PER SHARE
-------------- ------- -------------- ------- -----------------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 28,597(1) 80.3 $ 60,000(1) 46.2 $ 2.10
New investors............. 7,000 19.7 70,000 53.8 10.00
------ ----- -------- -----
Total........... 35,597 100.0 $130,000 100.0
====== ===== ======== =====
</TABLE>
The foregoing table assumes no exercise of stock options outstanding. As of
the date hereof, there are options outstanding to purchase a total of 3,086,411
shares of common stock at a weighted average per share exercise price of $2.83.
To the extent that any of these options are exercised, there will be further
dilution to new investors. See "Capitalization," "Management -- Stock Option
Plan," "Description of Capital Stock" and Note 7 of Notes to Consolidated
Financial Statements.
- ---------------
(1) Includes 2,647,658 shares of common stock issuable upon conversion of
preferred stock for total consideration of $13,000,000.
20
<PAGE> 205
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
The following selected consolidated financial data should be read in
conjunction with Interliant's (formerly Sage Networks, Inc.) Consolidated
Financial Statements and Notes thereto, the Unaudited Pro Forma Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this prospectus. The
statement of operations data for the period ended December 31, 1997 and the year
ended December 31, 1998, and the balance sheet data as of December 31, 1997 and
1998, are derived from the consolidated financial statements of Interliant that
have been audited by Ernst & Young LLP, independent auditors, whose report with
respect thereto is included elsewhere in this prospectus. The statement of
operations data for the three months ended March 31, 1998 and 1999 and the
balance sheet data as of March 31, 1999 have been derived from the unaudited
financial statements included in this prospectus. We believe that the unaudited
historical financial statements contain all adjustments needed to present fairly
the information in those statements, and that the adjustments made consist only
of recurring adjustments.
The unaudited pro forma statement of operations data for the year ended
December 31, 1998 and for the three months ended March 31, 1999 assumes that the
acquisitions completed in 1998 and 1999 had occurred on January 1, 1998, and
includes the historical consolidated statements of operations of Interliant,
adjusted for the pro forma effects of such acquisitions. The unaudited pro forma
balance sheet data gives effect to the exercise in April 1999 of warrants to
purchase 749,625 shares of common stock for gross proceeds of $5.0 million. See
"Description of Capital Stock -- The SOFTBANK Investment." The unaudited pro
forma as adjusted balance sheet data gives effect to the conversion of 2,647,658
shares of Series A Redeemable Convertible Preferred Stock into shares of common
stock upon consummation of this offering (see "Description of Capital
Stock -- The SOFTBANK Investment") and the sale of 7,000,000 shares of common
stock offered hereby.
Results of operations for the period from inception to December 31, 1997
and for the year ended December 31, 1998 and for the three months ended March
31, 1999 are not necessarily indicative of results of operations for future
periods. Interliant's development and expansion activities, including
acquisitions, during the periods shown below may significantly affect the
comparability of this data from one period to another. The unaudited pro forma
statement of operations data is not necessarily indicative of the results of
operations that would actually have occurred if the transactions had been
consummated as of January 1, 1998 and is not intended to indicate the expected
results for any future period. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
----------------------------------------------------------- ---------------------------
PERIOD FROM
DECEMBER 8,
1997 THREE MONTHS THREE MONTHS THREE MONTHS
(INCEPTION) TO YEAR ENDED ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1998 1999 1998 1999
-------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................... $ -- $ 4,905 $ 13 $ 5,434 $ 41,292 $ 10,341
Costs and expenses:
Cost of revenues............ -- 3,236 54 3,251 20,291 5,976
Sales and marketing......... -- 2,555 111 1,896 9,394 3,487
General and
administrative............ 156 5,121 256 3,700 20,575 5,559
Depreciation................ 2 696 9 700 3,820 1,279
Amortization of
intangibles............... -- 2,439 2 2,594 24,085 6,021
Start-up and acquisition
integration costs......... -- 1,728 134 1,063 1,728 1,063
---------- ---------- ---------- ----------- ----------- -----------
Operating loss................ (158) (10,870) (553) (7,770) (38,601) (13,044)
Interest income and other non-
operating expense........... -- 138 14 12 (429) (138)
---------- ---------- ---------- ----------- ----------- -----------
Net loss...................... $ (158) $ (10,732) $ (539) $ (7,758) $ (39,030) $ (13,182)
========== ========== ========== =========== =========== ===========
Net loss per share -- basic
and diluted................. $ (0.05) $ (1.22) $ (0.18) $ (0.31)
Weighted average shares used
in computing net loss per
share -- basic and
diluted..................... 3,000,000 8,799,432 3,000,000 24,769,890
Pro forma net loss per
share -- basic and
diluted..................... $ (2.47) $ (0.46)
Shares used in computing pro
forma net loss per share --
basic and diluted........... 15,829,762 28,626,240
</TABLE>
21
<PAGE> 206
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
AS OF AS OF ----------------------------------
DECEMBER 31, DECEMBER 31, PRO FORMA
1997 1998 ACTUAL PRO FORMA AS ADJUSTED
------------ ------------ -------- --------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 912 $ 6,813 $ 4,376 $ 9,376 $ 65,652
Working capital.............................. 4,815 3,755 (5,462) (462) 63,814
Total assets................................. 4,953 26,197 100,897 105,897 161,597
Debt and capital lease obligations, less
current portion............................ -- -- 914 914 914
Redeemable convertible preferred stock....... -- -- 13,000 13,000
Total stockholders' equity................... 4,842 21,693 69,528 74,528 151,228
</TABLE>
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-------------------------------------------- ----------------------------
PERIOD FROM
DECEMBER 8,
1997
(INCEPTION) THREE MONTHS THREE MONTHS
TO YEAR ENDED ENDED YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31, DECEMBER 31, MARCH 31,
1997 1998 1999 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
OTHER DATA:
EBITDA(1).......................... $ (156) $ (7,735) $ (4,476) $ (10,697) $ (5,744)
Net cash flows from operating
activities....................... (59) (6,001) (4,210)
Net cash flows from investing
activities....................... (29) (17,919) (21,807)
Net cash flows from financing
activities....................... 1,000 29,821 23,580
Net capital expenditures........... 29 4,322 984
</TABLE>
- ---------------
(1) EBITDA represents earnings before net interest expense, income taxes,
depreciation and amortization and other income (expense). EBITDA is
presented because it is a widely accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the basis
of operating performance and because our management believes that EBITDA is
an additional meaningful measure of performance and liquidity. EBITDA is not
intended to present cash flows for the period, nor has it been presented as
an alternative to operating income (loss) as an indicator of operating
performance and should not be considered in isolation or as a substitute for
measures of performance prepared in accordance with generally accepted
accounting principles. The items excluded from the calculation of EBITDA are
significant components in understanding and assessing our financial
performance. Our computation of EBITDA may not be comparable to the
computation of similarly titled measures of other companies. EBITDA does not
represent funds available for discretionary uses. See Interliant's (formerly
Sage Networks, Inc.) Consolidated Financial Statements and Notes thereto
appearing elsewhere in this prospectus.
22
<PAGE> 207
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following description of our financial condition and
results of operations in conjunction with the Consolidated Financial Statements
and the Notes thereto and the Unaudited Pro Forma Consolidated Financial
Statements included elsewhere in this prospectus. This discussion contains
forward-looking statements based upon current expectations that involve risks
and uncertainties. Any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Our actual
results and the timing of certain events may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a discrepancy include, but are not limited to, those discussed in "Risk
Factors," "Business" and elsewhere in this prospectus.
OVERVIEW
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Our Web
hosting services provide virtual, dedicated and co-located hosting solutions to
meet the needs of businesses of all sizes, as their Web sites develop from
low-end marketing brochures to more complex, interactive Web sites and finally
to Web sites that are integral to the operating, marketing and sales and
customer support functions, or mission-critical, of a business. Our application
hosting services consist of groupware hosting and application outsourcing
solutions that can provide our customers with 24x7 remote access to
mission-critical applications and data required by their businesses.
During 1998 and 1999, our strategy has been to rapidly acquire operating
companies in the Web hosting and application hosting services businesses, to
build or acquire data centers, and to integrate the acquired operations into
those data centers. We acquired 17 operating businesses during 1998 and 1999 for
total consideration of approximately $85.2 million, including transaction costs.
We have accounted for all acquisitions using the purchase method of accounting
which has resulted in the inclusion of substantial intangible assets on our
balance sheet. Of the total consideration, we paid $7.9 million of assumed
seller debt and have or will allocate approximately $(9.7) million to tangible
net assets and $87.0 million to intangible assets which are comprised of
covenants not to compete, customer lists, assembled work force, trade names and
goodwill. In connection with acquisitions where specific intangible assets were
not stated in the purchase agreements, an allocation methodology was applied to
each acquisition to determine the value to be assigned to each type of
intangible asset where appropriate. Amounts not allocated to specific intangible
assets have been recorded as goodwill. Recoverability of our investment in
intangible assets is dependent on our ability to operate our business
successfully and generate positive cash flows from operations. Annual charges to
operations for amortization of intangible assets will be approximately $25.4
million, which will result in increased losses or reduced net income. During
1998, we charged approximately $2.4 million of amortization of the intangible
assets to operations. Additionally, during 1998 we issued stock valued at
approximately $2.6 million as compensation in connection with agreements entered
into with sellers of acquired operating businesses. During 1998, we amortized
and charged to operations approximately $0.8 million of deferred compensation.
The purchase consideration for the acquisitions was in the form of cash, stock
or a combination of cash and stock. See "Business -- Acquisition Program."
Most of the operating businesses we acquired in 1998 have been small and
entrepreneurial in nature and highly dependent on the focus and attention of the
owners. It has been our experience that during the negotiation period prior to
an acquisition, the attention of the owners has been diverted from the operation
of the business. The result of this has often been a modest revenue decline
immediately following the closing of the acquisition. In most cases, the owner
continued to have direct responsibility for the acquired business, but in some
instances, we re-assigned the owner to take advantage of unique skill sets that
have broad application within our operations. In those cases, the operating
businesses have experienced a modest decline in revenues due to loss of
customers. These factors resulted in minimal aggregate internal growth in 1998
for us and the businesses we acquired.
23
<PAGE> 208
Since our inception in December 1997, we have experienced operating losses
and negative cash flows from operating activities for each quarterly and annual
period. As of December 31, 1998, we had an accumulated deficit of approximately
$10.9 million. Had the companies acquired to date been included since January 1,
1998, our accumulated deficit would have been $39.2 million. The revenue and
income potential of our business is unproven and its limited operating history
makes an evaluation of us and our prospects difficult. We anticipate increased
operating expenses as we:
- expand our sales and marketing initiatives to continue to grow our
brands;
- fund greater levels of product development;
- continue to complete and equip our data centers;
- implement centralized billing, accounting and customer service systems;
and
- continue our acquisition program.
Although we have experienced revenue growth, primarily attributable to
acquisitions, we do not believe that this growth is necessarily indicative of
future operating results. Future acquisitions are expected to increase operating
expenses and operating losses and as a result, we expect to incur operating
losses for the foreseeable future. We cannot assure you that we will ever
achieve profitability on a quarterly or annual basis, or, if achieved, that we
will sustain profitability. See "Risk Factors -- We have a history of
significant losses and these losses may increase in the future."
RESULTS OF OPERATIONS
We derive our revenues from Web hosting, enhanced Internet services and
consulting services. In March 1999, we acquired Interliant Texas to enter the
application hosting market. Revenues for our Web hosting business consist
primarily of hosting fees and setup fees, which cover costs incurred by us to
establish a customer's Web site. We provide virtual, dedicated and co-located
hosting. We charge our Web hosting customers a fixed amount for bandwidth
availability and incremental fees if those fixed amounts are exceeded. In
addition, our virtual Web hosting customers are also charged for disk space on a
server, dedicated hosting customers are charged for use of one or more dedicated
servers and our co-located customers are charged for the amount of physical
space such co-located customers' servers occupy. We charge flat rates for our
enhanced Internet services. For application hosting, our revenues are comprised
primarily of a one-time implementation fee and monthly usage fees per number of
end users, including bandwidth fees. For our consulting services, we charge
either a fixed fee or a fee based on time and materials.
Our contracts with our Web hosting customers typically range in length from
month-to-month to one year, a large proportion of which are cancellable by
either us or our customers with 30 days notice. Our contracts with our
application hosting customers typically range in length from one year to three
years. Revenues derived from hosting are recognized ratably over the applicable
contractual period. Payments received and billings in advance of providing
services are deferred until such services are provided. Revenues from consulting
services are recognized as the services are rendered. Substantially all of our
consulting contracts call for billings on a time and materials basis. We are
aware that the Staff of the Securities and Exchange Commission is developing a
Staff Accounting Bulletin on the topic of revenue recognition. There can be no
assurance as to what revenue recognition policies will be required by the Staff
when that Bulletin is released. If that Bulletin requires revenue recognition
policies different from those we are currently using, our results of operations
may be materially affected.
Cost of revenues consists primarily of salaries and related expenses
associated with consulting and network operations personnel as well as data
communications expenses, including one-time fees for circuit installation and
variable recurring circuit payments to network providers. Monthly circuit
charges vary based upon circuit type, distance and usage, as well as the term of
the contract with the carrier.
Sales and marketing expense consists of personnel costs associated with the
direct sales force, the internal telesales group and product marketing
employees, as well as costs associated with marketing
24
<PAGE> 209
programs, product literature, external telemarketing costs and corporate
marketing activities, including public relations.
Start-up and acquisition integration costs consist primarily of salaries
for our acquisition and integration team as well as related travel expenses.
General and administrative expense includes the cost of customer service
functions including:
- finance;
- accounting;
- human resources;
- legal and executive salaries; and
- fees paid for professional services and corporate overhead.
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Revenues
Revenues were $5.4 million for the three months ended March 31, 1999
representing an increase of $5.4 million from the comparable 1998 period. The
increase in revenues was due primarily to the 15 acquisitions consummated during
the last three quarters of 1998 and the first quarter of 1999.
On a pro forma basis, giving effect to acquisitions completed to date,
revenues for the quarter ended March 31, 1999 were $10.3 million. Interliant
Texas accounted for 44.8% of such revenues. Revenues for Interliant Texas were
$4.6 million for the quarter ended March 31, 1999 compared to $4.8 million for
the quarter ended March 31, 1998. This decrease was due to lower bandwidth
charges to our customers in 1999.
For the three months ended March 31, 1999, on a pro forma basis and giving
effect to acquisitions completed to date:
- Web hosting revenues comprised 31.4% of our revenues;
- application hosting revenues comprised 44.8% of our revenues;
- consulting services revenues comprised 16.0% of our revenues; and
- each of disk space, excess bandwidth and one-time implementation fee
revenues have been de minimis.
Cost of Revenues
Cost of revenues increased by $3.2 million for the three months ended March
31, 1999. This increase was attributable to the 15 acquisitions consummated
during the last three quarters of 1998 and the first quarter of 1999. In the
future, cost of revenues may fluctuate due to capacity utilization, the timing
of investments in data centers, changes in the mix of services, fluctuations in
bandwidth costs and increased levels of staffing.
On a pro forma basis, giving effect to acquisitions completed to date, cost
of revenues for the quarter ended March 31, 1999 were $6.0 million. Interliant
Texas accounted for 46.7% of such costs of revenues. Cost of revenues for
Interliant Texas were $2.8 million for the quarter ended March 31, 1999,
approximately the same as the amount for the quarter ended March 31, 1998.
Sales and Marketing
Sales and marketing expense increased by $1.8 million for the three months
ended March 31, 1999. This increase was attributable to the 15 acquisitions
consummated during the last three quarters of 1998 and the first quarter of
1999. A key component of our strategy is to significantly increase our sales and
25
<PAGE> 210
marketing activities for application hosting and Web hosting products. This will
include the expansion of our sales force, development of reseller and referral
partner channels and increased marketing efforts to grow recognition of our
brands. As a result, sales and marketing expenses will increase substantially in
future periods. We expect sales and marketing expenses for the year ending
December 31, 1999 to exceed $20.0 million.
On a pro forma basis, giving effect to acquisitions completed to date,
sales and marketing expense for the three months ended March 31, 1999 was $3.5
million. Interliant Texas accounted for 53.2% of such sales and marketing
expense. Sales and marketing expense for Interliant Texas were $1.9 million for
the three months ended March 31, 1999 compared to $1.5 million for the three
months ended March 31, 1998. This increase was attributable to increased
personnel in the sales force and the marketing staff.
General and Administrative
General and administrative expense increased by $3.4 million for the three
months ended March 31, 1999. This increase in general and administrative expense
was attributable to the 15 acquisitions consummated during the last three
quarters of 1998 and the first quarter of 1999 and increased investments in
infrastructure and levels of staffing to implement centralized billing,
accounting and customer service systems to integrate the operations of acquired
companies. Substantial staffing increases are expected to continue in future
periods.
On a pro forma basis, giving effect to acquisitions completed to date,
general and administrative expense for the three months ended March 31, 1999 was
$5.6 million. Interliant Texas accounted for 28% of such general and
administrative expense. General and administrative expense of Interliant Texas
was $1.6 million for the three months ended March 31, 1999 compared to $1.3
million for the three months ended March 31, 1998. This increase was
attributable to higher professional fees and training expenses.
Depreciation
Depreciation expense increased by $0.7 million for the three months ended
March 31, 1999. This increase in depreciation expense was attributable to the 15
acquisitions consummated during the last three quarters of 1998 and the first
quarter of 1999 and investment in plant and equipment by us to complete our data
center in Atlanta. We expect depreciation expense to increase in the future as
we continue to invest in data centers and systems to integrate future
acquisitions and support future growth.
On a pro forma basis, giving effect to acquisitions completed to date,
depreciation expense for the three month period ended March 31, 1999 was $1.3
million. Interliant Texas accounted for 53.8% of such depreciation expense.
Depreciation expense of Interliant Texas was $0.7 million compared to $0.5
million for the three month period ended March 31, 1998. This increase was due
to an increase in investment in computer hardware, primarily servers.
Amortization
Amortization expense increased by $2.6 million for the three months ended
March 31, 1999. This increase in amortization expense was attributable to the 15
acquisitions consummated during the last three quarters of 1998 and the first
quarter of 1999. We expect amortization expense to increase in future periods as
we continue to make additional acquisitions as well as reflect amortization of
intangibles associated with acquisitions consummated to date.
On a pro forma basis, giving effect to acquisitions completed to date,
amortization expense for the three month period ended March 31, 1999 was $6.0
million. Amortization expense related to the acquisition of Interliant Texas
represented 57.1% of such amortization expense.
Start-up and Acquisition Integration Costs
Start-up and acquisition integration costs increased by $0.9 million for
the three months ended March 31, 1999. This increase was attributable to our
continuing acquisition program and our expanded
26
<PAGE> 211
acquisition integration team, including salaries and travel expenses, and the
amortization of deferred stock compensation costs.
YEAR ENDED DECEMBER 31, 1998 AND 1997
Revenues
Our revenues increased by $4.9 million for the year ended December 31,
1998. This increase in revenues was primarily attributable to the 12
acquisitions consummated during 1998.
On a pro forma basis, giving effect to acquisitions completed to date,
revenues for the year ended December 31, 1998 were $41.3 million. Interliant
Texas accounted for 51% of such revenues. Revenues for Interliant Texas were
$21.2 million for the year ended December 31, 1998 compared to $16.9 million for
the year ended December 31, 1997. This increase was primarily due to an increase
in the number of higher revenue generating customers.
For the year ended December 31, 1998, on a pro forma basis and giving
effect to acquisitions completed to date:
- Web hosting revenues comprised 28.0% of our revenues;
- application hosting revenues comprised 51.3% of our revenues;
- consulting services revenues comprised 14.0% of our revenues; and
- revenues from disk space, excess bandwidth and one-time implementation
fee have each been de minimus.
Cost of Revenues
Cost of revenues increased by $3.2 million for the year ended December 31,
1998. This increase in cost of revenues was attributable to the 12 acquisitions
consummated during 1998. In the future, cost of revenues may fluctuate due to
capacity utilization, the timing of investments in data centers, changes in the
mix of services, fluctuations in bandwidth costs and increased levels of
staffing.
On a pro forma basis, giving effect to acquisitions completed to date, cost
of revenues for the year ended December 31, 1998 were $20.3 million. Interliant
Texas accounted for 58.5% of such cost of revenues. Cost of revenues for
Interliant Texas were $11.9 million for the year ended December 31, 1998
compared to $9.4 million for the year ended December 31, 1997. This increase was
primarily due to an increase in staffing, a change in mix of staff to higher
paid employees, including technical engineers, and increased connectivity costs
associated with network upgrades.
Sales and Marketing
Sales and marketing expense increased by $2.6 million for the year ended
December 31, 1998. This increase in sales and marketing expense was attributable
to the 12 acquisitions consummated during 1998. A key component of our strategy
is to significantly increase our sales and marketing activities for application
hosting and Web hosting products. See "Business -- Strategy" and "-- Marketing."
This will include the expansion of our sales force, development of reseller and
referral partner channels and increased marketing efforts to grow recognition of
our brands. As a result, sales and marketing expenses will increase
substantially in future periods.
On a pro forma basis, giving effect to acquisitions completed to date,
sales and marketing expense for the year ended December 31, 1998 was $9.4
million. Interliant Texas accounted for 71.6% of such sales and marketing
expense. Sales and marketing expense for Interliant Texas were $6.7 million for
the year ended December 31, 1998 compared to $4.4 million for the year ended
December 31, 1997. This increase was primarily due to an increase in staffing, a
change in mix of staff to higher paid employees and increased external marketing
costs.
27
<PAGE> 212
General and Administrative
General and administrative expense increased to $5.1 million for the year
ended December 31, 1998 as compared to $0.2 million for the period from December
8, 1997 (inception) to December 31, 1997. This increase in general and
administrative expense was attributable to the 12 acquisitions consummated
during 1998 and increased investments in infrastructure and levels of staffing
to implement centralized billing, accounting and customer service systems to
integrate the operations of acquired companies. Staffing for general and
administrative functions increased substantially late in 1998 and is expected to
continue to increase during 1999 and as a result, general and administrative
expense will increase substantially in future periods.
On a pro forma basis, giving effect to acquisitions completed to date,
general and administrative expense for the year ended December 31, 1998 was
$20.6 million. Interliant Texas accounted for 20.1% of such general and
administrative expense. General and administrative expense of Interliant Texas
was $4.1 million for the year ended December 31, 1998 compared to $2.9 million
for the year ended December 31, 1997. This increase was primarily due to an
increase in staffing, a change in mix of staff to higher paid employees,
increased training costs and increased telecommunications costs.
Depreciation
Depreciation expense increased by approximately $0.7 million for 1998. This
increase was due to the acquisition of approximately $5.7 million of furniture,
fixtures and equipment. This amount includes approximately $1.4 million acquired
with operating businesses we acquired during 1998. Investments included the
construction of and acquisition of equipment for our Web hosting facilities to
ensure high levels of service to our customers and capacity for future growth
and of technology and infrastructure to implement centralized billing,
accounting and customer service systems to integrate the operations of acquired
companies. We expect depreciation expense to increase in the future as we
continue to invest in data centers and systems to integrate future acquisitions
and support future growth.
On a pro forma basis, giving effect to acquisitions completed to date,
depreciation expense for the year ended December 31, 1998 was $3.8 million.
Interliant Texas accounted for 66.1% of such depreciation expense. Depreciation
expense of Interliant Texas was $2.5 million for the year ended December 31,
1998 compared to $1.6 million for the year ended December 31, 1997. This
increase was due to an increase in investment in computer hardware, primarily
servers.
Amortization
Amortization expense increased by approximately $2.4 million in 1998. The
amortization expense was attributable to intangible assets associated with the
12 acquisitions consummated during 1998. On a pro forma basis, giving effect to
acquisitions completed to date, amortization expense for the year ended December
31, 1998 was $24.1 million. Amortization expenses related to the acquisition of
Interliant Texas represented $13.8 million of such amortization expense. We
expect amortization expense to increase in the future as we continue to acquire
businesses.
Start-up and Acquisition Integration Costs
Start-up and acquisition integration costs increased by $1.7 million for
the year ended December 31, 1998. This increase was primarily attributable to
the 12 acquisitions consummated during 1998. We expect start-up and acquisition
integration costs to remain relatively constant in future periods.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations and acquisitions primarily
from private placements of equity. Net cash used in operations for the three
months ended March 31, 1999 was $4.2 million. This reflects primarily the net
loss for the period of $7.8 million along with changes in operating assets and
liabilities. Net cash used for investing activities for the three month period
ended March 31, 1999 was
28
<PAGE> 213
$21.8 million, of which $1.0 million was for purchases of furniture, fixtures
and equipment, and $18.9 million was for acquisitions of businesses. Net cash
from financing activities for the three month period ended March 31, 1999 was
$23.6 million, reflecting $24.0 million of proceeds from issuance of common
stock and preferred stock less issuance costs and repayment of debt under
equipment financing facilities.
We had $4.4 million in cash and cash equivalents at March 31, 1999. In
April 1999 the Company received $5.0 million for the issuance of common stock
upon the exercise of a warrant by SOFTBANK.
In connection with our acquisition of Interliant Texas, we assumed a
promissory note in favor of Mathew Wolf in the amount of $8.0 million and a
promissory note in favor of Erving Wolf in the amount of $7.9 million. Upon the
closing of this acquisition, we paid in full the note in favor of Erving Wolf,
and we canceled the note in favor of Mathew Wolf and replaced it with a note
issued by us for the same principal amount (the "Wolf Note") which bears
interest at a rate of 9% per annum and is payable in full upon the completion of
this offering.
In addition to funding ongoing operations and capital expenditures
including, without limitation, $4.0 million of expenditures planned to be made
in connection with the application hosting business, our principal commitments
consist of non-cancelable operating leases and contingent payments of earnouts
to certain sellers of operating companies acquired by us. If all earnout targets
are achieved in full, total payments pursuant to all earnouts will be $1.8
million in cash and 37,481 shares of common stock in 1999 and $1.3 million in
cash and 37,481 shares of common stock in 2000.
During 1998, we constructed a data center in Atlanta into which the
majority of the operating businesses we acquired have been or are being
integrated. We believe that this facility has the capacity to service a larger
number of customers than are currently serviced there. The cost of constructing
and equipping this facility was approximately $2.0 million. We intend to invest
approximately $5.0 million to construct and equip our data centers as more
operating businesses are acquired and integrated into these facilities, and as
sales and marketing efforts generate internal growth, requiring additional
servers, routers and related equipment. We may decide to construct one or more
additional facilities in 1999, dependent upon acquisition activity. Our current
anticipated level of capital expenditures for 1999 is expected to be
approximately $15.0 million, but may vary from that amount depending upon
acquisitions and changes in operating plans. As of July 7, 1999, we have
financed $1.3 million in capital equipment under a sale/leaseback arrangement.
We may seek additional financing under this arrangement in the future.
At March 31, 1999, restricted cash totaled $1.4 million. In connection with
our acquisition of Interliant Texas, we entered into an Assignment and
Assumption Agreement, dated March 10, 1999, pursuant to which we were assigned
all right, title and interest in and to, and assumed all obligations under, the
lease for the Houston data center. In connection with receiving the landlord's
consent to assignment of the lease, we were required to issue letters of credit
in favor of the landlord totaling approximately $0.7 million to replace the
letters of credit issued by Interliant Texas. The aggregate dollar amount which
may be drawn upon by the landlord under these letters of credit shall be reduced
at specified dates in specified amounts such that by August 8, 2000 all of the
letters of credit shall have lapsed. In addition, restricted cash includes
approximately $0.5 million held in escrow in connection with one of our
acquisitions and approximately $0.2 million held to secure outstanding letters
of credit used as deposits on our facilities.
We believe that our existing cash and cash equivalents together with the
net proceeds of this offering will be adequate to meet operating needs through
the end of 1999 and will provide enough funds to continue our acquisition
program through 1999. Thereafter, we expect to require additional financing. If
our plans or assumptions change or prove to be inaccurate, we may be required to
seek additional sources of capital or seek additional capital sooner than
currently anticipated. We may also seek to raise additional capital to take
advantage of favorable conditions in the capital markets. We have no credit
facility or other working capital credit line under which we may borrow funds
for working capital or other general corporate purposes.
29
<PAGE> 214
YEAR 2000 COMPLIANCE
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including our
own, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
State of Readiness. We have made a preliminary assessment of the Year 2000
readiness of our information technology, or IT, systems, including the hardware
and software that enable us to provide and deliver our solutions, and our non-IT
systems. Our plan consists of:
- quality assurance testing of our internally developed proprietary
software and systems;
- contacting third-party suppliers, vendors and licensors of material
hardware, software and services that are both directly and indirectly
related to the delivery of our solutions to our customers;
- contacting vendors of material non-IT systems;
- assessment of repair or replacement requirements;
- repair or replacement;
- implementation; and
- creation of contingency plans in the event of Year 2000 failures.
We have been informed by vendors of material hardware and software
components of our IT systems that their products are currently Year 2000
compliant. We are currently assessing the materiality of our non-IT systems and
will seek assurances of Year 2000 compliance from providers of material non-IT
systems. Until such testing is complete and such vendors and providers are
contacted, we will not be able to completely evaluate whether our IT systems or
non-IT systems will need to be revised or replaced. We plan to complete our Year
2000 evaluation during the second half of 1999.
Costs. To date, we have not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
our expenses have related to our internal staffing costs associated with the
evaluation process and Year 2000 compliance matters generally. This trend is
expected to continue in the future. At this time, we do not possess the
information necessary to estimate the potential costs of revisions to our
software and systems should such revisions be required or the replacement of
third party software, hardware or services that are determined not to be Year
2000 compliant. Although we do not anticipate that such expenses will be
material, such expenses, if higher than anticipated, could have an adverse
effect on our business.
Risks. We are not currently aware of any Year 2000 compliance problems
relating to our IT or non-IT systems that would have a material adverse effect
on our business, results of operations and financial condition. We cannot give
you any assurance that we will not discover Year 2000 compliance problems in our
software and systems that will require substantial revisions. In addition, we
cannot give you any assurance that third party software, hardware or services
incorporated into our material IT and non-IT systems will not need to be revised
or replaced, all of which could be time consuming and expensive. Our failure to
fix or replace our software, hardware or services on a timely basis could result
in lost revenues, increased operating costs and the loss of customers and other
business interruptions, any of which could have an adverse effect on our
business. Moreover, the failure to adequately address Year 2000 compliance
issues in our IT and non-IT systems could result in claims of mismanagement,
misrepresentation or breach of contract and related litigation, which could be
costly and time-consuming to defend. In addition, we cannot give you any
assurance that governmental agencies, utility companies, telecommunication
companies, other Internet service providers, third party service providers,
hardware and software manufacturers and others outside our control will be Year
2000 compliant. The failure by such entities to be Year 2000 compliant could
result in a systemic failure beyond our control, such as a prolonged
30
<PAGE> 215
Internet, telecommunications or electrical failure, which could also prevent us
from delivering our services to our customers, decrease the use of the Internet
or prevent users from accessing the Web sites of our customers. Any of these
occurrences could have an adverse effect on our business.
Contingency Plan. As discussed above, we are engaged in an ongoing Year
2000 assessment and have not yet developed any contingency plans. The responses
received from third-party vendors and service providers will be taken into
account in determining the nature and extent of any contingency plans.
INTEREST RATE RISK
We have limited exposure to financial market risks, including changes in
interest rates. At March 31, 1999, we had short-term investments of
approximately $2.1 million. These short-term investments consist of highly
liquid investments in debt obligations of highly rated entities with maturities
of between one and 90 days. These investments are subject to interest rate risk
and will fall in value if market interest rates increase. We expect to hold
these investments until maturity, and therefore expect to realize the full value
of these investments, even though changes in interest rates may affect their
value prior to maturity. If interest rates decline over time, this will result
in a reduction of our interest as our cash is reinvested at lower rates.
31
<PAGE> 216
BUSINESS
OUR COMPANY
We are a provider of a wide range of hosting and enhanced Internet services
that enable our customers to deploy and manage their Web sites and network-based
applications more effectively than internally developed solutions. Hosting
services we provide include:
- Virtual hosting, or shared server hosting, which allows customers to
store their databases, applications or Web sites on a shared server which
is owned and maintained by us;
- Dedicated hosting, which allows customers to store their databases,
applications or Web sites on a server typically owned and maintained by
us that is dedicated solely to that customer;
- Co-located hosting, which allows customers to store their databases,
applications or Web sites on servers that they own but which are
maintained by us and are located in our data centers;
- Groupware hosting, which allows customers to store groupware applications
such as email, discussion forums and document libraries on computers
which we own and manage in our data centers; and
- Application outsourcing, which combines hosting services with prepackaged
applications that can be sold directly to our customers. By doing so, our
customers can quickly deploy a software application solution without
having to purchase hardware, software or network connections.
Since our inception in December 1997, we have grown rapidly through the
acquisition of 17 hosting and related Internet service businesses. We provide
Web hosting solutions to more than 47,000 customers, representing more than
79,000 active domains. We also host more than 10,000 customized Lotus Notes/
Domino based applications for more than 1,300 customers and believe that we are
the leading provider of Lotus Notes/Domino hosting solutions. We have two
state-of-the-art primary data centers in Atlanta and Houston and a recently
leased facility in Vienna, Virginia. Our Atlanta and Houston data centers are
monitored on a 24x7 basis and include sophisticated monitoring and diagnosis,
24x7 customer support, redundant and high-speed network connectivity and
uninterruptible power supply.
INDUSTRY BACKGROUND
Growth of the Internet. The Internet is experiencing significant growth
and is emerging as a global medium for communications and commerce.
International Data Corporation or IDC estimates that the number of Web users
worldwide will increase from approximately 97.3 million at the end of 1998 to
319.8 million by the end of 2002, a 34.6% compounded annual growth rate. IDC
also estimates that the number of Web users in the United States will increase
from approximately 51.6 million at the end of 1998 to 135.9 million by the end
of 2002, a 27.4% compounded annual growth rate. During this same period, the
number of business Web sites in the United States is projected by Forrester
Research, Inc. to increase from approximately 650,000 in 1998 to approximately
2.6 million in 2002, a 41.1% compounded annual growth rate. This growth in the
number of Web users and number of Web sites is being driven by a number of
factors including:
- the large and growing installed base of personal computers;
- easier and less expensive alternatives for Internet access;
- improvements in the speed, reliability and security of the Internet;
- commerce-enabling technologies;
- higher quality and more diverse content;
- an increase in the number of networked applications; and
32
<PAGE> 217
- the proliferation of broadband technologies that promise consumers
faster, more convenient access to the Internet.
Growth in Business Use of the Internet. The dramatic growth in usage
combined with enhanced functionality and accessibility have made the Internet an
increasingly attractive medium for businesses to:
- disseminate information;
- engage in e-commerce;
- build customer relationships;
- streamline and automate data-intensive processes; and
- communicate more efficiently with dispersed employees.
In the last several years, businesses have emerged with operating models
that are exclusively dependent on the Internet, while traditional businesses of
all sizes are working quickly to establish a Web presence. Many of these
businesses establish their initial online presence with a simple, static
brochure for marketing purposes. As they become more familiar with the Internet
as a communications platform, an increasing number of businesses are
implementing more complex, mission-critical applications on the Web including
sales, customer service, customer acquisition and retention, employee
communications and e-commerce between suppliers and business partners.
Trend Toward Outsourcing. According to Forrester Research, Inc., U.S.
firms are now spending approximately 25% of their overall IT budgets on
outsourcing services. These services include packaged application software
implementation and support, customer support and network development and
maintenance. Reasons for the growth in outsourcing include:
- the desire of companies to focus on their core businesses;
- the increased costs that businesses experience in developing and
maintaining their networks and software applications;
- the fast pace of technological change that shortens time to obsolescence
and increases capital expenditures as companies attempt to capitalize on
leading-edge technologies;
- the challenges faced by companies in hiring, motivating and retaining
qualified application engineers and IT employees; and
- the desire of companies to reduce deployment time and risk.
Trend Toward Web Hosting Outsourcing. Many businesses, both small and
large, lack the resources and expertise to cost-effectively develop and
continually enhance their Web sites with evolving technologies while maintaining
a network infrastructure that remains operational in the event of a hardware or
software failure as well as supports increased bandwidth capability as their
business grows. Small- to medium-sized businesses typically lack the IT
resources, capital and scale to design their own Web sites and install, maintain
and monitor their own Web servers and Internet connectivity. Large businesses
typically require state-of-the-art facilities and networks that are monitored
and managed on a 24x7 basis by experts in Internet technology and that can be
upgraded and scaled to meet the needs of mission-critical Internet applications
that may be integral to their businesses. As a result, we believe enterprises of
all sizes are seeking outsourcing arrangements to help:
- build effective Web sites;
- improve their sites' reliability and performance;
- provide continuous monitoring of their Internet operations; and
- reduce costs.
33
<PAGE> 218
Trend Toward Application Hosting Outsourcing. Businesses increasingly face
competitive demands to automate business processes. This problem has been
exacerbated by a shortage of IT professionals. Until recently, implementation of
Internet applications required development of in-house software applications or
the customization of existing packages. This made each implementation unique and
costly. It also made implementation time frames and costs unpredictable. We
believe that businesses of all sizes have a significant need to outsource the
hosting of Internet and other software applications to improve core business
processes, reduce costs and enhance their global competitive position.
OUR OPPORTUNITY
Today the hosting market is fragmented, consisting for the most part of:
- small local and regional providers who do not have the capital, resources
or capabilities to provide quality services at competitive prices;
- large national providers who focus on Internet connectivity rather than
on hosting; and
- consulting and Web design firms for which hosting is not their core
competency.
We believe that a significant market opportunity exists for a
nationally-recognized hosting solutions provider with the scale and expertise to
offer a wide range of value-priced services to businesses of all sizes.
Interliant believes that through the acquisition and consolidation of hosting
and enhanced Internet service businesses, a hosting provider can offer a full
range of services that enable businesses to deploy, use, expand and update their
Web sites and applications infrastructures more rapidly and cost-effectively
than internally developed solutions.
Web Hosting Opportunity. The market for Web hosting services can be
segmented into virtual, dedicated and co-located hosting. Virtual hosting
primarily addresses the needs of small- to medium-sized businesses and includes
such services as disk space, shared connectivity and certain value-added
services such as e-mail hosting, e-commerce tools and other specialized
offerings. Dedicated and co-located hosting services primarily address the needs
of medium- to large-sized businesses and include:
- dedicated server equipment owned by either the hosting provider or the
customer, with an emphasis on network reliability;
- 24x7 monitoring;
- dedicated and redundant bandwidth;
- flexibility to scale rapidly; and
- high-end, value-added services such as consulting services, systems
integration and links to legacy systems.
We believe we are well positioned to take advantage of the opportunities
which exist for a nationally-recognized Web hosting solutions provider with the
scale and expertise to offer a wide range of value-priced services to businesses
of all sizes.
Application Hosting Opportunity. Traditionally, enterprises faced with the
issues of internal development and maintenance of application hosting
capabilities have sought solutions from a variety of information technology
providers including system integrators, Internet service providers, hardware and
software vendors and telecommunication companies. Thus, these companies have had
to work with at least three independent suppliers: a software applications
provider, a systems integrator and a site hosting provider, or have had to
support implementation with in-house resources. There are inherent conflicts and
difficulties with this approach, as each supplier is dedicated to providing its
own specific product or service with only limited knowledge of the bundle of
products and services required to provide the complete business solution. We
believe that these trends create a substantial market opportunity for a
single-source solution that combines software from multiple vendors, hardware,
systems integration and Internet-based communications in an integrated service
offering. Interliant believes it is well-positioned to take advantage
34
<PAGE> 219
of these opportunities as companies realize the value a single-source hosting
service provider can offer in facilitating deployment and improving management
of their corporate intranet and extranet solutions as well as mission-critical
applications.
OUR SOLUTION
We are a provider of hosting solutions that enable our customers to deploy
and manage their Web sites and network-based applications more effectively than
internally developed solutions, and to take advantage of a single-source
solution for their Internet-enabled application software needs. We offer a
unique blend of technological expertise, partnering ability and understanding of
the business and licensing models which we believe are essential to succeed in
the hosting marketplace. We believe we have developed the infrastructure,
resources, application management expertise and industry relationships required
to capitalize on this emerging market opportunity.
We provide the following advantages to our customers:
Comprehensive Hosting Solutions. We are able to provide Web hosting
services that meet our customers' needs as their Web sites evolve from low-end
marketing brochures to more complex, interactive Web sites and finally to
applications that are integral to their businesses. In addition, our application
hosting services such as groupware hosting and application outsourcing can
provide our customers with continuously available remote access to applications
and data which are mission-critical. Finally, we offer consulting services and a
broad range of enhanced Internet services such as e-commerce capabilities,
multimedia hosting and community hosting.
Performance and Reliability. Our hosting solutions help to ensure that our
customers' Web sites and networking applications are continuously online and
deliver data rapidly to users. Our state-of-the-art data centers in Atlanta and
Houston provide high-quality performance and reliability through features such
as a redundant, high-speed, secure network architecture, continuous monitoring,
alternate power sources, environmental controls, regular data back-ups and a
fault-tolerant hosting platform. Our Network Operations Centers, or NOCs,
monitor Interliant's network on a 24x7 basis and allow its staff to minimize
service interruptions.
Cost Savings. Our customers benefit from our focus on hosting and the
capital and labor investments that we have made to support hosting and enhanced
Internet services. For customers to replicate our performance and reliability,
they would be required to make significant expenditures for equipment, personnel
and dedicated bandwidth. We believe that our hosting solutions are significantly
more cost-effective and reliable than in-house solutions, both for businesses
with low-end application requirements as well as for those businesses whose
Internet operations are mission-critical and require sophisticated application
support.
Customer Service. We are dedicated to providing the highest quality
customer service. We endeavor to provide rapid and accurate responses through
customer service personnel who can answer questions over the telephone or via
e-mail. In addition, our customer service organizations in Atlanta and Houston
can address technical problems on a 24x7 basis. We have invested in advanced
customer service software and call routing technology to streamline the customer
service process. We also offer customers who are hosted in our Atlanta data
center a self-service customer support alternative which provides online access
to account and billing data and site statistics such as disk storage capacity
and bandwidth utilization.
STRATEGY
Our objective is to become the industry benchmark in the hosting services
market by providing businesses with cost-effective, innovative solutions that
will allow them to capitalize on the potential of the Internet. To achieve this
objective, our strategy includes the following key elements:
Build the Interliant Brand. We believe we have established a strong brand
identity within the application hosting industry under the Interliant brand. Our
brand will be enhanced as we begin marketing Web hosting products under the
Interliant brand and will be further enhanced as acquired companies are
35
<PAGE> 220
assimilated under our brands. We intend to continue to build name recognition
for our brand and strengthen our brand recognition by marketing our full range
of services through an integrated marketing communications program using public
relations, print and online advertising campaigns and other strategic
initiatives as well as cooperative promotions with key hardware and software
vendors.
Continue Acquisition Program. We intend to continue our acquisition
program to capitalize on consolidation opportunities in the hosting and enhanced
Internet services market in the United States and overseas. We expect that these
acquisitions will also result in substantial operating synergies, greater
internal growth and cost savings. Further, we plan to capitalize on best
practices we may identify within acquired companies to maintain our competitive
advantage and to ensure ongoing delivery of high quality hosting services to our
customers.
Expand Multiple Sales Channels. We reach our customers through multiple
sales channels including a direct sales force, indirect sales through numerous
resellers and referral partners, inbound and outbound telesales and Web
marketing programs. We intend to continue expanding these channels to further
enhance our ability to attract customers of all sizes. As an example, we
recently launched our business partner program, creating standard incentives
across our entire product line to foster growth of our business partner network.
Leverage the Interliant Customer Base. We intend to capitalize on the
enhanced revenue potential of the customer bases of our acquired companies,
leveraging the numerous cross-selling opportunities of our expanded line of
branded service offerings. We will use our multiple sales channels, including
our direct sales force, to target specific customer segments within our diverse
customer base with relevant new product offerings to realize increased revenues.
For example, we believe that we can grow our revenues by cross-selling existing
Web hosting customers with application hosting and consulting services. Further,
we believe that by coordinating the sales efforts of our combined Web hosting,
application hosting and consulting sales forces, we can increase customer leads
and referrals. Finally, we intend to assimilate the customer bases of our
acquired companies into a unified customer information management system to
facilitate sophisticated analysis and segmentation of our total customer base
and thus enable us to maximize marketing and sales opportunities.
Develop Strategic Relationships. We have established and continue to seek
strategic relationships that enhance our infrastructure and distribution
capabilities and broaden our product offerings. We believe that our strategic
alliances with companies such as IBM Corporation, Lotus Development Corporation,
Microsoft Corporation, UUNET Technologies, Inc., Equant, N.V., Allaire
Corporation, Elemental Software, Inc. and iMall, Inc. enable us to provide
complete, scalable and reliable hosting solutions to our customers, resellers
and referral partners.
SERVICES
Our service offerings comprise three main areas: Web hosting, application
hosting and consulting.
36
<PAGE> 221
WEB HOSTING SERVICES
We offer a comprehensive suite of solutions to meet the current and future
Web hosting needs of our customers. We provide virtual, dedicated and co-located
hosting services.
<TABLE>
<CAPTION>
HOSTING WEB SITE CUSTOMER
SERVICES PRICE* PROFILE KEY FEATURES BENEFITS
- -------- ------------ ---------------- ----------------- --------------
<S> <C> <C> <C> <C>
Virtual $25-$350 Static Web Shared space on Economical
per month pages, Interliant-owned
moderately server
accessed sites
Dedicated $100-$5,000 Dynamic Web Dedicated Greater server
per month content, heavily Interliant-owned resources
accessed sites server in shared requiring
rack minimal
customer
maintenance
Co-Located $500-$40,000 Mission-critical Secure cabinet Greater
per month applications for customer- customer
owned server control/access
to hardware
</TABLE>
- ---------------
* Prices are representative for products marketed under the Sage Networks and
Interliant brands and may not be representative for our products marketed
under other brand names.
All product offerings hosted in the Atlanta and Houston data centers are
designed to achieve optimal performance through features such as:
- sophisticated monitoring, notification and diagnosis;
- 24x7 customer support through the NOCs and customer service centers;
- remote access management and reporting tools;
- a high-speed network designed to continue operating in the case of any
software or hardware failure;
- uninterruptible power supply, including back-up generators capable of
sustaining server operations for more than one week;
- firewall, intrusion monitoring and site security auditing;
- full daily back-ups with off-site storage;
- air-conditioned, static and humidity controlled environment; and
- high level of physical security.
It is our intention that all product offerings marketed under our brands and
hosted at data centers other than Atlanta and Houston also have the above
features. Customers generally pay monthly, quarterly or annual fees for the
services used, as well as one-time fees for installation and any equipment
purchased by the customer.
On a pro forma basis, giving effect to acquisitions completed to date, Web
hosting revenues comprised 28.0% of our revenues in the year ended December 31,
1998 and 31.4% of our revenues for the three months ended March 31, 1999.
Although we do not account for revenues based on the virtual, dedicated and
co-located components of our Web hosting product offerings, we derive a
substantial majority of our revenues from virtual hosting as 84.0% of active
domains managed by us at March 31, 1999 are virtual hosting domains.
37
<PAGE> 222
Virtual Hosting. Our virtual hosting solution provides customers with all
the elements needed to establish a basic presence on the Web at a reasonable
cost. This entry-level service is known as virtual hosting because the
customer's home page has its own domain name, www.mycompany.com, and appears to
exist as a stand-alone server. It operates with the speed and efficiency of
Interliant's high-speed connections and its location at our facility remains
invisible to Web site visitors. Customers are able to have their own Web site
with a domain name at a fraction of the cost of maintaining it themselves. As a
result, virtual hosting is an economical solution for relatively simple or
moderately accessed Web sites. Because customers do not need to invest in costly
hardware or personnel to accommodate future growth, we believe this solution
also maximizes the customers' flexibility.
For these accounts, we host the site on a UNIX or Windows NT server that is
shared by multiple customers. Prices for virtual hosting products marketed under
the Sage Networks and Interliant brands range from $25 to $350 a month,
depending on the data transfer limit, storage capacity, number of e-mail
accounts provided and additional functionality requested such as e-commerce
capabilities, multimedia hosting and community hosting. For certain customers of
acquired businesses, the price range may be lower depending upon the
functionality of the services and reflecting a lower level of services requested
by such customers. In 1998, our average virtual hosting customer paid
approximately $20 per month.
Dedicated Hosting. As companies increase the complexity, level of traffic
or reliance on their Web sites, they may prefer to host their Web site on a
dedicated server, which is typically owned and maintained by us. A dedicated
server provides greater server and network resources to our customers than
virtual hosting and allows them to configure their hardware to optimize site
performance. Customers receive a high level of site security, maintenance, and
technical support without the prohibitive costs of setting up and maintaining
their own server and Internet connection. We support most leading Internet
hardware and software system vendor platforms, including Solaris which operates
on a Sun Microsystems, Inc. platform, Microsoft Windows NT which operates on a
Intel/PC platform and Linux which operates on a Cobalt Networks, Inc. platform.
Prices for dedicated hosting products marketed under the Sage Networks and
Interliant brands range from $100 to $5,000 a month, depending upon the hardware
configuration, bandwidth requirements and additional features that may be
requested by our customers. For certain customers of acquired businesses, the
price range may be lower. In 1998, our average dedicated hosting customer paid
$1,000 per month.
Co-located Hosting. We currently provide co-located hosting services in
our Atlanta and Washington, D.C. area data centers for customers with
sophisticated, mission-critical applications. This solution allows the customer
to own and access their servers on a 24x7 basis while delegating the day-to-day
management of their Web site to our IT specialists. In addition, co-located
servers are housed in separate, limited-access rooms in our data center. Prices
for co-located products marketed under our Sage Networks and Interliant brands
range from $500 to $40,000 a month, which incorporates fees such as bandwidth
charges and space. Bandwidth is the capacity of a telecommunications network to
carry voice, data and video information. For certain customers of acquired
businesses, the price range may be lower. In 1998, our average co-located
customer paid $750 per month.
We also provide the following enhanced Internet services to our Web hosting
customers:
E-commerce Capabilities. Through our reseller relationships, we offer a
variety of e-commerce solutions to help businesses create and maintain a
successful Web storefront. E-commerce provides businesses the ability to sell
products and services on the Internet. The e-commerce capability can be added to
an existing Web site or it can be the basis for a Web site, starting with the
customer's product catalog. Representative e-commerce offerings include:
- a full suite of Internet payment solutions offered by CyberCash, Inc.,
including payment services for credit card, micropayment and Internet
check transactions;
- ShopSite from Open Market, Inc. which allows users to build quickly a
simple catalog and begin taking orders; and
38
<PAGE> 223
- SoftCart from Mercantec which allows users to create sophisticated
e-commerce Web sites that includes order taking, credit card processing
and order fulfillment.
Multimedia Hosting. We allow our customers to include various multimedia
capabilities in their Web sites, including integrated text, graphics, video,
information and sound capabilities. With the acquisition of Telephonetics
International, Inc., we have added audio production and hosting capabilities to
the suite of Internet services available to our customers. In addition, we
provide our customers with the ability to include Real Networks and Microsoft
NetShow content within their Web sites.
Community Hosting. We allow customers of all sizes to include
community-building features such as e-mail and chat hosting. We provide POP or
Post Office Protocol e-mail boxes that can be used to send and receive e-mail
from any connection to the Internet and include unlimited aliases, forwarding
and auto-responders. We also offer chat hosting through our relationship with
eShare Technologies.
APPLICATION HOSTING SERVICES
We offer application hosting services which consist of groupware hosting
and application outsourcing solutions that provide our customers with 24x7
remote access to applications and data that are integral to their businesses.
On a pro forma basis, giving effect to acquisitions completed to date,
application hosting revenues comprised 51.3% of our revenues in the year ended
December 31, 1998 and 44.8% of our revenues for the three months ended March 31,
1999.
Groupware Hosting. We offer our customers a broad spectrum of groupware
hosting solutions for Lotus Notes/Domino, the industry-leading groupware
platform. Our groupware hosting solutions allow our customers who want to work
together collectively while located remotely from each other to store software
applications that facilitate this type of work environment on a computer that we
own and manage for them. Our groupware hosting services provide support for the
following:
- feature-rich e-mail and other types of messaging for internal and
external communication;
- workgroup and project team collaboration and document sharing;
- business process automation and workflow; and
- proprietary or custom applications built for the groupware platform.
We also can provide our customers with sophisticated, collaborative
Web-based intranets and extranet. An intranet is an Internet network which
usually belongs to a corporation and is accessible only by employees, or others
who have authorized access. An extranet is basically an intranet that provides
various levels of accessibility to outsiders who through a user name and
password can access selected parts of the extranet. We seek to provide the
following benefits to our customers hosting their groupware implementations with
us:
- reduced deployment time and risk;
- reduced day-to-day operational responsibility, allowing in-house IT
departments to focus on creating strategic value;
- lower ongoing cost;
- no capital investment in servers, facilities and other infrastructure;
- access to emerging technologies and improved responsiveness to change;
and
- 24x7 operations, high availability, rapid scalability and robust
security.
Customers generally pay monthly fees for the services offered, as well as
one-time fees for installation and deployment services. Customers typically sign
one- to three-year service contracts. Our customers have the option of using
shared or dedicated servers in one of our data centers for their groupware
hosting
39
<PAGE> 224
services, or can have their on-premise server managed by our customer-managed
server offering. Prices for our groupware hosting services range from $1,500 to
over $100,000 a month.
We provide hosting for groupware applications that are specifically
tailored for a Lotus Notes/Domino operating environment on both shared and
dedicated servers at one of our data centers or on the customer's premises. The
hosted servers support connections to:
- geographically dispersed Lotus Domino servers for messaging and
replication;
- Lotus Notes clients for remote access to e-mail and Lotus Notes
applications; and
- Web browsers for intranets and extranets.
Customers can connect to our servers using the Internet or a variety of
private network options, including frame relay, dedicated lines and local dialup
access in more than 105 countries. We provide messaging gateway services for
Lotus Domino, including:
- Internet e-mail;
- X.400 mail;
- Lotus cc:Mail;
- fax; and
- a variety of pager networks.
In addition, we and certain customers have established a Lotus
Domino/Microsoft Exchange messaging interoperability technology pilot program
which will allow users of both systems to communicate electronically, and we are
considering further expansion of this program to enhance our Microsoft Exchange
hosting offering.
As part of our groupware hosting implementation process, we start with what
we believe to be the best available system configurations and work with our
customers to modify them to the customer's specific needs. Customers may choose
from a wide variety of hardware capacity and availability options, including
RAID, or Redundant Array of Inexpensive Disks, storage and full server
clustering. Once installed, we not only monitor server hardware, operating
system and application-level system performance, but also can provide full
server administration services including adding or deleting users, database
installation, access control changes and other required server administration
tasks.
This groupware hosting service is also available for custom implementations
in conjunction with Interliant's consulting service offerings.
Application Outsourcing. Our application outsourcing offers customers an
integrated solution that combines packaged application software with managed
hosting services. We believe we are an industry leader in forging strategic
relationships with leading application developers and other key partners to
deliver these best-of-breed solutions. Through such strategic relationships, we
enable businesses of all sizes to capitalize on the latest Internet-enabled
technologies while outsourcing non-core business operations such as deployment
and migration strategies and maintenance or software upgrades to a third party.
Our branded application hosting services address the following major business
process areas:
- Legal Automation. Our legal automation solutions offer customers a suite
of collaborative applications that assist attorneys in securely and
reliably managing litigation, intellectual property matters and general
workflow within corporate legal departments and law firms. These
applications can be customized, deployed, supported and fully managed on
dedicated or shared servers at our data centers. The legal automation
suite of applications currently encompasses both Web-based and client
server applications that are priced from $100 to $300 per user per month,
as well as Internet rental applications that are priced as low as $20 per
user per month.
40
<PAGE> 225
- Sales Automation. Our sales automation services provide geographically
distributed sales and marketing organizations with all the elements
needed to quickly deploy a sales automation solution at a reasonable
cost. These solutions include modules for
- opportunity management;
- contact and account management;
- revenue forecasting reports;
- an integrated group calendar;
- automated proposal generator;
- pricing information;
- telesales campaign management; and
- correspondence and fulfillment in a shared hosting environment.
We believe that selling application outsourcing as part of a package of
hosting services rather than as a product to be installed and managed by
the customer, reduces the customer's initial capital investment, thereby
making it easier to minimize the customer's technology risk. Accordingly,
it also allows us to engage clients in long-term contracts with fixed
monthly payments. The application solution is customized, deployed, and
fully managed and supported by us, providing a single-source solution to
customers. We partner with leading packaged commercial software vendors,
hardware vendors and system integrators to deliver these solutions.
Our sales automation services can be accessed through our secure network
using a variety of dial-up or dedicated access methods on a 24x7 basis,
leading to more efficient practices and effective communications. The
solution can be easily configured to the customer's selling methodology
and can be deployed within 30 days. The solutions range in price from $100
to $200 per user per month depending upon the application features,
hardware configuration and amount of disk storage needed.
- Distributed Learning. Distributed Learning over the Web represents a
broad, horizontal market for us, with opportunities to deliver online
training in virtually all market segments. Working with leading software
technology vendors, best-of-breed content providers and business
partners, we offer comprehensive solutions for corporate, academic, and
non-profit customers. These solutions encompass:
- browser based, asynchronous or any time, any place learning
technologies;
- browser based, synchronous or same time, any place learning
technologies;
- sophisticated course and student management systems;
- online facilitation; and
- application sharing.
In addition, our distributed learning solutions leverage our core
competencies: Web hosting, multimedia technology and e-commerce, to
deliver a complete package to our customers.
Layering distributed learning know-how and functionality on top of our
existing infrastructure services allows us to quickly deliver
cost-effective solutions. Our Distributed Learning services are priced on
a "per user per course," or a "per person per year" basis, with the
typical cost of instruction per user per course in the range of $20 to
$75. Costs are driven largely by the course's duration and complexity, as
well as by the range of application level services that the customer
desires. Deployment of existing courses is very rapid, with students
typically able to access courses within a few days following registration.
- Rental Applications. We are working to create a new generation of 100%
Web-based application solutions that are designed to be delivered as
services over the Internet. No installation is required
41
<PAGE> 226
as users need only a Web browser and an Internet connection to select,
set up, configure and use a rental application. Pricing models vary based
on application usage models, but are all inclusive of the fees for
application licensing, hosting, and basic support. We establish
partnerships with software vendors to create these application services,
many of which will be based on Lotus Domino Instant!Host, a platform for
application hosting service providers co-developed by us and Lotus. We
have established a portal site, www.appsonline.com, that contains a
catalog for these Internet rental applications.
Our first Internet rental application is Lotus Instant!TEAMROOM, a
"teamware" collaboration tool available for a $14.95 monthly fee per end
user which allows distributed teams to discuss issues, share documents,
and track action items. Additional rental application services in
development include teamware for specific vertical market segments, an
application which allows companies to hold private auctions online, and
more sophisticated collaboration tools for project management,
calendaring and scheduling and document management.
CONSULTING SERVICES
We provide consulting services for Intranet, extranet and application
hosting solutions, as well as for internal networking implementations and
back-end Web development projects. In addition, we provide support for our
customers' enterprise networking needs. Our consulting services are scaled to
meet each client's needs. We address the complete spectrum of services,
including:
- desktop and network server support;
- network architecture and design;
- local area network, wide area network and virtual private network design;
- strategic technology planning;
- application development and implementation; and
- Web hosting.
On a pro forma basis, giving effect to acquisitions completed to date,
consulting services revenues comprised 14.0% of our revenues in the year ended
December 31, 1998 and 16.0% of our revenues for the three months ended March 31,
1999.
ACQUISITION PROGRAM
Since inception, we have acquired 17 companies and intend to continue our
acquisition program. Specifically, we seek to identify businesses which will
generate a positive return on investment and:
- expand our customer base;
- complement and expand our product and service offerings;
- enhance our engineering and technical capabilities;
- strengthen our reseller and referral partner relationships; and/or
- broaden our management team.
We believe that the integration of acquired companies will create economies of
scale and generate significant operating efficiencies. Because of our ongoing
acquisition strategy, we expect that at all times some portion of our acquired
companies will be in various stages of integration. We seek to identify areas in
which acquired companies outperform our competitors and adopt their best
practices. Once we acquire a company, a multi-disciplinary team begins the
four-step integration process:
Technical Integration. Technical integration begins with the physical move
of the acquired company's equipment into one of our facilities. Generally, the
customers of the acquired company are then
42
<PAGE> 227
migrated onto our hosting platforms. Migration entails duplicating the server
contents onto a new server, which runs in parallel for a test period, before
being switched over. For Web sites with real-time databases or customized
applications, the process can become significantly more complex. Our platform is
typically more robust than that of the acquired company and standardization
allows us to manage the servers more efficiently. In certain circumstances,
however, we find that it is not strategic or cost-effective to migrate customers
to our platform.
Customer Service Integration. We integrate our customer service operations
for our acquired Web hosting customers at our data center in Atlanta and for our
application hosting customers in Houston. By centralizing hosting customer
service, we believe that we can improve performance while reducing costs. In
Atlanta, we have implemented the Vantive Support system, a customer/asset
management tracking application, which enables a customer service representative
to view a customer's entire account, including past and recent interactions with
the customer. Further, the Vantive Support system provides a resolution database
that recognizes and documents support records into a central repository that can
be accessed by all customer service personnel.
Business Systems Integration. Many of the businesses we acquire do not
have adequate back-office systems or procedures. As a result, we are in the
process of transitioning acquired companies onto the PORTAL Infranet billing
system. With PORTAL Infranet, our resellers, referral partners and customers
will be able to obtain monthly statements delivered electronically which we
believe will provide them with easy access to, and accurate tracking of our
hosting expenditures. In particular, we believe that PORTAL will allow resellers
and referral partners to add new products and services, as well as pricing
discounts and incentive programs, in a timely and cost-effective manner.
Product Integration. We expect to integrate the majority of our acquired
companies into our product line, with uniform branding, pricing strategies and
distribution channels. In certain cases, however, where an acquired company's
brand is already established, we may for a period of time continue to market
certain products and services under the existing brand in order to capitalize on
the competitive advantages the acquired brand name may bring to us. Our
long-term goal, however, is to migrate most product offerings to our brand.
43
<PAGE> 228
The following chart identifies the 17 hosting and Internet-related service
companies acquired by Interliant, or from which we have acquired significant
assets.
<TABLE>
<CAPTION>
DATE NAME PRIMARY FOCUS LOCATION
- ---- ---- ------------- --------
<S> <C> <C> <C>
February 13, 1998.... Omnetrix, Inc. (dba "DirectNet") Web hosting Los Angeles, CA
April 7, 1998........ Clever Computers, Inc. Web hosting Atlanta, GA
April 30, 1998....... Server and Network connectivity Web hosting McLean, VA
assets from Knowledgelink
Interactive, Inc.
May 1, 1998.......... Tri-Star Web Creations, Inc. Web hosting New York, NY
June 10, 1998........ HostAmerica, a division of HomeCom Web hosting Atlanta, GA
Communications, Inc.
June 29, 1998........ All Information Systems, Inc. Web hosting Dallas, TX
July 1, 1998......... Software Business Technologies, Inc. Web hosting San Rafael, CA
Web Hosting Business Unit
July 1, 1998......... DevCom (division of Nextron, Inc.) Web hosting San Jose, CA
July 30, 1998........ BestWare, Inc. (dba "Maikon") Web hosting Dallas, TX
August 31, 1998...... B.N. Technologies, Inc. (dba "ICOM") Web hosting Los Angeles, CA
September 16, 1998... GEN International Inc. Web hosting St. Petersburg, FL
(Global Entrepreneur's Network, Inc.)
December 17, 1998.... Dialtone, Inc. Web hosting Pembroke Pines, FL
February 4, 1999..... Digiweb, Inc. Web hosting College Park, MD
February 4, 1999..... Telephonetics International, Inc. Multimedia Miami, FL
February 17, 1999.... Net Daemons Associates, Inc. Consulting Woburn, MA,
Burlingame, CA
and Boulder, CO
March 10, 1999....... Interliant Texas Application Houston, TX and
hosting London, England
May 4, 1999.......... Advanced Web Creations, Inc. Web hosting Fairfield, NJ
</TABLE>
CUSTOMERS
We have established a diversified customer base across our service
offerings. Our customers include a variety of business types, ranging from small
office/home office companies through Fortune 500 companies. In addition, our
customers also include resellers of our services such as Web consulting firms,
Internet service providers, network integration companies and system integrators
who sell our services to their customers. We do not believe that the loss of any
one customer would materially adversely affect us.
Our contracts with our Web hosting customers generally cover services for a
period ranging from one month to two years. We provide hosting solutions to more
than 47,000 customers, representing more than 79,000 active domains. Our
contracts with our application hosting customers generally cover services for a
period ranging from one to three years. We host more than 10,000 customized
Lotus Notes/Domino based applications for more than 1,300 customers. Our
contracts with our consulting customers generally cover services on a
project-by-project basis, with project periods typically ranging from six months
to one year.
STRATEGIC RELATIONSHIPS
Our strategic relationships and partnerships with leading technology
companies allow us to provide a wide range of services to meet our customers'
needs. The following is a list of selected companies with whom Interliant has a
strategic relationship:
IBM Corporation. We are an IBM BESTeam partner and began offering the IBM
Net.Commerce Hosting Server product in January 1999. IBM currently lists
Interliant on its Web site as one of a select group of partners that are able to
offer this product. Interliant intends to introduce Net.Commerce hosting
services to our large reseller community as a world-class end-to-end e-commerce
solution. Interliant is also
44
<PAGE> 229
hosting IBM Net.Commerce Pro solutions for dedicated server customers who
maintain large e-stores and require large scale implementations. There is no
written contract that governs this relationship with IBM and either of us can
terminate this relationship at any time. Currently, we do not have any financial
commitments to IBM as a result of this arrangement, and we do not expect this
relationship to generate any material financial commitments for us in the
future.
Lotus Development Corporation. We believe we are a leading partner of
IBM's Lotus software division and are a Lotus Net Service Provider, Lotus Net
Service Provider/Alliance Partner, as well as a Lotus Premier Business Partner.
We provide a variety of messaging and hosting services for Lotus Notes/ Domino
Internet, intranet and extranet applications. We are currently listed by Lotus
on several sections of Lotus' Web site as one of a select group of partners that
provide hosting services for Lotus Notes/Domino and other Lotus application
solutions and have twice been recognized with Lotus' highest recognition, the
Lotus Beacon Award, most recently in January 1999.
We are parties to a Joint Development Agreement with Lotus Development
Corporation, dated April 27, 1998, which is scheduled to expire on April 27,
2000, but will be automatically renewed for additional one year terms unless
terminated by either party upon prior written notice. Under this agreement,
together with Lotus we co-developed Lotus' Domino Instant! Host platform, which
enables application developers to deploy and offer Web-based collaborative
applications. Under the terms of this agreement, we share joint development
responsibilities with Lotus. Terms of this agreement include:
- We are obligated to contribute proprietary computer code owned by us, to
name one of our employees as the project liaison and to provide
non-dedicated architectural and project management assistance to Lotus.
- Lotus is obligated to contribute substantially similar type of
intellectual property and personnel resources to the project.
- Lotus is obligated to pay us a royalty equal to 25% of the net revenues
received from licensing Instant! Host. The royalty percentage may be
adjusted at the request of Lotus not more than once with respect to each
new release of Instant! Host, however, such adjustment may not reduce the
royalty percentage by more than half the percentage in effect at that
time.
- We must pay Lotus at its standard rate for all copies of Instant! Host
which we desire to license.
- If Lotus engages in product development or promotional activities which
impact its ability to generate revenues from the sale of Instant! Host,
the agreement will terminate and Lotus will be obligated to pay us up to
$250,000 in penalties depending upon the amount of royalties paid to us
through the date of termination.
Microsoft Corporation. We are a Microsoft Certified Solution Partner, or
MCSP, and are currently engaged in several strategic initiatives with Microsoft.
We have entered into a co-marketing and promotion agreement whereby Microsoft
will include our advertisements in a catalog that is inserted into every
FrontPage 2000 product box that is packaged for retail sale. Microsoft has also
agreed that it will issue a press release on its Web site highlighting our joint
involvement in the promotion of FrontPage 2000. In return, we have agreed to
feature Front Page 2000 on our Web site with greater frequency and visibility
than any competing product and have agreed to offer either free Web hosting with
a value of up to $105 or free or reduced registration and set-up fees with a
value of up to $500, in order to induce the public to host a FrontPage 2000 Web
site. This agreement remains in effect until the earlier of the initial release
of the next version of FrontPage, Microsoft ceasing to produce FrontPage, or
December 31, 2000.
We are also participating in a Microsoft initiative called the Complete
Commerce program. In conjunction with selected other MCSP's, we will incent
customers seeking to engage in e-commerce activities on the Web to enter into
this program by offering a specially priced, all inclusive storefront hosting
package integrating shipping, credit card processing and tax elements. The
service will also include consulting and development of the storefront
application Web site, back-end integration and hosting activities. Microsoft
will provide resources to help us market this program, including promotional
activities,
45
<PAGE> 230
marketing activities and participation in the customer engagement activities.
Our marketing activities for the Complete Commerce program commenced in April
1999. This relationship may be terminated at any time by either party. We
currently have no material financial commitments under either of these
agreements; and we do not expect either of these agreements to generate any
material financial commitments for us in the future.
UUNET Technologies, Inc. On February 17, 1999 we entered into an agreement
with UUNET to be our primary connectivity provider on a worldwide basis. The
agreement is scheduled to expire on February 19, 2002, but will be renewed
automatically for an additional year unless either party notifies the other of
its intent not to renew. Terms of this agreement include:
- UUNET has agreed to provide and we have agreed to purchase monthly
minimum levels of connectivity ranging from 100 Mbps to 600 Mbps of
bandwidth.
- Upon execution of this agreement we were committed to purchase 100 Mbps
of bandwidth per month.
- Our minimum monthly bandwidth purchase commitment increases to 300 Mbps
starting in December 1999 and increases further to 600 Mbps in December
2000.
- - We have agreed that, if during the second and third years of this agreement,
we obtain over 600 Mbps of bandwidth per month for our Internet traffic, we
will purchase 51% of all bandwidth in excess of 600 Mbps from UUNET. If we do
not purchase 51% of all bandwidth over 600 Mbps from UUNET, we are obligated
to pay UUNET $21.66 for each Mbps we are obligated but fail to purchase from
them.
Under the terms of the agreement, the connectivity may range in capacity
from T-1 to DS-3 to OC-12 which are the technical names of the physical
telecommunications connections or pipelines that will be used to transport data.
A larger pipeline can carry a greater volume of data at a greater speed. For
example, a T-1 can carry 1.544 megabytes per second; a DS-3 can carry 44.736
megabytes per second and an OC-12 can carry 622 megabytes per second. At our
Atlanta data center, we are currently installing four OC-3 connections, each of
which can carry 155.52 megabytes of data per second, to diverse hubs in UUNET's
network which use diverse fiber for redundancy. In addition to the connectivity
provisions, our companies have agreed to develop and implement a joint marketing
program including:
- allowing us to resell UUNET services through our network of resellers;
- cooperating on mutually beneficial hosting and co-located remarketing
agreements; and
- cooperating on an international co-location facilities agreement.
Our minimum financial commitment during each year of the agreement is as
follows: $0.7 million in year 1; $2.1 million in year 2; and $4.1 million in
year 3.
Equant, N.V. We have entered into a Network Services agreement in which
Equant, N.V. provides worldwide local dialup (X.25 and PPP) and dedicated (frame
relay) connectivity from more than 160 countries. The original agreement expired
on December 31, 1997, and since then we have continually renewed it for
successive three month terms. The current term expires on September 30, 1999.
Equant, N.V. provides significant discounts to us and competitive pricing
assurances. In addition, Equant, N.V. has entered into a distribution agreement
with us, in which Equant, N.V.'s worldwide sales force is able to offer our
groupware and application hosting services to its customers. The distribution
agreement terminates on December 19, 1999. We currently have no material
financial commitments under either of these agreements, nor do we expect either
of these agreements to generate any material financial commitments for us in the
future.
46
<PAGE> 231
Allaire Corporation. Allaire markets and distributes proprietary
commercial computer software products such as Cold Fusion Enterprise Application
Server, Cold Fusion Professional Application Server and Home Site. We have a
worldwide non-exclusive fee-bearing license to:
- reproduce exact copies of these software products onto our servers and to
allow our customers to use these products;
- reproduce exact object code copies of the products; and
- market and distribute the products as stand-alone products or bundled
with our other product offerings.
This one-year agreement commenced on February 2, 1999 and will be automatically
renewed for another year unless either party notifies the other that it elects
not to renew within sixty days of the original termination date. Upon execution
of the agreement we paid Allaire an aggregate of $66,552 covering product user
and subscription fees, distribution copies, training fees and annual support
fees. We are also obligated to purchase five additional hosted copies, products
and subscriptions during each of the last three calendar quarters of the
original term of the agreement at an aggregate price of approximately $15,000
per quarter.
In addition to the fees we pay for these licenses, we have agreed to
promote and market actively Allaire's products. We have also agreed to
participate in certain joint marketing and promotional activities.
Elemental Software, Inc. We have been granted a non-exclusive,
royalty-free license to market and resell Drumbeat(TM) 2000. By working with a
Drumbeat(TM) 2000 ISP Hosting Partner such as our company, organizations will be
able to publish data-driven Active Server Pages, or ASP, applications without
the need to set up and administer Web servers locally. As an ISP Hosting
Partner, we also provide hosting accounts for trial Drumbeat(TM) 2000 users.
Under this agreement, we are a Drumbeat(TM) 2000 reseller which means our
customers receive preferred pricing on each sale of Drumbeat(TM) 2000 generated
through the Elemental Software/Interliant e-commerce Web site. We have agreed to
undertake certain cross marketing activities to promote the launch of our
partnership, including press releases, Web advertising and a special promotion
by us of Drumbeat(TM) 2000. In addition, we have been given the opportunity to
provide an insert card to be included in the Drumbeat(TM) 2000 product packaging
promoting our services. This agreement, dated December 13, 1998, may be
terminated by either Elemental or us with thirty days prior notice to the other.
We do not have, nor do we expect to incur in the future any material financial
commitments as a result of this agreement.
iMALL, Inc. iMALL operates an Internet shopping mall and has created a
suite of e-commerce tools labeled iSTORE(TM) and Bolt-on e-commerce(TM).
Interliant and iMALL have agreed to use iMALL's experience and technical
infrastructure to create a mall where our customers can sell their products and
services online. Under the terms of the agreement, we pay iMALL for the use of
the Bolt-on e-commerce(TM) solution and iSTORE(TM) at various discounted rates
based on the number of iMALL accounts created by us. The aggregate amount of
fees payable under this agreement over the term of the agreement are not
material. Our agreement with iMALL states that it is intended to establish a
long-term relationship between us and iMALL and as such has a three-year term
which commenced on October 23, 1998.
Revenues and expenses generated by these strategic relationships are
recognized on an accrual basis. Where appropriate, revenue and expenses are
matched.
47
<PAGE> 232
SALES AND DISTRIBUTION
We sell our hosting services to our customers through a variety of sales
channels. The following schematic represents our sales approach. The prices set
forth below are for product offerings marketed under our brand.
[FLOW CHART]
<TABLE>
<S> <C> <C>
SMALL - MEDIUM MEDIUM -LARGE
TARGET BUSINESSES BUSINESSES
CUSTOMER ---------------------------------------- ----------------------------------------
MAINSTREAM RESELLERS VERY COMPLEX
WEB DEVELOPERS HOSTING SOLUTIONS
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
SERVICES WEB HOSTING & APPLICATION HOSTING &
OFFERED CONSULTING CONSULTING
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C> <C>
PRICING $25/MONTH $1,000 - 2,000/MONTH $100,000/MONTH
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C> <C>
SALES INTERNET TELESALES/ DIRECT
STRATEGY MARKETING INDIRECT SALES SALES
</TABLE>
We have historically used a variety of marketing and sales techniques,
including Internet marketing, telesales, indirect sales channels, such as
resellers and referral partners, and direct sales in order to increase our
market share. Our acquisition strategy has facilitated the integration of
different indirect and direct distribution channel models used by acquired
companies and has enabled us to customize them to fit the needs of specific
markets in which we compete.
Internet Marketing. Our Internet marketing sales program offers an
automated online sales interface to our customers that enables them to purchase
hosting services on a 24x7 basis from our Web site at www.interliant.com and
www.sagenetworks.com, or to purchase Internet rental application services at
www.appsonline.com.
Telesales. In the telesales area, we currently acquire, and plan to
develop further, our hosting accounts through inbound calls generated through
traditional media and outbound telesales to pre-qualified potential customers.
Indirect Sales. In the indirect sales channel area, our goal is to develop
the leading reseller and referral partner program in the industry through our
recently introduced business partner program. Our target partners include
reseller and referral partners, such as Web consulting firms, Internet service
providers, independent software vendors, network integration companies and
system integrators that have an established relationship with our prospective
customer base as well as a sales force capable of selling Internet services. The
benefits to us of using these indirect sales channels include greater market
reach without fixed overhead costs and the ability to use the partners to assist
in the delivery of complete
48
<PAGE> 233
solutions to meet customer needs. We offer our partners a discount from our
retail price on both products and services.
We believe that our business partner program offers its reseller and
referral partners a wide variety of benefits such as:
- financial incentives including volume discounts and/or royalties, waived
set up fees and advantageous software leasing opportunities;
- access to our hosting services and applications;
- advanced technical support;
- sales and marketing support services; and
- training and support programs.
Direct Sales. We have a sales group dedicated to selling hosting and
consulting solutions to large enterprises and other businesses whose Internet
operations are mission-critical.
As of the date hereof, we have 61 employees engaged in distribution and
sales.
MARKETING
We market our full range of hosting solutions under the Sage Networks and
Interliant brands via a marketing program that seeks to use a variety of media
and channels. We will continue to invest in building greater equity of the
Interliant brand worldwide, using a variety of marketing techniques including
print advertisements in key industry publications, broadcast advertising, direct
marketing and online advertising, such as general rotation and keyword-specific
Web banner advertisements. The focus of these branding efforts is primarily to
reinforce our position as a full service hosting provider. In addition, we will
also employ a number of other marketing tactics and communications vehicles,
such as product literature, trade shows, promotions with key hardware and
software vendors, direct response programs and our Web site to generate greater
numbers of qualified leads and to further increase awareness of our brand.
When an acquired company's brand is already well-established, we may for a
period of time continue to market certain products and services under that brand
to capitalize on the competitive advantages the acquired brand may bring to us.
Our long-term goal, however, is to migrate most of our acquired product
offerings to our brands. Our products are available from our primary Web site at
www.interliant.com as well as at www.appsonline.com.
We expect to increase our marketing expenditures in order to support our
brand marketing and lead-generation efforts. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
CUSTOMER SERVICE
We view customer service as a critical part of our business strategy. As of
the date hereof, our customer service group has 142 employees who are mainly
located in our Atlanta and Houston data centers. This group is responsible for
providing customer service to all of our customers as well as our resellers and
referral partners, including helping customers to initially set up their Web
sites, answering technical questions or helping customers use our application
hosting solutions and other enhanced offerings. Through our customer service
systems, customer service representatives can generally resolve any issues in a
timely manner via e-mail or our toll-free number.
Web Hosting Customer Service. Our Web hosting customers are primarily
serviced through our Atlanta data center. To ensure that each Web hosting
customer is connected with the customer service representative best able to
address its needs, our call center routing system, provided by Aspect
Communications, directs calls based on the phone number dialed or the menu
choice selected. In addition, the Vantive Support system, a customer/asset
management tracking application, enables a customer
49
<PAGE> 234
service representative to view a customer's entire account, including past and
recent interactions with such customer. Further, the Vantive Support system
provides a resolution database that recognizes and documents support records
into a central repository that can be accessed by all customer service
personnel. This database categorizes all reported problems so that if a
particular problem recurs, customer service representatives can view its prior
resolution and provide timely and accurate customer service. The Vantive Support
system is also linked to the Vantive Sales Force Automation module which helps
sales staff get current information on the status of accounts, recent problems
or account issues prior to calling customers to pursue new business
opportunities.
In addition to the Aspect and Vantive systems, we are in the process of
implementing the PORTAL Infranet billing system. With PORTAL Infranet, our
resellers, referral partners and customers will be able to obtain monthly
statements delivered electronically which we believe will provide them with
easily accessible and accurate tracking of their hosting expenditures. In
particular, we believe that PORTAL will allow resellers and referral partners to
add new products and services, as well as pricing discounts and incentive
programs, in a timely and cost-effective manner.
Application Hosting Customer Service. Our application hosting customers
are primarily serviced through our Houston data center. Customers serviced in
Houston can contact a Technical Support Engineer on a 24x7 basis to address
issues including registration, mail routing, connectivity or enhancements to a
customer account such as rolling out new databases and changing access control
lists. Certain customer accounts also have access to dedicated support engineers
who are familiar with each unique configuration or requirement a larger customer
may have. A focused support team handles all the application hosting support
requirements via several mechanisms including a facilitated discussion database
environment available over the Internet where customers, application developers
and support technicians can discuss pertinent issues and build a relevant
knowledge base. Customers may also access support staff through e-mail as well
as through a toll-free number.
Online Customer Service. We also provide resellers and customers who are
hosted in our Atlanta data center the opportunity to access an online control
panel which serves as a personalized, virtual customer service representative.
When fully implemented through PORTAL, this online control panel will enable
customers to find information they need such as billing histories, orders and
account profiles in a timely manner. In addition, at that time, the online
control panel will offer viewing of real-time billing statements and invoices,
the ability to order new or additional services, access to an online Web
development library, free applications and step-by-step guidance through common
Web publishing procedures. Thus, our resellers, referral partners and end users
hosted in Atlanta will have the option of accessing account and services
information themselves online or by calling the customer service centers.
TECHNOLOGY AND NETWORK OPERATIONS
We have developed a secure, reliable, high-performance, and scalable
hosting solution, which we believe provides a significant competitive advantage
in the market. This solution is comprised of multiple hosting platforms that
incorporate automated functionality and a network infrastructure that includes
multiple Internet data centers and is monitored on a 24x7 basis by our personnel
in Atlanta and Houston. Our strategy in developing our hosting solution focuses
on utilizing internally created technological innovations that we integrate with
leading software and hardware providers.
Web Hosting Platform. Although industry-standard Web servers are adequate
for basic Web hosting, we believe that efficiently managing large numbers of Web
sites and users on a single server requires significant technological
innovations. Accordingly, we have focused our technology development efforts on
creating various operating system level tools to facilitate a high customer to
server ratio. We have developed multiple Web hosting platforms that permit
efficient hosting of more than 5,000 Web sites on a Sun Microsystems, Inc.
Solaris server. We have also developed Web server applications designed to
improve performance in a virtual server environment, and we have implemented
resource monitoring tools designed to report and address scarcity of shared
computer processing units and memory resources. Our solution is scalable,
allowing servers to be added while being monitored centrally, independent of
where
50
<PAGE> 235
they are located. To address the diverse requirements of our customers, we offer
Web hosting services on a range of operating systems and computing platforms
including Solaris which operates on a Sun Microsystems, Inc. platform, Microsoft
Windows NT which operates on an Intel/PC platform and Linux which operates on a
Cobalt Networks, Inc. platform.
Application Hosting Platform. We maintain a state-of-the-art data center
in Houston from which we manage our application hosting services. This facility
features separate, redundant fiber and power connections, diesel generators,
cooling systems and uninterruptible power supplies designed to provide on site
power for up to four weeks. Quality and security are paramount concerns for our
customer base. Consequently, we employ several security measures including:
- 24x7 building guards;
- electronic surveillance;
- limited access electronic card key measures; as well as
- the physical separation of servers from administrative workstations.
The Houston facility includes high-end Compaq servers equipped with
multiple power supplies and RAID technology. Other strategic providers include
Sun Microsystems, Microsoft, and Lotus. We offer connectivity to our systems
from virtually anywhere in the world, enabling customers to deploy global
solutions. Customers can access us:
- via the Internet;
- through X.28 connections provided by Compuserve and Equant, N.V. in more
than 105 countries;
- over Frame Relay through AT&T Corp., Sprint Corporation and MCI Worldcom,
Inc.; or
- domestically via a toll-free number.
We use two DS-3 connections to the Internet provisioned directly off a
SONET ring. Internally developed management and monitoring systems provide
insight into the performance of our entire network, as well as consistency of
security measures across all of our current hosting platforms.
Network Operations. In order to provide our customers with high-quality
service, we have invested substantial resources in building our network
infrastructure. We have designed our network to minimize the effect of any
interruptions. We have also implemented security measures and monitoring systems
to ensure that our network is protected, identify potential sources of failure,
limit downtime and notify staff of any problems. Although we have attempted to
build redundancy into our network and hosting facilities, our data centers are
currently subject to various single points of failure, and a problem with one of
our routers or switches could cause an interruption in the services we provide
to some of our customers.
Our NOCs are responsible for monitoring our entire network on a 24x7 basis.
We monitor each piece of equipment, including routers, switches and servers. The
NOCs also monitor all Internet and telecommunications connections and ensure
that they are functional and properly loaded. The design of the NOCs enables
systems administrators and support staff to be promptly alerted to problems, and
we have established procedures for rapidly resolving any technical problems that
arise. The NOCs are fully integrated into our customer service facilities.
We currently have two primary data centers located in Atlanta and Houston.
These data centers are fitted with continuous monitoring capabilities, back-up
generators and environmental controls to ensure high-quality service with
minimal interruptions. The Atlanta data center is our primary Web hosting
facility and the Houston data center is our primary groupware and application
outsourcing facility. The customer service and network monitoring
infrastructures are based in Atlanta and Houston.
Our Virginia data center currently serves as a co-location facility. We
have recently entered into a ten-year lease for approximately 13,000 square feet
of space in Vienna, Virginia. We intend to use a portion of the proceeds from
this offering to complete construction of this space and create a third state-
51
<PAGE> 236
of-the-art data center for hosting and providing customer service. Once the
construction of this new space is completed, all of our Washington, D.C. area
operations will be moved into the new space. See " -- Facilities" and "Use of
Proceeds."
COMPETITION
The market served by us is highly competitive. Although barriers to entry
and continued growth are increasing, there are still few substantial barriers to
entry, particularly with respect to virtual hosting, and we expect that we will
face additional competition from existing competitors and new market entrants in
the future. The principal competitive factors in this market include:
- quality of service, including network capability, scalability,
reliability and functionality;
- customer service and support;
- variety of services and products offered;
- price;
- brand name;
- Internet system engineering and technical expertise;
- timing of introductions of additional value services and products;
- network security;
- financial resources; and
- conformity with industry standards.
We may not have the resources, expertise or other competitive factors to
compete successfully in the future.
Our current and potential competitors include:
- other Web hosting and Internet services companies such as AboveNet
Communications, Inc., Exodus Communications, Inc., Frontier GlobalCenter,
Globix Corporation and local and regional hosting providers;
- national and regional Internet service providers such as Concentric
Network Corporation, MindSpring Enterprises, Inc., UUNET Technologies,
Inc., PSINet Inc. and Verio Inc.;
- global telecommunications companies including AT&T Corp., British
Telecommunications plc, Telecom Italia SpA and Nippon Telegraph and
Telephone Corp.;
- regional and local telecommunications companies, including the regional
Bell operating companies such as Bell Atlantic Corporation and US West,
Inc.;
- companies that focus on application hosting such as USinternetworking,
Inc. and IBM Global Services; and
- audio and video content hosting companies such as broadcast.com.
Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do.
As a result, certain of these competitors may be able to develop and expand
their network infrastructures and service offerings more rapidly, adapt to new
or emerging technologies and changes in customer requirements more quickly, take
advantage of acquisition and other opportunities more readily, devote greater
resources to the marketing and sale of their services and adopt more aggressive
pricing policies than we can. In addition, these competitors have entered and
will likely continue to enter into joint ventures or consortia to provide
additional services competitive with those provided by us.
52
<PAGE> 237
In an effort to gain market share, certain of our competitors have offered
hosting services similar to ours at lower prices than ours or with incentives
not matched by us. In addition, certain of our competitors may be able to
provide customers with additional benefits, which could reduce the overall costs
of their services relative to those of us. We may not be able to reduce the
pricing of our services or offer incentives in response to the actions of our
competitors without a material adverse impact on our operating results. We also
believe that the market in which we compete is likely to encounter consolidation
in the near future, which could result in increased price and other competition
that could have an adverse effect on our business.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of copyright, trademark, service mark, trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in our services. We have no patented technology that would
preclude or inhibit competitors from entering our market. The steps taken by us
to protect our intellectual property may not prove sufficient to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies. The laws of certain foreign countries may
not protect our services or intellectual property rights to the same extent as
do the laws of the United States. We also rely on certain technologies that we
license from third parties. These third-party technology licenses may not
continue to be available to us on commercially reasonable terms. The loss of the
ability to use such technology could require us to obtain the rights to use
substitute technology, which could be more expensive or offer lower quality or
performance, and therefore have an adverse effect on our business.
To date, we have not been notified that our services infringe on the
proprietary rights of third parties, but third parties could claim infringement
by us with respect to current or future services. From time to time, we are
notified that the content of one of our customer's sites infringes on a third
party's trademark or copyright. In response, we inform the customer of such
claim and, if necessary, will terminate a customer's service. We expect that
participants in our markets will be increasingly subject to infringement claims
as the number of services and competitors in our industry segment grows. Any
such claim, whether meritorious or not, could be time-consuming, result in
costly litigation, cause service installation delays or require us to enter into
royalty or licensing agreements. Such royalty or licensing agreements might not
be available on terms acceptable to us or at all. As a result, any such claim
could have an adverse effect upon our business.
GOVERNMENT REGULATION
We are not currently subject to direct federal, state or local government
regulation, other than regulations that apply to businesses generally. Only a
small body of laws and regulations currently applies specifically to hosting and
commerce activities, or access to the Internet. Due to the increasing popularity
and use of the Internet, however, it is possible that laws and regulations with
respect to the Internet may be adopted at international, federal, state and
local levels, covering issues such as user privacy, freedom of expression,
pricing, characteristics and quality of products and services, taxation,
advertising, intellectual property rights, information security and the
convergence of traditional telecommunications services with Internet
communications. Although sections of the Communication Decency Act of 1996, the
CDA, that, among other things, proposed to impose criminal penalties on anyone
distributing "indecent" material to minors over the Internet were held to be
unconstitutional by the U.S. Supreme Court, similar laws may be proposed,
adopted and upheld. The nature of future legislation and the manner in which it
may be interpreted and enforced cannot be fully determined and, therefore,
legislation similar to the CDA could subject us and/or our customers to
potential liability, which in turn could have a material adverse effect on our
business, results of operations and financial condition. The adoption of any
such laws or regulations might decrease the growth of the Internet, which in
turn could decrease the demand for the services of us or increase the cost of
doing business or in some other manner have an adverse effect on our business.
We currently do not collect sales or other taxes with respect to the sale
of services or products in states and countries where we believe we are not
required to do so. We do collect sales and other taxes in
53
<PAGE> 238
the states we have offices and are required by law to do so. One or more
jurisdictions have sought to impose sales or other tax obligations on companies
that engage in online commerce within their jurisdictions. A successful
assertion by one or more jurisdictions that we should collect sales or other
taxes on our products and services, or remit payment of sales or other taxes for
prior periods, could have an adverse effect on our business.
In addition, applicability to the Internet of existing laws governing
issues such as property ownership, copyright and other intellectual property
issues, taxation, libel, obscenity and personal privacy is uncertain. The vast
majority of such laws were adopted prior to the advent of the Internet and
related technologies and, as a result, do not contemplate or address the unique
issues of the Internet and related technologies. Changes to such laws intended
to address these issues could create uncertainty in the marketplace that could
reduce demand for our services or increase the cost of doing business as a
result of costs of litigation or increased service delivery costs, or could in
some other manner have an adverse effect on our business.
Any new legislation or regulation, or the application of laws or
regulations from jurisdictions whose laws do not currently apply to our
business, could have an adverse effect on our business.
EMPLOYEES
As of the date hereof, we have 516 employees, including 19 on a contract
basis, of which 93 are in sales, distribution and marketing, 175 are in
engineering and service development, 142 are in customer service and technical
support, 99 are in finance and administration and 7 are in acquisition
integration. We believe that our future success will depend in part upon our
continued ability to attract, hire and retain qualified personnel. Although we
believe we have thus far been successful in this endeavor (including a high
retention rate of key employees from acquired companies), the competition for
such personnel is intense, and we may not be able to identify, attract and
retain such personnel in the future. None of our employees are represented by a
labor union, and management believes that our employee relations are good.
FACILITIES
Our executive offices are located in Purchase, New York and consist of
approximately 12,300 square feet that are leased pursuant to agreements that
expire in June 2004. We also lease approximately 15,740 square feet in Atlanta,
Georgia under an agreement that expires in June 2003 and approximately 1,000
square feet of space in McLean, Virginia area under a lease that expires in July
2001. We also lease 59,885 square feet of space in Houston, Texas under an
agreement that expires in August 2001 and office space in London, England. In
addition, we have recently leased approximately 13,000 square feet of space in
Vienna, Virginia under a lease that expires in 2009. A portion of the proceeds
of this offering will be used by us to complete and equip this space. Once the
construction of this space is completed, all of our McLean, Virginia operations
will be moved into this space. See "Use of Proceeds" and "Business -- Technology
and Network Operations."
LEGAL PROCEEDINGS
In the ordinary course of business, we may be involved in legal proceedings
from time to time. As of the date of this prospectus, there are no material
legal proceedings pending against us.
54
<PAGE> 239
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of Interliant are as follows:
<TABLE>
<CAPTION>
NAME AGE TITLE
- ---- --- -----
<S> <C> <C>
Leonard J. Fassler......................... 67 Co-Chairman, Director
Bradley A. Feld............................ 33 Co-Chairman, Director
Stephen W. Maggs........................... 45 Vice Chairman, Treasurer and Director
James M. Lidestri.......................... 38 President
Francis J. Alfano.......................... 38 Senior Vice President, Mergers and
Acquisitions
Rajat Bhargava............................. 26 Senior Vice President, Strategic Planning
and Integration
Jesse J. Bornfreund........................ 43 Senior Vice President, Business Development
Edward A. Cavazos.......................... 30 Senior Vice President, Legal and Business
Affairs and Assistant Secretary
Paul E. Chollett........................... 39 Senior Vice President, Finance and
Administration
Bruce S. Klein............................. 39 Senior Vice President, General Counsel and
Secretary
Jennifer J. Lawton......................... 35 Senior Vice President, Consulting and
Technology
Kristian Nelson............................ 35 Senior Vice President, Service Development
and Delivery
William A. Wilson.......................... 53 Chief Financial Officer
Merril M. Halpern.......................... 64 Director
Thomas C. Dircks........................... 41 Director
Patricia A. M. Riley....................... 57 Director
Jay M. Gates............................... 34 Director
Charles R. Lax............................. 39 Director
</TABLE>
Each director holds office for a one-year term or until a successor has
been duly elected and qualifies, or until his or her earlier death, resignation
or removal. Our executive officers are appointed annually by our Board of
Directors and serve at the discretion of the Board of Directors. Mr. Lax has
been elected to the Board of Directors pursuant to a contractual arrangement.
See "Description of Capital Stock -- The SOFTBANK Investment."
Leonard J. Fassler is one of our co-founders and has been one of our
Co-Chairmen and a Director since our formation in December 1997. Mr. Fassler was
also our Secretary from December 1997 through April 1999. From 1992 to 1996, Mr.
Fassler was a Co-Chairman of AmeriData Technologies, Inc. ("AmeriData"), a New
York Stock Exchange-listed reseller of computer equipment and provider of
computer consulting and other services that was acquired by General Electric
Capital Corporation in 1996. Mr. Fassler was a co-founder of AmeriData which
grew into a company with sales in excess of two billion dollars a year and
locations in ten countries at the time that it was acquired. Mr. Fassler holds a
bachelor's degree in business administration from City College of New York and a
law degree from Fordham Law School.
Bradley A. Feld is one of our co-founders and has been one of our
Co-Chairmen and a Director since our formation in December 1997. Since 1995, Mr.
Feld has been the President of Intensity Ventures Inc., a company that helps to
establish, advise and operate software companies. From 1993 to 1995, Mr. Feld
was the chief technology officer of AmeriData. From 1985 to 1993, he was
president of Feld Technologies, Inc., a computer consulting firm founded by Mr.
Feld to develop and implement information technology solutions for a wide
variety of businesses, which was acquired by AmeriData in 1993. Mr. Feld earned
a
55
<PAGE> 240
bachelor of science degree and a master of science degree from Massachusetts
Institute of Technology. Since 1997, Mr. Feld has been a General Partner of
SOFTBANK Technology Ventures IV, L.P. and SOFTBANK Technology Advisors Fund,
L.P., venture capital funds. Mr. Feld is a director and co-chairman of Message
Media, Inc., and director of a number of privately held companies.
Stephen W. Maggs is one of our co-founders. Mr. Maggs has been our Vice
Chairman since June 1999, and our Treasurer and a Director since our formation
in December 1997. Mr. Maggs held the positions of Chief Executive Officer and
President from our formation in December 1997 until June 1999. From December
1993 to December 1996, Mr. Maggs held a variety of senior management positions
with AmeriData, including serving as an executive vice president of operations
of AmeriData and Chairman of AmeriData Canada. From February 1992 to December
1993, he was the owner of Mericom Systems Inc., a reseller of computer equipment
and provider of computer consulting and other services, which was acquired by
AmeriData in 1993. From 1984 to 1991, he held various executive positions at
Inacom Information Systems, a provider of information technology products and
services. Mr. Maggs received a bachelor of science degree from Hillsdale
College, Hillsdale, Michigan and is a Certified Public Accountant.
James M. Lidestri has been our President since June 1999. Mr. Lidestri
served as our Executive Vice President from March 1999 until June 1999. From
March 1996 to March 1999, Mr. Lidestri was the President and Chief Executive
Officer of Interliant Texas. From February 1995 to March 1996, Mr. Lidestri was
employed at IBM Corporation, a vendor of technology systems, products, services
and software and financing where he served as Group Manager of the Collaborative
Services Division. As Group Manager, Mr. Lidestri was responsible for developing
market and product strategies for network-based collaborative services, with a
primary focus on Lotus Notes. From November 1990 to February 1995, Mr. Lidestri
served in a number of executive positions at Sprint Corporation, a global
communications company, including Director of Business Operations. Mr. Lidestri
holds a bachelor of science degree in computer science from Rensselaer
Polytechnic Institute and a masters degree in business administration from New
York University.
Francis J. Alfano has served as our Senior Vice President, Mergers and
Acquisitions since December 1998. From January 1997 to November 1998, Mr. Alfano
was Vice President of Business Development at GE Capital Information Technology
Solutions, Inc., formerly AmeriData. From July 1994 to December 1996, Mr. Alfano
was Director of Taxes at GE Capital Information Technology Solutions, Inc. From
January 1991 to June 1994, Mr. Alfano was employed by Ernst & Young, an
accounting, tax and consulting firm, and was a senior manager in the tax
department at the time of his departure. From 1984 to 1990, Mr. Alfano was
employed as a Certified Public Accountant with various public accounting firms.
Mr. Alfano holds a bachelor of science degree in business administration from
the University of Arizona and is a Certified Public Accountant.
Rajat Bhargava is one of our co-founders and has been our Senior Vice
President, Strategic Planning and Integration since March 1999. He was our Chief
Operating Officer from our formation in December 1997 through March 1999. During
the period from January 1994 to June 1997, he served as Chairman, President and
Chief Executive Officer of Net.Genesis Corp., an Internet software company which
he founded. From 1991 to 1993, he worked in various engineering positions at
Intel Corporation, a manufacturer of computer networking and communications
technologies. Mr. Bhargava received a bachelor of science degree in electrical
engineering and computer science from Massachusetts Institute of Technology in
1995.
Jesse J. Bornfreund has served as our Senior Vice President, Business
Development since March 1999. From July 1996 until he joined us, Mr. Bornfreund
was Senior Vice President, Strategic Alliances of Interliant Texas. In such
position, Mr. Bornfreund was responsible for managing the strategic alliances of
Interliant Texas and the development of its business. From February 1996 through
June 1996, Mr. Bornfreund served as a Corporate Strategy Consultant at IBM
Corporation with primary responsibilities that included the development of
corporate business and technology strategies and recommendations. From February
1994 to February 1996, Mr. Bornfreund was a Program Manager for the
Collaborative Services Group of IBM Corporation. As Program Manager, Mr.
Bornfreund was responsible
56
<PAGE> 241
for strategic planning, business and market development activities and
development and management of partner relationships. Mr. Bornfreund holds a
bachelor of science degree in biology from Stockton State College.
Edward A. Cavazos has served as Senior Vice President, Legal and Business
Affairs of Interliant since March 1999. In April 1999, he became our Assistant
Secretary. From March 1997 until he joined Interliant, Mr. Cavazos was Senior
Vice President, General Counsel of Interliant Texas. From May 1994 until March
1997, Mr. Cavazos was an associate attorney at the law firm of Andrews & Kurth,
L.L.P. In addition, Mr. Cavazos served as an Adjunct Professor at the University
of Texas School of Law from January 1998 through May 1998 and as an Adjunct
Professor at the University of Houston Law Center from September 1996 through
December 1996 and September 1997 through December 1997. Mr. Cavazos holds a
bachelor of arts degree in philosophy from the University of Texas and a law
degree from the University of Texas.
Paul E. Chollett has served as Senior Vice President, Finance and
Administration of Interliant since March 1999. From July 1996 until he joined
Interliant, Mr. Chollett was Senior Vice President and Chief Financial Officer
of Interliant Texas. From July 1993 to July 1996, Mr. Chollett was the Director
of Finance and Administration in the Audit Division of the accounting firm of
Arthur Andersen, LLP. In this role, Mr. Chollett was responsible for managing
the financial, risk management and quality control aspects of the firm's audit
practice. Mr. Chollett holds a bachelor of science degree in accounting from the
University of Houston at Clear Lake City. Mr. Chollett is a Certified Public
Accountant.
Bruce S. Klein has served as our Senior Vice President, General Counsel
since December 1998. In April 1999, Mr. Klein became our Secretary. From April
1998 to November 1998, he was our General Counsel, Vice President. In addition,
from June 1998 to present, Mr. Klein has been of counsel to the law firm of
McCarthy, Fingar, Donovan, Drazen & Smith, L.L.P. From January 1996 through
March 1998, Mr. Klein was of counsel to the law firm of Spitzer & Feldman P.C.,
prior to which he was partner at the law firm of Halperin Klein & Halperin, in
each case engaged in the general practice of law, with experience in mergers and
acquisitions and general corporate and business law. Mr. Klein is admitted to
practice law in New York and Massachusetts and holds a bachelor's degree in
business administration from Rutgers University and a law degree from Western
New England College School of Law.
Jennifer J. Lawton has served as our Senior Vice President, Consulting and
Technology since February 1999. From May 1992 until she joined us, Ms. Lawton
was the Chief Executive Officer of Net Daemons Associates, Inc., a provider of
Web development and system integration activity for Internet and IT Networks
which was acquired by Interliant in February 1999. Ms. Lawton is a co-founder of
Net Daemons Associates, Inc. Ms. Lawton holds a bachelor of science degree in
applied mathematics from Union College.
Kristian Nelson has served as our Senior Vice President, Service
Development and Delivery since March 1999. From July 1997 until he joined us,
Mr. Nelson was Senior Vice President, Operations of Interliant Texas and was
responsible for the direction and control of all operational aspects of
Interliant Texas's business including product development, customer service and
application and data center services. From June 1996 through May 1997, Mr.
Nelson served as Vice President, Operations at GST Telecommunications, a
full-service telecommunications provider. In this role, Mr. Nelson was
responsible for the oversight and control of such company's Internet subsidiary,
GST Internet Inc. From June 1995 to January 1996, Mr. Nelson was a Senior
Management Consultant in the Technology Strategy Practice area at Gartner Group,
Inc., a company which provides IT advisory services and consulting where his
responsibilities included providing technical consulting services to Fortune 500
companies. From May 1986 to May 1995, Mr. Nelson was the Product Assurance
Information Technology Director at Lockheed Martin Corporation, a diversified
technology company. As such, Mr. Nelson was responsible for developing and
implementing information technology strategic planning for the Product Assurance
Group. Mr. Nelson holds a bachelor of science degree in management science from
Orlando College.
William A. Wilson has served as our Chief Financial Officer since September
1998. During the period from February 1998 to July 1998, Mr. Wilson served as
Vice President, Finance and Chief Financial Officer at XCOM Technologies, Inc.,
a competitive local exchange carrier. From October 1997 to
57
<PAGE> 242
February 1998, Mr. Wilson served as a consultant to several private companies.
From June 1997 to October 1997, Mr. Wilson served as Senior Vice President,
Finance and Chief Financial Officer of Computervision Corporation, a software
publishing and development company. Prior thereto, Mr. Wilson was Executive Vice
President and Chief Financial Officer of Arch Communications Group, Inc., a
wireless messaging company, from June 1996 to June 1997 and was Vice President,
Finance and Chief Financial Officer of Arch Communications Group, Inc. from
January 1989 to June 1996. Mr. Wilson received a bachelor of arts degree from
Luther College, a master of science degree from Northeastern University and a
masters degree in business administration from Babson College. Mr. Wilson is a
Certified Public Accountant.
Merril M. Halpern has been one of our Directors since our formation in
December 1997 and is Chairman and Chief Executive of Charterhouse Group
International, Inc. ("Charterhouse"), which he founded in 1973. Mr. Halpern is a
director of Microwave Power Devices, Inc., and United Road Services, Inc., as
well as several private companies. He received a bachelor of science degree from
Rutgers University and a masters degree in business administration from Harvard
University.
Thomas C. Dircks has been one of our Directors since our formation in
December 1997 and is a Managing Director of Charterhouse. Mr. Dircks has been
employed as an officer of Charterhouse since 1983. He was previously employed as
a Certified Public Accountant at a predecessor of PricewaterhouseCoopers LLP. He
holds a bachelor of science degree in accounting and a masters degree in
business administration from Fordham University. He is a director of a number of
privately-held companies.
Patricia A. M. Riley has been one of our Directors since our formation in
December 1997 and is a Managing Director of Charterhouse and has been an
executive officer with the firm since 1977. She is a graduate of the Advanced
Management Program at Harvard Graduate School of Business Administration and
received a bachelor of arts degree from Hunter College.
Jay M. Gates has been one of our Directors since our formation in December
1997 and is a Vice President of Charterhouse. He joined Charterhouse in 1994 as
an Analyst. Mr. Gates was previously employed as a Senior Analyst in the
Financial Consulting Advisory Group of the accounting firm of Arthur Andersen
LLP. Prior to that he was an Assistant Treasurer at Bankers Trust Corporation.
He holds a bachelor of arts degree from the State University of New York at
Binghamton and a masters degree in business administration from New York
University, Leonard N. Stern School of Business. He is also a director of a
number of privately-held companies.
Charles R. Lax has been one of our Directors since January 1999. He has
been a General Partner of SOFTBANK Technology Ventures IV, L.P. since November
1997. From March 1996 to November 1997, Mr. Lax was a Vice President of SOFTBANK
Holdings Inc. He was previously a venture partner at Vimac Partners LLC, a
venture capital firm specializing in investments in the information technology
and Internet-related industry. Mr. Lax holds a bachelor of science degree from
Boston University. He is a director of a number of privately-held companies.
Our Board of Directors has nominated John B. Landry to serve as a Director
effective upon consummation of this offering. Mr. Landry, age 51, has been
Strategic Technology Consultant to senior management of IBM Corporation since
June 1995. In addition, from October 1995 to January 1999, he was Chairman of
the Board of Narrative Communications Corporation, an Internet-based interactive
advertising company. In January 1999, Narrative was acquired by At Home
Networks. From 1990 to 1995, Mr. Landry was Senior Vice President and Chief
Technology Officer of Lotus Development Corporation, a provider of software
products and services. Mr. Landry is also a director of Skycache, Inc., MCK
Communications Corp., FlexiInternational Software, Inc., and AnyDay.COM. Mr.
Landry is currently providing consulting services to us and in connection with
his consulting arrangement has been granted options to purchase 15,000 shares of
common stock at an exercise price of $10 per share.
58
<PAGE> 243
DIRECTOR COMPENSATION
Directors receive no remuneration for serving on our Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
Our Board of Directors has standing Audit and Compensation Committees. The
Audit Committee consists of Mr. Thomas C. Dircks and Ms. Patricia A. M. Riley.
Among other functions, the Audit Committee makes recommendations to our Board of
Directors regarding the selection of independent auditors, reviews the results
and scope of the audit and other services provided by our independent auditors,
reviews our financial statements and reviews and evaluates our internal control
functions. The Compensation Committee consists of Mr. Thomas C. Dircks, Ms.
Patricia A. M. Riley and Mr. Charles R. Lax. The Compensation Committee
determines executive compensation and stock option grants and makes
recommendations to our Board of Directors concerning salaries and incentive
compensation for our employees and consultants.
EXECUTIVE COMPENSATION
Effective January 1, 1999, we entered into one-year employment agreements
with each of Messrs. Fassler, Maggs and Bhargava pursuant to which they each
will receive a salary of $180,000 for the period ending December 31, 1999.
Effective January 1, 1999, we also entered into a one-year consulting agreement
with Mr. Feld through Intensity Ventures, Inc. pursuant to which he will receive
a consulting fee of $180,000. On March 10, 1999, we entered into an employment
agreement with Mr. Lidestri for a term commencing on that date and terminating
on March 1, 2001 unless either of us exercises our rights to terminate the
agreement sooner. The agreement provides for a $150,000 signing bonus,
two-thirds of which was paid in April 1999 and the balance of which is payable
on March 10, 2000, an annual base salary of $180,000 and a performance-based
annual bonus of up to $70,000. See "-- Employment Agreements." We also have
employment agreements with certain other senior officers.
59
<PAGE> 244
The following table sets forth the total compensation for fiscal 1998 of
our Vice Chairman and each of the other four most highly compensated executive
officers whose total salary and bonus for fiscal 1998 is estimated to exceed
$100,000:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
---------------------------------- NUMBER OF
OTHER SECURITIES
ANNUAL UNDERLYING ALL OTHER
NAME OF EXECUTIVE OFFICER AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SARS COMPENSATION
- ------------------------------------------------ ---- -------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Stephen W. Maggs........................... 1998 $130,232(1)
Vice Chairman,........................... -- -- -- --
Treasurer and Director
Francis J. Alfano.......................... 1998 $ 12,500(2) -- -- -- --
Senior Vice President,
Mergers and Acquisitions
Rajat Bhargava............................. 1998 $120,152
Senior Vice President,................... -- -- -- --
Strategic Planning and Integration
Bruce S. Klein............................. 1998 $116,667(3) -- $15,635(4) -- --
Senior Vice President,
General Counsel and Secretary
William A. Wilson.......................... 1998 $ 48,894(5) -- -- -- --
Chief Financial Officer
</TABLE>
- ---------------
(1) Although Mr. Maggs commenced employment with us on December 8, 1997, he was
not put on our payroll until January 1, 1998. As a result, Mr. Maggs was
paid $10,000 in 1998 as compensation for his employment in 1997.
(2) Reflects salary received by Mr. Alfano from the commencement of his
employment with us on December 1, 1998 through December 31, 1998.
(3) Reflects salary received by Mr. Klein from the commencement of his
employment with us in April 1998 through December 31, 1998.
(4) Reflects income received by Mr. Klein in his capacity as an independent
consultant prior to becoming our employee.
(5) Reflects salary received by Mr. Wilson from the commencement of his
employment with us on September 22, 1998 through December 31, 1998.
OPTION GRANTS IN LAST FISCAL YEAR
None of the named executive officers were granted options in the last
fiscal year. On April 15, 1999, our Compensation Committee granted an aggregate
of 375,000 options to senior management, including:
- options to purchase 30,000 shares of common stock at an exercise price of
$8.00 per share to Stephen W. Maggs;
- options to purchase 30,000 shares of common stock at an exercise prices
of $8.00 per share to Rajat Bhargava;
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to Francis J. Alfano;
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to Bruce S. Klein; and
60
<PAGE> 245
- options to purchase 25,000 shares of common stock at an exercise price of
$8.00 per share to William A. Wilson.
STOCK OPTION PLAN
Our Board of Directors has adopted and our stockholders have approved the
Interliant 1998 Stock Option Plan, under which stock options may be granted to
our officers, employees and consultants and to officers, employees and
consultants of our subsidiaries. Our stock option plan allows our Board of
Directors to award up to an aggregate of 3,800,000 options to purchase an
identical number of shares of our common stock to qualified recipients. As of
the date of this prospectus, our Board has granted a total of 3,713,994 options.
Any options which have been granted but which expire or terminate unexercised
are returned to the plan and may be granted at a later date to any qualified
recipient.
Our stock option plan is administered by the Compensation Committee of the
Board of Directors. The Committee has the authority to determine:
- the persons to whom options will be granted;
- when options will be granted;
- the number of shares subject to each option;
- the exercise price of each option;
- the time or times at which the options will become exercisable;
- the duration of the exercise period; and
- provide for the acceleration of the exercise period.
In addition, if we are involved in a merger, reorganization, stock split or
other type of corporate transaction that would diminish the value of our
outstanding options, the Compensation Committee may adjust the number of options
granted and/or the exercise price of such options in order to ensure that option
holders are treated equitably.
Our stock option plan also permits the grant of stock options that qualify
as incentive stock options ("ISOs") under Section 422 of the Internal Revenue
Code and nonqualified stock options ("NSOs"), which do not so qualify.
The exercise price of options granted under our stock option plan may not
be less than 100% of the fair market value of the common stock on the date of
grant. The maximum term of options granted under our stock option plan is 10
years from the date of grant. ISOs granted to any employee who is a 10%
shareholder of Interliant are subject to special limitations relating to the
exercise price and term of the options. The value of common stock subject to
ISOs that become exercisable by any one employee in any one year is limited by
the Internal Revenue Code to $100,000. For this purpose, the value of common
stock is determined at the time of grant. Options granted under our stock option
plan will generally become vested and exercisable over a four-year period in
equal annual installments. However, if any of the events listed below occurs and
provided that no written provision has been made, in connection with any such
event, for (1) the continuation of the stock option plan and/or the assumption
of all outstanding options by a successor corporation, or (2) the substitution
for such options of new options covering the stock of a successor corporation
then each option that was not then vested prior to such event will become fully
vested and immediately exercisable:
- An acquisition by any person or group of related individuals of
beneficial ownership of 30% or more of either the outstanding shares of
our common stock or the combined voting power of our outstanding voting
securities;
- A change in the composition of our Board of Directors during any period
of two consecutive years which results in the directors in office at the
beginning of such period plus any newly elected or nominated directors no
longer constituting at least a majority of our Board of Directors;
61
<PAGE> 246
- The approval by our stockholders of a merger, consolidation or
reorganization in which outstanding shares of our common stock are
converted into:
- shares of stock of another company, unless our stockholders end up
owning 80% or more of the voting power of such other company;
- other securities of our company or another company unless our
stockholders hold at least 80% of the voting power of our company or
such other company; or
- cash or other property;
- The approval by our stockholders of the sale or other disposition of all
or substantially all of our assets or our liquidation or dissolution; or
- The adoption by our Board of Directors of a resolution to the effect that
any person has acquired effective control of our business and affairs.
All options granted under our stock option plan may not be transferred,
except upon the death of the optionholder in accordance with his will or
applicable law. In the event of an optionee's death or permanent and total
disability, outstanding options that have become exercisable will remain
exercisable for a period of one year, and the Committee will have the discretion
to determine the extent to which any unvested options shall become vested and
exercisable in connection with such death or disability. In the case of any
other termination of employment, except for a termination for cause as described
below, outstanding options that have previously become vested will remain
exercisable for a period of 90 days. All unexercised options will be immediately
forfeited by any employee who is terminated as a result of any of the following:
- embezzlement or misappropriation of corporate funds;
- conviction for a felony;
- misconduct resulting in material injury to us;
- significant activities harmful to our reputation of the reputation or any
of our subsidiaries;
- a significant violation of our corporate policies;
- willful refusal to perform, or substantial disregard of, the duties
properly assigned to the option holder;
- a significant violation of any contractual, statutory or common law duty
of loyalty to us or any of our subsidiaries.
Under our stock option plan, the exercise price of an option is payable in
cash or, in the discretion of the Committee, in common stock or a combination of
cash and common stock. An optionee must satisfy all applicable tax withholding
requirements at the time of exercise.
Our stock option plan has a term of 10 years, and all options granted under
the Plan prior to its termination remain outstanding until they have been
exercised or are terminated in accordance with their terms. Our Board of
Directors may amend the Plan at any time.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Dircks and Ms. Riley served as members of our Compensation Committee
during fiscal year 1998. During 1998, no committee member was an officer or
employee of ours. In addition, no interlocking relationship exists between our
Board of Directors or our Compensation Committee and the board of directors or
compensation committee of any other company, nor has any such interlocking
relationship existed in the past.
62
<PAGE> 247
EMPLOYMENT AGREEMENTS
We have entered into employment agreements with Messrs. Fassler, Maggs and
Bhargava, pursuant to which each will receive annual compensation of $180,000.
The Agreements provide for a term of one year and will renew automatically for
additional one-year terms unless we or the employee deliver a notice of
non-renewal at least three months prior to termination of the term. Under the
Agreements, the employees are also entitled to participate in our employee
benefit plans which are generally available to our senior officers.
The Agreements include provisions that are effective upon the termination
of employment of the employees under certain circumstances. In general, the
employees are entitled to severance upon termination by us without "cause." The
severance shall be equal to the amount of the employee's base salary yet to be
paid for the unexpired portion of the term of the Agreement, discounted based on
a specified published interest rate. In the event of termination due to death or
disability for a specified period of time, the employee or the employee's
estate, as applicable, shall be entitled to receive one-year's base salary,
discounted based on a specified published interest rate and we shall continue to
provide the employee, his spouse and minor children, as applicable, with certain
medical and other benefits through the end of the term of the Agreement.
For our protection, the agreements prohibit Messrs. Fassler and Bhargava
during and for periods of twenty-four and twelve months, respectively after the
end of their individual employment, from:
- Soliciting any customers which are in any way related to our business;
- Competing with us in any way; or
- Disclosing or enabling anyone else to use any information he obtains
during his employment.
Each Agreement also prohibits Messrs. Fassler and Bhargava from:
- Interfering or attempting to disrupt our business relationship with
customers or suppliers; or
- Soliciting our employees.
The prohibitions contained in Mr. Maggs's contract are identical to those
contained in Mr. Fassler's contract, except Mr. Maggs is not prohibited from
engaging in Internet related business activities through Channel Reps, Inc. or
any of its subsidiaries or divisions or Channel Force, Inc.
Mr. Feld, through Intensity Ventures, Inc., has entered into a one-year
consulting agreement with us with substantially identical terms to the
agreements described above, except that Mr. Feld is not prohibited from
competing with us and is not entitled to participate in our employee benefit
plans. His annual consulting fee of $180,000 will be paid to Intensity Ventures,
Inc. on a gross basis as an independent contractor.
We have also entered into a two-year employment agreement with Mr. Lidestri
which shall automatically be extended on a month-to-month basis from the end of
the term unless we or Mr. Lidestri deliver a notice stating a desire to
terminate the agreement. The agreement provides for an annual base salary of
$180,000 and an annual bonus of up to $70,000 based upon whether Mr. Lidestri
meets or exceeds specified performance objectives. In addition, under the
agreement, we are obligated to pay Mr. Lidestri a signing bonus of $150,000 with
$100,000 of such bonus having been paid in April 1999 and the remaining $50,000
of which is payable on the first anniversary of the agreement.
Under the agreement, Mr. Lidestri is entitled to participate in our
employee benefit plans which are generally available to our employees. The
agreement states that upon termination of Mr. Lidestri's employment by us
without cause or by Mr. Lidestri as allowed under the agreement, he shall be
entitled to severance comprised of the following components:
- any remaining unpaid portion of his signing bonus; plus
63
<PAGE> 248
- the greater of (A) the unpaid portion of his annual base salary and
other compensation for the remainder of the term of the agreement,
including a pro rata portion of the performance-based bonus for the
year in which his employment is terminated, or (B) an amount equal
to six months of his annual base salary and other compensation for
the remainder of the term of the agreement plus a pro rata portion
of the performance-based bonus for the year in which his employment
is terminated.
In addition, Mr. Lidestri shall be entitled to participate in our benefit
programs for a minimum of six months from the date of termination.
If we terminate the agreement for cause, Mr. Lidestri shall be entitled to
receive only the unpaid portion of his base salary and all vested benefits under
any benefit programs, in each case, through the date of termination.
In the event of termination due to death or disability during the term of
the agreement, Mr. Lidestri or Mr. Lidestri's estate, as applicable, shall be
entitled to receive all accrued and unpaid portions of his annual base salary to
the date of his death or disability and all employee benefits accrued but unpaid
to the date of his death or disability.
Under the terms of the agreement for a period of time following termination
of Mr. Lidestri's employment with us, which shall be either one year from such
termination, one year following the expiration of the agreement or two years
following the date of the agreement depending upon the reason for termination,
Mr. Lidestri is prohibited from engaging in the following activities:
- Competing with us or any of our subsidiaries in any way, except as an
officer, director, shareholder or employee of ours or any of our
affiliates.
- Soliciting or interfering with, or attempting to hire:
- any person who was employed by us or one of our affiliates or
subsidiaries during the 12 months before the end of the agreement;
- any person who was a customer or client or requested or received a
proposal from us or one of our affiliates or subsidiaries during the
12 months before the end of the agreement; or
- Using, disclosing or publishing any confidential material related to our
business or the business of any of our subsidiaries or affiliates which
he acquired while employed with us, unless the material is publicly
available, otherwise lawfully obtained or must be disclosed by law.
64
<PAGE> 249
RELATED PARTY TRANSACTIONS
Since our inception, Web Hosting Organization LLC, SOFTBANK Technology
Ventures and SOFTBANK Technology Advisors Fund L.P. have each purchased
securities from us.
SALE OF STOCK TO THE SOFTBANK PURCHASERS
In January 1999, the SOFTBANK Purchasers purchased from us an aggregate of
2,647,658 shares of our Redeemable Convertible Preferred Stock and 749,625
warrants to purchase shares of common stock for an aggregate purchase price of
$13.0 million. In April 1999, the SOFTBANK Purchasers exercised the 749,625
warrants for an identical number of shares of common stock at an aggregate
exercise price $5.0 million.
SALE OF STOCK TO WEB HOSTING ORGANIZATION LLC
WEB owns 25,200,000 shares of our common stock which were acquired from us
in a series of six transactions in December 1997, May 1998, June 1998, September
1998, December 1998 and February 1999, in each case at a price, giving effect to
the 3-for-1 stock split effected in July 1998, of $1.67 per share.
The principal members of WEB are Charterhouse Equity Partners III, L.P.
("CEP III") and WHO Management LLC. Leonard J. Fassler and Bradley A. Feld, our
Co-Chairmen, are the member managers of WHO. Bradley A. Feld is a general
partner of the SOFTBANK Purchasers. See "Description of Capital Stock -- The WEB
Hosting Investment" and " -- The SOFTBANK Investment."
DISTRIBUTIONS BY OUR SIGNIFICANT STOCKHOLDER
Pursuant to the terms of the Limited Liability Company Agreement of WEB
dated as of November 26, 1997, as amended by Amendment No. 1, dated as of March
4, 1998, the members of WEB shall be entitled to receive a distribution of all
cash funds or other property of WEB available from any source other than the
ordinary operations of its subsidiaries, after payment of all expenses of WEB
due at the time of such distribution ("Total Proceeds"). The Total Proceeds
shall be distributed to the members of WEB in tranches with priority given to
covering members' federal tax liability, followed by return of capital and then
as necessary to achieve specified internal rates of return. Thereafter, portions
of the Total Proceeds will be distributed to WHO for the benefit of our
co-founders and the members of our senior management, other senior employees,
employees who were hired shortly after our formation and consultants as
described below.
Of the management distributions to WHO, 70% are retained by WHO for
distribution to our co-founders, who are Messrs. Fassler, Feld, Maggs and
Bhargava, and 30% are distributed to SMI Fund LLC, a New York limited liability
company, for distribution to its members.
There are a total of 18 members of SMI, all of whom are either executive
officers, senior employees, employees who were hired shortly after our formation
or consultants. Following is a list of the six senior management members who are
members of SMI. The percentage next to each of their names indicates the
percentage of amounts distributed to SMI that flow through to such person:
<TABLE>
<S> <C>
Mr. Frank Alfano...................................... 5.0%
Mr. Edward A. Cavazos................................. 3.5%
Mr. Paul E. Chollett.................................. 3.5%
Mr. Bruce S. Klein.................................... 10.0%
Mr. James M. Lidestri................................. 10.0%
Mr. William A. Wilson................................. 6.7%
</TABLE>
65
<PAGE> 250
The management distributions to WHO described above increase as the members
of WEB realize specified internal rates of return on their investment in WEB.
The following diagram depicts the flow of the distribution of Total Proceeds to
the members of WEB described above. No Total Proceeds have been distributed to
date.
[Flow Chart]
FEES PAID BY US TO OUR SIGNIFICANT STOCKHOLDERS
During 1999 and 1998, in connection with certain of our acquisitions, we
paid or accrued transaction fees of approximately $361,000 and $337,000,
respectively, to Charterhouse, which is an affiliate of CEP III. Such fees were
paid pursuant to the terms of the WEB LLC Agreement which require WEB or its
affiliates, which includes us, to pay Charterhouse two percent (2%) of the total
transaction costs of each acquisition or investment by WEB or its affiliates,
which includes us, in which Charterhouse or any of its affiliates directly or
indirectly provide all or a portion of the equity financing therefor.
Charterhouse will not receive any fees with respect to this arrangement in the
future.
CONSULTING AND EMPLOYMENTS AGREEMENTS WITH OUR CO-FOUNDERS
During 1998, we paid consulting fees of $120,000 to each of Sage Equities,
Inc. and Intensity Ventures Inc, whose principals are Messrs. Fassler and Feld,
respectively, pursuant to consulting agreements with each of them. Effective
January 1, 1999, we entered into employment agreements with Messrs. Fassler,
Maggs and Bhargava and a consulting agreement with Mr. Feld, through Intensity
Ventures, Inc., pursuant to which each will be paid annual compensation of
$180,000. See "Management -- Employment Agreements."
66
<PAGE> 251
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the common stock as of July 7, 1999 and as adjusted to reflect the
sale of the shares of common stock offered hereby by (i) each person or entity
known to us to own beneficially more than 5% of the outstanding shares of common
stock, (ii) each of our directors, (iii) each of the named executive officers
and (iv) all directors and executive officers as a group. Unless otherwise
indicated below, to our knowledge, all persons listed below have sole voting and
investment power with respect to their shares of common stock, except to the
extent authority is shared by spouses under applicable law.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE OWNED AFTER THE
OFFERING(1) OFFERING(1)
--------------------- ---------------------
BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- ---------------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Web Hosting Organization LLC(2).................. 25,200,000 77.4 25,200,000 59.7
c/o Charterhouse Group International, Inc.
535 Madison Avenue
New York, NY 10022
Charterhouse Group International, Inc.(2)........ 25,200,000 77.4 25,200,000 59.7
535 Madison Avenue
New York, NY 10022
Mathew Wolf(3)................................... 3,945,090 12.1 3,945,090 9.3
1001 Fannin Street
Suite 2000
Houston, TX 77002
SOFTBANK Technology Ventures IV, L.P.(4)......... 3,397,283 9.6 3,397,283 8.0
333 West San Carlos
Suite 1225
San Jose, CA
Leonard J. Fassler(5)............................ 25,200,000 77.4 25,200,000 59.7
Bradley A. Feld(5)(6)............................ 25,200,000 77.4 25,200,000 59.7
Stephen W. Maggs(5).............................. 25,200,000 77.4 25,200,000 59.7
Francis J. Alfano................................ -- -- -- --
Rajat Bhargava(5)................................ 25,200,000 77.4 25,200,000 59.7
Bruce S. Klein................................... -- -- -- --
William A. Wilson................................ -- -- -- --
Merril M. Halpern(8)............................. -- -- -- --
Thomas C. Dircks(8)(9)(10)....................... -- -- -- --
Patricia A.M. Riley(8)(9)(10).................... -- -- -- --
Jay M. Gates(8).................................. -- -- -- --
Charles R. Lax(7)(9)............................. 3,397,283 9.6 3,397,283 8.0
All Directors and Executive Officers as a
Group(5), (6), (7) and (8) (18 persons)........ 29,471,467 83.3 29,471,467 69.5
</TABLE>
- ---------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, based on factors including voting and
investment power with respect to shares. Shares of common stock subject to
options currently exercisable within 60 days of July 7, 1999 are deemed
outstanding for the purpose of computing the percentage of ownership of the
person holding such options, but are not deemed outstanding for computing
the percentage ownership of any other person.
(2) The principal members of WEB are CEP III, an affiliate of Charterhouse Group
International, Inc., and WHO. Their respective ownership interest in WEB are
as follows: CEP III: 95.2% and WHO 4.8%. Leonard J. Fassler and Bradley A.
Feld are the member managers of WHO and Stephen W. Maggs and Rajat Bhargava
are among the members. The general partner of CEP III is CHUSA
67
<PAGE> 252
Equity Investors III, L.P., whose general partner is Charterhouse Equity
III, Inc., a wholly-owned subsidiary of Charterhouse. As a result of the
foregoing, all of the shares of Common Stock of Interliant held by the WEB
would for purposes of Section 13(d) of the Securities Exchange Act of 1934,
as amended, be considered to be beneficially owned by Charterhouse.
(3) Includes 398,845 shares of common stock owned by the Ann Weltchek Wolf 1995
Marital Trust, 797,690 shares of common stock owned by the Mathew D. Wolf
Childrens Trust and 350,000 shares of common stock held in escrow until
March 31, 2000. Mr. Wolf disclaims beneficial ownership of all the shares of
common stock owned by both of the trusts named above.
(4) Includes 2,647,658 shares of Series A Redeemable Convertible Preferred Stock
which will be converted into an equal number of shares of common stock upon
consummation of the offering. Of these shares, 49,776 are held by SOFTBANK
Technology Advisors Fund, L.P., an affiliated entity. Also includes 14,093
shares of common stock held by SOFTBANK Technology Advisors Fund, L.P.
(5) Includes 25,200,000 shares held by WEB. Messrs. Fassler, Feld, Maggs and
Bhargava are members of WHO, which is a member of WEB. Each of Messrs.
Fassler, Feld, Maggs and Bhargava disclaim beneficial ownership of such
shares other than the shares attributable to each of them on a pro rata
basis as a result of their membership in WHO. Mr. Feld is a general partner
of Kodiak Technology Ventures II LLP. Kodiak received 5,176 shares of Common
Stock in connection with our acquisition of Net Daemons Associates, Inc. On
April 26, 1999, Kodiak distributed 2,588 shares of common stock to each of
its general partners.
(6) Excludes 3,333,414 shares held by SOFTBANK Technology Ventures IV, L.P. and
63,869 shares held by SOFTBANK Technology Advisors Fund, L.P. Mr. Feld, a
Co-chairman and Director of Interliant, is a general partner of each of
SOFTBANK Technology Ventures IV, L.P. and SOFTBANK Technology Advisors Fund,
L.P. Mr. Feld disclaims beneficial ownership of such shares.
(7) Includes 3,333,414 shares held by SOFTBANK Technology Ventures IV, L.P. and
63,869 shares held by SOFTBANK Technology Advisors Fund, L.P. Mr. Lax, a
director of Interliant, is a managing member of STV IV LLC, the general
partner of SOFTBANK Technology Ventures IV, L.P. Mr. Lax disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest therein.
(8) Excludes 25,200,000 shares held by WEB. Messrs. Halpern, Dircks, Gates and
Ms. Riley are directors and/or officers of Charterhouse. Charterhouse is an
affiliate of CEP III which is a member of WEB. Each of Messrs. Halpern,
Dircks, Gates and Ms. Riley disclaim beneficial ownership of such shares.
(9) A member of the Compensation Committee of the Board of Directors.
(10) A member of the Audit Committee of the Board of Directors.
68
<PAGE> 253
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED STOCK; ISSUED AND OUTSTANDING SHARES
Our authorized capital stock consists of 200,000,000 shares of common
stock, par value $0.01 per share, and 1,000,000 shares of undesignated preferred
stock, par value $0.01 per share.
COMMON STOCK
Immediately following the offering 42,215,268 shares of common stock will
be issued and outstanding based on the number of shares of common stock
outstanding as of the date hereof and assuming the issuance of 2,647,658 shares
of common stock upon the conversion of all outstanding Series A Redeemable
Convertible Preferred Stock (see "-- The SOFTBANK Investment"). All of the
issued and outstanding shares of common stock are, and the shares of common
stock offered hereby will upon completion of this offering be fully paid and
nonassessable.
The following summarizes the rights of holders of our common stock:
- each holder of shares of common stock is entitled to one vote per share
on all matters to be voted on by stockholders generally, including the
election of directors;
- there are no cumulative voting rights;
- the holders of our common stock are entitled to dividends which may be
paid in cash, property or shares of our capital stock and other
distributions as may be declared from time to time by the board of
directors out of funds legally available for that purpose, if any;
- upon our liquidation, dissolution or winding up, the holders of shares of
common stock will be entitled to share ratably in the distribution of all
of our assets remaining available for distribution after satisfaction of
all our debts and liabilities and the payment of the liquidation
preference of any outstanding preferred stock; and
- upon completion of this offering, the holders of common stock have no
preemptive or other subscription rights to purchase shares of our stock,
nor will holders be entitled to the benefits of any redemption or sinking
fund provisions.
As of the date hereof, there were 56 record owners of common stock.
Certain stockholders of Interliant have been given the right to nominate
persons for election as directors. See "-- The SOFTBANK Investment" and "-- The
Interliant Acquisition."
PREFERRED STOCK
Our certificate of incorporation authorizes our board of directors to
create and issue one or more series of preferred stock and determine the rights
and preferences of each series within the limits set forth in our certificate of
incorporation and applicable law. Among other rights, the board of directors may
determine, without further vote or action by our stockholders:
- the number of shares constituting the series and the distinctive
designation of the series;
- the dividend rate on the shares of the series, whether dividends will be
cumulative, and if so, from which date or dates, and the relative rights
of priority, if any, of payment of dividends on shares of the series;
- whether the series will have voting rights in addition to the voting
rights provided by law and, if so, the terms of such voting rights;
- whether the series will have conversion privileges and, if so, the terms
and conditions of conversion;
- whether or not the shares of the series will be redeemable or
exchangeable, and if so, the dates, terms and conditions of redemption or
exchange, as the case may be;
69
<PAGE> 254
- whether the series will have a sinking fund for the redemption or
purchase of shares of that series, and, if so, the terms and amount of
the sinking fund; and
- the rights of the shares of the series in the event of our voluntary or
involuntary liquidation, dissolution or winding up and the relative
rights or priority, if any, of payment of shares of the series.
Unless otherwise provided by our Board of Directors, the shares of all
series of preferred stock will rank on a parity with respect to the payment of
dividends and to the distribution of assets upon liquidation. Although we have
no present plans to issue any shares of preferred stock, any future issuance of
shares of preferred stock, or the issuance of rights to purchase preferred
shares, may have the effect of delaying, deferring or preventing a change of
control in our company or an unsolicited acquisition proposal. The issuance of
preferred stock also could decrease the amount of earnings and assets available
for distribution to the holders of common stock or could adversely affect the
rights and powers, including voting rights, of the holders of the common stock.
Accordingly, the issuance of shares of preferred stock may discourage bids for
the common stock at a premium or may otherwise adversely affect the market price
of the common stock.
Currently, excluding 2,647,658 shares of Series A Redeemable Convertible
Preferred Stock that will be converted into an equal number of shares of common
stock upon the consummation of this offering and which will then cease to exist
(see "Description of Capital Stock -- The SOFTBANK Investment"), there are no
shares of preferred stock issued or outstanding.
THE WEB HOSTING ORGANIZATION INVESTMENT
WEB owns 25,200,000 shares of our common stock, which will represent
approximately 59.7% of our outstanding common stock following consummation of
this offering. The shares were acquired for an aggregate purchase price of $42.0
million in a series of 6 transactions in December 1997, May 1998, June 1998,
September 1998, December 1998 and February 1999, in each case at a price, giving
effect to the 3-for-1 stock split effective in July 1998, of $1.67 per share.
The terms of the sale and purchase of these shares are set forth in a
subscription agreement dated December 8, 1997 between WEB and us. The principal
members of WEB are (1) CEP III, which is an affiliate of Charterhouse and (2)
WHO (collectively with CEP III, the "WEB Members"), of which Leonard J. Fassler
and Bradley A. Feld are the member managers. The WEB Members have agreed that
WEB shall be under the exclusive direction of a management committee comprised
of seven members and will vote such member's interest in WEB so that a majority
of the members of such management committee will be designees of Charterhouse.
WEB has certain demand and incidental registration rights under the terms of an
Investors Agreement dated as of January 28, 1999 and a Registration Rights
Agreement dated as of December 8, 1997. See "Description of Capital
Stock -- Registration Rights of Certain Holders."
THE SOFTBANK INVESTMENT
On January 28, 1999, the SOFTBANK Purchasers purchased from us an aggregate
of 2,647,658 shares of our Redeemable Convertible Preferred Stock and warrants
to purchase 749,625 shares of our common stock for an aggregate purchase price
of $13.0 million. On April 19, 1999, the SOFTBANK Purchasers exercised their
warrants at an aggregate exercise price of $5.0 million and now own 749,625
shares of our common stock. Upon the consummation of this offering, all of the
outstanding shares of Redeemable Convertible Preferred Stock will automatically
be converted into an equal number of shares of our common stock, and the
SOFTBANK Purchasers will own approximately 8.0% of our outstanding common stock.
Bradley A. Feld, our Co-Chairman and director, is a general partner of the
SOFTBANK Purchasers. See "Related Party Transactions." The SOFTBANK Purchasers
have certain demand and incidental registration rights under the terms of the
Investors Agreement. See "Registration Rights of Certain Holders." A majority in
interest of the SOFTBANK Purchasers also have the right, under the Investors
Agreement, to nominate one person for election to our Board of Directors and
have the Board cause that director to be a member of the Compensation Committee
and/or the Audit Committee of the
70
<PAGE> 255
Board. Such director will be subject to removal by the SOFTBANK Purchasers at
any time, with or without cause, and the SOFTBANK Purchasers will have the right
to call a special meeting of stockholders at any time for the sole purpose of
removing and replacing such director. WEB has agreed to vote its shares in a
manner consistent with these and the other terms of the Investors Agreement. Mr.
Charles R. Lax is currently serving as a director and a member of the
Compensation Committee of our Board of Directors pursuant to such provisions.
THE INTERLIANT ACQUISITION
On March 10, 1999, pursuant to an Asset Purchase Agreement with Interliant
Texas and the shareholders of Interliant Texas, we, partly through a
wholly-owned subsidiary, acquired substantially all of the assets and assumed
specified liabilities of Interliant Texas for $100,000 in cash, 4,091,642 shares
of common stock and the assumption of promissory notes in favor of Mathew Wolf
and Erving Wolf in the aggregate amount of $15.9 million. Upon the closing of
the acquisition, the $7.9 million note in favor of Erving Wolf was paid in full
and the $8.0 million note issued by Interliant Texas in favor of Mathew Wolf was
canceled and replaced by the Wolf Note. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
The 4,091,642 shares of common stock issued in connection with the
acquisition were delivered pursuant to an Agreement to Deliver Shares which
provided, among other things, for 3,608,863 shares of common stock to be
delivered at the closing of the acquisition to the shareholders of Interliant
Texas, 114,644 shares of common stock to be delivered at the closing of the
acquisition to Broadview Holdings LLP, 18,135 shares of common stock to be
delivered on the first business day following January 1, 2000 and 350,000 shares
of common stock to be placed in escrow to support the indemnification
obligations of Interliant Texas and its shareholders under the Purchase
Agreement. Unless we make a claim against the escrowed shares in accordance with
the provisions of the Purchase Agreement, the shares of common stock placed in
escrow will be distributed to Mathew Wolf, one of the shareholders of Interliant
Texas, on March 31, 2000.
In addition, under the Purchase Agreement, we issued 2,322,139 options to
purchase shares of our common stock at an exercise price of $0.13 per share. All
or a portion of such Interliant Options are fully vested and exercisable.
The shareholders have certain incidental registration rights under the
terms of the Shareholders Agreement, dated as of March 10, 1999 by and among all
of our shareholders. See "-- Registration Rights of Certain Holders."
For so long as all of the parties who received shares of common stock
pursuant to the Agreement to Deliver Shares and certain holders of our options
own in the aggregate 5% of more of the issued and outstanding common stock, such
parties shall have the right to nominate one person for election to our Board of
Directors. To date, such parties have not exercised such rights.
REGISTRATION RIGHTS OF CERTAIN HOLDERS
We have granted the holders of an aggregate of 32,320,790 shares of common
stock certain demand and incidental registration rights. The SOFTBANK Purchasers
have such registration rights under the Investors Agreement with respect to
2,647,658 shares of common stock to be received upon the consummation of this
offering from the conversion of an equal number of shares of Redeemable
Convertible Preferred Stock and 749,625 shares of common stock received on April
19, 1999 upon the exercise of warrants. WEB has such registration rights under
the terms of each of the Investors Agreement and the Registration Rights
Agreement with respect to 25,200,000 shares of common stock purchased. The
Seller Shareholders have incidental registration rights under the terms of the
Shareholders Agreement with respect to 3,608,863 shares of common stock received
as consideration for the sale of substantially all of the assets of Interliant
Texas and Broadview Holdings LLP has incidental registration rights with respect
to 114,644 shares owned by it. The Shareholders Agreement provides that it shall
be amended as
71
<PAGE> 256
necessary to include any additional shares of common stock issuable pursuant to
the provisions in the Purchase Agreement regarding adjustment of purchase price.
If we propose to file a registration statement under the Securities Act
covering our common stock or any securities exercisable or exchangeable for or
convertible into our common stock, the holders of piggyback registration rights
may require us to include a requested amount of their common stock in our
registered offering on the same terms and conditions applicable to the other
equity securities included in such registration statement. We may reduce the
number of shares to be registered if the managing underwriter determines that
the inclusion of such shares would materially and adversely affect the success
of this offering. These piggyback registration rights do not apply to the
registration of securities in connection with our employee benefit plans or
securities issuable in a merger, exchange offer or similar transaction.
Demand registration rights entitle the holder to require us to include a
requested amount of their common stock in a registration statement on Form S-1,
Form S-2 or Form S-3 and to use our best efforts to register such shares under
the Securities Act of 1933, as amended based on the advice of the managing
underwriter. A majority of the SOFTBANK Purchasers may exercise two demand
registration rights with respect to the registration of shares of common stock
on Form S-1, and twenty percent of the SOFTBANK Purchasers may exercise two
demand registration rights with respect to the registration of shares of common
stock on Form S-3 at any time we become eligible to use Form S-3. WEB may
exercise three demand registration rights with respect to the shares of common
stock that it owns. However, we are not required to register shares under demand
registration rights sooner than six months following the consummation of this
offering.
Each stockholder with the foregoing piggyback registration rights and
demand registration rights whose shares of common stock are included in a
registration statement must agree not to offer for public sale any shares of
common stock or securities exercisable or exchangeable for or convertible into
common stock, or effect any sale of securities pursuant to Rule 144 under the
Securities Act of 1933, as amended, during the ten days prior to and the 180
days after the closing date of any underwritten offering unless such shares are
covered by such registration statement or a shorter period is agreed to by the
managing underwriter. We are required to bear all related registration expenses
(excluding any underwriting discounts or commissions, if any), disbursements and
fees in connection with the exercise of Piggyback Registration Rights and Demand
Registration Rights.
In addition, in connection with the issuance to Mr. Steven C. Dabbs of
150,000 shares of common stock in connection with the acquisition of
substantially all of the assets of Clever Computers, Inc., we have agreed that
in the event we grant registration rights with respect to shares of common stock
to any other employee of Interliant or its affiliates, employed in a position
comparable or junior to Mr. Dabbs, identical registration rights shall be given
to Mr. Dabbs.
LIMITATIONS ON DIRECTOR LIABILITY
Our certificate of incorporation provides that, to the fullest extent
permitted by the Delaware General Corporation Law, none of our directors will be
personally liable to us or our stockholders for monetary damages. Section
102(b)(7) of the Delaware General Corporation Law currently provides that a
director's liability for breach of fiduciary duty to a corporation may be
eliminated, except for liability:
- for any breach of the director's duty of loyalty to the corporation or
its stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- under Section 174 of the Delaware General Corporation Law, for unlawful
dividends or unlawful stock repurchases or redemptions; and
- for any transaction from which the director derives an improper personal
benefit.
72
<PAGE> 257
Any amendment to these provisions of the Delaware General Corporation Law
will automatically be incorporated by reference into our certificate of
incorporation without any vote on the part of its stockholders unless otherwise
required, including this provision in our Amended and Restated Certificate may,
however, discourage or deter stockholders or management from bringing a lawsuit
against directors for a breach of their fiduciary duties, even though such an
action, if successful, might otherwise have benefit us and our stockholders.
The By-laws provide that we will indemnify our directors and officers to
the fullest extent permitted by Delaware law. Generally, we are required to
indemnify our directors and officers for all:
- judgments;
- fines;
- settlements;
- legal fees; and
- other expenses
incurred in connection with pending or threatened legal proceedings because of
the director's or officer's position with us.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. Under Section 203, business combinations between a Delaware
corporation whose stock generally is publicly traded or held of record by more
than 2,000 stockholders and an interested stockholder are generally prohibited
for a three-year period following the date that such a stockholder became an
interested stockholder, unless:
- the corporation has elected in its original certificate of incorporation
not to be governed by Section 203. We did not make this election;
- the business combination was approved by the board of directors of the
corporation before the other party to the business combination became an
interested stockholder;
- upon consummation of the transaction that made it an interested
stockholder, the interested stockholder owned at least 85% of the voting
stock of the corporation outstanding at the commencement of the
transaction, excluding voting stock owned by directors who are also
officers or held in employee benefit plans in which the employees do not
have a confidential right to tender or vote stock held by the plan; or
- the business combination was approved by the board of directors of the
corporation and ratified by two-thirds of the voting stock not owned by
the interested stockholder.
The three-year prohibition also does not apply to some business
combinations proposed by an interested stockholder following the announcement or
notification of an extraordinary transaction involving the corporation and a
person who had not been an interested stockholder during the previous three
years or who became an interested stockholder with the approval of the majority
of the corporation's directors.
The term "business combination" is defined generally under Section 203 to
include mergers or consolidations between a Delaware corporation and an
interested stockholder, transactions with an interested stockholder involving
the assets or stock of the corporation or its majority-owned subsidiaries and
transactions which increase an interested stockholder's percentage ownership of
stock. The term "interested stockholder" is defined generally under Section 203
as a stockholder who, together with affiliates and associates, owns or within
three years prior did own 15% or more of a Delaware corporation's voting stock.
Section 203 could prohibit or delay a merger, takeover or other change in
control of us and therefore could discourage attempts to acquire us.
73
<PAGE> 258
Our Board approved both the acquisition of common stock by WEB as part of
their approval of WEB Hosting Organization Investment and the acquisition of
preferred stock and warrants by the SOFTBANK Purchasers as part of their
approval of the SOFTBANK Investment and, accordingly, the prohibitions under
Section 203 will not apply to any business combination with either WEB or the
SOFTBANK Purchasers.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is ChaseMellon
Shareholder Services, L.L.C.
SHARES ELIGIBLE FOR FUTURE SALE
SHARES ELIGIBLE FOR FUTURE SALE
Immediately following this offering, there will be 42,215,268 shares of our
common stock issued and outstanding assuming that no option holder exercises any
outstanding stock options after the date of this prospectus. Of these shares,
the 7,000,000 shares of common stock to be sold in this offering will be
immediately eligible for sale in the public market. All of the remaining shares
will be restricted securities within the meaning of Rule 144 and may not be
publicly resold, except in compliance with the registration requirements of the
Securities Act pursuant to an exemption from registration, including that
provided by Rule 144. All of the restricted shares are subject to the 180-day
Lock-up Agreements described below.
RULE 144
In general, under Rule 144, a person, or persons whose shares are
aggregated, who has beneficially owned restricted securities for at least one
year, including a person who may be deemed an affiliate, is entitled to sell
within any three month period a number of our shares of common stock that does
not exceed the greater of:
- 1% of the then-outstanding shares of our common stock; or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the date on
which notice of sale is filed with the Securities and Exchange
Commission.
Sales under Rule 144 are subject to restrictions relating to manner of sale,
notice and the availability of current public information about us. Commencing
90 days after the date of this prospectus, 3,150,000 shares of common stock will
be eligible for resale under Rule 144. All of such shares are subject to the
180-day Lock-up Agreements described below.
A person who is not deemed an affiliate of ours at any time during the 90
days preceding a sale and who has beneficially owned shares for at least two
years would be entitled to sell shares following this offering under Rule 144(k)
without regard to the volume limitations, manner of sale provisions or notice
requirements of Rule 144.
RULE 701
Our employees, directors, officers or consultants who purchase our shares
in connection with a written compensatory plan or contract may be entitled to
rely on the resale provisions of Rule 701. Rule 701 permits non-affiliates to
sell their Rule 701 shares without having to comply with the public information,
holding period, volume limitation or notice provisions of Rule 144. Affiliates
may sell their Rule 701 shares without having to comply with Rule 144's holding
period restrictions. In each of these cases Rule 701 allows the shareholders to
sell 90 days after the date of this prospectus.
74
<PAGE> 259
OPTIONS
We intend to file one or more registration statements on Form S-8 under the
Securities Act to register all shares of Common Stock subject to outstanding
stock options and Common Stock issuable pursuant to our stock option plans.
Shares covered by these registration statements will thereupon be eligible for
sale in the public markets, subject to the 180-day Lock-up Agreements described
below, to the extent applicable.
LOCK-UP AGREEMENTS
For a period of 180 days after the date of this prospectus, we, our
executive officers, directors and substantially all of our stockholders, have
agreed not to, without approval by Merrill Lynch & Co., on behalf of the several
underwriters:
- sell, dispose of or transfer any shares of common stock or securities
convertible into common stock;
- enter into any agreement that transfers any part of the economic
consequence of ownership of the common stock; or
- seek or exercise any right to register any share of common stock or
security convertible into common stock.
Our stockholders do, however, have the right to:
- transfer the securities as a gift, if the recipient agrees to be bound by
the provisions of the Lock-up Agreement; or
- pledge their securities to us in consideration for a loan from us.
In addition, we do have the right to transfer common stock in connection
with an acquisition, if any recipient of such shares agrees to be bound by the
provisions of the Lock-up Agreement.
EFFECT OF SALES OF SHARES
No prediction can be made as to the effect, if any, that future sales of
shares of common stock or the availability of shares for future sale will have
on the prevailing market price for the common stock. Sales of substantial
amounts of common stock, or the perception that such sales could occur, could
adversely affect prevailing market prices for the common stock and could impair
our future ability to raise capital through an offering of equity securities.
75
<PAGE> 260
UNDERWRITING
GENERAL
We intend to offer our common stock outside the United States and Canada
through a number of international managers and in the United States and Canada
through a number of U.S. underwriters. Merrill Lynch International, Donaldson,
Lufkin & Jenrette International and CIBC World Markets International Limited are
acting as lead managers for each of the international managers named below.
Subject to the terms and conditions set forth in an international purchase
agreement among us and the international managers, and concurrently with the
sale of 6,125,000 shares of common stock to the U.S. underwriters, we have
agreed to sell to the international managers, and each of the international
managers severally and not jointly has agreed to purchase from us, the number of
shares of common stock set forth opposite its name below.
<TABLE>
<CAPTION>
NUMBER
INTERNATIONAL MANAGER OF SHARES
- ------------------------------------------------------------ ---------
<S> <C>
Merrill Lynch International................................. 437,500
Donaldson, Lufkin & Jenrette International.................. 262,500
CIBC World Markets International Limited.................... 175,000
--------
Total.......................................... 875,000
</TABLE>
We have also entered into a U.S. purchase agreement with certain
underwriters in the United States and Canada for whom Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Donaldson, Lufkin & Jenrette and CIBC World Markets
Corp. are acting as U.S. representatives. Subject to the terms and conditions
set forth in the U.S. purchase agreement, and concurrently with the sale of
875,000 shares of common stock to the international managers pursuant to the
international purchase agreement, we have agreed to sell to the U.S.
underwriters and the U.S. underwriters severally have agreed to purchase from us
an aggregate of 6,125,000 shares of common stock. The initial public offering
price per share and the total underwriting discount per share of common stock
are identical under the U.S. purchase agreement and the international purchase
agreement.
In the international purchase agreement and the U.S. purchase agreement,
the several international managers and the several U.S. underwriters have
agreed, subject to the terms and conditions set forth therein, to purchase all
of the shares of common stock being sold pursuant to each such agreement if any
of the shares of common stock being sold pursuant to such agreement are
purchased. In the event of a default by an underwriter, the U.S. purchase
agreement and the international purchase agreement provide that, in certain
circumstances, the purchase commitments of the nondefaulting underwriters may be
increased or the purchase agreements may be terminated. The closings with
respect to the sale of shares of common stock to be purchased by the U.S.
underwriters and the international managers are conditioned upon one another.
We have agreed to indemnify the U.S. underwriters and the international
managers against some liabilities, including some liabilities under the
Securities Act, or to contribute to payments the U.S. underwriters and the
international managers may be required to make in respect of those liabilities.
The shares of common stock are being offered by the several underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of certain legal matters by counsel for the underwriters and certain
other conditions. The underwriters reserve the right to withdraw, cancel or
modify such offer and reject orders in whole or in part.
76
<PAGE> 261
COMMISSIONS AND DISCOUNTS
The lead managers have advised us that the lead managers propose initially
to offer the shares of common stock to the public at the initial public offering
price set forth on the cover page of this prospectus, and to certain dealers at
such price less a concession not in excess of $.40 per share of common stock.
The international managers may allow, and such dealers may reallow, a discount
not in excess of $.10 per share of common stock to certain other dealers. After
the initial public offering, the public offering price, concession and discount
may change.
The following table shows the per share and total public offering price,
underwriting discount to be paid by us to the U.S. underwriters and the
international managers and the proceeds before expenses to us. This information
is presented assuming either no exercise or full exercise by the U.S.
underwriters and the international managers of their over-allotment options.
<TABLE>
<CAPTION>
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
<S> <C> <C> <C>
Public Offering Price......................... $10.00 $70,000,000 $80,500,000
Underwriting Discount......................... $.70 $4,900,000 $5,635,000
Proceeds, before expenses, to Interliant...... $9.30 $65,100,000 $74,865,000
</TABLE>
The expenses of the offerings (exclusive of the underwriting discount and
commissions) are estimated at $1.4 million and are payable by us.
INTERSYNDICATE AGREEMENT
The international managers and the U.S. underwriters have entered into an
intersyndicate agreement that provides for the coordination of their activities.
Under the terms of the intersyndicate agreement, the international managers and
the U.S. underwriters are permitted to sell shares of our common stock to each
other for purposes of resale at the initial public offering price, less an
amount not greater than the selling concession. Under the terms of the
intersyndicate agreement, the U.S. underwriters and any dealer to whom they sell
shares of our common stock will not offer to sell or sell shares of our common
stock to persons who are non-U.S. or non-Canadian persons or to persons they
believe intend to resell to persons who are non-U.S. or non-Canadian persons,
and the international managers and any dealer to whom they sell shares of common
stock will not offer to sell or sell shares of common stock to U.S. persons or
to Canadian persons or to persons they believe intend to resell to U.S. or
Canadian persons, except in the case of transactions under the terms of the
intersyndicate agreement.
OVER-ALLOTMENT OPTION
We have granted options to the international managers, exercisable for 30
days after the date of this prospectus, to purchase up to an aggregate of
130,000 additional shares of common stock at the public offering price set forth
on the cover page of this prospectus, less the underwriting discount. The
international managers may exercise this option solely to cover over-allotments,
if any, made on the sale of the common stock offered hereby. To the extent that
the international managers exercise this option, each international manager will
be obligated, subject to certain conditions, to purchase a number of additional
shares of common stock proportionate to such international managers's initial
amount reflected in the foregoing table.
We also have granted an option to the U.S. underwriters, exercisable for 30
days after the date of this prospectus, to purchase up to an aggregate of
920,000 additional shares of common stock to cover over-allotments, if any, on
terms similar to those granted to the international managers.
RESERVED SHARES
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 350,000, or 5%, of the shares offered hereby, to be
sold to some of our directors, officers and employees and their family members,
officers and employees of SOFTBANK entities, and our resellers and strategic
77
<PAGE> 262
partners. The number of shares of common stock available for sale to the general
public will be reduced to the extent those persons purchase such reserved
shares. Any reserved shares which are not orally confirmed for purchase within
one day of the pricing of this offering will be offered by the underwriters to
the general public on the same terms as the other shares offered in this
prospectus.
NO SALES OF SIMILAR SECURITIES
For a period of 180 days after the date of this prospectus, we, our
executive officers, directors and substantially all of our stockholders, have
agreed not to directly or indirectly, without approval by Merrill Lynch
International on behalf of the several underwriters:
- Offer, pledge, sell, dispose of or transfer any shares of common stock or
securities convertible into common stock;
- Enter into any agreement that transfers any part of the economic
consequence of ownership of the common stock; or
- Seek or exercise any right to register any share of common stock or
security convertible into common stock.
Our stockholders do, however, have the right to:
- Transfer the securities as a gift, if the recipient agrees to be bound by
the provisions of the Lock-up Agreement; or
- Pledge their securities to us in consideration for a loan from us.
In addition, we have the right to transfer common stock in connection with
an acquisition, if any recipient of such shares agrees to be bound by the
provisions of the Lock-up Agreement.
QUOTATION ON THE NASDAQ NATIONAL MARKET
Our common stock will trade on the Nasdaq National Market under the symbol
"INIT."
Before this offering, there has been no public market for our common stock.
The initial public offering price has been determined through negotiations
between us and the U.S. representatives and the lead managers. The factors
considered in determining the initial public offering price, in addition to
prevailing market conditions, were the valuation multiples of publicly-traded
companies that the U.S. representatives and the lead managers believe to be
comparable to us, certain of our financial information, the history of, and the
prospects for, our company and the industry in which we compete, and an
assessment of our management, its past and present operations, the prospects
for, and timing of, our future revenues, the present state of our development,
and the above factors in relation to market values and various value measures of
other companies engaged in activities similar to ours. There can be no assurance
that an active trading market will develop for our common stock or that our
common stock will trade in the public market subsequent to this offering at or
above the initial public offering price.
The underwriters do not expect sales of the common stock to be made to any
accounts over which they exercise discretionary authority to exceed five percent
of the number of shares being offered in this offering.
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters and
certain selling group members to bid for and purchase our common stock. As an
exception to these rules, the U.S. representatives are permitted to engage in
certain transactions that stabilize the price of our common stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of our common stock.
78
<PAGE> 263
If the underwriters create a short position in our common stock in
connection with the offering contemplated hereby, i.e., if they sell more shares
of our common stock than are set forth on the cover page of this prospectus, the
U.S. representatives may reduce that short position by purchasing our common
stock in the open market. The U.S. representatives may also elect to reduce any
short position by exercising all or part of the over-allotment option described
above.
The U.S. representatives may also impose a penalty bid on our underwriters
and selling group members. This means that if the U.S. representatives purchase
shares of our common stock in the open market to reduce the underwriters' short
position or to stabilize the price of the our common stock, they may reclaim the
amount of the selling concession from the underwriters and selling group members
who sold those shares.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of our common stock to the extent that it
discourages resales of our common stock.
Neither we nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of our common stock. In addition, neither
we nor any of the underwriters makes any representation that the U.S.
representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued.
UK SELLING RESTRICTIONS
Each international manager has agreed that (1) it has not offered or sold
and, prior to the expiration of the period of six months from the closing date,
will not offer or sell any shares of common stock to persons in the United
Kingdom, except to persons whose ordinary activities involve them in acquiring,
holding, managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which do not
constitute an offer to the public in the United Kingdom within the meaning of
the Public Offers of Securities Regulations 1995; (2) it has complied and will
comply with all applicable provisions of the Financial Services Act 1986 with
respect to anything done by it in relation to the common stock in, from or
otherwise involving the United Kingdom; and (3) it has only issued or passed on
and will only issue or pass on in the United Kingdom any document received by it
in connection with the issuance of common stock to a person who is of a kind
described in Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) Order 1996 as amended by the Financial Services Act
1986 (Investment Advertisements) (Exemptions) Order 1997 or is a person to whom
such document may otherwise lawfully be issued or passed on.
NO PUBLIC OFFERING OUTSIDE THE UNITED STATES
No action has been or will be taken in any jurisdiction, except in the
United States, that would permit a public offering of the shares of common
stock, or the possession, circulation or distribution of this prospectus or any
other material relating to us or shares of our common stock in any jurisdiction
where action for that purpose is required. Accordingly, the shares of our common
stock may not be offered or sold, directly or indirectly, and neither this
prospectus nor any other offering material or advertisements in connection with
the shares of common stock may be distributed or published, in or from any
country or jurisdiction except in compliance with any applicable rules and
regulations of any such country or jurisdiction.
Purchasers of the shares offered by this prospectus may be required to pay
stamp taxes and other charges in accordance with the laws and practices of the
country of purchase in addition to the offering price set forth on the cover
page hereof.
79
<PAGE> 264
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for us by Dewey Ballantine LLP, New York, New York. Certain legal matters
in connection with the offering will be passed upon for the underwriters by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California.
EXPERTS
The consolidated financial statements of Interliant, Inc. (formerly known
as Sage Networks, Inc.) at December 31, 1997 and 1998, and for the period
December 8, 1997 (inception) to December 31, 1997 and the year ended December
31, 1998, and the financial statements of Interliant, Inc. (which is not the
registrant and which is referred to in this prospectus as Interliant Texas) at
December 31, 1997 and 1998, and for each of the three years in the period ended
December 31, 1998, appearing in this prospectus and registration statement, have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
reports thereon appearing elsewhere herein, and are included in reliance upon
the authority of such firm as experts in accounting and auditing.
The balance sheets of B.N. Technology, Inc. dba Internet Communications, as
of December 31, 1996 and 1997, and the related statements of operations and
accumulated deficit, and cash flows for the period April 15, 1996 (inception)
through December 31, 1996 and for the year ended December 31, 1997 included in
this prospectus have been so included in reliance on the report of Frankel,
Lodgen, Lacher, Golditch, Sardi & Howard, independent accountants given on the
authority of said firm as experts in auditing and accounting.
The balance sheets of Clever Computers, Inc., as of December 31, 1995, 1996
and 1997 and the related statements of income, retained earnings, and cash flows
for the years then ended included in this prospectus have been so included in
reliance on the report of BSC&E, independent accountants given on the authority
of said firm as experts in auditing and accounting.
The statements of assets and liabilities as of December 31, 1996 and 1997,
and the statements of revenue and expenses and of cash flows for each of the
three years in the period ended December 31, 1997, of HostAmerica, a division of
HomeCom Communications, Inc., included in this prospectus, have been included
herein in reliance on the report, which includes an explanatory paragraph
regarding basis of presentation, of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of that firm as experts in accounting and
auditing.
The financial statements of Net Daemons Associates, Inc., for the years
ended December 31, 1997 and 1998 included in this prospectus and in the
registration statement have been audited by Deloitte & Touche LLP, independent
accountants as stated in their report appearing herein and elsewhere in the
registration statement and is included in reliance upon the report of such firm
given upon the authority of said firm as experts in auditing and accounting.
The financial statements of Telephonetics International, Inc. and Affiliate
included in this prospectus and registration statement have been audited by BDO
Seidman, LLP, independent certified accountants to the extent and for the
periods set forth in their report appearing elsewhere herein and in this
registration statement and are included in reliance on such reports given upon
the authority of said firm as experts in auditing and accounting.
The balance sheets of Tri Star Web as of December 31, 1996 and 1997 and the
related statements of operations, and changes in retained earnings, and cash
flows for the years then ended, and the consolidated balance sheets of GEN
International Inc. and subsidiaries as of December 31, 1995, 1996 and 1997, and
the related consolidated statements of operations, changes in stockholders'
deficiency, and cash flows for the period April 4, 1995 (inception) through
December 31, 1995 and the years ended December 31, 1996 and 1997 and the balance
sheets of Digiweb, Inc. as of December 31, 1997 and 1998 and the related
statements of income, cash flows and changes in stockholders' equity for the
years then ended included in
80
<PAGE> 265
this prospectus have been so included in reliance on the reports of Urbach Kahn
& Werlin PC, independent accountants given on the authority of said firm as
experts in auditing and accounting.
AVAILABLE INFORMATION
We have filed with the Commission, Washington, D.C. 20549, a Registration
Statement on Form S-1 under the Securities Act with respect to the shares of
common stock offered hereby. This prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to us and the common
stock offered hereby, reference is made to the Registration Statement and the
exhibits and schedules filed therewith. Statements contained in this prospectus
as to the contents of any contract or any other document referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. A copy of
the Registration Statement may be inspected without charge at the offices of the
Commission in Washington, D.C. 20549, and copies of all or any part of the
Registration Statement may be obtained from the Public Reference Section of the
Commission, Washington, D.C. 20549 upon the payment of the fees prescribed by
the Commission. The Commission maintains a Web site (http://www.sec.gov) that
contains reports, proxy and information statements and other information
regarding registrants, such as Interliant, that file electronically with the
Commission.
We provide Web hosting services to a customer whose primary residence is
located in Cuba, Mr. Osvaldo Martinez. This information is correct as of the
date of this prospectus. Current information concerning business between any
person located in Cuba or the government of Cuba and Interliant may be obtained
from the Florida Department of Banking and Finance, Plaza Level, The Capitol,
Tallahassee, Florida 32399-0350, telephone number (904) 488-6311.
81
<PAGE> 266
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INTERLIANT, INC. (FORMERLY KNOWN AS SAGE NETWORKS, INC.)
Report of Independent Auditors.............................. F-4
Consolidated Balance Sheets as of December 31, 1997 and 1998
and March 31, 1999 (unaudited)............................ F-5
Consolidated Statements of Operations for the Period
December 8, 1997 (inception) to December 31, 1997 and the
Year Ended December 31, 1998 and for the three months
ended March 31, 1998 and 1999 (unaudited)................. F-6
Consolidated Statements of Stockholders' Equity for the
period December 8, 1997 (inception) to December 31, 1997
and the year ended December 31, 1998 and for the three
months ended March 31, 1999 (unaudited)................... F-7
Consolidated Statements of Cash Flows for the Period
December 8, 1997 (inception) to December 31, 1997 and the
Year Ended December 31, 1998 and for the three months
ended March 31, 1998 and 1999 (unaudited)................. F-8
Notes to Consolidated Financial Statements.................. F-9
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Pro Forma Consolidated Statement of Operations.............. F-20
Pro Forma Consolidated Statement of Operations.............. F-21
Notes to Pro Forma Consolidated Financial Statements........ F-22
ACQUIRED COMPANY (CLEVER COMPUTERS, INC.)
Independent Auditors' Report................................ F-23
Balance Sheets as of December 31, 1995, 1996 and 1997....... F-24
Statements of Income for the Years Ended December 31, 1995,
1996 and December 31, 1997 and for the three months ended
March 31, 1997 and 1998 (unaudited)....................... F-25
Statement of Retained Earnings for the Years Ended December
31, 1995, 1996 and December 31, 1997...................... F-26
Statement of Cash Flows for the Years Ended December 31,
1995, 1996 and December 31, 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-27
Notes to Financial Statements............................... F-28
ACQUIRED COMPANY (TRI STAR WEB CREATIONS, INC.)
Independent Auditor's Report................................ F-30
Balance Sheets as of December 31, 1996 and 1997............. F-31
Statements of Operations and Changes in Retained Earnings
For the Years Ended December 31, 1996 and 1997 and for the
three months ended March 31, 1997 and 1998 (unaudited).... F-32
Statements of Cash Flows for the Years Ended December 31,
1996 and 1997 and for the three months ended March 31,
1997 and 1998 (unaudited)................................. F-33
Notes to Financial Statements............................... F-34
ACQUIRED COMPANY (HOSTAMERICA DIVISION OF HOMECOM
COMMUNICATIONS, INC.)
Report of Independent Accountants........................... F-36
Statements of Assets and Liabilities as of December 31, 1996
and 1997.................................................. F-37
Statements of Revenues and Expenses for the Years ended
December 31, 1995, 1996 and 1997 and for the three months
ended March 31, 1997 and 1998 (unaudited)................. F-38
Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997 and for the three months ended March
31, 1997 and 1998 (unaudited)............................. F-39
Notes to Financial Statements............................... F-40
</TABLE>
F-1
<PAGE> 267
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ACQUIRED COMPANY (B.N. TECHNOLOGY, INC.)
Independent Auditor's Report................................ F-43
Balance Sheets as of December 31, 1996 and 1997............. F-44
Statements of Operations and Accumulated Deficit for the
Period from April 15, 1996 through December 21, 1996 and
the Year Ended December 31, 1997 and for the six months
ended June 30, 1997 and 1998 (unaudited).................. F-45
Statements of Cash Flows for the Period from April 15, 1996
through December 21, 1996 and the Year Ended December 31,
1997 and for the six months ended June 30, 1997 and 1998
(unaudited)............................................... F-46
Notes to Financial Statements............................... F-47
ACQUIRED COMPANY (GEN INTERNATIONAL, INC. AND SUBSIDIARIES)
Independent Auditor's Report................................ F-50
Balance Sheets as of December 31, 1995, 1996 and 1997....... F-51
Statements of Operations for the Period April 4, 1995
(inception) through December 31, 1995 and the Years Ended
December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998 (unaudited)........................ F-52
Statements of Cash Flows for the Period April 4, 1995
(inception) through December 31, 1995 and the Years Ended
December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998 (unaudited)........................ F-53
Statements of Changes in Stockholders' Deficiency for the
Period April 4, 1995 (inception) through December 31, 1995
and the Years Ended December 31, 1996 and 1997............ F-54
Notes to Financial Statements............................... F-55
ACQUIRED COMPANY (DIGIWEB, INC.)
Independent Auditor's Report................................ F-58
Balance Sheets as of December 31, 1997 and 1998............. F-59
Statements of Income for the Years Ended December 31, 1997
and 1998.................................................. F-60
Statements of Changes in Stockholders' Equity for the Years
Ended December 31, 1997 and 1998.......................... F-61
Statements of Cash Flows for the Years Ended December 31,
1997 and 1998............................................. F-62
Notes to Financial Statements............................... F-63
ACQUIRED COMPANY (TELEPHONETICS INTERNATIONAL, INC. AND
STATE OF THE ART, INC.)
Report of Independent Certified Public Accountants.......... F-66
Combined Balance Sheet as of December 31, 1998.............. F-67
Combined Statements of Operations for the Years Ended
December 31, 1997 and 1998................................ F-68
Combined Statements of Capital Deficit for the Years Ended
December 31, 1997 and 1998................................ F-69
Combined Statements of Cash Flows for the Years Ended
December 31, 1997 and 1998................................ F-70
Summary of Significant Accounting Policies.................. F-71
Notes to Combined Financial Statements...................... F-73
ACQUIRED COMPANY (NET DAEMONS ASSOCIATES, INC.)
Independent Auditor's Report................................ F-76
Balance Sheets as of December 31, 1997 and 1998............. F-77
Statements of Income for the Years Ended December 31, 1997
and 1998.................................................. F-78
Statements of Stockholders' Deficit for the Years Ended
December 31, 1997 and 1998................................ F-79
Statements of Cash Flows for the Years Ended December 31,
1997 and 1998............................................. F-80
Notes to Financial Statements............................... F-81
</TABLE>
F-2
<PAGE> 268
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ACQUIRED COMPANY (INTERLIANT, INC., WHICH IS NOT THE
REGISTRANT AND WHICH IS REFERRED TO IN THIS PROSPECTUS AS
INTERLIANT TEXAS)
Report of Independent Auditors.............................. F-86
Balance Sheets as of December 31, 1997 and 1998............. F-87
Statements of Operations for the Years Ended December 31,
1996, 1997 and 1998....................................... F-88
Statements of Shareholders' Deficit for the Years Ended
December 31, 1996, 1997 and 1998.......................... F-89
Statements of Cash Flows for the Years Ended December 31,
1996, 1997 and 1998....................................... F-90
Notes to Consolidated Financial Statements.................. F-91
</TABLE>
F-3
<PAGE> 269
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Interliant, Inc. (formerly known as Sage Networks, Inc.)
We have audited the accompanying consolidated balance sheets of Interliant,
Inc. (formerly known as Sage Networks, Inc.) (the Company) as of December 31,
1997 and 1998, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the period December 8, 1997 (inception)
to December 31, 1997 and the year ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Interliant, Inc. (formerly known as Sage Networks, Inc.) at December 31, 1997
and 1998, and the consolidated results of its operations and its cash flows for
the period December 8, 1997 (inception) to December 31, 1997 and the year ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
February 15, 1999, except for the second to last paragraph of Note 12,
as to which the date is March 10, 1999
F-4
<PAGE> 270
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- MARCH 31,
1997 1998 1999
---------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 912,085 $ 6,813,360 $ 4,376,478
Cash-restricted.................................. 1,392,371
Accounts receivable, net of allowance of $320,000
and $691,629 at December 31, 1998 and March
31, 1999, respectively........................ 806,322 5,097,716
Common stock subscription receivable............. 4,000,000
Prepaid expenses and other current assets........ 14,000 639,662 1,126,435
---------- ------------ ------------
Total current assets..................... 4,926,085 8,259,344 11,993,000
---------- ------------ ------------
Furniture, fixtures and equipment, net........... 27,063 5,103,123 11,467,239
Intangibles, net................................. 12,612,228 76,860,888
Other assets..................................... 222,172 575,738
---------- ------------ ------------
Total assets............................. $4,953,148 $ 26,196,867 $100,896,865
========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term
debt.......................................... $ 8,136,195
Accounts payable................................. $ 84,389 $ 787,412 2,587,650
Accrued expenses................................. 26,507 2,301,507 3,268,667
Deferred revenue................................. 1,414,969 3,462,214
---------- ------------ ------------
Total current liabilities................ 110,896 4,503,888 17,454,726
Long-term debt, less current portion............. 914,482
Series A, redeemable convertible preferred stock... 13,000,000
Stockholders' equity:
Common stock, par value $.01; 100,000,000 shares
authorized; 3,000,000, 19,217,197 and
30,998,802 shares issued and outstanding at
December 31, 1997, 1998 and March 31, 1999,
respectively.................................. 30,000 192,172 309,988
Additional paid-in capital....................... 4,970,000 34,160,334 89,067,255
Deferred compensation............................ (1,769,429) (1,201,867)
Accumulated deficit.............................. (157,748) (10,890,098) (18,647,719)
---------- ------------ ------------
Total stockholders' equity............... 4,842,252 21,692,979 69,527,657
---------- ------------ ------------
Total liabilities and stockholders'
equity................................. $4,953,148 $ 26,196,867 $100,896,865
========== ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE> 271
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD
DECEMBER 8,
1997 THREE MONTHS ENDED
(INCEPTION) TO YEAR ENDED MARCH 31,
DECEMBER 31, DECEMBER 31, ----------------------------
1997 1998 1998 1999
-------------- ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Service revenues..................... $ 4,905,027 $ 13,126 $ 5,434,162
Costs and expenses:
Cost of service revenues........... 3,236,385 53,774 3,250,703
Sales and marketing................ 2,555,035 110,882 1,896,357
General and administrative......... $ 155,898 5,120,595 256,019 3,699,847
Depreciation....................... 1,850 696,039 9,417 699,552
Amortization of intangibles........ 2,439,426 1,618 2,594,330
Start-up and acquisition
integration
costs........................... 1,727,970 134,106 1,063,458
---------- ------------ ---------- -----------
157,748 15,775,450 565,816 13,204,247
---------- ------------ ---------- -----------
Operating loss....................... (157,748) (10,870,423) (552,690) (7,770,085)
Interest income...................... 138,073 13,645 53,912
Other income (expense)............... (41,448)
---------- ------------ ---------- -----------
Net loss............................. $ (157,748) $(10,732,350) $ (539,045) $(7,757,621)
========== ============ ========== ===========
Net loss per share -- basic and
diluted............................ $ (0.05) $ (1.22) $ (0.18) $ (0.31)
========== ============ ========== ===========
Weighted average shares
outstanding........................ 3,000,000 8,799,432 3,000,000 24,769,890
========== ============ ========== ===========
</TABLE>
See accompanying notes.
F-6
<PAGE> 272
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN DEFERRED ACCUMULATED STOCKHOLDERS'
SHARES PAR VALUE CAPITAL COMPENSATION DEFICIT EQUITY
----------- --------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Sales of common stock................ 3,000,000 $ 30,000 $ 4,970,000 $ 5,000,000
Net loss............................. $ (157,748) (157,748)
----------- -------- ----------- ----------- ------------ ------------
Balance as of December 31, 1997...... 3,000,000 30,000 4,970,000 (157,748) 4,842,252
Sales of common stock.............. 15,600,000 156,000 25,884,000 26,040,000
Deferred compensation.............. 475,000 4,750 2,600,750 $(2,602,250) 3,250
Amortization of deferred
compensation..................... 832,821 832,821
Issuance of common stock in
connection with acquisitions..... 142,197 1,422 705,584 707,006
Net loss........................... (10,732,350) (10,732,350)
----------- -------- ----------- ----------- ------------ ------------
Balance as of December 31, 1998...... 19,217,197 192,172 34,160,334 (1,769,429) (10,890,098) 21,692,979
Sales of common stock (unaudited).... 6,600,000 66,000 10,934,000 11,000,000
Amortization of deferred compensation
(unaudited)........................ 567,562 567,562
Issuance of common stock in
connection with acquisitions
(unaudited)........................ 5,181,605 51,816 34,009,486 34,061,302
Issuance of stock options in
connection with acquisition
(unaudited)........................ 9,963,435 9,963,435
Net loss (unaudited)................. (7,757,621) (7,757,621)
----------- -------- ----------- ----------- ------------ ------------
Balance as of March 31, 1999
(unaudited)........................ 30,998,802 $309,988 $89,067,255 $(1,201,867) $(18,647,719) $ 69,527,657
=========== ======== =========== =========== ============ ============
</TABLE>
See accompanying notes.
F-7
<PAGE> 273
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD THREE MONTHS ENDED
DECEMBER 8, 1997 MARCH 31,
(INCEPTION) TO YEAR ENDED --------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998 1998 1999
----------------- ----------------- ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss...................................... $ (157,748) $(10,732,350) $ (539,045) $ (7,757,621)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for uncollectible accounts........ 320,000 205,182
Depreciation and amortization............... 1,850 3,135,465 11,035 3,293,882
Amortization of deferred compensation....... 832,821 567,562
Changes in operating assets and liabilities:
Accounts receivable....................... (980,391) (11,678) 56,124
Prepaid expenses and other current
assets.................................. (14,000) (602,457) (51,497) (150,354)
Accounts payable.......................... 84,389 639,607 75,831 (999,180)
Accrued expenses.......................... 26,507 1,140,135 4,914 253,940
Deferred revenue.......................... 246,502 320,560
---------- ------------ ----------- ------------
Net cash used in operating activities......... (59,002) (6,000,668) (510,440) (4,209,905)
INVESTING ACTIVITIES
Purchases of furniture, fixtures and
equipment................................... (28,913) (4,321,577) (90,392) (984,320)
Payments issued in connection with non-compete
agreements.................................. (500,000)
Transfers to restricted cash.................. (1,392,371)
Acquisitions of businesses, net of cash
acquired.................................... (13,597,558) (92,059) (18,930,098)
---------- ------------ ----------- ------------
Net cash used in investing activities......... (28,913) (17,919,135) (182,451) (21,806,789)
FINANCING ACTIVITIES
Proceeds from sale of common stock............ 1,000,000 30,043,250 4,040,000 11,000,000
Proceeds from issuance of Series A, redeemable
convertible preferred stock................. 13,000,000
Repayment of debt............................. (66,621)
Offering costs................................ (222,172) (353,567)
---------- ------------ ----------- ------------
Net cash provided by financing activities..... 1,000,000 29,821,078 4,040,000 23,579,812
---------- ------------ ----------- ------------
Net increase in cash and cash equivalents..... 912,085 5,901,275 3,347,109 (2,436,882)
Cash and cash equivalents at beginning of
period...................................... -- 912,085 912,085 6,813,360
---------- ------------ ----------- ------------
Cash and cash equivalents at end of period.... $ 912,085 $ 6,813,360 $ 4,259,194 $ 4,376,478
========== ============ =========== ============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING
AND FINANCING ACTIVITIES
Stock and options issued in acquisitions...... $ 707,006 $ 44,024,737
Stock issued for compensation agreements...... 2,602,250
Stock subscription receivable................. $4,000,000
</TABLE>
See accompanying notes.
F-8
<PAGE> 274
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM DECEMBER 8, 1997 (INCEPTION) TO DECEMBER 31, 1997, THE YEAR
ENDED DECEMBER 31, 1998 AND THE THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
1. BUSINESS
Interliant, Inc. (formerly known as Sage Networks, Inc.) (the Company) was
organized under the laws of the State of Delaware on December 8, 1997. Web
Hosting Organization LLC (WEB), a Delaware Limited Liability Company, is the
majority and controlling shareholder of the Company. WEB's investors are
comprised of Charterhouse Equity Partners III, L.P. and Chef Nominees Limited
(collectively, CEP Members) and WHO Management, LLC (WHO). As of December 31,
1998, CEP Members have invested $29,000,000, and WHO has invested $2,000,000 in
WEB. WEB has, in turn, invested $31,000,000 in the Company. CEP Members have
allocated an additional $11,000,000 to invest in WEB, and have funded the
remaining amount pursuant to a stock subscription agreement (see Notes 7 and
12).
Since its formation, the Company has been in the process of developing a
Web hosting business. The Company continues to build its Web hosting business
primarily through the acquisition of the Web hosting assets of Internet service
providers, system integrators and Web hosting companies. The primary sources of
revenue are from recurring fees charged to customers for hosting their Web sites
on the Company's server systems. The Company focuses on delivering high-quality,
reliable and flexible Web hosting services.
Prior to 1998, the Company was in the development stage.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Unaudited Interim Financial Information
The interim financial information as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999 is unaudited and has been prepared on the
same basis as the audited financial statements. In the opinion of management,
such unaudited information includes all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the interim
information. Operating results for the three months ended March 31, 1998 and
1999 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1999.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity (at date of purchase) of three months or less to be the
equivalent of cash for the purpose of balance sheet and statement of cash flows
presentation. Cash equivalents, which consist primarily of money market
accounts, are carried at cost, which approximates market value.
Fair Value of Financial Instruments
Carrying amounts of financial instruments held by the Company, which
include cash equivalents, accounts receivable, accounts payable and accrued
expenses, approximate fair value due to their short duration.
F-9
<PAGE> 275
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk are comprised principally of cash, cash
equivalents and accounts receivable. As of December 31, 1998, the Company's cash
and cash equivalents are deposited with various domestic financial institutions.
With respect to accounts receivable, the Company's customer base is dispersed
across many geographic areas. The Company monitors customer payment history,
generally does not require collateral and establishes reserves for uncollectible
accounts 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.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent 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.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost. 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.
Depreciation has been provided using the straight-line method over the estimated
useful lives of the assets as follows:
<TABLE>
<S> <C>
Network software and equipment............ 3 years
Furniture, fixtures and office
equipment............................... 3 years
Leasehold improvements.................... Lesser of remaining lease-term or useful
life
</TABLE>
Internally Developed Software
In 1998, the Company adopted Statement of Position 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1)
issued by the American Institute of Certified Public Accountants. SOP 98-1
permits the capitalization of certain internally developed costs related to the
development of internally used software. During 1998, the Company capitalized
approximately $650,000 of project costs related to software developed
internally.
Intangible Assets
Intangible assets consist primarily of customer lists, covenants not to
compete, other identifiable intangibles and goodwill, which arose from the
acquisitions of several Web hosting companies and are being amortized on a
straight-line basis over periods ranging from one to five years (see Note 4).
Impairment of Long-Lived Assets
The Company continually reviews amortization periods and the carrying value
of long-lived assets, including furniture, fixtures and equipment, and
intangible assets to determine whether there are any indications of reduction in
useful lives or impairment losses. If indications of impairment are present in
long-lived assets, the estimated future undiscounted cash flows associated with
the corresponding assets would be compared to its carrying amount to determine
if a change in useful life or a write-down to fair value is necessary.
F-10
<PAGE> 276
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition
Through December 31, 1998, revenues consisted of two revenue streams: Web
hosting fees and set-up fees. As a result of acquisitions in February and March
1999 (see Note 12) the Company began earning revenues from application hosting
and related one time implementation fees and from consulting services.
The Company sells its Web hosting services for contractual periods ranging
from one to twelve months. These contracts generally are cancelable by either
party without penalty. Revenues from these contracts are recognized ratably over
the contractual period as service is delivered. Payments received for billings
in advance of providing services are deferred until the period such services are
provided. Set-up fees are separately priced from hosting services and are
recognized at the time a new customer account is created. Therefore, the
customer has no expectation of any future value from set-up fees after the
account is set up and the Web site is activated. Set-up costs consist primarily
of labor by technical support personnel to activate the new Web site and are
incurred at the time of set-up. No future set-up costs are incurred. There is no
obligation of the Company to perform any future set-up services, and the set-up
fees are non-refundable. Following expiration of the initial contract period and
upon renewal of the contract by the customer, there are no additional set-up
charges and the renewal prices for Web hosting services are generally unchanged
from the original contract period. The Company does not provide any proprietary
technology or content to the customer. The Web site design and development,
including the underlying programming and content are provided by and belong to
the customer. Incremental fees for excess bandwidth usage and data storage are
billed and recognized as revenues in the period customers utilize such services.
Such fees have been de minimus.
Application hosting revenues are comprised of monthly usage fees per number
of end users, including bandwidth fees and one-time implementation fees, all of
which are recorded as revenue at the time the services are used by the customer.
One time implementation fees which cover costs incurred by the Company to
establish a customer's site and are nonrefundable, are recognized when the site
is established and the Company has no further obligation with respect to such
fees. To date such fees have been de minimus.
Revenues from consulting services are recognized as the services are
rendered, provided that no significant obligations remain and collection of the
receivable is considered probable. Generally, contracts call for billings on a
time and materials basis; however, in instances when a fixed fee contract is
signed, revenue is recognized on a percentage-of-completion basis.
The Company recognizes that the Staff of the Securities and Exchange
Commission is developing a Staff Accounting Bulletin on the topic of revenue
recognition. If that Bulletin requires revenue recognition policies different
from those the Company currently uses, the results of operations will be
affected accordingly.
Advertising Expenses
All advertising costs are expensed as incurred. Advertising expenses for
the year ended December 31, 1998 amounted to $672,000. No advertising costs were
incurred in the period December 8, 1997 (inception) through December 31, 1997.
Start-Up and Acquisition Integration Costs
In connection with acquisitions made by the Company during the year ended
December 31, 1998 (see Note 5), the Company incurred payroll, consulting and
travel costs to start-up and integrate the acquisitions into the Company.
F-11
<PAGE> 277
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
The Company accounts for income taxes using the liability method under
which 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 reverse.
Net Loss Per Share
Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic
net loss per share is computed based on the weighted average number of shares of
common stock outstanding. Diluted loss per share does not differ from basic loss
per share since potential common shares to be issued upon exercise of stock
options are anti-dilutive for the periods presented.
Stock-Based Compensation
The Company accounts for its stock-based compensation plan utilizing the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). The Company has adopted the disclosure provisions
only of Statement of Financial Accounting Standards No. 123, Accounting For
Stock-Based Compensation (SFAS 123).
Reclassifications
Certain 1997 amounts have been reclassified to conform to the 1998
presentation.
3. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- MARCH 31,
1997 1998 1999
------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Network software and equipment.................. $18,073 $5,213,879 $10,056,274
Furniture, fixtures and office equipment........ 10,840 303,742 1,241,054
Leasehold improvements.......................... 283,391 1,596,724
------- ---------- -----------
28,913 5,801,012 12,894,052
Less accumulated depreciation and
amortization............................... 1,850 697,889 1,426,813
------- ---------- -----------
$27,063 $5,103,123 $11,467,239
======= ========== ===========
</TABLE>
Depreciation expense amounted to $1,850, $696,039, and $699,552 for the
years ended 1997 and 1998, and the three months ended March 31, 1999,
respectively.
4. INTANGIBLE ASSETS
The Company has allocated the purchase price of acquired companies to
identifiable tangible assets and liabilities and intangible assets based on the
nature and the terms of the various purchase agreements and evaluation of the
acquired businesses. Covenants not to compete are amortized over periods not to
exceed the term of the respective agreement. Values are assigned to covenants
not to compete in accordance with APB 16, using values specified in the
respective agreement or, where not specified, using the Company's estimate of
fair value of the covenant. Amounts not allocated to tangible assets and
liabilities and identifiable intangible assets have been recorded as goodwill.
F-12
<PAGE> 278
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, AMORTIZATION
1998 1999 PERIOD
------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Covenants not to compete..................... $ 3,759,202 $10,880,510 1-5 Years
Customer lists............................... 3,295,369 12,129,003 3 Years
Assembled work force......................... 1,127,031 4,540,000 3 Years
Trade names.................................. 573,982 5,032,270 3 Years
Goodwill..................................... 6,296,070 49,312,861 5 Years
----------- -----------
15,051,654 81,894,644
Less accumulated amortization................ 2,439,426 5,033,756
----------- -----------
$12,612,228 $76,860,888
=========== ===========
</TABLE>
Amortization expense amounted to $2,439,426 in 1998 and $2,594,330 in the
three months ended March 31, 1999.
5. ACQUISITIONS
During the year ended December 31, 1998, the Company made the following
acquisitions, each of which was accounted for using the purchase method of
accounting. The operations of each of the acquired companies are included in the
operating results of the Company from the date of acquisition noted.
On February 13, 1998, the Company purchased certain Web hosting assets of
Omnetrix, Inc., dba DirectNet, a Web hosting provider, for cash of approximately
$78,000.
On April 7, 1998, the Company purchased the operating assets of Clever
Computers, Inc., a Web hosting company, for cash of approximately $2,500,000.
Pursuant to a three-year employment agreement, a shareholder of Clever received
150,000 shares of the Company's Common Stock, valued at $3.32 per share, which
vests and is being accounted for as compensation expense over the term of the
employment agreement.
On April 30, 1998, the Company purchased certain Web hosting assets from
KnowledgeLink Interactive, Inc. for cash of approximately $612,000.
On May 1, 1998, the Company purchased the operating assets of Tri Star Web
Creations, Inc., a Web hosting company, for cash of approximately $955,000 and
9,000 shares of the Company's Common Stock, having a valuation of $4.07 per
share.
On June 10, 1998, the Company purchased certain Web hosting assets of
HostAmerica, the Web hosting division of HomeCom Communications, Inc., for cash
of approximately $4,250,000.
On June 29, 1998, the Company purchased the operating assets of All
Information Systems, Inc., a Web hosting company, for cash of approximately
$171,000 and 115,707 shares of the Company's Common Stock, having a valuation of
$5.00 per share.
On July 1, 1998, the Company purchased certain Web hosting assets of
Software Business Technologies, Inc. for 12,000 shares of the Company's Common
Stock, having a valuation of $5.00 per share.
On July 1, 1998, the Company purchased certain Web hosting assets of
DevCom, the Web hosting division of Nextron, Inc., for cash of approximately
$600,000.
F-13
<PAGE> 279
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On July 30, 1998, the Company purchased certain Web hosting assets of
BestWare, Inc., dba Maikon, for cash of approximately $374,000 and 5,490 shares
of the Company's Common Stock, having a valuation of $5.38 per share.
On August 31, 1998, the Company purchased all of the outstanding stock of
B.N. Technology, Inc., dba ICOM, a Web hosting company, for cash of
approximately $2,000,000. The purchase agreement also provides for additional
payments of cash of up to $2,000,000 to the shareholders of ICOM if certain
earnings targets are achieved. As of December 31, 1998, the earnings targets for
periods then ended had been achieved and $1,000,000 has been accrued. This
amount has been recorded as an intangible asset and any future payments under
this agreement will be similarly recorded. Pursuant to one-year employment
agreements, two shareholders of ICOM received a total of 300,000 shares of the
Company's Common Stock valued at $6.47 per share, which vest and is being
accounted for as compensation expense over the terms of the agreements.
On September 16, 1998, the Company purchased certain Web hosting assets of
GEN International, Inc. (GEN) for cash of $455,000 and substantially all the
assets of Global Entrepreneurs Network, Inc. (a wholly-owned subsidiary of GEN)
for $295,000. Pursuant to a consulting agreement with a shareholder of GEN, the
Company issued 25,000 shares of the Company's Common Stock, having a valuation
of $6.66 per share, which vests and is being accounted for as compensation
expense over the term of the consulting agreement.
On December 17, 1998, the Company purchased certain Web hosting assets of
Dialtone, Inc. a Web hosting company for cash of $375,000.
The following unaudited condensed pro forma information presents the
unaudited results of operations of the Company as if the above acquisitions had
occurred on January 1, 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1998
----------- ------------
<S> <C> <C>
Service revenues......................................... $ 5,891,222 $ 8,893,389
Net loss................................................. (6,255,102) (11,211,583)
Net loss per share -- basic and diluted.................. $ (1.73) $ (1.23)
</TABLE>
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1997 1998 MARCH 31, 1999
------- ---------- --------------
(UNAUDITED)
<S> <C> <C> <C>
Amounts due to former owners under contingent
consideration arrangements (see Note 5)...... $1,000,000 $ 500,000
Compensation................................... 226,641 574,740
Communications costs........................... 121,000 224,866
Other.......................................... $26,507 953,866 1,969,061
------- ---------- ----------
$26,507 $2,301,507 $3,268,667
======= ========== ==========
</TABLE>
F-14
<PAGE> 280
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCKHOLDERS' EQUITY
Common Stock
Pursuant to a Stock Subscription Agreement dated December 8, 1997 between
the Company and WEB, WEB purchased 15,600,000 shares of the Company's Common
Stock during the year ended December 31, 1998 and 3,000,000 shares during the
period December 8, 1997 (inception) to December 31, 1997, all at $1.67 per
share. WEB is entitled to purchase an additional 6,600,000 shares at $1.67
pursuant to the Stock Subscription Agreement (see Note 12). In connection with
the Stock Subscription Agreement, the Company recorded a $4,000,000 common stock
subscription receivable from WEB as of December 31, 1997. The subscription was
collected on March 12, 1998.
The Board of Directors approved a three-for-one stock split of the
Company's Common Stock on July 28, 1998. The accompanying financial statements
have been retroactively restated to give effect to the stock split.
Stock Option Plan
On February 1, 1998, the Company adopted the Sage Networks, Inc. 1998 Stock
Option Plan (the Plan), which is administered by the Board of Directors (the
Committee). Under the terms of the Plan, the Committee may grant stock options
to officers, employees and consultants of the Company. The Plan permits the
grant of incentive stock options (ISOs) and nonqualified stock options (NSOs).
As of December 31, 1998, the Company has reserved 1,500,000 shares of Common
Stock for issuance under the Plan. Stock options may not be granted at less than
100% of the fair market value of the Common Stock on the date of the grant and
may not expire more than ten years from the date of the grant. Options granted
under the Plan generally will become exercisable over a four-year period in
equal annual installments unless the Committee specifies a different vesting
schedule. In the event of a change in control of the Company, each option
becomes immediately vested and exercisable, provided that no written provision
has been made, in connection with any such event, for (1) the continuation of
the stock option plan and/or the assumption of all outstanding options by a
successor corporation or (2) the substitution for such options of new options
covering the stock of a successor corporation. The Plan has a term of ten years,
subject to earlier termination or amendment by the Committee, and all options
under the Plan prior to its termination remain outstanding until they have been
exercised or terminated.
During the year ended December 31, 1998, the Company granted 440,500
options at prices ranging from $1.67 to $6.67 per share. The weighted-average
exercise price of the options granted was $4.11. No options were exercised,
canceled or forfeited during the year ended December 31, 1998. No options are
vested at December 31, 1998.
Stock-Based Compensation
As discussed in Note 2, the Company applies APB 25 and related
interpretations in accounting for its stock option plan. Accordingly, since the
Company grants stock options with exercise prices at least equal to fair value
at the date of grant, no compensation expense has been recognized relating to
option grants in 1998.
As required under FAS 123, the following pro forma net loss and net loss
per share presentations reflect the amortization of the option grant fair value
as expense. For purposes of this disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The Company's
pro forma information follows for the year ended December 31, 1998:
<TABLE>
<S> <C>
Pro forma net loss.......................................... $(9,756,000)
Pro forma net loss per share -- basic and diluted........... $ (1.11)
</TABLE>
F-15
<PAGE> 281
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average grant date value was $0.83 for stock options issued in
1998, and the weighted-average remaining contractual life for options
outstanding as of December 31, 1998 is 9.4 years. Significant assumptions used
in determining this value include a risk free interest rate of 5.6%, expected
life of the options of four years, and a dividend rate of zero.
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures in future years as the
period presented includes only one year of option grants under the Plan.
8. INCOME TAXES
As of December 31, 1998, the Company has federal and state net operating
loss carryforwards of approximately $7,700,000. The net operating loss
carryforwards will expire at various dates beginning in the years 2003 through
2018 if not utilized.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes consist of the following at December 31,
1998:
<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $3,063,000
Depreciation.............................................. (14,000)
Other, net................................................ 813,000
----------
Total deferred tax assets, net.............................. 3,862,000
Valuation allowance......................................... (3,862,000)
----------
Net deferred tax asset...................................... $ --
==========
</TABLE>
The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realization of
the deferred tax assets such that a full valuation allowance has been recorded.
The Company will continue to assess the realization of the deferred tax assets
based on actual and forecasted operating results.
9. LEASES
The Company leases its data centers and certain office space under
noncancelable operating leases, which expire at various dates through June 2009.
Some of the leases contain renewal options. Total rent expense for all operating
leases was approximately $7,000 and $420,000 for the period December 8, 1997
(inception) to December 31, 1997 and the year ended December 31, 1998,
respectively. In connection with one of the leases, the Company has given the
landlord a standby letter of credit in the amount of approximately $100,000 in
lieu of a security deposit.
Future minimum lease commitments for noncancelable operating leases are as
follows at December 31, 1998:
<TABLE>
<S> <C>
1999........................................................ $ 956,764
2000........................................................ 877,488
2001........................................................ 847,484
2002........................................................ 816,334
2003........................................................ 569,958
Thereafter.................................................. 2,079,107
----------
Total minimum lease payments...................... $6,147,135
==========
</TABLE>
F-16
<PAGE> 282
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED-PARTY TRANSACTIONS
In connection with the acquisitions of certain Web hosting assets of
various entities (see Note 5), the Company paid or accrued transaction fees of
approximately $319,000 to Charterhouse Group International, Inc., a related
party of WEB. These fees are included in the respective purchase price
allocations as capitalized transaction costs.
The Company receives consulting services from Sage Equities, Inc. and
Intensity Ventures, Inc., whose principals are the co-chairmen of the Company
and members of WHO, for the purpose of identifying and executing potential
acquisitions. Sage Equities, Inc. and Intensity Ventures, Inc. are each paid
fees of $10,000 (plus expenses) per month for such services. For the period
December 8, 1997 (inception) to December 31, 1997 and the year ended December
31, 1998, the Company incurred costs under these agreements of $25,000 and
$120,000, respectively, for Sage Equities, Inc., and $17,000 and $232,000 (of
which $112,000 were expenses), respectively, for Intensity Ventures. At December
31, 1997, these entities were owed a total of $84,959 by the Company for such
consulting services, which was paid in 1998.
The Company also receives consulting services from one other member of WHO.
During the period December 8, 1997 (inception) to December 31, 1997 and the year
ended December 31, 1998, the Company incurred costs relating to these services
totaling approximately $8,000 and $44,000, respectively.
11. EMPLOYEE BENEFIT PLAN
In 1998, the Company instituted a 401k Plan for all employees who have
attained age 21 and have been employed by the Company or by an acquired business
for one month. Participating employees may make contributions to the plan up to
15% of their compensation. The Plan provides that the Company may make
discretionary contributions to the Plan on behalf of participating employees.
The Company did not make any such contributions for the year ended December 31,
1998.
12. SUBSEQUENT EVENTS
On January 28, 1999, the Company's Board of Directors and Stockholders
approved an amendment to the Company's certificate of incorporation (Charter) to
increase the number of authorized shares to 35,000,000 shares of Common Stock
and up to 2,647,658 shares of Preferred Stock, all of which is designated as
Series A Convertible Preferred Stock (Series A Preferred).
On January 28, 1999, pursuant to a Securities Purchase Agreement (the
Purchase Agreement) the Company sold to Softbank Technology Ventures IV L.P. and
one of its affiliates (the Series A Investors), 2,647,658 shares of its Series A
Preferred at a price of $4.91 per Series A Preferred share and issued 749,625
Common Stock warrants of the Company for cash of $13,000,000. The Series A
Preferred is convertible at any time, at the option of the holder, into the
Company's Common Stock, subject to anti-dilution provisions as set forth in the
Charter. In the event of a qualifying public offering (as defined in the
Charter), however, the Series A Preferred is automatically converted into Common
Stock. If the Series A Preferred is not converted before January 28, 2006, a
majority in interest of the holders thereof may request the Company to redeem
the Series A Preferred at $4.91 per share plus any accrued but unpaid dividends
on such shares. Because of the redemption features of the Series A Preferred, it
will not be reported as a component of stockholders' equity. The warrants are
immediately exercisable at a price of $6.67 per share. The warrants expire on
the earlier of three years subsequent to the consummation of the Company's
initial public offering or January 28, 2003. The Company, the Series A Investors
and WEB have entered into an Investors Agreement dated January 28, 1999, which
provides the Series A Investors to nominate a director to the Company's Board of
Directors and grants the Series A Investors preemptive rights and certain
registration rights.
F-17
<PAGE> 283
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On February 9, 1999, pursuant to its stock subscription agreement, WEB
purchased the remaining 6,600,000 shares of the Company's Common Stock for an
aggregate of $11,000,000 (see Note 7).
The Company consummated the following acquisitions in the early part of
February 1999, each of which will be accounted for using the purchase method of
accounting:
The purchase of certain assets of Telephonetics International, Inc., a
provider of customized music and messages on hold recording services to
businesses utilizing on-hold telephone equipment. The purchase price
consists of cash of $3,000,000 and 140,000 shares of the Company's Common
Stock valued at $6.67 per share.
The purchase of all of the outstanding stock of Net Daemons
Associates, Inc. (NDA), a provider of Web development and system
integration activity for Internet and IP Networks. The purchase price
consists of cash of $500,000 and 425,000 shares of the Company's Common
Stock valued at $6.67 per share. In addition, the Company has agreed to pay
certain officers of NDA $2,371,000 to induce them to enter into non-compete
agreements and to pay approximately $436,000 to cancel certain NDA stock
options. The agreement also provides for contingent purchase consideration
of $500,000 in cash and 74,963 shares of the Company's Common Stock if
specified gross revenue and gross margin targets are achieved in the
twelve-month period following the acquisition. The payment of contingent
consideration, if any, will be recorded as additional purchase price. The
shares of stock and cash to be paid for the contingent purchase
consideration have been deposited with an escrow agent.
The purchase of the Web hosting assets of Digiweb, Inc., a Web hosting
company. The purchase price consists of cash of approximately $5,000,000
and 450,000 shares of the Company's Common Stock valued at $6.67. The
agreement provides for contingent purchase consideration of $1,000,000 if
specified revenue and earnings targets are achieved in the year ending
December 31, 1999. The payment of contingent consideration, if any, will be
recorded as additional purchase price.
In March 1999, the Company's stockholders approved an amendment to the
Company's certificate of incorporation to increase the number of authorized
shares of Common Stock to 100,000,000, and, on March 10, 1999, the Company
acquired substantially all of the assets and assumed specified liabilities of
Interliant, Inc., a provider of groupware hosting and application outsourcing
services. The purchase price consisted of $100,000 in cash and 4,091,642 shares
of the Company's Common Stock valued at $6.67 per share, and options to purchase
up to 2,322,179 shares of the Company's Common Stock. In addition, the Company
paid $7,900,000 on an outstanding note payable of Interliant, Inc. at closing
and will pay the balance of the note ($8,000,000) at the earlier of the
completion of an initial public offering of the Company's Common Stock or
September 1999. The transaction will be accounted for using the purchase method
of accounting. In connection with this acquisition, the Company changed its name
to Interliant, Inc.
F-18
<PAGE> 284
INTERLIANT, INC.
(FORMERLY KNOWN AS SAGE NETWORKS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The purchase consideration for the acquisitions referred to above is as
follows:
<TABLE>
<S> <C>
Cash, including estimated transaction costs and payments of
$7,900,000 of seller's note............................... $20,287,000
Common stock (6,630,103 shares, including 1,523,461 shares
issuable upon exercise of substitute options issued in
connection with the acquisition of the net assets of
Interliant, Inc.) ........................................ 44,025,000
-----------
64,312,000
Seller debt paid............................................ 7,900,000
Allocated to intangible assets (see note 4)................. 65,967,000
-----------
Allocated to net tangible assets acquired................... $(9,555,000)
===========
</TABLE>
The following unaudited condensed pro forma information presents the
unaudited results of operations of the Company as if the acquisitions completed
in 1999 had occurred on January 1, 1998:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, 1998 MARCH 31, 1998 MARCH 31, 1999
----------------- -------------- --------------
<S> <C> <C> <C>
Service revenues.......................... $ 41,291,564 $ 9,534,050 $ 10,340,535
Net loss.................................. (39,030,493) (8,651,687) (13,182,481)
Net loss per share -- basic and diluted... $ (2.47) $ (0.84) $ (0.46)
</TABLE>
13. INFORMATION ABOUT PRODUCTS AND SERVICES
For the three months ended March 31, 1999, revenues earned from Web
hosting, application hosting, consulting and other services were 56.9%; 20.8%;
15.0%; and 7.3%, respectively of total revenues.
For the three months ended March 31, 1999, 19.8% of total revenues were
from sources outside the United States, primarily from Europe, Asia and South
America.
For the year ended December 31, 1998 all revenues were from Web hosting and
18.8% of revenues were from sources outside the United States, primarily from
Europe and Asia.
F-19
<PAGE> 285
INTERLIANT, INC.
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
During the period from inception through March 10, 1999, Interliant, Inc.
(formerly, Sage Networks, Inc.) ("Interliant" or the "Company") completed
numerous business combinations, whereby the Company acquired shares of common
stock, or certain net assets of entities operating in the Internet industry.
Business combinations are accounted for using the purchase method of accounting.
The unaudited pro forma consolidated statement of operations for the year
ended December 31, 1998 and the three months ended March 31, 1999 assumes that
the acquisitions completed in 1998 and 1999 had occurred on January 1, 1998, and
includes the historical consolidated statements of operations of Interliant,
adjusted for the pro forma effects of the acquisitions.
The unaudited pro forma consolidated statement of operations is not
necessarily indicative of the results of operations that would actually have
occurred if the transactions had been consummated as of January 1, 1998 and is
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 Interliant, and of certain
acquired businesses, included elsewhere in this prospectus.
The unaudited pro forma adjustments are based upon preliminary estimates
and certain assumptions that management of Interliant believes are reasonable in
the circumstances. The actual adjustments may be revised upon completion of the
purchase price allocations. Except for additions to intangible assets on
contingent purchase price payments based on the underlying purchase agreements,
management of Interliant does not believe that actual adjustments will be
materially different from preliminary estimates.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
ACQUISITIONS COMPLETED IN 1999(2)
--------------------------------------------------
INTERLIANT INTERLIANT PRO FORMA
HISTORICAL TELEPHONICS NET DAEMONS DIGIWEB TEXAS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- -------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service revenues................ $ 5,434,162 $331,182 $836,289 $237,300 $ 3,501,602 $ 10,340,535
Costs and expenses:
Cost of service revenues...... 3,250,703 47,387 466,929 62,003 2,149,276 5,976,298
Sales and marketing........... 1,896,357 69,711 12,122 1,508,576 3,486,766
General and administrative.... 3,699,847 201,261 285,395 82,979 1,289,018 5,558,500
Depreciation.................. 699,552 6,000 16,206 25,000 532,192 1,278,950
Amortization of intangibles... 2,594,330 $ 3,426,845(5) 6,021,175
Start up and acquisition
costs....................... 1,063,458 1,063,458
------------ -------- -------- -------- ----------- ----------- ------------
Total costs and expenses........ 13,204,247 324,359 780,652 169,982 5,479,062 3,426,845 23,385,147
------------ -------- -------- -------- ----------- ----------- ------------
Operating income (loss)......... (7,770,085) 6,823 55,637 67,318 (1,977,460) (3,426,845) (13,044,612)
Interest income (expense)....... 53,912 (1,873) (148,460) (96,421)
Other income (expense).......... (41,448) (41,448)
Income (loss) before income
tax........................... (7,757,621) 6,823 53,764 67,318 (2,125,920) (3,426,845) (13,182,481)
Provision for income tax........ (13,313) 13,313(6) --
------------ -------- -------- -------- ----------- ----------- ------------
Net income (loss)............... $ (7,757,621) $ 6,823 $ 40,451 $ 67,318 $(2,125,920) $(3,413,532) $(13,182,481)
============ ======== ======== ======== =========== =========== ============
Net loss per share -- basic and
diluted....................... $ (0.31) $ (0.46)
Number of shares................ 24,769,890 28,626,240
</TABLE>
F-20
<PAGE> 286
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
ACQUISITIONS COMPLETED IN 1999 (2)
------------------------------------------------------
INTERLIANT 1998 COMPLETED INTERLIANT PRO FORMA
HISTORICAL ACQUISITIONS(1) TELEPHONETICS NET DAEMONS DIGIWEB TEXAS ADJUSTMENTS
------------ --------------- ------------- ----------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service revenues...... $ 4,905,027 $ 3,988,362 $2,769,606 $5,770,024 $2,685,676 $21,172,869
Costs and expenses:
Cost of service
revenues.......... 3,236,385 1,266,435 823,161 3,211,532 923,310 11,880,983 $ (1,050,921)(3)
Sales and
marketing......... 2,555,035 84,858 31,577 6,722,996
General and
administrative.... 5,120,595 3,473,637 2,605,725 2,161,094 578,993 4,137,668 2,497,463(3)(4)
Depreciation........ 696,039 142,099 74,758 135,129 246,329 2,525,530
Amortization of
intangibles....... 2,439,426 21,645,276(5)
Start up and
acquisition
costs............. 1,727,970
------------ ----------- ---------- ---------- ---------- ----------- ------------
Total costs and
expenses............ 15,775,450 4,967,029 3,503,644 5,507,755 1,780,209 25,267,177 23,091,818
------------ ----------- ---------- ---------- ---------- ----------- ------------
Operating
income(loss)........ (10,870,423) (978,667) (734,038) 262,269 905,467 (4,094,308) (23,091,818)
Interest income
(expense)........... 138,073 (180,987) (7,369) (101,485) (16,829) (715,643)
Equity in loss of
joint venture....... (144,735)
Gain on litigation
settlement.......... 600,000
Income (loss) before
income tax.......... (10,732,350) (1,159,654) (741,407) 160,784 888,638 (4,354,686) (23,091,818)
Provision for income
tax................. 100,800 (100,800)(6)
------------ ----------- ---------- ---------- ---------- ----------- ------------
Net income(loss)...... $(10,732,350) $(1,159,654) $ (741,407) $ 59,984 $ 888,638 $(4,354,686) $(22,991,018)
============ =========== ========== ========== ========== =========== ============
Net loss per share --
basic and diluted... $ (1.22)
Number of shares...... 8,799,432
<CAPTION>
PRO FORMA
------------
<S> <C>
Service revenues...... $ 41,291,564
Costs and expenses:
Cost of service
revenues.......... 20,290,885
Sales and
marketing......... 9,394,466
General and
administrative.... 20,575,175
Depreciation........ 3,819,884
Amortization of
intangibles....... 24,084,702
Start up and
acquisition
costs............. 1,727,970
------------
Total costs and
expenses............ 79,893,082
------------
Operating
income(loss)........ (38,601,518)
Interest income
(expense)........... (884,240)
Equity in loss of
joint venture....... (144,735)
Gain on litigation
settlement.......... 600,000
Income (loss) before
income tax.......... (39,030,493)
Provision for income
tax................. --
------------
Net income(loss)...... $(39,030,493)
============
Net loss per share --
basic and diluted... $ (2.47)
Number of shares...... 15,829,762
</TABLE>
F-21
<PAGE> 287
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(1) Set forth below are the pre acquisition operations of acquired businesses
completed in 1998 from January 1, 1998 through the date of acquisition.
<TABLE>
<CAPTION>
HOST AMERICA,
DIVISION OF HOME-
CLEVER COMPUTERS TRISTAR WEB COME COMMUN- B.N. TECHNOLOGY, GEN INTERNATIONAL
INC. CREATIONS, INC. CATIONS, INC. DBA ICOM INC.
---------------- --------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
Service revenues......... $554,020 $256,953 $ 533,159 $ 982,376 $ 776,503
-------- -------- --------- ---------- ---------
Cost of service
revenues............... 102,197 103,232 230,435 153,919 323,518
Sales and marketing...... 52,770 32,088
General and
administrative......... 387,236 183,521 629,727 984,223 785,972
Depreciation............. 9,557 63,642 10,817 26,496
-------- -------- --------- ---------- ---------
489,433 296,310 976,574 1,148,959 1,168,074
-------- -------- --------- ---------- ---------
Operating income(loss)... 64,587 (39,357) (443,415) (166,583) (391,571)
Interest income
(expense).............. (368) (156,399) (4,051) (12,557)
-------- -------- --------- ---------- ---------
Net income(loss)......... $ 64,587 $(39,725) $(599,814) $ (170,634) $(404,128)
======== ======== ========= ========== =========
<CAPTION>
OTHER TOTAL 1998
ACQUISITIONS ACQUISITIONS
------------------ ------------
<S> <C> <C>
Service revenues......... $885,351 $ 3,988,362
-------- -----------
Cost of service
revenues............... 353,134 1,266,435
Sales and marketing...... 84,858
General and
administrative......... 502,958 3,473,637
Depreciation............. 31,587 142,099
-------- -----------
887,679 4,967,029
-------- -----------
Operating income(loss)... (2,328) (978,667)
Interest income
(expense).............. (7,612) (180,987)
-------- -----------
Net income(loss)......... $ (9,940) $(1,159,654)
======== ===========
</TABLE>
(2) Represents the results of operations for businesses acquired in 1999 for
the year ended December 31, 1998 and from January 1, 1999 through the date
of acquisition.
(3) To reclassify Interliant Texas customer service costs to conform with
Registrant's presentation.
(4) To record amortization of stock based compensation awarded to employees
and owners of acquired businesses in connection with employment and/or
consulting agreements.
(5) To record amortization of intangibles arising as a result of acquisitions
for the period from January 1, 1998 to acquisition date based on
amortization periods ranging from one to five years.
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED
1998 MARCH 31, 1999
------------ --------------
<S> <C> <C>
Amortization:
1998 acquisitions from January 1, 1998 to
respective dates of acquisition,
(amortization period 1-5 years).......... $ 2,391,952 $ --
1999 acquisitions for the year ended
December 31, 1998 (amortization period 1
to 5 years).............................. 19,253,324 3,426,845
----------- ----------
$21,645,276 $3,426,845
=========== ==========
</TABLE>
(See Note 4 of Notes to Consolidated Financial Statements)
(6) To record elimination of income tax provision due to consolidated pre tax
loss.
F-22
<PAGE> 288
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholder
Clever Computers, Inc.
Atlanta, Georgia
We have audited the accompanying balance sheet of Clever Computers, Inc. as
of December 31, 1995, 1996 and 1997 and the related statements of income,
retained earnings, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Clever Computers, Inc. as of
December 31, 1995, 1996 and 1997 and the results of their operations and their
cash flows for the years then ended, in conformity with generally accepted
accounting principles.
BSC & E
Atlanta, Georgia
March 19, 1998
F-23
<PAGE> 289
CLEVER COMPUTERS, INC.
BALANCE SHEETS
DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
ASSETS
Current Assets
Cash -- operating..................................... $ 10,436 $ 72,263 $ 50,425
Cash -- payroll....................................... 12,723 50,655 42,693
Accounts receivable, net of allowance for doubtful
accounts of $16,199 in 1997........................ 1,441 25,659 91,792
Prepaid expenses...................................... 3,127 6,485
Prepaid income taxes.................................. 878
Deferred income taxes................................. 4,050
--------- --------- ---------
Total current assets.......................... 24,600 151,704 196,323
--------- --------- ---------
Property and Equipment
Furniture............................................. 1,338 1,868 2,617
Computer equipment.................................... 62,705 231,871 422,105
Computer software..................................... 13,944 30,101 34,365
--------- --------- ---------
77,987 263,840 479,087
Accumulated depreciation and amortization............. (53,601) (115,387) (231,264)
--------- --------- ---------
24,386 148,453 247,823
--------- --------- ---------
Other Assets
Other assets.......................................... 3,565 14,782 4,668
Organization costs, net of accumulated amortization of
$196, $292 and $391................................ 292 196 97
--------- --------- ---------
3,857 14,978 4,765
--------- --------- ---------
$ 52,843 $ 315,135 $ 448,911
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable...................................... $ 22,009 $ 33,941 $ 66,808
Accrued consulting fee................................ 34,000 100,000
Deferred revenues..................................... 5,000 95,536 127,324
Income taxes payable.................................. 15,906
Accrued payroll and payroll taxes..................... 11,910 42,363 35,249
Advances to stockholder............................... 10,084 22,520 2,358
--------- --------- ---------
Total current liabilities..................... 49,003 244,266 331,739
--------- --------- ---------
Stockholder's Equity
Common stock, no par value; 10,000 shares authorized;
1,000 shares issued and outstanding................ 5,000 5,000 5,000
Retained earnings..................................... (1,160) 65,869 112,172
--------- --------- ---------
3,840 70,869 117,172
--------- --------- ---------
$ 52,843 $ 315,135 $ 448,911
========= ========= =========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-24
<PAGE> 290
CLEVER COMPUTERS, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------- -------------------
1995 1996 1997 1997 1998
-------- ---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues............................. $303,443 $1,128,108 $2,156,982 $514,483 $518,320
Operating expenses................... 304,153 1,045,357 2,088,928 430,917 483,734
-------- ---------- ---------- -------- --------
Income from operations............. (710) 82,751 68,054 83,566 34,586
Other income and (expense)........... 185 (937) -- --
-------- ---------- ---------- -------- --------
Income before provision for income
taxes........................... (710) 82,936 67,117 83,566 34,586
Provision for income taxes........... 15,906 20,814 25,000 12,000
-------- ---------- ---------- -------- --------
Net income......................... $ (710) $ 67,030 $ 46,303 $ 58,566 $ 22,586
======== ========== ========== ======== ========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-25
<PAGE> 291
CLEVER COMPUTERS, INC.
STATEMENT OF RETAINED EARNINGS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<S> <C>
Balance, December 31, 1994.................................. $ (451)
Deduct net loss........................................... (710)
--------
Balance, December 31, 1995.................................. $ (1,161)
Add net income............................................ 67,030
--------
Balance, December 31, 1996.................................. 65,869
Add net income............................................ 46,303
--------
Balance, December 31, 1997.................................. $112,172
========
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-26
<PAGE> 292
CLEVER COMPUTERS, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------------- --------------------
1995 1996 1997 1997 1998
-------- --------- --------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................... $ (710) $ 67,030 $ 46,303 $ 58,565 $ 22,586
Adjustments to reconcile net income to
net cash provided by operating
activities:
Deferred income taxes............... -- (4,050)
Bad debts........................... -- 16,199
Gain on sale of assets.............. -- (1,426)
Depreciation and amortization....... 25,472 61,884 117,401 30,000 30,000
Changes in operating assets and
liabilities:
Accounts receivable............... 3,723 (24,218) (82,332) 17,159 35,535
Prepaid expenses.................. -- (3,127) (3,358) (13,234) (13,248)
Prepaid income taxes.............. -- (878)
Other assets...................... (3,565) (11,217) 10,114 14,490 4,765
Accounts payable.................. 11,250 11,931 16,961 (16,389) (48,164)
Accrued consulting fees........... -- 34,000 66,000
Deferred revenues................. 5,000 90,536 31,788 10,000 54,949
Income taxes payable.............. -- 15,906 25,000 12,000
Accrued payroll and payroll
taxes.......................... 12,094 30,454 (7,115) 30,773
Advances to stockholder........... 7,109 12,436 (20,162) 3,496
Other current liabilities......... (88,429) (11,000)
-------- --------- --------- -------- ---------
Net cash provided by operating
activities................... 60,373 285,615 185,445 40,658 118,196
-------- --------- --------- -------- ---------
Cash flows from investing activities:
Acquisition of property and
equipment........................... (39,997) (185,856) (219,206) (95,564) (116,677)
Proceeds from sale of assets........... -- 3,961
-------- --------- --------- -------- ---------
Net cash used in investing
activities................... (39,997) (185,856) (215,245) (95,564) (116,677)
-------- --------- --------- -------- ---------
Cash flows from financing activities..... -- -- -- -- --
-------- --------- --------- -------- ---------
Increase (decrease) in cash.............. 20,376 99,759 (29,800) (54,906) 1,519
Cash, beginning of year.................. 2,783 23,159 122,918 122,918 93,118
-------- --------- --------- -------- ---------
Cash, end of year........................ $ 23,159 $ 122,918 $ 93,118 $ 68,012 $ 94,637
======== ========= ========= ======== =========
Cash paid during the year for:
Interest............................... $ -- $ 51 $ 2,500
Income taxes........................... -- -- 36,931
</TABLE>
The Notes to Financial Statements are an integral part of these statements.
F-27
<PAGE> 293
CLEVER COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Nature of business
Clever Computers, Inc. was incorporated October 25, 1993 in the State of
Georgia. The Company is engaged in the business of Internet Web hosting.
Property and equipment
Property and equipment are recorded at cost. Depreciation is provided over
the estimated useful lives of the assets by accelerated and straight line
methods.
Statement of cash flows
The Company considers instruments with a maturity of three months or less
to be cash equivalents for purposes of the statement of cash flows.
Income taxes
Income taxes are accounted for in accordance with provisions of Statement
of Financial Accounting Standards No. 109. Deferred income taxes have been
provided for the difference in bad debt expense for income tax and financial
statement reporting purposes.
Organization costs
Organization costs are being amortized on a straight line basis over five
years.
Deferred revenues
As part of their standard service agreements with customers, the Company
bills for all services for three months in advance. As a result, a portion of
revenues collected and billed for as of year end relates to services not yet
performed. The deferred revenue associated with these services is recognized on
the balance sheet as a current liability.
Estimates
Management uses estimates and assumptions in preparing financial
statements. Those estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported revenues and expenses. Actual results could differ from those
estimates.
Unaudited information
The interim financial information for the three months ended March 31, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
NOTE 2. LEASES
The Company leases office facilities and certain equipment. Renewal options
are available on some of these leases.
F-28
<PAGE> 294
CLEVER COMPUTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments required on noncancelable operating leases
having initial or remaining terms in excess of one year as of December 31, 1997,
are as follows:
<TABLE>
<S> <C>
1998...................................................... $175,923
1999...................................................... 33,555
2000...................................................... 1,600
--------
$211,078
========
</TABLE>
Rent expense of $10,104, $40,508 and $97,655 in 1995, 1996 and 1997,
respectively, is included in operating expenses in the accompanying statements
of income.
NOTE 3. INCOME TAXES
The Company's provision for income taxes consisted of the following
amounts:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31
--------------------------
1995 1996 1997
---- ------- -------
<S> <C> <C> <C>
Current........................................... $-- $11,860 $24,864
Deferred benefit........................ -- (4,046) (4,050)
--- ------- -------
Provision for income taxes.............. $-- $15,906 $20,814
=== ======= =======
</TABLE>
NOTE 4. SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Company was approached by certain
parties regarding the potential sale of the Company. As of the report date, no
formal agreement was in place and negotiations were ongoing.
F-29
<PAGE> 295
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Sage Networks, Inc.
We have audited the accompanying balance sheets of Tri Star Web Creations,
Inc. as of December 31, 1996 and 1997, and the related statements of operations,
and changes in retained earnings, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Tri Star Web Creations, Inc.
as of December 31, 1996 and 1997, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
Urbach Kahn & Werlin PC
New York, New York
July 13, 1998
F-30
<PAGE> 296
TRI STAR WEB CREATIONS, INC.
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------ --------
<S> <C> <C>
ASSETS
Current Assets
Cash...................................................... $ 391 $ 997
Accounts receivable, net of an allowance for doubtful
accounts of $6,000 and $9,747.......................... 9,125 41,770
Prepaid expenses.......................................... -- 3,365
------ --------
Total current assets.............................. 9,516 46,132
Other assets................................................ -- 4,182
Fixed assets, net of accumulated depreciation............... -- 95,036
------ --------
Total assets...................................... $9,516 $145,350
------ --------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current Liabilities
Notes payable to related parties, current................. $ -- $ 18,510
Equipment purchase/obligations............................ -- 55,236
Accounts payable.......................................... 1,500 42,771
Deferred revenue.......................................... 2,420 26,131
------ --------
Total current liabilities......................... 3,920 142,648
------ --------
Long-term Liabilities
Note payable to related party, net of current portion..... -- 1,795
------ --------
Total liabilities................................. 3,920 144,443
------ --------
Stockholders' Equity
Capital stock, no par value; 100 shares authorized, 3
shares issued and outstanding.......................... 100 100
Retained earnings......................................... 5,496 807
------ --------
Total stockholder's equity........................ 5,596 907
------ --------
Total liabilities and stockholder's equity........ $9,516 $145,350
====== ========
</TABLE>
See Notes to Financial Statements
F-31
<PAGE> 297
TRI STAR WEB CREATIONS, INC.
STATEMENTS OF OPERATIONS AND CHANGES IN RETAINED EARNINGS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------ --------------------
1996 1997 1997 1998
---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Service revenues................................ $ 51,492 $178,251 $ 29,120 $143,256
-------- -------- -------- --------
Selling expenses................................ 7,727 25,234 18,937 19,108
General and administrative expenses............. 23,021 140,972 20,665 77,279
-------- -------- -------- --------
30,748 166,206 39,602 96,387
-------- -------- -------- --------
Operating income (loss)......................... 20,744 12,045 (10,482) 46,869
Interest expense................................ -- 1,424 147 294
-------- -------- -------- --------
Net income (loss)..................... 20,744 10,621 $(10,629) $ 46,575
======== ========
Retained earnings (accumulated deficit),
beginning of year............................. (420) 5,496
Distributions................................... (14,828) (15,310)
-------- --------
Retained earnings, end of year.................. $ 5,496 $ 807
======== ========
</TABLE>
See Notes to Financial Statements
F-32
<PAGE> 298
TRI STAR WEB CREATIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------ --------------------
1996 1997 1997 1998
---------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................... $ 20,744 $ 10,621 $(10,629) $ 46,575
Adjustments to reconcile net income to net
cash provided by operating activities:
Bad debts.................................. 6,000 3,747 -- --
Depreciation............................... -- 4,337 304 9,565
Changes in:
Accounts receivable...................... (15,125) (36,392) (1,985) (42,605)
Prepaid expenses......................... -- (3,365) -- 983
Other assets............................. -- (4,182) (1,300) 1,498
Accounts payable......................... 180 41,271 16,750 2,804
Deferred revenue......................... 2,420 23,711 (2,420) 78,393
-------- -------- -------- --------
Net cash provided by operating
activities.......................... 14,219 39,748 720 97,213
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets...................... -- (37,603) (18,251) (82,301)
-------- -------- -------- --------
Net cash used in investing
activities.......................... -- (37,603) (18,251) (82,301)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from related party borrowings........ -- 25,000 18,333 --
Principal payments on related party borrowings
and equipment purchase obligations......... -- (11,229) -- (14,285)
Cash distributions paid....................... (14,828) (15,310) -- --
-------- -------- -------- --------
Net cash used in financing
activities.......................... (14,828) (1,539) 18,333 (14,285)
-------- -------- -------- --------
Net increase (decrease) in cash....... (609) 606 802 627
Cash, beginning of year......................... 1,000 391 391 997
-------- -------- -------- --------
Cash, end of year............................... $ 391 $ 997 $ 1,193 $ 1,624
======== ======== ======== ========
Supplemental disclosures of cash flow
information
Cash payments for:
Interest................................... $ -- $ 1,424 $ -- $ --
-------- -------- -------- --------
Supplemental schedule of noncash investing and
financing activities
Equipment purchase obligations incurred for
use of equipment........................... $ -- $ 61,770 $144,404 $ --
-------- -------- -------- --------
</TABLE>
See Notes to Financial Statements
F-33
<PAGE> 299
TRI STAR WEB CREATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. DESCRIPTION OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Operations: Tri Star Web Creations, Inc. (the "Company") is
primarily engaged in the business of providing web hosting services for
companies and individuals nationwide placing websites on the Internet.
Summary of Significant Accounting Policies
Revenue Recognition: The Company recognizes service revenues ratably as
hosting services are provided.
Concentrations of Credit Risk: The Company extends credit based on an
evaluation of the customer's financial condition, generally without requiring
collateral. Exposure to losses on receivables is principally dependent on each
customer's financial condition. The Company monitors its exposure for credit
losses and maintains allowances for anticipated losses.
Fixed Assets: Fixed assets are carried at cost, less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful lives of the related assets which range from five to seven
years.
Income Taxes: The Company, with the consent of its stockholders, has
elected to be taxed under sections of the federal and state income tax laws
which provide that, in lieu of corporation income taxes, the stockholder
separately accounts for the Company's items of income, deduction, losses and
credits. Therefore, no provision or liability for Federal tax is reflected in
the financial statements. A provision for state taxes is included in operating
expenses.
Use of Estimates in the Preparation of Financial Statements: 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 dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Unaudited information: The interim financial information for the three
months ended March 31, 1998 and 1997 is unaudited. However, in the opinion of
management, such information has been prepared on the same basis as the audited
financial statements and includes all adjustments, consisting solely of normal
recurring adjustments, necessary for a fair presentation of the financial
position and results of operations for the periods presented. The interim
results, however, are not necessarily indicative of results for any future
period.
NOTE 2. FIXED ASSETS
Fixed assets consist of the following at December 31:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Computers.......................................... $98,369
Furniture and fixtures............................. 1,004
-------
99,373
Less accumulated depreciation...................... 4,337
-------
$95,036
=======
</TABLE>
F-34
<PAGE> 300
TRI STAR WEB CREATIONS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. NOTES PAYABLE, RELATED PARTIES
Loans from related parties at December 31, 1997 are represented by a
$15,305 obligation secured by substantially all assets of the Company with
interest at 8.25% and an unsecured non-interest bearing obligation of $5,000.
Notes payable, related parties at December 31, 1997 mature as follows:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Total.............................................. $20,305
Less amounts due currently......................... 18,510
-------
Amounts maturing in 1999........................... $ 1,795
=======
</TABLE>
NOTE 4. EQUIPMENT PURCHASE OBLIGATIONS
The Company finances a portion of its computer equipment under twelve month
equipment purchase obligations.
NOTE 5. OPERATING LEASE
The Company leases its office facility under an operating lease which
expires in January 2003. In addition to base rent, the leasing arrangements
obligate the Company to pay all taxes, insurance, utilities and maintenance
costs. The future minimum base rent payments under the lease are as follows:
<TABLE>
<CAPTION>
AMOUNT
--------
<S> <C>
1998.............................................. $ 21,281
1999.............................................. 22,961
2000.............................................. 23,556
2001.............................................. 24,169
2002.............................................. 25,936
--------
$117,903
========
</TABLE>
NOTE 6. SUBSEQUENT EVENT
In May 1998, the Company sold substantially all of its assets to Sage
Networks, Inc. ("Sage") for cash and assumption of certain of its liabilities
and common stock in Sage. The net consideration for this sale exceeded the
carrying amounts of the related assets at December 31, 1997.
F-35
<PAGE> 301
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
HomeCom Communications, Inc.
In our opinion, the accompanying statements of assets and liabilities and
the related statements of revenues and expenses and of cash flows present
fairly, in all material respects, the financial position of HostAmerica, a
division of HomeCom Communications, Inc., at December 31, 1996 and 1997, and the
results of its operations and its cash flows for the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been carved out of the
historical financial statements of HomeCom Communications, Inc. As such, these
financial statements represent a lesser business component and are not intended
to be a complete presentation of the financial position or the results of
operations or cash flows of the Company were it to operate on a stand-alone
basis. A description of the significant assumptions used to prepare the
carve-out financial statements is included in Note 1 to the financial
statements.
As discussed in Note 1 to the financial statements, substantially all the
assets of HostAmerica were sold to Sage Acquisition Corp. on June 9, 1998.
PricewaterhouseCoopers LLP
Atlanta, Georgia
August 18, 1998
F-36
<PAGE> 302
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF ASSETS AND LIABILITIES
AS OF DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Accounts receivable, net of allowance for
uncollectibles......................................... $ 54,306 $ 55,421
-------- --------
Total current assets.............................. 54,306 55,421
Computer equipment, net..................................... 62,610 83,662
-------- --------
Total assets...................................... $116,916 $139,083
======== ========
LIABILITIES AND BUSINESS UNIT EQUITY (DEFICIT)
Current liabilities:
Deferred revenue.......................................... $ 62,063 $173,458
-------- --------
Total current liabilities......................... 62,063 173,458
-------- --------
Commitments and contingencies
Business unit equity (deficit).............................. 54,853 (34,375)
-------- --------
Total liabilities and business unit equity
(deficit)....................................... $116,916 $139,083
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-37
<PAGE> 303
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF REVENUES AND EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------------ -----------------------
1995 1996 1997 1997 1998
-------- --------- ----------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Hosting revenues.............. $ 26,191 $ 304,399 $ 692,140 $211,617 $ 317,806
Cost of hosting revenues...... 32,298 163,767 407,785 75,207 114,780
-------- --------- ----------- -------- ---------
Gross margin.................. (6,107) 140,632 284,355 136,410 203,026
-------- --------- ----------- -------- ---------
Operating expenses:
Sales and marketing......... 7,187 99,005 407,375 21,704 37,634
General and
administrative........... 13,617 183,524 876,121 132,075 344,067
Depreciation................ 23,877 83,586 13,386 35,581
-------- --------- ----------- -------- ---------
Total operating
expenses.......... 20,804 306,406 1,367,082 167,165 417,282
-------- --------- ----------- -------- ---------
Operating loss................ (26,911) (165,774) (1,082,727) (30,755) (214,256)
Other expenses (income):
Interest expense............ 278 6,789 130,660 4,935 95,810
Other expense (income),
net...................... (868) (22,431) (210) (13,740)
-------- --------- ----------- -------- ---------
Excess of expenses over
revenues.................... $(27,189) $(171,695) $(1,190,956) ($35,480) $(296,326)
======== ========= =========== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-38
<PAGE> 304
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------- --------------------
1995 1996 1997 1997 1998
-------- --------- ----------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Excess of expenses over
revenues....................... $(27,189) $(171,695) $(1,190,956) $(35,480) $(296,326)
Adjustments to reconcile excess of
expenses over revenues to net
cash used in operating
activities:
Depreciation................... 23,877 83,586 13,386 35,582
Provision for bad debts........ 1,014 26,090 198,364 -- 7,675
Changes in assets and
liabilities:
Accounts receivables......... (6,032) (73,274) (201,583) (57,334) (26,036)
Unearned revenue............. 4,899 57,164 111,396 13,203 32,935
-------- --------- ----------- -------- ---------
Net cash used in operating
activities.............. (27,308) (137,838) (999,193) (66,225) (246,170)
-------- --------- ----------- -------- ---------
Cash flows from investing
activities:
Purchase of computer equipment.... -- (77,147) (55,589) -- (8,245)
-------- --------- ----------- -------- ---------
Net cash used in investing
activities.............. -- (77,147) (55,589) -- (8,245)
-------- --------- ----------- -------- ---------
Cash flows from financing activities
Allocated charges paid by HomeCom
Communications, Inc., net of
cash transferred............... 27,308 214,985 1,054,782 66,225 254,415
-------- --------- ----------- -------- ---------
Net cash provided by
financing activities.... 27,308 214,985 1,054,782 66,225 254,415
-------- --------- ----------- -------- ---------
Net increase (decrease) in cash..... 0 0 0 0 0
Cash and cash equivalents at
beginning of period............... 0 0 0 0 0
-------- --------- ----------- -------- ---------
Cash and cash equivalents at end of
period............................ $ 0 $ 0 $ 0 $ 0 $ 0
======== ========= =========== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-39
<PAGE> 305
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
HostAmerica is a trade name of HomeCom Communications, Inc. ("HomeCom")
under which HomeCom provides full service Internet Web site hosting services.
The Web hosting operations of HomeCom conducted under the HostAmerica trade name
are herein referred to as "HostAmerica" or "the Division".
On June 9, 1998, HomeCom sold certain assets of the Division, consisting
principally of hosting contracts, equipment and the trade name "HostAmerica" to
Sage Acquisition Corp. for $4,500,000. Pursuant to the terms of the Asset
Purchase Agreement (the "Agreement"), HomeCom retained all of the accounts
receivable of HostAmerica existing as of May 31, 1998, and retained certain
hosting contracts, and the right to perform hosting services in the future for
companies in the financial services industry. The Agreement required the deposit
of $250,000 of the proceeds to be held in escrow until May 1, 1999, for the
purpose of indemnifying Sage Acquisition Corp. for representations and
warranties made by HomeCom under the Agreement.
Basis of Presentation
Historically, financial statements were not prepared for the Division. The
accompanying financial statements have been prepared in accordance with
generally accepted accounting principles and have been "carved out" of the
financial statements of HomeCom for each of the periods, and as of each of the
dates presented. As such, these statements represent a lesser business component
and are not intended to be a complete presentation of the financial position or
the results of operations or cash flows of the Division were it to operate on a
stand-alone basis.
The accompanying financial statements exclude the assets, liabilities and
revenues related to certain premium hosting accounts referred to as Excluded
Customers in the Agreement. The statements of revenues and expenses of the
Division include all revenues and costs directly attributable to the Division
and also include allocations of corporate overhead from HomeCom. Expenses have
been allocated based on a variety of methods depending on the nature of the
expense. Such allocation methods include proportional HostAmerica revenues to
total HomeCom revenues, headcount equivalents and management estimates. The cost
of providing hosting services represents direct payroll and related costs of
those employees involved in providing hosting services and an allocation of
Internet connection services. An allocation of corporate marketing expenses and
corporate administrative functions (including data services, employee benefits,
legal, insurance, accounting and other corporate overhead) has been included in
the selling and marketing and general and administrative operating expenses in
the statements of revenues and expenses. Depreciation has been computed based
upon a computation of the direct expenses related to the assets sold under the
terms of the Agreement plus an allocation of general corporate depreciation.
Management believes these allocations are reasonable. These allocations are not
necessarily indicative of the costs and expenses that would have resulted if the
Division had been operated as a separate entity.
Accounts Receivable, Net
Accounts receivable represent amounts receivable from the class of hosting
customer subject to the Agreement and are shown net of the allowance for
doubtful accounts. The allowance was approximately $27,000 and approximately
$90,000 at December 31, 1996 and 1997, respectively.
F-40
<PAGE> 306
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Computer Equipment, Net
Computer equipment is recorded at cost less accumulated depreciation, which
is computed using the straight-line method over the estimated useful lives of
the related assets (three years). Maintenance and repairs are charged to expense
as incurred. Upon sale, retirement or other disposition of these assets, the
cost and the related accumulated depreciation are removed from the respective
accounts and any gain or loss on the disposition is included in income.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue Recognition
HostAmerica recognizes revenues ratably over the period for which the Web
site hosting services are provided. Deferred revenue, as reflected on the
accompanying statements of assets and liabilities, represents the amount of
billings recorded in advance of services being provided.
Advertising Expenses
All advertising costs are expensed when incurred. Advertising expenses
allocated to the Division were approximately $1,000, $32,000, and $384,000 for
the years ended December 31, 1995, 1996 and 1997, respectively.
Income Taxes
The Division is not a legal entity. The Division has been included in
HomeCom's consolidated federal income tax returns for all periods prior to June
9, 1998. The Division was not a party to any tax sharing agreement and,
accordingly, no benefit for income taxes has been reflected in the accompanying
statements of revenues and expenses.
Unaudited Information
The interim financial information for the three months ended March 31, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of results of operations and cash flows for
the periods presented. The interim results, however, are not necessarily
indicative of results for any future period.
F-41
<PAGE> 307
HOMECOM COMMUNICATIONS, INC.
HOSTAMERICA DIVISION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. COMPUTER EQUIPMENT
Computer equipment, net, represents the specific assets defined in the
agreement used in the provision of hosting services and is comprised of the
following as of:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Computer equipment......................... $ 77,147 $132,736
Less: accumulated depreciation............. (14,537) (49,074)
-------- --------
$ 62,610 $ 83,662
======== ========
</TABLE>
3. COMMITMENTS AND CONTINGENCIES
The Division's software and equipment are vulnerable to computer viruses or
similar disruptive problems caused by customers or other Internet users.
Computer viruses or problems caused by third parties could lead to
interruptions, delays or cessation in service to the Division's customers.
Moreover, customers of the Division could use computer files and information
stored on or transmitted to Web server computers maintained by the Division to
engage in illegal activities that may be unknown or undetectable by the
Division, including fraud and misrepresentation, and unauthorized access to
computer systems of others. Furthermore, inappropriate use of the Internet by
third parties could also jeopardize the security of customers' confidential
information that is stored in the Division's computer systems. Any such actions
could subject the Division to liability to third parties. The Division does not
have errors and omissions, product liability or other insurance to protect
against risks caused by computer viruses or other misuse of software or
equipment by third parties. Although the Division attempts to limit its
liability to customers for these types of risks through contractual provisions,
there can be no assurance that these provisions will be enforceable.
Various legal proceedings may arise in the normal course of business.
Management does not believe that there are currently any asserted or unasserted
claims that will have a material adverse effect on the statements of assets and
liabilities, statements of revenues and expenses or cash flows of the Division.
4. CONCENTRATION OF CREDIT RISKS
Financial instruments that potentially subject the Division to significant
concentrations of credit risk consist principally of accounts receivable.
Concentration of credit risk with respect to trade receivables is monitored
by the Division through ongoing credit evaluations of its customers' financial
condition. No customer accounted for more than 10% of the revenues of the
Division during 1995, 1996 or 1997.
F-42
<PAGE> 308
INDEPENDENT AUDITOR'S REPORT
Board of Directors
B.N. Technology, Inc.
dba Internet Communications
Los Angeles, California
We have audited the accompanying balance sheets of B.N. Technology, Inc.
dba Internet Communications as of December 31, 1996 and 1997, and the related
statements of operations and accumulated deficit, and cash flows for the period
April 15, 1996 (inception) through December 31, 1996 and for the year ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amount and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material aspects, the financial position of B.N. Technology, Inc. as of
December 31, 1996 and 1997, and the results of its operations and its cash flows
for the period April 16, 1996 (inception) through December 31, 1996 and the year
ended December 31, 1997.
Encino, California
FRANKEL, LODGEN, LACHER, GOLDITCH, SARDI & HOWARD
September 11, 1998
F-43
<PAGE> 309
B.N. TECHNOLOGY, INC.
DBA INTERNET COMMUNICATIONS
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
-------- ---------
<S> <C> <C>
ASSETS
Cash........................................................ $ 6,138 $ 14,982
Property and equipment, net................................. 20,076 33,861
Deposit..................................................... 1,100 1,100
Organization costs, net..................................... 1,445 1,105
Intangible costs, net....................................... 14,000 7,000
-------- ---------
$ 42,759 $ 58,048
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred revenue............................................ $ 15,787 $ 102,417
Accounts payable and accrued expenses....................... 7,217 36,883
Accrued payroll............................................. 8,861
Contract payable............................................ 5,664 4,033
Shareholders' loans......................................... 13,051 10,551
-------- ---------
41,719 162,745
-------- ---------
Shareholders' equity (deficit):
Common stock; no par value; 100,000 shares authorized,
issued and outstanding................................. 50,100 50,100
Accumulated deficit....................................... (49,060) (154,797)
-------- ---------
1,040 (104,697)
-------- ---------
$ 42,759 $ 58,048
======== =========
</TABLE>
See accompanying notes to financial statements.
F-44
<PAGE> 310
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 15, 1996 SIX MONTHS ENDED
(INCEPTION) THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998
------------------- ------------ --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue............................... $ 47,597 $ 497,445 $ 191,759 $ 663,633
Operating expenses.................... 94,974 601,278 235,855 719,774
-------- --------- --------- ---------
Loss from operations.................. (47,377) (103,833) (44,096) (56,141)
-------- --------- --------- ---------
Interest expense...................... (883) (1,104) -- (4,051)
-------- --------- --------- ---------
Loss before provision for income
tax................................. (48,260) (104,937) (44,096) (60,192)
Income tax benefit (expense).......... (800) (800) (800) 84,600
-------- --------- --------- ---------
Net loss.............................. (49,060) (105,737) (44,896) 24,408
Accumulated deficit, beginning of
period.............................. (49,060) (49,060) (154,797)
-------- --------- --------- ---------
Accumulated deficit, end of period.... $(49,060) $(154,797) $ (93,956) $(130,389)
======== ========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-45
<PAGE> 311
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 15,
1996
(INCEPTION) SIX MONTHS ENDED
THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998
------------ ------------ -------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net income (loss)................................ $(49,060) $(105,737) $(44,896) $ 24,408
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation................................... 5,020 13,484 6,368 7,147
Amortization................................... 7,255 7,340 3,670 3,670
Provision for deferred income tax.............. (188,300)
Increase (decrease) in cash due to changes in
operating assets and liabilities:
Deposits.................................... (1,100) (6,681)
Deferred revenue............................ 15,787 86,630 26,966 224,133
Accounts payable and accrued expense........ 7,217 29,666 14,265 80,646
Accrued payroll............................. 8,861 70,536
Income tax payable.......................... 103,700
-------- --------- -------- ---------
Net cash provided (used) by operating
activities..................................... (14,881) 40,244 6,373 319,259
-------- --------- -------- ---------
Cash flows from investing activities:
Acquisition of property and equipment.......... (18,518) (27,269) (8,638) (202,931)
Shareholders and employee advances............. (17,836)
Purchase of customer list...................... (21,000)
Organizational costs........................... (1,700)
-------- --------- -------- ---------
Net cash provided (used) by investing
activities..................................... 21,933 (27,269) (8,638) (220,767)
-------- --------- -------- ---------
Cash flows from financing activities:
Repayment of contract payable.................. (914) (1,631) (1,123) (953)
Proceeds from issuance of common stock......... 50,100
Repayment of capitalized lease payable......... (1,605)
Proceeds from shareholder loan................. 13,051
Repayment of shareholder loan.................. (2,500) (10,551)
-------- --------- -------- ---------
Net cash provided (used) by financing
activities:.................................... 62,237 (4,131) (1,123) (13,109)
-------- --------- -------- ---------
Net increase in cash............................. 6,138 8,844 (3,388) 85,383
Cash, beginning of period........................ 6,138 6,138 14,982
-------- --------- -------- ---------
Cash, end of period.............................. $ 6,138 $ 14,982 $ 2,750 $ 100,365
======== ========= ======== =========
Supplemental disclosure:
Interest paid.................................. $ 883 $ 1,104 $ $ 4,051
======== ========= ======== =========
Income tax paid................................ $ $ 1,600 $ $ 0
======== ========= ======== =========
Supplemental schedule of non-cash investing and
financing activities:
During 1996, a contract payable in the amount
of $6,578 was incurred to purchase a
vehicle.
Capital lease obligation incurred for use of
equipment...................................... $ 7,655
=========
</TABLE>
See accompanying notes to financial statements.
F-46
<PAGE> 312
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies of B.N. Technology, Inc.
(the Company) is presented to assist in understanding the Company's financial
statements. The financial statements and notes are representations of the
Company's management, which is responsible for their integrity and objectivity.
These accounting policies conform to generally accepted accounting principles
and have been consistently applied in the preparation of the financial
statements.
Business activity
The Company was incorporated on April 16, 1996, and is located in Los
Angeles, California. The Company is an Internet Web hosting service provider.
Revenue recognition
Revenue consists primarily of fees for hosting Web sites. Fees received are
earned according to the subscription period sold. Subscription periods are sold
on a monthly, quarterly and annual basis.
Deferred revenue represents fees received from quarterly and annual
subscriptions which extend beyond the current balance sheet date.
Property and equipment
Property and equipment is carried at cost. The cost is depreciated over the
estimated useful lives of the related assets. Depreciation is computed on the
straight-line method for financial reporting purposes and on the accelerated
cost recovery system method for income tax purposes.
Expenditures for major renewals and betterments that extend the useful
lives of property and equipment are capitalized. Expenditures for maintenance
and repairs are charged to expense as incurred.
Advertising
Advertising costs are expensed as incurred. Advertising expense was $8,818
and $98,484 for the period ended December 31, 1996 and the year ended December
31, 1997, respectively.
Use of estimates in preparation of financial statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that directly affect the results of reported assets, liabilities,
revenue and expenses. Actual results may differ from these estimates.
Income taxes
Current income taxes are based on the taxable income for the year, as
measured by the current year's tax returns. Deferred income taxes arise
primarily due to differences between the basis of deferred revenue used for
financial statements versus cash basis used for income tax reporting purposes.
Unaudited information
The interim financial information for the six months ended June 30, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
F-47
<PAGE> 313
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. PROPERTY AND EQUIPMENT
Major classes of fixed assets are as follows:
<TABLE>
<CAPTION>
ESTIMATED
LIVES 1996 1997
--------- ------- -------
<S> <C> <C> <C>
Equipment and software........................ 5 years $10,677 $34,774
Furniture................................... 5 years 850 4,022
Automobile.................................. 5 years 13,569 13,569
------- -------
25,096 52,365
Accumulated depreciation.................... (5,020) (18,504)
------- -------
$20,076 $33,861
======= =======
</TABLE>
Depreciation expense totaled $5,020 and $13,484 for 1996 and 1997,
respectively.
3. INTANGIBLE COSTS
In 1996, the Company purchased from the majority stockholder a customer
listing and goodwill for $21,000. The cost is being amortized over a three year
period.
4. CAPITAL STOCK TRANSACTIONS
Capital stock transactions in 1996 are as follows:
<TABLE>
<CAPTION>
ISSUED
SHARES AMOUNT
------- -------
<S> <C> <C>
Sale of common stock..................................... 100,000 $50,100
======= =======
</TABLE>
5. CONTRACT PAYABLE
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
The Company has a contract payable dated May 1996, payable
in monthly installments at $222, including interest at
20.98%, commencing May 1996 through October 1999. The
contract is secured by the Company automobile. ........... $5,664 $4,033
Less current portion........................................ 1,631 2,008
------ ------
$4,033 $2,025
====== ======
</TABLE>
The following are maturities of contract payable:
<TABLE>
<CAPTION>
DECEMBER 31:
- ------------
<S> <C>
1998...................................................... $2,008
1999...................................................... 2,025
------
$4,033
======
</TABLE>
6. RELATED PARTY TRANSACTIONS
The Company has transactions with certain shareholders and officers who
receive compensation in the form of wages from the Company. Officers' salaries
aggregated $0 and $84,591 for 1996 and 1997, respectively.
F-48
<PAGE> 314
B.N. TECHNOLOGY, INC.
dba INTERNET COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In 1996, the Company entered into an agreement with the majority
shareholder to purchase certain equipment, goodwill, and a customer listing for
$25,000.
Shareholders' loans payable are unsecured, non-interest bearing and due on
demand.
7. COMMITMENTS
The Company leases its office and marketing sales office under an operating
lease, commencing April 16, 1996 and expiring June 15, 1998. Under the terms of
the lease agreement, the Company has the option to extend the lease for an
additional three years. The Company is responsible to pay property taxes.
The expected future minimum lease payments are as follows:
<TABLE>
<S> <C>
1998....................................................... $28,682
1999....................................................... 29,137
2000....................................................... 30,012
2001....................................................... 10,102
-------
$97,933
=======
</TABLE>
Rent expense totaled $6,295 and $15,346 for 1996 and 1997, respectively.
8. SALE OF SHAREHOLDERS' INTERESTS
On August 31, 1998, the Company's shareholders entered into an agreement to
sell their respective stock to Sage Networks, Inc.
9. INCOME TAXES
The Company has $12,538 of a net operating loss available to offset future
federal taxable income through 2012.
Valuation allowances are established to reduce deferred tax assets to the
amount expected to be realized.
Provision for income taxes are as follows:
<TABLE>
<CAPTION>
1996 1997
------- --------
<S> <C> <C>
Current................................................. $ 800 $ 800
Deferred benefit........................................ (2,368) (15,932)
Less valuation allowance................................ 2,368 15,932
------- --------
Total provision for income taxes........................ $ 800 $ 800
======= ========
</TABLE>
10. YEAR 2000 COMPLIANCE (UNAUDITED)
The Company's management believes that all information technology included
in the operating system, together with all products and services provided to its
customers or for internal use, in coordination with technology shared with
customers, suppliers or vendors, will accurately process transactions from 1999
and through the Twenty-First Century, including leap year calculations. Neither
performance nor functionality of such technology will be affected by the year
2000 issue.
F-49
<PAGE> 315
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
GEN International, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of GEN
International, Inc. and Subsidiaries (formerly Global Entrepreneurs Network,
Inc.) as of December 31, 1995, 1996 and 1997, and the related consolidated
statements of operations, changes in stockholders' deficiency, and cash flows
for the period April 4, 1995 (inception) through December 31, 1995, and the
years ended December 31, 1996 and 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of GEN International, Inc. and
Subsidiaries as of December 31, 1995, 1996 and 1997, and the results of their
operations and their cash flows for the period April 4, 1995 (inception) to
December 31, 1995, and the years ended December 31, 1996, and 1997, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 9 to
the financial statements, the Company has incurred net losses, and has a working
capital deficiency and a stockholders' deficiency as of December 31, 1997. In
March 1998, Global Entrepreneurs Network, Inc., a wholly-owned subsidiary filed
a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans with regard to these matters are
discussed in Note 9. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Urbach Kahn & Werlin PC
New York, New York September 4, 1998
F-50
<PAGE> 316
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
BALANCE SHEETS
DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
-------- --------- -----------
<S> <C> <C> <C>
ASSETS
Current Assets
Cash.................................................. $ 362 $ 888
Prepaid expenses and other current assets............. 3,080 10,471 $ 687
-------- --------- -----------
Total current assets.......................... 3,442 11,359 687
-------- --------- -----------
Equipment, net of related depreciation.................. 23,243 271,649
-------- --------- -----------
Security deposit........................................ 2,252 4,154 5,834
-------- --------- -----------
$ 5,694 $ 38,756 $ 278,170
-------- --------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities
Line of credit........................................ $ 50,000
Capital lease obligations -- current portion.......... 76,421
Accounts payable...................................... $ 45,425 147,524
Advances from stockholder............................. 12,260 82,319
Deferred revenue...................................... $ 12,624 93,185 237,378
Accrued interest -- stockholder....................... 7,611
Accrued expenses and other current liabilities........ 12,355 53,368 174,380
-------- --------- -----------
Total current liabilities..................... 24,979 204,238 775,633
-------- --------- -----------
Capital lease obligations -- non-current portion........ 112,632
-------- --------- -----------
Commitments
Stockholders' deficiency
Common stock, no par value, 25,000,000 shares......... 4,000 20,000 409,545
authorized (1,000,000 -- 1995; 5,325,000 -- 1996
and 11,816,943 -- 1997) issued and outstanding
Accumulated deficit................................... (23,285) (185,482) (1,019,640)
-------- --------- -----------
(19,285) (165,482) (610,095)
-------- --------- -----------
$ 5,694 $ 38,756 $ 278,170
======== ========= ===========
</TABLE>
See Notes to Financial Statements
F-51
<PAGE> 317
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD
APRIL 4, 1995 SIX MONTHS ENDED
(INCEPTION) THROUGH YEAR ENDED YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, DECEMBER 31, -----------------------
1995 1996 1997 1997 1998
------------------- ------------ ----------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues............. $198,503 $ 828,652 $1,130,764 $ 545,540 $ 457,170
Cost of revenues......... 68,558 345,502 914,093 519,118 298,564
-------- --------- ---------- --------- ---------
Gross profit... 129,945 483,150 216,671 26,422 158,606
-------- --------- ---------- --------- ---------
Operating expenses:
Selling, advertising
and promotion....... 76,741 301,978 425,621 183,455 22,835
General and
administrative...... 76,489 268,369 608,265 152,178 636,508
Interest expense....... -- -- 16,943 5,100 8,470
Bad debt expense....... -- 75,000 -- -- --
-------- --------- ---------- --------- ---------
153,230 645,347 1,050,829 340,733 667,813
-------- --------- ---------- --------- ---------
Net loss....... $(23,285) $(162,197) $ (834,158) $(314,311) $(509,207)
======== ========= ========== ========= =========
</TABLE>
See Notes to Financial Statements
F-52
<PAGE> 318
GEN INTERNATIONAL, AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD
APRIL 4, 1995
(INCEPTION) THROUGH YEAR ENDED YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1995 1996 1997 1997 1998
------------------- ------------ ------------ --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.............................. $(23,285) $(162,197) $(834,158) $(314,311) $(509,207)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Common stock issued for services
provided.......................... 6,000 45,834 -- --
Depreciation expense................ 1,977 33,924 8,359 54,000
Bad debt expense.................... 75,000 -- --
Changes in assets and liabilities:
Due from related parties............ (75,000) --
Prepaid expenses and other current
assets............................ (3,080) (7,391) 9,784 (8,929) (8,668)
Accounts payable.................... 45,425 102,099 222,358 270,166
Deferred revenue.................... 12,624 80,561 144,193 33,547 16,616
Accrued interest stockholder....... 7,611 3,300 (6,111)
Accrued expenses and other current
liabilities....................... 12,355 41,013 121,012 43,558 20,604
-------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities......... (1,386) 5,388 (369,701) (12,118) (162,600)
-------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Security deposit...................... (2,252) (1,902) (1,680) -- (20,030)
Purchase of equipment................. (25,220) (58,982) (33,163) (3,976)
-------- --------- --------- --------- ---------
Net cash used in investing
activities................... (2,252) (27,122) (60,662) (33,163) (24,006)
-------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings from line of credit.... 50,000 -- --
Payments on capital lease
obligations......................... (34,295) 9,364 (45,030)
Proceeds from sale of common stock.... 4,000 10,000 343,711 -- 165,472
Advances from stockholder............. 12,260 70,059 35,029 66,164
-------- --------- --------- --------- ---------
Net cash provided by financing
activities................... 4,000 22,260 429,475 44,393 186,606
-------- --------- --------- --------- ---------
Net increase (decrease) in
cash......................... 362 526 (888) (888) --
CASH
Beginning of period................... -- 362 888 888 --
-------- --------- --------- --------- ---------
End of period......................... $ 362 $ 888 $ -- $ -- $ --
======== ========= ========= ========= =========
</TABLE>
SUPPLEMENTAL CASH FLOW DISCLOSURES
In 1997, the Company entered into capital lease arrangements aggregating
$223,300 for the purchase of equipment.
Cash paid for interest was approximately $16,900 in 1997.
F-53
<PAGE> 319
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
PERIOD APRIL 4, 1995 (INCEPTION) THROUGH DECEMBER 31, 1995
AND YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
---------- -------- ----------- ---------
<S> <C> <C> <C> <C>
April 4, 1995..............................
Sale of common stock for cash to founding
stockholder.............................. 1,000,000 $ 4,000 $ 4,000
Net loss -- 1995........................... $ (23,285) (23,285)
---------- -------- ----------- ---------
Balance, December 31, 1995................. 1,000,000 4,000 (23,285) (19,285)
Sale of common stock for cash.............. 5,000 10,000 10,000
Issuance of common stock for services...... 60,000 6,000 6,000
Additional shares of common stock in
connection with stock split.............. 4,260,000
Net loss -- 1996........................... (162,197) (162,197)
---------- -------- ----------- ---------
Balance, December 31, 1996................. 5,325,000 $ 20,000 $ (185,482) $(165,482)
Exchange of Global Entrepreneurs Network,
Inc. common stock -- Note 1.............. (2,662,500)
Sale of common stock for cash.............. 586,590 242,709 242,709
Issuance of common stock for services...... 557,853 45,834 45,834
Shares issued on exercise of options....... 1,010,000 101,000 101,000
Acquisition of GEN Events, Inc., GEN
Network Operations, Inc., and GEN Europe,
Inc...................................... 7,000,000 2 2
Net loss -- 1997........................... (834,158) (834,158)
---------- -------- ----------- ---------
Balance, December 31, 1997................. 11,816,943 $409,545 $(1,019,640) $(610,095)
========== ======== =========== =========
</TABLE>
See Notes to Financial Statements
F-54
<PAGE> 320
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. ORGANIZATION, BUSINESS COMBINATIONS AND ACQUISITIONS, AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Organization: GEN International, Inc. (the "Company"), a successor entity
to Global Entrepreneurs Network, Inc. (Global), is located in St. Petersburg,
Florida and is a global network and information provider connected to the
Internet. The Company also offers storage, transfer, and Web hosting services to
its members worldwide, primarily small and medium sized businesses. The Company
was organized as a shell in June 1997. In this connection, Global, originally
incorporated in April 1995 exchanged its then outstanding common stock
(5,325,000 shares) for the common stock (2,662,500 shares) of the Company. The
Company also issued options to the former stockholders of Global. The financial
statements from inception (April 4, 1995) through the exchange in June 1997,
represent the accounts and activities of Global. In connection with this
exchange, Global became a wholly-owned subsidiary of the Company. The Company
also acquired in June 1997, the outstanding common stock of GEN Events, Inc.,
GEN Network Operations Center, Inc., and GEN Europe, Inc., shell entities with
no assets, liabilities or operations, whose shares were also substantially owned
by the principal shareholder of Global. Nominal consideration was assigned to
the 7,000,000 shares issued by the Company in this connection.
Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include
the accounts of the Company, and its wholly-owned subsidiaries as follows:
- Global Entrepreneurs Network, Inc.
- GEN Network Operations Center, Inc.
- GEN Europe, Inc.
- GEN Events, Inc.
All significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
Revenue Recognition: Recurring revenues consist primarily of monthly fees
charged to members for Web hosting services and are recognized at the beginning
of each month for which services are rendered. Other revenues generally
represent one-time set up fees and are recorded as earned. Deferred revenue
consists primarily of the unexpired portion of annual prepaid membership fees.
Property and Equipment: Property and equipment is stated at cost and
depreciated using the straight-line method over the estimated useful life of the
assets, generally three years for computers and computer related equipment and
five years for other non-computer furniture and equipment. Leasehold
improvements are amortized over the term of the lease.
Capital Leases: The Company leases certain of its phone and other computer
related equipment under capital lease agreements. The assets and liabilities
under capital leases are recorded at the lesser of the present value of future
minimum lease payments, including estimated bargain purchase options, or the
fair value of the assets under lease. Assets under capital lease are amortized
over the lesser of their estimated useful lives of three to five years or the
term of the lease.
Income Taxes: Income taxes are computed using the asset and liability
method. Under this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and
liabilities and are measured using the currently enacted tax rates and laws.
There were no deferred taxes in 1995, 1996 and 1997.
Advertising: The Company expenses advertising costs as they are incurred.
F-55
<PAGE> 321
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Use of Estimates in the Preparation of Financial Statements: 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.
Unaudited information
The interim financial information for the six months ended June 30, 1998
and 1997 is unaudited. However, in the opinion of management, such information
has been prepared on the same basis as the audited financial statements and
includes all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial position and results of
operations for the periods presented. The interim results, however, are not
necessarily indicative of results for any future period.
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1996 and
1997:
<TABLE>
<CAPTION>
1996 1997
------- --------
<S> <C> <C>
Furniture and fixtures.................................. $ 1,482 $ 2,472
Computer equipment...................................... 23,736 303,455
Leasehold improvements.................................. -- 1,623
------- --------
25,218 307,550
Less: accumulated depreciation.......................... 1,975 35,901
------- --------
$23,243 $271,649
======= ========
</TABLE>
NOTE 3. LINE OF CREDIT
The Company has a line of credit with a financial institution amounting to
$50,000. The line bears interest at 2% above the prime lending rate and is due
on demand.
NOTE 4. ADVANCES FROM STOCKHOLDER
Advances from stockholder originally due in September 1996, bear interest
at 18% per annum. Repayment of the advances was extended until such time as the
Company has sufficient resources to satisfy the obligations. Interest expense
for the year ended December 31, 1997 was $7,611. Interest in 1996 was not
material.
NOTE 5. STOCK-BASED COMPENSATION
During 1997, the Company issued options to purchase 3,715,000 shares of
common stock of the Company to certain officers, directors, stockholders and
employees at exercise prices ranging from $0.10 to $1.00. The options are
exercisable upon certain vesting requirements and/or in the event the Company
has a public offering.
During 1997, 1,010,000 options not subject to vesting requirements were
exercised for $101,000. Options to purchase 2,705,000 shares of common stock
were outstanding at December 31, 1997 at a weighted average exercise price of
approximately $1.00. All outstanding options were exercisable at December 31,
1997.
In accordance with Accounting Principles Board Statement No. 25 (APB 25),
no compensation cost has been recognized in accounting for the stock options
issued during 1997. Because the Company's stock options have characteristics
significantly different than those of traded options, compensation cost for the
F-56
<PAGE> 322
GEN INTERNATIONAL, INC. AND SUBSIDIARIES
(FORMERLY GLOBAL ENTREPRENEURS NETWORK, INC.)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company's 1997 grants, based upon the fair value method consistent with
Financial Accounting Statement No. 123, is not determinable.
NOTE 6. COMMITMENT
Lease: The Company had an operating lease for its corporate office, which
expired in January 1998, and was renewed through October 1998. Rent expense for
the years ending December 31, 1997 and 1996, and for the period April 4, 1995
(inception) through December 31, 1995 was $27,000, $29,445 and $5,524,
respectively.
NOTE 7. INCOME TAXES
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $1,020,000, which expire in 2010 through 2012. At December 31,
1997, the expected tax benefit from the future realization of this operating
loss carryforward of approximately $401,000 has been offset by an equivalent
valuation allowance, in view of the uncertainty as to ultimate realization.
NOTE 8. CAPITAL LEASES
During 1997, the Company entered into capital lease arrangements for
computer equipment and other office equipment. The leases, which expire in 1999
through 2000, require the Company to pay taxes, maintenance and insurance.
Annual minimum commitments under the lease arrangements are as follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -------------------------
<S> <C>
1998........................................................ $ 91,540
1999........................................................ 88,550
2000........................................................ 24,678
2001........................................................ 5,592
2002........................................................ 3,741
--------
Total minimum payments...................................... 214,101
Less amount representing interest at approximately 10%...... 25,048
Present value of future lease payments...................... 189,053
Less current portion........................................ 76,421
--------
$112,632
--------
</TABLE>
NOTE 9. GOING CONCERN
As indicated in the accompanying financial statements, the Company and its
wholly-owned subsidiaries, have incurred net operating losses, and as of
December 31, 1997, has a working capital deficiency of approximately $775,000
and a stockholders' deficiency of approximately $610,000. During March 1998,
Global Entrepreneurs Network, Inc. filed a voluntary petition for reorganization
under Chapter 11 of the Federal Bankruptcy Code, and was authorized to continue
managing and operating the business as debtor in possession subject to the
control and supervision of the Bankruptcy Court.
Management of the Company is aggressively seeking additional sources of
capital and financing, and in August, 1998, the Company entered into a contract
with Sage Networks, Inc. for the sale of certain of its assets for cash and
assumption of certain of its liabilities, which sale was subsequently
consummated in September 1998. The ability of the Company to continue as a going
concern is dependent upon obtaining additional capital and financing. The
consolidated financial statements do not include any adjustments that might be
necessary if the Company is unable to continue as a going concern.
NOTE 10. SUBSEQUENT EVENTS
In March 1998, the Company effected a 2 for 1 stock split.
F-57
<PAGE> 323
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Digiweb, Inc.
We have audited the accompanying balance sheets of Digiweb, Inc. as of
December 31, 1997 and 1998, and the related statements of income, cash flows,
and changes in stockholders' equity for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Digiweb, Inc. as of December
31, 1997 and 1998, and the results of its operations and its cash flows for the
years then ended, in conformity with generally accepted accounting principles.
Urbach Kahn & Werlin PC
New York, New York
January 24, 1999
F-58
<PAGE> 324
DIGIWEB, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
ASSETS
Current Assets
Cash...................................................... $115,643 $134,343
Accounts receivable, net of allowance for doubtful
accounts of $12,075 and $43,431........................ 36,728 50,939
Prepaid expenses and other current assets................. -- 19,365
-------- --------
Total current assets.............................. 152,371 204,647
-------- --------
Equipment, net of related depreciation...................... 505,946 653,493
-------- --------
OTHER ASSETS
Restricted cash............................................. 50,000 50,000
Security deposit............................................ 3,376 9,685
Other assets, net of amortization of $462 and $219.......... 2,220 1,977
-------- --------
Total other assets................................ 55,596 61,662
-------- --------
$713,913 $919,802
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Note payable -- current portion........................... $ 17,411 $ 41,637
Capital lease obligations -- current portion.............. 2,910 13,030
Accounts payable.......................................... 44,834 121,673
Advances from stockholder................................. 4,966 4,966
Deferred revenue.......................................... 20,239 66,381
Accrued expenses and other current liabilities............ 12,344 6,087
-------- --------
Total current liabilities......................... 102,704 253,774
-------- --------
Note payable -- non-current portion......................... 83,627 42,605
Capital lease obligations -- non-current portion............ 30,661 55,232
-------- --------
Total long-term liabilities....................... 114,288 97,837
-------- --------
Commitments
Stockholders' equity
Common stock, no par value, 1,000 shares authorized,
issued and outstanding................................. 20,000 20,000
Retained earnings......................................... 476,921 548,191
-------- --------
496,921 568,191
-------- --------
$713,913 $919,802
======== ========
</TABLE>
See Notes to Financial Statements
F-59
<PAGE> 325
DIGIWEB, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Net revenues................................................ $1,768,322 $2,685,676
Cost of revenues............................................ 729,157 1,118,913
---------- ----------
Gross profit...................................... 1,039,165 1,566,763
---------- ----------
Operating expenses:
Selling, advertising and promotion........................ 17,997 31,577
General and administrative................................ 397,691 586,288
Interest expense.......................................... 10,020 16,829
Bad debt expense.......................................... 12,075 43,431
---------- ----------
437,783 678,125
---------- ----------
Net income........................................ $ 601,382 $ 888,638
========== ==========
</TABLE>
See Notes to Financial Statements
F-60
<PAGE> 326
DIGIWEB, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
COMMON STOCK
----------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------- --------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1996........................ 1,000 $20,000 $ 39,470 $ 59,470
Stockholder distributions......................... (163,931) (163,931)
Net income -- 1997................................ 601,382 601,382
----- ------- --------- ---------
Balance, December 31, 1997........................ 1,000 $20,000 $ 476,921 $ 496,921
Stockholder distributions......................... (817,368) (817,368)
Net income -- 1998................................ 888,638 888,638
----- ------- --------- ---------
Balance, December 31, 1998........................ 1,000 $20,000 $ 548,191 $ 568,191
===== ======= ========= =========
</TABLE>
See Notes to Financial Statements
F-61
<PAGE> 327
DIGIWEB, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
--------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................ $ 601,382 $ 888,638
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization expense.................. 138,210 246,329
Bad debt expense....................................... 12,075 31,356
Changes in assets and liabilities:
Accounts receivable.................................... (9,873) (45,567)
Prepaid expenses and other current assets.............. 9,308 (19,365)
Accounts payable....................................... (44,505) 76,839
Deferred revenue....................................... (23,821) 46,142
Accrued expenses and other current liabilities......... 14,337 (6,257)
--------- ----------
Net cash provided by operating activities......... 697,113 1,218,115
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Costs paid for trademark.................................. (1,655) --
Security deposits paid.................................... (1,981) (6,309)
Deposits into cash reserve................................ (50,000) --
Purchase of equipment..................................... (302,257) (347,394)
--------- ----------
Net cash used in investing activities............. (355,893) (353,703)
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on shareholder loans................... (136,578) --
Principal payments on capital lease obligations........... (5,054) (11,548)
Principal payments on notes payable....................... (9,931) (16,796)
Shareholder distributions................................. (163,931) (817,368)
--------- ----------
Net cash used in financing activities............. (315,494) (845,712)
--------- ----------
Net increase in cash.............................. 25,726 18,700
CASH:
Beginning of period....................................... 89,917 115,643
--------- ----------
End of period............................................. $ 115,643 $ 134,343
========= ==========
Supplemental Disclosure of Cash Flow Information
Cash payments for interest................................ $ 10,020 $ 16,829
--------- ----------
Capital Lease Obligations Incurred for Purchase of
Equipment................................................. $ 39,303 $ 85,542
--------- ----------
Note Payable Incurred for Leasehold Improvements............ $ 76,444 $ --
--------- ----------
</TABLE>
F-62
<PAGE> 328
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1998
NOTE 1. ORGANIZATION, BUSINESS COMBINATIONS AND ACQUISITIONS, AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Organization: Digiweb, Inc. ("Digiweb" or the "Company") is a provider of
Web hosting and co-located services catering to small and medium sized
businesses. Based in College Park, Maryland, Digiweb offers three core services:
shared server Web hosting, dedicated server Web hosting and co-located.
Revenue Recognition: Recurring revenues consist primarily of monthly fees
charged to members for Web hosting services and are recognized ratably over the
periods for which services are rendered. Other revenues generally represent
one-time set up fees and are recorded as earned. Deferred revenue consists
primarily of the unexpired portion of annual prepaid membership fees.
Property and Equipment: Property and equipment is stated at cost and
depreciated using the straight-line method over the estimated useful life of the
assets, generally three to five years for computers and computer related
equipment and seven years for other non-computer furniture and equipment.
Leasehold improvements are amortized over the term of the lease.
Capital Leases: The Company leases certain of its autos and other computer
related equipment under capital lease agreements. The assets and liabilities
under capital leases are recorded at the lesser of the present value of future
minimum lease payments, including estimated bargain purchase options, or the
fair value of the assets under lease. Assets under capital lease are amortized
over the lesser of their estimated useful lives of three to five years or the
term of the lease.
Income Taxes: No provision for income taxes has been recorded in the
financial statements due to the Company's S Corporation status. Individual
stockholders are taxed on their respective shares of the entities' income and
receive the benefits of the entities' income tax credits.
Advertising: The Company expenses advertising costs as they are incurred.
Use of Estimates in the Preparation of Financial Statements: 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.
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1997 and
1998:
<TABLE>
<CAPTION>
1997 1998
-------- ----------
<S> <C> <C>
Leasehold improvements............................... $ 76,444 $ 76,444
Office equipment..................................... 37,318 71,053
Furniture and fixtures............................... 11,006 13,703
Computer equipment................................... 488,363 799,325
Equipment under capital leases....................... 39,303 85,542
Auto................................................. 36,262 36,262
-------- ----------
686,696 1,082,329
Less: accumulated depreciation....................... 182,750 428,836
-------- ----------
$505,946 $ 653,493
======== ==========
</TABLE>
F-63
<PAGE> 329
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. NOTE PAYABLE
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Note payable (auto) in 42 monthly payments of $615,
including interest at 11.15% and one balloon payment of
$22,142 maturing in December 1999. The loan is
collateralized by the automobile ......................... $30,753 $27,160
Note payable (leasehold improvements) in 60 monthly
installments of $1,596, including interest at 9.25%
maturing June 2002. ...................................... 70,285 57,082
------- -------
Total............................................. 101,038 84,242
Less amounts due currently........................ 17,411 41,637
------- -------
$83,627 $42,605
------- -------
</TABLE>
Future maturities of notes payable are as follows:
<TABLE>
<S> <C>
1999....................................................... $41,637
2000....................................................... 15,875
2001....................................................... 17,407
2002....................................................... 9,323
-------
$84,242
-------
</TABLE>
NOTE 4. CAPITAL LEASES
During 1996 and 1997, the Company entered into capital lease
arrangements for computer equipment and automobiles. These leases expire in
1999 through 2000. Annual minimum commitments under these arrangements are
as follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31,
- ------------
<S> <C>
1999........................................................ $18,528
2000........................................................ 58,503
-------
Total minimum payments...................................... 77,031
Less amount representing interest at approximately 10%...... (8,769)
-------
Present value of future lease payments...................... 68,262
Less current portion........................................ 13,030
-------
$55,232
=======
</TABLE>
NOTE 5. COMMITMENT
Lease: The Company has an operating lease for its corporate office, which
expires in May 2004. Rent expense for the years ending December 31, 1997 and
1998, was $47,395 and $69,764, respectively, including tenant charges for
building improvements in 1998.
In January 1999, the Company executed an additional lease for office
expense which expires in December 2004.
The Company also has leases with two internet line service providers,
expiring in April 2000 and January 2002. Internet line service expense for the
years ending December 31, 1997 and 1998, was $199,746 and $325,787,
respectively.
F-64
<PAGE> 330
DIGIWEB, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum rental payments under these leases are as follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31, AMOUNTS
- ------------ ----------
<S> <C>
1999..................................................... $ 301,645
2000..................................................... 216,808
2001..................................................... 191,209
2002..................................................... 139,668
2003..................................................... 143,859
Thereafter............................................... 148,174
----------
$1,141,363
==========
</TABLE>
Total rental expense was $47,395 and $69,764 for the years ending December
31, 1997 and 1998, respectively.
NOTE 6. SUBSEQUENT EVENTS
In January 1999, the Company entered into a non-binding Letter of Intent
with Sage Networks, Inc. (Sage) for the sale of certain of its assets, at
amounts in excess of their carrying values, and assumption of certain of its
liabilities, for cash and stock in Sage.
F-65
<PAGE> 331
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Telephonetics International, Inc. and
State of the Art, Inc.
Miami, Florida
We have audited the accompanying combined balance sheet of Telephonetics
International, Inc. and Affiliate as of December 31, 1998, and the related
combined statements of operations, capital deficit and cash flows for each of
the two years in the period then ended. These combined financial statements are
the responsibility of the Companies management. Our responsibility is to express
an opinion on these combined financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe our audits provide a reasonable basis for our
opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Telephonetics
International, Inc. and Affiliate as of December 31, 1998, and the results of
their operations and their cash flows for each of the two years in the period
then ended in conformity with generally accepted accounting principles.
BDO Seidman, LLP
Miami, Florida
January 15, 1999
F-66
<PAGE> 332
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
ASSETS
Current assets
Cash and cash equivalents................................. $ 106,812
Accounts receivable, net of $94,100 allowance for doubtful
accounts (Notes 2 and 5)............................... 538,845
Inventories............................................... 50,836
Prepaid expenses and other current assets................. 34,197
-----------
Total current assets.............................. 730,690
Property and equipment, net (Note 1)........................ 68,598
-----------
$ 799,288
===========
LIABILITIES AND CAPITAL DEFICIT
Current liabilities
Note payable to bank (Note 2)............................. $ 90,000
Note payable to shareholder (Note 3)...................... 50,000
Accounts payable and accrued expenses..................... 137,610
-----------
Total current liabilities......................... 277,610
Deferred income............................................. 1,583,570
-----------
Total liabilities................................. 1,861,180
-----------
Commitments and Subsequent Event (Notes 7 and 10)
CAPITAL DEFICIT (Note 9)
Common stock, $.001 par value; 15,000,000 shares
authorized; 6,000,000 shares issued and outstanding,
Telephonetics International, Inc....................... 6,000
Common stock, $1.00 par value; 1,000 shares authorized,
issued and outstanding, State of the Art, Inc.......... 1,000
Additional paid-in capital................................ 557,815
Deficit................................................... (1,626,707)
-----------
Total capital deficit............................. (1,061,892)
-----------
$ 799,288
===========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-67
<PAGE> 333
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1998
---------- ----------
<S> <C> <C>
Revenues (Note 5)........................................... $2,991,849 $2,769,606
Cost of sales............................................... 1,023,946 823,161
---------- ----------
Gross profit................................................ 1,967,903 1,946,445
Selling, general and administrative (Notes 4 and 8)......... 2,561,887 2,687,852
---------- ----------
Net loss.................................................... $ (593,984) $ (741,407)
========== ==========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-68
<PAGE> 334
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF CAPITAL DEFICIT (NOTE 9)
<TABLE>
<CAPTION>
SUBSCRIBED ADDITIONAL TOTAL
COMMON COMMON PAID-IN TREASURY CAPITAL
STOCK STOCK CAPITAL DEFICIT STOCK DEFICIT
------- ---------- ---------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996... $ 8,375 $ -- $ 92,625 $ (71,139) $(31,185) $ (1,324)
Stock subscription............. -- 100 494,900 -- -- 495,000
Dividends -- cash.............. -- -- -- (220,177) -- (220,177)
Net loss....................... -- -- -- (593,984) -- (593,984)
------- ----- -------- ----------- -------- -----------
Balance at December 31, 1997... 8,375 100 587,525 (885,300) (31,185) (320,485)
Retirement of treasury stock,
1,475,000 shares at cost..... (1,475) -- (29,710) -- 31,185 --
Issuance of common stock....... 100 (100) -- -- -- --
Net loss....................... -- -- -- (741,407) -- (741,407)
------- ----- -------- ----------- -------- -----------
Balance at December 31, 1998... $ 7,000 $ -- $557,815 $(1,626,707) $ -- $(1,061,892)
======= ===== ======== =========== ======== ===========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-69
<PAGE> 335
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------
1997 1998
--------- ---------
<S> <C> <C>
Operating Activities:
Net loss.................................................. $(593,984) $(741,407)
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for losses on accounts and notes
receivable............................................ 20,850 110,000
Depreciation and amortization.......................... 31,451 74,758
(Increase) decrease in:
Accounts receivable.................................. (128,543) (135,292)
Inventories.......................................... 21,276 88,164
Prepaid expenses and other current assets............ 5,639 (24,232)
Other assets......................................... (1,840) 1,840
Increase in:
Accounts payable and accrued expenses................ 52,096 (96,962)
Deferred income...................................... 224,400 552,511
--------- ---------
Net cash used in operating activities....................... (368,655) (170,620)
--------- ---------
Investing Activities:
Proceeds from disposition of investments.................. 161,523 --
Additions to property and equipment....................... (5,960) (4,943)
Issuance of note receivable............................... (110,000) --
--------- ---------
Net cash (used in) provided by investing activities......... 45,563 (4,943)
--------- ---------
Financing Activities:
Proceeds from stock subscription.......................... 495,000 --
Proceeds from notes payable............................... 45,000 209,690
Payment of notes payable.................................. (44,889) (70,000)
Dividends................................................. (220,177) --
--------- ---------
Net cash provided by financing activities................... 274,934 139,690
--------- ---------
Net decrease in cash and cash equivalents................... (48,158) (35,873)
Cash, and cash equivalents at beginning of year............. 190,843 142,685
--------- ---------
Cash, and cash equivalents at end of year................... $ 142,685 $ 106,812
========= =========
Supplemental information:
Cash paid for:
Interest............................................... $ 2,600 $ 7,400
========= =========
</TABLE>
See accompanying summary of accounting policies and notes to combined financial
statements.
F-70
<PAGE> 336
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Telephonetics International, Inc. (Telephonetics) and State of the Art,
Inc. were incorporated in the State of Florida in 1982 and 1980, respectively,
for the purpose of providing customized audio programming for telephone hold
lines and other telecommunication applications. Presently such applications
include automated attendant, voice mail, integrated voice response and
computer/telephone integration applications, which collectively comprise the
Companies' sole business segment. The Companies' principle administrative,
production and sales facility is located in Miami, Florida.
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of Telephonetics
International, Inc. and its substantially inactive affiliate corporation, State
of the Art, Inc., collectively, the Companies. Telephonetics' majority
shareholder owns 85% of State of the Art, Inc.'s common stock and substantially
controls its operations. Intercompany advances and transactions have been
eliminated.
CASH AND CASH EQUIVALENTS
For the purpose of the statements of cash flows, the Companies consider all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents.
REVENUE RECOGNITION
A typical sales agreement for services entitles a customer to receive and
requires the Companies to provide upon customer request specified programming
services over a one year period. Billings to customers for such services are
rendered at the date of the agreement and recognized as revenue on a
straight-line basis over the term of the agreement. Revenue from telephone
answering devices and accessory sales are recognized upon shipment to the
customer.
INVENTORIES
Inventories are stated at the lower of cost or market using the first in,
first-out method.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation and amortization
is computed by the straight line method based on the estimated useful lives of
the related assets. Leasehold improvements are amortized over the shorter of the
life of the asset or the lease.
INCOME TAXES
The Companies, with the consent of all of their shareholders, have elected
to be taxed under the provisions of Subchapter S of the Internal Revenue Code.
Under those provisions, the Companies do not provide for or pay Federal and
certain State corporate income taxes on their taxable income. Instead, the
stockholders are liable for individual Federal and State income taxes, if any,
on their share of the Companies taxable income.
PREPARATION OF COMBINED FINANCIAL STATEMENTS
The preparation of the combined 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 at
the date of the combined financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from estimated amounts.
F-71
<PAGE> 337
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
CONCENTRATION OF CREDIT RISK
The Companies' credit risk relates to cash and cash equivalents and
accounts receivable. Cash and cash equivalents are primarily held in bank
accounts and overnight investments. These banks are insured up to $100,000 by
the FDIC. Periodically, cash balances may exceed this amount. The credit risk
associated with accounts receivable is minimal due to the Companies' customer
base and ongoing control procedures which monitor the credit worthiness of
customers.
NEW ACCOUNTING PRONOUNCEMENT
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The statement applies to
all entities and is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Companies did not engage in derivative instruments or
hedging activities in any periods presented in the financial statements.
F-72
<PAGE> 338
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS
1. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL DECEMBER 31,
LIFE(YEARS) 1998
----------- ------------
<S> <C> <C>
Office and other equipment................... 7 $ 94,757
Studio and production equipment.............. 7 204,579
Furniture and fixtures....................... 7 82,120
Art work..................................... -- 5,475
---------
386,931
Less: accumulated depreciation and
amortization............................... (318,333)
---------
$ 68,598
=========
</TABLE>
2. NOTES PAYABLE
At December 31, 1998, the Companies have a financing agreement with a
financial institution which provides for a demand revolving line of credit with
maximum borrowings of $150,000. Outstanding amounts under this facility bear
annual interest at 1% over the prime rate (8.75% at December 31, 1998), payable
monthly. Amounts borrowed under this facility are collateralized by
Telephonetics International, Inc.'s accounts receivable and guaranteed by the
Company's President and principal shareholder. At December 31, 1998, amounts
outstanding under the line of credit aggregate $90,000.
The revolving line of credit agreement, requires the Companies to comply
with certain covenants, the most restrictive of which requires the Companies to
maintain tangible net worth (as defined) of at least $500,000. At December 31,
1998, the Companies were not in compliance with this covenant and accordingly,
the obligation could be called for repayment.
3. NOTE PAYABLE TO SHAREHOLDER
On May 28, 1998, the Companies' principal shareholder loaned $70,000 to the
Companies for working capital purposes. The note bears interest at 10% annually
payable in monthly principal installments of $3,000 beginning September 1998. At
December 31, 1998, outstanding amount due to the principal shareholder
aggregated $50,000.
4. RELATED PARTY TRANSACTIONS
During 1997 and 1998, the Companies paid rent to companies owned by the
Companies' principal officers in the amount of $38,500 and $104,000,
respectively.
5. SIGNIFICANT CUSTOMER
For the years ended December 31, 1997 and 1998, one customer accounted for
47% and 55% of revenues, respectively; at December 31, 1998, accounts receivable
from this customer amounted to approximately $337,600.
6. FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including certificates of
deposit, accounts receivable, accounts payable and debt approximated fair value
due to the relatively short maturity.
F-73
<PAGE> 339
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS
The Companies rent office space and warehouse under non-cancelable leases.
The minimum future rental commitment for leases in effect at December 31, 1998,
including leases to related parties, approximates the following:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------
<S> <C>
1999...................................................... $ 98,700
2000...................................................... 92,600
2001...................................................... 72,000
2002...................................................... 72,000
2003...................................................... 54,000
--------
$389,300
========
</TABLE>
Rent expense in 1997 and 1998 aggregated approximately $102,000 and
$160,000, including $38,500 and $104,000 to related parties, respectively.
The Companies are required to pay a fee for the use of custom audio
production. During 1997 and 1998, approximately $33,000 and $40,000 of royalties
were paid, respectively.
8. DEFERRED COMPENSATION PLAN
The Companies have a defined contribution plan established pursuant to
Section 401(k) of the Internal Revenue Code. Employees contribute to the plan a
percentage of their salaries, subject to certain dollar limitations and the
Companies match a portion of the employees' contributions. The Companies'
contributions to the plan for the years ended December 31, 1997 and 1998
aggregated $16,200 and $17,000, respectively.
9. CAPITAL DEFICIT
On December 15, 1997 at a special meeting of the stockholders, an action
was approved to recapitalize Telephonetics by reducing the par value of each
share of common stock from $1 per share to $.001 per share and increasing the
number of authorized shares of common stock from 100,000 shares to 15,000,000
shares. The then issued 100,000 shares of $1 par value common stock (comprised
of 80,000 outstanding shares and 20,000 shares of Treasury stock) were
subsequently exchanged (at a ratio of 73.75 to 1) for 7,375,000 shares of $.001
par value common stock, comprised of 5,900,000 outstanding shares and 1,475,000
shares of Treasury stock. All share and per share data in the accompanying
financial statements have been retroactively restated to give effect to the
recapitalization.
In July 1997, an investor subscribed for the purchase of 100,000 shares of
Telephonetics' recapitalized $.001 par value common stock for aggregate
consideration of $495,000. The shares were issued during 1998 following
consummation of the recapitalization.
During the year ended December 31, 1997, Telephonetics temporarily acquired
all of the outstanding shares of common stock of Quicklab Multimedia Centers,
Inc. in exchange for 2,950,000 shares of common stock. To facilitate the
transaction, for which the Company did not then have sufficient authorized and
unissued shares of common stock, the Company's then sole stockholder contributed
2,950,000 shares owned by him to the Company which were issued to the seller.
The acquisition was subsequently rescinded and the 2,950,000 shares of common
stock were returned to the stockholder. In connection with the rescinded
transaction, the Company loaned Quick Lab Multimedia Centers, Inc. $110,000
under the terms of an unsecured note receivable bearing interest at prime plus
1% (8.75% at
F-74
<PAGE> 340
TELEPHONETICS INTERNATIONAL, INC. AND AFFILIATE
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998). During the year ended December 31, 1998, the Company
recorded a $110,000 provision for possible losses on the note.
10. SUBSEQUENT EVENT
In January 1999, the Companies entered into a letter of intent with Sage
Networks, Inc. (Sage) for the sale of substantially all their assets and
assumption of substantially all of their liabilities in exchange for $3,000,000
in cash and 140,000 shares of Sage common stock.
11. YEAR 2000 ISSUES (UNAUDITED)
Like other companies, the Companies could be adversely affected if the
computer systems we, our suppliers or customers use do not properly process and
calculate date-related information and data from the period surrounding and
including January 1, 2000. This is commonly known as the "Year 2000" issue.
Additionally, this issue could impact non-computer systems and devices such as
production equipment, elevators, etc.
The Companies are implementing a plan to modify their business technologies
to be ready for the year 2000 and are in the process of converting critical data
processing systems. The project is expected to be substantially complete by
June, 1999 and to cost between $125,000 and $150,000. The Companies do not
expect this effort to have a significant effect on operations.
F-75
<PAGE> 341
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Net Daemons Associates, Inc.:
We have audited the accompanying balance sheets of Net Daemons Associates,
Inc. (the "Company") as of December 31, 1997 and 1998, and the related
statements of income, stockholders' deficit and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 1997 and 1998,
and the results of its operations and its cash flows for the years then ended in
conformity with generally accepted accounting principles.
Boston, Massachusetts
Deloitte & Touche LLP
February 2, 1999 (February 17, 1999 as to Note 10)
F-76
<PAGE> 342
NET DAEMONS ASSOCIATES, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and equivalents...................................... $ 47,659 $ 274,100
Accounts receivable, net of allowance of $19,400 for 1997
and $36,500 for 1998................................... 804,290 882,664
Notes receivable.......................................... 9,988 4,979
Stockholders' receivable.................................. 35,759 5,936
Prepaid expenses and other................................ 11,071 20,901
Deferred income taxes..................................... 19,700 53,000
---------- ----------
Total current assets.............................. 928,467 1,241,580
Property and Equipment, Net................................. 310,200 222,749
Deposits.................................................... 39,419 38,650
---------- ----------
Total............................................. $1,278,086 $1,502,979
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Note payable -- bank...................................... $ 150,000 $ --
Accounts payable.......................................... 129,297 263,317
Accrued salaries, wages and related benefits.............. 76,137 189,291
Accrued profit sharing.................................... 26,000 30,000
Accrued expenses.......................................... 15,590 83,612
Current portion of long-term debt......................... 20,375 38,411
Current portion of subordinated stockholder debt.......... 135,960 --
Deferred revenue.......................................... 62,910 52,127
Accrued income taxes...................................... 84,552 102,955
---------- ----------
Total current liabilities......................... 700,821 759,713
---------- ----------
Long-Term Liabilities:
Long-term debt............................................ 91,855 107,998
Subordinated stockholder debt............................. 804,040 885,214
---------- ----------
Total long-term liabilities....................... 895,895 993,212
---------- ----------
Deferred Income Taxes....................................... 12,800 21,500
---------- ----------
Total liabilities................................. 1,609,516 1,774,425
---------- ----------
Commitments (Note 8)
Stockholders' Deficit:
Preferred stock, $.01 per share par value, 21,389 shares
authorized............................................. -- --
Common stock, $.01 per share par value, 2,500,000 shares
authorized for 1997 and 2,578,611 shares authorized for
1998; 2,062,500 shares issued (Note 6)................. 20,625 20,625
Additional paid-in capital................................ 149,267 149,267
Retained earnings......................................... 438,678 498,662
Treasury stock, at cost -- 855,000 shares................. (940,000) (940,000)
---------- ----------
Total stockholders' deficit....................... (331,430) (271,446)
---------- ----------
Total............................................. $1,278,086 $1,502,979
========== ==========
</TABLE>
See notes to financial statements.
F-77
<PAGE> 343
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Revenues.................................................... $4,656,975 $5,770,024
Costs of revenues........................................... 2,457,264 3,211,532
---------- ----------
Gross profit................................................ 2,199,711 2,558,492
General and administrative expenses......................... 2,021,064 2,293,060
---------- ----------
Income from operations...................................... 178,647 265,432
Other income (expense):
Interest income........................................... 408 4,350
Loss on sale of equipment................................. (503) (3,163)
Interest expense.......................................... (31,708) (105,835)
---------- ----------
Earnings before provision for income taxes.................. 146,844 160,784
Provision for income taxes.................................. 69,510 100,800
---------- ----------
Net income.................................................. $ 77,334 $ 59,984
========== ==========
</TABLE>
See notes to financial statements.
F-78
<PAGE> 344
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED TOTAL
------------------- ADDITIONAL OTHER TREASURY STOCK STOCKHOLDERS'
PAR PAID-IN RETAINED COMPREHENSIVE -------------------- EQUITY
SHARES VALUE CAPITAL EARNINGS INCOME SHARES COST (DEFICIT)
--------- ------- ---------- -------- ------------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997..... 2,000,000 $20,000 $ 24,892 $361,344 $ -- -- $ -- $ 406,236
--------- ------- -------- -------- -------- -------- --------- ---------
Comprehensive income -- net
income................... -- -- -- 77,334 -- -- -- 77,334
Issuance of common
shares................... 62,500 625 124,375 -- -- -- -- 125,000
Purchase of common stock... -- -- -- -- -- (855,000) (940,000) (940,000)
--------- ------- -------- -------- -------- -------- --------- ---------
Balance, December 31, 1997... 2,062,500 20,625 149,267 438,678 -- (855,000) (940,000) (331,430)
Comprehensive income -- net
income................... -- -- -- 59,984 -- -- -- 59,984
--------- ------- -------- -------- -------- -------- --------- ---------
Balance, December 31, 1998... 2,062,500 $20,625 $149,267 $498,662 $ -- (855,000) $(940,000) $(271,446)
========= ======= ======== ======== ======== ======== ========= =========
</TABLE>
See notes to financial statements.
F-79
<PAGE> 345
NET DAEMONS ASSOCIATES, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 77,334 $ 59,984
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 104,245 135,129
Loss on sale of equipment.............................. 503 3,163
Accrued interest on subordinated stockholder debt...... -- 81,174
Deferred income taxes.................................. (10,390) (24,600)
Changes in assets and liabilities:
Accounts receivable.................................. (63,693) (78,374)
Prepaid expenses and other........................... 2,144 (9,830)
Accounts payable..................................... 61,626 134,020
Accrued salaries, wages and related benefits......... (33,863) 113,154
Accrued profit sharing............................... (39,000) 4,000
Accrued expenses..................................... (71,382) 68,022
Deferred revenue..................................... (30,270) (10,783)
Accrued income taxes................................. (18,528) 18,403
--------- ---------
Net cash provided by (used in) operating
activities...................................... (21,274) 493,462
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment.................................... (228,985) (51,792)
Proceeds from sale of equipment........................... 6,200 951
Deposits.................................................. (39,419) 769
--------- ---------
Net cash used in investing activities............. (262,204) (50,072)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings undernote payable -- bank..... 195,108 (150,000)
Notes and stockholder receivable.......................... (13,025) 34,832
Proceeds from long-term borrowings........................ -- 54,892
Repayments of subordinated stockholder and long-term
debt................................................... (4,138) (156,673)
Proceeds from issuance of common stock.................... 100,000 --
--------- ---------
Net cash (used in) provided by financing
activities...................................... 277,945 (216,949)
--------- ---------
Increase (decrease) in cash and equivalents................. (5,533) 226,441
Cash and equivalents, beginning of year..................... 53,192 47,659
--------- ---------
Cash and equivalents, end of year........................... $ 47,659 $ 274,100
========= =========
Supplemental disclosures:
Fiscal year 1997 noncash financing activities:
Issuance of 12,500 common shares for a $25,000 note
receivable from stockholder Repurchase of 855,000
common shares from stockholder for $940,000 note
payable
Cash paid during the year for:
Interest............................................... $ 31,708 $ 22,303
========= =========
Taxes.................................................. $ 98,428 $ 108,997
========= =========
</TABLE>
See notes to financial statements.
F-80
<PAGE> 346
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1998
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Net Daemons Associates, Inc. ("NDA" or the "Company") specializes in
providing business with team-based network and system administration solutions.
NDA network and system services include outsourced network/system
administration; LAN/WAN design and implementation; network growth and transition
planning; Internet connectivity; security consulting; and customized network
solutions. In addition, NDA provides Web site development and network consulting
services.
NEW ACCOUNTING PRONOUNCEMENTS -- During the year, the Company adopted
Financial Accounting Standards Board ("FASB") Statement No. 130, "Reporting
Comprehensive Income." Statement No. 130 requires the reporting of comprehensive
income in addition to net income from operations. Comprehensive income is a more
inclusive financial reporting methodology that includes disclosure of certain
financial information that historically has not been recognized in the
calculation of net income. Comprehensive income encompasses all changes in
stockholders' equity (except those arising from transactions with stockholders).
The Company had no other components of comprehensive income. As this new
standard only requires additional information in the financial statements, it
does not affect the Company's financial position or results of operations.
USE OF ESTIMATES -- The preparation of financial statements in accordance
with generally accepted accounting principles requires the use of estimates.
These estimates include the allowance for doubtful accounts and certain accruals
and are based upon assumptions developed by management about the appropriate
carrying value of assets and liabilities. Actual results could differ from these
estimates.
REVENUE RECOGNITION -- Revenue from consulting services is recognized as
the services are rendered, provided that no significant obligations remain and
collection of the receivable is considered probable. Generally, contracts call
for billings on a time and materials basis; however, in instances when a fixed
fee contract is signed, revenue is recognized on a percentage-of-completion
basis. At December 31, 1997 and 1998, NDA had $62,910 and $52,127 of deferred
revenue recorded, respectively.
CONCENTRATION OF CREDIT RISK -- The majority of NDA's revenue is from
customers in high technology industries, who are not required to provide
collateral. NDA's customers are dispersed over a wide geographic area and are
subject to periodic review under the Company's credit policies. The Company does
not believe that it is subject to any unusual credit risks, other than the
normal level of risk attendant to operating its business.
PROPERTY AND EQUIPMENT -- Property and equipment are recorded at cost and
depreciated using the straight-line method over their estimated useful lives
(three to seven years). Leasehold improvements are amortized over the life of
the lease.
INCOME TAXES -- Deferred income taxes are provided for the tax consequences
of differences in bases between assets and liabilities for book and tax
purposes. Deferred taxes are measured using currently enacted tax rates which
are expected to be in effect when such differences reverse.
STOCK-BASED COMPENSATION -- Compensation cost associated with awards of
stock or options to employees is measured using the intrinsic-value method
prescribed by Accounting Principles Board Opinion No. 25 (see Note 6).
RECLASSIFICATIONS -- Certain amounts in the financial statements have been
reclassified to conform with the 1998 presentation.
F-81
<PAGE> 347
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. STOCKHOLDERS' RECEIVABLE
At December 31, 1998, stockholders' receivable consisted of $5,936 in notes
from NDA officers. The December 31, 1997 stockholders' receivable balance
consisted of a $25,000 note relating to the purchase of 12,500 shares of NDA's
common stock (paid on February 19, 1998) and $10,759 in notes from NDA officers.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Computer equipment and software...................... $ 329,241 $ 372,753
Furniture and fixtures............................... 50,632 54,194
Leasehold improvements............................... 13,939 13,939
Office equipment..................................... 28,405 33,124
Automobiles.......................................... 62,580 56,841
--------- ---------
Total...................................... 484,797 530,851
Less accumulated depreciation........................ (174,597) (308,102)
--------- ---------
Property and equipment, net.......................... $ 310,200 $ 222,749
========= =========
</TABLE>
4. NOTE PAYABLE -- BANK
Note payable -- bank represents the outstanding balance under a $400,000
working capital line of credit and a $100,000 line with a term conversion
feature ("the conversion line"). Interest on the lines are payable monthly based
on prime (7.75% at December 31, 1998). The lines are secured by and cross-
collateralized by substantially all assets of NDA, are personally guaranteed by
NDA's stockholders, and require the maintenance of customary financial covenants
including minimum retained earnings of $475,000. The lines are subject to
renewal annually and expires on July 1, 1999. The conversion line is to be
utilized to finance 80% of the purchase price of new equipment and converts to a
term loan in July 1999. After conversion, the loan will be payable in 48 equal
monthly installments of principal plus interest at the bank's then prime rate.
Amounts available under the lines were $500,000 at December 31, 1998.
5. LONG-TERM DEBT
EQUIPMENT LOAN -- The equipment loan requires monthly principal and
interest payments with principal payments based on a four-year straight-line
amortization schedule. Interest is based on prime (7.75% at December 31, 1998).
The equipment loan is secured by substantially all assets of NDA and is
personally guaranteed by NDA's stockholders.
TERM LOAN -- In connection with the acquisition of an automobile in June
1996, NDA entered into a term loan (the "term loan") with a bank for $23,504.
The term loan requires monthly payments of principal and interest (at 8.75%)
through May 2001.
STOCKHOLDER DEBT -- In connection with the repurchase of 855,000 shares of
common stock in December 1997, the Company entered into a $940,000 note payable
agreement (the "note payable"). This agreement calls for principal payments in
the amount of $125,333 to be made annually in 1999 through 2003 with a balloon
payment in 2004. However, NDA is only obligated to make payments, subject to
certain limitations, based on net profit as of the end of the fiscal year
preceding the relevant payment date. The note payable has an attached interest
rate of prime plus 1% (8.75% at December 31, 1998). The principal balance is
increased annually for the accrual of interest. The note payable is secured on a
pro
F-82
<PAGE> 348
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
rata basis by a security interest in the noted stock. Principal payments due
under the equipment loan, term loan and stockholder debt are as follows:
<TABLE>
<CAPTION>
EQUIPMENT STOCKHOLDER
YEAR ENDING DECEMBER 31, LOAN TERM LOAN DEBT TOTAL
- ------------------------ --------- --------- ----------- ----------
<S> <C> <C> <C> <C>
1999......................... $ 33,453 $ 4,958 $ -- $ 38,411
2000......................... 33,453 5,376 125,333 164,162
2001......................... 33,453 2,264 125,333 161,050
2002......................... 33,452 -- 125,333 158,785
2003......................... -- -- 125,333 125,333
Thereafter................... -- -- 383,882 383,882
-------- ------- -------- ----------
Total.............. $133,811 $12,598 $885,214 $1,031,623
======== ======= ======== ==========
</TABLE>
6. STOCKHOLDERS' DEFICIT
COMMON STOCK -- During fiscal year 1997, NDA issued 62,500 common shares at
a price of $2.00 per share. Of the $125,000 in proceeds due from the sale of
these shares, $100,000 had been collected, leaving an outstanding balance of
$25,000 at December 31, 1997. On February 19, 1998, the outstanding balance was
collected.
TREASURY STOCK -- In December 1997, NDA purchased 855,000 shares of common
stock. NDA's purchases of shares of common stock are recorded as "Treasury
Stock" and result in a reduction of "Stockholders' Deficit."
STOCK OPTION PLAN -- NDA's Incentive Stock Option Plan (the "Plan"),
established in December 1996, provides for grants of options to purchase up to
200,000 shares of common stock. Grants may be in the form of incentive stock
options or nonqualified options. Exercise prices and vesting periods are
determined by the Board on the date of grant. Options generally vest ratably
over a four-year period. A summary of activity in the Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- ---------
<S> <C> <C>
Outstanding at January 1, 1997.............................. 77,900 $0.20
Granted..................................................... 106,100 2.00
Cancelled................................................... (41,000) 0.20
-------
Outstanding at December 31, 1997............................ 143,000 $1.54
Granted..................................................... 116,560 3.08
Cancelled................................................... (60,300) 1.96
-------
Outstanding at December 31, 1998............................ 199,260 $2.31
=======
</TABLE>
F-83
<PAGE> 349
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth information regarding options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED-
NUMBER NUMBER AVERAGE
OF EXERCISE CURRENTLY REMAINING
OPTIONS PRICE EXERCISABLE LIFE
- ------- -------- ----------- ---------
<C> <C> <C> <S>
32,900 $0.20 23,800 8.0 years
66,160 2.00 33,784 8.6
100,200 3.20 35,600 9.5
- ------- ------
199,260 93,184
======= ======
</TABLE>
PRO FORMA DISCLOSURE -- As described in Note 1, NDA uses the
intrinsic-value method to measure compensation for equity awards to employees.
Had NDA used the fair-value method to measure compensation, reported net income
would have been $64,577 in 1997 and $9,097 in 1998.
The minimum-value method was used to measure the fair value of equity
awards in this disclosure. Key assumptions used to apply this pricing model were
average risk-free rates of 6% and expected option lives of ten years. The
estimated fair value of awards made in 1997 and 1998 were $94,710 and $190,332,
respectively.
RESERVED SHARES -- At December 31, 1997 and 1998, 200,000 shares of common
stock were reserved for issuance upon exercise of options.
7. INCOME TAXES
The provision for income taxes consisted of the following for the years
ended December 31:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Current:
Federal.............................................. $ 58,900 $112,000
State................................................ 21,000 26,500
-------- --------
Total........................................ 79,900 138,500
-------- --------
Deferred:
Federal.............................................. (9,039) (28,800)
State................................................ (1,351) (8,900)
-------- --------
Total........................................ (10,390) (37,700)
-------- --------
Provision for income taxes............................. $ 69,510 $100,800
======== ========
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
at December 31 were as follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets -- current:
Accrued vacation and benefits........................ $ 12,000 $ 38,000
Allowance for doubtful accounts...................... 7,700 15,000
-------- --------
Net deferred tax asset -- current...................... $ 19,700 $ 53,000
======== ========
Deferred tax liability -- noncurrent:
Depreciation......................................... $(12,800) $(21,500)
======== ========
</TABLE>
F-84
<PAGE> 350
NET DAEMONS ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation between the statutory and effective tax rates for the
years ended December 31 were as follows:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Statutory tax rate.......................................... 34.0% 34.0%
State income taxes -- net of federal benefit................ 6.2 6.2
Nondeductible expenses...................................... 7.1 6.4
Change in prior year's tax estimate......................... -- 16.1
---- ----
47.3% 62.7%
==== ====
</TABLE>
8. COMMITMENTS
OPERATING LEASES -- The Company leases its office facilities and certain
equipment under noncancelable operating leases. Total rent expense was $169,609
and $200,098 for the years ended December 31, 1997 and 1998, respectively.
Future minimum payments under noncancelable operating leases for the years
ending December 31 are as follows:
<TABLE>
<S> <C>
1999.............................................. $222,523
2000.............................................. 44,918
2001.............................................. 13,375
</TABLE>
9. PROFIT-SHARING PLAN
NDA has a profit-sharing plan (the "plan") pursuant to Section 401(k) of
the Internal Revenue Code (the "Code"). The plan allows participants to make
pretax contributions not in excess of the maximum allowed under the Code. The
plan does not provide matching contributions by the employer. The profit-sharing
portion of the plan consists of contributions made by NDA at the discretion of
the Board. Profit-sharing expense was approximately $26,000 in 1997 and $30,000
in 1998.
10. SUBSEQUENT EVENT
On February 12, 1999 Sage Networks, Inc. ("Sage") agreed to purchase all
the outstanding stock of the Company. The purchase price consists of cash of
$500,000 and 425,000 shares of Sage common stock. In addition Sage has agreed to
pay certain officers of the Company $2,417,000 for non-compete agreements and to
pay approximately $441,000 for outstanding stock options of the Company. The
Agreement also provides for contingent consideration of $500,000 in cash and
74,963 shares of Sage common stock if certain gross revenue and gross margin
targets are met in the twelve months period following the acquisition. The
transaction closed on February 17, 1999. As a result of the acquisition, on
February 12, 1999, the Company paid all of its outstanding bank debt. In
connection with the repayment, all bank credit facilities and borrowing
availability was cancelled.
The Company had service revenue from Sage of approximately $94,000 in 1998.
* * * * * *
F-85
<PAGE> 351
REPORT OF INDEPENDENT AUDITORS
To Shareholder
Interliant, Inc. (referred to in this prospectus as Interliant Texas)
We have audited the accompanying balance sheets of Interliant, Inc.
(referred to in this prospectus as Interliant Texas) (the "Company") as of
December 31, 1997 and 1998, and the related statements of operations,
shareholder's deficit and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interliant, Inc. (referred
to in this prospectus as Interliant Texas) at December 31, 1997 and 1998, and
the results of its operations and its cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Houston, Texas
February 26, 1999,
except for Note 11, as to which the date is
March 10, 1999
F-86
<PAGE> 352
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 917,566 $ 972,467
Accounts receivable, net of allowance of $103,940 in 1997
and $150,276 in 1998................................... 1,860,152 1,775,939
Unbilled revenue.......................................... 1,758,012 1,748,234
Prepaid expenses and other................................ 168,428 391,359
----------- -----------
Total current assets........................................ 4,704,158 4,887,999
Property and equipment, net................................. 5,693,201 5,661,351
Investment in and advances to joint venture................. 72,145 149,067
----------- -----------
Total assets................................................ $10,469,504 $10,698,417
=========== ===========
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable and accrued expenses..................... $ 1,597,521 $ 1,909,514
Notes payable to shareholder and related party............ 10,825,000 15,125,000
Current portion of capital lease obligations.............. 30,083 27,919
----------- -----------
Total current liabilities................................... 12,452,604 17,062,433
Capital lease obligations................................... 136,238 110,009
Commitments and contingencies
Shareholder's deficit:
Common stock, $.01 par value; 40,000,000 shares
authorized; 10,000,000 shares issued and outstanding... 100,000 100,000
Additional paid-in capital................................ 400,000 400,000
Accumulated deficit....................................... (2,619,338) (6,974,025)
----------- -----------
Total shareholder's deficit................................. (2,119,338) (6,474,025)
----------- -----------
Total liabilities and shareholder's deficit................. $10,469,504 $10,698,417
=========== ===========
</TABLE>
See accompanying notes.
F-87
<PAGE> 353
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------
1996 1997 1998
---------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Network service fees............................... $8,401,463 $15,316,756 $18,886,503
Consulting......................................... -- 1,423,071 2,020,598
Other.............................................. 4,504 136,037 265,768
---------- ----------- -----------
8,405,967 16,875,864 21,172,869
Costs and expenses:
Cost of service revenue............................ 5,056,552 9,414,476 11,880,983
General and administrative......................... 1,523,209 2,866,509 4,137,668
Sales and marketing................................ 1,697,214 4,408,597 6,722,997
Depreciation and amortization...................... 783,208 1,642,140 2,525,530
---------- ----------- -----------
9,060,183 18,331,722 25,267,178
---------- ----------- -----------
Operating loss....................................... (654,216) (1,455,858) (4,094,309)
Other income (expense):
Equity in losses of joint venture.................. (15,767) (214,735) (144,735)
Interest expense................................... (218,394) (469,817) (715,643)
Gain on settlement of litigation................... -- 1,351,630 600,000
---------- ----------- -----------
(234,161) 667,078 (260,378)
---------- ----------- -----------
Net loss............................................. $ (888,377) $ (788,780) $(4,354,687)
========== =========== ===========
</TABLE>
See accompanying notes.
F-88
<PAGE> 354
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF SHAREHOLDER'S DEFICIT
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1995........................ 2,500,000 $ 25,000 $475,000 $ (942,181) $ (442,181)
Stock split effected as a
stock dividend........... 7,500,000 75,000 (75,000) -- --
Net loss.................... -- -- -- (888,377) (888,377)
---------- -------- -------- ----------- -----------
Balance at December 31,
1996........................ 10,000,000 100,000 400,000 (1,830,558) (1,330,558)
Net loss.................... -- -- -- (788,780) (788,780)
---------- -------- -------- ----------- -----------
Balance at December 31,
1997........................ 10,000,000 100,000 400,000 (2,619,338) (2,119,338)
Net loss.................... -- -- -- (4,354,687) (4,354,687)
---------- -------- -------- ----------- -----------
Balance at December 31,
1998........................ 10,000,000 $100,000 $400,000 $(6,974,025) $(6,474,025)
========== ======== ======== =========== ===========
</TABLE>
See accompanying notes.
F-89
<PAGE> 355
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................................ $ (888,377) $ (788,780) $(4,354,687)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation...................................... 734,331 1,403,842 1,952,629
Amortization...................................... 48,877 525,391 572,901
Loss on disposals of property and equipment....... 115,037 14,856 3,783
Provision for doubtful accounts................... 50,178 97,433 150,966
Equity in losses of joint ventures................ 15,767 214,735 144,735
Changes in operating assets and liabilities:
Accounts receivable and unbilled revenue....... (1,338,004) (1,660,351) (56,975)
Prepaid expenses and other..................... (207,233) 91,727 (222,931)
Accounts payable and accrued liabilities....... 1,378,521 (136,301) 311,993
----------- ----------- -----------
Net cash used in operating activities............... (90,903) (237,448) (1,497,586)
INVESTING ACTIVITIES
Proceeds from sale of property and equipment........ 16,889 8,281 4,000
Expenditures for property and equipment............. (4,082,093) (2,834,563) (2,501,463)
Investments in and advances to joint venture........ (55,561) (247,086) (221,657)
----------- ----------- -----------
Net cash used in investing activities............... (4,120,765) (3,073,368) (2,719,120)
FINANCING ACTIVITIES
Net proceeds from notes payable from shareholder and
related party..................................... 4,423,623 3,901,698 4,271,607
----------- ----------- -----------
Net cash provided by financing activities........... 4,423,623 3,901,698 4,271,607
----------- ----------- -----------
Increase in cash.................................... 211,955 590,882 54,901
Cash at beginning of year........................... 114,729 326,684 917,566
----------- ----------- -----------
Cash at end of year................................. $ 326,684 $ 917,566 $ 972,467
=========== =========== ===========
</TABLE>
See accompanying notes.
F-90
<PAGE> 356
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Interliant, Inc. (the "Company") was organized under the laws of the State
of Texas on July 12, 1993, under the name Wolf Communications Company. The
Company's name was changed to Interliant, Inc., effective January 20, 1997.
Interliant, Inc., is a privately owned company that provides secure
network-based hosting and messaging services on a Lotus Notes platform, enabling
worldwide continuously available remote access to business-critical applications
and data. The Company also provides vertical solutions for various markets
including distance learning, sales force automation, legal, and mortgage
banking. It is also developing hosting solutions for Microsoft Exchange and
Microsoft's Commercial Internet System, as well as a remote server management
solution.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, except notes
payable to shareholder and related party and the capital lease obligation,
approximate fair value. The fair value of notes payable to shareholder and
related party and the capital lease obligation are not determinable as the
Company's borrowings are from the shareholder and a related party and the
capital lease obligation is guaranteed by the shareholder.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company grants stock options to employees for shares with an exercise
price no less than the value of the shares at the date of grant. The company
accounts for such stock option grants in accordance with Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25").
REVENUE RECOGNITION
Revenues consist primarily of network service and related fees for
services, generally provided under contractual periods ranging from one to
twelve months. Revenues from these services are generally recognized when the
services are performed. Revenues in excess of amounts billed are accrued and
presented as unbilled revenue in the accompanying balance sheets.
ADVERTISING EXPENSES
All advertising costs are expensed as incurred. Advertising expenses were
approximately $122,000, $415,000, and $571,000 for the years ended December 31,
1996, 1997, and 1998, respectively.
COST OF SERVICE REVENUE
Cost of service revenue includes internally-funded research and development
costs, which are expensed as incurred. Research and development costs were
approximately $600,000, $1,100,000, and $1,500,000 in 1996, 1997, and 1998,
respectively.
F-91
<PAGE> 357
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the assets as
follows:
<TABLE>
<S> <C>
Computer equipment and software............................. 3 years
Furniture, fixtures and office equipment.................... 5 to 7 years
</TABLE>
Amortization of leasehold improvements is provided using the straight-line
method over the shorter of the remaining estimated useful lives or the lease
terms. Depreciation expense in 1997 of approximately $287,000 is presented on
the statements of operations as an offset to the gain on settlement of
litigation.
The costs of ordinary maintenance and repairs are charged to expense while
renewals and replacements are capitalized.
INCOME TAXES
The shareholder has elected S corporation status for the Company for
federal income tax purposes. Under S corporation regulations, revenues and
expenses of the Company are reportable for federal income tax purposes in the
income tax return of the shareholder. Accordingly, no provision for federal
income tax is included in the accompanying financial statements.
CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit
risk consist principally of accounts receivable. The Company provides credit, in
the normal course of business, to a number of geographically dispersed
customers, primarily within the United States. Collateral is generally not
required on these receivables. The Company maintains allowances for potential
credit losses, and customers can be denied access to services in the event of
non-payment. During 1997 and 1998, the Company's largest customer represented
approximately 10% of total revenues.
RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components. Certain items which were previously required to be reported
separately in shareholder's equity, such as unrealized gains or losses on
available-for-sale securities, minimum pension liability adjustments and foreign
currency translation adjustments, are now required to be included in other
comprehensive income. For 1996, 1997, and 1998 the Company's comprehensive
income was the same as net income, and the adoption of SFAS 130 had no impact on
the presentation of the financial statements.
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS 131"). SFAS 131 requires disclosure of
certain information regarding operating segments, products, services, geographic
areas of operation and major customers. The disclosures prescribed by SFAS 131
are effective for the year ended December 31, 1998. The Company has determined
that it does not have separately reportable segments, as defined by SFAS 131,
and thus no segment disclosures have been presented.
In March 1998, the AICPA issued Statement of Position 98-1, Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use (SOP
98-1), which is effective for the financial statements for fiscal years
beginning after December 15, 1998. SOP 98-1 will result in the capitalization of
F-92
<PAGE> 358
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
certain qualifying costs incurred in the development of software for internal
use; however, the adoption of SOP 98-1 is not expected to have a material impact
on the Company's earnings or financial position.
2. INVESTMENT IN AND ADVANCES TO JOINT VENTURE
The Company is a 50% partner in TITLELINK, L.L.C., a joint venture which
offers a network-based service to facilitate the closing of real estate
transactions within the financial community. The Company provides working
capital requirements as needed. The Company has provided an allowance against
its advances to the joint venture of approximately $30,000 and $114,000 at
December 31, 1997 and 1998, respectively, which is included in investment in and
advances to joint venture.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
---------- -----------
<S> <C> <C>
Computer equipment and software............................ $4,926,000 $ 7,298,000
Furniture, fixtures and office equipment................... 1,559,000 1,682,000
Leasehold improvements..................................... 2,659,000 2,665,000
---------- -----------
9,144,000 11,645,000
Less accumulated depreciation and amortization............. 3,451,000 5,984,000
---------- -----------
$5,693,000 $ 5,661,000
========== ===========
</TABLE>
4. NOTES PAYABLE TO SHAREHOLDER AND RELATED PARTY
Notes payable to shareholder and related party includes unsecured
borrowings from the Company's shareholder totaling $4,310,000 and $7,910,000 at
December 31, 1997 and 1998, respectively, and unsecured borrowings from a
related party totaling $6,515,000 and $7,215,000 at December 31, 1997 and 1998,
respectively. These advances have been used to fund the Company's operations.
These notes bear interest, payable monthly, at annual rates ranging from 5.5% to
6.1% in 1997, and 4.3% to 5.6% in 1998. The borrowings mature on March 31, 1999.
The Company paid interest associated with the notes payable to affiliates
of approximately $199,000, $449,000, and $696,000 in 1996, 1997, and 1998,
respectively.
5. RELATED PARTY TRANSACTIONS
The Company has an informal agreement with a related party whereby the
Company provides certain administrative services to the related party. The
related party compensates the Company for these services on a monthly basis,
which totaled $12,000, $48,000, and $48,000 in 1996, 1997, and 1998,
respectively. The amount due to the Company for these services totaled $12,000
at December 31, 1998, and there was no related amount due to the Company at
December 31, 1997.
6. EMPLOYEE BENEFIT PLAN
Substantially all of the Company's employees are participants in a
discretionary, defined contribution plan with salary deferral contributions as
provided under Section 401(k) of the Internal Revenue Code. Voluntary salary
deferral contributions are made by employees, subject to a maximum of 15% of
annual compensation and are matched 100% of the first 5% by Company
contributions. The charge to expense for
F-93
<PAGE> 359
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the Company's contributions was $109,000, $254,000, and $404,000 for the years
ended December 31, 1996, 1997, and 1998, respectively.
7. STOCK SPLIT
Effective December 16, 1996, the Board of Directors approved a four-for-one
split of the Company's common stock effected in the form of a stock dividend,
resulting in a total of 10,000,000 shares outstanding. All references in the
financial statements which relate to the number of shares of Common Stock have
been restated to reflect the stock split.
8. EMPLOYEE STOCK OPTION PLAN
In 1995, the Company's sole director (the "Director") adopted the 1995
Employee Stock Option Plan (the "Option Plan"), pursuant to which options to
purchase up to an aggregate of 4,000,000 shares of the Company's common stock
may be granted. The Option Plan is administered by the Director. Among other
things, the Director determines which employees will receive options, the number
of shares covered by any option granted, and the exercise price and other terms
and conditions of each such option.
All options granted under the Option Plan are nontransferable except by the
laws of descent and distribution. All options also expire ten years after the
date of grant or upon earlier termination of employment unless due to death,
disability, or retirement, in which case the option remains exercisable for an
additional three months in the case for Incentive Options and one year for
Non-Qualified Options. Options granted vest over periods ranging from immediate
vesting to vesting in equal increments over four years from the date of grant.
The exercise price of the options approximated the fair value of the common
stock on the date of grant, and accordingly, no compensation expense has been
recorded. The weighted-average remaining contractual life of options at December
31, 1996, 1997, and 1998 was 9.7 years, 8.8 years, and 8.0 years, respectively.
A summary of the Option Plan as of December 31, 1996, 1997, and 1998 and
changes during the years ended on those dates are as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICES
--------- ----------------
<S> <C> <C>
Options outstanding January 1, 1996...................... 340,000 $.05
Granted................................................ 2,242,000 $.05
Exercised.............................................. -- --
Surrendered............................................ -- --
--------- ----
Options outstanding December 31, 1996.................... 2,582,000 $.05
Granted................................................ 646,100 $.05
Exercised.............................................. -- --
Surrendered............................................ (214,000) $.05
--------- ----
Options outstanding December 31, 1997.................... 3,014,100 $.05
Granted................................................ 801,100 $.05
Exercised.............................................. -- --
Surrendered............................................ (173,200) $.05
--------- ----
Options outstanding December 31, 1998.................... 3,642,000 $.05
========= ====
</TABLE>
F-94
<PAGE> 360
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICES
--------- ----------------
<S> <C> <C>
Exercisable at:
December 31, 1996...................................... 2,468,000 $.05
========= ====
December 31, 1997...................................... 2,620,000 $.05
========= ====
December 31, 1998...................................... 2,847,000 $.05
========= ====
</TABLE>
At December 31, 1996, 1997, and 1998, the Company had reserved 4,000,000
shares of common stock for issuance in connection with the exercise of stock
options.
The Company has elected to follow APB 25 and related interpretations in
accounting for employee stock options. Accordingly, no compensation expense has
been recognized for these stock options. Pro forma information regarding net
income and earnings per share is required by FASB Statement No. 123, Accounting
for Stock-Based Compensation ("FAS 123"), which also requires that the
information be determined as if the Company had accounted for its employee stock
options under the fair value method of FAS 123. The fair value for these options
was estimated at the date of grant using a minimum value option pricing model
with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Risk-free interest rate................................. 6.5% 5.6% 4.8%
Dividend yield.......................................... 0.0% 0.0% 0.0%
Weighted-average expected life of options............... 5 years 5 years 5 years
</TABLE>
The minimum value method calculated the fair value of these options as
zero; therefore, pro forma net loss is the same as net loss for each year
presented.
9. COMMITMENTS AND CONTINGENCIES
The Company leases various office space and equipment under noncancelable
operating leases expiring on various dates through 2001, generally with options
to renew under terms consistent with the original leases. The gross balance of
assets recorded under capital leases which are included in property and
equipment at December 31, 1997 and 1998 was approximately $287,000 and $291,000,
respectively. Associated accumulated depreciation was approximately $95,000 and
$165,000 at December 31, 1997 and 1998, respectively. At December 31, 1998,
future lease payments are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
1999........................................................ $ 41,000 $ 983,000
2000........................................................ 41,000 898,000
2001........................................................ 41,000 524,000
2002........................................................ 35,000 --
2003........................................................ -- --
-------- ----------
Total minimum lease payments................................ 158,000 $2,405,000
==========
Less amount representing interest........................... 20,000
--------
Present value of capital lease obligations.................. 138,000
Less current portion of capital lease obligations........... 28,000
--------
Long-term capital lease obligations......................... $110,000
========
</TABLE>
F-95
<PAGE> 361
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Total rent expense for operating leases for the years ended December 31,
1996, 1997, and 1998 was $797,000, $1,700,000, and $1,449,000, respectively.
The Company has a facility with a bank for letters of credit totaling
$541,000 at December 31, 1998 relating to the Company's data center operating
lease. There were no amounts outstanding under the letter of credit facility at
December 31, 1998.
10. LITIGATION
In 1997 and 1998, the Company received proceeds of $2,500,000 and $600,000,
respectively, from the settlement of legal claims relating to a trademark
dispute. These amounts are presented in the statements of operations net of
costs related to the settlement of $1,148,000 in 1997.
The Company is involved in various lawsuits and legal proceedings which
have arisen in the normal course of business. While the ultimate results of
these matters cannot be predicted with certainty, management does not expect
them to have a material adverse effect on the financial position of the Company.
11. SUBSEQUENT EVENT
In February 1999, the shareholder reached an agreement in principle to sell
substantially all of the assets and certain liabilities of the Company. The
transaction closed on March 10, 1999. The Company has obtained approval of the
proposed transaction with the holders of outstanding borrowings. On March 10,
1999, the Company changed its name to Rancher 1 Corp.
12. YEAR 2000 ISSUE (UNAUDITED)
Currently, many computer and software products are coded to accept
two-digit entries in the date code field. These date code fields will need to
accept four-digit entries to distinguish 21st century dates from 20th century
dates. As a result, many companies' software and computer systems, including the
Company's, may need to be upgraded or replaced in order to comply with Year 2000
requirements. We recognize the need to ensure that our operations will not be
adversely impacted by Year 2000 software and computer system failures.
State of Readiness
The Company has made a preliminary assessment of the Year 2000 readiness of
its information technology ("IT") systems, including the hardware and software
that enable it to provide and deliver its solutions, and its non-IT systems. The
Company's plan consists of (i) quality assurance testing of its internally
developed proprietary software and systems; (ii) contacting third-party
suppliers, vendors and licensors of material hardware, software and services
that are both directly and indirectly related to the delivery of the Company's
solutions to it customers; (iii) assessment of repair or replacement
requirements; (iv) repair or replacement; (v) implementation; and (vi) creation
of contingency plans in the event of Year 2000 failures. The Company is
currently assessing the materiality of its IT and non-IT systems and will seek
assurances of Year 2000 compliance from providers of material systems. Until
such testing is complete and such vendors and providers are contacted, the
Company will not be able to completely evaluate whether its IT systems or non-IT
systems will need to be revised or replaced. The Company plans to complete its
Year 2000 evaluation during the second half of 1999.
F-96
<PAGE> 362
INTERLIANT, INC.
(REFERRED TO IN THIS PROSPECTUS AS INTERLIANT TEXAS)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Costs
To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
its expenses have related to, and are expected to continue to relate to, the
internal staffing costs associated with the evaluation process and Year 2000
compliance matters generally. At this time, the Company does not possess the
information necessary to estimate the potential costs of revisions to its
software and systems should such revisions be required or the replacement of
third party software, hardware or services that are determined not to be Year
2000 compliant. Although the Company does not anticipate that such expenses will
be material, such expenses if higher than anticipated, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Risks
The Company is not currently aware of any Year 2000 compliance problems
relating to its IT or non-IT systems that would have a material adverse effect
on the Company's business, results of operations and financial condition. There
is no assurance that the Company will not discover Year 2000 compliance problems
in its software and systems that will require substantial revisions. In
addition, there is no assurance that third party software, hardware or services
incorporated into the Company's material IT and non-IT systems will not need to
be revised or replaced, all of which could be time consuming and expensive. The
failure of the Company to fix or replace its software, hardware or services on a
timely basis could result in lost revenues, increased operating costs and the
loss of customers and other business interruptions, any of which could have a
material adverse effect on the Company's business, results of operations and
financial condition. Moreover, the failure to adequately address Year 2000
compliance issues in its IT and non-IT systems could result in claims of
mismanagement, misrepresentation or breach of contract and related litigation,
which could be costly and time-consuming to defend. In addition, there can be no
assurance that governmental agencies, utility companies, telecommunication
companies, other Internet service providers, third party service providers,
hardware and software manufacturers and others outside Interliant control will
be Year 2000 compliant. The failure by such entities to be Year 2000 compliant
could result in a systemic failure beyond the control of the Company such as a
prolonged Internet, telecommunications or electrical failure, which could also
prevent the Company from delivering its services to its customers, decrease the
use of the Internet or prevent users from accessing the Web sites of its
customers. Any of these occurrences could have a material adverse effect on the
Company's business, financial condition and results of operations.
Contingency Plan
As discussed above, the Company is engaged in an ongoing Year 2000
assessment and has not yet developed any contingency plans. The responses
received from third-party vendors and service providers will be taken into
account in determining the nature and extent of any contingency plans.
F-97
<PAGE> 363
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
THROUGH AND INCLUDING AUGUST 1, 1999, ALL DEALERS EFFECTING TRANSACTIONS IN
THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
7,000,000 SHARES
[INTERLIANT LOGO]
COMMON STOCK
-----------------------
PROSPECTUS
-----------------------
MERRILL LYNCH INTERNATIONAL
DONALDSON, LUFKIN & JENRETTE
CIBC WORLD MARKETS
JULY 7, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
