<PAGE>
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-93299
PROSPECTUS
[LOGO]
USINTERNETWORKING, INC.
$125,000,000
7% CONVERTIBLE SUBORDINATED NOTES DUE NOVEMBER 1, 2004
AND 5,030,181 SHARES OF COMMON STOCK ISSUABLE
UPON CONVERSION OF THE NOTES
88,915 SHARES OF COMMON STOCK
------------------
Holders of our 7% Convertible Subordinated Notes due 2004 may offer for sale
the Notes and the shares of our common stock into which the Notes are
convertible at any time at market prices prevailing at the time of sale or at
privately negotiated prices. The selling holders may sell the Notes or the
common stock directly to purchasers or through underwriters, broker-dealers or
agents, who may receive compensation in the form of discounts, concessions or
commissions. We will not receive any proceeds from the sale of the Notes or the
common stock by the selling holders. We will pay all expenses (other than
selling commissions and fees and stock transfer taxes) of the registration and
sale of the Notes and the common stock into which the Notes are convertible.
Holders of the Notes may convert any portion of the note (in multiples of
$1,000) at any time on or before November 1, 2004 into shares of our common
stock at a conversion price of $24.85 per share, subject to adjustment in
certain events. On or about March 28, 2000, we will effect a three-for-two stock
split by means of a stock dividend, at which time the conversion price will be
adjusted to $16.57 per share. We will pay Interest on the Notes on May 1 and
November 1 of each year, beginning on May 1, 2000. We may redeem some or all of
the Notes at any time on or after November 5, 2002 at the redemption prices
described under the caption "Description of the Notes--Optional Redemption." If
we experience a change in control, holders of the Notes will have the right to
require us to purchase their Notes at a price equal to 100% of the principal
amount plus accrued interest.
The Notes are unsecured obligations that are subordinated in right of
payment to all of our existing and future senior indebtedness. See "Description
of the Notes--Subordination of Notes." The Notes are not entitled to any sinking
fund.
In addition, this Prospectus relates to the offering by five of our
stockholders of up to 133,372 shares of our common stock acquired in private
placement transactions. As part of these transactions, we granted these
stockholders the right to include resales of their shares in this Prospectus. We
will not receive any proceeds from the sale of the common stock by these
stockholders.
Our common stock is quoted on The Nasdaq National Market under the symbol
"USIX." On March 6, 2000, the last reported sale price of the common stock was
$85.31 per share. The Notes are eligible for trading in The PORTAL(Sm) Market, a
subsidiary of The Nasdaq Stock Market, Inc., however, no assurance can be given
as to the continued development or liquidity of any market for the Notes.
INVESTING IN THE NOTES OR OUR COMMON STOCK INVOLVES SUBSTANTIAL RISKS. SEE
"RISK FACTORS" BEGINNING ON PAGE 9.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is March 7, 2000
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary.................... 3
Risk Factors.......................... 9
Use of Proceeds....................... 20
Common Stock Price Range.............. 20
Dividend Policy....................... 20
Capitalization........................ 21
Selected Historical Consolidated
Financial Data...................... 22
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 26
Business.............................. 32
Management............................ 45
Certain Relationships and Related
Transactions........................ 57
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Principal Stockholders................ 61
Description of Certain Credit
Facilities.......................... 64
Description of the Notes.............. 65
Description of Capital Stock.......... 79
Certain United States Federal Income
Tax Considerations.................. 82
Selling Security Holders.............. 86
Plan of Distribution.................. 89
Legal Matters......................... 91
Experts............................... 91
Available Information................. 91
Index to Financial Statements......... F-1
</TABLE>
This Prospectus references and depicts certain trademarks, service marks and
trade names of other companies. "USINTERNETWORKING" and "USI" are our registered
trademarks. We have applied for federal registration of the marks "Internet
Managed Application Provider," "IMAP," "PriorityPeering," "USIView," "AppHost,"
"Global Enterprise Management Center" and "GEMC."
WE HAVE NOT AUTHORIZED ANY PERSON TO GIVE YOU ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS. YOU SHOULD NOT
RELY ON ANY INFORMATION OR REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS. THIS PROSPECTUS IS NOT ANY OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE CONVERTIBLE SUBORDINATED NOTES AND
THE COMMON STOCK INTO WHICH THE NOTES ARE CONVERTIBLE. IT IS NOT AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY SECURITIES IF THE OFFER OR
SOLICITATION WOULD BE UNLAWFUL. THE AFFAIRS OF USINTERNETWORKING MAY HAVE
CHANGED SINCE THE DATE OF THIS PROSPECTUS. YOU SHOULD NOT ASSUME THAT THE
INFORMATION IN THIS PROSPECTUS IS CORRECT AT ANY TIME SUBSEQUENT TO ITS DATE.
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION THAT MAY BE IMPORTANT TO
YOU. YOU SHOULD READ THE ENTIRE PROSPECTUS, INCLUDING THE FINANCIAL DATA AND
RELATED NOTES, BEFORE MAKING AN INVESTMENT DECISION. UNLESS OTHERWISE INDICATED,
ALL INFORMATION IN THIS PROSPECTUS REFLECTS BOTH A THREE-FOR-TWO STOCK SPLIT
EFFECTED BY A STOCK DIVIDEND DISTRIBUTED ON DECEMER 17, 1999 TO ALL SHAREHOLDERS
OF RECORD AT THE CLOSE OF BUSINESS ON DECEMBER 3, 1999 AND AN ADDITIONAL
THREE-FOR-TWO STOCK SPLIT THAT WILL BE EFFECTED BY AN ADDITIONAL STOCK DIVIDEND
TO ALL SHAREHOLDERS OF RECORD AT THE CLOSE OF BUSINESS ON MARCH 14, 2000. THIS
ADDITIONAL STOCK DIVIDEND WILL BE DISTRIBUTED ON OR ABOUT MARCH 28, 2000.
USINTERNETWORKING
USI implements, operates and supports packaged software applications that
can be accessed and used over the Internet. These IMAP, or Internet Managed
Application Provider, services are based on packaged applications from leading
software vendors and are designed to meet the needs of middle market and global
1000 companies for business functions such as e-commerce, sales force automation
and customer support, human resource and financial management, messaging and
collaboration and professional services automation. In order to deliver and
support our IMAP solutions, we have constructed a highly reliable, secure global
network, including four Enterprise Data Centers located around the world. We
implement selected packaged software applications in our data centers, configure
them to meet the needs of our clients and bundle them with Internet access,
back-up, security and operational support. We integrate these elements of
technology and sell them to clients as a service for a recurring monthly fee
over a fixed term. In addition, as part of our IMAP services, we offer complex
web hosting services to clients who want to run their own software applications
using our highly reliable and secure network.
The advantages our clients realize by purchasing our IMAP services rather
than purchasing the application software and implementing it themselves include:
- faster time to benefit;
- reduced technical and integration risk;
- reduced reliance on internal IT staff; and
- lower total costs and elimination of capital investment.
We are able to deliver these benefits to our clients in part because we have
designed and implemented a network of four Enterprise Data Centers located in
Annapolis, Silicon Valley, Amsterdam and Tokyo. The data centers are linked by a
dedicated network and by robust transit connections to twelve major Internet
backbones--eight in North America and two in Europe and two in Asia. Our data
centers comprise standardized hardware environments to support our applications,
embedded security, EMC disk arrays for storage and real-time back-up and
significant levels of infrastructure redundancy. Our network is monitored and
managed through USIView, which enables a client engineer to see all hardware,
software and network elements of a client application in a single view. Cisco
assisted in the design of our network and has designated it as a Cisco Powered
Network.
We believe that controlling all elements of the network from the client's
Internet backbone provider or LAN enables us to deliver superior response time,
reliability and security for our clients. We can substantially reduce
implementation time because we implement our applications in a consistent and
pre-configured environment. Moreover, our clients do not need to mediate among
disparate vendors, because we take total responsibility for application support
and system performance and availability.
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We implement and manage applications that are developed by others. To
execute this strategy, we have established agreements with leading software
vendors in key application areas, including:
- BroadVision and Microsoft in e-commerce;
- Ariba in business to business electronic commerce;
- Siebel in sales force automation, customer service and enterprise
marketing;
- Lawson and PeopleSoft in human resources and financial management;
- Microsoft in enterprise messaging and collaboration;
- Niku in professional services automation; and
- Sagent in decision-making support.
Our IMAP clients sign contracts that provide for fixed monthly service fees,
typically for a three- to five-year term, in exchange for the service we
provide. Once a client signs an IMAP contract, we invest in the additional
hardware, software and implementation needed to deliver that client's service.
This requires a substantial investment in the early years to build our client
base. Since we own or provide most of the elements and operational support for a
client's implementation, we anticipate that we will experience a high level of
client retention, even at the end of the contract's term. We also expect to
benefit from rapidly growing recurring revenue, which we believe will generate
substantial positive cash flow in later years.
We introduced our IMAP services in late 1998. For the year ended
December 31, 1999, we generated $35.5 million in revenues, of which 61% was
derived from IMAP sales and the balance from traditional IT services. As of
December 31, 1999, we had 109 signed contracts with 88 clients for our IMAP
services. The total expected revenue from these contracts, assuming payment over
the full contract terms, exceeds $140 million.
MARKET TREND HIGHLIGHTS
We believe there are several key trends occurring in our marketplace that
create a substantial market opportunity for a single-source service solution
that combines implementation and operation of software, hardware, systems
integration and Internet-based communications for middle market businesses at a
competitive price.
INCREASING ACCEPTANCE OF THE APPLICATION SERVICE PROVIDER MODEL.
The Application Service Provider model is being increasingly validated by
the emergence of new entrants into this market. International Data Corporation
estimates that the market opportunity in the high-end Application Service
Provider market will reach $2 billion by 2003, representing a four-year compound
annual growth rate of 91%.
RAPID GROWTH OF E-COMMERCE AND INTERNET-BASED COMMUNICATIONS.
E-commerce is becoming a critical element of many businesses' strategies, as
companies increasingly demand that their vendors communicate ordering, invoicing
and payment transactions through Internet-enabled applications. International
Data Corporation estimates that commerce on the Internet will be more than $1
trillion by 2003, reflecting a four-year compound annual growth rate of 85%.
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COMPETITIVE NEED OF MIDDLE MARKET ENTERPRISES TO AUTOMATE KEY BUSINESS
PROCESSES.
Middle market enterprises increasingly face competitive demands to automate
business processes, but they frequently have not been able to afford the
functionality available to their larger competitors. Many businesses recognize
that they do not have an infrastructure sufficient to ensure reliable and
responsive deployment of mission-critical applications on the Internet, and so
they are increasingly turning to Application Service Providers for outsourced
solutions. Moreover, many middle market enterprises lack the staff to implement,
operate and maintain these complex applications.
AVAILABILITY OF INTERNET-ENABLED PACKAGED SOFTWARE APPLICATIONS.
The trend among packaged software providers to Internet enable their
software is continuing. This is particularly true for those applications with
distributed users such as e-commerce, enterprise resource planning applications
and sales force automation, where the increasing ubiquity of the Internet makes
it a cost-efficient mechanism for implementing distributed functions.
COMPETITIVE STRENGTHS
We have built and are capitalizing on a number of key strengths to develop a
leading market position as a facilities-based Application Service Provider.
These strengths include:
SPECIALIZED GLOBAL NETWORK ALREADY IN PLACE.
We have a highly reliable, redundant global network specifically designed to
support our IMAP solutions. Our network is designed to provide the fastest
possible response time, the highest level of security and 99.9% availability to
our clients.
FIRST MOVER ADVANTAGE.
We believe we have created a recognized brand name in the emerging
Application Service Provider market by establishing relationships with leading
software providers in key application areas and by promoting our superior levels
of client service. We believe this is a first mover advantage that should give
us leverage in attracting new customers and in building additional partnerships
with leading software application providers.
SINGLE POINT OF RESPONSIBILITY.
Our IMAP solutions enable clients to buy the functionality of leading
enterprise software applications as a service from a single service provider,
rather than as a collection of technologies from multiple vendors. We take full
responsibility for the deployment and maintenance of these IMAP best-of-breed
packaged software applications. This allows our clients to focus on their core
competencies without mediating among disparate vendors.
KEY ALLIANCES WITH LEADING APPLICATION PROVIDERS.
We have established relationships with vendors in key application areas.
These agreements provide us with a software portfolio that can meet a broad
range of clients' e-commerce, enterprise resource planning and communication
needs. Some of these agreements also provide USI with an advantageous market
position. For example, we are the exclusive Application Service Provider of
Siebel enterprise relationship management applications for direct customers of
SiebelNet, headquartered in North America.
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RECURRING REVENUE AND CLIENT RETENTION MODEL.
Our business model is designed to capture significant recurring revenue
because our clients sign contracts that provide for fixed monthly service fees,
generally over a three- to five-year term. Furthermore, our ongoing support of
our clients provides us the opportunity to identify and supply additional IMAP
solutions. We believe that the level of integration and complexity associated
with our service offerings will create a significant inducement for our clients
to remain with us after their contract terms expire.
EXPERIENCED MANAGEMENT.
We have assembled a highly qualified management team that has considerable
experience in the management and growth of Internet, software, hardware and
telecommunications businesses. We believe that our management's experience in
the development of similar systems and services will be of significant value in
ensuring the quality and success of the IMAP service offerings. Key members of
management have previously held senior operating and management positions with
ARINC, Booz Allen & Hamilton, Clarus, Data General, DIGEX, EDS, IBM, Silicon
Graphics, Sprint, Sun Microsystems and Sybase.
BUSINESS STRATEGY
The focus of our strategy is to deliver timely, reliable and secure IMAP
services to our clients. We believe that by doing so we will rapidly build our
client base and secure long-term relationships, especially with those clients in
the middle market. We intend to continue investing to maintain a value advantage
over our competitors and to capitalize on our first mover advantages, as
follows:
DEVELOP NEW BUSINESS.
We will continue to develop new business by soliciting potential clients
through joint marketing campaigns with our hardware, software and integration
partners, advertising in periodicals and newspapers, sponsoring seminars and
trade shows in selected markets and conducting targeted mass mailings of
marketing material.
CROSS-SELL PRODUCTS TO INCREASE PENETRATION OF ACCOUNTS.
We are able to provide a range of packaged software applications and complex
Web hosting services to our clients. We actively seek to increase our sales to
clients by cross-selling our products and services. Our aim is to increase our
implementation and provision of our clients' mission-critical business
processes.
EXPAND OUR PORTFOLIO OF IMAP SOLUTIONS.
We have entered into strategic partnerships with numerous application
software vendors. These vendors are offering or developing additional
applications in specific vertical market segments which we expect to deploy in
order to expand our portfolio of IMAP solutions.
ENHANCE THE CAPACITY AND FUNCTIONALITY OF OUR GLOBAL NETWORK.
We will continue to deploy enhanced value features into our network. In
addition, as we begin to address clients located in Europe and Asia, we will
expand our capacity in those regions. Today, we provide European and Asian
mirror sites to our clients from collocated EDCs in Amsterdam and Tokyo.
EMPHASIZE THE IMAP BRAND.
We have focused our sales and marketing efforts to distinguish IMAP as a
branded product offering focused on the middle market and selected divisions of
larger multi-national organizations. Our direct sales organization allows our
sales representatives to understand each client's specific business needs better
and provide the ongoing support that facilitates effective cross-selling.
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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary historical financial data for the period from our date of
inception, January 14, 1998, through December 31, 1998 and for the year ended
December 31, 1999, presented below was derived from our audited consolidated
financial statements. You should read this information in conjunction with the
sections of this prospectus entitled "Selected Historical Consolidated Financial
Data," "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and in conjunction with the historical consolidated financial
statements and Notes included in the back of this prospectus.
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FOR THE PERIOD
FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
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STATEMENT OF OPERATIONS DATA:
Revenue..................................................... $ 4,122 $ 35,513
Costs and expenses:
Direct cost of services................................... 3,425 23,570
Network and infrastructure costs.......................... 2,186 16,239
Selling, general and administrative....................... 25,240 63,998
Non-cash stock compensation expense....................... 231 10,351
Depreciation and amortization............................. 3,179 22,480
-------- ---------
Total costs and expenses.................................... 34,261 136,638
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Operating loss.............................................. (30,139) (101,125)
Interest (expense) income................................... (2,314) (2,193)
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Net loss.................................................... (32,453) (103,318)
Dividends accrued on Series A Convertible Preferred Stock
and Series B Convertible Redeemable Preferred Stock(a).... (1,503) (2,328)
Accretion of common stock subject to repurchase to fair
value..................................................... (3,904) (23,938)
Accretion of Series B Convertible Redeemable Preferred Stock
to fair value(a).......................................... (237) (99)
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Net loss attributable to common stockholders................ $(38,097) $(129,683)
======== =========
Basic and diluted loss per common share attributable to
common stockholders....................................... $ (27.09) $ (1.95)
======== =========
OTHER DATA:
Capital expenditures...................................... 20,128 79,858
EBITDA(b)................................................. (26,729) (65,533)
Cash used in operating activities......................... (21,184) (78,214)
Cash used in investing activities......................... (37,087) (121,721)
Cash provided by financing activities..................... 102,074 268,435
Ratio of earnings to fixed charges(c)..................... -- --
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The following table summarizes consolidated balance sheet data as of
December 31, 1999 and as adjusted to give effect to our sale of 3,000,000 shares
of common stock in an offering of our common stock consummated in February 2000,
including the receipt by us of approximately $119.0 million in net proceeds from
that offering.
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<CAPTION>
AS OF DECEMBER 31, 1999
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ACTUAL AS ADJUSTED
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(IN THOUSANDS)
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BALANCE SHEET DATA:
Cash and cash equivalents................................... $112,303 $231,323
Available-for-sale securities............................... 31,707 31,707
Working capital............................................. 117,167 236,187
Total assets................................................ 325,454 444,474
Current portion of long-term debt and capital lease
obligations............................................... 18,421 18,421
Short-term obligations expected to be refinanced............ 2,117 2,117
Long-term debt, capital lease obligations and convertible
subordinated notes, excluding current portion............. 168,671 168,671
Stockholders' equity........................................ 102,461 221,481
</TABLE>
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(a) Our Series A Convertible Preferred Stock and our Series B Convertible
Redeemable Preferred Stock all converted to common stock upon the
consummation of our initial public offering on April 14, 1999.
(b) EBITDA consists of earnings (loss) before net interest, income taxes,
depreciation and amortization, stock option compensation expense (a non-cash
charge) and amortization of deferred IMAP costs. EBITDA is presented to
clarify our operating results and it is not intended to represent cash flow
or results of operations in accordance with generally accepted accounting
principles. EBITDA is not calculated under generally accepted accounting
principles and is not necessarily comparable to similarly titled measures of
other companies. For a presentation of cash flows calculated under generally
accepted accounting principles, see our historical consolidated financial
statements contained in this prospectus.
(c) The ratio of earnings to fixed charges is computed by dividing net loss
before fixed charges by fixed charges. Fixed charges consist of interest
charges, and amortization of discount related to indebtedness and that
portion of rental expense we believe to be representative of interest.
Earnings were insufficient to cover fixed charges by $26.8 million for the
period from our date of inception, January 14, 1998, through December 31,
1998 and $89.6 million for the year ended December 31, 1999.
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RISK FACTORS
INVESTING IN THE NOTES OR OUR COMMON STOCK INVOLVES RISK. YOU SHOULD
CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. THESE RISKS AND UNCERTAINTIES ARE NOT THE ONLY ONES THAT WE
FACE OR THAT MAY ADVERSELY AFFECT OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS OR
UNCERTAINTIES ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF
OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. THIS PROSPECTUS ALSO CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER FROM THOSE DESCRIBED IN THE FORWARD-LOOKING STATEMENTS. THIS
COULD OCCUR BECAUSE OF THE RISKS DESCRIBED BELOW AND ELSEWHERE IN THIS
PROSPECTUS.
OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING
HISTORY.
We began operating in January 1998. Our limited operating history makes
predicting future results difficult. Since our inception, we have focused on
developing our business and only since September 1998 have we begun to contract
with customers for our IMAP offerings. Because of our limited operating history
and the emerging nature of our markets, our historical financial information is
of limited value in projecting our future results. Therefore, it is difficult to
evaluate our business and prospects.
THE SIGNIFICANT AMOUNT OF OUR INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL
HEALTH AND PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER THE NOTES.
The issuance of the Notes increased our indebtedness and, therefore, made us
highly leveraged. The following chart shows certain important as adjusted credit
statistics, including a recently completed offering of our common stock and
realized net proceeds of approximately $119.0 million as of the date specified
below and had applied the proceeds as intended.
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AS OF DECEMBER 31, 1999
AS ADJUSTED
-----------------------
(DOLLARS IN THOUSANDS)
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Total long term liabilities............................. $170,788
Stockholders' equity.................................... 221,481
Debt to equity ratio.................................... 0.77:1
</TABLE>
Earnings were insufficient to cover fixed charges by $26.8 million for the
period from our date of inception, January 14, 1998 through December 31, 1998
and $89.6 million for the year ended December 31, 1999.
Our leverage could have important consequences to you. For example, it
could:
- make it more difficult for us to satisfy our obligations with respect to
the Notes or our other indebtedness;
- increase our vulnerability to general adverse economic and industry
conditions;
- limit our ability to fund future working capital, capital expenditures,
acquisitions and other general corporate requirements;
- require us to dedicate a substantial portion of our cash flow from
operations to repaying indebtedness, thereby reducing the availability of
our cash flow to fund working capital, capital expenditures, acquisitions
and other general corporate purposes;
- limit our flexibility in planning for, or reacting to, changes in our
business and industry; and
- limit our ability to borrow additional funds.
Any additional borrowings would further increase the amount of our leverage
and the associated risks.
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THE NOTES ARE SUBORDINATED TO OUR OTHER INDEBTEDNESS.
The Notes are unsecured and subordinated in right of payment to all of our
existing and future Senior Indebtedness. As of December 31, 1999, we had
approximately $62.1 million of Senior Indebtedness outstanding. We are also
presently pursuing a variety of sources of other debt financing which, if
obtained, would constitute additional Senior Indebtedness. As a result of this
subordination, in the event of bankruptcy, liquidation or reorganization or
certain other events, our assets will be available to pay obligations on the
Notes only after all Senior Indebtedness has been paid in full, and we may not
have sufficient assets remaining to pay amounts on any or all of the Notes then
outstanding. In addition, the Notes will be effectively subordinated to all
existing and future indebtedness and other liabilities (including trade
payables) of our subsidiaries, including any subsidiaries which we may acquire
or establish in the future. As of December 31, 1999, our subsidiaries had no
outstanding indebtedness. Our right to receive assets of one of our subsidiaries
upon its liquidation or reorganization (and the consequent right of the holders
of the Notes to participate in those assets) would be effectively subordinated
to the claims of a subsidiary's creditors (including trade creditors), except to
the extent that we are recognized as a creditor of a subsidiary. In that case,
our claims would still be subordinate to any security interests in the assets of
the subsidiary.
THE NOTES ARE NOT PROTECTED BY RESTRICTIVE COVENANTS THAT LIMIT OUR BUSINESS
ACTIVITIES.
The Indenture governing the Notes does not contain any financial covenants
or restrictions on the payment of dividends, the incurrence of indebtedness,
including Senior Indebtedness, or the issuance or repurchase of securities by us
or any of our subsidiaries. The Indenture contains no covenants or other
provisions to afford protection to holders of the Notes in the event of a highly
leveraged transaction or a change in control of the Company except to the extent
described under "Description of Notes--Purchase of Notes at the Option of
Holders Upon a Change in Control."
WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH TO SERVICE OUR INDEBTEDNESS.
Our ability to make payments on our indebtedness, including the Notes, and
to fund planned capital expenditures, development and operating costs will
depend on our ability to generate cash in the future through sales of our
services. We cannot assure you that our available liquidity will be sufficient
to service our indebtedness, including the Notes, or to fund our other cash
needs. We may need to refinance all or a portion of our indebtedness, including
the Notes, on or before maturity, but we may not be able to do so on
commercially reasonable terms, or at all. Without sufficient funds to service
our indebtedness, we would have serious liquidity constraints and would need to
seek additional financing from other sources, but we may not be able to do so on
commercially reasonable terms, or at all.
WE EXPECT TO CONTINUE TO INCUR LOSSES AND EXPERIENCE NEGATIVE CASH FLOW.
We expect to have significant operating losses and to record significant net
cash outflow before financing in the near term. Our business has not generated
sufficient cash flow to fund our operations without resorting to external
sources of capital. Starting up our company and building our network required
substantial capital and other expenditures. As a result, we reported a net loss
of $103.3 million for the year ended 1999 and EBITDA of negative $65.5 million
for the same period. Further developing our business and expanding our network
will require significant additional capital and other expenditures.
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WE MAY NEED ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH,
AND WE MAY NOT BE ABLE TO OBTAIN IT ON TERMS ACCEPTABLE TO US OR AT ALL.
We believe that the net proceeds from the sale of the Notes, together with
cash on hand and our existing and anticipated debt and capital lease financing,
will be sufficient to fund our operations for at least the next twelve months.
However, if we expand more rapidly than currently anticipated, if our working
capital needs exceed our current expectations or if we make acquisitions, we
will need to raise additional capital from equity or debt sources. If we cannot
obtain financing on terms acceptable to us or at all, we may be forced to
curtail our planned business expansion and may be unable to fund our ongoing
operations.
OUR HISTORICAL REVENUES WERE DERIVED FROM SERVICES THAT WE DO NOT EXPECT TO BE
THE FOCUS OF OUR BUSINESS IN THE FUTURE.
We derive a portion of our revenue from professional services. We acquired
two professional services businesses in the fall of 1998 and their services are
substantively different than our IMAP offerings. As a result, historical
financial information of the acquired businesses does not reflect the results we
expect from our core business offering in the future.
OUR SUCCESS DEPENDS ON THE ACCEPTANCE AND INCREASED USE OF INTERNET-BASED
BUSINESS SOFTWARE SOLUTIONS, AND WE CANNOT BE SURE THAT THIS WILL HAPPEN.
Our business model depends on the adoption of Internet-based business
software solutions by commercial users. Our business could suffer dramatically
if Internet-based solutions are not accepted or not perceived to be effective.
The market for Internet services, private network management solutions and
widely distributed Internet-enabled packaged application software has only
recently begun to develop and is now evolving rapidly.
The growth of Internet-based business software solutions could also be
limited by:
- concerns over transaction security and user privacy;
- inadequate network infrastructure for the entire Internet; and
- inconsistent performance of the Internet.
We cannot be certain that this market will continue to grow or to grow at
the rate we anticipate.
THE GROWTH IN DEMAND FOR OUTSOURCED BUSINESS SOFTWARE APPLICATIONS BY MIDDLE
MARKET COMPANIES IS HIGHLY UNCERTAIN.
Growth in demand for and acceptance of outsourced business software
applications, including our IMAP offerings, by middle market companies is highly
uncertain. We believe that many of our potential customers are not fully aware
of the benefits of outsourced solutions. It is possible that these solutions may
never achieve market acceptance. If the market for our products does not grow or
grows more slowly than we currently anticipate, our business, financial
condition and operating results would be materially adversely affected.
OUR BUSINESS STRATEGY MAY NOT EFFECTIVELY ADDRESS OUR MARKET AND WE MAY NEVER
REALIZE A RETURN ON THE RESOURCES WE HAVE INVESTED TO EXECUTE OUR STRATEGY.
We have made substantial investments to pursue our strategy. These
investments include:
- building a global network of data centers;
- allying with particular software providers;
- expanding our work force;
- investing to develop unique service offerings; and
- developing implementation resources around specific applications.
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<PAGE>
These investments may not be successful. More cost effective strategies may
be available to compete in this market. We may have chosen to focus on the wrong
application areas or to work with the wrong partners. Potential customers may
not value the specific product features in which we have invested. There is no
assurance that our strategy will prove successful.
THE MARKETS WE SERVE ARE HIGHLY COMPETITIVE AND MANY OF OUR COMPETITORS HAVE
MUCH GREATER RESOURCES.
Our current and potential competitors include Application Service Providers
and companies focused on the application hosting business, such as Aristasoft,
Breakaway Solutions, Corio, FutureLink, Interliant, Interpath, NaviSite and
Telecomputing; Web hosting companies, such as Concentric, Digex and Exodus;
enterprise applications vendors, such as Oracle, Siebel and SAP; business
Internet Service Providers, such as MCI WorldCom, PSINet and Verio;
telecommunications companies, such as AT&T, GTE and Qwest (which has agreed to
acquire our customer and significant stockholder, U S WEST); and systems
integrators, such as Andersen Consulting, EDS, IBM and KPMG. Our strategic
partners and suppliers could also become competitors either directly or through
strategic relationships with some of our other competitors. These relationships
may take the form of strategic investments or marketing or other contractual
arrangements.
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.
We cannot be sure that we will have the resources or expertise to compete
successfully in the future. Our competitors may be able to:
- more quickly develop and expand their network infrastructures and service
offerings;
- better adapt to new or emerging technologies and changing customer needs;
- take advantage of acquisitions and other opportunities more readily;
- negotiate more favorable licensing agreements with software application
vendors;
- devote greater resources to the marketing and sale of their products; and
- adopt more aggressive pricing policies.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs. We cannot be sure that we will be
able to match cost reductions by our competitors. In addition, we believe that
there is likely to be consolidation in our markets. Consolidation could increase
price competition and other competitive forces in ways that materially adversely
affect our business, results of operations and financial condition. Finally,
there are few substantial barriers to entry, and we have no patented technology
that would bar competitors from our market.
OTHERS MAY SEIZE THE MARKET OPPORTUNITY WE HAVE IDENTIFIED BECAUSE WE MAY NOT
EFFECTIVELY EXECUTE OUR STRATEGY.
If we fail to execute our strategy in a timely or effective manner, our
competitors may be able to seize the marketing opportunities we have identified.
Our business strategy is complex and requires that we successfully and
simultaneously complete many tasks. In order to be successful, we will need to:
- build and operate a highly reliable, complex global network;
- negotiate effective partnerships and develop economically attractive
service offerings;
- attract and retain IMAP customers;
- attract and retain highly skilled employees;
- integrate acquired companies into our operations;
- evolve our business to gain advantages in an increasingly competitive
environment; and
- expand our international operations.
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<PAGE>
In addition, although most of our management team has worked together for
approximately one year, there can be no assurance that we will be able to
successfully execute all elements of our strategy.
WE PLAN TO EXPAND VERY RAPIDLY, AND MANAGING OUR GROWTH MAY BE DIFFICULT.
We have rapidly expanded our operations since USI was founded in
January 1998. We expect our business to continue to grow both geographically and
in terms of the number of products and services we offer. We cannot be sure that
we will successfully manage our growth. In order to successfully manage our
growth we must:
- enlarge our network and infrastructure;
- improve our management, financial and information systems and controls;
and
- expand, train and manage our employee base effectively.
There will be additional demands on our customer service support and sales,
marketing and administrative resources as we increase our service offerings and
expand our target markets. The strains imposed by these demands are magnified by
the relatively early stage of our operations. If we cannot manage our growth
effectively, our business, financial condition or results of operations could be
adversely affected.
OUR GROWTH COULD BE LIMITED IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.
We believe that our short- and long-term success depends largely on our
ability to attract and retain highly skilled technical, managerial and marketing
personnel. We particularly require additional management personnel in the areas
of application integration and technical support. Individuals with information
technology skills are in short supply and competition for application
integration personnel is particularly intense. We may not be able to hire the
necessary personnel to implement our business strategy, or we may need to pay
higher compensation for employees than we currently expect. We cannot be sure
that we will succeed in attracting and retaining the personnel we need to
continue to grow.
WE DEPEND ON A LIMITED NUMBER OF KEY PERSONNEL WHO WOULD BE DIFFICULT TO
REPLACE.
Our success also depends in significant part on the continued services of
our key technical, sales and senior management personnel. Losing one or more of
our key employees could have a material adverse effect on our business, results
of operations and financial condition. We have employment agreements with most
of our vice presidents and other key employees, including Christopher R.
McCleary, Stephen E. McManus, Jeffery L. McKnight, Andrew A. Stern, Harold C.
Teubner, Jr. and Gary J. Rogers.
WE MAY NOT BE ABLE TO DELIVER OUR IMAP SERVICES IF THIRD PARTIES DO NOT PROVIDE
US WITH KEY COMPONENTS OF OUR INFRASTRUCTURE.
We depend on other companies to supply key components of our
telecommunications infrastructure and systems and network management solutions.
Any failure to obtain needed products or services in a timely fashion and at an
acceptable cost could have a material adverse effect on our business, results of
operations and financial condition. Although we lease redundant capacity from
multiple suppliers, a disruption in telecommunications capacity could prevent us
from maintaining our standard of service. Some of the key components of our
system and network are available only from sole or limited sources in the
quantities and quality we demand. For example, the hardware we use to support
our real-time mirroring and disaster recovery functions is supplied only by EMC
Corporation. We buy these components from time to time, do not carry significant
inventories of them and have no guaranteed supply arrangements with our vendors.
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OUR ABILITY TO PROVIDE OUR IMAP SERVICES DEPENDS ON STRATEGIC RELATIONSHIPS WITH
SOFTWARE VENDORS THAT WE MAY NOT BE ABLE TO MAINTAIN.
Our IMAP offerings are central to our business strategy. We obtain software
products under license agreements with BroadVision, Ariba, Siebel, PeopleSoft,
Lawson, Microsoft, Niku and Sagent and package them as part of our IMAP
solutions. The agreements are for terms ranging from one to three years. All the
agreements may be terminated upon a breach of the agreement, subject to cure
periods. The agreement with PeopleSoft may be terminated by either party for
convenience upon 90 days notice after an annual review, scheduled to first occur
on or about June 22, 2000. Under an earlier version of our contract, PeopleSoft
on one occasion notified us of its intention to terminate the agreement. After
significant discussion, the issues in dispute were resolved, our agreement with
PeopleSoft was renegotiated and PeopleSoft retracted its notification of its
intent to terminate the agreement. However, we cannot be sure that one or more
of our agreements with software vendors will not be terminated in the future. If
these agreements were to be terminated or not renewed or we otherwise could not
continue to use this software, we might have to discontinue products or services
or delay or reduce their introduction unless we could find, license and package
equivalent technology.
All but one of our agreements with software vendors are non-exclusive. Our
agreement with SiebelNet, Inc., a wholly owned subsidiary of Siebel
Systems, Inc., gives us exclusivity as the Application Service Provider of
Siebel enterprise relationship management applications for direct customers of
SiebelNet headquartered in North America. Our vendors may choose to compete with
us directly or to enter into strategic relationships with our competitors. These
relationships may take the form of strategic investments or marketing or other
contractual arrangements. 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 our vendors will not have a material adverse effect
upon the technologies incorporated in our products, or that, if these
technologies become unavailable, we will be able to find suitable alternatives.
TECHNOLOGY MAY CHANGE FASTER THAN WE CAN UPDATE OUR NETWORK AND TECHNOLOGY.
The markets we serve are characterized by rapidly changing technology,
evolving industry standards, emerging competition and the frequent introduction
of new services, software and other products. Our success depends partly on our
ability to enhance existing or develop new products, software and services that
meet changing customer needs in a timely and cost-effective way. We cannot be
sure, however, that we will do some or all of these things. For example, if
software application architecture changes in significant ways, the software for
which we have licenses could become obsolete, we may be forced to update our
hardware and network configurations or we may be forced to replace our mirroring
technology. This may require substantial time and expense, and even then we
cannot be sure that we will succeed in adapting our businesses to these and
other technological developments.
WE COULD BE HARMED IF OUR SYSTEMS ARE NOT COMPATIBLE WITH OTHER PRODUCTS AND
SERVICES.
We believe that our ability to compete successfully also depends on the
continued compatibility of our services with products, services and
architectures offered by various vendors. Our failure to conform to a prevailing
standard, or the failure of a common standard to emerge, could have a material
adverse effect on our business, results of operations and financial condition.
Although we will work with vendors to test new products, we cannot be sure that
their products will be compatible with ours or that they will adequately address
changing customer needs. Although we currently plan to support emerging
standards, we cannot be sure what new industry standards will develop. We also
cannot be sure that we will be able to conform to these new standards quickly
enough to stay
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<PAGE>
competitive. In addition, we cannot be sure that products, services or
technologies developed by others will not make ours noncompetitive or obsolete.
THE LOSS OF A KEY CUSTOMER COULD DECREASE OUR REVENUES.
During the year ended December 31, 1999, sales to SiebelNet accounted for
approximately 16% of our revenues. We expect sales to SiebelNet to continue to
constitute a significant portion of our revenues in the near term. During that
period, if our sales to SiebelNet decrease, our business will suffer.
IF WE CANNOT OBTAIN ADDITIONAL APPLICATION SOFTWARE WE WILL BE UNABLE TO EXPAND
OR ENHANCE OUR IMAP SERVICE OFFERINGS.
Our business strategy also depends on obtaining additional application
software. We cannot be sure, however, that we will be able to obtain the new or
enhanced applications we may need to keep our IMAP solutions competitive. If we
cannot obtain these applications and as a result must discontinue, delay or
reduce the availability of our IMAP solutions or other products or services, our
business, results of operations and financial condition may be materially
adversely affected.
DEVELOPING AND EXPANDING OUR OPERATIONS WILL DEPEND, AMONG OTHER THINGS, ON OUR
MANAGEMENT'S ABILITY TO SUCCESSFULLY INTEGRATE NEWLY ACQUIRED OPERATIONS.
In October 1999, we acquired Conklin & Conklin, Inc. We cannot be sure that
we will be able to continue to successfully integrate the business of Conklin
into our own, or that the Conklin business will perform as expected. In
addition, we cannot be sure that we will be able to successfully integrate any
business acquired in the future into our own. Our failure to successfully
integrate an acquired company or its subsequent underperformance could have a
material adverse effect on our business, results of operations and financial
condition.
WE MAY UNDERTAKE ADDITIONAL ACQUISITIONS WHICH POSE RISKS TO OUR BUSINESS.
From time to time, we may undertake additional acquisitions. If we do, our
risks may increase because:
- we may pay more for the acquired company than the value we realize from
the acquisition;
- we may not fully understand the business we acquire;
- we may be entering markets in which we have little or no direct prior
experience;
- our ongoing business may be disrupted and resources and management time
diverted; and
- our accounting for acquisitions could require us to amortize substantial
goodwill, adversely affecting our reported results of operations.
In addition, once we have made an acquisition we will face additional risks:
- it may be difficult to assimilate acquired operations and personnel;
- we may not be able to retain the management and other key personnel of the
acquired business;
- we may not be able to maintain uniform standards, controls, procedures and
policies; and
- changing management may impair relationships with an acquired business's
employees or customers.
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<PAGE>
WE MAY MAKE INVESTMENTS IN ENTITIES THAT WE DO NOT CONTROL.
In the future, we may make investments in joint ventures or other entities
over which we do not exercise control. We may make these investments in
connection with entering into strategic partnerships with software vendors,
systems integrators or Internet Service Providers or as strategic investments.
Our inability to control the entity in which we may invest may have consequences
on our ability to receive distributions from such entity or to implement our
business plan. Debt agreements, if entered into by a non-control entity, may
restrict or prohibit such entity from paying distributions to us. Applicable
state or local law may also limit the amount that a non-control entity is
permitted to pay a distribution on its equity interest, and we may not be able
to influence the payment of dividends. If any of the other investors in a
non-control entity fail to observe their commitments, that entity may not be
able to operate according to its business plans or we may be required to
increase our level of commitment to give effect to the plan. In addition, our
ability to implement a business plan for a non-control entity may be limited or
non-existent.
BECAUSE WE HAVE INTERNATIONAL OPERATIONS, WE FACE ADDITIONAL RISKS RELATED TO
FOREIGN POLITICAL AND ECONOMIC CONDITIONS.
We have established EDCs in Europe and Japan. We intend to expand further
into international markets. We cannot be sure that we will be able to obtain the
necessary telecommunications infrastructure in a cost-effective manner or
compete effectively in international markets. In addition, there are risks
inherent in conducting business internationally. These include:
- unexpected changes in regulatory requirements;
- export restrictions;
- tariffs and other trade barriers;
- challenges in staffing and managing foreign operations;
- differing technology standards;
- employment laws and practices in foreign countries;
- political instability;
- fluctuations in currency exchange rates;
- imposition of currency exchange controls; and
- potentially adverse tax consequences.
Any of these could adversely affect our international operations. We cannot
be sure that one or more of these factors will not have a material adverse
effect on our current or future international operations and, consequently, on
our business, results of operations and financial condition.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD ADD ADDITIONAL COSTS TO
DOING BUSINESS ON THE INTERNET AND COULD LIMIT OUR CLIENTS' USE OF THE
INTERNET.
Laws and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The adoption or modification of laws
or regulations relating to the Internet could adversely affect our business. In
recent sessions, the United States Congress has enacted Internet laws regarding
children's privacy, copyrights, taxation and the transmission of sexually
explicit material and other similar proposals are continuously being considered.
The European Union recently enacted its own privacy regulations. The law of the
Internet, however, remains largely unsettled, even in areas where there has been
some legislative action. It may take years to determine whether and how existing
laws such as those governing intellectual property, privacy, libel and taxation
apply to the Internet. In
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<PAGE>
addition, the growth and development of the market for online commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad, that may impose additional burdens on companies conducting
business online. For example, Germany and the European Union have enforced laws
and regulations on content distributed over the Internet that are more strict
than those currently in place in the United States.
THE OUTCOME OF PROPOSALS PUT TO A VOTE OF STOCKHOLDERS WILL BE DETERMINED BY OUR
EXISTING PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS.
Our executive officers, directors, existing 5% or greater stockholders and
their affiliates, in the aggregate, own shares representing approximately 57.0%
of our outstanding voting capital stock. As a result, these persons, acting
together, are able to control all matters submitted to our stockholders for
approval and to control our management and affairs. For example, these people,
acting together, control the election and removal of directors and any merger,
consolidation or sale of all or substantially all of our assets.
WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO FINANCE THE CHANGE
IN CONTROL OFFER REQUIRED BY THE INDENTURE.
Upon the occurrence of change in control events, holders of the Notes will
have the right to require us to purchase their Notes at a price equal to 100% of
the principal amount, plus accrued interest. Our ability to repurchase the Notes
upon a change in control event will be limited by the terms of our other debt
agreements. Upon such a change of control event, we may also be required
immediately to repay the outstanding principal and other amounts owed by us
under our other financing agreements.
We may not be able to repay amounts outstanding under our other financing
agreements or obtain necessary consents, if any, to repurchase the Notes. Any
requirement to offer to purchase the Notes may result in our having to refinance
our outstanding indebtedness, which we may not be able to do. In addition, even
if we were able to refinance that debt, the financing may be on unfavorable
terms. If we are not able to make the required repurchases, we would be in
default under the Indenture. See "Description of the Notes--Repurchase of Notes
at the Option of Holders Upon a Change in Control."
WE CANNOT ASSURE YOU THAT AN ACTIVE TRADING MARKET WILL DEVELOP FOR THE NOTES.
The Notes were originally issued on October 29, 1999. Since that time, the
initial purchasers have engaged in market-making activities with respect to the
Notes. However, the initial purchasers may cease their market-making at any
time. In addition, the liquidity of the trading market in the Notes, and the
market price quoted for the Notes, may be adversely affected by changes in the
overall market for high yield securities and by changes in our financial
performance or prospects or in the prospects for companies in our industry
generally. As a result, you cannot be sure that an active trading market will
develop for the Notes.
THE TRADING PRICE OF OUR SECURITIES COULD BE SUBJECT TO SIGNIFICANT
FLUCTUATIONS.
The trading price of our common stock has been volatile, and the trading
price for the Notes also may be volatile. Factors such as announcements of
fluctuations in our or our competitors' operating results and market conditions
for Internet related and other technology stocks in general could have a
significant impact on the future trading prices of our common stock and the
Notes. In particular, the trading price of the common stock of many Internet
related and other technology companies has experienced extreme price and volume
fluctuations, which have at times been unrelated to the operating performance of
such companies whose stocks were affected. In addition, the trading prices of
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<PAGE>
our common stock and the Notes could be subject to significant fluctuations in
response to variations in our prospects and operating results, which may in turn
be affected by changes in interest rates and other factors. There can be no
assurance that these factors will not have an adverse effect on the trading
prices of our common stock and the Notes.
THE MARKET PRICE OF OUR COMMON STOCK COULD BE AFFECTED BY THE SUBSTANTIAL NUMBER
OF SHARES THAT ARE ELIGIBLE FOR FUTURE SALE.
As of March 2, 2000, we had on a pre-split basis 64,080,294 shares of common
stock issued and outstanding, excluding 838,473 shares issuable upon the
exercise of warrants, 12,552,678 shares issuable upon the exercise of options
granted under our 1998 Stock Option Plan and 5,030,181 shares issuable upon
conversion of the Notes. We cannot predict the effect, if any, that future sales
of the Notes or shares of common stock, including common stock issuable upon
conversion of the Notes, or the availability of the Notes or shares of common
stock for future sale, will have on the market price of common stock prevailing
from time to time.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US, EVEN WITHOUT MERIT, COULD
COST A SIGNIFICANT AMOUNT OF MONEY TO DEFEND AND DIVERT MANAGEMENT'S ATTENTION
AWAY FROM OUR BUSINESS.
As the number of software products in our target markets increases and the
functionality of these products further overlap, software industry participants
may become increasingly subject to infringement claims. Someone may even claim
that our technology infringes their proprietary rights. Any infringement claims,
even if without merit, can be time consuming and expensive to defend. They may
divert management's attention and resources and could cause service
implementation delays. They also could require us to enter into costly royalty
or licensing agreements. If successful, a claim of product infringement against
us and our inability to license the infringed or similar technology could
adversely affect our business.
WE COULD BE REQUIRED TO USE OUR FINANCIAL RESOURCES TO REPURCHASE SHARES OF
COMMON STOCK FROM U S WEST.
We could be required to repurchase for cash some of the shares of our
capital stock owned by U S WEST. This would require us to divert our resources
at a time of rapid growth. If we engage in activities in which U S WEST would be
prohibited from engaging and we were considered an affiliate of U S WEST under
regulations of the Federal Communications Commission, U S WEST could force us to
repurchase the number of shares required to make us no longer an affiliate. We
are not presently considered an affiliate of U S WEST under these regulations.
See "Certain Relationships and Related Transactions--Purchases of Series A
Preferred Stock." Although we believe the possibility of this occurring is
remote, repurchasing the shares held by U S WEST could be costly.
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROSPECTUS ARE SUBJECT TO RISKS AND
UNCERTAINTIES.
This prospectus includes forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These statements relate
to, among other things, analyses and other information that are based on
forecasts of future results and estimates of amounts not yet determinable. These
statements also relate to our future prospects, developments and business
strategies.
These forward-looking statements are identified by their use of terms and
phrases such as "anticipate," "believe," "could," "estimate," "expect,"
"intend," "may," "plan," "predict," "project," "will" or the negative of those
or other variations, or comparable expressions, including references to
assumptions. These statements are contained in sections entitled "Prospectus
Summary," "Risk
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Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and other sections of this prospectus.
The forward-looking statements in this prospectus, including statements
concerning projections of our future results, operating profits and earnings,
are based on current expectations and are subject to risks and uncertainties
that could cause actual results to differ materially from those expressed or
implied by those statements. The risks and uncertainties include but are not
limited to our continued ability to:
- build and operate a highly reliable, complex global network;
- establish and maintain relationships with key software vendors and develop
economically attractive products;
- attract and retain IMAP customers;
- attract and retain highly skilled employees;
- effectively manage our rapid growth; and
- evolve our business to gain advantages in an increasingly competitive
environment.
Our risks are more specifically described in "Risk Factors." If one or more
of these risks or uncertainties materializes, or if underlying assumptions prove
incorrect, our actual results may vary materially from those expected, estimated
or projected. Given these uncertainties, you should not place undue reliance on
forward-looking statements.
We undertake no obligation to update forward-looking statements or risk
factors other than as required by applicable law, whether as a result of new
information, future events or otherwise.
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USE OF PROCEEDS
We will not receive any proceeds from the sale of the Notes by the selling
security holders, the issuance of the common stock issuable to the holders of
the Notes upon conversion of the Notes or the sale of any common stock under
this Prospectus.
COMMON STOCK PRICE RANGE
Our common stock has been traded on The Nasdaq National Market under the
symbol "USIX" since the completion of our initial public offering in
April 1999. All sales prices below have been adjusted to reflect our
three-for-two stock split effected by means of a stock dividend distributed on
December 17, 1999. The prices set forth in the table below under the heading
"Post-Split" reflect an additional three-for-two stock split to be effected by
means of a stock dividend to all shareholders of record at the close of business
on March 14, 2000. This stock dividend will be distributed on or about
March 28, 2000.
The folowing table sets forth, for the periods indicated, the high and low
prices of our common stock on The Nasdaq National Market for the second, third
and fourth quarters of 1999 and the first quarter of 2000 from the commencement
of trading on April 9, 1999 through March 6, 2000.
<TABLE>
<CAPTION>
PRE-SPLIT POST-SPLIT
------------------- -------------------
HIGH LOW HIGH LOW
-------- -------- -------- --------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1999:
Second Quarter (from April 9, 1999)..................... $40.00 $15.33 $26.67 $10.22
Third Quarter........................................... 27.96 9.54 18.64 6.36
Fourth Quarter.......................................... 69.88 16.92 46.59 11.28
YEAR ENDING DECEMBER 31, 2000:
First Quarter (through March 6, 2000)................... $85.31 $43.00 $56.88 $28.67
</TABLE>
The last sale price of the common stock on The Nasdaq National Market on
March 6, 2000 was $85.31.
DIVIDEND POLICY
We have never paid cash dividends on our common stock and have no plans to
do so in the forseeable future. The declaration and payment of any dividends in
the future will be determined by the board of directors and will depend on a
number of factors, including our earnings, capital requirements and overall
financial condition. The payment of dividends is also restricted by the terms of
our indebtedness.
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CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999.
We have presented our capitalization after giving effect to the three-for-two
stock split to be effected by means of a stock dividend that will be distributed
to stockholders on or about March 28, 2000:
- on an actual basis;
- on an adjusted basis to reflect the sale of the common stock in the
February offering and our receipt of the net proceeds of approximately
$119.0 million from the February offering.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
--------------------------
AS
ACTUAL ADJUSTED
------------ -----------
(IN THOUSANDS, EXCEPT FOR
SHARE AMOUNTS)
<S> <C> <C>
Cash, cash equivalents and available-for-sale securities.... $ 144,010 $263,030
Long-term liabilities:
Short-term obligations expected to be refinanced.......... 2,117 2,117
Long-term debt, excluding current portion................. 32,286 32,286
Capital lease obligations, excluding current portion...... 11,385 11,385
Convertible subordinated notes due 2004................... 125,000 125,000
--------- --------
Total long-term liabilities............................. 170,788 170,788
Stockholders' equity:
Common stock, $.001 par value; 75,000,000 shares
authorized; 92,065,911 shares issued and outstanding
actual and 94,065,911 shares issued and outstanding as
adjusted(a)............................................. 92 94
Additional paid-in capital................................ 241,861 360,879
Note receivable from officer for purchase of common
stock................................................... (2,250) (2,250)
Unearned compensation..................................... (1,782) (1,782)
Accumulated deficit....................................... (135,771) (135,771)
Accumulated other comprehensive income.................... 311 311
--------- --------
Total stockholders' equity.............................. 102,461 221,481
--------- --------
Total capitalization.................................. $ 273,249 $392,269
========= ========
</TABLE>
The share numbers in the table exclude:
- 18,829,017 shares of common stock issuable upon exercise of stock options
outstanding as of December 31, 1999 at a weighted-average exercise price
of $6.77;
- 1,257,709 shares of common stock reserved for issuance upon exercise of
warrants exercisable as of December 31, 1999 at a weighted-average
exercise price of $1.52; and
- 7,545,272 shares of common stock issuable upon conversion of the Notes at
a conversion price of $16.57 per share.
Please read this capitalization table together with the sections of this
prospectus entitled "Use of Proceeds," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and the financial statements of
USI and IIT included in this Prospectus.
- ------------------------
(a) Our authorized shares were increased to 450,000,000 on January 14, 2000.
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table summarizes:
- our historical consolidated financial data for the period from our date of
inception, January 14, 1998, through December 31, 1998 and as of December
31, 1998;
- our historical consolidated financial data for the year ended December 31,
1999 and as of December 31, 1999.
The selected financial data have been derived from, and is qualified by
reference to, our audited consolidated financial statements for the periods
presented. Our audited consolidated financial statements for the period from our
inception through December 31, 1998 include the results of I.I.T.
Holding, Inc., or IIT, from September 8, 1998 through December 31, 1998 and the
results of Advanced Communication Resources, Inc., or ACR, from October 2, 1998
through December 31, 1998. Our audited consolidated financial statements for the
year ended December 31, 1999 include the results of Conklin & Conklin, Inc. from
October 8, 1999 through December 31, 1999.
You should also read "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the financial statements and related
notes of USI and IIT included in this prospectus.
In the table below:
- the per share data reflect a three-for-two stock split to be effected by
means of a stock dividend to be distributed on or about March 28, 2000;
- the Series B preferred stock is not presented as a part of our
stockholders' equity in 1998 because it was mandatorily redeemable upon
the eighth anniversary of its issuance (the Series B was converted into
common stock upon the closing of our initial public offering); and
- we do not present shares of common stock held by three officers as part of
our stockholders' equity in 1998 because we would have been obligated to
repurchase these shares at fair market value if any of these officers had
died or had become disabled before our initial public offering. See Note
12 of the Notes to USI's Consolidated Financial Statements. These
provisions terminated upon the consummation of our initial public
offering.
22
<PAGE>
USINTERNETWORKING, INC.
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 14, 1998 YEAR
(DATE OF INCEPTION) ENDED
THROUGH DECEMBER 31, 1998 DECEMBER 31, 1999
------------------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................................... $ 4,122 $ 35,513
Costs and expenses:
Direct cost of services............................. 3,425 23,570
Network and infrastructure costs.................... 2,186 16,239
Selling, general and administrative................. 25,240 63,998
Non-cash stock compensation expense................. 231 10,351
Depreciation and amortization....................... 3,179 22,480
-------- ---------
Total costs and expenses............................ 34,261 136,638
-------- ---------
Operating loss........................................ (30,139) (101,125)
Other income (expense):
Interest income..................................... 367 4,114
Interest expense.................................... (2,681) (6,307)
-------- ---------
Net loss.............................................. $(32,453) $(103,318)
======== =========
Basic and diluted loss per common
share attributable to common stockholders........... $ (27.09) $ (1.95)
======== =========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 43,802 $112,303
Available-for-sale securities............................... -- 31,707
Working capital............................................. 22,551 117,167
Total assets................................................ 106,516 325,454
Current portion of long-term debt and capital lease
obligations............................................... 3,262 18,421
Short-term obligations expected to be refinanced............ 5,282 2,117
Long-term debt, capital lease obligations, and convertible
subordinated notes, excluding current portion............. 8,659 168,671
Series B Convertible Redeemable Preferred Stock............. 62,242 --
Common stock subject to repurchase.......................... 4,145 --
Stockholders' (deficit) equity.............................. (2,467) 102,461
</TABLE>
23
<PAGE>
On September 8, 1998, we acquired I.I.T. Holding, Inc. and its two
wholly-owned subsidiaries, International Information Technology Inc., a U.S.
subsidiary, and International Information Technology IIT, C.A., a Venezuelan
subsidiary. We refer to these businesses collectively as IIT. IIT's operations
commenced on May 20, 1994 upon the incorporation of the U.S. subsidiary. The
Venezuelan subsidiary was formed on March 6, 1996. For accounting purposes, IIT
is the predecessor of USI, which was incorporated in January 1998.
The following table summarizes:
- the historical consolidated financial data of IIT for the fiscal years
ended December 31, 1995, 1996 and 1997 and as of December 31, 1995, 1996
and 1997; and
- the historical consolidated operating statement data of IIT for the eight
month period ended August 31, 1997; and
- the historical consolidated operating statement data of IIT for the period
from January 1, 1998 through September 7, 1998.
The financial statement data for periods prior to 1996 and eight months
ended August 31, 1997 have been derived from the unaudited financial statements
of IIT. The selected financial data as of December 31, 1996 and 1997 and for the
years then ended and the selected financial data for the period from January 1,
1998 through September 7, 1998, has been derived from, and is qualified by
reference to, the audited consolidated financial statements of IIT included
elsewhere in this prospectus. You should also read "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the financial
statements and related notes of USI and IIT included in this prospectus.
24
<PAGE>
PREDECESSOR--IIT HOLDING, INC.
<TABLE>
PERIOD
FROM
EIGHT JANUARY 1,
MONTHS 1998
YEAR ENDED DECEMBER 31, ENDED TO
-------------------------------- AUGUST 31, SEPTEMBER
1995 1996 1997 1997 7, 1998
-------- -------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE
<S> <C> <C> <C> <C> <C>
DATA)
STATEMENT OF OPERATION DATA:
Revenue...................................... $ 801 $ 747 $ 2,812 $ 1,499 $ 4,406
------- ------- ---------- ---------- ----------
Costs and expenses
Cost of revenue............................ 613 519 1,881 1,112 2,976
Selling, general and administrative
expenses................................. 77 204 1,844 1,260 1,809
Depreciation and amortization.............. 7 14 30 15 28
------- ------- ---------- ---------- ----------
Total costs and expenses................. 697 737 3,755 2,387 4,813
------- ------- ---------- ---------- ----------
Operating (loss) income...................... 104 10 (943) (888) (407)
Interest expense............................. (5) (3) (9) (1) (17)
------- ------- ---------- ---------- ----------
Income (loss) before income taxes............ 99 7 (952) (889) (424)
Provision (benefit) for income taxes......... 28 15 (58) (58) --
Net income (loss)............................ $ 71 $ (8) $ (894) $ (831) $ (424)
======= ======= ========== ========== ==========
Basic and diluted income (loss) per common
share attributable to common
stockholders............................... $747.37 $(84.21) $(9,410.53) $(8,747.37) $(4,464.37)
======= ======= ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ -- $ 70 $ 14
Working capital............................................. 70 14 42
Total assets................................................ 147 348 769
Long-term debt and capital lease obligations, excluding
current position.......................................... 47 11 16
Stockholder's equity........................................ 66 45 132
</TABLE>
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ TOGETHER WITH THE
FINANCIAL STATEMENTS AND RELATED NOTES OF USI AND IIT INCLUDED IN THIS
PROSPECTUS. THE DISCUSSION IN THIS PROSPECTUS CONTAINS FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF OUR
PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE CAUTIONARY STATEMENTS MADE
IN THIS PROSPECTUS APPLY TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY
APPEAR IN THIS PROSPECTUS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO DIFFERENCES INCLUDE THOSE DISCUSSED IN "RISK FACTORS," AS WELL AS
THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS. THE FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS PROSPECTUS ARE MADE AS OF THE DATE OF THIS PROSPECTUS, AND WE
ASSUME NO OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS OR TO UPDATE THE
REASONS ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS. SEE "RISK FACTORS."
OVERVIEW
I.I.T. Holding, Inc., the predecessor of USI for accounting purposes,
specialized in systems analysis and design and systems integration solutions.
IIT provided PeopleSoft human resource management and financial system
implementation. IIT's consulting professionals have expertise in human resource
management as well as accounting and financial systems.
We acquired IIT in September 1998 as a part of our program to develop a new
Internet-based service offering. IIT provides implementation capabilities that
enable us to provide human resource and financial management functionality as
part of our IMAP service offerings.
We have developed an advanced, integrated service offering that provides our
clients the ability to use leading business software applications through our
state-of-the-art Internet-based network. During 1998, we devoted substantially
all of our efforts to developing our network infrastructure, recruiting and
training personnel, establishing strategic business partnerships with
application software providers, completing two strategic acquisitions and
raising capital. During our first full year of operations in 1999, we continued
the development activities started in 1998 and began to market and sell our new
IMAP product offerings. We have incurred a cumulative net loss since inception
and expect to incur additional losses for at least the next twelve months, due
primarily to additional start-up costs related to implementation of our services
and the continued expansion and enhancement of our network. As of December 31,
1999, we had an accumulated deficit of approximately $135.8 million. As of
December 31, 1999, we had 109 signed contracts with 88 clients accounting for
total revenue, assuming payment over the full contract terms, of over $140.0
million. While we have experienced significant growth in revenue under contract
in recent periods and currently expect substantial, although potentially lower,
growth in revenue under contract throughout 2000, prior growth rates should not
be considered as necessarily indicative of future growth rates or operating
results for 2000. See "Risk Factors--Our business is difficult to evaluate
because we have a limited operating history"; "--We expect to incur losses and
experiences negative cash flow"; "--The markets we serve are highly competitive
and many of our competitors have much greater resources"; and "--Our growth
could be limited if we are unable to attract and retain qualified personnel".
In October 1999, we purchased the assets of Conklin & Conklin, Inc. a
comprehensive provider of Lawson financial and human resources system
implementation services and a certified reseller of Lawson software licenses.
The purchase price consisted of cash of $7.7 million, assumed liabilities of
$1.5 million, and a $2.0 million secured note. The secured note is due on
October 8, 2001, and bears interest at 10%, with interest payable monthly until
the maturity date. In addition, the purchase price consists of contingent
payments of up to $4.6 million in cash. Portions of the contingent payments can
be earned by Conklin shareholders through January 2002 upon the attainment of
specified financial milestones.
In April 1999, we completed an initial public offering of our common stock.
The net proceeds from the sale of the 15,525,000 shares of common stock were
approximately $132.8 million. The initial
26
<PAGE>
public offering of common stock met the criteria for the automatic conversion of
our outstanding Series A Convertible Preferred Stock and Series B Redeemable
Convertible Preferred Stock into common stock. In addition, the repurchase
rights lapsed with respect to all common stock subject to repurchase.
In November 1999, we completed the sale of our 7% convertible subordinated
promissory notes for net proceeds of approximately $119.9 million.
REVENUE. We generate revenue from IMAP services and information technology
services. Revenues from professional IT services are recognized as services are
provided. IMAP revenues consist of implementation fees and monthly recurring
fees for services. Implementation fees are generally paid in advance and are
deferred and recognized ratably over the term of the IMAP service contract.
Monthly IMAP service fees are consideration for access to our network of EDCs
hosting application software, and the implementation and management of that
software. IMAP contracts generally have a three-to-five year term and revenues
are recognized ratably over the contract term. Payments received in advance of
revenue recognition, even if non-refundable, are recorded as deferred revenue.
Some contracts permit termination without cause by the clients. Contracts
permitting termination without cause generally provide for termination payments
to us that will be recognized as revenue when collectibility is assured.
COSTS AND EXPENSES. We incur operating costs and expenses related to the
delivery of IMAP and professional IT services. They include direct costs of
service, network and infrastructure, general and administrative, sales and
marketing, product research and development, stock compensation, depreciation
and amortization expenses. Since inception, we have incurred expenses consisting
primarily of compensation and benefits, recruiting, occupancy and consulting. We
have expensed all start-up costs as incurred.
We incur up-front costs related to the delivery of IMAP services. Product
research and development costs and the cost to operate our network and data
centers are recognized as period costs. Costs related to the acquisition of
hardware are capitalized and depreciated over the estimated useful life of the
hardware of five years. Costs related to the acquisition of software licenses
are capitalized and amortized over the lesser of either three years or the term
of the individual client contract, depending on the nature of the software
license agreement. Amortization is based on a straight-line basis over the
remaining useful life. Direct costs related to the integration of software
applications for a client on our network are capitalized and amortized over the
related contract period.
HISTORICAL RESULTS OF OPERATIONS--USINTERNETWORKING
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO THE PERIOD ENDED DECEMBER 31,
1998
REVENUE. For the year ended December 31, 1999, we generated $21.7 million
in IMAP revenue and $13.8 million in professional IT services revenue. For the
period January 14, 1998, our date of inception, through December 31, 1998 we
generated $0.1 million in IMAP revenue and $4.0 million in professional IT
services revenue. The increase of $21.6 million in IMAP revenue is a result of
signing a total 102 IMAP client contracts during 1999. The 1998 professional IT
services revenue can be attributable to our subsidiaries IIT ($2.0 million) and
ACR ($2.0 million) which were acquired during the third and fourth quarters of
1998, respectively. The increase of $9.8 million in professional IT services
revenue can be attributed to a full year of operations during 1999.
GROSS MARGINS, DIRECT COSTS OF SERVICES, NETWORK AND INFRASTRUCTURE
COSTS. For the year ended December 31, 1999, we incurred $14.8 million and $8.8
million of direct costs related to the delivery of our IMAP and professional IT
services, respectively. For the period from January 14, 1998, our date of
inception, through December 31, 1998, we incurred $0.9 million and $2.5 million
of direct costs related to the delivery of our IMAP and professional IT
services, respectively. Additionally, we also incurred $16.2 million of costs
related to the maintenance of our network and infrastructure for the year ended
December 31, 1999 and $2.2 million of such costs during the period ended
December 31, 1998. Gross margins, including IMAP network and infrastructure
costs, for the year ended December 31, 1999 were
27
<PAGE>
(42.5)% and 35.9% for IMAP and professional IT services, respectively. Gross
margins for professional IT services for the period ended December 31, 1998 were
37.6%.
GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended December 31, 1999,
we incurred $22.0 million of general and administrative expenses compared to
$19.4 million for the period from January 14, 1998, our date of inception,
through December 31, 1998. The increase of $2.6 million reflects the costs
required to support an additional 59 general and administrative personnel during
a full year of operations in 1999, offset by one time start-up costs incurred in
1998.
SALES AND MARKETING EXPENSES. For the year ended December 31, 1999, we
incurred $36.6 million of sales and marketing expenses compared to $5.1 million
for the period from January 14, 1998, our date of inception, through
December 31, 1998. The increase of $31.5 million reflects the costs associated
with our increased efforts to market and brand our service offerings, and the
sales commissions related to the increase in IMAP revenue for the year ended
December 31, 1999.
PRODUCT RESEARCH AND DEVELOPMENT EXPENSES. For the year ended December 31,
1999, we incurred $5.4 million of product research and development expenses
compared to $0.7 million for the period from January 14, 1998, our date of
inception, through December 31, 1998. The increase of $4.7 million reflects the
costs associated with the continued development of our new products and
infrastructure during a full year of operations for the year ended December 31,
1999, compared to start-up activities during 1998.
NON-CASH STOCK COMPENSATION EXPENSE. For the year ended December 31, 1999,
we incurred $10.4 million in non-cash compensation expense. Of this amount,
$8.5 million resulted from employee stock options issued at an exercise price of
$2.67 after giving effect to our stock split and an estimated fair market value
of $8.87 to $14.89 per share at the date of grant after giving effect to our
stock split. We will record an additional $26.5 million over the next two years
in relation to those options. The remaining amount of $1.9 million resulted from
our contribution of common stock to the employee benefit plan and the
amortization of unearned compensation from restricted stock grants. There was
minimal non-cash stock compensation expense for the comparable period in 1998.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the year
ended December 31, 1999 totaled $22.5 million. Of this amount, $6.0 million
represents the amortization of the goodwill recorded upon our acquisitions of
ACR, IIT and Conklin; the remaining $16.5 million represents depreciation of our
property and equipment and the amortization of our prepaid software licenses. As
described in the "Change in Accounting Estimate" below, depreciation expense for
1999 was approximately $2.9 million lower as a result of changing our useful
life of computer equipment from 3 to 5 years. There was minimal depreciation and
no amortization expense for the comparable period in 1998.
INTEREST INCOME AND EXPENSE. For the year ended December 31, 1999, we
incurred $6.3 million in interest expense principally from increased borrowings
including $1.5 million of expense from our convertible subordinated notes. We
generated $4.1 million of interest income principally from the investment of the
proceeds from our initial public offering and convertible subordinated notes
offering. We had minimal interest income and expense during the period ended
December 31, 1998.
HISTORICAL RESULTS OF OPERATIONS--PREDECESSOR
COMPARISON OF THE PERIOD ENDED SEPTEMBER 7, 1998 TO THE PERIOD ENDED AUGUST 31,
1997
REVENUE. Revenues for the period ended September 7, 1998, increased 194%
over the period ended August 31, 1997. This increase is attributable to the
growth in IIT's PeopleSoft implementation services.
GROSS MARGINS, COSTS OF SALES AND SERVICES. IIT incurred $3.0 million and
$1.1 million of expenses in the delivery of its PeopleSoft implementation
services for the periods ended September 7, 1998 and August 31, 1997,
respectively. As a result, IIT's PeopleSoft implementation services generated
gross
28
<PAGE>
margins of 32.4% and 25.8% for the periods ended September 7, 1998 and August
31, 1997, respectively. The improved gross margins from period to period is
attributable to a reduction in the use of subcontractors, an increase in IIT's
staff utilization and continued improvement in the demand for PeopleSoft
implementation services.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. IIT incurred $1.8 million and
$1.3 million of selling, general and administrative expenses for the periods
ended September 7, 1998, and August 31, 1997, respectively. Selling, general and
administrative expenses for the period ended August 31, 1997 include $1.0
million attributable to non-cash compensation expense related to the issuance of
stock to three of IIT's officers. Selling, general and administrative expenses
increased $1.3 million for the period ended September 7, 1998, as a result of
bonuses and related payroll taxes. The remaining increase of approximately $0.2
million is attributable to the additional selling, general and administrative
support required to support IIT's growing customer base.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1997 TO THE YEAR ENDED DECEMBER 31,
1996
REVENUE. Revenues for 1997 over 1996 increased 276%. The significant
increase in 1997 is attributable growth in IIT's PeopleSoft implementation
services.
GROSS MARGIN, COSTS OF SALES AND SERVICES. IIT incurred $0.5 million and
$1.9 million of expenses in the delivery of services for the years ended
December 31, 1996 and 1997, respectively. As a result, IIT services generated
gross margins of 30.5% and 33.1% for the years ended December 31, 1996 and 1997,
respectively. The improved gross margin from year to year is attributable to a
reduction in the use of subcontractors, an increase in IIT's staff utilization,
and improving market conditions for the PeopleSoft implementation services
industry during this period.
SELLING GENERAL AND ADMINISTRATIVE EXPENSES. IIT incurred $0.2 million and
$1.8 million in selling, general and administrative expenses for the years ended
December 31, 1996 and 1997, respectively. The primary factor in the $1.6 million
increase from 1996 to 1997 is due to $1.0 million of non-cash compensation
expense related to the issuance of stock to three of IIT's officers. The
remaining increase is attributable to the additional support required for IIT's
growing customer base.
FUTURE ASSESSMENT OF RECOVERABILITY AND IMPAIRMENT OF GOODWILL
In connection with our acquisition of IIT, ACR and Conklin we recorded
goodwill that is being amortized on a straight line basis over its estimated
useful life. At December 31, 1999, the unamortized portion of these intangibles
was $29.6 million, which represented 9.1% of total assets and 28.9% of
stockholders' equity. Goodwill represents the amount that we paid for these
acquired businesses in excess of the fair value of the acquired tangible and
separately measurable intangible net assets. We have estimated the useful life
of our goodwill to be five years based upon several factors, the most
significant of which is the susceptibility of acquired businesses to change as a
result of technological advances and the rapidly changing needs of their
customers.
We periodically review the carrying value and recoverability of our
unamortized goodwill and other intangible assets for impairment. If the facts
and circumstances suggest that the goodwill or other intangible assets may be
impaired, the carrying value of this goodwill will be adjusted by an immediate
charge against income during the period of the adjustment. The length of the
remaining amortization period may also be shortened, which will result in an
increase in the amount of goodwill amortization during the period of adjustment
and each period thereafter until fully amortized. Once adjusted, there can be no
assurance that there will not be further adjustments for impairment and
recoverability in future periods. We have integrated the acquired businesses
into our primary IMAP service offerings. Therefore, in evaluating impairment a
principal factor we consider is the failure to achieve expected cash flows from
operations.
29
<PAGE>
CHANGE IN ACCOUNTING ESTIMATE
On July 1, 1999, we changed our estimate of the useful life of our computer
equipment from three to five years. The change in estimate will be accounted for
prospectively, with depreciation expense for periods subsequent to June 30, 1999
calculated so as to depreciate the remaining book value of the equipment at
June 30, 1999 equally over the revised estimated useful life which has an annual
impact of reducing depreciation expense by approximately $6 million.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999, we had cash and cash equivalents of $112.3 million and
available-for-sale securities of $31.7 million.
For the year ended December 31, 1999, we have used $78.2 million in
operating activities, $121.7 million in investing activities and generated
$268.4 million through financing activities. Included in financing activities
was $132.8 million raised from an initial public common stock offering in April
1999. We invested these proceeds primarily in marketable securities. During
1999, we purchased $147.0 million of marketable securities and sold $115.6
million of marketable securities. We used the proceeds of the sale of the
marketable securities to fund our current operations.
We have used debt and capital leases to partially finance our capital
investments for the development of our infrastructure and the hardware required
to support the increase in our IMAP clients. As of December 31, 1999, we had
obtained commitments for secured financing from several sources, including Cisco
System Capital Corporation ($8.8 million), Venture Lending & Leasing II, Inc.
($10.0 million), Finova Capital Corporation ($11.7 million), Transamerica
Business Credit Corporation ($9.0 million), Charter Financial Corporation ($5.0
million), LINC Capital ($6.0 million) and EMC Corporation ($6.4 million). At
December 31, 1999, the total of our secured financing commitments was
$79.9 million, of which $72.6 million had been funded.
In the fourth quarter of 1999, we issued $125 million in principal amount of
the Notes. The net proceeds from the issuance were approximately
$119.9 million. The subordinated convertible notes pay interest at 7% and are
convertible into common stock at the holder's option at a price of $16.57 per
common share after giving effect to our stock split.
In April 1999 we purchased an office building for $11.8 million. The seller
financed $7.1 million of the purchase price through a first mortgage note due
May 2006 bearing interest at 7.5% per annum. We spent approximately $9 million
in 1999 on improvements to the building and have obtained financing for $4.75
million of these improvements.
We believe that these resources, together with the net proceeds received
from the issuance of our common stock in the February offering, will be
sufficient to fund our operations for at least the next twelve months. The
majority of the base infrastructure required to provide our IMAP services has
been purchased. As a result, our capital expenditures for the next several years
will now largely be success-based, consisting of software licenses, hardware and
the expansion of existing data center facilities required to implement IMAP
solutions for our new customers. These new customer contracts are expected to
have an average term of three to five years; however, we anticipate that many of
our customers will renew their contracts due to the cost and complexity of
switching service providers.
If we expand more rapidly than currently anticipated, if our working capital
needs exceed our current expectations or if we make acquisitions, we will need
to raise additional capital from equity or debt sources. We cannot be sure that
we will be able to obtain the additional financing to satisfy our cash
requirements or to implement our growth strategy on acceptable terms or at all.
If we cannot obtain such financing on terms acceptable to us, we may be forced
to curtail our planned business expansion and may be unable to fund our ongoing
operations. We are presently pursuing a variety of sources of other debt
financing, but no additional commitments have been obtained to date.
30
<PAGE>
YEAR 2000 COMPLIANCE
YEAR 2000 ISSUE. The Year 2000 issue is a result of computer programs or
systems, which store or process date-related information using only two digits
to represent the year. These programs or systems may not be able to properly
distinguish between a year in the 1900's and a year in the 2000's. Failure of
these programs or systems to distinguish between the two centuries could cause
the programs or systems to yield erroneous results or even to fail.
EFFECT ON USI. To date, we have not experienced any material difficulties
associated with the Year 2000 and we have not incurred any material liability or
costs due to the Year 2000 issue. Our total expenses related to Year 2000
compliance through the end of 1999 were $1.0 million. We do not anticipate that
we will incur any material additional costs due to Year 2000 compliance.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates. In addition,
changes in the quoted market price of our common stock will effect the fair
value of convertible subordinated notes.
INTEREST RATE RISK
The fair value of our cash and cash equivalents would not be significantly
impacted by either a 10% increase or a 10% decrease in interest rates due to the
short-term nature of our portfolio.
Our earnings and financial position are affected by changes in interest
rates as a result of our purchase of various fixed rate municipal bonds included
in available-for-sale investments. If market interest rates for municipal bonds
increase by 10%, the fair value of our available-for-sale investments will
decrease, and unrealized gains/losses recognized as other comprehensive income
will decrease by an estimated $0.7 million. Conversely, if market interest rates
for municipal bonds decrease by 10%, the fair value of our available-for-sale
investments will increase, and unrealized gains/losses recognized as other
comprehensive income will increase by an estimated $0.8 million. These amounts
are determined by discounting future cash flows using hypothetical interest
rates.
We have financed capital expansion through various long-term debt
instruments bearing interest at both fixed and variable interest rates. At
December 31, 1999, the fair value of this debt is not significantly impacted by
either a 10% increase or a 10% decrease in interest rates.
OTHER MARKET RISK
Our convertible subordinated notes bear interest at 7% through November 1,
2004. The market value of these notes is affected by fluctuations in the quoted
market value of our common stock. If the quoted market value of our common stock
increased by 10%, the estimated fair value of the notes will increase by an
estimated $35 million. Conversely, if the quoted market value of our common
stock decreases by 10%, the estimated fair value of the notes will decrease by
an estimated $35 million.
These analyses do not consider the effects of the reduced level of overall
economic activity that could exist in such an environment. Further, in the event
of a change of such magnitude, we would likely take actions to further mitigate
our exposure to the change. However, due to the uncertainty of the specific
actions that would be taken and their possible effects, the sensitivity analysis
assumes no changes in our financial structure.
31
<PAGE>
BUSINESS
ABOUT USI
USI's service offerings integrate leading packaged software applications
with computing hardware, network security and operational support to meet the
needs of middle market companies for business functions such as e-commerce,
sales force automation and customer support, messaging and collaboration and
professional services automation. We implement these applications in our data
centers and enable our clients to access and utilize the applications over the
Internet. We take full responsibility for providing these services to our
clients, freeing them from the need to own and manage related computer systems,
networks and software.
MARKET TRENDS
We believe that there are four key market trends that drive our business
opportunity:
- the increased acceptance of the applications hosting model;
- the rapid growth of e-commerce and Internet-based communications;
- the competitive need of middle market and global 1000 enterprises to
automate key business processes; and
- the availability of Internet-enabled packaged software applications.
THE INCREASED ACCEPTANCE OF THE APPLICATION SERVICE PROVIDER MODEL.
The Application Service Provider model is being increasingly validated by
the emergence of new entrants into this market. The "pure play" applications
hosting companies today include companies such as Aristasoft, Breakaway
Solutions, Corio, FutureLink, Interliant, Interpath and Telecomputing. KPMG, a
leading systems integrator has announced a partnership with Qwest to provide
applications hosting solutions. USWeb/CKS, another systems integrator, also
provides application hosting solutions. The leading enterprise application
companies such as Oracle, Siebel and SAP are either in the process of or are
already providing applications hosting solutions. The Web hosting companies such
as Concentric, Digex and Verio either by themselves or in partnership with other
companies are expected to be participants in the Application Service Provider
market. International Data Corporation estimates that the market opportunity in
the high-end Application Service Provider market will reach $2 billion by 2003,
representing a four-year compound annual growth rate of 91%.
THE RAPID GROWTH OF E-COMMERCE AND INTERNET-BASED COMMUNICATIONS.
An increasing number of companies use the Internet to enable fast and
efficient communications between various constituents of their enterprises. The
following examples illustrate this trend.
- E-commerce is becoming a critical element of many businesses' strategies.
Companies increasingly demand that their vendors communicate ordering,
invoicing and payment transactions through Internet-enabled applications.
International Data Corporation estimates that commerce on the Internet
will be more than $1 trillion by 2003, reflecting a four-year compound
annual growth rate of 85%.
- Enterprises are relying on the Internet to communicate with employees who
are increasingly dispersed due to globalization and the development of
alternative workplaces. According to Forrester Research, Inc. there are
between 30 and 40 million telecommuters or home-based workers in the
United States.
- To interact with customers, suppliers and remote employees efficiently, an
increasing number of businesses are implementing mission-critical
applications over intranets and extranets rather than
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through dedicated private networks. Forrester Research, Inc. forecasts
that the increasing demand for corporate intranets and extranets will fuel
growth rates in excess of 30% in distributed infrastructure services
resulting in a $140 billion market in 2002.
As more companies implement mission-critical business applications on the
Internet, the demand for the outsourced provision of key Internet infrastructure
and services, or Web hosting, has significantly increased. The outsourcing of
Web sites is occurring because businesses recognize that they do not have an
infrastructure sufficient to ensure reliable and responsive deployment of
mission-critical applications on the Internet. Web site hosting providers
address these concerns by building substantial redundancy and capacious network
bandwidth into their facilities. Moreover, they provide a physically secure data
center environment, which helps to address businesses' security concerns as they
begin to move proprietary business information over the Internet.
THE COMPETITIVE NEED OF MIDDLE MARKET ENTERPRISES TO AUTOMATE KEY BUSINESS
PROCESSES.
Middle market enterprises increasingly face competitive demands to automate
business processes, but they have frequently not been able to afford the
functionality available to their larger competitors. This has been exacerbated
by the shortage of IT professionals. We believe that these enterprises have a
significant need for packaged application software to improve core business
processes, reduce costs and enhance their global competitive position.
We believe that many of the leading enterprise resource planning software
packages remain too complex and too costly to be effective solutions for middle
market companies. While many enterprise resource planning providers have begun
offering products that are targeted for the middle market, implementation of
these packages generally still requires specialized skill sets and frequently
takes three to twelve months. In addition, the infrastructure required to
support these packages, once implemented is also beyond the capabilities of many
middle market businesses. Faced with these costs and time frames, many middle
market companies choose to forgo the capabilities of leading enterprise resource
planning packages in favor of less functional products. We believe that a lower
cost, more easily implemented approach would allow these middle market
businesses to capitalize on the functionality of leading enterprise resource
planning packages and better position these businesses against larger
competitors.
THE AVAILABILITY OF INTERNET-ENABLED PACKAGED SOFTWARE APPLICATIONS.
Until recently, companies wanting to implement Internet applications had to
develop their own software applications or customize existing packages. This
made each implementation unique and costly. It also made implementation time
frames and costs unpredictable. Over the past two years, however, major packaged
application providers, such as Siebel, PeopleSoft, Lawson, Oracle, J.D. Edwards
and others, have released versions of their software which can be accessed and
used over the Internet. Internet-enabled software is becoming an increasingly
common offering of providers of applications for distributed users such as
e-commerce, enterprise resource planning applications, and sales force
automation, where the increasing ubiquity of the Internet makes it a
cost-efficient mechanism for implementing distributed functions.
We believe that the availability of Internet-enabled packaged software makes
it possible, for the first time, to implement these applications on the Internet
in predictable time frames, with predictable costs, and without writing custom
code.
THE USI SOLUTION
We believe that we are well positioned to take advantage of these trends. We
have established our IMAP services as a leading single-source solution for the
Internet-enabled application software needs of middle market enterprises. We
take responsibility for the deployment and maintenance of the IMAP
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best-of-breed packaged software applications. This allows our clients to focus
on their core competencies without mediating among disparate vendors. Our IMAP
solutions enable clients to buy these mission-critical functions as a service
from a single vendor, rather than as a collection of technologies from multiple
vendors.
We have teamed with major packaged application software providers to
implement our IMAP solutions. We have built a network of EDCs through which our
clients' business software applications are deployed. The network offers fast,
reliable and secure access to the client application web sites that we manage,
which serve as the "Internet gateways" for enterprises and their employees,
customers and partners to access and use business application software and data.
The servers are generally procured and maintained by us and dedicated to
specific clients. Clients can define specific groups, such as their sales force,
customers, or investors, to have full or limited access to their web sites.
Because our network is deployed globally, access to client applications can be
equally responsive in North America, Europe and Asia. Moreover, geographically
dispersed backup is designed to ensure high reliability and data integrity. We
provide packaged application software and support along with our services on the
basis of multi-year contracts paid on a monthly basis. We believe that the
combination of our Internet communications capability along with
Internet-enabled software applications makes our IMAP offerings the first truly
integrated Internet communications and computing solution.
OPERATE A SPECIALIZED GLOBAL NETWORK
We have constructed a highly reliable, fully redundant, global network
specifically designed to support our IMAP solutions. Our network is designed to
provide the fastest possible response time, the highest level of security and
99.9% availability to our clients. We have EDCs in Annapolis, Silicon Valley,
Amsterdam and Tokyo. These EDCs are monitored and managed from our Global
Enterprise Management Center in Annapolis and a remote back-up GEMC in Silicon
Valley. The network is designed around dual primary backbones connecting our
EDCs and GEMCs. Our dedicated network is linked to the Internet in North America
via eight major backbone providers, allowing our clients to bypass congested
public exchange points. In addition, our network is linked with two backbone
providers in each of Europe and Asia, enabling us to provide global connectivity
to our clients. Large storage arrays in Annapolis and Silicon Valley can provide
real-time back-up of North American client sites, enabling us to provide an
unusually high level of data integrity. We use our network operations platform,
USIView, to proactively manage and monitor our network systems,
telecommunications hardware, network connectivity, operating systems and
applications software.
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[LOGO]
This specialized network enables us to provide very high levels of
reliability, security and responsiveness to client constituents, whether they
access our applications through the Internet or from behind a client LAN (as
illustrated above).
DELIVER INTEGRATED SERVICE OFFERINGS AROUND BUSINESS PROCESSES
We have expert product teams that specialize in implementing IMAP solutions
to support specific business processes. Our consulting and implementation teams
have specific expertise in implementing our IMAP solutions for e-commerce, sales
force automation and customer support, human resource and financial management,
messaging and collaboration and professional services automation. Each team can
integrate a specific application software package and the required Internet
communications services, which together provide a total solution for a specific
business process. These teams can implement applications and generate value for
customers very quickly. For example, our typical implementation of Siebel
technology is designed to be completed in 45 days. We believe that this provides
a competitive advantage over a more conventional implementation which requires
six months to more than a year for completion. The consulting and implementation
teams hand off the implemented application to our operations group, which runs
and maintains the application as well as provides ongoing support to the client
through our client care organization.
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LEVERAGE STRATEGIC RELATIONSHIPS WITH LEADING SOFTWARE APPLICATION PROVIDERS
We have established relationships in key application areas with vendors,
including BroadVision and Microsoft in e-commerce; Ariba in business-to-business
e-commerce; Siebel in sales force automation, customer service and enterprise
marketing; PeopleSoft and Lawson in human resources and financials; Microsoft
Exchange in messaging and collaboration; Niku in professional services
automation; and Sagent in decision-making support. We are the exclusive
Application Service Provider of Siebel enterprise relationship management
applications for customers of SiebelNet, Inc. which is headquartered in North
America and are one of two currently certified PeopleSoft Application Service
Providers. The agreements with software providers generally enable us to deploy
the applications as a service, without the need to establish a separate
licensing arrangement for each client. The agreements also enable us to provide
our clients with an economically attractive service offering, and afford us co-
marketing and co-branding opportunities. These agreements provide us with an
initial software portfolio that can meet a broad range of our clients'
enterprise resource planning, e-commerce and communication needs. In addition,
the agreements provide us with an accelerated path to developing our expert
product teams around the software applications and business processes these
applications support.
IMPLEMENT SERVICES-BASED BUSINESS MODEL
We sell our IMAP solutions as a service, not as a technology. Accordingly,
our clients sign long-term contracts with fixed monthly payments made as the
service is delivered. We believe that selling our IMAP solutions as a service
reduces our clients' initial capital expenditures and makes it easier for
non-technical executives to purchase our products.
THE USI STRATEGY
The focus of our strategy is to deliver timely, reliable and secure IMAP
services to our clients. We believe that by doing so we will rapidly build our
client base and secure long-term relationships, especially with those clients in
the middle market. We intend to continue investing to maintain a value advantage
over our competitors and to capitalize on our first mover advantages, as
follows:
- DEVELOP NEW BUSINESS. We will continue to develop new business by
soliciting potential clients through joint marketing campaigns with our
hardware, software and integration partners, advertising in industry
specific periodicals and newspapers, sponsoring seminars and trade shows
in selected markets, and conducting targeted mass mailings of marketing
material.
- CROSS-SELL PRODUCTS TO INCREASE PENETRATION OF ACCOUNTS. We are able to
provide a range of packaged software applications and complex web hosting
services to our clients. We actively seek to increase our sales to clients
by cross-selling our products and services. Our aim is to increase our
implementation and provision of our clients' mission-critical business
processes.
- EXPAND OUR PORTFOLIO OF IMAP SOLUTIONS. We have entered into strategic
partnerships with numerous application software vendors. These vendors are
offering or developing additional applications in specific vertical market
segments which we expect to deploy in order to expand our portfolio of
IMAP solutions.
- ENHANCE THE CAPACITY AND FUNCTIONALITY OF OUR GLOBAL NETWORK. We will
continue to deploy enhanced value features into our network. In addition,
as we begin to address clients located in Europe and Asia, we will expand
our capacity in those regions. Today, we provide European and Asian mirror
sites to our clients from collocated EDCs in Amsterdam and Tokyo.
- EMPHASIZE THE IMAP BRAND. We have focused our sales and marketing efforts
to distinguish IMAP as a branded product offering focused on the middle
market and selected divisions of larger multi-national organizations. Our
direct sales organization allows our sales representatives to understand
each client's specific business needs better and provide the ongoing
support that facilitates effective cross-selling.
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IMAP OFFERINGS
Our current IMAP offerings provide integrated solutions to meet the needs of
middle market and global 1000 clients implementing distributed business
functions, whether based on applications we provide or where we are hosting
existing applications provided by the client. These solutions integrate four
basic components.
- LEADING PACKAGED APPLICATION AND DATABASE SOFTWARE. Our application
packages address major business process areas including e-commerce, sales
force automation and customer support, human resource and financial
management, messaging and collaboration and professional services
automation. We have chosen to focus on mission-critical business processes
that serve distributed users. These processes can gain maximum value from
Internet implementations, our management of database platforms and from
our infrastructure.
- USI-MANAGED CLIENT APPLICATION WEB SITES AVAILABLE VIA OUR GLOBAL NETWORK.
USI-managed client application Web sites are housed on dedicated
USI-managed servers and available via a reliable, high-performance and
secure global Internet network. Our network architecture is designed to
ensure responsiveness and allows clients to define which groups will have
full or limited access to the Web site or the server.
- CONSULTING AND SYSTEMS INTEGRATION SERVICES. IMAP consulting and systems
integration services define, develop and offer a service that provides
access to a combination of our network services, application software and
related hardware necessary to provide our service and meet a specific
client's needs. Within the IMAP solutions, we do not develop software nor
do we implement substantial customization of existing packages. Rather,
modular packages applications are configured to meet a client's
requirements.
- INTEGRATED CLIENT SERVICE. Once implemented, IMAP solutions are
efficiently managed in our network of EDCs. We provide client support
twenty-four hours a day, seven days a week, from dedicated teams with
specific knowledge of each client implementation.
In addition to the specific application areas that we support, we allow
clients to host their own software applications in our highly reliable and
secure data center environment. In this context, the IMAP offering consists of
all of the above elements other than the provision of application layer
software. Clients for this complex Web hosting realize all the reliability,
security and responsiveness benefits of our network; however, we take no
responsibility for the application itself. We believe that many of our complex
Web site management clients intend to migrate to a USI-supported application
over time.
Most of our IMAP contracts, including our contracts for complex Web hosting,
provide for a modest initial payment and are generally not less than three years
in length. However, client contracts signed under our agreement with Siebel may
have a term as short as six months and we foresee that some Web hosting
contracts may also have shorter terms. Several of our earliest IMAP contracts
permit early termination without substantial penalty. Our contracts provide for
prospective payment reductions in the event that agreed service levels, as
measured and quantified by system performance benchmarks, are not met.
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[LOGO]
USI'S SPECIAL APPLICATIONS NETWORK
We designed our global network specifically to provide superior performance
for the IMAP offerings. By maintaining architectural and operational control
over our network up to the point at which the client's traffic leaves its ISP
backbone or corporate LAN, our network is designed to:
- provide uptime of 99.9% or better to the entire network, which includes
the dedicated customer server;
- provide fast and predictable response time and access to customer content
globally; and
- provide reliable and customized network security.
NETWORK UPTIME
Our global network is designed to ensure 99.9% uptime by following four
specific principles:
- avoiding incompatibility through standardization;
- utilizing redundant components;
- offering the ability to mirror client servers in separate EDCs; and
- implementing USIView, our global end-to-end network management system.
Our network is designed around Cisco networking hardware, which minimizes
multi-vendor integration and reduces the risks of hardware incompatibility and
implementation delay. Cisco has designated our network as a Cisco Powered
Network, indicating that Cisco has reviewed and approved the network design. Our
network architecture relies on redundancy of network hardware, facilities
infrastructure such as power supplies and telecommunications circuits, which
maximizes the network availability. In addition, we have redundant EDCs, GEMCs
and wide area networks connecting our EDCs. The wide-area network connection can
be used to dynamically mirror or provide a duplicate site for each client at an
alternative EDC location. This mirroring feature protects the site from downtime
resulting from catastrophic failure at a specific geographic location. For
clients requiring real time disaster recovery, we use storage arrays that enable
real time data mirroring and are designed to maintain the integrity of data to
within minutes.
The GEMC staff manages and monitors the network systems environment,
telecommunications hardware and data content servers in all of our EDCs, both
domestic and international, using USIView, our global network operations
technology, an end-to-end network management platform. USIView consists of an
integrated suite of scalable software tools that allow the GEMC staff to
proactively monitor systems-level events, processes and thresholds. USIView is
the foundation of our systems and operations management strategy, providing us
with:
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- a unified configuration and change management method;
- an event correlation facility that collects, processes, and responds to
management event information from a variety of sources; and
- a central repository for inventory and asset management information.
FAST RESPONSE TIME
In order to facilitate the faster response time, we have designed our
PriorityPeering network to avoid congestion areas on the Internet and have
specifically designed our primary GEMC to support our integrated network. We
seek to avoid the known Internet congestion points at the Metro Area Exchanges
and at the network access points. In order to bypass the MAEs and network access
points, our network in North America connects directly with eight major Internet
Service Providers' backbones, which carry about 85% of all the traffic on the
Internet today. Client data is routed directly over an ISP's network to our
network, bypassing congested public exchange points.
NETWORK SECURITY
Each EDC features multiple levels of security to isolate private information
from public information. Private network infrastructure is physically isolated
with cabling, switches and routers separately maintained from the hardware for
the public network infrastructure. In addition, access to the EDCs and GEMCs is
restricted to authorized personnel by hand scan readers, which also monitor and
record entrances and departures. The public network and the private network have
minimal electronic or logical interconnection and are connected only through a
redundant firewall. The network also includes firewall products that enforce
data security and policy-based routing for clients who prefer secure access to
server resources. We believe that these measures ensure complete separation and
security between its public and private networks.
STRATEGIC SOFTWARE VENDOR RELATIONSHIPS
In developing our IMAP solutions, we have formed relationships with some of
the market-leading software providers whose applications support critical
business processes. These application providers include BroadVision, Ariba,
Siebel, Lawson, PeopleSoft, Microsoft, Niku and Sagent. We believe that we have
proven to be an attractive partner for these software companies because of our
strategy to deliver integrated solutions to middle market enterprises in a
cost-effective service model. Each of our software agreements is unique, but
most allow us to deploy packaged application software as a service without the
need to establish a separate licensing arrangement for each client. The
agreements also generally include co-marketing, specialized product training and
preferred pricing on the licenses to the software. We plan to enter into
additional agreements with other software vendors over time.
Each of our key application software relationships is described below.
BROADVISION. We have agreed with BroadVision to offer BroadVision's
e-commerce application as an IMAP solution. BroadVision's e-commerce application
has been adopted by enterprises across a broad range of industries. The
agreement with BroadVision allows us to offer a robust set of e-commerce
solutions for business-to-business and business-to-consumer commerce.
BroadVision has named us as its first certified e-commerce application service
provider worldwide.
Our agreement with BroadVision allows for attractive discounts on licenses.
Our arrangement with BroadVision also provides for flexible use of licenses
worldwide, sharing of development methodology, technical support, joint sales
activity and co-marketing. We maintain IMAP solutions engineers, trained and
certified on BroadVision applications, in nine major metropolitan areas.
ARIBA. Ariba is a leading provider of intranet- and Internet-based
business-to-business electronic commerce solutions. The company's products
efficiently connect requestors to approvers and buyers to suppliers to deliver
an automated solution for improving the acquisition and management of the goods
and services required to operate a company.
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Our comprehensive partnership with Ariba includes product development,
application implementation and management services, as well as cooperative sales
and marketing. Under terms of the agreement, USI is a preferred ASP for the
Ariba ORMX solution. Our arrangement with Ariba enables us to not only offer
buyers the Ariba ORMX solution as part of our IMAP portfolio, but it also allows
us the opportunity to provide other IMAP solutions to the suppliers that want to
connect to the Ariba Network.
SIEBEL. Siebel is the recognized leader in providing enterprise
relationship management applications, a range of product offerings that includes
sales force automation, customer service/help desk and enterprise marketing. We
have entered into an agreement with SiebelNet, Inc., a wholly owned subsidiary
of Siebel Systems, Inc., pursuant to which we serve as the exclusive application
service provider of Siebel enterprise relationship management applications for
customers of SiebelNet that are headquartered in North America. Under this
agreement, SiebelNet pays us a monthly fee for services including
ready-to-service hardware, network connectivity and client support.
Our agreement with Siebel establishes a joint program in which the Siebel
sales force will offer outsourcing as a product option. While Siebel, in most
instances, retains control of the application licensing, we implement the
application in our EDCs, provide on-going management and support, and provide
our consulting and implementation services. Enterprise relationship management
opportunities identified by our sales force are handled in the same manner. In
return for the exclusivity of this relationship, we have agreed not to offer any
competing enterprise relationship management applications as part of our IMAP
solutions. The agreement mandates joint marketing programs, joint oversight of,
and agreement on, the program to sell enterprise relationship management
application outsourcing services, and commissioning of both Siebel's and our
sales representatives participating in each sale.
We have extended our strategic partnership with Siebel Systems, Inc., to
include Siebel for Workgroups applications, a powerful suite of e-business
applications that automate the sales marketing and service functions of small to
mid-sized businesses as a term license IMAP product. USI's Workgroups offering
is focused on providing mid-tier companies with Siebel business applications
functionality over secure Internet and dedicated network connections, hosted and
managed out of USI's EDCs. Additionally, USI provides as a free download from
its web site Siebel Sales, a single user sales marketing solution.
LAWSON. Lawson is an established leader in the enterprise resource planning
software industry and one of the pioneers of fully Internet-enabling its
software products. Lawson is also a recognized leader in selling its enterprise
applications on a worldwide basis. Lawson's product functionality includes human
resources, financial management, supply chain, collaborative commerce,
enterprise budgeting and procurement. Lawson has selected USI as a global
Application Service Provider.
Our agreement with Lawson provides that qualified new outsourcing leads
identified by Lawson will be referred to USI for hosting and application
management. Outsourcing leads identified by USI or Lawson will be jointly
marketed and quoted. USI has committed to provide marketing support and
resources for our Lawson offering. The term of the Lawson agreement is one year,
and will renew annually for up to five years unless either party provides notice
of termination prior to the end of any given year. In October 1999, we purchased
Conklin & Conklin, Inc. a comprehensive provider of Lawson financial and human
resources system implementation services and a certified reseller of Lawson
software licenses.
PEOPLESOFT. We have agreed with PeopleSoft to offer PeopleSoft human
resource and core financial applications as IMAP solutions. PeopleSoft is an
established leader in the enterprise resource planning software industry and the
recognized leader in human resource management solutions. We are one of 10
currently certified PeopleSoft Application Service Providers.
Our agreement with PeopleSoft provides that opportunities identified by our
sales force be jointly marketed and quoted. Opportunities identified by the
PeopleSoft sales force may be jointly marketed
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and quoted with us. Customers who elect outsourcing through us will purchase our
IMAP solutions. The agreement also provides for the sharing of rapid deployment
methodologies, complete software support, the ability to joint market products
and services, shared visibility at industry events, sharing of sales leads and
joint training efforts.
MICROSOFT. We have agreed with Microsoft to offer Microsoft's Exchange and
Site Server products as IMAP solutions. Microsoft Exchange is the recognized
leader in messaging and collaboration management solutions. Microsoft Site
Server is a leading e-commerce platform.
Our multi-year Exchange agreement with Microsoft grants us the right to
distribute the Exchange software as part of our IMAP solution on a pay-per-user
licensing fee basis. Under our other licensing agreement with Microsoft we
implement, host and manage e-commerce solutions based on Microsoft Site Server.
NIKU. Niku is a leading developer of Professional Services Automation
solutions.
Our agreement with Niku allows us to offer, as an IMAP solution, up-front
installation, training and conversion services for Niku's PSA solutions. Under
our agreement, we pay a discounted fee for each Niku license included in any
IMAP solution.
SAGENT. We have agreed with Sagent to offer Sagent Internet Enterprise
Intelligence applications as an IMAP solution. Sagent is currently fully
prepared to service the emerging Internet Enterprise Intelligence market with
its single, integrated, fully Internet-enabled, data warehousing solution.
Oracle and Siebel have selected Sagent as the exclusive data modeling and data
movement technology upon which their data warehouse products are based.
Our agreement with Sagent allows for attractive discounts on licenses and
services and grants us the right to distribute the software as part of our IMAP
solutions without the need to establish a separate licensing arrangement for
each client. The agreement also provides for flexible use of the licenses
worldwide, access to rapid deployment methodology, software support, joint
marketing and visibility as a Sagent Premier Partner at industry events, shared
training resources and sharing of sales leads.
SALES AND MARKETING
We offer our products and services through a direct sales organization based
in the U.S. Each sales representative is responsible for a limited number of
client relationships. We believe this approach enables our sales representatives
to understand each client's specific business needs thoroughly and to provide
top quality ongoing support. We currently have 45 sales representatives located
throughout the U.S. We intend to expand our sales organization into all major
U.S. markets.
Our sales teams target medium-sized enterprises based in the U.S. with
annual revenues ranging from $50 million to $1 billion and selected divisions of
larger multi-national organizations. Our sales strategy emphasizes that IMAP
solutions enable clients to avoid extensive initial capital outlays, maintain
focus on their core businesses, reduce technical and integration risks and
shorten implementation time for software applications.
We have developed programs to attract and retain high quality, motivated
sales representatives that have the technical skills and consultative selling
experience necessary to sell our IMAP solutions. In addition, our acquisitions
have augmented our sales and technical team and have created opportunities for
more rapid market penetration in their geographic region and access to
established business relationships for cross-selling.
We have established a marketing communications organization that is
responsible for the branding and marketing of all our IMAP solutions and for
distinguishing IMAP as a branded product offering. The marketing organization is
responsible for all new service launches to ensure both internal execution and
marketplace acceptance. The marketing organization has developed cooperative
marketing and trade show participation programs in conjunction with our
strategic software and hardware partners.
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USI and AT&T Corp. have entered into a cooperative market agreement whereby
USI and AT&T will jointly market and deliver ASP services to mid-market and
high-growth companies. AT&T sales channels will refer customers seeking to
leverage our applications and services expanding the sales channel for all of
our IMAP offerings. We will utilize AT&T's domestic and international frame,
ATM, and IP Services to connect and deliver the functionality of our IMAP
services.
Under the agreement, we have been named the first "Platinum Member" of
AT&T's Ecosystem for ASPs. Additionally, we have named AT&T our "Preferred
Network Provider," whereby AT&T becomes the recommended network provider to our
customers for Frame and ATM connectivity requirements. AT&T and USI will
initially focus on marketing in the DC/Northern Virginia/Maryland area, with
additional areas to be added later. Sales may also occur outside of the target
geographic markets. The initial term is one year with an optional two year
extension.
The Agreement may be terminated by either party for cause or, after six
months, if certain performance objectives are not met. In connection with
entering into the agreement we will issue AT&T warrants to acquire up to 150,000
shares of common stock at an exercise price of $32.00 per share. We will also
agree to nominate for election as a director at our annual meeting in 2000 a
designee of AT&T.
We are a party to a marketing agreement with U S WEST Communications, Inc.,
the incumbent local exchange carrier in fourteen western states. By the terms of
that agreement, U S WEST gained exclusive rights to market some of our IMAP
products in its fourteen-state region. We make our products available to U S
WEST at a discount and provide technical support during the sales process. Due
to the pending acquisition of U S WEST by Qwest, a competitor of USI's, U S WEST
and USI have mutually agreed to transition out of the marketing agreement. See
"Risk Factors--The markets we serve are highly competitive and many of our
competitors have much greater resources."
CLIENT CARE
A central element of the IMAP solution is a high level of responsive
personalized service, referred to as client care. Through our client care
process, a specific technical account manager is assigned to each client and
support teams are designated to back up the account managers. This structure is
designed to ensure service is available twenty-four hours a day, seven days a
week. Assigned support teams comprise senior client support specialists, network
engineers, and packaged application engineers. The teams have further support
from a group of product-specific application engineers who are trained in the
specific software applications that we offer.
CLIENTS
We target primarily North American-based middle market enterprises and
divisions of larger multinational organizations. We believe that these
organizations will gain the most competitive advantage from IMAP solutions and
that they provide the greatest opportunity for the outsourcing of information
technology operations. Currently, business software application vendors are
providing software predominantly to larger organizations. Historically, attempts
to market to middle market enterprises have generally been unsuccessful due to
the high up-front costs to obtain the required software, the long lead time to
integrate the software into the specific business process and the competition
for and shortage of IT resources in middle market companies.
We currently have clients for both our IMAP offerings and traditional
information technology services. Revenues from IMAP services comprise 61% of
total revenue for the year ended December 31, 1999. As of December 31, 1999 we
had 109 signed contracts with 88 clients for our IMAP services, representing
over $140.0 million in expected contract revenue (assuming payments over the
full contract terms) and approximately $43.1 million of 12 month backlog, which
we define as revenue under contract expected to be recognized in the next 12
months. As of December 31, 1999, selected clients of ours include:
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Actuate Software
AllBooks4Less.com
Baltimore Sun
Clarus
CornerStone Brands
DEBTCOLLECT.COM
Franklin Covey
GE Capital Investments
Health Care Online
Herman Miller
Hershey Foods
HP Shopping Village
(hpshopping.com)
INSLAW
Intraware
Knoll Pharmaceutical
Lattice Partners
Legg Mason
Liberty Financial Companies
liveprint.com
LHS Communications
Loan Market Resources
LocalVoice.com
Niku
Perfumania.com
PSDI
rdental.com
Rhythms NetConnections
Sagent
Samsung
Service Hub
Star Telecommunications
Sunburst Hospitality
TeleChoice
The Luggage Center
U S WEST
V Technologies
Ventana
WeTheShoppers.com
XL Capital
COMPETITION
The market for Internet-related services is extremely competitive. We
anticipate that competition will continue to intensify as the use of the
Internet grows. The tremendous growth and potential market size of the Internet
market have attracted many start-ups as well as extensions of existing
businesses from different industries. In the market for Internet-enabled
application software and network solutions, we compete on the basis of
performance, price, software functionality and overall network design. While our
competition comes from many industry segments, we believe that no single segment
provides the integrated, single-source solution that we provide.
Our current and potential competitors include Application Service Providers
and companies focused on the application hosting business such as Aristasoft
Breakaway Solutions, Corio, FutureLink, Interliant, Interpath, NaviSite and
Telecomputing; Web hosting companies, such as Concentric, Digex and Exodus;
enterprise applications vendors, such as Oracle, Siebel and SAP; business
Internet Service Providers, such as MCI WorldCom, PSINet and Verio;
telecommunications companies, such as AT&T, GTE, and Qwest (which has agreed to
acquire our customer and significant stockholder, U S WEST); and systems
integrators, such as Andersen Consulting, EDS, IBM and KPMG. While we believe
that our network of proprietary EDCs together with our level of service, support
and targeted business focus distinguish us from these competitors, some of these
competitors have significantly greater market presence, brand recognition, and
financial, technical and personnel resources than we do, and have extensive
coast-to-coast Internet networks.
We compete with national, regional, and local commercial systems integrators
who bundle their services with software and hardware providers and perform a
facilities management outsourcing role for the customer. These competitors
generally have greater name recognition or more extensive experience than we do.
Andersen Consulting, EDS and PricewaterhouseCoopers, among others, provide
professional consulting services in the use and integration of software
applications in single-project client engagements. Large systems integrators may
establish strategic relationships with software vendors to offer services
similar to our IMAP offerings. We expect that regional systems integrators are
likely to compete with us based on local customer awareness and relationships
with hardware and software companies. Additionally, regional systems integrators
may align themselves with ISPs to offer complex Web site management combined
with professional implementation services.
We compete with hardware and software companies in providing packaged
application solutions as well as network infrastructure. In order to build
market share, both hardware and software providers may establish strategic
relationships to enhance their service offerings. IBM currently provides
applications outsourcing for its Lotus Notes products and other non-IBM software
applications. J.D. Edwards & Company, a developer of enterprise resource
planning software, is offering its software in an outsourced model. Oracle is
offering Oracle Business Online, a hosted enterprise resource planning
application software solution. SAP has formed an outsourcing organization which
is developing key
43
<PAGE>
partnerships with leading consulting firms to offer SAP software. We believe
that additional hardware and software providers, potentially including our
strategic partners, may enter the outsourcing market in the future.
All of the major long distance companies, including AT&T, MCI WorldCom,
Qwest Communications and Sprint, offer Internet access services. Qwest has
partnered with KPMG to deliver hosted enterprise resource planning solutions
over the Internet, and Qwest has agreed to acquire our customer and substantial
stockholder, U S WEST. In order to address the Internet connectivity
requirements of the current business customers of long distance and local
carriers, we believe that there is a move toward horizontal integration through
acquisitions of, joint ventures with, and purchasing connectivity from, ISPs.
Accordingly, we expect that we will experience increased competition from the
traditional telecommunications carriers. Many of these telecommunications
carriers, in addition to their substantially greater network coverage, market
presence, and financial, technical and personnel resources, also have large
existing commercial customer bases. We believe that our local presence, our
strong technical and data-oriented sales force and our offering of branded
software applications are important features distinguishing us from the
telecommunications companies.
It is possible that new competitors or alliances may emerge and gain market
share. Such competitors could materially affect our ability to obtain new
contracts. Further, competitive pressure could require us to reduce the price of
our products and services thus affecting our business, financial condition and
results from operations.
PROPERTIES
We are headquartered in Annapolis, Maryland. Our training and conference
facilities are located in a building we own in Annapolis, Maryland. We believe
that the building we own, due to its age, may contain limited amounts of
asbestos containing materials. We do not believe that the limited asbestos
presence would subject us to any material liability.
On April 30, 1999, we purchased land and a building in Annapolis, Maryland
for $11.8 million. The seller financed $7.1 million of the purchase price
through a first mortgage note and will lend us an additional $1.5 million for
construction costs if we meet certain conditions. We are primarily finished
renovating this building, which became our headquarters in November of 1999.
Total cost of these renovations are anticipated to be $12 million.
In December of 1999, we obtained additional financing for the acquisition
and renovations to our headquarters in the amount of $4.75 million from a major
institutional lender. Partial payment of the loan is guaranteed by the Maryland
Industrial Development Financing Authority.
We lease space in a number of other locations, primarily for EDC and GEMC
installations and to house our consulting and implementation staff. We believe
that our leased facilities are adequate to meet our current needs in the markets
in which we have begun to deploy our services, and that additional facilities
are available to meet our expansion needs in our target markets for the
foreseeable future.
Our leases are for terms varying from 30 to 84 months and generally contain
renewal options of two to three years as well as rent escalation clauses. During
1999 we incurred approximately $3.1 million in rent expense.
EMPLOYEES
As of December 31, 1999, we employed approximately 980 people, including
full-time and part-time employees at our corporate headquarters, our GEMCs and
EDCs and at our subsidiaries. We consider our employee relations to be good.
None of our employees is covered by a collective bargaining agreement.
LEGAL PROCEEDINGS
From time to time we may be involved in litigation that arises in the normal
course of business operations. As of the date of this prospectus, we are not a
party to any litigation that we believe could reasonably be expected to have a
material adverse effect on our business or results of operations.
44
<PAGE>
MANAGEMENT
The following sets forth certain information regarding our current directors
and executive officers as of February 29, 2000.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- -------- ------------------------------------------
<S> <C> <C>
Christopher R. McCleary................... 47 Chief Executive Officer and Chairman of
the Board
Stephen E. McManus........................ 50 President--E-Commerce Business Unit and
Director
Jeffery L. McKnight....................... 56 Executive Vice President--Technical
Operations
Andrew A. Stern........................... 42 Executive Vice President--Commercial
Operations
Harold C. Teubner, Jr..................... 53 Executive Vice President and Chief
Financial Officer
Gary J. Rogers............................ 49 Senior Vice President, Worldwide Sales
Lance H. Conklin.......................... 50 President and General Manager of Lawson
Business Unit
Michael S. Harper......................... 34 President and General Manager of
PeopleSoft Business Unit
Alistair Johnson-Clague................... 49 President and General Manager of Siebel
Business Unit
Matthew D. Kanter......................... 37 President and General Manager of USI New
York
Nicholas Magliato......................... 34 President and General Manager of
Enterprise Messaging and Collaboration
Business Unit
Mark J. McEneaney......................... 36 Senior Vice President and Corporate
Controller
William T. Price.......................... 37 Vice President, Secretary and General
Counsel
R. Dean Meiszer(2)........................ 43 Director
Benjamin Diesbach(1)...................... 53 Director
David J. Poulin(2)........................ 41 Director
Ray A. Rothrock(2)........................ 44 Director
Frank A. Adams(1)......................... 54 Director
William F. Earthman(1).................... 48 Director
John H. Wyant............................. 53 Director
Joseph R. Zell............................ 40 Director
Michael C. Brooks(1)(2)................... 54 Director
Cathy M. Brienza.......................... 51 Director
</TABLE>
- ------------------------
(1) Member of the compensation committee
(2) Member of the audit committee
CHRISTOPHER R. MCCLEARY is a co-founder of USI and has served as the
Chairman and Chief Executive Officer of USI since January 1998. Prior to
founding USI, he was the Chairman and Chief Executive Officer of DIGEX, Inc.
from January 1996 to December 1997. Prior to serving at DIGEX, Mr. McCleary
served as Vice President and General Manager for Satellite Telephone Service at
American Mobile Satellite Corporation, a satellite communications company, from
October 1990 to January 1996.
45
<PAGE>
STEPHEN E. MCMANUS is a co-founder of USI and has served as a director since
April 1998. He served as President of USI until June 1999, at which time he
became President of our E-Commerce Business Unit. Prior to joining USI,
Mr. McManus was Director of U.S. Sales for the telecommunications unit of Data
General Corporation from January 1998 to March 1998. From June 1995 to
December 1997 Mr. McManus served as a Branch Manager for Silicon Graphics. Prior
to joining Silicon Graphics, Mr. McManus held several positions at Data General
Corporation from June 1988 to May 1995, including District Manager for
Distributor Sales, VAR District Manager and Branch Manager.
JEFFERY L. MCKNIGHT has been Executive Vice President of our Technical
Operations since December 1998. He originally joined USI in June of 1998 as
Senior Vice President of Client Care. Previously, he held senior marketing and
operations positions with Aeronautical Radio, Inc., or ARINC, the communications
arm of all of the domestic airlines from May 1989 to July 1997. Prior to ARINC,
he held senior operations positions with System One, Inc. from February 1963 to
April 1989.
ANDREW A. STERN has been Executive Vice President of our Commercial
Operations since June of 1999. He originally joined USI on July 24, 1998 as
Executive Vice President and Chief Financial Officer. Prior to joining USI,
Mr. Stern held positions at USF&G Corporation, an insurance company, from
May 1993 to July 1998, most recently as Executive Vice President, Strategic
Planning and Reinsurance Operations. In addition, Mr. Stern was a partner of
Booz Allen & Hamilton, an international management and technology consulting
firm with whom he was employed from August 1981 to May 1993.
HAROLD C. TEUBNER, JR. has been Executive Vice President and Chief
Financial Officer of USI since October 1999. From July 1998 until joining USI,
Mr. Teubner worked as an independent consultant in the technology industry.
Mr. Teubner served as the Executive Vice President and Chief Operating Officer
at Concept Five Technologies from July 1997 to July 1998. During September 1996,
Mr. Teubner served as COO of Nat Systems International, a French software
company. Prior to joining Concept Five Technologies, Mr. Teubner was President
and CEO of Visix Software, a company that builds high-end, object oriented,
application development tools. Mr. Teubner was with Visix from July 1995 to
June 1996. Mr. Teubner held positions with Sybase Inc. from January 1988 to
April 1995. While at Sybase, Mr. Teubner served as the Senior Vice President of
North American Operations from July 1992 to April 1995.
GARY J. ROGERS joined USI in October 1999 as Vice President, Worldwide
Sales. Prior to joining USI, Mr. Rogers was with CMS/Data, a division of PC Docs
Group International, Inc. from September 1997 to September 1999. While at
CMS/Data, Rogers served in various capacities including: Vice President, Sales
and Marketing and President, Chief Operating Officer. From May 1994 to July
1997, Mr. Rogers was with SQL Financials International, Inc. where he worked as
Vice President of Sales and Regional Sales Manager. Mr. Rogers was an Area Sales
Manager with The ASK Group/ Ingres from August 1990 to April 1994.
LANCE H. CONKLIN has been President and General Manager, Lawson Business
Unit since September of 1999. Mr. Conklin was a Vice-President and Co-Founder of
Conklin & Conklin, Inc., a leading reseller and systems integrator of Lawson
Software applications, from June 1982 until September 1999 when USI acquired
Conklin & Conklin, Inc.
MICHAEL HARPER joined USI in April of 1998 as Vice President of Product
Marketing. In January of 1999, Mr. Harper was promoted to Vice President and
General Manager of PeopleSoft Business Unit. In July of 1999, Harper was named
President and General Manager, PeopleSoft Business Unit. Prior to joining USI,
Mr. Harper served as the Mid-Atlantic Systems Manager for Silicon Graphics, Inc.
from July 1997 to April 1998 with responsibility for pre-sales and professional
service to federal and commercial customers. Prior to Silicon Graphics, Mr.
Harper was with IBM in various marketing, sales and professional service
capacities from July 1989 to July 1994.
46
<PAGE>
ALISTAR JOHNSON-CLAGUE joined USI in October of 1999 as the President &
General Manager, Siebel Business Unit. Prior to joining USI, Mr. Johnson-Clague
was with Avent Inc., from December 1998 to June of 1999. From August of 1985 to
December of 1998 Mr. Johnson-Clague served in various capacities while at JBA
Holdings Plc, including: President/CEO--Computer Solutions Division,
President--US Software Solutions Division, General Manager-JBA (Northern) Ltd.,
and General Sales Manager-JPA Southeast.
MATTHEW D. KANTER has been President and General Manager of USI New York
since July 1999. He originally joined USI in October of 1998 as Vice President
and General Manager of USI New York. Prior to joining USI, Mr. Kanter served as
President and Chief Executive Officer of Advanced Communications Resources, Inc.
from July 1995 to October 1998. Prior to serving as President and Chief
Executive Officer, Mr. Kanter served as Vice President and Technical Director of
Advanced Communications Resources, Inc. from January 1993 to July 1995.
NICK MAGLIATO has been President and General Manager of Enterprise Messaging
and Collaboration Business Unit since July 1999. Previously he served as the
General Manager of the Private Networking Unit for DIGEX from March 1996 to May
1998. Prior to that, he was Director-Land Mobile Product, Sales and
Distribution, for American Mobile Satellite Corporation from March 1994 to March
1996.
MARK J. MCENEANEY joined USI in April 1998 as its Vice President and
Corporate Controller. In October 1999 Mr. McEneaney was promoted to Senior Vice
President and Controller. Prior to USI, he was Chief Financial Officer of
Questar Builders, Inc., from November 1997 to March 1998 and of William Ryan
Homes, Inc. from April 1995 to October 1997.
WILLIAM T. PRICE has been Vice President, Secretary and General Counsel of
USI since April 1998. Prior to joining USI, Mr. Price was the senior trial
associate in the Baltimore-based law firm of Albright, Brown & Goertemiller from
April 1997 to April 1998, where he represented major corporate clients in
antitrust, copyright intellectual property and other commercial matters in
various state and federal courts. Prior to joining Albright, Brown &
Goertemiller, Mr. Price was a litigator and Managing Attorney for the New York
based law firm of Finklestein and Levine. Mr. Price was with Finklestein and
Levine from April 1993 to October 1996.
R. DEAN MEISZER has been a director of USI since it was founded. Currently,
Mr. Meiszer serves as the President of Lattice Communications, Ltd. Lattice
Communications was formed in October 1997 by the principals and associates of
Crisler Company to own, operate, and manage wireless transmission towers and
related businesses. Meiszer has been President and Managing Director of The
Crisler Company, a Cincinnati-based investment firm, since May 1989. Prior to
Crisler, Mr. Meiszer was Senior Vice President of Society Bank from March 1978
to May 1989.
BENJAMIN DIESBACH was appointed to the board of directors in May 1998 as a
designee of Mr. McCleary in his role as Chief Executive Officer of USI. He has
been President of Midwest Research, Inc., a consulting firm, since he formed it
in January 1995. Prior to forming Midwest Research, Mr. Diesbach was Chief
Executive Officer of Continental Broadcasting, Ltd., a broadcasting company,
from September 1993 to January 1995.
DAVID J. POULIN was appointed to the board of directors in May 1998 as a
designee of Mr. McCleary in his role as Chief Executive Officer. He has been the
head hockey coach at the University of Notre Dame since May 1995. Prior to
joining Notre Dame as hockey coach, Mr. Poulin played in the National Hockey
League for 13 years.
RAY A. ROTHROCK was appointed to the board of directors in June 1998 as a
designee of the Venrock Group. He has been a General Partner of Venrock
Associates, the high technology venture capital investment firm of the
Rockefeller Family, since June 1988. Mr. Rothrock serves on the boards of
directors of CheckPoint Software Technology and several private companies
including Qpass, Rights Exchange, Appliant, Inc., Sbyn Technology and Simba
Technology.
47
<PAGE>
FRANK A. ADAMS was appointed to the board of directors in June 1998 as a
designee of the Grotech Group. He is the President and Chief Executive Officer
of Grotech Capital Group, which he co-founded in August 1984. Mr. Adams has
served as President of the Mid-Atlantic Venture Association since July 1985. He
has served on the board of directors of a number of technology companies
including Thunderbird Technologies, Inc. and EPIC Therapeutics, Inc.
WILLIAM F. EARTHMAN was appointed to the board of directors in June 1998 as
a designee of the Massey Burch Group. He has been a Partner of Massey Burch
Capital Corporation since January 1994. Prior to becoming a Partner at Massey
Burch Capital Corporation, Mr. Earthman served from January 1990 as a Vice
President of Massey Burch Investment Group. Prior to Massey Burch, he worked for
the investment banks J.C. Bradford & Co. from September 1975 to October 1981,
Prudential-Bache Securities from October 1981 to November 1985 and First
Nashville Corp. from December 1985 to December 1989. He currently serves on the
board of directors of Intellivoice Communications, Inc. and Legal Technologies
Network, Inc.
JOHN H. WYANT was appointed to the board of directors in June 1998 as a
designee of the Blue Chip Group. He is the Managing Partner and President of
Blue Chip Venture Company, which he founded in 1990. Mr. Wyant is currently a
director of Regent Communications, Inc., Zaring Homes, Inc., Delicious Brands,
Inc. and Ciao Cucina Corporation. He previously served as a director of DIGEX.
JOSEPH R. ZELL was appointed to the board of directors in July 1998 as a
designee of U S WEST. Mr. Zell has informed us that he will resign as a director
effective February 1, 2000, upon acceptance of his resignation by the board of
directors. We expect the board of directors to accept his resignation prior to
our 2000 annual meeting. Since December 1991, he has held several positions with
the !NTERPRISE Networking division of U S WEST Communications, Inc., including
Director of Product Development for !NTERPRISE, Executive Director of
Applications Innovation, President of U S WEST's Wholesale Division and Vice
President of Markets and innovation at !NTERPRISE. He has been President of the
division since March 1997.
MICHAEL C. BROOKS was appointed to the board of directors in December 1998
as a designee of the Whitney Group. He has been a general partner of J. H.
Whitney & Co. since 1984. He is also a director of SunGard Data Systems, Inc.,
Pegasus Communications Corporation, Media Metrix, Inc., Homestore.com, Inc.,
VitaminShoppe.com, Inc. and various other private companies.
CATHY M. BRIENZA was appointed to the board of directors in May 1999 as a
designee of Waller-Sutton Media Partners, L.P. Since July 1997, Ms. Brienza has
been a member of Waller-Sutton Media, L.L.C., the general partner of
Waller-Sutton Media Partners, L.P. Prior to joining Waller-Sutton Media, she was
a principal of Sutton Capital Associates, Inc., and its affiliated companies,
which engaged in the ownership and operation of cable television and cellular
telephone systems.
CLASSIFICATION OF THE BOARD OF DIRECTORS
Each director holds office until his or her successor has been elected and
qualified. In April 1999, the board of directors divided itself into three
classes. Messrs. Brooks, Earthman and Zell and Ms. Brienza serve in the class
whose term expires in 2000; Messrs. Adams, McManus, Rothrock and Wyant serve in
the class whose term expires in 2001; and Messrs. Diesbach, Meiszer, Poulin and
McCleary serve in the class whose terms expires in 2002. Upon the expiration of
the term of each class of directors, the stockholders will at their next annual
meeting elect directors to serve in that class for a three-year term.
48
<PAGE>
COMMITTEES OF THE BOARD OF DIRECTORS
In June 1998, the board of directors established a compensation committee
and an audit committee. The compensation committee makes recommendations
concerning salaries and incentive compensation of our employees and consultants
and administers our stock option plan. The audit committee reviews, acts on and
reports to the board of directors with respect to various auditing and
accounting matters, including reviewing our audit policies, overseeing the
engagement of our independent auditors and developing our financial strategies.
In December 1999, the Securities and Exchange Commission adopted new rules to
improve disclosure relating to the functioning of corporate audit committees. We
are currently evaluating the impact of these new rules; however, we believe
these rules will not have a significant impact.
COMPENSATION OF DIRECTORS
All non-employee directors are reimbursed for travel and other related
expenses incurred in attending meetings of the board of directors. In addition,
each non-employee director then serving on the board of directors is eligible to
receive option grants under our stock option plan. The shares of common stock
purchased pursuant to these options will be subject to repurchase by us as
described in " --Stock Option Plan."
EMPLOYMENT AGREEMENTS
We have entered into the following employment agreements with our executive
officers.
<TABLE>
<CAPTION>
OFFICER TERM SALARY POSITION
- ------- ---------------------- -------- ------------------------------
<S> <C> <C> <C>
Christopher R. McCleary....... January 1998- $250,000 Chairman and Chief Executive
December 2000 Officer
Stephen E. McManus............ April 1998-April 2003 $175,000 President, E-Commerce Business
Unit
Andrew A. Stern............... July 1998-July 2001 $175,000 Executive Vice President--
Commercial Operations
Jeffery L. McKnight........... July 1998-July 2001 $175,000 Executive Vice President--
Technical Operations
Harold C. Teubner, Jr......... September 1999- $250,000 Executive Vice President and
September 2002 Chief Financial Officer
Gary J. Rogers................ September 1999- $225,000 Senior Vice President,
September 2002 Worldwide Sales
Lance H. Conklin.............. October 1999- $200,000 President and General Manager
December 2001 of Lawson Business Unit
Michael S. Harper............. September 1999- $175,000 President and General Manager
September 2002 of PeopleSoft Business Unit
Alistair Johnson-Clague....... October 1999- $225,000 President and General Manager
October 2002 of Siebel Business Unit
Matthew D. Kanter............. October 1998- $225,000 President and General Manager
October 2001 of USI New York
Nicholas Magliato............. July 1999- $200,000 President and General Manager
July 2002 of Enterprise Messaging and
Collaboration Business Unit
Mark J. McEneaney............. September 1999- $175,000 Senior Vice President and
September 2002 Corporate Controller
William T. Price.............. September 1999- $110,000 Vice President, Secretary and
September 2002 General Counsel
</TABLE>
49
<PAGE>
Mr. McCleary's agreement also provides for:
- automatic renewal for subsequent one year terms unless either party elects
not to renew prior to 90 days from the end of the then current term of the
agreement;
- a bonus to be determined based on his meeting established management
objectives with a minimum of $250,000 in the second year of the agreement
and $500,000 in the third year of the agreement;
- the right to terminate him for cause upon a vote of two-thirds of the
board of directors preceded by a finding by the compensation committee or
executive committee that he has breached the agreement;
- the payment of his full salary for the term of the agreement if he
terminates the agreement because:
-- we breach the agreement;
-- there is a material adverse change in his job responsibilities, duties,
function or reporting relationships; or
-- he is required to travel more than 50 miles to a relocated office;
- the payment of his full salary for the term of the agreement if he is
terminated without cause; and
- the payment of his bonus after he terminates the agreement for other than
the reasons described above if its amount had already been determined by
the compensation committee.
Mr. McManus, Mr. McKnight, Mr. Stern and Mr. Conklin's agreements all
provide for:
- No obligation to pay salary after a termination for cause due to:
-- a breach of the agreement by the officer;
-- engaging in illegal or immoral practices or activities which can
reasonably be expected to be materially detrimental to our reputation;
--being dishonest, disloyal, or fraudulent in performing his duties;
--willful misconduct or dereliction of his duties;
--using, possessing, selling or delivering illegal drugs; or
--in the case of Mr. McManus and Mr. Conklin, substantial failure to
perform his duties;
if the action giving rise to the termination is not cured within 60 days and an
arbitrator finds the termination to be valid.
Mr. Stern's agreement also provides for:
- the right, which he has exercised, to purchase 1,406,250 shares of our
common stock;
- a life insurance policy provided by us in an amount equal to twice his
salary less the amount of any group insurance he selects as part of our
standard group insurance plan;
- our right to repurchase the 1,406,250 shares of stock, less the number of
shares Mr. Stern sold in our February 2000 public offering of common stock
for the total tax liability incurred by Mr. Stern as a result of his
purchase, if he is terminated for cause or if he terminates the agreement
on or before May 31, 2000, unless it is a termination for good reason;
50
<PAGE>
- our obligation to register the 1,406,250 shares of stock for sale under
the Securities Act as soon as practicable in the event the officer's
employment is terminated due to death or disability; and
- the obligation to pay the officer's full salary for the remainder of the
term of the agreement or one year, if longer, and a bonus pro rated for
the remaining term of the agreement if we terminate one of them without
cause.
Mr. McManus' agreement also provides for:
- the right, which he has exercised, to purchase 1,125,000 shares, less the
number of shares Mr. McManus has sold in our February 2000 public offering
of our common stock;
- a life insurance policy provided by us in an amount equal to twice his
salary less the amount of any group insurance he selects as part of our
standard group insurance plan;
- our right to repurchase 281,250 shares of stock for $100 if he is
terminated for cause or if he terminates the agreement on or before May
31, 2000; and
- our right to repurchase all or part of 843,750 shares of stock for $100.00
if he is terminated for cause (including substantial failure to perform
his duties) or if he terminates the agreement before April 1, 2003.
Mr. McKnight's agreement also provides for:
- the grant of an option to purchase 843,750 shares of common stock under
our stock option plan; and
- the termination of our right to repurchase his shares under the option
plan 24 hours before any termination of his employment without cause.
If Mr. Rogers is terminated without cause, we must pay him an amount equal
to his annual base salary until the end of the term or for twelve months
whichever is greater, accelerate all unvested stock options and pay any sales
commissions or bonuses owed.
Mr. Rogers' agreement also provides for:
- the grant of an option to purchase 225,000 shares of our common stock
under our stock option plan; and
- the grant of 40,500 shares of common stock, half of which vests
immediately upon the execution of the agreement and the balance vests upon
the first anniversary of Mr. Rogers' employment.
Mr. Teubner's agreement provides for:
- the grant of an option to purchase 675,000 shares of our common stock
under our stock option plan; and
- the termination of our right to repurchase his shares under the option
plan upon termination of his employment without cause.
Mr. Conklin's agreement also provides for:
- a bonus of 40% to 80% of his annual base salary to be determined based on
his attainment of performance goals;
- the payment of his full salary and a continuation of benefits for the
remainder of the term of the agreement and the payment of a prorated bonus
if he terminates the agreement because:
51
<PAGE>
-- we breach the agreement; or
-- we breach any of the post-closing obligations under the asset purchase
agreement between USI and the shareholders of Conklin dated September
20, 1999;
- the payment of his full salary and the continuation of benefits for the
remainder of the term of the agreement and a prorated bonus if he is
terminated without cause;
Mr. Harper's agreement also provides for:
- a discretionary bonus of 50% to 100% of his annual base salary;
- the grant of an option to purchase 140,625 shares of common stock at a
strike price of $2.67 per share; and
- the grant of an incentive stock option to purchase 50,625 shares of common
stock at a price of $9.11 per share.
Mr. Johnson-Clague's agreement also provides for:
- a discretionary bonus of 50% to 100% of his annual base salary along with
a one time signing bonus of $55,000 to be paid in February 2000;
- the grant of an incentive stock option to purchase 202,500 shares of
common stock at a price of $13.45 per share; and
- the grant of 22,500 shares of restricted stock at $0.001 per share.
Mr. Kanter's agreement also provides for:
- a bonus of $75,000 contingent on the attainment of predetermined
objectives; and
- a retention bonus of $200,000 for employment through October 9, 1999 and
$195,000 for employment through December 31, 2000.
Mr. Magliato's agreement also provides for:
- a discretionary bonus of up to 100% of his annual salary and a signing
bonus of $100,000;
- the grant of 37,500 shares of common stock with periodic vesting over a
three year period; and
- the grant of a non-qualified option to purchase 168,750 shares of common
stock at an exercise price of $12.89 per share.
Mr. McEneaney's agreement also provides for:
- a discretionary bonus of 50% of his annual salary; and
- a grant of an incentive stock option to purchase 112,500 shares of common
stock at a price of $9.11 per share.
Mr. Price's agreement also provides for:
- a discretionary bonus of 35% of his annual salary; and
- a grant of an incentive stock option to purchase 56,250 shares of common
stock at a price of $9.11 per share.
Some of the agreements provide for the termination of our right to
repurchase shares held by the officers upon a change in control of the company.
All of the agreements provide for review of the salary and bonus terms by our
compensation committee.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to June 1998, we had no separate compensation or stock option
committee or other board committee performing equivalent functions, and these
functions were performed by our board of directors. Both Mr. McCleary and Mr.
McManus were members of the board of directors during that period. In June 1998,
we established compensation and audit committees of our board of directors. The
compensation committee is composed of non-employee directors. See "--Committees
of the Board of Directors."
52
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION. The following table provides summary information
concerning compensation that we paid to or accrued on behalf of our "Named
Executive Officers," which are our Chief Executive Officer and each of the three
most highly compensated executive officers of USI other than the Chief Executive
Officer who earned more than $100,000, in salary and bonus, for all services
rendered in all capacities during the fiscal year ended December 31, 1999. The
aggregate amount of perquisites and other personal benefits, securities or
property received by each of the Named Executive Officers was less than either
$50,000 or 10% of the total annual salary and bonus reported for that Named
Executive Officer:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------------ LONG TERM COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS SHARES UNDERLYING OPTIONS
- --------------------------- -------- ------ ----- -------------------------
<S> <C> <C> <C> <C>
Christopher R. McCleary
Chief Executive Officer and Chairman of
the Board................................. 1998 $131,250 $ 75,000 --
1999 250,000 (a) 843,750
Stephen E. McManus
President--E-Commerce Business Unit and
Director.................................. 1998 131,250 75,000 --
1999 175,000 (a) --
Jeffery L. McKnight,
Executive Vice President--Technical
Operations................................ 1998 75,962 125,000 843,750
1999 175,000 (a) --
Andrew A. Stern
Executive Vice President--Commercial
Operations................................ 1998 78,076 75,000 --
1999 175,000 (a) --
Matthew D. Kanter
President and General Manager--USI New
York...................................... 1998 40,215 -- 30,938
1999 201,000 275,000 194,063
</TABLE>
- ------------------------
(a) We have accrued an aggregate estimated bonus amount for all employees for
the year ended December 31, 1999, but individual bonus amounts have not yet
been finally determined for 1999.
STOCK OPTIONS. The following table contains information after giving effect
to our stock split concerning the stock option grants made to each of the Named
Executive Officers during the fiscal year ended December 31, 1999:
- The options described in the table below are immediately exercisable and
expire on the tenth anniversary of the date of grant. Shares of common
stock purchased pursuant to these options will be subject to our right to
repurchase them at the option exercise price upon the termination of the
holder's employment or business relationship with us. The repurchase right
with respect to the shares purchased upon exercise of Mr. McCleary's
option has lapsed with respect to three-quarters of the shares purchasable
upon exercise of the option. The repurchase right with respect to the
remainder of the shares purchasable upon exercise of an option will lapse
upon the earlier of the fourth anniversary of the date of grant as USI
meeting certain performance objectives set by the compensation committee.
The repurchase rights with respect to the shares purchasable upon exercise
of Mr. Kanter's options expire with respect to one-third of these options
on the first anniversary of their grant and thereafter, in eight equal
quarterly installments.
53
<PAGE>
- The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the SEC. There can be no assurance that the
actual stock price appreciation over the ten-year option term will be at
the assumed 5% and 10% levels or at any other defined level. Unless the
market price of the common stock appreciates over the option term, no
value will be realized from the option grants. The potential realizable
value is calculated by assuming that the fair market value of the common
stock on the date of grant of the options appreciates at the indicated
rate for the entire term of the option and that the option is exercised at
the exercise price and sold on the last day at the appreciated price.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES
OF STOCK PRICE
NUMBER OF SHARES OF % OF TOTAL APPRECIATION
COMMON STOCK OPTIONS GRANTED EXERCISE FOR OPTION TERM
UNDERLYING OPTIONS TO EMPLOYEES IN PRICE EXPIRATION --------------------
NAME GRANTED 1999 PER SHARE DATE 5% 10%
- ---- ------------------- --------------- --------- ---------- -- ---
<S> <C> <C> <C> <C> <C> <C>
Christopher R. 843,750 8.0% $ 2.67 3/19/09 $3,665,013 $5,835,921
McCleary..............
Stephen E. McManus...... -- -- -- -- -- --
Jeffery L. McKnight..... -- -- -- -- -- --
Andrew A. Stern......... -- -- -- -- -- --
Matthew D. Kanter....... 56,250 0.5 2.67 3/19/09 244,334 389,061
Matthew D. Kanter....... 84,375 0.7 2.67 5/14/09 366,501 583,592
Matthew D. Kanter....... 10,976 0.1 9.11 9/24/09 162,928 259,435
Matthew D. Kanter....... 42,462 0.3 9.11 9/24/09 630,334 1,003,701
</TABLE>
OPTION EXERCISES AND YEAR-END OPTION VALUES. The following table sets forth
information after giving effect to our stock split concerning each option
exercise by the Named Executive Officers in fiscal 1999 and option holdings
through December 31, 1999 by the Named Executive Officers who held options at
the end of fiscal 1999:
- "Exercisable" refers to those options which will be vested and exercisable
immediately upon completion of this offering, while "Unexercisable" refers
to those options which will be unvested at such time.
- Value is determined by subtracting the exercise price from the fair market
value of the common stock multiplied by the number of shares underlying
the options.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES OF
COMMON STOCK VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
OPTIONS AT YEAR END OPTIONS AT YEAR END
SHARES ACQUIRED VALUE ------------------- --------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- --------------- ---------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Christopher R.
McCleary........... 843,750 $5,439,375(1) -- -- -- --
Jeffery L. McKnight.. -- -- 843,750 -- $38,314,687(2) --
Matthew D. Kanter.... 10,125 -- 214,875 -- $10,009,594(2) --
</TABLE>
- ------------------------
(1) Fair market value is based on the last reported sale price of the common
stock on September 24, 1999, the date Mr. McCleary exercised his shares, of
$9.11 per share.
(2) Fair market value is based on the last reported sale price of the common
stock on December 31, 1999 of $46.58 per share.
54
<PAGE>
STOCK OPTION PLAN
Our 1998 Stock Option Plan, approved by the board of directors in July 1998,
amended and restated in February 1999 and further amended in October and
December of 1999, provides for the issuance of up to 25,160,063 shares of common
stock pursuant to the grant of stock options, both nonqualified stock options
and incentive stock options, as defined in our option plan, stock appreciation
rights, restricted stock awards, deferred stock awards, dividend equivalents and
other stock-related benefits to independent directors, employees and
consultants. As of December 31, 1999, after giving effect to our stock split,
options to purchase 11,919,073 shares of common stock were outstanding, each
with a weighted average exercise price of $6.77 per share and 11,559,591 options
are available for future grant. The options vest immediately upon the date of
grant.
Shares of common stock purchased pursuant to options under our option plan
will be subject to our right to repurchase them at the option exercise price
upon the termination of the holder's employment or business relationship with
us. Generally the repurchase right will lapse with respect to one-third of the
shares purchasable upon exercise of an option on the first anniversary of the
date of grant of the option. The repurchase right with respect to the remainder
of the shares purchasable upon exercise of an option will lapse in equal
quarterly installments over the subsequent eight calendar quarters. Our
repurchase right with respect to shares held by any particular employee will
lapse completely if there is a change in control of USI and the employee's
employment is terminated within 12 months of the change of control.
The compensation committee appointed to administer our option plan has
discretion to determine which employees and consultants will be granted stock
options, the number of shares to be optioned, and the terms and conditions of
such options. The full board of directors conducts the administration of the
option plan with respect to options granted to independent directors or to
officers subject to section 16 of the Exchange Act. The compensation committee,
or the board of directors, as applicable, also has discretion to make
adjustments to options in the event of a change in control or other corporate
event including, without limitation, the discretion to accelerate the vesting of
options or waive our repurchase right.
The federal income tax consequences, in general, of the grant and exercise
of an ISO under our option plan are as follows.
- In general, an employee will not recognize taxable income upon the grant
or exercise of an ISO and we will not be entitled to any business expense
deduction with respect to the grant or exercise of an ISO.
- If the employee holds the shares for at least two years after the date of
grant and for at least one year after the date of exercise, the
difference, if any, between the sales price of the shares and the exercise
price of the option will be treated as long-term capital gain or loss upon
subsequent disposition of the shares.
- If the employee disposes of the shares prior to satisfying the holding
period requirements, the employee will recognize ordinary income at the
time of the disposition, generally in an amount equal to the excess of the
fair market value of the shares at the time the option was exercised over
the exercise price of the option. Generally, we will be allowed a business
expense deduction to the extent an employee recognizes ordinary income.
The balance of the gain realized, if any, will be short-term or long-term
capital gain, depending upon whether the shares have been held for at
least twelve months after the date of exercise.
The federal income tax consequences, in general, of the grant and exercise
of an NSO under our option plan are as follows.
55
<PAGE>
- In general, a recipient who receives a NSO will recognize no income at the
time of the grant of the option.
- Upon exercise of an NSO, a recipient will recognize ordinary income in an
amount equal to the excess of the fair market value of the shares on the
date of exercise over the exercise price of the option. Generally, we will
be entitled to a business expense deduction in the amount and at the time
the recipient recognizes ordinary income.
- The basis in shares acquired upon exercise of an NSO will equal the fair
market value of the shares at the time of exercise, and the holding period
of the shares, for capital gain purposes, will begin on the date of
exercise.
EMPLOYEE STOCK PURCHASE PLAN
Our Board of Directors has adopted the 2000 Employee Stock Purchase Plan, or
the Purchase Plan. The Purchase Plan is intended to be an "employee stock
purchase plan" as described in Section 423 of the Code. The Purchase Plan is
administered by the compensation committee of our Board of Directors. A total of
2,250,000 shares of our common stock are reserved and available for purchase
under the Purchase Plan, subject to antidilution and other adjustment
provisions.
The Purchase Plan permits eligible employee participants to purchase our
common stock through payroll deductions at a price per share which is equal to
the lesser of eight-five percent (85%) of the fair market value of the common
stock on the first or the last day of an offering period. The Purchase Plan
provides for two offering periods each calendar year. The first is March 24
through August 31 and the second is September 1 through February 28 (or, each
leap year, February 29). On the last day of each offering period, each
participant's accrued payroll deductions are automatically applied to the
purchase of common stock.
Employees eligible to participate in the Purchase Plan consist of all
persons employed for at least 90 days by us or by certain of our subsidiaries
described in the Purchase Plan, except that the Purchase Plan excludes from
participation any employee whose customary employment is for less than 20 hours
per week or for not more than 5 months during a calendar year and any employee
who owns stock representing 5% or more of the total combined voting power or
value of all classes of our stock or the stock of our subsidiaries. No
participant may purchase shares of common stock in any calendar year under the
Purchase Plan with an aggregate fair market value (generally determined as of
the beginning of the plan year) in excess of $25,000.
401(K) PLAN
In 1998, we adopted a 401(k) plan covering substantially all of our
employees. Under the plan, eligible employees may elect to reduce their current
compensation and have the amount of the reduction contributed to the plan on the
employee's behalf as salary deferral contributions. Beginning as of June 30
1999, we have begun to make matching contributions to the plan on behalf of our
employees in the amounts equal to 50 percent of the first six percent of an
employee's earnings contributed to the plan. Matching contributions are in the
form of our common stock and not in cash. All contributions to the plan by or on
behalf of employees are subject to aggregate annual limits prescribed by the
Internal Revenue Code.
56
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PURCHASES OF SERIES A PREFERRED STOCK
On May 31, 1998, pursuant to an agreement dated May 13, 1998, Blue Chip
Capital Fund II Limited Partnership; Miami Valley Venture Fund L.P.; Grotech
Partners IV L.P.; Grotech Partners V L.P.; Southern Venture Fund SBIC, L.P.;
Southern Venture Fund II, L.P.; Venrock Associates; and Venrock
Associates II, L.P., a group we refer to as the Initial Series A Purchasers,
purchased, in the aggregate, 38,333.33 shares of Series A Preferred Stock for an
aggregate purchase price of $23.0 million.
In connection with the issuance of the shares to the Initial Series A
Purchasers, we issued 1,666.67 shares of Series A Preferred Stock to
Christopher R. McCleary, in exchange for the cancellation of $1.0 million of
debt that we owed to Mr. McCleary.
In an agreement dated June 18, 1998, we issued an additional 5,000 shares of
Series A Preferred Stock to certain of the Initial Series A Purchasers for an
aggregate purchase price of $3.0 million.
In an agreement dated June 18, 1998, we issued 5,833.33 shares of Series A
Preferred Stock to U S WEST for $3.5 million.
In agreements dated June 19, 1998, we issued 3,000 shares of Series A
Preferred Stock to HAGC Partners; Chris Horgan, who later transferred his
interest to his affiliate, Southeastern Technology Fund, L.P.; and a series of
purchasers represented by Account Management Corporation, a group we refer to as
the Account Management Purchasers; for an aggregate purchase price of
$1.8 million. Also on June 19, 1998, 1,166.67 shares of Series A Preferred Stock
were sold to USI Partners, Ltd. for $700,002.
Upon the closing of our initial public offering in April 1999, each holder
of Series A Preferred Stock received on conversion the number of shares of
common stock arrived at by dividing the aggregate purchase price for the
holder's shares of Series A Preferred Stock by the conversion price of $1.18.
BRIDGE FINANCINGS AND PURCHASES OF SERIES B PREFERRED STOCK
In agreements dated September 8, 1998, all of the existing holders of
Series A Preferred Stock, other than Southern Venture Fund SBIC, L.P., HAGC
Partners, Christopher McCleary and two of the Account Management Purchasers,
purchased our convertible promissory notes in the aggregate principal amount of
$9,095,000, together with warrants to purchase 2,192,513 shares of common stock
for $0.035 per share. Each note was convertible into preferred stock of USI
having an aggregate fair market value equal to the principal amount of the note.
The principal amount of these notes was converted into Series B Convertible
Preferred Stock on December 31, 1998 at a conversion price equal to the $1,050
per share purchase price of the Series B Preferred Stock, and the accrued
interest was paid in cash.
On December 16, 1998, Blue Chip Capital Fund II, L.P. lent us $1.0 million,
which was repaid with interest, in cash, as of December 31, 1998.
In an agreement dated December 16, 1998, Grotech Partners V L.P.; Southern
Venture Fund II, L.P.; Venrock Associates; Venrock Associates II, L.P.; USI
Partners, Ltd.; and Siebel Systems, Inc. purchased our convertible promissory
notes in the aggregate amount of $8.0 million. Each note was convertible into
preferred stock of USI having an aggregate fair market value equal to the
principal amount of the note. The principal amount of these notes was converted
into Series B Preferred Stock on December 31, 1998 at a conversion price equal
to the $1,050 per share purchase price of the Series B Preferred Stock, and the
accrued interest was paid in cash.
57
<PAGE>
In an agreement dated December 29, 1998, U S WEST purchased our convertible
promissory note in the amount of $5.0 million. Each note was convertible into
preferred stock of USI having an aggregate fair market value equal to the
principal amount of the note. The principal amount of this note was converted
into Series B Preferred Stock on December 31, 1998, at a conversion price equal
to the $1,050 per share purchase price of the Series B Preferred Stock, and the
accrued interest was paid in cash.
On December 31, 1998, the principal amount of all of our outstanding
convertible promissory notes, $22,095,000, was converted into 21,042 shares of
Series B Preferred Stock with a purchase price of $1,050 per share. The accrued
interest on these notes was paid in cash. In addition, the warrants we issued in
connection with the issuance of our convertible promissory notes were exchanged
for otherwise identical warrants having an exercise price of $1.53 per share
after giving effect to our stock split.
In an agreement dated December 31, 1998, we issued 59,278.56 shares of
Series B Preferred Stock for an aggregate purchase price of $62,242,500, of
which $22,095,000 was paid by conversion of the convertible promissory notes
identified above, to the holders of the convertible promissory notes described
above and J. H. Whitney III, L.P.; Whitney Strategic Partners III, L.P.;
Waller-Sutton Media Partners, L.P.; Arbor Venture Partners, L.L.C.; Southeastern
Technology Fund, L.P.; PNC Bank, N.A., Trustee; PNC Bank, N.A., Custodian; AEH
Profit Sharing Trust; Castellini Management Company; and all of the holders of
Series A Preferred Stock except Southern Venture Fund SBIC, L.P.; HAGC Partners;
and two of the Account Management Purchasers. Upon the closing of our initial
public offering in April 1999, each holder of Series B Preferred Stock received
on conversion the number of shares of common stock arrived at by dividing the
aggregate purchase price for the holder's shares of Series B Preferred Stock by
the conversion price of $1.49 per share after giving effect to our stock split.
The agreement in which we issued the Series B Preferred Stock includes a
repurchase requirement. In the event that we become an "Affiliate" of
U S WEST, as that term is defined in Section 3(1) of the Communications Act of
1934, and we are also providing services that an Affiliate of U S WEST would be
prohibited from providing, then U S WEST can require us to purchase, and we can
require U S WEST to sell to us, the minimum number of our shares needed to
prevent us from being deemed an Affiliate of U S WEST. The repurchase price, in
either instance, would be the last reported price on the Nasdaq National Market,
or as determined by the board of directors if we are no longer publicly traded.
We are not presently an Affiliate of U S WEST.
AMENDED AND RESTATED STOCKHOLDERS' AGREEMENT
REGISTRATION RIGHTS. According to the terms of the Amended and Restated
Stockholders' Agreement, the holders of the Preferred Stock, together referred
to as the investors, have rights to register shares of our capital stock. At any
time 90 days after the effective date of the first registration statement that
we filed under the Securities Act, holders of at least 33% of the Registrable
Securities, as defined in the Stockholders' Agreement, may require us to effect
registration under the Securities Act of their registrable securities, subject
to the board of directors' right to defer the registration for a period of up to
180 days. The investors also have the right to cause us to register their
securities on Form S-3 when it becomes available to us if they propose to
register securities having a value of at least $10 million. In addition, if we
propose to register securities under the Securities Act, other than
registrations on Form S-4 or Form S-8, then any of the investors has a right,
subject to quantity limitations we determine, or determined by underwriters if
this offering involves an underwriting, to request that we register such
holder's registrable securities. We will bear all registration expenses incurred
in connection with registrations. We have agreed to indemnify the investors
against liabilities related to the accuracy of the registration statement used
in connection with any registration effected pursuant to the foregoing.
58
<PAGE>
GOVERNANCE PROVISIONS. The Stockholders' Agreement gives the Whitney Group
the continuing right to designate one member of our board of directors.
IMAP AGREEMENT WITH U S WEST
USI and U S WEST entered into an agreement on January 15, 1999 in which USI
grants to U S WEST and its affiliates a limited, nontransferable, non-exclusive
license to use the IMAP solution. The agreement has an initial term of three
years. After the end of the initial three year term, the agreement will
automatically be extended on the same terms for an additional 24 months. After
the first extension term, the agreement may be extended by mutual written
agreement. After the initial term, the agreement may be terminated by U S WEST
for convenience if it pays a termination fee ranging from $1,800,000 to
$360,000, depending on how many months are left in the term of the agreement.
U S WEST will pay USI a total of $4,121,250 in thirty-six monthly installments
for use of the IMAP solution for up to 1,000 users. For more than 1,000 users,
U S WEST will pay USI an additional monthly installment amount per user. The
amount payable to USI under the agreement will be reduced if USI does not
provide U S WEST with agreed upon service levels. The agreement contains
standard warranty, limitation of liability and indemnity provisions. On
March 31, 1999, we amended the agreement to allow twenty-five additional users
of U S WEST's affiliate, U S WEST Business and Government Services, to use the
IMAP solution for an additional $3,125 per month. On May 14, 1999, we further
amended the agreement to include architectural changes in the production of the
IMAP solution for an additional fee of $9,750 per month.
MARKETING AGREEMENT WITH U S WEST
USI entered into a marketing agreement on January 30, 1999 with U S WEST
Communications Services, Inc. and U S WEST Enterprise America, Inc. The
agreement establishes a contractual teaming arrangement for the creation and
distribution of network services, some of our IMAP services, system integration
services and comprehensive customer service. The agreement provides U S WEST
with the exclusive rights to market some of our IMAP services in U S WEST's
fourteen-state service region and to some of U S WEST's existing customers and
other customers as mutually agreed to by U S WEST and USI. USI is prohibited
from entering into similar agreements within U S WEST's fourteen-state region
with competitors of U S WEST. USI will make its IMAP services, including
consultation and implementation services, available to U S WEST at discounted
prices. USI will also provide U S WEST with training and technical support
during the term of the agreement. Training and technical support will be
provided at no cost for the first twelve months of the agreement. U S WEST will
pay the current rates for such training and support beginning in the thirteenth
month of the agreement's term. If a U S WEST customer terminates its contract
for IMAP services prematurely, U S WEST will be obligated to make an accelerated
payment to USI of an amount equal to up to 36 months of contract payments under
that customer's contract. U S WEST will provide USI with favorable pricing and
terms on U S WEST's services used to deliver USI's IMAP services. The agreement
may be terminated for cause upon 90 days notice. USI can terminate U S WEST's
overall exclusivity if U S WEST fails to reach performance levels equal to at
least 75% of established sales quotas for the IMAP services. USI can terminate
U S WEST's exclusivity with respect to a particular IMAP product if U S WEST
fails to reach performance levels for that product equal to at least 50% of
established sales quotas so long as USI has performance levels with respect to
that product comparable to the performance required from U S WEST. The
exclusivity provisions will also terminate upon an acquisition or change of
control of USI. Either party may terminate the agreement upon a change in
control of the other. U S WEST has publicly announced its acquisition by Qwest
Communications International, Inc., one of our competitors. On account of the
pending acquisition of U S WEST by Qwest, a competitor of USI's, U S WEST and
USI have mutually agreed to transition out of the marketing agreement.
59
<PAGE>
LOAN FROM CHRISTOPHER R. MCCLEARY TO USI
In April 1998, Christopher R. McCleary loaned USI $1.0 million pursuant to a
short-term non-interest-bearing loan. As disclosed above, we repayed this loan
by issuing 1,666.67 shares of Series A Preferred Stock to Mr. McCleary in May
1998.
PROPERTY SALE BETWEEN CHRISTOPHER R. MCCLEARY AND USI
On July 21, 1998 Christopher R. McCleary sold USI real property located in
Anne Arundel County, Maryland for a purchase price of $220,000. The property is
used by USI for housing transferring executives, summer interns and corporate
guests.
IMAP AGREEMENT WITH MMP, LLC
USI and MMP, LLC entered into an agreement in March 1999 in which MMP, LLC
became an IMAP customer of USI. The agreement expires in three years unless
terminated earlier in a manner consistent with the agreement or unless extended
by mutual written agreement. MMP, LLC has agreed to pay USI a total of $48,400
in thirty-six equal monthly installments. The agreement contains standard
warranty, limitation of liability and indemnity provisions. Christopher R.
McCleary is a member and officer of MMP, LLC.
IMAP AGREEMENT WITH LATTICE PARTNERS, LTD.
USI and Lattice Partners, Ltd. entered into an agreement on December 14,
1998 in which Lattice Partners, Ltd. became an IMAP customer of USI. The
agreement expires in three years unless terminated earlier in a manner
consistent with the agreement or unless extended by mutual written agreement.
Lattice Partners, Ltd. will pay USI a total of $108,000 in thirty-six equal
monthly installments. The agreement contains standard warranty, limitation of
liability and indemnity provisions. R. Dean Meiszer, a member of our board of
directors, is also a director of Lattice Partners, Ltd.
LOAN FROM USI TO CHRISTOPHER R. MCCLEARY
During the third quarter of 1999, we loaned Christopher R. McCleary
$2.25 million pursuant to a note bearing interest at 5% per annum, payable on or
before July 31, 2000 and secured by shares of Mr. McCleary's USI common stock.
The purpose of the loan was to finance Mr. McCleary's exercise of his option to
purchase 843,750 shares of our common stock. During the fourth quarter of 1999,
we loaned Christopher R. McCleary approximately $2 million pursuant to a note
bearing interest at 7% per annum, payable within 90 days of demand and secured
by shares of Mr. McCleary's USI common stock. The purpose of the loan was to
fund Mr. McCleary's tax liability resulting from the exercise of his option
described above.
60
<PAGE>
PRINCIPAL STOCKHOLDERS
The table below sets forth, as of March 2, 2000, information with respect to
the beneficial ownership of our common stock after giving effect to our stock
split by (1) each person who we know to be the beneficial owner of more than 5%
of our outstanding common stock; (2) each of the directors and Named Executive
Officers individually; and (3) all directors and executive officers as a group.
Except as otherwise indicated, each of the stockholders has sole voting and
investment power with respect to the shares beneficially owned. The address of
each executive officer and director is c/o USINTERNETWORKING, Inc., One USI
Plaza, Annapolis, MD 21401-7478.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF
NAMED EXECUTIVE OFFICERS AND DIRECTORS BENEFICIALLY OWNED(1)(2) OWNERSHIP(1)(2)
- -------------------------------------- ------------------------ -------------------
<S> <C> <C>
EXECUTIVE OFFICERS
Christopher R. McCleary(3).................................. 3,292,442 3.43%
Andrew A. Stern(4).......................................... 1,230,273 1.28
Stephen E. McManus.......................................... 984,218 1.02
Jeffery L. McKnight(5)...................................... 845,250 *
Matthew D. Kanter........................................... 282,384 *
DIRECTORS
R. Dean Meiszer(6).......................................... 123,770 *
Ray A. Rothrock(7).......................................... 4,285,332 4.44
Frank A. Adams(8)........................................... 15,707,148 16.34
William F. Earthman(9)...................................... 2,657,696 2.76
John H. Wyant(10)........................................... 7,222,154 7.47
Benjamin Diesbach(11)....................................... 101,529 *
David J. Poulin(12)......................................... 16,875 *
Michael C. Brooks(13)....................................... 11,139,476 11.59
Joseph Zell(14)............................................. -- --
Cathy M. Brienza(15)........................................ -- --
All Executive Officers and Directors as a group (23 50,007,975 49.95
persons)..................................................
BENEFICIAL OWNERS OF 5% OR MORE OF THE OUTSTANDING COMMON
STOCK OF USI
Blue Chip Group(16)......................................... 7,205,279 7.46
c/o Blue Chip Venture Company, Ltd.
250 East Fifth Street
Suite 1100
Cincinnati, Ohio 45202
Grotech Capital Group(17)................................... 15,690,273 16.32
9690 Deereco Road, Suite 800
Timonium, Maryland 21093
Whitney Group(18)........................................... 11,131,038 11.58
c/o J.H. Whitney & Co.
177 Broad Street
Stamford, CT 06901
U S WEST Internet Ventures, Inc.(19)........................ 6,315,231 6.55
1801 California Street
Denver, Colorado 80202
</TABLE>
- ------------------------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. Except where community property laws
apply or as indicated in the footnotes of this table, to our knowledge, each
stockholder identified in the table possesses sole voting and investment
power with respect to all shares of common stock shown as beneficially owned
by the stockholder. The number of shares beneficially owned by a person
includes shares of common stock subject to options and warrants held by that
person that are currently exercisable within 60 days of January 15, 2000.
Shares issuable pursuant to options and warrants are deemed outstanding for
computing the percentage ownership of the person holding the options and
warrants but are
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not deemed outstanding for the purposes of computing the percentage
ownership of any other person.
(2) For purposes of this table, the number of shares of common stock outstanding
as of March 2, 2000 is deemed to be 96,120,443 after giving effect to our
stock split. For purposes of calculating the percentage beneficially owned
by any person, shares of common stock issuable to such person upon the
exercise of any options or warrants exercisable within 60 days of
February 29, 2000 are also assumed to be outstanding.
(3) Includes 669,641 shares of common stock held by The CRM Childrens' Trust I
of which Christopher McCleary is grantor.
(4) Includes 2,250 shares held by an irrevocable trust for the benefit of
Mr. Stern's children. Mr. Stern's spouse is the trustee of the trust.
(5) Includes options to purchase 843,750 shares of common stock exercisable
within 60 days of March 2, 2000.
(6) Includes options to purchase 16,875 shares of common stock and warrants to
purchase 4,715 shares of common stock each exercisable within 60 days of
March 2, 2000.
(7) Includes 1,892,753 shares of common stock owned by Venrock Associates and
2,475,216 shares of common stock owned by Venrock Associates II, L.P.
Mr. Rothrock is a general partner of Venrock Associates and Venrock
Associates II, L.P. and as such shares voting and investment power with
other general partners. Mr. Rothrock disclaims beneficial ownership in the
common stock except to the extent of his general partner interests in
Venrock Associates and Venrock Associates II, L.P. Also includes options to
purchase 16,875 shares of common stock and warrants to purchase 296,517
shares of common stock each exercisable within 60 days of March 2, 2000.
(8) Includes 6,359,298 shares of common stock owned by Grotech Partners IV, L.P.
and 11,448,581 shares of common stock owned by Grotech Partners V L.P.
Mr. Adams is a member of the general partner of Grotech Partners IV L.P. and
Grotech Partners V, L.P. and as such shares voting and investment power with
other members of the general partner. Mr. Adams disclaims beneficial
ownership of the shares owned by Grotech Partners IV L.P. and Grotech
Partners V L.P. Also includes options to purchase 16,875 shares of common
stock exercisable within 60 days of March 2, 2000.
(9) Includes 1,687,497 shares of common stock owned by Southern Venture Fund
SBIC, L.P. and 1,289,735 shares of common stock owned by Southern Venture
Fund II, L.P. Mr. Earthman is a general partner of both Southern Venture
Fund SBIC, L.P. and Southern Venture Fund II, L.P. and as such shares voting
and investment power. Mr. Earthman disclaims beneficial ownership in the
shares owned by Southern Venture Fund SBIC, L.P. and Southern Venture Fund
II, L.P., except to the extent of his interests in the general partnerships
of Southern Venture Fund SBIC, L.P. and Southern Venture Fund II, L.P. Also
includes options to purchase 16,875 shares of common stock and warrants to
purchase 36,161 shares of common stock each exercisable within 60 days of
March 2, 2000. Southern Venture Fund SBIC, L.P. and Southern Venture Fund
II, L.P. are part of an affiliated group of investment partnerships and are
collectively referred to as the Massey Burch Group.
(10) Includes 6,532,100 shares of common stock owned by Blue Chip Capital Fund
II Limited Partnership and 1,152,714 shares of common stock owned by Miami
Valley Venture Fund L.P. Mr. Wyant is a manager of Blue Chip Venture
Company, Ltd., which is an affiliate of both Blue Chip Capital Fund II
Limited Partnership and Miami Valley Venture Fund L.P. Mr. Wyant disclaims
beneficial ownership of the shares owned by Blue Chip Capital Fund II
Limited Partnership and Miami Valley Venture Fund L.P. Also includes options
to purchase 16,875 shares
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of common stock and warrants to purchase 482,142 shares of common stock each
exercisable within 60 days of March 2, 2000.
(11) Includes options to purchase 16,875 shares of common stock exercisable
within 60 days of March 2, 2000.
(12) Includes options to purchase 16,875 shares of common stock exercisable
within 60 days of March 2, 2000.
(13) Includes 12,423,851 shares of common stock owned by J.H. Whitney III, L.P.
and 299,370 shares of common stock owned by Whitney Strategic Partners III,
L.P. Mr. Brooks is a general partner of J.H. Whitney & Co. and a Managing
Member of J.H. Whitney Equity Partners III, L.L.C. which is the general
partner of J.H. Whitney III, L.P. and Whitney Strategic Partners III, L.P.
Mr. Brooks disclaims beneficial ownership of the shares owned by J.H.
Whitney III, L.P and Whitney Strategic Partners III, L.P. except to the
extent of his proportionate interest. Also includes options to purchase
8,438 shares of common stock exercisable within 60 days of March 2, 2000.
(14) Mr. Zell transferred options to purchase 16,875 shares of common stock
which he received under our option plan to U S WEST Internet Ventures, Inc.
U S WEST policy prevents Mr. Zell from exercising these options for his own
benefit.
(15) Ms. Brienza is a member of Waller-Sutton Media, L.L.C., the general partner
of Waller-Sutton Media Partners, L.P. Ms. Brienza disclaims beneficial
ownership of the shares held by Waller-Sutton Media Partners, L.P.
(16) Includes 6,532,100 shares of common stock owned by Blue Chip Capital Fund
II Limited Partnership and 1,152,714 shares of common stock owned by Miami
Valley Venture Fund, L.P. Blue Chip Capital Fund II Limited Partnership and
Miami Valley Venture Fund, L.P. are part of an affiliated group of
investment partnerships commonly controlled by Blue Chip Venture Company and
are collectively referred to as the Blue Chip Group. Also includes warrants
to purchase 482,142 shares of common stock exercisable within 60 days of
March 2, 2000.
(17) Includes 6,359,298 shares of common stock owned by Grotech Partners IV,
L.P. and 11,448,581 shares of Common Stock owned by Grotech Partners V,
L.P., Grotech Partners IV, L.P. and Grotech Partners V, L.P. are part of an
affiliated group of investment partnerships commonly controlled by Grotech
Capital Group and are collectively referred to as the Grotech Capital Group.
(18) Includes 12,423,851 shares of common stock owned by J.H. Whitney III, L.P.
and 299,370 shares of common stock owned by Whitney Strategic Partners III,
L.P., J.H. Whitney III, L.P and Whitney Strategic Partners III, L.P. are
affiliated entities collectively referred to as the Whitney Group.
(19) Includes warrants to purchase 229,017 shares of common stock and options to
purchase 16,875 shares of common stock exercisable within 60 days of
March 2, 2000.
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DESCRIPTION OF CERTAIN CREDIT FACILITIES
As of December 31, 1999, USI has obtained numerous secured financing
commitments for capital leases and real estate and equipment loans to finance
real estate and various types of capital equipment, including computer hardware,
software, furniture and fixtures and leasehold improvements. These secured
financing arrangements are collectively called the Credit Facilities. The Credit
Facilities allow us to finance an aggregate amount of up to $79.9 million, of
which an aggregate amount of $72.6 million had been drawn at December 31, 1999.
A description follows of the Credit Facilities with financing commitments of
$10.0 million or more.
VENTURE LENDING & LEASING TECHNOLOGIES INTERNATIONAL, INC. USI has a
commitment from Venture Lending & Leasing providing for a line of credit to
enable USI to finance up to $10.0 million of various types of equipment as
described above. As of December 31, 1999, $9.6 million of this commitment has
been funded. This facility is not available for further funding.
FINOVA CAPITAL CORPORATION. USI has a commitment from Finova providing for
a line of credit to enable USI to lease up to $11.7 million of various types of
equipment. As of December 31, 1999, all of this commitment has been funded. Each
schedule of this facility has a term of 36 months.
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DESCRIPTION OF THE NOTES
The Notes were issued under an Indenture, dated as of October 29, 1999,
between USI, as issuer, and The Bank of New York, as Trustee. The following
description is a summary of the material provisions of the Indenture. It does
not restate this agreement in its entirety. We urge you to read the Indenture
because it, and not this description, defines your rights as a holder of the
Notes. A copy of the form of Indenture and the form of certificate evidencing
the Notes is available to you upon request.
You can find the definitions of the capitalized terms used in this
description under the subheading "Definitions." In this section of the
Prospectus, entitled "Description of the Notes," when we refer to "USI," "we,"
"our," or "us," we are referring to USINTERNETWORKING, INC. and not any of its
subsidiaries.
GENERAL
The Notes are general unsecured obligations of USI, were offered in the
principal amount of $125,000,000 and will mature on November 1, 2004. The Notes
are contractually subordinated in right of payment to all existing and future
Senior Indebtedness. As of December 31, 1999, we had approximately $62.1 million
of Senior Indebtedness outstanding. In addition, the Notes are effectively
subordinated to all obligations, indebtedness and other liabilities (including
trade payables) of any of our Subsidiaries. As of December 31, 1999, our
Subsidiaries had no indebtedness outstanding. Our rights to receive assets of
our Subsidiaries upon their liquidation or reorganization (and the consequent
right of the holders of the Notes to participate in those assets) are
effectively subordinated to the claims of that Subsidiary's creditors (including
trade creditors), in which case our claims are still subordinate to any security
interests in the assets of the Subsidiary and any indebtedness of the Subsidiary
senior to that held by us. In addition, our cash flow and the consequent ability
to service our debt, including the Notes, may depend upon the results of
operations of our Subsidiaries and upon the ability of our Subsidiaries to
provide cash (whether in the form of dividends, loans, or otherwise) to pay
amounts due in respect of our obligations, including the Notes. The Indenture
does not restrict the incurrence of indebtedness (including Senior Indebtedness)
by us or our Subsidiaries. In addition, the Notes are not protected by financial
covenants that limit our business activities.
The Notes bear interest from October 29, 1999 at the rate per annum of 7%.
Interest is payable semi-annually on May 1 and November 1 of each year,
commencing May 1, 2000, to holders of record at the close of business on April
15 or October 15 preceding each such interest payment date. Interest is
calculated on the basis of a 360-day year consisting of twelve 30-day months.
Principal of and interest on the Notes is payable at the office of the Paying
Agent. The Trustee has initially acted as the Paying Agent.
CONVERSION RIGHTS
A holder may, at any time prior to the close of business on November 1,
2004, convert the principal amount of a Note (or any portion thereof equal to
$1,000 or any integral multiple thereof) into shares of our common stock at the
conversion price of $24.85 per share on a pre-split basis, subject to adjustment
as described below (the "Conversion Price"); except that if a Note is called for
redemption, the conversion right will terminate at the close of business on the
Business Day immediately preceding the redemption date for the Note (unless we
default in making the redemption payment when due, in which case the conversion
right shall terminate at the close of business on the date the default is cured
and the Note is redeemed). A Note for which a holder has delivered a notice
exercising the option to require us to purchase the Note may be converted only
if the holder's notice is withdrawn by a written notice of withdrawal delivered
by the holder to a Paying Agent prior to the close of business on the second
Business Day prior to the Change in Control Payment Date in accordance with the
Indenture.
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No payment or adjustment will be made for dividends or distributions with
respect to shares of common stock issued upon conversion of a Note. Except as
otherwise provided in the Indenture, interest accrued shall not be paid on Notes
converted. If any holder surrenders a Note for conversion between the record
date for the payment of an installment of interest and the related interest
payment date, then notwithstanding the conversion, the interest payable on the
interest payment date will be paid to the person in whose name the Note was
registered at the close of business on the record date. However, in this event,
unless the Note has been called for redemption, the Note, when surrendered for
conversion, must be accompanied by delivery by the holder of payment in an
amount equal to the interest payable on the interest payment date on the
principal amount of the converted Note. No fractional shares will be issued upon
conversion, but a cash payment will be made for any fractional interest based
upon the closing price (as defined in the Indenture) of the common stock on the
trading day immediately prior to the date of conversion.
The Conversion Price is subject to adjustment upon the occurrence of certain
events, including:
(1) the issuance of shares of common stock as a dividend or distribution on
our common stock;
(2) the subdivision or combination of our outstanding common stock;
(3) the issuance to all or substantially all holders of common stock of
rights or warrants entitling them to subscribe for or purchase common
stock (or securities convertible into common stock) at a price per share
(or having a conversion price per share) less than the current market
price per share (as defined in the Indenture);
(4) the distribution to all or substantially all holders of common stock of
shares of capital stock of USI (other than common stock), evidences of
indebtedness or other non-cash assets (including securities of any person
other than USI but excluding (a) dividends on distributions paid
exclusively in cash, (b) dividends or distributions referred to in
clauses (1) and (2) above and (c) distributions in connection with a
reclassification, consolidation or sale referred to in the next
succeeding paragraph);
(5) the distribution to all or substantially all holders of common stock of
rights or warrants to subscribe for USI's securities (other than those
rights and warrants referred to in (3) above and other than the
distribution of rights to all holders of common stock pursuant to the
adoption of a stockholders rights plan or the detachment of such rights
under the terms of such plan);
(6) the distribution to all or substantially all holders of common stock of
cash in an aggregate amount that (together with (A) any cash and the fair
market value of any other consideration payable in respect of any tender
offer by USI or any of our Subsidiaries for common stock consummated
within the preceding 12 months not triggering a Conversion Price
adjustment and (B) all other cash distribution to all or substantially
all holders of common stock made within the preceding 12 months not
triggering a Conversion Price adjustment) exceeds an amount equal to
10.0% of our market capitalization (determined as provided in the
Indenture) on the Business Day immediately preceding the day on which we
declare the distribution; and
(7) the purchase of common stock pursuant to a tender offer made by USI or
any of its Subsidiaries to the extent that the same involves aggregate
consideration that (together with (A) any cash and the fair market value
of any other consideration payable in respect of any other tender offer
by USI or any of our Subsidiaries for common stock consummated within the
preceding 12 months not triggering a Conversion Price adjustment and (B)
all cash distributions to all or substantially all holders of common
stock made within the preceding 12 months not triggering a Conversion
Price adjustment) exceeds an amount equal to 10.0% of
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USI's market capitalization (determined as provided in the Indenture) on
the expiration date of such tender offer.
Notwithstanding the foregoing, no adjustment need be made in the Conversion
Price for a transaction of the nature described above in this paragraph if all
holders of Notes are entitled to participate in the transaction on a basis and
with notice that the Board of Directors determines to be fair and appropriate in
light of the basis and notice on which holders of common stock participate in
the transaction; no adjustment to the Conversion Price need be made or any
issuance of common stock pursuant to any of our plans for reinvestment of
dividends or interest or for a change in the par value of the common stock; and,
to the extent that the Notes become convertible into the right to receive cash,
no adjustment to the Conversion Price need be made thereafter as to the cash,
and interest will not accrue on the cash. We, from time to time, may reduce the
Conversion Price by an amount for any period of time if the period is at least
20 days or such longer period as may be required by law and if the reduction is
irrevocable during the period; PROVIDED, HOWEVER, that in no event may we reduce
the Conversion Price to be less than the par value of a share of our common
stock. No adjustment of the Conversion Price will be required to be made until
the cumulative adjustments require an increase or decrease of at least 1% in the
Conversion Price as last adjusted.
Subject to any applicable right of the holders upon a Change in Control, if
USI reclassifies or changes its common stock issuable upon conversion of the
Notes (other than a change in par value, or as a result of a subdivision or
combination, or any other change for which a Conversion Price adjustment is
provided in the Indenture) or mergers into or transfers or leases all or
substantially all of its assets to any person, or is a party to a merger that
reclassifies or changes its outstanding common stock, the Notes will become
convertible into the kind and amount of securities and property (including cash)
which the holders of the Notes would have owned immediately after the
transaction if the holders had converted the Notes immediately before the
effective date of the transaction.
Adjustments to the Conversion Price to reflect our issuance of other rights,
warrants, evidences of indebtedness, securities or other property (including
cash) to holders of the common stock may result in constructive distributions
taxable as dividends to holders of the Notes.
OPTIONAL REDEMPTION
The Notes may not be redeemed at the option of the Company prior to November
5, 2002. On that date and thereafter, the Notes may be redeemed at our option,
in whole or, in part, upon not less than 30 nor more than 60 days' notice by
mail.
The redemption prices (expressed as a percentage of principal amount) are as
follows for Notes redeemed during the periods set forth below:
<TABLE>
<CAPTION>
PERIOD PERCENTAGE
- ------ ----------
<S> <C>
November 5, 2002 through October 31, 2003................... 101.75%
November 1, 2003 and thereafter............................. 100.00%
</TABLE>
in each case together with accrued interest up to but not including the
redemption date; provided that if the redemption date falls after an interest
payment record date and on or before an interest payment date, then the interest
payment shall be payable to holders of record on the relevant record date.
If less than all of the outstanding Notes are to be redeemed, the Trustee
shall select the Notes to be redeemed in principal amounts of $1,000 or
multiples thereof by lot, PRO RATA or by another method the Trustee considers
fair and appropriate. If a portion of a holder's Notes is selected for partial
redemption and that holder converts a portion of those Notes, the converted
portion shall be deemed to be of the portion selected for redemption.
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All Notes which are redeemed or otherwise acquired by us or any of our
Subsidiaries prior to maturity will be immediately canceled and may not be held,
reissued or resold.
PURCHASE OF NOTES AT THE OPTION OF HOLDERS UPON A CHANGE IN CONTROL
In the event of a Change in Control each holder has the option, subject to
the terms and conditions of the Indenture, to require us to purchase all or any
part (provided that the principal amount must be $1,000 or an integral multiple
thereof) of the holder's Notes for a purchase price equal to 100% of the
principal amount thereof, plus accrued interest up to but not including the
Change in Control Payment Date, as described below. This payment is referred to
as the Change in Control Payment.
Within 30 days following any Change in Control, we will mail a notice to
each holder, stating:
(1) that the Change in Control Offer is being made pursuant to the covenant
entitled "Change in Control" in the Indenture and that all the Notes
tendered will be accepted for payment;
(2) the purchase price and the purchase date, which shall be no earlier than
30 days nor later than 40 days from the date such notice is mailed. This
date is referred to as the Change in Control Payment Date;
(3) that interest will continue to accrue on any convertible notes not
tendered, as provided in the convertible notes;
(4) that, unless USI defaults in the payment of the Change in Control
Payment, with respect to all the Notes accepted for payment pursuant to
the Change in Control Offer, interest will cease to accrue after the
Change in Control Payment Date;
(5) that holders electing to have any of the Notes purchased pursuant to a
Change in Control Offer will be required to surrender the Notes, with the
form entitled Option of Holder to Elect Purchase on the reverse of the
Notes completed, to the Paying Agent at the address specified in the
notice prior to the close of business on the third Business Day preceding
the Change in Control Payment Date;
(6) that holders will be entitled to withdraw their election if the Paying
Agent receives, not later than the close of business on the second
Business Day preceding the Change in Control Payment Date, a telegram,
facsimile transmission or letter setting forth the name of the holder,
the principal amount of the Notes delivered for purchase, and a statement
that such holder is withdrawing his election to have the Notes purchased;
and
(7) that holders whose Notes are being purchased only in part will be issued
new Notes equal in principal amount to the unpurchased portion of the
Notes surrendered, which unpurchased portion must be equal to $1,000 in
principal amount.
A Change in Control shall be deemed to have occurred if any of the following
occurs after the Issue Date of the Notes:
(1) the consolidation with or merger by USI into any other Person, or any
other Person merges into USI, unless the stockholders of USI immediately
before such transaction own, directly or indirectly immediately following
such transaction, at least a majority of the combined voting power of our
outstanding voting securities entitled to vote generally in the election
of directors of USI or the Person resulting from such transaction;
(2) the sale, lease or transfer of all or substantially all of our assets to
any "person" or "group", within the meaning of Sections 13(d)(3) and
14(d)(2) of the Exchange Act or any successor provision to either of the
foregoing, including any group acting for the purpose of acquiring,
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holding or disposing of securities within the meaning of Rule 13d-5(b)(1)
under the Exchange Act;
(3) the approval by the requisite stockholders of USI of a plan of
liquidation or dissolution of USI;
(4) any "person" or "group," within the meaning of Sections 13(d) and
14(d)(2) of the Exchange Act or any successor provision to either of the
foregoing, including any group acting for the purpose of acquiring,
holding or disposing of securities within the meaning of Rule 13d-5(b)(1)
under the Exchange Act, becomes the "beneficial owner," as defined in
Rule 13d-3 under the Exchange Act, of more than 50% of the total voting
power of all classes of our voting stock and/or warrants or options to
acquire such voting stock, calculated on a fully diluted basis, unless,
as a result of such transaction, the ultimate direct or indirect
ownership USI is substantially the same immediately after such
transaction as it was immediately prior to such transaction; or
(5) during any period of two consecutive years, individuals who at the
beginning of such period constituted our Board of Directors, together
with any new directors whose election or appointment by such board or
whose nomination for election by our stockholders was approved by a vote
of a majority of the directors then still in office who were either
directors at the beginning of such period or whose election or nomination
for election was previously so approved, cease for any reason to
constitute a majority of our Board of Directors then in office.
We will comply with the requirements of Rule 13e-4 and Rule 14e-1, under the
Exchange Act, and with any other securities laws and regulations thereunder to
the extent these laws and regulations are applicable in connection with any
offer by USI to purchase Notes at the option of the holders upon a Change in
Control.
The Change in Control purchase feature of the Notes may in some
circumstances make more difficult or discourage a takeover of USI and the
removal of incumbent management. We are not aware of any specific effort to
accumulate shares of common stock or to obtain control of USI by means of a
merger, tender offer, solicitation or otherwise, nor is the Change in Control
purchase feature part of a plan by management to adopt a series of anti-takeover
provisions. Instead, the Change in Control purchase feature is a result of
negotiations between USI and the initial purchasers.
Subject to the limitation on mergers and consolidations discussed below, we
could, in the future, enter into transactions, including recapitalizations of
USI, that would not constitute a Change in Control under the Indenture, but that
would increase the amount of indebtedness (including Senior Indebtedness)
outstanding or otherwise adversely affect the holders of the Notes. There will
be no restrictions in the Indenture on the creation of additional indebtedness
(including Senior Indebtedness) by USI or its Subsidiaries and the incurrence of
significant amounts of additional indebtedness could have an adverse effect on
our ability to service our indebtedness, including the Notes.
If a Change in Control were to occur, there can be no assurance that we
would have sufficient funds to pay the Change in Control Payment for the Notes
tendered by the holders thereof. In addition, other indebtedness which we may
incur in the future may have similar change in control provisions permitting the
holders thereof to accelerate or require us to repurchase such indebtedness upon
the occurrence of events similar to a Change in Control. Our failure to
repurchase the Notes when required following a Change in Control will result in
an Event of Default under the Indenture whether or not such repurchase is
permitted by the subordination provisions thereof.
Other than granting holders the option to require USI to purchase all or
part of their Notes upon the occurrence of the Change in Control as described
above, the Indenture will not contain any
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covenants or other provisions designed to afford holders protection in the event
of takeovers, recapitalizations, highly leveraged transactions or similar
restructurings involving USI.
In the event that Certificated Notes are issued under the limited
circumstances described herein, holders electing to exercise the option to have
their Notes repurchased following a Change in Control must surrender the
Certificated Notes, together with such additional documents as are required by
the Indenture, at the office of a Paying Agent. Where not all of the Notes
represented by a Certificated Notes are submitted for purchase, a new
Certificated Note in respect of the principal amount of the Notes that have not
been so submitted for purchase will be issued to the holder.
SUBORDINATION OF NOTES
To the extent set forth in the Indenture, the Notes are subordinated in
right of payment to all of our existing and future Senior Indebtedness. Upon any
payment or distribution of our assets in connection with any dissolution,
winding-up, liquidation or reorganization of USI (whether in insolvency or
bankruptcy proceedings or otherwise), all Senior Indebtedness must be paid in
full before any payment is made in respect of the Notes. In the event of a
default in payment (whether at maturity or at a date fixed for prepayment or by
acceleration or otherwise) of principal of or premium, if any, or interest on
Senior Indebtedness, no payment may be made by us in respect of the Notes until
payment in full of the Senior Indebtedness then due or the cure, waiver or
cessation of the default. Upon an event of default with respect to any Senior
Indebtedness (other than a default in the payment of principal of, or premium,
if any or interest on Senior Indebtedness) permitting a holder thereof to
accelerate its maturity, and upon written notice, referred to as a Default
Notice, of such default to the Trustee and USI by any holder of such Senior
Indebtedness or its representative, then, unless and until such default has been
cured, waived or has ceased to exist, no payment may be made by USI in respect
of the Notes; except that nothing in the foregoing provisions of this sentence
will prevent the making of any payment (which is not otherwise prohibited by the
provisions described in the immediately preceding sentence) in respect of the
Notes for a period of more than 180 days after the date such Default Notice is
given unless the maturity of the Senior Indebtedness has been accelerated, in
which case no payment on the Notes may be made until the acceleration has been
waived, rescinded or annulled or the Senior Indebtedness has been paid in full.
Notwithstanding the provisions described in the preceding sentence, not more
than one Default Notice shall be given with respect to the same issue of Senior
Indebtedness within a period of 360 consecutive days, and no event of default
which existed on the date of any Default Notice and was known to the holders of
any issue of Senior Indebtedness shall be made the basis for the giving of a
subsequent Default Notice by the holders of the issue of Senior Indebtedness.
In the event that, notwithstanding the provisions set forth in the
immediately preceding paragraph, the Trustee, any Paying Agent or any holder of
the Notes receives any payment or distribution of assets of USI of any kind in
contravention of any of the terms of the Indenture, whether in cash, property or
securities, in respect of the Notes before all Senior Indebtedness is paid in
full, then such payment or distribution will be held by the recipient in trust
for the benefit of holders of Senior Indebtedness or their representatives to
the extent necessary to make payment in full of all Senior Indebtedness
remaining unpaid, after giving effect to any concurrent payment or distribution
to or for the holders of Senior Indebtedness.
As a result of these subordination provisions, in the event of our
insolvency, holders of the Notes may recover ratably less, than our other
creditors. Such subordination will not prevent the occurrence of any Event of
Default under the Indenture.
The Indenture does not limit the amount of indebtedness, including Senior
Indebtedness, that USI, or any Subsidiary, can create, incur, assume or
guarantee.
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DEFINITIONS
"BUSINESS DAY" means each day which is not a Legal Holiday.
"CAPITAL LEASE OBLIGATIONS" means an obligation that is required to be
classified and accounted for as a capital lease for financial reporting purposes
in accordance with GAAP, and the amount of Indebtedness represented by such
obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the stated maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease prior to the first
date upon which such lease may be terminated by the lessee without payment of a
penalty.
"CAPITAL STOCK" of any Person means any and all shares, interests, rights to
purchase, warrants, options, participations or other equivalents of or interests
in (however designated) equity of such Person, but excluding any debt securities
convertible into such equity.
"CURRENCY AGREEMENT" means in respect of a Person, any foreign exchange
contract, currency swap agreement or other similar agreement designed to protect
such Person against fluctuations in currency values.
"EVENT OF DEFAULT" means an event of default under the Indenture.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Issue Date, including those set forth in:
(1) the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants;
(2) statements and pronouncements of the Financial Accounting Standards
Board;
(3) such other statements by such other entity as approved by a significant
segment of the accounting profession; and
(4) the rules and regulations of the Commission governing the inclusion of
financial statements (including pro forma financial statements) in
registration statements filed under the Securities Act of 1933 and
periodic reports required to be filed pursuant to Section 13 of the
Exchange Act, including opinions and pronouncements in staff accounting
bulletins and similar written statements from the accounting staff of the
Commission.
"INDEBTEDNESS" means, with respect to any person, without duplication:
(1) all liabilities of such person for borrowed money or for the deferred
purchase price of property or services, excluding any trade accounts
payable and other current liabilities incurred in the ordinary course of
business;
(2) all obligations of such person evidenced by bonds, notes, debentures, or
other similar instruments;
(3) all Capital Lease Obligations of such person;
(4) all guarantees of Indebtedness referred to in this definition by such
person;
(5) all obligations of such person under or in respect of Currency
Agreements and Interest Rate Agreements of such person; and
(6) any amendment, supplement, modification, deferral, renewal, extension or
refunding of any liability of the types referred to in clauses (1)
through (5) above.
"INTEREST RATE AGREEMENT" means in respect of a Person any interest rate
swap agreement, interest rate cap agreement or other financial agreement or
arrangement designed to protect such Person against fluctuations in interest
rates.
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"ISSUE DATE" means the date on which the Notes are originally issued.
"LEGAL HOLIDAY" means a Saturday, a Sunday or a day on which banking
institutions in the State of New York are authorized or required by law to
close. If a payment date is a Legal Holiday, payment shall be made on the next
succeeding day that is not a Legal Holiday, and no interest shall accrue for the
intervening period. If a regular record date is a Legal Holiday, the record
shall not be affected.
"PERSON" means any individual, corporation, partnership, limited liability
company, joint venture, association, joint-stock company, trust, unincorporated
organization, government or any agency or political subdivision thereof or any
other entity.
"SENIOR INDEBTEDNESS" means the principal of, premium, if any, interest and
other amounts payable on or in respect of any Indebtedness of USI, whether
outstanding on the date of the Indenture or thereafter created, incurred or
assumed, unless, in the case of any particular Indebtedness, the instrument
creating or evidencing the same or pursuant to which the same is outstanding
expressly provides that such Indebtedness shall not be senior in right of
payment to, or shall be junior in right of payment to, or shall be PARI PASSU,
in right of payment with, the Notes. Notwithstanding the foregoing, "Senior
Indebtedness" shall not include:
(1) Indebtedness evidenced by the Notes;
(2) Indebtedness which, when incurred and without respect to any election
under Section 1111 (b) of Title 11, United States Code (or any successor
provision thereto), is without recourse to USI;
(3) trade accounts payable or other current liabilities incurred in the
ordinary course of business;
(4) Indebtedness of or amounts owed by USI for compensation to employees or
for services rendered to USI;
(5) any liability for federal, state, local or other taxes owed or owing by
USI;
(6) Indebtedness of USI to a Subsidiary of USI; and
(7) amounts owing under leases (other than Capital Lease Obligations).
"SIGNIFICANT SUBSIDIARY" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of USI within the meaning of Rule 1-02 under Regulation
S-X promulgated by the SEC.
"SUBSIDIARY" means, in respect of any Person, any corporation, association,
partnership or other business entity of which more than 50% of the total voting
power of shares of Capital Stock or other interests (including partnership
interests) entitled (without regard to the occurrence of any contingency) to
vote in the election of directors, managers, general partners or trustees
thereof is at the time owned or controlled, directly or indirectly, by:
(1) such Person;
(2) such Person and one or more Subsidiaries of such Person; or
(3) one or more Subsidiaries of such Person.
"VOTING STOCK" of a Person means all classes of Capital Stock or other
interests (including partnership interests) of such Person then outstanding and
normally entitled (without regard to the occurrence of any contingency) to vote
in the election of directors, managers or trustees thereof.
EVENTS OF DEFAULT; NOTICE WAIVER
If an Event of Default (other than an Event of Default resulting from
bankruptcy, insolvency or reorganization with respect to USI or any Significant
Subsidiary) occurs and is continuing, the Trustees
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may, by notice to USI, declare all unpaid principal of and accrued interest to
the date of acceleration on the Notes then outstanding to be due and payable
immediately. Also, in such event, the holders of at least 25% in principal
amount at the Notes then outstanding may, by notice to USI and the Trustee,
declare all unpaid principal of and accrued interest to the date of acceleration
on the Notes then outstanding to be due and payable immediately. If an Event of
Default resulting from events of bankruptcy, insolvency or reorganization with
respect to USI or any Significant Subsidiary shall occur, all unpaid principal
of and accrued interest on the Notes then outstanding shall become and be
immediately due and payable without any declaration or other act on the part of
the Trustee or any holder.
The Indenture provides that the holders of a majority in principal amount of
the outstanding Notes may on behalf of all holders waive any existing default or
Event of Default and its consequences except a default or Event of Default in
the payment of principal or accrued interest on the Notes or any default in
respect of any provision of the Indenture that cannot be modified or amended
without the consent of the holder of each Note affected.
The following are Events of Default under the Indenture:
(1) failure of USI to pay any interest on the Notes for 30 days after the
same is due or failure of USI to pay any principal of or premium, if any,
on the Notes when due (whether at maturity, upon redemption, on a Change
in Control Payment Date or otherwise);
(2) failure of USI to comply with any of its other agreements contained in
the Notes or the Indenture for 60 days after receipt of notice of such
failure from the Trustee or the holders of not less than 25% in aggregate
principal amount of the Notes then outstanding;
(3) default under any bond, debenture, note or other evidence of
indebtedness for money borrowed of USI or any Significant Subsidiary
having an aggregate outstanding principal amount in excess of $15
million, which default shall have resulted in such indebtedness being
accelerated, without such indebtedness being discharged, or such
acceleration having been rescinded or annulled, within ten days from the
date of such acceleration; and
(4) certain events of bankruptcy, insolvency or reorganization with respect
to the Company or any Significant Subsidiary.
The Trustee shall, within 90 days after the occurrence of any default known
to it, give to the holders notice of such default, PROVIDED that, except in the
case of default in the payment of principal of or interest on any of the Notes,
the Trustee may withhold such notice if it in good faith determines that the
withholding of such notice is in the interests of the holders.
No holder may pursue any remedy under the Indenture or the Notes against USI
(except actions for payment of overdue principal or interest or for the
conversion of the Notes), unless:
(1) the holder gives to the Trustee written notice of a continuing Event of
Default;
(2) the holders of at least 25% in principal amount of the outstanding Notes
make a written request to the Trustee to pursue the remedy;
(3) such holder or holders offer satisfactory indemnity to the Trustee
against any loss or expense;
(4) the Trustee does not comply with the request within the 60 days after
receipt of the request and the offer of indemnity; and
(5) the Trustee shall not have received during such 60-day period a contrary
direction from the holders of at least a majority in principal amount of
the outstanding Notes.
We must deliver an Officer's Certificate to the Trustee within 90 days after
the end of each fiscal year of USI as to the signer's knowledge of our
compliance with all conditions and covenants on our
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part contained in the Indenture, and stating whether or not the signers know of
any default or Event of Default. If any such signer knows of such a default or
Event of Default, the Officer's Certificate shall describe the default or Event
of Default and the efforts to remedy the same.
AMENDMENT
USI and the Trustee may amend or supplement the Indenture or the Notes with
the written consent of the holders of at least a majority in principal amount of
the outstanding Notes. The holders of a majority in principal amount of the
Notes outstanding may waive compliance in a particular instance by USI with any
provision of the Indenture or the Notes without notice to any holder. However,
without the consent of the holder of each Note affected thereby, an amendment,
supplement or waiver may not:
(1) reduce the percentage of the principal amount of outstanding Notes whose
holders must consent to an amendment, supplement or waiver;
(2) reduce the rate of or change the fixed maturity of any Note;
(3) alter the conversion provisions with respect to any Note in a manner
adverse to the holder thereof;
(4) waive a default in the payment (whether at maturity, upon redemption, on
an interest payment date, on a Change in Control Payment Date or
otherwise) of the principal of or premium or interest on any Note;
(5) reduce the percentage of Notes necessary to waive defaults or Events of
Default;
(6) modify any of the subordination provisions in the Indenture in a manner
adverse to the holders of the Notes; or
(7) make any Note payable in money other then that stated in the Note.
USI and the Trustee may amend or supplement the Indenture or the Notes
without notice to or consent of any holder in some events, such as to comply
with the conversion, adjustment, liquidation and merger provisions described in
the Indenture, to cure any ambiguity, defect or inconsistency or to make any
other change that does not adversely affect the rights of the holders, to comply
with the provisions of the Trust Indenture Act or to appoint a successor
Trustee.
No amendment may be made that adversely affects the rights under the
provisions described under "--Subordination of Notes" above of a holder of an
issue of Senior Indebtedness unless the holders of that issue, pursuant to its
terms, consents to such amendment.
REGISTRATION RIGHTS
The following summary of the registration rights provided in the
registration rights agreement and the Notes is not complete. You should refer to
the registration rights agreement and the Notes for a full description of the
registration rights that apply to the Notes.
USI has agreed, pursuant to a Registration Rights Agreement to be dated the
Issue Date between USI and the initial purchasers, to file a Shelf Registration
Statement under the Securities Act within 60 days after the latest date of
original issuance of the Notes, referred to as the Filing Date, to register
resales of the Notes and the shares of common stock into which the Notes are
convertible, referred to as Registrable Securities. USI has complied with this
provision of the Registration Rights Agreement by filing the Registration
Statement of which this Prospectus is a part. USI will use reasonable efforts to
have such Shelf Registration Statement declared effective as soon as practicable
after it is filed and, in
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any event, within 150 days after the latest date of original issuance of the
Notes, and to keep it effective until the earliest of:
(1) two years after the Filing Date;
(2) the date when all Registrable Securities shall have been registered
under the Securities Act and disposed of; or
(3) the date on which all Registrable Securities are eligible to be sold to
the public pursuant to Rule 144(k) under the effectiveness period.
A holder of Registrable Securities that sells Registrable Securities
pursuant to the Shelf Registration Statement generally will be required to
provide information about itself and the specifics of the sale, be named as a
selling security holder in the related prospectus and deliver a prospectus to
purchasers, be subject to relevant civil liability provisions under the
Securities Act in connection with such sales and be bound by the provisions of
the Registration Rights Agreements which are applicable to such holder
(including certain indemnification obligations).
If:
(1) on or prior to the 60th day after the first date of original issuance of
the Notes, the Shelf Registration Statement has not been filed with the
Commission;
(2) on or prior to the 150th day after the latest date of original issuance
of the Notes, the Shelf Registration Statement has not been declared
effective by the Commission;
(3) USI fails to supplement the Shelf Registration Statement in a timely
manner in order to name additional selling security holders; or
(4) after the Shelf Registration Statement has been declared effective, such
Shelf Registration Statement ceases to be effective or usable (subject to
certain exceptions) in connection with resales of Notes and the common
stock issuable upon the conversion of the Notes in accordance with and
during the periods specified in the Registration Rights Agreement (each
such event referred to in clauses (1) through (4), a "Registration
Default"),
additional interest will accrue on the Notes over and above the rate set forth
in the title of the Notes, from and including the date on which any such
Registration Default shall occur to but excluding the date on which all
Registration Defaults have been cured, at the rate of 0.5% per annum. We will
have no other liabilities for monetary damages with respect to our registration
obligations. With respect to each holder, our obligations to pay additional
interest remain in effect only so long as the Notes and the common stock
issuable upon the conversion of the Notes held by the holder are "Registrable
Securities" within the meaning of the Registrable Rights Agreement.
We will pay all expenses of the Shelf Registration Statement, provide each
holder that is selling Registrable Securities pursuant to the Shelf Registration
Statement copies of the related prospectus and take other actions as are
required to permit, subject to the foregoing, unrestricted resales of the
Registrable Securities.
SATISFACTION AND DISCHARGE
If all of the Notes have been delivered to the Trustee for cancellation
(subject to certain limited exceptions) or if all of the Notes not theretofore
delivered to the Trustee for cancellation have become due and payable or will
become due and payable within one year at their stated maturity or upon
redemption, then USI may terminate all of its obligations under the Indenture,
other than its obligations (including its obligation to deliver shares of common
stock upon conversion of the Notes and its obligation to purchase Notes
following a Change in Control), at any time, by depositing with
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the Trustee or a Paying Agent other than USI, money sufficient to pay the
principal of and interest on the Notes then outstanding to maturity or
redemption, as the case may be.
MERGERS AND CONSOLIDATIONS
Subject to the right of the holders to require USI to purchase the Notes in
the event of a Change in Control, USI may consolidate or merge with or into any
other corporation, and USI may sell, lease, convey, assign, or otherwise
transfer all or substantially all its property and assets to any other
corporation; PROVIDED:
(1) either USI is the resulting or surviving corporation, or the successor
corporation is organized and existing under the laws or the Unites States
of America, any state thereof or the District of Columbia which expressly
assumes, by supplemental indenture executed and delivered to the Trustee,
payment of the principal of and interest on the Notes and performance and
observance of every covenant of USI in the Indenture and the Notes
(including, without limitation, the agreement to deliver shares of common
stock upon conversion of Notes);
(2) immediately after giving effect to such transaction, no default or Event
of Default shall have occurred and be continuing; and
(3) other conditions are met.
Thereafter, in any transaction (other than a lease) in which USI is not the
surviving or resulting corporation, USI shall be released from all of its
obligations under the Indenture and the Notes.
CONCERNING THE TRUSTEE
The Bank of New York serves as the Trustee under the Indenture. The Trustee
will be permitted to deal with USI and any affiliate of USI with the same rights
as if it were not Trustee; PROVIDED, HOWEVER, that under the Trust Indenture
Act, if the Trustee acquires any conflicting interest (as defined in the Trust
Indenture Act) and there exists a default with respect to the Notes, it must
eliminate such conflicts or resign.
The holders of a majority in principal amount of all outstanding Notes will
have the right to direct the time, method and place of conducting any proceeding
for exercising any remedy or power available to the Trustee, PROVIDED that such
direction does not conflict with any law or the Indenture, is not unduly
prejudicial to the rights of another holder or the Trustee and does not involve
the Trustee in personal liability.
BOOK-ENTRY; DELIVERY AND FORM
We issued the Notes in the form of one or more global notes (the "Global
Note"). The Global Note was deposited with the Trustee as custodian for DTC and
registered in the name of a nominee of DTC. The Global Note (and any shares of
common stock issuable upon conversion) is subject to certain restrictions on
transfer set forth therein and will bear the legend regarding these restrictions
set forth under "Transfer Restrictions." Except as set forth below, the Global
Note may be transferred, in whole and not in part, only to DTC or another
nominee of DTC. You may hold your beneficial interests in the Global Note
directly through DTC if you have an account with DTC or indirectly through
organizations which have accounts with DTC. Notes in definitive certificated
form (the "Certificated Notes") will be issued only in certain limited
circumstances described below.
DTC has advised us as follows: DTC is a limited-purpose trust company
organized under the laws of the State of New York, a member of the Federal
Reserve System, a "clearing corporation" within the meaning of the New York
Uniform Commercial Code, and "a clearing agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. DTC was created to hold
securities of
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institutions that have accounts with DTC ("participants") and to facilitate the
clearance and settlement of securities transactions among its participants in
such securities through electronic book-entry changes in accounts of the
participants, thereby eliminating the need for physical movement of securities
certificates. DTC's participants include securities brokers and dealers (which
may include the initial purchasers), banks, trust companies, clearing
corporations and certain other organizations. Access to DTC's book-entry system
is also available to others such as banks, brokers, dealers and trust companies
(collectively, the "indirect participants") that clear through or maintain a
custodial relationship with a participant, whether directly or indirectly.
We expect that pursuant to procedures established by DTC, upon the deposit
of the Global Note with DTC, DTC credited, on its book-entry registration and
transfer system, the principal amount of Notes represented by such Global Note
to the accounts of participants. The accounts to be credited were designated by
the initial purchasers. Ownership of beneficial interests in the Global Note has
been limited to participants or persons that may hold interests through
participants. Ownership of beneficial interests in the Global Note is shown on,
and the transfer of those ownership interests will be effected only through,
records maintained by DTC (with respect to participants' interests), the
participants and the indirect participants (with respect to the owners of
beneficial interests in the Global Note other than participants). The laws of
some jurisdictions may require that certain purchasers of securities take
physical delivery of such securities in definitive form. These limits and laws
may impair the ability to transfer or pledge beneficial interests in the Global
Note.
Beneficial owners of interests in Global Notes who desire to convert their
interests into common stock should contact their brokers or other participants
or indirect participants through whom they hold such beneficial interests to
obtain information on procedures, including proper forms and cut-off times, for
submitting requests for conversion.
So long as DTC, or its nominee, is the registered owner or holder of a
Global Note, DTC or its nominee, as the case may be, will be considered the sole
owner or holder of the Notes represented by the Global Note for all purposes
under the Indenture and the Notes. In addition, no beneficial owner of an
interest in a Global Note will be able to transfer that interest except in
accordance with the applicable procedures of DTC (in addition to those under the
Indenture referred to in this Prospectus; see "Transfer Restrictions"). Except
as set forth below, as an owner of a beneficial interest in the Global Note, you
will not be entitled to have the Notes represented by the Global Note registered
in your name, will not receive or be entitled to receive physical delivery of
certificated Notes and will not be considered to be the owner or holder of any
Notes under the Global Note. We understand that under existing industry
practice, in the event an owner of a beneficial interest in the Global Note
desires to take any action that DTC, as the holder of the Global Note, is
entitled to take, DTC would authorize the participants to take such action, and
the participants would authorize beneficial owners owning through such
participants to take such action or would otherwise act upon the instructions of
beneficial owners owning through them.
We have and will continue to make payments of principal of, premium, if any,
and interest on the Notes represented by the Global Note registered in the name
of and held by DTC or its nominee to DTC or its nominee, as the case may be, as
the registered owner and holder of the Global Note. Neither we, the Trustee nor
any Paying Agent have or will have any responsibility or liability for any
aspect of the records relating to or payments made on account of beneficial
ownership interests in the Global Note or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
We expect that DTC or its nominee, upon receipt of any payment of principal
of, premium, if any, or interest on the Global Note, will credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of the Global Note as shown on the records of
DTC or its nominee. We also expect that payments by participants or indirect
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participants to owners of beneficial interests in the Global Note held through
such participants or indirect participants will be governed by standing
instructions and customary practices and will be the responsibility of such
participants or indirect participants. We do not have any responsibility or
liability for any aspect of the records relating to, or payments made on account
of, beneficial ownership interests in the Global Note for any Note or for
maintaining, supervising or reviewing any records relating to such beneficial
ownership interests or for any other aspect of the relationship between DTC and
its participants or indirect participants or the relationship between such
participants or indirect participants and the owners of beneficial interests in
the Global Note owning through such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same-day funds.
DTC has advised us that it will take any action permitted to be taken by a
holder of Notes (including the presentation of Notes for conversion as described
above) only at the direction of one or more participants to whose account the
DTC interests in the Global Note is credited and only in respect of such portion
of the aggregate principal amount of Notes as to which such participant or
participants has or have given such direction. However, if there is an Event of
Default under the Notes, DTC will exchange the Global Note for Certificated
Notes which it will distribute to its participants and which will be legended as
set forth under the heading "Transfer Restrictions."
Although DTC is expected to follow the foregoing procedures in order to
facilitate transfers of interests in the Global Note among participants of DTC,
they are under no obligation to perform or continue to perform such procedures,
and such procedures may be discontinued at any time. Neither we nor the Trustee
will have any responsibility or liability for the performance by DTC or the
participants or indirect participants of their respective obligations under the
rules and procedures governing their respective operations.
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DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock is only a summary and is
qualified in its entirety by reference to the actual terms and provisions of the
capital stock contained in our Second Amended and Restated Certificate of
Incorporation, which became effective on April 14, 1999 and our bylaws, which
were amended at the same time.
Our certificate of incorporation authorizes 450,000,000 shares of common
stock, par value $.001 per share and 1,000,000 shares of preferred stock, par
value $.001 per share, the rights and preferences of which may be designated by
the board of directors. As of February 29, 2000, on a pre-split basis there were
64,080,294 shares of common stock issued and outstanding and no shares of
preferred stock issued and outstanding. As of February 29, 2000, there were
12,031 holders of record of our common stock.
COMMON STOCK
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of common stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of common stock are entitled to receive ratably
such dividends, if any, as may be declared by the board of directors out of
funds legally available therefor, subject to any preferential dividend rights of
outstanding preferred stock. Upon the liquidation, dissolution or winding up of
USI, the holders of common stock are entitled to receive ratably the net assets
of USI available after the payment of all debts and other liabilities and
subject to the prior rights of any outstanding preferred stock. Holders of the
common stock have no preemptive, subscription, redemption or conversion rights.
The outstanding shares of common stock are, and the shares that we offer in this
offering will be, when issued and paid for, validly issued, fully paid and
nonassessable. The rights, preferences and privileges of holders of common stock
are subject to, and may be adversely affected by, the rights of the holders of
shares of any series of preferred stock which we may designate and issue in the
future. Upon the closing of this offering, there will be no shares of preferred
stock outstanding.
PREFERRED STOCK
The board of directors is authorized, subject to certain limitations
prescribed by law, without further stockholder approval, to issue from time to
time up to an aggregate of 1,000,000 shares of preferred stock in one or more
series and to fix or alter the designations, preferences, rights and any
qualifications, limitations or restrictions of the shares of each such series
thereof, including the dividend rights, dividend rates, conversion rights,
voting rights, terms of redemption, including sinking fund provisions,
redemption price or prices, liquidation preferences and the number of shares
constituting any series or designations of such series. The issuance of
preferred stock may have the effect of delaying, deferring or preventing a
change of control of USI. We have no present plans to issue any shares of
preferred stock.
WARRANTS
At February 29, 2000, there were warrants outstanding to purchase a total of
1,257,709 shares of common stock after giving effect to our stock split.
Warrants to purchase 1,174,004 shares at $1.52 per share after giving effect to
our stock split will expire in September 2008, and warrants to purchase 83,705
shares at $1.49 per share after giving effect to our stock split will expire in
September 2005.
CONVERTIBLE NOTES
At January 15, 2000 there were subordinated convertible notes outstanding
convertible into a total of 5,030,181 shares of common stock on a pre-split
basis. These notes are convertible at the election of the holder at any time
prior to the close of business on the business day immediately preceeding the
date they are called for redemption or November 1, 2004.
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REGISTRATION RIGHTS
The holders of 69,523,934 shares of common stock and 2,144,300 shares of
common stock, in each case after giving effect to our stock split, issuable upon
the exercise of warrants to purchase common stock are entitled to rights with
respect to registration of such shares under the Securities Act described at
"Certain Relationship and Related Transactions--Amended and Restated Stockholder
Agreement." The holders of warrants to purchase 195,536 shares of common stock
are entitled to rights with respect to registration of such shares under the
Securities Act. Under these registration rights, in the event we elect to
register any of our shares of common stock for purposes of effecting any public
offering, the holders of the warrants or the shares issued upon exercise of the
warrants are entitled to include their shares of common stock in the
registration, subject however to the right of USI or the underwriters of the
proposed offering, if any, to reduce the number of shares proposed to be
registered in view of market conditions. All expenses in connection with any
registration other than underwriting discounts and commissions will be borne by
USI.
We have agreed to register after giving effect to our stock split up to
3,023,438 shares held by officers of USI in the event an officer's employment is
terminated due to death or disability.
RESTRICTIONS ON SALE
Stockholders holding 55,463,376 shares of common stock in the aggregate
after giving effect to our stock split have agreed with us that, upon the
expiration of the agreement they have with the underwriters not to dispose of
their shares of common stock for a period ending ninety days after the date of
our February offering of common stock, they will not sell, pledge or otherwise
dispose of their shares of common stock until December 31, 2000. Pursuant to the
agreement that each of the stockholders has with us, the stockholder will be
allowed to dispose of up to one-seventh of the shares beneficially owned by the
stockholder that are subject to the agreement each month beginning May 15, 2000.
CERTAIN ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
As noted above, our board of directors, without stockholder approval, has
the authority under our certificate of incorporation to issue preferred stock
with rights superior to the rights of the holders of common stock. As a result,
preferred stock could be issued quickly and easily, could adversely affect the
rights of holders of common stock and could be issued with terms calculated to
delay or prevent a change of control of USI or make removal of management more
difficult.
ELECTION AND REMOVAL OF DIRECTORS. The certificate and bylaws provides for
the division of our board of directors into three classes, as nearly equal in
number as possible, with the directors in each class serving for a three-year
term, and one class being elected each year by our stockholders. Directors may
be removed only for cause. This system of electing and removing directors may
tend to discourage a third party from making a tender offer or otherwise
attempting to obtain control of USI and may maintain the incumbency of the board
of directors, as it generally makes it more difficult for stockholders to
replace a majority of directors.
STOCKHOLDER MEETINGS. Our bylaws provide that the stockholders may not call
a special meeting of the stockholders of USI. Rather, only the board of
directors, the chairman of the board or the president will be able to call
special meetings of stockholders.
REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS. Our bylaws establish advance notice procedures with respect to
stockholder proposals and the nomination of candidates for election as
directors, other than nominations made by or at the direction of the board of
directors or one of its committees.
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DELAWARE ANTI-TAKEOVER LAW. We are a Delaware corporation subject to
Section 203 of the Delaware General Corporation Law. Under Section 203, certain
"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 prohibited for a three-year period following the
date that such stockholder became an interested stockholder, unless:
- The corporation has elected in its certificate of incorporation not to be
governed by Section 203. We have not made such an election,
- The business combination or the transaction which resulted in the
stockholder becoming an interested stockholder was approved by the board
of directors of the corporation before such stockholder became an
interested stockholder,
- Upon consummation of the transaction that made such stockholder 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 stock held by the plan in a tender or
exchange offer, or
- The business combination is approved by the board of directors of the
corporation and authorized at a meeting by two-thirds of the voting stock
which the interested stockholder did not own.
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 a majority of the corporation's
directors. The term "business combination" is defined generally 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 as those stockholders who
become beneficial owners of 15% or more of a Delaware corporation's voting
stock, together with the affiliates or associates of that stockholder.
LIMITATION OF OFFICER AND DIRECTOR LIABILITY AND INDEMNIFICATION
ARRANGEMENTS. Our certificate limits the liability of our directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
will not be personally liable for monetary damages for breach of their fiduciary
duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders,
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law,
- unlawful payments of dividends or unlawful stock repurchases or
redemptions, or
- any transaction from which the director derived an improper personal
benefit.
This charter provision has no effect on any non-monetary remedies that may
be available to us or our stockholders, nor does it relieve us or our officers
or directors from compliance with federal or state securities laws. The
certificate also generally provides that we shall indemnify, to the fullest
extent permitted by law, any person who was or is a party or is threatened to be
made a party to any threatened, pending or completed action, suit,
investigation, administrative hearing or any other proceeding by reason of the
fact that he is or was a director or officer of ours, or is or was serving at
our request as a director, officer, employee or agent of another entity, against
expenses incurred by him
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in connection with such proceeding. An officer or director shall not be entitled
to indemnification by us if:
- The officer or director did not act in good faith and in a manner
reasonably believed to be in, or not opposed to, our best interests, or
- With respect to any criminal action or proceeding, the officer or director
had reasonable cause to believe his conduct was unlawful.
These charter and bylaw provisions and provisions of Delaware law may have
the effect of delaying, deterring or preventing a change of control of USI.
TRANSFER AGENT AND REGISTRAR
American Stock Transfer & Trust Company is the transfer agent and registrar
for the common stock.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is a summary of certain United States federal
income tax considerations that may be relevant to the purchase, ownership and
disposition of the Notes by U.S. holders, as defined below, and the ownership
and disposition of our common stock received upon conversion of the Notes by
U.S. holders. This discussion does not purport to be a full description of all
United States federal income tax considerations that may be relevant to the
purchase, holding and disposition of the Notes or our common stock and does not
address any other taxes that might be applicable to a holder of the Notes or our
common stock, such as tax consequences arising under the tax laws of any state,
locality or foreign jurisdiction. We cannot assure you that the United States
Internal Revenue Service will take a similar view of these consequences.
Further, this discussion does not address all aspects of taxation that may be
relevant to particular holders of Notes or common stock in light of their
personal circumstances and does not deal with persons that are subject to
special tax rules, such as dealers in securities, financial institutions,
insurance companies, tax-exempt entities, persons holding the Notes as part of a
hedging or conversion transaction, a straddle or constructive sale, persons
whose functional currency is not the United States dollar and persons who are
not U.S. holders. The discussion below assumes that the Notes and the common
stock into which such Notes are convertible are held as capital assets within
the meaning of section 1221 of the Internal Revenue Code.
The discussion of the United States federal income tax considerations below
is based on currently existing provisions of the Internal Revenue Code, the
applicable Treasury regulations promulgated and proposed under the Internal
Revenue Code, judicial decisions and administrative interpretations, all of
which are subject to change, possibly on a retroactive basis. Because individual
circumstances may differ, you are strongly urged to consult your tax advisor
with respect to your particular tax situation and the particular tax effects of
any state, local, non-United States or other tax laws and possible changes in
the tax laws.
As used herein, a U.S. holder means a beneficial owner of a Note or common
stock who is, for United States federal income tax purposes:
- a citizen or resident of the United States;
- a corporation or partnership created or organized in or under the laws of
the United States or of any state thereof or in the District of Columbia,
unless in the case of a partnership Treasury regulations enacted in the
future provide otherwise;
- an estate the income of which is subject to United States federal income
taxation regardless of its source; or
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- a trust if either (a) a court within the United States is able to exercise
primary supervision over the administration of the trust and one or more
United States persons have the authority to control all substantial
decisions of the trust or (b) the trust has a valid election in effect
under applicable Treasury regulations to be treated as a United States
person.
STATED INTEREST. Interest on a Note will be includable in the income of a
U.S. holder as ordinary income at the time interest is received or accrued, in
accordance with a holder's method of accounting for United States federal income
tax purposes.
REGISTRATION RIGHTS. The registration of the Notes pursuant to our
obligation as described under "Description of the Notes--Registration Rights"
will not constitute a taxable event for United States federal income tax
purposes, will not affect a U.S. holder's tax basis in the Notes, and a U.S.
holder's holding period for the registered Notes will include the holding period
such U.S. holder had in the Notes before such Notes were registered.
MANDATORY PURCHASE AND OPTIONAL REDEMPTION. In the event of a Change in
Control, the holders of the Notes will have the right to require us to purchase
their Notes at a price equal to 100% of the aggregate principal amount, plus
accrued interest. Under Treasury regulations issued under provisions of the
Internal Revenue Code relating to original issue discount, computation of yield
and maturity of the Notes is not affected by this purchase right and obligation
if, based on all the facts and circumstances as of the issue date, payments on
the Notes are significantly more likely than not to occur in accordance with the
stated payment schedule on the Notes (which does not reflect a Change in
Control). We believe, based on all the facts and circumstances as of the issue
date, it was significantly more likely than not that the Notes would be paid
according to their stated schedule. Therefore, we have not and will not take the
purchase right and obligation into account in determining the yield and maturity
of the Notes.
We may redeem the Notes, in whole or in part, at any time on or after
November 5, 2002, at prices specified under the heading "Description of the
Notes--Optional Redemption." The Treasury regulations that relate to original
issue discount contain rules for determining the yield and maturity of any
instrument that may be redeemed prior to its stated maturity date at the option
of the issuer. Under these regulations, solely for purposes of the accrual of
original issue discount, it is assumed that the issuer will exercise any option
to redeem a debt instrument if the exercise will lower the yield-to-maturity of
the debt instrument. We believe that we will not be presumed to redeem the Notes
prior to their stated maturity under the foregoing rules because the exercise of
the option would not lower the yield-to-maturity of the Notes.
SALE, EXCHANGE OR REDEMPTION OF NOTES. A U.S. holder of a Note will
recognize gain or loss upon the sale, exchange, redemption or other taxable
disposition of a Note in an amount equal to the difference between (i) the
amount of cash plus the fair market value of any property received, other than
an amount received in respect of accrued interest, which will be taxable as
interest if not previously included in income which is taxable as ordinary
income and (ii) the U.S. holder's adjusted tax basis in the Note. A U.S.
holder's adjusted tax basis in a Note generally will equal the cost of the Note
to the holder. Generally, gain or loss recognized on the disposition of a Note
will be capital gain or loss and will be long-term capital gain or loss if the
U.S. holder's holding period in the Note is more than one year at the time of
the disposition.
MARKET DISCOUNT. The tax treatment of a U.S. holder with respect to the
Notes may be altered if the holder acquires the Notes at a "market discount."
Market discount on a Note will generally equal the amount, if any, by which the
principal amount of the Note exceeds the holder's initial tax basis in the Note
(generally the Note's acquisition price). Subject to a de minimis exception, a
U.S. holder of a Note acquired at a market discount is generally required to
treat as ordinary income any gain recognized on the disposition of the Note to
the extent of the "accrued market discount" at the time of
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<PAGE>
disposition, unless the holder elects to include accrued market discount in
income currently. Market discount on a Note will be treated as accruing on a
straight-line basis over the term of such Note, or at the election of the
holder, under a constant-yield method. A U.S. holder of a Note acquired at a
market discount who does not elect to include accrued market discount in income
currently may be required to defer the deduction of the portion of the interest
on any indebtedness incurred or maintained to purchase or carry the Note until
the Note is disposed of in a taxable transaction. If a Note with accrued market
discount is converted into our common stock, the amount of such accrued market
discount at the time of conversion generally will be taxable to the U.S. holder
as ordinary income upon disposition of our common stock.
AMORTIZABLE BOND PREMIUM. A U.S. holder that purchases a Note at a premium
over its stated principal amount generally may elect to amortize such premium as
amortizable bond premium from the purchase date to the Note's maturity date
(taking into account earlier call dates, as appropriate) under a yield to
maturity formula if an election by the taxpayer under section 171 of the Code is
in effect or is made. The amortizable bond premium will not include any premium
attributable to the Note's conversion feature. The premium attributable to the
conversion feature is the excess, if any, of the Note's purchase price over what
the Note's fair market value would be if there were no conversion feature. In
addition, under Treasury Regulations, the amount of amortizable bond premium
that a U.S. holder may deduct in any accrual period is limited to the amount by
which the holder's total interest inclusions on the Note in prior accrual
periods exceeds the total amount treated by the holder as a bond premium
deduction in prior accrual periods. If any of the excess bond premium is not
deductible under section 171, that amount is carried forward to the next accrual
period and is treated as bond premium allocable to that period.
An election under section 171 of the Code is available only if the Notes are
held as capital assets. Such election is revocable only with the consent of the
Internal Revenue Service and applies to all debt obligations owned or
subsequently acquired by the taxpayer. In general, a U.S. holder's tax basis in
a Note will be reduced by the amount of any bond premium that is amortized or
used to offset interest income. Such amortization will cease upon conversion of
the Note into our common stock.
CONVERSION. A U.S. holder of a Note will not recognize gain or loss on the
conversion of a Note solely into our common stock except with respect to cash in
lieu of fractional shares and except to the extent that the common stock issued
upon conversion is treated as attributable to accrued interest on the Note. The
holding period of the common stock received upon conversion will include the
period during which the Note was held, and the holder's aggregate tax basis in
the common stock received upon conversion of the Note will be equal to the
holder's aggregate tax basis in the Note at the time of conversion, less any
portion allocable to any fractional share. However, a holder's tax basis in
shares of common stock considered attributable to accrued interest generally
will equal the amount of such accrued interest included in income and the
holding period will begin on the day following the date of conversion. A U.S.
holder of a Note will recognize gain or loss for federal income tax purposes
upon the receipt of cash in lieu of a fractional share of our common stock in an
amount equal to the difference between the amount of cash received and the
holder's tax basis in such fractional share. This gain or loss should be capital
gain or loss and should be taxable as described under "Sale, Exchange or
Redemption of the Notes." The fair market value of shares of common stock
received, which is attributable to accrued interest, will be taxable as ordinary
interest income.
CONSTRUCTIVE DISTRIBUTIONS. The conversion price of the Notes is subject to
adjustment under specified circumstances. Under section 305 of the Internal
Revenue Code and applicable Treasury regulations, adjustments or the failure to
make adjustments to the conversion price of the Notes may result in a taxable
constructive distribution to U.S. holders of Notes, resulting in ordinary income
(subject to a possible dividends received deduction in the case of corporate
shareholders) to the extent of our earnings and profits, as determined in
accordance with United States federal income tax principles, if, and to the
extent that, these adjustments in the conversion price increase the
proportionate interest of a U.S. holder of a Note in our fully diluted common
stock, whether or not the holder ever converts the Notes into our common stock.
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ADDITIONAL INTEREST. We intend to take the position that payments of
additional interest as described under the heading "Description of the
Notes--Registration Rights" if paid as required therein, should be taxable to
U.S. holders as ordinary income when received or accrued in accordance with the
U.S. holder's method of accounting for United States federal income tax
purposes. The Internal Revenue Service may take a different position, however,
which could affect the timing of a U.S. holder's income with respect to
additional interest.
DISTRIBUTIONS ON COMMON STOCK. A distribution by our company with respect to
our common stock will be treated for United States federal income tax purposes
as ordinary dividend income to the extent that such distributions do not exceed
our earnings and profits as determined under United States federal income tax
principles. To the extent a distribution exceeds our earnings and profits, it
will be treated first as a tax-free return of the U.S. holder's tax basis in the
common stock to the extent of the holder's tax basis, and then will generally be
treated as gain from the sale of a capital asset.
DISPOSITION OF COMMON STOCK. A U.S. holder of our common stock will
recognize capital gain or loss upon the sale or other taxable disposition of our
common stock in an amount equal to the difference between the amount of cash
plus the fair market value of any property received and the U.S. holder's tax
basis in the common stock. The taxation of such capital gains will be as
described above under "Sale, Exchange or Redemption of Notes."
UNITED STATES INFORMATION REPORTING AND BACKUP WITHHOLDING. Under current
United States federal income tax law, "reportable" payments, including payments
on interest and dividends and under specified circumstances principal payments
on the Notes made to, specified U.S. holders may be subject to backup
withholding tax at the rate of 31%, if these persons fail to supply correct
taxpayer identification numbers and other required information in the specified
manner.
Any amounts withheld under the backup withholding rules from payment to a
holder of Notes or common stock will be refunded or credited against the
holder's United States federal income tax liability provided that the required
information is furnished to the United States Internal Revenue Service.
We will report to holders of Notes and common stock and to the Internal
Revenue Service the amount of any reportable payments for each calendar year and
the amount of any tax withheld with respect to reportable payments.
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SELLING SECURITY HOLDERS
The Notes were originally issued by us and sold by the initial purchasers in
a transaction exempt from the registration requirements of the Securities Act to
persons reasonably believed by the initial purchasers to be qualified
institutional buyers or other institutional accredited investors. Credit Suisse
First Boston Corporation, Morgan Stanley & Co. Incorporated, Bear, Stearns & Co.
Inc., Legg Mason Wood Walker, Incorporated, Wasserstein Perella Securities,
Inc., C.E. Unterberg, Towbin and The Robinson-Humphrey Company, LLC acted as the
initial purchasers in this transaction. Selling security holders, including
their transferees, pledgees or donees or their successors, may from time to time
offer and sell pursuant to this Prospectus any or all of the Notes and common
stock into which the Notes are convertible.
The following table sets forth information, as of February 29, 2000, with
respect to the selling security holders and the principal amounts of Notes
benefically owned by each selling holder that may be offered under this
Prospectus. The information is based on information provided by or on behalf of
the selling security holders. The selling security holders may offer all, some
or none of the Notes or common stock into which the Notes are convertible.
Accordingly, no estimate can be given as to the amount of the Notes or common
stock that will be held by the selling security holders upon termination of any
sales. In addition, the selling security holders identified below may have sold,
transferred or otherwise disposed of all or a portion of their Notes since the
date on which they provided the information regarding their Notes in
transactions exempt from the registration requirements of the Securities Act.
All common share numbers presented in the table below reflect the three-for-two
stock split to be effected by means of a stock dividend that will be distributed
to our stockholders on or about March 28, 2000.
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT OF NUMBER OF
NOTES CONVERSION SHARES
BENEFICIALLY OWNED THAT PERCENTAGE OF THAT MAY BE
SELLING SECURITYHOLDER MAY BE SOLD NOTES OUTSTANDING SOLD(1)(2)
- ---------------------- ----------------------- ----------------- -----------------
<S> <C> <C> <C>
AAM/Zazone Institutional Income Fund,
L.P...................................... $ 1,150,000 * 69,416
AIG SoundShore Holdings Ltd................ 12,306,000 9.8% 742,817
AIG SoundShore Opportunity Holding Fund
Ltd...................................... 4,984,000 4 300,845
AIG SoundShore Strategic Holding Fund
Ltd...................................... 2,239,000 1.8 135,150
AIG/National Union Fire Insurance.......... 375,000 * 22,635
Aftra Health Fund.......................... 200,000 * 12,072
Argent Classical Convertible Arbitrage Fund
(Bermuda) L.P............................ 1,000,000 * 60,362
Aristeia International, Ltd................ 3,022,000 2.4 182,414
Aristeia Trading, LLC...................... 1,478,000 1.2 89,214
Associated Electric & Gas Insurance
Services Limited......................... 200,000 * 12,072
BNP Arbitrage SNC.......................... 6,250,000 5 377,264
BS Debt Income Fund-Class A................ 5,000 * 302
Black Diamond Offshore, Ltd................ 381,000 * 22,997
Boilermaker-Blacksmith Pension Trust....... 700,000 * 42,254
Brown & Williamson Tobacco Master
Retirement Trust......................... 50,000 * 3,018
CALAMOS Convertible Fund-CALAMOS Investment
Trust.................................... 1,350,000 1.1 81,488
CALAMOS Convertible Portfolio-CALAMOS
Advisors Trust........................... 15,000 * 905
CALAMOS Global Growth and Income Fund-
CALAMOS Investment Trust................. 90,000 * 5,432
CALAMOS Growth and Income Fund-CALAMOS
Investment Trust......................... 620,000 * 37,424
Champion International Corporation Master
Retirement Trust......................... $ 595,000 * 35,915
</TABLE>
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<TABLE>
<CAPTION>
PRINCIPAL AMOUNT OF NUMBER OF
NOTES CONVERSION SHARES
BENEFICIALLY OWNED THAT PERCENTAGE OF THAT MAY BE
SELLING SECURITYHOLDER MAY BE SOLD NOTES OUTSTANDING SOLD(1)(2)
- ---------------------- ----------------------- ----------------- -----------------
<S> <C> <C> <C>
City of Knoxville Pension System........... 210,000 * 12,675
Convexity Partners, L.P.................... 750,000 * 45,272
Credit Suisse First Boston Corporation..... 29,029,000 23.2% 1,752,254
Credit Suisse First Boston Corporation
London................................... 4,900,000 3.9 295,775
Delaware PERS.............................. 875,000 * 52,817
Delta Airlines Master Trust................ 1,300,000 1 78,470
Deutsche Bank Securities Inc............... 1,900,000 1.5 114,687
Double Black Diamond Offshore LDC.......... 1,029,000 * 62,112
The Dow Chemical Company Employees'
Retirement Plan.......................... 1,395,000 1.1 84,204
ELF Aquitaine.............................. 50,000 * 3,018
Elliott Associates, L.P.................... 745,000 * 44,969
Evergreen Income & Growth Fund............. 3,000,000 2.4 181,086
Family Service Life Insurance Co........... 300,000 * 18,108
The Fondren Foundation..................... 40,000 * 2,414
General Motors Employees Global Group
Pension Trust............................ 691,000 * 41,709
Guardian Life Insurance Co................. 4,500,000 3.6 271,629
Guardian Pension Trust..................... 200,000 * 12,072
Highbridge Capital Co...................... 1,000,000 * 60,362
ICI American Holdings Trust................ 485,000 * 292,761
Island Holdings............................ 25,000 * 1,509
Jackson Investment Fund Ltd. C/o Leeds
Management Services (Cayman) Ltd......... 130,000 * 7,847
JMG Capital Partners, L.P.................. 1,500,000 1.2 90,543
JMG Triton Offshore Fund, Ltd.............. 8,000,000 6.4 482,897
Kettering Medical Center Funded
Depreciation Account..................... 40,000 * 2,414
Nelson Partners Ltd. C/o Leeds Management
Services (Cayman) Ltd.................... 455,000 * 27,464
Knoxville Utilities Board Retirement
System................................... 125,000 * 7,545
LLT Limited................................ 150,000 * 9,054
The Liverpool Limited Partnership.......... 255,000 * 15,324
Lord Abbett Bond Debenture Fund............ 3,000,000 2.4 181,086
Mainstay Convertible Fund.................. 825,000 * 49,799
McMahan Securities Company, L.P............ 325,000 * 19,617
Merrill Lynch Pierce Fenner and Smith
Inc...................................... 250,000 * 15,090
Nalco Chemical Retirement.................. 155,000 * 9,356
New York Life Insurance and Annuity
Corporation (NYLIAC)..................... 750,000 * 45,272
New York Life Insurance Company (NYLIC).... 5,250,000 4.2 316,902
New York Life Separate Account #7.......... 300,000 * 18,108
Olympus Securities, Ltd. C/o Leeds
Management Services Ltd.................. 740,000 * 44,667
Port Authority of Allegheny County
Retirement and Disability Allowance...... 740,000 * 44,667
Putnam Convertible Income--Growth Trust.... 601,000 * 36,278
SPT........................................ 585,000 * 35,312
San Diego County Employees Retirement
Assoc.................................... 1,650,000 1.3 99,597
Southern Farm Bureau Life Insurance -
FRIC..................................... 450,000 * 27,162
Southport Management Partners, L.P......... 450,000 * 27,162
Southport Partners International, Ltd...... 900,000 * 54,326
State of Oregon Equity..................... 3,525,000 2.8 212,777
Tucker Anthony Incorporated................ $ 500,000 * 30,180
Unifi, Inc. Profit Sharing Plan and
Trust.................................... 65,000 * 3,923
</TABLE>
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<TABLE>
<CAPTION>
PRINCIPAL AMOUNT OF NUMBER OF
NOTES CONVERSION SHARES
BENEFICIALLY OWNED THAT PERCENTAGE OF THAT MAY BE
SELLING SECURITYHOLDER MAY BE SOLD NOTES OUTSTANDING SOLD(1)(2)
- ---------------------- ----------------------- ----------------- -----------------
<S> <C> <C> <C>
United Food and Commercial Workers
Local 1262............................... 310,000 * 18,711
Value Line Convertible Fund, Inc........... 500,000 * 30,180
Van Waters & Rogers, Inc. Retirement Plan
(f.k.a. Univar Corporation).............. 210,000 * 12,675
Wasserstein Perella Securities, Inc. ...... 1,000,000 * 60,362
Westgate International, L.P................ 1,000,000 * 60,362
Worldwide Transaction Ltd.................. 90,000 * 5,432
Zeneca Holdings Trust...................... 470,000 * 26,258
</TABLE>
- ------------------------
* Less than 1%
(1) Consists of shares of common stock issuable upon conversion of the Notes.
(2) Assumes a conversion price of $16.57 and a cash payment in lieu of any
fractional share interest. The conversion price is subject to adjustment as
described under "Description of Notes--Conversion."
The following table sets forth information, as of March 2, 2000, with
respect to the five selling stockholders and the number of shares of common
stock beneficially owned by each selling stockholder that may be offered under
this prospectus. The selling stockholders acquired these shares in private
placement transactions and have contractual rights to include resales of their
shares in this prospectus.
<TABLE>
<CAPTION>
NUMBER OF
SHARES THAT MAY
SELLING STOCKHOLDER BE SOLD
- ------------------- ---------------
<S> <C>
Luis Sebastian Alegrett..................................... 43,608
Carlos E. Bravo............................................. 5,388
Michael Q. Mai.............................................. 26,590
Vicente Perez de Tudela..................................... 9,573
Southeastern Technology Fund L.P............................ 48,213
-------
Total................................................... 133,372
</TABLE>
None of the selling holders nor any of their affiliates, officers, directors
or principal equity holders has held any position or office or has had any
material relationship with USI within the past three years other than Luis
Sebastian Alegrett, Carlos E. Bravo, Michael Q. Mai and Vicente Perez de Tudela,
who are all consultants of USI.
Information concerning the selling holders may change from time to time and
any changed information will be set forth in supplements to this prospectus if
and when necessary. In addition, the conversion rate and therefore, the number
of shares of common stock issuable upon conversion of the Notes, is subject to
adjustment under certain circumstances. Accordingly, the aggregate principal
amount of Notes and the number of shares of common stock into which the notes
are convertible may increase or decrease.
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PLAN OF DISTRIBUTION
The selling holders and their successors, including their transferees,
pledgees or donees or their successors, may sell the Notes and the common stock
into which the Notes are convertible directly to purchasers or through
underwriters, broker-dealers or agents, who may receive compensation in the form
of discounts, concessions or commissions from the selling holders or the
purchasers. These discounts, concessions or commissions as to any particular
underwriter, broker-dealer or agent may be in excess of those customary in the
types of transactions involved.
The Notes and the common stock into which the Notes are convertible may be
sold in one or more transactions at fixed prices, at prevailing market prices at
the time of sale, at prices related to the prevailing market prices, at varying
prices determined at the time of sale, or at negotiated prices. These sales may
be effected in transactions, which may involve crosses or block transactions:
- on any national securities exchange or U.S. inter-dealer system of a
registered national securities association on which the Notes or the
common stock may be listed or quoted at the time of sale;
- in the over-the-counter market;
- in transactions otherwise than on these exchanges or systems or in the
over-the-counter market;
- through the writing of options, whether the options are listed on an
options exchange or otherwise; or
- through the settlement of short sales.
In connection with the sale of the Notes and the common stock into which the
Notes are convertible or otherwise, the selling holders may enter into hedging
transactions with broker-dealers or other financial institutions, which may in
turn engage in short sales of the Notes or the common stock into which the Notes
are convertible in the course of hedging the positions they assume. The selling
holders may also sell the Notes or the common stock into which the Notes are
convertible short and deliver these securities to close out their short
positions, or loan or pledge the Notes or the common stock into which the Notes
are convertible to broker-dealers that in turn may sell these securities.
The aggregate proceeds to the selling holders from the sale of the Notes or
common stock into which the Notes are convertible offered by them will be the
purchase price of the Notes or common stock less discounts and commissions, if
any. Each of the selling holders reserves the right to accept and, together with
their agents from time to time, to reject, in whole or in part, any proposed
purchase of Notes or common stock to be made directly or through agents. We will
not receive any of the proceeds from this offering.
Our outstanding common stock is listed for trading on the Nasdaq National
Market. We do not intend to list the Notes for trading on any national
securities exchange or on the Nasdaq National Market and can give no assurance
about the development of any trading market for the Notes.
In order to comply with the securities laws of some states, if applicable,
the Notes and common stock into which the Notes are convertible may be sold in
these jurisdictions only through registered or licensed brokers or dealers. In
addition, in some states the Notes and common stock into which the Notes are
convertible may not be sold unless they have been registered or qualified for
sale or an exemption from registration or qualification requirements is
available and is complied with.
The selling holders and any underwriters, broker-dealers or agents that
participate in the sale of the Notes and common stock into which the Notes are
convertible may be "underwriters" within the meaning of Section 2(11) of the
Securities Act. Any discounts, commissions, concessions or profit they earn on
any resale of the shares may be underwriting discounts and commissions under the
Securities Act. Selling holders who are "underwriters" within the meaning of
Section 2(11) of the Securities Act will be subject to the prospectus delivery
requirements of the Securities Act. The selling holders have
89
<PAGE>
acknowledged that they understand their obligations to comply with the
provisions of the Exchange Act and the rules thereunder relating to stock
manipulation, particularly Regulation M.
In addition, any securities covered by this prospectus that qualify for sale
pursuant to Rule 144 or Rule 144A of the Securities Act may be sold under Rule
144 or Rule 144A rather than pursuant to this prospectus. A selling holder may
not sell any Notes or common stock described in this prospectus and may not
transfer, devise or gift these securities by other means not described in this
prospectus.
To the extent required, the specific Notes or common stock to be sold, the
names of the selling holders, the respective purchase prices and public offering
prices, the names of any agent, dealer or underwriter, and any applicable
commissions or discounts with respect to a particular offer will be set forth in
an accompanying prospectus supplement or, if appropriate, a post- effective
amendment to the registration statement of which this prospectus is a part.
The Registration Statement of which this Prospectus is a part is being filed
pursuant to a registration rights agreement that we entered into for the benefit
of holders of the Notes to register their Notes and common stock under
applicable federal and state securities laws under specific circumstances and at
specific times. The registration rights agreement provides for
cross-indemnification of the selling holders and us and their and our respective
directors, officers and controlling persons against specific liabilities in
connection with the offer and sale of the Notes and the common stock, including
liabilities under the Securities Act.
The seven selling stockholders acquired their shares of common stock in
private placement transactions. As part of these transactions, we entered into
agreements that granted the selling stockholders rights to include resales of
their shares in this Prospectus. These agreements provide for
cross-indemnification provisions similar to those in the registration rights
agreement discussed above. The selling stockholders may distribute their shares
in the same manner as the shares of common stock underlying the Notes may be
distributed.
We will pay substantially all of the expenses incurred by the selling
holders incident to the offering and sale of the Notes and the common stock.
90
<PAGE>
LEGAL MATTERS
Certain legal matters in connection with the offering and sale of the Notes
will be passed upon for USI by Latham & Watkins, Washington, D.C. Partners of
Latham & Watkins own in total shares of our common stock representing less than
1% of the total number of shares of common stock outstanding.
EXPERTS
Ernst & Young LLP, independent auditors, has audited our consolidated
financial statements at December 31, 1998, and 1999, for the period January 14,
1998 (date of inception) through December 31, 1998 and the year ended December
1999, as set forth in their report. We've included our consolidated financial
statements in the prospectus and elsewhere in the registration statement in
reliance on Ernst & Young LLP's report, given on their authority as experts in
accounting and auditing.
Ernst & Young LLP has also audited I.I.T. Holding, Inc. and subsididaries'
consolidated financial statements at December 31, 1996 and 1997, and September
7, 1998, and for each of the two years in the period ended December 31, 1997,
and for the period from January 1, 1998 through September 7, 1998, as set forth
in their report. As to the years 1996 and 1997, their report is based in part on
the report of Bassan & Associates S.C., independent auditors. We've included
IIT's consolidated financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on their
authority as experts in accounting and auditing.
AVAILABLE INFORMATION
We are currently subject to the periodic reporting and other requirements of
the Securities Exchange Act of 1934. You may read and copy any document we file
at the Commission's public reference rooms located at 450 5th Street, N.W.,
Washington, D.C. 20549, at Seven World Trade Center, 13th Floor, New York, New
York 10048 and at Northwest Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661-2511. Please call the Commission at 1-800-SEC-0330 for
further information on the public reference rooms. Our Commission filings are
also available to the public from commercial document retrieval services and at
the web site maintained by the Commission at: http://www.sec.gov. Our common
stock trades on The Nasdaq National Market.
You may request a copy of any of this information, at no cost, by writing or
telephoning us at the following address or phone number:
USINTERNETWORKING, Inc.
One USI Plaza
Annapolis, Maryland 21401-7478
(410) 897-4400
91
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF USINTERNETWORKING, INC.
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 1998 and
1999...................................................... F-3
Consolidated Statements of Operations for the period January
14, 1998 (date of inception) through December 31, 1998 and
for the year ended December 31, 1999...................... F-4
Consolidated Statement of Stockholders' Equity (Deficit) for
the period January 14, 1998
(date of inception) through December 31, 1998............. F-5
Consolidated Statement of Stockholders' Equity (Deficit) for
the year ended
December 31, 1999......................................... F-6
Consolidated Statements of Cash Flows for the period January
14, 1998 (date of inception) through December 31, 1998 and
for the year ended December 31, 1999...................... F-7
Notes to Consolidated Financial Statements.................. F-8
CONSOLIDATED FINANCIAL STATEMENTS OF I.I.T. HOLDING, INC.
AND SUBSIDIARIES
Report of Independent Auditors.............................. F-28
Report of Independent Auditors.............................. F-29
Consolidated Balance Sheets as of December 31, 1997, 1996
and September 7, 1998..................................... F-30
Consolidated Statements of Operations for the years ended
December 31, 1997 and 1996 for the period from January 1,
1998 through September 7, 1998............................ F-31
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997
and 1996 and for the period from January 1, 1998 through
September 7, 1998......................................... F-32
Consolidated Statements of Cash Flows for the years ended
December 31, 1997 and 1996 and for the period from January
1, 1998 through September 7, 1998......................... F-33
Notes to Consolidated Financial Statements.................. F-34
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
USINTERNETWORKING, Inc.
We have audited the accompanying consolidated balance sheets of
USINTERNETWORKING, Inc. ("the Company") as of December 31, 1998 and 1999, and
the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for the period from January 14, 1998 (date of
inception) through December 31, 1998 and for the year ended December 31, 1999.
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 auditing standards generally
accepted in the United States. 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
USINTERNETWORKING, Inc. as of December 31, 1998 and 1999, and the consolidated
results of its operations and its cash flows for the period from January 14,
1998 (date of inception) through December 31, 1998 and for the year ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ Ernst & Young LLP
Baltimore, Maryland
January 24, 2000,
except for Note 21, as to which
the date is March 3, 2000
F-2
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $43,802,465 $112,302,621
Available-for-sale securities............................. -- 31,706,991
Accounts receivable, less allowance of $142,000 and
$543,447 in 1998 and 1999, respectively................. 2,882,119 16,557,356
Due from officer.......................................... -- 1,900,000
Prepaid expenses and other current assets................. 3,017,959 6,904,595
------------ ------------
Total current assets........................................ 49,702,543 169,371,563
Deferred iMAP costs, net of accumulated amortization of
$2,415,848 in 1999........................................ -- 8,899,837
Software licenses, net of accumulated amortization of
$3,728,103 in 1999........................................ 9,596,760 10,806,710
Property and equipment, net of accumulated depreciation of
$1,567,885 and $14,319,115 in 1998 and 1999,
respectively.............................................. 21,640,145 101,166,670
Goodwill, net of accumulated amortization of $1,611,763 and
$7,566,763 in 1998 and 1999, respectively................. 25,137,296 29,646,621
Deferred financing costs and other assets, net of
accumulated amortization of $128,029 in 1999.............. 439,734 5,562,771
------------ ------------
Total assets................................................ $106,516,478 $325,454,172
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 6,571,767 $ 13,145,394
Accrued compensation...................................... 4,870,690 8,187,517
Other accrued expenses.................................... 1,569,570 3,385,262
Deferred revenue.......................................... 51,247 9,066,452
Due to former shareholders of acquired businesses......... 10,826,735 --
Current portion of capital lease obligations.............. 1,503,947 5,834,076
Current portion of long-term debt......................... 1,757,588 12,586,553
------------ ------------
Total current liabilities................................... 27,151,544 52,205,254
Short-term obligations expected to be refinanced............ 5,282,450 2,116,753
Capital lease obligations, less current portion............. 3,427,254 11,385,029
Long-term debt, less current portion........................ 5,231,794 32,286,111
Dividends payable........................................... 1,503,004 --
Convertible subordinated notes.............................. -- 125,000,000
------------ ------------
Total liabilities........................................... 42,596,046 222,993,147
Commitments and contingent liabilities...................... -- --
Series B Convertible Redeemable Preferred Stock, $.01 par
value, 115,000 shares authorized, 59,279 shares issued and
outstanding in 1998, none in 1999......................... 62,242,500 --
Common stock subject to repurchase, 2,015,625 shares issued
and outstanding in 1998, none in 1999..................... 4,145,000 --
Stockholders' equity (deficit):
Series A Convertible Preferred Stock, $.01 par value,
110,000 shares authorized, 55,000 shares issued and
outstanding in 1998, none in 1999....................... 550 --
Common stock, $.001 par value, 450,000,000 shares
authorized, 1,406,250 and 92,065,911 shares issued and
outstanding in 1998 and 1999, respectively.............. 1,406 92,066
Additional paid-in capital................................ 29,984,288 241,861,378
Note receivable from officer for purchase of common
stock................................................... -- (2,250,000)
Unearned compensation..................................... -- (1,782,433)
Accumulated deficit....................................... (32,453,312) (135,771,335)
Accumulated other comprehensive income.................... -- 311,349
------------ ------------
Total stockholders' equity (deficit)...................... (2,467,068) 102,461,025
------------ ------------
Total liabilities and stockholders' equity (deficit)........ $106,516,478 $325,454,172
============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
F-3
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31,
1998 1999
------------------- -------------
<S> <C> <C>
Revenue..................................................... $ 4,122,449 $ 35,512,760
Costs and expenses:
Direct cost of services................................... 3,425,111 23,570,279
Network and infrastructure costs.......................... 2,185,893 16,238,568
General and administrative................................ 19,426,575 22,051,990
Sales and marketing....................................... 5,123,334 36,595,021
Product research and development.......................... 690,388 5,351,678
Non-cash stock compensation expense....................... 231,135 10,350,729
Depreciation and amortization............................. 3,179,648 22,480,006
------------ -------------
Total costs and expenses.................................... 34,262,084 136,638,271
------------ -------------
Operating loss.............................................. (30,139,635) (101,125,511)
------------ -------------
Other income (expense):
Interest income........................................... 367,411 4,114,732
Interest expense.......................................... (2,681,088) (6,307,244)
------------ -------------
(2,313,677) (2,192,512)
------------ -------------
Net loss.................................................... (32,453,312) (103,318,023)
Dividends accrued on Series A and Series B Convertible
Preferred Stock........................................... (1,503,004) (2,328,150)
Accretion of common stock subject to repurchase to fair
value..................................................... (3,903,865) (23,938,069)
Accretion of Series B Convertible Redeemable Preferred Stock
to fair value............................................. (236,991) (99,252)
------------ -------------
Net loss attributable to common stockholders................ $(38,097,172) $(129,683,494)
============ =============
Basic and diluted loss per common share attributable to
common stockholders....................................... $ (27.09) $ (1.95)
============ =============
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM JANUARY 12, 1998 (DATE OF INCEPTION) THROUGH DECEMBER 31,
1998
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL NOTE
-------------------- ---------------------- PAID-IN RECEIVABLE UNEARNED
SHARES PAR VALUE SHARES PAR VALUE CAPITAL FROM OFFICER COMPENSATION
-------- --------- ---------- --------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 14, 1998........ -- $ -- -- $ -- $ -- $ -- $ --
Issuance of common stock to founder
upon inception................... -- -- 1,406,250 1,406 3,594 -- --
Issuance of Series A Convertible
Preferred Stock on May 28, 1998
for cash......................... 38,333 383 -- -- 22,999,617 -- --
Issuance of Series A Convertible
Preferred Stock on May 28, 1998
in exchange for $1,000,000
note............................. 1,667 17 -- -- 999,983 -- --
Issuance of Series A Convertible
Preferred Stock on June 22, 1998
for cash......................... 6,167 62 -- -- 3,699,938 -- --
Issuance of Series A Convertible
Preferred Stock on July 2, 1998
for cash......................... 5,833 58 -- -- 3,499,942 -- --
Issuance of Series A Convertible
Preferred Stock on July 30, 1998
for cash......................... 3,000 30 -- -- 1,799,970 -- --
Transaction costs associated with
the issuance of Series A
Convertible Preferred Stock...... -- -- -- --...... (205,225) -- --
Issuance of warrants to purchase
112,500 shares of common stock
associated with the acquisition
of I.I.T on September 8, 1998.... -- -- -- --...... 40,000 -- --
Issuance of warrants to purchase
2,192,512 shares of common stock
in connection with $9,095,000 of
debt on September 7, 1998........ -- -- -- -- 1,948,930 -- --
Issuance of warrants to purchase
167,409 shares of common stock
in connection with a $5,000,000
financing commitment on September
22, 1998......................... -- -- -- -- 148,810 -- --
Issuance of warrants to purchase
971 shares of Series B
Convertible Redeemable Preferred
Stock in connection with a
$10,000,000 financing commitment
on September 30, 1998 -- -- -- --...... 606,875 -- --
Issuance of warrants to purchase
140,625 shares of common stock
associated with the acquisition
of ACR on October 2, 1998........ -- -- -- -- 50,000 -- --
Issuance of warrants to purchase
40,179 shares of common stock
in connection with a $200,000,000
financing commitment on
December 18, 1998................ -- -- -- -- 35,714 -- --
Dividends accrued on Series A
Convertible Preferred Stock...... -- -- -- -- (1,503,004) -- --
Accretion of common stock subject
to repurchase to fair value...... -- -- -- -- (3,903,865) -- --
Accretion of Series B Convertible
Redeemable Preferred Stock
to fair value.................... -- -- -- -- (236,991) -- --
Net loss for the period January 14,
1998 through December 31, 1998... -- -- -- -- -- -- --
------ ------- ---------- ------- ----------- ------- -------
Balance at December 31, 1998....... 55,000 $ 550 1,406,250 $ 1,406 $29,984,288 $ -- $ --
====== ======= ========== ======= =========== ======= =======
<CAPTION>
ACCUMULATED TOTAL
OTHER STOCKHOLDERS'
ACCUMULATED COMPREHENSIVE EQUITY
DEFICIT INCOME (DEFICIT)
------------ -------------- -------------
<S> <C> <C> <C>
Balance at January 14, 1998........ $ -- $ -- $ --
Issuance of common stock to founder
upon inception................... -- -- 5,000
Issuance of Series A Convertible
Preferred Stock on May 28, 1998
for cash......................... -- -- 23,000,000
Issuance of Series A Convertible
Preferred Stock on May 28, 1998
in exchange for $1,000,000
note............................. -- -- 1,000,000
Issuance of Series A Convertible
Preferred Stock on June 22, 1998
for cash......................... -- -- 3,700,000
Issuance of Series A Convertible
Preferred Stock on July 2, 1998
for cash......................... -- -- 3,500,000
Issuance of Series A Convertible
Preferred Stock on July 30, 1998
for cash......................... -- -- 1,800,000
Transaction costs associated with
the issuance of Series A
Convertible Preferred Stock...... -- -- (205,225)
Issuance of warrants to purchase
112,500 shares of common stock
associated with the acquisition
of I.I.T on September 8, 1998.... -- -- 40,000
Issuance of warrants to purchase
2,192,512 shares of common stock
in connection with $9,095,000 of
debt on September 7, 1998........ -- -- 1,948,930
Issuance of warrants to purchase
167,409 shares of common stock
in connection with a $5,000,000
financing commitment on September
22, 1998......................... -- -- 148,810
Issuance of warrants to purchase
971 shares of Series B
Convertible Redeemable Preferred
Stock in connection with a
$10,000,000 financing commitment
on September 30, 1998 -- -- 606,875
Issuance of warrants to purchase
140,625 shares of common stock
associated with the acquisition
of ACR on October 2, 1998........ -- -- 50,000
Issuance of warrants to purchase
40,179 shares of common stock
in connection with a $200,000,000
financing commitment on
December 18, 1998................ -- -- 35,714
Dividends accrued on Series A
Convertible Preferred Stock...... -- -- (1,503,004)
Accretion of common stock subject
to repurchase to fair value...... -- -- (3,903,865)
Accretion of Series B Convertible
Redeemable Preferred Stock
to fair value.................... -- -- (236,991)
Net loss for the period January 14,
1998 through December 31, 1998... (32,453,312) -- (32,453,312)
------------ ------- -----------
Balance at December 31, 1998....... $(32,453,312) $ -- $(2,467,068)
============ ======= ===========
</TABLE>
SEE ACCOMPANYING NOTES.
F-5
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL NOTE
-------------------- ---------------------- PAID-IN RECEIVABLE UNEARNED
SHARES PAR VALUE SHARES PAR VALUE CAPITAL FROM OFFICER COMPENSATION
-------- --------- ---------- --------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1999......... 55,000 $ 550 1,406,250 $ 1,406 $ 29,984,288 $ -- $ --
Dividends accrued on Series A and
Series B Convertible Preferred
Stock............................ -- -- -- -- (2,328,150) -- --
Accretion of common stock subject
to repurchase to fair value...... -- -- -- -- (23,938,069) -- --
Accretion of Series B Convertible
Redeemable Preferred Stock
to fair value.................... -- -- -- -- (99,252) -- --
Conversion of Series A Convertible
Preferred Stock
to common stock.................. (55,000) (550) 27,843,737 27,844 (27,294) -- --
Conversion of Series B Convertible
Redeemable Preferred Stock to
common stock..................... -- -- 41,680,197 41,680 62,200,820 -- --
Reclassification of common stock
subject to repurchase to common
stock............................ -- -- 3,023,438 3,023 28,848,911 -- (633,184)
Issuance of common stock upon
initial public offering.......... -- -- 15,525,000 15,525 144,884,475 -- --
Initial public offering issuance
costs............................ -- -- -- -- (12,072,427) -- --
Issuance of common stock upon
exercise of stock options........ -- -- 837,860 838 982,153 -- --
Issuance of common stock upon
exercise of stock options in
exchange for note................ -- -- 843,750 844 2,249,156 (2,250,000) --
Issuance of common stock upon
exercise of warrants............. -- -- 1,113,977 1,114 3,085,089 -- --
Contribution of common stock to
employee benefit plan............ -- -- 54,738 55 600,365 -- --
Issuance of restricted common
stock............................ -- -- 141,750 142 2,008,858 -- (2,009,000)
Repurchase of common stock......... -- -- (404,786) (405) (3,022,193) -- --
Amortization of unearned
compensation..................... -- -- -- -- -- -- 859,751
Stock compensation expense for
issuance of common stock options
at below fair market value....... -- -- -- -- 8,504,648 -- --
Comprehensive income:.............. -- -- -- -- -- -- --
Net loss for the period January 1,
1999 through
December 31, 1999................ -- -- -- -- -- -- --
Other comprehensive
income--unrealized gain on
marketable securities -- -- -- -- -- -- --
Total comprehensive income
(loss)........................... -- -- -- -- -- -- --
------- ----- ---------- ------- ------------ ----------- -----------
Balance at December 31, 1999....... -- $ -- 92,065,911 $92,066 $241,861,378 $(2,250,000) $(1,782,433)
======= ===== ========== ======= ============ =========== ===========
<CAPTION>
ACCUMULATED TOTAL
OTHER STOCKHOLDERS'
ACCUMULATED COMPREHENSIVE EQUITY
DEFICIT INCOME (DEFICIT)
------------- -------------- -------------
<S> <C> <C> <C>
Balance at January 1, 1999......... $ (32,453,312) $ -- $ (2,467,068)
Dividends accrued on Series A and
Series B Convertible Preferred
Stock............................ -- -- (2,328,150)
Accretion of common stock subject
to repurchase to fair value...... -- -- (23,938,069)
Accretion of Series B Convertible
Redeemable Preferred Stock
to fair value.................... -- -- (99,252)
Conversion of Series A Convertible
Preferred Stock
to common stock.................. -- -- --
Conversion of Series B Convertible
Redeemable Preferred Stock to
common stock..................... -- -- 62,242,500
Reclassification of common stock
subject to repurchase to common
stock............................ -- -- 28,218,750
Issuance of common stock upon
initial public offering.......... -- -- 144,900,000
Initial public offering issuance
costs............................ -- -- (12,072,427)
Issuance of common stock upon
exercise of stock options........ -- -- 982,991
Issuance of common stock upon
exercise of stock options in
exchange for note................ -- -- --
Issuance of common stock upon
exercise of warrants............. -- -- 3,086,203
Contribution of common stock to
employee benefit plan............ -- -- 600,420
Issuance of restricted common
stock............................ -- -- --
Repurchase of common stock......... -- -- (3,022,598)
Amortization of unearned
compensation..................... -- -- 859,751
Stock compensation expense for
issuance of common stock options
at below fair market value....... -- -- 8,504,648
Comprehensive income:.............. -- -- --
Net loss for the period January 1,
1999 through
December 31, 1999................ (103,318,023) -- (103,318,023)
Other comprehensive
income--unrealized gain on
marketable securities --........... 311,349 311,349
-------------
Total comprehensive income
(loss)........................... -- (103,006,674)
------------- -------- -------------
Balance at December 31, 1999....... $(135,771,335) $311,349 $ 102,461,025
============= ======== =============
</TABLE>
SEE ACCOMPANYING NOTES.
F-6
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH
DECEMBER 31, YEAR ENDED
1998 DECEMBER 31, 1999
-------------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(32,453,312) $(103,318,023)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation............................................ 1,567,885 16,525,006
Amortization............................................ 1,611,763 5,955,000
Non-cash stock compensation expense..................... 231,135 10,350,729
Non-cash interest expense............................... 2,011,904 379,925
Changes in operating assets and liabilities:
Accounts receivable................................... 43,293 (13,675,237)
Prepaid expenses and other current assets............. (3,052,457) (3,886,636)
Deferred IMAP costs................................... -- (8,899,837)
Accounts payable...................................... 4,333,579 4,456,874
Accrued compensation.................................. 4,287,023 3,316,827
Accrued expenses and other current liabilities........ 234,800 1,565,692
Deferred revenue...................................... -- 9,015,205
------------ -------------
Net cash used in operating activities....................... (21,184,387) (78,214,475)
INVESTING ACTIVITIES
Due from officer............................................ -- (1,900,000)
Purchase of property and equipment.......................... (20,127,849) (79,858,273)
Purchases of available-for-sale securities.................. -- (147,014,320)
Sales of available-for-sale securities...................... -- 115,618,678
Acquisitions, net of cash acquired.......................... (16,899,991) (8,464,325)
Change in other assets...................................... (59,080) (102,438)
------------ -------------
Net cash used in investing activities....................... (37,086,920) (121,720,678)
FINANCING ACTIVITIES
Proceeds from issuance of Series A Convertible Preferred
Stock..................................................... 31,794,775 --
Proceeds from loan from officer, subsequently converted into
Series A Convertible Preferred Stock...................... 1,000,000 --
Proceeds (expenses) from issuance of Series B Convertible
Redeemable Preferred Stock................................ 39,910,509 (99,252)
Proceeds from issuance of common stock and common stock
subject to repurchase, net of issuance cost............... 15,000 132,827,573
Proceeds from the exercise of warrants...................... -- 73,605
Proceeds from exercise of employee stock options............ -- 982,991
Proceeds from issuance of long-term debt.................... 9,486,969 38,149,514
Proceeds from issuance of notes, subsequently converted into
Series B Convertible Redeemable Preferred Stock........... 22,095,000 --
Proceeds from issuance of convertible subordinated notes,
net of issuance costs..................................... -- 119,851,371
Dividends paid to preferred stockholders.................... -- (3,831,154)
Payment to former shareholders of acquired businesses....... -- (10,826,735)
Payments on long-term debt.................................. (1,804,876) (5,683,824)
Payments on capital lease obligations....................... (423,605) (3,008,780)
------------ -------------
Net cash provided by financing activities................... 102,073,772 268,435,309
------------ -------------
Net increase in cash and cash equivalents................... 43,802,465 68,500,156
Cash and cash equivalents at beginning of period............ -- 43,802,465
------------ -------------
Cash and cash equivalents at end of period.................. $ 43,802,465 $ 112,302,621
============ =============
</TABLE>
See accompanying notes.
F-7
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
USINTERNETWORKING, Inc., (the "Company") was incorporated on January 14,
1998 principally to provide clients the ability to use leading business software
applications through the Company's Internet-based network. The Company is an
"Internet Managed Application Provider.(SM)" The Company's IMAP services
integrate Internet communications, data center management, packaged software
applications, implementation and support to meet the technology needs of
businesses in a number of areas. These areas include sales force automation,
customer support, e-commerce, and human resource and financial systems. The
Company also makes its infrastructure available to clients who want to run their
own applications in a highly reliable and secure Internet environment and
provides information technology consulting services.
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. Intercompany transactions and
balances have been eliminated.
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 consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
The Company considers all money market accounts and all other investments
with a maturity of three months or less when purchased to be cash equivalents.
INVESTMENTS
Available-for-sale securities are carried at fair value with the unrealized
gains and losses, net of tax, reported as other comprehensive income. Realized
gains and losses and declines in value judged to be other than temporary on
available-for-sale securities are included in investment income. The cost of
securities sold is based on the specific identification method. Interest and
dividends on securities classified as available-for-sale are included in
investment income.
At December 31, 1999, available-for-sale securities consisted principally of
corporate and government agency obligations.
DEFERRED COSTS
Direct costs related to the implementation of software under IMAP contracts
are deferred and expensed ratably over the term of the related contract. Costs
related to the issuance of debt are deferred and expensed over the term of the
debt using the interest method.
SOFTWARE LICENSES
The Company capitalizes the costs associated with the purchase of licenses
for major business process application software used in providing IMAP services.
The licenses specify the maximum number of users permitted to utilize the
license in connection with the Company's service, and whether the licenses may
be later transferred to subsequent users by the Company. All amounts are
F-8
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
non-refundable, regardless of the actual number of users assigned a license in
connection with IMAP services.
Transferable licenses are amortized over their estimated useful life of
three years. Non-transferable licenses are amortized over the lesser of the
minimum contract period for IMAP clients subject to these licenses, or three
years. Amortization commenced in January 1999, the date that transferable and
non-transferable licenses were first available to generate revenue, and the
average amortization period is expected to be three years.
The Company also purchases maintenance services from its software vendors
under agreements that require annual payments for software maintenance,
including technical support and software upgrades. These payments are included
in prepaid expenses and amortized ratably over the annual service period.
PROPERTY AND EQUIPMENT AND ACCOUNTING CHANGES
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is computed for owned assets using the straight-line method over
estimated useful lives of the assets. Assets under capital leases are amortized
using the straight-line method over the lesser of the lease term or the
estimated useful life of the assets.
Estimated useful lives for furniture and equipment range from five to seven
years. Computer hardware and software, is depreciated over three to five years.
Buildings are depreciated over 25 years, and leasehold improvements are
depreciated over the term of the related lease.
On July 1, 1999, the Company changed its estimate of the useful life of its
computer equipment from three to five years. The change in estimate will be
accounted for prospectively, with depreciation expense for periods subsequent to
June 30, 1999 calculated so as to depreciate the remaining book value of the
equipment at June 30, 1999 equally over the revised estimated useful life.
The effect of this change was to decrease depreciation expense and net loss
by $2,901,656 for the year ended December 31, 1999. Basic and diluted loss per
share for the year ended December 31, 1999 was lower by $0.05 per share as a
result of the change.
On January 1, 1999, the Company adopted Statement of Position 98-1 ("SOP
98-1"), ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR
INTERNAL USE. SOP 98-1 requires the capitalization of direct costs incurred in
connection with developing or obtaining software for internal-use, including
external direct costs of materials and services and payroll and payroll related
costs for employees who are directly associated with and devote time to an
internal use software development project. In 1998, the Company expensed
approximately $1 million of costs related to the implementation of internal-use
software. During 1999, the Company capitalized $2.3 million of costs related to
the implementation of internal-use software which is included in computers and
software at December 31, 1999.
ADVERTISING COSTS
The Company expenses advertising as incurred. Advertising expense totaled
approximately $700,000 and $2.5 million in 1998 and 1999, respectively.
F-9
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, consisting principally of software licenses, property and
equipment and goodwill, are evaluated for possible impairment through a review
of undiscounted expected future cash flows. If the sum of the undiscounted
expected future cash flows is less than the carrying amount of the asset, an
impairment loss is recognized.
SHORT-TERM OBLIGATIONS EXPECTED TO BE REFINANCED
At December 31, 1998 and 1999, the Company had liabilities for the purchase
of fixed assets for which the Company had outstanding commitments to finance on
a long-term basis. The Company has executed or will execute these financings
early in the subsequent year, and therefore classified the long-term portion of
the liabilities due based on the subsequent financings in the accompanying
balance sheets. These obligations will bear interest at rates from 9% to 17% per
annum, and will mature in varying installments through October 2001.
REVENUE RECOGNITION
The Company generates revenue from IMAP services and information technology
services. Revenues from professional IT services are recognized as services are
provided. IMAP revenues consist of implementation fees and monthly recurring
fees for services.
Implementation fees are generally paid in advance, and are deferred and
recognized ratably over the term of the IMAP service contract. Monthly IMAP
service fees are consideration for access to the Company's network of Enterprise
Data Centers hosting application software, and the implementation and management
of that software. IMAP contracts generally have a two to five year term, and
revenues are recognized ratably over the contract term. Payments received in
advance of revenue recognition, even if non-refundable, are recorded as deferred
revenue. Some contracts permit termination without cause by the clients.
Contracts permitting termination without cause generally provide for termination
payments to the Company that will be recognized as revenue when collectibility
is assured.
PRODUCT RESEARCH AND DEVELOPMENT
The Company incurs product research and development costs related to
expanding its portfolio of IMAP solutions. These costs primarily include labor
costs associated with the testing of new product offerings including the
evaluation of hardware and software applications functionality in an IMAP
environment. Product research and development costs are expensed as incurred.
GOODWILL AMORTIZATION
The Company amortizes goodwill arising from purchase business combinations
on a straight-line basis over its estimated useful life of 5 years.
STOCK-BASED COMPENSATION
The Company records compensation expense for all stock-based compensation
plans using the intrinsic value method prescribed by Accounting Principles Board
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB No. 25"). Under
APB No. 25, if the exercise price of the Company's employee stock-based awards
equals or exceeds the estimated fair value of the underlying stock on the date
of grant, no compensation expense is generally recognized.
F-10
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Financial Accounting Standards Board Statement No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION ("Statement No. 123") encourages companies to recognize
expense for stock-based awards based on their estimated fair value on the date
of grant. Statement No. 123 requires the disclosure of pro forma net income or
loss in the notes to the financial statements if the fair value method is not
elected. The Company supplementally discloses in Note 15 to these consolidated
financial statements the pro forma information as if the fair value method had
been adopted.
INCOME TAXES
The Company uses the liability method in accounting for income taxes. Under
this method, deferred income 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.
STOCK SPLITS
In February 1999, the Company's Board of Directors approved an 8 for 1
reverse stock split of common stock, options and warrants which became effective
on April 8, 1999. Accordingly, all share and per share data including stock
option, warrant and loss per share information have been restated in the
consolidated financial statements to retroactively reflect the stock split.
In November 1999, the Board of Directors approved a 3 for 2 stock split of
common stock, options and warrants for holders of record on December 3, 1999.
Accordingly, all share and per share data including stock option, warrant and
loss per share information have been restated in the consolidated financial
statements to retroactively reflect the stock split.
RECLASSIFICATIONS
Certain amounts in the 1998 consolidated financial statements have been
reclassified to conform to the 1999 presentation.
2. ACQUISITIONS
On September 8, 1998, the Company acquired all of the outstanding common
stock of I.I.T. Holding, Inc. (IIT), a provider of Internet and intranet
consulting, integration and support services principally to commercial companies
located throughout the United States and South America. The initial purchase
price consisted of cash of $12,887,000 and warrants to purchase 112,500 shares
of common stock for $7.11 per share valued at $40,000. Direct acquisition costs
of $394,968 were also incurred. The acquisition was accounted for using the
purchase method of accounting, and the results of operations of IIT are included
in the accompanying consolidated statements of operations commencing
September 8, 1998. At the acquisition date, $14,131,788 of goodwill was
recorded.
Additional contingent consideration was payable to the former shareholders
of IIT to the extent that defined amounts of revenue, earnings before interest,
income taxes, depreciation and amortization (EBITDA), and employee retention
percentages (as related to the operations of IIT) in 1998 were exceeded. At
December 31, 1998, the Company determined that the amount of additional
consideration due to the sellers was $2,326,735, and therefore recorded that
amount as due to former shareholders of acquired businesses and as additional
goodwill. The contingent consideration was paid in May 1999.
On October 2, 1998, the Company acquired all of the outstanding common stock
of Advanced Communication Resources, Inc. (ACR), a New York based systems
integrator focused on the financial
F-11
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS (CONTINUED)
services industry. The initial purchase price aggregated $6,050,000, consisting
of cash of $2,500,000, a $3,500,000 secured promissory note due in January 1999
bearing interest at 8.25%, and warrants to purchase 140,625 shares of common
stock for $7.11 per share valued at $50,000. Direct acquisition costs of
$338,916 were also incurred. The acquisition was accounted for using the
purchase method of accounting, and the results of operations of ACR are included
in the accompanying consolidated statements of operations commencing October 2,
1998. At the acquisition date, $5,290,535 of goodwill was recorded.
Additional contingent consideration was payable to the former shareholders
of ACR to the extent that defined amounts of revenue, EBITDA, and employee
retention percentages (as related to the operations of ACR) in 1998 were
exceeded. At December 31, 1998, the Company determined that the amount of
additional consideration due to the sellers was $5,000,000, and therefore
recorded that amount as due to former shareholders of acquired businesses and as
additional goodwill. The contingent consideration was paid in January 1999.
On October 8, 1999, the Company purchased the assets of Conklin &
Conklin, Inc. ("Conklin"), a comprehensive provider of Lawson financial and
human resources system implementation services and a certified reseller of
Lawson software licenses. The initial purchase price aggregated $11.2 million,
and consisted of cash of $7.7 million, assumed liabilities of $1.5 million, and
a $2.0 million secured note due on October 8, 2001. Additional contingent cash
consideration of up to $4.6 million will be payable to the extent that specified
financial milestones are achieved over a 26 month period, and any such payment
will result in the recording of additional goodwill. The acquisition was
accounted for as a purchase, and goodwill of approximately $9.4 million was
recorded at the acquisition date, and is being amortized over its estimated
useful life of five years.
The results of operations of Conklin are included in the accompanying
consolidated statement of operations commencing October 8, 1999. The following
summarizes unaudited pro forma consolidated results of operations for 1998 and
1999 assuming the Conklin acquisition had occurred at the beginning of each
period. The results are not necessarily indicative of what would have occurred
had this transaction been consummated as of the beginning of each period, or of
future operations of the Company (in thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- -----------------
(UNAUDITED)
<S> <C> <C>
Revenue..................................... $ 15,486 $ 44,086
Net loss.................................... $(31,739) $(103,882)
Basic and diluted loss per common share..... $ (22.57) $ (1.56)
</TABLE>
F-12
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. LOSS PER SHARE
The following table sets forth the computation of basic and diluted loss per
common share:
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- -----------------
<S> <C> <C>
Numerator:
Net loss.................................. $(32,453,312) $(103,318,023)
Dividends on Series A Convertible
Preferred Stock......................... (1,503,004) (2,328,150)
Accretion of common stock subject to
repurchase to fair value................ (3,903,865) (23,938,069)
Accretion of Series B Convertible
Redeemable Preferred Stock to fair
value................................... (236,991) (99,252)
------------ -------------
$(38,097,172) $(129,683,494)
============ =============
Denominator:
Weighted-average number of shares of
common stock outstanding and not subject
to repurchase during the period......... 1,406,250 66,503,639
------------ -------------
Basic and diluted loss per common share..... $ (27.09) $ (1.95)
============ =============
</TABLE>
Basic loss per share is based upon the average number of shares of common
stock outstanding during the periods. The 1998 computation excludes 3,023,438
shares of common stock subject to repurchase.
Diluted loss per common share is equal to basic loss per common share
because if potentially dilutive securities were included in the computation, the
result would be anti-dilutive. These potentially dilutive securities consist of
common stock subject to repurchase, convertible preferred stocks, stock options
and warrants in the 1998 period, and stock options and warrants in the 1999
period.
4. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The Company acquired equipment totaling $5,188,489 and $15,812,110 under
leases classified as capital leases for the period from January 14, 1998 (date
of inception) through December 31, 1998 and for the year ended December 31,
1999, respectively. The Company also acquired $7,500,000 and $3,000,000 of
equipment in 1998 and 1999 that was included in accounts payable and short-term
obligations expected to be refinanced at December 31, 1998 and 1999,
respectively.
Interest paid was approximately $368,000 and $5,902,000 for the period from
January 14, 1998 (date of inception) through December 31, 1998 and for the year
ended December 31, 1999, respectively.
In December 1998, $22,095,000 of notes payable and a $1,000,000 loan from an
officer of the Company were converted into Series B Convertible Redeemable
Preferred Stock.
F-13
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (CONTINUED)
In 1998, the Company purchased all of the capital stock of IIT and ACR for
approximately $27.8 million. In conjunction with these acquisitions, assets with
a fair market value of approximately $30.8 million were acquired and liabilities
of approximately $3.0 million were assumed.
In 1999, the Company purchased the assets of Conklin for approximately
$11.2 million. In conjunction with this acquisition, assets with a fair market
value of approximately $9.7 million were acquired and liabilities of
approximately $1.5 million were assumed.
In July 1998, the Company sold 1,406,250 shares of common stock to an
executive officer for $5,000. The common stock at the date of issuance had an
appraised estimated fair value of $0.71 per share, or $1,000,000. The difference
between the estimated fair value of the common stock of $1,000,000 and the
amount paid of $5,000 ($995,000) was recorded as unearned compensation and is
being amortized over the 22 month period in which it is earned. Other non-cash
compensation of $5,000 related to common stock issuances was also recorded in
1998.
During 1999, the Company issued 141,750 shares of restricted common stock to
executive officers at a weighted average price of $14.17 per share. The
restricted common stock at the date of issuance had an aggregate quoted market
value of $2,009,000, which was recorded as stockholders' equity.
5. AVAILABLE-FOR-SALE SECURITIES
The following is a summary of available-for-sale securities at December 31,
1999:
<TABLE>
<S> <C>
Corporate commercial paper.................................. $ 8,958,808
Corporate bonds............................................. 10,548,183
Municipal bonds............................................. 12,200,000
-----------
$31,706,991
===========
</TABLE>
At December 31, 1999, aggregate unrealized gains of $311,349 are recorded in
other comprehensive income. At December 31, 1999, the Company has approximately
$19.5 million of investments that mature within one year and $12.2 million of
investments that mature beyond ten years. These investments are classified as
current as the Company views its available-for-sale investments as available for
use in its current operations.
F-14
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
Building and land................................. $ 959,124 $ 19,534,132
Furniture and fixtures............................ 779,332 4,120,661
Equipment and automobiles......................... 2,151,877 3,353,722
Computers and software............................ 16,018,565 79,430,230
Leasehold improvements............................ 3,299,132 9,047,040
----------- ------------
23,208,030 115,485,785
Accumulated depreciation.......................... (1,567,885) (14,319,115)
----------- ------------
Total............................................. $21,640,145 $101,166,670
=========== ============
</TABLE>
During 1999, the Company capitalized $346,106 of interest associated with
assets under construction. Substantially all property and equipment is
collateralized under financing arrangements.
7. CAPITAL LEASE OBLIGATIONS
The Company has entered into capital lease agreements to acquire certain
equipment. Property and equipment includes the following amounts for leases that
have been capitalized.
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
Computers and software............................. $5,188,489 $21,000,599
Accumulated amortization........................... (349,716) (4,367,137)
---------- -----------
Total.............................................. $4,838,773 $16,633,462
========== ===========
</TABLE>
Amortization of leased property is included in depreciation and amortization
expense.
Future minimum payments under capital lease obligations consist of the
following at December 31, 1999:
<TABLE>
<S> <C>
2000........................................................ $ 8,147,628
2001........................................................ 7,799,455
2002........................................................ 3,783,135
2003........................................................ 730,080
2004........................................................ 2,388
-----------
Total minimum lease payments................................ 20,462,686
Amounts representing interest............................... (3,243,581)
-----------
Present value of capital lease obligations.................. 17,219,105
Current portion............................................. (5,834,076)
-----------
Capital lease obligations, non-current...................... $11,385,029
===========
</TABLE>
F-15
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT AND CONVERTIBLE SUBORDINATED NOTES
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
Notes payable to banks due in June and July 2001 and bearing
interest at 9.0% per annum. These notes are payable in
aggregate monthly installments of principal and interest
of $8,893 with all unpaid principal and interest due at
maturity. These notes are secured by mortgages on the real
property purchased with the proceeds and with $106,913 in
letters of credit pledged as additional security.......... $ 857,206 $ 828,127
Notes payable due August 1, 2001 through October 1, 2002 and
bearing interest at 12.1% to 17.1% per annum. These notes
are payable in aggregate monthly installments of principal
and interest of $585,252 and are collateralized by certain
furniture, fixtures, equipment and software............... 2,216,082 15,148,548
Notes payable due January 1, 2002 and October 1, 2001 and
bearing interest at 11.9% and 17.1% per annum,
respectively. The notes are payable in aggregate monthly
installments of principal and interest of $367,028 with
all unpaid principal and interest due at maturity. These
notes are collateralized by certain software licenses..... 4,501,175 5,025,976
Note payable due on June 1, 2002 and bearing interest at 14%
per annum. This note is payable in aggregate monthly
installments of principal and interest of $391,694 and is
collateralized by certain equipment....................... -- 9,868,975
Note payable due on May 1, 2006 and bearing interest at 7.5%
per annum. The note is payable in aggregate monthly
installments of principal and interest of $49,295 with all
unpaid principal and interest due at maturity. The note is
secured by a mortgage on the real property purchased with
the proceeds.............................................. -- 7,012,681
Notes payable due on March 1, 2001 and bearing interest at
6.6% per annum. These notes are payable in aggregate
monthly installments of principal and interest ranging
from $10,908 to $28,237 and are collateralized by the
general assets of the Company............................. -- 562,162
Notes payable due between February 28, 2003 and March 11,
2004 and bearing interest at rates ranging from 8.25% to
10.25% per annum. The notes are payable in aggregate
monthly installments of principal and interest ranging
from $533 to $1,274 and are secured by automobiles
purchased with the proceeds............................... 107,630 117,012
Note payable due on December 29, 2003 bearing interest at
9.8% per annum. The note is payable in monthly principal
installments of $98,958 plus interest and is
collateralized by a $750,000 certificate of deposit and
certain building improvements............................. -- 4,750,000
Note payable to former shareholders of Conklin, bearing
interest at 10% per annum and due with accrued interest on
October 8, 2001........................................... -- 2,000,000
---------- -----------
Total....................................................... 7,682,093 45,313,481
Less: current portion....................................... 1,757,588 12,586,553
Less: discounts............................................. 692,711 440,817
---------- -----------
$5,231,794 $32,286,111
========== ===========
</TABLE>
F-16
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT AND CONVERTIBLE SUBORDINATED NOTES (CONTINUED)
Aggregate maturities of long-term debt at December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000........................................................ $12,586,553
2001........................................................ 16,640,735
2002........................................................ 8,046,459
2003........................................................ 1,290,796
2004........................................................ 132,223
2005 and thereafter......................................... 6,616,715
-----------
Total....................................................... $45,313,481
===========
</TABLE>
In 1999, the Company issued $125 million (principal amount at maturity) of
Convertible Subordinated Notes (the "Notes"), due November 1, 2004. Interest on
the Notes accrues at 7% per annum, payable semi-annually on May 1 and
November 1 of each year, commencing May 1, 2000. A holder may, at any time prior
to maturity, convert the principal amount of the Notes into shares of common
stock at a conversion price of $16.57 per share. The Company has the option to
redeem the Notes after November 5, 2002 through October 31, 2003 for 101.75% of
the principal amount.
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating
its fair value disclosures of its significant financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amounts reported for cash and cash equivalents approximate fair
value.
AVAILABLE-FOR-SALE SECURITIES
Available-for-sale securities are stated at quoted market value.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
The carrying amounts of accounts receivable and accounts payable and accrued
expenses approximate fair value because of the short-term nature of those
transactions.
LONG-TERM DEBT
The fair values of the long-term debt are estimated using a discounted cash
flow analysis, based on the Company's incremental borrowing rates for similar
types of borrowing arrangements at December 31, 1999.
CONVERTIBLE SUBORDINATED NOTES
The fair values of the convertible subordinated notes are estimated using
quoted market rates as of December 31, 1999.
F-17
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and fair values of the Company's financial instruments
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1999
---------------------------- -----------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ----------- -------------- ------------
<S> <C> <C> <C> <C>
Cash and cash equivalents............... $43,802,465 $43,802,465 $112,302,621 $112,302,621
Available-for-sale securities........... -- -- 31,706,991 31,706,991
Long-term debt.......................... 7,682,093 7,682,093 44,872,664 45,911,984
Convertible subordinated notes.......... -- -- 125,000,000 362,187,500
</TABLE>
10. INITIAL PUBLIC OFFERING
In April 1999, the Company completed an initial public offering of
15,525,000 shares of common stock which resulted in net proceeds of
$132,827,573, after deducting underwriting discounts, commissions and offering
expenses. Upon the closing of the offering, the Series A Preferred Stock and
Series B Preferred Stock automatically converted into 69,523,934 shares of
common stock, and the common stock subject to repurchase no longer became
mandatorily redeemable by the Company upon the occurrence of certain events.
(See Notes 11 and 12.)
11. PREFERRED STOCK
The Company has authorized the issuance of up to 225,000 shares of preferred
stock, par value $.01 per share, of which 110,000 has been designated Series A
Convertible Preferred Stock ("Series A") and 115,000 has been designated
Series B Convertible Redeemable Preferred Stock ("Series B"). During 1998, the
Company issued 55,000 shares of Series A for a total aggregate purchase price of
$33.0 million, and 59,279 shares of Series B for a total aggregate purchase
price of $62.2 million, including $22.1 million of Series B issued upon
conversion of notes payable. Upon the conversion of notes payable with a face
value of $9,095,000 into Series B, unamortized debt discount of approximately
$1,350,000 was recorded as additional interest expense.
SERIES A:
CONVERSION
The Series A outstanding at December 31, 1998 automatically converted into
shares of common stock upon the closing of the initial public offering in
April 1999. Each share of Series A was converted into 506.25 shares of common
stock.
DIVIDENDS
The holders of the Series A were entitled to receive cumulative quarterly
dividends at the annual rate of $48 per share. All accrued dividends were paid
at the closing of the initial public offering in April 1999.
VOTING RIGHTS
Each share of Series A had substantially the same voting rights as the
number of shares of common stock into which it was converted. In addition,
certain corporate actions required the consent of two-thirds of the outstanding
shares of Series A.
F-18
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SERIES B:
CONVERSION
The Series B outstanding at December 31, 1998 automatically converted into
shares of common stock upon the closing the initial public offering in
April 1999. Each share of Series B was converted into 703.12 shares of common
stock.
DIVIDENDS
The holders of the Series B were entitled to receive cumulative quarterly
dividends at the annual rate of $84 per share. All accrued dividends were paid
at the closing of the initial public offering in April 1999.
VOTING RIGHTS
Each share of Series B had substantially the same voting rights as the
number of shares of common stock into which it was converted.
12. COMMON STOCK SUBJECT TO REPURCHASE
The Company sold 3,023,438 shares of common stock to three officers that at
December 31, 1998 required the Company to repurchase the common stock at fair
value in the event of disability or death. These agreements were amended on
February 25, 1999 to void the repurchase obligation upon death or disability
upon the closing of an initial public offering of the common stock.
The Company initially recorded the common stock subject to repurchase at an
amount equal to the consideration received of $1,010,000 (purchase price of
$1,057,500, less $47,500 represented by notes receivable). The common stock
subject to repurchase was accreted to its estimated fair value during all
periods the common stock was subject to repurchase through charges to additional
paid-in capital. The estimated value per share of $1.39 at December 31, 1998 was
determined through an independent appraisal of the Company's common stock.
Additional accretion in 1999 prior to the April initial public offering was
recorded based on valuations consistent with the expected initial public
offering price. As a result of the initial public offering in April 1999, these
shares are no longer subject to mandatory repurchase by the Company, and their
accreted value at that date of $28,218,750 was reclassified to stockholders'
equity.
13. STOCK WARRANTS
In 1998, in connection with the issuance of debt or capital leases, the
Company issued warrants to purchase 2,400,101 shares of common stock and
warrants to purchase 971 shares of Series B. The warrants to purchase Series B
converted into warrants to purchase 682,734 shares of common stock in
April 1999 upon the closing of the initial public offering. The warrants expire
from 2003 through 2008, and are exerciseable for $1.49 or $1.53 per share.
Upon issuance, the Company estimated the fair value of the warrants using a
Black-Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate of 5.50%, dividend yield of 0%; volatility
factor of the expected market price of the Company's common stock of 40%; and a
weighted-average expected life of the warrant of 10 years. The range of values
assigned to the warrants was $0.35 to $0.93 per share, and the total value
assigned was $2,740,329. This amount
F-19
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK WARRANTS (CONTINUED)
was recorded as additional paid-in capital, and a corresponding debt discount
was recorded that is being recognized as additional interest expense over the
term of the related debt or capital lease.
Also, as discussed in Note 2, the Company issued warrants to purchase
253,125 shares of common stock in connection with the acquisition of IIT and
ACR. These warrants expire in 2008 and are exerciseable for $7.11 per share. The
Company estimated the value of these warrants considering the various terms,
including the exercise price of the warrants, the estimated fair value of the
Company's common stock, and the length of time the warrants are exercisable. The
aggregate value assigned to these warrants was $90,000.
During 1999, warrants to purchase 1,113,977 shares of common stock were
exercised for proceeds of $3,086,203. A summary of warrants outstanding at
December 31, 1999 is as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES EXERCISE PRICE EXPIRATION DATE
- ---------------- -------------- ---------------
<C> <C> <S>
83,705 $1.49 September 2005
2,138,281 $1.53 September 2008
---------
2,221,986
=========
</TABLE>
14. SHARES RESERVED FOR FUTURE ISSUANCE
The Company at December 31, 1999 has reserved 23,478,794 shares of common
stock for future issuance upon the exercise of stock options eligible for
granting or previously granted under the 1998 Stock Option Plan (see Note 15),
7,545,272 shares of common stock issuable upon the conversion of the
subordinated notes and 2,221,986 shares of common stock attributable to
outstanding warrants.
15. STOCK COMPENSATION PLAN
STOCK OPTIONS
Effective July 2, 1998, the Company adopted the 1998 Stock Option Plan of
USINTERNETWORKING, Inc. ("the Plan") which is administered by the Compensation
Committee of the Board of Directors. The Plan, as amended, provides for the
granting of either qualified or non-qualified options to purchase an aggregate
of up to 25,160,063 shares of common stock to eligible employees, officers,
directors and consultants of the Company.
F-20
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCK COMPENSATION PLAN (CONTINUED)
A summary of the Company's stock option activity follows:
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 1, 1998
(DATE OF INCEPTION)
THROUGH
DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1999
-------------------- -----------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- -------- ---------------- ----------
<S> <C> <C> <C> <C>
Outstanding at beginning of year................ -- $ -- 3,785,062 $ 1.17
Granted......................................... 3,845,532 1.17 10,735,674 7.57
Exercised....................................... -- -- (1,681,269) 1.93
Forfeited....................................... (60,470) 1.17 (920,394) 2.53
--------- ------ ----------- ------
Outstanding and exercisable at end of year...... 3,785,062 $ 1.17 11,919,073 $ 6.77
========= ====== =========== ======
</TABLE>
Weighted average fair value of options granted during 1999 is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE FAIR VALUE
---------- ---------------- ----------------
<S> <C> <C> <C>
Fair value equal to exercise price................. 4,476,495 $ 11.08 $ 9.11
Fair value greater than exercise price............. 5,509,593 $ 3.82 $ 9.43
Exercise price greater than fair value............. 749,586 $ 14.99 $ 10.66
</TABLE>
Exercise prices for options outstanding as of December 31, 1999 ranged from
$1.17 to $46.59 as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES REMAINING CONTRACTUAL
RANGE OF OPTIONS OF OPTIONS LIFE OF OPTIONS
EXERCISE PRICES OUTSTANDING OUTSTANDING OUTSTANDING
- --------------- ----------- ---------------- ---------------------
<S> <C> <C> <C>
$1.17-$1.49 2,745,195 $ 1.19 8.7
$2.67 3,699,540 2.67 9.3
$6.67-$9.11 2,756,235 8.23 9.7
$10.14-$14.89 1,921,392 12.03 9.7
$15.50-$21.95 235,088 18.43 9.8
$23.50-$35.11 470,086 28.95 9.9
$37.79-$46.59 91,537 41.59 10.0
----------
11,919,073
==========
</TABLE>
All options granted vested immediately at the date of grant. Shares of
common stock purchased pursuant to these options will be subject to the
Company's right to repurchase them at the option exercise price upon the
termination of the holder's employment or business relationship with the
Company. The repurchase right will lapse with respect to one-third of the shares
purchasable upon exercise of an option on the first anniversary of the date of
grant of the option. The repurchase right with respect to the remainder of the
shares purchasable upon exercise of an option will lapse in equal quarterly
installments over the subsequent eight calendar quarters. The options expire
10 years from
F-21
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCK COMPENSATION PLAN (CONTINUED)
the date of issuance. At December 31, 1999, the weighted-average remaining
contractual life of outstanding options is 9.3 years.
Certain options granted in 1999 are exercisable at prices less than the fair
market value of the Company's common stock at the date of grant. The Company
will record stock compensation expense of approximately $35.0 million as a
result of these 1999 option grants that will be recognized ratably over the
four-year period that the employees earn the right to retain the shares obtained
upon exercise of the stock options without regard to continued employment. For
the year ended December 31, 1999, the Company recorded non-cash stock
compensation expense of $8.5 million related to these grants.
RESTRICTED STOCK GRANTS
During 1999, the Company issued for no consideration 141,750 shares of
common stock to four officers. The common stock vests over a maximum four year
period from the date of issuance. The common stock at the issuance date had an
aggregate fair value of $2,009,000, which is being recognized as compensation
expense over the vesting period. During 1999, the Company recognized as
compensation expense $452,708 under these arrangements. At December 31, 1999,
20,250 shares of these restricted stock awards are vested.
PRO FORMA INFORMATION
For the year ended December 31, 1998, pro forma net loss and loss per share
information required by Statement No. 123 was determined using the minimum value
method. The minimum value method calculates the fair value of options as the
excess of the estimated fair value of the underlying stock at the date of grant
over the present value of both the exercise price and the expected dividend
payments, each discounted at the risk-free rate, over the expected life of the
option. In determining the estimated fair value of granted stock options under
the minimum value method, the risk-free interest rate was assumed to be 5.50%,
the dividend yield was estimated to be 0% and the expected life of granted
options was assumed to be four years.
The grant-date fair value of all options granted during 1998 using the
minimum value method was less than $.01, thus no pro forma information has been
presented. The exercise price at the grant-date of all options granted through
December 31, 1998 was greater than the market value of the underlying common
stock on the grant date, as determined by independent appraisal. As a result,
the Company has not recognized compensation expense related to these options.
For the year ended December 31, 1999, pro forma net loss and loss per share
information required by Statement No. 123 has been determined as if the Company
had accounted for its stock-based awards using the fair value method. The fair
value of these awards was estimated at the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions for 1999:
risk-free interest rate of 5.67%, dividend yield of 0%, volatility factors of
the expected market price of the Company's common stock of 1.28, and an expected
life of 4 years.
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock-based awards have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect
F-22
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCK COMPENSATION PLAN (CONTINUED)
the fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
stock-based awards.
For purposes of pro forma disclosures, the estimated fair value of the
awards is amortized to expense over the period the employees earn the right to
retain the shares obtained upon exercise of the stock options or upon the
issuance of restricted common stock. The Company's pro forma net loss is
$116.8 million for the year ended December 31, 1999. Pro forma basic and diluted
loss per share is $1.75 for the year ended December 31, 1999.
Pro forma compensation expense from stock-based awards reflects only the
vesting of 1998 and 1999 awards in 1999. Not until 2001 is the full effect of
recognizing compensation expense for stock-based awards representative of the
possible effects on pro-forma net income (loss) for future years.
16. INCOME TAXES
At December 31, 1999, the Company has a U.S. federal net operating loss
carryforward of $107.7 million. Included in the net operating loss is
approximately $4.6 million that will not result in future tax benefits and will
be recorded to stockholder's equity. This carryforward expires in 2019. The
amount available to be used in any given year will be limited by operation of
certain provisions of the Internal Revenue Code. The Company also has state net
operating loss carryforwards available, the utilization of which will be
similarly limited. The Company has established a valuation allowance with
respect to these federal and state loss carryforwards.
F-23
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
at December 31 are as follows:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 7,855,560 $42,582,874
Start-up and organizational costs capitalized for tax
purposes................................................ 3,632,867 2,565,709
Allowance for doubtful accounts........................... -- 214,933
Accrued vacation.......................................... -- 493,172
Accrued compensation...................................... -- 229,583
Deferred revenue.......................................... -- 2,514,797
Non-cash compensation expense............................. -- 3,542,634
Other..................................................... 192,230 168,406
----------- -----------
Total deferred tax assets................................... 11,680,657 52,312,108
----------- -----------
Deferred tax liabilities:
Stock options............................................. -- 1,821,929
Tax over book depreciation................................ 314,930 278,374
Prepaid maintenance contracts............................. -- 958,268
Other..................................................... 467,169 174,325
----------- -----------
Total deferred tax liability................................ 782,099 3,232,896
----------- -----------
Net future income tax benefit............................... 10,898,558 49,079,212
Valuation allowance for net deferred tax assets............. (10,898,558) (49,079,212)
----------- -----------
Net deferred tax assets..................................... $ -- $ --
=========== ===========
</TABLE>
The reconciliation of the reported income tax expense to the amount that
would result by applying the U.S. federal statutory rate to the net loss is as
follows:
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- -----------------
<S> <C> <C>
Tax benefit at U.S. statutory rate........................ $(11,358,659) $(36,161,308)
State income taxes, net of federal benefit................ (984,188) (4,373,033)
Non-deductible goodwill................................... 559,839 2,056,250
Non-deductible meals and entertainment.................... 39,108 315,870
Non-deductible interest expense........................... 704,166 92,330
Non-deductible transactions costs......................... 154,777 --
Other..................................................... (13,601) (110,763)
Change in valuation allowance............................. 10,898,558 38,180,654
------------ ------------
Total..................................................... $ -- $ --
============ ============
</TABLE>
F-24
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. OPERATING LEASES
The Company conducts a significant amount all of its operations from leased
facilities under operating leases that have terms of up to seven years and that
generally contain renewal options of two to three years and rent escalation
clauses. Future minimum payments under noncancellable operating leases with
initial terms of one year or more consist of the following at December 31, 1999:
<TABLE>
<S> <C>
2000........................................................ $ 4,789,202
2001........................................................ 3,696,091
2002........................................................ 3,327,853
2003........................................................ 2,308,908
2004........................................................ 1,005,636
Thereafter.................................................. 1,217,488
-----------
$16,345,178
===========
</TABLE>
The Company incurred rent expense of $718,416 and $3,181,911 during the
period from January 14, 1998 (date of inception) through December 31, 1998 and
for the year ended December 31, 1999, respectively.
18. EMPLOYEE BENEFIT PLAN
The Company established a defined contribution benefit plan effective
July 1, 1998. The plan covers substantially all employees who have 30 days of
service with the Company. Participants may contribute from 1% to 15% of their
annual compensation to the plan. The Company makes matching contributions of
common stock up to 6% of the participant's contributions pursuant to the terms
of the plan. No contributions were made by the Company in 1998. In 1999, the
Company contributed to the plan 54,738 shares of common stock with a fair value
of $600,420.
19. RELATED PARTY TRANSACTIONS
During 1998, the Company received a non-interest bearing loan from an
officer in the amount of $1,000,000. The loan was subsequently converted into
1,667 shares of Series A Convertible Preferred Stock.
In September 1999, the Company loaned $2,250,000 to an officer to purchase
843,750 shares of common stock pursuant to a stock option exercise. The loan is
evidenced by a full recourse note that bears interest at 5% per annum, and is
payable on or before July 31, 2000. The Company has classified the note as a
reduction of stockholders' equity at December 31, 1999. Additionally, the
Company loaned the same officer $1.9 million evidenced by a note bearing
interest at 7% per annum and payable within 90 days on demand. The purpose of
the loan was to fund the officer's tax liability resulting from the exercise of
the options described above.
20. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION
During 1998 and through June 1999, the Company was organized into two
business units--IMAP and Professional IT Services. In the third quarter of 1999,
the Company changed the manner in which it manages its operations and reports
the activities of those operations. The Company is now organized
F-25
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
into seven business units that offer unique software solutions. These operating
segments have been aggregated for reporting purposes into two segments, as
follows:
- ENTERPRISE WIDE SOLUTIONS -- provides enterprise relationship management,
financial management, human resource, and professional services automation
software product offerings; and
- E-COMMERCE AND WEB-BASED SOLUTIONS -- provides electronic commerce,
enhanced messaging and decision support product offerings.
Management believes that the aggregation of the operating segments helps
users of the financial statements better understand performance. The combined
operating segments have similar economic characteristics and products and meet
other criteria for aggregation. Both business units utilize an Internet-based
network, which enables clients to use leading business software applications
without the burden of owning, or managing the underlying technology. These
services are delivered to customers through a network of Enterprise Data Centers
located in Maryland, California, Amsterdam and Tokyo.
The Company evaluates the performance of its new operating segments based on
contribution margin, or revenues less variable direct costs. This contribution
margin excludes an allocation of network and infrastructure costs, selling,
general and administrative costs, product research and development costs,
non-cash stock compensation expense, and depreciation and amortization.
The Company does not prepare information regarding segment assets. The
accounting policies used by the reportable segments are the same as those used
by the Company as described in Note 1 to the consolidated financial statements.
The following table sets forth information on the Company's reportable
segments. The 1998 data has been restated to conform to the new segment
classifications.
<TABLE>
<CAPTION>
FOR THE PERIOD FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- -----------------
<S> <C> <C>
Revenue:
Enterprise Wide Solutions............................... $2,138,290 $17,928,199
E-Commerce and Web-Based Solutions...................... 1,984,159 17,584,561
---------- -----------
Consolidated............................................ $4,122,449 $35,512,760
========== ===========
Segment operating profit (loss):
Enterprise Wide Solutions............................... $ (20,876) $ 9,008,909
E-Commerce and Web-Based Solutions...................... 718,214 2,933,572
---------- -----------
Consolidated............................................ $ 697,338 $11,942,481
========== ===========
</TABLE>
F-26
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
A reconciliation of segment operating profit to net loss during the periods
presented is as follows:
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
JANUARY 14, 1998
(DATE OF INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- -----------------
<S> <C> <C>
Segment operating profit for all segments................... $ 697,338 $ 11,942,481
Network and infrastructure costs............................ (2,185,893) (16,238,568)
General and administrative.................................. (19,426,575) (22,051,990)
Sales and marketing......................................... (5,123,334) (36,595,021)
Product research and development............................ (690,388) (5,351,678)
Non-cash stock compensation expense......................... (231,135) (10,350,729)
Depreciation and amortization............................... (3,179,648) (22,480,006)
Interest income............................................. 367,411 4,114,732
Interest expense............................................ (2,681,088) (6,307,244)
------------ -------------
Net loss.................................................... $(32,453,312) $(103,318,023)
============ =============
</TABLE>
Revenues from one customer of the Company's Enterprise Wide Solutions
segment accounted for approximately 16% of the Company's consolidated revenue
for the year ended December 31, 1999.
21. SUBSEQUENT EVENTS
In March 2000, the Board of Directors approved a 3 for 2 stock split of
common stock, options and warrants for holders of record on March 14, 2000.
Accordingly, all share and per share data including stock option, warrant and
loss per share information have been restated in the consolidated financial
statements to retroactively reflect the stock split.
On January 14, 2000 the Company increased its authorized shares of common
stock from 75,000,000 shares to 450,000,000 shares. This increase is reflected
in the accompanying balance sheet at December 31, 1999.
F-27
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
I.I.T. Holding, Inc.
We have audited the accompanying consolidated balance sheets of I.I.T.
Holding, Inc. and subsidiaries as of December 31, 1996 and 1997, and
September 7, 1998, and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for the years ended December 31,
1996 and 1997, and for the period from January 1, 1998 through September 7,
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 did not audit the 1996 and 1997 financial
statements of International Information Technology IIT, C.A., a wholly-owned
subsidiary, which statements reflect total assets of $68,247 and $76,361 as of
December 31, 1996 and 1997, respectively, and total revenues of $3,336 and
$147,797 for the period from March 6, 1996 (inception) through December 31, 1996
and for the year ended December 31, 1997, respectively. Those statements were
audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to data included for International Information
Technology IIT, C.A., is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of I.I.T. Holding, Inc.
and subsidiaries as of December 31, 1996 and 1997, and September 7, 1998 and the
consolidated results of their operations and their cash flows for the years
ended December 31, 1996 and 1997, and for the period from January 1, 1998
through September 7, 1998, in conformity with accounting principles generally
accepted in the United States.
Baltimore, Maryland /s/ Ernst & Young LLP
March 23, 1999
F-28
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
USINTERNETWORKING, Inc.
We have audited the accompanying balance sheets of International Information
Technology IIT, C.A., at December 31, 1997 and for the period from March 5, 1996
(date of inception) through December 31, 1996, and the related statements of
operations, changes in stockholders' equity and cash flows for the years then
ended (not presented separately herein). 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 U.S. 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 International Information
Technology IIT, C.A. at December 31, 1997 and for the period from March 5, 1996
(date of inception) through December 31, 1996, and the results of its operations
and its cash flows for the years then ended in conformity with U.S. generally
accepted accounting principles.
At December 31, 1997 and 1996, the accompanying financial statements have
been prepared assuming that the Company will continue its ongoing operations,
despite of the negative stockholder's equity, which shows uncertainty about the
Company's ability to continue in operation. These financial statements do not
include any adjustments that could result as a consequence of this uncertainty.
BASSAN & ASSOCIADOS S.C.
Ana Escudero de D'Aguiar
Certified Public Accountant
CPA D.F. Venezuela No. 7558
August 20, 1998
F-29
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1997 SEPTEMBER 7, 1998
-------- ---------- -----------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 69,563 $ 14,443 $ 331,013
Accounts receivable --trade, less allowance of
$50,000 in 1998.................................... 225,500 634,215 1,299,469
Other current assets................................. 2,451 13,902 68,799
-------- ---------- ----------
Total current assets................................... 297,514 662,560 1,699,281
Equipment and vehicles:
Computer equipment................................... 30,407 116,850 161,449
Vehicles............................................. 45,119 45,119 --
-------- ---------- ----------
75,526 161,969 161,449
Less: accumulated depreciation....................... (25,831) (56,084) (55,700)
-------- ---------- ----------
49,695 105,885 105,749
Other assets........................................... 654 618 --
-------- ---------- ----------
Total assets........................................... $347,863 $ 769,063 $1,805,030
======== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Bank overdraft....................................... $ -- $ 157,056 $ --
Accounts payable..................................... 13,899 7,162 53,787
Accrued expenses..................................... 60,000 366,685 1,974,395
Current portion of note payable...................... 4,443 10,036 --
Current portion of capital lease obligations......... -- 18,230 9,803
Unsecured demand note payable to stockholder, non-
interest bearing................................... 99,951 62,160 8,500
Client advances...................................... 55,824 -- --
Current deferred income taxes........................ 49,270 -- --
-------- ---------- ----------
Total current liabilities.............................. 283,387 621,329 2,046,485
Note payable........................................... 10,676 -- --
Capital lease obligations, net of current portion...... -- 15,953 8,596
Deferred income taxes.................................. 9,103 -- --
Commitments and contingent liabilities................. -- -- --
Stockholders' equity (deficit):
Common stock......................................... 2,724 3,197 475
Additional paid-in capital........................... -- 1,001,843 1,004,565
Accumulated other comprehensive income (loss)........ 835 (20,918) 21,365
Retained earnings (deficit).......................... 41,138 (852,341) (1,276,456)
-------- ---------- ----------
44,697 131,781 (250,051)
-------- ---------- ----------
Total liabilities and stockholders' equity............. $347,863 $ 769,063 $1,805,030
======== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES.
F-30
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE PERIOD
YEAR ENDED DECEMBER 31 JANUARY 1, 1998
------------------------ THROUGH
1996 1997 SEPTEMBER 7, 1998
-------- ---------- -----------------
<S> <C> <C> <C>
Consulting revenue................................... $747,023 $2,812,011 $4,405,560
Cost of revenue...................................... 519,261 1,881,031 2,976,499
-------- ---------- ----------
Gross profit......................................... 227,762 930,980 1,429,061
Operating expenses:
General and administrative......................... 131,037 778,342 1,803,611
Sales and marketing................................ 73,305 62,943 4,632
Stock compensation expense......................... -- 1,002,316 --
Depreciation....................................... 13,556 30,253 27,580
-------- ---------- ----------
217,898 1,873,854 1,835,823
-------- ---------- ----------
Income (loss) from operations........................ 9,864 (942,874) (406,762)
Interest expense..................................... (2,917) (8,977) (17,353)
-------- ---------- ----------
Income (loss) before provision for income taxes...... 6,947 (951,851) (424,115)
Provision (benefit) for income taxes................. 14,832 (58,372) --
-------- ---------- ----------
Net income (loss).................................... $ (7,885) $ (893,479) $ (424,115)
======== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES.
F-31
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER RETAINED
COMMON PAID-IN COMPREHENSIVE EARNINGS
STOCK CAPITAL INCOME (DEFICIT) TOTAL
-------- ---------- ------------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1996........ $1,000 $ -- $ -- $ 49,023 $ 50,023
Issuance of common stock......... 1,724 -- -- -- 1,724
Comprehensive income:
Net loss....................... -- -- -- (7,885) (7,885)
Other comprehensive income--
translation adjustment....... -- -- 835 -- 835
----------
Total comprehensive income
(loss)......................... -- -- -- -- (7,050)
------ ---------- -------- ----------- ----------
Balances at December 31, 1996...... 2,724 -- 835 41,138 44,697
Stock grant to employees for no
consideration.................. 473 1,001,843 -- -- 1,002,316
Comprehensive income:
Net loss....................... -- -- -- (893,479) (893,479)
Other comprehensive income--
translation adjustment....... -- -- (21,753) -- (21,753)
----------
Total comprehensive income
(loss)......................... -- -- -- -- (915,232)
------ ---------- -------- ----------- ----------
Balances at December 31, 1997...... 3,197 1,001,843 (20,918) (852,341) 131,781
Corporate reorganization......... (2,722) 2,722 -- -- --
Comprehensive income:
Net loss....................... -- -- -- (424,115) (424,115)
Other comprehensive income--
translation adjustment....... -- -- 42,283 -- 42,283
Total comprehensive income
(loss)......................... -- -- -- -- (381,832)
------ ---------- -------- ----------- ----------
Balances at September 7, 1998...... $ 475 $1,004,565 $ 21,365 $(1,276,456) $ (250,051)
====== ========== ======== =========== ==========
</TABLE>
SEE ACCOMPANYING NOTES.
F-32
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD
YEAR ENDED DECEMBER 31 JANUARY 1, 1998
----------------------- THROUGH
1996 1997 SEPTEMBER 7, 1998
--------- ----------- -------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................ $ (7,885) $ (893,479) $ (424,115)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Non-cash compensation expense.................. -- 1,002,316 --
Depreciation................................... 13,556 30,253 27,580
Deferred taxes................................. 14,832 (58,372) --
Change in assets and liabilities:
Accounts receivable.......................... (72,937) (408,715) (665,254)
Other current assets......................... (1,655) (11,415) (54,897)
Other assets................................. -- -- 618
Accounts payable............................. 13,899 (6,737) 46,625
Accrued expenses............................. 59,200 306,685 1,607,710
Client advances.............................. 55,824 (55,824) --
-------- ---------- ----------
Net cash provided by (used in) operating
activities..................................... 74,834 (95,288) 538,267
INVESTING ACTIVITIES
Acquisition of equipment and vehicle............. (19,989) (41,779) (44,948)
Sale of vehicle.................................. -- -- 17,504
-------- ---------- ----------
Net cash used in investing activities............ (19,989) (41,779) (27,444)
FINANCING ACTIVITIES
Issuance of common stock......................... 1,724 -- --
Proceeds (repayments) from note payable to
stockholder.................................... 68,890 (37,791) (53,660)
Bank overdraft................................... (50,733) 157,056 (157,056)
Repayments of note payable....................... (5,998) (5,083) (10,036)
Repayments of capital leases..................... -- (10,482) (15,784)
-------- ---------- ----------
Net cash provided by (used in) financing
activities..................................... 13,883 103,700 (236,536)
Effect of exchange rate changes on cash.......... 835 (21,753) 42,283
-------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents.................................... 69,563 (55,120) 316,570
Cash and cash equivalents at beginning of year... -- 69,563 14,443
-------- ---------- ----------
Cash and cash equivalents at end of year......... $ 69,563 $ 14,443 $ 331,013
======== ========== ==========
SUPPLEMENTAL INFORMATION
Interest paid.................................... $ 2,917 $ 8,977 $ 19,735
======== ========== ==========
SCHEDULE OF NONCASH INVESTING ACTIVITIES
Property and equipment acquired under capital
leases......................................... $ -- $ 44,465 $ --
======== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES.
F-33
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REORGANIZATION AND BASIS OF PRESENTATION
I.I.T. Holding, Inc. and subsidiaries ("the Company") provides internet
consulting, integration, and support services to commercial companies in the
United States and South America. I.I.T. Holding, Inc. was formed in February
1998 when the shareholders of International Information Technology Inc. and
International Information Technology IIT, C.A., enterprises under common
control, exchanged their stock for 100% of the stock of I.I.T. Holding, Inc. The
accompanying consolidated financial statements for all periods presented include
the combined financial position and results of operations of the companies
previously under common control. All significant intercompany transactions have
been eliminated in preparation of the consolidated financial statements.
CONVERSION TO U.S. DOLLARS
The financial information for a Venezuelan subsidiary includes financial
information converted from Venezuelan Bolivares to U.S. Dollars.
Assets and liabilities were converted at the rate in effect at the balance
sheet date and the statement of operations was converted at the average rate
during the periods.
USE OF ESTIMATES
The preparation of the consolidated 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 amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all
highly-liquid instruments, including certificates of deposit, purchased with a
maturity of three months or less to be cash equivalents.
CONCENTRATION OF CREDIT RISK
Financial instruments that subject the Company to concentrations of credit
risk consist primarily of accounts receivable. The Company grants credit in the
normal course of business to its clients. As part of this ongoing procedure, the
Company monitors the creditworthiness of its clients. The Company does not
believe that it is subject to any unusual credit risk beyond the normal credit
risk inherent in its business.
For the period ended September 7, 1998, two customers accounted for 24%
($1,042,674), and 10% ($457,784) of total revenue, and three customers accounted
for 38% ($508,212), 13% ($177,874) and 10% ($139,758) of accounts receivable at
September 7, 1998.
For the year ended December 31, 1997, three clients accounted for 33%
($927,964), 17% ($478,042), and 11% ($309,321) of total revenues, and three
clients accounted for 44% ($279,055), 16% ($101,474), and 11% ($69,764) of
accounts receivable at December 31, 1997. For the year ended December 31, 1996,
three clients accounted for 57% ($425,803), 29% ($216,637), and 11% ($82,173) of
F-34
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
total revenues, and three clients accounted for 42% ($94,710), 24% ($54,120),
and 11% ($24,805) of accounts receivable at December 31, 1996.
REVENUE RECOGNITION
Revenue is recognized in the period the services are performed.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense was
approximately $73,000 and $30,000 in 1997 and 1996, respectively. Advertising
expense was approximately $27,000 for the period ended September 7, 1998.
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No.
130). SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components. SFAS No. 130 only impacts display as
opposed to actual amounts recorded. Comprehensive income includes net income and
all other non-owner changes in equity that are excluded from net income, such as
foreign currency translation adjustments. SFAS No. 130 was adopted in 1998.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information (SFAS No. 131). This Statement requires that
public business enterprises report certain information about operating segments
in complete sets of financial statements of the enterprise and in condensed
financial statements of interim periods issued to shareholders. It also requires
that public business enterprises report certain information about their product
and services, the geographic areas in which they operate, and their major
customers. The Company adopted the provisions of SFAS No. 131 in 1998 which did
not have a significant impact on the Company's definition of operating segments
and related disclosures.
2. LEASES
The Company has entered into various capital leases for computer equipment
during 1997. Computer equipment acquired under capital lease obligations was
approximately $44,000. Depreciation expense was $11,116 and $6,000 for the
period ended September 7, 1998 and for the year ended December 31, 1997,
respectively.
F-35
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. LEASES (CONTINUED)
Future lease payments under capital and operating leases are summarized as
follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
<S> <C> <C>
Four months ended December 31, 1998..................... $ 3,703 $ 14,884
1999.................................................. 13,503 54,454
2000.................................................. 5,844 39,165
2001.................................................. -- 517
------- --------
Total minimum lease payments........................ 23,050 $109,020
========
Less amounts representing interest...................... 4,651
-------
Present value of minimum lease payments (including
current portion of $9,803)............................ $18,399
=======
</TABLE>
Rent expense was $47,476, $32,000 and $17,000 for the period ended September
7, 1998, and for the years ended December 31, 1997 and 1996, respectively.
Capital leases have effective interest rates which range from 6% to 25%.
3. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1997 SEPTEMBER 7, 1998
---------- -------- -----------------
<S> <C> <C> <C>
Accrued bonuses, payroll and payroll taxes..... $60,000 $287,120 $1,763,891
Accrued consulting............................. -- 67,965 124,236
Accrued expenses............................... -- 11,600 86,268
------- -------- ----------
Total accrued expenses..................... $60,000 $366,685 $1,974,395
======= ======== ==========
</TABLE>
4. EMPLOYEE BENEFIT PLAN
The Company has established a defined contribution benefit plan effective
January 1, 1998. The plan covers substantially all employees of the Company who
are 21 years of age or older. Participants may contribute up to 15% of their
annual compensation to the plan, and the Company matches up to 3% of annual
compensation. In 1998, the Company recorded contributions to the plan of
$37,502.
5. NOTE PAYABLE
The note payable, which matured in 1997, was due to a financing
organization, and required monthly installments of $552, including interest at
9.90%.
6. COMMON STOCK
Upon reorganization in February 1998, the Company was authorized to issue
100 shares of common stock with a par value of $5.00 per share. At September 7,
1998, 95 shares were issued and outstanding.
F-36
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCK COMPENSATION EXPENSE
In August 1997, the sole stockholder of the Company transferred 473 shares
of the outstanding common stock to management employees for no consideration. An
independent appraisal was obtained which estimated the fair value of the shares
on the date of transfer at $1,002,316. This transfer was treated as a
contribution to additional paid-in capital by the sole stockholder, with an
offsetting charge to compensation expense. In 1997, the Company recorded
compensation expense of $1,002,316 relating to the transfer of these shares.
8. INCOME TAXES
Deferred income tax assets and liabilities are determined based upon
differences between financial reporting and the tax basis of assets and
liabilities and are measured using the enacted tax rate and laws that will be in
effect when the differences are expected to reverse.
The components of the income tax provision are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------- PERIOD ENDED
1996 1997 SEPTEMBER 7, 1998
-------- -------- -----------------
<S> <C> <C> <C>
Current...................................... $ -- $ -- $ --
Deferred..................................... 14,832 (58,372) --
------- -------- ---------
Total.................................... $14,832 $(58,372) $ --
======= ======== =========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
net deferred income taxes are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 7,
----------------------- ------------
1996 1997 1998
-------- -------- ------------
<S> <C> <C> <C>
Deferred tax assets:
Payroll accrual............................... $ 23,964 $ 71,734 $ 53,801
Bonus accrual................................. -- 30,934 365,395
Other accruals................................ 5,239 40,537 50,849
Contributions................................. 40 -- --
Stock compensation............................ -- 219,150
U.S. net operating loss carryforward.......... 11,871 163,092 143,267
-------- -------- --------
Total deferred tax assets..................... 41,114 525,447 613,312
Valuation allowance for deferred tax assets... -- (279,506) (431,882)
-------- -------- --------
Net deferred tax assets....................... 41,114 245,941 181,430
Deferred tax liabilities:
Accounts receivable........................... (90,065) (235,744) (176,808)
Depreciation.................................. (9,103) (9,570) (3,995)
Other......................................... (319) (627) (627)
-------- -------- --------
(99,487) (245,941) (181,430)
-------- -------- --------
Total net deferred tax liability............ $(58,373) $ -- $ --
======== ======== ========
</TABLE>
F-37
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
At September 7, 1998 the Company's U.S. subsidiary has net operating loss
carryforwards of approximately $359,000 available to offset future taxable
income of the U.S. operations. These carryforwards begin to expire in 2012.
The Company's Venezuelan subsidiary had cumulative net operating losses in
the amount of $110,000 through December 31, 1997. These net operating losses
resulted in net deferred tax assets of approximately $23,000 and $5,000 at
December 31, 1997 and 1996, respectively. Management has determined that it is
more likely than not that these net operating losses will not be utilized;
therefore, a full valuation allowance was recorded against these deferred tax
assets at December 31, 1997 and 1996. During the period from January 1, 1998
through September 7, 1998, the subsidiary utilized approximately $92,000 of the
net operating loss carryforward, and increased the valuation allowance by
approximately $2,500 to $25,500, which fully offsets the net deferred tax asset
of $25,500 at September 7, 1998. The remaining net operating loss carryforward
of approximately $18,000 will expire in 2000.
9. GEOGRAPHIC SEGMENT INFORMATION
The Company is engaged in one business segment. This segment includes
providing internet consulting, integration, and support services principally to
commercial companies located throughout the United States and South America. The
following table presents information regarding geographic segments for the
period from January 1, 1998 through September 7, 1998 and the years ended
December 31, 1997 and 1996. There were no service transfers between the United
States and South America. Operating profit (loss) is total service revenue less
cost of service revenue, general and administrative expenses, sales and
marketing and depreciation.
<TABLE>
<CAPTION>
UNITED STATES SOUTH AMERICA TOTAL
------------- ------------- ----------
<S> <C> <C> <C> <C>
Consulting revenue:.............................. 1998 $3,896,502 $509,058 $4,405,560
1997 2,664,214 147,797 2,812,011
1996 743,687 3,336 747,023
Depreciation:.................................... 1998 $ 21,819 $ 5,761 $ 27,580
1997 26,919 3,334 30,253
1996 12,720 836 13,556
Operating profit (loss):......................... 1998 $ (382,361) $(24,401) $ (406,762)
1997 (844,036) (98,838) (942,874)
1996 39,481 (29,617) 9,864
Interest expense:................................ 1998 $ 5,420 $ 11,933 $ 17,353
1997 4,782 4,195 8,977
1996 2,345 572 2,917
Identifiable assets:............................. 1998 $1,646,768 $158,262 $1,805,030
1997 692,702 76,361 769,063
1996 279,616 68,247 347,863
</TABLE>
10. IMPACT OF YEAR 2000 (UNAUDITED)
Some older computer programs were written using two digits rather than four
to define the applicable year. As a result, those computer programs have
time-sensitive software that recognize a date using "00" as the year 1900 rather
than the year 2000. This could cause a system failure or
F-38
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. IMPACT OF YEAR 2000 (UNAUDITED) (CONTINUED)
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
The Company is assessing the modifications or replacement of its software
that may be necessary for its computer systems to function properly with respect
to the dates in the year 2000 and thereafter. The Company does not believe that
the cost of either modifying existing software or converting to new software
will be significant or that the year 2000 issue will pose significant
operational problems for its computer systems.
F-39
<PAGE>
USINTERNETWORKING, INC.
[LOGO]
$125,000,000
7% CONVERTIBLE SUBORDINATED NOTES DUE NOVEMBER 1, 2004
AND 5,030,181 SHARES OF COMMON STOCK ISSUABLE
UPON CONVERSION OF THE NOTES
88,915 SHARES OF COMMON STOCK
