<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 17, 1999.
REGISTRATION NO. 333-74793
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SECURITIES AND EXCHANGE COMMISSION
------------------------
AMENDMENT NO. 7
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
CRL NETWORK SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C>
DELAWARE NO. 4813 68-0312353
(STATE OF INCORPORATION) (PRIMARY STANDARD INDUSTRIAL (IRS EMPLOYER
CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
ONE KEARNY STREET, SUITE 1450
SAN FRANCISCO, CALIFORNIA 94108
(415) 837-5300
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
JAMES G. COUCH
PRESIDENT AND CHIEF EXECUTIVE OFFICER
ONE KEARNY STREET, SUITE 1450
SAN FRANCISCO, CALIFORNIA 94108
(415) 837-5300
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
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<S> <C>
KENNETH R. LAMB, ESQ. NORA L. GIBSON, ESQ.
LISA A. FONTENOT, ESQ. PETER S. BUCKLAND, ESQ.
PATRICK L. WONG, ESQ. TAYLOR L. STEVENS, ESQ.
GIBSON, DUNN & CRUTCHER LLP PATRICK J. O'LOUGHLIN, ESQ.
ONE MONTGOMERY STREET, TELESIS TOWER BROBECK, PHLEGER & HARRISON LLP
SAN FRANCISCO, CALIFORNIA 94104 ONE MARKET, SPEAR STREET TOWER
SAN FRANCISCO, CALIFORNIA 94105
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement of the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
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<PAGE> 2
SUBJECT TO COMPLETION, DATED JUNE 17, 1999
THE INFORMATION CONTAINED IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY
BE CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE JURISDICTION WHERE THE OFFER OR SALE
IS NOT PERMITTED.
PROSPECTUS
LOGO
CRL NETWORK SERVICES, INC.
COMMON STOCK
$ PER SHARE
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This is the initial public offering of CRL Network Services, Inc. We are
offering 5,000,000 shares. This is a firm commitment underwriting.
We expect that the price to the public in the offering will be between $9.00 and
$10.00 per share. The market price of the shares after the offering may be
higher or lower than the offering price.
We have applied to have the common stock approved for quotation on the Nasdaq
National Market under the symbol "CRLX."
INVESTING IN THE COMMON STOCK INVOLVES MATERIAL RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 5.
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<CAPTION>
PER SHARE TOTAL
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<S> <C> <C>
Price to Public............................................. $ $
Underwriting discounts......................................
Proceeds to CRL Network Services, Inc.......................
</TABLE>
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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.
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<S> <C>
Joint Lead Manager and Bookrunner Joint Lead Manager
CIBC WORLD MARKETS LEHMAN BROTHERS
</TABLE>
DLJdirect INC.
The date of this prospectus is , 1999.
<PAGE> 3
[INSIDE FRONT COVER]
[Graphic depicts a map of United States entitled "Networks Built for Business"
with the CRL logo, reflecting CRL's network connecting cities nationwide,
including symbols designating CRL's Regional Hubs, CRL Points of Presence or
Service Areas, Internet Protocol Backbone and Switched Backbone]
<PAGE> 4
TABLE OF CONTENTS
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PAGE
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Prospectus Summary.......................................... 1
Risk Factors................................................ 5
How We Intend to Use the Proceeds from the Offering......... 22
Dividend Policy............................................. 22
Capitalization.............................................. 23
Dilution.................................................... 24
Selected Consolidated Financial Data........................ 25
Management's Discussion and Analysis of Results of
Operations and Financial Condition........................ 26
Business.................................................... 35
Management.................................................. 56
Principal Stockholders...................................... 63
Description of Capital Stock................................ 64
Shares Eligible for Future Sale............................. 67
Underwriting................................................ 69
Legal Matters............................................... 71
Experts..................................................... 71
Where You Can Find More Information......................... 71
Index to Financial Statements............................... F-1
</TABLE>
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PROSPECTUS SUMMARY
This summary contains basic information about us and this offering. Because it
is a summary, it does not contain all of the information that you should
consider before investing. You should read this entire prospectus carefully,
including the section entitled "Risk Factors" and the financial statements and
the related notes to those statements included in this prospectus. This
prospectus assumes that the underwriters have not exercised the over-allotment
option and gives effect to our reincorporation in Delaware and the associated
exchange of one share of common stock of CRL for every three shares of common
stock of CRL's California predecessor.
CRL NETWORK SERVICES, INC.
CRL Network Services is a Tier 1 Internet service provider offering customized
Internet and network management solutions to small and medium-sized businesses.
As a Tier 1 provider we can be characterized as having a high quality, national
backbone network which can reach every other Internet destination through
agreements to exchange data, known as peering, without paying transit fees to
other network operators. We provide high quality, reliable and scalable Internet
and network connectivity and value-added services designed to meet our
customers' needs. Our services include:
- connectivity to the Internet and secure private networks through our
national backbone network from which our Internet access customers can reach
every other Internet address and our network customers can reach other
destinations within their private network.
- value-added services, which are additional services delivered over the same
circuit as our connectivity services. Our current value-added services are
remote management of our customers' networks and systems integration, which
includes the resale, installation and configuration of our customers'
computer systems and software.
- hosting, which is the distribution of customers' Internet content from our
facilities.
Our customers outsource the management of their Internet and network needs to
us. We develop and construct our data switched networks and perform all data
routing and transmission for our customers. We lease fiber-optic capacity from
third-party providers over which we transmit data and peer with other
telecommunications providers to exchange data traffic.
We believe we were among the first companies involved in the development of
connectivity solutions and services for the commercial Internet. We have
developed our own high speed network, which enables us to reliably and cost
effectively deliver customized, comprehensive solutions. Our competitive
strengths include our:
- engineering and technical expertise arising from our direct participation in
the evolution of the commercial Internet, which has enabled us to develop
our own sophisticated network infrastructure
- high speed, private switched network, which means it relies on our own
switches which enables us to maximize our quality of service by reducing
delay and data loss as well as increasing the level of security
- status as a Tier 1 provider, which resulted from being one of the first
commercial Internet providers and, which allows us to exchange data directly
with other Tier 1 providers without paying transit fees, reducing the costs
of operating our network
- our proprietary network management process, acquired through our recent
merger with Integral Networking Corporation in December 1998, which enables
us to connect directly to our customer's network and manage our customer's
network from the server to the desktop without the need to be on-site at our
customer's facilities, which we refer to as remote management
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<PAGE> 6
As of June 16, 1999, we had 30 network equipment centers located in major
metropolitan areas from which we deliver our services. Our network connects to
all of the interexchange points sanctioned by the National Science Foundation
for the transfer of Internet Protocol-based traffic between Internet backbone
networks. Our network is comprised of several elements, including 24 Cascade
switches, 54 Cisco routers, facilities and clear channel fiber-optic bandwidth,
which together provide a fast, secure, high quality network capable of
minimizing outages resulting from hardware or software faults. Our customers
include Internet service and content providers like Internet America, Inc. and
Walnut Creek CDROM, Incorporated; companies engaged in electronic commerce like
Citizen One Software; government agencies like the U.S. Federal Reserve Board
and the U.S. Department of Commerce; and educational institutions like the
Pacific Union College and the Tustin Unified School District. These
representative customers are among those customers from the business sectors
indicated providing the highest revenues for CRL in 1998 or who were one of the
top 20 customers on the basis of revenues for CRL in the first quarter of 1999.
Our objective is to become the leading nationwide provider of customized
comprehensive Internet and network services to small and medium-sized
businesses. To achieve this objective, we intend to:
- FURTHER CAPITALIZE ON OUR EXISTING NETWORK INFRASTRUCTURE. We intend to
utilize our status as a Tier 1 Internet service provider and competitive
local exchange carrier in California as well as our fast, secure, reliable
and scalable network to cost effectively expand our customer base and
deliver additional services to our customers.
- CROSS SELL VALUE-ADDED SERVICES. We intend to capitalize on our existing
customer base and future customers by aggressively cross selling our current
and future value-added services to address their Internet and other network
management requirements.
- PROVIDE BUNDLED, COMPREHENSIVE NETWORKING SOLUTIONS. By combining our
network infrastructure with our existing and planned array of networking
services, we believe we are well positioned to become one of the premier,
comprehensive providers of bundled networking solutions to small and medium-
sized businesses.
- EXPAND CUSTOMER BASE AND SALES EFFORTS. We believe we will be able to
successfully market and sell our comprehensive networking solutions to a
large national customer base by significantly increasing our direct sales
force and expanding our relationships with potential channel partners.
- DRIVE REVENUE GROWTH BY INCREASING HOSTING SERVICES. We intend to optimize
our physical presence and facilities located at key Internet network access
points, which provide an attractive opportunity for us to market and sell
hosting services to existing and potential customers.
- ACCELERATE GROWTH THROUGH TARGETED ACQUISITIONS. We intend to seek
acquisition candidates that we believe we can integrate with our existing
network to increase our customer base or provide additional value-added
services. In this regard, we recently acquired Integral Networking
Corporation, which enables us to provide our remote management services.
------------------------
Our principal executive offices are located at One Kearny Street, Suite 1450,
San Francisco, California 94108, and our telephone number at that address is
(415) 837-5300.
This prospectus contains product names, trade names and trademarks that belong
to us or to other organizations.
2
<PAGE> 7
THE OFFERING
Common stock offered by us.... 5,000,000 shares
Common stock to be outstanding
after the offering(1)......... 24,038,832 shares
Use of proceeds by CRL Network
Services.................... We intend to use the net proceeds from the sale
of common stock to repay indebtedness totaling
$1,088,000 as of March 31, 1999, for working
capital and other general corporate purposes,
including expansion of our sales and marketing
activities. We may also use a portion of the
net proceeds for acquisitions. See "How We
Intend to Use the Proceeds from the Offering."
Proposed Nasdaq National
Market symbol................. CRLX
Risk Factors.................. See "Risk Factors" for a discussion of factors
you should carefully consider before deciding
to invest in our common stock.
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(1) Based on 19,038,832 shares outstanding on June 16, 1999, which excludes
946,320 shares issuable upon exercise of currently outstanding options with
a weighted average exercise price of $2.20 per share and 2,000,000 shares
available for the grant of additional options under our 1999 Stock
Incentive Plan. See "Management -- Stock Options."
3
<PAGE> 8
SUMMARY CONSOLIDATED FINANCIAL DATA
The summary consolidated financial data as of December 31, 1998 and for the
years ended December 31, 1996, 1997 and 1998 are calculated from our audited
consolidated statements included in this prospectus. The summary consolidated
financial data for the years ended December 31, 1994 and 1995 and for the three
months ended March 31, 1998 and 1999 are calculated from unaudited consolidated
financial statements not included in this prospectus. The unaudited financial
statements have been prepared by us on a basis consistent with our audited
consolidated financial statements and include, in the opinion of our management,
all adjustments consisting only of normal recurring adjustments necessary for a
fair presentation of our results of operations and financial position for those
years.
You should read the following data with the more detailed information contained
in "Selected Consolidated Financial Data," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and our consolidated financial
statements and the notes to the consolidated financial statements, each included
in this prospectus.
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<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------- -------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................... $ 1,961 $ 3,831 $ 6,353 $10,375 $11,692 $ 2,981 $ 3,003
Total costs and expenses...... 1,555 3,184 6,043 8,904 11,726 2,694 3,525
Operating income (loss)....... 406 647 310 1,471 (34) 287 (522)
Net interest income
(expense).................. (1) 1 1 5 (30) (1) (22)
Net income (loss)............. 248 437 161 885 (151) 203 (387)
Net income (loss) per common
share basic and diluted.... $ 0.01 $ 0.02 $ 0.01 $ 0.05 $ (0.01) $ 0.01 $ (0.02)
Weighted average common shares
outstanding:
Basic...................... 18,979 18,979 18,979 18,979 18,979 18,979 18,979
Diluted.................... 18,979 18,979 18,979 19,142 18,979 19,283 18,979
</TABLE>
The following table indicates a summary of our balance sheet at March 31, 1999,
which has been adjusted to reflect the sale of 5,000,000 shares of common stock
offered by us after deducting underwriting discounts and commissions and
estimated offering expenses at an assumed initial public offering price of $9.50
per share and the repayment of the amounts outstanding under our loan
agreements. See "How We Intend to Use the Proceeds from the Offering."
<TABLE>
<CAPTION>
AT MARCH 31, 1999
---------------------
ACTUAL AS ADJUSTED
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<S> <C> <C>
BALANCE SHEET DATA:
Cash and equivalents...................................... $ 354 $42,131
Working capital........................................... 229 42,256
Total assets.............................................. 4,522 45,785
Total liabilities......................................... 2,998 1,426
Long-term obligations, excluding current portion.......... 822 14
Stockholders' equity...................................... 1,524 44,359
</TABLE>
- -------------------------
See notes 1 and 12 of the notes to the consolidated financial statements
included in this prospectus for an explanation of the determination of the
number of shares used in computing per share data.
4
<PAGE> 9
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are the
material risks currently known to us but not the only risks facing us. These
risk factors are not intended to represent a complete list of the general or
specific risk factors that may affect us as additional risks and uncertainties
not presently known to us or that we currently deem immaterial may also impair
our business operations. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected. If that happens, the trading price of our common stock could
decline, and you may lose all or part of your investment.
THE SUCCESS OF OUR GROWTH STRATEGY DEPENDS ON OUR ABILITY TO MARKET AND SELL OUR
EXISTING AND FUTURE SERVICES.
Historically, our business has focused on selling Internet and other network
connection services. A critical component to the successful implementation of
our growth strategy is our ability to offer and expand our value-added services
and the acceptance of those services by our existing and potential customers.
Our future growth depends, in part, on the acceptance and use of remote
management and systems integration services by small and medium-sized
businesses. Until our December 1998 merger with Integral Networking Corporation,
we had very little experience in either of these markets and to date have
derived insignificant revenues from services in these markets. In particular,
the market for remote management services is new, making it difficult to
determine the size and growth of the market and to predict how this market will
develop. Changes in technology, the availability of qualified information
technology professionals and other factors that make internal network management
more cost effective than remote network management, would negatively impact the
market for our services. Our business may be seriously damaged if this market
fails to grow, grows more slowly than we expect or develops in some way that is
different from our expectations. We are also actively seeking to develop or
acquire a variety of other services we can offer and cross sell. In addition, we
recently began offering digital subscriber line services but have generated no
revenues from these services. For many reasons, including the reasons described
in the risk factors below, we cannot assure you that we will be successful in
developing or acquiring those or any other services or, that if we do, we will
be successful in marketing and selling those services to our existing or
potential customers.
OUR OPERATING RESULTS IN ONE OR MORE FUTURE PERIODS ARE LIKELY TO FLUCTUATE
SIGNIFICANTLY.
We expect to experience significant fluctuations in our future quarterly and
annual results of operations due in part to our growth strategy and the emerging
nature of the data communications industry in our markets. A variety of factors
likely to cause fluctuations in our operating results, some of which are outside
our control, include:
- demand for and market acceptance of our services
- capacity utilization of our facilities
- fluctuations in data communications and telecommunications costs
- reliable continuity of service and network availability
- customer retention
- the timing and success of sales and marketing efforts
- the timely expansion of existing facilities and completion of new facilities
- the ability to increase bandwidth as necessary
- fluctuations in bandwidth used by customers
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<PAGE> 10
- the timing and magnitude of expenditures for sales and marketing and capital
expenditures
- introductions of new services or enhancements by us and our competitors
- the timing of customer installations and related payments
- the ability to maintain or increase peering relationships
- increased competition including the introduction by third parties of new
Internet and network services
- general growth of Internet use and establishment of Internet operations by
enterprises
- changes in our pricing policies and those of our competitors
- changes in regulatory laws and policies
- the success of our acquisition strategy
- the timing and amount of charges related to acquisitions
- economic conditions specific to the Internet and networking industry
Our expenses, particularly our telecommunications costs, depreciation, real
estate expenditures and personnel costs are expected to increase significantly
as we grow. Of our total costs and expenses, these costs comprise 73% of our
total costs for 1998 and 71% of our total costs for the first quarter of 1999.
We anticipate that such costs will continue to constitute a similar or higher
percentage of our total costs over the next twelve months. As we grow, we may
also incur one-time costs associated with capital expenditures for network and
facilities growth, acquisition expenses and development of our existing and new
service offerings. In addition, we are in the process of hiring new employees.
Consequently, our future results of operations will be particularly sensitive to
fluctuations in revenues. Over the next five years, we will record an expense of
approximately $739,000 related to some of our option grants. For more
information about these charges, see "Management's Discussion and Analysis of
Financial Conditions and Results of Operations."
For the year ended December 31, 1998 and for the three months ended March 31,
1999, we experienced operating losses for the first time in our operating
history due in part to increased sales and marketing and general and
administrative expenses, and the incurrence of stock-based compensation expense.
In addition, our revenue increase from the year ended December 31, 1997 to the
year ended December 31, 1998 was less than we have experienced in previous
years. If our revenues fail to grow at anticipated rates, our operating expenses
increase without a commensurate increase in our revenues or we fail to adjust
operating expense levels accordingly, our business and financial results could
be harmed.
We anticipate that we will continue to incur net losses for the foreseeable
future. The extent of these losses will be contingent, in part, on the amount of
growth in our revenues, particularly from new service offerings. We expect our
operating expenses to increase significantly, especially in the areas of sales
and marketing, and, as a result, we will need to generate increased quarterly
revenues to become profitable.
Due to the factors listed above and the other risk factors described in this
section of the prospectus, we believe that comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. As a result, the fluctuation of our results
of operations in future periods could cause the trading price of our common
stock to suffer a significant decrease.
WE MAY NOT SUCCESSFULLY IMPLEMENT OUR ACQUISITION STRATEGY.
As part of our growth strategy, we will seek strategic acquisitions of
additional assets, technologies and businesses complementary to our operations.
We may not be able to locate suitable acquisition targets or be able to acquire
any target companies we locate on acceptable terms. Our recent merger with
Integral
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Networking Corporation is, and any future acquisitions would be, accompanied by
risks including, among other things:
- loss of customers and key personnel of an acquired company
- inability to achieve cost savings
- acquisition expenses and charges incurred
- difficulties integrating the operations and personnel of acquired companies
- additional financial resources that may be needed to fund the combined
company operations
- the potential disruption of our business
- our management's ability to realize financial and strategic benefits of
incorporating acquired technologies or businesses into our service offerings
- difficulty of maintaining uniform quality control and other standards,
policies and procedures in a larger organization
- impairment of employee relationships due to changes in management or
perceived conflicts
- assumption of unexpected liabilities and incurrence of significant
unexpected expenses in completing acquisitions
Any of the above risks could prevent us from realizing significant benefits from
our acquisitions. In connection with our merger with Integral, we experienced a
loss of Integral personnel, incurred unanticipated costs and required greater
than expected management attention to establish and maintain uniform quality
control, standards and policies. In addition, issuing our common stock in
acquisitions will dilute our stockholders' percentage interests in our company,
while using cash will deplete our cash reserves. Finally, if we are unable to
account for our acquisitions under the "pooling of interests" method of
accounting, we may incur significant, one-time write-offs and amortization
charges for acquisition or debt-related expenses, goodwill and other intangible
assets. These write-offs and charges would decrease our future earnings or
increase our future losses and could hurt the trading price of our common stock.
THE MARKETS FOR OUR SERVICES ARE CHARACTERIZED BY MANY COMPETING TECHNOLOGIES,
AND THE TECHNOLOGIES ON WHICH OUR SERVICES ARE BASED MAY NOT COMPETE
EFFECTIVELY.
The markets for the network connectivity services we provide are extremely
competitive and fragmented. There are no substantial barriers to entry in these
markets, and we expect that competition will intensify in the future. We believe
that our ability to compete successfully depends upon a number of factors,
including:
- the capacity, reliability, low delay and security of our network
infrastructure
- our ability to maintain existing and develop future peering relationships
- our technical expertise and the functionality, performance and quality of
services
- our ability to provide custom solutions for our customers
- the experience and technical expertise of our sales force and engineers
- the ease of access to our services
- our remote management capabilities
- the pricing policies of our competitors and suppliers
- our ability to operate as a competitive local exchange carrier
- our ability to scale our services to meet growing customer demand
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- the variety of services we offer
- our geographical presence
- the timing of introductions of new services by us and our competitors
- the responsiveness and quality of our customer support
- our financial resources
- our ability to support industry standards
To be competitive, we must respond promptly and effectively to the challenges of
technological change, evolving standards and our competitors' innovations by
continuing to enhance our services, as well as our sales programs and channels.
Any pricing pressures, reduced margins or loss of market share resulting from
increased competition or our failure to compete effectively, could seriously
damage our business and financial results.
THE MARKETS IN WHICH WE COMPETE ARE HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE
TO COMPETE EFFECTIVELY, ESPECIALLY AGAINST COMPANIES WITH GREATER RESOURCES.
Many of our competitors have greater market presence, engineering and marketing
capabilities and financial, technological and personnel resources than those
available to us. As a result, they may develop, deploy and expand their
communications and network infrastructures more quickly, adapt more swiftly to
new technologies and changes in customer requirements, take advantage of
acquisition and other opportunities more readily and devote greater resources to
the marketing and sale of their services than we can. Additionally, many
organizations have entered into or are forming joint ventures or consortiums to
provide services competitive with ours.
Our competitors generally may be divided into four principal groups:
- telecommunications carriers including regional Bell operating companies
- Internet service providers
- network and system integrators
- online network service providers
We believe the market for network management services will be highly competitive
if it grows as we expect. Competition will probably increase significantly as
new companies enter the market and current competitors expand their services and
product lines. Many potential competitors are likely to enjoy substantial
competitive advantages, including those listed above. As a result, our existing
and potential customers may contract with other competitive communications
providers, decreasing demand for CRL's services. For a list of our principal
competitors, see "Business -- Competition."
OUR BUSINESS MAY BE HARMED IF NEW COMPETITORS ENTER OUR MARKETS.
We believe that new competitors will enter our markets. These new competitors
could include large computer hardware, software, media and other technology and
telecommunications companies. A large number of companies with short operating
histories have entered the markets for the services we offer as these markets,
some of which are in an emerging state, develop. In addition, telecommunications
companies and online services providers currently offer or have announced plans
to offer or expand their network services. These telecommunications companies
and online services providers are able to devote greater resources to developing
and marketing competitive products and services. In addition, they often have
the ability to bundle other services and products with their Internet services,
such as voice and video communications, placing us at a competitive disadvantage
because we do not currently offer some of these services. Other companies are
also exploring the possibility of providing or are currently providing high
speed data services using alternative delivery methods that could be faster or
less expensive, decreasing customer demand for CRL's services. As new
competitors enter our markets, they sometimes offer special
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promotions to attract customers, such as free Internet access or computers,
which could adversely impact our ability to attract or retain customers.
Increased competition from new competitors could negatively affect our business
and financial results.
WE MAY HAVE TO REDUCE THE COST OF OUR SERVICES TO REMAIN COMPETITIVE.
Increased competition and industry consolidation has in the past and could in
the future result in significant pricing pressure. This pricing pressure could
cause large reductions in the average selling price of our services and has
resulted in a general industry decrease in the prices for the services we
provide. For example, telecommunications companies that compete with us may
provide customers with reduced communications costs for their Internet access or
private network services, reducing the overall cost of their solutions and
significantly increasing pricing pressures on us. Combined Internet services and
access companies can bundle their offerings and remain profitable at lower price
levels while realizing economies of scale. As a result, we have experienced
pricing pressures on our connectivity offerings, including our T-1 and
fractional T-1 services, have lowered prices on a case-by-case basis and have
introduced new lower price products. We may not be able to offset the effects of
any price reductions by increasing the number of our customers, generating
higher revenues from enhanced services, reducing cost, or by obtaining approvals
to operate as a competitive local exchange carrier. We believe that the
businesses of providing network connectivity, value-added network services and
hosting services will likely see increased consolidation in the future.
Consolidation could decrease selling prices and increase competition in these
industries which could erode our market share and could have a material negative
effect on our business and financial results.
WE DEPEND ON OUR NETWORK INFRASTRUCTURE AND OTHER SUPPLIERS TO PROVIDE
AFFORDABLE, RELIABLE, SCALABLE AND SECURE SERVICES.
Our success will depend upon our network infrastructure's capacity, scalability,
reliability and security, including the bandwidth capacity leased from
telecommunications network suppliers. In particular, we rely on Metropolitan
Fiber Systems, IXC Communications, Inc., Qwest Communications Corporation, Cable
& Wireless USA, Inc. and other telecommunications providers for backbone and
local loop capacity. These companies provide our dedicated clear channel
network, the backbone connecting our wide area data switches. These companies
also permit our networks to exchange Internet traffic with other Internet
service providers and distribute our services to our customers. We depend on the
ability of those companies to maintain the operational integrity of our backbone
and interconnections. If one or more of these companies is unable or unwilling
to provide or expand its current levels of service to us in the future, our
operations could be seriously and adversely affected. Most of our agreements
with these companies are for a one-year term with renewal options. These
agreements do not require minimum commitments and are on an as used basis. While
these companies have additional capacity available, they are under no obligation
under these agreements to provide it to us. We estimate that Qwest
Communications Corporation, IXC Communications, Inc. and MCI WorldCom, Inc.
provide approximately three-quarters of our bandwidth. In addition, rapid
changes within the telecommunications industry have led to the merging of many
telecommunications companies. These mergers have and in the future may further
cause the pricing we receive for the services we use and the quality of service
that we receive to vary significantly. The consolidation of companies providing
Internet services and access has and can result in preferential provision of
services to acquired companies and potential targets or business partners and
could cause the length of time it takes to deliver the telecommunications
services that we use to increase significantly.
We are currently in a dispute with Qwest Communications Corporation, one of our
three principal providers, involving fiber cable they own connecting several
cities. Qwest agreed to lease fiber to us to be installed and available to us by
specified dates. Qwest did not complete installation as agreed. Despite their
failure to install the fiber in a timely manner, Qwest alleges that we owe them
approximately $479,000 through March 31, 1999 for use of the fiber cable. We
believe Qwest is obligated to provide us with free service as a result of this
installation delay. We are currently attempting to resolve this dispute by
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negotiation. We cannot assure you that the dispute will be resolved to our
satisfaction or that Qwest will not suspend service, potentially resulting in an
interruption of service.
WE DEPEND ON OUR RELATIONSHIPS WITH TELECOMMUNICATIONS CARRIERS TO PROVIDE OUR
DATA COMMUNICATIONS CAPACITY.
We rely on local telephone companies and other companies to provide data
communications capacity via local telecommunications lines and leased long
distance lines. These arrangements are generally terminable at will or are for a
short term. We are also subject to potential disruptions or capacity constraints
in these telecommunications services and may have no means of replacing these
services on a timely basis or at all if disruption or capacity constraints
occur. In addition, local phone service is sometimes available only from one
local telephone company in a particular market we serve. We compete with those
regional Bell operating companies and other network operators providing Internet
services. Telecommunications carriers may be able to provide both Internet
services and data communications capacity at a lower rate than what we can
offer. Some telecommunications carriers have provided Internet access services
comparable to those provided by CRL at lower rates than CRL's prices. We believe
that the federal Telecommunications Act of 1996 generally will lead to increased
competition in the provision of local telephone service, but we cannot predict
the timing or extent of any such developments or the effect of increased
competition on pricing or supply. Some of our suppliers, including the regional
Bell operating companies and competitive local exchange carriers, are subject to
price constraints, including tariff controls, which in the future may change.
Recent regulatory changes and industry consolidation may increase the prices
that these carriers may charge us. Those increases may have a serious and
negative effect on our business and financial results.
WE DEPEND ON OUR PEERING RELATIONSHIPS AND TIER 1 STATUS TO DELIVER OUR SERVICES
ECONOMICALLY.
The Internet consists of many network providers operating their own networks and
interconnecting them at a number of public and private peering points, through
peering arrangements with one another. Our peering relationships, which allow us
to maintain high network performance levels without paying higher non-peered
transit costs to exchange traffic, are not regulated, are rarely subject to any
written agreement, and are subject to revision in terms, conditions or costs
over time. Network service providers may unilaterally elect at any time not to
maintain peering relationships with us which could increase requirements or
costs to maintain these peering relationships. A loss of any of these
relationships, the failure of our peering partners to increase bandwidth
commensurate to increased data traffic or increased pricing would diminish the
level of connectivity available to our customers or cause us to incur additional
operating expenses by requiring us to identify alternative methods to transmit
our customers' information and to pay for transit. No economical alternatives
may be available if that happens.
Many operators of the private peering interexchanges are also our competitors.
As a result, these competitors may cancel their peering relationships if they
find that the benefits of having a peering relationship with us are outweighed
by competitive conditions in our business.
OUR FAILURE TO PROPERLY MANAGE OUR BUSINESS EXPANSION MAY STRAIN OR EXCEED OUR
RESOURCES OR COULD HARM OUR BUSINESS.
Our company has recently experienced significant business expansion as seen in
the number of new hires, its recent merger with Integral and the expansion of
our service offerings and facilities. Continued growth is necessary to increase
our revenues in the accelerated manner contemplated by our business plan.
In particular, to successfully integrate newly acquired assets and continue to
implement a nationwide growth strategy and network, we must:
- closely monitor service quality
- increase our direct and indirect sales and marketing efforts
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- continue to implement and improve our operational, financial and management
information systems and controls
- hire, train and retain a relatively large number of additional qualified
personnel
- continue to expand and upgrade our network infrastructure
We must continue to enhance and develop our network to maintain our competitive
position and continue to meet the increasing demands for service quality,
availability and competitive pricing. Despite the availability of additional
network capacity from third-party network providers, we intend to maintain the
flexibility to expand or open new points of presence or make other capital
investments as dictated by customer demand or strategic considerations. To open
new points of presence, we must spend significant amounts of money for new
equipment and leased telecommunications facilities. In addition, to expand our
customer base nationwide, we will likely have to spend significant amounts of
money on additional equipment to maintain the high speed and reliability of our
Internet and other network access services.
We intend to begin consolidation of our San Francisco administrative and network
operations in one or more new, larger facilities during the third quarter of
1999 and to complete the consolidation in the fourth quarter of 1999. We are
still negotiating the location of this new site or sites. We also anticipate
completing the expansion of our Sacramento operations center by the end of the
fourth quarter of 1999. We expect management of the transition of our
information systems, personnel and operational equipment to new facilities to
place additional strain on our resources. This transition may not be completed
successfully or on a timely basis and may require a significant amount of
management's attention and could cause interruptions in our operations which
could harm our business.
Our increasing customer base necessitates that our network infrastructure and
technical support resources grow accordingly. We cannot assure you that our
technical support or other resources will be sufficient to facilitate our
growth. We are striving to increase total network utilization and to optimize
this utilization throughout a 24 hour period. There will be additional demands
on our customer support, sales and marketing resources as we pursue this
utilization strategy. If we fail to manage our growth effectively, our business
and financial results will be seriously adversely affected.
OUR SUCCESS WILL DEPEND ON THE INTEGRATION OF OUR NEW MANAGEMENT PERSONNEL.
We recently hired several of our executives, including our Vice President of
Business Development, our Executive Vice President/Chief Financial Officer and
Vice President of Direct Sales. As a result, our management team has worked
together for only a brief time, and may have a limited understanding of our
specific business. Our ability to effectively execute our strategies will depend
in part upon our ability to integrate these and future managers into our
operations. We also plan to hire additional executive management personnel,
including a Vice President of Marketing, Vice President of Operations and Vice
President of Engineering. If our executives do not integrate effectively, our
business could be materially negatively affected.
OUR SUCCESS WILL DEPEND ON THE CONTINUED PERFORMANCE OF OUR KEY PERSONNEL.
Our success depends in significant part upon the continued services of our
senior management and key technical and sales personnel, currently consisting of
our Executive Vice President and Chief Financial Officer, our Vice President of
Direct Sales, our Vice President of Business Development, our Vice President of
Finance, our Vice President of Channel Sales, Integral's President, our
Directors of Marketing and Systems Engineering and our National Sales Director
and particularly our President and Chief Executive Officer, James Couch. We do
not maintain key man insurance on the life of Mr. Couch or any other executive
officers. Any of our officers or employees can terminate his or her relationship
with us at any time. Only Mr. Couch and Robert Ross, the President of our
subsidiary, Integral Networking Corporation, have employment agreements for
specified terms with us. For more information about Messrs. Ross' and Couch's
employment agreements, see "Management -- Employment Agreements." The loss of
key personnel would materially negatively impact our business and financial
results.
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OUR SUCCESS WILL DEPEND ON ATTRACTING AND RETAINING ADDITIONAL PERSONNEL.
Approximately 60% of our current employees joined CRL within the past 12 months
and our growth strategy necessitates that we more than double the number of our
employees during the next 24 months. Our success depends upon our ability to
attract and retain additional highly qualified management, technical, sales and
marketing and customer support personnel. Locating personnel with the
combination of skills and attributes required to carry out our strategy is often
a lengthy process. Our future growth particularly depends upon our ability to
increase substantially the size of our sales and marketing organization. The
market for highly qualified technical and sales and marketing personnel is
intensely competitive, especially in the San Francisco Bay Area, where a
substantial portion of our operations are located. In the year ended December
31, 1998, we experienced a reduction in our sales force due to a number of
factors including normal attrition and our involvement in negotiations in the
second and third quarters of 1998 relating to potential business combinations
with companies possessing established sales forces. We believe our involvement
in these negotiations caused a higher attrition rate for our sales staff than we
have historically experienced. These negotiations also caused us to postpone our
efforts to hire additional and replace lost sales staff. We may not be
successful in meeting our hiring goals. Our inability to attract additional,
qualified personnel or to retain existing personnel would have a material
adverse effect on our business and financial results.
OUR NETWORK SYSTEM COULD FAIL, AND WE MAY BE UNABLE TO PROVIDE OUR SERVICES.
Network expansion and growth in usage will increase stress upon our network
hardware and traffic management systems. Our network has been designed with
redundant backbone circuits which means that we connect each of our network
switches together through the use of both primary and secondary backbone
circuits. These backbone circuits are generally data circuits purchased from
long distance data carriers. The secondary backbone circuit provides an
alternate method for two switches to reroute data should the primary backbone
circuit between them fail. The secondary backbone circuit permits our network to
respond to an unexpected hardware or software failure without a complete outage.
However, we could experience failures relating to individual network points of
presence or even catastrophic failure of the entire network. Our operations
depend on our ability to protect our network infrastructure against damage from
power loss, telecommunications failures and similar events such as damage from
human error or sabotage, acts of nature, power failures and telecommunications
failures. A significant portion of our computer equipment, including critical
equipment dedicated to our Internet access services and our switches and routers
that serve large areas of the United States, are located at our facilities in
San Francisco, Palo Alto and Los Angeles, California and Vienna, Virginia. Our
network operations center, which manages the entire network, is in San
Francisco, California. At each site, we maintain off-site backups for our
network configurations in case a natural disaster occurs. We do not, however,
have a comprehensive disaster recovery program in place. In the past,
unanticipated problems outside of our control have caused service interruptions.
During a major power outage in the San Francisco Bay Area on December 8, 1998
lasting over six hours, our network continued to operate but prevented some
dial-up customers from logging on to our network and caused an outage in one of
our switches, resulting in a fluctuation in service for a brief period. Also, in
the fourth quarter of 1998, a portion of our network was interrupted for part of
a day as a result of substantial flooding in the state of Texas. A natural
disaster, such as an earthquake, or other unanticipated problem at the network
operations center, at one of our hubs, sites where routers, switches and other
computer equipment that make up the backbone of our network infrastructure are
located, or at a number of our points of presence in the future could cause,
interruptions in our services, including a complete loss of operations. In
addition, our services could be interrupted if our telecommunications providers
fail to provide the data communications capacity in the time frame we require as
a result of a natural disaster or for some other reason. Any damage or failure
that causes interruptions in our operations could have a material adverse effect
on our business and financial results.
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IF OUR NETWORK SYSTEM FAILS, WE COULD BE LIABLE TO OUR CUSTOMERS FOR DAMAGES.
We could incur significant warranty obligations in connection with system
downtime. Our customer contracts for several of our services currently provide a
limited service warranty related to the continuous availability of service on a
24 hour-a-day, seven day-a-week basis, except for scheduled maintenance periods.
This warranty is generally limited to a credit of free service for a specified
limited period of time for disruptions in Internet transmission services. Our
customer contracts provide for our liability for personal injury or equipment
damage in only limited circumstances. Although these customer contracts
typically provide for no recovery with respect to incidental, punitive, indirect
and consequential damages resulting from damages to equipment or disruption of
service, we cannot assure you that we would not be found liable if these damages
occurred or that these damages would be covered by or would not exceed our
liability insurance.
WE FACE THE RISK OF FUNDAMENTAL CHANGES IN THE WAY ELECTRONIC DATA, INCLUDING
INTERNET ACCESS, IS DELIVERED.
Internet services are currently accessed primarily by computers connected by
telephone lines. Several companies have announced the development and sales of
digital subscriber lines, cable television modems, wireless modems and satellite
modems to provide Internet access. We believe that our competitors offering
Internet access using Cable TV can provide access for up to ten megabits per
second, those using satellite, up to two megabits per second and those using
wireless modems, up to 1.544 megabits per second. Our competitors are also
continually developing technology to offer Internet access using alternate
delivery methods at higher speeds. While we are capable of offering similar
speeds through the equipment we currently use, we currently generally do not and
likely will not be able to offer such speeds as cheaply as cable or wireless
modems. For example, wireless modems may reduce the cost of network services as
they are capable of delivering data, including Internet access, without
incurring local loop charges, which are charges by the local telephone companies
for use of their lines. As the Internet becomes more accessible through these
cable television, wireless and satellite modems and by screen based telephones,
televisions or other consumer electronic devices, or customer requirements
change the way Internet access is provided, we will have to develop new
technology or modify our existing technology to accommodate these new
developments. We may also have to modify how we deliver our services. Our
pursuit of these technological advances may require substantial time and
expense, and we may not succeed in adapting our Internet access business to
alternate access devices and conduits.
OUR SUCCESS DEPENDS ON THE CONTINUED GROWTH OF THE INTERNET.
Our success will depend in large part on continued growth in Internet use, which
in turn will depend on a variety of factors including security, reliability,
cost, ease of access, quality of service and necessary increases in bandwidth
availability. Many of our existing and proposed services target Internet users.
Increased Internet use for retrieving, sharing and transferring information
among businesses, consumers, suppliers and partners only recently began to
develop. As is typical in the case of a new and rapidly evolving industry
characterized by rapidly changing technology, evolving industry standards and
frequent new product and service introductions, demand and market acceptance for
recently introduced products and services is highly uncertain. In addition,
critical issues concerning the commercial use of the Internet remain unresolved
and may impact the growth of Internet use, especially in the business market we
target. Despite growing interest in commercial Internet uses, many businesses
have not purchased Internet access and other related services for a number of
reasons, including:
- inconsistent quality of service
- lack of availability of cost effective, high speed options
- a limited number of points of presence for corporate users
- inability to integrate business applications on the Internet
- the need to use multiple and frequently incompatible vendors
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- inadequate protection of the confidentiality of stored data and information
moving across the Internet
- a lack of tools to simplify Internet access and use
- increased risk that third parties may obtain unauthorized access to
confidential information
- concerns arising from the year 2000 problem
Individuals and enterprises historically relying upon alternative means of
commerce and communication must understand and accept a new way of conducting
business and exchanging information to adopt the Internet for their means of
commerce and communication. Enterprises with substantial resources invested in
other means of commerce and exchanging information may be particularly reluctant
or slow to adopt a new strategy that may make their existing personnel and
infrastructure obsolete.
OUR SUCCESS DEPENDS ON THE CONTINUED ACCEPTANCE OF THE INTERNET AS A VIABLE
COMMERCIAL MEDIUM.
Demand for and market acceptance of the Internet are highly uncertain and depend
on a number of factors, including growth in consumer access to and acceptance of
new interactive technologies, the development of technologies facilitating
interactive communication between organizations and targeted audiences, and
increases in user bandwidth. If the Internet as a commercial or business medium
fails to develop or develops more slowly than expected, our business would be
materially adversely affected. The recent growth in Internet use has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
Internet's infrastructure by Internet service providers, operators of
interexchange points and other organizations with links to the Internet. Any
perceived degradation in the Internet's performance could undermine the benefits
of our services. Potentially increased performance provided by our services and
others is ultimately limited by and reliant upon the speed and reliability of
the networks operated by third parties. Consequently, the emergence and growth
of the market for our services depends on improvements being made to the entire
Internet infrastructure to alleviate overloading and congestion.
WE MUST KEEP UP WITH RAPID TECHNOLOGICAL CHANGE AND EVOLVING INDUSTRY STANDARDS
TO COMPETE EFFECTIVELY IN OUR MARKETS.
The markets for our services are characterized by rapidly changing technology,
evolving industry standards, changes in customer needs, rapidly growing
competition and frequent new product and service introductions. Our future
success will depend, in part, on our ability to:
- effectively use and offer leading technologies
- continue to develop our technical expertise
- enhance our current networking services
- develop new products and services that meet changing customer needs
- advertise and market our services
- influence and respond to emerging industry standards and other technological
changes
We must accomplish these tasks in a timely and cost effective manner. New
technologies or industry standards may replace or provide lower cost
alternatives to our existing products and services or could render our existing
products and services obsolete and unmarketable. We also believe that our
ability to compete successfully depends on the continued compatibility and
interoperability of our services with products and architectures offered by
other vendors. Although we intend to support emerging standards in the market
for Internet and other network connectivity, new industry standards could
emerge, and we may not be able to conform to these new standards in a timely
fashion and maintain a competitive position in the market. Our pursuit of
necessary technological advances and maintenance of technological compatibility
may require substantial time and expense.
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WE MAY HAVE PROBLEMS MAINTAINING HIGH QUALITY STANDARDS.
Market acceptance of new or enhanced services could be significantly delayed or
hindered if we introduce services with reliability or compatibility problems.
Despite testing by us or our customers, our services or enhancements may contain
undetected errors or defects when first introduced after commencement of
commercial deployment. Any problems or delays could adversely affect our ability
to attract or retain customers.
In the past we have experienced shortages in bandwidth capacity, both at the
level of particular points of presence affecting only those customers using that
particular point of presence and with system-wide services such as e-mail and
news group services. In early 1999, we neared full capacity for our connections
with MAE West. The primary carriers from whom we purchased bandwidth also filled
capacity at MAE West. As a result, we were required to wait approximately 60
days while our providers acquired additional capacity, which limited our ability
to add more customers on those connections. A similar shortage in bandwidth
occurred at MAE East in 1998 and, as a result, we lost one customer. If we do
not maintain sufficient bandwidth capacity in our network connections, or
insufficient bandwidth is maintained on the networks operated by our peering
partners, our customers will experience a general slowdown of all Internet
services. To protect our customers' service levels, we may sometimes temporarily
delay adding new customers in cities or regions experiencing significant
capacity constraints until we alleviate these constraints. While our objective
is to maintain excess capacity, our failure to expand or enhance our network
infrastructure on a timely basis or to adapt it to an expanding customer base,
changing customer requirements or evolving industry standards could seriously
adversely affect us.
If we do not achieve balanced network utilization over a 24 hour period, our
network could become overburdened at busy periods during the day, which could
diminish our quality of service by increased delay or system failure.
Conversely, due to the high fixed cost nature of our infrastructure, under-
utilization of our network during low use times could hinder our ability to
provide cost efficient services at other times. Any failure to achieve balanced
network utilization could harm our business, financial condition and results of
operations.
WE MAY FACE POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR
NETWORK.
As the law relating to liability of Internet service providers for information
carried on or disseminated through their networks is not settled, we may be
subject to such liability. A number of lawsuits have sought to impose liability
for defamatory speech, indecent materials and infringement of copyrighted
materials. The United States Supreme Court has let stand a lower court ruling
that an Internet service provider was protected from liability for material
posted on its system by a provision of the Communications Decency Act. However,
the findings in that case may not apply in other circumstances. Other courts
have held that online service providers and Internet service providers may be
subject to damages for copying or distributing copyrighted materials. Provisions
of the Communications Decency Act that imposed criminal penalties for using an
interactive computer service for transmitting obscene or indecent communications
have been found unconstitutional by the United States Supreme Court. However, on
October 21, 1998, new federal legislation was enacted that requires limits on
access to pornography and other material deemed "harmful to minors." This
legislation has been challenged in court as a violation of the First Amendment
of the United States Constitution. We are unable to predict the outcome of this
case. Potential liability imposed on Internet service providers like us for
material carried on or disseminated through network systems could require us to
implement measures to reduce our exposure to that liability. These measures may
require us to spend substantial resources or discontinue certain service
offerings. Our errors and omissions insurance coverage may not be adequate or
available to compensate us for all liability that may be imposed. The imposition
of liability in excess of, or the unavailability in the future of, such coverage
could have a material adverse effect on our business or financial results.
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WE MAY BECOME SUBJECT TO BURDENSOME AND EXPENSIVE GOVERNMENT REGULATION THAT MAY
HARM OUR BUSINESS.
Consistent with our growth and acquisition strategy, we are now engaged in, or
will soon be engaged in, activities that subject us to varying degrees of
federal, state and local regulation. Currently only a small body of laws and
regulations directly apply to access to or commerce on the Internet. However,
due to the Internet's increasing popularity and use, laws and regulations have
or may be proposed and may be adopted at the international, federal, state and
local levels with respect to the Internet, covering a range of issues. The
nature of any new laws and regulations and the manner in which existing and new
laws and regulations may be interpreted and enforced cannot be fully determined.
The adoption of any future laws might decrease the Internet's growth, decrease
demand for our services, impose taxes or other costly technical requirements or
otherwise increase the cost of doing business or in some other manner have a
material adverse effect on us. In addition, applicability to the Internet of
existing laws governing issues such as property ownership, copyrights and other
intellectual property issues, taxation, libel, obscenity and personal privacy is
uncertain. The application of any of these laws or regulations to our business
could increase our costs of compliance or otherwise affect our ability to
operate in those jurisdictions. In addition, as our services are available over
the Internet in multiple states, and as we facilitate sales by our customers to
end users located in such states, such jurisdictions may claim that we are
required to qualify to do business as a foreign corporation in each such state,
which may subject us to new taxes and costs.
Both the provisioning of Internet access service and the provisioning of
underlying telecommunications services are affected by federal, state and local
regulation. In March 1998, the California Public Utilities Commission approved
our operation as a competitive local exchange carrier in that state.
Subsequently, we negotiated an Interconnection Agreement with Pacific Bell, the
incumbent local exchange carrier in California, which was approved by the
California Public Utilities Commission in December 1998. The agreement provides
for reciprocal compensation payments for the termination of local traffic by
either party onto the other's network. While we believe that Pacific Bell will
send more traffic to our network than we will send to theirs, we cannot assure
you that this will continue, or that Pacific Bell will pay the amounts we
believe are required under the agreement. In the past, Pacific Bell has taken
the position that Internet traffic is considered inherently long distance and
not subject to reciprocal compensation. We do not believe any amounts that we
might receive as reciprocal compensation are material to our business, but we do
intend to defend our position regarding our rights to receive fair compensation
under the agreement. On February 25, 1999, the Federal Communications Commission
ruled that calls to Internet service providers for Internet access were long
distance, not local, calls. However, the ruling upheld existing reciprocal
compensation agreements in some states, including California. Because of our
reciprocal compensation agreement with Pacific Bell, we do not expect this
ruling will have a material effect on our costs in the near future. If incumbent
local exchange carriers charge fees for carrying Internet traffic and Internet
access becomes more expensive in the longer term, this ruling may have an
adverse effect on our potential future revenues as well as increase our costs.
We intend to apply for competitive local exchange carrier status in other
states. As we become a competitive local exchange carrier in additional states,
we will become subject to state requirements applicable to such carriers.
New laws or regulations relating to Internet or network services, or existing
laws found to apply to them, could have a material adverse effect on our
business or financial results. For a detailed discussion of government
regulation impacting our business, see "Business -- Government Regulation."
WE FACE RISKS ASSOCIATED WITH BECOMING YEAR 2000 COMPLIANT.
The year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. As a result, date
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. In addition, the year 2000 is a leap year, and some computer
programs may not properly provide for February 29, 2000. System failures and
miscalculations causing disruptions of normal business activities may occur. We
are currently in the process of reviewing our
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services, as well as our internal management information systems, in order to
identify and modify those services and systems that are not year 2000 compliant.
We do not have and are not developing a contingency plan in the event our
systems fail due to year 2000 related problems. For a detailed discussion of our
year 2000 readiness review, see "Management's Discussion and Analysis of Results
of Operations and Financial Condition -- Year 2000 Compliance Disclosure."
Based on our assessment to date, we believe that our internally developed
systems are year 2000 compliant. However, we utilize software and hardware
developed by third parties both for our network and internal information
systems. Additionally, we are continuing to assess the year 2000 compliance of
our services and systems.
Our services and systems operate in complex network environments and directly
and indirectly interact with a number of other hardware and software systems. We
face risks to the extent that suppliers of products, services and systems
purchased by us and others with whom we transact business, including those which
form significant portions of our network and may be sole or limited source
suppliers, do not have business systems or products that comply with year 2000
requirements. If these networks fail, our business will be significantly
impacted.
We do not currently have any information regarding the year 2000 status of our
customers, many of whom are private companies. As is the case with similarly
situated companies, if our customers experience Year 2000 problems, which result
in business interruptions or otherwise impact their operations, we could
experience a decrease in the demand for our services, which could have a
material adverse impact on our business, results of operations and financial
condition.
Our expectation that we will be able to upgrade our services and systems to
address the year 2000 issue and our expectation regarding the costs associated
with these upgrades are forward-looking statements subject to a number of risks
and uncertainties. Actual results may vary materially as a result of a number of
factors. We cannot assure you that we will be able to timely and successfully
modify our services and systems to comply with year 2000 requirements. Any
failure to do so could have a material adverse effect on our business, results
of operations and financial condition. Furthermore, despite testing by us and
our vendors, our services and systems may contain undetected errors or defects
in the technology associated with year 2000 date functions. In the event any
material errors or defects are not detected and fixed or third parties cannot
timely provide us with products, services or systems that meet the year 2000
requirements, on our business, results of operations and financial condition
could be materially adversely affected. Known or unknown errors or defects that
affect the operation of our services or systems could result in delay or loss of
revenues, interruption of network services, cancellation of customer contracts,
diversion of development resources, damage to our reputation, damages paid to
customers and litigation costs.
WE ARE SUBJECT TO THE RISKS FROM OUR LENGTHY SALES CYCLE.
Our customers and potential customers often take a long time to evaluate our
services. We spend a lot of time educating and providing information to our
prospective customers regarding the benefits of the Internet and our services.
Changes in the growth rate in our customer base, customer renewal rates and the
sales cycle for our services have caused, and are expected in the future to
cause, significant fluctuations in our results of operations from period to
period. In addition, we intend to significantly increase our sales and marketing
expenditures. Due to the lengthy sales cycle for our services, these expenses
will occur prior to customer commitments for our services. As a result, the
increase in our sales and marketing efforts may not result in increased sales of
our services.
OUR NETWORK IS SUBJECT TO SECURITY RISKS.
Our business depends upon the security of our network and, in part, on the
security of the network infrastructures of our third-party providers, which we
do not control. Despite implementing network security measures, the core of our
network infrastructure and our network providers' infrastructures are vulnerable
to denial of service attacks, computer viruses, break-ins and similar disruptive
problems such as the sending of excessive volumes of unsolicited bulk e-mail,
commonly referred to as spamming, caused by
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our customers or other Internet or network users. In the past, spamming has
caused our mail server to overload which caused us to delay sending our
customers' e-mail until the offending spam was deleted. Denial of service
attacks, computer viruses, break-ins or other problems caused by third parties
could lead to interruptions, delays or cessation in service to our customers,
which could cause losses to us or our customers or deter businesses from
subscribing to our services. Also, the inappropriate network uses by third
parties described above could jeopardize the security of confidential
information stored in our customers' computer systems and cause commercial
transactions to be delayed, not completed or completed with compromised
security.
We may face liability and may lose existing or potential customers as a result.
Although we intend to continue to implement industry-standard security measures,
these measures occasionally have been circumvented in the past, and others may
be able to circumvent our security measures or the security measures of our
third-party network providers in the future. Eliminating computer viruses and
alleviating other security problems may require significant expenditures,
distractions to management, and interruptions, delays or cessation of service to
our customers, all of which could harm us. Further, until more comprehensive
security technologies are developed, the security and privacy concerns of
existing and potential customers may inhibit Internet service industry growth in
general and our customer base and revenues in particular.
WE MAY REQUIRE SUBSTANTIAL FUTURE CAPITAL TO IMPLEMENT OUR BUSINESS PLAN.
We anticipate that our available cash resources, combined with the net proceeds
from this offering, will be sufficient to meet our anticipated working capital
and capital expenditure requirements for the foreseeable future. However, these
resources may not be sufficient for unanticipated working capital and capital
expenditure requirements. We may need to raise additional funds through public
or private debt or equity financings to take advantage of unanticipated
opportunities, including more rapid expansion or acquisitions of complementary
businesses or technologies or to develop new products or services. Any
additional financing we may need may not be available on terms favorable to us,
or at all.
WE DEPEND ON THIRD PARTIES TO SUPPLY US WITH HARDWARE.
We depend on a number of third-party equipment suppliers. We purchase the
components we use to provide our networking services from third parties,
including wide area data switches supplied by Ascend Communications, Inc. and
high performance routers from Cisco Systems, Inc. The expansion of our network
infrastructure and network services places a significant demand on our
suppliers, some of which have limited resources and production capacity. We have
experienced delayed delivery from suppliers of new communications lines,
switches, routers, terminal servers and other equipment. If our suppliers cannot
adjust to meet increasing demand, the higher demand levels may prevent them from
continuing to supply components and products in the quantities, at the quality
levels and at the times we require, or at all. If we are unable to develop
alternative sources of supply, we could experience delays and increased costs in
expanding our network infrastructure.
WE DEPEND ON OUR PROPRIETARY TECHNOLOGY AND TECHNOLOGICAL EXPERTISE.
We believe our success depends more upon our technical expertise than our
proprietary rights. We rely upon a combination of copyright, trademark and trade
secret laws and contractual restrictions to protect our proprietary technology
and rights in our services. We have no patented technology that would preclude
or inhibit competitors from entering our market. We have entered into
confidentiality and invention assignment agreements with all of our Integral
Networking Corporation employees and our technical personnel at CRL, and
nondisclosure agreements with some of our major suppliers, distributors and
appropriate customers to control access to and disclosure of our proprietary
information. Despite these precautions, a third-party could potentially copy or
otherwise obtain and use our technology without authorization or to develop
similar technology independently. We cannot assure you that such measures have
been, or will be, adequate to protect our proprietary technology or deter
third-party development of similar technologies. We also rely on technologies
that we license from third parties such as network
18
<PAGE> 23
management software. We do not license any other technology that is not
generally available. These third-party technology licenses may not always
continue to be available to us on commercially reasonable terms. The loss of
such technology could require us to obtain substitute technology of lower
quality or performance standards or at greater cost, which could affect us in a
material adverse manner. To date, we have not been notified that we infringe the
proprietary rights of third parties, but there can be no assurance that third
parties will not claim infringement by us. We expect that participants in our
markets will be increasingly subject to infringement claims as the number of
technologies and competitors in our industry grows. Any such claim, whether
meritorious or not, could be time consuming, result in costly litigation, cause
service delays or require us to enter into royalty or licensing agreements. Such
royalty or licensing agreements might not be available on terms acceptable to us
or at all. As a result, any such claim could have a material adverse effect upon
our business, results of operations and financial condition.
THE INTERESTS OF OUR CONTROLLING STOCKHOLDER, JAMES COUCH, MAY CONFLICT WITH OUR
AND YOUR INTERESTS.
After completion of this offering, James Couch will own approximately 74.9% of
our outstanding common stock, 71.8% if the underwriters' over-allotment option
is exercised in full and sold by Mr. Couch, and will continue to be our
President and Chief Executive Officer and Chairman of our Board of Directors. As
a result of his stock ownership and board representation, Mr. Couch will be in a
position to affect corporate actions that could conflict with your interests and
ours. Mr. Couch will have the ability to control all matters submitted to our
stockholders for approval, including the election and removal of directors and
any merger, consolidation or sale of all or substantially all of our assets, and
to control our management and affairs. This ownership concentration may delay,
defer or prevent a change in corporate control, may impede a merger,
consolidation, takeover or other business combination involving us, or
discourage a potential acquirer from making a tender offer or otherwise
attempting to obtain control of us. These circumstances could cause the price of
our common stock to decline. See "Management" and "Principal Stockholders."
MANAGEMENT MAY APPLY THE PROCEEDS OF THIS OFFERING TO USES THAT DO NOT INCREASE
OUR PROFITS OR MARKET VALUE.
Our management will have considerable discretion in the application of the net
proceeds, and you will not have the opportunity, as part of your investment
decision, to assess whether the proceeds are being used appropriately. The net
proceeds may be used for corporate purposes that do not increase our
profitability or our market value. Pending application of the proceeds, they may
be placed in investments that do not produce income or that lose value.
ANTITAKEOVER PROVISIONS COULD NEGATIVELY IMPACT OUR STOCKHOLDERS.
Provisions of our certificate of incorporation, bylaws and the Delaware General
Corporation Law could make it more difficult for a third party to acquire us,
even if a change of ownership would benefit our stockholders. Specifically, our
charter documents:
- - limit the ability to call a special meeting of our stockholders to our Board
of Directors, the chairman of our Board and our president
- - prohibit any action to be taken by stockholders without a meeting
- - require advanced notice to be given for any business or director nominee
brought forward at any stockholder meeting by any of our stockholders
- - require cause and 80% stockholder approval to remove a director
- - provide that our Board of Directors will be divided into three classes of
directors, who will serve for staggered three-year terms.
In addition, Section 203 of the Delaware General Corporation Law generally
prohibits a 15% stockholder from engaging in any business combination with us,
including a merger or a sale of more than 10% of our
19
<PAGE> 24
assets, unless our Board of Directors approves the transaction. For more
information see "Description of Capital Stock."
WE MAY EXPERIENCE SUBSTANTIAL SALES OF OUR COMMON STOCK AFTER THE OFFERING.
Sales of a substantial number of shares of common stock after the offering could
cause the market price of our common stock to decline and could impair our
ability to raise capital through the sale of additional equity securities. Upon
completion of this offering, we will have 24,038,832 shares of common stock
outstanding and 946,320 shares subject to currently outstanding options
exercisable at different times and 24,916,332 shares outstanding if we issue
shares upon exercise of the underwriters over-allotment option. The 5,000,000
shares sold in the offering, or 5,750,000 shares if the underwriters
over-allotment option is fully exercised, will be freely tradable without
restriction or further registration under the federal securities laws unless
purchased by our "affiliates" as that term is defined in Rule 144 under the
Securities Act. The remaining 19,038,832 shares of common stock outstanding on
completion of the offering will be "restricted securities" as that term is
defined in Rule 144.
Our stockholders and stock option holders are generally limited by lock-up
agreements restricting their ability to sell their CRL common stock. These
securityholders cannot sell or otherwise dispose of any shares of our common
stock for a period of at least 180 days after the date of this prospectus
without the prior written consent of CIBC World Markets Corp. When the lock-up
agreements expire, the shares and the shares underlying the options will be
eligible for sale, in some cases only by complying with the volume, manner and
sale notice requirements of Rule 144.
On April 27, 1999, our principal stockholder, James Couch, sold 542,888 shares
of CRL common stock to ZeroDotNet, Inc. at a price equal to $9.21 per share in a
private transaction. Mr. Thor Geir Ramleth, who has agreed to serve as a
director of CRL upon completion of this offering, is the Chief Executive Officer
and a director of ZeroDotNet, Inc. In connection with this sale, CRL granted
registration rights to the buyer, including the right to demand one registration
for at least 50% of the purchased shares at any time during the period beginning
120 days after CRL's initial public offering through the second anniversary of
CRL's initial public offering. The registration rights terminate if all the
purchased shares could be sold in one transaction under Rule 144 without
exceeding the volume limitations of that rule. In addition, if we propose to
register any of our shares of common stock under the Securities Act, the buyer
is entitled to notice of and may include the purchased shares in the
registration. If the registration involves an underwriting, the underwriters may
eliminate shares in the registration and underwriting, and the shares included
in the registration must be allocated first to CRL, then to the buyer. CRL
agreed to provide the registration rights described above in exchange for the
buyer agreeing to enter into the lock-up agreement for a period of 180 days
after the date of this prospectus. The buyer must obtain a waiver of the lock-up
agreement to exercise the registration rights described above during the 180 day
period of the lock-up.
WE EXPECT THE PRICE OF OUR COMMON STOCK TO BE VOLATILE.
The market price of our shares of common stock is likely to be highly volatile
and could be subject to wide fluctuations in response to factors such as, among
others:
- actual or anticipated variations in our results of operations
- announcements of technological innovations
- new services introduced by us or our competitors
- changes in financial estimates by security analysts, conditions and trends
in the Internet and computer industries
- fluctuations in the valuation of companies perceived by investors to be
comparable to us
- any shortfall in reserve or net income or any increase in losses from levels
expected by securities analysts
- general market conditions
20
<PAGE> 25
Furthermore, the stock markets, and in particular Nasdaq, have experienced
extreme price and volume fluctuations that have affected and continue to affect
the market prices of equity securities of many technology companies. These
fluctuations often have been unrelated or disproportionate to the operating
performance of those companies. The trading prices of many technology companies'
stocks are at or near historical highs and reflect price to earnings ratios well
above historical levels. These trading prices and price to earnings ratios may
not be sustained. These broad market factors may cause the market price of our
common stock to decline. These market fluctuations, as well as general economic,
political and market conditions such as political and military conflict,
recessions, interest rate changes or international currency fluctuations, may
negatively impact the market price of our common stock. In the past, following
periods of volatility in the market price of a company's securities, class
action litigation has often been brought against such companies. We may in the
future be the target of similar litigation. Securities litigation could result
in substantial costs and distract management's attention and resources, which
would likely have a material adverse effect on us.
NEW INVESTORS WILL SUFFER IMMEDIATE SUBSTANTIAL DILUTION.
This offering is expected to create a public market for our common stock and
will substantially increase the market value of the initial investments of our
management and other existing stockholders, particularly James Couch, our
President and Chief Executive Officer. As of June 16, 1999, our existing
stockholders held 19,038,832 shares of our common stock. Based on an assumed
initial public offering price of $9.50 per share, the value of the shares held
by the existing stockholders following this offering would be approximately
$180.9 million, representing an aggregate increase of approximately $180.8
million over the amount of consideration paid for those shares by the existing
stockholders. In addition, the initial public offering price is substantially
higher than the book value per share of our outstanding common stock. As a
result, investors purchasing common stock in this offering will incur immediate
and substantial dilution of $7.65 per share in the net tangible book value of
the common stock from the initial public offering price. We also have issued
options to acquire common stock at prices significantly below the initial public
offering price. As these outstanding options are exercised, there will be
further dilution. See "Dilution."
YOU SHOULD NOT RELY ON OUR FORWARD-LOOKING STATEMENTS.
Certain statements under the captions "Summary," "Risk Factors," "How We Intend
to Use the Proceeds from the Offering," "Management's Discussions and Analysis
of Financial Condition and Results of Operations" and "Business," and elsewhere
in this prospectus are forward-looking statements. When used in this prospectus,
the words "anticipate," "believe," "estimate," "will," "may," "should," "plan,"
"future," "intend," "expect" and similar expressions identify some of these
forward-looking statements. These statements may discuss future expectations or
contain projections of results of operations or financial condition or expected
benefits to us resulting from possible acquisitions, transactions or
developments. Although we believe that our plans, intentions and expectations
reflected in these forward-looking statements are reasonable, we can give no
assurance that such plans, intentions or expectations will be achieved. Actual
results, performance or achievements could differ materially from those
contemplated, expressed or implied by the forward-looking statements contained
in this prospectus. Important factors that could cause actual results to differ
materially from our forward-looking statements are contained in this prospectus,
including under the heading "Risk Factors."
21
<PAGE> 26
HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING
Our net proceeds from the sale of the 5,000,000 shares of common stock offered
by us are estimated to be approximately $42,835,000, based on an assumed initial
public offering price per share of $9.50, and after deducting estimated
underwriting discounts and commissions and offering expenses payable by us. If
the underwriters exercise the over-allotment option in full, and the
over-allotment shares are sold by us instead of our principal stockholder, our
net proceeds are estimated to be $49,461,000. See "Underwriting." The principal
purposes of this offering are to obtain additional capital, create a public
market for our common stock and facilitate our future access to the public
capital markets.
We intend to use a portion of the net proceeds to repay amounts then outstanding
under our loan agreements with our banks and our capital lease. As of March 31,
1999, approximately $1,088,000 was outstanding under these agreements as
follows:
<TABLE>
<CAPTION>
BALANCE AT INTEREST RATE AT MATURITY
MARCH 31, 1999 MARCH 31, 1999 DATE
-------------- ---------------- --------------
<S> <C> <C> <C>
General Line of Credit........................ $ 46,000 10.25% September 2002
Capital Lease................................. 68,000 12.55% July 2000
Equipment Line of Credit...................... 382,000 9.50% September 2002
Equipment Line of Credit...................... 592,000 9.25% March 2003
</TABLE>
Amounts borrowed under these agreements are secured by substantially all of our
assets. Various portions of these borrowed amounts must be repaid in full
between July 2000 and March 2003. We also expect to use a portion of the net
proceeds for working capital and other general corporate purposes, including
expansion of our sales and marketing activities.
As part of our growth strategy, we intend to aggressively seek suitable
acquisition candidates, such as regional Internet service providers, that have
an existing customer base that we can add to our customer base, and companies
that have products that will enable us to expand the range of our value-added
network and hosting services. We may use a portion of the net proceeds for those
acquisitions. We have no current plans, agreements or commitments with respect
to any acquisitions, and we are not currently engaged in any negotiations with
respect to any acquisitions.
Pending the uses described above, we will invest our net proceeds in high
quality, income-producing securities such as short-term investment grade or
United States Government interest-bearing securities.
DIVIDEND POLICY
We have not paid and do not anticipate paying any cash dividends on our common
stock in the foreseeable future. We intend to retain our earnings, if any, for
use in our growth and ongoing operations.
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<PAGE> 27
CAPITALIZATION
The table below sets forth our capitalization as of March 31, 1999, (i) on an
actual basis and (ii) on an as adjusted basis and to reflect our sale of the
5,000,000 shares of common stock offered by us at an assumed initial public
offering price of $9.50, after deducting the estimated underwriting discounts
and commissions and offering expenses, and the anticipated application of the
net proceeds. See "How We Intend to Use the Proceeds From the Offering." The
capitalization information in the table below is qualified by the more detailed
consolidated financial statements and related notes beginning on page F-1 of
this prospectus. The table should be read in conjunction with those consolidated
financial statements and related notes and the sections of this prospectus
titled "Selected Financial Data" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The number of shares of common stock in the table below for the purposes of
determining stockholders' equity excludes 946,320 shares issuable upon exercise
of currently outstanding options and 2,000,000 shares available for the grant of
additional options under our 1999 Stock Incentive Plan. See "Management -- Stock
Options."
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------
AS
ACTUAL ADJUSTED
------ --------
<S> <C> <C>
Current portion of long-term obligations.................... $ 280 $ --
====== =======
Long-term obligations, less current portion................. $ 822 $ 14
------ -------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized; none issued and outstanding................
Common stock, $.0001 par value; 70,000,000 shares
authorized; 18,978,832 shares outstanding; 23,978,832
shares outstanding as adjusted for this offering....... 6 42,841
Common Stock options........................................ 1,046 1,046
Deferred stock compensation................................. (739) (739)
Retained earnings........................................... 1,211 1,211
------ -------
Total stockholders' equity........................ 1,524 44,359
------ -------
Total capitalization.............................. $2,346 $44,373
====== =======
</TABLE>
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<PAGE> 28
DILUTION
At March 31, 1999, our net tangible book value was approximately $1.5 million,
or $0.08 per share of common stock. Net tangible book value per share represents
the amount of our total tangible assets less total liabilities, divided by the
number of shares of common stock outstanding. Net tangible book value dilution
represents the difference between the amount per share of common stock paid by
new purchasers in this offering and the net tangible book value per share after
this offering. Without taking into account any changes in net tangible book
value after March 31, 1999, other than to give effect to the sale of the
5,000,000 shares of common stock offered by us, assuming an initial public
offering price of $9.50 per share and after deducting the estimated underwriting
discounts and commissions and estimated offering expenses, our adjusted net
tangible book value at March 31, 1999 would have been approximately $44.4
million, or $1.85 per share of common stock. This amount represents an immediate
increase in net tangible book value of $1.77 per share to the existing
stockholders and an immediate net tangible book value dilution of $7.65 per
share to purchasers of common stock in the offering. The following table
illustrates this per share dilution.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $ 9.50
Net tangible book value per share at March 31, 1999....... $0.08
Increase in net tangible book value per share attributable
to new investors....................................... 1.77
Adjusted net tangible book value per share after the
offering.................................................. 1.85
------
Net tangible book value dilution per share to new
investors................................................. $ 7.65
======
</TABLE>
The table below summarizes, as of March 31, 1999, the difference between the
number of shares of common stock purchased from us, the total cash consideration
paid and the average price per share paid by existing stockholders and to be
paid by new investors purchasing shares in this offering assuming the sale of
5,000,000 shares by us at an assumed initial public offering price of $9.50 per
share.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)............. 18,978,832 79.1% $ 6,000 0.01% $0.0003
New investors(1)..................... 5,000,000 20.9 47,500,000 99.99 $ 9.50
---------- ---- ----------- -----
Total...................... 23,978,832 100% $47,506,000 100%
========== ==== =========== =====
</TABLE>
- -------------------------
(1) If the over-allotment option is exercised in full and sold by our principal
stockholder, such over-allotment option exercise will increase the number
of shares held by new investors to 5,750,000 or 24.0% of the total number
of shares of common stock outstanding after the offering.
24
<PAGE> 29
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data should be read with the consolidated
financial statements and related notes beginning on page F-1 of this prospectus
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" beginning on page 26 of this prospectus. The consolidated statement
of operations data for each of the three years in the period ended December 31,
1998 and consolidated balance sheet data as of December 31, 1997 and 1998 are
calculated from financial statements that have been audited by Deloitte & Touche
LLP, independent auditors, and are included elsewhere in this prospectus. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The selected consolidated financial data for the years ended December 31, 1994
and 1995 and for the three months ended March 31, 1998 and 1999 are calculated
from unaudited consolidated financial statements not included in this
prospectus. The unaudited financial statements have been prepared by us on a
basis consistent with our audited consolidated financial statements and include,
in the opinion of our management, all adjustments consisting only of normal
recurring adjustments necessary for a fair presentation of our results of
operations and financial position for those years.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------- -------------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues.................... $ 1,961 $ 3,831 $ 6,353 $10,375 $11,692 $ 2,981 $ 3,003
------- ------- ------- ------- ------- ------- -------
Costs and expenses:
Cost of revenues.......... 965 2,131 3,346 4,640 6,166 1,499 1,798
Selling and marketing..... 93 380 345 522 371 158 41
General and 411
administrative......... 448 1,840 2,997 4,124 847 1,325
Depreciation expense...... 86 225 512 745 909 190 210
Stock-based compensation --
expense................ -- -- -- 156 - 151
Total costs and 1,555
expenses........ 3,184 6,043 8,904 11,726 2,694 3,525
------- ------- ------- ------- ------- ------- -------
Operating income (loss)..... 406 647 310 1,471 (34) 287 (522)
Net interest income (1)
(expense)................. 1 1 5 (30) (1) (22)
------- ------- ------- ------- ------- ------- -------
Income (loss) before income 405
taxes..................... 648 311 1,476 (64) 286 (544)
Income tax provision 157
(benefit)................. 211 150 591 87 83 (157)
------- ------- ------- ------- ------- ------- -------
Net income (loss)........... $ 248 $ 437 $ 161 $ 885 $ (151) $ 203 $ (387)
======= ======= ======= ======= ======= ======= =======
Net income (loss) per common $ 0.01
share basic and diluted... $ 0.02 $ 0.01 $ 0.05 $ (0.01) $ 0.01 $ (0.02)
Weighted average common
shares outstanding:
Basic..................... 18,979 18,979 18,979 18,979 18,979 18,979 18,979
Diluted................... 18,979 18,979 18,979 19,142 18,979 19,283 18,979
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------- MARCH 31,
1994 1995 1996 1997 1998 1999
---- ------ ------ ------ ------ -----------
(IN THOUSANDS)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and equivalents..................... $289 $ 210 $ 235 $1,115 $ 840 $ 354
Working capital.......................... (36) 95 (182) 554 430 229
Total assets............................. 777 1,377 2,339 4,455 4,855 4,522
Long-term obligations, excluding current
portion................................ 0 20 76 402 847 822
Stockholders' equity..................... 284 709 870 1,755 1,760 1,524
</TABLE>
25
<PAGE> 30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion should be read with the consolidated financial
statements and related notes beginning on page F-1 of this prospectus. The
results shown in this prospectus do not necessarily suggest or predict the
results to be expected in any future periods. This discussion contains
forward-looking statements based on current expectations which involve risks and
uncertainties. Actual results and the timing of events may differ significantly
from those projected in these forward-looking statements due to a number of
factors, including those contained in the section entitled "Risk Factors" and
elsewhere in this prospectus.
OVERVIEW
We are a Tier 1 Internet service provider offering customized Internet and
network management solutions to small and medium-sized businesses. We provide
high quality, reliable and scalable Internet and private network connectivity,
value-added network and hosting services designed to meet our customers' needs.
Our operations are based in San Francisco, California. As a Tier 1 Internet
service provider, we have peering relationships at all of the interexchange
points sanctioned by the National Science Foundation, which also constitute all
of the major domestic network access points at which Internet data is exchanged.
We have private peering relationships with other major Internet service
providers. We are also a national backbone provider with our owned and
controlled private switched network with points of presence in 30 major
metropolitan areas. As a result of our Tier 1 status and network, we are able to
provide high speed and reliable access to the Internet, secure private networks
and hosting services. Our hosting services include colocation services which
allow customers to place their computer equipment inside our facilities for
direct connection to the Internet. Also, our network serves as the platform by
which we are able to deliver value-added services, such as remote management
services, systems and network integration services and network security
services, to our customer base. Historically, we have provided our services to a
variety of customers including businesses of various sizes, other Internet
service providers, government agencies and educational institutions. We intend
to expand our direct and indirect sales force to increase our customer base. We
also intend to cross sell our value-added service offerings to both existing and
future customers in order to provide comprehensive service offerings. We view
being a comprehensive service provider as a key element to our strategy to
increase revenues and reduce customer loss.
Our customers outsource the management of their Internet and network needs to
us. We develop and construct our data switched networks and perform all data
routing and transmission for our customers. Due to the nature of the
telecommunications infrastructure and the fragmented nature of the
telecommunications industry, we lease fiber-optic capacity from third-party
providers over which we transmit data and peer with other telecommunications
providers to exchange data traffic.
In December 1998, we acquired Integral Networking Corporation in a merger
accounted for as a pooling of interests. Integral has a ten-year operating
history in the area of systems integration. Over the past three years, Integral
has developed a proprietary process to manage customer networks from the server
to the desktop while remaining off-site. We are able to capitalize on our
existing network to provide cost effective remote management services to our
customers from a single location operated by CRL. With our remote management
service, customers are able to outsource a portion or all of their information
technology departments as well as add functionality and applications to their
networks. We intend to offer remote management services on a nationwide basis.
Prior to the merger with Integral, we had little experience in, and derived
insignificant revenues from, remote management services and systems integration.
Revenues. We derive our revenues from four principal services:
- Internet and secure private network connectivity
- remote management
26
<PAGE> 31
- hosting services
- systems integration and hardware sales
Revenues from Internet and private network connectivity are typically derived
from monthly fixed prices paid by customers based upon access speed. We offer
dedicated connectivity in a range of access speeds, including fractional T1
(from 64 kilobits per second up to 1.536 megabits per second), T1 (1.536
megabits per second), T3 (45 megabits per second) and OC3 (155 megabits per
second) as well as dial-up access and transit services. We also offer our
customers the ability to upgrade access speeds as their needs increase. We
recently began offering digital subscriber line services but have generated no
revenues from these services. We currently generate Internet and private network
connectivity revenues from a wide range of customers including Internet service
and content providers, businesses, government agencies and educational
institutions. We intend to increase our sales and marketing focus, particularly
on small and medium-sized businesses.
Revenues from our remote management services are typically derived from monthly
fees for a fixed level of service. Pricing for our remote management services is
based on the number of users and a fixed maximum number of calls per month. Our
remote management services are focused on small and medium-sized businesses.
Historically, revenues from value-added services have represented an
insignificant portion of our total revenues and have not been reported
separately in our financial results. With our acquisition of Integral
Networking, we intend to increase our focus on our value-added services, as
evidenced by our recent rollout of remote management services.
Revenues from hosting services are typically derived from renting space to our
customers in which they place their file servers and equipment within our
facilities. The rental fee is based on the size of the space and access speeds.
Our customers can select from a variety of options in terms of access speeds and
space such as rack, half-rack or shelf. Access speeds include switched or
dedicated ethernet service (10 megabits per second), switched or dedicated fast
ethernet service (100 megabits per second) and gigabit fast ethernet services
(1,000 megabits per second). Our customers can purchase additional space and
increase their access speeds as needed. Our current facilities are sufficient to
permit our customers to purchase additional space. However, we will be required
to expand our facilities if future customer demand exceeds our existing
capacity.
Revenues from systems integration services are derived from hardware sales and
consulting fees. Our systems integration services including hardware sales are
currently provided primarily in California. Prior to our merger with Integral
Networking we derived insignificant revenues from hardware sales to customers,
and no revenues from systems integration services.
Cost of Revenues. Cost of revenues from Internet and private network
connectivity consists primarily of backbone costs and monthly access charges by
local exchange carriers to connect our customers to our network and colocation
costs. Backbone costs include all leased fiber-optic capacity to interconnect
our points of presence and to connect to public and private peering points. We
lease our fiber-optic capacity typically under short-term leases and are billed
monthly by our bandwidth providers. Colocation costs consist of monthly fees for
leasing space in facilities in which we colocate with other telecommunications
providers.
Cost of revenues from remote management services consists primarily of personnel
costs to provide customer support and network monitoring services. We believe
our cost of revenues from remote management services and other value-added
services as a percentage of revenues may decline as we increasingly provide
remote management services and other value-added services to existing customers
over the existing connection we provide to the customer.
Cost of revenues from hosting services consists primarily of rent expenses for
colocation space.
Cost of revenues from systems integration services consists primarily of the
cost of hardware purchased.
Selling and Marketing Expense. Selling and marketing expense consists primarily
of sales commissions, travel and entertainment and sales and marketing programs.
We intend to expand our investment in our
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sales and marketing personnel to achieve and properly support the intended
expansion in our customer base.
General and Administrative Expense. General and administrative expense consists
primarily of personnel expense, occupancy, general operating costs, professional
fee expenses and bad debt. We expect general and administrative expense to
increase in dollar amount in the future, reflecting anticipated growth in our
operations and the costs associated with being a publicly held company.
Stock-Based Compensation Expense. In connection with the grant of stock options
to employees in 1999 and 1998, we recorded an aggregate deferred compensation
expense of approximately $1,046,000, representing the difference between the
estimated fair market value of the common stock and the option exercise price at
the date of grant. This amount is presented as a reduction of stockholder's
equity and is amortized over the vesting period of the applicable options. These
valuations resulted in charges to operations of $156,000 in the year ended
December 31, 1998, and $151,000 for the three months ended March 31, 1999, and
will result in charges of the remaining $739,000 over the next five years.
Depreciation. Depreciation expense consists primarily of depreciation of
computer equipment, office furniture and leasehold improvements. On January 1,
1998, we changed the estimated useful lives for our switches and routers from
three to five year lives as a result of our determination, based on historical
experience, that the vast majority of assets in this class have service lives of
approximately five years.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data for the years
indicated as a percentage of revenues. This information should be read in
conjunction with the financial statements and notes included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------- --------------
1996 1997 1998 1998 1999
------ ------ ------ ----- -----
<S> <C> <C> <C> <C> <C>
Revenues................................... 100.0% 100.0% 100.0% 100.0% 100.0%
----- ----- ----- ----- -----
Costs and expenses:
Costs of revenues........................ 52.7 44.7 52.7 50.3 59.9
Selling and marketing.................... 5.4 5.0 3.2 5.3 1.4
General and administrative............... 29.0 28.9 35.3 28.4 44.1
Depreciation............................. 8.1 7.2 7.8 6.4 7.0
Stock-based compensation expense......... -- -- 1.3 -- 5.0
----- ----- ----- ----- -----
Total costs and expenses......... 95.1 85.8 100.3 90.4 117.4
----- ----- ----- ----- -----
Operating income (loss).................... 4.9 14.2 (0.3) 9.6 (17.4)
Net interest (expense)..................... -- -- (0.3) -- (0.7)
Income tax provision (benefit)............. 2.4 5.7 0.7 2.8 (5.2)
----- ----- ----- ----- -----
Net income (loss).......................... 2.5% 8.5% (1.3)% 6.8% (12.9)%
===== ===== ===== ===== =====
</TABLE>
COMPARISON OF QUARTERS ENDED MARCH 31, 1999 TO MARCH 31, 1998
Revenues
Our revenues increased 0.7% to $3.00 million in the quarter ended March 31,
1999, compared to $2.98 million in the quarter ended March 31, 1998. Increased
revenues resulting from two major systems integration sales were offset by a
12.6% reduction in colocation and Internet connectivity revenues.
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Cost of Revenues
Our cost of revenues increased 20% to $1.8 million in the quarter ended March
31, 1999, compared with $1.5 million in the quarter ended March 31, 1998. This
increase was primarily the result of the increased volume of computer equipment
sold in connection with the increased systems integration sales recognized.
Selling and Marketing
Our sales and marketing expenses decreased 74.1% to $41,000 in the quarter ended
March 31, 1999, compared to $158,000 in the quarter ended March 31, 1998. This
decrease is attributable primarily to sales commissions and costs associated
with a 1998 trade show that were not incurred in the 1999 period.
General and Administrative
General and administrative expenses increased 56.4% to $1.3 million for the
quarter ended March 31, 1999, compared to $847,000 for the quarter ended March
31, 1998. The increase was primarily due to an increase in personnel expense of
$280,000, facilities cost increase of $65,000, and an increase in outside
services and professional fees of $60,000.
Depreciation
Our depreciation expense increased 10.5% to $210,000 in the quarter ended March
31, 1999, compared to $190,000 in the quarter ended March 31, 1998. The increase
is due primarily to the buildout of our new network operations center in 1998.
Stock-Based Compensation
Stock-based compensation of $151,000 was amortized during the quarter ended
March 31, 1999.
Net Interest Income (Expense)
We incurred net interest expense of $22,000 in the quarter ended March 31, 1999,
compared to $1,000 in the quarter ended March 31, 1998. This change was a result
of increased borrowing for network equipment under our lines of credit that was
used to purchase network equipment.
COMPARISON OF YEARS ENDED 1998 TO 1997
Revenues
Our revenues increased 12.7% to $11.7 million in 1998, compared to $10.4 million
in 1997. This growth in revenues resulted from an 11% increase in sales of
dedicated Internet connectivity and hosting services, a tenfold increase in
revenues derived from private network connectivity services and a 34% increase
in sales generated by systems integration services. Dedicated Internet
connectivity service is service provided over a circuit which is available 24
hours-a-day, seven days-a-week for the sole purpose of delivering the Internet
connectivity. Approximately 74% of our 1998 revenues was generated from our
Internet and network connectivity services, approximately 16% from value-added
services and approximately 7% from hosting services. Our revenue increase for
the year ended December 31, 1997 to the year ended December 31, 1998 was less
than we have experienced in previous years, due in part to a reduction in our
sales force. This reduction was due in part to our involvement in negotiations
during 1998 relating to potential business combinations with companies
possessing established sales forces. Offsetting these increases were reductions
in revenues of $545,000 realized from dial-up customers and reduced fees for
installation services. This decrease resulted from our increased focus on
providing dedicated Internet and higher value services to business and
government customers.
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Cost of Revenues
Our cost of revenues increased 32.9% to $6.2 million in 1998, compared with $4.6
million in 1997. Of this increase, $1.2 million was primarily due to increased
one time connectivity charges arising from the expansion of our network and
installation charges of $139,000. The expansion resulted in incremental unused
capacity. In addition, we had increased costs of $286,000 arising from hardwares
sales with our systems integration services.
Selling and Marketing
Our selling and marketing expenses decreased 28.9% to $371,000 in 1998, compared
to $522,000 in 1997. This decrease is attributable primarily to reduced
commissions expense. Commissions in 1998 were based upon total contract value
equalling the term of the contract multiplied by monthly service fees. The
decrease in commissions expense in 1998 results from fewer sales of longer-term
versus shorter-term contracts than in 1997 and increased purchases by our
existing customer base of increased access speeds and additional space rather
than increases in the number of new customers. The decrease in longer-term
contracts is due to a general industry decrease in the prices for the services
we provide, making customers reluctant to sign longer-term contracts. The
increase in shorter-term contracts does not materially impact the conduct of our
business. We also experienced a reduction in our sales force in 1998 due to a
number of factors including normal attrition and our being involved in
negotiations in the second and third quarters of 1998, relating to potential
business combinations with companies with existing sales forces. We believe our
involvement in these negotiations caused a higher attrition rate for our sales
staff than we have historically experienced. These negotiations, none of which
led to a business combination, also caused us to postpone our efforts to hire
additional and replace lost sales staff.
General and Administrative
General and administrative expenses increased 37.6% to $4.1 million for 1998,
compared to $3.0 million for 1997. Approximately $675,000 of this increase
relates to salaries and benefits resulting from an increase in personnel.
Facilities and related expenses increased by $424,000 primarily as a result of
the expansion of our network infrastructure.
Depreciation
Our depreciation expense increased 22.0% to $909,000 in 1998, compared to
$745,000 in 1997. The increase is due to additional capital expenditures
incurred during 1998 for telecommunications equipment and facilities
improvements. On January 1, 1998, we changed the estimated useful lives for our
switches and routers from three to five-year lives. This change reduced 1998
depreciation by $237,000. We made this change to more accurately reflect our
historical experience with respect to the actual useful lives of the equipment.
Stock-Based Compensation
Stock-based compensation of $156,000 was amortized during the year ended
December 31, 1998, and stock-based compensation of $792,000 will be amortized
over the remaining vesting periods of the related options, including $394,000 in
the year ending December 31, 1999. In addition, we issued stock options to
employees during the first quarter of 1999, which will result in additional
stock-based compensation of $98,000 being recorded in 1999, $50,000 of which
will be amortized as an expense in 1999. Based on these issuances of stock
options below the fair value of our stock, we will record a total stock-based
compensation charge in 1999 of approximately $444,000.
Net Interest Income (Expense)
We incurred net interest expense of $30,000 in 1998, compared to $5,000 in
income in 1997. This change was a result of increased borrowing for network
equipment under our lines of credit.
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COMPARISON OF YEARS ENDED 1997 TO 1996
Revenues
Our revenues increased 63.3% to $10.4 million in 1997, compared to $6.4 million
in 1996. Approximately $4.9 million of this increase is due to growth in
revenues generated by our Internet connectivity services and installation fees.
This increase was slightly offset by a $917,000 aggregate decrease in dial-up
customer and systems integration services revenues.
Cost of Revenues
Our cost of revenues increased 38.7% to $4.6 million in 1997, compared to $3.3
million in 1996. This increase resulted from a $1.4 million increase due to
larger connectivity charges and other costs incurred with our network expansion.
In addition, costs arising from our systems integration services were $118,000
less than the prior year.
Selling and Marketing
Our selling and marketing expenses increased 51.3% to $522,000 in 1997, compared
to $345,000 in 1996. This increase is attributable primarily to increased
commissions and travel and entertainment expenses.
General and Administrative
General and administrative expenses increased 62.9% to $3.0 million in 1997,
compared to $1.8 million in 1996. Salaries and general office expenses increased
by $584,000 as we hired more personnel to keep pace with the growth in demand
for our services. In addition, bad debt expenses increased by $573,000.
Depreciation
Our depreciation expense increased 45.5% to $745,000 in 1997, compared to
$512,000 in 1996. The increase was primarily the result of additional capital
expenditures incurred for telecommunications equipment and facilities
improvements.
FACTORS AFFECTING OPERATING RESULTS
We expect to experience significant fluctuations in our future quarterly and
annual results of operations due to a variety of factors, most of which are
outside our control. For a list of factors affecting our operating results, see
"Risk Factors -- Our operating results in one or more future periods are likely
to fluctuate significantly" and the other risk factors described in this
prospectus. Due to all of these factors, we believe that period-to-period
comparisons of our operating results are not necessarily meaningful and should
not be relied upon as indications of future performance.
YEAR 2000 COMPLIANCE DISCLOSURE
The year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. As a result,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. In addition, the year 2000 is a leap year, and some computer
programs may not properly provide for February 29, 2000. System failures and
miscalculations causing disruptions of normal business activities may occur
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. As a result,
many companies' software and computer systems may need to be upgraded or
replaced in order to comply with year 2000 requirements. We are currently in the
process of reviewing our network switching, routing and telephone equipment,
constituting the equipment used in providing our Internet and network connection
services, as well as our internal management information systems, in order to
identify and modify those items and systems that are not year 2000 compliant. We
do not have and are not developing a contingency plan in the event our systems
fail due to year 2000 related problems.
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Our year 2000 readiness review includes assessment, implementation, testing and
upgrading or replacing non-compliant items as appropriate. We have completed
most of our review of all of our software, switches and routers and other
systems and anticipate completion of our assessment and implementation by
mid-1999 and completion of all year 2000 testing during the third quarter of
1999. To date, we have evaluated our internally developed systems, consisting of
our management information system, provisioning tracking system, technical
information database and customer and network information database and believe
that they are year 2000 compliant. However, we utilize software and hardware
developed by third parties both for our network and internal information
systems. We have reviewed the year 2000 compliance statements issued by,
reviewed publicly available information regarding, or have sought oral and
written assurances from, our significant suppliers. Nine of them, constituting
approximately one-third of our significant suppliers, have indicated that their
products are year 2000 compliant, and none have indicated that remediation
measures are necessary. We intend to continue to seek assurances from our other
suppliers during the course of our year 2000 readiness review. To the extent
that our systems are not year 2000 compliant, we are modifying such systems to
make them compliant. Noncompliant items are replaced or otherwise remediated and
then tested during the review process. To date, we have identified the need to
upgrade our Cascade OpenView Layer 2 network management and switch operating
system software to Ascend Naviscare software. We anticipate completing this
upgrade by mid-1999. Assessment of our telephony systems has not yet been
completed but is currently in process. We expect these modifications will be
made on a timely basis and do not believe that the cost of the modifications
will have a material effect on our business, results of operations or financial
condition. To date, we have not incurred material costs in upgrading and
replacing non-compliant items. Additionally, we are continuing to assess the
year 2000 compliance of our services and systems. We believe our services and
systems assessed to date do not contain material year 2000 deficiencies. We
estimate that the capital and other costs associated with any upgrade and
conversion of our existing services and systems relating to the year 2000 issue
will not be material.
We expect to continue assessing and testing our internal information technology,
which we refer to as IT, and non-IT systems to mid-1999 with the assessment and
remediation process described above. To ensure year 2000 compliance we will
upgrade the server on which our accounting software runs in the third quarter of
1999. We are not currently aware of any material operations issues or costs
associated with preparing our internal IT and non-IT systems for the year 2000.
However, we may experience material unanticipated problems and costs caused by
undetected errors or defects in the technology, including embedded technology,
used in our internal IT and non-IT systems.
Based upon our correspondence with and the publicly available information
regarding our primary equipment, telecommunications and data communications
providers, we are aware that more than three-quarters of these providers are in
the process of reviewing and implementing their own year 2000 compliance
programs. We are in the process of contacting the remaining quarter of our
suppliers to determine the scope of their year 2000 compliance programs. Of the
providers from whom we received correspondence, none of them has indicated that
they have not considered year 2000 compliance, approximately 10% have indicated
that they are currently year 2000 compliant and the remaining 90% have indicated
that they expect to be year 2000 compliant by the end of 1999. At this time, CRL
is not aware of, and cannot determine, apart from the public materials reviewed
and assurances received, how many of its providers are implementing remediation
measures which affect CRL. We do not believe that we will be afforded the
opportunity to test the systems of these providers. If our primary providers
experience business interruptions as a result of the failure to achieve year
2000 compliance, our ability to provide Internet connectivity could be impaired,
which could have a material adverse effect on our business, results of
operations and financial condition.
Our services and systems operate in complex network environments and directly
and indirectly interact with a number of other hardware and software systems. We
face risks to the extent that suppliers of products, services and systems
purchased by us and others with whom we transact business, including those which
form significant portions of our network and may be sole or limited source
suppliers, such as Ascend Communications, Inc., the provider of our Cascade
switches, do not have business systems or
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products that comply with year 2000 requirements, despite the implementation of
a year 2000 compliance program or assurances of year 2000 compliance by all of
such suppliers. Ascend Communications, Inc.'s public disclosure indicates that
it has a plan in place to become, to the extent it is not already, year 2000
compliant by June 1999. We have received assurances from 14 suppliers,
constituting approximately 40% of our suppliers, including our two most
significant equipment suppliers, Ascend and Cisco, regarding their year 2000
compliance of their systems or networks. One has indicated that its systems are
year 2000 compliant and the others have indicated that they are currently in the
remediation or testing stages of their year 2000 review and that they will be
compliant by the end of 1999. If these networks fail, our business will be
significantly impacted.
We do not currently have any information regarding the year 2000 status of our
customers, many of whom are private companies. As is the case with similarly
situated companies, if our customers experience year 2000 problems, which result
in business interruptions or otherwise impact their operations, we could
experience a decrease in the demand for our services, which could have a
material adverse impact on our business, results of operations and financial
condition.
We have not incurred any significant expenses to date associated with our year
2000 plan and are not aware of any material costs associated with our
anticipated year 2000 efforts. Our expectation that we will be able to upgrade
our services and systems to address the year 2000 issue and our expectation
regarding the costs associated with these upgrades are forward-looking
statements subject to a number of risks and uncertainties. Actual results may
vary materially as a result of a number of factors. We cannot assure you that we
will be able to timely and successfully modify our services and systems to
comply with year 2000 requirements. Any failure to do so could have a material
adverse effect on our business, results of operations and financial condition.
Furthermore, despite testing by us and our vendors, our services and systems may
contain undetected errors or defects associated with year 2000 date functions.
In the event any material errors or defects are not detected and fixed or third
parties cannot timely provide us with products, services or systems that meet
the year 2000 requirements, our business, results of operations and financial
condition could be materially adversely affected. Known or unknown errors or
defects that affect the operation of our services or systems could result in
delay or loss of revenues, interruption of network services, cancellation of
customer contracts, diversion of development resources, damage to our
reputation, damages paid to customers and litigation costs.
LIQUIDITY AND CAPITAL RESOURCES
We have historically generated positive cash flows from operating activities and
have financed our growth, as well as necessary capital expenditures and working
capital needs, primarily through the use of internally generated funds and lines
of credit. In addition, we have made limited use of capital lease financing. We
expect to experience a substantial increase in our operating expenses as we
implement our growth strategy and incur expenses for hiring new personnel and
for additional leased network capacity. We also anticipate an increase in our
capital expenditures consistent with our anticipated need for additional network
infrastructure. We expect our operating expenses and capital expenditures will
be a significant use of our cash resources.
We currently have agreements with commercial lenders providing for equipment
financing arrangements. Integral also has a line of credit with a commercial
lender. As of March 31, 1999, approximately $1,088,000 was outstanding under
these agreements. Amounts borrowed under these agreements are secured by
substantially all of our assets and bear interest at a weighted average rate
equal to 9.6% as of May 31, 1999. Various portions of these borrowed amounts
must be repaid in full between July 2000 and March 2003. We intend to use a
portion of the proceeds from the offering to repay the amounts outstanding under
these loan agreements. In addition, we have a $200,000 working capital line of
credit. As of March 31, 1999, we had no cash borrowings with that facility. See
"How We Intend to Use the Proceeds from the Offering."
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Our net cash flows from operating activities were $705,000 for 1998, $1.7
million for 1997, and $944,000 for 1996. Our borrowings were $703,000 for 1998,
$358,000 for 1997 and zero for 1996. At December 31, 1998, we had $840,000 in
cash and cash equivalents.
Net cash used in investing activities was $1,529,000 for the year ended December
31, 1998, $1,182,000 for the year ended December 31, 1997, and $905,000 for the
year ended December 31, 1996. Cash used in investing activities was primarily
used to purchase property and network equipment.
Net cash provided by (used in) financing activities was $549,000 for the year
ended December 31, 1998, $316,000 for the year ended December 31, 1997 and
$(14,000) for the year ended December 31, 1996. In the years ended December 31,
1998 and 1997, net cash provided by financing activities resulted primarily from
borrowings. Net cash used in financing activities in the year ended December 31,
1996, resulted from debt payments.
We believe that the net proceeds of this offering, together with our existing
cash, cash equivalents and short-term investments and available credit
facilities, will be sufficient to meet our anticipated cash needs for working
capital, repayment of debt and capital expenditures for at least the next 12
months. Thereafter, we may require additional funds to support our working
capital and capital expenditure requirements and may seek to raise additional
funds through public or private equity or debt financings or other sources for
such requirements and acquisitions of technologies, companies and development of
our existing and new services. Any additional financing we may need may not be
available on terms favorable to us, or at all. See "Risk Factors -- We may
require substantial future capital to implement our business plan" and "How We
Intend to Use the Proceeds from the Offering."
RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued SOP 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1
provides guidance for an enterprise on accounting for the costs of computer
software developed or obtained for internal use. SOP 98-1 is effective for us in
fiscal 1999. We anticipate that accounting for transactions under SOP 98-1 will
not have a material impact on our financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which defines derivatives, requires that all
derivatives be carried at fair value, and provides for hedge accounting when
conditions specified in SFAS No. 133 are met. SFAS No. 133 is effective for us
in fiscal 2000. We do not believe adoption of this statement will have a
material impact on our financial position or results of operations.
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BUSINESS
GENERAL
CRL Network Services is a Tier 1 Internet service provider offering customized
Internet and network management solutions to small and medium-sized businesses.
Our services include:
- connectivity to the Internet and secure private networks through our
national backbone network from which our Internet access customers can reach
every other Internet address and our network customers can reach other
destinations within their private network.
- value-added services, which are additional services delivered over the same
circuit as our connectivity services. Our current value-added services are
remote management of our customer's networks and systems integration, which
includes the resale, installation and configuration of our customers'
computer systems and software.
- hosting, which is the distribution of customers' Internet content from our
facilities.
Our customers outsource the management of their Internet and network needs to
us. We develop and construct our data switched networks and perform all data
routing and transmission for our customers. We lease fiber-optic capacity from
third-party providers over which we transmit data and peer with other
telecommunications providers to exchange data traffic.
We believe we were among the first companies involved in the development of
connectivity solutions and services for the commercial Internet. We have
developed our own high speed network, which enables us to reliably and cost
effectively deliver customized, comprehensive solutions. As of June 16, 1999, we
had 30 points of presence in major metropolitan areas that connect to the
interexchange points sanctioned by the National Science Foundation for the
transfer of Internet Protocol-based traffic between Internet backbone networks.
Our network is comprised of several elements, including 24 Cascade switches, 54
Cisco routers, facilities and clear channel fiber-optic bandwidth, which
together provide a fast, secure, high quality network capable of minimizing
outages resulting from hardware or software faults.
INDUSTRY OVERVIEW
To remain competitive, businesses today must have the ability to reliably access
and share information both externally and internally. In response, companies are
increasingly conducting business over the public Internet and their own private
networks. As a result, businesses are expanding their connectivity to the
Internet and use of both local area networks, commonly referred to as LANs, and
wide area networks, commonly referred to as WANs. The Internet's functionality
and accessibility have created an increasingly attractive commercial medium to
quickly and efficiently provide services and distribute information that
historically has been more difficult to obtain through traditional communication
channels. At the same time, businesses are continuing to develop private
networks to distribute and share information, resulting in a dramatic increase
in private network traffic as well as heightened performance requirements for
these networks. Increased use of the Internet and public and private networks
has also driven growth in the amount of sensitive corporate information shared
over networks, causing network security to become a high priority for many
businesses. As a result of these trends, a growing number of businesses view
responsive, reliable and secure networks as integral to their operations. As
these businesses evolve, the effectiveness of their networks depends largely on
the scalability and flexibility of these networks.
The proliferation of Internet use is driven by the emergence of electronic
commerce and availability of applications such as the outsourcing of help desk
functions, Internet Protocol-based voice, fax and video conferencing, purchasing
and provisioning functions, and corporate and product marketing. Businesses are
confronted with increasing customer demand for offerings of products and
services over the Internet as a result of the immediacy and convenience it
affords. As the Internet evolves, companies are transitioning from Internet use
for business-supportive functions such as marketing and customer support, to
functions integral to business such as transaction execution, including sales
orders and customer billing. As Internet
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use becomes increasingly integral to business, businesses' emphasis on the
reliability and security of their Internet access grows in importance. Also,
many businesses have emerged that focus solely on delivering services over the
Internet through Web sites and electronic commerce applications. Their ability
to offer these kinds of products and services requires high bandwidth Internet
sites and operations which are sufficiently scalable to meet their changing
needs. Due to advances in online security and payment mechanisms, the number of
businesses establishing commerce-enabled Web sites is expected to increase
dramatically. International Data Corporation estimates that the number of
consumers buying goods and services on the Internet will grow from 18 million in
1997 to 128 million in 2002, and that the total value of goods and services
purchased over the Internet will increase from approximately $12 billion in 1997
to approximately $425 billion by 2002. Businesses are positioning themselves to
capture this rapid growth opportunity by enhancing their Internet presence.
The need for businesses to establish secure private wide area networks using the
services of companies like CRL has been driven by the growing importance of
connecting the geographically dispersed sites of their business, their customers
and their suppliers. As networks become a more integral part of day-to-day
operations, many companies seek to minimize network costs and improve operating
efficiencies. Traditional wide area network architectures consist of dedicated
circuits between computing facilities utilizing the same fixed bandwidth
regardless of traffic flow. New switched data technologies such as that utilized
by us share and dynamically allocate bandwidth based on prevailing traffic
patterns. The shared bandwidth of switched data technologies typically results
in wide area networks that are more reliable and cost efficient than those based
on traditional leased-line services.
Local area networks have emerged from businesses' need to access and share
internal electronic information. To enable effective internal communication and
distribution of company information, the local area network is used by
businesses seeking to decentralize their information databases. Local area
networks facilitate access to client/server-based technology such as Web-enabled
databases, shared file servers, e-mail, electronic commerce applications, and
other online information. Use of local area networks and the services of LAN
service providers will continue to grow as businesses increasingly decentralize
information.
As local area networks and wide area networks become more prominent, businesses
increasingly need remote access to their network for mobile workers. Many
businesses recognize the importance of controlling the method by which
electronic automation takes place and ensuring the security of communications
between mobile workers and the proprietary networked resources they access. The
benefits of efficiently distributing proprietary information to those with a
need to know must be weighed carefully against the possibility that unauthorized
access to sensitive information can occur due to failed security mechanisms or
poor network design.
Internet access services provided by Internet service providers interconnect
businesses and individuals to the Internet, private data networks and other
interconnected networks. Access services include high speed dedicated access
used primarily by medium-sized and larger organizations and dial-up access for
individuals and small or home office businesses. In addition to Internet access
services, business-focused Internet service providers such as CRL are
increasingly providing a range of additional communications services, including
remote management, shared and dedicated Web hosting, server colocation, network
security services, electronic commerce applications and new applications such as
Internet Protocol-based voice, fax and video conferencing. Internet service
providers who can bundle several of these communications services can satisfy
more of the needs of their customers and enhance their cross-selling
opportunities.
Several different types of Internet service providers have emerged and are
generally referred to as Tier 1, Tier 2, and Tier 3 network service providers.
International Data Corporation defines a Tier 1 network service provider as an
operator of a high quality, national backbone facility, specializing in leased
line connectivity. Also according to International Data Corporation, most Tier 1
network service providers peer directly at the National Science
Foundation-approved network access points. International Data Corporation
defines Tier 2 and Tier 3 network service providers as those who do not have a
national backbone network.
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Peering is critical to providing high quality, high speed Internet access. By
peering directly with other networks, Tier 1 Internet service providers such as
CRL are able to send Internet traffic via the most direct and reliable path to
its final destination (the fewest "hops"), thereby minimizing potential delay
and lost or corrupted data. Additionally, Tier 1 Internet service providers
maintain and control their own national backbones and are generally better able
to control the quality of service, level of data integrity and degree of
reliability than non-Tier 1 Internet service providers. Many Tier 1 providers
are also fully peered, which means they can route traffic to every other
Internet destination through peering arrangements without paying transit fees.
Because Tier 1 Internet service providers typically do not pay for the privilege
of interconnecting with other Tier 1 networks with whom they peer, they can
increase their available Internet capacity by expanding existing peering
connections with their peer networks without the high costs associated with the
retail purchase of additional Internet access. The following is a list of
Internet service providers whom we believe to be some of the Tier 1 Internet
service providers: MCI WorldCom, Inc. (UUNET), Cable & Wireless P.L.C., Sprint
Corporation, ICG Communications, Inc. (Netcom), PSINet Inc., GTE Internetworking
Incorporated (BBN Planet), Intermedia Communications Inc. (Digex), AT&T
Corporation and CRL. As the number of Internet service providers has grown, Tier
1 Internet service providers have increased their requirements for peering
arrangements, which has raised the barriers to acquiring and maintaining Tier 1
status.
The internal network design of the Internet service provider's network is also a
significant factor in determining the speed and reliability of data delivery
from source to destination. Traditional networks constructed solely of routing
devices require that a packet of information stop at a router in every point of
presence along the traveled network path. Each of these routed hops requires the
data packet to be examined by the router and a policy-based routing decision to
be made regarding the egress of the packet back onto the network. Many routing
decisions can delay the delivery of the packet to its destination. By contrast,
switched data networks can deliver information directly between the source and
destination without the need to disassemble the data packets during transit. As
a result, switched data networks generally provide higher speeds, less data
delay and overall better quality of service than traditionally routed networks.
THE MARKET OPPORTUNITY
Overview
Internet and private network operations are increasingly becoming integral to
the commercial and communication operations of businesses. The evolution and
expansion of Internet services and the networks over which they are delivered
has led to a growing need for comprehensive, bundled Internet and network
services such as those offered by CRL.
The Need for Internet Connectivity Services
The Internet continues to increase in size and importance as its role in
integral business operations expands. Businesses are looking to third-party
providers for expertise in implementing their Internet strategies. According to
Forrester Research, Internet access revenues from businesses are expected to
increase from less than $1 billion in 1997 to more than $16 billion in 2002.
Internet service providers are ideally positioned to capitalize on this growing
need of businesses to access and utilize more of the Internet.
Demand for Secure Private Networks
Historically, data communications services offered over private leased lines
were expensive, not monitored or managed for quality of service nor capable of
deflecting outages from software or hardware faults. Seeking a less expensive
alternative, some businesses use the public Internet for communications but are
confronted with potential problems inherent in the Internet, such as
unauthorized access and data loss and reduced transmission speed, commonly
referred to as degradation. Virtual private networks are also used as another
less expensive alternative, but similarly include security concerns and
unreliable performance due
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to their reliance on the Internet for data transmission. By contrast, Layer 2,
switched private networks used by providers like CRL offer a networking option
which is more cost effective than traditional point-to-point private leased
lines but is an owned and controlled network not depending upon the Internet for
data transfer, eliminating security concerns and permitting lower and more
stable delay levels than data communications alternatives relying upon the
Internet.
Enhanced Network Management Services
Businesses need to ensure that their networks, information systems and
applications operate continuously as their reliance on public and private
networks increases. While large businesses are able to build and maintain
information technology departments capable of servicing their networks,
information systems and applications, small and medium-sized businesses find it
difficult to cost effectively maintain information technology departments
capable of ensuring the continuous availability of complex networks running
multiple applications. It is also difficult and expensive for small and
medium-sized businesses to continuously train their information technology
departments to support new technologies and applications. As a result, many
small and medium-sized businesses have chosen to outsource their information
technology department functions to network service providers capable of offering
a full range of these services. Traditionally, outsourcing information
technology services has required site visits from the service provider even for
routine problems often resulting in lengthy delays. As a result, small and
medium-sized businesses are seeking the ability to affordably outsource their
information technology departments to network service providers capable of
rapidly responding to problems and minimizing network downtime. International
Data Corporation reports that the U.S. market for network monitoring and
management was $2.4 billion in 1998 and is projected to reach $4.7 billion in
2002, representing an 18% annual growth rate.
Hosting Services
As Internet presence becomes increasingly critical to business operations, many
businesses are seeking to outsource hosting services, including Internet
colocation, to network service providers. By outsourcing these functions,
businesses can establish a strong Internet presence while remaining focused on
their core business operations. According to Forrester Research, revenues from
complex Web hosting will increase from approximately $200 million in 1997 to $8
billion in 2002, while intranet hosting will generate nearly $400 million in
revenues for Internet service providers by 2002. Traditional hosting companies
operate geographically dispersed networks that are subject to increased risks of
data delay and degradation or loss, as data travels across multiple network
connections, or hops. Many hosting companies also do not have the flexibility,
peering arrangements or capacity to quickly scale their services to meet the
sharp growth and high bandwidth requirements of Internet operations integral to
business. Network service providers who are able to overcome these obstacles
will be well positioned to capitalize on the growth of the Web hosting market.
OUR SOLUTION
Through our national, facilities-based fully-peered network, we offer our
customers high quality, flexible and scalable services, including:
- connectivity to the Internet and secure private networks through our
national backbone network from which our Internet access customers can reach
every other Internet address and our network customers can reach other
destinations within their private network
- value-added services delivered over the same circuit as our connectivity
services in addition to those services, consisting of remote network
management of our customers' networks and systems integration services
- hosting services
Approximately 74% of our 1998 revenues was generated from our Internet and
network connectivity services, approximately 16% from value-added services and
approximately 7% from hosting services.
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Our comprehensive suite of services enables our customers to easily and more
cost effectively address their networking needs without having to assemble
services from different vendors including resellers, Internet service providers
and information technology service providers. Our ability to provide "one-stop,"
customized network solutions facilitates our customers' ability to exploit
opportunities created by the Internet and other network systems on a timely
basis. Key advantages of our solution are:
High-Quality Performance and Reliability. We believe our high speed, private
switched network, coupled with our status as a Tier 1 Internet service provider,
enables us to provide our customers with fast and reliable data transmission
solutions. Our network operations center controls and monitors the switches,
routers and fiber-optic capacity for all data transmitted over our network 24
hours-a-day, seven days-a-week, allowing our staff to be immediately aware and
responsive to problems as they arise. This control of our network infrastructure
allows us to improve quality of service by minimizing network down time.
Management of Businesses' Critical and Support Operations. We offer our clients
the ability to outsource their network management operations to us. The services
we offer are performed by CRL, allowing us to control the quality of these
services. Through an off-site connection and our proprietary process, we can
manage our customers' internal networks as well as solving common problems that
our customers encounter. When end-users encounter a problem, we are able to
attach in real-time to our customer's desktop computers and servers to evaluate
and solve the problem as if located on-site at the customer's premises from our
facilities. In addition, we proactively monitor our customers' networks to
predict and, in some cases, prevent outages. The ability to manage our
customers' systems remotely enables us to offer custom, cost-effective network
management solutions. Businesses able to outsource many aspects of an
information technology department, from the "help desk" to enterprise-wide
server maintenance, can implement more complex applications without being
constrained by a lack of in-house computer professionals. We believe that our
services can enable our customers to implement selected intranet and extranet
business functions such as electronic commerce, free of any information
technology-related concerns. Our solutions allow our customers to more rapidly
grow their businesses with relatively modest initial and recurring information
technology-related expenditures.
Scalability and Flexibility. Our services are designed to be highly scalable and
flexible in order to meet the needs of our customers as their Internet, network
operations, and bandwidth requirements expand. Our network is designed to
provide our customers with available and uncongested bandwidth during network
traffic spikes by maintaining excess capacity and additional sources of
bandwidth. We also provide flexibility for our customers by supporting most
leading Internet hardware and software systems vendor platforms.
Bundled Service Offerings. Many enterprises today, especially those in the small
and medium-sized business market, often purchase services from a number of
vendors. For example, a company may receive its Internet access, file/Web server
connection and colocation space all from different vendors. We are able to offer
these services under customized packages through a single network connection and
also offer additional customer support and management expertise. We are able to
serve our customers' Internet and network management requirements without the
need for any additional service providers or connections.
STRATEGY
Our objective is to become the leading nationwide provider of customized
comprehensive Internet and network services to small and medium-sized
businesses. To achieve this objective, we intend to:
Further Capitalize On Our Existing Network Infrastructure. Through our direct
participation in the development and evolution of the commercial Internet, we
believe we are one of a limited number of fully-peered, Tier 1 Internet service
providers, which means we have legacy peering relationships with major Internet
service providers, including MCI WorldCom, Inc., Sprint Corporation and Cable &
Wireless P.L.C. As a result, we can transfer traffic efficiently to other
networks without paying the costs typically associated with transport. During
the past year, we became a licensed competitive local exchange carrier in the
State of California and have begun the application process to become a
competitive local exchange carrier in several other states to complement our
national backbone network. As a competitive local
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exchange carrier in any particular state, we are able to purchase unbundled
network elements from the applicable regional Bell operating company operating
in that state rather than purchase retail local loops, resulting in a
significant cost savings to us. Also, our 15 years of experience developing our
network provides us with an in-depth understanding of the key elements of
network connectivity technology. As a result, over the past decade we have built
a national backbone network which currently consists of clear channel
fiber-optic capacity, Cascade switches and Cisco routers, which are controlled
through our network operations center. Our network is fast, secure and reliable,
as well as scalable to approximately one hundred times the traffic our current
customers generate. We intend to aggressively further capitalize on our existing
network infrastructure to cost-effectively expand our customer base and deliver
additional service to our customers.
Cross Sell Value-Added Services. We intend to capitalize on our existing
customer base and future customers by aggressively cross selling our value-added
services. We are committed to offering our customers reliable value-added
network services necessary to address their Internet and network management
requirements. We believe we are currently one of only a few companies remotely
managing the customer's network from the Internet all the way to the desktop.
Based on our existing network infrastructure and expertise, we are able to offer
these services continuously, reliably and on a cost effective basis. Through
acquisitions or development of relationships with providers of leading Internet
and other network technologies, we intend to enhance and increase the services
we offer to include other value-added services, such as enhanced network
security solutions, that address our customers' rapidly evolving critical
networking needs such as electronic commerce.
Provide Bundled, Comprehensive Networking Solutions. The fragmentation among
Internet and other network service providers has resulted in users often faced
with an overwhelming array of providers and services from which to choose. For
example, it is typical for a user to purchase local loop connectivity from a
regional Bell operating company or a competitive local exchange carrier, to
purchase Internet or other wide area network connectivity from a separate
Internet or other network service provider, and to purchase network services,
like remote management, systems integration and network security, from one or
more other companies. We believe the Internet and network service provider model
is evolving towards providers who are capable of providing comprehensive
solutions by bundling several or all of these functions efficiently, reliably
and on a cost effective basis. By combining our network infrastructure with our
existing and planned array of value-added networking services, we believe we are
well positioned to become one of the premier providers of comprehensive, bundled
networking solutions to small and medium-sized businesses. Additionally, we
believe that by offering bundled services, we can reduce customer loss, increase
network usage by existing customers, cross sell additional services to existing
customers and differentiate ourselves from our competitors.
Expand Customer Base and Sales Efforts. We intend to expand our customer base by
significantly increasing our direct and indirect sales forces as well as our
marketing efforts. Our direct sales force consisted of 17 persons in four sales
offices located in San Francisco, Sacramento, Anaheim and San Diego as of June
16, 1999. Our sales force is supported in their efforts by sales engineers and,
in many instances, our senior management. We intend to increase the number of
our sales offices and to significantly expand the size of our direct sales force
with the goal of having an effective selling presence in all major domestic
metropolitan and regional markets. In addition, we are exploring other
strategies to grow our direct sales force, including developing an inside sales
center to generate additional sales. We also intend to establish and expand
relationships with potential channel partners including hardware vendors,
value-added resellers, system integrators and Web hosting companies to leverage
their sales organizations and existing customer bases. By combining an expanding
direct sales force with the sales and marketing power of targeted channel
partners, we believe we will be able to effectively market and sell our
comprehensive networking solutions to a large potential customer base throughout
the United States.
Drive Revenue Growth by Increasing Hosting Services. Our physical presence at
key network access points provides attractive opportunities for many customers
to lease a portion of our space and purchase our colocation services. Our
hosting services permit our customers to install their equipment in close
physical proximity to major Internet access points. These connections at the
"edge" of the Internet are among the
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most reliable connections available. Our presence in these locations, as well as
the hardware we have installed there, are designed to satisfy the electronic
commerce and other requirements of the most demanding Internet service
providers, content providers, businesses and government agencies. We intend to
aggressively market our existing hosting services to service these applications
that are integral to business.
Accelerate Growth Through Targeted Acquisitions. The goal of our acquisition
strategy is to accelerate market penetration, build upon our core competencies
and expand our technical staff and sales force. We evaluate acquisition
candidates based on their fit with our overall business plan. When a candidate
is acquired, we will integrate our existing Internet and network connectivity
and value-added services with the service offerings of the acquired company and
use the acquired sales force and customer base to expand market opportunities.
The types of acquisitions we target include business Internet service providers
and companies with leading edge network connectivity and services technologies
that expand or enhance our existing services. Other types of targeted
acquisitions include local or regional business Internet service providers in
markets where we have established points of presence and would benefit from the
acquired company's local sales force and installed customer base through the
potential increase in our network utilization. Our recent acquisition of
Integral Networking Corporation, a systems integrator and developer of advanced
remote management services, is an example of the implementation of this
strategy.
SERVICES
We currently offer customized, comprehensive Internet and private network
solutions as well as network connectivity and value-added network services to
our customers. The diversity of services we offer permits each customer to
purchase individual services or a bundle of services that provide the most
efficient, reliable and cost effective solution to that customer's particular
needs.
Network Connectivity Services
We are a national provider of connectivity services, including a variety of
dedicated and dial-up access and customized wide area networking solutions in
both stand-alone and bundled packages, which provide high-speed continuous
access to the Internet and other networks for our customers. We also provide
turnkey configuration solutions encompassing such services as domain name
registration, leased-line ordering and installation assistance, Internet
Protocol address assignment, router configuration, installation and management,
and technical consultation services. All of our connectivity customers receive
24 hour-a-day, seven day-a-week technical support.
Dedicated Access. We offer a broad line of high speed dedicated connectivity
services providing business customers with direct access to a full range of
Internet applications. Our dedicated access service provides companies with
robust, full-time, dedicated Internet connectivity in a range of access speeds,
including fractional T1 (from 64 kilobits per second up to 1.536 megabits per
second), T1 (1.536 megabits per second), T3 (45 megabits per second) and OC3
(155 megabits per second). We recently began offering digital subscriber line
services but have generated no revenues from these services. Our dedicated
Internet access is designed to help ensure bandwidth availability for priority
business applications. We believe that the traffic-management advantages of the
data switching technology deployed in our network provide our customers with
fully integrated Internet access and improved performance.
Customized Wide Area Networking Solutions. We are dedicated to providing
effective, privately managed wide area networking services. Our customized wide
area networking services combine the high performance of private lines with the
redundancy and bandwidth efficiency of a switched service. These wide area
networking services utilize the superior line management features and cost
effectiveness of data switching technology to provide a high performance and
secure wide area network that is scalable to our customers' growing network
demands.
The versatility of data switching technology allows our customers to easily
manage connectivity to multiple sites at a wide range of connection speeds. With
our customized wide area networking services, our engineers can help a customer
design a network to match the specific needs of the customer. Locations
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can be partially or fully-meshed, offering route redundancy where necessary, and
allowing the customer to provision only the bandwidth they need.
By linking a wide area network with our national backbone network, our customers
can optimize the bandwidth of their businesses and minimize expenses. We also
offer service level guarantees and extensive 24 hour-a-day, seven day-a-week
customer support with all of our integrated solution products.
Dial-Up Access. Our dial-up services offer a cost effective, entry-level
Internet solution that provides access to our advanced network backbone via
ordinary telephone lines at speeds of up to 56 kilobits per second using V.90
protocol.
Transit Service. Our transit service is designed for other, non-Tier 1 Internet
service providers whose networks are insufficient to transmit their customers'
data to the peering points of other networks. Our transfer service provides the
necessary link for these Internet service providers to transmit and receive data
to other networks on the Internet. This service can usually be installed in a
short time frame and gives our customers the flexibility they need to expand
their operations.
Value-Added Services
We believe that businesses will continue to increase their use of the Internet
and private networks to remain competitive and will increasingly rely upon an
expanding range of value-added services to enhance productivity, reduce costs
and improve service reliability. We offer value-added services consisting of
remote management and systems integration services. As part of our strategic
plan, we also intend to offer network security services. In addition, to
capitalize on our technologically advanced, high-capacity network
infrastructure, we intend to continue developing new value-added services that
facilitate customer use of the Internet and other networks, including
bandwidth-intensive multimedia services such as video conferencing.
Remote Management Services. Traditional network management solutions outsourced
by businesses to network service providers require network problems to be
diagnosed and resolved at the customer's site, which often results in a lengthy
response time. Through our alarm notification capability, our monitoring service
immediately alerts us to our customers' network problems and details the reason
for the problem. We can manage our customers' internal networks and solving
common problems encountered by our customers through an off-site connection and
proprietary process which permits us to attach in real-time to our customers'
desktop computers and servers and evaluate and solve the problem as if located
on-site at our customers' premises. For these reasons, our remote management
services help to significantly reduce the necessary time and expense to diagnose
and resolve network and application-oriented problems. We structure our remote
management solution to be scalable to our customers' growing needs.
Systems and Network Integration. We provide integration services such as local
and wide area network configurations, Web and database server integration and
application-specific software solutions. We configure equipment by loading
customer programs, connecting equipment to the network and servicing hardware
and software. Our staff of engineers works closely with our customers to design,
assemble, configure and install a network architecture meeting our customers'
requirements.
Firewall Solutions. The sensitive nature of business Internet traffic demands
protection from unauthorized access. Our firewall solutions provide users with
secure access to the Internet as well as create an electronic barrier between a
customer's internal network and the public Internet. Our firewalls can also
restrict access between departments as well as track communications to ensure
that these communications follow a customer's established security procedures.
We work with a variety of vendors to provide customized firewall solutions for
each of our customers with specialized security needs.
Hosting Services
Our existing network infrastructure, with its physical presence of network
equipment at major domestic network access points connecting all of the
interexchange points sanctioned by the National Science Foundation, provides an
easy and cost-effective solution for businesses to directly connect their
equipment
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through CRL to the Internet and other networks through our existing nationwide
backbone. Our colocation facilities allow our customers to install their
equipment as close to our network core as physically possible and are configured
in a manner to satisfy their networking and Internet operations that are
integral to business. Our infrastructure supports the Internet hardware and
software vendor platforms of most leading vendors, including Intel Corporation,
Microsoft Corporation and Sun Microsystems, Inc. The flexibility and scalability
of our network infrastructure permits our customers to purchase additional space
and power as needed, and to install and maintain their own hardware and
software. Our primary colocation facilities have uninterruptible AC or DC power
supply and back up equipment, fire suppression equipment, HVAC (heating,
ventilation and air conditioning), separate cooling zones, seismically-braced
racks and high levels of physical security, including card key access and video
surveillance.
Customers can select from a variety of options including shared rack facilities,
highly secure cabinets and enclosed cage facilities based upon their business
and technical requirements. Because many applications are dynamic and require
immediate hardware and software upgrades to maintain or achieve targeted service
levels, our colocation customers are offered 24 hour-a-day, seven day-a-week
physical and remote access to our facilities. We offer five options to satisfy
our customers' needs:
- Switched Ethernet Service, which is a 10 megabit per second service
connection onto our backbone router shared by other customers
- Dedicated Ethernet Service, which is a 10 megabit per second service
connection directly onto our backbone router not shared with any other
customers
- Switched Fast Ethernet Service, which is a switched ethernet service with a
100 megabit per second Internet connection
- Dedicated Fast Ethernet Service, which is a dedicated ethernet service with
a 100 megabit per second Internet connection
- Gigabit Fast Ethernet Service, which is a switched ethernet service with a
1,000 megabit per second Internet connection
The majority of our revenues from hosting services during 1998 and the first
quarter of 1999 was generated by our Dedicated Fast Ethernet Service. While the
Switched Ethernet Service is currently used by the greatest number of our
hosting service customers, our customers are able to choose the speed that best
suits their diverse needs which is generally based on our customers' projections
of the quantity of data to be delivered from their respective Web sites.
CUSTOMERS
We have established a diverse customer base including Internet service and
content providers, businesses, government agencies and educational institutions
to whom we offer a wide range of services including Internet and network
connectivity, value-added and hosting services. In addition, we provide dial-up
Internet access services to consumers. No customer accounted for more than 2.6%
of our revenues in either 1997 or 1998. The revenues derived from our top 10
customers accounted for 16% of our total revenues in 1998. The following is a
representative list of customers as of June 16, 1999 including the
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customers from each area of business from which CRL generated the largest amount
of revenue in 1998 or that were among the top 20 customers on the basis of
revenues to CRL during the first quarter of 1999:
<TABLE>
<S> <C> <C> <C>
------------------------------------------------------------------------------------------
INTERNET SERVICE INTERNET CONTENT BUSINESSES ENGAGED GOVERNMENTAL AGENCIES
PROVIDERS PROVIDERS IN ELECTRONIC AND EDUCATIONAL
--------------------- --------------------- COMMERCE INSTITUTIONS
--------------------- ---------------------
CTSNET AdForce, Inc. Citizen One Software City of Vallejo
(Imgis.com) Police
GST Call America Intersat Department
Digiweb Inc. Interprovincial
Harvard Net/Comstor Satellite Services Pacific Union College
Information Access Limited
Interaccess Co. Technologies, Inc. Tustin Unified School
Red Storm District
Internet America, Pathlink Technology Entertainment, Inc.
Inc. Corporation U.S. Department of
Ulead Systems, Inc. Commerce
Lightspeed Software Walnut Creek
CDROM, Wilshire Associates U.S. Federal Reserve
Incorporated Incorporated Board
------------------------------------------------------------------------------------------
</TABLE>
We aggressively pursue small and medium-sized business customers and seek to
provide them with connectivity and customized, cost-effective network management
solutions. The following are representative examples of the needs of our
customers and the core solutions we currently provide to our customers.
WALNUT CREEK CDROM, INCORPORATED: Walnut Creek CDROM, Incorporated is an
Internet-based freeware site using file transfer protocol, a tool used to
download files from the Internet and is our customer with the highest volume of
data. Typical of the demands of our customers who are high bandwidth content
users, Walnut Creek CDROM needed a reliable, Tier 1 provider to support its
traffic flows, which can often reach 98 megabits per second for a sustained
period of time. Walnut Creek CDROM uses our 100 megabits per second dedicated
fast ethernet service to connect directly to our core backbone at our San
Francisco network operations center. This high speed, direct Internet solution
meets our customer's bandwidth requirements and increases network reliability by
reducing the number of router hops to the Internet. We provide the 24
hour-a-day, seven day-a-week network management required to deliver Walnut Creek
CDROM's round-the-clock Internet applications.
J. LINNEMAN & CO.: J. Linneman & Co., a reinsurance agency associated with
Lloyd's of London, like many of our customers using our wide area network
services, required a reliable, private data switched network to handle sensitive
and mission-critical information. Without a managed network to facilitate
internal company communication, company officials were concerned that
underwriters could potentially over-insure national clients. Using our wide area
networking services, we developed and deployed a customized data network between
J. Linneman's headquarters in San Francisco and regional offices in Atlanta,
Chicago and Hartford. An Internet connection was also secured for each location.
In order to meet J. Linneman's demand for scalability and cost control, we
provide varying bandwidth to each city, with the option for an increase at any
time.
RIVER CITY PETROLEUM: River City Petroleum, Inc. is a fleet fueling and
wholesale fuels provider and is one of our largest remote management services
customers. River City Petroleum had built a local area network but had little
expertise to install new network elements, nor, like many of our value-added
service customers, did they want to oversee the day-to-day management and
administration activities a network requires. Using our proprietary remote
management services, we developed and deployed a customized solution for River
City Petroleum that reduces costly systems administrator fees and protects the
firm's mission-critical data by handing off the day-to-day management to us.
River City Petroleum can now focus on continuing its acquisition-oriented
growth, not its local area network.
These customers and the services which we provide them reflect our focus on
small and medium-sized businesses.
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Our success substantially depends on the continued growth of our customer base
and retention of our customers. Our ability to attract new customers will depend
on a variety of factors, including the willingness of businesses to outsource
their mission-critical networking and Internet operations, the reliability and
cost effectiveness of our services and our ability to effectively market such
services. Substantially all of our customer contracts have terms ranging from
one to three years.
A failure on our part to develop these relationships could materially and
adversely impact our ability to generate increased revenues, which would
negatively affect our financial results. We also intend to significantly
increase our sales and marketing expenditures, which may not necessarily result
in increased sales of our services. For a detailed discussion of the risks, see
"Risk Factors -- We are subject to the risks from our lengthy sales cycle."
OUR NETWORK
Our network enables us to provide our current service offerings and is the
platform from which we intend to expand our service offerings. Our network is
comprised of several elements, including routers, switches, facilities and clear
channel fiber-optic capacity, which together provide a fast, secure, high
quality network capable of reducing the risk of outages resulting from hardware
or software faults. In addition, we have both public and private peering
agreements allowing us to connect directly with all major Internet service
providers. The following map illustrates our network and peering relationships:
[Graphics depict a map of United States Entitled "Networks Built for Business"
with CRL logo, reflecting CRL's network connecting cities nationwide, including
symbols designating CRL's Regional Hubs, CRL Points of Presence or Service
Areas, Internet Protocol Backbone and Switched Backbone]
[Graphic depicts a map of United States entitled "Networks
built for Business" with the CRL logo, reflecting CRL's network connecting
cities nationwide, including symbols designating CRL's Regional Hubs, CRL
Points of Presence or Service Areas, Internet Protocal Backbone and Switched
Backbone]
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Network Equipment
Our network consists of 24 Cascade data switches and 54 Cisco routers located
throughout our points of presence. Routers are typically used as "Layer 3"
networking devices, which must disassemble each packet of data they receive,
make a policy-based routing destination decision according to Internet
Protocol-based routing tables, and then reassemble the packet and send it to the
destination determined by the routing protocol then in effect. These routing
protocol tables must be frequently updated by the router to reflect changes in
the tables arising from numerous events, including changes in peering
relationships.
Switches are typically "Layer 2" networking devices, which means they make
connections a layer below the Internet. Switches determine routing destinations
based on the Layer 2 addresses attached to each packet without disassembling the
data packets. By operating one layer below the Internet without the need to
disassemble packets, switches can significantly reduce delay and data
degradation, as well as increase security. As a result of the complexity and
multitude of networks that transport information over the Internet, switches are
often an essential component to deliver information in the fastest and most
reliable manner.
We have invested significant capital in switches, which are more expensive than
routers. Switches, when properly configured with routers, enhance the speed and
reliability of networks by:
- minimizing the number of connections, or hops, a data packet must take,
which minimizes the time required to deliver the packet
- reducing the number of times a packet must be disassembled by routers, which
reduces the opportunities for router errors
- decreasing the instances where packets must travel over public networks,
which decreases the likelihood of delay and data degradation
Our national network of switches and routers permits us to customize our network
connectivity by creating an efficient "virtual circuit" for each customer, a
logical connection between the physical devices transmitting, directing and
receiving the data packets.
Switches have other advantages over routers as well. If a network outage occurs,
our Cascade switches can re-route data between our routers so that our network
does not experience an interruption of service during the outage. This process
allows our routers to forward more packets without making complex routing
decisions. Our Cascade switches are multi-protocol capable, allowing us to
operate Internet Protocol and other protocols as required.
Network Facilities
We have constructed a national backbone network with points of presence in 30
cities including 16 of the largest 20 cities in the United States. We control
our points of presence, including our network operations center in San
Francisco, under leases with terms ranging from month-to-month to six years,
that allow us to control the quality and security of the operations. We can
upgrade our points of presence as desired and are able to significantly reduce
the length of time of network interruptions because we control our facilities.
We have points of presence in major population centers around the United States,
including San Francisco, Los Angeles, San Diego, Phoenix, Denver, Dallas, Vienna
(Virginia) and Chicago, which represent the locations of the largest volume of
our data traffic. We also have points of presence in 22 other cities throughout
the United States.
Many of our points of presence are located in, or in close physical proximity
to, "carrier hotels." Carrier hotels are facilities where major interexchange
carriers and Internet service providers have physical points of presence. Our
actual location in, or in close proximity to, the same building in which the
switches and routers of these carriers and providers are located offers us the
ability to quickly and easily interconnect our equipment to theirs by our simply
installing a "pipe" connection between our equipment and theirs. Without this
close physical proximity, the services and expense of a third party, like an
incumbent local exchange carrier or competitive access provider, would be
necessary to connect us to the interexchange
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carrier or other provider. Our leases in these carrier hotels have expiration
terms ranging from December 2000 to 2003. Based upon our discussions with these
carrier hotels or from our customers who have recently tried to rent space at
these carrier hotels, we believe that at least half of the carrier hotels have
limited availability for new lessees due to a lack of physical space, lack of
infrastructure required for additional lessees or the carrier hotels' desire not
to admit additional lessees because of the nature of such lessees' equipment and
its requirements for the leased space. Because of this limitation, we have an
advantage over many of our competitors who are unable to lease space in the
facility or in close enough proximity to the facility and need the services of a
third party to provide similar connectivity.
As we expand, we expect to increase our number of points of presence. Each point
of presence is monitored through our network operations center on a 24
hour-a-day, seven day-a-week basis, which allows us to rapidly identify and
resolve any service interruptions. All of our points of presence are connected
directly to local operators including regional Bell operating companies and
competitive local exchange carriers. Where practical, our local connections are
made at the DS-3 level, which allows us to install up to 28 customers at a time
on an expedited basis without the need for any wiring or physical changes within
our points of presence.
We currently lease clear channel fiber-optic capacity on networks from companies
such as Qwest Communications Corporation and IXC Communications, Inc. We have
chosen short-term leases of fiber-optic capacity as opposed to acquiring
indefeasible rights of use for fiber-optic capacity due to rapidly declining
bandwidth costs. We believe that our choice has had a significant impact on our
ability to maintain a relatively low cost structure network. Through our leased
fiber-optic capacity, we are able to easily create customized data switched
networks for ourselves or others. As we expand and seek additional leased
fiber-optic capacity, we believe that capacity will be available. Several major
fiber construction projects have commenced in the domestic United States, and
frequently the developer of a fiber route will exchange access with other fiber
carriers in a "route swap." Such "route swaps" bring a new vendor of fiber along
a particular route to the marketplace, and ultimately serve to drive the price
of fiber-optic capacity down.
Our network operations center located in San Francisco is operated on a 24
hour-a-day, seven day-a-week basis. This network operations center functions
primarily to ensure that our backbone network is operational at an optimal level
and has the ability to ingress and egress traffic. In addition, the center
monitors the connections between the backbone network and the customer. If the
customer's network fails, we notify the customer of their network failure and
begin working immediately to correct the failure.
Peering Relationships
We have both public and private peering relationships. A peering relationship
permits the direct connection of two providers to exchange data without the
necessity of paying a third party. We believe we were one of the first companies
to provide commercial Internet access to both consumers and corporations. As the
Internet and Internet interexchange points have evolved, we have been well
positioned to become and have become a significant peering partner. We currently
have public peering at the major interexchange points sanctioned by the National
Science Foundation including the following locations where we experience the
highest volume of data exchange:
- MAE East in Vienna, Virginia
- MAE West at Nasa Ames Research Center in Palo Alto, California
- the Fix West Federal Interconnect Exchange at Nasa Ames Research Center in
Palo Alto, California
- the Sprint Network Access Point in Pensauken, New Jersey
- the AADS Network Access Point in Chicago, Illinois
- the Pacific Bell Network Access Point in San Francisco, California
- the Pacbell Switched Multimegabit Data Service Cloud in Northern California
- the Commercial Internet Exchange router in Santa Clara, California
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As is typical industry practice, we have reciprocal peering relationships with
other Internet service providers that offer significant traffic exchange. Our
open network policy allows us to make cost-based peering decisions between
public and private peering points to route traffic efficiently.
Subject to few exceptions, our peering relationships generally are not subject
to any written agreements and could be terminated at any time. For those peering
arrangements subject to contracts, there are no minimum or fixed charges for
data exchange. Such agreements generally do impose minimum usage requirements at
levels which CRL has in the past always exceeded. However, these contracts can
be terminated by either party where the peering could have a detrimental impact
on a party's network. Any network may refuse to peer with any other network. As
the Internet has evolved, network service providers have determined whether they
will recognize a second provider as a peer based on the impact on its customers
of failing to do so. The first provider makes this determination by analyzing
how many customers of the second provider rely on it as their sole source of
connectivity to the Internet. If the second provider has customers who look to
that provider as their sole source, and the first and second providers refuse to
peer with one another, the portions of each provider's customer base that are
sole source will be unable to connect with each other over the Internet. Another
basis upon which a network may refuse to peer with another is to avoid peering
with a network run by inexperienced technicians which can result in data being
sent to the wrong location.
As a result of our early involvement in the Internet, we are a Tier 1 Internet
service provider and have peering relationships with other Tier 1 Internet
service providers.
SALES AND MARKETING
Our sales and marketing objective is to achieve broad market penetration and
increase brand name recognition among small and medium-sized businesses,
Internet service and content providers, government agencies and educational
institutions on a national basis through the expansion of our sales organization
and extensive marketing activities. As of June 16, 1999, we employed 24 persons
in sales and marketing. We have developed a multi-tiered sales strategy to sell
and market to our target markets through direct sales, Internet alliances,
channel relationships and customer referrals.
Direct Sales. Our direct sales force currently consists of highly trained
individuals located in San Francisco, California and three other sales offices
in the United States. Approximately 99% of our sales are currently generated by
our direct sales force. Our sales force is supported in their sales efforts by a
sales engineer and, in many instances, by senior management. We believe that the
integration of our sales engineers with our sales account managers assists both
the establishment of customer relationships as well as the migration of
customers to increased use of our services through cross selling of our
value-added services. We have developed programs to attract and retain high
quality, motivated sales representatives with the necessary technical skills,
consultative sales experience and knowledge of their local markets. These
programs include technical and sales process training and instruction in
consultative selling techniques. We have also developed sales compensation plans
that provide significant incentives for exceeding performance targets. We are
actively seeking to expand our direct sales force and sales engineering staff.
Our direct sales process consists of a multifaceted approach to lead generation
and includes direct mail, advertising, Web-based marketing, networking and cold
calling. We target small and medium-sized businesses nationwide with particular
emphasis on those geographic areas where we have points of presence. Prospects
are qualified through a needs-based consultative sales process and, depending
upon the complexity of the client need, sales engineers and senior management
are called upon to develop solutions.
Develop Channel Relationships. We are in the process of developing relationships
with potential channel partners including hardware vendors, value-added
resellers, system integrators and Web hosting companies to leverage their sales
organizations. A channel partner is a CRL customer who acts as a reseller of our
services. Compensation received by our channel partners may consist of a
one-time payment based upon a percentage of the price of the services sold, a
one-time payment and a residual percentage of CRL's monthly customer billings,
or payment based upon the differential between the price at which the channel
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partner sold the services and CRL's price for such services. We began our
channel partnerships in the first quarter of 1999 and had contracts with 25
partners at June 16, 1999. We believe that by relying upon the sales forces of
these companies, we can attract customers in a cost-effective manner, as well as
provide co-branded Internet and network management service offerings for our
channel partners. We are actively engaged in hiring experienced channel managers
to focus exclusively on developing these relationships.
By providing Internet and network management solutions, our partners can satisfy
the demands of their customers, as well as create opportunities for new
business. We will offer the expertise involved with a complex networking
infrastructure that will allow our partners to focus on their own areas of
expertise. This relationship will provide our partner with the tools needed to
bundle Internet access with a variety of services provided by us or our partner,
and gain the competitive edge needed to attract and maintain more customers,
increase market share and grow.
Because we realize that most companies have specific operating requirements, we
have designed a flexible program to accommodate specific needs. We will both
provide the necessary network connectivity and serve as a technical resource for
our partners. Engineers in our networking operating center monitor the network
around the clock to ensure the highest quality Internet, remote management
service and hosting services and technical support for our partner and its
customers. Instead of spending time and money building a national network
infrastructure, partners will be able to simply add Internet, remote management
service and hosting services to their existing products by becoming part of our
network. By bundling Internet, remote management service and hosting services
with existing products, the partner will be able to offer a high quality network
connection to the Internet with the ease of one bill and one point-of-contact
for customers.
Marketing. Our marketing program is intended to build national and local
strength and brand awareness. We use print advertising and direct mail in
targeted markets and publications to enhance awareness and acquire leads for our
direct sales force. We also use telemarketing programs, Web marketing and joint
promotional efforts.
CUSTOMER SUPPORT
We offer a high level of customer service and quality assurance by understanding
the technical requirements and business objectives of our customers and
addressing their needs proactively on an individual basis. By working closely
with our customers, we are able to enhance the performance of our customers'
Internet and network operations, avoid downtime, rapidly resolve problems and
make appropriate adjustments in services as customer needs change over time. We
work with our customers over time to ensure that we are offering the appropriate
types and quality of service. As of June 16, 1999, we had 15 employees dedicated
to customer service and quality assurance.
Upon receipt of a signed sales contract, the salesperson prepares a sales order
form and sends it to our provisioning department which, after initial review,
forwards the sales order to our finance department for approval and set up on
the billing system.
Within the provisioning department the sales order is logged into a tracking
system that is reviewed by management on a weekly basis. The provisioning
department arranges all internal and external activities to complete the
installation of the sales order. As necessary, they arrange for purchase,
delivery and setup of equipment, arrange for necessary circuits with various
telecommunications vendors and complete necessary changes to our network through
our engineering department.
Upon completion of all necessary installations, the customer is contacted for
testing and acceptance. Customer information is entered into an operations
database and our finance department is notified to begin billing.
Ongoing customer service is provided by our technical support group. Our network
operations center operates and is available for technical support 24
hours-a-day, seven days-a-week, 365 days-a-year. They monitor customer circuits
real-time on the same basis. As problems are identified or customer calls are
received they are logged into a trouble ticket system and worked through to
resolution. Inquiries can be
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accepted by voice or e-mail and are typically answered within a few minutes or
hours of receipt. Resolution times vary depending upon the problem's severity
and complexity. Resolution times that exceed a few hours are escalated to
management.
Our enhanced customer support systems monitor and track support questions from
our customers. These systems were developed to help the network engineers track
problems efficiently and reliably. They provide an accurate history of each
account enabling the engineers to quickly access support inquiries and provide
us with valuable historical data about each account. Every time a support
question is called in, a historical record, commonly referred to as a
"trouble-ticket," is opened. Until the problem is resolved, the trouble-ticket
remains open. When necessary, the trouble-ticket is escalated in order to reach
the fastest possible resolution. The escalation chart is made available to our
customers.
COMPETITION
Our competitors generally may be divided into four principal groups:
- telecommunications carriers including regional Bell operating companies
- Internet service providers
- network and system integrators
- online network service providers
Telecommunications Carriers. Many long distance companies including AT&T
Corporation, Cable & Wireless P.L.C., Sprint Corporation, MCI WorldCom, Inc.,
Qwest Communications International Inc., Level 3 Communications Inc., IXC
Communications, Inc. and Frontier Corporation offer Internet access services and
network services. Recent reforms in federal regulation of the telecommunications
industry have created greater opportunities for incumbent local exchange
carriers such as PacBell Internet, and competitive local exchange carriers such
as WinStar Communications, Inc., to enter the Internet connectivity market. We
believe that there is a move toward horizontal integration by these kinds of
carriers through acquisitions of, joint ventures with, or the wholesale purchase
of connectivity from, Internet service providers in order to meet the Internet
connectivity requirements of their business customers. Accordingly, we expect
that we will experience increased competition from the traditional
telecommunications carriers. In addition to their greater network coverage,
market presence and financial, technical and personnel resources, many of these
telecommunications carriers also have large existing commercial customer bases.
Internet Service Providers. Our competitors include Internet service providers
with a national or global presence that focus on business customers, such as
PSINet, Inc. and UUNET Technologies, Inc. We also compete with Internet service
providers that cluster in major markets and regional Internet service providers
that have facilities in key metropolitan areas, including Verio, Inc., and
specialized Internet service providers such as Concentric Network Corporation,
Exodus Communications, Inc., AboveNet Communications Inc. and AppliedTheory
Corporation, as well as emerging Internet service providers. While we believe
that our state-of-the-art network infrastructure, quality customer service and
proactive support teams distinguish us from most Internet service providers,
many of these competitors have greater financial, technical, and marketing
resources, larger customer bases, greater name recognition and more established
relationships in the industry.
Network and System Integrators. We compete with large information technology
outsourcing firms such as the Big 5 accounting firms, EDS Corp., Perot Systems
Corporation and similar firms. These firms tend to focus on large customers who
outsource entire information technology functions or re-engineer their
information technology infrastructure. We believe that we are distinguished from
these competitors because we specialize in Internet Protocol-based integration
for the businesses and government agencies focused on Internet and other network
operations. We also compete with smaller network and systems integrators.
However, we believe that our expertise with large and complex systems, our
methodology and our ability to offer one-stop solutions for integration, data
center services and network connectivity set us apart from this segment of the
competition.
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Online Network Service Providers. In providing consumer Internet access, we
compete with online network service providers such as America Online,
Compuserve, MSN (The Microsoft Network) and Prodigy Communication Corporation.
The services offered by these companies often includes access to content
specific to each company. While we believe that our consumer products are
competitively priced and that our support and proactive network maintenance give
us an advantage over our competitors, many of these competitors have greater
financial, technical and marketing resources, larger customer bases, greater
name recognition, wider customer reach and more established relationships in the
industry.
We believe the primary competitive factors in our markets are:
- a reliable and powerful network infrastructure
- a broad range of services and technical expertise
- quality of customer service
- experienced and knowledgeable sales force and engineers
Many of our competitors may be able to develop and expand their communications
and network infrastructures more quickly, adapt more swiftly to new or emerging
technologies and changes in customer requirements, take advantage of acquisition
and other opportunities more readily, and devote greater resources to the
marketing and sale of their services than we can. In addition, we believe
competition in our markets will intensify as new competitors enter our markets
which have no significant barriers to entry. In addition, some of our
competitors may bundle other services and products, offer their services at more
attractive prices, or offer other high speed data services using alternative
delivery methods.
We do not currently compete internationally. If the ability to provide Internet
access internationally becomes a competitive advantage in the Internet access
industry, we may be at a competitive disadvantage relative to our competitors.
For more information concerning the competition we face and the factors
affecting our ability to compete, see "Risk Factors -- The markets for our
services is characterized by many competing technologies, and the technologies
on which our services are based may not compete effectively," "-- The markets in
which we compete are highly competitive and we may not be able to compete
effectively especially against companies with greater resources" and "-- We may
have to reduce the cost of our services to remain competitive."
INTELLECTUAL PROPERTY RIGHTS
We believe our success depends more upon our technical expertise than our
proprietary rights. We rely upon a combination of copyright, trademark and trade
secret laws and contractual restrictions to protect our proprietary technology
and rights in our services. We have no patented technology that would preclude
or inhibit competitors from entering our market. We have entered into
confidentiality and invention assignment agreements with all of our Integral
Networking Corporation employees and our technical personnel at CRL, and
nondisclosure agreements with our suppliers, distributors and appropriate
customers to control access to and disclosure of our proprietary information.
Despite these precautions, a third party could potentially copy or otherwise
obtain and use our products or technology without authorization or to develop
similar technology independently. We cannot assure you that such measures have
been, or will be, adequate to protect our proprietary technology or deter
third-party development of similar technologies. We also rely on technologies
that we license from third parties such as network management software. We do
not license any other technology that is not generally available. These
third-party technology licenses may not always continue to be available to us on
commercially reasonable terms. The loss of such technology could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, which could affect us in a material adverse manner. To date, we
have not been notified that we infringe the proprietary rights of third parties,
but there can be no assurance that third parties will not claim infringement by
us. We expect that participants in our markets will be increasingly subject to
infringement claims as the number of technologies and competitors in our
industry grows. Any such claim, whether meritorious or not, could be time
consuming, result in costly litigation, cause service delays or
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require us to enter into royalty or licensing agreements. Such royalty or
licensing agreements might not be available on terms acceptable to us or at all.
As a result, any such claim could have a material adverse effect upon our
business, results of operations and financial condition.
GOVERNMENT REGULATION
Currently only a small body of laws and regulations directly apply to access to
or commerce on the Internet. However, due to the Internet's increasing
popularity and use, laws and regulations may be adopted at the international,
federal, state and local levels with respect to the Internet, covering issues
such as user privacy, freedom of expression, pricing, characteristics and
quality of products and services, taxation, advertising, intellectual property
rights, information security and the convergence of traditional
telecommunications services with Internet communications. Moreover, a number of
laws and regulations have been proposed and are currently being considered by
federal, state and foreign legislatures with respect to such issues. The nature
of any new laws and regulations and the manner in which existing and new laws
and regulations may be interpreted and enforced cannot be fully determined. The
adoption of any future laws or regulations might decrease the Internet's growth,
decrease demand for our services, impose taxes or other costly technical
requirements or otherwise increase the cost of doing business or in some other
manner have a material adverse effect on us. In addition, applicability to the
Internet of existing laws governing issues such as property ownership,
copyrights and other intellectual property issues, taxation, libel, obscenity
and personal privacy is uncertain. As our services are available over the
Internet in multiple states, and as we facilitate sales by our customers to end
users located in such states, such jurisdictions may claim that we are required
to qualify to do business as a foreign corporation in each such state. Any such
new legislation or regulation, or the application of laws or regulations from
jurisdictions whose laws may not currently apply to our business, could have a
material adverse effect on us.
The Telecommunications Act of 1996 imposes criminal liability on persons sending
or displaying in a manner available to minors indecent material on an
interactive computer service such as the Internet and on an entity knowingly
permitting facilities under its control to be used for such activities. Sections
of the Communications Decency Act of 1996 that, among other things, proposed to
impose criminal penalties on anyone distributing "indecent" material to minors
over the Internet, were held to be unconstitutional by the United States Supreme
Court. Legislation similar to the Communications Decency Act could subject us
and/or our customers to potential liability, which in turn could have an adverse
effect on us. Additionally, the Child Online Protection Act of 1998 prohibits
and imposes criminal penalties and civil liability on anyone engaged in the
business of selling or transferring, by means of the World Wide Web, material
that is harmful to minors without restricting access to such material by persons
under seventeen years of age. Numerous states have adopted or are currently
considering similar types of legislation. The imposition upon us, our customers
or other persons of potential liability for such materials carried on or
disseminated through our systems could require us to implement measures to
reduce our exposure to such liability. Such measures may require the expenditure
of substantial resources or the discontinuation of some of our product or
service offerings. Further, the costs of defending against any such claims and
potential adverse outcomes of such claims could have a material adverse effect
on us. The Child Online Protection Act has been challenged by civil rights
organizations in part on the grounds that it violates the First Amendment. A
United States District Court has preliminary enjoined enforcement of the law
until final resolution of the case. A similar statute was held unconstitutional
by the United States Supreme Court in 1997.
The law relating to the liability of online service providers, private network
operators and Internet service providers for information carried on or
disseminated through the facilities of their networks is continuing to evolve
and remains unsettled. In the past, one federal district court in the northern
district of California, where we conduct business, has ruled that Internet
service providers could be found liable for copyright infringement as a result
of information disseminated through their networks. We cannot assure you that
similar claims will not be asserted in the future. Federal laws have been
enacted, however, which provide Internet service providers with immunity from
publisher or speaker liability for information that is disseminated through
their networks when they are acting as mere conduits of information. A Federal
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Court of Appeals has recently held that the Telecommunications Act creates
immunity from liability on the part of Internet service providers for libel
claims arising out of information disseminated over their services by
third-party content providers. In addition, the Digital Millennium Copyright
Act, enacted in 1998, creates a safe-harbor from copyright infringement
liability for Internet service providers if:
- the transmission was initiated by or at the direction of a person other than
us
- the transmission or routing is carried out through an automatic technical
process without selection of the material by us
- we do not elect the recipients of the material except as an automatic
response to the request of another person
- a copy of the material in the course of intermediate or transient storage is
maintained on the system in a manner accessible to no one other than the
recipients or for a period longer than is reasonably necessary for the
transmission or routing to occur and
- no modification of the transmission's content occurs through our system
We cannot assure you, however, that the Digital Millennium Copyright Act or any
other legislation will protect us from copyright infringement liability. We
maintain general liability insurance. However, any imposition of liability on us
for alleged negligence, intentional torts such as infringement, or other
liability could have a material adverse effect on us.
Both the provisioning of Internet access service and the provisioning of
underlying telecommunications services are affected by federal, state and local
regulation. The Federal Communications Commission exercises jurisdiction over
all facilities of, and services offered by, telecommunications carriers to the
extent that they involve the provision, origination or termination of
jurisdictionally interstate or international communications, including by
competitive local exchange carriers. The state regulatory commissions retain
jurisdiction over the same facilities and services to the extent they involve
origination or termination of jurisdictionally intrastate communications. In
addition, as a result of the passage of the Telecommunications Act, state and
federal regulators share responsibility for implementing and enforcing the
domestic pro-competitive policies of the Telecommunications Act. In particular,
state regulatory commissions have substantial oversight over the provision of
interconnection and non-discriminatory network access by incumbent local
exchange carriers. Municipal authorities generally have some jurisdiction over
access to rights of way, franchises, zoning and other matters of local concern.
Government agencies do not regulate Internet operations distinctly from their
regulation of businesses generally. However, the Federal Communications
Commission continues to review its regulatory position on the usage of the basic
network and communications facilities by Internet and other network service
providers. In an April 1998 report, the Federal Communications Commission
determined that Internet service providers should not be treated as
telecommunications carriers and should consequently not regulated. However, this
report stated that it expected the regulatory status of Internet service
providers in the future to continue to be uncertain. The report concluded that
some services offered over the Internet, such as phone-to-phone Internet
protocol telephony, may be functionally indistinguishable from traditional
telecommunications service offerings, and their non-regulated status may have to
be re-examined.
Changes in the regulatory structure and environment affecting the Internet
access market, including regulatory changes that directly or indirectly affect
telecommunications costs or increase the likelihood of competition from regional
Bell operating companies or other telecommunications companies, could have an
adverse effect on our business. Although the Federal Communications Commission
has decided not to allow local telephone companies to impose per-minute access
charges on Internet service providers, and that decision has been upheld by the
reviewing court, further regulatory and legislative consideration of this issue
is likely. In addition, some telephone companies are seeking relief through
state regulatory agencies. Such rules, if adopted, are likely to have a greater
impact on consumer-oriented Internet access providers than on business-oriented
Internet service providers, such as us. Nonetheless, the imposition of access
charges would affect our costs of serving dial-up customers and could have a
material adverse effect on us.
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We have recently received approval to operate as a competitive local exchange
carrier in California and intend to apply to receive similar status in other
states. Where we have competitive local exchange carriers status, regional Bell
operating companies are obligated to provide us with local connectivity loops at
prices that are substantially below the prices paid by Internet and other
network service providers that are not competitive local exchange carriers. As a
provider of domestic basic telecommunications services, particularly competitive
local exchange services, we could become subject to further regulation by the
Federal Communications Commission and/or other regulatory agencies, including
those at the state and local levels. The Telecommunications Act has caused
fundamental changes in the markets for local exchange services. In particular,
the Telecommunications Act and the Federal Communications Commission rules
issued pursuant to it mandate competition in local markets and require that
incumbent local exchange carriers interconnect with competitive local exchange
carriers. Under the provisions of the Telecommunications Act, the Federal
Communications Commission and state public utility commissions share
jurisdiction over the implementation of local competition, the Federal
Communication Commission was required to promulgate general rules and the state
commissions were required to arbitrate and approve individual agreements.
However, the Federal Communication Commission interconnection rules implementing
the Telecommunications Act were appealed and the U.S. Court of Appeals for the
Eighth Circuit issued a decision vacating the FCC's pricing rules, as well as
other portions of the FCC's interconnection rules, on the grounds that the FCC
had improperly intruded into matters reserved for state jurisdiction. On January
25, 1999, the Supreme Court largely reversed the Eighth Circuit's order, holding
that the FCC had general jurisdiction to implement local competition provisions
of the Telecommunications Act. In so doing, the Supreme Court stated that the
FCC has authority to set pricing guidelines for unbundled network elements, to
prevent incumbent local exchange carriers from disaggregating existing
combinations of network elements, and to establish "pick and choose" rules
regarding interconnection agreements (which would permit a carrier seeking
interconnection to "pick and choose" among the terms of service from other
interconnection agreements between the incumbent local exchange carriers and
other competitive local exchange carriers). This action reestablishes the
validity of many of the FCC rules vacated by the Eighth Circuit. Although the
Supreme Court affirmed the FCC's authority to develop pricing guidelines, the
Supreme Court did not evaluate the specific pricing methodology adopted by the
FCC and has remanded the case to the Eighth Circuit for further consideration.
In its decision, however, the Supreme Court also vacated the FCC's rule that
identifies the unbundled network elements that incumbent local exchange carriers
must provide to competitive local exchange carriers. The Supreme Court found
that the FCC had not adequately considered certain statutory criteria for
requiring incumbent local exchange carriers to make those network elements
available to competitive local exchange carriers and must reexamine the matter.
Thus, while the Supreme Court resolved many issues, including the FCC's
jurisdictional authority, other issues remain subject to further consideration
by the courts and the FCC. The Eighth Circuit has not yet reinstated the FCC's
rules that were affirmed by the Supreme Court, and several incumbent local
exchange carriers have asked the Eighth Circuit not to reinstate those rules
until further legal challenges have been resolved. We cannot predict the
ultimate disposition of those matters. The possible impact of this decision,
including the portion dealing with unbundled network elements, on existing
interconnection agreements between incumbent local exchange carriers and
competitive local exchange carriers or on agreements that may be negotiated in
the future also cannot be determined at this time.
A critical issue for competitive local exchange carriers is the right to receive
reciprocal compensation for the transport and termination of Internet traffic.
We believe that, under the Telecommunications Act and current Federal
Communications Commission rules, competitive local exchange carriers are
entitled to receive reciprocal compensation from incumbent local exchange
carriers. However, some incumbent local exchange carriers have disputed payment
of reciprocal compensation for Internet traffic, arguing that Internet service
provider traffic is not local traffic. Most states have required incumbent local
exchange carriers to pay Internet service providers reciprocal compensation.
However, federal regulators and some state regulators are currently considering
the proper jurisdictional classification of local calls placed to an Internet
service provider and whether Internet service provider calling triggers an
obligation to pay reciprocal compensation. On October 30, 1998, the Federal
Communications Commission determined that dedicated digital subscriber line
service is an interstate service and properly tariffed at the interstate level.
On February 25, 1999, the Federal Communications Commission ruled that calls to
Internet service
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providers for Internet access were long distance, not local, calls. However, the
ruling upheld existing reciprocal compensation agreements in some states,
including California. Because of our reciprocal compensation agreement with
Pacific Bell, we do not expect this ruling will have a material effect on our
operating costs in the near future. If incumbent local exchange carriers charge
fees for carrying Internet traffic and Internet access becomes more expensive in
the longer term, this ruling may have an adverse effect on our potential future
revenues as well as increase our costs.
As we become a competitor in local exchange markets, we will become subject to
state requirements regarding provision of intrastate services. These
requirements may include the filing of tariffs containing rates and conditions.
As a new entrant without market power, we expect to face a relatively flexible
regulatory environment. Nevertheless, it is possible that some states could
impose a variety of requirements on our operations, such as the approval of the
public utilities commission for the issuance of debt or equity or other
transactions that would result in a lien on our property used to provide
intrastate services.
EMPLOYEES
As of June 16, 1999, we had 61 employees, of which 24 were employed in sales and
marketing, 8 were assigned to engineering and service development, 15 were
employed in customer service and technical support, and 14 were in finance and
administration. We believe that our future success will depend in part upon our
continued ability to attract, hire and retain qualified personnel. The
competition for such personnel is intense, and we may not be able to identify,
attract and retain such personnel in the future. None of our employees is
represented by a labor union and management believes that our employee relations
are good.
FACILITIES
Our executive offices are located in San Francisco, California and consist of
approximately 4,650 square feet that are leased pursuant to an agreement that
expires in August 1999 with a three year renewal option. Additionally, we
sublease additional offices in San Francisco, California of approximately 3,500
square feet pursuant to an agreement that expires in September 1999. We also
have a network operating center in San Francisco of approximately 4,000 square
feet under a lease expiring in 2005. Beginning in the third quarter 1999, we
intend to commence relocating and consolidating our San Francisco operations. We
intend to complete the relocation and consolidation in the fourth quarter of
1999. We are also currently in negotiations with the lessor of our San Francisco
network operating center to lease additional space. We also intend to complete
the expansion of our main operational center in Sacramento, California in the
fourth quarter of 1999. This Sacramento facility consists of 4,000 square feet
under a lease agreement that expires in 2001. In addition, we lease
approximately 1,100 square feet in Vienna, Virginia (a major network access
point often referred to as MAE East) under an agreement that expires in 2000
with a five year renewal option. We also lease approximately 1,400 square feet
in the One Wilshire Building in Los Angeles under an agreement that expires in
2001. We lease facilities in 26 other cities throughout the United States for
our sales offices and regional network operating centers.
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<PAGE> 60
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
Our directors, director nominees, executive officers and key employees are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
DIRECTORS AND EXECUTIVE
OFFICERS:
James G. Couch............. 34 President, Chief Executive Officer, Chairman of the
Board and Secretary
Robert B. Murphy, Jr....... 47 Executive Vice President and Chief Financial Officer
John A. Blair.............. 52 Vice President of Business Development
Sam S. Traznik............. 34 Vice President of Direct Sales
Steven T. Stenberg......... 38 Director and Member of the Audit and Compensation
Committees
Jack M. Fields, Jr......... 47 Director Nominee and Member of the Compensation
Committee
Stephen C. Mott............ 49 Director Nominee
Thor Geir Ramleth.......... 40 Director Nominee and Member of the Audit Committee
KEY EMPLOYEES:
Robyn L. Raschke........... 34 Vice President of Finance
Philip A. Burkhart......... 37 Vice President of Channel Sales
Robert L. Ross............. 30 President, Integral Networking Corporation
Tracy M. Corrington........ 33 Director of Marketing
David L. Greenman.......... 31 Director of Systems Engineering
Richard J. Quosig.......... 45 National Sales Director
</TABLE>
JAMES G. COUCH founded our company in 1983 and has been President, Chief
Executive Officer and Chairman of the Board since incorporation in 1993. He
began developing applications for advanced networking systems with CRL and
worked closely with the National Science Foundation and Bellcore in the
transition of the Internet to a commercial medium.
ROBERT B. MURPHY, JR. has served as our Executive Vice President and Chief
Financial Officer since April 1999. Prior to joining us, Mr. Murphy was the
Executive Vice President/Chief Financial Officer of Savvis Communications
Corporation, a nationwide provider of access and Internet services, from 1997 to
April 1999. From 1992 to 1996, Mr. Murphy was the Senior Vice President/Chief
Financial Officer of Access America Telemanagement, a provider of
telecommunications services to small and medium-sized businesses. Mr. Murphy
also held positions as Vice President/Chief Financial Officer at United
Telemanagement, Inc. from 1989 to 1992 and at Belmac Corporation from 1988 to
1989. Prior to this, Mr. Murphy had seven years of investment banking
experience.
JOHN A. BLAIR has served as Vice President of Business Development since October
1998. Prior to joining us, Mr. Blair had been, since 1996, the President and a
director of Executive Strategies, his own management consulting company that
served the hi-tech and Internet service provider markets. From 1994 to 1996, Mr.
Blair was the Vice President of Operations with DG Systems, a company engaged in
digital distribution of advertising media. Mr. Blair also has more than 15 years
experience with financial institutions including Citibank N.A., Ameritrust and
Crocker Bank.
SAM S. TRAZNIK has served as our Vice President of Direct Sales since April
1999. Mr. Traznik has worked previously with GTE Internetworking as its Regional
Vice President and General Manager, Pacific Northwest from 1997 to April 1999.
From 1996 to 1997, Mr. Traznik was the President and General Manager of Advanced
Technology Marketing, a provider of Internet consulting services. From 1995 to
1996, Mr. Traznik was the Director of VAR Channels and Sales, Southern
California at Exodus
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<PAGE> 61
Communications, Inc., an Internet service provider. From 1989 to 1995, Mr.
Traznik was the National Sales Manager at Qualstar Corporation, a provider of
data communications and data storage products.
JACK M. FIELDS, JR. has agreed to serve as a director of our company upon
completion of the offering. Since January 1997, Mr. Fields has been the Chief
Executive Officer of Twenty-First Century Group, a government affairs company,
and the Chief Executive Officer of Texana Global, a firm dealing with
entrepreneurial projects in the telecommunications industry. From 1981 to 1996,
Mr. Fields was a member of the United States Congress. During 1995 and 1996, Mr.
Fields served as Chairman of the House Telecommunications and Finance
Subcommittee, which authored the Telecommunications Act of 1996 and has
jurisdiction and oversight over the Federal Communications Commission and the
Securities and Exchange Commission. Mr. Fields is also a director of AIM
Management, Administaff, Inc. and Telscape International, Inc.
STEVEN T. STENBERG has served as a director of our company since March 1999.
Since 1992, Mr. Stenberg has been President and Chief Executive Officer of his
own accounting firm, which currently has six employees, and is a certified
public accountant.
STEPHEN C. MOTT has agreed to serve as director of our company upon completion
of the offering. Since 1995, Mr. Mott has been the Chief Executive Officer of
CSI Management, Inc., an internet consulting and investment firm. From October
1995 until February 1998, Mr. Mott was the Senior Vice President -- Electronic
Commerce/New Ventures at Mastercard International Incorporated. From 1987 to
1995, Mr. Mott was the Chief Executive Officer, Chief Operating Officer and
Chief Financial Officer of Cognitive Systems, Inc., an artificial intelligence
and database mining technology company, and was the Chief Executive Officer of
Ingenia, Inc. when Ingenia purchased a portion of Cognitive Systems' business
from September 1994 to October 1995.
THOR GEIR RAMLETH has agreed to serve as director of our company upon completion
of the offering. Mr. Ramleth has been the Chief Executive Officer and a director
of ZeroDotNet, Inc. since April 1999. Mr. Ramleth was the President and Chief
Executive Officer of Genuity, Inc., an Internet service provider, from December
1995 to November 1998. Prior to that, Mr. Ramleth was the Manager of Commercial
Systems at Bechtel Group, Inc. from February 1995 to December 1995, where he was
responsible for consolidating all commercial systems activities. From February
1993 to February 1995, Mr. Ramleth was the Practice Director at Oracle
Corporation. Since January 1998, Mr. Ramleth has served as a director at
UWI.com.
ROBYN L. RASCHKE was appointed as our Vice President of Finance effective March
1, 1999. Prior to that, she served as Controller of our company since March
1997. She held the position of Assistant Controller at Greenbrier Capital
Corporation from 1992 to 1997. She has also worked at Touche Ross & Co. as a
senior auditor. Ms. Raschke has a masters degree in accounting from the
University of Georgia and is a certified public accountant.
PHILIP A. BURKHART has served as Vice President of Channel Sales since December
1998. Prior to that, he served as our Vice President of Operations since May
1995. He was instrumental in the build-out of our national backbone network and
developed the technical support/customer service and provisioning departments
within our company. Between 1991 and 1994, Mr. Burkhart worked for KBLCOM/Time
Warner where he managed its data, voice communications and video services and
Internet network throughout South Texas.
ROBERT L. ROSS founded Integral Networking Corporation in 1989 and continues to
serve as its President since our merger with Integral in December 1998. In 1996,
Mr. Ross developed Integral's remote management services. Mr. Ross was
instrumental in the completion of Integral's Network Operations Center, and, as
President of Integral, continues to provide support and vision to the remote
management service program. He has prior experience as a systems engineer at
Microage Corp. and is a Certified Novell Engineer.
TRACY M. CORRINGTON has served as Director of Marketing since September 1998 and
is responsible for marketing communications, marketing product development and
media relations. Ms. Corrington worked
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<PAGE> 62
previously with Teleport Communications Group, Inc. between 1994 and 1998,
holding management positions in marketing, public relations and communications.
Prior to that, she worked for seven years as a print investigative reporter with
several media/newspaper companies.
DAVID L. GREENMAN has served as Director of Systems Engineering since December
1998. Mr. Greenman has prior systems management and consulting experience at
Walnut Creek CDROM, Incorporated, where he has been the Systems Manager from
1995 to the present. He also was cofounder and principal architect in 1993 of
The FreeBSD Project, an operating support system that is currently used by a
variety of Fortune 500 businesses, and remains active in that project. Mr.
Greenman has also held positions with Artisans Northwest Productions, Telecom
Broadcasting, Inc., Clear View Satellite Systems and Reynolds Media Services.
RICHARD J. QUOSIG has served as National Sales Director since September 1998 and
has 12 years of telecommunications sales experience. Prior to joining us, Mr.
Quosig worked as General Manager of the flagship Silicon Valley office of
Frontier Global Center from 1997 to September 1998. From March 1996 to February
1997, Mr. Quosig worked as a Strategic Account Manager with Teleport
Communications Group, Inc. From January 1995 to January 1996, Mr. Quosig was a
Regional Sales Manager with Winstar Wireless, where he managed the eastern
portion of the United States. Prior to that, Mr. Quosig was a sales manager with
Nynex Mobile Communications from January 1994 to January 1995. Mr. Quosig was
also the national account manager at McCaw Communications (AT&T Wireless) from
January 1992 to January 1994.
BOARD COMMITTEES
The Audit Committee has the responsibility of reviewing our audited financial
statements and accounting practices, and to consider and recommend the
employment of, and approve the fee arrangements with, independent accountants
for both audit functions and for advisory and other consulting services. Upon
completion of the offering, the Audit Committee will be comprised of Messrs.
Ramleth and Stenberg. The Compensation Committee reviews and approves the
compensation and benefits for our key executive officers, administers our
employee benefit plans and makes recommendations to the Board of Directors
regarding such matters. Upon completion of the offering, the Compensation
Committee will be comprised of Messrs. Fields and Stenberg.
DIRECTORS COMPENSATION
Each non-employee director receives an initial option grant for 30,000 shares
upon becoming a director of CRL and a minimum annual option grant under our 1999
Stock Incentive Plan to purchase 5,000 shares. This amount may be increased for
any particular non-employee directors or all non-employee directors at the
discretion of the Board of Directors, but the maximum number of shares
underlying any annual option granted to any non-employee director may not exceed
50,000 shares. The initial option grants and annual option grants generally vest
over a period of three years. See "Management -- Stock Options." We also pay the
expenses of our non-employee directors in attending Board meetings. No
additional compensation is paid to any of our employee directors for serving on
our Board of Directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to this offering, our Board of Directors did not have a compensation
committee and all compensation decisions were made by the full Board of
Directors. In the year ended December 31, 1998, the full Board of Directors,
which solely consisted of James G. Couch, determined the compensation of all
executive officers, including Mr. Couch in his capacity as President and Chief
Executive Officer. Upon completion of this offering, the Compensation Committee
will make all compensation decisions. No interlocking relationship exists
between the Board of Directors or Compensation Committee and the board of
directors or compensation committee of any other company, nor has any such
interlocking relationship existed in the past.
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<PAGE> 63
EXECUTIVE COMPENSATION
The table below summarizes the annual and long term compensation paid by us
during the fiscal year ended December 31, 1998 to those persons who were, as of
December 31, 1998, (i) our President and Chief Executive Officer and (ii) our
other compensated executive officer whose total annual salary and bonus exceeded
$100,000 during the year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
------------------------------------ SECURITIES
OTHER UNDERLYING
NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION(1) OPTIONS(#)
--------------------------- -------- ----- --------------- ------------
<S> <C> <C> <C> <C>
James G. Couch........................ $329,527 $ -- -- --
President, Chief
Executive Officer and Director
Philip Burkhart....................... $115,972 $ -- $8,730 --
Vice President of Channel Sales
</TABLE>
- -------------------------
(1) The figures shown in the last column designated "Other Compensation"
represent our forgiveness of a portion of a loan made by CRL to Mr.
Burkhart. Until December 1998, Mr. Burkhart served as the Vice President of
Operations and was an executive officer of CRL.
No options were granted to the named executives in the last fiscal year.
AGGREGATED OPTION EXERCISES DURING LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES
The table below sets forth information regarding options exercised during the
year ended December 31, 1998 by the executive officers identified in the Summary
Compensation Table above, as well as the aggregate value of unexercised options
held by those executive officers at December 31, 1998. We have no outstanding
stock appreciation rights.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
James G. Couch............ -- -- 38,421 153,685 $125,637 $502,550
Philip Burkhart........... -- -- 38,421 153,685 125,637 502,550
</TABLE>
- -------------------------
(1) There was no public trading market for the common stock as of December 31,
1998. Accordingly, these values have been calculated on the basis of fair
market value of common stock of $5.10 per share. Therefore, the value of
options in the table is calculated based on the $5.10 per share value, less
the applicable exercise price per share, multiplied by the number of shares
underlying these options.
401(k) PLAN
We have an employee profit sharing plan that is intended to qualify as a
deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Under our 401(k) Plan, our officers and other employees may elect to defer up to
15% of their compensation, subject to limitations under the Internal Revenue
Code. We may from time to time also make contributions on behalf of each officer
or other employee, which contributions vest depending on the length of
employment of each respective officer or employee. Amounts deferred are
deposited by us in a trust account for distribution to employees upon
retirement, attaining age 65, permanent disability, death, termination of
employment or the occurrence of conditions constituting extraordinary hardship.
We have not made matching contributions on behalf of our officers and other
employees in the past.
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STOCK OPTIONS
1997 Equity Incentive Plan
On August 8, 1997, our Board of Directors adopted, and our stockholders
approved, the CRL Network Services, Inc. 1997 Equity Incentive Plan. The 1997
Equity Incentive Plan provides for the grant of incentive and non-statutory
options, restricted stock or stock bonuses to purchase up to an aggregate of the
number of shares of common stock equal to 10% of the total number of shares of
our authorized common stock. Incentive stock options can be granted only to our
full-time employees, including officers and directors who are also employees,
while non-statutory stock options, restricted stock and stock bonuses can be
granted to our employees, officers and directors, consultants and advisors.
Participants in the 1997 Equity Incentive Plan are selected by our Board of
Directors, or by a committee of directors selected by the Board of Directors.
The Board of Directors or the committee is empowered to determine the terms and
conditions of each award granted under the 1997 Equity Incentive Plan, subject
to limitations including that no option can have a term in excess of ten years,
or five years if granted to an employee owning more than 10% of our outstanding
common stock. In the event of:
- a merger or consolidation in which we are not the surviving corporation
(other than a merger or consolidation with a wholly-owned subsidiary or a
reincorporation in a different jurisdiction)
- our dissolution or liquidation
- a sale of all or substantially all of our assets
- any other transaction that qualifies as a "corporate action" under Section
424(a) of the Internal Revenue Code
the number of vested shares under all options granted pursuant to the 1997
Equity Incentive Plan will increase as if the holder had remained our employee
for an additional one year from the date of such event. The Board of Directors
may amend or modify the 1997 Equity Incentive Plan at any time subject to any
required stockholder approval. The 1997 Equity Incentive Plan will terminate on
the earliest of:
- August 7, 2007
- the date in which all shares available for issuance under the 1997 Equity
Incentive Plan have been issued as fully-vested shares
- the termination of all outstanding options in connection with a change of
control in which the successor corporation does not assume the 1997 Equity
Incentive Plan
As of March 31, 1999, options to purchase 1,006,320 shares, at a weighted
average exercise price of $2.18, were outstanding under the 1997 Equity
Incentive Plan. There have been no restricted stock awards or stock bonuses
awarded. We do not intend to make any further option grants under this plan.
1999 Stock Incentive Plan
On March 18, 1999, our Board of Directors adopted, and our stockholders
approved, the CRL Network Services, Inc. 1999 Stock Incentive Plan. The 1999
Stock Incentive Plan does not limit any award to any specified form or
structure. The types and amount of awards will be determined at the discretion
of the Board of Directors or committee of the Board of Directors empowered to
administer the 1999 Stock Incentive Plan. As amended on May 18, 1999, the
maximum number of shares of common stock that may be issued under the 1999 Stock
Incentive Plan is 2,000,000 shares. If incentive stock options are issued, these
options must comply with Section 422 of the Internal Revenue Code. Participants
in the 1999 Stock Incentive Plan are selected by a committee of directors
selected by the Board of Directors as a whole, each member of which must be a
"non-employee director" as this term is defined under the Securities Exchange
Act of 1934, as amended. This committee is also empowered to determine the terms
and conditions of each option or other stock-based award granted under the 1999
Stock Incentive Plan, subject to the limitations regarding incentive stock
options imposed by the Internal Revenue Code. The Board of
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Directors may amend or modify the 1999 Stock Incentive Plan at any time subject
to any required stockholder approval. The 1999 Stock Incentive Plan will
terminate on March 17, 2009. There are currently no options or other awards
outstanding under the 1999 Stock Incentive Plan.
EMPLOYMENT AGREEMENTS
We entered into an employment agreement with James G. Couch, our President and
Chief Executive Officer, on March 15, 1999. Under the terms of this employment
agreement, Mr. Couch will receive an annual base salary of $320,000, which may
be increased at the discretion of the Board of Directors, and at the discretion
of the Board of Directors, a bonus. The term of this employment agreement ends
on February 28, 2002, and is automatically renewable for consecutive one-year
periods unless advance notice is given by either party. We may terminate Mr.
Couch or Mr. Couch may voluntarily resign at any time. If Mr. Couch is
terminated by us without cause, he will be entitled to receive twelve months'
salary, payable in equal monthly installments over the twelve month period
following termination. We are not obligated to pay any specified amount if we
terminate Mr. Couch for cause.
In connection with our merger with Integral Networking Corporation, we entered
into an employment agreement and a non-competition agreement with Robert L.
Ross, Integral's President, to continue to serve as President of Integral
Networking Corporation, our wholly-owned subsidiary. The employment agreement's
term expires December 21, 2000. Mr. Ross receives a salary of at least $56,500
and a bonus of up to $100,000 based upon targeted personal and company
performance. We may terminate Mr. Ross at any time upon written notice. Mr. Ross
may terminate his employment with us if we fail to cure any breach within 30
days following written notice from him to us describing the breach. In the event
that we terminate Mr. Ross's employment without cause before the end of its
term, we are obligated to pay Mr. Ross his then current salary until the end of
the term or for three months, whichever is less.
For more information regarding our arrangements with our key employees, See
"Risk Factors -- Our success will depend on the continued performance of our key
personnel."
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our Certificate of Incorporation and Bylaws require us to indemnify our
officers, directors, employees and other agents to the full extent permitted by
law, including those circumstances in which indemnification would otherwise be
discretionary. Delaware law provides that a corporation's certificate of
incorporation may contain a provision eliminating or limiting the personal
liability of a director for monetary damages for breach of their fiduciary
duties as directors, except for 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 as
provided in Section 174 of the Delaware General Corporation Law or any
transaction from which the director derived an improper personal benefit. Our
Bylaws also permit us to advance expenses incurred by an indemnified director or
officer in connection with the defense of any action or proceeding arising out
of such director's or officer's status or service as one of our directors or
officers upon any undertaking by such director or officer to repay such advances
if it is ultimately determined that such director or officer is not entitled to
such indemnification. In addition, our Certificate of Incorporation expressly
authorizes the use of indemnification agreements. We currently have no
indemnification agreements with our officers, directors or employees.
CERTAIN TRANSACTIONS
We were party to an airplane leasing agreement with FBN Holding Corp., the sole
stockholder of which is James G. Couch, our President and Chief Executive
Officer. Under the terms of this agreement, we were able to lease aircraft from
FBN on an hourly basis at FBN's then prevailing rate, which included, without
additional charge, all fuel, insurance, repairs and maintenance. Changes in the
FBN prevailing hourly rate required 30 days written prior notice to us. This
agreement was terminated effective April 30, 1999. During 1998, we paid FBN an
aggregate of approximately $144,000 for our use, at various times during the
year,
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of an airplane owned by FBN. We believe the rates charged by FBN were equivalent
to the rates we could obtain from unaffiliated third parties.
In August 1995, we made a loan in the amount of $106,000 with an interest rate
of 7.5% to Mr. Couch. The promissory note delivered to us specified that the
entire principal amount plus accrued interest was to be repaid by July 10, 2000.
During 1998, the stockholder repaid the entire remaining amount outstanding
under the promissory note.
We have employment agreements for specified terms with Messrs. Couch and Ross.
See "Management -- Employment Agreements."
All future transactions among us, our directors, principal stockholders and
their affiliates will be approved by a majority of the Board of Directors,
including a majority of the independent and disinterested directors.
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<PAGE> 67
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of our common stock as of June 16, 1999, and as adjusted to reflect
the sale of 5,000,000 shares by us, by (i) each of our directors and director
nominees, (ii) each person or group known to us to be the beneficial owner of
more than 5% of our outstanding common stock, (iii) our named executive officers
whose total salary and bonus exceeded $100,000 during the year ended December
31, 1998, and (iv) all of our directors and executive officers as a group. Each
of these persons has the sole voting and investment power with respect to the
shares owned. Except as otherwise indicated, the address of each holder
identified below is care of CRL Network Services, Inc., One Kearny Street, Suite
1450, San Francisco, California 94108.
<TABLE>
<CAPTION>
SHARES SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING(1) AFTER THE OFFERING(1)
--------------------- ---------------------
NAME NUMBER PERCENT NUMBER PERCENT
---- ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
James G. Couch(3).............................. 18,039,533(2) 94.6% 18,039,533 74.9%
Philip Burkhart(4)............................. 60,000(5) 0.3% 60,000 0.2%
Steven T. Stenberg............................. -- -- -- --
Jack M. Fields, Jr. ........................... -- -- -- --
Stephen C. Mott................................ -- -- -- --
Thor Geir Ramleth.............................. -- -- -- --
All directors and executive officers as a group
(5 persons).................................. 18,039,533(2) 94.6% 18,039,533 74.9%
</TABLE>
- -------------------------
(1) In calculating beneficial and percentage ownership, all shares of common
stock that a named stockholder or specified group will have the right to
acquire within 60 days of the date of this prospectus upon exercise of
stock options are deemed to be outstanding for the purpose of computing the
ownership of such stockholder, but are not deemed to be outstanding for the
purpose of computing the percentage of common stock owned by any other
stockholder. As of June 16, 1999, an aggregate of 19,038,832 shares of
common stock were outstanding.
(2) Includes 38,421 shares issuable upon exercise of stock options held by Mr.
Couch but does not include 153,685 shares issuable upon exercise of stock
options that have been granted but are not exercisable within 60 days of
the date of this prospectus.
(3) Mr. Couch and CRL have granted the underwriters an over-allotment option to
purchase a maximum of 750,000 additional shares from Mr. Couch or, at his
option, CRL. See "Underwriting."
(4) Until December 1998, Mr. Burkhart was an executive officer of CRL, serving
as Vice President of Operations.
(5) Does not include 132,106 shares issuable upon exercise of stock options
which have been granted but are not exercisable within 60 days of the date
of this prospectus.
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DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 70,000,000 shares of common stock,
$.0001 par value, and 5,000,000 shares of preferred stock, $.01 par value. The
description of our capital stock below and provisions of our charter documents
is not complete and is qualified by our Certificate of Incorporation and Bylaws,
which are included as exhibits to the Registration Statement that this
prospectus is a part of.
COMMON STOCK
As of June 16, 1999, there were 19,038,832 shares of common stock outstanding
that were held of record by five stockholders. Upon completion of this offering,
there will be 24,038,832 shares of our common stock outstanding assuming no
exercise of the underwriters' over-allotment option and no exercise of
outstanding options. Holders of the common stock are entitled to one vote per
share on each matter submitted to a vote of our stockholders. Cumulative voting
for the election of directors is not authorized by our Certificate of
Incorporation, which means that the holders of a majority of the shares voted
can elect all of the directors then standing for election. Subject to
preferences that may be applicable to the holders of any outstanding series of
our preferred stock, each holder of common stock is entitled to receive
dividends, if any, as may be declared by our Board of Directors out of funds
legally available for the payment of dividends. We have not granted dividends in
the past and have no current plans to do so in the future. See "Dividend
Policy." Upon our liquidation, dissolution or winding up, our common
stockholders are entitled to share ratably in all of our assets which are
legally available for distribution, after payment of all debts and other
liabilities and the liquidation preference of any outstanding series of
preferred stock. Holders of common stock have no preemptive, subscription,
redemption or conversion rights. The outstanding shares of common stock are, and
the shares to be sold by us in the offering will be, when issued and delivered,
validly issued, fully-paid and non-assessable under the Delaware General
Corporation Law.
PREFERRED STOCK
As of June 16, 1999, no shares of preferred stock were outstanding. Our Board of
Directors is authorized, subject to any limitations of the Delaware General
Corporation Law, but without further vote or action by our stockholders, to
issue preferred stock in one or more series. The Board of Directors can
establish the number of shares of each series, to fix the designations, powers,
preferences and rights of the shares of each such series, including dividend
rights, dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices and liquidation preferences. The Board of Directors can also
establish any qualifications, limitations or restrictions of the preferred
stock, and to increase or decrease the number of shares of any such series, but
not below the number of shares of such series then outstanding. The Board of
Directors may authorize the issuance of preferred stock with voting or
conversion rights that could adversely affect the voting power or other rights
of the holders of common stock. While providing flexibility in connection with
possible acquisitions and other corporate purposes, the issuance of preferred
stock may have the effect of delaying, deferring or preventing a change in
control of our company. We have no current plans to issue any shares of
preferred stock.
CERTAIN PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS
Stockholder Meetings
Our Bylaws provide that any action required to be taken or that may be taken at
any meeting of our stockholders may only be taken at a meeting of stockholders
and may not be taken by the written consent of the stockholders. Special
meetings of stockholders may only be called by the Board of Directors, the
Chairman of the Board or the President and only such business brought forth by
or at the direction of the Board of Directors or the stockholders may be
conducted. If a stockholder wishes to propose an item for consideration at any
meeting, the stockholder must give written notice to us not less than 90 days
before the meeting or, if later, the tenth day following the date of the first
public announcement of the meeting,
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<PAGE> 69
or such other date as is necessary to comply with applicable federal proxy
solicitation rules and other regulations.
Board of Directors
Our Bylaws provide that the number of directors may not be less than two nor
more than seven until changed by an amendment duly adopted by the Board of
Directors or stockholders. The Bylaws further provide that the exact number of
directors shall be fixed from time to time, within such range, by the Board of
Directors. Currently, the number of directors is fixed at two. The Bylaws
provide that the Board of Directors will be divided into three classes of
directors, who will serve for staggered three-year terms. The Bylaws do not
provide for cumulation of stockholder votes in the election of directors.
According to the Bylaws, each director may be removed only for cause and only by
the affirmative vote of at least 80% of the outstanding shares of common stock.
The Bylaws provide that nominations for election of directors may be made by the
Board of Directors or any stockholder entitled to vote in the election of
directors. If a stockholder wishes to nominate a director, the stockholder must
give written notice to us not less than 90 days before the meeting or, if later,
the tenth day following the date of the first public announcement of the
meeting.
Amendment of Our Charter Documents
Our Certificate of Incorporation may not be amended without the approval the
holders of a majority of our outstanding voting shares or the approval of at
least a majority of our directors. Our Bylaws contain provisions requiring the
affirmative vote of at least 80% of outstanding shares of common stock to amend,
alter or repeal the provisions of the Bylaws relating to the calling of special
meetings of stockholders, advance notice of stockholder business or nominees,
removal of directors or stockholder action without a meeting.
These provisions of our charter documents may delay, defer or prevent a change
in control without further action by our stockholders, may discourage bids for
the common stock at a premium over the market price of the common stock and may
adversely affect the market price of the common stock.
Effect of Delaware Anti-takeover Statute
We are subject to Section 203 of the Delaware General Corporation Law which,
subject to exceptions, prohibits a Delaware corporation from engaging in any
"business combination" which includes a merger or sale of more than 10% of the
corporation's assets, with any interested stockholder for a period of three
years following the date that such stockholder became an interested stockholder,
unless:
- before such date, the board of directors of the corporation approved either
the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder;
- upon completion of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding those shares owned by persons who are
directors and also officers; or
- on or after such date, the business combination is approved by the board of
directors and authorized at an annual or special meeting of stockholders,
and not by written consent, by the affirmative vote of at least two-thirds
of the outstanding voting stock which is not owned by the interested
stockholder.
In general, Section 203 defines an "interested stockholder" as any entity or
person beneficially owning 15% or more of the outstanding voting stock of the
corporation or any entity or person affiliated with or controlling or controlled
by such entity or person. See "Risk Factors -- Anti-takeover provisions could
negatively impact our stockholders."
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<PAGE> 70
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is ChaseMellon Shareholder
Services, L.L.C. Its address is 400 S. Hope Street, 4th Floor, Los Angeles, CA
90071 and its telephone number is (213) 553-9700.
LISTING
Application has been made to have our common stock approved for quotation on the
Nasdaq National Market under symbol "CRLX."
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<PAGE> 71
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock. Future
sales of substantial amounts of our common stock in the public market could
adversely affect prevailing market prices.
Upon completion of this offering, there will be 24,038,832 shares of our common
stock outstanding assuming no exercise of the underwriters' over-allotment
option and no exercise of outstanding options. Of these shares, the 5,000,000
shares sold in this offering will be freely tradable without restriction or
further registration under the Securities Act, except for any such shares held
by our "affiliates" (as defined below). The remaining 19,038,832 shares held by
existing stockholders are "restricted securities" as that term is defined in
Rule 144 under the Securities Act. Restricted securities and any shares
purchased in the offering by one of our "affiliates" may not be sold in the
public market without registration under the Securities Act or in compliance
with an applicable exemption from registration as provided in Rule 144 or 701
under the Securities Act, which rules are summarized below.
In general, under Rule 144 as currently in effect, a person or persons whose
shares are aggregated who has beneficially owned shares of our common stock for
at least one year including the holding period of any prior owner other than any
of our "affiliates," or who is one of our "affiliates," is entitled to sell
within any three-month period a number of shares or, in the case of an
"affiliate," a number of such restricted securities and shares purchased in the
public market, that does not exceed the greater of:
- 1% of the shares of our common stock then outstanding, equaling
approximately 240,000 shares immediately after this offering, or
- the average weekly trading volume of our common stock in the public market
during the four calendar weeks immediately before such sale.
Sales under Rule 144 are also subject to certain requirements as to the manner
of sale, notice and availability of current public information about us.
Under Rule 144(k), a person who has not been one of our "affiliates" at any time
during the 90 days before a sale, and who has beneficially owned shares proposed
to be sold for at least two years, is entitled to sell such shares without
regard to the volume limitations, manner of sale provisions or notice
requirements.
Subject to a number of limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 of the Securities Act, as currently
in effect, permits the resale of securities originally purchased from us by our
employees, directors, officers, consultants or advisers prior to the closing of
this offering in connection with a compensatory stock or option plan or written
agreement, by persons who are not our "affiliates" subject only to the
manner-of-sale provisions of Rule 144 and by our affiliates under Rule 144
without compliance with its minimum holding period requirement.
All of our officers, directors and stockholders have generally agreed that they
will not, without the prior written consent of CIBC World Markets Corp., which
consent may be withheld in its sole discretion, and subject to limited
exceptions, directly or indirectly, sell, offer, contract or grant any option to
sell, make any short sale, pledge, transfer, establish an open "put equivalent
position" within the meaning of Rule 16a-1(h) under the Exchange Act, or
otherwise dispose of any shares of common stock, options or warrants to acquire
common stock, or securities exchangeable or exercisable for or convertible into
common stock currently owned either of record or beneficially by them or
announce the intention to do any of the acts listed above, for a period
beginning on the date of this prospectus and continuing to the date which is 180
days after the date of this prospectus. CIBC World Markets Corp. may, in its
sole discretion and any time without notice, release all or any portion of the
securities subject to these lock-up agreements. In addition, we have agreed
that, for a period of 180 days after the date of this prospectus, we will not,
without the consent of CIBC World Markets Corp., issue, offer, sell or grant
options to purchase or otherwise dispose of any equity securities or securities
convertible into or exchangeable for equity securities except for (i) the
issuance of shares of common stock offered hereby and (ii) the grant of options
to purchase shares of common stock under the 1999 Stock Incentive Plan and
shares of common
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<PAGE> 72
stock issued upon the exercise of outstanding options on or after the date of
this prospectus. See "Underwriting."
There are no restrictions on resale with respect to any of our securities, other
than restrictions imposed by lock-up agreements and applicable securities laws.
As a result of the lock-up agreements described above and the provisions of Rule
144 and 701, the restricted shares will be available for sale in the public
market immediately upon expiration of the 180 day lock-up period, subject to the
volume limitations and other conditions of Rule 144. Sales of our common stock
by these stockholders could have a material adverse effect on the trading price
of our common stock.
We have granted options to purchase up to 1,006,320 shares of common stock under
the 1997 Equity Incentive Plan of which, options to purchase 60,000 shares have
been exercised as of June 16, 1999. Concurrently with the sale of the shares
offered hereby, we intend to grant options to purchase an additional 350,000
shares of common stock pursuant to the 1999 Equity Incentive Plan. An additional
1,650,000 shares currently are reserved for issuance under the 1999 Stock
Incentive Plan. No options are outstanding under the 1999 Stock Incentive Plan.
Immediately after this offering, we intend to register the sale of the shares of
common stock issued and issuable under the 1997 Equity Incentive Plan and 1999
Stock Incentive Plan under the Securities Act. See "Management -- Stock
Options." Accordingly, as awards under the stock option plans vest, shares
issued upon exercise of these stock options will be freely tradable and
available for sale in the open market, immediately after the 180-day lock-up
agreements expire, except such shares as may be acquired by one of our
"affiliates."
On April 27, 1999, our principal stockholder, James Couch, sold 542,888 shares
of CRL common stock to ZeroDotNet, Inc. at a price equal to $9.21 per share in a
private transaction. Mr. Thor Geir Ramleth, who has agreed to serve as a
director of CRL upon completion of this offering, is the Chief Executive Officer
and a director of ZeroDotNet, Inc. In connection with this sale, CRL granted
registration rights to the buyer, including the right to demand one registration
for at least 50% of the purchased shares at any time during the period beginning
120 days after CRL's initial public offering through the second anniversary of
CRL's initial public offering. The registration rights terminate if all the
purchased shares could be sold in one transaction under Rule 144 without
exceeding the volume limitations of that rule. In addition, if we propose to
register any of our shares of common stock under the Securities Act, the buyer
is entitled to notice of and may include the purchased shares in the
registration. If the registration involves an underwriting, the underwriters may
eliminate shares in the registration and underwriting, and the shares included
in the registration must be allocated first to CRL, then to the buyer. CRL
agreed to provide the registration rights described above in exchange for the
buyer agreeing to enter into the lock-up agreement for a period of 180 days
after the date of this prospectus. The buyer must obtain a waiver of the lock-up
agreement to exercise the registration rights described above during the 180 day
period of the lock-up.
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<PAGE> 73
UNDERWRITING
CRL Network Services, Inc. and our principal stockholder, James G. Couch, have
entered into an underwriting agreement with the underwriters named below. CIBC
World Markets Corp., Lehman Brothers Inc. and DLJdirect Inc. are acting as
representatives of the underwriters.
The underwriting agreement provides for the purchase of a specific number of
shares of common stock by each of the underwriters. The underwriters'
obligations are several, which means that each underwriter is required to
purchase a specified number of shares, but is not responsible for the commitment
of any other underwriter to purchase shares. Subject to the terms and conditions
of the underwriting agreement, each underwriter has severally agreed to purchase
the number of shares of common stock set forth opposite its name below:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
CIBC World Markets Corp. ...................................
Lehman Brothers Inc.........................................
DLJdirect Inc...............................................
---------
Total....................................................... 5,000,000
=========
</TABLE>
The underwriting fee will be an amount equal to the offering price per share to
the public of the common stock, less the amount paid by the underwriters to CRL
per share of common stock. The underwriting fee is currently expected to be no
more than 7% of the total offering price to the public.
This is a firm commitment underwriting. This means that the underwriters have
agreed to purchase all of the shares offered by this prospectus (other than
those covered by the over-allotment option described below) if any are
purchased.
The representatives have advised CRL that the underwriters propose to offer the
shares directly to the public at the public offering price that appears on the
cover page of this prospectus. In addition, the representatives may offer some
of the shares to selected securities dealers at such price less a concession of
$ per share. The underwriter may also allow, and such dealers may reallow, a
concession not in excess of $ per share to other dealers. After the shares
are released for sale to the public, the representatives may change the offering
price and other selling terms at various times. An electronic prospectus is
available on the website maintained by DLJdirect Inc.
CRL and our principal stockholder, James G. Couch, have granted the underwriters
an over-allotment option. This option, which is exercisable for up to 30 days
after the date of this prospectus, permits the underwriters to purchase a
maximum of 750,000 additional shares from our principal stockholder or, at our
principal stockholder's option, CRL, to cover over-allotments. If the
underwriters exercise all or part of this option, they will purchase shares
covered by the option at the initial public offering price that appears on the
cover page of this prospectus, less the underwriting discount. If this option is
exercised in full from our principal stockholder, the total price to public will
be $ , the total proceeds to CRL will be $ and the total proceeds to
our principal stockholder will be $ . If this option is exercised in full
from CRL, the total proceeds to CRL will be $ . The underwriters have
severally agreed that, to the extent the over-allotment option is exercised,
they will each purchase a number of additional shares proportionate to the
underwriter's initial amount reflected in the foregoing table.
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<PAGE> 74
The following table provides information regarding the amount of the discount to
be paid to the underwriters by CRL.
<TABLE>
<CAPTION>
TOTAL WITH FULL TOTAL WITH FULL
EXERCISE OF EXERCISE OF
TOTAL WITHOUT EXERCISE OF OVER-ALLOTMENT OVER-ALLOTMENT
PER SHARE OVER-ALLOTMENT OPTION OPTION(1) OPTION(2)
--------- ------------------------- --------------- ---------------
<S> <C> <C> <C> <C>
CRL Network Services, Inc.........
Our Principal Stockholder.........
Total...................
</TABLE>
- -------------------------
(1) Assumes the over-allotment shares are sold by our principal stockholder.
(2) Assumes the over-allotment shares are sold by CRL.
The expenses of the offering, exclusive of the underwriting discount, include
the Securities and Exchange Commission registration fee, the National
Association of Securities Dealers filing fee, the Nasdaq National Market listing
fee, printing expenses, legal fees and expenses, accounting fees and expenses,
road show expenses, Blue Sky fees and expenses, transfer agent and registrar
fees and other miscellaneous fees. CRL estimates that the total expenses of the
offering to be paid by CRL, excluding the underwriting discount, will be
approximately $1,340,000. These fees and expenses are payable entirely by CRL.
Our principal stockholder will not bear any of the expenses of the offering
other than the underwriting discount in connection with the sale of his shares
of our common stock.
An electronic prospectus is available on the web site maintained by DLJdirect
Inc., a selected dealer and an affiliate of Donaldson, Lufkin & Jenrette
Securities Corporation. The Underwriters have agreed to allocate a limited
number of shares to DLJdirect Inc. for sale to its brokerage account holders.
CRL and our principal stockholder have agreed to indemnify the underwriters
against some specified liabilities, including liabilities under the Securities
Act of 1933.
CRL, its officers and directors and other stockholders have generally agreed to
a 180-day "lock up" with respect to 18,962,832 shares of common stock and other
CRL securities that they beneficially own, including securities that are
convertible into shares of common stock and securities that are exchangeable or
exercisable for shares of common stock. This means that, for a period of 180
days following the date of this prospectus, CRL and such persons may not offer,
sell, pledge or otherwise dispose of these CRL securities without the prior
written consent of CIBC World Markets Corp.
The representatives have informed CRL that they do not expect discretionary
sales by the underwriters to exceed five percent of the shares offered by this
prospectus.
There is no established trading market for the shares. The offering price for
the shares has been determined by CRL and the representatives, based on the
following factors:
- negotiations among CRL and the representatives
- prevailing market and economic conditions
- the financial information of CRL
- the history of, and the prospects for CRL
- CRL and the industry in which it competes
- an assessment of CRL management, its past and present operations, the
prospects for, and timing of, future revenues of CRL
- the present stage of CRL's development and the above factors in relation to
market values and valuation measures of other companies engaged in
activities similar to those of CRL's
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<PAGE> 75
The initial public offering price set forth on the cover page of this prospectus
should not, however, be considered an indication of the actual value of the
common stock. Such price is subject to change as a result of market conditions
and other factors. There can be no assurance that an active trading market will
develop for the common stock or that the common stock will trade in the public
market subsequent to this offering at or above the initial offering price.
Rules of the Securities and Exchange Commission may limit the ability of the
underwriters to bid for or purchase shares before the distribution of the shares
is completed. However, the underwriters may engage in the following activities
in accordance with the rules of the Securities and Exchange Commission:
- Stabilizing transactions -- The representatives may make bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares,
so long as stabilizing bids do not exceed a specified maximum.
- Over-allotments and syndicate covering transactions -- The underwriters may
create a short position in the shares by selling more shares than are set
forth on the cover page of this prospectus. If a short position is created
in connection with the offering, the representatives may engage in syndicate
covering transactions by purchasing shares in the open market. The
representatives may also elect to reduce any short position by exercising
all or part of the over-allotment option.
- Penalty bids -- If the representatives purchase shares in the open market in
a stabilizing transaction or syndicate covering transaction, they may
reclaim a selling concession from the underwriters and selling group members
who sold those shares as part of this offering.
Stabilization and syndicate covering transactions may cause the price of the
shares to be higher than it would be in the absence of such transactions. The
imposition of a penalty bid might also have an effect on the price of the shares
if it discourages resales of the shares.
Neither CRL nor the underwriters makes any representation or prediction as to
the effect that the transactions described above may have on the price of the
shares. These transactions may occur on the Nasdaq National Market or otherwise.
If such transactions are commenced, they may be discontinued without notice at
any time.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the shares
of common stock offered hereby will be passed upon for us by Gibson, Dunn &
Crutcher LLP, San Francisco, California. Certain legal matters in connection
with this offering will be passed upon for the underwriters by Brobeck, Phleger
& Harrison LLP, San Francisco, California.
EXPERTS
The financial statements included in this prospectus have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report appearing
herein in the registration statement, and have been so included in reliance upon
the report of such firm given upon their authority as experts in accounting and
auditing.
WHERE YOU CAN FIND MORE INFORMATION
We filed with the Securities and Exchange Commission a Registration Statement on
Form S-1 under the Securities Act with respect to the shares of common stock
offered hereby. This prospectus does not contain all of the information
contained in the Registration Statement and the exhibits and schedule filed with
the Registration Statement. For further information with respect to CRL Network
Services, Inc. and the common stock offered hereby, reference is made to the
Registration Statement and the exhibits and schedules filed as a part of the
Registration Statement. Statements contained in this prospectus concerning
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<PAGE> 76
the contents of any contract or any other document referred to are not
necessarily complete; reference is made in each instance to the copy of such
contract or document filed as an exhibit to the Registration Statement. Each
such statement is qualified in all respects by such reference to such exhibit.
The Registration Statement, including exhibits and schedules thereto, may be
inspected without charge at the Securities and Exchange Commission's public
reference facilities in Room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Securities and Exchange Commission's regional offices located
at the Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York
10048, and copies of all or any part of the Registration Statement may be
obtained from such offices after payment of fees prescribed by the Securities
and Exchange Commission. The Securities and Exchange Commission maintains a
World Wide Web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Securities and Exchange Commission at http://www.sec.gov.
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<PAGE> 77
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998
and as of March 31, 1999 (unaudited)...................... F-3
Consolidated Statements of Operations for the Years ended
December 31, 1996, 1997 and 1998 and the Three Months
Ended March 31, 1998 and 1999 (unaudited)................. F-4
Consolidated Statements of Stockholders' Equity for the
Years ended December 31, 1996, 1997
and 1998 and March 31, 1999 (unaudited)................... F-5
Consolidated Statements of Cash Flows for the Years ended
December 31, 1996, 1997 and 1998 and the Three Months
Ended March 31, 1998 and 1999 (unaudited)................. F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 78
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of
CRL Network Services, Inc.:
We have audited the accompanying consolidated balance sheets of CRL Network
Services, Inc. and subsidiary as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of CRL Network Services, Inc. and
subsidiary as of December 31, 1997 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
March 18, 1999 (April 28, 1999 as to the last paragraph in Note 12)
F-2
<PAGE> 79
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------- MARCH 31,
1997 1998 1999
------ ------ -----------
(UNAUDITED)
(NOTE 1)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and equivalents...................................... $1,115 $ 840 $ 354
Accounts receivable, net of allowances for doubtful
accounts of $162, $484 and $484, respectively.......... 1,229 1,309 1,008
Deferred tax assets....................................... 101 85 85
Other..................................................... 161 131 645
------ ------ ------
Total current assets................................... 2,606 2,365 2,092
Property and equipment, net................................. 1,801 2,445 2,385
Other assets................................................ 48 45 45
------ ------ ------
Total assets...................................... $4,455 $4,855 4,522
====== ====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 637 $ 892 $ 814
Deferred revenue.......................................... 603 594 217
Accrued liabilities....................................... 628 170 546
Current portion of long-term obligations.................. 166 270 280
Other..................................................... 18 9 6
------ ------ ------
Total current liabilities.............................. 2,052 1,935 1,863
Deferred tax liabilities.................................... 246 313 313
Long-term obligations....................................... 402 847 822
------ ------ ------
Total liabilities...................................... 2,700 3,095 2,998
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized; none issued and outstanding................
Common stock, $0.0001 par value, 70,000,000 shares
authorized; 18,978,832 shares issued and outstanding... 6 6 6
Common stock options...................................... 948 1,046
Deferred stock compensation............................... (792) (739)
Retained earnings......................................... 1,749 1,598 1,211
------ ------ ------
Total stockholders' equity............................. 1,755 1,760 1,524
------ ------ ------
Total liabilities and stockholders' equity........ $4,455 $4,855 4,522
====== ====== ======
</TABLE>
See notes to the consolidated financial statements.
F-3
<PAGE> 80
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------- ----------------
1996 1997 1998 1998 1999
------ ------ ------ ------ ------
(UNAUDITED)
(NOTE 1)
<S> <C> <C> <C> <C> <C>
REVENUES:
Colocation and internet connectivity........ $4,600 $8,873 $9,681 $2,452 $2,142
Systems integration and hardware sales...... 1,753 1,502 2,011 529 861
------ ------ ------ ------ ------
Total revenues...................... 6,353 10,375 11,692 2,981 3,003
------ ------ ------ ------ ------
COSTS AND EXPENSES:
Cost of colocation and internet
connectivity............................. 2,219 3,631 4,871 1,211 1,229
Cost of system integration and services..... 1,127 1,009 1,295 288 569
Selling and marketing....................... 345 522 371 158 41
General and administrative.................. 1,840 2,997 4,124 847 1,325
Depreciation................................ 512 745 909 190 210
Stock-based compensation expense............ 156 151
------ ------ ------ ------ ------
Total costs and expenses............ 6,043 8,904 11,726 2,694 3,525
------ ------ ------ ------ ------
OPERATING INCOME (LOSS)....................... 310 1,471 (34) 287 (522)
Net interest income (expense)................. 1 5 (30) (1) (22)
------ ------ ------ ------ ------
Net income (loss) before income taxes......... 311 1,476 (64) 286 (544)
Income tax provision (benefit)................ 150 591 87 83 (157)
------ ------ ------ ------ ------
NET INCOME (LOSS)............................. $ 161 $ 885 $ (151) $ 203 $ (387)
====== ====== ====== ====== ======
Net income (loss) per common share --
Basic and diluted........................... $ 0.01 $ 0.05 $(0.01) $ 0.01 $(0.02)
Weighted average common shares outstanding:
Basic....................................... 18,979 18,979 18,979 18,979 18,979
Diluted..................................... 18,979 19,142 18,979 19,283 18,979
</TABLE>
See notes to the consolidated financial statements.
F-4
<PAGE> 81
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMMON STOCK COMMON DEFERRED TOTAL
------------------- STOCK STOCK RETAINED STOCKHOLDERS'
SHARES AMOUNT OPTIONS COMPENSATION EARNINGS EQUITY
---------- ------ ------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996........... 18,978,832 $6 $ $ $ 703 $ 709
Net income......................... 161 161
---------- -- ------ ----- ------ ------
Balance, December 31, 1996......... 18,978,832 6 864 870
Net income......................... 885 885
---------- -- ------ ----- ------ ------
Balance, December 31, 1997......... 18,978,832 6 1,749 1,755
Compensatory stock arrangements.... 948 (948)
Amortization of deferred stock
compensation..................... 156 156
Net loss........................... (151) (151)
---------- -- ------ ----- ------ ------
Balance, December 31, 1998......... 18,978,832 6 948 (792) 1,598 1,760
Compensatory stock arrangements
(unaudited)...................... 98 (98)
Amortization of deferred stock
compensation (unaudited)......... 151 151
Net loss (unaudited)............... (387) (387)
---------- -- ------ ----- ------ ------
Balance, March 31, 1999
(unaudited)...................... 18,978,832 $6 $1,046 $(739) $1,211 $1,524
========== == ====== ===== ====== ======
</TABLE>
See notes to the consolidated financial statements.
F-5
<PAGE> 82
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ---------------
1996 1997 1998 1998 1999
----- ------- ------- ------- -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating Activities:
Net income (loss)................................. $ 161 $ 885 $ (151) $ 203 $(387)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation................................... 512 745 909 190 210
Stock-based compensation expense............... 156 151
Loss on disposal of fixed assets............... 13 3
Deferred taxes................................. 52 50 89 (14)
Changes in assets and liabilities:
Accounts receivable, net..................... (372) (588) (80) (119) 301
Other assets................................. 4 (64) 9 39 (514)
Accounts payable and accrued expenses........ 337 535 (209) (344) 298
Other liabilities............................ 250 170 (18) 34 (380)
----- ------- ------- ------- -----
Net cash provided by (used in) operating
activities.............................. 944 1,746 705 (11) (318)
----- ------- ------- ------- -----
Cash Flows from Investing Activities:
Additions to property and equipment............... (988) (1,336) (1,553) (275) (159)
Proceeds from sale of property and equipment...... 17 143 6
Decrease in notes receivable from related parties,
net............................................ 66 11 24
----- ------- ------- ------- -----
Net cash used in investing activities..... (905) (1,182) (1,529) (275) (153)
----- ------- ------- ------- -----
Cash Flows from Financing Activities:
Credit line borrowings............................ 358 703 136 48
Principal payments on borrowings.................. (14) (42) (154) (36) (63)
----- ------- ------- ------- -----
Net cash provided by (used in) financing
activities.............................. (14) 316 549 100 (15)
----- ------- ------- ------- -----
Net Increase (Decrease) in Cash and Equivalents..... 25 880 (275) (186) (486)
Cash and Equivalents at Beginning of Period......... 210 235 1,115 1,115 840
----- ------- ------- ------- -----
Cash and Equivalents at End of Period............... $ 235 $ 1,115 $ 840 $ 929 $ 354
===== ======= ======= ======= =====
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest............................ $ 7 $ 23 $ 70 $ 13 $ 22
Cash paid for taxes............................... 165 166 577 351
Supplemental Disclosure of Noncash Financing
Activities:
Equipment acquired under capital lease............ $ 133 $ 133
</TABLE>
See notes to the consolidated financial statements.
F-6
<PAGE> 83
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998, AND
THE MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE INFORMATION)
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY -- CRL Network Services, Inc. and subsidiary ("CRL" or the
"Company") was incorporated in the state of California in 1993. CRL is a Tier 1
Internet service provider focused on offering tailored Internet and network
management solutions to small and medium-sized businesses across the United
States through a national fiber-optic data network.
UNAUDITED INTERIM FINANCIAL INFORMATION -- The interim financial information as
of March 31, 1999 and for the three months ended March 31, 1998 and 1999 is
unaudited and has been prepared on the same basis as the audited financial
statements. In the opinion of management, such unaudited information includes
all adjustments (consisting only of normal recurring adjustments) necessary for
a fair presentation of the interim information. Operating results for the three
months ended March 31, 1999 are not necessarily indicative of the results that
may be expected for the year ending December 31, 1999.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the
accounts of CRL and its wholly owned subsidiary. All intercompany balances and
transactions 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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND EQUIVALENTS -- The Company considers all highly liquid monetary
instruments with an original maturity of three months or less from the date of
purchase to be cash equivalents.
PROPERTY AND EQUIPMENT -- Property and equipment are recorded at cost and
depreciated using the straight-line method over their useful lives. Equipment
held under capital leases is amortized on the straight-line method over the
shorter of the lease term or the estimated useful life of the asset. Estimated
useful lives are as follows:
<TABLE>
<S> <C>
Machinery, equipment and purchased software................. 3 to 5
Furniture and fixtures...................................... 5 to 7
Airplane.................................................... 10
</TABLE>
REVENUE RECOGNITION -- Revenues from colocation and internet connectivity
include internet and secure private network connectivity, remote management
services and hosting services. Revenues from these services are generally earned
from fixed term contracts lasting from 12 to 36 months. Revenues are recognized
on a pro rata basis when the services are performed. Deferred revenue represents
amounts billed in advance of services not yet provided. Revenues from systems
integration and hardware sales result from short term contracts and revenue is
recognized when hardware is shipped and the installation and integration is
complete.
ADVERTISING EXPENSES -- All costs related to marketing and advertising the
Company's products are expensed in the periods incurred. Advertising expenses
were $80, $27 and $60 for 1996, 1997 and 1998, respectively.
INCOME TAXES -- The Company accounts for income taxes using the asset and
liability method in accordance with Statement of Financial Accounting Standards
No. 109 ("SFAS 109"). Under this method, deferred tax liabilities and assets are
determined based on the difference between the financial
F-7
<PAGE> 84
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse.
STOCK-BASED COMPENSATION -- The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with APB No. 25,
Accounting for Stock Issued to Employees. Accordingly, no accounting recognition
is given to stock options granted at fair market value until they are exercised.
Compensation expense related to employee stock options is recorded if, on the
date of grant, the fair value of the underlying stock exceeds the exercise
price.
CONCENTRATION OF CREDIT RISK -- Financial instruments that potentially subject
the Company to concentration of credit risk consist of trade receivables. The
Company's receivables are subject to geographic concentrations of credit risk.
This risk is mitigated by the Company's credit evaluation process and the
reasonably short collection terms. The Company does not require collateral or
other security to support accounts receivable and maintains reserves for
potential credit losses.
FINANCIAL INSTRUMENTS -- The Company's financial instruments include cash and
equivalents, accounts receivable and debt. At December 31, 1997 and 1998, the
carrying amounts of these instruments approximates their fair values.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF -- The
Company evaluates its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets or
intangibles may not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to future
undiscounted net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
NET INCOME (LOSS) PER SHARE -- Basic income (loss) per share excludes dilution
and is computed by dividing net income (loss) by the weighted-average number of
common shares outstanding for the period. Diluted income (loss) per share
reflects the potential dilution that could occur if options to issue common
stock were exercised.
STOCKHOLDERS' EQUITY -- In August 1997, the Company's Board of Directors
authorized a 2,318 for 1 stock split. The stock split was effective and
distributed to the sole stockholder of record on August 8, 1997. Additionally,
in December 1998, the Company's Board of Directors authorized a 20 for 1 stock
split. The stock split was effective and distributed to the sole stockholder of
record on December 2, 1998. All share information in the financial statements
has been restated to give retroactive recognition to the stock splits.
In December 1998, the Board also authorized an increase in the number of
authorized shares of common stock to 200,000,000 (not giving effect to the
reincorporation).
COMPREHENSIVE INCOME -- There are no differences between comprehensive income
and net income as reported in the Company's statements of operations.
RECLASSIFICATIONS -- Certain prior years amounts have been reclassified to
conform to the current year presentation. Such reclassifications had no effect
on stockholders' equity or net income (loss).
RECENTLY ISSUED ACCOUNTING STANDARDS -- In March 1998, the Accounting Standards
Executive Committee of the American Institute of Certified Public Accountants
issued SOP 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. SOP 98-1 provides guidance for an enterprise on
accounting for the costs of computer software developed or obtained for internal
use. SOP 98-1 is
F-8
<PAGE> 85
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
effective for the Company in fiscal 1999. The Company anticipates that
accounting for transactions under SOP 98-1 will not have a material impact on
the Company's financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which defines derivatives, requires that all
derivatives be carried at fair value, and provides for hedge accounting when
conditions specified in SFAS No. 133 are met. SFAS No. 133 is effective for the
Company in fiscal 2000. The Company does not believe adoption of this statement
will have a material impact on the Company's financial position or results of
operations.
NOTE 2 -- MERGER
On December 21, 1998, the merger of Integral Networking Corporation ("Integral")
was completed. Under the terms of the Integral merger, which was accounted for
as a pooling-of-interests, 434,832 shares of CRL common stock were exchanged for
all of the outstanding Integral common shares at an exchange ratio of 5.80
shares of CRL for each share of Integral.
The financial information for all prior periods presented has been restated to
present the combined financial condition and results of operations for both
companies as if the merger had been in effect for all periods presented.
The following table presents a reconciliation of net sales and net income (loss)
previously reported by the company to those presented in the accompanying
consolidated financial statements.
<TABLE>
<CAPTION>
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
Net sales:
CRL.......................................... $5,206 $ 9,340 $ 9,929
Integral..................................... 1,147 1,035 1,763
------ ------- -------
Combined....................................... $6,353 $10,375 $11,692
------ ------- -------
Net income (loss):
CRL.......................................... $ 237 $ 891 $ (123)
Integral..................................... (76) (6) (28)
------ ------- -------
Combined....................................... $ 161 $ 885 $ (151)
====== ======= =======
</TABLE>
NOTE 3 -- ALLOWANCES FOR DOUBTFUL ACCOUNTS
Allowances for doubtful accounts are estimated and established based on
historical experience and specific circumstances of each customer. Additions to
the allowance are charged to general and administrative expenses. Accounts
receivable are written off against the allowance for doubtful accounts when an
account is deemed uncollectible. Recoveries on accounts receivable previously
charged off as uncollectible are credited to the allowance for doubtful
accounts. Changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
1996 1997 1998 MARCH 31, 1999
---- ----- ---- ------------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Beginning balance................. $ 7 $ 96 $162 $ 484
Additions......................... 112 624 508 126
Writeoffs......................... (23) (558) (186) (126)
---- ----- ---- -----
Balance, end of period............ $ 96 $ 162 $484 484
==== ===== ==== =====
</TABLE>
F-9
<PAGE> 86
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 -- PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
1997 1998
------ ------
<S> <C> <C>
Machinery, equipment and purchased software................ $2,892 $4,208
Furniture and equipment held under capital lease........... 265 135
Furniture and fixtures..................................... 191 558
Airplane................................................... 40 40
------ ------
Total............................................ 3,388 4,941
Less accumulated depreciation.............................. (1,587) (2,496)
------ ------
Total............................................ $1,801 $2,445
====== ======
</TABLE>
On April 15, 1997, the Company sold an airplane with book value of $148 for
$143.
The accumulated depreciation associated with furniture and equipment held under
capital lease was $70 and $67 at December 31, 1997 and 1998, respectively.
Effective January 1, 1998, the Company changed the estimated service lives of
its switches and routers from three to five years. The effect of this change in
estimate increased 1998 operating income by $237, increased net income by $142
and increased diluted earnings per share by $0.01.
NOTE 5 -- LONG-TERM OBLIGATIONS
On September 2, 1997, the Company entered into a revolving line of credit
agreement for $50 with a bank. As of December 31, 1998, the line had no
available credit and a variable interest rate that is 2.5% above the prime rate
(10.25% at December 31, 1998). All borrowings are to be repaid over a period of
no more than five years.
On September 26, 1997, the Company entered into a line of credit agreement for
$500 with a bank. As of December 31, 1998 the line has no available credit and
has a variable interest rate that is 1.75% above the prime rate (9.5% at
December 31, 1998). All borrowings are personally guaranteed by the Chief
Executive Officer and are to be repaid over a period of no more than 8 years. On
March 30, 1998, the Company entered into an equipment line of credit agreement
for $692 with a bank. The equipment line is available for one year at an
interest rate of prime plus 1.5% (9.25% at December 31, 1998). As of December
31, 1998 the line had $95 of available credit. All borrowings are personally
guaranteed by the Chief Executive Officer and are to be repaid over a period of
no more than eight years. At December 31, 1998, principal repayments under these
credit agreement are required as follows:
<TABLE>
<S> <C>
1999........................................................ $ 222
2000........................................................ 223
2001........................................................ 222
2002........................................................ 257
2003........................................................ 104
------
Total............................................. $1,028
======
</TABLE>
In September 1998 the Company entered into two additional credit agreements with
a bank. The first agreement makes $200 available for one year at an interest
rate of prime plus 1.5% for general business purpose. The second agreement is an
equipment line of credit for $650. The equipment line of credit is available for
one year with a variable interest rate of prime plus 1.8%. As of December 31,
1998 the Company has had no borrowings under these agreements. All future
borrowings are to be repaid over a period of no more than eight years.
F-10
<PAGE> 87
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 -- LONG-TERM OBLIGATIONS (CONTINUED)
Amounts borrowed under these agreements are secured by substantially all of the
Company's assets.
NOTE 6 -- INCOME TAXES
Income taxes consist of the following at December 31:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Current:
Federal............................................. $ 72 $412 $ 21
State............................................... 26 129 (23)
---- ---- ----
Total current............................... 98 541 (2)
---- ---- ----
Deferred:
Federal............................................. 42 49 41
State............................................... 10 1 48
---- ---- ----
Total deferred.............................. 52 50 89
---- ---- ----
Total provision............................. $150 $591 $ 87
==== ==== ====
</TABLE>
The primary components of the deferred tax accounts as of December 31 are as
follows:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Current deferred tax assets (liabilities):
Allowance for bad debts and other................ $ 27 $ 111 $ 120
Deferred rent.................................... (48) 1
Other............................................ 46 (10) (36)
----- ----- -----
Total current deferred tax assets........ $ 25 $ 101 $ 85
===== ===== =====
Noncurrent deferred tax assets (liabilities):
Deferred rent.................................... $ 8 $ 8 $ 9
Depreciation..................................... (84) (215) (386)
Federal net operating loss....................... 89
Cash to accrual adjustment....................... (42) (33) (25)
Other............................................ (6)
----- ----- -----
Total noncurrent deferred tax
liabilities............................ $(118) $(246) $(313)
===== ===== =====
</TABLE>
F-11
<PAGE> 88
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 -- INCOME TAXES (CONTINUED)
The Company's effective tax rate differs from the federal statutory tax rate as
follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Federal statutory tax rate.............................. 34% 34% (34)%
State taxes, net of federal benefit..................... 6 6 (6)
Tax effect of permanent items........................... 72
50% disallowance of state tax net operating loss........ 7
Nondeductible compensation expense...................... 97
Disallowance of net operating losses.................... 12
Other................................................... (4) (1)
-- -- ---
Effective tax rate...................................... 48% 39% 136%
== == ===
</TABLE>
No valuation allowance has been established for the deferred tax asset.
Management believes that the Company will be able to realize the tax benefit of
the deferred tax assets based on expected future taxable income and the future
reversal of taxable temporary differences.
NOTE 7 -- STOCK OPTION AND OTHER EMPLOYEE BENEFIT PLANS
401(K) PLAN -- In September 1997, the Company implemented a 401(k) plan covering
all employees who have met eligibility requirements specified in the 401(k)
plan. Under the 401(k) plan, employees may elect to contribute up to 15% of
their eligible compensation (to a maximum of $10) to the 401(k) plan, subject to
limitations. The Company may make matching contributions at its discretion. As
of December 31, 1997 and 1998, the Company had not made any contributions to the
401(k) plan.
STOCK BASED COMPENSATION PLAN -- In August 1997, the Board of Directors approved
and the Company adopted the 1997 Equity Incentive Plan (the "Plan"). Under the
Plan, the Company may grant options to purchase 1,812,107 shares of common stock
to officers and employees. These options generally expire 10 years from the date
of grant and vest over a period of five years.
Option activity under the plans is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
OPTIONS EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Balance, January 1, 1997........................... -- $ --
Granted............................................ 647,547 1.83
Canceled........................................... (66,667) 1.83
--------- -----
Balance, December 31, 1997 (no shares vested)...... 580,880 1.83
Granted............................................ 468,773 2.40
Canceled........................................... (96,666) 1.83
--------- -----
Balance, December 31, 1998......................... 952,987 $2.11
Granted (unaudited)................................ 53,333 3.41
--------- -----
Balance, March 31, 1999 (unaudited)................ 1,006,320 $2.18
========= =====
</TABLE>
At December 31, 1998, 96,843 shares were exercisable and 899,120 were available
for grant under the 1997 stock option plan.
During the year ended December 31, 1998, deferred compensation of $948 was
recorded for options granted of which $156 was amortized to compensation
expense. The remaining deferred compensation will be amortized over the balance
of the five-year vesting period of the stock options.
F-12
<PAGE> 89
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 -- STOCK OPTION AND OTHER EMPLOYEE BENEFIT PLANS (CONTINUED)
During the first quarter, CRL granted 43,333 stock options at a weighted average
exercise price of $2.73. These grants were made under the 1997 Equity Incentive
Plan. These options were granted below the fair market value of the stock on the
grant date. These transactions resulted in total deferred compensation expense
of $98. The compensation expense will be recorded over the five-year vesting
period of the options.
The following table summarizes information about currently outstanding and
vested stock options at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS VESTED
--------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
OUTSTANDING AT REMAINING AVERAGE VESTED AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICE 1998 LIFE PRICE 1998 PRICE
-------------- -------------- ----------- -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$1.83............................ 484,213 8.69 $1.83 96,843 $1.83
2.28............................ 332,107 9.71 2.28
2.73............................ 136,667 9.98 2.73
--------- ----- ------- -----
952,987 $2.11 96,843 $1.83
========= ===== ======= =====
</TABLE>
ADDITIONAL STOCK PLAN INFORMATION -- As discussed in Note 1, the Company
accounts for its stock-based awards to employees using the intrinsic value
method in accordance with APB No. 25, Accounting for Stock Issued to Employees,
and its related interpretations.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure
of pro forma net income (loss) and earnings (loss) per share had the Company
adopted the fair value method since the Company's inception. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
The Company's calculations for employee grants were made using the minimum
option pricing model with the following weighted average assumptions:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------
1997 1998
---- ----
<S> <C> <C>
Dividend yield.............................................. None None
Risk free interest rate..................................... 5.7% 4.4%
Expected term, in years..................................... 5.5 3
</TABLE>
The weighted average minimum value per option as of the date of grant for
options granted during 1997 and 1998 was $0.48 and $2.13, respectively.
If the computed minimum values of the Company's stock-based awards to employees
had been amortized to expense over the vesting period of the awards as specified
under SFAS No. 123, loss attributable to
F-13
<PAGE> 90
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 -- STOCK OPTION AND OTHER EMPLOYEE BENEFIT PLANS (CONTINUED)
common stockholders and basic and diluted loss per share on a pro forma basis
(as compared to such items as reported) would have been:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------
1997 1998
----- ------
<S> <C> <C>
Net income (loss) attributable to common stockholders:
As reported............................................... $ 885 $ (151)
Pro forma................................................. 828 (192)
Diluted net income (loss) per share:
As reported............................................... $0.05 $(0.01)
Pro forma................................................. 0.04 (0.01)
</TABLE>
NOTE 8 -- NET INCOME (LOSS) PER SHARE
The following is a reconciliation of the denominators used in computing basic
and diluted net income (loss) per share (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------- ------------------
1996 1997 1998 1998 1999
------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Shares used in the computation of Basic EPS... 18,979 18,979 18,979 18,979 18,979
Effect of dilutive stock options.............. 163 304
------ ------ ------ ------ ------
Shares used in the computation of Diluted
EPS......................................... 18,979 19,142 18,979 19,283 18,979
====== ====== ====== ====== ======
</TABLE>
The Company had options to purchase 952,987 and 1,006,320 shares of common stock
at December 31, 1998, and March 31, 1999, respectively outstanding which could
potentially dilute basic earnings per share in the future, but were excluded in
the computation of diluted net loss per share in the periods presented, as their
effect would have been antidilutive.
NOTE 9 -- RELATED PARTY TRANSACTIONS
In August 1995, the Company received a 7.5% promissory note for $106 from a
stockholder for cash. The note specified that the entire principal plus accrued
interest were to be paid by July 10, 2000. During 1998, the stockholder repaid
the remaining amount outstanding.
In April 1996, the Company received an 8% promissory note for $25 from an
employee. The note specified that payment of principal and interest is to be
paid annually in the amount of $5 plus accrued interest until fully paid. At
December 31, 1998, the remaining balance on this note was $15.
In 1997 CRL entered into an agreement with FBN Holding Co. ("FBN") to lease
aircraft time. The sole owner of FBN is also the President and Chief Executive
Officer of CRL. This agreement may be canceled at any time by either party with
30-day notice. The amount paid to FBN for travel services under the agreement
amounted to $0, $104 and $144 for the years ended December 31, 1996, 1997 and
1998, respectively.
NOTE 10 -- GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
CRL operates in a single industry segment encompassing internet access and
related managed data services and equipment sales. All of CRL's revenues in each
year is received from customers based in the
F-14
<PAGE> 91
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS (CONTINUED)
United States. Approximately $5,221, $8,181 and $8,950 of CRL's revenues were
received from customers in the thirteen Western U.S. states and $5,010, $7,653
and $8,174 was received from customers in California for 1996, 1997 and 1998,
respectively.
No single customer accounted for 10% or more of CRL's net sales in any year.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
LEASES -- CRL leases office and storage space under operating leases with terms
ranging from month-to-month to six years at various times through 2005. Rent
expense under all leases was $145, $224 and $377 for 1996, 1997 and 1998,
respectively. Future minimum lease payments for capital lease obligations and
net lease payments under noncancelable operating leases with remaining terms in
excess of one year at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
CAPITAL LEASE OPERATING
OBLIGATIONS LEASES
------------- ---------
<S> <C> <C>
Year ending December 31:
1999............................................... $49 $ 453
2000............................................... 38 326
2001............................................... 253
2002............................................... 205
2003............................................... 121
Thereafter......................................... 201
--- ------
Total minimum lease payments............... 87 $1,559
======
Less amount representing interest.................... (9)
---
Capital lease obligations............................ 78
Less current portion................................. (49)
---
Long-term portion.................................... $29
===
</TABLE>
TELECOMMUNICATIONS AND PEERING ARRANGEMENTS -- CRL enters into
telecommunications agreements with telephone companies who provide local access
for dial-up customers to CRL's Internet backbone. The terms of the service
agreements vary from one to two years and provide CRL with preferred rates. If
CRL prematurely cancels one of these service contracts, the service provider, at
its discretion, can charge the difference between their regular rates and the
preferred rate over the term of the service. Accordingly, the financial
commitment under these agreements would be the cancellation fee. In the past, no
service provider has exercised this option. Management believes that potential
additional charges, if any, from early cancellation of vendor service contracts
would not have a material effect on the financial statements.
CRL is party to numerous peering arrangements with other internet providers to
allow for the exchange of internet traffic. CRL does not record any revenue or
expense associated with these non-cash transactions as such transactions do not
represent the culmination of the earnings process and the fair value of such
transactions are not reasonably determinable. There is no financial commitment
under these peering arrangements.
Subject to few exceptions, CRL's peering relationships are not subject to any
written agreements and could be terminated at any time. For those peering
arrangements subject to contracts, there are no minimum fixed charges for data
exchange. Such agreements generally do impose minimum usage requirements at
levels which CRL has in the past always exceeded.
F-15
<PAGE> 92
CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEGAL MATTERS -- CRL is involved in a limited number of claims and legal actions
arising out of the normal course of business. Management does not expect that
the outcome of these cases will have a material effect on CRL's financial
position, results of operations or cash flow.
QWEST DISPUTE -- CRL is currently in a dispute with Qwest Communications
Corporation involving fiber cable they own connecting several cities. Qwest
agreed to lease fiber that was to be installed and available to CRL by specified
dates. Qwest did not complete installation as agreed. CRL believes that Qwest is
obligated to provide free service as a result of the installation delay. As of
December 31, 1998, Qwest has demanded payment of $136 which includes a credit of
$108 for free service. CRL disputes the installation dates and application of
service order terms and is seeking to negotiate a settlement of the dispute. As
of December 31, 1998, no accrual had been made for the Qwest dispute.
NOTE 12 -- SUBSEQUENT EVENTS
On March 11, 1999, CRL terminated its relationship with FBN effective April 30,
1999 (see Note 9).
On March 18, 1999, the Board of Directors adopted, subject to stockholder
approval, the reincorporation of CRL in the State of Delaware and the associated
exchange of one share of common stock of CRL for every three shares of common
stock of CRL's California predecessor. Such reincorporation and stock exchange
will become effective prior to the effective date of the initial public offering
contemplated by CRL. All share and per share amounts in these financial
statements have been adjusted to give effect to the reincorporation and one for
three stock exchange. In addition, upon reincorporation in the State of
Delaware, the Board of Directors is authorized to issue up to 5,000,000 shares
of preferred stock in one or more series.
On April 28, 1999 CRL completed the reincorporation of CRL in the State of
Delaware and the associated exchange of one share of common stock of CRL for
every three shares of common stock of CRL's California predecessor.
The Board of Directors adopted, subject to stockholder approval, the 1999 Stock
Incentive Plan. A total of 2,000,000 shares of common stock have initially been
reserved for issuance under the 1999 Stock Incentive Plan.
F-16
<PAGE> 93
- --------------------------------------------------------------------------------
LOGO
5,000,000 SHARES
COMMON STOCK
--------------------
PROSPECTUS
--------------------
, 1999
CIBC WORLD MARKETS
LEHMAN BROTHERS
DLJdirect INC.
- --------------------------------------------------------------------------------
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE PROSPECTIVE INVESTORS WITH DIFFERENT OR ADDITIONAL
INFORMATION FROM THAT CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN
OFFER TO SELL NOR IS IT SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY
CIRCUMSTANCES WHERE THE OFFER OR SALE IS UNLAWFUL. THE INFORMATION CONTAINED IN
THIS PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF
THE TIME OF THE DELIVERY OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES.
DEALER PROSPECTUS DELIVERY OBLIGATION: UNTIL , 1999 (25 DAYS AFTER
THE DATE OF THIS PROSPECTUS), ALL DEALERS THAT BUY, SELL OR TRADE THESE SHARES
OF COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
<PAGE> 94
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following costs and expenses, other than underwriting discounts and
commissions, payable by the Registrant in connection with this offering. All
amounts are estimates except the SEC registration fee, the NASD filing fee and
the Nasdaq National Market listing fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $ 28,054
NASD fee.................................................... 10,592
Nasdaq National Market listing fee.......................... 95,000
Printing and engraving costs................................ 200,000
Legal fees and expenses..................................... 450,000
Accounting fees and expenses................................ 375,000
Blue Sky fees and expenses.................................. 3,000
Transfer agent and registrar fees and expenses.............. 3,500
Miscellaneous............................................... 174,854
----------
Total............................................. $1,340,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the General Corporation Law of the State of Delaware provides for
the indemnification of officers and directors under certain circumstances
against expenses incurred in successfully defending against a claim and
authorizes Delaware corporations to indemnify their officers and directors under
certain circumstances against expenses and liabilities incurred in legal
proceedings involving such persons because of their being or having been an
officer or director. Article VIII of the Registrant's Certificate of
Incorporation and the Registrant's Bylaws provide that all persons who the
Registrant is empowered to indemnify pursuant to the provisions of Section 145
of the Delaware General Corporation Law (or any similar provision or provisions
of applicable law at the time in effect), shall be indemnified by the Registrant
to the full extent permitted thereby. The foregoing right of indemnification
shall not be deemed to be exclusive of any other rights to which those seeking
indemnification may be entitled under any by-law, agreement, vote of
stockholders or disinterested directors, or otherwise.
Section 102(b) of the Delaware General Corporation Law permits a corporation, by
so providing in its certificate of incorporation, to eliminate or limit
director's liability to the corporation and its stockholders for monetary
damages arising out of certain alleged breaches of their fiduciary duty. Section
102(b)(7) provides that no such limitation of liability may affect a director's
liability with respect to any of the following: (i) breaches of the director's
duty of loyalty to the corporation or its stockholders; (ii) acts or omissions
not made in good faith or which involve intentional misconduct of knowing
violations of law; (iii) liability for dividends paid or stock repurchased or
redeemed in violation of the Delaware General Corporation Law; or (iv) any
transaction from which the director derived an improper personal benefit.
Section 102(b)(7) does not authorize any limitation on the ability of the
corporation or its stockholders to obtain injunctive relief, specific
performance or other equitable relief against directors.
Reference is made to the Underwriting Agreement, the proposed form of which is
filed as Exhibit 1.1, pursuant to which the underwriters agree to indemnify the
directors and certain officers of the Registrant and certain other persons in
certain circumstances.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since January 1, 1996, the Registrant's predecessor company has issued and sold
the following securities:
On December 21, 1998, in connection with the Registrant's merger with Integral
Networking Corporation, the Registrant issued 413,091 shares of its common stock
to Robert Ross and 21,741 shares of its common stock to Jim and Judy Linstruth
(giving effect to the Registrant's reincorporation in Delaware and the
associated exchange of one share of common stock of the Registrant for every
three shares of common
II-1
<PAGE> 95
stock of CRL's California predecessor), the three former shareholders of
Integral Networking Corporation, as consideration for all the outstanding shares
of Integral Networking Corporation.
The issuance and sale of the above securities were exempt from registration
under the Securities Act in reliance upon Section 4(2) of the Securities Act
promulgated thereunder. The recipients of securities in each such transaction
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof, and
appropriate legends were affixed to the share certificates issued in such
transactions. All recipients had adequate access to information about the
Registrant.
On April 27, 1999, Philip Burkhart exercised an option to purchase 60,000 shares
of the Registrant's common stock for an aggregate exercise price of $109,800.
The issuance of these securities was exempt from registration under the
Securities Act in reliance on Rule 701 promulgated under the Securities Act.
Such issuance was made pursuant to the Registrant's 1997 Equity Incentive Plan.
On April 28, 1999, CRL Network Services, Inc., a California corporation ("CRL
California"), merged with and into its wholly-owned subsidiary, CRL Network
Services, Inc., a Delaware corporation ("CRL Delaware"). In connection with the
merger, CRL Delaware issued shares of its common stock to the holders of common
stock of CRL California, such that the holders of common stock of CRL California
received a proportionate interest in CRL Delaware common stock. The issuance of
the securities and such reincorporation were exempt from the registration
requirements of the Securities Act, due to the exemptions from registration
provided by Sections 3(a)(9) and 4(2) thereof.
ITEM 16. EXHIBITS
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
1.1 Form of Underwriting Agreement.
2.1 Certificate of Merger between the Registrant and CRL Network
Services, Inc., a California corporation ("CRL
California").(3)
3.1 Articles of Incorporation of CRL California.(1)
3.2 Certificate of Incorporation of the Registrant.(1)
3.3 Bylaws of CRL California.(1)
3.4 Bylaws of the Registrant.(3)
4.1 Specimen form of Registrant's Common Stock Certificate.(4)
5.1 Opinion of Gibson, Dunn & Crutcher LLP.(4)
10.1 Employment Agreement between the Registrant and James G.
Couch dated as of March 15, 1999.(1)
10.2 Employment Agreement between the Registrant and Robert A.
Ross dated December 21, 1998.(1)
10.3 1997 Equity Incentive Plan.(1)
10.4 1999 Stock Incentive Plan, as amended.(4)
10.5 Equipment Lease between Saddleback Financial Corporation and
CRL Network Services, Inc. executed on June 12, 1997.(1)
10.6 Addendum to Lease between Saddleback Financial Corporation
and CRL Network Services, Inc. executed June 12, 1997.(1)
10.7 Mandatory Purchase Option Letter between Saddleback
Financial Corporation and CRL Network Services, Inc.
executed June 12, 1997.(1)
10.8 Wells Fargo Bank $500,000 Equipment Line of Credit made
available to CRL Network Services dated September 25,
1997.(1)
10.9 Wells Fargo Bank $692,000 Equipment Line of Credit made
available to CRL Network Services dated March 30, 1998.(1)
</TABLE>
II-2
<PAGE> 96
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
10.10 Wells Fargo Bank $650,000 Equipment Line of Credit made
available to CRL Network Services dated September 29,
1998.(1)
10.11 Wells Fargo Bank $200,000 PrimeLine of Credit made available
to CRL Network Services dated September 28, 1998.(1)
10.12** Agreement between Pacific Bell and CRL Network Services
dated as of September 22, 1998.(4)
10.13** Master Services Agreement between GST-Telecom California
Inc. and CRL Network Services dated August 31, 1998.(4)
10.14 Domestic (U.S.) Direct Peering Agreement between MCI
Telecommunications Corporation and CRL Network Services
dated August 1, 1998.(2)
10.15** Agreement between CRL Network Services, Inc. and the
National Aeronautics and Space Administration dated July 16,
1998.(4)
10.16** Service Agreement between IXC Carrier, Inc. and CRL Network
Services dated April 22, 1996.(4)
10.17** Amendment #1 to Service Agreement between IXC Carrier, Inc.
and CRL Network Services dated April 16, 1997.(4)
10.18** Terms and Conditions Governing the Provision of Network
Connectivity Products and Services by Sprint dated January
6, 1998.(4)
10.19** Private Line Services Agreement between Qwest Communications
Corporation and CRL Network Services dated October 10,
1997.(4)
10.20 Reimbursable Space Act Agreement between the National
Aeronautics and Space Administration Ames Research Center
and CRL Network Services, Inc. dated December 3, 1996 and
executed March 7, 1997.(1)
10.21 Office Lease Agreement between Maria Chen, as Lessor and the
Registrant dated December 5, 1995.(1)
10.22 Amendment to lease by and between Maria Chen and the
Registrant dated December 1, 1998.(1)
10.23 The 120 Montgomery Street Office Lease dated February 4,
1994 between the Equitable Montgomery Company and Orrell &
Company, Inc.(1)
10.24 Sublease between Orrell & Company, Inc., 120 Montgomery
Associates, LLC and the Registrant dated February 20,
1998.(1)
10.25 Office Lease between WHLNF Real Estate Limited Partnership
and the Registrant dated August 28, 1998.(1)
10.26 Office Lease between One Wilshire Arcade Imperial, Ltd. by
Paramount Group, Inc. and the Registrant dated March 8,
1998.(1)
10.27 Deed of Lease between Gosnell Properties, Inc. and the
Registrant dated September 20, 1996.(1)
10.28 Standard Industrial Lease -- Multi Tenant between Robert A.
Bell and Bob Ross, d/b/a/ Integral Network Corporation dated
March 30, 1998.(1)
10.29 Qualified Retirement Plan and Trust Defined Contribution
Basic Plan Document.(1)
10.30 Defined Contribution Plan and Trust Adoption Agreement.(1)
10.31 Agreement and Plan of Reorganization among the Registrant,
Integral Networking Corporation, RMS Sub Inc. and the
shareholders of Integral Networking Corporation dated
December 21, 1998.(1)
10.32 U.S. Simply Business Premium Line Agreement between Integral
Networking Corporation and U.S. Bank dated September 2,
1997.(1)
10.33 Airplane Leasing Agreement dated February 15, 1999, between
the Registrant and FBN Holding Corp.(1)
21.1 Subsidiaries of the Registrant.(1)
</TABLE>
II-3
<PAGE> 97
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
23.1 Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit
5.1).
23.2 Consent of Deloitte & Touche LLP.
23.3 Consent of Jack M. Fields, Jr.(1)
23.4 Consent of Steven T. Stenberg.(1)
23.5 Consent of John A. Blair.(1)
23.6 Consent of Thor Geir Ramleth.(1)
23.7 Consent of Stephen C. Mott(4)
24.1 Power of Attorney.(1)
24.2 Power of Attorney for Robert B. Murphy, Jr.(3)
27.1 Financial Data Schedule.(1)
</TABLE>
- -------------------------
** Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request as to omitted portions of the exhibit.
(1) Previously filed as an exhibit to the Registrant's Registration on Form S-1
(File No. 333-34793) filed with the Commission on March 22, 1999.
(2) Previously filed as an exhibit to Amendment No. 1 to the Registration
Statement filed with the Commission on April 2, 1999.
(3) Previously filed as an exhibit to Amendment No. 2 to the Registration
Statement filed with the Commission on April 28, 1999.
(4) Previously filed as an exhibit to Amendment No. 4 to the Registration
Statement filed with the Commission on May 20, 1999.
ITEM 17. UNDERTAKINGS
The Registrant hereby undertakes to the underwriters at the closing specified in
the underwriting agreement to provide certificates in such denominations and
registered in such names as required by the underwriters to permit prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act of
1933, as amended (the "Securities Act") may be permitted to directors, officers
and controlling persons of the Registrant pursuant to the Delaware General
Corporation Law, the Registrant's Certificate of Incorporation, the Registrant's
Bylaws, or otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act, and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(i) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Act is part of this Registration Statement as of the time
it was declared effective.
(ii) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement for the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 98
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 7 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of San Francisco, State of California, on the 16th day of June 1999.
CRL Network Services, Inc.
By: /s/ JAMES G. COUCH
------------------------------------
James G. Couch
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 7 to the Registration Statement on Form S-1 has been signed below
by the following persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ JAMES G. COUCH President, Chief Executive Officer, June 16, 1999
- ------------------------------------------ Chairman of the Board and Secretary
James G. Couch (Principal Executive Officer)
* Executive Vice President and Chief June 16, 1999
- ------------------------------------------ Financial Officer (Principal Financial
Robert B. Murphy, Jr. Officer)
* Vice President of Finance (Principal June 16, 1999
- ------------------------------------------ Accounting Officer)
Robyn L. Raschke
* Director June 16, 1999
- ------------------------------------------
Steven T. Stenberg
</TABLE>
* By: /s/ JAMES G. COUCH
-------------------------
James G. Couch
Attorney-in-fact
II-5
<PAGE> 99
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
1.1 Form of Underwriting Agreement.
2.1 Certificate of Merger between the Registrant and CRL Network
Services, Inc., a California corporation ("CRL
California").(3)
3.1 Articles of Incorporation of CRL California.(1)
3.2 Certificate of Incorporation of the Registrant.(1)
3.3 Bylaws of CRL California.(1)
3.4 Bylaws of the Registrant.(3)
4.1 Specimen form of Registrant's Common Stock Certificate.(4)
5.1 Opinion of Gibson, Dunn & Crutcher LLP.(4)
10.1 Employment Agreement between the Registrant and James G.
Couch dated as of March 15, 1999.(1)
10.2 Employment Agreement between the Registrant and Robert A.
Ross dated December 21, 1998.(1)
10.3 1997 Equity Incentive Plan.(1)
10.4 1999 Stock Incentive Plan, as amended.(4)
10.5 Equipment Lease between Saddleback Financial Corporation and
CRL Network Services, Inc. executed on June 12, 1997.(1)
10.6 Addendum to Lease between Saddleback Financial Corporation
and CRL Network Services, Inc. executed June 12, 1997.(1)
10.7 Mandatory Purchase Option Letter between Saddleback
Financial Corporation and CRL Network Services, Inc.
executed June 12, 1997.(1)
10.8 Wells Fargo Bank $500,000 Equipment Line of Credit made
available to CRL Network Services dated September 25,
1997.(1)
10.9 Wells Fargo Bank $692,000 Equipment Line of Credit made
available to CRL Network Services dated March 30, 1998.(1)
10.10 Wells Fargo Bank $650,000 Equipment Line of Credit made
available to CRL Network Services dated September 29,
1998.(1)
10.11 Wells Fargo Bank $200,000 PrimeLine of Credit made available
to CRL Network Services dated September 28, 1998.(1)
10.12** Agreement between Pacific Bell and CRL Network Services
dated as of September 22, 1998.(4)
10.13** Master Services Agreement between GST-Telecom California
Inc. and CRL Network Services dated August 31, 1998.(4)
10.14 Domestic (U.S.) Direct Peering Agreement between MCI
Telecommunications Corporation and CRL Network Services
dated August 1, 1998.(2)
10.15** Agreement between CRL Network Services, Inc. and the
National Aeronautics and Space Administration dated July 16,
1998.(4)
10.16** Service Agreement between IXC Carrier, Inc. and CRL Network
Services dated April 22, 1996.(4)
10.17** Amendment #1 to Service Agreement between IXC Carrier, Inc.
and CRL Network Services dated April 16, 1997.(4)
10.18** Terms and Conditions Governing the Provision of Network
Connectivity Products and Services by Sprint dated January
6, 1998.(4)
10.19** Private Line Services Agreement between Qwest Communications
Corporation and CRL Network Services dated October 10,
1997.(4)
</TABLE>
<PAGE> 100
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
10.20 Reimbursable Space Act Agreement between the National
Aeronautics and Space Administration Ames Research Center
and CRL Network Services, Inc. dated December 3, 1996 and
executed March 7, 1997.(1)
10.21 Office Lease Agreement between Maria Chen, as Lessor and the
Registrant dated December 5, 1995.(1)
10.22 Amendment to lease by and between Maria Chen and the
Registrant dated December 1, 1998.(1)
10.23 The 120 Montgomery Street Office Lease dated February 4,
1994 between the Equitable Montgomery Company and Orrell &
Company, Inc.(1)
10.24 Sublease between Orrell & Company, Inc., 120 Montgomery
Associates, LLC and the Registrant dated February 20,
1998.(1)
10.25 Office Lease between WHLNF Real Estate Limited Partnership
and the Registrant dated August 28, 1998.(1)
10.26 Office Lease between One Wilshire Arcade Imperial, Ltd. by
Paramount Group, Inc. and the Registrant dated March 8,
1998.(1)
10.27 Deed of Lease between Gosnell Properties, Inc. and the
Registrant dated September 20, 1996.(1)
10.28 Standard Industrial Lease -- Multi Tenant between Robert A.
Bell and Bob Ross, d/b/a/ Integral Network Corporation dated
March 30, 1998.(1)
10.29 Qualified Retirement Plan and Trust Defined Contribution
Basic Plan Document.(1)
10.30 Defined Contribution Plan and Trust Adoption Agreement.(1)
10.31 Agreement and Plan of Reorganization among the Registrant,
Integral Networking Corporation, RMS Sub Inc. and the
shareholders of Integral Networking Corporation dated
December 21, 1998.(1)
10.32 U.S. Simply Business Premium Line Agreement between Integral
Networking Corporation and U.S. Bank dated September 2,
1997.(1)
10.33 Airplane Leasing Agreement dated February 15, 1999, between
the Registrant and FBN Holding Corp.(1)
21.1 Subsidiaries of the Registrant.(1)
23.1 Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit
5.1).
23.2 Consent of Deloitte & Touche LLP.
23.3 Consent of Jack M. Fields, Jr.(1)
23.4 Consent of Steven T. Stenberg.(1)
23.5 Consent of John A. Blair.(1)
23.6 Consent of Thor Geir Ramleth.(1)
23.7 Consent of Stephen C. Mott(4)
24.1 Power of Attorney.(1)
24.2 Power of Attorney for Robert B. Murphy, Jr.(3)
27.1 Financial Data Schedule.(1)
</TABLE>
- -------------------------
** Certain information in this exhibit was omitted and filed separately with
the Securities and Exchange Commission pursuant to a confidential treatment
request as to the omitted portions of the exhibit.
(1) Previously filed as an exhibit to the Registrant's Registration Statement on
Form S-1 (File No. 333-34793) (the "Registration Statement") filed with the
Commission on March 22, 1999.
(2) Previously filed as an exhibit to Amendment No. 1 to the Registration
Statement filed with the Commission on April 2, 1999.
(3) Previously filed as an exhibit to Amendment No. 2 to the Registration
Statement filed with the Commission on April 28, 1999.
(4) Previously filed as an exhibit to Amendment No. 4 to the Registration
Statement filed with the Commission on May 20, 1999.
<PAGE> 1
5,000,000 Shares
CRL NETWORK SERVICES, INC.
COMMON STOCK
UNDERWRITING AGREEMENT
June___, 1999
CIBC World Markets Corp.,
Lehman Brothers, Inc. and
DLJdirect Inc.
c/o CIBC World Markets Corp.
As Representatives of the
Several Underwriters
World Financial Center
New York, New York 10281
On behalf of the Several
Underwriters named on
Schedule I attached hereto.
Ladies and Gentlemen:
CRL Network Services, Inc., a Delaware corporation (the
"Company") propose to sell to you and the other underwriters named on Schedule I
to this Agreement (the "Underwriters"), for whom you are acting as
Representatives, an aggregate of 5,000,000 shares of the Company's Common Stock
(the "Firm Shares"). In addition, the Principal Stockholder named on the
signature page hereto and the Company propose to grant, jointly and severally,
to the several Underwriters, an option to purchase, severally and not jointly,
up to an additional 750,000 shares (the "Option Shares") of Common Stock from
them for the purpose of covering over-allotments in connection with the sale of
the Firm Shares. The Firm Shares and the Option Shares are together called the
"Shares."
1. Sale and Purchase of the Shares.
On the basis of the representations, warranties and agreements contained
in, and subject to the terms and conditions of, this Agreement:
(a) The Company agrees to sell to each of the Underwriters, and
each of the Underwriters agrees, severally and not jointly, to purchase from the
Company, at $_____ per share (the "Initial Price"), the number of Firm Shares
set forth opposite the name of such Underwriter on Schedule I to this Agreement.
<PAGE> 2
(b) The Principal Stockholder and the Company grant, jointly and
severally, to the several Underwriters an option to purchase, severally and not
jointly, all or any part of the Option Shares at the Initial Price. The
Principal Stockholder shall have the first option to grant to the Underwriters
an option to purchase all or any part of the Option Shares at the Initial Price.
In the event the Principal Stockholder elects not to sell any Option Shares or
elects to sell less than all of the total Option Shares, then in such event, the
Company shall grant to the several Underwriters an Option to purchase, severally
and not jointly, the remainder of the Option Shares at the Initial Price. The
number of Option Shares to be purchased by each Underwriter shall be the same
percentage (adjusted by the Representatives to eliminate fractions) of the total
number of Option Shares to be purchased by the Underwriters as such Underwriter
is purchasing of the Firm Shares. Such option may be exercised only to cover
over-allotments in the sales of the Firm Shares by the Underwriters and may be
exercised in whole or in part at any time on or before 12:00 noon, New York City
time, on the business day before the Firm Shares Closing Date (as defined
below), and on one or more occasions thereafter within 30 days after the date of
this Agreement, in each case upon written or telegraphic notice, or verbal or
telephonic notice confirmed by written or telegraphic notice, by the
Representatives to the Company and the Principal Stockholder no later than 12:00
noon, New York City time, on the business day before the Firm Shares Closing
Date or at least two business days before the Option Shares Closing Date (as
defined below), as the case may be, setting forth the number of Option Shares to
be purchased and the time and date (if other than the Firm Shares Closing Date)
of such purchase.
2. Delivery and Payment. Delivery by the Company of the Firm Shares to
the Representatives for the respective accounts of the Underwriters, and payment
of the purchase price by wire transfer payable in same day funds to the Company
shall take place at the offices of CIBC World Markets Corp., at CIBC Oppenheimer
Tower, World Financial Center, New York, New York 10281, at 10:00 a.m., New York
City time, on the third full business day following the first day the Shares are
traded, or at such time on such other date, not later than 10 business days
after the date of this Agreement, as shall be agreed upon by the Company and the
Representatives (such time and date of delivery and payment are called the "Firm
Shares Closing Date"); provided, however, that if the Company has not made
available to the Representatives copies of the Prospectus within the time
provided in Section 7(a)(v) hereof the Representatives may, in their sole
discretion, postpone the Closing Date until no later than two (2) full business
days following delivery of copies of the Prospectus to the Representatives. If
the Representatives so elect, delivery of the Firm Shares may be made by credit
through full fast transfer to the accounts at The Depository Trust Company
designated by the Representative.
In the event the option with respect to the Option Shares is exercised,
delivery by the Principal Stockholder and the Company, as applicable, of the
Option Shares to the Representatives for the respective accounts of the
Underwriters and payment of the purchase price by wire transfer, payable in same
day funds to the Principal Stockholder and the Company, as applicable, shall
take place at the offices of CIBC World Markets Corp. specified above at the
time and on the date or dates (which may be the same date as, but in no event
shall be earlier than, the Firm Shares Closing Date) specified in the notice
referred to in Section 1(c) (such time and date of delivery and payment are
called the "Option Shares Closing Date"). The Firm Shares Closing Date and the
Option Shares Closing Date are called, individually, a "Closing Date" and,
together, the "Closing Dates."
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<PAGE> 3
Certificates evidencing the Shares shall be registered in such names and
shall be in such denominations as the Representatives shall request at least two
full business days before the Firm Shares Closing Date or, in the case of Option
Shares, on the day of notice of exercise of the option as described in Section
l(c) and shall be made available to the Representatives for checking and
packaging, at such place as is designated by the Representatives, on the full
business day before the Firm Shares Closing Date (or the Option Shares Closing
Date in the case of the Option Shares).
3. Registration Statement and Prospectus; Public Offering. The Company
has prepared in conformity with the requirements of the Securities Act of 1933,
as amended (the "Securities Act"), and the published rules and regulations
thereunder (the "Rules") adopted by the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (No. 333-74793), including a
preliminary prospectus relating to the Shares, and has filed with the Commission
the Registration Statement (as hereinafter defined) and such amendments thereof
as may have been required to the date of this Agreement. Copies of such
Registration Statement (including all amendments thereto) to and of the related
preliminary prospectus have heretofore been delivered by the Company to you.
The Company understands that the Underwriters propose to make a public
offering of the Shares, as set forth in and pursuant to the Prospectus, as soon
after the Effective Date (as hereinafter defined) and the date of this Agreement
as the Representatives deem advisable. The Company hereby confirms that the
Underwriters and dealers have been authorized to distribute or cause to be
distributed each preliminary prospectus and are authorized to distribute the
Prospectus (as from time to time amended or supplemented if the Company
furnishes amendments or supplements thereto to the Underwriters).
4. Representations and Warranties of the Company and the Principal
Stockholder. The Company and the Principal Stockholder hereby, jointly and
severally, represent and warrant to each Underwriter as follows:
(a) If the registration statement relating to the Shares has been
declared effective under the Securities Act by the Commission, the Company will
prepare and promptly file with the Commission the information omitted from the
registration statement pursuant to Rule 430A(a) or, if the Representatives, on
behalf of the several Underwriters, shall agree to the utilization of Rule 434
of the Rules, the information required to be included in any term sheet filed
pursuant to Rule 434(b) or (c), as applicable, of the Rules pursuant to
subparagraph (1), (4) or (7) of Rule 424(b) of the Rules or as part of a
post-effective amendment to the registration statement (including a final form
of prospectus). If the registration statement relating to the Shares has not
been declared effective under the Securities Act by the Commission, the Company
will prepare and promptly file an amendment to the registration statement,
including a final form of prospectus, or, if the Representatives, on behalf of
the several Underwriters, shall agree to the utilization of Rule 434 of the
Rules, the information required to be included in any term sheet filed pursuant
to Rule 434(b) or (c), as applicable, of the Rules. The term "Registration
Statement" as used in this Agreement shall mean such registration statement,
including consolidated financial statements, schedules and exhibits, in the form
in which it became or becomes, as the case may be, effective (including, if the
Company omitted information from the registration statement pursuant to Rule
430A(a) or files a term
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<PAGE> 4
sheet pursuant to Rule 434 of the Rules, the information deemed to be a part of
the registration statement at the time it became effective pursuant to Rule
430A(b) or Rule 434(d) of the Rules) and, in the event of any amendment thereto
or the filing of any abbreviated registration statement pursuant to Rule 462(b)
of the Rules relating thereto after the effective date of such registration
statement (the "Effective Date"), shall also mean (from and after the
effectiveness of such amendment or the filing of such abbreviated registration
statement) such registration statement as so amended, together with any such
abbreviated registration statement. The term "Prospectus" as used in this
Agreement shall mean the prospectus relating to the Shares as included in such
Registration Statement at the time it becomes effective (including, if the
Company omitted information from the Registration Statement pursuant to Rule
430A(a) of the Rules, the information deemed to be a part of the Registration
Statement at the time it became effective pursuant to Rule 430A(b) of the
Rules); provided, however, that if in reliance on Rule 434 of the Rules and with
the consent of the Representatives, on behalf of the several Underwriters, the
Company shall have provided to the Underwriters a term sheet pursuant to Rule
434(b) or (c), as applicable, prior to the time that a confirmation is sent or
given for purposes of Section 2(10)(a) of the Securities Act, the term
"Prospectus" shall mean the "prospectus subject to completion" (as defined in
Rule 434(g) of the Rules) last provided to the Underwriters by the Company and
circulated by the Underwriters to all prospective purchasers of the Shares
(including the information deemed to be a part of the Registration Statement at
the time it became effective pursuant to Rule 434(d) of the Rules).
Notwithstanding the foregoing, if any revised prospectus shall be provided to
the Underwriters by the Company for use in connection with the offering of the
Shares that differs from the prospectus referred to in the immediately preceding
sentence (whether or not such revised prospectus is required to be filed with
the Commission pursuant to Rule 424(b) of the Rules), the term "Prospectus"
shall refer to such revised prospectus from and after the time it is first
provided to the Underwriters for such use. If in reliance on Rule 434 of the
Rules and with the consent of the Representatives, on behalf of the several
Underwriters, the Company shall have provided to the Underwriters a term sheet
pursuant to Rule 434(b) or (c), as applicable, prior to the time that a
confirmation is sent or given for purposes of Section 2(10)(a) of the Securities
Act, the Prospectus and the term sheet, together, will not be materially
different from the prospectus in the Registration Statement.
On the Effective Date, the Registration Statement complied, and on the
date of the Prospectus, on the date any post-effective amendment to the
Registration Statement shall become effective, on the date any supplement or
amendment to the Prospectus is filed with the Commission and on each Closing
Date, the Registration Statement and the Prospectus (and any amendment thereof
or supplement thereto) will comply, in all material respects, with the
applicable provisions of the Securities Act and the Rules and the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and
regulations of the Commission thereunder; the Registration Statement did not, as
of the Effective Date, contain any untrue statement of a material fact or omit
to state any material fact required to be stated therein or necessary in order
to make the statements therein, in light of the circumstances under which they
were made, not misleading; and on the other dates referred to above neither the
Registration Statement nor the Prospectus, nor any amendment thereof or
supplement thereto, will contain any untrue statement of a material fact or will
omit to state any material fact required to be stated therein or necessary in
order to make the statements therein, in light of the circumstances under which
they were made, not misleading. When any related preliminary prospectus was
first filed with the Commission (whether filed as part of the Registration
Statement or any amendment
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<PAGE> 5
thereto or pursuant to Rule 424(a) of the Rules) and when any amendment thereof
or supplement thereto was first filed with the Commission, such preliminary
prospectus as amended or supplemented complied in all material respects with the
applicable provisions of the Securities Act and the Rules and did not contain
any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading. Notwithstanding the foregoing, the Company and the Principal
Stockholder make no representation or warranty as to the statements contained
under the caption "Underwriting" in the Prospectus. The Company and the
Principal Stockholder acknowledge that the statements referred to in the
previous sentence constitute the only information furnished in writing by the
Representatives on behalf of the several Underwriters specifically for inclusion
in the Registration Statement, any preliminary prospectus or the Prospectus.
(b) The consolidated financial statements of the Company and its
subsidiary (including all notes and schedules thereto) included in the
Registration Statement and Prospectus present fairly, in all material respects,
the financial position, the results of operations and cash flows and the
stockholders' equity and the other information purported to be shown therein of
the Company and its subsidiary at the respective dates and for the respective
periods to which they apply; and such financial statements have been prepared in
conformity with generally accepted accounting principles, consistently applied
throughout the periods involved, and all adjustments necessary for a fair
presentation of the results for such periods have been made. The selected and
summary consolidated financial and operational data included in the Registration
Statement present fairly, in all material respects, the information shown
therein and have been compiled on a basis consistent with the audited financial
statements. No other financial statements or schedules are required to be
included in the Registration Statement.
(c) Deloitte & Touche LLP, whose reports are filed with the
Commission as a part of the Registration Statement, are and, during the periods
covered by their reports, were independent public accountants as required by the
Securities Act and the Rules.
(d) The Company has been duly incorporated and is validly
existing as corporation in good standing under the laws of the State of Delaware
and the Company's subsidiary has been duly incorporated and is validly existing
as a corporation in good standing under the laws of the State of California. The
Company has no subsidiary or subsidiaries and does not control, directly or
indirectly, any corporation, partnership, joint venture, association or other
business organization other than the subsidiaries listed in Exhibit 21.1 to the
Registration Statement. Each of the Company and its subsidiary are duly
qualified and in good standing as foreign corporations in each jurisdiction in
which the character or location of its assets or properties (owned, leased or
licensed) or the nature of its businesses makes such qualification necessary
except for such jurisdictions where the failure to so qualify would not have a
material adverse effect on the assets or properties, business, results of
operations or financial condition of the Company and its subsidiary, taken as a
whole. Except as disclosed in the Registration Statement and the Prospectus,
neither the Company nor its subsidiary own, lease or license any asset or
property or conduct any businesses outside the United States of America. Each of
the Company and its subsidiary has all requisite corporate power and authority,
and all necessary authorizations, approvals, consents, orders, licenses,
certificates and permits of and from all governmental or regulatory bodies or
any other person or entity, to own, lease and license its
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<PAGE> 6
assets and properties and conduct its businesses as now being conducted and as
described in the Registration Statement and the Prospectus except for such
authorizations, approvals, consents, orders, material licenses, certificates and
permits the failure to so obtain would not have a material adverse effect upon
the assets or properties, business, results of operations, prospects or
condition (financial or otherwise) of the Company and its subsidiary, taken as a
whole, and the Company has all such corporate power and authority, and such
authorizations, approvals, consents, orders, licenses, certificates and permits
to enter into, deliver and perform this Agreement and to issue and sell the
Shares (except as may be required under the Securities Act and state and foreign
Blue Sky laws).
(e) Each of the Company and its subsidiary owns or possesses
adequate rights to use all patents, patent rights, inventions, trade secrets,
know-how, trademarks, service marks, trade names and copyrights which are
necessary to conduct its businesses as described in the Registration Statement
and Prospectus; the expiration of any patents, patent rights, trade secrets,
trademarks, service marks, trade names or copyrights would not have a material
adverse effect on the condition (financial or otherwise), earnings, operations,
business or business prospects of the Company and its subsidiary, taken as a
whole. Neither the Company, its subsidiary nor the Principal Stockholder have
received any notice of, and neither the Company, its subsidiary nor the
Principal Stockholder has any knowledge of, any infringement of or conflict with
asserted rights of the Company or its subsidiary by others with respect to any
patent, patent rights, inventions, trade secrets, know-how, trademarks, service
marks, trade names or copyrights which, singularly or in the aggregate, might
have a material adverse effect on the condition (financial or otherwise),
earnings, operations, business or business prospects of the Company and its
subsidiary, taken as a whole; and neither the Company nor its subsidiary has
received any notice of, and neither the Company, its subsidiary, nor the
Principal Stockholder has any knowledge of, any infringement of or conflict with
asserted rights of others with respect to any patent, patent rights, inventions,
trade secrets, know-how, trademarks, service marks, trade names or copyrights
which, singly or in the aggregate, if the subject of an unfavorable decision,
ruling or finding, might have a material adverse effect on the condition
(financial or otherwise), earnings, operations, business or business prospects
of the Company and its subsidiary, taken as a whole.
(f) Each of the Company and its subsidiary has good title to each
of the items of personal property which are reflected in the financial
statements referred to in Section 4(b) or are referred to in the Registration
Statement and the Prospectus as being owned by it and valid and enforceable
leasehold interests in each of the items of real and personal property which are
referred to in the Registration Statement and the Prospectus as being leased by
it, in each case free and clear of all liens, encumbrances, claims, security
interests and defects, other than those described in the Registration Statement
and the Prospectus and those which do not and will not have a material adverse
effect upon the assets or properties, business, results of operations or
financial condition of the Company and its subsidiary, taken as a whole.
(g) There is not any pending or, to the best of the Company's and
the Principal Stockholder's knowledge, threatened action, suit, claim or
proceeding against the Company or its subsidiary, any of their respective
officers or any of their respective properties, assets or rights before any
court, government or governmental agency or body, domestic or foreign, having
jurisdiction over the Company or its subsidiary, or over their respective
officers
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<PAGE> 7
or properties or otherwise which (i) might result in any material adverse change
in the condition (financial or otherwise), earnings, operations, business or
business prospects of the Company and its subsidiary, taken as a whole, or might
materially and adversely affect their properties, assets or rights, (ii) might
prevent consummation of the transactions contemplated hereby or (iii) is
required to be disclosed in the Registration Statement or Prospectus and is not
so disclosed.
(h) Subsequent to the respective dates as of which information is
given in the Registration Statement and the Prospectus, except as described
therein, (i) there has not been any material adverse change in the assets or
properties, business, results of operations, prospects or condition (financial
or otherwise), of the Company and its subsidiary, taken as a whole, whether or
not arising from transactions in the ordinary course of business; (ii) neither
the Company nor its subsidiary has sustained any material loss or interference
with its assets, businesses or properties (whether owned or leased) from fire,
explosion, earthquake, flood or other calamity, whether or not covered by
insurance, or from any labor dispute or any court or legislative or other
governmental action, order or decree; and (iii) since the date of the latest
balance sheet included in the Registration Statement and the Prospectus, except
as reflected therein, neither the Company nor its subsidiary has (a) issued any
securities or incurred any liability or obligation, direct or contingent, for
borrowed money, except such liabilities or obligations incurred in the ordinary
course of business, (b) entered into any transaction not in the ordinary course
of business or (c) declared or paid any dividend or made any distribution on any
shares of its stock or redeemed, purchased or otherwise acquired or agreed to
redeem, purchase or otherwise acquire any shares of its stock.
(i) There is no document or contract required to be described in
the Registration Statement or Prospectus or to be filed as an exhibit to the
Registration Statement which is not described or filed as required. Each
agreement listed in the Exhibits to the Registration Statement is in full force
and effect and is valid and enforceable by and against the Company or its
subsidiary in accordance with its terms, assuming the due authorization,
execution and delivery thereof by each of the other parties thereto, except (A)
as such enforceability may be limited by applicable bankruptcy, insolvency,
fraudulent conveyance, reorganization, moratorium or other similar laws
affecting the enforcement of creditors' rights generally and by general
equitable principles and (B) to the extent that rights to indemnity or
contribution under this Agreement may be limited by Federal or state securities
laws or the public policy underlying such laws. Except as disclosed in the
Registration Statement, neither the Company nor its subsidiary, nor to the best
of the Company's, its subsidiary's and the Principal Stockholder's knowledge, is
any other party in default in the observance or performance of any term or
obligation to be performed by it under any such agreement, and no event has
occurred which with notice or lapse of time or both would constitute such a
default, in any such case which default or event would have a material adverse
effect on the assets or properties, business, results of operations, prospects
or condition (financial or otherwise) of the Company and its subsidiary, taken
as a whole. No default exists, and no event has occurred which with notice or
lapse of time or both would constitute a default, in the due performance and
observance of any term, covenant or condition, by the Company or its subsidiary
of any other agreement or instrument to which the Company or its subsidiary is a
party or by which it or its properties or business may be bound or affected
which default or event would have a material adverse effect on the assets or
properties, business, results of operations, prospects or condition (financial
or otherwise) of the Company and its subsidiary, taken as a whole.
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<PAGE> 8
(j) Neither the Company nor its subsidiary is in violation of any
term or provision of its respective charter or by-laws or of any franchise,
license, permit, judgment, decree, order, statute, rule or regulation, where the
consequences of such violation would have a material adverse effect on the
assets or properties, business, results of operations, prospects or condition
(financial or otherwise) of the Company and its subsidiary, taken as a whole.
(k) Neither the execution, delivery and performance of this
Agreement by the Company nor the consummation of any of the transactions
contemplated hereby (including, without limitation, the issuance and sale of the
Shares by the Company, and sale by the Principal Stockholder of the Option
Shares, if any) will give rise to a right to terminate or accelerate the due
date of any payment due under, or conflict with or result in the breach of any
term or provision of, or constitute a default (or an event which with notice or
lapse of time or both would constitute a default) under, or require any consent
or waiver under, or result in the execution or imposition of any lien, charge or
encumbrance upon any properties or assets of the Company or its subsidiary
pursuant to the terms of, any indenture, mortgage, deed of trust or other
agreement or instrument to which the Company or its subsidiary is a party or by
which it or any of its properties or businesses is bound, or any franchise,
license, permit, judgment, decree, order, statute, rule or regulation applicable
to the Company or its subsidiary or violate any provision of the charter or
by-laws of the Company or its subsidiary, except (1) for such consents or
waivers which have already been obtained and are in full force and effect or (2)
where the failure to obtain such consents or waivers, either singly or in the
aggregate, would not have a material adverse effect on the assets or properties,
business, results of operations, prospects or condition (financial or otherwise)
of the Company and its subsidiary, taken as a whole.
(l) The Company has an authorized and outstanding capital stock
as set forth under the caption "Capitalization" in the Prospectus. All of the
outstanding shares of Common Stock have been duly and validly issued, are fully
paid and nonassessable and were not issued in violation of or subject to any
preemptive rights. None of such Shares were issued in violation of any
preemptive or other similar right. The Shares, when issued and sold pursuant to
this Agreement, will be duly and validly issued, fully paid and nonassessable,
and will not be issued in violation of or subject to any preemptive rights. None
of such Shares will be issued in violation of any preemptive or other similar
rights. Except as disclosed in the Registration Statement and the Prospectus,
there is no outstanding option, warrant or other right calling for the issuance
of, and there is no commitment, plan or arrangement to issue, any share of stock
of the Company or any security convertible into, or exercisable or exchangeable
for, such stock. The Common Stock and the Shares conform in all material
respects to all statements in relation thereto contained in the Registration
Statement and the Prospectus. The description of the Company's stock option,
stock bonus and other stock plans or arrangements set forth in the Prospectus
accurately and fairly presents the information required to be shown with respect
to such plans, arrangements, options and rights. All the outstanding shares of
capital stock of the Company's subsidiary have been duly and validly authorized
and issued and are fully paid and nonassessable, and, except as otherwise set
forth in the Prospectus, all outstanding shares of capital stock of the
subsidiary are owned by the Company free and clear of any security interests,
claims, liens or encumbrances.
(m) Each officer and director of the Company, the Principal
Stockholder and each person set forth in Schedule II hereto has agreed in
writing that such
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<PAGE> 9
person will not, for a period of 180 days from the date that the Registration
Statement is declared effective by the Commission (the "Lock-up Period"), offer
to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant
any rights with respect to (collectively, a "Disposition") any shares of Common
Stock, any options or warrants to purchase any shares of Common Stock or any
securities convertible into or exchangeable for shares of Common Stock
(collectively, "Securities") now owned or hereafter acquired directly by such
person or with respect to which such person has or hereafter acquires the power
of disposition, otherwise than (i) as a bona fide gift or gifts, provided the
donee or donees thereof agree in writing to be bound by this restriction, (ii)
as a distribution to partners or stockholders of such person, provided that the
distributees thereof agree in writing to be bound by the terms of this
restriction, or (iii) with the prior written consent of the Representatives. The
foregoing restriction has been expressly agreed to preclude the holder of the
Securities from engaging in any hedging or other transaction which is designed
to or reasonably expected to lead to or result in a disposition of Securities
during the Lock-up Period, even if such Securities would be disposed of by
someone other than such holder. Such prohibited hedging or other transactions
would include, without limitation, any short sale (whether or not against the
box) or any purchase, sale or grant of any right (including, without limitation,
any put or call option) with respect to any Securities or with respect to any
security (other than a broad-based market basket or index) that includes,
relates to or derives any significant part of its value from Securities.
Furthermore, such person has also agreed and consented to the entry of stop
transfer instructions with the Company's transfer agent against the transfer of
the Securities held by such person except in compliance with this restriction.
The Company has provided to counsel for the Underwriters a complete and accurate
list of all securityholders of the Company and the number and type of securities
held by each securityholder. The Company has provided to counsel for the
Underwriters true, accurate and complete copies of all of the agreements
pursuant to which its officers, directors and stockholders have agreed to such
or similar restrictions (the "Lock-up Agreements") presently in effect or
effected hereby. The Company hereby represents and warrants that it will not
release any of its officers, directors or other stockholders from any lock-up
agreements currently existing or hereafter effected without the prior written
consent of the Representatives.
(n) All necessary corporate action has been duly and validly
taken by the Company to authorize the execution, delivery and performance of
this Agreement and the issuance and sale of the Shares by the Company. This
Agreement has been duly and validly authorized, executed and delivered by the
Company and constitutes a legal, valid and binding obligation of the Company
enforceable against the Company in accordance with its terms, except (A) as the
enforceability thereof may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar laws affecting the enforcement of creditors' rights
generally and by general equitable principles and (B) to the extent that rights
to indemnity or contribution under this Agreement may be limited by Federal and
state securities laws or the public policy underlying such laws.
(o) The Company is not involved in any labor dispute nor, to the
knowledge of the Company and the Principal Stockholder, is any such dispute
threatened, which dispute would have a material adverse effect on the assets or
properties, business, results of operations, prospects or condition (financial
or otherwise) of the Company and its subsidiary, taken as a whole.
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<PAGE> 10
(p) No transaction has occurred between or among the Company and
any of its officers or directors or any affiliate or affiliates of any such
officer or director that is required to be described in and is not described in
the Registration Statement and the Prospectus.
(q) The Company has not taken, nor will it take, directly or
indirectly, any action designed to or which might reasonably be expected to
cause or result in, or which has constituted or which might reasonably be
expected to constitute, the stabilization or manipulation of the price of the
Common Stock to facilitate the sale or resale of any of the Shares.
(r) The Company has filed all Federal, state, local and foreign
tax returns which are required to be filed through the date hereof, or has
received extensions thereof, and has paid all taxes shown on such returns and
all assessments received by it to the extent that the same are material and have
become due, except where the failure to make such filing or payment would not
have a material adverse effect on the assets or properties, business, results of
operations, prospects or condition (financial or otherwise) of the Company and
its subsidiary, taken as a whole.
(s) The Shares have been duly authorized for quotation on the
National Association of Securities Dealers Automated Quotation ("NASDAQ")
National Market System.
(t) Neither the Company nor its subsidiary does business with the
government of Cuba or with any person or entity located in Cuba.
(u) Except as set forth in the Registration Statement and
Prospectus, (i) each of the Company and its subsidiary is in compliance with all
rules, laws and regulations relating to the use, treatment, storage and disposal
of toxic substances and protection of health or the environment ("Environmental
Laws") which are applicable to its business, except where a failure to comply
with such rules, laws and regulations would not have a material adverse effect
on the assets or properties, business, results of operations, prospects or
condition (financial or otherwise) of the Company and its subsidiary, taken as a
whole, (ii) neither the Company nor its subsidiary has received notice from any
governmental authority or third party of an asserted claim under Environmental
Laws, which claim is required to be disclosed in the Registration Statement and
the Prospectus, (iii) neither the Company nor its subsidiary will be required to
make future material capital expenditures to comply with Environmental Laws and
(iv) no property which is owned, if any, leased or occupied by the Company or
its subsidiary has been designated as a Superfund site pursuant to the
Comprehensive Response, Compensation, and Liability Act of 1980, as amended (42
U.S.C. Section 9601, et seq.), or otherwise designated as a contaminated site
under applicable state or local law.
(v) Each of the Company and its subsidiary maintains a system of
internal accounting controls sufficient to provide reasonable assurances that
(i) transactions are executed in accordance with management's general or
specific authorizations, (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain accountability for assets, (iii) access to
assets is permitted only in accordance with management's general or specific
authorization, and
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(iv) the recorded accountability for assets is compared with existing assets at
reasonable intervals and appropriate action is taken with respect to any
differences.
(w) There are no issues related to the Company's, or
subsidiaries', preparedness for the Year 2000 that (i) are of a character
required to be described or referred to in the Registration Statement or by the
Securities Act which have not been accurately described in the Registration
Statement or Prospectus or (ii) except as disclosed in the Prospectus or the
Registration Statement, might reasonably be expected to result in a material
adverse effect on the assets or properties, business, results of operations,
prospects or condition (financial or otherwise) of the Company and its
subsidiary, taken as a whole. Except as disclosed in the Prospectus or the
Registration Statement, all internal computer systems and, to the Company's
knowledge, each Constituent Component (as defined below) of those systems and
all computer-related products and each Constituent Component (as defined below)
of those products of the Company and its subsidiary fully comply with Year 2000
Qualification Requirements. "Year 2000 Qualifications Requirements" means that
the internal computer systems and each Constituent Component (as defined below)
of those systems and all computer-related products and each Constituent
Component (as defined below) of those products of the Company and its Subsidiary
(i) have been reviewed to confirm that they store, process (including sorting
and performing mathematical operations, calculations and computations), input
and output data containing date and information correctly regardless of whether
the date contains dates and times before, on or after January 1, 2000, (ii) have
been designated to ensure date and time entry recognition and calculations, and
date data interface values that reflect the century, (iii) accurately manage and
manipulate data involving dates and times, including single century formulas and
multi-century formulas, and will not cause an abnormal ending scenario within
the application or generate incorrect values or invalid results involving such
dates, (iv) accurately process any date rollover, and (v) accept and respond to
two-digit year date input in a manner that resolves any ambiguities as to the
century. "Constituent Component" means all software (including operating
systems, programs, packages and utilities), firmware, hardware, networking
components, and peripherals provided as part of the configuration. Except as
disclosed in the Prospectus and the Registration Statement, the Company has
inquired of material vendors as to their preparedness for the Year 2000. The
Company has disclosed in the Registration Statement or Prospectus to the extent
required by the Securities Act, any issues that might reasonably be expected to
result in a material adverse effect on the assets or properties, business,
results of operations, prospects or condition (financial or otherwise) of the
Company and its subsidiary, taken as a whole.
(x) Neither the Company nor its subsidiary has any knowledge that
any of the activities or types of conduct enumerated below have been or may have
been engaged in, either directly or indirectly, at any time since the founding
of the Company: (a) any bribes or kickbacks to government officials or their
relatives, or any other payments to such persons, whether or not legal, to
obtain or retain business or to receive favorable treatment with regard to
business; (b) any bribes or kickbacks to persons other than government
officials, or to relatives of such persons, or any other payments to such
persons or their relatives, whether or not legal, to obtain or retain business
or to receive favorable treatment with regard to business; (c) any
contributions, whether or not legal, made to any political party, political
candidate or holder of governmental office; (d) any bank accounts, funds or
pools of funds created or maintained without being reflected on the corporate
books of account, or as to which the receipts and
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disbursements therefrom have not been reflected on such books; (e) any receipts
or disbursements, the actual nature of which has been "disguised" or
intentionally misrecorded on the corporate books of account of the Company or
its subsidiary; (f) any fees paid to consultants or commercial agents that
exceeded the reasonable value of the services purported to have been rendered;
or (g) any payments or reimbursements made to personnel of the Company or its
subsidiary for the purposes of enabling them to expend time or to make
contributions or payments of the kind or for the purpose referred to in subparts
(a)-(f) above.
5. The Principal Stockholder represents and warrants to each
Underwriter that:
(a) The Principal Stockholder now has and on the Option Share
Closing Date (if applicable) will have valid marketable title to the Shares to
be sold by such Principal Stockholder, free and clear of any pledge, lien,
security interest, encumbrance, claim or equitable interest other than pursuant
to this Agreement; and upon delivery of such Shares hereunder and payment of the
purchase price as herein contemplated, each of the Underwriters will obtain
valid marketable title to the Shares purchased by it from such Principal
Stockholder, free and clear of any pledge, lien, security interest pertaining to
such Principal Stockholder or such Principal Stockholder's property,
encumbrance, claim or equitable interest, including any liability for estate or
inheritance taxes, or any liability to or claims of any creditor, devisee,
legatee or beneficiary of such Principal Stockholder.
(b) All consents, approvals, authorizations and orders required
for the execution and delivery by or on behalf of such Principal Stockholder of
this Agreement and the sale and delivery of the Option Shares sold by the
Principal Stockholder under this Agreement (other than, at the time of the
execution hereof (if the Registration Statement has not yet been declared
effective by the Commission), the issuance of the order of the Commission
declaring the Registration Statement effective and such consents, approvals,
authorizations or orders as may be necessary under state or other securities or
Blue Sky laws) have been obtained and are in full force and effect; such
Principal Stockholder has full legal right, power and authority to enter into
and perform its obligations under this Agreement and to sell, assign, transfer
and deliver the Shares to be sold by such Principal Stockholder under this
Agreement.
Such Principal Stockholder will not, during the Lock-up Period, effect
the Disposition of any Securities now owned or hereafter acquired directly by
such Principal Stockholder or with respect to which such Principal Stockholder
has or hereafter acquires the power of disposition, otherwise than to Securities
(i) to be sold in the Offering, (ii) transferred as a gift or gifts (provided
that any donee thereof agrees in writing to be bound by the terms hereof), (iii)
transferred or bequested to immediate family members or a trust established for
their benefit (provided that any such transferee thereof agrees in writing to be
bound by the terms hereof) or (iv) with the prior written consent of the
Representatives. The foregoing restriction is expressly agreed to preclude the
holder of the Securities from engaging in any hedging or other transaction which
is designed to or reasonably expected to lead to or result in a Disposition of
Securities during the Lock-up Period, even if such Securities would be disposed
of by someone other than the Principal Stockholder. Such prohibited hedging or
other transactions would including, without limitation, any short sale (whether
or not against the box) or any purchase, sale or grant of any right (including,
without limitation, any put or call option) with respect to
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<PAGE> 13
any Securities or with respect to any security (other than a broad-based market
basket or index) that includes, relates to or derives any significant part of
its value from Securities. Such Principal Stockholder also agrees and consents
to the entry of stop transfer instructions with the Company's transfer agent
against the transfer of the securities held by such Principal Stockholder except
in compliance with this restriction.
(c) Such Principal Stockholder has not taken and will not take,
directly or indirectly, any action designed to or that might reasonably be
expected to cause or result in stabilization or manipulation of the price of the
Common Stock to facilitate the sale or resale of the Shares.
(d) Such Principal Stockholder has not distributed and will not
distribute any prospectus or other offering material in connection with the
offering and sale of the Shares.
(e) All information furnished by or on behalf of such Principal
Stockholder relating to such Principal Stockholder and the Principal Stockholder
Shares that is set forth in the Registration Statement or the Prospectus is, and
at the time the Registration Statement became or becomes, as the case may be,
effective and at all times subsequent thereto up to and on the Closing Date was
or will be, true, correct and complete, and does not, and at the time the
Registration Statement became or becomes, as the case may be, effective and at
all times subsequent thereto up to and on the Closing Date will not, contain any
untrue statement of a material fact or omit to state a material fact required to
be stated therein or necessary to make such information not misleading, in light
of the circumstances under which they were made.
(f) Such Principal Stockholder will review the Prospectus and
will comply with all agreements and satisfy all conditions on its part to be
complied with or satisfied pursuant to this Agreement on or prior to the Closing
Date and will advise the Representatives prior to the Closing Date if any
statement to be made on behalf of such Principal Stockholder in the certificate
contemplated by Section 6 would be inaccurate if made as of the Closing Date.
(g) Such Principal Stockholder does not have, or has waived prior
to the date hereof, any preemptive right, co-sale right or right of first
refusal or other similar right to purchase any of the Shares that are to be sold
by the Company to the Underwriters pursuant to this Agreement; such Principal
Stockholder does not have, or has waived prior to the date hereof, any
registration right or other similar right to participate in the offering made by
the Prospectus, other than such rights of participation as have been satisfied
by the participation of such Principal Stockholder in the transactions to which
this Agreement relates in accordance with the terms of this Agreement; and such
Principal Stockholder does not own any warrants, options or similar rights to
acquire, and does not have any right or arrangement to acquire, any capital
stock, rights, warrants, options or other securities from the Company, other
than those described in the Registration Statement and the Prospectus.
6. Conditions of the Underwriters' Obligations. The obligations of the
Underwriters under this Agreement are several and not joint. The respective
obligations of the Underwriters to purchase the Shares are subject to each of
the following terms and conditions:
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<PAGE> 14
(a) The Prospectus shall have been timely filed with the
Commission in accordance with Section 7(a) of this Agreement.
(b) No order preventing or suspending the use of any preliminary
prospectus or the Prospectus shall have been or shall be in effect and no order
suspending the effectiveness of the Registration Statement shall be in effect
and no proceedings for such purpose shall be pending before or threatened by the
Commission, and any requests for additional information on the part of the
Commission (to be included in the Registration Statement or the Prospectus or
otherwise) shall have been complied with to the satisfaction of the counsel to
the Representatives.
(c) The representations and warranties of the Company, its
subsidiary and the Principal Stockholder contained in this Agreement and the
representations and warranties of the Company and its subsidiary in the
certificates delivered pursuant to Section 6(d) shall be true and correct in all
material respects when made and on and as of each Closing Date as if made on
such date, and the Company shall have performed all covenants and agreements and
satisfied all the conditions contained in this Agreement required to be
performed or satisfied by it at or before such Closing Date.
(d) The Representatives shall have received on each Closing Date
a certificate, addressed to the Representatives and dated such Closing Date, of
the chief executive or chief operating officer and the chief financial officer
or chief accounting officer of the Company to the effect that, and you shall be
satisfied that:
(i) The representations and warranties of the Company in
this Agreement are true and correct in all material respects, as if made on and
as of the Closing Date and the Company has complied with all the agreements and
satisfied all the conditions on its part to be performed or satisfied at or
prior to the Closing Date;
(ii) No stop order suspending the effectiveness of the
Registration Statement has been issued and no proceedings for that purpose have
been instituted or are pending or threatened under the Act;
(iii) When the Registration Statement became effective and
at all times subsequent thereto up to the delivery of such certificate, the
Registration Statement and the Prospectus, and any amendments or supplements
thereto, contained all material information required to be included therein by
the Securities Act and the Rules and in all material respects conformed to the
requirements of the Securities Act and the Rules, the Registration Statement,
and any amendment or supplement thereto, did not and does not include any untrue
statement of a material fact or omit to state a material fact required to be
stated therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading, the Prospectus, and
any amendment or supplement thereto, did not and does not include any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements therein, in the light of the circumstances under which they were
made, not misleading, and, since the Effective Date, there has occurred no event
required to be set forth in an amended or supplemented Prospectus which has not
been so set forth; and
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<PAGE> 15
(iv) Subsequent to the respective dates as of which
information is given in the Registration Statement and Prospectus, there has not
been (a) any material adverse change in the condition (financial or otherwise),
earnings, operations, business or business prospects of the Company and its
subsidiary, taken as a whole, (b) any transaction that is material to the
Company and its subsidiary, taken as a whole, except transactions entered into
in the ordinary course of business, (c) any obligation, direct or contingent,
that is material to the Company and its subsidiary, taken as a whole, incurred
by the Company or its subsidiary, except obligations incurred in the ordinary
course of business, (d) any change in the capital stock or outstanding
indebtedness of the Company or its subsidiary that is material to the Company
and its subsidiary, taken as a whole, (e) any dividend or distribution of any
kind declared, paid or made on the capital stock of the Company or its
subsidiary, or (f) any loss or damage (whether or not insured) to the property
of the Company or its subsidiary which has been sustained or will have been
sustained which has a material adverse effect on the condition (financial or
otherwise), earnings, operations, business or business prospects of the Company
and its subsidiary, taken as a whole.
(e) The Representatives shall have received on the Effective Date
and on each Closing Date a signed letter from Deloitte & Touche LLP addressed to
the Representatives and dated the Effective Date, and each such Closing Date, in
form and substance reasonably satisfactory to the Representatives, confirming
that they are independent accountants within the meaning of the Securities Act
and the Rules, and shall:
(i) represent that they are independent auditors with
respect to the Company within the meaning of the Securities Act and the
applicable published Rules;
(ii) set forth their opinion with respect to their
examination of the balance sheet of the Company as of December 31, 1998 and
related statements of operations, stockholders' equity, and cash flows for the
twelve (12) months ended December 31, 1998;
(iii) state that Deloitte & Touche LLP has performed the
procedures set out in Statement on Auditing Standards No. 71 ("SAS 71") for a
review of interim financial information and providing the report of Deloitte &
Touche LLP as described in SAS 71 on the financial statements for the
first-quarter period ended March 31, 1999 (the "Quarterly Financial
Statements");
(iv) state that in the course of such review, nothing came
to their attention that leads them to believe that any material modifications
need to be made to any of the Quarterly Financial Statements in order for them
to be in compliance with generally accepted accounting principles consistently
applied across the periods presented; and
(v) address other matters agreed upon by Deloitte & Touche
LLP and you. In addition, you shall have received from Deloitte & Touche LLP a
letter addressed to the Company and made available to you for the use of the
Underwriters stating that their review of the Company's system of internal
accounting controls, to the extent they deemed necessary in establishing the
scope of their examination of the Company's financial statements as of December
31, 1998, did not disclose any weaknesses in internal controls that they
considered to be material weaknesses.
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<PAGE> 16
References to the Registration Statement and the Prospectus in this
paragraph (e) are to such documents as amended and supplemented at the date of
the letter.
(f) The Representatives shall have received on each Closing Date
from Gibson, Dunn and Crutcher LLP, counsel for the Company, an opinion,
addressed to the Representatives and dated such Closing Date, in the form
attached hereto as Annex A.
To the extent deemed advisable by such counsel, they may rely as to
matters of fact on certificates of responsible officers of the Company and
public officials and on the opinions of other counsel satisfactory to the
Representatives as to matters which are governed by laws other than the laws of
the State of California, the General Corporation Law of the State of Delaware
and the Federal laws of the United States. Copies of such certificates and other
opinions shall be furnished to the Representatives and counsel for the
Underwriters.
In addition, such counsel shall state that such counsel has participated
in conferences with officers and other representatives of the Company,
representatives of the Representatives and representatives of the independent
certified public accountants of the Company, at which conferences the contents
of the Registration Statement and the Prospectus and related matters were
discussed and, although such counsel is not passing upon and does not assume any
responsibility for the accuracy, completeness or fairness of the statements
contained in the Registration Statement and the Prospectus (except as specified
in the foregoing opinion), on the basis of the foregoing, no facts have come to
the attention of such counsel which lead such counsel to believe that the
Registration Statement at the time it became effective (except with respect to
the financial statements and notes and schedules thereto and other financial
data, as to which such counsel need express no belief) contained any untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not misleading, or
that the Prospectus as amended or supplemented (except with respect to the
financial statements and notes schedules thereto and other financial data, as to
which such counsel need make no statement) on the date thereof contained any
untrue statement of a material fact or omitted to state a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading.
(g) All proceedings taken in connection with the sale of the Firm
Shares and the Option Shares as herein contemplated shall be reasonably
satisfactory in form and substance to the Representatives and their counsel.
(h) The Representatives shall have received on each Closing Date,
a certificate addressed to each representative, and dated such Closing Date, of
the chief executive officer or president of the Company's subsidiary to the
effect that the financial statements of the Company's subsidiary, Integral
Networking Corporation, (the "Subsidiary Financial Statements") (i) are in
accordance with the books and records of the Company, on a consolidated basis
(the "Consolidated Company") (ii) are true, correct and complete and present
fairly the financial condition of the Consolidated Company, at the date or dates
therein indicated and the results of operations for the period or periods
therein specified, (iii) disclose all of the Consolidated Company's material
debts, liabilities and obligations of any nature, whether due or to become due,
owing to the operations of the subsidiary, as of their respective dates
(including, without limitation, absolute liabilities, accrued liabilities and
contingent liabilities) to the extent
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<PAGE> 17
such debts, liabilities and obligations are required to be disclosed in
accordance with generally accepted accounting principles, and (iv) have been
prepared in accordance with United States generally accepted accounting
principles applied on a consistent basis, except for the omission of notes
thereto and normal year-end adjustments.
7. Covenants of the Company and the Principal Stockholder.
(a) The Company covenants and agrees as follows:
(i) The Company will use its best efforts to cause the
Registration Statement and any amendment thereto, if not effective at the time
and date that this Agreement is executed and delivered by the parties hereto, to
become effective as promptly as possible; the Company will use its best efforts
to cause any abbreviated registration statement pursuant to Rule 462(b) of the
Rules as may be required subsequent to the date the Registration Statement is
declared effective to become effective as promptly as possible; the Company will
notify you, promptly after it shall receive notice thereof, of the time when the
Registration Statement, any subsequent amendment to the Registration Statement
or any abbreviated registration statement has become effective or any supplement
to the Prospectus has been filed; if the Company omitted information from the
Registration Statement at the time it was originally declared effective in
reliance upon Rule 430A(a) of the Rules, the Company will provide evidence
satisfactory to you that the Prospectus contains such information and has been
filed, within the time period prescribed, with the Commission pursuant to
subparagraph (1) or (4) of Rule 424(b) of the Rules or as part of a
post-effective amendment to such Registration Statement as originally declared
effective which is declared effective by the Commission; if the Company files a
term sheet pursuant to Rule 434 of the Rules, the Company will provide evidence
satisfactory to you that the Prospectus and term sheet meeting the requirements
of Rule 434(b) or (c), as applicable, of the Rules, have been filed, within the
time period prescribed, with the Commission pursuant to subparagraph (7) of Rule
424(b) of the Rules; if for any reason the filing of the final form of
Prospectus is required under Rule 424(b)(3) of the Rules, it will provide
evidence satisfactory to you that the Prospectus contains such information and
has been filed with the Commission within the time period prescribed; it will
notify you promptly of any request by the Commission for the amending or
supplementing of the Registration Statement or the Prospectus or for additional
information; promptly upon your request, it will prepare and file with the
Commission any amendments or supplements to the Registration Statement or
Prospectus which, in the reasonable opinion of counsel for the several
Underwriters, may be necessary or advisable in connection with the distribution
of the Shares by the Underwriters; it will promptly prepare and file with the
Commission, and promptly notify you of the filing of, any amendments or
supplements to the Registration Statement or Prospectus which may be necessary
to correct any statements or omissions, if, at any time when a prospectus
relating to the Shares is required to be delivered under the Securities Act, any
event shall have occurred as a result of which the Prospectus or any other
prospectus relating to the Shares as then in effect would include any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements therein, in the light of the circumstances under which they were
made, not misleading; in case any Underwriter is required to deliver a
prospectus nine (9) months or more after the effective date of the Registration
Statement in connection with the sale of the Shares, it will prepare promptly
upon request, but at the expense of such Underwriter, such amendment or
amendments to the Registration Statement and such prospectus or prospectuses as
may be
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<PAGE> 18
necessary to permit compliance with the requirements of Section 10(a)(3) of the
Securities Act; and it will file no amendment or supplement to the Registration
Statement or Prospectus which shall not previously have been submitted to you a
reasonable time prior to the proposed filing thereof or to which you shall
reasonably object in writing, subject, however, to compliance with the
Securities Act and the Rules and the provisions of this Agreement. The Company
shall use its best efforts to prevent the issuance of any stop order and, if
issued, to obtain as soon as possible the withdrawal thereof.
(ii) The Company will advise you, promptly after it shall
receive notice or obtain knowledge of the issuance of any stop order by the
Commission suspending the effectiveness of the Registration Statement or of the
initiation or threat of any proceeding for that purpose; and it will promptly
use its best efforts to prevent the issuance of any stop order or to obtain its
withdrawal at the earliest possible moment if such stop order should be issued.
(iii) If, at any time when a prospectus relating to the
Shares is required to be delivered under the Securities Act and the Rules, any
event occurs as a result of which the Prospectus as then amended or supplemented
would include any untrue statement of a material fact or omit to state any
material fact necessary to make the statements therein in the light of the
circumstances under which they were made not misleading, or if it shall be
necessary to amend or supplement the Prospectus to comply with the Securities
Act or the Rules, the Company promptly shall prepare and file with the
Commission, subject to this Section 7, an amendment or supplement which shall
correct such statement or omission or an amendment which shall effect such
compliance.
(iv) The Company shall make generally available to its
security holders and to the Representatives as soon as practicable, but not
later than 45 days after the end of the 12-month period beginning at the end of
the fiscal quarter of the Company during which the Effective Date occurs (or 90
days if such 12-month period coincides with the Company's fiscal year), an
earning statement (which need not be audited) of the Company, covering such
12-month period, which shall satisfy the provisions of Section 11(a) of the
Securities Act or Rule 158 of the Rules.
(v) The Company will furnish to you, as soon as available,
and, in the case of the Prospectus and any term sheet or abbreviated term sheet
under Rule 434, in no event later than the first (1st) full business day
following the first day that Shares are traded, copies of the Registration
Statement (two of which will be signed and which will include all exhibits),
each Preliminary Prospectus, the Prospectus and any amendments or supplements to
such documents, including any prospectus prepared to permit compliance with
Section 10(a)(3) of the Securities Act, all in such quantities as you may from
time to time reasonably request. Notwithstanding the foregoing, if the
Representatives, on behalf of the several Underwriters, shall agree to the
utilization of Rule 434 of the Rules, the Company shall provide to you copies of
a Preliminary Prospectus updated in all respects through the date specified by
you in such quantities as you may from time to time reasonably request.
(vi) The Company will use its best efforts to cooperate
with the Representatives and counsel for the Underwriters in endeavoring to
qualify the Shares for
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<PAGE> 19
offering and sale under the securities laws of such jurisdictions as the
Representatives may designate and to continue such qualifications in effect for
so long as may be required for purposes of the distribution of the Shares,
except that the Company shall not be required in connection therewith or as a
condition thereof to qualify as a foreign corporation or to execute a general
consent to service of process in any jurisdiction in which it is not otherwise
required to be so qualified or to so execute a general consent to service of
process. In each jurisdiction in which the Shares shall have been qualified as
above provided, the Company will make and file such statements and reports in
each year as are or may be required by the laws of such jurisdiction.
(vii) During a period of five (5) years after the date
hereof, the Company will furnish to its stockholders as soon as practicable
after the end of each respective period, annual reports (including financial
statements audited by independent certified public accountants) and unaudited
quarterly reports of operations for each of the first three quarters of the
fiscal year, and will furnish to the Representatives, and to each other of the
several Underwriters hereunder, upon request (i) concurrently with furnishing
such reports to its stockholders, statements of operations of the Company for
each of the first three (3) quarters in the form furnished to the Company's
stockholders, (ii) concurrently with furnishing to its stockholders, a balance
sheet of the Company as of the end of such fiscal year, together with statements
of operations, of stockholders' equity, and of cash flows of the Company for
such fiscal year, accompanied by a copy of the certificate or report thereon of
independent certified public accountants, (iii) as soon as they are available,
copies of all reports (financial or other) mailed to stockholders, (iv) as soon
as they are available, copies of all reports and financial statements furnished
to or filed with the Commission, any securities exchange or the National
Association of Securities Dealers, Inc. ("NASD"), (v) every material press
release and every material news item or article in respect of the Company or its
affairs which was generally released to stockholders or prepared by the Company
or any of its subsidiaries, and (vi) any additional information of a public
nature concerning the Company or its subsidiaries, or its business which you may
reasonably request. During such five (5) year period, if the Company shall have
active subsidiaries, the foregoing financial statements shall be on a
consolidated basis to the extent that the accounts of the Company and its
subsidiaries are consolidated, and shall be accompanied by similar financial
statements for any significant subsidiary which is not so consolidated.
(viii) Without the prior written consent of the
Representatives, for a period of 180 days after the date of this Agreement, the
Company shall not issue, sell or register with the Commission, (except for any
registration on Form S-8 or on any successor form) or otherwise dispose of,
directly or indirectly, any equity securities of the Company (or any securities
convertible into or exercisable or exchangeable for equity securities of the
Company), except for the issuance of the Shares pursuant to the Registration
Statement and the issuance of shares or grant of awards pursuant to the
Company's existing stock option plans or bonus plans. In the event that during
this period, (i) any shares are issued pursuant to the Company's existing stock
option plan or bonus plan or (ii) any registration is effected on Form S-8 or on
any successor form, the Company shall obtain the written agreement of such
grantee or purchaser or holder of such registered securities that, for a period
of 180 days after the date of this Agreement, such person will not, without the
prior written consent of the Representatives, offer for sale, sell, distribute,
grant any option for the sale of, or otherwise dispose of, directly or
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<PAGE> 20
indirectly, or exercise any registration rights with respect to, any shares of
Common Stock (or any securities convertible into, exercisable for, or
exchangeable for any shares of Common Stock) owned by such person.
(ix) On or before completion of this offering, the Company
shall make all filings required under applicable securities laws and by the
Nasdaq National Market (including any required registration under the Exchange
Act).
(x) The Company shall cause to be prepared and delivered,
at its expense, within one business day from the effective date of this
Agreement, to the Representatives an "electronic Prospectus" to be used by the
Underwriters in connection with the offering and sale of the Common Shares. As
used herein, the term "electronic Prospectus" means a form of Prospectus, and
any amendment or supplement thereto, that meets each of the following
conditions: (i) it shall be encoded in an electronic format, satisfactory to the
Representatives, that may be transmitted electronically by the Representatives
to offerees and purchasers of the Common Shares for at least the Prospectus
delivery period; (ii) it shall disclose the same information as the paper
Prospectus and Prospectus filed pursuant to EDGAR, except to the extent that
graphic and image material cannot be disseminated electronically, in which case
such graphic and image material shall be replaced in the electronic Prospectus
with a fair and accurate narrative description or tabular representation of such
material, as appropriate; and (iii) it shall be in or convertible into a paper
format or an electronic format, satisfactory to the Representatives, that will
allow investors to store and have continuously ready access to the Prospectus at
any future time, without charge to investors (other than any fee charged for
subscription to the system as a whole and for on-line time). Such electronic
Prospectus may consist of a Rule 434 preliminary prospectus, together with the
applicable term sheet, provided that it otherwise satisfies the format and
conditions described in the immediately preceding sentence. The Company hereby
confirms that it has included or will include in the Prospectus filed pursuant
to EDGAR or otherwise with the Commission and in the Registration Statement at
the time it was declared effective an undertaking that, upon receipt of a
request by an investor or his or her representative within the Prospectus
delivery period, the Company shall transmit or cause to be transmitted promptly,
without charge, a paper copy of the Prospectus.
(xi) The Company intends to apply the net proceeds from
the sale of the Shares being sold by it in the manner set forth under the
caption "Use of Proceeds" in the Prospectus.
(xii) The Company will maintain a transfer agent and, if
necessary under the jurisdiction of incorporation of the Company, a registrar
(which may be the same entity as the transfer agent) for its Common Stock.
(xiii) If the transactions contemplated hereby are not
consummated by reason of any failure, refusal or inability on the part of the
Company or any Principal Stockholder to perform any agreement on their
respective parts to be performed hereunder or to fulfill any condition of the
Underwriters' obligations hereunder, or if the Underwriters shall terminate this
Agreement pursuant to Section 10(b), the Company will reimburse the several
Underwriters for all reasonable out-of-pocket expenses (including fees and
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disbursements of Underwriters' Counsel) incurred by the Underwriters in
investigating or preparing to market or marketing the Shares.
(xiv) If at any time during the ninety (90) day period
after the Registration Statement becomes effective, any rumor, publication or
event relating to or affecting the Company shall occur as a result of which in
your opinion the market price of the Common Stock has been or is likely to be
materially affected (regardless of whether such rumor, publication or event
necessitates a supplement to or amendment of the Prospectus), the Company will,
after written notice from you advising the Company to the effect set forth
above, forthwith prepare, consult with you and your counsel concerning the
substance of and, unless advised otherwise by your counsel, disseminate a press
release or other public statement, reasonably satisfactory to you, responding to
or commenting on such rumor, publication or event.
(b) The Company agrees to pay, or reimburse if paid by the
Representatives, whether or not the transactions contemplated hereby are
consummated or this Agreement is terminated, all costs and expenses incident to
the public offering of the Shares and the performance of the obligations of the
Company under this Agreement including those relating to: (i) the preparation,
printing, filing and distribution of the Registration Statement including all
exhibits thereto, each preliminary prospectus, the Prospectus, all amendments
and supplements to the Registration Statement and the Prospectus, and the filing
and distribution of this Agreement, the Agreement Among Underwriters, the
Selected Dealer Agreement, the Underwriter's Questionnaire and Power of Attorney
and any instruments related to any of the foregoing; (ii) the issuance and
delivery of the Shares hereunder to the several Underwriters, including transfer
taxes, if any, and the cost of all certificates representing the Shares and
transfer agents' and registrars' fees; (iii) the registration or qualification
of the Shares for offer and sale under the securities or Blue Sky laws of the
various jurisdictions referred to in Section 7(a)(vi), including the reasonable
fees and disbursements of counsel for the Underwriters in connection with such
registration and qualification and the preparation, distribution and shipment of
preliminary and supplementary Blue Sky memoranda; (iv) the furnishing (including
costs of shipping and mailing) to the Representatives and to the Underwriters of
copies of each preliminary prospectus, the Prospectus and all amendments or
supplements to the Prospectus, and of the several documents required by this
Section to be so furnished, as may be reasonably requested for use in connection
with the offering and sale of the Shares by the Underwriters or by dealers to
whom Shares may be sold; (v) the filing fees of the National Association of
Securities Dealers, Inc. in connection with its review of the terms of the
public offering; (vi) the furnishing (including costs of shipping and mailing)
to the Representatives and to the Underwriters of copies of all reports and
information required by Section 7(a)(vii); (vii) inclusion of the Shares for
quotation on the Nasdaq National Market; (viii) the fees and disbursements of
counsel for the Company; and (ix) all fees and other charges of the Company's
independent certified public accountants. Subject to the provisions of Section
10, the Underwriters agree to pay, whether or not the transactions contemplated
hereby are consummated or this Agreement is terminated, all costs and expenses
incident to the performance of the obligations of the Underwriters under this
Agreement not payable by the Company pursuant to the preceding sentence,
including, without limitation, the fees and disbursements of counsel for the
Underwriters.
8. Indemnification.
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<PAGE> 22
(a) The Company agrees to indemnify and hold harmless each
Underwriter and each person, if any, who controls any Underwriter within the
meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act
against any and all losses, claims, damages and liabilities, joint or several
(including any reasonable investigation, legal and other expenses incurred in
connection with, and any amount paid in settlement of, any action, suit or
proceeding or any claim asserted), to which they, or any of them, may become
subject under the Securities Act, the Exchange Act or other Federal or state law
or regulation, at common law or otherwise, insofar as such losses, claims,
damages or liabilities arise out of or are based upon (i) any breach of any
representation, warranty, agreement or covenant of the Company herein or (ii)
any untrue statement or alleged untrue statement of a material fact contained in
any preliminary prospectus, the Registration Statement, the electronic
Prospectus or the Prospectus or any amendment thereof or supplement thereto, or
arise out of or are based upon any omission or alleged omission to state therein
a material fact required to be stated therein or necessary to make the
statements therein not misleading; provided, however, that such indemnity shall
not inure to the benefit of any Underwriter (or any person controlling such
Underwriter) on account of any losses, claims, damages or liabilities arising
from the sale of the Shares to any person by such Underwriter if such untrue
statement or omission or alleged untrue statement or omission was made in such
preliminary prospectus, the Registration Statement or the Prospectus, or such
amendment or supplement, in reliance upon and in conformity with information
furnished in writing to the Company by the Representatives on behalf of any
Underwriter specifically for use therein. This indemnity agreement will be in
addition to any liability which the Company and the Principal Stockholder may
otherwise have.
(b) The Principal Stockholder agrees to indemnify and hold
harmless each Underwriter and each person, if any, who controls any Underwriter
within the meaning of Section 15 of the Securities Act or Section 20 of the
Exchange Act against any and all losses, claims, damages and liabilities, joint
or several (including any reasonable investigation, legal and other expenses
incurred in connection with, and any amount paid in settlement of, any action,
suit or proceeding or any claim asserted), to which they, or any of them, may
become subject under the Securities Act, the Exchange Act or other Federal or
state law or regulation, at common law or otherwise, insofar as such losses,
claims, damages or liabilities arise out of or are based upon (i) any breach of
any representation, warranty, agreement or covenant of the Principal Stockholder
herein or (ii) any untrue statement or alleged untrue statement of a material
fact contained in any preliminary prospectus, the Registration Statement, the
electronic Prospectus or the Prospectus or any amendment thereof or supplement
thereto, or arise out of or are based upon any omission or alleged omission to
state therein a material fact required to be stated therein or necessary to make
the statements therein not misleading; provided, however, that such indemnity
shall not inure to the benefit of any Underwriter (or any person controlling
such Underwriter) on account of any losses, claims, damages or liabilities
arising from the sale of the Shares to any person by such Underwriter if such
untrue statement or omission or alleged untrue statement or omission was made in
such preliminary prospectus, the Registration Statement or the Prospectus, or
such amendment or supplement, in reliance upon and in conformity with
information furnished in writing to the Company by the Representatives on behalf
of any Underwriter specifically for use therein. This indemnity agreement will
be in addition to any liability which the Company and the Principal Stockholder
may otherwise have. The liability of the Principal Stockholder under the
representations, warranties and agreements contained herein, under the indemnity
agreements contained in the provisions of this Section 8,
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<PAGE> 23
and otherwise with respect to the transactions and other matters contemplated by
this Agreement shall be limited to an amount equal to the initial public
offering price of the Shares, if any, sold by the Principal Stockholder to the
Underwriters (minus the amount of the underwriting discount paid thereon to the
Underwriters and minus any federal or state capital gains or other income taxes
paid or payable by the Principal Stockholder in connection with his sale of the
Shares). The Company and the Principal Stockholder may agree, as among
themselves and without limiting the rights of the Underwriters under this
Agreement, as to the respective amounts of such liability for which they each
shall be responsible.
(c) Each Underwriter agrees, severally and not jointly, to
indemnify and hold harmless the Company, each person, if any, who controls the
Company within the meaning of Section 15 of the Securities Act or Section 20 of
the Exchange Act, the Principal Stockholder and each director of the Company and
each officer of the Company who signs the Registration Statement, to the same
extent as the foregoing indemnity from the Company and the Principal Stockholder
to each Underwriter, but only insofar as such losses, claims, damages or
liabilities arise out of or are based upon (i) any breach of any representation,
warranty, agreement or covenant of such Underwriter herein or (ii) any untrue
statement or omission or alleged untrue statement or omission which was made in
any preliminary prospectus, electronic Prospectus, the Registration Statement or
the Prospectus, or any amendment thereof or supplement thereto, contained in the
last paragraph of the cover page and the statements contained under the caption
"Underwriting" in the Prospectus; provided, however, that the obligation of each
Underwriter to indemnify the Company (including any controlling person, director
or officer thereof) shall be limited to the net proceeds received by the Company
from such Underwriter.
(d) Any party that proposes to assert the right to be indemnified
under this Section 8 will, promptly after receipt of notice of commencement of
any action, suit or proceeding against such party in respect of which a claim is
to be made against an indemnifying party or parties under this Section, notify
each such indemnifying party of the commencement of such action, suit or
proceeding, enclosing a copy of all papers served. No indemnification provided
for in Section 8(a) or 8(b) shall be available to any party who shall fail to
give notice as provided in this Section 8(d) if the party to whom notice was not
given was unaware of the proceeding to which such notice would have related and
was prejudiced by the failure to give such notice but the omission so to notify
such indemnifying party of any such action, suit or proceeding shall not relieve
it from any liability that it may have to any indemnified party for contribution
or otherwise than under this Section 8, except to the extent the indemnifying
party is prejudiced as a result of any failure or delay in providing such
notice. In case any such action, suit or proceeding shall be brought against any
indemnified party and it shall notify the indemnifying party of the commencement
thereof, the indemnifying party shall be entitled to participate in, and, to the
extent that it shall wish, jointly with any other indemnifying party similarly
notified, to assume the defense thereof, with counsel reasonably satisfactory to
such indemnified party, and after notice from the indemnifying party to such
indemnified party of its election so to assume the defense thereof and the
approval by the indemnified party of such counsel, the indemnifying party shall
not be liable to such indemnified party for any legal or other expenses, except
as provided below and except for the reasonable costs of investigation
subsequently incurred by such indemnified party in connection with the defense
thereof. The indemnified party shall have the right to employ its counsel in any
such action, but the fees and
23
<PAGE> 24
expenses of such counsel shall be at the expense of such indemnified party
unless (i) the employment of counsel by such indemnified party has been
authorized in writing by the indemnifying parties, (ii) the indemnified party
shall have reasonably concluded that there may be a conflict of interest between
the indemnifying parties and the indemnified party in the conduct of the defense
of such action (in which case the indemnifying parties shall not have the right
to direct the defense of such action on behalf of the indemnified party) or
(iii) the indemnifying parties shall not have employed counsel to assume the
defense of such action within a reasonable time after notice of the commencement
thereof, in each of which cases the fees and expenses of counsel shall be at the
expense of the indemnifying parties. An indemnifying party shall not be liable
for any settlement of any action, suit, proceeding or claim effected without its
written consent.
(e) No indemnification provided for in Section 8(b) by the
Principal Stockholder shall be available to any Underwriter, or any person who
controls any Underwriter within the meaning of Section 15 of the Securities Act
or Section 20 of the Exchange Act (each an "Underwriter Indemnified Party")
until such Underwriter Indemnified Party has first used its best efforts to
pursue and exhaust all remedies (including the enforcement and collection of
judgments or claims against the Company) it may have against the Company under
Section 8(a). Without limiting the generality of the foregoing, an Underwriter
Indemnified Party shall be deemed to have used its best efforts to pursue and
exhaust all remedies it may have against the Company, and may pursue any
remedies it may have against the Principal Stockholder, if (A) such Underwriter
Indemnified Party is in the process of pursuing remedies against the Company and
any of the following events occurs, or, immediately prior to the time at which
such Underwriter Indemnified Party commences the process of pursuing remedies
against the Company, any of the following events has occurred and is continuing:
(1) the Company files a petition, answer or any pleading seeking or acquiescing
in any reorganization, liquidation or other relief under chapter 7 or 11 of the
Bankruptcy Code; (2) the Company seeks or acquiesces in the appointment of a
trustee (other than a trustee appointed solely for purposes of facilitating the
issuance of any debt securities of the Company), receiver or liquidator of all
or part of its assets; or (3) the Company makes a general assignment for the
benefit of its creditors, (B) a court of competent jurisdiction: (1) appoints a
trustee, receiver or liquidator of all or part of the Company's assets; or (2)
determines in any action, suit or proceeding that the Company is insolvent (in
the accounting, bankruptcy, equity or legal definitions), or (C) a court or
arbitration panel of competent jurisdiction enters an order in any action, suit
or proceeding by such Underwriter Indemnified Party for indemnification by the
Company that is adverse to such Underwriter Indemnified Party. Notwithstanding
the foregoing, if, in the reasonable judgment of any Underwriter Indemnified
Party, the applicable statute of limitations for any potential action, suit or
proceeding by such Underwriter Indemnified Party for indemnification against the
Principal Stockholder will expire, such Underwriter Indemnified Party may name
the Principal Stockholder in any action, suit or proceeding to which the Company
is also a party solely for purposes of preserving any rights such Underwriter
Indemnified Party may have to seek indemnification from the Principal
Stockholder after using its best efforts to pursue and exhaust all remedies it
may have against the Company.
(f) The parties to this Agreement hereby acknowledge that they
are sophisticated business persons who were represented by counsel during the
negotiations regarding the provisions hereof including, without limitation, the
provisions of this Section 8,
24
<PAGE> 25
and are fully informed regarding said provisions. They further acknowledge that
the provisions of this Section 8 fairly allocate the risks in light of the
ability of the parties to investigate the Company and its business in order to
assure that adequate disclosure is made in the Registration Statement and
Prospectus as required by the Securities Act and the Exchange Act.
9. Contribution. In order to provide for just and equitable contribution
in circumstances in which the indemnification provided for in Section 8 is due
in accordance with its terms but for any reason is held to be unavailable from
the Company, or the Principal Stockholder or the Underwriters, the Company, the
Principal Stockholder and the Underwriters shall contribute to the aggregate
losses, claims, damages and liabilities (including any investigation, legal and
other expenses reasonably incurred in connection with, and any amount paid in
settlement of, any action, suit or proceeding or any claims asserted, but after
deducting any contribution received by the Company or the Principal Stockholder
from persons other than the Underwriters, such as persons who control the
Company within the meaning of the Securities Act, officers of the Company who
signed the Registration Statement and directors of the Company, who may also be
liable for contribution) to which the Company, the Principal Stockholder and one
or more of the Underwriters may be subject in such proportion as is appropriate
to reflect the relative benefits received by the Company and the Principal
Stockholder on the one hand and the Underwriters on the other from the offering
of the Shares or, if such allocation is not permitted by applicable law or
indemnification is not available as a result of the indemnifying party not
having received notice as provided in Section 8 hereof, in such proportion as is
appropriate to reflect not only the relative benefits referred to above but also
the relative fault of the Company and the Principal Stockholder on the one hand
and the Underwriters on the other in connection with the statements or omissions
which resulted in such losses, claims, damages, liabilities or expenses, as well
as any other relevant equitable considerations. The relative benefits received
by the Company and the Principal Stockholder and the Underwriters shall be
deemed to be in the same proportion as (x) the total proceeds from the offering
(net of underwriting discounts but before deducting expenses) received by the
Company and the Principal Stockholder, respectively, as set forth in the table
on the cover page of the Prospectus or in the table regarding the discount to be
paid to the Underwriters in the Underwriting section of the Prospectus, bear to
(y) the underwriting discounts received by the Underwriters, as set forth in the
table on the cover page of the Prospectus or in the table regarding the discount
to be paid to the Underwriters in the Underwriting section of the Prospectus.
The relative fault of the Company and the Principal Stockholder or the
Underwriters shall be determined by reference to, among other things, whether
the untrue or alleged untrue statement of a material fact related to information
supplied by the Company or the Principal Stockholder or the Underwriters and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission. The Company, the Principal
Stockholder and the Underwriters agree that it would not be just and equitable
if contribution pursuant to this Section 9 were determined by pro rata
allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take account of the
equitable considerations referred to above. Notwithstanding the provisions of
this Section 9, (i) in no case shall any Underwriter (except as may be provided
in the Agreement Among Underwriters) be liable or responsible for any amount in
excess of the underwriting discount applicable to the Shares purchased by such
Underwriter hereunder, and (ii) the Company and the Principal Stockholder shall
be liable and responsible for any amount in excess of such underwriting
discount; provided, however, that the Principal Stockholder shall not be liable
under this clause (ii) for any amount in excess of the initial public offering
price of the Shares, if any, sold by the Principal Stockholder to the
Underwriters (minus the amount of the underwriting discount paid thereon to
25
<PAGE> 26
the Underwriters and minus any federal or state capital gains or other income
taxes paid or payable by the Principal Stockholder in connection with his sale
of the Shares); and provided, further, that no person guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the Securities Act)
shall be entitled to contribution from any person who was not guilty of such
fraudulent misrepresentation. For purposes of this Section 9, each person, if
any, who controls an Underwriter within the meaning of Section 15 of the
Securities Act or Section 20(a) of the Exchange Act shall have the same rights
to contribution as such Underwriter, and each person, if any, who controls the
Company within the meaning of the Section 15 of the Securities Act or Section
20(a) of the Exchange Act, each officer of the Company who shall have signed the
Registration Statement and each director of the Company shall have the same
rights to contribution as the Company, subject in each case to clauses (i) and
(ii) in the immediately preceding sentence of this Section 9. Any party entitled
to contribution will, promptly after receipt of notice of commencement of any
action, suit or proceeding against such party in respect of which a claim for
contribution may be made against another party or parties under this Section,
notify such party or parties from whom contribution may be sought, but the
omission so to notify such party or parties from whom contribution may be sought
shall not relieve the party or parties from whom contribution may be sought from
any other obligation it or they may have hereunder or otherwise than under this
Section, except to the extent the party or parties from whom contribution is
sought have been prejudiced as a result thereof. No party shall be liable for
contribution with respect to any action, suit, proceeding or claim settled
without its written consent; provided, however, that such written consent shall
not be unreasonably withheld. The Underwriter's obligations to contribute
pursuant to this Section 9 are several in proportion to their respective
underwriting commitments and not joint.
10. Termination. This Agreement may be terminated with respect to the
Shares to be purchased on a Closing Date by the Representatives by notifying the
Company and the Principal Stockholder at any time:
(a) in the absolute discretion and judgment of the
Representatives at or before any Closing Date: (i) if on or prior to such date,
any domestic or international event or act or occurrence has materially
disrupted, or in the opinion of the Representatives will in the future
materially disrupt, the securities markets; (ii) if there has occurred any new
outbreak or material escalation of hostilities or other calamity or crisis the
effect of which on the financial markets of the United States is such as to make
it, in the judgment of the Representatives, inadvisable to proceed with the
offering; (iii) if there shall be such a material adverse change in general
financial, political or economic conditions or the effect of international
conditions on the financial markets in the United States is such as to make it,
in the judgment of the Representatives, inadvisable or impracticable to market
the Shares; (iv) if trading in the Shares has been suspended by the Commission
or trading generally on the New York Stock Exchange, Inc. or on the American
Stock Exchange, Inc. has been suspended or limited, or minimum or maximum ranges
for prices for securities shall have been fixed, or maximum ranges for prices
for securities have been required, by said exchanges or by order of the
Commission, the National Association of Securities Dealers, Inc., or any other
governmental or regulatory authority; or (v) if a banking moratorium has been
declared by any state or Federal authority, or
(b) at or before any Closing Date, that any of the conditions
specified in Section 6 shall not have been fulfilled when and as required by
this Agreement.
26
<PAGE> 27
If this Agreement is terminated pursuant to any of its provisions,
neither the Company nor the Principal Stockholder shall be under any liability
to any Underwriter, and no Underwriter shall be under any liability to the
Company or the Principal Stockholder, except that no Underwriter who shall have
failed or refused to purchase the Shares agreed to be purchased by it under this
Agreement, in circumstances where it was obligated to purchase such Shares under
this Agreement, shall be relieved of liability to the Company or to the other
Underwriters for damages occasioned by its failure or refusal.
11. Substitution of Underwriters. If one or more of the Underwriters
shall fail (other than for a reason sufficient to justify the cancellation or
termination of this Agreement under Section 10) to purchase on any Closing Date
the Shares agreed to be purchased on such Closing Date by such Underwriter or
Underwriters, the Representatives may find one or more substitute underwriters
to purchase such Shares or make such other arrangements as the Representatives
may deem advisable or one or more of the remaining Underwriters may agree to
purchase such Shares in such proportions as may be approved by the
Representatives, in each case upon the terms set forth in this Agreement. If no
such arrangements have been made by the close of business on the business day
following such Closing Date:
(a) if the number of Shares to be purchased by the defaulting
Underwriters on such Closing Date shall not exceed 10% of the Shares that all
the Underwriters are obligated to purchase on such Closing Date, then each of
the nondefaulting Underwriters shall be obligated to purchase such Shares on the
terms herein set forth in proportion to their respective obligations hereunder;
provided, that in no event shall the maximum number of Shares that any
Underwriter has agreed to purchase pursuant to Section 1 be increased pursuant
to this Section 11 by more than one-ninth of such number of Shares without the
written consent of such Underwriter; or
(b) if the number of Shares to be purchased by the defaulting
Underwriters on such Closing Date shall exceed 10% of the Shares that all the
Underwriters are obligated to purchase on such Closing Date, then the Company
shall be entitled to an additional two business days within which it may, but is
not obligated to, find one or more substitute underwriters reasonably
satisfactory to the Representatives to purchase such Shares upon the terms set
forth in this Agreement.
In any such case, either the Representatives or the Company shall have
the right to postpone the applicable Closing Date for a period of not more than
five business days in order that necessary changes and arrangements (including
any necessary amendments or supplements to the Registration Statement or
Prospectus) may be effected by the Representatives and the Company. If the
number of Shares to be purchased on such Closing Date by such defaulting
Underwriter or Underwriters shall exceed 10% of the Shares that all the
Underwriters are obligated to purchase on such Closing Date, and none of the
nondefaulting Underwriters or the Company shall make arrangements pursuant to
this Section within the period stated for the purchase of the Shares that the
defaulting Underwriters agreed to purchase, this Agreement shall terminate with
respect to the Shares to be purchased on such Closing Date without liability on
the part of any nondefaulting Underwriter to the Company and without liability
on the part of the Company, except in both cases as provided in Sections 7, 8, 9
and 10. The provisions of this Section shall not in any way affect the liability
of any defaulting Underwriter to the Company or
27
<PAGE> 28
the nondefaulting Underwriters arising out of such default. A substitute
underwriter hereunder shall become an Underwriter for all purposes of this
Agreement.
12. Miscellaneous. The respective agreements, representations,
warranties, indemnities and other statements of the Company, its subsidiary or
any of its officers, the Principal Stockholder and of the Underwriters set forth
in or made pursuant to this Agreement shall remain in full force and effect,
regardless of any investigation made by or on behalf of any Underwriter, the
Principal Stockholder or the Company, or any of their officers, directors or
controlling persons referred to in Sections 8 and 9 hereof, and shall survive
delivery of and payment for the Shares. The provisions of Sections 7(b), 8, 9
and 10 shall survive the termination or cancellation of this Agreement.
This Agreement has been and is made for the benefit of the Underwriters,
the Principal Stockholder and the Company and their respective successors and
assigns, and, to the extent expressed herein, for the benefit of persons
controlling any of the Underwriters, or the Company, and directors and officers
of the Company, and their respective successors and assigns, and no other person
shall acquire or have any right under or by virtue of this Agreement. The term
"successors and assigns" shall not include any purchaser of Shares from any
Underwriter merely because of such purchase.
All notices and communications hereunder shall be in writing and mailed
or delivered or by telephone or telegraph if subsequently confirmed in writing,
(a) if to the Representatives, c/o CIBC World Markets Corp., CIBC Oppenheimer
Tower, World Financial Center, New York, New York 10281 Attention: Richard D.
White, (b) if to the Principal Stockholder, to the Company as the Company's
address appears on the cover page of the Registration Statement with a copy to
Gibson, Dunn & Crutcher LLP, Telesis Tower, One Montgomery Street, 26th Floor,
San Francisco, California 94104, Attention: Kenneth R. Lamb, Esq. and (c) if to
the Company, to its agent for service as such agent's address appears on the
cover page of the Registration Statement, with a copy to Gibson, Dunn & Crutcher
LLP, Telesis Tower, One Montgomery Street, 26th Floor, San Francisco, California
94104, Attention: Kenneth R. Lamb, Esq.
This Agreement shall be governed by and construed in accordance with the
laws of the State of New York without regard to principles of conflict of laws.
This Agreement may be signed in any number of counterparts, each of
which shall be an original, with the same effect as if the signatures thereto
and hereto were upon the same instrument.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
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<PAGE> 29
Please confirm that the foregoing correctly sets forth the agreement
among us.
Very truly yours,
CRL Network Services, Inc.
By:_____________________________________
Name: James G. Couch
Title: Chief Executive Officer
PRINCIPAL STOCKHOLDER
By:_____________________________________
Name: James G. Couch
The foregoing Agreement is hereby
confirmed and accepted by the
Representatives as of the date first above
written:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
CIBC World Markets Corp. Lehman Brothers, Inc. DLJdirect Inc.
- ---------------------------- ------------------------------ --------------------------------------
<S> <C> <C>
Acting severally on behalf of itself Acting severally on behalf of itself Acting severally on behalf of itself
and as a representative of the and as a representative of the and as a representative of the several
several Underwriters named in several Underwriters named in Underwriters named in Schedule I
Schedule I annexed hereto. Schedule I annexed hereto. annexed hereto.
CIBC World Markets Corp. Lehman Brothers, Inc. DLJdirect Inc.
By___________________________ By___________________________ By___________________________
Title: Title: Title:
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE> 30
SCHEDULE I
<TABLE>
<CAPTION>
Name Number of Firm Shares to be Purchased
- ---- ------------------------------------------------
<S> <C>
CIBC World Markets Corp.
Lehman Brothers, Inc.
DLJdirect Inc.
------------------------------------------------
Total
------------------------------------------------
</TABLE>
<PAGE> 31
SCHEDULE II
Stockholders Subject to Lock-Up
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 7 to Registration Statement
No. 333-74793 of CRL Network Services, Inc. of our report dated March 18, 1999
(April 28, 1999 as to the last paragraph in Note 12), appearing in the
Prospectus, which is part of such Registration Statement, and to the reference
to us under the headings "Selected Consolidated Financial Data" and "Experts"
in such Prospectus.
/s/ Deloitte & Touche LLP
San Francisco, California
June 16, 1999
