<PAGE>
10,000,000 Shares
[LOGO]
NETZERO, INC.
Common Stock
------------------
This is an initial public offering of shares of common stock of NetZero,
Inc. NetZero is offering all of the 10,000,000 shares of common stock to be sold
in this offering.
Prior to this offering, there has been no public market for the common
stock. The common stock has been approved for quotation on The Nasdaq National
Market under the symbol "NZRO".
SEE "RISK FACTORS" BEGINNING ON PAGE 5 TO READ ABOUT CERTAIN FACTORS YOU
SHOULD CONSIDER BEFORE BUYING SHARES OF THE COMMON STOCK.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
----------- ----------------
<S> <C> <C>
Initial public offering price.................................................. $ 16.00 $ 160,000,000
Underwriting discount.......................................................... $ 1.12 $ 11,200,000
Proceeds, before expenses, to NetZero.......................................... $ 14.88 $ 148,800,000
</TABLE>
The underwriters have the right to purchase up to an additional 1,500,000
shares of common stock from NetZero, at the initial public offering price less
the underwriting discount.
------------------------
The underwriters expect to deliver the shares on September 29, 1999.
GOLDMAN, SACHS & CO.
DONALDSON, LUFKIN & JENRETTE
HAMBRECHT & QUIST
WIT CAPITAL CORPORATION
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Prospectus dated September 23, 1999.
<PAGE>
THE INSIDE FRONT COVER INCLUDES:
THE FOLLOWING TEXT IS ACROSS THE TOP OF THE INSIDE FRONT COVER:
The ZeroPort-TM-
The following information is centered directly below the initial text:
[depiction of The ZeroPort]
The following text surrounds the outside of the depiction of The ZeroPort,
starting at the left hand corner of The ZeroPort and follows clockwise around
the entire screen shot:
SEARCH: Users access our search and directory services.
E-MAIL: Our E-mail Button lights up when the user has new e-mail. A click on
the button launches the user's e-mail program.
NEWS: Users access world affairs, entertainment news, local weather, and other
newsworthy items.
SPORTS: Check sports scores and highlights.
STOCKS: Online stock brokers such as AMERITRADE and DLJDIRECT.
WEATHER: The latest weather and forecasts.
CUSTOMIZED TICKER: Sports, news and stock information are delivered to the
user's desktop-- without having to open a browser. Data in the ticker can be
customized to keep track of favorite sports teams, stocks, and breaking news.
The "channel" can be changed by clicking on any of the four buttons.
AUCTIONS: Users access online auction sites such as eBay or uBid.
SHOPPING: A drop-down menu of select shopping sites.
SERVICES: A drop-down menu of select service offerings.
Across the bottom of the page is NetZero's logo.
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY SHOULD BE READ TOGETHER WITH THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS APPEARING
ELSEWHERE IN THIS PROSPECTUS.
NETZERO, INC.
NetZero is pioneering a new Internet service model that provides consumers
with free and easy access to the Internet while offering online advertisers an
effective way to target those users. We offer users a simple and compelling
proposition--free and unlimited Internet access as well as free e-mail and
navigational tools to enhance their online experience. For advertisers, we
believe our service offers a powerful online direct marketing tool with features
and functionality that have distinct advantages over traditional forms of online
advertising. The value of NetZero's proposition is evidenced by our growth;
between our October 1998 launch and August 31, 1999, approximately 1.68 million
users registered for our service. During August 1999, approximately 891,000 of
these users accessed our service and were delivered over 1.15 billion
advertising impressions. Our services are offered in over 1,600 cities
nationwide.
An important feature of our service is The ZeroPort, a small window
displayed on our users' computer screens while they are online that is always
visible regardless of where they navigate. Users can move The ZeroPort to any
location on their screen but cannot close it or reduce its size. The ZeroPort
displays advertisements and advertiser-sponsored buttons and icons, all of which
can link directly to sites and services such as news, financial information,
sports and shopping. While we do not charge Internet access fees, we do generate
revenues by selling advertisements and sponsorships on The ZeroPort and by
referring our users to sponsors' Web-sites. We also receive fees from
advertisers when our users subscribe for services or purchase products or when
other performance criteria are satisfied. While we believe that our targeted
banner advertising will generate higher advertising rates than traditional
untargeted banner advertising, our ability to sell targeted advertising is in
its early stages and is largely untested. To date, the majority of our revenues
have been generated from untargeted banner advertising and start page referrals.
As of June 30, 1999, our accumulated deficit was approximately $15.3 million and
our net loss for the year ended June 30, 1999 was approximately $15.3 million.
While the Internet has emerged as an attractive new advertising medium,
advertisers are seeking solutions to enhance its effectiveness for targeting
users and delivering messages. Most online advertisers have difficulties
successfully targeting their audiences, largely due to a lack of precise data on
user demographics and online behavior. Online advertisers also face challenges
capturing the attention of users and delivering messages for a sustained period
of time as they can with television and radio. We obtain demographic information
from our users and track their online activity, enabling us to offer advertisers
the ability to target users, measure advertising effectiveness and potentially
improve the return on their advertising dollars. Moreover, in contrast to
traditional online advertisements which can generally be scrolled off of a
viewer's screen, The ZeroPort is always visible during a user's online session,
enabling our advertisers to display messages for a sustained period of time. Our
objective is to redefine the Internet access model and the way products and
services are marketed online by creating a service funded by advertising, not by
Internet access fees.
We were incorporated in California in July 1997 and reincorporated in
Delaware in September 1999. Our executive offices are located at 2555 Townsgate
Road, Westlake Village, California 91361, and our telephone number is (805)
418-2000. Information contained on our Web-site or The ZeroPort does not
constitute part of this prospectus.
3
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THE OFFERING
<TABLE>
<S> <C>
Common stock offered by NetZero.................... 10,000,000 shares
Common stock to be outstanding after this
offering......................................... 102,905,217 shares
Use of proceeds.................................... For general corporate purposes, principally
working capital, capital expenditures, and
possible acquisitions.
Nasdaq National Market symbol...................... "NZRO"
</TABLE>
The number of shares to be outstanding after this offering excludes
8,451,842 shares of common stock available for issuance pursuant to our stock
plans, of which 4,110,793 shares are subject to outstanding options as of August
31, 1999, at a weighted average exercise price of $2.12 per share.
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table sets forth summary financial data for NetZero. This
information should be read in conjunction with the financial statements and the
notes to those financial statements appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
JULY 21, 1997 THREE MONTHS ENDED YEAR
(INCEPTION) -------------------------------------------------------- ENDED
THROUGH SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, JUNE 30,
JUNE 30, 1998 1998 1998 1999 1999 1999
-------------- -------------- -------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ -- $ -- $ 122 $ 781 $ 3,731 $ 4,634
Gross loss........................... -- (6) (942) (3,198) (3,646) (7,792)
Loss from operations................. (19) (217) (1,789) (5,125) (8,284) (15,415)
Net loss............................. (25) (217) (1,795) (5,095) (8,193) (15,300)
Net loss per share:
Basic and diluted(1)............... $ -- $ (0.02) $ (0.22) $ (0.50) $ (0.72) $ (1.42)
Weighted average shares--basic and
diluted(1)....................... 15,000 13,451 8,025 10,277 11,413 10,792
Pro forma basic and diluted net
loss per share(2)................ $ (0.44)
Shares outstanding used in pro
forma basic and diluted net loss
per share calculation(2)......... 34,800
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
-----------------------------------------
ACTUAL PRO FORMA(2) AS ADJUSTED(3)
--------- ------------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................................... $ 24,035 $ 24,035 $ 171,585
Working capital......................................................... 16,097 16,097 163,647
Total assets............................................................ 47,501 47,501 195,051
Capital leases and notes payable, less current portion.................. 3,527 3,527 3,527
Redeemable convertible preferred stock.................................. 2,140 -- --
Deferred stock compensation............................................. (7,783) (7,783) (7,783)
Total stockholders' equity.............................................. 30,954 33,094 180,644
</TABLE>
- --------------------------
(1) See Notes 2 and 9 of Notes to Financial Statements for determination of
shares used in computing basic and diluted net loss per share.
(2) Pro forma to give effect to the conversion of all issued and outstanding
shares of preferred stock into common stock.
(3) As adjusted to reflect the sale of 10,000,000 shares of common stock offered
hereby at the initial public offering price of $16.00 per share after
deducting the underwriting discount and estimated offering expenses payable
by NetZero. See "Use of Proceeds" on page 21 for more information on our
intended use of the proceeds from this offering and "Capitalization" on page
22 for more information on our capital structure.
Except as otherwise noted, all information in this prospectus:
- reflects the automatic conversion of our outstanding Series A, Series
B, Series C and Series D preferred stock into common stock immediately
prior to the closing of this offering;
- reflects the 3-for-2 stock split effected in July 1999;
- reflects our reincorporation into Delaware in September 1999; and
- assumes that the underwriters do not exercise the over-allotment
option granted to them.
4
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RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE
ONLY ONES WE FACE. 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, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION COULD BE MATERIALLY AND ADVERSELY AFFECTED,
THE VALUE OF OUR STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF YOUR
INVESTMENT.
WE FACE RISKS ASSOCIATED WITH OUR OPERATIONS
WE CANNOT PREDICT OUR SUCCESS BECAUSE OUR FREE INTERNET SERVICE PROVIDER
BUSINESS MODEL IS UNPROVEN, AND WE HAVE OPERATED OUR BUSINESS FOR ONLY A SHORT
PERIOD OF TIME.
Our business model is unproven and a number of other businesses offering
free Internet access have failed. Since we only began offering Internet access
in October 1998, we have a limited operating history, which will make it
difficult for you to evaluate our performance. In addition, the new version of
The ZeroPort was introduced in August 1999 and we do not know to what extent our
users will accept The ZeroPort or utilize its new features. You should carefully
consider the risks we may encounter, including the risks described in this
prospectus.
These risks are particularly acute in our business model because, unlike
traditional Internet service providers, we do not have a measurable and
predictable revenue stream from user access fees. If we are not able to
successfully address these risks, we will not be able to grow our business,
compete effectively or achieve profitability. These factors could cause our
stock price to fall significantly. Please see "Management's Discussion and
Analysis of Financial Condition and Results of Operations" beginning on page 25
for more detailed information on our limited operating history.
IF WE FAIL TO GROW OUR USER BASE, WE MAY NOT BE ABLE TO GENERATE REVENUES,
DECREASE PER-USER TELECOMMUNICATIONS COSTS OR IMPLEMENT OUR STRATEGY.
If we are unable to grow our user base, we may not be able to generate
revenues, decrease per-user telecommunications costs or implement our strategy.
To date, we have relied extensively on "word-of-mouth" marketing to attract the
vast majority of our users and will continue to do so for the foreseeable
future. This type of marketing is outside of our control and may not generate
rates of growth in our user base comparable to what we have experienced to date.
We intend to generate new users through other distribution channels, such as
television, radio and print media advertising, direct marketing campaigns, and
bundling, co-branding and retail distribution arrangements. However, we have
little practical experience with marketing our service through these channels.
If these distribution channels prove more costly or less effective than
anticipated, it could adversely impact our ability to grow.
We would also be unable to grow our user base if a significant number of our
current registered users stopped using our service. There are a variety of
reasons why users would discontinue using our service, including:
- users may decide they do not like the always-present nature of The
ZeroPort;
- users may not like having their online activities tracked;
- reliability issues, which we have experienced in the past and may
experience in the future, may cause user dissatisfaction; and
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<PAGE>
- our limited user support may frustrate users who have difficulty using
our service.
We cannot assure you that we will be able to successfully address these issues
and retain our existing user base.
OUR ADVERTISING REVENUES WILL SUFFER IF WE ARE UNABLE TO DEMONSTRATE THAT OUR
REGISTERED USERS ARE ACTIVELY USING OUR SERVICE.
If we are not able to demonstrate to our advertisers that our registered
users are actively using our service, advertisers may choose not to advertise
with us and our advertising revenues could be materially and adversely affected.
While approximately 1.68 million users had registered for our service as of
August 31, 1999, approximately 891,000 had used our service during that month.
We believe that a number of our users have Internet access accounts with our
competitors. As a result, these users may not use NetZero as their primary
Internet service provider. Also, some new users use the Internet only as a
novelty and do not become consistent users of Internet services and, therefore,
may be less likely to continue using our service.
IF WE FAIL TO GENERATE SUFFICIENT ADVERTISING REVENUES, WE MAY NOT BE ABLE TO
SUPPORT OUR OPERATIONS.
Since we do not charge our users any fees for our Internet access and e-mail
services, we depend primarily on our ability to generate advertising revenues.
Accordingly, if we fail to generate sufficient advertising revenues, we may not
be able to support our operations. We generate, and intend to generate, revenues
from a variety of different arrangements including sales of targeted and
untargeted banner advertising, sponsorships, performance-based arrangements and
referrals to third party Web-sites. We have limited experience marketing and
pricing these types of arrangements, and have limited actual experience with
respect to the performance of such arrangements. As such, we do not know if we
are appropriately pricing, marketing or structuring these arrangements, or
whether we will perform under these arrangements to the satisfaction of the
other parties. Our failure to appropriately price, market or structure these
arrangements could impact our ability to enter into and perform under these
arrangements, or to renew these arrangements on similar or acceptable terms. In
addition, the success of some of these arrangements will depend on our ability
to effectively target users based on demographic and other information. We may
encounter technical and other limitations on this ability, including problems
associated with the accuracy of the information provided by our users, which we
do not corroborate. In light of these factors, we cannot assure you that we will
be able to attract sufficient advertising revenues to support our operations.
In addition, competition for Internet-based advertising revenues is intense
and the amount of available standard banner advertising space on the Internet is
increasing at a significant rate. These factors are causing Internet advertising
rates to decline, and it is possible that rates will continue to decline in the
future. Also, our growth in users has resulted in, and in the future may result
in, our advertising inventory growing faster than our ability to sell the
inventory at reasonable rates.
Many of our advertising competitors have longer operating histories, greater
name recognition, larger user bases, significantly greater financial, technical,
sales and marketing resources and more established relationships with
advertisers than we do. These advantages may allow such competitors to respond
more quickly than we can to new or emerging technologies and changes in
advertiser requirements. They may also be able to devote greater resources than
we can to develop, promote and sell their products and services. Such
competitors may also engage in more extensive research and development,
undertake more far-reaching marketing campaigns, adopt more aggressive pricing
policies and make more attractive offers to existing and potential employees,
strategic partners, advertisers and Web publishers. In addition, current and
potential
6
<PAGE>
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products or
services to address the needs of our prospective customers. We must also compete
with television, radio, cable and print media for a share of advertisers' total
advertising budgets. Advertisers may be reluctant to devote a significant
portion of their advertising budget to Internet advertising if they perceive the
Internet to be a limited or ineffective advertising medium.
WE MAY NOT BE ABLE TO PROVIDE INTERNET ACCESS FOR OUR USERS IF OUR
TELECOMMUNICATIONS CARRIERS RAISE THEIR RATES OR IF THEY DISCONTINUE DOING
BUSINESS WITH US.
Our business substantially depends on the capacity, affordability,
reliability and security of our telecommunications networks. Only a small number
of telecommunications providers offer the network services we require. There has
been significant consolidation in the telecommunications industry, and there is
a significant risk that further consolidation could make us reliant on an even
smaller number of providers. Most of our telecommunications services are
provided pursuant to short-term agreements that the providers can terminate or
elect not to renew. As a result, any or all of our current telecommunications
service providers could decide not to provide us with service at rates
acceptable to us, or at all, in which event, we may not be able to provide
Internet access to our users. See "Business--Communications Network" on page 45
for a more complete discussion of the services provided by these carriers.
WE MAY LOSE OUR USERS IF OUR TELECOMMUNICATIONS PROVIDERS DELIVER UNACCEPTABLE
SERVICE QUALITY.
If our third-party telecommunications service providers deliver unacceptable
service, the quality of our Internet access service would suffer. In this event,
we would likely lose users who are dissatisfied with our service. Since we do
not have direct control over our telecommunications carriers' network
reliability and the quality of their service, we cannot assure you that we will
be able to provide consistently reliable Internet access for our users.
IF TELECOMMUNICATIONS PRICES INCREASE, OUR MARGINS WOULD BE ADVERSELY IMPACTED.
Our margins are highly sensitive to variations in prices for the
telecommunications services we purchase. Our business could be harmed if minimum
connection charges increase or become more prevalent. In addition, the
availability and pricing of telecommunications services varies geographically,
and we may not be able to obtain new or substitute telecommunications services
in certain geographic areas on commercially reasonable terms, if at all. We
cannot assure you that our telecommunications providers will continue to provide
their services on commercially acceptable price terms, or that alternative
services will be available on similar terms.
OUR ABILITY TO SERVE ADVERTISEMENTS TO THE ZEROPORT COULD BE SEVERELY LIMITED IF
THE SOFTWARE WE LICENSE FROM NETGRAVITY FAILS TO PERFORM OR IF WE ARE NOT ABLE
TO RENEW OUR LICENSE.
All of our advertisements are served using software licensed from
NetGravity. While there is other software available, it would substantially
disrupt our business to switch to another provider. As such, we are reliant on
NetGravity and its software. Our agreement with NetGravity expires in June 2001;
however we have an option to renew the agreement for an additional two year term
upon initial expiration. If NetGravity's software fails to perform as expected,
or if we are not able to renew such agreement or license or internally develop
similar software in the future, we may not be able to effectively display
advertisements to our users. In this event, our ability to generate advertising
revenues would be severely limited. In July 1999, DoubleClick, an Internet
advertising provider, and NetGravity announced that they had entered into a
merger agreement, pursuant to which DoubleClick will acquire NetGravity. Since
our agreement with NetGravity does not expire until June
7
<PAGE>
2001 and we have an option to renew for an additional two year term upon initial
expiration, we do not believe the merger will have a material effect on our
contractual rights with NetGravity.
OUR STOCK PRICE COULD FALL AS A RESULT OF FUTURE LOSSES AND NEGATIVE CASH FLOW.
As of June 30, 1999, we had an accumulated deficit of approximately $15.3
million. We expect that our losses and negative cash flow will increase for the
foreseeable future as we continue to expand our operations. Our ability to
achieve profitability or positive cash flow depends upon a number of factors,
including our ability to increase revenue and reduce per-user costs. Although
our revenues have grown in recent quarters, we cannot be certain that we will be
able to sustain these growth rates or that we will obtain sufficient revenues to
achieve profitability or positive cash flow. If we do achieve profitability, we
cannot be certain that we can sustain or increase profitability on a quarterly
or annual basis in the future. If we fail to do so, the market price for our
common stock could suffer.
OUR MARKET SHARE AND REVENUES WOULD SUFFER IF WE ARE NOT ABLE TO COMPETE
EFFECTIVELY FOR USERS WITH ESTABLISHED, AND NEW PROVIDERS OF, INTERNET ACCESS
SERVICES.
EXISTING COMPETITORS
We currently compete or expect to compete for users with the following types
of companies that provide access services:
- established online service and content providers, such as America
Online and The Microsoft Network;
- independent national Internet service providers, such as EarthLink and
MindSpring, which have announced plans to merge, and Prodigy;
- national long-distance carriers, such as AT&T, GTE and MCI WorldCom;
- local telephone companies and regional Bell operating companies, such
as Pacific Bell;
- numerous regional and local commercial Internet service providers;
- computer hardware and software and other technology companies, such as
IBM and Microsoft;
- cable operators and online cable services, such as Excite@Home;
- Internet portals and search engines such as Yahoo!;
- other free Internet service providers; and
- nonprofit or educational Internet service providers.
We expect that competition for users will continue to intensify for the
foreseeable future. Increased competition could result in additional sales and
marketing expenses and user-acquisition costs and could also result in increased
user turnover and decreased advertising revenues. Since we do not charge our
users membership fees, we may not be able to offset the effects of these
increased costs, and we may not have the resources to continue to compete
successfully. The ability of our competitors to acquire other Internet service
providers or to enter into strategic alliances or joint ventures could also put
us at a significant competitive disadvantage.
8
<PAGE>
NEW COMPETITORS
In addition, we believe that new competitors for Internet users, including
major computer manufacturers and software, media and telecommunications
companies, will continue to enter the Internet access market. Existing
competitors may take steps such as reducing their subscriber fees, offering
promotions for access services or bundling free access services with other
product offerings. For example, AltaVista, a leading portal and search engine,
recently began offering a free Internet access solution to strengthen its
relationship with its users, and both Microsoft and CompuServe have recently
announced that they will partner with personal computer makers and consumer
electronics retailers to offer consumers up to $400 of rebates on computer
equipment when the consumer signs up for three years of their Internet access
services. New entrants have announced Internet access models similar to ours,
and the implementation of similar models by new entrants or existing competitors
could limit the value of our consumer proposition. As awareness of the Internet
grows, existing competitors are likely to further increase their emphasis on
their Internet access services, resulting in even greater competition for us.
TELECOMMUNICATIONS SERVICES
In addition, telecommunications companies with far greater resources,
distribution channels and brand awareness offer or have announced that they will
offer, their own Internet access services to users. Since these companies have
their own telecommunications network infrastructure, they have lower
communications costs than we do. These advantages reduce the overall cost of
Internet access for such companies and may significantly increase competitive
pressures on us. In addition, each of our telecommunications providers supplies
network access to some of our competitors, and could choose to grant those
competitors preferential network access, potentially limiting our users' ability
to access the Internet. If our telecommunications service providers were to
decrease the levels of service or access provided to us, or if they were to
terminate their relationships with us for competitive or other reasons, and we
were not able to develop alternate sources of supply, we would not be able to
provide Internet access to our customers, which could ultimately result in a
significant loss of users and revenues.
BROADBAND PROVIDERS
We also face competition from companies that provide broadband Internet
access, including local and long-distance telephone companies, cable television
companies, electric utility companies, wireless communications companies and
other Internet service providers. Most of our service is offered via dial-up
modems which are limited to access speeds of up to 56 kbps. Broadband
technologies enable users to transmit and receive print, video, voice and data
in digital form at significantly faster access speeds. We may have to develop
new technologies or add broadband access services to remain competitive which
could require substantial time and expense. We cannot be certain that we will
succeed in adapting our Internet access service business to compete effectively
with these technologies.
The telephone, cable and other companies that own broadband networks may
prevent us from offering broadband Internet access through the wire and cable
networks that they own. Our ability to compete with telephone and cable
television companies that are able to support broadband transmission may depend
on future regulation to guarantee open access to their broadband networks.
However, in January 1999, the Federal Communications Commission declined to take
any action to mandate or otherwise regulate access by Internet service providers
to broadband cable facilities at this time. We do not know whether local, state
or federal regulatory
9
<PAGE>
agencies will take any initiatives to implement this type of regulation, and
whether they will be successful in establishing their authority to do so.
In addition to competing directly in the Internet access market, both cable
and telephone companies are also aligning themselves with Internet service
providers who would receive preferential or exclusive use of broadband local
connections to users. If broadband Internet access becomes the preferred mode by
which users access the Internet and we are unable to gain access to broadband
networks on reasonable terms, our ability to compete could be materially and
adversely affected.
OUR REVENUES WOULD SIGNIFICANTLY DECREASE IF WE LOSE KEY CUSTOMERS.
A small number of customers have accounted for, and may in the future
account for, a significant portion of our revenues. For example, we derived
approximately 27% of our revenues for the year ended June 30, 1999 and
approximately 34% of our revenues for the quarter ended June 30, 1999 from an
agreement with LookSmart. We also derived approximately 26% of our revenues for
the year ended June 30, 1999 and approximately 28% of our revenues for the
quarter ended June 30, 1999 from an agreement with Adsmart. Our agreement with
LookSmart will expire in April 2000 and our agreement with Adsmart will expire
in February 2000. Our revenues will be materially and adversely affected if we
are unable either to renew our material agreements or to replace such agreements
with similar agreements with new customers.
OUR REPUTATION AND ABILITY TO GENERATE REVENUES WILL BE HARMED IF USER DEMAND
FOR OUR SERVICE EXCEEDS OUR TELECOMMUNICATIONS AND SERVER CAPACITY.
We may from time to time experience increases in our telecommunications
usage which exceed our then-available telecommunications capacity and the
capacity of our internal servers. As a result, users may be unable to register
or log on to our service, may experience a general slow-down in their Internet
access or may be disconnected from their sessions. Excessive user demand could
also result in system failures of our internal server networks, which would
prevent us from generating advertising revenues. Inaccessability, interruptions
or other limitations on the ability to access our service due to excessive user
demand, or any failure of our servers to handle user traffic, would have a
material adverse effect on our reputation and our revenues.
WE WILL NOT BE ABLE TO SUPPORT INCREASED NUMBERS OF USERS IF WE ARE UNABLE TO
ENHANCE OUR INTERNAL NETWORK INFRASTRUCTURE.
Our internal network infrastructure is composed of a complex system of
application, database, ad and e-mail servers. Service interruptions originating
within our internal network have occurred in the past and may occur in the
future, especially when usage exceeds capacity. We will need to invest in
substantial financial, operational, and management resources to enhance our
systems, particularly our database servers and storage capabilities, to handle a
large number of users. We cannot be certain that we will be able to accomplish
this on a timely basis and at a commercially reasonable cost, or at all. If we
fail to do so, we will be unable to grow our business.
IF WE FAIL TO MANAGE OUR TELECOMMUNICATIONS CAPACITY, OUR SERVICE LEVELS MAY
SUFFER OR WE MAY EXPERIENCE INCREASED PER-USER COSTS.
We will have to accurately anticipate our future telecommunications capacity
needs within lead-time requirements. If we fail to procure sufficient quantities
of telecommunications products and services, we may be unable to provide our
current and future users with acceptable service levels. We also run the risk of
purchasing excessive amounts of telecommunications products and services based
on incorrect projections regarding increased usage. In that event, we would be
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<PAGE>
required to bear the costs of excess telecommunications capacity without
commensurate increases in revenues. We cannot assure you that we will be able to
effectively manage these and other aspects of our business. Our failure to do so
would likely have a material adverse effect on our business, results of
operations and financial condition.
WE MAY NOT BE ABLE TO GROW OUR USER BASE IF WE ARE UNSUCCESSFUL IN ESTABLISHING
AND MAINTAINING THE NETZERO BRAND.
If we are unsuccessful in establishing or maintaining the NetZero brand, we
may not be able to grow our user base. We believe that establishing and
maintaining the NetZero brand is critical to retain and expand our user base.
Promotion of the NetZero brand will depend on our success in providing
high-quality Internet products and services. However, such success will depend,
in part, on the services, products and efforts of third parties, over which we
have little or no control. For instance, if our third party telecommunications
service providers fail to provide quality service, our users' ability to access
the Internet may be interrupted, which may adversely affect the NetZero brand.
If our users and advertisers do not perceive our existing products and services
as high quality, or if we introduce new products or services or enter into new
business ventures that are not favorably received by our users and advertisers,
then we will be unsuccessful in building brand recognition and brand loyalty in
the marketplace. In addition, we may also need to devote substantial resources
to create and maintain a distinct brand loyalty among our users and to promote
and maintain the NetZero brand in a very competitive market. If we incur
excessive expenses in promoting and maintaining our brand, our financial results
could be seriously harmed.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IF WE ARE NOT ABLE TO RESPOND TO
CHANGING INDUSTRY STANDARDS.
We may not be able to compete effectively if we are not able to adapt to
changes in technology and industry standards, and to develop and introduce new
and enhanced products and service offerings. We believe that our ability to
compete successfully will also depend upon the continued compatibility of our
services with products offered by various vendors. Although we intend to support
emerging standards in the market for Internet access, we may not be able to
conform our technology and equipment to support these new standards in a timely
fashion. For instance, we have been notified that Sun Microsystems is upgrading
its JAVA language and that the new version will require more memory to
implement. Our software uses the JAVA language extensively and we will have to
modify our resources accordingly to accommodate the new version. We cannot
assure you that we will be able to make such modifications, or any other
modifications which may be required to adapt to new or changing standards, in a
cost-effective and timely manner, or at all.
WE MAY NOT BE ABLE TO DEVELOP NEW PRODUCT OR SERVICE OFFERINGS IF WE ARE UNABLE
TO OBTAIN NEEDED TECHNOLOGY.
We rely upon third parties to help us develop technologies that enhance our
current product and service offerings. If our relationships with these third
parties are impaired or terminated, then we would have to find other developers
on a timely basis or develop technology completely on our own. We cannot predict
whether we will be able to obtain the third-party technology necessary for
continued development and introduction of new and enhanced products and
services.
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CONSUMERS MAY DECIDE NOT TO USE OUR SERVICE IF OUR TECHNOLOGY AND SERVICES
BECOME OBSOLETE.
Others may develop services or technologies that render our services or
technology noncompetitive or obsolete. For instance, a number of companies are
offering broadband and other high speed Internet access services, which allow
users to access the Internet at much faster speeds than the access services we
currently provide. Our ability to remain technologically competitive may require
substantial expenditures and lead time. If we are unable to respond in a timely
manner to technological advances, we may not be able to compete effectively for
users, which could cause our revenues to decrease.
IF OUR SOFTWARE OR HARDWARE CONTAIN ERRORS, OUR BUSINESS COULD BE SERIOUSLY
HARMED.
The software and hardware used to operate and provide our services is
complex and, accordingly, may contain undetected errors or failures. We have in
the past, and may in the future, encounter errors in the software or hardware
used to operate and provide our services. This has resulted in, and may in the
future result in, a number of adverse consequences, including:
- users being disconnected from our service or being unable to access our
service;
- loss of data or revenue;
- injury to reputation; and
- diversion of development resources.
We introduced a new version of The ZeroPort in August 1999. We have experienced
technical and customer support issues associated with this and other products,
and we cannot assure you that we will not experience additional problems in the
future.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IF WE ARE NOT ABLE TO PROTECT OUR
PROPRIETARY RIGHTS.
If we are not able to protect our proprietary rights, we may not be able to
compete effectively. We principally rely upon copyright, trade secret, and
contract laws to protect our proprietary technology. We cannot be certain that
we have taken adequate steps to prevent misappropriation of our technology or
that our competitors will not independently develop technologies that are
substantially equivalent or superior to our technology.
In addition, since we provide our Internet access software for free, we are
extremely susceptible to various forms of unauthorized use of our software. For
instance, we have experienced, and expect to continue to experience, numerous
instances of third parties selling unauthorized copies of our software. Others
have attempted to charge fees for installing our software without our
permission. These actions could adversely affect our brand name.
WE MAY INCUR SUBSTANTIAL COSTS AND DIVERSION OF OUR MANAGEMENT'S RESOURCES IF WE
INFRINGE UPON THE PROPRIETARY RIGHTS OF OTHERS.
We have permission and, in some cases, licenses from each developer of the
software that we use in our software. Although we do not believe that the
software or the trademarks we use or any of the other elements of our business
infringe on the proprietary rights of any third parties, third parties may
assert claims against us for infringement of their proprietary rights and these
claims may be successful. In addition, a number of third-party owners of patents
have claimed to hold patents that cover various forms of online transactions or
online technology. As with other online service providers, patent claims could
be asserted against us based upon our services or technologies.
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We could incur substantial costs and diversion of management resources in
the defense of any claims relating to proprietary rights. Parties making these
claims could secure a judgment awarding substantial damages as well as
injunctive or other equitable relief that could effectively block our ability to
license our products in the United States or abroad. If a third party asserts a
claim relating to proprietary technology or information against us, we may seek
licenses to the intellectual property from the third party. We cannot be
certain, however, that third parties will extend licenses to us on commercially
reasonable terms, or at all. If we fail to obtain the necessary licenses or
other rights, it could materially and adversely affect our ability to operate
our business.
OUR SERVICE COULD BE DISRUPTED BY A SECURITY BREACH, VIRUS OR INAPPROPRIATE USE
BY INTERNET USERS.
The future success of our business will depend on the security of our
network and, in part, on the security of the network infrastructures of our
third-party telecommunications service providers, over which we have no control.
Computer viruses or problems caused by our users or other third parties, such as
the sending of excessive volumes of unsolicited bulk e-mail or "spam", could
lead to interruptions, delays, or cessation in service to our users. In
addition, the sending of "spam" through our network could result in third
parties asserting claims against us. We cannot assure you that we would prevail
in such claims and our failure to do so could result in large judgments against
us. Users or other third parties could also potentially jeopardize the security
of confidential information stored in our computer systems or our users'
computer systems by their inappropriate use of the Internet, including breaking
into our computer network, which could cause losses to us or our users. Users or
third parties may also potentially expose us to liability by "identity theft",
or posing as another NetZero user. Unauthorized access by current and former
employees or others could also potentially jeopardize the security of
confidential information stored in our computer systems and those of our users.
We expect that our users will increasingly use the Internet for commercial
transactions in the future. Any network malfunction or security breach could
cause these transactions to be delayed, not completed at all, or completed with
compromised security. Users or others may assert claims of liability against us
as a result of any failure by us to prevent these network malfunctions and
security breaches, and may deter others from using our services, which could
cause our business prospects to suffer. Although we intend to continue using
industry-standard security measures, such measures have been circumvented in the
past, and we cannot assure you that these measures will not be circumvented in
the future. We also cannot assure you that the security measures of our
third-party network providers will be adequate. In addition, to alleviate
problems caused by computer viruses or other inappropriate uses or security
breaches, we may have to interrupt, delay, or temporarily cease service to our
users, which could have a material adverse effect on our revenues and could also
result in increased user turnover.
OUR REVENUES COULD BE ADVERSELY AFFECTED IF PROGRAMS TO DISABLE THE ZEROPORT
BECOME PREVALENT.
Various software programs have been developed that specifically target The
ZeroPort to disable our ability to deliver advertisements to a user. These
programs attempt to blank out, or block, banner advertisements on The ZeroPort
or completely delete The ZeroPort from users' computer screens. To date, such
programs have not interrupted our operations or caused us to fail to meet the
terms of our advertising agreements. While we believe we have been able to limit
the effectiveness of such attempts, we cannot assure you that we will be able to
continue to do so in the future. Widespread adoption of this type of software
would seriously damage our ability to operate our business and generate
revenues.
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WE MAY NOT BE ABLE TO EXPAND OUR OPERATIONS IF WE ARE NOT ABLE TO OBTAIN
ADDITIONAL EQUIPMENT FROM THIRD-PARTY HARDWARE SUPPLIERS.
The expansion of our network infrastructure and Internet services in general
is placing, and will continue to place, a significant demand on our suppliers.
From time to time, we have experienced delayed delivery from suppliers of
modems, servers, and other equipment. We may be unable to implement our planned
expansion and our users may be unable to connect to our network if we are not
able to obtain additional equipment in a timely manner and on commercially
acceptable terms. In particular, our servers are a critical part of our
infrastructure and we will need additional servers to expand our operations. We
currently purchase, and expect to continue to purchase, all of our servers from
Sun Microsystems. Since we do not have an agreement with Sun Microsystems
regarding future server purchases, we have no assurance that Sun Microsystems
will continue to supply servers to us on commercially acceptable terms, if at
all.
WE MAY EXPERIENCE LOSS OF DATA, DISRUPTION OF OPERATIONS, OR ERRONEOUS
OVERCHARGES OR UNDERCHARGES TO ADVERTISING CUSTOMERS IF THE ORACLE SOFTWARE WE
USE TO RUN OUR OPERATIONS FAILS TO OPERATE CORRECTLY.
Virtually every aspect of our operations, including finance, billing,
accounting, storage and retrieval of user data, and advertisement tracking, uses
or interfaces with a centralized software system provided by Oracle. We have
only limited experience with the operation of this system. Difficulty with the
operation of, or errors, defects or malfunctions in the operation of, this
system, could result in loss of data, erroneous overcharges or undercharges to
advertising customers or disruption of operations.
FAILURE TO ACHIEVE YEAR 2000 COMPLIANCE COULD CAUSE SUBSTANTIAL DISRUPTION TO
OUR BUSINESS AND RESULT IN LOSS OF USERS.
Our failure, or the failure of third parties on which we rely, to adequately
address Year 2000 readiness issues could result in an interruption, or a
failure, of our normal business activities or operations. Presently, we believe
that the primary risks that we face with regard to the Year 2000 are those
arising from third-party services or products. In particular, we depend heavily
on third party vendors to provide both network services and equipment. A
significant Year 2000-related disruption of these services or equipment could
cause our users and advertisers to consider seeking alternate providers or
advertising space, or cause an unmanageable burden on user service and technical
support. This, in turn, could materially and adversely affect our revenues and
result in increased user turnover. Furthermore, if the normal operation of the
Internet is disrupted by the Year 2000 issue, or if a large portion of our users
and advertisers are unable to access the Internet due to Year 2000-related
issues in connection with their own systems, users would not be able to use our
service and our revenues would be materially and adversely affected.
In addition, the failure of our internal computer systems or of third-party
equipment or software to operate without Year 2000 complications could require
us to incur significant unanticipated expenses to remedy any problems and could
expose us to claims for losses incurred by our users due to such Year 2000
complications. The defense of any such claims, with or without merit, could
require us to incur substantial costs and would divert management's time and
attention, which could have a material adverse effect on our ability to operate
our business.
It is possible that any of the Year 2000 factors listed above could result
in an extended interruption of our ability to provide services to our users and
to fulfill commitments to advertisers. A complete and extended interruption
would be our worst possible scenario. The longer the interruption, the more
likely our business would be adversely affected. Moreover, if the factors giving
rise to the interruption are particular to us, such as the failure of our
internal network infrastructure, we could lose a significant number of users and
advertisers to our competitors. This would not only adversely impact us
financially, but could also significantly impact our reputation
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and our prospects. Please refer to our discussion in "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Year 2000"
beginning on page 33 for further information with respect to Year 2000 related
issues.
OUR ABILITY TO OPERATE OUR BUSINESS COULD BE SERIOUSLY HARMED IF WE LOSE, OR
FAIL TO ASSIMILATE, MEMBERS OF OUR SENIOR MANAGEMENT TEAM AND OTHER KEY
EMPLOYEES.
Most of our senior management team has only recently joined us. For example,
Mark Goldston, our Chief Executive Officer, joined us in March 1999, Charles
Hilliard, our Chief Financial Officer, joined us in April 1999, and Perri
Procida, our Senior Vice President, Sales, joined us in May 1999. There can be
no assurance that we will successfully assimilate our recently hired officers or
that we can successfully locate, hire, assimilate and retain qualified key
management personnel. Our business is largely dependent on the personal efforts
and abilities of our senior management and other key personnel. Any of our
officers or employees can terminate his or her employment relationship at any
time. The loss of these key employees or our inability to attract or retain
other qualified employees could seriously harm our business and prospects. We do
not carry key man life insurance on any of our employees.
WE WILL NOT BE ABLE TO GROW OUR BUSINESS IF WE ARE NOT ABLE TO HIRE ADDITIONAL
PERSONNEL.
Our future success also depends on our ability to attract, retain and
motivate highly skilled technical, managerial, editorial, merchandising, sales,
marketing and user service personnel. We plan to dramatically hire additional
personnel in all areas of our business. Competition for such personnel is
intense, particularly in the Internet and high technology industry. As a result,
we may be unable to successfully attract, assimilate or retain qualified
personnel. We may also be unable to retain the employees we currently employ or
attract additional technical personnel. If we fail to retain and attract the
necessary personnel, we may not be able to operate and grow our business.
OUR BUSINESS COULD BE SHUT DOWN OR SEVERELY IMPACTED IF A NATURAL DISASTER
OCCURS.
Our operations and services depend on the extent to which our computer
equipment and the telecommunications infrastructure of our third-party network
providers is protected against damage from fire, earthquakes, power loss,
telecommunications failures, and similar events. A significant portion of our
computer equipment, including critical equipment dedicated to our Internet
access services, is located at our headquarters and at a facility in Los
Angeles, California. Despite precautions taken by us and our third-party network
providers, over which we have no control, a natural disaster or other
unanticipated problems at our headquarters or at a network hub, or within a
third-party network provider's network, could cause interruptions in the
services that we provide. For example, if an earthquake damages equipment at our
network operations center, we may have no means of replacing this equipment on a
timely basis or at all and our service would be shut down. We do not currently
maintain fully redundant or back-up Internet services, backbone facilities or
other fully redundant computing and telecommunications facilities. Furthermore,
we do not currently have any business disruption insurance. Any prolonged
disruption of our services due to system failure could result in user turnover
and decreased revenues.
IF WE ARE UNABLE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS INTO OUR
OPERATIONS, THEN OUR RESULTS AND FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED.
We may make acquisitions or undertake other business combinations that can
complement our current or planned business activities. Such acquisitions may not
be available at the times or on terms acceptable to us, or at all. In addition,
acquiring a business involves many risks, including:
- disruption of our ongoing business and diversion of resources and
management time;
- unforeseen obligations or liabilities;
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- difficulty assimilating the acquired operations and personnel;
- risks of entering markets in which we have little or no direct prior
experience;
- potential impairment of relationships with employees or users as a
result of changes in management; and
- potential dilutive issuances of equity, large and immediate write-offs,
the incurrence of debt, and amortization of goodwill or other
intangible assets.
We cannot assure you that we will make any acquisitions or that we will be
able to obtain additional financing for such acquisitions, if necessary. If any
acquisitions are made, we cannot assure you that we will be able to successfully
integrate the acquired business into our operations or that the acquired
business will perform as expected. To date, we have not made any material
acquisitions of other businesses.
WE FACE RISKS RELATED TO THE INTERNET INDUSTRY
WE COULD BE EXPOSED TO SIGNIFICANT LEGAL LIABILITY IF NEW CASE LAW IS DECIDED,
OR NEW GOVERNMENT REGULATION IS ENACTED, REGARDING THE INTERNET AND INTERNET
SERVICE PROVIDERS.
The law relating to our business and operations is evolving and no clear
legal precedents have been established. The adoption of new laws or the
application of existing laws may decrease the growth in the use of the Internet,
affect telecommunications costs or increase the likelihood or scope of
competition from regional telephone companies. These results could decrease the
demand for our services or increase our cost of doing business, each of which
would cause our gross margins and revenues to fall. In particular, the following
risks could occur:
REGULATION OF CONTENT AND ACCESS COULD LIMIT OUR ABILITY TO GENERATE
REVENUES AND EXPOSE US TO LIABILITY.
Prohibition and restriction of Internet content and access could dampen the
growth of Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. A variety of
restrictions on content and access, primarily as they relate to children, have
been enacted or proposed, including laws which would require Internet service
providers to supply, at cost, filtering technologies to limit or block the
ability of minors to access unsuitable materials on the Internet. Because of
these content restrictions and potential liability to us for materials carried
on or disseminated through our systems, we may be required to implement measures
to reduce our exposure to liability. These measures may require the expenditure
of substantial resources or the discontinuation of our product or service
offerings that subject us to this liability. Further, we could incur substantial
costs in defending against any of these claims and we may be required to pay
large judgments or settlements or alter our business practices. In addition, our
liability insurance may not cover potential claims relating to the Internet
services we provide or may not be adequate to indemnify us for all liabilities
that may be imposed on us.
WE COULD BE EXPOSED TO LIABILITY FOR DEFAMATION, NEGLIGENCE AND
INFRINGEMENT.
Because users download and redistribute materials that are cached or
replicated by us in connection with our Internet services, claims could be made
against us for defamation, negligence, copyright or trademark infringement, or
other theories based on the nature and content of such materials. While we have
attempted to obtain safe harbor protection against claims of copyright
infringement under the Digital Millenium Copyright Act of 1998, there can be no
guarantee that we will prevail in any such claims. We also could be exposed to
liability because of third-party content that may be accessible through our
services, including links to Web-sites maintained by our users or other third
parties, or posted directly to our Web-site, and subsequently retrieved by a
third party
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through our services. It is also possible that if any third-party content
provided through our services contains errors, third parties who access such
material could make claims against us for losses incurred in reliance on such
information. You should know that these types of claims have been successfully
brought against other online service providers. In particular, copyright and
trademark laws are evolving and it is uncertain how broadly the rights provided
under these laws will be applied to online environments. It is impossible for us
to determine who the potential rights holders may be with respect to all
materials available through our services.
OUR ABILITY TO SELL TARGETED ADVERTISING MAY BE LIMITED IF NEW LAWS RELATING
TO USER PRIVACY ARE ENACTED.
Our ability to sell targeted advertising depends on our ability to use
personal information collected from our users. We cannot assure you that our
current information collection procedures and disclosure policies will be found
to be in compliance with existing or future laws or regulations. Our failure to
comply with existing laws, or the adoption of new laws or regulations that
require us to change the way we conduct our business, could make it
cost-prohibitive to operate our business, and prevent us from pursuing our
business strategies including the sale of targeted advertising.
OUR MARGINS AND COSTS WOULD BE ADVERSELY AFFECTED IF OUR BUSINESS BECOMES
SUBJECT TO TAXATION.
The tax treatment of activities on or relating to the Internet is currently
unsettled. A number of proposals have been made at the federal, state and local
levels and by foreign governments that could impose taxes on the online sale of
goods and services and other Internet activities. Recently, the Internet Tax
Freedom Act was signed into law, placing a three-year moratorium on new state
and local taxes on Internet commerce. However, there can be no assurance that
future laws imposing taxes or other regulations on commerce over the Internet
would not substantially impair the growth of Internet commerce and, as a result,
harm our margins or make it cost-prohibitive to operate our business.
TELECOMMUNICATIONS REGULATION COULD MAKE IT MORE EXPENSIVE FOR US TO DO
BUSINESS.
As an Internet service provider, we are not currently directly regulated by
the Federal Communications Commission or any other agency, other than
regulations applicable to businesses generally. Nevertheless, Internet-related
regulatory policies are continuing to develop, and it is possible that we could
be exposed to regulation in the future. We could be adversely affected if any
regulatory change results in the application of access charges to Internet
service providers because this would substantially increase the cost of using
the Internet. Since the largest component of our operating costs is comprised of
telecommunications costs, any increase in such costs would have a material
adverse effect on our gross margins and revenues. We could also be affected by
any change in the ability of our users to reach our network through a dial-up
telephone call without any additional charges.
For more information on governmental regulation issues, please see
"Business-- Governmental Regulation" on page 47.
SEASONAL TRENDS IN INTERNET USAGE AND ADVERTISING SALES MAY NEGATIVELY AFFECT
OUR BUSINESS.
Seasonal trends could affect the advertising revenues we generate from
operating our Internet services. To the extent that our advertising revenues
depend on the amount of usage by our users, seasonal fluctuations in Internet
usage could affect our advertising revenues during these periods of
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fluctuation. In addition, the rate at which new users sign up for our services
may be lower during certain seasons and holiday periods. Because our operating
history is so limited, it is difficult for us to accurately predict these trends
and plan accordingly. Since our operating expenses are based on our expectations
of future revenues, it is possible that seasonal fluctuations could materially
and adversely affect our revenues and our operating results.
IF INTERNET USAGE DOES NOT CONTINUE TO GROW, WE MAY NOT BE ABLE TO GROW OUR
BUSINESS AND INCREASE OUR REVENUES.
If our assumption that use of the Internet will continue to grow turns out
to be incorrect, we will not be able to grow our business and increase our
revenues. Substantially all of our revenues are dependent on the continued use
and expansion of the Internet. Use of the Internet has grown dramatically, but
we cannot assure you that usage of the Internet will continue to expand. A
decrease in the demand for Internet services or a reduction in the currently
anticipated growth for such services could cause our user base and our
advertising revenues to decrease.
OUR BRAND AND BUSINESS COULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO PROTECT
OUR DOMAIN NAMES OR ACQUIRE OTHER RELEVANT DOMAIN NAMES.
We currently hold the Web domain name relating to our brand, NetZero.com, as
well as numerous other related Web domain names. The acquisition and maintenance
of domain names generally is regulated by governmental agencies and their
designees. The regulation of domain names in the United States and in foreign
countries is subject to change in the near future. As a result, we may be unable
to acquire or maintain relevant domain names in the countries in which we
conduct, or plan to conduct, business. Furthermore, the relationship between
regulations governing domain names and laws protecting trademarks and similar
proprietary rights is unclear. Therefore, we may be unable to prevent third
parties from acquiring domain names that are similar to, infringe upon, dilute
or otherwise decrease the value of our trademarks and other proprietary rights.
WE ARE SUBJECT TO RISKS RELATED TO THE OFFERING
YOU MAY NOT BE ABLE TO SELL YOUR STOCK AT OR FOR MORE THAN THE PRICE YOU PAID OR
WHEN YOU WANT TO SELL IT IF A PUBLIC MARKET DOES NOT EXIST FOR OUR STOCK.
We cannot be sure that an active trading market for our common stock will be
available for you to sell shares of our common stock that you purchase in this
offering. If an active trading market for our stock is not available, the
liquidity of our stock may suffer and the trading price of our common stock may
decline. We will determine the initial public offering price of the shares of
our common stock through negotiations with the underwriters and this price may
not be indicative of prices that will prevail in the trading market. Please see
"Underwriting" on page U-1 for more information about these negotiations.
WE MAY BE UNABLE TO OBTAIN THE ADDITIONAL CAPITAL REQUIRED TO GROW OUR BUSINESS.
Our ability to grow depends significantly on our ability to expand our
operations by contracting for additional telecommunications capacity and
expanding our internal network infrastructure. These expansion efforts will
require significant advance capital equipment expenditures and commitments for
telecommunications capacity. If the proceeds from this offering, cash on hand,
cash generated from operations and the amounts available under lease lines, are
not sufficient to meet our cash requirements, we will need to seek additional
capital to fund our growth. To date we have been able to raise needed capital
for our business; however, we cannot assure you that we will continue to be able
to raise needed cash on terms acceptable to us or at all. Financings may be on
terms that are dilutive or potentially dilutive to our stockholders. If
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sources of financing are required, but are insufficient or unavailable, we will
be required to modify our growth and operating plans to the extent of available
funding, which would have a material adverse effect on our ability to grow our
business.
OUR STOCKHOLDERS COULD BE ADVERSELY AFFECTED IF OUR MANAGEMENT AND LARGER
STOCKHOLDERS USE THEIR INFLUENCE IN A MANNER ADVERSE TO OUR STOCKHOLDERS'
INTERESTS.
After this offering, our executive officers, directors and 5% stockholders,
in the aggregate, will control approximately 70.1% of our voting stock. As a
result, these stockholders will have significant influence and ability to
control most matters requiring board and stockholder approval, including a
significant corporate transaction like the sale of our company, a change in
control or the terms of future equity financings. These stockholders may use
their influence to approve or take actions which are adverse to your interests.
See "Principal Stockholders" on page 64 for more information on the stock
holdings of our directors and officers.
PURCHASERS IN THIS OFFERING WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION.
If you purchase common stock in this offering, you will incur immediate and
substantial dilution in the net tangible book value of the shares purchased.
This dilution will be approximately $14.25 per share, at the initial public
offering price of $16.00 per share. Additional dilution will occur upon the
exercise of outstanding stock options and will also cause your percentage
ownership of NetZero to decrease. Please see "Dilution" on page 23 for more
information on the dilution you will incur.
YOU MAY NOT BE ABLE TO RESELL YOUR SHARES OF OUR STOCK AT, OR FOR MORE THAN, THE
PRICE YOU PAID IF OUR STOCK PRICE FLUCTUATES SIGNIFICANTLY.
The trading price of our common stock is likely to be volatile and could
fluctuate widely in response to factors which are beyond our control. In
particular, following initial public offerings, the market prices for stocks of
Internet and technology-related companies often reach levels that bear no
relationship to the operating performance of these companies. These market
prices are generally not sustainable and could vary widely. If our common stock
trades to such high levels following this offering, it could eventually
experience a significant decline. In addition, a company's stock price often
experiences significant price and volume fluctuations in response to general
economic, political and other conditions unrelated to the performance of the
company. Therefore, you may not be able to resell shares of our stock at, or for
more than, the price you paid.
SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD ADVERSELY AFFECT OUR
STOCK PRICE.
The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of their common stock after this offering,
or the perception that these sales could occur. These sales also might make it
difficult for us to sell securities in the future at a time and at a price that
we deem appropriate. You should read "Shares Eligible For Future Sale" on page
73 for a more detailed discussion of when and how many additional shares of our
stock may be sold after this offering.
IF OUR MANAGEMENT DOES NOT EFFECTIVELY USE THE PROCEEDS FROM THIS OFFERING, WE
MAY NOT BE ABLE TO SUCCESSFULLY OPERATE AND GROW OUR BUSINESS.
If our management does not use the proceeds from this offering effectively,
we may not be able to successfully operate and grow our business. The net
proceeds of this offering are estimated to be approximately $147.6 million, or
approximately $169.9 million if the underwriters' over-allotment option is
exercised in full, at the initial public offering price of $16.00 per share and
after deducting the estimated underwriting discount and estimated offering
expenses. At present,
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we have wide ranges in planned expenditures to be funded with the proceeds due
to our need to retain flexibility to respond to factors affecting our business.
Accordingly, our management will retain broad discretion as to the allocation of
the proceeds of this offering and may use such proceeds in a manner with which
you may not agree. Please see "Use of Proceeds" on page 21 for more information
regarding the use of proceeds from this offering.
PROVISIONS IN OUR CHARTER DOCUMENTS MAY DETER TAKEOVER EFFORTS THAT YOU FEEL
WOULD BE BENEFICIAL TO STOCKHOLDER VALUE.
Provisions in our charter and bylaws and Delaware law may have the effect of
delaying or preventing a change of control or changes in our management that you
might consider favorable. See "Description of Capital Stock" on page 69 for a
detailed description of these provisions. If a change of control or change in
management is delayed or prevented, the market price of our common stock could
decline.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that are based on our
current expectations, assumptions, estimates and projections about us and our
industry. When used in this prospectus, the words "expects", "anticipates",
"estimates", "intends", "believes" and similar expressions are intended to
identify forward-looking statements. These statements include, but are not
limited to, statements under the captions "Risk Factors", "Use of Proceeds",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", and "Business".
These forward-looking statements are subject to risks and uncertainties that
could cause actual results to differ materially from those projected. The
cautionary statements made in this prospectus should be read as being applicable
to all related forward-looking statements wherever they appear in this
prospectus. We assume no obligation to update such forward-looking statements
publicly for any reason, or to update the reasons actual results could differ
materially from those anticipated in such forward-looking statements, even if
new information becomes available in the future.
TRADEMARKS
NetZero-TM-, The ZeroPort-TM-, zCast-TM- and SPEEDY Assistant-TM- are our
trademarks. This prospectus also includes trademarks of entities other than
NetZero.
20
<PAGE>
USE OF PROCEEDS
Our net proceeds from the sale of the 10,000,000 shares of common stock sold
in this offering are estimated to be approximately $147.6 million, or $169.9
million if the underwriters exercise their over-allotment option in full, based
upon the offering price of $16.00 per share and after deducting estimated
underwriting discounts and commissions and estimated offering expenses payable
by us.
We intend to use the net proceeds of the offering:
- for use in expansion of our business, including additions and
enhancements to our server and network infrastructure and the
functionality of The ZeroPort;
- for brand marketing, advertising and user acquisition programs; and
- to fund operating losses and as additional working capital and for
general corporate purposes.
As of the date of this prospectus, we have not allocated any specific amount
of the proceeds for the purposes listed above. We presently anticipate that we
will spend between $20 million and $60 million in capital expenditures during
the year ending June 30, 2000, including additions and enhancements to our
server and network infrastructure, software licenses to enhance the
functionality of The ZeroPort and furniture, fixtures and equipment. We
presently anticipate that we will spend between $25 million and $50 million in
sales and marketing expenses during the year ending June 30, 2000 to market our
brand and attract users. The amounts actually expended for the purposes listed
above will depend upon a number of factors, including the growth of our user
base, the type of efforts we make to build our brand and competitive
developments in the Internet access market. Therefore, we cannot specify with
certainty the particular uses of the net proceeds of this offering, and the
amounts we actually spend could exceed the ranges set forth above. Our
management will have significant flexibility and discretion in applying the net
proceeds of this offering.
Pending any use, the net proceeds of this offering will be invested
generally in short-term, interest-bearing securities.
From time to time, in the ordinary course of business, we evaluate possible
acquisitions of, or investments in, businesses, products and technologies that
are complementary to our business. A portion of the net proceeds may be used to
fund acquisitions or investments. We currently have no arrangements, agreements
or understandings, and are not engaged in active negotiations for any such
acquisitions or investments.
DIVIDEND POLICY
We have never declared nor paid cash dividends on our capital stock. We
currently intend to retain all available funds for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in the
foreseeable future. Any future determination to pay dividends will be at the
discretion of our board of directors and will depend on our results of
operations, financial conditions, contractual and legal restrictions and other
factors the board deems relevant. We expect that any lease financing or credit
agreements we enter into will prohibit the payment of dividends without the
lender's consent.
21
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999
- on an actual basis;
- on a pro forma basis to reflect the automatic conversion of all
outstanding shares of preferred stock into shares of common stock upon
the closing of this offering and the reincorporation into Delaware; and
- on an as adjusted basis to give effect to the pro forma adjustments and
the receipt of the estimated net proceeds from the sale of 10,000,000
shares of common stock at the initial public offering price of $16.00
per share.
<TABLE>
<CAPTION>
JUNE 30, 1999
------------------------------------
<S> <C> <C> <C>
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- ------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents.................................................. $ 24,035 $ 24,035 $ 171,585
--------- ----------- ------------
--------- ----------- ------------
Capital leases and notes payable, less current portion..................... $ 3,527 $ 3,527 $ 3,527
Redeemable convertible preferred stock, no-par value; actual-- 19,231,000
shares authorized, 19,230,000 shares issued and outstanding; pro forma
and pro forma as adjusted--no shares authorized, issued or
outstanding.............................................................. 2,140 -- --
Stockholders' equity:
Convertible preferred stock, $0.001 par value; actual-- 55,769,000 shares
authorized, 45,182,000 shares issued and outstanding; pro forma and pro
forma as adjusted-- 10,000,000 shares authorized; no shares issued and
outstanding............................................................ 44,720 -- --
Common stock, $0.001 par value; actual--150,000,000 shares authorized,
28,624,000 shares issued and outstanding; pro-forma--500,000,000 shares
authorized, 93,036,000 shares issued and outstanding; pro forma as
adjusted-- 500,000,000 shares authorized, 103,036,000 shares issued and
outstanding............................................................ 1,352 93 103
Additional paid-in capital............................................... 9,019 57,138 204,678
Notes receivable from stockholders....................................... (1,029) (1,029) (1,029)
Deferred stock compensation.............................................. (7,783) (7,783) (7,783)
Accumulated deficit...................................................... (15,325) (15,325) (15,325)
--------- ----------- ------------
Total stockholders' equity................................................. 30,954 33,094 180,644
--------- ----------- ------------
Total capitalization....................................................... $ 36,621 $ 36,621 $ 184,171
--------- ----------- ------------
--------- ----------- ------------
</TABLE>
22
<PAGE>
DILUTION
Our pro forma net tangible book value as of June 30, 1999 was approximately
$33.1 million, or $0.36 per share. Pro forma net tangible book value per share
represents the amount of total tangible assets less total liabilities divided by
the number of shares of common stock outstanding as of June 30, 1999 after
giving pro forma effect to the automatic conversion of all outstanding shares of
preferred stock. After giving effect to our sale of 10,000,000 shares of common
stock offered by this prospectus at the initial public offering price of $16.00
per share and after deducting the underwriting discounts and commissions and
estimated offering expenses, the pro forma net tangible book value as of June
30, 1999 would have been $180.6 million, or $1.75 per share. This represents an
immediate increase in pro forma net tangible book value of $1.39 per share to
existing stockholders and an immediate dilution in pro forma net tangible book
value of $14.25 per share to investors purchasing common stock in this offering.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share............................... $ 16.00
Pro forma net tangible book value per share as of June 30, 1999..... $ 0.36
Increase per share attributable to new investors.................... 1.39
---------
Pro forma net tangible book value per share after this offering....... 1.75
---------
Dilution per share to new investors................................... $ 14.25
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis as of June 30, 1999,
the difference between the number of shares of common stock purchased from us,
the total consideration paid and the average price per share paid by existing
stockholders and by new investors before deducting the underwriting discounts
and commissions and estimated offering expenses payable by us:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------------- ----------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
-------------- ----------- ---------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......................... 93,036,000 90% $ 48,212,000 23% $ 0.52
New investors.................................. 10,000,000 10 160,000,000 77 16.00
-------------- --- ---------------- ---
Total.......................................... 103,036,000 100% $ 208,212,000 100%
-------------- --- ---------------- ---
-------------- --- ---------------- ---
</TABLE>
The foregoing table gives pro forma effect to the automatic conversion of
all outstanding shares of preferred stock as if it had occurred at June 30,
1999, and assumes no exercise of the underwriters' over-allotment option or
shares underlying outstanding options. As of June 30, 1999, options to purchase
3,497,100 shares of common stock were outstanding at a weighted average exercise
price of $0.69 per share. To the extent that these options are exercised, new
investors will experience further dilution. See "Description of Capital Stock"
on page 69 and note 7 of the notes to our financial statements for more
information on our capital stock and further dilution you may experience.
23
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
You should read the following selected financial data in conjunction with
the financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
in this prospectus. The statement of operations data for the period from July
21, 1997 (inception) through June 30, 1998, the year ended June 30, 1999, and
the balance sheet data as of June 30, 1998 and 1999 are derived from the audited
financial statements of NetZero, Inc. included in the financial statements to
this prospectus. The statement of operations data for the three months ended
September 30, 1998, December 31, 1998, March 31, 1999 and June 30, 1999, have
been derived from our unaudited financial statements. The unaudited financial
statements have been prepared on the same basis as the audited financial
statements and, in the opinion of management, include all adjustments,
consisting only of normal recurring adjustments, that we consider necessary for
a fair presentation of the financial position and results of operations for the
period.
<TABLE>
<CAPTION>
JULY 21, 1997 THREE MONTHS ENDED YEAR
(INCEPTION) ------------------------------------------------------ ENDED
THROUGH SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, JUNE 30,
JUNE 30, 1998 1998 1998 1999 1999 1999
------------- -------------- -------------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................... $ -- $ -- $ 122 $ 781 $ 3,731 $ 4,634
Cost of revenues.............. -- 6 1,064 3,979 7,377 12,426
------------- -------------- -------------- ----------- --------- -----------
Gross loss.................... -- (6) (942) (3,198) (3,646) (7,792)
Operating expenses:
Sales and marketing......... -- 11 138 290 437 876
Product development......... -- 8 210 292 472 982
General and
administrative............ 19 77 429 1,114 2,687 4,307
Stock-based compensation.... -- 110 46 188 892 1,236
Depreciation and
amortization.............. -- 5 24 43 150 222
------------- -------------- -------------- ----------- --------- -----------
Total operating
expenses.............. 19 211 847 1,927 4,638 7,623
------------- -------------- -------------- ----------- --------- -----------
Loss from operations.......... (19) (217) (1,789) (5,125) (8,284) (15,415)
Interest and other income
(expense), net.............. (6) -- (6) 30 91 115
------------- -------------- -------------- ----------- --------- -----------
Net loss...................... $ (25) $ (217) $ (1,795) $ (5,095) $ (8,193) $ (15,300)
------------- -------------- -------------- ----------- --------- -----------
------------- -------------- -------------- ----------- --------- -----------
Basic and diluted net loss per
share....................... $ -- $ (0.02) $ (0.22) $ (0.50) $ (0.72) $ (1.42)
Shares used to calculate basic
and diluted net loss per
share....................... 15,000 13,451 8,025 10,277 11,413 10,792
Pro forma basic and diluted
net loss per share.......... $ (0.44)
Shares outstanding used in pro
forma basic and diluted net
loss per share
calculation................. 34,800
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30,
1998 1999
--------- ---------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................................................................... $ 1 $ 24,035
Working capital (deficit).................................................................... (23) 16,097
Total assets................................................................................. 1 47,501
Capital leases and notes payable, less current portion....................................... -- 3,527
Redeemable convertible preferred stock....................................................... -- 2,140
Deferred stock compensation.................................................................. -- (7,783)
Total stockholders' equity (deficit)......................................................... (23) 30,954
</TABLE>
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS ALSO SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND
NOTES TO THE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
NetZero is pioneering a new Internet service model that provides consumers
with free and unlimited Internet access while offering online advertisers an
effective way to reach those users through precise targeting technology.
We were incorporated in July 1997 and launched our service in October 1998.
For the period from inception until October 1998, we had no revenues and our
operating activities related primarily to the development of our proprietary
zCast software. Since launching our service, we have continued these operating
activities and have also focused on:
- developing changes to The ZeroPort to enhance its features and
functionality;
- implementing the zCast Server network cell infrastructure;
- hiring personnel;
- contracting with third-party communications providers;
- selling advertising;
- marketing our service to potential sponsors of placements on The
ZeroPort; and
- pursuing distribution arrangements such as those with Compaq and Xerox.
We have spent, and will continue to spend, significant resources on these
activities.
REVENUES. We generate revenues through banner advertisements, sponsorships
on The ZeroPort, performance-based agreements, referrals of our users to other
Web-sites and distribution agreements. Banner advertisements are images
displayed in the window of The ZeroPort. A user can click on the image and be
routed to an advertiser's Web-site. Advertisers pay us for the number of
advertisements displayed, the number of times users click on advertisements, or
based on other criteria. Sponsorships on The ZeroPort involve providing an
advertiser the right to be displayed on the face of The ZeroPort or on a drop
down menu for a specified period of time, usually one year or less. We may
receive fees for this right alone, although many sponsorships also involve a
commitment by us to deliver banner advertisements or fulfill performance
criteria. Performance-based arrangements may involve payments dependent on the
success of an advertising campaign, which may be measured by the number of times
users visit a Web-site, purchase products or register for services. We also have
the ability to refer users to advertisers' Web-sites when they log on to our
service or when they click on buttons, drop down menus or the ticker window on
The ZeroPort. Referral payments are, in general, based upon the number of times
users are directed to advertisers' Web-sites. In distribution arrangements, we
may be paid by third parties for the right to distribute the software containing
our service with products of third parties. We do not expect distribution
agreements to be material to our overall revenues.
Historically, The ZeroPort was limited in its capabilities and our revenues
have been generated primarily from non-targeted banner advertising, a majority
of which has been sold through third parties such as Adsmart. We anticipate that
a significant portion of our banner inventory will be sold in a similar manner
in the future. We recently began generating revenues from selling targeted
banner advertisements and by referring our users to a Web-site we developed with
LookSmart.
25
<PAGE>
In August 1999, we released a substantially upgraded version of The ZeroPort
with features offering additional ways to generate revenues, including selling
exclusive and non-exclusive sponsorships of buttons and marquee space on The
ZeroPort as well as sponsorships of a customizable ticker tape and browser
window. For example, we entered into agreements with eBay, priceline.com,
NetNation Communications, Ameritrade and FiNet for sponsorship of services
offered on The ZeroPort or on drop-down menus on The ZeroPort. We have also
entered into an agreement with Cisco Systems for sponsored advertising on The
ZeroPort. Many of these agreements involve fee arrangements based on performance
criteria. We intend to enter into similar arrangements with other entities.
However, since we have limited experience marketing these types of arrangements,
and have no actual experience with respect to the performance of such
arrangements, we cannot predict the degree to which they will become part of our
revenue mix.
We anticipate that we will receive higher advertising rates for targeted
advertisements and sponsorships than for non-targeted banner advertisements.
However, we have limited experience in selling and managing these types of
arrangements and there can be no assurance that we will successfully sell all of
the various advertising services we intend to offer or that such arrangements
will generate significant revenues or higher advertising rates. To date, we have
sold targeted advertising based upon Web-sites visited, key word searches, and
users' demographic information. In addition, the growth in our user base has
resulted, and may result in the future, in situations where our advertising
inventory capacity has increased faster than our ability to sell such inventory
at desired rates. While we rely on agreements with third parties to sell a
significant portion of our banner advertisements, such agreements are short term
in nature and are subject to termination and pricing pressures. Due to increased
costs associated with more users and greater inventory, our failure to renew
such agreements or the failure of the combination of such agreements and the
efforts of our in-house sales force to sell increased inventory at reasonable
rates may materially and adversely affect our operating results. In addition,
our success with performance-based fee arrangements may depend on our ability to
effectively target users. We are in the early stages of that process and may
encounter technical and other limitations on our ability to successfully target
users, including limitations associated with privacy concerns. In addition,
while we believe that the growth of our user base will enhance the value of our
services to our advertising customers, there can be no assurance that we will
adequately perform under these arrangements or that we will be able to replace
such arrangements on comparable terms, if at all. The failure to generate
significant sponsorships on The ZeroPort or the failure to replace significant
contracts when they expire could adversely affect our revenues and results of
operations.
Banner advertising and sponsorship revenues are recognized in the periods in
which the advertisement or sponsorship placement is displayed, based upon the
lesser of impressions delivered over the total number of guaranteed impressions
or ratably over the period in which the advertisement is displayed, provided
that no significant obligations on our part remain and collection of the related
receivable is probable. Our obligations typically include the guarantee of a
minimum number of impressions or the satisfaction of other performance criteria.
The guaranteed minimum number of impressions are generally required to be
delivered over the term of the commitment which has generally averaged one to
two months. Revenues from performance-based arrangements, including arrangements
based on users' clicking on ads, buttons or other placements on The ZeroPort,
are recognized as the related performance criteria are met. Referral revenues
are recognized as referrals are made to advertisers' or sponsors' Web-sites,
provided that no significant obligations on our part remain and collection of
the related receivable is probable.
Our advertising revenues are subject to the effects of seasonality.
Advertisers typically purchase impressions on a forward basis. If purchasing
patterns or timing of purchasing by advertisers were to change, our operations
and quarter to quarter comparisons could be materially affected.
26
<PAGE>
Our revenues will be significantly affected by our ability to grow our user
base. If we are unable to grow our user base or our user demographics are not
attractive to advertisers, we may be unable to attract significant commitments
from advertisers or satisfy our agreements with our advertisers relating to
performance criteria.
We do not currently anticipate that inflation will have a material impact on
our results of operations.
COST OF REVENUES. Cost of revenues consists of telecommunications costs,
depreciation of our network equipment, occupancy costs and personnel and related
expenses of our network. We intend to expend significant amounts of capital,
which will result in increased depreciation expense associated with these
capital expenditures, and to make significant commitments to future
telecommunications capacity with the expectation of a rapidly increasing
subscriber base and anticipated usage patterns. Telecommunications costs for
network access are expensed as incurred. Our failure to accurately forecast our
users' needs could result in significant overcapacity, which would adversely
impact our results of operations. Conversely, underforecasting usage could
adversely impact the ability of our users to receive adequate service and
adversely impact our reputation and our ability to maintain or increase our
subscriber base. We have a limited history in forecasting our users'
requirements and there can be no assurance that we will be able to accurately
forecast such requirements in the future.
SALES AND MARKETING. Sales and marketing expenses include salaries, sales
commissions, employee benefits, travel and related expenses for our direct sales
force, fees paid to third-party advertising sales agents, marketing, and sales
support functions. In an effort to increase our revenues, user base and brand
awareness, we expect to increase significantly the amount of spending on sales
and marketing over the next year. Marketing costs associated with increasing our
user base, which to date have been minimal, are expensed in the period incurred.
PRODUCT DEVELOPMENT. Product development costs include expenses for the
development of new or improved technologies designed to enhance the performance
of our service, including the salaries and related expenses for our software
engineering department, as well as costs for contracted services, content,
facilities and equipment. We believe that a significant level of product
development activity is necessary for our business and intend to increase
significantly the amount of spending to fund this activity.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include
salaries, employee benefits and expenses for our executive, finance, legal and
human resources personnel. In addition, general and administrative expenses
include fees for professional services and occupancy costs. We expect general
and administrative expenses to increase in absolute dollars as we continue to
expand our administrative infrastructure to support the anticipated growth of
our business, including costs associated with being a public company.
STOCK-BASED COMPENSATION. In connection with the grant of stock options to
employees and the imposition of restrictions on shares of stock held by certain
founders during the year ended June 30, 1999, we recorded total deferred
compensation of approximately $9.0 million. This deferred compensation
represented the difference between the deemed fair value of our common stock for
accounting purposes and the exercise price of these options or shares at the
date of grant. We are amortizing this amount over the vesting periods of the
applicable options or shares, resulting in an expense of $1.2 million for the
year ended June 30, 1999. Annual amortization of deferred stock compensation for
options granted and restricted shares as of June 30, 1999 is approximately $4.0
million, $2.1 million, $1.2 million, and $500,000 for the years ending June 30,
2000, 2001, 2002 and 2003, respectively. Deferred compensation is presented as a
reduction of
27
<PAGE>
stockholders' equity and amortized over the vesting period of applicable
options, generally four years.
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations data as a
percentage of total revenues:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR
---------------------------------------- ENDED
DECEMBER 31, MARCH 31, JUNE 30, JUNE 30,
1998 1999 1999 1999
-------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
AS A PERCENTAGE OF REVENUES
Revenues..................................................... 100% 100% 100% 100%
Cost of revenues............................................. 872 509 198 268
------- ----- ----- -----
Gross loss................................................... (772) (409) (98) (168)
Operating expenses:
Sales and marketing........................................ 113 37 12 19
Product development........................................ 172 37 12 21
General and administrative................................. 351 143 72 93
Stock-based compensation................................... 38 24 24 27
Depreciation and amortization.............................. 20 6 4 5
------- ----- ----- -----
Total operating expenses................................. 694 247 124 165
------- ----- ----- -----
Loss from operations......................................... (1,466) (656) (222) (333)
Interest and other income (expense), net..................... (5) 4 3 3
------- ----- ----- -----
Net loss..................................................... (1,471)% (652)% (219)% (330)%
------- ----- ----- -----
------- ----- ----- -----
</TABLE>
THREE MONTHS ENDED JUNE 30, 1999
REVENUES. Revenues for the quarter ended June 30, 1999 were $3.7 million,
which represented an increase of $3.0 million, or 378%, from $781,000 for the
quarter ended March 31, 1999. The increase was primarily attributable to
revenues generated from our start page agreement with LookSmart, as well as
increased sales of banner advertisements, primarily through our third-party
sales force. In particular, we generated approximately $1.3 million, or 34% of
our total revenues for the quarter ended June 30, 1999, from our agreement with
LookSmart, which we entered into in April 1999. We also generated approximately
$1.0 million, or 28% of our total revenues for the quarter ended June 30, 1999,
from banner advertisements sold through Adsmart. This amount represented an
increase of approximately $856,000 from the $178,000 of revenues generated from
Adsmart for the quarter ended March 31, 1999, which represented approximately
23% of our total revenues for that period.
COST OF REVENUES. Cost of revenues for the quarter ended June 30, 1999 was
$7.4 million, which represented an increase of $3.4 million, or 85%, from $4.0
million for the quarter ended March 31, 1999. The increase was primarily
attributable to increased telecommunications expense related to the growth in
our user base and depreciation related to our network costs.
SALES AND MARKETING. Sales and marketing expenses for the quarter ended
June 30, 1999 were $437,000, which represented an increase of $147,000, or 51%,
from $290,000 for the quarter ended March 31, 1999. The increase was primarily
due to the hiring of additional direct sales force personnel.
PRODUCT DEVELOPMENT. Product development expenses for the quarter ended
June 30, 1999 were $472,000, which represented an increase of $180,000, or 62%,
from $292,000 for the quarter
28
<PAGE>
ended March 31, 1999. The increase was primarily due to the hiring of additional
software engineers.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
quarter ended June 30, 1999 were $2.7 million, which represented an increase of
$1.6 million, or 141%, from $1.1 million for the quarter ended March 31, 1999.
The increase was primarily due to the hiring of additional administrative
personnel and increased professional and consulting expense.
STOCK-BASED COMPENSATION. In the year ended June 30, 1999, we recorded
total deferred compensation of $9.0 million in connection with stock option
grants and restricted founders' shares. We are amortizing this amount over the
vesting periods of the applicable options or shares, resulting in an expense of
$1.2 million for the year ended June 30, 1999. Stock-based compensation for the
year ended June 30, 1999 also includes a charge for $67,000 related to the
issuance of options to purchase shares of Series A and B redeemable convertible
preferred stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the
quarter ended June 30, 1999 was $150,000, which represented an increase of
$107,000, or 249%, from $43,000 for the quarter ended March 31, 1999. The
increase was primarily attributable to the purchase of fixed assets to be used
in the business.
INTEREST AND OTHER INCOME (EXPENSE), NET. Interest income consists of
earnings on our cash and cash equivalents. Interest expense consists primarily
of interest expense on capital equipment leases. Interest income, net, for the
quarter ended June 30, 1999 was $91,000, which represented an increase of
$61,000 from net interest income of $30,000 in the quarter ended March 31, 1999.
The increase was primarily attributable to interest on the $33.2 million in
proceeds from our Series D preferred stock financing in May 1999.
INCOME TAXES. As a result of operating losses and our inability to
recognize a benefit from our deferred tax assets, we have not recorded a
provision for income tax for the fiscal year ended June 30, 1999. We have
provided a full valuation allowance on our deferred tax assets, consisting
primarily of net operating loss carry-forwards of $5.9 million, because of
uncertainty regarding their realizability.
THREE MONTHS ENDED MARCH 31, 1999
REVENUES. Revenues for the quarter ended March 31, 1999 were $781,000,
which represented an increase of $659,000, or 540%, from $122,000 for the
quarter ended December 31, 1998. The increase was primarily attributable to
increased sales of banner advertisements.
COST OF REVENUES. Cost of revenues for the quarter ended March 31, 1999 was
$4.0 million, which represented an increase of $2.9 million, or 274%, from $1.1
million for the quarter ended December 31, 1998. The increase was primarily
attributable to increased telecommunications expense related to the growth in
our user base.
SALES AND MARKETING. Sales and marketing expenses for the quarter ended
March 31, 1999 were $290,000, which represented an increase of $152,000, or
110%, from $138,000 for the quarter ended December 31, 1998. The increase was
due to the hiring of additional direct sales force personnel.
PRODUCT DEVELOPMENT. Product development expenses for the quarter ended
March 31, 1999 were $292,000, which represented an increase of $82,000, or 39%,
from $210,000 for the quarter ended December 31, 1998. The increase was due to
the hiring of additional software engineers.
29
<PAGE>
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
quarter ended March 31, 1999 were $1.1 million, which represented an increase of
$685,000, or 160%, from $429,000 for the quarter ended December 31, 1998. The
increase was primarily due to the hiring of additional employees, including Mark
Goldston, our Chief Executive Officer.
STOCK-BASED COMPENSATION. In the nine months ended March 31, 1999, we
recorded total deferred compensation of $5.0 million in connection with stock
option grants and restricted founders' shares. We are amortizing this amount
over the vesting periods of the applicable options or shares, resulting in
expense of $277,000 for the nine months ended March 31, 1999. Stock-based
compensation in the nine months ended March 31, 1999 also include a charge for
$67,000 related to the issuance of options on the Series A and B redeemable
convertible preferred stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the
quarter ended March 31, 1999 was $43,000, which represented an increase of
$19,000, or 79%, from $24,000 for the quarter ended December 31, 1998. The
increase was due primarily to the purchase of fixed assets to be used in the
business.
INTEREST AND OTHER INCOME (EXPENSE), NET. Interest income consists of
earnings on our cash and cash equivalents. Interest expense consists primarily
of interest expense on capital equipment leases. Interest income, net, for the
quarter ended March 31, 1999 was $30,000, which represented an increase of
$36,000 from net interest expense of $6,000 in the quarter ended December 31,
1998. The increase was primarily attributable to interest on the $11.4 million
in proceeds from our Series C preferred stock financing in February 1999.
INCOME TAXES. As a result of operating losses and our inability to
recognize a benefit from our deferred tax assets, we have not recorded a
provision for income tax for the nine months ended March 31, 1999. We have
provided a full valuation allowance on our deferred tax assets, consisting
primarily of net operating loss carry-forwards, because of uncertainty regarding
their realizability.
YEAR ENDED JUNE 30, 1999 COMPARED TO THE PERIOD FROM JULY 21, 1997
(INCEPTION) THROUGH JUNE 30, 1998
We began business operations in October 1998, and as a result, operating
results for the period from July 21, 1997 (inception) through June 30, 1998
included no revenues, no cost of revenues, and no expenses other than $19,000 of
general and administrative expenses and $6,000 of miscellaneous expenses.
Accordingly, the results for this period are not meaningful or material in
comparison to the operating results for the year ended June 30, 1999.
REVENUES. Revenues for the year ended June 30, 1999 were $4.6 million,
compared to no revenue for the period from July 21, 1997 (inception) through
June 30, 1998. The increase was primarily attributable to revenues generated
from banner advertisements and revenues generated from our start page agreement
with Looksmart, as well as increased sales of banner advertisements, primarily
through our third party sales force. In particular, we generated approximately
$1.3 million, or 28% of our total revenues for the year ended June 30, 1999,
from our agreement with LookSmart, which we entered into in April 1999. We also
generated approximately $1.2 million, or 26% of our total revenues for the year
ended June 30, 1999, from banner advertisements sold through Adsmart.
COST OF REVENUES. Cost of revenues for the year ended June 30, 1999 were
$12.4 million, compared to no cost of revenues for the period from July 21, 1997
(inception) through June 30, 1998. The increase was primarily attributable to
increased telecommunication expense related to the growth in our user base and
depreciation related to our network costs.
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SALES AND MARKETING. Sales and marketing expenses for the year ended June
30, 1999 were $876,000, compared to no sales and marketing expenses for the
period from July 21, 1997 (inception) through June 30, 1998. The increase was
primarily due to the hiring of additional direct sales force personnel.
PRODUCT DEVELOPMENT. Product development expenses for the year ended June
30, 1999 were $982,000, compared to no product development expense for the
period from July 21, 1997 (inception) through June 30, 1998. The increase was
primarily due to the hiring of additional software engineers.
GENERAL AND ADMINISTRATIVE. General and administrative expense for the year
ended June 30, 1999 increased to $4.3 million from $19,000 for the period from
July 21, 1997 (inception) through June 30, 1998. The increase was primarily due
to the hiring of additional management and administrative personnel and
increased professional and consulting expense. The $19,000 of general and
administrative expense for the period from July 21, 1997 through June 30, 1998
primarily represented employee salaries.
STOCK-BASED COMPENSATION. Stock-based compensation for the year ended June
30, 1999 was $1.2 million, compared to no stock-based compensation for the
period from July 21, 1997 (inception) through June 30, 1998. The increase was
primarily due to stock option grants and restrictions placed on founders'
shares.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the year
ended June 30, 1999 was $ 222,000, compared to no depreciation and amortization
expense for the period from July 21, 1997 (inception) through June 30, 1998. The
increase was primarily due to the purchase of fixed assets to be used in the
business.
INTEREST AND OTHER INCOME (EXPENSE) NET. Interest income is comprised
primarily of interest income earned on cash and cash equivalents. Interest
expense is comprised primarily of interest expense on capital equipment leases.
Interest income, net, for the year ended June 30, 1999, was $115,000, compared
to no interest income or expense for the period from July 21, 1997 (inception)
through June 30, 1998. The increase was primarily due to interest earned on the
proceeds from the Series C and Series D preferred stock financings.
FACTORS AFFECTING OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Our operating results may fluctuate substantially in the future as a result
of a variety of factors, many of which are outside of our control, including
those discussed elsewhere in this prospectus. We plan to significantly increase
our operating expenses and capital expenditures to expand our sales and
marketing efforts, promote the NetZero brand, continue to enhance the features
and functionality of The ZeroPort, upgrade our internal network infrastructure,
pursue new distribution channels and hire new personnel across all levels of our
organization. We determine our operating expenses largely on the basis of
anticipated growth in our revenues and some of our expenses are fixed in the
short term. There are risks associated with the timing and achievement of
revenue targets due to a variety of factors, and there can be no assurance that
revenues will increase commensurately with expenses. We believe that our
expenses will significantly exceed our revenues for the foreseeable future. As a
result of these and other factors, our operating results may vary substantially
from quarter to quarter. See "Risk Factors" starting on page 5 for a discussion
of some of the factors which could lead to substantial operating losses.
In addition, seasonal trends could affect the revenues we generate. To the
extent that our revenues depend on the amount of usage by our users, any
seasonal fluctuations in Internet usage could affect our revenues during such
periods of fluctuation. We anticipate that user traffic levels will be impacted
by the summer and year-end vacation and holiday periods. Moreover, the rate at
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which new users sign up for our services may be related to gifts or purchases of
personal computers, which typically increase during the fourth quarter as a
result of the holiday season and may decline during other periods. As a result,
new user registration may be subject to seasonality. However, because our
operating history is so limited, it is difficult for us to accurately predict
these trends and plan accordingly. Since our operating expenses are based on our
expectations of future revenues, it is possible that seasonal fluctuations could
materially and adversely affect our business, results of operations and
financial condition.
A small number of customers have accounted for, and may in the future
account for, a significant portion of our revenues. For example, we derived
approximately 27% of our revenues for the year ended June 30, 1999 and
approximately 34% of our revenues for the quarter ended June 30, 1999 from an
agreement with LookSmart. We also derived approximately 26% of our revenues for
the year ended June 30, 1999 and approximately 28% of our revenues for the
quarter ended June 30, 1999 from an agreement with Adsmart. Our agreement with
LookSmart will expire in April 2000 and our agreement with Adsmart will expire
in January 2000. Our business, results of operations and financial condition
will be materially and adversely affected if we are unable either to renew our
material agreements or to replace such agreements with similar agreements with
new customers.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons
of operating results are not necessarily a good indication of future
performance.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through the
private placement of equity securities, raising $46.9 million through June 1999.
We have also received advance payments from LookSmart. During the year ended
June 30, 1999, these payments totaled $4.0 million and, as of June 30, 1999, the
deferred revenues related to these advance payments were $2.7 million. At June
30, 1999 we had $24.0 million in cash and cash equivalents.
Net cash used for our operating activities was $9.4 million for the year
ended June 30, 1999. Net cash used for operating activities consisted primarily
of net operating losses and increases in accounts receivable and restricted cash
balances, which were partially offset by increases in depreciation, stock-based
compensation, accounts payable and deferred revenue.
Net cash used for our investing activities was $13.4 million for the year
ended June 30, 1999. Net cash used for investing activities consisted primarily
of capital expenditures for computer equipment, purchased software, office
equipment and leasehold improvements. As our operations expand, we anticipate
that our planned purchases of capital equipment will require significant
additional expenditures over the next 12 months.
Net cash provided by our financing activities was $46.8 million for the year
ended June 30, 1999. Net cash provided by financing activities was principally
attributable to the private sale of convertible preferred stock.
As of June 30, 1999, our principal commitments consisted of office and
equipment leases. Future minimum cash payments under these non-cancelable
commitments are $18.1 million through the year 2009.
We expect to continue to incur significant capital expenditures in the
future, including additions and enhancements to our server and network
infrastructure, software licenses and furniture, fixtures and equipment. We
presently anticipate that we will spend between $20 million and $60 million in
capital expenditures during the year ending June 30, 2000. The actual amount of
capital expenditures will depend on the rate of growth in our user base, which
is difficult to predict and which could change dramatically over time.
Technological advances may also require us to make
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capital expenditures to develop or acquire new equipment or technology. We
intend to use a combination of our cash and capital lease financing to fund our
capital expenditures in a manner which minimizes our cost of capital. However,
we cannot assure you that we will be able to obtain lease financing on favorable
terms, if at all. In the event we cannot, we would be required to use a greater
portion of the proceeds from this offering to fund our capital expenditures.
We currently anticipate that our existing cash and cash equivalents, the net
proceeds from this offering, proceeds from equipment leases and any cash
generated from operations will be sufficient to fund our operating activities,
capital expenditures and other obligations through at least the next 12 months.
However, we may need to raise additional capital in order to fund more rapid
expansion, to expand our marketing activities, to develop new or enhance
existing services or products, to respond to competitive pressures or to acquire
complementary services, businesses or technologies. If we are not successful in
generating sufficient cash flow from operations, we may need to raise additional
capital through public or private financings, strategic relationships or other
arrangements. This additional funding, if needed, might not be available on
terms acceptable to us, or at all. Our failure to raise sufficient capital when
needed could have a material adverse effect on our business, results of
operations and financial condition. If additional funds were raised through the
issuance of equity securities, the percentage of stock owned by our then-current
stockholders would be reduced. Furthermore, such equity securities might have
rights, preferences or privileges senior to those of our common stock.
YEAR 2000
Many existing computer systems and software are coded to accept only two
digit entries in the date code field and cannot distinguish 21st century dates
from 20th century dates. If not corrected, various problems may arise from the
improper processing of dates and date-sensitive calculations by computers and
other machinery as the Year 2000 is approached and reached. These problems
include system failures or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar business activities. As a result, many
companies' software and computer systems may need to be upgraded or replaced to
comply with these "Year 2000" requirements.
OUR STATE OF READINESS
We are currently implementing the following assessment and processes in an
effort to assess and remedy any Year 2000 issues which could impact our existing
operations:
Phase I: Assessment of Operations (completed in August 1999);
Phase II: Prepare Formal Test Plan (completed in September 1999);
Phase III: Implement Test (In process--estimated completion in September
1999); and
Phase IV: Remediation of Year 2000 issues (In process--estimated completion
in October 1999).
We have completed our formal assessment of the impact that the Year 2000
problem may have on our existing operations and believe the following four
distinct areas of our existing operations may be affected by the Year 2000
problem:
INTERNALLY DEVELOPED SOFTWARE. We have internally developed a substantial
portion of the systems and software that we use to operate and monitor our
online operations. We designed and developed these systems and software to be
Year 2000 compliant. Based upon our assessment and testing to date, we believe
that our internally developed systems and software are Year 2000 compliant. We
plan to complete testing of our existing internal systems and software by the
end of September 1999.
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THIRD-PARTY HARDWARE AND SOFTWARE SUPPLIERS. We use third-party equipment
and software and as a result, our ability to address Year 2000 issues is to a
large extent dependent upon the Year 2000 readiness of these third parties'
hardware and software products. These products include servers manufactured by
Sun Microsystems, network equipment manufactured by Cisco, database management,
financial application and other software licensed from Oracle, our advertisement
server software from NetGravity, data storage equipment from EMC, and JAVA, a
programming language licensed from Sun Microsystems that we use to implement
most of our internally developed software. We have reviewed documentation on
Year 2000 compliance prepared by the third parties from whom we have purchased
hardware and software products. Based upon our review of such documentation and
the fact that we either purchased the most current product versions available
from these third parties or installed the latest patches or upgrades available,
we believe these applications are Year 2000 compliant.
TELECOMMUNICATIONS CARRIERS. We are entirely dependent on our
telecommunications carriers to provide access between their networks and our
network. We have initiated discussions with all of our telecommunications
carriers to determine the extent to which we are vulnerable to those third
parties' Year 2000 issues. We have obtained Year 2000 readiness disclosure
statements from these carriers which confirm that their systems are Year 2000
compliant or that they are in the process of becoming Year 2000 compliant. We
expect to resolve any significant Year 2000 issues with our telecommunications
carriers; however, in the event they do not achieve Year 2000 compliance, we may
have to seek alternate suppliers of telecommunications services.
NON-IT SYSTEMS. Our non-information technology systems, such as heating and
air conditioning, security systems and other embedded technology, may also be
subject to Year 2000 risks. We have obtained Year 2000 compliance statements
from the manufacturers of our non-IT systems, all of which were placed in
service in 1999. In addition, based on our assessment to date, we believe that
these systems are Year 2000 compliant.
In addition, we plan to continue to assess and test any new systems that we
add to our operations for Year 2000 compliance.
THE COSTS OF ADDRESSING OUR YEAR 2000 ISSUES
To date, we have not incurred any material expense in connection with
identifying, evaluating and remediating Year 2000 compliance issues. We believe
that substantially all of the expense that we will incur in the future relating
to the Year 2000 problem will be costs associated with time spent by our
employees in the evaluation process and Year 2000 compliance in general. We do
not expect the total costs of our Year 2000 compliance efforts to be material.
However, if these costs are substantially higher than we anticipate, they could
have a material adverse effect on our business.
THE RISKS ASSOCIATED WITH OUR YEAR 2000 ISSUES
If Year 2000 issues prevent our users from accessing the Internet, our
business and operations will suffer. Any failure of our systems and our
communications infrastructure with respect to the Year 2000 problem could result
in:
- increased user turnover and corresponding loss of advertising revenues
resulting from decreased impressions; or
- increased allocation of our resources to address Year 2000 problems
without additional revenues commensurate with such dedication of
resources.
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Please see "Risk factors--Failure to achieve Year 2000 compliance could cause
substantial disruption to our business and result in loss of users" on page 14
for more information on the risks we face regarding Year 2000 issues.
OUR CONTINGENCY PLANS
We have not completed our contingency plan with respect to Year 2000 risks.
However, we plan on completing our contingency plan in the near future.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-1, "Software for Internal Use", which provides
guidance on accounting for the cost of computer software developed or obtained
for internal use. We expect that the adoption of SOP 98-1 will not have a
material impact on our financial position, results of operations or cash flows.
We will be required to implement SOP No. 98-1 in the first quarter of fiscal
2000.
In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of
Start-Up Activities". SOP No. 98-5 requires that all start-up costs related to
new operations must be expensed as incurred. In addition, start-up costs that
were capitalized in the past must be written off when SOP No. 98-5 is adopted.
We expect that the adoption of SOP No. 98-5 will not have a material impact on
our financial position, results of operations or cash flows. We will be required
to implement SOP No. 98-1 in the first quarter of fiscal 2000.
In June 1998, The Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities". The statement
requires the recognition of all derivatives as either assets or liabilities in
the balance sheet and the measurement of those instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the planned
use of the derivative and the resulting designation. Because we do not currently
hold any derivative instruments or engage in hedging activities, the impact of
the adoption of SFAS No. 133 is not currently expected to have a material impact
on our business, results of operations or financial condition. We will be
required to implement SFAS No. 133 in the first quarter of fiscal 2001.
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BUSINESS
NETZERO
NetZero is pioneering a new Internet service model that provides consumers
with free and easy access to the Internet while offering online advertisers an
effective way to reach those users through our proprietary targeting technology.
We offer users a simple and compelling proposition-- free and unlimited Internet
access, as well as free e-mail and navigational tools to enhance their online
experience. The value of NetZero's proposition is evidenced by our growth;
between our October 1998 launch and August 31, 1999, approximately 1.68 million
users registered for our service. During August 1999, approximately 891,000 of
these users accessed our service and were delivered over 1.15 billion
advertising impressions. Our services are offered in over 1,600 cities
nationwide.
When users access the Internet through our service, we display a small
window on their computer screen called The ZeroPort which is always visible
while they are online, regardless of where they navigate. Users can move The
ZeroPort to different locations on their screens but cannot close it or reduce
its size. The ZeroPort displays advertisements, advertiser-sponsored buttons,
icons and drop-down menus. By clicking on The ZeroPort, users can navigate
directly to sites and services such as news, sports, finance and shopping. We
generate revenues by selling advertisements and sponsorships on The ZeroPort and
by referring our users to sponsors' Web-sites. We also generate revenues from
performance-based arrangements with advertisers and merchants when our users
subscribe for services, purchase products or satisfy other performance criteria.
Our service is based on two key principles. First, we provide users free
Internet access and other free services. We obtain demographic information when
users register for our services, which we supplement with our ability to track
their online activity. Second, we offer advertisers access to a large audience
and enable them to target messages, based on user demographics and online
behavior, for extended periods of time. Our model combines certain of the
characteristics of network television--where a mass audience has free access to
an advertising-supported medium-- with the targeting advantages of direct
marketing. Our objective is to redefine the Internet access model and the way
products and services are marketed online by creating a service funded by
advertising, not by Internet access fees.
INDUSTRY BACKGROUND
GROWTH OF THE INTERNET
The emergence and wide acceptance of the Internet has fundamentally changed
how millions of people worldwide share information, communicate and conduct
business. International Data Corporation estimates that the number of Internet
users in the United States will increase from approximately 63 million in 1998
to approximately 177 million by the end of 2003. The growth in Internet usage is
being driven by a number of factors, including:
- a large and growing installed base of personal computers;
- easier, faster, and more reliable access to the Internet;
- improvements in network security, infrastructure and bandwidth;
- the rapidly expanding availability of online content and commerce
sites; and
- an increasing amount of offline advertising promoting the Internet.
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TRADITIONAL INTERNET ACCESS
There are more than 6,000 Internet service providers in the United States
today, varying widely in geographic coverage, user focus and the nature and
quality of services provided to users. With the exception of a few large
providers, the vast majority of Internet service providers do not offer branded
nationwide coverage. A number of Internet service providers are beginning to
supplement their basic access with services such as electronic commerce and
telecommunications.
Internet service providers generally charge users monthly access fees and
fees for additional services, such as hosting users' Web-sites. We believe that
users spend an average of approximately $250 per year for Internet access.
Telecommunications costs associated with providing dial-up Internet access have
declined in recent years with the emergence of wholesale providers that resell
capacity to Internet service providers. These providers have built and continue
to build networks on a large scale and are able to spread the cost of their
networks over multiple Internet service providers. Though access fees charged to
users have declined over time, they have not fallen as quickly as the costs of
personal computers or telecommunications. We believe that while users are
generally focused on speed and reliability as they evaluate Internet access
services, they are also increasingly focusing on cost, particularly as their
other computing costs decline and since the rest of their online experience is
generally free.
GROWTH OF INTERNET ADVERTISING
Traditional television, radio and print advertising has focused on building
awareness-- repeating a branded message with high frequency to a large
audience--rather than targeting individual users based on demographics or
behavior. The Internet has emerged as an attractive new medium for advertising
because it offers features that are unavailable in traditional media. For
example, the Internet enables advertisers to target specific types of users,
receive direct feedback on their advertisements, and capture valuable data on
user preferences while reaching a broad, global audience.
The Internet also represents an attractive medium for direct marketing,
which has traditionally been conducted through direct mail and telemarketing.
The interactive nature of the Internet enables direct marketers to deliver
targeted promotions to users. The success of any direct marketing campaign is
generally measured by the response rate of users. The Internet has the potential
to enable direct marketers to increase user response rates and decrease costs
per transaction by targeting campaigns to particular users based on their
demographic profile, interests and online behavior. Forrester Research estimates
that the amount spent on Internet advertising in the United States will grow
from $2.8 billion in 1999 to $22 billion in 2004.
LIMITATIONS OF CURRENT INTERNET ADVERTISING
While the Internet offers advertisers and direct marketers a number of
advantages over traditional media, there remain significant challenges to
realizing the full potential of online advertising. To date, online advertising
has generally consisted of banner advertisements and sponsorships on heavily
trafficked portals and other Web content sites. We believe that users who visit
those sites tend not to spend a great deal of time on any one page and can
generally scroll traditional banner advertisements off of their screens, leading
advertisers to increasingly question the effectiveness of these advertisements.
In addition, most online advertisers are unable to successfully target their
audiences, largely due to a lack of precise demographic and navigation data on
users. As advertisers and direct marketers continue to increase their online
spending, they are seeking solutions and technologies which will enable them to
deliver highly-targeted messages, receive real-time feedback and capitalize on
other potential advantages of online advertising.
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THE NETZERO SOLUTION
We have created a business model that provides free, unlimited Internet
access to users and a powerful direct marketing tool for advertisers and
sponsors.
OUR VALUE PROPOSITION TO USERS
FREE, UNLIMITED INTERNET ACCESS AND E-MAIL. We offer users free, unlimited
access to the Internet and navigational tools to enhance their online
experience. We also provide each of our users with a free e-mail account. Users
can access our services with a computer running Windows 95, Windows 98 or
Windows NT 4.x and with at least 16 MB of RAM, a 14.4 kbps or faster dial-up
modem and any standard Internet browser.
THE ZEROPORT. We combine navigational tools with our other service to
enhance our users' online experience. The ZeroPort contains buttons conveniently
displayed in a dashboard-like setting around the advertising window. These
buttons enable users to go directly to specific Web-sites across a variety of
categories. For example, The ZeroPort has a button that allows users to search
the Internet through LookSmart, an Internet services directory that currently
appears as the start page for our service. The ZeroPort also includes a
customizable ticker which displays sports, headlines, stock quotes and news. Our
users can link directly to various Web-sites by clicking on quotes that appear
on the ticker. We continually evaluate the need to add additional functionality
and features to The ZeroPort. Our user data enables us to deliver information
and advertising intended to be tailored to our users' interests.
The following schematic illustrates The ZeroPort:
[Graphic depiction of The Zero Port, including an advertising window,
sponsorship buttons and information ticker appears here]
OUR VALUE PROPOSITION TO ADVERTISERS AND DIRECT MARKETERS
PROMINENT AND SUSTAINED ADVERTISING MEDIUM. In contrast to most portal and
content sites which display advertising, NetZero remains with users the entire
time they are online. Once users are logged on through NetZero, The ZeroPort
remains in full view throughout the session, including when they are waiting for
pages to download, navigating the Internet and even engaging in non-browsing
activities such as sending or receiving e-mail. The constant visibility of The
ZeroPort allows advertisements to be displayed for a specified period of time,
typically from 20 to 40 seconds.
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DYNAMIC TARGETING AND INFORMATION GATHERING. Our users provide demographic
information, such as age, gender, income, geographic location and personal
interests, when they register for our service. In addition, our proprietary
zCast technology allows us to track our users' behavior the entire time they are
online through our service. As a result, we are able to deliver targeted
advertisements based on information provided by users during the registration
process, actual Web-sites visited, Web-site then being viewed, or a combination
of this information, and measure their effectiveness. For example, a local bank
could deliver ads only to users who live near the bank, based on information
provided by the user at the time of registration. Users can also receive ads
from a brokerage firm when they are viewing sites containing stock quotes or
financial news, or receive promotions from a bookseller when browsing sites
containing book reviews. We also offer advertisers the ability to display ads in
The ZeroPort while users are viewing a competitor's Web-site or when viewing the
advertisers' own Web-site, thereby complementing their site and precluding
competitive ads from being displayed at that time. In general, the actual data
we use to target advertisements varies for each targeted advertising
arrangement.
PERFORMANCE-BASED ADVERTISING. While the Internet has emerged as an
important mass advertising medium, advertisers are increasingly seeking
solutions to ensure that they maximize their return on investment. To meet the
demands of advertisers who value specific results from their online marketing
campaigns, we intend to offer pricing alternatives where we are paid only if our
users link to an advertiser's site and subscribe for services, purchase products
or satisfy some other performance criteria.
THE NETZERO STRATEGY
Our objective is to redefine the Internet access model and the way products
and services are marketed online by creating a service funded by advertising,
not by Internet access fees. The key elements of our strategy are:
BUILD A PREMIER BRAND. We believe that establishing brand awareness is
critical to attracting and retaining users and advertisers and intend to make
brand building prominent in our marketing efforts. Our strategy is to promote
the perception of the NetZero brand among users as a premier provider of
Internet services and among advertisers as the most effective means of targeting
potential customers. To achieve this objective, we plan to advertise the NetZero
brand extensively online, as well as through traditional media, including
television, radio and print advertising. We plan to support the quality brand
image conveyed through our marketing campaign by establishing sponsorship
relationships with leading online and offline consumer brands as advertisers.
INCREASE USER BASE. We intend to continue to rapidly increase our user
base. Aggregating a large audience will provide economies of scale, increase our
attractiveness to advertisers and enhance our ability to enter into strategic
marketing arrangements. To date, our user base has grown almost exclusively
through word-of-mouth referrals by existing users. We plan to expand our
audience through more aggressive user-acquisition programs, including
co-branding, distribution of compact discs to install our service, bundling and
retail distribution relationships, and television, radio and print advertising.
IMPROVE USER EXPERIENCE. We will continue efforts to improve the experience
of users and maximize their retention by enhancing the technical capabilities
and ease of use of our service, making our users' online experience more
relevant and personal, providing additional user support options and adding new
services.
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PURSUE DIVERSE REVENUE SOURCES. Our service enables us to pursue revenues
from diverse sources, including banner advertising, sponsorships and electronic
commerce. Advertisers and merchants pay us for placements of ads and
sponsorships on The ZeroPort and for referrals to their Web-sites. We also offer
advertisers enhanced advertising and tracking tools and generate fees through
referrals and other arrangements when our users open accounts with, or purchase
products or services from, our advertisers.
MAXIMIZE SALES AND MARKETING EFFICIENCY. We intend to continue to pursue a
two-pronged strategy to sell and market advertising and sponsorship on The
ZeroPort. First, our internal sales and marketing organization will focus on
developing innovative sponsor relationships with leading brand marketers in
addition to selling banner advertisements on The ZeroPort. We believe sponsoring
arrangements will tend to have longer terms, elements of exclusivity and higher
rates than typical banner advertising. Second, we will leverage the resources of
outside sales organizations to enhance our ability to sell large quantities of
ad inventory within a short period of time. We have entered into agreements with
Adsmart and other companies to augment our efforts to sell traditional banner
advertising as we continue to expand our internal sales organization.
MINIMIZE NETWORK COSTS. Network costs associated with providing our service
are a major component of our cost structure. Our strategy of purchasing
telecommunications capacity from third-party wholesale providers, rather than
building and managing our own network, has enabled us to rapidly expand the
geographic scope of our service and accommodate user growth while reducing
capital expenditures. Although we may at some point consider investing in
various forms of networking infrastructure, particularly in cases where a given
type of access would otherwise be difficult or prohibitively costly to obtain,
we currently intend to continue using wholesale providers and to negotiate
volume discounts as our purchasing power increases. We believe this will enable
us to reduce costs, continue to rapidly expand our service coverage and ensure
reliable service through multiple wholesale providers.
We also believe that our strategy of using wholesale providers will enable
us to remain network-independent and to switch providers or technologies as cost
or performance improvements become available. As a result, we believe we can be
flexible in responding to user demand for higher-speed access and other types of
improved service such as DSL, cable modems, high-speed wireless access and other
broadband technologies.
SOURCES OF REVENUE
We generate revenues from the following services. An agreement with a
significant customer typically involves a number of the services offered to
maximize the effectiveness of the customer's advertising or sponsorship
campaigns.
BANNER ADVERTISING. Our advertisers can purchase standard "banner
advertising" which is advertising displayed through The ZeroPort on a user's
computer screen. Our banner ad rates are comparable to those generally available
for banner advertising. Advertisers typically purchase banner ads on a
cost-per-thousand ads displayed basis, or on a cost-per-click basis which is
measured by the number of times users click on that specific advertisement.
Advertisers can also purchase targeted advertising on The ZeroPort so that their
advertisements are displayed only to users satisfying the criteria specified by
our advertisers, such as gender, interests, language preferences and geographic
location. We also offer advertisers the opportunity to target specific Web-sites
so that their ads are displayed on The ZeroPort when users are viewing those
Web-sites, including those of competitors of the advertisers. They can also
purchase advertising space on The ZeroPort when users are viewing advertisers'
own Web-sites, which allows them to complement the site and preclude competitors
from displaying their advertisements on The ZeroPort at that time. We charge our
advertisers premium rates for targeted advertising services. Direct advertisers
that have
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placed banner advertisements on The ZeroPort include Bell South, eBay,
Microsoft, Netscape and theglobe.com.
SPONSORSHIP. The ZeroPort contains a number of buttons and drop-down menus,
additional advertising space above the banner advertising window and a
customizable ticker tape and browser window which are available for sponsorship
by advertisers. The buttons and drop-down menus are organized into categories
such as news, sports, finance and shopping. These buttons and drop-down menus
automatically link users to the sponsor's Web-site when they are clicked on.
This allows advertisers to purchase exclusive or non-exclusive sponsorships for
a specific category, and helps direct interested users to their sites. Our
sponsorship arrangements differ from banner advertisements in that a sponsor's
name or logo is displayed on the face of, or on a drop-down menu on, The
ZeroPort for the term of the sponsor's contract, while banner advertisements
generally rotate throughout a user's session. The ticker tape displays sports,
news and stock market quotes.
WEB-REFERRALS. We have the ability to direct users to other parties'
Web-sites when they log on to our service or when they click on buttons or other
placements on The ZeroPort. For example, our agreement with LookSmart provides
that, with some exceptions, each user who logs on to our service or clicks on
the search or start button on The ZeroPort will automatically be directed to a
start page or search page which contains the brands of both LookSmart and
NetZero. In each instance, NetZero is paid a specified sum. LookSmart manages
the start and search pages. The agreement expires April 30, 2000.
INTERNET COMMERCE. We have entered into arrangements with merchants who sell
goods and services over the Internet where we receive fees based on the number
of users who are referred to their Web-site, subscribe for their services,
purchase their products, or satisfy other performance criteria. These
arrangements are based on advertisements and sponsorships on The ZeroPort, as
well as on targeted e-mail messages sent directly by advertisers to users who
elect to receive such messages via their free e-mail accounts. An example is our
agreement with Fleet Credit Card Services to develop and market co-branded
credit card accounts as well as Fleet proprietary credit card accounts. Fleet
will purchase a minimum number of advertising impressions, pay additional fees
for each credit card account opened through The ZeroPort, and pay royalties for
open credit card accounts. The agreement also provides that Fleet will market
and distribute the NetZero service. In exchange, NetZero will deliver a minimum
number of credit card accounts and a minimum number of impressions advertising
Fleet products and services. NetZero has also agreed not to advertise or market
co-branded credit cards other than Fleet's during the term of the agreement.
OTHER. We also receive revenues from various other sources, including
distribution arrangements where we receive revenues for allowing others to
include our software with their products and services. For example, we receive
revenues from a distribution agreement with Xerox in which we are paid to allow
Xerox to include our software with its products. We also intend to pursue
similar arrangements in the future as well as other diverse revenue
opportunities.
Our revenues from any of the above sources could include a variety of fee
arrangements, including fixed fees or fees based on the number of users referred
to the advertiser, the number of ads delivered, other performance criteria, or
any combination of the foregoing. During the year ended June 30, 1999, LookSmart
and Adsmart accounted for approximately 27% and 26%, respectively, of NetZero's
revenues. No other customer accounted for more than 10% of NetZero's revenues
during that year.
The success of our revenue model will depend on a variety of variables
including the number of users accessing our service, the time they spend on
line, the frequency with which they access advertisers' products and services
through The ZeroPort and the amounts we are able to charge advertisers for our
services. A portion of our operating costs are covered by revenues from banner
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advertising on The ZeroPort and from referrals to third party Web-sites, such as
our start page agreement with LookSmart. We intend to increase revenues from
these sources, primarily through growth in our user base and the use of targeted
advertising. We intend to create additional sources of revenue that do not have
incremental telecommunications costs. For example, a new user may decide to set
up an account with Ameritrade and to acquire a Fleet co-branded credit card. If
this occurs, we will generate additional revenues while incurring no additional
telecommunications costs. Our objective is to generate enough additional sources
of revenue, without commensurate increases in costs, to achieve profitability.
However, due to our limited history, our lack of experience with respect to our
sources of revenue, the uncertainty of our future cost structure and other
factors, we are unable to predict the relative importance of our various revenue
sources and when, or if, we will generate sufficient revenues to cover our
operating costs.
Our longer-term objective is to generate electronic commerce revenues that
do not have incremental telecommunications costs. For example, a new user may
decide to set up an account with Ameritrade or acquire a Fleet co-branded credit
card. If this occurs, we will receive incremental revenue without incurring any
additional telecommunications costs of providing service to that user. However,
because of our limited operating history, we do not have enough meaningful
experience to predict the success and relative importance of our revenue sources
to our ultimate profitability.
SALES AND MARKETING
ADVERTISING SALES
We sell traditional banner advertising through third party advertising
firms, including Adsmart. Adsmart purchases a specified volume of our banner
advertising inventory at specified rates. Our agreement with Adsmart expires in
February 2000. We also sell and market banner advertisements and sponsorship on
The ZeroPort through our direct sales force, which comprised 12 people as of
June 30, 1999. Our sales force is structured as a multi-region organization with
regional managers, key account managers and a national planning group. Our sales
personnel operate out of our headquarters in Westlake Village, California and
our offices in New York and San Francisco. We intend to continue to capitalize
on our agreements with third parties to sell traditional banner advertising as
we continue to expand our internal sales organization.
We recently started selling sponsorships for placements on, and links from,
The ZeroPort. For example, we granted eBay the sponsorship for person-to-person
auctions, linking eBay to the "Auction" button or a drop-down menu on The
ZeroPort, and we granted FiNet the sponsorship for mortgage services, linking
FiNet to a drop-down menu on The ZeroPort. We have also entered into agreements
with priceline.com and Ameritrade to link and refer our users to their Web-sites
from within The ZeroPort, and an agreement with Cisco Systems, which provides
sponsorship advertising within The ZeroPort. We expect our sponsorship
arrangements could involve some level of exclusivity. Sponsorship advertising
involves a greater degree of integration and consultation between NetZero and
the marketer than banner advertising arrangements. We intend to focus our sales
and marketing organization on building and sustaining these relationships,
including working to select the appropriate media strategy based on the
sponsor's requirements for timing, number of impressions and desired response
rate.
USER ACQUISITION
To date, we have relied extensively on word-of-mouth marketing to attract
the vast majority of our users. Historically, our users have either downloaded
our software from our Web-site or contacted us by phone or e-mail to have a
compact disc containing our software shipped to them. We plan to increase our
user marketing efforts, including television, radio and print media advertising,
direct marketing campaigns such as widespread direct mailing and distribution of
compact discs to install our software, and bundling, co-branding, and retail
distribution
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arrangements. For instance, we have entered into the following distribution
arrangements to build our brand, acquire users and generate revenues:
COMPAQ. In April 1999, we entered into a 12-month agreement with Compaq
under which Compaq bundles and distributes our NetZero software with its
Presario products. Compaq pays for substantially all of the marketing,
distribution and advertising costs of the bundled product in exchange for up to
10% of The ZeroPort's banner advertising inventory on NetZero sessions initiated
from the bundled Presario products. In addition, all users who sign up for
NetZero's service through software installed on the bundled product are directed
to a Web-site determined by NetZero each time they log-on to NetZero's service
for the term of the agreement. Each time a user logs on to NetZero's service on
the Presario product during the term of the agreement, NetZero is required to
pay Compaq $0.02. The agreement also provides that through February 2000, Compaq
is generally restricted from offering any other free Internet access services on
its Presario products and that we are restricted from bundling our service with
the personal computers of any other manufacturer and entering into any
agreements with Compaq's retailers for the distribution of our services.
XEROX. In June 1999, we entered into a non-exclusive arrangement with Xerox
under which Xerox agreed to bundle and distribute compact discs for installing
our software with its computer peripheral products. Xerox has agreed to pay us a
fee per compact disc and purchase advertising from us through December 1999.
FLEET. Our agreement with Fleet Credit Card Services also provides that
Fleet will market and distribute NetZero's service. See "--Sources of
Revenues--Other" on page 41 for more information on our agreement with Fleet.
USER SUPPORT
Our user service strategy is to build programs designed to increase user
satisfaction and retention, while controlling costs and accommodating our rapid
growth. To date, our user service has been handled in-house, but we plan to
engage in selective outsourcing of certain aspects of our user service to
vendors to provide us with greater efficiency and scalability for future growth.
We provide online and offline "self-help" services that provide a variety of
support options to our users, including our SPEEDY Assistant offline software
which is loaded onto the user's computer when the service is initially installed
from the compact disc and can also be downloaded from our Web-site. This offline
tool assists users in loading and operating our software, provides answers to
common questions and helps users set up their e-mail account through
step-by-step instructions. We also provide comprehensive help, tutorials,
advisories, answers to frequently asked questions and tips via our Web-site, fax
back support and e-mail. We intend to provide the same support via real-time
chat and message boards. We also provide telephone support between 8:00 a.m. and
9:00 p.m. PST, Monday through Saturday. We have entered into an agreement with
Taima Corporation to have Taima develop and provide a "pay for what you need"
program which will provide our users with toll-free telephone access, 24 hours
per day, 7 days per week, to a support representative. Users will pay Taima for
its services on a per-incident basis.
Our user service organization continually monitors different quantitative
measurements such as average wait time, first call resolution rate and abandon
rate. We plan to implement a problem tracking system that will allow recurring
problems to be identified and communicated to the appropriate user service
function for resolution. We are also in the process of enhancing our in-house
support system through the addition of an e-mail distribution system and a
dynamic Web-based database. The database will be accessible by our outsourcing
partners, in-house user service representatives and our customers on a real-time
basis to provide answers to frequently asked questions and to ensure delivery of
user service in a consistent manner.
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TECHNOLOGY
We have developed and continue to expand a proprietary software system
called zCast that enables us to track our users' navigational activities and to
deliver highly-targeted advertising. zCast has two major components:
THE ZCAST CLIENT SOFTWARE
The zCast Client application is the software product that includes The
ZeroPort which is installed on all of our users' personal computers. The
ZeroPort is visible and appears on top of other windows while a connection to
NetZero's service is maintained. The zCast Client performs multiple tasks,
including:
- establishing a connection to the NetZero service;
- capturing demographic information;
- authenticating a user via a user ID and password;
- tracking Web-sites visited;
- managing the display of advertising banners;
- targeting advertising based on Web-sites visited and on keyword search;
- logging the number of times an ad was shown and the number of times an
ad was clicked on;
- monitoring the quality of the online session including dial-up and
network errors;
- providing a mechanism for customer feedback;
- short-cut buttons to content sites;
- an information ticker for stocks, sports and news; and
- a new message indicator.
We intend to continue to extend the functionality of The ZeroPort to enhance
our users' experience.
The zCast Client is a JAVA application that runs on a user's personal
computer. Using JAVA affords us the ability to run on multiple operating systems
with minimal code changes. In addition to JAVA, native Microsoft Windows
applications and system files are used to extend the functionality of the zCast
Client. The zCast Client currently operates on the Windows 95, Windows 98 and
Windows NT 4.x operating systems. We also plan to operate on the Apple Macintosh
operating system in the future.
THE ZCAST SERVER NETWORK
The zCast Server network is a group of software applications running on
multiple servers that manage and collect important data relating to each user's
online session. The servers consist of the following components:
APPLICATION SERVER. The application server software interacts with The
ZeroPort to send and receive information such as authentication, playlists of
advertisements and impression and click counts. This proprietary software is
written in JAVA, which helps make interaction between The ZeroPort and the
server seamless and robust. The application server also distributes the traffic
loads utilizing various hardware and software products, both of which enhance
the scalability of the system.
DATABASE SERVER. The database server stores session information, user
information and ad display and click counts. This server is based on Oracle
database technology and is designed by NetZero to handle very large volumes of
data.
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AD SERVER. The ad server manages the ad inventory and determines which ads
users will view during their online session. This server is based on NetGravity
technology and has been customized by NetZero to create a playlist of
advertising banners for each online session. The implementation of the
NetGravity ad server has been further customized to significantly improve its
performance and scalability.
All of the above components run on Sun Microsystems' servers and are
connected to disk arrays. These provide NetZero with the ability to quickly
scale and improve overall system performance.
We are in the process of implementing a multiple "cell" architecture to
enhance the scalability of the zCast Server network. Each cell, which will
operate independently of other cells, will consist of application servers,
database servers and ad servers and is being designed to handle two to three
million users, based on current average usage. Once implemented, we intend to
balance traffic across different cells based on capacity, providing us with a
fault-tolerant infrastructure.
As part of our free Internet service, we provide industry standard POP3
e-mail accounts for our registered users. POP3 e-mail can be accessed by most
popular e-mail client software applications such as Microsoft Outlook Express.
Our e-mail servers run Qmail software in a Sun Sparc Solaris environment. We
have modified and continue to modify the Qmail server software to provide the
capacity to service millions of users. We have placed rigorous anti-spamming
mechanisms in place on our e-mail servers to limit abuses of our free e-mail
service.
COMMUNICATIONS NETWORK
To use our services, users initiate telephone connections between their
personal computers and computer hardware in local or regional telecommunications
facilities known as points of presence. We contract for the use of points of
presence around the country from various wholesale providers, including GTE
Internetworking, Level 3 Communications, NaviNet and Apex Global Information
Systems. These providers also carry our data between their points of presence
and our central computers in Los Angeles, California. Through our network
providers, we are able to offer local dial-up phone numbers in over 1,600 cities
across the United States. Thus, our users typically bear no expenses for
communication beyond the cost, if any, of an ordinary local or regional phone
call. Our service provides full point-to-point protocol access to the Internet,
and supports the v.90 standard for 56 kbps connections and Integrated Services
Digital Network, or ISDN, in certain areas. We continuously monitor network
service levels around the country and work with our partners to help maintain
high levels of network availability and throughput for our users.
Our agreements with wholesale telecommunications providers are generally
structured in one of two ways. We have usage agreements under which we are
charged for the aggregate number of hours that our users are connected to a
provider's network. We also have capacity agreements under which we are charged
for a fixed amount of wholesaler's telecommunications capacity in specific
locations whether or not the capacity is actually used. Our contract with GTE is
a usage agreement that expires in December 2000 and includes a minimum purchase
commitment which extends through July 2000. Our contract with Level 3
Communications is a capacity agreement under which we have committed to minimum
telecommunications capacity for up to three years.
Our zCast and e-mail servers reside at a facility provided by Level 3
Communications in Los Angeles, California and at our data center in our offices
in Westlake Village, California. Our data center is equipped with battery and
generator power backup systems to prevent outages from interruption of utility
power to the building.
COMPETITION
We compete for users and advertising customers.
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COMPETITION FOR USERS
We believe that the primary competitive factors determining success in the
market for Internet users include a reputation for reliability of service,
effective customer support, pricing, easy-to-use software, geographic coverage
and scope of services. Other important factors include the timing and
introduction of new products and services and industry as well as general
economic trends. While we believe that we compete favorably with respect to
these factors, numerous of our competitors may have an advantage over us with
respect to specific factors. We currently compete with established online
service and content providers, such as America Online, The Microsoft Network,
independent national Internet service providers such as EarthLink, MindSpring
and Prodigy, numerous regional and local commercial Internet service providers,
and portals and search engines such as Yahoo! and Alta Vista. Some of these
providers offer significantly greater customer support and scope of services
than we currently offer, such as instant messaging and online content. We also
compete against other companies that offer free Internet access services or free
products, such as personal computers, bundled with, or as promotions for, access
services, and we expect that more companies will begin to offer such services or
products in the future. We also compete with, and expect increased competition
from, telecommunications service providers, such as AT&T, GTE and MCI WorldCom.
These companies generally have far greater resources, distribution channels and
brand awareness as well as lower costs because they control the
telecommunications services we are required to purchase. This cost advantage,
which could result in significant discounts to the user, could significantly
increase competitive pressures on us. We also believe that new competitors,
including large computer hardware and software, media and telecommunications
companies, will continue to enter the Internet access market and that our
competition will increase as large diversified telecommunications and media
companies acquire Internet service providers and as Internet service providers
consolidate into larger, more competitive companies. Diversified competitors may
also bundle other services and products with Internet connectivity services,
potentially placing us at a significant competitive disadvantage.
We also face competition from companies that provide broadband connections
to users' homes, including local and long-distance telephone companies, cable
television companies, electric utility companies, and wireless communications
companies. These companies may use broadband technologies to include Internet
access or business services such as hosting a user's individual Web-site in
their basic bundle of services or may offer Internet access or business services
for little or no additional charge. Broadband technologies enable users to
access the Internet at much faster speeds than the dial-up service we currently
offer. While the market for such broadband technologies is still emerging, we
believe it will continue to grow and pose an increasingly significant source of
competition.
COMPETITION FOR ADVERTISING CUSTOMERS
We believe that the primary competitive factors determining success in the
market for advertising customers include
- the size and demographic profile of a user base;
- the ability to target users based on specific demographic criteria;
- pricing; and
- geographic coverage.
While we believe that we compete favorably with respect to these factors,
numerous of our competitors may have an advantage over us with respect to
specific factors. We compete for Internet advertising and sponsorship revenues
with major Internet service providers, content providers, large Web publishers,
Web search engine and portal companies, Internet advertising providers, content
aggregation companies, and various other companies which facilitate Internet
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advertising. Many of these companies have longer operating histories, greater
name recognition, larger user bases and significantly greater financial,
technical, sales and marketing resources than we do. This may allow them to
respond more quickly than we can to new or emerging technologies and changes in
advertiser requirements. It may also allow them to devote greater resources than
we can to the development, promotion and sale of their products and services.
These competitors may also engage in more extensive research and development,
undertake more far-reaching marketing campaigns, adopt more aggressive pricing
policies and make more attractive offers to existing and potential employees,
strategic partners, advertisers and Web publishers. In addition, current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products or services to address the needs of our prospective advertising
and sponsorship customers. Increased competition is likely to result in price
reductions, reduced gross margins and loss of market share. We also compete with
television, radio, cable and print media for a share of advertisers' total
advertising budgets.
GOVERNMENTAL REGULATION.
OVERVIEW. The law relating to our business and operations is evolving and
no clear precedents have been established. In addition, a number of legislative
and regulatory proposals under consideration by federal, state, local and
foreign governmental organizations may lead to laws or regulations concerning
online content, user privacy, taxation, parental consent for access by their
minor children, access charges, liability for third-party activities, bulk
e-mail or "spam", encryption standards, online sales of goods and services,
domain name registration and use, copyright infringement, and other intellectual
property issues.
REGULATION OF CONTENT AND ACCESS. A variety of restrictions on content and
access, primarily as they relate to children, have been enacted or proposed. The
Children's Online Privacy 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, unless access to this material is blocked to persons under 17 years of
age. In addition, the Federal Telecommunications Act of 1996 imposes fines on
any entity that knowingly permits any telecommunications facility under such
entity's control to be used to make obscene or indecent material available to
minors via an interactive computer service. Numerous states have adopted or are
currently considering similar types of legislation. In addition, laws have been
proposed which would require Internet service providers to supply, at cost,
filtering technologies to limit or block the ability of minors to access
unsuitable materials on the Internet. Because of these content restrictions and
potential liability to us for materials carried on or disseminated through our
systems, we may be required to implement measures to reduce our exposure to
liability.
USER PRIVACY ISSUES. Internet user privacy has become an issue both in the
United States and abroad. Some commentators, privacy advocates and government
bodies have recommended or taken actions to limit the use of personal profiles
or other personal information by those collecting such information, particularly
as it relates to children. For example, the Children's Online Privacy Protection
Act of 1998 requires, among other things, that online operators obtain
verifiable parental consent for the collection, use, or disclosure of personal
information from children. The Act further mandates that the Federal Trade
Commission publish regulations for the collection of data from children by
commercial Web-site operators. We cannot predict the exact form of the
regulations that the FTC may finally adopt.
INTERNET TAXATION. The tax treatment of activities on or relating to the
Internet is currently unsettled. A number of proposals have been made at the
federal, state and local levels and by foreign governments that could impose
taxes on the online sale of goods and services and other Internet activities.
Recently, the Internet Tax Information Act was signed into law, placing a three-
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year moratorium on new state and local taxes on Internet commerce. However,
there can be no assurance that future laws imposing taxes or other regulations
on commerce over the Internet would not substantially impair the growth of
Internet commerce and as a result could make it cost-prohibitive to operate our
business.
TELECOMMUNICATIONS REGULATION. As an Internet service provider, we are not
currently directly regulated by the Federal Communications Commission or any
other agency, other than regulations applicable to businesses generally. In a
report to Congress adopted on April 10, 1998, the FCC reaffirmed that Internet
service providers should be classified as unregulated "information service
providers", rather than regulated "telecommunications providers" under the terms
of the Telecommunications Act of 1996. This finding is important because it
means that regulations that apply to telephone companies and similar carriers do
not apply to us. We also are not required to contribute a percentage of our
gross revenues to support "universal service" subsidies for local telephone
services and other public policy objectives, such as enhanced communications
systems for schools, libraries, and some health care providers. The FCC action
is also likely to discourage states from regulating Internet service providers
as telecommunications carriers or imposing similar subsidy obligations.
Nevertheless, Internet-related regulatory policies are continuing to
develop, and it is possible that we could be exposed to regulation in the
future. For example, in the same report to Congress, the FCC stated its
intention to consider whether to regulate voice and fax telephony services
provided over the Internet as "telecommunications" even though Internet access
itself would not be regulated.
We could also be affected by any change in the ability of our users to reach
our network through a dial-up telephone call without any additional charges. The
FCC has ruled that connections linking end users to their Internet service
providers are jurisdictionally interstate rather than local, but the FCC did not
subject such calling to the access charges that apply to traditional
telecommunications companies. Local telephone companies assess access charges to
long distance companies for the use of the local telephone network to originate
and terminate long distance calls, generally on a per-minute basis. We could be
adversely affected by any regulatory change that would result in the application
of access charges to Internet service providers because this would substantially
increase the cost of using the Internet. Since the largest component of our
operating costs is comprised of telecommunications costs, any increase in such
costs would have a material adverse effect on our gross margins and revenues.
State public utility commissions generally have declined to regulate
enhanced or information services. Some states, however, have continued to
regulate particular aspects of enhanced services in limited circumstances, such
as where they are provided by incumbent local exchange carriers that operate
telecommunications networks. Moreover, the public service commissions of some
states continue to review potential regulation of these services. We cannot
assure you that state regulatory authorities will not seek to regulate aspects
of these activities as telecommunications services.
THE WORKFORCE INVESTMENT ACT OF 1998. Section 508 of the Workforce
Investment Act of 1998 requires that all Web-sites operated by a federal agency,
as well as those operated by anyone doing business with the federal government,
modify their Web-sites to make them accessible to those who are handicapped.
There are proposals to extend this Act to all Web-sites, which could increase
our costs and make our service less attractive to the non-handicapped.
INTELLECTUAL PROPERTY
Our success and ability to compete are substantially dependent on our
internally developed technologies and trademarks, which we protect through a
combination of patent, copyright, trade
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secret and trademark law. We have filed four patent applications relating to
NetZero's techniques for delivering advertisements on computer desktops.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our technologies, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights from
unauthorized use or disclosure, parties may attempt to disclose, obtain or use
NetZero's solutions or technologies. We cannot be certain that the steps we have
taken will prevent misappropriation of our solutions or technologies,
particularly in foreign countries where the laws or law enforcement may not
protect our proprietary rights as fully as in the United States. We have
licensed, and may license in the future, elements of our trademarks, trade dress
and similar proprietary right to third parties. While we attempt to ensure that
the quality of our brand is maintained by such business partners, such partners
may take actions that could materially and adversely affect the value of our
proprietary rights or reputation.
Our zCast technology collects and utilizes data derived from our user
activity. This data is used for ad targeting and measuring ad performance.
Although we believe that we have the right to use this data, there can be no
assurance that third parties will not assert claims against us for using this
information. In addition, others may claim rights to the same information. We
may also be required, upon request, to delete "identifying information" of users
under the age of 18.
We cannot be certain that any of our proprietary rights will be viable or of
value in the future since the validity, enforceability and scope of protection
of proprietary rights in Internet-related industries is uncertain and still
evolving. In particular, there can be no assurance that any of our patent,
copyright or trademark applications, now pending or to be filed in the future,
will be approved. Even if they are approved, such patents, trademarks or
copyrights may be successfully challenged by others or invalidated. If our
trademark registrations are not approved because third parties own such
trademarks, our use of the trademarks will be restricted unless we enter into
arrangements with such third parties. These arrangements may not be available on
commercially reasonable terms.
Furthermore, third parties may assert infringement claims against us. From
time to time we may be subject to claims in the ordinary course of our business,
including claims of alleged infringement of the trademarks, patents and other
intellectual property rights of third parties by us or our users. Any such
claims, or any resultant litigation, should it occur, could subject us to
significant liability for damages and could result in the invalidation of our
proprietary rights. In addition, even if we were to win any such litigation,
such litigation could be time-consuming and expensive to defend, and could
result in the diversion of our time and attention, any of which could materially
and adversely affect our business, results of operations and financial
condition. Any claims or litigation may also result in limitations on our
ability to use such trademarks, patents and other intellectual property unless
we enter into arrangement with such third parties, which may be unavailable on
commercially reasonable terms.
We currently license from Oracle the software we use to run our accounting,
billing, finance and data storage functions. The license agreement requires us
to pay annual support and license fees to Oracle. The agreement terminates in
April 2004. We also license from NetGravity the software we use to deliver
advertisements on The ZeroPort. The agreement requires that we pay NetGravity an
upfront license fee and ongoing consulting and support fees.
PRIVACY POLICY
We believe that issues relating to the privacy of Internet users and the use
of personal information about these users are critically important as the
Internet and its commercial use grow. We have adopted and disclosed to our users
a detailed policy outlining the permissible uses of information about users and
the extent to which such information may be shared with others. Our
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users must acknowledge and agree to this policy when registering to use our
service. We do not sell or license to third parties any personally identifiable
information about users unless they specifically authorize us to do so. However,
we do use information about users to improve the effectiveness of advertising by
our advertising customers. We are a member of the TRUSTe program, an independent
non-profit organization that audits the privacy statements of Web-sites and
their adherence to those privacy statements.
EMPLOYEES
As of June 30, 1999, we employed 116 persons, including 22 in sales and
marketing, 20 in customer care, 33 in product development, 15 in information
systems and 26 in finance, accounting and administration. None of our employees
are subject to any collective bargaining agreement.
FACILITIES
Our principal executive offices are located in a 49,000 square feet facility
in Westlake Village, California under a lease expiring in March 2009. We also
have leased space for our sales and marketing efforts in San Francisco and New
York. We are continually evaluating our facilities requirements.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information regarding our directors,
executive officers and key employees as of June 30, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ---------------------------- --- -----------------------------------------------------
<S> <C> <C>
Mark R. Goldston............ 44 Chairman, Chief Executive Officer and Director
Ronald T. Burr.............. 34 President, Chief Technology Officer, Co-Founder and
Director
Charles S. Hilliard......... 35 Senior Vice President, Finance and Chief Financial
Officer
Frederic A. Randall, Jr..... 42 Senior Vice President, General Counsel and Secretary
Perri S. Procida............ 42 Senior Vice President, Sales
Stacy A. Haitsuka........... 33 Senior Vice President, Technology and Co-Founder
Harold R. MacKenzie......... 33 Vice President, Software Development and Co-Founder
Marwan A. Zebian............ 39 Vice President, Networking and Communications and Co-
Founder
Janet C. Daly............... 38 Vice President, Marketing
David J. Dowling............ 32 Vice President, Business Development
Dennis L. Gordon............ 49 Vice President, Information Systems and Customer Care
James T. Armstrong(1)(2).... 33 Director
David C. Bohnett(1)......... 43 Director
Jennifer S. Fonstad(1)...... 33 Director
Bill Gross(2)............... 41 Director
Paul G. Koontz(2)........... 39 Director
</TABLE>
- ------------------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
MARK R. GOLDSTON has been our Chairman and Chief Executive Officer and a
director since March 1999. Prior to joining NetZero, Mr. Goldston served as
Chairman and Chief Executive Officer of The Goldston Group, a strategic advisory
firm, from December 1997 to March 1999. From April 1996 to December 1997, he
served as President, Chief Executive Officer and a director of Einstein/Noah
Bagel Corp. after founding and serving his initial term with The Goldston Group
from June 1994 to April 1996. Mr. Goldston also served as President and Chief
Operating Officer of L.A. Gear from September 1991 to June 1994 and as a
principal of Odyssey Partners, L.P., a private equity firm, from September 1989
to September 1991. Mr. Goldston received his B.S.B.A. in Marketing and Finance
from Ohio State University and his M.B.A. (M.M.) from the J.L. Kellogg School at
Northwestern University.
RONALD T. BURR is a co-founder of NetZero and has been our President and a
director since July 1997, and our Chief Technology Officer since March 1999. Mr.
Burr was also our Chief Executive Officer from July 1997 to March 1999. From
1991 to 1998, Mr. Burr was President of Impact Software, a software consulting
firm which he co-founded. From 1989 to 1991, Mr. Burr held a senior position as
a consulting technical team leader on a development project jointly produced by
IBM and Security Pacific Automation Company. From 1983 to 1989, Mr. Burr held
various management positions, including vice president of software development
with Vault Corporation, an Allen & Co. venture-funded software startup.
CHARLES S. HILLIARD has been our Senior Vice President, Finance and Chief
Financial Officer since April 1999. Prior to joining NetZero, Mr. Hilliard
served as an investment banker with Morgan Stanley Dean Witter & Co. from May
1994 to April 1999, most recently as a Principal in the
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<PAGE>
Corporate Finance Department. From August 1990 to May 1994, he served in the
Mergers & Acquisitions and Corporate Finance departments of Merrill Lynch & Co.
Mr. Hilliard served as a tax accountant with Arthur Andersen & Co. from
September 1985 to July 1988 and was licensed as a Certified Public Accountant in
January 1988. Mr. Hilliard received his B.S. in Business Administration from the
University of Southern California and his M.B.A. with distinction from the
University of Michigan.
FREDERIC A. RANDALL, JR. has been our Senior Vice President and General
Counsel since March 1999. Mr. Randall was appointed Secretary in May 1999. Prior
to joining NetZero, Mr. Randall was a partner at Brobeck, Phleger & Harrison LLP
from January 1991, and an associate from 1984 to December 1990. Mr. Randall
received his B.A. in English Literature with distinction from the University of
Michigan and his J.D., CUM LAUDE, from the University of San Francisco School of
Law.
PERRI S. PROCIDA has been our Senior Vice President, Sales since May 1999.
From October 1998 to April 1999, Ms. Procida acted as an independent consultant
for various Internet companies. From September 1996 to September 1998, Ms.
Procida was the Senior Vice President, Network Sales of the UPN Television
Network. From October 1979 to September 1996, she held various positions at NBC
Television Network, including Vice President of News Sales. Ms. Procida received
her B.S. from Syracuse University, majoring in Radio/Television and English.
STACY A. HAITSUKA is a co-founder of NetZero and has been our Senior Vice
President, Technology since March 1999. From July 1997 to March 1999, Mr.
Haitsuka was our Chief Technology Officer and a member of our board of
directors. Mr. Haitsuka also served as our Secretary from July 1997 to May 1999.
From May 1991 to September 1998, Mr. Haitsuka was the vice-president of Impact
Software, a software consulting company which he co-founded. Prior to May 1991,
Mr. Haitsuka held various positions at Security Pacific Automation Company. Mr.
Haitsuka received his B.S. in Computer Science from California State University
at Dominguez Hills.
HAROLD R. MACKENZIE is a co-founder of NetZero and has been our Vice
President, Software Development since July 1997. Prior to joining NetZero, he
was a manager with Impact Software from September 1996 to August 1998. From
December 1995 to September 1996, Mr. MacKenzie was an independent consultant
focusing on custom computer applications. From February 1992 to December 1995,
Mr. MacKenzie was a senior consultant for Andersen Consulting. From 1989 to
1992, he worked for the Robotics Division of Seiko Instruments, Inc. Mr.
MacKenzie received his B.S. in Computer Science from California State University
at Northridge.
MARWAN A. ZEBIAN is a co-founder of NetZero and has been our Vice President,
Networking and Communications since July 1997. Prior to joining NetZero, Mr.
Zebian was a technical expert with Impact Software from 1994 to 1998. From 1990
to 1994, Mr. Zebian founded and operated Megasoftware Engineering. From 1989 to
1991, Mr. Zebian held various technical positions at Security Pacific Automation
Company.
JANET C. DALY has been our Vice President, Marketing since December 1998.
Prior to joining NetZero, Ms. Daly was the Vice President of Marketing of
Quarterdeck from November 1997 to August 1998. From March 1996 to November 1997,
she was the Director of Marketing of CyberMedia. From September 1994 through
March 1996, Ms. Daly was the Senior Brand Manager and the Product Marketing
Manager, Consumer Division at Davidson and Associates. From November 1991 to
August 1994, Ms. Daly was the Senior Marketing Manager at Symantec-Peter Norton
Group. Ms. Daly received her B.A. from the University of California at Santa
Barbara.
DAVID J. DOWLING has been our Vice President, Business Development since
April 1999. From March 1997 to March 1999, he was President of media.com, the
interactive media and marketing communications affiliate of Grey Advertising.
From January 1996 to March 1997, Mr. Dowling served
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<PAGE>
as the Director of Media for Grey Interactive. From September 1994 through
January 1996, Mr. Dowling served as the Director of Media Connections, another
affiliate of Grey Advertising. Mr. Dowling received his B.S., CUM LAUDE, in
Marketing from the University of Connecticut.
DENNIS L. GORDON has been our Vice President, Information Systems and
Customer Care since April 1998 and also our Vice President of Information
Systems since March 1999. Prior to joining NetZero, Mr. Gordon held various
information technology management and technical positions with the Southern
California Gas Company, a subsidiary of Pacific Enterprises, from 1977 to 1998.
JAMES T. ARMSTRONG has been a director since September 1998. Mr. Armstrong
has been a principal with idealab! Capital Partners since August 1998. From May
1995 to August 1998, Mr. Armstrong was a senior associate with Austin Ventures.
From September 1989 to March 1992, Mr. Armstrong was a senior auditor with Ernst
& Young. Mr. Armstrong serves on the board of directors of several private
companies including CarsDirect.com, Aveo, OpenSales.com, and Jobs.com. Mr.
Armstrong received his B.A. in Economics from the University of California at
Los Angeles and his M.B.A. with honors from the University of Texas.
DAVID C. BOHNETT has been a director since December 1998. Mr. Bohnett served
as Chairman of the Board and Secretary of GeoCities, which he founded, from
November 1994 until May 1999, when GeoCities merged with Yahoo!. From November
1994 to April 1998, Mr. Bohnett also served as GeoCities' Chief Executive
Officer and President. From November 1994 to November 1997, Mr. Bohnett also
served as GeoCities' Chief Financial Officer. Mr. Bohnett also serves on the
Board of Directors of Stamps.com, Inc. and several private companies. Mr.
Bohnett received his B.S. degree in Business Administration from the University
of Southern California and his M.B.A. degree in Finance from the University of
Michigan.
JENNIFER S. FONSTAD has been a director since January 1999. Ms. Fonstad is a
partner with Draper Fisher Jurvetson. Ms. Fonstad also serves on the board of
directors of several private companies including iShip.com, Conduit,
Saltare.com, Global Sight and Troika Networks. From January 1997 to May 1997,
she worked with SensAble Technologies. She held management positions with the
Planning Technologies Group, now part of the Nextera Group, from January 1995 to
May 1996 and a start-up based in Central Europe from September 1991 to May 1993.
Ms. Fonstad began her career as an Associate Consultant with Bain & Company. Ms.
Fonstad received her B.S. CUM LAUDE in Economics from Georgetown University and
her M.B.A. with distinction from Harvard University.
BILL GROSS has been a director since September 1998. Since March 1996, Mr.
Gross has served as Chairman of the Board, Chief Executive Officer and President
of Bill Gross' idealab!, an incubator and venture capital firm which he founded
that specializes in Internet companies. He also has served as a Managing
Director of idealab! Capital Management I, LLC, a venture capital firm, since
March 1998. From June 1991 to January 1997, he served as Chairman of Knowledge
Adventure, Inc., an educational software developer of multimedia CD-ROMs for
children, which was founded by Mr. Gross. From February 1986 to March 1991, he
was a developer at Lotus Development Corporation. Mr. Gross serves on the board
of directors of Ticketmaster Online-CitySearch, Inc. (formerly CitySearch, Inc.)
and GoTo.com, Inc. He also serves on the board of directors of several private
companies. Mr. Gross received his B.S. in Mechanical Engineering from the
California Institute of Technology.
PAUL G. KOONTZ has been a director since January 1999. Since 1996, Mr.
Koontz has been a member of Foundation Capital Management II L.L.C., the general
partner of Foundation Capital II, L.P. From 1995 to 1996, he was with Sutter
Hill Ventures and in 1994 he was the initial Vice President of Marketing of
Netscape Communications Corporation. From 1987 to 1994, Mr. Koontz was with
Silicon Graphics, Inc., where he held a number of positions, including Director
of
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Marketing. Mr. Koontz serves on the boards of directors of Onyx Software
Corporation and several privately held companies. Mr. Koontz received his B.S.
in mechanical engineering from Princeton University and his Masters in
engineering management from Stanford University.
BOARD OF DIRECTORS
Our board of directors currently comprises seven directors. Directors are
elected by the stockholders at each annual meeting of stockholders and serve for
one year or until their successors are duly elected and qualified. However, our
certificate of incorporation provides that, following the offering, our board of
directors will be divided into three classes as nearly equal in size as possible
with staggered, three-year terms. The term of office of our Class I directors
will expire at the annual meeting of stockholders to be held in 2000; the term
of office of our Class II directors will expire at the annual meeting of
stockholders to be held in 2001; and the term of office of our Class III
directors will expire at the annual meeting of the stockholders to be held in
2002. At each annual meeting of the stockholders, beginning with the 2000 annual
meeting, the successors to the directors whose terms will then expire will be
elected to serve from the time of their election and qualification until the
third annual meeting following their election or until their successors have
been duly elected and qualified, or until their earlier resignation or removal,
if any. Messrs. Bohnett and Koontz have been designated as Class I directors;
Mr. Burr and Ms. Fonstad have been designated as Class II directors; and Messrs.
Armstrong, Goldston and Gross have been designated as Class III directors. The
classification of our board of directors could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
acquiring, control of NetZero.
BOARD COMMITTEES
The board has established an audit committee to meet with and consider
suggestions from members of management and our internal accounting personnel, as
well as our independent accountants, concerning our financial operations. The
audit committee also has the responsibility to review our audited financial
statements and consider and recommend the appointment of, and approve the fee
arrangements with, independent accountants for both audit functions and for
advisory and other consulting services. The audit committee is currently
comprised of Messrs. Armstrong and Bohnett and Ms. Fonstad. The board has also
established a compensation committee to review and make recommendations to the
board regarding the compensation and benefits for our key executive officers,
and to administer our stock purchase, equity incentive and stock option plans.
The compensation committee is currently comprised of Messrs. Armstrong, Gross
and Koontz.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the compensation committee is or has been an employee
of ours at any time since our formation. None of our executive officers serves
as a member of the board of directors or compensation committee of any entity
that has one or more executive officers serving as a member of our board of
directors or compensation committee.
DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS
Our directors receive no cash remuneration for serving on the board of
directors or any board committee; however, directors are reimbursed for all
reasonable expenses incurred by them in attending board and committee meetings.
In December 1998, David C. Bohnett was granted an option to purchase 225,000
shares of Series C preferred stock at an exercise price of $0.4297. The
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<PAGE>
options vest ratably over a four year period. Mr. Bohnett also purchased 101,260
shares of NetZero's Series B preferred stock in January 1999 for a purchase
price of $15,000.
Certain non-employee directors may also receive option grants and other
equity incentives under our new 1999 Stock Incentive Plan, including the
director fee option grant programs in effect under that plan. See "--1999 Stock
Incentive Plan" on page 57 for more information on these option grants and
equity incentives.
Employee directors are also eligible to receive stock option grants and
direct issuances of common stock under our 1999 Stock Incentive Plan. See
"--1999 Stock Incentive Plan" on page 57 for more information on these option
grants and stock issuances.
EXECUTIVE COMPENSATION
The following summary compensation table sets forth information concerning
cash and non-cash compensation earned during the fiscal year ended June 30, 1999
by Mark Goldston, who has been our current Chief Executive Officer since March
1999, and Ronald Burr, who acted as our Chief Executive Officer during the
fiscal year ended June 30, 1999 prior to Mr. Goldston. None of our other
executive officers received total compensation in excess of $100,000 during the
fiscal year ended June 30, 1999. Since the close of our June 30, 1999 fiscal
year, we have added several additional officers. For a list of our current
executive officers and certain members of our senior management, see
"--Directors and Executive Officers" above.
SUMMARY COMPENSATION TABLE FOR FISCAL YEAR 1999
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
--------------
ANNUAL COMPENSATION SECURITIES
------------------------ OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITIONS SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#) COMPENSATION($)
- --------------------------------- ----------- ----------- ----------------------- -------------- ---------------------
<S> <C> <C> <C> <C> <C>
Mark R. Goldston ................ 56,154 70,383 -- 6,286,383 --
Chairman and Chief Executive
Officer
Ronald T. Burr .................. 102,542 25,000 -- -- --
President, Chief Technology
Officer, Co-Founder and
director
</TABLE>
In addition to the above named executive officers for the fiscal year ended
June 30, 1999, NetZero currently employs certain other executive officers who it
anticipates will qualify as named executive officers in future years. Those
executives include Charles S. Hilliard, Senior Vice President, Finance and Chief
Financial Officer (annual salary of $140,000), Perri S. Procida, Senior Vice
President, Sales (annual salary of $135,000) and Frederic A. Randall, Jr.,
Senior Vice President, General Counsel and Secretary (annual salary of
$135,000).
STOCK OPTIONS GRANTED DURING FISCAL YEAR 1999
The following table sets forth certain information regarding options to
purchase common stock granted to named executive officers during the fiscal year
ended June 30, 1999 including the potential realizable value over the ten-year
term of the options, based on assumed, annually compounded rates of stock value
appreciation. These assumed rates of appreciation comply with the rules of the
Securities and Exchange Commission and do not represent our estimate of future
stock price. Actual gains, if any, on stock option exercises will be dependent
on the future performance of our common stock. No stock appreciation rights were
granted to these individuals during the year.
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<PAGE>
The option for Mark Goldston was granted under our 1999 Stock Option/Stock
Issuance Plan. See "--Employment Agreements and Change in Control Arrangements"
below for more information on the vesting of the option shares.
During the fiscal year ended June 30, 1999, we granted options to purchase a
total of approximately 13,865,000 shares of common stock, including Mr.
Hilliard's option to purchase 1,200,000 shares of our common stock and Mr.
Randall's option to purchase 1,050,000 shares of our common stock. Please see
"--Employment Agreements and Change in Control Arrangements" below for specific
option information for Messrs. Goldston, Hilliard and Randall.
The following table sets forth information regarding the option grants to
our named executive officers. All the options were granted at an exercise price
which our board of directors believed to be equal to the fair market value of
our common stock on the date of grant. The potential realizable values set forth
in the table are computed by:
- multiplying the number of shares of common stock subject to the option
by the initial public offering price of $16.00 per share;
- assuming that the stock value derived from that calculation compounds
at the annual 0%, 5% or 10% rate shown in the table for the entire
ten-year term of the option; and
- subtracting that result from the total option exercise price. The 5%
and 10% values assume annual rates of stock price appreciation as
mandated by the rules of the Securities and Exchange Commission and do
not represent our estimate or projection of future common stock prices.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
-------------------------------------------------------------- VALUE AT ASSUMED ANNUAL
NUMBER OF PERCENTAGE OF TOTAL RATES OF STOCK
SECURITIES OPTIONS GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES IN THE FISCAL EXERCISE TERM
OPTIONS YEAR ENDED JUNE 30, PRICE PER EXPIRATION -----------------------------------------
NAME GRANTED(#) 1999 SHARE DATE 0% 5% 10%
- --------------------- ----------- ----------------------- ----------- ----------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Mark R. Goldston..... 6,286,383 45.3% $ 0.10 3/19/09 $99,953,490 $ 163,209,050 $ 260,255,498
Ronald T. Burr....... 0 -- -- -- -- -- --
</TABLE>
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED JUNE 30, 1999 AND YEAR-END
OPTION VALUES
The following table sets forth certain information concerning options to
purchase common stock exercised by the named executive officers during the
fiscal year ended June 30, 1999. None of the named executive officers held any
unexercised stock options or stock appreciation rights on June 30, 1999.
<TABLE>
<CAPTION>
SHARES ACQUIRED ON VALUE
NAME EXERCISE REALIZED
- ---------------------------------------------------------------------------- -------------------- --------------
<S> <C> <C>
Mark R. Goldston............................................................ 6,286,383 $ 99,953,490
Ronald T. Burr.............................................................. -- --
</TABLE>
EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS
Mark R. Goldston entered into a four-year employment agreement, effective as
of March 20, 1999, under which Mr. Goldston serves as our Chief Executive
Officer and Chairman. Under this agreement, Mr. Goldston receives a base salary
of $200,000 per year and during the first two years of the agreement, Mr.
Goldston receives a guaranteed bonus of $200,000 per year, payable in four
quarterly installments. Mr. Goldston is also entitled to receive a signing bonus
of $300,000 payable on January 1, 2000 so long as he is employed by us on that
date. In addition, we gave Mr. Goldston benefits that we make available to our
employees in comparable positions, and we
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<PAGE>
granted Mr. Goldston an immediately exercisable option to purchase 6,286,383
shares of our common stock. Mr. Goldston exercised his option to purchase common
stock in full; however, the option shares are subject to repurchase by us at the
price paid for his shares. Our repurchase right lapses pursuant to a 48 equal
monthly vesting schedule. If Mr. Goldston's employment is terminated by us
without cause, or if following a change in control of NetZero, Mr. Goldston
resigns for specified reasons, he will be entitled to receive a $1,000,000 lump
sum severance payment. In addition, if Mr. Goldston's employment is terminated
by us without cause within the first year of his employment, an additional 25%
of his option shares of common stock will vest, and if his employment is
terminated by us without cause following the first year of his employment, all
of his shares will vest. Mr. Goldston will also be credited with an additional
24 months of vesting on his option shares in the event his employment is
terminated by reason of death or permanent disability. Further, Mr. Goldston's
option shares automatically vest upon a change in control of NetZero.
Charles S. Hilliard entered into a four-year employment agreement, effective
as of April 17, 1999, under which Mr. Hilliard serves as Senior Vice President,
Finance and Chief Financial Officer. Pursuant to this agreement, Mr. Hilliard
receives a base salary of $140,000 plus a performance-based bonus of up to 50%
of his base salary. In addition, we gave Mr. Hilliard benefits that we make
available to our employees in comparable positions, and we granted Mr. Hilliard
an immediately exercisable option to purchase 1,200,000 shares of our common
stock at a price per share of $0.33. Mr. Hilliard exercised his option to
purchase common stock in full; however, such option shares are subject to
repurchase by us at the price paid for his shares. Our repurchase right lapses
with respect to 25% of the option shares upon the one-year anniversary of Mr.
Hilliard's employment and with respect to the remaining 75% of the option shares
over 36 equal monthly installments thereafter. We also agreed to sell 225,000
shares of our Series D preferred stock to Mr. Hilliard at a price per share of
$1.84. Mr. Hilliard's employment is subject to termination at any time by him or
by us. If Mr. Hilliard's employment is terminated without cause, he will be
entitled to receive a lump sum payment of $280,000 and shall be credited with an
additional 12 months of vesting on his option shares. Mr. Hilliard will also be
credited with an additional 12 months of vesting on his option shares in the
event his employment is terminated by reason of death or permanent disability.
If, following a change in control, Mr. Hilliard's employment is terminated
without cause or is constructively terminated, all of the option shares shall
vest immediately; provided, if the change in control occurs on or prior to
January 17, 2000, only 75% of the option shares shall vest.
Frederic A. Randall, Jr. entered into a four-year employment agreement,
effective as of March 20, 1999, pursuant to which Mr. Randall serves as a Senior
Vice President and our General Counsel. Under this agreement, Mr. Randall
receives a base salary of $135,000 plus a performance-based bonus of up to 50%
of his base salary. In addition, we gave Mr. Randall benefits that we make
available to our employees in comparable positions, and we granted Mr. Randall
an immediately exercisable option to purchase 1,050,000 shares of our common
stock at a price per share of $0.10. Mr. Randall exercised his option to
purchase common stock in full; however, the option shares are subject to
repurchase by us at the price paid for his shares. Our repurchase right lapses
with respect to 25% of the option shares upon the one-year anniversary of Mr.
Randall's employment and with respect to the remaining 75% of the option shares
over 36 equal monthly installments thereafter. Mr. Randall's employment is
subject to termination at any time by him or by us. If Mr. Randall's employment
is terminated without cause, he will be entitled to receive a lump sum payment
of $270,000 and shall be credited with an additional 12 months of vesting on his
option shares. Mr. Randall will also be credited with an additional 12 months of
vesting on his option shares in the event his employment is terminated by reason
of death or permanent disability. If, following a change in control, Mr.
Randall's employment is terminated without cause or is constructively
terminated, all of the option shares shall vest immediately; provided, if the
change in control occurs on or prior to December 19, 1999, only 75% of the
option shares shall vest.
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Our 1999 Stock Incentive Plan includes change in control provisions which
may result in the accelerated vesting of outstanding option grants and stock
issuances. See "--1999 Stock Incentive Plan--Change in Control" beginning on
page 59 for more information about these provisions.
1999 STOCK INCENTIVE PLAN
The 1999 Stock Incentive Plan is the successor program to our existing stock
option/stock issuance plans. The new 1999 Stock Incentive Plan was adopted by
the board in July 1999 and was approved by the stockholders in September 1999.
The 1999 Stock Incentive Plan will become effective upon the closing of this
offering. At that time, all outstanding options under our existing stock
option/stock issuance plans will be transferred to the 1999 Stock Incentive
Plan, and no further option grants will be made under those plans. The
transferred options will continue to be governed by their existing terms, unless
our compensation committee decides to extend one or more features of the 1999
Stock Incentive Plan to those options. Except as otherwise noted below, the
transferred options have substantially the same terms as will be in effect for
grants made under the discretionary option grant program of our 1999 Stock
Incentive Plan.
SHARE RESERVE. Under the 1999 Stock Incentive Plan, 21.9 million shares of
our common stock have been authorized for issuance. This share reserve consists
of the shares that will be carried over from our existing stock option/stock
issuance plans, including the shares subject to outstanding options under these
plans, plus an additional increase of approximately 2.4 million shares. As of
August 31, 1999, options to purchase approximately 4.3 million shares of common
stock remained available for grant under the 1999 Stock Incentive Plan. The
share reserve under our 1999 Stock Incentive Plan will automatically increase on
the first trading day in January of each year, beginning with calendar year
2000, by an amount equal to 3% of the total number of shares of our common stock
outstanding on the last trading day in December in the prior year, but in no
event will any such annual increase exceed 6.5 million shares. In addition, no
participant in the 1999 Stock Incentive Plan may be granted stock options or
direct stock issuances for more than 2.0 million shares of common stock in total
in any calendar year.
PROGRAMS. Our 1999 Stock Incentive Plan has four separate programs:
- the discretionary option grant program, under which eligible
individuals in our employ may be granted options to purchase shares of
our common stock at an exercise price not less than the fair market
value of those shares on the grant date;
- the stock issuance program, under which eligible individuals may be
issued shares of common stock directly, upon the attainment of
performance milestones or the completion of a specified service period
or as a bonus for past services;
- the salary investment option grant program, under which our executive
officers and other highly compensated employees may be given the
opportunity to apply a portion of their base salary each year to the
acquisition of special below market stock option grants; and
- the director fee option grant program, under which our non-employee
board members may be given the opportunity to apply a portion of any
retainer fee otherwise payable to them in cash for the year to the
acquisition of special below-market option grants.
ELIGIBILITY. The individuals eligible to participate in our 1999 Stock
Incentive Plan include our officers and other employees, our board members and
any consultants we hire.
ADMINISTRATION. The discretionary option grant and stock issuance programs
will be administered by our compensation committee. This committee will
determine which eligible individuals are to receive option grants or stock
issuances under those programs, the time or times
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when the grants or issuances are to be made, the number of shares subject to
each grant or issuance, the status of any granted option as either an incentive
stock option or a nonstatutory stock option under the federal tax laws, the
vesting schedule to be in effect for the option grant or stock issuance and the
maximum term for which any granted option is to remain outstanding. The
compensation committee will also have the authority to select the executive
officers and other highly compensated employees who may participate in the
salary investment option grant program in the event that program is put into
effect for one or more calendar years.
PLAN FEATURES. Our 1999 Stock Incentive Plan will include the following
features:
- The exercise price for any options granted pursuant to the plan may be
paid in cash or in shares of our common stock valued at fair market
value on the exercise date. The option may also be exercised through a
same-day sale program without any cash outlay by the optionee.
- The compensation committee will have the authority to cancel
outstanding options under the discretionary option grant program,
including any transferred options from our existing stock option/stock
issuance plan, in return for the grant of new options for the same or
different number of option shares with an exercise price per share
based upon the fair market value of our common stock on the new grant
date.
- Stock appreciation rights may be issued under the discretionary option
grant program. These rights will provide the holders with the election
to surrender their outstanding options for a payment from us equal to
the fair market value of the shares subject to the surrendered options
less the exercise price payable for those shares. We may make the
payment in cash or in shares of our common stock. None of the
outstanding options under our existing stock option/stock issuance plan
have any stock appreciation rights.
CHANGE IN CONTROL. The 1999 Stock Incentive Plan will include the following
change in control provisions which may result in the accelerated vesting of
outstanding option grants and stock issuances:
- In the event that we are acquired by merger or asset sale, each
outstanding option under the discretionary option grant program which
is not to be assumed by the successor corporation will immediately
become exercisable for all the option shares, and all outstanding
unvested shares will immediately vest, except to the extent our
repurchase rights with respect to those shares are to be assigned to
the successor corporation.
- The compensation committee will have complete discretion to grant one
or more options which will become exercisable for all the option shares
in the event those options are assumed in the acquisition but the
optionee's service with us or the acquiring entity is subsequently
terminated. The vesting of any outstanding shares under our 1999 Stock
Incentive Plan may be accelerated upon similar terms and conditions.
- The compensation committee may grant options and structure repurchase
rights so that the shares subject to those options or repurchase rights
will immediately vest in connection with a successful tender offer for
more than 50% of our outstanding voting stock or a change in the
majority of our board through one or more contested elections. Such
accelerated vesting may occur either at the time of such transaction or
upon the subsequent termination of the individual's service.
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- The options outstanding under our existing stock option/stock issuance
plan will immediately vest in the event we are acquired and the
acquiring company does not assume those options. In addition, any
options which are so assumed may vest in whole or in part on an
accelerated basis upon an involuntary termination of the optionee's
employment within 12 months after the acquisition. In general, an
employee with such an acceleration provision will, after taking that
acceleration into account, be vested at the time of his or her
involuntary termination in the greater of:
(i) the number of shares in which he or she would have been vested
at that time had his or her service been twice as long as the
actual period of service rendered prior to such involuntary
termination or
(ii) the number of shares in which he or she would have been vested
in had he or she completed one year of service prior to such
termination.
SALARY INVESTMENT OPTION GRANT PROGRAM. In the event the compensation
committee decides to put this program into effect for one or more calendar
years, each of our executive officers and other highly compensated employees may
elect to reduce his or her base salary for the calendar year by an amount not
less than $10,000 nor more than $50,000. Each selected individual who makes such
an election will automatically be granted, on the first trading day in January
of the calendar year for which his or her salary reduction is to be in effect,
an option to purchase that number of shares of common stock determined by
dividing the salary reduction amount by two-thirds of the fair market value per
share of our common stock on the grant date. The option will have an exercise
price per share equal to one-third of the fair market value of the option shares
on the grant date. As a result, the option will be structured so that the fair
market value of the option shares on the grant date less the exercise price
payable for those shares will be equal to the amount of the salary reduction.
The option will become exercisable in a series of twelve equal monthly
installments over the calendar year for which the salary reduction is to be in
effect.
DIRECTOR FEE OPTION GRANT PROGRAM. If this program is put into effect in
the future, then each non-employee board member may elect to apply all or a
portion of any cash retainer fee for the year to the acquisition of a
below-market option grant. The option grant will automatically be made on the
first trading day in January of the calendar year for which the non-employee
board member would otherwise be paid the cash retainer fee in the absence of his
or her election. The option will have an exercise price per share equal to
one-third of the fair market value of the option shares on the grant date, and
the number of shares subject to the option will be determined by dividing the
amount of the retainer fee applied to the program by two-thirds of the fair
market value per share of our common stock on the grant date. As a result, the
option will be structured so that the fair market value of the option shares on
the grant date less the exercise price payable for those shares will be equal to
the portion of the retainer fee applied to that option. The option will become
exercisable in a series of twelve equal monthly installments over the calendar
year for which the election is in effect. However, the option will become
immediately exercisable for all the option shares upon the death or disability
of the optionee while serving as a board member.
ADDITIONAL PROGRAM FEATURES. Our 1999 Stock Incentive Plan will also have
the following features:
- Outstanding options under the salary investment option grant and
director fee option grant programs will immediately vest if we are
acquired by a merger or asset sale or if there is a successful tender
offer for more than 50% of our outstanding voting stock or a change in
the majority of our board through one or more contested elections.
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- Limited stock appreciation rights will automatically be included as
part of each grant made under the salary investment option grant and
the director fee option grant programs, and these rights may also be
granted to one or more officers as part of their option grants under
the discretionary option grant program. Options with this feature may
be surrendered to us upon the successful completion of a hostile tender
offer for more than 50% of our outstanding voting stock. In return for
the surrendered option, the optionee will be entitled to a cash
distribution from us in an amount per surrendered option share based
upon the highest price per share of our common stock paid in that
tender offer.
- The board 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 no later than July 12, 2009.
1999 EMPLOYEE STOCK PURCHASE PLAN
Our 1999 Employee Stock Purchase Plan was adopted by the board in July 1999
and approved by the stockholders in September 1999 offering. The plan became
effective immediately upon the signing of the underwriting agreement for this
offering. The plan is designed to allow our eligible employees and the eligible
employees of our participating subsidiaries to purchase shares of common stock,
at semi-annual intervals, with their accumulated payroll deductions.
SHARE RESERVE. 500,000 shares of our common stock will initially be
reserved for issuance. The reserve will automatically increase on the first
trading day in January each year, beginning in calendar year 2000, by an amount
equal to one and one half percent (1.5%) of the total number of outstanding
shares of our common stock on the last trading day in December in the prior
year, but in no event will any such annual increase exceed 3,250,000 shares.
OFFERING PERIODS. The plan will have a series of successive offering
periods, each with a maximum duration of 24 months. The initial offering period
started on September 23, 1999 and will end on the last business day in October
2001. The next offering period will start on the first business day in November
2001, and subsequent offering periods will be set by our compensation committee.
ELIGIBLE EMPLOYEES. Individuals scheduled to work more than 20 hours per
week for more than 5 calendar months per year may join an offering period on the
start date or any semi-annual entry date within that period. Semi-annual entry
dates will occur on the first business day of May and November each year.
Individuals who become eligible employees after the start date of an offering
period may join the plan on any subsequent semi-annual entry date within that
offering period.
PAYROLL DEDUCTIONS. A participant may contribute up to 15% of his or her
cash earnings through payroll deductions, and the accumulated deductions will be
applied to the purchase of shares on each semi-annual purchase date. The
purchase price per share will be equal to 85% of the fair market value per share
on the participant's entry date into the offering period or, if lower, 85% of
the fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of April and October each
year. In no event, however, may any participant purchase more than 2,500 shares
on any purchase date, and not more than 500,000 shares may be purchased in total
by all participants on any purchase date. Our compensation committee may
increase or decrease these limits prior to the start of any new offering period
under the plan.
RESET FEATURE. If the fair market value per share of our common stock on
any purchase date is less than the fair market value per share on the start date
of the two-year offering period, then
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that offering period will automatically terminate, and a new two-year offering
period will begin on the next business day. All participants in the terminated
offering will be transferred to the new offering period.
CHANGE IN CONTROL. Should we be acquired by merger or sale of substantially
all of our assets or more than fifty percent of our voting securities, then all
outstanding purchase rights will automatically be exercised immediately prior to
the effective date of the acquisition. The purchase price will be equal to 85%
of the market value per share on the participant's entry date into the offering
period in which an acquisition occurs or, if lower, 85% of the fair market value
per share immediately prior to the acquisition.
PLAN PROVISIONS. The following provisions are also in effect under the
plan:
- The plan will terminate no later than the last business day of October
2009.
- The board may at any time amend, suspend or discontinue the plan.
However, certain amendments may require stockholder approval.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
The certificate of incorporation that we will adopt immediately prior to the
closing of this offering provides that, except to the extent prohibited by the
Delaware General Corporation Law, our directors will not be personally liable to
us or our stockholders for monetary damages for any breach of fiduciary duty as
directors. Under the Delaware General Corporation Law, the directors have a
fiduciary duty to NetZero which is not eliminated by this provision of the
certificate of incorporation and, in appropriate circumstances, equitable
remedies such as injunctive or other forms of nonmonetary relief will remain
available. In addition, each director will continue to be subject to liability
under the Delaware law for breach of the director's duty of loyalty, for acts or
omissions which are found by a court of competent jurisdiction to be not in good
faith or which involve intentional misconduct, or knowing violations of law, for
actions leading to improper personal benefit to the director, and for payment of
dividends or approval of stock repurchases or redemptions that are prohibited by
Delaware law. This provision also does not affect the director's
responsibilities under any other laws, such as the federal securities laws or
state or federal environmental laws. We have obtained liability insurance for
our officers and directors.
Section 145 of the Delaware law empowers a corporation to indemnify its
directors and officers and to purchase insurance with respect to liability
arising out of their capacity or status as directors and officers, provided that
this provision shall not eliminate or limit the liability of a director:
- for any breach of the director's duty of loyalty to the corporation or
its stockholders;
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- arising under Section 174 of the Delaware law; or
- for any transaction from which the director derived an improper
personal benefit.
The indemnification permitted under Delaware law is not exclusive of any
other rights to which the directors and officers may be entitled under the
corporation's bylaws, any agreement, a vote of stockholders or otherwise. Our
certificate of incorporation will provide that we shall, to the fullest extent
permitted by the Delaware law, indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding (whether civil, criminal, administrative or investigative) by
reason of the fact that such person is or was a director or officer, or is or
was serving at our request as a director or officer of another corporation,
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partnership, joint venture, trust, employee benefit plan or other enterprise,
against expenses including attorneys' fees, judgements, fines and amounts paid
in settlement actually and reasonably incurred by such person in connection with
such action, suit or proceeding.
We have entered into indemnification agreements with our directors and some
of our officers. These agreements contain provisions that may require us, among
other things, to indemnify these directors and officers against certain
liabilities that may arise because of their status or service as directors or
officers, except for liabilities arising from willful misconduct of a culpable
nature, advance their expenses incurred as a result of any proceeding against
them as to which they could be indemnified, and obtain directors' and officers'
liability insurance if it is maintained for other directors or officers.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent as to which indemnification will be
required or permitted. We are not aware of any threatened litigation or
proceeding which may result in a claim for such indemnification.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our common stock as of August 31, 1999 by:
- each stockholder whom we know to beneficially own 5% or more of the
outstanding shares of common stock;
- each of our directors and named executive officers; and
- all of our directors and executive officers as a group.
The information set forth in the table below gives effect to the conversion of
all issued and outstanding preferred stock. Unless otherwise indicated, the
address of each beneficial owner listed below is c/o NetZero, Inc., 2555
Townsgate Road, Westlake Village, California.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Except as indicated by the footnotes below, we
believe, based on information furnished to us, that the persons and entities
named in the table below have sole voting and investment power with respect to
all shares of common stock shown as beneficially owned by them. Percentage of
beneficial ownership is based on 92,905,217 shares of common stock outstanding
as of August 31, 1999, and 102,905,217 shares of common stock outstanding after
the completion of this offering. In computing the number of shares of common
stock subject to options held by that person that are exercisable within 60 days
of August 31, 1999, these shares are deemed outstanding for the purpose of
determining the percentage ownership of the optionee. These shares, however, are
not deemed outstanding for the purpose of computing the percentage ownership of
any other stockholder.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
------------------------------
NUMBER OF SHARES AFTER
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE OFFERING OFFERING
- ------------------------------------------------------------ ------------------- --------------- -------------
<S> <C> <C> <C>
Named Executive Officers and Directors:
Mark R. Goldston(1)....................................... 6,040,731 6.5% 5.9%
Ronald T. Burr............................................ 3,707,500 4.0 3.6
Bill Gross(2)............................................. 28,917,104 31.1 28.1
James T. Armstrong(3)..................................... 23,949,278 25.6 23.3
Jennifer S. Fonstad(4).................................... 15,050,677 16.2 14.6
Paul G. Koontz(5)......................................... 10,899,406 11.7 10.6
David C. Bohnett.......................................... 326,260 * *
OTHER 5% STOCKHOLDERS:
Entities affiliated with Bill Gross(6)...................... 28,917,104 31.1 28.1
130 West Union Street
Pasadena, CA 91103
Entities affiliated with Draper Fisher Jurvetson Management
Company V, LLC(7)(11)..................................... 15,050,677 16.2 14.6
400 Seaport Court, Suite 350
Redwood City, CA 94063
Entities affiliated with Foundation Capital Management II,
LLC(8)(11)................................................ 10,899,406 11.7 10.6
70 Willow Road, Suite 200
Menlo Park, CA 94025
</TABLE>
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<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
------------------------------
NUMBER OF SHARES AFTER
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE OFFERING OFFERING
- ------------------------------------------------------------ ------------------- --------------- -------------
<S> <C> <C> <C>
CPQ Holdings, Inc.(9)(11)................................... 8,125,000 8.7 7.9
20555 State Highway 249
Houston, TX 77070
All directors and executive officers as a group (11
people)(10)............................................... 72,055,813 77.4 70.1
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
common stock.
(1) Includes (i) 5,926,383 shares held by the Mark and Nancy Jane Goldston
Family Trust dated November 8, 1997, over which Mr. Goldston exercises
voting power, as trustee, and (ii) 60,000 shares held by the Kogan Family
Irrevocable Trust, over which Mr. Goldston exercises voting power, as
trustee.
(2) Includes 28,917,104 shares held by affiliates of idealab! Capital Management
I, LLC and idealab! Holdings, L.L.C. Mr. Gross is a managing member of both
idealab! Capital Management I, LLC and idealab! Holdings, L.L.C., and as
such may be deemed to exercise voting and investment power over such shares.
Mr. Gross disclaims beneficial ownership of such shares, except to the
extent of his proportionate interest therein.
(3) Includes 23,949,278 shares held by idealab! Capital Partners I-A, L.P. and
idealab! Capital Partners I-B, L.P. Mr. Armstrong is a principal of each of
these entities and disclaims beneficial ownership of such shares, except to
the extent of his proportionate interest therein.
(4) Includes 15,050,677 shares held by entities affiliated with Draper Fisher
Jurvetson, as set forth in note (7) below. Ms. Fonstad is a partner of
Draper Fisher Jurvetson and disclaims beneficial ownership of such shares,
except to the extent of her proportionate interest therein.
(5) Includes 10,899,406 shares held by entities affiliated with Foundation
Capital Management II, LLC, as set forth in note (8) below. Mr. Koontz
disclaims beneficial ownership of such shares, except to the extent of his
proportionate interest therein.
(6) Includes (i) 10,215,281 shares owned by idealab! Capital Partners I-A, L.P.,
(ii) 13,733,997 shares owned by idealab! Capital Partners I-B, L.P., and
(iii) 4,967,826 shares owned by idealab! Holdings, L.L.C. idealab! Capital
Management I, LLC is the general partner of both idealab! Capital Partners
I-A, L.P. and idealab! Capital Partners I-B, L.P. In addition, Bill Gross is
a managing member of both idealab! Capital Management I, LLC and idealab!
Holdings, L.L.C. and is therefore deemed to exercise voting and investment
power over such shares.
(7) Includes 13,921,876 shares owned by Draper Fisher Jurvetson Fund V, L.P. and
1,128,801 shares owned by Draper Fisher Jurvetson Partners V, LLC. Draper
Fisher Jurvetson Management Company V, LLC is the general partner of Draper
Fisher Jurvetson Fund V, L.P. and the manager of Draper Fisher Jurvetson
Partners V, LLC and is therefore deemed to exercise voting and investment
power over such shares.
(8) Includes 9,264,496 shares owned by Foundation Capital II, L.P., 1,089,940
shares owned by Foundation Capital II Entrepreneurs Fund, LLC, and 544,970
shares owned by Foundation Capital II Principals Fund, LLC. Foundation
Capital Management II, LLC is the general partner of Foundation Capital II,
L.P. and the manager of both Foundation Capital II Entrepreneurs Fund, LLC
and Foundation Capital II Principals Fund, LLC and is thus deemed to
exercise voting and investment power over such shares.
(9) Includes 8,125,000 shares owned by CPQ Holdings, Inc., an affiliate of
Compaq Computer Corporation.
(10) Includes 807,693 shares subject to options, all of which are immediately
exercisable. Also includes 11,693,050 shares subject to our right of
repurchase. Of such shares, 426,696 shall be released from such right of
repurchase within 60 days of August 31, 1999.
(11) The Company believes that the voting and dispositive powers over these
shares are exercised by committee.
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CERTAIN TRANSACTIONS
The following table summarizes the shares of common stock and preferred
stock purchased by executive officers, directors and 5% stockholders of NetZero
and persons associated with them since July 1997. All share numbers reflect (a)
the number of shares of common stock purchased by the respective party on an
as-converted basis and (b) the 3-2 stock split that occurred in July 1999.
<TABLE>
<CAPTION>
PREFERRED STOCK
EXECUTIVE OFFICERS, DIRECTORS AND 5% COMMON ------------------------------------------------------
STOCKHOLDERS STOCK SERIES A SERIES B SERIES C SERIES D
- -------------------------------------- --------------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Entities affiliated with Bill
Gross(1)............................ -- 11,956,121 7,172,593 4,630,783 5,157,607
Entities affiliated with Draper,
Fisher, Jurvetson Management Company
V, LLC(2)........................... -- -- -- 12,798,634 2,252,043
Entities affiliated with Foundation
Capital Management II, LLC(3)....... -- -- -- 9,261,557 1,637,849
CPQ Holdings, Inc.(4)................. -- -- -- -- 8,125,000
David C. Bohnett...................... -- -- 101,260 225,000
Mark R. Goldston...................... 6,286,383 -- -- -- 54,348
Ronald T. Burr........................ 3,975,000 -- -- -- --
Stacy A. Haitsuka..................... 3,975,000 -- -- -- --
Charles S. Hilliard................... 1,200,000 -- -- -- 225,000
Frederic A. Randall, Jr............... 1,050,000 -- -- 11,635 --
</TABLE>
- ------------------------
(1) Bill Gross is (a) a managing member of idealab! Capital Management I, LLC,
which is the general partner of both idealab! Capital Partners I-A, L.P. and
idealab! Capital Partners I-B, L.P., and (b) the managing member of idealab!
Holdings, L.L.C., and therefore is deemed to exercise voting and investment
power over all of the shares held by idealab! Holdings, L.L.C., idealab!
Capital Partners I-A, L.P., and idealab! Capital Partners I-B, L.P.
(2) Draper Fisher Jurvetson Management Company V, LLC is (a) the general partner
of Draper Fisher Jurvetson Fund V, L.P. and (b) the manager of Draper Fisher
Jurvetson Partners V, LLC, and therefore is deemed to exercise voting and
investment power of all of the shares held by Draper Fisher Jurvetson Fund
V, L.P. and Draper Fisher Jurvetson Partners V, LLC.
(3) Foundation Capital Management II, LLC is (a) the general partner of
Foundation Capital II, L.P. and (b) the manager of both Foundation Capital
II Entrepreneurs Fund, LLC and Foundation Capital II Principals Fund, LLC,
and therefore is deemed to exercise voting and investment power over all of
the shares held by Foundation Capital II, L.P., Foundation Capital II
Entrepreneurs Fund, LLC, and Foundation Capital II Principals Fund, LLC.
(4) CPQ Holdings, Inc. is an affiliate of Compaq Computer Corporation.
ISSUANCE OF FOUNDERS STOCK
In July 1997, we sold a total of 15,000,000 shares of our common stock to
Ronald Burr, Stacy Haitsuka, Marwan Zebian and Harold MacKenzie. The shares were
issued at a price per share of $0.00013. As a condition to the September 1998
issuance of Series A preferred stock described below, each of the foregoing
individuals entered into a stock restriction agreement with NetZero, pursuant to
which each such individual agreed to subject half of his shares of common stock
to vesting over a four-year period. The stock restriction agreements provide for
accelerated vesting in the event of termination in connection with or following
a change in control.
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ISSUANCE OF SERIES A AND SERIES B PREFERRED STOCK
In September, October and November 1998, and March and June 1999, we sold a
total of 11,956,121 shares of Series A preferred stock at $0.0889 per share to
Bill Gross' idealab!, idealab! Holdings, L.L.C., idealab! Capital Partners I-A,
L.P., and idealab! Capital Partners I-B, L.P. In December 1998, and January,
March and June 1999, we sold a total of 7,172,593 shares of Series B preferred
stock at $0.1481 per share to Bill Gross' idealab!, idealab! Holdings, L.L.C.,
idealab! Capital Partners I-A, L.P., and idealab! Capital Partners I-B, L.P.
In January 1999, David C. Bohnett, a director of NetZero, purchased 101,260
shares of our Series B preferred stock for a purchase price of $15,000.
ISSUANCE OF WARRANTS FOR SERIES C PREFERRED STOCK
In January 1999, we issued warrants to purchase a total of 23,271 shares of
Series C preferred stock to idealab! Capital Partners I-A, L.P. and idealab!
Capital Partners I-B, L.P. in connection with a $100,000 bridge loan from such
entities. The warrants were exercised immediately after the closing of our
Series C preferred stock financing in February 1999.
ISSUANCE OF SERIES C PREFERRED STOCK
In February 1999, we sold a total of 26,851,533 shares of Series C preferred
stock at $0.4297 per share to several investors pursuant to a stock purchase
agreement, including:
- idealab! Capital Partners I-A, L.P. and idealab! Capital Partners I-B,
L.P. who purchased a total of 4,607,512 shares of Series C preferred
stock for a total purchase price of $1,980,002;
- two affiliates of Draper Fisher Jurvetson who purchased a total of
12,798,634 shares of Series C preferred stock for a total purchase
price of $5,500,000;
- several affiliates of Foundation Capital who purchased a total of
9,261,557 shares of Series C preferred stock for a total purchase price
of $3,980,000; and
- Frederic A. Randall, Jr., who purchased 11,635 shares of Series C
preferred stock for a purchase price of $5,000.
EXERCISE OF OPTION TO PURCHASE SERIES C PREFERRED STOCK
In March 1999, David C. Bohnett purchased 225,000 shares of our Series C
preferred stock for a purchase price of $96,690, in connection with the exercise
of the option to purchase such shares which was granted to Mr. Bohnett in
December 1998 in connection with his joining our board of directors. The option
shares are subject to NetZero's right of repurchase at the price paid per share.
The repurchase right lapses in a series of 48 equal monthly installments which
began December 1, 1998.
ISSUANCE OF SERIES D PREFERRED STOCK
In May 1999, we sold a total of 18,082,283 shares of Series D preferred
stock at $1.84 per share to several investors, including:
- idealab! Capital Partners I-A, L.P., idealab! Capital Partners, I-B,
L.P. and idealab! Holdings, L.L.C., who purchased a total of 5,157,607
shares of Series D preferred stock for a total purchase price of
$9,489,998;
- two affiliates of Draper Fisher Jurvetson who purchased a total of
2,252,043 shares of Series D preferred stock at a total purchase price
of $4,143,759;
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- several affiliates of Foundation Capital Management II, LLC, who
purchased a total of 1,637,849 shares of Series D preferred stock for a
total purchase price of $3,013,644;
- CPQ Holdings, Inc., which purchased 8,125,000 shares of Series D
preferred stock for a purchase price of $14,950,001;
- Mark R. Goldston, who purchased 54,348 shares of Series D preferred
stock for a purchase price of $100,000; and
- Charles S. Hilliard, who purchased 225,000 shares of Series D preferred
stock for a purchase price of $414,000.
EXERCISE OF OPTIONS TO PURCHASE COMMON STOCK
In March 1999, Mark R. Goldston purchased 6,286,383 shares of our common
stock for a purchase price of $628,638 in connection with the exercise of an
option granted to Mr. Goldston in connection with his employment. The purchase
price for the common stock was paid with a note payable to NetZero for the
entire amount.
In April 1999, Frederic A. Randall, Jr. purchased 1,050,000 shares of our
common stock for a purchase price of $105,000 in connection with the exercise of
an option granted to him in connection with his employment.
In April 1999, Charles S. Hilliard purchased 1,200,000 shares of our common
stock for a purchase price of $400,000, in connection with the exercise of an
option granted to Mr. Hilliard in connection with his employment. The purchase
price for the common stock was paid with a note payable to NetZero for the
entire amount.
TECHNOLOGY ASSIGNMENT AGREEMENT WITH IMPACT SOFTWARE, INC.
During the nine months ended March 31, 1999, we paid an aggregate of
$100,000 to Impact Software, Inc. pursuant to a Technology Assignment Agreement
approximately $81,000 of which was allocated to purchase our zCast technology
and approximately $19,000 of which was used to repay existing indebtedness owed
to Impact Software. Messrs. Burr, Haitsuka, MacKenzie and Zebian are directors,
officers and/or employees of NetZero and were shareholders and officers of
Impact Software at the time this agreement was executed.
INVESTORS' RIGHTS AGREEMENT
In May 1999, we entered into an Amended and Restated Investors' Rights
Agreement with some of our stockholders, which provides those stockholders
certain rights to require us to register their shares of NetZero common stock.
DISTRIBUTION AGREEMENT WITH COMPAQ
In April 1999, we entered into a Distribution, License and Alliance
Agreement with Compaq Computer Corporation, pursuant to which Compaq will
distribute our NetZero software with its Presario products over a 12 month
period. Immediately after the offering, Compaq, through its affiliate CPQ
Holdings, Inc., will own approximately 7.9% of our outstanding capital stock.
See "Business--Sales and Marketing--User Acquisition" on page 42 for more
information regarding this agreement.
We believe that all of the transactions set forth above were made on terms
no less favorable to us than could have been otherwise obtained from
unaffiliated third parties.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
We are authorized to issue 500,000,000 shares of common stock, par value
$0.001, and 10,000,000 shares of undesignated preferred stock, par value $0.001.
The following description of our securities and certain provisions of our
certificate of incorporation and bylaws are summaries. Statements contained in
this prospectus relating to these provisions are not necessarily complete.
Copies of our certificate of incorporation and bylaws have been filed with the
Commission as exhibits to our registration statement, of which this prospectus
forms a part. The descriptions of common stock and preferred stock reflect
changes to our capital structure that will occur upon the closing of this
offering in accordance with the terms of the certificate that will be adopted by
us immediately prior to the closing of this offering.
COMMON STOCK
As of August 31, 1999, there were 92,905,217 shares of common stock
outstanding and held of record by 173 stockholders, assuming conversion of all
shares of preferred stock into common stock. Based on the number of shares
outstanding as of that date and giving effect to the issuance of the 10,000,000
shares of common stock offered by us hereby, there will be 102,905,217 shares of
common stock outstanding, assuming no exercise of the underwriters'
over-allotment option, upon the closing of the offering.
Holders of the common stock are entitled to one vote for each share held on
all matters submitted to a vote of the stockholders. Cumulative voting for the
election of directors is not provided for in 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. Holders of common stock are entitled
to receive ratably any dividends that may be declared by the board of directors
out of legally available funds, subject to any preferential dividend rights of
any outstanding preferred stock. Upon our liquidation, dissolution or winding
up, the holders of common stock are entitled to receive ratably our net assets
available after the payment of all debts and other liabilities and subject to
the prior rights of any outstanding preferred stock. Holders of common stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of common stock are, and the shares offered by us in this
offering will be upon receipt of payment for such shares, fully paid and
nonassessable. The rights, preferences and privileges of holders of common stock
are subject to, and may be adversely affected by, the rights of holders of
shares of any series of preferred stock which we may designate and issue in the
future without further stockholder approval. Upon the closing of the offering,
there will be no shares of preferred stock outstanding.
PREFERRED STOCK
Upon the closing of this offering, all outstanding shares of our Series A,
Series B, Series C and Series D preferred stock will convert into shares of
common stock. Thereafter, the board of directors will be authorized without
further stockholder approval to issue from time to time up to an aggregate of
10,000,000 shares of preferred stock in one or more series and to fix or alter
the designations, preferences, rights, qualifications, limitations or
restrictions of the shares of each series, including the dividend rights,
dividend rates, conversion rights, voting rights, term of redemption including
sinking fund provisions, redemption price or prices, liquidation preferences and
the number of shares constituting any series or designations of such series
without further vote or action by the stockholders. The issuance of preferred
stock may have the effect of delaying, deferring or preventing a change in
control of our management without further action by the stockholders and may
adversely affect the voting and other rights of the holders of common stock. The
issuance of preferred stock with voting and conversion rights may adversely
affect the voting
69
<PAGE>
power of the holders of common stock, including the loss of voting control to
others. We have no present plans to issue any shares of preferred stock.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF DELAWARE LAW AND OUR CERTIFICATE OF
INCORPORATION AND BYLAWS
Certain provisions of our certificate of incorporation and bylaws, which
will become effective upon the closing of this offering, may make it more
difficult to acquire control of NetZero by various means. These provisions could
deprive the stockholders of opportunities to realize a premium on the shares of
common stock owned by them. In addition, these provisions may adversely affect
the prevailing market price of the stock. These provisions are intended to:
- enhance the likelihood of continuity and stability in the composition
of the board and in the policies formulated by the board;
- discourage certain types of transactions which may involve an actual or
threatened change in control of NetZero;
- discourage certain tactics that may be used in proxy fights;
- encourage persons seeking to acquire control of NetZero to consult
first with the board of directors to negotiate the terms of any
proposed business combination or offer; and
- reduce our vulnerability to an unsolicited proposal for a takeover that
does not contemplate the acquisition of all outstanding shares of
NetZero or that is otherwise unfair to our stockholders.
CLASSIFIED BOARD OF DIRECTORS; REMOVAL; FILLING VACANCIES AND
AMENDMENT. The certificate and bylaws provide that upon the closing of this
offering the board shall be divided into three classes of directors serving
staggered, three-year terms. The classification of the board has the effect of
requiring at least two annual stockholder meetings, instead of one, to replace a
majority of members of the board. Subject to the rights of the holders of any
outstanding series of preferred stock, the certificate authorizes only the board
to fill vacancies, including newly created directorships. Accordingly, this
provision could prevent a stockholder from obtaining majority representation on
the board by enlarging the board of directors and filling the new directorships
with its own nominees. The certificate also provides that directors may be
removed by stockholders only for cause and only by the affirmative vote of
holders of two-thirds of the outstanding shares of voting stock.
STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS. The certificate
provides that stockholders may not take action by written consent, but may only
take action at duly called annual or special meetings of stockholders. The
certificate further provides that special meetings of our stockholders may be
called only by the chairman of the board of directors or a majority of the board
of directors. This limitation on the right of stockholders to call a special
meeting could make it more difficult for stockholders to initiate actions that
are opposed by the board of directors. These actions could include the removal
of an incumbent director or the election of a stockholder nominee as a director.
They could also include the implementation of a rule requiring stockholder
ratification of specific defensive strategies that have been adopted by the
board of directors with respect to unsolicited takeover bids. In addition, the
limited ability of the stockholders to call a special meeting of stockholders
may make it more difficult to change the existing board and management.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATIONS. The bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for election
as directors at an annual meeting of
70
<PAGE>
stockholders, must provide timely notice thereof in writing. To be timely, a
stockholder's notice must be delivered to or mailed and received at our
principal executive offices not less than 120 days prior to the date of our
annual meeting. The bylaws also specify certain requirements as to the form and
content of a stockholder's notice. These provisions may preclude stockholders
from bringing matters before an annual meeting of stockholders or from making
nominations for directors at an annual meeting of stockholders.
AUTHORIZED BUT UNISSUED SHARES. The authorized but unissued shares of
common stock and preferred stock are available for future issuance without
stockholder approval. These additional shares may be utilized for a variety of
corporate purposes, including future public offerings to raise additional
capital, corporate acquisitions and employee benefit plans. The existence of
authorized but unissued shares of common stock and preferred stock could render
more difficult or discourage an attempt to obtain control of us by means of a
proxy contest, tender offer, merger or otherwise.
SUPERMAJORITY VOTE TO AMEND CHARTER AND BYLAWS. The Delaware General
Corporation Law provides generally that the affirmative vote of a majority of
the shares entitled to vote on any matter is required to amend a corporation's
certificate of incorporation or bylaws, unless a corporation's certificate of
incorporation or bylaws, as the case may be, requires a greater percentage. Our
amended and restated certificate of incorporation imposes supermajority vote
requirements in connection with business combination transactions and the
amendment of certain provisions of our certificate of incorporation and bylaws,
including those provisions relating to the classified board of directors, action
by written consent, the ability of stockholders to call special meetings and the
ability of stockholders to bring business before an annual meeting or to
nominate directors. Following the completion of this offering, our present
directors and executive officers and their respective affiliates will
beneficially own approximately 70.1% of our common stock. This gives them veto
power with respect to any stockholder action or approval requiring either a
two-thirds vote or a simple majority.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW. We are subject to the
provisions of Section 203 of the Delaware General Corporation Law, as amended
from time to time. Section 203 generally prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years from the date of the transaction in
which the person became an interested stockholder, unless the interested
stockholder attained such status with the approval of the board of directors or
unless the business combination is approved in a prescribed manner. A "business
combination" includes mergers, asset sales and other transactions resulting in a
financial benefit to the interested stockholder. Generally, an "interested
stockholder" is a person who, together with his or its affiliates and
associates, owns, or within three years did own, 15% or more of the
corporation's voting stock. This statute could prohibit or delay the
accomplishment of mergers or other takeover or change in control attempts with
respect to us and, accordingly, may discourage attempts to acquire us.
REGISTRATION RIGHTS
Under the Amended and Restated Investor Rights Agreement dated as of May 10,
1999, among NetZero and certain holders of its securities, the holders of
approximately 85,698,444 shares of common stock, or Registrable Securities,
after this offering will be entitled to certain rights with respect to the
registration of the Registrable Securities under the Securities Act. Under the
Investors Rights Agreement, if NetZero proposes to register any of its
securities under the Securities Act, either for its own account or the account
of other stockholders, the holders of Registrable Securities are entitled to
notice of such registration and are entitled to include their Registrable
Securities in
71
<PAGE>
the registration. Of the approximately 85,698,444 shares of Registrable
Securities, approximately 21,286,383 shares are only entitled to these "piggy
back" registration rights.
In addition, if at any time after August 15, 2000, NetZero receives a
request from certain holders of at least 20% of the Registrable Securities,
NetZero is obligated to cause these shares to be registered under the Securities
Act, provided that the offering size would exceed $5,000,000. Certain holders of
Registrable Securities have the right to cause two demand registrations.
Further, holders of Registrable Securities may require NetZero to register all
or a portion of their Registrable Securities on Form S-2 or Form S-3 under the
Securities Act, provided that the offering size would exceed $1,000,000, when
these forms become available for use by NetZero, and subject to other conditions
and limitations. The holders' rights with respect to all these registrations are
subject to additional conditions, including the right of the underwriters of any
of these offerings to limit the number of shares included in any of these
registrations. NetZero has agreed to pay all expenses related to certain of
these registrations, except for underwriting discounts and commissions, to
effect the registration and sale of the Registrable Securities. Upon
registration, such shares are freely tradeable in the public market without
restriction.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for our common stock will be U.S. Stock
Transfer Corporation.
LISTING
Our common stock has been approved for listing on The Nasdaq National Market
under the trading symbol "NZRO".
72
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the offering, we will have 102,905,217 shares of common
stock outstanding, or 104,405,217 shares if the underwriters' over-allotment
option is exercised in full, in each case, assuming no exercise of options after
August 31, 1999. Of this amount, the 10,000,000 shares offered by this
prospectus will be available for immediate sale in the public market as of the
date of this prospectus. Approximately 60,113,579 additional shares will be
available for sale in the public market following the expiration of 180-day
lock-up agreements with the representatives of our underwriters, subject in some
cases to compliance with the volume and other limitations of Rule 144. If the
underwriters waive the 180-day lock-up agreements within the first 90 days after
the date of this prospectus, an additional 28,604,394 shares will be available
for sale in the public market 90 days following the date of this prospectus,
subject in some cases to compliance with the volume and other limitations of
Rule 144.
<TABLE>
<CAPTION>
APPROXIMATE SHARES
DAYS AFTER THE DATE OF THIS ELIGIBLE FOR FUTURE
PROSPECTUS SALE COMMENT
- ---------------------------------- -------------------- ----------------------------------
<S> <C> <C>
Upon Effectiveness................ 10,000,000 Freely tradeable shares sold in
offering and shares saleable under
Rule 144(k) that are not subject
to 180-day lock-up
90 days........................... 0 Shares saleable under Rule 144,
144(k) or 701 that are not subject
to 180-day lock-up
180 days.......................... 60,113,579 Lock-up released; shares saleable
under Rule 144, 144(k) or 701
</TABLE>
In general, under Rule 144 as currently in effect, a person who has
beneficially owned shares, including shares attributed to such person, for at
least one year is entitled to sell within any three-month period commencing 90
days after the date of this prospectus a number of shares that does not exceed
the greater of
- 1% of the then outstanding shares of common stock, which will be equal
to approximately 1,029,052 shares immediately after the offering; or
- the average weekly trading volume during the four calendar weeks
preceding such sale, subject to the filing of a Form 144 with respect
to such sale.
A person, or persons whose shares are aggregated, who is not deemed to have
been an affiliate of NetZero at any time during the 90 days immediately
preceding the sale and who has beneficially owned his or her shares for at least
two years is entitled to sell such shares pursuant to Rule 144(k) without regard
to the limitations described above. Persons deemed to be affiliates must always
sell pursuant to Rule 144, even after the applicable holding periods have been
satisfied.
We are unable to estimate the number of shares that will be sold under Rule
144, since this will depend on the market price for our common stock, the
personal circumstances of the sellers and other factors. Prior to the offering,
there has been no public market for the common stock, and there can be no
assurance that a significant public market for the common stock will develop or
be sustained after the offering. Any future sale of substantial amounts of the
common stock in the open market may adversely affect the market price of the
common stock offered hereby.
73
<PAGE>
Our directors, executive officers, stockholders with registration rights and
certain other stockholders and optionholders have agreed pursuant to the
underwriting agreement and other agreements that they will not sell any common
stock without the prior written consent of Goldman, Sachs & Co. for a period of
180 days from the date of this prospectus. We have also agreed not to issue any
shares during the 180-day lock-up period without the consent of Goldman, Sachs &
Co., except that we may, without such consent, grant options and sell shares
under our stock incentive and purchase plans.
Any of our employees or consultants who purchased his or her shares pursuant
to a written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701, which permits nonaffiliates to sell their Rule 701
shares without having to comply with the public information, holding period,
volume limitation or notice provisions of Rule 144 and permits affiliates to
sell their Rule 701 shares without having to comply with the Rule 144 holding
period restrictions, in each case commencing 90 days after the date of this
prospectus.
We intend to file a registration statement on Form S-8 under the Securities
Act within days after the completion of the offering to register the
shares of common stock subject to outstanding stock options reserved for
issuance under our 1999 Stock Incentive Plan, thus permitting the resale of such
shares by nonaffiliates in the public market without restriction under the
Securities Act. As of August 31, 1999, there were outstanding options to
purchase approximately 4,110,793 shares of common stock under our stock plans.
In addition, some of our stockholders have registration rights with respect
to approximately 85,698,444 shares of common stock and common stock equivalents.
Registration of these registrable securities under the Securities Act would
result in those shares becoming freely tradeable without restriction under the
Securities Act.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Brobeck, Phleger & Harrison LLP, Irvine, California. As of August 31, 1999,
Brobeck, Phleger & Harrison LLP and certain entities and individuals affiliated
with Brobeck, Phleger & Harrison LLP beneficially owned a total of 46,540 shares
of our Series C preferred stock and 40,761 shares of our Series D preferred
stock, all of which will convert to common stock immediately prior to the
closing of this offering. Certain legal matters relating to the sale of common
stock in this offering will be passed upon for the underwriters by Wilson,
Sonsini, Goodrich & Rosati, Professional Corporation, Palo Alto, California.
EXPERTS
The financial statements of NetZero, Inc. as of June 30, 1998 and 1999 and
for the period from July 21, 1997 (inception) through June 30, 1998 and the year
ended June 30, 1999 included in this prospectus and Registration Statement have
been audited by PricewaterhouseCoopers LLP, independent accountants, as set
forth in their report appearing elsewhere in this prospectus, and are included
in reliance upon their report given on the authority of said firm as experts in
accounting and auditing.
74
<PAGE>
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, including exhibits and schedules, under the Securities
Act with respect to the shares to be sold in the offering. This prospectus does
not contain all the information set forth in the registration statement. For
further information with respect to us and the shares to be sold in the
offering, reference is made to the registration statement and the exhibits and
schedules attached to the registration statement. Statements contained in this
prospectus as to the contents of any contract, agreement or other document
referred to are materially complete. In addition, we intend to file annual,
quarterly and current reports, proxy statements and other information with the
Commission.
You may read and copy all or any portion of the registration statement or
any reports, statements or other information that we file at the Commission's
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can
request copies of these documents, upon payment of a duplicating fee, by writing
to the Commission. Please call the Commission at 1-800-SEC-0330 for further
information on the operation of the Public Reference Room. Our Commission
filings, including the registration statement, are also available to you on the
Commission's Web-site (http://www.sec.gov).
75
<PAGE>
NETZERO, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Accountants.................................................... F-2
Balance Sheets....................................................................... F-3
Statements of Operations............................................................. F-4
Statements of Stockholders' Equity (Deficit)......................................... F-5
Statements of Cash Flows............................................................. F-6
Notes to Financial Statements........................................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
NetZero, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, stockholders' equity (deficit) and cash flows present fairly, in
all material respects, the financial position of NetZero, Inc. (the "Company")
as of June 30, 1998 and 1999 and the results of its operations and its cash
flows for the period from July 21, 1997 (Inception) through June 30, 1998 and
for the year ended June 30, 1999 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Woodland Hills, California
July 28, 1999, except for Note 13 as
to which the date is September 22, 1999
F-2
<PAGE>
NETZERO, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1998 1999
----------- -------------- PRO FORMA
STOCKHOLDERS'
EQUITY
JUNE 30,
1999
--------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 1,000 $ 24,035,000
Accounts receivable, net of allowance for doubtful accounts of
$160,000 at June 30, 1999....................................... -- 2,253,000
Other current assets.............................................. -- 689,000
----------- --------------
Total current assets.......................................... 1,000 26,977,000
Property and equipment, net......................................... -- 18,116,000
Restricted cash..................................................... -- 1,789,000
Deposits............................................................ -- 619,000
----------- --------------
Total assets.................................................. $ 1,000 $ 47,501,000
----------- --------------
----------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.................................................. $ 4,000 $ 4,879,000
Due to related party.............................................. 19,000 --
Accrued liabilities............................................... 1,000 1,521,000
Deferred revenue.................................................. -- 2,739,000
Current portion of notes payable.................................. -- 560,000
Current portion of capital leases................................. -- 1,181,000
----------- --------------
Total current liabilities..................................... 24,000 10,880,000
Notes payable less current portion.................................. -- 1,210,000
Capital leases less current portion................................. -- 2,317,000
Commitments and contingencies (Note 12).............................
Redeemable convertible preferred stock, no-par value; 19,231,000
shares authorized; 19,230,000 issued and outstanding at June 30,
1999; liquidation preference and redemption value of $2,140,000... -- 2,140,000
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value; 55,769,000 shares
authorized; 45,182,000 shares issued and outstanding at June 30,
1999; liquidation preference of $44,917,000;
Pro forma--10,000,000 shares authorized; no shares issued and
outstanding..................................................... -- 44,720,000 --
Common stock, $0.001 par value; 30,000,000 and 150,000,000 shares
authorized at June 30, 1998 and June 30, 1999, respectively;
15,000,000 and 28,624,000 shares issued and outstanding at June
30, 1998 and June 30, 1999, respectively; Pro forma--500,000,000
authorized; 93,036,000 shares issued and outstanding............ 2,000 1,352,000 93,000
Additional paid-in capital........................................ -- 9,019,000 57,138,000
Notes receivable from stockholders................................ -- (1,029,000) (1,029,000)
Deferred stock compensation....................................... -- (7,783,000) (7,783,000)
Accumulated deficit............................................... (25,000) (15,325,000) (15,325,000)
----------- -------------- --------------
Total stockholders' equity (deficit).......................... (23,000) 30,954,000 $ 33,094,000
----------- -------------- --------------
--------------
Total liabilities and stockholders' equity.................... $ 1,000 $ 47,501,000
----------- --------------
----------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
NETZERO, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
JULY 21, 1997
(INCEPTION) THROUGH YEAR ENDED
JUNE 30, 1998 JUNE 30, 1999
------------------- ---------------
<S> <C> <C>
Net revenues............................................................... $ -- $ 4,634,000
Cost of revenues (Including $411,000 of depreciation expense).............. -- 12,426,000
------------------- ---------------
Gross loss................................................................. -- (7,792,000)
------------------- ---------------
Operating expenses:
Sales and marketing...................................................... -- 876,000
Product development...................................................... -- 982,000
General and administrative............................................... 19,000 4,307,000
Stock-based compensation................................................. -- 1,236,000
Depreciation and amortization............................................ -- 222,000
------------------- ---------------
Total operating expenses................................................... 19,000 7,623,000
------------------- ---------------
Loss from operations....................................................... (19,000) (15,415,000)
------------------- ---------------
Interest income............................................................ -- 225,000
Interest expense........................................................... -- (110,000)
Other expense.............................................................. (6,000) --
------------------- ---------------
Net loss................................................................... $ (25,000) $ (15,300,000)
------------------- ---------------
------------------- ---------------
Basic and diluted net loss per share....................................... $ -- $ (1.42)
------------------- ---------------
------------------- ---------------
Shares used to calculate basic and diluted net loss per share.............. 15,000,000 10,792,000
------------------- ---------------
------------------- ---------------
Unaudited pro forma basic and diluted net loss per share................... $ (0.44)
---------------
---------------
Unaudited shares used to calculate pro forma basic and diluted net loss per
share.................................................................... 34,800,000
---------------
---------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
NETZERO, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE NOTE
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE DEFERRED
------------------------- ------------------------ PAID-IN FROM STOCK
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION
----------- ------------ ----------- ----------- ----------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at July 21,
1997 (Inception)... -- $ -- -- $ -- $ -- $ -- $ --
Issuance of common
stock............ -- -- 15,000,000 2,000 -- -- --
Net loss........... -- -- -- -- -- -- --
----------- ------------ ----------- ----------- ----------- ------------- --------------
Balance at June 30,
1998............... -- -- 15,000,000 2,000 -- -- --
Issuance of common
stock............ -- -- 23,000 2,000 -- -- --
Issuance of Series
C convertible
preferred stock,
net.............. 27,077,000 11,512,000 -- -- -- -- --
Exercise of
warrants for
Series C
convertible
preferred
stock............ 23,000 10,000 -- -- -- -- --
Exercise of stock
options.......... -- -- 6,115,000 319,000 -- -- --
Exercise of options
for a note
receivable....... -- -- 7,486,000 1,029,000 -- (1,029,000) --
Deferred stock
compensation..... -- -- -- -- 8,952,000 -- (8,952,000)
Amortization of
deferred stock-
based
compensation..... -- -- -- -- -- -- 1,169,000
Charge for issuance
of Series A and B
options.......... -- -- -- -- 67,000 -- --
Issuance of Series
D convertible
preferred
stock............ 18,082,000 33,198,000 -- -- -- -- --
Net loss........... -- -- -- -- -- -- --
----------- ------------ ----------- ----------- ----------- ------------- --------------
Balance at June 30,
1999............... 45,182,000 44,720,000 28,624,000 1,352,000 9,019,000 (1,029,000) (7,783,000)
Assumed conversion
of convertible
preferred
stock............ (45,182,000) (44,720,000) 45,182,000 44,720,000 -- -- --
Assumed conversion
of redeemable
convertible
preferred
stock............ -- -- 19,230,000 2,140,000 -- -- --
Reincorporation into
Delaware and change
in par value of
common stock....... -- -- -- (48,119,000) 48,119,000 -- --
----------- ------------ ----------- ----------- ----------- ------------- --------------
Balance at June 30,
1999, pro forma
(unaudited)........ -- $ -- 93,036,000 $ 93,000 $57,138,000 $(1,029,000) $ (7,783,000)
----------- ------------ ----------- ----------- ----------- ------------- --------------
----------- ------------ ----------- ----------- ----------- ------------- --------------
<CAPTION>
TOTAL
STOCKHOLDERS'
ACCUMULATED EQUITY
DEFICIT (DEFICIT)
------------- --------------
<S> <C> <C>
Balance at July 21,
1997 (Inception)... $ -- $ --
Issuance of common
stock............ -- 2,000
Net loss........... (25,000) (25,000)
------------- --------------
Balance at June 30,
1998............... (25,000) (23,000)
Issuance of common
stock............ -- 2,000
Issuance of Series
C convertible
preferred stock,
net.............. -- 11,512,000
Exercise of
warrants for
Series C
convertible
preferred
stock............ -- 10,000
Exercise of stock
options.......... -- 319,000
Exercise of options
for a note
receivable....... -- --
Deferred stock
compensation..... -- --
Amortization of
deferred stock-
based
compensation..... -- 1,169,000
Charge for issuance
of Series A and B
options.......... -- 67,000
Issuance of Series
D convertible
preferred
stock............ -- 33,198,000
Net loss........... (15,300,000) (15,300,000)
------------- --------------
Balance at June 30,
1999............... (15,325,000) 30,954,000
Assumed conversion
of convertible
preferred
stock............ -- --
Assumed conversion
of redeemable
convertible
preferred
stock............ -- 2,140,000
Reincorporation into
Delaware and change
in par value of
common stock....... -- --
------------- --------------
Balance at June 30,
1999, pro forma
(unaudited)........ $(15,325,000) $ 33,094,000
------------- --------------
------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
NETZERO, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
JULY 21, 1997 YEAR
(INCEPTION) THROUGH ENDED
JUNE 30, 1998 JUNE 30, 1999
------------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................ $ (25,000) $(15,300,000)
Adjustments to reconcile net loss to net cash provided by (used for)
operating activities:
Depreciation and amortization......................................... -- 633,000
Provision for doubtful accounts....................................... -- 160,000
Stock-based compensation.............................................. -- 1,236,000
Loss on disposal of fixed assets...................................... -- 98,000
Changes in operating assets and liabilities:
Accounts receivable................................................. -- (2,413,000)
Deposits............................................................ -- (619,000)
Other current assets................................................ -- (689,000)
Restricted cash..................................................... -- (1,789,000)
Accounts payable.................................................... 4,000 5,085,000
Accrued liabilities................................................. 1,000 1,520,000
Due to related party................................................ 19,000 (19,000)
Deferred revenue.................................................... -- 2,739,000
---------- --------------
Net cash used for operating activities............................ (1,000) (9,358,000)
---------- --------------
Cash flows from investing activities:
Purchases of property and equipment..................................... -- (13,609,000)
Proceeds from the sale of fixed assets.................................. -- 226,000
---------- --------------
Net cash used for investing activities............................ -- (13,383,000)
---------- --------------
Cash flows from financing activities:
Payments on capital leases.............................................. -- (241,000)
Proceeds from bridge loan............................................... -- 100,000
Payments on note payable................................................ -- (165,000)
Proceeds from exercise of stock options................................. -- 319,000
Net proceeds from issuance of common stock.............................. 2,000 2,000
Net proceeds from issuance of redeemable convertible preferred stock.... -- 2,140,000
Net proceeds from issuance of convertible preferred stock............... -- 44,620,000
---------- --------------
Net cash provided by financing activities......................... 2,000 46,775,000
---------- --------------
Change in cash and cash equivalents............................... 1,000 24,034,000
Cash and cash equivalents, beginning of period............................ -- 1,000
---------- --------------
Cash and cash equivalents, end of period.................................. $ 1,000 $ 24,035,000
---------- --------------
---------- --------------
Supplemental disclosure of cash flow activities:
Cash paid during the year for interest.................................... $ -- $ 110,000
---------- --------------
---------- --------------
Notes receivable from stockholders in connection with the exercise of
stock options........................................................... $ -- $ 1,029,000
---------- --------------
---------- --------------
Bridge loan repayment in exchange for issuance of convertible preferred
stock................................................................... $ -- $ 100,000
---------- --------------
---------- --------------
Equipment financed with note payable...................................... $ -- $ 1,725,000
---------- --------------
---------- --------------
Accounts payable financed with note payable............................... $ -- $ 210,000
---------- --------------
---------- --------------
Equipment obtained under capital leases................................... $ -- $ 3,739,000
---------- --------------
---------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS:
NetZero, Inc. ("NetZero" or the "Company") was incorporated in July 1997 and
launched its service in October 1998. NetZero provides consumers with free
access to the Internet while offering online advertisers a highly effective way
to reach those consumers. The Company offers its users free and unlimited
Internet access as well as free e-mail and navigational tools to enhance the
users' online experience. For advertisers, the Company offers an online direct
marketing tool with features and functionality that have distinct advantages
over traditional forms of online advertising.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent liabilities and the reported amounts of revenues and
expenses. Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist of deposits in money market funds.
CONCENTRATION OF RISK
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents and accounts
receivable. Cash and cash equivalents are deposited with major financial
institutions; at times, such balances with any one financial institution may be
in excess of FDIC insurance limits. The Company's accounts receivable are
derived primarily from revenue earned from customers located in the United
States. The Company extends credit based upon an evaluation of the customer's
financial condition and generally collateral is not required. The Company
maintains an allowance for doubtful accounts based upon the expected
collectibility of accounts receivable; to date such losses, if any, have been
within management's expectations.
At June 30, 1999, two customers comprised 43% and 13% of the accounts
receivable balance, respectively. For the year ended June 30, 1999, two
customers comprised 27% and 26% of revenues, respectively.
SOURCES OF SUPPLIES
The Company relies on third-party networks, local telephone companies and
other companies to provide data communications capacity. Although management
believes that alternate telecommunications facilities could be found in a timely
manner, any disruption of these services could have an adverse effect on the
Company's financial position and results of operations.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable, and lease obligations are carried at
historical cost, which
F-7
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
approximates their fair value because of the short-term maturity of these
instruments and the relatively stable interest rate environment.
PROPERTY AND EQUIPMENT
Property and equipment are stated at historical cost. Depreciation and
amortization is computed using the straight-line method over the estimated
useful lives of the assets, generally three to five years, or the shorter of the
lease term or the estimated useful lives of the assets, if applicable.
RESTRICTED CASH
Under the terms its facility lease agreement, the Company maintains a letter
of credit as collateral for this lease with a financial institution as a
security deposit.
DEPOSITS
The Company is required to maintain refundable security deposits with its
telecommunications service providers.
LONG-LIVED ASSETS
The Company identifies and records impairment losses on long-lived assets
when events and circumstances indicate that such assets might be impaired. In
the event the expected undiscounted future cash flows attributable to the asset
is less than the carrying amount of the asset, an impairment loss equal to the
excess of the asset's carrying value over its fair value is recorded. To date,
no such impairment has been recorded.
REVENUE RECOGNITION
The Company's revenues are derived principally from the sale of advertising,
which includes arrangements for the delivery of impressions or click-throughs,
sponsorships, and referrals of users to other web-sites. The foregoing may
include additional performance-based revenues based on arrangements with
individual sponsors or advertisers. To date, most of the Company's revenues have
been generated from banner advertisements and referrals of users to other
web-sites. Banner advertising and sponsorship revenues are recognized in the
periods in which the advertisement or sponsorship placement is displayed, based
upon the lesser of impressions delivered over the total number of guaranteed
impressions or ratably over the period in which the advertisement is displayed,
provided that no significant Company obligations remain and collection of the
related receivable is probable. The Company's obligations typically include the
guarantee of a minimum number of impressions or the satisfaction of other
performance criteria. The guaranteed minimum number of impressions are generally
required to be delivered over the term of the commitment which has generally
averaged one to two months. Revenues from performance-based arrangements,
including click-throughs, are recognized as the related performance criteria are
met. Referral revenues are recognized as referrals are made to other web-sites,
provided that no significant Company obligations remain and collection of the
related receivable is probable.
F-8
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
COST OF REVENUES
Cost of revenues consist of telecommunications costs, depreciation of
network equipment, occupancy costs and personnel and related expenses of the
Company's network infrastructure. These costs are expensed as incurred.
SALES AND MARKETING
Sales and marketing expenses include salaries, sales commissions, employee
benefits, travel and related expenses for the Company's direct sales force, fees
paid to third-party advertising sales agents, marketing, and sales support
functions. These costs are expensed as incurred.
Advertising costs included in sales and marketing expenses totalled $0 and
$102,000 for the period from July 21, 1997 (Inception) through June 30, 1998 and
for the year ended June 30, 1999, respectively.
PRODUCT DEVELOPMENT COSTS
Product development costs incurred by the Company to develop, enhance,
manage, monitor and operate the Company's Web-sites and related technologies are
expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses include salaries, employee benefits and
expenses for our executive, finance, legal and human resources personnel. In
addition, general and administrative expenses include fees for professional
services and occupancy costs. These costs are expensed as incurred.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation." Under APB 25, compensation
expense is recognized over the vesting period based on the difference, if any,
on the date of grant between the deemed fair value of the Company's stock for
accounting purposes and the exercise price. The Company accounts for stock
issued to non-employees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force 96-18.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes.
Under this method, deferred tax liabilities and assets are determined based on
the difference between the financial statement and the tax bases of assets and
liabilities using enacted tax rates in effect for the period in which the
differences are expected to reverse. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.
F-9
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
NET LOSS PER SHARE
Basic and diluted net loss per share is computed by dividing the net loss
for the period by the weighted average number of common shares outstanding
during the period. Shares associated with stock options, warrants and
convertible preferred stock are not included to the extent they are
antidilutive.
UNAUDITED PRO FORMA NET LOSS PER SHARE
Unaudited pro forma net loss per share is computed by dividing the net loss
for the period by the weighted average number of common shares outstanding,
including the pro forma effects of the automatic conversion of the Company's
convertible preferred stock into shares of the Company's common stock effective
upon the closing of the Company's initial public offering as if such conversion
occurred on July 1, 1998 or at the date of original issuance, if later. The
resulting pro forma adjustment includes an increase in weighted average shares
used to compute basic and diluted net loss per share of 24,008,000 for the year
ended June 30, 1999.
COMPREHENSIVE INCOME
Effective July 1, 1998, the Company adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from non-owner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income.
SEGMENTS
Effective July 1, 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The Company has determined that it does not have any separately
reportable business segments as of June 30, 1998 and June 30, 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Software for Internal
Use," which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. The Company expects that the adoption of
SOP 98-1 will not have a material impact on its financial position, results of
operations or cash flows. The Company will be required to implement SOP No. 98-1
in the first quarter of fiscal 2000.
In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of
Start-Up Activities." SOP No. 98-5 requires that all start-up costs related to
new operations must be expensed as incurred. In addition, start-up costs that
were capitalized in the past must be written off when SOP No. 98-5 is adopted.
The Company expects that the adoption of SOP No. 98-5 will not have a
F-10
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
material impact on its financial position, results of operations or cash flows.
The Company will be required to implement SOP No. 98-1 in the first quarter of
fiscal 2000.
In June 1998, The Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities." The statement
requires the recognition of all derivatives as either assets or liabilities in
the balance sheet and the measurement of those instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the planned
use of the derivative and the resulting designation. Because the Company does
not currently hold any derivative instruments and does not engage in hedging
activities, the impact of the adoption of SFAS No. 133 is not currently expected
to have a material impact on financial position, results of operations or cash
flows. The Company will be required to implement SFAS No. 133 in the first
quarter of fiscal 2001.
STOCK SPLIT
In July 1999, the Company authorized and implemented a three-for-two forward
stock split. The share information in the accompanying financial statements has
been retroactively restated to reflect the effect of the stock split.
3. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following:
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1999
-------------- --------------
<S> <C> <C>
Computer software and equipment.............................. $ -- $ 14,068,000
Furniture and fixtures....................................... -- 929,000
Assets under capital leases.................................. -- 3,739,000
-------------- --------------
Total........................................................ -- 18,736,000
Less: accumulated depreciation, including accumulated capital
lease amortization of $0 and $246,000 at June 30, 1998 and
1999, respectively......................................... -- (620,000)
-------------- --------------
$ -- $ 18,116,000
-------------- --------------
-------------- --------------
</TABLE>
Depreciation expense for the period from July 21, 1997 (Inception) through
June 30, 1998 and for the year ended June 30, 1999 was $0 and $633,000,
respectively.
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1999
-------------- --------------
<S> <C> <C>
Accrued payroll............................................... $ -- $ 619,000
Accrued expenses.............................................. 1,000 642,000
Accrued offering expenses..................................... -- 260,000
-------------- --------------
$ 1,000 $ 1,521,000
-------------- --------------
-------------- --------------
</TABLE>
F-11
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT
Long-term debt consisted of the following at June 30, 1999:
<TABLE>
<CAPTION>
Notes Payable to vendor, quarterly payments of $198,000,
including interest at 15.29% through March 2002,
uncollateralized.............................................. $1,770,000
<S> <C>
Less current portion........................................... 560,000
----------
$1,210,000
----------
----------
</TABLE>
Future minimum principal payments required are as follows:
<TABLE>
<CAPTION>
Year Ended June 30:
<S> <C>
2000........................................................... $ 560,000
2001........................................................... 652,000
2002........................................................... 558,000
----------
$1,770,000
----------
----------
</TABLE>
6. RELATED-PARTY TRANSACTIONS:
In September 1998, the Company purchased certain software technology for
$80,000 in cash from a related party.
At June 30, 1999, the Company held notes receivable from two employees for
$1,029,000 for the exercise of stock options. The notes bear interest at 4.83%
and 5.28% per annum, respectively and are due on March 20, 2004 and April 16,
2004, respectively, unless paid earlier. The notes, which are classified as a
component of stockholders' equity, are full recourse to the Company and are
collateralized by the shares of common stock issued upon exercise, as well as
Series D Convertible Preferred Stock of the Company for one of the employees.
7. STOCK OPTIONS AND STOCK ISSUANCE PLANS:
The Company's 1998 and 1999 Stock Option and Stock Issuance Plans (the
"Plans") provide for the issuance of stock and stock options at prices not less
than 85% (110% if the award is issued to a 10% stockholder) of the fair market
value at the date of issue. An aggregate of 19,500,000 shares were reserved
under the Plans, of which 2,379,000 shares were available for future grant at
June 30, 1999 and 3,497,000 options were outstanding at June 30, 1999.
The Plans provide for the grant of nonstatutory and incentive stock options
to employees, officers, directors and consultants of the Company. Options
granted generally vest 25% after one year of service, and ratably over 36 months
thereafter and are immediately exercisable for unvested shares of common stock,
with the unvested portion of the shares remaining subject to repurchase by the
Company at the exercise price until the vesting period is complete. The Company
had 10,907,000 unvested shares of common stock issued and outstanding under the
Plans at June 30, 1999 (Note 8), which were subject to repurchase by the Company
at the exercise price.
The Stock Issuance Equity Program provides for the issuance of common stock
directly to participants and may vest immediately or in one or more installments
over the service period but at not less than 20% per year. Unvested shares of
common stock remain subject to repurchase by the
F-12
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. STOCK OPTIONS AND STOCK ISSUANCE PLANS: (CONTINUED)
Company at the original issuance price. There were 23,000 shares issued under
the Stock Issuance program as of June 30, 1999.
The following table summarizes activity under the Stock Option Plans for the
period from July 21, 1997 (Inception) through June 30, 1998 and for the year
ended June 30, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER PRICE EXERCISE
OF SHARES PER SHARE PRICE
-------------- ------------ -----------
<S> <C> <C> <C>
OPTIONS OUTSTANDING AT JULY 21, 1997 (INCEPTION)........................ -- $ -- $ --
Granted............................................................... 4,285,000 .03 .03
--------------
OPTIONS OUTSTANDING AT JUNE 30, 1998.................................... 4,285,000 .03 .03
Granted............................................................... 13,865,000 .03-3.33 .26
Exercised............................................................. (13,601,000) .03-.87 .10
Canceled.............................................................. (1,052,000) .03-.10 .04
--------------
OPTIONS OUTSTANDING AT JUNE 30, 1999.................................... 3,497,000 $ .03-3.33 $ .69
--------------
--------------
</TABLE>
Options granted during the year ended June 30, 1999 resulted in a total
deferred compensation amount of $8,619,000 which was included in deferred stock
compensation in stockholders' equity. Deferred compensation expense is computed
over the service period by using the aggregate percentage of compensation
accrued by the end of each year of service (the vesting period). During the year
ended June 30, 1999, such compensation expense included in stock-based
compensation in the statement of operations amounted to $996,000. Annual
amortization of deferred stock compensation for options granted as of June 30,
1999 is approximately $3.9 million, $2.1 million, $1.2 million and $500,000 for
the years ending June 30, 2000, 2001, 2002 and 2003, respectively.
Additional information with respect to the outstanding options as of March
31, 1999 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISED
------------------------------------ SUBJECT TO
AVERAGE OPTIONS EXERCISABLE REPURCHASE
REMAINING --------------------- ------------------------
CONTRACTUAL AVERAGE AVERAGE AVERAGE
NUMBER OF LIFE (IN EXERCISE NUMBER OF EXERCISE NUMBER OF REPURCHASE
PRICES SHARES YEARS) PRICE SHARES PRICE SHARES PRICE
- ------ --------- ----------- -------- --------- -------- --------- -----------
$.03 758,000 9.08 $ .03 758,000 $ .03 2,270,000 $ .03
<S> <C> <C> <C> <C> <C> <C> <C>
.10 674,000 9.70 .10 674,000 .10 7,377,000 .10
.33 -- -- .33 -- .33 1,200,000 .33
.87 1,860,000 9.87 .87 1,860,000 .87 60,000 .87
3.33 205,000 9.95 3.33 205,000 3.33 -- 3.33
--------- --------- ---------
3,497,000 3,497,000 10,907,000
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-13
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. STOCK OPTIONS AND STOCK ISSUANCE PLANS: (CONTINUED)
The Company calculated the minimum fair value of each option grant on the
date of the grant using the minimum value option pricing model as prescribed by
SFAS No. 123 using the following assumptions:
<TABLE>
<CAPTION>
JULY 21, 1997
(INCEPTION)
THROUGH YEAR ENDED
JUNE 30, 1998 JUNE 30, 1999
----------------- ---------------------
<S> <C> <C>
Risk-free interest rates............................................................. 6% 5%
Expected lives (in years)............................................................ 4 4
Dividend yield....................................................................... 0% 0%
Expected volatility.................................................................. 0% 0%
</TABLE>
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
--------------- ---------------
<S> <C> <C>
Year Ended June 30, 1999:
Net loss....................................................................... $ (15,300,000) $ (15,331,000)
Basic and diluted net loss per share........................................... (1.42) (1.42)
Period from July 21, 1997 (Inception) through June 30, 1998:
Net loss....................................................................... $ (25,000) $ (25,000)
Basic and diluted net loss per share........................................... -- --
</TABLE>
The weighted average grant-date fair value of options granted was $0 and
$.07 per share for the period from July 21, 1997 (inception) through June 30,
1998 and for the year ended June 30, 1999, respectively.
In September 1998, the Company issued options to a non employee investor to
purchase 704,000 and 422,000 shares of Series A and Series B redeemable
convertible preferred stock, respectively, at exercise prices equal to the
respective Series A and Series B issuance prices. The Company incurred a charge
of $67,000 relating to these options which is included in stock-based charges in
the accompanying statement of operations. The options were exercised and the
preferred shares issued in March 1999.
In December 1998, the Company issued, to a non-employee director, 225,000
options to purchase Series C convertible preferred stock at $.4297 per share.
These options, which have a 48-month vesting period from the date of grant, were
exercised in March 1999. The unvested portion remains subject to repurchase by
the Company at the original issue price.
F-14
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. CAPITALIZATION:
PREFERRED STOCK
Convertible and redeemable convertible preferred stock ("preferred stock")
at June 30, 1999 consist of the following:
<TABLE>
<CAPTION>
SHARES
---------------------------- LIQUIDATION REDEMPTION
AUTHORIZED OUTSTANDING AMOUNT AMOUNT
------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Series A redeemable convertible..................... 11,956,000 11,956,000 $ 1,063,000 $ 1,063,000
Series B redeemable convertible..................... 7,275,000 7,274,000 1,077,000 1,077,000
Series C convertible................................ 27,681,000 27,100,000 11,646,000 --
Series D convertible................................ 19,500,000 18,082,000 33,271,000 --
Undesignated........................................ 8,588,000 -- -- --
------------- ------------- -------------- -------------
75,000,000 64,412,000 $ 47,057,000 $ 2,140,000
------------- ------------- -------------- -------------
------------- ------------- -------------- -------------
</TABLE>
VOTING. Each share of preferred stock has a number of votes equal to the
number of shares of common stock then issuable upon its conversion. The
preferred stock generally votes together with the common stock and not as a
separate class.
DIVIDENDS. The holders of each series of preferred stock are entitled to
receive noncumulative dividends when, as and if declared by the Board of
Directors at a rate of 8% of the respective issuance price per share per annum.
No dividends have been declared or paid from inception.
LIQUIDATION. In the event of any liquidation or winding up of the Company,
the holders of each series of preferred stock will be entitled to receive, in
preference to the holders of common stock, any distribution of assets of the
Company equal to the sum of the respective issuance price of such shares plus
any accrued and unpaid dividends.
After the full liquidation preference on all outstanding shares of preferred
stock has been paid, any remaining funds and assets of the Company will be
distributed pro rata among the holders of the Series A, Series B and Series C
preferred stock and common stock, assuming conversion of each such series of the
preferred shares until the holders of the Series A, Series B and Series C shares
have received an aggregate of five times the then-existing conversion price
which would result in maximum per share distribution amounts of $0.44, $0.74 and
$2.15, respectively. The conversion price is considered the original issuance
price adjusted for certain dilutive issuances, stock splits and combinations, if
any.
REDEMPTION. If a liquidation or initial public offering has not occurred by
September 9, 2003, the holders of Series A and B redeemable convertible
preferred stock are entitled to a redemption out of the assets of the Company
equal to the issue price per share and any declared but unpaid dividends at the
date of redemption.
CONVERSION. Each share of preferred stock is convertible at the holder's
option at any time into common stock, according to a ratio which is one-for-one,
subject to adjustment for dilution. Each share of preferred stock automatically
converts into common stock at the then applicable conversion rate upon (i) the
closing of an underwritten public offering pursuant to which the post-closing
enterprise value is at least $50,000,000 and the Company receives proceeds of
not less
F-15
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. CAPITALIZATION: (CONTINUED)
than $10,000,000, or (ii) the consent of the holders of a majority of the then
outstanding shares of preferred stock. As of June 30, 1999, the Company was
required to keep available, out of its authorized but unissued shares of common
stock, 64,412,000 shares for conversion of preferred stock.
COMMON STOCK
As a condition to the issuance of Series A redeemable convertible preferred
stock in September 1998, the employee founding stockholders of all of the then
15 million outstanding common shares entered into stock restriction agreements
with the Company pursuant to which 7.5 million of the outstanding common shares
were restricted and were made subject to monthly vesting over a four-year period
based on the founders' continued employment with the Company. Under the terms of
the restricted stock agreements, the Company has the right to repurchase the
unvested shares at the original issue price in the event a founder ceases to be
an employee or service provider to the Company. The repurchase right shall
automatically lapse with respect to the unvested shares in the event the founder
is constructively or involuntarily terminated without cause following a
corporate transaction, defined as a (i) merger or consolidation with more than a
50% change of control or (ii) sale, transfer or disposition of substantially all
the Company's assets in a dissolution. The Company recorded deferred stock
compensation amounting to $333,000 for the shares covered under the restricted
stock agreements. The deferred amount will be recognized as compensation expense
over the vesting period. During the year ended June 30, 1999, such compensation
expense included in stock-based compensation in the statement of operations
amounted to $173,000.
At June 30, 1999, 17,001,000 shares of common stock were subject to
repurchase, of which 6,094,000 shares related to unvested shares under the
restricted stock agreements and 10,907,000 shares related to unvested stock
options exercised.
WARRANTS
Under the terms of a loan outstanding during the third quarter of 1999, the
Company issued fully vested and exercisable warrants to purchase 23,000 shares
of its Series C convertible preferred stock at an exercise price of $.4297 per
share. The Company determined the fair value of the warrants to be immaterial at
the date of issuance.
F-16
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. NET LOSS PER SHARE:
The following table sets forth the computation of basic, diluted and pro
forma net loss per share for the periods indicated:
<TABLE>
<CAPTION>
JULY 21, 1997
(INCEPTION)
THROUGH YEAR ENDED
JUNE 30, 1998 JUNE 30, 1999
-------------- ---------------
<S> <C> <C>
HISTORICAL PRESENTATION
Numerator:
Net loss....................................................................... $ (25,000) $ (15,300,000)
-------------- ---------------
Denominator:
Weighted average common shares................................................. 15,000,000 19,401,000
Adjustment for common shares subject to repurchase............................. -- (8,609,000)
-------------- ---------------
Adjusted weighted average common shares........................................ 15,000,000 10,792,000
-------------- ---------------
-------------- ---------------
Basic and diluted net loss per share............................................. $ -- $ (1.42)
-------------- ---------------
</TABLE>
<TABLE>
<S> <C>
PRO FORMA PRESENTATION
Denominator:
Shares used above............................................................ 10,792,000
Weighted average effect of convertible securities:
Series A redeemable convertible preferred stock............................ 7,825,000
Series B redeemable convertible preferred stock............................ 3,515,000
Series C convertible preferred stock....................................... 10,818,000
Series D convertible preferred stock....................................... 1,850,000
----------
Denominator for pro forma calculation (unaudited).............................. 34,800,000
----------
----------
Unaudited pro forma basic and diluted net loss per share....................... $ (.44)
----------
----------
</TABLE>
The diluted per share computations exclude convertible preferred stock,
unvested common stock and options which were antidilutive. The number of shares
excluded from the diluted net loss per share computation were 4,285,000 and
84,910,000 for the period from July 21, 1997 (Inception) through June 30, 1998
and for the year ended June 30, 1999, respectively. The number of such shares
excluded from the pro forma diluted net loss per share computation was
20,498,000 for the year ended June 30, 1999.
10. EMPLOYEE BENEFIT PLAN:
The Company has a 401(k) Profit Sharing Plan (the "Plan") available to all
employees who meet the Plan's eligibility requirements. Under the Plan,
participating employees may defer a percentage (not to exceed 15%) of their
eligible pretax earnings up to the Internal Revenue Service's annual
contribution limit. Company matching and profit sharing contributions are
discretionary. To date, the Company has not made any contributions to the Plan
as of June 30, 1999.
F-17
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES:
As a result of net operating losses, the Company has not recorded a
provision for income taxes. The components of the deferred tax assets and
related valuation allowance at June 30, 1998 is as follows:
<TABLE>
<CAPTION>
JUNE 30, 1998 JUNE 30, 1999
-------------- --------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............................ $ 10,000 $ 5,868,000
Other....................................................... -- 125,000
-------------- --------------
Total deferred tax assets................................... 10,000 5,993,000
Less: valuation allowance................................... (10,000) (5,993,000)
-------------- --------------
Net deferred taxes............................................ $ -- $ --
-------------- --------------
-------------- --------------
</TABLE>
Due to the uncertainty surrounding the realization of the benefits in future
tax returns, the Company has placed a valuation allowance against its deferred
tax assets.
At June 30, 1999, the Company had net operating losses for federal and state
income tax purposes of approximately $13,697,000 and $13,696,000, respectively,
which begin to expire in 2019 and 2006, respectively. The net operating losses
can be carried forward to offset future taxable income. Utilization of the above
carryforwards may be subject to utilization limitations, which may inhibit the
Company's ability to use carryforwards in the future.
12. COMMITMENTS AND CONTINGENCIES:
CAPITAL LEASES
During the year ended June 30, 1999, the Company entered into certain
noncancelable lease obligations for computer equipment. The future minimum lease
payments are discounted using interest rates of 13-29% over the two- to
five-year lease terms.
Future minimum lease payments under noncancelable capital leases for the
following fiscal years at June 30, 1999 are:
<TABLE>
<S> <C>
2000........................................................... $ 1,678,000
2001........................................................... 1,628,000
2002........................................................... 895,000
2003........................................................... 100,000
2004........................................................... 20,000
-----------
Total minimum obligations...................................... 4,321,000
Less amounts representing interest............................. (823,000)
-----------
Present value of minimum obligations........................... 3,498,000
Less current portion........................................... (1,181,000)
-----------
Total.......................................................... $ 2,317,000
-----------
-----------
</TABLE>
F-18
<PAGE>
NETZERO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
OPERATING LEASE
The Company leases its facilities under a noncancelable operating lease
expiring in 2009. The lease contains a provision that payments may be adjusted
for increases in the lessor's direct costs as well as a five-year renewal
option. The Company must maintain a letter of credit with a financial
institution as a security deposit in accordance with the facility lease
agreement. The letter of credit, which remains in effect until March 2000, is
collateralized by a certificate of deposit account which is classified as
restricted cash at June 30, 1999.
Future minimum lease payments under the facility lease for the following
fiscal years at June 30, 1999 are:
<TABLE>
<CAPTION>
<S> <C>
2000.......................................................................... $ 1,444,000
2001.......................................................................... 1,539,000
2002.......................................................................... 1,402,000
2003.......................................................................... 1,247,000
2004.......................................................................... 1,349,000
Thereafter.................................................................... 6,754,000
--------------
Total......................................................................... $ 13,735,000
--------------
--------------
</TABLE>
Total rental expense for operating leases was $0 and $153,000 for the period
from July 21, 1997 (Inception) through June 30, 1998 and for the year ended June
30, 1999, respectively.
13. SUBSEQUENT EVENTS:
INITIAL PUBLIC OFFERING AND UNAUDITED PRO FORMA STOCKHOLDERS' EQUITY:
In July 1999, the Board of Directors authorized the filing of a registration
statement with the Securities and Exchange Commission ("SEC") that would permit
the Company to sell shares of the Company's common stock in connection with a
proposed initial public offering ("IPO"). If the IPO is consummated under the
terms presently anticipated, upon the closing of the proposed IPO, all of the
then outstanding shares of the Company's convertible preferred stock and
redeemable convertible preferred stock will automatically convert into shares of
common stock on a one-for-one basis, subject to antidilution provisions.
In July 1999, the Board of Directors approved the reincorporation of the
Company in the State of Delaware, the change in the par value of the Company's
common stock and the increase in the number of authorized shares which will be
effected prior to the closing of the IPO. The reincorporation was effected on
September 22, 1999.
The conversion of the Series A and B redeemable convertible preferred stock
and the Series C and D convertible preferred stock, and the planned
reincorporation of the Company in Delaware have been reflected in the
accompanying unaudited pro forma balance sheet and statement of stockholders'
equity as if these events had occurred on June 30, 1999.
F-19
<PAGE>
UNDERWRITING
NetZero, Inc. and the underwriters named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
certain conditions, each underwriter has severally agreed to purchase the number
of shares indicated in the following table. Goldman, Sachs & Co., Donaldson,
Lufkin & Jenrette Securities Corporation, Hambrecht & Quist LLC and Wit Capital
Corporation are the representatives of the underwriters.
<TABLE>
<CAPTION>
Underwriters Number of Shares
- -------------------------------------------------------- ------------------
<S> <C>
Goldman, Sachs & Co..................................... 3,936,000
Donaldson, Lufkin & Jenrette Securities Corporation..... 2,187,000
Hambrecht & Quist LLC................................... 2,187,000
Wit Capital Corporation................................. 438,000
Robert W. Baird & Co. Incorporated...................... 65,000
Banc of America Securities LLC.......................... 122,000
BancBoston Robertson Stephens Inc....................... 122,000
J.C. Bradford & Co. .................................... 65,000
Deutsche Bank Securities Inc............................ 122,000
A.G. Edwards & Sons, Inc. .............................. 122,000
First Union Capital Markets Corp........................ 65,000
Edward D. Jones & Co., L.P.............................. 122,000
Pryor & Company, LLC.................................... 65,000
Scott & Stringfellow, Inc. ............................. 65,000
Salomon Smith Barney Inc................................ 122,000
Stephens Inc............................................ 65,000
Stifel, Nicolaus & Company, Incorporated................ 65,000
Sutro & Co. Incorporated................................ 65,000
------------------
Total............................................. 10,000,000
------------------
------------------
</TABLE>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
1,500,000 shares from NetZero to cover such sales. They may exercise that option
for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same proportion
as set forth in the table above.
The following table shows the per share and total underwriting discounts and
commissions to be paid to the underwriters by NetZero. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase 1,500,000 additional shares.
<TABLE>
<CAPTION>
Paid by NetZero
---------------------------
No Exercise Full Exercise
------------ -------------
<S> <C> <C>
Per Share...................................... $ 1.12 $ 1.12
Total.......................................... $11,200,000 $12,880,000
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $0.66 per share from the initial public offering price. Any such
securities dealers may resell any shares purchased from the underwriters to
certain other brokers or dealers at a discount of up to $0.10 per share from the
initial public offering price. If all the shares are not sold at the initial
offering price, the representatives may change the offering price and the other
selling terms.
NetZero has agreed with the underwriters not to dispose of or hedge any of
its common stock or securities convertible into or exchangeable for shares of
common stock during the period from
U-1
<PAGE>
the date of this prospectus continuing through the date 180 days after the date
of this prospectus, except with the prior written consent of Goldman, Sachs &
Co. This agreement does not apply to any existing employee benefit plans. See
"Shares Eligible for Future Sale" for a discussion of certain transfer
restrictions.
At the request of NetZero, the underwriters have reserved for sale, at the
initial public offering price, up to approximately 6.4% of the common stock
offered hereby for sale to certain directors, employees and associates of
NetZero. There can be no assurance that any of the reserved shares will be
purchased. The number of shares available for sale to the general public in this
offering will be reduced by the number of reserved shares sold. Any reserved
shares not so purchased will be offered to the general public on the same basis
as the other shares offered hereby.
Prior to the offering, there has been no public market for the shares. The
initial public offering price was negotiated among NetZero and the
representatives. Among the factors considered in determining the initial public
offering price of the shares, in addition to prevailing market conditions, were
NetZero's historical performance, estimates of the business potential and
earnings prospects of NetZero, an assessment of NetZero's management and the
consideration of the above factors in relation to market valuation of companies
in related businesses.
The common stock has been approved for quotation on The Nasdaq National
Market under the symbol "NZRO".
A prospectus in electronic format is being made available on an Internet Web
site maintained by Wit Capital Corporation. In addition, pursuant to an e-Dealer
Agreement, all dealers purchasing shares from Wit Capital in the offering
similarly have agreed to make a prospectus in electronic format available on Web
sites maintained by each of the e-Dealers.
Wit Capital, a member of the National Association of Securities Dealers,
Inc., will participate in the offering as one of the underwriters. The National
Association of Securities Dealers, Inc. approved the membership of Wit Capital
on September 4, 1997. Since that time, Wit Capital has acted as an underwriter,
e-manager or selected dealer in over 100 public offerings.
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offerings are in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on The Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
NetZero estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1.3 million.
NetZero will pay all such expenses.
NetZero has agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act of 1933.
U-2
<PAGE>
THE INSIDE BACK COVER INCLUDES:
CENTERED IN THE PAGE IS A VIEW OF THE NETZERO HOME PAGE. AT THE TOP LEFT
HAND CORNER OF THE GRAPHIC IS THE TEXT: Consumers click this button to download
NetZero software
ACROSS THE BOTTOM OF THE PAGE IS THE TEXT: www.netzero.net
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
-----
<S> <C>
Prospectus Summary................... 3
Risk Factors......................... 5
Information Regarding Forward-Looking
Statements......................... 20
Use of Proceeds...................... 21
Dividend Policy...................... 21
Capitalization....................... 22
Dilution............................. 23
Selected Financial Data.............. 24
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 25
Business............................. 36
Management........................... 51
Principal Stockholders............... 64
Certain Transactions................. 66
Description of Capital Stock......... 69
Shares Eligible For Future Sale...... 73
Legal Matters........................ 74
Experts.............................. 74
Additional Information............... 75
Index to Financial Statements........ F-1
Underwriting......................... U-1
</TABLE>
------------------
Through and including October 18, 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to an unsold allotment or subscription.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
10,000,000 Shares
NETZERO, INC.
Common Stock
-------------
[LOGO]
-------------
GOLDMAN, SACHS & CO.
DONALDSON, LUFKIN & JENRETTE
HAMBRECHT & QUIST
WIT CAPITAL CORPORATION
Representatives of the Underwriters
