<PAGE> 1
Filed pursuant to Rule 424(b)(3)
File Number 333-92581
(COMSTAR.NET, INC. LOGO)
100 INVESTMENT UNITS
CONSISTING OF AN 8% SENIOR CONVERTIBLE NOTE
WITH A STOCK PURCHASE WARRANT
comstar.net, inc. is offering 100 investment units at a price of $50,000
per investment unit. Each investment unit consists of an 8% senior convertible
note in the principal amount of $50,000 which is convertible into 38,760 shares
of our common stock and a stock purchase warrant which entitles the holder to
acquire 13,566 shares of our common stock at an exercise price of $.01 per
share. This is a registered offering to a limited number of investors. No public
market for our investment units or shares currently exists or will exist as a
result of this offering.
We anticipate that we will raise a minimum of $4,000,000 and a maximum of
$5,000,000 in this offering. The minimum permitted purchase will be $500,000 per
entity and $50,000 per individual.
The placement agents must sell the minimum $4,000,000 of investment units
offered if any are sold. The placement agents are required to use their
reasonable efforts to sell the investment units offered. We will end the
offering on January 15, 2000. Branch Banking & Trust Company will act as escrow
agent for the offering and will accept, deposit and retain all subscriptions
until the minimum amount is sold.
At the closing of this offering, we will also issue a total of 780,075
shares of common stock to two of our founders and their affiliate in exchange
for their forgiveness of approximately $1,006,297 in outstanding indebtedness.
---------------------------
INVESTING IN THE INVESTMENT UNITS INVOLVES RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 7.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------------
<TABLE>
<CAPTION>
PLACEMENT PROCEEDS
OFFERING AGENTS' TO
PRICE COMMISSIONS COMSTAR.NET
--------------- ----------- -----------
<S> <C> <C> <C>
Per investment unit................................. $ 50,000 $ 3,000 $ 47,000
Total (80 investment units minimum)................. $4,000,000 $240,000 $3,760,000
Total (100 investment units maximum)................ $5,000,000 $300,000 $4,700,000
</TABLE>
---------------------------
SCOTT & STRINGFELLOW, INC. SUNTRUST EQUITABLE SECURITIES
The date of this prospectus is December 30, 1999.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary.......................... 1
Risk Factors..................... 7
Use of Proceeds.................. 25
Dividend Policy.................. 25
Capitalization................... 26
Selected Financial Data.......... 27
Management's Discussion and
Analysis of Financial Condition
and Results of Operations...... 29
Business......................... 45
Management....................... 67
Related Party Transactions....... 75
Principal Shareholders........... 76
Description of Capital Stock..... 78
Description of Notes............. 81
Description of Warrants.......... 84
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
U.S. Federal Income Tax
Considerations................. 85
Plan of Distribution............. 90
Legal Matters.................... 91
Experts.......................... 91
Where You Can Find More
Information.................... 91
Index to Financial Statements.... F-1
Appendix A -- Form of 8% Senior
Convertible Note............... A-1
Appendix B -- Form of Stock
Purchase Warrant............... B-1
Appendix C -- Form of
Shareholders Agreement......... C-1
Appendix D -- Subscription
Agreement...................... D-1
</TABLE>
---------------------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
In this prospectus, "comstar.net," "we," "us" and "our" refer to
comstar.net, inc. and its subsidiaries unless the context otherwise requires.
<PAGE> 3
SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary may not contain all the information that you should consider before
buying shares in this offering. We urge you to read the entire prospectus
carefully, including the information provided under "Risk Factors," before
deciding to invest in our investment units.
Unless otherwise stated, all information in this prospectus assumes that
(1) we will effect a two-for-one stock split immediately before the closing of
this offering; (2) we will issue a total of 1,276,658 shares of common stock to
purchasers in our private placement of shares concluded in June 1999, pro rata
and without any additional cash payment by those investors; and (3) we will
issue a total of 780,075 shares to two of our founders and their affiliate in
exchange for their forgiveness of approximately $1,006,297 in outstanding
indebtedness.
COMSTAR.NET, INC.
OUR BUSINESS
We are a rapidly growing Internet service provider, or ISP, that targets
middle market businesses, educational institutions and governmental
organizations. Our services provide high quality, cost-effective business
solutions that allow our customers to take advantage of the Internet while
outsourcing a significant portion of their Internet technology and staff.
Our primary services, which we tailor to meet each customer's needs,
include:
- dedicated Internet access through our highly reliable network, which
provides our customers with Internet access that is "always on,"
- co-location services, in which we provide secure space to house
customer-owned Internet equipment, and
- managed application hosting, in which we provide and maintain a server
for the customer's exclusive use to install any software application the
customer chooses.
We refer to our co-location services, our managed application hosting
services and some of the other services we offer through our Atlanta, Georgia
data center as data center services. Our managed application hosting services
are similar to the services offered by computer service providers, or CSPs,
which house, maintain and supply power to their customers' Internet equipment.
We can deliver our services to customers throughout the world from our data
center. We also have various other points of presence, or POPs, located in the
southeastern United States that aggregate our customers' Internet traffic and
transport the traffic to our data center. We connect the traffic to very large
ISPs, including UUNET, GTE Internetworking, Sprint and Intermedia Internet, who
provide access to central Internet exchanges. Through our network, most of our
customers' Internet traffic bypasses congested points on the Internet and avoids
breakdowns at the central Internet exchanges and network access points. We
believe our innovative network infrastructure and superior customer support by
our network experts give us a significant competitive advantage over many other
Internet access and Internet-based solutions providers.
Our senior management team has more than sixty years of combined experience
in designing, implementing and managing telecommunications networks.
<PAGE> 4
OUR INDUSTRY
The number of businesses, educational institutions and governmental
organizations using the Internet as a means of conducting business is growing
rapidly. According to International Data Corporation, corporate Internet access
and value-added services, such as Web hosting and co-location, are the fastest
growing services offered by ISPs. Corporate access revenue and value-added
services revenue were $5.9 billion in 1998 and are expected to grow to
approximately $25.0 billion by 2003.
Many of the enterprises using the Internet lack the expertise to
cost-effectively develop and maintain their Web sites while also managing their
core operations. In addition, these organizations often do not have the
resources needed to keep up with rapidly changing technologies and to support a
network infrastructure that must be both reliable and expandable. As a result,
we believe enterprises of all sizes are seeking collaborative outsourcing
arrangements to:
- acquire reliable Internet access,
- help them establish effective, secure and reliable Web sites,
- provide required monitoring and maintenance of their Internet-related
facilities, and
- control their Internet service costs.
Recent changes in the regulations affecting the telecommunications industry
in the United States and abroad have made it easier and more cost-effective for
new companies to compete with existing carriers in providing local voice and
data communication services. These communication services can often be offered
via the same communication lines over which companies currently offer Internet
access. This increase in competition, combined with customer demand to acquire
all communication services from a single source, is driving the convergence of
voice and data communication technologies toward providers capable of delivering
a broad range of communication services.
OUR BUSINESS STRATEGY
We intend to become a leader in providing businesses, educational
institutions and governmental organizations with high quality, cost-effective
Internet services. To accomplish this objective, we intend to continue to rely
on the following core elements of our business strategy:
- delivering highly reliable Internet access that enables our customers'
traffic to avoid congestion and breakdowns at major Internet exchanges,
- increasing the percentage of our revenues from data center services,
specifically co-location and managed application hosting services, which
typically provide higher margins than our Internet access services,
- targeting middle market business, educational and governmental customers,
rather than individual consumers, to take advantage of the outsourcing
needs of these enterprises, and
- providing superior customer support by our network experts.
2
<PAGE> 5
We intend to further develop our business by focusing on the core elements
of our business strategy discussed above and pursuing the following key growth
strategies:
- expanding our network nationally,
- broadening our marketing activities,
- pursuing strategic sales and distribution alliances,
- engaging in strategic acquisitions, and
- eventually becoming an integrated communications provider offering both
voice and data services.
OUR CUSTOMERS
Since our inception in 1996, we have grown rapidly and now provide Internet
services to more than 500 customers across the United States and in Cuba. In
addition to middle market enterprises, we currently provide service to other
ISPs and larger customers like BellSouth Wireless, Net.B@nk, AGL Resources,
Mohawk Industries, Hartsfield Atlanta International Airport and Guantanamo Bay
Naval Air Station, Cuba under a contract with Local Communications Network.
Our revenues for the year ended December 31, 1998 were $2,142,345, an
increase of 217% from our revenues of $675,569 for the year ended December 31,
1997. Our revenues for the nine months ended September 30, 1999 were $2,288,073,
an increase of 56.3% from our revenues of $1,464,051 for the nine months ended
September 30, 1998. For the nine months ended September 30, 1999, we derived
63.0% of our revenues from providing Internet access and 37.0% of our revenues
from all our other services. For the nine months ended September 30, 1999, our
average monthly revenue per customer was approximately $516.
OUR CORPORATE PROFILE
comstar.net, inc. was formed in March 1996 as ComStar Communications, Inc.,
a Georgia corporation. We changed our name to comstar.net, inc. in July 1999. We
began operating on June 10, 1996, and by December 31, 1996, we had 26 customers.
Our customer base increased to 243 customers at the end of 1997, and to 474
customers at the end of 1998. We had 521 customers at September 30, 1999.
Our principal executive offices are located at 2812 Spring Road, Suite 210,
Atlanta, Georgia 30339, and our main telephone number is (770) 485-6000. We
operate our business primarily from our data center located at our offices in
Atlanta, Georgia. We also have POPs in Raleigh, North Carolina; Birmingham,
Alabama; Athens, Columbus and Gainesville, Georgia; and Miami, Florida. We are
establishing a POP in Houston, Texas.
Our Web site is located at http://www.comstar.net. Information on our Web
site is not, however, part of this prospectus, and you should rely only on the
information contained in this prospectus before deciding to invest in the
investment units.
3
<PAGE> 6
THE OFFERING
<TABLE>
<S> <C>
Minimum offering..................... $4,000,000
Maximum offering..................... $5,000,000
Per investment unit price............ $50,000
Minimum subscription................. $500,000 per entity purchaser and $50,000 per
individual purchaser
Securities offered by comstar.net.... Investment units consisting of an 8% senior
convertible note and a stock purchase warrant
8% senior convertible note
features........................... Each note matures on the earlier of (a) January
15, 2005 or (b) the closing of an underwritten
public offering or any other offering of
securities for gross proceeds to us of at least
$10,000,000. Simple interest accrues at 8% per
year and is payable at maturity. The notes are
convertible by the holder in whole or in part
at any time before the maturity date into
38,760 shares of our common stock, and the
initial conversion price per share is $1.29.
The notes contain customary anti-dilution
provisions that adjust the conversion price in
the event of stock splits, combinations,
mergers and similar events. In addition, if we
issue securities in the future at a lower price
than the conversion price, the conversion price
will be reduced to that lower price, unless an
exception applies.
Warrant features..................... Each warrant has a ten-year term and is
exercisable immediately for 13,566 shares of
our common stock at an exercise price of $.01
per share. The warrants contain customary
anti-dilution provisions to reflect stock
splits, combinations, mergers and similar
events. Each warrant may be transferred
separately from the related note.
Common stock to be outstanding
immediately after the offering..... 12,428,519 shares
Use of proceeds...................... Provide working capital and repay debt.
</TABLE>
4
<PAGE> 7
SUMMARY FINANCIAL DATA
You should read the following summary financial data of comstar.net along
with "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our financial statements and related
notes included elsewhere in this prospectus. During the nine months ended
September 30, 1999 we incurred compensation expense of approximately $3.4
million as a result of options we granted to purchase our common stock. Without
giving effect to this compensation expense, for the nine months ended September
30, 1999, operating loss would have been $1,156,999, net loss would have been
$1,373,343, net loss per share (basic and diluted) would have been $(.27), and
total shareholders' deficit would have been $(673,693). For an explanation of
the determination of the number of shares used to compute basic and diluted net
loss per share and weighted average shares outstanding, see note 2 of the notes
to our financial statements. The data "as adjusted for the offering -- minimum"
and "as adjusted for the offering -- maximum" reflect the sale by us of
$4,000,000 and $5,000,000 in investment units and our receipt and application of
the estimated net proceeds as described in "Use of Proceeds." Our historical
financial information has not been restated for the anticipated two-for-one
stock split expected to be effected immediately before the closing of this
offering.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION YEAR ENDED NINE MONTHS ENDED
(MARCH 5, 1996) DECEMBER 31, SEPTEMBER 30,
TO DECEMBER 31, ------------------------ ------------------------
1996 1997 1998 1998 1999
----------------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues................... $ 65,398 $ 675,569 $ 2,142,345 $1,464,051 $ 2,288,073
Operating loss............. (267,686) (487,585) (445,138) (237,011) (4,562,394)
Net loss................... (278,120) (547,244) (597,730) (357,132) (4,778,738)
PER SHARE DATA:
Net loss per share (basic
and diluted)............. $ (.06) $ (.11) $ (.12) $ (.07) $ (.93)
========== ========== =========== ========== ===========
Weighted average shares
outstanding.............. 5,000,000 5,000,000 5,002,866 5,000,000 5,117,109
========== ========== =========== ========== ===========
OTHER FINANCIAL DATA:
Purchases of property and
equipment, net........... $ (120,442) $ (263,858) $ (414,329) $ (456,826) $ (304,778)
Net cash used in operating
activities............... (202,080) (402,451) (210,355) (121,240) (1,185,399)
Net cash used in investing
activities............... (120,442) (349,196) (1,010,909) (919,460) (304,778)
Net cash provided by
financing activities..... 328,924 799,921 1,450,209 986,024 1,562,245
EBITDA(1).................. (256,064) (423,788) (162,527) (90,703) (4,341,143)
Insufficient earnings to
cover fixed charges...... 278,120 547,244 597,730 357,132 4,695,994
</TABLE>
- ---------------
(1) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is provided because it is a measure
commonly used in the industry. EBITDA is not a measurement of financial
performance under generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to
cash flow as a measure of liquidity. EBITDA is not necessarily comparable
with similarly titled measures for other companies.
5
<PAGE> 8
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
---------------------------------------
AS ADJUSTED AS ADJUSTED
FOR THE FOR THE
OFFERING -- OFFERING --
ACTUAL MINIMUM MAXIMUM
----------- ----------- -----------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................. $ 355,689 $2,800,604 $3,740,604
Working capital (deficit)............................. (1,711,409) 190,996 478,286
Total assets.......................................... 2,358,037 4,802,952 5,742,952
Total debt, including current maturities.............. 2,018,555 2,656,575 3,309,285
Total shareholders' (deficit) equity.................. (673,693) 1,699,712 2,047,002
</TABLE>
DIVIDEND POLICY
We have never paid cash dividends on our common stock, and the terms of the
notes we are offering prohibit us from paying any cash dividends.
RECENT DEVELOPMENTS
In November 1999, we withdrew our registration statement on Form S-1
relating to our proposed initial public offering of our common stock after that
registration statement had been declared effective under the Securities Act of
1933. Because we did not receive the funding anticipated from the initial public
offering, we are making this offering to provide the funds we need to provide
working capital and to repay a portion of our outstanding debt.
---------------------------
Comstar Internet & Wireless(TM), Comstar Internet Service, Inc.(TM),
comstar.net, inc.(TM) and Switch Hotel(TM) are trademarks of comstar.net. We
have applied for federal registration of the Comstar Internet & Wireless (with
logo design)(TM), Comstar Internet Service, Inc. (with logo design)(TM) and
comstar.net, inc. (with logo design)(TM) trademarks.
This prospectus includes statistical data regarding the Internet industry.
This data is taken or derived from information published by International Data
Corporation, a provider of market and strategic information for the technology
industry. We believe that this data is generally indicative of the matters
reflected in this source. This data is inherently imprecise, however, and we
caution you not to place undue reliance on it.
6
<PAGE> 9
RISK FACTORS
An investment in our investment units involves a high degree of risk.
Before you invest in our investment units, you should carefully consider the
risks described below, along with all of the other information included in this
prospectus. Any of the following risks could seriously harm our business and
results of operations. As a result, the value of your investment could decline,
and you could lose part or all of your investment.
Some of the information in this prospectus contains forward-looking
statements that involve substantial risks and uncertainties. You can identify
these statements by forward-looking words such as "anticipate," "believe,"
"continue," "estimate," "expect," "intend," "may," "plan," "will," or similar
words. You should read statements that contain these words carefully because
they:
- discuss our future expectations,
- contain projections of our future results of operations and financial
condition, or
- state other "forward-looking" information.
We believe that it is important to communicate our future expectations to
our investors. Events may occur in the future, however, that we have not
accurately predicted or over which we have no control. These events may affect
our future operating results, our ability to implement our business plan, our
efforts to address year 2000 issues and potential competition, among other
things. The risk factors listed in this section, as well as other cautionary
language in this prospectus, provide examples of risks, uncertainties and events
that may cause our actual results to differ materially from the expectations we
describe in our forward-looking statements. Before you invest in our investment
units, you should be aware that the occurrence of any of the events described in
these risk factors and elsewhere in this prospectus could have a material
adverse effect on our business, financial condition and results of operations
and on the value of your investment.
RISKS RELATED TO COMSTAR.NET
WE FACE A SEVERE CASH SHORTAGE AND WILL NEED ADDITIONAL FINANCING IN THE NEAR
FUTURE TO CONTINUE TO OPERATE.
The minimum $4,000,000 to be raised in this offering will allow us to repay
all of our loans that mature in the first quarter of 2000. We anticipate,
however, that the net proceeds of this offering and our cash reserves will not
be adequate to fund our operations and the development of additional data
centers and POPs. As a result, we expect that we will need additional funds in
the first quarter of 2000 to continue operations.
We anticipate seeking additional financing in the near future to fund
ongoing capital expenditures and liquidity requirements and to begin to achieve
our goal of purchasing and leasing new data centers and POPs. There is no
guarantee that we will obtain this financing on acceptable terms or at all or
that if we do obtain the financing, it will be adequate to purchase or lease the
required data centers and POPs and satisfy our cash requirements. If we cannot
obtain that financing on terms acceptable to us, we may be forced to curtail our
planned business expansion and may be unable to fund our ongoing operations. In
that happens, we will again face a severe cash shortage that could result in our
inability to repay the notes being offered in a timely manner or at all. In that
event, investors in the investment units could lose their entire investment.
7
<PAGE> 10
WE ARE AN EARLY STAGE COMPANY IN A RAPIDLY EVOLVING INDUSTRY, WHICH MAKES IT
DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS.
We began operations in June 1996, and our limited operating history makes
an evaluation of us and our prospects difficult. You should consider our
business and our prospects in light of the risks, expenses and difficulties
frequently encountered by companies in their early stages of development,
particularly companies in the new and rapidly evolving market for Internet
services and technologies. Some of the risks we may face as an early stage
company include our ability to:
- implement our business model and strategy and adapt it as needed,
- continue to attract Internet access and data center services customers,
- develop strategic relationships with other Internet-based service
providers that can refer customers to us, and
- continue to develop and upgrade our network systems and infrastructure.
If we fail to manage these early stage risks successfully or the Internet
services industry does not evolve as we expect, current evaluations of our
business and prospects may prove to be inaccurate.
WE EXPECT TO CONTINUE TO SUFFER LOSSES AND EXPERIENCE NEGATIVE CASH FLOW.
We have incurred substantial losses since inception and expect to continue
to suffer substantial losses in the future. Our business has not generated
sufficient cash flow to fund our operations without acquiring capital from other
sources. We have incurred net losses and negative cash flows from operations as
follows:
<TABLE>
<CAPTION>
NET CASH USED IN
NET LOSS OPERATING ACTIVITIES
----------- --------------------
<S> <C> <C>
Period from inception (March 5, 1996) to December
31, 1996........................................ $ (278,120) $ (202,080)
Year ended December 31, 1997...................... (547,244) (402,451)
Year ended December 31, 1998...................... (597,730) (210,355)
Nine months ended September 30, 1999.............. (4,778,738) (1,185,399)
</TABLE>
As of September 30, 1999, we had an accumulated deficit of approximately $6.2
million. We expect to incur additional capital costs and other expenses in
developing and expanding our network and business. As a result, we expect to
incur significant additional losses and negative operating cash flow for the
foreseeable future, and we may not ever be able to achieve profitability. Even
if we do achieve profitability and positive cash flow, we may not be able to
sustain or increase profitability and positive cash flow on a quarterly or
annual basis. If our revenues grow more slowly than we anticipate, or if our
operating expenses exceed our expectations and cannot be adjusted accordingly,
our operating cash flow will decline, our business will suffer and the value of
your investment could decline substantially.
8
<PAGE> 11
OUR OPERATING RESULTS AND LIQUIDITY ARE UNPREDICTABLE AND MAY FLUCTUATE, WHICH
MAY CAUSE THE VALUE OF YOUR INVESTMENT TO DECLINE.
Our results of operations are difficult to predict. We have experienced
significant fluctuations on a quarterly and annual basis in our results of
operations, which has affected our liquidity. We expect our operating results
and liquidity to fluctuate significantly from quarter to quarter in the future.
Our results of operations and liquidity may fluctuate significantly in response
to the risk factors described in this section, as well as the following factors,
some of which are beyond our control:
- how quickly we are able to acquire new customers,
- how expensive it is to acquire new customers,
- how much money we have to spend to improve our business and expand our
operations,
- how quickly we are able to develop new services that our customers
require,
- how much our operating expenses increase,
- the mix of services we sell,
- the timing and size of our capital expenditures and changes in our
working capital,
- pricing decisions by us or our competitors,
- whether we experience business disruptions resulting from year 2000
computer problems,
- changes in laws and regulations which affect our business,
- the extent to which we experience increased competition in our markets,
and
- general economic factors that might cause our existing and potential
customers to decrease what they spend on their Internet operations.
WE MAY BE UNABLE TO EFFECTIVELY MANAGE OUR RAPID GROWTH, WHICH IS PLACING AND
MAY CONTINUE TO PLACE A STRAIN ON OUR RESOURCES AND MAY CONTRIBUTE TO FUTURE
LOSSES.
We have rapidly expanded our operations and customer base and anticipate
further growth in the future. Our rapid growth has placed significant demands on
our financial resources, management, personnel, systems, procedures and
controls, which may be inadequate to support our existing and future operations.
If we are unable to manage our growth, we may not be able to implement our
business plan and strategy, and our financial results may suffer. To manage our
growth effectively, we must:
- accurately predict growth in the demand for our Internet access and data
center services and expand our capacity to meet that demand,
- continue to expand and improve our operating and financial systems,
procedures and controls,
- attract, train, motivate, manage and retain key employees, particularly
our network experts,
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<PAGE> 12
- continue to provide high quality Internet access, data center services
and customer support, while dealing with the distractions and strain of
rapid growth,
- acquire and install new equipment and facilities,
- successfully integrate the operations and personnel of any ISPs or other
businesses we acquire, and
- respond quickly and effectively to unanticipated changes in the industry.
IF WE ARE UNABLE TO MANAGE AND EXECUTE OUR PLANNED GEOGRAPHIC EXPANSION, WE MAY
INCUR SUBSTANTIAL COSTS BUT NOT RECEIVE THE REVENUES WE ANTICIPATE.
A key element of our growth strategy is the planned domestic expansion of
our network by opening additional data centers. We cannot guarantee that we will
successfully manage this geographic expansion. To do so we must perform the
following tasks successfully:
- efficiently assess potential markets,
- identify data center sites,
- acquire and make necessary improvements to facilities,
- install equipment,
- expand our employee base to staff new data centers adequately,
- adjust our operational and financial systems to accommodate the new data
centers, and
- integrate the completed data centers into our network.
We may not accurately anticipate the customer demand for the services these
additional data centers will provide, and we may be unable to attract a
sufficient number of customers to our new facilities to justify the expense of
establishing the facility. If we are unable to attract customers for these new
data centers as we expect, our costs of establishing these facilities may exceed
the revenues we derive from them, which would adversely affect our financial
results.
Part of our geographic expansion strategy includes opening POPs throughout
the United States to supplement our data centers. Although the cost to establish
a POP is typically much less than to establish a data center, we also face some
of the above risks in establishing additional POPs.
10
<PAGE> 13
WE MAY MAKE ACQUISITIONS OR INVESTMENTS THAT ARE NOT SUCCESSFUL AND THAT
ADVERSELY AFFECT OUR ONGOING OPERATIONS.
To execute our growth strategy, we may make acquisitions and investments to
complement and strengthen our business. We could acquire or invest in
businesses, including other ISPs; customer lists and related customer accounts;
products; services; or technologies. We have very limited experience in these
activities. In making acquisitions or investments, we face numerous risks,
including:
- the difficulty of identifying and hiring one or more senior executives
with acquisition experience,
- the difficulty of identifying suitable acquisition or investment
candidates and negotiating acceptable terms for acquisitions and
investments,
- our need for additional debt or equity financings to complete any
acquisitions,
- the terms of any additional financing used to fund an acquisition may
significantly limit our future financing and operating activities,
- the potential disruption of our ongoing business,
- the potential distraction of our management and diversion of our
resources,
- our inability to maintain uniform standards, controls and procedures,
- the difficulty of successfully integrating the services, products and
personnel of any acquired business or assets into our operations,
- our retention and motivation of key employees of the acquired businesses,
- our entry into geographic markets in which we have little or no prior
experience,
- competition for acquisition opportunities with competitors that are
larger than us or have greater financial and other resources than we
have; and
- our inability to maintain good relations with the customers and suppliers
of the acquired businesses.
OUR MANAGEMENT TEAM HAS WORKED TOGETHER FOR ONLY A SHORT TIME AND MAY EXPERIENCE
INTEGRATION DIFFICULTIES THAT COULD CAUSE OUR BUSINESS TO SUFFER.
We have recently hired several key employees and officers, including our
Chief Operating Officer, Cynthia A. St. Ores; our Chief Financial Officer,
Christopher K. Martin; and our Executive Vice President of Sales and Marketing,
Steven J. Edwards. As a result, our complete management team has worked together
for only a brief time. Our ability to execute our growth strategies effectively
will depend in part on our ability to integrate these and future executives into
our operations. If we are unsuccessful in integrating the new members of our
management team quickly and effectively, our business could suffer
significantly.
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IF WE ARE UNABLE TO ATTRACT AND RETAIN KEY PERSONNEL, WE MAY HAVE TO EMPLOY LESS
QUALIFIED PERSONNEL AND WE MAY EXPERIENCE HIGH PERSONNEL TURNOVER COSTS.
The loss of the services of one or more of our key employees or our failure
to attract and retain additional qualified personnel could cause us to employ
less qualified personnel, increase our personnel costs or otherwise have a
significant adverse effect on our business. Our success depends in significant
part upon the continued services of our key management, technical and sales
personnel, including our Chief Executive Officer, J. Cary Howell, and our Chief
Technology Officer, Edward N. Landa. None of our officers or employees is a
party to an employment agreement. Any officer or employee can terminate his or
her relationship with us at any time.
To execute our strategy successfully, we must attract, train, retain and
motivate highly qualified management, technical, marketing and sales personnel.
Competition for personnel with the technological and other attributes we require
is intense, and turnover of technical personnel is particularly high in our
industry. We may not be able to attract or retain qualified key personnel, and
we may not recoup the cost of training employees if they leave after a short
time.
IF WE CANNOT IMPLEMENT OUR SALES AND MARKETING PLAN, WE WILL NOT ACHIEVE OUR
PROJECTED GROWTH.
Our projected growth depends on our ability to successfully execute our
sales and marketing plan. Our marketing efforts have been limited in the past,
and we have only recently hired our Executive Vice President of Sales and
Marketing, Steven J. Edwards. To improve our sales and marketing results, we
must recruit and retain a competent and sufficient sales force and marketing
group. If we are unable to develop our sales and marketing expertise, our
business will not grow and our financial results will suffer. If we have
insufficient funds to launch the necessary marketing programs, we may lose
customers or fail to attract additional customers, which would prevent us from
achieving our sales goals and could slow or eliminate our growth.
OUR ABILITY TO SUSTAIN OR GROW OUR BUSINESS MAY BE HARMED IF WE ARE UNABLE TO
PROVIDE ADEQUATE CUSTOMER SUPPORT.
Our ability to continue to grow our business and to retain current and
future customers depends in part on our ability to provide responsive and
knowledgeable customer support through our network experts. A failure to offer
adequate customer support could materially and adversely affect our reputation,
cause us to lose customers or cause demand for our services to decline
significantly.
WE MAY BE UNABLE TO RETAIN OUR CUSTOMERS AFTER THEIR CONTRACTS WITH US EXPIRE,
WHICH WOULD REDUCE OUR REVENUES.
Our success substantially depends not only on adding new customers but on
retaining the ones we have. We face the risk that our current and future
customers may not renew their initial contracts after they expire. Therefore, to
grow as we intend, we must add to our customer base to offset any customer
cancellations. If we fail to retain our existing customers or attract new
customers, we may not only fail to meet our growth projections but may
experience declining revenues.
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DISRUPTIONS OF OUR SERVICES AT OUR DATA CENTER COULD RESULT IN CUSTOMER
CANCELLATIONS, SIGNIFICANT CREDITS FOR FREE SERVICE TO AFFECTED CUSTOMERS AND
LIABILITY FOR DAMAGES THAT EXCEED OUR LIABILITY INSURANCE.
The bulk of our computer and telecommunications equipment, including
critical equipment dedicated to our Internet access services, is presently
located at one data center in Atlanta, Georgia. Despite precautions we take, we
may experience system failures or shut-downs at our data center, particularly
due to natural disasters, vandalism, severed telecommunications lines resulting
from utility construction or repairs near our data center or other unanticipated
problems. If disruptions occur, we may have no means of replacing these services
on a timely basis or at all. Extensive or multiple interruptions in providing
customers with Internet access and other services are primary reasons for
customer decisions to switch to another ISP or cancel their use of Internet
access and related services. Accordingly, any disruption of our services at our
data center could cause us to lose existing customers and damage our ability to
gain new customers.
Our customer contracts currently provide a limited service level warranty
related to the continuous availability of service on a 24 hours per day, seven
days per week basis, except for scheduled maintenance periods. This warranty
provides a credit for free service for disruptions in our Internet access
services. If we incur significant free service obligations because of these
disruptions, we will likely suffer financial losses for the periods in which we
provide the free service. In addition, although our service contracts limit our
liability to our customers for actual damages, we may be found liable for
damages that exceed our liability insurance.
We have developed an important enhancement to our T1, fractional T1, T3 and
fractional T3 leased line Internet access options -- the eCommerce Guarantee. We
will compensate those customers who purchase the eCommerce Guarantee option for
the lost profits, up to $500,000 per access line, for each interruption they
suffer in their Internet access service if the interruption occurs outside the
customer's demarcation point, which is the point at which the customer assumes
responsibility for the communications network, and the interruption causes the
customer to lose profits. An insurance company rated "A" by A.M. Best Company
has insured our liability for the eCommerce Guarantee, and we will be
responsible for a per interruption deductible of $10,000 for each T3 or
fractional T3 line and $2,500 for each T1 or fractional T1 line, with an initial
overall deductible limit of $100,000 for any single event that causes multiple
interruptions. This deductible increases to $250,000 once more than 250 of our
customers are covered by the eCommerce Guarantee and to $500,000 once more than
500 of our customers are covered. The maximum insured amount per interruption is
$500,000 for each T3 or fractional T3 line and $25,000 for each T1 or fractional
T1 line. The maximum amount any customer will be able to recover during the term
of its contract is $500,000 for each T3 or fractional T3 line and $25,000 for
each T1 or fractional T1 line. We will pay the eCommerce Guarantee compensation
first by providing the affected customer with a credit for future access fees
and second by paying the customer in cash within 60 days after the claim is
finally determined for the amount of lost profits in excess of the customer's
contract value. We have not yet implemented our eCommerce Guarantee and we
cannot assure that it will be implemented. If we incur significant free service
obligations or are required to pay significant amounts as a result of our
eCommerce Guarantee, we will likely suffer financial losses for the periods in
which we incur the obligations and pay the amounts.
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BREACHES IN THE SECURITY OF OUR NETWORK COULD REQUIRE US TO PAY MONEY DAMAGES TO
OUR CUSTOMERS FOR LOSS OF INFORMATION AND COULD RESULT IN LOSS OF CUSTOMERS AND
NEGATIVE PUBLICITY.
To conduct electronic commerce and communications effectively, we must
ensure our customers that the information they transmit over our network will be
safe. We provide security for our customers' information by licensing encryption
and authentication technology from others. Despite our design and implementation
of a variety of network security measures, our network, our data center or our
POPs may be the victim of unauthorized access, computer viruses, accidental or
intentional acts and other disruptions of our business. We may be held
responsible and required to pay damages for the loss of any confidential
information stored in our computers or the equipment of our customers arising
from the inappropriate use of our network by others. We may also lose customers
if any of these disruptions occur.
Although we provide industry-standard security measures, these measures
have been defeated in the past, and we cannot guarantee that they will not be
defeated on our network or at our data center or POPs. Any security breach could
result in expensive litigation and harmful publicity. In addition, if many
enterprises choose not to use the Internet because of security concerns, the
growth of the Internet would be inhibited, which would have a material adverse
effect on our business.
IF WE CANNOT EXPAND OUR TELECOMMUNICATIONS NETWORK RAPIDLY OR BROADLY ENOUGH TO
MEET CUSTOMER DEMAND, THE QUALITY OF OUR SERVICE MAY SUFFER.
We must continue to expand and adapt our network infrastructure as the
number of customers and the amount of information they wish to transport
increases and their requirements evolve. A rapid and significant expansion of
our network will place additional stress upon our network hardware and traffic
management systems. The ability of our network to connect and manage a
substantially larger number of customers at high transmission speeds has not
been tested. Consequently, we face the risk that we cannot expand our network as
we intend. Even if we are able to do so, we face the risk that an expanded
network will not maintain the levels of performance our network currently
provides.
From time to time we must upgrade our infrastructure to increase bandwidth
capacity. This allows us to handle increases in information flow while
maintaining the speeds of data transfer our customers require. We believe that
further expansion and improvement of our network infrastructure will require
substantial financial, operational and management resources that may not be
available when we need them. We may not be able to acquire additional network
capacity from our suppliers when we need it, on reasonable terms or at all. In
addition, as we upgrade our infrastructure, we may need to use equipment or
software that is incompatible with our current network. As a result, we may
experience delays in installing the needed equipment or software. Without
additions to our infrastructure, we may not be able to install or maintain
sufficient bandwidth capacity to provide transportation speeds that are
acceptable to our customers, especially if they significantly increase their
usage. If we are unable to maintain acceptable speeds or if we encounter delays
in upgrading our network, we may lose customers and our revenues could decline
significantly.
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A DISRUPTION OR REDUCTION IN THE INTERNET CAPACITY OF ANY OF THE ISPS THAT
PROVIDE OUR INTERNET CONNECTION COULD LOWER THE QUALITY OF OUR SERVICE AND CAUSE
US TO LOSE CUSTOMERS.
Our success depends upon the size, ease of expansion, reliability and
security of our network infrastructure, including the transmission capabilities
we lease from the ISPs that connect us to the Internet. In particular, we depend
on UUNET, GTE Internetworking, Sprint and Intermedia Internet for our Internet
connection. Although we lease Internet access capacity from multiple suppliers,
a disruption or reduction in Internet capacity by any of them could prevent us
from maintaining the high quality of our service and cause us to lose customers.
If our business relationship with any of these providers were to be terminated,
we would need to identify and acquire alternative sources for the service, which
may not be available at all or on prices and terms acceptable to us.
IF PROVIDERS OF LOCAL AND LONG DISTANCE TELECOMMUNICATIONS LINES EXPERIENCE
DISRUPTIONS OR CAPACITY CONSTRAINTS, OUR ABILITY TO PROVIDE SERVICE TO OUR
AFFECTED CUSTOMERS MAY BE ELIMINATED OR SUBSTANTIALLY CONSTRAINED.
We presently rely on BellSouth and other regional and local companies to
provide data communications capacity via local telecommunications lines and
leased long-distance lines to connect us to our customers. We may experience
disruptions or capacity constraints in these telecommunications services. If
disruptions or capacity constraints occur, we may have no means of replacing
these services on a timely basis or at all. In particular, local telephone
service is sometimes available only from BellSouth or another incumbent local
exchange carrier in the markets we serve. Although we believe that the federal
Telecommunications Act of 1996 will generally lead to increased competition in
the local telephone service market, we cannot predict when or to what extent
this will occur or the effect of increased competition on pricing or supply. In
addition, our telecommunica-tions carriers also sell or lease services to our
competitors and either are, or in the future may become, competitors themselves.
As a result, when capacity constraints and disruptions occur, our carriers may
allocate any remaining capacity to themselves or to our competitors.
IF OUR SUPPLIERS ARE UNABLE TO SUPPLY THE EQUIPMENT WE NEED TO MAINTAIN AND
IMPROVE OUR NETWORK AND DATA CENTER SERVICES, OUR SERVICE QUALITY MAY SUFFER AND
WE MAY LOSE CUSTOMERS.
We depend on a few suppliers of hardware components for which alternative
sources are not readily available. We purchase some of our parts from Cisco
Systems, Inc. and Lucent Technologies, Inc. under purchase orders we place from
time to time. We do not have a long-term contract or guaranteed supply
arrangement with these providers, and we do not carry significant inventories of
these parts. If we are unable to obtain these parts on a timely basis and at an
acceptable cost, we could be unable to upgrade or repair our network as required
to remain competitive. As a result, we could lose customers and our business
could be significantly harmed.
OUR SALES CYCLE FOR SOME OF OUR CUSTOMERS IS LONG, AND WE MAY INCUR SUBSTANTIAL
SALES-RELATED EXPENSES BEFORE WE RECEIVE REVENUES, IF ANY, FROM THESE CUSTOMERS.
The period from our initial contact with a potential customer to the
commencement of services for that customer generally varies in relation to the
level of services we provide. For example, services that are more comprehensive
have a four-to-six month sales cycle.
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Our customers' decisions regarding Internet service are often critical to their
business, and they frequently require extensive information and education
regarding the benefits of our Internet access and data center services. We
expect that most of our sales-related expenses will occur before our customers
commit to use our services. This places demands on our working capital and
exposes us to the risk that we may expend significant marketing resources to
pursue customers who ultimately choose not to use our services. Although we
intend to significantly increase our sales and marketing expenditures to attract
new customers, we expect that the sales cycle for new customers who desire more
than basic Internet access will continue to be lengthy.
ANY FAILURE BY US TO PROTECT OUR PROPRIETARY TECHNOLOGY AND OTHER PROPRIETARY
RIGHTS COULD RESULT IN THE LOSS OF OUR RIGHTS, LOSS OF BUSINESS OR INCREASED
COSTS.
One important element of our success and competitive ability is our
technology and our technological expertise. We rely on a combination of
copyright, trademark and trade secret laws and contractual restrictions to
establish and protect proprietary rights in our services. We have no patented
technology that would preclude or inhibit competitors from entering our market.
To limit access to and disclosure of our proprietary information, we enter into
confidentiality agreements with our employees and consultants, and, if possible,
nondisclosure agreements with appropriate suppliers and customers. These
contractual arrangements and any other steps we take to protect our intellectual
property may not prevent misappropriation of our technology or deter others from
developing similar technologies. In addition, the laws of some foreign countries
may not protect our services or intellectual property rights to the same extent
as do the laws of the United States.
To date, we have not been notified that our services infringe the
proprietary rights of others, but others may claim that we infringe their
proprietary rights in current or future products or services. We expect that
participants in our markets will be increasingly subject to infringement claims
as the number of competitors in our industry grows. An infringement claim
against us could result in a loss of our proprietary rights and, whether
meritorious or not, could be time-consuming, result in costly litigation, or
require us to pay damages or to enter into royalty or licensing agreements on
terms that are unfavorable to us. Acceptable royalty or licensing agreements
might not be available to us. As a result, any infringement claim could
seriously harm our business.
IF WE FAIL TO PROTECT OUR COMSTAR SERVICE MARKS, IT COULD WEAKEN THE VALUE OF
THE COMSTAR.NET NAME AND RESULT IN OUR LOSS OF CUSTOMERS TO COMPETITORS.
We believe we have begun to build awareness of the comstar.net brand in our
markets, and we intend to use part of the net proceeds from this offering to
further increase market awareness of the comstar.net name. However, several
other companies use the mark "Comstar" and similar terms for their company names
and various products, services, and brands. Some of these companies have
obtained trademark registrations from the United States Patent and Trademark
Office to protect their use of the mark "Comstar" and similar terms. We have
recently filed applications with the United States Patent and Trademark Office
to obtain federal trademark registration of the following marks: comstar.net,
inc., together with our design logo; Comstar Internet Services, Inc., and the
related design; and Comstar Internet & Wireless, Inc., and the related design.
In addition, our wholly owned subsidiary, Comstar Telecom & Wireless, Inc.,
filed an application with the United States Patent and Trademark Office to
obtain federal trademark registration of the mark Comstar Telecom & Wireless,
Inc.
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The United States Patent and Trademark Office has now examined our
application to register the mark Comstar Internet Services, Inc. and the related
design and our application to register the mark Comstar Internet & Wireless,
Inc. and the related design. Registration of both marks has been refused on the
ground that the marks, when used on or in connection with the identified
services, so resemble a currently registered mark for COMSTAR as to be likely to
cause confusion, to cause mistake or to deceive. Registration has also been
provisionally refused in view of a pending application to register a mark that
includes the term COMSTAR owned by a different party. We disagree with the
findings of the examining attorney and are taking steps to vigorously contest
the rejection and pursue the registrations.
The Patent and Trademark Office has not yet responded to our application
for the comstar.net mark or our subsidiary's application for the Comstar Telecom
& Wireless, Inc. mark. If the Patent and Trademark Office issues final
rejections of that application or our other applications discussed above, we
will likely experience greater expense and difficulty in protecting our
trademarks. We may also be unable to stop others from using similar marks in
connection with competing goods or services. If that happens, our customers,
suppliers and others in our industry could confuse us and our products and
services for another person or company and its products and services. This could
weaken the value of the comstar.net name and result in our loss of business to
competitors, which could have a material adverse effect on our business and
financial condition.
WE COULD BE CHARGED WITH TRADEMARK INFRINGEMENT AND INCUR SIGNIFICANT COSTS IN
CONTESTING THESE CHARGES AND FOR ANY RELATED LIABILITY.
Other companies that use or have registrations for the mark "Comstar" or
terms similar to "Comstar" for various products and services, or for their
company or brand name, could claim that we are infringing their federal or state
trademark rights by our use of the mark "comstar.net" or its derivations. An
infringement claim of that nature, whether meritorious or not, could be time
consuming and result in costly litigation. In addition, it could result in our
loss of the right to use the mark "comstar.net" and its derivations, including
losing the right to use them:
- in our corporate name,
- as part of the services we offer, and
- as part of our URL, or our address on the Web, which is currently
www.comstar.net.
Litigation or settlement of an infringement claim could also require us to
pay damages or enter into royalty or licensing agreements on terms that are
unfavorable to us. If we are unable to use the mark "comstar.net" and its
derivations, we will be required to adopt a new company and brand name, and
market our services under a new name. To do so, we will be required to incur
significant costs. Any of these events could have a material and adverse effect
on our business and financial condition.
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POTENTIAL YEAR 2000 PROBLEMS MAY CAUSE US TO LOSE CUSTOMERS AND SUBJECT US TO
SIGNIFICANT LIABILITIES AND COSTS.
The risks posed by year 2000 issues could adversely affect our business in
a number of significant ways. We note in particular that the information
technology systems we depend on may not be year 2000 compliant by the end of
1999. These systems include:
- our own critical information technology and non-information technology
systems,
- the systems of suppliers on which we rely, including the ISPs that
provide our link to the Internet, and
- the systems of our customers, particularly those who maintain their
Internet operations on UNIX-based servers that may be particularly
affected by year 2000 complications.
Further, our costs and liabilities related to year 2000 issues may be
significant, and we may become involved in litigation related to year 2000
issues.
If year 2000 problems cause the failure of any of our systems, the systems
of our suppliers on which we rely, or the servers or other internal systems of
our customers, we could lose customers, suffer significant disruptions in our
business, lose revenues, and incur substantial liabilities and expenses. In
addition, the Internet could face serious disruptions arising from year 2000
issues, which generally may have an adverse impact on traffic and commerce on
the Internet.
Even if year 2000 problems do not cause any of these failures or
disruptions, if our suppliers, current or prospective customers or others expect
that these failures or disruptions will occur, during the fourth quarter of 1999
it could:
- cause potential customers to delay purchases from us until the year 2000,
- reduce the growth of the Internet and electronic commerce,
- hamper existing Internet activity and electronic commerce, and
- reduce the demand for our services.
If this happens, it could materially and adversely affect our business,
particularly our results of operations. For more information about how year 2000
issues affect us, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000 Compliance."
IF WE SUCCEED IN OUR GOAL OF BECOMING A COMPETITIVE LOCAL EXCHANGE CARRIER, WE
COULD BE SUBJECT TO NUMEROUS ADDITIONAL RISKS.
One of our goals is to become licensed as a competitive local exchange
carrier, or CLEC, within the state of Georgia and in other states in which we
operate. A CLEC provides local access lines as well as long-distance or other
telecommunications services. The approval process for becoming a CLEC can be
costly and lengthy, and obtaining this approval will divert important management
and capital resources from our business. We have not yet begun the approval
process for becoming a CLEC in any state in which we operate. We may be unable
to obtain approval as a CLEC, if and when we seek such approval, in some or all
of the states in which we operate.
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None of our current management team has any experience in managing a CLEC,
and we may have to retain senior management with that experience to successfully
capitalize on being authorized as a CLEC. We cannot assure you that we will be
able to locate and hire appropriate management personnel on terms we find to be
reasonable or at all.
Even if we do obtain approval to operate as a CLEC, we cannot assure you
that we will be a successful competitor in the industry. Numerous companies,
some of which are our competitors in our current business, already have obtained
this approval and have invested significant resources to build their access
lines, hire and train personnel, develop their services and obtain customers. We
may not be able to fund the substantial capital and other costs that may be
required to operate as a CLEC. In addition, to operate successfully as a CLEC,
we will need to enter into interconnection agreements with incumbent local
exchange carriers, such as BellSouth. These agreements permit carriers to
exchange telecommunications traffic. We may experience difficulties in entering
into these agreements on terms that are acceptable to us and in enforcing these
agreements.
If we attain CLEC status and conduct business as a CLEC, the
telecommunications services that we provide will be subject to significant
regulation at the federal, state and local levels. We may experience delays in
receiving required regulatory approvals or onerous conditions imposed on these
approvals.
Recent federal laws and regulations governing the United States
telecommunications industry remains subject to judicial review and rule-making
by the Federal Communications Commission. As a result, we cannot predict the
effect these laws and regulations will have on our future operations or results.
Federal, state and local authorities have initiated many regulatory actions
regarding important items that impact CLECs. Changes in current or future
regulations adopted by federal, state or local regulators, or other legislative
or judicial initiatives relating to the telecommunications industry, could have
a material adverse effect on us if we become a CLEC.
If we attain CLEC status, we will be required to publicly file our tariffs
with governmental authorities. These tariffs describe the prices we will charge
our customers for telecommunications services and the terms and conditions for
some intrastate, interstate and international telecommunications services. If
governmental regulators or others challenge these tariffs, we could incur
substantial legal and administrative expenses.
We also may be subject to requirements in some states to obtain prior
approval for, or notify the state commission of, any transfers of our voting
securities, sales of our assets, corporate reorganizations involving us,
issuances of our stock or debt instruments and similar transactions involving
us.
MEMBERS OF MANAGEMENT MAY DERIVE BENEFITS FROM OTHER COMPANIES WITH WHICH WE DO
BUSINESS OR IN WHICH WE OWN A SUBSTANTIAL MINORITY INTEREST.
Dr. Samuel F. Dayton, our Chairman of the Board, and James L. Bruce, Jr.,
one of our directors, are substantial shareholders of both comstar.net and db
Telecom Technologies, Inc. Dr. Dayton and Mr. Bruce are also officers and
directors of db Telecom Technologies. Because db Telecom Technologies has in the
past and is expected in the future to perform services for us and engage in
other transactions with us, conflicts of interest may arise in connection with
those transactions. For example, we expect that from time to time we will retain
db Telecom Technologies to perform work for us as a subcontractor on
communications projects.
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In addition, we own 25% of the outstanding common stock of nschool
Communication Systems, Inc., a company involved in developing and licensing
software to link educators, parents and students. We also have a bilateral
license agreement with nschool governing our rights and the rights of nschool
relating to software we developed for nschool. Dr. Samuel F. Dayton, our
Chairman of the Board, is the chairman of the board of directors of nschool. As
a result, conflicts of interest may arise in connection with any transaction
between nschool and us.
We have a policy that requires any material transaction with our officers,
directors, or principal shareholders, or their affiliates, to be on terms no
less favorable to us than we reasonably could have obtained in arm's-length
transactions with independent parties. We believe that all current relationships
between either db Telecom Technologies or nschool on one hand and comstar.net on
the other hand comply with this policy and all future relationships will be made
subject to and must comply with this policy. Nevertheless, transactions between
us and db Telecom Technologies or nschool that are approved under our policy
could result in substantial benefits to Dr. Dayton and/or Mr. Bruce because they
own db Telecom, and substantial benefits to Dr. Dayton because he is the
Chairman of the Board of nschool.
OUR EXISTING SHAREHOLDERS WILL CONTROL SHAREHOLDER ACTIONS AFTER THIS OFFERING,
AND THEY MAY VOTE THEIR SHARES IN WAYS WITH WHICH YOU DISAGREE.
When this offering is closed, our present executive officers, directors and
current holders of more than 5% of the common stock will, in the aggregate,
beneficially own approximately 87.9% of our outstanding common stock. As a
result, these shareholders, voting together, will have the ability to control
all matters submitted to our shareholders for approval, including the election
and removal of directors and any merger, consolidation or sale of all or
substantially all of our assets. This concentration of ownership may have the
effect of delaying or preventing a change in control of comstar.net or of
impeding or discouraging a merger, consolidation, takeover or other business
combination involving comstar.net.
RISKS RELATED TO OUR INDUSTRY
IF OUR TARGET MARKET DOES NOT INCREASE ITS USE OF THE INTERNET, WE WILL BE
UNABLE TO CONTINUE OUR GROWTH.
The increased use of the Internet for retrieving, sharing and transferring
information among businesses, consumers, suppliers and partners has only
recently begun to develop, and our success depends upon the continued growth of
the Internet. The Internet will grow only if those enterprises that have relied
upon more traditional means of commerce and communications accept the Internet
as a new medium of communicating, conducting business and exchanging
information. Despite growing interest in the commercial uses of the Internet,
many businesses have not purchased Internet services for a number of reasons,
including:
- inadequate protection of confidential information moving across the
Internet,
- inconsistent quality of service,
- inability to integrate business applications on the Internet,
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- incompatibility between the products of multiple vendors, and
- lack of availability of cost-effective, high-speed services.
Future demand and market acceptance of the Internet may not develop. If the
Internet as a commercial or business medium fails to develop or develops more
slowly than expected, we will be unable to continue our growth or we may grow
more slowly than anticipated.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT AND RELIABILITY OF THE INTERNET
INFRASTRUCTURE.
The recent growth of the Internet has caused periods of diminished
performance, requiring entities with links to the Internet to periodically
upgrade the links and components that form the infrastructure of the Internet to
alleviate congestion. Because the Internet access we provide is limited by the
speed and reliability of the networks of others, including the ISPs that provide
our connection to the Internet, the public perception of our services could be
undermined by any publicized or perceived downturn in the performance of the
Internet as a whole. Consequently, the emergence and growth of the market for
our services depends on improvements being made to the entire Internet
infrastructure to alleviate congestion.
THE TECHNOLOGY USED IN OUR INDUSTRY IS RAPIDLY CHANGING, AND OUR BUSINESS MAY
SUFFER IF WE DO NOT ADAPT TO THE CHANGING STANDARDS.
Our future success will depend, in part, on our ability to offer services
that:
- incorporate leading technology,
- address the increasingly sophisticated and varied needs of our current
and prospective customers, and
- respond to technological advances and emerging industry standards and
practices on a timely and cost-effective basis.
We may not be able to incorporate future technological advances into our
business on a cost-effective and timely basis or at all. Moreover, technological
advances may encourage our current or future customers to rely on in-house
personnel and equipment to provide the services we currently provide, which
would reduce those customers' need for our services. In addition, we may require
substantial expenditures and lead-time to keep pace and ensure compatibility
with technological advances in our industry.
We believe that our future success also depends upon the continued ability
of our services to work with the products, services and other technologies
offered by various vendors. New products may not be compatible with our network
and services or adequately address the changing needs of our customers. In
addition, industry standards may not be established, or we may not be able to
conform to new standards in a timely fashion to remain competitive. Our failure
to conform to prevailing technology standards, or the failure of common
technology standards to emerge, could limit our ability to compete and adversely
affect our business. In addition, the products, services or technologies
developed by others may make our services less competitive or obsolete.
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OUR INDUSTRY IS VERY COMPETITIVE, AND MANY OF OUR COMPETITORS HAVE GREATER
RESOURCES THAN WE DO.
The Internet services and technologies industries are highly competitive.
The tremendous growth and potential size of the market for Internet services has
attracted many new start-ups as well as existing businesses. It is relatively
easy for new entities to enter the industry, and we expect that competition will
continue to grow as use of the Internet increases. We may not have the resources
or expertise to compete successfully with existing or new competitors, which
include:
- national, regional and local ISPs, including the ISPs that provide our
connection to the Internet,
- national and regional long distance and local exchange telecommunications
carriers,
- cable operators and their affiliates,
- providers of co-location and other data center services, and
- wireless and satellite ISPs.
When compared to us, many of our competitors have substantially greater
financial, technical, marketing and personnel resources; a broader range of
services; larger customer bases; more extensive networks and facilities; longer
operating histories; greater name recognition and market presence; and more
established business relationships in the industry. As a result, some of our
competitors may be better able than we are to:
- develop and expand their network infrastructures and service offerings,
- adapt to new or emerging technologies and changes in customer
requirements,
- take advantage of acquisitions and other opportunities,
- devote resources to the marketing and sale of their services, and
- adopt aggressive pricing policies.
Many cable television operators and other alternative service providers,
such as companies utilizing wireless and satellite-based service technologies,
have begun offering, or have announced their plans to offer, Internet access and
related services. In particular, cable television operators have sought to take
advantage of their existing cable infrastructure to offer Internet access
services. They could prevent us from delivering Internet access through their
wire and cable connections, and are not currently required to permit us to use
their facilities. We expect to experience increased competition from these cable
operators and other alternative service providers.
Advances in technology, as well as changes in the marketplace and the
regulatory environment, are constantly occurring, and we cannot predict the
effect that ongoing or future developments may have on us or on the pricing of
our services. For example, telecommunications companies, including incumbent
local exchange carriers and competitive local exchange carriers, have
increasingly begun to enter the Internet access market. To address the Internet
access requirements of the current business customers of long distance and local
carriers, many carriers are integrating horizontally through acquisitions of or
joint ventures with ISPs, or by wholesale purchase of Internet access from ISPs.
22
<PAGE> 25
With these pressures, we may not be able to remain competitive with the
prices of our competitors or with their mix of services. In particular, intense
price competition could significantly reduce our operating margins and adversely
affect our operating results. Any failure by us to compete effectively could
significantly harm our business.
THE MARKET FOR OUTSOURCED INTERNET SOLUTIONS IS UNCERTAIN, AND THE FAILURE OF
THIS MARKET TO DEVELOP AS WE ANTICIPATE COULD PREVENT OUR GROWTH.
Although we believe that the desire of middle market businesses to
outsource their Internet systems and technologies is still growing, future
growth is uncertain. We cannot guarantee that the outsourced Internet solutions
market will ultimately prove to be viable or, if it becomes viable, that it will
grow. The market for our services may not develop as we anticipate, and our
potential customers may not continue to use the Internet for commerce and
communication. To succeed, we must differentiate ourselves from our competition
through service offerings. If we incur increased costs or experience delays in
the development and introduction of new services or enhancements of our existing
services, we may not achieve market acceptance of our services. If our market
develops more slowly than we expect, or if our services do not achieve market
acceptance, we may not achieve our growth plans or develop our business.
OUR INDUSTRY MAY BECOME SUBJECT TO GOVERNMENTAL REGULATION AND OTHER LEGAL
UNCERTAINTIES THAT COULD INCREASE OUR COSTS, RESULT IN DELAYS AND DECREASE THE
DEMAND FOR OUR SERVICES.
We are not currently subject to direct federal, state or local government
regulation as a result of the Internet services we provide, other than
regulations applicable to businesses generally. Currently, only a small body of
laws and regulations directly apply to access to or commerce on the Internet.
Due to the increasing popularity and use of the Internet, however, laws and
regulations may be adopted at the federal, state and local levels. We cannot
predict what regulations may be adopted in the future or to what extent existing
laws and regulations may be altered in response to use of the Internet and the
convergence of traditional telecommunications services with Internet
communications. The adoption of new laws or regulations governing the Internet
or changes made to existing laws might decrease the growth of the Internet. This
would likely decrease the demand for our services or increase the cost of doing
business. Any new laws or regulations or changes to existing laws or regulations
could also subject us and/or our customers to potential liability, which in turn
could have a material adverse effect on our business.
In addition, any one of the numerous states where we provide Internet
services or where we facilitate sales by our customers to end users may require
us to qualify to do business as a foreign corporation in the state. We are
qualified to do business in only a limited number of states, and our failure to
qualify as a foreign corporation in a jurisdiction where we are required to
qualify could subject us to taxes and penalties for failing to qualify,
including the inability to enforce contracts in the jurisdictions. The
application of the laws or regulations of jurisdictions whose laws do not
currently apply to our business could adversely affect our business.
WE MAY BE LIABLE FOR THE MATERIAL OUR CUSTOMERS DISTRIBUTE OVER THE INTERNET.
The law relating to the liability of ISPs for information carried on or
disseminated through their networks is currently unsettled. We may become
subject to legal claims relating to the content in the Web sites we host. For
example, lawsuits may be brought
23
<PAGE> 26
against us claiming that material inappropriate for viewing by young children
can be accessed from Web sites we host. Other potential claims include
defamation, invasion of privacy and copyright infringement. Providers of
Internet services have been sued in the past, sometimes successfully, based on
the content of material available on their networks or through their services.
Our business could suffer if we have to take costly measures to reduce our
exposure to these risks or if we incur liability for, or are required to defend
ourselves against, those types of claims.
RISKS RELATED TO THE OFFERING
THERE IS NO PUBLIC MARKET FOR ANY OF THE SECURITIES WE ARE OFFERING.
No public market exists for our units, notes, warrants or common stock. We
cannot guarantee that a public market for any of these securities will ever
exist or that investors will be able to sell their units, notes, warrants or the
shares of common stock into which the notes are convertible or for which the
warrants may be exercised.
THE VALUE OF OUR INVESTMENT UNITS AND OUR COMMON STOCK PRICE MAY BE VOLATILE,
WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INDIVIDUAL INVESTORS.
The value of the investment units and the underlying common stock may
fluctuate significantly in response to the following and other factors, some of
which are beyond our control:
- variations in quarterly operating results,
- announcements of significant contracts, technological innovations or new
services by us or our competitors, and
- the operating and stock price performance of other companies in our
industry.
Because our business is Internet-related, the value of the investment units and
our common stock could fluctuate widely if the market price of equity securities
of other Internet-related companies becomes volatile.
OUR MANAGEMENT HAS BROAD DISCRETION OVER THE USE OF PROCEEDS FROM THIS OFFERING
AND MAY FAIL TO USE THEM EFFECTIVELY TO GROW OUR BUSINESS.
The net proceeds of this offering are estimated to be between approximately
$3,529,000 and approximately $4,469,000. We have allocated approximately $1.2
million of this amount for the repayment of debt, including accrued interest, to
various lenders. Our board of directors and management will have significant
flexibility in applying the remaining net proceeds of this offering, and they
may use these funds for purposes you may think are unwise. Our failure to apply
these funds effectively could impede our ability to grow our business.
OUR ARTICLES OF INCORPORATION AND BYLAWS MAY DISCOURAGE CHANGE IN CONTROL
TRANSACTIONS.
Our articles of incorporation and bylaws contain provisions that may make
it more difficult for others to acquire control of comstar.net, even if the
change in control would be beneficial to our shareholders. If these provisions
discourage any proposed change in control that could be beneficial to
shareholders, our stock price could decline significantly.
24
<PAGE> 27
USE OF PROCEEDS
The minimum net proceeds we will receive from the sale of investment units
in this offering will be approximately $3,529,000. The maximum net proceeds we
will receive from the sale of investment units in this offering will be
approximately $4,469,000. We intend to spend all of the net proceeds of this
offering for working capital and to repay outstanding debt and accrued interest
of approximately $1.2 million. The terms of the debt to be repaid are as
follows:
<TABLE>
<CAPTION>
PRINCIPAL MATURITY ANNUAL
LENDER AMOUNT DATE INTEREST RATE
- ------ --------- -------- -------------
<S> <C> <C> <C>
Premier Bank.................................... $100,100 1/15/00 prime + 1%
Premier Bank.................................... 700,000 1/15/00 prime + 1%
Dr. Samuel F. Dayton............................ 140,000 1/15/00* 10%
Dr. Samuel F. Dayton and James L. Bruce, Jr..... 283,985 1/27/00 8.75%
</TABLE>
* or the closing of this offering, if earlier.
We will pay the $283,985 we currently owe to Dr. Dayton and Mr. Bruce,
together with accrued interest, directly to The First National Bank of Commerce,
their lender. This payment will satisfy the remaining balance of the $383,985
that Dr. Dayton and Mr. Bruce borrowed from First National on our behalf, which
they loaned to us to fund our purchase of Athens' ISP, Inc. in July 1998. Dr.
Dayton loaned us $140,000 in November 1999 on a short-term basis to fund working
capital.
Pending application of the net proceeds described above, we intend to
invest the net proceeds in investment-grade, interest-bearing securities.
DIVIDEND POLICY
We have never paid any cash dividends on our common stock, and we currently
anticipate that we will retain all future earnings for use in our business.
Additionally, the terms of the notes we are offering prohibit us from paying any
cash dividends.
25
<PAGE> 28
CAPITALIZATION
The following table describes our capitalization at September 30, 1999 on a
historical basis and as adjusted to give effect to our sale of the minimum
$4,000,000 in investment units and the maximum $5,000,000 in investment units
offered in this offering and the application of the estimated net proceeds from
the offering, as well as the anticipated two-for-one stock split, the
anticipated issuance of a total of 1,276,658 shares of common stock to
purchasers in our private placement of shares completed in June 1999, and the
anticipated issuance of 780,075 shares of common stock to related parties in
exchange for their forgiveness of indebtedness (762,982 shares as of September
30, 1999). The information in the table does not include 1,736,250 shares of
common stock that may be issued under outstanding options at September 30, 1999
at an exercise price of $5.71 per share. You should read this table along with
our financial statements and related notes, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and other financial
data appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
-----------------------------------------
AS ADJUSTED AS ADJUSTED
ACTUAL -- MINIMUM -- MAXIMUM
----------- ----------- -----------
<S> <C> <C> <C>
Long-term debt, including current
maturities(1)....................... $ 1,972,822 $ 2,610,842 $3,263,552
Obligations under capital leases,
including current portion........... 45,733 45,733 45,733
Shareholders' deficit:
Preferred stock, no par value:
5,000,000 shares authorized, none
issued and outstanding......... -- --
Common stock, no par value:
50,000,000 shares authorized;
5,185,893 shares issued and
outstanding (actual),
12,411,426 shares issued and
outstanding (as adjusted)(2)... 2,122,744 3,106,991 3,106,991
Additional paid in capital(1)......... 3,522,412 4,911,570 5,258,860
Deferred compensation................. (117,017) (117,017) (117,017)
Accumulated deficit................... (6,201,832) (6,201,832) (6,201,832)
----------- ----------- ----------
Total shareholders' (deficit)
equity...................... (673,693) 1,699,712 2,047,002
----------- ----------- ----------
$ 1,344,862 $ 4,356,287 $5,356,287
=========== =========== ==========
</TABLE>
(1) Of the $4,000,000 minimum and $5,000,000 maximum gross proceeds of the
investment units we are offering, we have allocated $2,610,842 and
$3,263,552, respectively, to the initial value of the notes and $1,389,158
and $1,736,448, respectively, to additional paid in capital to reflect the
estimated value of the warrants. We cannot assure you that the value
allocated to the warrants reflects the price at which the warrants may
actually be exercised.
(2) Excludes the 1,085,280 (minimum) and 1,356,600 (maximum) shares of common
stock issuable upon the exercise of the warrants.
26
<PAGE> 29
SELECTED FINANCIAL DATA
The following selected financial data of comstar.net for the period from
inception, March 5, 1996, to December 31, 1996, and for the years ended December
31, 1997 and 1998 and as of December 31, 1997 and 1998 are derived from our
audited financial statements. The selected statement of operations data for the
nine month periods ended September 30, 1998 and 1999 and the selected balance
sheet data as of December 31, 1996 and September 30, 1999 are derived from our
unaudited financial statements which, in the opinion of management, include all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the information provided in them. The results of operations for
the nine months ended September 30, 1999 are not necessarily indicative of the
results for a full year. You should read the following data along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and related notes included elsewhere in
this prospectus.
During the nine months ended September 30, 1999 we incurred compensation
expense of approximately $3.4 million as a result of options we granted to
purchase our common stock. Without giving effect to this compensation expense,
for the nine months ended September 30, 1999, operating loss would have been
$1,156,999, net loss would have been $1,373,343, net loss per share (basic and
diluted) would have been $(.27), and total shareholders' deficit would have been
$(673,693). For an explanation of the determination of the number of shares used
to compute basic and diluted net loss per share and weighted average shares
outstanding, see note 2 of the notes to our financial statements. The balance
sheet data "as adjusted" as of September 30, 1999 reflect our sale of the
minimum $4,000,000 in investment units and the maximum $5,000,000 in investment
units, respectively, and our receipt and application of the estimated net
proceeds as described in "Use of Proceeds." Our historical financial information
has not been restated for the anticipated two-for-one stock split expected to be
effected immediately before the closing of this offering.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(MARCH 5, 1996) YEAR ENDED NINE MONTHS
TO DECEMBER 31, DECEMBER 31, ENDED SEPTEMBER 30,
---------------- ------------------------ ------------------------
1996 1997 1998 1998 1999
---------------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Internet access................ $ 29,579 $ 399,167 $ 1,334,053 $ 925,005 $ 1,441,132
Data center services........... 33,048 205,171 417,112 269,167 420,814
Circuit rebill................. 276 44,459 255,230 164,888 361,594
Other.......................... 2,495 26,772 135,950 104,991 64,533
---------- ---------- ----------- ---------- -----------
Total............................ 65,398 675,569 2,142,345 1,464,051 2,288,073
---------- ---------- ----------- ---------- -----------
COSTS AND EXPENSES:
Cost of network services....... 73,963 528,835 1,235,862 819,440 1,461,932
Salaries and wages............. 150,448 370,145 521,570 403,030 958,010
General and administrative..... 67,259 131,767 379,036 210,398 615,922
Rent........................... 21,792 33,152 106,417 70,540 87,659
Management fees................ 8,000 42,000 60,000 45,000 30,000
Depreciation and
amortization................. 11,622 57,255 284,598 152,654 291,549
Stock compensation expense..... -- -- -- -- 3,405,395
---------- ---------- ----------- ---------- -----------
OPERATING LOSS................... (267,686) (487,585) (445,138) (237,011) (4,562,394)
---------- ---------- ----------- ---------- -----------
OTHER INCOME (EXPENSE):
Interest expense............... (10,434) (66,201) (150,605) (113,775) (146,046)
Other income (loss)............ -- 6,542 (1,987) (6,346) 12,446
Equity in net loss of
investee..................... -- -- -- -- (82,744)
========== ========== =========== ========== ===========
NET LOSS......................... $ (278,120) $ (547,244) $ (597,730) $ (357,132) $(4,778,738)
========== ========== =========== ========== ===========
</TABLE>
27
<PAGE> 30
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(MARCH 5, 1996) YEAR ENDED NINE MONTHS
TO DECEMBER 31, DECEMBER 31, ENDED SEPTEMBER 30,
---------------- ------------------------ ------------------------
1996 1997 1998 1998 1999
---------------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
PER SHARE DATA:
NET LOSS PER SHARE (BASIC AND
DILUTED)....................... $ (.06) $ (.11) $ (.12) $ (.07) $ (.93)
========== ========== =========== ========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING.................... 5,000,000 5,000,000 5,002,866 5,000,000 5,117,109
========== ========== =========== ========== ===========
OTHER FINANCIAL DATA:
Purchases of property and
equipment, net............... $ (120,442) $ (263,858) $ (414,329) $ (456,826) $ (304,778)
Net cash used in operating
activities................... (202,080) (402,451) (210,355) (121,240) (1,185,399)
Net cash used in investing
activities................... (120,442) (349,196) (1,010,909) (919,460) (304,778)
Net cash provided by financing
activities................... 328,924 799,921 1,450,209 986,024 1,562,245
EBITDA (1)..................... (256,064) (423,788) (162,527) (90,703) (4,341,143)
Insufficient earnings to cover
fixed charges................ 278,120 547,244 597,730 357,132 4,695,994
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
AS OF DECEMBER 31, ---------------------------------------
------------------------------------ AS ADJUSTED AS ADJUSTED
1996 1997 1998 ACTUAL -- MINIMUM -- MAXIMUM
--------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............. $ 6,402 $ 54,676 $ 283,621 $ 355,689 $2,800,604 $3,740,604
Working capital
(deficit)............... (379,483) (883,047) (2,174,370) (1,711,409) 190,996 478,286
Total assets.............. 123,965 529,519 1,649,847 2,358,037 4,802,952 5,742,952
Total debt, including
current maturities...... 328,924 1,128,845 2,214,232 2,018,555 2,656,575 3,309,285
Total shareholders'
(deficit) equity........ (278,120) (825,364) (1,058,272) (673,693) 1,699,712 2,047,002
</TABLE>
- ---------------
(1) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is provided because it is a measure
commonly used in the industry. EBITDA is not a measurement of financial
performance under generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to
cash flow as a measure of liquidity. EBITDA is not necessarily comparable
with similarly titled measures for other companies.
28
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
You should read the following discussion in conjunction with our financial
statements and related notes and other financial information appearing elsewhere
in this prospectus. This discussion contains forward-looking statements relating
to our future financial performance, business strategy, financing plans and
other future events that involve risks and uncertainties. Our actual results
could differ materially from the results anticipated in these forward-looking
statements as a result of many known and unknown factors, including those
factors described in "Risk Factors" and elsewhere in this prospectus.
OVERVIEW
We are a rapidly growing ISP that targets middle market businesses,
educational institutions and governmental organizations. Our primary services
include Internet access, co-location services and managed application hosting
services.
We began operations in June 1996. From inception through December 31, 1996,
we had total revenues of $65,398. During the year ended December 31, 1997, we
expanded operations from one to three POPs and purchased the business customer
lists and related customer accounts of one Atlanta-based ISP to end the year
with revenues totaling $675,569, an approximate ten-fold growth in revenues.
During the year ended December 31, 1998, we expanded our Atlanta data center,
purchased the business customer lists and related customer accounts of two
Atlanta-based ISPs and purchased Athens' ISP, Inc., based in Athens, Georgia.
For the year ended December 31, 1998, we had revenues totaling $2,142,345. For
the nine months ended September 30, 1999, we had revenues totaling $2,288,073.
Our customer base grew as follows during these periods:
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION NINE MONTHS
(MARCH 5, 1996) YEAR ENDED ENDED
TO DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
---------------- ------------- -------------
1996 1997 1998 1999
---------------- ----- ----- -------------
<S> <C> <C> <C> <C>
Customers at beginning of period............. 0 26 243 474
New customers................................ 26 233 297 120
Non-renewing and terminated customers........ 0 (16) (66) (73)
--- --- --- ---
Customers at end of period................... 26 243 474 521
=== === === ===
</TABLE>
Since 1997, our rate of growth has declined due to the lack of capital
needed to expand our network, market and sell our services and add technical and
support staff. The capital we receive from this offering will provide us the
means to repay our debt that matures in January 2000 and to fund our operations
for the first quarter of 2000. We anticipate seeking additional financing to
repay the notes that we are offering by this prospectus and to fund our
operations beyond the first quarter of 2000, develop our network, expand our
operations into new markets, roll out a new marketing campaign and increase our
sales force.
Although we have experienced significant growth in customers and in
revenues, we have experienced operating losses and negative cash flows from
operations in each quarterly and annual period since our inception. We expect to
continue to incur losses and negative cash flows for the foreseeable future. As
of September 30, 1999, we had an accumulated deficit of approximately $6.2
million.
29
<PAGE> 32
We derive most of our revenues from Internet access fees and data center
services. Our data center services currently include co-location, Web hosting
and managed application hosting. We expect revenues derived from our
higher-priced services, such as co-location, managed application hosting and
leased lines, to increase as a percentage of revenues in the future. For
example, monthly T1, fractional T1 and T3 leased line revenues increased by
173.6% for the nine months ended September 30, 1999 over the nine months ended
September 30, 1998. We also expect Web hosting revenues to decline as a
percentage of revenues in the future.
We offer a variety of services to our customers. Depending on the
complexity of their Internet strategies, our customers subscribe to as few as
one service to over 20 services. For the nine months ended September 30, 1999,
the average customer subscribed to 2.9 services. Based on revenues during this
period, our top three Internet access services were ISDN, T1 and frame relay,
and our top two data center services were co-location and Web hosting. For the
nine months ended September 30, 1999, the average number of customers using each
of these services was 378 for ISDN, 41 for leased lines, 21 for frame relay, 35
for co-location and 114 for Web hosting.
We generally provide our services under one-year, two-year and three-year
contracts. Of the 212 contracts signed during the nine months ended September
30, 1999, 172 were one-year contracts, 37 were two-year contracts and three were
three-year contracts. We have experienced a low rate of customer turnover,
averaging 1.4% for the year ended December 31, 1997, 1.5% for the year ended
December 31, 1998 and 1.7% for the nine months ended September 30, 1999.
We charge installation fees for the initial setup of Internet access and
monthly access fees based on a set amount of bandwidth, with additional
incremental fees if the customer orders additional bandwidth. Bandwidth refers
to the amount of data that can be moved in a given period. We charge
installation fees to recover our cost of installing and setting up each customer
for data center services and monthly fees according to the services we provide
under our agreement with the customer. We recognize monthly revenues in the
period in which the services are provided.
Our installation fees are non-refundable and are priced close to or less
than our cost as an incentive to attract the customer. We do not defer
recognition of these fees because we cannot ensure recovery of these costs
through future billings. For example, we may lose the customer in the future. By
recognizing these fees when they are incurred, we match these revenues with the
costs associated with them. We recognize all installation fees in the period in
which the service is installed. Installation revenues were 8.5% of total
revenues for the year ended December 31, 1997, 6.0% for the year ended December
31, 1998 and 2.7% for the nine months ended September 30, 1999.
We also receive revenues from circuit rebill charges, which primarily
result from the resale to our customers of distance-sensitive circuits that we
purchase from local circuit providers such as BellSouth and MCI Worldcom.
Circuit rebill charges consist of both one-time fixed fees for circuit
installations that connect the customer to the local provider and variable
recurring circuit charges. Recurring circuit charges are billed on a monthly
basis and vary based upon circuit type, the distance the circuit spans and/or
the circuit usage, as well as the term of the contract. The local circuit
provider charges us for the installation and recurring charges, and we then
rebill those charges to the customer. Our bill to the customer includes an
add-on charge to the recurring circuit charges for which the provider bills us.
30
<PAGE> 33
We also receive other revenues, consisting primarily of transaction
processing fees and miscellaneous hardware sales. Transaction processing fees
are revenues generated from our e-commerce software and are recognized based on
monthly usage. Hardware sales consist of the resale of some hardware components
to our customers. Because hardware sales are one-time sales, the revenues we
derive from them may vary significantly from period to period.
Our most significant expense item is our cost of network services, which
consists of data communications costs for upstream access, or our connections to
the Internet, and data communications charges for downstream access, or our
connections to our customers. Upstream access costs consist primarily of
payments to network providers such as UUNET, MCI Worldcom, Sprint, GTE
Internetworking and other providers. Our downstream access costs consist
primarily of payments to BellSouth and MediaOne. The next most significant
expense item is salaries and wages paid to our employees.
Our other costs and expenses include:
- selling, general and administrative expenses, including advertising
costs, employee benefits, professional fees, insurance, general office
expense, recruiting, utilities and equipment rentals incurred in the
normal course of business,
- management fees, consisting of charges from db Telecom Technologies,
Inc., an affiliated company that provided us with consulting and
management services through June 30, 1999, after which no more management
fees will accrue,
- depreciation and amortization, consisting primarily of the depreciation
of our fixed assets, ordinarily over a three to ten-year period, and the
amortization of our customer lists, on a customer-by-customer basis, over
the lesser of three years or the period the customer uses our services,
and
- interest incurred on our debt.
We have significantly increased our sales and marketing activities through
the expansion of our sales force, increased emphasis on developing reseller and
referral channels and increased marketing efforts to build the comstar.net
brand. In June 1999, we hired Steven J. Edwards, our Executive Vice President of
Sales and Marketing, to design and implement a comprehensive sales and marketing
plan. Before his hiring, we had not undertaken significant marketing activities.
In the third quarter of 1999, however, we significantly increased our hiring of
sales and marketing personnel to a level that we believe will support our sales
and marketing efforts for the foreseeable future.
31
<PAGE> 34
RESULTS OF OPERATIONS
The following table provides a summary statement of operations, expressed
as a percentage of revenues, for the period from inception (March 5, 1996) to
December 31, 1996, for the years ended December 31, 1997 and 1998, and for the
nine months ended September 30, 1998 and 1999. Operating results for any period
are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(MARCH 5, 1996) YEAR ENDED NINE MONTHS
TO DECEMBER 31, DECEMBER 31, ENDED SEPTEMBER 30,
--------------- ----------------------- -------------------------
1996 1997 1998 1998 1999
--------------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
REVENUES:.............. $65,398 $675,569 $2,142,345 $1,464,051 $2,288,073
======= ======== ========== ========== ==========
Internet access........ 45.2% 59.1% 62.3% 63.2% 63.0%
Data center services... 50.5 30.4 19.5 18.4 18.4
Circuit rebill......... 0.5 6.5 11.9 11.3 15.8
Other.................. 3.8 4.0 6.3 7.1 2.8
------- -------- ---------- ---------- ----------
Total.................. 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======== ========== ========== ==========
COSTS AND EXPENSES:
Cost of network
services............. 113.1% 78.3% 57.7% 56.0% 63.9%
Salaries and wages..... 230.0 54.8 24.3 27.5 41.9
General and
administrative....... 102.9 19.5 17.7 14.4 26.9
Rent................... 33.3 4.9 5.0 4.8 3.8
Management fees........ 12.2 6.2 2.8 3.1 1.3
Stock compensation
expense.............. 0.0 0.0 0.0 0.0 149.0
Depreciation and
amortization......... 17.8 8.5 13.3 10.4 12.7
------- -------- ---------- ---------- ----------
OPERATING LOSS......... (409.3)% (72.2)% (20.8)% (16.2)% (199.5)%
======= ======== ========== ========== ==========
OTHER INCOME (EXPENSE):
Interest expense....... (16.0)% (9.8)% (7.0)% (7.8)% (6.4)%
Other income (loss).... 0.0 1.0 (0.1) (0.4) 0.5
Equity in net loss of
investee............. 0.0 0.0 0.0 0.0 (3.6)
------- -------- ---------- ---------- ----------
NET LOSS............... (425.3)% (81.0)% (27.9)% (24.4)% (209.0)%
======= ======== ========== ========== ==========
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998
REVENUES
Total revenues increased 56.3% to $2,288,073 for the nine months ended
September 30, 1999 from $1,464,051 for the nine months ended September 30, 1998
due to substantial increases in Internet access revenues, data center services
revenues and circuit rebill revenues as described in the following paragraphs.
The increase in total revenues is attributable primarily to a larger number of
customers and a higher amount of sales per customer. We had 521 customers at
September 30, 1999 with an average monthly billing of approximately $516 per
customer for the nine months ended September 30, 1999 compared with 436
customers with an average monthly billing of approximately $471 per customer for
the nine months ended September 30, 1998. The increase in customers at September
30, 1999 was due primarily to successful marketing efforts and additions to our
sales force. The average monthly billing per customer for the
32
<PAGE> 35
nine months ended September 30, 1999 increased by approximately 9.6% over the
average monthly billing per customer for the nine months ended September 30,
1998 due to existing customers upgrading their level of service and new
customers purchasing our higher-priced data center services. We added SDSL
services in May 1999 and managed application server hosting services in June
1999.
Internet access. Internet access revenues increased to $1,441,132, or
63.0% of total revenues, for the nine months ended September 30, 1999 from
$925,005, or 63.2% of total revenues, for the nine months ended September 30,
1998 primarily due to overall increases in the customer base and average billing
per customer discussed above, along with new services.
Data center services. Data center services revenues increased to $420,814,
or 18.4% of total revenues, for the nine months ended September 30, 1999 from
$269,167, or 18.4% of total revenues, for the nine months ended September 30,
1998 primarily due to the overall increase in the customer base and average
billing per customer discussed above. We completed our expansion of the Atlanta
data center facilities in April 1998. This expanded facility, which allowed us
to offer our data center services to a broader market, was available to us for
the entire nine months ended September 30, 1999, compared to only five of the
nine months ended September 30, 1998.
Circuit rebill. Circuit rebill revenues increased to $361,594, or 15.8% of
total revenues, for the nine months ended September 30, 1999 from $164,888, or
11.3% of total revenues, for the nine months ended September 30, 1998. This
increase is due to new and existing customers purchasing or upgrading to
higher-end, more expensive services such as T1 and frame relay.
Other. Other revenues decreased to $64,533, or 2.8% of total revenues, for
the nine months ended September 30, 1999 from $104,991, or 7.1% of total
revenues, for the nine months ended September 30, 1998. The decrease is
primarily attributable to a $38,433 decrease in revenues from non-recurring
hardware resales.
COST AND EXPENSES
Cost of network services. Cost of network services increased to
$1,461,932, or 63.9% of total revenues, for the nine months ended September 30,
1999 from $819,440, or 56.0% of total revenues, for the nine months ended
September 30, 1998. The increase in cost of network services is due primarily to
the increase in the amount of upstream and downstream access services we
purchased to serve our growing customer base. As a percentage of revenues, the
cost of network services increased due to our purchase of excess upstream
capacity to ensure the availability of bandwidth for network growth.
Salaries and wages. Salaries and wages increased to $958,010, or 41.9% of
total revenues, for the nine months ended September 30, 1999 from $403,030, or
27.5% of total revenues, for the nine months ended September 30, 1998. We had 37
employees, including three new executive officers, as of September 30, 1999
compared to 20 employees at September 30, 1998.
General and administrative. General and administrative expenses increased
to $615,922, or 26.9% of total revenues, for the nine months ended September 30,
1999 from $210,398, or 14.4% of total revenues, for the nine months ended
September 30, 1998. The increase in general and administrative expenses is
attributed primarily to an increase in advertising costs, employee benefits,
professional fees, insurance, general office expenses,
33
<PAGE> 36
recruiting, utilities and bad debt expense. These costs increased as we added
senior management and other personnel to plan for future growth.
Rent. As a percentage of total revenues, rent decreased to 3.8% of total
revenues for the nine months ended September 30, 1999 from 4.8% for the nine
months ended September 30, 1998. Rent increased to $87,659 for the nine months
ended September 30, 1999 from $70,540 for the nine months ended September 30,
1998. The increase in rent is primarily attributable to the addition of the
offices in Athens, Georgia in July 1998, Raleigh, North Carolina in February
1999 and Miami, Florida in April 1999.
Management fees. Management fees decreased to $30,000, or 1.3% of total
revenues, for the nine months ended September 30, 1999 from $45,000, or 3.1% of
total revenues, for the nine months ended September 30, 1998. As of July 1,
1999, we assumed the management functions provided by db Telecom Technologies,
and we expect to incur no further management fees after that date. We expect no
material effects on our results of operations as a result of the cancellation of
this arrangement. For more information about our relationship with db Telecom
Technologies, see "Management -- Compensation Committee Interlocks and Insider
Participation."
Stock compensation expense. We incurred stock compensation expense of
$3,405,395 on September 1, 1999 related to stock options that we granted to our
two outside directors, to two other directors who are principal shareholders and
to db Telecom Technologies employees. See "Management -- Compensation Committee
Interlocks and Insider Participation," "-- comstar.net, inc. Amended and
Restated 1999 Stock Option and Incentive Plan" and "-- comstar.net, inc.
Director Stock Option Plan."
Depreciation and amortization. Depreciation and amortization increased to
$291,549, or 12.7% of total revenues, for the nine months ended September 30,
1999 from $152,654, or 10.4% of total revenues, for the nine months ended
September 30, 1998 as we purchased more network equipment to serve our growing
customer base and office equipment to serve our growing employee base. Property
and equipment totaled $1,154,606 at September 30, 1999, and $838,063 as of
September 30, 1998. During the nine months ended September 30, 1998, we
purchased Athens' ISP and the business customer lists of two Atlanta-based ISPs,
which increased the cost basis of our customer lists by $462,636. Accordingly,
we incurred a full nine months of amortization expense on these customer lists
during the nine months ended September 30, 1999.
Interest expense. Net interest expense decreased as a percentage of total
revenues to 6.4% for the nine months ended September 30, 1999 from 7.8% of total
revenues for the nine months ended September 30, 1998. Interest expense, net of
interest income of $15,280, increased to $146,046 for the nine months ended
September 30, 1999 from $113,775 for the nine months ended September 30, 1998
due to the additional debt we incurred to fund our capital purchases and working
capital needs. Total debt and obligations under capital leases at September 30,
1999 was $2,018,555 compared to $2,095,427 at September 30, 1998.
Other income (loss). Other income increased to $12,446, or 0.5% of total
revenues, for the nine months ended September 30, 1999 from a loss of $6,346, or
(0.4%) of total revenues, for the nine months ended September 30, 1998. We
recognized a non-recurring loss of $14,111 on the sale of fixed assets during
the nine months ended September 30, 1998.
34
<PAGE> 37
Equity in net loss of investee. We own 25% of the outstanding equity
interests of nschool Communication Systems, Inc. Our share of nschool's net loss
was $82,744 for the nine months ended September 30, 1999, which reduced our
investment in nschool to $0.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Total revenues increased 217.1% to $2,142,345 for the year ended December
31, 1998 from $675,569 for the year ended December 31, 1997 due to substantial
increases in Internet access revenues, data center services revenues, circuit
rebill revenues and other revenues as described in the following paragraphs. The
increase in total revenues is attributable primarily to a larger number of
customers, partially offset by a lower amount of sales per customer. We had 474
customers at December 31, 1998 and an average monthly billing of approximately
$476 per customer for the year ended December 31, 1998, as compared to 243
customers at December 31, 1997 and an average monthly billing of approximately
$518 per customer for the year ended December 31, 1997. The increase in
customers at December 31, 1998 was due in part to our purchase of the business
customer lists of two ISPs in April 1998 and July 1998 and our purchase of
Athens' ISP in July 1998. The average monthly billing per customer for the year
ended December 31, 1998 decreased by approximately 8.1% over the average monthly
billing for the year ended December 31, 1997 because revenues from lower-priced
Internet access services increased at a higher rate than revenues from
higher-priced data center services.
Internet access. Internet access revenues increased to $1,334,053, or
62.3% of total revenues, for the year ended December 31, 1998 from $399,167, or
59.1% of total revenues, for the year ended December 31, 1997 primarily due to
the overall increase in the customer base, partially offset by a decrease in the
average monthly billing per customer. Internet access revenues increased 234.2%
for the year ended December 31, 1998 over the year ended December 31, 1997.
Data center services. Data center services revenues increased to $417,112,
or 19.5% of total revenues, for the year ended December 31, 1998 from $205,171,
or 30.4% of total revenues, for the year ended December 31, 1997 primarily due
to the overall increase in the customer base, partially offset by a decrease in
the average monthly billing per customer. We completed our expansion of the
Atlanta data center facilities in April 1998. This expanded facility allowed us
to offer our data center services to a broader market. Data center services
revenues increased 103.3% for the year ended December 31, 1998 over the year
ended December 31, 1997.
Circuit rebill. Circuit rebill revenues increased to $255,230, or 11.9% of
total revenues, for the year ended December 31, 1998 from $44,459, or 6.5% of
total revenues, for the year ended December 31, 1997. The increase is due to new
and existing customers purchasing or upgrading to higher-end, more expensive
services such as T1 and frame relay.
Other. Other revenues increased to $135,950, or 6.3% of total revenues,
for the year ended December 31, 1998 from $26,772, or 4.0% of total revenues,
for the year ended December 31, 1997. The increase is primarily due to a $42,846
increase in non-recurring hardware resales and $37,533 in transaction processing
fees associated with our e-commerce software. We began offering our e-commerce
software for customer use in July 1998.
35
<PAGE> 38
COSTS AND EXPENSES
Cost of network services. As a percentage of total revenues, cost of
network services decreased to 57.7% for the year ended December 31, 1998 from
78.3% for the year ended December 31, 1997. Cost of network services increased
to $1,235,862 for the year ended December 31, 1998 from $528,835 for the year
ended December 31, 1997. This increase in cost of network services is due
primarily to the increase in the amount of upstream and downstream access we
purchased to serve our growing customer base. The decrease as a percentage of
revenues is due to increased use of excess upstream capacity resulting from the
increase in our customer base.
Salaries and wages. As a percentage of total revenues, salaries and wages
decreased to 24.3% for the year ended December 31, 1998 from 54.8% for the year
ended December 31, 1997. Salaries and wages increased to $521,570 for the year
ended December 31, 1998 from $370,145 for the year ended December 31, 1997. The
increase in salaries and wages is primarily due to the increased workforce
needed to serve the expanding customer base. We had 18 employees at December 31,
1998 compared to nine employees at December 31, 1997.
General and administrative. As a percentage of total revenues, general and
administrative expenses decreased to 17.7% for the year ended December 31, 1998
from 19.5% for the year ended December 31, 1997. General and administrative
expenses increased to $379,036 for the year ended December 31, 1998 from
$131,767 for the year ended December 31, 1997. The increase in general and
administrative expenses is primarily attributable to increases in advertising
expenditures, additional insurance policies, professional fees, general office
equipment and computer supply costs as well as dues for our membership in
various industry trade organizations.
Rent. Rent increased to $106,417, or 5.0% of total revenues, for the year
ended December 31, 1998 from $33,152, or 4.9% of total revenues, for the year
ended December 31, 1997. This increase in rent is due primarily to additional
rent incurred with the expansion of our data center and our assumption of a
lease in our acquisition of Athens' ISP.
Management fees. As a percentage of total revenues, management fees
decreased to 2.8% for the year ended December 31, 1998 from 6.2% for the year
ended December 31, 1997. Management fees increased to $60,000 for the year ended
December 31, 1998 from $42,000 for the year ended December 31, 1997. The
increase is directly attributable to an increase in monthly management fees from
$2,000 to $5,000 that became effective on July 1, 1997.
Depreciation and amortization expense. Depreciation and amortization
increased to $284,598, or 13.3% of total revenues, for the year ended December
31, 1998 from $57,255, or 8.5% of total revenues, for the year ended December
31, 1997. The increase in depreciation expense is primarily due to an increase
in the capitalized costs of property and equipment acquired during the year. The
cost basis of property and equipment increased to $849,828 at December 31, 1998
from $384,300 at December 31, 1997. The increase in amortization expense is
directly attributed to the amortization of the customer lists and related
customer accounts purchased from two other ISPs in April and July 1998 and the
amortization of the customer list and related customer accounts acquired with
Athens' ISP in 1998. The cost basis of customer lists increased to $547,974 at
December 31, 1998 from $85,338 at December 31, 1997.
36
<PAGE> 39
Interest expense. As a percentage of total revenues, interest expense
decreased to 7.0% for the year ended December 31, 1998 from 9.8% for the year
ended December 31, 1997. Interest expense increased to $150,605 for the year
ended December 31, 1998 from $66,201 for the year ended December 31, 1997 due to
the additional debt we incurred to fund our capital purchases, customer list
purchases, the Athens' ISP acquisition, and working capital needs. Total debt
and obligations under capital leases at December 31, 1998 was $2,214,232
compared to $1,128,845 at December 31, 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE PERIOD FROM INCEPTION (MARCH 5,
1996) TO DECEMBER 31, 1996
REVENUES
Total revenues increased 933.0% to $675,569 for the year ended December 31,
1997 from $65,398 for the period from inception to December 31, 1996 due to
substantial increases in Internet access revenues, data center services
revenues, circuit rebill revenues and other revenues as described in the
following paragraphs. The increase in total revenues is primarily attributable
to a full twelve months of operations for the year ended December 31, 1997
compared to only seven months of operations for the period from inception to
December 31, 1996, as well as a significant increase in the number of customers
due to the opening of POPs in Miami, Florida and Raleigh, North Carolina in
August 1997 and another POP in Athens, Georgia in September 1997 and the
purchase of a customer list in July 1997. Overall, our customer base increased
from 26 at December 31, 1996 to 243 at December 31, 1997.
Internet access. Internet access revenues increased to $399,167, or 59.1%
of total revenues, for the year ended December 31, 1997 from $29,579, or 45.2%
of total revenues, for the period from inception to December 31, 1996. This
increase in access revenues resulted primarily from internal growth, from the
opening of the additional POPs and from the acquisition of a customer list
referred to above.
Data center services. Data center services revenues increased to $205,171,
or 30.4% of total revenues, for the year ended December 31, 1997 from $33,048,
or 50.5% of total revenues, for the period from inception to December 31, 1996.
The increase in data center services revenues was attributable to the increase
in the customer base for the reasons described above as well as expanded data
center service offerings.
Circuit rebill. Circuit rebill revenues increased to $44,459, or 6.5% of
total revenues, for the year ended December 31, 1997 from $276, or 0.5% of total
revenues, for the period from inception to December 31, 1996. During the year
ended December 31, 1997, we began offering our customers the option of a total
access package and consolidated billing to include the local circuit fees, which
we previously required our customers to pay directly to the telecommunications
carriers.
Other. Other revenues increased to $26,772, or 4.0% of total revenues, for
the year ended December 31, 1997 from $2,495, or 3.8% of total revenues, for the
period from inception to December 31, 1996. The increase is due primarily to the
increase in revenues from non-recurring hardware resales.
COSTS AND EXPENSES
Cost of network services. As a percentage of total revenues, cost of
network services decreased to 78.3% for the year ended December 31, 1997 from
113.1% for the period
37
<PAGE> 40
from inception to December 31, 1996. Cost of network services increased to
$528,835 for the year ended December 31, 1997 from $73,963 for the period from
inception to December 31, 1996. This increase in cost of network services is due
primarily to the increase in the amount of upstream and downstream access we
purchased to serve our growing customer base. The decrease as a percentage of
total revenues is due to our increased use of excess upstream capacity resulting
from the increase in our customer base.
Salaries and wages. As a percentage of total revenues, salaries and wages
decreased to 54.8% for the year ended December 31, 1997 from 230.0% for the
period from inception to December 31, 1996. Salaries and wages increased to
$370,145 for the year ended December 31, 1997 from $150,448 for the period from
inception to December 31, 1996. We had nine employees at December 31, 1997
compared to seven employees at December 31, 1996.
General and administrative. As a percentage of total revenues, general and
administrative expenses decreased to 19.5% for the year ended December 31, 1997
from 102.9% for the period from inception to December 31, 1996. General and
administrative expenses increased to $131,767 for the year ended December 31,
1997 from $67,259 for the period from inception to December 31, 1996. The
increase in general and administrative expenses is attributed primarily to an
increase in advertising costs, travel and entertainment expenses relating to
potential customers and the new POPs in Miami, Raleigh and Athens; equipment and
software purchases and installation costs related to the expansion of the data
center facilities; and equipment rentals. The decrease as a percentage of
revenues is due to the economies of scale realized, as general and
administrative costs generally do not fluctuate with increases and decreases in
total revenues.
Rent. As a percentage of total revenues, rent decreased to 4.9% for the
year ended December 31, 1997 from 33.3% for the period from inception to
December 31, 1996. Rent increased to $33,152 for the year ended December 31,
1997 from $21,792 for the period from inception to December 31, 1996. This
increase in rent expense is due primarily to a full twelve months of rent in the
year ended December 31, 1997 compared to only seven months for the period from
inception to December 31, 1996.
Management fees. As a percentage of total revenues, management fees
decreased to 6.2% for the year ended December 31, 1997 from 12.2% for the period
from inception to December 31, 1996. Management fees increased to $42,000 for
the year ended December 31, 1997 from $8,000 for the period from inception to
December 31, 1996. We paid db Telecom Technologies $2,000 per month from January
1, 1997 through June 30, 1997 and $5,000 per month from July 1, 1997 through
December 31, 1997 compared to $1,000 per month for the period from inception to
December 31, 1996.
Depreciation and amortization. As a percentage of total revenues,
depreciation and amortization decreased to 8.5% for the year ended December 31,
1997 from 17.8% for the period from inception to December 31, 1996. Depreciation
and amortization increased to $57,255 for the year ended December 31, 1997 from
$11,622 for the period from inception to December 31, 1996. The increase is due
primarily to an increase in capitalized costs of property and equipment acquired
during the year ended December 31, 1997. The cost basis of property and
equipment increased to $384,300 at December 31, 1997 from $120,442 at December
31, 1996. The increase in amortization expense is directly attributed to the
amortization of the customer list and related customer accounts purchased in
July 1997. The cost basis of this customer list and related customer accounts
was $85,338.
38
<PAGE> 41
Interest expense. As a percentage of total revenues, interest expense
decreased to 9.8% for the year ended December 31, 1997 from 16.0% for the period
from inception to December 31, 1996. Interest expense increased to $66,201 for
the year ended December 31, 1997, from $10,434 for the period from inception to
December 31, 1996 due to the additional debt we incurred to fund our capital
purchases, the purchase of a customer list in July 1997 and working capital
needs. Total debt at December 31, 1997 was $1,128,845 compared to $328,925 at
December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our operations and capital expenditures
primarily through cash flow from operations; borrowings from banks, shareholders
and db Telecom Technologies; capital leases; and sales of common stock. At
December 31, 1998, we had outstanding debt and accrued interest of $2,349,733.
Our lenders have secured this debt with security interests in our accounts
receivable, inventory, and personal property. At September 30, 1999, we had
outstanding debt and accrued interest of $2,119,879, as follows:
<TABLE>
<CAPTION>
PRINCIPAL MATURITY ANNUAL
LENDER AMOUNT DATE INTEREST RATE
- ------ --------- -------- -------------
<S> <C> <C> <C>
Premier Bank.............................................. $100,100 1/15/00 prime + 1%
Premier Bank.............................................. 700,000 1/15/00 prime + 1%
Dr. Samuel F. Dayton and James L. Bruce, Jr............... 283,985 1/27/00 8.75%
Dr. Samuel F. Dayton and James L. Bruce, Jr............... 618,549 4/30/00 10%
db Telecom Technologies, Inc.............................. 270,188 4/30/00 10%
</TABLE>
We used the proceeds of this debt for equipment purchases, the purchase of
Athens' ISP and working capital.
We expect to use a portion of the net offering proceeds to repay $800,100
of the outstanding debt and accrued interest owed to Premier Bank. We will also
use a portion of the net offering proceeds to pay the $283,985 and accrued
interest that we currently owe to Dr. Dayton and Mr. Bruce directly to The First
National Bank of Commerce. This payment will satisfy the remaining balance of
the $383,985 borrowed from First National by Dr. Dayton and Mr. Bruce on our
behalf, which they loaned to us to fund our purchase of Athens' ISP in July
1998. Additionally, we will use a portion of the net proceeds to repay $140,000
and accrued interest owed to Dr. Dayton under a short-term loan that he extended
to us in November 1999. This loan bears interest at 10% per year and matures on
the earlier of the closing of this offering or January 15, 2000. In addition, at
the closing of this offering, we will issue a total of 543,738 shares of common
stock to Dr. Dayton and Mr. Bruce (one half to each) in exchange for their
forgiveness of the additional $618,549 and accrued interest that we owe to them,
and we will issue 236,337 shares to db Telecom Technologies in exchange for its
forgiveness of $270,188 and accrued interest that we owe to it. In addition to
the debt described above, we have approximately $46,000 of capital leases that
we intend to continue to pay in the ordinary course of business.
From November 23, 1998 through June 30, 1999, we sold 371,786 shares of our
common stock in a private placement at a price of $5.71 per share. We used the
$2,122,744 of net proceeds of that private placement for working capital.
Net cash used by operating activities was $1,185,399 for the nine months
ended September 30, 1999, $210,355 for the year ended December 31, 1998,
$402,451 for the
39
<PAGE> 42
year ended December 31, 1997 and $202,080 for the period from inception (March
5, 1996) to December 31, 1996. Net cash used in investing activities was
$304,778 for the nine months ended September 30, 1999, $1,010,909 for the year
ended December 31, 1998, $349,196 for the year ended December 31, 1997 and
$120,442 for the period from inception (March 5, 1996) to December 31, 1996.
Cash used in investing activities was primarily for the purchase of Athens' ISP
in 1998, the purchase of customer lists and related customer accounts from other
ISPs in 1998 and 1997, the investment in nschool in 1998 and the purchase of
property and equipment in all three years. Financing activities provided cash in
the amounts of $1,562,245 for the nine months ended September 30, 1999,
$1,450,209 for the year ended December 31, 1998, $799,921 for the year ended
December 31, 1997 and $328,924 for the period from inception (March 5, 1996) to
December 31, 1996. The primary source of this cash was proceeds from the
issuance of long-term debt in each of those three years and the issuance of
common stock in the year ended December 31, 1998 and the nine months ended
September 30, 1999.
The net proceeds of this offering, funds currently on hand and funds to be
provided by operations will be sufficient to repay the approximately $1.2
million in debt and accrued interest that will become due between the closing of
this offering and January 27, 2000 and fund our working capital needs through
the first quarter of 2000. The proceeds of this offering will not provide the
funds we will need to pursue our long term plans and growth strategies.
We anticipate seeking additional financing in the near future to repay the
notes that we are offering by this prospectus, to fund ongoing capital
expenditures and liquidity requirements and to begin to achieve our goal of
purchasing and leasing new data centers and POPs. There is no guarantee that we
will obtain this financing on acceptable terms or at all or that if we do obtain
the financing, it will be adequate to purchase or lease the required data
centers and POPs and satisfy our cash requirements.
In addition, numerous factors, including those described in "Risk Factors,"
could accelerate our need for additional funding. For example, we intend to
grow, in part, through strategic acquisitions, some of which may require
significant cash expenditures, but we cannot predict the timing and amount of
any acquisitions and expenditures that may occur.
Our ability to grow will depend not only on acquisitions but also on our
ability to expand and improve our Internet operations, the effectiveness of our
marketing efforts and our customer support capabilities. In addition, we will
need to raise additional capital from equity or debt sources. If we raise
additional funds by issuing equity or convertible debt securities, shareholders
may experience dilution, and those securities may have rights, preferences or
privileges senior to those of our common stock.
We cannot be sure that we will be able to obtain the additional financing
to repay the notes, to satisfy our other cash requirements or to implement our
growth strategy on acceptable terms or at all. If we cannot obtain that
financing on terms acceptable to us, we may be forced to curtail our planned
business expansion and may be unable to fund our ongoing operations.
40
<PAGE> 43
YEAR 2000 COMPLIANCE
OVERVIEW
We rely on computer software programs, internal operating systems and
telephone and other network communications connections to conduct our business.
If any of these programs, systems or network connections are not programmed to
recognize and properly process dates after December 31, 1999, significant system
failures or errors may result. These matters are commonly referred to as year
2000 issues, and they could have a material adverse effect on both our affected
customers and us. Our potential areas of exposure include:
- information technology, including computers, software and systems that we
have developed internally or purchased or licensed from others, such as
our billing system and accounts receivable system,
- non-information technology, including telephone systems and other
equipment that we use internally, and
- external systems, particularly the systems that comprise the Internet and
those services that allow us access to the Internet and our customers to
access our network.
If our operational systems are not year 2000 ready on December 31, 1999, we
may be unable to provide our services.
STATE OF READINESS
Our overall plan to achieve year 2000 readiness includes the following
phases with respect to our information technology and non-information technology
systems:
- assessment of repair requirements, which includes assessing all systems,
significant business processes and connections with others on whom we
depend,
- remediation, which includes updating or modifying systems identified as
critical to our efforts to become year 2000 ready,
- testing of systems which have been altered or replaced as part of our
efforts to become year 2000 ready, and
- contingency planning.
We have completed our assessment phase, including the determination of
whether the system we were reviewing was internally developed, an external
system critical to our operations, or a non-critical system or piece of software
or hardware. We believe that we have completed all necessary modifications with
respect to both our critical and our non-critical systems. We consider any
information technology systems to be "critical" if the failure of that system
would result in our being unable to provide Internet access or data center
services or would prevent us from billing customers. We also have successfully
completed the testing phase of our year 2000 plan.
During the course of our year 2000 plan, we reviewed publicly available
disclosures from the other companies who provide hardware and software that
comprise our critical information technology systems or who operate external
systems on which we rely. Almost all of our outside vendors and providers have
indicated that their hardware, software or
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systems are, or will be, year 2000 ready. Nevertheless, we remain vulnerable to
a significant vendor's or provider's inability to remedy its own year 2000
issues. We cannot assure you that the components of our information technology
systems provided by others, or the external systems on which we rely, will be
year 2000 ready in a timely manner. We have not entered into any material
contracts with external contractors to complete our year 2000 plan.
COSTS
Our costs for assessment, remediation and testing have been minimal to
date, and we do not expect to incur any additional costs that are material.
RISKS
Our failure to correct a material year 2000 problem could result in an
interruption in, or a failure of, normal business activities or operations.
Presently, however, we believe that our most reasonably likely worst case
scenario related to the year 2000 is associated with potential failures of third
party services or products we use in our operations or with the other services
and products our customers use in their operations.
We supply Internet related services to our customers and have not tested
any other products or systems used in our customers' businesses. If our
customers do not successfully address year 2000 issues in their operations, and
as a result they experience temporary or permanent interruptions in their
businesses, we may lose revenues from these customers. We believe that many
businesses, including our customers, are still in the preliminary stages of
analyzing their systems for year 2000 issues. We cannot estimate the potential
expenses involved or delays that may result from the failure of these customers
and third parties to resolve their year 2000 issues in a timely manner. If these
expenses, failures or delays do in fact occur, they may have a material adverse
effect on our business, financial condition or results and operations.
In providing Internet access to our customers, we depend upon providers of
telecommunications and data services, government agencies, utility companies and
other service providers over which we have little or no control. If any of these
entities fails to correct its year 2000 issues, our customers may be unable to
use the Internet, and our operations would suffer. See "Risk
Factors -- Potential year 2000 problems may cause us to lose customers and
subject us to significant liabilities and costs."
CONTINGENCY PLANS
We have no specific contingency plans for year 2000 failures other than the
redundancies already built into our system. For example, we have multiple
connections to ISPs, allowing us to route traffic away from any particular
provider that may experience problems. We believe if one or more of our
providers fail, we will be able to obtain additional connections from either our
current providers or new providers. In addition, we have a back-up generator
powered by diesel fuel that will provide power for approximately 36-48 hours.
Provided we can refuel the generator, we can continue our corporate functions
indefinitely. We have a relationship with a local fuel provider from whom we can
request fuel if there is a lengthy outage. If most or all of our providers fail,
however, we will be unable to furnish our services until our providers are again
able to offer services to us. We
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have no plans to establish a more specific contingency plan in the event of year
2000 disruptions.
The estimates and conclusions included in this discussion contain
forward-looking statements and are based on our management's best estimates of
future events. Our expectations about risks, future costs and timely completion
of our year 2000 testing may turn out to be incorrect, and any variance from
these expectations could cause actual results to differ from this discussion.
Factors that could influence risks, amount of future costs and the timing of
remediation efforts include our success in identifying and correcting potential
year 2000 issues and the ability of others to address their year 2000 issues.
The statements above related to the ability of our services to operate
properly before, on and after January 1, 2000 are "Year 2000 Readiness
Disclosures" under the Year 2000 Information and Readiness Disclosure Act of
1998. Those statements are not a guaranty, contract or warranty, and our
compliance with that act does not preclude any claims against us based on the
federal securities laws.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general-purpose
financial statements. This statement was effective for periods beginning after
December 15, 1997. The adoption of SFAS No. 130 did not have an impact on our
financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information," which establishes standards for the way
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
services, geographic areas and major customers. This statement was effective for
financial statements for periods beginning after December 15, 1997. The adoption
of SFAS No. 131 did not have a material impact on our financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. In June 1999,
the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." This
statement defers the effective date of SFAS No. 133 to fiscal years beginning
after June 15, 2000. We believe that the adoption of SFAS No. 133 and SFAS No.
137 will not have a material impact on our financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our interest income and expense is sensitive to changes in the general
level of United States interest rates. Changes in United States interest rates
affect the interest that we
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earn on our cash investments as well as the interest that we incur on our debt.
Based on our cash equivalents balance and level of debt at September 30, 1999,
our exposure to interest rate risk is not material.
We believe our exposure to market risks is immaterial. We hold no market
risk sensitive instruments for trading purposes. At present, we do not employ
any derivative financial instruments, other financial instruments or derivative
commodity instruments to hedge any market risks, and we do not currently plan to
employ them in the future.
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BUSINESS
OVERVIEW
We are a rapidly growing ISP that targets middle market businesses,
educational institutions and government organizations. Our primary services
include:
- dedicated Internet access through our highly reliable network, which
provides our customers with Internet access that is "always on,"
- co-location services, in which we provide secure space to house
customer-owned Internet equipment, and
- managed application hosting, in which we provide a server for the
customer's exclusive use to install any software application the customer
chooses.
We refer to our co-location services, our managed application hosting
services and some of the other services we offer through our data center as data
center services. Our managed application hosting services are similar to the
services offered by computer service providers, or CSPs, which house, maintain
and supply power to their customers' Internet equipment.
We believe our growth and success in serving our target customer base is
the direct result of our competitive strengths, including:
- a network that permits our customers to bypass congested Internet
exchanges and access points and avoid Internet exchange breakdowns,
increasing the speed and reliability of our customers' Internet
connection,
- Internet access that we can tailor to meet each customer's needs,
- knowledgeable and responsive customer support by our network experts,
- business Internet solutions that allow our customers to outsource a
significant portion of their Internet technology and staff, and
- a senior management team with more than sixty years of combined
experience in designing, implementing and managing telecommunications
networks.
We anticipate seeking additional financing in the near future to fund
ongoing capital expenditures and liquidity requirements and to begin to pursue
our business and growth strategies as explained below. There is no guarantee
that we will obtain this financing on acceptable terms or at all or that if we
do obtain the financing, it will be adequate to fund our planned strategies.
INDUSTRY BACKGROUND AND OPPORTUNITY
The Internet was originally conceived as a communications tool to be used
by a limited number of researchers and academics. Today, it has escalated into a
web of approximately 196 million interconnected users. The Internet has evolved
from a static, text-based medium to a graphically rich communications
infrastructure. The creation and rapid development of the desktop computer
simplified access to the Internet, encouraging consumers to seek information
through this new medium. As the breadth of the information expanded, the
Internet's applications and users grew as well. Businesses began investigating
the potential of the Internet to reach the growing volume of customers on the
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Internet. To capture this emerging customer base, businesses needed a presence
on the Internet and applications to facilitate electronic commerce.
THE INTERNET INFRASTRUCTURE
The Internet has emerged as a significant global business communications
medium, enabling millions of people to communicate, publish and retrieve
information, and conduct business electronically. A multi-tiered system of
local, regional and national ISPs has evolved to provide access to the Internet,
transport data and, more recently, to provide value-added Internet services.
ISPs exchange data in packets generated by their customers through direct or
indirect connections with other ISPs. To meet the needs of ISPs to exchange data
at centralized points, large ISPs have established a series of central Internet
exchanges, which facilitate the transmission of data.
Despite the relatively centralized nature of these exchange points, data
traveling across the Internet often makes multiple connections or "hops" through
a variety of local, regional and national ISPs, as it moves from the originating
site, through a central exchange point, and to its final destination. While
these centralized points have the advantage of having dozens of ISPs
interconnected and exchanging Internet data, they increasingly face congestion
problems that cause significantly longer response times for a user. In addition,
because data traveling across the Internet must often make connections through
multiple ISPs, the failure of a single ISP's Internet connection can interrupt a
user's Internet transmission. Many ISPs have sought to improve data transmission
reliability and speed by establishing private "peering connections" and network
access points. This permits the ISPs to directly exchange Internet traffic while
reducing the number of hops in their Internet connection and avoiding the often
congested major Internet exchanges.
THE GROWTH OF THE INTERNET
The Internet has experienced tremendous growth and has become a global
medium for communications and commerce. According to International Data
Corporation, or IDC, the ISP market in the United States reached $10.7 billion
in 1998, representing a 43.0% increase over 1997 revenues. Business-related
Internet access services generated approximately $2.9 billion of the $10.7
billion aggregate 1998 ISP revenue. Moreover, IDC predicts revenues generated
from access services by business-related ISPs will increase by 75.9% to $5.1
billion in 1999 and reach $12.0 billion by 2003, growing at a compound annual
growth rate of 36.2% from 1998 to 2003. In addition, IDC estimates that the
total value of goods and services purchased over the Internet will increase from
$50.5 billion in 1998 to approximately $734.0 billion by the end of 2002.
Trends contributing to the growth of the business-related Internet market
include:
- the increasing availability of high bandwidth capacity,
- the proliferation of Internet access and ancillary Internet services,
- the competitive need of small and mid-sized businesses to automate key
business processes,
- the convenience and speed of conducting business over the Internet,
- the availability of Internet-enabled packaged software applications,
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- an increase in the amount and diversity of business and educational
information available on the Internet and the Web, and
- recent enhancements in the Internet's security and reliability.
The demand generated by these new dynamics, combined with business
customers' high quality service requirements, has fueled the growth of dedicated
access connections and other Internet-related products and services for
businesses.
WEB HOSTING AND CO-LOCATION
To realize the opportunities of the Internet, companies must develop an
attractive Internet presence using a "Web site" that is easily accessible to
potential customers. However, rapid Internet and technology growth have outpaced
the ability of many businesses to develop the necessary internal information
technology knowledge and tools. A variety of companies, including Web hosting
companies and ISPs, have begun to focus on providing Internet co-location and
other Web-related services to their customers. Typically, companies offering
these services build networks of numerous geographically dispersed data centers
to be physically close to their customers. This reduces the cost of the services
and the risk of transmission delay and data loss as data travels through
multiple network connections. According to IDC, corporate Internet access and
value-added services, such as Web hosting and co-location, are the fastest
growing services offered by ISPs. Corporate access revenue and value-added
services revenue were $5.9 billion in 1998 and are expected to grow to
approximately $25.0 billion by 2003.
THE TREND TOWARD OUTSOURCING OF INTERNET OPERATIONS
Many businesses lack the resources and expertise to cost-effectively
develop, maintain and continually upgrade their network facilities and systems.
Also, individuals with the expertise to establish and maintain sophisticated
Internet technology are in great demand and their services are costly.
Furthermore, businesses often find it difficult to keep up with new technologies
and to integrate them into their infrastructure. Even if enterprises possess the
necessary resources to accomplish these tasks, we believe that they often
determine that this ongoing and significant investment in their own Internet
technology and personnel is an inefficient use of their overall resources.
Consequently, many enterprises are seeking outsourcing arrangements for their
Internet needs. These arrangements allow enterprises to focus on their core
operations, enhance the reliability and performance of their Web sites and
reduce their Internet-related operating expenses.
THE CONVERGENCE OF SERVICES IN THE COMMUNICATIONS INDUSTRY
The traditional divisions within the communications industry are
disappearing due to new regulations, customer demand, and technology evolution.
Regulatory changes in the United States and around the world have opened the
communications industry to increased competition. In particular, the
Telecommunications Act of 1996 provides for comprehensive reform of
telecommunications laws in the United States and is designed to foster
competition in the local telecommunications marketplace.
With greater competition in the communications industry, customers have
increasingly demanded that communications providers offer multiple services at
lower prices. These services may include local and long distance calling,
wireless, Internet access, and high-
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speed dedicated lines. Also included are ancillary services such as single bill
presentment, call forwarding, caller identification, voicemail and similar
services.
We believe that these integrated providers will increase efficiency in the
deployment of communications services by selling multiple services in bundles
over a single connection. Enhancements in switching technologies are beginning
to permit the delivery of numerous services over a single network, offering cost
savings over traditional networks which were designed to deliver a limited
number of services. We believe that as competition increases, providers who
offer a range of services in a cost-effective manner will be best positioned to
capitalize on the convergence of services within the communications industry.
These providers will offer a well-designed package of services they can tailor
to satisfy each customer's needs.
THE COMSTAR.NET STRATEGY
CURRENT BUSINESS STRATEGIES
We intend to become a leader in providing businesses, educational
institutions and governmental organizations with high quality, cost-effective
business solutions that will allow our customers to take advantage of the
Internet without having to develop and maintain their own Internet technology
and hire and retain an extensive Internet staff. To achieve this objective, we
intend to continue to rely on the following core elements of our business
strategy:
Providing Highly Reliable Internet Access. We intend to continue
increasing the capacity, fault-tolerance and geographic reach of our network to
support customer growth. Our network is designed to respond quickly, be secure
and provide continuous availability to our clients. We can deliver our services
to customers throughout the world from our Atlanta data center. We connect our
customers' Internet traffic to four very large ISPs who provide access to the
central Internet exchanges. Our innovative network architecture often permits
our customers' Internet traffic to bypass congested points on the Internet and
avoid breakdowns at the Internet exchanges, which increases the speed and
reliability of their Internet connection. We proactively manage and monitor
traffic on the Internet and reroute traffic to provide high quality access.
Increasing the Percentage of our Revenues from Data Center Services. We
intend to generate a higher percentage of our revenues from our data center
services, specifically co-location and managed application hosting services,
which typically provide higher margins than our Internet access services. We
believe that services like our data center services are among the fastest
growing segments of the Internet marketplace. Our data center services provide a
variety of options to our customers, and we work with their management and
information technology teams to analyze their varied Internet service needs and
choose the option that best addresses those needs. We have offered our
co-location services since June 1996, and as of September 30, 1999 we had 35
co-location customers. We have offered our managed application hosting services
since June 1999, and, as of September 30, 1999, had 11 managed application
hosting customers. We intend to emphasize our managed application hosting
business in our marketing, and we have allocated greater resources to developing
these services.
Targeting Middle Market Business, Educational and Governmental
Customers. The Internet service needs of middle market businesses, educational
institutions and governmental organizations differ significantly from those of
the typical individual consumer because Internet access and related services are
often critical to enterprise
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customers' businesses. They demand dedicated, high speed Internet access and
knowledgeable, prompt and responsive customer support. When marketing our
services, we focus on creating the best solution to meet our customers' needs
and not simply promoting our technology. Compared to individual consumers,
enterprise customers are usually less price sensitive and more willing to pay a
premium for custom solutions that meet their needs. As a result, we believe that
providing services to enterprise customers generates greater revenues and higher
margins per customer than servicing individual consumers.
Providing Superior Customer Support by Network Experts. Enterprise
customers seeking broader access to the Internet increasingly face significant
technological challenges, in part because the Internet is an evolving and
rapidly growing medium. In addition, as new and more complex applications for
the Internet are developed, we believe that even sophisticated users will
increasingly encounter problems. Unlike many other ISPs who outsource their
technical support to independent call centers, the comstar.net professionals who
implemented our network are among those who respond to and resolve customer
inquiries and problems. We intend to continue providing superior customer
support by hiring only customer support personnel who can demonstrate the
ability to understand and manage our network. We believe that our strong
emphasis on the superior customer support provided by our network experts has
resulted in a high level of customer satisfaction and significant subscriber
growth from customer referrals.
GROWTH STRATEGIES
We intend to further develop our business by focusing on the core elements
of our business strategy discussed above and pursuing the following key growth
strategies:
Expanding Our Network Nationally. We intend to build more data centers and
POPs throughout the United States. We believe that having a number of widely
distributed and networked data centers and POPs improves network performance and
reliability. We intend to add data centers in the following metropolitan areas
by the end of 2000: Washington, D.C., Chicago, Boston, Miami and Dallas. Before
purchasing or leasing a new data center, we will evaluate the market opportunity
in the proposed location by analyzing Internet usage statistics and specific
economic criteria as well as pre-selling our services in that market. For any
given location we expect to require at least six months to select the
appropriate site, construct or acquire the necessary facilities, install
equipment and hire the operations and sales personnel needed to conduct business
at the site. We have already identified suitable sites for some of our proposed
data center locations. We also intend to supplement the data center expansion by
establishing POPs throughout the United States to aggregate and transport
traffic to and from our planned data centers.
Broadening Our Marketing Activities. We intend to expand our marketing
efforts to increase our customer base. We also intend to increase market
awareness of our name and our commitment to reliable service and superior
customer support. Therefore, while continuing to encourage referrals from
existing customers, we are increasing print publication, radio, outdoor, and
direct mail advertising and telemarketing in targeted metropolitan areas.
Pursuing Strategic Sales and Distribution Alliances. We are pursuing
strategic sales and distribution alliances in markets where there are
substantial opportunities to attract new customers. We believe that establishing
relationships with businesses that provide products and services which
complement our service offerings will permit us to use their expertise and
market access, while lowering our costs of entering new markets. These
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relationships will also give us additional customer referrals and new solutions
to offer existing customers. For example, we currently obtain customer referrals
through our Valued Internet Partner, or VIP program, in which we pay our
partners a fee for referring new customers who ultimately purchase our services.
We will also pursue strategic alliances with resellers or other authorized
partners through our comstar.net Affiliate Partner, or CAP program, which
permits others to resell our services directly to customers in specified
markets. We intend to further expand our customer base by establishing
additional distribution relationships with network integrators, resellers,
system vendors, consulting companies and other ISPs.
Engaging in Strategic Acquisitions. We will continue to consider
acquisitions of strategically located operations and customer lists and
associated customer accounts. In addition, we may consider acquisitions of
businesses, including other ISPs, with complementary products, services or
technologies. We may also consider acquisitions that can provide personnel who
augment our team of network experts.
Eventually Becoming an Integrated Communications Provider, Offering Both
Voice and Data Services. We plan to pursue a long-term strategy of providing a
complete portfolio of voice and data communications services. To achieve our
goal, we plan to undertake, in several states in which we operate, the approval
process necessary to become a competitive local exchange carrier, or CLEC, which
would permit us to provide voice and other data services to complement our
current services. We believe that technology advancements and customer
preferences are driving the convergence of communications services toward
service providers who can offer multiple communication services through a single
network. We also believe that to remain competitive in the face of these
changes, we must eventually become a single-source provider of voice and data
communications services.
NETWORK DESIGN
To increase Internet access speed for our customers, we designed our
network to avoid congested areas on the Internet. Most Internet traffic moves
through central Internet exchanges. To avoid transporting all of our customers'
traffic through these central exchanges and the related network access points,
we have established direct links to very large ISPs, including UUNET, GTE
Internetworking, Sprint and Intermedia Internet. Through this network, we can
dynamically reroute traffic quickly and efficiently. Our network experts monitor
traffic patterns and congestion points throughout the network and reroute our
customers' traffic to a different Internet link when there is excessive
congestion. As a result, we can deliver most of our customers' Internet traffic
while bypassing congested points on the Internet.
Another important characteristic of our network is its high level of
reliability. We maintain multiple links with very large ISPs to protect against
a service outage should one or more links fail. Our equipment automatically
monitors Internet traffic and reroutes it to avoid breakdowns at Internet
exchanges and access points so that our customers' upstream transmissions are
not affected by failures in other systems. In addition, each data center and POP
we operate has multiple fiber or copper telecommunications lines into the
facility so that downstream transmissions operate reliably.
Our network provides optimal service to our customers who are
geographically located relatively close to either a data center or a POP. Close
proximity allows the transportation of our customers' traffic from their server
to its destination and back in a shorter period of
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time. Close proximity also allows us to provide a greater range of services at
lower costs to our customers.
The following diagram describes how our network is linked to very large
ISPs and how we can distribute our customers' traffic:
Central Internet Exchanges diagram
A chart appears here, illustrating the manner in which comstar.net is connected
to major Internet access providers and its customers, showing various ways in
which comstar.net is able to distribute its customers' traffic over the
Internet.
The chart has 3 columns. The first column has five circles, containing the
following text: (1) UUNET, (2) GTE/BBN, (3) Sprint, (4) Intermedia and (5)
Others. The second column has two circles, containing the following text: (1)
comstar.net and(2) other ISP. The third column contains five circles, each of
which contains the following text: business customer. At the far left of the
three columns, there is a bar with the caption ''Central Internet Exchanges'',
illustrating the position of the Central Internet Exchanges.
SERVICES
We create tailored solutions for our customers based on their business and
technical requirements, modifying these solutions as our customers' needs
evolve. Unlike many other ISPs that outsource their technical support to
independent call centers, our highly reliable services are supported by our
knowledgeable and responsive network experts, some of whom are the same
professionals that implemented our network. Our primary services include
dedicated Internet access, co-location services and managed application hosting.
We also offer Web hosting, e-mail services and domain name services.
Our customer contracts require us to provide our services for a one-year,
two-year or three-year term, and contain, among other things, a limited service
level warranty related to the continuous availability of service on a 24 hours
per day, seven days per week basis, except for scheduled maintenance periods.
This warranty provides a credit for free service for disruptions in our Internet
access services. At the end of the term of a contract, a customer may elect to
extend the contract's term on a month-to-month basis. Any change or upgrade in
service, however, typically requires a new contract for a new term.
Internet Access. Our Internet access services are designed to deliver the
ease of expansion, high availability and performance required by moderate to
high volume Internet operations that are central to a customer's business.
Revenues from our Internet access services represented approximately 62.3% of
our revenues for the year ended December 31, 1998 and 63.0% of our revenues for
the nine months ended September 30, 1999.
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Our Internet access options include:
<TABLE>
<CAPTION>
SERVICE DESCRIPTION BENEFITS
- ------- ----------- --------
<S> <C> <C>
T1, Fractional T1 and Leased lines are a dedicated service Leased lines, which are priced
T3 Leased Lines that delivers access speeds from on a per-mile basis, provide a
56Kbps to 44Mbps. customer with a truly private
network where no other entity's
data flows over the same
network. Leased lines are very
cost-effective when reasonably
close to one of our POPs or our
data center.
Frame Relay Frame relay is a dedicated service Gives customers connecting
that delivers access speeds from geographically dispersed
56Kbps to 44Mbps. offices an affordable
alternative with pricing that
is not based on mileage.
Symmetrical Digital SDSL is a dedicated service using Provides inexpensive Internet
Subscriber Line, or digital technology to deliver access access for customers with high
SDSL speeds from 160Kbps to 1.54Mbps. bandwidth requirements.
Integrated Services ISDN is a dial-up service utilizing Provides inexpensive Internet
Digital Network, or digital signaling technology to access for customers with low
ISDN deliver access speeds of either bandwidth requirements.
64Kbps or 128Kbps.
</TABLE>
We have developed an important enhancement to our T1, fractional T1, T3 and
fractional T3 leased line Internet access options -- the eCommerce Guarantee. We
will compensate those customers for the lost profits, up to $500,000 per access
line, for each interruption they suffer in their Internet access service if the
interruption occurs outside the customer's demarcation point, which is the point
at which the customer assumes responsibility for the communications network, and
the interruption causes the customer to lose profits. An insurance company rated
"A" by A.M. Best Company has insured our liability for the eCommerce Guarantee,
and we will be responsible for a per interruption deductible of $10,000 for each
T3 or fractional T3 line and $2,500 for each T1 or fractional T1 line, with an
initial overall deductible limit of $100,000 for any single event that causes
multiple interruptions. This deductible increases to $250,000 once more than 250
of our customers are covered by the eCommerce Guarantee and to $500,000 once
more than 500 of our customers are covered. The maximum insured amount per
interruption is $500,000 for each T3 or fractional T3 line and $25,000 for each
T1 or fractional T1 line. The maximum amount any customer will be able to
recover during the term of its contract is $500,000 for each T3 or fractional T3
line and $25,000 for each T1 or fractional T1 line. We will pay the eCommerce
Guarantee compensation first by providing the affected customer with a credit
for future access fees and second by paying the customer in cash within 60 days
after the claim is finally determined for the amount of lost profits in excess
of the customer's contract value. We have not yet implemented our eCommerce
Guarantee and we cannot assure that it will be implemented.
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Co-location. Through our co-location services, we provide secure space to
house customer-owned Internet equipment. Based upon their business and technical
requirements, customers may select from shared cabinet facilities, exclusive
cabinets or custom-built rooms with additional security features. All
co-location facilities include dedicated electrical power circuits to ensure
that we meet each customer's power requirements. Because the Internet operations
of our co-location customers frequently require hardware and software upgrades,
we give customers unlimited but secure access to their leased co-location space.
Additional space, electrical power and Internet services can be tailored to meet
our customers' needs. Our co-location services represented approximately 10.0%
of our revenues for the year ended December 31, 1998 and approximately 11.4% of
our revenues for the nine months ended September 30, 1999.
Our Atlanta data center houses the computers that operate the core
functions of our business, including communications equipment, data storage and
retrieval systems, security software and hardware and related customer support.
Our data center provides customers with a secure, climate-controlled facility
that they cannot readily or inexpensively create at their own place of business.
The data center contains:
- a power supply with a back-up generator,
- fire suppression and containment capabilities,
- raised floors,
- fully redundant HVAC, and
- high levels of physical security.
We offer the following co-location services:
- SWITCH HOTEL(TM) -- A dedicated, enclosed custom-built room with separate
dedicated power circuits, providing additional security via key-card
entry, access barriers, motion camera and tiles bolted to the floor.
- CABINET CO-LOCATION -- Mid-level service providing an exclusive cabinet
for the customer. This is an economical solution for customers
co-locating multiple servers.
- SERVER CO-LOCATION -- Entry-level service providing an economical
solution for customers co-locating a single server. The customer's server
shares space in a cabinet with the servers of other customers.
We intend to open new data centers in Washington, D.C., Chicago, Boston,
Miami and Dallas before the end of 2000. We believe our data centers will be an
important factor in attracting customers and marketing our data center services.
Managed Application Hosting. Our managed application hosting service,
which we first introduced in June 1999 and which we refer to as our dedicated
application server hosting, or DASH, service, provides a server for the
customer's exclusive use to install any software application the customer
chooses. In addition, we will provide all required maintenance on the server
hardware. This service, which is similar to the services being
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offered by computer service providers, or CSPs, is targeted to businesses with
high volumes of Internet traffic and with Internet-based applications and Web
services that are extremely important to their daily operations. Unlike typical
Web hosting operations that host multiple customers' Web sites on a single
server, we provide our managed application hosting services with only one
customer per server. As a result, a customer need not be concerned about how its
actions or applications might impact other customers' applications housed on the
same server, or how its server might be affected by other customers' actions or
applications.
Our managed application hosting services offer a suite of applications from
leading software vendors that is designed to meet the Internet operations needs
of middle market companies. We also offer proprietary e-commerce and Web
development software as additional options for our managed application
customers. We presently offer these software products only in conjunction with
our managed application hosting services. We implement the applications selected
by the customer in our data center, configure them to meet the needs of the
customer, and package them with a server, security, Internet access, back-up and
operational support. A customer may also use software applications it obtains
from others on the server we provide to the customer in our data center.
Our managed application hosting services are compatible with the products
of many leading hardware and software system vendors, including Cobalt Networks,
VA Linux Systems, Hewlett-Packard Company, Sun Microsystems, Silicon Graphics,
Microsoft Corporation and Allaire Corporation. This multi-vendor flexibility
enables our customers to select their own technical solutions and to integrate
their Internet operations with their existing information technology. We offer
our customers four different levels of managed application hosting service that
range from simple to comprehensive solutions, each of which can be tailored to
meet the specific needs of a given customer. In addition, our customers can
augment their services with hardware or software that we provide or software
that they purchase directly from others.
CUSTOMERS
Most of our customers are middle market businesses, educational
institutions or governmental organizations, but our customer base also includes
other ISPs and several larger companies. The Internet service needs of our
target customers differ significantly from those of typical individual
consumers. Enterprises often view their Internet access and related services as
critical to their business. They demand dedicated, high speed Internet access
and knowledgeable, prompt and often highly technical customer support. When
marketing our services, we focus on creating the best solutions to meet our
customers' needs and not simply promoting our technology. We work with our
customers' management and information technology teams to analyze their Internet
needs and create solutions to specifically address those needs. Compared to
individual consumers, enterprise customers are usually less price sensitive and
more willing to pay a premium for creative solutions crafted to meet their
needs. As a result, we believe that providing Internet services to enterprise
customers generates greater revenues and higher margins per
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customer than servicing individual consumers. As of September 30, 1999, we had
521 customers. We provide service to a number of enterprises, including:
- - Atlanta Convention and Visitors Bureau
- - AGL Resources
- - Atlanta Historical Society
- - BellSouth Wireless Services
- - CLAUS.com
- - Elastic Networks, Inc. (formerly a division of Northern Telecom)
- - Georgia Professional Standards Commission
- - Georgia Society of Certified Public Accountants
- - Guantanamo Bay Naval Air Station, Cuba, through a contract with Local
Communications Network
- - Hartsfield Atlanta International Airport
- - Mohawk Industries
- - National Service Industries
- - nBank
- - Net.B@nk
- - nFront
- - NorthPoint Communications
- - Primerica
- - America Online, through a contract with TeleHouse
- - Tom's Foods
- - WATL-TV Channel 36, Atlanta
Our customer nBank, a division of The First National Bank of Commerce,
provided 9.1% of our revenues for the year ended December 31, 1998 and 10.7% of
our revenues for the nine months ended September 30, 1999. No other customer
accounted for more than 10% of our revenues during either period.
SALES AND MARKETING
We sell our services through a consultative approach developed by our
management team based on their cumulative business experience. We use local
technology-oriented sales personnel to understand individual customer needs and
make the proper recommendations regarding tailored Internet-based solutions. The
local field sales staff is supported by our in-house tele-sales staff based at
our corporate headquarters in Atlanta. We refer to our employees who use the
telephone to directly market and sell our services as our tele-sales staff. We
use our tele-sales staff or our CAP partners, discussed below, to complete sales
to smaller customers and to target customers in markets where we do not have
field sales staff. In addition, we hire independent telemarketing firms to
generate business leads. To support our sales efforts, we have also begun a new
advertising and media campaign to build awareness of our name and quality of
service. We intend to expand our field sales force, further develop our indirect
distribution channels and use telemarketing firms to increase sales leads and
grow our customer base.
Field Sales. Our field sales force consists of technically competent,
locally based and experienced Internet sales representatives. These individuals
have strong Internet technical backgrounds and understand the local
telecommunications tariffs as well as the needs of their local business
communities. In general, members of our field sales staff pursue leads generated
by our telemarketing campaign and our outdoor advertising efforts. Our field
sales personnel also make "cold calls" on potential customers. Most larger sales
are closed by a field salesperson who visits the customer. We believe that this
localized approach allows us to provide better solutions for our customers'
needs.
Tele-sales. Our tele-sales staff contacts smaller potential customers in
the geographic areas we serve as well as potential customers in new markets. We
expect our tele-sales staff to develop the interest of large customers and close
sales to small customers without
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requiring a face-to-face meeting between the customer and a member of our field
sales force.
Indirect Sales. We are developing relationships with partners, including
resellers, network integrators and Web design companies, to use the expertise of
their established sales organizations to help increase our sales.
For example, our Valued Internet Partner, or VIP program, is an agency
relationship that offers referral fees to VIP partners who bring us sales
opportunities that ultimately result in sales of our services. We intend to
expand the VIP program into each new market area we enter. We believe our VIP
program generated a significant number of our new customer installations for the
years ended December 31, 1996, 1997 and 1998. As of September 30, 1999, we had
signed more than 94 VIP partners to the program.
Also, our comstar.net Affiliate Program, or CAP program, allows our
authorized partners to resell our services and maintain a direct relationship
with customers in their local markets. In markets we have not identified as a
high priority for our network expansion, we forward leads directly to our CAP
partners so they can arrange a visit to the customer. We provide service and
technical support 24 hours a day, every day of the year and invoice the partners
at a reduced rate, allowing them to profit from the resale of our services.
Internet Sales. We use the Internet as another source to generate sales.
Our tele-sales staff handles many inquiries regarding our services received via
e-mail, either closing the sale or passing the leads to our field sales force.
We are internally developing systems and applications that will allow us to
receive, accept and implement sales electronically via the Internet.
Telemarketing. We began a telemarketing campaign in May 1999 using an
outside telemarketing firm that we pay on an hourly basis. We also compensate
the firm with performance-based bonuses. We create a sales script used by the
telemarketers and train all telemarketing personnel. Our telemarketing program
seeks to generate leads from small to medium sized businesses that are
pre-qualified for our services in our market areas. We may establish an internal
telemarketing department to ensure the quality of our sales efforts.
Strategic Marketing and Reseller Alliances. We enter into strategic
marketing and reseller alliances with partners to bundle and sell our services
with those of the partners. For example, our agreement with NorthPoint
Communications, Inc. allows us to resell NorthPoint's SDSL service, bundled with
our Internet access service. In addition, NorthPoint jointly funds our marketing
efforts for SDSL services in geographic areas where this service can be offered.
NorthPoint also promotes our services as one of a dedicated number of its
Internet access referral partners.
Branding. As a component of our marketing efforts, we plan to invest
aggressively in building the comstar.net brand. We have already begun outdoor
and radio advertising in the markets we currently serve. We intend to increase
customer awareness of us and our services through an integrated marketing plan,
which combines online and traditional advertising in business and trade
publications, trade show participation, direct mail and public relations
campaigns.
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COMPETITION
The market for Internet access, co-location, and managed application
hosting services is very competitive. The tremendous growth and potential size
of the market for Internet services has attracted many new start-ups as well as
existing businesses. In addition to other national, regional and local ISPs, our
current and prospective competitors include long distance and local exchange
telecommunications carriers, cable television operators and their affiliates,
satellite and wireless communications companies and providers of co-location and
other data center services. We also anticipate that if we offer services as a
CLEC, we will face new competitors that already have established a market
presence for local telecommunications access. When compared to us, many of our
competitors have substantially greater financial, technical, marketing and
personnel resources; larger customer bases; a broader range of services; more
extensive networks and facilities; longer operating histories; greater name
recognition and market presence; and more established business relationships in
the industry. In addition, many of our current competitors have already
developed the capacity to provide, and are providing, local telecommunications
access. Further, intense price competition could significantly reduce our
operating margins and adversely affect our operating results.
The principal competitive factors in our market include:
- Internet system engineering expertise and advanced technical functions,
- price of services,
- availability and quality of customer service and support,
- timing of introductions of new services,
- network capability,
- network security,
- reliability of services,
- financial resources,
- variety and quality of services,
- ease of expansion,
- ability to maintain, expand and add new distribution channels,
- broad geographic presence,
- brand name, and
- conformity with industry standards.
ISPs. Our primary competitors include other ISPs with a significant
national presence that focus on business customers, such as UUNET, GTE
Internetworking, PSINet, Concentric Network, MindSpring Enterprises, Verio and
Intermedia Internet. We also compete with smaller regional and local ISPs in our
targeted geographic regions such as Net Depot and Lyceum. Our customer base
includes smaller ISPs, which may also compete with us for customers in their
markets.
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Value-Added Service Providers. As we increasingly generate revenues from
our co-location and managed application hosting services, competition from other
value-added service providers will become more intense. Value-added service
providers are companies that provide a range of Internet-related services,
including co-location, server hosting, maintenance and security. Our competitors
in this market include co-location providers like Exodus Communications,
Frontier GlobalCenter, Digex and USInternetworking. They also include
application service providers such as NaviSite and Digital Nation, which was
recently acquired by Verio.
Telecommunications Carriers. All of the major long distance companies,
including AT&T, MCI Worldcom and Sprint, offer Internet access services and
compete with us. Local exchange carriers, including the regional Bell operating
companies, have also increasingly begun to enter the Internet access market and
compete with us. We believe that many long distance and local telecommunications
carriers will seek to acquire ISPs, enter into joint ventures with them and
purchase Internet access wholesale from ISPs to address the Internet access
requirements of those carriers' current enterprise customers. Worldcom's
acquisition of UUNET, GTE's acquisition of BBN and Cable & Wireless's
acquisition of internetMCI are indicative of this trend. Accordingly, we expect
to experience increased competition from the traditional large
telecommunications carriers.
Cable Operators, Direct Broadcast Satellite and Wireless Communications
Companies. Many of the major cable television operators, such as MediaOne, have
begun to offer or have announced an intention to offer Internet access through
their existing cable infrastructure. Seeking to take advantage of this installed
cable infrastructure and the Internet access opportunities it affords, many
telecommunications providers have acquired cable companies, such as AT&T's
acquisition of TCI and @Home. While many cable companies are faced with
large-scale upgrades of their existing plant equipment and infrastructure to
support connections to the Internet and become competitive, we believe that some
smaller enterprise customers may be attracted by the combined services already
being offered by cable operators. Other alternative service communications
companies have also announced plans to enter the Internet access market with
various wireless and satellite services and technologies.
GOVERNMENT REGULATION
INTERNET REGULATION
Currently, only a small body of laws and regulations directly apply to
access to or commerce on the Internet. Due to the increasing popularity and use
of the Internet, however, laws and regulations may be adopted at the
international, federal, state and local levels with respect to the Internet,
covering issues such as user privacy, freedom of expression, pricing,
characteristics and quality of products and services, taxation, advertising,
intellectual property rights, information security and the convergence of
traditional telecommunications services with Internet communications. Moreover,
a number of laws and regulations have been proposed and are currently being
considered by federal, state and foreign legislatures with respect to these
issues. We cannot predict the impact on our business of any new laws and
regulations or the manner in which existing and new laws and regulations may be
interpreted and enforced. For example, recently, Congress passed and the
President signed into law:
- The Communications Decency Act, which protects ISPs from defamatory
statements made on or accessible through the provider's service.
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- The Digital Millennium Copyright Act, which provides stronger copyright
protection for software, music and other works on the Internet. Under
this law, ISPs and Web site operators must register with the United
States Copyright Office to avoid liability for infringement by their
subscribers.
- The Child Online Protection Act, which makes it illegal to communicate
material that is harmful to minors on the Internet for commercial
purposes in a manner accessible by minors. This law also requires Web
sites to obtain parental consent before collecting information from
children who are age 12 and younger.
- The Child Protection and Sexual Predator Punishment Act, which imposes
criminal penalties for using the Internet to solicit minors for sexual
purposes, and for sending obscene material to persons under the age of
16.
- The Internet Tax Freedom Act, which imposes a three-year moratorium on
taxes which are multiple or discriminatory, to give state and federal
lawmakers time to develop a more comprehensive approach to Internet
taxation.
In addition, there is substantial uncertainty as to the applicability to
the Internet of existing laws governing issues such as property ownership,
copyrights and other intellectual property issues, taxation, libel, obscenity
and personal privacy. The vast majority of these laws were adopted before the
advent of the Internet and, as a result, did not contemplate the unique issues
of the Internet. Future developments in the law might decrease the growth of the
Internet, impose taxes or other costly requirements, create uncertainty in the
market or in some other manner have an adverse effect on Internet commerce.
These developments could, in turn, have a material adverse effect on our
business.
While no one has ever filed a claim against us relating to information
carried on, stored on, or disseminated through our network, someone may file a
claim of that type in the future and may be successful in imposing liability on
us. If that happens, we may have to spend significant amounts of money to defend
ourselves against these claims and, if we are not successful in our defense, the
amount of damages that we will have to pay may be significant. Any costs that we
incur as a result of defending these claims or the amount of liability that we
may suffer if our defense is not successful could materially adversely affect
our business. If, as the law in this area develops, we become liable for
information carried on, stored on or disseminated through our network, we may
decide to take actions to reduce our exposure to this type of liability. This
may require us to spend significant amounts for new equipment and discontinue
offering some of our services.
The United Kingdom and the European Union have adopted legislation and
directives that have a direct impact on business conducted over the Internet and
on the use of the Internet. For example, the United Kingdom Defamation Act of
1996 protects ISPs, under some circumstances, from liability for defamatory
materials stored on its servers. The European Directives on the Protection of
Consumers, Data Protection, and Distance Selling are expected to have direct
effects on the use of the Internet for commercial transactions and will create
additional layers of consumer protection legislation with respect to electronic
commerce. In addition, governmental authorities throughout the world are
contemplating numerous other regulatory schemes. As in the United States, there
is uncertainty as to the enactment and impact of foreign regulatory and legal
developments. These developments may have an adverse effect on our business.
Our Internet access service transmits some data over public telephone
lines. Regulations and policies establishing charges, terms and conditions for
communications
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govern these transmissions. As an ISP, we are not currently regulated directly
by the Federal Communications Commission, or the FCC, or any other agency, other
than regulations applicable to businesses generally. We could, however, become
subject in the future to regulation by the FCC and/or other regulatory agencies
if we become classified as a provider of basic telecommunications services. As a
result, compliance with these FCC regulations could affect the charges that we
pay to connect to the local telephone network because ISPs, unlike long distance
telephone companies, are not currently required to pay carrier access charges.
Access charges are assessed by local telephone companies on long-distance
companies for the use of the local telephone network when the local telephone
companies originate and terminate long-distance calls, generally on a per-
minute basis. The payment of access charges has been a matter of continuing
dispute, with long-distance companies arguing that the charges are substantially
in excess of actual costs and local telephone companies arguing that access
charges are justified to subsidize lower local rates for end users. In May 1997,
the FCC reaffirmed its decision that ISPs will not be required to pay these
access charges. Subsequent statements issued by the FCC have not altered this
conclusion. The FCC also has concluded that, unlike providers of basic
telecommunications services, ISPs are not currently required to contribute a
percentage of their revenues to the federal universal service fund and are not
expected to contribute to similar funds established at the state level.
Both the access charge issue and the universal service fund treatment of
ISPs are the subjects of further FCC proceedings and may change. Telephone
companies have requested the FCC to reconsider or reverse its decisions in these
areas, and their arguments are gaining support as Internet-based
telecommunications services begin to compete with conventional
telecommunications services. We cannot predict how these matters will be
resolved but it may adversely affect us if, in the future, ISPs are required to
pay access charges or contribute to the universal service fund.
TELECOMMUNICATIONS REGULATION
We intend to file applications to obtain the regulatory and contractual
approvals we need to provide local and long distance telecommunications services
to our customers. If we are successful in entering this marketplace, then our
services will be subject to varying degrees of federal, state and local
regulation. The FCC regulates the facilities and services of telecommunications
common carriers if those facilities are used to originate or terminate
interstate or international communications. The state regulatory commissions
regulate the same facilities and services if they are used to originate or
terminate intrastate communications. Local governments sometimes impose fees and
other requirements on competitive local exchange carriers, or CLECs. Many of
these regulations are currently the subject of lawsuits, legislative hearings
and administrative proposals that may change the manner in which the
telecommunications industry operates. We cannot predict the outcome of these
proceedings or their impact on our business.
Federal Telecommunications Regulations. If we become a CLEC, we will be
regulated at the federal level under the Communications Act of 1934. The
Communications Act of 1934 was substantially amended by the Telecommunications
Act of 1996. Before the passage of the Telecommunications Act, states typically
granted an exclusive franchise in each local service area to a single dominant
carrier. These were often former subsidiaries of AT&T known as regional Bell
operating companies, or RBOCs. An RBOC generally owned and operated the entire
local exchange network in the local service area it served. The
Telecommunications Act provides for comprehensive reform of the
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telecommunications laws in the United States and is designed to foster
competition in the local telecommunications marketplace by:
- prohibiting state and local governments from granting exclusive
telecommunications franchises,
- requiring incumbent local exchange carriers to grant CLECs the right to
interconnect their CLEC facilities to the incumbent carrier's facilities,
- making it easier for customers to switch service from incumbent local
exchange carriers to CLECs,
- requiring incumbent local exchange carriers and CLECs to permit resale of
their communications services without unreasonable conditions or
restrictions,
- requiring incumbent local exchange carriers and CLECs to provide
reciprocal compensation arrangements for transmitting telephone calls,
and
- requiring incumbent local exchange carriers and CLECs to permit competing
carriers access to poles, ducts, conduits and rights-of-way at regulated
prices.
The Telecommunications Act also provided for the removal of most of the
restrictions imposed on RBOCs by the 1982 consent decree which provided for
divestiture of the RBOCs from AT&T in 1984. For example, the Telecommunications
Act establishes procedures under which an RBOC can offer "in-region" long
distance services, which are provided to customers in the area where the RBOC
provides local exchange service. However, before an RBOC can provide in-region
long distance services in a state, it must obtain FCC approval by showing that:
- competitors exist in the state that use their own communications
facilities,
- the RBOC has entered into interconnection agreements with competitors in
the state where it seeks authority,
- the interconnection agreements satisfy a 14-point "checklist" of
competitive requirements, and
- the entry of the RBOC into the market for long distance services in the
state is in the public interest.
On December 22, 1999, the FCC granted this "in region" long distance
authority to BellAtlantic's operations in New York. The FCC has not granted this
authority to any other RBOC, but requests by RBOCs are the subject of pending
appeals at the FCC. As the FCC permits RBOCs to provide "in region" long
distance services, they will begin to compete with existing long distance
carriers. Because RBOCs provide their own local access services, we expect they
will not need the services of CLECs to the same extent as these existing long
distance carriers. If these existing long distance carriers experience a decline
in their businesses as a result of this competition, it may have an adverse
effect on the ability of CLECs to generate access revenues from providing
services to long distance carriers.
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FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act. In August 1996, the FCC adopted rules and policies
implementing the local competition provisions of the Telecommunications Act and
adopted national guidelines regarding:
- the unbundling of incumbent local exchange carriers' network elements,
- the resale of incumbent local exchange carrier services,
- the pricing of interconnection services and unbundled elements, and
- other local competition issues.
Numerous parties appealed the FCC's rules to the United States Eighth
Circuit Court of Appeals, and in 1997, the Eighth Circuit upheld some of the
FCC's rules but reversed many of the FCC's rules on other issues, including the
rules regarding the pricing of unbundled elements.
In January 1999, the United States Supreme Court largely reversed the
Eighth Circuit's decision and upheld many of the FCC's interconnection rules,
including the FCC's jurisdiction to adopt pricing guidelines under the
Telecommunications Act. The Supreme Court also upheld the FCC's "pick and
choose" rules, which allow CLECs to adopt rates, terms and conditions from
agreements that an incumbent local exchange carrier has with any other carriers.
The Supreme Court did not, however, evaluate the specific pricing method adopted
by the FCC, and we expect the Eighth Circuit to further consider that method.
Additionally, the Supreme Court vacated the FCC rules defining what network
elements must be unbundled and made available to the CLECs by the incumbent
local exchange carriers. The Supreme Court held that the FCC must provide a
stronger rationale to support the degree of unbundling ordered by the FCC. In
response, the FCC recently adopted a standard for determining which network
elements must be unbundled. Applying the revised standard, the FCC reaffirmed
that incumbent local exchange carriers must provide unbundled access to six of
the original seven network elements that the FCC required to be unbundled in its
original order in 1996:
- loops, including loops used to provide high-capacity and advanced
telecommunications services,
- network interface devices,
- local circuit switching (except for large customers in major urban
markets),
- dedicated and shared transport,
- signaling and call-related databases, and
- operations support systems.
The FCC determined that incumbent local exchange carriers are not required
to provide CLECs with the seventh element of the original list -- access to
their operator and directory assistance services. We view the Supreme Court
decision and the FCC's recent determination as favorable developments for the
CLEC industry, although we cannot predict the ultimate outcome of further FCC
and court proceedings resulting from these decisions.
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Other Federal Regulation. In general, the FCC has a policy of encouraging
new competitors, like comstar.net, to enter the telecommunications industry and
preventing anti-competitive practices. Therefore, the FCC has established
different levels of regulation for dominant carriers and nondominant carriers.
Large incumbent local exchange carriers such as the RBOCs and GTE Corporation
are currently considered dominant carriers, while CLECs are considered
nondominant carriers. If we gain approval to operate as a nondominant carrier,
we will be subject to relatively limited FCC regulation. At the federal level,
unlike incumbent local exchange carriers, we will not be subject to price cap or
rate of return regulations, which will give us more freedom to set our own
pricing policies.
As nondominant carriers, CLECs may install and operate facilities for
transmitting domestic interstate communications without prior FCC authorization.
The services of nondominant carriers have been subject to relatively limited
regulation by the FCC, primarily consisting of the filing of tariffs and
periodic reports concerning the carrier's interstate network facilities.
However, nondominant carriers must offer interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remain subject to FCC
compliance procedures. The FCC has sought to eliminate the requirement that
nondominant interstate carriers file tariffs, but has been prevented from doing
so by a federal Court of Appeals. However, the court may permit the FCC to take
this action in the future.
The FCC has granted incumbent local exchange carriers significant
flexibility in pricing their interstate switched access and dedicated services.
In May 1997, the FCC adopted an order which makes various reforms to the
existing rate structure for interstate access that are designed to move access
charges, over time, to more cost based rate levels and structures. We expect
that these changes will reduce access charges and shift charges currently based
on minutes to flat-rate, monthly per line charges. As a result, the aggregate
amount of access charges paid by long distance carriers to local exchange
carriers in the United States may decrease. In August 1999, the FCC implemented
a market-based approach to further access charge reform. This approach will give
incumbent local exchange carriers progressively greater flexibility in setting
rates as competition develops, gradually replacing regulation with competition
as the primary means of setting prices. This series of access charge reforms
will likely have a significant impact on our telecommunications services.
In May 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act which seek to advance universal telephone service.
Universal telephone service includes:
- broad access to advanced telecommunications services in rural and high
cost areas, schools, health care facilities and libraries,
- equitable, nondiscriminatory and predictable funding obligations under
the federal universal service fund, and
- affordable rates for telecommunications services.
All telecommunications carriers providing interstate telecommunications
services, which will include us if we obtain approval to provide interstate
services, must contribute to the federal universal service fund. The FCC may
decide in the future to increase the size of subsidy payments by CLECs or the
scope of the subsidy program. This would increase our costs of operating as a
CLEC.
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State Regulation. We believe that most, if not all, states in which we
propose to operate will require a certification or other authorization to offer
intrastate telecommunications services. These certifications generally require a
showing that the carrier has adequate financial, managerial, and technical
resources to offer the proposed services in a manner consistent with the public
interest.
We intend to file applications to obtain intrastate authority for the
provision of dedicated telecommunications services and a full range of local
switched services and long distance services. In most states, we will be
required to file tariffs describing the terms, conditions and prices for
services that are classified as intrastate. Additionally, some states may impose
reporting, customer service, quality requirements and universal service
requirements. There are many regulatory proceedings before the states, the
outcome of which may affect our competitive and economic position in the
telecommunications services markets.
In addition to obtaining state certifications, we must negotiate terms of
interconnection with the incumbent local exchange carrier before we can begin
providing telecommunication services. Our executed agreements will be subject to
the approval of the state commissions. If we are unable to voluntarily negotiate
an interconnection agreement with the incumbent local exchange carrier, we may
petition the state public service commission to arbitrate any open issues. We
may experience difficulties in entering into these agreements on terms
acceptable to us and in enforcing these agreements.
We also may be subject to requirements in some states to obtain prior
approval for, or notify the state commission of, any transfers of our voting
securities, sales of our assets, corporate reorganizations involving us,
issuances of our stock or debt instruments and similar transactions involving
us.
Local Government Authorizations. Under the Telecommunications Act, local
authorities retain jurisdiction to control access to municipally owned or
controlled easements and other rights of way. In addition, if a
telecommunications provider constructs a fiber optic network, it is often
required to obtain construction permits from local governments. In doing so,
however, municipalities may not prohibit or effectively prohibit any company
from providing any telecommunications services. In addition, the
Telecommunications Act requires that local governmental authorities treat
telecommunications carriers in a non-discriminatory and competitively neutral
manner. Many municipalities will require us to obtain franchises from them and
pay fees to them, often based on a percentage of gross revenues we receive from
providing telecommunications services.
PROPRIETARY RIGHTS
General. Although we believe that our success is more a function of our
technical expertise and customer service than our proprietary rights, our
success and ability to compete depend in part upon our technology. We rely on a
combination of contractual restrictions and copyright, trademark and trade
secret laws to establish and protect our technology. Our policy is to require
employees and consultants and, when possible, suppliers to execute
confidentiality agreements upon the commencement of their relationships with us.
The steps we have taken may not be adequate to prevent misappropriation of our
technology, or our competitors may independently develop technologies that are
substantially equivalent or superior to our technology.
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Licenses. We developed some software for nschool Communication Systems,
Inc. and received rights to use the software in exchange for the development of
the software. Specifically, we have the right to use the separable components of
the software for any purpose and to use the combined software product for
limited purposes. We are specifically prohibited from using the software to
provide electronic communications, Internet applications and services to
organized, group-based educational entities.
Trademarks. We own three federal trademark registration applications,
which are currently pending in the United States Patent and Trademark Office. We
filed two applications in May 1999 and one application in August 1999. In May
1999 we filed applications for the marks ComStar Internet Services, Inc., with
design, and ComStar Internet & Wireless, Inc., with design, and in August 1999
we filed an application for the mark comstar.net, inc., with logo. The
applications are based on our intent to use these marks in commerce in
connection with Internet access, web hosting and co-location services for
businesses. We have used marks containing variations of the word "comstar" since
1996, and no third party has notified us of any objection to our use of any of
these marks.
In addition, our wholly owned subsidiary, Comstar Telecom & Wireless, Inc.,
filed an application for the mark Comstar Telecom & Wireless, Inc. in September
1999. The application is based on our subsidiary's intent to use the mark in
commerce in connection with local exchange carrier and long distance
communication services.
The United States Patent and Trademark Office has now examined our
application to register the mark Comstar Internet Services, Inc. and the related
design and our application to register the mark Comstar Internet & Wireless,
Inc. and the related design. Registration of both marks has been refused on the
ground that the marks, when used on or in connection with the identified
services, so resemble a currently registered mark for COMSTAR as to be likely to
cause confusion, to cause mistake or to deceive. Registration has also been
provisionally refused in view of a pending application to register a mark that
includes the term COMSTAR owned by a different party. We disagree with the
findings of the examining attorney and are taking steps to vigorously contest
the rejection and pursue the registrations. The Patent and Trademark Office has
not yet responded to our application for the comstar.net mark or our
subsidiary's application for the Comstar Telecom & Wireless, Inc. mark. In
addition, we own the Switch Hotel(TM) trademark but have not filed a federal
trademark application for it.
EMPLOYEES
As of September 30, 1999, we employed 37 people, including full-time and
part-time employees. We consider our employee relations to be good. All
employees have entered into non-disclosure, non-compete, and non-solicitation
agreements with us. None of our employees is covered by a collective bargaining
agreement.
FACILITIES
We lease our headquarters facilities in Atlanta, Georgia under a lease that
expires on September 30, 2000. The lease covers approximately 4,200 square feet
and the annual rent is approximately $66,000. The lease relating to the data
center at our Atlanta facility expires on September 30, 2004 and has an annual
rent of approximately $67,000 for the first year. The annual rent will increase
by approximately 4.0% each year for the remainder
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of the lease. The data center comprises approximately 4,500 square feet,
including external space for a generator.
We lease approximately 660 square feet of office space in Athens, Georgia,
which contains our POP for that area, as well as several full-time and part-time
employees. We lease this space under an agreement that expires on June 30, 2001.
The annual rent for the Athens facility is approximately $7,600. Our office
space in Miami, Florida and Raleigh, North Carolina each comprises less than 500
square feet and averages approximately $13,000 in annual rent. We also house
servers in additional offices in Miami, Florida; Durham, North Carolina;
Birmingham, Alabama; Columbus, Georgia; and Houston, Texas under co-location
agreements with various customers and telecommunications providers.
LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings.
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<PAGE> 69
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS, AND KEY EMPLOYEES
The executive officers, directors and key employees of comstar.net, and
their ages as of December 1, 1999 are listed in the following table. Immediately
before the completion of this offering, our articles of incorporation will
provide that our board of directors will be divided into three classes, as
nearly equal in number as possible. Class I directors' terms expire at the
annual meeting of shareholders in 2000, Class II directors' terms expire at the
annual meeting of shareholders in 2001, and Class III directors' terms expire at
the annual meeting of shareholders in 2002.
<TABLE>
<CAPTION>
NAME AGE CLASS POSITION
- ---- --- ----- --------
<S> <C> <C> <C>
Samuel F. Dayton, Ph.D........... 64 I Chairman of the Board
J. Cary Howell................... 39 III Chief Executive Officer and
Director
Edward N. Landa.................. 30 I Chief Technology Officer,
Secretary and Director
Christopher K. Martin, C.P.A..... 33 -- Chief Financial Officer and
Treasurer
Cynthia A. St. Ores.............. 40 -- Chief Operating Officer
Steven J. Edwards................ 52 -- Executive Vice President of Sales
and Marketing
Michael A. Dayton................ 37 -- Vice President of Network
Operations
James L. Bruce, Jr............... 55 II Director
Glenn W. Sturm................... 46 III Director
Stephen R. Gross................. 52 II Director
</TABLE>
Samuel F. Dayton, Ph.D., a co-founder of comstar.net, has served as
Chairman of the Board since we were incorporated in March 1996, and he served as
President from our incorporation until November 1999. Since 1994, Dr. Dayton has
also served as Chairman and Chief Executive Officer of db Telecom Technologies,
Inc., which helps telecommunications companies develop and install their
transmission sites, test their equipment for quality and strength of signal, and
maintain their equipment after installation. Dr. Dayton is the father of Michael
A. Dayton.
J. Cary Howell, a co-founder of comstar.net, has served as Chief Executive
Officer and as a director since March 1996. From February 1995 to April 1996,
Mr. Howell was Manager of Network Operations for MindSpring Enterprises, Inc.,
an ISP. From February 1993 to February 1995, Mr. Howell was a communications
consultant with OmniTech Consulting Group, a consulting group for
telecommunications providers such as BellSouth and served as a consultant for
various other companies. From April 1991 to April 1993, Mr. Howell was a Senior
Engineer for Memotec Corporation, a voice and data service provider. In June
1996, Mr. Howell co-founded the Association of Internet Professionals. He is a
life member and served as its first Chairman from June 1996 to May 1998.
Edward N. Landa, a co-founder of comstar.net, has served as Chief
Technology Officer since January 1999, as Vice President of Engineering from
March 1996 to January 1999, and as Secretary and a director since March 1996.
From February 1996 to May 1996, Mr. Landa was an engineer with MindSpring
Enterprises, Inc. From February 1994
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<PAGE> 70
to February 1996, Mr. Landa served as Network Systems Administrator for Lida
Stretch Fabrics, a textile manufacturer. From March 1990 to February 1994, Mr.
Landa worked for the Electric Power Research Institute, a company that
researches technological solutions for the electricity industry, as an employee
of J.A. Jones Applied Research, a research company. Mr. Landa served in various
positions at American Communications Company and its parent American Systems
Corporation, both of which are communications companies, from 1986 to 1988.
Christopher K. Martin, C.P.A., has served as Chief Financial Officer since
March 1999 and as Treasurer since August 1999. From April 1998 to March 1999,
Mr. Martin served as Experienced Manager of the Business Audit Development Team
for Arthur Andersen Performance and Learning in Chicago, Illinois and assisted
in developing the Business Audit methodology being implemented globally by
Arthur Andersen LLP. From September 1990 to February 1998, Mr. Martin served as
an auditor/consultant with the Assurance and Business Advisory Division of
Arthur Andersen in the telecommunications, distribution and logistics,
manufacturing and service industries. From June 1995 to February 1999, Mr.
Martin served as an Experienced Manager within this division. Mr. Martin has
also been a certified public accountant since May 1991.
Cynthia A. St. Ores has served as Chief Operating Officer since July 1999.
From January 1995 to July 1999, Ms. St. Ores served as firmwide technology
implementation specialist with Arthur Andersen. From July 1998 until she joined
comstar.net in July 1999, she was a member of the Knowledge Services Business
Solutions Team at Arthur Andersen, sharing best practices with worldwide firm
personnel and global clients regarding strategies for technology implementation
for knowledge sharing and distance learning environments. From September 1992 to
June 1994, Ms. St. Ores was a research assistant at the University of Illinois.
Steven J. Edwards has served as Executive Vice President of Sales and
Marketing since June 1999. From July 1997 to May 1999, Mr. Edwards served as
Director, Global Business Programs, EMEA (Europe, Middle East, Africa) for Bay
Networks, a hardware provider of networking equipment that was acquired by
Nortel Networks in September 1998. Mr. Edwards served as Director, Customer
Development, EMEA for Bay Networks from May 1996 to June 1997. From June 1993 to
May 1996, Mr. Edwards held various sales positions at SynOptics Communications,
Inc., a hardware provider of networking equipment which merged with another
company and was renamed Bay Networks in October 1994. Mr. Edwards began his
career in 1970 with International Business Machines Corporation and worked in
many sales and marketing functions until his departure in 1989.
Michael A. Dayton has served as Vice President of Network Operations since
August 1999 and served from June 1999 to August 1999 as Vice President of
Finance and Mergers and Acquisitions. Mr. Dayton coordinated our engineering and
accounting functions from June 1997 to June 1999. From September 1994 to May
1997, Mr. Dayton attended the Whiting School of Engineering at Johns Hopkins
University as a graduate student and was also a research scientist at the Center
for Nondestructive Evaluation at Johns Hopkins University. Mr. Dayton is the son
of Dr. Samuel F. Dayton.
James L. Bruce, Jr., a co-founder of comstar.net, has served as a director
since 1996. He has also served as the President and a director of db Telecom
Technologies since 1994. Since 1970, Mr. Bruce has served as an executive with a
variety of businesses in the textile and manufacturing industries.
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<PAGE> 71
Glenn W. Sturm has served as a director since July 1999. Mr. Sturm has been
a partner in the law firm of Nelson Mullins Riley & Scarborough, L.L.P. since
1992, and he presently serves as its Corporate Chairman and as a member of its
Executive Committee. He is a director of Phoenix International Ltd., Inc., The
InterCept Group, Inc. and Towne Services, Inc. Mr. Sturm is a principal of
Capital Appreciation Partners II and the chief executive officer of Netzee, Inc.
Stephen R. Gross has served as a director since July 1999. In 1979, Mr.
Gross co-founded HLB Gross Collins, P.C., a full-service accounting firm in
Atlanta, Georgia. Mr. Gross also serves as a director of the Concert Investment
Series Funds, ebank.com, Inc., Ikon Ventures, Inc. and SuperCorp, Inc.
Upon the completion of this offering, the purchasers of the units, acting
through the purchaser of the largest number of units in this offering, will have
the right to:
- designate two persons as nominees to our board of directors (one of whom
shall have relevant industry experience and shall be reasonably
satisfactory to the other members of the board), which together with the
four principal shareholders shall constitute a majority of the board
unless the holders of 66 2/3% of the outstanding principal amount of the
notes consent otherwise (this right is effective so long as the holders
of the notes in the aggregate own 5% or more of our equity on a fully
diluted basis),
- designate one additional person as an observer who will be permitted to
receive all materials provided to members of the board and its committees
and to attend all meetings of the board and its committees, and
- upon an event of default under the notes, designate as nominees to the
board such number of persons as would then be necessary for all such
designees to constitute a majority of the board.
For additional information relating to these designation rights, see
"-- Compensation Committee Interlocks and Insider Participation" below. We have
no information regarding the identities of any potential designees to our board.
COMMITTEES OF OUR BOARD OF DIRECTORS
<TABLE>
<CAPTION>
COMMITTEES AND MEMBERS FUNCTION OF COMMITTEES
---------------------- ----------------------
<S> <C>
Executive committee - exercises the power of the board of directors
James L. Bruce, Jr. between board meetings, with some limitations
Samuel F. Dayton
Stephen R. Gross
J. Cary Howell
Audit committee - reviews our audit functions, including our
Glenn W. Sturm accounting and financial reporting practices
Stephen R. Gross - reviews the adequacy of our system of internal
accounting controls and the quality and integrity
of our financial statements
- maintains relations with our independent auditors
Compensation committee - establishes the compensation of our executive
Glenn W. Sturm officers, including salaries, bonuses, commissions,
Stephen R. Gross and benefit plans
- administers our option and incentive plans
</TABLE>
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<PAGE> 72
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of our compensation committee is or previously has been an
officer or employee of ours. None of our executive officers currently serves as
a member of the compensation committee or as a director of any entity of which
any of our directors serves as an executive officer. Before establishing the
compensation committee in August 1999, our board of directors, acting as a
whole, determined executive compensation. Dr. Samuel F. Dayton, our Chairman of
the Board, and James L. Bruce, Jr., one of our directors, are also directors,
executive officers and the sole shareholders of db Telecom Technologies, and Dr.
Dayton is also the chairman of the board of nschool Communication Systems, Inc.
We have entered into transactions with each of those companies as explained
below.
From the date of our inception in March 1996 and through September 1997,
Dr. Dayton and Mr. Bruce loaned us an aggregate of $618,549. These loans bear
simple interest at a rate of 10% per year. Immediately before the closing of
this offering, we will issue a total of 543,738 shares to Dr. Dayton and Mr.
Bruce (one half to each) in exchange for their forgiveness of this indebtedness.
From the date of our inception through June 30, 1999, we have paid monthly
management fees to db Telecom Technologies in exchange for various
administrative, accounting, consulting and other management services. For the
year ended December 31, 1998, we paid db Telecom Technologies an aggregate
amount of $60,000 for management fees and $4,305 for other services.
In December 1996, db Telecom Technologies agreed to provide additional
periodic loans to us on an "as needed" basis. Under this agreement, db Telecom
Technologies has loaned us an aggregate of $270,188. All amounts extended under
this loan bear simple interest at a rate of 10% per year. Immediately before the
closing of this offering, we will issue a total of 236,337 shares to db Telecom
Technologies in exchange for its forgiveness of this indebtedness. The repayment
of this debt is personally guaranteed by each of Dr. Dayton, Mr. Bruce, J. Cary
Howell, our Chief Executive Officer and a director, and Edward N. Landa, our
Chief Technology Officer and a director. Dr. Dayton and Mr. Bruce are the sole
shareholders of db Telecom Technologies.
In May 1998, we established a line of credit with Premier Bank to borrow up
to an aggregate of $700,000 from time to time, at an annual interest rate of
prime plus 1%. Each of Dr. Dayton, Mr. Howell, Mr. Landa and Mr. Bruce gave
personal guarantees to Premier Bank that the amounts due under the credit line
would be repaid. As of September 30, 1999, we owed $700,000 under the line of
credit, which becomes due in January 2000. We intend to repay this loan and the
accrued interest with a portion of the net proceeds from this offering.
In July 1998, Dr. Dayton and Mr. Bruce personally borrowed $383,985 from
The First National Bank of Commerce on our behalf, and then loaned us the money
to fund our purchase of Athens' ISP. We repaid approximately $100,000 of this
loan in February 1999, when Dr. Dayton and Mr. Bruce obtained an extension of
the loan's maturity date to August 27, 1999. The loan, which was subsequently
extended in August 1999, currently accrues interest at the rate of 8.75% per
year, and is due on January 27, 2000. We are obligated to repay the remaining
principal amount of $283,985 and accrued interest with a portion of the net
proceeds of this offering.
In September 1998, we borrowed $200,100 from Premier Bank under a
promissory note bearing interest at an annual rate of prime plus 1%. Dr. Dayton
personally guaranteed
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<PAGE> 73
the repayment of this note. We made a principal payment of $50,000 in each of
March 1999 and July 1999. The current amount outstanding is $100,100, and the
loan is due in January 2000. We intend to repay this loan and the accrued
interest with a portion of the net proceeds from this offering.
In December 1998, we entered into an agreement with nschool Communication
Systems, Inc., a developer and licensor of software that links educators,
parents and students. Under the agreement, we developed software applications
for nschool in exchange for 25% of the outstanding common stock of nschool. In
addition, we promised not to compete with nschool by utilizing the developed
technology, and nschool granted us the right to match any contract for Internet
access presented to nschool by any other ISP. We granted to nschool a license to
use both the combined software product and the separable components for limited
purposes, and nschool granted to us a license to use the components of the
software for any purpose and to use the combined software product for limited
purposes.
In September 1999, we granted options to purchase an aggregate of 520,000
shares of our common stock to key employees of db Telecom Technologies at an
exercise price of $5.71 per share in connection with consulting services these
employees performed for us. All of these options were granted pursuant to our
Amended and Restated 1999 Stock Option and Incentive Plan and are currently
exercisable. In December 1999, 2,000 of the options were forfeited.
In September 1999, the board granted each of Mr. Dayton and Mr. Bruce an
option to purchase 137,500 shares of common stock at an exercise price of $5.71
per share in consideration for their financial and management support of us
since our inception. These options were granted under our Amended and Restated
1999 Stock Option and Incentive Plan, are immediately exercisable and have a
term of ten years from the date of grant.
In November 1999, Dr. Dayton agreed to lend us up to $140,000 to cover
short-term expenses. The outstanding principal amount of this loan earns
interest at a rate of 10% per year and is payable on the earlier of January 15,
2000 or the closing of this offering. As of the date of this prospectus we have
borrowed the full $140,000 from Dr. Dayton under this arrangement. We are
obligated to repay this loan and the accrued interest with a portion of the net
proceeds of this offering.
Upon the completion of this offering, we and our four principal
shareholders -- Dr. Dayton, Mr. Bruce, Mr. Landa and Mr. Howell -- will enter
into a shareholders agreement with the purchaser of the largest number of units
in this offering, as agent for all of the holders of the notes. The shareholders
agreement will provide that so long as the holders of the notes in the aggregate
beneficially own 5% or more of our equity on a fully diluted basis, the agent,
acting on behalf of the noteholders, will have the right to designate two people
as nominees to serve on our board of directors. These two nominees, together
with the four principal shareholders, must constitute a majority of the board
unless the holders of 66 2/3% of the outstanding principal amount of the notes
consent otherwise. One of these two nominees must have relevant experience in
our industry and must be reasonably satisfactory to the other members of the
board. Additionally, until we complete an initial underwritten public offering
of securities, the agent will have the right to designate one person as an
observer who will be entitled to receive notice of all meetings of the board and
its committees, to receive all materials distributed to members of the board and
its committees, and to attend all meetings of the board and its committees. Upon
an event of default under the notes, the agent will have the right to
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<PAGE> 74
designate as nominees to the board such number of persons as would then be
necessary for all of the agent's designees to constitute a majority of the
board. Each of the principal shareholders will agree to vote his shares of our
stock and to vote as a director to achieve the board composition described
above. We have no information regarding the identities of any potential
designees under the shareholders agreement. Under the shareholders agreement,
each of the principal shareholders will also agree not to sell or otherwise
dispose of any shares of our capital stock except to members of his immediate
family or related trusts or estates, and these permitted transferees must agree
to hold the shares subject to the terms of the shareholders agreement.
Since our inception, a substantial portion of our business has resulted
from our relationship with db Telecom Technologies. We expect to continue to
benefit from this relationship in the future, particularly with respect to
educational and governmental contracts we may jointly pursue.
DIRECTOR COMPENSATION
Our bylaws allow our board of directors to determine from time to time the
compensation that directors may receive for their service as directors. Since
inception, however, our directors have served without cash compensation, except
for reimbursement for out-of-pocket expenses for each meeting attended.
We granted to each of Mr. Gross and Mr. Sturm options to purchase 100,000
shares of common stock at an exercise price of $5.71 per share in September
1999. These options were vested with respect to one-third of the shares as of
the date of grant and will vest with respect to the remaining shares in two
equal installments on each of the next two anniversaries of the date they
commenced service on the board. The options have a term of five years from the
date of grant. For additional information regarding options and awards directors
are eligible to receive under the comstar.net Director Stock Option Plan, see
"-- comstar.net, inc. Director Stock Option Plan" below.
EXECUTIVE COMPENSATION
The following table describes all compensation earned by or paid or awarded
to our chief executive officer for services rendered to us in all capacities
during the year ended December 31, 1998. No other officer received compensation
in excess of $100,000 for the year ended December 31, 1998.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
--------------------------
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS ALL OTHER COMPENSATION
--------------------------- ---- ------- ----- ----------------------
<S> <C> <C> <C> <C>
J. Cary Howell, Chief Executive
Officer............................ 1998 $69,030 -0- -0-
</TABLE>
EMPLOYMENT AGREEMENTS
As a general matter, we do not enter into employment agreements, and we
have not entered into employment agreements with any of our executive officers.
Rather, the employment relationships with each executive officer are "at will."
However, in connection with the initial employment of each executive officer,
comstar.net and the executive executed an offer letter which outlines the
general compensation and benefits provided to the executive, including base
salary, targeted annual bonus, option grants and employee
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benefits. We granted each of Christopher K. Martin, our Chief Financial Officer,
Cynthia A. St. Ores, our Chief Operating Officer and Steven J. Edwards, our
Executive Vice President of Sales and Marketing, an option to purchase 100,000
shares of common stock at an exercise price of $5.71 per share concurrently with
the commencement of their employment. These options, which were granted under
the comstar.net, inc. Amended and Restated 1999 Stock Option and Incentive Plan,
vest in three equal installments on the first three anniversaries of the
commencement of their employment and have a term of ten years from the date of
grant. In addition, in March 1999 we granted Michael A. Dayton, our Vice
President of Network Operations, an option under the 1999 Option Plan to
purchase 100,000 shares of common stock at an exercise price of $5.71 per share.
As of the date of this prospectus, 66,667 shares subject to the option are
vested and the remaining shares vest in June 2000. Mr. Dayton's options have a
term of ten years from the date of grant.
COMSTAR.NET, INC. AMENDED AND RESTATED 1999 STOCK OPTION AND INCENTIVE PLAN
In March 1999, the board of directors adopted the 1999 Stock Option and
Incentive Plan under which a maximum of 1,700,000 shares of our common stock
were available to be granted to employees, consultants and others rendering
services to us. In September 1999, we increased the number of shares available
for grant under this plan to 2,300,000 shares, and in October 1999 our
shareholders approved the 1999 Option Plan, as amended. The number of shares
that may be granted under the 1999 Option Plan automatically increases on
January 1 of each calendar year to an amount equal to 15% of our common stock
outstanding on December 31 of the previous year, calculated on a fully diluted
basis, if that amount is greater than the maximum amount previously available
for grant under the 1999 Option Plan. Options may be either incentive stock
options within the meaning of Section 422 of the Internal Revenue Code, which
permits the deferral of taxable income related to the exercise of the option, or
nonqualified options not entitled to the tax deferral. Incentive stock options
may only be granted to employees, and the exercise price must be at least equal
to the fair market value of the common stock on the date the options are
granted. In addition, the 1999 Option Plan allows for awards of restricted stock
and stock appreciation rights.
The board of directors and the compensation committee administer the 1999
Option Plan. Under the 1999 Option Plan, the number of shares for which options
may be granted and the number of shares that may be issued under unexercised
options are adjusted to take into account some of the events affecting the
common stock, including stock splits, dividends payable in common stock and
business combinations. Within the limits specified in the 1999 Option Plan, the
board of directors and the compensation committee, in their discretion, select
the recipients of awards and the number of options granted under the 1999 Option
Plan and determine other matters such as:
- vesting and exercisability schedules,
- the exercise price of options, which cannot be less than 100% of the fair
market value of the common stock on the date of grant for all stock
options, and
- the duration of awards.
Our general practice has been to make all options granted under the 1999
Option Plan vest in three equal installments on the first three anniversaries of
the date the optionee commences employment. As of September 30, 1999, we had
granted options to purchase
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1,537,250 shares of common stock under the 1999 Option Plan at an exercise price
of $5.71 per share. All of these options have a term of ten years from the date
of grant. In December 1999, 2,000 of the options were forfeited.
COMSTAR.NET, INC. DIRECTOR STOCK OPTION PLAN
Our board of directors approved the Director Stock Option Plan in September
1999, and our shareholders approved the Director Stock Option Plan in October
1999. The Director Option Plan provides for the grant of non-qualified stock
options to our non-employee directors. The Director Option Plan authorizes the
issuance of up to 600,000 shares of common stock under options having an
exercise price equal to the fair market value of the common stock on the date
the options are granted. Under the Director Option Plan, the number of shares
for which options may be granted and the number of shares that may be issued
under unexercised options are adjusted to take into account some of the events
affecting the common stock, including stock splits, dividends payable in common
stock and business combinations. The board of directors administers the Director
Option Plan.
The Director Option Plan provides for grants of options to acquire shares
of common stock to each non-employee director who is initially elected to the
board of directors after the date of approval of the Director Option Plan. The
board of directors will establish the number of shares in each grant, the
exercise terms and vesting schedules of each option on the grant date. Each
option will expire five years after the date of grant, unless cancelled sooner
as a result of termination of service or death, or unless the option is fully
exercised before the end of the option period. As of September 30, 1999, options
to acquire 200,000 shares of common stock were outstanding under the Director
Option Plan at an exercise price of $5.71 per share. All of these options have a
term of five years from the date of grant.
DIRECTOR AND OFFICER LIABILITY AND INDEMNIFICATION
Our articles of incorporation provide that no director will be personally
liable to us or any of our shareholders for any breach of the duties of office,
except that the elimination of liability does not apply to:
- appropriations of business opportunities in violation of the director's
duties,
- knowing or intentional misconduct or violation of law,
- liability for assenting to distributions which are illegal or improper
under Georgia law or our articles of incorporation, and
- liability for any transaction in which the director derived an improper
personal benefit.
In addition, our articles of incorporation state that if Georgia law is
ever amended to allow for greater exculpation of directors than presently
permitted, the directors will be relieved from liabilities to the fullest extent
provided by Georgia law, as so amended. No further action by the board of
directors or our shareholders is required, unless Georgia law provides
otherwise. No modification or repeal of our articles of incorporation will
adversely
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affect the elimination or reduction in liability provided by them with respect
to any alleged act occurring before the effective date of that modification or
repeal.
We have entered into indemnification agreements with each of our directors
and executive officers that give these individuals similar rights to
indemnification and contribution.
RELATED PARTY TRANSACTIONS
We believe that all of the following transactions, as well as all of the
transactions described in "Management -- Compensation Committee Interlocks and
Insider Participation," were made on terms no less favorable to us than could
have been obtained from other unaffiliated parties. All future transactions,
including loans, between us and our officers, directors, principal shareholders
and their affiliates will be approved by a majority, but not fewer than two, of
our disinterested directors, and will continue to be on terms no less favorable
to us than could be obtained from other unaffiliated parties.
In June 1999, we sold 8,758 shares of common stock at $5.71 per share to
each of Christopher K. Martin, our Chief Financial Officer, and Steven J.
Edwards, our Executive Vice President of Sales and Marketing, each of whom was
an officer at the time of sale.
Our director Glenn W. Sturm is a partner in the law firm of Nelson Mullins
Riley & Scarborough, L.L.P., where he serves as Corporate Chairman and a member
of the executive committee. Nelson Mullins has advised us regarding securities
and corporate law matters since August 1998.
In addition to the transactions described above, other transactions
involving Dr. Samuel F. Dayton, our Chairman of the Board, James L. Bruce, Jr.,
one of our directors and principal shareholders, their affiliates, J. Cary
Howell, our Chief Executive Officer and a director, and Edward N. Landa, our
Chief Technology Officer and a director, are described in
"Management -- Compensation Committee Interlocks and Insider Participation."
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PRINCIPAL SHAREHOLDERS
The following table provides information with respect to the beneficial
ownership of our common stock as of December 27, 1999 and immediately after this
offering by:
- each person known by us to beneficially own more than 5% of the
outstanding shares of common stock,
- each of our directors and executive officers named in the summary
compensation table, and
- all of our directors and executive officers as a group.
Unless otherwise indicated, the address of each of the beneficial owners
identified is c/o comstar.net, inc., 2812 Spring Road, Suite 210, Atlanta,
Georgia 30339. Except as otherwise indicated, the beneficial owners have sole
voting and investment power with respect to all shares of common stock owned by
them. Percentage of ownership before this offering is based on 10,371,786 shares
of common stock outstanding as of December 27, 1999, giving effect to the
two-for-one stock split to be effective immediately before the closing of this
offering. Percentage of ownership after this offering is based on 12,428,519
shares of common stock outstanding after this offering, giving effect to the
stock split, to the issuance of a total of 1,276,658 shares to purchasers in our
private placement concluded in June 1999 and to the issuance of a total of
780,075 shares to two of our founders and their affiliate in exchange for their
forgiveness of approximately $1,006,297 in outstanding indebtedness. Shares of
common stock issuable under options held by the respective person or group which
may be exercised within 60 days after December 27, 1999 are referred to in this
prospectus as "presently exercisable stock options." Under SEC rules, presently
exercisable stock options are deemed to be outstanding and to be beneficially
owned by the person or group holding those options for the purpose of computing
the percentage ownership of the person or group, but are not treated as
outstanding for the purpose of computing the percentage ownership of any other
person or group.
<TABLE>
<CAPTION>
SHARES SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
BEFORE AFTER
THE OFFERING THE OFFERING
-------------------- --------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- ------------------------ ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Samuel F. Dayton(1)...................... 2,646,258 25.2% 3,184,538 25.3%
J. Cary Howell........................... 2,482,490 23.9 2,482,490 20.0
Edward N. Landa(2)....................... 2,502,764 24.1 2,502,764 20.0
James L. Bruce, Jr.(3)................... 2,637,500 25.1 3,145,706 25.0
Glenn W. Sturm(4)........................ 33,333 * 33,333 *
Stephen R. Gross (4)..................... 33,333 * 33,333 *
All directors and executive officers as a
group (9 persons)(5)................... 10,353,194 96.6 11,223,491 87.9
</TABLE>
- -------------------------
* Less than 1% of the outstanding common stock.
(1) Includes 137,500 shares of common stock that may be issued on the exercise
of presently exercisable stock options. Also includes: 8,758 shares of
common stock held before the offering and 38,832 shares of common stock held
after the offering by the Mauney Family Limited Partnership; and 236,337
shares of common stock held after
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the offering by db Telecom Technologies, Inc., all of which may be deemed to be
beneficially owned by Dr. Dayton. Dr. Dayton disclaims beneficial ownership of
the shares held by the Mauney Family Limited Partnership and db Telecom
Technologies, Inc., except to the extent of his pecuniary interest in the
shares.
(2) Includes 10,000 shares of common stock owned by Mr. Landa's wife and 12,264
shares of common stock held by seven trusts of which Mr. Landa is the sole
trustee, all of which may be deemed to be beneficially owned by Mr. Landa.
Mr. Landa disclaims beneficial ownership of all of these 22,264 shares,
except to the extent of his pecuniary interest in the shares.
(3) Includes 400,000 shares of common stock held by Tartan Family Properties,
L.P., all of which may be deemed to be owned by Mr. Bruce. Mr. Bruce
disclaims beneficial ownership of these 400,000 shares except to the extent
of his pecuniary interest in the shares. Includes 137,500 shares of common
stock that may be issued on the exercise of presently exercisable stock
options. Also includes 236,337 shares of common stock held after the
offering by db Telecom Technologies, Inc., all of which may be deemed to be
beneficially owned by Mr. Bruce. Mr. Bruce disclaims beneficial ownership of
the shares owned by db Telecom Technologies, Inc., except to the extent of
his pecuniary interest in the shares. Mr. Bruce's address is c/o Yonah
Manufacturing Company, P.O. Box 280, Cornelia, Georgia 30531.
(4) Consists of 33,333 shares of common stock that may be issued on the exercise
of presently exercisable stock options.
(5) The number of shares owned before the offering includes 341,666 shares of
common stock that may be issued on the exercise of presently exercisable
stock options granted to our directors, 418,758 shares of common stock held
by affiliates of certain members of the group and 12,264 shares of common
stock held by trusts for which members of the group serve as trustee, which
may be deemed to be beneficially owned by those members. The number of
shares of common stock owned after the offering includes, in addition to the
shares noted in the preceding sentence, 30,074 shares held by an affiliate
of a director and 236,337 shares held by db Telecom Technologies, Inc., all
of the stock of which is held by Dr. Dayton and Mr. Bruce.
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DESCRIPTION OF CAPITAL STOCK
The following summary is qualified in its entirety by the provisions of our
articles of incorporation and our bylaws, and by the applicable provisions of
Georgia law.
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Our authorized capital stock consists of:
- 50,000,000 shares of common stock, without par value and without
designation as to series, and
- 5,000,000 shares of preferred stock, without par value, with the rights
and preferences the board of directors determines.
COMMON STOCK
The holders of common stock are entitled to one vote for each share they
hold of record for matters on which they are entitled to vote. There are no
sinking fund provisions or any cumulative voting, preemptive, redemption or
conversion rights applicable to the common stock.
The rights, preferences and privileges of holders of common stock are
subject to, and may be adversely affected by, the rights of holders of any
shares of any series of preferred stock that our board of directors may
designate from time to time in the future. Subject to the preference rights of
the holders of any outstanding shares of preferred stock, holders of common
stock are entitled to receive ratably any dividends and other distributions that
the board of directors may declare out of funds legally available for that
purpose. On the liquidation, dissolution or winding up of comstar.net, holders
of common stock are entitled to share ratably in all assets remaining after the
payment of our debts and other liabilities, and, if applicable, dividends on our
preferred stock. The outstanding shares of common stock are fully paid and
non-assessable.
PREFERRED STOCK
Under our articles of incorporation, our board of directors has the
authority, without shareholder approval or action, to issue up to 5,000,000
shares of preferred stock in the series and with the preferences, limitations
and relative rights as the board of directors may determine from time to time.
The terms of the voting, conversion, dividend, liquidation, preemptive,
redemption and other rights, privileges and preferences conferred on the holders
of any preferred stock may be more favorable than those granted to holders of
common stock. The designation of any preferred stock with greater rights,
privileges and preferences than those applicable to the common stock may
adversely affect the voting power, market price and other rights and privileges
of the common stock, and may hinder or delay the removal of directors, attempted
tender offers, proxy contests or takeovers, or other attempts to change control
of comstar.net, some or all of which the holders of common stock may desire.
Our board of directors can issue portions of the authorized but unissued
shares of our common stock and preferred stock without obtaining shareholder
approval. The board of directors may use these issuances to retain our current
management team or to prevent a
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tender offer or other attempt to take over comstar.net, some or all of which our
shareholders may desire.
RELEVANT PROVISIONS OF THE ARTICLES, BYLAWS AND GEORGIA LAW
Some of the provisions of our articles of incorporation and bylaws and of
Georgia law, summarized in the following paragraphs, may be considered to have
anti-takeover effects. These provisions may hinder, delay, deter or prevent a
tender offer, proxy contest or other attempted takeover that a shareholder may
deem to be in that shareholder's best interest, including an attempted
transaction that might result in payment of a premium over the market price for
shares the shareholder holds.
Classified Board of Directors; Number, Term and Removal of Directors. Our
board of directors is divided into three classes of directors, each serving for
staggered three-year terms. As a result, approximately one-third of our board of
directors will be elected each year. Our articles of incorporation provide that
we may not have more than 15 directors, and that the number of directors will be
set by resolution of the board of directors under our bylaws. Currently, we have
six directors. Directors may only be removed from the board of directors with
cause upon the affirmative vote of at least a majority of the shareholders
entitled to vote for directors at a duly held shareholders' meeting for which
notice of the removal action was properly given. Upon a vacancy created in the
board of directors by a removal action or for any other reason, including an
increase in the size of the board of directors, a successor or new director may
be appointed only by the affirmative vote of a majority of the directors then in
office. The classification of directors, together with the limitation on the
removal of directors, and the ability of the remaining directors to fill any
vacancies on the board of directors, has the effect of making it more difficult
for shareholders to change the composition of the board of directors. In
particular, it will ordinarily require two annual meetings of shareholders to
change a majority of the board of directors, even if holders of a majority of
the shares outstanding desire to change a majority of the board of directors
before that time.
Shareholder Meetings; Actions by Written Consent of Shareholders. Our
bylaws provide that special meetings of shareholders or a class or series of
shareholders may be called at any time by the board of directors, the Chairman
of the Board or the Chief Executive Officer, and must be called on the written
request of the holders of shares representing at least 25% of the votes entitled
to be cast on each issue presented at the meeting, or a majority of the votes
entitled to be cast if we have more than 100 beneficial owners. The bylaws also
provide that shareholders seeking to bring business before an annual
shareholders' meeting or to nominate candidates for election as directors must
provide notice of their proposed action not less than 45 nor more than 90 days
before the first anniversary of the previous year's annual shareholder meeting,
and, in that notice, provide to us information concerning the proposal or
nominee. This provision may prevent shareholders from bringing matters before
the shareholders at an annual meeting or from making nominations for directors
at an annual meeting. All actions by the shareholders either must be taken at a
meeting with prior notice under the bylaws or without a meeting if a written
consent describing the action to be taken is signed by all shareholders entitled
to vote on the action.
Constituency Provisions. Our articles of incorporation permit the board of
directors, its committees and individual directors to consider the interests of
various constituencies, including our employees, customers, suppliers, and
creditors, communities in which we
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maintain offices or operations and other factors which directors deem pertinent
in carrying out and discharging the duties and responsibilities of their
positions and in determining what they believe to be in our best interests. As a
result, it is possible that the board of directors may make a decision that is
in the best interests of some or all of these other constituencies and which is
not in the best interests of all of our shareholders.
Georgia Anti-Takeover Statutes. Some provisions of Georgia law that may
apply to us if we so choose may be considered to have anti-takeover effects and
may hinder, delay, deter or prevent a tender offer, proxy contest or other
attempted takeover that a shareholder may deem to be in his or her best
interest.
Georgia law generally restricts a company from entering into business
combinations with an interested shareholder or an affiliate of an interested
shareholder for a period of five years after the date the shareholder became an
interested shareholder, unless one of the conditions summarized below is met. An
"interested shareholder" is any person or entity that is the beneficial owner of
at least 10% of the company's voting stock. The conditions are:
- before the shareholder became an interested shareholder, the company's
board of directors approved either the business combination or
transaction which resulted in the shareholder becoming an interested
shareholder,
- the interested shareholder acquires 90% of the company's voting stock in
the same transaction in which it exceeds 10%, or
- after becoming an interested shareholder, the shareholder acquires 90% of
the company's voting stock and the holders of a majority of the remaining
voting stock, not including voting stock held by the interested
shareholder, directors or officers of comstar.net or their affiliates,
approve the business combination.
Georgia law states that the above restrictions will not apply unless the
company's bylaws specifically provide that these restrictions are applicable to
the company. We have not elected to be covered by this statute, but we could do
so by action of the board of directors at any time.
Georgia law also imposes fair price and other procedural requirements on
some business combinations with any person who owns 10% or more of the common
stock. These statutory requirements restrict business combinations with, and
accumulations of shares of voting stock of, some Georgia corporations. The
statute will apply to a company only if it elects to be covered by the
restrictions imposed by these statutes. We have not elected to be covered by
this statute, but we could do so by action of our board of directors at any
time.
DIRECTOR EXCULPATION AND INDEMNIFICATION
Our articles of incorporation and bylaws limit the liability of our
directors to us and our shareholders as described above in "Management -
Director and Officer Liability and Indemnification." We have also entered into
indemnification agreements with each of our directors and our executive officers
that give them similar rights to indemnification and contribution.
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DESCRIPTION OF NOTES
Each investment unit includes an 8% senior convertible note. Notes are
offered in principal increments of $50,000, with a minimum of $4,000,000 of
notes and a maximum of $5,000,000 of notes to be sold in the offering. Although
no notes are currently outstanding, we have authorized up to $5,000,000
principal amount of 8% senior convertible notes for issuance. We will not issue
any notes before the closing of this offering. Each note may be transferred
separately from the related warrant.
Each note will mature on the earlier of (1) January 15, 2005, or (2) the
closing of a sale of our securities if the gross proceeds to us are $10,000,000
or more. Simple interest accrues on the notes at the rate of 8% per year and is
payable on the last day of each year commencing on December 31, 2000 and on the
maturity date of the notes. Accrued interest is payable in cash, but the holder
of the note may elect to receive shares of our common stock in payment of the
accrued interest, based on the conversion price. Repayment of principal and
interest is not secured by any collateral, and there is no indenture or trustee
for the notes. The notes will be subordinate in the right of payment to purchase
money indebtedness permitted by the notes.
The notes limit our ability to make payments with respect to the principal
of or other amounts owing with respect to other indebtedness until we pay the
principal of and interest on the notes in full. This provision may limit our
ability to incur additional indebtedness.
Each note is convertible into common stock by the holder in whole or in
part at any time before the maturity date. Any conversion must be in an integral
multiple of $100,000 or the remaining principal amount of the note being
converted. The initial conversion price is $1.29 per share. Therefore, the note
included in a $50,000 investment unit is initially convertible into a total of
38,760 shares of our common stock. The notes contain customary anti-dilution
provisions that take into account common stock dividends, subdivisions or
combinations of our common stock and reorganizations, mergers or consolidations.
In addition, as a general rule, if we issue shares of common stock, or
options, warrants or other rights convertible into common stock, for a per share
price, exercise price or consideration of less than the conversion price then in
effect, the conversion price shall be reduced to a price equal to the lower per
share price, exercise price or consideration. Exceptions to this general rule
include the following events if approved by a majority of our board of
directors:
- our acquisition of another entity or its assets if we or our shareholders
prior to the transaction own more than 50% of the voting power of the
survivor,
- our issuance of options and warrants to our employees, consultants or
directors under an incentive agreement approved by our shareholders,
- our issuance of securities in connection with equipment leases or
borrowings from financial or other institutions regularly engaged in that
business,
- our issuance of securities in connection with a transaction in which we
license intellectual property to be used in our business, or
- our issuance of securities to a strategic joint venture partner.
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We have the right to prepay the notes after giving 20 days notice to the
holders. The holder of a note may convert the note into common stock by
surrendering it to us before the 20 day notice period expires.
Events of default include the following:
- our failure to pay principal or interest on the note when due,
- our failure to undertake a public or private offering intended to raise
at least $10,000,000 in aggregate gross proceeds to us prior to March 15,
2000 or to close such a transaction prior to April 15, 2000,
- our failure to perform, or our breach of, any of the covenants contained
in the note, relating to such matters as:
(1) incurrence of additional indebtedness,
(2) the convertibility of the notes,
(3) the creation or incurrence of specified liens,
(4) the offering or issuance of additional securities,
(5) payment of dividends,
(6) changing our primary line of business,
(7) engaging in a merger, dissolution or specified dispositions of
assets,
(8) transactions with affiliates,
(9) compensation of our officers,
(10) use of the proceeds of this offering, and
(11) delivery of information to the holders of the notes,
- defaults in our other indebtedness,
- a judgment being rendered against us for an amount in excess of $100,000,
which is not appealed or stayed within 60 days from the date of its entry
against us, or
- the commencement of bankruptcy proceedings with respect to us.
If an event of default involving a failure to pay the principal of or
interest on the notes when due occurs, a holder may elect to cause the principal
and accrued interest to become immediately due and payable. If an event of
default involving the commencement of bankruptcy proceedings with respect to us
occurs, then the principal of and accrued interest on the notes shall become due
and payable immediately without any action by a holder. If an event of default
of any type other than those discussed in the immediately preceding two
sentences occurs, then the holders of 33 1/3% of the principal amount of the
notes then outstanding may declare the principal amount of and accrued interest
on the notes to be due and payable immediately.
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We have granted holders of the notes preemptive rights to purchase, under
specified circumstances, a pro rata portion of any additional securities we may
issue, other than:
- securities issued in an underwritten public offering if the gross
proceeds to us are $10,000,000 or more,
- shares of our common stock issued pursuant to options granted pursuant to
a stock option plan approved by our board of directors or committee of
our board,
- shares of our common stock issued in connection with any merger or
acquisition approved by our board of directors and shareholders,
- shares of common stock issued in connection with any joint venture,
strategic alliance or similar relationship approved by our board of
directors, and
- shares of our common stock issued for consideration less than $150,000 in
the aggregate.
The preemptive rights no longer apply after the closing of an underwritten
public offering of our securities if the gross proceeds to us are $10,000,000 or
more.
Beginning 180 days after the effective date of an initial public offering
of our securities, the holders of more than 50% of the shares of common stock
issued and issuable upon the conversion of all notes and the exercise or
conversion of all warrants will have the right to demand that we prepare and
file, and use our best efforts to cause to become effective, a registration
statement under the Securities Act to permit the sale of shares of common stock
issuable upon such conversion and exercise. We will be obligated to file one
such registration statement for which all expenses, other than fees of counsel
for the holders and underwriting discounts, will be payable by us and one
additional registration statement for which all expenses will be payable by the
holders demanding registration. The holders will also be entitled to certain
piggyback registration rights beginning after the later of (1) the first
anniversary of the closing of this offering and (2) the completion of an initial
public offering of our securities. If the registration for which those piggyback
rights are asserted involves an underwriting and the managing underwriter
reasonably believes that marketing factors require a limitation of the number of
shares to be underwritten, we may limit pro rata the number of shares that the
holders may include in the registration to the extent necessary to reduce the
total number of shares to be included in the offering to the number of shares to
be underwritten.
The notes may be amended or the terms of the notes waived upon the written
consent of comstar.net and the holder of the note. The notes are governed by
Georgia law.
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DESCRIPTION OF WARRANTS
Each investment unit includes a stock purchase warrant. Each warrant has a
ten-year term and is exercisable immediately at a price of $.01 per share for a
total of 13,566 shares of our common stock. No warrants are currently
outstanding, and we will not issue any warrants before the closing of this
offering. Each warrant may be transferred separately from the related note.
A warrant holder may exercise a warrant in whole or in part from time to
time by delivering to us a certified or bank cashier's check in the amount of
the aggregate exercise price of the shares being purchased. Instead of paying
the exercise price by check, holders of warrants may elect to convert their
warrants into the number of shares of common stock equal to the quotient
obtained by dividing (1) the aggregate value of the warrant or portion thereof
being converted, which is equal to the aggregate fair market value, at the time
of conversion, of the shares underlying the warrant or portion thereof being
converted less the aggregate per share exercise price, by (2) the fair market
value of one share of common stock at the time of conversion.
The warrants contain customary anti-dilution terms that provide for
adjustment of the exercise price and the number and kind of securities or other
property issuable on exercise or conversion of the warrants upon the occurrence
of events such as stock dividends, stock splits, recapitalizations,
consolidations, mergers, and the sale or lease of all or substantially all of
our assets.
The warrants contain registration and preemptive rights similar to those
associated with the notes.
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U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain United States federal income tax
considerations relevant to the original holders of the investment units. This
summary is based upon the Internal Revenue Code of 1986, as amended, Treasury
Regulations, Internal Revenue Service rulings and judicial decisions now in
effect, all of which are subject to change, possibly with retroactive effect, or
different interpretations. The Internal Revenue Service, or IRS, could challenge
one or more of the conclusions described in this prospectus, and we have not
obtained, nor do we intend to obtain, a ruling from the IRS with respect to the
United States federal income tax consequences of acquiring or holding investment
units. This discussion does not purport to deal with all aspects of United
States federal income taxation that may be relevant to a particular holder in
light of the holder's circumstances. Also, it is not intended to be applicable
to all categories of investors, some of which (such as dealers in securities,
banks, insurance companies, tax-exempt organizations, foreign persons and
persons holding notes as part of a hedging or conversion transaction or straddle
or other risk reduction transaction) may be subject to special rules. The
discussion also does not discuss the tax consequences arising under the laws of
any state, local or foreign jurisdiction. In addition, this discussion is
limited to persons who will hold the notes and warrants (and common stock into
which the notes and warrants may be converted or exercised) as "capital assets"
within the meaning of Section 1221 of the Internal Revenue Code.
Persons considering the purchase, ownership, conversion, exercise or other
disposition of notes or warrants should consult their own tax advisors regarding
the federal income tax consequences and the consequences arising under the laws
of any state, local or foreign taxing jurisdiction.
GENERAL
Because the original purchasers of the notes also will acquire warrants,
each note will be treated for federal income tax purposes as having been issued
as part of an investment unit consisting of a note and a warrant. The issue
price of an investment unit consisting of a note and a warrant will be the price
the first buyer pays for an investment unit. The issue price of an investment
unit is allocated between the note and the warrant based on their relative fair
market values. We will allocate the issue price of an investment unit between
the note and the warrant in accordance with our determination of their relative
fair market values on the issue date. Although our allocation will not be
binding on the Internal Revenue Service, each holder of an investment unit must
use our allocation unless the holder discloses on its federal income tax return
that it plans to use an allocation that is inconsistent with our allocation.
NOTES
Interest and Original Issue Discount. Holders of the notes will be
required to include payments of "qualified stated interest" (as defined below)
received thereon in taxable income in accordance with their respective methods
of accounting for federal income tax purposes. In addition, the notes will be
issued with a substantial amount of "original issue discount" for federal income
tax purposes. A note holder generally is required to include original issue
discount in gross income as it accrues, regardless of the holder's method of
accounting for federal income tax purposes. Accordingly, each holder will be
required to
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include amounts in gross income without regard to when the cash or other
payments to which this income is attributable are received.
The amount of original issue discount with respect to each note is an
amount equal to the excess of the "stated redemption price at maturity" of each
note over its issue price (the initial price at which a substantial number of
notes are sold for money). The stated redemption price at maturity of each note
will include all cash payments including principal and interest, required to be
made on the note until maturity, other than "qualified stated interest"
payments. "Qualified stated interest" is stated interest that is required to be
paid at least annually during the term of the note. Stated interest on the notes
will be treated as qualified stated interest.
A holder of a note must include in gross income for federal income tax
purposes the sum of the daily portions of original issue discount with respect
to the note for each day during the taxable year or portion of a taxable year on
which each holder holds the note ("accrued original issue discount"). The daily
portion is determined by allocating to each day of an accrual period a pro rata
portion of an amount equal to the adjusted issue price of the note at the
beginning of the accrual period multiplied by the yield to maturity of the note.
The accrual period of a note may be of any length and may vary in length over
the term of the note, provided that each accrual period is no longer than one
year and each scheduled payment of principal or interest occurs at the end of an
accrual period or on the first day of an accrual period. The adjusted issue
price of the note at the start of any accrual period is the issue price of the
note increased by the accrued original issue discount for each prior accrual
period. Under these rules, note holders will have to include in gross income
increasingly greater amounts of original issue discount in each successive
accrual period. Any amount included in income as original issue discount will
increase a holder's tax basis in the note.
If your purchase price for a note exceeds the "adjusted issue price" (the
sum of the issue price of the note and the aggregate amount of original issue
discount includable in the gross income of all holders of the note for periods
before your acquisition of the note reduced by the amount of any payment
previously made on the note other than a payment of qualified stated interest),
the excess (referred to as "acquisition premium") may offset the amount of
original issue discount otherwise includible in your taxable income unless the
purchase price also exceeds the sum of all amounts payable on the note after the
purchase date other than payments of qualified stated interest, i.e., the note
is purchased at a "premium." The above described rules for inclusion in gross
income of original issue discount do not apply to holders who have purchased the
notes at a premium.
We will be required to furnish annually to the IRS and to some noncorporate
note holders information regarding the amount of the original issue discount
attributable to that year.
Bond Premium. Generally, the holder of a note has bond premium if the
holder's basis in the note (reduced by, in the case of a convertible note, the
value attributable to the conversion feature of the note) exceeds the stated
redemption price on maturity of the note. If the holder elects, an allocable
portion of the bond premium may be used to offset interest income on the note.
Pursuant to Treasury Regulations, the value of the conversion feature may be
determined under any reasonable method.
Disposition or Conversion. Except as described below, gain or loss upon a
sale or other disposition of a note will generally be capital gain or loss
(which will be long term if
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the note is held for more than one year). Net capital gains of individuals are,
under some circumstances, taxed at lower rates than items of ordinary income. In
the case of individuals, long-term capital gains with respect to property held
for more than one year are taxed at a maximum 20% federal tax rate. Net capital
gain of corporations is taxed the same as ordinary income, with a maximum
federal tax rate of 35%.
A holder's conversion of a note into common stock is generally not a
taxable event (except with respect to cash received in lieu of a fractional
share and common stock received as interest, if any). The holder's basis in the
common stock received on conversion of a note will be the same as the holder's
basis in the note at the time of conversion (increased by the value of the
common stock received as interest, if any, but exclusive of any tax basis
allocable to a fractional share), and the holding period for the common stock
received on conversion (other than common stock received as interest, if any)
will include the holding period of the note converted (assuming each is held as
a capital asset).
Cash received in lieu of a fractional share of common stock upon conversion
of a note should be treated as a payment in exchange for the fractional share.
Accordingly, if the common stock is a capital asset in the hands of a note
holder, the receipt of cash in lieu of a fractional share of common stock should
generally result in capital gain or loss, if any, measured by the difference
between the cash received for the fractional share and the holder's basis in the
fractional share.
Gain or loss upon a sale or other disposition of the common stock received
upon conversion of a note will be capital gain or loss if the common stock is
held as a capital asset (which gain or loss will be long-term if the holding
period for the common stock is more than one year). In the case of individuals,
long-term capital gains with respect to property held for more than one year
generally are taxed at a maximum 20% federal tax rate. Net capital gain of
corporations is taxed at the same rate as ordinary income, with a maximum
federal tax rate of 35%.
Constructive Dividend. If at any time we make a distribution of property
to our shareholders that would be taxable to the shareholders as a dividend for
United States federal income tax purposes and, in accordance with the
anti-dilution provisions of the notes, the conversion price of the notes is
decreased, the decrease may be deemed to be the payment of a taxable dividend to
holders of the notes.
Backup Withholding and Information Reporting. Information reporting will
apply to payments of interest or dividends, if any, made by us on, or the
proceeds of the sale or other disposition of, the notes or shares of common
stock with respect to some noncorporate note holders, and backup withholding at
a rate of 31% may apply unless the recipient of the payment supplies a taxpayer
identification number, certified under penalties of perjury, as well as
designated other information or otherwise establishes an exemption from backup
withholding. Any amount withheld under the backup withholding rules will be
allowable as a credit against the holder's federal income tax, provided that the
required information is provided to the Internal Revenue Service.
WARRANTS
Exercise. No gain or loss will be recognized for United States federal
income tax purposes by holders of the warrants upon the exercise thereof in
exchange for common stock (except to the extent of cash, if any, received in
place of the issuance of fractional
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shares of common stock). A holder's tax basis in the common stock will equal the
sum of the tax basis in the warrants plus the exercise price paid on exercise.
The holding period of the common stock received on the exercise of the warrants
will not include the holding period of the warrants. If any cash is received in
place of fractional shares, the holder will recognize gain or loss, and the
character and the amount of the gain or loss will be determined as if the holder
had received the fractional shares and then immediately sold them for cash.
Sale of Warrants or Common Stock. The sale of a warrant ordinarily will
result in the recognition of gain or loss to the holder for United States
federal income tax purposes in an amount equal to the difference between the
amount realized on the sale or exchange and the holder's tax basis in the
warrant. The gain or loss will be capital gain or loss, provided the common
stock would have been a capital asset in the hands of the warrant holder had the
warrant been exercised, and will be long-term capital gain or loss with respect
to the warrants held for more than one year.
Similarly, gain or loss generally will be recognized upon a sale of the
common stock received upon exercise of a warrant in an amount equal to the
difference between the amount realized on the transfer and the holder's adjusted
tax basis in the common stock. The gain or loss will be capital gain or loss,
provided the common stock is held as a capital asset, and will be long-term
capital gain or loss with respect to common stock held for more than one year.
Lapse. If the warrants lapse without exercise, the holder will recognize a
capital loss (assuming the sale or exchange of the warrants by the holder would
have given rise to capital gain or loss) equal to the holder's tax basis in the
warrants. Any capital loss would be long-term if the holding period for the
warrants exceeds one year.
88
<PAGE> 91
PLAN OF DISTRIBUTION
We cannot be certain that we will be able to sell all of the investment
units offered, and it is possible that we will close this offering for less than
the $5,000,000 of investment units being offered.
Scott & Stringfellow, Inc. and SunTrust Equitable Securities Corporation
have agreed to act as placement agents in connection with the offering and will
use their commercially reasonable efforts to place the investment units. Scott &
Stringfellow, Inc. and SunTrust Equitable Securities Corporation have no
obligation to buy any investment units in the offering.
The offering is being made on a minimum-maximum basis, and no investment
units will be sold unless at least $4,000,000 of investment units are sold on or
before January 15, 2000. Although neither we nor the placement agents will
purchase investment units in the offering, affiliates of us and the placement
agents are permitted to do so. If the offering is terminated for any reason,
then all funds that were deposited into escrow as described below will be
returned to investors.
All investor funds will be deposited into an escrow account established on
the investors' behalf with Branch Banking & Trust Company. Subscriber checks
will be made payable to the escrow agent. Investors' funds not transmitted
directly to the escrow account will be received by the placement agents. The
placement agents will then promptly transmit them to the escrow account by noon
the business day after receipt. No investor funds will be accepted for deposit
in escrow until the registration statement is declared effective, and we will
not receive any investor funds before issuing the investment units.
We have agreed to pay the placement agents a fee of 6% of the gross
proceeds of this offering. The following table shows the fees that we will pay
to the placement agents in connection with the offering:
<TABLE>
<S> <C>
Per investment unit......................................... $ 3,000
Total minimum............................................... $240,000
Total maximum............................................... $300,000
</TABLE>
We may be required under certain circumstances to pay Scott & Stringfellow
a fee in the amount of 6% of the gross proceeds that we raise in any private
placements of our securities that occurs before the earlier of (1) an initial
public offering of our common stock and (2) November 19, 2000, whether or not
Scott & Stringfellow or another advisor or broker has assisted us in the private
placements.
We estimate our expenses of this offering, exclusive of the placement
agents' fee, will be $231,000. We also have agreed to indemnify the placement
agents against certain liabilities under the Securities Act of 1933 or to
contribute to payments the placement agents may be required to make in respect
of those liabilities.
89
<PAGE> 92
No public trading market for our investment units, notes, warrants or
common stock currently exists or will exist as a result of this offering.
Consequently, the offering price of the investment units, the conversion price
of the notes and the exercise price of the warrants have been determined by
negotiations among us and the placement agents. The factors we considered in
determining the offering price, conversion price and exercise price included the
following:
- the history and future prospects of us and our industry,
- the present state of our development,
- an assessment of our management, and
- the general condition of the economy and the securities markets at the
time of this offering.
LEGAL MATTERS
The validity of the notes and warrants comprising the investment units and
the underlying common stock offered by this prospectus will be passed upon for
us by Nelson Mullins Riley & Scarborough, L.L.P., Atlanta, Georgia. Glenn W.
Sturm, a partner of Nelson Mullins, is one of our directors and owns options to
purchase 100,000 shares of our common stock. Certain legal matters in connection
with this offering will be passed upon for the placement agents by Alston & Bird
LLP, Atlanta, Georgia.
EXPERTS
The audited financial statements of comstar.net as of December 31, 1997 and
1998, and from the period of inception, March 5, 1996, to December 31, 1996 and
for each of the two years ended December 31, 1997 and 1998, included in this
prospectus and elsewhere in the registration statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
The audited financial statements of Athens' ISP as of December 31, 1996 and
1997 and for each of the two years ended December 31, 1997, included in this
prospectus and elsewhere in the registration statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, through the
Electronic Data Gathering and Retrieval, or EDGAR, system, a registration
statement on Form S-1 under the Securities Act for the common stock offered by
this prospectus. This prospectus does not contain all of the information
provided in the registration statement because we have omitted parts of the
registration statement as permitted by SEC rules. For further information about
us and our common stock, you should refer to the registration statement,
including its exhibits and schedule. Statements in this prospectus about any
contract or other document may only be a summary of that document, and in each
instance we refer
90
<PAGE> 93
you to the copy of that contract or other document filed as an exhibit to the
registration statement.
You may read the registration statement at the SEC's Public Reference Room
at 450 Fifth Street, N.W., Washington, D.C. 20549, and you may obtain copies of
the registration statement from the Public Reference Room at prescribed rates.
You may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. Additionally, the SEC maintains an Internet
site at http://www.sec.gov through which you may review the registration
statement. You may also review the registration statement at the offices of the
Nasdaq National Market, 1735 K Street, N.W., Washington, D.C. 20006.
We are not presently a reporting company under the Securities Exchange Act
of 1934 and do not file reports or other information with the SEC. On the
effective date of the registration statement, however, we will become a
reporting company and will register our securities under the Exchange Act.
Accordingly, the additional reporting requirements of the Exchange Act will
apply to us, and we will file reports, proxy statements and other information
with the SEC.
91
<PAGE> 94
COMSTAR.NET, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
COMSTAR.NET, INC.
Report of Independent Public Accountants.................... F-2
Balance Sheets as of December 31, 1997 and 1998, and
September 30, 1999 (unaudited)............................ F-3
Statements of Operations for the Period from Inception
(March 5, 1996) to December 31, 1996, for the Years Ended
December 31, 1997 and 1998, and for the Periods Ended
September 30, 1998 and 1999 (unaudited)................... F-4
Statements of Shareholders' Deficit for the Period from
Inception (March 5, 1996) to December 31, 1996, for the
Years Ended December 31, 1997 and 1998, and for the Nine
Months Ended September 30, 1998 and 1999 (unaudited)...... F-5
Statements of Cash Flows for the Period from Inception
(March 5, 1996) to December 31, 1996, for the Years Ended
December 31, 1997 and 1998, and for the Periods Ended
September 30, 1998 and 1999 (unaudited)................... F-6
Notes to Financial Statements............................... F-7
ATHENS' ISP, INC.
Report of Independent Public Accountants.................... F-24
Balance Sheets as of December 31, 1996 and 1997............. F-25
Statements of Operations and Accumulated Deficit for the
Years Ended December 31, 1996 and 1997.................... F-26
Statements of Cash Flows for the Years Ended December 31,
1996 and 1997............................................. F-27
Notes to Financial Statements............................... F-28
</TABLE>
F-1
<PAGE> 95
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To comstar.net, inc.:
We have audited the accompanying balance sheets of COMSTAR.NET, INC. (a
Georgia corporation) as of December 31, 1997 and 1998 and the related statements
of operations, shareholders' deficit, and cash flows for the period from
inception (March 5, 1996) to December 31, 1996 and for each of the two years
ended December 31, 1997 and 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of comstar.net, inc. as of
December 31, 1997 and 1998 and the results of its operations and its cash flows
for the period from inception (March 5, 1996) to December 31, 1996 and for each
of the two years ended December 31, 1997 and 1998 in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
Atlanta, Georgia
June 30, 1999
(except with respect to Note 10,
as to which the date is
November 22, 1999)
F-2
<PAGE> 96
COMSTAR.NET, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1997 1998 1999
---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 54,676 $ 283,621 $ 355,689
Accounts receivable, net of allowance for doubtful
accounts of $19,426, $25,447, and $103,107 in 1997,
1998, and 1999, respectively............................ 74,082 234,390 362,852
Prepaid and other current assets.......................... 0 4,764 33,419
Deferred transaction costs................................ 0 0 548,520
---------- ----------- -----------
Total current assets.................................. 128,758 522,775 1,300,480
---------- ----------- -----------
PROPERTY AND EQUIPMENT:
Computers and telecommunications equipment................ 376,597 689,350 956,103
Furniture and fixtures.................................... 3,628 11,613 23,527
Property under capital leases (Note 8).................... 0 46,886 72,997
Leasehold improvements.................................... 4,075 101,979 101,979
---------- ----------- -----------
384,300 849,828 1,154,606
Less accumulated depreciation............................. (61,765) (195,999) (350,552)
---------- ----------- -----------
Property and equipment, net........................... 322,535 653,829 804,054
---------- ----------- -----------
OTHER ASSETS:
Investment in nschool (Note 4)............................ 0 82,744 0
Acquired customer base, net of accumulated amortization of
$7,112, $157,475, and $294,471 in 1997, 1998, and 1999,
respectively (Note 3)................................... 78,226 390,499 253,503
---------- ----------- -----------
Total other assets.................................... 78,226 473,243 253,503
---------- ----------- -----------
Total assets.......................................... $ 529,519 $ 1,649,847 2,358,037
========== =========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Current maturities of long-term debt (Note 5)............. $ 110,094 $ 902,469 $ 800,100
Note payable to related party (Note 5).................... 57,124 270,188 270,188
Notes payable to shareholders (Note 5).................... 618,549 1,002,534 902,534
Current portion of obligations under capital leases (Note
8)...................................................... 0 28,067 25,892
Accounts payable.......................................... 111,565 113,604 397,926
Accrued liabilities....................................... 34,986 169,729 421,751
Accrued interest.......................................... 60,940 135,501 101,324
Advance billings.......................................... 18,547 75,053 92,174
---------- ----------- -----------
Total current liabilities............................. 1,011,805 2,697,145 3,011,889
---------- ----------- -----------
LONG-TERM LIABILITIES:
Long-term debt, less current maturities (Note 5).......... 343,078 0 0
Obligations under capital leases (Note 8)................. 0 10,974 19,841
---------- ----------- -----------
Total long-term liabilities........................... 343,078 10,974 19,841
---------- ----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
SHAREHOLDERS' DEFICIT (NOTE 6):
Preferred stock, $0 par value; 5,000,000 shares
authorized, 0 shares issued and outstanding in 1997,
1998, and 1999.......................................... 0 0 0
Common stock, $0 par value:
50,000,000 shares authorized, 0 shares authorized,
issued and outstanding in 1997 and 5,031,946 and
5,185,893 shares issued and outstanding in 1998 and
1999, respectively.................................... 0 364,822 2,122,744
Additional paid-in capital.............................. 0 0 3,522,412
Deferred compensation (Notes 6 and 10).................. 0 0 (117,017)
Accumulated deficit....................................... (825,364) (1,423,094) (6,201,832)
---------- ----------- -----------
Total shareholders' deficit........................... (825,364) (1,058,272) (673,693)
---------- ----------- -----------
Total liabilities and shareholders' deficit........... $ 529,519 $ 1,649,847 $ 2,358,037
========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE> 97
COMSTAR.NET, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MARCH 5, 1996) TO YEARS ENDED PERIODS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
--------------------- ------------------------- -------------------------
1996 1997 1998 1998 1999
--------------------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES:
Internet access....... $ 29,579 $ 399,167 $ 1,334,053 $ 925,005 $ 1,441,132
Data center
services............ 33,048 205,171 417,112 269,167 420,814
Circuit rebills....... 276 44,459 255,230 164,888 361,594
Other................. 2,495 26,772 135,950 104,991 64,533
----------- ----------- ----------- ----------- -----------
Total revenues...... 65,398 675,569 2,142,345 1,464,051 2,288,073
----------- ----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of network
services............ 73,963 528,835 1,235,862 819,440 1,461,932
Salaries and wages.... 150,448 370,145 521,570 403,030 958,010
General and
administrative...... 67,259 131,767 379,036 210,398 615,922
Rent.................. 21,792 33,152 106,417 70,540 87,659
Management fees (Note
9).................. 8,000 42,000 60,000 45,000 30,000
Depreciation and
amortization........ 11,622 57,255 284,598 152,654 291,549
Stock compensation
expense............. 0 0 0 0 3,405,395
----------- ----------- ----------- ----------- -----------
Total costs and
expenses.......... 333,084 1,163,154 2,587,483 1,701,062 6,850,467
----------- ----------- ----------- ----------- -----------
OPERATING LOSS.......... (267,686) (487,585) (445,138) (237,011) (4,562,394)
----------- ----------- ----------- ----------- -----------
OTHER (EXPENSE) INCOME:
Interest expense,
net................. (10,434) (66,201) (150,605) (113,775) (146,046)
Other income (loss)... 0 6,542 (1,987) (6,346) 12,446
Equity in net loss of
investee............ 0 0 0 0 (82,744)
----------- ----------- ----------- ----------- -----------
Total other
expenses.......... (10,434) (59,659) (152,592) (120,121) (216,344)
----------- ----------- ----------- ----------- -----------
LOSS BEFORE INCOME
TAXES................. (278,120) (547,244) (597,730) (357,132) (4,778,738)
INCOME TAX BENEFIT...... 0 0 0 0 0
----------- ----------- ----------- ----------- -----------
NET LOSS................ $ (278,120) $ (547,244) $ (597,730) $ (357,132) $(4,778,738)
=========== =========== =========== =========== ===========
NET LOSS PER SHARE:
Basic and diluted..... $ (0.06) $ (0.11) $ (0.12) $ (0.07) $ (0.93)
=========== =========== =========== =========== ===========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING.... 5,000,000 5,000,000 5,002,866 5,000,000 5,117,109
=========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 98
COMSTAR.NET, INC.
STATEMENTS OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
COMMON STOCK
----------------------
UNDESIGNATED ADDITIONAL
---------------------- PAID IN DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
--------- ---------- ---------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at inception, March 5, 1996.............. 0 $ 0 $ 0 $ 0 $ 0 $ 0
Net loss........................................ 0 0 0 0 (278,120) (278,120)
Issuance of common stock, as previously
reported...................................... 1000 0 0 0 0 0
1-for-2 reverse stock split, effective upon
consummation of proposed initial public
offering...................................... (500) 0 0 0 0 0
--------- ---------- ---------- ---------- ----------- -----------
Balance, December 31, 1996...................... 500 0 0 0 (278,120) (278,120)
Net loss........................................ 0 0 0 0 (547,244) (547,244)
--------- ---------- ---------- ---------- ----------- -----------
Balance, December 31, 1997....................... 500 0 0 0 (825,364) (825,364)
Net loss........................................ 0 0 0 0 (597,730) (597,730)
Exchange of common stock........................ 4,999,500 0 0 0 0 0
Issuance of common stock........................ 31,946 364,822 0 0 0 364,822
--------- ---------- ---------- ---------- ----------- -----------
Balance, December 31, 1998....................... 5,031,946 364,822 0 0 (1,423,094) (1,058,272)
Net loss (unaudited)............................ 0 0 0 (4,778,738) (4,778,738)
Issuance of common stock (unaudited)............ 153,947 1,757,922 0 0 0 1,757,922
Issuance of stock options (unaudited)........... 0 0 3,522,412 (3,522,412) 0 0
Amortization of deferred compensation
(unaudited)................................... 0 0 0 3,405,395 3,405,395
--------- ---------- ---------- ---------- ----------- -----------
Balance, September 30, 1999 (unaudited).......... 5,185,893 $2,122,744 $3,522,412 $ (117,017) $(6,201,832) $ (673,693)
========= ========== ========== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 99
COMSTAR.NET, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(MARCH 5, 1996)
TO YEARS ENDED PERIODS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
--------------- ------------------------ ------------------------
1996 1997 1998 1998 1999
--------------- --------- ----------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss..................... $(278,120) $(547,244) $ (597,730) $(357,132) $(4,778,738)
--------- --------- ----------- --------- -----------
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization............. 11,622 57,255 284,598 152,654 291,549
Equity in net loss of
investee................. 0 0 0 0 82,744
Stock compensation
expense.................. 0 0 0 0 3,405,395
Changes in operating assets
and liabilities:
Accounts receivable,
net.................... (8,743) (65,339) (160,308) (134,837) (128,462)
Prepaid and other current
assets................. 0 0 (4,764) (20,485) (28,655)
Deferred transaction
costs.................. 0 0 0 0 (548,520)
Accounts payable......... 0 111,565 2,039 28,490 284,322
Accrued liabilities...... 63,114 (28,128) 134,743 80,573 252,022
Accrued interest......... 10,047 50,893 74,561 70,265 (34,177)
Advance billings......... 0 18,547 56,506 59,232 17,121
--------- --------- ----------- --------- -----------
Total adjustments...... 76,040 144,793 387,375 235,892 3,593,339
--------- --------- ----------- --------- -----------
Net cash used in
operating
activities........... (202,080) (402,451) (210,355) (121,240) (1,185,399)
--------- --------- ----------- --------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of businesses and
customer base.............. 0 (85,338) (513,836) (462,634) 0
Purchases of property and
equipment, net............. (120,442) (263,858) (414,329) (456,826) (304,778)
Investment in nschool........ 0 0 (82,744) 0 0
--------- --------- ----------- --------- -----------
Net cash used in
investing
activities........... (120,442) (349,196) (1,010,909) (919,460) (304,778)
--------- --------- ----------- --------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from issuance of
long-term debt............. 15,312 455,355 469,731 369,731 0
Proceeds from note payable to
related party.............. 8,000 55,124 233,080 206,396 0
Proceeds from notes payable
to shareholders............ 306,643 313,250 409,095 383,985 0
Principal payments on
long-term debt............. (1,031) (16,464) (20,434) (16,271) (102,369)
Repayments of note payable to
related party.............. 0 (6,000) (20,016) (20,518) 0
Repayments of notes payable
to shareholders............ 0 (1,344) (25,110) 0 (100,000)
Obligations under capital
leases..................... 0 0 39,041 43,259 6,692
Proceeds from issuance of
common stock............... 0 0 364,822 0 1,757,922
Bank overdraft............... 0 0 0 19,442 0
--------- --------- ----------- --------- -----------
Net cash provided by
financing
activities........... 328,924 799,921 1,450,209 986,024 1,562,245
--------- --------- ----------- --------- -----------
NET INCREASE (DECREASE) IN
CASH......................... 6,402 48,274 228,945 (54,676) 72,068
CASH AT BEGINNING OF PERIOD.... 0 6,402 54,676 54,676 283,621
--------- --------- ----------- --------- -----------
CASH AT END OF PERIOD.......... $ 6,402 $ 54,676 $ 283,621 $ 0 $ 355,689
========= ========= =========== ========= ===========
CASH PAID FOR INTEREST......... $ 387 $ 15,308 $ 76,044 $ 43,510 $ 180,223
========= ========= =========== ========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE> 100
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997, AND 1998
AND SEPTEMBER 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND BUSINESS OPERATIONS
comstar.net, inc. (formerly Comstar Communications, Inc.) (the "Company")
(a Georgia corporation) is a local, regional, and national provider of Internet
access and other enhanced Internet services to businesses, educational
institutions, and governmental organizations. The Company was incorporated on
March 5, 1996 and commenced operations on June 10, 1996.
The Company has incurred significant net operating losses in each year
since its formation. As of December 31, 1998, the Company had an accumulated
deficit of approximately $1.4 million. The Company expects that it will continue
to incur net losses as it continues to expend substantial resources on sales and
marketing initiatives and expansion efforts. There can be no assurance that the
Company will achieve or sustain profitability or positive cash flow from its
operations.
In addition, any increase in the Company's growth rate, shortfalls in
anticipated revenues, increases in anticipated expenses, increases in the number
of customers acquired, or significant acquisition opportunities could have a
material adverse effect on the Company's liquidity and capital resources and
would require the Company to raise additional capital from public or private
equity or debt sources in order to finance operating losses, anticipated growth,
and contemplated capital expenditures. If such sources of financing are
insufficient or unavailable, the Company will be required to modify its growth
and operating plans in accordance with the extent of available funding and
attempt to attain profitability in its existing markets. The Company may need to
raise additional funds in order to take advantage of unanticipated
opportunities, such as the acquisition of a complementary business or the
development of new services, or otherwise respond to unanticipated competitive
pressures. There can be no assurance that the Company will be able to raise any
such capital on terms acceptable to the Company or at all.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
INTERIM UNAUDITED FINANCIAL INFORMATION
The accompanying financial statements for the nine months ended September
30, 1999 and 1998 are unaudited; however, in the opinion of management, all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the unaudited financial statements have been included. The
results for the nine months ended
F-7
<PAGE> 101
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
September 30, 1999 are not necessarily indicative of the results to be obtained
for a full year.
SOURCES OF SUPPLIES
The Company relies on third-party networks, local and long distance
telephone companies, and other companies to provide data communications
capacity. Although management feels that alternative telecommunications
facilities could be found in a timely manner, any disruption of these services
could have an adverse effect on operating results.
SIGNIFICANT CUSTOMERS
During the year ended December 31, 1997, sales to one of the Company's
customers were approximately $128,000, representing approximately 19% of the
Company's total revenues. There were no amounts due from this customer as of
December 31, 1997. There were no sales to customers representing 10% or more of
the Company's revenues during the years ended December 31, 1996 or December 31,
1998.
During the nine months ended September 30, 1999, sales to a different
customer were approximately $244,046, representing approximately 10.7% of the
Company's total revenues. Accounts receivable due from this customer as of
September 30, 1999 totaled approximately $55,403. The loss of this customer
could have a material adverse effect on the Company's future operations
(unaudited).
LONG-LIVED ASSETS
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." SFAS No. 121 establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles, and cost in excess of net assets acquired related to those assets
to be held and used and for long-lived assets and certain identifiable
intangible assets to be disposed of.
The Company periodically reviews the values assigned to long-lived assets,
such as property and equipment and acquired customer base to determine whether
any impairment exists. If circumstances suggest that the asset values may be
impaired, an assessment of the assets' estimated fair values is performed based
on the estimated undiscounted cash flows expected to be generated from such
assets over the remaining lives of the long-lived assets, and an impairment loss
is recognized in the statement of operations equal to the difference between the
estimated fair values and the assets' carrying values. Management believes that
the long-lived assets in the accompanying balance sheets are appropriately
valued.
F-8
<PAGE> 102
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures for improvements
are capitalized, and replacements, maintenance, and repairs that do not improve
or extend the lives of the respective assets are expensed as incurred.
Depreciation is provided on a straight-line basis over the remaining estimated
useful lives, as follows:
<TABLE>
<S> <C>
Computers and telecommunications equipment................ Five years
Furniture and fixtures.................................... Ten years
Leasehold improvements.................................... Three years
</TABLE>
PROPERTY UNDER CAPITAL LEASES
The Company leases certain of its data communication and other equipment
under lease agreements accounted for as capital leases. The assets and
liabilities under capital leases are recorded at the lesser of the present value
of aggregate future minimum lease payments, including estimated bargain purchase
options, or the fair value of the assets under lease. Property under capital
leases is depreciated over their estimated useful lives of five years, which is
longer than the terms of the leases.
ADVERTISING COSTS
The Company expenses all advertising costs as incurred.
ACCRUED LIABILITIES
Accrued liabilities as of December 31, 1997 and 1998 consisted of the
following:
<TABLE>
<CAPTION>
1997 1998
------- ---------
<S> <C> <C>
Accrued telecommunication expenses.......................... $17,839 $ 69,958
Accrued professional fees................................... 5,000 59,517
Other accrued liabilities................................... 12,147 40,254
------- ---------
$34,986 $ 169,729
======= =========
</TABLE>
REVENUE RECOGNITION
The Company's revenues consist primarily of (i) Internet access, (ii) data
center services, (iii) circuit rebills, and (iv) other revenues. Internet access
revenues consist primarily of recurring revenues received for Internet access
services. Data center services revenues consist primarily of recurring revenues
received for co-location, managed application hosting, E-mail, domain name, and
Web hosting services. Circuit rebills consists primarily of the resale of
distance-sensitive circuits from local loop providers to the Company's
customers. Other revenues consist primarily of transaction processing fees and
miscellaneous hardware sales.
Revenues are recognized as services are provided. Installation and customer
set-up fees are recognized upon completion of services and historically comprise
3% to 8% of total
F-9
<PAGE> 103
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
monthly revenues. Fees billed to customers related to installation and customer
set-up are charged in order to recover the Company's cost of installing and
setting up each customer. Transaction processing fees are generated from the use
of the Company's e-commerce software and are recognized based upon monthly
usage. Hardware sales are recognized upon the delivery of the hardware to the
customer.
ADVANCE BILLINGS
Advance billings represent the liability for billings made to customers in
advance of services being provided. Such amounts are recognized as revenue when
the related services are performed.
LIMITED SERVICE WARRANTIES
The Company's customer contracts provided a limited service level warranty
related to the continuous availability of service. This warranty provides a
credit for free service for disruption in Internet access services. The Company
accrues for such costs as estimated at the time of the sale. Credits issued for
disruption in service were approximately $1,400, $5,200, and $2,800 for the
years ended December 31, 1997 and 1998 and for the nine months ended September
30, 1999 (unaudited), respectively. There were no credits issued during the year
ended December 31, 1996.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, debt, and other
short-term assets and liabilities. Based on the short-term nature or variable
interest rates of these financial instruments, the estimated fair values of the
Company's financial instruments approximate their carrying values as of December
31, 1996, 1997, and 1998.
CREDIT RISK
The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. The Company's risk of loss is
limited due to advance billings to customers for services and the ability to
terminate access on delinquent accounts. The concentration of credit risk is
mitigated by the large number of customers comprising the customer base. The
carrying amounts of the Company's receivables approximate their fair values as
of December 31, 1997 and 1998.
NET LOSS PER SHARE
Basic and diluted net loss per share was computed in accordance with SFAS
No. 128, "Earnings per Share," using the weighted average number of common
shares outstanding. Basic loss per share is based on the weighted average number
of shares outstanding. Diluted loss per share is based on the weighted average
number of shares outstanding, and the dilutive effect of common stock equivalent
shares issuable upon the exercise of stock options (using the treasury stock
method). Net loss for basic and diluted earnings per
F-10
<PAGE> 104
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
share is the same for basic and diluted earnings per share; therefore, no
reconciliation of the numerator is presented.
On February 4, 1998, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") No. 98, "Computation of Earnings Per Share." SAB No.
98 requires the retroactive inclusion of nominal issuances of common stock and
common stock equivalents on earnings per share calculations for all periods
presented and precludes the use of the treasury stock method for these
issuances. Management believes that all issuances of common stock and stock
options have been made at the current market value at the time of issuance and
that there have been no nominal issuances.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income," which establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of general-purpose financial statements. This statement was effective for
periods beginning after December 15, 1997. The adoption of SFAS No. 130 did not
have an impact on the Company's financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information," which establishes standards for the way
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. This statement was
effective for financial statements for periods beginning after December 15,
1997. The adoption of SFAS No. 131 did not have an impact on the Company's
financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is the type of hedge transaction. In June 1999, the
FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133". This
statement defers the effective date of SFAS No. 133 to fiscal years beginning
after June 15, 2000. The Company believes that the adoption of SFAS No. 133 and
SFAS No. 137 will not have a material impact on the Company's financial
statements.
3. ACQUISITIONS
ATHENS' ISP, INC.
On July 1, 1998, Comstar acquired certain assets of Athens' ISP, Inc. under
the terms of an asset purchase agreement. The acquisition consisted primarily of
Internet access business subscribers and related computer and telecommunications
equipment. The
F-11
<PAGE> 105
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
purchase price was $326,678, of which $275,478 was allocated to the customer
list and related accounts and $51,200 was allocated to the equipment acquired.
The customer list and related accounts acquired is being amortized on a
straight-line basis over three years. No goodwill was recorded.
This acquisition was accounted for under the purchase method in accordance
with Accounting Principles Board ("APB") Opinion No. 16, "Business
Combinations." Accordingly, the purchase price has been allocated to the net
assets acquired based on their estimated fair values.
The following unaudited pro forma information has been prepared assuming
that the purchase acquisition occurred at the beginning of the year of
acquisition and the year immediately preceding. The unaudited pro forma
information is presented for informational purposes only and may not be
indicative of the actual results of operations which would have occurred had the
purchase acquisitions been consummated at the beginning of the respective
periods, nor is the information necessarily indicative of the results of
operations which may occur in the future operations of the combined entities.
<TABLE>
<CAPTION>
1997 1998
--------- ----------
<S> <C> <C>
Pro forma revenues....................................... $ 801,349 $2,232,367
Pro forma loss from operations........................... (604,841) (501,630)
Pro forma loss per share................................. $ (.12) $ (.10)
</TABLE>
ACQUIRED CUSTOMER BASE
The Company capitalizes specific costs incurred related to the purchase of
customer lists and related accounts from other Internet service providers. These
costs include the actual fees paid as well as other expenses specifically
related to the transactions. The following less significant purchases of
customer lists and related accounts occurred during fiscal years 1997 and 1998:
SYSTEMS ATLANTA COMMUNICATIONS SYSTEMS, INC.
On July 25, 1997, the Company acquired the business customer list and
related accounts of Systems Atlanta Communications Systems, Inc. and
certain related generic computer and telecommunications equipment under the
terms of a purchase agreement. The purchase price was $148,343, of which
$85,338 was allocated to the customer list and related accounts and $63,005
was allocated to the equipment acquired.
HOLLANDER, DOWS AND REINHARDT
On April 3, 1998, Comstar acquired the business customer list and
related accounts of Hollander, Dows and Reinhardt under the terms of a
purchase agreement. The purchase price was $30,808, all of which was
allocated to the customer list and related accounts.
F-12
<PAGE> 106
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
WATCH ME NOW, INC.
On July 31, 1998, the Company acquired the business customer list and
related accounts and certain related computer and telecommunications
equipment from Watch Me Now, Inc. under the terms of a purchase agreement.
The purchase price was $179,350, of which $156,350 was allocated to the
customer list and related accounts and $23,000 was allocated to the
equipment acquired.
The Company amortizes customer lists and related accounts over the lesser
of three years or their calculated customer churn. Subsequent to an acquisition
that results in the recording of customer lists or other intangible assets, the
Company continually evaluates whether later events and circumstances have
occurred that indicate that the remaining estimated useful lives of intangible
assets may warrant revision or that the remaining balance of intangible assets
may not be recoverable. When factors indicate that intangible assets should be
evaluated for possible impairment, the Company uses a calculation of customer
churn or an estimate of the related business segment's undiscounted net income
or cash flows, as appropriate, over the remaining life of the assets in
measuring whether such assets are recoverable in accordance with SFAS No. 121.
4. INVESTMENT IN NSCHOOL COMMUNICATIONS SYSTEMS, INC.
On December 18, 1998, the Company entered into an agreement with nschool
Communications Systems, Inc. ("nschool"), an internet communications company
servicing educational institutions. The agreement required the Company to
develop specialized software applications and provide related services to
nschool in exchange for a 25% ownership interest in nschool. In accordance with
APB Opinion No. 17, "Intangible Assets," the ownership interest in nschool was
valued at the cost incurred to develop the software provided. The Company
accounts for the investment in nschool under the equity method of accounting.
The activity between December 18, 1998 and December 31, 1998 was immaterial to
the Company's investment balance.
During the period ending June 30, 1999, the Company recorded its percentage
of the net loss of nschool bringing its investment balance to zero as of June
30, 1999. nschool sustained operating losses during the period ending September
30, 1999 (unaudited), exceeding the Company's investment balance. Therefore, the
Company will track those losses in excess separately, and any subsequent
realization of income from nschool will first go to reduce the excess losses.
F-13
<PAGE> 107
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. LONG-TERM DEBT
Long-term debt at December 31, 1997 and 1998 consisted of the following:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Note payable to related party, interest at 10%,
principal and interest payable at maturity,
January 1, 2000 or upon closing of an initial public
offering, whichever is sooner; secured by certain
assets of the Company and personal guarantees by
four of the Company's principal shareholders.......... $ 57,124 $ 270,188
Note payable to shareholders, interest at 9%, principal
and interest payments payable at maturity, January 31,
1999 (subsequently extended, Note 10)................. 0 383,985
Note payable to shareholders, interest at 10%, principal
and interest payable at maturity, January 1, 2000 or
upon closing of an initial public offering, whichever
is sooner; secured by certain assets of the Company... 618,549 618,549
$200,100 note payable to bank, interest at prime plus 1%
(8.25% at December 31, 1998), principal and interest
payments payable monthly through July 1, 1999; secured
by certain assets of the Company and personal
guarantees by one of the Company's principal
shareholders (subsequently extended, Note 10)......... 0 200,100
$700,000 revolving credit facility, interest at prime
plus 1% (8.25% at December 31, 1997 and 1998),
principal and accrued interest due at maturity, May
25, 1999 secured by certain assets of the Company and
personal guarantees by four of the Company's principal
shareholders (subsequently extended, Note 10)......... 430,369 700,000
$25,085 note payable to bank, interest at prime plus 1%
(8.25% at December 31, 1997 and 1998), principal and
interest payments payable monthly through February 15,
1999; secured by certain assets of the Company........ 15,345 2,369
$15,412 note payable to bank, interest at prime plus 1%
(8.25% at December 31, 1996 and 1997), principal and
interest payments payable monthly through November 5,
1998; secured by certain assets of the Company........ 7,458 0
---------- ----------
1,128,845 2,175,191
Less current portion.................................... 785,767 (2,175,191)
---------- ----------
$ 343,078 $ 0
========== ==========
</TABLE>
In April 1997, the Company entered into a one-year revolving credit
facility (the "Revolving Credit Facility") with a local commercial lending
institution to provide up to
F-14
<PAGE> 108
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
$500,000 of financing for the Company's operations. In May 1998, the Company
extended the Revolving Credit Facility an additional year and increased the
available credit to $700,000. At December 31, 1997 and 1998, $69,631 and $0,
respectively, were available to the Company under the Revolving Credit Facility.
On June 22, 1999, the Company extended the Revolving Credit Facility to October
1, 1999.
In July 1998, two of the Company's principal shareholders entered into a
lending arrangement with a bank on behalf of the Company. In connection with
this lending arrangement, the shareholders then loaned the funds obtained to the
Company with terms that mirrored the terms of the shareholders' note payable to
the bank. The Company has been making principal and interest payments directly
to the bank on behalf of the shareholders since the inception of the obligation.
On February 28, 1999, the shareholders extended the maturity of the obligation
to August 27, 1999, and the interest rate was lowered from 9% to 8.5%.
The principal shareholders of the Company have agreed not to require
repayment of the notes payable to them before June 30, 2000 or upon closing of
an initial public offering, whichever is sooner.
6. SHAREHOLDERS' DEFICIT
COMMON STOCK
In April 1996, the Company's board of directors authorized the creation of
500 shares of zero par value common stock. Each of the Company's four founders
received 125 shares of the common stock.
On November 19, 1998, the Company's board of directors authorized the
creation of 55,000,000 shares of stock of all series. The authorization included
5,000,000 shares of common stock designated as Series A, 5,000,000 shares of
common stock designated as Series B, 40,000,000 shares of undesignated common
stock, and 5,000,000 shares designated as preferred stock. The two classes of
common stock are identical except that shares of common stock Series A are
entitled to one vote per share and shares of common stock Series B are entitled
to ten votes per share. All of the series of stock have zero par values. Two of
the original shareholders exchanged 125 shares each of the previously issued
common stock for 1,250,000 shares each of the Series A common stock. The two
remaining shareholders exchanged their previously issued shares for 1,250,000
shares each of the newly issued Series B common stock. All per share and share
amounts (except for shareholders' deficit) have been restated for the exchanges
(Note 10).
SALE OF COMMON STOCK
In November and December 1998, the Company sold 31,946 shares of Series A
common stock for $11.42 per share to several private investors resulting in
total proceeds of $364,822.
From January 1, 1999 to June 30, 1999, the Company sold 153,947 shares of
Series A common stock to several private investors for total proceeds of
$1,757,922. All shares were sold at $11.42 per share.
F-15
<PAGE> 109
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
EMPLOYEE STOCK OPTION PLAN
On March 1, 1999, the Company's board of directors approved the 1999 Stock
Option and Incentive Plan ("the Plan") to grant incentive stock options to
purchase the Company's common stock. The Plan provided for the issuance of
options to purchase up to 850,000 shares of the Company's common stock; 202,625,
12,500, and 16,000 options were granted to employees of the Company under the
Plan on March 10, 1999, March 12, 1999, and March 30, 1999, respectively, at
$11.42 per share. On May 17, 1999 and June 1, 1999, 7,500 and 50,000 additional
option grants were made to two additional employees at $11.42 per share,
respectively. In the opinion of management, the fair value of the Company's
common stock on the dates of grant was equal to the exercise price; therefore,
no compensation expense was recorded at the dates of grant. As of June 30, 1999,
all options granted under the Plan vest at the rate of one-third per year from
the date of original hire and expire ten years from the date of grant. At June
30, 1999, a total of 288,625 options had been granted, 93,834 of which were
fully vested. No options had been forfeited and none had expired; 561,375 shares
of stock were available for future grants under the Plan as of June 30, 1999. A
summary of the status of the Company's stock options at September 30, 1999
(unaudited) and changes during the period then ended is presented in the
following table:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
PRICE PER
SHARES SHARE
------- ---------
<S> <C> <C>
Outstanding at December 31, 1998............................ 0 $ 0.00
Granted................................................... 768,625 11.42
Forfeited................................................. (500) (11.42)
------- -------
Outstanding at September 30, 1999........................... 768,125 $ 11.42
======= =======
Exercisable at September 30, 1999........................... 490,834 $ 11.42
======= =======
</TABLE>
The Company accounts for its stock-based compensation plan under APB
Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123,
"Accounting for Stock-Based Compensation," defines a fair value-based method of
accounting for an employee stock option plan or similar equity instrument and
allows an entity to continue to measure compensation cost for those plans using
the method of accounting prescribed by APB Opinion No. 25. Entities electing to
remain with the accounting in APB Opinion No. 25 must make pro forma disclosures
of net income and, if presented, earnings per share, as if the fair value-based
method of accounting defined in the statement had been applied.
F-16
<PAGE> 110
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company has computed for pro forma disclosure purposes the value of all
options granted during the period ended September 30, 1999 using the minimum
value method as prescribed by SFAS No. 123 using the following assumptions
(unaudited):
<TABLE>
<S> <C>
Risk free interest rate..................................... 5.6% to 5.9%
Expected dividend yield..................................... 0
Expected lives.............................................. Five years
Expected volatility......................................... 84%
</TABLE>
If the Company had accounted for these grants in accordance with SFAS No.
123, the Company's reported pro forma net loss for the period ended September
30, 1999 would have increased to the following pro forma amount (unaudited):
<TABLE>
<S> <C>
Net loss:
As reported............................................... $(4,778,738)
Pro forma................................................. (7,807,742)
Net loss per share:
Basic and diluted:
As reported............................................ $ (.93)
Pro forma.............................................. (1.53)
</TABLE>
7. INCOME TAXES
Prior to January 1, 1999, the Company was an S corporation and was
generally not subject to corporate level taxes on its net income because such
income was attributed to the Company's stockholders, and taxes on such income
were directly payable by them.
On January 1, 1999, the Company became a C corporation for income tax
purposes. Accordingly, the Company adopted SFAS No. 109, "Accounting for Income
Taxes," which requires the use of the liability method in accounting for income
taxes. Under SFAS No. 109, deferred tax assets and liabilities are determined
based on the difference between the financial reporting and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Deferred income taxes also reflect the
value of net operating losses and offsetting valuation allowances provided
against assets which are not likely to be realized.
F-17
<PAGE> 111
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Upon conversion to C corporation status, the Company recorded deferred
taxes for which it will be responsible resulting from the termination of S
corporation status. The components of the pro forma total deferred tax assets as
of December 31, 1998 are as follows:
<TABLE>
<S> <C>
Deferred tax assets:
Allowance for doubtful accounts........................... $ 9,670
Amortization of customer lists............................ 50,458
Accrued interest.......................................... 51,509
--------
Total deferred tax assets.............................. 111,637
Deferred tax liabilities:
Depreciation of property and equipment.................... 36,953
--------
Net deferred tax assets before valuation allowance..... 74,684
Less valuation allowance.................................. (74,684)
--------
Net deferred tax assets................................ $ 0
========
</TABLE>
At December 31, 1998, the Company provided a valuation allowance against
the entire net deferred tax asset balance because it is uncertain that the net
deferred tax assets resulting from these deferred tax items will not be realized
through future taxable income.
The following summarizes the components of the pro forma income tax benefit
for the years ended December 31, 1996, 1997, and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal...................................... $ 0 $ 0 $ 0
State........................................ 0 0 0
Deferred:
Federal...................................... (94,540) (184,231) (202,185)
State........................................ (11,122) (21,675) (23,787)
Valuation allowance.......................... 105,662 205,906 225,972
--------- --------- ---------
$ 0 $ 0 $ 0
========= ========= =========
</TABLE>
A reconciliation from the federal statutory rate to the pro forma tax
benefit for the years ended December 31, 1996, 1997, and 1998 is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Statutory federal tax rate............................. (34.0)% (34.0)% (34.0)%
State income taxes, net of federal tax benefits........ (4.0) (4.0) (4.0)
Permanent differences -- meals and entertainment....... 0.0 0.4 0.2
Valuation allowance.................................... 38.0 37.6 37.8
----- ----- -----
0.0% 0.0% 0.0%
===== ===== =====
</TABLE>
F-18
<PAGE> 112
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
The Company leases office space under noncancelable operating leases
expiring on various dates through 2001. The Company recorded rent expense of
approximately $33,152 and $106,417 for the years ended December 31, 1997 and
1998, respectively, related to these operating leases.
Minimum future payments under noncancelable capital and operating leases as
of December 31, 1998 for each of the next five years ended December 31 are as
follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ---------
<S> <C> <C>
1999....................................................... $ 28,067 $ 68,914
2000....................................................... 22,904 68,914
2001....................................................... 11,005 21,675
2002....................................................... 0 0
2003....................................................... 0 0
-------- --------
Total minimum lease payments............................. 61,976 $159,503
========
Less imputed interest...................................... (22,935)
--------
Present value of minimum capitalized lease payments........ 39,041
Less current portion of capital lease obligations.......... (28,067)
--------
Long-term portion of capital lease obligation.............. $ 10,974
========
</TABLE>
LEGAL PROCEEDINGS
The Company is subject to lawsuits arising in the ordinary course of
business. In the opinion of management, the ultimate resolution of any pending
legal proceedings will not have a material adverse effect on the Company's
business or financial condition.
DEPENDENCE ON OTHER INTERNET ACCESS AND TELECOMMUNICATIONS PROVIDERS
The Company depends on other corporations such as UUNET Technologies, Inc.
("UUNET"), GTE Internetworking ("GTE"), Sprint Communications Company, L.P.
("Sprint"), Intermedia Communications, Inc., and other facilities-based and
nonfacilities-based carriers for the Company's subscribers' access to internet.
The Company has entered into supply agreements with Sprint, GTE, UUNET, and
other carriers to provide access to the Internet. The contracts are generally
for a term of one to three years but are subject to early termination in certain
instances. Some of the contracts also contain minimum purchase requirements. In
addition, the Company depends on local carriers such as BellSouth and MediaOne
for their subscribers' transmission to the Company's network. The Company's
ability to maintain and expand business depends in part on its ability to enter
into favorable contracts with the aforementioned access providers and carriers.
The Company's success also depends on the cooperation of interexchange and local
exchange carriers originating and terminating service in a timely manner. The
partial or total loss of
F-19
<PAGE> 113
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ability to initiate or terminate access to the internet would result in a loss
of revenues and could lead to a loss of subscribers.
9. RELATED-PARTY TRANSACTIONS
DBTELECOM TECHNOLOGIES, INC.
dbTelecom Technologies, Inc. ("Teletech") is a communications company that
builds, maintains and installs technology upgrades on cellular and PCS networks.
Teletech is co-owned by two of the shareholders of the Company. In December
1996, Teletech agreed to pay certain operating expenditures on the Company's
behalf and began to charge the Company a management fee for the use of certain
employees of Teletech. All expenditures paid by Teletech are included in the
Company's note payable to Teletech. During 1997 and 1998, Teletech paid $7,124
and $153,065, respectively, in operating expenses on the Company's behalf.
Additionally, Teletech charged the Company management fees of $42,000 and
$60,000 during 1997 and 1998, respectively. As of December 31, 1997 and 1998,
the Company's note payable balance to Teletech was $57,124 and $270,188,
respectively. The Company also reimbursed Teletech directly in cash for various
expenses totaling $4,305 during 1998.
The Company paid Teletech approximately $30,000 in management fees during
the six-month period ended June 30, 1999. On July 1, 1999, the Company assumed
the management functions previously provided by Teletech and therefore will no
longer pay management fees in the future.
NSCHOOL
The Company owns 25% of the outstanding common stock of nschool (Note 4).
In addition to the development of the software, the Company performed services
related to the design of nschool's corporate logo for which it charged a total
of $1,462. One of the Company's principal shareholders and its Chairman of the
board of directors is also the Chairman of the board of directors of nschool.
SALE OF COMMON STOCK TO EXECUTIVES
In connection with the sale of the Company's shares to several private
investors from November 23, 1998 through June 30, 1999 (Note 6), the Company
sold 4,379 shares of common stock at $11.42 per share to each of two executives
of the Company on June 30, 1999.
10. SUBSEQUENT EVENTS
DEBT EXTENSIONS
On July 21, 1999, the Company extended both the Revolving Credit Facility
and the note payable with a local commercial lending institution to November 1,
1999. On October 21, 1999, both the credit facility and note payable were
further extended to January 15, 2000. The Company made two payments of $50,000,
one in each of March and July of 1999 on its note payable to the lending
institution.
F-20
<PAGE> 114
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
On August 27, 1999, the two principal shareholders who had previously
entered into a lending arrangement with a bank and then loaned the monies to the
Company, extended the maturity of that obligation from August 27, 1999 to
December 27, 1999. The interest rate was raised from 8.5% to 8.75%.
SHAREHOLDER LOAN
In November 1999, one of the Company's principal shareholders agreed to
lend the Company up to $140,000 to cover short-term operating expenses. The
outstanding principal amount of this loan earns interest at a rate of 10% per
year and is payable on the earlier of January 15, 2000 or the closing of the
Company's proposed initial public offering. The Company has borrowed
approximately $66,000 from the shareholder under this arrangement as of November
22, 1999.
DIRECTOR APPOINTMENT
On July 29, 1999, a partner in a law firm which is providing services to
the Company with respect to general corporate matters as well as in connection
with the Company's proposed initial public offering was one of two directors
appointed to the board of directors of the Company. As of September 30, 1999,
approximately $268,000 was due to this law firm for previously provided services
(unaudited). No professional fees were paid to this law firm during the year
ended December 31, 1998. Approximately $40,000 was paid to the law firm during
the nine months ended September 30, 1999 (unaudited).
COMPANY NAME CHANGE
On July 29, 1999, the Company's board of directors unanimously voted to
change the name of the Company to comstar.net, inc. from ComStar Communications
Corporation, Inc. The name change became legally effective on August 2, 1999.
The accompanying financial statements have been modified to reflect that change.
STOCK OPTION GRANTS
On July 16, 1999, 50,000 option grants were made to an employee of the
Company under the Plan at $11.42 per share. These options vest at the rate of
one-third per year from the date of original hire and expire ten years from the
date of grant. In the opinion of management, these options were granted at
management's best estimate of fair market value at the date of grant and thus no
compensation expense was recorded.
On September 1, 1999, the Company's board of directors amended the Plan.
The Amended and Restated 1999 Stock Option and Incentive Plan (the "Amended
Plan") provides for an additional 300,000 shares of the Company's common stock
to be available for grant, bringing the total amount of shares available from
850,000 (the original amount provided by the Plan) to 1,150,000.
On September 1, 1999, two of the Company's principal shareholders were
granted 68,750 options each under the Amended Plan at $11.42 per share. These
options vest immediately upon the date of grant and expire ten years from the
date of grant.
F-21
<PAGE> 115
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Compensation expense of approximately $162,000 was recorded in connection with
this grant.
On September 1, 1999, 260,000 option grants were made to certain employees
of Teletech under the Amended Plan at $11.42 per share. These options vest
immediately upon the date of grant and expire ten years from the date of grant.
Compensation expense of approximately $3,204,000 was recorded in connection with
these grants using the fair value method of accounting as prescribed by SFAS No.
123.
DIRECTOR STOCK OPTION PLAN
On September 1, 1999, the Company's board of directors approved the
Director Stock Option Plan (the "Director Plan"). This Director Plan provides
for the issuance of options to purchase up to 300,000 shares of the Company's
common stock. On September 1, 1999, the Company granted 50,000 options each to
two of the Company's directors at $11.42 per share. These options vest one-third
immediately upon the date of grant, and then at a rate of one-third per year for
the next two years from the date they commenced services as directors. The
options expire five years from the date of grant. Compensation expense of
approximately $39,000 was recorded in connection with this grant. The Company's
board of directors will establish the number of shares, exercise terms, and
vesting schedules for all future grants made under the Director Plan.
REVERSE STOCK SPLIT
On September 1, 1999, the Company's Board of Directors approved a 1-for-2
reverse stock split with respect to its outstanding capital stock. The split is
contingent upon the consummation of the Company's proposed initial public
offering. The Board also voted to decrease the number of authorized shares of
its undesignated common stock to 50,000,000, eliminate the authorized shares of
Series A and Series B common stock, and convert all outstanding shares of each
series to shares of common stock without designation as to series. Additionally
the Board voted to require supermajority approval by the directors and
shareholders of change of control transactions, such as mergers, a sale of
substantially all assets, etc., and to implement a classified board of
directors. All common share and per share information in these financial
statements have been retroactively adjusted to reflect the stock split, the
decrease in the number of authorized shares of the Company's undesignated common
stock to 50,000,000 and the elimination of the authorized shares of Series A and
Series B common stock (unaudited).
STOCK OPTION GRANTS
On September 17, 1999, 32,500 options grants were made to four employees of
the Company under the Amended Plan at $11.42 per share. These options vest at
the rate of one-third per year from the date of original hire and expire ten
years from the date of grant. Compensation expense of approximately $38,000 will
be recognized at a rate of one-third per year calculated from the individuals'
original hire dates (unaudited).
F-22
<PAGE> 116
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
11. SUBSEQUENT EVENTS (UNAUDITED)
CANCELLED INITIAL PUBLIC EQUITY OFFERING
In November 1999, the Company withdrew a planned initial public equity
offering of its common stock. As a result of the decision not to complete the
offering, the Company wrote off associated expenses of approximately $1,030,000
which primarily related to SEC filing fees, accounting and legal fees, and
printing costs directly attributable to the cancelled initial public equity
offering.
PROPOSED REGISTERED OFFERING AND RELATED TRANSACTIONS
The Company is in the process of registering with the Securities and
Exchange Commission an offering of a minimum of eighty investment units and a
maximum of one hundred investment units, each unit consisting of an 8% Senior
Promissory Note and a Stock Purchase Warrant. This is a registered offering to a
limited number of investors. In connection with and concurrent with the closing
of the proposed offering of investment units, the Company plans to complete the
following three transactions. First, the Company will effect a two-for-one stock
split. Second, based upon the final terms of the offering of investment units,
the Company plans to issue a total of 1,276,658 shares of common stock (after
completion of the two-for-one stock split) to purchasers in the private
placement of common stock completed in June 1999 (Note 6) without any additional
cash payment by those investors. Third, the Company plans to issue a total of
780,075 shares of common stock (after completion of the two-for-one stock split)
to shareholders and a related party to settle the outstanding principal and
accrued interest of the $270,188 note payable to related party and the $618,549
note payable to shareholders (Note 5). There can be no assurance that this
offering or the related transactions will be completed.
DEBT EXTENSIONS
On December 10, 1999 the Company obtained extensions relating to the debt
owed to Teletech and to two of the Company's principal shareholders. The
extensions delayed the maturities until April 30, 2000.
F-23
<PAGE> 117
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Athens' ISP, Inc.:
We have audited the accompanying balance sheets of ATHENS' ISP, INC. (a
Georgia corporation) as of December 31, 1996 and 1997 and the related statements
of operations and shareholders' deficit, and cash flows for each of the two
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Athens' ISP, Inc. as of
December 31, 1996 and 1997 and the results of its operations and its cash flows
for each of the two years in the period ended December 31, 1997 in conformity
with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Atlanta, Georgia
May 28, 1999
F-24
<PAGE> 118
ATHENS' ISP, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash................................................... $ 1,334 $ 4,603
Accounts receivable, net of allowance for doubtful
accounts of $292 and $497 in 1996 and 1997,
respectively........................................ 1,653 2,983
Unbilled revenues...................................... 9,145 28,925
Loan receivable........................................ 505 0
Prepaid expenses....................................... 898 5,793
--------- ---------
Total current assets.............................. 13,535 42,304
--------- ---------
PROPERTY AND EQUIPMENT:
Computer and telecommunications equipment.............. 83,404 95,068
Furniture and fixtures................................. 5,594 6,837
Property under capital leases (Note 2)................. 47,055 47,055
Software............................................... 17,633 18,398
--------- ---------
153,686 167,358
Less accumulated depreciation.......................... (23,287) (53,046)
--------- ---------
Property and equipment, net......................... 130,399 114,312
--------- ---------
OTHER ASSETS:
Organization costs, net of accumulated amortization of
$111 and $206 in 1996 and 1997, respectively........ 364 269
Acquired Customer Base, net of accumulated amortization
of $0 and $1,025 in 1996 and 1997, respectively
(Note 2)............................................ 0 9,940
--------- ---------
Total other assets................................ 364 10,209
--------- ---------
Total assets...................................... $ 144,298 $ 166,825
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Current portion of obligations under capital leases
(Note 3)............................................ $ 8,268 $ 9,344
Accounts payable....................................... 10,296 12,050
Accrued liabilities.................................... 1,676 5,091
Accrued interest....................................... 10,010 27,518
Notes payable (Note 4)................................. 218,308 240,401
--------- ---------
Total current liabilities......................... 248,558 294,404
--------- ---------
LONG-TERM LIABILITIES:
Obligations under capital lease (Note 3)............... 13,588 4,244
--------- ---------
SHAREHOLDERS' DEFICIT (NOTE 5):
Common stock, $1 par value............................. 500 500
Accumulated deficit.................................... (118,348) (132,323)
--------- ---------
Total shareholders' deficit....................... (117,848) (131,823)
--------- ---------
Total liabilities and shareholders' deficit....... $ 144,298 $ 166,825
========= =========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-25
<PAGE> 119
ATHENS' ISP, INC.
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
REVENUES:
Access................................................. $ 109,652 $ 292,511
--------- ---------
OPERATING EXPENSES:
Cost of service........................................ 61,578 96,280
Payroll................................................ 63,471 106,810
General and administrative............................. 27,240 25,200
Rent................................................... 7,500 14,289
Professional fees...................................... 3,654 2,241
Insurance.............................................. 4,882 7,576
Depreciation and amortization.......................... 21,966 30,879
--------- ---------
Total operating expenses............................ 190,291 283,275
--------- ---------
OPERATING (LOSS) INCOME.................................. (80,639) 9,236
--------- ---------
OTHER (EXPENSES) INCOME:
Interest expense....................................... (9,874) (23,145)
Other.................................................. (6,760) (66)
--------- ---------
Total other (expenses) income....................... (16,634) (23,211)
--------- ---------
NET LOSS................................................. (97,273) (13,975)
ACCUMULATED DEFICIT, BEGINNING OF YEAR................... (20,575) (117,848)
--------- ---------
ACCUMULATED DEFICIT, END OF YEAR......................... $(117,848) $(131,823)
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
F-26
<PAGE> 120
ATHENS' ISP, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................. $(97,273) $(13,975)
-------- --------
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization......................... 21,966 30,879
Gain on sale of equipment............................. 0 196
Changes in operating assets and liabilities:
Accounts receivable, net............................ (1,653) (1,330)
Unbilled revenues................................... (9,145) (19,780)
Prepaid expenses.................................... (898) (4,895)
Accounts payable.................................... 9,620 1,754
Accrued liabilities................................. 1,114 3,415
Accrued interest.................................... 9,643 17,508
-------- --------
Total adjustments................................ 30,647 27,747
-------- --------
Net cash (used in) provided by operating
activities.................................... (66,626) 13,772
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net................. (117,189) (13,868)
Purchase of customer base................................ 0 (10,965)
Loan receivable.......................................... (505) 505
-------- --------
Net cash used in investing activities............ (117,694) (24,328)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt........................... 170,010 39,563
Repayment of debt........................................ (6,546) (17,470)
Obligations under capital lease.......................... 21,856 (8,268)
-------- --------
Net cash provided by financing activities........ 185,320 13,825
-------- --------
NET INCREASE............................................... 1,000 3,269
CASH AT BEGINNING OF YEAR.................................. 334 1,334
-------- --------
CASH AT END OF YEAR........................................ $ 1,334 $ 4,603
======== ========
CASH PAID FOR INTEREST..................................... $ 224 $ 2,232
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-27
<PAGE> 121
ATHENS' ISP, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. ORGANIZATION AND BUSINESS OPERATIONS
Athens' ISP, Inc. (the "Company") (a Georgia corporation) is a local and
regional provider of Internet access services to individuals and small
businesses. The Company has provided Internet access services since September
1995.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
LONG-LIVED ASSETS
The Company carries long-lived assets, as defined, at cost less accumulated
depreciation and amortization. Long-lived assets are evaluated periodically for
other than temporary impairment. If circumstances suggest that their value may
be impaired and the write-down would be material, an assessment of
recoverability is performed prior to any write-down of the asset. Impairment, if
any, is recognized through a valuation allowance with a corresponding charge
recorded in the income statement. Management believes that the long-lived assets
in the accompanying balance sheets are appropriately valued.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures for improvements
are capitalized, and replacements, maintenance, and repairs that do not improve
or extend the lives of the respective assets are expensed as incurred.
Depreciation is provided on a straight-line basis over the remaining estimated
useful lives, as follows:
<TABLE>
<S> <C>
Computers and telecommunications equipment.................. Five years
Furniture and fixtures...................................... Seven years
Software.................................................... Three years
</TABLE>
PROPERTY UNDER CAPITAL LEASES
The Company leases certain data communication and other equipment under
lease agreements accounted for as capital leases. The assets and liabilities
under capital leases are recorded at the lesser of the present value of
aggregate future minimum lease payments, including estimated bargain purchase
options, or the fair value of the assets under lease. Property under capital
leases is depreciated over their estimated useful lives of five years, which is
longer than the terms of the leases.
F-28
<PAGE> 122
ATHENS' ISP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ACQUIRED CUSTOMER BASE
On August 21, 1997, the Company acquired the customer list and related
accounts of Interlinks Online, Inc. ("Interlinks") and some related computer and
telecommunications equipment under the terms of a purchase agreement. The
purchase price was approximately $18,465, of which $10,965 was allocated to the
customer list and related accounts and $7,500 was allocated to the equipment
acquired. The Company capitalized the cost of the customer list and related
accounts and amortizes them over a period of three years.
INCOME TAXES
The Company is an S corporation and is not subject to corporate level taxes
on its net income because such income is attributed to the Company's
stockholders and taxes on such income is directly payable by them.
REVENUE RECOGNITION
The Company's revenues consist primarily of access revenues. Access
revenues are recurring revenues received for Internet access and web domain
hosting services. Revenue related to access services is recognized as the
service is provided. Installation and customer set-up fees are recognized upon
completion of the services. Unbilled revenues as of December 31, 1996 and 1997
consist of revenues associated with services provided in advance of billings.
CREDIT RISK
The Company's accounts receivable potentially subjects the Company to
credit risk, as collateral is generally not required. The Company's risk of loss
is limited due to the ability to terminate access on delinquent accounts. The
carrying amounts of the Company's receivables approximate their fair values as
of December 31, 1997 and 1996.
MAJOR CUSTOMERS
Sales to Kali, Inc. ("Kali"), a computer developer, during 1997 were
approximately 35% of the Company's total sales during 1997. No other customer
accounted for more than 10% of the Company's sales during 1996 and 1997. As of
years ended December 31, 1996 and 1997, respectively, there were no accounts
receivable balances due from Kali.
F-29
<PAGE> 123
ATHENS' ISP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LEASES
OPERATING LEASES
Beginning in 1997, the Company entered into various noncancelable operating
lease agreements for certain telecommunications equipment. The obligations
extend through 2000. The following is a schedule of future minimum rent payments
required under the leases at December 31, 1997:
<TABLE>
<S> <C>
1998........................................................ $21,834
1999........................................................ 18,749
2000........................................................ 4,193
2001........................................................ 0
2002........................................................ 0
Thereafter.................................................. 0
-------
Total..................................................... $44,776
=======
</TABLE>
Rent expense for the equipment was $6,789 for the year ended December 31,
1997 and is included in rent in the accompanying statement of operations and
shareholders' deficit. The Company rents office space on a month to month basis.
Office rent expense was $7,500 for the years ended December 31, 1996 and 1997,
respectively.
CAPITAL LEASE
The Company leases telecommunications equipment through a noncancelable
capital lease agreement. The capital lease obligation totaled $21,856 and
$13,588 for the years ended December 31, 1996 and 1997, respectively. The
capital lease obligation is secured by the telecommunications equipment. The
following is a schedule of future minimum payments required under the capital
lease at December 31, 1997:
<TABLE>
<S> <C>
1998........................................................ $10,500
1999........................................................ 4,375
-------
14,875
Less imputed interest..................................... (1,287)
-------
Net obligations under capital lease.................... $13,588
=======
</TABLE>
F-30
<PAGE> 124
ATHENS' ISP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. DEBT
Debt at December 31, 1996 and 1997 consisted of the following:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Note payable to shareholder, interest at 8.27%% and 8.44%
for 1996 and 1997, respectively, principal and interest
payable on demand........................................ $199,945 $214,945
Note payable to Interlinks, payable monthly through
September 5, 1998, non-interest bearing.................. 0 15,219
Note payable to shareholder for credit card purchases,
non-interest bearing, payable on demand.................. 18,363 10,237
-------- --------
Total debt............................................... $218,308 $240,401
======== ========
</TABLE>
Following are maturities of the debt as of December 31, 1997 for each of
the next five years ending on December 31:
<TABLE>
<S> <C>
1998........................................................ $240,401
1999........................................................ 0
2000........................................................ 0
2001........................................................ 0
2002........................................................ 0
Thereafter.................................................. 0
--------
Total..................................................... $240,401
========
</TABLE>
There were payments of approximately $65,000, $75,000,and $100,000 made
July 1998, January 1999, and April 1999, respectively, against the outstanding
debt balances.
5. SHAREHOLDERS' DEFICIT
In July 1995, the Company authorized for issuance 10,000 shares of common
stock with a $1 par value. There were 500 shares outstanding at December 31,
1996 and 1997, respectively.
6. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
The Company is subject to lawsuits arising in the ordinary course of
business. In the opinion of management, the ultimate resolution for these
pending legal proceedings will not have a material adverse effect on the
Company's business or financial condition.
DEPENDENCE ON OTHER INTERNET ACCESS AND TELECOMMUNICATIONS PROVIDERS
The Company depends on other corporations such as Sprint, BellSouth, AT&T,
and other facilities-based and nonfacilities-based carriers for the Company's
subscribers' access to the Internet. The Company's success depends on the
cooperation of interexchange and
F-31
<PAGE> 125
ATHENS' ISP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
local exchange carriers originating and terminating service in a timely manner.
The partial or total loss of the ability to initiate or terminate access to the
Internet would result in a loss of revenues and could lead to a loss of
subscribers.
7. SUBSEQUENT EVENT
On July 1, 1998, comstar.net,inc. acquired certain assets of Athens' ISP,
Inc. under the terms of an asset purchase agreement. The acquisition consisted
primarily of Internet access business subscribers and related computer and
telecommunications equipment. The purchase price was approximately $327,000. On
the same date, an unrelated party also acquired certain assets of Athens' ISP,
Inc. under a separate asset purchase agreement. The acquisition consisted
primarily of Internet access individual dial-up subscribers, accounts
receivable, and related computer and telecommunications equipment. The purchase
price was approximately $186,000.
F-32
<PAGE> 126
APPENDIX A
THIS PROMISSORY NOTE AND THE SHARES ISSUABLE UPON CONVERSION HEREOF HAVE BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), PURSUANT TO
A REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
HOWEVER, NEITHER THIS NOTE, SUCH SHARES, NOR ANY INTEREST THEREIN MAY BE OFFERED
OR SOLD EXCEPT PURSUANT TO (i) A POST-EFFECTIVE AMENDMENT TO SUCH REGISTRATION
STATEMENT, (ii) A SEPARATE REGISTRATION STATEMENT UNDER THE ACT, OR (iii) AN
EXEMPTION FROM REGISTRATION UNDER THE ACT.
comstar.net, inc.
Form of 8% Senior Promissory Note
$________________ , 1999
Atlanta, Georgia
comstar.net, Inc., a Georgia corporation (the "Company" or the
"Borrower"), for value received, hereby promises to pay to
_____________________________________________, with an address at
______________________________________________________________, or registered
assigns (the "Holder"), the principal amount of _______________________________
dollars ($____________) on the Maturity Date (as defined below), and to pay
interest on the unpaid principal balance hereof at the rate of 8% per annum
(calculated on the basis of a 360-day year consisting of twelve 30-day months)
on the last day of each year commencing December 31, 2000 and on the Maturity
Date (each such date being an "Interest Payment Date") all as hereafter further
provided.
All agreements herein made are expressly limited so that in no event
whatsoever, whether by reason of advancement of proceeds hereof, acceleration of
maturity of the unpaid balance hereof or otherwise, shall the amount paid or
agreed to be paid to the Holder for the use of the money advanced or to be
advanced hereunder exceed the maximum rate permitted by law (the "Maximum
Rate"). If, for any circumstances whatsoever, the fulfillment of any provision
of this Note or any other agreement or instrument now or hereafter evidencing,
securing or in any way relating to the debt evidenced hereby shall involve the
payment of interest in excess of the Maximum Rate, then, ipso facto, the
obligation to pay interest hereunder shall be reduced to the Maximum Rate; and
if for any circumstance whatsoever, the Holder shall ever receive interest, the
amount of which would exceed the amount collectible at the Maximum Rate, such
amount as would be excessive interest shall be applied to the reduction of the
principal balance remaining unpaid hereunder and not to the payment of interest.
This provision shall control every other provision in any and all other
agreements and instruments existing or hereafter arising between the Borrower
and the Holder with respect to the debt evidenced hereby.
1. Offering, Subscription Agreement and Security.
This Note was issued by the Borrower in an offering of units consisting
of notes and warrants
A-1
<PAGE> 127
(the "Offering") made pursuant to a certain Registration Statement on Form S-1
(Reg. No. 333-95281) (the "Registration Statement") filed with the Securities
and Exchange Commission (the "Commission") under the Securities Act of 1933, as
amended (the "Act"), and a subscription agreement (the "Subscription Agreement")
between the Company and the original Holder hereof. The series of promissory
notes issued in connection with the Offering is referred to hereafter as the
"Notes" and the warrants issued in connection with the Offering are referred to
hereafter as the "Warrants."
2. Payments.
(a) Subject to Section 10 hereof, principal of, and any accrued
and unpaid interest on, this Note shall be due and payable in full on the
Maturity Date. The "Maturity Date" shall be the date which is the earliest of
(i) January 15, 2005 (the "Stated Maturity Date"), (ii) the date of the closing
of an underwritten public offering of securities of the Company pursuant to a
registration statement filed with the Commission under the Act, and (iii) the
date of the closing of a sale (or the closing of the last of a series of sales)
of securities of the Company after the date hereof in the case of (ii) or (iii)
above, the gross proceeds of which, in the aggregate, equal or exceed
$10,000,000 (any such transaction or transactions referred to in clause (ii) or
(iii) being hereinafter referred to as a "Qualified Financing"). The Company
shall give the Holder at least 20 days' prior to written notice of the earliest
scheduled closing date of a Qualified Financing.
(b) Interest on this Note shall accrue from the most recent
Interest Payment Date to which interest has been paid or, if no interest has
been paid on this Note, from the date hereof, to but excluding the next Interest
Payment Date, and shall be payable in arrears on each Interest Payment Date.
(c) If any Interest Payment Date or the Maturity Date would fall
on a day that is not a Business Day (as defined below), the payment due on such
Interest Payment Date or Maturity Date will be made on the next succeeding
Business Day with the same force and effect as if made on the Interest Payment
Date or the Maturity Date, as the case may be. "Business Day" means any day
which is not a Saturday or Sunday and is not a day on which banking institutions
are generally authorized or obligated to close in the City of New York, New
York.
(d) The Borrower may, at its option, prepay the full principal of
this Note plus all accrued interest thereon, without payment of any premium or
penalty, by giving written notice thereof to the Holder at least 20 days prior
to the date selected for prepayment.
(e) Payment of principal and interest on this Note shall be made
by check sent to the Holder's address set forth above or to such other address
as the Holder may designate for such purpose from time to time by written notice
to the Borrower, in such coin or currency of the United States of America as at
the time of payment shall be legal tender for the payment of public and private
debts; provided, however, that, the Holder may elect by written notice to the
Company at least 10 days prior to the scheduled Interest Payment Date to receive
payment of interest due and payable on this Note in shares of Common Stock (as
hereinafter defined) based upon the then applicable Conversion Price (as
hereinafter defined).
A-2
<PAGE> 128
(f) The obligations to make the payments provided for in this
Note are absolute and unconditional and not subject to any defense, setoff,
counterclaim, rescission, recoupment or adjustment whatsoever. The Borrower
hereby expressly waives demand and presentment for payment, notice of
non-payment, notice of dishonor, protest, notice of protest and diligence in
taking any action to collect any amount called for hereunder, and shall be
directly and primarily liable for the payment of all sums owing and to be owing
hereon, regardless of and without any notice, diligence, act or omission with
respect to the collection of any amount called for hereunder.
3. Ranking of Note.
(a) The Borrower, for itself, its successors and assigns,
covenants and agrees that the payment of the principal of and interest on this
Note is senior in right of payment to the payment of all existing and future
Junior Debt (as hereinafter defined). "Junior Debt" shall mean all existing and
future Indebtedness (as hereinafter defined) other than (i) the Indebtedness
represented by the Notes, (ii) capital lease obligations existing on the date
hereof, and (iii) other Indebtedness permitted by Section 8 (a) (iv).
"Indebtedness" shall mean (A) any liability of the Borrower for borrowed money,
(x) evidenced by a note, debenture, bond or other instrument of indebtedness
(including, without limitation, a purchase money obligation), including any
given in connection with the acquisition of property, assets or service, or (y)
for the payment of rent or other amounts relating to capitalized lease
obligations; (B) any liability of others of the nature described in clause (A)
which the Borrower has guaranteed or which is otherwise its legal liability; and
(C) any modification, renewal, extension, replacement or refunding of any such
liability described in clause (A) or (B); provided, that Indebtedness does not
include unsecured trade credit.
(b) The Borrower covenants and agrees to cause any current holder
of Junior Debt and to cause any future holder of Junior Debt permitted to be
incurred pursuant to this Note to execute such subordination agreements,
instruments or waivers as may be necessary to reflect the terms set forth
herein.
(c) Until the payment in full of all amounts of principal of and
interest on the Notes, and all other amounts owing under the Notes and the
Subordination Agreement, no payment may be made with respect to the principal of
or other amounts owing with respect to any Junior Debt, or in respect of any
redemption, retirement, purchase or other acquisition thereof, provided that the
Borrower may pay scheduled interest thereon so long as no Event of Default shall
have occurred and be continuing.
4. Conversion.
(a) The Holder shall have the right (the "Conversion Right"), at
any time prior to full payment of the principal amount due and owing under this
Note, on the terms set forth in this Section 4, to convert all or any portion of
the principal of this Note into a number of shares of the Company's common
stock, without par value (the "Common Stock"), determined by dividing the
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principal amount so converted (the "Conversion Amount") by $1.29 (as adjusted in
accordance herewith, the "Conversion Price"). The Conversion Price is subject to
adjustment as hereafter provided. (The Conversion Price stated herein reflects
the recapitalization of the Company described in the prospectus included in the
Registration Statement, and no adjustment shall be made hereunder in that
regard.) Upon conversion, the Company shall pay all accrued and unpaid interest
on the Conversion Amount.
(b) To exercise the Conversion Right, the Holder, shall deliver
to the Company, at its office at 2812 Spring Road, Suite 210, Atlanta, Georgia
30339; or at such other place as is designated in writing by the Company, a
notice (the "Conversion Notice") stating that the Holder is exercising the
Conversion Right, the intended Conversion Amount and the name or names in which
the Holder wishes the certificates for shares of Common Stock to be issued. The
Conversion Amount, unless equal to the remaining principal amount under this
Note, shall be an integral multiple of $100,000.
(c) Upon exercise of the Conversion Right, the Holder shall be
deemed to be the holder of record of the shares of Common Stock issuable upon
such exercise (the "Conversion Shares"), notwithstanding that the transfer books
of the Company shall then be closed or certificates representing such Conversion
Shares shall not then have been actually delivered to the Holder. As soon as
practicable after exercise of the Conversion Right, the Company shall issue and
deliver to the Holder a certificate or certificates for the Conversion Shares
issuable upon such exercise registered in the name of the Holder or its
designee; provided, that the Company, by notice given to the Holder promptly
after receipt of the Conversion Notice, may require the Holder, as a condition
to the delivery of such certificate or certificates, to present this Note to the
Company for the placement hereon of a legend indicating that the Conversion
Right has been exercised and of the Conversion Amount, and this Note (unless
thereby paid in full) shall be immediately returned to the Holder.
(d) The issuance of any shares or other securities upon the
exercise of the Conversion Right, and the delivery of certificates or other
instruments representing such shares or other securities, shall be made without
charge to the Holder for any tax or other charge in respect of such issuance.
The Company shall not, however, be required to pay any tax which may be payable
in respect of any transfer involved in the issue and delivery of any certificate
in a name other than that of the Holder, and the Company shall not be required
to issue or deliver any such certificate unless and until the person or persons
requesting the issue thereof shall have paid to the Company the amount of such
tax or shall have established to the satisfaction of the Company that such tax
has been paid.
(e) The Holder shall not have, solely on account of such status
as a Holder of this Note, any rights of a shareholder of the Company, either at
law or in equity, or any notice of meetings of shareholders or of any other
proceedings of the Company except as provided in this Note.
(f) The Company shall at all times reserve and keep available out
of its authorized and unissued Common Stock, solely for the purpose of providing
for the exercise of the
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Conversion Right, such number of shares of Common Stock as shall, from time to
time, be sufficient for the exercise of the Conversion Right in full. The
Company covenants that all shares of Common Stock issuable upon exercise of the
Conversion Right shall be validly issued, fully paid, nonassessable, and free of
preemptive rights.
(g) If, at the time of exercise of this Conversion Right, the
Registration Statement (or any other registration statement covering the
Conversion Shares) is not effective, then the Holder shall make such
representations as are reasonably necessary to allow the Company to issue such
Conversion Shares in compliance with all applicable securities laws, and the
certificate(s) evidencing such Conversion Shares shall be appropriately legended
to reflect that such Conversion Shares were not registered under the Act and any
applicable state securities laws.
5. Adjustment of Conversion Price.
(a) In case the Company shall at any time after the date the
Notes were first issued (i) declare a dividend on the outstanding Common Stock
payable in shares of its capital stock, (ii) subdivide the outstanding Common
Stock, (iii) combine the outstanding Common Stock into a smaller number of
shares, or (iv) issue any shares of its capital stock by reclassification of the
Common Stock (including any such reclassification in connection with a
consolidation or merger in which the Company is the continuing corporation),
then, in each case, the Conversion Price, and the number of Conversion Shares
issuable upon exercise of this Note, in effect at the time of the record date
for such dividend or of the effective date of such subdivision, combination, or
reclassification, shall be proportionately adjusted so that the Holder after
such time shall be entitled to receive the aggregate number and kind of shares
which, if the Conversion Right had been exercised immediately prior to such
time, he would have owned upon such exercise and been entitled to receive by
virtue of such dividend, subdivision, combination, or reclassification. Such
adjustment shall be made successively whenever any event listed above shall
occur.
(b) In case the Company shall issues shares of Common Stock or
rights, warrants or options to subscribe for or purchase Common Stock, or
securities convertible into or exchangeable for Common Stock, or securities
convertible into or exchangeable for Common Stock, at a price per share, or with
an exercise, conversion or exchange price per share, less than the Conversion
Price in effect on the date of such issuance, then the Conversion Price shall be
reduced to such lower price. The provisions of this Section 5(b) shall not apply
to the grant of options, or the issuance of shares of Common Stock upon exercise
thereof, to the extent permitted under the terms of this Note, to employees of
the Company pursuant to a stock option plan or plans approved by the Board of
Directors and shareholders of the Company and to securities issued in any of the
following transactions, to the extent permitted by the terms of this Note, if
approved by a majority of the Company's Board of Directors, including a majority
of the directors who are not employees of the Company: (i) the acquisition of
another corporation or entity by the Company by merger, purchase of
substantially all the assets or other reorganization as a result of which the
Company by merger, purchase of substantially all the assets or other
reorganization as a result of which the Company or its shareholders prior to the
transaction own more than 50% of the voting power of the resulting corporation
or other entity; (ii) equipment leases or borrowings from financial or other
institutions
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regularly engaged in such business; (iii) a transaction in which the Company
licenses any intellectual property to be used in the business of the Company; or
(iv) a strategic joint venture or alliance between the Company and another party
to which the securities are issued, or an affiliate thereof.
(c) Whenever there shall be an adjustment as provided in this
Section 5, the Company shall promptly cause written notice thereof to be sent to
the Holder, which notice shall be accompanied by an officer's certificate
setting forth the number of Conversion Shares issuable upon the exercise of the
Conversion Right and the Conversion Price after such adjustment and setting
forth a brief statement of the facts requiring such adjustment and the
computation thereof, which officer's certificate shall be conclusive evidence of
the correctness of any such adjustment absent manifest error.
(d) The Company shall not be required to issue fractions of
shares of Common Stock or other capital stock of the Company upon the exercise
of the Conversion Right. If any fraction of a share would be issuable on any
exercise of the Conversion Right (or specified portions thereof), the Company
shall purchase such fraction for an amount in cash equal to the same fraction of
the Current Market Price (as defined in the Warrants) of such share of Common
Stock on the date of exercise of the Conversion Right.
6. Registration Rights.
(a) If, at any time following the later of (i) the first
anniversary of the date of this Note, and (ii) the consummation of the Company's
initial underwritten public offering of securities (an "IPO"), the Company shall
file a registration statement (other than any registration statement on Form
S-4, Form S-8, or any successor form) with the Commission while any Registrable
Securities (as hereinafter defined) are outstanding, the Company shall give all
the then holders of any Registrable Securities (the "Eligible Holders") at least
30 days prior written notice of the filing of such registration statement. If
requested by any Eligible Holder in writing within 20 days after receipt of any
such notice, the Company shall, at the Company's sole expense (other than the
fees and disbursements of counsel for the Eligible Holders and the underwriting
discounts, if any, payable in respect of the Registrable Securities sold by any
Eligible Holder), register or qualify all or, at each Eligible Holder's option,
any portion of the Registrable Securities of any Eligible Holders who shall have
made such request, concurrently with the registration of such other securities,
all to the extent requisite to permit the public offering and sale of the
Registrable Securities through the facilities of all securities exchanges and
the over-the-counter markets on which the Company's securities are traded, and
will use its best efforts through its officers, directors, auditors, and counsel
to cause such registration statement to become effective as promptly as
practicable. Notwithstanding the foregoing, if the managing underwriter of any
such offering shall advise the Company in writing that, in its opinion, the
distribution of all or a portion of the Registrable Securities requested to be
included in the registration concurrently with the securities being registered
by the Company would materially adversely affect the distribution of such
securities by the Company for its own account, then any Eligible Holder who
shall have requested registration of his or its Registrable Securities shall not
be entitled to have such Eligible Holder's Registrable Securities (or the
portions thereof so designated by the managing underwriter) included in such
registration statement, provided that no such exclusion or reduction shall be
made as to any Registrable Securities if any securities of the
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Company are included in such registration statement for the account of any
person other than the Company and any Eligible Holder unless the securities
included in such registration statement for such other person shall have been
reduced pro rata to the reduction of the Registrable Securities which were
requested to be included in such registration. As used herein, "Registrable
Securities" shall mean the Conversion Shares and the shares of Common Stock
issued or issuable upon exercise of the Warrants issued to the Holder together
with this Note pursuant to the Offering which, in each case, have not been
previously sold pursuant to a registration statement or Rule 144 promulgated
under the Act.
(b) If, at any time after 180 days following the effective date
of the IPO, the Company shall receive a written request from Eligible Holders
who in the aggregate own (or upon exercise of the Conversion Right and the
Warrants would own) a majority of the total number of shares of Common Stock
then included (or upon such exercise and conversion would be included) in the
Registrable Securities (the "Majority Holders"), to register the sale of all or
part of such Registrable Securities, the Company shall, as promptly as
practicable, prepare and file with the Commission a registration statement
sufficient to permit the public offering and sale of the Registrable Securities
through the facilities of all securities exchanges and the over-the-counter
markets on which the Company's securities are traded, and will use its efforts
through its officers, directors, auditors, and counsel to cause such
registration statement to become effective as promptly as practicable; provided,
however, that, subject to its continued compliance with Section 6(h) hereof, (i)
the Company shall only be obligated to file one such registration statement for
which all expenses incurred in connection with such registration (other than the
fees and disbursements of counsel for the Eligible Holders and underwriting
discounts, if any, payable in respect of the Registrable Securities sold by the
Eligible Holders) shall be borne by the Company and one additional such
registration statement for which all such expenses shall be paid by the Eligible
Holders, and (ii) the Company shall not be obligated to effect (x) more than one
registration pursuant to this Section 6(b) in any 12-month period, (y) any
registration statement within six months after the effective date of a
registration statement prepared and filed in accordance with Section 6(a) in
which Registrable Securities could have been included, or (z) any registration
statement that covers Registrable Securities that are proposed to be sold at an
aggregate price to the public of less than $5,000,000. Any additional
registration statement required to be filed as a result of the Company's failure
to comply with Section 6(h) hereof shall be at the Company's expense. Within ten
business days after receiving any request contemplated by this Section 6(b), the
Company shall send written notice to all the other Eligible Holders advising
each of them that the Company is proceeding with such registration and offering
to include therein all or any portion of any such other Eligible Holder's
Registrable Securities, provided that the Company receives a written request to
do so from such Eligible Holder within 20 days after receipt by him or it of the
Company's notice. Notwithstanding the foregoing, if the Company shall furnish to
the Holders requesting a registration statement pursuant to this Section 6 (b) a
certificate signed by the President of the Company stating that in the good
faith judgment of the Board of Directors of the Company, it would be seriously
detrimental to the Company and its shareholders for such registration statement
to be filed by reason of a material pending transaction and it is therefore
essential to defer the filing of such registration statement, the Company shall
have the right to defer such filing for a period of not more than 60 days after
receipt of the request of the Majority Holders; provided, however, that the
Company may not utilize this right more than once in any 12-month
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period.
(c) In the event of a registration pursuant to the provisions of
this Section 6, the Company shall use its best efforts to cause the Registrable
Securities so registered to be registered or qualified for sale under the
securities or blue sky laws of such jurisdictions as the Holder or such holders
may reasonably request; provided, however, that the Company shall not by reason
of this Section 6(c) be required to qualify to do business in any state in which
it is not otherwise required to qualify to do business or to file a general
consent to service of process.
(d) The Company shall keep effective any registration or
qualification contemplated by this Section 6 and shall from time to time amend
or supplement each applicable registration statement, preliminary prospectus,
final prospectus, application, document, and communication for such period of
time as shall be required to permit the Eligible Holders to complete the offer
and sale of the Registrable securities covered thereby. Provided the Company is
in continued compliance with the requirement of Section 6(h) hereof, the Company
shall in no event be required to keep any such registration or qualification in
effect for a period in excess of nine months from the date on which the Eligible
Holders are first free to sell such Registrable Securities; provided, however,
that, if the Company is required to keep any such registration or qualification
in effect with respect to securities other than the Registrable Securities
beyond such period, the Company shall keep such registration or qualification in
effect as it relates to the Registrable Securities for so long as such
registration or qualification remains or is required to remain in effect in
respect of such other securities.
(e) In the event of a registration pursuant to the provisions of
this Section 6, the Company shall furnish to each Eligible Holder such
reasonable number of copies of the registration statement and of each amendment
and supplement thereto (in each case, including all exhibits), such reasonable
number of copies of each prospectus contained in such registration statement and
each supplement or amendment thereto (including each preliminary prospectus),
all of which shall conform to the requirements of the Act and the rules and
regulations thereunder, and such other documents, as any Eligible Holder may
reasonably request to facilitate the disposition of the Registrable Securities
included in such registration.
(f) In the event of a registration pursuant to the provisions
of this Section 6, the Company shall furnish each Eligible Holder of any
Registrable Securities so registered with an opinion of its counsel (reasonably
acceptable to the Eligible Holders) substantially in the form rendered in
connection with the closing of the Offering. The Company also shall furnish to
each Eligible Holder a cold comfort letter from the independent certified public
accountants of the Company in the customary form and substance.
(g) In the event of a registration pursuant to the provisions of
this Section 6, the Company and each Eligible Holder shall enter into a
cross-indemnity agreement and a contribution agreement, each in customary form,
with each underwriter, if any, and, if requested, enter into an underwriting
agreement containing conventional representations, warranties, allocation of
expenses, and customary closing conditions, including, without limitation,
opinions of counsel and accountants' cold comfort letters, with any underwriter
who acquires any
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Registrable Securities.
(h) The Company agrees that, after the completion of the IPO and
until all the Registrable Securities have been sold under a registration
statement or pursuant to Rule 144 under the Act, it shall keep current in filing
all reports, statements and other materials required to be filed with the
Commission to permit holders of the Registrable Securities to sell such
securities under Rule 144.
(i) Except for rights granted to holders of the Warrants and the
Notes, the Company will not, without the written consent of the Majority
Holders, grant to any persons the right to request the Company to register any
securities of the Company, provided that the Company may grant such registration
rights to other persons so long as such rights are subordinate to the rights of
the holders of the Registrable Securities.
7. Indemnification.
(a) Subject to the conditions set forth below, the Company agrees
to indemnify and hold harmless each Eligible Holder, its officers, directors,
partners, employees, agents, and counsel, and each person, if any, who controls
any such person within the meaning of Section 15 of the Act or Section 20(a) of
the Exchange Act, from and against any and all loss, liability, charge, claim,
damage, and expense, whatsoever (which shall include, for all purposes of this
Section 7, without limitation, reasonable attorneys' fees actually incurred and
any and all expense whatsoever reasonably incurred in investigating, preparing,
or defending against any litigation, commenced or threatened, or any claim
whatsoever, and any and all amounts paid in settlement of any claim or
litigation), as and when incurred, arising out of, based upon, or in connection
with any untrue statement or alleged untrue statement of a material fact
contained (A) in any registration statement, preliminary prospectus, or final
prospectus (as from time to time amended and supplemented), or any amendment or
supplement thereto, relating to the sale of any of the Registrable Securities,
or (B) in any application or other document or communication (in this Section 7
collectively called an "application") executed by or on behalf of the Company or
based upon written information furnished by or on behalf of the Company filed in
any jurisdiction in order to register or qualify any of the Registrable
Securities under the securities or blue sky laws thereof, or filed with the
Commission or any securities exchange; or any omission or alleged omission to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading, unless such statement or omission was made in
reliance upon and in conformity with written information furnished to the
Company with respect to such Eligible Holder by or on behalf of such person
expressly for inclusion in any registration statement, preliminary prospectus,
or final prospectus, or any amendment or supplement thereto, or in any
application, as the case may be. The foregoing agreement to indemnify shall be
in addition to any liability the Company may otherwise have, including
liabilities arising under any of the Notes or Warrants.
If any action is brought against any Eligible Holder or any of its
officers, directors, partners, employees, agents, or counsel, or any controlling
persons of such person (an
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"indemnified party") in respect of which indemnity may be sought against the
Company pursuant to the foregoing paragraph, such indemnified party or parties
shall promptly notify the Company in writing of the institution of such action
(but the failure so to notify shall not relieve the Company from any liability
under this Section 7(a) unless the Company shall have been materially prejudiced
by such failure or relieve the Company from any liability other than pursuant to
this Section 7(a)) and the Company shall promptly assume the defense of such
action, including the employment of counsel (reasonably satisfactory to such
indemnified party or parties) and payment of expenses. Such indemnified party or
parties shall have the right to employ its or their own counsel in any such
case, but the fees and expenses of such counsel shall be at the expense of such
indemnified party or parties unless the employment of such counsel shall have
been authorized in writing by the Company in connection with the defense of such
action or the Company shall not have employed counsel reasonably satisfactory to
such indemnified party or parties to have charge of the defense of such action
or such indemnified party or parties shall have reasonably concluded that there
may be one or more legal defenses available to it or them or to other
indemnified parties which are different from or additional to those available to
the Company, in any of which events such fees and expenses shall be borne by the
Company and the Company shall not have the right to direct the defense of such
action on behalf of the indemnified party or parties. Anything in this Section 7
to the contrary notwithstanding, the Company shall not be liable for any
settlement of any such claim or action effected without its written consent,
which shall not be unreasonably withheld. The Company shall not, without the
prior written consent of each indemnified party that is not released as
described in this sentence, settle or compromise any action, or permit a default
or consent to the entry of judgment in or otherwise seek to terminate any
pending or threatened action, in respect of which indemnity may be sought
hereunder (whether or not any indemnified party is a party thereto), unless such
settlement, compromise, consent, or termination includes an unconditional
release of each indemnified party from all liability in respect of such action.
The Company agrees promptly to notify the Eligible Holders of the commencement
of any litigation or proceedings against the Company or any of its officers or
directors in connection with the sale of any Registrable Securities or any
preliminary prospectus, prospectus, registration statement, or amendment or
supplement thereto, or any application relating to any sale of any Registrable
Securities.
(b) The Holder agrees to indemnify and hold harmless the Company,
each director of the Company, each officer of the Company who shall have signed
any registration statement covering Registrable Securities held by the Holder,
each other person, if any, who controls the Company within the meaning of
Section 15 of the Act or Section 20(a) of the Exchange Act, and its or their
respective counsel, to the same extent as the foregoing indemnity from the
Company to the Eligible Holders in Section 7(a), but only with respect to
statements or omissions, if any, made in any registration statement, preliminary
prospectus, or final prospectus (as from time to time amended and supplemented),
or any amendment or supplement thereto, or in any application, in reliance upon
and in conformity with written information furnished to the Company with respect
to the Holder by or on behalf of the Holder expressly for inclusion in any such
registration statement, preliminary prospectus, or final prospectus, or any
amendment or supplement thereto, or in any application, as the case may be. If
any action shall be brought against the Company or any other person so
indemnified based on any such registration statement, preliminary prospectus, or
final prospectus, or any amendment or supplement thereto, or in any application,
and in respect of which indemnity may be sought against the Holder pursuant to
this Section 7(a), the Holder shall have the rights and duties given to the
Company, and the Company and each other person so indemnified shall have the
rights and duties given to the indemnified parties, by the provisions of Section
7(a).
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(c) To provide for just and equitable contribution, if (i) an
indemnified party makes a claim for indemnification pursuant to Section 7(a) or
7(b) (subject to the limitations thereof) but it is found in a final judicial
determination, not subject to further appeal, that such indemnification may not
be enforced in such case, even though this Note expressly provides for
indemnification in such case, or (ii) any indemnified or indemnifying party
seeks contribution under the Act, the Exchange Act or otherwise, then the
Company (including for this purpose any contribution made by or on behalf of any
director of the Company, any officer of the Company who signed any such
registration statement, any controlling person of the Company, and its or their
respective counsel), as one entity, and the Eligible Holders of the Registrable
Securities included in such registration in the aggregate (including for this
purpose any contribution by or on behalf of an indemnified party), as a second
entity, shall contribute to the losses, liabilities, claims, damages, and
expenses whatsoever to which any of them may be subject, on the basis of
relevant equitable considerations such as the relative fault of the Company and
such Eligible Holders in connection with the facts which resulted in such loses,
liabilities, claims, damages, and expenses. The relative fault, in the case of
an untrue statement, alleged untrue statement, omission, or alleged omission,
shall be determined by, among other things, whether such statement, alleged
statement, omission, or alleged omission relates to information supplied by the
Company or by such Eligible Holders, and the parties, relative intent,
knowledge, access to information, and opportunity to correct or prevent such
statement, alleged statement, omission or alleged omission. The Company and the
Holder agree that it would be unjust and inequitable if the respective
obligations of the Company and the Eligible Holders for contribution were
determined by pro rata or per capita allocation of the aggregate losses,
liabilities, claims, damages, and expenses (even if the Eligible Holders and the
other indemnified parties were treated as one entity for such purpose) or by any
other method of allocation that does not reflect the equitable considerations
referred to in this Section 7(c). In no case shall any Eligible Holder be
responsible for a portion of the contribution obligation imposed on all Eligible
Holders in excess of its pro rata share based on the number of shares of Common
Stock owned by it (or which would be owned upon exercise or conversion of all
Registrable Securities) and included in such registration compared to the number
of shares of Common Stock owned (or which would be owned upon exercise or
conversion of all Registrable Securities) by all Eligible Holders and included
in such registration. No person guilty of a fraudulent misrepresentation (within
the meaning of Section 11(f) of the Act) shall be entitled to contribution from
any person who is not guilty of such fraudulent misrepresentation. For purposes
of this Section 7(c), each person, if any, who controls any Eligible Holder
within the meaning of Section 15 of the Act or Section 20(a) of the Exchange
Act, and each officer, director, partner, employee, agent, and counsel of each
such Eligible Holder or control person shall have the same rights to
contribution as such Eligible Holder or control person and each person, if any,
who controls the Company within the meaning of Section 15 of the Act or Section
20(a) of the Exchange Act, each officer of the Company who shall have signed any
such registration statement, each director of the Company, and its or their
respective counsel shall have the same rights to contribution as the Company,
subject in each case to the provisions of this Section 7(c). Anything in this
Section 7(c) to the contrary notwithstanding, no party shall be liable for
contribution with respect to the settlement of any claim or action effected
without its written consent. This Section 7 (c) is intended to supersede any
right to contribution under the Act, the Exchange Act or otherwise.
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8. Covenants.
The Borrower covenants and agrees with the Holder that, so long as any
amount remains unpaid on the Notes, unless the consent of the holders of 66 2/3%
of the principal amount outstanding under the Notes is obtained, such Borrower:
(a) Shall not create, incur, or suffer to exist any Indebtedness except (i) the
Indebtedness represented by the Notes, (ii) Junior Debt in existence on the date
hereof, (iii) capitalized lease obligations in existence on the date hereof or
otherwise permitted hereunder, (iv) purchase money Indebtedness, (v) the
Indebtedness to be repaid out of the proceeds of the Offering no later than
January 15, 2000 as described in the Use of Proceeds section of the prospectus
included in the Registration Statement; and (vi) the Indebtedness owed to Dr.
Samuel F. Dayton and Mr. James L. Bruce, Jr. in the principal amount of
approximately $618,549 and accrued interest thereon, and to db Telecom
Technologies, Inc. in the principal amount of approximately $270,188 and
accrued interest thereon (collectively, the "Insider Debt"), which shall be
exchanged for shares of Common Stock at the Conversion Price at the closing of
the Offering.
(b) Shall not create, incur or suffer to exist any mortgage,
lien, pledge, charge, security interest or encumbrance of any kind on any of its
property or assets (collectively, "Liens"), except (i) Liens for taxes not yet
due or contested in good faith with appropriate reserves maintained on the books
of the Borrower; (ii) carriers', warehousemen's, mechanics', and similar Liens
arising in the ordinary course of business which are not overdue for more than
90 days or are being contested in good faith; (iii) easements, rights of way,
zoning restrictions, and similar Liens on real property, which in the aggregate
are not material and do not materially detract from the use of such property;
(iv) Liens for Indebtedness permitted to be incurred or in existence under
Sections 8(a) (iii) and (iv); (v) landlord Liens with respect to real property
leased by the Borrower; and (v) Liens securing the Indebtedness to be repaid out
of the proceeds of the Offering no later than January 15, 2000 as described in
the Use of Proceeds section of the prospectus included in the Registration
Statement, which Liens are to be released upon the repayment of such
Indebtedness.
(c) Shall not create, acquire, or maintain any subsidiaries other
than the subsidiary listed in the Registration Statement.
(d) Shall not offer, issue sell, contract to sell, grant any
option, warrant, or other right exercisable, convertible, or exchangeable for,
or otherwise dispose of any securities of the Company, except (i) the Conversion
Shares and shares issuable upon exercise of the Warrants, (ii) shares issuable
upon exercise of options, warrants, or rights outstanding on the date hereof,
(iii) in connection with a Qualified Financing, the proceeds of which shall be
used to repay all outstanding principal and accrued interest on all of the Notes
in full, (iv) the issuance of 276,658 shares of Common Stock for no additional
cash consideration to investors in the Company's private placement in June 1999,
(v) options to purchase not more than an aggregate of 2,000,000 shares of Common
Stock granted by the Board of Directors or committee thereof to employees of the
Company pursuant to a stock option plan or plans approved by the Board of
Directors and shareholders of the Company the exercise price of which shall be
no less than the
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lesser of the Conversion Price and the fair market value of the Common Stock on
the date of grant, and the shares of Common Stock issuable upon exercise of such
options, provided that the Company shall not grant options to purchase an
aggregate of more than 50,000 shares to any one employee unless approved by the
directors designated by the Agent for the holders of the Notes under the
Shareholders Agreement (as defined in the Subscription Agreement) and (vi)
shares of Common Stock issuable in connection with a stock split or in payment
of a stock dividend to all shareholders of the Company.
(e) Shall not pay any dividend or make any distribution on, or
purchase, redeem, or retire, any shares of its capital stock or other securities
or any warrants, options, or other rights to acquire any such shares or other
securities, except that the Company may pay dividends on its Common Stock
payable solely in shares of its Common Stock and the Company may issue shares of
Common Stock in exchange for the Insider Debt as described above.
(f) Shall not change its primary line of business.
(g) Shall not (i) enter into any merger, consolidation, or other
similar transaction, (ii) liquidate, wind up its affairs or dissolve, or (iii)
convey, sell, lease, transfer or otherwise dispose of, or purchase or acquire,
any business, assets, other property except for (i) the purchase and sale of
goods and services in the ordinary course of business, (ii) capital expenditures
necessary in connection with the business of the Company not in excess of
$250,000 for any one item and $1,000,000 in the aggregate, and (ii) the
disposition of obsolete inventory or equipment no longer saleable or useful in
the business of the Company.
(h) Shall not, directly or indirectly, enter into any transaction
with or for the benefit of an affiliate (other than reasonable compensation
for services as an officer, director, partner or
employee).
(i) Shall not in any manner increase the cash compensation of its
existing officers and directors from the levels in effect on the date of
issuance of this Note.
(j) Shall use the proceeds of the Offering in substantially the
manner specified in the Registration Statement.
(k) Shall deliver to the Holder:
(i) within two Business Days after the end of each week
during the period this Note remains outstanding, weekly cash reports in such
detail as the Holder may reasonably request;
(ii) as soon as available, and in any event within 10 days
after the end of each month during the period this Note remains outstanding,
copies of all internal reports and other information delivered to management of
the Borrower during such month;
(iii) as soon as available, and in any event within 45 days
after the end of each quarterly fiscal period of each fiscal year of the
Company, consolidated statements of
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income, retained earnings and cash flow of the Company, for such period and for
the period from the beginning of the respective fiscal year to the end of such
period, and the related consolidated balance sheet of the Company as at the end
of such period setting forth in the case of each such statement in comparative
form the corresponding figures for the corresponding period in the preceding
fiscal year, accompanied by a certificate of the chief financial officer of the
Company, which certificate shall state that (A) such financial statements fairly
present in all material respects the financial position and results of
operations of the Company, all in accordance with generally accepted accounting
principles consistently applied, and (B) no Default (as hereinafter defined) has
occurred and is continuing or, if any Default has occurred and is continuing, a
description thereof in reasonable detail and of the action the Borrower has
taken or proposes to take with respect thereto;
(iv) as soon as available and in any event within 90 days
after the end of each fiscal year of the Company, consolidated statements of
income, retained earnings and cash flow of the Company for such fiscal year, and
the related consolidated balance sheet of the Company as at the end of such
fiscal year, setting forth in the case of each such statement in comparative
form the corresponding figures for the preceding fiscal year, and accompanied by
(A) an opinion thereon of independent certified public accountants of recognized
national standing, which opinion shall state that such consolidated financial
statements present fairly, in all material respects, the financial position and
results of operations of the Company in conformity with generally accepted
accounting principles consistently applied, and (B) a certificate of the chief
financial officer of the Company stating that no Default has occurred and is
continuing or, if any Default has occurred and is continuing, a description
thereof in reasonable detail and of the action the Company or any Borrower has
taken or proposes to take with respect thereto;
(v) promptly upon their becoming available, copies of all
registration statements which the Company shall have filed with the Commission
(or any governmental agency substituted therefor) or any national securities
exchange;
(vi) promptly after any Borrower shall obtain knowledge of
such, written notice of all legal or arbitral proceedings, and of all
proceedings by or before any governmental or regulatory authority or agency, and
each material development in respect of such legal or other proceedings,
affecting the Borrowers; and
(vii) promptly after the Borrower shall obtain knowledge of
the occurrence of any Event of Default (as hereinafter defined) or any event
which with notice or lapse of time or both would become an Event of Default (an
Event of Default or such other event being a "Default"), a notice specifying
that such notice is a "Notice of Default" and describing such Default in
reasonable detail, and, in such Notice of Default or as soon thereafter as
practicable, a description of the action the Company has taken or proposes to
take with respect thereto.
9. Events of Default.
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The occurrence of any of the following events shall constitute an event
of default (an "Event of Default"):
(a) A default in the payment of the principal or interest on any
Note, when and as the same shall become due and payable.
(b) The Company shall not have filed a registration statement
with the Commission relating to a public offering or shall not have commenced a
private placement of securities (which for purposes of this Note shall mean that
the Company has engaged a reputable placement agent and shall have prepared and
circulated a private offering memorandum and related materials in connection
therewith) which, in either case, constitutes a Qualified Financing on or before
March 15, 2000.
(c) The Company shall have failed to consummate a Qualified
Financing on or before April 15, 2000.
(d) A default in the performance, or a breach, of any of the
covenants of the Borrower contained in Sections 3, 4 or 8 (a), (d), (e), (f ),
(g), (h), (i) or (j) of this Note or a default in the performance, or a breach,
of any of the covenants contained in Section 8(b), (c) or (k) of this Note and
continuance of such default or breach of Section 8(b), (c) or (k) for a period
of 15 days after receipt of notice from the Holder as to such breach or after
the Borrower had or should have had knowledge of such breach.
(e) A default in the performance, or a breach, of any other
covenant or agreement of the Borrower in this Note and continuance of such
default or breach for a period of 30 days after receipt of notice from the
Holder as to such breach or after the Borrower had or should have had knowledge
of such breach.
(f) A default or event of default which remains uncured following
any applicable cure period shall have occurred with respect to any Junior Debt.
(g) Any representation, warranty or certification made by the
Borrower in or pursuant to this Note or the Subscription Agreement shall prove
to have been false or misleading as of the date made in any material respect.
(h) A final judgment or judgments for the payment of money in
excess of $100,000 in the aggregate shall be rendered by one or more courts,
administrative or arbitral tribunals or other bodies having jurisdiction against
the Borrower and the same shall not be discharged (or provision shall not be
made for such discharge), or a stay of execution thereof shall not be procured,
within 60 days from the date of entry thereof and the Borrower shall not, within
such 60-day period, or such longer period during which execution of the same
shall have been stayed, appeal therefrom and cause the execution thereof to be
stayed during such appeal.
(i) The entry of a decree or order by a court having jurisdiction
adjudging the Borrower a bankrupt or insolvent, or approving a petition seeking
reorganization, arrangement,
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adjustment or composition of or in respect of the Borrower, under federal
bankruptcy law, as now or hereafter constituted, or any other applicable federal
or state bankruptcy, insolvency or other similar law, and the continuance of any
such decree or order unstayed and in effect for a period of 60 days; or the
commencement by the Borrower of a voluntary case under federal bankruptcy law,
as now or hereafter constituted, or any other applicable federal or state
bankruptcy, insolvency, or other similar law, or the consent by the Borrower to
the institution of bankruptcy or insolvency proceedings against it, or the
filing by the Borrower of a petition or answer or consent seeking reorganization
or relief under federal bankruptcy law or any other applicable federal or state
law, or the consent by the Borrower to the filing of such petition or to the
appointment of a receiver, liquidator, assignee, trustee, sequestrator or
similar official of the Borrower or of any substantial part of the property of
the Borrower, or the making by the Borrower of an assignment for the benefit of
creditors, or the admission by the Borrower in writing of its inability to pay
its debts generally as they become due, or the taking of corporate action by the
Borrower in furtherance of any such action.
10. Remedies Upon Default.
(a) Upon the occurrence of an Event of Default referred to in
Section 9(i), the principal amount then outstanding of, and the accrued interest
on, this Note shall automatically become immediately due and payable without
presentment, demand, protest or other formalities of any kind, all of which are
hereby expressly waived by the Borrower. Upon the occurrence of an Event of
Default referred to in Section 9(a), the Holder, by notice in writing given to
the Borrower, may declare the entire principal amount then outstanding of, and
the accrued interest on, this Note to be due and payable immediately, and upon
any such declaration the same shall become and be due and payable immediately,
without presentation, demand, protest or other formalities of any kind, all of
which are expressly waived by the Borrowers. Upon the occurrence of an Event of
Default other than one referred to in Sections 9(a) and (i), the Holders of not
less than 33 1/3% in principal amount of then outstanding Notes (excluding any
Notes held by or for the account of the Borrower or any affiliate of the
Borrower) may declare the principal amount then outstanding of, and the accrued
interest on, the Notes to be due and payable immediately, and upon such
declaration the same shall become due and payable immediately, without
presentation, demand, protest or other formalities of any kind, all of which are
expressly waived by the Borrower.
(b) The Holder may institute such actions or proceedings in law
or equity as it shall deem expedient for the protection of its rights and may
prosecute and enforce its claims against all assets of the Borrower, and in
connection with any such action or proceeding shall be entitled to receive from
the Borrower payment of the principal amount of this Note plus accrued interest
to the date of payment plus reasonable expenses of collection, including,
without limitation, reasonable attorneys' fees and expenses actually incurred.
11. Transfer.
Any Notes issued upon the transfer of this Note shall be numbered
and shall be
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registered in a Note Register as they are issued. The Borrower shall be
entitled to treat the registered holder of any Note on the Note Register as the
owner in fact thereof for all purposes and shall not be bound to recognize any
equitable or other claim to or interest in such Note on the part of any other
person, and shall not be liable for any registration or transfer of Notes which
are registered or to be registered in the name of a fiduciary or the nominee of
a fiduciary unless made with the actual knowledge that a fiduciary or nominee is
committing a breach of trust in requesting such registration or transfer, or
with the knowledge of such facts that its participation therein amounts to bad
faith. This Note shall be transferable only on the books of the Borrower upon
delivery thereof to the Borrower, duly endorsed by the Holder or by his duly
authorized attorney or representative, or accompanied by proper evidence of
succession, assignment, or authority to transfer. In all cases of transfer by an
attorney, executor, administrator, guardian, or other legal representative, duly
authenticated evidence of his or its authority shall be produced. Upon any
registration of transfer, the Borrower shall deliver a new Note or Notes to the
person entitled thereto. This Note may be exchanged, at the option of the Holder
thereof, for another Note, or other Notes of different denominations, of like
tenor and representing in the aggregate a like principal amount, upon surrender
to the Borrower, or its duly authorized agent. Notwithstanding the foregoing,
the Borrower shall have no obligation to cause Notes to be transferred on its
books to any person if, in the opinion of counsel to the Borrowers, such
transfer does not comply with the provisions of the Act and the rules and
regulations thereunder.
12. Miscellaneous.
(a) Any notice or other communication required or permitted to be
given hereunder shall be in writing and shall be mailed by certified mail,
return receipt requested, or by Federal Express, Express Mail or similar
overnight delivery or courier service or delivered (in person or by telecopy,
telex or similar telecommunications equipment) against receipt to the party to
whom it is to be given, (i) if to the Borrower, at its address at 2812 Spring
Road, Suite 210, Atlanta, Georgia 30339, Attention: President, (ii) if to the
Holder, at its address set forth on the first page hereof, or (iii) in either
case, to such other address as the party shall have furnished in writing in
accordance with the provisions of this Section 12(a). Notice to the estate of
any party shall be sufficient if addressed to the party as provided in this
Section 12(a). Any notice or other communication given by certified mail shall
be deemed given at the time of certification thereof, except for a notice
changing a party's address which shall be deemed given at the time of receipt
thereof. Any notice given by other means permitted by this Section 12(a) shall
be deemed given at the time of receipt thereof.
(b) Upon receipt of evidence satisfactory to the Borrower, of the
loss, theft, destruction or mutilation of this Note (and upon surrender of this
Note if mutilated), including an affidavit of the Holder thereof that this Note
has been lost, stolen, destroyed or mutilated together with an indemnity against
any claim that may be made against the Borrower on account of such lost, stolen,
destroyed or mutilated Note, and upon reimbursement of the Borrower's reasonable
incidental expenses, the Borrower shall execute and deliver to the Holder a new
Note of like date, tenor and denomination.
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(c) No course of dealing and no delay or omission on the part
of the Holder inexercising any right or remedy shall operate as a waiver thereof
or otherwise prejudice the Holder's rights, powers or remedies. No right, power
or remedy conferred by this Note upon the Holder shall be exclusive of any other
right, power or remedy referred to herein or now or hereafter available at law,
in equity, by statute or otherwise, and all such remedies may be exercised
singly or concurrently.
(d) This Note may be amended only by a written instrument
executed by the Borrower and the Holder hereof. Any amendment shall be endorsed
upon this Note, and all future Holders shall be bound thereby.
(e) This Note shall be governed by and construed in accordance
with the laws of the State of Georgia, without giving effect to principles
governing conflicts of law.
(f) The Borrower irrevocably consents to the exclusive
jurisdiction of the courts of the State of New York and of any federal court
located in such State in connection with any action or proceeding arising out of
or relating to this Note, any document or instrument delivered pursuant to, in
connection with or simultaneously with this Note, or a breach of this Note or
any such document or instrument.
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IN WITNESS WHEREOF, the Borrower has caused this Note to be executed and
dated the day and year first above written.
comstar.net, inc.
By:
------------------------------
Name:
Title:
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<PAGE> 145
APPENDIX B
THIS WARRANT AND THE SHARES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, PURSUANT TO A
REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION. HOWEVER, NEITHER THIS WARRANT NOR SUCH SHARES MAY BE
OFFERED OR SOLD EXCEPT PURSUANT TO (i) A POST-EFFECTIVE AMENDMENT TO
SUCH REGISTRATION STATEMENT, (ii) A SEPARATE REGISTRATION STATEMENT
UNDER SUCH ACT, OR (iii) AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT.
comstar.net, inc.
Form of Warrant for the Purchase of Shares of Common Stock,
without par value
No. 1 [__________] Shares
THIS CERTIFIES that, for receipt in hand of $10.00 and other
value received, _____________________________, (the "Holder"), [Address] is
entitled to subscribe for and purchase from comstar.net, inc., a Georgia
corporation (the "Company"), upon the terms and conditions set forth herein, at
any time or from time to time after the date hereof, and before 5:00 P.M. on the
tenth anniversary of the date hereof, New York time (the "Exercise Period"),
[________] shares of the Company's Common Stock, without par value ("Common
Stock"), at a price of $.01 per Share (the "Exercise Price"). This Warrant is
the warrant or one of the warrants issued pursuant to an offering (the
"Offering") of units consisting of notes and warrants by the Company pursuant to
a registration statement on Form S-1 (Reg. No. 333-92581) (the "Registration
Statement"), and a Subscription Agreement, dated December 30, 1999 , between the
Company and the Holder (the "Subscription Agreement"). As used herein the term
"this Warrant" shall mean and include this Warrant and any Warrant or Warrants
hereafter issued as a consequence of the exercise or transfer of this Warrant in
whole or in part.
The number of shares of Common Stock issuable upon exercise of
the Warrants (the "Warrant Shares") and the Exercise Price may be adjusted from
time to time as hereinafter set forth. (The number of shares of Common Stock for
which this Warrant is exercisable or convertible reflects the recapitalization
of the Company described in the prospectus included in the Registration
Statement, and no adjustment shall be made hereunder in that regard.)
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1. This Warrant may be exercised during the Exercise Period,
as to the whole or any lesser number of whole Warrant Shares, by the surrender
of this Warrant (with the election at the end hereof duly executed) to the
Company at its office at 2812 Spring Road, Suite 210, Atlanta, Georgia 30339, or
at such other place as is designated in writing by the Company, together with a
certified or bank cashier's check payable to the order of the Company in an
amount equal to the Exercise Price multiplied by the number of Warrant Shares
for which this Warrant is being exercised (the "Stock Purchase Price");
provided, however, that this Warrant must be exercised in minimum increments of
500 shares (or, if fewer, the number of Warrant Shares for which this Warrant is
then exercisable).
2. (a) In lieu of the payment of the Stock Purchase Price, the
Holder shall have the right (but not the obligation), to require the Company to
convert this Warrant, in whole or in part (subject to the final clause of
Section 1), into shares of Common Stock (the "Conversion Right") as provided for
in this Section 2. Upon exercise of the Conversion Right, the Company shall
deliver to the Holder (without payment by the Holder of any of the Stock
Purchase Price) that number of shares of Common Stock (the "Conversion Shares")
equal to the quotient obtained by dividing (x) the value of this Warrant (or
portion thereof as to which the Conversion Right is being exercised if the
Conversion Right is being exercised in part) at the time the Conversion Right is
exercised (determined by subtracting the aggregate Stock Purchase Price of the
shares of Common Stock as to which the Conversion Right is being exercised in
effect immediately prior to the exercise of the Conversion Right from the
aggregate Current Market Price (as defined in Section 2(c) hereof) of the shares
of Common Stock as to which the Conversion Right is being exercised) by (y) the
Current Market Price of one share of Common Stock immediately prior to the
exercise of the Conversion Right.
(b) The Conversion Rights provided under this Section 2 may be
exercised in whole or in part and at any time and from time to time while any
Warrants remain outstanding. In order to exercise the Conversion Right, the
Holder shall surrender to the Company, at its offices, this Warrant with the
Notice of Conversion at the end hereof duly executed. The presentation and
surrender shall be deemed a waiver of the Holder's obligation to pay all or any
portion of the aggregate purchase price payable for the shares of Common Stock
as to which such Conversion Right is being exercised. This Warrant (or so much
thereof as shall have been surrendered for conversion) shall be deemed to have
been converted immediately prior to the close of business on the day of
surrender of such Warrant for conversion in accordance with the foregoing
provisions.
(c) For the purpose of any computation under this Warrant, the
Current Market Price per share of Common Stock on any date shall be deemed to be
the average of the daily closing prices for the five consecutive trading days
immediately preceding the date in question. The closing price for each day shall
be the last reported sales price, regular way, or, in case no such reported sale
takes place on such day, the closing bid price, regular way, in either case on
the principal national securities exchange on which the Common Stock is listed
or admitted to trading or, if the Common Stock is not listed or admitted to
trading on any national securities exchange, the last reported sales price,
regular way, or, in case no such reported sale takes place on such day, the
closing bid price, regular way, in either case on the NASDAQ Stock Market, or if
the Common Stock is not quoted on the NASDAQ Stock Market, the highest reported
bid price for the Common Stock as furnished by the National Association of
Securities Dealers, Inc. through NASDAQ or a
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similar organization if NASDAQ is no longer reporting such information. If on
any such date the Common Stock is not listed or admitted to trading on any
national securities exchange or the NASDAQ Stock Market and is not quoted by
NASDAQ or any similar organization, the fair value of a share of Common Stock on
such date, as determined in good faith by the board of directors of the Company,
whose determination shall be conclusive absent manifest error, shall be used.
3. Upon each exercise of the Holder's rights to purchase
Warrant Shares or Conversion Shares, the Holder shall be deemed to be the holder
of record of the Warrant Shares or Conversion Shares issuable upon such exercise
or conversion, notwithstanding that the transfer books of the Company shall then
be closed or certificates representing such Warrant Shares or Conversion Shares
shall not then have been actually delivered to the Holder. As soon as
practicable after each such exercise or conversion of this Warrant, the Company
shall issue and deliver to the Holder a certificate or certificates for the
Warrant Shares or Conversion Shares issuable upon such exercise or conversion,
registered in the name of the Holder or its designee. If this Warrant should be
exercised or converted in part only, the Company shall, upon surrender of this
Warrant for cancellation, execute and deliver a new Warrant evidencing the right
of the Holder to purchase the balance of the Warrant Shares (or portions
thereof) subject to purchase hereunder.
4. Any Warrants issued upon the transfer or exercise or
conversion in part of this Warrant shall be numbered and shall be registered in
a Warrant Register as they are issued. The Company shall be entitled to treat
the registered holder of any Warrant on the Warrant Register as the owner in
fact thereof for all purposes and shall not be bound to recognize any equitable
or other claim to or interest in such Warrant on the part of any other person,
and shall not be liable for any registration or transfer of Warrants which are
registered or to be registered in the name of a fiduciary or the nominee of a
fiduciary unless made with the actual knowledge that a fiduciary or nominee is
committing a breach of trust in requesting such registration or transfer, or
with the knowledge of such facts that its participation therein amounts to bad
faith. This Warrant shall be transferable only on the books of the Company upon
delivery thereof duly endorsed by the Holder or by his duly authorized attorney
or representative, or accompanied by proper evidence of succession, assignment,
or authority to transfer. In all cases of transfer by an attorney, executor,
administrator, guardian, or other legal representative, duly authenticated
evidence of his or its authority shall be produced. Upon any registration of
transfer, the Company shall deliver a new Warrant or Warrants to the person
entitled thereto. This Warrant may be exchanged, at the option of the Holder
thereof, for another Warrant, or other Warrants of different denominations, of
like tenor and representing in the aggregate the right to purchase a like number
of Warrant Shares (or portions thereof), upon surrender to the Company or its
duly authorized agent. Notwithstanding the foregoing, the Company shall have no
obligation to cause Warrants to be transferred on its books to any person, or
Warrant Shares or Conversion Shares to be issued, if, in the opinion of counsel
to the Company, such transfer or issuance does not comply with the provisions of
the Securities Act of 1933, as amended (the "Act"), and the rules and
regulations thereunder.
5. The Company shall at all times reserve and keep available
out of its authorized and unissued Common Stock, solely for the purpose of
providing for the exercise of the rights to purchase all Warrant Shares and/or
Conversion Shares granted pursuant to the Warrants, such number of shares of
Common Stock as shall, from time to time, be sufficient therefor. The Company
covenants that all shares of Common Stock issuable upon exercise of this
Warrant, upon
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receipt by the Company of the full Exercise Price therefor, and all shares of
Common Stock issuable upon conversion of this Warrant, shall be validly issued,
fully paid, nonassessable, and free of preemptive rights.
6. (a) In case the Company shall at any time after the date
the Warrants were first issued (i) declare a dividend on the outstanding Common
Stock payable in shares of its capital stock, (ii) subdivide the outstanding
Common Stock, (iii) combine the outstanding Common Stock into a smaller number
of shares, or (iv) issue any shares of its capital stock by reclassification of
the Common Stock (including any such reclassification in connection with a
consolidation or merger in which the Company is the continuing corporation),
then, in each case, the Exercise Price, and the number and kind of securities
issuable upon exercise or conversion of this Warrant, in effect at the time of
the record date for such dividend or of the effective date of such subdivision,
combination, or reclassification, shall be proportionately adjusted so that the
Holder after such time shall be entitled to receive the aggregate number and
kind of shares which, if such Warrant had been exercised or converted
immediately prior to such time, he would have owned upon such exercise or
conversion and been entitled to receive by virtue of such dividend, subdivision,
combination, or reclassification. Such adjustment shall be made successively
whenever any event listed above shall occur.
(b) Whenever there shall be an adjustment as provided in this
Section 6, the Company shall promptly cause written notice thereof to be sent by
registered mail, postage prepaid, to the Holder, at its address as it shall
appear in the Warrant Register, which notice shall be accompanied by an
officer's certificate setting forth the number of Warrant Shares purchasable
upon the exercise of this Warrant and the Exercise Price after such adjustment
and setting forth a brief statement of the facts requiring such adjustment and
the computation thereof, which officer's certificate shall be conclusive
evidence of the correctness of any such adjustment absent manifest error.
(c) The Company shall not be required to issue fractions of
shares of Common Stock or other capital stock of the Company upon the exercise
or conversion of this Warrant. If any fraction of a share would be issuable on
the exercise or conversion of this Warrant (or specified portions thereof), the
Company shall purchase such fraction for an amount in cash equal to the same
fraction of the Current Market Price of such share of Common Stock on the date
of exercise or conversion of this Warrant.
7. (a) In case of any consolidation with or merger of the
Company with or into another corporation (other than a merger or consolidation
in which the Company is the surviving or continuing corporation), or in case of
any sale, lease, or conveyance to another corporation of the property and assets
of any nature of the Company as an entirety or substantially as an entirety,
such successor, leasing, or purchasing corporation, as the case may be, shall
(i) execute with the Holder an agreement providing that the Holder shall have
the right thereafter to receive upon exercise or conversion of this Warrant
solely the kind and amount of shares of stock and other securities, property,
cash, or any combination thereof receivable upon such consolidation, merger,
sale, lease, or conveyance by a holder of the number of shares of Common Stock
for which this Warrant might have been exercised or converted immediately prior
to such consolidation, merger, sale, lease, or conveyance, and (ii) make
effective provision in its certificate of incorporation or
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otherwise, if necessary, to effect such agreement. Such agreement shall provide
for adjustments which shall be as nearly equivalent as practicable to the
adjustments in Section 6.
(b) In case of any reclassification or change of the shares of
Common Stock issuable upon exercise or conversion of this Warrant (other than a
change in par value or from no par value to a specified par value, or as a
result of a subdivision or combination, but including any change in the shares
into two or more classes or series of shares), or in case of any consolidation
or merger of another corporation into the Company in which the Company is the
continuing corporation and in which there is a reclassification or change
(including a change to the right to receive cash or other property) of the
shares of Common Stock (other than a change in par value, or from no par value
to a specified par value, or as a result of a subdivision or combination, but
including any change in the shares into two or more classes or series of
shares), the Holder shall have the right thereafter to receive upon exercise or
conversion of this Warrant solely the kind and amount of shares of stock and
other securities, property, cash, or any combination thereof receivable upon
such reclassification, change, consolidation, or merger by a holder of the
number of shares of Common Stock for which this Warrant might have been
exercised or converted immediately prior to such reclassification, change,
consolidation, or merger. Thereafter, appropriate provision shall be made for
adjustments which shall be as nearly equivalent as practicable to the
adjustments in Section 6.
(c) The above provisions of this Section 7 shall similarly
apply to successive reclassifications and changes of shares of Common Stock and
to successive consolidations, mergers, sales, leases, or conveyances.
8. In case at any time the Company shall propose
(a) to pay any dividend or make any distribution on
shares of Common Stock in shares of Common Stock or make any other
distribution (other than regularly scheduled cash dividends which are
not in a greater amount per share than the most recent such cash
dividend) to all holders of Common Stock; or
(b) to issue any rights, warrants, or other
securities to all holders of Common Stock entitling them to purchase
any additional shares of Common Stock or any other rights, warrants, or
other securities; or
(c) to effect any reclassification or change of
outstanding shares of Common Stock, or any consolidation, merger, sale,
lease, or conveyance of property, described in Section 7; or
(d) to effect any liquidation, dissolution, or
winding-up of the Company; or
(e) to take any other action which would cause an
adjustment to the Exercise Price;
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then, and in any one or more of such cases, the Company shall give written
notice thereof, by registered mail, postage prepaid, to the Holder at the
Holder's address as it shall appear in the Warrant Register, mailed at least 15
days prior to (i) the date as of which the holders of record of shares of Common
Stock to be entitled to receive any such dividend, distribution, rights,
warrants, or other securities are to be determined, (ii) the date on which any
such reclassification, change of outstanding shares of Common Stock,
consolidation, merger, sale, lease, conveyance of property, liquidation,
dissolution, or winding-up is expected to become effective, and the date as of
which it is expected that holders of record of shares of Common Stock shall be
entitled to exchange their shares for securities or other property, if any,
deliverable upon such reclassification, change of outstanding shares,
consolidation, merger, sale, lease, conveyance of property, liquidation,
dissolution, or winding-up, or (iii) the date of such action which would require
an adjustment to the Exercise Price.
9. The issuance of any shares or other securities upon the
exercise or conversion of this Warrant, and the delivery of certificates or
other instruments representing such shares or other securities, shall be made
without charge to the Holder for any tax or other charge in respect of such
issuance. The Company shall not, however, be required to pay any tax which may
be payable in respect of any transfer involved in the issue and delivery of any
certificate in a name other than that of the Holder and the Company shall not be
required to issue or deliver any such certificate unless and until the person or
persons requesting the issue thereof shall have paid to the Company the amount
of such tax or shall have established to the satisfaction of the Company that
such tax has been paid.
10. (a) If, at any time after the later of (i) the first
anniversary of the date of this Warrant, and (ii) the consummation of the
Company's initial underwritten public offering of securities (an "IPO"), the
Company shall file a registration statement (other than any registration
statement on Form S-4, Form S-8, or any successor form) with the Securities and
Exchange Commission (the "Commission") while any Registrable Securities (as
hereinafter defined) are outstanding, the Company shall give all the then
holders of any Registrable Securities (the "Eligible Holders") at least 30 days
prior written notice of the filing of such registration statement. If requested
by any Eligible Holder in writing within 20 days after receipt of any such
notice, the Company shall, at the Company's sole expense (other than the fees
and disbursements of counsel for the Eligible Holders and the underwriting
discounts, if any, payable in respect of the Registrable Securities sold by any
Eligible Holder), register or qualify all or, at each Eligible Holder's option,
any portion of the Registrable Securities of any Eligible Holders who shall have
made such request, concurrently with the registration of such other securities,
all to the extent requisite to permit the public offering and sale of the
Registrable Securities through the facilities of all appropriate securities
exchanges and the over-the-counter markets on which the Company's securities are
traded, and will use its best efforts through its officers, directors, auditors,
and counsel to cause such registration statement to become effective as promptly
as practicable. Notwithstanding the foregoing, if the managing underwriter of
any such offering shall advise the Company in writing that, in its opinion, the
distribution of all or a portion of the Registrable Securities requested to be
included in the registration concurrently with the securities being registered
by the Company would materially adversely affect the distribution of such
securities by the Company for its own account, then any Eligible Holder who
shall have requested registration of his or its Registrable Securities shall not
be entitled to have such Eligible Holder's Registrable Securities (or the
portions thereof so designated by the managing underwriter) included in such
registration statement, provided that no such exclusion or reduction shall be
made as to any Registrable Securities if any securities of the Company are
included in such registration statement for the account of any person other than
the Company and any Eligible Holder unless the securities included in such
registration statement for such other person shall have been reduced pro rata
to the reduction of the Registrable Securities which were requested to be
included in such registration.
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As used herein, "Registrable Securities" shall mean the Warrant Shares, the
Conversion Shares and shares of Common Stock issued or issuable in connection
with the conversion of any notes issued to the Holder pursuant to the Offering
(the "Notes") which, in each case, have not been previously sold pursuant to a
registration statement or Rule 144 promulgated under the Act.
(b) If, at any time after 180 days following the effective
date of the IPO, the Company shall receive a written request from Eligible
Holders who in the aggregate own (or upon exercise of all Warrants and
conversion of all Notes then outstanding would own) a majority of the total
number of shares of Common Stock then included (or upon such exercise and
conversion would be included) in the Registrable Securities (the "Majority
Holders"), to register the sale of all or part of such Registrable Securities,
the Company shall, as promptly as practicable, prepare and file with the
Commission a registration statement sufficient to permit the public offering and
sale of the Registrable Securities through the facilities of all appropriate
securities exchanges and the over-the-counter markets on which the Company's
securities are traded, and will use its best efforts through its officers,
directors, auditors, and counsel to cause such registration statement to become
effective as promptly as practicable; provided, however, that, subject to
continued compliance with Section 10(h) hereof, (i) the Company shall only be
obligated to file one such registration statement for which all expenses in
curred in connection with such registration (other than the fees and
disbursements of counsel for the Eligible Holders and underwriting discounts, if
any, payable in respect of the Registrable Securities sold by the Eligible
Holders) shall be borne by the Company and one additional such registration
statement for which all such expenses shall be paid by the Eligible Holders, and
(ii) the Company shall not be obligated to effect (x) more than one registration
pursuant to this Section 10(b) in any 12-month period, (y) any registration
statement within six months after the effective date of a registration statement
prepared and filed in accordance with Section 10(a) in which Registrable
Securities could have been included, or (z) any registration statement that
covers Registrable Securities that are proposed to be sold at an aggregate price
to the public of less than $5,000,000. Any additional registration statement
required to be filed as a result of the Company's failure to comply with Section
10(h) hereof shall be at the Company's expense. Within ten business days after
receiving any request contemplated by this Section 10(b), the Company shall give
written notice to all the other Eligible Holders, advising each of them that the
Company is proceeding with such registration and offering to include therein all
or any portion of any such other Eligible Holder's Registrable Securities,
provided that the Company receives a written request to do so from such Eligible
Holder within 20 days after receipt by him or it of the Company's notice.
Notwithstanding the foregoing, if the Company shall furnish to the Holders
requesting a registration statement pursuant to this Section 10(b) a certificate
signed by the President of the Company stating that in the good faith judgment
of the Board of Directors of the Company, it would be seriously detrimental to
the Company and its shareholders for such registration statement to be filed by
reason of a material pending transaction and it is therefore essential to defer
the filing
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of such registration statement, the Company shall have the right to defer such
filing for a period of not more than 60 days after receipt of the request of the
Majority Holders; provided, however, that the Company may not utilize this right
more than once in any 12-month period.
(c) In the event of a registration pursuant to the provisions of this Section
10, the Company shall use its best efforts to cause the Registrable Securities
so registered to be registered or qualified for sale under the securities or
blue sky laws of such jurisdictions as the Holder or such holders may reasonably
request; provided, however, that the Company shall not by reason of this Section
10(c) be required to qualify to do business in any state in which it is not
otherwise required to qualify to do business or to file a general consent to
service of process.
(d) The Company shall keep effective any registration or
qualification contemplated by this Section 10 and shall from time to time amend
or supplement each applicable registration statement, preliminary prospectus,
final prospectus, application, document, and communication for such period of
time as shall be required to permit the Eligible Holders to complete the offer
and sale of the Registrable Securities covered thereby. Provided the Company is
in continued compliance with the requirements of Section 10(h) hereof, the
Company shall in no event be required to keep any such registration or
qualification in effect for a period in excess of nine months from the date on
which the Eligible Holders are first free to sell such Registrable Securities;
provided, however, that, if the Company is required to keep any such
registration or qualification in effect with respect to securities other than
the Registrable Securities beyond such period, the Company shall keep such
registration or qualification in effect as it relates to the Registrable
Securities for so long as such registration or qualification remains or is
required to remain in effect in respect of such other securities.
(e) In the event of a registration pursuant to the provisions
of this Section 10, the Company shall furnish to each Eligible Holder such
number of copies of the registration statement and of each amendment and
supplement thereto (in each case, including all exhibits), such reasonable
number of copies of each prospectus contained in such registration statement and
each supplement or amendment thereto (including each preliminary prospectus),
all of which shall conform to the requirements of the Act and the rules and
regulations thereunder, and such other documents, as any Eligible Holder may
reasonably request to facilitate the disposition of the Registrable Securities
included in such registration.
(f) In the event of a registration pursuant to the provisions
of this Section 10, the Company shall furnish each Eligible Holder of any
Registrable Securities so registered with an opinion of its counsel (reasonably
acceptable to the Eligible Holders) substantially in the form rendered in
connection with the closing of the Offering. The Company also shall furnish to
each Eligible Holder a cold comfort letter from the independent certified public
accountants of the Company in the customary form and substance.
(g) In the event of a registration pursuant to the provisions of this Section
10, the Company and each Eligible Holder shall enter into a cross-indemnity
agreement and a contribution agreement, each in customary form, with each
underwriter, if any, and, if requested, enter into an underwriting agreement
containing conventional representations, warranties, allocation of expenses, and
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customary closing conditions, including, but not limited to, opinions of counsel
and accountants' cold comfort letters, with any underwriter who acquires any
Registrable Securities.
(h) The Company agrees that until all the Registrable Securities
have been sold under a registration statement or pursuant to Rule 144 under the
Act, it shall keep current in filing all reports, statements and other materials
required to be filed with the Commission to permit holders of the Registrable
Securities to sell such securities under Rule 144.
(i) Except for rights granted to holders of the Warrants and the
Notes, the Company will not, without the written consent of the Majority
Holders, grant to any persons the right to request the Company to register any
securities of the Company, provided that the Company may grant such registration
rights to other persons so long as such rights are subordinate to the rights of
the holders of Registrable Securities.
11. (a) Subject to the conditions set forth below, the Company
agrees to indemnify and hold harmless each Eligible Holder, its officers,
directors, partners, employees, agents, and counsel, and each person, if any,
who controls any such person within the meaning of Section 15 of the Act or
Section 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), from and against any and all loss, liability, charge, claim, damage, and
expense whatsoever (which shall include, for all purposes of this Section 11,
but not be limited to, reasonable attorneys' fees actually incurred and any and
all expense whatsoever reasonably incurred in investigating, preparing, or
defending against any litigation, commenced or threatened, or any claim
whatsoever, and any and all amounts paid in settlement of any claim or
litigation), as and when incurred, arising out of, based upon, or in connection
with any untrue statement or alleged untrue statement of a material fact
contained (A) in any registration statement, preliminary prospectus, or final
prospectus (as from time to time amended and supplemented), or any amendment or
supplement thereto, relating to the sale of any of the Registrable Securities,
or (B) in any application or other document or communication (in this Section 11
collectively called an "application") executed by or on behalf of the Company or
based upon written information furnished by or on behalf of the Company filed in
any jurisdiction in order to register or qualify any of the Registrable
Securities under the securities or blue sky laws thereof or filed with the
Commission or any securities exchange; or any omission or alleged omission to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading, unless such statement or omission was made in
reliance upon and in conformity with written information furnished to the
Company with respect to such Eligible Holder by or on behalf of such person
expressly for inclusion in any registration statement, preliminary prospectus,
or final prospectus, or any amendment or supplement thereto, or in any
application, as the case may be. The foregoing agreement to indemnify shall be
in addition to any liability the Company may otherwise have, including
liabilities arising under any of the Warrants or Notes.
If any action is brought against any Eligible Holder or any of
its officers, directors, partners, employees, agents, or counsel, or any
controlling persons of such person (an "indemnified party") in respect of which
indemnity may be sought against the Company pursuant to the foregoing paragraph,
such indemnified party or parties shall promptly notify the Company in writing
of the institution of such action (but the failure so to notify shall not
relieve the Company
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from any liability pursuant to this Section 11(a), except to the extent it may
have been prejudiced in any material respect by such failure) and the Company
shall promptly assume the defense of such action, including the employment of
counsel (reasonably satisfactory to such indemnified party or parties) and
payment of expenses. Such indemnified party or parties shall have the right to
employ its or their own counsel in any such case, but the fees and expenses of
such counsel shall be at the expense of such indemnified party or parties unless
the employment of such counsel shall have been authorized in writing by the
Company in connection with the defense of such action or the Company shall not
have promptly employed counsel reasonably satisfactory to such indemnified party
or parties to have charge of the defense of such action or such indemnified
party or parties shall have reasonably concluded that there may be one or more
legal defenses available to it or them or to other indemnified parties which are
different from or additional to those available to the Company, in any of which
events such fees and expenses shall be borne by the Company and the Company
shall not have the right to direct the defense of such action on behalf of the
indemnified party or parties. Anything in this Section 11 to the contrary
notwithstanding, the Company shall not be liable for any settlement of any such
claim or action effected without its written consent, which shall not be
unreasonably withheld. The Company shall not, without the prior written consent
of each indemnified party that is not released as described in this sentence,
settle or compromise any action, or permit a default or consent to the entry of
judgment in or otherwise seek to terminate any pending or threatened action, in
respect of which indemnity may be sought hereunder (whether or not any
indemnified party is a party thereto), unless such settlement, compromise,
consent, or termination includes an unconditional release of each indemnified
party from all liability in respect of such action. The Company agrees promptly
to notify the Eligible Holders of the commencement of any litigation or
proceedings against the Company or any of its officers or directors in
connection with the sale of any Registrable Securities or any preliminary
prospectus, prospectus, registration statement, or amendment or supplement
thereto, or any application relating to any sale of any Registrable Securities.
(b) The Holder agrees to indemnify and hold harmless the Company,
each director of the Company, each officer of the Company who shall have signed
any registration statement covering Registrable Securities held by the Holder,
each other person, if any, who controls the Company within the meaning of
Section 15 of the Act or Section 20(a) of the Exchange Act, and its or their
respective counsel, to the same extent as the foregoing indemnity from the
Company to the Holder in Section 11(a), but only with respect to statements or
omissions, if any, made in any registration statement, preliminary prospectus,
or final prospectus (as from time to time amended and supplemented), or any
amendment or supplement thereto, or in any application, in reliance upon and in
conformity with written information furnished to the Company with respect to the
Holder by or on behalf of the Holder expressly for inclusion in any such
registration statement, preliminary prospectus, or final prospectus, or any
amendment or supplement thereto, or in any application, as the case may be. If
any action shall be brought against the Company or any other person so
indemnified based on any such registration statement, preliminary prospectus, or
final prospectus, or any amendment or supplement thereto, or in any application,
and in respect of which indemnity may be sought against the Holder pursuant to
this Section 11(b), the Holder shall have the rights and duties given to the
Company, and the Company and each other person so indemnified shall have the
rights and duties given to the indemnified parties, by the provisions of Section
11(a).
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(c) To provide for just and equitable contribution, if (i) an
indemnified party makes a claim for indemnification pursuant to Section 11(a) or
11(b) (subject to the limitations thereof) but it is found in a final judicial
determination, not subject to further appeal, that such indemnification may not
be enforced in such case, even though this Agreement expressly provides for
indemnification in such case, or (ii) any indemnified or indemnifying party
seeks contribution under the Act, the Exchange Act or otherwise, then the
Company (including for this purpose any contribution made by or on behalf of any
director of the Company, any officer of the Company who signed any such
registration statement, any controlling person of the Company, and its or their
respective counsel), as one entity, and the Eligible Holders of the Registrable
Securities included in such registration in the aggregate (including for this
purpose any contribution by or on behalf of an indemnified party), as a second
entity, shall contribute to the losses, liabilities, claims, damages, and
expenses whatsoever to which any of them may be subject, on the basis of
relevant equitable considerations such as the relative fault of the Company and
such Eligible Holders in connection with the facts which resulted in such
losses, liabilities, claims, damages, and expenses. The relative fault, in the
case of an untrue statement, alleged untrue statement, omission, or alleged
omission, shall be determined by, among other things, whether such statement,
alleged statement, omission, or alleged omission relates to information supplied
by the Company or by such Eligible Holders, and the parties' relative intent,
knowledge, access to information, and opportunity to correct or prevent such
statement, alleged statement, omission, or alleged omission. The Company and the
Holder agree that it would be unjust and inequitable if the respective
obligations of the Company and the Eligible Holders for contribution were
determined by pro rata or per capita allocation of the aggregate losses,
liabilities, claims, damages, and expenses (even if the Holder and the other
indemnified parties were treated as one entity for such purpose) or by any other
method of allocation that does not reflect the equitable considerations referred
to in this Section 11(c). In no case shall any Eligible Holder be responsible
for a portion of the contribution obligation imposed on all Eligible Holders in
excess of its pro rata share based on the number of shares of Common Stock owned
(or which would be owned upon exercise or conversion of all Registrable
Securities) by it and included in such registration as compared to the number of
shares of Common Stock owned (or which would be owned upon exercise or
conversion of all Underwriters' Securities) by all Eligible Holders and included
in such registration. No person guilty of a fraudulent misrepresentation (within
the meaning of Section 11(f) of the Act) shall be entitled to contribution from
any person who is not guilty of such fraudulent misrepresentation. For purposes
of this Section 11(c), each person, if any, who controls any Eligible Holder
within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act
and each officer, director, partner, employee, agent, and counsel of each such
Eligible Holder or control person shall have the same rights to contribution as
such Eligible Holder or control person and each person, if any, who controls the
Company within the meaning of Section 15 of the Act or Section 20(a) of the
Exchange Act, each officer of the Company who shall have signed any such
registration statement, each director of the Company, and its or their
respective counsel shall have the same rights to contribution as the Company,
subject in each case to the provisions of this Section 11(c). Anything in this
Section 11(c) to the contrary notwithstanding, no party shall be liable for
contribution with respect to the settlement of any claim or action effected
without its written consent. This Section 11(c) is intended to supersede any
right to contribution under the Act, the Exchange Act or otherwise.
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12. Upon receipt of evidence satisfactory to the Company of the
loss, theft, destruction, or mutilation of any Warrant (and upon surrender of
any Warrant if mutilated), and upon reimbursement of the Company's reasonable
incidental expenses, the Company shall execute and deliver to the Holder thereof
a new Warrant of like date, tenor, and denomination.
13. The Holder of any Warrant shall not have, solely on account
of such status, any rights of a shareholder of the Company, either at law or in
equity, or to any notice of meetings of shareholders or of any other proceedings
of the Company, except as provided in this Warrant.
14. This Warrant shall be construed in accordance with the laws
of the State of Georgia applicable to contracts made and performed within such
State, without regard to principles of conflicts of law.
15. The Company irrevocably consents to the exclusive
jurisdiction of the courts of the State of New York and of any federal court
located in such State in connection with any action or proceeding arising out of
or relating to this Warrant, any document or instrument delivered pursuant to,
in connection with or simultaneously with this Warrant, or a breach of this
Warrant or any such document or instrument.
Dated:
comstar.net, inc.
By:
------------------------------------
, President
[Seal]
- ---------------------------------
Secretary
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FORM OF ASSIGNMENT
(To be executed by the registered holder if such holder desires to transfer the
attached Warrant.)
FOR VALUE RECEIVED, _______________________ hereby sells,
assigns, and transfers unto __________________ a Warrant to purchase __________
shares of Common Stock, without par value of comstar.net, inc.(the "Company"),
together with all right, title, and interest therein, and does hereby
irrevocably constitute and appoint _____________________________ _____________
attorney to transfer such Warrant on the books of the Company, with full power
of substitution.
Dated:
Signature __________________________
NOTICE
The signature on the foregoing Assignment must correspond to the name as
written upon the face of this Warrant in every particular, without alteration or
enlargement or any change whatsoever.
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To: comstar.net, inc.
2812 Spring Road, Suite 210
Atlanta, Georgia 30339
Attention: Chief Financial Officer
ELECTION TO EXERCISE
The undersigned hereby exercises his or its rights to purchase _______
Warrant Shares covered by the within Warrant and tenders payment herewith in the
amount of $_________ in accordance with the terms thereof, and requests that
certificates for such securities be issued in the name of, and delivered to:
------------------------------------------
------------------------------------------
------------------------------------------
(Print Name, Address and Social Security
or Tax Identification Number)
and, if such number of Warrant Shares shall not be all the Warrant Shares
covered by the within Warrant, that a new Warrant for the balance of the Warrant
Shares covered by the within Warrant be registered in the name of, and delivered
to, the undersigned at the address stated below.
Dated: Name
---------------------------------
(Print)
Address:
------------------------------
---------------------------
(Signature)
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To: comstar.net, inc.
2812 Spring Road, Suite 210
Atlanta, Georgia 30339
Attention: Chief Financial Officer
CASHLESS EXERCISE FORM
(To be executed upon conversion of the attached Warrant)
The undersigned hereby irrevocably elects to surrender its Warrant for
the number of shares of Common Stock as shall be issuable pursuant to the
cashless exercise provisions of the within Warrant, in respect of _____ shares
of Common Stock underlying the within Warrant, and requests that certificates
for such securities be issued in the name of and delivered to:
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
(Print Name, Address and Social Security
or Tax Identification Number)
and, if such number of shares shall not be all the shares exchangeable or
purchasable under the within Warrant, that a new Warrant for the balance of the
Warrant Shares covered by the within Warrant be registered in the name of, and
delivered to, the undersigned at the addressed stated below.
Dated: Name:
----------------------------- ------------------------------
(Print)
Address:
-----------------------------------------------------------
----------------------------------
(Signature)
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APPENDIX C
FORM OF SHAREHOLDERS AGREEMENT
This SHAREHOLDERS AGREEMENT (this "Agreement") is made as of the ___
day of December, 1999 by and among comstar.net, inc., a Georgia corporation
(the "Company"), James L. Bruce, Jr, Samuel F. Dayton, J. Cary Howell and
Edward N. Landa, individuals (collectively, the "Principal Shareholders"), and
(the "Agent"), a partnership, solely as agent for the holders (the
"Noteholders") of 8% Senior Promissory Notes (the "Notes") of the Company.
WHEREAS, each of the Principal Shareholders beneficially owns the
number of shares of common stock, without par value, of the Company (the
"Common Stock") set forth opposite his respective name in a table set forth in
a certain Registration Statement on Form S-1 (Reg. No. 333 - 92581) (the
"Registration Statement") filed with the Securities and Exchange Commission
(the "Commission") under the Securities Act of 1933, and is also a director of
the Company; and
WHEREAS, the Noteholders have each extended credit or will extend
credit to the Company represented by separate Notes in an aggregate principal
amount of up to $5,000,000 (together with accrued interest and all other
amounts due and payable under the Notes, the "Senior Debt"); and
WHEREAS, to induce the Noteholders to purchase the Notes, the parties
have agreed to enter into this Agreement;
NOW, THEREFORE, in consideration of the premises, mutual covenants and
agreements contained herein, and for other good and valuable consideration, the
sufficiency of which is hereby acknowledged, the parties agree as follows:
SECTION I - BOARD REPRESENTATION.
1.1 Directors; Observer Rights.
(a) In General. So long as the Noteholders in the aggregate
beneficially own 5% or more of the equity interests of the Company on a fully
diluted basis, the Agent, on behalf of the Noteholders, shall have the right to
designate two persons as nominees to serve on the Board of Directors of the
Company (the "Board"), one of which shall have relevant industry experience and
shall be reasonably satisfactory to the other members of the Board. In addition,
unless Noteholders holding at least 66 2/3% of the outstanding principal amount
of the Notes consent otherwise, and subject to Section 1.1(c), (i) the Principal
Shareholders and the Agent's nominees shall constitute a majority of the Board
of Directors, and (ii) the number of directors shall not exceed nine.
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(b) Observer. Until completion of the IPO, as defined in
the Notes, the Agent shall also have the right to appoint an observer who shall
receive notice of and all materials distributed to members of the Board, and
all committees thereof in advance of meetings of the Board or any such
committee at the same time such notice and materials are given or distributed
to the Board or committee members, and shall be permitted to attend all such
meetings of the Board and such committees.
(c) Upon an Event of Default under the Notes. Upon an
Event of Default under the Notes, the Agent, on behalf of the Noteholders,
shall have the right to designate as nominees to the Board such number of
persons as would then be necessary in order that such persons would constitute
a majority of the Board.
(d) Voting Agreement. The Principal Shareholders shall (i)
vote their shares of capital stock of the Company (whether now owned or
hereafter acquired), and (ii) vote as directors, as required (including,
without limitation, by amending the Company's Articles of Incorporation and
By-Laws, if necessary), all in order to effect the Board composition described
in this Section 1.1.
1.2 Irrevocable Proxy. With respect to the actions described in
Section 1.1(d), each Principal Shareholder hereby irrevocably constitutes and
appoints the Agent its proxy and attorney-in-fact with full power of
substitution and acknowledges that the constitution and appointment of such
proxy and attorney-in-fact are coupled with an interest and are irrevocable
until the termination of the term of this Agreement.
SECTION II - TRANSFER OF SECURITIES
2.1 General. During the term of this Agreement, the Principal
Shareholders shall not sell, exchange, gift, give, pledge, encumber, transfer
or otherwise dispose of (each a "Transfer") any shares of capital stock of the
Company now owned or hereafter acquired, except to (i) any member of such
Principal Shareholder's immediate family (spouse, parents, children,
grandchildren or siblings), (ii) a trust for the benefit of such Principal
Shareholder and/or any or all of the persons described in clause (i), or (iii)
the estate of such Principal Shareholder upon his death. In the event any
shares of Common Stock are transferred pursuant to this Section 2.1, the
transferee shall hold the shares so acquired with all the rights conferred by
and subject to all the restrictions imposed by this Agreement.
2.2 Legends.
(a) Each certificate representing shares of capital stock
of the Company owned by the Principal Shareholders shall be imprinted with a
legend substantially in the following form (in addition to any other legend
required by law or otherwise):
"THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT
TO THE PROVISIONS OF A SHAREHOLDERS AGREEMENT, DATED AS OF
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DECEMBER __, 1999, AS AMENDED, AMONG THE ISSUER, THE HOLDER
OF THIS CERTIFICATE AND THE AGENT FOR THE HOLDERS OF CERTAIN
SENIOR DEBT OF THE ISSUER DESCRIBED THEREIN. THE SHAREHOLDERS
AGREEMENT CONTAINS PROVISIONS WITH RESPECT TO VOTING AND
RESTRICTING THE TRANSFER OF THE SECURITIES EVIDENCED BY THIS
CERTIFICATE."
2.3 Violations of this Agreement. Any Transfer made in violation
of this Section II shall be null and void. The Company shall not be required to
(a) transfer on its books any securities of the Company transferred in
violation of any provisions of this Agreement, or (b) to treat as the owner of
such securities, or to accord the right to vote as such owner, or to pay
dividends to, any transferee to whom such securities are transferred in
violation of this Agreement.
SECTION III - GENERAL TERMS
3.1 Term. Notwithstanding any other provision of this Agreement,
this Agreement shall terminate on the satisfaction in full of all of the Senior
Debt; provided, that if, after receipt of any payment of all or any part of the
Senior Debt, the Agent is for any reason compelled to surrender such payment to
any person or entity because such payment is determined to be void or voidable
as a preference, impermissible setoff, or a diversion of trust funds, or for
any other reason, this Agreement shall continue in full force (except to the
extent otherwise provided herein) notwithstanding any contrary action which may
have been taken by the Agent in reliance upon such payment, and any such
contrary action so taken shall be without prejudice to the Agent's rights under
this Agreement and shall be deemed to have been conditioned upon such payment
having become final and irrevocable.
3.2 Governing Law; Consent to Jurisdiction. This Agreement shall
be governed by and construed in accordance with the laws of the State of
Georgia applicable to contracts made and to be performed in the State of
Georgia. The Company and each Principal Shareholder irrevocably consents to the
exclusive jurisdiction of the courts of the State of New York and of any
federal court located in such State in connection with any action or proceeding
arising out of or relating to this Agreement, any document or instrument
delivered pursuant to, in connection with or simultaneously with this
Agreement, or a breach of this Agreement or any such document or instrument.
3.3 Entire Agreement. This Agreement constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes all prior oral or written agreements and understandings between them
or any of them as to such subject matter.
3.4 Amendment. Except as otherwise expressly provided herein,
this Agreement may be amended only upon the written consent of the parties
hereto.
3.5 Successors. This Agreement shall be binding upon and shall
inure to the benefit of the parties hereto and their respective heirs,
executors, legal representatives, successors, and permitted transferees, except
as may be expressly provided otherwise herein.
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3.6 Invalidity of Provisions. In the case any one or more of the
provisions contained in this Agreement shall for any reason to be held to be
invalid, illegal or unenforceable in any respect, such invalidity, illegality
or unenforceability shall not affect any other provision of this Agreement and
such invalid, illegal and unenforceable provision shall be reformed and
construed so that it will be valid, legal, and enforceable to the maximum
extent permitted by law.
3.7 Notices, etc. All notices and other communications required
or permitted under this Agreement shall be sent by registered or certified
mail, postage prepaid, overnight courier, confirmed telex or facsimile
transmission or otherwise delivered by hand or by messenger, addressed (a) if
to a Principal Shareholder, at such Principal Shareholder's address set forth
on the signature page hereto, or, at such other address as such Principal
Shareholder shall have furnished to the other parties in writing; (b) if to the
Company, to comstar.net, inc., 2812 Spring Road, Suite 210, Atlanta, Georgia
30339, Facsimile: (770) 485-6100, Attention: J. Cary Howell, Chief Executive
Officer; and (c) if to the Agent, to ______________ , Facsimile: ______________,
Attention: _______________________.
Each such notice or other communication shall for all purposes of this
Agreement be treated as effective or having been given (i) when delivered if
delivered personally, (ii) if sent by mail, at the earlier of its receipt or
five days after the same has been deposited in a regularly maintained
receptacle for the deposit of the United States mail, addressed and postage
prepaid as aforesaid, (iii) if sent by overnight courier, on the next business
day after the same has been deposited with a nationally recognized courier
service, or (iv) when sent by confirmed telex or facsimile, on the day sent (if
a business day) if sent during normal business hours of the recipient, and if
not, then on the next business day.
3.8 Further Assurances. The Principal Shareholders and the
Company agree, upon request of the Agent, to execute any further documents or
instruments necessary or desirable to carry out the purposes or intent of this
Agreement.
3.9 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be enforceable against the parties actually
executing such counterparts, and all of which together shall constitute one
instrument. This Agreement may be delivered by facsimile and facsimile
signatures shall be treated as original signatures for all applicable purposes.
3.10 Headings. The headings in this Agreement are for convenience
of reference only and shall not limit or otherwise affect the meaning hereof.
3.11 Delays or Omissions. Except as expressly provided in this
Agreement, no delay or omission to exercise any right, power or remedy accruing
to any party upon any breach or default of any other party under this Agreement
shall impair any such right, power or remedy of such party nor shall it be
construed to be a waiver of any such breach or default, or an acquiescence
therein, or of or in any similar breach or default thereafter occurring; nor
shall any waiver of any single breach or default be deemed a waiver of any
other breach or default theretofore or thereafter occurring. Any waiver,
permit, consent or approval of any kind or character on the part of any party
of any breach
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or default under this Agreement, or any waiver on the part of any party of any
provisions or conditions of this Agreement, must be in writing and shall be
effective only to the extent specifically set forth in such writing. All
remedies, either under this Agreement or by law or otherwise afforded to any
party shall be cumulative and not alternative.
3.12 Equitable Remedies. The parties hereto acknowledge that in
the event of a breach or a threatened breach by any other party hereto, the
non-breaching parties hereto will not have an adequate remedy at law.
Accordingly, in the event of any such breach or threatened breach, such other
non-breaching parties shall be entitled to such equitable and injunctive relief
as may be available in any available forum to restrain such breaching party
from participating in such breach or threatened breach from the violation of
the provisions hereof. Nothing herein shall be construed as prohibiting any
non-breaching party from pursuing any other remedies available at law or in
equity for such breach or threatened breach.
3.13 Other Shareholders Agreement. The Principal Shareholders
acknowledge and agree that, to the extent that the terms of this Agreement
conflict with the terms of any other agreement among them and if applicable,
any third party relating to their securities in the Company, the terms of this
Agreement shall control.
* * * * *
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IN WITNESS WHEREOF, the parties have caused this Shareholders'
Agreement to be duly executed as of the date first above written.
COMPANY: COMSTAR.NET, INC.
By:
------------------------------------
Name:
Title:
PRINCIPAL SHAREHOLDERS:
------------------------------------
James L. Bruce, Jr.
Address:
----------------------------
------------------------------------
------------------------------------
------------------------------------
Samuel F. Dayton
Address:
----------------------------
------------------------------------
------------------------------------
------------------------------------
J. Cary Howell
Address:
----------------------------
------------------------------------
------------------------------------
------------------------------------
Edward N. Landa
Address:
----------------------------
------------------------------------
------------------------------------
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AGENT:
By:
its
By:
---------------------------------
Name:
Title:
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APPENDIX D
SUBSCRIPTION AGREEMENT
comstar.net, inc.
2812 Spring Road
Suite 210
Atlanta, Georgia 30339
Attention: Chief Financial Officer
Gentlemen:
1. Subscription. The undersigned, intending to be legally bound,
hereby subscribes to purchase from comstar.net, inc., a Georgia corporation
(the "Company"), the number of units (the "Units") set forth on the signature
page hereof, for a purchase price of $50,000 per Unit (the "Purchase Price") .
Each Unit consists of (i) a senior promissory note of the Company in the
principal amount of $50,000 substantially in the form set forth as an exhibit
to the Registration Statement referred to below (the "Notes") , and (ii) a
warrant to purchase 13,566 shares of common stock, without par value (the
"Common Stock") , of the Company, at an exercise price equal to $.01 per share,
substantially in the form set forth as an exhibit to the Registration Statement
(the "Warrant"). The offering and sale of the Notes and the Warrant (the
"Offering") has been registered pursuant to a registration statement on Form
S-1 (Reg. No. 333-92581) (the "Registration Statement") filed with the
Securities and Exchange Commission (the "Commission") under the Securities Act
of 1933, as amended (the "Act"). This subscription is submitted to you in
accordance with and subject to the terms and conditions described in this
Agreement.
(a) If this Subscription is accepted by the Company,
payments for the Units hereby subscribed for will be made to the Company by
certified check or wire transfer at the Closing of the Offering (the "Closing")
which will be held at the offices of the Company as soon as practicable after
the Company has notified the undersigned that (i) the subscription has been
accepted by the Company, in whole or in part, and (ii) the conditions to
Closing set forth in Section 2 of this Agreement have been satisfied. If this
subscription is accepted by the Company, in whole or in part, subject to the
conditions set forth in Section 2 of this Agreement, the Company shall deliver
to the undersigned the Notes and the Warrant subscribed for hereby, dated the
date of Closing, a Shareholders Agreement substantially in the form annexed as
Exhibit A hereto (the "Shareholders Agreement"), and a fully executed copy of
this Agreement.
2. Conditions. It is understood and agreed that this
subscription is made subject to the following terms and conditions:
(a) The Company shall have the right to accept or reject
this subscription in whole or in part. Unless this subscription is accepted in
whole or in part or rejected by the Company prior to January 15, 2000, this
subscription shall be deemed rejected in whole.
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(b) On the date of the Closing, the Company, certain
principal shareholders of the Company (the "Principal Shareholders") and
Palisade Private Partnership, L.P. as agent for holders of Notes, shall have
entered into the Shareholders Agreement and shall be in compliance with all
applicable provisions thereof.
(c) On the date of the Closing, no Default or Event of
Default (as defined in the Notes) shall have occurred and be continuing.
(d) On the date of the Closing, the representations and
warranties contained in this Agreement shall be true and correct as if made on
such date.
(e) At the Closing, the undersigned shall have received
opinions of Nelson, Mullins, Riley & Scarborough, L.L.P., counsel for the
Company, Arnall, Golden & Gregory LLP, special communications counsel for the
Company, and Jones & Askew, L.L.P., special intellectual property counsel for
the Company, in each case addressed to the undersigned and dated the date of
the Closing, in form and substance reasonably satisfactory to the undersigned.
The Company hereby instructs such counsel to deliver such opinion to each
subscriber for Units.
(f) The conditions to the obligations of Scott &
Stringfellow, Inc. and SunTrust Equitable Securities Corporation (collectively
the "Agents") contained in Section 5 of the Placement Agreement, dated December
___, 1999, among the Agents and the Company (the "Placement Agreement"), shall
have been satisfied.
(g) At the date of the Closing, the undersigned shall have
been furnished such information, documents, certificates, and opinions as it
may reasonably require to evidence the accuracy, completeness, or satisfaction
of the representations, warranties, covenants, agreements, and conditions
herein contained or as it otherwise may reasonably request.
3. Representations and Warranties of the Company. The
representations and warranties made by the Company in the Placement Agreement
are hereby incorporated by this reference and made to the undersigned as if set
forth in full herein.
4. Representations and Warranties of the Subscriber. The
undersigned hereby represents and warrants to, and agrees with, the Company as
follows:
(a) If a natural person, the undersigned is: a bona fide
resident of the State contained in the address set forth on the signature page
of this Agreement as the undersigned's home address; at least 21 years of age;
and legally competent to execute this Subscription Agreement. If an entity, the
undersigned is duly authorized to execute this Agreement and this Agreement
constitutes the legal, valid and binding obligation of the undersigned
enforceable against the undersigned in accordance with its terms.
(b) The undersigned acknowledges that no market for the
Units, the Notes, the Warrant or the Common Stock presently exists and none may
develop in the future and that the
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<PAGE> 169
undersigned may find it impossible to liquidate the investment at a time when
it may be desirable to do so, or at any other time.
(c) The undersigned will acquire the Units for the
undersigned's own account for investment and not with a view to the sale or
distribution thereof or the granting of any participation therein, and has no
present intention of distributing or selling to others any of such interest or
granting any participation therein.
5. Indemnification. Each of the Company and the undersigned
agrees to and will indemnify, defend and hold the other (including for purposes
of this Section 5, each of the other's officers, directors, shareholders,
partners, members, employees, agents and representatives) harmless from and
against all demands, claims, actions or causes of action, assessments, losses,
damages, liabilities, costs and expenses, including, without limitation,
interest, penalties and reasonable attorneys' fees and expenses, imposed upon
or incurred by the other by reason of, resulting from or arising out of a
breach of any representation, warranty, covenant or agreement of the Company or
the undersigned contained in this Agreement, as the case may be.
6. Transferability. Neither this Agreement, nor any interest of
the undersigned herein, shall be assignable or transferable by the undersigned
in whole or in part except by operation of law.
7. Preemptive Rights.
(a) Subject to Section 7(b), if this subscription is
accepted in whole or in part, the Company agrees that the undersigned shall
have the preemptive right to purchase the undersigned's Pro Rata Portion of any
New Securities (as such terms are hereinafter defined) which the Company may,
from time to time, propose to sell and issue, which right may be exercised
pursuant to the notice provisions set forth below. A "Pro Rata Portion" shall
mean that percentage equal to the undersigned's fully-diluted percentage
ownership of Common Stock as determined immediately prior to such issuance (the
"Preemptive Rights").
(b) "New Securities" shall mean any shares of capital
stock or securities exercisable, convertible or exchangeable for capital stock
issued by the Company other than in an underwritten public offering of
securities that qualifies as a Qualified Financing (as defined in the Notes),
provided that "New Securities" shall not include: (a) shares of Common Stock
issued or issuable upon exercise of stock options granted pursuant to any stock
option plan of the Company approved by the Board of Directors of the Company;
(b) shares issued in connection with any merger or acquisition approved by the
Board of Directors and Shareholders of the Company; (c) shares issued in
connection with any strategic alliance, joint venture or similar relationship
approved by the Board of Directors; (d) shares of Common Stock issued in
consideration for less than $150,000 in any transaction or series of
transactions where the purchase price per share of such shares is not less than
the then applicable Conversion Price per share (as defined in the Notes),
provided that the amount of all such transactions will not exceed $150,000 in
the aggregate; and (e) shares issued in the recapitalization described in the
Registration Statement.
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(c) In the event the Company proposes to undertake an
issuance of New Securities, it shall give the undersigned written notice of its
intention, describing the type of New Securities and the price and terms upon
which the Company proposes to issue the same. The undersigned shall have 15
days from the date of receipt of any such notice to agree to purchase such New
Securities (up to the amount referred to in Section 7(a)), for the price and
upon the terms specified in the notice, by giving written notice to the Company
and stating therein the quantity of New Securities to be purchased. The Company
shall promptly provide the undersigned with such information concerning the
Company, its subsidiaries and their respective businesses, properties, assets,
liabilities and prospects and the New Securities as the undersigned may
reasonably request for such purpose.
(d) If the undersigned exercises its Preemptive Right
under this Section 7, the closing of the purchase of the New Securities with
respect to which such right has been exercised shall take place within 30
calendar days after the undersigned gives notice of such exercise, which period
of time shall be extended in order to comply with applicable laws and
regulations. Upon exercise of such right of participation, the Company and the
undersigned shall be legally obligated to consummate the purchase contemplated
thereby and shall use their best efforts to secure any approvals required in
connection therewith.
(e) The undersigned may waive his, her or its Preemptive
Rights in any instance, and such waiver, if evidenced by a writing, is
irrevocable even though it is not supported by consideration. Shares subject to
Preemptive Rights that are not acquired by the undersigned may be issued to any
third party, for a period of six months after being offered to the undersigned
pursuant to such Preemptive Rights, at a consideration set by the Board that is
not less than the consideration set for the issuance of New Securities pursuant
to these Preemptive Rights. An offer at a lower consideration or after the
expiration of such six-month period shall once again be subject to the
undersigned's Preemptive Rights.
(f) The Preemptive Rights granted pursuant to this Section
7 shall cease to apply after the closing of the Company's initial underwritten
public offering of securities that qualifies as a Qualified Financing.
8. Miscellaneous.
(a) This Agreement and the Exhibits hereto set forth the
entire understanding of the parties with respect to the subject matter hereof,
supersede all existing agreements among them concerning such subject matter,
and (subject to Section 8(g)) may be modified only by a written instrument duly
executed by the party to be charged.
(b) Except as otherwise specifically provided herein, any
notice or other communication required or permitted to be given hereunder shall
be in writing and shall be mailed by certified mail, return receipt requested,
or by Federal Express, Express Mail or similar overnight delivery or courier
service or delivered (in person or by telecopy, telex or similar telecommuni
cations equipment) against receipt to the party to whom it is to be given, (i)
if to the Company, at the address set forth on the first page hereof, (ii) if
to the undersigned, at the address set forth on the
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<PAGE> 171
signature page hereof, or (iii) in either case, to such other address as the
party shall have furnished in writing in accordance with the provisions of this
section 8(b). Notice to the estate of any party shall be sufficient if
addressed to the party as provided in this Section 8(b). Any notice or other
communication given by certified mail shall be deemed given at the time of
certification thereof, except for a notice changing a party address which shall
be deemed given at the time of receipt thereof. Any notice given by other means
permitted by this Section 8(b) shall be deemed given at the time of receipt
thereof.
(c) This Agreement shall be binding upon and inure to the
benefit of the parties hereto, the successors and assigns of the Company, and
the permitted successors, assigns, heirs and personal representatives of the
undersigned (including permitted transferees of the Units).
(d) The headings in this Agreement are solely for
convenience of reference and shall be given no effect in the construction or
interpretation of this Agreement.
(e) This Agreement may be executed in any number of
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
(f) This Agreement shall be governed by and construed in
accordance with the laws of the State of Georgia, without giving effect to
principles governing conflicts of law.
(g) This Agreement does not create, and shall not be
construed as creating, any rights enforceable by any person not a party to this
Agreement (except as provided in Sections 5 and 8(c).
(h) The parties hereto irrevocably consent to the
jurisdiction of the courts of the State of New York and of any federal court
located in such State in connection with any action or proceeding arising out
of or relating to this Agreement, any document or instrument delivered pursuant
to, in connection with or simultaneously with this Agreement, or a breach of
this Agreement or any such document or instrument.
(i) The Company shall pay the reasonable fees and expenses
of Squadron, Ellenoff, Plesent & Sheinfeld, LLP, special counsel to the
prospective purchasers in the Offering, in connection with the Offering and the
transactions contemplated by this Agreement.
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<PAGE> 172
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year this subscription has been accepted by the Company as set
forth below.
Number of Units ---------------------------------------------
Being Purchased Print Name of Subscriber
By:
- ---------------- ------------------------------------------
(Signature of Subscriber or
Authorized Signatory)
Social Security Number or other
Taxpayer Identification Number:
---------------------------------------------
Address:
-------------------------------------
---------------------------------------------
ACCEPTED BY:
comstar.net, inc.
By:
-------------------------------------
Date:
---------------------
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<PAGE> 173
100 INVESTMENT UNITS
CONSISTING OF AN 8% SENIOR CONVERTIBLE NOTE
WITH A STOCK PURCHASE WARRANT
(COMSTAR.NET, INC. LOGO)
---------------------
PROSPECTUS
---------------------
SCOTT & STRINGFELLOW, INC.
SUNTRUST EQUITABLE SECURITIES
---------------------
DECEMBER 30, 1999
---------------------
We have not authorized any dealer, salesperson or other person to give you
written information other than this prospectus or to make representations as to
matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy these securities in any jurisdiction where
that would not be permitted or legal. Neither the delivery of this prospectus
nor any sales made pursuant to this prospectus after the date of this prospectus
shall create an implication that the information contained in this prospectus or
the affairs of comstar.net, inc. have not changed since the date of this
prospectus.
Until March 30, 2000, all dealers that buy, sell or trade in our common
stock, whether or not participating in this offering, may be required to deliver
a prospectus. This delivery requirement is in addition to the dealer's
obligation to deliver a prospectus when acting as an underwriter and with
respect to their unsold allotments or subscriptions.
