<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 9, 1999
REGISTRATION NO. 333-86877
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 3 TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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COMSTAR.NET, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C> <C>
GEORGIA 7379 58-2235514
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
2812 SPRING ROAD
SUITE 210
ATLANTA, GEORGIA 30339
(770) 485-6000
(770) 485-6100 (FACSIMILE)
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
CHRISTOPHER K. MARTIN, C.P.A.
CHIEF FINANCIAL OFFICER
COMSTAR.NET, INC.
2812 SPRING ROAD
SUITE 210
ATLANTA, GEORGIA 30339
(770) 485-6000
(770) 485-6100 (FACSIMILE)
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
---------------------------
Copies to:
<TABLE>
<S> <C>
CHARLES D. VAUGHN, ESQ. M. HILL JEFFRIES, ESQ.
JENNIFER A. MCCOID, ESQ. MARC L. HARRISON, ESQ.
NELSON MULLINS RILEY & SCARBOROUGH, L.L.P. ALSTON & BIRD LLP
FIRST UNION PLAZA, SUITE 1400 ONE ATLANTIC CENTER
999 PEACHTREE STREET, N.E. 1201 WEST PEACHTREE STREET
ATLANTA, GEORGIA 30309 ATLANTA, GEORGIA 30309-3424
(404) 817-6000 (404) 881-7000
(404) 817-6050 (FACSIMILE) (404) 881-4777 (FACSIMILE)
</TABLE>
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this form is filed to register additional securities for any offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] __________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
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AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF SECURITIES TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
TO BE REGISTERED REGISTERED PER SHARE(2) PRICE(2) REGISTRATION FEE(3)
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<S> <C> <C> <C> <C>
Common Stock, no par value........... 3,653,550(1) $14 $51,149,700 $14,220
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</TABLE>
(1) Includes 476,550 shares which the underwriters have an option to purchase
from comstar.net to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(a) under the Securities Act of 1933.
(3) Previously paid.
---------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE
MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS
NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO
BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
SUBJECT TO COMPLETION, DATED NOVEMBER 9, 1999
(COMSTAR.NET, INC. LOGO)
3,177,000 SHARES
COMMON STOCK
comstar.net, inc. is offering 3,100,000 shares of its common stock, and the
selling shareholders are offering an additional 77,000 shares. This is our
initial public offering, and no public market currently exists for our shares.
We have received approval to list the shares on the Nasdaq National Market,
subject to completion of this offering, under the symbol "CSTX." We anticipate
that the initial public offering price will be between $12.00 and $14.00 per
share.
---------------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING
ON PAGE 6.
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>
PER SHARE TOTAL
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<S> <C> <C>
Public offering price....................................... $ $
Underwriting discounts...................................... $ $
Proceeds to comstar.net..................................... $ $
Proceeds to the selling shareholders........................ $ $
</TABLE>
comstar.net has granted the underwriters a 30-day option to purchase up to
an additional 476,550 shares of common stock to cover any over-allotments.
The underwriters expect to deliver the shares of common stock to purchasers
on , 1999.
---------------------------
SCOTT & STRINGFELLOW, INC. SUNTRUST EQUITABLE SECURITIES
The date of this prospectus is , 1999.
<PAGE> 3
TABLE OF CONTENTS
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PAGE
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<S> <C>
Summary.......................... 1
Risk Factors..................... 6
Use of Proceeds.................. 26
Capitalization................... 27
Dividend Policy.................. 27
Dilution......................... 28
Selected Financial Data.......... 29
Management's Discussion and
Analysis of Financial Condition
and Results of Operations...... 31
Business......................... 46
</TABLE>
<TABLE>
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PAGE
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<S> <C>
Management....................... 68
Related Party Transactions....... 75
Principal and Selling
Shareholders................... 76
Description of Capital Stock..... 78
Shares Eligible for Future
Sale........................... 82
Underwriting..................... 84
Legal Matters.................... 87
Experts.......................... 88
Where You Can Find More
Information.................... 88
Index to Financial Statements.... F-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> 4
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 common stock. Unless otherwise stated, all information
in this prospectus assumes that (1) the price of our common stock to the public
will be $13.00 per share, (2) the underwriters will not exercise their
over-allotment option, (3) all outstanding shares of common stock series A and
common stock series B will convert into shares of common stock immediately
before the completion of this offering, and (4) we will effect a one-for-two
reverse stock split of all our outstanding shares immediately before the
completion of this offering.
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> 5
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> 6
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 and internationally,
- 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 our common
stock.
3
<PAGE> 7
THE OFFERING
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<S> <C>
Common stock offered by
comstar.net........................ 3,100,000 shares
Common stock offered by the selling
shareholders....................... 77,000 shares
Over-allotment option................ Up to an additional 476,550 shares to be issued
by comstar.net. If the over-allotment option is
exercised in full by the underwriters at a
public offering price per share of $13.00, the
total offering proceeds will be $47,496,150,
underwriting discounts will be $3,324,731 and
proceeds to comstar.net will be $44,171,419.
Common stock to be outstanding
immediately after the offering..... 8,285,893 shares
Use of proceeds...................... Repay debt; develop and deploy new data centers
and services; expand sales, marketing and
advertising efforts; and fund working capital
and general corporate purposes, including
acquisitions.
Proposed Nasdaq National Market
symbol............................. CSTX
</TABLE>
---------------------------
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.
4
<PAGE> 8
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. 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. 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). The data "as adjusted for the offering"
reflect the sale by us of 3,100,000 shares of common stock at an assumed initial
offering price of $13.00 per share and our receipt and application of the
estimated net proceeds as described in "Use of Proceeds."
<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)
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
========== ========== ========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
-------------------------
AS ADJUSTED
FOR THE
ACTUAL OFFERING
----------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 355,689 $34,860,367
Working capital (deficit)................................... (1,711,409) 36,738,913
Total assets................................................ 2,358,037 36,862,715
Total debt, including current maturities.................... 2,018,555 --
Total shareholders' (deficit) equity........................ (673,693) 35,803,807
</TABLE>
DIVIDEND POLICY
We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future.
5
<PAGE> 9
RISK FACTORS
An investment in our common stock involves a high degree of risk. Before
you invest in our common stock, 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 trading price of our common stock 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 common
stock, 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 price of our common stock.
RISKS RELATED TO COMSTAR.NET
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.
6
<PAGE> 10
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 business will suffer and the market price of our common stock could decline
substantially.
OUR OPERATING RESULTS AND LIQUIDITY ARE UNPREDICTABLE AND MAY FLUCTUATE, WHICH
MAY CAUSE OUR STOCK PRICE 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.
If our future results of operations fall below the expectations of investors or
public market analysts, the price of our common stock could fall substantially.
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,
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<PAGE> 11
- 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,
- 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 and
international 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,
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<PAGE> 12
- 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 and at various international sites 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.
WE MAY BE UNABLE TO FUND OUR PLANNED BUSINESS EXPANSION AND OTHER CAPITAL
REQUIREMENTS, WHICH MAY LIMIT OUR OPERATIONS AND GROWTH POTENTIAL.
We expect our planned business expansion to require significant cash
expenditures, including increased sales and marketing expenses and expenditures
to establish new data centers and POPs. Although we believe that the net
proceeds of this offering and our cash reserves will be adequate to fund our
operations and the development of additional data centers and POPs until the end
of the year 2000, we may need additional funds either during or after that
period. We may not be able to obtain additional financing or, if additional
financing is available, we may not be able to obtain it on terms favorable to
us. If we raise additional funds by issuing equity securities, your ownership
interest could be significantly diluted, and any additional equity securities we
issue may have rights, preferences or privileges senior to your rights. In
addition, the terms of any additional financing we obtain may significantly
limit our future financing and operating activities. If we cannot obtain
adequate funds to satisfy our capital requirements, we may be forced to limit
our operations and expansion plans significantly, sell assets, or seek to
refinance outstanding obligations. Any of these events could significantly harm
our business and financial condition and limit our growth.
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,
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- 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.
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
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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.
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.
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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 are completing the development of an important enhancement to our T1,
fractional T1, T3 and fractional T3 leased line Internet access options -- the
eCommerce Guarantee. We expect to include the eCommerce Guarantee in our
customer contracts. Under our eCommerce Guarantee, we will compensate our
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 is
our fault and the interruption causes the customer to lose profits. We are
arranging for an insurance company rated "A" by A.M. Best Company to insure our
liability for the eCommerce Guarantee, and we anticipate that 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 overall
deductible limit for any single event that causes multiple interruptions. We
anticipate that the maximum insured amount per interruption will be $500,000 for
each T3 or fractional T3 line and $25,000 for each T1 or fractional T1 line. We
expect that 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. We have not yet implemented our eCommerce
Guarantee. We cannot assure that it will be implemented at all or, if it is
implemented and included in our customer contracts, that it will be on the terms
and conditions described above. If we include the eCommerce Guarantee in our
customer contracts and incur significant free service obligations or are
required to pay significant amounts as a result of it, we will likely suffer
financial losses for the periods in which we incur the obligations and pay the
amounts.
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
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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.
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
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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. 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,
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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.
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
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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.
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.
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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.
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
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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.
OUR PLANNED EXPANSION INTO INTERNATIONAL MARKETS MAY BE DIFFICULT, COSTLY AND
UNSUCCESSFUL.
One of our longer-term goals is to expand into international markets, and
we currently plan to open a data center in the London metropolitan area in 2001.
As we have experience operating in only a limited number of markets and no
experience operating internationally, we may not be able to adapt our services
to the needs of customers in different markets. In addition, we may not be able
to obtain the required permits and licenses to hire and train employees and to
market, sell and successfully deliver our services outside the United States. We
intend to outsource the initial operation of our London data center. As a
result, we will depend, at least initially, on others to operate and manage our
London data center. If we enter into international markets, we will face these
and other risks of international operations, any of which could materially and
adversely affect our business and financial performance.
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.
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.
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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 60.3% 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,
- 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.
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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.
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
20
<PAGE> 24
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.
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.
21
<PAGE> 25
WE MAY FACE NEW AND DIFFERENT COMPETITIVE PRESSURES IF WE EXPAND TO FOREIGN
MARKETS, AND WE MAY NOT BE ABLE TO RESPOND EFFECTIVELY TO THESE PRESSURES.
If we expand our operations outside the United States, we will face new
competitors and competitive environments. In some cases, we will be forced to
compete with and buy services from government-owned or subsidized
telecommunications providers. Some of these providers may enjoy a monopoly on
telecommunications services essential to our business. We may not be able to
purchase those services at a reasonable price or at all. In addition to the
risks associated with our domestic competitors, foreign competitors may pose an
even greater risk, as they may possess a better understanding of their local
markets and better working relationships with local infrastructure providers and
others. We may not be able to obtain similar levels of local knowledge in
foreign markets, which could place us at a significant competitive disadvantage.
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
22
<PAGE> 26
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 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
THIS IS OUR INITIAL PUBLIC OFFERING, AND A LIQUID MARKET FOR OUR SHARES MAY NOT
DEVELOP.
Before this offering, you could not buy or sell our common stock publicly.
The initial public offering price for the shares will be determined by
negotiation among us, the representatives of the underwriters and the selling
shareholders based on several factors, and it may not indicate future market
prices. You may not be able to sell your stock for a price equal to or greater
than the initial offering price. As this is our initial public offering, the
number of shares available for public sale will be relatively small, and we
cannot predict how liquid the market for our shares will be. An active public
market for our common stock may not develop or be sustained after the offering.
OUR COMMON STOCK PRICE MAY BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES
FOR INDIVIDUAL SHAREHOLDERS.
If our revenues or results of operations fall below the expectations of
investors or public market analysts, the price of our common stock could fall
substantially. The market price of the 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,
- changes in financial estimates by securities analysts,
- the operating and stock price performance of other companies in our
industry, and
- fluctuations in stock market price and volume, which are particularly
common among securities of Internet companies.
Further, the stock markets, and in particular the Nasdaq National Market on
which we intend to list our common stock, have experienced extreme price and
volume
23
<PAGE> 27
fluctuations that have affected the market prices of equity securities of many
technology companies. These fluctuations often have been unrelated or
disproportionate to the operating performance of the companies. Because our
business is Internet-related, the price of our common stock could fluctuate
widely if the market price of equity securities of other Internet-related
companies becomes volatile. In the past, following periods of volatility in the
market price of a company's securities, securities class action litigation has
often been instituted against that company. Litigation of that nature is
expensive and could divert our management's attention and our other resources.
THE FUTURE SALE OF SHARES OF OUR COMMON STOCK COULD ADVERSELY AFFECT THE MARKET
PRICE OF OUR COMMON STOCK.
Substantial sales of our common stock in the public market following this
offering, or the perception by the market that those sales could occur, could
lower the market price of our common stock or make it difficult for us to raise
additional funds through the sale of equity in the future. Those sales also
could make it harder for us to sell stock or equity-related securities in the
future at a time or price that we believe is fair. The shares of common stock
being sold in this offering will generally be freely tradable without
restriction. The remaining 5,108,893 shares of common stock outstanding will be
"restricted securities" as defined in Rule 144 under the Securities Act. Except
as described in the following paragraph, the holders of these securities may
sell them in the future without registration under the Securities Act, subject
to compliance with Rule 144, Rule 701 or any other applicable exemption under
the Securities Act.
We, our directors and executive officers and some of our shareholders have
agreed with the underwriters not to sell any common stock or securities
convertible into or exchangeable for common stock for 180 days after the date of
this prospectus, subject to some exceptions. When these lock-up agreements
expire, 4,992,171 shares of common stock will be eligible for resale in the
future without registration under the Securities Act, subject to compliance with
Rule 144, Rule 701 or any other applicable exemption under the Securities Act.
In addition, within approximately 90 days after the date of this prospectus, we
expect to register under the Securities Act a total of 1,450,000 shares of
common stock issuable on exercise of stock options, of which approximately
553,374 shares will then be issuable and freely tradable upon the exercise of
vested options. You should read "Shares Eligible for Future Sale" for a more
detailed description of these risks.
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 approximately
$36,477,500 million. We have allocated approximately $2.2 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.
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION AND PAY A HIGHER PRICE
FOR OUR COMMON STOCK THAN EXISTING SHAREHOLDERS.
The initial public offering price will be substantially higher than the
book value per share of our outstanding common stock and the price per share
paid by existing
24
<PAGE> 28
shareholders. If you buy our common stock in this offering, the shares you buy
will experience an immediate dilution in tangible book value per share. The
shares of common stock owned by our existing shareholders will receive a
material increase in the tangible book value per share. The dilution to
investors in this offering will be approximately $8.71 per share. For more
information about this dilution, see "Dilution."
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.
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<PAGE> 29
USE OF PROCEEDS
The net proceeds to us from the sale of the 3,100,000 shares of common
stock offered by us are estimated to be $36.5 million, assuming an initial
public offering price of $13.00 per share and after deducting the estimated
underwriting discounts and estimated offering expenses payable by us. We will
not receive any proceeds from the sale of shares of common stock by the selling
shareholders. For more information regarding the selling shareholders, see
"Principal and Selling Shareholders."
We intend to use the net proceeds from this offering to:
- repay outstanding debt and accrued interest of approximately $2.2 million
for the following obligations:
<TABLE>
<CAPTION>
PRINCIPAL MATURITY ANNUAL
LENDER AMOUNT DATE INTEREST RATE
- ------------------------------------------------ --------- -------- -------------
<S> <C> <C> <C>
db Telecom Technologies, Inc................ $270,188 1/1/00 10%
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........................................ 618,549 1/1/00 10%
Dr. Samuel F. Dayton and James L. Bruce,
Jr........................................ 283,985 12/27/99 8.75%
Dr. Samuel F. Dayton........................ 140,000 1/15/00 10%
</TABLE>
- purchase or lease up to seven new data centers and eleven POPs in
targeted major metropolitan areas throughout the United States, using
approximately $28.3 million for these facilities in the aggregate, and
- expand our sales and marketing staffs and our overall marketing and
advertising efforts, using approximately $2.8 million to increase our
access to and visibility in the marketplace.
We will use any remaining net proceeds from this offering for general corporate
purposes, including research and development of new and enhanced services,
acquisitions and increased working capital requirements resulting from our
growth.
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 and to
provide working capital.
The amount of funds that we actually use for these purposes, other than
debt repayment, will depend on many factors, including revisions to our business
plan, material changes in our revenues or expenses, and other factors described
under "Risk Factors." Accordingly, our management will have significant
discretion over the use and investment of the net proceeds from the offering.
From time to time in the ordinary course of business, we evaluate the
acquisition of customer lists and related customer accounts, businesses,
products, services and technologies that may increase the size of our customer
base or complement our business. We may use a portion of the net proceeds for
any of these acquisitions. Currently, however, we do not have any
understandings, commitments or agreements with respect to any acquisitions, and
we may not be able to identify suitable acquisition candidates or complete any
acquisition.
Pending application of the net proceeds described above, we intend to
invest the net proceeds in investment-grade, interest-bearing securities.
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<PAGE> 30
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 3,100,000 shares
of common stock offered in this offering and the application of the net proceeds
from the offering. The information in the table does not include 868,125 shares
of common stock that may be issued under outstanding options at September 30,
1999 at an exercise price of $11.42 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
-------------------------
ACTUAL AS ADJUSTED
----------- -----------
<S> <C> <C>
Long-term debt, including current maturities......... $ 1,972,822 $ --
Obligations under capital leases, including current
portion............................................ 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); 8,285,893
shares issued and outstanding (as adjusted)... 2,122,744 38,600,244
Additional paid in capital........................... 3,522,412 3,522,412
Deferred compensation................................ (117,017) (117,017)
Accumulated deficit.................................. (6,201,832) (6,201,832)
----------- -----------
Total shareholders' (deficit) equity.......... (673,693) 35,803,807
----------- -----------
$ 1,344,862 $35,849,540
=========== ===========
</TABLE>
DIVIDEND POLICY
We have never paid any cash dividends on our common stock. We currently
anticipate that we will retain all future earnings for use in our business and
do not anticipate paying any cash dividends in the foreseeable future.
27
<PAGE> 31
DILUTION
Our pro forma net tangible book value as of September 30, 1999 was
$(927,196) or $(0.18) per share of common stock. Pro forma net tangible book
value per share is equal to total tangible assets less total liabilities,
divided by the total pro forma number of shares of common stock outstanding,
after giving effect to the conversion of all outstanding shares of common stock
series A and common stock series B into common stock. After giving effect to our
receipt of the net proceeds of our sale of 3,100,000 shares of common stock at
an assumed initial public offering price of $13.00 per share, our adjusted pro
forma net tangible book value as of September 30, 1999 would have been
approximately $35.6 million, or $4.29 per share. This amount represents an
immediate increase in pro forma net tangible book value of $4.47 per share to
existing shareholders and an immediate dilution of $8.71 per share to new
investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price....................... $13.00
Pro forma net tangible book value as of September 30,
1999................................................... $(0.18)
Increase in net tangible book value attributable to new
investors.............................................. 4.47
------
Pro forma net tangible book value after the offering........ 4.29
------
Dilution to new investors................................... 8.71
======
</TABLE>
The following table summarizes, on an as adjusted pro forma basis as of
September 30, 1999, the number of shares of common stock purchased from us, the
total consideration paid and the average price per share paid by existing
shareholders and to be paid by new investors at an assumed initial public
offering price of $13.00 per share, before deducting estimated underwriting
discounts and offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders........... 5,185,893 62.6% $ 2,122,744 5.0% $0.41
New investors................... 3,100,000 37.4 40,300,000 95.0 13.00
--------- ----- ----------- ------
Total........................... 8,285,893 100.0% $42,422,744 100.0%
========= ===== =========== ======
</TABLE>
Sales by the selling shareholders in this offering will reduce the number
of shares held by existing shareholders to 5,108,893, or 61.7% of the total
number of shares of common stock outstanding after the offering, and will
increase the number of shares held by new investors to 3,177,000, or 38.3% of
the total number of shares of common stock outstanding after the offering. For
more information regarding these sales, see "Principal and Selling
Shareholders."
The above computations exclude 868,125 shares of common stock issuable
under options outstanding as of September 30, 1999 at a weighted average
exercise price of $11.42 per share. To the extent any of these options are
exercised, new investors will incur further dilution. We have reserved an
additional 581,875 shares of common stock for issuance under our stock option
plans. For more information regarding our stock option plans, see
"Management -- Option Plans."
28
<PAGE> 32
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. 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. 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). The balance sheet data
"as adjusted" as of September 30, 1999 reflect our sale of 3,100,000 shares of
common stock at an assumed initial offering price of $13.00 per share and our
receipt and application of the estimated net proceeds as described in "Use of
Proceeds."
<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)
========== ========== ========== ========== ===========
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
========== ========== ========== ========== ===========
</TABLE>
29
<PAGE> 33
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30, 1999
------------------------------------ ------------------------
1996 1997 1998 ACTUAL AS ADJUSTED
--------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..... $ 6,402 $ 54,676 $ 283,621 $ 355,689 $34,860,367
Working capital (deficit)..... (379,483) (883,047) (2,174,370) (1,711,409) 36,738,913
Total assets.................. 123,965 529,519 1,649,847 2,358,037 36,862,715
Total debt, including current
maturities.................. 328,924 1,128,845 2,214,232 2,018,555 --
Total shareholders' (deficit)
equity...................... (278,120) (825,364) (1,058,272) (673,693) 35,803,807
</TABLE>
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<PAGE> 34
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. However, we believe that the capital we receive from this
offering will provide us the means to grow our business. We expect our rate of
growth to increase, due in part to our plan to use a portion of the net proceeds
of this offering to 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.
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<PAGE> 35
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.
32
<PAGE> 36
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.
An important aspect of our strategy is to significantly increase 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. As a result, we expect sales
and marketing expenses to increase substantially in future periods.
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<PAGE> 37
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
34
<PAGE> 38
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,
35
<PAGE> 39
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.
36
<PAGE> 40
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.
37
<PAGE> 41
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.
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<PAGE> 42
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
39
<PAGE> 43
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.
40
<PAGE> 44
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>
db Telecom Technologies, Inc.............................. $270,188 1/1/00 10%
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............... 618,549 1/1/00 10%
Dr. Samuel F. Dayton and James L. Bruce, Jr............... 283,985 12/27/99 8.75%
</TABLE>
We used the proceeds of this debt for equipment purchases, the purchase of
Athens' ISP and working capital. We expect to repay all outstanding debt with
the net proceeds of this offering. 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. 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
and to provide working capital. 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 185,893 shares of our
common stock in a private placement at a price of $11.42 per share. We are using
the $2,122,744 proceeds of this 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 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
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<PAGE> 45
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.
During the 14 months following completion of this offering, we expect to
purchase or lease up to seven new data centers and eleven additional POPs. We
anticipate that the net proceeds of the offering will be used in part to pay for
these additional data centers and POPs.
We believe that the net proceeds of this offering, funds currently on hand
and funds to be provided by operations will be sufficient to meet our
anticipated capital expenditures and liquidity requirements through at least the
end of 2000, excluding the funding of our long term plan to become an integrated
communications provider, for which we will need to find other sources of
capital. However, 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. If we expand more
rapidly than we currently expect or if our working capital needs exceed our
current expectations, 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 satisfy our 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.
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
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<PAGE> 46
- 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 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
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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 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.
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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 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.
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
Internet. To capture this emerging customer base, businesses needed a presence
on the Internet and applications to facilitate electronic commerce.
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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,
- 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.
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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-speed dedicated lines. Also included are
ancillary services such as single bill presentment, call forwarding, caller
identification, voicemail and similar services.
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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 customers' businesses. They demand dedicated, high
speed Internet access and knowledgeable, prompt and responsive customer support.
When marketing our services, we
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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 and Internationally. We intend to build
more data centers and POPs in the United States and pursue international
opportunities. 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, Phoenix, Miami, Dallas and San
Francisco. We intend to establish data centers in Denver and London by the end
of the first quarter of 2001. 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 and at various international sites 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
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expertise and market access, while lowering our costs of entering new markets.
These 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
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of our customers' traffic from their server to its destination and back in a
shorter period of 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
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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.
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 are completing the development of an important enhancement to our T1,
fractional T1, T3 and fractional T3 leased line Internet access options -- the
eCommerce Guarantee. We expect to include the eCommerce Guarantee in our
customer contracts. Under our eCommerce Guarantee, we will compensate our
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 is
our fault and the interruption causes the customer to lose profits. We are
arranging for an insurance company rated "A" by A.M. Best Company to insure our
liability for the eCommerce Guarantee, and we anticipate that 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 overall
deductible limit for any single event that causes multiple interruptions. We
anticipate that the maximum insured amount per interruption will be $500,000 for
each T3 or fractional T3 line and $25,000 for each T1 or fractional T1 line. We
expect that 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. We have not yet implemented our eCommerce
Guarantee. We cannot assure that it will be implemented at all or, if it is
implemented and included in our customer contracts, that it will be on the terms
and conditions set forth above.
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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,
Phoenix, Miami, Dallas and San Francisco 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, 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 offered by computer service
providers, or CSPs, is targeted to businesses with high volumes
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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.
The FCC has not yet granted this authority to any RBOCs, but requests by
RBOCs are the subject of pending appeals at the FCC. When 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.
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,
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- 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.
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
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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.
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
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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.
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.
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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 of the lease. The data center
comprises approximately 4,500 square feet, including external space for a
generator. We intend to expand our Atlanta facilities by leasing an additional
building to house a new data center and to serve as corporate headquarters. The
facility will comprise approximately 40,000 total square feet, including two
data centers of 5,200 and 6,600 square feet.
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
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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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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS, AND KEY EMPLOYEES
The executive officers, directors and key employees of comstar.net, and
their ages as of September 30, 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........... 63 I Chairman of the Board and
President
J. Cary Howell................... 39 III Chief Executive Officer and
Director
Edward N. Landa.................. 29 I Chief Technology Officer,
Secretary and Director
Christopher K. Martin, C.P.A..... 33 -- Chief Financial Officer and
Treasurer
Cynthia A. St. Ores.............. 39 -- Chief Operating Officer
Steven J. Edwards................ 49 -- 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................... 45 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 and President since we were incorporated in March 1996,
but he will resign from his position as President effective on the closing of
this offering. 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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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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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, the chief executive officer of Netzee, Inc.,
and a director of WebMD, 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.
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>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
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.
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 and become due on the earlier of
January 1, 2000 or the closing of this offering. We intend to repay these loans
and all accrued interest with a portion of the net proceeds from this offering.
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,
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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 and become due on the
earlier of January 1, 2000 or the closing of this offering. 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. We intend to repay this loan and the
accrued interest with a portion of the net proceeds from this offering.
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 and to provide working capital. 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 December 27, 1999. 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 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 260,000
shares of our common stock to key employees of db Telecom Technologies at an
exercise price of $11.42 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
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Option and Incentive Plan and are currently exercisable. In September 1999, 500
of the options were forfeited.
In November 1999, Dr. Dayton personally 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 annum 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 $67,000 from Dr. Dayton under this arrangement.
In September 1999, the board granted each of Mr. Dayton and Mr. Bruce an
option to purchase 68,750 shares of common stock at an exercise price of $11.42
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.
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 50,000
shares of common stock at an exercise price of $11.42 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
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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 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 50,000 shares of common stock at an exercise
price of $11.42 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 50,000 shares of
common stock at an exercise price of $11.42 per share. As of the date of this
prospectus, 33,333 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 850,000 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 1,150,000 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.
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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 768,625 shares of common stock under the 1999 Option
Plan at an exercise price of $11.42 per share. All of these options have a term
of ten years from the date of grant. In September 1999, 500 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 300,000 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 100,000 shares of common stock were outstanding under the Director
Option Plan at an exercise price of $11.42 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.
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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 4,379 shares of common stock series A at $11.42 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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<PAGE> 80
PRINCIPAL AND SELLING SHAREHOLDERS
The following table provides information with respect to the beneficial
ownership of our common stock as of September 30, 1999, and as adjusted to
reflect the sale of the common stock offered by this prospectus, 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,
- all of our directors and executive officers as a group, and
- each selling shareholder.
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 is based on 5,185,893 shares of common stock
outstanding as of September 30, 1999 and 8,285,893 shares outstanding after this
offering, assuming no exercise of the underwriters' over-allotment option.
Shares of common stock issuable under options held by the respective person or
group which may be exercised within 60 days after September 30, 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 BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE OWNED AFTER
THE OFFERING NUMBER OF THE OFFERING
------------------- SHARES -------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ------------------------ --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C>
Samuel F. Dayton(1)........................ 1,323,129 25.2% -- 1,323,129 15.8%
J. Cary Howell............................. 1,241,245 23.2 38,500 1,202,745 14.5
Edward N. Landa(2)......................... 1,251,382 23.4 38,500 1,212,882 14.6
James L. Bruce, Jr.(3)..................... 1,318,750 25.1 -- 1,318,750 15.8
Glenn W. Sturm(4).......................... 16,667 * -- 16,667 *
Stephen R. Gross (4)....................... 16,667 * -- 16,667 *
All directors and executive officers as a
group (9 persons)(5)..................... 5,176,598 96.6% 77,000 5,099,598 60.3%
</TABLE>
- -------------------------
* Less than 1% of the outstanding common stock.
(1) Includes 68,750 shares of common stock that may be issued on the exercise of
presently exercisable stock options. Also includes 4,379 shares of common
stock held by the Mauney Family Limited Partnership, all of which may be
deemed to be beneficially owned by Dr. Dayton. Dr. Dayton disclaims
beneficial ownership of these 4,379 shares, except to the extent of his
pecuniary interest in the shares.
(2) Includes 5,000 shares of common stock owned by Mr. Landa's wife and 6,132
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
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<PAGE> 81
beneficial ownership of all of these 11,132 shares, except to the extent of
his pecuniary interest in the shares.
(3) Includes 200,000 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 200,000 shares except to the extent
of his pecuniary interest in the shares. Includes 68,750 shares of common
stock that may be issued on the exercise of presently exercisable stock
options. Mr. Bruce's address is c/o Yonah Manufacturing Company, P.O. Box
280, Cornelia, Georgia 30531.
(4) Consists of 16,667 shares of common stock that may be issued on the exercise
of presently exercisable stock options.
(5) Includes 170,834 shares of common stock that may be issued on the exercise
of presently exercisable stock options granted to our directors, 209,379
shares of common stock held by affiliates of certain members of the group
and 6,132 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.
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<PAGE> 82
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. We will amend and restate our articles of incorporation and our
bylaws immediately before the completion of this offering, and effect a
one-for-two reverse stock split of all our outstanding shares. The discussion
below assumes that the amendment and restatement and the reverse stock split
have occurred.
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Our authorized capital stock will consist of the following after the
amendment and restatement of the articles of incorporation:
- 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.
All shares designated as common stock series A and common stock series B
currently issued and outstanding will be converted automatically by their terms
on a one-for-one basis into shares of common stock without designation
immediately before the completion of this offering. The authorized shares of
common stock series A and common stock series B will be eliminated. Accordingly,
no further information regarding the currently outstanding shares of common
stock series A and common stock series B is given below. As of September 30,
1999, 2,685,893 shares of common stock series A, after giving effect to the
one-for-two reverse stock split, were outstanding and held of record by 44
shareholders; 2,500,000 shares of common stock series B, after giving effect to
the one-for-two reverse stock split, were outstanding and held of record by
three shareholders, and no shares of preferred stock were outstanding.
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.
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<PAGE> 83
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 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
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<PAGE> 84
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 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.
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<PAGE> 85
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.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is SunTrust Bank,
Atlanta.
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<PAGE> 86
SHARES ELIGIBLE FOR FUTURE SALE
When we complete this offering, we will have 8,285,893 shares of common
stock outstanding, or 8,762,443 shares if the underwriters exercise their
over-allotment option, assuming no exercise of options after September 30, 1999.
Of this amount, the 3,177,000 shares sold in the offering will be freely
tradeable by persons other than our "affiliates," as that term is defined by the
SEC.
We sold the remaining 5,108,893 shares in private transactions. Unless
registered under the Securities Act, these shares, which we refer to as
"restricted shares," as well as shares held by our affiliates must be sold in
accordance with the holding period requirements, volume limits and other
conditions of an applicable exemption from registration, such as Rule 144 or
Rule 701 of the SEC discussed below. Additionally, we and our directors,
executive officers and some other shareholders have agreed not to sell any
common stock or securities convertible into or exchangeable for common stock for
180 days after the date of this prospectus without the prior approval of Scott &
Stringfellow, Inc., subject to some exceptions.
Based on the above, the following table indicates when the shares that will
be outstanding upon completion of this offering will be eligible for sale in the
public market (assuming the underwriters do not exercise their over-allotment
option):
<TABLE>
<CAPTION>
APPROXIMATE
SHARES ELIGIBLE
DAYS AFTER THE DATE OF THIS PROSPECTUS FOR FUTURE SALE COMMENT
- -------------------------------------- --------------- -------
<S> <C> <C>
Upon effectiveness................. 3,177,000 Freely tradeable shares sold in
offering and shares salable
under Rule 144(k) that are not
subject to 180-day lockup.
90 days............................ 47,272 Shares salable under Rule 144,
144(k) or 701 that are not
subject to 180-day lockup.
180 days........................... 5,030,056 Lockup released; shares salable
under Rule 144, 144(k) or 701.
Over 180 days...................... 31,565 Restricted shares held for one
year or less.
</TABLE>
In general, under Rule 144 as currently in effect, a person, or persons
whose shares are aggregated, who has beneficially owned shares for at least one
year is entitled to sell within any three-month period commencing 90 days after
the date of this prospectus a number of shares that does not exceed the greater
of:
- 1% of the then outstanding shares of common stock (approximately
shares immediately after the offering), or
- the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale, subject to the filing of a Form 144
with respect to the sale.
Persons selling under Rule 144 must also comply with the rule's requirements
concerning the availability of public information about us, the manner of sale
and filing of notice of sale. However, a person, or persons whose shares are
aggregated, who is not deemed to
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<PAGE> 87
have been an affiliate of comstar.net at any time during the 90 days immediately
preceding the sale and who has beneficially owned his or her shares for at least
two years is entitled to sell such shares under Rule 144(k) without regard to
the limitations described above. Persons deemed to be affiliates must always
sell under Rule 144 even after the one year holding period has been satisfied.
Any of our employees or consultants who purchased his or her shares under a
written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701, which permits nonaffiliates to sell their Rule 701
shares without having to comply with the public information, holding period,
volume limitation or notice provisions of Rule 144 and permits affiliates to
sell their Rule 701 shares without having to comply with the Rule 144 holding
period restrictions, in each case commencing 90 days after the date of this
prospectus. As of September 30, 1999, the holders of options to purchase
approximately 575,874 shares of common stock will be eligible to sell their
shares under Rule 701 upon the expiration of the 180-day lockup period, subject
in some cases to vesting of such options.
We intend to file a registration statement on Form S-8 under the Securities
Act within 90 days after the date of this prospectus to register shares of
common stock under outstanding stock options or reserved for issuance under our
1999 Option Plan and our Director Stock Option Plan. This will permit
nonaffiliates to immediately sell those shares in the public market without
limitation and will permit affiliates to immediately sell without compliance
with any holding period requirement but subject to the other conditions of Rule
144.
We cannot estimate the number of shares that will be sold under Rule 144,
Rule 701 or our Form S-8 registration statement, because this will depend on the
market price of our common stock, the personal circumstances of the sellers and
other factors. Before the offering, no public market for our common stock has
existed, and a significant public market for the common stock may not develop or
be sustained after the offering. Any future sale of substantial amounts of the
common stock in the open market may adversely affect the market price of the
common stock offered by this prospectus.
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<PAGE> 88
UNDERWRITING
Scott & Stringfellow, Inc. and SunTrust Equitable Securities Corporation
are acting as representatives of the underwriters named below. Subject to the
terms and conditions in the underwriting agreement among the representatives of
the underwriters, the selling shareholders and us, the underwriters have
severally agreed to purchase from comstar.net and the selling shareholders the
number of shares of common stock indicated opposite their respective names
below, at the public offering price less the underwriting discount shown on the
cover page of this prospectus.
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- ----------- ----------------
<S> <C>
Scott & Stringfellow, Inc...................................
SunTrust Equitable Securities Corporation...................
Total..................................................... 3,177,000
========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares of common stock
offered by this prospectus are subject to approval by their counsel of certain
legal matters and to certain other conditions. The underwriters are committed to
purchase and accept delivery of all the shares of common stock offered by this
prospectus, other than the shares covered by the over-allotment option described
below, if they purchase any. If an underwriter fails to keep its purchase
commitment, the underwriting agreement provides that, in some circumstances, the
purchase commitments of the nondefaulting underwriters may be increased or the
underwriting agreement may be terminated. The underwriters reserve the right to
withdraw, cancel or modify this offering and to reject orders in whole or in
part.
The underwriters propose initially to offer the common stock to the public
at the public offering price shown on the cover page of this prospectus, and to
specified dealers at that price less a concession of not more than
$ per share. The underwriters may allow, and the dealers may reallow, a
discount of not more than $ per share to other specified dealers. After
the initial public offering, the representatives may change the public offering
price and the other selling terms at any time without notice.
We have granted an option to the underwriters, exercisable during the
30-day period after the date of this prospectus, to purchase up to a maximum of
476,550 additional shares of common stock to cover over-allotments, if any, at
the same per share price as the initial shares to be purchased by the
underwriters. To the extent the underwriters exercise that option, each
underwriter will be committed, subject to certain conditions, to purchase
additional shares in approximately the same proportion as the number of shares
to be purchased initially by that underwriter bears to the total number of
shares to be purchased initially by all the underwriters.
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<PAGE> 89
The following table shows the underwriting fees that we and the selling
shareholders will pay to the underwriters in connection with the offering. These
amounts are shown assuming both no exercise and full exercise of the
underwriters' over-allotment option to purchase additional shares of our common
stock.
<TABLE>
<CAPTION>
TO BE PAID BY
TO BE PAID BY COMSTAR.NET SELLING SHAREHOLDERS
--------------------------- ---------------------------
NO EXERCISE FULL EXERCISE NO EXERCISE FULL EXERCISE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Per share........................ $ $ $ $
Total............................
</TABLE>
We estimate our expenses of this offering, exclusive of the underwriting
discount, will be $1,001,500. We and the selling shareholders have agreed to
indemnify the underwriters against certain liabilities, including civil
liabilities under the Securities Act, or to contribute to payments the
underwriters may be required to make in respect of these liabilities.
Upon purchase by the underwriters of the shares of common stock being
offered by this prospectus, we will issue to Scott & Stringfellow, Inc. warrants
to purchase up to 232,500 shares of our common stock at an exercise price equal
to 110% of the initial public offering price. The warrant exercise price has
been determined by negotiation between us and Scott & Stringfellow, Inc. These
warrants may not be exercised until after the first anniversary of the date of
issuance and expire, if not exercised sooner, on the fifth anniversary of the
date of issuance. If these warrants are issued, Scott & Stringfellow, Inc. will
have, at nominal cost, the opportunity to profit from an increase in the market
price of the common stock. To the extent these warrants are exercised, the value
of the common stock may be diluted.
We, our directors and executive officers and some of our shareholders, who
upon the completion of this offering will beneficially own 4,931,763 shares of
our common stock, or approximately 59.5% of our issued and outstanding common
stock, have agreed during the 180-day period following the date of this
prospectus not to, without the prior written consent of Scott & Stringfellow,
Inc.:
- directly or indirectly make, agree to or cause any offer, sale (including
short sale), loan, pledge or other disposition of, or grant any options,
rights or warrants to purchase with respect to, or otherwise transfer or
reduce any risk of ownership of, directly or indirectly, any shares of
our common stock or any securities convertible into or exchangeable or
exercisable for our common stock,
- enter into any swap or other arrangement that transfers all or a portion
of the economic consequences associated with the ownership of the common
stock, or
- in the case of our directors, executive officers and shareholders, make
any demand for or exercise any right with respect to the registration of
shares of our common stock or any securities convertible into or
exchangeable or exercisable for our common stock.
This restriction is subject to some exceptions. In addition, during the 180-day
period, we have also agreed not to file any registration statement with respect
to the registration of any shares of our common stock or any securities
convertible into or exercisable for our common stock, except that we intend to
file a registration statement on Form S-8 under the Securities Act within 90
days after the completion of the offering to register
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<PAGE> 90
shares of common stock issuable under outstanding stock options or reserved for
issuance under our 1999 Stock Option Plan and our Director Option Plan. This
will permit the holders of those shares to sell them in the public market
without compliance with any holding period requirement.
The representatives have informed us that the underwriters do not expect to
make sales of common stock offered by this prospectus to accounts over which
they exercise discretionary authority in excess of 5% of the number of shares of
common stock offered by this prospectus.
The underwriters have reserved for sale, at the initial public offering
price, up to 5.0% of the shares of common stock offered by us for our employees,
directors and other persons we have designated, who have expressed an interest
in purchasing shares of our common stock. The number of shares available for
sale to the general public in this offering will be reduced to the extent those
persons purchase the reserved shares. Any reserved shares not so purchased will
be offered to the general public on the same basis as other shares offered by
this prospectus.
Before this offering, no public trading market for the common stock has
existed. Consequently, the initial public offering price of the common stock has
been determined by negotiations among comstar.net, the representatives of the
selling shareholders and the representatives of the underwriters. The factors
considered in determining the initial public offering price included the
following:
- the history and future prospects of comstar.net and our industry,
- the present state of our development,
- an assessment of our management,
- the general condition of the economy and the securities markets at the
time of this offering, and
- the market prices of and demand for publicly traded common stock of
comparable companies at the time of the offering.
We have received approval to have the common stock listed for quotation on
the Nasdaq National Market, subject to completion of this offering, under the
symbol "CSTX."
Until the distribution of the common stock is completed, rules of the SEC
may limit the ability of the underwriters and specified selling group members to
bid for and purchase the common stock. As an exception to these rules, the
representatives of the underwriters are permitted to engage in specified
transactions that stabilize the price of the common stock. These transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the common stock. If the underwriters create a short position in
the common stock in connection with this offering (that is, if they sell more
shares of common stock than are set forth on the cover page of this prospectus),
the representatives may reduce that short position by purchasing common stock in
the open market. The representatives of the underwriters may also elect to
reduce any short position by exercising all or part of the over-allotment option
described above. The representatives of the underwriters may also impose a
penalty bid on underwriters and selling group members in some cases. This means
that if the representatives purchase shares of common stock in the open market
to reduce the underwriters' short position or to stabilize the price of the
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<PAGE> 91
common stock, they may reclaim the amount of the selling concession from the
underwriters and selling group members who sold those shares as part of this
offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of those purchases. The imposition of a penalty bid
might also have an effect on the price of a security if it discourages resales
of the security. None of comstar.net, the selling shareholders or any of the
underwriters make any representation or prediction as to the direction or
magnitude of any effect that the transactions described above may have on the
price of the common stock. In addition, the underwriters are not required to
engage in these activities and may end any of these activities at any time. Some
of the underwriters intend to make a market in the common stock upon the
completion of the offering.
There are restrictions on the offer and sale of the common stock in the
United Kingdom. All applicable provisions of the Financial Services Act 1986 and
the Public Offers of Securities Regulations 1995 with respect to anything done
by any person in relation to the common stock in, from or otherwise involving
the United Kingdom must be complied with.
Each underwriter has also agreed that it has:
- not offered or sold and, prior to the date six months after the date of
issue of the shares of common stock, will not offer or sell any shares of
common stock to persons in the United Kingdom except to persons whose
ordinary activities involve them in acquiring, holding, managing or
disposing of investments, as principal or agent, for the purpose of their
businesses or otherwise in circumstances which have not resulted and will
not result in an offer to the public in the United Kingdom within the
meaning of the Public Offers of Securities Regulations 1995,
- complied, and will comply with, all applicable provisions of the
Financial Services Act 1986 of Great Britain with respect to anything
done by it in relation to the shares of common stock in, from or
otherwise involving the United Kingdom, and
- only issued or passed on, and will only issue or pass on, in the United
Kingdom any document received by it in connection with the issuance of
the shares of common stock to a person who is of a kind described in
Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) Order 1996 (as amended) of Great Britain or
is a person to whom the document may otherwise lawfully be issued or
passed on.
LEGAL MATTERS
The validity of the 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 50,000 shares of our common stock. Certain legal matters in
connection with this offering will be passed upon for the underwriters by Alston
& Bird LLP, Atlanta, Georgia.
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<PAGE> 92
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 SEC, 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 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. In addition, after the completion of this offering, we intend to
furnish our shareholders with annual reports containing audited financial
statements and with quarterly reports containing unaudited summary financial
information for each of the first three quarters of each fiscal year.
89
<PAGE> 93
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 Nine Months 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 Nine Months Ended
September 30, 1998 and 1999 (unaudited)................... F-6
Notes to Financial Statements............................... F-7
ATHENS' ISP, INC.
Report of Independent Public Accountants.................... F-23
Balance Sheets as of December 31, 1996 and 1997............. F-24
Statements of Operations and Accumulated Deficit for the
Years Ended December 31, 1996 and 1997.................... F-25
Statements of Cash Flows for the Years Ended December 31,
1996 and 1997............................................. F-26
Notes to Financial Statements............................... F-27
</TABLE>
F-1
<PAGE> 94
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
After the one-for-two reverse stock split of the outstanding shares of
common stock and the recapitalization of the Company's equity discussed in Note
10 to comstar.net inc.'s financial statements is effected, we expect to be in a
position to render the following audit report.
/s/ Arthur Andersen LLP
Atlanta, Georgia
June 30, 1999
(except with respect to Note 10,
as to which the date is
September 1, 1999)
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.
F-2
<PAGE> 95
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> 96
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> 97
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> 98
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> 99
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> 100
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> 101
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> 102
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> 103
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> 104
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> 105
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> 106
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> 107
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> 108
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> 109
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> 110
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> 111
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> 112
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> 113
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%.
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. 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.
F-21
<PAGE> 114
COMSTAR.NET, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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.
PROPOSED INITIAL PUBLIC OFFERING OF COMMON STOCK
The Company is in the process of registering with the Securities and
Exchange Commission shares of its common stock. There can be no assurance that
this offering will be completed.
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> 115
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-23
<PAGE> 116
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-24
<PAGE> 117
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-25
<PAGE> 118
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-26
<PAGE> 119
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-27
<PAGE> 120
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-28
<PAGE> 121
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-29
<PAGE> 122
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-30
<PAGE> 123
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 Athen's 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-31
<PAGE> 124
3,177,000 SHARES
(COMSTAR.NET, INC. LOGO)
COMMON STOCK
---------------------
PROSPECTUS
---------------------
SCOTT & STRINGFELLOW, INC.
SUNTRUST EQUITABLE SECURITIES
---------------------
, 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 (25 days after the date of this prospectus), 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.
<PAGE> 125
PART II. INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table describes our expenses in connection with the offering
described in the registration statement. All amounts are estimates and may be
subject to future contingencies except the SEC registration fee and the NASD
fees:
<TABLE>
<S> <C>
SEC registration fee........................................ $ 15,150
NASD fees................................................... 5,948
Nasdaq fees................................................. 72,875
Blue Sky fees and expenses.................................. 5,000
Printing and engraving...................................... 200,000
Legal fees and expenses..................................... 450,000
Accounting fees and expenses................................ 250,000
Transfer agent fees......................................... 875
Miscellaneous expenses...................................... 1,652
----------
Total..................................................... $1,001,500
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Georgia Business Corporation Code, as amended, permits a corporation to
eliminate or limit the personal liability of a director to the corporation or
its shareholders for monetary damages for breach of duty of care or other duty
as a director, except a corporation cannot eliminate or limit the liability of a
director for:
- an appropriation, in violation of his duties, of any business opportunity
of the corporation,
- acts or omissions which involve intentional misconduct or a knowing
violation of law,
- unlawful corporate distributions, or
- any transaction from which the director received an improper personal
benefit.
This provision relates only to breaches of duty by directors in their capacity
as directors, and not in any other corporate capacity, such as officers. It
limits liability only for breaches of fiduciary duties under the Georgia Code,
and not for violation of other laws, such as the federal securities laws. Our
articles of incorporation exonerate our directors from monetary liability to the
extent described above.
In addition to the rights provided by law that are described above, our
bylaws provide broad indemnification rights to our directors and the officers,
employees and agents as the directors may select, with respect to various civil
and criminal liabilities and losses that may be incurred by the director,
officer, agent or employee in any pending or threatened litigation or other
proceedings. This indemnification does not apply in the same situations
described above with respect to the exculpation from liability of our directors.
We are also obligated to reimburse directors and other parties for expenses,
including legal fees, court costs and expert witness fees, incurred by those
persons in defending against any of these liabilities and losses, as long as the
person in good faith believes that he or she complied with the applicable
standard of conduct with respect to the underlying accusations giving
II-1
<PAGE> 126
rise to the liabilities or losses and agrees to repay to us any advances made
under the bylaws if it is ultimately determined that the person is not entitled
to indemnification by us. Any amendment or other modification to the bylaws
which limits or otherwise adversely affects the rights to indemnification
currently provided in the bylaws shall apply only to proceedings based upon
actions and events occurring after the amendment and delivery of notice of it to
the indemnified parties. In addition, if the Georgia Code is ever amended to
permit greater elimination of liability, our articles provide that such greater
protection shall be given automatically to our directors without further board
or shareholder action unless required by law.
We have entered into separate indemnification agreements with each of our
directors and some of our officers. We have agreed, among other things, to
provide for indemnification and advancement of expenses in a manner and under
terms and conditions similar to those stated in the bylaws. Our shareholders
cannot void these agreements. In addition, we hold an insurance policy covering
directors and officers under which the insurer agrees to pay, subject to certain
exclusions, for any claim made against our directors and officers for a wrongful
act that they may become legally obligated to pay or for which we are required
to indemnify the directors or officers.
We believe that the above protections are necessary to attract and retain
qualified persons as directors and officers.
The underwriting agreement, which is filed as Exhibit 1.1 hereto, also
contains the underwriters' agreement to indemnify our directors and officers and
some other persons against civil liabilities specified in the agreement.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers and controlling persons under the
foregoing provisions, or otherwise, we have been advised that in the opinion of
the SEC this indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. If a claim for indemnification
against these liabilities (other than our payment of expenses incurred or paid
by one of our directors, officers or controlling persons in the successful
defense of any action, suit or proceeding) is asserted by the director, officer
or controlling person in connection with the securities being registered, we
will, unless in the opinion of our counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether that indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of that issue.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
(a) Issuances of Capital Stock
In May 1996, we issued and sold 500 shares of our common stock to 4
investors in exchange for services and other consideration equal to $1.00.
In November 1998, we recapitalized comstar.net by converting the 500 shares
of common stock previously outstanding to 2,500,000 shares of common stock
series A and 2,500,000 shares of common stock series B.
Between November 23, 1998 and June 30, 1999, we sold 185,893 shares of
common stock series A at a price per share of $11.42 to 25 investors in a
private financing for a total of $2,122,744 in cash.
II-2
<PAGE> 127
(b) Certain Grants of Options
As of September 30, 1999, we had issued options to purchase 768,125 shares
of common stock pursuant to the Amended and Restated 1999 Stock Option and
Incentive Plan and options to purchase 100,000 shares of common stock pursuant
to the Director Stock Option Plan.
No underwriters were involved in the foregoing sales of securities. Each
issuance of securities described above was made in reliance on one or more of
the exemptions from registration provided by Sections 3(a)(11), 3(b), 4(2) and
4(6) of the Securities Act, Regulation D and Rule 701, as promulgated by the SEC
under the Securities Act. All recipients of securities in these transactions
were either (a) eligible participants in a compensatory plan or (b) accredited
investors who represented their intention to acquire the securities for
investment purposes only and not with a view to or for the sale in connection
with any distribution of those shares. We affixed appropriate legends to the
share certificates we issued in those transactions. All recipients of these
securities had adequate access, through their relationships with comstar.net, to
information about us. All of these securities are deemed restricted securities
for purposes of the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
1.1** -- Form of Underwriting Agreement.
2.1**+ -- Asset Purchase Agreement dated as of June 30, 1998 between
Athens' ISP, Inc. and the registrant.
3.1** -- Amended and Restated Articles of Incorporation dated
November 20, 1998 and Articles of Amendment to the Amended
and Restated Articles of Incorporation dated July 29, 1999.
3.2** -- Form of Amended and Restated Articles of Incorporation to be
filed upon the completion of this offering.
3.3** -- Bylaws.
3.4** -- Form of Amended and Restated Bylaws to be effective upon the
completion of this offering.
4.1 -- See Exhibits 3.1 through 3.4 for provisions defining the
rights of comstar.net shareholders.
4.2** -- Specimen common stock certificate.
4.3** -- Amended and Restated Shareholder Agreement dated December 1,
1998, and Amendment No. 1 to Amended and Restated
Shareholder Agreement dated August 31, 1999.
5.1** -- Opinion of Nelson Mullins Riley & Scarborough, L.L.P.
10.1** -- Amended and Restated 1999 Stock Option and Incentive Plan,
including form of Stock Option Agreement attached thereto.
10.2** -- Director Stock Option Plan, including form of Director Stock
Option Agreement attached thereto.
10.3** -- Form of Indemnification Agreement between comstar.net, inc.
and each of its directors and executive officers.
10.4** -- Lease of office space from The Emerson Center Company dated
September 30, 1999.
10.5** -- Lease of office space from The Emerson Center Company dated
October 15, 1999.
10.6** -- Form of Network Services Agreement between comstar.net and
its customers.
</TABLE>
II-3
<PAGE> 128
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
10.7** -- Form of Internet Access Service Addendum to the Network
Services Agreement.
10.8** -- Form of Colocation Service Addendum to the Network Services
Agreement.
10.9** -- Form of Corporate Acceptable Use Policy Addendum to the
Network Services Agreement.
10.10** -- Form of Special Access Services Agreement between
comstar.net and its customers.
10.11** -- Form of Non-Solicitation, Confidentiality and Assignment
Agreement between comstar.net, inc. and each of its
employees.
10.12** -- Loan agreement dated July 21, 1999 between Premier Bank and
the registrant.
10.13** -- Modification Note dated July 21, 1999 and loan agreement
dated June 22, 1999 between Premier Bank and the registrant.
10.14** -- Letter Agreement dated July 1, 1998 between Samuel F. Dayton
and the registrant relating to repayment of loans to First
National Bank of Commerce.
10.15** -- Form of Warrant.
10.16 -- Promissory Note dated November 9, 1999 given by the
registrant as maker in favor of Samuel F. Dayton as holder.
21.1** -- Subsidiaries.
23.1** -- Consent of Nelson Mullins Riley & Scarborough, L.L.P.
(included in legal opinion to be filed as Exhibit 5.1).
23.2 -- Consent of Arthur Andersen LLP.
24.1** -- Power of Attorney (included on signature pages hereto).
27.1** -- Financial Data Schedule (for SEC use only).
</TABLE>
- -------------------------
* To be filed by amendment.
** Previously filed.
+ We agree to furnish supplementally a copy of any omitted schedule or exhibit
to the SEC upon request, as provided in Item 601(b)(2) of Regulation S-K.
(b) Financial Statement Schedules
Schedule II -- Valuation and Qualifying Accounts
ITEM 17. UNDERTAKINGS.
We hereby undertake to provide to the underwriters, at the closing
specified in the underwriting agreement, certificates in such denominations and
registered in such names as required by the underwriter to permit prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the SEC this indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. If a claim for
indemnification against these liabilities (other than our payment of expenses
incurred or paid by one of our directors, officers or controlling persons in the
successful defense of any action, suit or proceeding) is asserted by the
director, officer or controlling person in connection with the securities being
registered, we will, unless in the opinion of our counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by us is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
II-4
<PAGE> 129
We hereby undertake that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus we file pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this registration statement as of
the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-5
<PAGE> 130
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment to the registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Atlanta,
State of Georgia, on this 9th day of November, 1999.
comstar.net, inc.
By: /s/ SAMUEL F. DAYTON
-----------------------------------
Samuel F. Dayton
President
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this amendment
to the registration statement has been signed by the following persons in the
capacities listed and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<C> <S> <C>
/s/ J. CARY HOWELL Chief Executive Officer November 9, 1999
- --------------------------------------------- and Director (Principal
J. Cary Howell Executive Officer)
/s/ CHRISTOPHER K. MARTIN Chief Financial Officer November 9, 1999
- --------------------------------------------- and Treasurer
Christopher K. Martin (Principal Financial
and Accounting Officer)
/s/ SAMUEL F. DAYTON Chairman of the Board and November 9, 1999
- --------------------------------------------- President
Samuel F. Dayton
* Chief Technology Officer, November 9, 1999
- --------------------------------------------- Secretary and Director
Edward N. Landa
* Director November 9, 1999
- ---------------------------------------------
James L. Bruce, Jr.
* Director November 9, 1999
- ---------------------------------------------
Glenn W. Sturm
* Director November 9, 1999
- ---------------------------------------------
Stephen R. Gross
*By: /s/ CHRISTOPHER K. MARTIN
----------------------------------------
Christopher K. Martin
Attorney-in-fact
</TABLE>
II-6
<PAGE> 131
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
After the one-for-two reverse stock split of the outstanding shares of
common stock and the recapitalization of the Company's equity discussed in Note
10 to comstar.net inc.'s financial statements are effected, we expect to be in a
position to render the following audit report.
/s/ Arthur Andersen LLP
Atlanta, Georgia
June 30, 1999 (except with respect to Note 10,
as to which the date is September 1, 1999)
To comstar.net, Inc.:
We have audited, in accordance with generally accepted auditing standards,
the financial statements of COMSTAR.NET, INC. (a Georgia corporation) included
in this registration statement and have issued our report thereon dated June 30,
1999 (except with respect to Note 10, as to which the date is September 1,
1999). Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Item 16(b) of the registration statement
is the responsibility of comstar.net inc.'s management and is presented for
purposed of complying with the Securities and Exchange Commission rules and is
not part of the basic financial statements. This schedule has been subjected to
the auditing procedures applied in the audit of the basic financial statements
and, in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
S-1
<PAGE> 132
SCHEDULE II
COMSTAR.NET, INC.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO
BEGINNING COSTS AND BALANCE AT
OF YEAR EXPENSES DEDUCTIONS* END OF YEAR
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
For the period from:
March 5, 1996 to December 31, 1996:
Allowance for doubtful accounts...... $ 0 $ 0 $ 0 $ 0
------- ------- ------- -------
For the fiscal year ended:
December 31, 1997: Allowance for
doubtful accounts.................... $ 0 $19,426 $ 0 $19,426
------- ------- ------- -------
December 31, 1998: Allowance for
doubtful accounts.................... $19,426 $24,039 $18,018 $25,447
------- ------- ------- -------
</TABLE>
- ---------------
* Principally charges for which reserves were provided, net of recoveries.
S-2
<PAGE> 133
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
1.1** -- Form of Underwriting Agreement.
2.1**+ -- Asset Purchase Agreement dated as of June 30, 1998 between
Athens' ISP, Inc. and the registrant.
3.1** -- Amended and Restated Articles of Incorporation dated
November 20, 1998 and Articles of Amendment to the Amended
and Restated Articles of Incorporation dated July 29, 1999.
3.2** -- Form of Amended and Restated Articles of Incorporation to be
filed upon the completion of this offering.
3.3** -- Bylaws.
3.4** -- Form of Amended and Restated Bylaws to be effective upon the
completion of this offering.
4.1 -- See Exhibits 3.1 through 3.4 for provisions defining the
rights of comstar.net shareholders.
4.2** -- Specimen common stock certificate.
4.3** -- Amended and Restated Shareholder Agreement dated December 1,
1998, and Amendment No. 1 to Amended and Restated
Shareholder Agreement dated August 31, 1999.
5.1** -- Opinion of Nelson Mullins Riley & Scarborough, L.L.P.
10.1** -- Amended and Restated 1999 Stock Option and Incentive Plan,
including form of Stock Option Agreement attached thereto.
10.2** -- Director Stock Option Plan, including form of Director Stock
Option Agreement attached thereto.
10.3** -- Form of Indemnification Agreement between comstar.net, inc.
and each of its directors and executive officers.
10.4** -- Lease of office space from The Emerson Center Company dated
September 30, 1999.
10.5** -- Lease of office space from The Emerson Center Company dated
October 15, 1999.
10.6** -- Form of Network Services Agreement between comstar.net and
its customers.
10.7** -- Form of Internet Access Service Addendum to the Network
Services Agreement.
10.8** -- Form of Colocation Service Addendum to the Network Services
Agreement.
10.9** -- Form of Corporate Acceptable Use Policy Addendum to the
Network Services Agreement.
10.10** -- Form of Special Access Services Agreement between
comstar.net and its customers.
10.11** -- Form of Non-Solicitation, Confidentiality and Assignment
Agreement between comstar.net, inc. and each of its
employees.
10.12** -- Loan agreement dated July 21, 1999 between Premier Bank and
the registrant.
10.13** -- Modification Note dated July 21, 1999 and loan agreement
dated June 22, 1999 between Premier Bank and the registrant.
10.14** -- Letter Agreement dated July 1, 1998 between Samuel F. Dayton
and the registrant relating to repayment of loans to First
National Bank of Commerce.
10.15** -- Form of Warrant.
10.16 -- Promissory Note dated November 9, 1999 given by the
registrant as maker in favor of Samuel F. Dayton as holder.
21.1** -- Subsidiaries.
23.1** -- Consent of Nelson Mullins Riley & Scarborough, L.L.P.
(included in legal opinion to be filed as Exhibit 5.1).
23.2 -- Consent of Arthur Andersen LLP.
24.1** -- Power of Attorney (included on signature pages hereto).
</TABLE>
<PAGE> 134
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
27.1** -- Financial Data Schedule (for SEC use only).
</TABLE>
- -------------------------
* To be filed by amendment.
** Previously filed.
+ We agree to furnish supplementally a copy of any omitted schedule or exhibit
to the SEC upon request, as provided in Item 601(b)(2) of Regulation S-K.
<PAGE> 1
EXHIBIT 10.16
THIS NOTE HAS NOT BEEN REGISTERED UNDER THE GEORGIA SECURITIES ACT OF 1973, AS
AMENDED (THE "GEORGIA ACT"), IN RELIANCE UPON AN EXEMPTION CONTAINED IN THE
GEORGIA ACT, AND HAS NOT BEEN REGISTERED UNDER ANY OTHER STATE SECURITIES LAW OR
THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT"). THIS NOTE HAS BEEN
ACQUIRED FOR INVESTMENT AND MAY NOT BE OFFERED FOR SALE, HYPOTHECATED, SOLD,
TRANSFERRED OR OTHERWISE DISPOSED OF, NOR WILL ANY ASSIGNEE OR TRANSFEREE OF
THIS NOTE BE RECOGNIZED BY THE CORPORATION AS HAVING AN INTEREST IN SUCH NOTE,
IN THE ABSENCE OF (I) AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THIS
NOTE UNDER THE GEORGIA ACT, THE 1933 ACT OR ANY APPLICABLE STATE SECURITIES LAW
OR (II) AN OPINION OF COUNSEL, WHICH OPINION OF COUNSEL SHALL BE SATISFACTORY TO
THE CORPORATION, TO THE EFFECT THAT THE TRANSACTION BY WHICH SUCH NOTE WILL BE
OFFERED FOR SALE, HYPOTHECATED, SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF, IS
OTHERWISE IN COMPLIANCE WITH THE REGISTRATION REQUIREMENTS OF SUCH ACTS.
PROMISSORY NOTE
November 9, 1999
comstar.net, inc., a Georgia corporation (the "Corporation"),
unconditionally promises to pay to the order of DR. SAMUEL F. DAYTON the
principal sum of One Hundred Forty Thousand and 00/100 Dollars ($140,000.00),
or, if less, the aggregate unpaid balance of all loans made by the holder to the
Corporation, in legal tender of the United States, with an initial simple
interest rate thereon as of the date of this Promissory Note (this "Note") of
ten percent (10%) per annum on the unpaid balance. All unpaid principal and all
accrued and unpaid interest shall be due and payable in full on the earlier of
(a) the closing date of the Corporation's initial public offering of its common
stock by Scott & Stringfellow, Inc. and SunTrust Equitable Securities as
managing underwriters, or (b) January 15, 2000.
The Corporation covenants, promises and agrees as follows:
1. INTEREST. Interest shall be calculated on the basis of three
hundred sixty (360) days per year for the actual number of days elapsed. All
payments of principal or interest shall be made at Gainesville, Georgia or at
such other place as may be designated by the holder. All payments received from
the Corporation will be applied first to interest to the extent then accrued and
then to principal.
2. PREPAYMENT. This Note is subject to prepayment at the option
of the Corporation in whole or in part before its maturity date at any time and
from time to time without penalty or premium..
<PAGE> 2
3. DEFAULT.
3.1 The entire unpaid balance of the principal amount and
all interest accrued and unpaid on this Note shall, at the election of the
holder, be and become immediately due and payable upon the occurrence of any of
the following events (a "Default Event"):
(a) the nonpayment by the Corporation when due
of principal and interest or principal or interest or of any other payment as
provided in this Note; or
(b) if the Corporation (i) applies for or
consents to the appointment of, or if there shall be a taking of possession by,
a receiver, custodian, trustee or liquidator for the Corporation or any of its
property; (ii) becomes generally unable to pay its debts as they become due;
(iii) makes a general assignment for the benefit of creditors or becomes
insolvent; (iv) files or is served with any petition for relief under the
federal Bankruptcy Code or any similar federal or state statute; (v) has any
judgment entered against it in excess of $50,000.00 in any one instance or in
the aggregate during any consecutive 12-month period or has any attachment or
levy made to or against any of its property or assets; (vi) defaults with
respect to any evidence of indebtedness or liability for borrowed money, or any
such indebtedness shall not be paid as and when due and payable; or (vii) has
assessed or imposed against it, or if there shall exist, any general or specific
lien for any federal, state or local taxes or charges against any of its
property or assets.
3.2 If the maturity date of this note is accelerated as
provided in this paragraph, this Note shall bear interest at the simple interest
rate of fourteen (14%) per annum, commencing on the date of such acceleration
without further notice. Each right, power or remedy of the holder upon the
occurrence of any Default Event as provided for in this Note or now or hereafter
existing at law or in equity or by statute shall be cumulative and concurrent
and shall be in addition to every other right, power or remedy provided for in
this Note or now or hereafter existing at law or in equity or by statute, and
the exercise or beginning of the exercise by the holder of any one or more of
such rights, powers or remedies shall not preclude the simultaneous or later
exercise by the holder of any or all such other rights, powers or remedies.
4. MISCELLANEOUS.
4.1. No failure or delay by the holder to insist upon the
strict performance of any term of this Note or to exercise any right, power or
remedy consequent upon a default hereunder shall constitute a waiver of any such
term or of any such breach, or preclude the holder from exercising any such
right, power or remedy at any later time or times. By accepting payment after
the due date of any amount payable under this Note, the holder shall not be
deemed to waive the right either to require payment when due of all other
amounts payable under this Note, or to declare a default for failure to effect
such payment of any such other amount.
4.2. The failure of the holder to give notice of any
failure or breach of the Corporation under this Note shall not constitute a
waiver of any right or remedy in respect of such continuing failure or breach or
any subsequent failure or breach.
2
<PAGE> 3
4.3. All notices and communications under this Note shall
be in writing and shall be either delivered in person or accompanied by a signed
receipt therefor or mailed first-class United States certified mail, postage
prepaid, and addressed as follows:
if to the Corporation, to:
comstar.net, inc.
2812 Spring Road, Suite 210
Atlanta, Georgia 30339
with a copy to:
Charles D. Vaughn, Esq.
Nelson Mullins Riley & Scarborough, L.L.P.
999 Peachtree Street, N.E., Suite 1400
Atlanta, Georgia 30309
and, if to the holder, to the address of the holder
on the books of the Corporation.
Any notice of communication shall be deemed given and received
as of the date of such delivery or if mailed, on the fourth day after the same
is deposited in the mail.
4.4 Nothing contained in this Note shall be deemed to
establish or require the payment of interest to the holder at a rate in excess
of the maximum rate permitted by Applicable Law (meaning each applicable law,
statute, code, act, ordinance, order, judgment, decree, injunction, rule,
regulation and other requirement of each governmental authority having
jurisdiction over the subject matter). If the rate of interest required to be
paid under this Note exceeds the maximum rate permitted by Applicable Law, the
rate of interest required to be paid hereunder shall be automatically reduced to
the maximum rate permitted by Applicable Law, and any amounts collected in
excess of the permissible amount shall be deemed a prepayment of principal on
this Note (and provided that if this Note has been or would thereby be paid in
full, then any such excess amount shall be promptly refunded to the
Corporation).
4.5. This Note shall be governed by and construed and
enforced in accordance with the laws of the State of Georgia, or, where
applicable, the laws of the United States.
4.6. This Note constitutes the full and entire
understanding between the Corporation and the holder and supercedes all prior
oral or written agreements and understandings relating to the subject matter
hereto. Neither this Note nor any terms hereof may be amended, waived,
discharged or terminated other than by a written instrument signed by the
Corporation and the holder.
3
<PAGE> 4
4.7 In addition to all principal and accrued interest on
this Note, the Corporation agrees to pay (a) all reasonable costs and expenses
incurred by the holder of this Note in collecting any amounts owing under this
Note through any reorganization, bankruptcy or any other proceeding and (b)
reasonable attorneys' fees actually incurred when and if this Note is placed in
the hands of an attorney for collection after default.
IN WITNESS WHEREOF, the Corporation has caused this Note to be executed
and sealed by its duly authorized officers.
comstar.net, inc.
By: /s/ Samuel F. Dayton
---------------------------------------
Samuel F. Dayton, President
4
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our reports
(and to all references to our firm) included in or made part of this
Registration Statement.
/s/ Arthur Andersen LLP
Atlanta, Georgia
November 9, 1999
