Initial Public Offering (IPO): Pre-Effective Amendment to Registration Statement (General Form) — Form S-1
Filing Table of Contents
Document/Exhibit Description Pages Size
1: S-1/A Form S-1 Amendment Number 1 107 579K
2: EX-3.1 Restated Certificate of Incorporation 25 111K
3: EX-3.2 Amended and Restated By-Laws 18 82K
4: EX-4.1 Specimen Common Stock Certificate 2 12K
5: EX-4.2 Warrant Agreement Dtd September 4, 1998 33 94K
6: EX-4.3 Common Stock Warrant Dtd 02/19/1999 8 37K
7: EX-4.4 Common Stock Warrant Dtd 02/19/1999 8 37K
8: EX-4.5 Stockholders Agreement Dated 02/19/1999 28 142K
9: EX-10.1 Investment Agreement Dated 04/22/1998 2 19K
16: EX-10.10 Assignment and Assumption Dtd 10/02/1998 3 18K
17: EX-10.12 Employment Agreement Dtd 6/29/1998 15 53K
18: EX-10.13 Agreement for Cooperative Use Dtd 11/5/1996 37 112K
19: EX-10.14 Letter of Agreement Dtd 2/28/1997 2 15K
20: EX-10.15 Letter of Agreement Option Dtd 4/4/1997 2± 14K
21: EX-10.16 Letter Amendement Agreement Dtd 8/1/1997 3 17K
22: EX-10.17 Letter Amendement Agreement Dtd 10/21/1997 2± 14K
23: EX-10.18 Application Transfer Dtd 01/06/1999 2± 15K
24: EX-10.19 Assignment of Ussn and Pct Dtd 01/06/1999 2 16K
25: EX-10.20 Letter Amendment Agreement Dtd 01/26/1999 2 20K
26: EX-10.21 Assignmt of 50% of Certain Patent Prop Dtd 3 24K
01/26/1999
27: EX-10.22 Assignmt of Certain Trademarks Dtd 02/09/1999 2 15K
28: EX-10.23 Internet Services Agreement Dtd 10/24/1997 6 37K
29: EX-10.24 Collaboration Agreement Dtd 02/18/1998 2 17K
30: EX-10.25 Cais Iport License Agreement Dtd 09/10/1998 19 70K
31: EX-10.26 Marketing Assoc. Solution Agreement Dtd 11/11/1998 10 50K
32: EX-10.27 Master License Agreement Dtd 12/23/1998 51 175K
33: EX-10.28 Agreement for High Speed Net Access Serv Dtd 26 93K
02/19/1999
34: EX-10.29 Deed of Lease Dtd July 28, 1997 13 44K
10: EX-10.3 Series A Stock Dtd 02/19/1999 43 177K
35: EX-10.30 Deed of Lease Dtd May 28, 1998 12 41K
36: EX-10.31 Office Building Lease Dtd 11/21/1998 71± 279K
37: EX-10.32 Settle Agreement Dtd 01/24/1999 17 48K
38: EX-10.33 Amended and Restated Equity Dtd 02/12/1999 9 46K
11: EX-10.4 Exchange Agreement Dtd 10/02/1998 5 22K
12: EX-10.5 Agreement of Merger Dtd 10/02/1998 5 25K
13: EX-10.6 Amended and Restated Employment Agreement Dtd 9 43K
06/03/1997
14: EX-10.7 Assignment and Assumption Dtd 10/02/1998 3 17K
15: EX-10.9 Amended Employment Agreement Dtd 9/8/1997 11 49K
| Page | (sequential) | | | | (alphabetic) | Top |
|---|
| | |
- Alternative Formats (Word, et al.)
- Amended and Restated Stock Option Plan
- Business
- Capitalization
- Certain Relationships and Related Transactions
- Cost of services
- Customers
- Depreciation and amortization
- Description of Capital Stock
- Dilution
- Dividend Policy
- Duncan M. Fitchet, Jr
- Exhibits and Financial Statement Schedules
- Income (loss) from discontinued operations
- Indemnification of Directors and Officers
- Legal Matters
- Liquidity and Capital Resources
- Loans to and from Executive Officers and Affiliates
- Management
- Management's Discussion and Analysis of Financial Condition and Results of Operations
- MDUs
- Net revenues
- Non-cash compensation
- Notes to Consolidated Financial Statements
- Notes to Financial Statements
- Offering, The
- Organization of the Company
- Other Expenses of Issuance and Distribution
- OverVoice
- Principal Stockholders
- Recent Sales of Unregistered Securities
- Report of Independent Public Accountants
- Risk Factors
- Selected Financial Data
- Selling, general and administrative
- Series A Shares
- Series B Shares
- Shares Eligible for Future Sale
- Some Of Our Contracts Are Nonexclusive And We May Not Be Able To Recover Our Installation Costs
- Statement of Cash Flows for the Period from January 1, 1996 to May 10, 1996
- Statement of Changes in Stockholders' Equity for the Period from January 1, 1996 to May 10, 1996
- Statement of Operations for the Period from January 1, 1996 to May 10, 1996
- The Offering
- Ulysses G. Auger, Sr
- Undertakings
- Underwriting
- Use of Proceeds
- We May Not Be Able To Manage Our Potential Rapid Growth And Expansion Effectively
- We Will Have Broad Discretion In Applying The Proceeds Of The Offering
- Where You Can Find More Information
|
| 1 | 1st Page - Filing Submission
|
| 4 | Where You Can Find More Information
|
| 8 | The Offering
|
| " | Risk Factors
|
| 11 | We May Not Be Able To Manage Our Potential Rapid Growth And Expansion Effectively
|
| 12 | OverVoice
|
| 13 | Some Of Our Contracts Are Nonexclusive And We May Not Be Able To Recover Our Installation Costs
|
| 17 | We Will Have Broad Discretion In Applying The Proceeds Of The Offering
|
| 21 | Use of Proceeds
|
| " | Dividend Policy
|
| 22 | Capitalization
|
| 23 | Dilution
|
| 24 | Selected Financial Data
|
| 25 | Management's Discussion and Analysis of Financial Condition and Results of Operations
|
| 27 | Net revenues
|
| " | Cost of services
|
| " | Selling, general and administrative
|
| " | Depreciation and amortization
|
| 28 | Non-cash compensation
|
| " | Income (loss) from discontinued operations
|
| 29 | Liquidity and Capital Resources
|
| 32 | Business
|
| 36 | MDUs
|
| 41 | Customers
|
| 46 | Management
|
| 48 | Duncan M. Fitchet, Jr
|
| " | Ulysses G. Auger, Sr
|
| 52 | Amended and Restated Stock Option Plan
|
| 54 | Principal Stockholders
|
| 55 | Certain Relationships and Related Transactions
|
| " | Organization of the Company
|
| 56 | Loans to and from Executive Officers and Affiliates
|
| 60 | Description of Capital Stock
|
| " | Series A Shares
|
| 61 | Series B Shares
|
| 64 | Shares Eligible for Future Sale
|
| 65 | Underwriting
|
| 67 | Legal Matters
|
| 69 | Report of Independent Public Accountants
|
| 75 | Notes to Consolidated Financial Statements
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| 91 | Statement of Operations for the Period from January 1, 1996 to May 10, 1996
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| 92 | Statement of Changes in Stockholders' Equity for the Period from January 1, 1996 to May 10, 1996
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| 93 | Statement of Cash Flows for the Period from January 1, 1996 to May 10, 1996
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| 94 | Notes to Financial Statements
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| 98 | Item 13. Other Expenses of Issuance and Distribution
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| " | Item 14. Indemnification of Directors and Officers
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| 99 | Item 15. Recent Sales of Unregistered Securities
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| 102 | Item 16. Exhibits and Financial Statement Schedules
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| 104 | Item 17. Undertakings
|
As filed with the Securities and Exchange Commission on February 22, 1999.
Registration Statement No. 333-72769
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
CAIS INTERNET, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 4813 52-2066769
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Classification Identification Number)
incorporation or Code Number)
organization)
1255 22nd Street, N.W. Ulysses G. Auger, II
Fourth Floor Chairman and Chief Executive Officer
Washington, D.C. 20037 CAIS Internet, Inc.
(202) 715-1300 1255 22nd Street, N.W.
(Address, including zip code, and Fourth Floor
telephone number, including area code, Washington, D.C. 20037
of registrant's principal executive Telephone (202) 715-1300
offices) Facsimile (202) 463-7190
(Name, address, including zip code, and
telephone number, including area code,
of agent for service)
Copies to:
Morris F. DeFeo, Jr. Lorraine Massaro
Swidler Berlin Shereff Friedman, LLP Chadbourne & Parke, LLP
3000 K Street, N.W., Suite 300 30 Rockefeller Plaza
Washington, D.C. 20007 New York, NY 10112
Telephone (202) 424-7500 Telephone (212) 408-5100
Facsimile (202) 424-7647 Facsimile (212) 541-5369
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
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, please check the following box: [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please 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, please check the following box and list the
Securities Act registration number of the the earlier effective registration
statement for the same offering: [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box: [_]
----------------
CALCULATION OF REGISTRATION FEE
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Proposed
Maximum
Title of Securities to be Aggregate Offering Amount of
Registered Price (1) Registration Fee
-------------------------------------------------------------------------------
Common stock, $.01 par value.............. $75,000,000 $20,850
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(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rules 457(c) and (o) under the Securities Act of 1933.
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 this Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+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 or any applicable state securities +
+commission becomes effective. This prospectus is not an offer to sell these +
+securities and is not soliciting an offer to buy these securities in any +
+state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED FEBRUARY 22, 1999
PROSPECTUS
Shares
[INSERT LOGO HERE]
Common Stock
-----------
CAIS Internet, Inc. is a tier one Internet Service Provider. We focus on
providing the most cost-effective, dedicated high-speed Internet connections to
commercial and residential customers primarily using digital subscriber line
technology and our patented OverVoice technology.
This is the initial public offering of shares of the Company's common stock.
There is currently no public market for our common stock. We expect that the
initial public offering price will be between $ and $ per share. The public
offering price may not reflect the market price of our shares after the
offering.
We have applied to list the common stock on The Nasdaq Stock Market's
National Market under the symbol "CAIS."
-----------
Investing in our shares involves a high degree of risk. See "Risk Factors"
beginning on page 7 for a discussion of certain factors that you should
consider before you invest in the common stock being sold with this prospectus.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
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Per Share Total
--------------------------------------------------------------------------------
Public Offering Price........................................... $ $
Underwriting Discounts and Commissions.......................... $ $
Proceeds to the Company......................................... $ $
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The underwriters may purchase up to an additional shares of common stock
from us at the public offering price less underwriting discounts solely to
cover over-allotments.
ING Baring Furman Selz LLC
This prospectus is dated , 1999
[INSIDE COVER PAGE]
[GRAPHIC APPEARS HERE]
The graphic includes a schematic of the complete OverVoice technology
solution, with a secondary graphic. The three dimensional drawing identifies
CAIS Internet, Inc. as the source of the dedicated high-speed Internet service
connection, which comes into a building's basement telephone closet. That
active Internet connection is then dispersed to each intermediate telephone
closet located on multiple floors of the building. An example of the connection
is shown from an intermediate telephone closet to a specific user's room, which
is expanded to show typical OverVoice wall jack placement. A detail of the
OverVoice wall jack and the OverVoice DeskJack shows where the telephone and
computer connect. The secondary graphic indicates the specific path of the
Internet connection in the telephone closet.
Our trademarks and pending trademark applications include "OVERVOICE,"
"CAIS," "LANJACK" and "DESKJACK." This prospectus also contains our product
names, trade names and trademarks and those of other entities.
ii
WHERE YOU CAN FIND MORE INFORMATION
Our fiscal year ends on December 31. We will furnish our stockholders annual
reports containing audited financial statements and other appropriate reports.
In addition, we will become a reporting company under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and file annual, quarterly and
current reports, proxy statements and other information with the Securities and
Exchange Commission (the "SEC"). You may read and copy any reports, statements
or other information we file at the SEC's Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. You can request copies of these
documents, upon payment of a duplicating fee, by writing to the SEC. You may
call the SEC at 1-800-SEC-0330 for further information on the operation of the
Public Reference Rooms. Our SEC filings are also available to the public on the
SEC's Internet site at http://www.sec.gov., which contains reports, proxy and
information statements, and other information regarding issuers.
We have applied to list our common stock on The Nasdaq National Market under
the symbol "CAIS," and reports, proxy statements and other information
concerning the Company will also be available to be inspected at the offices of
Nasdaq Operations, 9801 Washingtonian Boulevard, Fifth Floor, Gaithersburg, MD
20879.
If you want more information, write or call us at:
CAIS Internet, Inc.
1255 22nd Street, N.W.
Fourth Floor
Washington, D.C. 20037
Telephone: (202) 715-1300
Facsimile: (202) 463-7190
Internet address: www.cais.com
We have filed a registration statement on Form S-1 with the SEC under the
Securities Act of 1933, as amended (the "Securities Act"), covering the common
stock being offered by this prospectus. As permitted by SEC rules, this
prospectus omits certain information that is included in the registration
statement. For further information about us and our common stock, you should
refer to the registration statement and its exhibits. Since the prospectus may
not contain all the information that you may find important, you should review
the full text of these documents. If we have filed a contract, agreement or
other document as an exhibit to the registration statement, you should read the
exhibit for a more complete understanding of the document or matter involved.
Each statement in this prospectus regarding a contract, agreement or other
document is qualified in its entirety by reference to the actual document. In
addition, information available on our Web site is not part of this prospectus.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements contained in this prospectus discuss future
expectations and business strategies or state other "forward-looking"
information. Those statements are subject to known and unknown risks,
uncertainties and other factors that could cause the actual results to differ
materially from those contemplated by the statements. The forward-looking
information is based on various factors and was derived using numerous
assumptions. We undertake no obligation to publicly update or revise any
forward-looking statements.
Important factors that may cause actual results to differ from projections
include, for example:
. changes in business conditions;
. changes in the Internet services industry and the general economy;
. our limited operating history;
. our ability to manage rapid growth;
. our ability to enter into joint ventures and other strategic
relationships with companies on terms acceptable to us; and
. the impact of computer and related problems that may arise from the Year
2000 problem on our business.
iii
SUMMARY
We have prepared this summary to assist you in your review of this document.
We have highlighted in this summary certain information which we believe is
important for your review. However, we have not included all of the information
that may be important to you. You should carefully read this entire document,
including the specific risks described in the "Risk Factors" section beginning
on page 7 and the other documents to which we refer. References in this
prospectus to the Company include our subsidiary, CAIS, Inc. For more
information about the Company, see "Where You Can Find More Information."
Overview
CAIS Internet, Inc. is a tier one Internet Service Provider. We focus on
providing the most cost-effective, dedicated high-speed Internet connections to
commercial and residential customers primarily using digital subscriber line
technology and our patented OverVoice technology. We offer our commercial
customers dedicated high-speed Internet access, including our new HyperDSL
services that we currently provide with Covad Communications Company and Bell
Atlantic. Additionally, our OverVoice technology enables us to offer a multi-
user, dedicated high-speed Internet solution to residential customers by
creating an Ethernet local area network in a hotel, multiple dwelling unit or
single family home more cost-effectively than alternative technologies,
including cable modems, digital subscriber line services or Category 5 rewiring
upgrades.
We use our OverVoice technology to simultaneously transmit voice and data
over a single traditional copper telephone line at speeds of up to 300 times
those of conventional 28.8k dial-up modems. This enables an OverVoice user to
have both dedicated high-speed Internet access and complete use of the
telephone at the same time over one telephone line. By combining the OverVoice
technology with any dedicated high-speed Internet connection, such as digital
subscriber line technology, T-1 or wireless, we can provide a single, dedicated
high-speed Internet connection that can be shared simultaneously among many
users in a multiple dwelling unit building, hotel or single family home. Today,
we believe that the economies of scale associated with the OverVoice technology
are most obvious when providing high-speed Internet access to concentrated
residential communities such as multiple dwelling units and hotels.
Although our primary focus for OverVoice initially will be on the hotel and
multiple dwelling unit markets, we believe that the demand for high-speed
Internet access in single family homes and the trend toward using more than one
personal computer at home, will also make OverVoice the most cost-effective
solution for providing dedicated high-speed Internet access in single family
homes and for "home networking." As of February 15, 1999, we have installed the
OverVoice technology in over 1,900 apartment units in 15 multiple dwelling unit
buildings and in over 1,900 guest rooms in eight hotels. Additionally, we have
signed an agreement for the nationwide roll-out of OverVoice with Hilton Hotels
Corporation and an agreement with OnePoint Communications Corp. to install
OverVoice in certain multiple dwelling unit buildings where OnePoint has
agreements to provide Internet and other communications services.
Industry Background
Internet access and enhanced Internet services represent two of the fastest
growing segments of the telecommunications services marketplace. According to
industry estimates, the number of Internet users in the United States who
access the World Wide Web reached approximately 29.2 million in 1997 and is
forecasted to grow to approximately 72.1 million by the year 2000.
International Data Corporation has projected that total Internet service
provider revenues in the U.S. will grow from $4.6 billion in 1997 to $18.3
billion in 2000.
Currently, individuals most commonly access the Internet through a dial-up
service. However, dial-up access has several drawbacks including delays,
frequent busy signals and mid-use cut-offs (drops) from service.
1
Demand is ever increasing for cost-effective, high-speed Internet connectivity
in the hotel, business and residential communities. Internet usage continues to
be stimulated by the increasing number of Web sites, the increasing
sophistication of Internet browsers and software applications, and the
proliferation of bandwidth-intensive information (such as streaming video and
audio) published on the Internet. The infrastructure necessary to support this
greater bandwidth, and the resulting multimedia applications, is the threshold
issue to realizing the potential of the Internet as a medium for communication,
education, entertainment and commerce.
Our Business Strategy
Our objective is to become a leading national provider of dedicated high-
speed Internet services. The following are key elements of our business
strategy to achieve this objective:
Offer the Most Cost-Effective, Dedicated High-Speed Internet Access to Our
Customers. We believe our OverVoice technology is the most cost-effective,
dedicated high-speed Internet solution for hotels and multiple dwelling units.
We also focus on providing the most cost-effective, dedicated high-speed
Internet access for commercial customers through our digital subscriber line
technology. In addition, we believe that OverVoice enables us to economically
create an Ethernet local area network in a hotel, multiple dwelling unit or
single family home.
Roll-Out Our OverVoice Technology Nationwide. Our goal is to make our
OverVoice technology the de facto high-speed Internet access standard in hotels
and multiple dwelling units. We intend to continue to penetrate both of these
markets through direct sales and strategic relationships by targeting major
hotel chains and real estate investment trusts which control large numbers of
multiple dwelling units.
Attract End-Users in Hotels and Multiple Dwelling Units. We intend to
stimulate the demand for our OverVoice services among end users by making
dedicated high-speed Internet access simple and affordable. Our OverVoice
technology enables us to offer multiple dwelling unit residents various
Internet service plans from entry level service (128 Kbps) starting at $24.95
per month to shared T-1 connectivity at up to $49.95 per month. In hotel rooms,
the OverVoice DeskJack, with its highly visible, step-by-step insructions,
makes accessing the Internet quick and easy for typically $9.95 for a 24-hour
stay.
Accelerate the Roll-Out of Our HyperDSL Services. We have initiated the
roll-out of a new dedicated, high-speed Internet access service using digital
subscriber line technology under the name HyperDSL. We believe that this
technology currently represents the most economical, dedicated high-speed
Internet solution for commercial customers. We currently offer our HyperDSL
services with Covad Communications Company and Bell Atlantic.
Expand Our Internet Backbone. We operate a nationwide network and have
peering agreements with most of the major backbone providers to exchange
Internet traffic over their respective networks. We currently maintain six
points of presence and intend to add at least ten additional points of presence
in 1999. In June 1998, we signed a ten-year fiber agreement with Qwest
Communications Corporation, under which we have access to all of Qwest's points
of presence nationwide, which totaled 130 as of February 15, 1999.
Leverage the OverVoice Platform to Deliver Future Services and Products. We
believe that our OverVoice technology provides a platform to deliver a variety
of broadband services and products to our customers, including Internet
protocol telephony, video conferencing, traditional video services, high
definition television (HDTV) and digital audio radio. We intend to expand our
service and product offerings through internal research and development, and by
acquiring complementary businesses and technologies.
2
Recent Developments
Private Placement. In February 1999, Chancery Lane, L.P., an affiliate of R.
Theodore Ammon, a director of the Company, and CAIS-Sandler Partners, L.P., a
Delaware limited partnership, invested $11.5 million in the Company in exchange
for shares of the Company's Series A Convertible Preferred Stock. In addition,
the Company granted the holders of the preferred stock warrants to purchase up
to 3.0% of the total number of shares of common stock outstanding on a fully
diluted basis upon the completion of this offering, with the exercise price
equal to the initial public offering price.
Hilton Hotels Corporation. On December 23, 1998, we entered into a master
agreement with Hilton, under which Hilton has agreed to license us the right to
offer high-speed Internet access service in specified Hilton hotels throughout
the United States. In order to participate, each Hilton hotel must enter into
an addendum to the master agreement. As of February 19, 1999, 142 Hilton-owned,
managed or franchised hotels have notified Hilton that they intend to sign an
addendum to participate under the terms of the master agreement.
OnePoint Communications Corp. In April 1998, we entered into a trial
agreement with OnePoint Communications Corp., a provider of communications and
entertainment services to residents in multiple dwelling units. Under this
trial agreement, we have installed OverVoice in fourteen buildings within four
complexes.
We recently entered into a seven-year contract with OnePoint Communications
Corp. to install our OverVoice technology. Under this agreement, we anticipate
that we will install OverVoice in a minimum of 30 multiple dwelling unit
buildings with approximately 10,000 units. Additionally, together with OnePoint
Communications Corp., we will market high speed Internet services to
approximately 300 additional multiple dwelling unit buildings where OnePoint
Communications Corp. has a preferential right of entry to provide Internet and
other communications services.
The Restructuring. In October 1998 and February 1999, we completed two
transactions that resulted in the Company becoming a holding company with one
subsidiary, CAIS, Inc. In October 1998, we restructured the Company as a
holding company with CAIS, Inc., Cleartel Communications Limited Partnership
and Cleartel Communications, Inc. as subsidiaries. In February 1999, we: (1)
transferred the Company's partnership interests in Cleartel Communications
Limited Partnership to Cleartel Communications, Inc.; (2) liquidated Cleartel
Communications Limited Partnership; and (3) distributed to our existing
stockholders our shares in Cleartel Communications, Inc. The information in
this prospectus reflects these transactions.
3
Company Information
We are located at 1255 22nd Street, N.W., Fourth Floor, Washington, D.C.
20037. Our telephone number is (202) 715-1300, and our Internet address is
www.cais.com. Information available on our Web site is not part of this
prospectus.
The Offering
[Enlarge/Download Table]
Common stock offered by the Company................ shares
Common stock to be outstanding after the offering.. shares, based on the number of
shares outstanding on , 1999. This does
not include an aggregate of shares issuable
pursuant to the exercise of warrants and stock
options outstanding as of , 1999. This
figure also assumes that the underwriters do
not exercise their over-allotment option.
Over-allotment option.............................. Up to shares. If the over-allotment option
is exercised in full by the underwriters at
the public offering price, the total public
offering price, underwriters discounts and
proceeds to the Company will be $ , $ and
$ , respectively.
Use of proceeds.................................... To expand our business, including capital
expenditures, increased sales and marketing,
and for additional working capital associated
with the roll-out of our OverVoice technology
and digital subscriber line services. To
finance the build-out of our network
infrastructure, research and development,
repayment of indebtedness, redemption of
shares of Series B Cumulative Mandatory
Redeemable Convertible Preferred Stock and
possible strategic acquisitions of
complementary businesses, customer bases,
products or technologies, as well as for
general corporate purposes.
Proposed Nasdaq National Market symbol............. "CAIS"
Risk Factors
Investing in our shares of common stock involves a high degree of risk. You
should read "Risk Factors" beginning on page 7 as well as the other cautionary
statements throughout the prospectus to ensure you understand the risks
associated with an investment in our common stock.
Additional Information
For additional information concerning the common stock, see "Description of
Capital Stock" and "Where You Can Find More Information."
4
SUMMARY FINANCIAL DATA
(In thousands, except per share amounts)
[Enlarge/Download Table]
Predecessor Successor
--------------------------------------- ------------------------------
Period from Period from
January 1, 1996 May 11, 1996 Year Ended
Year Ended December 31, to to December 31,
----------------------- May 10, December 31, ------------
1994 1995 1996 1996 1997 1998
----------- ----------- --------------- ------------ ------- --------
(unaudited) (unaudited)
Statement of Operations Data: (1)
Net revenues....................................... $481 $2,240 $1,287 $ 2,410 $ 4,556 $ 5,315
Cost of services................................... 124 697 323 834 2,010 3,118
Operating expenses................................. 267 596 381 2,478 6,844 12,664
Interest and other expense (income)................ 1 3 (2) 212 288 1,101
---- ------ ------ ------- ------- --------
Income (loss) from continuing operations........... $ 89 $ 944 $ 585 $(1,114) $(4,586) $(11,568)
==== ====== ====== ======= ======= ========
Basic and diluted loss per common share from
continuing operations............................. $ (0.11) $ (0.48) $ (1.17)
Weighted--average common shares outstanding--basic
and diluted....................................... 9,648 9,648 9,869
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As of December 31, 1998
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Pro Pro Forma
Actual Forma (2) As Adjusted (3)
-------- --------- ---------------
Balance Sheet Data:
Cash...................................... $ 95 $ 9,750 $
Working (deficit) capital ................ (9,374) 3,266
Total assets.............................. 15,678 15,227
Long-term debt, net of current portion.... 10,767 6,183
Stockholders' deficit..................... (13,604) (12,904)
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(1) The historical financial data set forth for the periods ended, or as of
dates, on or prior to May 10, 1996, reflect the results of operations of
Capital Area Internet Service, Inc. prior to its acquisition by the
Company. This data is shown under the caption "Predecessor." The historical
financial data subsequent to May 10, 1996 reflect the results of operations
of the Company's continuing operations. See "Certain Relationships and
Related Transactions."
(2) The Pro Forma balances give effect to:
. the issuance of Series A Convertible Preferred Stock in February 1999 for
gross proceeds of $11,500,000 ($3,500,000 in cash and an $8,000,000
unconditional promissory note), less issuance costs of $135,000, the
repayment of $1,500,000 of borrowings from Cleartel Communications
Limited Partnership, and the payment of $210,000 to extend the ING Credit
Agreement;
. the Spin-off of Cleartel Communications, Inc. to our stockholders in
February 1999 and the related $700,000 of Owners' Deficit as of December
31, 1998;
. the Company's assumption of debt in the aggregate principal amount of
$1,450,000 originally payable by Cleartel Communications Limited
Partnership ("Cleartel LP") to Ulysses G. Auger, Sr., a director of the
Company, in exchange for an equal reduction in the account payable by the
Company to Cleartel LP;
5
. the Company's issuance of Series B Cumulative Mandatory Redeemable
Preferred Stock to Ulysses G. Auger, Sr. in exchange for the retirement
of the $1,450,000 of assumed debt;
. the issuance of additional Series B Cumulative Mandatory Redeemable
Convertible Preferred Stock in exchange for $3,107,000 of related party
debt;
. the collection of the note receivable for $8,000,000 related to the
issuance of Series A Convertible Preferred Stock; and
. the warrants issued in connection with the Series A Convertible Preferred
Stock will be valued upon determination of the terms of this offering,
and have not been valued in the accompanying table.
(3) The Pro Forma as adjusted balances give effect to:
. the issuance of shares of common stock in the offering and application
of the net proceeds therefrom;
. the conversion of the Series A Convertible Preferred Stock upon the
closing of the offering;
. the redemption of $3,000,000 in aggregate face value of Series B
Cumulative Mandatory Redeemable Convertible Preferred Stock and the
conversion of the remaining shares into common stock;
. the repayment of remaining amounts due to Cleartel Communications, Inc.
and amounts outstanding under the ING Credit Agreement;
. the write-off of unamortized debt discount and deferred financing costs
to be recorded upon the repayment of borrowings outstanding under the ING
Credit Agreement; and
. the acceleration of deferred compensation expense upon the acceleration
of the vesting of options to purchase common stock held by the President
and Chief Operating Officer upon signing the underwriting agreement for
this offering.
See "Use of Proceeds," "Capitalization" and "The Offering."
6
RISK FACTORS
You should carefully consider the following factors and other information in
this document before you decide whether to purchase our common stock. The risks
set forth below are in addition to risks that apply to most businesses,
including risks of competition and reliance on employees.
We Have Had A Limited Operating History During Which We Have Incurred
Significant Net Losses, Experienced Negative Cash Flows And Accumulated A
Significant Deficit
Our limited historical operating data may make it more difficult for you to
evaluate our performance. We incurred a net loss for the fiscal year ended
December 31, 1997 of approximately $2.7 million, and we incurred net losses and
negative cash flows from operations for the fiscal year ended December 31, 1998
in the amounts of approximately $12.2 million and $3.2 million, respectively.
On December 31, 1998, we had a stockholders' deficit of approximately $13.6
million.
Following the completion of this offering, we believe that we will incur
further losses, in part due to expenses incurred in connection with the roll-
out of OverVoice. However, we cannot assure you that after incurring these
additional losses and expenses:
. there will be an increase in revenues;
. we will gain profits in future operating periods; or
. we will have sufficient cash available to meet continuing losses and/or
necessary capital expenditures.
We May Not Be Able To Manage Our Potential Rapid Growth And Expansion
Effectively
Our business strategy depends in large part on our ability to rapidly deploy
OverVoice. This will require significant capital expenditures and we expect to
fund our near-term capital requirements through the funds raised in this
offering. Further expansion of our business over the long term will require
substantial additional capital and will likely require additional outside
financing. This growth will also increase our operating complexity as well as
the level of responsibility for both existing and new management personnel. As
a result, in order to manage our growth, we must, among other things:
. continue to implement and improve our operational, financial and
management information systems, including our billing, accounts
receivable and payables tracking, fixed assets and other financial
management systems;
. hire and train additional qualified personnel; and
. continue to expand and upgrade our network infrastructure.
We also expect that demands on our network infrastructure and technical
support resources will increase rapidly as our customer base continues to grow.
We may therefore experience difficulties meeting a high demand for services in
the future. We cannot assure you that our infrastructure, technical support or
other resources will be sufficient to facilitate this growth. As we strive to
increase network utilization, there will be additional demands on our customer
support, sales and marketing resources. Competition for qualified employees is
intense and salaries are escalating very quickly. In addition, the process of
locating such personnel with the combination of skills and attributes required
to carry out our strategy is often lengthy.
Our failure to manage our growth effectively could have a material adverse
effect on our business, financial condition and results of operations.
We May Need Additional Capital To Finance Our Growth And Capital Requirements
We intend to rapidly enhance and develop our network and effect a broad-
based roll-out of OverVoice in order to attain our business goals. We intend to
add at least ten additional points of presence from third-party providers in
1999 and make substantial capital investments in our own points of presence or
otherwise as
7
dictated by customer demand or strategic considerations. If we do not have
enough cash from this offering, cash on hand and cash generated from our
operations to meet these cash requirements, we will need to seek alternative
sources of financing to carry out our growth and operating plans. We may not be
able to raise any such cash on terms acceptable to us or at all. Financings may
be on terms that are dilutive or potentially dilutive to our stockholders. If
alternative sources of financing are required, but are insufficient or
unavailable, we will be required to modify our growth and operating plans,
which may negatively affect our operations, financial condition and stock
performance.
The Inline Agreement Requires Us To Pay Ongoing Royalties
We are required to pay Inline Connection Corporation royalties equal to
between 3.0% and 5.5% of net sales of the OverVoice technology. In the rare
cases where we do not provide the Internet access or own the OverVoice
equipment installed, this percentage may be as high as 70.0%. If we sublicense
the patents and pending patent applications relating to the OverVoice
technology to a third party, we are required to pay Inline Connection
Corporation a percentage of the income received from the sublicense.
Additionally, we have minimum annual royalty payments starting at $100,000 for
the current year and increasing to $250,000. If we fail to pay the minimum
payments, or otherwise breach our agreement with Inline Connection Corporation,
we will lose our exclusive right to use the OverVoice technology in hotels and
multiple dwelling units, which would have a material adverse effect on our
business, financial condition and results of operations.
Our Business Is Subject To Risks Of Technological Change And Evolving Industry
Standards
Our future success will depend, in part, on our ability to: (1) offer
services that address the increasingly sophisticated and varied needs of our
current and prospective customers, and (2) respond to technological advances
and emerging industry standards and practices on a timely and cost-effective
basis. Internet access operations are characterized by:
. rapidly changing and unproven technology;
. evolving industry standards;
. changing customer needs; and
. numerous competitive services and product offerings.
We cannot assure you that:
. future advances in technology will be beneficial to, or compatible with,
our business;
. we will be able to incorporate such advances on a cost-effective or
timely basis; or
. such advances will not render our services unnecessary or less cost-
effective.
Although we intend to support emerging standards, we cannot assure you that
industry standards will be established, or that, if established, we will be
able to conform to the new standards in a timely fashion or maintain a
competitive position in the market. In addition, we cannot assure you that
products, services or technologies developed by others will not render our
services noncompetitive, unnecessary or obsolete.
We Operate In A Highly Competitive Market
We operate in a highly competitive environment for each of our lines of
business and we believe that competition is increasing. The competitive
environments for our different lines of business are as follows:
OverVoice. We face several major groups of competitors in the business of
providing high-speed Internet access to hotels and multiple dwelling units.
These include local exchange carriers and other digital subscriber line
providers, cable TV companies and other providers using cable modems, and
installation firms that upgrade the wiring in hotels and multiple dwelling unit
buildings. Many of our competitors have extensive marketplace presence and
greater technological and financial resources than we do.
8
In addition, the OverVoice technology also competes with technologies using
other transmission media, such as coaxial cable, wireless facilities and fiber
optic cable. To the extent that telecommunications service providers, hotels,
multiple dwelling units or single family residences choose to install any of
these alternative transmission media, demand for OverVoice may decline.
CAIS Internet. Because the Internet services market has no substantial
barriers to entry, we expect that competition will continue to intensify. Our
principal competitors include other tier one national backbone providers such
as UUNET Technologies, Inc., PSINet Inc., BBN (a GTE subsidiary), and other
providers of dedicated high-speed Internet access including DSL, T-1 and
wireless access. To a lesser extent, we also compete for dedicated and dial-up
access and Web services business with regional, tier two Internet service
providers and cable companies that operate in the same geographic markets that
we serve. Accordingly, we expect the market for Internet access services to
continue to grow and to be highly competitive with a variety of regional and
national players vying for new business. In many instances, we compete directly
with our downstream Internet service provider customers. Eventually, we expect
some form of a market consolidation to occur, with those Internet service
providers that furnish the most value-added solutions ultimately surviving.
Some Of Our Contracts Are Nonexclusive And We May Not Be Able To Recover Our
Installation Costs
We have incurred, and will continue to incur, significant up-front costs
installing OverVoice in hotels. Certain of our agreements to provide services,
including our agreement with Hilton Hotels Corporation, do not require hotel
owners and operators to offer our services exclusively. As a result, hotels may
allow others to offer Internet access services that compete with our service,
even though we have incurred the cost of installing OverVoice. In addition, our
trial and long-term agreements for both hotels and multiple dwelling units
generally do not contain any minimum use requirements.
We May Not Be Able To Protect Our Patent Rights
We are a licensee and joint-owner with Inline Connection Corporation of
certain domestic and foreign patents and patent applications relating to the
OverVoice technology. As our competitive advantage depends on this technology,
our success relies substantially on our ability to protect the OverVoice
technology, both domestically and abroad. We face the following two major risks
in connection with our patent rights.
(1) Others may infringe on our patent rights, resulting in:
. lack of competitiveness in the market;
. expense of time and resources to protect our patents; and
. dilution of the brand value of our service.
(2) Although we do not believe this to be the case, we may infringe others'
patents, resulting in:
. significant expense in defending our patents, even in the case of a
frivolous suit;
. requirement to pay damages; and
. costly and potentially impracticable redesign of our technology.
Any of the above could have a materially adverse affect on our business,
financial condition and results of operations.
We Depend Upon Our Suppliers
In order to provide Internet access and other on-line services to our
customers, we lease long distance fiber optic telecommunications lines from
national telecommunications services providers. We depend upon these providers
substantially.
9
Certain of our suppliers, including regional Bell operating companies and
competitive local exchange carriers, are currently subject to various price
constraints, including tariff controls, which in the future may change. In
addition, pending regulatory proposals may affect the prices charged to us by
the regional Bell operating companies and competitive local exchange carriers.
These regulatory changes could result in increased prices for products and
services, which could have a material adverse effect on our business, financial
condition or results of operations.
We rely wholly on other companies to supply our network infrastructure
(including telecommunications services and networking equipment) which, in the
quantities and quality we require, is available only from sole or limited
sources. We cannot assure you that our suppliers will not:
. compete directly with us;
. enter into exclusive arrangements with our competitors; or
. stop selling their products or components to us at commercially
reasonable prices, or at all.
In addition, we do not manufacture our proprietary OverVoice equipment, such
as wall jacks and the OverVoice DeskJack; rather we depend on third parties to
manufacture and supply it. Any interruption in the operations of any of these
manufacturers could adversely affect our ability to meet our customers'
requirements.
Our Network Infrastructure Depends Upon Third Party Providers
The Internet relies on the exchange of traffic over a network of networks
that is owned and operated by many parties. We currently exchange traffic with
other Internet service providers with whom we maintain relationships. These
exchange agreements are not regulated and may be changed. If they become
regulated, modified or are altogether terminated, we may have to find
alternate, more expensive means to exchange traffic, or we may not be able to
do so, which would have a material adverse affect on our business, financial
condition or results of operations.
We Are Subject To Risks Associated With Acquisitions Of Assets And Businesses
As part of our business strategy, we may acquire assets or businesses that
complement our current operations. Any future acquisitions will be accompanied
by the risks commonly encountered in such transactions, including:
. the difficulty of assimilating the operations and personnel of the
companies;
. the potential disruption of our ongoing business;
. the costs associated with the development and integration of acquired
operations;
. the inability of management to maximize our financial and strategic
position by the successful incorporation of licensed or acquired
technology into our service offerings;
. the maintenance of uniform standards, controls, procedures and policies;
. the impairment of relationships with employees and customers as a result
of changes in management, and higher customer attrition with respect to
customers obtained through acquisitions; and
. the impact on our liquidity.
Additionally, any future acquisitions may give rise to financial risks
including both our incurrence of indebtedness to finance such acquisitions and
the need to service this indebtedness.
In addition, expansion through joint ventures with strategic partners
provides us with additional potential risks including:
. the potential that our joint venture partner may not have economic,
business or legal interests or goals that are consistent with ours or
those of the joint venture; and
10
. the potential that our joint venture partner may be unable to meet its
economic or other obligations and that we may be required to fulfill
those obligations.
Our Operations Are Subject To Risks Of System Failure
Our operations depend upon our ability to protect our network against damage
from acts of nature, power failures, telecommunications failures and similar
events. Because we lease our lines from long-distance telecommunications
companies, Internet backbone providers, the regional Bell operating companies
and competitive local exchange carriers, we depend upon those companies for
physical repair and maintenance of those lines. Despite the precautions we and
our telecommunications providers take, the occurrence of a natural disaster,
fire, electrical outage or other unanticipated problems at one of our
facilities may cause interruptions in the services we provide. Such
interruptions in operations could have a material adverse effect on our
business, financial condition or results of operations.
Our System May Be Vulnerable To Viruses, Break-ins And Other Security Risks
Despite the implementation of network security measures, the core of our
Internet network infrastructure is vulnerable to computer viruses, break-ins
and similar disruptive problems. We may experience future interruptions in
service as a result of the accidental or intentional actions of Internet users,
current and former employees or others. Unauthorized use could also potentially
jeopardize the security of confidential information stored in our computer
systems and the computer systems of our customers. Although we intend to
continue to implement security measures to prevent this, these measures have
occasionally been circumvented in the past, and we cannot assure you that the
measures we implement will not be circumvented in the future. In addition,
eliminating such viruses and remedying such security problems may cause
interruptions, delays or cessation of service to our customers that could have
a material adverse effect on our business, financial condition or results of
operations. We do not carry any insurance against these risks because it is
unavailable at a reasonable cost.
Our Success Depends Upon Management And Other Key Personnel
Our success depends in significant part upon the continued service of our
senior management personnel and certain other employees who possess
longstanding industry relationships and technical knowledge of our operations.
While we do not maintain any "key person" insurance, we have entered into
employment agreements with certain key employees. Our future success also
depends on our ability to attract, train, retain and motivate highly skilled
personnel. Competition for qualified, high-level telecommunications personnel
is intense and we cannot assure you that we will be able to attract and retain
such personnel. The loss of the services of one or more of our key individuals,
or the failure to attract and retain additional key personnel, could have a
material adverse effect on our business, financial condition or results of
operation.
We Depend Upon Effective Management Information Systems
We depend upon information systems to provide service to our customers,
manage our network, collect billing information and perform other vital
functions. Like other systems, our management information systems are subject
to hardware defects and software bugs, the existence of which may be outside
our control. Technical difficulties with our hardware or software could
materially adversely affect our business, financial condition or results of
operations.
We May Be Subject To Government Regulation And Potential Taxes
We provide Internet access, in part, through transmissions over public
telephone lines. These transmissions are governed by regulatory policies
establishing charges and terms for communications. As an Internet service
provider, we are not currently subject to direct regulation by the Federal
Communications Commission or any other agency, other than regulations
applicable to businesses generally. In a report to Congress
11
adopted on April 10, 1998, the Federal Communications Commission reaffirmed
that Internet service providers should be classified as unregulated
"information service providers" rather than regulated "telecommunications
providers" under the terms of the Telecommunications Act of 1996, as amended.
This finding is important because it means that we are not subject to
regulations that apply to telephone companies and similar carriers. We also are
not required to contribute a percentage of our gross revenues to support
"universal service" subsidies for local telephone services and other public
policy objectives, such as enhanced communications systems for schools,
libraries and certain health care providers. Although there can be no
assurance, the Federal Communications Commission action may also discourage
states from separately regulating Internet service providers as
telecommunications carriers or imposing similar subsidy obligations.
Nevertheless, Internet-related regulatory policies are continuing to
develop, and it is possible that we could be exposed to regulation in the
future. For example, in the same report to Congress, the Federal Communications
Commission stated its intention to consider whether to regulate voice and fax
telephony services provided over the Internet as "telecommunications" even
though Internet access itself would not be regulated. The Federal
Communications Commission is also considering whether such Internet-based
telephone service should be subject to universal service support obligations,
or pay carrier access charges on the same basis as traditional
telecommunications companies.
Local telephone companies assess access charges to long distance companies
for the use of the local telephone network to originate and terminate long
distance calls, generally on a per-minute basis. Access charges have been a
matter of continuing dispute, with long distance companies complaining that the
rates are substantially in excess of cost, and local telephone companies
arguing that access rates are justified to subsidize lower local rates for end
users and other purposes. Both local and long distance companies, however,
contend that Internet-based telephony should be subject to these charges. We
have no current plans to install gateway equipment and offer telephony, and so
we do not believe we would be directly affected by these developments. However,
we cannot predict whether these debates will cause the Federal Communications
Commission to reconsider its current policy of not regulating Internet service
providers.
In addition, a number of state and local government officials have asserted
the right or indicated a willingness to impose taxes on Internet-related
services and commerce, including sales, use and access taxes. We cannot
accurately predict whether the imposition of any such taxes would have a
material adverse effect on our business, financial condition or results of
operations.
We May Be Liable For Information Sent Through Our Network
The law relating to the liability of Internet service providers and on-line
services companies for information carried on, stored on, or disseminated
through their network is unsettled, even with the recent enactment of the
Digital Millennium Copyright Act. We believe that it is currently also
unsettled as to whether the Telecommunications Act of 1996, as amended,
prohibits and imposes liability for any of the services we provide should the
content of information transmitted be subject to the statute. 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, financial condition or results of operation.
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 steps to reduce our exposure to this type of liability. This may require
us to spend significant amounts of money for new equipment and may also require
us to discontinue offering certain of our products or services.
12
Due to the increasing popularity and use of the Internet, it is possible
that additional laws and regulations may be adopted with respect to the
Internet, covering issues such as content, privacy, access to certain content
by minors, pricing, bulk e-mail (spam), encryption standards, consumer
protection, electronic commerce, taxation, copyright infringement and other
intellectual property issues. We cannot predict the impact, if any, that future
regulatory changes or developments may have on our business, financial
condition, or results of operation. Changes in the regulatory environment
relating to the Internet access industry, including regulatory changes that
directly or indirectly affect telecommunication costs or increase the
likelihood or scope of competition from regional telephone companies or others,
could have a material adverse effect on our business, financial condition or
results of operation.
We May Not Be Able To Protect Our Servicemarks And Trademarks
We intend to protect and defend our name, servicemarks and trademarks in the
United States and internationally. We achieved federal registration for several
of our trademarks, including the mark CAIS, and filed for federal trademark
protection for a number of other marks which we use or intend to use, for
example OVERVOICE. We cannot assure you that:
. our efforts to protect our proprietary rights in the U.S. or abroad will
be successful;
. other companies will not challenge our use of our trademarks and
servicemarks; or
. we will have sufficient funds to withstand such challenges or claims,
regardless of their merit.
If we are unable to protect our proprietary rights it could have a material
adverse effect on our business, financial condition and results of operations.
We Will Have Broad Discretion In Applying The Proceeds Of The Offering
We estimate that we will receive net proceeds from this offering of
approximately $ million (approximately $ million if the underwriters' over-
allotment option is exercised in full) after deducting estimated underwriting
discounts and commissions and other fees and expenses. We intend to use the net
proceeds from this offering to fund expansion of our business, including
capital expenditures, increased sales and marketing and for working capital
associated with the roll-out of our OverVoice technology and digital subscriber
line (DSL) services. In addition, we intend to use a portion of the proceeds to
further build-out our network infrastructure nationwide. The Company also
intends to use proceeds from the offering to finance research and development
of future products and services, as well as for general corporate purposes. In
addition, we intend to use proceeds from the offering to repay indebtedness in
the aggregate principal amount of approximately $9.0 million and to redeem
shares of Series B Cumulative Mandatory Redeemable Convertible Preferred Stock
with an aggregate face value of $3.0 million. We also from time to time
consider the acquisition of complementary businesses, customer bases, products
or technologies, and may use proceeds of the offering to make such
acquisitions. However, these are estimates only and there could be significant
variations in the actual use of proceeds. Accordingly, we will have broad
discretion as to the application of such proceeds without prior stockholder
approval.
Our Directors Are Not Personally Liable For Breach Of Fiduciary Duties
As permitted by the Delaware General Corporation Law, our Certificate of
Incorporation includes a provision eliminating the personal liability of our
directors for monetary damages for breach or alleged breach of their fiduciary
duties as directors, subject to certain exceptions. In addition, pursuant to
our By-Laws and separate indemnification agreements, we must indemnify our
officers and directors under certain circumstances, including those
circumstances in which indemnification would otherwise be discretionary. We
also must advance to our officers and directors expenses incurred in connection
with proceedings against them for which they may be indemnified. We are not
currently aware of any pending or threatened litigation or proceeding involving
any of our directors, officers, employees or agents in which indemnification
would be required or permitted.
13
The Executive Officers and Directors of the Company, As A Group, Control The
Company
As of February , 1999, the executive officers and directors of the Company,
as a group, beneficially owned or controlled approximately % of the
outstanding shares of common stock on a fully diluted basis. Consequently, as a
practical matter, even after this offering, the executive officers and
directors of the Company, as a group, will be able to control the election of
our Board of Directors, management policy and all fundamental corporate
actions, including mergers, substantial acquisitions and dispositions of
assets.
Future Sales Of Our Common Stock Could Have A Negative Impact On The Market
Price Of Our Common Stock
Sales of a substantial number of shares of common stock in the public market
following this offering, or the appearance that such shares are available for
sale, could adversely affect the market price for the Company's common stock.
Upon completion of the offering, the Company will have outstanding shares
of common stock. In addition to these shares, upon completion of the offering:
. shares will be issuable upon the exercise of options granted;
. shares will be issuable upon the exercise of warrants;
. 2,827,168 shares of common stock will be issuable upon the conversion of
Series A Convertible Preferred Stock; and
. shares of common stock will be issuable upon the conversion of
Series B Cumulative Mandatory Redeemable Convertible Preferred Stock.
The Company may also grant options for up to additional shares of
common stock under the Company's Amended and Restated 1998 Equity Incentive
Plan.
The Company and certain stockholders of the Company (including Chancery
Lane, L.P. and all directors and officers of the Company) who will hold, upon
consummation of the offering, an aggregate of approximately shares of
common stock and options, warrants and preferred stock exercisable for or
convertible into a total of additional shares of common stock, have agreed
pursuant to lock-up agreements with representatives of our underwriters, not to
offer, sell, contract to sell or otherwise dispose of any common stock, or any
options, warrants or other securities convertible into or exercisable for
common stock for 180 days after the date of this prospectus, subject to certain
exceptions.
Upon the expiration of the lock-up agreements, 8,930,535 shares of common
stock outstanding upon completion of the offering will be eligible for sale in
the public market pursuant to Securities Act Rule 144. In addition, holders of
the Series A Convertible Preferred Stock and warrants have certain demand and
piggyback registration rights covering the shares of common stock issuable upon
exercise of these instruments. Following the consummation of the offering, the
Company intends to register an aggregate of 3,534,495 shares of common stock
issuable upon the exercise of options granted under the Amended and Restated
1998 Equity Incentive Plan and under other compensatory arrangements.
We are unable to predict the effect that sales made under Rule 144, upon the
exercise of registration rights or otherwise may have on the then prevailing
market price of the common stock.
There Is Currently No Public Market For The Common Stock And Our Stock Price
May Fluctuate Significantly In The Future
Prior to this offering, there was no public market for the common stock and
we cannot assure you that an active trading market will develop or continue
after this offering. The initial public offering price will be determined by
negotiation between us and the representatives of the underwriters and may not
be indicative of the price that will prevail in the open market. See
"Underwriting" for a discussion of the factors to be
14
considered in determining the initial public offering price. The market price
of the shares of common stock is likely to be highly volatile and could be
subject to wide fluctuations in response to factors such as:
. actual or anticipated variations in our results of operations;
. announcements of technological innovations;
. new services introduced by us or our competitors;
. conditions in the economy in general and in the Internet service
provider sectors in particular;
. inflated price to earning ratios in the telecommunications industry;
. changes in financial estimates by securities analysts;
. conditions and trends in the Internet;
. general market conditions; and
. sales of a substantial number of shares of common stock in the public
market or the appearance that such shares are eligible for sale.
In addition, in the past, following periods of volatility in the market
price of a company's securities, class action litigation has often been
instituted against such companies. Such litigation, if instituted, could result
in substantial costs and a diversion of management's attention and resources,
which could have a material adverse effect on our business, financial condition
or results of operation.
Investors Will Experience Immediate And Substantial Dilution
The initial public offering price is substantially higher than the book
value per share of the outstanding common stock. As a result, investors
purchasing common stock will experience immediate and substantial dilution in
the pro forma combined net tangible book value of their shares of $ per
share. Upon the issuance of additional shares of common stock in the future,
whether pursuant to the exercise of outstanding convertible securities,
warrants or options, purchasers of common stock in the offering may experience
further dilution.
The Ability Of Stockholders To Effect Changes In Control Of The Company Is
Limited
There are provisions in our Certificate of Incorporation and By-Laws and the
Delaware General Corporation Law that discourage and make it more difficult for
a third party to acquire, or attempt to acquire, control of the Company. In
particular, our Certificate of Incorporation divides the Board of Directors
into three classes of directors, serving staggered three-year terms. Our
Certificate of Incorporation also grants our Board of Directors the authority
to issue, without stockholder approval, one or more series of preferred stock
having such preferences, powers and relative, participating, optional and other
rights (including preferences over the common stock respecting dividends and
distributions and voting rights) as the Board of Directors may determine. The
issuance of this "blank-check" preferred stock could render more difficult or
discourage an attempt to obtain control of our Company by means of a tender
offer, merger, proxy contest or otherwise. The Certificate of Incorporation
further provides that stockholder action can be taken only at an annual or
special meeting of stockholders and cannot be taken by written consent in lieu
of a meeting. The Certificate of Incorporation and the By-Laws also provide
that, except as otherwise required by law, special meetings of the stockholders
can only be called pursuant to a resolution adopted by a majority of the Board
of Directors or by the chief executive officer of the Company. In addition, the
By-Laws establish an advance notice procedure for stockholder proposals to be
brought before an annual meeting of our stockholders, including proposed
nominations of persons for election to the Board of Directors. Certain
provisions of the Delaware General Corporation Law, including Section 203, may
also discourage takeover attempts that have not been approved by our Board of
Directors.
15
We Do Not Anticipate That We Will Pay Cash Dividends
We plan to retain future net income, if any, to fund internal growth.
Therefore, we do not anticipate paying any cash dividends on the common stock
in the foreseeable future.
Failure To Obtain Year 2000 Compliance May Have Adverse Effects On The Company
The term "Year 2000 issue" is a general term used to describe the various
problems that may result from the improper processing of dates and date-
sensitive calculations by computers and other machinery as the Year 2000 is
approached and reached. Our failure to correct a material Year 2000 problem
could result in an interruption in, or a failure of, certain of our normal
business activities or operations. During 1998, we established a Year 2000
compliance program to coordinate appropriate activity and report to our Board
of Directors with regard to Year 2000 issues. We continue to assess the impact
of Year 2000 issues on our internal computer, operational and financial
systems, and to review with our key vendors and suppliers, the compliance of
their systems with Year 2000 processing requirements. We currently believe that
our most reasonably likely worst case scenario related to the Year 2000 is
associated with potential concerns with our customers' and suppliers' Internet
operations. The failure of such parties to ensure Year 2000 compliance would
lead to decreased Internet usage and the delay or inability to obtain necessary
data communication and telecommunication capacity. These factors could in turn
have a material adverse effect on our business, financial condition or results
of operation.
This Prospectus Contains Forward-Looking Information
Some of the statements contained in this prospectus discuss future
expectations and business strategies or state other "forward-looking"
information. Those statements are subject to known and unknown risks,
uncertainties and other factors that could cause the actual results to differ
materially from those contemplated by the statements. You should carefully
consider all of the risk factors discussed in this prospectus.
16
USE OF PROCEEDS
We estimate that we will receive net proceeds from this offering of
approximately $ million (approximately $ million if the underwriters' over-
allotment option is exercised in full) after deducting estimated underwriting
discounts and commissions and other fees and expenses. We intend to use the net
proceeds from this offering to expand our business, including capital
expenditures, increased sales and marketing and working capital associated with
the roll-out of our OverVoice technology and digital subscriber line (DSL)
services and to further build-out our network infrastructure nationwide. In
addition, we intend to use proceeds from the offering to (1) repay
approximately $7,000,000 of outstanding indebtedness under the credit agreement
the Company, together with CAIS Inc. and certain of its affiliates entered into
with ING (U.S.) Capital Corporation, which bears interest at the one-month
LIBOR rate plus 5%, due September 4, 1999; (2) to repay a non-interest bearing
account payable in the amount of approximately $2,000,000 owed to Cleartel
Communications, Inc.; and (3) to redeem shares of Series B Cumulative Mandatory
Redeemable Convertible Preferred Stock with an aggregate face value of $3.0
million. The Company also intends to use proceeds from the offering to finance
research and development of future products and services, as well as for
general corporate purposes. We also from time to time consider the acquisition
of complementary businesses, customer bases, products or technologies, and may
use proceeds of the offering to make such acquisitions.
We currently intend to allocate substantial proceeds to each of the
foregoing categories. However, the precise allocation of funds among these uses
will depend on future technological, regulatory and other developments in or
affecting our business, the competitive climate in which we operate and the
emergence of future opportunities. Pending such uses, we intend to invest the
net proceeds of this offering in short-term, investment grade interest-bearing
securities. See "Risk Factors--We Will Have Broad Discretion In Applying The
Proceeds Of The Offering."
See "Capitalization," "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources," and
"Certain Relationships and Related Transactions."
DIVIDEND POLICY
We plan to retain all of our earnings, if any, to finance the expansion of
our business and for general corporate purposes and do not anticipate paying
any cash dividends on the common stock for the foreseeable future. Our future
dividend policy will be determined by the Board of Directors on the basis of
various factors, including our results of operations, financial condition,
capital requirements and investment opportunities.
17
CAPITALIZATION
The following table sets forth our cash, short-term debt and capitalization
as of December 31, 1998, (1) on an actual basis, (2) on a pro forma basis and
(3) on a pro forma as adjusted basis to give effect to the pro forma
adjustments and to give effect to this offering and the application of the
estimated net proceeds of the offering. You should read this table together
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Company's historical financial statements, including the
related notes thereto, included elsewhere in this prospectus.
[Download Table]
AS OF DECEMBER 31, 1998
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA(1) AS ADJUSTED(2)
-------- ------------ --------------
(IN THOUSANDS)
Cash.................................... $ 95 $ 9,750 $
======== ======= ========
Short-term debt:
Payable to discontinued operations...... $ 5,342 $ 2,392 $
======== ======= ========
Long-term debt:
Bridge Loan, net of unamortized debt
discount of $817...................... $ 6,183 $ 6,183 $
Notes payable to related parties, net
of current portion.................... 1,983 --
Long-term liabilities of discontinued
operations............................ 2,601 --
10,767 6,183
-------- ------- --------
Series A Convertible Preferred Stock,
2,827,168 shares authorized, issued and
outstanding............................ -- 11,365
-------- ------- --------
Series B Cumulative Mandatory Redeemable
Convertible Preferred Stock, 1,119,679
shares authorized, issued and
outstanding............................ -- 4,557
-------- ------- --------
Stockholders' (deficit) equity:
Common stock, $0.01 par value,
100,000,000 shares authorized,
9,965,000; 9,965,000 and issued
and outstanding(3).................... 100 100
Additional paid-in capital............. 7,544 7,544
Warrants outstanding(4)................ 1,226 1,226
Deferred compensation.................. (2,888) (2,888)
Accumulated deficit.................... (19,586) (18,886)
-------- ------- --------
Total stockholders' (deficit)
equity.............................. (13,604) (12,904)
-------- ------- --------
Total Capitalization................. $ (2,837) $ 9,201 $
======== ======= ========
-------
(1) The Pro Forma balances give effect to:
. the issuance of Series A Convertible Preferred Stock in February 1999 for
$11,500,000 ($3,500,000 in cash and an $8,000,000 unconditional
promissory note), less issuance costs of $135,000, and the repayment of
$1,500,000 of amounts due to Cleartel Communications Limited Partnership;
. the Spin-off of Cleartel Communications, Inc. to our stockholders in
February 1999 and the related $700,000 of Owners' Deficit as of
December 31, 1998;
. the assumption of related party notes payable of approximately $1,450,000
from Cleartel in exchange for an equal reduction in amounts due to
Cleartel, and the subsequent conversion to Series B Cumulative Mandatory
Redeemable Convertible Preferred Stock thereof;
. the issuance of additional Series B Cumulative Mandatory Redeemable
Convertible Preferred Stock in payment of $3,107,000 of related party
debt; and
. the collection of the note receivable for $8,000,000 related to the
issuance of Series A Convertible Preferred Stock; and
. the payment of $210,000 to extend the ING Credit Agreement
(2) The Pro Forma balances give effect to:
. the issuance of Series A Convertible Preferred Stock in February 1999 for
gross proceeds of $11,500,000 ($3,500,000 in cash and an $8,000,000
unconditional promissory note), less issuance costs of $135,000, the
repayment of $1,500,000 of borrowings from Cleartel Communications
Limited Partnership, and the payment of $210,000 to extend the ING Credit
Agreement;
. the Spin-off of Cleartel Communications, Inc. to our stockholders in
February 1999 and the related $700,000 of Owners' Deficit as of
December 31, 1998;
. the Company's assumption of debt in the aggregate principal amount of
$1,450,000 originally payable by Cleartel Communications Limited
Partnership ("Cleartel LP") to Ulysses G. Auger, Sr., a director of the
Company, in exchange for an equal reduction in the account payable by the
Company to Cleartel LP;
. the Company's issuance of Series B Cumulative Mandatory Redeemable
Preferred Stock to Ulysses G. Auger, Sr. in exchange for the retirement
of the $1,450,000 of assumed debt;
. the issuance of additional Series B Cumulative Mandatory Redeemable
Convertible Preferred Stock in exchange for $3,107,000 of related party
debt; and
. the collection of the note receivable for $8,000,000 related to the
issuance of Series A Convertible Preferred Stock.
(3) The Pro Forma as adjusted balances give effect to:
. the issuance of shares of common stock in the offering and application
of the net proceeds therefrom;
. the conversion of the Series A Convertible Preferred Stock upon the
closing of the offering;
. the redemption of $3,000,000 in aggregate face value of Series B
Cumulative Mandatory Redeemable Convertible Preferred Stock and the
conversion of the remaining shares into common stock;
. the repayment of remaining amounts due to Cleartel Communications, Inc.
and amounts outstanding under the ING Credit Agreement;
. the write-off of unamortized debt discount and deferred financing costs
to be recorded upon the repayment of borrowings outstanding under the ING
Credit Agreement; and
. the acceleration of deferred compensation expense upon the acceleration
of the vesting of options to purchase common stock held by the President
and Chief Operating Officer upon signing the underwriting agreement for
this offering.
(4) The warrants issued in connection with the Series A Convertible Preferred
Stock will be valued upon determination of the terms of this offering, and
have not been valued in the accompanying table.
18
DILUTION
The Company's pro forma net tangible book value as of December 31, 1998 was
, or $ per share of common stock. Pro forma net tangible book value per
share is equal to the Company's total pro forma tangible assets less its total
pro forma liabilities divided by the number of shares of common stock
outstanding. After giving effect to the sale by the Company of shares of
common stock offered hereby, at an assumed initial public offering price of $
per share, and the application of the estimated net proceeds therefrom as
described under "Use of Proceeds," the Company's pro forma net tangible book
value at December 31, 1998, would have been approximately $ million, or
approximately $ per share. This represents an immediate increase of $ per
share in the pro forma net tangible book value to existing stockholders and an
immediate dilution of $ per share in pro forma net tangible book value to new
investors purchasing common stock in the offering.
The following table illustrates the per share dilution to new investors:
[Download Table]
Assumed initial public offering price per share........ $
Pro forma net tangible book value per share before
the offering.......................................
Increase per share attributable to new investors.....
Pro forma net tangible book value per share after
the offering.........................................
Dilution per share to new investors....................
The following table gives effect, on a pro forma basis, to the number of
shares of common stock purchased from the Company, the total consideration paid
and the average price per share paid by existing stockholders and the new
investors purchasing shares of common stock in the offering (before deducting
underwriting discounts and commissions and estimated offering expenses):
[Download Table]
SHARES
PURCHASED TOTAL CONSIDERATION
-------------- ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT(1) PER SHARE
------ ------- ------------------- -------------
Existing stockholders.......... % $ $
New investors..................
--- --- ----
Total.......................... %
=== === ====
--------
(1) Total consideration paid by existing stockholders includes only cash
consideration for common stock, warrants, Series A Convertible Preferred
Stock and Series B Cumulative Mandatory Redeemable Convertible Preferred
Stock.
19
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere herein. The selected financial data for the fiscal years
ended December 31, 1996, 1997 and 1998 are derived from the Company's financial
statements, which have been audited by Arthur Andersen LLP, independent public
accountants and included elsewhere herein. The selected financial data for the
period from January 1, 1996 through May 10, 1996 are derived from Capital Area
Internet Service Inc.'s ("Capital Area") financial statements which have been
audited by Arthur Andersen LLP, independent public accountants and are
presented seperately herein. The selected financial data for the fiscal years
ended December 31, 1994 and 1995 are derived from unaudited financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring accruals, which the Company considers necessary
for a fair presentation of the financial position and results of operations for
these periods. The financial data set forth for the periods ended, or as of
dates, on or prior to May 10, 1996 reflect the results of operations of Capital
Area prior to its acquisition by CAIS, Inc. Capital Area is captioned as
"predecessor." The historical financial data subsequent to May 10, 1996 reflect
the results of operations of the Company's continuing operations. See "Certain
Relationships and Related Transactions--Organization of the Company." The
operating results for the period ended December 31, 1998 are not necessarily
indicative of the results to be expected for any future period. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
[Enlarge/Download Table]
PREDECESSOR SUCCESSOR
---------------------------- ------------------------------
PERIOD FROM PERIOD FROM
YEAR ENDED JANUARY 1, 1996 MAY 11, 1996 YEAR ENDED
DECEMBER 31, TO TO DECEMBER 31,
------------ MAY 10, DECEMBER 31, -----------------
1994 1995 1996 1996 1997 1998
----- ------ --------------- ------------ ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENTS OF OPERATIONS
DATA:
Net revenues............ $ 481 $2,240 $1,287 $ 2,410 $ 4,556 $ 5,315
Cost of services........ 124 697 323 834 2,010 3,118
Operating expenses:
Selling, general and
administrative....... 228 514 339 2,126 5,550 10,407
Depreciation and
amortization......... 39 82 42 352 678 831
Non-cash
compensation......... -- -- -- -- 616 1,426
----- ------ ------ ------- ------- --------
Total operating
expenses........... 267 596 381 2,478 6,844 12,664
----- ------ ------ ------- ------- --------
Income (loss) from
operations 90 947 583 (902) (4,298) (10,467)
Interest and other
expense (income)....... 1 3 (2) 212 288 1,101
----- ------ ------ ------- ------- --------
Income (loss) from
continuing operations.. $ 89 $ 944 $ 585 $(1,114) $(4,586) $(11,568)
===== ====== ====== ======= ======= ========
Loss per share from
continuing operations.. $ (0.11) $ (0.48) $ (1.17)
======= ======= ========
Weighted-average common
shares outstanding -
basic and diluted...... 9,648 9,648 9,869
======= ======= ========
BUSINESS SEGMENTS:
Net revenues:
Internet services..... $ 481 $2,240 $1,287 $ 2,410 $ 4,556 $ 5,278
OverVoice............. -- -- -- -- -- 37
----- ------ ------ ------- ------- --------
Total............... $ 481 $2,240 $1,287 $ 2,410 $ 4,556 $ 5,315
----- ------ ------ ------- ------- --------
Income (loss) from
continuing operations:
Internet services..... $ 89 $ 944 $ 585 $(1,114) $(3,807) $ (8,228)
OverVoice............. -- -- -- -- (779) (3,340)
----- ------ ------ ------- ------- --------
Total............... $ 89 $ 944 $ 585 $(1,114) $(4,586) $(11,568)
----- ------ ------ ------- ------- --------
OTHER FINANCIAL DATA:
EBITDA(1)............... $ 129 $1,029 $ 625 $ (550) $(3,620) $ (9,636)
[Download Table]
PREDECESSOR SUCCESSOR
------------- -----------------------
DECEMBER 31, DECEMBER 31,
------------- -----------------------
1994 1995 1996 1997 1998
------ ------ ------ ------ -------
BALANCE SHEET DATA:
Cash and cash equivalents.............. $ 50 $ 113 $ 73 $ 149 $ 95
Working capital (deficit).............. 48 454 (3,755) (6,440) (9,374)
Total assets........................... 139 997 13,120 15,038 15,678
Long-term liabilities, net of current
portion............................... 23 -- 4,863 4,110 10,767
Stockholders' equity (deficit)......... 111 748 (3,133) (5,278) (13,604)
-------
(1) EBITDA represents operating income (loss) before depreciation and
amortization. EBITDA is presented to enhance understanding of the Company's
operating results and should not be construed (1) as an alternative to
operating income (as determined in accordance with generally accepted
accounting principles ("GAAP"), as an indicator of the Company's operating
performance or (2) as an alternative to cash flows from operating
activities (as determined in accordance with GAAP) as a measure of
liquidity. EBITDA as calculated by the Company may be calculated
differently than EBITDA for other companies. See the Company's Consolidated
Financial Statements and the related Notes thereto contained elsewhere in
this prospectus.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements of the Company and Notes thereto appearing
elsewhere in this prospectus.
Overview
During the years presented, the Company has derived most of its revenue from
the sale of various Internet services, including dedicated Internet access
services, Web hosting and domain registration services and, to a lesser extent,
dial-up Internet access. During this period the Company has incurred
significant costs and devoted substantial resources associated with the
research, development and trial deployment of its OverVoice technology. In
addition, the Company intends to make significant investments in its nationwide
network infrastructure in conjunction with OverVoice and its other dedicated
high-speed Internet services. The Company also plans to devote considerable
sales and marketing resources to the sale of dedicated high-speed Internet
access using its OverVoice technology in hotels and multiple dwelling units
("MDUs") and digital subscriber line ("DSL") services in the commercial and
residential markets. The Company plans to continue to expand its research and
development activities to develop new products and services to be offered using
the OverVoice technology.
The Company's nationwide deployment of OverVoice and other services, and the
expansion of its network, will result in increased cost of services, selling,
general and administrative expenses and capital expenditures. The Company's
ability to generate positive cash flow from operations and achieve
profitability is dependent upon the Company's ability to successfully expand
its customer base for OverVoice and other services and achieve further
operating efficiencies. There can be no assurance that the Company will be able
to achieve or sustain revenue growth, positive cash flow or profitability in
the future.
Statements of Operations
The Company records revenues for all services when the services are provided
to commercial and other users of the Company's Internet access and Web hosting
services. Amounts for services billed in advance of the service period are
recorded as unearned revenues.
The Company's costs include: (1) cost of services; (2) selling, general and
administrative expenses; (3) research and development; (4) depreciation and
amortization, which includes the amortization of goodwill recorded as a result
of the acquisition of Capital Area in May 1996; (5) non-cash compensation
attributable to the grant of options to certain executives; and (6) interest
and other expense.
Cost of services represents primarily recurring expenses for the lease of
data facilities from national and local fiber providers. These costs include
long haul bandwidth and local interconnection charges.
Selling, general and administrative costs are incurred in the areas of sales
and marketing, customer support, network operations and maintenance,
engineering, accounting and administration. Selling, general and administrative
costs will increase over time as the Company's operations, including the
nationwide deployment of OverVoice services and the expansion of its HyperDSL
services, increase. In addition, significant levels of marketing activity may
be necessary for the Company to build or increase its customer base among MDU
residents and hotel guests to a significant enough size in a particular
building or market. Any such increased marketing efforts may have a negative
effect on earnings.
During 1997, the Company granted options to purchase common stock to William
M. Caldwell, IV, the Company's President and Evans K. Anderson, the Company's
Chief Operating Officer and Executive Vice President of Sales and Marketing. As
a result of these grants, the Company recorded paid-in capital of $4,930,000
and unearned compensation of $4,930,000. Of this unearned compensation,
$616,000 and $1,426,000 were charged to expense during the fiscal years ended
December 31, 1997 and 1998, respectively.
21
For the years ended December 31, 1996, 1997 and 1998, the Company's
operations generated net losses. As of December 31, 1997 and 1998, the Company
had negative working capital of approximately $6,440,000 and $9,374,000,
respectively, and a stockholders' deficit of approximately $5,278,000 and
$13,604,000, respectively.
History
The Company was incorporated in Delaware in December 1997, under the name
CGX Communications, Inc. ("CGX"), to serve as a holding company for CAIS, Inc.
and Cleartel Communications Limited Partnership ("Cleartel LP"). CAIS, Inc. was
formed as a Virginia corporation by certain current stockholders of the Company
in May 1996, to acquire Capital Area, a tier one ISP that was owned by persons
unaffiliated with the Company. CAIS, Inc. acquired all of the outstanding
capital stock of Capital Area for approximately $3.07 million. Capital Area
merged with and into CAIS, Inc. in May 1996.
In October 1998, the Company completed a reorganization whereby CAIS, Inc.,
Cleartel Communications, Inc. ("Cleartel") and Cleartel LP became wholly owned
subsidiaries of the Company (the "Reorganization"). The Company issued common
stock in exchange for the ownership of these entities. The Reorganization was
accounted for on a basis similar to a pooling-of-interests, since the Company,
Cleartel, Cleartel LP and CAIS, Inc. were under common ownership.
In February 1999, CGX transferred all of its limited partnership interests
in Cleartel LP to Cleartel and Cleartel LP was dissolved. The Company then
completed the spin-off of Cleartel (the "Spin-off") by means of a distribution
of all of its shares in Cleartel to the Company's stockholders pro rata based
on their percentage ownership of the outstanding shares of the Company. As a
result of the Spin-off, Cleartel ceased to be a subsidiary of the Company. In
addition, CGX changed its name to CAIS Internet, Inc.
Prior to the Reorganization in October 1998, CAIS, Inc. and Cleartel LP were
not subject to federal income taxes since any federal tax effects were passed
through to such entity's S corporation shareholders (as to CAIS, Inc.) or its
partners (as to Cleartel LP). Cleartel LP was subject to state unincorporated
business franchise taxes on any profits in the District of Columbia. In
addition, Cleartel LP has reimbursed its limited partners for any state tax
liabilities related to allocated taxable income. Since the Company is a C
corporation, all earnings and losses generated after the Reorganization are no
longer passed through to the Company's stockholders.
The Spin-off of Cleartel in February 1999 was a taxable transaction.
Accordingly, the Company will be subject to income taxes on the excess of the
fair value of the spun-off assets (stock) over the Company's basis in the
assets distributed. Management believes that the net operating losses available
for carryforward into 1999 together with the losses expected to be generated in
1999 will offset any potential gain for income tax purposes. To the extent that
net operating losses are used to offset the taxable gain upon the Spin-off,
such operating losses will not be available to offset any future operating
income. If carryforward losses are used to offset the gain from the Spin-off,
the Company may be subject to the Alternative Minimum Tax ("AMT"). Any AMT
imposed would be allowed as a credit to offset future regular tax liability.
The Consolidated Financial Statements include the results of operations of
the Company, its wholly owned subsidiary, CAIS, Inc., and Cleartel LP, for the
years ended December 31, 1996, 1997 and 1998 and the balance sheets as of
December 31, 1997 and 1998. The Company's results of continuing operations for
1996 only include operating results from May 11, 1996 (the date of CAIS, Inc.'s
acquisition of Capital Area) through December 31, 1996. The results of Cleartel
LP for these years and the applicable balance sheets at those dates have been
presented as discontinued operations in accordance with Accounting Principles
Board ("APB") Opinion No. 30.
22
Results of Operations
The following table sets forth, for the periods indicated, certain items
from the Company's Consolidated Statements of Operations and their percentage
of net revenues. Operating results for any period are not necessarily
indicative of results for any future period.
[Download Table]
Period from Years Ended December 31,
May 11, 1996 to --------------------------------
December 31, 1996 % 1997 % 1998 %
----------------- --- -------- ---- --------- ----
(in thousands except for percentages)
Net revenues:
Internet Services...... $ 2,410 100% $ 4,556 100% $ 5,278 99%
OverVoice.............. -- -- -- -- 37 1
------- --- -------- ---- --------- ----
Total.................. 2,410 100 4,556 100 5,315 100
------- --- -------- ---- --------- ----
Cost of services:
Internet Services...... 834 35 2,010 44 3,016 57
OverVoice.............. -- -- -- -- 102 2
------- --- -------- ---- --------- ----
Total.................. 834 35 2,010 44 3,118 59
------- --- -------- ---- --------- ----
Operating expenses:
Internet Services...... 2,381 98 6,110 134 9,677 182
OverVoice.............. 97 4 734 16 2,987 56
------- --- -------- ---- --------- ----
Total.................. 2,478 102 6,844 150 12,664 238
------- --- -------- ---- --------- ----
Loss from operations.... (902) (37) (4,298) (94) (10,467) (197)
Interest and other
expense................ 212 9 288 6 1,101 21
------- --- -------- ---- --------- ----
Loss from continuing
operations............. (1,114) (46) (4,586) (100) (11,568) (218)
Income (loss) from
discontinued
operations............. 799 33 1,923 42 (671) (13)
------- --- -------- ---- --------- ----
Net loss................ $ (315) (13)% $ (2,663) (58)% $ (12,239) (231)%
======= === ======== ==== ========= ====
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net revenues. Net revenues for the year ended December 31, 1998 totaled
approximately $5,315,000, compared to approximately $4,556,000 for the year
ended December 31, 1997. Net revenues increased primarily due to an increase of
$793,000 resulting from the sale of dedicated Internet access services and an
increase of $237,000 from the sale of Web hosting services. Both of these
increases were due to an increase in the number of customers for these
services. This increase in net revenues was offset by a decrease in consulting
revenues from $159,000 in 1997 to zero in 1998.
Cost of services. Cost of services for the year ended December 31, 1998
totaled approximately $3,118,000, compared to approximately $2,010,000 for the
year ended December 31, 1997. This increase resulted primarily from an increase
of $944,000 due to the purchase of additional nationwide bandwidth and the
expansion to new geographic locations. The Company also incurred bandwidth and
local connection charges of $102,000 in 1998 for the deployment of OverVoice in
trial properties. There was no OverVoice related cost of services for 1997.
Selling, general and administrative. Selling, general and administrative
expenses for the year ended December 31, 1998 totaled approximately
$10,407,000, compared to approximately $5,550,000 for the year ended December
31, 1997. This increase resulted primarily from increases of $1,101,000
attributable to Internet services payroll, $2,341,000 related to OverVoice
costs (e.g., payroll, market trials and marketing and professional fees and
expenses) and $347,000 for professional fees relating to the Reorganization.
Depreciation and amortization. Depreciation and amortization totaled
approximately $831,000 for the year ended December 31, 1998, compared to
approximately $678,000 for the year ended December 31, 1997. This increase was
attributable primarily to the purchase of capital equipment necessary to
support the expansion of the Company's network.
23
Non-cash compensation. Non-cash compensation totaled approximately
$1,426,000 for the year ended December 31, 1998, compared to approximately
$616,000 for the year ended December 31, 1997. This increase reflects
amortization of deferred compensation for an entire year in 1998 compared to a
partial year in 1997.
Interest and other expense. Interest and other expense totaled approximately
$1,101,000 for the year ended December 31, 1998, compared to approximately
$288,000 for the year ended December 31, 1997. This increase was attributable
primarily to interest on indebtedness incurred, including amortization of
financing costs relating to the ING Credit Agreement.
Loss from continuing operations. Loss from continuing operations totaled
approximately $11,568,000 for the year ended December 31, 1998, compared to
approximately $4,586,000 for the year ended December 31, 1997, due to the
foregoing factors.
Income (loss) from discontinued operations. Loss from discontinued
operations totaled $671,000 for the year ended December 31, 1998, compared to
income of approximately $1,923,000 for the year ended December 31, 1997. This
decrease in earnings resulted primarily from a reduction in net revenues
generated from operator assisted telephone calls.
Year Ended December 31, 1997 Compared to the Period from May 11, 1996 to
December 31, 1996
Net revenues. Net revenues for the year ended December 31, 1997 totaled
approximately $4,556,000. Net revenues for the year ended December 31, 1996
consisted of approximately $2,410,000 for the period from May 11, 1996 to
December 31, 1996 and approximately $1,287,000 with respect to Capital Area for
the period from January 1, 1996 to May 10, 1996, for a total of approximately
$3,697,000. Net revenues increased primarily due to a $859,000 increase in
sales of dedicated Internet access services, a $250,000 increase in dial-up
revenues and a $60,000 increase resulting from the sale of Web hosting
services. Both of these increases were primarily due to an increase in the
number of customers for these services.
Cost of services. Cost of services for the year ended December 31, 1997
totaled approximately $2,010,000. Cost of services for the year ended December
31, 1996 consisted of approximately $834,000 for the period from May 11, 1996
to December 31, 1996 and $323,000 with respect to Capital Area for the period
from January 1, 1996 to May 1996, for a total of $1,157,000. This increase
resulted primarily from building network redundancy and the purchase of
additional nationwide bandwidth for dedicated access customers.
Selling, general and administrative. Selling, general and administrative
expenses for the year ended December 31, 1997 totaled approximately $5,550,000.
Selling, general and administrative expenses for the year ended December 31,
1996 consisted of approximately $2,126,000 for the period from May 11, 1996 to
December 31, 1996 and $339,000 with respect to Capital Area for the period from
January 1, 1996 to May 10, 1996, for a total of $2,465,000. A major portion of
this increase consisted of an additional $1,559,000 in payroll costs related to
new employees in the areas of sales, operations, and engineering and, to a
lesser extent, various expenditures related to the initial marketing and
development of, and the purchase of $402,000 of market trial equipment for
OverVoice.
Depreciation and amortization. Depreciation and amortization totaled
approximately $678,000 for the year ended December 31, 1997. Depreciation and
amortization for the year ended December 31, 1996 consisted of $352,000 for the
period from May 11, 1996 to December 31, 1996 and $42,000 with respect to
Capital Area for the period from January 1, 1996 to May 10, 1996, for a total
of $394,000. This increase was attributable primarily to the purchase of
capital equipment necessary to support the expansion of the Company's network
and a full year's amortization of goodwill and interest costs relating to the
acquisition of Capital Area in May 1996.
Non-cash compensation. Non-cash compensation totaled approximately $616,000
for the year ended December 31, 1997, reflecting the amortization of deferred
compensation incurred upon the grant of options to purchase shares of the
Company's common stock in 1997 to two executive officers. There was no non-cash
compensation for 1996.
24
Interest and other expense. Interest and other expense totaled approximately
$288,000 for the year ended December 31, 1997, compared to approximately
$212,000 for the period from May 11, 1996 to December 31, 1996. This increase
was attributable primarily to debt incurred by CAIS, Inc. in May 1996 to
finance the acquisition of Capital Area.
Loss from continuing operations. Loss from continuing operations totaled
approximately $4,586,000 for the year ended December 31, 1997. Loss from
continuing operations for the year ended December 31, 1996 consisted of
$1,114,000 for the period from May 11, 1996 to December 31, 1996 and income of
$585,000 for the period from January 1, 1996 to May 10, 1996 for a total loss
of $529,000, due to the foregoing factors.
Income from discontinued operations. Income from discontinued operations
totaled $1,923,000 for the year ended December 31, 1997, compared to $799,000
for the year ended December 31, 1996. This was due primarily to rate increases
charged to customers for long distance telephone calls.
Liquidity and Capital Resources
To date, the Company has satisfied its cash requirements primarily through
borrowings, the sale of capital stock and internally generated funds. The
Company's continuing operations have been financed in part from operating
profits and cash flows generated from its now discontinued operation (i.e.,
Cleartel). Net cash provided by (used in) operating activities for continuing
operations for the years ended December 31, 1996, 1997 and 1998 was
approximately $804,000, $(97,000) and ($4,939,000), respectively. Cash used in
operating activities in each period was primarily affected by the net losses
caused by increased costs relating to the Company's expansion in infrastructure
and personnel for its Internet-related businesses.
In connection with the acquisition of Capital Area on May 10, 1996 the
Company obtained a $2,000,000 bank loan from First Union National Bank
("FUNB"). Interest on the loan accrued at a rate of prime plus one
and one-half percent, or 9.75% at that date, with payments on a five-year
amortization schedule and a maturity date of May 10, 1999. In October 1996, the
Company and FUNB entered into an interest rate swap agreement in which the
effective interest rate on the remaining principal balance of approximately
$1,833,000 was fixed at 8.65%. In December 1997, the Company refinanced this
loan. This resulted in an increase in the principal balance outstanding at that
time from $1,400,000 to $2,000,000. In addition, the maturity date of the
refinanced note and the swap agreement was extended to December 2000.
In September 1998, the Company, together with CAIS and certain of their
affiliates, entered into a credit agreement, as amended, with ING (U.S.)
Capital Corporation to borrow up to $7,000,000 to repay existing debt with
FUNB, fund the development of the OverVoice program and for general corporate
purposes (the "ING Credit Agreement"). The loans extended under the ING Credit
Agreement bear interest at the one-month LIBOR rate plus 5%. The principal,
premium and interest on any outstanding loan will convert to senior secured
notes bearing interest at a rate of 5% over the 5-year U.S. Treasury Securities
rate if borrowings under the ING Credit Agreement are not repaid by September
4, 1999. The Company is in compliance with the terms of the ING Credit
Agreement. The current outstanding principal balance under the ING Credit
Agreement is $7,000,000.
In February 1999, the Company converted approximately $4.6 million of
indebtedness owed to Ulysses G. Auger, Sr. and Ulysses G. Auger, II into
1,119,679 shares of the Company's Series B Cumulative Mandatory Redeemable
Convertible Preferred Stock, par value $.01 per share (the "Series B Shares").
See "Certain Relationships and Related Party Transactions."
In February 1999, after the Spin-off, the Company issued $11.5 million of
Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A
Shares"). The Company received $3.5 million in cash and an unconditional
promissory note due in March 1999 for the remaining $8 million. The Company
will use $10 million of the proceeds for capital expenditures and general
corporate purposes, with the remaining $1.5 million being used to reduce
outstanding debt owed by the Company to Cleartel. See "Certain Relationships
and Related Party Transactions."
25
As of February 19, 1999, the Company had cash on hand of approximately
$3,500,000. The Company expects that its cash and financing needs in 1999 can
be met by cash on hand and additional capital financing arrangements (including
the net proceeds of this offering). If such sources of financing are
insufficient or unavailable, or if the Company experiences shortfalls in
anticipated revenue or increases in anticipated expenses, the Company would
curtail the planned roll-out of OverVoice and reduce marketing and development
activities.
Network Capacity. In June 1998, the Company signed a ten-year fiber
agreement with Qwest Communications Corporation ("Qwest"). The agreement calls
for a graduated commitment to purchase $100 million of services over a ten-year
period.
OverVoice License and Royalty Agreement. The Company entered into a license
agreement with Inline Connection Corporation ("Inline") in November 1996,
pursuant to which Inline granted the Company an exclusive license to use, make,
sub-license, or sell the OverVoice technology in hotels and MDUs. We have
minimum annual royalty obligations to Inline which began at $100,000 in 1998
and increase to a maximum of $250,000 during the term of the agreement. Unless
terminated by the Company with thirty days' notice, the agreement remains in
effect through the full life of all existing or future patents related to the
technology or future enhancements. In consideration for meeting the $750,000
compensation benchmark set forth in the license agreement, in January 1999,
Inline assigned the Company a 50% ownership interest in the OverVoice patents
and patent applications covered by the Inline agreement.
Terk Litigation Settlement. On or about August 5, 1997, Inline instituted an
arbitration proceeding against Terk Technologies Corp. ("Terk") to terminate
Inline's contract with Terk, based on Terk's failure to perform under the
contract's best efforts clause. On or about September 24, 1998, Terk
counterclaimed and filed a lawsuit against CAIS, Inc., Ulysses G. Auger, II,
Inline and others, for, among other things, patent infringement of U.S. Patent
No 5 010 399 and other patent properties owned by or assigned to Inline and/or
a principal of Inline. On January 24, 1999, CAIS, Inc., Inline and Terk entered
into a settlement agreement pursuant to which the parties agreed to dismiss the
case against all parties, with prejudice. As a result of the settlement
agreement the Company agreed to pay Terk $500,000. $250,000 of the payment was
made in February 1999, an additional $150,000 is payable on or before July 1,
1999, and the remaining $100,000 is payable on or before July 1, 2000. The
Company also agreed to issue Terk 25,000 shares of common stock and to issue
additional shares if the 25,000 shares, multiplied by the price at which shares
are issued in this offering, does not equal or exceed $250,000. In exchange,
Terk and Inline modified their contract changing Terk's license from exclusive
to nonexclusive and eliminating Terk's ability to sublicense. As a result, the
Company now has the right to install the OverVoice technology in single family
residences and the exclusive right to sublicense such technology to third
parties.
The Company from time to time engages in discussions involving potential
business acquisitions. Depending on the circumstances, the Company may not
disclose material acquisitions until completion of a definitive agreement. The
Company may determine to raise additional debt or equity capital to finance
potential acquisitions and/or to fund accelerated growth. Any significant
acquisitions or increases in the Company's growth rate could materially affect
the Company's operating and financial expectations and results, liquidity and
capital resources.
Year 2000 Issues
The term "Year 2000 issue" is a general term used to describe the various
problems that may result from the improper processing of dates and date-
sensitive calculations by computers and other machinery as the Year 2000 is
approached and reached. Our failure to correct a material Year 2000 problem
could result in an interruption in, or a failure of, certain of our normal
business activities or operations. During 1998, we established a Year 2000
compliance program to coordinate appropriate activity and report to our Board
of Directors with regard to Year 2000 issues. We continue to assess the impact
of Year 2000 issues on our internal computer, operational and financial
systems, and to review with our key vendors and suppliers, the compliance of
their systems with Year 2000 processing requirements. We currently believe that
our most
26
reasonably likely worst case scenario related to the Year 2000 is associated
with potential concerns with our customers' and suppliers' Internet operations.
The failure of such parties to ensure Year 2000 compliance would lead to
decreased Internet usage and the delay or inability to obtain necessary data
communication and telecommunication capacity.
During the year ended December 31, 1998, the Company spent over $1.4 million
for capital expenditures related to the upgrade and continuing build-out of its
technical operations and network. The Company believes that all of this
equipment is Year 2000 compliant. We expect to incur additional costs in 1999
to implement the remainder of our Year 2000 program, and we believe that these
amounts will not be material. In addition, we expect to acquire a new billing
and customer care system as part of our business strategy, which the Company
believes will also be Year 2000 compliant. These additional costs are based on
our best estimates and, in our opinion, will not have a material adverse effect
on our business, financial condition and results of operations. If the actual
costs of implementing our Year 2000 program significantly exceed our estimates,
it may have a material adverse effect on our business, financial condition or
results of operations.
There can be no assurance that we will be able to timely and successfully
modify our products, services and systems to be Year 2000 compliant. If we fail
to do so, it may have a material adverse effect on our business, financial
condition or results of operations. Currently, we do not have a contingency
plan if our systems fail as a result of Year 2000 related issues.
27
BUSINESS
Overview
CAIS Internet, Inc. is a tier one Internet Service Provider ("ISP"). We
focus on providing the most cost-effective, dedicated high-speed Internet
connections to commercial and residential customers primarily using DSL and our
patented OverVoice technology. We offer our commercial customers dedicated
high-speed Internet access, including our new HyperDSL services that we
currently provide with Covad Communications Company ("Covad") and Bell
Atlantic. Additionally, our OverVoice technology enables us to offer a multi-
user, dedicated high-speed Internet solution to residential customers by
creating an Ethernet local area network in a hotel, MDU or single family home
more cost-effectively than alternative technologies, including cable modems,
DSL services or Category 5 ("CAT5") rewiring upgrades.
We use our OverVoice technology to simultaneously transmit voice and data
over a single traditional copper telephone line at speeds of up to 300 times
those of conventional 28.8k dial-up modems. This enables an OverVoice user to
have both dedicated high-speed Internet access and complete use of the
telephone at the same time over one telephone line. By combining the OverVoice
technology with any dedicated high-speed Internet connection, such as DSL, T-1
or wireless, we can provide a single, dedicated high-speed Internet connection
that can be shared simultaneously among many users in an MDU building, hotel or
single family home. Today, we believe that the economies of scale associated
with the OverVoice technology are most obvious when providing high-speed
Internet access to concentrated residential communities such as MDUs and
hotels.
Although our primary focus for OverVoice initially will be on the hotel and
MDU markets, we believe that the demand for high-speed Internet access in
single family homes and the trend toward using more than one personal computer
at home, will also make OverVoice the most cost-effective solution for
providing dedicated high-speed Internet access in single family homes and for
"home networking." As of February 15, 1999, we have installed the OverVoice
technology in over 1,900 apartment units in 15 MDU buildings and in over 1,900
guest rooms in eight hotels. Additionally, we have signed an agreement for the
nationwide roll-out of OverVoice with Hilton Hotels Corporation ("Hilton") and
an agreement with OnePoint Communications Corp. ("OnePoint") to install
OverVoice in certain MDU buildings where OnePoint has agreements to provide
Internet and other communications services.
Industry Background
Internet access and enhanced Internet services represent two of the fastest
growing segments of the telecommunications services marketplace. According to
industry estimates, the number of Internet users in the United States who
access the World Wide Web reached approximately 29.2 million in 1997 and is
forecasted to grow to approximately 72.1 million by the year 2000. According to
International Data Corporation, total ISP revenues in the United States are
projected to grow from $4.6 billion in 1997 to $18.3 billion in 2000.
Currently, individuals most commonly access the Internet through a dial-up
service. However, dial-up access has several drawbacks including:
. delays when down-loading data and images from the Internet;
. requiring that a user pay both its ISP for Internet access and its
telephone company for the local call;
. frequent busy signals;
. mid-use cut-offs (drops) from service;
. long connection delays; and
. loss of the use of the customer's phone line service while accessing the
Internet.
Due to the inconveniences of dial-up Internet service, most businesses that
are large enough to justify the costs opt for a dedicated high-speed Internet
connection, such as a T-1. Smaller businesses are also moving rapidly toward
high-speed access solutions as newer technologies like DSL become available.
However, until
28
recently, high-speed Internet access has been unavailable to most single family
and multifamily homes and to hotel guests due to the cost and difficulty of
implementing such service.
Demand is ever increasing for cost-effective, high-speed Internet
connectivity in the hotel, business and residential communities. Internet usage
continues to be stimulated by the increasing number of Web sites, the
increasing sophistication of Internet browsers and software applications, and
the proliferation of bandwidth-intensive information (such as streaming video
and audio) published on the Internet. Increased Internet use and the
availability of powerful new tools for the development and distribution of
Internet content have led to an explosion of Internet-based services, such as
advertising, online magazines, specialized news feeds, interactive games and
educational and entertainment applications, that are increasingly incorporating
multimedia information such as video and near-CD-quality audio clips. The
Internet has the potential to become a platform through which consumers and
businesses easily access rich multimedia information and entertainment,
creating new sources of revenue for advertisers, content providers and
businesses. The infrastructure necessary to support this greater bandwidth, and
the resulting multimedia applications, is the threshold issue to realizing the
potential of the Internet as a medium for communication, education,
entertainment and commerce.
We believe that increased demand and evolving technology make the hotel and
MDU markets attractive for high-speed dedicated Internet access. The economies
of scale present in the hotel and MDU markets create the opportunity to price
high-speed dedicated Internet access services at levels comparable to current
dial-up services. The increasing use by hotel guests of dial-up Internet access
is overloading many hotels' phone systems. This has resulted in increasing
service problems and heightened concerns for the safety of hotel guests (and
the hotel's associated liability) who may be unable to obtain help promptly in
an emergency. As a result, hotels are increasingly confronted with the
expensive option of upgrading their private branch exchange (PBX) switches to
handle the increased traffic. In addition, many MDU property owners believe
high-speed Internet access is an attractive building amenity for enhancing
rental and occupancy rates.
Major hotel chains and MDU property owners are currently evaluating
alternative solutions to meet the need for faster Internet connections and
simultaneous voice and data transmission. Examples of such solutions are:
. second phone lines and more powerful telecommunications switching
systems (PBX) within a building, which are very costly and fail to
address the need for higher connection speeds;
. CAT5 rewiring, which involves the labor and capital intensive solution
of rewiring a building, resulting in significant cost, construction,
disturbance and time; and
. high speed technologies, including DSL and cable modems, which are less
expensive than comparable T-1 connections, but require a separate DSL or
cable modem for each personal computer or laptop connection in a home,
apartment unit or hotel room. While these and other technologies exist,
to date none has been widely deployed as a solution for high-speed
Internet connectivity.
THE OVERVOICE SOLUTION
We believe that our OverVoice technology is the most cost-effective,
dedicated high-speed Internet solution for hotel guests and MDU residents. We
also believe OverVoice to be the most cost-effective solution for providing
dedicated high-speed Internet access in single family homes and for "home-
networking."
We use our OverVoice technology to simultaneously transmit voice and data
over a single copper telephone line at speeds of up to 300 times those of
conventional 28.8k dial-up modems. This enables an OverVoice user to have both
dedicated high-speed Internet access and complete use of the telephone at the
same time over one traditional telephone line. While we believe DSL technology
is the most cost-effective high-speed Internet solution available to our
commercial customers today, we believe that its point-to-point nature (i.e.,
each Internet user requiring an expensive DSL modem and therefore his own
Internet connection) significantly impedes its widespread deployment in the
residential market. OverVoice's point-to-multipoint technology enables us to
create an Ethernet local area network within a hotel, MDU building or single
family home. By combining our OverVoice technology with any dedicated high-
speed Internet connection, such as DSL, T-1 or wireless, we can
29
provide a single high-speed Internet connection which can be shared
simultaneously among many users in a hotel, MDU building or single family home.
Our OverVoice technology allows the coexistence of multiple signals (voice,
data and, in the future, video) on the same wire, by protecting the natural
frequency range of each signal from interference with the other signals. The
pictorial below demonstrates how, through the use of OverVoice technology,
voice, data and video can co-exist simultaneously on a single traditional
copper wire.
[GRAPH APPEARS HERE]
Standard telephone service (POTS - Plain Old Telephone Service) operates
between 0 and 5KHz, while standard 10baseT Ethernet (which is the standard for
most of the world's local area networks) operates between 3 and 15MHz. The
future video signal will operate between 15 and 30 MHz.
In hotels and MDUs, the OverVoice solution requires only a retrofit with
OverVoice equipment in the telephone closet and the installation of proprietary
OverVoice telephone jacks in each hotel guest room or apartment unit. The
OverVoice passive circuitry uses electronic filters to separate signals at the
control unit and at each wall jack. The OverVoice wall jack has two ports, one
which connects to the telephone and the other which connects to an Ethernet
adapter card inside the user's computer.
The OverVoice wall jack has two ports, one which connects to the telephone
and the other which connects to an Ethernet adapter card inside the user's
computer. Ethernet is the standard networking protocol used to create local
area networks. To connect to a local area network, computers require an
Ethernet adapter card, which is a standard supplemental hardware device that
can easily be installed into most computers and typically costs approximately
$50. In most cases, an Ethernet card is required for any high speed Internet
connectivity, including T1, cable modem or DSL services.
The Company also expects in the near future to offer a universal serial bus
("USB") connectivity option for OverVoice. The USB is a new standard plug-in
protocol being integrated into most new computers (i.e., a new port to plug in
devices, such as printers). With a USB connection, the user will have the
ability to connect directly to an Ethernet network without an Ethernet adapter
card.
The Company is in the final stages of developing the OverVoice DeskJack to
be installed in hotel guest rooms. The OverVoice DeskJack has both Ethernet and
USB connections, thereby allowing hotel guests to choose the connection method
that best suits their needs. Its highly visible, step-by-step instructions
direct the hotel guest through the log-on page to the CAIS Internet promotional
home page.
We can install the OverVoice technology in an average-sized hotel or MDU
building (300 units) for approximately $225 per hotel guest room or apartment
unit, which we believe is less than half the cost of any competing technology.
In addition, we can install OverVoice in a hotel or MDU building with very
minimal disruption to the property owners, hotel guests or MDU residents.
MARKET OPPORTUNITY
We believe that the domestic hotel segment represents a significant market
opportunity for the Company. Nationwide, we estimate that as of December 31,
1997, there were 49,000 hotel properties with a total of 3.8
30
million hotel rooms. In the top ten hotel markets we estimate that there were
more than 3,600 properties with a total of 630,000 rooms. During the initial
roll-out of our OverVoice technology, we will focus on larger hotels and those
most likely to cater to business travelers. According to the American Hotel and
Motel Association, as of December 31, 1997, hotel properties with 300 or more
rooms represented 3.0% of all hotel properties, but 20.8% of total hotel rooms.
Examples of the companies operating within this segment include familiar hotel
chains such as Hilton, Sheraton, Hyatt, Wyndham, Westin and Marriott.
We believe that the domestic MDU segment is another highly promising market
for OverVoice. As of November 1998, approximately 30% of the U.S. population,
or over 81 million people, lived in MDUs and there were over four million
apartment units in buildings with 50 or more units. In the top ten U.S.
metropolitan markets alone, there were over two million apartment units in such
buildings. Within those markets, we intend to initially target Class A and B
buildings, whose residents typically have higher incomes and are more likely to
be Internet users. Within the top ten U.S. metropolitan markets, as of December
31, 1997, there were approximately 2.2 million apartment units in Class A and B
buildings.
Although we intend to initially roll-out our OverVoice technology in the
United States, we believe that international markets represent another
significant opportunity. International demand for Internet access is expected
to increase as a result of a number of factors, including worldwide economic
growth, global deregulation of the telecommunications market, technological
advancements and the introduction of new services. Outside the United States,
we estimate that as of January 1, 1998, there were over 250,000 hotel
properties comprising 8 million hotel rooms.
We believe that the single family home market offers a significant
opportunity for OverVoice in the future. According to industry sources, as of
December 1998, 38% of U.S. households with Internet access have at least two
personal computers. We believe that the demand for simultaneous high-speed
Internet access and interoperability between multiple personal computers in a
single family home or MDU will further increase the demand for OverVoice.
Approximately 99% of single family homes in the United States have standard
copper telephone wire that can support home networking using OverVoice.
National Contracts and Long-Term Commitments
Hilton Hotels Corporation. On December 23, 1998, we entered into a master
agreement with Hilton, under which Hilton agreed to license us the right to
offer high-speed Internet access service in certain guest rooms, meeting rooms
and other areas in specified Hilton hotels throughout the United States. In
order to participate, each Hilton hotel must enter into an addendum to the
master agreement. As of February 19, 1999, 142 Hilton-owned, managed or
franchised hotels have notified Hilton that they intend to sign an addendum to
participate under the terms of the master agreement.
The initial term of the agreement is for either two or three years,
depending on the total room count of the specific Hilton hotel, with an option
for a multi-year extension. Under the agreement, we are responsible for the
costs of installing, maintaining and operating all necessary equipment, and as
a result we will incur significant up-front costs. See "Risk Factors--Some Of
Our Contracts Are Nonexclusive And We May Not Be Able To Recover Our
Installation Costs."
OnePoint Communications Corp. In April 1998, we entered into a trial
agreement with OnePoint, a provider of communications and entertainment
services to residents in MDUs. Under this trial agreement, we installed
OverVoice in fourteen buildings within four complexes.
We recently entered into a seven-year contract with OnePoint to install our
OverVoice technology. Under this agreement, we anticipate that we will install
OverVoice in a minimum of 30 MDU buildings with approximately 10,000 units.
Additionally, together with OnePoint, we will market high-speed Internet
service to approximately 300 additional MDU buildings where OnePoint has a
preferential right of entry to provide Internet and other communications
services.
31
Under the agreement, the Company generally bears all of the costs of
providing Internet services to the MDU and receives 90% to 98% of the net
revenues from the sale of services, with OnePoint receiving the remaining
revenues. OnePoint has the option of contributing 25% of the costs of providing
Internet services to specified MDU buildings. In those circumstances,
OnePoint's share of net revenues would range from 15% to 25%.
Ongoing Trials
As set forth in the following tables, as of February 15, 1999, we have
ongoing agreements for the installation of OverVoice technology in 15 MDU
buildings and 13 hotels across the United States. OverVoice systems already are
fully installed and operating on a trial basis in 8 hotels and 15 MDU
buildings. We typically initiate a 90 to 120 day trial with a major hotel chain
or MDU real estate investment trust ("REIT") with the goal of signing a long-
term contract.
HOTELS
[Enlarge/Download Table]
Number of Units Target
Property Location Committed to Trial Installation Date Completion Date
-------- -------- ------------------ ----------------- ---------------
Washington Marriott..... Washington, D.C. 418 6/1/98
Embassy Square.......... Washington, D.C. 232 4/29/98
Bellevue Courtyard...... Bellevue, WA 131 5/6/98
Sea Tac Marriott........ Seattle, WA 459 6/15/98
La Jolla Marriott....... La Jolla, CA 360 5/22/98
Anaheim Hilton.......... Anaheim, CA 20 12/98
Las Colinas
Wyndham(/1/)........... Irving, TX 185 7/30/98
Sunnyvale Wyndham(/1/).. Sunnyvale, CA 179 7/30/98
Metro Marriott.......... Washington, D.C. 163 3/99
Westin Peachtree
Plaza(/2/)............. Atlanta, GA 200 4/99
The Washington Court
Hotel.................. Washington, D.C. 264 3/31/99
Westin Innisbrook(/2/).. Palm Harbor, FL 200 3/99
BWI Airport
Marriott(/2/).......... Baltimore, MD 200 5/1/99
--------
(1) The trial period for these properties concluded in December 1998. We are
currently negotiating a long-term contract for these properties.
(2) These properties are owned by Starwood Hotels and Resorts Worldwide, Inc.
and are the first of up to six properties which will be installed in
accordance with the Starwood trial agreement.
MDUs
[Download Table]
Number of
Property Location Installed Units Completion Date
-------- -------- --------------- ---------------
Arlington Court House......... Arlington, VA 396 3/31/98
Lincoln Towers................ Arlington, VA 673 6/8/98
Water Park Towers............. Arlington, VA 323 7/98
Springfield Station (5
buildings)................... Springfield, VA 280 7/98
Summit Fair Lakes (7
buildings)................... Fairfax, VA 280 12/17/98
Business Strategy
Our objective is to become a leading national provider of dedicated high-
speed Internet services. The following are key elements of our business
strategy to achieve this objective:
Offer the Most Cost-Effective, Dedicated High-Speed Internet Access to Our
Customers. We believe our OverVoice technology is the most cost-effective,
dedicated high-speed Internet solution for hotel guests and MDU residents. In
addition, we believe OverVoice is less expensive to install than competing
technologies,
32
such as DSL, cable modems and CAT5 rewiring. We use our OverVoice technology to
deliver T-1 or higher Internet access speeds to hotel rooms and apartment
units, while allowing the user to simultaneously access voice services on the
telephone. We also focus on providing the most cost-effective, dedicated high-
speed Internet access for commercial customers through our HyperDSL services,
which we are currently rolling-out with Covad and Bell Atlantic.
Roll-out Our OverVoice Technology Nationwide. Our goal is to make our
OverVoice technology the de facto high-speed Internet access standard in hotels
and MDUs. We intend to continue to penetrate the hotel and MDU markets through
both direct sales and strategic relationships. We have signed an agreement for
the roll-out of OverVoice with Hilton hotels throughout North America. In
addition, we are currently rolling-out OverVoice to MDUs with OnePoint. We have
currently installed OverVoice in selected properties of Marriott International
(including Marriott and Courtyard) and Patriot American (including Wyndham
hotels and Summerfield Suites). Installations are pending with Starwood Hotels
and Resorts Worldwide, Inc. (including Sheraton and Westin hotels) and Harbaugh
Hotel Corp.
Attract End-Users in Hotels and MDUs. We intend to stimulate the demand for
our OverVoice services among hotel guests by making dedicated high-speed
Internet access simple and affordable. In hotel rooms, the OverVoice DeskJack
(an access device into which hotel guests plug their laptop computer), with its
highly visible, step-by-step instructions, makes accessing the Internet quick
and easy. We also believe that the use of OverVoice services in hotel meeting
rooms will further increase the awareness of, and demand for, our services in
hotel guest rooms by business travelers who gain exposure while in the meeting
room. Our OverVoice technology allows us to offer MDU residents multiple
Internet connection speeds at different price points, under our rate shaper
program. This program allows us to offer an MDU resident dedicated high-speed
Internet access at an entry level connection speed and price. We are then able
to upgrade the service to meet the user's demand for faster Internet connection
speeds.
Accelerate the Roll-out of Our HyperDSL Services. We have initiated the
roll-out of a new dedicated, high-speed Internet access service using DSL
technology under the name HyperDSL. Unlike traditional forms of dedicated
Internet access, DSL uses the customer's existing copper voice telephone wire
to deliver high-speed Internet service. We believe DSL technology currently
represents the most economical dedicated high-speed Internet solution for
commercial customers. In addition, we believe that DSL technology, used in
conjunction with OverVoice, provides the most cost-effective Internet solution
for single-family residences requiring multiple points of access.
Expand Our Internet Backbone. We operate a nationwide clear channel DS-3,
OC-3 and asynchronous transfer mode network and have peering agreements with
most of the major backbone providers to exchange Internet traffic over their
respective networks. We currently maintain six points of presence ("POPs") in
Washington, D.C., McLean, VA, New York, San Francisco, Baltimore and Chicago.
We intend to add at least ten additional POPs in major metropolitan areas such
as Dallas, Philadelphia, Phoenix, Los Angeles, Seattle, Atlanta, Miami and
Orlando by the end of 1999. In addition, in June 1998, we signed a ten-year
fiber agreement with Qwest, under which we have access to all of Qwest's POPs
nationwide, which totaled 130 as of February 15, 1999. We intend to continue to
evaluate strategic relationships and acquisitions that will allow us to further
expand this network.
Leverage the OverVoice Platform to Deliver Future Services and Products. The
OverVoice platform creates a cost-effective Ethernet local area network in a
hotel, MDU building or single family residence. This platform enables us to
deliver a variety of broadband services and products to our customers. We are
developing a broad array of services and products including Internet protocol
telephony, video conferencing, traditional video services, high definition
television (HDTV) and digital audio radio. We intend to expand our service and
product offerings through internal research and development, and by acquiring
complementary businesses and technologies.
33
Services
The Company currently offers a variety of services under two brand names as
illustrated by the following table:
[Enlarge/Download Table]
Brand Service Lines Pricing
----- ------------------------------------- ----------------------------
OverVoice............... Hotel Guest Room Service $7.95 to $14.95 per 24 hours
Hotel Meeting Room Service Varies by property
MDU Service $24.95 to $49.95 per month
CAIS Internet........... HyperDSL $57.95 to $699 per month
Web Hosting $69 to $295 per month
Dedicated Access
Fractional DS-3 to full DS-3 $5,500 to $30,000 per month
Fractional T-1 to full T-1 $695 to $1,750 per month
Dial-Up and Other Narrowband Services $24.95 to $250 per month
The following subsections describe each of our brand names and their
related product lines.
OverVoice Services
Hotel Guest Room Service. We provide OverVoice services to hotel guests by
placing our OverVoice DeskJack (pictured below) beside the telephone. The
OverVoice DeskJack provides simple, step-by-step directions on how to access
the Internet. The guest first plugs an Ethernet-enabled, or USB-enabled,
laptop into an Ethernet port or USB port within the OverVoice DeskJack. Once
connected, the guest launches the Web browser, logs-on to the OverVoice server
and is launched on to the Internet starting at the CAIS Internet promotional
home page. The guest will have dedicated high-speed Internet access and may
leave the laptop connected to the Internet for the duration of the stay, all
while having the option to simultaneously talk on the same telephone line. A
hotel guest is typically charged between $7.95 and $14.95 per 24-hour stay in
a hotel, comparable to that of in-room hotel entertainment services.
. Highly visible in-room
marketing
The OverVoice DeskJack . Ethernet card or USB port
connectivity
. Step-by-step simple
instructions
[PICTURE OF OVERVOICE DESK JACK]
Meeting Room Service. Hotels typically have dedicated sales staff to
solicit meeting room business. As corporate and independent meeting planners
have particular needs, hotels offer meeting room customers a menu of
facilities, including Internet services, guest room availability and food
services. Once the planner has selected a particular hotel, hotel sales books
the meeting room and arranges for the particular add-ons requested. A turn key
marketing program for hotel sales staff will assist them in selling OverVoice
Internet access to currently booked and prospective corporate meeting
customers.
Prior to the availability of OverVoice, corporate meeting planners and
hotel facilities generally had only two options for providing Internet
services. The first option is dial-up Internet access, which has several
drawbacks including: (1) delays when down-loading data and images, (2)
frequent busy signals, (3) dropped connections, and (4) long connection
delays. The second option is to make special arrangements for a temporary
dedicated high-speed Internet connection which: (1) typically takes up to 60
days to order; and (2) usually requires a minimum 1-month commitment and the
payment of installation fees, which is very expensive.
34
By installing OverVoice in the meeting and conference areas, a cost-
effective and simple to use high-speed Internet solution is immediately
available to the property staff, the corporate meeting planner and meeting room
guests. The user simply connects the Ethernet-enabled computer to the OverVoice
wall jack in the room. The user then has dedicated high-speed Internet access
at various price points and is able to simply launch the Web browser and access
all Internet applications. Once connected, the OverVoice server prompts the
property management system to bill the user for the appropriate Internet
connection charge. We anticipate that hotels will be able to offer this
instantaneous, high-speed Internet connection for corporate meetings at a
fraction of the current cost of establishing a dedicated connection. We believe
that the meeting room program will also increase OverVoice brand recognition
and credibility among business travelers who gain exposure to the technology
while in the meeting room.
MDU Service. Once an apartment or condominium building is installed with the
high-speed OverVoice technology, we can provide Internet access to all of its
residents. Prior to launching OverVoice in a particular building, we generally
pre-market the service to residents through building management, using flyers
and direct mailings. We also typically have a marketing day in the building
during which we distribute marketing materials, demonstrate the system and
answer questions. Once OverVoice is installed, the resident simply connects the
Ethernet-enabled computer to the OverVoice wall jack in the apartment unit. The
resident then has dedicated high-speed Internet access and is able to launch
the Web browser and access all Internet applications. Our rate shaping server
allows us to tailor the speed of the user's Internet connection and to offer
multiple connection speeds at different price points. An MDU resident is
typically charged between $24.95 and $49.95 per month for OverVoice service,
depending upon the transmission speed choice.
We believe that our pricing is extremely competitive with typical $19.95 to
$21.95 per month dial-up services. In order for a resident to enjoy
simultaneous voice and data transmission, a dial-up user must incur the cost of
a second phone line and is limited to the much slower access speeds of
traditional dial-up modems. While cable modems and DSL allow high-speed
dedicated access, both involve equipment costs to the provider well in excess
of those of the OverVoice solution. In addition, unlike cable modems and DSL,
OverVoice enables the user to have multiple points of access within one unit on
a cost-effective basis.
CAIS Internet Services
The primary services we offer are HyperDSL, Web hosting, dedicated access
and dial-up access. As of February 15, 1999, we had over 370 dedicated access
subscribers and over 500 Web hosting customers.
HyperDSL Services. We have initiated the roll-out of a new dedicated, high-
speed Internet access service using DSL technology under the name HyperDSL.
Unlike traditional forms of dedicated Internet access, DSL services use the
customer's existing copper voice telephone wire to deliver high-speed Internet
access.
HyperLINK DSL is our consumer-grade DSL service for the residential,
home office and small business markets. We currently provide the service in
conjunction with Bell Atlantic. After a two-year trial with Bell Atlantic,
HyperLINK DSL was introduced in the Washington, D.C. metro area. In 1999,
we intend to enter eight additional major metropolitan areas, including
Baltimore, New York, Philadelphia, Chicago, Dallas, San Fransisco, Miami
and Los Angeles. HyperLINK DSL services currently range in price from
$57.95 to $187.95 per month. Installation fees are approximately $425,
which includes approximately $325 for the purchase of a required DSL modem.
HyperLAN DSL is our DSL service for the small and medium-sized business
markets, which we currently offer jointly with Covad. We believe that
HyperLAN DSL will be attractive to business customers who traditionally
have been unwilling to pay the higher costs of conventional dedicated high-
speed Internet access. In addition, we believe that this service will
attract customers who currently incur the cost of high-speed Internet
access and who will now for a comparable cost be able to significantly
increase their bandwidth. We currently offer this service in Washington,
D.C. In 1999, we intend to enter eight additional major metropolitan areas,
including Baltimore, New York, Philadelphia, Chicago, Dallas, San
Fransisco, Miami and Los Angeles. Under the terms of our agreement with
Covad, we co-develop and implement
35
targeted marketing and advertising programs to stimulate sales. HyperLAN
DSL services range in price from $129 to $699 per month. Installation fees,
including equipment, generally range from $999 to $1,099.
Web Hosting Service. Web hosting can be defined as housing a customer's Web
pages on our servers. Web hosting is an ideal solution for customers who want
to "publish" Web pages on the Internet without purchasing, configuring,
maintaining and administering the necessary sophisticated hardware and
software. Due to economies of scale, we can generally offer Web hosting
solutions far more sophisticated than customers can provide for themselves. Our
staff of Internet engineers and system administrators enables us to offer
multiple platforms for Web hosting. These hosting servers are located within
our POP infrastructure and make use of multiple high bandwidth connections to
the Internet backbone. File structure directories, domain name registration and
security privileges are set-up for customers on our hosting servers, thus
enabling customers to remotely "publish" their content for distribution over
the Internet. In addition, we provide network and systems administration and
maintenance, tape back-ups and security. Web hosting services range in price
from $69 to $295 per month.
High-Speed Dedicated Access Service. We provide dedicated access services to
other ISPs and commercial customers. See "--Customers." This type of
connectivity is generally used to connect local area networks, wide area
networks or server applications to the Internet, ensuring a dedicated
connection. These services include a wide range of connectivity options
tailored to the requirements of the customer, including: T-1 (1.54 Mbps) or
fractional T-1 connections and DS-3 (45 Mbps) or fractional DS-3 connections.
Dedicated services range in price from $695 to $30,000 per month depending on
the connection type. Installation fees generally range from $300 to $5,000.
Dial-Up and Other Narrowband Services. We offer high-quality, digital dial-
up, dedicated dial-up, integrated services digital network connections (ISDN)
and dedicated integrated services digital network connections, with Internet
access speeds up to 128 Kbps. These are primarily amenity services provided to
dedicated access services customers upon request, but are not marketed
generally. Dial-up and other narrowband services range in price from $24.95 to
$250 per month.
New Products and Services
We intend to continue expanding the OverVoice product line as well as
introducing additional integrated communications services that leverage the
convergence of voice and data communications. Because OverVoice is a point-to-
multipoint distribution technology, we believe that it is particularly well-
suited for a wide array of existing and new applications, including Internet
protocol telephony services, laser disk video services, digital audio radio and
high definition television (HDTV). We will continue to research and develop new
products and services to be offered in the future, using the OverVoice
technology.
Sales and Marketing
OverVoice. We market OverVoice services primarily through our direct sales
group which: (1) focuses on securing hotel chains' endorsements of OverVoice as
the preferred Internet infrastructure solution for the chain's properties, and
(2) sells directly to hotel properties owned or managed by the hotel chain and
to hotel chain franchisees. In addition, we are continuing to aggressively
pursue opportunities to increase OverVoice awareness within the hospitality and
MDU industries. We participate in major industry trade shows and events such as
HITEC (Hospitality Industry Technology Exposition and Conference), IH/M&RS
(International Hotel, Motel and Restaurant Show), NAREIT (National Association
of Real Estate Investment Trusts) Annual Convention and COMNET (Communications
Network).
We also continue to identify strategic partners that have existing
relationships with hotel chains, MDUs and MDU/REITs for the installation and
maintenance of various communications services in these properties. This allows
us to package OverVoice in a pre-existing "bundle" of services, thus providing
the opportunity to maximize in-building penetration rates. We believe that by
working directly with hotel chains, REITS and carefully selected strategic
partners, OverVoice will become the industry standard Internet infrastructure
solution.
36
CAIS Internet. We offer Internet services to ISPs, commercial dedicated
accounts and small and medium-sized businesses using a direct sales force.
Direct mail and print advertising is utilized to both further
generate sales leads and to build awareness of the Company and our services. In
addition, we are regularly featured in the Boardwatch directory of national
Internet backbone providers and exhibit at select trade shows. With respect to
dial-up and other narrowband services, leads are handled on a "demand only"
basis by a technical support division. Finally, public relations efforts and a
routine program of press releases and contacts are conducted to focus attention
on the Company in the print, on-line and TV media.
Customers
OverVoice. The ultimate customers for our services are hotel guests and MDU
residents. In the hotel market, we primarily target the frequent business
traveler with a laptop computer who needs to be connected to the Internet. We
believe that our OverVoice technology overcomes the connection problems that
these customers currently encounter with dial-up service while enabling them to
use the same telephone line for conversations and Internet access
simultaneously. In the MDU market, we target individuals in Class A and B
apartment buildings who typically already own a personal computer and have some
experience with the Internet and/or on-line services.
CAIS Internet. As a tier one ISP, we have historically offered dedicated
Internet access to tier two ISPs in the Washington, D.C. metro area and select
international markets. As of February 15, 1999, we continue to provide
dedicated Internet connections to more than 50 ISPs in the Washington, D.C.
area and 5 international ISPs in Europe, Latin America and Asia. Over the past
year, we have actively sought to diversify our dedicated customer base to
commercial and other institutional accounts, while maintaining a presence in
the ISP market. As of February 15, 1999, we had 324 business customers for
high-speed dedicated Internet access. We also maintain a base of over 3,200
dial-up and other narrowband accounts, though this is not a market we actively
pursue. Furthermore, we have developed a base of more than 500 small and
medium-sized businesses as Web site hosting customers since June 1997.
For the fiscal year ended December 31, 1998, one customer, Hongkong Telecom,
accounted for 15% of the Company's consolidated net revenues.
Customer Service
Our Customer and Account Management division provides comprehensive customer
support. The division consists of three principal departments: Customer
Support, Technical Support and Account Management. As of February 15, 1999,
this division consisted of 34 persons. We intend to continue to emphasize
customer support for the nationwide roll-out of OverVoice and our HyperDSL
services.
The Customer Support and Technical Support departments maintain quality
service standards and respond to customer inquiries 24 hours a day, 365 days a
year. Established standards are continuously monitored and evaluated through
detailed trouble tickets, phone logs, bandwidth utilization reports, server
log-in reports as well as network and service up time reports. Our technical
support representatives are trained in an effort to ensure superior customer
service. The Technical Support department is further strengthened by a network
operations center, located in McLean, VA, which continuously monitors our
network and supporting infrastructure. We are currently building a second
network operations center in our corporate headquarters in Washington, D.C. The
new network operations center will utilize state-of-the-art network monitoring
and will include remote capabilities. Once the second network operations center
is complete, we will continue to maintain the McLean, VA network operations
center as a redundant facility. The Account Management department acts as a
single point of contact for major account customers for the coordination,
management and implementation of all of our services.
Network Topology
Our infrastructure is a nationwide clear-channel DS-3, OC-3 and asynchronous
transfer mode network. We provide high-speed Internet access from our POPs to
commercial and residential customers through dedicated
37
high-capacity leased lines over local exchange facilities. In June 1998, we
entered into a 10-year fiber agreement with Qwest, under which we have access
to all of Qwest's POPs nationwide, which totaled 130 as of February 15, 1999.
Access to these POPs enables us to provide OverVoice services to customers
throughout the country. We are migrating our existing asynchronous transfer
mode backbone links to the Qwest fiber network.
We currently maintain six POPs in Washington, D.C., McLean, VA, New York,
San Francisco, Baltimore, and Chicago. By the end of 1999 we intend to have at
least 10 additional POPs located within the following cities: Dallas, Boston,
Philadelphia, Phoenix, Los Angeles, Seattle, Houston, Atlanta, Miami and
Orlando. The network is monitored 24 hours per day, 365 days per year from our
network operations center in McLean, VA.
We maintain private and public peering arrangements with most major ISPs. We
will continue to add additional private and public peering, as necessary to
deliver the highest quality of service to our customers.
Suppliers
Equipment Procurement and Manufacturing. Q-TEL Subsidiary of GTE Codetel
("Q-Tel"), the manufacturing subsidiary of Compania Dominicana de Telefonos, c.
por a. (also known as GTE Codetel, a wholly owned subsidiary of GTE Corporation
) has begun production of 10,000 OverVoice control units. Q-Tel is an offshore
manufacturing facility that performs functions for major U.S. telecom equipment
providers such as Lucent Technologies and Nortel Networks, Inc. Currently, Q-
Tel is able to produce the control units for substantially less than domestic
manufacturers. The initial shipment is expected to be delivered by mid-March.
Equipment Warehousing, Distribution and Installation. We intend to support
the nationwide roll-out of OverVoice through strategic relationships with
warehousing, distribution and installation companies. We have entered into an
agreement with Farnor Enterprises, Inc. to receive, barcode, warehouse and
distribute nationally OverVoice equipment inventory. We have made arrangements
with AmeriLink d/b/a NaCom, Volt Information Sciences, Inc. and MasTec, Inc. to
perform national OverVoice installation functions. All three of these companies
have experience in handling thousands of work orders per week, have attended
OverVoice installation training provided by The Siemon Company and are
designated as Certified Installers of the Siemon Cabling System. We believe
that these relationships will enable us to deploy OverVoice under large
national contracts promptly and on a cost-effective basis.
The OverVoice technology is economical, easy to implement and does not
involve a disruptive installation procedure. We can install the OverVoice
technology in an average size hotel or MDU (300 units) in two to three weeks
for approximately $225 per hotel guest room or apartment unit. Installation can
be accomplished at full occupancy, as the in-room installation time is only 10-
15 minutes per room.
Competition
We operate in a highly competitive environment for each of our lines of
business and we believe that competition is increasing. The competitive
environments for our different lines of business are as follows:
OverVoice. We face several major groups of competitors in the business of
providing high-speed Internet access to hotels and MDUs. These include local
exchange carriers and other DSL providers, cable TV companies and other
providers using cable modems, and installation firms that deploy CAT5 rewiring
in hotels and MDUs. Although we believe OverVoice is the most cost-effective,
user-friendly and easily deployable high-speed Internet infrastructure solution
available, several of our competitors have extensive marketplace presence and
much greater technological and financial resources than we possess.
In addition, the OverVoice technology also competes with technologies using
other transmission media, such as coaxial cable, wireless facilities and fiber
optic cable. To the extent that telecommunications service providers, hotels,
MDUs or single family residences choose to install any of these alternative
transmission media, demand for OverVoice may decline.
38
CAIS Internet. Because the Internet services market has no substantial
barriers to entry, we expect that competition will continue to intensify. Our
principal competitors include other tier one national backbone providers such
as UUNET Technologies, Inc., PSINet Inc. and BBN (a GTE subsidiary). To a
lesser extent, we also compete for dedicated and dial-up access and Web
services business with regional, tier two ISPs and cable companies that operate
in the same geographic markets that we serve. Accordingly, we expect the market
for Internet access services to continue to grow and to be highly competitive
with a variety of regional and national players vying for new business. In many
instances, we compete directly with our downstream tier two ISP customers.
Eventually, we expect some form of a market consolidation to occur, with those
ISPs that furnish the most value-added solutions ultimately surviving.
Government Regulation; Potential Taxes
We provide Internet access, in part, through transmissions over public
telephone lines. These transmissions are governed by regulatory policies
establishing charges and terms for communications. As an ISP, we are not
currently subject to direct regulation by the Federal Communications Commission
(the "FCC") or any other agency, other than regulations applicable to
businesses generally. In a report to Congress adopted on April 10, 1998, the
FCC reaffirmed that ISPs should be classified as unregulated "information
service providers" rather than regulated "telecommunications providers" under
the terms of the Telecommunications Act of 1996, as amended.
This finding is important because it means that we are not subject to
regulations that apply to telephone companies and similar carriers. We also are
not required to contribute a percentage of our gross revenues to support
"universal service" subsidies for local telephone services and other public
policy objectives, such as enhanced communications systems for schools,
libraries and certain health care providers. Although there can be no
assurance, the FCC action may also discourage states from separately regulating
ISPs as telecommunications carriers or imposing similar subsidy obligations.
Nevertheless, Internet-related regulatory policies are continuing to
develop, and it is possible that we could be exposed to regulation in the
future. For example, in the same report to Congress, the FCC stated its
intention to consider whether to regulate voice and fax telephony services
provided over the Internet as "telecommunications" even though Internet access
itself would not be regulated. The FCC is also considering whether such
Internet-based telephone service should be subject to universal service support
obligations, or pay carrier access charges on the same basis as traditional
telecommunications companies.
Local telephone companies assess access charges to long distance companies
for the use of the local telephone network to originate and terminate long
distance calls, generally on a per-minute basis. Access charges have been a
matter of continuing dispute, with long distance companies complaining that the
rates are substantially in excess of cost, and local telephone companies
arguing that access rates are justified to subsidize lower local rates for end
users and other purposes. Both local and long distance companies, however,
contend that Internet-based telephony should be subject to these charges. We
have no current plans to install gateway equipment and offer telephony, and so
we do not believe we would be directly affected by these developments. However,
we cannot predict whether these debates will cause the FCC to reconsider its
current policy of not regulating ISPs.
In addition, a number of state and local government officials have asserted
the right or indicated a willingness to impose taxes on Internet-related
services and commerce, including sales, use and access taxes. We cannot
accurately predict whether the imposition of any such taxes would have a
material adverse effect on our business, financial condition or results of
operations.
Patents and Other Proprietary Information
We are a licensee and joint-owner of certain patents and patent applications
of Inline relating to the OverVoice technology. We, together with Inline, have
a total of two U.S. patents and nine U.S. patent applications. Two of these
nine patent applications have recently been allowed and, therefore, are
expected to become patents in the next few months.
39
The first U.S. patent granted relates to transmission of video over active
voice telephone wires. Related patents have also been obtained in Canada,
Germany, France and the United Kingdom. In addition, an application was
recently allowed in South Korea and a divisional application was filed in
Europe.
The second U.S. patent granted relates to some or all aspects of the
following systems, among others:
. provision of high-speed Internet service through the communication of
Ethernet signals over the active telephone wiring in residences, hotels,
apartment buildings and similar structures;
. provision of video services over the telephone wiring in the same
structures;
. provision of WebTV-type services over the telephone wiring in these
structures;
. creation of a standard Ethernet network, using existing telephone
wiring, among all personal computers in a structure; and
. communication of Ethernet signals over 1,000 feet over a single active
telephone line.
Novel ideas are embodied in many of the different parts that make up these
systems. Among these parts are:
. different electronic processes for converting the video and data
signals;
. special connectors that are easy to install, convenient to use and
promote smooth signal flow across the wiring;
. different arrangements of the components to facilitate the operation of
the systems; and
. special "command and control" procedures that help implement the
different applications.
Of the two allowed applications, one is a continuation of the first U.S.
patent and the other describes new features related to communication of video
and data over active telephone wires. These additional features are also
embodied in applications filed by Inline in Israel and under the Patent
Cooperation Treaty, and in applications we have filed in Canada, Europe,
Mexico, Australia and New Zealand.
Inline Agreement. We have a license agreement with Inline, pursuant to which
Inline granted us rights to all patents and patent applications relating to the
OverVoice technology (the "Patent Rights"). In the United States, we have the
exclusive right to make, use and sell the OverVoice technology for all
structures except for single family residential units and certain food
establishments, for which we have non-exclusive rights. We further have the
exclusive right to make, use and sell under all foreign patents and patent
applications relating to the OverVoice technology for all structures except for
single family residential units and certain food establishments, for which we
have non-exclusive rights, with the exception of Israel, which Inline reserved
for itself.
We own 50% of all U.S. and foreign (with the exception of Israel) patents
and patent applications relating to the OverVoice technology. We own the patent
applications we filed in Canada, Europe, Mexico, Australia and New Zealand.
Inline retains the authority to control prosecution and maintenance of the
Patent Rights, except for the patent applications we own. However, if Inline
decides not to: (1) file a patent application; (2) prevent a patent application
from being abandoned; or (3) keep a patent or application in force, we may
elect to have Inline assign the patent, application or invention to us. We have
the right to enforce the Patent Rights against potential infringers, although
we must share any recovery with Inline.
Legal Proceedings
We are not a party to any lawsuit or proceeding which, in the opinion of our
management, is likely to have a material adverse effect on our business,
financial condition or results of operation.
Employees
As of February 15, 1999, we employed approximately 109 full-time employees.
In addition to our full-time employees, we also employ part-time personnel from
time to time in various departments. None of our
40
employees are covered by a collective bargaining agreement. We believe that our
employee relations are satisfactory. See "Risk Factors--We May Not Be Able To
Manage Our Potential Rapid Growth And Expansion Effectively."
Properties
Our principal executive offices are located in Washington, D.C. In addition
to our corporate headquarters, we lease office space in a number of locations
across the United States. We do not believe that any of these locations are
material to our operations. The leases expire at various times between December
31, 1999 and February 15, 2009.
[Download Table]
Location Type Square Footage
-------- ------ --------------
McLean, Virginia.......................................... Office 7,033
McLean, Virginia.......................................... Office 1,566
Washington, D.C........................................... Office 32,500
We consider that, in general, our physical properties are well maintained,
in good operating condition and adequate for our purposes.
41
MANAGEMENT
Officers, Directors and Other Key Employees
The officers, directors and other key employees of the Company, and their
ages as of February 15, 1999 are set forth below.
[Download Table]
Name Age Position
---- --- --------
Ulysses G. Auger, II(2)........... 46 Chairman of the Board and Chief
Executive Officer
William M. Caldwell, IV........... 51 President and Director
Evans K. Anderson................. 51 Chief Operating Officer and Executive
President of Sales and Marketing
Richard W. Durkee................. 42 Vice President of Information Technology
and Operations
Barton R. Groh.................... 45 Vice President, Chief Financial Officer
and Treasurer
Michael G. Plantamura............. 43 Vice President, Secretary and General
Counsel
Laura A. Neuman................... 33 Vice President of Sales
Duncan M. Fitchet, Jr. ........... 44 Vice President of Marketing and Business
Development
Tara Pierson Dunning.............. 35 Vice President of Customer and Account
Management of CAIS, Inc.
Ulysses G. Auger, Sr.............. 77 Director
Richard F. Levin(1)(2)............ 45 Director
Vernon L. Fotheringham(1)(2)...... 50 Director
R. Theodore Ammon................. 49 Director
--------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Ulysses G. Auger, II has served as the Chairman of the Board and Chief
Executive Officer of the Company since January 1998. Mr. Auger has an extensive
background in the telecommunications industry, and is a three-term member of
the Board of Directors of Comptel, a telecommunications industry trade
association with approximately 225 member companies. Until February 1999, Mr.
Auger chaired Comptel's IP Committee, which was formed to address Internet
issues affecting the telecommunications industry. In 1987, Mr. Auger founded
Cleartel and has served as a director since July 1987. Mr. Auger also served as
President of Cleartel from August 1987 to June 1988, and then again from June
1990 to February 1999. In addition, Mr. Auger has served as President and a
Board Member of CAIS, Inc. since May 1996, and assumed the roles of Chairman of
the Board and Chief Executive Officer of CAIS, Inc. in January 1998. Mr. Auger
is the son of Ulysses G. Auger, Sr., a director of the Company.
William M. Caldwell, IV has served as a member of the Board of Directors of
the Company since January 1998 and of CAIS, Inc. since May 1996, as the
Company's Vice Chairman from January 1998 to February 1999 and as the Company's
and CAIS, Inc.'s President since February 1999. Mr. Caldwell also served as the
Vice Chairman of CAIS, Inc. and Cleartel from September 1997 to February 1999.
Since June 1995, Mr. Caldwell also has served as a member of the Board of
Directors of Cleartel. Mr. Caldwell has an extensive background in the areas of
marketing, financial management, investment banking and general corporate
management. Prior to joining CAIS, Inc. and Cleartel, from 1993 to August 1997,
Mr. Caldwell served as President of Digital Satellite Broadcasting Corporation.
Prior to 1993, Mr. Caldwell founded The Union Jack Group, an investment banking
advisory firm, and served as a Vice President in Corporate Finance at Kidder
Peabody. In addition, Mr. Caldwell
42
also has served as both President and Chief Financial Officer of Van Vorst
Industries, an international home furnishing manufacturer; as Vice President of
Marketing for Flying Tiger Line, Inc., one of the world's largest all-cargo air
carriers before its acquisition by Federal Express Corporation; and a
consultant with Booz Allen, Hamilton Inc. Mr. Caldwell currently sits on the
Board of directors for both Lee Pharmaceuticals and King Koil Franchising, Inc.
Evans K. Anderson has served as the Chief Operating Officer and Executive
Vice President of Sales and Marketing of the Company and CAIS, Inc. since
February 1999. Prior to that, he served as the Company's and CAIS Inc.'s Senior
Vice President of Sales and Marketing and the General Manager of CAIS, Inc.
from January 1998 to February 1999. Mr. Anderson also has served as a member of
the Board of Directors of CAIS, Inc. since December 1997. In addition, from
June 1998 to February 1999, Mr. Anderson served as Cleartel's Senior Vice
President of Sales and Marketing. Mr. Anderson brings 20 years of experience in
the telecommunications and related industries and is currently responsible for
all of the Company's and CAIS, Inc.'s sales and marketing functions and for
CAIS, Inc.'s overall management, including customer service, technical support,
OverVoice operations and account management. Prior to joining CAIS, Inc., from
March 1996 to March 1997, Mr. Anderson served as Director of Sales for the
Northeast region for Advanced Radio Telecom, a leading provider of advanced
38GHz digital wireless technology. From January 1993 to February 1996, Mr.
Anderson was a principal in Vitel International, Inc., a nationwide provider of
sales and distribution for Airborne Express and telecommunications products.
Prior to 1993, Mr. Anderson held the position of Executive Vice President of
Sales and Marketing at Oncor Communications, a communications company, where he
was responsible for the sales, marketing and customer service functions. Prior
to that, Mr. Anderson served as Director of Sales with Contel Texocom, a
national distributor of telecommunications equipment, and held various sales
and management positions with ITT U.S.T.S. and Sprint Communications Company,
L.P.
Richard W. Durkee has served as the Company's Vice President of Information
Technology and Operations since September 1998. Mr. Durkee also has served as
CAIS, Inc.'s Vice President of Information Technology and Operations since
September 1998, and served in the same capacity at Cleartel from September 1998
to February 1999. Mr. Durkee has over 20 years of experience in Systems and
Network Development, Operations and Management. Prior to joining the Company,
from April 1996 to September 1998, Mr. Durkee served as Director of Information
Technology for ORBCOMM Global, L.P., a global messaging and data communications
company. From March 1995 to March 1996, Mr. Durkee served as Vice President,
Information Technology and Network Operations, for GTS/Global Link, a
facilities based provider of telecommunications services. From June 1989 to
February 1995, Mr. Durkee served as Director of Information Systems for Oncor
Communications, Inc.
Barton R. Groh has served as the Company's Vice President, Chief Financial
Officer and Treasurer since January 1998. Mr. Groh also has served as CAIS,
Inc.'s Vice President and Chief Financial Officer since May 1996, as CAIS,
Inc.'s Assistant Secretary since December 1996, and as CAIS, Inc.'s Treasurer
since December 1997. Mr. Groh joined Cleartel in July 1989 as Director of
Finance and Administration and served as Cleartel's Vice President and Chief
Financial Officer from June 1992 to February 1999. In addition, Mr. Groh served
as Cleartel's Assistant Secretary from June 1993 to February 1999 and as
Cleartel's Treasurer from June 1998 to February 1999. Prior to joining
Cleartel, Mr. Groh held positions as a Senior Auditor with Price Waterhouse
from 1974 to 1979, as an accounting manager with Comsat Corporation from 1979
to 1987, and as Controller, Franchise Operations with Entre Computer Centers
from 1987 to 1989. Mr. Groh is a Certified Public Accountant.
Michael G. Plantamura has served as the Company's Vice President, Secretary
and General Counsel since January 1998. Mr. Plantamura also has served as Vice
President and General Counsel of CAIS, Inc. since September 1996, and as CAIS,
Inc.'s Secretary since December 1997. From September 1996 to February 1999, Mr.
Plantamura served as Vice President and General Counsel of Cleartel and as
Cleartel's Secretary from June 1998 to February 1999. Mr. Plantamura is
currently responsible for all of the Company's and CAIS, Inc.'s legal,
regulatory, human resources, corporate, contract and litigation issues. From
April 1996 to September 1996, Mr. Plantamura served as Cleartel's Director of
Legal and Regulatory Affairs, and from May 1996 to September 1996, Mr.
Plantamura held the same position at CAIS, Inc. From December 1986 to March
1996, Mr. Plantamura served as in-house General Counsel for WBDC-TV50,
Washington, D.C. and WUNI-TV27, Worcester/Boston, MA.
43
Laura A. Neuman has served as the Company's Vice President of Sales since
June 1998. Ms. Neuman's responsibilities include sales team development,
revenue generation, negotiating contracts and developing partnerships. Ms.
Neuman joined CAIS, Inc. in October 1997 as Director of OverVoice Development
and since June 1998 she has served as Vice President of Sales for CAIS Internet
and OverVoice. Prior to joining CAIS, Inc., from February 1997 to October 1997,
Ms. Neuman served as Channel Sales Manager for DIGEX Inc., an Internet service
provider. From October 1996 to January 1997, Ms. Neuman operated her own
independent consulting business. From January 1994 to September 1996, Ms.
Neuman served as Major Relationships Manager and Manager--Account Management
for National Data Corporation.
Duncan M. Fitchet, Jr. has served as the Company's Vice President of
Marketing and Business Development since January 1998. Mr. Fitchet also has
served as Vice President of Marketing and Business Development for CAIS, Inc.
since January 1997, and held the same position at Cleartel from January 1997 to
February 1999. Mr. Fitchet's responsibilities include strategic planning and
marketing strategies, product management, market research, product and service
promotions, public relations and marketing communications activities. From May
1996 to December 1996, Mr. Fitchet served as Director of Marketing and Business
Development for CAIS, Inc., and from August 1995 to December 1996, Mr. Fitchet
held the same position at Cleartel. Prior to joining Cleartel, from June 1991
to August 1995, Mr. Fitchet served as Senior Group Product Manager at GTE
Telephone Operations.
Tara Pierson Dunning has served as CAIS, Inc.'s Vice President of Customer
and Account Management since September 1998. Previously, Ms. Dunning served as
Director of Marketing for the Company from January 1998 to September 1998;
Director of Marketing for CAIS, Inc. and Cleartel from October 1997 to
September 1998; Director of Business Development for CAIS, Inc. and Cleartel
from January 1997 to October 1997; and as Manager of Business Development for
CAIS, Inc. and Cleartel from September 1996 to December 1996. Prior to joining
CAIS, Inc. and Cleartel, from September 1993 to September 1996, Ms. Dunning
founded and served as Vice President of Marketing for New Vision
Communications.
Ulysses G. Auger, Sr. has served as a member of the Board of Directors of
the Company since December 1997. Mr. Auger served as Secretary, Treasurer and a
director of Cleartel from June 1993 to June 1998. From April 1996 to December
1997, Mr. Auger served as Secretary, Treasurer and a director of CAIS, Inc. Mr.
Auger is a private investor and entrepeneur who founded the nationally renowned
Blackie's House of Beef in 1946. Mr. Auger's financial interests include
hotels, commercial real estate and Mid-Atlantic region restaurants. Mr. Auger,
Sr. is the father of Ulysses G. Auger, II, the Chairman of the Board and Chief
Executive Officer of the Company.
Richard F. Levin has served as a member of the Board of Directors of the
Company since December 1997. Mr. Levin also served as a member of the Board of
Directors of Cleartel from June 1995 to June 1998. Mr. Levin is a partner in
the Washington, D.C. law firm of Grossberg, Yochelson, Fox and Beyda, where he
has practiced since 1979.
Vernon L. Fotheringham has served as a member of the Board of Directors of
the Company since January 1999. Mr. Fotheringham has served as Chairman,
President and Chief Executive Officer of Nutel Corporation since August 1998.
From December 1995 to August 1998, Mr. Fotheringham served as Chairman and
Chief Executive Officer of Advanced Radio Telecom. Prior to that, from April
1993 to December 1995, Mr. Fotheringham served as President and Chief Executive
Officer of Norcom Networks Corporation, a nationwide provider of mobile
satellite services. Over the last ten years, Mr. Fotheringham has advised
several businesses in the telecommunications industry, including American
Mobile Satellite Corporation, ClairCom Communications and McCaw Cellular
Communications, Inc.
R. Theodore Ammon has served as a member of the Board of Directors of the
Company since February 1999. Mr. Ammon has served as the Chairman of the Board
of Big Flower Holdings, Inc. (and predecessors) since its inception in 1993 and
was the Chief Executive Officer of a Big Flower Holdings, Inc. predecessor from
inception until April 1997. Mr. Ammon is also a director of Big Flower Press
Holdings, Inc., a subsidiary of Big Flower Holdings, Inc. Mr. Ammon was a
General Partner of Kohlberg Kravis Roberts & Co. from 1990
44
to 1992, and an executive of such firm prior to 1990. Mr. Ammon is also a
member of the Board of Directors of Host Marriott Corporation and Chairman of
the Board of Directors of 24/7 Media, Inc. In addition, Mr. Ammon serves on the
Board of Directors of the New York YMCA, The Municipal Art Society of New York,
Jazz@Lincoln Center and on the Board of Trustees of Bucknell University.
All officers serve at the discretion of the Board.
Board Committees
The Board has established an Audit Committee and a Compensation Committee.
The Audit Committee will review the results and scope of the audit and other
services provided by the Company's independent accountants and consists of
Messrs. Auger, II, Levin and Fotheringham. The Compensation Committee will
approve salaries and certain incentive compensation for management and key
employees of the Company and administer the Company's Amended and Restated 1998
Equity Incentive Plan and consists of Messrs. Levin and Fotheringham.
Executive Compensation
The following table sets forth certain summary information concerning
compensation for services in all capacities awarded to, earned by or paid to,
the Company's Chief Executive Officer and each of the four other most highly
compensated executive officers of the Company, whose aggregate cash and cash
equivalent compensation exceeded $100,000 (collectively, the "Named Officers"),
with respect to the fiscal year ended December 31, 1998:
Summary Compensation Table
[Enlarge/Download Table]
Long-Term
Compensation
------------
Annual Compensation Awards
-------------------------------------------- ------------
Other Securities All
Salary Bonus Annual Underlying Other
Name and Principal Position Year ($) ($) Compensation($)(1) Options(#) Compensation
--------------------------- ----- -------- ------- ------------------ ------------ ------------
Ulysses G. Auger, II..... 1998 $280,140 $28,000 -- -- --
Chairman of the Board
and
Chief Executive Officer
William M. Caldwell, IV.. 1998 237,498(2) -- -- 1,733,075(3) --
President and Director
Evans K. Anderson........ 1998 179,956 -- -- 437,220(4) --
Chief Operating Officer
and Executive Vice
President
of Sales and Marketing
Laura A. Neuman.......... 1998 148,076 50,000 -- 60,000(5) --
Vice President of Sales
of CAIS, Inc.
Duncan M. Fitchet, Jr. .. 1998 127,961 10,000 -- 40,000(6) --
Vice President of
Marketing
and Business Development
--------
(1) Each of the Company's officers received perquisites and other personal
benefits in addition to salary and bonuses. The aggregate amount of such
perquisites and other personal benefits, however, does not exceed the
lesser of $50,000 or 10% of the total of the annual salary and bonus
reported for any of the Named Officers for 1998.
(2) Mr. Caldwell received a base salary of $206,922 and $30,576 in deferred
income during 1998.
(3) In exchange for Mr. Caldwell's ownership interest in CAIS, Inc., Mr.
Caldwell was awarded options to purchase 97,465 shares of the Company's
common stock at an exercise price of $.9732 per share. In connection with
his employment agreement, Mr. Caldwell was awarded options to purchase
1,635,610 shares of the Company's common stock at an exercise price of
$.9732 per share.
45
(4) Mr. Anderson was awarded options to purchase 100,000 shares of the
Company's common stock at an exercise price of $3.07 per share on April 15,
1998. In connection with his employment agreement. Mr. Anderson was awarded
options to purchase 301,420 shares of the Company's common stock at an
exercise price of $1.1942 per share. On December 10, 1998, pursuant to the
1998 Equity Incentive Plan, Mr. Anderson was awarded options to purchase
35,800 shares of the Company's common stock, at an exercise price of $4.31
per share.
(5) Ms. Neuman was awarded options to purchase 20,000 shares of the Company's
common stock, at an exercise price of $3.07 per share, on April 15, 1998
and options to purchase 40,000 shares of the Company's common stock at the
same exercise price per share on June 29, 1998.
(6) Mr. Fitchet was awarded options to purchase 40,000 shares of the Company's
common stock, at an exercise price of $3.07 per share, on April 15, 1998.
The following table sets forth certain information regarding options to
acquire common stock granted to the Named Officers with respect to the fiscal
year ended December 31, 1998. There were no stock appreciation rights granted
in 1998.
Options Granted in Fiscal Year 1998
[Enlarge/Download Table]
Potential
Realizable
Value at
Assumed
Annual
Rates of
Stock Price
Percent of Appreciation for
Total Options Exercise Option Term(1)
Options Granted in Price Expiration ----------------------
Name Granted Fiscal Year ($/sh) Date 5%($) 10%($)
---- --------- ------------- -------- ----------------- ---------- -----------
Ulysses G. Auger, II..... -- -- -- -- -- --
William M. Caldwell, IV.. 97,465(2) 3.3% $ .9732 October 2, 2008 $ 392,540 $ 97,464
1,635,610(3) 54.6 .9732 October 2, 2008 6,587,419 11,432,260
Evans K. Anderson........ 100,000 3.3 3.07 April 15, 2008 193,070 489,280
301,420(4) 10.1 1.1942 October 2, 2008 1,147,355 2,040,191
35,800 1.3 4.31 December 10, 2008 97,036 245,910
Laura A. Neuman.......... 20,000 .7 3.07 April 15, 2008 38,614 97,856
40,000 1.3 3.07 June 29, 2008 77,228 195,712
Duncan M. Fitchet, Jr. .. 40,000 1.3 3.07 April 15, 2008 77,228 195,712
--------
(1) The dollar amounts under these columns are the results of calculations at
assumed rates of stock appreciation of 5% and 10%. These assumed rates of
growth were selected for illustration purposes only. They are not intended
to forecast possible future appreciation, if any, of stock prices. No gain
to the optionees is possible without an increase in stock prices, which
will benefit all stockholders.
(2) In exchange for Mr. Caldwell's ownership interest in CAIS, Inc., on October
2, 1998, Mr. Caldwell was awarded options to purchase 97,465 shares of the
Company's common stock at an exercise price of $.9732 per share.
(3) In connection with his employment agreement, Mr. Caldwell was awarded
options to purchase 1,635,610 shares of the Company's common stock at an
exercise price of $.9732 per share.
(4) In connection with his employment agreement, Mr. Anderson was awarded
options to purchase 301,420 shares of the Company's common stock at an
exercise price of $1.1942 per share.
46
FISCAL YEAR END OPTION VALUES
The following table sets forth certain information regarding unexercised
options held by the Named Officers with respect to the fiscal year ended
December 31, 1998. There were no options exercised in 1998.
[Enlarge/Download Table]
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS
FISCAL YEAR END(#) AT FISCAL YEAR END($)(1)
--------------------------------- -------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- --------------- ------------------- ----------- -------------
Ulysses G. Auger, II.... -- -- -- --
William M. Caldwell,
IV..................... -- 1,733,075 -- $5,782,924
Evans K. Anderson....... -- 437,220 -- 1,063,164
Laura A. Neuman......... -- 60,000 -- 74,400
Duncan M. Fitchet,
Jr. ................... -- 40,000 -- 49,600
--------
(1) The calculations of the value of unexercised options are based on the
difference between the fair market value per share of the common stock on
December 31, 1998 ($4.31), and the exercise price of each option,
multiplied by the number of shares covered by the option.
EMPLOYMENT AGREEMENTS; COVENANTS-NOT-TO-COMPETE
On September 8, 1997, the Company entered into an employment agreement with
William M. Caldwell, IV. The agreement, as amended, provides that Mr. Caldwell
will be employed as the Company's President. The term of the agreement is for a
period of four years commencing on September 8, 1997. The agreement establishes
a base salary of $175,000 per annum. Such base salary is subject to such
periodic increase as the Company may determine. If the Company terminates Mr.
Caldwell's employment without cause, Mr. Caldwell shall be entitled to receive
nine months of his then current base salary. The agreement contains non-
competition and non-solicitation covenants which prohibit Mr. Caldwell, during
the term of his employment and for a period of 24 months thereafter, from
engaging in competition with the Company or from soliciting any of the
Company's customers. The agreement also prohibits Mr. Caldwell from disclosing
confidential or proprietary information of the Company. In connection with his
employment agreement, Mr. Caldwell was granted options for 1,635,610 shares of
the Company's common stock at an exercise price of $.9732 per share, of which
50% of the options vest after Mr. Caldwell's third employment year and 50% of
the options vest at the end of Mr. Caldwell's fourth employment year. As a
result of this offering, however, 75% of the options will vest on the day the
underwriting agreement relating to an initial public offering is signed and 25%
of the options will vest at the end of Mr. Caldwell's fourth employment year.
On June 3, 1997, the Company entered into an employment agreement with Evans
K. Anderson. The agreement, as amended, provides that Mr. Anderson will be
employed as the Company's Chief Operating Officer and Executive Vice President
of Sales and Marketing. The term of the agreement is for a period of four years
commencing on March 3, 1997. The agreement established an initial base salary
of $125,000 per annum, and as of November 1, 1997, a base salary of $150,000
per annum. Such base salary is subject to such periodic increase as the Company
may determine. If the Company terminates Mr. Anderson's employment without
cause, Mr. Anderson shall be entitled to receive nine months of his then
current base salary. The agreement contains non-competition and non-
solicitation covenants which prohibit Mr. Anderson, during the term of his
employment and for a period of twenty-four months thereafter, from engaging in
competition with the Company or from soliciting any of the Company's customers.
The agreement also prohibits Mr. Anderson from disclosing confidential or
proprietary information of the Company. In connection with his employment
agreement. Mr. Anderson was granted options to purchase 301,420 shares of the
Company's common stock at an exercise price of $1.1942 per share, of which one
third of the options vest after Mr. Anderson's third employment year and the
remaining two-thirds of the options vest at the end of Mr. Anderson's fourth
employment year. As a result of this offering, however, one third of the
options will vest on the day the underwriting agreement relating to an initial
public offering is signed and two-thirds of the options will vest at the end of
Mr. Anderson's fourth employment year.
47
On June 29, 1998, the Company entered into an employment agreement with
Laura A. Neuman. The agreement provides that Ms. Neuman will be employed as the
Company's Vice President of Sales. The term of the agreement is for a period of
one year commencing on June 29, 1998. Ms. Neuman and the Company may extend the
term of the agreement by mutual consent. The agreement establishes a base
salary of $150,000 per annum. Such base salary is subject to such periodic
increase as the Company may determine. In addition, the agreement entitles Ms.
Neuman to receive cash incentive compensation of $25,000 per quarter for
achieving a minimum of 70% of the Company's budgeted performance target.
Subject to vesting and forfeiture provisions contained therein, the agreement
further grants Ms. Neuman options to purchase 40,000 shares of the Company's
common stock at an exercise price of $3.07 per share. As a result of this
offering, however, one eighth of the options (5,000) will vest on the day the
underwriting agreement relating to an initial public offering is signed. If the
Company terminates Ms. Neuman's employment without cause, Ms. Neuman shall be
entitled to receive six months of her then current base salary, plus a pro-
rated amount equal to six months of the calculated cash incentive compensation
immediately upon such termination. The agreement contains non-competition and
non-solicitation covenants which prohibit Ms. Neuman, during the term of her
employment and for a period of 24 months thereafter, from engaging in
competition with the Company or from soliciting any of the Company's customers.
The agreement also prohibits Ms. Neuman from disclosing confidential or
proprietary information of the Company.
AMENDED AND RESTATED STOCK OPTION PLAN
On February 12, 1999, the Board of Directors of the Company adopted and the
stockholders of the Company approved the Amended and Restated 1998 Equity
Incentive Plan (the "Stock Option Plan"), which provides for the grant to
officers, key employees and directors of the Company and its subsidiaries of
both "incentive stock options" within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), and stock options that
are nonqualified for federal income tax purposes. The total number of shares
for which options may be granted pursuant to the Stock Option Plan and the
maximum number of shares for which options may be granted to any person is
1,500,000 shares, subject to certain adjustments reflecting changes in the
Company's capitalization. As of February 15, 1999, options to purchase
1,180,800 shares of the Company's common stock were outstanding under the Stock
Option Plan. The Stock Option Plan is currently administered by the Company's
Board of Directors. Upon the completion of this offering, the Stock Option Plan
will be administered by the Compensation Committee. The Compensation Committee
will determine, among other things, which officers, employees and directors
will receive options under the plan, the time when options will be granted, the
type of option (incentive stock options, nonqualified stock options, or both)
to be granted, the number of shares subject to each option, the time or times
when the options will become exercisable, and, subject to certain conditions
discussed below, the option price and duration.
The exercise price of incentive and nonqualified stock options will be
determined by the Compensation Committee, but may not be less than the fair
market value of the common stock on the date of grant and the term of any such
option may not exceed ten years from the date of grant. With respect to any
Stock Option Plan participant who owns stock representing more than 10% of the
voting power of all classes of the outstanding capital stock of the Company or
of its subsidiaries, the exercise price of any incentive stock option may not
be less than 110% of the fair market value of such shares on the date of grant
and the term of such option may not exceed five years from the date of grant.
Payment of the option price may be made in cash or, with the approval of the
Compensation Committee, in shares of common stock having a fair market value in
the aggregate equal to the option price. Options granted pursuant to the Stock
Option Plan are not transferable, except by will or the laws of descent and
distribution. During an optionee's lifetime, the option is exercisable only by
the optionee.
The Compensation Committee has the right at any time and from time to time
to amend or modify the Stock Option Plan, without the consent of the Company's
stockholders or optionees; provided, that no such
48
action may adversely affect options previously granted without the optionee's
consent, and provided further that no such action, without the approval of a
majority of the stockholders of the Company, may increase the total number of
shares of common stock which may be purchased pursuant to options under the
plan, increase the total number of shares of common stock which may be
purchased pursuant to options under the plan by any person, expand the class of
persons eligible to receive grants of options under the plan, decrease the
minimum option price, extend the maximum term of options granted under the
plan, extend the term of the plan or change the performance criteria on which
the granting of options is based.
Promptly after the completion of this offering, the Company expects to file
with the SEC a registration statement on Form S-8 covering the shares of common
stock underlying the options granted under the Stock Option Plan and other
compensatory plans and arrangements.
DIRECTORS AND OFFICERS INSURANCE
Upon the closing of this offering, the Company intends to obtain directors
and officers liability and company reimbursement insurance. Under the policy,
the insurance carrier will pay, on behalf of directors and officers of the
Company, certain losses incurred as a result of certain wrongful acts by such
persons, for which they would not otherwise be indemnified by the Company.
49
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's capital stock after giving effect to the offering
by:
. each person known by the Company to beneficially own 5% or more of any
class of the Company's capital stock;
. each director of the Company;
. each executive officer of the Company that is a Named Officer; and
. all directors and executive officers of the Company as a group.
All persons listed have an address in care of the Company's principal
executive offices and have sole voting and investment power with respect to
their shares unless otherwise indicated. All information with respect to
beneficial ownership has been furnished to the Company by the respective
stockholders of the Company.
[Download Table]
Shares Beneficially
Owned after Offering(/1/)
----------------------------------
Common Stock
----------------------------------
Name Number Percent
---- ---------------- -------------
Ulysses G. Auger, II........................... 4,824,214(2) %
William M. Caldwell, IV........................ 1,324,173(3)
Evans K. Anderson.............................. 134,323(4)
Laura A. Neuman................................ 11,660(5)
Duncan M. Fitchet, Jr. ........................ 13,320(6)
Ulysses G. Auger, Sr. ......................... 4,726,758(7)
Richard F. Levin............................... 15,000(8)
Vernon L. Fotheringham......................... 15,000(8)
R. Theodore Ammon.............................. 2,775,480(9)
All executive officers and directors as a group
(13 persons).................................. 13,975,808(10)
--------
* Less than 1%
(1) Under the SEC's rules, a person is deemed to be the beneficial owner of a
security if such person has or shares the power to vote or direct the
voting of such security or the power to dispose or direct the disposition
of such security. A person is also deemed to be a beneficial owner of a
security if that person has the right to acquire beneficial ownership
within 60 days. Accordingly, more than one person may be deemed to be a
beneficial owner of the same security. Unless otherwise indicated by
footnote, the named entities or individuals have sole voting and investment
power with respect to the shares of common stock beneficially owned.
(2) Includes shares issuable upon the conversion of the remaining outstanding
Series B Shares upon consummation of the offering.
(3) Includes 1,324,173 shares which may be acquired upon the exercise of
options exercisable within 60 days following the offering.
(4) Includes 134,323 shares which may be acquired upon the exercise of options
exercisable within 60 days following the offering.
(5) Includes 11,660 shares which may be acquired upon the exercise of options
exercisable within 60 days following the offering.
(6) Includes 13,320 shares which may be acquired upon the exercise of options
exercisable within 60 days following the offering.
(7) Includes shares issuable upon the conversion of the remaining outstanding
Series B Shares upon consummation of the offering.
(8) Includes 15,000 shares which are currently exercisable.
(9) Includes 2,458,407 Series A Shares.
(10) Includes shares issuable upon the conversion of the remaining
outstanding Series B Shares upon consummation of the offering.
50
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Organization of the Company
The Company is a closely held corporation. It was organized under Delaware
law in December 1997 under the name CGX Communications, Inc., as a holding
company. The Company changed its name to CAIS Internet, Inc. in February 1999.
CAIS, Inc., currently the Company's only subsidiary, was formed by certain
current stockholders of the Company to acquire Capital Area, a tier one ISP
that was owned by persons unaffiliated with the Company.
In October 1998, the Company completed a reorganization pursuant to which,
among other things:
. CAIS, Inc. was merged with a newly formed acquisition subsidiary of the
Company, with CAIS, Inc. surviving as a wholly owned subsidiary of the
Company;
. Cleartel, which owns certain telecommunications authorizations and is
the general partner of Cleartel LP, a long distance telecommunications
entity owned substantially by the shareholders of CAIS, Inc., was merged
with a second newly formed acquisition subsidiary of the Company, with
Cleartel surviving as a wholly owned subsidiary of the Company;
. the former shareholders of CAIS, Inc. and Cleartel exchanged their
shares in such companies for shares of the Company's common stock at a
rate of 62,938 shares of the Company's common stock for each share of
Cleartel common stock and at a rate of 500 shares of the Company's
common stock for each share of CAIS, Inc.'s common stock;
. the limited partners of Cleartel LP who were substantially the
shareholders of Cleartel, exchanged their limited partnership interests
in Cleartel LP at a rate of 5,349.7 shares of the Company's common stock
for each 1% limited partnership interest in Cleartel LP; and
. the Company acquired all of the limited partnership interests in
Cleartel LP and Cleartel became the sole general partner of Cleartel LP
with a 1% general partnership interest.
In February 1999, the Company transferred all of its limited partnership
interests in Cleartel LP to Cleartel and Cleartel LP was dissolved. The Company
then completed the Spin-off of Cleartel by means of a distribution of all of
its shares in Cleartel to the Company's stockholders pro rata based on their
percentage ownership of the outstanding shares of the Company. As a result of
the Spin-off, Cleartel ceased to be a subsidiary of the Company.
Intercompany Relationships
Prior to and after the Reorganization, the Company, Cleartel LP, Cleartel
and CAIS, Inc. were all under common ownership and management. During that
time, all of these companies purchased goods, services and facilities from each
other.
As of December 31, 1996, 1997 and 1998, the Company owed Cleartel LP
indebtedness totaling approximately $980,000, $3,735,000 and $5,342,000,
respectively, for monies advanced from Cleartel LP to the Company (the
"Cleartel Loan"). As of the date of the Spin-off, the aggregate amount of the
Cleartel Loan was $4,941,000. This balance was reduced by $1,450,000 as a
result of the Company's assumption of a note payable by Cleartel LP to Ulysses
G. Auger, Sr., a director of the Company. See "--Loans to and from Executive
Officers and Affiliates." The Cleartel Loan balance was further reduced by an
additional $1,500,000 with a portion of the proceeds from the Company's
issuance of Series A Shares. As a result of these reductions, the total
principal amount of the Cleartel Loan as of February 19, 1999 was $1,991,000.
No interest is payable in respect of the Cleartel Loan.
The Company will provide certain administrative and other support services
to Cleartel pursuant to a services agreement for cost plus a fixed percentage
until Cleartel replaces this arrangement with its own services or outsources
such support from third parties, which is expected to occur by the end of 1999.
In addition, Cleartel will sublease certain office space from the Company at
the Company's headquarters offices in Washington, D.C., pursuant to a sublease
agreement between the Company and Cleartel.
51
Cleartel may also purchase dedicated Internet connections from CAIS, Inc. The
Company believes that these arrangements are at least as favorable to the
Company as those which could have been negotiated with an unaffiliated third
party.
The Company may purchase certain services from Cleartel including, but not
limited to: (1) the license of certain co-location space at Cleartel's switch
site facilities in Washington, D.C.; (2) the purchase of certain long distance
telephone and other telecommunications services; and (3) the purchase of
certain private branch exchange, telephone and other telecommunications
equipment and computer equipment.
Real Property Leases
Until February 25, 1999, Cleartel LP leased its corporate headquarters
office space from Ulysses G. Auger, Sr., a director of the Company, and Lulu H.
Auger, his wife. The lease for the space expired on February 28, 1996; however,
the parties verbally agreed to extend the lease until February 25, 1999.
Cleartel LP paid total annual rents of $180,000 for the space during each of
the years ended December 31, 1996, 1997 and 1998. The Company believes that the
terms of the lease, including the rental rate, were at least as favorable to
the Company as those which could have been negotiated with an unaffiliated
third party.
On November 21, 1998, the Company entered into a ten-year lease for its
corporate headquarters office space commencing February 15, 1999. Ulysses G.
Auger, Sr. and Lulu H. Auger hold a 44.8% limited partnership interest in the
entity which owns the building. Annual base rent is $861,250, subject to annual
adjustments. The Company believes that the terms of the lease, including the
rental rate, are at least as favorable to the Company as those which could have
been negotiated with an unaffiliated third party.
Indemnification Agreements
The Company has entered into indemnification agreements with its directors
and certain of its senior executive officers. Pursuant to the terms of the
indemnification agreements, each of the senior executive officers and directors
of the Company will be indemnified by the Company to the fullest extent
permitted by Delaware law in the event such officer is made or threatened to be
made a party to a claim arising out of such person acting in his capacity as an
officer or director of the Company.
Loans to and from Executive Officers and Affiliates
CAIS, Inc. had a note payable due to Ulysses G. Auger, II, the Company's
Chairman and Chief Executive Officer, in the principal amount of $100,000,
dated as of March 15, 1996. The note bore interest at a rate of 10% per annum,
and was payable as follows: accrued interest due monthly on the 15th day of
each month, and the $100,000 in principal due on March 15, 1999.
CAIS, Inc. had a note payable due to Ulysses G. Auger, II in the principal
amount of $250,000, dated as of October 31, 1997. The note bore interest at a
rate of 10% per annum, and was payable as follows: accrued interest due monthly
on the last day of each month, and the $250,000 in principal due on April 30,
1999.
CAIS, Inc. had a note payable due to Ulysses G. Auger, Sr., a director of
the Company, in the principal amount of $1,000,000, dated as of May 8, 1996.
The note bore interest at a rate of 13% per annum, and was payable as follows:
monthly installments of $10,000 plus interest commencing on June 8, 1996, and
continuing thereafter on the 8th of each month, until May 8, 1999, whereupon
the remaining outstanding principal balance and any accrued and unpaid interest
are due.
The Company had a note payable due to Ulysses G. Auger, Sr. in the principal
amount of $500,000, dated as of February 27, 1998. The note bore interest at a
rate of 10% per annum, and was payable as follows: accrued interest due monthly
on the 27th day of each month, and the $500,000 in principal due on February
27, 1999.
The Company had a note payable due to Ulysses G. Auger, Sr. in the amount of
$500,000, dated as of July 9, 1998. The note bore interest at a rate of 10% per
annum, and was payable as follows: accrued interest due quarterly on the 9th
day of each month, and the $500,000 in principal due on July 9, 1999.
52
The Company had a note payable due to Ulysses G. Auger, Sr. in the principal
amount of $1,000,000, dated as of January 6, 1999. The note bore interest at a
rate of 10% per annum, and was payable as follows: accrued interest due
quarterly on the 6th day of each quarter, and the $1,000,000 in principal due
on demand upon thirty days advance written notice by the holder of the note to
the Company.
All of the foregoing promissory notes were subordinated to the loans made to
these companies by ING (U.S.) Capital Corporation, pursuant to the ING Credit
Agreement.
Cleartel LP had a note payable due to Ulysses G. Auger, Sr. in the principal
amount of $2.1 million, dated as of January 2, 1994. The note bore interest at
a rate of 1% per annum, plus the prime rate, and was payable as follows:
accrued interest in arrears due monthly on the first day of each month, and the
principal balance, together with all interest accrued and unpaid, due on August
1, 2001.
Immediately prior to the Spin-off, (1) Mr. Auger, Sr. contributed $650,000
of such principal to the capital of Cleartel and forgave accrued interest of
$434,123; and (2) in consideration of indebtedness in the aggregate principal
amount of $4,941,000 owed by CAIS, Inc. to Cleartel LP, the Company assumed the
remaining obligations on this note in the aggregate principal amount of
$1,450,000.
Immediately prior to the Spin-off, (1) all of the foregoing remaining
indebtedness owed by the Company and CAIS, Inc. to Ulysses G. Auger, Sr., in
the aggregate principal amount of $4,083,000, plus accrued interest thereon
totaling $89,757, was exchanged for a total of 1,025,247 Series B Shares; and
(2) all of the foregoing indebtedness owed by CAIS, Inc. to Ulysses G. Auger,
II, in the aggregate principal amount of $350,000, plus accrued interest
thereon totaling $34,339, was exchanged for a total of 94,432 Series B Shares.
The ING Credit Agreement
In September 1998, the Company, together with CAIS, Inc. and certain of
their affiliates, entered into the ING Credit Agreement with ING (U.S.) Capital
Corporation to borrow up to $7,000,000 to repay existing debt, fund the
development and roll-out of the OverVoice program and for general corporate
purposes. The loans extended under the ING Credit Agreement bear interest at
the one-month LIBOR rate plus 5%. The principal, premium and interest on any
outstanding loan will convert to senior secured notes bearing interest at a
rate of 5% over the 5-year U.S. Treasury Securities rate if borrowings under
the ING Credit Agreement are not repaid by September 4, 1999. Pursuant to the
ING Credit Agreement, ING (U.S.) Capital Corporation was granted warrants to
purchase 390,000 shares of the Company's common stock at an exercise price of
$0.01 per share and was paid fees totaling $345,000. In addition, if the ING
Credit Agreement is not paid in full by September 4, 1999, ING (U.S.) Capital
Corporation will receive warrants to purchase 3.0% of the Company's outstanding
shares on a fully diluted basis. In connection with an amendment to the ING
Credit Agreement, the Company paid a $210,000 extension fee. The Company is in
compliance with the terms of the ING Credit Agreement. The current outstanding
principal balance under the ING Credit Agreement is $7,000,000.
Other Transactions
For the past several years, Richard F. Levin, a director of the Company, has
performed legal services on the Company's behalf in his capacity as a partner
in the Washington, D.C., law firm of Grossberg, Yochelson, Fox & Beyda.
However, at no time were the fees paid by the Company to the law firm in excess
of 5% of the law firm's gross revenues. The Company believes that the costs of
such services are at least as favorable to the Company as those which could
have been negotiated with an unaffiliated third party.
Issuances of Securities
On April 22, 1998, 317,073 shares of common stock were issued to R. Theodore
Ammon at $3.15378 per share for an aggregate price of $1,000,000.
53
On October 2, 1998, in connection with the Reorganization, the Company
exchanged 5,349.7 shares of common stock for each 1.0% limited partnership
interest in Cleartel LP, 62,938 shares of common stock for each share of
Cleartel common stock and 500 shares of common stock for each share of CAIS,
Inc. common stock. As a result, the Company issued an aggregate of 1,034,970
shares of common stock as follows:
Ulysses G. Auger, Sr., 245,000 shares of common stock in exchange for his
shares of CAIS, Inc. and 267,483 shares of common stock in exchange for
his shares of Cleartel and limited partnership interest in Cleartel LP;
Ulysses G. Auger, II, 250,000 shares of common stock in exchange for his
shares of CAIS, Inc. and 259,527 shares of common stock in exchange for
his shares of Cleartel and limited partnership interest in Cleartel LP;
The Constandinos Ulysses Francisco Auger Economides Trust, 500 shares of
common stock in exchange for its shares of CAIS, Inc. and 796 shares of
common stock in exchange for its shares of Cleartel and limited
partnership interest in Cleartel LP;
The Constandina Francisca Auger Economides Trust, 500 shares of common
stock in exchange for its shares of CAIS, Inc. and 796 shares of common
stock in exchange for its shares of Cleartel and limited partnership
interest in Cleartel LP;
The Vassiliki Illias Auger Economides Trust, 500 shares of common stock
in exchange for its shares of CAIS, Inc. and 796 shares of common stock
in exchange for its shares of Cleartel and limited partnership interest
in Cleartel LP;
The Annabel-Rose Auger Trust, 500 shares of common stock in exchange for
its shares of CAIS, Inc. and 796 shares of common stock in exchange for
its shares of Cleartel and limited partnership interest in Cleartel LP;
The James Frederick Auger Trust, 500 shares of common stock in exchange
for its shares of CAIS, Inc. and 796 shares of common stock in exchange
for its shares of Cleartel and limited partnership interest in Cleartel
LP;
The Ulysses George Hawthorne Auger, III Trust, 500 shares of common stock
in exchange for its shares of CAIS, Inc. and 796 shares of common stock
in exchange for its shares of Cleartel and limited partnership interest
in Cleartel LP;
The Alexander Robert Auger Trust, 500 shares of common stock in exchange
for its shares of CAIS, Inc. and 796 shares of common stock in exchange
for its shares of Cleartel and limited partnership interest in Cleartel
LP;
The Gregory Ulysses Auger, II Trust, 500 shares of common stock in
exchange for its shares of CAIS, Inc. and 796 shares of common stock in
exchange for its shares of Cleartel and limited partnership interest in
Cleartel LP;
The Bridgette Kathryn Auger Trust, 500 shares of common stock in exchange
for its shares of CAIS, Inc. and 796 shares of common stock in exchange
for its shares of Cleartel and limited partnership interest in Cleartel
LP; and
The Nicholas William Randolph Auger Trust, 500 shares of common stock in
exchange for its shares of CAIS, Inc. and 796 shares of common stock in
exchange for its shares of Cleartel and limited partnership interest in
Cleartel LP.
54
On February 12, 1999, pursuant to a private placement and in exchange for
approximately $4.6 million of indebtedness owed by the Company or CAIS, Inc. to
Ulysses G. Auger, Sr. and Ulysses G. Auger, II, the Company issued 1,119,679
Series B Shares to Ulysses G. Auger, Sr. and Ulysses G. Auger, II.
On February 19, 1999, pursuant to a private placement, the Company issued:
2,458,407 Series A Shares and warrants to purchase an aggregate of 2.61% of
the total outstanding shares of common stock upon completion of this
offering on a fully diluted basis (except for shares issued upon the
conversion of the Series B Shares), at an exercise price of the initial
public offering price per share to Chancery Lane, L.P. for the aggregate
consideration of $10,000,000; and
368,761 Series A Shares and warrants to purchase an aggregate of .39% of
the total outstanding shares of common stock upon completion of this
offering on a fully diluted basis (except for shares issued upon the
conversion of the Series B Shares), at an exercise price of the initial
public offering price per share to CAIS-Sandler Partners, L.P. for the
aggregate consideration of $1,500,000.
55
DESCRIPTION OF CAPITAL STOCK
The following summary of the terms of our capital stock does not purport to
be complete and is qualified in its entirety by reference to the terms of the
capital stock contained in our Certificate of Incorporation.
General
Our authorized capital stock consists of 100,000,000 shares of common stock,
par value $.01 per share, and 25,000,000 shares of preferred stock, par value
$.01 per share, of which 2,827,168 shares are designated as Series A Shares,
and 1,119,679 shares are designated as Series B Shares.
Common Stock
Holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of stockholders. Subject to
preferences that may be applicable to any outstanding preferred stock,
including the Series B Shares, the holders of common stock are entitled to
receive ratably the dividends, if any, that may be declared from time to time
by the Board of Directors out of funds legally available for such dividends. We
have never declared a dividend and do not anticipate doing so in the
foreseeable future. See "Dividend Policy." In the event of a liquidation,
dissolution or winding up of the Company, subject to the prior rights of the
preferred stock, the holders of common stock are entitled to share ratably in
any remaining assets after payment of liabilities. The common stock has no
preemptive or other subscription rights and is not subject to any future calls
or assessments. There are no conversion rights or redemption or sinking fund
provisions applicable to shares of common stock. All of the outstanding shares
of common stock are fully paid and nonassessable.
Preferred Stock
The preferred stock may be issued from time to time by the Board as shares
of one or more classes or series. Subject to the provisions of our Amended and
Restated Certificate of Incorporation (the "Restated Certificate") and
limitations prescribed by law, the Board is expressly authorized to issue the
shares, fix the number of shares, change the number of shares constituting any
series, and provide for or change the voting powers, designations, preferences
and relative, participating, optional or other special rights, qualifications,
limitations or restrictions thereof, including dividend rights (including
whether dividends are cumulative), dividend rates, terms of redemption
(including sinking fund provisions), redemption prices, conversion rights, and
liquidation preferences of the shares constituting any class or series of the
preferred stock, in each case without any further action or vote by the
stockholders.
One of the effects of undesignated preferred stock may be to enable the
Board to render more difficult or to discourage an attempt to obtain control of
the Company by means of a tender offer, proxy contest, merger or otherwise, and
thereby to protect the continuity of the Company's management. The issuance of
shares of the preferred stock pursuant to the Board's authority described above
may adversely affect the rights of the holders of common stock. For example,
preferred stock issued by the Company may rank prior to common stock as to
dividend rights, liquidation preference or both, may have full or limited
voting rights and may be convertible into shares of common stock. Accordingly,
the issuance of shares of preferred stock may discourage bids for common stock
or may otherwise adversely affect the market price of common stock.
Series A Shares. The Series A Shares are convertible at the option of the
holder, initially on a one-to-one basis, into common stock. The Series A Shares
will automatically convert into common stock upon the earlier of: (1) an
initial public offering for aggregate offering proceeds of at least $35 million
and an offering price per share equal to at least $8.14 (a "Qualified IPO");
(2) in the case of a non-qualified initial public offering, if the closing
price of the common stock equals at least $16.28 for a period of 20 consecutive
days (a "Non-Qualified
56
IPO Conversion Event"); or (3) by the affirmative vote of at least 75% of the
then outstanding Series A Shares. The Series A Shares rank senior to the common
stock and Series B Shares in the event of a liquidation of the Company. The
Series A Shares are entitled to a liquidation preference equal to the full
conversion price per share, an 8% cumulative return and all accumulated but
unpaid dividends thereon. The Series A Shares will vote with the common stock
on an as-converted basis. However, the consent of the holders of 75% of the
Series A Shares is required for actions that: (1) materially and adversely
affect the Series A Shares' rights; (2) increase the number of shares
designated as Series A Shares; (3) pay or declare dividends or redeem,
repurchase or acquire shares of junior stock; (4) enter into certain employment
agreements; (5) enter into an acquisition, merger, reorganization or re-
capitalization transaction; (6) transfer shares of the Company's common stock
to a third party enabling him to elect a majority of the Company's Board of
Directors; (7) enter into financial commitments in excess of $250,000; (8)
dismiss or hire certain executive officers; (9) approve the Company's annual
budget; (10) permit the existence of certain liens; (11) incur certain debt; or
(12) liquidate or dissolve the Company. The Series A Shares rank pari-passu
with the common stock and the Series B Shares on any declared dividends. The
Series A Shares shall participate on an as-if converted basis on all dividends
paid on common stock. The Series A Shares are entitled to unlimited pro rata
piggy back registration rights. Once the Company is public, Chancery Lane,
L.P., will be entitled to demand and piggy back registration rights under
certain circumstances. The Series A Shares are entitled to anti-dilution
protection. Until the Company is a public company, Chancery Lane, L.P. will
have the right to designate one director to the Company's Board of Directors.
Upon the election of a majority of the Series A Shares, at any time after
February 1, 2004, the Series A Shareholders may require the Company to redeem
shares at a price equal to the greater of: (1) the conversion price per share
plus accumulated but unpaid dividends and an 8% cumulative return, or (2) the
fair market value.
Series B Shares. Upon consummation of a Qualified IPO, the Company shall
redeem for cash $3.0 million in aggregate face amount of the Series B Shares,
comprising $2.65 million held by Ulysses G. Auger, Sr. and $350,000 held by
Ulysses G. Auger, II. Any accrued but unpaid dividends thereon shall be paid in
cash at the time of such redemption. Any remaining Series B Shares shall
automatically convert into common stock on the earlier of: (1) the consummation
of a Qualified IPO, or (2) a Non-Qualified IPO Conversion Event. The conversion
price per share shall be the price to the public in any such public offering.
The Series B Shares shall rank junior to the Series A Shares, but senior to
common stock, with respect to liquidation preference. The Series B Shares are
entitled to a liquidation preference of $4,557,096 plus interest thereon at
the rate of 8.0% per annum and accumulated but unpaid dividends. The Series B
Shares will vote with the common stock on an as-converted basis. However, the
consent of the holders of 75% of the Series B Shares is required for actions
that: (1) materially and adversely affect the Series B Shares' rights; (2)
increase the number of shares designated as Series B Shares; (3) pay or declare
dividends or redeem, repurchase or acquire shares of junior stock; or (4)
liquidate or dissolve the Company.
Debt Warrants
Pursuant to the ING Credit Agreement, on September 4, 1998, the Company
granted to ING (U.S.) Capital Corporation warrants to purchase 390,000 shares
of the Company's common stock at an exercise price of $0.01 per share. In
connection with the warrants, ING (U.S.) Capital Corporation received both
demand and piggyback registration rights and is entitled to anti-dilution
protection. The warrants expire September 4, 2008. In the event the ING Credit
Agreement is not paid in full by September 4, 1999, ING (U.S.) Capital
Corporation will receive additional warrants to purchase 3.0% of the Company's
outstanding shares on a fully diluted basis.
Equity Warrants
The holders of Series A Shares (Chancery Lane, L.P. and CAIS-Sandler
Partners, L.P.) will receive, on a pro rata basis, warrants for shares of
common stock equal to 3.0% of the total number of shares of common stock
outstanding at the close of this offering. The warrants will have an exercise
price equal to the price per share of the common stock in this offering. The
holders of Series A Shares will receive registration rights and are entitled to
anti-dilution protection. The warrants expire February 19, 2009.
57
Statutory Business Combination Provision
Upon consummation of the offering, the Company will be subject to the
provisions of Section 203 ("Section 203") of the Delaware General Corporation
Law (the "DGCL"). Section 203 provides, with certain exceptions, that a
Delaware corporation may not engage in any of a broad range of business
combinations with a person or an affiliate or associate of such person, who is
an "interested stockholder" for a period of three years from the date that such
person became an interested stockholder unless:
. the transaction resulting in a person becoming an interested
stockholder, or the business combination, is approved by the Board of
Directors of the corporation before the person becomes an interested
stockholder;
. upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction is commenced, excluding for purposes of determining the
number of shares outstanding those shares owned (a) by persons who are
directors and officers and (b) by employee stock plans in which employee
participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange
offer; or
. on or after the date the person becomes an interested stockholder, the
business combination is approved by the corporation's board of directors
and by the holders of at least 66 2/3% of the corporation's outstanding
voting stock at an annual or special meeting, excluding shares owned by
the interested stockholder. Under Section 203, an "interested
stockholder" is defined as any person who is (x) the owner of 15% or
more of the outstanding voting stock of the corporation or (y) an
affiliate or associate of the corporation and who was the owner of 15%
or more of the outstanding voting stock of the corporation at any time
within the three-year period immediately prior to the date on which it
is sought to be determined whether such person is an interested
stockholder.
The provisions of Section 203 could delay or frustrate a change in control
of the Company, deny stockholders the receipt of a premium on their common
stock and have an adverse effect on the common stock. The provisions also could
discourage, impede or prevent a merger or tender offer, even if such event
would be favorable to the interests of stockholders. The Company's
stockholders, by adopting an amendment to the Restated Certificate, may elect
not to be governed by Section 203, which election would be effective 12 months
after such adoption.
Limitations on Directors' Liability
The DGCL authorizes corporations to limit or eliminate the personal
liability of directors to corporations and their stockholders for monetary
damages for breach of directors' fiduciary duty of care. This duty of care
requires that, when acting on behalf of the corporation, directors must
exercise an informed business judgment based on all material information
reasonably available to them. Absent the limitations authorized by Delaware
law, directors could be accountable to corporations and their stockholders for
monetary damages for conduct that does not satisfy their duty of care. Although
Delaware law does not change directors' duty of care, it enables corporations
to limit available relief to equitable remedies such as injunction or
rescission. The Company's Restated Certificate limits the liability of the
Company's directors to the Company and its stockholders to the fullest extent
permitted by Delaware law. Specifically, directors of the Company will not be
personally liable for monetary damages for breach of a director's fiduciary
duty as a director, except for liability for:
. any breach of the director's duty of loyalty to the Company or its
stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in DGCL Section 174; or
. any transaction from which the director derived an improper personal
benefit.
58
The inclusion of this provision in the Restated Certificate may have the
effect of reducing the likelihood of derivative litigation against directors,
and may discourage or deter stockholders or management from bringing a lawsuit
against directors for breach of their duty of care, even though such an action,
if successful, might otherwise have benefitted the Company and its
stockholders.
Potential Anti-takeover Effect of Certain Provisions of the Certificate of
Incorporation and By-Laws
The Restated Certificate and By-Laws contain other provisions that could
have an anti-takeover effect. The provisions are intended to enhance the
likelihood of continuity and stability in the composition of the Board and in
the policies formulated by the Board. These provisions also are intended to
help ensure that the Board, if confronted by an unsolicited proposal from a
third party which has acquired a block of stock of the Company, will have
sufficient time to review the proposal and appropriate alternatives to the
proposal and to act in what it believes to be the best interest of the
stockholders. The following is a summary of such provisions included in the
Restated Certificate and By-Laws of the Company.
The Restated Certificate divides the Board of Directors into three classes
of directors, serving staggered three-year terms. The Restated Certificate also
provides that stockholder action can be taken only at an annual or special
meeting of stockholders and cannot be taken by written consent in lieu of a
meeting. The Restated Certificate and the By-Laws provide that, except as
otherwise required by law, special meetings of the stockholders can only be
called pursuant to a resolution adopted by a majority of the Board or by the
chief executive officer of the Company. Stockholders will not be permitted to
call a special meeting or to require the Board to call a special meeting.
The By-Laws establish an advance notice procedure for stockholder proposals
to be brought before an annual meeting of stockholders of the Company,
including proposed nominations of persons for election to the Board.
Stockholders at an annual meeting may only consider proposals or nominations
specified in the notice of meeting or brought before the meeting by or at the
direction of the Board or by a stockholder who was a stockholder of record on
the record date for the meeting, who is entitled to vote at the meeting and who
has given to the Company's Secretary timely written notice, in proper form, of
the stockholder's intention to bring that business before the meeting. Although
the By-Laws do not give the Board the power to approve or disapprove
stockholder nominations of candidates or proposals regarding other business to
be conducted at an annual meeting, the aforementioned procedures may have the
effect of prohibiting stockholders from raising proposals at annual meetings if
the proper procedures are not followed or may discourage or deter a potential
acquiror from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of the Company.
The Restated Certificate and By-Laws provide that the affirmative vote of
holders of at least 66 2/3% of the total votes eligible to be cast in the
election of directors is required to amend, alter, change or repeal certain of
their provisions. This requirement of a super-majority vote to approve
amendments to the Restated Certificate and By-Laws could enable a minority of
the Company's stockholders to exercise veto power over any such amendments. The
Board has no current plans to formulate or effect additional measures that
could have an anti-takeover effect.
Transfer Agent and Registrar
The Transfer Agent and Registrar for the common stock will be American
Securities Transfer & Trust, Inc.
59
SHARES ELIGIBLE FOR FUTURE SALE
The market price of the common stock may be adversely affected by the sale,
or availability for sale, of substantial amounts of the common stock in the
public market following the offering. The shares being sold in the offering
will be freely tradable unless held by affiliates of the Company. Upon
completion of the offering: (1) executive officers and directors of the Company
will own an aggregate of (a) shares of common stock, (b) options to acquire
shares of common stock, (c) an aggregate of 2,827,168 Series A Shares
currently convertible into 2,827,168 shares of common stock (subject to
antidilution protection), (d) an aggregate of 1,119,679 Series B Shares
convertible in certain circumstances into shares of common stock, and
(e) warrants exercisable for shares of common stock; and (2) ING (U.S.)
Capital Corporation will hold warrants exercisable for 390,000 shares of common
stock. The securities issued prior to the offering have not been registered
under the Securities Act, and, therefore, may not be sold unless registered
under the Securities Act or sold pursuant to an exemption form registration,
such as the exemption provided by Rule 144.
In general, under Rule 144, if one year has elapsed since the later of the
date of the acquisition of restricted shares of common stock from the Company
or from any affiliate of the Company, the acquiror or subsequent holder thereof
may 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 1.0% of
the then outstanding shares of the common stock, or the average weekly trading
volume of the common stock on the Nasdaq National Market during the four
calendar weeks preceding the date on which notice of the proposed sale is sent
to the SEC. Sales under Rule 144 are also subject to certain manner of sale
provisions, notice requirements and the availability of current public
information about the Company. If two years have elapsed since the later of the
date of the acquisition of restricted shares of common stock from the Company
or any affiliate of the Company, a person who is not deemed to have been an
affiliate of the Company at any time for 90 days preceding a sale would be
entitled to sell such shares under Rule 144 without regard to the volume
imitations, manner of sale provisions or notice requirements.
The Company and certain stockholders of the Company (including Chancery
Lane, L.P. and all directors and officers of the Company) owning in the
aggregate shares of common stock, options and warrants exercisable for
shares of common stock and preferred stock convertible into shares of
common stock, have agreed not to offer, sell, contract to sell or otherwise
dispose of any shares of common stock, options or warrants to acquire shares of
common stock or securities convertible into or exchangeable for, any rights to
purchase or acquire, shares of common stock during the 180 days after the date
of this prospectus, subject to certain limited exceptions. The Company has
agreed to provide registration rights with respect to the common stock issued
to certain existing stockholders, including .
The Company intends to register the 3,534,495 shares of common stock
reserved for issuance upon exercise of stock options granted pursuant to the
Stock Option Plan and under other compensatory arrangements as soon as
practicable after the date of this prospectus. See "Management," "Description
of Capital Stock" and "Underwriting."
Prior to the offering, there has been no public market for the common stock,
and no prediction can be made as to the effect, if any, that the sale of shares
or the availability of shares for sale will have on the market price for the
common stock prevailing from time to time. Nevertheless, sales, or the
availability for sale, of substantial amounts of the common stock in the public
market could adversely affect prevailing market prices and the ability of the
Company to raise equity capital in the future.
60
UNDERWRITING
Subject to the terms and conditions contained in an underwriting agreement,
dated , 1999, the underwriters named below, who are represented by ING
Baring Furman Selz LLC (the "Representative"), have severally agreed to
purchase from the Company the number of shares of common stock set forth
opposite their names below.
[Download Table]
Underwriters Number of Shares
------------ ----------------
ING Baring Furman Selz LLC..................................
---
Total.....................................................
===
The underwriting agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares of common stock
offered hereby are subject to approval by their counsel of certain legal
matters and to certain other conditions. The underwriters are obligated to
purchase and accept delivery of all the shares of common stock (other than
those shares covered by the over-allotment option described below) if any are
purchased.
The underwriters propose initially to offer the shares of common stock in
part directly to the public at the initial public offering price set forth on
the cover page of this prospectus and in part to certain dealers (including the
underwriters) at such price less a concession not in excess of $ per share.
The underwriters may allow, and such dealers may re-allow, to certain other
dealers, a concession not in excess of $ per share. After the initial offering
of the shares of common stock, the public offering price and other selling
terms may be changed by the Representative at any time without notice.
The following table shows the underwriting fees to be paid to the
underwriters by the Company in connection with this offering. These amounts are
shown assuming both no exercise and full exercise of the underwriters' option
to purchase additional shares of common stock.
[Download Table]
No Exercise Full Exercise
----------- -------------
Per Share.......................................... $ $
Total.............................................. $ $
Other expenses of this offering (including the registration fees and the
fees of financial printers, counsel and accountants) payable by the Company are
expected to be approximately $ .
The Company has granted to the underwriters an option, exercisable within 30
days after the date of this prospectus, to purchase, from time to time, in
whole or in part, up to an aggregate of additional shares of common stock
at the public offering price less the underwriting discounts and commissions.
The underwriters may exercise such option solely to cover over-allotments, if
any, made in connection with this offering. To the extent that the underwriters
exercise such option, each underwriter will become obligated, subject to
certain conditions, to purchase its pro rata portion of such additional shares
based on such underwriter's percentage underwriting commitment as indicated in
the table above.
The Company has agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute
to payments that the underwriters may be required to make in respect of any of
those liabilities.
Each of the Company, its executive officers, directors and stockholders has
agreed, subject to certain exceptions, not to: (1) issue, offer, pledge, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or
61
dispose of, directly or indirectly, any shares of common stock or any
securities convertible into, exercisable or exchangeable for, or represent the
right to receive common stock, except the Company may issue and sell common
stock pursuant to (A) any employee stock plan stock ownership plan or dividend
reinvestment plan of the Company, (B) this offering, or (C) pursuant to the
exercise of the warrants held by ING (U.S.) Capital Corporation; or (2) grant
any options or warrants to purchase common stock or enter into any swap or
other arrangement that transfers all or a portion of the economic consequences
associated with the ownership of any common stock (regardless of whether any of
the transactions described in clause (1) or (2) is to be settled by the
delivery of common stock, or such other securities, in cash or otherwise) for a
period of 180 days after the date of this prospectus without the prior written
consent of ING Baring Furman Selz LLC. In addition, during such period, the
Company has also agreed not to file any registration statement with respect to,
and each of its executive officers, directors and certain stockholders of the
Company has agreed not to make any demand for, or exercise any right with
respect to, the registration of any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock without the
prior written consent of ING Baring Furman Selz LLC.
At the request of the Company, the underwriters have reserved for sale, at
the initial public offering price, shares of common stock offered hereby to
be sold to certain directors, officers and employees of the Company and other
persons who have expressed an interest in purchasing such shares. The number of
shares of common stock available for sale to the general public will be reduced
to the extent such persons purchase such reserved shares. Any reserved shares
which are not orally confirmed for purchase within one day of the pricing of
this offering will be offered by the underwriters to the general public on the
same terms as the other shares offered by this prospectus.
In September 1998, the Company and certain other affiliates of the Company
(the "Borrowers") entered into a credit agreement with ING (U.S.) Capital
Corporation, an affiliate of ING Baring Furman Selz LLC, whereby ING (U.S.)
Capital Corporation agreed to lend the Borrowers up to $7,000,000. In
connection with the ING Credit Agreement, ING (U.S.) Capital Corporation
received warrants to purchase 390,000 shares of common stock of the Company at
an exercise price of $0.01 per share, which amount and price are subject to
change under certain circumstances and fees of $555,000. The Company is
repaying this loan using some of the proceeds of this offering.
Other than in the United States, no action has been taken by the Company or
the underwriters that would permit a public offering of the shares of common
stock offered hereby in any jurisdiction where action for that purpose is
required. The shares of common stock offered hereby may not be offered or sold,
directly or indirectly, nor may this prospectus or any other offering material
or advertisements in connection with the offer and sale of any such shares of
common stock be distributed or published in any jurisdiction, except under
circumstances that will result in compliance with the applicable rules and
regulations of such jurisdiction. Persons into whose possession this prospectus
comes are advised to inform themselves about, and to observe, any restrictions
relating to the offering of the common stock and the distribution of this
prospectus. This prospectus is not an offer to sell or a solicitation of an
offer to buy any shares of common stock offered hereby in any jurisdiction in
which such an offer or solicitation is unlawful.
The Representative has informed the Company that the underwriters do not
intend to confirm sales to any accounts over which they exercise discretionary
authority without the prior written approval of the customer.
Prior to this offering, there has been no public market for the common stock
of the Company. Consequently, the initial public offering price has been
determined by negotiations between the Company and the Representative. Among
the factors considered in determining the initial public offering price were
the history of and prospects for the Company's business and the industry in
which it competes, an assessment of the Company's management and the present
state of the Company's development, the past and present revenues, earnings and
cash flows of the Company, the prospects for growth of the Company's revenues,
earnings and cash flows, the current state of the economy in the United States
and the current level of economic activity in the industry in which the Company
competes and in related or comparable industries, and
62
currently prevailing conditions in the securities markets, including current
market valuations of publicly traded companies which are comparable to the
Company.
The Company has applied to list the common stock on The Nasdaq National
Market, under the symbol "CAIS."
Until the distribution of the common stock of the Company is completed,
rules of the SEC may limit the ability of the underwriters and certain selling
group members to bid for and purchase the common stock. As an exception to
these rules, the Representative is permitted to engage in certain transactions
that stabilize the price of the common stock. Such 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 the offering, i.e., if they sell more shares of the common
stock than are set forth on the cover pages of this prospectus, the
Representative may reduce that short position by purchasing the common stock in
the open market. The Representative may also elect to reduce any short position
by exercising all or part of the over-allotment option described above.
The Representative may also impose a penalty bid on certain underwriters and
selling group members. This means that if the Representative purchases shares
of the common stock in the open market to reduce the underwriters' short
position or to stabilize the price of the common stock, it may reclaim the
amount of the selling concession from the underwriters and selling group
members who sold those shares as part of the 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 such purchases. The imposition of a penalty bid
might also have an effect on the price of the common stock to the extent that
it were to discourage resales of the common stock.
Neither the Company nor any of the underwriters makes 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, neither
the Company nor any of the underwriters makes any representation that the
Representative will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
LEGAL MATTERS
Certain legal matters relating to the offering and sale of the common stock
will be passed upon for the Company by Swidler Berlin Shereff Friedman, LLP,
3000 K Street, N.W., Suite 300, Washington, D.C. 20007, and for the
underwriters by Chadbourne & Parke LLP, 30 Rockefeller Plaza, New York, New
York 10112.
EXPERTS
The audited financial statements of the Company and Capital Area Internet
Service, Inc. included in this prospectus and the audited financial statement
schedule of the Company included in the registration statement of which this
prospectus forms a part 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.
63
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Index to Financial Statements
[Download Table]
Page
----
CAIS Internet, Inc., Consolidated Financial Statements
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998............. F-3
Consolidated Statements of Operations for the Years Ended December 31,
1996, 1997 and 1998..................................................... F-5
Consolidated Statements of Changes in Stockholders' Deficit for the Years
Ended December 31, 1996, 1997 and 1998.................................. F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1996, 1997 and 1998..................................................... F-7
Notes to Consolidated Financial Statements............................... F-8
Capital Area Internet Service, Inc. (Predecessor Company)
Report of Independent Public Accountants................................. F-23
Statement of Operations for the Period from January 1, 1996 to May 10,
1996.................................................................... F-24
Statement of Changes in Stockholders' Equity for the Period from January
1, 1996 to
May 10, 1996............................................................ F-25
Statement of Cash Flows for the Period from January 1, 1996 to May 10,
1996.................................................................... F-26
Notes to Financial Statements............................................ F-27
F-1
Report of Independent Public Accountants
To CAIS Internet, Inc. and subsidiaries
(formerly CGX Communications, Inc.):
We have audited the accompanying consolidated balance sheets of CAIS Internet,
Inc. (a Delaware corporation, formerly CGX Communications, Inc.) and
subsidiaries, as of December 31, 1997 and 1998, and the related consolidated
statements of operations, changes in stockholders' deficit, and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of CAIS
Internet, Inc. and subsidiaries, as of December 31, 1997 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to
the consolidated financial statements, the Company has suffered recurring
losses from operations and has a net capital deficiency that raises substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Arthur Andersen LLP
Washington, D.C.
February 19, 1999
F-2
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Consolidated Balance Sheets
(in thousands)
Assets
[Download Table]
December 31
---------------
1997 1998
------- -------
Current assets:
Cash......................................................... $ 149 $ 95
Accounts receivable, net of allowance for doubtful accounts
of $179 and $137, respectively.............................. 466 648
Prepaid expenses and other current assets.................... 79 228
Net current assets of discontinued operations (Note 3)....... 9,072 8,170
------- -------
Total current assets...................................... 9,766 9,141
------- -------
Property and equipment, net................................... 1,149 2,638
Deferred debt financing and offering costs, net............... -- 529
Intangible assets, net of accumulated amortization of
approximately $586 and $968, respectively.................... 1,816 1,434
Noncurrent assets of discontinued operations (Note 3)......... 2,307 1,936
------- -------
Total noncurrent assets................................... 5,272 6,537
------- -------
Total assets.............................................. $15,038 $15,678
======= =======
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Consolidated Balance Sheets
(in thousands except share and per share data)
Liabilities and Stockholders' Deficit
[Download Table]
December 31,
----------------
1997 1998
------- -------
Current liabilities:
Accounts payable and accrued expenses ...................... $ 1,038 $ 4,396
Current portion of long-term debt........................... 2,000 --
Payable to discontinued operations.......................... 3,735 5,342
Notes payable to related parties ........................... 173 --
Unearned revenues........................................... 456 572
Net current liabilities of discontinued operations (Note
3)......................................................... 8,804 8,205
------- -------
Total current liabilities................................ 16,206 18,515
------- -------
Bridge loan, net of unamortized debt discount of $817........ -- 6,183
Notes payable to related parties, net of current portion
(Note 9).................................................... 1,342 1,983
Long-term liabilities of discontinued operations (Note 3).... 2,768 2,601
------- -------
Total liabilities........................................ 20,316 29,282
------- -------
Commitments and contingencies (Notes 1, 6, 7, 8, 9, 10, and
12)
Stockholders' deficit (Note 10):
Common stock, $0.01 par value; 100,000,000 shares
authorized; 9,648,000 and
9,965,000 shares issued and outstanding, respectively...... 97 100
Additional paid-in capital.................................. 6,230 7,544
Warrants outstanding........................................ -- 1,226
Deferred compensation....................................... (4,314) (2,888)
Accumulated deficit......................................... (7,291) (19,586)
------- -------
Total stockholders' deficit.............................. (5,278) (13,604)
------- -------
Total liabilities and stockholders' deficit.............. $15,038 $15,678
======= =======
The accompanying notes are an integral part of these consolidated balance
sheets.
F-4
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Consolidated Statements of Operations
(in thousands, except per share amounts)
[Download Table]
Years Ended December
31,
-------------------------
1996 1997 1998
------ ------- --------
Net revenues........................................ $2,410 $ 4,556 $ 5,315
Cost of services.................................... 834 2,010 3,118
Operating expenses:
Selling, general and administrative................ 2,126 5,550 10,407
Depreciation and amortization...................... 352 678 831
Non-cash compensation.............................. -- 616 1,426
------ ------- --------
Total operating expenses.......................... 2,478 6,844 12,664
------ ------- --------
Loss from operations................................ (902) (4,298) (10,467)
Interest and other (income) expense:
Interest income.................................... (1) (2) --
Interest expense................................... 213 283 1,090
Other expense, net................................. -- 7 11
------ ------- --------
Total interest and other expense.................. 212 288 1,101
------ ------- --------
Loss from continuing operations before income
taxes.............................................. (1,114) (4,586) (11,568)
Provision for income taxes.......................... -- -- --
------ ------- --------
Loss from continuing operations................... (1,114) (4,586) (11,568)
Income (loss) from discontinued operations of
Cleartel (less applicable state (taxes) benefit of
$(30), $(108), and $34, respectively).............. 799 1,923 (671)
------ ------- --------
Net loss.......................................... $ (315) $(2,663) $(12,239)
====== ======= ========
Basic and diluted earnings (loss) per share:
Continuing operations.............................. $(0.11) $ (0.48) $ (1.17)
Discontinued operations............................ 0.08 0.20 (0.07)
------ ------- --------
Total............................................. $(0.03) $ (0.28) $ (1.24)
====== ======= ========
Weighted-average common shares outstanding--basic
and diluted 9,648 9,648 9,869
====== ======= ========
The accompanying notes are an integral part of these consolidated statements.
F-5
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Consolidated Statements of Changes in Stockholders' Deficit
For the Years Ended December 31, 1996, 1997, and 1998
(in thousands)
[Enlarge/Download Table]
Common Stock Additional
------------ Paid-In Warrants Deferred Accumulated
Shares Par Capital Outstanding Compensation Deficit Total
------- ----- ---------- ----------- ------------ ----------- --------
December 31, 1995....... 9,648 $ 97 $ -- $ -- $ -- $ (4,139) $ (4,042)
Capital contribution... -- -- 1,300 -- -- -- 1,300
Distributions declared
to equity holders..... -- -- -- -- -- (76) (76)
Net loss............... -- -- -- -- -- (315) (315)
------ ----- ------ ------ ------- -------- --------
December 31, 1996....... 9,648 $ 97 1,300 -- -- (4,530) (3,133)
Unearned compensation
pursuant to issuance
of stock options...... -- -- 4,930 -- (4,930) -- --
Amortization of
unearned
compensation.......... -- -- -- -- 616 -- 616
Distributions declared
to equity holders..... -- -- -- -- -- (98) (98)
Net loss............... -- -- -- -- -- (2,663) (2,663)
------ ----- ------ ------ ------- -------- --------
December 31, 1997....... 9,648 97 6,230 -- (4,314) (7,291) (5,278)
Capital contribution... -- -- 317 -- -- -- 317
Distributions declared
to equity holders..... -- -- -- -- -- (56) (56)
Issuance of common
stock................. 317 3 997 -- -- -- 1,000
Amortization of
unearned
compensation.......... -- -- -- -- 1,426 -- 1,426
Warrants issued in
connection with Bridge
Loan (Note 7)......... -- -- -- 1,226 -- -- 1,226
Net loss............... -- -- -- -- -- (12,239) (12,239)
------ ----- ------ ------ ------- -------- --------
December 31, 1998....... 9,965 $ 100 $7,544 $1,226 $(2,888) $(19,586) $(13,604)
====== ===== ====== ====== ======= ======== ========
The accompanying notes are an integral part of these consolidated statements.
F-6
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
Consolidated Statements of Cash Flows
(in thousands)
[Download Table]
Years Ended December
31,
-------------------------
1996 1997 1998
------ ------- --------
Cash flows from operating activities:
Net loss........................................... $ (315) $(2,663) $(12,239)
Adjustments to reconcile net loss to net cash
provided by operating
activities:
Compensation pursuant to stock options........... -- 616 1,426
Amortization of debt discount and deferred
financing costs................................. -- -- 555
Loss on disposal of fixed assets................. -- 63 --
Depreciation and amortization.................... 352 678 831
Depreciation and amortization of discontinued
operations...................................... 684 668 520
Changes in operating assets and liabilities, net
of Capital Area acquisition:
Accounts receivable, net........................ 67 (104) (182)
Prepaid expenses and other current assets....... (18) (46) (148)
Accounts payable and accrued expenses........... 424 380 2,984
Payable to discontinued operations.............. 980 2,755 1,047
Unearned revenues............................... 113 147 116
Changes in operating assets and liabilities of
discontinued operations........................ (888) (1,802) 1,882
------ ------- --------
Net cash provided by (used in) operating
activities.................................... 1,399 692 (3,208)
------ ------- --------
Cash flows from investing activities:
Purchases of property and equipment................ (542) (556) (1,435)
Purchases of property and equipment of discontinued
operations........................................ (623) (551) (387)
Payment for Capital Area acquisition............... (3,068) -- --
Net payments received on notes receivable.......... 13 129 (265)
Net payments received on related party accounts
receivable........................................ 190 180 317
------ ------- --------
Net cash used in investing activities.......... (4,030) (798) (1,770)
------ ------- --------
Cash flows from financing activities:
Net (repayments) borrowings under receivables-based
credit facility of discontinued operations........ 38 (211) (1,451)
Borrowings under Bridge Loan....................... -- -- 7,000
Borrowings under long-term debt.................... 2,000 600 --
Repayments under long-term debt.................... (233) (367) (2,000)
Borrowings under notes payable--related parties.... 1,100 675 1,000
Repayments under notes payable--related parties.... (114) (162) (107)
Principal payments under capital lease
obligations....................................... (250) (337) (173)
Payment of loan commitment, debt financing and
offering costs.................................... (82) (16) (345)
Proceeds from issuance of common stock............. -- -- 1,000
Distribution to equity holders..................... (43) -- --
------ ------- --------
Net cash provided by financing activities...... 2,416 182 4,924
------ ------- --------
Net (decrease) increase in cash..................... (215) 76 (54)
Cash, beginning of year............................. 288 73 149
------ ------- --------
Cash, end of year................................... $ 73 $ 149 $ 95
====== ======= ========
Supplemental disclosure of cash flow information:
Cash paid for interest of continuing operations.... $ 190 $ 246 $ 412
====== ======= ========
Cash paid for interest of discontinued operations.. $ 832 $ 870 $ 791
====== ======= ========
Supplemental disclosure of noncash activities:
Equipment acquired under capital lease of
discontinued operations........................... $ 80 $ -- $ 228
====== ======= ========
The accompanying notes are an integral part of these consolidated statements.
F-7
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business Description:
Organization
CAIS Internet, Inc. (the "Company") was incorporated under the name CGX
Communications, Inc. ("CGX") as a "C" corporation in Delaware in December 1997
to serve as a holding company for two operating entities, CAIS, Inc. ("CAIS"),
a Virginia "S" Corporation, and Cleartel Communications Limited Partnership
("Cleartel"), a District of Columbia partnership. The Company completed a
reorganization in October 1998 such that CAIS and Cleartel became wholly owned
subsidiaries of the Company. The reorganization has been accounted for similar
to a pooling-of-interests as CAIS and Cleartel were under common ownership. The
Company changed its name from CGX Communications, Inc. to CAIS Internet, Inc.
in February 1999.
CAIS was formed in May 1996 by the owners of Cleartel to acquire Capital
Area Internet Service, Inc. ("Capital Area") from its founders. It is a tier
one Internet Service Provider ("ISP"), connecting with other major internet
providers at various equipment locations in the United States. CAIS sells full-
time, dedicated connections to the Internet to commercial customers, dial-up
connections to the Internet to residential and smaller commercial customers,
and various ancillary Internet services, including hosting of web sites. It is
also a licensee and joint-owner of a new Internet technology that allows high-
speed data and voice traffic to travel simultaneously over one standard
telephone line. CAIS is marketing this technology under the name of OverVoice
for use primarily in hotels and apartment buildings (multiple dwelling units,
or "MDU's").
Cleartel began operations in 1987 to provide operator-assisted long-distance
telephone services to hotels and payphones, and provides commercial and
residential long-distance services, mainly in the eastern United States.
Cleartel's corporate headquarters and telephone switch equipment are located in
Washington, D.C. Operator services are provided as part of a contractual
relationship with a subsidiary of GTE International, located in the Dominican
Republic. A second operator center has been maintained in the corporate offices
in Washington for overflow traffic and redundancy. In February 1999, the
Company spun-off Cleartel to the Company's stockholders (see Notes 2 and 3).
Risks and Other Important Factors
The Company's net loss from continuing operations has increased from
$1,114,000 in 1996 to $11,568,000 in 1998. As of December 31, 1998, the Company
had negative working capital of approximately $9,374,000, and an accumulated
deficit of approximately $19,586,000. The Company has financed its operations
with various debt and equity placements. The Company's continuing operations
have also been financed in part from operating profits and cash flows generated
from its now discontinued operation (Cleartel). As more fully described in Note
7, the Company obtained a $7,000,000 bridge loan in September 1998, which has
been fully drawn by the Company as of December 1998. In January 1999 the
Company borrowed $1,000,000 from a stockholder (See Note 9). As described in
Note 10, the Company issued $11,500,000 of convertible preferred stock in
February 1999 after the spin-off of Cleartel. The Company received $3,500,000
in cash, $1,500,000 of which was used to repay amounts due to Cleartel in
February 1999, and an unconditional promissory note due in March 1999 for the
remaining $8,000,000. In addition to this preferred stock issuance, Management
intends to obtain equipment financing to help fund the roll-out of OverVoice.
Management believes that without additional financing such as the equipment
financing or the Company's anticipated initial public offering (the "IPO") in
1999, the Company would curtail the planned roll-out of OverVoice and reduce
marketing and development activities.
F-8
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
There can be no assurance that additional capital will be available to the
Company or that the terms of such capital will be acceptable to management.
Further, there can be no assurance that the Company will generate positive cash
flows or income from operations in the future.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations,
dependence on effective billing and information systems, intense competition,
rapid technological change, and any effects on the Company or its suppliers
relating to the Year 2000 issue. The Company's future plans are substantially
dependent on the successful roll-out of OverVoice. Net revenues generated from
OverVoice through December 31, 1998 were approximately $37,000. There can be no
assurance that the Company will be successful in its roll-out of OverVoice nor
can there be any assurance that the Company will be successful in defending its
related patent rights. Many of the Company's competitors are significantly
larger and have substantially greater financial, technical, and marketing
resources than the Company.
Year 2000
The Year 2000 Issue arises because many computerized systems use two digits
rather than four to identify a year. The effects of the Year 2000 Issue may be
experienced before, on, or after January 1, 2000, and, if not addressed, the
impact on operations and financial reporting may range from minor errors to
significant systems failure, which could affect the Company's ability to
conduct normal business operations. It is not possible to be certain that all
aspects of the Year 2000 Issue affecting the Company, including those related
to the efforts of customers, suppliers, or other third parties will be fully
resolved.
2. Summary of Significant Accounting Principles:
Consolidated Financial Statements
The consolidated financial statements include the results of CAIS, Inc.
after its acquisition of Capital Area on May 11, 1996 through December 31, 1996
and for the years ended December 31, 1997 and 1998. They also include the
results of Cleartel, presented as discontinued operations, for the years ended
December 31, 1996, 1997 and 1998.
In February 1999, the Company spun-off its operator and long-distance
services subsidiary, Cleartel, to its stockholders as a noncash distribution.
The spin-off has been presented as discontinued operations and, accordingly,
the Company has presented its financial statements for all periods prior to
that date in accordance with Accounting Principles Board ("APB") Opinion No.
30. All expenses related to members of senior management that will be
continuing with the Company are included within income from continuing
operations.
Use of Estimates in Preparation of Financial Statements
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 revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
The Company records revenues for all services when the services are provided
to customers. Amounts for services billed in advance of the service period are
recorded as unearned revenues and recognized as revenue when earned.
Cost of Services
Cost of services represent primarily recurring expenses for the lease of
data facilities from national and local fiber providers. These direct charges
include long haul bandwidth and local interconnection charges.
F-9
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fair Value of Financial Instruments
The carrying amounts for current assets and liabilities, other than the
current portion of notes payable to related parties, approximate their fair
value due to their short maturity. The fair value of notes payable to related
parties cannot be reasonably and practicably estimated due to the unique nature
of the related underlying transactions and terms (see Note 9). However, given
the terms and conditions of these instruments, if these financial instruments
were with unrelated parties, interest rates and payment terms could be
substantially different than the currently stated rates and terms.
Property and Equipment
Property and equipment are stated at historical cost less accumulated
depreciation and amortization. Depreciation is provided using the straight-line
method over the estimated useful lives of the assets ranging from three to five
years, or for leasehold improvements, the life of the lease, if shorter. Costs
of additions and improvements are capitalized and repairs and maintenance are
charged to expense as incurred. Upon sale or retirement of property and
equipment, the costs and related accumulated depreciation are eliminated from
the accompanying consolidated balance sheets, and any resulting gain or loss is
reflected in the accompanying consolidated statements of operations.
Debt Discount and Deferred Debt Financing and Offering Costs
As more fully discussed in Note 7, in September 1998, the Company entered
into a bridge loan facility (the "Bridge Loan") with an investment banking
firm. Debt discount costs of $1,226,000 represent amounts attributable to the
redeemable warrants issued in connection with the Bridge Loan. The unamortized
debt discount as of December 31, 1998, was approximately $817,000. These costs
are reflected as an offset to the related Bridge Loan in the accompanying
consolidated balance sheets as of December 31, 1998. Unamortized deferred debt
financing costs of approximately $292,000 represent other direct financing
costs incurred in connection with the placement of the Bridge Loan. Both the
debt discount and the deferred financing costs are being amortized over the
extended one-year term of the Bridge Loan using the effective interest method.
In connection with the Company's anticipated IPO, the Company also has
incurred direct costs of $237,000 associated with the offering. These costs are
reflected as deferred offering costs and will be offset against the proceeds
from the anticipated IPO or expensed if the IPO is unsuccessful.
Excess of Cost over Net Assets Acquired (Goodwill)
Goodwill recorded as a result of the acquisition of Capital Area by CAIS in
1996 (see Note 4) is being amortized over seven years. The Company continually
evaluates whether events and circumstances have occurred which indicate that
the remaining estimated useful life of goodwill may warrant revision or that
the remaining balance of goodwill may not be recoverable. Management believes
that no such impairment existed as of December 31, 1998. Goodwill for all
periods presented is included in intangible assets in the accompanying
consolidated balance sheets, net of accumulated amortization.
Amortization of goodwill was approximately $212,000, $329,000, and $382,000
for the years ended December 31, 1996, 1997, and 1998, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of trade accounts receivable. For trade
accounts receivable, the risk is limited due to the large number of customers,
the dispersion of those customers across many industries and geographic
regions, and the ability to terminate access on delinquent accounts.
F-10
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Recently Adopted Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 requires "comprehensive income" and the
components of "other comprehensive income," to be reported in the financial
statements and/or notes thereto. There was no difference between the Company's
net loss and its total comprehensive loss for the years ended December 31,
1996, 1997, and 1998.
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information" requires an entity to disclose financial and descriptive
information about its reportable operating segments. It also establishes
standards for related disclosures about products and services, geographic
areas, and major customers. The Company has adopted SFAS No. 131 for the year
ended December 31, 1998 (see Note 13).
In July 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, and its purpose is to replace existing
pronouncements with a single, integrated accounting framework for derivatives
and hedging activities. The Company has not yet evaluated the effect of this
standard on the financial statements. The Company will adopt this standard in
its December 31, 1999 financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." It provides guidance on accounting for
costs of computer software developed or obtained for internal use. It is
effective for fiscal years beginning after December 15, 1998, for projects in
progress and prospectively, with earlier application encouraged. The Company
has not yet evaluated the effect of this standard on the financial statements.
The Company will adopt this standard in its December 31, 1999 financial
statements.
Stock Compensation
The Company accounts for its stock option plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." The Company has adopted SFAS No.
123, "Accounting for Stock-Based Compensation," for disclosure purposes. The
Company has recognized non-cash compensation expense on certain stock options
granted to management (see Note 10).
Interest Rate Swaps
In late 1996, the Company entered into a forward interest rate swap
agreement to hedge its interest rate exposure. The Company was the fixed rate
payor and the lender was the floating rate payor. The swap, which did not
involve any exchange of the underlying principal amount, had been designated as
a hedge. As discussed in Note 8, the swap agreement was terminated in September
1998 upon repayment of the related bank loan. The net settlement amount under
the swap agreement resulted in a charge to interest expense of $39,000 in the
accompanying statements of operations.
Income Taxes
Until the Company's reorganization in October 1998, the federal income tax
obligations of CAIS and Cleartel were passed through to their respective
subchapter S shareholders and partners. Cleartel was subject to state
unincorporated business franchise taxes on any profits in the District of
Columbia.
The Company accounts for federal, state and local income taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred
tax assets and liabilities are computed based on the difference between the
financial statement and income tax bases of assets and liabilities using the
enacted marginal tax rate. SFAS No. 109 requires that a net deferred tax asset
be reduced by a valuation allowance if, based on the weight of available
evidence, it is more likely than not that some portion or all of the net
deferred tax asset will not be realized.
F-11
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net Loss Per Share
SFAS No. 128, "Earnings Per Share," requires dual presentation of basic and
diluted earnings per share on the face of the statements of operations. Basic
earnings per share excludes dilution and is computed by dividing income or loss
available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
Options to purchase approximately 2,034,000 and 2,946,000 shares of common
stock were excluded from the computation of diluted loss per share in 1997 and
1998, respectively, and warrants to purchase approximately 390,000 shares of
common stock were excluded from the computation of diluted loss per share in
1998, because inclusion of these options and warrants would have an anti-
dilutive effect on loss per share.
3.Spin-off/Discontinued Operations:
On February 12, 1999, the Company completed a spin-off of Cleartel, its
operator and long-distance services subsidiary, pursuant to which ownership of
Cleartel was transferred to the Company's stockholders. The Company distributed
all of the shares of common stock to its stockholders on a pro rata basis, and
the holders of options to acquire the Company's stock and warrants were granted
stapled rights to acquire shares in Cleartel. For financial reporting purposes,
the Company has presented the results of operations for Cleartel as
discontinued operations. A summary of the statement of the assets and
liabilities of discontinued operations are as follows (in thousands):
[Download Table]
December 31, Date of Spin-Off
1998 February 12, 1999
------------ -----------------
Balance Sheets
Cash........................................... $ 21 $ 1
Accounts receivable, net of allowance for
doubtful accounts of $1,450 and $1,395,
respectively.................................. 2,224 2,129
Notes receivable, current...................... 530 437
Advances receivable from CAIS.................. 5,342 4,941
Prepaid expenses and other assets.............. 53 59
------- ------
Total current assets......................... 8,170 7,567
------- ------
Property and equipment, net of accumulated
depreciation of $3,142 and $3,201,
respectively.................................. 1,305 1,260
Notes receivable, net of current portion....... 607 632
Other noncurrent assets........................ 24 27
------- ------
Total noncurrent assets...................... 1,936 1,919
------- ------
Total assets................................. $10,106 $9,486
======= ======
Accounts payable and accrued liabilities....... $ 5,410 $4,827
Borrowings under receivable-based financing.... 2,714 3,027
Capital leases, current........................ 81 77
------- ------
Total current liabilities.................... 8,205 7,931
------- ------
Notes payable to related party................. 2,100 1,450
Accrued interest to related party.............. 411 --
Capital leases, net of current portion......... 69 62
Other liabilities.............................. 21 --
------- ------
Total liabilities............................ 10,806 9,443
------- ------
Owners' (deficit) equity....................... (700) 43
------- ------
Total liabilities and owners' deficit........ $10,106 $9,486
======= ======
Statement of Changes in Owners' Deficit
Beginning owners' deficit, December 31, 1998... $ (700)
Conversion of related party debt to equity..... 1,083
Net loss....................................... (340)
------
Ending owners' equity, February 12, 1999....... $ 43
======
F-12
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of results for the discontinued operations for the years ended
December 31, 1996, 1997, and 1998 are as follows (in thousands):
[Download Table]
1996 1997 1998
------- ------- -------
Statements of Operations:
Net revenues.................................. $32,484 $33,959 $27,424
Operating expenses:
Cost of services............................ 19,685 19,319 17,880
Selling, general, and administrative........ 10,475 11,158 8,996
Depreciation and amortization............... 684 668 519
------- ------- -------
Total operating expenses.................. 30,844 31,145 27,395
------- ------- -------
Income from operations........................ 1,640 2,814 29
Interest expense, net of interest income...... 811 783 734
------- ------- -------
Income (loss) before taxes.................... 829 2,031 (705)
(Provision) benefit for state taxes........... (30) (108) 34
------- ------- -------
Net income (loss)............................. $ 799 $ 1,923 $ (671)
======= ======= =======
Income (loss) related to discontinued operations reflect those revenues and
expenses directly incurred by Cleartel and allocations of shared corporate
costs based primarily on methodologies established by management between the
Company and Cleartel to reflect the cost sharing agreement between both
companies.
During the years ended December 31, 1996, 1997, and 1998, CAIS and Cleartel
shared certain support services such as bookkeeping, information systems, and
advertising and marketing support. After the spin-off, the Company will provide
these services at cost plus a fixed percentage until Cleartel replaces this
arrangement with its own services in 1999. Amounts charged for services are
included as an offset to the respective operating expenses in the accompanying
statements of operations. A summary of these transactions for the years ended
December 31, 1996, 1997, and 1998, are as follows (in thousands):
[Download Table]
December 31,
--------------
1996 1997 1998
---- ---- ----
Bookkeeping, MIS, advertising, and marketing support..... $272 $302 $227
Office lease............................................. $159 $161 $164
Through December 31, 1998, profits and cash flows from Cleartel were used to
finance operating losses at CAIS. This obligation of the Company as of February
12, 1999, was approximately $4,941,000 and was reduced to $1,991,000 in
February 1999 upon cash payments of $1,500,000 and the Company's assumption of
related party debt totaling $1,450,000 from Cleartel. The remaining balance is
due at the earlier of thirty days after the closing date of the anticipated IPO
or June 30, 2000.
4. Acquisition:
CAIS purchased the capital stock and operations of Capital Area on May 10,
1996 for a purchase price of approximately $3,100,000, including penalties
related to closing delays. The purchase price (plus the closing delay
penalties) was paid to the sellers at closing and was financed through loans of
$2,000,000 from a bank (Note 8), $1,000,000 from a stockholder and $100,000
from another stockholder (Note 9).
F-13
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company recorded goodwill in 1996 related to the acquisition of Capital
Area in the amount of approximately $2,402,000. The goodwill is being amortized
over seven years. The Company accounted for the acquisition under purchase
accounting.
5. Property and Equipment:
Property and equipment consists of the following (in thousands):
[Download Table]
December 31,
--------------
1997 1998
------ ------
Internet equipment........................................ $ 660 $1,287
OverVoice Equipment....................................... -- 802
Computer hardware and software............................ 154 384
Office furniture and fixtures............................. 662 747
Leasehold improvements.................................... 46 207
------ ------
1,522 3,427
Less Accumulated depreciation............................. (373) (789)
------ ------
$1,149 $2,638
====== ======
6. Accounts Payable and Accrued Expenses:
Accounts payable and accrued expenses consist of the following (in
thousands):
[Download Table]
December 31,
-------------
1997 1998
------ ------
Accounts payable........................................... $ 823 $2,917
Accrued salaries and vacation.............................. 69 186
Accrued legal settlement (Note 12)......................... -- 500
Accrued professional fees.................................. 60 495
Accrued interest........................................... 27 150
Other...................................................... 59 148
------ ------
$1,038 $4,396
====== ======
7. Bridge Loan:
On September 4, 1998, the Company signed an agreement for a $7 million
Bridge Loan with the Company's investment banking firm. The Bridge Loan
required a commitment fee and a facility fee totaling $345,000. The Bridge Loan
was for a six-month term, converting to a five-year Senior Note if not repaid
prior to expiration of the initial term. In February 1999, the initial term was
extended to September 1999 for an additional fee of $210,000. Borrowings bear
interest at a rate of LIBOR plus 5 percent (10.625 percent as of December 31,
1998). The Bridge Loan was secured by substantially all of the assets of the
Company and Cleartel. The Bridge Loan contains certain covenants and
restrictions, including, but not limited to, limitations on additional
indebtedness, acquisition or transfer of assets, payment of dividends, new
ventures or mergers, and issuance of additional equity. In February 1999, the
agreement was revised such that Cleartel is no longer a borrower and Cleartel's
assets no longer serve as security for the loan. In addition, the revised
agreement allows specific indebtedness and specific equity issuances. The use
of proceeds is limited to repayment of the Bank Loan, funding for OverVoice
expenditures, and general corporate purposes. The weighted-average interest
rate under the Bridge Loan during 1998 was approximately 10 percent. The amount
of interest expense incurred related to the Bridge Loan, including amortization
of the debt discount and deferred debt financing costs totaled approximately
$747,000 during 1998.
F-14
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In connection with the Bridge Loan, the Company issued the investment
banking firm warrants to acquire 3 percent of the diluted outstanding shares of
common stock of the Company or 390,000 shares at September 4, 1998. The
warrants have an exercise price of $0.01 per share and expire on the tenth
anniversary after issuance, or September 4, 2008. The warrants fully vested
upon closing of the Bridge Loan and include certain anti-dilution provisions.
The fair value of the warrants, totaling approximately $1,226,000, is
classified as a component of additional paid-in capital as of December 31,
1998.
8.Bank Loan and Interest Rate Swap
In connection with the acquisition of Capital Area on May 10, 1996, the
Company obtained a $2,000,000 loan from a bank (the "Bank Loan"). Interest on
the Bank Loan accrued at a rate of prime plus one and one-half percent (9.75
percent at that date), with payments on a five-year amortization schedule and a
maturity date of May 10, 1999. The Bank Loan was guaranteed by one of the
principal stockholders of the Company and was secured by investments from
another principal stockholder of the Company.
On October 17, 1996, CAIS entered into an interest rate swap transaction
with the bank, and refinanced the remaining principal balance of approximately
$1,833,000 at that time into a new promissory note. Interest on the refinanced
note was based on the LIBOR rate, plus 2 percent. The bank also entered into a
hedging transaction to control fluctuation in the LIBOR rate, which had the
effect of converting the variable interest rate on the Bank Loan into a fixed
rate of 8.65 percent as of December 31, 1996.
On December 5, 1997, CAIS again refinanced the Bank Loan to increase the
principal balance outstanding at that time of $1,400,000 to the original
$2,000,000, thus netting CAIS $600,000 in cash proceeds. In addition, the
maturity date of the refinanced Bank Loan and the swap agreement was extended
to December 10, 2000.
On September 4, 1998, the entire Bank Loan principal and interest and
interest rate swap totaling $1,782,000 was paid off with proceeds from the
Bridge Loan (see Note 7). The amount of interest expense incurred related to
the Bank Loan was $115,000, $137,000, and $151,000 for the years ended December
31, 1996, 1997, and 1998, respectively.
9. Transactions with Related-Parties:
Notes Payable to Related Parties
Notes payable to related parties of $1,515,000 and $1,983,000 as of December
31, 1997 and 1998, respectively, consist of notes payable to stockholders with
interest accruing at annual rates of 10 to 13 percent. In February 1999,
related party notes totaling $4,433,000, including the $1,983,000 outstanding
as of December 31, 1998, the $1,450,000 assumed from Cleartel, and the
$1,000,000 borrowed in 1999, were converted into cumulative mandatory
redeemable convertible preferred stock (see Note 10).
Interest expense of approximately $97,000, $131,000, and $128,000 was
accrued during the years ended December 31, 1996, 1997, and 1998, respectively,
related to related party loans.
In January 1999, a principal stockholder lent $1,000,000 to the Company
under a note which accrues interest quarterly at 10 percent with principal due
on the earlier of thirty days after the closing date of the anticipated IPO or
March 31, 2000. As described above, the note was converted into cumulative
mandatory redeemable convertible preferred stock in February 1999.
Related Party Lease
During the years ended December 31, 1996, 1997 and 1998, the Company leased
a building in Washington D.C. for their corporate headquarters from a
stockholder. Rent expense of $180,000 was incurred
F-15
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for this lease during the years ended December 31, 1996, 1997, and 1998.
Beginning in February 1999, the Company will be relocating to a new building in
Washington, D.C. that is approximately 45 percent owned by the same stockholder
and his spouse.
10.Stockholders' Deficit:
Common Stock
On April 22, 1998, an individual invested $1,000,000 in the Company in
exchange for approximately 317,000 shares of common stock. Since the Company
had not yet been reorganized, the investor received a 2.439 percent equity
interest in CAIS and Cleartel, subject to any future corporate restructurings.
In February 1999, the Company increased its authorized common stock from
25,000,000 to 100,000,000 shares of common stock.
Convertible Preferred Stock
In February 1999, the Company authorized the issuance of up to 25,000,000
shares of preferred stock, par value $0.01 per share. Of these authorized
shares, 2,827,168 shares have been designated as Series A Convertible Preferred
Stock, par value $0.01 per share (the "Series A Shares") and 1,119,679 shares
have been designated as Series B Cumulative Mandatory Redeemable Convertible
Preferred Stock, par value $0.01 per share (the "Series B Shares").
In February 1999, after the Spin-off, the Company issued 2,827,168 Series A
Shares for total gross proceeds of $11,500,000. The Company received $3,500,000
in cash, $1,500,000 of which was used to pay amounts due to Cleartel, and an
unconditional promissory note due in March 1999 for the remaining $8,000,000.
The Series A Shares are convertible at the option of the holder, initially on a
one-to-one basis into common stock. The shares automatically convert into
common stock upon certain events including a qualified IPO as defined in the
certificate of incorporation. The Series A Shares are entitled to a liquidation
preference equal to $11,500,000, plus a return of 8 percent per annum thereon,
and all accrued but unpaid dividends thereon. The Series A Shares vote with the
common stock on an as converted basis. The Series A Shares contain certain
protective provisions regarding significant business decisions affecting the
Company's future operations such as to increase the number of shares designated
as Series A; pay or declare dividends or redeem, repurchase or acquire shares
of junior stock; enter into certain employment agreements; enter into an
acquisition, merger, reorganization or re-capitalization transaction; enter
into financial commitments in excess of $250,000; and, liquidate or dissolve
the Company, among other protective provisions. The holders of the Series A
Shares may require the Company to redeem the shares on February 1, 2004 at a
price equal to the greater of the liquidation preference or the fair market
value. The Company also issued to the purchasers of the Series A Shares,
warrants to purchase a number of shares of common stock equal to 3.0% of the
total number of shares outstanding at the close of the IPO. The warrants will
have an exercise price equal to the price per share of common stock at the IPO.
In February 1999, after the Spin-off, the Company issued 1,119,679 Series B
Shares in exchange for indebtedness, including accrued interest, totaling
$4,557,000 payable by the Company to the Stockholders. Upon consummation of a
qualified IPO, as defined, the Company is required to redeem for cash
$3,000,000 of the face amount of the Series B Shares, plus a return of 8
percent per annum thereon, and all accrued but unpaid dividends thereon. Any
remaining Series B Shares convert into common stock at the IPO on the earlier
of a qualified IPO at the IPO price or the conversion of the Series A Shares
upon a nonqualified IPO. The Series B Shares are entitled to a liquidation
preference of $4,557,000, a return of 8 percent per annum thereon, plus all
accumulated but unpaid dividends thereon. The Series B Shares vote with the
common stock on a one-for-one basis. The Series B Shares also contain certain
protective provisions regarding
F-16
CAIS INTERNET, INC.
(FORMERLY CGX COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
significant business decisions affecting the Company's future operations,
including voting rights with respect to increasing the number of shares
designated as Series B Shares, paying or declaring dividends to redeem,
repurchase or acquire shares of junior stock, and liquidating or dissolving the
Company.
EXECUTIVE STOCK OPTIONS
During 1997, the Company issued stock options to two members of executive
management as part of their four-year employment contracts. Since the Company
had not yet been reorganized at the time of the grants, the executives received
options to purchase equal interests in CAIS, Inc. and Cleartel. In February
1997, one of the members of executive management received options to acquire
approximately 301,000 shares of common stock at an exercise price of $1.19 per
share. One-third of these options vest at the earlier of the day the
underwriting agreement relating to an IPO is signed or the end of year three of
the employment contract and the remainder at the end of year four of the
employment contract. In September 1997, another member of executive management
received options to acquire approximately 1,733,000 shares of common stock at
an exercise price of $0.9732 per share. Approximately 97,000 options fully vest
on April 1, 1999. Of the remaining 1,636,000 options, 50 percent vest at the
end of employment years three and four, respectively. If the Company completes
an IPO prior to the end of employment year two, 75 percent of these remaining
options will vest on the day the underwriting agreement relating to an IPO is
signed, with the remaining 25 percent vesting at the end of employment year
four.
As a result of these grants, the Company recorded deferred compensation of
$4,930,000 to be amortized over the vesting period relating to these options.
The amount of deferred compensation was based upon the difference between the
estimated fair market value of the Company at the date of the grants and the
applicable exercise prices. Accordingly, the Company amortized $616,000 and
$1,426,000 for the years ended December 31, 1997 and 1998, respectively, in the
consolidated statements of operations.
EMPLOYEE STOCK OPTION PLAN
On March 24, 1998, the Company's stockholders approved the 1998 Equity
Incentive Plan (the "Stock Option Plan"). In February 1999, the Stock Option
Plan was amended and currently provides for the grant of both incentive and
nonstatutory stock options to eligible employees and consultants of the Company
and reserves 1,500,000 shares of common stock for issuance under the Stock
Option Plan. Options granted under the Stock Option Plan must have an exercise
price of no less than fair market value of the Company's common stock at the
date of grant and expire ten years after grant date. As of December 31, 1998,
approximately 912,000 shares were outstanding under the Stock Option Plan. The
stock options outstanding under the Stock Option Plan generally vest over three
to four year periods.
A summary of the Company's aggregate stock option activity and related
information under the Stock Option Plan, including the Executive Stock Options,
is as follows (in thousands, except per share prices):
[Download Table]
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
----------------- -----------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
------- --------- ------- ---------
Options outstanding at beginning of
period................................... -- $ -- 2,034 $1.00
Granted................................... 2,034 1.00 960 3.13
Exercised ................................ -- -- -- --
Forfeited................................. -- -- 48 3.07
----- ----- ----- -----
Options outstanding at end of period...... 2,034 $1.00 2,946 $1.66
===== ===== ===== =====
Options exercisable at end of period...... -- $-- -- $ --
===== ===== ===== =====
F-17
CAIS INTERNET, INC.
(FORMERLY CGX COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Exercise prices for options outstanding under the Plan and for the Executive
Stock Options as of December 31, 1998, are as follows:
[Download Table]
NUMBER OF OPTIONS WEIGHTED-AVERAGE
RANGE OF EXERCISE OUTSTANDING REMAINING CONTRACTUAL WEIGHTED-AVERAGE
PRICES (IN THOUSANDS) LIFE IN YEARS EXERCISE PRICE
----------------- ----------------- --------------------- ----------------
$0.97 1,733 8.67 $0.97
$1.19 301 8.42 $1.19
$3.07 866 9.31 $3.07
$4.31 46 9.96 $4.31
----------- ----- ---- -----
$0.97-$4.31 2,946 8.85 $1.66
=========== ===== ==== =====
The Company has elected to account for stock and stock rights in accordance
with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and has
adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-
Based Compensation."
Had compensation cost for the Company's employee stock options been
determined based on fair value at the grant date, consistent with the
provisions of SFAS No. 123, the Company's net loss from continuing operations
and loss per share from continuing operations would have been (in thousands,
except per share data):
[Download Table]
1997 1998
------- --------
Loss from continuing operations pro forma............... $(4,859) $(12,125)
Basic and diluted loss per share from continuing
operations pro forma................................... $ (0.50) $ (1.23)
The fair value of options granted in the years ended December 31, 1997 and
1998, were estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted-average assumptions: risk-free interest rates
of 5.68 and 4.55 percent, respectively, no dividend yield, weighted-average
expected lives of the options of 4 years, and expected volatility of 70
percent. There were no options granted in 1996.
The weighted-average fair value of options granted during the year ended
December 31, 1997 and 1998, were $2.64, and $1.75, respectively. For purposes
of pro forma disclosures, the estimated fair value of the options are amortized
to expense over the estimated service period. The options granted in 1997 were
granted below fair market value, while options granted in 1998 were granted at
fair market value.
11. INCOME TAXES:
Until the Company's Reorganization in October 1998, all earnings and losses
were passed through to the individual equity holders. At December 31, 1998, the
Company had net operating loss carryforwards of approximately $3,954,000 for
income tax purposes that expire in 2018. Net operating loss carryforwards are
subject to review and possible adjustment by the Internal Revenue Service and
may be limited in the event of changes in ownership pursuant to Section 382 of
the Internal Revenue Code.
The Spin-off of Cleartel in February 1999 was a taxable transaction.
Accordingly, the Company will be subject to income taxes on the excess of the
fair value of the spun-off assets (stock) over the Company's basis in the
assets distributed. Management believes that the net operating losses available
for carryforward into 1999 together with the losses expected to be generated in
1999 will offset any potential gain for income tax purposes. To the extent that
net operating losses are used to offset the taxable gain upon the Spin-off,
such operating losses will not be available to offset any future operating
income. If carryforward losses are used to offset the gain from the Spin-off,
the Company may be subject to the Alternative Minimum Tax ("AMT"). Any AMT
imposed would be allowed as a credit to offset future regular tax liability.
F-18
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the Company's net deferred tax asset as of
December 31, 1998 are as follows (in thousands):
[Download Table]
Deferred tax assets:
Net operating loss carryforwards.................................. $ 1,582
Unearned stock compensation....................................... 817
Allowance for doubtful accounts................................... 635
Book over tax goodwill............................................ 190
Accrued vacation.................................................. 56
Other deferred tax assets......................................... 154
-------
Total deferred tax assets....................................... 3,434
Deferred tax liabilities:
Tax over book depreciation........................................ (84)
-------
Net deferred tax asset.............................................. 3,350
Valuation allowance for net deferred tax assets..................... (3,350)
-------
$ --
=======
The Company has determined that the net deferred tax assets as of December
31, 1998 do not satisfy the recognition criteria set forth in SFAS No. 109.
Accordingly a valuation allowance was recorded against the applicable net
deferred tax assets.
12. Commitments and Contingencies:
Leases
The Company leases office space under noncancellable operating leases, one
of which was from a related party (see Note 9). The Company entered into a new
lease in 1999 for office space for its corporate headquarters. The lease term
will commence in February 1999 for a period of ten years. The initial base
annual rent will be approximately $861,000 per year with annual rent
escalations of 2 percent each year thereafter. The Company will have no
remaining lease obligation in its existing corporate headquarters office space,
after it has completed the office move.
The new building is approximately 45% owned by one of the principal
stockholders of the Company and his wife. The Company believes that the terms
of the lease, including the rental rate, are at least as favorable to the
Company as those which could have been negotiated with an unaffiliated third
party.
Total rental expense for operating leases, including related party rent, was
approximately $241,000, $300,000, and $329,000 for the years ended December 31,
1996, 1997, and 1998, respectively.
Minimum future lease payments at December 31, 1998 are as follows (in
thousands):
[Download Table]
Operating
Leases
---------
1999............................................................... $ 910
2000............................................................... 1,042
2001............................................................... 1,008
2002............................................................... 914
2003............................................................... 932
2004 and thereafter................................................ 5,080
------
$9,886
======
F-19
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
OverVoice Litigation
The Company, one of its principal officers and the corporate inventor of
OverVoice (the "Corporate Inventor") were named as defendants in a federal
civil action filed in the Eastern District of New York in September 1998. The
plaintiff alleged patent infringement, unfair competition, breach of contract
and related claims. On January 24, 1999, the parties in this litigation signed
a Settlement Agreement (the "Settlement"). Under the terms of the Settlement,
the Company agreed to pay the plaintiff $500,000 as follows: $250,000 upon
dismissal of this action, $150,000 on or before July 1, 1999, and $100,000 on
or before July 1, 2000. The Company also agreed to issue the plaintiff 25,000
shares of common stock and to issue additional shares if the 25,000 shares,
multiplied by the price at which shares are issued in this offering, does not
equal or exceed $250,000. In exchange, the plaintiff also agreed to modify
their exclusive license agreement with the Corporate Inventor to a nonexclusive
agreement. As a result, the Company now has the right to install the OverVoice
technology in single family residences and food establishments. The Company
also granted the plaintiff the right to purchase an additional 25,000 shares of
common stock at the offering price in any IPO.
From time to time, certain other claims and suits have been filed or are
pending against the Company and senior management. In management's opinion,
resolution of these matters will not have a material adverse effect on the
Company's financial position or results of operations.
Network Capacity
In June 1998, CAIS signed a Memorandum of Understanding ("MOU") with Qwest
Communications, Inc. This agreement will provide the basis for a long-term
contractual relationship to provide considerable nationwide bandwidth capacity
at prices which are significantly below the Company's current cost structures.
Although the agreement calls for a commitment to purchase $100 million of
services over a ten-year period, the commitment for the first three years of
the agreement only totals $5 million.
License and Royalty Agreement
In November 1996, the Company and the Corporate Inventor entered into a
license agreement that provided the Company with an option to acquire an
exclusive license to use, make, sub-license or sell the OverVoice technology,
subject only to certain geographical and pre-existing contract limitations
described in the license agreement. The Company paid $50,000 for this option
and an additional $50,000 when it exercised its option to acquire the license
in April 1997. Unless the Company terminates the license agreement, it will
remain in effect until the lapse of the last patent existing at the time of the
agreement or any additional patents filed during the term. Following the
exercise of the option, the Company agreed to expend up to $200,000 for
research and development efforts to design and build a system that incorporated
the patented technology, and to hire the individual inventor of OverVoice
("Individual Inventor") for a two year consulting contract.
The license agreement calls for royalties to be paid to the Corporate
Inventor equal to a variable percentage of net revenues, depending both upon
the specific type of service provided and the total annual revenue from all
services. The royalty percentage for services in which the Company is an active
participant either by selling proprietary equipment or by selling Internet
services ranges up to 5.5%. In cases where the Company is an inactive
participant and merely sub-licenses its rights, the Corporate Inventor receives
a royalty percentage that ranges from 40-70%. Management plans to remain an
active participant in all or substantially all OverVoice activities at this
time.
The Company has annual royalty obligations to the Corporate Inventor of
$100,000 for 1998 and increasing to a maximum of $250,000 per year during the
term of the agreement, unless the license agreement is terminated at the
Company's option.
F-20
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In August 1997, the Corporate Inventor and the Company signed an amendment
that states that the Company would advance funds for approved expenses related
to patent applications. As of December 31, 1997 and 1998, respectively, the
Company has recorded notes receivables for patent fund advances totaling
$38,000 and $82,000. These notes receivable balances have been fully reserved
in the accompanying consolidated balance sheets.
In a January 1999 amendment, the Company and the Corporate Inventor agreed
to transfer 50% of the patent ownership to the Company.
13. Segment Reporting
The Company has two reportable segments: "Internet Services" and
"OverVoice." During the years presented, the Company derived most of its
revenue from the sale of dedicated Internet access services, Web hosting and
dial-up Internet access ("Internet Services"). During 1998, the Company began
to market dedicated high-speed Internet access to hotels and multiple dwelling
units ("MDUs") using OverVoice.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. Since OverVoice is a new
product, its revenues and costs are being reported on an incremental basis
without any allocations of corporate overhead. Interest is allocated based upon
the respective percentage of losses before interest of the two segments. The
evaluation of the OverVoice segment's performance is only based on the
accumulation of revenues and specific costs identified to OverVoice operations.
The following is a summary of information about each of the Company's
reportable segments that are used by the Company to measure the segment's
operations (in thousands):
[Download Table]
1998
--------------------------------
Internet
Services OverVoice Consolidated
-------- --------- ------------
Revenues....................................... $ 5,278 $ 37 $ 5,315
Depreciation and amortization.................. 824 7 831
Interest expense............................... 802 288 1,090
Segment losses................................. (8,228) (3,340) (11,568)
Segment assets................................. 2,404 882 3,286
Expenditures for segment assets................ 623 812 1,435
[Download Table]
1997
--------------------------------
Internet
Services OverVoice Consolidated
-------- --------- ------------
Revenues....................................... $ 4,556 $ -- $ 4,556
Depreciation and amortization.................. 678 -- 678
Interest expense............................... 238 45 283
Segment losses................................. (3,807) (779) (4,586)
Segment assets................................. 1,615 -- 1,615
Expenditures for segment assets................ 556 -- 556
All 1996 results relate to the Internet Services segment except for $97,000
of research and development expenses.
F-21
CAIS INTERNET, INC.
(formerly CGX Communications, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is a reconciliation of the reportable segments' losses and
assets to the Company's consolidated totals (in thousands):
[Download Table]
December 31,
-----------------
1997 1998
------- --------
Losses
Total losses for reportable segments........................ $(4,586) $(11,568)
Income (loss) from discontinued operations.................. 1,923 (671)
------- --------
Consolidated net loss....................................... $(2,663) $(12,239)
======= ========
Assets
Total assets for reportable segments........................ $ 1,615 $ 3,286
Total current assets, excluding reportable segment assets... 9,300 8,493
Deferred financing and offering costs, net.................. -- 529
Intangible assets, net...................................... 1,816 1,434
Noncurrent assets of discontinued operations................ 2,307 1,936
------- --------
Consolidated total assets................................... $15,038 $ 15,678
======= ========
Major Customer and Geographical Information
During the year ended December 31, 1998, one customer in Hong Kong
represented 15 percent of the Company's consolidated net revenues.
Substantially all other net revenues were earned from customers in the United
States.
14. Regulatory Matters
At the present time, ISPs like the Company are not subject to direct
regulation by the Federal Communications Commission ("FCC") even though they
provide Internet access through transmission over public telephone lines.
However, as the growth of the Internet industry continues, there has been
considerable discussion and debate about whether the industry should be
subjected to regulation. This regulation could include universal service
subsidies for local telephone services and enhanced communications systems for
schools, libraries and certain health care providers. Local telephone companies
could be allowed to charge ISPs for the use of their local telephone network to
originate calls, similar to charges currently assessed on long distance
telecommunications companies. In addition, many state and local government
officials have asserted the right or indicated a willingness to impose taxes on
Internet-related services and commerce, including sales, use and excise taxes.
F-22
Report of Independent Public Accountants
To Capital Area Internet Service, Inc.:
We have audited the accompanying statements of operations, changes in
stockholders' equity and cash flows of Capital Area Internet Service, Inc. (a
Virginia S corporation), for the period from January 1, 1996, to May 10, 1996.
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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations of Capital Area Internet
Service, Inc. and its cash flows for the period from January 1, 1996, to
May 10, 1996, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
February 19, 1999
F-23
Capital Area Internet Service, Inc.
(Predecessor Company)
Statement of Operations
For the Period From January 1, 1996 to May 10, 1996
(In Thousands)
[Download Table]
Net revenues............................................................ $1,287
Cost of services........................................................ 323
Operating expenses:
Selling, general and administrative................................... 339
Depreciation.......................................................... 42
------
Total operating expenses.......................................... 381
------
Income from operations.................................................. 583
Other income.......................................................... 2
------
Net income.............................................................. $ 585
======
The accompanying notes are an integral part of these statements.
F-24
Capital Area Internet Service, Inc.
(Predecessor Company)
Statement of Changes in Stockholders' Equity
For the Period From January 1, 1996 to May 10, 1996
(In Thousands)
[Download Table]
Common Stock Additional
-------------- Paid-In Retained
Shares Par Capital Earnings Total
------- ----- ---------- -------- -----
Balance, January 1, 1996............... 1,000 $ 1 $474 $ 273 $ 748
Distribution to stockholders......... -- -- -- (500) (500)
Net income........................... -- -- -- 585 585
------- ----- ---- ----- -----
Balance, May 10, 1996.................. 1,000 $ 1 $474 $ 358 $ 833
======= ===== ==== ===== =====
The accompanying notes are an integral part of these statements.
F-25
Capital Area Internet Service, Inc.
(Predecessor Company)
Statement of Cash Flows
For the Period From January 1, 1996 to May 10, 1996
(In Thousands)
[Download Table]
Cash flows from operating activities:
Net income............................................................ $ 585
Adjustments to reconcile net income to net cash provided by operating
activities-
Depreciation........................................................ 42
Changes in operating assets and liabilities:
Accounts receivable, net.......................................... (11)
Inventory......................................................... 57
Other current assets.............................................. (15)
Accounts payable.................................................. 85
Accrued liabilities............................................... 95
Unearned revenues................................................. 62
-----
Net cash provided by operating activities....................... 900
-----
Cash flows from investing activities:
Purchases of property and equipment................................... (225)
-----
Net cash used in investing activities........................... (225)
-----
Cash flows from financing activities:
Distribution to shareholders.......................................... (500)
-----
Net cash used in financing activities........................... (500)
-----
Net increase in cash.................................................... 175
Cash at January 1, 1996................................................. 113
-----
Cash at May 10, 1996.................................................... $ 288
=====
The accompanying notes are an integral part of these statements.
F-26
Capital Area Internet Service, Inc.
(Predecessor Company)
Notes to Financial Statements
For the Period From January 1, 1996 to May 10, 1996
1. Business Description:
Capital Area Internet Service, Inc. ("Capital Area"), a Virginia S corporation,
was formed in October 1995 as a tier one Internet services provider connecting
with other major Internet providers at various equipment locations in the
United States.
Capital Area was formerly known as Pimmit Run Research, a sole proprietorship,
from 1993 until its name and structure change in 1995.
Capital Area was acquired on May 10, 1996, by the owners of Cleartel through
their commonly-controlled Virginia "S" corporation, CAIS. CAIS purchased the
capital stock and operations of Capital Area for a purchase price of
approximately $3,100,000. The purchase was accounted for under purchase
accounting.
2. Significant Accounting Principles:
Use of Estimates in Preparation of Financial Statements
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 revenue and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
The Company records revenues for all telecommunications services when the
services are provided to customers. Amounts for services billed in advance of
the service period are recorded as unearned revenues.
Cost of Services
Cost of services represents primarily recurring expenses for the lease of data
facilities from national and local fiber providers. These direct charges
include long haul bandwidth and local interconnection charges.
Income Taxes
Capital Area was not subject to federal income taxes for the period from
January 1 through May 10, 1996. Any federal tax effects on Capital Area were
passed through to the Subchapter S shareholders.
3. Stockholders' Equity:
As of May 10, 1996, prior to the acquisition, Capital Area had 5,000 shares of
no par common stock authorized for issuance. Of these authorized shares, 1,000
shares were issued and outstanding to two individuals. In April 1996, the
shareholders received a distribution totaling $500,000 for taxes related to the
period prior to May 10, 1996.
F-27
Capital Area Internet Service, Inc.
(Predecessor Company)
Notes to Financial Statements--(Continued)
For the Period From January 1, 1996 to May 10, 1996
4. Commitments and Contingencies:
Leases
Capital Area leased office space for their headquarters. Total rental expense
for operating leases was approximately $36,000 for the period from January 1
through May 10, 1996.
F-28
[INSIDE BACK COVER]
The graphic is a map of the United States which illustrates our current
POPs as well as planned POPs to be installed in 1999 and 2000. Red lines
indicate the connections between POPs which will form our network backbone.
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No dealer, salesperson or other person is authorized to give any informa-
tion or to represent anything not contained in this prospectus. You must not
rely on any unauthorized information or representations. This prospectus is an
offer to sell or a solicitation of an offer to buy only the shares offered
hereby, but only under circumstances and in jurisdictions where it is lawful
to do so. The information contained in this prospectus is current only as of
its date.
----------------
TABLE OF CONTENTS
[Download Table]
Page
----
Where You Can Find More Information...................................... iii
Cautionary Note Regarding Forward-Looking Information.................... iii
Prospectus Summary....................................................... 1
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 17
Dividend Policy.......................................................... 17
Capitalization........................................................... 18
Dilution................................................................. 19
Selected Financial Data.................................................. 20
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 21
Business................................................................. 28
Management............................................................... 42
Principal Stockholders................................................... 50
Certain Relationships and Related Transactions........................... 51
Description of Capital Stock............................................. 56
Shares Eligible for Future Sale.......................................... 60
Underwriting............................................................. 61
Legal Matters............................................................ 63
Index to Consolidated Financial Statements............................... F-1
Report of Independent Public Accountants................................. S-1
Until , 1999 (25 days after the date of this prospectus), all dealers
effecting transactions in the shares of common stock, whether or not partici-
pating in this distribution, may be required to deliver a prospectus. This is
in addition to the obligation of dealers to deliver a prospectus when acting
as underwriters and with respect to their unsold allotments or subscriptions.
Shares
[INSERT LOGO]
Common Stock
----------------
PROSPECTUS
----------------
ING Baring Furman Selz LLC
, 1999
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PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The table below sets forth the expenses to be incurred by the Company in
connection with the issuance and distribution of the shares registered for
offer and sale hereby, other than underwriting discounts and commissions. All
amounts shown represent estimates except the Securities Act of 1933, as amended
(the "Securities Act"), registration fee and the NASD filing fee.
[Download Table]
Registration fee under the Securities Act of 1933................... $20,850
NASD filing fee..................................................... 8,000
Nasdaq National Market fee.......................................... *
Printing expenses................................................... *
Registrar and Transfer Agent's fees and expenses.................... *
Accountants' fees and expenses...................................... *
Legal fees and expenses (not including Blue Sky).................... *
Blue Sky fees and expenses.......................................... *
Miscellaneous....................................................... *
-------
Total............................................................. $ *
=======
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Under Section 145 of the Delaware General Corporation Law (the "DGCL"), a
corporation may indemnify its directors, officers, employees and agents and its
former directors, officers, employees and agents and those who serve, at the
corporation's request, in such capacities with another enterprise, against
expenses (including attorney's fees), as well as judgement, fines and
settlements in nonderivative lawsuits, actually and reasonably incurred in
connection with the defense of any action, suit or proceeding in which they or
any of them were or are made parties or are threatened to be made parties by
reason of their serving or having served in such capacity. The DGCL provides,
however, that such person must have acted in good faith and in a manner such
person reasonably believed to be in (or not opposed to) the best interests of
the corporation and, in the case of a criminal action, such person must have
had no reasonable cause to believe his or her conduct was unlawful. In
addition, the DGCL does not permit indemnification in an action or suit by or
in the right of the corporation, where such person has been adjudged liable to
the corporation, unless, and only to the extent that, a court determines that
such person fairly and reasonably is entitled to indemnity for costs the court
deems proper in light of liability adjudication. Indemnity is mandatory to the
extent a claim, issue or matter has been successfully defended.
The Company's Certificate of Incorporation and By-Laws provide that, to the
extent permitted by law, the Company shall fully indemnify any person who was
or is a party or is threatened to be made a party to any threatened, pending,
or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that such person is or
was or has agreed to become a director, officer, employee, or agent of the
Company, or is or was serving at the request of the Company as a director,
officer, employee, or agent of another corporation, partnership, joint venture,
trust, employee benefit, plan or other enterprise, or by reason of any action
alleged to have been taken or omitted in such capacity, and may indemnify any
person who was or is a party or is threatened to be made a party to such an
action, suit or proceeding by reason of the fact that the person is or was or
has agreed to become an employee or agent of the Company, or is or was serving
or has agreed to serve at the request of the Company as an employee or agent of
another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorneys' fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by the person in connection with
such action, suit or proceeding and any appeal therefrom, if the person acted
in good faith and in a manner reasonably believed to be in or not opposed to
the best interests of the Company, and, with respect
II-1
to any criminal action or proceeding had no reasonable cause to believe the
person's conduct was unlawful; except that in the case of an action or suit by
or in the right of the Company to procure a judgment in its favor (1) such
indemnification shall be limited to expenses (including attorneys' fees)
actually and reasonably incurred by such person in the defense or settlement of
such proceeding, and (2) no indemnification shall be made in respect of any
claim, issue or matter as to which such person shall have been adjudged to be
liable to the Company unless and only to the extent that the Delaware Court of
Chancery or the court in which such action or suit was brought shall determine
upon application that, despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses which the Delaware Court of Chancery or such other
court shall deem proper.
The Certificate of Incorporation and By-Laws further provide that the
Company shall advance expenses incurred by a director or officer in defending
any such action if the director or officer undertakes to repay such amount if
it is determined that the director or officer is not entitled to
indemnification. The Company also shall purchase and maintain insurance to
protect itself and any such director, officer, or other person against any
liability asserted against him and incurred by him in respect of such service
whether or not the Company would have the power to indemnify him against such
liability by law or under the provisions of the Company's Certificate of
Incorporation or By-Laws.
Further, the Company has entered into indemnification agreements with its
directors and certain of its senior executive officers. Pursuant to the terms
of the indemnification agreements, each of the senior executive officers and
directors of the Company will be indemnified by the Company to the fullest
extent permitted by Delaware law in the event such officer is made or
threatened to be made a party to a claim arising out of such person acting in
his capacity as an officer or director of the Company.
Additionally, the Underwriting Agreement provides for indemnification by the
Underwriters of the directors, officers and controlling persons of the Company
against certain liabilities, including liabilities under the Securities Act,
under certain circumstances.
Item 15. Recent Sales of Unregistered Securities.
The following paragraphs of this Item 15 describe all sales of securities by
the Company within the past three years which were not registered under the
Securities Act.
On January 1, 1998, the Company issued:
4,214,275 shares of common stock to Ulysses G. Auger, Sr. for the
aggregate consideration of $42,142.75.
4,314,687 shares of common stock to Ulysses G. Auger, II for the
aggregate consideration of $43,146.87.
8,450 shares of common stock to The Constandinos Ulysses
Francisco Auger Economides Trust for the aggregate consideration
of $84.50.
8,450 shares of common stock to The Constandina Francisca Auger
Economides Trust for the aggregate consideration of $84.50.
8,450 shares of common stock to The Vassiliki Illias Auger
Economides Trust for the aggregate consideration of $84.50.
8,450 shares of common stock to The Annabel-Rose Auger Trust for
the aggregate consideration of $84.50.
8,450 shares of common stock to The James Frederick Auger Trust
for the aggregate consideration of $84.50.
II-2
8,450 shares of common stock to The Ulysses George Hawthorne Auger, III
Trust for the aggregate consideration of $84.50;
8,450 shares of common stock to The Alexander Robert Auger Trust for the
aggregate consideration of $84.50;
8,450 shares of common stock to The Gregory Ulysses Auger, II Trust for
the aggregate consideration of $84.50;
8,450 shares of common stock to The Bridgette Kathryn Auger Trust for
the aggregate consideration of $84.50; and
8,450 shares of common stock to The Nicholas William Randolph Auger
Trust for the aggregate consideration of $84.50.
On April 22, 1998, 317,073 shares of common stock were issued to R. Theodore
Ammon at a price of $3.15378 per share for an aggregate price of $1,000,000.
On October 2, 1998, in connection with the Reorganization, the Company
exchanged 5,349.7 shares of common stock for each 1% limited partnership
interest in Cleartel LP, 62,938 shares of common stock for each share of
Cleartel common stock and 500 shares of common stock for each share of CAIS,
Inc. common stock. As a result, the Company issued an aggregate of 1,034,970
shares of common stock as follows:
Ulysses G. Auger, Sr., 245,000 shares of common stock in exchange for
his shares of CAIS, Inc. and 267,483 shares of common stock in exchange
for his shares of Cleartel and limited partnership interest in Cleartel
LP;
Ulysses G. Auger, II, 250,000 shares of common stock in exchange for his
shares of CAIS, Inc. and 259,527 shares of common stock in exchange for
his shares of Cleartel and limited partnership interest in Cleartel LP;
The Constandinos Ulysses Francisco Auger Economides Trust, 500 shares of
common stock in exchange for its shares of CAIS, Inc. and 796 shares of
common stock in exchange for its shares of Cleartel and limited
partnership interest in Cleartel LP;
The Constandina Francisca Auger Economides Trust, 500 shares of common
stock in exchange for its shares of CAIS, Inc. and 796 shares of common
stock in exchange for its shares of Cleartel and limited partnership
interest in Cleartel LP;
The Vassiliki Illias Auger Economides Trust, 500 shares of common stock
in exchange for its shares of CAIS, Inc. and 796 shares of common stock
in exchange for its shares of Cleartel and limited partnership interest
in Cleartel LP;
The Annabel-Rose Auger Trust, 500 shares of common stock in exchange for
its shares of CAIS, Inc. and 796 shares of common stock in exchange for
its shares of Cleartel and limited partnership interest in Cleartel LP;
The James Frederick Auger Trust, 500 shares of common stock in exchange
for its shares of CAIS, Inc. and 796 shares of common stock in exchange
for its shares of Cleartel and limited partnership interest in Cleartel
LP;
The Ulysses George Hawthorne Auger, III Trust, 500 shares of common
stock in exchange for its shares of CAIS, Inc. and 796 shares of common
stock in exchange for its shares of Cleartel and limited partnership
interest in Cleartel LP;
The Alexander Robert Auger Trust, 500 shares of common stock in exchange
for its shares of CAIS, Inc. and 796 shares of common stock in exchange
for its shares of Cleartel and limited partnership interest in Cleartel
LP;
II-3
The Gregory Ulysses Auger, II Trust, 500 shares of common stock in
exchange for its shares of CAIS, Inc. and 796 shares of common stock in
exchange for its shares of Cleartel and limited partnership interest in
Cleartel LP;
The Bridgette Kathryn Auger Trust, 500 shares of common stock in
exchange for its shares of CAIS, Inc. and 796 shares of common stock in
exchange for its shares of Cleartel and limited partnership interest in
Cleartel LP; and
The Nicholas William Randolph Auger Trust, 500 shares of common stock in
exchange for its shares of CAIS, Inc. and 796 shares of common stock in
exchange for its shares of Cleartel and limited partnership interest in
Cleartel LP.
On October 2, 1998, the Company granted options for 97,465 shares of common
stock to William M. Caldwell, IV, at an exercise price of $.9732 per share in
exchange for Mr. Caldwell's ownership interest in CAIS, Inc.
In connection with their respective employment agreements, on October 2,
1998, Messrs. Caldwell and Anderson were issued replacement options as follows:
Options for 1,635,610 shares of common stock were granted to William M.
Caldwell, IV, at an exercise price of $.9732 per share.
Options for 301,420 shares of common stock were granted to Evans K.
Anderson, at an exercise price of $1.1942 per share.
On October 2, 1998, pursuant to the ING Credit Agreement dated September 4,
1998, the Company executed a Warrant Certificate issuing warrants to purchase
an aggregate of 390,000 shares of common stock, at an exercise price of $.01
per share, to ING (U.S.) Capital Corporation, or its registered assigns.
On January 24, pursuant to a Settlement Agreement, the Company agreed to
issue 25,000 shares of common stock to Terk Technologies Corp. ("Terk") and, if
necessary, such additional shares of common stock such that the total shares
delivered to Terk multiplied by the initial public offering price equals
$250,000. The Company also granted Terk the right to purchase up to 25,000
additional shares of common stock as part of this initial public offering in
connection with the Company's directed share program.
On February 12, 1999, pursuant to a private placement and in exchange for
approximately $4.6 million of indebtedness owed by the Company or CAIS, Inc. to
Ulysses G. Auger, Sr. and Ulysses G. Auger, II, the Company issued 1,119,679
Series B Shares to Ulysses G. Auger, Sr. and Ulysses G. Auger, II.
On February 19, 1999, pursuant to a private placement, the Company issued:
2,458,407 Series A Shares and warrants to purchase an aggregate of 2.61% of
the total outstanding shares of common stock upon completion of this
offering on a fully diluted basis (except for shares issued upon the
conversion of the Series B Shares), at an exercise price of the initial
public offering price per share to Chancery Lane, L.P. for the aggregate
consideration of $10,000,000; and
368,761 Series A Shares and warrants to purchase an aggregate of .39% of the
total outstanding shares of common stock upon completion of this offering on
a fully diluted basis (except for shares issued upon the conversion of the
Series B Shares), at an exercise price of the initial public offering price
per share to CAIS-Sandler Partners, L.P. for the aggregate consideration of
$1,500,000.
Amended and Restated Stock Option Plan. See "Management--Amended and
Restated Stock Option Plan," which is incorporated by reference herein from the
prospectus included in Part I of this registration statement.
II-4
Each issuance of securities described above was made in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act as a
transaction by an issuer not involving any public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with the Company, to information about the Company.
Item 16. Exhibits and Financial Statement Schedules
(A) Exhibits.
EXHIBIT INDEX
[Download Table]
Exhibit Exhibit
Number Description
------- -----------
*1.1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation of CAIS Internet, Inc.
3.2 Amended and Restated By-Laws of CAIS Internet, Inc.
4.1 Specimen Common Stock Certificate.
4.2 Warrant Agreement, dated September 4, 1998.
4.3 Common Stock Warrant, among CAIS Internet, Inc. and Chancery Lane,
L.P., dated February 19, 1999.
4.4 Common Stock Warrant, among CAIS Internet, Inc. and CAIS-Sandler
Partners, L.P., dated February 19, 1999.
4.5 Stockholders Agreement, dated February 19, 1999.
**5.1 Opinion of Swidler Berlin Shereff Friedman, LLP.
10.1 Investment Agreement, among the Company, CAIS, Inc. and R. Theodore
Ammon, dated April 22, 1998.
*10.2 Credit Agreement, as amended, by ING (U.S.) Capital Corporation to the
Company, CAIS, Inc. and certain of the Company's affiliates for
$7,000,000, dated September 4, 1998.
10.3 Series A Preferred Stock and Warrant Purchase Agreement, among the
Company, Chancery Lane, L.P. and CAIS-Sandler Partners, L.P., dated
February 19, 1999.
10.4 Exchange Agreement, among the Company, the limited partners of
Cleartel LP, Cleartel, Inc. and the shareholders of Cleartel, Inc.,
dated October 2, 1998.
10.5 Agreement of Merger among the Company, CAIS, Inc. and CGX2 Merger
Corp., dated October 2, 1998.
10.6 Amended and Restated Employment Agreement, among CAIS, Inc. and Evans
K. Anderson, dated June 3, 1997.
10.7 Assignment and Assumption Agreement and Release, among the Company,
CAIS, Inc. and Evans K. Anderson, dated October 2, 1998.
*10.8 Amendment to Amended and Restated Employment Agreement, among the the
Company, CAIS, Inc. and Evans K. Anderson, dated February 22, 1999.
10.9 Amended and Restated Employment Agreement, among CAIS, Inc. and
William M. Caldwell, IV, dated September 8, 1997.
10.10 Assignment and Assumption Agreement and Release, among the Company,
CAIS, Inc. and William M. Caldwell, IV, dated October 2, 1998.
*10.11 Amendment to Amended and Restated Employment Agreement, among the
Company, CAIS, Inc. and William M. Caldwell, IV, dated February 22,
1999.
10.12 Employment Agreement, among the Company and Laura Neuman, dated June
29, 1998.
P10.13 Agreement for Cooperative Use of Communication Patents, Purchase of an
Option to Obtain Intellectual Property Rights, among Inline Connection
Corporation and CAIS, Inc., dated November 5, 1996.
II-5
[Download Table]
Exhibit Exhibit
Number Description
------- -----------
10.14 Letter Agreement Extending Option Period provided in the Agreement for
Cooperative Use of Communication Patents, among Inline Connection
Corporation and CAIS, Inc., dated February 28, 1997.
10.15 Letter Exercising Option Pursuant to Agreement for Cooperative Use of
Communication Patents, among Inline Connection Corporation and CAIS,
Inc., dated April 4, 1997.
10.16 Letter Amendment Agreement to Agreement for Cooperative Use of
Communication Patents, among Inline Connection Corporation and CAIS,
Inc., dated August 1, 1997.
10.17 Letter Amendment Agreement to Agreement for Cooperative Use of
Communication Patents, among Inline Connection Corporation and CAIS,
Inc., dated October 21, 1997.
10.18 Application Transfer for Inline PCT Serial No. PCT/US97/12045, among
Inline Connection Corporation and CAIS, Inc., dated January 6, 1999.
10.19 Assignment of USSN 08/893,403 and PCT/US97/12045, among Inline
Connection Corporation and CAIS, Inc., dated January 6, 1999.
10.20 Letter Amendment Agreement to Agreement for Cooperative Use of
Communication Patents among Inline Connection Corporation and CAIS,
Inc., dated January 26, 1999.
10.21 Assignment of 50% of Certain Patent Properties, among Inline
Connection Corporation and CAIS, Inc., dated January 26, 1999.
10.22 Assignment of Certain Trademarks, among Cleartel Communications, Inc.
and CAIS, Inc., dated February 9, 1999.
10.23 CAIS Internet Services Agreement, among CAIS, Inc. and Hongkong
Telecom, dated October 24, 1997.
10.24 Collaboration on IPORT Market Trial Agreement, among CAIS, Inc. and
Microsoft Corporation, dated February 18, 1998.
P10.25 CAIS IPORT Integrator License Agreement, among CAIS and ATCOM, Inc.
d/b/a ATCOM/INFO dated September 10, 1998.
P10.26 Marketing Associate Solution Alliance Agreement, among CAIS, Inc. and
Unisys Corporation, dated November 11, 1998.
P10.27 Master License Agreement for High Speed Internet Service, among Hilton
Hotels Corporation and CAIS, Inc., dated December 23, 1998.
P10.28 Agreement for High Speed Internet Access Service in Multiple Dwelling
Units, among CAIS, Inc. and OnePoint Communications Corp., dated
February 19, 1999.
10.29 Deed of Lease, among Ramay Family Partnership and CAIS, Inc., dated
July 28, 1997.
10.30 Deed of Lease, among Ramay Family Partnership and CAIS, Inc., dated
May 28, 1998.
10.31 Office Building Lease for 1255 22nd Street, among 1255 22nd Street
Associates Limited Partnership and the Company, dated November 21,
1998.
10.32 Settlement Agreement, among CAIS, Inc. and Terk Technologies Corp.,
dated January 24, 1999.
10.33 The Company's Amended and Restated 1998 Equity Incentive Plan, dated
February 12, 1999.
**21.1 List of Subsidiaries.
**23.1 Consent of Swidler Berlin Shereff Friedman, LLP (filed as part of
Exhibit 5.1).
**23.2 Consent of Arthur Andersen, LLP.
II-6
[Download Table]
Exhibit Exhibit
Number Description
------- -----------
**24.1 Power of Attorney (set forth on signature page).
*27.1 Financial Data Schedule.
--------
* To be filed by amendment.
** Previously filed.
p Portions of this Exhibit have been omitted pursuant to a request for
confidential treatment and filed separately with the SEC.
(B) Financial Statement Schedules.*
* To be completed by amendment.
Item 17. Undertakings.
The undersigned Registrant hereby undertakes 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 Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
The undersigned Registrant hereby further undertakes 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 filed by the Registrant 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-7
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this amendment to Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in Washington D.C.,
on March 16, 1999.
CAIS INTERNET, INC.
/s/ Ulysses G. Auger, II
By: __________________________________
Ulysses G. Auger, II
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Ulysses G. Auger, II, and William M.
Caldwell, IV, and each of them acting individually, as his attorneys-in-fact
and agents, each with full power of substitution and resubstitution, for him in
his name, place and stead, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this Registration
Statement, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
amendment to Registration Statement has been signed by the following persons
in the capacities indicated on March 16, 1999.
[Enlarge/Download Table]
Name Title Date
Chairman of the Board and Chief Executive
----------------------------- Officer (Principal Executive Officer)
Ulysses G. Auger, II
* President and Director March 16, 1999
-----------------------------
William M. Caldwell, IV
* Vice President, Treasurer and Chief Financial March 16, 1999
----------------------------- Officer (Principal Financial and Accounting
Barton R. Groh Officer)
* Director March 16, 1999
-----------------------------
Ulysses G. Auger, Sr.
* Director March 16, 1999
-----------------------------
Richard F. Levin
* Director March 16, 1999
-----------------------------
Vernon L. Fotheringham
Director
-----------------------------
R. Theodore Ammon
*Ulysses G. Auger, II, by signing his name hereto signs this document on behalf
of each of the persons so indicated above pursuant to the powers of attorney
duly executed by such persons and previously filed with the Securities and
Exchange Commission.
II-8
Report of Independent Public Accountants
To CAIS Internet, Inc. and subsidiaries
(formerly CGX Communications, Inc.):
We have audited, in accordance with generally accepted auditing standards,
the financial statements of CAIS Internet, Inc. (a Delaware corporation,
formerly CGX Communications, Inc.) and subsidiaries, included in this
Registration Statement and have issued our report thereon dated February 19,
1999. Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Schedule II--Valuation and
Qualifying Accounts is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits 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.
Arthur Andersen LLP
Washington, D.C.
February 19, 1999
S-1
CAIS Internet, Inc.
(formerly CGX Communications, Inc.)
Schedule II--Valuation and Qualifying Accounts
For the Years Ended December 31, 1996, 1997 and 1998
(amounts in thousands)
[Download Table]
Balance at Charged to Balance at
Beginning Costs End of
Description of Period and Expenses Deductions(a) Period
----------- ---------- ------------ ------------- ----------
Deduction on the Balance
Sheet from the asset to
which it applies:
Allowance for doubtful
accounts
Year ended December 31,
1996...................... $ 52 $173 $ (88) $137
Year ended December 31,
1997...................... 137 106 (64) 179
Year ended December 31,
1998...................... 179 80 (122) 137
--------
(a) Represents amounts written off as uncollectible.
S-2
Dates Referenced Herein and Documents Incorporated by Reference
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