<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 18, 1998
REGISTRATION NUMBER 333-63899
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
COVAD COMMUNICATIONS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
---------------
<TABLE>
<S> <C> <C>
DELAWARE 4813 77-0461529
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
2330 CENTRAL EXPRESSWAY, SANTA CLARA, CALIFORNIA 95050
(408) 844-7500
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
ROBERT E. KNOWLING, JR.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
COVAD COMMUNICATIONS GROUP, INC.
2330 CENTRAL EXPRESSWAY, SANTA CLARA, CALIFORNIA 95050
(408) 844-7500
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S AGENT FOR SERVICE)
---------------
COPIES TO:
<TABLE>
<S> <C>
BARRY E. TAYLOR, ESQ. GREGORY K. MILLER, ESQ.
ROBERT G. O'CONNOR, ESQ. KAREN E. EBERLE, ESQ.
CECILIA M. DE LEON, ESQ. RICHARD G. CHISHOLM, ESQ.
CHARLES J. PROBER, ESQ. LATHAM & WATKINS
WILSON SONSINI GOODRICH & ROSATI 505 MONTGOMERY STREET, SUITE 1900
PROFESSIONAL CORPORATION SAN FRANCISCO, CALIFORNIA 94111
650 PAGE MILL ROAD, PALO ALTO, CA 94304 (415) 391-0600
(650) 493-9300
</TABLE>
---------------
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 in this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
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, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_] ...............................................
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_] ...............................................
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS +
+OF ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS
SUBJECT TO COMPLETION, DATED DECEMBER 18, 1998
SHARES
[LOGO OF COVAD]
COVAD COMMUNICATIONS GROUP, INC.
COMMON STOCK
All of the shares of Common Stock offered hereby are being sold by Covad
Communications Group, Inc. ("Covad" or the "Company"). Prior to the offering,
there has been no public market for the Common Stock of the Company. It is
currently estimated that the initial public offering price will be between
$ and $ per share. See "Underwriting" for a discussion of
the factors considered in determining the initial public offering price.
Application has been made for quotation of the Common Stock on the Nasdaq
National Market under the symbol "COVD."
-----------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" COMMENCING ON PAGE 8 HEREOF.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share.............................. $ $ $
- -----------------------------------------------------------------------------
Total(3)............................... $ $ $
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
(1) The Company has agreed to indemnify the Underwriters (as defined) against
certain liabilities, including liabilities under the Securities Act of
1933, as amended (the "Securities Act"). See "Underwriting."
(2) Before deducting expenses of the offering payable by the Company, estimated
at $ .
(3) The Company has granted the Underwriters a 30-day option to purchase up to
an aggregate of additional shares of Common Stock on the same
terms as the Common Stock offered hereby solely to cover over-allotments,
if any (the "Over-Allotment Option"). If the Over-Allotment Option is
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
-----------
The shares of Common Stock are being offered by the Underwriters, subject to
prior sale, when, as and if accepted by them, subject to certain conditions.
The Underwriters reserve the right to withdraw, cancel or modify such offer and
to reject orders in whole or in part. It is expected that delivery of the
shares will be made on or about , 1999 at the offices of Bear,
Stearns & Co. Inc., 245 Park Avenue, New York, New York, 10167.
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN
DONALDSON, LUFKIN & JENRETTE
GOLDMAN, SACHS & CO.
The date of this Prospectus is , 1999.
<PAGE>
[DESCRIPTION OF ARTWORK TO BE PROVIDED BY AMENDMENT]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET PRICE OF THE COMMON
STOCK, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS
AND THE IMPOSITION OF PENALTY BIDS. THESE TRANSACTIONS, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME. SEE "UNDERWRITING."
"Covad(TM)," "TeleSpeed(R)," "The Speed to Work(TM)" and the Covad crescent
logo names and marks are among the trademarks of the Company. This Prospectus
contains other product names, trade names and trademarks of the Company and of
other organizations.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary does not purport to be complete and is qualified in its
entirety by the more detailed information and Consolidated Financial
Statements, including the related Notes thereto, appearing elsewhere in this
Prospectus. This discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in the forward-looking statements. The Company disclaims
any obligation to update information contained in any forward-looking
statement. Unless the context otherwise requires, "Covad" and the "Company"
refer to Covad Communications Group, Inc. and its subsidiaries (the
"Subsidiaries"). The definitions of certain terms used herein are set forth in
the Appendix to this Prospectus. Except as otherwise noted, the information in
this Prospectus (i) assumes no exercise of the Over-Allotment Option, (ii)
reflects the conversion of all outstanding shares of the Company's Preferred
Stock into shares of Common Stock on a one-for-one basis upon completion of
this offering (not giving effect to the payment in shares of Common Stock of
cumulated but unpaid dividends on the Preferred Stock as of the closing of this
offering), and (iii) reflects the exercise for cash of warrants to purchase
1,800,000 shares of Common Stock immediately prior to the consummation of this
offering.
THE COMPANY
Covad is a leading packet-based Competitive Local Exchange Carrier ("CLEC")
that provides dedicated high-speed digital communication services using Digital
Subscriber Line ("DSL") technology to Internet Service Provider ("ISP") and
enterprise customers. ISPs purchase the Company's services in order to provide
high-speed Internet access to their business and consumer end-users. Enterprise
customers purchase the Company's services to provide employees with remote
access to their Local Area Networks ("LANs") to improve employee productivity
and reduce operating costs. The Company believes its services offer a superior
value proposition as compared to currently available high-speed Internet and
remote LAN ("RLAN") access alternatives. The Company's services are provided
over standard copper telephone lines at speeds of up to 1.5 Megabits per second
("Mbps"), approximately 25 times the speed available through a 56.6 Kilobits
per second ("Kbps") modem. As of December 15, 1998, the Company had installed
over DSL lines and received orders for its services from approximately
100 enterprise and ISP customers, including Cisco Systems, Concentric Network,
Epoch Networks, Oracle, PeopleSoft, Sprint, Stanford University, Verio and
Whole Earth Networks.
Covad introduced its services in the San Francisco Bay Area in December 1997.
The Company launched its services in the Los Angeles, New York and Boston
metropolitan areas in August 1998 and in the Washington, D.C. metropolitan area
in December 1998 and expects to introduce its services in the Seattle
metropolitan area in the first quarter of 1999. In March 1998, the Company
raised approximately $135 million through the issuance of its Senior Discount
Notes (as defined) to fund the deployment of its networks in these initial six
metropolitan areas (the "Initial Regions"). As a result of the strong market
demand for high-speed digital communication services, the Company has decided
to increase to 22 the number of regions in which it plans to build its networks
and offer its services. The Company estimates that, when complete, its networks
in these 22 regions will enable the Company to provide service to over
28 million homes and businesses in 28 of the top 50 metropolitan statistical
areas ("MSAs") in the United States.
MARKET OPPORTUNITY
Covad was formed to capitalize on the substantial business opportunity
created by the growing demand for high-speed digital communication, the
commercial availability of low cost DSL technology and the passage of the
Telecommunications Act of 1996 (the "1996 Act"). The Company's principal equity
investors include Warburg, Pincus Ventures, L.P., Crosspoint Venture Partners
1996 and Intel Corporation.
3
<PAGE>
Growing Market Demand for High-Speed Digital Communications Bandwidth. As
businesses increase their use of the Internet, intranets and extranets, the
Company expects the market size for both small- and medium-sized business
Internet access and RLAN access to continue to grow rapidly. According to
International Data Corporation ("IDC"), the number of Internet users worldwide
reached approximately 69 million in 1997 and will grow to approximately 320
million by 2002. In addition, industry analysts estimate that the value of
goods and services sold by businesses through the Internet will increase from
$2.6 billion in 1997 to $37.5 billion in 2002. High-speed digital connections
are becoming increasingly important to businesses and consumers as more high
bandwidth information and applications become available on the Internet.
Industry analysts also estimate that the number of remote access lines in the
U.S. will grow from approximately ten million in 1996 to approximately 30
million in 2000, a compound annual growth rate in excess of 30%.
Emergence of DSL Technology. The full potential of Internet and RLAN
applications cannot be realized without removing the performance bottlenecks of
the existing public switched telephone network. DSL technology removes these
performance bottlenecks by increasing the data carrying capacity of the copper
telephone lines from analog modem speeds of 56.6 Kbps and ISDN speeds of 128
Kbps to DSL speeds of up to 6 Mbps. Because DSL technology reuses the existing
copper plant, DSL technology is significantly less expensive to deploy on a
broad scale than existing alternative high-speed digital communication
technologies, such as cable modems, wireless data and satellite data. As a
result, a significant portion of the investment in a DSL network is success-
based, as such networks require a comparatively lower initial fixed investment,
and the subsequent variable investments in DSL electronics are directly related
to the number of paying subscribers.
Telecommunications Act of 1996. The passage of the 1996 Act created a legal
framework for CLECs, such as the Company, to provide local analog and digital
communication services in competition with the Incumbent Local Exchange
Carriers ("ILECs"). The 1996 Act eliminated a substantial barrier to entry for
CLECs by enabling them to leverage the existing infrastructure built by the
ILECs, which required a $200 billion investment by ILECs and ILEC ratepayers,
rather than constructing a competing infrastructure at significant cost. The
1996 Act in particular emphasized the need for competition-driven innovations
in the deployment of advanced telecommunications services, such as the
Company's DSL services.
THE COVAD SOLUTION
Covad's objective is to become the leading provider of DSL-based high-speed
digital communication services in each region that it enters. Key aspects of
the Company's solution to provide high-speed digital communication services
include:
Attractive Value Proposition. The Company offers higher bandwidth digital
connections than alternative services at similar or lower prices that do not
vary with usage. For business Internet users, the Company's high-end services
offer comparable bandwidth to T1 and Frame Relay circuits at approximately 25%
of the cost. For the RLAN market, the Company's mid-range services are three to
six times the speed of ISDN and up to ten times the speed of analog modems at
monthly rates similar to or lower than those for heavily used ISDN lines. The
Company believes that many of its enterprise customers can justify deploying
lines to their employees if productivity improves by only a few hours per month
based on increases in the number of hours worked and decreases in commute time
and time spent waiting for information. For consumer Internet users, the
Company expects that it can offer a G.Lite compatible service at prices
comparable to prices offered by cable modem services today.
Widely Available, Always-Connected, Secure Network. The Company's strategy of
providing blanket coverage in each region it serves is designed to ensure that
the Company's services are available to the vast majority of its customers'
end-users. The Company's networks provide 24-hour, always-on connectivity,
unlike ISDN lines and analog modems which require customers to connect to the
Internet or their LAN for each use. Also, because the Company uses dedicated
connections from each end-user to the ISP or enterprise network, its customers
can reduce the risk of unauthorized access.
4
<PAGE>
Experienced Management Team. The Company's management team includes
individuals with extensive experience in the data communications,
telecommunications and personal computer industries. In July 1998, the Company
hired as its Chief Executive Officer Robert Knowling, Jr., who formerly served
as the Executive Vice President of Operations and Technologies at U S WEST
Communications and as Vice President of Network Operations at Ameritech. The
Company has also hired Regional General Managers in order to cover all 22 of
its announced regions who collectively have over 210 years of
telecommunications service experience.
BUSINESS STRATEGY
The key elements of the Company's strategy are (i) to secure CLEC status and
sign interconnection agreements for the top U.S. markets, (ii) to roll out its
service rapidly to maintain its first-mover advantage, (iii) to provide blanket
coverage in each of its 22 targeted regions, (iv) to focus on packet data
services, (v) to concentrate its sales efforts on ISP and enterprise customers
that can provide a large number of end-users, (vi) to leverage the success-
based economics of DSL technology, (vii) to establish relationships with
leading ISPs, systems integrators and Interexchange Carriers ("IXCs") in order
to expand its distribution channels, and (viii) to provide a superior and
comprehensive product and service solution that includes line installation,
equipment sale and configuration and RLAN design.
RISK FACTORS
The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors" beginning on page 8 hereof.
THE OFFERING
<TABLE>
<C> <S>
Common Stock offered by the Company.........
Common Stock to be outstanding after this
offering................................... (1)
Use of proceeds............................. For capital expenditures to expand the
Company's networks and for working capital
purposes. See "Use of Proceeds."
Proposed Nasdaq National Market Symbol...... COVD
</TABLE>
- --------
(1) Based on the number of shares of Common Stock outstanding as of December
15, 1998. Includes 1,800,000 shares of Common Stock to be issued pursuant
to exercise for cash of warrants immediately prior to the consummation of
this offering. Excludes (i) an aggregate of 16,196,727 shares of Common
Stock reserved for issuance under the Company's 1997 Stock Plan, of which
12,509,922 shares were subject to outstanding options at December 15, 1998,
(ii) an aggregate of 1,000,000 shares of Common Stock reserved for issuance
under the Company's 1998 Employee Stock Purchase Plan, (iii) an aggregate
of 5,188,764 shares of Common Stock issuable upon exercise of outstanding
warrants and (iv) shares of Common Stock issued as cumulated but unpaid
dividends on Preferred Stock as of the closing of this offering.
----------------
The address of the Company's principal executive office is 2330 Central
Expressway, Santa Clara, California 95050, and the Company's telephone number
is (408) 844-7500.
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
YEAR ENDED ENDED ENDED
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1998
------------ ------------- -------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE
AND PER SHARE AMOUNTS)
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues.............................. $ 26 $ 1,565 $ 2,560
Operating expenses:
Network and product costs........... 54 1,355 2,316
Sales, marketing, general and
administrative..................... 2,374 10,681 17,231
Amortization of deferred
compensation....................... 295 1,837 2,695
Depreciation and amortization....... 70 738 1,348
----------- ----------- -----------
Total operating expenses.......... 2,793 14,611 23,590
----------- ----------- -----------
Income (loss) from operations......... (2,767) (13,046) (21,030)
Net interest income (expense)........ 155 (3,511) (7,231)
----------- ----------- -----------
Net income (loss)..................... $ (2,612) $ (16,557) $ (28,261)
=========== =========== ===========
Net income (loss) per common share.... $ (0.80) $ (2.75) $ (5.26)
Shares used in computing net income
(loss) per share..................... 3,271,546 6,011,610 5,374,924
Pro forma net income (loss) per common
share(1)............................. $ (0.23) $ (0.64) $ (1.14)
Shares used in computing pro forma net
income (loss) per share(1)........... 11,522,916 26,057,772 24,844,824
OTHER DATA:
EBITDA(2)............................. $ (2,402) $ (10,471) $ (16,987)
CONSOLIDATED CASH FLOW DATA:
Provided by (used in) operating
activities........................... $ (1,895) $ (3,319) $ (4,196)
Provided by (used in) investing
activities........................... (2,494) (21,084) (33,464)
Provided by (used in) financing
activities........................... 8,767 (406) 130,358
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF SEPTEMBER 30, 1998
DECEMBER 31, -----------------------------
1997 ACTUAL AS ADJUSTED(3)
------------ -------------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents........... $ 4,378 $ 97,076 $
Net property and equipment.......... 3,014 34,003
Total assets........................ 8,074 144,622
Long-term obligations, including
current portion.................... 783 137,926
Total stockholders' equity (net
capital deficiency)................ 6,498 (6,417)
<CAPTION>
AS OF
DECEMBER 31,
1997 AS OF SEPTEMBER 30, 1998
------------ -----------------------------
<S> <C> <C> <C>
OTHER OPERATING DATA:
Homes and businesses passed......... 278,000 3,302,000
Lines installed..................... 26 1,948
</TABLE>
- --------
(1) Under the Company's Certificate of Incorporation, all outstanding Preferred
Stock will convert into Common Stock on a one-for-one basis upon the
completion of this offering. The pro forma net loss per share assumes the
conversion of the Preferred Stock and the exercise for cash of warrants to
purchase 1,800,000 shares of Common Stock immediately prior to the
consummation of this offering.
6
<PAGE>
(2) EBITDA consists of net loss excluding net interest, taxes, depreciation and
amortization (including amortization of deferred compensation). EBITDA is
provided because it is a measure of financial performance commonly used in
the telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and should not be
construed (i) 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 (ii) 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.
(3) Adjusted to reflect the receipt of net proceeds of $ from this offering
(after deducting estimated underwriting discounts and commissions and
offering expenses payable by the Company).
7
<PAGE>
RISK FACTORS
An investment in the Common Stock involves a high degree of risk. In
addition to the other information contained in this Prospectus, prospective
investors should carefully consider the following factors in evaluating an
investment in the Common Stock offered hereby. This Prospectus also includes
"forward-looking" statements within the meaning of Section 27A of the
Securities Act and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"); provided, however, that the safe harbor
provisions of Section 27A and Section 21E are not applicable to any "forward
looking" statements made in connection with the initial issuance of shares of
Common Stock offered hereby pursuant to this Prospectus, although such
provisions are applicable to such statements made in connection with resales
of such shares. The forward-looking statements involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors
including, but not limited to, those discussed below, in "Business" and
elsewhere in this Prospectus. All forward-looking statements attributable to
the Company or persons acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth herein. The Company disclaims
any obligation to update information contained in any forward-looking
statement. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Forward Looking Statements."
LIMITED OPERATING HISTORY
The Company was incorporated in October 1996 and introduced its service
commercially in the San Francisco Bay Area in December 1997, in the Los
Angeles, New York City and Boston metropolitan areas in August 1998 and in the
Washington, D.C. metropolitan area in December 1998. As a result of the
Company's limited operating history, and because the issuance of its 13 1/2%
Senior Discount Notes due March 2008 and Warrants (as defined) (together, the
"Senior Discount Notes") and the Company's use of proceeds therefrom make
recent and future operating results not comparable to historical operating
results, the Company has limited historical financial data upon which an
evaluation of the Company or its prospects can be based. The Company's
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in an early stage of deployment,
particularly those in new and rapidly evolving markets. To address these
risks, the Company must, among other things, rapidly expand the geographic
coverage of its services; attract and retain customers within its existing and
in new regions; increase awareness of the Company's services; respond to
competitive developments; continue to attract, retain and motivate qualified
persons; continue to upgrade its technologies; commercialize its network
services incorporating such technologies; and effectively manage its expanding
operations. There can be no assurance that the Company will be successful in
addressing such risks, and failure to do so could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition.
HISTORY AND CONTINUATION OF OPERATING LOSSES
The Company has incurred substantial and increasing net operating losses and
experienced negative cash flow each month since its inception. As of September
30, 1998, the Company had an accumulated deficit of approximately $30.9
million. The Company currently intends to increase significantly its capital
expenditures and operating expenses in order to expand its networks to support
additional expected end-users in existing and future markets and to market and
provide the Company's services to a growing number of potential end-users. As
a result, the Company expects to incur substantial additional net operating
losses and substantial negative cash flow for at least the next several years.
In addition, the Company raised approximately $135 million through the
issuance of the Senior Discount Notes in March 1998, which accrete to $260
million by March 2003. The Company expects that annual interest and
amortization charges relating to the Senior Discount Notes will be
approximately $16.0 million during the year ending December 31, 1998, will
increase to approximately $36.9 million for the year ending December 31, 2004
and will remain at that level through maturity of the Senior Discount Notes in
March 2008. Accordingly, the Company's operating losses will increase
significantly as a result of the interest and amortization charges related to
the Senior Discount Notes. In addition, the Company expects to incur
substantial additional debt in the future. Any additional debt would increase
the Company's
8
<PAGE>
interest and amortization charges. See "--Unproven Business Model and Pricing
Sensitivity" and
"--Substantial Future Capital Requirements."
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
The Company's annual and quarterly operating results may fluctuate
significantly in the future as a result of numerous factors, many of which are
outside the Company's control. Factors that may affect the Company's operating
results include the timing and ability of ILECs to provide and construct the
required central office ("CO") collocation facilities, the rate at which
customers subscribe to the Company's services, the prices the customers pay
for such services and end-user churn rates. The Company's operating results
are sensitive to the pricing of its services and volume commitments from
individual customers. The Company believes its financial performance depends
to a great extent on retaining ISP and enterprise customers and on levels of
subscriber churn, which can vary due to a variety of factors, including
relocation of end-users of ISP customers and employee turnover within
enterprise customers. Additionally, the Company does not currently have long-
term contracts with any of its customers, and there can be no assurance that
the Company's ISP and enterprise customers will not experience substantial
customer or subscriber churn as a result of customers or subscribers
discontinuing the use of its services or switching to an alternative service
provider. Further factors that may add to volatility in the Company's annual
or quarterly operating results include the amount and timing of capital
expenditures and other costs relating to the expansion of the Company's
network, the introduction of new services by the Company or its competitors,
technical difficulties or network downtime, general economic conditions and
economic conditions specific to the Company's industry, among other factors.
There can be delays in the commencement and recognition of revenue because the
installation of telecommunication lines to implement certain services has lead
times that are controlled by third parties. In addition, the Company plans to
increase operating expenses to fund operations, sales, marketing, general and
administrative activities and infrastructure. To the extent that these
expenses are not accompanied by an increase in revenues, the Company could
experience a material adverse effect on its business, prospects, operating
results and financial condition. As a result of all of the foregoing factors,
it is likely that in some future quarter the Company's operating results will
be below the expectations of securities analysts and investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected. Fluctuations in operating results may also result in volatility in
the price of the Company's Common Stock.
UNPROVEN BUSINESS MODEL AND PRICING SENSITIVITY
The Company believes that it was the first packet-based CLEC to provide
high-speed digital communication services using DSL technology. As such, the
Company's business strategy is unproven. To be successful, the Company must,
among other things, develop and market services that are widely accepted by
ISPs, enterprises and consumers. The Company's TeleSpeed services are
currently its principal services and have only been launched in the San
Francisco Bay Area and the Los Angeles, New York City, Boston and Washington,
D.C. metropolitan areas. There can be no assurance that the Company's services
will achieve broad commercial acceptance. The prices the Company charges for
certain services are in some cases higher than those charged by its
competitors for the same services. There can be no assurance that a sufficient
number of end-users will be willing to pay the prices charged by the Company
for its TeleSpeed services. Additionally, prices for digital communication
services have fallen historically, and prices in the industry in general, and
for the services the Company offers and plans to offer in particular, are
expected to continue to fall. The Company expects in the future to provide
price discounts to customers that commit to a large number of end-users, and
therefore the Company's average prices over the relevant period may be below
its list prices. In addition, the Company may be required to reduce prices
periodically to respond to competition and to generate increased sales volume.
Accordingly, it is difficult to predict whether the Company's pricing model
will prove to be viable, whether demand for the Company's services will
materialize at the prices it expects to charge or whether current or future
pricing levels will be sustainable. The failure to achieve or sustain
projected pricing levels or to achieve or sustain broad market acceptance of
the Company's services could result in a material adverse effect on the
Company's business, prospects, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Business Strategy."
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DEPENDENCE UPON INDIRECT SALES CHANNELS
The Company markets its Internet access services through ISPs for resale to
their business and consumer end-users. To date, ISPs have accounted for a
majority of the Company's revenues, and the Company expects that its ISP
customers will generate the majority of its future market penetration and
revenue growth. The Company plans to build relationships with numerous ISP
customers in order to gain access and provide its services to as many ISP
business and consumer end-users as possible. The Company's agreements with its
ISP customers are non-exclusive, and many of the Company's ISP customers also
resell services offered by the Company's competitors. In addition, a number of
the Company's ISP customers have committed to provide large numbers of end-
users in exchange for price discounts. If the number of business and consumer
end-users of the Company's services provided through the ISP channel is
significantly lower than the Company's forecast for any reason, or if the ISPs
with which the Company has entered into such arrangements are unsuccessful in
competing in their own intensely competitive markets, the Company's business,
prospects, operating results and financial condition would be materially
adversely affected. The Company also intends to market its products through
value added resellers and systems integrators and to enter into strategic
marketing relationships with leading IXCs, which the Company believes will
enable it to penetrate its markets and gain market acceptance more rapidly. No
assurance can be given that the Company will establish strategic relationships
with these third parties or, if it does, that such relationships will improve
the Company's business, prospects, operating results or financial condition.
See "Business--Customers" and "--Sales and Marketing."
LENGTHY SALES CYCLE FOR ENTERPRISE CUSTOMERS
The Company's practice with respect to its enterprise customers has been to
enter into an arrangement for a negotiated price to install the service
initially for a small number of end-users. An enterprise customer decides
whether to implement a broad rollout of the Company's services after
evaluating the results of this initial phase of deployment. Based on its
experience to date, the Company believes that an enterprise customer's initial
phase of deployment and its decision to roll out the Company's service to
additional end-users has taken at least six months, and has generally taken
longer than the Company originally expected. As of December 15, 1998, a
substantial majority of the Company's enterprise customers had not yet rolled
out the Company's services broadly to their employees, and it is not certain
when such rollouts will occur, if at all. The Company will not receive
significant revenue from enterprise customers until and unless these rollouts
occur. During this lengthy sales cycle the Company incurs significant expenses
in advance of the receipt of revenues. Therefore, any continued or ongoing
failure for any reason of enterprise customers to roll out the Company's
services will have a material adverse effect on the Company's business,
prospects, operating results and financial condition. See "Business--
Customers."
UNCERTAIN AVAILABILITY OF COLLOCATION SPACE AND DEPENDENCE ON ILECS TO PROVIDE
COLLOCATION SPACE AND COLLOCATION FACILITIES
The primary dependency of the Company in its initial years is the ability to
secure space from the various ILECs for physical collocation of the Company's
equipment in the ILECs' COs. Such physical collocation allows the Company to
own, install, operate, maintain and upgrade its own equipment at the ILECs'
COs. The Company has experienced initial rejections of its applications to
obtain collocation space from Pacific Bell in a significant number of COs in
Pacific Bell's service areas in California. The Company has also experienced
similar rejections in certain COs in the Los Angeles region from GTE
Corporation ("GTE") and in Massachusetts, Virginia and in other states from
Bell Atlantic and other ILECs. The Company expects that as it proceeds with
its deployment, it will submit applications for collocation space and it will
face additional rejections, which may be material in number, for COs in its
other target markets. Although a majority of CO applications that were
initially rejected by Pacific Bell have been subsequently accepted, there can
be no assurance that the Company will continue to be successful in reversing
CO rejections in other regions. The Company cannot predict the extent of these
rejections or their impact on its ability to provide broad service
availability in its target markets. The rejection of the Company's
applications for collocation space has in the past resulted, and could in the
future result, in delays in, and increased expenses associated with, the
rollout of its services in its target markets, which could result in a
material adverse effect on its business, prospects, operating results and
financial condition.
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Broad service availability is important for the Company's ISP and enterprise
customers that desire to provide Internet access and RLAN access on a regional
basis. The Company's inability to obtain physical collocation space could have
a material adverse impact on the Company's ability to secure and retain
customers. In this regard, the Company is in arbitration proceedings with
multiple ILECs regarding certain collocation spaces which have adversely
affected and, in the future, may continue to adversely affect the Company's
ability to deploy its network, provide service to customers, and enter into
additional interconnection agreements with the ILECs in other states. The
availability of collocation space in high demand target markets will also be
affected to the extent that other CLECs are seeking or have obtained
collocation space to offer services. In such COs, the Company has the option
of virtual collocation (where the ILEC manages and operates the Company's
equipment), which the Company believes is an unattractive solution due to
restrictions on the Company's ability to maintain the quality of its network.
In addition, in some COs where the Company plans to collocate, the Company
believes space will become available at a later date. Currently, however,
ILECs are not in all cases agreeing to maintain the Company's position in the
queue for CO collocation space where the Company is seeking collocation;
hence, the Company is unable to determine if or when it will be able to obtain
collocation space in these COs. The Company is engaged in a variety of
negotiations and legal actions to resolve situations where ILECs assert that
certain COs lack sufficient space for physical collocation by the Company. The
Federal Communications Commission (the "FCC") is reviewing the collocation
policies and practices of the ILECs with the goal of facilitating the efforts
of CLECs such as the Company to obtain collocation space more easily and on
more favorable terms. There is no guarantee that the FCC's review will result
in fewer ILEC rejections of the Company's physical collocation applications or
collocation availability on more favorable terms for the Company. There can be
no assurance that the Company's legal and regulatory disputes will be resolved
successfully or that it will achieve collocation arrangements in a sufficient
number of COs in one or more of its target markets within the Company's
desired time frame, if at all.
Under the 1996 Act and a December 31, 1997 ruling of the Federal District
Court for the Northern District of Texas (the "December 31, 1997 Ruling"), the
Regional Bell Operating Companies ("RBOCs"), formerly subject to antitrust
decree restrictions on interLATA (interexchange) long distance services, would
no longer be barred from entry into this market. The December 31, 1997 Ruling
declared that the portions of the 1996 Act subjecting RBOCs to a prior FCC
approval process in order to provide interLATA services within their
respective incumbent service regions are unconstitutional. Under the December
31, 1997 Ruling, RBOCs would no longer be compelled to prove to the FCC that,
in the states where they desire to provide interLATA services, they have
entered into one or more state utility commission-approved agreements with one
or more facilities-based competitors which provide business and residential
local exchange service and such agreement satisfies 14 specified
interconnection requirements. On September 8, 1998, the United States Appeals
Court for the Fifth Circuit reversed the December 31, 1997 Ruling. This
decision itself may be appealed to the United States Supreme Court. If the
December 31, 1997 Ruling is reinstated by the United States Supreme Court,
RBOCs will no longer have incentives to promote local facilities-based
competition and sign interconnection agreements as a quid pro quo for
obtaining approval to provide interLATA service. The outcome or the duration
of this litigation may adversely affect the level of cooperation the Company
receives from the RBOCs.
The 1996 Act nevertheless continues to impose interconnection obligations on
ILECs and the obligation that ILECs provide CLECs, such as the Company, access
to their unbundled network elements ("UNEs"). The 1996 Act generally requires
that interconnection charges as well as charges for UNEs be cost-based and
nondiscriminatory. In particular, the Company depends on ILECs to provide
unbundled DSL-capable lines that connect each end-user to the Company's
equipment collocated in the COs. The FCC has commenced a review of the manner
in which ILECs provision DSL-capable lines to CLECs, including the Company,
with the goal of increasing CLECs' access to such lines. For instance, the FCC
is examining the imposition of additional obligations on the ILECs to allow
CLECs such as the Company to provide higher speed DSL services through local
loops that involve digital loop carrier ("DLC") systems. The nonrecurring and
recurring monthly charges for DSL-capable lines required by the Company vary
greatly. These rates are subject to the approval of the appropriate state
regulatory commission. The rate approval processes for DSL-capable lines
typically involve a lengthy review of the ILEC-proposed rates in each state.
The ultimate rates approved typically depend greatly on
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the ILEC's initial rate proposals and such factors as the geographic
deaveraging/averaging policy of the state public utility commission. These
rate approval proceedings are time-consuming and absorb scarce resources
including legal personnel and cost experts as well as participation by Company
management. Consequently, the Company is subject to the risk that the non-
recurring and recurring charges for DSL-capable lines will increase based on
new rates proposed by the ILECs and approved by state regulatory commissions
from time to time. See "Business--Network Architecture and Technology," "--
Government Regulation" and "--Legal Proceedings."
DEPENDENCE ON ILECS TO PROVIDE TRANSMISSION FACILITIES AND TO PROVISION COPPER
LINES
The Company interconnects with and uses ILECs' networks to service its
customers, and accordingly, the Company is highly dependent upon the
technology and capabilities of the ILEC to meet certain telecommunications
needs of the Company's customers and to maintain its service standards. The
availability and reliability of transmission and other telecommunication
services from other CLECs is limited. The Company is also dependent to some
extent on cooperation from the ILECs, including the provision and repair of
transmission facilities. For example, the Company depends on the ILECs to
provide the Company's DSL service through DLC systems. The ILECs in turn rely
significantly on unionized labor. Labor-related issues and actions on the part
of the ILECs have in the past, and in the future may, adversely affect the
ILEC's provision of services and network components ordered by the Company.
The Company's dependence on the ILECs has caused and could continue to cause
the Company to encounter delays in establishing its network and providing
higher speed DSL services. Any such delays could adversely affect the
Company's relationships with its customers, result in harm to the Company's
reputation or could otherwise have a material adverse effect on the Company's
business, prospects, operating results and financial condition.
In particular, the Company has not yet established a history of ordering and
obtaining the provisioning and repair of very large volumes of DSL-capable
lines from any ILEC. For example, the Company is not certain whether it can
successfully deploy higher speed DSL services through the growing number of
copper lines provided through DLC systems. It is uncertain whether the Company
will be successful in doing so or whether the ordering and provisioning
processes achieved by the Company will be satisfactory for the retention and
growth of its end-user base and customer base, and any failure to do so could
have a material adverse effect on the Company's business, prospects, operating
results and financial condition. Further, the Company does not have an
established history of addressing the billing practices of the different
ILECs. As the Company's geographic and customer base grows, the Company may
encounter billing disputes with the ILECs that could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition.
DEPENDENCE ON INTERCONNECTION AGREEMENTS WITH ILECS
The success of the Company's strategy is dependent upon the Company's
ability to enter into and implement interconnection agreements in each of its
target markets with the appropriate ILECs on a timely basis. The Company's
interconnection agreements have a maximum term of three years, requiring the
Company to renegotiate agreements with the ILECs. There is no guarantee that
existing or new agreements will be extended or renegotiated on terms favorable
to the Company. Additionally, the Company's interconnection agreements are
subject to interpretation by both parties, and differences in interpretation
may arise that cannot be resolved on favorable terms to the Company. For
example, the Company is in arbitration proceedings with two ILECs under the
dispute resolution clauses of the Company's interconnection agreements. These
disputes have adversely affected and, in the future, may continue to adversely
affect the Company's ability to deploy its network, provide service to
customers, and enter into additional interconnection agreements with the ILECs
in other states. Finally, the interconnection agreements are subject to state
commission, FCC and judicial oversight. There can be no assurance that
modification to the terms, conditions or prices of the Company's
interconnection agreements by these governmental bodies, or that disputes with
ILECs over the terms of the interconnection agreements generally, will not
have a material adverse affect on the Company's business, prospects, operating
results and financial condition. See "Business--Interconnection Agreements
with ILECs."
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UNCERTAIN QUALITY AND AVAILABILITY OF THE ILEC COPPER LINES USED BY THE
COMPANY
The 1996 Act imposes obligations on ILECs and generally requires that
interconnection charges and charges for UNEs and provisioning of
interconnection facilities and UNEs be cost-based and nondiscriminatory. The
Company's strategy requires the Company to interconnect with and use an ILEC's
copper telecommunications lines to service the Company's customers. As such,
the Company is dependent upon the technology and capabilities of the ILECs to
meet certain telecommunications needs of the Company's customers and maintain
its service standards. The Company is highly dependent on the quality and
availability of the ILECs' copper lines and the ILECs' maintenance of such
lines. There can be no assurance that the Company will be able to obtain the
services it requires from the ILECs and at rates, terms and conditions
satisfactory to the Company, and the failure to obtain such services and
satisfactory rates, terms and conditions would have a material adverse effect
on the Company's business, prospects, operating results and financial
condition.
INTENSE COMPETITION
The markets for business and consumer Internet access and RLAN access
services are intensely competitive, and the Company expects that such markets
will become increasingly competitive in the future. The Company's most
immediate competitors are the ILECs, Cable Modem Service Providers ("CMSPs"),
IXCs, Fiber-Based CLECs ("FCLECs"), ISPs, Online Service Providers ("OSPs"),
Wireless and Satellite Data Service Providers ("WSDSPs") and other CLECs. Many
of these competitors are offering, or may soon offer, technologies and
services that directly compete with some or all of the Company's high-speed
digital services. Such technologies include ISDN, DSL, wireless data and cable
modems. The principal bases of competition in the Company's markets include
transmission speed, reliability of service, breadth of service availability,
price/performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital
availability and exclusive contracts. The Company believes that it compares
unfavorably with its competitors with respect to such factors as, among other
things, brand recognition, operating experience, exclusive contracts and
capital availability. Many of the Company's competitors and potential
competitors have substantially greater resources than the Company and there
can be no assurance that the Company will be able to compete effectively in
its target markets.
All of the largest ILECs present in the Company's target markets are
conducting technical and/or market trials or have entered into commercial
deployment of the DSL-based services. For example, U S WEST Communications,
Inc. is offering commercial DSL services in 13 states of its 14-state region.
Ameritech Corporation is offering service in certain smaller cities and has
announced plans to introduce DSL services in the Detroit and Chicago suburbs
in the near future. Bell Atlantic has announced such services in Washington,
D.C. and one other metropolitan area and expects to offer service in the
Philadelphia metropolitan area and in New Jersey's Hudson River area. In
addition, Pacific Bell (a subsidiary of SBC Communications) announced its
commercial DSL services for California in 1998. SBC Communications is offering
DSL on a trial basis in Austin, Texas and has announced plans to deploy
service in other locations after the trial is complete. BellSouth has
announced service availability in seven cities and plans to have service in 30
cities by the end of 1999. GTE has announced plans to have DSL services
deployed in 16 states by the end of 1998. The Company recognizes that each
ILEC has the potential to quickly overcome many of the issues that the Company
believes have slowed wide deployment of DSL services by ILECs in the past. As
they do so the ILECs will represent strong competition in all of the Company's
target service areas. The ILECs have an established brand name and reputation
for high quality in their service areas, possess sufficient capital to deploy
DSL equipment rapidly, have their own copper lines and can bundle digital data
services with their existing analog voice services to achieve economies of
scale in serving customers. Certain of the ILECs have aggressively priced
their consumer asymmetric digital subscriber line ("ADSL") services as low as
$30-$40 per month, placing pricing pressure on the Company's TeleSpeed
services. The ILECs are in a position to offer service from COs where the
Company is unable to secure collocation space and offer service because of
space restrictions, which provides the ILECs with a potential competitive
advantage compared with the Company. Accordingly, the Company may be unable to
compete successfully against the ILECs, and any failure to do so would
materially and adversely affect the Company's business, prospects, operating
results and financial condition.
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In addition to the ILECs, many of the Company's potential competitors have
longer operating histories, greater name recognition and significantly greater
financial, technical and marketing resources than the Company. As a result,
they may be able to develop and adopt new or emerging technologies and respond
to changes in customer requirements or devote greater resources to the
development, promotion and sale of their products and services more
effectively than the Company. It is also possible that such competitors may
form new alliances and rapidly acquire significant market share. Such
competitors may be able to undertake more extensive marketing campaigns, adopt
more aggressive pricing policies and devote substantially more resources to
developing high-speed digital services. Such intense competition could
materially and adversely affect the Company's business, prospects, operating
results and financial condition.
The telecommunications industry is subject to rapid and significant changes
in technology, and the effect of technological changes on the business of the
Company, such as continuing developments in DSL technology and alternative
technologies for providing high-speed communications data, cannot be
predicted. There can be no assurance that technological developments in the
telecommunications industry will not have a material adverse effect on the
competitive position, business, prospects, operating results and financial
condition of the Company. For a detailed description of the current and
potential competition of the Company, including competition from ILECs, CMSPs,
IXCs, FCLECs, ISPs, OSPs, WSDSPs and other CLECs, see "Business--Competition"
and "--Government Regulation."
RISKS ASSOCIATED WITH MANAGEMENT OF SUBSTANTIAL GROWTH IN OPERATIONS
The Company's strategy is to significantly expand its network within its
existing regions and to deploy networks in a total of 22 regions by . The
development and expansion of the Company's operations will depend upon, among
other things, the Company's ability to identify, access and initiate service
in key COs within existing and target regions, design an adequate Operating
Support System ("OSS"), design and construct regional data centers ("RDCs"),
obtain CO collocation facilities, obtain the required government
authorizations (which allow the Company to obtain cost-based pricing from the
ILECs in each of its target regions), enter into and renew interconnection
agreements with the appropriate ILECs on satisfactory terms and conditions,
and raise additional capital to fund the completion of the deployment of its
networks. To grow at its desired pace, the Company must, among other things,
(i) market to and acquire a substantial number of customers and end-users;
(ii) continue to implement and improve its operational, financial and
management information systems, including its client ordering, provisioning,
installation, dispatch, trouble ticketing and other operational systems as
well as its billing, accounts receivable and payable tracking, fixed assets
and other financial management systems; (iii) hire and train additional
qualified personnel; and (iv) continue to expand and upgrade its network
infrastructure. There can be no assurance that the Company will deploy its
networks as scheduled, will gain ISP and enterprise customers as expected, or
will otherwise achieve the operational growth necessary to achieve its
business strategy, and any material or ongoing failure to do so may adversely
affect the price of the Company's Common Stock in the public market.
The Company is currently experiencing a period of rapid and substantial
growth, and it expects to continue to experience substantial growth as the
Company executes its strategy of expanding its networks into 22 regions and
providing blanket coverage within each region. This growth has placed, and is
expected to place, a significant strain on the Company's management and
operational resources. The Company has increased its employees from 42 at
December 31, 1997, to 332 at December 15, 1998, and expects to continue to
increase significantly its employee base to support the deployment of its
networks. In addition, the Company expects the demands on its network
infrastructure and technical support resources to grow rapidly along with the
Company's customer base, and if the Company is successful in implementing its
marketing strategy, it may experience difficulties responding to demand for
its services and technical support in a timely manner and in accordance with
its customers' expectations. These demands are expected to require the
addition of new management personnel and the development of additional
expertise by existing management personnel. There can be no assurance that the
Company's networks, procedures or controls will be adequate to support the
Company's operations or that management will be able to keep pace with such
growth. If the Company is unable to manage growth effectively, the Company's
business, prospects, operating results and financial condition will be
materially adversely affected. See "Management."
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SUBSTANTIAL FUTURE CAPITAL REQUIREMENTS
The Company will require substantial additional funds for the continued
development, commercial deployment and expansion of its networks. As of
September 30, 1998, the Company had approximately $97.1 million in cash and
cash equivalents. From inception until September 30, 1998, the Company had
made approximately $35.4 million in capital expenditures and had incurred
operating expenses of approximately $26.4 million in the development of its
business, the development of technology and operating support systems, the
conduct of sales and marketing activities and the establishment of its
management team. In addition, the Company has made and expects to continue to
make significant capital outlays in order to continue to commercially deploy
its networks. The Company believes its current capital resources, including
the proceeds of this offering, will be sufficient to fund the Company's
aggregate capital expenditures and working capital requirements, including
operating losses, through the . The Company will require substantial
additional financing to support its operations after that date, including
funding the significant capital expenditures and working capital requirements
necessary for the Company to provide services in its 22 targeted regional
networks. The Company could also require additional financing before the
to meet higher-than-expected subscription rates for its services or
to respond to competition. If demand for the Company's services is less than
expected, the Company may require additional financing at an earlier date,
although the Company believes it would be able to reduce certain costs that
are, to a large extent, demand-driven, or delay its entry into various
targeted regions. There can be no assurance that the Company will be able to
raise the additional capital necessary to implement its rollout strategy in a
timely fashion, if at all.
In addition, the Company's ability to fund the commercial deployment and
expansion of its network should also be considered in light of the Company's
significant interest and amortization charges relating to the Senior Discount
Notes. Although no cash interest is payable on the Senior Discount Notes until
September 2003, the Senior Discount Notes accrete to $260 million until March
2003. Thereafter, the Company expects interest and amortization charges
relating to the Senior Discount Notes to accrue at a rate of $36.9 million for
the year ending December 31, 2004 and to remain at that level through the
maturity of the Senior Discount Notes in March 2008. Such interest and
amortization charges may require the Company to obtain additional financing
earlier than expected or on terms less favorable than the Company would
otherwise agree.
The Company has no present commitments or arrangements assuring it of any
future equity or debt financing, and there can be no assurance that any such
equity or debt financing will be available to the Company on favorable terms
or at all. The Company expects to seek to raise additional capital prior to
through additional debt and possibly equity financing. Such financing may
be dilutive to existing stockholders. The indenture governing the Senior
Discount Notes (the "Indenture") contains certain covenants restricting the
Company's ability to incur further indebtedness, and future borrowing
instruments such as credit facilities are likely to contain similar or more
restrictive covenants and could require the Company to pledge assets as
security for borrowings thereunder. If the Company is unable to obtain such
additional capital or is required to obtain it on terms less satisfactory than
desired by the Company, the Company will be required to delay the expansion of
its business or take or forego actions, any or all of which would materially
adversely affect the Company's business, prospects, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
DEPENDENCE ON GROWTH IN DEMAND FOR DSL-BASED SERVICES
The markets for high bandwidth small- and medium-sized business Internet and
RLAN access are in the early stages of development. Since these markets are
new and because current and future competitors are likely to introduce
competing services, it is difficult to predict the rate at which these markets
will grow, if at all, or whether new or increased competition will result in
market saturation. Because packet-based high-speed digital communication
services using copper telephone lines is a relatively new and evolving market,
it is difficult to predict its future growth rate and size. Various providers
of high-speed digital communication services are testing products from various
suppliers for various applications, and no industry standard has been broadly
adopted. Certain critical issues concerning commercial use of DSL for Internet
and RLAN access, including security,
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reliability, ease and cost of access and quality of service, remain unresolved
and may impact the growth of such services. If the markets for the services
offered by the Company, including Internet access, fail to develop, grow more
slowly than anticipated or become saturated with competitors, the Company's
business, prospects, operating results and financial condition could be
materially adversely affected. See "Business--Industry Background."
SUBSTANTIAL AND INCREASING LEVERAGE
The Company is highly leveraged. As of September 30, 1998, the Company and
its Subsidiaries had approximately $137.7 million of long-term obligations.
The Company's indebtedness should be considered in light of expected annual
interest and amortization charges relating to the Senior Discount Notes, which
the Company expects will be approximately $16.0 million during the year ending
December 31, 1998 to $36.9 million for the year ending December 31, 2004 and
will remain at that level through the maturity of the Senior Discount Notes in
March 2008. The Company plans to incur substantial additional indebtedness to
finance the continued development, commercial deployment and expansion of its
networks for funding operating losses and working capital. The degree to which
the Company is leveraged could have important consequences to the holders of
the Common Stock, including, but not limited to, the following: (i) the
Company's ability to obtain additional financing or refinancing in the future
for working capital, capital expenditures, service development and
enhancement, acquisitions, general corporate purposes or other purposes may be
materially limited or impaired; (ii) the Company's cash flow, if any, may be
unavailable for the Company's business as a substantial portion of the
Company's cash flow must be dedicated to the payment of principal and interest
on its indebtedness on the Senior Discount Notes beginning in March 2003 or
other indebtedness that the Company incurs in the future; and (iii) the
Company's high degree of leverage may make it more vulnerable to economic
downturns, may limit its ability to withstand competitive pressures and may
reduce its flexibility in responding to changing business and economic
conditions.
NO ASSURANCE OF ABILITY TO SERVICE INDEBTEDNESS
The Company expects that it will continue to generate substantial operating
losses and negative cash flow for at least the next several years. No
assurance can be given that the Company will be successful in developing and
maintaining a level of cash flow from operations sufficient to permit it to
pay the principal, premium, if any, and interest on its indebtedness,
including the Senior Discount Notes, and the substantial additional
indebtedness the Company plans to incur. The Senior Discount Notes accrete to
$260 million by March 2003. The Company must begin paying cash interest on the
Senior Discount Notes in September 2003, and the Company expects that annual
interest and amortization charges relating to the Senior Discount Notes will
be approximately $36.9 million for the year ending December 31, 2004 and will
remain at that level through the maturity of the Senior Discount Notes in
March 2008. The ability of the Company to make scheduled payments with respect
to indebtedness, including the Senior Discount Notes, will depend upon, among
other things: (i) the Company's ability to achieve significant and sustained
growth in cash flow; (ii) the rate of and successful commercial deployment of
its network; (iii) the market acceptance, customer demand, rate of utilization
and pricing for the Company's services; (iv) the future operating performance
of the Company and the extent to which the Company's TeleSpeed service is
subject to performance problems; (v) the Company's ability to successfully
complete development, upgrades and enhancements of its network; and (vi) the
Company's ability to complete additional financings, as necessary. Each of
these factors is, to a large extent, subject to economic, financial,
competitive and other factors, many of which are beyond the Company's control.
If the Company is unable to generate sufficient cash flow to service its
indebtedness, including the Senior Discount Notes, it may have to reduce or
delay network deployments, restructure or refinance its indebtedness or seek
additional equity capital. There can be no assurance that any of these
strategies could be effected on satisfactory terms, if at all, in light of the
Company's high leverage, or that any such strategy would yield sufficient
proceeds to service and repay the Company's indebtedness, including the Senior
Discount Notes. Any failure by the Company to satisfy its obligations with
respect to the Senior Discount Notes at maturity or prior thereto would
constitute a default under the Indenture and could cause a default under
agreements governing other indebtedness of the Company. In the event of such
default, the holders of such indebtedness would have enforcement rights,
including the right to accelerate such debt and the right to commence an
involuntary bankruptcy proceeding against the Company.
16
<PAGE>
The inability of the Company to service its current and future indebtedness
would have a material adverse effect on the Company's business, prospectus,
operating results and financial condition and the price of the Common Stock.
UNPROVEN NETWORK SCALABILITY AND SPEED
Due to the limited deployment of the Company's services, the ability of the
Company's DSL networks and OSS to connect and manage a substantial number of
online end-users at high transmission speeds is still unknown, and the Company
faces risks related to its ability to scale its network and OSS up to its
expected end-user numbers while achieving superior performance. While peak
digital data transmission speeds across the Company's DSL networks are 1.5
Mbps downstream, the actual data transmission speeds over the Company's
networks could be significantly slower and will depend on a variety of
factors, including the type of DSL technology deployed, the distance an end-
user is located from a CO, the configuration of the telecommunications line
being used, the existence of analog load coils, the number of bridged taps,
the gauge of the copper wires, the presence and severity of interfering
transmissions on nearby lines and the Company's OSS which manages its network.
As a result, there can be no assurance that the Company's networks will be
able to achieve and maintain the highest possible digital transmission speed.
The Company's failure to achieve or maintain high-speed digital transmissions
would significantly reduce customer and end-user demand for its services and
have a material adverse effect on its business, prospects, operating results
and financial condition. See "Business--Covad's Product and Service Offerings"
and "--Network Architecture and Technology."
DIGITAL COMMUNICATION SIGNAL COMPATIBILITY AND POTENTIAL NETWORK INTERFERENCE
Certain technical laboratory tests and field experience indicate that the
DSL technology the Company and others are using may cause interference with
and be interfered with by other signals present in an ILEC's copper plant,
usually with lines in close proximity, while other laboratory tests indicate
that this equipment does not cause interference. Interference, if present,
could cause degradation of performance of the Company's services or render the
Company unable to offer its services on selected lines. The amount and extent
of such interference will depend on the condition of the ILEC's copper plant
and the number and distribution of DSL and other signals in such plant and
cannot now be ascertained. When interference occurs, it is difficult to
detect. Further, the procedures to resolve interference issues between CLECs
and an ILEC are still being developed and there is no assurance that these
procedures will be effective. Although the Company has agreed to interference
resolution procedures with certain ILECs, there can be no assurance that the
Company will successfully negotiate similar procedures with other ILECs in
future interconnection agreements or in renewals of existing interconnection
agreements, or that the ILECs will not unilaterally take action to resolve
interference issues to the detriment of the Company's services. If the
Company's TeleSpeed services cause widespread network degradation or are
perceived to cause such interference, responsive actions by the ILECs or state
or federal regulators could have a material adverse effect on the Company's
reputation, brand image, service quality, and customer satisfaction and
retention. Any such network interference or network interference perceived by
the ILECs or state or federal regulators could have a material adverse effect
on the Company's business, prospects, operating results and financial
condition.
RISK OF SYSTEM FAILURE
The Company's operations are dependent upon its ability to support its
highly complex network infrastructure and avoid damage from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts
and similar events. The occurrence of a natural disaster or other
unanticipated problem at the Company's Network Operations Center ("NOC") or
any of the Company's RDCs could cause interruptions in the services provided
by the Company. Additionally, failure of an ILEC or other service provider,
such as other CLEC service providers, to provide communications capacity
required by the Company, as a result of a natural disaster, operational
disruption or any other reason, could cause interruptions in the services
provided by the Company. Any damage or failure that
17
<PAGE>
causes interruptions in the Company's operations could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. See "Business--Network Architecture and Technology."
SECURITY RISK IN THE NETWORK
Despite the implementation of security measures, the Company's networks may
be vulnerable to unauthorized access, computer viruses and other disruptive
problems. ISPs and corporate networks have in the past experienced, and may in
the future experience, interruptions in service as a result of accidental or
intentional actions of Internet users, current and former employees and
others. Unauthorized access could also potentially jeopardize the security of
confidential information stored in the computer systems of the Company's
customers and such customers' end-users, which might result in liability of
the Company to its customers and also might deter potential customers.
Although the Company intends to implement security measures that are standard
within the telecommunications industry, as well as new Company-developed
security measures, the Company has not yet done so and there can be no
assurance that the Company will implement such measures in a timely manner or
to the degree that may be compatible with its various customers' expectations,
or that if and when implemented, such measures will not be circumvented.
Eliminating computer viruses and alleviating other security problems may
require interruptions, delays or cessation of service to the Company's
customers and such customers' end-users, which could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. See "Business--Network Architecture and Technology."
DEPENDENCE UPON SUPPLIERS AND LIMITED SOURCES OF SUPPLY
The Company relies and will continue to rely on outside parties to
manufacture its network equipment, such as digital subscriber line access
multiplexers ("DSLAMs"), customer premise equipment ("CPE") modems, network
routing and switching hardware, network management software, systems
management software and database management software. As the Company signs
additional service contracts, the Company believes there may need to be a
significant ramp-up in the amount of manufacturing by third parties in order
for the Company to meet its contractual commitments. The Company has in the
past experienced supply problems with certain of its vendors and there can be
no assurance that these manufacturers will be able to meet the Company's
manufacturing needs in a satisfactory and timely manner in the future or that
the Company will be able to obtain additional manufacturers when and if
needed. Although the Company has identified alternative suppliers for each of
these technologies and it is not constrained to use the same DSLAM or CPE
vendor in multiple regions, it could take a significant period of time to
establish relationships with alternative suppliers for each of these
technologies and substitute their technologies into the Company's networks.
The Company's reliance on third-party manufacturers involves a number of
additional risks, including the absence of guaranteed capacity and reduced
control over delivery schedules, quality assurance, production yields and
costs. The loss of any of the Company's relationships with these suppliers
could have a material adverse effect on the Company's business, prospects,
operating results and financial condition. See "Business--Network Architecture
and Technology."
DEPENDENCE UPON AND NEED TO HIRE ADDITIONAL KEY PERSONNEL
The Company's performance is dependent on the performance of its executive
officers and key employees. In particular, the Company's senior management has
significant experience in the data communications, telecommunications and
personal computer industries, and the loss of any one of the Company's
executive officers could have a material adverse effect of the Company's
ability to execute its business strategy effectively. In addition, the Company
is dependent upon the regional general managers for each region the Company
has entered and prepares to enter. Regional general managers have direct
responsibility for sales, service and market development efforts in their
respective regions, and the loss of one could disrupt significantly the
operations in the region. Additionally, given the Company's early stage of
deployment, the Company is dependent on its ability to retain and motivate
high quality personnel, especially its management. The Company does not have
"key person" life insurance policies on any of its employees. There can be no
assurance that key personnel will continue to be employed by the Company or
that the Company will be able to attract and retain qualified personnel in the
future. The Company's future success also depends on its continuing ability to
identify, hire,
18
<PAGE>
train and retain other highly qualified technical, sales, marketing and
managerial personnel in connection with its expansion within its existing
regions and the deployment and marketing of its network into targeted regions.
Competition for such qualified personnel is intense, particularly in software
development, network engineering and product management. There can be no
assurance that the Company will be able to attract, assimilate or retain other
highly qualified technical, sales, marketing and managerial personnel in the
future. The inability to attract and retain its officers and key employees and
the necessary technical, sales, marketing and managerial personnel could have
a material adverse effect upon the Company's business, prospects, operating
results and financial condition. See "Business--Employees" and "Management."
UNCERTAIN FEDERAL AND STATE TAX AND OTHER SURCHARGES ON THE COMPANY'S SERVICES
Telecommunications providers pay a variety of surcharges and fees on their
gross revenues from interstate services and intrastate services. Interstate
surcharges include Federal Universal Service Fees, Common Carrier Regulatory
Fees and TRS Fund fees. In addition, state regulators impose similar
surcharges and fees on intrastate services. The division of the Company's
services between interstate services and intrastate services is a matter of
interpretation and may in the future be contested by the FCC or relevant state
commission authorities. A change in the characterization of the jurisdiction
of its services could cause the Company's payment obligations pursuant to the
relevant surcharges to increase. In addition, pursuant to periodic revisions
by state and federal regulators of the applicable surcharges, the Company may
be subject to increases in the surcharges and fees currently paid.
GOVERNMENT REGULATION AND CURRENT INDUSTRY LITIGATION
The services offered by the Company are subject to federal, state and local
government regulation. The 1996 Act, which became effective in February 1996,
introduced widespread changes in the regulation of the telecommunications
industry, including the digital access services segment in which the Company
operates. The 1996 Act eliminates many of the pre-existing legal barriers to
competition in the telecommunications services business and sets basic
criteria for relationships between telecommunications providers.
Among other things, the 1996 Act removes barriers to entry in the local
exchange telephone market by preempting state and local laws that restrict
competition by providing competitors interconnection, access to UNEs and
retail services at wholesale rates. The FCC's primary rules interpreting the
1996 Act, which were issued on August 8, 1996 (the "FCC Order"), have been
reviewed by the U.S. Court of Appeals for the Eighth Circuit, which has
overruled certain of the FCC's pricing and nondiscrimination regulations and
upheld the FCC's definition of UNEs and OSS rules. The Company has entered
into competitive interconnection agreements using the federal guidelines
established in the FCC's interconnection order, which agreements remain in
effect notwithstanding the overruling of certain of the FCC's regulations. The
Eighth Circuit's overruling of the FCC Order has been appealed to the U.S.
Supreme Court, which has agreed to decide the case. The U.S. Supreme Court's
ruling, expected in 1999, could have a material adverse effect on the
Company's business, prospects, operating results and financial condition.
In August 1998, the FCC promulgated new rules that would allow ILECs to
provide their own DSL services free from ILEC regulation through a separate
affiliate. The FCC has also simultaneously proposed additional rules requiring
ILECs to provide collocation and loops to CLECs such as the Company on more
favorable terms to the CLECs than previously prescribed by the FCC. The FCC's
August 1998 ruling and its actions thereunder may be appealed or reconsidered,
and it is uncertain whether the FCC will in fact order more favorable
collocation and loop availability for CLECs. The provision of DSL services by
an affiliate of an ILEC not subject to ILEC regulation could have a material
adverse effect on the Company's business, prospects, operating results and
financial condition.
No assurance can be given that changes to current regulations or the
adoption of new regulations by the FCC or state regulatory authorities or
legislative initiatives or court decisions would not have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. See "Business--Government Regulations" and "--Legal Proceedings."
19
<PAGE>
RISKS ASSOCIATED WITH POTENTIAL GENERAL ECONOMIC DOWNTURN
In the last few years the general health of the economy, particularly the
California economy, has been relatively strong and growing, a consequence of
which has been increasing capital spending by individuals and growing
companies to keep pace with rapid technological advances. To the extent the
general economic health of the United States or of California declines from
recent historically high levels, or to the extent individuals or companies
fear such a decline is imminent, such individuals and companies may reduce, in
the near term, expenditures such as those for the services offered by the
Company. Any such decline or concern about an imminent decline could delay
decisions among certain of the Company's customers to roll out the Company's
services or could delay decisions by prospective customers to make initial
evaluations of the Company's services. Such delays would have a material
adverse effect on the Company's business, prospects, operating results and
financial condition.
CONTROL BY PRINCIPAL STOCKHOLDERS AND MANAGEMENT
The Company's executive officers and directors and principal stockholders
together will beneficially own over % of the outstanding Common Stock
after completion of this offering ( % if the Over-Allotment Option is
exercised in full). Accordingly, these stockholders will be able to determine
the composition of the Company's Board of Directors, will retain the voting
power to approve all matters requiring stockholder approval and will continue
to have significant influence over the affairs of the Company. This
concentration of ownership could have the effect of delaying or preventing a
change in control of the Company or otherwise discouraging a potential
acquirer from attempting to obtain control of the Company, which in turn could
have a material adverse effect on the market price of the Common Stock or
prevent the Company's stockholders from realizing a premium over the then
prevailing market prices for their shares of Common Stock. See "Management"
and "Principal Stockholders."
YEAR 2000 ISSUES
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field and cannot distinguish
21st century dates from 20th century dates. These date code fields will need
to distinguish 21st century dates from 20th century dates and, as a result,
many companies' software and computer systems may need to be upgraded or
replaced in order to comply with such "Year 2000" requirements. The Company
has reviewed its internally developed information technology systems and
programs and believes that its systems are Year 2000 compliant and that there
are no significant Year 2000 issues within the Company's systems or services.
The Company has not reviewed its non-information technology systems for Year
2000 issues relating to embedded microprocessors. To the extent that such
issues exist, these systems may need to be replaced or upgraded to become Year
2000 compliant. The Company believes that its non-information technology
systems will not present any significant Year 2000 issues, although there can
be no assurance in this regard. In addition, the Company utilizes third-party
equipment and software and interacts with ILECs that have equipment and
software that may not be Year 2000 compliant. Failure of such third-party or
ILEC equipment or software to operate properly with regard to the year 2000
and thereafter could require the Company to incur unanticipated expenses to
remedy any problems, which could have a material adverse effect on the
Company's business, prospects, operating results and financial condition.
Furthermore, the purchasing patterns of the Company's ISP and enterprise
customers may be affected by Year 2000 issues as companies expend significant
resources to correct their current systems for Year 2000 compliance. These
expenditures may result in reduced funds available for the Company's services,
which could have a material adverse effect on the Company's business,
prospects, operating results and financial condition. The Company, to date,
has not made any assessment of the Year 2000 risks associated with its third-
party or ILEC equipment or software or with its ISP and enterprise customers,
has not determined the risks associated with the reasonably likely worst-case
scenario and has not made any contingency plans to address such risks.
However, the Company intends to devise a Year 2000 contingency plan prior to
December 1999. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Issues."
20
<PAGE>
NO PRIOR PUBLIC MARKET; DETERMINATION OF OFFERING PRICE; POSSIBLE VOLATILITY
OF STOCK PRICE
Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market for the
Common Stock will develop or be sustained after the offering. The initial
public offering price will be determined by negotiation between the Company
and the Underwriters based upon several factors and may not be indicative of
the market price of the Common Stock after the offering. See "Underwriting"
for a discussion of the factors to be considered in determining the initial
public offering price. The trading price of the Common Stock could be subject
to wide fluctuations in response to factors such as actual or anticipated
variations in quarterly operating results, the addition or loss of customers
or subscribers, announcements of technological innovations, new products or
services by the Company or its competitors, changes in financial estimates or
recommendations by securities analysts, conditions or trends in the
telecommunications industry, growth of the Internet and online commerce
industries, announcements by the Company of significant acquisitions,
strategic partnerships, joint ventures or capital commitments, additions or
departures of key personnel, future equity or debt financings, general market
and general economic conditions and other events or factors, many of which are
beyond the Company's control. In addition, in recent years the stock market
has experienced extreme price and volume fluctuations. These fluctuations have
had a substantial effect on the market prices for many emerging growth
companies, often unrelated to the operating performance of the specific
companies. Such market fluctuations could adversely affect the price of the
Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
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.
The number of shares of Common Stock available for sale in the public market
is limited by restrictions under the Securities Act and lock-up agreements
under which the holders of all of the Company's outstanding shares of Common
Stock and options and warrants to purchase Common Stock have agreed not to
sell or otherwise dispose of any of their shares for a period of 180 days
after the date of this Prospectus without the prior written consent of Bear,
Stearns & Co. Inc. However, Bear, Stearns & Co. Inc. may, in its sole
discretion and at any time without notice, release all or any portion of the
securities subject to lock-up agreements. Based on shares of Common Stock,
options and warrants outstanding as of December 15, 1998, the following shares
of Common Stock will be eligible for future sale. On the date of this
Prospectus, the shares offered hereby will be eligible for sale in the
public market without restriction. An additional 29,964,428 shares will be
eligible for sale without restriction 180 days after the date of this
Prospectus, except that shares held by "affiliates" of the Company within the
meaning of Rule 144 under the Securities Act are subject to certain volume
limitations thereunder and registration rights. An additional 1,800,000 shares
of Common Stock will be eligible for sale without restriction one year after
the closing of the offering subject to volume limitations pursuant to Rule 144
and the exercise of registration rights. In addition, the Company has
16,196,727 shares of Common Stock reserved for issuance pursuant to options
under its 1997 Stock Plan, of which 12,509,922 were subject to outstanding
options at December 15, 1998, and the Company had 5,188,764 shares underlying
outstanding warrants.
The Company intends to register, following the effective date of this
offering, a total of 16,196,727 shares of Common Stock reserved for issuance
under the Company's 1997 Stock Plan and 1,000,000 shares of Common Stock
reserved for issuance under its 1998 Employee Stock Purchase Plan. Further,
upon expiration of the lock-up agreements referred to above, holders of
approximately 31,529,866 shares of Common Stock will be entitled to certain
registration rights with respect to such shares. In addition, there are
5,188,764 shares underlying outstanding warrants, including 5,053,764 shares
issuable upon exercise of the Warrants that will be eligible for resale upon
expiration of their respective one-year holding periods under Rule 144,
subject to the exercise of registration rights. If such holders, by exercising
their registration rights, cause a large number of shares to be registered and
sold in the public market, such sales could have a material adverse effect on
the market price for the Company's Common Stock. See "Description of Capital
Stock--Registration Rights" and "Shares Eligible for Future Sale."
21
<PAGE>
ANTITAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS AND DELAWARE LAW
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the stockholders. The rights of the holders of
Common Stock will be subject to, and may be adversely affected by, the rights
of the holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of the outstanding voting stock of the Company. The Company has no current
plans to issue shares of Preferred Stock. The Company's charter and bylaws
provide for a classified Board of Directors, limitations on the ability of
stockholders to call special meetings, the lack of cumulative voting for
directors and procedures for advance notification of stockholder nominations
and proposals. These provisions of the Company's charter and bylaws, as well
as Section 203 under the Delaware General Corporation Law to which the Company
is subject, could discourage potential acquisition proposals and could delay
or prevent a change of control of the Company. These provisions are intended
to enhance the likelihood of continuity and stability in the composition of
the Board of Directors and in the policies formulated by the Board of
Directors and to discourage certain types of transactions that may involve an
actual or threatened change of control of the Company. These provisions are
designed to reduce the vulnerability of the Company to an unsolicited
acquisition proposal and to discourage certain tactics that may be used in
proxy fights. The Indenture provides that in the event of certain changes in
control of the Company, each holder will have the right to require the Company
to repurchase such holder's Senior Discount Notes at a premium over the
accreted value of such debt. The provisions in the charter and bylaws and the
Indenture could have the effect of discouraging others from making tender
offers for the Company's shares and, as a consequence, they also may inhibit
increases in the market price of the Company's shares that could result from
actual or rumored takeover attempts. Such provisions also may have the effect
of preventing changes in the management of the Company. See "Description of
Capital Stock--Antitakeover Effects of Certain Provisions of Covad's Charter,
Bylaws and Delaware Law."
DILUTION
Investors participating in this offering will incur immediate, substantial
dilution. To the extent outstanding warrants and options to purchase the
Company's Common Stock are exercised, there will be further dilution. In
addition, to the extent the Company issues additional equity securities to
fund future capital expenditures and working capital needs, investors
participating in this offering may experience further dilution. See "--
Substantial Future Capital Needs" and "Dilution."
ABSENCE OF DIVIDENDS
The Company has not declared or paid any dividends since its inception. The
Company currently anticipates that it will retain all of its future earnings
for use in the expansion and operation of its business and does not anticipate
paying any cash dividends in the foreseeable future. In addition, the
Company's existing financing arrangements restrict the payment of any
dividends. See "Dividend Policy."
22
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby are estimated to be approximately $ million ($ million if
the Over-Allotment Option is exercised in full) assuming an initial public
offering price of $ per share and after deducting estimated underwriting
discounts and commissions and offering expenses.
The Company anticipates that the net proceeds of this offering will be used
to fund capital expenditures to be incurred in the deployment of the Company's
networks in existing and new regions, for expenses associated with continued
development and sales and marketing activities, to fund operating losses and
for general corporate purposes. The Company believes that these net proceeds
will be sufficient to fund the Company's aggregate capital expenditures and
working capital requirements, including operating losses, through . The
amounts actually expended by the Company for these purposes will vary
significantly depending upon a number of factors, including future revenue
growth, if any, capital expenditures and the amount of cash generated by the
Company's operations. Additionally, if the Company determines it would be in
its best interest, the Company may increase or decrease the number, selection
and timing of entry of its targeted regions. Accordingly, the Company's
management will retain broad discretion in the allocation of such net
proceeds. Although the Company may use a portion of the net proceeds to pursue
possible acquisitions of businesses, technologies or products complementary to
those of the Company in the future, there are no present understandings,
commitments or agreements with respect to any such acquisitions. Pending use
of such net proceeds for the above purposes, the Company intends to invest
such funds in short-term, interest-bearing, investment-grade securities. See
"Risk Factors--Substantial Future Capital Requirements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DIVIDEND POLICY
The Company has not declared or paid any dividends since its inception. The
Company currently anticipates that it will retain all of its future earnings
for use in the expansion and operation of its business and does not anticipate
paying any cash dividends in the foreseeable future. The Company's future
dividend policy will be determined by its Board of Directors. The Company's
existing financing arrangements restrict the payment of any dividends. The
Company anticipates that it and its Subsidiaries will incur substantial
additional indebtedness, which is likely to be subject to additional
restrictions on dividends.
23
<PAGE>
CAPITALIZATION
The following table sets forth (i) the capitalization of the Company as of
September 30, 1998, (ii) the pro forma capitalization of the Company after
giving effect to the automatic conversion of all outstanding shares of
Preferred Stock into Common Stock and assumes the exercise for cash of
warrants to purchase 1,800,000 shares of Common Stock immediately prior to the
closing of this offering (not giving effect to the payment of cumulated
dividends on Preferred Stock in shares of Common Stock immediately prior to
the closing of this offering), and (iii) the as adjusted capitalization of the
Company to reflect the receipt of the estimated net proceeds from the sale of
the Common Stock in the offering at the estimated initial public offering
price of $ per share and after deducting estimated underwriting discounts
and commissions and offering expenses payable by the Company.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
-----------------------------
AS
ACTUAL PRO FORMA ADJUSTED
-------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents......................... $ 97,076 $ 97,082 $
======== ======== =======
LONG-TERM OBLIGATIONS:
Capital lease obligations (including current
portion)......................................... 634 634 634
13 1/2% Senior Discount Notes due 2008, net....... 137,292 137,292 137,292
-------- -------- -------
Total long-term obligations (including current
portion)....................................... 137,926 137,926 137,926
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY):
Preferred Stock, $0.001 par value; 5,000,000
shares authorized pro forma and as adjusted, no
shares issued and outstanding pro forma and as
adjusted......................................... -- -- --
Convertible Preferred Stock, $0.001 par value;
30,000,000 shares authorized actual, no shares
authorized pro forma and as adjusted; 18,246,162
shares issued and outstanding actual; no shares
issued and outstanding pro forma and as adjusted. 18 -- --
Common Stock, $0.001 par value; 65,000,000 shares
authorized; 11,634,149 shares issued and
outstanding actual; 150,000,000 shares authorized
and 31,680,311 shares issued and outstanding pro
forma and shares issued and outstanding as
adjusted(1)...................................... 12 32 --
Additional paid-in capital........................ 30,732 30,736 --
Deferred compensation............................. (6,306) (6,306) (6,306)
Accumulated deficit............................... (30,873) (30,873) (30,873)
-------- -------- -------
Total stockholders' equity (net capital
deficiency).................................... (6,417) (6,411)
-------- -------- -------
Total capitalization............................ $131,509 $131,515 $
======== ======== =======
</TABLE>
- --------
(1) Excludes (i) an aggregate of 16,196,727 shares of Common Stock reserved
for issuance under the Company's 1997 Stock Plan, of which 12,509,922
shares were subject to outstanding options at December 15, 1998 at a
weighted average exercise price of $1.97 per share, (ii) an aggregate of
1,000,000 shares of Common Stock reserved for issuance under the Company's
1998 Employee Stock Purchase Plan, (iii) an aggregate of 5,188,764 shares
of Common Stock issuable upon exercise of outstanding warrants at December
15, 1998 at a weighted average exercise price of $.029 per share, and (iv)
shares of Common Stock issued as cumulated but unpaid dividends on
Preferred Stock as of the closing of this offering.
24
<PAGE>
DILUTION
The pro forma deficit in net tangible book value (deficit) of the Company as
of September 30, 1998 was $(14,715,000) or $(0.46) per share of outstanding
Common Stock after giving effect to the conversion of the Company's
outstanding Preferred Stock and the exercise for cash of warrants to purchase
1,800,000 shares of Common Stock immediately prior to the consummation of this
offering. The pro forma deficit in net tangible book value per share
represents the Company's total tangible assets less total liabilities, divided
by the number of shares of Common Stock outstanding (assuming conversion of
the Preferred Stock). Dilution per share represents the difference between the
amount per share paid by investors in this offering and the pro forma deficit
in net tangible book value per share after the offering. After giving effect
to this offering at an assumed initial public offering price of $ per share
resulting in estimated net proceeds to the Company of approximately $
(after deducting estimated underwriting discounts and commissions and offering
expenses payable by the Company), the as adjusted pro forma deficit in net
tangible book value of the Company at September 30, 1998 would have been $
or $ per share. This represents an immediate decrease in the deficit in net
tangible book value of $ per share to existing stockholders and an immediate
dilution in net tangible book value of $ per share to new investors
purchasing shares at the assumed initial public offering price. The following
table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share..................... $
Pro forma net tangible book value (deficit) per share as of
September 30, 1998............................................... $(0.46)
Increase per share attributable to new investors..................
------
As adjusted pro forma net tangible book value (deficit) per share
after the offering.................................................
---
Dilution per share to new investors................................. $
===
</TABLE>
The following table summarizes, on a pro forma basis as of September 30,
1998, the difference between the existing stockholders and new investors with
respect to the number of shares of Common Stock purchased from the Company,
the total consideration paid and the average price per share paid at an
assumed initial public offering price of $ per share (before deducting
estimated underwriting discounts and commissions and offering expenses payable
by the Company):
<TABLE>
<CAPTION>
WEIGHTED
SHARES TOTAL AVERAGE
PURCHASED CONSIDERATION PRICE
-------------- -------------- PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------ ------- ------ ------- --------
<S> <C> <C> <C> <C> <C>
Existing stockholders.................... % $ % $
New investors............................
--- --- --- ---
Total.................................. 100% $ 100%
=== === === ===
</TABLE>
The foregoing table assumes no exercise of the Over-Allotment Option and no
exercise of stock options or warrants outstanding at December 15, 1998, other
than the exercise for cash of warrants to purchase 1,800,000 shares of Common
Stock immediately prior to the consummation of this offering. At December 15,
1998, there were options and warrants outstanding to purchase 17,698,686
shares of Common Stock at a weighted average exercise price of $1.40 per
share. To the extent outstanding options and warrants are exercised, there
will be further dilution to new investors. See "Management."
25
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and the
related Notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included herein. The consolidated
statement of operations data and the consolidated cash flow data for the year
ended December 31, 1997 and for the nine months ended September 30, 1998, and
the consolidated balance sheet data at December 31, 1997 and at September 30,
1998 are derived from, and are qualified by reference to, the audited
Consolidated Financial Statements and the related Notes thereto included
herein. The consolidated statement of operations data and consolidated cash
flow data for the three months ended September 30, 1998 are derived from
unaudited consolidated financial statements of the Company not included
herein. These unaudited financial statements include, in the opinion of
management, all adjustments, consisting of normal, recurring adjustments,
necessary for a fair presentation of the information set forth therein. The
consolidated results of operations for the three and nine months ended
September 30, 1998 are not necessarily indicative of future results. For the
nine months ended September 30, 1997, the Company had no revenues and total
expenses were not significant.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30, NINE MONTHS ENDED
1997 1998 SEPTEMBER 30, 1998
------------ ------------- ------------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE
AND PER SHARE AMOUNTS)
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues......................... $ 26 $ 1,565 $ 2,560
Operating expenses:
Network and product costs...... 54 1,355 2,316
Sales, marketing, general and
administrative................ 2,374 10,681 17,231
Amortization of deferred
compensation.................. 295 1,837 2,695
Depreciation and amortization.. 70 738 1,348
----------- ---------- ----------
Total operating expenses..... 2,793 14,611 23,590
----------- ---------- ----------
Income (loss) from operations.... (2,767) (13,046) (21,030)
Net interest income (expense).. 155 (3,511) (7,231)
----------- ---------- ----------
Net income (loss)................ $ (2,612) $ (16,557) $ (28,261)
=========== ========== ==========
Net income (loss) per common
share........................... $ (0.80) $ (2.75) $ (5.26)
Shares used in computing net
income (loss) per share.......... 3,271,546 6,011,610 5,374,924
Pro forma net income (loss) per
common share(1)................. $ (0.23) $ (0.64) $ (1.14)
Shares used in computing pro
forma net income (loss) per
share........................... 11,522,916 26,057,772 24,844,824
OTHER FINANCIAL DATA:
EBITDA(2)........................ $ (2,402) $ (10,471) $ (16,987)
CONSOLIDATED CASH FLOW DATA:
Provided by (used in) operating
activities...................... $ (1,895) $ (3,319) $ (4,196)
Provided by (used in) investing
activities...................... (2,494) (21,084) (33,464)
Provided by (used in) financing
activities...................... 8,767 (406) 130,358
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(IN THOUSANDS)
CONSOLIDATED BALANCE
SHEET DATA:
<S> <C> <C>
Cash and cash
equivalents............ $4,378 $ 97,076
Net property and
equipment.............. 3,014 34,003
Total assets............ 8,074 144,622
Long-term obligations,
including current
portion................ 783 137,926
Total stockholders'
equity (net capital
deficiency)............ 6,498 (6,417)
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
OTHER OPERATING DATA:
Homes and businesses passed.......................... 278,000 3,302,000
Lines installed...................................... 26 1,948
</TABLE>
- --------
(1) Under the Company's Certificate of Incorporation, all outstanding
Preferred Stock will convert into Common Stock on a one-for-one basis upon
the completion of this offering. The pro forma net loss per share assumes
the conversion of the Preferred Stock and reflects the exercise for cash
of warrants to purchase 1,800,000 shares of Common Stock immediately prior
to the consummation of this offering.
(2) EBITDA consists of net loss excluding net interest, taxes, depreciation
and amortization (including amortization of deferred compensation). EBITDA
is provided because it is a measure of financial performance commonly used
in the telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and should not be
construed (i) as an alternative to operating income (as determined in
accordance with GAAP) as an indicator of the Company's operating
performance or (ii) 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.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements and the related Notes thereto included elsewhere in this
Prospectus. This discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in the forward-looking statements as a result of
certain factors including, but not limited to, those discussed in "Risk
Factors," "Business" and elsewhere in this Prospectus. The Company disclaims
any obligation to update information contained in any forward-looking
statement. See "--Forward Looking Statements."
OVERVIEW
Covad is a leading packet-based CLEC that provides dedicated high-speed
digital communication services using DSL technology to enterprise and ISP
customers. The Company introduced its services in the San Francisco Bay Area
in December 1997. The Company launched its services in the Los Angeles,
New York and Boston metropolitan areas in August 1998 and in the Washington,
D.C. metropolitan area in December 1998 and expects to introduce its services
in the Seattle metropolitan area in the first quarter of 1999. In March 1998,
the Company raised approximately $135 million through the issuance of the
Senior Discount Notes to fund the deployment of its networks in the Initial
Regions. As a result of the strong market demand for high-speed digital
communication services, the Company has decided to increase to 22 the number
of regions in which it plans to build a network and offer its services. See
"Risk Factors--Dependence Upon Growth in Demand For DSL-Based Services."
During 1998, the Company expanded its network in the San Francisco Bay Area
and increased its sales and marketing efforts in that region, which resulted
in higher revenue in each successive month in 1998. As of December 15, 1998,
the Company's network passed over million homes and businesses, including
million in the San Francisco Bay Area. In addition, as of December 15,
1998, the Company had installed over lines.
In connection with the Company's expansion within existing regions and into
new regions, it expects to significantly increase its capital expenditures, as
well as its sales and marketing expenditures, to deploy its networks and
support additional subscribers in those regions. Accordingly, the Company
expects to incur substantial and increasing net losses for at least the next
several years. See "Risk Factors--Limited Operating History" and "--History
and Continuation of Operating Losses."
For each region, the Company has targeted three market segments: business
Internet, business RLAN and consumer Internet. Business Internet and consumer
Internet services are sold indirectly through ISPs. Business RLAN services are
sold directly to enterprise customers. Using the approach described below, the
Company has estimated the size of the addressable portion of these market
segments in its existing and targeted regions. No assurance can be given as to
the accuracy of the Company's estimates regarding the size of its addressable
market segments. See "Risk Factors--Dependence on Growth in Demand for DSL-
Based Services."
To determine the overall potential market, Covad specifically identified
each service area in which it plans to offer service and each CO within these
service areas. This determination was based primarily upon both business and
population demographics as well as Covad's desire to be in most COs in order
to provide blanket coverage in a region. To estimate the addressable market
for each market segment from the overall potential market, Covad analyzed the
demographics in the following manner:
Business Internet Addressable Market: Based on an estimate of the number
of small businesses served by the local CO and a third party estimate of
the number of small businesses expected to be online and the percentage of
such small businesses that will purchase high-speed connectivity.
28
<PAGE>
RLAN Addressable Market: Based on an estimate of the number of households
served by the local CO with employees working for large enterprises and a
third party estimate for the entire U.S. of the percentage of households
that will purchase high-speed connectivity.
Consumer Internet Addressable Market: Based on an estimate of the number
of online households (excluding RLAN households) served by the local CO
that will be heavy online users and an estimate of the percentage of such
households that will purchase high-speed connectivity.
A key determinant of the Company's revenues will be its service penetration
into the addressable portion of these market segments. The market for DSL
communications services is nascent and estimates of penetration are
necessarily highly speculative. Notwithstanding the above, the Company
believes it can achieve its economic goals at market penetration rates of less
than 10% in its business Internet and RLAN markets and less than 4% in the
consumer Internet market. No assurance can be given that the Company will meet
its penetration estimates. See "Risk Factors--Dependence on Growth in Demand
for DSL-Based Services" and "--Intense Competition."
The Company derives revenue from (i) monthly recurring service charges for
connections from the end-user to the Company's facilities and for backhaul
services from the Company's facilities to the ISP or enterprise customer, (ii)
service activation, installation and other non-recurring charges and (iii) the
sale of CPE which the Company provides to its customers due to the general
unavailability of CPE through retail channels. The Company intends to sell and
install CPE at prices that will provide the Company with positive margins on
such sales and installations. The current prices for the Company's services
range from $90 per month for TeleSpeed 144 to $195 per month for TeleSpeed 1.1
and TeleSpeed 1.5, before volume discounts. To date, the Company has not
entered into any agreements for volume discounts which are material to its
financial results. The Company expects prices for the major components of both
recurring and non-recurring charges to decrease each year. The Company
believes its revenues from the sale of CPE will decline over time as CPE
becomes more generally available. The Company expects that the prices it
charges to customers for CPE will decrease each year. See "Risk Factors--
Unproven Business Model and Pricing Sensitivity."
The Company's network and product costs include costs of recurring and
nonrecurring circuit fees charged to the Company by ILECs and other CLECs,
including installation, activation, monthly line costs, maintenance and repair
of circuits between and among the Company's DSLAMs and its RDCs, customer
backhaul, and subscriber lines. Other costs the Company incurs include those
for materials used by the Company in installation and the servicing of
customers and end-users, and the cost of CPE. As the Company's end-user base
grows, the largest element of network and product cost is expected to be the
ILECs' charges for the Company's leased copper lines.
The Company believes its regions will generate positive EBITDA (before
allocation of corporate overhead), on average, within 24 months of launching
service, based on the Company's current expectations regarding operating
expenses, customer subscription and retention rates and service pricing.
However, there can be no assurances in this regard, and the Company expects
that financial performance will vary from region to region and that the time
it will take for a region to generate positive EBITDA will range up to 48
months or longer, depending upon region-specific characteristics. Such
characteristics include the size of the addressable markets in a region and
competitive dynamics including, among other things, pricing, the number of COs
and the cost of necessary infrastructure to service a region, the timing of
market entry and the cost to access the ILEC's UNEs. As the Company continues
to develop its network within its targeted regions, positive EBITDA from more
developed regions is expected to be offset partially or completely by negative
EBITDA from less developed regions, costs associated with entering new regions
and corporate overhead. This trend is expected to continue until the Company
has a sufficiently large customer and end-user base to absorb operating costs
of new regions or the Company ceases entering new regions. See "Risk Factors--
History and Continuation of Operating Losses."
The development and expansion of the Company's business will require
significant expenditures. The principal capital expenditures incurred during
the buildup phase of any region involve the procurement, design and
construction of the Company's CO collocation cages, end-user DSL line cards,
and expenditures for other
29
<PAGE>
elements of the Company's network design, which includes an RDC in each
region. The average capital cost to deploy the Company's facilities in a CO,
excluding subscriber line cards, is expected to average approximately $85,000
per CO collocation facility. Following the buildout of its collocation
facilities, the major portion of the Company's capital expenditures is the
purchase of DSL line cards to support incremental subscribers. The Company
expects that the average cost of such line cards will decline over the next
several years. Network expenditures will continue to increase with the number
of end-users. However, once an operating region is fully built out, a
substantial majority of the regional capital expenditures will be tied to
incremental customer and end-user growth. In addition to developing the
Company's network, the Company will use its capital for marketing its
services, acquiring ISP and enterprise customers, and funding its customer
care and field service operations. The Company believes that the net proceeds
of this offering together with its existing capital resources will be
sufficient to fund the Company's aggregate capital expenditures and working
capital requirements, including operating losses, through . See "Risk
Factors--Substantial Future Capital Requirements."
The Company believes that it may take several months from the time a
customer is first contacted to the point at which it will be able to book and
invoice a customer for its services. In the case of ISP customers, this sales
cycle will depend on the time it takes the ISP to market and sell the
Company's services to its subscribers. In the case of enterprise customers,
this long sales cycle is partially due to the technical requirements that must
be satisfied before a customer's telecommunications manager will make the
Company's service widely available to the customer's employees. See "Risk
Factors--Lengthy Sales Cycle for Enterprise Customers."
RESULTS OF OPERATIONS
The Company's operations from inception in October 1996 to December 1997
were limited principally to the development of the technology and activities
related to the commencement of its business operations. As a result, the
Company's revenues and expenditures prior to such period are not indicative of
anticipated revenues which may be attained or expenditures which may be
incurred by the Company in future periods. In particular, the Company's
expenditure levels during the year ended December 31, 1997 do not reflect the
issuance of the Senior Discount Notes in March 1998 and the related interest
and amortization charges, which the Company expects will be approximately
$16.0 million during the year ending December 31, 1998 and will increase
annually thereafter up to $36.9 million for the year ending December 31, 2004
and will remain at that level through the maturity of the Senior Discount
Notes in March 2008. See "Risk Factors--Limited Operating History." The
Company did not have any revenue until the fourth quarter of 1997. As a
result, any comparison of the nine month period ended September 30, 1998 with
the nine month period September 30, 1997 is not meaningful.
Revenues
Revenues were $26,000 for the year ended December 31, 1997 and were $2.6
million for the nine months ended September 30, 1998. This increase was
attributable to the expansion of the Company's network in the San Francisco
Bay Area and the Company's increased sales and marketing efforts in that
region. As of September 30, 1998, the Company had an installed base of over
1,900 end-user lines with a network that passed approximately 3.3 million
homes and businesses. The Company expects revenues to increase in future
periods as the Company expands its network within its existing regions,
deploys networks in new regions and increases its sales and marketing efforts
in all of its target regions.
Network and Product Costs
Total network and product costs were approximately $54,000 for the year
ended December 31, 1997 and approximately $2.3 million for the nine months
ended September 30, 1998. This increase is attributable to the expansion of
the Company's network and increased orders resulting from the Company's sales
and marketing efforts. The Company expects aggregate line costs to increase
significantly in future periods due to increased sales activity and expected
revenue growth.
30
<PAGE>
Sales, Marketing, General and Administrative Expenses
Sales, marketing, general and administrative expenses consist primarily of
salaries, expenses for the development of the Company's business, the
development of corporate identification, promotional and advertising
materials, expenses for the establishment of its management team, and sales
commissions. These expenses increased from $2.4 million for the year ended
December 31, 1997 to $17.2 million for the nine months ended September 30,
1998, as a result of increased headcount in all areas as the Company expanded
its sales and marketing efforts, expanded the deployment of its network and
built operational infrastructure. Sales, marketing, general and administrative
expenses are expected to increase significantly as the Company continues to
expand its business.
Deferred Compensation
Through September 30, 1998, the Company had recorded a total of $9.3 million
of deferred compensation, with an unamortized balance of $6.3 million on its
balance sheet as of September 30, 1998. This deferred compensation arose as a
result of the granting of stock options to employees with exercise prices per
share subsequently determined to be below the fair values per share for
accounting purposes of the Company's Common Stock at the dates of grant. The
deferred compensation is being amortized over the vesting period of the
applicable options, and resulted in a charge to operations of $295,000 during
the year ended December 31, 1997 and $2.7 million during the nine months ended
September 30, 1998. The total charge to operations during the year ending
December 31, 1998 for amortization of the deferred compensation associated
with the options granted through September 30, 1998 will approximate $4.1
million.
Depreciation and Amortization
Depreciation and amortization includes: (i) depreciation of network
infrastructure equipment, (ii) depreciation of information systems, furniture
and fixtures, (iii) amortization of improvements to COs, RDC and NOC
facilities and corporate facilities and (iv) amortization of capitalized
software costs. Depreciation and amortization was approximately $70,000 for
the year ended December 31, 1997 and approximately $1.3 million for the nine
months ended September 30, 1998. The increase was due to the increase in
equipment and facilities placed in service throughout the period. The Company
expects depreciation and amortization to increase significantly as the Company
increases its capital expenditures to expand its network.
Net Interest Income and Expense
Net interest income and expense consists primarily of interest income on the
Company's cash balance and interest expense associated with the Company's
debt. For the year ended December 31, 1997, net interest income was
approximately $155,000, which was primarily attributable to the interest
income earned from the proceeds raised in the Company's Preferred Stock
financing in July 1997. Interest income for the nine months ended
September 30, 1998 was approximately $3.7 million, resulting primarily from
investing the proceeds from the Company's Senior Discount Notes. Interest
expense for the nine months ended September 30, 1998 was approximately $10.9
million and consisted primarily of interest on the Senior Discount Notes and
capital lease obligations. The Company expects interest expense to increase
significantly as a result of the issuance of the Senior Discount Notes. The
Senior Discount Notes accrete to $260 million by March 15, 2003, and as a
result, the Company expects that annual interest charges (which includes
amortization of debt discount and debt issuance costs) relating to the
accretion of the Senior Discount Notes will be approximately $16.0 million
during the year ending December 31, 1998, will increase to approximately $22.3
million for the year ending December 31, 1999 and will increase to
approximately $32.7 million for the year ending December 31, 2002. Thereafter,
the Company expects that interest expense attributable to the Senior Discount
Notes (including amortization of debt discount and debt issuance costs) will
increase to approximately $36.9 million for the year ending December 31, 2004
and will remain at that level through maturity of the Senior Discount Notes in
March 2008.
31
<PAGE>
Income Taxes
Income taxes consist of federal, state and local taxes, when applicable. The
Company expects significant consolidated net losses for the foreseeable future
which should generate net operating loss ("NOL") carryforwards. However,
utilization of NOLs is subject to substantial annual limitations. In addition,
income taxes may be payable during this time due to operating income in
certain tax jurisdictions. Once the Company achieves operating profits and the
NOLs have been exhausted or have expired, the Company may experience
significant tax expense. The Company recognized no provision for taxes as it
operated at a loss throughout 1997 and through the nine months ended September
30, 1998.
Certain Pro Forma Financial Information
Giving pro forma effect to the issuance of the Senior Discount Notes as if
it had been consummated on January 1, 1997 and the related interest and
amortization charges relating to the Senior Discount Notes accruing from such
date through September 30, 1998, the Company's interest expense would have
been approximately $20.3 million and $17.1 million, net loss would have been
approximately $22.9 million and $34.4 million, and net loss per Common Share
would have been $(7.00) and $(6.40) for the year ended December 31, 1997 and
the nine months ended September 30, 1998, respectively. For purposes of such
pro forma calculation, the Company has assumed (i) no correlating additional
interest income attributable to interest earned on the cash proceeds of the
issuance of the Senior Discount Notes and (ii) no application of the use of
proceeds from such issuance for the Company's corporate purposes. Therefore,
the interest and amortization charges relating to the Senior Discount Notes
would have had a significant adverse effect on the Company's net loss and net
loss per share had the issuance occurred on January 1, 1997.
QUARTERLY FINANCIAL INFORMATION
The following table sets forth certain consolidated statements of operations
data for the Company's most recent five quarters. This information has been
derived from the Company's unaudited consolidated financial statements. In
management's opinion, this unaudited information has been prepared on the same
basis as the annual consolidated financial statements and includes all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the information for the quarters presented. This
information should be read in conjunction with the Consolidated Financial
Statements and related Notes thereto included elsewhere in this Prospectus.
The operating results for any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1997 1997 1998 1998 1998
------------- ------------ --------- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues................ $ -- $ 26 $ 186 $ 809 $ 1,565
Operating expenses:
Network and product
costs................ 10 44 203 758 1,355
Sales, marketing,
general and
administrative....... 783 1,334 1,944 4,606 10,681
Amortization of
deferred
compensation......... 134 161 227 631 1,837
Depreciation and
amortization......... -- 70 164 446 738
----- ------- ------- ------- --------
Total operating
expenses........... 927 1,609 2,538 6,441 14,611
----- ------- ------- ------- --------
Income (loss) from
operations............. (927) (1,583) (2,352) (5,632) (13,046)
Net interest income
(expense).............. 80 75 (429) (3,291) (3,511)
----- ------- ------- ------- --------
Net income (loss)..... $(847) $(1,508) $(2,781) $(8,923) $(16,557)
===== ======= ======= ======= ========
</TABLE>
32
<PAGE>
The Company has generated greater revenues in each successive month and
quarter in the last five quarters, reflecting increases in the number of
customers and subscribers. The Company's network and product costs have
increased in every quarter, reflecting costs associated with customer and
subscriber growth and the deployment of the Company's networks in existing and
new regions. The Company's selling, marketing, general and administrative
expenses have increased in every quarter and reflect sales and marketing costs
associated with the acquisition of customers and subscribers, including sales
commissions, and the development of regional and corporate infrastructure.
Depreciation and amortization has increased in each quarter, primarily
reflecting the purchase of equipment associated with the deployment of the
Company's networks. The Company has experienced increasing net losses on a
quarterly basis as it increases its capital expenditures and operating
expenses, and the Company expects to sustain increasing quarterly losses for
at least the next several years. See "Risk Factors--History and Continuation
of Operating Losses."
The Company's annual and quarterly operating results may fluctuate
significantly in the future as a result of numerous factors, many of which are
outside the Company's control. Factors that may affect the Company's operating
results include the timing and ability of the ILECs to provide and construct
the required CO collocation facilities, the rate at which customers subscribe
to the Company's services, the prices the customers pay for such services and
end-user churn rates. The Company's operating results are sensitive to the
pricing of its services and volume commitments from individual customers. The
Company believes its financial performance depends to a great extent on
retaining ISP and enterprise customers and on levels of subscriber churn,
which can vary due to a variety of sources, including relocation of end-users
of ISP customers and employee turnover within enterprise customers.
Additionally, the Company does not currently have long-term contracts with any
of its customers, and there can be no assurance that the Company's ISP and
enterprise customers will not experience substantial subscriber churn as a
result of customers or subscribers discontinuing the use of its services or
switching to an alternative service provider. Further factors that may add to
volatility in the Company's annual or quarterly operating results include the
amount and timing of capital expenditures and other costs relating to the
expansion of the Company's network, the introduction of new services by the
Company or its competitors, technical difficulties or network downtime,
general economic conditions and economic conditions specific to the Company's
industry, among other factors. There can be delays in the commencement and
recognition of revenue because the installation of telecommunication lines to
implement certain services has lead times that are controlled by third
parties. In addition, the Company plans to increase operating expenses to fund
operations, sales, marketing, general and administrative activities and
infrastructure. To the extent that these expenses are not accompanied by an
increase in revenues, the Company could experience a material adverse effect
on its business, prospects, operating results and financial condition. See
"Risk Factors--Potential Fluctuations in Operating Results."
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have required substantial capital investment for
the procurement, design and construction of the Company's CO collocation
cages, the purchase of telecommunications equipment and the design and
development of the Company's networks. Capital expenditures were approximately
$32.3 million for the first nine months of 1998. The Company expects that its
capital expenditures will be substantially higher in future periods in
connection with the purchase of infrastructure equipment necessary for the
development and expansion of its network and the development of new markets.
Since inception, the Company has financed its operations primarily through
private placements of $10.3 million of equity securities, $865,000 of lease
financings and $129.3 million in net proceeds raised from the issuance of the
Senior Discount Notes. As of September 30, 1998, the Company had an
accumulated deficit of $30.9 million, and cash and cash equivalents of $97.1
million.
Net cash used in the Company's operating activities was approximately $1.9
million and $4.2 million for the year ended December 31, 1997 and the nine
months ended September 30, 1998, respectively. The net cash used for operating
activities during these periods was primarily due to net losses and increases
in current assets,
33
<PAGE>
offset by noncash expenses, increases in accounts payable and accrued
liabilities. Net cash used by the Company for acquisitions of property and
equipment was $2.3 million during the year ended December 31, 1997 and $32.3
million during the nine months ended September 30, 1998. Net cash provided by
financing activities for the year ended December 31, 1997 was $8.8 million and
related to the issuance of Common and Preferred Stock. Net cash provided by
financing activities for the nine months ended September 30, 1998 was
$130.4 million, which primarily related to the issuance of the Senior Discount
Notes and Series C Preferred Stock.
The Company believes its current capital resources, including the proceeds
of this offering, will be sufficient to fund the Company's aggregate capital
expenditures and working capital requirements, including operating losses,
through the . The Company will require substantial additional
financing to support its operations after that date, including funding the
significant capital expenditures and working capital requirements necessary
for the Company to provide services in a total of 22 markets. The Company
could also require additional financing before the to meet higher-
than-expected subscription rates for its services or to respond to
competition. If demand for the Company's services is less than expected, the
Company may require additional financing at an earlier date, although the
Company believes it would be able to reduce certain costs that are, to a large
extent, demand-driven, or delay its entry into various targeted regions. The
Company expects to raise additional capital prior to the end of 1999 through
the issuance of debt and possibly equity securities. There can be no assurance
as to the availability of any financing or the terms upon which such financing
might be available. The Company expects to experience substantial negative
cash flow from operating activities and negative free cash flow before
financing activities for at least the next several years due to continued
development, commercial deployment and expansion of its networks. The
Company's future cash requirements for developing, deploying and enhancing its
networks and operating its business, as well as the Company's revenues, will
depend on a number of factors including (i) the number of regions entered, the
timing of entry and services offered; (ii) network development schedules and
associated costs due to issues including the physical requirements of the CO
collocation process; (iii) the rate at which customers and subscribers
purchase the Company's services and the pricing of such services; (iv) the
level of marketing required to acquire and retain customers and to attain a
competitive position in the marketplace; and (v) the rate at which the Company
invests in engineering and development and intellectual property with respect
to existing and future technology.
In addition, the Company may wish to selectively pursue possible
acquisitions of businesses, technologies or products complementary to those of
the Company in the future in order to expand its geographic presence and
achieve operating efficiencies. There can be no assurance that the Company
will have sufficient liquidity, or be able to obtain additional debt or equity
financing on favorable terms or at all, in order to finance such an
acquisition. However, no acquisitions are currently contemplated. See "Risk
Factors--Substantial Future Capital Requirements."
YEAR 2000 ISSUES
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field and cannot distinguish
21st century dates from 20th century dates. These date code fields will need
to distinguish 21st century dates from 20th century dates and, as a result,
many companies' software and computer systems may need to be upgraded or
replaced in order to comply with such "Year 2000" requirements. The Company
has reviewed its internally developed information technology systems and
programs and believes that its systems are Year 2000 compliant and that there
are no significant Year 2000 issues within the Company's systems or services.
The Company has not reviewed its non-information technology systems for Year
2000 issues relating to embedded microprocessors. To the extent that such
issues exist, these systems may need to be replaced or upgraded to become Year
2000 compliant. The Company believes that its non-information technology
systems will not present any significant Year 2000 issues, although there can
be no assurance in this regard. In addition, the Company utilizes third-party
equipment and software and interacts with ILECs that have equipment and
software that may not be Year 2000 compliant. Failure of such third-party or
ILEC equipment or software to operate properly with regard to the year 2000
and thereafter could require the Company to incur
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<PAGE>
unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, prospects, operating results and
financial condition. Furthermore, the purchasing patterns of the Company's ISP
and enterprise customers may be affected by Year 2000 issues as companies
expend significant resources to correct their current systems for Year 2000
compliance. These expenditures may result in reduced funds available for the
Company's services, which could have a material adverse effect on the
Company's business, prospects, operating results and financial condition. The
Company, to date, has not made any assessment of the Year 2000 risks
associated with its third-party or ILEC equipment or software or with its ISP
and enterprise customers, has not determined the risks associated with the
reasonably likely worst-case scenario and has not made any contingency plans
to address such risks. However, the Company intends to devise a Year 2000
contingency plan prior to December 31, 1999. See "Risk Factors--Year 2000
Issues."
FORWARD LOOKING STATEMENTS
The statements contained in this Prospectus that are not historical facts
are "forward-looking statements" (as such term is defined in Section 27A of
the Securities Act and Section 21E of the Exchange Act), which can be
identified by the use of forward-looking terminology such as "estimates,"
"projects," "anticipates," "expects," "intends," "believes," or the negative
thereof or other variations thereon or comparable terminology, or by
discussions of strategy that involve risks and uncertainties; provided,
however, that the safe harbor provisions of Section 27A and Section 21E are
not applicable to any "forward looking" statements made in connection with the
initial issuance of Common Stock offered pursuant to this Prospectus, although
such provisions are applicable to such statements made in connection with the
resales of such shares of Common Stock. These forward-looking statements, such
as the Company's plans to expand its existing network or to commence service
in new areas, the market opportunity presented by the Company's target
regions, estimates regarding the timing of launching its service in new
regions, expectations regarding the extent to which enterprise customers roll
out the Company's service, statements regarding development of the Company's
business, the estimate of market sizes and addressable markets for the
Company's services and products, the estimates of future operating results,
including the estimates of the time needed to achieve positive EBITDA, the
Company's anticipated capital expenditures, the effect of regulatory reform
and regulatory litigation, other statements contained in this Prospectus
regarding matters that are not historical facts, are only estimates or
predictions and cannot be relied upon. No assurance can be given that future
results will be achieved; actual events or results may differ materially as a
result of risks facing the Company or actual results differing from the
assumptions underlying such statements. Such risks and assumptions include,
but are not limited to, the Company's ability to successfully market its
services to current and new customers, generate customer demand for its
services in the particular regions where it plans to market services, achieve
acceptable pricing for its services, respond to increasing competition, manage
growth of the Company's operations, access regions and negotiate suitable
interconnection agreements with the ILECs, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions, as well as
regulatory, legislative and judicial developments that could cause actual
results to vary materially from the future results indicated, expressed or
implied in such forward-looking statements. All written and oral forward-
looking statements made in connection with this Prospectus which are
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by the "Risk Factors" and other cautionary
statements included in this Prospectus. The Company disclaims any obligation
to update information contained in any forward-looking statement.
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BUSINESS
The following discussion contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in the forward-looking statements as a result of
certain factors including, but not limited to, those discussed in "Risk
Factors" and elsewhere in this Prospectus. The Company disclaims any
obligation to update information contained in any forward-looking statement.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Forward Looking Statements."
OVERVIEW
Covad is a leading packet-based CLEC that provides dedicated high-speed
digital communication services using DSL technology to ISP and enterprise
customers. ISPs purchase the Company's services in order to provide high speed
Internet access to their business and consumer end-users. Enterprise customers
purchase the Company's services to provide employees with remote access to
their LANs to improve employee productivity and reduce operating costs. The
Company believes its services offer a superior value proposition as compared
to currently available high-speed Internet and RLAN access alternatives. The
Company's services are provided over standard copper telephone lines at speeds
of up to 1.5 Mbps, approximately 25 times the speed available through a 56.6
Kbps modem. As of December 15, 1998, the Company had installed over DSL
lines and received orders for its services from approximately 100 ISP and
enterprise customers, including Cisco Systems, Concentric Network, Epoch
Networks, Oracle, PeopleSoft, Sprint, Stanford University, Verio and Whole
Earth Networks.
The Company introduced its services in the San Francisco Bay Area in
December 1997. The Company launched its services in the Los Angeles, New York
and Boston metropolitan areas in August 1998 and in the Washington, D.C.
metropolitan area in December 1998 and expects to introduce its services in
the Seattle metropolitan area in the first quarter of 1999. In March 1998, the
Company raised approximately $135 million through the issuance of the Senior
Discount Notes to fund the deployment of its networks in the Initial Regions.
As a result of the strong market demand for high-speed digital communication
services, the Company has decided to increase to 22 the number of regions in
which it plans to build its networks and offer its services. The Company
estimates that when complete, its networks in these 22 regions will enable the
Company to provide service to over 28 million homes and businesses in 28 of
the top 50 MSAs in the United States.
The Company believes that its business model offers attractive economics.
Through its use of DSL technology, the Company can effectively leverage the
existing telephone network copper infrastructure to deploy service more
quickly and at lower costs than technologies such as cable modems and wireless
data networks that require large initial infrastructure investments before
service can be provided. Accordingly, the Company believes it can achieve
positive EBITDA with fewer customers than companies offering such alternative
technologies. See "Risk Factors--History and Continuation of Operating
Losses."
INDUSTRY BACKGROUND
Growing Market Demand for High-Speed Digital Communications Bandwidth
High-speed connectivity has become important to small- and medium-sized
businesses due to the dramatic increase in Internet usage. According to IDC,
the number of Internet users worldwide reached approximately 69 million in
1997 and is forecasted to grow to approximately 320 million by 2002. The
popularity of the Internet with consumers has driven the rapid proliferation
of the Internet as a commercial medium, as businesses establish Web sites and
corporate intranets and extranets to expand their customer reach and improve
their communications efficiency. In addition, industry analysts estimate that
the value of goods and services sold by businesses through the Internet will
increase from $2.6 billion in 1997 to $37.5 billion in 2002. Accordingly, to
remain competitive, small- and medium-sized businesses increasingly need high-
speed Internet connections to
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maintain complex Web sites, access critical business information and
communicate with employees, customers and business partners more efficiently.
High-speed digital connections are also becoming increasingly important to
businesses and consumers as more high bandwidth information and applications
become available on the Internet.
The demand for high-speed digital communication services is also growing
rapidly. Over the past ten years, high-speed LANs have become increasingly
important to enterprises to enable employees to share information, send e-
mail, search databases and conduct business. The Company believes that a large
majority of personal computers used in enterprises are connected to LANs.
Enterprises are now seeking to extend this same high-speed connectivity to
employees accessing the LAN from home to improve employee productivity and
reduce operating costs.
As businesses continue to increase their use of the Internet, intranets and
extranets, the Company expects the market size for both small- and medium-
sized business Internet access and RLAN access to continue to grow rapidly.
Industry analysts estimate that the number of remote access lines in the U.S.
will grow from approximately ten million in 1996 to approximately 30 million
in 2000, a compound annual growth rate in excess of 30%.
Business and consumer Internet access and RLAN access are creating
increasing demands for high-speed digital services. However, the full
potential of Internet and LAN applications cannot be realized without removing
the performance bottlenecks of the existing public switched telephone network.
Increases in telecommunications bandwidth have significantly lagged
improvements in microprocessor performance over the last ten years. Since
1988, microprocessor performance has improved nearly 80-fold, while the
fastest consumer modem connection has improved from 9.6 Kbps to 56.6 Kbps, a
factor of six. According to industry analysts, there are nearly 40 million
personal computers in U.S. homes today, and most of them can only connect to
the Internet or their corporate LAN by low-speed analog lines. Higher speed
connections are available, including ISDN, Frame Relay and T1 lines, and this
segment has recently experienced dramatic growth in the U.S. However, these
alternatives are expensive and complex to order, install and maintain.
Emergence of DSL Technology
DSL technology emerged in 1990 and is commercially available today to
address the performance bottlenecks of the public switched telephone network.
DSL equipment, when deployed at each end of standard copper telephone lines,
increases the data carrying capacity of these lines from analog modem speeds
of 56.6 Kbps and ISDN speeds of 128 Kbps to DSL speeds of up to 6 Mbps
depending on the length and condition of the copper line. Also, recent
advances in semiconductor technology and Digital Signal Processing ("DSP")
algorithms have made the deployment of DSL technology on a widespread basis
more economical, with equipment prices falling by up to 75% over the last two
years. The Company anticipates that equipment prices will continue to fall as
a result of continued advances in semiconductor technologies and increases in
equipment production volumes.
Because DSL technology reuses the existing copper plant, it is significantly
less expensive to deploy on a broad scale than existing alternative high-speed
digital communication technologies, such as cable modems, wireless data and
satellite data. As a result, a significant portion of the investment in a DSL
network is success- based, as such networks require a comparatively lower
initial fixed investment, and the subsequent variable investments in DSL
electronics are directly related to the number of paying customers.
In January 1998, a number of companies, including Intel Corporation
("Intel"), Compaq Computer Corp., Microsoft Corp. and certain of the major
ILECs, jointly announced the formation of the Universal ADSL Working Group
("UAWG"). The goal of UAWG is to publish a standard specification for a low-
cost, consumer oriented ADSL hardware and software solution. Since the Company
is a purchaser of ADSL equipment and a service provider, the Company has
joined the UAWG and supports its objectives. The Company believes that
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the efforts of the UAWG will lead to lower cost and more standardized ADSL
hardware and software products. An initial draft of the specification was
approved in June 1998 and a draft standard was adopted in October 1998. Aimed
at consumers, the so-called G.lite specification has a maximum data throughput
rate of 1.5 Mbps incoming and 512 Kbps outgoing.
Impact of the Telecommunications Act of 1996
The passage of the 1996 Act created a legal framework for CLECs to provide
local analog and digital communication services in competition with the ILECs.
The 1996 Act eliminated a substantial barrier to entry for CLECs by enabling
them to leverage the existing infrastructure built by the ILECs, which
required a $200 billion investment by ILECs and ILEC ratepayers, rather than
constructing a competing infrastructure at significant cost. The 1996 Act
requires ILECs, among other things, to allow CLECs to lease copper lines on a
line by line basis, to collocate equipment, including DSL equipment, in the
ILECs' COs to connect to these lines, to lease access on the ILECs' inter-CO
fiber backbone to link the CLECs' equipment and to use the ILECs' own OSS to
place orders and access the ILECs' databases. The 1996 Act in particular
emphasized the need for competition-driven innovations in the deployment of
advanced telecommunications services, such as the Company's DSL services.
THE COVAD SOLUTION
Covad was formed to capitalize on the substantial business opportunity
created by the growing demand for high-speed digital communication, the
commercial availability of low cost DSL technology and the passage of the 1996
Act. Key aspects of the Company's solution to provide high-speed digital
communication services include: (i) an attractive value proposition that
provides high-speed connections at similar or lower prices than alternative
high-speed technologies currently available to customers; (ii) a widely
available, always-connected, secure network that facilitates deployment of
Internet and intranet applications; and (iii) a management team experienced in
the data communications, telecommunications and personal computer industries.
Attractive Value Proposition. The Company offers higher bandwidth digital
connections than alternative services at similar or lower prices that do not
vary with usage. For business Internet users, the Company's high-end services
offer comparable bandwidth to T1 and Frame Relay circuits at approximately 25%
of the cost. For the RLAN market, the Company's mid-range services are three
to six times the speed of ISDN and up to ten times the speed of analog modems
at monthly rates similar to or lower than those for heavily used ISDN lines.
The Company believes that many of its enterprise customers can justify
deploying lines to their employees if productivity improves by only a few
hours per month based on increases in the number of hours worked and decreases
in commute time and time spent waiting for information. For consumer Internet
users, the Company expects that it can offer a G.lite compatible service at
prices comparable to prices offered by cable modem services today.
Widely Available, Always-Connected, Secure Network. The Company's strategy
of providing blanket coverage in each region it serves is designed to ensure
that the Company's services are available to the vast majority of its
customers' end-users. The Company's network provides 24-hour, always-on
connectivity, unlike ISDN lines and analog modems which require customers to
connect to the Internet or their LAN for each use. Also, because the Company
uses dedicated connections from each end-user to the ISP or enterprise
network, its customers can reduce the risk of unauthorized access.
Experienced Management Team. The Company's management team includes
individuals with extensive experience in the data communications,
telecommunications and personal computer industries, including Robert
Knowling, Jr., President and Chief Executive Officer (former Executive Vice
President of Operations and Technology at U S WEST Communications), founders
Charles McMinn, Chairman of the Board, Charles Haas, Vice President of Sales,
and Dhruv Khanna, Vice President, General Counsel and Secretary (all of whom
worked at Intel), Timothy Laehy, Chief Financial Officer, Treasurer and Vice
President, Finance (former Vice President of Corporate Finance and Treasurer
of Leasing Solutions, Inc.), Rex Cardinale, Vice President of Engineering
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(former General Manager of the cc:Mail division of Lotus Development
Corporation), Catherine Hemmer, Vice President of Operations (former Vice
President, Network Reliability and Operations at U S WEST Communications,
Inc., former General Manager, Network Provisioning at Ameritech Corporation
and former Vice President, Network Services at MFS), Walter Pienkos, Vice
President of Human Resources and Administration (former Vice President of
Administration at Netpower, Inc. and MIPS Computer Systems) and Robert Roblin,
Vice President of Marketing (former Executive Vice President of Marketing at
Adobe Systems, Inc. and former Vice President and General Manager of
Marketing, Consumer Division at IBM Corporation). The Company has also hired
Regional General Managers to cover all 22 of its announced regions who
collectively have over 210 years of telecommunications service experience.
BUSINESS STRATEGY
Covad's objective is to become the leading provider of DSL-based high-speed
digital communication services in each region it enters. The Company's Initial
Regions consist of San Francisco, Los Angeles, New York, Boston, Seattle and
Washington, D.C. The Company introduced its services in the San Francisco Bay
Area in December 1997, in the Los Angeles, New York and Boston regions in
August 1998 and in the Washington, D.C. metropolitan area in December 1998.
The Company expects to introduce its services in the Seattle metropolitan area
in the first quarter of 1999. As a result of the strong market demand for
high-speed digital communication services, the Company has decided to increase
to 22 the number of regions in which it plans to build its networks and offer
its services. The key elements of the Company's strategy which it has deployed
in the San Francisco Bay Area and its other Initial Regions and which it plans
to deploy in each additional region it enters are as follows:
Secure CLEC Status and Sign Interconnection Agreements in the Top U.S.
Markets. To provide its services, the Company obtains CLEC status in each
state that it enters and signs interconnection agreements with the relevant
ILECs. To date, the Company is authorized under state law to operate as a CLEC
in 17 states, has pending applications in nine additional states and intends
to obtain authorization in the other states necessary to cover the Company's
22 target regions. In the aggregate, the Company's 22 existing and target
regions represent over 40% of the U.S. population. The Company has entered
into interconnection agreements with six different major ILECs in the majority
of the states covering the Company's 22 target markets and is negotiating
interconnection agreements with ILECs in the remaining states. The Company
believes it has gained a competitive advantage by rapidly securing CLEC status
and signing interconnection agreements in multiple regions.
Roll Out Service Rapidly in These Markets. The Company seeks to be the first
company to roll out service broadly in its target regions in order to: (i)
secure CO collocation space prior to competitors; (ii) secure and retain
customers before significant DSL competition arises; (iii) maintain advantages
over competitors through superior coverage and high customer satisfaction; and
(iv) build the largest volume and market share in order to allow the Company
to reduce the costs and prices of its services and, where it is first to
market, maintain its leadership position.
Provide Pervasive Coverage. The Company is pursuing a blanket coverage
strategy of providing service in a substantial majority of the COs in each
region that it enters since the Company's ISP customers desire to market their
Internet access services on a region-wide basis. Blanket coverage is also
important to the Company's enterprise customer since the typical enterprise
desires to offer RLAN access to all employees regardless of where they reside
in the region. In addition, the Company believes its presence in 22 markets
will allow it to better serve its ISP and enterprise customers which are
increasingly seeking a single supplier in multiple metropolitan areas.
Focus on Packet Data Services. Although the Company is authorized to provide
both data and voice services, it is presently focusing exclusively on packet
data services and does not currently plan to offer analog voice services. The
Company believes that it can provide a superior digital service while avoiding
the significant investment that would be required to compete in the analog
voice market.
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Sell Directly to ISPs and Enterprises that Can Provide a Large Number of
End-Users. The Company targets ISPs that can offer their end-users similar
cost and performance advantages for Internet access using the Company's
services. Over 100 ISPs currently resell the Company's services. The Company's
direct sales force also specifically targets enterprises that it estimates to
have over 500 existing ISDN or analog modem-based RLAN users. The Company
believes it offers these customers higher performance and dedicated services
at similar or lower prices than those of alternative technologies.
Leverage the Success-Based Economics of DSL. Because it uses DSL technology,
a significant portion of the Company's capital expenditures are success-based.
The Company estimates that approximately 50% of its cumulative capital
expenditures over the next five years will be for DSL equipment that is
directly related to the Company's end-user subscription rate.
Establish Relationships with ISPs and Other Industry Participants. The
Company does not provide Internet access directly to any of its customers.
Instead, the Company provides connections to ISPs, which in turn offer high-
speed Internet access using the Company's network. In this way, the Company:
(i) carries the traffic of multiple ISPs in any region, increasing its volume
and reducing its costs; (ii) leverages its selling efforts through the sales
and support staff of these ISPs; (iii) offers ISPs a non-competitive transport
alternative, since the ILEC typically provides its own Internet access
services in competition with ISPs; and (iv) provides ISPs a high-speed service
offering to compete with cable-based Internet access.
The Company also believes that it is developing a service offering that will
be increasingly attractive to IXCs and other CLECs. As the Company rolls out
its network in 22 markets nationwide, it can increasingly serve as a single
packet network service provider to other telecommunications service companies
who seek to offer packet based services to their customers. Also, the Company
can carry the traffic of multiple IXC and CLEC partners and potentially
provide these services at price points that are more attractive than any one
other company can provide for itself. These companies are also seeking an
alternative to dealing with each ILEC in every region they would like to offer
service. Finally, since the Company's networks serve predominately small
business and residential end-users these networks are complementary to the
large business focused networks of these IXCs and other CLECs. The Company has
discussed strategic relationships with both IXCs and other CLECs and intends
to continue these discussions as its networks are deployed in its 22 target
markets.
Provide a Superior Product and Service Solution. The Company believes that
it can build a significant competitive position by providing a comprehensive
product and service solution to its customers. The Company undertakes to
provide all of the necessary product and service elements required to
establish and maintain digital services in its target markets including: (i)
managing the ILEC's installation and testing of copper lines used for its
service; (ii) installing any in-building wiring required to initiate service;
(iii) selling, configuring and installing the DSL modem required at each end-
user site; (iv) providing 24 hour, seven days a week ("24x7") monitoring of
each end-user line; and (v) designing and provisioning an enterprise's overall
RLAN network including equipment selection, programming and troubleshooting.
COVAD'S PRODUCT AND SERVICE OFFERINGS
Covad currently offers six flat rate digital services under the TeleSpeed
brand to connect its customers' end-users to Covad's RDCs. In addition, ISP
and enterprise customers may purchase backhaul services from the Company to
connect their facilities to Covad's RDC.
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TeleSpeed Services
The Company's TeleSpeed services connect individual end-users on
conventional copper lines to Covad DSL equipment in their serving CO and from
there to the Covad packet digital network serving that metropolitan area. An
ILEC's infrastructure consists of numerous COs which are connected by a fiber
optic backbone to a regional office that routes local and long distance
traffic. Each CO collects the individual copper lines from customers' premises
in the neighborhood.
The six TeleSpeed services are TeleSpeed 144, TeleSpeed 192, TeleSpeed 384,
TeleSpeed 768, TeleSpeed 1.1 and TeleSpeed 1.5. The chart below compares the
pricing, performance and markets for each of these services as of December 15,
1998. The particular TeleSpeed service available to an end-user depends on the
user's distance to the CO. The Company believes that substantially all of its
potential end-users in its target markets can be served with one of the
Company's services. The Company estimates that approximately 70% of end-users
are within 18,000 feet of a CO and can be served by at least the Company's
TeleSpeed 384 services. The Company also believes at least a majority of
potential end-users will be able to obtain the Company's highest speed service
offering. However, the specific number of potential users for the higher
speeds will vary by CO and by region and will be affected by line quality.
<TABLE>
<CAPTION>
SPEED
SPEED TO FROM PRICE* RANGE**
SERVICE END-USER END-USER ($/MONTH) (FEET) MARKET/USAGE
- ------------------------ -------- -------- --------- ------- ------------------------------------
<S> <C> <C> <C> <C> <C>
TeleSpeed 144........... 144 Kbps 144 Kbps $ 90 35,000 ISDN replacement, non-standard lines
TeleSpeed 192........... 192 Kbps 192 Kbps $ 90 18,000 RLAN, business Internet
TeleSpeed 384........... 384 Kbps 384 Kbps $125 16,000 RLAN, business Internet
TeleSpeed 768........... 768 Kbps 768 Kbps $160 13,500 Business Internet
TeleSpeed 1.1........... 1.1 Mbps 1.1 Mbps $195 12,000 Business Internet
TeleSpeed 1.5........... 1.5 Mbps 384 Kbps $195 15,000 High-speed Web access
</TABLE>
- --------
* Current list prices for Boston, Los Angeles, New York, Washington, D.C. and
the San Francisco Bay Area. Prices are lower for high volume customers and
may be different in other regions. See "Risk Factors--Unproven Business
Model and Pricing Sensitivity" for a discussion of the risks associated
with the Company's ability to sustain current price levels in the future.
**Estimated maximum distance from the end-user to the CO.
TeleSpeed 144. Covad's TeleSpeed 144 service operates at up to 144 Kbps in
each direction, which is similar to the performance of an ISDN line. This
service, which can use existing ISDN equipment at the end-user site, is
targeted at the ISDN replacement market where its per month flat rate can
compare favorably to ISDN services from the ILEC when per-minute usage charges
apply. It is also the service that Covad offers on copper lines that are
either too long to carry the Company's higher speed services or are served by
DLCs or similar equipment where a continuous copper connection is not
available from the end-user site to the CO.
TeleSpeed 192. This service provides one and a half to three times the
performance of ISDN at similar or lower price points to heavily-used ISDN
lines. The Company expects TeleSpeed 192 to be deployed within the RLAN
market.
TeleSpeed 384. This service provides three to six times the performance of
ISDN at similar price points to heavily-used ISDN lines. The Company expects
TeleSpeed 384 to be deployed within the RLAN market.
TeleSpeed 768. This service provides one-half the bandwidth of a T1 data
circuit at substantially less than one-half of the monthly price that the
Company estimates is typical for T1 service. The target market for the
TeleSpeed 768 service is small businesses needing moderate speed access to the
Internet but who have previously been unable to afford the price of such
service. The service also competes favorably from a price/performance
standpoint with traditional fractional T1 and Frame Relay services for these
same customers.
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TeleSpeed 1.1. This service provides over two-thirds the bandwidth of a T1
data circuit at substantially less than one-half of the monthly price that the
Company estimates is typical for T1 service. The target market for the
TeleSpeed 1.1 service is small businesses needing T1-level access to the
Internet which have previously been unable to afford the price of such
service. The service also competes favorably from a price/performance
standpoint with traditional fractional T1 and Frame Relay services for these
same customers.
TeleSpeed 1.5. TeleSpeed 1.5 is the Company's only asymmetric service, i.e.,
with different speeds to and from the end-user. This service is intended for
end-users who consume more bandwidth than they generate, and is especially
useful for accessing Web sites. The service also provides the highest
performance of any TeleSpeed service to stream video or other multimedia
content to end-user locations.
Backhaul Services
Covad provides two backhaul services from its regional network to an ISP or
enterprise customer site. These services include the aggregation of all
individual end-users in a metropolitan area and transmission of the packet
information to the customer on a single high-speed line. The services, prices
and suggested maximum aggregation of end-user traffic are as follows:
Covad DS1. Covad's DS1 backhaul service is intended for the small business
with up to 50 RLAN end-users. The service operates at 1.5 Mbps and implements
a Frame Relay protocol compatible with most low-end and mid-range routers. The
price is $975 per month.
Covad DS3. The Company's DS3 backhaul service is targeted to large ISPs and
enterprises with up to 1,000 end-users. The service utilizes an ATM protocol
that efficiently handles the high data rates involved and operates at up to 45
Mbps. The price is $4,000 per month.
Activation Services
In addition to monthly service charges, Covad has a one-time activation
charge of $325 for ISP and RLAN end-users. The Company also charges $2,500 for
DS1 and $7,500 for DS3 activation. Customers must also purchase a DSL modem,
currently $399 to $600, from the Company or a third party for each end-user of
the TeleSpeed 144 service, or from the Company for $400 to $550 for higher
speed TeleSpeed services. Fees and charges described herein are subject to
change.
COVAD'S REGIONAL ROLLOUT
As part of the Company's strategy to become a leading provider of DSL high-
speed digital communication services in the U.S., the Company intends to build
networks and offer services in 22 regions. The Company introduced its services
in the San Francisco Bay Area in December 1997, in the Los Angeles, New York
and Boston metropolitan areas in August 1998 and in the Washington, D.C.
metropolitan area in December 1998. The Company expects to introduce its
services in the Seattle metropolitan area in the first quarter of 1999. As a
result of the strong market demand for high-speed digital communication
services, the Company has increased its target markets to the following 22
regions:
<TABLE>
<CAPTION>
WEST CENTRAL EAST
------------- ----------- ----------------
<S> <C> <C>
Los Angeles Austin Atlanta
Phoenix Chicago Baltimore
Portland Dallas Boston
Sacramento Denver Miami
San Diego Detroit New York
San Francisco Houston Philadelphia
Seattle Minneapolis Raleigh
Washington, D.C.
</TABLE>
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CUSTOMERS
The Company offers its services to ISPs and enterprises. According to
Claritas, Inc., a leading provider of diagnostic databases, there are over
169,000 businesses in the U.S. with over 100 employees, of which the Company
estimates that 34,000 are in the Company's Initial Regions and approximately
71,000 are in all of the Company's 22 targeted regions. Covad has entered into
service agreements with more than 200 ISP and enterprise customers. As of
December 15, 1998, the Company had approximately end-user lines in
operation with approximately 100 ISP and enterprise customers, and the Company
was in the initial stages of provisioning backhaul service and end-user lines
with approximately 100 additional ISP and enterprise customers located
principally in the regions recently entered into by the Company. The following
is a list of selected ISP and enterprise customers:
<TABLE>
<CAPTION>
SELECTED ISP CUSTOMERS SELECTED ENTERPRISE CUSTOMERS
---------------------- -----------------------------
<S> <C>
Bay Junction Technology Apple Computer
Brainstorm Networks Cisco Systems
Concentric Network Corporation E*Trade Group
Direct Network Access, Ltd. (DNAI) Hewlett Packard
DSL Networks Inc. Inktomi
Epoch Networks Intel
Flashcom, Inc. Oracle Corporation
Globix PeopleSoft
Lan Minds, Inc. Sagent Technology
Prodigy Stanford University
Slip.Net, Inc. Sun Microsystems Inc.
Verio Inc. Tandem Computers
Whole Earth Networks WebTV
</TABLE>
The Company's agreements with ISPs generally have terms of one year and
provide for cooperative advertising of the TeleSpeed brand. The agreements are
nonexclusive and do not require the ISP to have a minimum number of TeleSpeed
users. See "Risk Factors--Dependence Upon Indirect Sales Channels."
The Company's practice with respect to its enterprise customers has been to
enter into an arrangement for a negotiated price to install the service
initially to a small number of end-users. An enterprise customer decides
whether to implement a broad rollout of the Company's services after evaluating
the results of this initial phase of deployment. To date, an enterprise
customer's initial phase of deployment and its decision to roll out the
Company's service to additional end users has taken at least six months, and
has generally taken longer than the Company originally expected. As of December
15, 1998, substantially all of the Company's enterprise customers had not yet
rolled out the Company's services broadly to their employees, and it is not
certain when such roll outs will occur, if at all. The Company will not receive
significant revenue from an enterprise customer until and unless these rollouts
occur. During the lengthy sales cycle for an enterprise customer, the Company
incurs significant expenses in advance of the receipt of revenues. Therefore,
any continued or ongoing failure for any reason of enterprise customers to roll
out the Company's services will have a material adverse effect on the Company's
business, prospects, operating results and financial condition. See "Risk
Factors--Lengthy Sales Cycles for Enterprise Customers."
SALES AND MARKETING
Business and Consumer Internet. For the business and consumer Internet access
markets, the Company sells its service to ISPs that combine the Company's lines
with their Internet access services and resell the combination to their
existing and new end-users. The Company addresses these markets through sales
and marketing personnel dedicated to the ISP sales channel. The Company
supplements its sales efforts to ISPs through training programs and marketing
programs that include promotions and sales incentives designed to encourage the
ISPs to sell the Company's services instead of those of its competitors. As of
December 15, 1998,
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the Company had more than 100 ISP customers with their own sales personnel
marketing Internet services. See "Risk Factors--Dependence Upon Indirect Sales
Channels."
Remote LAN. The Company markets its RLAN services to businesses through a
direct sales force, augmented by marketing programs with value added resellers
and IXCs. The direct sales force is organized by region, each managed by a
regional sales director who is responsible for lead generation and sales and
marketing efforts to RLAN customers. The sales force deals directly with the
chief information officer and the telecommunications manager responsible for
remote access within an enterprise. The Company augments its sales efforts to
its RLAN customers through partnerships with value added resellers, including
systems integrators that can offer the Company's TeleSpeed service as part of
a complete work-at-home solution to businesses.
Strategic Relationships. The Company intends to enter into strategic
relationships with leading telecommunications companies, including CLECs and
IXCs, in which those companies resell the Company's TeleSpeed services to
their customers. The Company believes that these indirect sales channels will
enable the Company to penetrate its target markets more rapidly and eventually
will generate the majority of sales of the Company's services.
The Company is also pursuing several types of joint marketing arrangements
with its ISP and enterprise customers. For example, the Company provides its
ISP customers with market development funds for the promotion of the TeleSpeed
service. In addition, certain of the Company's equipment suppliers have
promoted the Company's services through seminars to corporate communications
managers in the San Francisco Bay Area. The Company also supports its sales
efforts with marketing efforts that include advertising programs through radio
and other popular media, attendance at trade shows and presentations at
industry conferences.
SERVICE DEPLOYMENT AND OPERATIONS
ISPs and corporate communications managers typically have had to assemble
their digital communication connections using multiple service and equipment
suppliers. This leads to additional work, cost and coordination problems. With
its TeleSpeed service, the Company emphasizes a one-stop total service
solution for its customers. This service solution includes: customer
installation, end-user line installation, end-user premises wiring and modem
configuration, ongoing network monitoring, customer reporting and customer
service and technical support.
Customer Installation. The Company works with its ISP and enterprise
customers to establish all required connectivity and configuration of the
backhaul connection from the customer to Covad's network. The Company orders
the backhaul circuit for the customer, tests the installed circuit, assists
the customer in configuring the router or switch that terminates the backhaul
circuit and monitors this circuit from the NOC.
End-User Line Installation. The Company orders all end-user connections from
the ILECs, monitors the ILECs' performance, tests the installed lines and
monitors the end-user lines from the NOC.
End-User Premises Wiring and Modem Configuration. The Company uses its own
and subcontracted installation crews and trucks to install any required inside
wiring at each end-user site. The Company's installation crews also configure
and install end-user modems with information specific to each ISP and
enterprise.
Network Monitoring. The Company monitors its network from the NOC on a
continuous basis, which often enables the correction of potential network
problems before a customer or end-user is affected. The Company has also
developed network capability to provide ISP and enterprise customers direct
monitoring access of their end-users for more efficient monitoring of their
own network performance.
Customer Reporting. The Company communicates regularly with its customers
about the status of their end-users. The Company also operates a toll-free
customer care help line. Additionally, the Company provides
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Web-based tools to allow individual ISPs and enterprise communications
managers to monitor their end-users directly, to place orders for new end-
users, to enter trouble tickets on end-user lines and to communicate with the
Company on an ongoing basis.
Customer Service and Technical Support. The Company provides 24x7 service
and technical support to its ISP customers and enterprise communications
managers. The ISP and communications manager serve as the initial contact for
service and technical support with the Company providing the second level of
support. By avoiding the higher cost of providing direct end-user support, the
Company believes it can grow its customer base more rapidly with lower
customer support costs.
NETWORK ARCHITECTURE AND TECHNOLOGY
The key design principles of the Covad network are to provide: (i) robust
network security required for enterprise intranet applications, (ii)
consistent and scalable performance and (iii) intelligent end-to-end network
management.
Robust Network Security. Modem access to enterprise networks presents
significant security risks, since any telephone can be used to attempt to
access such a network simply by dialing the telephone number. As a result,
enterprises expend significant effort and resources to prevent unauthorized
access. Enterprises also typically limit remote access users to reading e-mail
or other non-sensitive applications. The Covad network is designed to provide
enhanced security to ensure secure availability of all internal applications
and information for remote locations. The Company's permanent virtual circuit
network architecture connects individual end-users at fixed locations to a
single enterprise, which reduces the possibility of unauthorized access and
allows the Company's customers to safely transmit sensitive information and
applications over the Company's TeleSpeed lines.
Consistent and Scalable Performance. The Company believes that eventually
public packet networks will evolve to replace over 40 million modems currently
connected to circuit switched networks that have been deployed in the U.S. As
such, the Company designed its network for scalability and consistent
performance to all users as the network grows. The Company has designed a
"star topology" network similar to the most popular LAN networking
architecture currently used in high performance enterprise networks. In this
model, new capacity is added automatically as each new user receives a new
line. The Company also uses Asynchronous Transfer Mode ("ATM") switches in its
networks that implement packet switching directly in silicon circuits rather
than slower router-based designs that implement switching in router software.
Intelligent End-to-End Network Management. Because the customers' and end-
users' lines are "always-on," they can also always be monitored. The Company
has visibility from the ISP or enterprise site across the network and into the
end-user's home or business. Because its network is centrally managed, the
Company can identify and dynamically enhance network quality, service and
performance and address network problems promptly.
The primary components of the Company's network are the NOC, RDCs, its high-
speed private metropolitan networks, CO collocation spaces (including DSLAMs),
copper telephone lines and DSL modems.
NOC. The entire Covad network is managed from the NOC. The Company provides
end-to-end network management using advanced network management tools on a
24x7 basis, which enhances its ability to address performance or connectivity
issues before they affect the end-user experience. From the NOC, the Company
can monitor the equipment and circuits in each metropolitan network (including
the ATM switches), each CO (including the DSLAMs) and individual end-user
lines (including the DSL modems). Currently, the NOC is collocated with the
Company's San Francisco Bay Area RDC. See "Risk Factors--Risk of System
Failure."
RDCs. The RDCs act as service hubs for each metropolitan area the Company
enters. Data and network management traffic from each CO is collected at the
RDC and switched to the Company's NOC. The Company designs the RDC for high
availability including battery backup power, redundant equipment and active
network monitoring.
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<PAGE>
Private Metropolitan Network. The Company operates its own private
metropolitan network in each region that it enters. The network consists of
high-speed ATM communications circuits that the Company leases to connect its
RDCs, its equipment in individual COs and its enterprise and ISP customers.
This network operates at a speed of 45 to 155 Mbps.
Collocation Spaces. Through its interconnection agreements with the ILECs,
the Company seeks to secure collocation space in every CO where it desires to
offer service. These collocation spaces are designed to offer the same high
reliability and availability standards as the ILEC's other CO space. The
Company requires access to these collocation spaces for its equipment and for
persons employed by, or under contract with, the Company. The Company places
DSLAMs in its collocation spaces to provide the high-speed DSL signals on each
copper line to its end-users. The Company builds its collocation spaces to
handle thousands of end-user lines each and expects to deploy 40 to 250
collocation facilities in any metropolitan area that it enters. As of December
15, 1998, the Company had CO spaces operational with over
additional spaces on order from various ILECs.
Copper Telephone Lines. The Company leases the copper telephone lines
running to end-users from the ILEC under terms specified in its
interconnection agreements. The Company leases lines that, in numerous cases,
must be specially conditioned by the ILEC to carry digital signals, usually at
an additional charge relative to that for voice grade copper lines. The price
the Company is obligated to pay for these lines currently varies from $4 to
$43 per month per line with additional one-time charges in some cases for
installation, modification or removal of lines.
DSL Modems and On-Site Connectivity. The Company buys its DSL modems from
its suppliers for resale to its ISP or enterprise customers for use by their
end-users. The Company configures and installs these modems along with any
required on-site wiring needed to connect the modem to the copper line leased
from the ILEC. Currently, the DSL modem and DSLAM equipment used must come
from the same vendor for all services, except the equipment used in the
Company's TeleSpeed 144 services, since there are not yet interoperability
standards for the equipment used in the Company's higher-speed services.
The Company is also pursuing a program of ongoing network development. The
Company's service development and engineering efforts focus on the design and
development of new technologies and services to increase the speed,
efficiency, reliability and security of the Covad network and to facilitate
the development of network applications by third parties that will increase
the use of the Company's network. See "Risk Factors--Unproven Network
Scalability and Speed."
COMPETITION
The markets for business and consumer Internet transport and RLAN access
services are intensely competitive and the Company expects that such markets
will become increasingly competitive in the future. The Company's most
immediate potential competitors are the ILECs, CMSPs, IXCs, FCLECs, ISPs,
OSPs, WSDSPs and other CLECs. Many of these competitors are offering, or may
soon offer, technologies and services that directly compete with some or all
of the Company's high-speed digital services. Such technologies include ISDN,
DSL, wireless data and cable modems. The principal bases of competition in the
Company's markets include transmission speed, reliability of service, breadth
of service availability, price/performance, network security, ease of access
and use, content bundling, customer support, brand recognition, operating
experience, capital availability and exclusive contracts. The Company believes
that it compares unfavorably with its competitors with regard to, among other
things, brand recognition, operating experience, exclusive contracts, and
capital availability. Many of the Company's competitors and potential
competitors have substantially greater resources than the Company and there
can be no assurance that the Company will be able to compete effectively in
its target markets.
Incumbent Local Exchange Carriers. All of the largest ILECs present in the
Company's target markets are conducting technical and/or market trials or have
entered into commercial deployment of the DSL-based services. For example, U S
WEST Communications, Inc. is offering commercial DSL services in 13 states of
its
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<PAGE>
14-state region. Ameritech Corporation is offering service in certain smaller
cities and has announced plans to introduce DSL services in the Detroit and
Chicago suburbs in the near future. Bell Atlantic has announced such services
in Washington, D.C. and one other metropolitan area and expects to offer
service in the Philadelphia metropolitan area and in New Jersey's Hudson River
area. In addition, Pacific Bell (a subsidiary of SBC Communications) announced
its commercial DSL services for California in 1998. SBC Communications is
offering DSL on a trial basis in Austin, Texas and has announced plans to
deploy service in other locations after the trial is complete. BellSouth has
announced service availability in seven cities and plans to have service in
30 cities by the end of 1999. GTE has announced plans to have DSL services
deployed in 16 states by the end of 1998. The Company recognizes that each
ILEC has the potential to quickly overcome many of the issues that the Company
believes have slowed wide deployment of DSL services by ILECs in the past. As
they do so the ILECs will represent strong competition in all of the Company's
target service areas. The ILECs have an established brand name and reputation
for high quality in their service areas, possess sufficient capital to deploy
DSL equipment rapidly, have their own copper lines and can bundle digital data
services with their existing analog voice services to achieve economies of
scale in serving customers. Certain of the ILECs have aggressively priced
their consumer asymmetric digital subscriber line ("ADSL") services as low as
$30-$40 per month, placing pricing pressure on the Company's TeleSpeed
services. The ILECs are in a position to offer service from COs where the
Company is unable to secure collocation space and offer service because of
space restrictions, which provides the ILECs with a potential competitive
advantage compared with the Company. Accordingly, the Company may be unable to
compete successfully against the ILECs, and any failure to do so would
materially and adversely affect the Company's business, prospects, operating
results and financial condition. See "Risk Factors--Intense Competition."
Cable Modem Service Providers. CMSPs such as @Home Network and MediaOne (and
their respective cable partners) are deploying high-speed Internet access
services over Hybrid Fiber Coaxial cable networks. Where deployed, these
networks provide similar and in some cases higher-speed Internet access and
RLAN access than the Company provides. They also offer these services at lower
price points than the Company's TeleSpeed services and target residential
consumers, as well as business customers. They achieve these lower price
points in part by offering a consumer grade of service, which shares the
bandwidth available on the cable network among multiple end-users. This
architecture is well-suited to compete with the Company's consumer Internet
market but is less well-suited to the Company's markets for business Internet
access and RLAN access where guaranteed bandwidth, symmetric upstream and
downstream bandwidth and network security issues are more important than in
the consumer market. In addition, different regions within a metropolitan area
may be served by different CMSPs, making it more difficult to offer the
blanket coverage required by potential business and RLAN access customers.
Also, much of the current cable infrastructure in the U.S. must be upgraded to
support cable modems, a process which the Company believes is significantly
more expensive and time-consuming than the deployment of DSL-based networks.
Actual or prospective CMSP competition may have a significant negative effect
on the ability of the Company to secure customers and may create downward
pressure on the prices the Company can charge for its services.
National Long Distance Carriers. IXCs, such as AT&T, Sprint, MCI and Qwest
Communications have deployed large-scale Internet access networks and ATM net-
works, sell connectivity to businesses and residential customers, and have
high brand recognition. They also have interconnection agreements with many of
the ILECs and a number of collocation spaces from which they are currently of-
fering or could begin to offer competitive DSL services.
Fiber-Based CLECs. Companies such as Teleport Communications Group, Inc.
(TCG) (acquired by AT&T), Brooks Fiber Properties, Inc. (acquired by WorldCom)
and MFS (acquired by WorldCom) have extensive fiber networks in many
metropolitan areas primarily providing high-speed digital and voice circuits
to large corporations. They also have interconnection agreements with the
ILECs pursuant to which they have acquired collocation space in many markets
targeted by Covad. These companies are modifying or could modify their current
business focus to include residential and small business customers using DSL
in combination with their current fiber networks.
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Internet Service Providers. ISPs such as BBN (acquired by GTE), UUNET
Technologies (acquired by WorldCom), Earthlink Networks, Concentric Network,
Mindspring Enterprises, Netcom On-Line Communication Services (acquired by
ICG) and PSINet provide Internet access to residential and business customers,
generally using the existing public switched telephone network at ISDN speeds
or below. Some ISPs such as UUNET Technologies in California and New York,
HarvardNet Inc., InterAccess and Vitts Corporation have begun offering DSL-
based services. To the extent the Company is not able to recruit ISPs as
customers for its service, ISPs could become DSL service providers competitive
with the Company.
Online Service Providers. OSPs include companies such as America Online
("AOL"), Compuserve (acquired by AOL), MSN (a subsidiary of Microsoft Corp.)
and WebTV (acquired by Microsoft Corp.) that provide, over the Internet and on
proprietary online services, content and applications ranging from news and
sports to consumer video conferencing. These services are designed for broad
consumer access over telecommunications-based transmission media, which enable
the provision of digital services to the significant number of consumers who
have personal computers with modems. In addition, they provide Internet
connectivity, ease-of-use and consistency of environment. Many of these OSPs
have developed their own access networks for modem connections. If these OSPs
were to extend their access networks to DSL, they would be competitors of the
Company.
Wireless and Satellite Data Service Providers. WSDSPs are developing
wireless and satellite-based Internet connectivity. The Company may face
competition from terrestrial wireless services, including two Gigahertz
("Ghz") and 28 Ghz wireless cable systems (Multi-channel Microwave
Distribution System ("MMDS") and Local Multi-channel Distribution System
("LMDS")), and 18 Ghz and 39 Ghz point-to-point microwave systems. For
example, the FCC is currently considering new rules to permit MMDS licensees
to use their systems to offer two-way services, including high-speed data,
rather than solely to provide one-way video services. The FCC also recently
auctioned spectrum for LMDS services in all markets. This spectrum is expected
to be used for wireless cable and telephony services, including high-speed
digital services. In addition, companies such as Teligent Inc., Advanced Radio
Telecom Corp. and WinStar Communications, Inc., hold point-to-point microwave
licenses to provide fixed wireless services such as voice, data and
videoconferencing.
The Company also may face competition from satellite-based systems. Motorola
Satellite Systems, Inc., Hughes Communications (a subsidiary of General Motors
Corporation), Teledesic and others have filed applications with the FCC for
global satellite networks which can be used to provide broadband voice and
data services, and the FCC has authorized several of these applicants to
operate their proposed networks.
Other CLECs. Other companies such as Rhythms NetConnections and NorthPoint
Communications offer high-speed data services using a business strategy
similar to that of the Company. The 1996 Act specifically grants any and all
CLECs the right to negotiate interconnection agreements with the ILEC.
Further, the 1996 Act allows CLECs to enter into interconnection agreements
which are identical in all respects to those of the Company. The Company has
already had an interconnection agreement copied in this manner.
As a first mover in selected markets that it enters, the Company seeks the
following strategic benefits: (i) securing and retaining customers before the
same high-speed services are available from others, (ii) engendering end-user
loyalty through superior coverage and high customer satisfaction and (iii)
capturing the largest customer base and thereby achieving economies of scale
sufficient to drive down prices and develop a leadership position. The Company
may not be able to achieve these benefits if substantial competition from any
of the foregoing competitors exists or develops in the Company's markets.
INTERCONNECTION AGREEMENTS WITH ILECS
A critical aspect of the Company's business is its interconnection
agreements with the ILECs. These agreements cover a number of aspects
including: (i) the price the Company pays to lease access to the ILEC's copper
lines; (ii) the special conditioning the ILEC provides on certain of these
lines to enable the transmission of DSL signals; (iii) the price and terms for
collocation of Company equipment in the ILEC's COs; (iv) the price
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paid by the Company and access the Company has to the ILEC's inter-CO
transport facilities that the Company uses to connect COs to its network; (v)
the ability of the Company to access conduits and other rights of way the ILEC
has to construct its own network facilities; (vi) the OSS and interfaces that
the Company can use to place orders and trouble reports and monitor the ILEC's
response to Company requests; (vii) the dispute resolution process the ILEC
and the Company use to resolve disagreements on the terms of the
interconnection contract; and (viii) the term of the interconnection
agreement, its transferability to successors, its liability limits and other
general aspects of the ILEC and Company relationship.
To date, the Company has entered into interconnection agreements with six
different major ILECs in the majority of the states covering the Company's
target markets. The Company believes that the ILECs have been willing to sign
agreements with the Company to date for a variety of reasons including: (i)
the ILECs have a legal obligation to do so; (ii) the Company is perceived as a
start-up entity whose digital services are a small part of the ILEC's total
business; (iii) the Company is providing residential, facilities-based
competition to the ILEC, an element of competition that few other CLECs are
pursuing and an element of competition that can bolster the arguments of the
RBOC-ILECs to be permitted to enter the long distance voice business; and (iv)
the Company is not offering local analog voice services that could capture
revenue from the ILEC. Nevertheless, the ILECs do not in many cases agree to
the Company's requested provisions in interconnection agreements and the
Company has not consistently prevailed in obtaining all of its desired
provisions in such agreements either voluntarily or through the
interconnection arbitration process. There can be no guarantee that the
Company will be able to continue to sign favorable interconnection agreements
with subsequent ILECs. The Company is currently negotiating agreements with
several ILECs in its 22 announced regions which are necessary before the
Company can expand its services into these metropolitan areas served by such
ILECs. The ILECs are also permitting CLECs to adopt previously signed
interconnection agreements. In certain instances, the Company has adopted the
interconnection agreement of another CLEC. Other CLECs have also adopted the
same or modified versions of the Company's interconnection agreements, and may
continue to do so in the future.
The Company's interconnection agreements have a maximum term of three years,
requiring the Company to renegotiate its existing agreements in the future.
Although the Company expects to renew its interconnection agreements and
believes the 1996 Act limits the ability of ILECs not to renew such
agreements, there can be no assurance that existing or new agreements will be
extended or renegotiated on terms favorable to the Company. Additionally, the
Company's interconnection agreements are subject to interpretation by both
parties and there may arise differences in interpretation that cannot be
resolved on favorable terms to the Company. Finally the interconnection
agreements are subject to state commission, FCC and judicial oversight. There
can be no assurance that these bodies will not modify the terms or prices of
the Company's interconnection agreements in ways that adversely affect the
Company's business, prospects, operating results and financial condition.
GOVERNMENT REGULATION
Overview. The Company's services are subject to a variety of federal
regulations. With respect to certain activities and for certain purposes, the
Company has submitted its operations to the jurisdiction of state and local
authorities who may also assert more extensive jurisdiction over the
facilities and services of the Company. The FCC has jurisdiction over all
services and facilities of the Company to the extent that the Company provides
interstate and international services. To the extent the Company provides
identifiable intrastate services, the Company's services and facilities are
subject to state regulations. In addition, local municipal government
authorities also assert jurisdiction over the Company's facilities and
operations. The jurisdictional reach of the various federal, state and local
authorities is subject to ongoing controversy and judicial review, and the
Company cannot predict the outcome of such review.
Federal Regulation. The Company's provision of its services must comply with
the requirements of the Communications Act of 1934, as amended by the 1996
Act, as well as the FCC's regulations under the statute. The 1996 Act
eliminates many of the pre-existing legal barriers to competition in the
telecommunications and video programming communications businesses, preempts
many of the state barriers to local telecommunications service competition
that previously existed in state and local laws and regulations, and sets
basic standards for
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relationships between telecommunications providers. The law delegates to the
FCC and the states broad regulatory and administrative authority to implement
the 1996 Act.
Among other things, the 1996 Act removes barriers to entry in the local
telecommunications market by preempting state and local laws that are barriers
to competition and by requiring ILECs to provide nondiscriminatory access and
interconnection to potential competitors, such as cable operators, wireless
telecommunications providers, IXCs and CLECs such as the Company.
Regulations promulgated by the FCC under the 1996 Act specify in greater
detail the requirements of the 1996 Act imposed on the ILECs, among other
things, to open their networks to competition by providing competitors
interconnection, collocation space, access to UNEs, retail services at
wholesale rates and nondiscriminatory access to telephone poles, ducts,
conduits, and rights-of-way. As a result of these changes, companies such as
Covad are now able to interconnect with the ILECs in order to provide local
telephone exchange services and to use portions of the ILECs' existing network
to offer new and innovative services such as the Company is currently
offering. Numerous parties have appealed certain aspects of these regulations.
The appeals have been consolidated and have been reviewed by the U.S. Court of
Appeals for the Eighth Circuit, which has overruled certain of the FCC's
pricing and nondiscrimination regulations and upheld others. The Eighth
Circuit Court's ruling has been appealed to the U.S. Supreme Court which has
agreed to accept the case for review. Covad has entered into competitive
interconnection agreements using the federal guidelines established in the
FCC's interconnection order, which agreements may be modified to conform to
the Court of Appeals rulings and any subsequent rulings of the U.S. Supreme
Court.
The 1996 Act also allows the RBOCs to enter the long distance market within
their own local service regions upon meeting certain requirements. The timing
of the various RBOCs' entry into their respective in-region long distance
service businesses is also extremely uncertain. The timing of the various
RBOCs' in-region long distance entry will likely affect the level of
cooperation the Company receives from each of the RBOCs. The December 31, 1997
Ruling declared that the portions of the 1996 Act subjecting RBOCs to a prior
FCC approval process in order to provide interLATA services within their
respective regions are unconstitutional. On September 8, 1998, the United
States Court of Appeals for the Fifth Circuit affirmed the constitutionality
of the state and FCC approval process for RBOC in-region long distance entry.
This decision may be appealed to the U.S. Supreme Court.
In addition, the 1996 Act provides relief from the earnings restrictions and
price controls that have governed the local telephone business for many years.
ILEC tariff filings at the FCC have been subjected to increasingly less
regulatory review. However, precisely when and to what extent the ILECs will
secure pricing flexibility or other regulatory freedom for their services is
uncertain. For example, under the 1996 Act, the FCC is considering eliminating
certain regulations that apply to the ILEC's provision of services that are
competitive with those of the Company. The timing and the extent of regulatory
freedom and pricing flexibility and regulatory freedom granted to the ILECs
will affect the competition the Company faces from the ILECs' competitive
services.
Further, the 1996 Act provides the FCC with the authority to forbear from
regulating entities such as the Company who are classified as "non-dominant"
carriers. The FCC has exercised its forbearance authority. As a result, the
Company is not obligated to obtain prior certificate approval from the FCC for
its interstate services or file tariffs for such services. The Company has
determined not to file tariffs for its interstate services. The Company
provides its interstate services to its customers on the basis of contracts
rather than tariffs. The Company believes that it is unlikely that the FCC
will require the Company to file tariffs for its interstate services in the
future.
Finally, the 1996 Act allows the FCC to take explicit regulatory action in
order to encourage the deployment of advanced services to all Americans. In
August 1998 the FCC released an Order and a Notice of Proposed Rulemaking
proposing additional regulations it believes are required to ensure this goal.
These rules would place conditions on the ability of the ILECs to offer DSL
services on an unregulated basis through a separate affiliate. In addition,
the FCC has proposed rules that would provide the Company an enhanced ability
to gain collocation
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space in ILEC COs. While the Company believes that these proposed rules are
advantageous to the Company, there can be no guarantee that the actual
regulations, when and if implemented, will enhance the Company's ability to
compete.
Any changes in applicable federal law and regulations, in particular,
changes in its interconnection agreements with ILECs, the prospective entry of
the RBOCs into the in-region long distance business and grant of regulatory
freedom and pricing flexibility to the ILECs, could have a material adverse
impact on the Company's business prospects, operating results and financial
condition.
State Regulation. To the extent the Company provides identifiable intrastate
services or has otherwise submitted itself to the jurisdiction of the relevant
state telecommunications regulatory commissions, the Company is subject to
such jurisdiction. In addition, certain states have required prior state
certification as a prerequisite for processing and deciding an arbitration
petition for interconnection under the 1996 Act. To date, the Company is
authorized under state law to operate as a CLEC in 17 states, has pending
applications in nine additional states, and intends to obtain authorization in
the other states necessary to cover the Company's 22 target regions. The
Company has pending four arbitration petitions in four different Bell Atlantic
states for interconnection arrangements. The Company has concluded three
arbitration proceedings in three states by entering into interconnection
agreements with the relevant ILECs. The Company has filed tariffs in certain
states for intrastate services as required by state law or regulation. The
Company is also subject to periodic financial and other reporting requirements
of these states with respect to its intrastate services.
The different state commissions have various proceedings to determine the
rates, charges and terms and conditions for UNEs, as well as the discount for
wholesale services purchased by the Company from the relevant ILEC. The rates
set forth in the Company's interconnection agreements are interim rates and
will be prospectively, and, in some cases, retroactively, affected by the
permanent rates set by the various state commissions for such UNEs as
unbundled loops and interoffice transport. The Company has participated in UNE
rate proceedings in the states of California and Washington in an effort to
reduce these rates. Any state commission rate determinations to increase UNE
rates could have a material adverse effect on the Company's business,
prospects, operating results and financial condition.
The applicability of the various state regulations on the Company's business
and compliance requirements will be further affected to the extent to which
the Company's services are determined to be intrastate services.
Jurisdictional determinations of the Company's services as intrastate services
could have a material adverse effect on the Company's business, prospects,
operating results and financial condition.
Local Government Regulation. The Company in certain instances may be
required to obtain various permits and authorizations from municipalities in
which it operates its own facilities. Whether various actions of local
governments over the activities of telecommunications carriers such as the
Company, including requiring payment of franchise fees or other surcharges,
pose barriers to entry for CLECs which may be preempted by the FCC is the
subject of litigation. Although the Company relies primarily on the UNEs of
the ILECs, in certain instances the Company deploys its own facilities,
including fiber optic cables, and therefore may need to obtain certain
municipal permits or other authorizations. The actions of municipal
governments in imposing conditions on the grant of permits or other
authorizations or their failure to act in granting such permits or other
authorizations could have a material adverse effect on the Company's business,
prospects, operating results and financial condition.
The foregoing does not purport to describe all present and proposed federal,
state and local regulations and legislation affecting the telecommunications
industry. Other existing federal regulations are currently the subject of
judicial proceedings, legislative hearings and administrative proposals, which
could change, in varying degrees, the manner in which communications companies
operate in the U.S. The ultimate outcome of these proceedings, and the
ultimate impact of the 1996 Act or any final regulations adopted pursuant to
the 1996 Act on the Company or its business cannot be determined at this time
but may well be adverse to the Company's interests. The Company cannot predict
the impact, if any, that future regulation or regulatory changes may have
51
<PAGE>
on its business and there can be no assurance that such future regulation or
regulatory changes will not have a material adverse effect on the Company's
business, prospects, operating results and financial condition. See "Risk
Factors--Uncertain Availability of Collocation Space and Dependence on ILECs
to Provide Collocation Space and Collocation Facilities" and "--Government
Regulation and Current Industry Litigation."
INTELLECTUAL PROPERTY
The Company regards its technology as proprietary and attempts to protect it
with copyrights, trademarks, trade secret laws, restrictions on disclosure and
other methods. There can be no assurance these methods will be sufficient to
protect the Company's technology. The Company also generally enters into
confidentiality or license agreements with its employees and consultants, and
generally controls access to and distribution of its documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's products,
services or technology without authorization, or to develop similar technology
independently. Currently the Company has five patent applications and intends
to prepare additional applications and to seek patent protection for its
systems and services to the extent possible. There is no assurance that the
Company will obtain any issued patents or that any such patents would protect
the Company's intellectual property from competition which could seek to
design around or invalidate such patents. In addition, effective patent,
copyright, trademark and trade secret protection may be unavailable or limited
in certain foreign countries, and the global nature of the Internet makes it
virtually impossible to control the ultimate destination of the Company's
proprietary information. There can be no assurance that the steps taken by the
Company will prevent misappropriation or infringement of its technology. In
addition, litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, prospects,
operating results and financial condition.
EMPLOYEES
As of December 15, 1998, the Company had 332 employees (excluding temporary
personnel and consultants), employed in engineering, sales, marketing,
customer support and related activities, and general and administrative
functions. None of the Company's employees is represented by a labor union,
and the Company considers its relations with its employees to be good. The
Company's ability to achieve its financial and operational objectives depends
in large part upon the continued service of its senior management and key
technical, sales, marketing and managerial personnel, and its continuing
ability to attract and retain highly qualified technical, sales, marketing and
managerial personnel. Competition for such qualified personnel is intense,
particularly in software development, network engineering and product
management.
BOARD OF ADVISORS
The Company maintains a Board of Advisors and conducts meetings of this
advisory group for two days each quarter. The Board of Advisors gives the
Company guidance on issues such as developments in communications equipment
technology, network design strategy, regulatory matters, the competitive
landscape, marketing of the Company's services, identification of potential
employees, financial strategy, and introductions to potential strategic
partners and alliances. The Board of Advisors serves in an advisory capacity
and does not have any managerial control over the Company. Below is a list of
the Company's Board of Advisors as of December 15, 1998 and their backgrounds.
ROBERT BERGER is a founder of InterNex Information Services, an ISDN and
high bandwidth services-focused ISP in California.
DUNCAN DAVIDSON is a founder of the Company and is currently Senior Vice
President of InterTrust Technologies Corporation, a leading provider of trust
management systems for electronic commerce and digital rights management. He
previously served as Managing Partner of Regis McKenna's consulting company.
52
<PAGE>
DAVE FARBER is a chaired telecommunications professor at the University of
Pennsylvania and currently serves as a member of the Presidential Advisory
Committee on Information Technology (PACIT).
ROBERT HAWK is a member of the Company's Board of Directors. For a
description of his professional background, see "Management--Directors and
Executive Officers."
WILLIAM LANE is the former Chief Financial Officer at Intuit Inc. and is a
board member of MetaCreations Corporation, Quarterdeck Corporation, Expert
Software Inc., Storm Technology Inc. and several private companies.
DANIEL LYNCH is a member of the Company's Board of Directors. For a
description of his professional background, see "Management--Directors and
Executive Officers."
FRANK MARSHALL is a member of the Company's Board of Directors. For a
description of his professional background, see "Management--Directors and
Executive Officers."
KIM MAXWELL is the former Chairperson of the ADSL Forum and founder of Racal
Vadic and Amati.
SHARON NELSON is the former Chairperson of the Washington State Public
Utilities Commission.
DAVID PISCITELLO is the President of Core Competence, Inc., program chairman
for U.S. (domestic) Networld and Interop Conferences, and co-producer of the
Internet Security Conference.
DAVID STROM is the president of David Strom, Inc. and was the founding
editor-in-chief of Network Computing Magazine.
FACILITIES
The Company is headquartered in Santa Clara, California in facilities
consisting of approximately 62,000 square feet pursuant to a lease that will
expire on or before July 14, 2002. The Company also leases office space in
each of its Initial Regions. The Company is in the process of acquiring office
space for regional headquarters for each of its additional target regions. In
addition, the Company's San Francisco Bay Area RDC consists of approximately
2,000 square feet and is located in San Jose, California, which the Company
occupies under a ten-year lease with two five-year renewal options. Currently,
and until a permanent location is secured, the Company utilizes a portion of
the San Francisco Bay Area RDC space to operate its NOC. The Company also
leases collocation space in COs from the ILEC in each region that it operates
or plans to operate under the terms of its interconnection agreements and
obligations imposed by state public utilities commissions and the FCC. While
the terms of these leases are perpetual, the productive use of the Company's
collocation facilities are subject to the terms of its interconnection
agreements which expire on or before March 2001. The Company will increase its
collocation space as it expands its network in the San Francisco Bay Area and
other regions.
LEGAL PROCEEDINGS
The Company is engaged in a variety of negotiations, arbitrations and
regulatory and court proceedings with multiple ILECs. These negotiations,
arbitrations and proceedings concern the ILECs' denial of physical collocation
space to the Company in certain COs, the cost and delivery of collocation
spaces, the delivery of transmission facilities and telephone lines, billing
issues and other operational issues. For example, the Company is currently
involved in commercial arbitration proceedings with Pacific Bell and U S WEST
Communications over these issues. The Company has also filed a lawsuit against
Pacific Bell in the Federal District Court in the Northern District of
California. The Company is pursuing a variety of contract, tort, antitrust and
other claims, such as violations of the Telecommunications Act in these
proceedings. In November, 1998, the Company prevailed in its commercial
arbitration proceeding against Pacific Bell. The arbitration panel has found
that Pacific Bell has breached its interconnection agreement with Covad and
has failed to act in good faith on multiple
53
<PAGE>
counts. The arbitration panel has ruled in favor of awarding Covad direct
damages, as well as attorneys fees and costs of the arbitration. Failure to
resolve the various legal disputes and controversies between the Company and
the various ILECs without excessive delay and cost and in a manner that is
favorable to the Company could have a material adverse effect on the Company's
business, prospects, operating results and financial condition. In addition,
on August 28, 1998, U S WEST Communications sued the Company and one of its
employees and sought a preliminary injunction in federal court in connection
with such employee's departure from U S WEST Communications to join the
Company. U S WEST Communications has sought to enjoin and obtain other
remedies, including damages for, the potential improper disclosure of U S WEST
Communications' alleged trade secrets to the Company. The Company is not
currently engaged in any other legal proceedings that it believes could have a
material adverse effect on the Company's business, prospects, operating
results and financial condition. The Company is, however, subject to state
commission, FCC and court decisions as they relate to the interpretation and
implementation of the 1996 Act, the interpretation of CLEC interconnection
agreements in general and the Company's interconnection agreements in
particular. In some cases, the Company may be deemed to be bound by the
results of ongoing proceedings of these bodies or the legal outcomes of other
contested interconnection agreements that are similar to the Company's
agreements. The results of any of these proceedings could have a material
adverse effect on the Company's business, prospects, operating results and
financial condition.
54
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below are the names, ages, and positions of the directors and
executive officers of the Company. All directors hold office until their
successors are duly elected and qualified and all executive officers hold
office at the pleasure of the Board of Directors.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Charles McMinn.......... 46 Chairman, Board of Directors
Robert Knowling, Jr. ... 43 President, Chief Executive Officer and Director
Timothy Laehy........... 42 Chief Financial Officer, Treasurer and Vice President, Finance
Rex Cardinale........... 46 Vice President, Engineering
Charles Haas............ 39 Vice President, Sales
Catherine Hemmer........ 40 Vice President, Operations
Dhruv Khanna............ 39 Vice President, General Counsel and Secretary
Walter Pienkos.......... 52 Vice President, Administration
Robert Roblin........... 46 Vice President, Marketing
Robert Hawk............. 59 Director
Henry Kressel........... 65 Director
Joseph Landy............ 37 Director
Daniel Lynch............ 57 Director
Frank Marshall.......... 51 Director
Rich Shapero............ 50 Director
</TABLE>
CHARLES MCMINN is a founder of the Company and has been the Chairman of the
Board of Directors since July 1998. He served as the Company's President,
Chief Executive Officer and a member of its Board of Directors from October
1996 to July 1998. Mr. McMinn has over 20 years of experience in creating,
financing, operating and advising high technology companies. From July 1995 to
October 1996, and from August 1993 to June 1994, Mr. McMinn managed his own
consulting firm, Cefac Consulting, which focused on strategic development for
information technology and communications businesses. From June 1994 to
November 1995, he served as Principal, Strategy Discipline, at Gemini
Consulting. From August 1992 to June 1993, he served as President and Chief
Executive Officer of Visioneer Communications, Inc. and from October 1985 to
June 1992 was a general partner at InterWest Partners, a venture capital firm.
Mr. McMinn began his Silicon Valley career as the product manager for the 8086
microprocessor at Intel.
ROBERT KNOWLING, JR. has served as the Company's President, Chief Executive
Officer and a member of the Company's Board of Directors since July 1998. From
October 1997 through July 1998, Mr. Knowling served as the Executive Vice
President of Operations and Technologies at U S WEST Communications, Inc., an
RBOC. In this capacity, Mr. Knowling was responsible for planning, delivering
and maintaining high-quality telecommunications services for more than 25
million customers in 14 western and midwestern states. From March 1996 through
September 1997, he served as Vice President of Network Operations at U S WEST
Communications, Inc. From November 1994 through March 1996, he served as Vice
President of Network Operations for Ameritech Corporation. Mr. Knowling began
his career in 1977 at Indiana Bell and progressed through a variety of
assignments in operations, engineering and marketing. When Indiana Bell became
a part of Ameritech Corporation, Mr. Knowling assumed positions of increasing
responsibility in marketing, product development, large business marketing and
network operations, including service on Ameritech Corporation's re-
engineering breakthrough development team, through November 1994. As lead
architect of the Ameritech
55
<PAGE>
Corporation transformation, Mr. Knowling reported directly to the chairman.
Mr. Knowling currently serves on the board of directors of Shell Oil Company.
TIMOTHY LAEHY joined the Company in August 1997 as its Chief Financial
Officer, Treasurer and Vice President, Finance. Prior to joining the Company,
Mr. Laehy served as Vice President, Corporate Finance and Treasurer of Leasing
Solutions, Inc., a computer equipment leasing company, from February 1991 to
August 1997. From 1990 through 1991, Mr. Laehy served as senior associate at
Recovery Equity Partners, a private venture capital investment fund. From 1985
through 1990, he served in various capacities at Guarantee Acceptance Capital
Corporation, an investment bank, Liberty Mutual Insurance Company and Union
Carbide Corporation.
REX CARDINALE has served as the Company's Vice President, Engineering since
June 1997. From February 1996 to March 1997, Mr. Cardinale served as Chief
Executive Officer and Vice President, Engineering at GlobalCenter Inc., an
Internet service provider for small businesses. From January 1994 to February
1996, Mr. Cardinale served as Vice President and General Manager, Internet
Services Division, at Global Village Communication. From June 1992 to
September 1993, Mr. Cardinale was Vice President and General Manager of the
cc:Mail division of Lotus Development Corporation. Prior to that time, he
served for five years as Vice President, Engineering for Ultra Network
Technologies, a provider of high-speed networking systems for supercomputers
and for ten years in various engineering management roles at Rolm Corporation.
CHARLES HAAS is a founder of the Company. He served as the Company's Vice
President, Sales and Marketing from May 1997 until November 1998 and has
served as Vice President, Sales since that date. Mr. Haas has over fourteen
years of sales and business development experience with Intel where he held
various positions from July 1982 to April 1997. At Intel, Mr. Haas served as
manager of corporate business development, focusing on opportunities in the
broadband computer communications area, and played a principal role in the
development of the Company's Residential Broadband strategy for telephone and
satellite companies (DSL, Fiber-to-the-Curb and satellite modems).
CATHERINE HEMMER joined the Company in August 1998 as its Vice President,
Operations. From 1996 to August 1998, she was Vice President, Network
Reliability and Operations at U S WEST Communications, Inc., an RBOC. From
1995 to 1996, she served as General Manager, Network provisioning at Ameritech
Services, Inc. a telecommunications company. From 1987 to 1995, she served in
various capacities, including Vice President, Network Services, at MFS
Telecom, Inc., a company responsible for establishing a new competitive
industry in telecommunications. From 1987 to 1988, she served as Senior
Manager, Management Information Systems at Chicago Fiber Optic Corporation
d/b/a Metropolitan Fiber Systems of Chicago, Inc., a start-up venture
developing a market niche for fiber optic local access networks.
DHRUV KHANNA is a founder of the Company and has served as the Company's
Vice President, General Counsel and Secretary since October 1996. He was an
in-house counsel for Intel's communications products division and its Senior
Telecommunications Attorney between 1993 and 1996. Between 1987 and 1993,
Mr. Khanna was an associate at Morrison & Foerster where his clients included
Teleport Communications Group (now AT&T), McCaw Cellular Communications, Inc.
(now AT&T Wireless), and Southern Pacific Telecom (now Qwest). Mr. Khanna has
extensive experience with regulatory matters and business transactions
involving the RBOCs and other telecommunications companies. While at Intel, he
helped shape the computer industry's positions on the Telecommunications Act
of 1996 and the FCC's rules implementing the 1996 Act.
WALTER S. PIENKOS has served as the Company's Vice President, Administration
since May 1998. Prior to joining the Company, Mr. Pienkos was the Vice
President of Administration and a founder of NetPower, a Windows NT
workstation and server manufacturer, from February 1993 to May 1998. From 1987
through 1992, he served as Vice President of Administration at MIPS Computer
Systems. Prior to that time, he spent 15 years at Hewlett Packard in a variety
of management positions, most recently as Hewlett Packard's Corporate
Personnel Manager.
ROBERT ROBLIN has served as Vice President, Marketing at the Company since
November 1998. Prior to joining the Company, he was Executive Vice President
of Marketing at Adobe Systems, Inc. from 1996 to November 1998. From 1994 to
1996, Mr. Roblin served as Vice President and General Manager of Marketing of
56
<PAGE>
the Consumer Division of IBM Corporation. Between 1992 and 1994, Mr. Roblin
was the Vice President of Marketing of Pensoft, a start-up pen-based software
company that produced a database-driven personal information manager.
ROBERT HAWK has served as a member of the Company's Board of Directors since
April 1998. Mr. Hawk is President of Hawk Communications and recently retired
as President and Chief Executive Officer of U S WEST Multimedia
Communications, Inc., where he headed the cable, data and telephony
communications business from May 1996 to April 1997. He was president of the
Carrier Division of U S West Communications, a regional telecommunications
service provider, from September 1990 to May 1996. Prior to that time, Mr.
Hawk was Vice President of Marketing and Strategic Planning for CXC
Corporation. Prior to joining CXC Corporation, Mr. Hawk was director of
Advanced Systems Development for AT&T/American Bell. He currently serves on
the boards of Xylan Corporation, PairGain Technologies, Inc., Premisys
Communications, Concord Communications and Radcom.
HENRY KRESSEL has served as a member of the Company's Board of Directors
since July 1997. Dr. Kressel has been with E.M. Warburg, Pincus & Co., LLC
since 1983 and is currently a managing director of the firm. He is also a
partner of Warburg, Pincus & Co., the general partner of Warburg, Pincus
Investors, L.P. Prior to that time, he served as Staff Vice President of the
RCA Corporation responsible for research and development of optoelectronics,
semiconductors and related software and technologies. Dr. Kressel serves as a
director of Earthweb, Inc., Level One Communications, Inc., IA Corporation,
NOVA Corporation, Inc. and several privately held companies.
JOSEPH LANDY has served as a member of the Company's Board of Directors
since July 1997. Mr. Landy has been with E.M. Warburg, Pincus & Co., LLC since
1985 and is currently a managing director and a partner of the firm.
Throughout his career at E.M. Warburg, Pincus & Co., LLC, Mr. Landy has
focused primarily on investments in information technology and specialty
semiconductors. Mr. Landy is a director of four publicly traded companies
including CN Biosciences, Inc., Indus International, Inc., Level One
Communications, Inc. and NOVA Corporation, and of several privately held
companies.
DANIEL LYNCH has served as a member of the Company's Board of Directors
since April 1997. Mr. Lynch is also a founder of CyberCash, Inc. and has
served as chairman of its board of directors since August 1994. From December
1990 to December 1995, he served as Chairman of the Board of Directors of
Softbank Forums, a provider of education and conference services for the
information technology industry. Mr. Lynch founded Interop Company in 1986,
which is now a division of ZD Comdex and Forums. Mr. Lynch is a member of the
Association for Computing Machinery and the Internet Society. He is also a
member of the Board of Trustees of the Santa Fe Institute, the Bionomics
Institute and CommerceNet. He previously served as Director of the Information
Processing Division for the Information Sciences Institute in Marina del Rey,
where he led the Arpanet team that made the transition from the original NCP
protocols to the current TCP/IP based protocols. He has served as a director
of Exodus Communications since January 1998. Mr. Lynch previously served as a
member of the board of directors at UUNET Technologies from April 1994 until
August 1996.
FRANK MARSHALL has served as a member of the Company's Board of Directors
since October 1997. Mr. Marshall currently serves on the board of directors of
PMC-Sierra Inc. and several private companies. Mr. Marshall also serves on the
technical advisory board of several high technology private companies. He is a
member of the InterWest Partners Advisory Committee and a Venture Partner at
Sequoia Capital. From 1992 to 1997, Mr. Marshall served as Vice President of
Engineering and Vice President and General Manager, Core Business Unit of
Cisco Systems Inc. From 1982 to 1992, he served as Senior Vice President,
Engineering at Convex Computer Corporation.
RICH SHAPERO has served as a member of the Company's Board of Directors
since July 1997. Mr. Shapero has been a general partner of Crosspoint Venture
Partners, L.P., a venture capital investment firm, since April 1993. From
January 1991 to June 1992, he served as Chief Operating Officer of Shiva
Corporation, a computer network company. Previously, he was a Vice President
of Sun Microsystems, Senior Director of Marketing at
AST, and held marketing and sales positions at Informatics General Corporation
and UNIVAC's Communications Division. Mr. Shapero serves as a member of the
board of directors of Powerwave Corporation.
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<PAGE>
CLASSIFIED BOARD
Effective upon the closing of this offering, the Board will be divided into
three classes, with the term of office of the first class (which will consist
of Messrs. Lynch and Shapero) to expire at the first annual meeting of
stockholders after this offering; the term of office of the second class
(which will consist of Dr. Kressel and Messrs. Marshall and McMinn) to expire
at the second annual meeting of stockholders after this offering; the term of
office of the third class (which will consist of Messrs. Hawk, Knowling and
Landy) to expire at the third annual meeting of stockholders after this
offering. Thereafter, each such term will expire at each third succeeding
annual meeting of stockholders held after such meeting. See "Description of
Capital Stock--Antitakeover Effects of Certain Provisions of Covad's Charter,
Bylaws and Delaware Law."
BOARD COMMITTEES
In April 1998, the Board established an Audit Committee and a Compensation
Committee. The Audit Committee consists of Messrs. Landy and Lynch, both of
whom are outside directors of the Company. The Audit Committee recommends
engagement of the Company's independent auditors and approves the services
performed by such auditors and reviews and evaluates the Company's accounting
policies and its systems of internal accounting controls. The Compensation
Committee consists of Dr. Kressel and Mr. Shapero, both of whom are outside
directors of the Company. The Compensation Committee makes recommendations to
the Board of Directors in connection with matters of compensation, including
determining the compensation of the Company's executive officers.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Board or the Compensation
Committee and the board of directors or compensation committee of any other
company, nor has any such interlocking relationship existed in the past. Dr.
Kressel and Mr. Shapero are affiliated with Warburg, Pincus Ventures, L.P. and
Crosspoint Venture Partners L.P., respectively, which are parties along with
the Company to a Series C Preferred Stock and Warrant Subscription Agreement
dated February 23, 1998. See "Certain Relationships and Related Transactions."
DIRECTOR COMPENSATION
Except for grants of stock options subject to vesting and restricted stock
subject to repurchase, directors of the Company generally do not receive
compensation for services provided as a director or committee member. The
Company does not pay additional amounts for committee participation or special
assignment of the Board of Directors, except for reimbursement of their
expenses in attending Board and committee meetings.
58
<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning compensation
during the years ended December 31, 1997 and 1998 of each person who served as
the Company's Chief Executive Officer or one of the four other most highly
compensated executive officers (collectively, the "Named Executive Officers")
during the year ended December 31, 1998.
<TABLE>
<CAPTION>
ANNUAL LONG-TERM
COMPENSATION COMPENSATION
-------------------- ---------------------
NAME AND PRINCIPAL SECURITIES UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS OPTIONS/SARS COMPENSATION(1)
- ------------------ ---- -------- -------- --------------------- ---------------
<S> <C> <C> <C> <C> <C>
Charles McMinn,
Chairman, Board of
Directors(2)........... 1998 $167,019 $ 15,764 -- 820
1997 87,500(3) -- -- $203.00
Robert Knowling, Jr.,
President and Chief
Executive Officer(4)... 1998 $180,768 $750,000 2,100,000 540
1997 -- -- -- --
Rex Cardinale, Vice
President, Engineering. 1998 $144,451 $ 15,764 -- 796
1997 73,233(3) -- -- --
Charles Haas, Vice
President, Sales....... 1998 $133,615 $ 15,962 -- 701
1997 70,000(3) -- -- --
Dhruv Khanna, Vice
President, General
Counsel and Secretary.. 1998 $133,615 $ 15,943 -- 701
1997 70,000(3) -- -- --
Timothy Laehy, Chief
Financial Officer,
Treasurer and
Vice President,
Finance................ 1998 $129,327 $ 16,189 -- 678
1997 45,000(3) -- -- --
</TABLE>
- --------
(1) The dollar amount in this column represents premium payments made by the
Company with respect to life insurance policies.
(2) Mr. McMinn stepped down as President and Chief Executive Officer in July
1998 and assumed the position of Chairman of the Board.
(3) Based on annual salaries of $150,000 and $140,000 for Messrs. McMinn and
Cardinale, respectively, and $120,000 for Messrs. Haas, Khanna and Laehy.
(4) Mr. Knowling assumed the offices of President and Chief Executive Officer
in July 1998.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
during the fiscal year ended December 31, 1998 to Robert Knowling, Jr.,
President and Chief Executive Officer of the Company. Stock options were not
granted to any other Named Executive Officer during the fiscal year ended
December 31, 1998.
OPTION GRANTS IN FISCAL 1998
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES
OF STOCK PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS(1) OPTION TERM ($)(3)
--------------------------------------------------- ---------------------
NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS GRANTED EXERCISE
UNDERLYING TO EMPLOYEES IN PRICE PER
OPTIONS FISCAL 1998 SHARE EXPIRATION
NAME GRANTED(#)(1) (%)(2) ($) DATE 5% 10%
---- ------------- ---------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Robert Knowling, Jr..... 2,100,000 22.78% $1.00 7/7/2006 $1,002,656 $2,401,530
</TABLE>
- --------
(1) Such options become exercisable over a four-year period, with 12.5% of the
shares subject to such options vesting on the six month anniversary of the
grant date and the remainder vesting in 42 equal monthly
59
<PAGE>
installments. All such options have a term of eight years, subject to
earlier termination in certain situations related to termination of
employment. See "1997 Stock Plan."
(2) Based on an aggregate of 9,220,228 options to purchase Common Stock of the
Company granted during the fiscal year ended December 31, 1998 under the
Company's 1997 Stock Plan.
(3) Potential realizable values are net of exercise price, but before taxes
associated with exercise. Amounts represent hypothetical gains that could
be achieved for the options if exercised at the end of the option term.
The assumed 5% and 10% rates of stock price appreciation are provided in
accordance with the rules of the Securities and Exchange Commission and do
not represent the Company's estimate or projection of the future Common
Stock price.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES
The following table sets forth the number and value of shares of Common
Stock underlying the unexercised options held by Robert Knowling, Jr.,
President and Chief Executive Officer of the Company. As of the fiscal year
ended December 31, 1998, no stock options have been granted to any other Named
Executive Officer.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY OPTIONS
UNEXERCISED OPTIONS AT AT DECEMBER 31,
DECEMBER 31, 1998 1998(1)
------------------------- ---------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISED UNEXERCISED
- ---- ----------- ------------- --------- -----------
<S> <C> <C> <C> <C>
Robert Knowling, Jr. ........... -- 2,100,000
</TABLE>
- --------
(1) Calculated on the basis of the fair market value of the Company's Common
Stock as of December 31, 1998 ( ), as determined by the Company's Board
of Directors, less the aggregate exercise price.
EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS
The Company has entered into a written employment agreement with Robert
Knowling, Jr., the Company's Chief Executive Officer (the "Knowling Employment
Agreement"). The employment commencement date for Mr. Knowling was July 7,
1998. Pursuant to the Knowling Employment Agreement, Mr. Knowling receives
compensation in the form of an annual base salary of $400,000 and an annual
minimum bonus of $250,000. Mr. Knowling received (i) a signing bonus of
$1,500,000, one half of which was paid on commencement of employment, and the
remaining half of which will be paid on the earlier of the one year
anniversary of employment or a change of control (as defined in the Knowling
Employment Agreement), and (ii) stock options to purchase 2,100,000 shares of
Common Stock at an exercise price of $1.00 per share. If the Company
terminates Mr. Knowling's employment relationship without Cause (as such term
is defined in the Knowling Employment Agreement), or if Mr. Knowling resigns
for Good Reason (as such term is defined in the Knowling Employment
Agreement), the Company must continue to pay Mr. Knowling's annual base salary
and targeted bonus for a period of two years after the date of termination;
provided Mr. Knowling does not become employed by a direct competitor of the
Company. During the term of his employment, Mr. Knowling agrees to be bound by
customary confidentiality provisions. Pursuant to the Knowling Employment
Agreement, in August 1998 the Company loaned Mr. Knowling $500,000 pursuant to
a secured promissory note that bears no interest during his employment, has
provisions for forgiveness based on continued employment and matures in four
years, subject to acceleration in certain events. See "Certain Relationships
and Related Transactions--Employee Loans."
The Company has entered into written employment agreements with Dhruv Khanna
and Rex Cardinale (the "Employees") whereby the Company has agreed to hire
each Employee for a two-year term. Pursuant to the employment agreements,
Messrs. Khanna and Cardinale currently receive compensation in the form of
annual base salaries of $160,000 and $160,000, respectively and bonuses to be
determined by the Board of Directors or the Compensation Committee. The
employment commencement date for both Messrs. Khanna and Cardinale was July
15, 1997. During the two-year term, the Employee can only be terminated for
cause (as defined in the agreement), at which time the Employee is only
eligible for benefits in accordance with the Company's established policies.
After the two-year term, either the Employee or the Company may terminate the
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<PAGE>
employment relationship with or without cause. If the Company terminates the
Employee's employment relationship without cause, the Company must continue to
pay to the Employee such salary and benefits as he received immediately before
termination for a period of six months after the date of termination. Under
the employment agreements, the Employees agree, during the terms of their
employment with the Company, not to (i) open or operate a business which is
then in competition with the Company, (ii) act as an employee, agent, advisor
or consultant of any then existing competitor of the Company, or (iii) take
any action to divert business from the Company or influence any existing
customer of the Company to cease doing business with the Company or to alter
its then existing business relationship with the Company.
With respect to all options granted under the Company's 1997 Stock Plan, in
the event of a merger of the Company with or into another corporation
resulting in a change of control involving a shift in 50% or more of the
voting power of the Company, or the sale of all or substantially all of the
assets of the Company, the options will fully vest and become exercisable one
year after the change of control or earlier in the event the individual is
constructively terminated or terminated without cause or in the event the
successor corporation refuses to assume the options. See "--1997 Stock Plan."
The Company has also entered into restricted stock purchase agreements with
certain officers and directors of the Company. The Common Stock issued
pursuant to the restricted stock purchase agreements are subject to a
repurchase right on the part of the Company that is subject to vesting. The
agreements include similar provisions to the stock options, providing for
accelerated vesting in the event of a change of control. See "Certain
Relationships and Related Transactions--Issuance of Common Stock."
1997 STOCK PLAN
The Company's 1997 Stock Plan (the "1997 Stock Plan") was adopted by the
Board of Directors and the stockholders in July 1997 and was amended in
January 1998, April 1998, August 1998 and December 1998. The number of shares
of Common Stock which are currently available for the grant of options and
sale under the 1997 Stock Plan is 16,196,727 shares, plus an annual increase
to be added on January 1 of each year beginning in 1999, equal to the lesser
of (i) 3% of the outstanding shares on such date or (ii) an amount determined
by the Board. The annual increase is subject to adjustment upon changes in
capitalization of the Company. The 1997 Stock Plan provides for the granting
to employees (including officers and directors) of qualified "incentive stock
options" within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended (the "Code"), and for the granting to employees (including
officers and directors) and consultants of nonqualified stock options. The
1997 Stock Plan also provides for the granting of stock purchase rights
("SPRs"). As of December 16, 1998, options to purchase an aggregate of
12,634,172 shares were outstanding and 3,404,787 shares remained available for
future grants.
The 1997 Stock Plan is administered by the Board of Directors or a committee
appointed by the Board of Directors. The administrator of the 1997 Stock Plan
has the power to determine the terms of the options or SPRs granted, including
the exercise price of the option or SPR, the number of shares subject to each
option or SPR, the exercisability thereof, and the form of consideration
payable upon such exercise. In addition, the administrator has the authority
to amend, suspend or terminate the 1997 Stock Plan, provided that no such
action may affect any share of Company Common Stock previously issued and sold
or any option previously granted under the 1997 Stock Plan. The Company may
grant each optionee a maximum of 2,000,000 shares covered by option during a
fiscal year. The Company may grant up to an additional 2,000,000 shares
covered by option in connection with an optionee's initial employment with the
Company. Options generally vest at a rate of 12.5% of the shares subject to
the option on the date six months following the grant date and 1/48th of the
shares subject to the option at the end of each one-month period thereafter
and generally expire eight years from the date of grant.
Options and SPRs granted under the 1997 Stock Plan generally are not
transferable by the optionee, and each option and SPR is exercisable during
the lifetime of the optionee only by such optionee. Options granted under the
1997 Stock Plan generally must be exercised within thirty days after the end
of optionee's status as an
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<PAGE>
employee, director or consultant of the Company, or within twelve months after
such optionee's termination by death or disability, but in no event later than
the expiration of the option's term.
In the case of SPRs, unless the administrator determines otherwise,
Restricted Stock Purchase Agreements must grant the Company a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's employment or consulting relationship with the Company for any
reason (including death or disability). The purchase price for shares
repurchased pursuant to Restricted Stock Purchase Agreements will be the
original price paid by the purchaser and may be paid by cancellation of any
indebtedness of the purchaser to the Company. Repurchase options lapse at a
rate determined by the administrator.
The exercise price of all incentive stock options granted under the 1997
Stock Plan must be at least equal to the fair market value of the Common Stock
on the date of grant. The exercise price of nonstatutory stock options and
SPRs granted under the 1997 Stock Plan is determined by the Administrator, but
with respect to nonstatutory stock options intended to qualify as
"performance-based compensation" within the meaning of Section 162(m) of the
Code, the exercise price must be at least equal to the fair market value of
the Common Stock on the date of grant. With respect to any participant who
owns stock possessing more than 10% of the voting power of all classes of the
Company's outstanding capital stock, the exercise price of any incentive stock
option granted must be at least equal to 110% of the fair market value on the
grant date and the term of such incentive stock option must not exceed five
years. The term of all other options granted under the 1997 Stock Plan may not
exceed ten years.
All stock options and restricted stock grants to officers, employees,
directors and consultants provide that in the event of a merger of the Company
with or into another corporation resulting in a change of control involving a
shift in 50% or more of the voting power of the Company, or the sale of all or
substantially all of the assets of the Company, the options will fully vest
and become exercisable one year after the change of control or earlier in the
event the individual is constructively terminated or terminated without cause
or in the event that the successor corporation refuses to assume or substitute
the options.
1998 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1998 Employee Stock Purchase Plan (the "1998 Purchase Plan")
was adopted by the Board of Directors in December 1998, and approved by the
stockholders in December 1998. A total of 1,000,000 shares of Common Stock has
been reserved for issuance under the 1998 Purchase Plan, plus annual increases
equal to the lesser of (i) 2% of the outstanding shares on such date or (ii)
an amount determined by the Board. As of the date of this Prospectus, no
shares have been issued under the 1998 Purchase Plan.
The 1998 Purchase Plan, which is intended to qualify under Section 423 of
the Code, contains consecutive, overlapping, twenty-four month offering
periods. Each offering period includes four six-month purchase periods. The
offering periods generally start on the first trading day on or after May 1
and November 1 of each year, except for the first such offering period which
commences on the first trading day on or after the effective date of this
Offering and ends on the last trading day on or before October 31, 2000.
Employees are eligible to participate if they are customarily employed by
the Company or any participating subsidiary for at least 20 hours per week and
more than five months in any calendar year. However, no employee may be
granted an option under the 1998 Purchase Plan (i) to the extent that,
immediately after the grant, the employee would own stock possessing 5% or
more of the total combined voting power or value of all classes of the capital
stock of the Company, or (ii) to the extent that his or her rights to purchase
stock under all employee stock purchase plans of the Company accrues at a rate
which exceeds $25,000 worth of stock for each calendar year. The 1998 Purchase
Plan permits participants to purchase Common Stock through payroll deductions
of up to 12% of the participant's "compensation." Compensation is defined as
the participant's base straight time
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<PAGE>
gross earnings and commissions but excludes payments for overtime, shift
premium, incentive compensation, incentive payments, bonuses and other
compensation. The maximum number of shares a participant may purchase during a
single purchase period is 5,000 shares.
Amounts deducted and accumulated by the participant are used to purchase
shares of Common Stock at the end of each purchase period. The price of stock
purchased under the 1998 Purchase Plan is generally 85% of the lower of the
fair market value of the Common Stock (i) at the beginning of the offering
period or (ii) at the end of the purchase period. In the event the fair market
value at the end of a purchase period is less than the fair market value at
the beginning of the offering period, the participants will be withdrawn from
the current offering period following exercise and automatically re-enrolled
in a new offering period. The new offering period will use the lower fair
market value as of the first date of the new offering period to determine the
purchase price for future purchase periods. Participants may end their
participation at any time during an offering period, and they will be paid
their payroll deductions to date. Participation ends automatically upon
termination of employment with the Company.
Rights granted under the 1998 Purchase Plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the 1998 Purchase Plan. The 1998 Purchase Plan
provides that, in the event of a merger of the Company with or into another
corporation or a sale of substantially all of the Company's assets, each
outstanding option may be assumed or substituted for by the successor
corporation. If the successor corporation refuses to assume or substitute for
the outstanding options, the offering period then in progress will be
shortened and a new exercise date will be set.
The Board of Directors has the authority to amend or terminate the 1998
Purchase Plan, except that no such action may adversely affect any outstanding
rights to purchase stock under the 1998 Purchase Plan, provided that the Board
of Directors may terminate an offering period on any exercise date if the
Board determines that the termination of the 1998 Purchase Plan is in the best
interests of the Company and its stockholders. Notwithstanding anything to the
contrary, the Board of Directors may in its sole discretion amend the 1998
Purchase Plan to the extent necessary and desirable to avoid unfavorable
financial accounting consequences by altering the purchase price for any
offering period, shortening any offering period or allocating remaining shares
among the participants. Unless sooner terminated by the Board of Directors,
the 1998 Purchase Plan will terminate automatically ten years from the
effective date of this Offering.
MANAGEMENT BONUS PLAN
On July 22, 1998, the Company's Board approved its Executive Bonus
Performance Plan. Under the Plan, each officer of the Company receives a cash
bonus up to a designated percentage of their annual base salary depending upon
the extent to which specific performance metrics are achieved.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
The Company's Amended and Restated Certificate of Incorporation limits the
liability of directors to the maximum extent permitted by Delaware law, and
the Company's Bylaws provide that the Company shall indemnify its directors
and officers and may indemnify its other employees and agents to the fullest
extent permitted by law. The Company has also entered into agreements to
indemnify its directors and executive officers, in addition to the
indemnification provided for in the Company's Bylaws. The Company believes
that these provisions and agreements are necessary to attract and retain
qualified directors and executive officers. At present, there is no pending
litigation or proceeding involving any director, officer, employee or agent of
the Company in which indemnification will be required or permitted. The
Company is not aware of any threatened litigation or proceeding that might
result in a claim for such indemnification. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers or persons controlling the Company pursuant to the foregoing
provisions, the Company has been informed that, in the opinion of the SEC,
such indemnification is against public policy as expressed in the Securities
Act and is therefore unenforceable.
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SERIES C PREFERRED STOCK AND WARRANT SUBSCRIPTION AGREEMENT
On February 20, 1998, the Company entered into a Series C Preferred Stock
and Warrant Subscription Agreement (the "Subscription Agreement") with Warburg
Pincus Ventures, L.P. ("Warburg") and Crosspoint Venture Partners 1996
("Crosspoint") pursuant to which Warburg and Crosspoint unconditionally agreed
to purchase an aggregate of 5,764,143 shares of Series C Preferred Stock and
warrants to purchase an aggregate of 4,729,500 shares of Series C Preferred
Stock (the "Series C Warrants") for an aggregate purchase price of
$16.0 million at a date to be determined by the Company but no later than
March 11, 1999. The Company has agreed either to call this commitment or to
complete an alternate equity financing of at least $16.0 million by March 11,
1999. A proposed alternate equity financing providing for a price per share
greater than or equal to $2.7767 and securities that are pari passu (equal)
with, or more favorable to the Company than, the Series C Preferred Stock as
set forth in the Company's Amended Certificate of Incorporation (as currently
in effect) requires approval by the disinterested directors of the Company. A
proposed alternate equity financing providing for a price per share of less
than $2.7767 or securities whose terms are less favorable to the Company than
the Series C Preferred Stock requires unanimous approval by the Company's
entire Board of Directors. In consideration of this commitment, the Company
issued to Warburg and Crosspoint warrants to purchase an aggregate of
1,694,148 shares of the Company's Common Stock at a purchase price of $0.0033
per share (the "Common Warrants"). The parties have agreed that the offering
contemplated by this Prospectus constitutes an alternate equity financing;
therefore, the Company will not issue and sell the Series C Preferred Stock
and Series C Warrants to Warburg and Crosspoint. Messrs. Henry Kressel and
Joseph Landy, directors of the Company, are affiliated with Warburg, and Mr.
Shapero, also a director of the Company, is affiliated with Crosspoint.
On April 24, 1998, the Subscription Agreement was amended pursuant to an
Assignment and Assumption Agreement between the Company, Warburg, Crosspoint
and Mr. Hawk (the "Assignment and Assumption Agreement") whereby Warburg and
Crosspoint assigned to Mr. Hawk their obligation to purchase 36,015 shares of
Series C Preferred Stock and 29,559 Series C Warrants for an aggregate
purchase price of $100,001.65. On the same date, Mr. Hawk purchased 36,015
shares of Series C Preferred Stock at a price per share of $2.7767. As a
result of this amendment, the aggregate obligation of Warburg and Crosspoint
to purchase Series C Preferred Stock and Series C Warrants was reduced from
5,764,143 shares to 5,728,128 shares and from 4,729,500 shares to 4,699,941
shares, respectively, for an aggregate purchase price of $15.9 million,
reduced from $16.0 million. On the same date, the Amended and Restated
Stockholder Rights Agreement dated March 11, 1998 (the "Stockholder Rights
Agreement") was amended to add Mr. Hawk as a party.
The Common Warrants issued upon the signing of the Subscription Agreement
have five-year terms (but must be exercised prior to the closing of an initial
public offering of equity securities by the Company), have purchase prices of
$0.0033 per share, are immediately exercisable and contain net exercise
provisions.
On March 11, 1998, the Company amended the Stockholder Rights Agreement
among it and certain of its stockholders, including all of the holders of the
outstanding Preferred Stock, to extend the rights held by Warburg, Crosspoint
and Intel to the Common Warrants, the Series C Preferred Stock and the Series
C Warrants issued or issuable to Warburg, Crosspoint and Intel pursuant to the
Subscription Agreement.
THE INTEL STOCK PURCHASE
Pursuant to the Subscription Agreement, Intel purchased 360,144 shares of
Series C Preferred Stock and Series C Warrants to purchase an aggregate of
295,500 shares of Series C Preferred Stock for an aggregate purchase price of
$1,000,000 concurrently with the closing of the issuance of the Senior
Discount Notes; provided, that the Company does not have any obligation to
issue such Series C Warrants to Intel until such time as Warburg and
Crosspoint fund their respective commitments under the Subscription Agreement.
The parties have agreed that the offering contemplated by this Prospectus
constitutes an alternate equity financing; therefore the Company will not
issue the Series C Warrants to Intel. In connection with its agreement to
purchase such Series C Preferred Stock and Series C Warrants, the Company
issued to Intel Common Warrants to purchase an aggregate of 105,852 shares of
Common Stock at a purchase price of $0.0033 per share.
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<PAGE>
TRANSACTIONS IN CONNECTION WITH THE FORMATION OF THE DELAWARE HOLDING COMPANY
The Company originally was incorporated in California as Covad Communication
Company ("Covad California") in October 1996. In July 1997, the Company was
incorporated in Delaware as part of its strategy to operate through a holding
company structure and to conduct substantially all of its operations through
subsidiaries. To effect the holding company structure, in July 1997 the
Company entered into an Exchange Agreement (the "Exchange Agreement") with the
existing holders of the Common Stock and Series A Preferred Stock of Covad
California to acquire all of such stock in exchange for a like number of
shares of Common Stock and Preferred Stock in the Company, so that after
giving effect to the exchange Covad California became a wholly-owned
Subsidiary of the Company. In addition, the Company entered into an Assumption
Agreement pursuant to which the Company assumed certain outstanding
obligations of Covad California, including a $500,000 demand note issued to
Warburg and certain commitments to issue stock options to two consultants of
the Company.
In connection with the Exchange Agreement, Messrs. McMinn, Khanna and Haas,
officers of the Company, each exchanged 3,000,000 shares of Common Stock of
Covad California, originally purchased for $0.0042 per share, for a like
number of shares of Common Stock of the Company pursuant to restricted stock
purchase agreements. In addition, Mr. Lynch, a director of the Company,
exchanged 144,000 shares of Common Stock of Covad California, originally
purchased for $0.0333 per share, for a like number of shares of Common Stock
of the Company pursuant to a restricted stock purchase agreement. The Common
Stock issued to Messrs. McMinn, Khanna, Haas and Lynch are generally subject
to vesting over a period of four years. This vesting is subject to
acceleration upon a change of control involving a merger, sale of all or
substantially all of the assets of the Company or a shift in 50% or more of
the voting power of the Company. The Company's repurchase rights lapse one
year after the change of control or earlier in the event the individual is
constructively terminated or terminated without cause, or in the event the
successor corporation refuses to assume the agreements.
ISSUANCE OF COMMON STOCK
On July 15, 1997, the Company issued 1,125,000 shares of Common Stock to Mr.
Cardinale, an officer of the Company, for a purchase price of $0.0333 per
share. On August 30, 1997, the Company issued 345,000 shares of Common Stock
to Mr. Laehy, an officer of the Company, for $0.05 per share. On October 14,
1997, the Company issued 144,000 shares of Common Stock to Mr. Marshall, a
director of the Company, for a purchase price of $0.05 per share. On April 24,
1998, the Company issued 96,000 shares of Common Stock to Mr. Hawk, a director
of the Company, for a purchase price of $0.6667 per share. On August 28, 1998,
the Company issued 40,000 shares of Common Stock to Mr. Hawk for a purchase
price of $5.75 per share. The shares of Common Stock issued to Messrs.
Cardinale, Laehy, Marshall and Hawk were issued pursuant to restricted stock
purchase agreements which contain vesting and change of control provisions
similar to those contained in the above-described restricted stock purchase
agreements of Messrs. McMinn, Khanna, Haas and Lynch.
ISSUANCE OF SERIES A PREFERRED STOCK
On June 30, 1997 Covad California issued 150,000 shares of Series A
Preferred Stock, to each of Messrs. McMinn, Khanna and Haas and 300,000 shares
of Series A Preferred Stock to Mr. Lynch for a purchase price of $0.3333 per
share. In July 1997, these shares were exchanged for a like number of shares
of Series A Preferred Stock of the Company pursuant to the Exchange Agreement.
ISSUANCE OF SERIES B PREFERRED STOCK
In July 1997, the Company sold an aggregate of 17,000,001 shares of Series B
Preferred, of which 12,000,000 shares were sold to Warburg, 3,000,000 shares
were sold to Crosspoint and 2,000,001 shares were sold to Intel. The purchase
price of the Series B Preferred was $0.50 per share. A portion of the purchase
price of the Series B Preferred was paid by cancellation of a $500,000 demand
note issued to Warburg in June 1997. Messrs. Kressel and Landy, each of whom
currently serve as members of the Company's Board of Directors, are
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affiliated with Warburg. Mr. Shapero, who currently serves on the Company's
Board of Directors, is affiliated with Crosspoint. See "Management--Directors
and Executive Officers."
On February 12, 1998, the Company sold an additional 100,002 shares of
Series B Preferred at a purchase price of $1.00 per share to Mr. Marshall, a
director of the Company. For a description of the rights and preferences of
the Series B Preferred, see "Description of Capital Stock--Preferred Stock."
EQUIPMENT LEASE FINANCING
Through September 30, 1998, the Company has incurred a total of $860,000 of
equipment lease financing obligations (including principal and interest)
through a sale lease-back transaction with Charter Financial, Inc. ("Charter
Financial"). Through September 30, 1998, the Company has made total payments
of approximately $241,000 to Charter Financial on these obligations. Warburg,
a principal stockholder of the Company, owns a majority of the capital stock
of Charter Financial. The Company believes that the terms of the lease
financing with Charter Financial were completed at rates similar to those
available from alternative providers. The Company's belief that the terms of
the sale lease-back arrangement are similar to those available from
alternative providers is based on the advice of its officers who reviewed at
least two alternative proposals and who reviewed and negotiated the terms of
the arrangement with Charter Financial.
VENDOR RELATIONSHIP
Crosspoint, a principal stockholder of the Company, owns approximately 12%
of the capital stock of Diamond Lane, a vendor of the Company. The Company's
payments to Diamond Lane through September 30, 1998 totaled approximately
$1,492,000. The Company believes that the terms of its transactions with
Diamond Lane were completed at rates similar to those available from
alternative vendors. This belief is based on the Company's management team's
experience in obtaining vendors and the fact that the Company sought
competitive bidders before entering into the relationship with Diamond Lane.
REGISTRATION RIGHTS
Certain holders of Common Stock and Common Stock issuable upon conversion of
the Preferred Stock are entitled to registration rights. See "Description of
Capital Stock--Registration Rights."
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain of its
officers. See "Management--Employment Agreements and Change in Control
Arrangements."
EMPLOYEE LOANS
In August 1998, the Company loaned Robert Knowling, Jr., the Company's Chief
Executive Officer, the principal amount of $500,000 pursuant to a Note Secured
by Deed of Trust (the "Knowling Note"), which was secured by certain real
property of Mr. Knowling. The entire principal balance of the Knowling Note
becomes due and payable in one lump sum on August 14, 2002. No interest is
charged on the Knowling Note. The Knowling Note has provisions for forgiveness
based on continued employment and is subject to acceleration in certain
events.
In October 1998, the Company loaned Catherine Hemmer, the Company's Vice
President, Operations, and her husband, an employee of the Company (the
"Hemmers"), the principal amount of $600,000 pursuant to a Note Secured By
Deed of Trust (the "Hemmer Note"), which was secured by certain real property
of the Hemmers. The outstanding principal balance of the Hemmer Note becomes
due in four equal annual installments commencing August 10, 1999, with the
last installment due on August 10, 2002. No interest is charged on the Hemmer
Note. The Hemmer Note has provisions for forgiveness based upon continued
employment of each of the Hemmers with the Company and is subject to
acceleration in certain events.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding ownership of
the Company's Common Stock (after giving effect to the issuance of 1,800,000
shares of Common Stock upon exercise of warrants that will be exercised prior
to the closing of the offering, the conversion of outstanding Preferred Stock
into Common Stock, and excluding Common Stock that will be issued upon the
closing of this offering pursuant to cumulative dividend rights of the
Preferred Stock) as of December 15, 1998 by (i) each Named Executive Officer,
(ii) each director of the Company, (iii) all executive officers and directors
as a group, and (iv) all persons who directly own 5% or more of the Company's
Common Stock on an as-converted basis.
<TABLE>
<CAPTION>
NUMBER OF
SHARES PERCENTAGE BENEFICIALLY OWNED
BENEFICIALLY ------------------------------
BENEFICIAL OWNER OWNED(1) BEFORE OFFERING AFTER OFFERING
---------------- ------------ --------------- --------------
<S> <C> <C> <C>
Charles McMinn(2).................. 3,150,000 9.92% %
Robert Knowling Jr.(3)............. 306,250 * %
Robert Hawk(4)..................... 176,515 * %
Henry Kressel(5)................... 13,355,319 40.32% %
Joseph Landy(5).................... 13,355,319 40.32% %
Daniel Lynch(6).................... 460,500 1.45% %
Frank Marshall(6).................. 260,502 * %
Rich Shapero(7).................... 3,338,829 10.40% %
Rex Cardinale...................... 1,125,000 3.54%
Charles Haas....................... 3,150,000 9.92% %
Dhruv Khanna(8).................... 3,150,000 9.92% %
Timothy Laehy...................... 345,000 1.09%
All executive officers and
directors as a group(9)........... 28,847,915 85.32% %
Warburg, Pincus Ventures, L.P.
(10).............................. 13,355,319 40.32% %
Crosspoint Venture Partners 1996
(11).............................. 3,338,829 10.40% %
Intel Corporation (12)............. 2,465,997 7.74% %
</TABLE>
- --------
* Less than 1% of the outstanding voting stock.
(1) Based on 31,764,428 shares of Common Stock outstanding as of December 15,
1998. Beneficial ownership is determined in accordance with the rules of
the Securities and Exchange Commission. In computing the aggregate number
of shares beneficially owned by the individual stockholders and groups of
stockholders described above and the percentage ownership of such
individuals and groups, shares of Common Stock subject to options or
warrants that are currently exercisable or exercisable within 60 days of
December 15, 1998 are deemed outstanding. Such shares, however, are not
deemed outstanding for the purposes of computing the percentage ownership
of the other stockholders or groups of stockholders. Except as otherwise
indicated, the address of each of the persons in this table is as
follows: c/o Covad Communications Group, Inc., 2330 Central Expressway,
Santa Clara, CA 95050.
(2) Includes 475,000 shares of Common Stock held by a trust for the benefit
of two members of Mr. McMinn's immediate family, who also serve as co-
trustees. Mr. McMinn disclaims beneficial ownership of the shares of
Common Stock held by such trust.
(3) Consists of 306,250 shares of Common Stock subject to options exercisable
within 60 days of December 15, 1998.
(4) Includes 4,500 shares of Common Stock subject to options exercisable
within 60 days of December 15, 1998.
(5) All of the shares indicated are owned of record by Warburg and are
included because of Dr. Kressel's and Mr. Landy's affiliation with
Warburg. Dr. Kressel and Mr. Landy disclaim beneficial ownership of these
shares within the meaning of Rule 13d-3 under the Exchange Act. The
address of Dr. Kressel and Mr. Landy is c/o E.M. Warburg, Pincus & Co.,
LLC, 466 Lexington Avenue, New York, NY 10017-3147.
(6) Includes 16,500 shares of Common Stock subject to options exercisable
within 60 days of December 15, 1998.
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(7) All of the shares indicated are owned of record by Crosspoint and are
included because of Mr. Shapero's affiliation with Crosspoint. Mr.
Shapero disclaims beneficial ownership of these shares within the meaning
of Rule 13d-3 under the Exchange Act. The address of Mr. Shapero is c/o
Crosspoint Venture Partners, The Pioneer Hotel Building, 2925 Woodside
Road, Woodside, CA 94062.
(8) Includes 375,000 shares of Common Stock held by a limited partnership of
which Mr. Khanna is a general partner and a limited partner. Mr. Khanna
disclaims beneficial ownership of the shares of Common Stock held by such
limited partnership except to the extent of his pecuniary interest
therein.
(9) Includes 351,250 shares of Common Stock subject to options and 1,694,148
shares of Common Stock subject to warrants exercisable within 60 days of
December 15, 1998.
(10) Includes 1,355,319 shares to be issued upon exercise of a warrant
immediately prior to the closing of this offering. The sole general
partner of Warburg is Warburg, Pincus & Co., a New York general
partnership ("WP"). E.M. Warburg, Pincus & Co., LLC, a New York limited
liability company ("EMW LLC"), manages Warburg. The members of EMW LLC
are substantially the same as the partners of WP. Lionel I. Pincus is the
managing partner of WP and the managing member of EMW LLC and may be
deemed to control both WP and EMW LLC. WP has a 15% interest in the
profits of Warburg as a general partner and also owns approximately 1.3%
of the limited partnership interests in Warburg. Dr. Kressel and
Mr. Landy, directors of the Company, Managing Directors and members of
EMW LLC and partners of WP and as such may be deemed to have an indirect
pecuniary interest (within the meaning of Rule 16a-1 under the Exchange
Act) in an indeterminate portion of the shares beneficially owned by
Warburg. See Note 5 above. The address of Warburg is c/o E.M. Warburg,
Pincus & Co., LLC, 466 Lexington Avenue, New York, NY 10017-3147.
(11) Includes 338,829 shares to be issued upon exercise of a warrant
immediately prior to the closing of this offering. Mr. Shapero, a
director of the Company, is affiliated with Crosspoint and as such may be
deemed to have an indirect pecuniary interest (within the meaning of Rule
16a-1 under the Exchange Act) in an indeterminate portion of the shares
beneficially owned by Crosspoint. See Note 7 above. The address of
Crosspoint is The Pioneer Hotel Building, 2925 Woodside Road, Woodside,
CA 94062.
(12) Includes 105,852 shares to be issued upon exercise of a warrant
immediately prior to the closing of this offering. The address of Intel
is 2200 Mission College Boulevard, Mail Stop SC4-210, Santa Clara, CA
95052-8199.
68
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following summary of the terms of the Company's capital stock does not
purport to be complete and is qualified in its entirety by reference to the
actual terms of the capital stock contained in the Company's Amended and
Restated Certificate of Incorporation and other agreements referenced below
which are filed as exhibits to the Registration Statement of which this
Prospectus is a part. The following summary gives effect to the conversion of
all outstanding shares of Preferred Stock into Common Stock upon the closing
of this offering and the amendment and restatement of the Company's Amended
and Restated Certificate of Incorporation immediately following the closing of
this offering.
Upon the closing of this offering, the authorized capital stock of the
Company, after giving effect to the amendment of the Company's Amended and
Restated Certificate of Incorporation, will consist of 150,000,000 shares of
Common Stock and 5,000,000 shares of Preferred Stock. As of December 15, 1998,
there were 39 holders of record of Common Stock. The Common Stock and
Preferred Stock each have a par value of $0.001 per share. As of December 15,
1998, there were 31,764,428 shares of Common Stock outstanding, after giving
effect to the issuance of 1,800,000 shares of Common Stock upon exercise of
warrants that terminate upon the closing of the offering. No shares of
Preferred Stock are currently outstanding. As of December 15, 1998, options to
purchase 12,509,922 shares of Common Stock at a weighted average exercise
price of $1.97 per share were outstanding.
COMMON STOCK
The holders of Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may
be applicable to any outstanding series of Preferred Stock, the holders of
Common Stock are entitled to receive ratably such dividends, if any, as may be
declared from time to time by the board of directors out of funds legally
available for that purpose. See "Dividend Policy." In the event of a
liquidation, dissolution or winding up of the Company, the holders of Common
Stock are entitled to share ratably in all assets remaining after payment of
liabilities, subject to prior distribution rights of Preferred Stock, if any,
then outstanding. The Common Stock has no preemptive or conversion rights or
other subscription rights. There are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock are
fully paid and non-assessable, and the shares of Common Stock offered hereby
will, upon the closing of the offering, be fully paid and non-assessable.
PREFERRED STOCK
Upon the closing of this offering, all outstanding shares of Preferred Stock
will automatically be converted into 18,246,162 shares of Common Stock. See
Note 6 of Notes to Consolidated Financial Statements for a description of the
currently outstanding Preferred Stock. The Board of Directors has the
authority to issue up to 5,000,000 shares of Preferred Stock in one or more
series and to fix the rights, preferences, privileges, and restrictions
granted to or imposed upon such Preferred Stock, including dividend rights,
conversion rights, terms of redemption, liquidation preference, sinking fund
terms and the number of shares constituting any series or the designation of
such series, without any further vote or action by the stockholders. The Board
of Directors, without stockholder approval, can issue additional Preferred
Stock with voting and conversion rights which could adversely affect the
voting power of the holders of Common Stock. The issuance of Preferred Stock
could have the effect of delaying, deferring or preventing a change in control
of the Company. The Company has no present plan to issue any shares of
Preferred Stock.
WARRANTS
In connection with the issuance of the Senior Discount Notes in March 1998,
the Company issued warrants (the "Warrants") to purchase an aggregate of
5,053,764 shares of Common Stock of the Company with exercise prices of
$0.0033 per share. The Warrants became exercisable on September 15, 1998 and
automatically expire
69
<PAGE>
on March 15, 2008. The Company also issued to a consultant a five-year warrant
to purchase 135,000 shares with an exercise price of $1.00 per share. Such
warrant is immediately exercisable.
REGISTRATION RIGHTS
Pursuant to the Stockholder Rights Agreement, holders of 31,529,866 shares
of Common Stock (collectively, the "Rights Holders") are entitled to certain
rights with respect to the registration under the Securities Act of the shares
of Common Stock held by them. The Rights Holders are entitled to demand,
"piggy-back" and S-3 registration rights, subject to certain limitations and
conditions. The number of securities requested to be included in a
registration involving the exercise of demand and "piggy-back" rights are
subject to a pro rata reduction based on the number of shares of Common Stock
held by each Rights Holder and any other security holders exercising their
respective registration rights to the extent that the Company is so advised by
the managing underwriter, if any, therefor that the total number of securities
requested to be included in the underwriting is such as to materially and
adversely affect the success of the offering. The registration rights
terminate as to any Rights Holder at the later of (i) two years after the
offering made hereby or (ii) such time as such Rights Holder may sell under
Rule 144 in a three month period all Registrable Securities then held by such
Rights Holder.
Pursuant to the Warrant Registration Rights Agreement dated March 11, 1998,
among the Company and Bear, Stearns & Co. Inc. and BT Alex. Brown
Incorporated, holders of the Warrants are entitled to certain registration
rights with respect to the shares of Common Stock issuable upon exercise of
the Warrants. The Warrant holders are entitled to demand and "piggy-back"
registration rights, subject to certain limitations and conditions. Like the
Rights Holders, the number of securities that a Warrant holder may request to
be included in a registration involving an exercise of its demand or "piggy-
back" rights is subject to a pro rata reduction based on the number of shares
held by each Warrant holder and any other security holders exercising their
respective registration rights, to the extent that the Company is so advised
by the managing underwriter, if any, therefor that the total number of
securities requested to be included in the underwriting is such as to
materially and adversely affect the success of the offering.
ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF COVAD'S CHARTER, BYLAWS AND
DELAWARE LAW
As noted above, the Company's Board of Directors, without stockholder
approval, has the authority under the Company's Amended and Restated
Certificate of Incorporation to issue Preferred Stock with rights superior to
the rights of the holders of Common Stock. As a result, Preferred Stock could
be issued quickly and easily, could adversely affect the rights of holders of
Common Stock and could be issued with terms calculated to delay or prevent a
change of control of the Company or make removal of management more difficult.
Election and Removal of Directors. Effective upon the closing of this
offering, the Company's charter and Bylaws provide for the division of the
Company's Board of Directors into three classes, as nearly equal in number as
possible, with the directors in each class serving for a three-year term, and
one class being elected each year by the Company's stockholders. Directors may
be removed only for cause. This system of electing and removing directors may
tend to discourage a third party from making a tender offer or otherwise
attempting to obtain control of the Company and may maintain the incumbency of
the Board of Directors, as it generally makes it more difficult for
stockholders to replace a majority of directors. See "Management--Classified
Board."
Stockholder Meetings. Under the Company's Bylaws, the stockholders may not
call a special meeting of the stockholders of the Company. Rather, only the
Board of Directors, the Chairman of the Board and the President may call
special meetings of stockholders.
Requirements for Advance Notification of Stockholder Nominations and
Proposals. The Company's Bylaws establish advance notice procedures with
respect to stockholder proposals and the nomination of candidates for election
as directors, other than nominations made by or at the direction of the Board
of Directors or a committee thereof.
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<PAGE>
Section 203 of the Delaware General Corporation Law. The Company is subject
to Section 203 of the Delaware General Corporation Law ("Section 203"), which
prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years
after the date of the transaction in which the person became an interested
stockholder, unless (i) prior to such date, the board of directors of the
corporation approves either the business combination or the transaction that
resulted in the stockholder's becoming an interested stockholder, (ii) upon
consummation of the transaction that resulted in the stockholder's becoming an
interested stockholder, the interested stockholder owns at least 85% of the
outstanding voting stock, excluding shares held by directors, officers and
certain employee stock plans, or (iii) on or after the consummation date the
business combination is approved by the board of directors and by the
affirmative vote at an annual or special meeting of stockholders of at least
66 2/3% of the outstanding voting stock that is not owned by the interested
stockholder. For purposes of Section 203, a "business combination" includes,
among other things, a merger, asset sale or other transaction resulting in a
financial benefit to the interested stockholder, and an "interested
stockholder" is generally a person who, together with affiliates and
associates of such person, (i) owns 15% or more of the corporation's voting
stock or (ii) is an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation as any
time within the prior three years.
These charter and bylaw provisions and provisions of Delaware law may have
the effect of delaying, deterring or preventing a change of control of the
Company.
TRANSFER AGENT AND REGISTRAR
Boston EquiServe, L.P. is the transfer agent and registrar for the Company's
Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for the Common Stock
of the Company. Future sales of substantial amounts of Common Stock in the
public market could adversely affect market prices prevailing from time to
time. Sales of substantial amounts of Common Stock of the Company in the
public market after the restrictions lapse could adversely affect the
prevailing market price and the ability of the Company to raise equity capital
in the future.
Upon the completion of this offering, the Company will have shares of
Common Stock outstanding. Of these shares, the shares sold in this
offering will be freely tradable without restriction under the Securities Act,
unless held by "affiliates" of the Company, as that term is defined in Rule
144 under the Securities Act. The remaining 31,764,428 shares of Common Stock
held by existing stockholders were issued and sold by the Company in reliance
on exemptions from the registration requirements of the Securities Act. These
shares may be sold in the public market only if registered, or pursuant to an
exemption from registration such as Rule 144, 144(k) or 701 under the
Securities Act. The Company's directors, executive officers, all other
stockholders and all option and warrant holders, who in the aggregate hold all
of the shares of Common Stock or securities convertible into Common Stock of
the Company outstanding immediately prior to the completion of this offering,
are subject to lock-up agreements under which they have agreed not to directly
or indirectly, offer, sell, contract to sell, grant any option to purchase,
pledge or otherwise dispose of, or, in any manner, transfer all or a portion
of the economic consequences associated with the ownership of any shares of
Common Stock or any securities convertible into or exercisable or exchangeable
for Common Stock beneficially owned by them for a period of 180 days after the
date of this Prospectus, without the prior written consent of Bear, Stearns &
Co. Inc. However, Bear, Stearns & Co. Inc. may, in its sole discretion and at
any time without notice, release all or any portion of the securities subject
to lock-up agreements. The Company has entered into a similar agreement,
except that the Company may grant options and issue stock under its 1997 Stock
Plan and 1998 Purchase Plan and pursuant to other currently outstanding
options and warrants.
Upon expiration of the lock-up agreements, approximately 29,964,428 shares
of Common Stock will become eligible for immediate public resale, subject in
some cases to volume limitations pursuant to Rule 144.
71
<PAGE>
The remaining approximately 1,800,000 shares held by existing stockholders
will become eligible for public resale one year after their date of issuance
upon the exercise of warrants prior to the closing of this offering, subject
to volume limitation pursuant to Rule 144 and the exercise of registration
rights subject to volume limitations pursuant to Rule 144 and the exercise of
registration rights. In addition, 31,529,866 of the shares outstanding
immediately following the completion of this offering will be entitled to
registration rights with respect to such shares upon the release of lock-up
agreements. The number of shares sold in the public market could increase if
such rights are exercised.
As of December 15, 1998, 12,509,922 shares were subject to outstanding
options under the Company's 1997 Stock Plan and 5,188,764 shares were subject
to outstanding warrants to purchase Common Stock. All of these shares are
subject to the lock-up agreements described above. The Company also has
adopted its 1998 Purchase Plan and reserved 1,000,000 shares for issuance
thereunder. Approximately 90 days after the date of this Prospectus, the
Company intends to file a Registration Statement on Form S-8 covering shares
issuable under the Company's 1998 Purchase Plan and 1997 Stock Plan (including
shares subject to then outstanding options under such plan, thus permitting
the resale of such shares in the public market without restriction under the
Securities Act after expiration of the applicable lock-up agreements. In
addition, the holders of the warrants to purchase 5,053,764 shares of Common
Stock are entitled to certain registration rights with respect to such shares.
See "Description of Capital Stock--Registration Rights."
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least
one year (including the holding period of any prior owner, except an
affiliate) is entitled to sell in a "broker's transaction" or to market
makers, 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
(i) one percent of the number of shares of Common Stock then outstanding or
(ii) the average weekly trading volume of the Common Stock during the four
calendar weeks preceding the required filing of a Form 144 with respect to
such sale. Sales under Rule 144 are generally subject to certain manner of
sale provisions and notice requirements and to the availability of current
public information about the Company. Under Rule 144(k), a person who is not
deemed to have been an affiliate of the Company at any time during the 90 days
preceding a sale, and who has beneficially owned the shares proposed to be
sold for at least two years, is entitled to sell such shares without having to
comply with the manner of sale, public information, volume limitation or
notice provisions of Rule 144. Under Rule 701 under the Securities Act,
persons who purchase shares upon exercise of options granted prior to the
effective date of this offering are entitled to sell such shares 90 days after
the effective date of this offering in reliance on Rule 144, without having to
comply with the holding period requirements of Rule 144 and, in the case of
non-affiliates, without having to comply with the public information, volume
limitation or notice provisions of Rule 144.
72
<PAGE>
UNDERWRITING
The underwriters named below (the "Underwriters") have severally agreed,
subject to the terms and conditions of the Underwriting Agreement, to purchase
from the Company the number of shares of Common Stock set forth opposite their
names below:
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
Bear, Stearns & Co. Inc. .................................
BT Alex. Brown Incorporated...............................
Donaldson, Lufkin & Jenrette Securities Corporation.......
Goldman, Sachs & Co. .....................................
----
Total...................................................
====
</TABLE>
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters have agreed to purchase all of the shares of Common Stock being
sold pursuant to the Underwriting Agreement if any are purchased (excluding
shares covered by the Over-Allotment Option).
The Underwriters have advised the Company that the Underwriters propose to
offer the Common Stock to the public initially at the public offering price
set forth on the cover page of this Prospectus and to certain dealers at such
price less a concession of not more than $ per share. Additionally, the
Underwriters may allow, and such dealers may reallow, a discount of not more
than $ per share on sales to certain other dealers. After the initial public
offering, the public offering price and other selling terms may be changed by
the Underwriters.
At the Company's request, the Underwriters have reserved for sale at the
initial public offering price up to shares of Common Stock offered hereby
for certain individuals who have expressed an interest in purchasing such
shares of Common Stock in the offering. The number of shares available for
sale to the general public will be reduced to the extent such persons purchase
such reserved shares. Any reserved shares not so purchased will be offered by
the Underwriters to the general public on the same basis as other shares
offered hereby.
The Company has granted to the Underwriters an option to purchase up to
additional shares of Common Stock at the initial public offering price, less
the underwriting discount, set forth on the cover page of this Prospectus,
solely to cover over-allotments, if any. This option may be exercised in whole
or in part at any time within 30 days after the date of this Prospectus. To
the extent that the Underwriters exercise this option, each Underwriter will
have a firm commitment, subject to certain conditions, to purchase a number of
shares of Common Stock proportionate to such Underwriter's purchase
obligations set forth in the foregoing table.
The offering of the shares is made for delivery, when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the
right to reject an order for the purchase of shares in whole or in part.
The officers, directors, stockholders and option holders of the Company, who
in the aggregate own all of the issued and outstanding shares of Common Stock
or securities convertible into Common Stock of the Company outstanding
immediately prior to the completion of this offering, have agreed that they
will not, without the prior written consent of Bear, Stearns & Co. Inc.,
directly or indirectly, offer, sell, contract to sell, grant any option to
purchase, pledge or otherwise dispose of, or, in any manner, transfer all or a
portion of the economic consequences associated with the ownership of any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock beneficially owned by them during the 180 day
period following the date of this Prospectus. The Company has agreed that it
will not, without the prior written consent of Bear, Stearns & Co. Inc.,
offer, sell or otherwise dispose of any shares of Common Stock,
73
<PAGE>
options or warrants to acquire shares of securities exchangeable for or
convertible into shares of Common Stock during the 180 day period following
the date of this Prospectus, except that the Company may issue shares of
Common Stock and options to purchase Common Stock under its 1997 Stock Plan
and its 1998 Purchase Plan.
The Company has agreed to indemnify the Underwriters against certain civil
liabilities, including liabilities under the Securities Act and to contribute
to payments the Underwriters may be required to make in respect thereof.
Prior to the offering, there has been no public market for the Common Stock.
The initial public offering price for the Common Stock will be determined by
negotiation among the Company and the Underwriters. Among the factors to be
considered in determining the initial public offering price are prevailing
market and economic conditions, revenues and operating results of the Company,
market valuations of other companies engaged in the telecommunications
industry, estimates of the business potential and prospects of the Company,
the present state of the Company's operations, the Company's management and
other factors deemed relevant. The estimated initial public offering price
range set forth on the cover of this preliminary Prospectus is subject to
change as a result of market conditions and other factors. The negotiated
initial public offering price may bear no relationship to the price at which
the Common Stock trades after the offering. Application has been made for
quotation of the Common Stock on the Nasdaq National Market under the symbol
"COVD."
The Underwriters have advised the Company that, pursuant to Regulation M
promulgated under the Exchange Act, certain persons participating in the
offering may engage in transactions, including stabilizing bids, syndicate
covering transactions or the imposition of penalty bids, which may have the
effect of stabilizing or maintaining the market price of the Common Stock at a
level above that which might otherwise prevail in the open market. A
"stabilizing bid" is a bid for or the purchase of the Common Stock on behalf
of the Underwriters for the purpose of pegging, fixing or maintaining the
price of the Common Stock. A "syndicate covering transaction" is the bid for
or the purchase of the Common Stock on behalf of the Underwriters to reduce a
short position created in connection with the offering. The Underwriters may
also cover all or a portion of such short position by exercising the Over-
Allotment Option. A "penalty bid" is an arrangement permitting the
Underwriters to reclaim the selling concession otherwise accruing to an
Underwriter or syndicate member in connection with the offering if the Common
Stock originally sold by such Underwriter or syndicate member is purchased by
the Underwriters in a syndicate covering transaction and has therefore not
been effectively placed by such Underwriter or syndicate member. The
Underwriters have advised the Company that such transactions may be effected
on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
The Underwriters do not intend to confirm sales for accounts over which they
exercise discretionary authority.
Bear, Stearns & Co. Inc. and BT Alex. Brown Incorporated acted as initial
purchasers of the Senior Discount Notes in March 1998, for which Bear, Stearns
& Co. Inc. and BT Alex. Brown Incorporated received usual and customary fees.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto,
California. Certain legal matters in connection with this offering will be
passed upon for the Underwriters by Latham & Watkins, San Francisco,
California.
EXPERTS
The consolidated financial statements of the Company as of December 31, 1997
and September 30, 1998 and for the year ended December 31, 1997 and the nine
months ended September 30, 1998, appearing in this Prospectus and Registration
Statement, have been audited by Ernst & Young LLP, independent auditors, as
set forth in their report thereon appearing elsewhere herein, and are included
in reliance upon such report given upon the authority of such firm as experts
in accounting and auditing.
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<PAGE>
ADDITIONAL INFORMATION
This Prospectus constitutes a part of a registration statement on Form S-1
(together with all amendments thereto, the "Registration Statement") filed by
the Company with the SEC under the Securities Act. This Prospectus, which
forms a part of the Registration Statement, does not contain all the
information set forth in the Registration Statement, certain parts of which
have been omitted in accordance with the rules and regulations of the SEC.
Reference is hereby made to the Registration Statement and related exhibits
and schedules filed therewith for further information with respect to the
Company and the Shares offered hereby. Statements contained herein concerning
the provisions of any document are not necessarily complete and, in each
instance, reference is made to the copy of such document filed as an exhibit
to the Registration Statement or otherwise filed by the Company with the SEC
and each such statement is qualified in its entirety by such reference. The
Registration Statement and the exhibits and schedules thereto may be inspected
and copied at the public reference facilities maintained by the SEC at 450
Fifth Street, NW, Washington, D.C. 20594, and at the following regional
offices of the SEC: New York Regional Office, Seven World Trade Center, New
York, New York 10048, and Chicago Regional Office, 500 West Madison Street,
Chicago, Illinois 60661. Copies of such reports and other information may be
obtained from the Public Reference Section of the SEC: 450 Fifth Street, NW,
Washington, D.C. 20549, upon payment of the prescribed fees.
The Company is currently subject to the periodic reporting and other
information requirements of the Exchange Act, and in accordance therewith
files reports and other information with the SEC. Such reports and other
information may be inspected and copied at the public reference facilities
maintained by the SEC at 450 Fifth Street, NW, Washington, D.C. 20594, and at
the following regional offices of the SEC: New York Regional Office, Seven
World Trade Center, New York, New York 10048, and Chicago Regional Office,
500 West Madison Street, Chicago, Illinois 60661. Copies of such reports and
other information may be obtained from the Public Reference Section of the
SEC: 450 Fifth Street NW, Washington, D.C. 20549, upon payment of the
prescribed fees. The SEC maintains a Web site that contains reports and
information statements and other information regarding registrants that file
electronically with the SEC. Copies of such documents may be obtained from the
SEC's Internet address at HYPERLINK http://www.sec.gov.
75
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors............................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and September 30,
1998..................................................................... F-3
Consolidated Statements of Operations for the year ended December 31, 1997
and the nine months ended September 30, 1997 (unaudited) and 1998........ F-4
Consolidated Statements of Stockholders' Equity (Net Capital Deficiency)
for the year ended December 31, 1997 and the nine months ended September
30, 1998................................................................. F-5
Consolidated Statements of Cash Flows for the year ended December 31, 1997
and the nine months ended September 30, 1997 (unaudited) and 1998........ F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Covad Communications Group, Inc.
We have audited the accompanying consolidated balance sheets of Covad
Communications Group, Inc. as of December 31, 1997 and September 30, 1998, and
the related consolidated statements of operations, stockholders' equity (net
capital deficiency), and cash flows for the year ended December 31, 1997 and
the nine months ended September 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Covad Communications
Group, Inc. as of December 31, 1997 and September 30, 1998, and the
consolidated results of its operations and its cash flows for the year ended
December 31, 1997 and the nine months ended September 30, 1998, in conformity
with generally accepted accounting principles.
/s/ Ernst & Young LLP
San Jose, California
October 16, 1998
F-2
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
EQUITY
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1998
------------- ------------- -------------
(RESTATED)(1) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............ $ 4,378 $ 97,076
Accounts receivable, net of
allowances for uncollectibles of $0
and $75............................. 25 1,062
Unbilled revenue..................... 4 450
Inventories.......................... 43 868
Prepaid expenses..................... 52 722
Other current assets................. 317 446
------- --------
Total current assets............... 4,819 100,624
PROPERTY AND EQUIPMENT:
Networks and communication equipment. 2,185 30,321
Computer equipment................... 600 3,660
Furniture and fixtures............... 185 890
Leasehold improvements............... 114 550
------- --------
3,084 35,421
Less accumulated depreciation and
amortization........................ (70) (1,418)
------- --------
Net property and equipment......... 3,014 34,003
OTHER ASSETS:
Restricted cash...................... 210 233
Deposits............................. 31 282
Deferred debt issuance costs (net)... -- 8,304
Other long term assets............... -- 1,176
------- --------
Total other assets................. 241 9,995
------- --------
Total assets....................... $ 8,074 $144,622
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable..................... $ 651 $ 8,777
Unearned revenue..................... 7 290
Accrued network costs................ 58 1,238
Other accrued liabilities............ 77 2,808
Current portion of capital lease
obligations......................... 229 254
------- --------
Total current liabilities.......... 1,022 13,367
Long-term debt (net of discount)..... -- 137,292
Long-term capital lease obligations.. 554 380
------- --------
Total liabilities.................. 1,576 151,039
STOCKHOLDERS' EQUITY (NET CAPITAL
DEFICIENCY):
Preferred stock ($0.001 par value)
(pro forma--unaudited):
Authorized shares--5,000,000
Issued and outstanding--none........ -- -- --
Convertible preferred stock ($0.001
par value):
Authorized shares--30,000,000 (none
pro forma--unaudited)
Issued and outstanding shares--
17,750,001 and 18,246,162 at
December 31, 1997 and September 30,
1998, respectively (none pro
forma--unaudited).................. 18 18 --
Common stock ($0.001 par value):
Authorized shares--65,000,000
(150,000,000 pro forma--unaudited)
Issued and outstanding shares--
11,361,204 and 11,634,149 at
December 31, 1997 and September 30,
1998, respectively (31,680,311
shares pro forma--unaudited)....... 11 12 32
Additional paid-in capital........... 9,692 30,732 30,736
Deferred compensation................ (611) (6,306) (6,306)
Retained earnings (deficit).......... (2,612) (30,873) (30,873)
------- -------- -------
Total stockholders' equity (net
capital deficiency)................ 6,498 (6,417) $(6,411)
------- -------- =======
Total liabilities and stockholders'
equity (net capital deficiency).... $ 8,074 $144,622
======= ========
</TABLE>
- --------
(1) See Note 7.
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
YEAR ENDED -----------------------
DECEMBER 31, 1997 1997 1998
----------------- ----------- ----------
(RESTATED)(1) (UNAUDITED)
<S> <C> <C> <C>
Revenues............................. $ 26 $ -- $ 2,560
Operating expenses:
Network and product costs.......... 54 10 2,316
Sales, marketing, general and
administrative.................... 2,374 1,040 17,231
Amortization of deferred
compensation...................... 295 134 2,695
Depreciation and amortization...... 70 -- 1,348
----------- ---------- ----------
Total operating expenses......... 2,793 1,184 23,590
----------- ---------- ----------
Income (loss) from operations........ (2,767) (1,184) (21,030)
Interest income (expense):
Interest income.................... 167 80 3,673
Interest expense................... (12) -- (10,904)
----------- ---------- ----------
Net interest income (expense)...... 155 80 (7,231)
----------- ---------- ----------
Net income (loss).................... $ (2,612) $ (1,104) $ (28,261)
=========== ========== ==========
Net income (loss) per common share... $ (0.80) $ (0.37) $ (5.26)
Weighted average shares used in
computing net loss per share........ 3,271,546 3,009,329 5,374,924
Pro forma net income (loss) per
common share........................ $ (0.23) $ (0.14) $ (1.14)
Weighted average shares used in
computing pro forma net loss per
share............................... 11,522,916 8,059,696 24,844,824
</TABLE>
- --------
(1) See Note 7.
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(RESTATED)(1)
(AMOUNTS IN 000'S, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
TOTAL
CONVERTIBLE STOCKHOLDERS'
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED EQUITY (NET
----------------- ------------------ PAID-IN DEFERRED EARNINGS CAPITAL
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) DEFICIENCY)
---------- ------ ---------- ------ ---------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Initial issuance of
common stock........... -- $-- 12,000,000 $ 12 $ 38 $ -- $ -- $ 50
Repurchase of common
stock.................. -- -- (2,410,296) (3) (7) -- -- (10)
Issuance of common
stock.................. -- -- 1,771,500 2 66 -- -- 68
Issuance of Series A
Preferred Stock........ 750,000 1 -- -- 249 -- -- 250
Issuance of Series B
Preferred Stock (net of
$43 of financing
costs)................. 17,000,001 17 -- -- 8,440 -- -- 8,457
Deferred compensation... -- -- -- -- 906 (906) -- --
Amortization of deferred
compensation........... -- -- -- -- -- 295 -- 295
Net loss................ -- -- -- -- -- -- (2,612) (2,612)
---------- ---- ---------- ---- ------- ------- -------- --------
Balance at December 31,
1997................... 17,750,001 18 11,361,204 11 9,692 (611) (2,612) 6,498
Issuance of common
stock.................. -- -- 272,945 1 301 -- -- 302
Issuance of Series B
Preferred Stock........ 100,002 -- -- -- 100 -- -- 100
Issuance of Series C
Preferred Stock........ 396,159 -- -- -- 1,100 -- -- 1,100
Issuance of common stock
warrants as part of
debt offering issuance
costs.................. -- -- -- -- 2,928 -- -- 2,928
Issuance of common stock
warrants pursuant to
debt offering.......... -- -- -- -- 8,221 -- -- 8,221
Deferred compensation... -- -- -- -- 8,390 (8,390) -- --
Amortization of deferred
compensation........... -- -- -- -- -- 2,695 -- 2,695
Net loss................ -- -- -- -- -- -- (28,261) (28,261)
---------- ---- ---------- ---- ------- ------- -------- --------
Balance at September 30,
1998................... 18,246,162 $ 18 11,634,149 $ 12 $30,732 $(6,306) $(30,873) $ (6,417)
========== ==== ========== ==== ======= ======= ======== ========
</TABLE>
- -------
(1) See Note 7.
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN 000'S)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30,
DECEMBER 31, --------------------
1997 1997 1998
------------- ----------- --------
(RESTATED)(1) (UNAUDITED)
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss................................... $(2,612) $(1,104) $(28,261)
Reconciliation of net loss to net cash
provided by (used in) operating
activities:
Depreciation and amortization............ 70 -- 1,348
Amortization of deferred compensation.... 295 134 2,695
Accreted interest and amortization of
debt discount and deferred debt issuance
costs................................... -- -- 10,809
Net changes in current assets and
liabilities:
Accounts receivable.................... (25) -- (1,037)
Inventories............................ (43) -- (825)
Other current assets................... (373) (32) (1,245)
Accounts payable....................... 651 662 8,126
Unearned revenue....................... 7 -- 283
Other current liabilities.............. 135 35 3,911
------- ------- --------
Net cash used in operating activities ..... (1,895) (305) (4,196)
INVESTING ACTIVITIES:
Purchase of restricted investment.......... (210) -- (23)
Deposits................................... (31) (47) (251)
Long term receivable....................... -- -- (887)
Purchase of property and equipment......... (2,253) (1,104) (32,303)
------- ------- --------
Net cash used in investing activities ..... (2,494) (1,151) (33,464)
FINANCING ACTIVITIES:
Net proceeds from issuance of long-term
debt and warrants......................... -- -- 129,328
Principal payments under capital lease
obligations............................... (48) -- (183)
Proceeds from common stock issuance, net of
repurchase................................ 108 100 302
Proceeds from preferred stock issuance..... 8,707 8,707 1,200
Offering costs related to common stock
offering.................................. -- -- (289)
------- ------- --------
Net cash provided by financing activities.. 8,767 8,807 130,358
------- ------- --------
Net increase in cash and cash equivalents.. 4,378 7,351 92,698
Cash and cash equivalents at beginning of
period.................................... -- -- 4,378
------- ------- --------
Cash and cash equivalents at end of year... $ 4,378 $ 7,351 $ 97,076
======= ======= ========
Supplemental disclosures of cash flow
information:
Cash paid during the year for interest... $ 9 $ -- $ 78
======= ======= ========
Supplemental schedule of non-cash investing
and financing activities:
Equipment purchased through capital
leases.................................. $ 831 $ -- $ 34
======= ======= ========
Warrants issued for equity commitment.... -- -- $ 2,928
======= ======= ========
</TABLE>
- --------
(1) See Note 7.
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
Covad Communications Company was organized in October 1996. On July 16,
1997, Covad Communications Group, Inc. (the "Company") was incorporated in the
state of Delaware. Simultaneous with the Company's incorporation, an exchange
agreement was executed which effectively made Covad Communications Company a
wholly-owned subsidiary of the Company.
The Company is a packet-based Competitive Local Exchange Carrier that
provides dedicated high-speed digital communication services using Digital
Subscriber Line ("DSL") technology to enterprise and Internet Service Provider
customers. Enterprise customers purchase the Company's services to provide
employees with remote access to their Local Area Networks to improve employee
productivity and reduce operating costs. ISPs purchase the Company's services
in order to provide high-speed Internet access to their business and consumer
end-users. The Company's services are provided over standard copper telephone
lines at considerably faster speeds than available through a standard modem.
The Company's operations are subject to significant risks and uncertainties
including competitive, financial, developmental, operational, growth and
expansion, technological, regulatory, and other risks associated with an
emerging business.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Basis of Presentation
The consolidated financial statements of the Company include the accounts of
all of its wholly-owned subsidiaries. There were no intercompany accounts and
transactions which required elimination.
The consolidated financial statements and related footnotes as of and for
the nine months ended September 30, 1997 are unaudited, but include all
adjustments (consisting of normal recurring adjustments) that the Company
considers necessary for a fair presentation of financial position and
operating results.
The accompanying statements of operations, stockholders' equity, and cash
flows for the year ended December 31, 1997 and the nine months ended September
30, 1997 include $50,000 received during 1996 upon issuance of the initial
capital stock of the Company and $2,000 expended in 1996 for general and
administrative expenses. Due to the insignificance of balances at December 31,
1996 and activity for the period from inception through December 31, 1996,
financial statements for 1996 have not been presented.
B. Revenue Recognition
Revenue related to installation of service and sale of customer premise
equipment is recognized when equipment is delivered and installation is
completed. Revenue from monthly recurring service is recognized in the month
the service is provided. Payments received in advance of providing services
are recorded as unearned revenue until the period such services are provided.
C. Cash and Cash Equivalents
All highly liquid investments with a maturity of three months or less from
the date of original issuance are considered to be cash equivalents.
F-7
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
D. Restricted Cash
As of December 31, 1997 and September 30, 1998, the Company had $210,000 and
$233,000, respectively, in commercial deposits held in the Company's name but
restricted as security for certain of the Company's capital lease
arrangements.
E. Inventories
Inventories are stated at the lower of cost or market. Costs are based on
the first-in first-out method.
F. Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the following estimated useful lives:
<TABLE>
<S> <C>
Leasehold improvements......................... 15 years or life of the lease
Electronic communication equipment............. 2 to 5 years
Furniture and fixtures......................... 5 to 7 years
Computer equipment............................. 3 years
Office equipment............................... 2 to 5 years
Computer software.............................. 3 to 7 years
</TABLE>
The Company capitalizes costs associated with the design and implementation
of the Company's network including internally and externally developed
software. Capitalized external software costs include the actual costs to
purchase existing software from vendors. Capitalized internal software costs
generally include personnel costs incurred in the enhancement and
implementation of purchased software packages. As of December 31, 1997 and
September 30, 1998, total capitalized internal costs were $139,000 and
$1,454,000, respectively.
G. Equipment Under Capital Leases
The Company leases certain of its equipment and other fixed assets under
capital lease agreements. The assets and liabilities under capital leases are
recorded at the lesser of the present value of aggregate future minimum lease
payments, including estimated bargain purchase options, or the fair value of
the assets under lease, whichever is less. Assets under capital lease are
amortized over the lease term or useful life of the assets.
H. Income Taxes
From January 1, 1997 to June 30, 1997, Covad Communications Company was an S
Corporation under the provisions of the Internal Revenue Code. Effective June
30, 1997, Covad Communications Company terminated its S Corporation status and
became a C Corporation, and on July 16, 1997 Covad Communications Company
became a wholly-owned subsidiary of the Company. Under S Corporation
provisions, income or losses of Covad Communications Company were reported by
the stockholders on their individual federal and state income tax returns, and
Covad Communications Company did not pay income taxes or receive income tax
benefits.
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes"
which provides for the establishment of deferred tax assets and liabilities
for the net tax effects of temporary differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the amounts
used for income tax purposes. As of December 31, 1997, the Company had
deferred tax assets of approximately $820,000 primarily related to federal and
California net operating loss carryforwards. The net deferred tax asset has
been fully offset by a valuation allowance. The
F-8
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
federal and California net operating loss carryforwards of approximately
$2,062,000 at December 31, 1997, expire in 2012 and 2005, respectively. For
the nine months ended September 30, 1998, the Company has incurred additional
operating losses which are expected to generate net operating loss
carryforwards for the 1998 tax year. Utilization of the net operating losses
is subject to a substantial annual limitation provided by the Internal Revenue
Code of 1986 and similar state provisions. The annual limitation may result in
the expiration of net operating losses before utilization.
I. Use of Estimates in the 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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
J. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," as
amended by SFAS No. 119, "Disclosures About Derivative Financial Instruments
and Fair Value of Financial Instruments," which are effective for the
Company's December 31, 1997 financial statements, requires disclosure of fair
value information about financial instruments whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available for identical or comparable
financial instruments, fair values are based on estimates using the present
value of estimated cash flows or other valuation techniques. The resulting
fair values can be significantly affected by the assumptions used, including
the discount rate and estimates as to the amounts and timing of future cash
flows.
The following methods and assumptions were used to estimate the fair value
for financial instruments:
Cash and cash equivalents. The carrying amount approximates fair value.
Borrowings. The fair values of borrowings, including long-term debt, capital
lease obligations and other obligations, were estimated based on quoted market
prices, where available, or by discounting the future cash flows using
estimated borrowing rates at which similar types of borrowing arrangements
with the same remaining maturities could be obtained by the Company. For all
borrowings outstanding at December 31, 1997 and September 30, 1998, fair value
approximates recorded value.
K. Earnings (Loss) Per Share
In March 1997, SFAS No. 128 "Earnings Per Share" ("SFAS 128") was issued
specifying the computation, presentation, and disclosure requirements for
earnings per share for publicly held entities. This statement is effective for
financial statements for both interim and annual periods ending after December
15, 1997. The Company has applied the provisions of SFAS 128.
Basic earnings per share is computed by dividing income or loss applicable
to common shareholders by the weighted average number of shares of the
Company's common stock ("Common Stock"), after giving consideration to shares
subject to repurchase, outstanding during the period.
Diluted earnings per share is determined in the same manner as basic
earnings per share except that the number of shares is increased assuming
exercise of dilutive stock options and warrants using the treasury stock
method and conversion of the Company's convertible preferred stock ("Preferred
Stock"). In addition, income or loss is adjusted for dividends and other
transactions relating to preferred shares for which conversion is assumed. The
diluted earnings per share amount has not been reported because the Company
has a net loss and
F-9
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the impact of the assumed exercise of the stock options and warrants and the
assumed preferred stock conversion is not dilutive.
Under the Company's Certificate of Incorporation, all outstanding Preferred
Stock will convert into Common Stock on a one-for-one basis upon the
completion of the Company's initial public offering of Common Stock. The pro
forma net loss per share assumes the conversion of the Preferred Stock and the
exercise for cash of warrants to purchase 1,800,000 shares of Common Stock
immediately prior to the consummation of the Company's initial public offering
of Common Stock.
The consolidated financial statements applicable to the prior periods have
been restated to reflect a two-for-one stock split effective May 1998 and a
three-for-two stock split effective August 1998.
The following table presents the calculation of basic and diluted and pro
forma net income (loss) per share (in thousands, except share and per share
amounts):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30,
DECEMBER 31, ------------------------
1997 1997 1998
------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Net income (loss)........................ $ (2,612) $ (1,104) $ (28,261)
Basic and diluted:
Weighted average shares of common stock
outstanding........................... 11,021,269 10,892,714 11,446,004
Less: Weighted average shares subject
to repurchase......................... 7,749,723 7,883,385 6,071,080
----------- ----------- -----------
Weighted average shares used in computing
basic and diluted net income (loss) per
share................................... 3,271,546 3,009,329 5,374,924
=========== =========== ===========
Basic and diluted net income (loss) per
share................................... $ (0.80) $ (0.37) $ (5.26)
=========== =========== ===========
Pro forma (unaudited):
Shares used above........................ 3,271,546 3,009,329 5,374,924
Pro forma adjustment to reflect weighted
effect of assumed conversion of
convertible preferred stock............. 8,251,370 5,050,367 18,124,845
Pro forma adjustment to reflect weighted
effect of assumed exercise of common
warrants................................ -- -- 1,345,055
----------- ----------- -----------
Shares used in computing pro forma basic
and diluted net income (loss) per common
share................................... 11,522,916 8,059,696 24,844,824
=========== =========== ===========
Pro forma basic and diluted net income
(loss) per share........................ $ (0.23) $ (0.14) $ (1.14)
=========== =========== ===========
</TABLE>
L. Concentration of Credit Risk
The Company typically offers its customers credit terms. The Company
performs ongoing credit evaluations of its customers' financial condition and
generally does not require collateral. The Company has incurred no bad debt
losses through September 30, 1998.
2. DEBT
On March 11, 1998, the Company completed a private placement (the "1998
Private Offering") through the issuance of 260,000 units (the "Units"), each
unit consisting of $1,000 in principal amount at maturity of 13 1/2% Senior
Discount Notes due 2008 (the "Notes") and one warrant, initially exercisable
to purchase 19.4376 shares of common stock, $0.001 par value, of the Company
(the "Unit Warrants"). Net proceeds from the 1998 Private Offering were
approximately $129.6 million, after transaction costs of approximately $5.5
million.
F-10
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The principal amount of the Notes will accrete from the date of issuance at
the rate of 13 1/2% per annum through March 15, 2003, compounded semi-
annually, and thereafter bear interest at the rate of 13 1/2% per annum,
payable semi-annually, in arrears on March 15 and September 15 of each year,
commencing on September 15, 2003. The Notes are unsecured senior obligations
of the Company that will mature on March 15, 2008. The Notes will be
redeemable at the option of the Company at any time after March 15, 2003 plus
accrued and unpaid interest thereon, if any, to the redemption date.
The Notes were originally recorded at approximately $126.9 million, which
represents the $135.1 million in gross proceeds less the approximate $8.2
million value assigned to the Unit Warrants, which is included in additional
paid-in capital. The value assigned to the Unit Warrants, representing debt
discount, is being amortized over the life of the Notes. Additional debt
issuance costs were incurred through the issuance of warrants associated with
the commitment of equity by certain investors. The debt issuance costs are
also being amortized over the life of the Notes. For the nine months ended
September 30, 1998, the accretion of the Notes and the amortization of debt
discount and debt issuance costs was $10.8 million and is included in interest
expense in the accompanying consolidated financial statements.
The Unit Warrants have ten year terms, have exercise prices of $0.0033 per
share (subject to adjustment in certain events), contain net exercise
provisions and are currently exercisable.
3. CAPITAL LEASES
The Company has entered into capital lease arrangements to finance the
acquisition of certain operating assets, two of which have bargain purchase
options. The principal value of these leases totaled $831,000 and $865,000 as
of December 31, 1997 and September 30, 1998, respectively, and was equivalent
to the fair value of the assets leased.
Future minimum lease payments under capital leases are as follows:
<TABLE>
<CAPTION>
PERIOD
ENDING
DECEMBER 31,
------------
<S> <C>
1998........................................................... $ 81,000
1999........................................................... 331,000
2000........................................................... 294,000
2001........................................................... 44,000
2002........................................................... 4,000
Thereafter..................................................... --
---------
754,000
Less amount representing interest.............................. (120,000)
Less current portion........................................... (254,000)
---------
Total long-term portion........................................ $ 380,000
=========
</TABLE>
Accumulated amortization for equipment under capital leases is reflected in
accumulated depreciation and amortization for property and equipment.
F-11
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. OPERATING LEASES
The Company leases vehicles, equipment, and office space under various
operating leases. Future minimum lease payments by year under operating leases
are as follows:
<TABLE>
<CAPTION>
PERIOD ENDING
DECEMBER 31,
-------------
<S> <C>
1998.......................................................... $ 701,000
1999.......................................................... 2,508,000
2000.......................................................... 2,105,000
2001.......................................................... 2,159,000
2002.......................................................... 1,436,000
Thereafter.................................................... 858,000
----------
Total..................................................... $9,767,000
==========
</TABLE>
Rental expense on operating leases totaled $131,000 and $744,000 for the
year ended December 31, 1997 and the nine months ended September 30, 1998,
respectively.
5. OTHER ASSETS AND OTHER LIABILITIES
On December 30, 1997, the Company entered into a capital lease agreement
(see Note 3) with a principal balance of $316,000. As of December 31, 1997,
this amount had not yet been received into the Company's bank account and is,
therefore, included as part of other current assets on the balance sheet.
6. STOCKHOLDERS' EQUITY
COVAD COMMUNICATIONS GROUP, INC.
Common Stock:
The number of shares of Common Stock authorized for issuance by the Company
is 65,000,000 shares with a par value of $.001 per share. Shares of Common
Stock outstanding at December 31, 1997 and September 30, 1998, were 11,361,204
and 11,634,149 shares, respectively, of which 7,033,107 and 5,375,583 shares,
respectively, remain subject to repurchase provisions which generally lapse
over a four year period from the date of issuance.
Common Stock reserved for future issuance as of September 30, 1998 is as
follows:
<TABLE>
<S> <C>
Convertible preferred stock..................................... 18,246,162
Outstanding and reserved options................................ 13,878,555
Outstanding warrants............................................ 6,988,764
----------
Total......................................................... 39,113,481
==========
</TABLE>
F-12
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Convertible Preferred Stock:
Convertible preferred stock consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Authorized shares--30,000,000
Series A preferred stock ($0.001 par value):
Authorized shares--750,000
Issued and outstanding shares--750,000 at December
31, 1997 and September 30, 1998.................... $ 1 $ 1
Series B preferred stock ($0.001 par value):
Authorized shares--17,100,003
Issued and outstanding shares--17,000,001 at
December 31, 1997 and 17,100,003 at September 30,
1998............................................... 17 17
Series C preferred stock ($0.001 par value):
Authorized shares--11,149,287
Issued and outstanding shares--None at December 31,
1997 and 396,159 at September 30, 1998............. -- --
--- ---
$18 $18
=== ===
</TABLE>
Equity Commitment
On February 20, 1998, the Company entered into a Series C Preferred Stock
and Warrant Subscription Agreement (the "Subscription Agreement") with certain
of its investors (the "Series C Investors") pursuant to which the Series C
Investors have unconditionally agreed to purchase an aggregate of 5,764,143
shares of Series C Preferred Stock and warrants to purchase an aggregate of
4,729,500 shares of Series C Preferred Stock (the "Series C Warrants") for an
aggregate purchase price of $16.0 million at a date to be determined by the
Company but no later than March 11, 1999. The Company either has agreed to
call the Equity Commitment or to complete an alternate equity financing of at
least $16.0 million by March 11, 1999. In consideration of this commitment,
the Company has issued to the Series C Investors warrants to purchase an
aggregate of 1,694,148 shares of the Company's Common Stock at a purchase
price of $0.0033 per share (the "Common Warrants").
On April 24, 1998, the Subscription Agreement was amended pursuant to an
Assignment and Assumption Agreement between the Company, the Series C
Investors, and a director of the Company whereby the Series C Investors
assigned to the director of the Company their obligation to purchase 36,015
shares of Series C Preferred Stock and 29,559 Series C Warrants for an
aggregate purchase price of $100,000. On the same date, the director purchased
36,015 shares of Series C Preferred Stock. As a result of this amendment, the
aggregate obligation of the Series C Investors to purchase Series C Preferred
Stock and Series C Warrants was reduced from 5,764,143 shares to 5,728,128
shares, and from 4,729,500 shares to 4,699,941 shares, respectively, for an
aggregate purchase price of $15.9 million, reduced from $16.0 million.
The Series C Warrants issuable in connection with the closing of the Equity
Commitment will have five-year terms, have an exercise price of $2.7767 per
share of Series C Preferred Stock (subject to adjustment in certain events),
are immediately exercisable and contain a net exercise provision. The Common
Warrants issued upon the signing of the Subscription Agreement have five-year
terms (but must be exercised prior to the closing of an initial public
offering of equity securities by the Company), have exercise prices of $0.0033
per share, are immediately exercisable and contain net exercise provisions.
F-13
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Stock Purchase
On March 11, 1998, an investor in the Company purchased 360,144 shares of
Series C Preferred Stock and Series C Warrants to purchase an aggregate of
295,500 shares of Series C Preferred Stock for an aggregate purchase price of
$1.0 million; provided, that the Company does not have any obligation to issue
such Series C Warrants to this investor until such time as the Equity
Commitment is called. In connection with its agreement to purchase such Series
C Preferred Stock and Series C Warrants, the Company issued to this investor
Common Warrants to purchase an aggregate of 105,852 shares of Common Stock at
a purchase price of $0.0033 per share.
Preferred Stock Attributes
The holders of Series A, Series B and Series C are entitled to receive in
any fiscal year, dividends at the rate of $0.0167 per share, $0.04 per share
and $0.2233 per share, respectively, payable in preference and priority to any
payment of dividends on Common Stock. The rights to such dividends are
cumulative and accrue to the holders to the extent they are not declared or
paid and are payable, in cash or Common Stock, only in the event of a
liquidation, dissolution or winding up of the Company, or other liquidity
event (as defined in the Certificate of Incorporation). The cumulative
dividends at December 31, 1997 and September 30, 1998 for Preferred Stock were
$318,250 and $578,903, respectively, none of which has been declared or paid.
Subject to certain adjustments as set forth in the Certificate of
Incorporation, each share of Series A, Series B and Series C is convertible
into one share of Common Stock. Each share of Series A, Series B and Series C
is entitled to the number of votes equal to the number of shares of Common
Stock in which such shares of Series A, Series B and Series C, respectively,
could be converted.
In the event of any liquidation or dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series A, Series B and Series
C are entitled to receive, in addition to the cumulated and unpaid dividends,
$0.3333, $0.50 and $2.7767 per share, respectively (the "Initial Preference"),
until, with respect to Series A and Series B only, a "Liquidation Preference
Threshold" is met based on a formula as set forth in the Certificate of
Incorporation. After payment of these preferences, any remaining amounts are
distributed to the holders of Series A, Series B, Series C and Common Stock on
a pro rata basis based on the number of shares of Common Stock held by each
holder on an as-converted basis. If the "Liquidation Preference Threshold" is
met, the Initial Preference is eliminated with respect to Series A and Series
B only.
7. STOCK OPTIONS
In 1997, the Company adopted the Covad Communications Group, Inc. 1997 Stock
Plan (the "Plan"). The Plan provides for the grant of stock purchase rights
and options to purchase shares of Common Stock to employees and consultants
from time to time as determined by the Board of Directors. The options expire
from two to eight years after the date of grant. As of September 30, 1998 the
Plan has reserved 13,970,250 shares of the Company's Common Stock for sale and
issuance under the Plan at prices to be determined by the Board of Directors.
The following is a summary of the status of stock options outstanding at
September 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------- ------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
EXERCISE NUMBER OF AVERAGE AVERAGE NUMBER OF AVERAGE
PRICE RANGE SHARES LIFE REMAINING EXERCISE PRICE SHARES EXERCISE PRICE
----------- --------- -------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
$0.033-$0.667. 6,835,793 7.08 years $0.276 1,291,659 $0.091
$1.00-$1.627.. 2,870,029 7.83 years $1.168 26,029 $1.627
$5.75......... 1,506,428 7.92 years $5.750 -- --
$7.38-$7.93... 569,250 8.00 years $7.546 1,000 $7.930
</TABLE>
F-14
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes stock option activity for the year ended
December 31, 1997 and the nine months ending September 30, 1998:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF OPTION PRICE
COMMON STOCK PER SHARE
------------ -------------
<S> <C> <C>
Balance as of December 31, 1996.................. -- N/A
Granted.......................................... 3,843,750 $0.033-$0.05
Exercised........................................ (6,000) $ 0.033
Forfeited........................................ (33,000) $0.033-$0.05
---------- -------------
Balance as of December 31, 1997.................. 3,804,750 $0.033-$0.05
Granted.......................................... 8,377,356 $0.10 -$7.93
Exercised........................................ (85,695) $0.033-$0.667
Forfeited........................................ (314,911) $0.05 -$7.38
---------- -------------
Balance as of September 30, 1998................. 11,781,500 $0.033-$7.93
========== =============
</TABLE>
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," ("APB 25") and related
interpretations in accounting for its employee stock options and the
disclosure only provisions of SFAS No. 123, "Accounting and Disclosure of
Stock-Based Compensation," ("SFAS 123"). Under APB 25, compensation expense is
recognized based on the amount by which the fair value of the underlying
common stock exceeds the exercise price of stock options at the date of grant.
As a result of the Company's reassessment during 1998 of the fair values per
share of its common stock, the Company has restated its financial statements
for the year ended December 31, 1997 to record deferred compensation of
$906,000 as a result of granting stock options and issuing restricted stock
with exercise or issue prices per share below the revised fair value per share
of the Company's common stock at the date of grant or issuance. This amount
was recorded as a reduction of stockholders' equity and is being amortized as
a charge to operations over the vesting period of the applicable options. Such
amortization was $295,000 for the year ended December 31, 1997. During the
nine months ended September 30, 1998, the Company recorded additional deferred
compensation of approximately $8.4 million. Amortization of deferred
compensation during this same period was $2.7 million.
Stock-Based Compensation
Pro forma information regarding results of operations and loss per share is
required by SFAS 123 as if the Company had accounted for its stock-based
awards under the fair value method of SFAS 123. The fair value of the
Company's stock-based awards to employees has been estimated using the minimum
value option pricing model which does not consider stock price volatility.
Because the Company does not have actively traded equity securities,
volatility is not considered in determining the fair value of stock-based
awards to employees.
For the year ended December 31, 1997 and the nine months ended September 30,
1998, the fair value of the Company's stock-based awards to employees was
estimated using the following weighted average assumptions:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Expected life of options in years.............................. 4.0 4.0
Risk-free interest rate........................................ 7.0 % 7.0 %
Expected dividend yield........................................ 0.00% 0.00%
</TABLE>
The weighted average fair value of stock options granted during the year
ended December 31, 1997 and the nine months ended September 30, 1998 was $0.26
and $1.49 per share, respectively. For pro forma purposes,
F-15
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the estimated fair value of the Company's stock-based awards to employees is
amortized over the options' vesting period which would result in an increase
in net loss of approximately $12,000 and $313,000 for the year ended December
31, 1997 and nine months ended September 30, 1998, respectively. The result of
applying SFAS 123 to the Company's option grants was not material to the
results of operations or loss per share for the year ended December 31, 1997
and would have increased the net loss per share by $0.06 per share for the
nine months ended September 30, 1998.
8. LEGAL PROCEEDINGS
The Company is engaged in a variety of negotiations, arbitrations and
regulatory and court proceedings with multiple incumbent local exchange
carriers (ILECs). These negotiations, arbitrations and proceedings concern the
ILECs' denial of physical collocation space to the Company in certain central
offices (COs), the cost and delivery of collocation spaces, the delivery of
transmission facilities and telephone lines, billing issues and other
operational issues. None of these actions involve a potential liability for
the Company. However, failure to resolve any of these matters without undue
delay or expense could have a material adverse effect on the Company's
business, prospects, operating results and financial condition. In addition,
on August 28, 1998, U S WEST Communications sued the Company and one of its
employees and sought a preliminary injunction in federal court in connection
with such employee's departure from U S WEST Communications to join the
Company and the potential improper disclosure of U S WEST Communications'
alleged trade secrets to the Company. The Company is not currently engaged in
any other legal proceedings that it believes could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. The Company is, however, subject to state commission, FCC and court
decisions as they relate to the interpretation and implementation of the
Telecommunications Act of 1996, the interpretation of competitive local
exchange carrier interconnection agreements in general and the Company's
interconnection agreements in particular. In some cases, the Company may be
deemed to be bound by the results of ongoing proceedings of these bodies or
the legal outcomes of other contested interconnection agreements that are
similar to the Company's agreements. The results of any of these proceedings
could have a material adverse effect on the Company's business, prospects,
operating results and financial condition.
9. YEAR 2000 COMPLIANT (UNAUDITED)
The Company has reviewed its internally developed information technology
systems and programs and believes that its systems are Year 2000 compliant and
that there are no significant Year 2000 issues within the Company's systems or
services. The Company has not reviewed its non-information technology systems
for Year 2000 issues relating to embedded microprocessors. To the extent that
such issues exist, these systems may need to be replaced or upgraded to become
Year 2000 compliant. The Company believes that its non-information technology
systems will not present any significant Year 2000 issues, although there can
be no assurance in this regard. In addition, the Company utilizes third-party
equipment and software and interacts with ILECs that have equipment and
software that may not be Year 2000 compliant. Failure of such third-party or
ILEC equipment or software to operate properly with regard to the year 2000
and thereafter could require the Company to incur unanticipated expenses to
remedy any problems, which could have a material adverse effect on the
Company's business, prospects, operating results and financial condition.
Furthermore, the purchasing patterns of the Company's ISP and enterprise
customers may be affected by Year 2000 issues as companies expend significant
resources to correct their current systems for Year 2000 compliance. These
expenditures may result in reduced funds available for the Company's services,
which could have a material adverse effect on the Company's business,
prospects, operating results and financial condition. The Company, to date,
has not made any assessment of the Year 2000 risks associated with its third-
party or ILEC equipment or software or with its ISP and enterprise customers,
has not determined the risks associated with the reasonably likely worst-case
scenario and has not made any contingency plans to address such risks.
However, the Company intends to devise a Year 2000 contingency plan prior to
December 1999.
F-16
<PAGE>
APPENDIX
COVAD COMMUNICATIONS GROUP, INC.
GLOSSARY OF TERMS
Access Line--A circuit that connects a telephone end-user to the ILEC CO.
Analog Modem--A telecommunications device that allows the communication of
digital information over analog telephone lines and through the public
switched telephone network by translating such information in a way that
simulates and uses only the bandwidth of normal voice transmissions.
Asynchronous Transfer Mode (ATM)--A protocol that segments digital
information into 53-byte cells (5-byte header and 48-byte payload) that are
switched throughout a network over virtual circuits. Able to accommodate
multiple types of media (voice, video, data).
Bandwidth--Refers to the maximum amount of data that can be transferred
through a computer's backplane or communication channel in a given time. It is
usually measured in Hertz for analog communications and bits per second for
digital communication.
CO (Central Office)--ILEC facility where subscriber lines are joined to
switching equipment.
CLEC (Competitive Local Exchange Carrier)--Category of telephone service
provider (carrier) that offers services similar to those of the ILEC, as
allowed by recent changes in telecommunications law and regulation. A CLEC may
also provide other types of services such as long distance, Internet access
and entertainment.
CLEC Certification--Granted by a state public service commission or public
utility commission, this certification provides a telecommunications services
provider with the legal standing to offer telecommunications services in
direct competition with the ILEC and other CLECs. Such certifications are
granted on a state-by-state basis.
Communications Act of 1934--The federal legislation governing broadcast and
non-broadcast communications, including both wireless and wired telephone
service, and which established the FCC.
CPE--Customer Premise Equipment.
Digital Service 3 (DS-3)--In the digital hierarchy, this signaling standard
defines a transmission speed of 44.736 Mbps, equivalent to 28 T1 channels;
this term is often used interchangeably with T3.
DSL--Digital Subscriber Line.
FCC (Federal Communications Commission)--The U.S. government agency charged
with the oversight of communications originating in the U.S. and crossing
state lines.
Facilities-Based Provider--A telecommunications provider that delivers its
services to the end-user via owned equipment and leased (or owned) transport
in contrast to a reseller of an ILEC's services.
Frame Relay--A high-speed packet-switched data communications protocol.
G.lite--A specification to define a standard for a mass market version of
ADSL which is interoperable with full rate ADSL but is not as fast. The
specification is intended to reduce the installation complexity and cost of a
consumer DSL solution.
HFC (Hybrid Fiber Coax)--A combination of fiber optic and coaxial cable,
which has become the primary architecture utilized by cable operators in
recent and ongoing upgrades of their systems. An HFC architecture generally
utilizes fiber optic wire between the headend and the nodes and coaxial wire
from nodes to individual end-users.
ILEC (Incumbent Local Exchange Carrier)--The local exchange carrier that was
the monopoly carrier in a region, prior to the opening of local exchange
services to competition.
A-1
<PAGE>
ILEC Collocation--A location serving as the interface point for a CLEC
network's interconnection to that of the ILEC. Collocation can be (i)
physical, in which the CLEC places and directly maintains equipment in the
ILEC CO, or (ii) virtual, in which the CLEC leases a facility, similar to that
which it might build, to effect a presence in the ILEC CO.
Interconnection (Co-Carrier) Agreement--A contract between an ILEC and a
CLEC for the interconnection of the two networks and CLEC access to ILEC UNEs.
These agreements set out the financial and operational aspects of such
interconnection and access.
ISP (Internet Service Provider)--A vendor that provides subscribers access
to the Internet.
ISDN (Integrated Services Digital Network)--ISDN provides standard
interfaces for digital communication networks and is capable of carrying data,
voice, and video over digital circuits. ISDN protocols are used worldwide for
connections to public ISDN networks or to attach ISDN devices to ISDN-capable
PBX systems (ISPBXs). Developed by the International Telecommunications Union,
ISDN includes two user-to-network interfaces: basic rate interface (BRI) and
primary rate interface (PRI). An ISDN interface contains one signaling channel
(D-channel) and a number of information channels ("bearer" or B channels). The
D-channel is used for call setup, control, and call clearing on the B-
channels. It also transports feature information while calls are in progress.
The B-channels carry the voice, data, or video information.
IXC (Interexchange Carrier)--Facilities-based long distance/interLATA
carriers (e.g., AT&T, MCI WorldCom and Sprint), who also provide intraLATA
toll service and may operate as CLECs.
Kbps (Kilobits per second)--One thousand bits per second.
LATA (Local Access and Transport Area)--A geographic area inside of which a
local telephone company can offer switched telecommunications services,
including long distance (known as toll). There are 196 LATAs in the U.S.
Mbps (Megabits Per Second)--One million bits per second.
RBOCs (Regional Bell Operating Companies)--ILECs created by AT&T's
divestiture of its local exchange business. The remaining RBOCs include
BellSouth, Bell Atlantic Corporation, Ameritech Corporation, U S WEST
Communications, Inc. and SBC Communications, Inc.
T1--This is a Bell system term for a digital transmission link with a
capacity of 1.544 Mbps.
UNEs (Unbundled Network Elements)--The various portions of an ILEC's network
that a CLEC can lease for purposes of building a facilities-based competitive
network, including copper lines, CO collocation space, inter-office transport,
operational support systems, local switching and rights of way.
A-2
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATION IN CONNECTION WITH THE OFFER OTHER THAN
THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF ANY OFFER TO BUY ANY SECURITY OTHER THAN THOSE TO WHICH IT RE-
LATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER
TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
THE DATE HEREOF.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 23
Dividend Policy........................................................... 23
Capitalization............................................................ 24
Dilution.................................................................. 25
Selected Consolidated Financial Data...................................... 26
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 28
Business.................................................................. 36
Management................................................................ 55
Certain Relationships and Related Transactions............................ 64
Principal Stockholders.................................................... 67
Description of Capital Stock.............................................. 69
Shares Eligible for Future Sale........................................... 71
Underwriting.............................................................. 73
Legal Matters............................................................. 74
Experts................................................................... 74
Additional Information.................................................... 75
Index to Financial Statements............................................. F-1
Glossary.................................................................. A-1
</TABLE>
UNTIL , 1999 (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPAT-
ING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SHARES
[LOGO]
COVAD COMMUNICATIONS GROUP, INC.
COMMON STOCK
---------------
PROSPECTUS
---------------
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN
DONALDSON, LUFKIN & JENRETTE
GOLDMAN, SACHS & CO.
, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions. All of the amounts shown are estimated
except the Securities and Exchange Commission registration fee, the NASD
filing fee and the Nasdaq National Market listing fee.
<TABLE>
<S> <C>
SEC registration fee............................................... $ 42,406
NASD filing fee.................................................... 14,875
Nasdaq National Market listing fee................................. *
Blue sky fees and expenses......................................... *
Printing and engraving expenses.................................... *
Legal fees and expenses............................................ *
Accounting fees and expenses....................................... *
Transfer agent and registrar fees.................................. *
D&O premium increase............................................... *
Miscellaneous...................................................... *
--------
Total............................................................ $ *
========
</TABLE>
- --------
* To be filed by amendment.
The Company will bear all of the foregoing fees and expenses.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article X of the Registrant's Amended and Restated Certificate of
Incorporation provides for the indemnification of directors to the fullest
extent permissible under Delaware law.
Article VI of the Registrant's Bylaws provides for the indemnification of
officers, directors, employees and agents of the corporation if such person
acted in good faith and in a manner reasonably believed to be in and not
opposed to the best interest of the corporation, and, with respect to any
criminal action or proceeding the indemnified party had no reason to believe
his conduct was unlawful.
Section 145 of the Delaware General Corporation Law permits a corporation to
include in its charter documents, and in agreements between the corporation
and its directors and officers, provisions expanding the scope of
indemnification beyond that specifically provided by the current law.
The Registrant has entered into indemnification agreements with its
directors and executive officers, and intends to enter into indemnification
agreements with any new directors and executive officers in the future.
The Underwriting Agreement included as Exhibit 1.1 to this Registration
Statement contains provisions for the indemnification of the Underwriters and
the Company's directors and officers from certain liabilities, including
liabilities under the Securities Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since its incorporation in October 1996, the Registrant has issued and sold
unregistered securities as follows:
(1) An aggregate of 12,144,000 shares of Common Stock was issued in a
private placement in November 1996 to Messrs. McMinn, Khanna, Haas,
Davidson and Lynch pursuant to Restricted Stock Purchase Agreements. The
consideration received for such shares was $50,600. The Company repurchased
2,410,296 shares of Common Stock issued to Mr. Davidson in July 1997. See
"Certain Transactions."
(2) An aggregate of 1,125,000 shares of Common Stock was issued in a
private placement in July 1997 to Mr. Cardinale pursuant to a Restricted
Stock Purchase Agreement. The consideration received for such shares was
$37,500.
II-1
<PAGE>
(3) An aggregate of 750,000 shares of Series A Preferred Stock was issued
in a private placement in June 1997 to Messrs. McMinn, Khanna, Haas and
Lynch. The aggregate consideration received for such shares was $249,975.
In July 1997, these shares were exchanged for a like number of shares of
Series A Preferred Stock of the Company pursuant to the Exchange Agreement.
(4) An aggregate of 17,000,001 shares of Series B Preferred Stock was
issued in a private placement in July 1997 to Warburg, Crosspoint and
Intel. The aggregate consideration received for such shares was
$8,500,000.50, a portion of which was paid by cancellation of a $500,000
demand note issued to Warburg in June 1997.
(5) An aggregate of 345,000 shares of Common Stock was issued in a
private placement in August 1997 to Mr. Laehy pursuant to a Restricted
Stock Purchase Agreement. The consideration received for such shares was
$17,250.
(6) An aggregate of 144,000 shares of Common Stock was issued in a
private placement in October 1997 to Mr. Marshall pursuant to a Restricted
Stock Purchase Agreement. The consideration received for such shares was
$7,200.
(7) An aggregate of 7,500 shares of Common Stock was issued in a private
placement in December 1997 to one investor pursuant to an Assignment,
Transfer and Sale Agreement and a Restricted Stock Purchase Agreement. The
consideration for such shares was receipt of a Mark and Domain Name.
(8) An aggregate of 100,002 shares of Series B Preferred Stock was issued
in a private placement in February 1998 to Mr. Marshall. The consideration
received for such shares was $100,002.
(9) Warrants for the purchase of an aggregate of 1,800,000 shares of
Common Stock with an exercise price of $0.0033 per share were issued in
February 1998 to Warburg, Crosspoint and Intel in connection with a Series
C Preferred Stock and Warrant Subscription Agreement.
(10) An aggregate of 360,144 shares of Series C Preferred Stock was
issued in a private placement in March 1998 to Intel. The consideration
received for such shares was $999,999.84.
(11) In March 1998, the Registrant issued 260,000 Units consisting of 13
1/2% Senior Discount Notes due 2008 and Warrants to purchase 5,053,764
shares of Common Stock with exercise prices of $0.0033 per share to Bear,
Stearns & Co. Inc. and BT Alex. Brown Incorporated, as initial purchasers,
for resale to qualified institutional buyers. Bear, Stearns & Co. Inc. and
BT Alex. Brown Incorporated received commissions of $4,728,542 for acting
as initial purchasers in connection with this transaction.
(12) An aggregate of 36,015 shares of Series C Preferred Stock was issued
in a private placement in April 1998 to Mr. Hawk. The consideration
received for such shares was $100,001.65.
(13) An aggregate of 96,000 shares of Common Stock was issued in a
private placement pursuant to a Restricted Stock Purchase Agreement in
April 1998 to Mr. Hawk. The consideration received for such shares was
$64,000.
(14) A Warrant for the purchase of an aggregate of 135,000 shares of
Common Stock with an exercise price of $1.00 per share was issued in July
1998 to a consultant in connection with services rendered.
(15) An aggregate of 40,000 shares of Common Stock was issued in a
private placement pursuant to a Restricted Stock Purchase Agreement in
August 1998 to Mr. Hawk. The consideration received for such shares was
$230,000.
(16) An aggregate of 9,000 shares of Common Stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in October 1998
to one investor. The consideration received for such shares was services
rendered.
(17) An aggregate of 8,778 shares of Common Stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in November
1998 to two consultants. The consideration received for such shares was
services rendered.
(18) An aggregate of 8,000 shares of Common Stock was issued in a private
placement pursuant to a Restricted Stock Purchase Agreement in December
1998 to a consultant. The consideration received for such shares was
services rendered.
II-2
<PAGE>
(19) From July 1997 through December 15, 1998, the Registrant granted
stock options to purchase an aggregate of 13,149,790 shares of Common Stock
to employees, consultants and directors with exercise prices ranging from
$0.0333 to $8.16 per share pursuant to the Registrant's 1997 Stock Plan. To
date, 157,768 shares of Common Stock have been issued upon exercise of
vested options.
No underwriters were used in connection with these sales and issuances
except for the issuance of the Senior Discount Notes and related warrants in
(11) above. The sales and issuances of these securities except for those in
note (11) were exempt from registration under the Securities Act pursuant to
Rule 701 promulgated thereunder on the basis that these options were offered
and sold either pursuant to a written compensatory benefit plan or pursuant to
written contracts relating to consideration, as provided by Rule 701, or
pursuant to Section 4(2) thereof on the basis that the transactions did not
involve a public offering. The sales and issuance in note (11) were exempt
from registration under the Securities Act pursuant to Section 4(2) and, in
connection with the resale by the initial purchasers of the securities
described in note (11), Rule 144A thereunder.
II-3
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1** Amended and Restated Certificate of Incorporation, as currently in
effect.
3.2** Form of Amended and Restated Certificate of Incorporation of the
Registrant to be effective immediately following the closing of the
offering.
3.3** Bylaws, as currently in effect.
3.4** Form of Bylaws of the Registrant to be effective upon the closing of
the offering.
4.1** Indenture dated as of March 11, 1998 between the Registrant and The
Bank of New York, including form of 13 1/2% Senior Discount Note Due
2008.
4.2** Registration Rights Agreement dated as of March 11, 1998 among the
Registrant and Bear, Stearns & Co. Inc. and BT Alex. Brown (the
"Initial Purchasers").
4.3** Warrant Agreement dated as of March 11, 1998 between the Registrant
and The Bank of New York.
4.4** Warrant Registration Rights Agreement dated as of March 11, 1998 among
the Registrant and the Initial Purchasers.
4.5** Specimen 13 1/2% Senior Discount Note Due 2008, Series B.
4.6** Amended and Restated Stockholders Rights Agreement dated March 11,
1998 among the Registrant and certain of its stockholders, as amended
by Amendment No. 1 to the Amended and Restated Stockholder Rights
Agreement among the Registrant and certain of its stockholders dated
as of April 24, 1998.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation.
10.1** Form of Indemnification Agreement entered into between the Registrant
and each of the Registrant's executive officers and directors.
10.2** Employment Agreement entered into between the Registrant and Rex
Cardinale.
10.3** Employment Agreement entered into between the Registrant and Dhruv
Khanna.
10.4 1997 Stock Plan and related option agreement, as currently in effect.
10.5** Series C Preferred Stock and Warrant Subscription Agreement dated as
of February 20, 1998 among the Registrant, Warburg, Pincus Ventures,
L.P., Crosspoint Venture Partners 1996 and Intel Corporation, as
amended by the Assignment and Assumption Agreement and First Amendment
to the Series C Preferred Stock and Warrant Subscription Agreement
dated as of April 24, 1998 among the Registrant, Warburg, Crosspoint
and Robert Hawk.
10.6* Employment Agreement dated June 21, 1998 between the Registrant and
Robert E. Knowling, Jr.
10.7** Sublease Agreement dated July 6, 1998 between Auspex Systems, Inc. and
the Registrant with respect to Registrant's facilities in Santa Clara,
California.
10.8 1998 Employee Stock Purchase Plan and related agreements in the form
to be effective upon the closing of the offering.
10.9* Note Secured by Deed of Trust dated August 14, 1998 issued by Robert
E. Knowling, Jr. in favor of the Registrant.
10.10** Form of Warrant to purchase Common Stock issued by the Registrant on
February 20, 1998 to Warburg, Pincus Ventures, L.P., Crosspoint
Venture Partners 1996 and Intel Corporation.
10.11* Note Secured by Deed of Trust dated October 7, 1998 issued by
Catherine A. Hemmer and John J. Hemmer in favor of the Registrant.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.12 1997 Stock Plan and related option agreement in the form to be
effective upon the closing of the offering.
21.1** Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
23.2** Consent of Counsel.
24.1** Power of Attorney.
27.1 Financial Data Schedules.
</TABLE>
- --------
* To be filed by amendment.
** Previously filed.
(b) Financial Statement Schedules
Schedules not listed above have been omitted because the information to be
set forth therein is not applicable or is shown in the financial statements or
Notes thereto.
ITEM 17. UNDERTAKINGS
1. 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.
2. The undersigned Registrant hereby undertakes:
(a) 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; and
(b) For purposes of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE
REGISTRANT HAS DULY CAUSED THIS AMENDMENT TO THE REGISTRATION STATEMENT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE
CITY OF SANTA CLARA, STATE OF CALIFORNIA ON DECEMBER 18, 1998
COVAD COMMUNICATIONS GROUP, INC.
/s/ TIMOTHY LAEHY
By: _________________________________
TIMOTHY LAEHY
CHIEF FINANCIAL OFFICER, TREASURER
AND VICE PRESIDENT, FINANCE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON
DECEMBER 18, 1998 IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
* Chairman of the Board of Directors
___________________________________________
(CHARLES MCMINN)
/s/ ROBERT KNOWLING, JR. President, Chief Executive Officer and
___________________________________________ Director (Principal Executive Officer)
(ROBERT KNOWLING, JR.)
/s/ TIMOTHY LAEHY Chief Financial Officer, Treasurer and Vice
___________________________________________ President, Finance (Principal Financial
(TIMOTHY LAEHY) and Accounting Officer)
* Director
___________________________________________
(ROBERT HAWK)
* Director
___________________________________________
(HENRY KRESSEL)
* Director
___________________________________________
(JOSEPH LANDY)
* Director
___________________________________________
(DANIEL LYNCH)
* Director
___________________________________________
(FRANK MARSHALL)
* Director
___________________________________________
(RICH SHAPERO)
/s/ TIMOTHY LAEHY
*By: ______________________________________
TIMOTHY LAEHY, ATTORNEY-IN-FACT
</TABLE>
II-6
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
REGISTRATION STATEMENT ON FORM S-1
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1** Amended and Restated Certificate of Incorporation, as currently in
effect.
3.2** Form of Amended and Restated Certificate of Incorporation of the
Registrant to be effective immediately following the closing of the
offering.
3.3** Bylaws, as currently in effect.
3.4** Form of Bylaws of the Registrant to be effective upon the closing of
the offering.
4.1** Indenture dated as of March 11, 1998 between the Registrant and The
Bank of New York, including form of 13 1/2% Senior Discount Note Due
2008.
4.2** Registration Rights Agreement dated as of March 11, 1998 among the
Registrant and Bear, Stearns & Co. Inc. and BT Alex. Brown (the
"Initial Purchasers").
4.3** Warrant Agreement dated as of March 11, 1998 between the Registrant
and The Bank of New York.
4.4** Warrant Registration Rights Agreement dated as of March 11, 1998 among
the Registrant and the Initial Purchasers.
4.5** Specimen 13 1/2% Senior Discount Note Due 2008, Series B.
4.6** Amended and Restated Stockholders Rights Agreement dated March 11,
1998 among the Registrant and certain of its stockholders, as amended
by Amendment No. 1 to the Amended and Restated Stockholder Rights
Agreement among the Registrant and certain of its stockholders dated
as of April 24, 1998.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation.
10.1** Form of Indemnification Agreement entered into between the Registrant
and each of the Registrant's executive officers and directors.
10.2** Employment Agreement entered into between the Registrant and Rex
Cardinale.
10.3** Employment Agreement entered into between the Registrant and Dhruv
Khanna.
10.4 1997 Stock Plan and related option agreement, as currently in effect.
10.5** Series C Preferred Stock and Warrant Subscription Agreement dated as
of February 20, 1998 among the Registrant, Warburg, Pincus Ventures,
L.P., Crosspoint Venture Partners 1996 and Intel Corporation, as
amended by the Assignment and Assumption Agreement and First Amendment
to the Series C Preferred Stock and Warrant Subscription Agreement
dated as of April 24, 1998 among the Registrant, Warburg, Crosspoint
and Robert Hawk.
10.6* Employment Agreement dated June 21, 1998 between the Registrant and
Robert E. Knowling, Jr.
10.7** Sublease Agreement dated July 6, 1998 between Auspex Systems, Inc. and
the Registrant with respect to Registrant's facilities in Santa Clara,
California.
10.8 1998 Employee Stock Purchase Plan and related agreements in the form
to be effective upon the closing of the offering.
10.9* Note Secured by Deed of Trust dated August 14, 1998 issued by Robert
E. Knowling, Jr. in favor of the Registrant.
10.10** Form of Warrant to purchase Common Stock issued by the Registrant on
February 20, 1998 to Warburg, Pincus Ventures, L.P., Crosspoint
Venture Partners 1996 and Intel Corporation.
</TABLE>
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
REGISTRATION STATEMENT ON FORM S-1
INDEX TO EXHIBITS--(CONTINUED)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.11* Note Secured by Deed of Trust dated October 7, 1998 issued by
Catherine A. Hemmer and John J. Hemmer in favor of the Registrant.
10.12 1997 Stock Plan and related option agreement in the form to be
effective upon the closing of the offering.
21.1** Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
23.2** Consent of Counsel.
24.1** Power of Attorney.
27.1 Financial Data Schedules.
</TABLE>
- --------
* To be filed by amendment.
** Previously filed.
<PAGE>
EXHIBIT 10.4
COVAD COMMUNICATIONS GROUP, INC.
1997 STOCK PLAN
(AMENDED DECEMBER, 1998)
1. Purposes of the Plan. The purposes of this Stock Plan are to attract
--------------------
and retain the best available personnel for positions of substantial
responsibility, to provide additional incentive to Employees, Directors and
Consultants and to promote the success of the Company's business. Options
granted under the Plan may be Incentive Stock Options or Nonstatutory Stock
Options, as determined by the Administrator at the time of grant. Stock
Purchase Rights may also be granted under the Plan.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" means the Board or any of its Committees as shall
-------------
be administering the Plan in accordance with Section 4 hereof.
(b) "Applicable Laws" means the requirements relating to the
---------------
administration of stock option plans under U.S. state corporate laws, U.S.
federal and state securities laws, the Code, any stock exchange or quotation
system on which the Common Stock is listed or quoted and the applicable laws of
any other country or jurisdiction where Options or Stock Purchase Rights are
granted under the Plan.
(c) "Board" means the Board of Directors of the Company.
-----
(d) "Code" means the Internal Revenue Code of 1986, as amended.
----
(e) "Committee" means a committee of Directors appointed by the Board
---------
in accordance with Section 4 hereof.
(f) "Common Stock" means the Common Stock of the Company.
------------
(g) "Company" means Covad Communications Group, Inc., a Delaware
-------
corporation.
(h) "Consultant" means any person who is engaged by the Company or
----------
any Parent or Subsidiary to render consulting or advisory services to such
entity.
(i) "Director" means a member of the Board of Directors of the
--------
Company.
(j) "Disability" means total and permanent disability as defined in
----------
Section 22(e)(3) of the Code.
<PAGE>
(k) "Employee" means any person, including Officers and Directors,
--------
employed by the Company or any Parent or Subsidiary of the Company. A Service
Provider shall not cease to be an Employee in the case of (i) any leave of
absence approved by the Company or (ii) transfers between locations of the
Company or between the Company, its Parent, any Subsidiary, or any successor.
For purposes of Incentive Stock Options, no such leave may exceed ninety days,
unless reemployment upon expiration of such leave is guaranteed by statute or
contract. If reemployment upon expiration of a leave of absence approved by the
Company is not so guaranteed, on the 181st day of such leave any Incentive Stock
Option held by the Optionee shall cease to be treated as an Incentive Stock
Option and shall be treated for tax purposes as a Nonstatutory Stock Option.
Neither service as a Director nor payment of a director's fee by the Company
shall be sufficient to constitute "employment" by the Company.
(l) "Exchange Act" means the Securities Exchange Act of 1934, as
------------
amended.
(m) "Fair Market Value" means, as of any date, the value of Common
-----------------
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system, including without limitation the Nasdaq
National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its
Fair Market Value shall be the closing sales price for such stock (or the
closing bid, if no sales were reported) as quoted on such exchange or system for
the last market trading day prior to the time of determination, as reported in
The Wall Street Journal or such other source as the Administrator deems
reliable;
(ii) If the Common Stock is regularly quoted by a recognized
securities dealer but selling prices are not reported, its Fair Market Value
shall be the mean between the high bid and low asked prices for the Common Stock
on the last market trading day prior to the day of determination; or
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(n) "Incentive Stock Option" means an Option intended to qualify as
----------------------
an incentive stock option within the meaning of Section 422 of the Code.
(o) "Nonstatutory Stock Option" means an Option not intended to
-------------------------
qualify as an Incentive Stock Option.
(p) "Officer" means a person who is an officer of the Company within
-------
the meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.
(q) "Option" means a stock option granted pursuant to the Plan.
------
-2-
<PAGE>
(r) "Option Agreement" means a written or electronic agreement
----------------
between the Company and an Optionee evidencing the terms and conditions of an
individual Option grant. The Option Agreement is subject to the terms and
conditions of the Plan.
(s) "Option Exchange Program" means a program whereby outstanding
-----------------------
Options are exchanged for Options with a lower exercise price.
(t) "Optioned Stock" means the Common Stock subject to an Option or a
--------------
Stock Purchase Right.
(u) "Optionee" means the holder of an outstanding Option or Stock
--------
Purchase Right granted under the Plan.
(v) "Parent" means a "parent corporation," whether now or hereafter
------
existing, as defined in Section 424(e) of the Code.
(w) "Plan" means this 1997 Stock Plan.
----
(x) "Restricted Stock" means shares of Common Stock acquired pursuant
----------------
to a grant of a Stock Purchase Right under Section 11 below.
(y) "Section 16(b)" means Section 16(b) of the Securities Exchange
-------------
Act of 1934, as amended.
(z) "Service Provider" means an Employee, Director or Consultant.
----------------
(aa) "Share" means a share of the Common Stock, as adjusted in
-----
accordance with Section 12 below.
(bb) "Stock Purchase Right" means a right to purchase Common Stock
--------------------
pursuant to Section 11 below.
(cc) "Subsidiary" means a "subsidiary corporation," whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 12 of
-------------------------
the Plan, the maximum aggregate number of Shares which may be subject to option
and sold under the Plan is 16,196,727 Shares. The Shares may be authorized but
unissued, or reacquired Common Stock.
If an Option or Stock Purchase Right expires or becomes unexercisable
without having been exercised in full, or is surrendered pursuant to an Option
Exchange Program, the unpurchased Shares which were subject thereto shall become
available for future grant or sale under the Plan (unless the Plan has
terminated). However, Shares that have actually been issued
-3-
<PAGE>
under the Plan, upon exercise of either an Option or Stock Purchase Right, shall
not be returned to the Plan and shall not become available for future
distribution under the Plan, except that if Shares of Restricted Stock are
repurchased by the Company at their original purchase price, such Shares shall
become available for future grant under the Plan.
4. Administration of the Plan.
--------------------------
(a) Administrator. The Plan shall be administered by the Board or a
-------------
Committee appointed by the Board, which Committee shall be constituted to comply
with Applicable Laws.
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan and, in the case of a Committee, the specific duties delegated by the Board
to such Committee, and subject to the approval of any relevant authorities, the
Administrator shall have the authority in its discretion:
(i) to determine the Fair Market Value;
(ii) to select the Service Providers to whom Options and Stock
Purchase Rights may from time to time be granted hereunder;
(iii) to determine the number of Shares to be covered by each
such award granted hereunder;
(iv) to approve forms of agreement for use under the Plan;
(v) to determine the terms and conditions, of any Option or
Stock Purchase Right granted hereunder. Such terms and conditions include, but
are not limited to, the exercise price, the time or times when Options or Stock
Purchase Rights may be exercised (which may be based on performance criteria),
any vesting acceleration or waiver of forfeiture restrictions, and any
restriction or limitation regarding any Option or Stock Purchase Right or the
Common Stock relating thereto, based in each case on such factors as the
Administrator, in its sole discretion, shall determine;
(vi) to determine whether and under what circumstances an
Option may be settled in cash under subsection 9(e) instead of Common Stock;
(vii) to reduce the exercise price of any Option to the then
current Fair Market Value if the Fair Market Value of the Common Stock covered
by such Option has declined since the date the Option was granted;
(viii) to initiate an Option Exchange Program;
-4-
<PAGE>
(ix) to prescribe, amend and rescind rules and regulations
relating to the Plan, including rules and regulations relating to sub-plans
established for the purpose of qualifying for preferred tax treatment under
foreign tax laws;
(x) to allow Optionees to satisfy withholding tax obligations by
electing to have the Company withhold from the Shares to be issued upon exercise
of an Option or Stock Purchase Right that number of Shares having a Fair Market
Value equal to the amount required to be withheld. The Fair Market Value of the
Shares to be withheld shall be determined on the date that the amount of tax to
be withheld is to be determined. All elections by Optionees to have Shares
withheld for this purpose shall be made in such form and under such conditions
as the Administrator may deem necessary or advisable; and
(xi) to construe and interpret the terms of the Plan and awards
granted pursuant to the Plan.
(c) Effect of Administrator's Decision. All decisions,
----------------------------------
determinations and interpretations of the Administrator shall be final and
binding on all Optionees.
5. Eligibility.
-----------
(a) Nonstatutory Stock Options and Stock Purchase Rights may be
granted to Service Providers. Incentive Stock Options may be granted only to
Employees.
(b) Each Option shall be designated in the Option Agreement as either
an Incentive Stock Option or a Nonstatutory Stock Option. However,
notwithstanding such designation, to the extent that the aggregate Fair Market
Value of the Shares with respect to which Incentive Stock Options are
exercisable for the first time by the Optionee during any calendar year (under
all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such
Options shall be treated as Nonstatutory Stock Options. For purposes of this
Section 5(b), Incentive Stock Options shall be taken into account in the order
in which they were granted. The Fair Market Value of the Shares shall be
determined as of the time the Option with respect to such Shares is granted.
(c) Neither the Plan nor any Option or Stock Purchase Right shall
confer upon any Optionee any right with respect to continuing the Optionee's
relationship as a Service Provider with the Company, nor shall it interfere in
any way with his or her right or the Company's right to terminate such
relationship at any time, with or without cause.
6. Term of Plan. The Plan shall become effective upon its adoption by
------------
the Board. It shall continue in effect for a term of ten (10) years unless
sooner terminated under Section 14 of the Plan.
-5-
<PAGE>
7. Term of Option. The term of each Option shall be stated in the Option
--------------
Agreement; provided, however, that the term shall be no more than ten (10) years
from the date of grant thereof. In the case of an Incentive Stock Option
granted to an Optionee who, at the time the Option is granted, owns stock
representing more than ten percent (10%) of the voting power of all classes of
stock of the Company or any Parent or Subsidiary, the term of the Option shall
be five (5) years from the date of grant or such shorter term as may be provided
in the Option Agreement.
8. Option Exercise Price and Consideration.
---------------------------------------
(a) The per share exercise price for the Shares to be issued upon
exercise of an Option shall be such price as is determined by the Administrator,
but shall be subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time of grant of
such Option, owns stock representing more than ten percent (10%) of the voting
power of all classes of stock of the Company or any Parent or Subsidiary, the
exercise price shall be no less than 110% of the Fair Market Value per Share on
the date of grant.
(B) granted to any other Employee, the per Share exercise
price shall be no less than 100% of the Fair Market Value per Share on the date
of grant.
(ii) In the case of a Nonstatutory Stock Option
(A) granted to a Service Provider who, at the time of
grant of such Option, owns stock representing more than ten percent (10%) of the
voting power of all classes of stock of the Company or any Parent or Subsidiary,
the exercise price shall be no less than 110% of the Fair Market Value per Share
on the date of grant.
(B) granted to any other Service Provider, the per Share
exercise price shall be no less than 85% of the Fair Market Value per Share on
the date of grant.
(iii) Notwithstanding the foregoing, Options may be granted with
a per Share exercise price other than as required above pursuant to a merger or
other corporate transaction.
(b) The consideration to be paid for the Shares to be issued upon
exercise of an Option, including the method of payment, shall be determined by
the Administrator (and, in the case of an Incentive Stock Option, shall be
determined at the time of grant). Such consideration may consist of (1) cash,
(2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares
acquired upon exercise of an Option, have been owned by the Optionee for more
than six months on the date of surrender, and (y) have a Fair Market Value on
the date of surrender equal to the aggregate exercise price of the Shares as to
which such Option shall be exercised, (5)
-6-
<PAGE>
consideration received by the Company under a cashless exercise program
implemented by the Company in connection with the Plan, or (6) any combination
of the foregoing methods of payment. In making its determination as to the type
of consideration to accept, the Administrator shall consider if acceptance of
such consideration may be reasonably expected to benefit the Company.
9. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Stockholder. Any Option
-----------------------------------------------
granted hereunder shall be exercisable according to the terms hereof at such
times and under such conditions as determined by the Administrator and set forth
in the Option Agreement. Except in the case of Options granted to Officers,
Directors and Consultants, Options shall become exercisable at a rate of no less
than 20% per year over five (5) years from the date the Options are granted.
Unless the Administrator provides otherwise, vesting of Options granted
hereunder shall be tolled during any unpaid leave of absence. An Option may not
be exercised for a fraction of a Share.
An Option shall be deemed exercised when the Company receives:
(i) written or electronic notice of exercise (in accordance with the Option
Agreement) from the person entitled to exercise the Option, and (ii) full
payment for the Shares with respect to which the Option is exercised. Full
payment may consist of any consideration and method of payment authorized by the
Administrator and permitted by the Option Agreement and the Plan. Shares issued
upon exercise of an Option shall be issued in the name of the Optionee or, if
requested by the Optionee, in the name of the Optionee and his or her spouse.
Until the Shares are issued (as evidenced by the appropriate entry on the books
of the Company or of a duly authorized transfer agent of the Company), no right
to vote or receive dividends or any other rights as a stockholder shall exist
with respect to the Shares, notwithstanding the exercise of the Option. The
Company shall issue (or cause to be issued) such Shares promptly after the
Option is exercised. No adjustment will be made for a dividend or other right
for which the record date is prior to the date the Shares are issued, except as
provided in Section 12 of the Plan.
Exercise of an Option in any manner shall result in a decrease in
the number of Shares thereafter available, both for purposes of the Plan and for
sale under the Option, by the number of Shares as to which the Option is
exercised.
(b) Termination of Relationship as a Service Provider. If an Optionee
-------------------------------------------------
ceases to be a Service Provider, such Optionee may exercise his or her Option
within such period of time as is specified in the Option Agreement (of at least
thirty (30) days) to the extent that the Option is vested on the date of
termination (but in no event later than the expiration of the term of the Option
as set forth in the Option Agreement). In the absence of a specified time in the
Option Agreement, the Option shall remain exercisable for three (3) months
following the Optionee's termination. If, on the date of termination, the
Optionee is not vested as to his or her entire Option, the Shares covered by the
unvested portion of the Option shall revert to the Plan. If, after
-7-
<PAGE>
termination, the Optionee does not exercise his or her Option within the time
specified by the Administrator, the Option shall terminate, and the Shares
covered by such Option shall revert to the Plan.
(c) Disability of Optionee. If an Optionee ceases to be a Service
----------------------
Provider as a result of the Optionee's Disability, the Optionee may exercise his
or her Option within such period of time as is specified in the Option Agreement
(of at least six (6) months) to the extent the Option is vested on the date of
termination (but in no event later than the expiration of the term of such
Option as set forth in the Option Agreement). In the absence of a specified
time in the Option Agreement, the Option shall remain exercisable for twelve
(12) months following the Optionee's termination. If, on the date of
termination, the Optionee is not vested as to his or her entire Option, the
Shares covered by the unvested portion of the Option shall revert to the Plan.
If, after termination, the Optionee does not exercise his or her Option within
the time specified herein, the Option shall terminate, and the Shares covered by
such Option shall revert to the Plan.
(d) Death of Optionee. If an Optionee dies while a Service Provider,
-----------------
the Option may be exercised within such period of time as is specified in the
Option Agreement (of at least six (6) months) to the extent that the Option is
vested on the date of death (but in no event later than the expiration of the
term of such Option as set forth in the Option Agreement) by the Optionee's
estate or by a person who acquires the right to exercise the Option by bequest
or inheritance. In the absence of a specified time in the Option Agreement, the
Option shall remain exercisable for twelve (12) months following the Optionee's
termination. If, at the time of death, the Optionee is not vested as to the
entire Option, the Shares covered by the unvested portion of the Option shall
immediately revert to the Plan. If the Option is not so exercised within the
time specified herein, the Option shall terminate, and the Shares covered by
such Option shall revert to the Plan.
(e) Buyout Provisions. The Administrator may at any time offer to
-----------------
buy out for a payment in cash or Shares, an Option previously granted, based on
such terms and conditions as the Administrator shall establish and communicate
to the Optionee at the time that such offer is made.
10. Non-Transferability of Options and Stock Purchase Rights. The Options
--------------------------------------------------------
and Stock Purchase Rights may not be sold, pledged, assigned, hypothecated,
transferred, or disposed of in any manner other than by will or by the laws of
descent or distribution and may be exercised, during the lifetime of the
Optionee, only by the Optionee.
11. Stock Purchase Rights.
---------------------
(a) Rights to Purchase. Stock Purchase Rights may be issued either
------------------
alone, in addition to, or in tandem with other awards granted under the Plan
and/or cash awards made outside of the Plan. After the Administrator determines
that it will offer Stock Purchase Rights under the Plan, it shall advise the
offeree in writing or electronically of the terms, conditions and restrictions
related to the offer, including the number of Shares that such person shall be
entitled to
-8-
<PAGE>
purchase, the price to be paid, and the time within which such person must
accept such offer. The terms of the offer shall comply in all respects with
Section 260.140.42 of Title 10 of the California Code of Regulations. The offer
shall be accepted by execution of a Restricted Stock purchase agreement in the
form determined by the Administrator.
(b) Repurchase Option. Unless the Administrator determines
-----------------
otherwise, the Restricted Stock purchase agreement shall grant the Company a
repurchase option exercisable upon the voluntary or involuntary termination of
the purchaser's service with the Company for any reason (including death or
disability). The purchase price for Shares repurchased pursuant to the
Restricted Stock purchase agreement shall be the original price paid by the
purchaser and may be paid by cancellation of any indebtedness of the purchaser
to the Company. The repurchase option shall lapse at such rate as the
Administrator may determine. Except with respect to Shares purchased by
Officers, Directors and Consultants, the repurchase option shall in no case
lapse at a rate of less than 20% per year over five (5) years from the date of
purchase.
(c) Other Provisions. The Restricted Stock purchase agreement shall
----------------
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the Administrator in its sole discretion.
(d) Rights as a Stockholder. Once the Stock Purchase Right is
-----------------------
exercised, the purchaser shall have rights equivalent to those of a stockholder
and shall be a stockholder when his or her purchase is entered upon the records
of the duly authorized transfer agent of the Company. No adjustment shall be
made for a dividend or other right for which the record date is prior to the
date the Stock Purchase Right is exercised, except as provided in Section 12 of
the Plan.
12. Adjustments Upon Changes in Capitalization, Merger or Asset Sale.
----------------------------------------------------------------
(a) Changes in Capitalization. Subject to any required action by the
-------------------------
stockholders of the Company, the number of shares of Common Stock covered by
each outstanding Option or Stock Purchase Right, and the number of shares of
Common Stock which have been authorized for issuance under the Plan but as to
which no Options or Stock Purchase Rights have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option or Stock
Purchase Right, as well as the price per share of Common Stock covered by each
such outstanding Option or Stock Purchase Right, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of issued shares of Common Stock effected without receipt
of consideration by the Company. The conversion of any convertible securities
of the Company shall not be deemed to have been "effected without receipt of
consideration." Such adjustment shall be made by the Board, whose determination
in that respect shall be final, binding and conclusive. Except as expressly
provided herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason
-9-
<PAGE>
thereof shall be made with respect to, the number or price of shares of Common
Stock subject to an Option or Stock Purchase Right.
(b) Dissolution or Liquidation. In the event of the proposed
--------------------------
dissolution or liquidation of the Company, the Administrator shall notify each
Optionee as soon as practicable prior to the effective date of such proposed
transaction. The Administrator in its discretion may provide for an Optionee to
have the right to exercise his or her Option or Stock Purchase Right until
fifteen (15) days prior to such transaction as to all of the Optioned Stock
covered thereby, including Shares as to which the Option or Stock Purchase Right
would not otherwise be exercisable. In addition, the Administrator may provide
that any Company repurchase option applicable to any Shares purchased upon
exercise of an Option or Stock Purchase Right shall lapse as to all such Shares,
provided the proposed dissolution or liquidation takes place at the time and in
the manner contemplated. To the extent it has not been previously exercised, an
Option or Stock Purchase Right will terminate immediately prior to the
consummation of such proposed action.
(c) Merger or Asset Sale. In the event of a merger of the Company
--------------------
with or into another corporation, or the sale of substantially all of the assets
of the Company, each outstanding Option and Stock Purchase Right shall be
assumed or an equivalent option or right substituted by the successor
corporation or a Parent or Subsidiary of the successor corporation. In the event
that the successor corporation refuses to assume or substitute for the Option or
Stock Purchase Right, the Optionee shall fully vest in and have the right to
exercise the Option or Stock Purchase Right as to all of the Optioned Stock,
including Shares as to which it would not otherwise be vested or exercisable. If
an Option or Stock Purchase Right becomes fully vested and exercisable in lieu
of assumption or substitution in the event of a merger or sale of assets, the
Administrator shall notify the Optionee in writing or electronically that the
Option or Stock Purchase Right shall be fully exercisable for a period of
fifteen (15) days from the date of such notice, and the Option or Stock Purchase
Right shall terminate upon the expiration of such period. For the purposes of
this paragraph, the Option or Stock Purchase Right shall be considered assumed
if, following the merger or sale of assets, the option or right confers the
right to purchase or receive, for each Share of Optioned Stock subject to the
Option or Stock Purchase Right immediately prior to the merger or sale of
assets, the consideration (whether stock, cash, or other securities or property)
received in the merger or sale of assets by holders of Common Stock for each
Share held on the effective date of the transaction (and if holders were offered
a choice of consideration, the type of consideration chosen by the holders of a
majority of the outstanding Shares); provided, however, that if such
consideration received in the merger or sale of assets is not solely common
stock of the successor corporation or its Parent, the Administrator may, with
the consent of the successor corporation, provide for the consideration to be
received upon the exercise of the Option or Stock Purchase Right, for each Share
of Optioned Stock subject to the Option or Stock Purchase Right, to be solely
common stock of the successor corporation or its Parent equal in fair market
value to the per share consideration received by holders of Common Stock in the
merger or sale of assets.
-10-
<PAGE>
13. Time of Granting Options and Stock Purchase Rights. The date of grant
--------------------------------------------------
of an Option or Stock Purchase Right shall, for all purposes, be the date on
which the Administrator makes the determination granting such Option or Stock
Purchase Right, or such other date as is determined by the Administrator.
Notice of the determination shall be given to each Service Provider to whom an
Option or Stock Purchase Right is so granted within a reasonable time after the
date of such grant.
14. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may at any time amend,
-------------------------
alter, suspend or terminate the Plan.
(b) Stockholder Approval. The Board shall obtain stockholder
--------------------
approval of any Plan amendment to the extent necessary and desirable to comply
with Applicable Laws.
(c) Effect of Amendment or Termination. No amendment, alteration,
----------------------------------
suspension or termination of the Plan shall impair the rights of any Optionee,
unless mutually agreed otherwise between the Optionee and the Administrator,
which agreement must be in writing and signed by the Optionee and the Company.
Termination of the Plan shall not affect the Administrator's ability to exercise
the powers granted to it hereunder with respect to Options granted under the
Plan prior to the date of such termination.
15. Conditions Upon Issuance of Shares.
----------------------------------
(a) Legal Compliance. Shares shall not be issued pursuant to the
----------------
exercise of an Option unless the exercise of such Option and the issuance and
delivery of such Shares shall comply with Applicable Laws and shall be further
subject to the approval of counsel for the Company with respect to such
compliance.
(b) Investment Representations. As a condition to the exercise of an
--------------------------
Option, the Administrator may require the person exercising such Option to
represent and warrant at the time of any such exercise that the Shares are being
purchased only for investment and without any present intention to sell or
distribute such Shares if, in the opinion of counsel for the Company, such a
representation is required.
16. Inability to Obtain Authority. The inability of the Company to obtain
-----------------------------
authority from any regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the lawful issuance and sale
of any Shares hereunder, shall relieve the Company of any liability in respect
of the failure to issue or sell such Shares as to which such requisite authority
shall not have been obtained.
-11-
<PAGE>
17. Reservation of Shares. The Company, during the term of this Plan,
---------------------
shall at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.
18. Stockholder Approval. The Plan shall be subject to approval by the
--------------------
stockholders of the Company within twelve (12) months after the date the Plan is
adopted. Such stockholder approval shall be obtained in the degree and manner
required under Applicable Laws.
19. Information to Optionees and Purchasers. The Company shall provide to
---------------------------------------
each Optionee and to each individual who acquires Shares pursuant to the Plan,
not less frequently than annually during the period such Optionee or purchaser
has one or more Options or Stock Purchase Rights outstanding, and, in the case
of an individual who acquires Shares pursuant to the Plan, during the period
such individual owns such Shares, copies of annual financial statements. The
Company shall not be required to provide such statements to key employees whose
duties in connection with the Company assure their access to equivalent
information.
-12-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
1997 STOCK PLAN
STOCK OPTION AGREEMENT
Unless otherwise defined herein, the terms defined in the Plan shall have
the same defined meanings in this Option Agreement.
I. NOTICE OF STOCK OPTION GRANT
----------------------------
[Optionee's Name and Address]
The undersigned Optionee has been granted an Option to purchase Common
Stock of the Company, subject to the terms and conditions of the Plan and this
Option Agreement, as follows:
Grant Number _________________________
Date of Grant _________________________
Vesting Commencement Date _________________________
Exercise Price per Share $________________________
Total Number of Shares Granted _________________________
Total Exercise Price $_________________________
Type of Option: Incentive Stock Option
---
____ Nonstatutory Stock Option
Term/Expiration Date: _________________________
Vesting Schedule:
----------------
This Option shall be exercisable, in whole or in part, according to the
following vesting schedule:
<PAGE>
12.5% of the Shares subject to the Option shall vest six months on the
Vesting Commencement Date, and 1/48 of the Shares subject to the Option shall
vest each month thereafter, subject to Optionee's continuing to be a Service
Provider on such dates.
Termination Period:
------------------
This Option shall be exercisable for thirty days after Optionee ceases to
be a Service Provider. Upon Optionee's death or Disability, this Option may be
exercised for one year after Optionee ceases to be a Service Provider. In no
event may Optionee exercise this Option after the Term/Expiration Date as
provided above.
II. AGREEMENT
---------
1. Grant of Option. The Plan Administrator of the Company hereby grants
---------------
to the Optionee named in the Notice of Grant (the "Optionee"), an option (the
"Option") to purchase the number of Shares set forth in the Notice of Grant, at
the exercise price per Share set forth in the Notice of Grant (the "Exercise
Price"), and subject to the terms and conditions of the Plan, which is
incorporated herein by reference. Subject to Section 14(c) of the Plan, in the
event of a conflict between the terms and conditions of the Plan and this Option
Agreement, the terms and conditions of the Plan shall prevail.
If designated in the Notice of Grant as an Incentive Stock Option
("ISO"), this Option is intended to qualify as an Incentive Stock Option as
defined in Section 422 of the Code. Nevertheless, to the extent that it exceeds
the $100,000 rule of Code Section 422(d), this Option shall be treated as a
Nonstatutory Stock Option ("NSO").
2. Exercise of Option.
------------------
(a) Right to Exercise. This Option shall be exercisable during its
-----------------
term in accordance with the Vesting Schedule set out in the Notice of Grant and
with the applicable provisions of the Plan and this Option Agreement.
(b) Method of Exercise. This Option shall be exercisable by delivery
------------------
of an exercise notice in the form attached as Exhibit A (the Exercise Notice@)
which shall state the election to exercise the Option, the number of Shares with
respect to which the Option is being exercised, and such other representations
and agreements as may be required by the Company. The Exercise Notice shall be
accompanied by payment of the aggregate Exercise Price as to all Exercised
Shares. This Option shall be deemed to be exercised upon receipt by the Company
of such fully executed Exercise Notice accompanied by the aggregate Exercise
Price.
No Shares shall be issued pursuant to the exercise of an Option unless
such issuance and such exercise complies with Applicable laws. Assuming such
compliance, for income tax
-2-
<PAGE>
purposes the Shares shall be considered transferred to the Optionee on the date
on which the Option is exercised with respect to such Shares.
3. Optionee's Representations. In the event the Shares have not been
--------------------------
registered under the Securities Act of 1933, as amended, at the time this Option
is exercised, the Optionee shall, if required by the Company, concurrently with
the exercise of all or any portion of this Option, deliver to the Company his or
her Investment Representation Statement in the form attached hereto as Exhibit
B.
4. Lock-Up Period. Optionee hereby agrees that, if so requested by the
--------------
Company or any representative of the underwriters (the "Managing Underwriter")
in connection with any registration of the offering of any securities of the
Company under the Securities Act, Optionee shall not sell or otherwise transfer
any Shares or other securities of the Company during the 180-day period (or such
other period as may be requested in writing by the Managing Underwriter and
agreed to in writing by the Company) (the "Market Standoff Period") following
the effective date of a registration statement of the Company filed under the
Securities Act. Such restriction shall apply only to the first registration
statement of the Company to become effective under the Securities Act that
includes securities to be sold on behalf of the Company to the public in an
underwritten public offering under the Securities Act. The Company may impose
stop-transfer instructions with respect to securities subject to the foregoing
restrictions until the end of such Market Standoff Period.
5. Method of Payment. Payment of the aggregate Exercise Price shall be by
-----------------
any of the following, or a combination thereof, at the election of the Optionee:
(a) cash or check;
(b) consideration received by the Company under a formal cashless
exercise program adopted by the Company in connection with the Plan; or
(c) surrender of other Shares which, (i) in the case of Shares
acquired upon exercise of an option, have been owned by the Optionee for more
than six (6) months on the date of surrender, and (ii) have a Fair Market Value
on the date of surrender equal to the aggregate Exercise Price of the Exercised
Shares.
6. Restrictions on Exercise. This Option may not be exercised until such
------------------------
time as the Plan has been approved by the stockholders of the Company, or if the
issuance of such Shares upon such exercise or the method of payment of
consideration for such shares would constitute a violation of any Applicable
Law.
7. Non-Transferability of Option. This Option may not be transferred in
-----------------------------
any manner otherwise than by will or by the laws of descent or distribution and
may be exercised during the lifetime of Optionee only by Optionee. The terms of
the Plan and this Option Agreement shall be binding upon the executors,
administrators, heirs, successors and assigns of the Optionee.
-3-
<PAGE>
8. Term of Option. This Option may be exercised only within the term set
--------------
out in the Notice of Grant, and may be exercised during such term only in
accordance with the Plan and the terms of this Option.
9. Tax Consequences. Set forth below is a brief summary as of the date of
----------------
this Option of some of the federal tax consequences of exercise of this Option
and disposition of the Shares. THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE
TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE SHOULD CONSULT A
TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES.
(a) Exercise of ISO. If this Option qualifies as an ISO, there will
---------------
be no regular federal income tax liability upon the exercise of the Option,
although the excess, if any, of the Fair Market Value of the Shares on the date
of exercise over the Exercise Price will be treated as an adjustment to the
alternative minimum tax for federal tax purposes and may subject the Optionee to
the alternative minimum tax in the year of exercise.
(b) Exercise of Nonstatutory Stock Option. There may be a regular
-------------------------------------
federal income tax liability upon the exercise of a Nonstatutory Stock Option.
The Optionee will be treated as having received compensation income (taxable at
ordinary income tax rates) equal to the excess, if any, of the Fair Market Value
of the Shares on the date of exercise over the Exercise Price. If Optionee is an
Employee or a former Employee, the Company will be required to withhold from
Optionee's compensation or collect from Optionee and pay to the applicable
taxing authorities an amount in cash equal to a percentage of this compensation
income at the time of exercise, and may refuse to honor the exercise and refuse
to deliver Shares if such withholding amounts are not delivered at the time of
exercise.
(c) Disposition of Shares. In the case of an NSO, if Shares are held
---------------------
for at least one year, any gain realized on disposition of the Shares will be
treated as long-term capital gain for federal income tax purposes. In the case
of an ISO, if Shares transferred pursuant to the Option are held for at least
one year after exercise and of at least two years after the Date of Grant, any
gain realized on disposition of the Shares will also be treated as long-term
capital gain for federal income tax purposes. If Shares purchased under an ISO
are disposed of within one year after exercise or two years after the Date of
Grant, any gain realized on such disposition will be treated as compensation
income (taxable at ordinary income rates) to the extent of the difference
between the Exercise Price and the lesser of (1) the Fair Market Value of the
Shares on the date of exercise, or (2) the sale price of the Shares. Any
additional gain will be taxed as capital gain, short-term or long-term depending
on the period that the ISO Shares were held.
(d) Notice of Disqualifying Disposition of ISO Shares. If the Option
-------------------------------------------------
granted to Optionee herein is an ISO, and if Optionee sells or otherwise
disposes of any of the Shares acquired pursuant to the ISO on or before the
later of (1) the date two years after the Date of Grant, or (2) the date one
year after the date of exercise, the Optionee shall immediately notify the
Company in
-4-
<PAGE>
writing of such disposition. Optionee agrees that Optionee may be subject to
income tax withholding by the Company on the compensation income recognized by
the Optionee.
10. Entire Agreement; Governing Law. The Plan is incorporated herein by
-------------------------------
reference. The Plan and this Option Agreement constitute the entire agreement
of the parties with respect to the subject matter hereof and supersede in their
entirety all prior undertakings and agreements of the Company and Optionee with
respect to the subject matter hereof, and may not be modified adversely to the
Optionee's interest except by means of a writing signed by the Company and
Optionee. This agreement is governed by the internal substantive laws but not
the choice of law rules of California.
11. No Guarantee of Continued Service. OPTIONEE ACKNOWLEDGES AND AGREES
---------------------------------
THAT THE VESTING OF SHARES PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED
ONLY BY CONTINUING AS A SERVICE PROVIDER AT THE WILL OF THE COMPANY (NOT THROUGH
THE ACT OF BEING HIRED, BEING GRANTED THIS OPTION OR ACQUIRING SHARES
HEREUNDER). OPTIONEE FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE
TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO
NOT CONSTITUTE AN EXPRESS OR IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A
SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL, AND SHALL
NOT INTERFERE IN ANY WAY WITH OPTIONEE'S RIGHT OR THE COMPANY'S RIGHT TO
TERMINATE OPTIONEE'S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR
WITHOUT CAUSE.
Optionee acknowledges receipt of a copy of the Plan and represents that he
or she is familiar with the terms and provisions thereof, and hereby accepts
this Option subject to all of the terms and provisions thereof. Optionee has
reviewed the Plan and this Option in their entirety, has had an opportunity to
obtain the advice of counsel prior to executing this Option and fully
understands all provisions of the Option. Optionee hereby agrees to accept as
binding, conclusive and final all decisions or interpretations of the
Administrator upon any questions arising under the Plan or this Option.
Optionee further agrees to notify the Company upon any change in the residence
address indicated below.
12. Vesting Acceleration on Change of Control.
-----------------------------------------
(a) Vesting Acceleration. In the event of a "Change of Control,"
--------------------
all of the Optionee's rights to purchase stock under this Agreement with the
Company shall be automatically vested in their entirety on an accelerated basis
and be fully exercisable:
(A) as of the date immediately preceding such "Change of Control" in
the event this stock option agreement is or will be terminated or
canceled (except by mutual consent) or any successor to the Company
fails to assume and agree to perform such stock option agreement as
provided in Section 2(13) hereof at or prior to such time as any such
person becomes a successor to the Company; or
-5-
<PAGE>
(B) as of the date immediately preceding such "Change of Control" in
the event the Optionee does not or will not receive upon exercise of
the Optionee's stock purchase rights under such stock option agreement
the same identical securities and/or other consideration as is
received by all other shareholders in any merger, consolidation, sale,
exchange or similar transaction occurring upon or after such "Change
of Control"; or
(C) as of the date immediately preceding any "Involuntary Termination"
of the Optionee occurring upon or after any such "Change of Control";
or
(D) as of the date one (1) year following the first such "Change of
Control," provided that the Optionee shall have remained an employee
of the Company continuously throughout such one-year period, other
than a termination as a result of death or disability;
whichever shall first occur (all quoted terms as defined below).
(b) Change of Control. "Change of Control" means the occurrence
-----------------
of any of the following events:
(i) Any "person" (as such term is used in Sections 13(d)
and 14(d) of the Securities Exchange Act of 1934, as amended) is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under said Act), directly or
indirectly, of securities of the Company representing fifty percent (50%) or
more of the total voting power represented by the Company's then outstanding
voting securities; or
(ii) A change in the composition of the Board of Directors
of the Company occurring within a two-year period as a result of which fewer
than a majority of the directors are "Incumbent Directors." "Incumbent
Directors" shall mean directors who either (A) are directors of the Company as
of the date hereof, or (B) are elected, or nominated for election, to the Board
of Directors with the affirmative votes (either by a specific vote or by
approval of the proxy statement of the Company in which such person is named as
a nominee for election as a director without objection to such nomination) of at
least a majority of the Incumbent Directors at the time of such election or
nomination; or
(iii) The consummation of (A) a merger or consolidation of
the Company with any other entity, other than a merger or consolidation which
would result in the voting securities of the Company outstanding immediately
prior thereto continuing to represent (either by remaining outstanding or by
being converted into voting securities of the surviving entity or the entity
that controls the Company or such surviving entity) at least fifty percent (50%)
of the total voting power represented by the voting securities of the Company or
such surviving entity or the entity that controls the Company or such surviving
entity outstanding immediately
-6-
<PAGE>
after such merger or consolidation, or (B) the sale or disposition by the
Company of all or substantially all the Company's assets; or
(iv) The shareholders approve a plan of complete liquidation
of the Company.
(c) Involuntary Termination. "Involuntary Termination" shall
-----------------------
mean without the Optionee's written consent: (i) a termination by the Company of
the Optionee's employment with the Company other than for Cause; (ii) a material
reduction of or variation in the Optionee's duties, authority or
responsibilities, relative to the Optionee's duties, authority or
responsibilities as in effect immediately prior to such reduction or variation;
(iii) a reduction by the Company in the base salary of the Optionee as in effect
immediately prior to such reduction; (iv) a material reduction by the Company in
the kind or level of employee benefits, including bonuses, to which the Optionee
was entitled immediately prior to such reduction, with the result that the
Optionee's overall benefits package is materially reduced; (v) the relocation of
the Optionee to a facility or a location more than thirty (30) miles from the
Optionee's then present location; (vi) the failure of the Company to obtain the
assumption of this Agreement by any successor as required in Section 2(13) or
(vii) any act or set of facts that would under applicable law constitute a
constructive termination of Optionee.
(d) Cause. "Cause" shall mean (i) any willful act of personal
-----
dishonesty, fraud or misrepresentation taken by the Optionee in connection with
his or her responsibilities as an employee which was intended to result in
substantial gain or personal enrichment of the Optionee at the expense of the
Company and was materially and demonstrably injurious to the Company; (ii) the
Optionee's conviction of a felony on account of any act which was materially and
demonstrably injurious to the Company; or (iii) the Optionee's willful and
continued failure to substantially perform his or her principal duties and
obligations of employment including under any written agreements (other than any
such failure resulting from incapacity due to physical or mental illness), which
failure is not remedied in a reasonable period of time after receipt of written
notice from the Company. For the purposes of this Section 12(d), no act or
failure to act shall be considered "willful" unless done or omitted to be done
in bad faith and without reasonable belief that the act or omission was in or
not opposed to the best interests of the Company. Any act or failure to act
based upon authority given pursuant to a resolution duly adopted by the Board of
Directors of the Company or based upon the advice of counsel for the Company
shall be conclusively presumed to be done or omitted to be done in good faith
and in the best interests of the Company.
(e) Voluntary Resignation; Termination For Cause. If the
--------------------------------------------
Optionee terminates employment as a result of an Involuntary Termination, the
Optionee shall be entitled to receive accelerated vesting under Section 12(a)
hereof. If the Optionee's continuous status as an employee of the Company
terminates by reason of the Optionee's voluntary resignation (and not
Involuntary Termination) or if the Optionee's continuous status as an employee
of the Company is
-7-
<PAGE>
terminated for Cause, in either case prior to such time as accelerated vesting
occurs as provided in Section 12(a) hereof, then the Optionee shall not be
entitled to receive accelerated vesting under Section 12(a) hereof.
13. Successors.
----------
Any successor to the Company (whether direct or indirect and
whether by purchase, merger or consolidation) shall assume the obligations under
this Agreement and agree expressly to perform the obligations under this
Agreement in the same manner and to the same extent as the Company would be
required to perform such obligations in the absence of a succession.
The terms of this Agreement and all rights of the Optionee
hereunder shall inure to the benefit of, and be enforceable by, the Optionee's
personal or legal representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees.
-8-
<PAGE>
OPTIONEE: COVAD COMMUNICATIONS GROUP, INC.
_______________________________ ________________________________
Signature By
_______________________________ ________________________________
Print Name Title
_______________________________
_______________________________
Residence Address
-9-
<PAGE>
EXHIBIT A
---------
1997 STOCK PLAN
EXERCISE NOTICE
Covad Communications Group, Inc.
3560 Bassett St.
Santa Clara, CA 95054
Attention: Secretary
1. Exercise of Option. Effective as of today, ___________, 19__, the
------------------
undersigned ("Optionee") hereby elects to exercise Optionee's option to purchase
_________ shares of the Common Stock (the "Shares") of Covad Communications
Group, Inc. (the "Company") under and pursuant to the 1997 Stock Plan (the
"Plan") and the Stock Option Agreement dated ________, 19____ (the "Option
Agreement").
2. Delivery of Payment. Purchaser herewith delivers to the Company the
-------------------
full purchase price of the Shares, as set forth in the Option Agreement.
3. Representations of Optionee. Optionee acknowledges that Optionee has
---------------------------
received, read and understood the Plan and the Option Agreement and agrees to
abide by and be bound by their terms and conditions.
4. Rights as Stockholder. Until the issuance of the Shares (as evidenced
---------------------
by the appropriate entry on the books of the Company or of a duly authorized
transfer agent of the Company), no right to vote or receive dividends or any
other rights as a stockholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Shares shall be issued to the
Optionee as soon as practicable after the Option is exercised. No adjustment
shall be made for a dividend or other right for which the record date is prior
to the date of issuance except as provided in Section 12 of the Plan.
5. Company's Right of First Refusal. Before any Shares held by Optionee
--------------------------------
or any transferee (either being sometimes referred to herein as the "Holder")
may be sold or otherwise transferred (including transfer by gift or operation of
law), the Company or its assignee(s) shall have a right of first refusal to
purchase the Shares on the terms and conditions set forth in this Section (the
"Right of First Refusal").
(a) Notice of Proposed Transfer. The Holder of the Shares shall
---------------------------
deliver to the Company a written notice (the "Notice") stating: (i) the Holder's
bona fide intention to sell or otherwise transfer such Shares; (ii) the name of
each proposed purchaser or other transferee ("Proposed Transferee"); (iii) the
number of Shares to be transferred to each Proposed Transferee; and (iv) the
bona fide cash price or other consideration for which the Holder proposes to
transfer the
<PAGE>
Shares (the "Offered Price"), and the Holder shall offer the Shares at the
Offered Price to the Company or its assignee(s).
(b) Exercise of Right of First Refusal. At any time within thirty
----------------------------------
(30) days after receipt of the Notice, the Company and/or its assignee(s) may,
by giving written notice to the Holder, elect to purchase all, but not less than
all, of the Shares proposed to be transferred to any one or more of the Proposed
Transferees, at the purchase price determined in accordance with subsection (c)
below.
(c) Purchase Price. The purchase price ("Purchase Price") for the
--------------
Shares purchased by the Company or its assignee(s) under this Section shall be
the Offered Price. If the Offered Price includes consideration other than cash,
the cash equivalent value of the non-cash consideration shall be determined by
the Board of Directors of the Company in good faith.
(d) Payment. Payment of the Purchase Price shall be made, at the
-------
option of the Company or its assignee(s), in cash (by check), by cancellation of
all or a portion of any outstanding indebtedness of the Holder to the Company
(or, in the case of repurchase by an assignee, to the assignee), or by any
combination thereof within 30 days after receipt of the Notice or in the manner
and at the times set forth in the Notice.
(e) Holder's Right to Transfer. If all of the Shares proposed in the
--------------------------
Notice to be transferred to a given Proposed Transferee are not purchased by the
Company and/or its assignee(s) as provided in this Section, then the Holder may
sell or otherwise transfer such Shares to that Proposed Transferee at the
Offered Price or at a higher price, provided that such sale or other transfer is
consummated within 120 days after the date of the Notice, that any such sale or
other transfer is effected in accordance with any applicable securities laws and
that the Proposed Transferee agrees in writing that the provisions of this
Section shall continue to apply to the Shares in the hands of such Proposed
Transferee. If the Shares described in the Notice are not transferred to the
Proposed Transferee within such period, a new Notice shall be given to the
Company, and the Company and/or its assignees shall again be offered the Right
of First Refusal before any Shares held by the Holder may be sold or otherwise
transferred.
(f) Exception for Certain Family Transfers. Anything to the contrary
--------------------------------------
contained in this Section notwithstanding, the transfer of any or all of the
Shares during the Optionee's lifetime or on the Optionee's death by will or
intestacy to the Optionee's immediate family or a trust for the benefit of the
Optionee's immediate family shall be exempt from the provisions of this Section.
"Immediate Family" as used herein shall mean spouse, lineal descendant or
antecedent, father, mother, brother or sister. In such case, the transferee or
other recipient shall receive and hold the Shares so transferred subject to the
provisions of this Section, and there shall be no further transfer of such
Shares except in accordance with the terms of this Section.
(g) Termination of Right of First Refusal. The Right of First Refusal
-------------------------------------
shall terminate as to any Shares upon the first sale of Common Stock of the
Company to the general
-2-
<PAGE>
public pursuant to a registration statement filed with and declared effective by
the Securities and Exchange Commission under the Securities Act of 1933, as
amended.
6. Tax Consultation. Optionee understands that Optionee may suffer
----------------
adverse tax consequences as a result of Optionee's purchase or disposition of
the Shares. Optionee represents that Optionee has consulted with any tax
consultants Optionee deems advisable in connection with the purchase or
disposition of the Shares and that Optionee is not relying on the Company for
any tax advice.
7. Restrictive Legends and Stop-Transfer Orders.
--------------------------------------------
(a) Legends. Optionee understands and agrees that the Company shall
-------
cause the legends set forth below or legends substantially equivalent thereto,
to be placed upon any certificate(s) evidencing ownership of the Shares together
with any other legends that may be required by the Company or by state or
federal securities laws:
THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933 (THE "ACT") AND MAY NOT BE
OFFERED, SOLD OR OTHERWISE TRANSFERRED, PLEDGED OR
HYPOTHECATED UNLESS AND UNTIL REGISTERED UNDER THE ACT OR, IN
THE OPINION OF COMPANY COUNSEL SATISFACTORY TO THE ISSUER OF
THESE SECURITIES, SUCH OFFER, SALE OR TRANSFER, PLEDGE OR
HYPOTHECATION IS IN COMPLIANCE THEREWITH.
THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO
CERTAIN RESTRICTIONS ON TRANSFER AND A RIGHT OF FIRST REFUSAL
HELD BY THE ISSUER OR ITS ASSIGNEE(S) AS SET FORTH IN THE
EXERCISE NOTICE BETWEEN THE ISSUER AND THE ORIGINAL HOLDER OF
THESE SHARES, A COPY OF WHICH MAY BE OBTAINED AT THE PRINCIPAL
OFFICE OF THE ISSUER. SUCH TRANSFER RESTRICTIONS AND RIGHT OF
FIRST REFUSAL ARE BINDING ON TRANSFEREES OF THESE SHARES.
(b) Stop-Transfer Notices. Optionee agrees that, in order to ensure
---------------------
compliance with the restrictions referred to herein, the Company may issue
appropriate "stop transfer" instructions to its transfer agent, if any, and
that, if the Company transfers its own securities, it may make appropriate
notations to the same effect in its own records.
(c) Refusal to Transfer. The Company shall not be required (i) to
-------------------
transfer on its books any Shares that have been sold or otherwise transferred in
violation of any of the provisions of
-3-
<PAGE>
this Agreement or (ii) to treat as owner of such Shares or to accord the right
to vote or pay dividends to any purchaser or other transferee to whom such
Shares shall have been so transferred.
8. Successors and Assigns. The Company may assign any of its rights under
----------------------
this Agreement to single or multiple assignees, and this Agreement shall inure
to the benefit of the successors and assigns of the Company. Subject to the
restrictions on transfer herein set forth, this Agreement shall be binding upon
Optionee and his or her heirs, executors, administrators, successors and
assigns.
9. Interpretation. Any dispute regarding the interpretation of this
--------------
Agreement shall be submitted by Optionee or by the Company forthwith to the
Administrator which shall review such dispute at its next regular meeting. The
resolution of such a dispute by the Administrator shall be final and binding on
all parties.
10. Governing Law; Severability. This Agreement is governed by the
---------------------------
internal substantive laws but not the choice of law rules, of California.
-4-
<PAGE>
11. Entire Agreement. The Plan and Option Agreement are incorporated
----------------
herein by reference. This Agreement, the Plan, the Option Agreement and the
Investment Representation Statement constitute the entire agreement of the
parties with respect to the subject matter hereof and supersede in their
entirety all prior undertakings and agreements of the Company and Optionee with
respect to the subject matter hereof, and may not be modified adversely to the
Optionee's interest except by means of a writing signed by the Company and
Optionee.
Submitted by: Accepted by:
OPTIONEE: COVAD COMMUNICATIONS GROUP, INC.
_____________________________ ________________________________
Signature By
_____________________________ ________________________________
Print Name Its
Address: Address:
- ------- -------
_____________________________ 3560 Bassett St.
_____________________________ Santa Clara, CA 95054
________________________________
Date Received
-5-
<PAGE>
EXHIBIT B
---------
INVESTMENT REPRESENTATION STATEMENT
OPTIONEE:
COMPANY: COVAD COMMUNICATIONS GROUP, INC.
SECURITY: COMMON STOCK
AMOUNT:
DATE:
In connection with the purchase of the above-listed Securities, the undersigned
Optionee represents to the Company the following:
(a) Optionee is aware of the Company's business affairs and financial
condition and has acquired sufficient information about the Company to reach an
informed and knowledgeable decision to acquire the Securities. Optionee is
acquiring these Securities for investment for Optionee's own account only and
not with a view to, or for resale in connection with, any "distribution" thereof
within the meaning of the Securities Act of 1933, as amended (the "Securities
Act").
(b) Optionee acknowledges and understands that the Securities
constitute "restricted securities" under the Securities Act and have not been
registered under the Securities Act in reliance upon a specific exemption
therefrom, which exemption depends upon, among other things, the bona fide
nature of Optionee's investment intent as expressed herein. In this connection,
Optionee understands that, in the view of the Securities and Exchange
Commission, the statutory basis for such exemption may be unavailable if
Optionee's representation was predicated solely upon a present intention to hold
these Securities for the minimum capital gains period specified under tax
statutes, for a deferred sale, for or until an increase or decrease in the
market price of the Securities, or for a period of one year or any other fixed
period in the future. Optionee further understands that the Securities must be
held indefinitely unless they are subsequently registered under the Securities
Act or an exemption from such registration is available. Optionee further
acknowledges and understands that the Company is under no obligation to register
the Securities. Optionee understands that the certificate evidencing the
Securities will be imprinted with a legend which prohibits the transfer of the
Securities unless they are registered or such registration is not required in
the opinion of counsel satisfactory to the Company, a legend prohibiting their
transfer without the consent of the Commissioner of Corporations of the State of
California and any other legend required under applicable state securities laws.
(c) Optionee is familiar with the provisions of Rule 701 and Rule
144, each promulgated under the Securities Act, which, in substance, permit
limited public resale of "restricted
<PAGE>
securities" acquired, directly or indirectly from the issuer thereof, in a non-
public offering subject to the satisfaction of certain conditions. Rule 701
provides that if the issuer qualifies under Rule 701 at the time of the grant of
the Option to the Optionee, the exercise will be exempt from registration under
the Securities Act. In the event the Company becomes subject to the reporting
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
ninety (90) days thereafter (or such longer period as any market stand-off
agreement may require) the Securities exempt under Rule 701 may be resold,
subject to the satisfaction of certain of the conditions specified by Rule 144,
including: (1) the resale being made through a broker in an unsolicited
"broker's transaction" or in transactions directly with a market maker (as said
term is defined under the Securities Exchange Act of 1934); and, in the case of
an affiliate, (2) the availability of certain public information about the
Company, (3) the amount of Securities being sold during any three month period
not exceeding the limitations specified in Rule 144(e), and (4) the timely
filing of a Form 144, if applicable.
In the event that the Company does not qualify under Rule 701 at the time
of grant of the Option, then the Securities may be resold in certain limited
circumstances subject to the provisions of Rule 144, which requires the resale
to occur not less than one year after the later of the date the Securities were
sold by the Company or the date the Securities were sold by an affiliate of the
Company, within the meaning of Rule 144; and, in the case of acquisition of the
Securities by an affiliate, or by a non-affiliate who subsequently holds the
Securities less than two years, the satisfaction of the conditions set forth in
sections (1), (2), (3) and (4) of the paragraph immediately above.
(d) Optionee further understands that in the event all of the
applicable requirements of Rule 701 or 144 are not satisfied, registration under
the Securities Act, compliance with Regulation A, or some other registration
exemption will be required; and that, notwithstanding the fact that Rules 144
and 701 are not exclusive, the Staff of the Securities and Exchange Commission
has expressed its opinion that persons proposing to sell private placement
securities other than in a registered offering and otherwise than pursuant to
Rules 144 or 701 will have a substantial burden of proof in establishing that an
exemption from registration is available for such offers or sales, and that such
persons and their respective brokers who participate in such transactions do so
at their own risk. Optionee understands that no assurances can be given that any
such other registration exemption will be available in such event.
Signature of Optionee:
_____________________________________
Date:__________________________, 19__
-2-
<PAGE>
EXHIBIT 10.8
COVAD COMMUNICATIONS GROUP, INC.
1998 EMPLOYEE STOCK PURCHASE PLAN
The following constitute the provisions of the 1998 Employee Stock Purchase
Plan of Covad Communications Group, Inc..
1. Purpose. The purpose of the Plan is to provide employees of the
-------
Company and its Designated Subsidiaries with an opportunity to purchase Common
Stock of the Company through accumulated payroll deductions. It is the
intention of the Company to have the Plan qualify as an "Employee Stock Purchase
Plan" under Section 423 of the Internal Revenue Code of 1986, as amended. The
provisions of the Plan, accordingly, shall be construed so as to extend and
limit participation in a manner consistent with the requirements of that section
of the Code.
2. Definitions.
-----------
(a) "Board" shall mean the Board of Directors of the Company.
-----
(b) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(c) "Common Stock" shall mean the common stock of the Company.
------------
(d) "Company" shall mean Covad Communications Group, Inc. and any
-------
Designated Subsidiary of the Company.
(e) "Compensation" shall mean all base straight time gross earnings
------------
and commissions, but exclusive of payments for overtime, shift premium,
incentive compensation, incentive payments, bonuses and other compensation.
(f) "Designated Subsidiary" shall mean any Subsidiary which has been
---------------------
designated by the Board from time to time in its sole discretion as eligible to
participate in the Plan.
(g) "Employee" shall mean any individual who is an Employee of the
--------
Company for tax purposes whose customary employment with the Company is at least
twenty (20) hours per week and more than five (5) months in any calendar year.
For purposes of the Plan, the employment relationship shall be treated as
continuing intact while the individual is on sick leave or other leave of
absence approved by the Company. Where the period of leave exceeds 90 days and
the individual's right to reemployment is not guaranteed either by statute or by
contract, the employment relationship shall be deemed to have terminated on the
91st day of such leave.
(h) "Enrollment Date" shall mean the first Trading Day of each
---------------
Offering Period.
(i) "Exercise Date" shall mean the last Trading Day of each Purchase
-------------
Period.
<PAGE>
(j) "Fair Market Value" shall mean, as of any date, the value of
-----------------
Common Stock determined as follows:
(1) If the Common Stock is listed on any established stock exchange or
a national market system, including without limitation the Nasdaq National
Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market
Value shall be the closing sales price for such stock (or the closing bid, if no
sales were reported) as quoted on such exchange or system for the last market
trading day on the date of such determination, as reported in The Wall Street
Journal or such other source as the Board deems reliable;
(2) If the Common Stock is regularly quoted by a recognized securities
dealer but selling prices are not reported, its Fair Market Value shall be the
mean of the closing bid and asked prices for the Common Stock on the date of
such determination, as reported in The Wall Street Journal or such other source
as the Board deems reliable;
(3) For purposes of the Enrollment Date of the first Offering Period
under the Plan, the Fair Market Value shall be the initial price to the public
as set forth in the final prospectus included within the registration statement
in Form S-1 filed with the Securities and Exchange Commission for the initial
public offering of the Company's Common Stock (the "Registration Statement"); or
(4) In the absence of an established market for the Common Stock, the
Fair Market Value thereof shall be determined in good faith by the Board.
(k) "Offering Periods" shall mean the periods of approximately twenty-
----------------
four (24) months during which an option granted pursuant to the Plan may be
exercised, commencing on the first Trading Day on or after May 1 and November 1
of each year and terminating on the last Trading Day in the periods ending
twenty-four months later; provided, however, that the first Offering Period
under the Plan shall commence with the first Trading Day on or after the date on
which the Securities and Exchange Commission declares the Company's Registration
Statement effective and ending on the last Trading Day on or before October 31,
2000. The duration and timing of Offering Periods may be changed pursuant to
Section 4 of this Plan.
(l) "Plan" shall mean this 1998 Employee Stock Purchase Plan.
----
(m) "Purchase Period" shall mean the approximately six month period
---------------
commencing after one Exercise Date and ending with the next Exercise Date,
except that the first Purchase Period of any Offering Period shall commence on
the Enrollment Date and end with the next Exercise Date; provided, however, that
the first Purchase Period under the Plan shall commence with the first Trading
Day on or after the date on which the Securities and Exchange Commission
declares the Company's Registration Statement effective and shall end on the
last Trading Day on or before October 31, 1999.
-2-
<PAGE>
(n) "Purchase Price" shall mean 85% of the Fair Market Value of a
--------------
share of Common Stock on the Enrollment Date or on the Exercise Date, whichever
is lower; provided however, that the Purchase Price may be adjusted by the Board
pursuant to Section 20.
(o) "Reserves" shall mean the number of shares of Common Stock covered
--------
by each option under the Plan which have not yet been exercised and the number
of shares of Common Stock which have been authorized for issuance under the Plan
but not yet placed under option.
(p) "Subsidiary" shall mean a corporation, domestic or foreign, of
----------
which not less than 50% of the voting shares are held by the Company or a
Subsidiary, whether or not such corporation now exists or is hereafter organized
or acquired by the Company or a Subsidiary.
(q) "Trading Day" shall mean a day on which national stock exchanges
-----------
and the Nasdaq System are open for trading.
3. Eligibility.
-----------
(a) Any Employee who shall be employed by the Company on a given
Enrollment Date shall be eligible to participate in the Plan.
(b) Any provisions of the Plan to the contrary notwithstanding, no
Employee shall be granted an option under the Plan (i) to the extent that,
immediately after the grant, such Employee (or any other person whose stock
would be attributed to such Employee pursuant to Section 424(d) of the Code)
would own capital stock of the Company and/or hold outstanding options to
purchase such stock possessing five percent (5%) or more of the total combined
voting power or value of all classes of the capital stock of the Company or of
any Subsidiary, or (ii) to the extent that his or her rights to purchase stock
under all employee stock purchase plans of the Company and its subsidiaries
accrues at a rate which exceeds Twenty-Five Thousand Dollars ($25,000) worth of
stock (determined at the fair market value of the shares at the time such option
is granted) for each calendar year in which such option is outstanding at any
time.
4. Offering Periods. The Plan shall be implemented by consecutive,
----------------
overlapping Offering Periods with a new Offering Period commencing on the first
Trading Day on or after May 1 and November 1 of each year, or on such other date
as the Board shall determine, and continuing thereafter until terminated in
accordance with Section 20 hereof; provided, however, that the first Offering
Period under the Plan shall commence with the first Trading Day on or after the
date on which the Securities and Exchange Commission declares the Company's
Registration Statement effective and ending on the last Trading Day on or before
October 31, 2000. The Board shall have the power to change the duration of
Offering Periods (including the commencement dates thereof) with respect to
future offerings without stockholder approval if such change is announced prior
to the scheduled beginning of the first Offering Period to be affected
thereafter.
-3-
<PAGE>
5. Participation.
-------------
(a) An eligible Employee may become a participant in the Plan by
completing a subscription agreement authorizing payroll deductions in the form
of Exhibit A to this Plan and filing it with the Company's payroll office prior
to the applicable Enrollment Date.
(b) Payroll deductions for a participant shall commence on the first
payroll following the Enrollment Date and shall end on the last payroll in the
Offering Period to which such authorization is applicable, unless sooner
terminated by the participant as provided in Section 10 hereof.
6. Payroll Deductions.
------------------
(a) At the time a participant files his or her subscription
agreement, he or she shall elect to have payroll deductions made on each pay day
during the Offering Period in an amount not exceeding twelve percent (12%) of
the Compensation which he or she receives on each pay day during the Offering
Period.
(b) All payroll deductions made for a participant shall be credited to
his or her account under the Plan and shall be withheld in whole percentages
only. A participant may not make any additional payments into such account.
(c) A participant may discontinue his or her participation in the Plan
as provided in Section 10 hereof, or may increase or decrease the rate of his or
her payroll deductions during the Offering Period by completing or filing with
the Company a new subscription agreement authorizing a change in payroll
deduction rate. The Board may, in its discretion, limit the number of
participation rate changes during any Offering Period. The change in rate shall
be effective with the first full payroll period following five (5) business days
after the Company's receipt of the new subscription agreement unless the Company
elects to process a given change in participation more quickly. A participant's
subscription agreement shall remain in effect for successive Offering Periods
unless terminated as provided in Section 10 hereof.
(d) Notwithstanding the foregoing, to the extent necessary to comply
with Section 423(b)(8) of the Code and Section 3(b) hereof, a participant's
payroll deductions may be decreased to zero percent (0%) at any time during a
Purchase Period. Payroll deductions shall recommence at the rate provided in
such participant's subscription agreement at the beginning of the first Purchase
Period which is scheduled to end in the following calendar year, unless
terminated by the participant as provided in Section 10 hereof.
(e) At the time the option is exercised, in whole or in part, or at
the time some or all of the Company's Common Stock issued under the Plan is
disposed of, the participant must make adequate provision for the Company's
federal, state, or other tax withholding obligations, if any, which arise upon
the exercise of the option or the disposition of the Common Stock. At any time,
the
-4-
<PAGE>
Company may, but shall not be obligated to, withhold from the participant's
compensation the amount necessary for the Company to meet applicable withholding
obligations, including any withholding required to make available to the Company
any tax deductions or benefits attributable to sale or early disposition of
Common Stock by the Employee.
7. Grant of Option. On the Enrollment Date of each Offering Period, each
---------------
eligible Employee participating in such Offering Period shall be granted an
option to purchase on each Exercise Date during such Offering Period (at the
applicable Purchase Price) up to a number of shares of the Company's Common
Stock determined by dividing such Employee's payroll deductions accumulated
prior to such Exercise Date and retained in the Participant's account as of the
Exercise Date by the applicable Purchase Price; provided that in no event shall
an Employee be permitted to purchase during each Purchase Period more than 5,000
shares of the Company's Common Stock (subject to any adjustment pursuant to
Section 19), and provided further that such purchase shall be subject to the
limitations set forth in Sections 3(b) and 12 hereof. The Board may, for future
Offering Periods, increase or decrease, in its absolute discretion, the maximum
number of shares of the Company's Common Stock an Employee may purchase during
each Purchase Period of such Offering Period. Exercise of the option shall
occur as provided in Section 8 hereof, unless the participant has withdrawn
pursuant to Section 10 hereof. The option shall expire on the last day of the
Offering Period.
8. Exercise of Option.
------------------
(a) Unless a participant withdraws from the Plan as provided in
Section 10 hereof, his or her option for the purchase of shares shall be
exercised automatically on the Exercise Date, and the maximum number of full
shares subject to option shall be purchased for such participant at the
applicable Purchase Price with the accumulated payroll deductions in his or her
account. No fractional shares shall be purchased; any payroll deductions
accumulated in a participant's account which are not sufficient to purchase a
full share shall be retained in the participant's account for the subsequent
Purchase Period or Offering Period, subject to earlier withdrawal by the
participant as provided in Section 10 hereof. Any other monies left over in a
participant's account after the Exercise Date shall be returned to the
participant. During a participant's lifetime, a participant's option to
purchase shares hereunder is exercisable only by him or her.
(b) If the Board determines that, on a given Exercise Date, the number
of shares with respect to which options are to be exercised may exceed (i) the
number of shares of Common Stock that were available for sale under the Plan on
the Enrollment Date of the applicable Offering Period, or (ii) the number of
shares available for sale under the Plan on such Exercise Date, the Board may in
its sole discretion (x) provide that the Company shall make a pro rata
allocation of the shares of Common Stock available for purchase on such
Enrollment Date or Exercise Date, as applicable, in as uniform a manner as shall
be practicable and as it shall determine in its sole discretion to be equitable
among all participants exercising options to purchase Common Stock on such
Exercise Date, and continue all Offering Periods then in effect, or (y) provide
that the Company shall make a pro rata allocation of the shares available for
purchase on such Enrollment Date or Exercise Date, as
-5-
<PAGE>
applicable, in as uniform a manner as shall be practicable and as it shall
determine in its sole discretion to be equitable among all participants
exercising options to purchase Common Stock on such Exercise Date, and terminate
any or all Offering Periods then in effect pursuant to Section 20 hereof. The
Company may make pro rata allocation of the shares available on the Enrollment
Date of any applicable Offering Period pursuant to the preceding sentence,
notwithstanding any authorization of additional shares for issuance under the
Plan by the Company's stockholders subsequent to such Enrollment Date.
9. Delivery. As promptly as practicable after each Exercise Date on which
--------
a purchase of shares occurs, the Company shall arrange the delivery to each
participant, as appropriate, of a certificate representing the shares purchased
upon exercise of his or her option.
10. Withdrawal.
----------
(a) A participant may withdraw all but not less than all the payroll
deductions credited to his or her account and not yet used to exercise his or
her option under the Plan at any time by giving written notice to the Company in
the form of Exhibit B to this Plan. All of the participant's payroll deductions
credited to his or her account shall be paid to such participant promptly after
receipt of notice of withdrawal and such participant's option for the Offering
Period shall be automatically terminated, and no further payroll deductions for
the purchase of shares shall be made for such Offering Period. If a participant
withdraws from an Offering Period, payroll deductions shall not resume at the
beginning of the succeeding Offering Period unless the participant delivers to
the Company a new subscription agreement.
(b) A participant's withdrawal from an Offering Period shall not have
any effect upon his or her eligibility to participate in any similar plan which
may hereafter be adopted by the Company or in succeeding Offering Periods which
commence after the termination of the Offering Period from which the participant
withdraws.
11. Termination of Employment.
-------------------------
Upon a participant's ceasing to be an Employee, for any reason, he or
she shall be deemed to have elected to withdraw from the Plan and the payroll
deductions credited to such participant's account during the Offering Period but
not yet used to exercise the option shall be returned to such participant or, in
the case of his or her death, to the person or persons entitled thereto under
Section 15 hereof, and such participant's option shall be automatically
terminated. The preceding sentence notwithstanding, a participant who receives
payment in lieu of notice of termination of employment shall be treated as
continuing to be an Employee for the participant's customary number of hours per
week of employment during the period in which the participant is subject to such
payment in lieu of notice.
-6-
<PAGE>
12. Interest. No interest shall accrue on the payroll deductions of a
--------
participant in the Plan.
13. Stock.
-----
(a) Subject to adjustment upon changes in capitalization of the
Company as provided in Section 19 hereof, the maximum number of shares of the
Company's Common Stock which shall be made available for sale under the Plan
shall be one million (1,000,000) shares, plus an annual increase to be added on
the first day of the Company's fiscal year beginning in 2000 equal to the lesser
of (i) 2% of the outstanding shares on such date, or (ii) an amount determined
by the Board.
(b) The participant shall have no interest or voting right in shares
covered by his option until such option has been exercised.
(c) Shares to be delivered to a participant under the Plan shall be
registered in the name of the participant or in the name of the participant and
his or her spouse.
14. Administration. The Plan shall be administered by the Board or a
--------------
committee of members of the Board appointed by the Board. The Board or its
committee shall have full and exclusive discretionary authority to construe,
interpret and apply the terms of the Plan, to determine eligibility and to
adjudicate all disputed claims filed under the Plan. Every finding, decision
and determination made by the Board or its committee shall, to the full extent
permitted by law, be final and binding upon all parties.
15. Designation of Beneficiary.
--------------------------
(a) A participant may file a written designation of a beneficiary who
is to receive any shares and cash, if any, from the participant's account under
the Plan in the event of such participant's death subsequent to an Exercise Date
on which the option is exercised but prior to delivery to such participant of
such shares and cash. In addition, a participant may file a written designation
of a beneficiary who is to receive any cash from the participant's account under
the Plan in the event of such participant's death prior to exercise of the
option. If a participant is married and the designated beneficiary is not the
spouse, spousal consent shall be required for such designation to be effective.
(b) Such designation of beneficiary may be changed by the participant
at any time by written notice. In the event of the death of a participant and
in the absence of a beneficiary validly designated under the Plan who is living
at the time of such participant's death, the Company shall deliver such shares
and/or cash to the executor or administrator of the estate of the participant,
or if no such executor or administrator has been appointed (to the knowledge of
the Company), the Company, in its discretion, may deliver such shares and/or
cash to the spouse or to any one or more dependents or relatives of the
participant, or if no spouse, dependent or relative is known to the Company,
then to such other person as the Company may designate.
-7-
<PAGE>
16. Transferability. Neither payroll deductions credited to a
---------------
participant's account nor any rights with regard to the exercise of an option or
to receive shares under the Plan may be assigned, transferred, pledged or
otherwise disposed of in any way (other than by will, the laws of descent and
distribution or as provided in Section 15 hereof) by the participant. Any such
attempt at assignment, transfer, pledge or other disposition shall be without
effect, except that the Company may treat such act as an election to withdraw
funds from an Offering Period in accordance with Section 10 hereof.
17. Use of Funds. All payroll deductions received or held by the Company
------------
under the Plan may be used by the Company for any corporate purpose, and the
Company shall not be obligated to segregate such payroll deductions.
18. Reports. Individual accounts shall be maintained for each participant
-------
in the Plan. Statements of account shall be given to participating Employees at
least annually, which statements shall set forth the amounts of payroll
deductions, the Purchase Price, the number of shares purchased and the remaining
cash balance, if any.
19. Adjustments Upon Changes in Capitalization, Dissolution, Liquidation,
---------------------------------------------------------------------
Merger or Asset Sale.
--------------------
(a) Changes in Capitalization. Subject to any required action by the
-------------------------
stockholders of the Company, the Reserves, the maximum number of shares each
participant may purchase each Purchase Period (pursuant to Section 7), as well
as the price per share and the number of shares of Common Stock covered by each
option under the Plan which has not yet been exercised shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of shares of Common Stock effected without receipt of
consideration by the Company; provided, however, that conversion of any
convertible securities of the Company shall not be deemed to have been "effected
without receipt of consideration". Such adjustment shall be made by the Board,
whose determination in that respect shall be final, binding and conclusive.
Except as expressly provided herein, no issuance by the Company of shares of
stock of any class, or securities convertible into shares of stock of any class,
shall affect, and no adjustment by reason thereof shall be made with respect to,
the number or price of shares of Common Stock subject to an option.
(b) Dissolution or Liquidation. In the event of the proposed
--------------------------
dissolution or liquidation of the Company, the Offering Period then in progress
shall be shortened by setting a new Exercise Date (the "New Exercise Date"), and
shall terminate immediately prior to the consummation of such proposed
dissolution or liquidation, unless provided otherwise by the Board. The New
Exercise Date shall be before the date of the Company's proposed dissolution or
liquidation. The Board shall notify each participant in writing, at least ten
(10) business days prior to the New Exercise Date, that the Exercise Date for
the participant's option has been changed to the New Exercise Date and that the
participant's option shall be exercised automatically on the New Exercise
-8-
<PAGE>
Date, unless prior to such date the participant has withdrawn from the Offering
Period as provided in Section 10 hereof.
(c) Merger or Asset Sale. In the event of a proposed sale of all or
--------------------
substantially all of the assets of the Company, or the merger of the Company
with or into another corporation, each outstanding option shall be assumed or an
equivalent option substituted by the successor corporation or a Parent or
Subsidiary of the successor corporation. In the event that the successor
corporation refuses to assume or substitute for the option, any Purchase Periods
then in progress shall be shortened by setting a new Exercise Date (the "New
Exercise Date") and any Offering Periods then in progress shall end on the New
Exercise Date. The New Exercise Date shall be before the date of the Company's
proposed sale or merger. The Board shall notify each participant in writing, at
least ten (10) business days prior to the New Exercise Date, that the Exercise
Date for the participant's option has been changed to the New Exercise Date and
that the participant's option shall be exercised automatically on the New
Exercise Date, unless prior to such date the participant has withdrawn from the
Offering Period as provided in Section 10 hereof.
20. Amendment or Termination.
------------------------
(a) The Board of Directors of the Company may at any time and for any
reason terminate or amend the Plan. Except as provided in Section 19 hereof, no
such termination can affect options previously granted, provided that an
Offering Period may be terminated by the Board of Directors on any Exercise Date
if the Board determines that the termination of the Offering Period or the Plan
is in the best interests of the Company and its stockholders. Except as
provided in Section 19 and this Section 20 hereof, no amendment may make any
change in any option theretofore granted which adversely affects the rights of
any participant. The Company shall obtain stockholder approval of any Plan
amendment to the extent necessary and desirable to comply with Section 423 of
the Code (or any successor rule or provision or any other applicable law,
regulation or stock exchange rule), the Company shall obtain stockholder
approval in such a manner and to such a degree as required.
(b) Without stockholder consent and without regard to whether any
participant rights may be considered to have been "adversely affected," the
Board (or its committee) shall be entitled to change the Offering Periods, limit
the frequency and/or number of changes in the amount withheld during an Offering
Period, establish the exchange ratio applicable to amounts withheld in a
currency other than U.S. dollars, permit payroll withholding in excess of the
amount designated by a participant in order to adjust for delays or mistakes in
the Company's processing of properly completed withholding elections, establish
reasonable waiting and adjustment periods and/or accounting and crediting
procedures to ensure that amounts applied toward the purchase of Common Stock
for each participant properly correspond with amounts withheld from the
participant's Compensation, and establish such other limitations or procedures
as the Board (or its committee) determines in its sole discretion advisable
which are consistent with the Plan.
(c) In the event the Board determines that the ongoing operation of
the Plan may result in unfavorable financial accounting consequences, the Board
may, in its discretion and, to the
-9-
<PAGE>
extent necessary or desirable, modify or amend the Plan to reduce or eliminate
such accounting consequence including, but not limited to:
(1) altering the Purchase Price for any Offering Period including an
Offering Period underway at the time of the change in Purchase Price;
(2) shortening any Offering Period so that the Offering Period ends on
a new Exercise Date, including an Offering Period underway at the time of the
Board action; and
(3) allocating shares.
Such modifications or amendments shall not require stockholder
approval or the consent of any Plan participants.
21. Notices. All notices or other communications by a participant to the
-------
Company under or in connection with the Plan shall be deemed to have been duly
given when received in the form specified by the Company at the location, or by
the person, designated by the Company for the receipt thereof.
22. Conditions Upon Issuance of Shares. Shares shall not be issued with
----------------------------------
respect to an option unless the exercise of such option and the issuance and
delivery of such shares pursuant thereto shall comply with all applicable
provisions of law, domestic or foreign, including, without limitation, the
Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as
amended, the rules and regulations promulgated thereunder, and the requirements
of any stock exchange upon which the shares may then be listed, and shall be
further subject to the approval of counsel for the Company with respect to such
compliance.
As a condition to the exercise of an option, the Company may require
the person exercising such option to represent and warrant at the time of any
such exercise that the shares are being purchased only for investment and
without any present intention to sell or distribute such shares if, in the
opinion of counsel for the Company, such a representation is required by any of
the aforementioned applicable provisions of law.
23. Stockholder Approval. The Plan shall be subject to approval by the
--------------------
stockholders of the Company within twelve (12) months after the date the Plan is
adopted by the Board. Such stockholder approval shall be obtained in the degree
and manner required under applicable state and federal law and any stock
exchange rules.
24. Term of Plan. Subject to Section 23 of the Plan, the Plan shall
------------
become effective upon the date of the Company's initial public offering of its
equity securities registered on Form S-1 with the Securities and Exchange
Commission. It shall continue in effect for a term of ten (10) years unless
sooner terminated under Section 20 of the Plan.
-10-
<PAGE>
25. Automatic Transfer to Low Price Offering Period. To the extent
-----------------------------------------------
permitted by any applicable laws, regulations, or stock exchange rules if the
Fair Market Value of the Common Stock on any Exercise Date in an Offering Period
is lower than the Fair Market Value of the Common Stock on the Enrollment Date
of such Offering Period, then all participants in such Offering Period shall be
automatically withdrawn from such Offering Period immediately after the exercise
of their option on such Exercise Date and automatically re-enrolled in the
immediately following Offering Period as of the first day thereof.
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<PAGE>
EXHIBIT A
---------
COVAD COMMUNICATIONS GROUP, INC.
1998 EMPLOYEE STOCK PURCHASE PLAN
SUBSCRIPTION AGREEMENT
_____ Original Application Enrollment Date: ___________
_____ Change in Payroll Deduction Rate
_____ Change of Beneficiary(ies)
1. _____________________________________________________ hereby elects to
participate in the Covad Communications Group, Inc. 1998 Employee Stock
Purchase Plan (the "Employee Stock Purchase Plan") and subscribes to
purchase shares of the Company's Common Stock in accordance with this
Subscription Agreement and the Employee Stock Purchase Plan.
2. I hereby authorize payroll deductions from each paycheck in the amount of
____% of my Compensation on each payday (from 1 to 15%) during the Offering
Period in accordance with the Employee Stock Purchase Plan. (Please note
that no fractional percentages are permitted.)
3. I understand that said payroll deductions shall be accumulated for the
purchase of shares of Common Stock at the applicable Purchase Price
determined in accordance with the Employee Stock Purchase Plan. I
understand that if I do not withdraw from an Offering Period, any
accumulated payroll deductions will be used to automatically exercise my
option.
4. I have received a copy of the complete Employee Stock Purchase Plan. I
understand that my participation in the Employee Stock Purchase Plan is in
all respects subject to the terms of the Plan. I understand that my
ability to exercise the option under this Subscription Agreement is subject
to stockholder approval of the Employee Stock Purchase Plan.
5. Shares purchased for me under the Employee Stock Purchase Plan should be
issued in the name(s) of (Employee or Employee and Spouse only):
___________________________________________________________________________
____________.
6. I understand that if I dispose of any shares received by me pursuant to the
Plan within 2 years after the Enrollment Date (the first day of the
Offering Period during which I purchased such shares) or one year after the
Exercise Date, I will be treated for federal income tax purposes as having
received ordinary income at the time of such disposition in an amount equal
to the excess of the fair market value of the shares at the time such
shares were purchased by me over the price which I paid for the shares. I
-
hereby agree to notify the Company in writing
---------------------------------------------
<PAGE>
within 30 days after the date of any disposition of my shares and I will
------------------------------------------------------------------------
make adequate provision for Federal, state or other tax withholding
-------------------------------------------------------------------
obligations, if any, which arise upon the disposition of the Common Stock.
-------------------------------------------------------------------------
The Company may, but will not be obligated to, withhold from my
compensation the amount necessary to meet any applicable withholding
obligation including any withholding necessary to make available to the
Company any tax deductions or benefits attributable to sale or early
disposition of Common Stock by me. If I dispose of such shares at any time
after the expiration of the 2-year and 1-year holding periods, I understand
that I will be treated for federal income tax purposes as having received
income only at the time of such disposition, and that such income will be
taxed as ordinary income only to the extent of an amount equal to the
lesser of (1) the excess of the fair market value of the shares at the time
of such disposition over the purchase price which I paid for the shares, or
(2) 15% of the fair market value of the shares on the first day of the
Offering Period. The remainder of the gain, if any, recognized on such
disposition will be taxed as capital gain.
7. I hereby agree to be bound by the terms of the Employee Stock Purchase
Plan. The effectiveness of this Subscription Agreement is dependent upon
my eligibility to participate in the Employee Stock Purchase Plan.
8. In the event of my death, I hereby designate the following as my
beneficiary(ies) to receive all payments and shares due me under the
Employee Stock Purchase Plan:
NAME: (Please print)______________________________________________
(First) (Middle) (Last)
____________________________ ______________________________________________
Relationship
_____________________________________________
(Address)
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<PAGE>
Employee's Social
Security Number: _____________________________________________
Employee's Address: _____________________________________________
_____________________________________________
_____________________________________________
I UNDERSTAND THAT THIS SUBSCRIPTION AGREEMENT SHALL REMAIN IN EFFECT THROUGHOUT
SUCCESSIVE OFFERING PERIODS UNLESS TERMINATED BY ME.
Dated:____________________ ____________________________________________
Signature of Employee
____________________________________________
Spouse's Signature (If beneficiary other than
spouse)
-3-
<PAGE>
EXHIBIT B
---------
COVAD COMMUNICATIONS GROUP, INC.
1998 EMPLOYEE STOCK PURCHASE PLAN
NOTICE OF WITHDRAWAL
The undersigned participant in the Offering Period of the Covad
Communications Group, Inc. 1998 Employee Stock Purchase Plan which began on
____________, 19____ (the "Enrollment Date") hereby notifies the Company that he
or she hereby withdraws from the Offering Period. He or she hereby directs the
Company to pay to the undersigned as promptly as practicable all the payroll
deductions credited to his or her account with respect to such Offering Period.
The undersigned understands and agrees that his or her option for such Offering
Period will be automatically terminated. The undersigned understands further
that no further payroll deductions will be made for the purchase of shares in
the current Offering Period and the undersigned shall be eligible to participate
in succeeding Offering Periods only by delivering to the Company a new
Subscription Agreement.
Name and Address of Participant:
________________________________
________________________________
________________________________
Signature:
________________________________
Date:____________________________
<PAGE>
EXHIBIT 10.12
COVAD COMMUNICATIONS GROUP, INC.
1997 STOCK PLAN
(AMENDED EFFECTIVE AS OF THE EFFECTIVE DATE OF THE COMPANY'S
INITIAL PUBLIC OFFERING)
1. Purposes of the Plan. The purposes of this Stock Plan are to attract
--------------------
and retain the best available personnel for positions of substantial
responsibility, to provide additional incentive to Employees, Directors and
Consultants and to promote the success of the Company's business. Options
granted under the Plan may be Incentive Stock Options or Nonstatutory Stock
Options, as determined by the Administrator at the time of grant. Stock Purchase
Rights may also be granted under the Plan.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" means the Board or any of its Committees as shall
-------------
be administering the Plan, in accordance with Section 4 of the Plan.
(b) "Applicable Laws" means the requirements relating to the
---------------
administration of stock option plans under U.S. state corporate laws, U.S.
federal and state securities laws, the Code, any stock exchange or quotation
system on which the Common Stock is listed or quoted and the applicable laws of
any foreign country or jurisdiction where Options or Stock Purchase Rights are,
or will be, granted under the Plan.
(c) "Board" means the Board of Directors of the Company.
-----
(d) "Code" means the Internal Revenue Code of 1986, as amended.
----
(e) "Committee" means a committee of Directors appointed by the Board
---------
in accordance with Section 4 of the Plan.
(f) "Common Stock" means the common stock of the Company.
------------
(g) "Company" means Covad Communications Group, Inc., a Delaware
-------
corporation.
(h) "Consultant" means any person, including an advisor, engaged by the
----------
Company or a Parent or Subsidiary to render services to such entity.
(i) "Director" means a member of the Board.
--------
(j) "Disability" means total and permanent disability as defined in
----------
Section 22(e)(3) of the Code.
<PAGE>
(k) "Employee" means any person, including Officers and Directors,
--------
employed by the Company or any Parent or Subsidiary of the Company. A Service
Provider shall not cease to be an Employee in the case of (i) any leave of
absence approved by the Company or (ii) transfers between locations of the
Company or between the Company, its Parent, any Subsidiary, or any successor.
For purposes of Incentive Stock Options, no such leave may exceed ninety days,
unless reemployment upon expiration of such leave is guaranteed by statute or
contract. If reemployment upon expiration of a leave of absence approved by the
Company is not so guaranteed, on the 181st day of such leave any Incentive Stock
Option held by the Optionee shall cease to be treated as an Incentive Stock
Option and shall be treated for tax purposes as a Nonstatutory Stock Option.
Neither service as a Director nor payment of a director's fee by the Company
shall be sufficient to constitute "employment" by the Company.
(l) "Exchange Act" means the Securities Exchange Act of 1934, as
------------
amended.
(m) "Fair Market Value" means, as of any date, the value of Common
-----------------
Stock determined as follows:
(i) If the Common Stock is listed on any established stock exchange
or a national market system, including without limitation the Nasdaq National
Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market
Value shall be the closing sales price for such stock (or the closing bid, if no
sales were reported) as quoted on such exchange or system for the last market
trading day prior to the time of determination, as reported in The Wall Street
Journal or such other source as the Administrator deems reliable;
(ii) If the Common Stock is regularly quoted by a recognized
securities dealer but selling prices are not reported, the Fair Market Value of
a Share of Common Stock shall be the mean between the high bid and low asked
prices for the Common Stock on the last market trading day prior to the day of
determination, as reported in The Wall Street Journal or such other source as
the Administrator deems reliable; or
(iii) In the absence of an established market for the Common Stock,
the Fair Market Value shall be determined in good faith by the Administrator.
(n) "Incentive Stock Option" means an Option intended to qualify as an
----------------------
incentive stock option within the meaning of Section 422 of the Code and the
regulations promulgated thereunder.
(o) "Inside Director" means a Director who is an Employee.
---------------
(p) "Nonstatutory Stock Option" means an Option not intended to qualify
-------------------------
as an Incentive Stock Option.
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<PAGE>
(q) "Notice of Grant" means a written or electronic notice evidencing
---------------
certain terms and conditions of an individual Option or Stock Purchase Right
grant. The Notice of Grant is part of the Option Agreement.
(r) "Officer" means a person who is an officer of the Company within
-------
the meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.
(s) "Option" means a stock option granted pursuant to the Plan.
------
(t) "Option Agreement" means an agreement between the Company and an
----------------
Optionee evidencing the terms and conditions of an individual Option grant. The
Option Agreement is subject to the terms and conditions of the Plan.
(u) "Option Exchange Program" means a program whereby outstanding
-----------------------
Options are surrendered in exchange for Options with a lower exercise price.
(v) "Optioned Stock" means the Common Stock subject to an Option or
--------------
Stock Purchase Right.
(w) "Optionee" means the holder of an outstanding Option or Stock
--------
Purchase Right granted under the Plan.
(x) "Outside Director" means a Director who is not an Employee.
----------------
(y) "Parent" means a "parent corporation," whether now or hereafter
------
existing, as defined in Section 424(e) of the Code.
(z) "Plan" means this 1997 Stock Plan.
----
(aa) "Restricted Stock" means shares of Common Stock acquired pursuant
----------------
to a grant of Stock Purchase Rights under Section 11 of the Plan.
(bb) "Restricted Stock Purchase Agreement" means a written agreement
-----------------------------------
between the Company and the Optionee evidencing the terms and restrictions
applying to stock purchased under a Stock Purchase Right. The Restricted Stock
Purchase Agreement is subject to the terms and conditions of the Plan and the
Notice of Grant.
(cc) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any successor
----------
to Rule 16b-3, as in effect when discretion is being exercised with respect to
the Plan.
(dd) "Section 16(b)" means Section 16(b) of the Exchange Act.
-------------
(ee) "Service Provider" means an Employee, Director or Consultant.
----------------
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<PAGE>
(ff) "Share" means a share of the Common Stock, as adjusted in
-----
accordance with Section 14 of the Plan.
(gg) "Stock Purchase Right" means the right to purchase Common Stock
--------------------
pursuant to Section 11 of the Plan, as evidenced by a Notice of Grant.
(hh) "Subsidiary" means a "subsidiary corporation", whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 14 of
-------------------------
the Plan, the maximum aggregate number of Shares which may be optioned and sold
under the Plan is 16,196,727 post-split Shares, plus an annual increase to be
added on the first day of the Company's fiscal year beginning in 2000 equal to
the lesser of (i) 3% of the outstanding shares on such date, or (ii) an amount
determined by the Board. The Shares may be authorized, but unissued, or
reacquired Common Stock.
If an Option or Stock Purchase Right expires or becomes unexercisable
without having been exercised in full, or is surrendered pursuant to an Option
Exchange Program, the unpurchased Shares which were subject thereto shall become
available for future grant or sale under the Plan (unless the Plan has
terminated); provided, however, that Shares that have actually been issued under
--------
the Plan, whether upon exercise of an Option or Right, shall not be returned to
the Plan and shall not become available for future distribution under the Plan,
except that if Shares of Restricted Stock are repurchased by the Company at
their original purchase price, such Shares shall become available for future
grant under the Plan.
4. Administration of the Plan.
--------------------------
(a) Procedure.
---------
(i) Multiple Administrative Bodies. The Plan may be administered by
------------------------------
different Committees with respect to different groups of Service Providers.
(ii) Section 162(m). To the extent that the Administrator determines
--------------
it to be desirable to qualify Options granted hereunder as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the Plan shall
be administered by a Committee of two or more "outside directors" within the
meaning of Section 162(m) of the Code.
(iii) Rule 16b-3. To the extent desirable to qualify transactions
----------
hereunder as exempt under Rule 16b-3, the transactions contemplated hereunder
shall be structured to satisfy the requirements for exemption under Rule 16b-3.
(iv) Other Administration. Other than as provided above, the Plan
--------------------
shall be administered by (A) the Board or (B) a Committee, which committee shall
be constituted to satisfy Applicable Laws.
-4-
<PAGE>
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan, and in the case of a Committee, subject to the specific duties delegated
by the Board to such Committee, the Administrator shall have the authority, in
its discretion:
(i) to determine the Fair Market Value;
(ii) to select the Service Providers to whom Options and Stock
Purchase Rights may be granted hereunder;
(iii) to determine the number of shares of Common Stock to be
covered by each Option and Stock Purchase Right granted hereunder;
(iv) to approve forms of agreement for use under the Plan;
(v) to determine the terms and conditions, not inconsistent with
the terms of the Plan, of any Option or Stock Purchase Right granted hereunder.
Such terms and conditions include, but are not limited to, the exercise price,
the time or times when Options or Stock Purchase Rights may be exercised (which
may be based on performance criteria), any vesting acceleration or waiver of
forfeiture restrictions, and any restriction or limitation regarding any Option
or Stock Purchase Right or the shares of Common Stock relating thereto, based in
each case on such factors as the Administrator, in its sole discretion, shall
determine;
(vi) to reduce the exercise price of any Option or Stock Purchase
Right to the then current Fair Market Value if the Fair Market Value of the
Common Stock covered by such Option or Stock Purchase Right shall have declined
since the date the Option or Stock Purchase Right was granted;
(vii) to institute an Option Exchange Program;
(viii) to construe and interpret the terms of the Plan and awards
granted pursuant to the Plan;
(ix) to prescribe, amend and rescind rules and regulations
relating to the Plan, including rules and regulations relating to sub-plans
established for the purpose of qualifying for preferred tax treatment under
foreign tax laws;
(x) to modify or amend each Option or Stock Purchase Right
(subject to Section 16(c) of the Plan), including the discretionary authority to
extend the post-termination exercisability period of Options longer than is
otherwise provided for in the Plan;
(xi) to allow Optionees to satisfy withholding tax obligations by
electing to have the Company withhold from the Shares to be issued upon exercise
of an Option or Stock Purchase Right that number of Shares having a Fair Market
Value equal to the amount required to be withheld. The Fair Market Value of the
Shares to be withheld shall be determined on the date that
-5-
<PAGE>
the amount of tax to be withheld is to be determined. All elections by an
Optionee to have Shares withheld for this purpose shall be made in such form and
under such conditions as the Administrator may deem necessary or advisable;
(xii) to authorize any person to execute on behalf of the Company
any instrument required to effect the grant of an Option or Stock Purchase Right
previously granted by the Administrator;
(xiii) to make all other determinations deemed necessary or
advisable for administering the Plan.
(c) Effect of Administrator's Decision. The Administrator's decisions,
----------------------------------
determinations and interpretations shall be final and binding on all Optionees
and any other holders of Options or Stock Purchase Rights.
5. Eligibility. Nonstatutory Stock Options and Stock Purchase Rights may
-----------
be granted to Service Providers. Incentive Stock Options may be granted only to
Employees.
6. Limitations.
-----------
(a) Each Option shall be designated in the Option Agreement as either
an Incentive Stock Option or a Nonstatutory Stock Option. However,
notwithstanding such designation, to the extent that the aggregate Fair Market
Value of the Shares with respect to which Incentive Stock Options are
exercisable for the first time by the Optionee during any calendar year (under
all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such
Options shall be treated as Nonstatutory Stock Options. For purposes of this
Section 6(a), Incentive Stock Options shall be taken into account in the order
in which they were granted. The Fair Market Value of the Shares shall be
determined as of the time the Option with respect to such Shares is granted.
(b) Neither the Plan nor any Option or Stock Purchase Right shall
confer upon an Optionee any right with respect to continuing the Optionee's
relationship as a Service Provider with the Company, nor shall they interfere in
any way with the Optionee's right or the Company's right to terminate such
relationship at any time, with or without cause.
(c) The following limitations shall apply to grants of Options:
(i) No Service Provider shall be granted, in any fiscal year of
the Company, Options to purchase more than 2,000,000 Shares.
(ii) In connection with his or her initial service, a Service
Provider may be granted Options to purchase up to an additional 2,000,000 Shares
which shall not count against the limit set forth in subsection (i) above.
-6-
<PAGE>
(iii) The foregoing limitations shall be adjusted proportionately
in connection with any change in the Company's capitalization as described in
Section 14.
(iv) If an Option is canceled in the same fiscal year of the
Company in which it was granted (other than in connection with a transaction
described in Section 14), the canceled Option will be counted against the limits
set forth in subsections (i) and (ii) above. For this purpose, if the exercise
price of an Option is reduced, the transaction will be treated as a cancellation
of the Option and the grant of a new Option.
7. Term of Plan. Subject to Section 20 of the Plan, the Plan shall become
------------
effective upon its adoption by the Board. It shall continue in effect for a
term of ten (10) years unless terminated earlier under Section 16 of the Plan.
8. Term of Option. The term of each Option shall be stated in the Option
--------------
Agreement. In the case of an Incentive Stock Option, the term shall be ten (10)
years from the date of grant or such shorter term as may be provided in the
Option Agreement. Moreover, in the case of an Incentive Stock Option granted to
an Optionee who, at the time the Incentive Stock Option is granted, owns stock
representing more than ten percent (10%) of the total combined voting power of
all classes of stock of the Company or any Parent or Subsidiary, the term of the
Incentive Stock Option shall be five (5) years from the date of grant or such
shorter term as may be provided in the Option Agreement.
9. Option Exercise Price and Consideration.
---------------------------------------
(a) Exercise Price. The per share exercise price for the Shares to be
--------------
issued pursuant to exercise of an Option shall be determined by the
Administrator, subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time the Incentive
Stock Option is granted, owns stock representing more than ten percent (10%) of
the voting power of all classes of stock of the Company or any Parent or
Subsidiary, the per Share exercise price shall be no less than 110% of the Fair
Market Value per Share on the date of grant.
(B) granted to any Employee other than an Employee described in
paragraph (A) immediately above, the per Share exercise price shall be no less
than 100% of the Fair Market Value per Share on the date of grant.
(ii) In the case of a Nonstatutory Stock Option, the per Share
exercise price shall be determined by the Administrator. In the case of a
Nonstatutory Stock Option intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the per Share
exercise price shall be no less than 100% of the Fair Market Value per Share on
the date of grant.
-7-
<PAGE>
(iii) Notwithstanding the foregoing, Options may be granted with a
per Share exercise price of less than 100% of the Fair Market Value per Share on
the date of grant pursuant to a merger or other corporate transaction.
(b) Waiting Period and Exercise Dates. At the time an Option is
---------------------------------
granted, the Administrator shall fix the period within which the Option may be
exercised and shall determine any conditions which must be satisfied before the
Option may be exercised.
(c) Form of Consideration. The Administrator shall determine the
---------------------
acceptable form of consideration for exercising an Option, including the method
of payment. In the case of an Incentive Stock Option, the Administrator shall
determine the acceptable form of consideration at the time of grant. Such
consideration may consist entirely of:
(i) cash;
(ii) check;
(iii) promissory note;
(iv) other Shares which (A) in the case of Shares acquired upon
exercise of an option, have been owned by the Optionee for more than six months
on the date of surrender, and (B) have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to which said
Option shall be exercised;
(v) consideration received by the Company under a cashless
exercise program implemented by the Company in connection with the Plan;
(vi) a reduction in the amount of any Company liability to the
Optionee, including any liability attributable to the Optionee's participation
in any Company-sponsored deferred compensation program or arrangement;
(vii) any combination of the foregoing methods of payment; or
(viii) such other consideration and method of payment for the
issuance of Shares to the extent permitted by Applicable Laws.
10. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Stockholder. Any Option granted
-----------------------------------------------
hereunder shall be exercisable according to the terms of the Plan and at such
times and under such conditions as determined by the Administrator and set forth
in the Option Agreement. Unless the Administrator provides otherwise, vesting
of Options granted hereunder shall be tolled during any unpaid leave of absence.
An Option may not be exercised for a fraction of a Share.
-8-
<PAGE>
An Option shall be deemed exercised when the Company receives: (i)
written or electronic notice of exercise (in accordance with the Option
Agreement) from the person entitled to exercise the Option, and (ii) full
payment for the Shares with respect to which the Option is exercised. Full
payment may consist of any consideration and method of payment authorized by the
Administrator and permitted by the Option Agreement and the Plan. Shares issued
upon exercise of an Option shall be issued in the name of the Optionee or, if
requested by the Optionee, in the name of the Optionee and his or her spouse.
Until the Shares are issued (as evidenced by the appropriate entry on the books
of the Company or of a duly authorized transfer agent of the Company), no right
to vote or receive dividends or any other rights as a stockholder shall exist
with respect to the Optioned Stock, notwithstanding the exercise of the Option.
The Company shall issue (or cause to be issued) such Shares promptly after the
Option is exercised. No adjustment will be made for a dividend or other right
for which the record date is prior to the date the Shares are issued, except as
provided in Section 14 of the Plan.
Exercising an Option in any manner shall decrease the number of Shares
thereafter available, both for purposes of the Plan and for sale under the
Option, by the number of Shares as to which the Option is exercised.
(b) Termination of Relationship as a Service Provider. If an Optionee
-------------------------------------------------
ceases to be a Service Provider, other than upon the Optionee's death or
Disability, the Optionee may exercise his or her Option within such period of
time as is specified in the Option Agreement to the extent that the Option is
vested on the date of termination (but in no event later than the expiration of
the term of such Option as set forth in the Option Agreement). In the absence
of a specified time in the Option Agreement, the Option shall remain exercisable
for three (3) months following the Optionee's termination. If, on the date of
termination, the Optionee is not vested as to his or her entire Option, the
Shares covered by the unvested portion of the Option shall revert to the Plan.
If, after termination, the Optionee does not exercise his or her Option within
the time specified by the Administrator, the Option shall terminate, and the
Shares covered by such Option shall revert to the Plan.
(c) Disability of Optionee. If an Optionee ceases to be a Service
----------------------
Provider as a result of the Optionee's Disability, the Optionee may exercise his
or her Option within such period of time as is specified in the Option Agreement
to the extent the Option is vested on the date of termination (but in no event
later than the expiration of the term of such Option as set forth in the Option
Agreement). In the absence of a specified time in the Option Agreement, the
Option shall remain exercisable for twelve (12) months following the Optionee's
termination. If, on the date of termination, the Optionee is not vested as to
his or her entire Option, the Shares covered by the unvested portion of the
Option shall revert to the Plan. If, after termination, the Optionee does not
exercise his or her Option within the time specified herein, the Option shall
terminate, and the Shares covered by such Option shall revert to the Plan.
(d) Death of Optionee. If an Optionee dies while a Service Provider,
-----------------
the Option may be exercised within such period of time as is specified in the
Option Agreement (but in no event later than the expiration of the term of such
Option as set forth in the Notice of Grant), by the
-9-
<PAGE>
Optionee's estate or by a person who acquires the right to exercise the Option
by bequest or inheritance, but only to the extent that the Option is vested on
the date of death. In the absence of a specified time in the Option Agreement,
the Option shall remain exercisable for twelve (12) months following the
Optionee's termination. If, at the time of death, the Optionee is not vested as
to his or her entire Option, the Shares covered by the unvested portion of the
Option shall immediately revert to the Plan. The Option may be exercised by the
executor or administrator of the Optionee's estate or, if none, by the person(s)
entitled to exercise the Option under the Optionee's will or the laws of descent
or distribution. If the Option is not so exercised within the time specified
herein, the Option shall terminate, and the Shares covered by such Option shall
revert to the Plan.
(e) Buyout Provisions. The Administrator may at any time offer to buy
-----------------
out for a payment in cash or Shares an Option previously granted based on such
terms and conditions as the Administrator shall establish and communicate to the
Optionee at the time that such offer is made.
11. Stock Purchase Rights.
---------------------
(a) Rights to Purchase. Stock Purchase Rights may be issued either
------------------
alone, in addition to, or in tandem with other awards granted under the Plan
and/or cash awards made outside of the Plan. After the Administrator determines
that it will offer Stock Purchase Rights under the Plan, it shall advise the
offeree in writing or electronically, by means of a Notice of Grant, of the
terms, conditions and restrictions related to the offer, including the number of
Shares that the offeree shall be entitled to purchase, the price to be paid, and
the time within which the offeree must accept such offer. The offer shall be
accepted by execution of a Restricted Stock Purchase Agreement in the form
determined by the Administrator.
(b) Repurchase Option. Unless the Administrator determines otherwise,
-----------------
the Restricted Stock Purchase Agreement shall grant the Company a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's service with the Company for any reason (including death or
Disability). The purchase price for Shares repurchased pursuant to the
Restricted Stock Purchase Agreement shall be the original price paid by the
purchaser and may be paid by cancellation of any indebtedness of the purchaser
to the Company. The repurchase option shall lapse at a rate determined by the
Administrator.
(c) Other Provisions. The Restricted Stock Purchase Agreement shall
----------------
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the Administrator in its sole discretion.
(d) Rights as a Stockholder. Once the Stock Purchase Right is
-----------------------
exercised, the purchaser shall have the rights equivalent to those of a
stockholder, and shall be a stockholder when his or her purchase is entered upon
the records of the duly authorized transfer agent of the Company. No adjustment
will be made for a dividend or other right for which the record date is prior to
the date the Stock Purchase Right is exercised, except as provided in Section 14
of the Plan.
-10-
<PAGE>
12. Non-Transferability of Options and Stock Purchase Rights. Unless
--------------------------------------------------------
determined otherwise by the Administrator, an Option or Stock Purchase Right may
not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any
manner other than by will or by the laws of descent or distribution and may be
exercised, during the lifetime of the Optionee, only by the Optionee. If the
Administrator makes an Option or Stock Purchase Right transferable, such Option
or Stock Purchase Right shall contain such additional terms and conditions as
the Administrator deems appropriate.
13. Adjustments Upon Changes in Capitalization, Dissolution, Merger or
------------------------------------------------------------------
Asset Sale.
----------
(a) Changes in Capitalization. Subject to any required action by the
-------------------------
stockholders of the Company, the number of shares of Common Stock covered by
each outstanding Option and Stock Purchase Right, and the number of shares of
Common Stock which have been authorized for issuance under the Plan but as to
which no Options or Stock Purchase Rights have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option or Stock
Purchase Right, as well as the price per share of Common Stock covered by each
such outstanding Option or Stock Purchase Right, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of issued shares of Common Stock effected without receipt
of consideration by the Company; provided, however, that conversion of any
convertible securities of the Company shall not be deemed to have been "effected
without receipt of consideration." Such adjustment shall be made by the Board,
whose determination in that respect shall be final, binding and conclusive.
Except as expressly provided herein, no issuance by the Company of shares of
stock of any class, or securities convertible into shares of stock of any class,
shall affect, and no adjustment by reason thereof shall be made with respect to,
the number or price of shares of Common Stock subject to an Option or Stock
Purchase Right.
(b) Dissolution or Liquidation. In the event of the proposed
--------------------------
dissolution or liquidation of the Company, the Administrator shall notify each
Optionee as soon as practicable prior to the effective date of such proposed
transaction. The Administrator in its discretion may provide for an Optionee to
have the right to exercise his or her Option until ten (10) days prior to such
transaction as to all of the Optioned Stock covered thereby, including Shares as
to which the Option would not otherwise be exercisable. In addition, the
Administrator may provide that any Company repurchase option applicable to any
Shares purchased upon exercise of an Option or Stock Purchase Right shall lapse
as to all such Shares, provided the proposed dissolution or liquidation takes
place at the time and in the manner contemplated. To the extent it has not been
previously exercised, an Option or Stock Purchase Right will terminate
immediately prior to the consummation of such proposed action.
(c) Merger or Asset Sale. In the event of a merger of the Company with
--------------------
or into another corporation, or the sale of substantially all of the assets of
the Company, each outstanding Option and Stock Purchase Right shall be assumed
or an equivalent option or right substituted by the successor corporation or a
Parent or Subsidiary of the successor corporation. In the event that the
-11-
<PAGE>
successor corporation refuses to assume or substitute for the Option or Stock
Purchase Right, the Optionee shall fully vest in and have the right to exercise
the Option or Stock Purchase Right as to all of the Optioned Stock, including
Shares as to which it would not otherwise be vested or exercisable. If an
Option or Stock Purchase Right becomes fully vested and exercisable in lieu of
assumption or substitution in the event of a merger or sale of assets, the
Administrator shall notify the Optionee in writing or electronically that the
Option or Stock Purchase Right shall be fully vested and exercisable for a
period of fifteen (15) days from the date of such notice, and the Option or
Stock Purchase Right shall terminate upon the expiration of such period. For
the purposes of this paragraph, the Option or Stock Purchase Right shall be
considered assumed if, following the merger or sale of assets, the option or
right confers the right to purchase or receive, for each Share of Optioned Stock
subject to the Option or Stock Purchase Right immediately prior to the merger or
sale of assets, the consideration (whether stock, cash, or other securities or
property) received in the merger or sale of assets by holders of Common Stock
for each Share held on the effective date of the transaction (and if holders
were offered a choice of consideration, the type of consideration chosen by the
holders of a majority of the outstanding Shares); provided, however, that if
such consideration received in the merger or sale of assets is not solely common
stock of the successor corporation or its Parent, the Administrator may, with
the consent of the successor corporation, provide for the consideration to be
received upon the exercise of the Option or Stock Purchase Right, for each Share
of Optioned Stock subject to the Option or Stock Purchase Right, to be solely
common stock of the successor corporation or its Parent equal in fair market
value to the per share consideration received by holders of Common Stock in the
merger or sale of assets.
14. Date of Grant. The date of grant of an Option or Stock Purchase Right
-------------
shall be, for all purposes, the date on which the Administrator makes the
determination granting such Option or Stock Purchase Right, or such other later
date as is determined by the Administrator. Notice of the determination shall
be provided to each Optionee within a reasonable time after the date of such
grant.
15. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may at any time amend, alter,
-------------------------
suspend or terminate the Plan.
(b) Stockholder Approval. The Company shall obtain stockholder
--------------------
approval of any Plan amendment to the extent necessary and desirable to comply
with Applicable Laws.
(c) Effect of Amendment or Termination. No amendment, alteration,
----------------------------------
suspension or termination of the Plan shall impair the rights of any Optionee,
unless mutually agreed otherwise between the Optionee and the Administrator,
which agreement must be in writing and signed by the Optionee and the Company.
Termination of the Plan shall not affect the Administrator's ability to exercise
the powers granted to it hereunder with respect to Options granted under the
Plan prior to the date of such termination.
-12-
<PAGE>
16. Conditions Upon Issuance of Shares.
----------------------------------
(a) Legal Compliance. Shares shall not be issued pursuant to the
----------------
exercise of an Option or Stock Purchase Right unless the exercise of such Option
or Stock Purchase Right and the issuance and delivery of such Shares shall
comply with Applicable Laws and shall be further subject to the approval of
counsel for the Company with respect to such compliance.
(b) Investment Representations. As a condition to the exercise of an
--------------------------
Option or Stock Purchase Right, the Company may require the person exercising
such Option or Stock Purchase Right to represent and warrant at the time of any
such exercise that the Shares are being purchased only for investment and
without any present intention to sell or distribute such Shares if, in the
opinion of counsel for the Company, such a representation is required.
17. Inability to Obtain Authority. The inability of the Company to obtain
-----------------------------
authority from any regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the lawful issuance and sale
of any Shares hereunder, shall relieve the Company of any liability in respect
of the failure to issue or sell such Shares as to which such requisite authority
shall not have been obtained.
18. Reservation of Shares. The Company, during the term of this Plan, will
---------------------
at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.
19. Stockholder Approval. The Plan shall be subject to approval by the
--------------------
stockholders of the Company within twelve (12) months after the date the Plan is
adopted. Such stockholder approval shall be obtained in the manner and to the
degree required under Applicable Laws.
-13-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
1997 STOCK PLAN
STOCK OPTION AGREEMENT
Unless otherwise defined herein, the terms defined in the Plan shall have
the same defined meanings in this Option Agreement.
I. NOTICE OF STOCK OPTION GRANT
----------------------------
Name:
Address:
The undersigned Optionee has been granted an Option to purchase Common Stock
of the Company, subject to the terms and conditions of the Plan and this Option
Agreement, as follows:
Grant Number _____________
Date of Grant _____________
Vesting Commencement Date _____________
Exercise Price per Share $_____________
Total Number of Shares Granted _____________
Total Exercise Price $_____________
Type of Option: ____ Incentive Stock Option
____ Nonstatutory Stock Option
Term/Expiration Date: ______________
Vesting Schedule:
----------------
This Option shall be exercisable, in whole or in part, according to the
following vesting schedule:
<PAGE>
6/48 (or 12.5%) of the Shares subject to the Option shall vest six months
after the Vesting Commencement Date, and 1/48 (or approximately 2.083%) of the
Shares subject to the Option shall vest each month thereafter, subject to
Optionee's continuing to be a Service Provider on such dates.
Termination Period:
------------------
This Option shall be exercisable for thirty days after Optionee ceases to be
a Service Provider. Upon Optionee's death or Disability, this Option may be
exercised for one year after Optionee ceases to be a Service Provider. In no
event may Optionee exercise this Option after the Term/Expiration Date as
provided above.
II. AGREEMENT
---------
1. Grant of Option. The Plan Administrator of the Company hereby grants
---------------
to the Optionee named in the Notice of Grant (the "Optionee"), an option (the
"Option") to purchase the number of Shares set forth in the Notice of Grant, at
the exercise price per Share set forth in the Notice of Grant (the "Exercise
Price"), and subject to the terms and conditions of the Plan, which is
incorporated herein by reference. Subject to Section 15(c) of the Plan, in the
event of a conflict between the terms and conditions of the Plan and this Option
Agreement, the terms and conditions of the Plan shall prevail.
If designated in the Notice of Grant as an Incentive Stock Option
("ISO"), this Option is intended to qualify as an Incentive Stock Option as
defined in Section 422 of the Code. Nevertheless, to the extent that it exceeds
the $100,000 rule of Code Section 422(d), this Option shall be treated as a
Nonstatutory Stock Option ("NSO").
2. Exercise of Option.
------------------
(a) Right to Exercise. This Option shall be exercisable during its
-----------------
term in accordance with the Vesting Schedule set out in the Notice of Grant and
with the applicable provisions of the Plan and this Option Agreement.
(b) Method of Exercise. This Option shall be exercisable by delivery
------------------
of an exercise notice in the form attached as Exhibit A (the Exercise Notice)
which shall state the election to exercise the Option, the number of Shares with
respect to which the Option is being exercised, and such other representations
and agreements as may be required by the Company. The Exercise Notice shall be
accompanied by payment of the aggregate Exercise Price as to all Exercised
Shares. This Option shall be deemed to be exercised upon receipt by the Company
of such fully executed Exercise Notice accompanied by the aggregate Exercise
Price.
No Shares shall be issued pursuant to the exercise of an Option unless
such issuance and such exercise complies with Applicable laws. Assuming such
compliance, for income tax
<PAGE>
purposes the Shares shall be considered transferred to the Optionee on the date
on which the Option is exercised with respect to such Shares.
3. Optionee's Representations. In the event the Shares have not been
--------------------------
registered under the Securities Act of 1933, as amended, at the time this Option
is exercised, the Optionee shall, if required by the Company, concurrently with
the exercise of all or any portion of this Option, deliver to the Company his or
her Investment Representation Statement in the form attached hereto as Exhibit
B.
4. Lock-Up Period. Optionee hereby agrees that, if so requested by the
--------------
Company or any representative of the underwriters (the "Managing Underwriter")
in connection with any registration of the offering of any securities of the
Company under the Securities Act, Optionee shall not sell or otherwise transfer
any Shares or other securities of the Company during the 180-day period (or such
other period as may be requested in writing by the Managing Underwriter and
agreed to in writing by the Company) (the "Market Standoff Period") following
the effective date of a registration statement of the Company filed under the
Securities Act. Such restriction shall apply only to the first registration
statement of the Company to become effective under the Securities Act that
includes securities to be sold on behalf of the Company to the public in an
underwritten public offering under the Securities Act. The Company may impose
stop-transfer instructions with respect to securities subject to the foregoing
restrictions until the end of such Market Standoff Period.
5. Method of Payment. Payment of the aggregate Exercise Price shall be by
-----------------
any of the following, or a combination thereof, at the election of the Optionee:
(a) cash or check;
(b) consideration received by the Company under a formal cashless
exercise program adopted by the Company in connection with the Plan; or
(c) surrender of other Shares which, (i) in the case of Shares acquired
upon exercise of an option, have been owned by the Optionee for more than six
(6) months on the date of surrender, and (ii) have a Fair Market Value on the
date of surrender equal to the aggregate Exercise Price of the Exercised Shares.
6. Non-Transferability of Option. This Option may not be transferred in
-----------------------------
any manner otherwise than by will or by the laws of descent or distribution and
may be exercised during the lifetime of Optionee only by Optionee. The terms of
the Plan and this Option Agreement shall be binding upon the executors,
administrators, heirs, successors and assigns of the Optionee.
7. Term of Option. This Option may be exercised only within the term set
--------------
out in the Notice of Grant, and may be exercised during such term only in
accordance with the Plan and the terms of this Option.
<PAGE>
8. Tax Consequences. Set forth below is a brief summary as of the date of
----------------
this Option of some of the federal tax consequences of exercise of this Option
and disposition of the Shares. THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE
TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE SHOULD CONSULT A
TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES.
(a) Exercise of ISO. If this Option qualifies as an ISO, there will be
---------------
no regular federal income tax liability upon the exercise of the Option,
although the excess, if any, of the Fair Market Value of the Shares on the date
of exercise over the Exercise Price will be treated as an adjustment to the
alternative minimum tax for federal tax purposes and may subject the Optionee to
the alternative minimum tax in the year of exercise.
(b) Exercise of Nonstatutory Stock Option. There may be a regular
-------------------------------------
federal income tax liability upon the exercise of a Nonstatutory Stock Option.
The Optionee will be treated as having received compensation income (taxable at
ordinary income tax rates) equal to the excess, if any, of the Fair Market Value
of the Shares on the date of exercise over the Exercise Price. If Optionee is
an Employee or a former Employee, the Company will be required to withhold from
Optionee's compensation or collect from Optionee and pay to the applicable
taxing authorities an amount in cash equal to a percentage of this compensation
income at the time of exercise, and may refuse to honor the exercise and refuse
to deliver Shares if such withholding amounts are not delivered at the time of
exercise.
(c) Disposition of Shares. In the case of an NSO, if Shares are held
---------------------
for at least one year, any gain realized on disposition of the Shares will be
treated as long-term capital gain for federal income tax purposes. In the case
of an ISO, if Shares transferred pursuant to the Option are held for at least
one year after exercise and of at least two years after the Date of Grant, any
gain realized on disposition of the Shares will also be treated as long-term
capital gain for federal income tax purposes. If Shares purchased under an ISO
are disposed of within one year after exercise or two years after the Date of
Grant, any gain realized on such disposition will be treated as compensation
income (taxable at ordinary income rates) to the extent of the difference
between the Exercise Price and the lesser of (1) the Fair Market Value of the
Shares on the date of exercise, or (2) the sale price of the Shares. Any
additional gain will be taxed as capital gain, short-term or long-term depending
on the period that the ISO Shares were held.
(d) Notice of Disqualifying Disposition of ISO Shares. If the Option
-------------------------------------------------
granted to Optionee herein is an ISO, and if Optionee sells or otherwise
disposes of any of the Shares acquired pursuant to the ISO on or before the
later of (1) the date two years after the Date of Grant, or (2) the date one
year after the date of exercise, the Optionee shall immediately notify the
Company in writing of such disposition. Optionee agrees that Optionee may be
subject to income tax withholding by the Company on the compensation income
recognized by the Optionee.
9. Entire Agreement; Governing Law. The Plan is incorporated herein by
-------------------------------
reference. The Plan and this Option Agreement constitute the entire agreement
of the parties with respect to the subject matter hereof and supersede in their
entirety all prior undertakings and agreements of the
<PAGE>
Company and Optionee with respect to the subject matter hereof, and may not be
modified adversely to the Optionee's interest except by means of a writing
signed by the Company and Optionee. This agreement is governed by the internal
substantive laws but not the choice of law rules of California.
10. No Guarantee of Continued Service. OPTIONEE ACKNOWLEDGES AND AGREES
---------------------------------
THAT THE VESTING OF SHARES PURSUANT TO THE VESTING SCHEDULE HEREOF IS EARNED
ONLY BY CONTINUING AS A SERVICE PROVIDER AT THE WILL OF THE COMPANY (NOT THROUGH
THE ACT OF BEING HIRED, BEING GRANTED THIS OPTION OR ACQUIRING SHARES
HEREUNDER). OPTIONEE FURTHER ACKNOWLEDGES AND AGREES THAT THIS AGREEMENT, THE
TRANSACTIONS CONTEMPLATED HEREUNDER AND THE VESTING SCHEDULE SET FORTH HEREIN DO
NOT CONSTITUTE AN EXPRESS OR IMPLIED PROMISE OF CONTINUED ENGAGEMENT AS A
SERVICE PROVIDER FOR THE VESTING PERIOD, FOR ANY PERIOD, OR AT ALL, AND SHALL
NOT INTERFERE IN ANY WAY WITH OPTIONEE'S RIGHT OR THE COMPANY'S RIGHT TO
TERMINATE OPTIONEE'S RELATIONSHIP AS A SERVICE PROVIDER AT ANY TIME, WITH OR
WITHOUT CAUSE.
Optionee acknowledges receipt of a copy of the Plan and represents that he
or she is familiar with the terms and provisions thereof, and hereby accepts
this Option subject to all of the terms and provisions thereof. Optionee has
reviewed the Plan and this Option in their entirety, has had an opportunity to
obtain the advice of counsel prior to executing this Option and fully
understands all provisions of the Option. Optionee hereby agrees to accept as
binding, conclusive and final all decisions or interpretations of the
Administrator upon any questions arising under the Plan or this Option.
Optionee further agrees to notify the Company upon any change in the residence
address indicated below.
11. Vesting Acceleration on Change of Control.
-----------------------------------------
(a) Vesting Acceleration. In the event of a "Change of Control,"
--------------------
all of the Optionee's rights to purchase stock under this Agreement with the
Company shall be automatically vested in their entirety on an accelerated basis
and be fully exercisable:
(i) as of the date immediately preceding such "Change of Control" in
the event this stock option agreement is or will be terminated or
canceled (except by mutual consent) or any successor to the Company
fails to assume and agree to perform such stock option agreement as
provided in Section 12 hereof at or prior to such time as any such
person becomes a successor to the Company; or
(ii) as of the date immediately preceding such "Change of Control" in
the event the Optionee does not or will not receive upon exercise of
the Optionee's stock purchase rights under such stock option agreement
the same identical securities and/or other consideration as is received
by all other shareholders in any merger, consolidation, sale, exchange
or similar transaction occurring upon or after such "Change of
Control"; or
<PAGE>
(iii) as of the date immediately preceding any "Involuntary
Termination" of the Optionee occurring upon or after any such "Change
of Control"; or
(iv) as of the date one (1) year following the first such "Change of
Control," provided that the Optionee shall have remained an employee of
the Company continuously throughout such one-year period, other than a
termination as a result of death or disability;
whichever shall first occur (all quoted terms as defined below).
(b) Change of Control. "Change of Control" means the occurrence
-----------------
of any of the following events:
(i) Any "person" (as such term is used in Sections 13(d) and 14(d)
of the Securities Exchange Act of 1934, as amended) is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under said Act), directly or
indirectly, of securities of the Company representing fifty percent (50%) or
more of the total voting power represented by the Company's then outstanding
voting securities; or
(ii) A change in the composition of the Board of Directors of the
Company occurring within a two-year period as a result of which fewer than a
majority of the directors are "Incumbent Directors." "Incumbent Directors"
shall mean directors who either (A) are directors of the Company as of the date
hereof, or (B) are elected, or nominated for election, to the Board of Directors
with the affirmative votes (either by a specific vote or by approval of the
proxy statement of the Company in which such person is named as a nominee for
election as a director without objection to such nomination) of at least a
majority of the Incumbent Directors at the time of such election or nomination;
or
(iii) The consummation of (A) a merger or consolidation of the
Company with any other entity, other than a merger or consolidation which would
result in the voting securities of the Company outstanding immediately prior
thereto continuing to represent (either by remaining outstanding or by being
converted into voting securities of the surviving entity or the entity that
controls the Company or such surviving entity) at least fifty percent (50%) of
the total voting power represented by the voting securities of the Company or
such surviving entity or the entity that controls the Company or such surviving
entity outstanding immediately after such merger or consolidation, or (B) the
sale or disposition by the Company of all or substantially all the Company's
assets; or
(iv) The shareholders approve a plan of complete liquidation
of the Company.
(c) Involuntary Termination. "Involuntary Termination" shall mean
-----------------------
without the Optionee's written consent: (i) termination by the Company of the
Optionee's employment with the Company other than for Cause; (ii) a material
reduction of or variation in the Optionee's duties, authority or
responsibilities, relative to the Optionee's duties, authority or
responsibilities as in effect
<PAGE>
immediately prior to such reduction or variation; (iii) a reduction by the
Company in the base salary of the Optionee as in effect immediately prior to
such reduction; (iv) a material reduction by the Company in the kind or level of
employee benefits, including bonuses, to which the Optionee was entitled
immediately prior to such reduction, with the result that the Optionee's overall
benefits package is materially reduced; (v) the relocation of the Optionee to a
facility or a location more than thirty (30) miles from the Optionee's then
present location; (vi) the failure of the Company to obtain the assumption of
this Agreement by any successor as required in Section 2(13) or (vii) any act or
set of facts that would under applicable law constitute a constructive
termination of Optionee.
(d) Cause. "Cause" shall mean (i) any willful act of personal
-----
dishonesty, fraud or misrepresentation taken by the Optionee in connection with
his or her responsibilities as an employee which was intended to result in
substantial gain or personal enrichment of the Optionee at the expense of the
Company and was materially and demonstrably injurious to the Company; (ii) the
Optionee's conviction of a felony on account of any act which was materially and
demonstrably injurious to the Company; or (iii) the Optionee's willful and
continued failure to substantially perform his or her principal duties and
obligations of employment including under any written agreements (other than any
such failure resulting from incapacity due to physical or mental illness), which
failure is not remedied in a reasonable period of time after receipt of written
notice from the Company. For the purposes of this Section 12(d), no act or
failure to act shall be considered "willful" unless done or omitted to be done
in bad faith and without reasonable belief that the act or omission was in or
not opposed to the best interests of the Company. Any act or failure to act
based upon authority given pursuant to a resolution duly adopted by the Board of
Directors of the Company or based upon the advice of counsel for the Company
shall be conclusively presumed to be done or omitted to be done in good faith
and in the best interests of the Company.
(e) Voluntary Resignation; Termination For Cause. If the Optionee
--------------------------------------------
terminates employment as a result of an Involuntary Termination, the Optionee
shall be entitled to receive accelerated vesting under Section 12(a) hereof. If
the Optionee's continuous status as an employee of the Company terminates by
reason of the Optionee's voluntary resignation (and not Involuntary Termination)
or if the Optionee's continuous status as an employee of the Company is
terminated for Cause, in either case prior to such time as accelerated vesting
occurs as provided in Section 12(a) hereof, then the Optionee shall not be
entitled to receive accelerated vesting under Section 12(a) hereof.
12. Successors.
----------
Any successor to the Company (whether direct or indirect and whether
by purchase, merger or consolidation) shall assume the obligations under this
Agreement and agree expressly to perform the obligations under this Agreement in
the same manner and to the same extent as the Company would be required to
perform such obligations in the absence of a succession.
The terms of this Agreement and all rights of the Optionee hereunder
shall inure to the benefit of, and be enforceable by, the Optionee's personal or
legal representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees.
<PAGE>
OPTIONEE: COVAD COMMUNICATIONS GROUP, INC.
_______________________________ ______________________________________
Signature By
_______________________________ ______________________________________
Print Name Title
_______________________________
_______________________________
Residence Address
<PAGE>
EXHIBIT A
---------
1997 STOCK PLAN
EXERCISE NOTICE
Covad Communications Group, Inc.
2330 Central Expressway
Santa Clara, CA 95050
Attention: Secretary
1. Exercise of Option. Effective as of today, ___________, 19__, the
------------------
undersigned ("Optionee") hereby elects to exercise Optionee's option to purchase
_________ shares of the Common Stock (the "Shares") of Covad Communications
Group, Inc. (the "Company") under and pursuant to the 1997 Stock Plan (the
"Plan") and the Stock Option Agreement dated ________, 19______ (the "Option
Agreement"). The purchase price for the Shares shall be $_____, as required by
the Option Agreement.
2. Delivery of Payment. Purchaser herewith delivers to the Company the
-------------------
full purchase price of the Shares, as set forth in the Option Agreement.
3. Representations of Optionee. Optionee acknowledges that Optionee has
---------------------------
received, read and understood the Plan and the Option Agreement and agrees to
abide by and be bound by their terms and conditions.
4. Rights as Stockholder. Until the issuance of the Shares (as evidenced
---------------------
by the appropriate entry on the books of the Company or of a duly authorized
transfer agent of the Company), no right to vote or receive dividends or any
other rights as a stockholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Shares shall be issued to the
Optionee as soon as practicable after the Option is exercised. No adjustment
shall be made for a dividend or other right for which the record date is prior
to the date of issuance except as provided in Section 12 of the Plan.
5. Tax Consultation. Optionee understands that Optionee may suffer
----------------
adverse tax consequences as a result of Optionee's purchase or disposition of
the Shares. Optionee represents that Optionee has consulted with any tax
consultants Optionee deems advisable in connection with the purchase or
disposition of the Shares and that Optionee is not relying on the Company for
any tax advice.
6. Successors and Assigns. The Company may assign any of its rights under
----------------------
this Agreement to single or multiple assignees, and this Agreement shall inure
to the benefit of the successors and assigns of the Company. Subject to the
restrictions on transfer herein set forth, this
<PAGE>
Agreement shall be binding upon Optionee and his or her heirs, executors,
administrators, successors and assigns.
7. Interpretation. Any dispute regarding the interpretation of this
--------------
Agreement shall be submitted by Optionee or by the Company forthwith to the
Administrator which shall review such dispute at its next regular meeting. The
resolution of such a dispute by the Administrator shall be final and binding on
all parties.
8. Governing Law; Severability. This Agreement is governed by the
---------------------------
internal substantive laws but not the choice of law rules, of California.
9. Entire Agreement. The Plan and Option Agreement are incorporated
----------------
herein by reference. This Agreement, the Plan and the Option Agreement
constitute the entire agreement of the parties with respect to the subject
matter hereof and supersede in their entirety all prior undertakings and
agreements of the Company and Optionee with respect to the subject matter
hereof, and may not be modified adversely to the Optionee's interest except by
means of a writing signed by the Company and Optionee.
Submitted by: Accepted by:
OPTIONEE: COVAD COMMUNICATIONS GROUP, INC.
_______________________________ ___________________________________
Signature By
_______________________________ ___________________________________
Print Name Its
Address: Address:
- ------- -------
_________________________________ 2330 Central Expressway
_________________________________ Santa Clara, CA 95050
_____________________________________
Date Received
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated October 16, 1998, in Amendment No. 1 to the
Registration Statement (Form S-1 No. 333-63899) and related Prospectus of Covad
Communications Group, Inc. for the registration of its common stock.
Ernst & Young LLP
San Jose, California
December 17, 1998
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<PAGE>
<ARTICLE> 5
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<S> <C> <C>
<PERIOD-TYPE> 12-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 SEP-30-1998
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0 0
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<CHANGES> 0 0
<NET-INCOME> (2,612) (28,261)
<EPS-PRIMARY> (0.80) (5.26)
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