<PAGE>
As filed with the Securities and Exchange Commission on January 19, 1999
Registration Number 333-63899
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
AMENDMENT NO. 3
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. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JANUARY 19, 1999
PROSPECTUS
7,500,000 Shares
[LOGO OF COVAD COMMUNICATIONS GROUP, INC. APPEARS HERE]
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
$12.00 and $15.00 per share. See "Underwriting" for a discussion of the factors
considered in determining the initial public offering price. The Common Stock
has been approved for quotation on the Nasdaq National Market under the symbol
"COVD," subject to official notice of issuance.
-----------
The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors" commencing on page 9 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 $1.0 million.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
an aggregate of 1,125,000 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>
[NATIONAL COVERAGE GRAPHIC]
Header: National DSL Coverage.
Description: Graphic illustration of the United States territory marked with
symbols identifying the 6 cities in which the Company's services are available
and the 16 cities in which the Company's services are planned to be made
available. The name of the city is identified beside each symbol.
Caption: Covad estimates that, when complete, its DSL Networks in these 22
regions will enable the Company to provide service to over 28 million homes
and businesses.
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."
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 that operate as
competitive local exchange carriers (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
or Class B Common Stock immediately prior to the closing 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 prior to the closing of this offering.
The Company
Covad is a leading packet-based Competitive Local Exchange Carrier ("CLEC")
that provides dedicated high-speed digital communications 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
high-speed 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. The Company currently has
installed over 4,000 DSL lines and received orders for its services from
approximately 100 ISP and enterprise customers, including Cisco Systems,
Concentric Network, Epoch Networks, Oracle, PeopleSoft, 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. and Seattle
metropolitan areas in December 1998. 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 communications 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.
The Company recently entered into strategic relationships with AT&T Corp.
("AT&T"), NEXTLINK Communications, Inc. ("NEXTLINK") and Qwest Communications
Corporation ("QCC"). As part of these strategic relationships, the Company
received equity investments of $25 million from AT&T's venture capital arm and
two affiliated funds (collectively "AT&T Ventures"), $20 million from NEXTLINK
and $15 million from QCC's wholly owned subsidiary, U.S. Telesource, Inc. (as
used herein, "Qwest" refers to QCC or its subsidiary, as applicable).
Furthermore, AT&T, NEXTLINK and Qwest each entered into commercial agreements
with the Company providing for the purchase, marketing and resale of the
Company's services, the purchase by the Company of fiber optic transport
bandwidth, and collocation of network equipment.
3
<PAGE>
Market Opportunity
Covad was formed to capitalize on the substantial business opportunity
created by the growing demand for high-speed digital communications, 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. ("Warburg"), Crosspoint
Venture Partners 1996 ("Crosspoint"), Intel Corporation ("Intel"), AT&T
Ventures, NEXTLINK and Qwest.
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. IDC also estimates that the value of goods and services sold
worldwide through the Internet will increase from $12 billion in 1997 to over
$400 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 communications
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
communications 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 communications services in each region that it enters. Key aspects of
the Company's solution to provide high-speed digital communications 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
4
<PAGE>
expects that it will offer G.Lite compatible services 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.
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 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 enter and
roll out its service rapidly in its target regions 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, other CLECs and
Interexchange Carriers ("IXCs") in order to expand its distribution channels
and accelerate the sale of its services, and (viii) to provide a superior and
comprehensive product and service solution that includes line installation,
equipment sale and configuration and RLAN design.
5
<PAGE>
Risk Factors
The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors" beginning on page 9 hereof.
The Offering
<TABLE>
<C> <S>
Common Stock offered by the Company......... 7,500,000
Common Stock to be outstanding after this
offering................................... 46,625,263(1)
Use of proceeds............................. For capital expenditures to expand the
Company's networks and for working capital
purposes. See "Use of Proceeds."
Nasdaq National Market Symbol............... COVD
</TABLE>
- --------
(1) Based on the number of shares of Common Stock outstanding as of December
31, 1998. Includes (i) 1,800,000 shares of Common Stock to be issued
pursuant to exercise prior to the closing of this offering for cash of
warrants issued to three investors, (ii) 7,305,104 shares of Class B Common
Stock issued (based on an initial public offering price of $13.50 per
share) on conversion of Preferred Stock purchased by AT&T Ventures,
NEXTLINK and Qwest (collectively, the "Strategic Investors") in January
1999, which shares may be converted into Common Stock on a one-for-one
basis beginning in January 2000 and (iii) 18,246,162 shares of Common Stock
to be issued on conversion of Preferred Stock immediately prior to the
closing of this offering. Excludes (i) an aggregate of 12,288,779 shares of
Common Stock subject to outstanding options under the Company's 1997 Stock
Plan at December 31, 1998, (ii) 5,053,764 shares of Common Stock issuable
upon exercise of outstanding warrants issued as part of the issuance of the
Senior Discount Notes (as defined) (the "High Yield Warrants"), (iii)
135,000 shares of Common Stock issuable upon exercise of a warrant issued
to a consultant, and (iv) 79,765 shares of Common Stock to be 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.
"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.
6
<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 Pro Forma(3) As Adjusted(4)
------------ -------- ------------ --------------
(in thousands)
<S> <C> <C> <C> <C>
Consolidated Balance Sheet
Data:
Cash and cash equivalents... $ 4,378 $ 97,076 $157,082 $250,751
Net property and equipment.. 3,014 34,003 34,003 34,003
Total assets................ 8,074 144,622 233,328 326,997
Long-term obligations,
including current portion.. 783 137,926 137,926 137,926
Total stockholders' equity
(net capital deficiency)... 6,498 (6,417) 82,289 175,958
<CAPTION>
As of
December 31,
1997 As of September 30, 1998
------------ -------------------------------------
<S> <C> <C> <C> <C>
Other Operating Data:
Homes and businesses passed. 278,000 3,302,000
Lines installed............. 26 1,948
</TABLE>
- --------
(1) The pro forma net loss per share assumes the conversion of the Preferred
Stock outstanding as of September 30, 1998 into Common Stock on a one-for-
one basis and the exercise for cash of warrants to purchase 1,800,000
shares of Common Stock prior to the closing of this offering.
7
<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) In addition to the adjustments in Note (1) hereof, the pro forma balance
sheet information reflects the issuance of Preferred Stock to the Strategic
Investors, which shares will automatically convert into Class B Common
Stock immediately prior to the closing of this offering, and includes the
effect of recording intangible assets of $28.7 million associated with the
issuance of such shares. Such amounts will be amortized for periods of
three to six years.
(4) In addition to the adjustments in Notes (1) and (3) hereof, the as adjusted
balance sheet information reflects the receipt of net proceeds of $93.7
million from this offering (after deducting estimated underwriting
discounts and commissions and offering expenses payable by the Company).
8
<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. and Seattle metropolitan areas 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 High Yield Warrants
(collectively, 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. The Company intends to record intangible assets of $28.7 million
associated with the issuance of Preferred Stock to the Strategic Investors.
Such amounts will result in an annual amortization charge of approximately
$8.4 million in each of the three years ending December 31, 2001,
9
<PAGE>
decreasing to approximately 1.2 million per year through the year ending
December 31, 2004. Accordingly, the Company's operating losses will increase
significantly as a result of the interest and amortization charges related to
the Senior Discount Notes and the amortization charge associated with the
investments by the Strategic Investors. In addition, the Company expects to
incur substantial additional debt in the future. Any additional debt would
increase the Company's 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. 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. Furthermore, the Company's operating results may
fluctuate depending on, among other things, (i) the success of the Company's
relationships with AT&T, NEXTLINK and Qwest and other potential third parties
in generating significant subscriber demand, (ii) the ability of the Company
to deploy on a timely basis its services to adequately satisfy such subscriber
demand, (iii) the ability of the Company to maintain targeted subscriber
levels and (iv) the mix of line orders between consumer end-users and business
end-users (which typically have higher margins). Other 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. Many of these factors are outside the Company's control. In addition,
the Company plans to increase operating expenses to fund operations, sales,
marketing, general and administrative activities and infrastructure, including
increased expenses associated with its relationships with AT&T, NEXTLINK and
Qwest. 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 communications 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, Washington,
D.C. and Seattle 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 communications
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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 has provided and expects in the
future to provide price discounts to customers that commit to a large number
of end-users. 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 adequate
pricing levels or to achieve or sustain a profitable business model would
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."
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 the
majority of the Company's revenues, and the Company expects that its ISP
customers will account for 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 marketing
relationships with leading CLECs and IXCs, which the Company believes will
enable it to penetrate its markets and gain market acceptance more rapidly.
For example, the Company recently entered into commercial agreements with each
of AT&T, NEXTLINK and Qwest providing for the purchase, marketing and resale
of the Company's services, primarily to their small business and enterprise
customers. The Company cannot predict the number of line orders that AT&T,
NEXTLINK or Qwest will generate, if any, whether line orders will be below the
Company's, AT&T's, NEXTLINK's or Qwest's expectations or whether AT&T,
NEXTLINK or Qwest will discontinue purchasing or selling the Company's
services entirely. No assurance can be given that the Company will establish
similar relationships with other third parties or, if it does, that such
relationships or the AT&T, NEXTLINK or Qwest relationships will improve the
Company's business, prospects, operating results or financial condition. In
addition, the Company expects that AT&T, NEXTLINK, Qwest and other potential
third parties will purchase, market and resell the Company's RLAN services
primarily to their small business and enterprise customers. Therefore, future
growth in the Company's RLAN business may depend in part on the efforts of
these parties, which are outside the Company's control. See "Business--
Customers" and "--Sales and Marketing" and "Certain Relationships and Related
Transactions--The Strategic Investments and Relationships."
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 31, 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
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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 and Unbundled Network Elements
("UNEs")
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.
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 offer broad service
availability and therefore to secure and retain customers. In this regard, the
Company is in a variety of proceedings with multiple ILECs regarding certain
collocation spaces in which it has faced rejections 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
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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 4,
1998, the United States Appeals Court for the Fifth Circuit reversed the
December 31, 1997 Ruling. This decision has been 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 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 and other UNEs typically involve
a lengthy review of the ILEC-proposed rates in each state. The ultimate rates
approved typically depend greatly on 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
and other UNEs will increase based on new rates proposed by the ILECs and
approved by state regulatory commissions from time to time. Any of the
foregoing matters could result in a material adverse effect on the Company's
business, prospects, operating results and financial condition. 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
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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."
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
copper lines and the services it requires from the ILECs and at quality
levels, rates, terms and conditions satisfactory to the Company, and the
failure to obtain such services and satisfactory quality levels, 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
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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 DSL-based services. 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. The ILECs
currently represent and will in the future increasingly 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 asserted or actual 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.
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. 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.
In addition to the ILECs and CMSPs, 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 digital communications, 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 end of
the first quarter of 2000. The development and expansion of the
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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 335 at December 31, 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."
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 (including
capitalized leases) 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 and the
investments from the Strategic Investors, will be sufficient to fund the
Company's aggregate capital expenditures and working capital requirements,
including operating losses, through the end of 1999. The Company expects to
raise substantial additional financing during 1999 to fund the growth of its
operations, including funding the significant capital expenditures and working
capital requirements necessary for the Company to provide services in its 22
targeted regional networks. 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
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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 during 1999
through additional debt and possibly equity financing, the timing of which
will depend on market conditions and which could occur in the near term. 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 communications
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 communications 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, 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 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 increase from 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 and to fund operating losses and investments in working capital,
which could occur in the near term. 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
17
<PAGE>
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 in 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. 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."
18
<PAGE>
Digital Communications 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 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,
19
<PAGE>
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 and other services supplied
by third parties in order for the Company to meet its contractual commitments.
For example, the Company has recently entered into a service arrangement with
Lucent Technologies Inc. ("Lucent Technologies") to increase its ability to
order, install and manage its collocation facilities and associated equipment.
The Company has in the past experienced supply problems with certain of its
vendors and there can be no assurance that these vendors will be able to meet
the Company's needs in a satisfactory and timely manner in the future or that
the Company will be able to obtain additional vendors when and if needed.
Although the Company has identified alternative suppliers for technologies
that it deems critical 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 critical technologies
and substitute their technologies into the Company's networks. The Company's
reliance on third-party vendors 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, 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.
20
<PAGE>
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, UNE combination, nondiscrimination and
other 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 proposed 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 rulings, proposals and 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, such as changes to the 1996 Act, 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."
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 72.8% of the outstanding Common Stock
after completion of this offering (70.7% if the Over-Allotment
21
<PAGE>
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."
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
22
<PAGE>
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 31, 1998, the following shares
of Common Stock will be eligible for future sale. On the date of this
Prospectus, the 7,500,000 shares offered hereby will be eligible for sale in
the public market without restriction. An additional 31,820,159 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 7,305,104 shares
of Common Stock issuable upon conversion of the Class B Common Stock will be
eligible for sale beginning in January 2000 subject to volume limitations
pursuant to Rule 144 and the exercise of registration rights. In addition, the
Company has 15,520,342 shares of Common Stock reserved for issuance pursuant
to options under its 1997 Stock Plan, of which 12,288,779 shares were subject
to outstanding options at December 31, 1998, and the Company has 5,188,764
shares underlying outstanding warrants. All of such outstanding options and
warrants are also subject to the 180 day lock-up.
The Company intends to register, following the effective date of this
offering, a total of 15,520,342 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
31,529,866 shares of Common Stock and holders of 7,305,104 shares of Class B
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 High Yield
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."
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'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
23
<PAGE>
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."
24
<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 $93.7 million ($107.9 million
if the Over-Allotment Option is exercised in full) assuming an initial public
offering price of $13.50 per share and after deducting estimated underwriting
discounts and commissions and offering expenses.
The Company anticipates that the net proceeds of this offering, together
with the aggregate proceeds of $60 million from the investments by the
Strategic Investors, 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, provide working capital and for general
corporate purposes. The Company believes that the net proceeds of this
offering, together with the aggregate proceeds from the investments by the
Strategic Investors, will be sufficient to fund the Company's aggregate
capital expenditures and working capital requirements, including operating
losses, through the end of 1999. 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.
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<PAGE>
CAPITALIZATION
The following table sets forth (A) the capitalization of the Company as of
September 30, 1998, (B) the pro forma capitalization of the Company after
giving effect to the automatic conversion of all shares of Preferred Stock
outstanding as of September 30, 1998 into Common Stock and assuming the
exercise for cash of warrants to purchase 1,800,000 shares of Common Stock
prior to the closing of this offering, (C) the pro forma capitalization of the
Company to reflect additionally the issuance of Preferred Stock to the
Strategic Investors and to give effect to the automatic conversion of such
shares (based on an initial public offering price of $13.50 per share) into
Class B Common Stock immediately prior to the closing of this offering, and
(D) the as adjusted capitalization of the Company to reflect additionally 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 $13.50 per share
and after deducting estimated underwriting discounts and commissions and
offering expenses payable by the Company.
<TABLE>
<CAPTION>
As of September 30, 1998
-------------------------------------------
(A) (B) (C) (D)
Actual Pro Forma Pro Forma As Adjusted
-------- --------- --------- -----------
(in thousands)
<S> <C> <C> <C> <C>
Cash and cash equivalents......... $ 97,076 $ 97,082 $157,082 $250,751
======== ======== ======== ========
Long-term obligations:
Capital lease obligations
(including current portion)...... 634 634 634 634
13 1/2% Senior Discount Notes due
2008, net........................ 137,292 137,292 137,292 137,292
-------- -------- -------- --------
Total long-term obligations
(including current portion).... 137,926 137,926 137,926 137,926
Stockholders' equity (net capital
deficiency):
Preferred Stock, $0.001 par value;
no shares authorized, issued and
outstanding (A) actual; 5,000,000
shares authorized (B) pro forma,
(C) pro forma and (D) as
adjusted, no shares issued and
outstanding (B) pro forma, (C)
pro forma and (D) as adjusted.... -- -- -- --
Convertible Preferred Stock,
$0.001 par value; 30,000,000
shares authorized, 18,246,162
shares issued and outstanding (A)
actual; no shares authorized,
issued and outstanding (B) pro
forma, (C) pro forma and (D) as
adjusted......................... 18 -- -- --
Common Stock, $0.001 par value;
65,000,000 shares authorized and
11,634,149 shares issued and
outstanding (A) actual;
200,000,000 shares authorized and
31,680,311 shares issued and
outstanding (B) pro forma and (C)
pro forma and 39,180,311 shares
issued and outstanding (D) as
adjusted(1)...................... 12 32 32 40
Class B-Common Stock, $0.001 par
value; no shares authorized,
issued and outstanding (A) actual
and (B) pro forma; 10,000,000
shares authorized (C) pro forma
and (D) as adjusted; 7,305,104
shares issued and outstanding (C)
pro forma and (D) as adjusted.... -- -- 7 7
Additional paid-in capital(2)..... 30,732 30,736 119,429 213,090
Deferred compensation............. (6,306) (6,306) (6,306) (6,306)
Accumulated deficit............... (30,873) (30,873) (30,873) (30,873)
-------- -------- -------- --------
Total stockholders' equity (net
capital deficiency)............ (6,417) (6,411) 82,289 175,958
-------- -------- -------- --------
Total capitalization.......... $131,509 $131,515 $220,215 $313,884
======== ======== ======== ========
</TABLE>
- --------
(1) Excludes (i) an aggregate of 15,520,342 shares of Common Stock reserved
for issuance under the Company's 1997 Stock Plan, of which 12,288,779
shares were subject to outstanding options at December 31, 1998 at a
weighted average exercise price of $1.96 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) 5,053,764 shares of Common Stock
issuable upon exercise of outstanding High Yield Warrants at December 31,
1998 at an exercise price of $.0033 per share, (iv) 135,000 shares of
Common Stock issuable upon exercise of a warrant issued to a consultant at
December 31, 1998 at an exercise price of $1.00 per share and (v) 79,765
shares of Common Stock to be issued as cumulated but unpaid dividends on
Preferred Stock as of the closing of this offering.
(2) The amounts under (C) pro forma and (D) as adjusted include the effect of
recording intangible assets of $28.7 million associated with the issuance
of Preferred Stock to the Strategic Investors. Such amounts will be
amortized over a period of three to six years.
26
<PAGE>
DILUTION
The pro forma net tangible book value of the Company as of September 30,
1998 was $45,285,000 or $1.16 per share of outstanding Common Stock after
giving effect to the conversion of the Company's Preferred Stock outstanding
as of September 30, 1998, the exercise for cash of warrants to purchase
1,800,000 shares of Common Stock prior to the consummation of this offering
and the issuance of Preferred Stock to the Strategic Investors after giving
effect to the automatic conversion of such shares to Class B Common Stock
immediately prior to the closing of this offering. The pro forma net tangible
book value per share represents the Company's total pro forma tangible assets
less total liabilities, divided by the pro forma number of shares of Common
Stock outstanding. Dilution per share represents the difference between the
amount per share paid by investors in this offering and the as adjusted pro
forma net tangible book value per share after the offering. After giving
effect to this offering at an assumed initial public offering price of $13.50
per share resulting in estimated net proceeds to the Company of approximately
$93.7 million (after deducting estimated underwriting discounts and
commissions and offering expenses payable by the Company), the as adjusted pro
forma net tangible book value of the Company at September 30, 1998 would have
been $138,954,000 or $2.99 per share. This represents an immediate increase in
the net tangible book value of $1.83 per share to existing stockholders and an
immediate dilution in net tangible book value of $10.51 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................... $13.50
Pro forma net tangible book value per share as of September 30,
1998........................................................... $1.16
Increase per share attributable to new investors................ 1.83
-----
As adjusted pro forma net tangible book value per share after the
offering......................................................... 2.99
------
Dilution per share to new investors............................... $10.51
======
</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 $13.50 per share (before deducting
estimated underwriting discounts and commissions and offering expenses payable
by the Company):
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ -------------------- Price Per
Number Percent Amount Percent Share
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders......... 38,985,415 83.9% $ 70,360,000 41.0% $ 1.80
New investors................. 7,500,000 16.1 101,250,000 59.0 13.50
---------- ---- ------------ ----
Total....................... 46,485,415 100% $171,610,000 100% 3.69
========== ==== ============ ====
</TABLE>
The foregoing table assumes no exercise of the Over-Allotment Option and no
exercise of stock options or warrants outstanding at December 31, 1998, other
than the exercise for cash of warrants to purchase 1,800,000 shares of Common
Stock prior to the consummation of this offering. At December 31, 1998, there
were options and warrants outstanding to purchase 17,477,543 shares of Common
Stock at a weighted average exercise price of $1.39 per share. To the extent
outstanding options and warrants are exercised, there will be further dilution
to new investors. See "Management."
27
<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(1)........................ 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>
28
<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) The pro forma net loss per share assumes the conversion of the Preferred
Stock outstanding as of September 30, 1998 into Common Stock on a one-for-
one basis and reflects the exercise for cash of warrants to purchase
1,800,000 shares of Common Stock prior to the closing 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.
29
<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 communications 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. and Seattle metropolitan areas in December 1998. 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 communications
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 31, 1998,
the Company's networks passed over 5.8 million homes and businesses, including
1.7 million in the San Francisco Bay Area. In addition, the Company currently
has installed over 4,000 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.
30
<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
performed services under any agreements for volume discounts which are
material to its financial results. However, the Company expects prices for the
major components of both recurring and non-recurring revenues to decrease each
year in part due to the effects of future volume discounts. 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, 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
31
<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 the end of 1999. 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,
the 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."
The Company recently entered into strategic relationships with AT&T,
NEXTLINK and Qwest. As part of these strategic relationships, the Company
received equity investments of $25 million from AT&T Ventures, $20 million
from NEXTLINK and $15 million from Qwest. Furthermore, AT&T, NEXTLINK and
Qwest each entered into commercial agreements with the Company providing for
the purchase, marketing and resale of the Company's services, the purchase by
the Company of fiber optic transport bandwidth, and collocation of network
equipment. As a result, the Company expects that in the future AT&T, NEXTLINK,
Qwest and other potential third parties, if any, will increasingly account for
a significant portion of new line orders, although there can be no assurance
in this regard. See "Risk Factors--Dependence Upon Indirect Sales Channels."
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 during such periods 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 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 increased customers and subscribers resulting from the
Company's increased sales and marketing efforts and the expansion of the
Company's network in the San Francisco Bay Area. 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.
32
<PAGE>
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.
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 and Intangible Asset Amortization
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.
The Company intends to record intangible assets of $28.7 million associated
with the issuance of Preferred Stock to the Strategic Investors. Such amounts
will result in an annual amortization charge of approximately $8.4 million in
each of the three years ending December 31, 2001, decreasing to approximately
$1.2 million per year through the year ending December 31, 2004.
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 and resulted primarily from
the investment of the proceeds raised in the issuance of the Company's Senior
Discount Notes in March 1998. Interest expense for the nine
33
<PAGE>
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 and will increase to approximately $22.3 million for the
year ending December 31, 1999. 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.
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 $(7.01) 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 from 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.
34
<PAGE>
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
-----------------------------------------------------------
June
September 30, December 31, March 31, 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>
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 increased 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. 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. Furthermore, the Company's operating results may
fluctuate depending on, among other things, (i) the success of the
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Company's relationships with AT&T, NEXTLINK and Qwest and other potential
third parties in generating significant subscriber demand, (ii) the ability of
the Company to deploy on a timely basis its services to adequately satisfy
such subscriber demand, (iii) the ability of the Company to maintain targeted
subscriber levels and (iv) the mix of line orders between consumer end-users
and business end-users (which typically have higher margins). Other 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. Many of these factors are outside the Company's
control. In addition, the Company plans to increase operating expenses to fund
operations, sales, marketing, general and administrative activities and
infrastructure, including increased expenses associated with its relationships
with AT&T, NEXTLINK and Qwest. 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 regions.
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, 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.
In January 1999, the Company received equity investments of $25 million from
AT&T Ventures, $20 million from NEXTLINK and $15 million from Qwest,
representing an aggregate equity investment of $60 million.
The Company believes its current capital resources, including the proceeds
of this offering and the investments from the Strategic Investors, will be
sufficient to fund the Company's aggregate capital expenditures and working
capital requirements, including operating losses, through the end of 1999. The
Company expects to raise substantial additional financing during 1999 to fund
the growth of its operations, 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 expects to raise
additional capital during 1999 through the issuance of debt and possibly
equity securities, the timing of which will depend on market conditions, and
which could occur in the near term. There can be no assurance as to the
availability of any financing or the terms upon which
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such financing might be available. The Company expects to experience
substantial negative cash flow from operating activities and negative 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 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
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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, expectations regarding the Company's relationships with
AT&T, NEXTLINK, Qwest and other potential third parties, expectations as to
pricing for the Company's services in the future, 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 and 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 that could cause actual results to vary materially from the future
results indicated, expressed or implied in such forward-looking statements
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. 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 communications 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. The Company currently has installed over 4,000 DSL lines and
received orders for its services from approximately 100 ISP and enterprise
customers, including Cisco Systems, Concentric Network, Epoch Networks,
Oracle, PeopleSoft, 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. and
Seattle metropolitan areas in December 1998. 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 communications 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 recently entered into strategic relationships with AT&T,
NEXTLINK and Qwest. As part of these strategic relationships, the Company
received equity investments of $25 million from AT&T Ventures, $20 million
from NEXTLINK and $15 million from Qwest. Furthermore, AT&T, NEXTLINK and
Qwest each entered into commercial agreements with the Company providing for
the purchase, marketing and resale of the Company's services, the purchase by
the Company of fiber optic transport bandwidth, and collocation of network
equipment.
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
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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. IDC also estimates that the value of goods and services sold
worldwide through the Internet will increase from $12 billion in 1997 to over
$400 billion in 2002. Accordingly, to remain competitive, small- and medium-
sized businesses increasingly need high-speed Internet connections to 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 communications services for RLAN access 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. 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%.
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
causing the demand for high-speed digital communications services to also grow
rapidly. 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, Compaq Computer
Corp., Microsoft Corp. and certain of the major ILECs, jointly announced the
formation of the Universal ADSL Working Group
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("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 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 communications 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 communications, 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
communications 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 will offer G.lite compatible services 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,
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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 (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
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. and Seattle metropolitan areas in
December 1998. As a result of the strong market demand for high-speed digital
communications 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.
Enter and Roll Out Service Rapidly in These Markets. The Company seeks to be
the first CLEC to enter and 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 customers since the typical enterprise
customer 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
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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.
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 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 in which 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
believes that these are some of the reasons AT&T, NEXTLINK and Qwest have
entered into relationships with the Company. The Company is currently
discussing relationships with other 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 end- users'
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 31,
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 service. 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 18,000 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. List prices are lower in Seattle and 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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<PAGE>
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 communications 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. and Seattle metropolitan areas in December 1998. As a result of the
strong market demand for high-speed digital communications 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>
45
<PAGE>
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. The Company
currently has over 4,000 end-user lines in operation with approximately 100 ISP
and enterprise customers, and the Company is 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) Fireman's Fund Insurance
DSL Networks Inc. Inktomi
Epoch Networks Intel
Flashcom, Inc. Oracle Corporation
Globix Corporation PeopleSoft
Lan Minds, Inc. Spelling Entertainment
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
31, 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 rollouts 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 31, 1998,
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<PAGE>
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.
Third Party Relationships. A key element of the Company's strategy is to
enter into relationships with leading telecommunications companies, including
CLECs and IXCs, in which those companies resell the Company's TeleSpeed
services to their customers. For example, the Company recently entered into
commercial agreements with each of AT&T, NEXTLINK and Qwest providing for the
purchase, marketing and resale of the Company's services, primarily to their
small business and enterprise 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. See "Risk Factors--Dependence Upon Indirect Sales
Channels."
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 communications 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
47
<PAGE>
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 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") equipment 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 equipment), each CO
48
<PAGE>
(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.
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 expects to deploy 40 to 250 CO
spaces in any metropolitan area that it enters. Currently, the Company has
approximately 165 CO spaces operational. In addition, the Company has a
significant number of additional spaces under construction as well as other
spaces on order from various ILECs. In December 1998, the Company entered into
a professional service arrangement with Lucent Technologies to augment and
accelerate its ability to deploy its collocation facilities.
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
49
<PAGE>
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. 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. The ILECs currently represent and will in the future
increasingly 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 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 asserted or actual 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
have deployed large-scale Internet access networks and ATM networks, sell
connectivity to businesses and residential customers, and have high brand rec-
ognition. They also have interconnection agreements with many of the ILECs and
a number of collocation spaces from which they are currently offering 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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<PAGE>
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 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.
and InterAccess 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 or other high-speed service
technologies, they would become 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 digital 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
51
<PAGE>
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
paid by the Company and access the Company has to the ILEC's transport
facilities; (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. 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 interconnection
agreements with existing or other 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 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.
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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 those 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, UNE combination, nondiscrimination and other 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 4, 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 has been 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 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.
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<PAGE>
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 two arbitration proceedings in two different states for
interconnection arrangements with the relevant ILECs. The Company has
concluded arbitration proceedings in a number of 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 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 products, services and 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
54
<PAGE>
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 31, 1998, the Company had 335 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 31, 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.
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.
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<PAGE>
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 found that
Pacific Bell breached its interconnection agreement with Covad and failed to
act in good faith on multiple counts. The arbitration panel 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. 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.
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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
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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. 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, litigation 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
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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 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 two publicly traded companies, Indus International, Inc. and
Level One Communications, Inc., 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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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 which is expected to occur in 2000; 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 and Crosspoint,
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.
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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 -- $286
1997 87,500(3) -- -- 126
Robert Knowling, Jr.,
President and Chief
Executive Officer(4)... 1998 180,768 750,000 2,100,000 196
1997 -- -- -- --
Rex Cardinale, Vice
President, Engineering. 1998 144,451 15,764 -- 281
1997 73,233(3) -- -- 126
Charles Haas, Vice
President, Sales....... 1998 133,615 15,962 -- 269
1997 70,000(3) -- -- 126
Dhruv Khanna, Vice
President, General
Counsel and Secretary.. 1998 133,615 15,943 -- 269
1997 70,000(3) -- -- 126
Timothy Laehy, Chief
Financial Officer,
Treasurer and
Vice President,
Finance................ 1998 129,327 16,189 -- 269
1997 45,000(3) -- -- 126
</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 22.45% $1.00 7/7/2006 $1,002,656 $2,401,537
</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
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<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 9,352,978 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 -- $26,250,000
</TABLE>
- --------
(1) Calculated on the basis of the fair market value of the Company's Common
Stock based on an assumed initial public offering price of $13.50, 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 reserved for issuance under the 1997 Stock Plan is
15,520,342 shares, plus an annual increase to be added on January 1 of each
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 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 nonstatutory stock options. The 1997 Stock Plan also
provides for the granting of stock purchase rights ("SPRs"). As of December
31, 1998, options to purchase an aggregate of 12,288,779 shares were
outstanding and 3,018,064 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 January 1999. 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 a right to purchase stock under the 1998 Purchase Plan (i) to the
extent that, immediately after the grant of the right to purchase stock, 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 gross earnings and commissions but excludes payments for
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<PAGE>
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 to purchase stock 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 right to purchase stock may be assumed or substituted
for by the successor corporation. If the successor corporation refuses to
assume or substitute for the outstanding rights to purchase stock, 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.
65
<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
and 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 AT&T
Ventures and NEXTLINK stock purchases constitute 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
$1.0 million 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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<PAGE>
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."
The Strategic Investments and Relationships
In January 1999, the Company received equity investments from AT&T Ventures,
NEXTLINK and Qwest. AT&T Ventures purchased an aggregate of 1,500,583 shares
of Series C-1 Preferred Stock at $2.7767 per share and an aggregate of
1,157,408 shares of Series D-1 Preferred Stock at $18.00 per share. These
purchases represent an aggregate investment of $25 million, of which $11
million was invested by AT&T Venture Fund II, LP and $14 million was invested
by the two affiliated funds. NEXTLINK purchased 1,200,466 shares of Series C-1
Preferred Stock at $2.7767 per share and 925,926 shares of Series of D-1
Preferred Stock at $18.00 per share, representing an investment of $20
million. Qwest purchased 900,349 shares of Series C-1 Preferred Stock at
$2.7767 per share and 694,445 shares of Series D-1 Preferred Stock at $18.00
per share, representing an aggregate investment of $15 million. Upon
completion of this offering, the Series C-1 Preferred Stock will convert into
Class B Common Stock on a one-for-one basis. The Series D-1 Preferred Stock
will also convert into Class B Common Stock at that time on a one-for-one
basis if the initial public offering price is $18.00 per share or greater. If
the initial public offering price is less than $18.00 per share, the number of
shares of Class B Common Stock into which the Series D-1 Preferred Stock will
convert will be increased so that the effective purchase price per share of
the Series D-1 Preferred Stock will be the same as the initial public offering
price. Based on an initial public offering price of $13.50 per share, the
Series C-1 Preferred Stock and Series D-1 Preferred Stock purchased by the
Strategic Investors will convert into 7,305,104 shares of Class B Common
Stock. The Strategic Investors have each agreed not to transfer any Series C-1
Preferred Stock, Series D-1 Preferred Stock or Class B Common Stock to any
non-affiliated third party until January 2000. The Strategic Investors have
also each agreed not to acquire more than 10% of the voting stock of the
Company without the consent of the Company until January 2002. In addition,
until January 2002, each of the Strategic Investors has agreed to vote any
voting securities it holds as recommended by the Board of Directors. See
"Description of Capital Stock--Class B Common Stock."
Concurrently with these strategic equity investments, AT&T, NEXTLINK and
Qwest entered into commercial agreements with the Company providing for the
purchase, marketing and resale of the Company's services at volume discounts,
purchase by the Company of fiber optic transport bandwidth at volume
discounts, collocation of network equipment and development of new DSL
services. These agreements have terms ranging from six months to several years
subject to earlier termination in certain circumstances. The Company cannot
predict the number of line orders that AT&T, NEXTLINK or Qwest will generate,
if any, whether line orders will be below the Company's, AT&T's, NEXTLINK's or
Qwest's expectations or whether AT&T, NEXTLINK or Qwest will discontinue
selling the Company's services entirely.
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.
68
<PAGE>
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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<PAGE>
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 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
31, 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.
<TABLE>
<CAPTION>
Number of
Shares Percentage Beneficially Owned(1)
Beneficially ----------------------------------------
Beneficial Owner Owned(1) Before Offering After Offering
---------------- ------------ ---------------- ----------------
<S> <C> <C> <C>
Charles McMinn(2)....... 3,150,000 9.9% 8.0%
Robert Knowling Jr.(3).. 306,250 * *
Robert Hawk(4).......... 176,515 * *
Henry Kressel(5)........ 13,355,319 42.0 34.0
Joseph Landy(5)......... 13,355,319 42.0 34.0
Daniel Lynch(6)......... 460,500 1.5 1.2
Frank Marshall(6)....... 260,502 * *
Rich Shapero(7)......... 3,338,829 10.5 8.5
Rex Cardinale........... 1,125,000 3.5 2.9
Charles Haas............ 3,150,000 9.9 8.0
Dhruv Khanna(8)......... 3,150,000 9.9 8.0
Timothy Laehy........... 345,000 1.1 *
All executive officers
and directors as a
group(9)............... 28,888,669 89.7 72.8
Warburg, Pincus
Ventures, L.P. (10).... 13,355,319 42.0 34.0
Crosspoint Venture
Partners 1996 (11)..... 3,338,829 10.5 8.5
Intel Corporation (12).. 2,465,997 7.8 6.3
</TABLE>
- --------
* Less than 1% of the outstanding voting stock.
(1) Based on 31,820,159 shares of Common Stock outstanding as of December 31,
1998. Does not include 7,305,104 shares of Class B Common Stock to be
issued to the Strategic Investors upon the closing of this offering
(based on an initial public offering price of $13.50 per share) on
conversion of Series C-1 Preferred Stock and Series D-1 Preferred Stock
acquired by them in January 1999. The Class B Common Stock is non-voting.
See "Certain Relationships and Related Transactions--The Strategic
Investments and Relationships" and "Description of Capital Stock--Class B
Common Stock." 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 31, 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 31, 1998.
70
<PAGE>
(4) Includes 4,500 shares of Common Stock subject to options exercisable
within 60 days of December 31, 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 31, 1998.
(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 392,004 shares of Common Stock subject to options and 1,694,148
shares of Common Stock subject to warrants exercisable within 60 days of
December 31, 1998.
(10) Includes 1,355,319 shares to be issued upon exercise of a warrant 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, are 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 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 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.
71
<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 190,000,000 shares of
Common Stock, 10,000,000 shares of Class B Common Stock and 5,000,000 shares
of Preferred Stock. As of December 31, 1998, there were 51 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 31, 1998, there were 31,820,159 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 will be outstanding upon
completion of this offering. As of December 31, 1998, options to purchase
12,288,779 shares of Common Stock at a weighted average exercise price of
$1.96 per share were outstanding. In January 1999 the Company issued Preferred
Stock which will be converted into 7,305,104 shares of Class B Common Stock
upon the closing of this offering (based on an initial public offering price
of $13.50 per share).
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.
Class B Common Stock
The rights of holders of Class B Common Stock are identical to the rights of
holders of Common Stock except that the holders of Class B Common Stock do not
have voting rights. Commencing in January 2000, the Class B Common Stock may
be converted into Common Stock on a one-for-one basis at the election of the
holder, provided that such holder and its affiliates would not hold more than
10% of the voting stock of the Company, or will automatically convert into
Common Stock upon transfer after such date to a third party.
Preferred Stock
Upon the closing of this offering, all outstanding shares of Preferred Stock
will automatically be converted into shares of Common Stock and Class B Common
Stock. See Notes 6 and 10 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.
72
<PAGE>
Warrants
In connection with the issuance of the Senior Discount Notes in March 1998,
the Company issued the High Yield 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 High Yield Warrants became exercisable on September 15,
1998 and automatically expire 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 and holders of 7,305,104 shares of Class B 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 or issuable upon conversion of the Class B Common Stock
commencing January 2000. 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) three 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.
73
<PAGE>
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.
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
BankBoston, N.A. 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 46,625,263
shares of Common Stock outstanding. Of these shares, the 7,500,000 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. An additional 7,305,104 shares
of Common Stock issuable upon conversion of the Class B Common Stock will be
eligible for sale beginning in January 2000 subject to volume limitations
pursuant to Rule 144 and the exercise of Registration Rights. The remaining
31,820,159 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
74
<PAGE>
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 upon exercise of warrants outstanding on the
date of this Prospectus, and may issue stock in connection with strategic
relationships and in connection with acquisitions of businesses, technologies
or products complementary to those of the Company, so long as the recipients
of such stock agree to be bound by a lock-up agreement for the remainder of
the 180-day lock-up period.
Upon expiration of the lock-up agreements, approximately 31,820,159 shares
of Common Stock will become eligible for immediate public resale, subject in
some cases to volume limitations pursuant to Rule 144. An additional 7,305,104
shares of Common Stock issuable upon conversion of the Class B Common Stock
will be eligible for sale in January 2000 subject to volume limitation
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 31, 1998, 12,288,779 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.
75
<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................................................... 7,500,000
=========
</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 450,000 shares of Common Stock offered
hereby for certain individuals and entities 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
1,125,000 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,
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<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 and upon exercise of warrants outstanding on the
date of this Prospectus, and may issue stock in connection with strategic
relationships and in connection with acquisitions of businesses, technologies
or products complementary to those of the Company, so long as the recipients
of such stock agree to be bound by a lock-up agreement for the remainder of
the 180-day lock-up period.
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. The Common Stock has been approved
for quotation on the Nasdaq National Market under the symbol "COVD," subject
to official notice of issuance.
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.
77
<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 http://www.sec.gov.
78
<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
(Net Capital
Deficiency)
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 $887,830, 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. 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>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Subsequent Event (unaudited)
In December 1998 and January 1999, the Company entered into strategic
relationships with AT&T Corp. ("AT&T"), NEXTLINK Communications, Inc.
("NEXTLINK") and Qwest Communications Corporation ("QCC"). As part of these
strategic relationships, the Company received equity investments of $25
million from AT&T's venture capital arm and two affiliated funds, $20 million
from NEXTLINK and $15 million from QCC's wholly owned subsidiary, U.S.
Telesource, Inc. (as used herein, "Qwest" refers to QCC or its subsidiary, as
applicable). The Company intends to record intangible assets of $28.7 million
associated with these transactions. Furthermore, AT&T, NEXTLINK and Qwest each
entered into commercial agreements with the Company providing for the
purchase, marketing and resale of the Company's services, the purchase by the
Company of fiber optic transport bandwidth, and collocation of network
equipment.
F-17
<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>
[TELESPEED SERVICE GRAPHIC]
First Header: The TeleSpeed Service.
Second Header: Covad Regional Network.
Description: Graphic illustration of Covad's Network Operations Centre
connected by lines representing the Company's DSL subscriber lines to graphic
illustrations of two homes, a business, a corporation and an internet service
provider. The graphic illustration of the corporation is connected to the
graphic illustration of the internet service provider by a shaded area
imprinted with "www" representing the Internet.
Caption: Advantages: FAST--Enables high-speed downloading of Web pages and
files. ALWAYS ON--No dial-up process required. SECURE--A dedicated connection
to the home or business.
<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.............................................................. 9
Use of Proceeds........................................................... 25
Dividend Policy........................................................... 25
Capitalization............................................................ 26
Dilution.................................................................. 27
Selected Consolidated Financial Data...................................... 28
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 30
Business.................................................................. 39
Management................................................................ 57
Certain Relationships and Related Transactions............................ 66
Principal Stockholders.................................................... 70
Description of Capital Stock.............................................. 72
Shares Eligible for Future Sale........................................... 74
Underwriting.............................................................. 76
Legal Matters............................................................. 77
Experts................................................................... 77
Additional Information.................................................... 78
Index to Financial Statements............................................. F-1
Glossary.................................................................. A-1
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
7,500,000 Shares
[LOGO OF COVAD COMMUNICATIONS GROUP, INC. APPEARS HERE]
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............................... 95,000
Blue sky fees and expenses....................................... 5,000
Printing and engraving expenses.................................. 200,000
Legal fees and expenses.......................................... 250,000
Accounting fees and expenses..................................... 200,000
Transfer agent and registrar fees................................ 10,000
Miscellaneous.................................................... 182,719
----------
Total.......................................................... $1,000,000
==========
</TABLE>
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 31, 1998, the Registrant granted
stock options to purchase an aggregate of 13,196,727 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, 213,499 shares of Common Stock have been issued upon exercise of
vested options.
(20) An aggregate of 2,701,049 shares of Series C-1 Preferred Stock and
2,083,334 shares of Series D-1 Preferred Stock were issued in a private
placement in January 1999 to four investors. The consideration received for
such shares was $45 million.
(21) An aggregate of 900,349 shares of Series C-1 Preferred Stock and
694,445 shares of Series D-1 Preferred Stock were issued in a private
placement in January 1999 to an investor. The consideration received for
such shares was $15 million.
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 immediately following
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 January 19,
1999 among the Registrant and certain of its stockholders.
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.
10.13 Series C-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 among the Registrant, AT&T Venture Fund II, LP and two affiliated
funds.
10.14 Series D-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 among the Registrant, AT&T Venture Fund II, LP and two affiliated
funds.
10.15 Series C-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 between the Registrant and NEXTLINK Communications, Inc.
10.16 Series D-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 between the Registrant and NEXTLINK Communications, Inc.
10.17 Series C-1 Preferred Stock Purchase Agreement dated as of January 19,
1999 between the Registrant and U.S. Telesource, Inc.
10.18 Series D-1 Preferred Stock Purchase Agreement dated as of January 19,
1999 between the Registrant and U.S. Telesource, Inc.
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>
- --------
* Previously filed.
** Incorporated by reference to Registrant's Form 10-Q for the quarter ended
September 30, 1998, filed November 16, 1998.
(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 January 19, 1999.
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
January 19, 1999 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 immediately following
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 January 19,
1999 among the Registrant and certain of its stockholders.
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>
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
REGISTRATION STATEMENT ON FORM S-1
INDEX TO EXHIBITS--(Continued)
<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.
10.13 Series C-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 among the Registrant, AT&T Venture Fund II, LP and two affiliated
funds.
10.14 Series D-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 among the Registrant, AT&T Venture Fund II, LP and two affiliated
funds.
10.15 Series C-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 between the Registrant and NEXTLINK Communications, Inc.
10.16 Series D-1 Preferred Stock Purchase Agreement dated as of December 30,
1998 between the Registrant and NEXTLINK Communications, Inc.
10.17 Series C-1 Preferred Stock Purchase Agreement dated as of January 19,
1999 between the Registrant and U.S. Telesource, Inc.
10.18 Series D-1 Preferred Stock Purchase Agreement dated as of January 19,
1999 between the Registrant and U.S. Telesource, Inc.
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>
- --------
* Previously filed.
** Incorporated by reference to Registrant's Form 10-Q for the quarter ended
September 30, 1998, filed November 16, 1998.
<PAGE>
EXHIBIT 1.1
COVAD COMMUNICATIONS GROUP, INC.
7,500,000 Shares of Common Stock
UNDERWRITING AGREEMENT
January . , 1999
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN INCORPORATED
DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION
GOLDMAN, SACHS & CO.
<PAGE>
7,500,000 Shares of Common Stock
COVAD COMMUNICATIONS GROUP, INC.
UNDERWRITING AGREEMENT
----------------------
January , 1999
Bear, Stearns & Co. Inc.
BT Alex. Brown Incorporated
Donaldson, Lufkin & Jenrette Securities Corporation
Goldman, Sachs & Co.
c/o Bear, Stearns & Co. Inc.
245 Park Avenue
New York, NY 10167
Ladies and Gentlemen:
Covad Communications Group, Inc., a corporation organized and existing
under the laws of Delaware (the "Company"), proposes, subject to the terms and
-------
conditions stated herein, to issue and sell to Bear, Stearns & Co. Inc. ("Bear
----
Stearns"), BT Alex. Brown Incorporated, Donaldson, Lufkin & Jenrette Securities
- -------
Corporation and Goldman, Sachs & Co. (collectively, the "Underwriters") an
------------
aggregate of 7,500,000 shares (the "Firm Shares") of its common stock, par value
-----------
$0.001 per share (the "Common Stock") and, for the sole purpose of covering
------------
over-allotments in connection with the sale of the Firm Shares, at the option of
the Underwriters, up to an additional 1,125,000 shares (the "Additional Shares")
-----------------
of Common Stock. The Firm Shares and any Additional Shares purchased by the
Underwriters are referred to herein as the "Shares". The Shares are more fully
------
described in the Registration Statement referred to below.
1. Representations and Warranties of the Company. The Company
---------------------------------------------
represents and warrants to, and agrees with, each of the Underwriters that:
(i) The Company has filed with the Securities and Exchange
Commission (the "Commission") a registration statement on Form S-1 (No.
-----------
333-63899), and any amendments thereto, and related preliminary
prospectuses for the registration under the Securities Act of 1933 (the
"Securities Act") of shares of common stock, which registration statement,
--------------
as so amended, has been declared effective by the Commission and copies of
which have heretofore been delivered to the Underwriters. Such registration
statement (and any registration statement increasing the size of the
offering (a "Rule 462(b) Registration Statement") filed pursuant to Rule
----------------------------------
462(b) under the Securities Act), in the respective forms in which they
were declared effective, as amended, including all exhibits thereto, are
each hereinafter referred to as the "Registration Statement". Other than a
----------------------
Rule 462(b) Registration Statement, which became effective upon filing, no
other document with respect
<PAGE>
to the Registration Statement has heretofore been filed with the Commission
(other than prospectuses filed pursuant to Rule 424(b) of the rules and
regulations of the Commission under the Securities Act (the "Securities Act
--------------
Regulations"), each in the form heretofore delivered to the Underwriters).
-----------
No stop order suspending the effectiveness of either Registration Statement
or the Rule 462(b) Registration Statement, if any, has been issued and no
proceeding for that purpose has been initiated or, to the Company's
knowledge, threatened by the Commission. The Company, if required by the
Securities Act Regulations, proposes to file the Prospectus with the
Commission pursuant to Rule 424(b) of the Securities Act Regulations. The
Prospectus, in the form in which it is to be filed with the Commission
pursuant to Rule 424(b) of the Securities Act Regulations, is hereinafter
referred to as the "Prospectus", except that if any revised prospectus or
----------
prospectus supplement shall be provided to the Underwriters by the Company
for use in connection with the offering and sale of the Shares (the
"Offering") which differs from the Prospectus (whether or not such revised
--------
prospectus or prospectus supplement is required to be filed by the Company
pursuant to Rule 424(b) of the Securities Act Regulations), the term
"Prospectus" shall refer to such revised prospectus or prospectus
supplement, as the case may be, from and after the time it is first
provided to the Underwriters for such use; and, provided, further, that the
term "Prospectus" shall be deemed to include any wrapper or supplement
thereto prepared in connection with the distribution of any Reserved Shares
(as defined in Section 2(f), below). Any preliminary prospectus or
prospectus subject to completion included in the Registration Statement or
filed with the Commission pursuant to Rule 424 under the Securities Act is
hereafter called a "Preliminary Prospectus". All references in this
----------------------
Agreement to the Registration Statement, the Rule 462(b) Registration
Statement, a Preliminary Prospectus and the Prospectus, or any amendments
or supplements to any of the foregoing, shall be deemed to include any copy
thereof filed with the Commission pursuant to its Electronic Data
Gathering, Analysis and Retrieval System ("EDGAR").
-----
(ii) The Registration Statement and the Prospectus, at the time
the Registration Statement became effective and as of the Closing Date
referred to in Section 2 hereof, complied and comply in all material
respects with the requirements of the Securities Act and the Securities Act
Regulations, and did not and as of the Closing Date do not contain an
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein
not misleading. The Prospectus, as of the date hereof (unless the term
"Prospectus" refers to a prospectus which has been provided to the
Underwriters by the Company for use in connection with the offering of the
Shares which differs from the Prospectus filed with the Commission pursuant
to Rule 424(b) of the Securities Act Regulations, in which case at the time
it is first provided to the Underwriters for such use) and on the Closing
Date, does not and will not include an untrue statement of a material fact
or omit to state a material fact necessary to make the statements therein,
in the light of the circumstances under which they were made, not
misleading; provided, however, that the representations and warranties in
this Section (1)(ii) shall not apply to statements in or omissions from the
Registration Statement or Prospectus made in reliance upon and in
conformity with information relating to any Underwriter furnished to the
Company in writing by any Underwriter expressly for use in the Registration
Statement or the Prospectus. Each Preliminary Prospectus and Prospectus
filed as part of the Registration Statement, as part of any amendment
thereto or pursuant to Rule 424 under the Securities Act Regulations, if
filed by electronic transmission pursuant to EDGAR (except as may be
permitted by Regulation S-T under the Securities Act) was identical to the
copy
2
<PAGE>
thereof delivered to the Underwriters for use in connection with the offer
and sales of the Shares. There are no contracts or other documents required
to be described in the Prospectus or to be filed as exhibits to the
Registration Statement under the Securities Act that have not been
described or filed therein as required, and there are no business
relationships or related-party transactions involving the Company or any
subsidiary or any other person required to be described in the Prospectus
that have not been described therein as required.
(iii) Each of the Company and its subsidiaries has been duly
incorporated and is validly existing as a corporation in good standing
under the laws of the jurisdiction of its incorporation and has corporate
power and authority to own, lease and operate its properties and to conduct
its business as described in the Prospectus. Each of the Company and each
subsidiary is duly qualified as a foreign corporation to transact business
and is in good standing in the State of California and each other
jurisdiction in which such qualification is required, whether by reason of
the ownership or leasing of property or the conduct of business, except for
such jurisdictions (other than the State of California) where the failure
to so qualify or to be in good standing would not, individually or in the
aggregate, result in a material adverse change, or any development that
could reasonably be expected to result in a material adverse change, in the
condition, financial or otherwise, or in the business, operations or
prospects, whether or not arising from transactions in the ordinary course
of business, of the Company and its subsidiaries, considered as one entity
(any such change is called a "Material Adverse Change"). The Company does
-----------------------
not own or control, directly or indirectly, any corporation, association or
other entity other than Covad Communications Company, a California
corporation, and DIECA Communications, Inc., a Virginia corporation. As of
the date hereof, (a) the Company has obtained CLEC regulatory approval in
each of the following States: California, Illinois, Maryland,
Massachusetts, New York, Oregon, Texas, Virginia, Washington, Delaware,
Colorado, New Jersey, New Hampshire, District of Columbia, Pennsylvania,
Michigan and Florida, and no such regulatory approval has been withdrawn,
and to the Company's knowledge no such regulatory approval is the subject
of any legal challenge (except as disclosed in the Prospectus) and (b) the
Company has not received any notice of rejection or denial, nor has it
withdrawn, any of its applications for CLEC approval in 10 additional
States where such applications, as of the date of the Prospectus, are
pending approval.
(iv) All of the outstanding shares of capital stock of the Company
have been duly authorized, validly issued, and are fully paid and
nonassessable and were not issued in violation of any preemptive or similar
rights. The Shares, when issued, delivered and sold in accordance with this
Agreement, will be duly authorized and validly issued, fully paid and
nonassessable, and will not have been issued in violation of or subject to
any preemptive or similar rights. At September 30, 1998, after giving
effect to the issuance and sale of the Shares pursuant hereto and the
application of the net proceeds from the sale thereof, the Company had the
pro forma consolidated capitalization as set forth in the Prospectus under
the caption "Capitalization".
(v) All of the outstanding capital stock of each subsidiary of
the Company is owned, directly or indirectly, by the Company, free and
clear of any security interest, claim, lien, limitation on voting rights or
encumbrance; and all such securities have been duly authorized, validly
issued, and are fully paid and nonassessable and were not issued in
violation of any preemptive or similar rights.
3
<PAGE>
(vi) Except as disclosed in the Prospectus, there are not
currently, and will not be as a result of the Offering, any outstanding
subscriptions, rights, warrants, calls, commitments of sale or options to
acquire, or instruments convertible into or exchangeable for, any capital
stock or other equity interest of the Company or any of its subsidiaries.
(vii) The Common Stock (including the Shares) is registered
pursuant to Section 12(g) of the Securities Exchange Act of 1934 (the
"Exchange Act") and is listed for quotation on the Nasdaq National Market
------------
System ("Nasdaq"), and the Company has taken no action designed to, or
------
likely to have the effect of, terminating the registration of the Common
Stock under the Exchange Act or delisting the Common Stock from Nasdaq, nor
has the Company received any notification that the Commission or Nasdaq is
contemplating terminating such registration or listing.
(viii) The Company has all requisite corporate power and authority to
execute, deliver and perform its obligations under this Agreement and to
consummate the transactions contemplated hereby, including, without
limitation, the corporate power and authority to issue, sell and deliver
the Shares as provided herein and the power to effect the Use of Proceeds
as described in the Prospectus.
(ix) This Agreement has been duly and validly authorized, executed
and delivered by the Company and is the legally valid and binding agreement
of the Company, enforceable against it in accordance with its terms, except
insofar as indemnification and contribution provisions may be limited by
applicable law or equitable principles and subject to applicable
bankruptcy, insolvency, fraudulent conveyance, reorganization or similar
laws affecting the rights of creditors generally and subject to general
principles of equity.
(x) Neither the Company nor any of its subsidiaries is, or, after
giving effect to the offering of the Shares, will be (a) in violation of
its charter or bylaws, (b) in default in the performance of any bond,
debenture, note, indenture, mortgage, deed of trust or other agreement or
instrument to which it is a party or by which it is bound or to which any
of its properties is subject, or (c) in violation of any local, state or
federal law, statute, ordinance, rule, regulation, requirement, judgment or
court decree (including, without limitation, the Communications Act and the
rules and regulations of the FCC and environmental laws, statutes,
ordinances, rules, regulations, judgments or court decrees) applicable to
the Company, its subsidiaries or any of their assets or properties (whether
owned or leased) other than, in the case of clauses (b) and (c), any
default or violation that could not reasonably be expected to (1)
individually or in the aggregate, result in a material adverse effect on
the properties, business, results of operations, condition (financial or
otherwise), affairs or prospects of the Company and its subsidiaries, taken
as a whole, (2) interfere with or adversely affect the sale of the Shares
pursuant hereto or (3) in any manner draw into question the validity of
this Agreement (any of the events set forth in clauses (1), (2) or (3), a
"Material Adverse Effect"). There exists no condition that, with notice,
-----------------------
the passage of time or otherwise, would constitute a default under any such
document or instrument, except as disclosed in the Prospectus, except for
any such condition which would not reasonably be expected to result in a
Material Adverse Effect.
(xi) None of (a) the execution, delivery or performance by the
Company of this Agreement, (b) the issuance and sale of the Shares and (c)
consummation by the Company of the transactions contemplated hereby
violate, conflict with or constitute a breach of any
4
<PAGE>
of the terms or provisions of, or a default under (or an event that with
notice or the lapse of time, or both, would constitute a default), or
require consent which has not been obtained under, or result in the
imposition of a lien on any properties of the Company or any of its
subsidiaries, or an acceleration of any indebtedness of the Company or any
of its subsidiaries pursuant to, (1) the charter or bylaws of the Company
or any of its subsidiaries, (2) any bond, debenture, note, indenture,
mortgage, deed of trust or other agreement or instrument to which the
Company or any of its subsidiaries is a party or by which the Company or
its subsidiaries or their properties is or may be bound, (3) any statute,
rule or regulation applicable to the Company or any of its subsidiaries or
any of their assets or properties or (4) any judgment, order or decree of
any court or governmental agency or authority having jurisdiction over the
Company or any of its subsidiaries or any of their assets or properties,
except in the case of clauses (2), (3) and (4) for such violations,
conflicts, breaches, defaults, consents, impositions of liens or
accelerations that (x) would not singly, or in the aggregate, have a
Material Adverse Effect or (y) which are disclosed in the Prospectus. Other
than as described in the Prospectus, no consent, approval, authorization or
order of, or filing, registration, qualification, license or permit of or
with, (A) any court or governmental agency, body or administrative agency
(including, without limitation, the FCC) or (B) any other person is
required for (1) the execution, delivery and performance by the Company of
this Agreement, (2) the issuance and sale of the Shares and the
transactions contemplated hereby, except (x) such as have been obtained and
made under the Securities Act and state securities or Blue Sky laws and
regulations or such as may be required by the NASD or (y) where the failure
to obtain any such consent, approval, authorization or order of, or filing
registration, qualification, license or permit would not reasonably be
expected to result in a Material Adverse Effect.
(xii) Except as set forth in the Prospectus, there are no legal or
governmental actions, suits or proceedings pending or, to Company's
knowledge, threatened (a) against or affecting the Company or any of its
subsidiaries, (b) which has as the subject thereof any officer or director
(in any such capacity) of, or property owned or leased by, the Company or
any of its subsidiaries or (c) relating to environmental or discrimination
matters, where in any such case (1) there is a reasonable possibility that
such action, suit or proceeding might be determined adversely to the
Company or such subsidiary and (2) any such action, suit or proceeding, if
so determined adversely, would reasonably be expected to result in a
Material Adverse Change or adversely affect the consummation of the
transactions contemplated by this Agreement. No material labor dispute with
the employees of the Company or any of its subsidiaries exists or, to the
Company's knowledge, is threatened or imminent.
(xiii) No action has been taken and no statute, rule, regulation or
order has been enacted, adopted or issued by any governmental agency that
prevents the issuance of the Shares or prevents or suspends the use of the
Prospectus; no injunction, restraining order or order of any nature by a
federal or state court of competent jurisdiction has been issued that
prevents the issuance of the Shares, prevents or suspends the sale of the
Shares in any jurisdiction referred to in Section 4(d) hereof or that could
adversely affect the consummation of the transactions contemplated by this
Agreement or the Prospectus; and every request of any securities authority
or agency of any jurisdiction for additional information has been complied
with in all material respects.
5
<PAGE>
(xiv) Except as would not, individually or in the aggregate,
reasonably be expected to result in a Material Adverse Change, (a) to the
Company's knowledge, neither the Company nor any of its subsidiaries is in
violation of any federal, state, local or foreign law or regulation
relating to pollution or protection of human health or the environment
(including, without limitation, ambient air, surface water, groundwater,
land surface or subsurface strata) or wildlife, including without
limitation, laws and regulations relating to emissions, discharges,
releases or threatened releases of chemicals, pollutants, contaminants,
wastes, toxic substances, hazardous substances, petroleum and petroleum
products (collectively, "Materials of Environmental Concern"), or otherwise
----------------------------------
relating to the manufacture, processing, distribution, use, treatment,
storage, disposal, transport or handling of Materials of Environmental
Concern (collectively, "Environmental Laws"), which violation includes, but
is not limited to, noncompliance with any permits or other governmental
authorizations required for the operation of the business of the Company or
its subsidiaries under applicable Environmental Laws, or noncompliance with
the terms and conditions thereof, nor has the Company or any of its
subsidiaries received any written communication, whether from a
governmental authority, citizens group, employee or otherwise, that alleges
that the Company or any of its subsidiaries is in violation of any
Environmental Law; (b) there is no claim, action or cause of action filed
with a court or governmental authority, no investigation with respect to
which the Company or any of its subsidiaries has received written notice,
and no written notice by any person or entity alleging potential liability
for investigatory costs, cleanup costs, governmental response costs,
natural resources damages, property damages, personal injuries, attorneys'
fees or penalties arising out of, based on or resulting from the presence,
or release into the environment, of any Material of Environmental Concern
at any location owned, leased or operated by the Company or any of its
subsidiaries, now or in the past (collectively, "Environmental Claims"),
--------------------
pending or, to Company's knowledge, threatened against the Company or any
of its subsidiaries or any person or entity whose liability for any
Environmental Claim the Company or any of its subsidiaries has retained or
assumed either contractually or by operation of law; and (c) to the
Company's knowledge, there are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without
limitation, the release, emission, discharge, presence or disposal of any
Material of Environmental Concern, that reasonably could result in a
violation of any Environmental Law or form the basis of a potential
Environmental Claim against the Company or any of its subsidiaries or
against any person or entity whose liability for any Environmental Claim
the Company or any of its subsidiaries has retained or assumed either
contractually or by operation of law.
(xv) The Company and each of its subsidiaries has (a) good and
marketable title to all of the properties and assets described in the
Prospectus or the financial statements included in the Prospectus as owned
by it, free and clear of all liens, charges, encumbrances and restrictions,
except such as are described in the Prospectus or as would not have a
Material Adverse Effect, (b) peaceful and undisturbed possession to the
extent described in the Prospectus under all material leases to which it is
a party as lessee, (c) all licenses, certificates, permits, authorizations,
approvals, franchises and other rights from, and has made all declarations
and filings with, all federal, state and local authorities (including,
without limitation, the FCC), all self-regulatory authorities and all
courts and other tribunals (each an "Authorization") necessary to engage in
-------------
the business conducted by the Company and its subsidiaries in the manner
described in the Prospectus, except as described in the Prospectus and
except insofar as the failure to obtain any such
6
<PAGE>
Authorization would not reasonably be expected to have a Material Adverse
Effect, and no such Authorization contains a materially burdensome
restriction that is not disclosed in the Prospectus and (d) not received
any notice that any governmental body or agency is considering limiting,
suspending or revoking any such Authorization. Except where the failure to
be in full force and effect would not have a Material Adverse Effect, all
such Authorizations are valid and in full force and effect and the Company
and each of its subsidiaries is in compliance in all material respects with
the terms and conditions of all such Authorizations and with the rules and
regulations of the regulatory authorities having jurisdiction with respect
thereto. All material leases to which the Company and each of its
subsidiaries is a party are valid and binding and no default by the Company
or any of its subsidiaries has occurred and is continuing thereunder and,
to the Company's knowledge, no material defaults by the landlord are
existing under any such lease that could reasonably be expected to result
in a Material Adverse Effect.
(xvi) Except as described in the Prospectus, the Company and its
subsidiaries own, possess or have the right to employ sufficient patents,
patent rights, licenses (including all FCC, state, local or other
jurisdictional regulatory licenses), inventions, copyrights, know-how
(including trade secrets and other unpatented and/or unpatentable
proprietary or confidential information, software, systems or procedures),
trademarks, service marks and trade names, inventions, computer programs,
technical data and information (collectively, the "Intellectual Property
---------------------
Rights") reasonably necessary to conduct their businesses as now conducted;
------
and the expected expiration of any of such Intellectual Property Rights
would not result in a Material Adverse Change. The Intellectual Property
Rights presently employed by the Company and its subsidiaries in connection
with the businesses now operated by them or which are proposed to be
operated by them are owned, to the Company's knowledge, free and clear of
and without violating any right, claimed right, charge, encumbrance,
pledge, security interest, restriction or lien of any kind of any other
person and neither the Company nor any of its subsidiaries has received any
notice of infringement of or conflict with asserted rights of others with
respect to any of the foregoing except as would not reasonably be expected
to have a Material Adverse Effect. The use of the Intellectual Property in
connection with the business and operations of the Company and its
subsidiaries does not infringe on the rights of any person, except as could
not reasonably be expected to have a Material Adverse Effect.
(xvii) None of the Company or any of its subsidiaries, or, or to the
knowledge of the Company, any of their respective officers, directors,
partners, employees, agents or affiliates or any other person acting on
behalf of the Company or any of its subsidiaries has, directly or
indirectly, given or agreed to give any money, gift or similar benefit
(other than legal price concessions to customers in the ordinary course of
business) to any customer, supplier, employee or agent of a customer or
supplier, official or employee of any governmental agency (domestic or
foreign), instrumentality of any government (domestic or foreign) or any
political party or candidate for office (domestic or foreign) or other
person who was, is or may be in a position to help or hinder the business
of the Company or any of its subsidiaries (or assist the Company or any of
its subsidiaries in connection with any actual or proposed transaction)
which (a) would reasonably be expected to subject the Company, or any other
individual or entity to any damage or penalty in any civil, criminal or
governmental litigation or proceeding (domestic or foreign), (b) if not
given in the past, would reasonably be expected to have had a Material
Adverse Effect or (c) if not continued in the future, would reasonably be
expected to have a Material Adverse Effect.
7
<PAGE>
(xviii) All material tax returns required to be filed by the Company
and its subsidiaries in all jurisdictions have been so filed. All taxes,
including withholding taxes, penalties and interest, assessments, fees and
other charges due or claimed to be due from such entities or that are due
and payable have been paid, other than those being contested in good faith
and for which adequate reserves have been provided or those currently
payable without penalty or interest. To the knowledge of the Company, there
are no material proposed additional tax assessments against the Company or
any of its subsidiaries or the assets or property of the Company or any of
its subsidiaries. The Company has made adequate charges, accruals and
reserves in the applicable financial statements included in the Prospectus
in respect of all federal, state and foreign income and franchise taxes for
all periods as to which the tax liability of the Company or any of its
consolidated subsidiaries has not been finally determined.
(xix) The Company is not an "investment company" or a company
"controlled" by an "investment company" within the meaning of the
Investment Company Act of 1940, as amended (the "Investment Company Act").
----------------------
(xx) Except as disclosed in the Prospectus, there are no holders
of securities of the Company or any of its subsidiaries who, by reason of
the execution by the Company of this Agreement to which it is a party or
the consummation by the Company or any of its subsidiaries of the
transactions contemplated hereby, have the right to request or demand that
the Company or any of its subsidiaries register under the Securities Act or
analogous foreign laws and regulations securities held by them, other than
such that have been duly waived.
(xxi) The Company and its subsidiaries each maintain a system of
internal accounting controls sufficient to provide reasonable assurance
that: (a) transactions are executed in accordance with management's general
or specific authorizations; (b) transactions are recorded as necessary to
permit preparation of financial statements in conformity in all material
respects with generally accepted accounting principles and to maintain
accountability for assets; and (c) the recorded accountability for assets
is compared with the existing assets at reasonable intervals and
appropriate action is taken with respect to any differences.
(xxii) Each of the Company and its subsidiaries are insured by
recognized, financially sound institutions with policies in such amounts
and with such deductibles and covering such risks as are customary for
similarly situated businesses including, but not limited to, policies
covering real and personal property owned or leased by the Company and its
subsidiaries against theft, damage, destruction and acts of vandalism. The
Company has no reason to believe that it or any subsidiary will not be able
(a) to renew its existing insurance coverage as and when such policies
expire or (b) to obtain comparable coverage from similar institutions as
may be necessary or appropriate to conduct its business as now conducted
and at a cost that would not result in a Material Adverse Change.
(xxiii) The Company has not (a) taken, directly or indirectly, any
action designed to, or that might reasonably be expected to, cause or
result in stabilization or manipulation of the price of any security of the
Company to facilitate the sale or resale of the Shares or (b) since the
date of the Preliminary Prospectus (1) sold, bid for, purchased or paid any
person any compensation for soliciting purchases of, the Shares or (2) paid
or agreed to pay to any
8
<PAGE>
person any compensation for soliciting another to purchase any other
securities of the Company.
(xxiv) The Company and its subsidiaries and any "employee benefit
plan" (as defined under the Employee Retirement Income Security Act of
1974, as amended, and the regulations and published interpretations
thereunder (collectively, "ERISA")) established or maintained by the
-----
Company, its subsidiaries or their "ERISA Affiliates" (as defined below)
are in compliance in all material respects with ERISA. "ERISA Affiliate"
---------------
means, with respect to the Company or a subsidiary, any member of any group
of organizations described in Sections 414(b), (c), (m) or (o) of the
Internal Revenue Code of 1986, as amended, and the regulations and
published interpretations thereunder (the "Code") of which the Company or
----
such subsidiary is a member. No "reportable event" (as defined under ERISA)
has occurred or is reasonably expected to occur with respect to any
"employee benefit plan" established or maintained by the Company, its
subsidiaries or any of their ERISA Affiliates. No "employee benefit plan"
established or maintained by the Company, its subsidiaries or any of their
ERISA Affiliates, if such "employee benefit plan" were terminated, would
have any "amount of unfunded benefit liabilities" (as defined under ERISA).
Neither the Company, its subsidiaries nor any of their ERISA Affiliates has
incurred or reasonably expects to incur any liability under (a) Title IV of
ERISA with respect to termination of, or withdrawal from, any "employee
benefit plan" or (b) Sections 412, 4971, 4975 or 4980B of the Code. Each
"employee benefit plan" established or maintained by the Company, its
subsidiaries or any of their ERISA Affiliates that is intended to be
qualified under Section 401(a) of the Code is so qualified and nothing has
occurred, whether by action or failure to act, which would cause the loss
of such qualification.
(xxv) Except as otherwise disclosed in the Prospectus, subsequent
to the respective dates as of which information is given in the Prospectus:
(a) there has been no Material Adverse Change; (b) the Company and its
subsidiaries, considered as one entity, have not incurred any material
liability or obligation, indirect, direct or contingent, not in the
ordinary course of business nor entered into any material transaction or
agreement not in the ordinary course of business; (c) there has been no
dividend or distribution of any kind declared, paid or made by the Company
or, except for dividends paid to the Company or other subsidiaries, any of
its subsidiaries on any class of capital stock or repurchase or redemption
by the Company or any of its subsidiaries of any class of capital stock;
(d) there has been no capital expenditure or commitment by the Company or
any of its subsidiaries exceeding $100,000, either individually or in the
aggregate except in the ordinary course of business as generally
contemplated by the Prospectus; (e) there has been no change in accounting
methods or practices (including any change in depreciation or amortization
policies or rates) by the Company or any of its subsidiaries; (f) there has
been no revaluation by the Company or any of its subsidiaries of any of
their assets; (g) there has been no increase in the salary or other
compensation payable or to become payable by the Company or any of its
subsidiaries to any of their officers, directors, employees or advisors,
nor any declaration, payment or commitment or obligation of any kind for
the payment by the Company or any of its subsidiaries of a bonus or other
additional salary or compensation to any such person; (h) there has been no
amendment or termination of any material contract, agreement or license to
which the Company or any subsidiary is a party or by which it is bound; (i)
there has been no waiver or release of any material right or claim of the
Company or any subsidiary, including any write-off or other compromise of
any material account receivable of the Company or any subsidiary; and (j)
there has been no change in pricing or
9
<PAGE>
royalties set or charged by the Company or any subsidiary to their
respective customers or licensees or in pricing or royalties set or charged
by persons who have licensed Intellectual Property Rights to the Company or
any of its subsidiaries.
(xxvi) Ernst & Young LLP, who have expressed their opinion with
respect to the financial statements (which term as used in this Agreement
includes the related notes thereto) and supporting schedules included in
the Prospectus are independent public or certified public accountants
within the meaning of Regulation S-X under the Securities Act and the
Exchange Act.
(xxvii) The financial statements, together with the related notes,
included in the Prospectus present fairly in all material respects the
consolidated financial position of the Company and its subsidiaries as of
and at the dates indicated and the results of their operations and cash
flows for the periods specified. Such financial statements have been
prepared in conformity with generally accepted accounting principles
applied on a consistent basis throughout the periods involved, except as
may be expressly stated in the related notes thereto. The financial data
set forth in the Prospectus under the captions "Prospectus Summary--Summary
Financial Data", "Selected Financial Data" and "Capitalization" fairly
present the information set forth therein on a basis consistent with that
of the audited financial statements contained in the Prospectus.
(xxviii) Except pursuant to this Agreement, there are no contracts,
agreements or understandings between the Company and any other person that
would give rise to a valid claim against the Company or either of the
Underwriters for a brokerage commission, finder's fee or like payment in
connection with the issuance, purchase and sale of the Shares.
(xxix) The statements (including the assumptions described therein)
included in the Prospectus (a) are within the coverage of Rule 175(b) under
the Securities Act to the extent such data constitute forward looking
statements as defined in Rule 175(c) and (b) were made by the Company with
a reasonable basis and reflect the Company's good faith estimate of the
matters described therein.
(xxx) Each of the (i) Series C-1 Preferred Stock Purchase
Agreement, dated as of December 30, 1998, by and among the Company and AT&T
Venture Fund II, LP, Special Partners Fund, LP and Special Partners Fund
International, LP (collectively, "AT&T Ventures"); (ii) Series D-1
-------------
Preferred Stock Purchase Agreement, dated as of December 30, 1998, by and
among the Company and AT&T Venture Fund II, LP, Special Partners Fund, LP
and Special Partners Fund International, LP; (iii) Series C-1 Preferred
Stock Purchase Agreement, dated as of December 30, 1998, by and among the
Company and NEXTLINK Communications, Inc. ("Nextlink"); (iv) Series D-1
--------
Preferred Stock Purchase Agreement, dated as of December 30, 1998, by and
among the Company and Nextlink; (v) Series C-1 Stock Purchase Agreement,
dated as of January 19, 1999, by and between the Company and U.S.
Telesource, Inc., a wholly owned subsidiary of Qwest Communications
Corporation (as used herein, "Qwest" refers to U.S. Telesource, Inc. or
-----
Qwest Communications Corporation, as applicable); and (vi) Series D-1 Stock
Purchase Agreement, dated as of January 19, 1999, by and between the
Company and Qwest has been duly authorized, executed and delivered by each
of the Company and each of the other parties thereto, and each of the
purchases and sales of Series C-1 and D-1 Preferred Stock pursuant thereto
has been consummated in accordance with the terms and provisions of such
stock purchase agreements and the Amended and Restated Certificate of
Incorporation of the Company (such shares of Series C-1 and D-1 Preferred
Stock issued by the Company
10
<PAGE>
and sold to AT&T Ventures, Nextlink and Qwest shall be herein collectively
referred to as the "Strategic Investor Preferred Shares", and such stock
-----------------------------------
purchase agreements shall be herein collectively referred to as the
"Strategic Investor Stock Purchase Agreements").
--------------------------------------------
(xxxi) Each of the __________ Agreement, dated as of December 31,
1998, between the Company and AT&T Corp.; the ___________________________
Agreement between the Company and AT&T Corp., dated as of December 30,
1998; the ___________ Agreement, dated as of December 29, 1998, between the
Company and Nextlink; and the ________ Agreement, dated as of January 19,
1999, between the Company and Qwest (together, the "Strategic Alliance
------------------
Agreements"), has been duly authorized, executed and delivered by the
----------
Company, AT&T, Nextlink and Qwest, as the case may be, and is in full force
and effect, and no party to any such agreement has given any notice of
termination or amendment of any material provisions thereof, or of any
intention to terminate or amend any material provision thereof, to any
other party.
(xxxii) No registration under the Securities Act of the Strategic
Investor Preferred Shares, or the Class B Common Stock, par value $0.001
per share (the "Class B Common Stock"), into which the Strategic Investor
--------------------
Preferred Shares are convertible upon consummation of the Offering, is
required for the offer or sale of the Strategic Investor Preferred Shares
to AT&T Ventures, Nextlink or Qwest, as contemplated by the respective
Strategic Investor Stock Purchase Agreements.
(xxxiii) Each certificate signed by any officer of the Company and
delivered to the Underwriters or counsel for the Underwriters pursuant to
this Agreement shall be deemed to be a representation and warranty by the
Company to the Underwriters as to the matters covered thereby.
The Company acknowledges that each of the Underwriters and, for
purposes of the opinions to be delivered to the Underwriters pursuant to Section
8 hereof, counsel to the Company and counsel to the Underwriters, will rely upon
the accuracy and truth of the foregoing representations and hereby consents to
such reliance.
2. Purchase, Sale and Delivery of the Shares.
-----------------------------------------
(a) On the basis of the representations, warranties, covenants and
agreements herein contained, but subject to the terms and conditions herein set
forth, the Company agrees to sell to the Underwriters and the Underwriters,
severally and not jointly, agree to purchase from the Company, at a purchase
price per share of $ , the number of Firm Shares set forth opposite the
respective names of the Underwriters in Schedule I hereto plus any additional
number of Shares which such Underwriter may become obligated to purchase
pursuant to the provisions of Section 9 hereof.
(b) Payment of the purchase price for, and delivery of
certificates for, the Firm Shares shall be made at the office of Bear, Stearns &
Co. Inc., 245 Park Avenue, New York, New York, or at such other place as shall
be agreed upon by the Underwriters and the Company, at 10:00 A.M. on , 1999
(unless postponed in accordance with the provisions of Section 9 hereof) after
the determination of the public offering price of the Firm Shares, or such other
time not later than ten business days after such date as shall be agreed upon by
the Underwriters and the Company (such time and date of payment and delivery
being herein called the "Closing Date").
11
<PAGE>
Payment shall be made to the Company by wire transfer in same day funds, against
delivery to the Underwriters of certificates for the Shares to be purchased by
them. Certificates for the Firm Shares shall be registered in such name or names
and in such authorized denominations as the Underwriters may request in writing
at least two full business days hours prior to the Closing Date. The Company
will permit the Underwriters to examine and package such certificates for
delivery at least one full business day prior to the Closing Date.
(c) In addition, the Company hereby grants to the Underwriters the
option to purchase up to 1,125,000 Additional Shares at the same purchase price
per share to be paid by the Underwriters to the Company for the Firm Shares as
set forth in this Section 2, for the sole purpose of covering over-allotments in
the sale of Firm Shares by the Underwriters. This option may be exercised at any
time, in whole or in part, on or before the thirtieth day following the date of
the Prospectus, by written notice by the Underwriters to the Company. Such
notice shall set forth the aggregate number of Additional Shares as to which the
option is being exercised and the date and time, as reasonably determined by the
Underwriters, when the Additional Shares are to be delivered (such date and time
being herein sometimes referred to as the "Additional Closing Date"); provided,
-----------------------
however, that the Additional Closing Date shall not be earlier than the Closing
Date or earlier than the second full business day after the date on which the
option shall have been exercised nor later than the eighth full business day
after the date on which the option shall have been exercised (unless such time
and date are postponed in accordance with the provisions of Section 9 hereof).
Certificates for the Additional Shares shall be registered in such name or names
and in such authorized denominations as the Underwriters may request in writing
at least two full business days prior to the Additional Closing Date. The
Company will permit the Underwriters to examine and package such certificates
for delivery at least one full business day prior to the Additional Closing
Date.
(d) The number of Additional Shares to be sold to each Underwriter
shall be the number which bears the same ratio to the aggregate number of
Additional Shares being purchased as the number of Firm Shares set forth
opposite the name of such Underwriter in Schedule I hereto (or such number
increased as set forth in Section 9 hereof) bears to the total number of Firm
Shares being purchased from the Company, subject, however, to such adjustments
to eliminate any fractional shares as the Underwriters in their sole discretion
shall make.
(e) Payment for the Additional Shares shall be made by wire
transfer in same day funds each payable to the order of the Company at the
office Bear, Stearns & Co. Inc., 245 Park Avenue, New York, New York, or such
other location as may be mutually acceptable, upon delivery of the certificates
for the Additional Shares to the Underwriters.
(f) The Company and the Underwriters agree that up to 450,000 of
the Firm Shares to be purchased by the Underwriters (the "Reserved Shares")
---------------
shall be reserved for sale by the Underwriters to certain individuals and
entities having business relationships with the Company, as part of the
distribution of the Shares by the Underwriters, subject to the terms of this
Agreement, the applicable rules, regulations and interpretations of the National
Association of Securities Dealers, Inc. (the "NASD") and all other applicable
----
laws, rules and regulations. To the extent that such Reserved Shares are not
orally confirmed for purchase by such individuals and entities having business
relationships with the Company by the end of the first business day after the
date of this Agreement, such Reserved Shares may be offered to the public as
part of the public offering contemplated hereby.
12
<PAGE>
3. Offering. Upon the Underwriters' authorization of the release
--------
of the Firm Shares, the Underwriters propose to offer the Shares for sale to the
public upon the terms set forth in the Prospectus.
4. Covenants of the Company. The Company covenants and agrees with
------------------------
each of the Underwriters that:
(a) The Company will notify the Underwriters immediately (and,
if requested by the Underwriters, will confirm such notice in writing) (i)
when any post-effective amendment to the Registration Statement becomes
effective, (ii) of any request by the Commission for any amendment of or
supplement to the Registration Statement or the Prospectus or for any
additional information, (iii) of the mailing or the delivery to the
Commission for filing of the Prospectus or any amendment of or supplement
to the Registration Statement or the Prospectus or any document to be filed
pursuant to the Exchange Act during any period when the Prospectus is
required to be delivered under the Securities Act, (iv) of the issuance by
the Commission of any stop order suspending the effectiveness of either
Registration Statement or any post-effective amendment thereto or of the
initiation, or the threatening, of any proceedings therefor, (v) of the
receipt of any comments or inquiries from the Commission, and (vi) of the
receipt by the Company of any notification with respect to the suspension
of the qualification of the Shares for sale in any jurisdiction or the
initiation or threatening of any proceeding for that purpose. If the
Commission shall propose or enter a stop order at any time, the Company
will make every reasonable effort to prevent the issuance of any such stop
order and, if issued, to obtain the lifting of such order as soon as
possible. The Company will not file any post-effective amendment to the
Registration Statement or any amendment of or supplement to the Prospectus
(including any revised prospectus which the Company proposes for use by the
Underwriters in connection with the offering of the Shares which differs
from the prospectus filed with the Commission pursuant to Rule 424(b) of
the Securities Act Regulations, whether or not such revised prospectus is
required to be filed pursuant to Rule 424(b) of the Securities Act
Regulations) to which the Underwriters or Underwriters' Counsel (as
hereinafter defined) shall reasonably object, will furnish the Underwriters
with copies of any such amendment or supplement a reasonable amount of time
prior to such proposed filing or use, as the case may be, and will not file
any such amendment or supplement or use any such prospectus to which the
Underwriters or counsel for the Underwriters shall reasonably object.
(b) If any event shall occur as a result of which the Prospectus
would, in the judgment of the Underwriters or the Company include an untrue
statement of a material fact or omit to state any material fact required to
be stated therein or necessary to make the statements therein, in the light
of the circumstances under which they were made, not misleading, or if it
shall be necessary at any time to amend or supplement the Prospectus or
either Registration Statement to comply with the Securities Act or the
Securities Act Regulations, the Company will notify the Underwriters
promptly and prepare and file with the Commission an appropriate amendment
or supplement (in form and substance satisfactory to the Underwriters)
which will correct such statement or omission or which will effect such
compliance.
(c) The Company has delivered to the Underwriters five signed
copies of the Registration Statement as originally filed, including
exhibits, and all amendments thereto, and the Company will promptly deliver
to each of the Underwriters,
13
<PAGE>
from time to time during the period that the Prospectus is required to be
delivered under the Securities Act, such number of copies of the Prospectus
and the Registration Statement, and all amendments of and supplements to
such documents, if any, as the Underwriters may reasonably request.
(d) The Company will endeavor in good faith, in cooperation with
the Underwriters, to qualify the Shares for offering and sale under the
securities laws relating to the offering or sale of the Shares of such
jurisdictions as the Underwriters may designate and to maintain such
qualification in effect for so long as required for the distribution
thereof; except that in no event shall the Company be obligated in
connection therewith to qualify as a foreign corporation or to execute a
general consent to service of process.
(e) The Company will make generally available (within the
meaning of Section 11(a) of the Securities Act) to its security holders and
to the Underwriters as soon as practicable, but not later than 45 days
after the end of its fiscal quarter in which the first anniversary date of
the effective date of the Registration Statement occurs (or if such fiscal
quarter is the Company's fourth fiscal quarter, not later than 90 days
after the end of such quarter), an earnings statement (in form complying
with the provisions of Rule 158 of the Regulations) covering a period of at
least twelve consecutive months beginning after the effective date of the
Registration Statement (as defined in Rule 158(c) under the Securities
Act).
(f) During the period of 180 days from the date of the
Prospectus, the Company will not, directly or indirectly, without the prior
written consent of Bear Stearns, offer, sell, contract to sell, grant any
option to purchase, pledge or otherwise dispose (or announce any offer,
sale, contract to sell, grant of an option to purchase, pledge or other
disposition) of any shares of Common Stock of the Company or any securities
convertible into or exercisable or exchangeable for such Common Stock,
except that the Company may issue (i) shares of Common Stock and options to
purchase Common Stock under its 1997 Stock Plan and its 1998 Purchase Plan
(as such terms are defined in the Prospectus), (ii) shares of Common Stock
upon exercise of warrants to purchase Common Stock that were issued and
outstanding on the date of the Prospectus or (iii) shares of Common Stock
issued in connection with strategic relationships and acquisitions of
businesses, technologies and products complementary to those of the
Company, so long as the recipients of such shares agree to be bound by a
lock-up agreement (which shall provide that any transferees and assigns of
such recipients shall be bound by the lock-up agreement) for the remainder
of the 180-day lock-up period.
(g) During a period of three years from the date of the
Prospectus, the Company will furnish to the Underwriters copies of (i) all
reports to its stockholders; and (ii) all reports, financial statements and
proxy or information statements filed by the Company with the Commission or
any national securities exchange.
(h) The Company will apply the proceeds from the sale of the
Shares as set forth under "Use of Proceeds" in the Prospectus.
(i) If the Company elects to rely upon Rule 462(b), the Rule
462(b) Registration Statement shall have become effective by 10:00 P.M.,
Washington, D.C. time, on the date of this Agreement, no stop order
suspending the effectiveness of the Registration Statement or any part
thereof shall have been issued and no proceeding for that purpose shall
have been initiated or threatened by the Commission, and all requests for
additional information on the part of the Commission shall have been
complied with to the Underwriters' reasonable satisfaction.
14
<PAGE>
(j) The Company, during the period when the Prospectus is
required to be delivered under the Securities Act or the Exchange Act, will
file all documents required to be filed with the Commission pursuant to
Sections 13, 14 or 15 of the Exchange Act within the time periods required
by the Exchange Act and the rules and regulations thereunder.
5. Payment of Expenses. Whether or not the transactions
-------------------
contemplated in this Agreement are consummated or this Agreement is terminated,
the Company hereby agrees to pay all costs and expenses incident to the
performance of the obligations of the Company hereunder, including those in
connection with (i) preparing, printing, duplicating, filing and distributing
the Registration Statement, as originally filed and all amendments thereto
(including all exhibits thereto), any Preliminary Prospectus, the Prospectus and
any amendments or supplements thereto (including, without limitation, fees and
expenses of the Company's accountants and counsel), the underwriting documents
(including this Agreement, the Agreement Among Underwriters and the Selling
Agreement) and all other documents related to the public offering of the Shares
(including those supplied to the Underwriters in quantities as hereinabove
stated), (ii) the issuance, transfer and delivery of the Shares to the
Underwriters, including any transfer or other taxes payable thereon, (iii) the
qualification of the Shares under state or foreign securities or Blue Sky laws,
including the costs of printing and mailing a preliminary and final "Blue Sky
Memorandum" and the fees of counsel in connection therewith and such counsel's
disbursements in relation thereto, (iv) listing of the Shares for quotation on
the Nasdaq, (v) filing fees of the Commission and the NASD, (vi) the cost of
printing certificates representing the Shares, (vii) the cost and charges of any
transfer agent or registrar and (viii) all costs and expenses of the
Underwriters, including the fees and disbursements of counsel for the
Underwriters, in connection with matters related to the Reserved Shares.
6. Conditions of Underwriters' Obligations. The obligations of the
---------------------------------------
Underwriters to purchase and pay for the Firm Shares and the Additional Shares,
as provided herein, shall be subject to the accuracy of the representations and
warranties of the Company herein contained, as of the date hereof and as of the
Closing Date (for purposes of this Section 6, "Closing Date" shall refer to the
------------
Closing Date for the Firm Shares and any Additional Closing Date, if different,
for the Additional Shares), to the absence from any certificates, opinions,
written statements or letters furnished to the Underwriters or to Latham &
Watkins ("Underwriters' Counsel") pursuant to this Section 6 of any material
---------------------
misstatement or omission, to the performance by the Company of its obligations
hereunder, and to the following additional conditions:
(a) On the Closing Date, no stop order suspending the
effectiveness of the Registration Statement shall have been issued under
the Securities Act or proceedings therefor initiated or, to the Company's
knowledge, threatened by the Commission. The Prospectus shall have been
filed or transmitted for filing with the Commission pursuant to Rule 424(b)
of the Securities Act Regulations within the prescribed time period, and
prior to Closing Date the Company shall have provided evidence satisfactory
to the Underwriters of such timely filing or transmittal.
(b) All of the representations and warranties of the Company
contained in this Agreement shall be true and correct on the date hereof
and on the Closing Date with the same force and effect as if made on and as
of the date hereof and the Closing Date, respectively. The Company shall
have performed or complied with all of the agreements
15
<PAGE>
herein contained and required to be performed or complied with by it at or
prior to the Closing Date.
(c) The Prospectus shall have been printed and copies
distributed to the Underwriters not later than 10:00 a.m., New York City
time, on the second business day following the date of this Agreement or at
such later date and time as to which the Underwriters may agree, and no
stop order suspending the qualification or exemption from qualification of
the Shares in any jurisdiction referred to in Section 4(d) shall have been
issued and no proceeding for that purpose shall have been commenced or
shall be pending or threatened.
(d) No action shall have been taken and no statute, rule,
regulation or order shall have been enacted, adopted or issued by any
governmental agency which would, as of the Closing Date, prevent the
issuance of the Shares; no action, suit or proceeding shall have been
commenced and be pending against or affecting or, to the best knowledge of
the Company, threatened against, the Company before any court or arbitrator
or any governmental body, agency or official that (1) could reasonably be
expected to result in a Material Adverse Effect and (2) has not been
disclosed in the Prospectus.
(e) Since the respective dates as of which information is given
in the Prospectus, (i) there shall not have been any Material Adverse
Change, or any development that is reasonably likely to result in a
Material Adverse Change, in the capital stock or the long-term debt, or
material increase in the short-term debt, of the Company or any of its
subsidiaries from that set forth in the Prospectus, (ii) no dividend or
distribution of any kind shall have been declared, paid or made by the
Company or any of its subsidiaries on any class of its capital stock, other
than as described in the Prospectus, (iii) neither the Company nor any of
its subsidiaries shall have incurred any liabilities or obligations, direct
or contingent, that are material, individually or in the aggregate, to the
Company and its subsidiaries, taken as a whole, and that are required to be
disclosed on the latest balance sheet or notes thereto included in the
Prospectus in accordance with generally accepted accounting principles and
are not so disclosed. Since the date hereof and since the dates as of which
information is given in the Prospectus, there shall not have occurred any
Material Adverse Effect.
(f) The Underwriters shall have received a certificate, dated
the Closing Date, signed on behalf of the Company by each of the Company's
Chief Executive Officer and Chief Financial Officer in form and substance
reasonably satisfactory to the Underwriters, confirming, as of the Closing
Date, the matters set forth in paragraphs (a), (b), (d) and (e) of this
Section 6 and that, as of the Closing Date, the obligations of the Company
to be performed hereunder on or prior thereto have been duly performed in
all material respects.
(g) The Underwriters shall have received on the Closing Date an
opinion, dated the Closing Date, in form and substance satisfactory to the
Underwriters and counsel to the Underwriters, of Wilson Sonsini Goodrich &
Rosati, P.C., counsel for the Company, to the effect set forth in Exhibit A
---------
hereto.
(h) The Underwriters shall have received on the Closing Date an
opinion, dated the Closing Date, in form and substance satisfactory to the
Underwriters and counsel to the Underwriters, of Dhruv Khanna, General
Counsel of the Company, to the effect set forth in Exhibit B hereto.
---------
16
<PAGE>
(i) All proceedings taken in connection with the sale of the
Firm Shares and the Additional Shares as herein contemplated shall be
satisfactory in form and substance to the Underwriters and to Underwriters'
Counsel, and the Underwriters shall have received from Underwriters'
Counsel a favorable opinion, dated as of the Closing Date with respect to
the issuance and sale of the Shares, the Registration Statement and the
Prospectus and such other related matters as the Underwriters may
reasonably require, and the Company shall have furnished to Underwriters'
Counsel such documents as they request for the purpose of enabling them to
pass upon such matters.
(j) At the time this Agreement is executed and at the Closing
Date, the Underwriters shall have received a letter from Ernst & Young LLP,
independent public accountants for the Company, dated, respectively, as of
the date of this Agreement and as of the Closing Date addressed to the
Underwriters and in form and substance reasonably satisfactory to the
Underwriters, containing statements and information of the type ordinarily
included in auditors' "comfort letters" to underwriters with respect to
financial statements and certain information of the Company and its
subsidiaries contained or incorporated by reference (if any) in the
Registration Statement and the Prospectus.
(k) At the time this Agreement is executed, the Underwriters
shall have received a "lock-up" agreement, substantially in the form
attached as Exhibit C hereto, from each of the officers, directors and
---------
stockholders of the Company identified on Exhibit D hereto.
---------
(l) At the Closing Date, the Shares shall have been approved
for quotation on the Nasdaq.
(m) At the time this Agreement is executed and at the Closing
Time, the NASD shall not have withdrawn, or given notice of an intention to
withdraw, its approval of the fairness of the underwriting terms and
arrangements of the offering of the Shares by the Underwriters.
(n) All opinions, certificates, letters and other documents
required by this Section 6 to be delivered by the Company will be in
compliance with the provisions hereof only if they are reasonably
satisfactory in form and substance to the Underwriters. The Company will
furnish the Underwriters with such conformed copies of such opinions,
certificates, letters and other documents as Bear Stearns shall reasonably
request. Prior to the Closing Date, the Company shall have furnished to the
Underwriters such further information, certificates and documents as the
Underwriters may reasonably request.
If any of the conditions specified in this Section 6 shall not have been
fulfilled when and as required by this Agreement, or if any of the certificates,
opinions, written statements or letters furnished to the Underwriters or to
Underwriters' Counsel pursuant to this Section 6 shall not be in all material
respects reasonably satisfactory in form and substance to the Underwriters and
to Underwriters' Counsel, all obligations of the Underwriters hereunder may be
canceled by the Underwriters at, or at any time prior to, the Closing Date and
the obligations of the Underwriters to purchase the Additional Shares may be
canceled by the Underwriters at, or at any time prior to, the Additional Closing
Date. Notice of such cancellation shall be given to the Company in writing, or
by telephone, telex or telegraph, confirmed in writing.
17
<PAGE>
7. Indemnification.
---------------
(a) The Company agrees to indemnify and hold harmless each
Underwriter and each person, if any, who controls any Underwriter within the
meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act
against any and all losses, liabilities, claims, damages and expenses whatsoever
as incurred (including but not limited to attorneys' fees and any and all
expenses whatsoever incurred in investigating, preparing or defending against
any litigation, commenced or threatened, or any claim whatsoever, and any and
all amounts paid in settlement of any claim or litigation), joint or several, to
which they or any of them may become subject under the Securities Act, the
Exchange Act or otherwise, insofar as such losses, liabilities, claims, damages
or expenses (or actions in respect thereof) arise out of or are based upon any
untrue statement or alleged untrue statement of a material fact contained in
either Registration Statement, as originally filed or any amendment thereof, or
any related Preliminary Prospectus or the Prospectus, or in any supplement
thereto or amendment thereof, or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated therein
or necessary to make the statements therein not misleading; provided, however,
that the Company will not be liable in any such case (i) to the extent but only
to the extent that any such loss, liability, claim, damage or expense arises out
of or is based upon any such untrue statement or alleged untrue statement or
omission or alleged omission made therein in reliance upon and in conformity
with written information furnished to the Company by or on behalf of any
Underwriter expressly for use therein and (ii) with respect to any preliminary
prospectus or preliminary prospectus supplement to the extent that any such
loss, claim, damage or liability results from the fact that an Underwriter sold
Shares to a person as to whom it shall be established that there was not sent or
given, at or prior to written confirmation of such sale, a copy of the
prospectus or prospectus supplement as then amended or supplemented in any case
where such delivery is required by the Securities Act if the Company has
previously furnished copies thereof in sufficient quantity to such Underwriter
and with sufficient time to effect a recirculation pursuant to Rule 461 under
the Securities Act and the loss, claim, damage or liability of the Underwriters
results from an untrue statement or omission of a material fact contained in the
preliminary prospectus or preliminary prospectus supplement which was identified
in writing prior to the effective date of the registration statement to such
underwriter and corrected in the prospectus or prospectus supplement as then
amended, and such correction would have cured the defect giving rise to such
loss, claim, damage or liability. This indemnity agreement will be in addition
to any liability which the Company may otherwise have including under this
Agreement.
(b) Each Underwriter severally, and not jointly, agrees to
indemnify and hold harmless the Company, each of the directors of the Company,
each of the officers of the Company who shall have signed the Registration
Statement, and each other person, if any, who controls the Company within the
meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange
Act, against any and all losses, liabilities, claims, damages and expenses
whatsoever as incurred (including but not limited to attorneys' fees and any and
all expenses whatsoever incurred in investigating, preparing or defending
against any litigation, commenced or threatened, or any claim whatsoever, and
any and all amounts paid in settlement of any claim or litigation), joint or
several, to which they or any of them may become subject under the Securities
Act, the Exchange Act or otherwise, insofar as such losses, liabilities, claims,
damages or expenses (or actions in respect thereof) arise out of or are based
upon any untrue statement or alleged untrue statement of a material fact
contained in either Registration Statement, as originally filed or any amendment
thereof, or any related preliminary prospectus, preliminary prospectus
supplement or prospectus, or in any amendment thereof or supplement thereto, or
arise out of or are based upon the omission
18
<PAGE>
or alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, in each case
to the extent, but only to the extent, that any such loss, liability, claim,
damage or expense arises out of or is based upon any such untrue statement or
alleged untrue statement or omission or alleged omission made therein in
reliance upon and in conformity with written information furnished to the
Company by or on behalf of any Underwriter expressly for use therein; provided,
however, that in no case shall any Underwriter be liable or responsible for any
amount in excess of the underwriting discount applicable to the Shares purchased
by such Underwriter hereunder. This indemnity will be in addition to any
liability which any Underwriter may otherwise have including under this
Agreement.
(c) Promptly after receipt by an indemnified party under
Subsection (a) or (b) above of notice of the commencement of any action, such
indemnified party shall, if a claim in respect thereof is to be made against the
indemnifying party under such subsection, notify each party against whom
indemnification is to be sought in writing of the commencement thereof (but the
failure so to notify an indemnifying party shall not relieve the indemnifying
party from any liability which it may have under this Section 7, except to the
extent that the indemnifying party has been prejudiced in any material respect
by such failure or from any liability that it may have otherwise). In case any
such action is brought against any indemnified party, and it notifies an
indemnifying party of the commencement thereof, the indemnifying party will be
entitled to participate therein, and to the extent it may elect by written
notice delivered to the indemnified party promptly after receiving the aforesaid
notice from such indemnified party, to assume the defense thereof with counsel
satisfactory to such indemnified party. Notwithstanding the foregoing, the
indemnified party or parties shall have the right to employ its or their own
counsel in any such case, but the fees and expenses of such counsel shall be at
the expense of such indemnified party or parties unless (i) the employment of
such counsel shall have been authorized in writing by one of the indemnifying
parties in connection with the defense of such action, (ii) the indemnifying
parties shall not have employed counsel to have charge of the defense of such
action within a reasonable time after notice of commencement of the action, or
(iii) such indemnified party or parties shall have reasonably concluded that
there may be defenses available to it or them which are different from or
additional to those available to one or all of the indemnifying parties (in
which case the indemnifying parties shall not have the right to direct the
defense of such action on behalf of the indemnified party or parties), in any of
which events such fees and expenses shall be borne by the indemnifying parties.
Anything in this Subsection to the contrary notwithstanding, an indemnifying
party shall not be liable for any settlement of any claim or action effected
without its written consent; provided, however, that such consent was not
unreasonably withheld.
8. Contribution. In order to provide for contribution in
-- ------------
circumstances in which the indemnification provided for in Section 7 hereof is
for any reason held to be unavailable from any indemnifying party or is
insufficient to hold harmless a party indemnified thereunder, the Company and
the Underwriters shall contribute to the aggregate losses, claims, damages,
liabilities and expenses of the nature contemplated by such indemnification
provision (including any investigation, legal and other expenses incurred in
connection with, and any amount paid in settlement of, any action, suit or
proceeding or any claims asserted, but after deducting in the case of losses,
claims, damages, liabilities and expenses suffered by the Company any
contribution received by the Company from persons, other than the Underwriters,
who may also be liable for contribution, including persons who control the
Company within the meaning of Section 15 of the Securities Act or Section 20(a)
of the Exchange Act, officers of the Company who signed the Registration
Statement and directors of the Company) as incurred to which the Company and one
or more of the Underwriters may be subject, in such proportions as is
appropriate to reflect the
19
<PAGE>
relative benefits received by the Company and the Underwriters from the offering
of the Shares or, if such allocation is not permitted by applicable law or
indemnification is not available as a result of the indemnifying party not
having received notice as provided in Section 7 hereof, in such proportion as is
appropriate to reflect not only the relative benefits referred to above but also
the relative fault of the Company and the Underwriters in connection with the
statements or omissions which resulted in such losses, claims, damages,
liabilities or expenses, as well as any other relevant equitable considerations.
The relative benefits received by the Company on the one hand and the
Underwriters on the other hand shall be deemed to be in the same proportion as
(x) the total proceeds from the offering (net of underwriting discounts and
commissions but before deducting expenses) received by the Company and (y) the
underwriting discounts and commissions received by the Underwriters,
respectively, in each case as set forth in the table on the cover page of the
Prospectus. The relative fault of the Company and the Underwriters shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to state
a material fact relates to information supplied by the Company or the
Underwriters and the parties' relative intent, knowledge, access to information
and opportunity to correct or prevent such statement or omission. The Company
and the Underwriters agree that it would not be just and equitable if
contribution pursuant to this Section 8 were determined by pro rata allocation
(even if the Underwriters were treated as one entity for such purpose) or by any
other method of allocation which does not take account of the equitable
considerations referred to above. Notwithstanding the provisions of this Section
8, (i) in no case shall any Underwriter be liable or responsible for any amount
in excess of the underwriting discount applicable to the Shares purchased by
such Underwriter hereunder, and (ii) no person guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the Securities Act)
shall be entitled to contribution from any person who was not guilty of such
fraudulent misrepresentation. Notwithstanding the provisions of this Section 8
and the preceding sentence, no Underwriter shall be required to contribute any
amount in excess of the amount by which the total price at which the Shares
underwritten by it and distributed to the public were offered to the public
exceeds the amount of any damages that such Underwriter has otherwise been
required to pay by reason of such untrue or alleged untrue statement or omission
or alleged omission. For purposes of this Section 8, each person, if any, who
controls an Underwriter within the meaning of Section 15 of the Securities Act
or Section 20(a) of the Exchange Act shall have the same rights to contribution
as such Underwriter, and each person, if any, who controls the Company within
the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange
Act, each officer of the Company who shall have signed the Registration
Statement and each director of the Company shall have the same rights to
contribution as the Company, subject in each case to clauses (i) and (ii) of
this Section 8. Any party entitled to contribution will, promptly after receipt
of notice of commencement of any action, suit or proceeding against such party
in respect of which a claim for contribution may be made against another party
or parties, notify each party or parties from whom contribution may be sought,
but the omission to so notify such party or parties shall not relieve the party
or parties from whom contribution may be sought from any obligation it or they
may have under this Section 8 or otherwise. No party shall be liable for
contribution with respect to any action or claim settled without its consent;
provided, however, that such consent was not unreasonably withheld.
9. Default by an Underwriter.
-------------------------
(a) If any Underwriter or Underwriters shall default in its or
their obligation to purchase Firm Shares or Additional Shares hereunder, and if
the Firm Shares or Additional Shares with respect to which such default relates
do not (after giving effect to
20
<PAGE>
arrangements, if any, made by the Underwriters pursuant to Subsection (b) below)
exceed in the aggregate 10% of the number of Firm Shares or Additional Shares,
the Firm Shares or Additional Shares which such defaulting Underwriter or
Underwriters agreed but failed or refused to purchase shall be purchased by the
non-defaulting Underwriters in proportion to the respective proportions which
the numbers of Firm Shares set forth opposite their respective names in Schedule
I hereto bear to the aggregate number of Firm Shares set forth opposite the
names of the non-defaulting Underwriters.
(b) In the event that such default relates to more than 10% of
the Firm Shares or Additional Shares, as the case may be, the Underwriters may
in their discretion arrange for themselves or for another party or parties
(including any non-defaulting Underwriter or Underwriters who so agree) to
purchase such Firm Shares or Additional Shares, as the case may be, to which
such default relates on the terms contained herein. In the event that within 5
calendar days after such a default the Underwriters do not arrange for the
purchase of the Firm Shares or Additional Shares, as the case may be, to which
such default relates as provided in this Section 9, this Agreement, or in the
case of a default with respect to the Additional Shares, the obligations of the
Underwriters to purchase and of the Company to sell the Additional Shares, shall
thereupon terminate, without liability on the part of the Company with respect
thereto (except in each case as provided in Section 5, 7(a) and 8 hereof) or the
Underwriters, but nothing in this Agreement shall relieve a defaulting
Underwriter or Underwriters of its or their liability, if any, to the other
Underwriters and the Company for damages occasioned by its or their default
hereunder.
(c) In the event that the Firm Shares or Additional Shares to
which the default relates are to be purchased by the non-defaulting
Underwriters, or are to be purchased by another party or parties as aforesaid,
the Underwriters or the Company shall have the right to postpone the Closing
Date or Additional Closing Date, as the case may be for a period, not exceeding
five business days, in order to effect whatever changes may thereby be made
necessary in the Registration Statement or the Prospectus or in any other
documents and arrangements, and the Company agrees to file promptly any
amendment or supplement to the Registration Statement or the Prospectus which,
in the opinion of Underwriters' Counsel, may thereby be made necessary or
advisable. The term "Underwriter" as used in this Agreement shall include any
party substituted under this Section 9 with like effect as if it had originally
been a party to this Agreement with respect to such Firm Shares or Additional
Shares.
10. Survival of Representations and Agreements. All representations
------------------------------------------
and warranties, covenants and agreements of the Underwriters and the Company
contained in this Agreement, including the agreements contained in Section 5,
the indemnity agreements contained in Section 7 and the contribution agreements
contained in Section 8, shall remain operative and in full force and effect
regardless of any investigation made by or on behalf of any Underwriter or any
controlling person thereof or by or on behalf of the Company, any of its
officers and directors, or any controlling person of the Company, and shall
survive delivery of and payment for the Shares to and by the Underwriters. The
representations contained in Section 1 and the agreements contained in Sections
5, 7, 8, 11(d) and 12 hereof shall survive the termination of this Agreement,
including termination pursuant to Section 9 or 11 hereof.
11. Effective Date of Agreement; Termination.
----------------------------------------
(a) This Agreement shall become effective upon the execution
and delivery of a counterpart hereof by each of the parties hereto.
21
<PAGE>
(b) The Underwriters shall have the right to terminate this
Agreement at any time prior to the Closing Date or the obligations of the
Underwriters to purchase the Additional Shares at any time prior to the
Additional Closing Date, as the case may be, if on or prior to such date, (i)
the Company shall have failed, refused or been unable to perform in any material
respect any agreement on its part to be performed hereunder, (ii) any other
condition to the obligations of the Underwriters hereunder as provided in
Section 6 is not fulfilled when and as required in any material respect, (iii)
in the reasonable judgment of the Underwriters any Material Adverse Change shall
have occurred since the respective dates as of which information is given in the
Prospectus, other than as set forth in the Prospectus, (iv) any downgrading
shall have in the rating accorded the Company's debt securities by any
"nationally recognized statistical rating organization", as that term is defined
by the Commission for purposes of Rule 436(g)(2) under the Securities Act, or
any such organization shall have publicly announced that it has under
surveillance or review, with possible negative implications, its rating of any
of the Company's debt securities, or (v)(A) any domestic or international event
or act or occurrence has materially disrupted, or in the opinion of the
Underwriters will in the immediate future materially disrupt, the market for the
Company's securities or for securities in general; or (B) trading in securities
generally on the New York Stock Exchange ("NYSE") or quotations on the
----
Nasdaq shall have been suspended or materially limited, or minimum or maximum
prices for trading shall have been established, or maximum ranges for prices for
securities shall have been required, on such exchange, or by such exchange or
other regulatory body or governmental authority having jurisdiction; or (C) a
banking moratorium shall have been declared by federal or state authorities, or
a moratorium in foreign exchange trading by major international banks or persons
shall have been declared; or (D) there is an outbreak or escalation of armed
hostilities involving the United States on or after the date hereof, or if there
has been a declaration by the United States of a national emergency or war, the
effect of which shall be, in the Underwriters' judgment, to make it inadvisable
or impracticable to proceed with the offering, sale and delivery of the Firm
Shares or the Additional Shares, as the case may be, on the terms and in the
manner contemplated by the Prospectus; or (E) there shall have been such a
material adverse change in general economic, political or financial conditions
or if the effect of international conditions on the financial markets in the
United States shall be such as, in the Underwriters' judgment, makes it
inadvisable or impracticable to proceed with the offering, sale and delivery of
the Firm Shares or the Additional Shares, as the case may be, on the terms and
in the manner contemplated by the Prospectus.
(c) Any notice of termination pursuant to this Section 11 shall
be by telephone, telex, telegraph or telephonic facsimile, confirmed in writing
by letter.
(d) If this Agreement shall be terminated pursuant to any of
the provisions hereof (other than pursuant to Section 9(b) or 11(b) hereof), or
if the sale of the Shares provided for herein is not consummated because any
condition to the obligations of the Underwriters set forth herein is not
satisfied or because of any refusal, inability or failure on the part of the
Company to perform any agreement herein or comply with any provision hereof, the
Company will, subject to demand by the Underwriters, reimburse the Underwriters
for all out-of-pocket expenses (including the fees and expenses of their
counsel), incurred by the Underwriters in connection herewith.
12. Underwriters' Information. The Company and the Underwriters
-------------------------
severally acknowledge that the statements set forth in (i) the last paragraph of
the outside front cover of the Prospectus concerning the delivery of the shares
of Common Stock to the Underwriters and the offering of such shares by the
Underwriters; (ii) the paragraph on the inside front cover of the
22
<PAGE>
Prospectus Supplement concerning transactions that stabilize, maintain, or
otherwise affect the price of the Common Stock; (iii) the third paragraph under
the caption "Underwriting" in the Prospectus concerning the proposed public
offering price, discount and concession; and (iv) the tenth and eleventh
paragraphs under the caption "Underwriting" in the Prospectus concerning
transactions that stabilize, maintain, or otherwise affect the price of the
Common Stock, constitute the only information furnished in writing by or on
behalf of any Underwriter expressly for use in the Registration Statement, as
originally filed or in any amendment thereof, any related Preliminary Prospectus
or preliminary prospectus supplement or the Prospectus or in any amendment
thereof or supplement thereto, as the case may be.
13. Notices. All communications hereunder, except as may be
-------
otherwise specifically provided herein, shall be in writing and, if sent to the
Underwriters shall be mailed, delivered, or telexed, telegraphed or telecopied
and confirmed in writing to Bear, Stearns & Co. Inc., BT Alex. Brown
Incorporated, Donaldson Lufkin Jenrette Securities Corporation and Goldman,
Sachs & Co., c/o Bear, Stearns & Co. Inc., 245 Park Avenue, New York, New York
10167, Attention: Corporate Finance Department, telecopy number: (212) 272-3092,
with a copy, which shall not constitute notice, to Latham & Watkins, Attn:
Gregory K. Miller, 505 Montgomery Street, Suite 1900, San Francisco, California
94111; telecopy number: (415) 395-8095; and if sent to the Company, shall be
mailed, delivered or telexed, telegraphed or telecopied and confirmed in writing
to Covad Communications Group, Inc., 2330 Central Expressway, Santa Clara,
California 95050, Attention: Chief Executive Office, telecopy number: (408) 844-
7501, with a copy, which shall not constitute notice, to Wilson Sonsini Goodrich
& Rosati, P.C., 650 Page Mill Road, Palo Alto, California 94304, Attn: Barry
Taylor, telecopy number: (650) 493-6811.
14. Parties. This Agreement shall inure solely to the benefit of,
-------
and shall be binding upon, the Underwriters, the Company and the controlling
persons, directors, officers, employees and agents referred to in Section 7 and
8, and their respective successors and assigns, and no other person shall have
or be construed to have any legal or equitable right, remedy or claim under or
in respect of or by virtue of this Agreement or any provision herein contained.
The term "successors and assigns" shall not include a purchaser, in its capacity
as such, of Shares from any of the Underwriters.
15. GOVERNING LAW; Construction. This Agreement shall be construed
---------------------------
in accordance with the internal laws of the State of New York applicable to
agreements made and to be performed within such State, without giving any effect
to any provisions thereof relating to conflicts of law. TIME IS OF THE ESSENCE
IN THIS AGREEMENT.
16. Captions. The captions included in this Agreement are included
--------
solely for convenience of reference and are not to be considered a part of this
Agreement.
17. Counterparts. This Agreement may be executed in various
------------
counterparts which together shall constitute one and the same instrument.
23
<PAGE>
If the foregoing correctly sets forth the understanding among the
Underwriters and the Company, please so indicate in the space provided below for
that purpose, whereupon this letter shall constitute a binding agreement among
us.
Very truly yours,
COVAD COMMUNICATIONS GROUP, INC.
By_______________________________
Name_____________________________
Title____________________________
Accepted as of the date first above written
BEAR, STEARNS & CO. INC.
BT ALEX. BROWN INCORPORATED
DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION
GOLDMAN, SACHS & CO.
BEAR, STEARNS & CO. INC.
By _______________________________
Name_____________________________
Title____________________________
<PAGE>
SCHEDULE I
Number of Firm
Name of Underwriter Shares to be Purchased
- ----------------------------------------------------------------------
Bear, Stearns & Co. Inc. .............................
BT Alex. Brown Incorporated...........................
Donaldson, Lufkin & Jenrette Securities Corporation...
Goldman, Sachs & Co. .................................
Total............................................... 7,500,000
<PAGE>
Exhibit A
Form of Opinion of Wilson Sonsini Goodrich & Rosati, P.C.
1. The Company has been duly incorporated, is validly existing as a
corporation in good standing under the laws of the State of Delaware, has
the corporate power and authority to own its property and to conduct its
business as described in the Prospectus. The Company is duly qualified to
transact business and is in good standing in each jurisdiction in which the
conduct of its business or its ownership or leasing of property requires
such qualification, except to the extent that the failure to be so
qualified or be in good standing would not have a Material Adverse Effect
on the Company on a consolidated basis.
2. Each of Covad California and Covad Virginia is a corporation duly
incorporated and validly existing as a corporation in good standing under
the laws of its jurisdiction of incorporation, has all requisite corporate
power and authority to carry on its business as it is currently being
conducted and as described in the Prospectus and to own, lease and operate
its properties. Each of Covad California and Covad Virginia is duly
qualified and in good standing as a foreign corporation authorized to do
business in each jurisdiction in which the nature of its business or its
ownership or leasing of property requires such qualification, except to the
extent that the failure to be so qualified or be in good standing would not
have a Material Adverse Effect on the Company on a consolidated basis.
3. All of the outstanding shares of capital stock of the Company
(including, without limitation, the Strategic Investor Preferred Shares)
have been, to such counsel's knowledge, duly authorized and validly issued,
are fully paid and nonassessable and were not issued in violation of any
preemptive or similar rights contained in the Amended and Restated
Certificate of Incorporation, Bylaws of the Company or any Reviewed
Agreement (as defined). As of September 30, 1998, the authorized, issued
and outstanding capital stock of the Company is as set forth in the
Prospectus in the column entitled "Actual" under the caption
"Capitalization". Upon consummation of the Offering, (i) each of the
Strategic Investor Preferred Shares shall have been converted into Class B
Common Stock of the Company and (ii) each share of Class B Common Stock
shall have been duly authorized and validly issued, fully paid and
nonassessable and shall not have been issued in violation of any preemptive
or similar rights contained in the Amended and Restated Certificate of
Incorporation, Bylaws of the Company or any Reviewed Agreement.
4. To such counsel's knowledge, there are not currently, and will not
be following the offering of the Shares, any outstanding subscriptions,
rights, warrants, calls, commitments of sale or options to acquire, or
instruments convertible into or exchangeable for, any capital stock or
other equity interest of the Company, except as described in the Prospectus
and except as contained in the Amended and Restated Certificate of
Incorporation, Bylaws of the Company or any Reviewed Agreement.
5. The Company has all requisite corporate power and authority to
execute, deliver and perform its obligations under this Agreement and to
consummate the transactions contemplated hereby, including, without
limitation, the corporate power and authority to issue, sell and deliver
the Shares.
<PAGE>
6. This Agreement has been duly and validly authorized, executed and
delivered by the Company.
7. Each of the Strategic Alliance Agreements and the Strategic Investor
Stock Purchase Agreements has been duly and validly authorized, executed
and delivered by the Company.
8. The execution and delivery by the Company of, and the performance
by the Company of its obligations under, this Agreement and the issuance
and sale of the Shares will not contravene any provision of (a) the
Delaware General Corporation Law or any federal statute, rule or regulation
known to us to be applicable to the Company (other than federal or state
securities laws, which are specifically addressed elsewhere herein, and
other than as are specifically addressed in the opinion of Dhruv Khanna,
General Counsel of the Company, separately delivered to you pursuant to
Section 6(h) of the Underwriting Agreement), (b) the Amended and Restated
Certificate of Incorporation or bylaws of the Company, (c) any Reviewed
Agreement (as defined) binding upon the Company that is material to the
Company on a consolidated basis or (d) to such counsel's knowledge, any
order, judgment, or decree of any governmental body, agency or court having
jurisdiction over the Company. No consent, approval, authorization or order
of or qualification with any governmental body or agency is required for
the performance by the Company of its obligations under this Agreement,
except such as has been obtained under the Securities Act and as may be
required by the securities or "blue sky" laws of the various states in
connection with the offer and sale of the Shares as contemplated by the
Prospectus.
9. The Company is not and, after giving effect to the offering of the
Shares and the application of the proceeds therefrom as described in the
Prospectus, will not be an "investment company" or a company "controlled"
by an "investment company" within the meaning of the Investment Company Act
of 1940, as amended.
10. The Registration Statement, Preliminary Prospectus and Prospectus
comply as to form in all material respects with the requirements for
registration statements on Form S-1 under the Securities Act and the
Securities Act Regulations; it being understood, however, that such counsel
need not express an opinion with respect to the financial statements,
schedules and other financial data included in the Registration Statement,
Preliminary Prospectus or Prospectus. To such counsel's knowledge, there
are no contracts, indentures, mortgages, loan agreements, notes, leases or
other instruments required to be described or referred to in the
Registration Statement or to be filed as exhibits thereto other than those
described or referred to therein, and, to such counsel's knowledge, the
descriptions thereof or references thereto are correct in all material
respects.
11. Except as set forth in this Agreement, to such counsel's knowledge,
there are no holders of securities of the Company who, by reason of the
execution by the Company of this Agreement or the consummation by the
Company of the transactions contemplated hereby, have the right to request
or demand that the Company register securities held by them under the
Securities Act.
12. To such counsel's knowledge, there is no legal or governmental
proceeding pending or threatened to which the Company or any of its
Subsidiaries is a party or to which any of the properties of the Company or
any of its Subsidiaries is subject other than proceedings fairly summarized
in all material respects in the Prospectus and proceedings
ii
<PAGE>
which we believe are not likely to have a Material Adverse Effect on the
Company and its subsidiaries, taken as a whole, or on the power or ability
of the Company to perform its obligations under this Agreement or to
consummate the offering of the Shares as contemplated by the Prospectus.
13. The statements contained in the Prospectus under the captions
"Management - Employment Agreements and Change in Control Arrangements",
"Management - 1997 Stock Plan", "Management - 1998 Employee Stock Purchase
Plan", "Certain Relationships and Related Transactions - Series C Preferred
Stock and Warrant Subscription Agreement", "Certain Relationships and
Related Transactions - The Intel Stock Purchase", "Certain Relationships
and Related Transactions - Equipment Lease Financing", "Management -
Limitation on Liability and Indemnification Matters" and "Description of
Capital Stock", in each case, insofar as such statements constitute
summaries of the legal matters, documents or proceedings referred to
therein, fairly present the information required with respect to such legal
matters, documents and proceedings and fairly summarize the matters
referred to therein in all material respects.
14. Such counsel has participated in conferences with officers and other
representatives of the Company, representatives of the independent
certified public accountants of the Company and the Underwriters and its
representatives at which the contents of the Registration Statement,
Preliminary Prospectus and the Prospectus and related matters were
discussed and, although such counsel is not passing upon and assumes no
responsibility for, the accuracy, completeness or fairness of the
statements contained in the Registration Statement, Preliminary Prospectus
or the Prospectus (except as indicated above), on the basis of the
foregoing, no facts have come to such counsel's attention which led such
counsel to believe that the Registration Statement, at the time it became
effective, contained an untrue statement of a material fact or omitted to
state a material fact required to be stated therein or necessary to make
the statements therein not misleading, or that the Prospectus, as of its
date or the Closing Date, contained or contains an untrue statement of a
material fact or omitted or omits to state a material fact necessary to
make the statements therein, in the light of the circumstances under which
they were made, not misleading (except as to financial statements and
schedules and other financial data, included therein).
In rendering such opinion, such counsel may rely as to matters
involving the application of laws other than the laws of the United States,
California and any other jurisdictions in which they are admitted, to the extent
such counsel deems proper and to the extent specified in such opinion, if at
all, upon an opinion or opinions (in form and substance reasonably satisfactory
to Underwriters' Counsel) of other counsel familiar with the applicable laws and
reasonably acceptable to Underwriters' Counsel; provided, that such opinion
shall expressly state that the Underwriters may rely on such opinion as if it
were addressed to them. In rendering such opinion, such counsel may rely as to
matters of fact, to the extent they deem proper, on certificates of responsible
officers of the Company and its subsidiaries and certificates or other written
statements of officers of departments of various jurisdictions having custody of
documents respecting the existence or good standing of the Company and its
subsidiaries, provided that such opinion shall state that such counsel and the
Underwriters are justified in so relying upon any such certificate. The opinion
of such counsel for the Company shall state that the opinion of any such other
counsel is in form satisfactory to such counsel and, in their opinion, the
Underwriters and they are justified in relying thereon.
iii
<PAGE>
Exhibit B
Form of Opinion of Dhruv Khanna, General Counsel of the Company
1. Neither the execution and delivery of this Agreement nor the sale
of the Shares contemplated hereby will violate (i) the Communications Act
of 1934 (the "Communications Act") as interpreted as of this date, (ii) the
Telecommunications Act of 1996 (the "Telecom Act of 1996") as interpreted
as of this date, (iii) any rules or regulations of the Federal
Communications Commission (the "FCC") applicable to the Company as
interpreted as of this date or (iv) any rules or regulations of the
California Public Utilities Commission, New York Public Service Commission,
Massachusetts Department of Public Utilities, Washington Utilities and
Transportation Commission, Illinois Commerce Commission, the Oregon Public
Utilities Commission or any other jurisdiction where the Company has
obtained CLEC regulatory approval (collectively, the "State
Telecommunications Agencies") as interpreted as of this date.
2. The Company (i) has made all reports and filings, and paid all
fees, required by the FCC and any of the State Telecommunications Agencies
and (ii) has all certificates, orders, permits, licenses, authorizations,
consents and approvals of and from, and has made all filings and
registrations with, the FCC and any of the State Telecommunications
Agencies necessary to own, lease, license and use its properties and assets
and to conduct its business as described in the Prospectus; and, except as
described in the Prospectus, there is no pending or, to my knowledge,
threatened proceedings before the FCC or any State Telecommunications
Agency relating to the revocation or modification or any such certificates,
orders, permits, licenses, authorizations, consents or approvals which, if
determined adversely, would have a Material Adverse Effect.
3. No decree or order of the FCC or any State Telecommunications
Agency is outstanding against the Company and no litigation, proceeding,
inquiry or investigation has been commenced or, to such counsel's
knowledge, threatened, and no formal notice of violation or order to show
cause has been issued, against the Company before the FCC or any of the
State Telecommunications Agencies.
4. The statements in the Prospectus under the headings of "Risk
Factors--Uncertain Availability of Collocation Space and Dependence on
ILECs to Provide Collocation Space and Collocation Facilities and Unbundled
Network Elements ("UNEs")", "Risk Factors--Dependence on ILECs to Provide
Transmission Facilities and to Provision Copper Lines", "Risk Factors--
Uncertain Quality and Availability of the ILEC Copper Lines Used by the
Company", "Risk Factors--Government Regulation and Current Industry
Litigation", "Business--Industry Background--Impact of the
Telecommunications Act of 1996" and "Business--Government Regulation", to
the extent such statements constitute summaries of the Telecom Act of 1996
or rules and regulations of the FCC or any of the State Telecommunications
Agencies, fairly and accurately summarize the matters therein described.
5. Neither the execution and delivery of this Agreement nor the sale
of the Shares contemplated hereby will conflict with or result in a
violation of any of the Material
<PAGE>
Agreements (as defined), except for such conflicts or violations which
would not have a Material Adverse Effect.
6. As of the date hereof, (A) the Company has obtained CLEC regulatory
approval in each of the following States: California, Illinois, Maryland,
Massachusetts, New York, Oregon, Texas, Virginia, Washington, Delaware,
Colorado, New Jersey, New Hampshire, District of Columbia, Pennsylvania,
Michigan and Florida, and no such regulatory approval has been withdrawn,
and no such regulatory approval is the subject of any legal challenge
(except as disclosed in the Prospectus) and (B) the Company has not
received any notice of rejection or denial, nor has it withdrawn, any of
its applications for CLEC approval in 10 additional States where such
applications, as of the date of the Prospectus, are pending approval.
7. The Company has the consents, approvals, authorizations, licenses,
certificates, permits, or orders of the FCC or the State Telecommunications
Agencies, if any is required, for the sale of the Shares as contemplated in
the Prospectus, except where the failure to obtain the consents, approvals,
authorizations, licenses, certificates, permits or orders would not have a
Material Adverse Effect.
In rendering such opinion, such counsel may rely as to matters
involving the application of laws other than the laws of the United States,
California and any other jurisdictions in which he is admitted, to the extent
such counsel deems proper and to the extent specified in such opinion, if at
all, upon an opinion or opinions (in form and substance reasonably satisfactory
to Underwriters' Counsel) of other counsel familiar with the applicable laws and
reasonably acceptable to Underwriters' Counsel; provided, that such opinion
shall expressly state that the Underwriters may rely on such opinion as if it
were addressed to them. In rendering such opinion, such counsel may rely as to
matters of fact, to the extent he deems proper, on certificates of responsible
officers of the Company and its subsidiaries and certificates or other written
statements of officers of departments of various jurisdictions having custody of
documents respecting the existence or good standing of the Company, and its
subsidiaries, provided that such opinion shall state that such counsel and the
Underwriters are justified in so relying upon any such certificate. The opinion
of such counsel for the Company shall state that the opinion of any such other
counsel is in form satisfactory to such counsel and, in their opinion, the
Underwriters and they are justified in relying thereon.
ii
<PAGE>
Exhibit C
Covad Communications Group, Inc.
2330 Central Expressway
Santa Clara, California 95050
Lock-Up Agreement
_________________, 1999
Bear, Stearns & Co. Inc.
BT Alex. Brown Incorporated
Donaldson, Lufkin & Jenrette Securities Corporation
Goldman, Sachs & Co.
c/o Bear, Stearns & Co. Inc.
245 Park Avenue
New York, New York 10167
Dear Ladies and Gentlemen:
The undersigned understands that Bear, Stearns & Co. Inc. (the
"Representative") of the several underwriters (the "Underwriters"), proposes to
enter into an Underwriting Agreement with Covad Communications Group, Inc. (the
"Company") providing for the initial public offering (the "Initial Public
Offering") by the Underwriters, including the Representative, of the Company's
Common Stock, par value $.001 per share (the "Common Stock").
In consideration of the Underwriters' agreement to purchase and
undertake the Initial Public Offering and for other good and valuable
consideration, receipt of which is hereby acknowledged, the undersigned,
pursuant to this letter agreement (this "Agreement"), agrees that, without the
prior written consent of the Representative, the undersigned will not, directly
or indirectly, offer, sell, contract to sell, grant any option to purchase,
pledge or otherwise dispose of any shares of Common Stock of the Company
(including, without limitation, shares of Common Stock of the Company that may
be deemed to be beneficially owned by the undersigned in accordance with the
rules and regulations of the Securities and Exchange Commission and shares of
Common Stock that may be issued upon exercise of a stock option or warrant) or
any securities convertible into or exercisable or exchangeable for such Common
Stock (such Common Stock and securities are referred to herein as, collectively,
"Securities"), or, in any manner, transfer all or a portion of the economic
consequences associated with the ownership of Securities, for a period (the
"Lock-Up Period") of 180 days after the date of the Prospectus used by the
Company in connection with the Initial Public Offering (any of the foregoing, a
"Disposition"); provided, however, that the undersigned may make a Disposition:
(i) as a bona fide gift or gifts, provided that the donee or donees thereof
agree in writing to be bound by the terms of this Agreement; (ii) as a
distribution to limited partners or shareholders of the undersigned, provided
that the distributees thereof agree in writing to be bound by the terms of this
Agreement; (iii) if the undersigned is an individual, either during his or her
lifetime or on death by will or intestacy to his or her immediate family or to a
trust the beneficiaries of which are exclusively the undersigned and/or a member
or members of his or her immediate family, provided that prior to any such
transfer each transferee agrees in writing to be bound by the terms of this
Agreement; or (iv) with the prior written consent of the
<PAGE>
Representative. For the purposes of this paragraph, "immediate family" shall
mean spouse, lineal descendant, father, mother, brother or sister of the
transferor.
In addition, the undersigned agrees that the Company may, and that the
undersigned will, (i) with respect to any shares for which the undersigned is
the record holder, cause the transfer agent for the Company to note stop
transfer instructions with respect to such shares on the transfer books and
records of the Company and (ii) with respect to any shares for which the
undersigned is the beneficial holder but not the record holder, cause the record
holder of such shares to cause the transfer agent for the Company to note stop
transfer instructions with respect to such shares on the transfer books and
records of the Company.
The foregoing restrictions are expressly agreed to preclude the holder
of any Securities from engaging in any hedging or other transaction that is
designed to or is reasonably expected to lead to or result in a Disposition of
Securities during the Lock-Up Period even if such Securities would be disposed
of by someone other than the undersigned. Such prohibited hedging or other
transactions would include, without limitation, any short sale (whether or not
against the box) or any purchase, sale or grant of any right (including, without
limitation, any put or call option) with respect to any of the Securities or any
security (other than a broad-based market basket or index) that includes,
relates to or derives any significant part of its value from any of the
Securities.
The undersigned hereby represents and warrants that the undersigned
has full power and authority to enter into this Agreement, and that, upon
request, the undersigned will execute any additional documents necessary or
desirable in connection with the enforcement hereof. All authority herein
conferred or agreed to the conferred shall survive the death or incapacity of
the undersigned and any obligations of the undersigned shall be binding upon the
heirs, personal representatives, successors, and assigns of the undersigned.
[signature page follows]
ii
<PAGE>
The undersigned hereby executes this Agreement and agrees to its terms
as of the date first written above.
Very truly yours,
____________________________________
(Signature)
Please type: ____________________________________
(Name)
____________________________________
(Address)
____________________________________
(Social Security or
Taxpayer Identification No.)
Number of shares owned or Certificate numbers:
subject to warrants, options
or convertibles securities: ____________________________________
__________________________ ____________________________________
iii
<PAGE>
Exhibit D
Individuals Delivering a Lock-Up Agreement Pursuant to Section 6(k)
Charles McMinn
Robert Knowling Jr.
Robert Hawk
Henry Kressel
Joseph Landy
Daniel Lynch
Frank Marshall
Rich Shapero
Charles Haas
Dhruv Khanna
Warburg, Pincus Ventures, L.P.
Crosspoint Venture Partners 1996
Intel Corporation
Rex Cardinale
Timothy Laehy
Catherine Hemmer
Walter Pienkos
Robert Roblin
Heidrick & Struggles International, Inc.
<PAGE>
EXHIBIT 3.1
COVAD COMMUNICATIONS GROUP, INC.
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
Covad Communications Group, Inc., a Delaware corporation, hereby
certifies as follows:
The Certificate of Incorporation of Covad Communications Group, Inc.
(the "CORPORATION") was filed in the office of the Secretary of State of the
State of Delaware on July 14, 1997. The Certificate of Incorporation was
amended on February 11, 1998. The Certificate of Incorporation was
subsequently amended and restated on February 23, 1998, on May 20, 1998 and on
August 28, 1998. The Certificate of Incorporation is hereby amended and
restated pursuant to Section 242 and Section 245 of the Delaware General
Corporation Law. All amendments to the Certificate of Incorporation reflected
herein have been duly authorized and adopted by the Corporation's Board of
Directors and stockholders in accordance with the provisions of Sections 242
and 245 of the Delaware General Corporation Law.
This Amended and Restated Certificate of Incorporation restates and
integrates and further amends the Certificate of Incorporation of the
Corporation. The text of the Certificate of Incorporation is amended hereby to
read as herein set forth in full:
ARTICLE I
The name of the corporation is Covad Communications Group, Inc.
ARTICLE II
The address of the Corporation's registered office in the State of
Delaware is Corporation Trust Center, 1209 Orange Street, in the City of
Wilmington, County of New Castle, zip code 19801. The name of its registered
agent at such address is The Corporation Trust Company.
ARTICLE III
The nature of the business or purpose to be conducted or promoted by the
Corporation is to engage in any lawful act or activity for which corporations
may be organized under the General Corporation Law of the State of Delaware.
<PAGE>
ARTICLE IV
The Corporation is authorized to issue two classes of shares to be
designated respectively, "Common Stock" and "Preferred Stock." The number of
shares of Common Stock authorized to be issued is One Hundred Million
(100,000,000), of which Ten Million (10,000,000) shares are hereby designated as
Class B Common Stock ("Class B Common"). The number of shares of Preferred
Stock authorized to be issued is Fifty Million (50,000,000), of which Seven
Hundred Fifty Thousand (750,000) shares have been designated as Series A
Preferred Stock (the "SERIES A PREFERRED"), Seventeen Million One Hundred
Thousand and Three (17,100,003) shares have been designated Series B Preferred
Stock (the "SERIES B PREFERRED"), Eleven Million One Hundred Forty-Nine Thousand
Two Hundred Eighty-Seven (11,149,287) shares have been designated Series C
Preferred Stock (the "SERIES C PREFERRED"), Six Million (6,000,000) shares have
been designated Series C-1 Preferred Stock (the "SERIES C-1 PREFERRED"), Five
Million (5,000,000) shares have been designated Series D Preferred Stock (the
"SERIES D PREFERRED") and Five Million (5,000,000) shares have been designated
Series D-1 Preferred Stock ("SERIES D-1 PREFERRED"). The Common Stock and the
Preferred Stock shall each have a par value of $.001 per share.
The remaining shares of Preferred Stock may be issued from time to
time in one or more series. The Board of Directors is authorized, subject to
limitations prescribed by law and the provisions of this Article IV, to
provide for the issuance of the shares of Preferred Stock in series and, by
filing a certificate pursuant to the applicable law of the State of Delaware,
to establish from time to time the number of shares to be included in each
such series, and to fix the designation, powers, preferences and rights of the
shares of each such series and the qualifications, limitations or restrictions
thereof.
The authority of the Board with respect to each series shall include,
but not be limited to, determination of the following: (a) The number of
shares constituting that series and the distinctive designation of that
series; (b) The dividend rate on the shares of that series, whether dividends
shall be cumulative, and, if so, from which date or dates, and the relative
rights of priority, if any, of payment of dividends on shares of that series;
(c) Whether that series shall have voting rights, in addition to the voting
rights provided by law, and, if so, the terms of such voting rights; (d)
Whether that series shall have conversion privileges, and, if so, the terms
and conditions of such conversion, including provision for adjustment of the
conversion rate in such events as the Board of Directors shall determine; (e)
Whether or not the shares of that series shall be redeemable and, if so, the
terms and conditions of such redemption, including the date or dates upon or
after which they shall be redeemable, and the amount per share payable in case
of redemption, which amount may vary under different conditions and at
different redemption dates; (f) Whether that series shall have a sinking fund
for the redemption or purchase of shares of that series and, if so, the terms
and amount of such sinking fund; (g) The rights of the shares of that series
in the event of voluntary or involuntary liquidation, dissolution or winding
up of the Corporation and the relative rights of priority, if any, of payment
of shares of that series; and (h) Any other relative or participating rights,
preferences and limitations of that series.
The relative designations, rights, preferences and restrictions of the
Preferred Stock are as follows:
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<PAGE>
1. Dividends.
---------
(a) The holders of the Series D Preferred, Series D-1 Preferred,
Series C Preferred, Series C-1 Preferred, the Series B Preferred and the
Series A Preferred shall be entitled to receive in any fiscal year, out of the
funds legally available therefor, dividends at the rate of $1.44 per share,
$1.44 per share, $0.2233 per share, $0.2233 per share, $0.04 per share and
$0.0167 per share (adjusted for any subdivisions, combinations, consolidations
or stock distributions or stock dividends with respect to such shares) per
annum, respectively, on each outstanding share of Series D Preferred, Series D-
1 Preferred, Series C Preferred, Series C-1 Preferred, Series B Preferred and
Series A Preferred, respectively, payable in preference and priority to any
payment of any dividend on the Common Stock. The right to such dividends on
the Series C Preferred, Series C-1 Preferred, the Series B Preferred and the
Series A Preferred shall be cumulative, and the right to receive such
dividends shall accrue to holders of Series C Preferred, Series C-1 Preferred,
Series B Preferred and the Series A Preferred, respectively, by reason of
the fact that dividends on such shares are not declared or paid in any prior
year. Any accrued and unpaid dividends on the Series C Preferred, Series C-1
Preferred, the Series B Preferred and the Series A Preferred shall be payable
only in the event of a liquidation, dissolution or winding up of the
Corporation or other Liquidity Event (as defined in Section 2(d) below);
provided, that, in the event that the Liquidity Event is an underwritten
public offering, no accrued and unpaid cumulative dividends shall be payable
on the Series C Preferred and Series C-1 Preferred and any such accrued and
unpaid cumulative dividends on the Series B Preferred and the Series A
Preferred shall be paid in shares of Common Stock of the Corporation, in which
case the value of such shares of Common Stock shall be equal to the initial
public offering price per share of Common Stock (prior to any underwriting
discounts and commissions). Dividends on the Series D Preferred and the Series
D-1 Preferred shall be noncumulative and shall be paid only when, as and if
declared by the Board of Directors.
(b) No dividends shall be paid on any share of Common Stock
during any fiscal year of the Corporation until dividends in the total amount
of $1.44 per share, $1.44 per share, $0.2233 per share, $0.2233 per share,
$0.04 per share and $0.0167 per share (adjusted for any subdivisions,
combinations, consolidations or stock distributions or stock dividends with
respect to such shares) on the Series D Preferred, the Series D-1 Preferred,
the Series C Preferred, Series C-1 Preferred, the Series B Preferred and the
Series A Preferred, respectively, shall have been paid or declared and set
apart during that fiscal year and any prior year in which dividends
accumulated but remain unpaid, and no dividends shall be paid on any share of
Common Stock unless a dividend is paid with respect to all outstanding shares
of Series D Preferred, Series D-1 Preferred, Series C Preferred, Series C-1
Preferred, Series B Preferred and Series A Preferred, in an amount for each
such share of Series D Preferred, Series D-1 Preferred, Series C Preferred,
Series C-1 Preferred, Series B Preferred and Series A Preferred equal to or
greater than the aggregate amount of such dividends for all shares of Common
Stock into which each such share of Series D Preferred, Series D-1 Preferred,
Series C Preferred, Series C-1 Preferred, Series B Preferred or Series A
Preferred could then be converted, as the case may be.
2. Liquidation Preference. In the event of any liquidation,
----------------------
dissolution or winding up of the Corporation, either voluntary or involuntary,
distributions to the stockholders of the Corporation shall be made in the
following manner:
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<PAGE>
(a) The holders of the Series D Preferred shall be entitled to
receive, prior and in preference to any distribution of any of the assets or
surplus funds of the Corporation to the holders of the Common Stock by reason
of their ownership of such stock, the amount equal to the Initial Series D
Preferred Price (as defined in paragraph (b) below) for each share of Series D
Preferred then held by them and, in addition, an amount equal to all declared
and unpaid dividends on the Series D Preferred. The holders of the Series D-1
Preferred shall be entitled to receive, prior and in preference to any
distribution of any of the assets or surplus funds of the Corporation to the
holders of the Common Stock by reason of their ownership of such stock, the
amount equal to the Initial Series D-1 Preferred Price (as defined in
paragraph (b) below) for each share of Series D-1 Preferred then held by them
and, in addition, an amount equal to all declared and unpaid dividends on the
Series D-1 Preferred. The holders of the Series C Preferred shall be entitled
to receive, prior and in preference to any distribution of any of the assets
or surplus funds of the Corporation to the holders of the Common Stock by
reason of their ownership of such stock, the amount equal to the Initial
Series C Preferred Price (as defined in paragraph (b) below) for each share of
Series C Preferred then held by them and, in addition, an amount equal to all
cumulated and unpaid dividends on the Series C Preferred. The holders of the
Series C-1 Preferred shall be entitled to receive, prior and in preference to
any distribution of any of the assets or surplus funds of the Corporation to
the holders of the Common Stock by reason of their ownership of such stock,
the amount equal to the Initial Series C-1 Preferred Price (as defined in
paragraph (b) below) for each share of Series C-1 Preferred then held by them
and, in addition, an amount equal to all cumulated and unpaid dividends on the
Series C-1 Preferred. The holders of the Series B Preferred shall be entitled
to receive, prior and in preference to any distribution of any of the assets
or surplus funds of the Corporation to the holders of the Common Stock by
reason of their ownership of such stock, the amount equal to the Initial
Series B Preferred Price (as defined in paragraph (b) below) for each share of
Series B Preferred then held by them and, in addition, an amount equal to all
cumulated and unpaid dividends on the Series B Preferred. The holders of the
Series A Preferred shall be entitled to receive, prior and in preference to
any distribution of any of the assets or surplus funds of the Corporation to
the holders of the Common Stock by reason of their ownership of such stock,
the amount equal to the Initial Series A Preferred Price (as defined in
paragraph (b) below) for each share of Series A Preferred then held by them
and, in addition, an amount equal to all cumulated and unpaid dividends on the
Series A Preferred. The Series D Preferred, the Series D-1 Preferred, the
Series C Preferred, the Series C-1 Preferred, the Series B Preferred and the
Series A Preferred shall rank on a parity (based on the amount of the
respective aggregate liquidation preference for all outstanding shares of each
such series) as to the receipt of the respective preferential amounts for each
such series upon the occurrence of such a liquidation, dissolution or winding
up of the Corporation.
(b) For purposes of this Section 2, the "Initial Series D
Preferred Price" is $18.00 for each share of Series D Preferred then held by a
holder thereof, adjusted for any subdivisions, combinations, consolidations or
stock distributions or dividends with respect to such shares. For purposes of
this Section 2, the "Initial Series D-1 Preferred Price" is $18.00 for each
share of Series D-1 Preferred then held by a holder thereof, adjusted for any
subdivisions, combinations, consolidations or stock distributions or dividends
with respect to such shares. For purposes of this Section 2, the "Initial
Series C Preferred Price" is $2.7767 for each share of Series C Preferred then
held by a holder thereof, adjusted for any subdivisions, combinations,
consolidations or stock distributions or dividends with respect to such
shares. For purposes of this Section 2, the "Initial
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<PAGE>
Series C-1 Preferred Price" is $2.7767 for each share of Series C-1 Preferred
then held by a holder thereof, adjusted for any subdivisions, combinations,
consolidations or stock distributions or dividends with respect to such
shares. For purposes of this Section 2, the "Initial Series B Preferred Price"
(i) in the event that the Liquidation Preference Threshold is achieved, is
$0.00 for each share of Series B Preferred then held by a holder thereof,
adjusted for any subdivisions, combinations, consolidations or stock
distributions or dividends with respect to such shares, or (ii) in the event
that the Liquidation Preference Threshold is not achieved, is $0.50 for each
such share, adjusted for any subdivisions, combinations, consolidations or
stock distributions or dividends with respect to such shares. For purposes of
this Section 2, the "Initial Series A Preferred Price" (i) in the event that
the Liquidation Preference Threshold is achieved, is $0.00 for each share of
Series A Preferred then held by a holder thereof, adjusted for any
subdivisions, combinations, consolidations or stock distributions or dividends
with respect to such shares, or (ii) in the event that the Liquidation
Preference Threshold is not achieved, is $0.3333 for each such share, adjusted
for any subdivisions, combinations, consolidations or stock distributions or
dividends with respect to such shares. If upon the occurrence of a
liquidation, dissolution or winding-up of the Corporation the assets and funds
thus distributed among the holders of the Series D Preferred, the Series D-1
Preferred, the Series C Preferred, the Series C-1 Preferred, the Series B
Preferred and the Series A Preferred shall be insufficient to permit the
payment to such holders of the full preferential amount, then the entire
assets and funds of the Corporation legally available for distribution shall
be distributed ratably among the holders of the Series D Preferred, the Series
D-1 Preferred, the Series C Preferred, the Series C-1 Preferred, the Series B
Preferred and the Series A Preferred in proportion to the preferential amount
each such holder is otherwise entitled to receive. For purposes of this
Section 2, the "LIQUIDATION PREFERENCE THRESHOLD" shall be deemed to have been
achieved if the quotient obtained by dividing (i) (A) the aggregate value to
be received by the holders of the Corporation's capital stock in such
liquidation, dissolution, winding-up or other Liquidity Event or, if the
Liquidity Event is an underwritten public offering of the Corporation's Common
Stock, the pre-offering valuation of the Corporation, less (B) the sum of the
aggregate purchase price received by the Corporation for the Series B
Preferred plus the aggregate purchase price received by the Corporation for
the Series A Preferred, less (C) the sum of the cumulated but unpaid dividends
on the Series B Preferred plus the cumulated but unpaid dividends on the
Series A Preferred, by (ii) the total number of shares of the Corporation's
Common Stock outstanding on the date of such event on a fully-diluted, as-
converted basis, equals or exceeds $2.00, adjusted for any subdivisions,
combinations, consolidations, stock distributions or dividends.
(c) After setting apart or paying in full the preferential
amounts due pursuant to Section 2(a) above, the remaining assets of the
Corporation available for distribution to stockholders, if any, shall be
distributed to the holders of the Series A Preferred, Series B Preferred,
Series C Preferred, Series C-1 Preferred and Common Stock on a pro rata basis,
based on the number of shares of Common Stock then held by each holder on an
as-converted basis. The Series D Preferred and Series D-1 Preferred shall be
non-participating in such distribution.
(d) A consolidation or merger of this Corporation with or into
any other corporation or corporations in which the stockholders of this
Corporation immediately prior to such transaction do not hold at least a
majority of the voting power of the surviving corporation or acquiring
corporation or such surviving or acquiring corporation's parent immediately
thereafter, or
-5-
<PAGE>
a sale, conveyance or disposition of all or substantially all of the assets of
this Corporation, the effectuation by the Corporation of a transaction or
series of related transactions in which more than 50% of the voting power of
the Corporation is disposed of (each, a "LIQUIDITY EVENT"), shall be deemed to
be a liquidation, dissolution or winding up within the meaning of this Section
2; provided, further, that solely with respect to the holders of the Series A
Preferred and the Series B Preferred for the purpose solely of any cumulative
but unpaid dividends on shares of Series A Preferred and Series B Preferred an
underwritten public offering pursuant to an effective registration statement
under the Securities Act of 1933, as amended (the "Securities Act"), of shares
of Common Stock of this Corporation shall also be deemed to be a Liquidity
Event.
(e) Notwithstanding any other provision of this Section 2, the
Corporation may at any time, out of funds legally available therefor,
repurchase shares of Common Stock of the Corporation issued to or held by
employees, officers or consultants of the Corporation or its subsidiaries upon
termination of their employment or services, pursuant to any agreement
providing for such right of repurchase, whether or not dividends on the Series
D Preferred, Series D-1 Preferred, Series C Preferred, Series C-1 Preferred,
Series B Preferred and Series A Preferred shall have been declared and funds
set aside therefor and such repurchases shall not be subject to the
liquidation preferences of the Series D Preferred, Series D-1 Preferred,
Series C Preferred, Series C-1 Preferred, Series B Preferred or Series A
Preferred.
(f) In the event the Corporation proposes to distribute assets
other than cash in connection with any liquidation, dissolution or winding up
of the Corporation (other than an underwritten public offering of the
Corporation's Common Stock), the value of the assets to be distributed to the
holders of shares of Series D Preferred, Series D-1 Preferred, Series C
Preferred, Series C-1 Preferred, Series B Preferred, Series A Preferred and
Common Stock shall be determined in good faith by the Board. Any securities
not subject to investment letter or similar restrictions on free marketability
shall be valued as follows:
(i) If traded on a securities exchange, the value shall be
deemed to be the average of the security's closing prices on such exchange
over the thirty (30) day period ending one (1) day prior to the distribution;
(ii) If actively traded over-the-counter, the value shall be
deemed to be the average of the closing bid prices over the thirty (30) day
period ending three (3) days prior to the distribution; and
(iii) If there is no active public market, the value shall be
the fair market value thereof as determined in good faith by the Board.
The method of valuation of securities subject to investment letter or
other restrictions on free marketability shall be adjusted to make an
appropriate discount from the market value determined as above in clauses (i),
(ii) or (iii) to reflect the fair market value thereof as determined in good
faith by the Board. The holders of at least a majority of the outstanding
Preferred Stock shall have the right to challenge any determination by the
Board of fair market value pursuant to this Section 2(f), in which case the
determination of fair market value shall be made by an independent appraiser
selected
-6-
<PAGE>
jointly by the Board and the challenging parties, the cost of such appraisal
to be borne equally by the Corporation and the challenging parties.
(g) Notwithstanding any provision of this Section 2 to the
contrary, in the event of a deemed liquidation of this Corporation in
connection with an underwritten public offering in which the Liquidation
Preference Threshold is not achieved with respect to the Series A Preferred
and the Series B Preferred, in addition to (and not in lieu of) the conversion
rights set forth in Section 4 below, the holders of the Series A Preferred and
the Series B Preferred shall be entitled to receive, immediately upon the
closing of such underwritten public offering, that number of shares of Common
Stock of the Corporation equal to the quotient obtained by dividing (i) the
full preferential amount to which such holder of Series A Preferred and Series
B Preferred is entitled under paragraph (a) above, by (ii) the public offering
price per share (prior to any underwriters' discounts and commissions) in such
underwritten public offering.
3. Voting Rights. Except as otherwise required by law or as set forth
-------------
herein, the holder of each share of Common Stock (other than Class B Common)
issued and outstanding shall have one vote for each share of Common Stock held
by such holder, and the holder of each share of Series D Preferred, Series C
Preferred, Series B Preferred and Series A Preferred shall be entitled to the
number of votes equal to the number of shares of Common Stock into which such
share of Series D Preferred, Series C Preferred, Series B Preferred and Series
A Preferred, respectively, could be converted at the record date for
determination of the stockholders entitled to vote on such matters, or, if no
such record date is established, at the date such vote is taken or any written
consent of stockholders is solicited, such votes to be counted together with
all other shares of stock of the Corporation having general voting power and
not counted separately as a class. Holders of Common Stock, Series A
Preferred, Series B Preferred, Series C Preferred and Series D Preferred shall
be entitled to notice of any stockholders' meeting in accordance with the
Bylaws of the Corporation. Except as required by law or as set forth herein,
holders of Class B Common, holders of Series C-1 Preferred and holders of
Series D-1 Preferred shall not be entitled to vote for the election of
directors or to vote on any other matter.
4. Conversion. The holders of the Series D Preferred, Series D-1
----------
Preferred, Series C Preferred, Series C-1 Preferred, Series B Preferred,
Series A Preferred and Class B Common have conversion rights as follows (the
"CONVERSION RIGHTS"):
(a) Right to Convert Series D Preferred. Each share of Series D
-----------------------------------
Preferred shall be convertible, at the option of the holder thereof, at any
time after the date of issuance of such share at the office of the Corporation
or any transfer agent for the Series D Preferred, into such number of fully
paid and nonassessable shares of Common Stock as is determined in the case of
the Series D Preferred by dividing $18.00 by the Series D Conversion Price,
determined as hereinafter provided, in effect at the time of the conversion.
The price at which shares of Common Stock shall be deliverable upon conversion
of the Series D Preferred (the "SERIES D CONVERSION PRICE") shall initially be
$18.00 per share of Common Stock. Such initial Conversion Price shall be
subject to adjustment as hereinafter provided.
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<PAGE>
(b) Right to Convert Series D-1 Preferred.
-------------------------------------
(i) Into Class B Common. Each share of Series D-1 Preferred
-------------------
shall be convertible, at the option of the holder thereof, at any time after
the date of issuance of such share at the office of the Corporation or any
transfer agent for the Series D-1 Preferred, into such number of fully paid
and nonassessable shares of Class B Common as is determined in the case of the
Series D-1 Preferred by dividing $18.00 by the Series D-1 Conversion Price,
determined as hereinafter provided, in effect at the time of the conversion.
The price at which shares of Class B Common shall be deliverable upon
conversion of the Series D-1 Preferred (the "SERIES D-1 CONVERSION PRICE")
shall initially be $18.00 per share of Class B Common. Such initial Conversion
Price shall be subject to adjustment as hereinafter provided.
(ii) Into Series D Preferred. Beginning one year after the
-----------------------
date on which a share of Series D-1 Preferred was originally issued, such
share of Series D-1 Preferred shall be convertible, at the option of the
holder thereof, at the office of the Corporation or any transfer agent for the
Series D-1 Preferred, into one fully paid and nonassessable share of Series D
Preferred, so long as, after giving effect to such conversion, the total
number of shares of the Corporation's capital stock entitled to vote in any
election of directors of the Corporation ("VOTING SHARES") held by such
holder, together with all of its Affiliates, shall be less than ten percent
(10%) (by voting power) of the total number of Voting Shares then issued and
outstanding. No conversion of shares of Series D-1 Preferred that would have
the effect of giving the holder, together with all of its Affiliates, of such
holder an aggregate number of Voting Shares equal to or greater than ten
percent (10%) (by voting power) of the total number of Voting Shares then
issued and outstanding shall be effected pursuant to this paragraph. For the
purposes of this Article, the term "AFFILIATE" shall mean, as to any person or
entity, a person or entity that, directly or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control
with, such person or entity. In addition, with respect to AT&T Venture Fund
II, LP, Special Partners Fund, LP and Special Partners Fund International, LP
(the "AT&T ENTITIES"), only for the purposes of this Certificate of
Incorporation, AT&T Corp., all Affiliates of AT&T Corp., each of the other
AT&T Entities and all owners of equity interests in the AT&T Entities shall be
deemed to be Affiliates of each of the AT&T Entities.
(c) Right to Convert Series C Preferred. Each share of Series C
-----------------------------------
Preferred shall be convertible, at the option of the holder thereof, at any
time after the date of issuance of such share at the office of the Corporation
or any transfer agent for the Series C Preferred, into such number of fully
paid and nonassessable shares of Common Stock as is determined in the case of
the Series C Preferred by dividing $2.7767 by the Series C Conversion Price,
determined as hereinafter provided, in effect at the time of the conversion.
The price at which shares of Common Stock shall be deliverable upon conversion
of the Series C Preferred (the "SERIES C CONVERSION PRICE") shall initially be
$2.7767 per share of Common Stock. Such initial Series C Conversion Price
shall be subject to adjustment as hereinafter provided.
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<PAGE>
(d) Right to Convert Series C-1 Preferred.
-------------------------------------
(i) Into Class B Common. Each share of Series C-1 Preferred
-------------------
shall be convertible, at the option of the holder thereof, at any time after
the date of issuance of such share at the office of the Corporation or any
transfer agent for the Series C-1 Preferred, into such number of fully paid
and nonassessable shares of Class B Common Stock as is determined in the case
of the Series C-1 Preferred by dividing $2.7767 by the Series C-1 Conversion
Price, determined as hereinafter provided, in effect at the time of the
conversion. The price at which shares of Class B Common Stock shall be
deliverable upon conversion of the Series C-1 Preferred (the "SERIES C-1
CONVERSION PRICE") shall initially be $2.7767 per share of Common Stock. Such
initial Conversion Price shall be subject to adjustment as hereinafter
provided.
(ii) Into Series C Preferred. Beginning one year after the
-----------------------
date on which a share of Series C-1 Preferred was originally issued, such
share of Series C-1 Preferred shall be convertible, at the option of the
holder thereof, at the office of the Corporation or any transfer agent for the
Series C-1 Preferred, into one fully paid and nonassessable share of Series C
Preferred, so long as, after giving effect to such conversion, the total
number of Voting Shares held by such holder, together with all of its
Affiliates, shall be less than ten percent (10%) (by voting power) of the
total number of Voting Shares then issued and outstanding. No conversion of
shares of Series C-1 Preferred that would have the effect of giving the
holder, together with all of its Affiliates, an aggregate number of Voting
Shares equal to or greater than ten percent (10%) (by voting power) of the
total number of Voting Shares then issued and outstanding shall be effected
pursuant to this paragraph.
(e) Right to Convert Series B Preferred. Each share of Series B
-----------------------------------
Preferred shall be convertible, at the option of the holder thereof, at any
time after the date of issuance of such share at the office of the Corporation
or any transfer agent for the Series B Preferred, into such number of fully
paid and nonassessable shares of Common Stock as is determined in the case of
the Series B Preferred by dividing $0.50 by the Series B Conversion Price,
determined as hereinafter provided, in effect at the time of the conversion.
The price at which shares of Common Stock shall be deliverable upon conversion
of the Series B Preferred (the "SERIES B CONVERSION PRICE") shall initially be
$0.50 per share of Common Stock. Such initial Conversion Price shall be
subject to adjustment as hereinafter provided.
(f) Right to Convert Series A Preferred. Each share of Series A
-----------------------------------
Preferred shall be convertible, at the option of the holder thereof, at any
time after the date of issuance of such share at the office of the Corporation
or any transfer agent for the Series A Preferred, into such number of fully
paid and nonassessable shares of Common Stock as is determined in the case of
the Series A Preferred by dividing $0.3333 by the Series A Conversion Price,
determined as hereinafter provided, in effect at the time of the conversion.
The price at which shares of Common Stock shall be deliverable upon conversion
of the Series A Preferred (the "SERIES A CONVERSION PRICE") shall initially be
$0.3333 per share of Common Stock. Such initial Conversion Price shall be
subject to adjustment as hereinafter provided.
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<PAGE>
(g) Right to Convert Class B Common. Each share of Class B Common
-------------------------------
shall be convertible, at the option of the holder thereof, at any time one
year after the date such share of the Series C-1 Preferred or Series D-1
Preferred, as the case may be, was originally issued, from which such share of
Class B Common was previously converted, at the office of the Corporation or
any transfer agent for the Class B Common, into one fully paid and
nonassessable shares of Common Stock, so long as, after giving effect to such
conversion, the total number of Voting Shares held by such holder, together
with all of its Affiliates, shall be less than ten percent (10%) (by voting
power) of the total number of Voting Shares then issued and outstanding. No
conversion of shares of Class B Common that would have the effect of giving
the holder, together with all of its Affiliates, an aggregate number of Voting
Shares equal to or greater than ten percent (10%) (by voting power) of the
total number of Voting Shares then issued and outstanding shall be effected
pursuant to this paragraph.
(h) Automatic Conversion.
--------------------
(i) Each share of Series D Preferred shall automatically be
converted into shares of Common Stock at the then effective Series D
Conversion Price, subject to adjustment in Section 5(f)(ii) below, upon the
earlier of (i) the date specified by vote or written consent of holders of
seventy percent (70%) of the then outstanding shares of Series D Preferred, or
(ii) upon the closing of an underwritten public offering pursuant to an
effective registration statement under the Securities Act covering the offer
and sale of Common Stock for the account of the Corporation to the public with
aggregate gross proceeds to the Corporation of not less than Twenty-Five
Million Dollars ($25,000,000). In the event of the automatic conversion of the
Series D Preferred upon a public offering as aforesaid, the person(s) entitled
to receive the Common Stock issuable upon such conversion of Series D
Preferred shall not be deemed to have converted such Series D Preferred until
immediately prior to the closing of such sale of securities.
(ii) If, as a result of any transaction or any event, a
holder of Series D Preferred, together with all of its Affiliates, would hold
ten percent (10%) or more (by voting power) of the total number of Voting
Shares then issued and outstanding, then the number of shares of Series D
Preferred held by such holder of Series D Preferred, if any, that would reduce
the total number of Voting Shares held by such holder of Series D Preferred,
together with all of its Affiliates, to less than ten percent (10%) (by voting
power) of the total number of Voting Shares then issued and outstanding shall
be automatically converted into the identical number of shares of Series D-1
Preferred. Such conversion shall be deemed to have occurred immediately prior
to the transaction or events that would otherwise increase the Voting Shares
held by such holder of Series D Preferred, together with all of its
Affiliates, to ten percent (10%) or more of total number of Voting Shares.
(iii) Each share of Series D-1 Preferred shall automatically
be converted into shares of Class B Common at the then effective Series D-1
Conversion Price, subject to adjustment in Section 5(f)(ii) below, upon the
earlier of (i) the date specified by vote or written consent of holders of
seventy percent (70%) of the then outstanding shares of Series D-1 Preferred,
or (ii) upon the closing of an underwritten public offering pursuant to an
effective registration statement under the Securities Act covering the offer
and sale of Common Stock for the account of
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<PAGE>
the Corporation to the public with aggregate gross proceeds to the Corporation
of not less than Twenty-Five Million Dollars ($25,000,000). In the event of
the automatic conversion of the Series D-1 Preferred upon a public offering as
aforesaid, the person(s) entitled to receive the Class B Common issuable upon
such conversion of Series D-1 Preferred shall not be deemed to have converted
such Series D-1 Preferred until immediately prior to the closing of such sale
of securities.
(iv) Upon any sale, disposition, assignment or transfer
(each, a "Transfer") of any shares of Series D-1 Preferred by the original
holder thereof after one year from the date of issuance of such shares, other
than a Transfer to an Affiliate and subject to the provisions of subsection
(h)(ii), such shares of Series D-1 Preferred so transferred shall, by virtue
of, and simultaneously with, the occurrence of the Transfer, without any
action on the part of the transferee, be automatically converted into the
identical number of fully paid and nonassessable shares of Series D Preferred.
(v) Each share of Series C Preferred shall automatically be
converted into shares of Common Stock at the then effective Series C
Conversion Price upon the earlier of (i) the date specified by vote or written
consent of holders of seventy percent (70%) of the then outstanding shares of
Series C Preferred, or (ii) the closing of an underwritten public offering
pursuant to an effective registration statement under the Securities Act
covering the offer and sale of Common Stock for the account of the Corporation
to the public at a per share price of $2.7767 or greater (adjusted for any
subdivisions, combinations, consolidations or stock distributions or dividends
with respect to such shares) prior to any underwriter's discounts or
commissions and with aggregate gross proceeds to the Corporation of not less
than Fifteen Million Dollars ($15,000,000). In the event of the automatic
conversion of the Series C Preferred upon a public offering as aforesaid, the
person(s) entitled to receive the Common Stock issuable upon such conversion
of Series C Preferred shall not be deemed to have converted such Series C
Preferred until immediately prior to the closing of such sale of securities.
(vi) If, as a result of any transaction or any event, an
original holder of Series C-1 Preferred, together with all of its Affiliates,
would hold ten percent (10%) or more (by voting power) of the total number of
Voting Shares then issued and outstanding, then the number of shares of Series
C Preferred held by such original holder of Series C-1 Preferred, if any, that
would reduce the total number of Voting Shares held by such original holder of
Series C-1 Preferred, together with all of its Affiliates, to less than ten
percent (10%) (by voting power) of the total number of Voting Shares then
issued and outstanding shall be automatically converted into the identical
number of shares of Series C-1 Preferred. Such conversion shall be deemed to
have occurred immediately prior to the transaction or events that would
otherwise increase the Voting Shares held by such original holder of Series C-
1 Preferred, together with all of its Affiliates, to ten percent (10%) or more
of total number of Voting Shares.
(vii) Each share of Series C-1 Preferred shall automatically
be converted into shares of Class B Common Stock at the then effective Series
C-1 Conversion Price upon the earlier of (i) the date specified by vote or
written consent of holders of seventy percent (70%) of the then outstanding
shares of Series C-1 Preferred, or (ii) the closing of an underwritten public
offering pursuant to an effective registration statement under the Securities
Act covering the offer and sale of
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<PAGE>
Common Stock for the account of the Corporation to the public at a per share
price of $2.7767 or greater (adjusted for any subdivisions, combinations,
consolidations or stock distributions or dividends with respect to such
shares) prior to any underwriter's discounts or commissions and with aggregate
gross proceeds to the Corporation of not less than Fifteen Million Dollars
($15,000,000). In the event of the automatic conversion of the Series C-1
Preferred upon a public offering as aforesaid, the person(s) entitled to
receive the Class B Common Stock issuable upon such conversion of Series C-1
Preferred shall not be deemed to have converted such Series C-1 Preferred
until immediately prior to the closing of such sale of securities.
(viii) Upon any sale, disposition, assignment or transfer
(each, a "TRANSFER") of any shares of Series C-1 Preferred by the original
holder thereof, other than a Transfer to an Affiliate and subject to the
provisions of subsection (h)(vi), such shares of Series C-1 Preferred so
transferred shall, by virtue of, and simultaneously with, the occurrence of
the Transfer, without any action on the part of the transferee, be
automatically converted into the identical number of fully paid and
nonassessable shares of Series C Preferred.
(ix) Each share of Series A Preferred and Series B
Preferred shall automatically be converted into shares of Common Stock at the
then effective Series A Conversion Price or Series B Conversion Price,
respectively, upon the earlier of (i) the date specified by vote or written
consent of holders of seventy percent (70%) of the then outstanding shares of
Series A Preferred and Series B Preferred, voting together as a single class
on an as converted to Common Stock basis, or (ii) upon the closing of an
underwritten public offering pursuant to an effective registration statement
under the Securities Act covering the offer and sale of Common Stock for the
account of the Corporation to the public with aggregate gross proceeds to the
Corporation of not less than Fifteen Million Dollars ($15,000,000). In the
event of the automatic conversion of the Series A Preferred and Series B
Preferred upon a public offering as aforesaid, the person(s) entitled to
receive the Common Stock issuable upon such conversion of Series A Preferred
or Series B Preferred shall not be deemed to have converted such Series A
Preferred or Series B Preferred, respectively, until immediately prior to the
closing of such sale of securities.
(x) If, as a result of any transaction or event occurring
within three years after the Original Issue Date of such shares of Series D-1
Preferred unless such transaction or event is approved by Board of Directors,
an original holder of Series D-1 Preferred, together with all of its
Affiliates, would hold ten percent (10%) or more (by voting power) of the
total number of Voting Shares then issued and outstanding, then the number of
shares of Common Stock held by such original holder of Series D-1 Preferred
that would reduce the total number of Voting Shares held by such original
holder of Series D-1 Preferred, together with all of its Affiliates, to less
than ten percent (10%) (by voting power) of the total number of Voting Shares
then issued and outstanding shall be automatically converted into the
identical number of shares of Class B Common. Such conversion shall be deemed
to have occurred immediately prior to the transaction or event that would
otherwise increase the Voting Shares held by such original holder of Series D-
1 Preferred, together with all of its Affiliates, to ten percent (10%) or more
of the total number of Voting Shares.
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<PAGE>
(xi) Upon any Transfer of any shares of Class B Common by
the original holder thereof, after one year from the date such shares of
Series C-1 Preferred or Series D-1 Preferred (as the case may be) were
originally issued, from which such shares of Class B Common were previously
converted, other than a Transfer to an Affiliate, such shares of Class B
Common so transferred shall, by virtue of, and simultaneously with, the
occurrence of the Transfer, without any action on the part of the transferee,
be automatically converted into the identical number of fully paid and
nonassessable shares of Common Stock.
(i) Mechanics of Conversion. No fractional shares of Common Stock
-----------------------
or Class B Common Stock, as the case may be, shall be issued upon conversion
of Series D Preferred, Series D-1 Preferred, Series C Preferred, Series C-1
Preferred, Series B Preferred or Series A Preferred. In lieu of any fractional
shares to which the holder would otherwise be entitled, the Corporation shall
pay cash equal to such fraction multiplied by the then effective applicable
Conversion Price. Before any holder of Series D Preferred, Series D-1
Preferred, Series C Preferred, Series C-1 Preferred, Series B Preferred,
Series A Preferred or Class B Common shall be entitled to convert the same as
set forth in Section 4(a)-(g) and to receive certificates therefor, such
holder shall surrender the certificate or certificates therefor, duly
endorsed, at the office of the Corporation or of any transfer agent for the
Series D Preferred, Series D-1 Preferred, Series C Preferred, Series C-1
Preferred, Series B Preferred, Series A Preferred or Class B Common, as the
case may be, and shall give written notice to the Corporation at such office
that such holder elects to convert the same. The Corporation shall, as soon as
practicable thereafter, issue and deliver at such office to such holder of
Series D Preferred, Series D-1 Preferred, Series C Preferred, Series C-1
Preferred, Series B Preferred, Series A Preferred or Class B Common, as the
case may be, a certificate or certificates for the number of shares to which
he shall be entitled as aforesaid as set forth in Section 4(a)-(g) and a check
payable to the holder in the amount of any cash amounts payable as the result
of a conversion into fractional shares. Such conversion shall be deemed to
have been made immediately prior to the close of business on the date of such
surrender of the shares of Series D Preferred, Series D-1 Preferred, Series C
Preferred, Series C-1 Preferred, Series B Preferred, Series A Preferred or
Class B Common, as the case may be, to be converted, and the person or persons
entitled to receive the shares issuable upon such conversion as set forth in
Section 4(a)-(g) shall be treated for all purposes as the record holder or
holders of such shares as set forth in Section 4(a)-(g) on such date. In the
event of an automatic conversion pursuant to Section 4, the outstanding shares
of Series A Preferred, Series B Preferred, Series C Preferred, Series C-1
Preferred, Series D Preferred, Series D-1 Preferred or Class B Common shall be
converted automatically without any further action by the holders of such
shares and whether or not the certificates representing such shares are
surrendered to the Corporation or its transfer agent; provided, that the
Corporation shall not be obligated to issue certificates evidencing the shares
of the class or series of stock issuable upon such automatic conversion unless
the certificates evidencing such shares of Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred,
Series D-1 Preferred or Class B Common are delivered to the Corporation or its
transfer agent as provided above, or the holder notifies the Corporation or
its transfer agent that such certificates have been lost, stolen or destroyed,
executes an agreement and provides an indemnity bond satisfactory to the
Corporation to indemnify the Corporation from any loss incurred by it in
connection with such certificates.
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<PAGE>
(j) Reservation of Stock Issuable Upon Conversion. This
---------------------------------------------
Corporation shall at all times reserve and keep available out of its
authorized but unissued shares of Common Stock, Class B Common, Series C
Preferred, Series C-1 Preferred, Series D Preferred or Series D-1 Preferred,
as the case may be, solely for the purpose of effecting the conversion of the
shares of the Series A Preferred, Series B Preferred, Series C Preferred,
Series C-1 Preferred, Series D Preferred, Series D-1 Preferred, Common Stock
and Class B Common such number of its shares, as the case may be, as shall
from time to time be sufficient to effect such conversion; and if at any time
the number of authorized but unissued shares of Common Stock, Class B Common,
Series C Preferred, Series C-1 Preferred, Series D Preferred or Series D-1
Preferred, as the case may be, shall not be sufficient to effect the
conversion of all then outstanding shares of the Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred,
Series D-1 Preferred, Common and Class B Common, in addition to such other
remedies as shall be available to the holder of such Series A Preferred,
Series B Preferred, Series C Preferred, Series C-1 Preferred, Series D
Preferred, Series D-1 Preferred, Common or Class B Common, this Corporation
will take such corporate action as may, in the opinion of its counsel, be
necessary to increase its authorized but unissued shares of Common Stock,
Class B Common, Series C Preferred, Series C-1 Preferred, Series D Preferred
or Series D-1 Preferred, as the case may be, to such number of shares as shall
be sufficient for such purposes.
5. Adjustments to Conversion Price.
-------------------------------
(a) Special Definitions. For purposes of this Section 5, the
--------------------
following definitions shall apply:
(i) "OPTIONS" shall mean rights, options or warrants to
subscribe for, purchase or otherwise acquire either Common Stock or
Convertible Securities.
(ii) "ORIGINAL ISSUE DATE" for the Series A Preferred,
Series B Preferred, Series C Preferred, Series C-1 Preferred, Series D
Preferred and Series D-1 Preferred shall mean the date on which a share of
Series A Preferred, Series B Preferred, Series C Preferred, Series C-1
Preferred, Series D Preferred or Series D-1 Preferred, as the case may be, was
first issued.
(iii) "CONVERTIBLE SECURITIES" shall mean any evidences of
indebtedness, shares (other than the Series A Preferred, Series B Preferred,
Series C Preferred, Series C-1 Preferred, Series D Preferred, Series D-1
Preferred, Class B Common and Common Stock) or other securities directly or
indirectly convertible into or exchangeable for Common Stock.
(iv) "ADDITIONAL SHARES OF COMMON STOCK" shall mean all
shares (including reissued shares) of Common Stock issued (or, pursuant to
paragraph 5(c), deemed to be issued) by the Corporation after the Original
Issue Date, other than:
(A) shares of Common Stock, Class B Common, Series C
Preferred, Series C-1 Preferred, Series D Preferred or Series D-1 Preferred,
as the case may be, issued upon conversion of the Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1
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<PAGE>
Preferred, Series D Preferred, Series D-1 Preferred, Common and Class B Common
authorized herein;
(B) shares of Common Stock (including any of such
shares which are repurchased) issued to officers, directors, employees and
consultants of the Corporation pursuant to stock option or purchase plans
approved by at least 80% of the members of the Board of Directors and any
other shares of Common Stock held by officers, directors, employees, and
consultants which are repurchased at cost subsequent to the Original Issue
Date; and
(C) as a dividend or distribution on Series A
Preferred, Series B Preferred, Series C Preferred, Series C-1 Preferred,
Series D Preferred, Series D-1 Preferred or any event for which adjustment is
made pursuant to paragraph 5(h) or 5(i) hereof.
(D) Options (or shares of Common Stock issued upon
exercise thereof) issued or issuable in connection with any commitments to
purchase the Series C Preferred; or
(E) Options (or shares of Common Stock issued upon
exercise thereof) issued in connection with the issuance of the Senior Notes.
(v) "SENIOR NOTES" shall mean the Senior Discount Notes due
2008 issued by the Corporation on or before April 30, 1998.
(vi) "RATCHET CUT-OFF DATE" shall mean the date that is the
earlier to occur of (i) the business day next following the closing of a
Replacement Financing within the meaning of the Series C Subscription
Agreement, or (ii) the Second Closing within the meaning of the Series C
Subscription Agreement.
(vii) "SERIES C SUBSCRIPTION AGREEMENT" shall mean that
certain Series C Preferred Stock and Warrant Subscription Agreement dated as
of February 20, 1998 among the Corporation and certain stockholders of the
Corporation, as amended.
(viii) "SERIES D/D-1 RATCHET CUT-OFF DATE" shall mean the
business day next following the earliest to occur of (i) the closing of an
underwritten public offering pursuant to an effective registration statement
under the Securities Act covering the offer and sale of Common Stock for the
account of the Corporation to the public with aggregate gross proceeds to the
Corporation of not less than Twenty-Five Million Dollars ($25,000,000), (ii)
the closing of a private equity financing in the aggregate amount of $50
million or greater in gross proceeds from the sale to new investors of Common
Stock or Preferred Stock, such financing occurring after the issuance of the
Series D-1 Preferred, and (iii) the closing of a Liquidity Event other than an
underwritten public offering.
(b) No Adjustment of Conversion Price. No adjustment in the
---------------------------------
Conversion Price of the Series A Preferred, Series B Preferred, Series C
Preferred, Series C-1 Preferred, Series D Preferred or Series D-1 Preferred
shall be made in respect of the issuance of Additional Shares of Common Stock
unless the consideration per share for an Additional Share of Common Stock
issued
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<PAGE>
or deemed to be issued by the Corporation is less than the applicable
Conversion Price of such series in effect on the date of and immediately prior
to such issue.
(c) Deemed Issue of Additional Shares of Common Stock. In the
-------------------------------------------------
event the Corporation at any time or from time to time after the Original
Issue Date shall issue any Options or Convertible Securities or shall fix a
record date for the determination of holders of any class of securities
entitled to receive any such Options or Convertible Securities, then the
maximum number of shares (as set forth in the instrument relating thereto
without regard to any provisions contained therein for a subsequent adjustment
of such number that would result in an adjustment pursuant to clause (ii)
below) of Common Stock issuable upon the exercise of such Options or, in the
case of Convertible Securities and Options therefor, the conversion or
exchange of such Convertible Securities, shall be deemed to be Additional
Shares of Common Stock issued as of the time of such issue or, in case such a
record date shall have been fixed, as of the close of business on such record
date, provided that Additional Shares of Common Stock shall not be deemed to
have been issued unless the consideration per share (determined pursuant to
paragraph 5(g) hereof) of such Additional Shares of Common Stock would be less
than the applicable Conversion Price of the Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred or
Series D-1 Preferred, as the case may be, in effect on the date of and
immediately prior to such issue, or such record date, as the case may be, and
provided further that in any such case in which Additional Shares of Common
Stock are deemed to be issued:
(i) no further adjustment in the Conversion Price shall be
made upon the subsequent issue of Convertible Securities or shares of Common
Stock upon the exercise of such Options or conversion or exchange of such
Convertible Securities;
(ii) if such Options or Convertible Securities by their
terms provide, with the passage of time or otherwise, for any increase or
decrease in the consideration payable to the Corporation, or increase or
decrease in the number of shares of Common Stock issuable, upon the exercise,
conversion or exchange thereof, the Conversion Price computed upon the
original issue thereof (or upon the occurrence of a record date with respect
thereto), and any subsequent adjustments based thereon, shall, upon any such
increase or decrease becoming effective, be recomputed to reflect such
increase or decrease insofar as it affects such Options or the rights of
conversion or exchange under such Convertible Securities;
(iii) upon the expiration of any such Options or any rights
of conversion or exchange under such Convertible Securities which shall not
have been exercised, the Conversion Price computed upon the original issue
thereof (or upon the occurrence of a record date with respect thereto), and
any subsequent adjustments based thereon, shall, upon such expiration, be
recomputed as if:
(A) in the case of Convertible Securities or Options
for Common Stock, the only Additional Shares of Common Stock issued were
shares of Common Stock, if any, actually issued upon the exercise of such
Options or the conversion or exchange of such Convertible Securities and the
consideration received therefor was the consideration actually received by the
Corporation for the issue of all such Options, whether or not exercised, plus
the consideration
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<PAGE>
actually received by the Corporation upon such exercise, or for the issue of
all such Convertible Securities which were actually converted or exchanged,
plus the additional consideration, if any, actually received by the
Corporation upon such conversion or exchange, and
(B) in the case of Options for Convertible
Securities, only the Convertible Securities, if any, actually issued upon the
exercise thereof were issued at the time of issue of such Options, and the
consideration received by the Corporation for the Additional Shares of Common
Stock deemed to have been then issued was the consideration actually received
by the Corporation for the issue of all such Options, whether or not
exercised, plus the consideration deemed to have been received by the
Corporation upon the issue of the Convertible Securities with respect to which
such Options were actually exercised;
(iv) no readjustment pursuant to clause (ii) or (iii) above
shall have the effect of increasing the Conversion Price to an amount which
exceeds the lower of (i) the Conversion Price on the original adjustment date,
or (ii) the Conversion Price that would have resulted from any issuance of
Additional Shares of Common Stock between the original adjustment date and
such readjustment date; and
(v) in the case of any Options which expire by their terms
not more than 30 days after the date of issue thereof, no adjustment of the
Conversion Price shall be made until the expiration or exercise of all such
Options, whereupon such adjustment shall be made in the manner provided in
clause (iii) above.
(d) Adjustment of Conversion Price of Series A Preferred Stock and
--------------------------------------------------------------
Series B Preferred Stock Upon Issuance of Additional Shares of Common Stock.
- ---------------------------------------------------------------------------
In the event that after the Original Issue Date this Corporation shall issue
Additional Shares of Common Stock without consideration or for a consideration
per share less than the Conversion Price of the Series A Preferred Stock or
the Series B Preferred Stock, as the case may be, in effect on the date of and
immediately prior to such issue, then and in such event, such Conversion Price
for such Series A Preferred Stock or Series B Preferred Stock, as the case may
be, shall be reduced, concurrently with such issue, to a price (calculated to
the nearest cent) determined by multiplying such Conversion Price, by a
fraction, the numerator of which shall be the number of shares of Common Stock
outstanding immediately prior to such issue plus the number of shares of
Common Stock which the aggregate consideration received by the Corporation for
the total number of Additional Shares of Common Stock so issued would purchase
at such Conversion Price; and the denominator of which shall be the number of
shares of Common Stock outstanding immediately prior to such issue plus the
number of such Additional Shares of Common Stock so issued; and provided
further that, for the purposes of this subsection (d), all shares of Common
Stock issuable upon conversion of outstanding Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred,
Series D-1 Preferred and Class B Common and outstanding Convertible Securities
or exercise of outstanding Options shall be deemed to be outstanding, and
immediately after any Additional Shares of Common Stock are deemed issued
pursuant to subsection 5(c), such Additional Shares of Common Stock shall be
deemed to be outstanding.
(e) Adjustment of Conversion Prices of Series C Preferred and
---------------------------------------------------------
Series C-1 Preferred Upon Issuance of Additional Shares of Common Stock.
- -----------------------------------------------------------------------
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<PAGE>
(i) ISSUANCES ON OR BEFORE THE RATCHET CUT-OFF DATE. In the
event that after the Original Issue Date (A) this Corporation shall issue
Additional Shares of Common Stock without consideration or for a consideration
per share less than the Series C Conversion Price in effect on the date of and
immediately prior to such issue, and (B) such issuance of Additional Shares of
Common Stock occurs on or before the Ratchet Cut-Off Date, then and in such
event, the Series C Conversion Price shall be reduced, concurrently with such
issue, to a price (calculated to the nearest cent) determined by dividing the
aggregate consideration received by the Corporation for the total number of
Additional Shares of Common Stock so issued by the total number of Additional
Shares of Common Stock so issued.
(ii) ISSUANCES AFTER THE RATCHET CUT-OFF DATE. In the event
that after the Original Issue Date (A) this Corporation shall issue Additional
Shares of Common Stock without consideration or for a consideration per share
less than the Series C Conversion Price in effect on the date of and
immediately prior to such issue, and (B) such issuance of Additional Shares of
Common Stock occurs after the Ratchet Cut-Off Date, then and in such event,
the Series C Conversion Price shall be reduced, concurrently with such issue,
to a price (calculated to the nearest cent) determined by multiplying such
Conversion Price, by a fraction, the numerator of which shall be the number of
shares of Common Stock outstanding immediately prior to such issue plus the
number of shares of Common Stock which the aggregate consideration received by
the Corporation for the total number of Additional Shares of Common Stock so
issued would purchase at such Conversion Price; and the denominator of which
shall be the number of shares of Common Stock outstanding immediately prior to
such issue plus the number of such Additional Shares of Common Stock so
issued; and provided further that, for the purposes of this subsection (e),
all shares of Common Stock issuable upon conversion of outstanding Series A
Preferred, Series B Preferred, Series C Preferred, Series C-1 Preferred,
Series D Preferred, Series D-1 Preferred and Class B Common and outstanding
Convertible Securities or exercise of outstanding Options shall be deemed to
be outstanding, and immediately after any Additional Shares of Common Stock
are deemed issued pursuant to subsection 5(f), such Additional Shares of
Common Stock shall be deemed to be outstanding.
(f) Adjustment of Conversion Price of Series D Preferred and
--------------------------------------------------------
Series D-1 Preferred Upon Issuance of Additional Shares of Common Stock.
- -----------------------------------------------------------------------
(i) ISSUANCES ON OR BEFORE THE SERIES D/D-1 RATCHET CUT-
OFF DATE. In the event that after the Original Issue Date (A) this Corporation
shall issue Additional Shares of Common Stock without consideration or for a
consideration per share less than the Series D Conversion Price or the Series
D-1 Conversion Price, as the case may be, in effect on the date of and
immediately prior to such issue, and (B) such issuance of Additional Shares of
Common Stock occurs on or before the Series D/D-1 Ratchet Cut-Off Date, then
and in such event, the Series D Conversion Price or the Series D-1 Conversion
Price, as the case may be, shall be reduced, concurrently with such issue, to
a price (calculated to the nearest cent) determined by dividing the aggregate
consideration received by the Corporation for the total number of Additional
Shares of Common Stock so issued by the total number of Additional Shares of
Common Stock so issued.
(ii) ISSUANCES SUBJECT TO AUTOMATIC CONVERSION ON OR BEFORE
THE SERIES D/D-1 RATCHET CUT-OFF DATE. In the event that after the Original
Issue Date (A) this Corporation shall issue Additional Shares of Common Stock
in an underwritten public offering for a
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<PAGE>
consideration per share less than the Series D Conversion Price or the Series
D-1 Conversion Price, as the case may be, in effect on the date of and
immediately prior to such issue, (B) such issuance of Additional Shares of
Common Stock occurs on or before the Series D/D-1 Ratchet Cut-Off Date, and
(C) the shares of Series D Preferred and Series D-1 Preferred are subject to
automatic conversion pursuant to Section 4(h) above, then and in such event,
the Series D Conversion Price or the Series D-1 Conversion Price, as the case
may be, shall be reduced, immediately prior to such issue and immediately
prior to such automatic conversion pursuant to Section 4(h) above, to a price
(calculated to the nearest cent) determined by dividing the aggregate
consideration received by the Corporation for the total number of Additional
Shares of Common Stock so issued by the total number of Additional Shares of
Common Stock so issued.
(iii) CHANGE OF CONTROL EVENT ON OR BEFORE THE SERIES D/D-1
RATCHET CUT-OFF DATE. In the event that after the Original Issue Date (A) this
Corporation shall close a Liquidity Event (other than an underwritten public
offering pursuant to an effective registration statement under the Securities
Act) in which the quotient (the "Liquidity Quotient") obtained by dividing (I)
the aggregate value received by the Corporation or the holders of the
Corporation's capital stock in such Liquidity Event (excluding options or
warrants outstanding at the closing of such Liquidity Event), by (II) the
total number of shares of the Corporation's Common Stock outstanding on the
date of such event on an as-converted basis (excluding options or warrants
outstanding at the closing of such Liquidity Event), is less than the Series D
Conversion Price or the Series D-1 Conversion Price, as the case may be, in
effect on the date of and immediately preceding such Liquidity Event, and (B)
such Liquidity Event occurs on or before the Series D/D-1 Ratchet Cut-Off
Date, then and in such event, the Series D Conversion Price or the Series D-1
Conversion Price, as the case may be, shall be reduced, immediately prior to
the closing of such Liquidity Event and immediately prior to any conversion
pursuant to Section 4(a) or 4(b) above, as the case may be, to a price
(calculated to the nearest cent) equal to the Liquidity Quotient.
(iv) ISSUANCES AFTER THE SERIES D/D-1 RATCHET CUT-OFF DATE.
In the event that after the Original Issue Date (A) this Corporation shall
issue Additional Shares of Common Stock without consideration or for a
consideration per share less than the Series D Conversion Price or the Series
D-1 Conversion Price, as the case may be, in effect on the date of and
immediately prior to such issue, and (B) such issuance of Additional Shares of
Common Stock occurs after the Series D/D-1 Ratchet Cut-Off Date, then and in
such event, the Series D Conversion Price or the Series D-1 Conversion Price,
as the case may be, shall be reduced, concurrently with such issue, to a price
(calculated to the nearest cent) determined by multiplying such Conversion
Price, by a fraction, the numerator of which shall be the number of shares of
Common Stock outstanding immediately prior to such issue plus the number of
shares of Common Stock which the aggregate consideration received by the
Corporation for the total number of Additional Shares of Common Stock so
issued would purchase at such Conversion Price; and the denominator of which
shall be the number of shares of Common Stock outstanding immediately prior to
such issue plus the number of such Additional Shares of Common Stock so
issued; and provided further that, for the purposes of this subsection (f),
all shares of Common Stock issuable upon conversion of outstanding Series A
Preferred, Series B Preferred, Series C Preferred, Series C-1 Preferred,
Series D Preferred, Series D-1 Preferred and Class B Common and outstanding
Convertible Securities or exercise of outstanding Options shall be deemed to
be outstanding, and immediately after any Additional Shares
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<PAGE>
of Common Stock are deemed issued pursuant to subsection 5(c), such Additional
Shares of Common Stock shall be deemed to be outstanding.
(g) Determination of Consideration. For purposes of this Section
------------------------------
5, the consideration received by the Corporation for the issue of any Additional
Shares of Common Stock shall be computed as follows:
(i) CASH AND PROPERTY. Except as provided in clause (ii)
below, such consideration shall:
(A) insofar as it consists of cash, be computed at
the aggregate amount of cash received by the Corporation excluding amounts
paid or payable for accrued interest or accrued dividends;
(B) insofar as it consists of property other than
cash, be computed at the fair value thereof at the time of such issue, as
determined in good faith by the Board; provided, however, that no value shall
be attributed to any services performed by any employee, officer or director
of the Corporation; and
(C) in the event Additional Shares of Common Stock
are issued together with other shares or securities or other assets of the
Corporation for consideration which covers both, be the proportion of such
consideration so received with respect to such Additional Shares of Common
Stock, computed as provided in clauses (A) and (B) above, as determined in
good faith by the Board.
(ii) EXPENSES. In the event the Corporation pays or incurs
expenses, commissions or compensation, or allows concessions or discounts to
underwriters, dealers or others performing similar services in connection with
such issue, in an aggregate amount in excess of 10% of the gross proceeds for
such issue, as determined in clause (i) above, consideration shall be computed
as provided in clause (i) above after deducting the aggregate amount in excess
of 10% of the gross proceeds for the issue. In a financing where the
Corporation issues securities to an underwriter (or underwriters) which in
turn sells the securities to the initial investors, gross proceeds shall be
determined by the amount paid by such initial investors.
(iii) OPTIONS AND CONVERTIBLE SECURITIES. The consideration
per share received by the Corporation for Additional Shares of Common Stock
deemed to have been issued pursuant to Section 5(c), relating to Options and
Convertible Securities, shall be determined by dividing
(x) the total amount, if any, received or receivable
by the Corporation as consideration for the issue of such Options or
Convertible Securities, plus the minimum aggregate amount of additional
consideration (as set forth in the instruments relating thereto, without
regard to any provision contained therein for a subsequent adjustment of such
consideration) payable to the Corporation upon the exercise of such Options or
the conversion or exchange of such Convertible Securities, or in the case of
Options for Convertible Securities, the
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exercise of such Options for Convertible Securities and the conversion or
exchange of such Convertible Securities by
(y) the maximum number of shares of Common Stock (as
set forth in the instruments relating thereto, without regard to any provision
contained therein for a subsequent adjustment of such number) issuable upon
the exercise of such Options or the conversion or exchange of such Convertible
Securities.
(h) Adjustments for Stock Dividends, Subdivisions, Combinations or
--------------------------------------------------------------
Consolidations of Common Stock. In the event the outstanding shares of Common
- ------------------------------
Stock shall be subdivided (by stock dividend, stock split, or otherwise), into
a greater number of shares of Common Stock (and there is no corresponding
subdivision of the outstanding shares of Preferred Stock), the Series A,
Series B, Series C, Series C-1, Series D and Series D-1 Conversion Prices then
in effect shall, concurrently with the effectiveness of such subdivision, be
proportionately decreased. In the event the outstanding shares of Common Stock
shall be combined or consolidated, by reclassification or otherwise, into a
lesser number of shares of Common Stock (and there is no corresponding
combination or consolidation of the outstanding shares of Preferred Stock),
the Series A, Series B, Series C, Series C-1, Series D and Series D-1
Conversion Prices then in effect shall, concurrently with the effectiveness of
such combination or consolidation, be proportionately increased.
(i) Adjustments for Other Distributions. In the event the
-----------------------------------
Corporation at any time or from time to time makes, or fixes a record date for
the determination of holders of Common Stock entitled to receive any
distribution payable in securities or assets of the Corporation other than
shares of Common Stock then and in each such event provision shall be made so
that the holders of Series A Preferred, Series B Preferred, Series C
Preferred, Series C-1 Preferred, Series D Preferred and Series D-1 Preferred
shall receive upon conversion thereof, in addition to the number of shares of
Common Stock receivable thereupon, the amount of securities or assets of the
Corporation which they would have received had their Series A Preferred,
Series B Preferred, Series C Preferred, Series C-1 Preferred, Series D
Preferred and Series D-1 Preferred been converted into Common Stock on the
date of such event and had they thereafter, during the period from the date of
such event to and including the date of conversion, retained such securities
or assets receivable by them as aforesaid during such period, subject to all
other adjustments called for during such period under this Section 5 with
respect to the rights of the holders of the Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred and
Series D-1 Preferred.
(j) Adjustments for Reclassification, Exchange and Substitution.
-----------------------------------------------------------
If the Common Stock issuable upon conversion of the Series A Preferred, Series
B Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred and
Series D-1 Preferred shall be changed into the same or a different number of
shares of any other class or classes of stock, whether by capital
reorganization, reclassification or otherwise (other than a subdivision or
combination of shares provided for above), then and in each such event the
holder of each share of Series A Preferred, Series B Preferred, Series C
Preferred, Series C-1 Preferred, Series D Preferred and Series D-1 Preferred
shall have the right thereafter to convert such share into the kind and amount
of shares of stock and other securities and property receivable upon such
reorganization or reclassification or other change by holders of the number of
shares of Common Stock that would have been subject to receipt by the holders
upon
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conversion of the Series A Preferred, Series B Preferred, Series C Preferred,
Series C-1 Preferred, Series D Preferred and Series D-1 Preferred immediately
before that change, all subject to further adjustment as provided herein.
(k) No Impairment. The Corporation will not, by amendment of its
-------------
Certificate of Incorporation or through any reorganization, transfer of
assets, consolidation, merger, dissolution, issue or sale of securities or any
other voluntary action, avoid or seek to avoid the observance or performance
of any of the terms to be observed or performed hereunder by the Corporation
but will at all times in good faith assist in the carrying out of all the
provisions of Section 5 and in the taking of all such action as may be
necessary or appropriate in order to protect the Conversion Rights of the
holders of the Series A Preferred, Series B Preferred, Series C Preferred,
Series C-1 Preferred, Series D Preferred and Series D-1 Preferred against
impairment.
(l) Certificate as to Adjustments. Upon the occurrence of each
-----------------------------
adjustment or readjustment of the Conversion Price pursuant to Section 5, the
Corporation at its expense shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and furnish to each holder of
Series A Preferred, Series B Preferred, Series C Preferred, Series C-1
Preferred, Series D Preferred and Series D-1 Preferred a certificate setting
forth such adjustment or readjustment and showing in detail the facts upon
which such adjustment or readjustment is based. The Corporation shall, upon
the written request at any time of any holder of Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred or
Series D-1 Preferred, furnish or cause to be furnished to such holder a like
certificate setting forth (i) such adjustments and readjustments, (ii) the
Conversion Price at the time in effect, and (iii) the number of shares of
Common Stock and the amount, if any, of other property which at the time would
be received upon the conversion of Series A Preferred, Series B Preferred,
Series C Preferred, Series C-1 Preferred, Series D Preferred or Series D-1
Preferred, as the case may be.
(m) Miscellaneous.
-------------
(i) All calculations under this Section 5 shall be made to
the nearest cent or to the nearest one hundredth (1/100) of a share, as the
case may be.
(ii) The holders of at least 50% of the outstanding
Preferred Stock shall have the right to challenge any determination by the
Board of fair value pursuant to this Section 5, in which case such
determination of fair value shall be made by an independent appraiser selected
jointly by the Board and the challenging parties, the cost of such appraisal
to be borne equally by the Corporation and the challenging parties.
(iii) No adjustment in the applicable Conversion Price of
the Series A Preferred, Series B Preferred, Series C Preferred, Series C-1
Preferred, Series D Preferred and Series D-1 Preferred, as the case may be,
need be made if such adjustment would result in a change in such Conversion
Price of less than $0.01. Any adjustment of less than $0.01 which is not made
shall be carried forward and shall be made at the time of and together with
any subsequent adjustment which, on a cumulative basis, amounts to an
adjustment of $0.01 or more in such Conversion Price.
6. Notices of Record Date. In the event that this Corporation shall
----------------------
propose at any time:
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<PAGE>
(a) to declare any dividend or distribution upon its Common
Stock, whether in cash, property, stock or other securities, whether or not a
regular cash dividend and whether or not out of earnings or earned surplus;
(b) to offer for subscription pro rata to the holders of any
class or series of its stock any additional shares of stock of any class or
series or other rights;
(c) to effect any reclassification or recapitalization of its
Common Stock outstanding involving a change in the Common Stock; or
(d) to merge or consolidate with or into any other corporation,
or sell, lease or convey all or substantially all its property or business, or
to liquidate, dissolve or wind up, then, in connection with each such event,
this Corporation shall send to the holders of the Series A Preferred, Series B
Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred and
Series D-1 Preferred:
(i) at least 20 days' prior written notice of the date on
which a record shall be taken for such dividend, distribution or subscription
rights (and specifying the date on which the holders of Common Stock shall be
entitled thereto) or for determining rights to vote in respect of the matters
referred to in (c) and (d) above; and
(ii) in the case of the matters referred to in (c) and (d)
above, at least 20 days' prior written notice of the date when the same shall
take place (and specifying the date on which the holders of Common Stock shall
be entitled to exchange their Common Stock for securities or other property
deliverable upon the occurrence of such event).
Each such written notice shall be delivered personally or given by first
class mail, postage prepaid, addressed to the holders of the Preferred Stock at
the address for each such holder as shown on the books of this Corporation.
7. Protective Provisions. So long as any shares of Series B Preferred
---------------------
or Series C Preferred are outstanding, the Corporation shall not, without first
obtaining the approval of the holders of at least a majority of the then-
outstanding shares of Series A Preferred, Series B Preferred and Series C
Preferred, so long as such shares were issued and outstanding prior to April 30,
1998, voting together as a single class, take any action that:
(a) alters the rights, preferences or privileges of the Preferred
Stock;
(b) creates any new class or series of shares that has a
preference over or is on a parity with the Preferred Stock with respect to
voting, dividends or liquidation preferences;
(c) reclassifies stock into shares having a preference over or on
a parity with the Preferred Stock with respect to voting, dividends or
liquidation preferences;
(d) repurchases, redeems or retires any shares of capital stock
of the Corporation other than pursuant to contractual rights to repurchase
shares of Common Stock held by employees,
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<PAGE>
directors or consultants of the Corporation or its subsidiaries upon
termination of their employment or services or pursuant to the exercise of a
contractual right of first refusal held by the Corporation;
(e) other than in the ordinary course of business, results in the
consolidation or merger with or into any other Corporation or the sale or
other transfer in a single transaction or a series of related transactions of
all or substantially all of the assets of this Corporation, or otherwise
results in the reorganization of this Corporation;
(f) materially alters or changes the strategic direction or
business operations of the Corporation in a manner that is not contemplated by
the Corporation's most recent Board approved operating plan;
(g) increases the authorized number of directors as set forth in
the Bylaws of the Corporation;
(h) amends or repeals any provision of the Corporation's
certificate of incorporation or by-laws;
(i) results in a change in the Company's accounting policies or
in the Company's auditors;
(j) permits a subsidiary of the Corporation to sell stock to a
third party;
(k) results in the dissolution, liquidation or winding up of the
Corporation;
(l) causes aggregate capital expenditures that are not included
in the Corporation's most recent annual operating plan to exceed, in any given
12-month period, $500,000;
(m) results in the acquisition of stock or assets of any other
business for an aggregate consideration in excess of $500,000;
(n) other than in the ordinary course of the Corporation's
business, results in a pledge of any assets of the Corporation or results in a
security interest, lien, or other encumbrance on any assets of the
Corporation; or
(o) results in the issuance of any equity securities of the
Corporation, other than stock options, warrants or other rights to purchase
equity securities approved by the Board of Directors, or the issuance of any
long-term debt.
8. Treatment of Series C Preferred and Series C-1 Preferred. Except as
--------------------------------------------------------
specifically set forth herein, the rights, preferences, privileges and
restrictions of the Series C Preferred and the Series C-1 Preferred shall be
identical in all respects, and any action by the Corporation affecting the
shares of Series C Preferred or the Series C-1 Preferred, including without
limitation, stock dividends, subdivisions, combinations, consolidations,
distributions, reclassifications, exchanges and substitutions, shall affect the
shares of the Series C Preferred and Series C-1 Preferred equally.
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<PAGE>
9. Treatment of Series D Preferred and Series D-1 Preferred. Except as
--------------------------------------------------------
specifically set forth herein, the rights, preferences, privileges and
restrictions of the Series D Preferred and the Series D-1 Preferred shall be
identical in all respects, and any action by the Corporation affecting the
shares of Series D Preferred or the Series D-1 Preferred, including without
limitation, stock dividends, subdivisions, combinations, consolidations,
distributions, reclassifications, exchanges and substitutions, shall affect the
shares of the Series D Preferred and Series D-1 Preferred equally.
10. Treatment of Common Stock and Class B Common. Except as otherwise
--------------------------------------------
set forth herein, the rights, privileges and restrictions of the Common Stock
and the Class B Common shall be identical in all respects, and any action by
the Corporation affecting the Common Stock or Class B Common, including
without limitation, stock dividends, subdivisions, combinations,
consolidations, distributions, reclassifications, exchanges and substitutions,
shall affect the shares of Common Stock and Class B Common equally.
ARTICLE V
The Corporation is to have perpetual existence.
ARTICLE VI
In furtherance and not in limitation of the powers conferred by statute,
the Board of Directors is expressly authorized to make, alter, amend or repeal
the Bylaws of the Corporation.
ARTICLE VII
The number of directors which will constitute the whole Board of
Directors of the Corporation shall be as designated in the Bylaws of the
Corporation.
ARTICLE VIII
The election of directors need not be by written ballot unless the
Bylaws of the Corporation shall so provide.
ARTICLE IX
Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
(subject to any provision contained in the statutes) outside the State of
Delaware at such place or places as may be designated from time to time by the
Board of Directors or in the Bylaws of the Corporation.
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<PAGE>
ARTICLE X
1. To the fullest extent permitted by the Delaware General
Corporation Law as the same exists or as may hereafter be amended, a director
of the Corporation shall not be personally liable to the Corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director.
2. The Corporation shall indemnify to the fullest extent permitted by
law any person made or threatened to be made a party to an action or
proceeding, whether criminal, civil administrative or investigative, by reason
of the fact that he or she, or his or her testator or intestate is or was a
director or officer of the Corporation or any predecessor of the Corporation
or serves or served at any other enterprise as a director, officer or employee
at the request of the Corporation or any predecessor to the Corporation.
3. Neither any amendment nor repeal of this Article, nor the adoption
of any provision of this Corporation's Certificate of Incorporation
inconsistent with this Article, shall eliminate or reduce the effect of this
Article in respect of any matter occurring, or any action or proceeding
accruing or arising or that, but for this Article, would accrue or arise,
prior to such amendment, repeal or adoption of an inconsistent provision.
ARTICLE XI
Except as provided in Article X above, the Corporation reserves the
right to amend, alter, change or repeal any provision contained in this
Certificate of Incorporation, in the manner now or hereafter prescribed by
statute, and all rights conferred upon stockholders herein are granted subject
to this reservation.
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<PAGE>
IN WITNESS WHEREOF, said Corporation has caused this Certificate to be
signed by Robert E. Knowling, Jr., the President and Chief Executive Officer of
the Corporation, and attested by Dhruv Khanna, the Secretary of the Corporation.
The signatures below shall constitute the affirmation and acknowledgment under
penalties of perjury, that the facts herein stated are true.
Dated: December 31, 1998
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ ROBERT E. KNOWLING, JR.
----------------------------
Robert E. Knowling, Jr.
President and Chief
Executive Officer
ATTEST:
/s/ DHRUV KHANNA
- ---------------------------
Dhruv Khanna
Secretary
<PAGE>
EXHIBIT 3.2
COVAD COMMUNICATIONS GROUP, INC.
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
Covad Communications Group, Inc., a Delaware corporation, hereby certifies
as follows:
The Certificate of Incorporation of Covad Communications Group, Inc. (the
"Corporation") was filed in the office of the Secretary of State of the State of
Delaware on July 14, 1997. The Certificate of Incorporation was amended on
February 11, 1998. The Certificate of Incorporation was subsequently amended
and restated on February 23, 1998, May 20, 1998, August 28, 1998 and January 6,
1999. The Certificate of Incorporation is hereby amended and restated pursuant
to Section 242 and Section 245 of the Delaware General Corporation Law. All
amendments to the Certificate of Incorporation reflected herein have been duly
authorized and adopted by the Corporation's Board of Directors and stockholders
in accordance with the provisions of Sections 242 and 245 of the Delaware
General Corporation Law.
This Amended and Restated Certificate of Incorporation restates and
integrates and further amends the Certificate of Incorporation of the
Corporation. The text of the Certificate of Incorporation is amended hereby to
read as herein set forth in full:
ARTICLE I
The name of the corporation is Covad Communications Group, Inc.
ARTICLE II
The address of the Corporation's registered office in the State of Delaware
is Corporation Trust Center, 1209 Orange Street, in the City of Wilmington,
County of New Castle, zip code 19801. The name of its registered agent at such
address is The Corporation Trust Company.
ARTICLE III
The nature of the business or purpose to be conducted or promoted by the
Corporation is to engage in any lawful act or activity for which corporations
may be organized under the General Corporation Law of the State of Delaware.
ARTICLE IV
The Corporation is authorized to issue two classes of shares to be
designated. respectively, "Common Stock" and "Preferred Stock." The number of
shares of Common Stock authorized to be issued is Two Hundred Million
(200,000,000), of which Ten Million (10,000,000) shares are hereby designated as
Class B Common Stock ("Class B Common"). The number of shares of Preferred
<PAGE>
Stock authorized to be issued is Five Million (5,000,000). The Common Stock and
the Preferred Stock shall each have a par value of $.001 per share.
The Board of Directors is authorized, subject to limitations prescribed by
law and the provisions of this Article IV, to provide for the issuance of the
Preferred Stock in series and, by filing a certificate pursuant to the
applicable law of the State of Delaware, to establish from time to time the
number of shares to be included in each such series, and to fix the designation,
powers, preferences and rights of the shares of each such series and the
qualifications, limitations or restrictions thereof.
The authority of the Board with respect to each series shall include, but
not be limited to, determination of the following: (a) the number of shares
constituting that series and the distinctive designation of that series; (b) the
dividend rate on the shares of that series, whether dividends shall be
cumulative, and, if so, from which date or dates, and the relative rights of
priority, if any, of payment of dividends on shares of that series; (c) whether
that series shall have voting rights in addition to the voting rights provided
by law, and, if so, the terms of such voting rights; (d) whether that series
shall have conversion privileges, and, if so, the terms and conditions of such
conversion, including provision for adjustment of the conversion rate in such
events as the Board of Directors shall determine; (e) whether or not the shares
of that series shall be redeemable and, if so, the terms and conditions of such
redemption, including the date or dates upon or after which they shall be
redeemable, and the amount per share payable in case of redemption, which amount
may vary under different conditions and at different redemption dates; (f)
whether that series shall have a sinking fund for the redemption or Purchase of
shares of that series and, if so, the terms and amount of such sinking fund; (g)
the rights of the shares of that series in the event of voluntary or involuntary
liquidation, dissolution or winding up of the Corporation and the relative
rights of priority, if any, of payment of shares of that series; and (h) any
other relative or participating rights, preferences and limitations of that
series.
ARTICLE V
Section 1. Class B Common Stock. Subject to the conversion and voting
rights of the Class B Common described below, the rights (including, but not
limited to, rights to dividends and rights upon liquidation), preferences,
privileges and restrictions of the Common Stock and the Class B Common shall be
identical in all respects, except as follows:
(a) Voting Rights. Holders of Class B Common shall not be entitled to
vote such shares for the election of directors or on any other matter except
changes or amendments to this Article V and except as required by law; provided,
however, that no such change or amendment shall provide additional voting rights
to the holders of Class B Common.
(b) Conversion.
(i) Right to Convert. Each share of Class B Common shall be
convertible, at the option of the holder thereof, at any time one year after the
Original Issuance Date (as defined
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in Section 1(b)(viii)(B) hereof), at the office of the Corporation or any
transfer agent for the Class B Common, into such whole number of shares of
Common Stock as shall be obtained by multiplying the number of shares of Class B
Common being converted by the "Class B Common Conversion Rate" (as hereinafter
defined), so long as, after giving effect to such conversion, the total number
of "Voting Shares" (as defined in Section 1(b)(viii)(C) hereof) held by such
holder, together with all of its "Affiliates" (as defined in Section
1(b)(viii)(A) hereof), shall be less than ten percent (10%) (by voting power) of
the total number of Voting Shares then issued and outstanding. The Class B
Common Conversion Rate shall be one (1) divided by the "Class B Common
Conversion Price" (as hereinafter defined). The Class B Common Conversion Price
shall initially be one (1); provided, however, that such Class B Common
Conversion Price shall be subject to adjustment as set forth in Section 1(b)(v)
hereof. No conversion of shares of Class B Common that would have the effect of
giving the holder, together with all of its Affiliates, an aggregate number of
Voting Shares equal to or greater than ten percent (10%) (by voting power) of
the total number of Voting Shares then issued and outstanding shall be effected
pursuant to this Section 1(b)(i). The holder of any shares of Class B Common
Stock exercising the aforesaid right to convert such shares into shares of
Common Stock shall be entitled to payment of all declared but unpaid dividends,
if any, payable on or with respect to such shares of Class B Common up to and
including the "Conversion Date" (as hereinafter defined)
(ii) Conversion Upon Transfer. Upon any sale, disposition,
assignment or transfer (each, a "Transfer") of any shares of Class B Common by
the holder thereof, after one year from the Original Issuance Date, other than a
Transfer to an Affiliate of such holder, such shares of Class B Common so
Transferred shall, by virtue of, and simultaneously with, the occurrence of the
Transfer, without any action on the part of the transferee, be automatically
converted into such whole number of fully paid and nonassessable shares of
Common Stock as shall be obtained by multiplying the number of shares of Class B
Common so Transferred by the Class B Common Conversion Rate. The holder of any
shares of Class B Common converted into Common Stock pursuant to this Section
1(b)(ii) shall be entitled to payment of declared but unpaid dividends, if any,
payable on or with respect to such shares of Class B Common up to and including
the Conversion Date.
(iii) Mechanics of Conversion. The holder of any shares of Class
B Common may exercise the conversion rights pursuant to Section 1(b)(i) hereof
as to any part thereof by delivering to the Corporation during regular business
hours, at the office of the Corporation or at such other place as may be
designated by the Corporation, the certificate or certificates for the shares to
be converted, duly endorsed or assigned in blank, accompanied by a written
notice stating that the holder elects to convert such shares and stating the
name or names (with address) in which the certificate or certificates for the
shares of Common Stock are to be issued. Conversion shall be deemed to have been
effected (A) with respect to conversion under Section 1(b)(i) hereof, on the
date when the aforesaid delivery is made and (B) with respect to conversion
under Section 1(b)(ii) hereof, on the date of occurrence of the Transfer, and
such date, in either case, is referred to herein as the "Conversion Date". As
promptly as practicable after the Conversion Date, and in the case of Section
1(b)(ii) hereof, upon the delivery to the Corporation during regular business
hours, at the office of the Corporation or at such
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<PAGE>
other place as may be designated by the Corporation or at such other place as
may be designated by the Corporation, of the certificate or certificates for the
shares to be converted, duly endorsed or assigned in blank, the Corporation
shall issue and deliver to or upon the written order of such holder, to the
place designated by such holder, a certificate or certificates for the number of
full shares of Common Stock as provided in Section 1(b)(i) and (ii) hereof, and
a check or cash in payment of all declared but unpaid dividends (to the extent
permissible under law), if any, payable with respect to the shares of Class B
Common so converted up to and including the Conversion Date. The person in whose
name the certificate or certificates for Common Stock are to be issued shall be
deemed to have become a stockholder of record on the applicable Conversion Date
unless the transfer books of the Corporation are closed on that date, in which
event such person shall be deemed to have become a stockholder of record on the
next succeeding date on which the transfer books are open, but the Class B
Common Conversion Rate shall be that in effect on the Conversion Date. Upon
conversion of only a portion of the number of shares covered by a certificate
representing shares of Class B Common surrendered for conversion, the
Corporation shall issue and deliver to or upon the written order of the holder
of the certificate as surrendered for conversion, at the expense of the
Corporation, a new certificate covering the number of shares of Class B Common
representing the unconverted portion of the certificate so surrendered, which
new certificate shall entitle the holder thereof to dividends on the shares of
Class B Common represented thereby to the same extent as if the certificate
theretofore covering such unconverted shares had not been surrendered for
conversion.
(iv) No Fractional Shares. No fractional shares of Common Stock
or scrip shall be issued upon conversion of shares of Class B Common. The number
of full shares of Common Stock issuable upon conversion of Class B Common
surrendered by a holder thereof of Class B Common surrendered by a holder
thereof for conversion shall be computed on the basis of the aggregate number of
shares of Class B Common so surrendered, rounded to the next higher whole
number.
(v) Adjustments to Conversion Price. The Class B Common
Conversion Price shall be subject to adjustment from time to time as follows:
(A) If the number of shares of Common Stock outstanding is
increased by a stock dividend payable in shares of Common Stock or by a
subdivision or split-up of shares of Common Stock, then, following the
record date fixed for the determination of holders of Common Stock entitled
to receive such stock dividend, subdivision or split-up, the Class B Common
Conversion Price shall be appropriately decreased so that the number of
shares of Common Stock issuable on conversion of each share of Class B
Common shall be increased in proportion to such increase in outstanding
shares.
(B) If the number of shares of Common Stock outstanding is
decreased by a combination of the outstanding shares of Common Stock, then,
following the record date for such combination, the Class B Common
Conversion Price shall be appropriately increased so that the number of
shares of Common Stock issuable on conversion of each share of Class B
Common shall be decreased in proportion to such decrease in outstanding
shares.
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(C) In case of any capital reorganization, or any
reclassification of the capital stock of the Corporation (other than a
change in par value or from par value to no par value or from no par value
to par value or as a result of a stock dividend or subdivision, split-up or
combination of shares) or the consolidation or merger of the Corporation
with or into another person (other than a consolidation or merger in which
the Corporation is the continuing corporation and which does not result in
any change in the Common Stock) or of the sale or other disposition of all
or substantially all the properties and assets of the Corporation as an
entirety to any other person, such shares of Class B Common shall after
such reorganization, reclassification, consolidation, merger, sale or other
disposition be convertible into the kind and number of shares of stock or
other securities or property of the Corporation or of the Corporation
resulting from such consolidation or surviving such merger or to which such
properties and assets shall have been sold or otherwise disposed, to which
the holder of the number of shares of Common Stock deliverable (immediately
prior to the time of such reorganization, reclassification, consolidation,
merger, sale or other disposition) upon conversion of such share would have
been entitled upon such reorganization, reclassification, consolidation,
merger, sale or other disposition. The provisions of this Section
1(b)(v)(C) shall similarly apply to successive reorganization,
reclassifications, consolidations, mergers, sales or other dispositions.
(D) In the event the Corporation at any time or from time to time
makes, or fixes a record date for the determination of holders of Common
Stock entitled to receive any distribution payable in securities or assets
of the Corporation other than shares of Common Stock, then, and in each
such event, provision shall be made so that the holders of Class B Common
shall receive upon conversion thereof, in addition to the number of shares
of Common Stock receivable thereupon, the amount of securities or assets of
the Corporation which they would have received had their Class B Common
been converted into Common Stock on the date of such event and had they
thereafter, during the period from the date of such event to and including
the date of conversion, retained such securities or assets receivable by
them as aforesaid during such period, subject to all other adjustments
called for during such period under this paragraph (v).
(E) All calculations under this paragraph (v) shall be made to
the nearest one hundredth (1/100) of a share.
(vi) Reservation of Shares. The Corporation shall at all times
when the Class B Common shall be outstanding, reserve and keep available out of
its authorized but unissued stock, for the purpose of effecting the conversion
of the Class B Common, such number of its duly authorized shares of Common Stock
as shall from time to time be sufficient to effect the conversion of all
outstanding Class B Common; and if at any time the number of authorized but
unissued shares of Common Stock shall not be sufficient to effect the conversion
of all then outstanding shares of Class B Common, the Corporation will take such
corporate action as may, in the opinion of its counsel, be necessary to increase
its authorized but unissued shares of Common Stock to such number of shares as
shall be sufficient for the purpose.
(vii) Certificate as to Adjustments. Upon the occurrence of each
adjustment or readjustment of the Class B Common Conversion Price pursuant to
Section 1(b)(v), the Corporation at its expense shall promptly compute such
adjustment or readjustment in accordance with the terms hereof and furnish to
each holder of Class B Common a certificate setting forth such adjustment or
readjustment and showing in detail the facts upon which such adjustment or
readjustment is based. The Corporation shall, upon the written request at any
time of any holder of Class B Common, furnish or cause to be furnished to such
holder a like certificate setting forth (i) such adjustments and readjustments,
(ii) the Class B Common Conversion Price at the time in effect, and (iii) the
number of shares of Common Stock and the amount, if any, of other property which
at the time would be received upon the conversion of Class B Common.
(viii) Definitions.
(A) "Affiliate" shall mean, as to any person or entity, a
person or entity that, directly or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with,
such person or entity. In addition, with respect to AT&T Venture Fund II, LP,
Special Partners Fund, LP and Special Partners Fund International, LP (the "AT&T
Entities"), only for the purposes of this Certificate of Incorporation, AT&T
Corp., all Affiliates of AT&T Corp., each of the other AT&T Entities and all
owners of equity interests in the AT&T Entities shall be deemed to be Affiliates
of each of the AT&T Entities.
(B) "Original Issuance Date" shall mean, with respect to a
share of Class B Common, the date that the share of the Series C-1 Preferred
Stock or Series D-1 Preferred
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<PAGE>
Stock of the Corporation, as the case may be, from which such share of Class B
Common was previously automatically converted upon the closing of the
Corporation's underwritten initial public offering pursuant to an effective
registration statement under the Securities Act of 1933, as amended, was
originally issued.
(C) "Voting Shares" shall mean any shares of the
Corporation's capital stock entitled to vote in any election of directors of the
Corporation.
ARTICLE VI
The Corporation is to have perpetual existence.
ARTICLE VII
In furtherance and not in limitation of the powers conferred by statute,
the Board of Directors is expressly authorized to make, alter, amend or repeal
the Bylaws of the Corporation.
ARTICLE VIII
The number of directors which will constitute the whole Board of Directors
of the Corporation shall be as designated in the Bylaws of the Corporation.
Effective upon the filing of this Amended and Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware (the "Filing
Date"), the directors shall be divided into three classes, with the term of
office of the first class, which class shall initially consist of two (2)
directors, to expire at the first annual meeting of stockholders held after the
Filing Date; the term of office of the second class, which class shall initially
consist of three (3) directors, to expire at the second annual meeting of
stockholders held after the IPO; the term of office of the third class, which
class shall initially consist of three (3) directors, to expire at the third
annual meeting of stockholders held after the IPO; and thereafter for each such
term to expire at each third succeeding annual meeting of stockholders held
after such election.
In the event of an increase in the authorized number of directors, the
newly created directorship shall be assigned to one of the above-referenced
classes in accordance with resolutions adopted by the board of directors. No
decrease in the authorized number of directors shall have the effect of
shortening the term of any incumbent director.
ARTICLE IX
The election of directors need not be by written ballot unless the Bylaws
of the Corporation shall so provide.
ARTICLE X
Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
(subject to any provision contained in the statutes) outside the State of
Delaware at such place or places as may be designated from time to time by the
Board of Directors or in the Bylaws of the Corporation.
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<PAGE>
ARTICLE XI
1. To the fullest extent permitted by the Delaware General Corporation Law
as the same exists or as may hereafter be amended, a director of the Corporation
shall not be personally liable to the Corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director.
2. The Corporation shall indemnify to the fullest extent permitted by law
any person made or threatened to be made a party to an action or proceeding,
whether criminal, civil administrative or investigative, by reason of the fact
that he or she, or his or her testator or intestate is or was a director or
officer of the Corporation or any predecessor of the Corporation or serves or
served at any other enterprise as a director, officer or employee at the request
of the Corporation or any predecessor to the Corporation.
3. Neither any amendment nor repeal of this Article, nor the adoption of
any provision of this Corporation's Certificate of Incorporation inconsistent
with this Article, shall eliminate or reduce the effect of this Article in
respect of any matter occurring, or any action or proceeding accruing or arising
or that, but for this Article, would accrue or arise, prior to such amendment,
repeal or adoption of an inconsistent provision.
ARTICLE XII
Except as provided in Article XI above, the Corporation reserves the right
to amend, alter, change or repeal any provision contained in this Certificate of
Incorporation, in the manner now or hereafter prescribed by statute, and all
rights conferred upon stockholders herein are granted subject to this
reservation.
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<PAGE>
IN WITNESS WHEREOF, said Corporation has caused this Certificate to be
signed by Robert E. Knowling, Jr., the President and Chief Executive Officer of
the Corporation, and attested by Dhruv Khanna, the Secretary of the Corporation.
The signatures below shall constitute the affirmation and acknowledgment under
penalties of perjury, that the facts herein stated are true.
Dated: January __, 1999
COVAD COMMUNICATIONS GROUP, INC.
By:
----------------------------------------
Robert E. Knowling, Jr.
President and Chief Executive Officer
ATTEST:
- ---------------
Dhruv Khanna
Secretary
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<PAGE>
EXHIBIT 3.4
AMENDED AND RESTATED
--------------------
BYLAWS
------
OF
--
COVAD COMMUNICATIONS GROUP, INC.
--------------------------------
ARTICLE I
CORPORATE OFFICES
-----------------
1.1 REGISTERED OFFICE
-----------------
The registered office of the corporation shall be in the City of
Wilmington, County of New Castle, State of Delaware. The name of the registered
agent of the corporation at such location is The Corporation Trust Company.
1.2 OTHER OFFICES
-------------
The board of directors may at any time establish other offices at any place
or places where the corporation is qualified to do business.
ARTICLE II
MEETINGS OF STOCKHOLDERS
------------------------
2.1 PLACE OF MEETINGS
-----------------
Meetings of stockholders shall be held at any place, within or outside the
State of Delaware, designated by the board of directors. In the absence of any
such designation, stockholders' meetings shall be held at the registered office
of the corporation.
2.2 ANNUAL MEETING
--------------
The annual meeting of stockholders shall be held each year on a date and at
a time designated by the board of directors. At the meeting, directors shall be
elected and any other proper business may be transacted.
<PAGE>
To be properly brought before any annual or special meeting, business must
be (a) specified in the notice of meeting (or any supplement thereto) given by
or at the direction of the Board of Directors, (b) otherwise properly brought
before the meeting by or at the direction of the Board of Directors, or (c)
otherwise properly brought before the meeting by a stockholder. For business to
be properly brought before the meeting by a stockholder, the secretary of the
corporation must have received notice in writing from the stockholder not less
than thirty (30) days nor more than sixty (60) days prior to the meeting;
provided, however, that if less than thirty-five (35) days' notice of the
meeting is given to stockholders, such notice shall have been received by the
secretary not later than the close of business on the seventh (7th) day
following the day on which the notice of meeting was mailed. Such written
notice to the secretary shall set forth, as to each matter the stockholder
proposes to bring before the annual meeting: (i) a brief description of the
business, (ii) the name and address, as they appear on the corporation's books,
of the stockholder proposing such business, (iii) the number of shares of stock
of the corporation beneficially owned by such stockholder, and (iv) any material
interest of such stockholder in such business. Notwithstanding any provision in
the bylaws to the contrary, no business shall be conducted at any annual or
special meeting except in accordance with the procedures set forth in this
Section 2.2
2.3 SPECIAL MEETING
---------------
A special meeting of the stockholders may be called only by the Board of
Directors of the corporation pursuant to a resolution adopted by a majority of
the total number of directors (whether or not there exist any vacancies in
previously authorized directorships at the time any such resolution is presented
to the Board for adoption), for the purpose of taking any action permitted to be
taken by the stockholders under the Delaware General Corporation Law and the
Certificate of Incorporation, by a committee of the Board of Directors which has
been duly designated by the Board of Directors and whose powers and authority,
as expressly provided in a resolution of the Board of Directors, include the
power to call such meetings or by the chairman of the board, the president, or
the chief executive officer.
2.4 NOTICE OF STOCKHOLDERS' MEETINGS
--------------------------------
All notices of meetings with stockholders shall be in writing and shall be
sent or otherwise given in accordance with Section 2.5 of these bylaws not less
than ten (10) nor more than sixty (60) days before the date of the meeting to
each stockholder entitled to vote at such meeting. The notice shall specify the
place, date, and hour of the meeting, and, in the case of a special meeting, the
purpose or purposes for which the meeting is called.
2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE
--------------------------------------------
Written notice of any meeting of stockholders, if mailed, is given when
deposited in the United States mail, postage prepaid, directed to the
stockholder at his address as it appears on the records of the corporation. An
affidavit of the secretary or an assistant secretary or of the transfer agent of
the corporation that the notice has been given shall, in the absence of fraud,
be prima facie evidence of the facts stated therein. If mailed, such notice
shall be deemed to be given when
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<PAGE>
deposited in the mail, postage prepaid, directed to the stockholder at his
address as it appears on the records of the corporation.
2.6 QUORUM
------
The holders of a majority of the stock issued and outstanding and entitled
to vote thereat, present in person or represented by proxy, shall constitute a
quorum at all meetings of the stockholders for the transaction of business
except as otherwise provided by statute or by the certificate of incorporation.
If, however, such quorum is not present or represented at any meeting of the
stockholders, then the stockholders entitled to vote thereat, present in person
or represented by proxy, shall have power to adjourn the meeting from time to
time, without notice other than announcement at the meeting, until a quorum is
present or represented. At such adjourned meeting at which a quorum is present
or represented, any business may be transacted that might have been transacted
at the meeting as originally noticed.
2.7 ADJOURNED MEETING; NOTICE
-------------------------
When a meeting is adjourned to another time or place, unless these bylaws
otherwise require, notice need not be given of the adjourned meeting if the time
and place thereof are announced at the meeting at which the adjournment is
taken. At the adjourned meeting the corporation may transact any business that
might have been transacted at the original meeting. If the adjournment is for
more than thirty (30) days, or if after the adjournment a new record date is
fixed for the adjourned meeting, a notice of the adjourned meeting shall be
given to each stockholder of record entitled to vote at the meeting.
2.8 VOTING
------
The stockholders entitled to vote at any meeting of stockholders shall be
determined in accordance with the provisions of Section 2.11 of these bylaws,
subject to the provisions of Sections 217 and 218 of the General Corporation Law
of Delaware (relating to voting rights of fiduciaries, pledgors and joint owners
of stock and to voting trusts and other voting agreements).
Except as provided in the last paragraph of this Section 2.8, or as may be
otherwise provided in the certificate of incorporation, each stockholder shall
be entitled to one vote for each share of capital stock held by such
stockholder.
2.9 WAIVER OF NOTICE
----------------
Whenever notice is required to be given under any provision of the General
Corporation Law of Delaware or of the certificate of incorporation or these
bylaws, a written waiver thereof, signed by the person entitled to notice,
whether before or after the time stated therein, shall be deemed equivalent to
notice. Attendance of a person at a meeting shall constitute a waiver of notice
of such meeting, except when the person attends a meeting for the express
purpose of objecting, at the
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<PAGE>
beginning of the meeting, to the transaction of any business because the meeting
is not lawfully called or convened. Neither the business to be transacted at,
nor the purpose of, any regular or special meeting of the stockholders need be
specified in any written waiver of notice unless so required by the certificate
of incorporation or these bylaws.
2.10 STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING
-------------------------------------------------------
Unless otherwise provided in the certificate of incorporation, any action
required by this chapter to be taken at any annual or special meeting of
stockholders of a corporation, or any action that may be taken at any annual or
special meeting of such stockholders, may be taken without a meeting, without
prior notice, and without a vote if a consent in writing, setting forth the
action so taken, is signed by the holders of outstanding stock having not less
than the minimum number of votes that would be necessary to authorize or take
such action at a meeting at which all shares entitled to vote thereon were
present and voted.
Prompt notice of the taking of the corporate action without a meeting by
less than unanimous written consent shall be given to those stockholders who
have not consented in writing. If the action which is consented to is such as
would have required the filing of a certificate under any section of the General
Corporation Law of Delaware if such action had been voted on by stockholders at
a meeting thereof, then the certificate filed under such section shall state, in
lieu of any statement required by such section concerning any vote of
stockholders, that written notice and written consent have been given as
provided in Section 228 of the General Corporation Law of Delaware.
2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS
-----------------------------------------------------------
In order that the corporation may determine the stockholders entitled to
notice of or to vote at any meeting of stockholders or any adjournment thereof,
or entitled to express consent to corporate action in writing without a meeting,
or entitled to receive payment of any dividend or other distribution or
allotment of any rights, or entitled to exercise any rights in respect of any
change, conversion or exchange of stock or for the purpose of any other lawful
action, the board of directors may fix, in advance, a record date, which shall
not be more than sixty (60) nor less than ten (10) days before the date of such
meeting, nor more than sixty (60) days prior to any other action.
If the board of directors does not so fix a record date:
(i) The record date for determining stockholders entitled to notice
of or to vote at a meeting of stockholders shall be at the close of business on
the day next preceding the day on which notice is given, or, if notice is
waived, at the close of business on the day next preceding the day on which the
meeting is held.
(ii) The record date for determining stockholders entitled to express
consent to corporate action in writing without a meeting, when no prior action
by the board of directors is necessary, shall be the day on which the first
written consent is expressed.
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<PAGE>
(iii) The record date for determining stockholders for any other
purpose shall be at the close of business on the day on which the board of
directors adopts the resolution relating thereto.
A determination of stockholders of record entitled to notice of or to vote
at a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the board of directors may fix a new record date for the
adjourned meeting.
2.12 PROXIES
-------
Each stockholder entitled to vote at a meeting of stockholders or to
express consent or dissent to corporate action in writing without a meeting may
authorize another person or persons to act for him by a written proxy, signed by
the stockholder and filed with the secretary of the corporation, but no such
proxy shall be voted or acted upon after three (3) years from its date, unless
the proxy provides for a longer period. A proxy shall be deemed signed if the
stockholder's name is placed on the proxy (whether by manual signature,
typewriting, telegraphic transmission or otherwise) by the stockholder or the
stockholder's attorney-in-fact. The revocability of a proxy that states on its
face that it is irrevocable shall be governed by the provisions of Section
212(c) of the General Corporation Law of Delaware.
2.13 LIST OF STOCKHOLDERS ENTITLED TO VOTE
-------------------------------------
The officer who has charge of the stock ledger of a corporation shall
prepare and make, at least ten (10) days before every meeting of stockholders, a
complete list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open
to the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period of at least ten (10) days prior to
the meeting, either at a place within the city where the meeting is to be held,
which place shall be specified in the notice of the meeting, or, if not so
specified, at the place where the meeting is to be held. The list shall also be
produced and kept at the time and place of the meeting during the whole time
thereof, and may be inspected by any stockholder who is present.
ARTICLE III
DIRECTORS
---------
3.1 POWERS
------
Subject to the provisions of the General Corporation Law of Delaware and
any limitations in the certificate of incorporation or these bylaws relating to
action required to be approved by the stockholders or by the outstanding shares,
the business and affairs of the corporation shall be
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<PAGE>
managed and all corporate powers shall be exercised by or under the direction of
the board of directors.
3.2 NUMBER OF DIRECTORS
-------------------
The authorized number of directors shall be not less than five (5) nor more
than nine (9). The exact number of directors shall be eight (8) until changed,
within the limits specified above, by a bylaw amending this Section 3.2, duly
adopted by the board of directors or by the stockholders. The indefinite number
of directors may be changed, or a definite number may be fixed without provision
for an indefinite number, by a duly adopted admendment to the certificate of
incorporation or by an amendment to this bylaw adopted by the vote or written
consent of the holders of a majority of the stock issued and outstanding and
entitled to vote or by resolution of a majority of the stock issued and
outstanding and entitled to vote or by resolution of a majority of the board of
directors. Effective upon the filing of an Amended and Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware following the
closing of the corporation's initial public offering of its Common Stock (the
"IPO"), the directors shall be divided into three classes, with the term of
office of the first class, which class shall initially consist of two (2)
directors, to expire at the first annual meeting of stockholders held after
the IPO; the term of office of the second class, which class shall initially
consist of three (3) directors, to expire at the second annual meeting of
stockholders held after the IPO; the term of office of the third class, which
class shall initially consist of three (3) directors, to expire at the third
annual meeting of stockholders held after the IPO; and thereafter for each
such term to expire at each third succeeding annual meeting of stockholders
held after such election.
In the event of an increase in the authorized number of directors, the
newly created directorship shall be assigned to one of the above-referenced
classes in accordance with resolutions adopted by the board of directors. No
decrease in the authorized number of directors shall have the effect of
shortening the term of any incumbent director.
No reduction of the authorized number of directors shall have the effect of
removing any director before that director's term of office expires.
Nominations for election to the Board of Directors of the corporation at
any annual or special meeting of stockholders may be made by the Board or on
behalf of the Board by a nominating committee appointed by the Board, or by any
stockholder of the corporation entitled to vote for the election of directors at
such meeting. Such nominations, other than those made by or on behalf of the
Board, shall be made by notice in writing received by the secretary of the
corporation not less than thirty (30) days nor more than sixty (60) days prior
to the date of the annual meeting; provided, however, that if less than thirty-
five (35) days notice of the meeting is given to stockholders, such nomination
shall have been received by the secretary not later than the close of business
on the seventh (7th) day following the day on which the notice was mailed. Such
notice shall set forth (i) the name and address of the stockholder who intends
to make the nomination; (ii) a representation that the nominating stockholder is
a holder of record of stock of the corporation entitled to vote at such meeting
and intends to appear in person or by proxy at the meeting and nominate the
person or persons specified in the notice; (iii) the number of shares of stock
held beneficially and of record by
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<PAGE>
the nominating stockholder; (iv) the name, age, business address and, if known,
residence address of each nominee proposed in such notice; (v) the principal
occupation or employment of each such nominee; (vi) the number of shares of
stock of the corporation beneficially owned by each such nominee; (vii) a
description of all arrangements or understandings between the nominating
stockholder and each nominee and any other person or persons (naming such person
or persons) pursuant to which the nomination or nominations are to be made by
the nominating stockholder; (viii) any other information concerning each nominee
that must be disclosed of nominees in proxy solicitations pursuant to Regulation
14A under the Securities Exchange Act of 1934; and (ix) the consent of each such
nominee to serve as a director of the corporation if so elected.
The chairman of the annual or special meeting may, if the facts warrant,
determine and declare to the meeting that a nomination was not made in
accordance with the foregoing procedure. If such determination and declaration
is made, the defective nomination shall be disregarded.
3.3 ELECTION AND TERM OF OFFICE OF DIRECTORS
----------------------------------------
Except as provided in Section 3.4 of these bylaws, directors shall be
elected at each annual meeting of stockholders to hold office as provided in
Section 3.2 of these bylaws. Each director, including a director elected or
appointed to fill a vacancy, shall hold office until the expiration of the term
for which elected and until a successor has been elected and qualified.
Elections of directors need not be by written ballot.
3.4 RESIGNATION AND VACANCIES
-------------------------
Any director may resign at any time upon written notice to the corporation.
When one or more directors so resigns and the resignation is effective at a
future date, a majority of the directors then in office, including those who
have so resigned, shall have power to fill such vacancy or vacancies, the vote
thereon to take effect when such resignation or resignations shall become effec
tive, and each director so chosen shall hold office as provided in this section
in the filling of other vacancies.
Unless otherwise provided in the certificate of incorporation or these
bylaws:
(i) Vacancies and newly created directorships resulting from any
increase in the authorized number of directors elected by all of the
stockholders having the right to vote as a single class may be filled by a
majority of the directors then in office, although less than a quorum, or by a
sole remaining director.
(ii) Whenever the holders of any class or classes of stock or series
thereof are entitled to elect one or more directors by the provisions of the
certificate of incorporation, vacancies and newly created directorships of such
class or classes or series may be filled by a majority of the directors elected
by such class or classes or series thereof then in office, or by a sole
remaining director so elected.
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<PAGE>
If at any time, by reason of death or resignation or other cause, the
corporation should have no directors in office, then any officer or any
stockholder or an executor, administrator, trustee or guardian of a stockholder,
or other fiduciary entrusted with like responsibility for the person or estate
of a stockholder, may call a special meeting of stockholders in accordance with
the provisions of the certificate of incorporation or these bylaws, or may apply
to the Court of Chancery for a decree summarily ordering an election as provided
in Section 211 of the General Corporation Law of Delaware.
If, at the time of filling any vacancy or any newly created directorship,
the directors then in office constitute less than a majority of the whole board
(as constituted immediately prior to any such increase), then the Court of
Chancery may, upon application of any stockholder or stockholders holding at
least ten (10) percent of the total number of the shares at the time outstanding
having the right to vote for such directors, summarily order an election to be
held to fill any such vacancies or newly created directorships, or to replace
the directors chosen by the directors then in office as aforesaid, which
election shall be governed by the provisions of Section 211 of the General
Corporation Law of Delaware as far as applicable.
Any and all directors may be removed without cause if the removal is
approved by the affirmative vote of a majority of the outstanding shares of the
corporation entitled to vote. Such approval shall include the affirmative vote
of a majority of the outstanding shares of each class and series entitled to
vote as a class or series on the subject matter being voted upon and shall also
include the affirmative vote of such greater proportion (including all) of the
outstanding shares of any class or series if such greater proportion is required
by the corporation's certificate of incorporation or by applicable laws.
3.5 PLACE OF MEETINGS; MEETINGS BY TELEPHONE
----------------------------------------
The board of directors of the corporation may hold meetings, both regular
and special, either within or outside the State of Delaware.
Unless otherwise restricted by the certificate of incorporation or these
bylaws, members of the board of directors, or any committee designated by the
board of directors, may participate in a meeting of the board of directors, or
any committee, by means of conference telephone or similar communications
equipment by means of which all persons participating in the meeting can hear
each other, and such participation in a meeting shall constitute presence in
person at the meeting.
3.6 FIRST MEETINGS
--------------
The first meeting of each newly elected board of directors shall be held at
such time and place as shall be fixed by the vote of the stockholders at the
annual meeting and no notice of such meeting shall be necessary to the newly
elected directors in order legally to constitute the meeting, provided a quorum
shall be present. In the event of the failure of the stockholders to fix the
time or place of such first meeting of the newly elected board of directors, or
in the event such meeting is not held at the time and place so fixed by the
stockholders, the meeting may be held at such time and
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<PAGE>
place as shall be specified in a notice given as hereinafter provided for
special meetings of the board of directors, or as shall be specified in a
written waiver signed by all of the directors.
3.7 REGULAR MEETINGS
----------------
Regular meetings of the board of directors may be held without notice at
such time and at such place as shall from time to time be determined by the
board.
3.8 SPECIAL MEETINGS; NOTICE
------------------------
Special meetings of the board may be called by the president on three (3)
days' notice to each director, either personally or by mail, telegram, telex, or
telephone; special meetings shall be called by the president or secretary in
like manner and on like notice on the written request of two (2) directors
unless the board consists of only one (1) director, in which case special
meetings shall be called by the president or secretary in like manner and on
like notice on the written request of the sole director.
3.9 QUORUM
------
At all meetings of the board of directors, a majority of the authorized
number of directors shall constitute a quorum for the transaction of business
and the act of a majority of the directors present at any meeting at which there
is a quorum shall be the act of the board of directors, except as may be
otherwise specifically provided by statute or by the certificate of
incorporation. If a quorum is not present at any meeting of the board of
directors, then the directors present thereat may adjourn the meeting from time
to time, without notice other than announcement at the meeting, until a quorum
is present.
3.10 WAIVER OF NOTICE
----------------
Whenever notice is required to be given under any provision of the General
Corporation Law of Delaware or of the certificate of incorporation or these
bylaws, a written waiver thereof, signed by the person entitled to notice,
whether before or after the time stated therein, shall be deemed equivalent to
notice. Attendance of a person at a meeting shall constitute a waiver of notice
of such meeting, except when the person attends a meeting for the express
purpose of objecting, at the beginning of the meeting, to the transaction of any
business because the meeting is not lawfully called or convened. Neither the
business to be transacted at, nor the purpose of, any regular or special meeting
of the directors, or members of a committee of directors, need be specified in
any written waiver of notice unless so required by the certificate of
incorporation or these bylaws.
3.11 ADJOURNED MEETING; NOTICE
-------------------------
If a quorum is not present at any meeting of the board of directors, then
the directors present thereat may adjourn the meeting from time to time, without
notice other than announcement at the meeting, until a quorum is present.
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3.12 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING
-------------------------------------------------
Unless otherwise restricted by the certificate of incorporation or these
bylaws, any action required or permitted to be taken at any meeting of the board
of directors, or of any committee thereof, may be taken without a meeting if all
members of the board or committee, as the case may be, consent thereto in
writing and the writing or writings are filed with the minutes of proceedings of
the board or committee.
3.13 FEES AND COMPENSATION OF DIRECTORS
----------------------------------
Unless otherwise restricted by the certificate of incorporation or these
bylaws, the board of directors shall have the authority to fix the compensation
of directors.
3.14 APPROVAL OF LOANS TO OFFICERS
-----------------------------
The corporation may lend money to, or guarantee any obligation of, or
otherwise assist any officer or other employee of the corporation or of its
subsidiary, including any officer or employee who is a director of the
corporation or its subsidiary, whenever, in the judgment of the directors, such
loan, guaranty or assistance may reasonably be expected to benefit the
corporation. The loan, guaranty or other assistance may be with or without
interest and may be unsecured, or secured in such manner as the board of
directors shall approve, including, without limitation, a pledge of shares of
stock of the corporation. Nothing in this section contained shall be deemed to
deny, limit or restrict the powers of guaranty or warranty of the corporation at
common law or under any statute.
ARTICLE IV
COMMITTEES
----------
4.1 COMMITTEES OF DIRECTORS
-----------------------
The board of directors may, by resolution passed by a majority of the whole
board, designate one or more committees, with each committee to consist of one
or more of the directors of the corpo ration. The board may designate one or
more directors as alternate members of any committee, who may replace any absent
or disqualified member at any meeting of the committee. In the absence or
disqualification of a member of a committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not he or
they constitute a quorum, may unanimously appoint another member of the board of
directors to act at the meeting in the place of any such absent or disqualified
member. Any such committee, to the extent provided in the resolution of the
board of directors or in the bylaws of the corporation, shall have and may
exercise all the powers and authority of the board of directors in the
management of the business and affairs of the corporation, and may authorize the
seal of the corporation to be affixed to all papers that may require it; but no
such committee shall have the power or authority to (i) amend the certificate of
incorporation (except
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that a committee may, to the extent authorized in the resolution or resolutions
providing for the issuance of shares of stock adopted by the board of directors
as provided in Section 151(a) of the General Corporation Law of Delaware, fix
any of the preferences or rights of such shares relating to dividends,
redemption, dissolution, any distribution of assets of the corporation or the
conversion into, or the exchange of such shares for, shares of any other class
or classes or any other series of the same or any other class or classes of
stock of the corporation), (ii) adopt an agreement of merger or consolidation
under Sections 251 or 252 of the General Corporation Law of Delaware, (iii)
recommend to the stockholders the sale, lease or exchange of all or
substantially all of the corporation's property and assets, (iv) recommend to
the stockholders a dissolution of the corporation or a revocation of a
dissolution, or (v) amend the bylaws of the corporation; and, unless the board
resolution establishing the committee, the bylaws or the certificate of
incorporation expressly so provide, no such committee shall have the power or
authority to declare a dividend, to authorize the issuance of stock, or to adopt
a certificate of ownership and merger pursuant to Section 253 of the General
Corporation Law of Delaware.
4.2 COMMITTEE MINUTES
-----------------
Each committee shall keep regular minutes of its meetings and report the
same to the board of directors when required.
4.3 MEETINGS AND ACTION OF COMMITTEES
---------------------------------
Meetings and actions of committees shall be governed by, and held and taken
in accordance with, the provisions of Article III of these bylaws, Section 3.5
(place of meetings and meetings by telephone), Section 3.7 (regular meetings),
Section 3.8 (special meetings and notice), Section 3.9 (quorum), Section 3.10
(waiver of notice), Section 3.11 (adjournment and notice of adjournment), and
Section 3.12 (action without a meeting), with such changes in the context of
those bylaws as are necessary to substitute the committee and its members for
the board of directors and its members; provided, however, that the time of
regular meetings of committees may also be called by resolution of the board of
directors and that notice of special meetings of committees shall also be given
to all alternate members, who shall have the right to attend all meetings of the
committee. The board of directors may adopt rules for the government of any
committee not inconsistent with the provisions of these bylaws.
ARTICLE V
OFFICERS
--------
5.1 OFFICERS
--------
The officers of the corporation shall be a president, one or more vice
presidents, a secretary, and a treasurer. The corporation may also have, at the
discretion of the board of directors, a
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chairman of the board, one or more assistant vice presidents, assistant
secretaries, assistant treasurers, and any such other officers as may be
appointed in accordance with the provisions of Section 5.3 of these bylaws. Any
number of offices may be held by the same person.
5.2 ELECTION OF OFFICERS
--------------------
The officers of the corporation, except such officers as may be appointed
in accordance with the provisions of Sections 5.3 or 5.5 of these bylaws, shall
be chosen by the board of directors, subject to the rights, if any, of an
officer under any contract of employment.
5.3 SUBORDINATE OFFICERS
--------------------
The board of directors may appoint, or empower the president to appoint,
such other officers and agents as the business of the corporation may require,
each of whom shall hold office for such period, have such authority, and perform
such duties as are provided in these bylaws or as the board of directors may
from time to time determine.
5.4 REMOVAL AND RESIGNATION OF OFFICERS
-----------------------------------
Subject to the rights, if any, of an officer under any contract of
employment, any officer may be removed, either with or without cause, by an
affirmative vote of the majority of the board of directors at any regular or
special meeting of the board or, except in the case of an officer chosen by the
board of directors, by any officer upon whom such power of removal may be
conferred by the board of directors.
Any officer may resign at any time by giving written notice to the
corporation. Any resignation shall take effect at the date of the receipt of
that notice or at any later time specified in that notice; and, unless otherwise
specified in that notice, the acceptance of the resignation shall not be
necessary to make it effective. Any resignation is without prejudice to the
rights, if any, of the corporation under any contract to which the officer is a
party.
5.5 VACANCIES IN OFFICES
--------------------
Any vacancy occurring in any office of the corporation shall be filled by
the board of directors.
5.6 AUTHORITY AND DUTIES OF OFFICERS
--------------------------------
In addition to the foregoing authority and duties, all officers of the
corporation shall respectively have such authority and perform such duties in
the management of the business of the corporation as may be designated from time
to time by the board of directors or the stockholders.
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5.7 LIMITATIONS ON POWERS AND DUTIES OF OFFICERS
--------------------------------------------
No officer shall take any action, enter into any agreement, make any
representation or, by purposeful inaction, effect any of the actions or
decisions which the Board of Directors is prohibited or restricted from enacting
pursuant to these Bylaws or the certificate of incorporation and their further
amendments.
ARTICLE VI
INDEMNITY
---------
6.1 INDEMNIFICATION OF DIRECTORS AND OFFICERS
-----------------------------------------
The corporation shall, to the maximum extent and in the manner permitted by
the General Corporation Law of Delaware, indemnify each of its directors and
officers against expenses (including attorneys' fees), judgments, fines,
settlements, and other amounts actually and reasonably incurred in connection
with any proceeding, arising by reason of the fact that such person is or was an
agent of the corporation. For purposes of this Section 6.1, a "director" or
"officer" of the corporation includes any person (i) who is or was a director or
officer of the corporation, (ii) who is or was serving at the request of the
corporation as a director or officer of another corporation, partnership, joint
venture, trust or other enterprise, or (iii) who was a director or officer of a
corporation which was a predecessor corporation of the corporation or of another
enterprise at the request of such predecessor corporation.
6.2 INDEMNIFICATION OF OTHERS
-------------------------
The corporation shall have the power, to the extent and in the manner
permitted by the General Corporation Law of Delaware, to indemnify each of its
employees and agents (other than directors and officers) against expenses
(including attorneys' fees), judgments, fines, settlements, and other amounts
actually and reasonably incurred in connection with any proceeding, arising by
reason of the fact that such person is or was an agent of the corporation. For
purposes of this Section 6.2, an "employee" or "agent" of the corporation (other
than a director or officer) includes any person (i) who is or was an employee or
agent of the corporation, (ii) who is or was serving at the request of the
corporation as an employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, or (iii) who was an employee or agent of a
corporation which was a predecessor corporation of the corporation or of another
enterprise at the request of such predecessor corporation.
6.3 INSURANCE
---------
The corporation may purchase and maintain insurance on behalf of any person
who is or was a director, officer, employee or agent of the corporation, or is
or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint
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venture, trust or other enterprise against any liability asserted against him
and incurred by him in any such capacity, or arising out of his status as such,
whether or not the corporation would have the power to indemnify him against
such liability under the provisions of the General Corporation Law of Delaware.
6.4 NON-EXCLUSIVITY OF RIGHTS
-------------------------
The rights conferred on any person by this Article 6 shall not be exclusive
of any other rights which such person may have or hereafter acquire under any
statute, provision of the certificate of incorporation, these by-laws,
agreement, vote of stockholders or disinterested directors or otherwise.
6.5 OTHER INDEMNIFICATION
---------------------
The corporation's obligation, if any, to indemnify any person who was or is
serving at its request as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, enterprise or non-profit entity
shall be reduced by any amount such person may collect as indemnification from
such other corporation, partnership, joint venture, trust, enterprise or non-
profit enterprise.
6.6 AMENDMENT OR REPEAL
-------------------
Any repeal or modification of the foregoing provisions of this Article 6
shall not adversely affect any right or protection hereunder of any person in
respect of any act or omission occurring prior to the time of such repeal or
modification.
ARTICLE VII
RECORDS AND REPORTS
-------------------
7.1 MAINTENANCE AND INSPECTION OF RECORDS
-------------------------------------
The corporation shall, either at its principal executive office or at such
place or places as designated by the board of directors, keep a record of its
shareholders listing their names and addresses and the number and class of
shares held by each shareholder, a copy of these bylaws as amended to date,
accounting books, and other records.
Any stockholder of record, in person or by attorney or other agent, shall,
upon written demand under oath stating the purpose thereof, have the right
during the usual hours for business to inspect for any proper purpose the
corporation's stock ledger, a list of its stockholders, and its other books and
records and to make copies or extracts therefrom. A proper purpose shall mean a
purpose reasonably related to such person's interest as a stockholder. In every
instance where an attorney or
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other agent is the person who seeks the right to inspection, the demand under
oath shall be accompanied by a power of attorney or such other writing that
authorizes the attorney or other agent to so act on behalf of the stockholder.
The demand under oath shall be directed to the corporation at its registered
office in Delaware or at its principal place of business.
The officer who has charge of the stock ledger of a corporation shall
prepare and make, at least ten (10) days before every meeting of stockholders, a
complete list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open
to the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period of at least ten (10) days prior to
the meeting, either at a place within the city where the meeting is to be held,
which place shall be specified in the notice of the meeting, or, if not so
specified, at the place where the meeting is to be held. The list shall also be
produced and kept at the time and place of the meeting during the whole time
thereof, and may be inspected by any stockholder who is present.
7.2 INSPECTION BY DIRECTORS
-----------------------
Any director shall have the right to examine the corporation's stock
ledger, a list of its stockholders, and its other books and records for a
purpose reasonably related to his position as a director. The Court of Chancery
is hereby vested with the exclusive jurisdiction to determine whether a director
is entitled to the inspection sought. The Court may summarily order the
corporation to permit the director to inspect any and all books and records, the
stock ledger, and the stock list and to make copies or extracts therefrom. The
Court may, in its discretion, prescribe any limitations or conditions with
reference to the inspection, or award such other and further relief as the Court
may deem just and proper.
7.3 REPRESENTATION OF SHARES OF OTHER CORPORATIONS
----------------------------------------------
The chairman of the board, the president, any vice president, the
treasurer, the secretary or assistant secretary of this corporation, or any
other person authorized by the board of directors or the president or a vice
president, is authorized to vote, represent, and exercise on behalf of this
corporation all rights incident to any and all shares of any other corporation
or corporations standing in the name of this corporation. The authority granted
herein may be exercised either by such person directly or by any other person
authorized to do so by proxy or power of attorney duly executed by such person
having the authority.
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ARTICLE VII
GENERAL MATTERS
---------------
8.1 CHECKS
------
From time to time, the board of directors shall determine by resolution
which person or persons may sign or endorse all checks, drafts, other orders for
payment of money, notes or other evidences of indebtedness that are issued in
the name of or payable to the corporation, and only the persons so authorized
shall sign or endorse those instruments.
8.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS
------------------------------------------------
The board of directors, except as otherwise provided in these bylaws, may
authorize any officer or officers, or agent or agents, to enter into any
contract or execute any instrument in the name of and on behalf of the
corporation; such authority may be general or confined to specific instances.
Unless so authorized or ratified by the board of directors or within the agency
power of an officer, no officer, agent or employee shall have any power or
authority to bind the corporation by any contract or engagement or to pledge its
credit or to render it liable for any purpose or for any amount.
8.3 STOCK CERTIFICATES; PARTLY PAID SHARES
--------------------------------------
The shares of a corporation shall be represented by certificates, provided
that the board of directors of the corporation may provide by resolution or
resolutions that some or all of any or all classes or series of its stock shall
be uncertificated shares. Any such resolution shall not apply to shares
represented by a certificate until such certificate is surrendered to the
corporation. Notwithstanding the adoption of such a resolution by the board of
directors, every holder of stock represented by certificates and upon request
every holder of uncertificated shares shall be entitled to have a certificate
signed by, or in the name of the corporation by the chairman or vice-chairman of
the board of directors, or the president or vice-president, and by the treasurer
or an assistant treasurer, or the secretary or an assistant secretary of such
corporation representing the number of shares registered in certificate form.
Any or all of the signatures on the certificate may be a facsimile. In case any
officer, transfer agent or registrar who has signed or whose facsimile signature
has been placed upon a certificate has ceased to be such officer, transfer agent
or registrar before such certificate is issued, it may be issued by the
corporation with the same effect as if he were such officer, transfer agent or
registrar at the date of issue.
The corporation may issue the whole or any part of its shares as partly
paid and subject to call for the remainder of the consideration to be paid
therefor. Upon the face or back of each stock certificate issued to represent
any such partly paid shares, upon the books and records of the corporation in
the case of uncertificated partly paid shares, the total amount of the
consideration to be paid therefor and the amount paid thereon shall be stated.
Upon the declaration of any dividend
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on fully paid shares, the corporation shall declare a dividend upon partly paid
shares of the same class, but only upon the basis of the percentage of the
consideration actually paid thereon.
8.4 SPECIAL DESIGNATION ON CERTIFICATES
-----------------------------------
If the corporation is authorized to issue more than one class of stock or
more than one series of any class, then the powers, the designations, the
preferences, and the relative, participating, optional or other special rights
of each class of stock or series thereof and the qualifications, limitations or
restrictions of such preferences and/or rights shall be set forth in full or
summarized on the face or back of the certificate that the corporation shall
issue to represent such class or series of stock; provided, however, that,
except as otherwise provided in Section 202 of the General Corporation Law of
Delaware, in lieu of the foregoing requirements there may be set forth on the
face or back of the certificate that the corporation shall issue to represent
such class or series of stock a statement that the corporation will furnish
without charge to each stockholder who so requests the powers, the designations,
the preferences, and the relative, participating, optional or other special
rights of each class of stock or series thereof and the qualifications,
limitations or restrictions of such preferences and/or rights.
8.5 LOST CERTIFICATES
-----------------
Except as provided in this Section 8.5, no new certificates for shares
shall be issued to replace a previously issued certificate unless the latter is
surrendered to the corporation and canceled at the same time. The corporation
may issue a new certificate of stock or uncertificated shares in the place of
any certificate theretofore issued by it, alleged to have been lost, stolen or
destroyed, and the corporation may require the owner of the lost, stolen or
destroyed certificate, or his legal represen tative, to give the corporation a
bond sufficient to indemnify it against any claim that may be made against it on
account of the alleged loss, theft or destruction of any such certificate or the
issuance of such new certificate or uncertificated shares.
8.6 CONSTRUCTION; DEFINITIONS
-------------------------
Unless the context requires otherwise, the general provisions, rules of
construction, and definitions in the Delaware General Corporation Law shall
govern the construction of these bylaws. Without limiting the generality of this
provision, the singular number includes the plural, the plural number includes
the singular, and the term "person" includes both a corporation and a natural
person.
8.7 DIVIDENDS
---------
The directors of the corporation, subject to any restrictions contained in
the certificate of incorporation, may declare and pay dividends upon the shares
of its capital stock pursuant to the General Corporation Law of Delaware.
Dividends may be paid in cash, in property, or in shares of the corporation's
capital stock.
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The directors of the corporation may set apart out of any of the funds of
the corporation available for dividends a reserve or reserves for any proper
purpose and may abolish any such reserve. Such purposes shall include but not be
limited to equalizing dividends, repairing or maintaining any property of the
corporation, and meeting contingencies.
8.8 FISCAL YEAR
-----------
The fiscal year of the corporation shall be fixed by resolution of the
board of directors and may be changed by the board of directors.
8.9 SEAL
----
The corporation may have a corporate seal, which shall be adopted and which
may be altered by the Board of Directors, and may use the same by causing it or
a facsimile thereof, to be impressed or affixed or in any other manner
reproduced.
8.10 TRANSFER OF STOCK
-----------------
Upon surrender to the corporation or the transfer agent of the corporation
of a certificate for shares duly endorsed or accompanied by proper evidence of
succession, assignation or authority to transfer, it shall be the duty of the
corporation to issue a new certificate to the person entitled thereto, cancel
the old certificate, and record the transaction in its books.
8.11 STOCK TRANSFER AGREEMENTS
-------------------------
The corporation shall have power to enter into and perform any agreement
with any number of shareholders of any one or more classes of stock of the
corporation to restrict the transfer of shares of stock of the corporation of
any one or more classes owned by such stockholders in any manner not prohibited
by the General Corporation Law of Delaware.
8.12 REGISTERED STOCKHOLDERS
-----------------------
The corporation shall be entitled to recognize the exclusive right of a
person registered on its books as the owner of shares to receive dividends and
to vote as such owner, shall be entitled to hold liable for calls and
assessments the person registered on its books as the owner of shares, and shall
not be bound to recognize any equitable or other claim to or interest in such
share or shares on the part of another person, whether or not it shall have
express or other notice thereof, except as otherwise provided by the laws of
Delaware.
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ARTICLE IX
AMENDMENTS
----------
The original or other bylaws of the corporation may be adopted, amended or
repealed by the stockholders entitled to vote; provided, however, that the
corporation may, in its certificate of incorporation, confer the power to adopt,
amend or repeal bylaws upon the directors. The fact that such power has been so
conferred upon the directors shall not divest the stockholders of the power, nor
limit their power to adopt, amend or repeal bylaws.
ARTICLE X
DISSOLUTION
-----------
If it should be deemed advisable in the judgment of the board of directors
of the corporation that the corporation should be dissolved, the board, after
the adoption of a resolution to that effect by a majority of the whole board at
any meeting called for that purpose, shall cause notice to be mailed to each
stockholder entitled to vote thereon of the adoption of the resolution and of a
meeting of stockholders to take action upon the resolution.
At the meeting a vote shall be taken for and against the proposed
dissolution. If a majority of the outstanding stock of the corporation entitled
to vote thereon votes for the proposed dissolution, then a certificate stating
that the dissolution has been authorized in accordance with the provisions of
Section 275 of the General Corporation Law of Delaware and setting forth the
names and residences of the directors and officers shall be executed,
acknowledged, and filed and shall become effective in accordance with Section
103 of the General Corporation Law of Delaware. Upon such certificate's
becoming effective in accordance with Section 103 of the General Corporation Law
of Delaware, the corporation shall be dissolved.
Whenever all the stockholders entitled to vote on a dissolution consent in
writing, either in person or by duly authorized attorney, to a dissolution, no
meeting of directors or stockholders shall be necessary. The consent shall be
filed and shall become effective in accordance with Section 103 of the General
Corporation Law of Delaware. Upon such consent's becoming effective in
accordance with Section 103 of the General Corporation Law of Delaware, the
corporation shall be dissolved. If the consent is signed by an attorney, then
the original power of attorney or a photocopy thereof shall be attached to and
filed with the consent. The consent filed with the Secretary of State shall
have attached to it the affidavit of the secretary or some other officer of the
corporation stating that the consent has been signed by or on behalf of all the
stockholders entitled to vote on a dissolution; in addition, there shall be
attached to the consent a certification by the secretary or some other officer
of the corporation setting forth the names and residences of the directors and
officers of the corporation.
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ARTICLE XI
CUSTODIAN
---------
11.1 APPOINTMENT OF A CUSTODIAN IN CERTAIN CASES
-------------------------------------------
The Court of Chancery, upon application of any stockholder, may appoint one
or more persons to be custodians and, if the corporation is insolvent, to be
receivers, of and for the corporation when:
(i) at any meeting held for the election of directors the
stockholders are so divided that they have failed to elect successors to
directors whose terms have expired or would have expired upon qualification of
their successors; or
(ii) the business of the corporation is suffering or is threatened
with irreparable injury because the directors are so divided respecting the
management of the affairs of the corporation that the required vote for action
by the board of directors cannot be obtained and the stockholders are unable to
terminate this division; or
(iii) the corporation has abandoned its business and has failed
within a reasonable time to take steps to dissolve, liquidate or distribute its
assets.
11.2 DUTIES OF CUSTODIAN
-------------------
The custodian shall have all the powers and title of a receiver appointed
under Section 291 of the General Corporation Law of Delaware, but the authority
of the custodian shall be to continue the business of the corporation and not to
liquidate its affairs and distribute its assets, except when the Court of
Chancery otherwise orders and except in cases arising under Sections 226(a)(3)
or 352(a)(2) of the General Corporation Law of Delaware.
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CERTIFICATE OF ADOPTION OF
AMENDED AND RESTATED BYLAWS
OF
COVAD COMMUNICATIONS GROUP, INC.
The undersigned hereby certifies that he is the duly elected, qualified,
and acting Secretary of Covad Communications Group, Inc. and that the foregoing
Amended and Restated Bylaws, comprising twenty (20) pages, were adopted as the
Amended and Restated Bylaws of the corporation on September __, 1998, by the
Board of Directors of the corporation to be effective upon the closing of the
corporation's initial public offering.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand and affixed
the corporate seal this ___th day of September 1998.
----------------------------------------
Dhruv Khanna, Secretary
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EXHIBIT 4.6
COVAD COMMUNICATIONS GROUP, INC.
AMENDED AND RESTATED STOCKHOLDER RIGHTS AGREEMENT
This Amended and Restated Stockholder Rights Agreement (the "Agreement") is
amended and restated as of January 19, 1999, by and among Covad Communications
Group, Inc., a Delaware corporation (the "Company"), and the individuals and
entities listed on Exhibit A attached hereto (collectively, the "Stockholders").
R E C I T A L S
---------------
A. The Company and certain of the Stockholders are parties to that certain
Stockholder Rights Agreement dated as of July 16, 1997, as amended by Amendment
No. 1 thereto dated February 12, 1998 and as amended and restated by the Amended
and Restated Stockholder Rights Agreement dated February 20, 1998 and as amended
and restated by the Amended and Restated Stockholder Rights Agreement dated
March 11, 1998, as amended by Amendment No. 1 thereto dated April 24, 1998 (the
"Prior Agreement") and amended and restated by the Amended and Restated
Stockholder Rights Agreement dated as of December 30, 1998.
B. The Company is selling and U.S. Telesource, Inc. (along with the other
entities listed on Exhibit A as holders of the Company's Series C-1 and Series
D-1 Preferred, the "Strategic Investors") is purchasing (i) Series C-1
Preferred, pursuant to a Series C-1 Purchase Agreement, and (ii) Series D-1
Preferred, pursuant to a Series D-1 Purchase Agreement.
C. In order to induce U.S. Telesource, Inc. to enter into a Series C-1
Purchase Agreement and a Series D-1 Purchase Agreement, the Stockholders wish to
amend and restate the Prior Agreement to, among other things, grant the rights
set forth herein to the securities issued and issuable to U.S. Telesource, Inc.
and to accept the rights created herein in lieu of rights provided by the Prior
Agreement.
NOW THEREFORE, in consideration of the mutual promises and covenants
hereinafter set forth, the parties hereto agree that the Prior Agreement is
terminated and superseded in its entirety by this Agreement, and further agree
as follows:
1. Certain Definitions. As used in this Agreement, the terms defined in the
-------------------
preamble to this Agreement shall have the meanings given therein and the
following terms shall have the following respective meanings:
"Affiliate" shall mean as to any person or entity, a person or entity that
directly or indirectly though one or more intermediaries, controls, or is
controlled by, or is under common control with, such person or entity. In
addition, with respect to AT&T Venture Fund II, LP,
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<PAGE>
Special Partners Fund, LP and Special Partners Fund International (the "AT&T
Entities"), only for the purposes of this Agreement, AT&T Corp., all Affiliates
of AT&T Corp., each of the other AT&T Entities and all owners of equity
interests in AT&T Entities shall be deemed to be Affiliates of each of the AT&T
Entities.
"Commission" shall mean the Securities and Exchange Commission or any other
Federal agency at the time administering the Securities Act.
"Common Stock" shall mean all shares of Common Stock and Class B Common
Stock of the Company.
"Common Warrants" shall mean the warrants to purchase Common Stock of the
Company issued to the Investors pursuant to the terms of the Original Series C
Agreement.
"Common Warrant Shares" shall mean the shares of Common Stock issued or
issuable upon exercise of the Common Warrants.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as amended,
or any similar successor federal statute and the rules and regulations
thereunder, all as the same shall be in effect from time to time.
"Holder" shall mean any person who holds of record or holds an option or
warrant for Registrable Securities and any holder of Registrable Securities to
whom the registration rights conferred by this Agreement have been transferred
in compliance with Section 2 and Section 13 hereof.
"Initiating Holders" shall mean any Holder or Holders of twenty percent
(20%) or more of the then outstanding Registrable Securities.
"Investors" shall mean Warburg, Pincus Ventures, L.P., Crosspoint Venture
Partners 1996 and Intel Corporation.
"IPO" shall mean an underwritten public offering pursuant to an effective
registration statement under the Securities Act, covering the initial offer and
sale of Common Stock for the account of the Company to the public with aggregate
gross proceeds to the Company of not less than Fifteen Million Dollars
($15,000,000).
"Original Registrable Securities" shall mean (i) all shares of Common Stock
issued or issuable upon conversion of the Series A Preferred, the Series B
Preferred and the Series C Preferred, excluding the Series C-1 Preferred issued
pursuant to the Series C-1 Purchase Agreements; (ii) the Common Warrant Shares;
and (iii) all shares of Common Stock issued as a
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<PAGE>
dividend or other distribution with respect to or in exchange for or in
replacement of the shares referenced in (i) and (ii) above.
"Original Series C Agreement" shall mean the Series C Preferred Stock and
Warrant Subscription Agreement, dated as of February 20, 1998, as amended on
April 24, 1998 among the Company, Warburg, Pincus Ventures, L.P., Crosspoint
Venture Partners 1996, Intel Corporation and Robert Hawk.
"Preferred Stock" shall mean the Series A Preferred, Series B Preferred,
Series C Preferred, Series C-1 Preferred, Series D Preferred and Series D-1
Preferred.
"Registrable Securities" shall mean the Original Registrable Securities and
the Strategic Registrable Securities.
The terms "register", "registered" and "registration" shall refer to a
registration effected by preparing and filing a registration statement in
compliance with the Securities Act and applicable rules and regulations
thereunder, and the declaration or ordering of the effectiveness of such
registration statement.
"Registration Expenses" shall mean all expenses incurred by the Company in
compliance with Sections 5, 6 and 8 hereof, including, without limitation, all
registration and filing fees, printing expenses, fees and disbursements of
counsel for the Company which shall include any fees and disbursements for legal
services provided by counsel for the Company on behalf of the Holders, blue sky
fees and expenses for state qualifications or registrations, and the expense of
any audit of the Company's fiscal year-end financial statements incident to or
required by any such registration (but excluding the compensation of regular
employees of the Company, which shall be paid in any event by the Company).
"Restricted Securities" shall mean the securities of the Company required
to bear or bearing the legend set forth in Section 3 hereof.
"Securities Act" shall mean the Securities Act of 1933, as amended, or any
similar successor federal statute and the rules and regulations thereunder, all
as the same shall be in effect from time to time.
"Selling Expenses" shall mean all underwriting discounts, selling
commissions and expense allowances applicable to the sale of Registrable
Securities and all fees and disbursements of counsel for any Holder (other than
the fees and disbursements of the Company's counsel included in Registration
Expenses, and the fees of one special counsel to the Holders, which shall be
borne by the Company).
-3-
<PAGE>
"Senior Notes" shall mean the 13.5% Senior Discount Notes due March 15,
2008 issued on March 11, 1998 as governed by the Indenture dated as of March 11,
1998 between the Company and The Bank of New York as Trustee.
"Senior Note Warrants" shall mean the warrants issued in connection with
the issuance of the Senior Notes on March 11, 1998 pursuant to the Warrant
Agreement and any additional warrants issued pursuant to the terms of the
Warrant Agreement.
"Senior Note Warrant Shares" shall mean the shares of Common Stock issued
or issuable upon exercise of the Senior Note Warrants.
"Series A Preferred" shall mean shares of Series A Preferred Stock of the
Company.
"Series B Preferred" shall mean shares of Series B Preferred Stock of the
Company.
"Series C Preferred" shall mean shares of Series C Preferred Stock of the
Company.
"Series C-1 Preferred" shall mean shares of Series C-1 Preferred Stock of
the Company.
"Series C-1 Purchase Agreements" shall mean the Series C-1 Preferred Stock
Purchase Agreements, dated as of December 30, 1998 and as of January 19, 1999
between the Company and the Strategic Investors.
"Series C Warrants" shall mean the warrants to purchase Series C Preferred
issued to the Investors pursuant to the terms of the Original Series C
Agreement.
"Series D Preferred" shall mean shares of Series D Preferred Stock of the
Company.
"Series D-1 Purchase Agreements" shall mean the Series D-1 Preferred Stock
Purchase Agreements, dated as of December 30, 1998 and as of January 19, 1999
between the Company and the Strategic Investors.
"Series D-1 Preferred" shall mean shares of Series D-1 Preferred Stock of
the Company.
"Shares" shall mean all Registrable Securities.
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<PAGE>
"Strategic Investment Agreements" shall mean the Series C-1 Purchase
Agreements and the Series D-1 Purchase Agreements.
"Strategic Investors" shall mean the investors listed on Exhibit A as
holders of Series C-1 Preferred and Series D-1 Preferred.
"Strategic Registrable Securities" shall mean (i) all shares of Common
Stock issued or issuable upon conversion of the Class B Common Stock issued upon
conversion of the Series C-1 Preferred issued pursuant to the Series C-1
Purchase Agreements and the Series D-1 Preferred issued pursuant to the Series
D-1 Purchase Agreement, (ii) all Common Stock issued upon conversion of any
Series C Preferred Stock and Series D Preferred Stock issued upon conversion of
the Series C-1 Preferred Stock and Series D-1 Preferred Stock and (iii) all
shares of Common Stock issued as a dividend or other distribution with respect
to or in exchange for or in replacement of the shares referenced in (i) and (ii)
above.
"Warrant Agreement" shall mean the Warrant Agreement dated as of March 11,
1998 by and between the Company and The Bank of New York as warrant agent.
"Warrant Registration Rights Agreement" shall mean the Warrant Registration
Rights Agreement dated as of March 11, 1998 entered into among the Company and
Bear, Stearns & Co. Inc. and BT Alex. Brown Incorporated.
"Warrants" shall mean the Common Warrants and the Series C Warrants.
2. Restrictions on Transferability. The Common Stock, the Preferred Stock
-------------------------------
and the Warrants held by any Stockholder, and any other securities issued in
respect of the foregoing upon any stock split, stock dividend, recapitalization,
merger, consolidation, or similar event, shall not be transferred except upon
the conditions specified in this Agreement, which conditions are intended to
ensure compliance with the provisions of the Securities Act. Any transferee of
such securities shall take and hold such securities subject to the provisions
and upon the conditions specified in this Agreement.
3. Restrictive Legend. Each certificate representing the Common Stock or
------------------
the Preferred Stock held by any Stockholder (other than the Strategic Investors,
whose certificates shall bear the legend set forth in the Strategic Investment
Agreements), and any other securities issued in respect of the foregoing upon
any stock split, stock dividend, recapitalization, merger, consolidation or
similar event, shall (unless otherwise permitted or unless the securities
evidenced by such certificate shall have been registered under the Securities
Act) be stamped or otherwise imprinted with a legend substantially in the
following form (in addition to any legend required under applicable state
securities laws):
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED
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<PAGE>
UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT") OR ANY STATE
SECURITIES LAWS. SUCH SHARES MAY NOT BE SOLD OR OFFERED FOR SALE IN THE
ABSENCE OF SUCH REGISTRATION OR AN OPINION OF COUNSEL SATISFACTORY TO THE
COMPANY AND ITS COUNSEL THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE
ACT. COPIES OF THE AGREEMENTS COVERING THE PURCHASE OF THESE SHARES AND
RESTRICTING THEIR TRANSFER MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST
MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF THE
CORPORATION AT THE PRINCIPAL EXECUTIVE OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, THAT CERTAIN STOCKHOLDER RIGHTS
AGREEMENT AMONG THE HOLDER OF THESE SECURITIES AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDES A VOTING AGREEMENT OF SUCH HOLDERS, A
COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF THE ISSUER.
Upon request of a holder of such a certificate, the Company shall remove
the foregoing legend from the certificate or issue to such holder a new
certificate therefor free of any transfer legend, if, with such request, the
Company shall have received either the opinion referred to in Section 4(a) or
the "no-action" letter referred to in Section 4(b) to the effect that any
transfer by such holder of the securities evidenced by such certificate will not
violate the Securities Act and applicable state securities laws, unless any such
transfer legend may be removed pursuant to Rule 144(k) or any successor rule, in
which case no such opinion or "no-action" letter shall be required, and provided
that the Company shall not be obligated to remove any such legends prior to the
date of the release of the lock-up provisions set forth in Section 15 hereof
following the initial public offering of the Company's Common Stock under the
Securities Act.
4. Notice of Proposed Transfers. The holder of each certificate
----------------------------
representing Restricted Securities by acceptance thereof agrees to comply in all
respects with the provisions of this Section 4. Prior to any proposed transfer
of any Restricted Securities (other than under circumstances described in
Section 5, 6 or 8 hereof), the holder thereof shall give written notice to the
Company of such holder's intention to effect such transfer. Each such notice
shall describe the manner and circumstances of the proposed transfer in
sufficient detail, and shall be accompanied (except (i) in transactions in
compliance with Rule 144 promulgated under the Securities Act, (ii) for a
transfer to an Affiliate of a holder, (iii) for a transfer to such holder's
spouse, ancestors, descendants or a trust for any of their benefit, (iv) in
transactions involving the distribution without consideration of Restricted
Securities by a holder to any of its partners or retired partners or to the
estate of any of its partners or retired partners, or (v) repurchases by the
-6-
<PAGE>
Company of Common Stock issued to employees or directors of the Company pursuant
to restricted stock purchase agreements (collectively, "Exempt Transactions"))
by either (a) a written opinion of legal counsel to the holder who shall be
reasonably satisfactory to the Company, addressed to the Company, to the effect
that the proposed transfer of the Restricted Securities may be effected without
registration under the Securities Act or (b) a "no-action" letter from the
Commission to the effect that the distribution of such securities without
registration will not result in a recommendation by the staff of the Commission
that action be taken with respect thereto, whereupon the holder of such
Restricted Securities shall be entitled to transfer such Restricted Securities
in accordance with the terms of the notice delivered by such holder to the
Company. Each certificate evidencing the Restricted Securities transferred as
above provided shall bear the restrictive legend set forth in Section 3 above
(or, in the case of the Strategic Investors, that set forth in the Strategic
Investment Agreements), except that such certificate shall not bear such
restrictive legend after the date of the Company's initial public offering under
the Securities Act if the opinion of counsel or "no-action" letter referred to
above expressly indicates that such legend is not required in order to establish
compliance with the Act or if such legend is no longer required pursuant to Rule
144(k) or any successor rule.
5. Requested Registrations.
-----------------------
(a) Request for Registration. If at any time beginning at the earlier of
------------------------
(i) six months after the closing of a public offering by the Company of its
Common Stock pursuant to a registration statement under the Securities Act and
(ii) the fourth anniversary of the date of this Agreement, the Company shall
receive from Initiating Holders a written request that the Company effect a
registration with respect to Registrable Securities held by such Initiating
Holders, the Company will:
(i) promptly give written notice of the proposed registration to all
other Holders; and
(ii) as soon as practicable, use its diligent best efforts to effect
such registration (including, without limitation, the execution of an
undertaking to file post-effective amendments, appropriate qualification under
applicable blue sky or other state securities laws and appropriate compliance
with applicable regulations issued under the Securities Act) as may be so
requested and as would permit or facilitate the sale and distribution of the
Registrable Securities requested to be registered by the Initiating Holders and
by any Holder or Holders joining in such request as are specified in a written
request given within 30 days after receipt of such written notice from the
Company. In the event that holders of a majority of the outstanding Registrable
Securities elect to limit the number of Registrable Securities to be registered,
the number of shares that are included in the registration shall be allocated
among all Holders of Registrable Securities in proportion, as nearly as
practicable, to the respective amounts of Registrable Securities held by each
Holder at the time of the filing of the registration statement.
-7-
<PAGE>
The Company shall file a registration statement covering the Registrable
Securities to be registered as soon as practicable after receipt of the request
of the Initiating Holders; provided, however, that if the Company shall furnish
to such Initiating Holders (in the event of an underwritten offering) a
certificate signed by the representatives of the underwriters of the offering to
which such registration statement relates, to the effect that market conditions
are such that a delay in the filing of such registration statement is advisable
(or, in the event of a non-underwritten offering, a certificate signed by the
President of the Company stating that in the good faith judgment of the Board of
Directors of the Company a delay in filing such registration statement is
necessary in order to avoid a serious detriment to the Company), the Company
shall have the right, exercisable on only one occasion in any twelve month
period, to defer such filing for a period of not more than 120 days after
receipt of the request of the Initiating Holders.
The Company shall not be obligated to effect, or to take any action to
effect, any registration pursuant to this Section 5 after the Company has
effected two such registrations pursuant to this Section 5 and such
registrations have been declared or ordered effective by the Commission.
Any registration statement filed pursuant to this Section 5(a) may, subject
to the provisions of Section 5(b) below, include securities of the Company being
sold for the account of the Company.
(b) Underwriting. If the Initiating Holders intend to distribute the
------------
Registrable Securities covered by their request by means of an underwriting,
they shall so advise the Company as a part of their request made pursuant to
Section 5(a) and the Company shall include such information in the written
notice referred to in Section 5(a)(i) above. The Company, together with all
Holders of Registrable Securities proposing to distribute their securities
through such underwriting, shall enter into an underwriting agreement in
customary form with the managing underwriter(s) selected for such underwriting
by a majority in interest of the Initiating Holders, which underwriter(s) shall
be reasonably acceptable to the Company.
Notwithstanding any other provision of this Section 5, if the managing
underwriter(s) have informed the Company and the Initiating Holders in writing
that in such underwriter's or underwriters' opinion the total number of
securities which the Holders and any other person desiring to participate in
such registration intend to include in such offering is such as to affect
adversely the success of such offering, including the price at which such
securities can be sold, then the Company will be required to include in such
registration only the amount of securities which it is so advised should be
included in such registration. In such event, securities shall be registered in
such registration in the following order of priority: (i) first, the securities
-----
which have been requested to be included in such registration by the Holders of
Registrable Securities pursuant to this Agreement and the Senior Note Warrant
Shares sought to be included in such registration pursuant to the exercise of
"piggy-back" registration rights under the Warrant Registration Rights Agreement
pro rata between the Holders of Registrable Securities and the
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<PAGE>
holders of Senior Note Warrant Shares based upon the aggregate amount of
securities then held, (ii) second, provided that no securities sought to be
------
included by the Holders of Registrable Securities and the holders of the Senior
Note Warrant Shares have been excluded from such registration, the securities of
other persons entitled to exercise "piggy-back" registration rights pursuant to
contractual commitments of the Company (pro rata based on the amount of
securities sought to be registered by such persons) and (iii) third, provided
-----
that no securities of any other person sought to be included therein have been
excluded from such registration, securities to be offered and sold for the
account of the Company.
If the Company or any Holder in its sole discretion disapproves of the
terms of the underwriting, it may elect to withdraw therefrom by written notice
to the underwriter and the Initiating Holders. The securities so withdrawn
shall also be withdrawn from registration.
6. Company Registration.
--------------------
(a) If, at any time, the Company shall determine to register any of its
securities either for its own account or the account of a security holder or
holders (other than Holders of Registrable Securities) exercising their
respective demand registration rights, other than (i) a registration relating
solely to employee benefit plans, (ii) a registration relating solely to a
Commission Rule 145 transaction involving the acquisition of a business (but not
a Rule 145 Transaction designed solely to exchange restricted securities for
registered securities in a manner that is the functional equivalent of
registration rights), (iii) a registration on any registration form which does
not permit secondary sales, or (iv) a registration relating solely to non-
convertible debt securities of the Company, the Company will:
(i) promptly give to each Holder written notice thereof (which shall
include a list of the jurisdictions in which the Company intends to attempt to
qualify such securities under the applicable blue sky or other state securities
laws); and
(ii) include in such registration (and any related qualification
under blue sky laws or other compliance), and in any underwriting involved
therein, all of the Registrable Securities specified in a written request or
requests made by any Holder within 30 days after receipt of the written notice
from the Company described in clause (i) above, except as set forth in Section
6(b) below. Such written request may specify all or a part of a Holder's
Registrable Securities.
(b) If a registration statement under which the Company gives notice
under Section 6(a)(i) is for an underwritten offering, and if the managing
underwriter or underwriters of such underwritten offering have informed the
Company and the Holders of Registrable Securities requesting inclusion in such
offering, in writing, that in such underwriter's or underwriters' opinion the
total number of securities which the Company, such Holders and any other persons
desiring to participate in such registration intend to include in such offering
is such as to adversely affect the success of such offering, including the price
at which such securities can be
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<PAGE>
sold, then the Company will be required to include in such registration only the
number of securities which it is so advised should be included in such
registration; provided, however, that the number of Registrable Securities,
together with Senior Note Warrant Shares and other securities which have been
requested to be included in such registration pursuant to a contractual "piggy-
back" right, shall not be reduced to less than 30% of the total number of
securities included in such registration or underwriting. In such event: (x) in
cases only involving the registration for sale of securities for the Company's
own account (other than pursuant to the exercise of "piggy-back" rights herein
and in other contractual commitments of the Company), securities shall be
registered in such offering in the following order of priority: (i) first, the
-----
securities which the Company proposes to register, (ii) second, provided that no
------
securities sought to be included by the Company have been excluded from such
registration, the securities which have been requested to be included in such
registration by the Holders of Registrable Securities and the holders of Senior
Note Warrant Shares pro rata between the Holders of Registrable Securities and
the holders of Senior Note Warrant Shares based upon the aggregate amount of
securities then held, (iii) third, provided that no securities sought to be
-----
included by the Company, the Holders and the holders of Senior Note Warrant
Shares have been excluded from such registration, the securities of other
persons entitled to exercise "piggy-back" registration rights pursuant to
contractual commitments of the Company (pro rata based on the respective numbers
of securities sought to be registered by such persons); (y) in cases not
involving the registration for sale of securities for the Company's own account
only or not for the account of any Holder, securities shall be registered in
such offering in the following order of priority: (i) first, the securities of
-----
any person whose exercise of a "demand" registration right pursuant to a
contractual commitment of the Company is the basis for the registration
(provided that if such person is a holder of Senior Note Warrant Shares, as
among holders of Senior Note Warrant Shares there shall be no priority and
Senior Note Warrant Shares sought to be included by holders thereof shall be
included pro rata based on the respective numbers of securities sought to be
registered by such persons), (ii) second, provided that no securities of such
------
person referred to in the immediately preceding clause (i) have been excluded
from such registration, the securities which have been requested to be included
in such registration by the Holders of Registrable Securities and the holders of
Senior Note Warrant Shares pro rata between the Holders of Registrable
Securities and the holders of Senior Note Warrant Shares based upon the
aggregate amount of securities held, (iii) third, provided that no securities of
-----
such person referred to in the immediately preceding clause (i) or of the
Holders of Registrable Securities or of the holders of Senior Note Warrant
Shares have been excluded from such registration, securities of other persons
entitled to exercise "piggy-back" registration rights pursuant to contractual
commitments (pro rata based on the respective numbers of securities sought to be
registered by such persons) and (iv) fourth, provided that no securities of any
------
other person have been excluded from such registration, the securities which the
Company proposes to register; and (z) in cases involving the registration for
sale of securities for the account of any Holder of Registrable Securities,
securities shall be registered in such offering in the following order of
priority: (i) first, the securities which have been requested to be included in
-----
such registration by the Holders of Registrable Securities and the holders of
Senior Note Warrant Shares pro rata based upon the aggregate amount of
securities then held, (ii) second, provided that no Senior Note Warrant
------
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<PAGE>
Shares or Registrable Securities have been excluded from such registration,
securities of other persons entitled to exercise "piggy-back" registration
rights pursuant to contractual commitments (pro rata based on the respective
numbers of securities sought to be registered by such persons) and (iii) third,
-----
provided that no securities of any other person has been excluded from such
registration, the securities which the Company proposes to register.
If, as a result of the provisions of this Section 6(b)), any Holder of
Registrable Securities shall not be entitled to include all Registrable
Securities in a "piggy-back" registration that such Holder of Registrable
Securities has requested to be included, such Holder of Registrable Securities
may elect to withdraw his request to include Registrable Securities in such
registration.
7. Expenses of Registration. The Company shall bear all Registration
------------------------
Expenses incurred in connection with any registration, qualification or
compliance pursuant to this Agreement and all underwriting discounts, selling
commissions and expense allowances applicable to the sale of any securities by
the Company for its own account in any registration. All Selling Expenses shall
be borne by the Holders, if any, whose securities are included in such
registration pro rata on the basis of the number of their Registrable Securities
so registered, provided, however, that if in such registration, the Company pays
any expenses included in the defined term "Selling Expenses" for other security
holders, the Company will pay such expenses for the Holders.
8. Registration on Form S-3.
------------------------
(a) The Company shall use its best efforts to qualify for registration
on Form S-3 or any comparable or successor form or forms, and to that end the
Company shall register (whether or not required by law to do so) the Common
Stock under the Exchange Act in accordance with the provisions of the Exchange
Act following the closing of the first registration of any securities of the
Company on Form SB-2, S-1 or any comparable or successor form. After the Company
has qualified for the use of Form S-3, in addition to the rights contained in
the foregoing provisions of this Agreement, the Holders of Registrable
Securities shall have unlimited rights to request from time to time
registrations on Form S-3 (such requests shall be in writing and shall state the
number of shares of Registrable Securities to be disposed of and the intended
methods of disposition of such shares by such Holder or Holders) provided that
in each case the aggregate proceeds of such registration are expected to exceed
$500,000; provided, however, that the Company shall not be required to effect
more than two registrations pursuant to this Section 8 in any six (6) month
period.
(b) Notwithstanding the foregoing, the Company shall not be obligated to
take any action pursuant to this Section 8:
(i) in any particular jurisdiction in which the Company would be
required to execute a general consent to service of process in effecting such
registration,
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<PAGE>
qualification or compliance unless the Company is already subject to service in
such jurisdiction and except as may be required by the Securities Act;
(ii) if the Company, within ten (10) days of the receipt of the
request of the Initiating Holders, gives notice of its bona fide intention to
effect the filing of a registration statement with the Commission within sixty
(60) days of receipt of such request (other than a registration of securities in
a Rule 145 transaction or with respect to an employee benefit plan);
(iii) during the period starting with the date of filing of, and
ending on the date 90 days immediately following the effective date of, any
registration statement pertaining to securities of the Company (other than a
registration of securities in a Rule 145 transaction or with respect to an
employee benefit plan), provided that the Company is actively employing in good
faith all reasonable efforts to cause such registration statement to become
effective; or
(iv) if the Company shall furnish to such Holder or Holders a
certificate signed by the President of the Company stating that in the good
faith judgment of the Board of Directors it would be seriously detrimental to
the Company or its stockholders for registration statements to be filed in the
near future, in which case the Company's obligation to use its best efforts to
file a registration statement shall be deferred for a period not to exceed
ninety (90) days from the receipt of the request to file such registration by
such Holder or Holders, provided that the Company may not exercise this deferral
right more than once per twelve-month period.
9. Registration Procedures. In the case of each registration effected by
-----------------------
the Company pursuant to this Agreement, the Company will keep each Holder who is
entitled to registration rights hereunder advised in writing as to the
initiation of each registration and as to the completion thereof. At its
expense, the Company will:
(a) Except as otherwise provided herein, keep such registration
effective for a period of six months or until such Holders, if any, have
completed the distribution described in the registration statement relating
thereto, whichever first occurs; provided, however, that in the case of any
registration of Registrable Securities on Form S-3 that are intended to be
offered on a continuous or delayed basis, such six month period shall be
extended, if necessary, to keep the registration statement effective until all
such Registrable Securities are sold;
(b) Prepare and file with the Commission such amendments and supplements
to such registration statement and the prospectus used in connection with such
registration statement as may be necessary to comply with the provisions of the
Securities Act with respect to the disposition of securities covered by such
registration statement;
(c) Furnish such number of prospectuses and other documents incident
thereto, including supplements and amendments, as a Holder may reasonably
request;
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<PAGE>
(d) Notify each seller of Registrable Securities covered by such
registration statement at any time when a prospectus relating thereto is
required to be delivered under the Securities Act of the happening of any event
as a result of which the prospectus included in such registration statement, as
then in effect, includes an untrue statement of a material fact or omits to
state a fact required to be stated therein or necessary to make the statements
therein not misleading or incomplete in the light of the circumstances then
existing, and at the request of any such seller, prepare and furnish to such
seller a reasonable number of copies of a supplement to or an amendment of such
prospectus as may be necessary so that, as thereafter delivered to the purchaser
of such shares, such prospectus shall not include an untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein not misleading or incomplete in the
light of the circumstances then existing;
(e) Cause all such Registrable Securities to be listed on each
securities exchange or interdealer quotation system on which the same securities
issued by the Company are then listed;
(f) Provide a transfer agent and registrar for all such Registrable
Securities and a CUSIP number for all such Registrable Securities not later than
the effective date of such registration;
(g) Make available for inspection by any seller of Registrable
Securities, any underwriter participating in any disposition pursuant to such
registration statement, and any attorney or accountant retained by any such
seller or underwriter, all financial and other records, pertinent corporate
documents and properties of the Company, and cause the Company's officers and
directors to supply all information reasonably requested by any such seller,
underwriter, attorney or accountant in connection with such registration
statement; provided, however, that such seller, underwriter, attorney or
accountant shall agree to hold in confidence and trust all information so
provided;
(h) Furnish to each selling Holder a signed counterpart, addressed to
the selling Holder, of
(i) an opinion of counsel for the Company, dated the effective date
of the registration statement, and
(ii) "comfort" letters signed by the Company's independent public
accountants who have examined and reported on the Company's financial statements
included in the registration statement, to the extent permitted by the standards
of the AICPA or other relevant authorities, covering substantially the same
matters with respect to the registration statement (and the prospectus included
therein) and (in the case of the accountants' "comfort" letters, with respect to
events subsequent to the date of the financial statements) as are customarily
covered in
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<PAGE>
opinions of issuer's counsel and in accountants' "comfort" letters delivered to
the underwriters in underwritten public offerings of securities;
(i) Furnish to each selling Holder a copy of all documents filed with
and all correspondence from or to the Commission in connection with any such
offering other than nonsubstantive cover letters and the like;
(j) Otherwise use its reasonable best efforts to comply with all
applicable rules and regulations of the Commission, and make available to its
security holders, as soon as reasonably practicable, an earnings statement
covering the period of at least twelve months, but not more than eighteen
months, beginning with the first month after the effective date of the
registration statement, which earnings statement shall satisfy the provisions of
Section 11(a) of the Securities Act;
(k) In connection with any underwritten offering pursuant to a
registration statement filed pursuant to Sections 5 or 6 hereof, the Company
will enter into any underwriting agreement reasonably necessary to effect the
offer and sale of Common Stock, provided such underwriting agreement contains
customary underwriting provisions and provided further that if the underwriter
so requests the underwriting agreement will contain customary contribution
provisions; and
(l) From and after the date of this Agreement, the Company shall not,
without the prior written consent of a majority in interest of the Holders,
enter into any agreement with any holder or prospective holder of any securities
of the Company giving such holder or prospective holder rights that are superior
to, or which adversely affect, the rights given to the holders of Registrable
Securities hereunder to require the Company to initiate registration of any
securities of the Company or to require the Company, upon any registration of
any of its securities, to include, among the securities that the Company is then
registering, securities owned by such holder.
10. Indemnification.
---------------
(a) The Company will indemnify each Holder, each of its officers,
directors, agents, employees and partners, and each person controlling such
Holder, with respect to each registration, qualification or compliance effected
pursuant to this Agreement, and each underwriter, if any, and each person who
controls any underwriter, and their respective counsel against all claims,
losses, damages and liabilities (or actions, proceedings or settlements in
respect thereof) arising out of or based on any untrue statement (or alleged
untrue statement) of a material fact contained in any prospectus, offering
circular or other document prepared by the Company (including any related
registration statement, notification or the like) incident to any such
registration, qualification or compliance, or based on any omission (or alleged
omission) to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, or any violation by the
Company of the Securities Act or any rule or
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<PAGE>
regulation thereunder applicable to the Company and relating to action or
inaction required of the Company in connection with any such registration,
qualification or compliance, and will reimburse each such Holder, each of its
officers, directors, agents, employees and partners, and each person controlling
such Holder, each such underwriter and each person who controls any such
underwriter, for any legal and any other expenses as they are reasonably
incurred in connection with investigating and defending any such claim, loss,
damage, liability or action, provided that the Company will not be liable in any
such case to the extent that any such claim, loss, damage, liability or expense
arises out of or is based on any untrue statement (or alleged untrue statement)
or omission (or alleged omissions) based upon written information furnished to
the Company by such Holder or underwriter and stated to be specifically for use
therein.
(b) Each Holder whose Registrable Securities are included in any
registration, qualification or compliance effected pursuant to this Agreement
will indemnify the Company, each of its directors and officers and each
underwriter, if any, of the Company's securities covered by such a registration
statement, each person who controls the Company or such underwriter within the
meaning of the Securities Act and the rules and regulations thereunder, each
other such Holder and each of their officers, directors and partners, and each
person controlling such Holder, and their respective counsel against all claims,
losses, damages and liabilities (or actions in respect thereof) arising out of
or based on any untrue statement (or alleged untrue statement) of a material
fact contained in any such registration statement, prospectus, offering circular
or other document, or any omission (or alleged omission) to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading, and will reimburse the Company and such Holders,
directors, officers, partners, persons, underwriters or control persons for any
legal or any other expenses as they are reasonably incurred in connection with
investigating or defending any such claim, loss, damage, liability or action, in
each case to the extent, but only to the extent, that such untrue statement (or
alleged untrue statement) or omission (or alleged omission) is made in such
registration statement, prospectus, offering circular or other document in
reliance upon and in conformity with written information furnished to the
Company by such Holder and stated to be specifically for use therein; provided,
however, that the obligations of such Holders hereunder shall be limited to an
amount equal to the net proceeds to each such Holder sold under such
registration statement, prospectus, offering circular or other document as
contemplated herein.
(c) Each party entitled to indemnification under this Section 10 (the
"Indemnified Party") shall give notice to the party required to provide
indemnification (the "Indemnifying Party") promptly after such Indemnified Party
has actual knowledge of any claim as to which indemnity may be sought, and shall
permit the Indemnifying Party to assume the defense of any such claim or any
litigation resulting therefrom, provided that counsel for the Indemnifying
Party, who shall conduct the defense of such claim or any litigation resulting
therefrom, shall be approved by the Indemnified Party (whose approval shall not
unreasonably be withheld), and the Indemnified Party may participate in such
defense at such party's expense; and provided further that if any Indemnified
Party reasonably concludes that there may be one or more legal defenses
available to it that are not available to the Indemnifying Party, or that such
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<PAGE>
claim or litigation involves or could have an effect on matters beyond the scope
of this Agreement, then the Indemnified Party may retain its own counsel at the
expense of the Indemnifying Party; and provided further that the failure of any
Indemnified Party to give notice as provided herein shall not relieve the
Indemnifying Party of its obligations under this Agreement unless and only to
the extent that such failure to give notice results in material prejudice to the
Indemnifying Party. No Indemnifying Party, in the defense of any such claim or
litigation, shall, except with the consent of each Indemnified Party, consent to
entry of any judgment or enter into any settlement which does not include as an
unconditional term thereof the giving by the claimant or plaintiff to such
Indemnified Party of a release from all liability in respect to such claim or
litigation. Each Indemnified Party shall furnish such information regarding
itself or the claim in question as an Indemnifying Party may reasonably request
in writing and as shall be reasonably required in connection with defense of
such claim and litigation resulting therefrom.
(d) If the indemnification provided for in this Section 10 is held by a
court of competent jurisdiction to be unavailable to an Indemnified Party with
respect to any loss, liability, claim, damage or expense referred to herein,
then the Indemnifying Party, in lieu of indemnifying such Indemnified Party
hereunder, shall contribute to the amount paid or payable by such Indemnified
Party as a result of such loss, liability, claim, damage or expense in such
proportion as is appropriate to reflect the relative fault of the Indemnifying
Party on the one hand and of the Indemnified Party on the other in connection
with the statements or omissions which resulted in such loss, liability, claim,
damage or expense as well as any other relevant equitable considerations. The
relative fault of the Indemnifying Party and of the Indemnified Party shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission to state a material fact
relates to information supplied by the Indemnifying Party or by the Indemnified
Party and the parties' relative intent, knowledge, access to information and
opportunity to correct or prevent such statement or omission.
11. Information by Holder. Each Holder of Registrable Securities to be
---------------------
included in a registration referred to in this agreement shall furnish to the
Company such information regarding such Holder, the securities to be offered and
sold and the intended plan of distribution of the securities by such Holder as
the Company may reasonably request in writing and as shall be reasonably
required in connection with any registration, qualification or compliance
referred to in this Agreement and shall promptly advise the Company in writing
of any material changes to such information while the registration is in effect.
12. Rule 144 Reporting. With a view to making available the benefits of
------------------
certain rules and regulations of the Commission which may permit the sale of the
Restricted Securities to the public without registration, the Company agrees to:
(a) Make and keep public information available, as those terms are
understood and defined in Rule 144 under the Securities Act, at all times from
and after the effective date of
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<PAGE>
the first registration under the Securities Act filed by the Company for an
offering of its securities to the general public;
(b) Use its reasonable best efforts to file with the Commission in a
timely manner all reports and other documents required of the Company under the
Securities Act and the Exchange Act at any time after it has become subject to
such reporting requirements; and
(c) So long as a Holder owns any Restricted Securities, furnish to the
Holder forthwith upon request a written statement by the Company as to its
compliance with the reporting requirements of Rule 144 (at any time from and
after ninety (90) days following the effective date of the first registration
statement filed by the Company for an offering of its securities to the general
public), and of the Securities Act and the Exchange Act (at any time after it
has become subject to such reporting requirements), a copy of the most recent
annual or quarterly report of the Company, and such other reports and documents
as a Stockholder may reasonably request in availing itself of any rule or
regulation of the Commission allowing a Stockholder to sell any such securities
without registration.
13. Transfer of Rights; Termination of Rights.
-----------------------------------------
(a) The rights to cause the Company to register a Holder's securities
granted by the Company under this Agreement may be transferred or assigned by a
Holder to a transferee or assignee of not less than five percent (5%) of the
total outstanding number of Registrable Securities, provided that the Company is
given written notice prior to the time that such right is exercised, stating the
name and address of said transferee or assignee and identifying the securities
with respect to which such registration rights are being transferred or
assigned, and provided further that the transferee or assignee of such rights is
not deemed by the Board of Directors of the Company, in its reasonable judgment,
to be a competitor of the Company; and provided further that the transferee or
assignee of such rights assumes in writing the obligations of the Holder under
this Agreement.
(b) The rights granted pursuant to Sections 5 through 12 of this
Agreement shall terminate as to any Holder at the later of (i) three years after
the Company's IPO or (ii) at such time as such Holder may sell under Rule 144 in
a three month period all Registrable Securities then held by such Holder without
regard to Rule 144(k).
(c) Notwithstanding the rights granted pursuant to Sections 5 through
12 of this Agreement, the Strategic Registrable Securities shall be subject to
restrictions on transfer set forth in the Strategic Investment Agreements.
14. "Lock-Up" Agreement. Each Stockholder agrees, if requested by the
------------------
Company and an underwriter of Common Stock (or other securities) of the Company
in connection with the IPO, not to sell or otherwise transfer or dispose of any
Common Stock (or other securities) of the Company held by such Stockholder
during a period of time determined by the Company and its
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<PAGE>
underwriters (not to exceed 180 days) following the date of the Prospectus filed
under the Securities Act relating to such IPO, provided that all officers and
directors of the Company who then hold Common Stock (or other securities) of the
Company enter into similar agreements, and provided further that, in no event,
shall a Stockholder be prohibited from transferring or selling Common Stock or
other securities of the Company to an affiliate of such Stockholder.
Such agreement shall be in writing in a form reasonably satisfactory to the
Company and such underwriter. The Company may impose stop-transfer instructions
with respect to the Shares (or securities) subject to the foregoing restriction
until the end of said period. The Company agrees that any release of shares
subject to the foregoing lock-up agreement shall be made on a pro rata basis
among all Stockholders based upon their percentage ownership of the outstanding
shares of Common Stock of the Company. Any shares so released shall be subject
to the provisions of Section 4 hereof.
15. Preemptive Rights.
-----------------
(a) New Issuances. The Company hereby agrees not to issue or sell any
-------------
"New Securities" (as defined in this Section 15) in a transaction in which the
Company receives any consideration other than cash without the prior written
consent of holders of a majority of the outstanding shares of Series B Preferred
and Series C Preferred. The Company hereby grants to the Investors and the
Strategic Investors a right (the "Preemptive Right") to purchase all or any part
of their pro rata share of any New Securities that the Company may, from time to
time, propose to sell and issue solely for cash. Such pro rata share, for
purposes of this Preemptive Right, is the ratio of (x) the sum of the number of
shares of Common Stock then held by such Investor or Strategic Investor
immediately prior to the issuance of the New Securities, assuming the full
conversion of any Preferred Stock held by such Investor or Strategic Investor
(but not including options or warrants to acquire Common Stock or Preferred
Stock), to (y) the total number of shares of Common Stock then outstanding
immediately prior to the issuance of the New Securities, assuming the full
conversion of outstanding Preferred Stock (but not including options or warrants
to acquire Common Stock or Preferred Stock). This Preemptive Right shall be
subject to the following provisions:
(i) "New Securities" shall mean any Common Stock or Preferred Stock
--------------
of the Company, whether or not authorized on the date hereof, and rights,
options or warrants to purchase Common Stock or Preferred Stock and securities
of any type whatsoever that are, or may become, convertible into Common Stock or
Preferred Stock; provided, however, that "New Securities" does not include the
following:
(A) shares of capital stock of the Company issuable upon
conversion or exercise of any currently outstanding securities or any New
Securities issued in accordance with this Agreement;
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<PAGE>
(B) shares or options granted to officers, directors and
employees of, and consultants to, the Company pursuant to stock option or
purchase plans approved by at least 80% of the members of the Board of
Directors;
(C) shares of Common Stock or Preferred Stock issued in
connection with any pro rata stock split, stock dividend or recapitalization by
the Company (in which case, all numbers of shares and per share amounts
referenced in this Section 15(a)(i) will be adjusted accordingly);
(D) the Warrants (or Common Stock issuable upon exercise
thereof);
(E) the Senior Note Warrants issued in connection with the
issuance of Senior Notes and the Senior Note Warrant Shares issued upon exercise
thereof;
(F) the shares of Series C Preferred or Series C-1 Preferred,
or Common Stock or Class B Common issuable upon conversion thereof or
(G) the shares of Series D Preferred or Series D-1 Preferred,
or Common Stock or Class B Common issuable upon conversion thereof.
(ii) In the event that the Company proposes to undertake an
issuance of New Securities for cash, it shall give each Investor and Strategic
Investor written notice (the "Notice") of its intention, describing the type of
New Securities, the price, and the general terms upon which the Company proposes
to issue the same. Each Investor and Strategic Investor shall have twenty (20)
business days after receipt of such notice to agree to purchase all or any
portion of its pro rata share of such New Securities at the price and upon the
terms specified in the notice by giving written notice to the Company and
stating therein the quantity of New Securities to be purchased. If any Investor
or Strategic Investor fails to agree to purchase its full pro rata share within
such twenty (20) business day period, the Company will give each Investor and
Strategic Investor who did so agree (the "Electing Stockholders") notice of the
number of shares that were not subscribed for. Such notice may be by telephone
if followed by written confirmation within two days. The Electing Stockholders
shall have five (5) business days from the date of receipt of such notice to
agree to purchase all or any share of any Investor's or Strategic Investor's pro
rata share of the New Securities not purchased in response to the Notice.
(iii) In the event that any New Securities subject to the
Preemptive Right are not purchased by the Investors or Strategic Investors
within the twenty (20) business day plus five (5) business day period specified
above, the Company shall have ninety (90) days thereafter to sell (or enter into
an agreement pursuant to which the sale of New Securities that had been subject
to the Preemptive Right shall be closed, if at all, within sixty (60) days from
the date of said agreement) the New Securities with respect to which the rights
of the Investors and Strategic Investors were not exercised at a price and upon
terms, including manner of payment,
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<PAGE>
no more favorable to the purchasers thereof than specified in the Notice. In the
event the Company has not sold all offered New Securities within such ninety
(90) day period (or sold and issued New Securities in accordance with the
foregoing within sixty (60) days from the date of such agreement) the Company
shall not thereafter issue or sell any New Securities, without first again
offering such New Securities to the Investors and Strategic Investors in the
manner provided above.
(iv) This Preemptive Right is nonassignable except to any
transferee to whom registration rights may be transferred under this Agreement.
(v) This Preemptive Right shall terminate as to any Investor or
Strategic Investor (or any transferee or assignee of such Investor or Strategic
Investor) at such time as such Investor or Strategic Investor ceases to own any
Series B Preferred, Series C Preferred, Series C-1 Preferred, Series D Preferred
and Series D-1 Preferred or Common Stock or Class B Common Stock issued upon
conversion thereof and shall terminate as to all Investors and Strategic
Investors immediately prior to the closing of an IPO.
(b) Restrictions on Strategic Investors. Notwithstanding the rights set
forth in this Section 15, the Strategic Investors shall at all times be subject
to the standstill provisions set forth in the Strategic Investment Agreements.
16. Rights of First Refusal and Co-Sale Respecting Shares.
-----------------------------------------------------
(a) Rights of First Refusal and Co-Sale.
-----------------------------------
(i) In the event that a Stockholder proposes to sell or otherwise
transfer any shares of stock of the Company, or any interest in such shares
("Transfer Shares"), now held by or hereafter acquired by such Stockholder (the
"Selling Stockholders") to any person or entity, the Company and the other
Stockholders shall have a right of first refusal on the terms described below to
purchase the Transfer Shares proposed to be transferred, and each of the other
Stockholders shall have a right of co-sale on the terms described below. At
least twenty-five (25) business days before the date of a sale or transfer of
Transfer Shares, the Selling Stockholder shall give a written notice (the
"Transfer Notice") simultaneously to the Company and to each of the other
Stockholders at such Stockholder's address as shown on the Company's records.
The Transfer Notice shall describe in detail the proposed transfer, including
the number of Transfer Shares proposed to be transferred, the proposed transfer
price or consideration to be paid, the address of the Selling Stockholder
proposing to transfer shares, and the name and address of the proposed
transferee (the "Transferee").
(ii) The Company shall have ten (10) business days following
receipt of the Transfer Notice to agree to purchase all or any portion of the
Transfer Shares at the price and upon the terms specified in the Transfer Notice
by giving written notice to the Selling Stockholder and stating the number of
shares to be purchased. If the Company fails to deliver
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<PAGE>
notice of its intent to purchase all of the Transfer Shares within such ten (10)
day period, the Selling Stockholder shall give each of the other Stockholders
notice of the number of shares which the Company did not elect to purchase. Such
notice may be by telephone if followed by written confirmation in two (2) days.
The other Stockholders shall each have five (5) business days from receipt of
such notice to agree to purchase all or any portion of their respective First
Refusal Pro Rata Shares (as hereinafter defined) of such Transfer Shares which
the Company did not elect to purchase, by giving written notice to the Selling
Stockholder and stating the number of shares to be purchased. If any Stockholder
fails to deliver notice of its intent to purchase all of its First Refusal Pro
Rata Share of the Transfer Shares which the Company did not elect to purchase,
the Selling Stockholder shall give Warburg notice of the number of shares the
Stockholders did not elect to purchase. Such notice may be by telephone if
followed by written confirmation in two (2) days. Warburg shall have five (5)
business days from receipt of such notice to agree to purchase all or portion of
such remaining Transfer Shares, by delivering written notice to the Selling
Stockholder and stating the number of shares to be purchased. Any Transfer
Shares not purchased by the Company or the Stockholders pursuant to this Section
16(a)(ii) are hereinafter referred to as the "Unsold Transfer Shares."
(iii) Each Stockholder shall have the right to sell to the
Transferee (or, upon the unwillingness of any Transferee to purchase directly
from such Stockholder, to the Selling Stockholder) not more than its Co-Sale Pro
Rata Share (as hereinafter defined) of the Unsold Transfer Shares subject to the
Transfer Notice on the terms set forth in the Transfer Notice. If the
consideration to be paid by the Transferee is of a nature that cannot be given
to the Stockholders, then each Stockholder shall have the right to sell its Co-
Sale Pro Rata Share of the Unsold Transfer Shares subject to the Transfer Notice
to the Selling Stockholder at the fair market value per share of such
consideration. To the extent that any prospective purchaser or purchasers
prohibits such assignment or otherwise refuses to purchase shares or other
securities from a Stockholder exercising its right of co-sale hereunder, the
Selling Stockholder shall not sell such prospective purchaser or purchasers any
Transfer Shares unless and until, simultaneously with such sale, the Selling
Stockholder shall purchase such shares or other securities from such other
Stockholders for the same consideration and on the same terms and conditions as
the proposed transfer described in the Transfer Notice. A Stockholder shall
exercise his right of co-sale by delivering a notice to the Selling Stockholder
within five (5) business days after receipt by such Purchaser of notice from the
Selling Stockholder stating the number of Unsold Transfer Shares such
Stockholder desires to sell.
(iv) Each Stockholder's "First Refusal Pro Rata Share" is the ratio
of (i) the total number of shares of Common Stock held by such Stockholder as of
the date of the Transfer Notice (after giving effect to the conversion of all
shares of Preferred Stock held by such Stockholder) to (ii) the number of shares
of Common Stock held by all Stockholders other than the Selling Stockholder as
of such date (after giving effect to the conversion of all shares of Preferred
Stock held by all Stockholders).
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<PAGE>
(v) Each Stockholder's "Co-Sale Pro Rata Share" is the ratio of (i)
the total number of shares of Common Stock of the Company held by such
Stockholder as of the date of the Transfer Notice (after giving effect to the
conversion of all shares of Preferred Stock held by such Stockholder) to (ii)
the number of shares of Common Stock held by all Stockholders as of such date
(after giving effect to the conversion of all shares of Preferred Stock held by
all Stockholders).
(b) Transfer of Shares Upon Failure to Exercise Right of Co-Sale.
------------------------------------------------------------
Subject to the rights of the Company Stockholders who have elected to exercise
rights of first refusal or co-sale, the Selling Stockholder may, not later than
sixty (60) days following delivery to the Company and each of the Stockholders
of the Transfer Notice, conclude a transfer of any or all of the Transfer Shares
covered by the Transfer Notice on terms and conditions substantially similar to
those described in the Transfer Notice. Any proposed transfer on terms and
conditions materially different than those described in the Transfer Notice, as
well as any subsequent proposed transfer of any of the Transfer Shares by the
Selling Stockholder, shall again be subject to the rights of first refusal and
rights of co-sale and shall require compliance by the Selling Stockholder with
the procedures described in this Section.
(c) Binding Effect of Right of Co-Sale. The rights of first refusal and
----------------------------------
co-sale shall be binding upon any transferee of Transfer Shares other than a
transferee acquiring Transfer Shares in a transaction which complies with this
Section.
(d) Termination of Right of Co-Sale. Notwithstanding anything in this
-------------------------------
Section to the contrary, the rights of first refusal and of co-sale shall
terminate on the earlier of (i) the closing date of the Company's IPO; or (ii)
as to any Stockholder at such time as such Stockholder holds less than 2.5% of
the total number of shares of Common Stock held by all Stockholders (after
giving effect to the conversion of all shares of Preferred Stock held by all
Stockholders).
(e) Exceptions. Without regard and not subject to the provisions of
----------
this Section, each Stockholder may transfer all or part of its Shares pursuant
to Section 4 above in an Exempt Transaction; provided, however, that this
Agreement shall be binding upon each transferee in any such Exempt Transaction
and, prior to the completion of such transfer, each transferee or his or her
legal representative shall have executed documents in form and substance
satisfactory to the Company and to a majority in interest of the Investors
evidenced by their written acknowledgment of such satisfaction, assuming the
obligations of the Transferring Stockholder under this Agreement with respect to
the Transfer Shares. Such Transfer Shares shall remain subject to this Section
hereunder, and references to the "Stockholders" hereunder shall be deemed
thereafter to apply to and include the transferor or transferees of any such
shares, provided that in the event of distributions to limited and general
partners of an Investor, such partners of an Investor shall not be required to
execute a written assumption of obligations but shall have notice of and be
bound by such obligations by virtue of the legends set forth in Section 6.2 of
the Strategic Investment Agreements.
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<PAGE>
(f) Conditions to Exercise of Rights. Exercise of the Stockholder's
--------------------------------
rights under this Section shall be subject to and conditioned upon, and the
Selling Stockholder and the Company shall use their best efforts to assist the
Stockholders in, compliance with applicable laws.
(g) Transferability. The rights of first refusal and co-sale rights
---------------
granted to the Stockholders pursuant to this Section shall be transferable only
to a transferee to whom registration rights may be transferred hereunder and who
following such transfer will hold no less than 2.5% of the total number of
shares of Common Stock held by all Stockholders (after giving effect to the
conversion of all shares of Preferred Stock held by all Stockholders).
(h) Restrictions on Strategic Investors. Notwithstanding the rights and
-----------------------------------
obligations set forth in this Section 16, the shares of Preferred Stock or
Common Stock held by the Strategic Investors shall at all times be subject to
the restrictions on transfer set forth in the Strategic Investment Agreements,
and the Strategic Investors shall at all times be subject to the standstill
provision set forth in the Strategic Investment Agreements.
17. Certain Rights.
(a) Basic Financial Information. The Company will furnish the following
---------------------------
reports to each Investor (or its representative) so long as such Investor owns
Preferred Stock (or Common Stock issued upon conversion of such Preferred
Stock):
(i) As soon as practicable after the end of each fiscal year of the
Company, and in any event within 90 days thereafter, the consolidated balance
sheet of the Company and its subsidiaries, if any, as at the end of such fiscal
year, consolidated statements of income and cash flow and notes thereto
(including notes with respect to each department or operating entity) of the
Company and its subsidiaries, if any, for such year, prepared in accordance with
generally accepted accounting principles consistently applied and setting forth
in each case in comparative form the figures for the previous fiscal year, all
in reasonable detail and certified by independent public accountants of
recognized national standing that are among the six largest accounting firms in
the United States selected by the Company and approved by its Board of
Directors.
(ii) As soon as practicable after the end of the first, second and
third quarterly accounting periods in each fiscal year of the Company and in any
event within 45 days thereafter, an unaudited consolidated balance sheet and an
unaudited statement of cash flows of the Company and its subsidiaries, if any,
as of the end of each such quarterly period, and unaudited consolidated
statements of income of the Company and its subsidiaries for such period and for
the current fiscal year to date, in each case with comparable prior periods,
prepared in accordance with generally accepted accounting principles
consistently applied, all in reasonable detail, including any material
discrepancies between the results reported and the Company's
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budgeted projections for the period, as well as other financial or business
events of material importance, and certified, subject to changes resulting from
year-end audit adjustments, by the principal financial or accounting officer of
the Company.
(iii) As soon as practicable after the end each month in each
fiscal year of the Company, and in any event within 30 days thereafter, a
consolidated balance sheet of the Company and its subsidiaries, if any, as of
the end of each such month, and consolidated statements of income and cash flows
and notes thereto (including notes with respect to each department or operating
entity) and its subsidiaries for such period and for the current fiscal year to
date, prepared in accordance with generally accepted accounting principles
consistently applied, subject to changes resulting from year-end audit
adjustments, all in reasonable detail and certified by the principal financial
or accounting officer of the Company.
(iv) Annually (but in any event at least 30 days prior to the
commencement of each fiscal year of the Company) the yearly budget and operating
plan of the Company, in such manner and form as approved by the Board of
Directors of the Company, which plan shall include projected statements of
income and cash flow for such fiscal year and a projected balance sheet as of
the end of such fiscal year. Any material changes in such plan shall be
delivered to the Investors as promptly as practicable after such changes have
been approved by the Board of Directors of the Company.
(v) Access to the Company's and its subsidiaries' books, records
and facilities during normal business hours, and reasonable access to the
Company's officers to discuss the Company's and its subsidiaries' accounts,
finances and affairs.
The provisions of this Section 17(a) shall not be in limitation of any
rights that the Stockholders may have with respect to the books and records of
the Company and its subsidiaries, or to inspect their properties or discuss
their affairs, finances and accounts; and, in the event that the Company is
unable to comply with the provisions of Section 17(a), the Board of Directors of
the Company shall, by resolution duly adopted, authorize and cause a firm of
independent public accountants of nationally recognized standing that is among
the five largest accounting firms in the United States to prepare promptly and
furnish such information to the eligible Stockholders at the Company's expense.
From the date the Company becomes subject to the reporting requirements of
the Exchange Act, and in lieu of the information required pursuant to this
Section 17(a), Company may furnish to the Investors copies of its annual reports
on Form 10-K, its quarterly reports on Form 10-Q, any current reports on Form 8-
K and such other information or interim reports as it provides to all
stockholders.
(b) Transfers of Rights. The rights granted to the Investors under
-------------------
Section 17(a) hereof may be transferred or assigned by an Investor to any
transferee or assignee of any Shares to whom registration rights may be assigned
provided that the Company is given
-24-
<PAGE>
written notice at the time of or within a reasonable time after such transfer or
assignment, stating the name and address of the transferee or assignee and
identifying the securities with respect to which such rights are being
transferred or assigned.
(c) Termination. The provisions of Section 17 shall terminate as to all
-----------
Investors and Strategic Investors upon the closing of an IPO.
18. Board Representation and Voting of Shares.
-----------------------------------------
(a) In any and all elections of directors of the Company (whether at a
meeting or by written consent in lieu of a meeting), each Stockholder shall vote
or cause to be voted all Preferred Stock or Common Stock (for purposes of this
Section 18, the "Voting Stock") owned by such Stockholder, or over which such
Stockholder has voting control, and otherwise use such Stockholder's respective
best efforts, so as to fix the number of directors constituting the Board of
Directors of the Company at eight (8) and to elect as members of said Board (i)
three persons designated by the Investors, of which two persons shall be
designees of Warburg and one person shall be a designee of Crosspoint; provided,
however, that so long as Crosspoint's aggregate investment in the Company is
less than $5,000,000, if Crosspoint fails to invest on a pro rata basis with
Warburg in a subsequent equity financing of the Company, the Crosspoint designee
shall resign and his or her vacancy shall be filled by, and the third such
person shall be, a person mutually designated by Warburg and the Company; (ii)
two persons who are senior officers of the Company, one of whom shall be the
Chief Executive Officer of the Company; and (iii) one person mutually designated
by Warburg and the Company. The directors initially designated by the Investors
are Joseph Landy, Henry Kressel and Rich Shapero, the directors initially
designated by the Company are Charles McMinn and Daniel Lynch and the director
initially designated by Warburg and the Company is Frank Marshall.
(b) The Company shall provide the Stockholders with prior written
notice of any intended mailing of notice to stockholders for a meeting at which
directors are to be elected and the Investors shall notify the Company in
writing, prior to such mailing, of the persons designated by the investors as
nominees for election as directors. If the Investors shall fail to give notice
to the Company as provided above, it shall be deemed that the designees of the
Investors then serving as directors shall be their designees for reelection.
(c) The Stockholders shall not vote to remove any director designated
pursuant to this Agreement, except for bad faith or willful misconduct.
(d) In the event of any vacancy in the Board, such vacancy shall be
filled by a person designated as provided in Section 18(a) above.
(e) In the event any shares of Preferred Stock, Common Stock or other
voting securities are issued by the Company to any Stockholder at any time
during the term of this Agreement, either directly or upon the exercise or
exchange of securities of the Company exer-
-25-
<PAGE>
cisable for or exchangeable into shares Preferred Stock, Common Stock or voting
securities, such additional shares of Preferred Stock, Common Stock or voting
securities, as the case may be, shall be voted, or consent in respect thereof
shall be given, in accordance with the provisions of this Agreement.
(f) Each Strategic Investor agrees to vote or cause to be voted all
Voting Stock owned by it, or over which such Strategic Investor has voting
control, in a manner recommended by the Board of Directors of the Company. Each
Strategic Investor shall either attend each meeting of the stockholders or grant
its proxy to the Secretary of the Company, or, in the case of a written consent
of the stockholders, execute and deliver such consent to the Company.
(g) The voting agreement contained in Section 18(f) shall terminate in
its entirety on January 6, 2002. The voting agreements contained in Section
18(a), (b), (c) and (d) shall terminate upon the closing of an IPO.
(h) The voting agreements contained in this Section 18 are coupled with
an interest and may not be revoked, except by written consent of all of the
Stockholders.
(i) Each and every transferee or assignee of the Voting Stock from any
Stockholder shall be bound by and subject to all the terms and conditions of
this Section 18; provided, however, that this Section 18 shall terminate upon
transfer or assignment to parties that are not Affiliates of the transferor or
assignor. Except with respect to transfers or assignments to parties that are
not Affiliates of the transferor or assignor, so long as the provisions of this
Section 18 are in effect, the Company shall require, as a condition precedent to
the transfer of any Voting Stock covered by this Section 18, that the transferee
agrees in writing to be bound by, and subject to, the terms and conditions of
this Section 18 as provided in this Section 18 and to ensure that Stockholder's
transferees of the Voting Stock shall be likewise bound provided that in the
event of distributions to limited and general partners of an Investor, such
partners of an Investor shall not be required to execute a written assumption of
obligations but shall have notice of and be bound by such obligations by virtue
of the legends set forth in Section 6.2 of the Strategic Investment Agreements.
(i) Each of the parties acknowledge that all other parties hereto will
be irreparably damaged in the event that the provisions of this Section 18 are
not specifically enforced. Accordingly, should any dispute arise pursuant to
this Section 18, the parties agree that a decree of specific performance shall
be an appropriate remedy. Such remedy shall be cumulative and shall be in
addition to any other remedies which any party may have at law or in equity.
19. Visitation. The Company shall permit each Investor (or a representative
----------
thereof), so long as such Investor owns no less than five percent (5%) of the
total number of shares of Preferred Stock outstanding, during such periods as no
designee of such Investor is a member of
-26-
<PAGE>
the Company's Board of Directors, to attend all meetings of the Board of
Directors and committees thereof and will provide to such Investor copies of
written materials provided to all members of the Board of Directors at the same
time and in the same manner that such materials are provided to the members of
the Board of Directors.
20. Governing Law. This Agreement shall be governed in all respects by the
-------------
laws of the State of California, without giving effect to the conflicts of laws
principles thereof.
21. Entire Agreement. This Agreement and the other documents delivered
----------------
pursuant hereto constitute the full and entire understanding and agreement
between the parties with regard to the subjects hereof and thereof.
22. Successors and Assigns. Except as otherwise provided herein, the
----------------------
provisions hereof shall inure to the benefit of and be binding upon, the
successors, assigns, heirs, executors, and administrators of the parties hereto.
23. Notices, etc. All notices and other communications required or
------------
permitted hereunder shall be in writing and shall be deemed effectively given
upon delivery to the party to be notified in person or by courier service or
five days after deposit with the United States mail, by First Class mail,
postage prepaid, addressed (a) if to a Stockholder, at the Stockholder's address
as set forth on Exhibit A hereto, or (b) if to any other holder of any
securities, at such address as such holder shall have furnished the other
parties hereto in writing, or, until any such holder so furnishes an address to
the Company, then to and at the address of the last holder of such Shares who
has so furnished an address to the Company, or (c) if to the Company, to Covad
Communications Group, Inc., 2330 Central Expressway, Santa Clara, CA 95050, and
addressed to the attention of the President, or at such other address as the
Company shall have furnished to the Stockholders.
24. Amendments or Waivers. This Agreement may not be amended, waived,
---------------------
discharged or terminated other than by written instrument signed by the Company
and (a) holders of more than a majority of the outstanding Original Registrable
Securities (on an as-converted to Common Stock basis); provided, however, this
Agreement may not be amended or modified in any manner which shall adversely
affect the rights or obligations of the Strategic Registrable Securities without
the written consent of holders of a majority of the outstanding Strategic
Registrable Securities, and provided further that any amendment adding
additional parties to thisAgreement on the same terms as set forth herein shall
not be deemed to adversely affect such rights or obligations.
25. Waiver of Conflict. Each party to this Agreement that has been or
------------------
continues to be represented by Wilson Sonsini Goodrich & Rosati P.C., counsel to
the Company, hereby acknowledges that Rule 3-310 of the Rules of Professional
Conduct promulgated by the State Bar of California requires an attorney to avoid
representations in which the attorney has or had a relationship with another
party interested in the representation without the informed written consent of
all parties affected. By executing this Agreement, each such party gives his or
its informed written consent to the representation of the Company by Wilson
Sonsini Goodrich & Rosati P.C. in connection with this Agreement and the
transactions contemplated hereby.
-27-
<PAGE>
26. Counterparts. This Agreement may be executed in any number of
------------
counterparts, each of which may be executed by fewer than all of parties hereto,
each of which shall be enforceable against the parties actually executing such
counterparts, and all of which together shall constitute one instrument.
27. Confidentiality. Each party hereto agrees that, except with the prior
---------------
written permission of the other parties, it shall at all times keep confidential
and not divulge, furnish or make accessible to anyone any confidential
information, knowledge or data concerning or relating to the business or
financial affairs of the other parties to which such party has been or shall
become privy by reason of this Agreement. The parties hereto further agree that
there shall be no press release or other public statement issued by either party
relating to this Agreement or the transactions contemplated hereby, unless the
parties otherwise agree in writing and except as required by law.
28. Applicability of Standstill Provision and Voting Agreement to Non-
-----------------------------------------------------------------
Affiliate Purchasers of Strategic Investors. Without changing the respective
- -------------------------------------------
construction of Section 6.3 of the Series C-1 Purchase Agreements and the Series
D-1 Purchase Agreements or Section 18 of this Agreement of an even date
herewith, such sections shall be inapplicable to non-Affiliate purchasers (with
respect to the transferring Investor) and to limited partners of AT&T Venture
Fund II, LP, and Special Partners Fund, LP and Special Partners Fund
International, LP not affiliated with AT&T Corp. who acquire any shares of
Series C-1 Preferred Stock, Series D-1 Preferred Stock, Series C Preferred
Stock, Series D Preferred Stock, Class B Common Stock or Common Stock from a
Strategic Investor.
-28-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first above written.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ DHRUV KHANNA
-------------------------------------
Name: Dhruv Khanna
Title: Vice President, General Counsel
WARBURG, PINCUS VENTURES, L.P.
By: Warburg, Pincus & Co., its General
Partner
By: /s/ JOSEPH P. LANDY
---------------------------------
Partner
CROSSPOINT VENTURE PARTNERS 1996
By: /s/ RICH SHAPERO
-------------------------------------
Name: Rich Shapero
Title: General Partner
INTEL CORPORATION
By: ___________________________________
Name:
Title:
[Stockholder Rights Agreement Signature Page]
-29-
<PAGE>
AT&T Venture Fund II, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management, LLC
its General Partner
By: _____________________
Neal Douglas
Manager
Special Partners Fund, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management III, LLC
its General Partner
By: ___________________
Neal Douglas
Manager
Special Partners Fund International, LP
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
By: Venture Management III, LLC
its Investment General Partner
By: ____________________
Neal Douglas
Manager
[Stockholder Rights Agreement Signature Page]
-30-
<PAGE>
NEXTLINK COMMUNICATIONS, INC.
By: ___________________________________
Name:
Title:
U.S. TELESOURCE, INC.
By: /s/ DRAKE S. TEMPEST
------------------------------------
Name: Drake S. Tempest
Title: Executive Vice President
and General Counsel
[Stockholder Rights Agreement Signature Page]
-31-
<PAGE>
/s/ CHARLES J. MCMINN
---------------------------------------
Charles J. McMinn
/S/ DHRUV KHANNA
---------------------------------------
Dhruv Khanna
---------------------------------------
Charles J. Haas
---------------------------------------
Duncan M. Davidson
/s/ DANIEL LYNCH
---------------------------------------
Daniel Lynch
---------------------------------------
Rex Cardinale
/s/ FRANK J. MARSHALL
---------------------------------------
Frank Marshall
/s/ TIMOTHY P. LAEHY
---------------------------------------
Timothy P. Laehy
/s/ ROBERT HAWK
---------------------------------------
Robert Hawk
[Stockholder Rights Agreement Signature Page]
-32-
<PAGE>
EXHIBIT A
SCHEDULE OF STOCKHOLDERS
Holders of Common Stock Number of Shares
- ----------------------- ----------------
Charles McMinn 3,000,000
24627 Olive Tree Lane
Los Altos Hills, CA 94024
Dhruv Khanna 3,000,000
742 Alester Ave.
Palo Alto, CA 94303
Charles J. Haas 3,000,000
10533 Esquire Place
Cupertino, CA 95014
Duncan Davidson 589,704
415 Camberly Way
Redwood City, CA 94061
Daniel Lynch 144,000
25660 La Lanne Court
Los Altos Hills, CA 94022
Rex Cardinale 1,125,000
Frank Marshall 144,000
20100 Hill Avenue
Saratoga, CA 95070
Timothy P. Laehy 345,000
Holders of Series A Preferred Stock Number of Shares
- ----------------------------------- ----------------
Charles McMinn 150,000
24627 Olive Tree Lane
Los Altos Hills, CA 94024
Dhruv Khanna 150,000
742 Alester Ave.
Palo Alto, CA 94303
-33-
<PAGE>
Charles J. Haas 150,000
10533 Esquire Place
Cupertino, CA 95014
Daniel Lynch 300,000
25660 La Lanne Court
Los Altos Hills, CA 94022
Holders of Series B Preferred Stock Number of Shares
- ----------------------------------- ----------------
Warburg, Pincus Ventures, L.P. 12,000,000
c/o E.M. Warburg, Pincus & Co., LLC
466 Lexington Avenue
New York, NY 10017-3147
Crosspoint Venture Partners 1996 3,000,000
The Pioneer Hotel Building
2925 Woodside Road
Woodside, CA 94062
Intel Corporation 2,000,001
2200 Mission College Boulevard
Santa Clara, CA 95052-8199
Frank Marshall 100,002
20100 Hill Avenue
Saratoga, CA 95070
Holders of Series C Preferred Stock Number of Shares
- ----------------------------------- ----------------
Intel Corporation 360,144
2200 Mission College Boulevard
Santa Clara, CA 95052-8199
Robert Hawk 36,015
6 Hilton Head Drive
Rancho Mirage, CA 92279
-34-
<PAGE>
Holders of Series C-1 Preferred Stock Number of Shares
- ------------------------------------- ----------------
NEXTLINK Communications, Inc. 1,200,466
500 108th Aven. NE, Suite 2200
Bellevue, WA 98004
U.S. Telesource, Inc. 900,349
700 Qwest Tower
555 17th Street
Denver, CO 80202
Special Partners Fund International, LP 712,451
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
AT&T Venture Fund II, LP 660,256
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
Special Partners Fund, LP 127,876
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
Holders of Series D-1 Preferred Stock
- -------------------------------------
NEXTLINK Communications, Inc. 925,926
U.S. Telesource, Inc. 694,445
Special Partners Fund International, LP 549,517
AT&T Venture Fund II, LP 509,260
Special Partners Fund, LP 98,631
-35-
<PAGE>
Exhibit 5.1
[LETTERHEAD OF WILSON SONSINI GOODRICH & ROSATI APPEARS HERE]
January 19, 1999
Covad Communications Group, Inc.
2330 Central Expressway
Santa Clara, CA 95050
Re: Registration Statement on Form S-1
Ladies and Gentlemen:
We have examined the Registration Statement on Form S-1, as amended,
filed by Covad Communications Group, Inc., a Delaware Corporation (the
"Company"), with the Securities and Exchange Commission in connection with the
registration under the Securities Act of 1933, as amended, of up to 8,625,000
shares of the Company's Common Stock (including an over-allotment of up to
1,125,000 shares of the Company's Common Stock granted to the underwriters) (the
"Shares"). The Shares are to be sold to the underwriters for resale to the
public as described in the Registration Statement and pursuant to the
Underwriting Agreement filed as an exhibit thereto. As legal counsel to the
Company, we have examined the proceedings proposed to be taken in connection
with said sale and issuance of the Shares.
Based upon the foregoing, we are of the opinion that the Shares, when
issued in the manner described in the Registration Statement, will be duly
authorized, validly issued, fully paid and nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in the
Registration Statement, including the Prospectus constituting a part thereof,
and any amendment thereto.
Very truly yours,
/s/ WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
Wilson Sonsini Goodrich & Rosati PC
<PAGE>
EXHIBIT 10.13
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF DECEMBER 30, 1998
<PAGE>
TABLE OF CONTENTS
Page
----
SECTION I Purchase and Sale of Shares..................................... 2
---------------------------
1.1 Authorization of Shares....................................... 2
1.2 Sale of the Stock............................................. 2
1.3 Closing....................................................... 2
SECTION II Representations and Warranties of the Company.................. 2
---------------------------------------------
2.1 Organization, Good Standing and Qualifications................ 2
2.2 Valid Issuance, Authority..................................... 3
2.3 No Conflict................................................... 3
2.4 Company Capital Structure..................................... 3
2.5 No Material Misstatements or Omissions........................ 4
2.6 Company Financial Statements.................................. 5
2.7 No Material Changes........................................... 5
2.8 Intellectual Property......................................... 5
SECTION III Representations and Warranties of the Investors............... 5
-----------------------------------------------
3.1 Investment Representations and Covenants...................... 5
3.2 No Public Market.............................................. 7
3.3 Domicile...................................................... 7
3.4 Authority..................................................... 7
3.5 No Conflict................................................... 7
SECTION IV Conditions of Investors' and Company's Obligations at Closing.. 8
-------------------------------------------------------------
4.1 Conditions.................................................... 8
SECTION V Deliveries at Closing........................................... 8
---------------------
5.1 Stockholder Rights Agreement.................................. 8
5.2 Corporate Proceedings......................................... 9
5.3 Amended Certificate of Incorporation.......................... 9
5.4 Opinion of Counsel............................................ 9
5.5 Payment of Purchase Price..................................... 9
SECTION VI Investor Covenants............................................. 9
------------------
6.1 Restrictions on Transfer...................................... 9
6.2 Legends....................................................... 9
6.3 Standstill....................................................10
SECTION VII Company Covenants.............................................11
-----------------
7.1 Periodic Reports..............................................11
7.2 Limitation on Sale............................................11
-i-
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
Page
----
7.3 HSR Filing.................................................... 11
SECTION VIII Miscellaneous................................................ 12
-------------
8.1 Governing Law................................................. 12
8.2 Survival...................................................... 12
8.3 Successors, Assigns........................................... 12
8.4 Notices....................................................... 12
8.5 Expenses...................................................... 12
8.6 Finder's Fees................................................. 12
8.7 Counterparts.................................................. 13
8.8 Severability.................................................. 13
8.9 Applicability of Standstill Provision and Voting Agreement
to Non-Affiliate
Purchasers.................................................... 13
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Share Allocation and Purchase Price of Each Investor
Exhibit D Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of December 30, 1998, by and between Covad
Communications Group, Inc., a Delaware corporation (the "COMPANY") and the
undersigned investors (each, an "INVESTOR" and collectively, the "INVESTORS").
RECITALS
WHEREAS, pursuant to a Series C Preferred Stock and Warrant Subscription
Agreement, dated as of February 20, 1998, as amended on April 24, 1998, among
the Company, Warburg, Pincus Ventures, L.P. ("WARBURG"), Crosspoint Venture
Partners 1996 ("CROSSPOINT"), Intel Corporation and Robert Hawk (the "ORIGINAL
SERIES C AGREEMENT"), the Company has the right to issue and sell to Warburg and
Crosspoint up to 5,728,128 shares of Series C Preferred Stock, par value $.001
per share, of the Company (the "SERIES C PREFERRED STOCK"), provided such
issuance and sale occurs on or prior to March 11, 1999 (the "SERIES C EQUITY
COMMITMENT");
WHEREAS, the Investors are willing to purchase and the Company is willing
to sell an aggregate of 1,500,583 shares of Series C-1 Preferred Stock, par
value $.001 per share (the "SERIES C-1 PREFERRED STOCK"), pursuant to
substantially similar terms as set forth in the Series C Equity Commitment, and
the Company is willing to release Warburg and Crosspoint from any further
obligation under the Series C Equity Commitment;
WHEREAS, simultaneously with the closing of the sale of the shares of
Series C-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 1,157,408 shares of Series D-1 Preferred Stock of the
Company to the Investors, pursuant to a Series D-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investors
(the "SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series C-1 Preferred Stock pursuant to this Agreement, the Company will
terminate the Original Series C Agreement with respect to the Series C Equity
Commitment of Warburg and Crosspoint; and
WHEREAS, the Company and the Investors wish to set forth the terms and
conditions upon which the Company will sell, and the Investors will purchase,
shares of Series C-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investors hereby agree as
follows:
1
<PAGE>
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series C-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set forth
in the Company's Amended and Restated Certificate of Incorporation (the "AMENDED
CERTIFICATE OF INCORPORATION") attached to this Agreement as Exhibit A,
sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investors, and the Investors will purchase
from the Company, at the Closing, an aggregate of 1,500,583 shares of Series C-1
Preferred Stock (the "SHARES") for the aggregate purchase price of
$4,166,668.82, with the respective individual share numbers and purchase prices
of each Investor as set forth in Exhibit C.
1.3 Closing.
-------
(a) The purchase and sale of the Shares shall take place at a closing
(the "CLOSING") to be held at the offices of Wilson Sonsini Goodrich & Rosati,
650 Page Mill Road, Palo Alto, CA 94304-1050, on January 7, 1999.
(b) On the date of the Closing (the "CLOSING DATE"), subject to the
conditions stated herein, the Company will deliver to each Investor stock
certificates representing the Shares to be purchased by each Investor as
provided in Exhibit C against payment to the Company of the purchase price
therefor by wire transfer in federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investors, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investors dated as of the date hereof (the "DISCLOSURE
LETTER") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions in
which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the failure
to be so qualified would not have a material adverse effect on the business,
2
<PAGE>
properties, financial condition or results of operations of the Company and its
subsidiaries, taken as a whole (a "MATERIAL ADVERSE EFFECT"). The outstanding
shares of capital stock of each of its subsidiaries have been duly authorized
and validly issued, are fully paid and non-assessable, and are owned by the
Company free and clear of all liens, encumbrances and equities and claims; and
no options, warrants or other rights to purchase, agreements or other
obligations to issue or other rights to convert any obligations into shares of
capital stock or ownership interests in such subsidiaries are outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation will
be duly and validly issued, fully paid and nonassessable. The Company has all
requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated hereby
and thereby. The execution and delivery of this Agreement and the Stockholder
Rights Agreement by the Company, and the consummation by the Company of the
transactions contemplated hereby and thereby have been duly authorized by all
necessary action on the part of the Company and, no other proceedings are
necessary to authorize this Agreement and the Stockholder Rights Agreement or to
consummate the transactions contemplated hereby and thereby. This Agreement and
the Stockholder Rights Agreement have been duly executed and delivered by the
Company and constitute legal, valid and binding obligations of the Company
enforceable against the Company in accordance with their respective terms. The
sale of the Shares and the subsequent conversion of the Shares into Series C
Preferred, Class B Common and Common Stock are not and will not be subject to
any preemptive rights, rights of first refusal or rights of participation that
have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any subsidiary
or any of their respective properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Company or any subsidiary or their respective properties or assets,
except in the case of (ii) and (iii) for any of the foregoing that in the
aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
-------------------------
(a) Immediately prior to Closing, the authorized capital stock of the
Company will consist of 100,000,000 shares of authorized Common Stock, $.001 par
value, of which 11,722,116 shares are issued and outstanding as of December 16,
1998 and of which 10,000,000 are designated Class B Common, none of which are
outstanding, and 50,000,000 shares of Preferred
3
<PAGE>
Stock, $.001 par value, of which 750,000 shares are designated Series A
Preferred Stock, all of which are outstanding, 17,100,003 shares are designated
Series B Preferred, all of which are outstanding, 11,149,287 shares are
designated Series C Preferred, 396,159 of which are outstanding, 6,000,000
shares are designated Series C-1 Preferred, none of which are outstanding,
5,000,000 shares are designated Series D Preferred, none of which are
outstanding and 5,000,000 shares are designated Series D-1 Preferred, none of
which are outstanding (collectively, the "COMPANY CAPITAL STOCK"). Except as
provided in the Stockholders Rights Agreement, all outstanding shares of Company
Capital Stock are duly authorized, validly issued, fully paid and non-
assessable, are not subject to preemptive rights created by statute, the
Certificate of Incorporation or Bylaws of the Company or any agreement to which
the Company is a party or by which it is bound and have been issued in
compliance with federal and state securities laws. The Company has no other
capital stock authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "OPTION
PLAN") and the 1998 Employee Stock Purchase Plan (the "PURCHASE PLAN"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person. The Company has reserved
15,520,342 shares of Company Common Stock for issuance to employees, directors
and consultants pursuant to the Option Plan, 12,358,723 of which are subject to
outstanding options under the Option Plan as of December 16, 1998 and has
reserved 1,000,000 shares for the Purchase Plan, none of which are issued and
outstanding. The Company has issued warrants to purchase 6,988,764 shares of
Common Stock, all of which are outstanding. The Company has reserved 6,988,764
shares of Company Common Stock for issuance upon the exercise of such warrants.
Except as described in this Section 2.4(b), there are no options, warrants,
calls, rights, commitments or agreements of any character, written or oral, to
which the Company is a party or by which it is bound obligating the Company to
issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered,
sold, repurchased or redeemed, any shares of the capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "REGISTRATION STATEMENT") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on December 18, 1998 (the "FILING
DATE"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"SECURITIES ACT") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading. In the event prior to
the Closing Date, the Company files an amendment to the Registration Statement,
then the term "Registration Statement" as used in this Agreement shall
thereafter refer to the most recently filed such amendment and the term "Filing
Date" shall thereafter refer to the date such most recent amendment is filed.
The information set forth in the next such amendment to the Registration
Statement filed with the Commission will not reflect any material adverse
change, when taken as a whole, from the information set forth in the draft of
such amendment provided to the Investors.
4
<PAGE>
2.6 Company Financial Statements. The Registration Statement includes
----------------------------
(i) the Company's audited balance sheet as of September 30, 1998, and the
related audited statements of operations, stockholders' equity and cash flows
for the nine-month period ended September 30, 1998 and (ii) the Company's
audited balance sheet as of December 31, 1997, and the related audited
statements of operations, stockholders' equity and cash flows for the year ended
December 31, 1997, (collectively, the "COMPANY FINANCIALS"). The Company
Financials have been prepared in accordance with U.S. generally accepted
accounting principles consistent with the reporting practices and principles
("GAAP"), applied on a basis consistent throughout the periods indicated and
consistent with each other. The Company Financials present fairly the financial
condition, operating results and cash flows of the Company as of the dates and
during the periods indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been
-------------------
any materially adverse change in the business, properties, financial condition
or results of operations of the Company, whether or not arising from
transactions in the ordinary course of business, other than as set forth in the
Registration Statement, and since such date, except in the ordinary course of
business, the Company has not entered into any material transaction not referred
to in the Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("INTELLECTUAL PROPERTY")
employed in the operation of their respective businesses as currently conducted,
and, to the knowledge of the Company, with no infringement of or conflict with
the rights of others respecting any of the same. Neither the Company nor any
subsidiary has received any communications alleging that the Company or any
subsidiary has violated any of the Intellectual Property of any other person or
entity. Reasonable security measures have been taken by the Company and its
subsidiaries to protect the secrecy, confidentiality and value of the Company's
and its subsidiaries' trade secrets, including their respective know-how,
technology, concepts and other technical data for the development, processing,
manufacture and sale of its products. Each employee of and consultant to the
Company or its subsidiaries has executed an invention assignment and
confidentiality agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investors
-----------------------------------------------
Each Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and not
with a view to the sale or
5
<PAGE>
distribution of any part thereof, and that it has no present intention of
selling, granting any participation in or otherwise distributing the same.
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series C
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided for
in this Agreement and the issuance of securities hereunder is exempt pursuant to
Section 4(2) of the Securities Act, and that the Company's reliance on such
exemption is predicated in part on the Investor's representations set forth
herein.
(c) Investor represents that it is experienced in evaluating companies
such as the Company, is able to fend for itself in transactions such as the one
contemplated by this Agreement, has such knowledge and experience in financial
and business matters that it is capable of evaluating the merits and risks of
its prospective investment in the Company and is able to afford a complete loss
of its investment. The Company acknowledges that the foregoing representation
shall not limit the right of the Investors to rely on the representations of the
Company set forth in Section 2 hereof.
(d) Investor acknowledges and understands that the Shares and any
Series C Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares or
Series C Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series C
Preferred, Class B Common Stock and Common Stock issued upon conversion thereof,
may be sold under Rule 144, the following conditions must be fulfilled, except
as otherwise described below: (i) certain public information about the Company
must be available; (ii) the sale must occur at least one year after the later of
the date the Shares were sold by the Company or the date they were sold by an
affiliate of the Company; (iii) the sale must be made in a broker's transaction;
and (iv) the number of Shares sold must not exceed certain volume limitations.
If, however, the sale occurs at least two years after the Shares were sold by
the Company or an affiliate of the Company, and if the Investor is not an
affiliate of the Company, the foregoing conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion that
persons proposing to sell restricted securities received in a private offering
other than in a registered offering or pursuant to Rule 144 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 the brokers who
participate in the transactions do so at their own risk.
6
<PAGE>
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer or
otherwise dispose of the Shares and any Series C Preferred, Class B Common Stock
and Common Stock issued on conversion thereof only in a manner consistent with
its representations and covenants set forth in this Agreement and the
Stockholder Rights Agreement. In connection therewith such Purchaser
acknowledges that the Company shall make a notation on its stock books regarding
the restrictions on transfer set forth in this Agreement and the Stockholder
Rights Agreement and shall transfer shares on the books of the Company only to
the extent not inconsistent therewith.
(h) Investor represents that it is an "ACCREDITED INVESTOR" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no assurance
a public market will be created.
3.3 Domicile. Each Investor is domiciled in the state set forth at its
--------
address in Section 8.4.
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out its
obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been duly
authorized by all necessary action on the part of the Investor and, no other
proceedings are necessary to authorize this Agreement and the Stockholder Rights
Agreement or to consummate the transactions contemplated hereby and thereby.
This Agreement and the Stockholder Rights Agreement have been duly executed and
delivered by the Investor and constitute legal, valid and binding obligations of
the Investor enforceable against the Investor in accordance with their
respective terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to which
the Investor or any of its properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Investor or its properties or assets, except in the case of (ii) and
(iii) for any of the foregoing that in the aggregate would not have a material
adverse effect on Investor.
7
<PAGE>
SECTION IV
Conditions of Investors' and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of each
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investors at the Closing except for the deliveries set forth in Section V and
the fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investors and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation of
the transactions contemplated by this Agreement.
(d) Stockholder Rights Agreement. The Company, the Investors and a
----------------------------
majority of such other parties required to amend the Stockholder Rights
Agreement shall have entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
(f) Series D-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investors shall have purchased an aggregate of 1,157,408 shares of Series D-
1 Preferred Stock of the Company, pursuant to the Series D-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investors, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the
8
<PAGE>
Company and the Investors on the date hereof (the "STOCKHOLDER RIGHTS
AGREEMENT") and as amended by its existing stockholders prior to the Closing.
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investors to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver such
------------------------------------
copy of the Amended Certificate of Incorporation as filed with the Secretary of
State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in
------------------
form of Exhibit D, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Each Investor shall deliver to the
-------------------------
Company payment for the Shares to be acquired by such Investor in the amounts
set forth in Exhibit C hereto.
---------
SECTION VI
Investor Covenants
------------------
6.1 Restrictions on Transfer. No Investor shall, directly or indirectly,
------------------------
sell or transfer any Shares or any Series C Preferred, Class B Common Stock or
Common Stock issued upon conversion thereof for a period of one year following
the Closing Date, except pursuant to a sale of all the capital stock of the
Company or a merger or consolidation in which the Company is acquired, or
pursuant to a liquidation of the Company. However, an Investor may sell or
transfer the Shares or Series C Preferred, Class B Common Stock or such Common
Stock to (i) any "AFFILIATE" (as such term is defined under Rule 501(b)
promulgated under the Securities Act) of an Investor, AT&T Corp. or any
Affiliates of AT&T Corp. during such one year period or (ii) any third party
after such one year period, provided that such Affiliate or third party, as the
case may be, agrees in writing to be bound by the obligations of this Agreement
and the restrictions on transfer, including without the limitation, the "lock-
up" agreement, set forth in the Stockholder Rights Agreement. No such transfer
shall be effective unless the transferee or assignee assumes in writing the
obligations of the Investor under this Agreement, provided that in the event of
distributions to limited and general partners of an Investor, such partners of
an Investor shall not be required to execute a written assumption of obligations
but shall have notice of and be bound by such obligations by virtue of the
legends set forth in Section 6.2 hereof.
6.2 Legends. Investor agrees that each certificate representing Shares
-------
or any Common Stock issued upon conversion thereof be endorsed with the
following restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR
9
<PAGE>
ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT BE SOLD OR OFFERED FOR SALE
IN THE ABSENCE OF SUCH REGISTRATION OR AN OPINION OF COUNSEL SATISFACTORY
TO THE COMPANY AND ITS COUNSEL THAT SUCH REGISTRATION IS NOT REQUIRED UNDER
THE ACT. COPIES OF THE AGREEMENTS COVERING THE PURCHASE OF THESE SHARES AND
RESTRICTING THEIR TRANSFER MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST
MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF THE
CORPORATION AT THE PRINCIPAL EXECUTIVE OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE, RESTRICTIONS ON TRANSFER AND
ACQUISITION OF ADDITIONAL SECURITIES OF THE COMPANY, COPIES OF WHICH ARE ON
FILE AT THE PRINCIPAL OFFICE OF THE COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
each Investor shall not, and shall cause each of its Affiliates (as defined
below) that it controls to not, acquire beneficial ownership (as such term is
defined in Rule 13d-3 of the Securities Exchange Act of 1934, as amended) of any
securities of the Company in addition to the Shares or any Series C Preferred,
Class B Common and Common Stock issued upon conversion thereof, which would
result in the aggregate beneficial ownership of each Investor and its Affiliates
of Voting Stock of the Company (as defined below) equaling or exceeding 10% of
the outstanding Voting Stock of the Company. Each Investor or any of its
Affiliates that it controls shall not purchase any securities of the Company
without having given 30 days prior written notice to the Company or without
having received the prior written consent of the Company. Upon notice thereof,
the Company shall inform the Investor whether such purchases cause the aggregate
beneficial ownership of Investor and its Affiliates to equal or exceed 10% of
the outstanding Voting Stock of the Company. For the purposes of this Agreement,
"Affiliate" shall mean, as to any person or entity, a person or entity that,
directly or indirectly through one or more intermediaries, controls, or is
controlled by, or is under common control with, such person or entity. In
addition, with respect to an Investor, only for the purposes of this Agreement,
AT&T Corp., all Affiliates of AT&T Corp., each of the other Investors and all
beneficial owners of equity interests in the Investor shall be deemed to be
Affiliates of such Investor. For the purposes of this Agreement, "Voting Stock
of the Company" shall mean, any class or Series of the Company's capital stock
entitled to vote in any election of directors of the Company.
10
<PAGE>
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as the Investor continues
to own Shares or any Common Stock issued upon conversion thereof, copies of the
Company's Forms 10-K, 10-Q and Annual Report to Shareholders, promptly after
such documents are filed with the SEC, or in lieu of such reports, unaudited
quarterly and audited annual financial statements of the Company, promptly after
completion.
7.2 Limitation on Sale. The Company covenants until the completion of
------------------
an underwritten public offering pursuant to an effective registration statement
under the Securities Act, covering the initial offer and sale of Common Stock
for the account of the Company to the public with aggregate gross proceeds to
the Company of not less than Fifteen Million Dollars ($15,000,000) (the "IPO")
not to issue or sell any shares of Series C Preferred Stock, Series D Preferred
Stock, Series C-1 Preferred Stock or Series D-1 Preferred Stock to any investor
at a more favorable price or upon more favorable terms (including rights,
preferences, privileges and restrictions) than those set forth in the Company's
Amended and Restated Certificate of Incorporation, this Agreement and the Series
D-1 Preferred Stock Purchase Agreement, and the Amended and Restated Stockholder
Rights Agreement without the prior written consent of Venture Management, LLC
and Venture Management III, LLC. Notwithstanding the foregoing, the Company
expressly reserves the right to sell shares of its Series C Preferred Stock
and/or Series D Preferred Stock without the prior written consent of Venture
Management, LLC and Venture Management III, LLC, provided that such shares shall
not have been sold or issued by the Company at a more favorable price or on more
favorable terms (other than the existence of voting rights) than those which are
reflected in this Agreement, the Series D-1 Preferred Stock Purchase Agreement,
the Amended and Restated Stockholder Rights and the Amended and Restated
Certificate of Incorporation.
7.3 HSR Filing. In the event the Investors determine that the purchase
----------
of the Shares hereunder has not been "solely for the purpose of investment" (as
defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investors determine that as a result the Company and the Investors are required
to make appropriate filings with the Federal Trade Commission and Department of
Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended (the "HSR ACT"), the Company and Investors agree to cooperate, to make
such filings in a timely manner, and to take all other appropriate action in
connection with such required filings.
11
<PAGE>
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the closing
of the transactions contemplated hereby.
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to AT&T Venture
Fund II, LP, at 3000 Sand Hill Road, Building 1, Suite 285, Menlo Park, CA
94025, Attn: Neal Douglas, or at such other address as such Investor shall have
furnished to the Company in writing; (b) if to Special Partners Fund, LP, at
3000 Sand Hill Road, Building 1, Suite 285, Menlo Park, CA 94025, Attn: Neal
Douglas, or at such other address as such Investor shall have furnished to the
Company in writing; (c) if to Special Partners Fund International, LP, at Ugland
House, South Church Street, Georgetown, Grand Cayman, Cayman Islands, with
copies to 3000 Sand Hill Road, Building 1, Suite 285, Menlo Park, CA 94025,
Attn: Neal Douglas, or at such other address as such Investor shall have
furnished to the Company in writing or (b) if to the Company, at 2330 Central
Expressway, Santa Clara, California 95050 addressed to the attention of the
Corporate Secretary, or at such other address as the Company shall have
furnished to the Investor. If notice is provided by facsimile, it must be
simultaneously confirmed via telephone and it shall be deemed to be given one
(1) day after transmission. If notice is provided by U.S. mail, notice shall be
deemed to be given three (3) days after proper deposit in a U.S. mailbox,
postage prepaid.
8.5 Expenses. The Company and the Investors shall bear their own
--------
expenses and legal fees incurred on their behalf with respect to this Agreement
and the transactions contemplated hereby; provided, however, that the Company
will pay the reasonable fees and expenses of counsel for the Investors up to an
aggregate amount of $15,000, for fees and expenses incurred in connection with
this Agreement, the Series D-1 Preferred Stock Purchase Agreement and the
Stockholder Rights Agreement.
8.6 Finder's Fees. The Company on the one hand and the Investors on the
-------------
other hand shall each indemnify and hold the other harmless from any liability
for any commission or compensation in the nature of a finder's fee, placement
fee or underwriter's discount (including the costs, expenses and legal fees of
defending against such liability) for which the Company or the
12
<PAGE>
Investors, or any of their respective partners, employees, or representatives,
as the case may be, is responsible.
8.7 Counterparts. This Agreement may be executed in counterparts, each
------------
of which shall be enforceable against the party actually executing the
counterpart, and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective if
it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and Restated
Stockholder Rights Agreement of an even date herewith, such sections shall be
inapplicable to non-Affiliate purchasers (with respect to the transferring
Investor) and to limited partners of AT&T Venture Fund II, LP, Special Partners
Fund, LP and Special Partners Fund International, LP not affiliated with AT&T
Corp. who acquire any shares of Series C-1 Preferred Stock, Series C Preferred
Stock, Class B Common Stock or Common Stock from an Investor.
13
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series C-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ Dhruv Khanna
------------------------------------
Name: Dhruv Khanna
Title: V.P. & General Counsel
AT&T VENTURE FUND II, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management, LLC
its General Partner
By:
-------------------------------
Neal Douglas
Manager
SPECIAL PARTNERS FUND, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management III, LLC
its General Partner
By:
-------------------------------
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series C-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By:
------------------------------------
Name:
Title:
AT&T VENTURE FUND II, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management, LLC
its General Partner
By: /s/ Neal Douglas
-------------------------------
Neal Douglas
Manager
SPECIAL PARTNERS FUND, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management III, LLC
its General Partner
By: /s/ Neal Douglas
-------------------------------
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
SPECIAL PARTNERS FUND INTERNATIONAL, LP
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
By: Venture Management III, LLC
its Investment General Partner
By: /s/ Neal Douglas
-------------------------------
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
EXHIBIT A
---------
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
<PAGE>
EXHIBIT B
---------
STOCKHOLDER RIGHTS AGREEMENT
<PAGE>
EXHIBIT C
---------
SHARE ALLOCATION AND PURCHASE PRICE OF EACH INVESTOR
<TABLE>
<CAPTION>
Investor Series C-1 Shares Purchase Price
-------- ----------------- --------------
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
AT&T Venture Fund II, LP 660,256 $1,833,332.84
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
- -----------------------------------------------------------------------------------------------------
Special Partners Fund, LP 127,876 $ 355,073.29
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
- -----------------------------------------------------------------------------------------------------
Special Partners Fund International, LP 712,451 $1,978,262.69
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
- -----------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
EXHIBIT D
---------
OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.14
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF DECEMBER 30, 1998
<PAGE>
TABLE OF CONTENTS
PAGE
----
SECTION I Purchase and Sale of Shares.........................................2
---------------------------
1.1 Authorization of Shares............................................2
1.2 Sale of the Stock..................................................2
1.3 Closing............................................................3
SECTION II Representations and Warranties of the Company......................3
---------------------------------------------
2.1 Organization, Good Standing and Qualifications.....................3
2.2 Valid Issuance, Authority..........................................3
2.3 No Conflict........................................................4
2.4 Company Capital Structure..........................................4
2.5 No Material Misstatements or Omissions.............................5
2.6 Company Financial Statements.......................................5
2.7 No Material Changes................................................5
2.8 Intellectual Property..............................................6
SECTION III Representations and Warranties of the Investors...................6
-----------------------------------------------
3.1 Investment Representations and Covenants...........................6
3.2 No Public Market...................................................7
3.3 Domicile...........................................................8
3.4 Authority..........................................................8
3.5 No Conflict........................................................8
SECTION IV Conditions of Investors' and Company's Obligations at Closing......8
-------------------------------------------------------------
4.1 Conditions.........................................................8
SECTION V Deliveries at Closing...............................................9
---------------------
5.1 Stockholder Rights Agreement.......................................9
5.2 Corporate Proceedings..............................................9
5.3 Amended Certificate of Incorporation...............................9
5.4 Opinion of Counsel.................................................9
5.5 Payment of Purchase Price..........................................9
SECTION VI Investor Covenants................................................10
------------------
6.1 Restrictions on Transfer..........................................10
6.2 Legends...........................................................10
6.3 Standstill........................................................11
SECTION VII Company Covenants................................................11
-----------------
7.1 Periodic Reports..................................................11
7.2 Limitation on Sale................................................11
7.3 HSR Filing........................................................12
-i-
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TABLE OF CONTENTS
(CONTINUED)
PAGE
----
SECTION VIII Miscellaneous...................................................12
-------------
8.1 Governing Law.....................................................12
8.2 Survival..........................................................12
8.3 Successors, Assigns...............................................12
8.4 Notices...........................................................12
8.5 Expenses..........................................................13
8.6 Finder's Fees.....................................................13
8.7 Counterparts......................................................13
8.8 Severability......................................................13
8.9 Applicability of Standstill Provision and Voting Agreement to
Non-Affiliate Purchasers..........................................13
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Share Allocation and Purchase Price of Each Investor
Exhibit D Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of December 30, 1998, by and between Covad
Communications Group, Inc., a Delaware corporation (the "COMPANY") and the
undersigned investors (each, an "INVESTOR" and collectively, the "INVESTORS").
RECITALS
WHEREAS, the Investors desire to purchase and the Company desires to sell
an aggregate of 1,157,408 shares of Series D-1 Preferred Stock, par value $.001
per share, of the Company (the "SERIES D-1 PREFERRED STOCK");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series D-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 1,500,583 shares of Series C-1 Preferred Stock of the
Company to the Investors, pursuant to a Series C-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investors
(the "SERIES C PREFERRED STOCK PURCHASE AGREEMENT"); and
WHEREAS, the Company and the Investors wish to set forth the terms and
conditions upon which the Company will sell, and the Investors will purchase,
shares of Series D-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investor hereby agree as
follows:
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series D-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set forth
in the Company's Amended and Restated Certificate of Incorporation (the "AMENDED
CERTIFICATE OF INCORPORATION") attached to this Agreement as Exhibit A,
sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investors, and the Investors will purchase
from the Company, at the Closing, an aggregate of 1,157,408 shares of Series D-1
Preferred Stock (the "SHARES") for the aggregate purchase price of $20,833,344,
with the respective individual share numbers and purchase prices of each
Investor as set forth in Exhibit C.
2
<PAGE>
1.3 Closing.
--------
(a) The purchase and sale of the Shares shall take place at a closing
(the "CLOSING") to be held at the offices of Wilson Sonsini Goodrich & Rosati,
650 Page Mill Road, Palo Alto, CA 94304-1050, on January 7, 1999.
(b) On the date of the Closing (the "CLOSING DATE"), subject to the
conditions stated herein, the Company will deliver to each Investor stock
certificates representing the Shares to be purchased by such Investor as
provided in Exhibit C against payment to the Company of the purchase price
therefor by wire transfer in federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investors, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investors dated as of the date hereof (the "Disclosure
Letter") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions in
which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the failure
to be so qualified would not have a material adverse effect on the business,
properties, financial condition or results of operations of the Company and its
subsidiaries, taken as a whole (a "MATERIAL ADVERSE EFFECT"). The outstanding
shares of capital stock of each of its subsidiaries have been duly authorized
and validly issued, are fully paid and non-assessable, and are owned by the
Company free and clear of all liens, encumbrances and equities and claims; and
no options, warrants or other rights to purchase, agreements or other
obligations to issue or other rights to convert any obligations into shares of
capital stock or ownership interests in such subsidiaries are outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation will
be duly and validly issued, fully paid and nonassessable. The Company has all
requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated hereby
and thereby. The execution and delivery of this Agreement and the Stockholder
Rights Agreement by the Company, and the consummation by the Company of the
transactions contemplated hereby and thereby have been duly authorized by all
necessary action on the part of the Company and, no other
3
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proceedings are necessary to authorize this Agreement and the Stockholder Rights
Agreement or to consummate the transactions contemplated hereby and thereby.
This Agreement and the Stockholder Rights Agreement have been duly executed and
delivered by the Company and constitute legal, valid and binding obligations of
the Company enforceable against the Company in accordance with their respective
terms. The sale of the Shares and the subsequent conversion of the Shares into
Series D Preferred, Class B Common and Common Stock are not and will not be
subject to any preemptive rights, rights of first refusal or rights of
participation that have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any subsidiary
or any of their respective properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Company or any subsidiary or their respective properties or assets,
except in the case of (ii) and (iii) for any of the foregoing that in the
aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
--------------------------
(a) Immediately prior to Closing, the authorized capital stock of the
Company will consist of 100,000,000 shares of authorized Common Stock, $.001 par
value, of which 11,722,116 shares are issued and outstanding as of December 16,
1998 and of which 10,000,000 are designated Class B Common, none of which are
outstanding, and 50,000,000 shares of Preferred Stock, $.001 par value, of which
750,000 shares are designated Series A Preferred Stock, all of which are
outstanding, 17,100,003 shares are designated Series B Preferred, all of which
are outstanding, 11,149,287 shares are designated Series C Preferred, 396,159 of
which are outstanding, 6,000,000 shares are designated Series C-1 Preferred,
none of which are outstanding, 5,000,000 shares are designated Series D
Preferred, none of which are outstanding and 5,000,000 shares are designated
Series D-1 Preferred, none of which are outstanding (collectively, the "COMPANY
CAPITAL STOCK"). Except as provided in the Stockholders Rights Agreement, all
outstanding shares of Company Capital Stock are duly authorized, validly issued,
fully paid and non-assessable, are not subject to preemptive rights created by
statute, the Certificate of Incorporation or Bylaws of the Company or any
agreement to which the Company is a party or by which it is bound and have been
issued in compliance with federal and state securities laws. The Company has no
other capital stock authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "OPTION
PLAN") and the 1998 Employee Stock Purchase Plan (the "Purchase Plan"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person. The Company has reserved
15,520,342 shares of Company Common Stock for issuance to
4
<PAGE>
employees, directors and consultants pursuant to the Option Plan, 12,358,723 of
which are subject to outstanding options under the Option Plan as of December
16, 1998 and has reserved 1,000,000 shares for the Purchase Plan, none of which
are issued and outstanding. The Company has issued warrants to purchase
6,988,764 shares of Common Stock, all of which are outstanding. The Company has
reserved 6,988,764 shares of Company Common Stock for issuance upon the exercise
of such warrants. Except as described in this Section 2.4(b), there are no
options, warrants, calls, rights, commitments or agreements of any character,
written or oral, to which the Company is a party or by which it is bound
obligating the Company to issue, deliver, sell, repurchase or redeem, or cause
to be issued, delivered, sold, repurchased or redeemed, any shares of the
capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "REGISTRATION STATEMENT") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on December 18, 1998 (the "FILING
DATE"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"SECURITIES ACT") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading. In the event prior to
the Closing Date, the Company files an amendment to the Registration Statement,
then the term "Registration Statement" as used in this Agreement shall
thereafter refer to the most recently filed such amendment and the term "Filing
Date" shall thereafter refer to the date such most recent amendment is filed.
The information set forth in the next such amendment to the Registration
Statement filed with the Commission will not reflect any material adverse
change, when taken as a whole, from the information set forth in the draft of
such amendment provided to the Investors.
2.6 Company Financial Statements. The Registration Statement includes
----------------------------
(i) the Company's audited balance sheet as of September 30, 1998, and the
related audited statements of operations, stockholders' equity and cash flows
for the nine-month period ended September 30, 1998 and (ii) the Company's
audited balance sheet as of December 31, 1997, and the related audited
statements of operations, stockholders' equity and cash flows for the year ended
December 31, 1997, (collectively, the "COMPANY FINANCIALS"). The Company
Financials have been prepared in accordance with U.S. generally accepted
accounting principles consistent with the reporting practices and principles
("GAAP"), applied on a basis consistent throughout the periods indicated and
consistent with each other. The Company Financials present fairly the financial
condition, operating results and cash flows of the Company as of the dates and
during the periods indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been any
-------------------
materially adverse change in the business, properties, financial condition or
results of operations of the Company, whether or not arising from transactions
in the ordinary course of
5
<PAGE>
business, other than as set forth in the Registration Statement, and since such
date, except in the ordinary course of business, the Company has not entered
into any material transaction not referred to in the Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("INTELLECTUAL PROPERTY")
employed in the operation of their respective businesses as currently conducted,
and, to the knowledge of the Company, with no infringement of or conflict with
the rights of others respecting any of the same. Neither the Company nor any
subsidiary has received any communications alleging that the Company or any
subsidiary has violated any of the Intellectual Property of any other person or
entity. Reasonable security measures have been taken by the Company and its
subsidiaries to protect the secrecy, confidentiality and value of the Company's
and its subsidiaries' trade secrets, including their respective know-how,
technology, concepts and other technical data for the development, processing,
manufacture and sale of its products. Each employee of and consultant to the
Company or its subsidiaries has executed an invention assignment and
confidentiality agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investors
-----------------------------------------------
Each Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
-----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and not
with a view to the sale or distribution of any part thereof, and that it has no
present intention of selling, granting any participation in or otherwise
distributing the same.
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series D
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided for
in this Agreement and the issuance of securities hereunder is exempt pursuant to
Section 4(2) of the Securities Act, and that the Company's reliance on such
exemption is predicated in part on the Investor's representations set forth
herein.
(c) Investor represents that it is experienced in evaluating
companies such as the Company, is able to fend for itself in transactions such
as the one contemplated by this Agreement, has such knowledge and experience in
financial and business matters that it is capable of evaluating the merits and
risks of its prospective investment in the Company and is able to afford a
complete loss of its investment. The Company acknowledges that the foregoing
representation shall not limit the right of the Investors to rely on the
representations of the Company set forth in Section 2 hereof.
6
<PAGE>
(d) Investor acknowledges and understands that the Shares and any
Series D Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares or
Series D Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series D
Preferred, Class B Common Stock and Common Stock issued upon conversion thereof,
may be sold under Rule 144, the following conditions must be fulfilled, except
as otherwise described below: (i) certain public information about the Company
must be available; (ii) the sale must occur at least one year after the later of
the date the Shares were sold by the Company or the date they were sold by an
affiliate of the Company; (iii) the sale must be made in a broker's transaction;
and (iv) the number of Shares sold must not exceed certain volume limitations.
If, however, the sale occurs at least two years after the Shares were sold by
the Company or an affiliate of the Company, and if the Investor is not an
affiliate of the Company, the foregoing conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion that
persons proposing to sell restricted securities received in a private offering
other than in a registered offering or pursuant to Rule 144 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 the brokers who
participate in the transactions do so at their own risk.
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer or
otherwise dispose of the Shares and any Series D Preferred, Class B Common Stock
and Common Stock issued on conversion thereof only in a manner consistent with
its representations and covenants set forth in this Agreement and the
Stockholder Rights Agreement. In connection therewith such Purchaser
acknowledges that the Company shall make a notation on its stock books regarding
the restrictions on transfer set forth in this Agreement and the Stockholder
Rights Agreement and shall transfer shares on the books of the Company only to
the extent not inconsistent therewith.
(h) Investor represents that it is an "ACCREDITED INVESTOR" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no assurance
a public market will be created.
7
<PAGE>
3.3 Domicile. Each Investor is domiciled in the state set forth at its
--------
address in Section 8.4.
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out its
obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been duly
authorized by all necessary action on the part of the Investor and, no other
proceedings are necessary to authorize this Agreement and the Stockholder Rights
Agreement or to consummate the transactions contemplated hereby and thereby.
This Agreement and the Stockholder Rights Agreement have been duly executed and
delivered by the Investor and constitute legal, valid and binding obligations of
the Investor enforceable against the Investor in accordance with their
respective terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to which
the Investor or any of its properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Investor or its properties or assets, except in the case of (ii) and
(iii) for any of the foregoing that in the aggregate would not have a material
adverse effect on Investor.
SECTION IV
Conditions of Investors' and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of each
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investors at the Closing except for the deliveries set forth in Section V and
the fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investors and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
8
<PAGE>
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation
of the transactions contemplated by this Agreement.
(d) Stockholder Rights Agreement. The Company, the Investors and a
----------------------------
majority of such other parties required to amend the Stockholder Rights
Agreement shall have entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
(f) Series C-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investors shall have purchased an aggregate of 1,500,583 shares of Series
C-1 Preferred Stock of the Company, pursuant to the Series C-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investors, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the Company and the Investors on the date hereof
(the "STOCKHOLDER RIGHTS AGREEMENT") and as amended by its existing stockholders
prior to the Closing.
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investors to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver such
------------------------------------
copy of the Amended Certificate of Incorporation as filed with the Secretary of
State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in
------------------
form of Exhibit D, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Each Investor shall deliver to the
-------------------------
Company payment for the Shares to be acquired by such Investor in the amounts
set forth in Exhibit C hereto.
---------
9
<PAGE>
SECTION VI
Investor Covenants
------------------
6.1 Restrictions on Transfer. No Investor shall, directly or indirectly,
------------------------
sell or transfer any Shares or any Series D Preferred, Class B Common Stock or
Common Stock issued upon conversion thereof for a period of one year following
the Closing Date, except pursuant to a sale of all the capital stock of the
Company or a merger or consolidation in which the Company is acquired, or
pursuant to a liquidation of the Company. However, an Investor may sell or
transfer the Shares or Series D Preferred, Class B Common Stock or such Common
Stock to (i) any "AFFILIATE" (as such term is defined under Rule 501(b)
promulgated under the Securities Act) of an Investor, AT&T Corp. or any
Affiliates of AT&T Corp. during such one year period or (ii) any third party
after such one year period, provided that such Affiliate or third party, as the
case may be, agrees in writing to be bound by the obligations of this Agreement
and the restrictions on transfer, including without the limitation, the "lock-
up" agreement, set forth in the Stockholder Rights Agreement. No such transfer
shall be effective unless the transferee or assignee assumes in writing the
obligations of the Investor under this Agreement, provided that in the event of
distributions to limited and general partners of an Investor, such partners of
an Investor shall not be required to execute a written assumption of obligations
but shall have notice of and be bound by such obligations by virtue of the
legends set forth in Section 6.2 hereof.
6.2 Legends. Investor agrees that each certificate representing Shares or
-------
any Common Stock issued upon conversion thereof be endorsed with the following
restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT
BE SOLD OR OFFERED FOR SALE IN THE ABSENCE OF SUCH REGISTRATION OR AN
OPINION OF COUNSEL SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT. COPIES OF THE AGREEMENTS
COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE
OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE,
10
<PAGE>
RESTRICTIONS ON TRANSFER AND ACQUISITION OF ADDITIONAL SECURITIES OF THE
COMPANY, COPIES OF WHICH ARE ON FILE AT THE PRINCIPAL OFFICE OF THE
COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
each Investor shall not, and shall cause each of its Affiliates (as defined
below) that it controls to not, acquire beneficial ownership (as such term is
defined in Rule 13d-3 of the Securities Exchange Act of 1934, as amended) of any
securities of the Company in addition to the Shares or any Series D Preferred,
Class B Common and Common Stock issued upon conversion thereof, which would
result in the aggregate beneficial ownership of each Investor and its Affiliates
of Voting Stock of the Company (as defined below) equaling or exceeding 10% of
the outstanding Voting Stock of the Company. Each Investor or any of its
Affiliates that it controls shall not purchase any securities of the Company
without having given 30 days prior written notice to the Company or without
having received the prior written consent of the Company. Upon notice thereof,
the Company shall inform the Investor whether such purchases cause the aggregate
beneficial ownership of Investor and its Affiliates to equal or exceed 10% of
the outstanding Voting Stock of the Company. For the purposes of this Agreement,
"Affiliate" shall mean, as to any person or entity, a person or entity that,
directly or indirectly through one or more intermediaries, controls, or is
controlled by, or is under common control with, such person or entity. In
addition, with respect to an Investor, only for the purposes of this Agreement,
AT&T Corp., all Affiliates of AT&T Corp., each of the other Investors and all
beneficial owners of equity interests in the Investor shall be deemed to be
Affiliates of such Investor. For the purposes of this Agreement, "Voting Stock
of the Company" shall mean, any class or series of the Company's capital stock
entitled to vote in any election of directors of the Company.
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as the Investor continues
to own Shares or any Common Stock issued upon conversion thereof, copies of the
Company's Forms 10-K, 10-Q and Annual Report to Shareholders, promptly after
such documents are filed with the SEC, or in lieu of such reports, unaudited
quarterly and audited annual financial statements of the Company, promptly after
completion.
7.2 Limitation on Sale. The Company covenants until the completion of an
------------------
underwritten public offering pursuant to an effective registration statement
under the Securities Act, covering the
11
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initial offer and sale of Common Stock for the account of the Company to the
public with aggregate gross proceeds to the Company of not less than Fifteen
Million Dollars ($15,000,000) (the "IPO") not to issue or sell any shares of
Series C Preferred Stock, Series D Preferred Stock, Series C-1 Preferred Stock
or Series D-1 Preferred Stock to any investor at a more favorable price or upon
more favorable terms (including rights, preferences, privileges and
restrictions) than those set forth in the Company's Amended and Restated
Certificate of Incorporation, this Agreement and the Series C-1 Preferred Stock
Purchase Agreement, and the Amended and Restated Stockholder Rights Agreement
without the prior written consent of Venture Management, LLC and Venture
Management III, LLC. Notwithstanding the foregoing, the Company expressly
reserves the right to sell shares of its Series C Preferred Stock and/or Series
D Preferred Stock without the prior written consent of Venture Management, LLC
and Venture Management III, LLC, provided that such shares shall not have been
sold or issued by the Company at a more favorable price or on more favorable
terms (other than the existence of voting rights) than those which are reflected
in this Agreement, the Series C-1 Preferred Stock Purchase Agreement, the
Amended and Restated Stockholder Rights and the Amended and Restated Certificate
of Incorporation.
7.3 HSR Filing. In the event the Investors determine that the purchase of
----------
the Shares hereunder has not been "solely for the purpose of investment" (as
defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investors determine that as a result the Company and the Investors are required
to make appropriate filings with the Federal Trade Commission and Department of
Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended (the "HSR ACT"), the Company and Investors agree to cooperate, to make
such filings in a timely manner, and to take all other appropriate action in
connection with such required filings.
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the closing
of the transactions contemplated hereby.
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to AT&T
12
<PAGE>
Venture Fund II, LP, at 3000 Sand Hill Road, Building 1, Suite 285, Menlo Park,
CA 94025, Attn: Neal Douglas, or at such other address as such Investor shall
have furnished to the Company in writing; (b) if to Special Partners Fund, LP,
at 3000 Sand Hill Road, Building 1, Suite 285, Menlo Park, CA 94025, Attn: Neal
Douglas, or at such other address as such Investor shall have furnished to the
Company in writing; (c) if to Special Partners Fund International, LP, at Ugland
House, South Church Street, Georgetown, Grand Cayman, Cayman Islands, with
copies to 3000 Sand Hill Road, Building 1, Suite 285, Menlo Park, CA 94025,
Attn: Neal Douglas, or at such other address as such Investor shall have
furnished to the Company in writing or (b) if to the Company, at 2330 Central
Expressway, Santa Clara, California 95050 addressed to the attention of the
Corporate Secretary, or at such other address as the Company shall have
furnished to the Investor. If notice is provided by facsimile, it must be
simultaneously confirmed via telephone and it shall be deemed to be given one
(1) day after transmission. If notice is provided by U.S. mail, notice shall be
deemed to be given three (3) days after proper deposit in a U.S. mailbox,
postage prepaid.
8.5 Expenses. The Company and the Investors shall bear their own expenses
--------
and legal fees incurred on their behalf with respect to this Agreement and the
transactions contemplated hereby; provided, however, that the Company will pay
the reasonable fees and expenses of counsel for the Investors up to an aggregate
amount of $15,000, for fees and expenses incurred in connection with this
Agreement, the Series C-1 Preferred Stock Purchase Agreement and the Stockholder
Rights Agreement.
8.6 Finder's Fees. The Company on the one hand and the Investors on the
-------------
other hand shall each indemnify and hold the other harmless from any liability
for any commission or compensation in the nature of a finder's fee, placement
fee or underwriter's discount (including the costs, expenses and legal fees of
defending against such liability) for which the Company or the Investors, or any
of their respective partners, employees, or representatives, as the case may be,
is responsible.
8.7 Counterparts. This Agreement may be executed in counterparts, each of
------------
which shall be enforceable against the party actually executing the counterpart,
and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective if
it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and Restated
Stockholder Rights Agreement of an even date herewith, such sections shall be
inapplicable to non-Affiliate purchasers (with respect to the transferring
Investor) and to limited partners of AT&T Venture Fund II, LP, Special Partners
Fund, LP and Special Partners Fund International, LP not affiliated with AT&T
Corp. who acquire any shares of Series D-1 Preferred Stock, Series D Preferred
Stock, Class B Common Stock or Common Stock from an Investor.
13
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series D-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
----
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ Dhruv Khanna
--------------------------------
Name: Dhruv Khanna
Title: V.P. & General Counsel
AT&T VENTURE FUND II, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management, LLC
its General Partner
By: _____________________
Neal Douglas
Manager
SPECIAL PARTNERS FUND, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management III, LLC
its General Partner
By: ___________________
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series D-1 Preferred
Stock Purchase Agreement as of this ____ day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By:
--------------------------------
Name:
Title:
AT&T VENTURE FUND II, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management, LLC
its General Partner
By: /s/ Neal Douglas
--------------------
Neal Douglas
Manager
SPECIAL PARTNERS FUND, LP
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
By: Venture Management III, LLC
its General Partner
By: /s/ Neal Douglas
--------------------
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
SPECIAL PARTNERS FUND INTERNATIONAL, LP
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
By: Venture Management III, LLC
its Investment General Partner
By: /s/ Neal Douglas
--------------------
Neal Douglas
Manager
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
EXHIBIT A
---------
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
<PAGE>
EXHIBIT B
---------
STOCKHOLDER RIGHTS AGREEMENT
<PAGE>
EXHIBIT C
---------
SHARE ALLOCATION AND PURCHASE PRICE OF EACH INVESTOR
- --------------------------------------------------------------------------------
Investor Series D-1 Shares Purchase Price
-------- ----------------- --------------
- --------------------------------------------------------------------------------
AT&T Venture Fund II, LP 509,260 $9,166,680
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
- --------------------------------------------------------------------------------
Special Partners Fund, LP 98,631 $1,775,358
3000 Sand Hill Road
Building 1, Suite 285
Menlo Park, CA 94025
- --------------------------------------------------------------------------------
Special Partners Fund International, LP 549,517 $9,891,306
Ugland House, South Church Street
Georgetown
Grand Cayman, Cayman Islands
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT D
---------
OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.15
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF DECEMBER 30, 1998
<PAGE>
TABLE OF CONTENTS
Page
----
SECTION I Purchase and Sale of Shares..................................... 2
---------------------------
1.1 Authorization of Shares....................................... 2
-----------------------
1.2 Sale of the Stock............................................. 2
-----------------
1.3 Closing....................................................... 2
-------
SECTION II Representations and Warranties of the Company.................. 2
---------------------------------------------
2.1 Organization, Good Standing and Qualifications................ 2
2.2 Valid Issuance, Authority..................................... 3
2.3 No Conflict................................................... 3
2.4 Company Capital Structure..................................... 3
2.5 No Material Misstatements or Omissions........................ 4
2.6 Company Financial Statements.................................. 5
2.7 No Material Changes........................................... 5
2.8 Intellectual Property......................................... 5
SECTION III Representations and Warranties of the Investors............... 5
-----------------------------------------------
3.1 Investment Representations and Covenants...................... 5
3.2 No Public Market.............................................. 7
3.3 Domicile...................................................... 7
3.4 Authority..................................................... 7
3.5 No Conflict................................................... 7
SECTION IV Conditions of Investors' and Company's Obligations at Closing.. 8
-------------------------------------------------------------
4.1 Conditions.................................................... 8
SECTION V Deliveries at Closing........................................... 8
---------------------
5.1 Stockholder Rights Agreement.................................. 8
5.2 Corporate Proceedings......................................... 9
5.3 Amended Certificate of Incorporation.......................... 9
5.4 Opinion of Counsel............................................ 9
5.5 Payment of Purchase Price..................................... 9
SECTION VI Investor Covenants............................................. 9
------------------
6.1 Restrictions on Transfer...................................... 9
6.2 Legends....................................................... 9
6.3 Standstill.................................................... 10
SECTION VII Company Covenants............................................. 10
-----------------
7.1 Periodic Reports.............................................. 10
7.2 Limitation on Sale............................................ 11
7.3 HSR Filing.................................................... 11
-i-
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
Page
----
SECTION VIII Miscellaneous................................................ 11
-------------
8.1 Governing Law................................................. 11
8.2 Survival...................................................... 11
8.3 Successors, Assigns........................................... 12
8.4 Notices....................................................... 12
8.5 Expenses...................................................... 12
8.6 Finder's Fees................................................. 12
8.7 Counterparts.................................................. 12
8.8 Severability.................................................. 12
8.9 Applicability of Standstill Provision and Voting Agreement
to Non-Affiliate Purchasers................................... 12
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of December 30, 1998, by and between Covad
Communications Group, Inc., a Delaware corporation (the "COMPANY") and the
undersigned investor (the "INVESTOR").
RECITALS
WHEREAS, pursuant to a Series C Preferred Stock and Warrant Subscription
Agreement, dated as of February 20, 1998, as amended on April 24, 1998, among
the Company, Warburg, Pincus Ventures, L.P. ("WARBURG"), Crosspoint Venture
Partners 1996 ("CROSSPOINT"), Intel Corporation and Robert Hawk (the "ORIGINAL
SERIES C AGREEMENT"), the Company has the right to issue and sell to Warburg and
Crosspoint up to 5,728,128 shares of Series C Preferred Stock, par value $.001
per share, of the Company (the "SERIES C PREFERRED STOCK"), provided such
issuance and sale occurs on or prior to March 11, 1999 (the "SERIES C EQUITY
COMMITMENT");
WHEREAS, the Investor is willing to purchase and the Company is willing to
sell to the Investor an aggregate of 1,200,466 shares of Series C-1 Preferred
Stock, par value $.001 per share (with rights and preferences identical to the
Series C Stock except that Series C-1 Preferred Stock shall be nonvoting and be
convertible into a nonvoting class of Common Stock) (the "SERIES C-1 PREFERRED
STOCK"), pursuant to substantially similar terms as set forth in the Series C
Equity Commitment and the Company is willing to release Warburg and Crosspoint
from any further obligation under the Series C Equity Commitment;
WHEREAS, simultaneously with the closing of the sale of the shares of
Series C-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 925,926 shares of Series D-1 Preferred Stock of the
Company to the Investor, pursuant to a Series D-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investor
(the "SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series C-1 Preferred Stock pursuant to this Agreement, the Company will
terminate the Original Series C Agreement with respect to the Series C Equity
Commitment of Warburg and Crosspoint; and
WHEREAS, the Company and the Investor wish to set forth the terms and
conditions upon which the Company will sell, and the Investor will purchase,
shares of Series C-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investor hereby agree as
follows:
<PAGE>
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series C-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set forth
in the Company's Amended and Restated Certificate of Incorporation (the "AMENDED
CERTIFICATE OF INCORPORATION") attached to this Agreement as Exhibit A,
sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investor, and the Investor will purchase from
the Company, at the Closing, an aggregate of 1,200,466 shares of Series C-1
Preferred Stock (the "SHARES") for the aggregate purchase price of
$3,333,333.94.
1.3 Closing.
-------
(a) The purchase and sale of the Shares shall take place at a closing
(the "CLOSING") to be held at the offices of Wilson Sonsini Goodrich & Rosati,
650 Page Mill Road, Palo Alto, CA 94304-1050, as soon as practicable after the
date hereof but in no event later than January 7, 1999.
(b) On the date of the Closing (the "CLOSING DATE"), subject to the
conditions stated herein, the Company will deliver to the Investor stock
certificates representing the Shares to be purchased by the Investor against
payment to the Company of the purchase price therefor by wire transfer in
federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investor, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investor dated as of the date hereof (the "DISCLOSURE
LETTER") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions in
which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the failure
to be so qualified would not have a material adverse effect on the business,
properties, financial condition or results of operations of the Company and its
subsidiaries, taken as a
2
<PAGE>
whole (a "MATERIAL ADVERSE EFFECT"). The outstanding shares of capital stock of
each of its subsidiaries have been duly authorized and validly issued, are fully
paid and non-assessable, and are owned by the Company free and clear of all
liens, encumbrances and equities and claims; and no options, warrants or other
rights to purchase, agreements or other obligations to issue or other rights to
convert any obligations into shares of capital stock or ownership interests in
such subsidiaries are outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation will
be duly and validly issued, fully paid and nonassessable. The Company has all
requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated hereby
and thereby. The execution and delivery of this Agreement and the Stockholder
Rights Agreement by the Company, and the consummation by the Company of the
transactions contemplated hereby and thereby have been duly authorized by all
necessary action on the part of the Company and, no other proceedings are
necessary to authorize this Agreement and the Stockholder Rights Agreement or to
consummate the transactions contemplated hereby and thereby. This Agreement and
the Stockholder Rights Agreement have been duly executed and delivered by the
Company and constitute legal, valid and binding obligations of the Company
enforceable against the Company in accordance with their respective terms. The
sale of the Shares and the subsequent conversion of the Shares into Series C
Preferred, Class B Common and Common Stock are not and will not be subject to
any preemptive rights, rights of first refusal or rights of participation that
have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any subsidiary
or any of their respective properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Company or any subsidiary or their respective properties or assets,
except in the case of (ii) and (iii) for any of the foregoing that in the
aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
-------------------------
(a) Immediately prior to Closing, the authorized capital stock of the
Company will consist of 100,000,000 shares of authorized Common Stock, $.001 par
value, of which 11,722,116 shares are issued and outstanding as of December 16,
1998 and of which 10,000,000 are designated Class B Common, none of which are
outstanding, and 50,000,000 shares of Preferred Stock, $.001 par value, of which
750,000 shares are designated Series A Preferred Stock, all of which are
3
<PAGE>
outstanding, 17,100,003 shares are designated Series B Preferred, all of which
are outstanding, 11,149,287 shares are designated Series C Preferred, 396,159 of
which are outstanding, 6,000,000 shares are designated Series C-1 Preferred,
none of which are outstanding, 5,000,000 shares are designated Series D
Preferred, none of which are outstanding and 5,000,000 shares are designated
Series D-1 Preferred, none of which are outstanding (collectively, the "COMPANY
CAPITAL STOCK"). Except as provided in the Stockholders Rights Agreement, all
outstanding shares of Company Capital Stock are duly authorized, validly issued,
fully paid and non-assessable, are not subject to preemptive rights created by
statute, the Certificate of Incorporation or Bylaws of the Company or any
agreement to which the Company is a party or by which it is bound and have been
issued in compliance with federal and state securities laws. The Company has no
other capital stock authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "OPTION
PLAN") and the 1998 Employee Stock Purchase Plan (the "PURCHASE PLAN"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person. The Company has reserved
15,520,342 shares of Company Common Stock for issuance to employees, directors
and consultants pursuant to the Option Plan, 12,358,723 of which are subject to
outstanding options under the Option Plan as of December 16, 1998 and has
reserved 1,000,000 shares for the Purchase Plan, none of which are issued and
outstanding. The Company has issued warrants to purchase 6,988,764 shares of
Common Stock, all of which are outstanding. The Company has reserved 6,988,764
shares of Company Common Stock for issuance upon the exercise of such warrants.
Except as described in this Section 2.4(b), there are no options, warrants,
calls, rights, commitments or agreements of any character, written or oral, to
which the Company is a party or by which it is bound obligating the Company to
issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered,
sold, repurchased or redeemed, any shares of the capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "REGISTRATION STATEMENT") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on December 18, 1998 (the "FILING
DATE"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"SECURITIES ACT") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading. In the event prior to
the Closing Date, the Company files an amendment to the Registration Statement,
then the term "Registration Statement" as used in this Agreement shall
thereafter refer to the most recently filed such amendment and the term "Filing
Date" shall thereafter refer to the date such most recent amendment is filed.
The information set forth in the next such amendment to the Registration
Statement filed with the Commission will not reflect any material adverse
change, when taken as a whole, from the information set forth in the draft of
such amendment provided to the Investor.
4
<PAGE>
2.6 Company Financial Statements. The Registration Statement includes
----------------------------
(i) the Company's audited balance sheet as of September 30, 1998, and the
related audited statements of operations, stockholders' equity and cash flows
for the nine-month period ended September 30, 1998 and (ii) the Company's
audited balance sheet as of December 31, 1997, and the related audited
statements of operations, stockholders' equity and cash flows for the year ended
December 31, 1997, (collectively, the "COMPANY FINANCIALS"). The Company
Financials have been prepared in accordance with U.S. generally accepted
accounting principles consistent with the reporting practices and principles
("GAAP"), applied on a basis consistent throughout the periods indicated and
consistent with each other. The Company Financials present fairly the financial
condition, operating results and cash flows of the Company as of the dates and
during the periods indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been
-------------------
any materially adverse change in the business, properties, financial condition
or results of operations of the Company, whether or not arising from
transactions in the ordinary course of business, other than as set forth in the
Registration Statement, and since such date, except in the ordinary course of
business, the Company has not entered into any material transaction not referred
to in the Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("INTELLECTUAL PROPERTY")
employed in the operation of their respective businesses as currently conducted,
and, to the knowledge of the Company, with no infringement of or conflict with
the rights of others respecting any of the same. Neither the Company nor any
subsidiary has received any communications alleging that the Company or any
subsidiary has violated any of the Intellectual Property of any other person or
entity. Reasonable security measures have been taken by the Company and its
subsidiaries to protect the secrecy, confidentiality and value of the Company's
and its subsidiaries' trade secrets, including their respective know-how,
technology, concepts and other technical data for the development, processing,
manufacture and sale of its products. Each employee of and consultant to the
Company or its subsidiaries has executed an invention assignment and
confidentiality agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investor
----------------------------------------------
The Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and not
with a view to the sale or distribution of any part thereof, and that it has no
present intention of selling, granting any participation in or otherwise
distributing the same.
5
<PAGE>
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series C
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided for
in this Agreement and the issuance of securities hereunder is exempt pursuant to
Section 4(2) of the Securities Act, and that the Company's reliance on such
exemption is predicated in part on the Investor's representations set forth
herein.
(c) Investor represents that it is experienced in evaluating companies
such as the Company, is able to fend for itself in transactions such as the one
contemplated by this Agreement, has such knowledge and experience in financial
and business matters that it is capable of evaluating the merits and risks of
its prospective investment in the Company and is able to afford a complete loss
of its investment. The Company acknowledges that the foregoing representation
shall not limit the right of the Investor to rely on the representations of the
Company set forth in Section 2 hereof.
(d) Investor acknowledges and understands that the Shares and any
Series C Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares or
Series C Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series C
Preferred, Class B Common Stock and Common Stock issued upon conversion thereof,
may be sold under Rule 144, the following conditions must be fulfilled, except
as otherwise described below: (i) certain public information about the Company
must be available; (ii) the sale must occur at least one year after the later of
the date the Shares were sold by the Company or the date they were sold by an
affiliate of the Company; (iii) the sale must be made in a broker's transaction;
and (iv) the number of Shares sold must not exceed certain volume limitations.
If, however, the sale occurs at least two years after the Shares were sold by
the Company or an affiliate of the Company, and if the Investor is not an
affiliate of the Company, the foregoing conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion that
persons proposing to sell restricted securities received in a private offering
other than in a registered offering or pursuant to Rule 144 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 the brokers who
participate in the transactions do so at their own risk.
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer or
otherwise dispose of the Shares and any
6
<PAGE>
Series C Preferred, Class B Common Stock and Common Stock issued on conversion
thereof only in a manner consistent with its representations and covenants set
forth in this Agreement and the Stockholder Rights Agreement. In connection
therewith such Purchaser acknowledges that the Company shall make a notation on
its stock books regarding the restrictions on transfer set forth in this
Agreement and the Stockholder Rights Agreement and shall transfer shares on the
books of the Company only to the extent not inconsistent therewith.
(h) Investor represents that it is an "ACCREDITED INVESTOR" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no assurance
a public market will be created.
3.3 Domicile. Investor is domiciled in the state set forth at its address
--------
in Section 8.4.
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out its
obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been duly
authorized by all necessary action on the part of the Investor and, no other
proceedings are necessary to authorize this Agreement and the Stockholder Rights
Agreement or to consummate the transactions contemplated hereby and thereby.
This Agreement and the Stockholder Rights Agreement have been duly executed and
delivered by the Investor and constitute legal, valid and binding obligations of
the Investor enforceable against the Investor in accordance with their
respective terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to which
the Investor or any of its properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Investor or its properties or assets, except in the case of (ii) and
(iii) for any of the foregoing that in the aggregate would not have a material
adverse effect on Investor.
7
<PAGE>
SECTION IV
Conditions of Investor's and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of the
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investor at the Closing except for the deliveries set forth in Section V and the
fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investor and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation of
the transactions contemplated by this Agreement.
(d) Stockholder Rights Agreement. The Company, the Investor and the
----------------------------
requisite parties required to amend the Stockholder Rights Agreement shall have
entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
(f) Series D-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investor shall have purchased an aggregate of 925,926 shares of Series D-1
Preferred Stock of the Company, pursuant to the Series D-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investor, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the Company and the Investors on the date hereof
(the "STOCKHOLDER RIGHTS AGREEMENT") and as amended by its existing stockholders
prior to the Closing.
8
<PAGE>
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investor to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver such
------------------------------------
copy of the Amended Certificate of Incorporation as filed with the Secretary of
State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in
------------------
form of Exhibit C, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Investor shall deliver to the Company
-------------------------
payment for the Shares to be acquired by such Investor in the amounts set forth
in Section 1.2 hereto.
SECTION VI
Investor Covenants
------------------
6.1 Restrictions on Transfer. Investor shall not, directly or
------------------------
indirectly, sell or transfer any Shares or any Series C Preferred, Class B
Common Stock or Common Stock issued upon conversion thereof for a period of one
year following the Closing Date, except pursuant to a sale of all the capital
stock of the Company or a merger or consolidation in which the Company is
acquired, or pursuant to a liquidation of the Company. However, Investor may
sell or transfer the Shares or Series C Preferred, Class B Common Stock or such
Common Stock to (i) any Affiliate (as defined below) of the Investor during such
one year period or (ii) any third party after such one year period, provided
that such Affiliate or third party, as the case may be, agrees in writing to be
bound by the obligations of this Agreement and the restrictions on transfer,
including without the limitation, the "lock-up" agreement, set forth in the
Stockholder Rights Agreement. No such transfer shall be effective unless the
transferee or assignee assumes in writing the obligations of the Investor under
this Agreement.
6.2 Legends. Investor agrees that each certificate representing Shares
-------
or any Common Stock issued upon conversion thereof be endorsed with the
following restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT
BE SOLD OR OFFERED FOR SALE IN THE ABSENCE OF SUCH REGISTRATION OR AN
OPINION OF COUNSEL SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT. COPIES OF THE AGREEMENTS
COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE
OBTAINED
9
<PAGE>
AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE
OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE, RESTRICTIONS ON TRANSFER AND
ACQUISITION OF ADDITIONAL SECURITIES OF THE COMPANY, COPIES OF WHICH ARE ON
FILE AT THE PRINCIPAL OFFICE OF THE COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
Investor shall not, and shall cause each of its Affiliates (as defined below) to
not, acquire beneficial ownership (as such term is defined in Rule 13d-3 of the
Securities Exchange Act of 1934, as amended) of any securities of the Company in
addition to the Shares or any Series C Preferred, Class B Common and Common
Stock issued upon conversion thereof, which would result in the aggregate
beneficial ownership of each Investor and its Affiliates of Voting Stock of the
Company (as defined below) equaling or exceeding 10% of the outstanding Voting
Stock of the Company. Investor or any of its Affiliates shall not purchase any
securities of the Company without having given 30 days prior written notice to
the Company or without having received the prior written consent of the Company.
Upon notice thereof, the Company shall inform the Investor whether such
purchases cause the aggregate beneficial ownership of Investor and its
Affiliates to equal or exceed 10% of the outstanding Voting Stock of the
Company. For the purposes of this Agreement, "Affiliate" shall mean, as to any
person or entity, a person or entity that, directly or indirectly through one or
more intermediaries, is controlled by such person or entity. For the purposes of
this Agreement, "Voting Stock of the Company" shall mean, any class or series of
the Company's capital stock entitled to vote in any election of directors of the
Company.
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as
10
<PAGE>
the Investor continues to own Shares or any Common Stock issued upon conversion
thereof, copies of the Company's Forms 10-K, 10-Q and Annual Report to
Shareholders, promptly after such documents are filed with the SEC, or in lieu
of such reports, unaudited quarterly and audited annual financial statements of
the Company, promptly after completion.
7.2 Limitation on Sale. The Company covenants until the completion of
------------------
an underwritten public offering pursuant to an effective registration statement
under the Securities Act, covering the initial offer and sale of Common Stock
for the account of the Company to the public with aggregate gross proceeds to
the Company of not less than Fifteen Million Dollars ($15,000,000) (the "IPO")
not to issue or sell any shares of Series C Preferred Stock, Series D Preferred
Stock, Series C-1 Preferred Stock or Series D-1 Preferred Stock to any investor
at a more favorable price or upon more favorable terms (including rights,
preferences, privileges and restrictions) than those set forth in the Company's
Amended and Restated Certificate of Incorporation, this Agreement and the Series
D-1 Preferred Stock Purchase Agreement, and the Amended and Restated Stockholder
Rights Agreement without the prior written consent of the Investor.
Notwithstanding the foregoing, the Company expressly reserves the right to sell
shares of its Series C Preferred Stock and/or Series D Preferred Stock without
the prior written consent of the Investor provided that such shares shall not
have been sold or issued by the Company at a more favorable price or on more
favorable terms (other than the existence of voting rights) than those which are
reflected in this Agreement, the Series D-1 Preferred Stock Purchase Agreement,
the Amended and Restated Stockholder Rights and the Amended and Restated
Certificate of Incorporation.
7.3 HSR Filing. In the event the Investor determines that the purchase
----------
of the Shares hereunder has not been "solely for the purpose of investment" (as
defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investor determines that as a result the Company and the Investors are required
to make appropriate filings with the Federal Trade Commission and Department of
Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended (the "HSR ACT"), the Company and Investor agree to cooperate, to make
such filings in a timely manner, and to take all other appropriate action in
connection with such required filings.
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the closing
of the transactions contemplated hereby.
11
<PAGE>
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to Investor, at
NEXTLINK Communications, Inc., 500 108th Avenue, NE, Suite 2200, Bellevue,
Washington 98004, Attn: R. Bruce Easter, Jr., Esq. or (b) if to the Company, at
2330 Central Expressway, Santa Clara, California 95050 addressed to the
attention of the Corporate Secretary, or at such other address as the Company
shall have furnished to the Investor. If notice is provided by facsimile, it
must be simultaneously confirmed via telephone and it shall be deemed to be
given one (1) day after transmission. If notice is provided by U.S. mail, notice
shall be deemed to be given three (3) days after proper deposit in a U.S.
mailbox, postage prepaid.
8.5 Expenses. The Company and the Investor shall bear their own expenses
--------
and legal fees incurred on their behalf with respect to this Agreement and the
transactions contemplated hereby; provided, however, that the Company will pay
the reasonable fees and expenses of counsel for the Investor up to an aggregate
amount of $15,000, for fees and expenses incurred in connection with this
Agreement, the Series D-1 Preferred Stock Purchase Agreement and the Stockholder
Rights Agreement.
8.6 Finder's Fees. The Company and the Investor shall each indemnify and
-------------
hold the other harmless from any liability for any commission or compensation in
the nature of a finder's fee, placement fee or underwriter's discount (including
the costs, expenses and legal fees of defending against such liability) for
which the Company or the Investors, or any of their respective partners,
employees, or representatives, as the case may be, is responsible.
8.7 Counterparts. This Agreement may be executed in counterparts, each
------------
of which shall be enforceable against the party actually executing the
counterpart, and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective if
it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and Restated
Stockholder Rights Agreement of an even date herewith, such sections shall be
inapplicable to non-Affiliate purchasers (with respect to the transferring
Investor) who acquire any shares of Series C-1 Preferred Stock, Series C
Preferred Stock, Class B Common Stock or Common Stock from an Investor.
12
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series C-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ Dhruv Khanna
-------------------------------------
Name:
Title:
NEXTLINK COMMUNICATIONS, INC.
BY:
-------------------------------------
NAME:
TITLE:
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series C-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By:
-------------------------------------
Name:
Title:
NEXTLINK COMMUNICATIONS, INC.
BY: /s/ Kathleen H. Iskra
-------------------------------------
NAME: Kathleen H. Iskra
TITLE: Vice President
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
EXHIBIT A
---------
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
<PAGE>
EXHIBIT B
---------
STOCKHOLDER RIGHTS AGREEMENT
<PAGE>
EXHIBIT C
---------
OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.16
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF DECEMBER 30, 1998
<PAGE>
TABLE OF CONTENTS
PAGE
----
SECTION I Purchase and Sale of Shares.........................................1
---------------------------
1.1 Authorization of Shares.............................................1
-----------------------
1.2 Sale of the Stock...................................................1
-----------------
1.3 Closing.............................................................2
-------
SECTION II....................................................................2
2.1 Organization, Good Standing and Qualifications......................2
----------------------------------------------
2.2 Valid Issuance, Authority...........................................2
-------------------------
2.3 No Conflict.........................................................3
-----------
2.4 Company Capital Structure...........................................3
-------------------------
2.5 No Material Misstatements or Omissions..............................4
--------------------------------------
2.6 Company Financial Statements........................................4
----------------------------
2.7 No Material Changes.................................................4
-------------------
2.8 Intellectual Property...............................................5
---------------------
SECTION III Representations and Warranties of the Investor....................5
----------------------------------------------
3.1 Investment Representations and Covenants............................5
----------------------------------------
3.2 No Public Market....................................................6
----------------
3.3 Domicile............................................................6
--------
3.4 Authority...........................................................7
---------
3.5 No Conflict.........................................................7
-----------
SECTION IV Conditions of Investor's and Company's Obligations at Closing......7
-------------------------------------------------------------
4.1 Conditions..........................................................7
----------
SECTION V Deliveries at Closing...............................................8
---------------------
5.1 Stockholder Rights Agreement........................................8
----------------------------
5.2 Corporate Proceedings...............................................8
---------------------
5.3 Amended Certificate of Incorporation................................8
------------------------------------
5.4 Opinion of Counsel..................................................8
------------------
5.5 Payment of Purchase Price...........................................8
-------------------------
SECTION VI Investor Covenants.................................................8
------------------
6.1 Restrictions on Transfer...........................................9
------------------------
6.2 Legends............................................................9
-------
6.3 Standstill........................................................10
----------
SECTION VII Company Covenants................................................10
-----------------
7.1 Periodic Reports..................................................10
----------------
7.2 Limitation on Sale................................................10
------------------
7.3 HSR Filing........................................................11
----------
-i-
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
PAGE
----
SECTION VIII Miscellaneous...................................................11
-------------
8.1 Governing Law......................................................11
-------------
8.2 Survival...........................................................11
--------
8.3 Successors, Assigns................................................11
-------------------
8.4 Notices............................................................11
-------
8.5 Expenses...........................................................11
--------
8.6 Finder's Fees......................................................12
-------------
8.7 Counterparts.......................................................12
------------
8.8 Severability.......................................................12
------------
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers...........................................12
------------------------
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of December 30, 1998, by and between Covad
Communications Group, Inc., a Delaware corporation (the "COMPANY") and the
undersigned investor (the "INVESTOR").
RECITALS
WHEREAS, the Investor desires to purchase and the Company desires to sell
an aggregate of 925,926 shares of Series D-1 Preferred Stock, par value $.001
per share, of the Company (the "SERIES D-1 PREFERRED STOCK");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series D-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 1,200,466 shares of Series C-1 Preferred Stock of the
Company to the Investor, pursuant to a Series C-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investor
(the "SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT"); and
WHEREAS, the Company and the Investor wish to set forth the terms and
conditions upon which the Company will sell, and the Investor will purchase,
shares of Series D-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investor hereby agree as
follows:
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series D-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set
forth in the Company's Amended and Restated Certificate of Incorporation (the
"AMENDED CERTIFICATE OF INCORPORATION") attached to this Agreement as Exhibit
A, sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investor, and the Investor will purchase
from the Company, at the Closing, an aggregate of 925,926 shares of Series D-1
Preferred Stock (the "SHARES") for the aggregate purchase price of
$16,666,668.
<PAGE>
1.3 Closing.
-------
(a) The purchase and sale of the Shares shall take place at a
closing (the "CLOSING") to be held at the offices of Wilson Sonsini Goodrich &
Rosati, 650 Page Mill Road, Palo Alto, CA 94304-1050, on January 7, 1999.
(b) On the date of the Closing (the "CLOSING DATE"), subject to the
conditions stated herein, the Company will deliver to the Investor stock
certificates representing the Shares to be purchased by the Investor against
payment to the Company of the purchase price therefor by wire transfer in
federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investor, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investor dated as of the date hereof (the "Disclosure
Letter") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions
in which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the
failure to be so qualified would not have a material adverse effect on the
business, properties, financial condition or results of operations of the
Company and its subsidiaries, taken as a whole (a "MATERIAL ADVERSE EFFECT").
The outstanding shares of capital stock of each of its subsidiaries have been
duly authorized and validly issued, are fully paid and non-assessable, and are
owned by the Company free and clear of all liens, encumbrances and equities
and claims; and no options, warrants or other rights to purchase, agreements
or other obligations to issue or other rights to convert any obligations into
shares of capital stock or ownership interests in such subsidiaries are
outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation
will be duly and validly issued, fully paid and nonassessable. The Company has
all requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated
hereby and thereby. The execution and delivery of this Agreement and the
Stockholder Rights Agreement by the Company, and the consummation by the
Company of the transactions contemplated hereby and thereby have been duly
-2-
<PAGE>
authorized by all necessary action on the part of the Company and, no other
proceedings are necessary to authorize this Agreement and the Stockholder
Rights Agreement or to consummate the transactions contemplated hereby and
thereby. This Agreement and the Stockholder Rights Agreement have been duly
executed and delivered by the Company and constitute legal, valid and binding
obligations of the Company enforceable against the Company in accordance with
their respective terms. The sale of the Shares and the subsequent conversion
of the Shares into Series D Preferred, Class B Common and Common Stock are not
and will not be subject to any preemptive rights, rights of first refusal or
rights of participation that have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of
the transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any
subsidiary or any of their respective properties or assets are subject, or
(iii) any judgment, order, decree, statute, law, ordinance, rule or regulation
applicable to the Company or any subsidiary or their respective properties or
assets, except in the case of (ii) and (iii) for any of the foregoing that in
the aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
--------------------------
(a) Immediately prior to Closing, the authorized capital stock of
the Company will consist of 100,000,000 shares of authorized Common Stock,
$.001 par value, of which 11,722,116 shares are issued and outstanding as of
December 16, 1998 and of which 10,000,000 are designated Class B Common, none
of which are outstanding, and 50,000,000 shares of Preferred Stock, $.001 par
value, of which 750,000 shares are designated Series A Preferred Stock, all of
which are outstanding, 17,100,003 shares are designated Series B Preferred,
all of which are outstanding, 11,149,287 shares are designated Series C
Preferred, 396,159 of which are outstanding, 6,000,000 shares are designated
Series C-1 Preferred, none of which are outstanding, 5,000,000 shares are
designated Series D Preferred, none of which are outstanding and 5,000,000
shares are designated Series D-1 Preferred, none of which are outstanding
(collectively, the "COMPANY CAPITAL STOCK"). Except as provided in the
Stockholders Rights Agreement, all outstanding shares of Company Capital Stock
are duly authorized, validly issued, fully paid and non-assessable, are not
subject to preemptive rights created by statute, the Certificate of
Incorporation or Bylaws of the Company or any agreement to which the Company
is a party or by which it is bound and have been issued in compliance with
federal and state securities laws. The Company has no other capital stock
authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "OPTION
PLAN") and the 1998 Employee Stock Purchase Plan (the "Purchase Plan"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person.
-3-
<PAGE>
The Company has reserved 15,520,342 shares of Company Common Stock for
issuance to employees, directors and consultants pursuant to the Option Plan,
12,358,723 of which are subject to outstanding options under the Option Plan
as of December 16, 1998 and has reserved 1,000,000 shares for the Purchase
Plan, none of which are issued and outstanding. The Company has issued
warrants to purchase 6,988,764 shares of Common Stock, all of which are
outstanding. The Company has reserved 6,988,764 shares of Company Common Stock
for issuance upon the exercise of such warrants. Except as described in this
Section 2.4(b), there are no options, warrants, calls, rights, commitments or
agreements of any character, written or oral, to which the Company is a party
or by which it is bound obligating the Company to issue, deliver, sell,
repurchase or redeem, or cause to be issued, delivered, sold, repurchased or
redeemed, any shares of the capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "REGISTRATION STATEMENT") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on December 18, 1998 (the "FILING
DATE"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"SECURITIES ACT") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading. In the event prior
to the Closing Date, the Company files an amendment to the Registration
Statement, then the term "Registration Statement" as used in this Agreement
shall thereafter refer to the most recently filed such amendment and the term
"Filing Date" shall thereafter refer to the date such most recent amendment is
filed. The information set forth in the next such amendment to the
Registration Statement filed with the Commission will not reflect any material
adverse change, when taken as a whole, from the information set forth in the
draft of such amendment provided to the Investor.
2.6 Company Financial Statements. The Registration Statement includes
----------------------------
(i) the Company's audited balance sheet as of September 30, 1998, and the
related audited statements of operations, stockholders' equity and cash flows
for the nine-month period ended September 30, 1998 and (ii) the Company's
audited balance sheet as of December 31, 1997, and the related audited
statements of operations, stockholders' equity and cash flows for the year
ended December 31, 1997, (collectively, the "COMPANY FINANCIALS"). The Company
Financials have been prepared in accordance with U.S. generally accepted
accounting principles consistent with the reporting practices and principles
("GAAP"), applied on a basis consistent throughout the periods indicated and
consistent with each other. The Company Financials present fairly the
financial condition, operating results and cash flows of the Company as of the
dates and during the periods indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been
-------------------
any materially adverse change in the business, properties, financial condition
or results of operations of the Company, whether or not arising from
transactions in the ordinary course of business, other than as set forth in
the Registration Statement, and since such date, except in the ordinary course
of
-4-
<PAGE>
business, the Company has not entered into any material transaction not
referred to in the Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("INTELLECTUAL
PROPERTY") employed in the operation of their respective businesses as
currently conducted, and, to the knowledge of the Company, with no
infringement of or conflict with the rights of others respecting any of the
same. Neither the Company nor any subsidiary has received any communications
alleging that the Company or any subsidiary has violated any of the
Intellectual Property of any other person or entity. Reasonable security
measures have been taken by the Company and its subsidiaries to protect the
secrecy, confidentiality and value of the Company's and its subsidiaries'
trade secrets, including their respective know-how, technology, concepts and
other technical data for the development, processing, manufacture and sale of
its products. Each employee of and consultant to the Company or its
subsidiaries has executed an invention assignment and confidentiality
agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investor
----------------------------------------------
The Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
-----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and
not with a view to the sale or distribution of any part thereof, and that it
has no present intention of selling, granting any participation in or
otherwise distributing the same.
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series D
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided
for in this Agreement and the issuance of securities hereunder is exempt
pursuant to Section 4(2) of the Securities Act, and that the Company's
reliance on such exemption is predicated in part on the Investor's
representations set forth herein.
(c) Investor represents that it is experienced in evaluating
companies such as the Company, is able to fend for itself in transactions such
as the one contemplated by this Agreement, has such knowledge and experience
in financial and business matters that it is capable of evaluating the merits
and risks of its prospective investment in the Company and is able to afford a
complete loss of its investment. The Company acknowledges that the foregoing
representation shall not limit the right of the Investor to rely on the
representations of the Company set forth in Section 2 hereof.
-5-
<PAGE>
(d) Investor acknowledges and understands that the Shares and any
Series D Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares
or Series D Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series D
Preferred, Class B Common Stock and Common Stock issued upon conversion
thereof, may be sold under Rule 144, the following conditions must be
fulfilled, except as otherwise described below: (i) certain public information
about the Company must be available; (ii) the sale must occur at least one
year after the later of the date the Shares were sold by the Company or the
date they were sold by an affiliate of the Company; (iii) the sale must be
made in a broker's transaction; and (iv) the number of Shares sold must not
exceed certain volume limitations. If, however, the sale occurs at least two
years after the Shares were sold by the Company or an affiliate of the
Company, and if the Investor is not an affiliate of the Company, the foregoing
conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion
that persons proposing to sell restricted securities received in a private
offering other than in a registered offering or pursuant to Rule 144 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
the brokers who participate in the transactions do so at their own risk.
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer
or otherwise dispose of the Shares and any Series D Preferred, Class B Common
Stock and Common Stock issued on conversion thereof only in a manner
consistent with its representations and covenants set forth in this Agreement
and the Stockholder Rights Agreement. In connection therewith such Purchaser
acknowledges that the Company shall make a notation on its stock books
regarding the restrictions on transfer set forth in this Agreement and the
Stockholder Rights Agreement and shall transfer shares on the books of the
Company only to the extent not inconsistent therewith.
(h) Investor represents that it is an "ACCREDITED INVESTOR" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no
assurance a public market will be created.
3.3 Domicile. Investor is domiciled in the state set forth at its
--------
address in Section 8.4.
-6-
<PAGE>
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out
its obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been
duly authorized by all necessary action on the part of the Investor and, no
other proceedings are necessary to authorize this Agreement and the
Stockholder Rights Agreement or to consummate the transactions contemplated
hereby and thereby. This Agreement and the Stockholder Rights Agreement have
been duly executed and delivered by the Investor and constitute legal, valid
and binding obligations of the Investor enforceable against the Investor in
accordance with their respective terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of
the transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to
which the Investor or any of its properties or assets are subject, or (iii)
any judgment, order, decree, statute, law, ordinance, rule or regulation
applicable to the Investor or its properties or assets, except in the case of
(ii) and (iii) for any of the foregoing that in the aggregate would not have a
material adverse effect on Investor.
SECTION IV
Conditions of Investor's and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of the
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investor at the Closing except for the deliveries set forth in Section V and
the fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investor and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation
of the transactions contemplated by this Agreement.
-7-
<PAGE>
(d) Stockholder Rights Agreement. The Company, the Investor and the
----------------------------
requisite parties required to amend the Stockholder Rights Agreement shall have
entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
(f) Series C-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investor shall have purchased an aggregate of 1,200,466 shares of Series
C-1 Preferred Stock of the Company, pursuant to the Series C-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investor, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the Company and the Investors on the date hereof
(the "STOCKHOLDER RIGHTS AGREEMENT") and as amended by its existing
stockholders prior to the Closing.
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investor to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver
------------------------------------
such copy of the Amended Certificate of Incorporation as filed with the
Secretary of State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in
------------------
form of Exhibit C, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Investor shall deliver to the Company
-------------------------
payment for the Shares to be acquired by such Investor in the amounts set
forth in Section 1.2 hereto.
SECTION VI
Investor Covenants
------------------
-8-
<PAGE>
6.1 Restrictions on Transfer. Investor shall not, directly or
------------------------
indirectly, sell or transfer any Shares or any Series D Preferred, Class B
Common Stock or Common Stock issued upon conversion thereof for a period of
one year following the Closing Date, except pursuant to a sale of all the
capital stock of the Company or a merger or consolidation in which the Company
is acquired, or pursuant to a liquidation of the Company. However, Investor
may sell or transfer the Shares or Series D Preferred, Class B Common Stock or
such Common Stock to (i) any "AFFILIATE" (as defined below) of an Investor
during such one year period or (ii) any third party after such one year
period, provided that such Affiliate or third party, as the case may be,
agrees in writing to be bound by the obligations of this Agreement and the
restrictions on transfer, including without the limitation, the "lock-up"
agreement, set forth in the Stockholder Rights Agreement. No such transfer
shall be effective unless the transferee or assignee assumes in writing the
obligations of the Investor under this Agreement.
6.2 Legends. Investor agrees that each certificate representing Shares
-------
or any Common Stock issued upon conversion thereof be endorsed with the
following restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT
BE SOLD OR OFFERED FOR SALE IN THE ABSENCE OF SUCH REGISTRATION OR AN
OPINION OF COUNSEL SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT. COPIES OF THE AGREEMENTS
COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE
OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE, RESTRICTIONS ON TRANSFER AND
ACQUISITION OF ADDITIONAL SECURITIES OF THE COMPANY, COPIES OF WHICH ARE ON
FILE AT THE PRINCIPAL OFFICE OF THE COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
-9-
<PAGE>
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
Investor shall not, and shall cause each of its Affiliates (as defined below)
to not, acquire beneficial ownership (as such term is defined in Rule 13d-3 of
the Securities Exchange Act of 1934, as amended) of any securities of the
Company in addition to the Shares or any Series C Preferred, Class B Common
and Common Stock issued upon conversion thereof, which would result in the
aggregate beneficial ownership of each Investor and its Affiliates of Voting
Stock of the Company (as defined below) equaling or exceeding 10% of the
outstanding Voting Stock of the Company. Investor or any of its Affiliates
shall not purchase any securities of the Company without having given 30 days
prior written notice to the Company or without having received the prior
written consent of the Company. Upon notice thereof, the Company shall inform
the Investor whether such purchases cause the aggregate beneficial ownership
of Investor and its Affiliates to equal or exceed 10% of the outstanding
Voting Stock of the Company. For the purposes of this Agreement, "Affiliate"
shall mean, as to any person or entity, a person or entity that, directly or
indirectly through one or more intermediaries, is controlled by such person or
entity. For the purposes of this Agreement, "Voting Stock of the Company"
shall mean, any class or series of the Company's capital stock entitled to
vote in any election of directors of the Company.
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as the Investor
continues to own Shares or any Common Stock issued upon conversion thereof,
copies of the Company's Forms 10-K, 10-Q and Annual Report to Shareholders,
promptly after such documents are filed with the SEC, or in lieu of such
reports, unaudited quarterly and audited annual financial statements of the
Company, promptly after completion.
7.2 Limitation on Sale. The Company covenants until the completion of
------------------
an underwritten public offering pursuant to an effective registration
statement under the Securities Act, covering the initial offer and sale of
Common Stock for the account of the Company to the public with aggregate gross
proceeds to the Company of not less than Fifteen Million Dollars ($15,000,000)
(the "IPO") not to issue or sell any shares of Series C Preferred Stock,
Series D Preferred Stock, Series C-1 Preferred Stock or Series D-1 Preferred
Stock to any investor at a more favorable price or upon more favorable terms
(including rights, preferences, privileges and restrictions) than those set
forth in the Company's Amended and Restated Certificate of Incorporation, this
Agreement and the Series C-1 Preferred Stock Purchase Agreement, and the
Amended and Restated Stockholder Rights Agreement without the prior written
consent of the Investor. Notwithstanding the foregoing, the Company expressly
reserves the right to sell shares of its Series C Preferred Stock and/or
Series D Preferred Stock without the prior written consent of Investor,
provided that such shares shall not have been sold or issued by the Company at
a more favorable price or on more favorable terms (other than the existence of
voting rights) than those which are reflected in this Agreement, the Series C-
1 Preferred
-10-
<PAGE>
Stock Purchase Agreement, the Amended and Restated Stockholder Rights and the
Amended and Restated Certificate of Incorporation.
7.3 HSR Filing. In the event the Investor determines that the purchase
----------
of the Shares hereunder has not been "solely for the purpose of investment"
(as defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investor determines that as a result the Company and the Investors are
required to make appropriate filings with the Federal Trade Commission and
Department of Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements
Act of 1976, as amended (the "HSR ACT"), the Company and Investor agree to
cooperate, to make such filings in a timely manner, and to take all other
appropriate action in connection with such required filings.
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the
closing of the transactions contemplated hereby.
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties
hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to Investor, at
NEXTLINK Communications, Inc., 500 108th Avenue, NE, Suite 2200, Bellevue,
Washington 98004, Attn: R. Bruce Easter, Jr., Esq. or (b) if to the Company,
at 2330 Central Expressway, Santa Clara, California 95050 addressed to the
attention of the Corporate Secretary, or at such other address as the Company
shall have furnished to the Investor. If notice is provided by facsimile, it
must be simultaneously confirmed via telephone and it shall be deemed to be
given one (1) day after transmission. If notice is provided by U.S. mail,
notice shall be deemed to be given three (3) days after proper deposit in a
U.S. mailbox, postage prepaid.
8.5 Expenses. The Company and the Investor shall bear their own
--------
expenses and legal fees incurred on their behalf with respect to this
Agreement and the transactions contemplated hereby; provided, however, that
the Company will pay the reasonable fees and expenses of counsel for the
Investor up to an aggregate amount of $15,000, for fees and expenses incurred
in connection with
-11-
<PAGE>
this Agreement, the Series C-1 Preferred Stock Purchase Agreement and the
Stockholder Rights Agreement.
8.6 Finder's Fees. The Company and the Investor shall each indemnify
-------------
and hold the other harmless from any liability for any commission or
compensation in the nature of a finder's fee, placement fee or underwriter's
discount (including the costs, expenses and legal fees of defending against
such liability) for which the Company or the Investors, or any of their
respective partners, employees, or representatives, as the case may be, is
responsible.
8.7 Counterparts. This Agreement may be executed in counterparts, each
------------
of which shall be enforceable against the party actually executing the
counterpart, and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective
if it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and
Restated Stockholder Rights Agreement of an even date herewith, such sections
shall be inapplicable to non-Affiliate purchasers (with respect to the
transferring Investor) who acquire any shares of Series D-1 Preferred Stock,
Series D Preferred Stock, Class B Common Stock or Common Stock from an
Investor.
-12-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series D-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ Dhruv Khanna
--------------------------------
Name: Dhruv Khanna
Title: V.P. & General Counsel
NEXTLINK COMMUNICATIONS, INC.
By:
--------------------------------
Name:
Title:
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series D-1 Preferred
Stock Purchase Agreement as of this 30th day of December, 1998.
COVAD COMMUNICATIONS GROUP, INC.
By:
--------------------------------
Name:
Title:
NEXTLINK COMMUNICATIONS, INC.
By: /s/ Kathleen H. Iskra
--------------------------------
Name: Kathleen H. Iskra
Title: Vice President
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
EXHIBIT A
---------
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
<PAGE>
EXHIBIT B
---------
STOCKHOLDER RIGHTS AGREEMENT
<PAGE>
EXHIBIT C
---------
OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.17
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF JANUARY 19, 1999
<PAGE>
TABLE OF CONTENTS
Page
----
SECTION I Purchase and Sale of Shares........................................ 1
---------------------------
1.1 Authorization of Shares.......................................... 1
-----------------------
1.2 Sale of the Stock................................................ 1
-----------------
1.3 Closing.......................................................... 2
-------
SECTION II Representations and Warranties of the Company..................... 2
---------------------------------------------
2.1 Organization, Good Standing and Qualifications................... 2
----------------------------------------------
2.2 Valid Issuance, Authority........................................ 2
-------------------------
2.3 No Conflict...................................................... 3
-----------
2.4 Company Capital Structure........................................ 3
-------------------------
2.5 No Material Misstatements or Omissions........................... 4
--------------------------------------
2.6 Company Financial Statements..................................... 4
----------------------------
2.7 No Material Changes.............................................. 4
-------------------
2.8 Intellectual Property............................................ 4
---------------------
SECTION III Representations and Warranties of the Investor................... 5
----------------------------------------------
3.1 Investment Representations and Covenants......................... 5
----------------------------------------
3.2 No Public Market................................................. 6
----------------
3.3 Domicile......................................................... 6
--------
3.4 Authority........................................................ 6
---------
3.5 No Conflict...................................................... 7
-----------
SECTION IV Conditions of Investor's and Company's Obligations at Closing..... 7
-------------------------------------------------------------
4.1 Conditions....................................................... 7
----------
SECTION V Deliveries at Closing.............................................. 8
---------------------
5.1 Stockholder Rights Agreement..................................... 8
----------------------------
5.2 Corporate Proceedings............................................ 8
---------------------
5.3 Amended Certificate of Incorporation............................. 8
------------------------------------
5.4 Opinion of Counsel............................................... 8
------------------
5.5 Payment of Purchase Price........................................ 8
-------------------------
SECTION VI Investor Covenants................................................ 8
------------------
6.1 Restrictions on Transfer......................................... 8
------------------------
6.2 Legends.......................................................... 9
-------
6.3 Standstill....................................................... 9
----------
SECTION VII Company Covenants................................................10
-----------------
7.1 Periodic Reports.................................................10
----------------
7.2 Limitation on Sale...............................................10
------------------
-i-
<PAGE>
7.3 HSR Filing.......................................................10
----------
SECTION VIII Miscellaneous...................................................11
-------------
8.1 Governing Law....................................................11
-------------
8.2 Survival.........................................................11
--------
8.3 Successors, Assigns..............................................11
-------------------
8.4 Notices..........................................................11
-------
8.5 Expenses.........................................................11
--------
8.6 Finder's Fees....................................................11
-------------
8.7 Counterparts.....................................................12
------------
8.8 Severability.....................................................12
------------
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers.........................................12
------------------------
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of January 19, 1999, by and between Covad
Communications Group, Inc., a Delaware corporation (the "Company") and the
undersigned investor (the "Investor").
RECITALS
WHEREAS, the Investor is willing to purchase and the Company is willing to
sell to the Investor an aggregate of 900,349 shares of Series C-1 Preferred
Stock, par value $.001 per share (with rights and preferences identical to the
Series C Stock except that Series C-1 Preferred Stock shall be nonvoting and be
convertible into a nonvoting class of Common Stock) (the "Series C-1 Preferred
Stock");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series C-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 694,445 shares of Series D-1 Preferred Stock of the
Company to the Investor, pursuant to a Series D-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investor
(the "Series D-1 Preferred Stock Purchase Agreement"); and
WHEREAS, the Company and the Investor wish to set forth the terms and
conditions upon which the Company will sell, and the Investor will purchase,
shares of Series C-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investor hereby agree as
follows:
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series C-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set
forth in the Company's Amended and Restated Certificate of Incorporation (the
"Amended Certificate of Incorporation") attached to this Agreement as Exhibit
A, sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investor, and the Investor will purchase
from the Company, at the Closing, an aggregate of 900,349 shares of Series C-1
Preferred Stock (the "Shares") for the aggregate purchase price of
$2,499,999.07.
<PAGE>
1.3 Closing.
-------
(a) The purchase and sale of the Shares shall take place at a
closing (the "Closing") to be held at the offices of Wilson Sonsini Goodrich &
Rosati, 650 Page Mill Road, Palo Alto, CA 94304-1050, on the date hereof.
(b) On the date of the Closing (the "Closing Date"), subject to the
conditions stated herein, the Company will deliver to the Investor stock
certificates representing the Shares to be purchased by the Investor against
payment to the Company of the purchase price therefor by wire transfer in
federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investor, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investor dated as of the date hereof (the "Disclosure
Letter") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions
in which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the
failure to be so qualified would not have a material adverse effect on the
business, properties, financial condition or results of operations of the
Company and its subsidiaries, taken as a whole (a "Material Adverse Effect").
The outstanding shares of capital stock of each of its subsidiaries have been
duly authorized and validly issued, are fully paid and non-assessable, and are
owned by the Company free and clear of all liens, encumbrances and equities
and claims; and no options, warrants or other rights to purchase, agreements
or other obligations to issue or other rights to convert any obligations into
shares of capital stock or ownership interests in such subsidiaries are
outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation
will be duly and validly issued, fully paid and nonassessable. The Company has
all requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated
hereby and thereby. The execution and delivery of this Agreement and the
Stockholder Rights Agreement by the Company, and the consummation by the
Company of the transactions contemplated hereby and thereby have been duly
authorized by all necessary action on the part of the Company and, no other
proceedings are
2
<PAGE>
necessary to authorize this Agreement and the Stockholder Rights Agreement or
to consummate the transactions contemplated hereby and thereby. This Agreement
and the Stockholder Rights Agreement have been duly executed and delivered by
the Company and constitute legal, valid and binding obligations of the Company
enforceable against the Company in accordance with their respective terms. The
sale of the Shares and the subsequent conversion of the Shares into Series C
Preferred, Class B Common and Common Stock are not and will not be subject to
any preemptive rights, rights of first refusal or rights of participation that
have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of
the transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any
subsidiary or any of their respective properties or assets are subject, or
(iii) any judgment, order, decree, statute, law, ordinance, rule or regulation
applicable to the Company or any subsidiary or their respective properties or
assets, except in the case of (ii) and (iii) for any of the foregoing that in
the aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
-------------------------
(a) Immediately prior to Closing, the authorized capital stock of
the Company will consist of 100,000,000 shares of authorized Common Stock,
$.001 par value, of which 11,773,997 shares are issued and outstanding as of
December 31, 1998 and of which 10,000,000 are designated Class B Common, none
of which are outstanding, and 50,000,000 shares of Preferred Stock, $.001 par
value, of which 750,000 shares are designated Series A Preferred Stock, all of
which are outstanding, 17,100,003 shares are designated Series B Preferred,
all of which are outstanding, 11,149,287 shares are designated Series C
Preferred, 396,159 of which are outstanding, 6,000,000 shares are designated
Series C-1 Preferred, 2,701,049 of which are outstanding, 5,000,000 shares are
designated Series D Preferred, none of which are outstanding and 5,000,000
shares are designated Series D-1 Preferred, 2,083,334 of which are outstanding
(collectively, the "Company Capital Stock"). Except as provided in the
Stockholders Rights Agreement, all outstanding shares of Company Capital Stock
are duly authorized, validly issued, fully paid and non-assessable, are not
subject to preemptive rights created by statute, the Certificate of
Incorporation or Bylaws of the Company or any agreement to which the Company
is a party or by which it is bound and have been issued in compliance with
federal and state securities laws. The Company has no other capital stock
authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "Option
Plan") and the 1998 Employee Stock Purchase Plan (the "Purchase Plan"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person. The Company has reserved
15,520,342 shares of Company Common Stock for issuance to
3
<PAGE>
employees, directors and consultants pursuant to the Option Plan, 12,249,907
of which are subject to outstanding options under the Option Plan as of
December 31, 1998 and has reserved 1,000,000 shares for the Purchase Plan,
none of which are issued and outstanding. The Company has issued warrants to
purchase 6,988,764 shares of Common Stock, all of which are outstanding. The
Company has reserved 6,988,764 shares of Company Common Stock for issuance
upon the exercise of such warrants. Except as described in this Section
2.4(b), there are no options, warrants, calls, rights, commitments or
agreements of any character, written or oral, to which the Company is a party
or by which it is bound obligating the Company to issue, deliver, sell,
repurchase or redeem, or cause to be issued, delivered, sold, repurchased or
redeemed, any shares of the capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "Registration Statement") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on January 19, 1999 (the "Filing
Date"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"Securities Act") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading.
2.6 Company Financial Statements. The Registration Statement includes
----------------------------
(i) the Company's audited balance sheet as of September 30, 1998, and the
related audited statements of operations, stockholders' equity and cash flows
for the nine-month period ended September 30, 1998 and (ii) the Company's
audited balance sheet as of December 31, 1997, and the related audited
statements of operations, stockholders' equity and cash flows for the year
ended December 31, 1997, (collectively, the "Company Financials"). The Company
Financials have been prepared in accordance with U.S. generally accepted
accounting principles consistent with the reporting practices and principles
("GAAP"), applied on a basis consistent throughout the periods indicated and
consistent with each other. The Company Financials present fairly the
financial condition, operating results and cash flows of the Company as of the
dates and during the periods indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been
-------------------
any materially adverse change in the business, properties, financial condition
or results of operations of the Company, whether or not arising from
transactions in the ordinary course of business, other than as set forth in
the Registration Statement, and since such date, except in the ordinary course
of business, the Company has not entered into any material transaction not
referred to in the Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("Intellectual
Property") employed in the operation of their respective businesses as
currently conducted, and, to the knowledge of the Company, with no
infringement of or conflict with the
4
<PAGE>
rights of others respecting any of the same. Neither the Company nor any
subsidiary has received any communications alleging that the Company or any
subsidiary has violated any of the Intellectual Property of any other person
or entity. Reasonable security measures have been taken by the Company and its
subsidiaries to protect the secrecy, confidentiality and value of the
Company's and its subsidiaries' trade secrets, including their respective know-
how, technology, concepts and other technical data for the development,
processing, manufacture and sale of its products. Each employee of and
consultant to the Company or its subsidiaries has executed an invention
assignment and confidentiality agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investor
----------------------------------------------
The Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and
not with a view to the sale or distribution of any part thereof, and that it
has no present intention of selling, granting any participation in or
otherwise distributing the same.
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series C
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided
for in this Agreement and the issuance of securities hereunder is exempt
pursuant to Section 4(2) of the Securities Act, and that the Company's
reliance on such exemption is predicated in part on the Investor's
representations set forth herein.
(c) Investor represents that it is experienced in evaluating
companies such as the Company, is able to fend for itself in transactions such
as the one contemplated by this Agreement, has such knowledge and experience
in financial and business matters that it is capable of evaluating the merits
and risks of its prospective investment in the Company and is able to afford a
complete loss of its investment. The Company acknowledges that the foregoing
representation shall not limit the right of the Investor to rely on the
representations of the Company set forth in Section 2 hereof.
(d) Investor acknowledges and understands that the Shares and any
Series C Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares
or Series C Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
5
<PAGE>
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series C
Preferred, Class B Common Stock and Common Stock issued upon conversion
thereof, may be sold under Rule 144, the following conditions must be
fulfilled, except as otherwise described below: (i) certain public information
about the Company must be available; (ii) the sale must occur at least one
year after the later of the date the Shares were sold by the Company or the
date they were sold by an affiliate of the Company; (iii) the sale must be
made in a broker's transaction; and (iv) the number of Shares sold must not
exceed certain volume limitations. If, however, the sale occurs at least two
years after the Shares were sold by the Company or an affiliate of the
Company, and if the Investor is not an affiliate of the Company, the foregoing
conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion
that persons proposing to sell restricted securities received in a private
offering other than in a registered offering or pursuant to Rule 144 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
the brokers who participate in the transactions do so at their own risk.
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer
or otherwise dispose of the Shares and any Series C Preferred, Class B Common
Stock and Common Stock issued on conversion thereof only in a manner
consistent with its representations and covenants set forth in this Agreement
and the Stockholder Rights Agreement. In connection therewith such Purchaser
acknowledges that the Company shall make a notation on its stock books
regarding the restrictions on transfer set forth in this Agreement and the
Stockholder Rights Agreement and shall transfer shares on the books of the
Company only to the extent not inconsistent therewith.
(h) Investor represents that it is an "accredited investor" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no
assurance a public market will be created.
3.3 Domicile. Investor is domiciled in the state set forth at its
--------
address in Section 8.4.
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out
its obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been
duly authorized by all necessary action on the part of the Investor and, no
other proceedings are necessary
6
<PAGE>
to authorize this Agreement and the Stockholder Rights Agreement or to
consummate the transactions contemplated hereby and thereby. This Agreement
and the Stockholder Rights Agreement have been duly executed and delivered by
the Investor and constitute legal, valid and binding obligations of the
Investor enforceable against the Investor in accordance with their respective
terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of
the transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to
which the Investor or any of its properties or assets are subject, or (iii)
any judgment, order, decree, statute, law, ordinance, rule or regulation
applicable to the Investor or its properties or assets, except in the case of
(ii) and (iii) for any of the foregoing that in the aggregate would not have a
material adverse effect on Investor.
SECTION IV
Conditions of Investor's and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of the
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investor at the Closing except for the deliveries set forth in Section V and
the fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investor and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation
of the transactions contemplated by this Agreement.
(d) Stockholder Rights Agreement. The Company, the Investor and the
----------------------------
requisite parties required to amend the Stockholder Rights Agreement shall
have entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
7
<PAGE>
(f) Series D-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investor shall have purchased an aggregate of 694,445 shares of Series D-1
Preferred Stock of the Company, pursuant to the Series D-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investor, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the Company and the Investors on the date hereof
(the "Stockholder Rights Agreement") and as amended by its existing
stockholders prior to the Closing.
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investor to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver
such copy of the Amended Certificate of Incorporation as filed with the
Secretary of State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in
------------------
form of Exhibit C, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Investor shall deliver to the Company
-------------------------
payment for the Shares to be acquired by such Investor in the amounts set
forth in Section 1.2 hereto.
SECTION VI
Investor Covenants
------------------
6.1 Restrictions on Transfer. Investor shall not, directly or
------------------------
indirectly, sell or transfer any Shares or any Series C Preferred, Class B
Common Stock or Common Stock issued upon conversion thereof for a period of
one year following the Closing Date, except pursuant to a sale of all the
capital stock of the Company or a merger or consolidation in which the Company
is acquired, or pursuant to a liquidation of the Company. However, Investor
may sell or transfer the Shares or Series C Preferred, Class B Common Stock or
such Common Stock to (i) any Affiliate (as defined below) of the Investor
during such one year period or (ii) any third party after such one year
period, provided that such Affiliate or third party, as the case may be,
agrees in writing to be bound by the
8
<PAGE>
obligations of this Agreement and the restrictions on transfer, including
without the limitation, the "lock-up" agreement, set forth in the Stockholder
Rights Agreement. No such transfer shall be effective unless the transferee or
assignee assumes in writing the obligations of the Investor under this
Agreement.
6.2 Legends. Investor agrees that each certificate representing Shares
-------
or any Common Stock issued upon conversion thereof be endorsed with the
following restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT
BE SOLD OR OFFERED FOR SALE IN THE ABSENCE OF SUCH REGISTRATION OR AN
OPINION OF COUNSEL SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT. COPIES OF THE AGREEMENTS
COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE
OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE, RESTRICTIONS ON TRANSFER AND
ACQUISITION OF ADDITIONAL SECURITIES OF THE COMPANY, COPIES OF WHICH ARE ON
FILE AT THE PRINCIPAL OFFICE OF THE COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
Investor shall not, and shall cause each of its Affiliates (as defined below)
to not, acquire beneficial ownership (as such term is defined in Rule 13d-3 of
the Securities Exchange Act of 1934, as amended) of any securities of the
Company in addition to the Shares or any Series C Preferred, Class B Common
and Common Stock issued upon conversion thereof, which would result in the
aggregate beneficial ownership of each Investor and its Affiliates of Voting
Stock of the Company (as defined below) equaling or exceeding 10% of the
outstanding Voting Stock of the Company. Investor or any of its Affiliates
shall not purchase any securities of the Company without having given 30 days
prior written notice to the Company or without having received the prior
written consent of the Company. Upon notice
9
<PAGE>
thereof, the Company shall inform the Investor whether such purchases cause
the aggregate beneficial ownership of Investor and its Affiliates to equal or
exceed 10% of the outstanding Voting Stock of the Company. For the purposes of
this Agreement, "Affiliate" shall mean, as to any person or entity, a person
or entity that, directly or indirectly through one or more intermediaries,
controls or is controlled by, or is under common control with, such person or
entity. For the purposes of this Agreement, "Voting Stock of the Company"
shall mean, any class or series of the Company's capital stock entitled to
vote in any election of directors of the Company.
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as the Investor
continues to own Shares or any Common Stock issued upon conversion thereof,
copies of the Company's Forms 10-K, 10-Q and Annual Report to Shareholders,
promptly after such documents are filed with the SEC, or in lieu of such
reports, unaudited quarterly and audited annual financial statements of the
Company, promptly after completion.
7.2 Limitation on Sale. The Company covenants until the completion of
------------------
an underwritten public offering pursuant to an effective registration
statement under the Securities Act, covering the initial offer and sale of
Common Stock for the account of the Company to the public with aggregate gross
proceeds to the Company of not less than Fifteen Million Dollars ($15,000,000)
(the "IPO") not to issue or sell any shares of Series C Preferred Stock,
Series D Preferred Stock, Series C-1 Preferred Stock or Series D-1 Preferred
Stock to any investor at a more favorable price or upon more favorable terms
(including rights, preferences, privileges and restrictions) than those set
forth in the Company's Amended and Restated Certificate of Incorporation, this
Agreement and the Series D-1 Preferred Stock Purchase Agreement, and the
Amended and Restated Stockholder Rights Agreement without the prior written
consent of the Investor. Notwithstanding the foregoing, the Company expressly
reserves the right to sell shares of its Series C Preferred Stock and/or
Series D Preferred Stock without the prior written consent of the Investor
provided that such shares shall not have been sold or issued by the Company at
a more favorable price or on more favorable terms (other than the existence of
voting rights) than those which are reflected in this Agreement, the Series D-
1 Preferred Stock Purchase Agreement, the Amended and Restated Stockholder
Rights and the Amended and Restated Certificate of Incorporation.
7.3 HSR Filing. In the event the Investor determines that the purchase
----------
of the Shares hereunder has not been "solely for the purpose of investment"
(as defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investor determines that as a result the Company and the Investors are
required to make appropriate filings with the Federal Trade Commission and
Department of Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements
Act of 1976, as
10
<PAGE>
amended (the "HSR Act"), the Company and Investor agree to cooperate, to make
such filings in a timely manner, and to take all other appropriate action in
connection with such required filings.
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the
closing of the transactions contemplated hereby.
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties
hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to Investor, at
U.S. Telesource, Inc., 700 Qwest Tower, 555 Seventeenth Street, Denver,
Colorado 80202, Attn: Executive Vice President and General Counsel, or at such
other address as the Investor shall have furnished to the Company, or (b) if
to the Company, at 2330 Central Expressway, Santa Clara, California 95050
addressed to the attention of the Corporate Secretary, or at such other
address as the Company shall have furnished to the Investor. If notice is
provided by facsimile, it must be simultaneously confirmed via telephone and
it shall be deemed to be given one (1) day after transmission. If notice is
provided by U.S. mail, notice shall be deemed to be given three (3) days after
proper deposit in a U.S. mailbox, postage prepaid.
8.5 Expenses. The Company and the Investor shall bear their own
--------
expenses and legal fees incurred on their behalf with respect to this
Agreement and the transactions contemplated hereby; provided, however, that
the Company will pay the reasonable fees and expenses of counsel for the
Investor up to an aggregate amount of $15,000, for fees and expenses incurred
in connection with this Agreement, the Series D-1 Preferred Stock Purchase
Agreement and the Stockholder Rights Agreement.
8.6 Finder's Fees. The Company and the Investor shall each indemnify
-------------
and hold the other harmless from any liability for any commission or
compensation in the nature of a finder's fee, placement fee or underwriter's
discount (including the costs, expenses and legal fees of defending against
such liability) for which the Company or the Investors, or any of their
respective partners, employees, or representatives, as the case may be, is
responsible.
11
<PAGE>
8.7 Counterparts. This Agreement may be executed in counterparts, each
------------
of which shall be enforceable against the party actually executing the
counterpart, and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective
if it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and
Restated Stockholder Rights Agreement of an even date herewith, such sections
shall be inapplicable to non-Affiliate purchasers (with respect to the
transferring Investor) who acquire any shares of Series C-1 Preferred Stock,
Series C Preferred Stock, Class B Common Stock or Common Stock from an
Investor.
12
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series C-1 Preferred
Stock Purchase Agreement as of this 19th day of January, 1999.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ DHRUV KHANNA
------------------------------------
Name: Dhruv Khanna
Title: Vice President, General Counsel
U.S. TELESOURCE, INC.
By: /s/ DRAKE S. TEMPEST
------------------------------------
Name: Drake S. Tempest
Title: Executive Vice President and
General Counsel
SIGNATURE PAGE TO SERIES C-1 PREFERRED STOCK PURCHASE AGREEMENT
<PAGE>
EXHIBIT A
---------
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
<PAGE>
EXHIBIT B
---------
STOCKHOLDER RIGHTS AGREEMENT
<PAGE>
EXHIBIT C
---------
OPINION OF COUNSEL
<PAGE>
EXHIBIT 10.18
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
DATED AS OF JANUARY 19, 1999
<PAGE>
TABLE OF CONTENTS
Page
----
SECTION I Purchase and Sale of Shares........................................ 1
---------------------------
1.1 Authorization of Shares. ........................................ 1
-----------------------
1.2 Sale of the Stock................................................ 1
-----------------
1.3 Closing.......................................................... 2
-------
SECTION II................................................................... 2
2.1 Organization, Good Standing and Qualifications................... 2
----------------------------------------------
2.2 Valid Issuance, Authority........................................ 2
-------------------------
2.3 No Conflict...................................................... 3
-----------
2.4 Company Capital Structure........................................ 3
-------------------------
2.5 No Material Misstatements or Omissions........................... 4
--------------------------------------
2.6 Company Financial Statements..................................... 4
----------------------------
2.7 No Material Changes.............................................. 4
-------------------
2.8 Intellectual Property............................................ 4
---------------------
SECTION III Representations and Warranties of the Investor................... 5
----------------------------------------------
3.1 Investment Representations and Covenants......................... 5
----------------------------------------
3.2 No Public Market................................................. 6
----------------
3.3 Domicile......................................................... 6
--------
3.4 Authority........................................................ 6
---------
3.5 No Conflict...................................................... 7
-----------
SECTION IV Conditions of Investor's and Company's Obligations at Closing..... 7
-------------------------------------------------------------
4.1 Conditions....................................................... 7
----------
SECTION V Deliveries at Closing.............................................. 8
---------------------
5.1 Stockholder Rights Agreement..................................... 8
----------------------------
5.2 Corporate Proceedings............................................ 8
---------------------
5.3 Amended Certificate of Incorporation............................. 8
------------------------------------
5.4 Opinion of Counsel............................................... 8
------------------
5.5 Payment of Purchase Price........................................ 8
-------------------------
SECTION VI Investor Covenants................................................ 9
------------------
6.1 Restrictions on Transfer......................................... 9
------------------------
6.2 Legends.......................................................... 9
-------
6.3 Standstill.......................................................10
----------
SECTION VII Company Covenants................................................10
-----------------
7.1 Periodic Reports.................................................10
----------------
7.2 Limitation on Sale...............................................10
------------------
-i-
<PAGE>
TABLE OF CONTENTS
(continued)
Page
----
7.3 HSR Filing.......................................................11
----------
SECTION VIII Miscellaneous...................................................11
-------------
8.1 Governing Law....................................................11
-------------
8.2 Survival.........................................................11
--------
8.3 Successors, Assigns..............................................11
-------------------
8.4 Notices..........................................................11
-------
8.5 Expenses.........................................................12
--------
8.6 Finder's Fees....................................................12
-------------
8.7 Counterparts.....................................................12
------------
8.8 Severability.....................................................12
------------
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers.........................................12
------------------------
Exhibit A Amended and Restated Certificate of Incorporation
Exhibit B Stockholder Rights Agreement
Exhibit C Opinion of Counsel
-ii-
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
This AGREEMENT is made as of January 19, 1999, by and between Covad
Communications Group, Inc., a Delaware corporation (the "Company") and the
undersigned investor (the "Investor").
RECITALS
WHEREAS, the Investor desires to purchase and the Company desires to sell
an aggregate of 694,445 shares of Series D-1 Preferred Stock, par value $.001
per share, of the Company (the "Series D-1 Preferred Stock");
WHEREAS, simultaneously with the closing of the sale of the shares of
Series D-1 Preferred Stock pursuant to this Agreement, the Company will issue
and sell an aggregate of 900,349 shares of Series C-1 Preferred Stock of the
Company to the Investor, pursuant to a Series C-1 Preferred Stock Purchase
Agreement, dated as of the date hereof, between the Company and the Investor
(the "Series C-1 Preferred Stock Purchase Agreement"); and
WHEREAS, the Company and the Investor wish to set forth the terms and
conditions upon which the Company will sell, and the Investor will purchase,
shares of Series D-1 Preferred Stock.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
and conditions herein contained, the Company and the Investor hereby agree as
follows:
SECTION I
Purchase and Sale of Shares
---------------------------
1.1 Authorization of Shares. The Company will prior to the Closing (as
-----------------------
defined) have authorized the issuance of shares of its Series D-1 Preferred
Stock, having the rights, preferences, privileges and restrictions as set forth
in the Company's Amended and Restated Certificate of Incorporation (the "Amended
Certificate of Incorporation") attached to this Agreement as Exhibit A,
sufficient to meet the purposes of Section 1.2.
1.2 Sale of the Stock. Subject to the terms and conditions hereof, the
-----------------
Company will issue and sell to the Investor, and the Investor will purchase from
the Company, at the Closing, an aggregate of 694,445 shares of Series D-1
Preferred Stock (the "Shares") for the aggregate purchase price of $12,500,010.
<PAGE>
1.3 Closing.
-------
(a) The purchase and sale of the Shares shall take place at a closing
(the "Closing") to be held at the offices of Wilson Sonsini Goodrich & Rosati,
650 Page Mill Road, Palo Alto, CA 94304-1050, on the date hereof.
(b) On the date of the Closing (the "Closing Date"), subject to the
conditions stated herein, the Company will deliver to the Investor stock
certificates representing the Shares to be purchased by the Investor against
payment to the Company of the purchase price therefor by wire transfer in
federal or other immediately available funds.
SECTION II
Representations and Warranties of the Company
---------------------------------------------
The Company hereby represents and warrants to the Investor, subject to the
exceptions specifically disclosed in writing in the disclosure letter supplied
by the Company to the Investor dated as of the date hereof (the "Disclosure
Letter") and certified by a duly authorized officer of the Company, as follows:
2.1 Organization, Good Standing and Qualifications. Each of the Company
----------------------------------------------
and its subsidiaries has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as currently conducted, and is duly
qualified as a foreign corporation and in good standing in all jurisdictions in
which the character of the property owned or leased or the nature of the
business transacted by it makes qualification necessary except where the failure
to be so qualified would not have a material adverse effect on the business,
properties, financial condition or results of operations of the Company and its
subsidiaries, taken as a whole (a "Material Adverse Effect"). The outstanding
shares of capital stock of each of its subsidiaries have been duly authorized
and validly issued, are fully paid and non-assessable, and are owned by the
Company free and clear of all liens, encumbrances and equities and claims; and
no options, warrants or other rights to purchase, agreements or other
obligations to issue or other rights to convert any obligations into shares of
capital stock or ownership interests in such subsidiaries are outstanding.
2.2 Valid Issuance, Authority. The Shares, when issued and sold to the
-------------------------
Investors as provided herein, and the Common Stock issuable upon conversion of
the Shares when issued pursuant to the Amended Certificate of Incorporation will
be duly and validly issued, fully paid and nonassessable. The Company has all
requisite right, power and authority to enter into this Agreement and the
Stockholder Rights Agreement (as defined below), to carry out its obligations
hereunder and thereunder and to consummate the transactions contemplated hereby
and thereby. The execution and delivery of this Agreement and the Stockholder
Rights Agreement by the Company, and the consummation by the Company of the
transactions contemplated hereby and thereby have been duly
-2-
<PAGE>
authorized by all necessary action on the part of the Company and, no other
proceedings are necessary to authorize this Agreement and the Stockholder Rights
Agreement or to consummate the transactions contemplated hereby and thereby.
This Agreement and the Stockholder Rights Agreement have been duly executed and
delivered by the Company and constitute legal, valid and binding obligations of
the Company enforceable against the Company in accordance with their respective
terms. The sale of the Shares and the subsequent conversion of the Shares into
Series D Preferred, Class B Common and Common Stock are not and will not be
subject to any preemptive rights, rights of first refusal or rights of
participation that have not been properly waived or complied with.
2.3 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Company do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the Amended
Certificate of Incorporation and Bylaws of the Company or any subsidiary, (ii)
any mortgage, indenture, lease, contract or other agreement or instrument,
permit, concession, franchise or license to which the Company or any subsidiary
or any of their respective properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Company or any subsidiary or their respective properties or assets,
except in the case of (ii) and (iii) for any of the foregoing that in the
aggregate would not have a Material Adverse Effect.
2.4 Company Capital Structure.
--------------------------
(a) Immediately prior to Closing, the authorized capital stock of the
Company will consist of 100,000,000 shares of authorized Common Stock, $.001 par
value, of which 11,773,997 shares are issued and outstanding as of December 31,
1998 and of which 10,000,000 are designated Class B Common, none of which are
outstanding, and 50,000,000 shares of Preferred Stock, $.001 par value, of which
750,000 shares are designated Series A Preferred Stock, all of which are
outstanding, 17,100,003 shares are designated Series B Preferred, all of which
are outstanding, 11,149,287 shares are designated Series C Preferred, 396,159 of
which are outstanding, 6,000,000 shares are designated Series C-1 Preferred,
2,701,049 of which are outstanding, 5,000,000 shares are designated Series D
Preferred, none of which are outstanding and 5,000,000 shares are designated
Series D-1 Preferred, 2,083,334 of which are outstanding (collectively, the
"Company Capital Stock"). Except as provided in the Stockholders Rights
Agreement, all outstanding shares of Company Capital Stock are duly authorized,
validly issued, fully paid and non-assessable, are not subject to preemptive
rights created by statute, the Certificate of Incorporation or Bylaws of the
Company or any agreement to which the Company is a party or by which it is bound
and have been issued in compliance with federal and state securities laws. The
Company has no other capital stock authorized, issued or outstanding.
(b) Except for the Company's 1997 Stock Option Plan (the "Option
Plan") and the 1998 Employee Stock Purchase Plan (the "Purchase Plan"), the
Company has never adopted or maintained any stock option plan or other plan
providing for equity compensation of any person.
-3-
<PAGE>
The Company has reserved 15,520,342 shares of Company Common Stock for issuance
to employees, directors and consultants pursuant to the Option Plan,
12,249,907 of which are subject to outstanding options under the Option Plan
as of December 31, 1998 and has reserved 1,000,000 shares for the Purchase Plan,
none of which are issued and outstanding. The Company has issued warrants to
purchase 6,988,764 shares of Common Stock, all of which are outstanding. The
Company has reserved 6,988,764 shares of Company Common Stock for issuance upon
the exercise of such warrants. Except as described in this Section 2.4(b), there
are no options, warrants, calls, rights, commitments or agreements of any
character, written or oral, to which the Company is a party or by which it is
bound obligating the Company to issue, deliver, sell, repurchase or redeem, or
cause to be issued, delivered, sold, repurchased or redeemed, any shares of the
capital stock of the Company.
2.5 No Material Misstatements or Omissions. The amended Registration
--------------------------------------
Statement (the "Registration Statement") on Form S-1 filed by the Company with
the U.S. Securities and Exchange Commission on January 19, 1999 (the "Filing
Date"), complies in all material respects as of the Filing Date and the date
hereof, with the provisions of the Securities Act of 1933, as amended (the
"Securities Act") and the rules and regulations of the SEC promulgated
thereunder; as of the Filing Date and the date hereof, the Registration
Statement did not and does not contain any untrue statement of a material fact
and did not and does not omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of the
circumstances under which they were made, not misleading.
2.6 Company Financial Statements. The Registration Statement includes (i)
----------------------------
the Company's audited balance sheet as of September 30, 1998, and the related
audited statements of operations, stockholders' equity and cash flows for the
nine-month period ended September 30, 1998 and (ii) the Company's audited
balance sheet as of December 31, 1997, and the related audited statements of
operations, stockholders' equity and cash flows for the year ended December 31,
1997, (collectively, the "Company Financials"). The Company Financials have been
prepared in accordance with U.S. generally accepted accounting principles
consistent with the reporting practices and principles ("GAAP"), applied on a
basis consistent throughout the periods indicated and consistent with each
other. The Company Financials present fairly the financial condition, operating
results and cash flows of the Company as of the dates and during the periods
indicated therein.
2.7 No Material Changes. Since September 30, 1998, there has not been any
-------------------
materially adverse change in the business, properties, financial condition or
results of operations of the Company, whether or not arising from transactions
in the ordinary course of business, other than as set forth in the Registration
Statement, and since such date, except in the ordinary course of business, the
Company has not entered into any material transaction not referred to in the
Registration Statement.
2.8 Intellectual Property. To the knowledge of the Company, the Company
---------------------
or its subsidiaries own and possess or are licensed under all patents, patent
applications, licenses, trademarks, trade secrets, trade names, brand names,
inventions and copyrights or other proprietary rights ("Intellectual Property")
employed in the operation of their respective businesses as currently
-4-
<PAGE>
conducted, and, to the knowledge of the Company, with no infringement of or
conflict with the rights of others respecting any of the same. Neither the
Company nor any subsidiary has received any communications alleging that the
Company or any subsidiary has violated any of the Intellectual Property of any
other person or entity. Reasonable security measures have been taken by the
Company and its subsidiaries to protect the secrecy, confidentiality and value
of the Company's and its subsidiaries' trade secrets, including their respective
know-how, technology, concepts and other technical data for the development,
processing, manufacture and sale of its products. Each employee of and
consultant to the Company or its subsidiaries has executed an invention
assignment and confidentiality agreement with the Company or its subsidiaries.
SECTION III
Representations and Warranties of the Investor
----------------------------------------------
The Investor hereby represents and warrants to the Company that:
3.1 Investment Representations and Covenants.
-----------------------------------------
(a) Investor represents that the Shares to be received will be
acquired for investment for its own account, not as a nominee or agent, and not
with a view to the sale or distribution of any part thereof, and that it has no
present intention of selling, granting any participation in or otherwise
distributing the same.
(b) Investor understands and acknowledges that the offering of the
Shares pursuant to this Agreement will not, and any issuance of Series D
Preferred, Class B Common Stock or Common Stock on conversion thereof may not,
be registered under the Securities Act on the ground that the sale provided for
in this Agreement and the issuance of securities hereunder is exempt pursuant to
Section 4(2) of the Securities Act, and that the Company's reliance on such
exemption is predicated in part on the Investor's representations set forth
herein.
(c) Investor represents that it is experienced in evaluating
companies such as the Company, is able to fend for itself in transactions such
as the one contemplated by this Agreement, has such knowledge and experience in
financial and business matters that it is capable of evaluating the merits and
risks of its prospective investment in the Company and is able to afford a
complete loss of its investment. The Company acknowledges that the foregoing
representation shall not limit the right of the Investor to rely on the
representations of the Company set forth in Section 2 hereof.
(d) Investor acknowledges and understands that the Shares and any
Series D Preferred, Class B Common Stock and Common Stock acquired upon the
conversion thereof, must be held indefinitely unless they are subsequently
registered under the Securities Act or an exemption from such registration is
available, and that, except as otherwise provided in the Stockholder Rights
Agreements, the Company is under no obligation to register either the Shares or
Series D Preferred, Class B Common Stock and Common Stock issuable upon
conversion thereof.
-5-
<PAGE>
(e) Investor acknowledges that it has reviewed Rule 144 promulgated
under the Securities Act, which permits limited public resales of securities
acquired in a non-public offering, subject to the satisfaction of certain
conditions. Investor understands that before the Shares, or any Series D
Preferred, Class B Common Stock and Common Stock issued upon conversion thereof,
may be sold under Rule 144, the following conditions must be fulfilled, except
as otherwise described below: (i) certain public information about the Company
must be available; (ii) the sale must occur at least one year after the later of
the date the Shares were sold by the Company or the date they were sold by an
affiliate of the Company; (iii) the sale must be made in a broker's transaction;
and (iv) the number of Shares sold must not exceed certain volume limitations.
If, however, the sale occurs at least two years after the Shares were sold by
the Company or an affiliate of the Company, and if the Investor is not an
affiliate of the Company, the foregoing conditions will not apply.
(f) Investor acknowledges that in the event the applicable
requirements of Rule 144 are not met, registration under the Securities Act or
compliance with another exemption from registration will be required for any
disposition of its stock. Investor understands that although Rule 144 is not
exclusive, the Securities and Exchange Commission has expressed its opinion that
persons proposing to sell restricted securities received in a private offering
other than in a registered offering or pursuant to Rule 144 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 the brokers who
participate in the transactions do so at their own risk.
(g) Investor covenants that, in the absence of an effective
registration statement covering the stock in question, it will sell, transfer or
otherwise dispose of the Shares and any Series D Preferred, Class B Common Stock
and Common Stock issued on conversion thereof only in a manner consistent with
its representations and covenants set forth in this Agreement and the
Stockholder Rights Agreement. In connection therewith such Purchaser
acknowledges that the Company shall make a notation on its stock books regarding
the restrictions on transfer set forth in this Agreement and the Stockholder
Rights Agreement and shall transfer shares on the books of the Company only to
the extent not inconsistent therewith.
(h) Investor represents that it is an "accredited investor" as such
term is defined in Rule 501(a) under the Securities Act.
3.2 No Public Market. Investor understands that no public market now
----------------
exists for any of the securities issued by the Company and there is no assurance
a public market will be created.
3.3 Domicile. Investor is domiciled in the state set forth at its address
--------
in Section 8.4.
3.4 Authority. Investor has all requisite right, power and authority to
---------
enter into this Agreement and the Stockholder Rights Agreement, to carry out its
obligations hereunder and thereunder and to consummate the transactions
contemplated hereby and thereby. The execution and delivery of this Agreement
and the Stockholder Rights Agreement by the Investor, and the consummation by
the Investor of the transactions contemplated hereby and thereby have been duly
authorized by all necessary action on the part of the Investor and, no other
proceedings are necessary
-6-
<PAGE>
to authorize this Agreement and the Stockholder Rights Agreement or to
consummate the transactions contemplated hereby and thereby. This Agreement and
the Stockholder Rights Agreement have been duly executed and delivered by the
Investor and constitute legal, valid and binding obligations of the Investor
enforceable against the Investor in accordance with their respective terms.
3.5 No Conflict. The execution and delivery of this Agreement and the
-----------
Stockholder Rights Agreement by the Investor do not, and the consummation of the
transactions contemplated hereby will not, conflict with, or result in any
violation of, or default under (with or without notice or lapse of time, or
both), or give rise to a right of termination, cancellation, modification or
acceleration of any obligation under (i) any provision of the organizational
documents of the Investor, (ii) any mortgage, indenture, lease, contract or
other agreement or instrument, permit, concession, franchise or license to which
the Investor or any of its properties or assets are subject, or (iii) any
judgment, order, decree, statute, law, ordinance, rule or regulation applicable
to the Investor or its properties or assets, except in the case of (ii) and
(iii) for any of the foregoing that in the aggregate would not have a material
adverse effect on Investor.
SECTION IV
Conditions of Investor's and Company's Obligations at Closing
-------------------------------------------------------------
4.1 Conditions. There shall be no conditions to the obligations of the
----------
Investor to purchase the Shares or of the Company to sell the Shares to the
Investor at the Closing except for the deliveries set forth in Section V and the
fulfillment on or before the Closing of each of the following conditions:
(a) Performance. The Investor and the Company shall have performed
-----------
and complied in all material respects with all covenants, agreements,
obligations and conditions contained in this Agreement that are required to be
performed or complied with by it on or before Closing.
(b) Securities Law Compliance. The Company shall have obtained all
-------------------------
necessary permits and qualifications, if any, required by any state or country
or secured an exemption therefrom, for the offer and sale of the Shares.
(c) No Injunction, etc. No preliminary or permanent injunction or
------------------
other binding order, decree or ruling issued by a court or governmental agency
shall be in effect which shall have the effect of preventing the consummation of
the transactions contemplated by this Agreement.
(d) Stockholder Rights Agreement. The Company, the Investor and the
----------------------------
requisite parties required to amend the Stockholder Rights Agreement shall have
entered into the Stockholder Rights Agreement.
(e) Amended Certificate of Incorporation. The Amended Certificate of
------------------------------------
Incorporation shall have been filed with the Secretary of State of the State of
Delaware prior to the Closing.
-7-
<PAGE>
(f) Series C-1 Preferred. Simultaneously with the Closing herewith,
--------------------
the Investor shall have purchased an aggregate of 900,349 shares of Series C-1
Preferred Stock of the Company, pursuant to the Series C-1 Preferred Stock
Purchase Agreement.
SECTION V
Deliveries at Closing
---------------------
At the Closing, the Company or the Investor, as applicable, shall deliver
the following:
5.1 Stockholder Rights Agreement. A copy of the Amended and Restated
----------------------------
Stockholder Rights Agreement in substantially the form attached hereto as
Exhibit B as entered into by the Company and the Investors on the date hereof
(the "Stockholder Rights Agreement") and as amended by its existing stockholders
prior to the Closing.
5.2 Corporate Proceedings. Such instruments and documents reasonably
---------------------
requested by the Investor to confirm any approvals of the transactions
contemplated hereby required by the Company's Board of Directors and
stockholders.
5.3 Amended Certificate of Incorporation. The Company shall deliver such
------------------------------------
copy of the Amended Certificate of Incorporation as filed with the Secretary of
State of the State of Delaware prior to the Closing.
5.4 Opinion of Counsel. A legal opinion of counsel to the Company in form
------------------
of Exhibit C, addressed to the Investor, dated as of the Closing.
5.5 Payment of Purchase Price. Investor shall deliver to the Company
-------------------------
payment for the Shares to be acquired by such Investor in the amounts set forth
in Section 1.2 hereto.
-8-
<PAGE>
SECTION VI
Investor Covenants
------------------
6.1 Restrictions on Transfer. Investor shall not, directly or indirectly,
------------------------
sell or transfer any Shares or any Series D Preferred, Class B Common Stock or
Common Stock issued upon conversion thereof for a period of one year following
the Closing Date, except pursuant to a sale of all the capital stock of the
Company or a merger or consolidation in which the Company is acquired, or
pursuant to a liquidation of the Company. However, Investor may sell or transfer
the Shares or Series D Preferred, Class B Common Stock or such Common Stock to
(i) any "Affiliate" (as defined below) of an Investor during such one year
period or (ii) any third party after such one year period, provided that such
Affiliate or third party, as the case may be, agrees in writing to be bound by
the obligations of this Agreement and the restrictions on transfer, including
without the limitation, the "lock-up" agreement, set forth in the Stockholder
Rights Agreement. No such transfer shall be effective unless the transferee or
assignee assumes in writing the obligations of the Investor under this
Agreement.
6.2 Legends. Investor agrees that each certificate representing Shares or
-------
any Common Stock issued upon conversion thereof be endorsed with the following
restrictive legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "ACT") OR ANY STATE SECURITIES LAWS. SUCH SHARES MAY NOT
BE SOLD OR OFFERED FOR SALE IN THE ABSENCE OF SUCH REGISTRATION OR AN
OPINION OF COUNSEL SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT. COPIES OF THE AGREEMENTS
COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE
OFFICE OF THE CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO, AND MAY BE
TRANSFERRED ONLY IN COMPLIANCE WITH, CERTAIN AGREEMENTS BY AND AMONG THE
HOLDERS OF THESE SECURITIES AND THE COMPANY AND CERTAIN OTHER HOLDERS OF
THE COMPANY'S STOCK, WHICH INCLUDE WITHOUT LIMITATION, OBLIGATIONS ON
VOTING, RIGHTS OF FIRST REFUSAL AND CO-SALE, RESTRICTIONS ON TRANSFER AND
ACQUISITION OF ADDITIONAL
-9-
<PAGE>
SECURITIES OF THE COMPANY, COPIES OF WHICH ARE ON FILE AT THE PRINCIPAL
OFFICE OF THE COMPANY.
ANY TRANSFEREE OR ASSIGNEE OF THE SHARES REPRESENTED BY THIS CERTIFICATE
SHALL BE BOUND BY THE OBLIGATIONS OF SUCH AGREEMENTS AS IF SUCH TRANSFEREE
OR ASSIGNEE HAD ASSUMED SUCH OBLIGATIONS BY WRITTEN INSTRUMENT.
6.3 Standstill. For a period of three (3) years after the Closing Date,
----------
Investor shall not, and shall cause each of its Affiliates (as defined below) to
not, acquire beneficial ownership (as such term is defined in Rule 13d-3 of the
Securities Exchange Act of 1934, as amended) of any securities of the Company in
addition to the Shares or any Series C Preferred, Class B Common and Common
Stock issued upon conversion thereof, which would result in the aggregate
beneficial ownership of each Investor and its Affiliates of Voting Stock of the
Company (as defined below) equaling or exceeding 10% of the outstanding Voting
Stock of the Company. Investor or any of its Affiliates shall not purchase any
securities of the Company without having given 30 days prior written notice to
the Company or without having received the prior written consent of the Company.
Upon notice thereof, the Company shall inform the Investor whether such
purchases cause the aggregate beneficial ownership of Investor and its
Affiliates to equal or exceed 10% of the outstanding Voting Stock of the
Company. For the purposes of this Agreement, "Affiliate" shall mean, as to any
person or entity, a person or entity that, directly or indirectly through one or
more intermediaries, controls or is controlled by, or is under common control
with, such person or entity. For the purposes of this Agreement, "Voting Stock
of the Company" shall mean, any class or series of the Company's capital stock
entitled to vote in any election of directors of the Company.
SECTION VII
Company Covenants
-----------------
7.1 Periodic Reports. For a period of five years from the Closing Date,
----------------
upon the Investor's written request and representation to the Company that the
documents described below are not publicly available through electronic means,
the Company will furnish to the Investor, for so long as the Investor continues
to own Shares or any Common Stock issued upon conversion thereof, copies of the
Company's Forms 10-K, 10-Q and Annual Report to Shareholders, promptly after
such documents are filed with the SEC, or in lieu of such reports, unaudited
quarterly and audited annual financial statements of the Company, promptly after
completion.
7.2 Limitation on Sale. The Company covenants until the completion of an
------------------
underwritten public offering pursuant to an effective registration statement
under the Securities Act, covering the initial offer and sale of Common Stock
for the account of the Company to the public with aggregate gross proceeds to
the Company of not less than Fifteen Million Dollars ($15,000,000) (the "IPO")
not to issue or sell any shares of Series C Preferred Stock, Series D Preferred
Stock, Series C-1 Preferred Stock or Series D-1 Preferred Stock to any investor
at a more favorable price or upon more
-10-
<PAGE>
favorable terms (including rights, preferences, privileges and restrictions)
than those set forth in the Company's Amended and Restated Certificate of
Incorporation, this Agreement and the Series C-1 Preferred Stock Purchase
Agreement, and the Amended and Restated Stockholder Rights Agreement without the
prior written consent of the Investor. Notwithstanding the foregoing, the
Company expressly reserves the right to sell shares of its Series C Preferred
Stock and/or Series D Preferred Stock without the prior written consent of
Investor, provided that such shares shall not have been sold or issued by the
Company at a more favorable price or on more favorable terms (other than the
existence of voting rights) than those which are reflected in this Agreement,
the Series C-1 Preferred Stock Purchase Agreement, the Amended and Restated
Stockholder Rights and the Amended and Restated Certificate of Incorporation.
7.3 HSR Filing. In the event the Investor determines that the purchase of
----------
the Shares hereunder has not been "solely for the purpose of investment" (as
defined in Rule 801.1(i)(1) under the HSR Act (as defined below)) and the
Investor determines that as a result the Company and the Investors are required
to make appropriate filings with the Federal Trade Commission and Department of
Justice pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended (the "HSR Act"), the Company and Investor agree to cooperate, to make
such filings in a timely manner, and to take all other appropriate action in
connection with such required filings.
SECTION VIII
Miscellaneous
-------------
8.1 Governing Law. This Agreement shall be governed in all respects by
-------------
the laws of the State of California as applied to agreements entered into and
performed entirely in the State of California by residents thereof.
8.2 Survival. The representations, warranties, covenants and agreements
--------
made herein shall survive any investigation made by the Investor and the closing
of the transactions contemplated hereby.
8.3 Successors, Assigns. Except as otherwise provided herein, the
-------------------
provisions hereof shall inure to the benefit of, and be binding upon, the
successors, assigns, heirs, executors and administrators of the parties hereto.
8.4 Notices. All notices and other communications required or permitted
-------
hereunder shall be in writing and shall be sent by facsimile or mailed by
registered or certified mail, postage prepaid, return receipt requested, or
otherwise delivered by hand or by messenger, addressed (a) if to Investor, at
U.S. Telesource, Inc., 700 Qwest Tower, 555 Seventeenth Street, Denver, Colorado
80202, Attn: Executive Vice President and General Counsel, or at such other
address as the Investor shall have furnished to the Company, or (b) if to the
Company, at 2330 Central Expressway, Santa Clara, California 95050 addressed to
the attention of the Corporate Secretary, or at such other address as the
Company shall have furnished to the Investor. If notice is provided by
facsimile, it
-11-
<PAGE>
must be simultaneously confirmed via telephone and it shall be deemed to be
given one (1) day after transmission. If notice is provided by U.S. mail, notice
shall be deemed to be given three (3) days after proper deposit in a U.S.
mailbox, postage prepaid.
8.5 Expenses. The Company and the Investor shall bear their own expenses
--------
and legal fees incurred on their behalf with respect to this Agreement and the
transactions contemplated hereby; provided, however, that the Company will pay
the reasonable fees and expenses of counsel for the Investor up to an aggregate
amount of $15,000, for fees and expenses incurred in connection with this
Agreement, the Series C-1 Preferred Stock Purchase Agreement and the Stockholder
Rights Agreement.
8.6 Finder's Fees. The Company and the Investor shall each indemnify and
-------------
hold the other harmless from any liability for any commission or compensation in
the nature of a finder's fee, placement fee or underwriter's discount (including
the costs, expenses and legal fees of defending against such liability) for
which the Company or the Investors, or any of their respective partners,
employees, or representatives, as the case may be, is responsible.
8.7 Counterparts. This Agreement may be executed in counterparts, each of
------------
which shall be enforceable against the party actually executing the counterpart,
and all of which together shall constitute one instrument.
8.8 Severability. In the event that any provision of this Agreement
------------
becomes or is declared by a court of competent jurisdiction to be illegal,
unenforceable or void, this Agreement shall continue in full force and effect
without said provision; provided that no such severability shall be effective if
it materially changes the economic benefit of this Agreement to any party.
8.9 Applicability of Standstill Provision and Voting Agreement to
-------------------------------------------------------------
Non-Affiliate Purchasers. Without changing the respective construction of
- ------------------------
Section 6.3 of this Agreement or Section 18 of that certain Amended and Restated
Stockholder Rights Agreement of an even date herewith, such sections shall be
inapplicable to non-Affiliate purchasers (with respect to the transferring
Investor) who acquire any shares of Series D-1 Preferred Stock, Series D
Preferred Stock, Class B Common Stock or Common Stock from an Investor.
-12-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Series D-1 Preferred
Stock Purchase Agreement as of this 19th of January, 1999.
COVAD COMMUNICATIONS GROUP, INC.
By: /s/ DHRUV KHANNA
--------------------------------------
Name: Dhruv Khanna
Title: Vice President, General Counsel
U.S. TELESOURCE, INC.
By: /s/ DRAKE S. TEMPEST
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Name: Drake S. Tempest
Title: Executive Vice President
and General Counsel
SIGNATURE PAGE TO SERIES D-1 PREFERRED STOCK PURCHASE AGREEMENT
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EXHIBIT A
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AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
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EXHIBIT B
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STOCKHOLDER RIGHTS AGREEMENT
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EXHIBIT C
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OPINION OF COUNSEL
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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. 3 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.
/s/ Ernst & Young LLP
San Jose, California
January 18, 1999
