<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
Commission file number: 000-25271
COVAD COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0461529
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
4250 BURTON DRIVE
SANTA CLARA, CALIFORNIA 95054
(Address of principal executive offices, including zip code)
(408) 987-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X___ No _____
As of August 9, 2000, 154,829,909 shares of the Registrants Common Stock, $0.001
par value, were issued and outstanding.
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
as of June 30, 2000 and December 31, 1999 3
Condensed Consolidated Statements of
Operations for the Three and Six Months Ended
June 30, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURE 23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31,
JUNE 30, 1999
2000 (NOTE 1)
----------- -----------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 422,820 $216,038
Accounts receivable, net 32,054 15,393
Short-term investments 340,334 551,319
Unbilled revenue 7,555 5,419
Inventories 18,362 8,547
Prepaid expenses and other current assets 19,500 7,267
----------- -----------
Total current assets 840,625 803,983
Property and equipment, net 466,137 237,542
Restricted cash 52,078 63,308
Goodwill and other intangible assets, net 375,172 --
Other assets, net 49,868 42,773
----------- -----------
Total assets $1,783,880 $1,147,606
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 70,188 $ 41,126
Unearned revenue 11,253 5,238
Accrued network costs 10,190 8,798
Other accrued liabilities 69,020 27,104
Current portion of capital lease obligations 146 268
----------- -----------
Total current liabilities 160,797 82,534
Long-term debt, net 811,820 374,737
Long-term capital lease obligations 25 44
Other long-term liabilities 16,919 --
----------- -----------
Total liabilities 998,561 457,315
Stockholders' equity:
Common stock 138 82
Common stock - Class B 6 6
Additional paid-in capital 1,260,089 851,589
Deferred compensation (8,361) (6,513)
Accumulated other comprehensive income 27,280 91,257
Accumulated deficit (484,833) (246,130)
----------- -----------
Total stockholders' equity 794,319 690,291
----------- -----------
Total liabilities and stockholders' equity $1,783,880 $1,147,606
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------
2000 1999 2000 1999
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues $ 58,160 $ 10,833 $ 99,967 $ 16,429
Operating expenses:
Network and product costs 43,614 10,565 74,963 15,525
Sales, marketing, general and administrative 102,462 24,976 187,907 43,089
Depreciation and amortization 24,285 8,671 41,717 13,318
Amortization of goodwill and other intangible assets 20,103 -- 23,453 --
Amortization of deferred compensation 725 1,234 1,911 2,887
---------- --------- ---------- ---------
Total operating expenses 191,189 45,446 329,951 74,819
---------- --------- ---------- ---------
Income (loss) from operations (133,029) (34,613) (229,984) (58,390)
Interest income (expense):
Interest income 13,353 4,585 27,180 8,094
Interest expense (25,590) (11,824) (46,960) (20,460)
---------- --------- ---------- ---------
Net interest income (expense) (12,237) (7,239) (19,780) (12,366)
Other income 13,788 -- 11,061 --
---------- --------- ---------- ---------
Net loss $ (131,478) $ (41,852) $ (238,703) $ (70,756)
Preferred dividends -- -- -- (1,146)
---------- --------- ---------- ---------
Net loss attributable to common stockholders $ (131,478) $ (41,852) $ (238,703) $ (71,902)
=========== ========= ========== =========
Basic and diluted net loss per common share $ (0.86) $ (0.41) $ (1.59) $ (0.79)
=========== ========= ========== =========
Weighted average shares used in computing basic and diluted
net loss per share 153,403 102,235 150,060 91,396
=========== ========= ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Net cash used in operating activities $(105,643) $ (27,721)
INVESTING ACTIVITIES:
Cash acquired through acquisitions 3,948 --
Acquisition of business, net of cash acquired (14,930) --
Net sale (purchase) of investments 147,008 (20,000)
Purchase of restricted cash -- (74,103)
Redemption of restricted cash 13,438 --
Purchase of property and equipment (262,914) (93,748)
Deposits (1,124) (291)
Other assets (631) (6,304)
--------- ---------
Net cash used in investing activities (115,205) (194,446)
FINANCING ACTIVITIES:
Net proceeds from issuance of long-term debt 413,269 205,076
Principal payments under capital lease obligations (141) (129)
Proceeds from common stock issuance, net of offering costs 14,502 150,318
Proceeds from preferred stock issuance -- 60,000
Payment of preferred dividends -- (77)
--------- ---------
Net cash provided by financing activities 427,630 415,188
--------- ---------
Net increase in cash and cash equivalents. 206,782 193,021
Cash and cash equivalents at beginning of period 216,038 64,450
--------- ---------
Cash and cash equivalents at end of period $ 422,820 $ 257,471
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 13,257 $ 43
========= =========
Issuance of common stock for acquisition of business $ 391,968 $ --
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ materially from those estimates. The
unaudited condensed consolidated financial statements of the Company include the
accounts of all of its wholly-owned subsidiaries. There were no intercompany
accounts or transactions which required elimination.
The unaudited condensed consolidated financial statements at June 30, 2000
and for the three and six months ended June 30, 2000 and 1999 are unaudited, but
include all normal recurring adjustments and accruals which are necessary to
fairly state the Company's consolidated financial position, results of
operations and cash flows for the periods presented. Operating results for the
three and six month periods ended June 30, 2000 and 1999 are not necessarily
indicative of results that may be expected for any future periods.
The consolidated balance sheet at December 31, 1999 has been derived from
the audited consolidated financial statements at that date but does not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements.
The information included in this report should be read in conjunction with
the Company's audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.
The unaudited condensed consolidated financial statements applicable to
the prior periods have been restated to reflect a three-for-two stock split
effective April 2000.
Certain June 30, 1999 amounts have been reclassified to conform to the
current year presentation.
NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of shares of the Company's
common stock, after giving consideration to shares subject to repurchase,
outstanding during the period.
Diluted net loss per share is determined in the same manner as basic net
loss per share except that the number of shares is increased assuming the
exercise of dilutive stock options and warrants using the treasury stock method.
Diluted net loss per share is the same as basic net loss per share, which has
not been reported because the Company has a net loss and the impact of the
assumed exercise of the stock options and warrants is not dilutive.
6
<PAGE>
The following table presents the calculation of basic and diluted net loss
per share for the three and six months ended June 30, 2000 and 1999 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-----------------------------------------------
2000 1999 2000 1999
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net loss $ (131,478) $ (41,852) $ (238,703) $ (70,756)
Preferred dividends -- -- -- (1,146)
------------ ---------- ----------- ----------
Net loss attributable to common stockholders $ (131,478) $ (41,852) $ (238,703) $ (71,902)
Basic and diluted:
Weighted average shares of common stock
outstanding 157,635 110,712 154,895 100,548
Less: Weighted average shares subject
to repurchase (4,232) (8,477) (4,835) (9,152)
------------ ---------- ----------- ----------
Weighted average shares used in computing
basic and diluted net loss per share 153,403 102,235 150,060 91,396
============ ========== =========== ===========
Basic and diluted net loss per share $(0.86) $ (0.41) $ (1.59) $ (0.79)
============ ========== =========== ===========
</TABLE>
2. COMPREHENSIVE INCOME
Comprehensive income for the three and six months ended June 30, 2000 and
1999 is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------
2000 1999 2000 1999
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Net loss $(131,478) $(41,852) $(238,703) $(70,756)
Unrealized holding gains (losses), net of tax effect (65,383) 25,638 ( 63,977) 25,638
---------- --------- ---------- ---------
Comprehensive income $(196,861) $(16,214) $(302,680) $(45,118)
========== ========= ========== =========
</TABLE>
3. SHORT-TERM INVESTMENTS
At June 30, 2000, all of the Company's investments were classified as
available for sale. Investments were also classified as short-term, as their
maturity date was less than one year from the balance sheet date. Management
determines the appropriate classification of investments at the time of purchase
and re-evaluates such designation at the end of each period. Unrealized gains
and losses on short-term investments as of June 30, 2000 and December 31, 1999,
are included as a separate component of stockholders' equity, net of any related
tax effect. The amount of net realized gains for the three and six months ended
June 30, 2000 was $12.8 million and $13.4 million, respectively.
7
<PAGE>
The following table summarizes the Company's short-term investments:
<TABLE>
<CAPTION>
JUNE 30, 2000
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(AMOUNTS IN $000'S)
<S> <C> <C> <C> <C>
Commercial paper $ 2,984 $ - $ (2) $ 2,982
Corporate notes 5,754 - (5) 5,759
U.S. Treasury & Agency notes 253,628 - (42) 253,586
Equity securities 50,738 27,279 - 78,017
--------- ---------- ---------- ----------
Total available for sale securities $313,104 $27,279 $ (49) $ 340,334
========= ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 2000
----------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(AMOUNTS IN $000'S)
<S> <C> <C> <C> <C>
Commercial paper $ 373,007 $ 125 $ -- $ 373,132
Corporate notes 53,767 -- (596) 53,171
Equity securities 32,200 92,816 -- 125,016
--------- ---------- ---------- ----------
Total available for sale securities $ 458,974 $ 92,941 $ (596) $ 551,319
========= ========== ========== ==========
</TABLE>
The company had net unrealized losses of $576,000 and $918,000 on long
term U.S. Treasury investments, at June 30, 2000 and December 31, 1999,
respectively, classified as restricted cash on the accompanying consolidated
balance sheet. The Company also had a net unrealized gain of $626,000 and a net
unrealized loss of $168,000 on cash and cash equivalents at June 30, 2000 and
December 31, 1999, respectively.
4. ACQUISITIONS
LASER LINK.NET, INC.
On March 20, 2000, Covad Communications Group, Inc. completed its
combination with Laser Link.Net, Inc. by issuing approximately 5.0 million
common shares for all of the outstanding Laser Link common shares. The Covad
common shares were valued for accounting purposes using the average market price
of $61.53 per share which is based on the average closing price for a range of
seven trading days around the announcement date (March 9, 2000) of the
transaction. In addition, the outstanding Laser Link stock options were
converted into approximately 1.4 million options to purchase Covad common shares
at a fair value of $58.61 per share. The value of the options, as well as direct
transaction expenses have been included as a part of the total purchase cost.
The Unaudited Condensed Consolidated Financial Statements at June 30,
2000 and for the three and six months then ended have been prepared on the basis
of assumptions relating to the allocation of the total purchase cost to the
assets and liabilities of Laser Link based upon estimates of their fair value.
Following is a table of the total purchase cost and annual amortization of the
intangible assets acquired (in thousands):
8
<PAGE>
<TABLE>
<S> <C>
Total purchase cost:
Value of common shares issued $ 307,869
Assumption of Laser Link.Net, Inc. options 84,100
----------
391,969
Acquisition costs 15,485
----------
Total purchase costs $ 407,454
==========
</TABLE>
<TABLE>
<CAPTION>
Life Annual
(yrs) Amortization
------ ------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets acquired $ 5,132
Intangible assets acquired:
Developed and core technology............ 13,023 5 2,605
Customer base............................ 28,552 5 5,710
Acquired workforce....................... 1,141 5 228
In-process research and development...... 3,726 -
Goodwill................................. 355,880 5 71,176
-------- --------
Total purchase price allocation................ $407,454 $79,719
======== ========
</TABLE>
Tangible net assets of Laser Link principally include cash and cash
equivalents, short-term investments, accounts receivable and fixed assets.
Liabilities assumed principally include a line of credit, accounts payable,
accrued compensation and other accrued expenses.
The customer based was valued using an Income Approach which projects
the associated revenue, expenses and cash flows attributable to the customer
base over its estimated life (five years). These cash flows are discounted to
their present value using a rate of return (20%) that reflects an appropriate
level of risk. The value attributed to the customer base is being amortized on a
straight line basis over its estimated useful life of five years.
The value of the assembled workforce was derived by estimating the costs
to replace the existing employees, including recruiting, hiring and training
costs for each category of employee. The value of the assembled workforce is
being amortized on a straight line basis over its estimated useful life of five
years.
A portion of the purchase price has been allocated to developed and core
technology and in-process research and development (IPRD). Developed and core
technology and IPRD were identified and valued through extensive interviews,
analysis of data provided by Laser Link concerning developmental products, their
stage of development, the time and resources needed to complete them, if
applicable, their expected income generating ability, target markets and
associated risks. The relief from royalty method, which assumes that the value
of an asset equals the amount a third party would pay to use the asset and
capitalize on the related benefits of the assets, was the primary technique
utilized in valuing the developed technology and IPRD.
Where developmental projects had reached technological feasibility,
they were classified as developed and core technology and the value assigned to
developed technology was capitalized. The developed and core technology is being
amortized on the straight-line basis over its estimated useful life of five
years. Where the developmental projects had not reached technological
feasibility and had no future alternative uses, they were classified as IPRD.
The value allocated to projects identified as IPRD were charged to expense
during the quarter ended March 31, 2000, the quarter in which the transaction
closed.
The nature of the efforts required to develop the purchased IPRD into
commercially viable products principally relate to the completion of all
planning, designing, prototyping, verification and testing activities that are
necessary to establish that the products can be produced to meet their design
specifications, including functions, features and technical performance
requirements.
9
<PAGE>
In valuing the IPRD, Covad considered, among other factors, the
importance of each project to the overall development plan, the projected
incremental cash flows from the projects when completed and any associated
risks. The projected incremental cash flows were discounted back to their
present value using a discount rate of 30%. This discount rate was determined
after consideration of Covad's weighted average cost of capital and the weighted
average return on assets. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility, anticipated levels of market acceptance and penetration, market
growth rates and risks related to the impact of potential changes in future
target markets.
The IPRD relates to internally developed proprietary software used in
its VISP business. This software has been designed with enhancements and
upgrades continually underway. With respect to the acquired in-process
technologies, the calculations of value were adjusted to reflect the value
creation efforts of Laser Link prior to the closing date. The percent complete
for the in-process technology is estimated to be 75%.
Goodwill is determined based on the residual difference between the
amount paid and the values assigned to identified tangible and intangible
assets. Goodwill is being amortized on a straight line basis over its estimated
useful life of five years.
BLUESTAR COMMUNICATIONS GROUP, INC.
On June 16, 2000, Covad Communications Group, Inc. announced a
definitive agreement to acquire BlueStar Communications, Inc. through the
issuance of 8 million Covad common shares for all of the outstanding BlueStar
preferred and common shares less the amount reserved for the issuance of
outstanding options and warrants. The actual number of Covad common shares and
stock options to be issued will be reduced to reflect (1) BlueStar's transaction
costs and (2) the principal, interest and expenses associated with interim
financing extended by Covad to BlueStar prior to the closing of the combination.
Based on outstanding options and warrants of BlueStar as of March 31, 2000,
approximately 7.2 million shares would be issued to the common and preferred
stockholders (This amount does not include BlueStar's transaction costs or the
principal, interest and expenses associated with interim financing extended by
Covad to BlueStar which would reduce the number of shares to be issued). For
purposes of the information provided below, the Covad common shares have been
valued at the closing market price on August 7, 2000 of $18 3/16 per share. The
actual value will be determined based on the average closing price per share of
Covad common shares for a few days before and after the actual closing date. In
addition, the outstanding BlueStar stock options and warrants were converted
into options to purchase approximately 800,000 shares of Covad common shares at
a fair value of $12.39 per share. The value of the options and warrants, as well
as estimated direct transaction expenses have been included as part of the total
estimated purchase cost. The information provided below does not give effect to
the potential issuance of up to 5 million additional Covad common shares which
depends on BlueStar reaching certain specified levels of revenue and earnings
before interest, taxes, depreciation and amortization (EBITDA) in fiscal 2001.
The information provided below has been prepared on the basis
of assumptions relating to the allocation of the total purchase cost to the
assets and liabilities of BlueStar based upon preliminary estimates of their
fair value. The actual allocation of the total purchase cost may differ from
those assumptions after finalization of the valuation and other procedures are
completed after the closing of the transaction and BlueStar's transaction costs
and the principal, interest and expense associated with interim financing
extended by Covad to BlueStar are finalized and reduced the number of shares to
be issued. Following is a table of the estimated total purchase cost and annual
amortization of the intangible assets acquired (in thousands):
10
<PAGE>
Estimated purchase cost
Value of common shares issued $ 130,600
Assumption of BlueStar Inc. options and warrants.......... 10,148
-----------
140,748
Covad's estimated acquisition costs.......................... 5,816
-----------
Total estimated purchase costs............................... $ 146,564
===========
<TABLE>
<CAPTION>
Life Annual
(yrs) Amortization
------ ------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets at March 31, 2000.... $ 31,694
Intangible assets acquired:
Developed and core technology......... 835 4 $ 209
Customer base......................... 9,430 5 1,886
Acquired workforce.................... 5,858 3 1,953
Deferred stock compensation........... 4,233 2.5 1,693
In-process research and development......... 1,000 --
Goodwill.................................... 93,514 5 18,703
--------- ---------
Total estimated purchase price allocation... $146,564 $ 24,444
========= =========
</TABLE>
Tangible net assets of BlueStar principally include cash and cash
equivalents, deferred charges and fixed assets. Liabilities assumed principally
include accounts payable, accrued expenses and a note payable.
The customer base was valued using an Income Approach which projects
the associated revenue, expenses and cash flows attributable to the customer
base over its estimated life. These cash flows are discounted to their present
value using a rate of return that reflects the appropriate level of risk. The
value attributed to the customer base is being amortized on a straight line
basis over its estimated useful life of five years.
The value of the assembled workforce was derived by estimating the
costs to replace the existing employees, including recruiting, hiring and
training costs for each category of employee. The value of the assembled
workforce is being amortized on a straight line basis over its estimated useful
life of three years.
A portion of the purchase price has been allocated to developed and
core technology and IPRD. Developed and core technology and IPRD were identified
and valued through extensive interviews, analysis of data provided by BlueStar
concerning developmental products, their stage of development, the time and
resources needed to complete them, if applicable, their expected income
generating ability, target markets and associated risks. The relief from royalty
method, which assumes that the value of an asset equals the amount of third
party would pay to use the asset and capitalize on the related benefits of the
assets, was the primary technique utilized in valuing the developed and core
technology and IRPD.
Where developmental projects had reached technological feasibility,
they were classified as developed and core technology and the value assigned to
developed and core technology was capitalized. The developed and core technology
is being amortized on the straight-line basis over its estimated useful life of
four years. Where the developmental projects had not reached technological
feasibility and had no future alternative uses, they were classified as IRPD.
The value allocated to projects identified as IPRD will be charged to expense
upon closing of the transaction.
The nature of efforts required to develop the purchased IPRD into
commercially viable products principally relate to the completion of all
planning, designing, prototyping, verification and testing activities that are
necessary to establish that the products can be produced to meet their design
specifications, including functions, features and technical performance
requirements.
11
<PAGE>
In valuing the IPRD, Covad considered, among other factors, the
importance of each project to the overall development plan, the projected
incremental cash flows from the projects when completed and any associated
risks. The projected incremental cash flows were discounted back to their
present value using a discount rate of 30%. This discount rate was determined
after consideration of Covad's weighted average cost of capital and the weighted
average return on assets. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility, anticipated levels of market acceptance and penetration, market
growth rates and risks related to the impact of potential changes in future
target markets.
Goodwill is determined based on the residual difference between the
amount paid and the values assigned to identified tangible and intangible
assets. Goodwill is being amortized on a straight line basis over its estimated
useful life of five years.
5. DEBT
On January 28, 2000, the Company completed a private placement of $425.0
million aggregate principal amount of the Company's 12% senior notes (the "2000
Notes') due 2010 which are redeemable at the option of the Company any time
after February 15, 2005 at stated redemption prices plus accrued and unpaid
interest thereon.
Net proceeds from the 2000 Notes were approximately $413.3 million, after
discounts, commissions and other transaction costs of approximately $11.7
million. The discount and debt issuance costs are being amortized over the life
of the 2000 Notes. For the three months ended June 30, 2000, the amortization of
debt discount and debt issuance costs was $205,000.
6. STOCKHOLDERS' EQUITY
COVAD COMMUNICATIONS GROUP, INC.
STRATEGIC INVESTMENT:
In January 1999, the Company entered into strategic relationships with
AT&T Corp. ("AT&T"), NEXTLINK Communications, Inc. ("NEXTLINK") and Qwest
Communications Corporation ("Qwest"). As part of these strategic relationships,
the Company received equity investments totaling approximately $60 million. The
Company recorded intangible assets of $28.7 million associated with these
transactions which will be amortized over periods of three to six years.
INITIAL PUBLIC OFFERING:
On January 27, 1999, the Company completed an Initial Public Offering
("IPO") of 20,182,500 shares of the Company's common stock at a price of $8.00
per share. Net proceeds to the Company from the IPO were $150.2 million after
deducting underwriting discounts and commissions and offering expenses payable
by the Company. As a result of the IPO, 41,053,865 shares of common stock and
6,379,177 shares of Class B common stock (which are convertible into 14,353,148
shares of common stock) were issued upon the conversion of preferred stock,
133,587 shares of common stock were issued for cumulative but unpaid dividends
on series A and series B preferred stock and 4,049,039 shares of common stock
were issued upon the exercise of common warrants.
SECONDARY OFFERING:
On June 23, 1999, the Company completed a public offering of 12,937,500
shares of Common Stock sold by certain stockholders of the Company. The Company
did not sell any shares in this offering. Accordingly, there were no net
proceeds to the Company from this offering. The Company incurred offering
expenses of approximately $600,000.
On November 3, 1999 the Company completed a public offering of 22,425,000
shares of common stock sold by the Company and certain stockholders of the
Company. The net proceeds to the Company from this offering were approximately
$568.8 million after deducting underwriting discounts and commissions and
offering expenses.
12
<PAGE>
ITEM 2. 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 UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO
INCLUDED ELSEWHERE IN THIS FORM 10-Q AND THE CONSOLIDATED AUDITED FINANCIAL
STATEMENTS AND NOTES THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31,
1999 INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS THE ACCURACY OF WHICH INVOLVES RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THE FORWARD-LOOKING STATEMENTS FOR MANY REASONS INCLUDING, BUT NOT LIMITED
TO, THOSE DISCUSSED HEREIN, IN OUR ANNUAL REPORT ON FORM 10-K, IN OUR
REGISTRATION STATEMENT ON FORM S-1/A FILED JULY 17, 2000 (SEC FILE NO.
333-38688) AND IN OUR REGISTRATION STATEMENT ON FORM S-4 FILED AUGUST 10, 2000
(SEC FILE NO. 333-43494). WE DISCLAIM ANY OBLIGATION TO UPDATE INFORMATION
CONTAINED IN ANY FORWARD-LOOKING STATEMENT OR IN THE REASONS WHY SUCH
FORWARD-LOOKING STATEMENTS MAY DIFFER MATERIALLY FROM ACTUAL RESULTS, WHICH
REASONS SPEAK AS OF THEIR DATES. SEE "FORWARD LOOKING STATEMENTS."
OVERVIEW
We are a leading provider of broadband communications services to Internet
service providers, enterprise and telecommunications carriers, and other
customers. Since March 1998, we have raised $1,537.2 million of gross proceeds
from debt and equity financings to fund the deployment and expansion of our
network to date. As of June 30, 2000, we offered our services in 81 metropolitan
statistical areas ("MSAs"). We plan to build our networks and offer our services
in 165 MSAs (which includes MSAs that will be added as a result of the
acquisition of BlueStar Communications discussed in "Recent Developments"
below). As of June 30, 2000, our networks passed 42 million homes and
businesses, and we had installed 138,000 end-user lines.
In connection with our expansion within existing metropolitan statistical
areas and into new metropolitan statistical areas, we expect to significantly
increase our capital expenditures, as well as our sales and marketing
expenditures, to deploy our networks and support additional end-users in those
regions. Accordingly, we expect to incur substantial and increasing net losses
for at least the next several years.
We derive revenue from:
o monthly recurring service charges for connections from the end-user to
our facilities and for backhaul services from our facilities to
Internet service provider or enterprise customer;
o service order set-up and other non-recurring charges; and
o the sale of customer premise equipment that we provide to our customers
due to the general unavailability of customer premise equipment through
retail channels.
We expect prices for the major components of both recurring and
non-recurring revenues to decrease each year in part due to the effects of
competitive pricing and future volume discounts. We believe our revenues from
the sale of customer premise equipment will decline over time, as prices for
such equipment decrease and customer premise equipment becomes more generally
available. We expect that the prices we charge to customers for customer premise
equipment will decrease each year.
The following factors comprise our network and service costs:
o Monthly non-recurring and recurring circuit fees. We pay traditional
telephone companies and other competitive telecommunications companies
non-recurring and recurring fees for services including installation,
activation, monthly line costs, maintenance and repair of circuits
between and among our digital subscriber line access multiplexers and
our regional data centers, customer backhaul, and end-user lines. As
our end-user base grows, we expect that in the near future the largest
element of network and product cost will be the traditional telephone
companies' charge for our leased copper wires; and
o Other costs. Other costs that we incur include those for materials in
installation and the servicing of customers and end-users, and the cost
13
<PAGE>
of customer premise equipment.
The development and expansion of our business will require significant
expenditures. The principal capital expenditures incurred during the buildup
phase of any metropolitan statistical area involve the procurement, design and
construction of our central office cages, end-user DSL line cards, and
expenditures for other elements of our network design. Currently, the average
cost to deploy our facilities in a central office, excluding end-user line
cards, is approximately $85,000 per central office facility. This cost may vary
in the future due to the quantity and type of equipment we initially deploy in a
central office facility as well as regulatory limitations imposed on the
traditional phone companies relative to pricing of central office space,
including cageless physical collocation. Following the buildout of our central
office space, the major portion of our capital expenditures is the purchase of
line cards to support incremental end-users. We expect 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 our networks, we will use our capital for marketing
our services, acquiring Internet service provider, enterprise, and
telecommunication carrier customers, and funding our customer care and field
service operations.
In connection with rolling out service on a national basis we have
commenced a branding campaign to differentiate our service offerings in the
marketplace. As a result, we expect our selling, general and administrative
expenses to increase significantly in future periods as we implement increased
marketing efforts as part of the campaign.
Recent Developments
On May 16, 2000, we announced that the American Arbitration Association
issued its Intended Award of Damages to us in our arbitration hearings against
Pacific Bell for violations of the Telecommunications Act of 1996. The
arbitrators awarded us $27.2 million plus attorneys' fees and costs which is in
addition to the panel's January 1999 interim decision to award us $257,166 in
damages and $474,995 in attorneys' fees and costs. In November 1998, the
arbitrators determined that Pacific Bell had violated the 1996
Telecommunications Act as well as its contract with us by failing to timely
deliver collocation space and operable loops.
On June 16, 2000, we announced the signing of a definitive agreement to
acquire BlueStar Communications Group Inc., a provider of broadband and Internet
services for small and medium-sized businesses throughout the Southeastern
United States. Under the acquisition agreement, we will issue up to 8 million
shares of our common stock and stock options for all of BlueStar's outstanding
common and preferred shares, stock options and warrants, plus assumption of all
outstanding BlueStar debt. Up to five million additional shares of our common
stock may be issued to the BlueStar shareholders if certain performance targets
are met by BlueStar over the 2001 fiscal year. We anticipate that this
acquisition will accelerate the national expansion of our network. We anticipate
that our acquisition of BlueStar will provide the following benefits:
o Speed to market in implementing our direct sales strategy in Tier
3 markets.
o A large, experienced direct sales force.
o BlueStar's customer base.
o Increased ability to provide enhanced broadband solutions to
small businesses.
In connection with the merger, Bear Stearns Corporate Lending, Inc. provided
BlueStar with a $40 million financing comitment to fund BlueStar's continuing
operations until the effective time of the merger. If the merger is not
completed, Covad Communications has agreed to purchase the loans made pursuant
to this financing comittment from Bear Stearns in exchange for shares of Covad
common stock. Bear Stearns also has the right to put the loan to Covad in
exchange for Covad common stock in certain other circumstances.
In addition, our acquisition of BlueStar will provide us with 135 new
central offices that were built out by BlueStar and had not been built out by
us. We believe that we acquired these new central offices at a cost savings in
comparison with what it would have cost us to build, operate and support those
central offices and the underlying business associated with the markets they
serve.
In connection with our announcement of the BlueStar acquisition, we
announced a reduction in the number of end-user lines that we expected to be in
service on June 30, 2000. At the same time, we reduced line growth expectations
for 2000 to 330%, primarily because of the channel conflict with our customers
that may result from our acquisition of BlueStar, which sells directly to
end-users.
14
<PAGE>
We are currently aware of a Staff Accounting Bulletin entitled SAB 101
"Revenue Recognition in Financial Statements" ("SAB 101"), which was issued in
December 1999 by the Securities and Exchange Commission. SAB 101 provides that,
in certain circumstances, revenues which are received in the first month of a
contract might have to be recognized over an extended period of time, instead of
in the first month of the contract. Due to the complex nature of the widespread
implementation of SAB 101, the SEC has deferred the implementation date of SAB
101 until the quarter ended December 31, 2000 with retroactive application to
the beginning of our fiscal year. The SEC intends to issue further definitive
guidance on the implementation of SAB 101. When and if that guidance is
received, we will fully evaluate this guidance and respond and comply
accordingly. If SAB 101 is implemented and its implementation is contrary to our
current practice, it may have an adverse effect on our financial statements.
On August 10, 2000, we signed an agreement with NTT Communications Corp.,
ACCA Networks and a Japan-based venture capital firm to provide local broadband
network services using digital subscriber lines to major metropolitan areas in
Japan. We will invest approximately $11.5 million in ACCA in exchange for a 41.8
percent interest in ACCA, which will be accounted for as an equity investment on
our balance sheet. The agreement requires no additional financial commitments,
and no additional expenses to be incurred. We will also hold two seats on ACCA's
Board of Directors.
RESULTS OF OPERATIONS
REVENUES
We recorded revenues of $58.2 million for the three months ended June 30,
2000 compared to $10.8 million for the three months ended June 30, 1999.
Revenues were $100.0 million for the six months ended June 30, 2000 compared to
$16.4 million for the six months ended June 30, 1999. These increases are
attributable to growth in the number of customers and end-users resulting from
our increased sales and marketing efforts and the expansion of our national
network. We expect revenues to increase in future periods as we expand our
network within our existing regions, deploy networks in new regions and increase
our sales and marketing efforts in all of our regions.
NETWORK AND PRODUCT COSTS
We recorded network and product costs of $43.6 million for the three
months ended June 30, 2000 and $10.6 million for the three months ended June 30,
1999. Network and product costs were $75.0 million for the six months ended June
30, 2000 and $15.5 million for the six months ended June 30, 1999. These
increases are attributable to the expansion of our networks and increased orders
resulting from our sales and marketing efforts. We expect network and product
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 our business, the development of
corporate identification, promotional and advertising materials, expenses for
the establishment of our management team, and sales commissions. Sales,
marketing, general and administrative expenses were $102.5 million for the three
months ended June 30, 2000 and $25.0 million for the three months ended June 30,
1999. Sales, marketing, general and administrative expenses were $187.9 million
for the six months ended June 30, 2000 and $43.1 million for the six months
ended June 30, 1999. These increases are attributable to growth in headcount in
all areas of our company, continued expansion of our sales and marketing
efforts, deployment of our networks and building of our operating
infrastructure. Sales, marketing, general and administrative expenses are
expected to increase significantly as we continue to expand our business.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization includes:
o depreciation of network costs and related equipment;
o depreciation of information systems, furniture and fixtures;
o amortization of improvements to central offices, regional data centers
and network operations center facilities and corporate facilities;
15
<PAGE>
o amortization of capitalized software costs; and
o amortization of intangible assets.
In January 1999, we recorded intangible assets of $28.7 million from the
issuance of preferred stock to AT&T Ventures, NEXTLINK and Qwest. Amortization
of these assets was $2.1 and $4.2 million during the three and six months ended
June, 2000, respectively, and is included in depreciation amortization on the
accompanying consolidated statement of operations. Annual amortization of these
assets will be approximately $8.4 million in each of the years in the three year
period ending December 31, 2001, decreasing to approximately $1.2 million per
year for each subsequent year through the year ending December 31, 2004.
Depreciation and amortization was approximately $24.3 million for the
three months ended June 30, 2000 and $8.7 million for the three months ended
June 30, 1999. Depreciation and amortization was approximately $41.7 million for
the six months ended June 30, 2000 and $13.3 million for the six months ended
June 30, 1999. These increases were due to the increase in equipment and
facilities placed in service throughout the periods as well as amortization of
intangible assets. We expect depreciation and amortization to increase
significantly as we increase our capital expenditures to expand our networks.
DEFERRED COMPENSATION
Through June 30, 2000, we recorded a total of approximately $19.3 million
of deferred compensation, with an unamortized balance of approximately $8.4
million on our June 30, 2000 consolidated balance sheet. This deferred
compensation is a result of us granting stock options to our employees, certain
of our directors, and certain contractors with exercise prices per share below
the fair values per share for accounting purposes of our common stock at the
dates of grant. We are amortizing the deferred compensation over the vesting
period of the applicable option using the graded vesting method. Amortization of
deferred compensation was $725,000 for the three months ended June 30, 2000 and
$1.2 million for the three months ended June 30, 1999. Amortization of deferred
compensation was $1.9 million for the six months ended June 30, 2000 and $2.9
million for the six months ended June 30, 1999.
GOODWILL AND OTHER INTANGIBLE ASSETS
In connection with the Laser Link acquisition completed in the first
quarter of 2000 (as discussed in Note 4 to the Condensed Consolidated Financial
Statements), we recorded on our balance sheet a total of approximately $402
million of goodwill and other intangible assets in March 2000. Goodwill was
determined based on the residual difference between the amount paid for Laser
Link and the values assigned to identified tangible and intangible assets. We
are amortizing goodwill and other intangible assets on a straight line basis
over its estimated useful life of five years. For the three and six months ended
June 30, 2000, amortization of goodwill and other intangible assets was $20.1
million and $23.5 million, respectively.
NET INTEREST INCOME AND EXPENSE
Net interest income and expense consists primarily of interest income on
our cash balance and interest expense associated with our debt. Net interest
expense for the three and six months ended June 30, 2000, was $12.2 million and
$19.8 million, respectively. Net interest expense during this period consisted
primarily of interest expense on the 1998 notes, the 1999 notes, and the 2000
notes and capital lease obligations partially offset by interest income earned
primarily from the investment of the proceeds raised from the issuance of the
1998 notes, the 1999 notes, and the 2000 notes as well as our initial public
offering and our issuance of preferred stock to AT&T Ventures, NEXTLINK and
Qwest. Net interest expense for the three and six months ended June 30, 1999,
was $7.2 million and $12.4 million, respectively. Net interest expense during
this period consisted primarily of interest expense on the 1998 notes and
capital lease obligations, partially offset by interest income earned primarily
from the investment of the proceeds raised from the issuance of the 1998 notes.
We expect interest expense to increase significantly over time.
LIQUIDITY AND CAPITAL RESOURCES
Our operations have required substantial capital investment for the
procurement, design and construction of our central office cages, the purchase
of telecommunications equipment and the design and development of our networks.
Capital expenditures were approximately $262.9 million for the six months ended
June 30, 2000. We expect that our
16
<PAGE>
capital expenditures will be less in future periods in connection with the
purchase of infrastructure equipment necessary for the development and expansion
of our networks and the development of new regions.
From our inception through June 30, 2000, we financed our operations
primarily through private placements of $10.6 million of equity securities,
$129.3 million in net proceeds raised from the issuance of the 1998 notes,
$150.2 million in net proceeds raised from our initial public offering, $60.0
million in net proceeds raised from strategic investors, $205.0 million in net
proceeds raised from the issuance of the 1999 notes, $568.8 million in net
proceeds raised from our public offering on November 3, 1999 and $413.3 million
in net proceeds from the issuance of the 2000 notes. As of June 30, 2000, we had
an accumulated deficit of $484.8 million, and cash, cash equivalents, and
short-term investments of $763.2 million.
Net cash used in our operating activities was $105.6 million for the six
months ended June 30, 2000. The net cash used for operating activities during
this period was primarily due to net losses and increases in current assets,
offset by non-cash expenses and increases in accounts payable and accrued
liabilities. Net cash used in our investing activities was $115.2 million for
the six months ended June 30, 2000. The net cash used for investing activities
during this period was primarily due to purchases of property and equipment, the
acquisition of Laser Link, and the proceeds received from the sale of
investments.
Net cash provided by financing activities for the six months ended June
30, 2000 was $427.6 million, which primarily related to the net proceeds of
$413.3 million from the issuance of the 2000 notes with an aggregate principal
amount of $425.0 million.
We believe that our current cash, cash equivalents and short-term
investments, including the proceeds received from our recently completed
issuance of 12% senior notes, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures into the second quarter of
2001.
We expect 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 our networks. We may also make investments in and acquisitions of
businesses that are complementary to ours to support the growth of our business.
Our future cash requirements for developing, deploying and enhancing our
networks and operating our business, as well as our revenues, will depend on a
number of factors including:
o the number of regions entered, the timing of entry and services
offered;
o network development schedules and associated costs;
o the rate at which customers and end-users purchase our services and the
pricing of such services;
o the level of marketing required to acquire and retain customers and to
attain a competitive position in the marketplace;
o the rate at which we invest in engineering and development and
intellectual property with respect to existing and future technology;
o existing and future technology; and
o unanticipated opportunities.
We will be required to raise additional capital, the timing and amount of
which we cannot predict. We expect to raise additional capital through debt or
equity financings, depending on market conditions, to finance the continued
development, commercial deployment and expansion of our networks and for funding
operating losses or to take advantage of unanticipated opportunities. If we are
unable to obtain required additional capital or are required to obtain it on
terms less satisfactory than we desire, we may be required to delay the
expansion of our business or take or forego actions, any or all of which could
harm our business.
In addition, we may wish to selectively pursue possible acquisitions of or
investments in businesses, technologies or products complementary to ours in the
future in order to expand our geographic presence and achieve operating
efficiencies. We may not have
17
<PAGE>
sufficient liquidity, or we may be unable to obtain additional debt or equity
financing on favorable terms or at all, in order to finance such an acquisition
or investment.
FORWARD-LOOKING STATEMENTS
The statements contained in this Report on Form 10-Q 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. Examples of such
forward-looking statements include but are not limited to:
o our plans to expand our existing networks or to commence service in new
metropolitan statistical areas;
o estimates regarding the timing of launching our service in new
metropolitan statistical areas;
o expectations regarding the time frames, rates, terms and conditions for
implementing line sharing;
o expectations regarding the extent to which enterprise customers roll
out our service;
o expectations regarding our relationships with our strategic partners
and other potential third parties;
o expectations as to pricing for our services in the future;
o expectations as to the impact of our TeleSurfer service offerings on
our margins;
o the possibility that we may obtain significantly increased sales
volumes;
o the impact of our national advertising campaign on brand recognition
and operating results;
o the plans to make strategic investments and acquisitions and the affect
of such investments and acquisitions;
o estimates of future operating results;
o plans to develop and commercialize value-added services;
o our anticipated capital expenditures;
o plans to enter into business arrangements with broadband-related
service providers;
o expectations regarding the commencement of our voice service; and
o the effect of regulatory reform and regulatory litigation; and other
statements contained in this Report regarding matters that are not
historical facts.
These statements are only estimates or predictions and cannot be relied
upon. We can give no assurance that future results will be achieved. Actual
events or results may differ materially as a result of risks facing us 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 our ability to:
o successfully market our services to current and new customers;
o generate customer demand for our services in the particular regions
where we plan to market services;
18
<PAGE>
o achieve favorable pricing for our services;
o respond to increasing competition;
o manage growth of our operations;
o access regions and negotiate suitable interconnection agreements with
the traditional telephone companies, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions consistent
with regulatory, legislative and judicial developments; and
o implement new network capabilities and new service offerings.
All written and oral forward-looking statements made in connection with
this Report on Form 10-Q which are attributable to us or persons acting on our
behalf are expressly qualified in their entirety by the "Risk Factors" and other
cautionary statements included in the Report on Form 10-K for the year ended
December 31, 1999, in our registration statement on Form S-1/A filed July 17,
2000 (SEC file no. 333-38688) and in our registration statement on Form S-4
filed August 10, 2000 (SEC file no. 333-43494). We disclaim any obligation to
update information contained in any forward-looking statement.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to financial market risk, including changes in interest rates
and marketable equity security prices, relates primarily to our investment
portfolio and outstanding debt obligations. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed-rate, short-term
securities. We do not have any derivative instruments. The fair value of our
investments portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due mainly to
the fixed-rate, short-term nature of the substantial majority of our investment
portfolio. In addition, substantially all of our outstanding indebtedness at
June 30, 2000 including our 1998 notes, our 1999 notes, and our 2000 notes is
fixed-rate debt.
19
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is engaged in a variety of negotiations, arbitrations and
regulatory and court proceedings with multiple traditional telephone companies.
These negotiations, arbitrations and proceedings concern the traditional
telephone companies' denial of physical central office space to the Company in
certain central offices, the cost and delivery of central office 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 over these issues. The
Company has also filed a lawsuit against Pacific Bell and certain of its
affiliates, including SBC Communications, in federal court. The Company is
pursuing a variety of contract, tort, and 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 the Company and failed to act in good faith on
multiple counts. The arbitration panel ruled in favor of awarding the Company
direct damages, as well as attorneys fees and costs of the arbitration. Pacific
Bell is currently attempting to have the decision vacated. Meanwhile, the
arbitration panel is evaluating the Company's claim for additional damages.
The Company also filed a lawsuit against Bell Atlantic and its affiliates
in federal court and is pursuing antitrust and other claims in this lawsuit. In
addition, Bell Atlantic has separately filed suit against the Company asserting
infringement of a patent issued to them in September 1998 entitled "Variable
Rate and Variable Mode Transmission System." However, on February 18, 2000 the
court issued a summary judgment ruling holding that the Company had not
infringed Bell Atlantic's patent. Bell Atlantic has filed a notice of appeal of
this decision and, while the Company expects that it would prevail on appeal,
the outcome of such an appeal is uncertain.
A former employee of the Company has filed a complaint against the Company
in California Superior Court, alleging that he was terminated wrongfully and is
entitled to commissions and other amounts arising from his employment. The
Company believes this employee resigned and it does not owe him any money, but
litigation is unpredictable and there is no guarantee the Company will prevail.
Another group of former employees has filed a complaint against the Company in
California Superior Court, alleging that they were terminated wrongfully and are
entitled to stock options, appreciation on stock options, and other amounts
arising out of their employment. The Company believes it does not owe these
employees any money, but there is no guarantee the Company will prevail. Failure
to resolve these various legal disputes and controversies without excessive
delay and cost and in a manner that is favorable, could significantly harm the
business.
The Company is not currently engaged in any other legal proceedings that
it believes could have a material adverse effect on the Company business,
prospects, operating results and financial condition. The Company is subject to
state commission, FCC and court decisions as they relate to the interpretation
and implementation of the 1996 Telecommunications Act, the interpretation of
competitive telecommunications company interconnection agreements in general and
the Company 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 our agreements. The results of any of these proceedings could harm
the business.
20
<PAGE>
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 30, 2000, we held our Annual Meeting of Stockholders. At this meeting,
the shareholders elected Daniel Lynch, Rich Shapero and Larry Irving to serve as
Class I directors on our Board of Directors: Daniel Lynch, Rich Shapero and
Larry Irving. Their terms will expire at our 2003 Annual Meeting. Our continuing
Class II directors are Frank Marshall and Hellene Runtagh and their terms expire
at our 2001 Annual Meeting. Our continuing Class III directors are Robert E.
Knowling, Jr., Robert Hawk and Debra Dunn and their terms expire at our 2002
Annual Meeting.
Set forth below is a summary of each matter voted upon at the meeting and the
number of votes cast for, against or withheld, as well as the number of
abstentions and broker non-votes.
PROPOSAL 1 - The election of three Class I directors to serve on our Board of
Directors for a term to expire at the third succeeding annual meeting and until
their successors are elected and qualified.
----------------------------------------------------------------------
Name For Withheld
----------------------------------------------------------------------
Daniel Lynch 111,890,436 14,410,361
----------------------------------------------------------------------
Richard Shapero 97,283,684 29,017,113
----------------------------------------------------------------------
Larry Irving 111,768,448 14,532,349
----------------------------------------------------------------------
PROPOSAL 2 - An amendment to our Amended and Restated Certificate of
Incorporation to increase the number of authorized shares of common stock from
200 million to 600 million: 116,600,241 votes in favor, 9,242,287 votes opposed,
and 458,269 votes abstained.
PROPOSAL 3 - An amendment to the annual increase provisions of our 1997 Stock
Plan to limit the eligible shares under the Plan and to add 5 million shares to
the total number of shares eligible to be optioned or granted for the Year 2000,
and to ratify the Plan as amended: 59,712,144 votes in favor, 42,888,304 votes
opposed, 501,261 votes abstained, and 23,199,088 broker non-votes.
PROPOSAL 4 - An amendment to the annual increase provisions of our 1997 Stock
Plan to limit the eligible shares under the Plan and to add 10 million shares to
the total number of shares eligible to be optioned or granted for the Year 2001,
and to ratify the Plan as amended: 59,782,731 votes in favor, 43,041,774 votes
opposed, 277,204 votes abstained, and 23,199,088 broker non-votes.
PROPOSAL 5 - Ratification of independent auditors, Ernst & Young LLP, for the
2000 fiscal year: 125,906,917 votes in favor, 330,324 votes against, and 63,556
votes abstained.
21
<PAGE>
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS
-------------- -----------------------
2.1 (1) Agreement and Plan of Merger and Reorganization, dated
as of June 15, 2000 among Covad Communications Group,
Inc., Covad Acquisition Corp. and BlueStar
Communications Group, Inc.
3.1 (2) Amended and Restated Certificate of Incorporation.
3.2 (2) Bylaws, as currently in effect.
3.3 (2) Form of Certificate of Amendment of Certificate of
Incorporation of Covad Communications filed on
July 14, 2000.
10.2 (2) Demand Loan Agreement dated as of June 15, 2000 among
BlueStar and Bear Stearns Corporate Lending Inc.
10.3 (2) Put/Call Option Agreement dated as of June 15, 2000 among
Covad Communications and Bear Stearns Corporate Lending,
Inc.
27.1 Financial Data Schedule
99.1 (1) Press Release, June 16, 2000 announcing the acquisition
by Covad Communications Group, Inc. of BlueStar
Communications Group, Inc.
--------------
(1) Incorporated by reference to Registrant's Current Report on Form
8-K filed on July 7, 2000.
(2) Incorporated by reference to Registrant's Registration Statement
on Form S-4 filed on August 10, 2000.
b. Reports on Form 8-K
Form 8-K filed on June 20, 2000.
Form 8-K filed on June 27, 2000.
Form 8-K filed on July 7, 2000.
Form 8-K/A filed on August 9, 2000.
22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVAD COMMUNICATIONS GROUP, INC.
Date: August 14, 2000 By: /s/ Mark Perry
-----------------------------------------
Mark Perry
Executive Vice President, Chief Financial
Officer
(Principal Financial and Accounting
Officer)
