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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 30, 2000.
REGISTRATION NO. 333-43494
====================================================================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
COVAD COMMUNICATIONS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
--------------
DELAWARE 77-0461529 4813
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER (PRIMARY STANDARD INDUSTRIAL
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) CLASSIFICATION CODE NUMBER)
4250 BURTON DRIVE, SANTA CLARA, CALIFORNIA 95054
(408) 987-1000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
--------------
ROBERT E. KNOWLING, JR.
CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER
COVAD COMMUNICATIONS GROUP, INC.
4250 BURTON DRIVE, SANTA CLARA, CALIFORNIA 95054
(408) 987-1000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE)
--------------
COPIES TO:
John W. Carr, Esq. Robert E. Dupuis Carmelo M. Gordian, Esq.
Simpson Thacher & Bartlett BlueStar Communications Group, Inc. Brobeck, Phleger & Harrison LLP
425 Lexington Avenue Five Corporate Centre, Suite 600 301 Congress Avenue, Suite 1200
New York, NY 10017 801 Crescent Centre Drive Austin, TX 78701
(212) 455-2000 Franklin, TN 37067 (512) 477-5000
(615) 778-6600
--------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this registration statement becomes effective and upon
consummation of the transactions described in the enclosed prospectus.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box: / /
If this form is filed to register additional securities for an offering
pursuant to Rule 426(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /_______________
If this form is a post-effective amendment filed pursuant to Rule 462(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. / /________________
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 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE SEC, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE.
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The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and is not soliciting an offer to buy these securities
in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED AUGUST 30, 2000
[BLUESTAR LOGO]
Dear BlueStar Stockholder:
The boards of directors of BlueStar Communications Group, Inc., Covad
Communications Group, Inc. and Covad Acquisition Corporation, a wholly owned
subsidiary of Covad Communications, have approved the acquisition of BlueStar by
Covad Communications. As a result of the merger, BlueStar will become a wholly
owned subsidiary of Covad Communications.
We believe that the merger is in the best interests of the BlueStar
stockholders. This is based upon, among other things, our belief that the merger
will help to accelerate BlueStar's network deployment and expand its presence as
a broadband service provider using DSL technology.
If we complete the merger, the BlueStar stockholders will receive shares of
Covad Communications common stock in exchange for their shares of BlueStar stock
based upon a formula described in detail elsewhere in this prospectus. Upon the
closing of the merger, stockholders of BlueStar are expected to own
approximately 4.9% of the outstanding common stock of Covad Communications,
while Covad Communications will own 100% of BlueStar.
We cannot complete the merger unless the stockholders of BlueStar approve
the merger, adopt the merger agreement and the form of escrow agreement, and
approve the appointment of Christopher Lord as the agent of the BlueStar
stockholders under the merger agreement and the escrow agreement.
The board of directors of BlueStar has arranged to undertake the approval
of this important matter by written consent.
BlueStar stockholders owning a majority of the shares of BlueStar common
stock and BlueStar preferred stock have entered into stockholder agreements with
Covad Communications, pursuant to which they have agreed to approve these items.
However, approval by 90% of BlueStar's stockholders is required under the merger
agreement, unless Covad Communications chooses to waive this condition and
accept a lesser percentage.
This prospectus provides you with detailed information about the proposed
merger. It also contains information about BlueStar and Covad Communications. We
encourage you to read this document thoroughly. IN PARTICULAR, YOU SHOULD
CAREFULLY READ THE "RISK FACTORS" SECTION BEGINNING ON PAGE 10 FOR A DESCRIPTION
OF THE VARIOUS RISKS YOU SHOULD CONSIDER IN EVALUATING THE PROPOSED TRANSACTION,
AND "THE MERGER--CONSIDERATION TO BE RECEIVED IN THE MERGER" AND "THE
MERGER--TREATMENT OF STOCK OPTIONS AND BENEFIT PLANS" FOR A DESCRIPTION OF THE
SHARE EXCHANGE PROVISIONS.
We are very enthusiastic about this merger and the opportunities we expect
from BlueStar's combination with Covad Communications. I join with the other
members of the BlueStar board of directors in recommending that you approve the
merger and the other related matters.
Please complete, sign, date and return the accompanying written consent in
the enclosed self-addressed stamped envelope by September 11, 2000, to ensure
the approval of these transactions. YOUR APPROVAL IS VERY IMPORTANT, SO PLEASE
TAKE THE TIME TO COMPLETE YOUR WRITTEN CONSENT.
Sincerely,
Robert E. Dupuis
CHAIRMAN OF THE BOARD
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THIS TRANSACTION OR THE SECURITIES
BEING OFFERED BY COVAD COMMUNICATIONS OR DETERMINED IF THIS PROSPECTUS IS
TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
--------------
The information in this prospectus is dated August 30, 2000 and is first
being mailed to the stockholders of BlueStar Communications Group, Inc. on or
about August 31, 2000.
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[BLUESTAR LOGO]
BLUESTAR COMMUNICATIONS GROUP, INC.
FIVE CORPORATE CENTRE
SUITE 600
801 CRESCENT CENTRE DRIVE
FRANKLIN, TENNESSEE 37067
ACTION TO BE TAKEN BY WRITTEN CONSENT OF STOCKHOLDERS
It is proposed that, by written consent of the BlueStar stockholders, the
following actions be taken:
The approval and adoption together as one matter of:
o an Agreement and Plan of Merger and Reorganization, dated as of June
16, 2000, by and among Covad Communications Group, Inc., a Delaware
corporation, Covad Acquisition Corporation, a newly organized Delaware
corporation and wholly owned subsidiary of Covad Communications, and
BlueStar Communications Group, Inc., a Delaware corporation, as
amended to date, and the merger contemplated by that agreement,
o the form of the escrow agreement referred to in the merger agreement,
and
o the appointment of Christopher Lord as agent of the BlueStar
stockholders under the merger agreement and the escrow agreement.
Only stockholders of BlueStar of record at the close of business on August
22, 2000 are entitled to participate in the written consent. Under Delaware law,
holders of BlueStar stock may be entitled to appraisal rights in connection with
the merger.
By Order of the Board of Directors,
Robert E. Dupuis
CHAIRMAN OF THE BOARD
Franklin, Tennessee
August 31, 2000
YOUR CONSENT IS IMPORTANT!
If you wish to approve the proposed transaction, please complete, date and
sign the enclosed written consent and mail it promptly in the enclosed
postage-paid envelope as soon as possible. PLEASE DO NOT SEND YOUR STOCK
CERTIFICATES WITH YOUR WRITTEN CONSENT.
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TABLE OF CONTENTS
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PAGE
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QUESTIONS AND ANSWERS ABOUT THE PROPOSED MERGER.................................................... 1
SUMMARY............................................................................................ 3
The Companies........................................................................... 3
Action to Be Taken by Written Consent................................................... 3
Consent Required........................................................................ 3
Share Ownership of Management........................................................... 4
Shares Subject to Stockholder Agreements................................................ 4
Recommendation of the BlueStar Board of Directors....................................... 4
The Merger.............................................................................. 4
Reasons for the Merger.................................................................. 4
Consideration to Be Received in the Merger.............................................. 4
Earn-Out Shares......................................................................... 5
Interim Financing....................................................................... 5
Conditions to the Merger................................................................ 5
Termination of the Merger Agreement..................................................... 6
Regulatory and Legal Constraints........................................................ 6
Material United States Federal Income Tax Consequences.................................. 6
Anticipated Accounting Treatment........................................................ 6
Opinion of Financial Advisor to BlueStar................................................ 6
Interests of Certain Persons in the Merger.............................................. 7
Resale of Covad Communications Common Stock............................................. 7
Dissenters' Rights...................................................................... 7
Stockholder Agreements.................................................................. 7
Stock Restriction Agreements............................................................ 8
Escrow Agreement........................................................................ 8
Stockholders' Agent..................................................................... 8
Comparison of Stockholder Rights........................................................ 8
MARKET PRICE AND DIVIDEND INFORMATION.............................................................. 9
Covad Communications Market Price Data.................................................. 9
BlueStar Market Price Data.............................................................. 9
Recent Closing Prices................................................................... 9
Dividend Information.................................................................... 9
Number of Stockholders.................................................................. 9
RISK FACTORS....................................................................................... 10
Risks Related to the Merger............................................................. 10
Risks Related to Covad Communications .................................................. 12
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS.................................................. 30
ACTION TO BE TAKEN BY WRITTEN CONSENT.............................................................. 32
Timing.................................................................................. 32
Matters to Be Approved by Written Consent............................................... 32
Record Date; Stockholders Entitled to Participate....................................... 32
Consent Required........................................................................ 32
Revoking Consents....................................................................... 33
Consent Solicitation.................................................................... 33
THE COMPANIES...................................................................................... 34
Covad Communications Group, Inc......................................................... 34
BlueStar Communications Group, Inc...................................................... 52
Covad Acquisition Corporation........................................................... 52
MANAGEMENT OF COVAD COMMUNICATIONS................................................................. 53
THE MERGER ........................................................................................ 60
Background of the Merger................................................................ 60
Reasons for the Merger.................................................................. 63
Recommendation of the BlueStar Board of Directors....................................... 63
Board Presentation and Opinion of Financial Advisor to BlueStar......................... 64
Structure of the Merger................................................................. 68
Closing Matters......................................................................... 68
Consideration to Be Received in the Merger.............................................. 69
Treatment of Stock Options and Benefit Plans............................................ 70
Conditions to the Merger................................................................ 71
Termination of the Merger Agreement..................................................... 72
Conduct of Business Pending the Closing of the Merger................................... 72
Additional Covenants and Agreements..................................................... 73
Representations and Warranties.......................................................... 74
Amendment............................................................................... 74
Regulatory Approvals Required........................................................... 74
Expenses................................................................................ 75
Material United States Federal Income Tax Consequences.................................. 75
Anticipated Accounting Treatment........................................................ 76
Interests of Certain Persons in the Merger.............................................. 76
Resale of Covad Communications Common Stock............................................. 78
Dissenters' Rights...................................................................... 78
Procedures for Exchanging BlueStar Stock Certificates................................... 79
Stockholder Agreements.................................................................. 80
Stock Restriction Agreements............................................................ 80
Escrow Agreement........................................................................ 81
Stockholders' Agent..................................................................... 81
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF
COVAD COMMUNICATIONS GROUP, INC............................................................... 82
COVAD COMMUNICATIONS MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................................... 84
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TABLE OF CONTENTS--(CONTINUED)
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF BLUESTAR
COMMUNICATIONS GROUP, INC..................................................................... 93
BLUESTAR MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................................................... 95
BLUESTAR SECURITY OWNERSHIP OF MANAGEMENT AND PRINCIPAL STOCKHOLDERS............................... 100
COMPARATIVE PER SHARE DATA......................................................................... 102
DESCRIPTION OF COVAD COMMUNICATIONS CAPITAL STOCK.................................................. 103
COMPARISON OF STOCKHOLDER RIGHTS................................................................... 106
Authorized Share........................................................................ 106
Directors............................................................................... 106
Bylaw Amendments........................................................................ 107
Stockholder Meeting Procedures.......................................................... 107
LEGAL OPINIONS..................................................................................... 108
EXPERTS............................................................................................ 108
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APPENDICES TO THE PROSPECTUS
APPENDIX A Agreement and Plan of Merger and Reorganization
APPENDIX B Form of Stockholder Agreement
APPENDIX C Form of Stock Restriction Agreement
APPENDIX D Form of Escrow Agreement
APPENDIX E Opinion of Donaldson, Lufkin & Jenrette Securities Corporation
APPENDIX F Section 262 of the Delaware General Corporation Law
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QUESTIONS AND ANSWERS ABOUT THE PROPOSED MERGER
Q: WHY ARE THE TWO COMPANIES PROPOSING TO MERGE?
A: The companies are merging in order to accelerate their network deployment
and expand their presence as broadband service providers using DSL
technology. The companies believe that the combined entity will have
greater visibility and market penetration and will increase revenues from
small- and medium-sized businesses located in Tier 2 and Tier 3 cities.
Q: WHAT ARE THE BENEFITS OF THE MERGER?
A: The companies expect to realize the following benefits as a result of the
merger:
o Additional distribution channels for their services and products;
o Speed to market in implementing a nationwide direct sales strategy in
smaller markets;
o Increased ability to provide enhanced broadband services to small- and
medium-sized businesses;
o Greater visibility and market penetration in Tier 2 and Tier 3 cities;
o A large sales force with extensive experience selling broadband
services to end users; and
o Higher margins on each end user line.
Q: HOW IS THIS TRANSACTION BEING STRUCTURED?
A: If all conditions to the merger are satisfied (or waived), Covad
Acquisition Corporation, a wholly owned subsidiary of Covad Communications
Group, Inc., will be merged into BlueStar Communications Group, Inc.
BlueStar will continue as the surviving corporation. Following the merger,
BlueStar will be a wholly owned subsidiary of Covad Communications.
Q: WHAT WILL I RECEIVE IN EXCHANGE FOR MY BLUESTAR STOCK?
A: When the merger becomes effective, 8,000,000 shares of Covad Communications
common stock, adjusted for certain deductions described later in this
prospectus, will be issued by Covad Communications to be divided among the
BlueStar stockholders, option holders and warrant holders in accordance
with an exchange ratio also described later in this prospectus. After the
effective time of the merger, BlueStar stockholders and other equity
owners of BlueStar may receive up to 5,000,000 additional shares of Covad
Communications common stock depending upon the financial performance of
BlueStar for its fiscal year 2001. These additional shares are called the
"earn-out shares" and are also described later in this prospectus. See
"The Merger--Consideration to Be Received in the Merger".
Q: WILL A PORTION OF THE COVAD COMMUNICATIONS COMMON STOCK ISSUED IN THE
MERGER BE HELD IN ESCROW?
A: Yes. 800,000 of the shares of Covad Communications common stock issued in
the merger will be placed in escrow to indemnify Covad Communications
against any breaches of the merger agreement by BlueStar. The shares will
be released and distributed to the former stockholders of BlueStar after
one year, unless reserved to cover pending claims. Up to 10% of the
earn-out shares may also be placed in escrow to cover pending claims.
Shares under BlueStar's stock option plans will not be subject to the
escrow.
Q: WILL THE SHARES OF COVAD COMMUNICATIONS COMMON STOCK ISSUED IN THE MERGER
BE LISTED ON THE NASDAQ NATIONAL MARKET?
A: Yes. The common stock of Covad Communications issued in the merger will be
listed on the NASDAQ National Market.
Q: WHAT ARE THE TAX CONSEQUENCES OF THE MERGER TO STOCKHOLDERS OF BLUESTAR AND
COVAD COMMUNICATIONS?
A: BlueStar stockholders who exchange their shares of BlueStar stock solely
for shares of Covad Communications common stock pursuant to the merger will
not recognize any gain or loss on the exchange for United States federal
income tax purposes, except with respect to the cash, if any, received
instead of fractional share interests of Covad Communications common stock.
The merger will not have any tax consequences for Covad Communications
stockholders. To review the tax consequences to stockholders in greater
detail, see "The Merger--Material United States Federal Income Tax
Consequences."
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Q: WHAT WILL MY TAX BASIS BE IN THE COVAD COMMUNICATIONS COMMON STOCK I
RECEIVE IN THE MERGER?
A: Your tax basis in your total shares of Covad Communications common stock
you receive in the merger will equal your current tax basis in your
BlueStar stock, reduced by the amount of basis allocable to fractional
shares for which you will receive cash payment.
Q: WILL I BE ABLE TO SELL THE SHARES OF COVAD COMMUNICATIONS COMMON STOCK THAT
I RECEIVE IN THE MERGER?
A: A number of BlueStar stockholders will be required under the merger
agreement to enter into stock restriction agreements, which will restrict
the disposal of their Covad Communications common stock received in the
merger for a period of either 12 months (in the case of certain management
stockholders) or six months (in all other cases). In addition, affiliates
of Covad Communications will be required to enter into agreements to ensure
their compliance with the securities laws restrictions placed on the
selling of shares by affiliates. Finally, 800,000 of the shares of Covad
Communications common stock issued in the merger will be placed into escrow
for at least one year pursuant to the escrow agreement.
Q: WHAT DO I NEED TO DO NOW?
A: After carefully reading and considering the information contained in this
prospectus, please fill out and sign your written consent if you wish to
approve this transaction. Then mail your completed, signed and dated
written consent in the enclosed return envelope as soon as possible so that
your shares are counted toward approval of the merger.
Q: CAN I CHANGE MY VOTE AFTER I HAVE MAILED MY WRITTEN CONSENT?
A: You may change your vote by sending a written notice stating that you would
like to revoke your written consent. However, BlueStar stockholders who are
parties to stockholder agreements with Covad Communications may not revoke
the proxies they granted to Covad Communications under those agreements.
The stockholder agreements are described under "The Merger--Stockholder
Agreements." Written consents or other communications received after
September 11, 2000 will not be considered.
Q: SHOULD I SEND IN MY BLUESTAR STOCK CERTIFICATES NOW?
A: No. You should not send in your BlueStar stock certificates now. After the
merger is completed, you will receive written instructions for exchanging
your BlueStar stock certificates for Covad Communications stock
certificates.
Q: WHEN DO YOU EXPECT THE MERGER TO BE COMPLETED?
A: We are working toward completing the merger as quickly as possible after
the merger is approved. We hope to complete the merger by the middle of
September 2000. Because the merger is subject to governmental approvals,
however, we cannot predict the exact timing of the closing.
Q: WHO CAN HELP ANSWER MY OTHER QUESTIONS?
A: If you have more questions about the merger, you should contact Norton
Cutler, BlueStar's general counsel, at (615) 778-7316.
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SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS PROSPECTUS AND MAY
NOT CONTAIN ALL OF THE INFORMATION THAT IS IMPORTANT TO YOU. TO UNDERSTAND THE
TRANSACTIONS FULLY, AND FOR A MORE COMPLETE DESCRIPTION OF THE LEGAL TERMS OF
THE TRANSACTIONS, YOU SHOULD CAREFULLY READ THIS ENTIRE DOCUMENT AND THE
DOCUMENTS TO WHICH WE HAVE REFERRED YOU. PLEASE REFER TO THE SECTION ENTITLED
"WHERE YOU CAN FIND MORE INFORMATION" FOR ADDITIONAL SOURCES OF INFORMATION.
THE COMPANIES
COVAD COMMUNICATIONS GROUP, INC.
4250 Burton Drive
Santa Clara, CA 95054
Attn: Investor Relations
(408) 987-1000
Covad Communications is a leading provider of broadband communications
services to Internet service provider, enterprise, telecommunications carrier
and other customers. These services include a range of high-speed, high capacity
Internet and network access services using digital subscriber line (DSL)
technology, and related value-added services. Internet service providers
purchase these services in order to provide high-speed Internet access to their
business and consumer end-users. Enterprise customers purchase these services
directly or indirectly from Covad Communications to provide employees with
high-speed remote access to the enterprise's local area network (RLAN access),
which improves employee productivity and reduces network connection cost.
Telecommunications carrier customers purchase these services for resale to their
Internet service provider affiliates, Internet users and enterprise customers.
BLUESTAR COMMUNICATIONS GROUP, INC.
Five Corporate Centre, Suite 600
801 Crescent Centre Drive
Franklin, TN 37067
Attn: Norton Cutler
(615) 778-7316
BlueStar is a provider of broadband communications and Internet services to
small- and medium-sized businesses in Tier 2 and Tier 3 markets. BlueStar began
deploying its network in the Southeast. BlueStar's Internet access services,
which are packaged with Web hosting and e-mail, and its high-speed real private
networking services are provided primarily using digital subscriber line, or
DSL, technology. BlueStar has deployed an asynchronous transfer mode, or ATM,
and Internet protocol backbone network that links all of its central offices and
markets. This network allows it to lower its Internet access costs, control
speed and quality of its broadband services and provides it with a superior
platform for the delivery of additional enhanced services.
COVAD ACQUISITION CORPORATION
c/o Covad Communications Group, Inc.
4250 Burton Drive
Santa Clara, CA 95054
Attn: Investor Relations
(408) 987-1000
Covad Acquisition Corporation is a wholly owned subsidiary of Covad
Communications that was organized solely for purposes of completing the merger.
ACTION TO BE TAKEN BY WRITTEN CONSENT
TIMING. All written consents must be received at Five Corporate Centre,
Suite 600, 801 Crescent Centre Drive, Franklin, TN 37067 by September 11, 2000
to be counted toward approval of the merger.
MATTERS TO BE APPROVED BY WRITTEN CONSENT. By written consent, the holders
of BlueStar stock will be asked to approve the merger, adopt the merger
agreement and the form of the escrow agreement, and approve the appointment of
Christopher Lord as the BlueStar stockholders' agent under the merger agreement
and the escrow agreement.
RECORD DATE; STOCK ENTITLED TO PARTICIPATE. The close of business on August
22, 2000 is the record date for determining which holders of BlueStar stock are
entitled to participate in the written consent. At the record date, there were
13,183,046 shares of BlueStar common stock and 22,687,646 shares of BlueStar
preferred stock outstanding.
Holders of BlueStar stock as of the record date are entitled to one vote
per share on each matter to be approved by written consent.
CONSENT REQUIRED
Adoption of the merger agreement by BlueStar's stockholders is required by
the General Corporation Law of the State of Delaware. The
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proposal to approve and adopt the merger and the associated transactions, the
merger agreement, the form of escrow agreement, and the appointment of
Christopher Lord as the BlueStar stockholders' agent under the merger agreement
and the escrow agreement, requires the affirmative vote or consent of
o 90% of the holders of outstanding shares of BlueStar common stock and
BlueStar preferred stock, voting together as a single class; and
o a majority of the holders of outstanding BlueStar preferred stock,
voting separately as a single class.
SHARE OWNERSHIP OF MANAGEMENT
As of the record date, the executive officers and directors of BlueStar and
their affiliates collectively owned 22,587,819 shares of BlueStar common stock
and BlueStar preferred stock, together representing approximately 63% of the
total outstanding BlueStar stock, and 15,856,043 shares of BlueStar preferred
stock, representing approximately 69% of the total outstanding BlueStar
preferred stock.
It is anticipated that the shares of BlueStar stock held by management of
BlueStar will be voted in favor of the various matters to be approved by
written consent.
SHARES SUBJECT TO STOCKHOLDER AGREEMENTS
Pursuant to stockholder agreements among Covad Communications and certain
stockholders of BlueStar, Covad Communications holds proxies for 4,026,978
shares of BlueStar common stock and 18,166,844 shares of BlueStar preferred
stock, representing approximately 62% of the total shares of BlueStar stock
outstanding on the record date, and 80% of the shares of BlueStar preferred
stock outstanding on the record date.
RECOMMENDATION OF THE BLUESTAR BOARD OF DIRECTORS
The BlueStar board of directors believes that the merger and the associated
transactions, the merger agreement and the form of escrow agreement are fair to
and in the best interests of BlueStar and its stockholders, and has approved and
declared advisable the merger and the associated transactions, the merger
agreement and the form of escrow agreement, and the appointment of Christopher
Lord as the BlueStar stockholders' agent under the merger agreement and the
escrow agreement.
THE BLUESTAR BOARD OF DIRECTORS RECOMMENDS THAT BLUESTAR STOCKHOLDERS GIVE
THEIR CONSENT TO APPROVE THESE MATTERS.
THE MERGER
The merger agreement provides for the acquisition of BlueStar by Covad
Communications. If the merger agreement and related matters are approved by
BlueStar's stockholders by written consent, BlueStar will merge with Covad
Acquisition Corporation and become a wholly owned subsidiary of Covad
Communications.
The merger agreement is attached as Appendix A to this prospectus. We
encourage you to read the merger agreement carefully because it is the legal
document that governs the merger.
REASONS FOR THE MERGER
The companies are merging in order to accelerate their network deployment
and expand their presence as broadband services providers using DSL technology.
The companies believe that together they will have greater visibility and market
penetration and will increase revenues from small- and medium-sized businesses
located in Tier 2 and Tier 3 cities. The companies expect the merger to result
in:
o additional distribution channels for their services and products;
o speed to market in implementing a nationwide direct sales strategy in
smaller markets;
o increased ability to provide enhanced broadband services to small- and
medium-sized businesses;
o greater visibility and market penetration in Tier 2 and Tier 3 cities;
o a large sales force with extensive experience selling broadband
services to end users; and
o higher margins for each end user.
CONSIDERATION TO BE RECEIVED IN THE MERGER
Under the merger agreement, Covad Communications will issue to the BlueStar
stockholders and other equity owners of BlueStar at the effective time of the
merger 8,000,000 shares of Covad Communications common stock, minus shares
(priced at the closing price for Covad Communications common stock on the NASDAQ
4
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National Market on the third business day prior to closing) with a value equal
to:
o BlueStar's transaction costs for the merger; and
o the principal, interest and expenses associated with the interim
financing extended to BlueStar prior to the merger. See "--Interim
Financing" below for a fuller description of this financing.
The remaining consideration will be divided among BlueStar stockholders and
other equity owners of BlueStar at the effective time of the merger according to
an exchange ratio calculated as follows:
o First, for the purpose of satisfying the liquidation preferences of
BlueStar preferred stockholders, shares of Covad Communications common
stock (priced at the average closing price for Covad Communications
common stock on the NASDAQ National Market over the 30 days ending
three days prior to closing) will be set aside with a value equal to
$71,121,770.57, the total amount of those preferences, and divided
among the BlueStar preferred stockholders pro rata according to their
share ownership; and
o Second, each share of BlueStar stock, including the BlueStar preferred
stock, will be converted into a number of shares of Covad
Communications common stock to be calculated by dividing the remaining
shares of Covad Communications common stock to be issued in the
merger, by the total number of BlueStar shares (calculated on a fully
diluted basis, excluding certain options that have been forfeited by
their owners and are incapable of exercise).
See "The Merger--Consideration to Be Received in the Merger" for more
detail as to merger consideration.
Covad Communications will not issue fractional shares in the merger.
Instead, the total number of shares of Covad Communications common stock to be
received by each BlueStar stockholder in the merger will be rounded down to the
nearest whole number, and the BlueStar stockholders will receive a cash payment
for the value of the fraction of a share of Covad Communications common stock
(based on the closing price for Covad Communications common stock on the NASDAQ
National Market on the third business day prior to closing) that they would
otherwise have received.
EARN-OUT SHARES
Following the conclusion of BlueStar's 2001 fiscal year, Covad
Communications will issue to the former BlueStar stockholders up to 5,000,000
additional shares of Covad Communications common stock, known as "earn-out
shares". The exact number of the earn-out shares will depend upon the financial
performance of BlueStar in fiscal year 2001 against pre-established revenue and
earnings benchmarks described in the merger agreement.
Each share of BlueStar stock outstanding as of the effective time of the
merger will represent the right to receive additional shares of Covad
Communications common stock to be calculated by dividing the total number of
earn-out shares by the total number of BlueStar shares outstanding at the
effective time of the merger (calculated on a fully diluted basis, excluding
certain options that have been forfeited by their owners and are incapable of
exercise). See "The Merger--Consideration to Be Received in the Merger--Exchange
Ratios" for more detail as to how the earn-out exchange ratio is calculated.
INTERIM FINANCING
In connection with the merger, Bear Stearns Corporate Lending Inc. is
providing BlueStar with interim financing. All of the interest, principal and
expenses of this interim financing will be subtracted from the merger
consideration to be received by the BlueStar stockholders in the merger.
BlueStar has currently borrowed $15.9 million for its continued operations to
the date of this prospectus, and currently expects to borrow up to approximately
$32.0 million to the effective time of the merger. See "The
Merger--Consideration to Be Received in the Merger--Interim Financing" for more
specifics on the interim financing.
CONDITIONS TO THE MERGER
BlueStar and Covad Communications will complete the merger only if certain
conditions specified in the merger agreement are either satisfied or waived,
including the following:
o adoption by 90% of the BlueStar stockholders of the merger agreement;
o absence of any injunction, restraining order or other decree that
restrains or prohibits the consummation of any of the
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transactions contemplated by the merger agreement;
o receipt of all orders, consents and approvals of any governmental
authorities legally required for the consummation of the transactions
contemplated by the merger agreement and termination or expiration of
the related waiting periods under applicable antitrust or merger
control or competition laws or regulations;
o absence of material adverse changes in the business of BlueStar or
Covad Communications;
o execution by each of the required parties of the additional agreements
contemplated by the merger agreement; and
o receipt of opinions from counsel as to the tax-free nature of the
merger.
TERMINATION OF THE MERGER AGREEMENT
Either Covad Communications or BlueStar may terminate the merger agreement
at any time prior to the effective time of the merger if:
o the transactions contemplated by the merger agreement are not
completed by December 31, 2000;
o a governmental authority or legal action permanently prohibits
consummation of the transactions contemplated by the merger agreement;
or
o the BlueStar stockholders do not adopt the merger agreement.
REGULATORY AND LEGAL CONSTRAINTS
The merger is subject to U.S. antitrust laws. We have made the required
filings with the U.S. Department of Justice and the Federal Trade Commission.
The applicable waiting period under those filings required before completing the
merger expired at 11:59 p.m. on August 4, 2000. The Department of Justice or the
Federal Trade Commission, as well as a state or private person, may challenge
the merger at any time before its completion, even after expiration of the
applicable waiting period.
In addition, Covad Communications and BlueStar must have received
authorization from the appropriate governmental authorities for the assignment
of BlueStar's CLEC authority required for the operation of BlueStar's business.
BlueStar has received all of the approvals from the appropriate governmental
authorities that it believes are necessary for the consummation of the merger.
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
We have structured the merger so that BlueStar stockholders will not
recognize gain or loss for United States federal income tax purposes in the
merger, except for taxes payable because of cash received by BlueStar
stockholders instead of fractional shares. It is a condition to the merger that
we receive legal opinions to the effect that the merger constitutes a
reorganization within the meaning of the Internal Revenue Code.
TAX MATTERS ARE VERY COMPLICATED, AND THE TAX CONSEQUENCES OF THE MERGER OF
COVAD COMMUNICATIONS WITH BLUESTAR WILL DEPEND ON THE FACTS OF YOUR OWN
SITUATION. YOU SHOULD CONSULT YOUR TAX ADVISORS FOR A FULL UNDERSTANDING OF THE
TAX CONSEQUENCES OF THE MERGER TO YOU.
ANTICIPATED ACCOUNTING TREATMENT
The merger will be accounted for using the purchase method of accounting.
OPINION OF FINANCIAL ADVISOR TO BLUESTAR
In deciding to approve the merger and the related transactions, BlueStar's
board of directors considered the presentation and a draft of a form opinion of
Donaldson, Lufkin & Jenrette, Securities Corporation, its financial advisors,
that, as of June 14, 2000, the aggregate merger consideration contemplated by
the merger agreement and the related agreements was fair, from a financial point
of view, to the BlueStar stockholders. Such presentation and a draft of a form
opinion were provided for the information and assistance of BlueStar's board of
directors in connection with its vote on the merger and related transactions and
does not constitute a recommendation as to how any holder of shares of BlueStar
stock should vote with respect to the merger.
On August 4, 2000, Donaldson, Lufkin & Jenrette, Securities Corporation,
delivered to the BlueStar board its written opinion dated August 4, 2000, to the
effect that, as of June 14, 2000, based on and subject to the assumptions,
qualifications and limitations set forth in that opinion, the consideration to
be received by the holders of BlueStar stock in the merger was fair to such
holders from a financial point of view. The full text of the written opinion of
Donaldson, Lufkin & Jenrette, Securities Corporation, dated August 4, 2000,
which sets
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forth assumptions made, matters considered and limitations on the review
undertaken in connection with the opinion, is attached as Appendix E to this
prospectus. You are urged to read the opinion in its entirety.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
A number of BlueStar stock option holders are entitled to accelerated
vesting of 50% of their unvested options in the event of a change of control
such as the merger. It is anticipated that 85% of these option holders will
enter into stock restriction agreements that require that these accelerated
options will be forfeited if the holders leave BlueStar or are dismissed for
cause within 12 months of the effective time of the merger.
Two officers of BlueStar, Robert E. Dupuis, the Chairman and CEO, and
Richard L. Burtner, the Chief Financial Officer, have agreements with BlueStar
that entitle them to certain benefits in the event of a change of control such
as the merger, or if they are dismissed without cause in certain circumstances.
Two directors of BlueStar also have significant interests in Covad
Communications. These interests were made known to and considered by the
BlueStar board of directors, and the relevant directors recused themselves from
voting on the merger proposal.
BlueStar and Covad Communications have agreed to indemnify the directors
and officers of BlueStar following the merger and to maintain their insurance
coverage.
RESALE OF COVAD COMMUNICATIONS COMMON STOCK
The shares of Covad Communications common stock to be issued to
stockholders of BlueStar pursuant to the merger have been registered under the
Securities Act, and may generally be freely traded without restriction by people
who will not be "affiliates" of Covad Communications after the merger and who
were not "affiliates" of BlueStar on the date of the BlueStar written consent
for purposes of Rule 145 under the Securities Act. Affiliates may resell the
Covad Communications common stock received by them in the merger only if the
shares are registered for resale under the Securities Act or if an exemption
from registration under the Securities Act is available or such sales do not
exceed volume limitations presented by Rule 145 under the Securities Act.
BlueStar stockholders signing stock restriction agreements will be contractually
prohibited from selling their shares for either six months or one year, as the
case may be, after the effective time of the merger.
DISSENTERS' RIGHTS
Under Delaware law, BlueStar stockholders are entitled to appraisal rights,
subject to certain conditions discussed more fully elsewhere in this prospectus.
Appraisal rights entitle a dissenting stockholder, under certain conditions, to
receive a valuation of their shares and a payment of that value in cash. Failure
to follow the steps required by law for perfecting appraisal rights may lead to
the loss of those rights, in which case the stockholder will be treated in the
same manner as other non-dissenting stockholders. In view of the complexity of
law relating to appraisal rights, BlueStar stockholders who are considering
objecting to the merger should consult their own legal advisors. See Appendix F
for a reproduction of Section 262 of the Delaware law relating to dissenters'
rights.
STOCKHOLDER AGREEMENTS
Covad Communications and certain stockholders of BlueStar entered into
stockholder agreements on June 15, 2000 as a condition to the signing of the
merger agreement. Under the stockholder agreements, these BlueStar stockholders
have agreed to retain ownership of their BlueStar stock prior to the merger and
to vote all of their shares of BlueStar stock in favor of the adoption of the
merger agreement and other related matters. These stockholders have also given
Covad Communications an irrevocable proxy over their stock in relation to
proposals relating to the approval of the merger and the merger agreement and
other matters that would facilitate such approval. Such stockholders have also
agreed, subject to the fiduciary duties of officers and directors of BlueStar,
not to initiate, solicit or negotiate other acquisition proposals prior to the
expiration of the stockholder agreements.
The stockholder agreements expire on the earlier of the date of the closing
of the merger or date of the termination of the merger agreement. Stockholders
holding a majority of the total outstanding stock and a majority of the
preferred stock of BlueStar have entered into such agreements.
A form of stockholder agreement is attached as Appendix B to this
prospectus. We encourage you to read this agreement carefully.
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STOCK RESTRICTION AGREEMENTS
BlueStar has agreed as a condition to closing the merger that it will
obtain stock restriction agreements from 85% of a selected group of BlueStar's
managers, 80% of its employees holding vested options, and holders of 75% of the
stock held by the remaining stockholders.
The stock restriction agreements restrict the ability of the signatories to
transfer the Covad Communications common stock they receive in the merger, or
any interest in it, for a period of 12 months (in the case of the selected
managers) or six months (in the case of other signatories).
The stock restriction agreements also provide that if an option holder has
received an accelerated vesting of options due to the merger, then the
accelerated options will be subject to forfeiture if the option holder leaves
the employment of BlueStar or is dismissed for cause within 12 months of the
effective time of the merger.
These agreements are designed to ensure that certain former stockholders of
BlueStar, after having exchanged their BlueStar stock for Covad Communications
common stock, nevertheless retain an interest in ensuring that BlueStar succeeds
in reaching, and exceeding, its performance goals.
A form of stock restriction agreement is attached as Appendix C to this
prospectus. We encourage you to read this agreement carefully.
ESCROW AGREEMENT
Before the effective time of the merger, Covad Communications, Christopher
Lord as agent for the BlueStar stockholders, and an escrow agent will enter into
an escrow agreement providing for 800,000 of the shares of common stock to be
issued by Covad Communications to BlueStar stockholders in the merger to be
delivered to the escrow agent upon the closing of the merger. This escrow fund
will be used to indemnify Covad Communications in the event that BlueStar is
found to have breached the merger agreement. In most cases of breach by
BlueStar, the escrow fund will be Covad Communications' exclusive source of
indemnification. Shares under BlueStar's stock option plan will not be subject
to the escrow. The escrow agreement is an integral part of the merger agreement.
When the escrow period expires 12 months after the merger becomes
effective, shares of Covad Communications common stock held in escrow that are
not required to meet pending claims will be released to the former BlueStar
stockholders.
If there are still claims pending against the escrow fund when the earn-out
shares are calculated, and there are inadequate shares of Covad Communications
common stock remaining in escrow to cover these claims, then up to 10% of the
total earn-out shares in an amount sufficient to cover the pending claims will
be deposited in the escrow fund.
The form of escrow agreement is attached as Appendix D to this prospectus.
We encourage you to read this agreement carefully.
STOCKHOLDERS' AGENT
Christopher Lord has been recommended by the BlueStar board of directors to
serve as the BlueStar stockholders' agent under the escrow agreement and the
merger agreement. As the BlueStar stockholders' agent, Mr. Lord will act on
behalf of the BlueStar stockholders on matters under the merger agreement and
the escrow agreement. By written consent, stockholders of BlueStar will be asked
to appoint Mr. Lord as the stockholders' agent under the merger agreement and
the escrow agreement.
COMPARISON OF STOCKHOLDER RIGHTS
BlueStar and Covad Communications are both Delaware corporations.
Currently, the rights of stockholders of BlueStar are determined by reference to
Delaware law and BlueStar's certificate of incorporation and bylaws. At the
effective time of the merger, stockholders of BlueStar will become stockholders
of Covad Communications. As a result, their rights as stockholders will then be
determined by reference to Delaware law and Covad Communications' certificate of
incorporation and bylaws. There are differences between the two corporations'
certificates of incorporation and bylaws.
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MARKET PRICE AND DIVIDEND INFORMATION
COVAD COMMUNICATIONS MARKET PRICE DATA
The Covad Communications common stock is listed on the NASDAQ National
Market under the symbol "COVD". The following table sets forth the range of high
and low sales prices for Covad Communications common stock as reported on the
NASDAQ National Market since January 22, 1999. Prior to that time, there was no
public market for Covad Communications common stock. These prices have been
split-adjusted to account for the stock splits in May 1999 and March 2000.
PRICE RANGE OF COMMON STOCK
FISCAL YEAR ENDED DECEMBER 31, 1999 HIGH LOW
----------------------------------- -------- --------
First Quarter........................................... 47.50 12.00
Second Quarter.......................................... 72.38 39.56
Third Quarter........................................... 67.50 37.31
Fourth Quarter.......................................... 65.38 38.78
FISCAL YEAR ENDED DECEMBER 31, 2000
-----------------------------------
First Quarter........................................... 66.25 38.63
Second Quarter.......................................... 45.75 15.44
Third Quarter (through August 25, 2000)................. 23.01 13.63
BlueStar stockholders are urged to obtain current quotations for the market
prices of Covad Communications common stock. No assurance can be given as to the
market price of Covad Communications common stock at the effective time of the
merger.
BLUESTAR MARKET PRICE DATA
There is no established trading market in BlueStar stock.
RECENT CLOSING PRICES
On June 15, 2000, the last trading day before the public announcement of
the merger agreement, the closing price of Covad Communications common stock as
reported on the NASDAQ National Market was $25.25 per share.
On August 25, 2000, the closing price of Covad Communications common stock
as reported on the NASDAQ National Market was $15.06 per share.
DIVIDEND INFORMATION
Neither Covad Communications nor BlueStar has ever paid any cash dividends
on its stock, and both anticipate that they will continue to retain any earnings
for the foreseeable future for use in the expansion and operation of their
respective businesses. The terms of Covad Communications' debt indentures
relating to the 13 1/2% senior discounted notes due 2008, its 12 1/2% senior
notes due 2009 and its 12% senior notes due 2010 also restrict its ability to
pay cash dividends on its capital stock. BlueStar is prohibited from paying cash
dividends to its stockholders pursuant to a loan agreement with Bear Stearns
Corporate Lending Inc.
NUMBER OF STOCKHOLDERS
As of August 1, 2000, there were 613 holders of record of Covad
Communications common stock and as of August 24, 2000, there were 79 holders of
record of BlueStar stock.
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RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS, TOGETHER WITH THE
OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, BEFORE DETERMINING WHETHER TO
VOTE TO APPROVE THE MERGER AND THE RELATED MATTERS. IF ANY OF THE FOLLOWING
RISKS ACTUALLY OCCUR, COVAD COMMUNICATIONS' BUSINESS AND FINANCIAL CONDITION OR
ITS RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. IF THAT HAPPENS, THE VALUE
OF THE COVAD COMMUNICATIONS COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR
PART OF YOUR INVESTMENT.
RISKS RELATED TO THE MERGER
THE MAXIMUM NUMBER OF SHARES OF COVAD COMMUNICATIONS COMMON STOCK TO BE
ISSUED AT THE EFFECTIVE TIME OF THE MERGER WILL NOT CHANGE DESPITE POTENTIAL
CHANGES IN THE COVAD COMMUNICATIONS COMMON STOCK PRICE PRIOR TO THE CLOSING
DATE.
The maximum number of shares of Covad Communications common stock to be
issued at the effective time of the merger, including Covad Communication
common stock to be reserved for issuance upon exercise of BlueStar stock options
and warrants assumed by Covad Communications, is 8,000,000. This amount will not
be adjusted based on fluctuations in the price of Covad Communications common
stock prior to the closing date. Accordingly, the value of the consideration
that you will receive if the merger occurs will depend on both the market price
of Covad Communications common stock on the closing date as well as an average
price of the Covad Communications common stock prior to closing. This value may
decrease from the date you submit your written consent. The closing price of
Covad Communications common stock on the NASDAQ National Market on June 15,
2000, the last trading day prior to the public announcement of the merger
agreement, was $25.25, and on August 25, 2000 was $15.06. A change in the price
of the Covad Communications common stock will affect the proportion of the
merger consideration allocated to the holders of BlueStar preferred stock and
BlueStar common stock. BlueStar preferred stockholders will receive prior to
payment of shares to all stockholders, a number of liquidation preference shares
determined by dividing $71,121,770.57 by the average of the closing prices of
Covad Communications common stock over a 30 day period ending three days prior
to the closing date. As a result, a declining Covad Communications common stock
price will result in the preferred stockholders receiving more of the total
fixed number of shares and the common stockholders receiving a lesser share. In
addition, many stockholders will be required to retain their ownership of their
Covad Communications common stock for a certain period after the effective time
of the merger, during which time the value of that stock may vary greatly from
the price at the time you submit your written consent. The Covad Communications
common stock may also vary greatly in price by the time the earn-out shares are
calculated, and hence the value of the earn-out consideration may decrease. You
are urged to obtain current market quotations for Covad Communications common
stock prior to submitting your written consent.
THE REQUIREMENT FOR REGULATORY APPROVALS MAY DELAY CONSUMMATION OF THE
MERGER, INCREASING THE RISK THAT THE VALUE OF THE COVAD COMMUNICATIONS COMMON
STOCK WILL FLUCTUATE OVER TIME.
Consummation of the merger is conditioned upon the receipt of all material
governmental authorizations, consents, orders and approvals, including the
expiration or termination of the applicable waiting periods, and any extension
of the waiting periods, under antitrust laws. BlueStar and Covad Communications
intend to pursue vigorously all required regulatory approvals. No assurance can
be given, however, that these approvals will be obtained, or, if they are
obtained, as to the terms, conditions and timing of these approvals. The
requirement for these approvals could delay the consummation of the merger after
BlueStar stockholders have approved the proposals relating to the merger by
written consent.
THE INTERESTS OF MANAGEMENT MAY BE DIFFERENT FROM THOSE OF STOCKHOLDERS.
Some members of BlueStar's management and board of directors, including
individuals who will be executive officers of the surviving corporation, have
various interests in the merger that may be different from, or in addition to,
the interests of BlueStar stockholders. See "The Merger--Interests of Certain
Persons in the Merger" for more information concerning matters relating to the
employment and compensation of the directors and executive officers of BlueStar.
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COVAD COMMUNICATIONS MAY ENCOUNTER DIFFICULTIES IN THE INTEGRATION AND
DEVELOPMENT OF THE BUSINESS OF BLUESTAR.
Covad Communications' strategy to integrate and develop the businesses of
Covad Communications and BlueStar following the merger involves a number of
elements that management may not be able to implement as expected. For example,
Covad Communications may encounter operational difficulties in the integration
of the facilities of the two companies such that expected cost savings may not
be realized. In addition, commercial and technological advances resulting from
the integration of technologies of Covad Communications and BlueStar may not be
achieved as successfully or as rapidly as currently anticipated, if at all. The
consolidation of operations, technologies and marketing and distribution methods
and the technological integration of the BlueStar and Covad Communications
networks present significant managerial challenges. There can be no assurance
that these actions will be accomplished as successfully or as rapidly as
currently anticipated. Some of the factors contributing to the risks attendant
to integration faced by Covad Communications are:
o difficulties and expenses of integrating operations, technology and
personnel into Covad Communications' operations while preserving the
goodwill of the BlueStar businesses;
o the additional financial resources that may be needed to fund the
operations of BlueStar;
o the potential disruption caused to the businesses of Covad
Communications and BlueStar by the need to dedicate management and
other resources to completing the merger transactions;
o the difficulty of creating and maintaining uniform standards,
controls, procedures and policies;
o the impairment of Covad Communications' relationships with its
resellers, who may view Covad Communications as a competitor after the
merger since BlueStar sells directly to potential customers of Covad
Communications' resellers;
o the ability of Covad Communications' management to manage the
substantial expansion of Covad Communications' employee base and the
integration of teams that have not previously worked together, while
dealing with the potential loss of key employees of BlueStar;
o the impairment of relationships with employees and customers as a
result of changes in management; and
o the different geographic locations of the principal operations of
Covad Communications and BlueStar.
THE COSTS OF THE TRANSACTIONS AND THE COSTS OF INTEGRATING COVAD
COMMUNICATIONS' AND BLUESTAR'S OPERATIONS ARE SUBSTANTIAL AND WILL MAKE IT MORE
DIFFICULT FOR COVAD COMMUNICATIONS TO ACHIEVE PROFITABILITY.
Covad Communications will incur substantial costs in connection with the
merger transactions which may make it more difficult to achieve profitability in
the future. Covad Communications estimates that it will incur costs associated
with the merger transactions, consisting of transaction fees for investment
bankers, attorneys, accountants and other related costs incurred by Covad
Communications (such nonrecurring transaction costs being recorded as goodwill
upon consummation of the merger transactions) and additional nonrecurring
restructuring charges, in an amount currently estimated to be approximately
$7,745,000. There can be no assurance that Covad Communications will not incur
additional charges in excess of these amounts to reflect costs associated with
the merger transactions, including the costs of integrating the Covad
Communications and BlueStar operations.
THE EARN-OUT CONSIDERATION DEPENDS UPON BLUESTAR ACHIEVING FINANCIAL
TARGETS THAT MAY BE DIFFICULT TO ACHIEVE.
The stockholders of BlueStar are eligible to receive up to 5,000,000
additional shares of Covad Communications common stock in the form of earn-out
shares if BlueStar achieves revenue and earnings targets for fiscal year 2001.
Achieving these goals will require significant improvement in BlueStar's ability
to raise revenue and reduce its EBITDA losses. There can be no assurance that
these targets can be achieved or that BlueStar stockholders will receive all or
any of the earn-out shares.
IF THE MERGER FAILS TO QUALIFY AS A TAX-FREE REORGANIZATION YOU WILL
RECOGNIZE GAIN OR LOSS ON YOUR BLUESTAR SHARES.
BlueStar and Covad Communications have structured the merger to qualify as
a tax-free organization under Section 368(a) of the Internal Revenue Code of
1986. Although the Internal Revenue Service has not provided a
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ruling on the merger, BlueStar and Covad Communications will each obtain a legal
opinion from their respective counsels that the merger qualifies as a tax-free
reorganization. These opinions neither bind the IRS nor prevent the IRS from
adopting a contrary position. If the merger fails to qualify as a tax-free
reorganization, you would generally recognize gain or loss on each BlueStar
share surrendered in the merger in the amount of the difference between your
basis in such share and the fair market value of the Covad Communications common
stock and other consideration you receive in exchange for such BlueStar share at
the time of the merger.
A PORTION OF YOUR SHARES WILL BE HELD IN AN ESCROW ACCOUNT FOR A PERIOD OF
AT LEAST ONE YEAR.
Upon completion of the merger, 800,000 shares of Covad Communications
common stock issued at the closing of the merger will be delivered to the escrow
agent, on behalf of the holders of BlueStar stock, as security for breaches by
BlueStar of any of its representations, warranties or covenants set forth in the
merger agreement. Up to 10% of the earn-out shares may also be placed in the
escrow account. The escrowed shares are to remain in an escrow account for at
least one year after the effective time of the merger. If Covad Communications
successfully asserts a claim while the escrowed shares remain in the escrow
account, you may not receive all or part of these escrowed shares.
THE ESCROW AGENT MAY NOT ACT IN THE MANNER YOU DESIRE.
The merger agreement provides that the escrow agent will act in certain
matters involving the shares of Covad Communications common stock to be held in
escrow. Your vote to approve the merger agreement and the merger also
effectively constitutes acceptance of the escrow agent to act as such in
accordance with the merger agreement and the escrow agreement by which it is
bound. The escrow agent may not act in the manner you desire and any arbitration
orders required to be enforced by the escrow agent pursuant to the terms of the
escrow agreement could have the effect of reducing the consideration you
ultimately receive in the merger.
THE STOCKHOLDERS' AGENT MAY NOT ACT IN THE MANNER YOU DESIRE.
You have been asked to approve the appointment of Christopher Lord as the
stockholders' agent to act in certain matters involving the shares of Covad
Communications common stock to be held to escrow. As stockholders' agent, Mr.
Lord will have the right, among other things, to compromise and to settle claims
made by Covad Communications against the escrowed shares. The stockholders'
agent may not act in the manner you desire and decisions made by him could have
the effect of reducing the consideration you ultimately receive in the merger.
FAILURE TO COMPLETE THE MERGER WOULD NEGATIVELY IMPACT BLUESTAR'S FUTURE
BUSINESS AND OPERATIONS.
If the merger is not completed for any reason, BlueStar may be subject to a
number of material risks, including the following:
o if BlueStar continues to incur substantial operating losses, it will
need to immediately and successfully establish new sources of
financing, the availability of which is uncertain;
o potential customers may defer purchases of BlueStar's services; and
o employee turnover may increase.
The occurrence of any of these factors would likely result in serious harm
to BlueStar's business, operating results and financial condition.
RISKS RELATED TO COVAD COMMUNICATIONS
REJECTIONS OF COVAD COMMUNICATIONS' APPLICATIONS FOR CENTRAL OFFICE AND
REMOTE TERMINAL SPACE BY TRADITIONAL TELEPHONE COMPANIES ARE LIKELY TO DELAY THE
EXPANSION OF COVAD COMMUNICATIONS' NETWORK AND THE ROLL OUT OF ITS SERVICES.
Covad Communications must secure physical space from traditional telephone
companies for its equipment in their central offices in order to provide its
services in targeted metropolitan statistical areas. In the past, Covad
Communications has experienced rejections of its applications to secure this
space in many central offices, and Covad Communications continues to receive
rejections in some central offices. In addition, to provide a full range of DSL
services, Covad Communications must access remote terminals, which are used by
traditional telephone companies to serve end-users through a combination of
fiber optic technology and copper wires. Traditional
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telephone companies are increasing their deployment of fiber-fed remote terminal
architectures. For Covad Communication to provide copper-based DSL services to
these end-users, Covad Communications needs to access the copper telephone wires
that terminate at these remote terminals.
Covad Communications expects that, as it proceeds with deployment, it will
face additional rejections of its applications for central office space in other
targeted metropolitan statistical areas. These rejections have in the past
resulted, and could in the future result, in delays and increased expenses in
the rollout of services in targeted metropolitan statistical areas, including
delays and expenses associated with engaging in legal proceedings with the
traditional telephone companies. This has harmed Covad Communications' business
and is likely to continue to harm Covad Communications' business in future
periods.
Covad Communications faces other challenges in dealing with the traditional
telephone companies:
o there may be real limitations on the availability of central office
space in certain central offices and remote terminals;
o they frequently claim lack of available facilities when asked by Covad
Communications to provide connections between central offices, remote
terminals and telephone wires to end-users;
o they frequently fail to promise delivery of, or actually deliver,
properly connected telephone wires to Covad Communications' end-users
on time;
o they frequently do not cooperate in providing Covad Communications
with relevant telephone wire information, such as the length of the
wire;
o they frequently do not deploy and provide Covad Communications with
integrated software systems that allow Covad Communications to
seamlessly place large volumes of orders for telephone lines;
o they frequently do not cooperate in maintaining and resolving problems
relating to delivery of telephone lines; and
o they frequently do not cooperate in providing relevant information
about the presence and types of remote terminals that may be serving
end-users.
Covad Communications is engaged in a variety of negotiations, regulatory
disputes and legal actions to resolve these situations. Covad Communications may
be unable to resolve these matters successfully.
The Federal Communications Commission has been reviewing the policies and
practices of the traditional telephone companies with the goal of facilitating
the efforts of competitive telecommunications companies to obtain central office
space and telephone wires more easily and on more favorable terms. On March 31,
1999, the FCC adopted rules to make it easier and less expensive for competitive
telecommunications companies to obtain central office space and to require
traditional telephone companies to make new alternative arrangements for
obtaining central office space. However, the FCC's new rules have not been
uniformly implemented in a timely manner, may not ultimately enhance Covad
Communications' ability to obtain central office space, and have been subject to
litigation.
Moreover, in March 2000, a federal appeals court struck portions of the
FCC's new rules and has required the FCC to reconsider and review those rules.
In particular, the appeals court has required the FCC to revise its rules
concerning the types of equipment that Covad Communications may collocate on the
traditional telephone company premises and the steps that traditional telephone
companies may take to separate their equipment from its equipment. The
traditional telephone companies may implement the court's ruling and any
subsequent FCC rules in a manner that impairs Covad Communications' ability to
obtain collocation space and collocate the equipment of Covad Communications'
choice on their premises. Such actions by the traditional telephone companies
could adversely affect Covad Communications' business and disrupt Covad
Communications' existing network design, configuration and services.
On November 5, 1999, the FCC adopted rules that require traditional
telephone companies to provide access to remote terminal locations and to
require them to provide access to copper wires that terminate at these
terminals. These rules went into effect in May 2000. These rules are currently
being appealed. Covad Communications has been very active in these and other
regulatory proceedings in order to ensure that it receives the full
nondiscriminatory access to these remote terminals and copper wires.
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CHARGES FOR UNBUNDLED NETWORK ELEMENTS ARE OUTSIDE OF COVAD COMMUNICATIONS'
CONTROL BECAUSE THEY ARE PROPOSED BY THE TRADITIONAL TELEPHONE COMPANIES AND ARE
SUBJECT TO COSTLY REGULATORY APPROVAL PROCESSES.
Traditional telephone companies provide the unbundled DSL-capable lines or
telephone wires that connect each end-user to Covad Communications' equipment
located in the central offices. The 1996 Telecommunications Act generally
requires that charges for these unbundled network elements be cost-based and
nondiscriminatory. The nonrecurring and recurring monthly charges for
DSL-capable lines that Covad Communications requires vary greatly. These rates
are subject to the approval of the state regulatory commissions. The rate
approval processes for DSL-capable lines and other unbundled network elements
typically involve a lengthy review of the rates proposed by the traditional
telephone companies in each state. The ultimate rates approved typically depend
on the traditional telephone company's initial rate proposals and the policies
of the state public utility commission. These rate approval proceedings are
time-consuming and expensive. Consequently, Covad Communications is subject to
the risk that the nonrecurring and recurring charges for DSL-capable lines and
other unbundled network elements will increase based on rates proposed by the
traditional telephone companies and approved by state regulatory commissions
from time to time, which would harm Covad Communications' operating results.
On July 18, 2000, the United States Court of Appeals for the Eighth Circuit
struck down the FCC's total element long run incremental cost methodology, which
the FCC previously required state commissions to use in setting the prices for
collocation and for unbundled network elements Covad Communications purchases
from the traditional telephone companies. The court also rejected an alternative
cost methodology based on "historical costs," which was advocated by the
traditional telephone companies. In rejecting the FCC's cost methodology, the
court held that it is permissible for the FCC to prescribe a forward-looking
incremental cost methodology that is based on actual incremental costs under the
1996 Telecommunications Act.
The Eight Circuit's decision creates some additional uncertainty concerning
the prices that Covad Communications is obligated to pay the traditional
telephone companies for collocation and unbundled network elements. While the
FCC may appeal the Eighth Circuit's decision, it may also adopt new rules to
reflect the cost methodology that was approved by the Eighth Circuit. If the
decision is appealed, it is uncertain whether the Eighth Circuit's decision will
be affirmed by the United States Supreme Court. It is also uncertain whether the
FCC and the state commissions will implement a new cost methodology as a result
of this decision.
The impact of these judicial and regulatory decisions on the prices Covad
Communications pays to the traditional telephone companies for collocation and
unbundled network elements is highly uncertain. There is a risk that any new
prices set by the regulators could be materially higher than current or
currently expected prices. If Covad Communications is required to pay higher
prices to the local telephone companies for collocation and unbundled network
elements, it could have a material adverse effect on Covad Communications'
business.
THE FAILURE OF TRADITIONAL TELEPHONE COMPANIES TO ADEQUATELY PROVIDE
TRANSMISSION FACILITIES AND PROVISION TELEPHONE WIRES IS LIKELY TO IMPAIR COVAD
COMMUNICATIONS' ABILITY TO INSTALL LINES AND ADVERSELY AFFECT COVAD
COMMUNICATIONS' GROWTH RATE.
Covad Communications interconnects with and uses traditional telephone
companies' networks to service its customers. This presents a number of
challenges because Covad Communications depends on traditional telephone
companies:
o to use their technology and capabilities to meet certain
telecommunications needs of its customers and to maintain its service
standards;
o to cooperate with Covad Communications for the provision and
maintenance of transmission facilities; and
o to provide the services and network components that Covad
Communications orders, for which they depend significantly on
unionized labor. Labor issues have in the past, and may in the future,
hurt the telephone companies' performance. For example, on August 6,
2000, employees of Verizon Communications (formerly GTE and Bell
Atlantic) began a work stoppage that will impair its ability to
provision, maintain and repair the telephone lines that Covad
Communications uses to deliver its services.
Covad Communications' dependence on the traditional telephone companies has
caused and could continue to cause Covad Communications to encounter delays in
establishing Covad Communications' network and providing
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higher speed DSL services. Covad Communications relies on the traditional
telephone companies to provision telephone wires to its customers and end-users.
Covad Communications must establish efficient procedures for ordering,
provisioning, maintaining and repairing large volumes of DSL-capable lines from
the traditional telephone companies. Covad Communications must also establish
satisfactory electronic billing and payment arrangements with the traditional
telephone companies. Covad Communications may not be able to do these things in
a manner that will allow it to retain and grow its customer and end-user base.
It has been and continues to be Covad Communications' experience that, at
any given time, one or more of the traditional telephone companies will fail to
deliver the central office space, transmission facilities, telephone wires or
other elements, features and functions that Covad Communications' business
requires. For example, the traditional telephone companies currently are
significantly impairing Covad Communications' ability to efficiently install its
services, and this has adversely affected the growth in the volume of orders
Covad Communications receives. The failure of the traditional telephone
companies to consistently and adequately deliver operable telephone wires to
Covad Communications on time has significantly contributed to an increase in the
backlog of uninstalled orders. The continued inadequate performance of the
traditional telephone companies could slow the growth in Covad Communications'
revenues and reduce the growth in orders placed by Covad Communications'
customers, which could materially harm Covad Communications' business.
On November 18, 1999, the FCC decided that the traditional local telephone
companies must provide Covad Communications and other competitive local exchange
carriers with access to line sharing. This allows Covad Communications to
provide its services over the same telephone wire used by the traditional
telephone companies to provide analog voice services. The FCC has directed the
traditional local telephone companies to enter into agreements with competitors,
such as Covad Communications, and take the necessary steps to provide such
access by mid-2000. However, it is unclear whether the traditional telephone
companies will provide Covad Communications with such access in a meaningful way
this year.
Although Covad Communications has entered into interim line sharing
agreements with the major local telephone carriers, the permanent rates, terms
and conditions of line sharing access have not yet been mutually agreed to
between the traditional local phone companies and Covad Communications. Many
state commissions have not yet arbitrated disputes or set line sharing rates in
connection with failed negotiations between traditional local phone companies
and Covad Communications. The efforts of traditional local telephone companies
to provide Covad Communications with line sharing may inadvertently or
purposefully cause disruption and dislocation to Covad Communications' existing
processes for obtaining full telephone lines and Covad Communications' ability
to provide its services.
COVAD COMMUNICATIONS DEPENDS ON THE TRADITIONAL TELEPHONE COMPANIES FOR THE
QUALITY AND AVAILABILITY OF THE TELEPHONE WIRES THAT COVAD COMMUNICATIONS USES.
Covad Communications depends significantly on the quality and availability
of the traditional telephone companies' telephone wires, shared lines and the
traditional telephone companies' maintenance of such wires. Covad Communications
may not be able to obtain the telephone wires and the services Covad
Communications requires from the traditional telephone companies at satisfactory
quality levels, rates, terms and conditions. Covad Communications' inability to
do so could delay the expansion of its network and degrade the quality of its
services to its customers.
COVAD COMMUNICATIONS' BUSINESS WILL SUFFER IF ITS INTERCONNECTION
AGREEMENTS ARE NOT RENEWED OR IF THEY ARE MODIFIED ON UNFAVORABLE TERMS.
Covad Communications is required to enter into and implement
interconnection agreements in each of its targeted metropolitan statistical
areas with the appropriate traditional telephone companies in order to provide
service in those regions. Covad Communications has not yet entered into all of
the interconnection agreements it requires to complete its 165 metropolitan
statistical area build-out. Covad Communications may be unable to timely enter
into these agreements, which are a prerequisite to Covad Communications'
provision of service in those areas. Many of Covad Communications' existing
interconnection agreements have a maximum term of three years. Therefore, Covad
Communications will have to renegotiate these agreements with the traditional
telephone companies when they expire. Covad Communications may not succeed in
extending or renegotiating them on favorable terms or at all.
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As the FCC modifies, changes and implements rules related to unbundling and
collocation, Covad Communications generally has to renegotiate its
interconnection agreements with the traditional telephone companies in order to
implement those new or modified rules. Covad Communications may be unable to
timely renegotiate these agreements, or may be forced to arbitrate and litigate
terms with the traditional telephone company that fully comply with FCC rules.
As a result, although the FCC may implement rules or policies designed to speed
or improve Covad Communications' ability to provide its services, Covad
Communications may not be able to timely implement those rules or policies.
Additionally, disputes have arisen and will continue to arise in the future
as a result of differences in interpretations of the interconnection agreements.
For example, Covad Communications is in litigation proceedings with certain of
the traditional telephone companies. These disputes have delayed the deployment
of Covad Communications' network, and resolution of the litigated matters will
cause Covad Communications' ongoing expenditure of money and management time.
These disputes may have also negatively affected Covad Communications' service
to its customers and its ability to enter into additional interconnection
agreements with the traditional telephone companies in other states. In
addition, the interconnection agreements are subject to state commission, FCC
and judicial oversight. These government authorities may modify the terms of the
interconnection agreements in a way that harms Covad Communications' business.
COVAD COMMUNICATIONS' BUSINESS IS DIFFICULT TO EVALUATE BECAUSE COVAD
COMMUNICATIONS HAS A LIMITED OPERATING HISTORY.
Covad Communications was incorporated in October 1996 and introduced its
services commercially in the San Francisco Bay Area in December 1997. Because of
Covad Communications' limited operating history, you have limited operating and
financial data upon which to evaluate Covad Communications' business. You should
consider that Covad Communications has the risks of an early stage company in a
new and rapidly evolving market. To overcome these risks, Covad Communications
must:
o rapidly expand the geographic coverage of its services;
o attract and retain customers within its existing and in new
metropolitan statistical areas;
o increase awareness of its services;
o respond to competitive developments;
o continue to attract, retain and motivate qualified persons;
o continue to upgrade its technologies in response to competition and
market factors;
o manage its traditional telephone company suppliers;
o rapidly install high-speed access lines;
o effectively manage the growth of its operations; and
o deliver additional value-added services to its customers without
causing existing customers to cease reselling its services or reducing
the volume or rate of growth of sales of its services.
COVAD COMMUNICATIONS HAS A HISTORY OF LOSSES AND EXPECTS INCREASING LOSSES
IN THE FUTURE.
Covad Communications has incurred substantial losses and experienced
negative cash flow each fiscal quarter since its inception. As of June 30, 2000,
Covad Communications had an accumulated deficit of approximately $484.8 million.
Covad Communications intends to increase its capital expenditures and operating
expenses in order to expand its business. As a result, Covad Communications
expects to incur substantial additional net losses and substantial negative cash
flow for the next several years due to continued development, commercial
deployment and expansion of its network. Covad Communications may also make
investments in and acquisitions of complementary businesses to support the
growth of its business. Covad Communications' future cash requirements for
developing, deploying and enhancing its network and operating its business, as
well as its 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 its services and
the pricing of such services;
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o the level of marketing required to acquire and retain customers and to
attain a competitive position in the market place;
o the rate at which Covad Communications invests in engineering and
development and intellectual property with respect to existing and
future technology; and
o unanticipated opportunities.
In addition, Covad Communications expects its net losses to increase in the
future due to interest and amortization charges related to its 13 1/2% senior
discounted notes (the "1998 notes") due 2008, its 12 1/2% senior notes (the
"1999 notes") due 2009, its 12% senior notes due 2010 (the "2000 notes") and the
amortization charges related to its issuance of preferred stock to AT&T Ventures
and two affiliated funds, NEXTLINK Communications, Inc. and Qwest Communications
International Inc. in January 1999. For example:
o Interest and amortization charges relating to the 1998 notes were
approximately $22.3 million during the year ending December 31, 1999.
These charges will increase each year until the year ending December
31, 2004, during which period the interest and amortization charges
will be approximately $36.9 million. This increase is due to the
accretion of the 1998 notes to $260 million through March 2003.
o Interest and amortization charges relating to the 1999 notes were
approximately $24.8 million during the year ending December 31, 1999,
and will increase slightly each year to approximately $29.3 million
during the year ending December 31, 2008.
o Interest and amortization charges relating to the 2000 notes will be
approximately $48.2 million during the year ending December 31, 2000,
and will be $52.2 million each following year through the maturity of
the notes in February 2010.
o Covad Communications recorded intangible assets of $28.7 million
associated with the issuance of its preferred stock to AT&T Ventures,
NEXTLINK and Qwest. Amortization charges relating to preferred stock
issuance were approximately $8.2 million during the year ending
December 31, 1999. These amounts will result in an annual amortization
charge of approximately $8.4 million in each of the years in the
two-year period ending December 31, 2001.
COVAD COMMUNICATIONS' BUSINESS WILL SUFFER IF ITS INTERNET SERVICE
PROVIDERS, TELECOMMUNICATIONS CARRIERS AND OTHER THIRD PARTIES ARE NOT
SUCCESSFUL IN MARKETING AND SELLING ITS SERVICES.
Covad Communications primarily markets its Internet access services through
Internet service providers, telecommunications carriers and other customers for
resale to their business and consumer end-users. To date, a limited number of
Internet service providers have accounted for the significant majority of Covad
Communications' revenues. As a result, a significant reduction in the number of
end-users or revenues provided by one or more of Covad Communications' key
Internet service providers could materially harm Covad Communications' operating
results in any given period. Covad Communications expects that its Internet
service provider customers and telecommunications carriers will account for the
majority of its future market penetration and revenue growth. Covad
Communications' agreements with its customers are generally non-exclusive. Many
of Covad Communications' customers also resell services offered by Covad
Communications' competitors. In addition, a number of Covad Communications'
customers have committed to provide large numbers of end-users in exchange for
price discounts. If Covad Communications' customers do not meet their volume
commitments or otherwise do not sell its services to as many end-users as Covad
Communications expects, Covad Communications' business will suffer. In addition,
these and future relationships Covad Communications may establish with other
third parties may not result in significant line orders or revenues.
COVAD COMMUNICATIONS' OPERATING RESULTS ARE LIKELY TO FLUCTUATE IN FUTURE
PERIODS AND MAY FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS AND
INVESTORS.
Covad Communications' annual and quarterly operating results are likely to
fluctuate significantly in the future as a result of numerous factors, many of
which are outside of Covad Communications' control. These factors include:
o the timing and willingness of traditional telephone companies to
provide Covad Communications with central office space and the prices,
terms and conditions on which they make available the space to Covad
Communications;
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o the amount and timing of capital expenditures and other costs relating
to the expansion of Covad Communications' network and the marketing of
Covad Communications' services;
o delays in the commencement of operations in new regions and the
generation of revenue because certain network elements have lead times
that are controlled by traditional telephone companies and other third
parties;
o the ability to develop and commercialize new services by Covad
Communications or Covad Communications' competitors;
o the ability to order or deploy Covad Communications' services on a
timely basis to adequately satisfy end-user demand;
o Covad Communications' ability to successfully operate its network;
o the rate at which customers subscribe to Covad Communications'
services;
o decreases in the prices for Covad Communications' services due to
competition, volume-based pricing and other factors;
o Covad Communications' ability to retain Internet service provider,
enterprise and telecommunications carrier customers and limit end-user
churn rates;
o the mix of line orders between consumer end-users and business
end-users (which typically have higher margins);
o the success of Covad Communications' relationship with AT&T and other
potential third parties in generating significant end-user demand;
o the development and operation of Covad Communications' billing and
collection systems and other operational systems and processes;
o the rendering of accurate and verifiable bills by Covad
Communications' traditional telephone company suppliers and resolution
of billing disputes;
o the incorporation of enhancements, upgrades and new software and
hardware products into Covad Communications' network and operational
processes that may cause unanticipated disruptions;
o the interpretation and enforcement of regulatory developments and
court rulings concerning the 1996 Telecommunications Act,
interconnection agreements and the antitrust laws; and
o the availability of equipment and services from key vendors.
As a result, it is likely that in some future quarters Covad
Communications' operating results will be below the expectations of securities
analysts and investors. If this happens, the trading price of the Covad
Communications common stock would likely decline.
COVAD COMMUNICATIONS CANNOT PREDICT WHETHER IT WILL BE SUCCESSFUL BECAUSE
ITS BUSINESS STRATEGY IS LARGELY UNPROVEN.
Covad Communications believes that it was the first competitive
telecommunications company to widely provide high-speed Internet and network
access using DSL technology. To date, Covad Communications' business strategy
remains significantly unproven. To be successful, Covad Communications must
develop and market services that achieve broad commercial acceptance by Internet
service provider, enterprise and telecommunications carrier customers in
targeted metropolitan statistical areas. Because Covad Communications' business
and the demand for high-speed digital communications services are in the early
stages of development, Covad Communications is uncertain whether its services
will achieve broad commercial acceptance.
It is uncertain whether Covad Communications' strategy of selling and
providing its services through Internet service providers, telecommunication
carriers and others will be successful. This strategy creates marketing,
operational and other challenges and complexities that are less likely to appear
in the case of a single entity providing integrated DSL and ISP services. For
example, cable modem service providers, such as Excite@Home Corporation and Time
Warner, Inc., market, sell and provide high-speed services, Internet access and
content services on an integrated basis. Also, Covad Communications' new DSL +
IP and VBSP services may adversely affect its relationship with its current ISP
customers, since Covad Communications will be providing some of the
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services that they provide. Covad Communications does not anticipate that this
will have a substantial adverse effect on its relationship with its ISP
customers because Covad Communications will be able to provide its ISP customers
with these additional services at a lower cost than they would pay if they
developed these additional services internally.
Three recently-announced mergers and acquisitions--between America Online,
Inc. and Time Warner, Inc., between NTT and Verio and between NEXTLINK and
Concentric Network Corporation--highlight a growing trend among service
providers and telecommunications carriers to combine the marketing, selling and
provision of high-speed data transmission services, Internet access and content
services. While Covad Communications does not believe that such combined
entities providing integrated services will adversely affect its business, no
assurance can be given that such combinations will not ultimately have such an
adverse effect. Further, no assurance can be given that additional acquisitions
of Internet service providers by traditional and local competitive
telecommunications carriers, and other strategic alliances between such
entities, will not harm Covad Communications' business.
In light of Covad Communications' acquisition of Laser Link.Net, Inc. and
other changes Covad Communications has made in its business to provide Internet
access services on a wholesale basis to Internet service providers, such as
Prodigy Communications Corporation and Juno On-Line, some of its existing
Internet service provider customers may perceive Covad Communications as a
potential or actual competitor instead of as a supplier. Similarly, Covad
Communications' agreement to acquire BlueStar, which sells its services directly
to end-users, may cause Covad Communications' existing Internet service provider
customers to view Covad Communications as a competitor. Such Internet service
providers may therefore reduce the volume or the rate of growth of the sales of
Covad Communications' services, or may cease to resell its services. No
assurance can be given that its provision of additional services will not
alienate some or all of Covad Communications' existing customers and thus harm
its business.
COVAD COMMUNICATIONS MAY EXPERIENCE DECREASING PRICES FOR ITS SERVICES,
WHICH MAY IMPAIR ITS ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW.
Covad Communications may experience decreasing prices for its services due
to competition, volume-based pricing, an increase in the proportion of its
revenues generated by its consumer services and other factors. Currently, Covad
Communications charges higher prices for some of its services than some of its
competitors do for their similar services. As a result, Covad Communications
cannot assure you that its customers and their end-user customers will select
Covad Communications' services over those of its competitors. In addition,
prices for digital communications services in general have fallen historically,
and Covad Communications expects this trend to continue. Covad Communications
has provided and expects in the future to provide price discounts to customers
that commit to sell its services to a large number of their end-user customers.
Covad Communications' consumer-grade services have lower prices than its
business-grade services. As a result, expected increases in the percentage of
Covad Communications' revenues which Covad Communications derives from its
consumer services will likely reduce its overall profit margins. Covad
Communications also expects to reduce prices periodically in the future to
respond to competition and to generate increased sales volume. As a result,
Covad Communications cannot predict whether demand for its services will exist
at prices that enable Covad Communications to achieve profitability or positive
cash flow.
COVAD COMMUNICATIONS' FAILURE TO MANAGE ITS GROWTH EFFECTIVELY MAY DELAY
ITS NETWORK EXPANSION AND SERVICE ROLLOUT.
Covad Communications' strategy is to significantly expand its network
within its existing metropolitan statistical areas and to deploy its network in
substantially all of its 165 targeted metropolitan statistical areas by the end
of 2000. The execution of this strategy involves:
o obtaining the required government authorizations;
o identifying, accessing and initiating service in key central offices
within existing and target regions;
o designing, maintaining and upgrading adequate operational support,
billing and collection systems;
o obtaining central office space and maintaining connections between
central offices;
o obtaining phone lines and electronic ordering facilities from its
traditional telephone company suppliers on a timely basis; and
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o entering into and renewing interconnection agreements with the
appropriate traditional telephone companies on satisfactory terms and
conditions.
To accomplish this strategy, Covad Communications must, among other things:
o establish a marketing strategy to acquire a substantial number of
customers and end-users;
o continue to implement and improve its operational, financial and
management information systems, including its client ordering,
provisioning, dispatch, trouble ticketing and other operational
systems as well as its billing, accounts receivable and payable
tracking, collection, fixed assets and other financial management
systems;
o hire and train additional qualified management and technical
personnel;
o manage and resolve any disputes which may arise with its traditional
telephone company suppliers;
o establish and maintain relationships with third parties to market
and sell Covad Communications' services, install network equipment and
provide field service; and
o continue to expand and upgrade its network infrastructure.
Covad Communications may be unable to do these things successfully. As a
result, Covad Communications may be unable to deploy its network as scheduled,
deploy its services in a timely manner or achieve the operational growth
necessary to achieve its business strategy.
Covad Communications' growth has placed, and is expected to continue to
place, significant demands on its management and operational resources. Covad
Communications expects to continue to significantly increase its employee base
to support the deployment of its network. Covad Communications also expects to
implement system upgrades, new software systems and other enhancements, which
could cause disruption and dislocation in its business. If Covad Communications
is successful in implementing its marketing strategy, Covad Communications may
have difficulty responding to demand for its services and technical support in a
timely manner and in accordance with its customers' expectations. Covad
Communications expects these demands to require the addition of new management
personnel and the increased outsourcing of company functions to third parties.
Covad Communications may be unable to do this successfully, in which case Covad
Communications could experience a reduction in the growth of its line orders
and, therefore, its revenues.
In February to March 2000, Covad Communications deployed new software
systems that caused some disruption to its business while enhancing the
productivity and efficiency of certain operational practices. Future changes in
Covad Communications' processes that it introduces or is required to introduce
as a result of its arrangements with the traditional telephone companies could
cause similar or more serious disruption to Covad Communications' ability to
provide its services and to its overall business.
Thus far Covad Communications has electronically linked its own ordering
software systems to the software systems of five of the traditional telephone
companies. Such electronic linkage is essential for Covad Communications to
successfully place a large volume of orders for access to telephone wires. There
can be no assurance that Covad Communications will be successful in
electronically linking its software system to those of all of the traditional
telephone companies who Covad Communications relies on for the supply of access
to their telephone wires. Even if Covad Communications has such electronic
links, Covad Communications cannot assure you that it will be able to process
all of its orders through such electronic links, which would require additional
human intervention. Covad Communications' failure to electronically link its
systems with those of all major traditional telephone companies would severely
harm its ability to provide its services in large volume to its customers.
THE MARKETS COVAD COMMUNICATIONS FACES ARE HIGHLY COMPETITIVE AND COVAD
COMMUNICATIONS MAY NOT BE ABLE TO COMPETE EFFECTIVELY, ESPECIALLY AGAINST
ESTABLISHED INDUSTRY COMPETITORS WITH SIGNIFICANTLY GREATER FINANCIAL RESOURCES.
The markets Covad Communications faces for business and consumer Internet
access and remote LAN access services are intensely competitive. Covad
Communications expects that these markets will become increasingly competitive
in the future. In addition, the traditional telephone companies dominate the
current market and have a monopoly on telephone wires. Covad Communications
poses a competitive risk to the traditional telephone companies and, as both
Covad Communications' competitors and its suppliers, they have the ability and
the
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motivation to harm its business. Covad Communications also faces competition
from cable modem service providers, competitive telecommunications companies,
traditional and new national long distance carriers, Internet service providers,
on-line service providers and wireless and satellite service providers. Many of
these competitors have longer operating histories, greater name recognition,
better strategic relationships and significantly greater financial, technical or
marketing resources than Covad Communications does. As a result, these
competitors:
o 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 Covad Communications can;
o may form new alliances and rapidly acquire significant market share;
and
o 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.
The intense competition from Covad Communications' competitors, including
the traditional telephone companies, the cable modem service providers and the
competitive telecommunications companies could harm Covad Communications'
business.
The traditional telephone companies represent the dominant competition in
all of Covad Communications' target service areas, and Covad Communications
expects this competition to intensify. For example, they 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 telephone
wires and can bundle digital data services with their existing analog voice
services to achieve economies of scale in serving customers. Certain of the
traditional telephone companies have aggressively priced their consumer DSL
services as low as $19-$29 per month, placing pricing pressure on Covad
Communications' TeleSurfer services. While Covad Communications may be allowed
to provide its data services over the same telephone wires that they provide
analog voice services, it may be unable to obtain this ability. Even if Covad
Communications does obtain this ability, there can be no assurance that it will
be permitted to provide its services in this manner without running into
operational or technical obstacles, including those created by the traditional
telephone companies. Further, they can offer service to end-users from certain
central offices where Covad Communications is unable to secure central office
space and offer service. In addition, mergers involving the traditional
telephone companies, such as the merger between Verizon Communications and
NorthPoint Communications, may further the traditional telephone companies'
efforts to compete with Covad Communications since the combined entities will
benefit from the resources of the traditional telephone company. Accordingly,
Covad Communications may be unable to compete successfully against the
traditional telephone companies.
Cable modem service providers, such as Excite@Home Corporation and
MediaOne, the broadband services arm of MediaOne Group (formerly U S West Media
Group), and their respective cable partners, are deploying high-speed Internet
access services over coaxial cable networks. Where deployed, these networks
provide similar, and in some cases, higher-speed Internet access and RLAN access
than Covad Communications provides. They also offer these services at lower
price points than Covad Communications' TeleSurfer services. As a result,
competition with the cable modem service providers may have a significant
negative effect on Covad Communications' ability to secure customers and may
create downward pressure on the prices Covad Communications can charge for its
services.
Many competitive telecommunications companies offer high-speed data
services using a business strategy similar to Covad Communications. Some of
these competitors have begun offering DSL-based access services and others are
likely to do so in the future. In addition, some competitive telecommunications
companies have extensive fiber networks in many metropolitan areas primarily
providing high-speed digital and voice circuits to large corporations, and have
interconnection agreements with traditional telephone companies pursuant to
which they have acquired central office space in many of Covad Communications'
existing and target markets. Further, certain of Covad Communications' customers
have made investments in Covad Communications' competitors. As a result of these
factors, Covad Communications may be unsuccessful in generating a significant
number of new customers or retaining existing customers.
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COVAD COMMUNICATIONS' LEVERAGE IS SUBSTANTIAL AND WILL INCREASE, MAKING IT
MORE DIFFICULT TO RESPOND TO CHANGING BUSINESS CONDITIONS.
As of June 30, 2000, Covad Communications had approximately $828.9 million
of long-term obligations (including current portion), which consists primarily
of the 1998 notes, the 1999 notes and the 2000 notes. Because the 1998 notes
accrete to $260 million through March 2003, Covad Communications will become
increasingly leveraged until then, whether or not it incurs new indebtedness in
the future. Covad Communications may also incur additional indebtedness in the
future, subject to certain restrictions contained in the indentures governing
the 1998 notes, the 1999 notes and the 2000 notes, to finance the continued
development, commercial deployment and expansion of its network and for funding
operating losses or to take advantage of unanticipated opportunities. The degree
to which Covad Communication is leveraged could have important consequences. For
example, it could:
o materially limit or impair Covad Communications' ability to obtain
additional financing or refinancing in the future for working capital,
capital expenditures, acquisitions, general corporate purposes or
other purposes;
o require Covad Communications to dedicate a substantial portion of its
cash flow to the payment of principal and interest on its
indebtedness, which reduces the availability of cash flow to fund
working capital, capital expenditures, acquisitions, general corporate
matters or other matters;
o limit Covad Communications' ability to redeem the 1998 notes, the 1999
notes and the 2000 notes in the event of a change of control; and
o increase Covad Communications' vulnerability to economic downturns,
limit its ability to withstand competitive pressures and reduce its
flexibility in responding to changing business and economic
conditions.
COVAD COMMUNICATIONS WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH TO SERVICE
ITS INDEBTEDNESS; ITS ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND
ITS CONTROL.
Covad Communications expects to continue to generate substantial net losses
and negative cash flow for at least the next several years. Covad Communications
may be unable to maintain a level of cash flow from operations sufficient to
permit it to pay the principal and interest on its current indebtedness or any
additional indebtedness it may incur. The 1998 notes accrete to $260 million
through March 2003, and Covad Communications must begin paying cash interest on
those notes in September 2003. Covad Communications has provided for the first
six payments on the 1999 notes by setting aside approximately $74.1 million in
government securities to fund such payments. Covad Communications began paying
cash interest on the 1999 notes in August 1999 and will begin paying cash
interest on the 2000 notes in August 2000. Covad Communications' ability to make
scheduled payments with respect to indebtedness will depend upon, among other
things:
o its ability to achieve significant and sustained growth in cash flow;
o the rate and success of the commercial deployment of its network;
o successful operation of its network;
o the market acceptance, customer demand, rate of utilization and
pricing for its services;
o its ability to successfully complete development, upgrades and
enhancements of its network; and
o its ability to complete additional financings, as necessary.
Each of these factors is affected by economic, financial, competitive and
other factors, many of which are beyond its control. If Covad Communications is
unable to generate sufficient cash flow to service its indebtedness, it may have
to reduce or delay network deployments, restructure or refinance its
indebtedness or seek additional equity capital, strategies that may not enable
it to service and repay it indebtedness. Any failure to satisfy its obligations
with respect to the 1998 notes, the 1999 notes or the 2000 notes at or before
maturity would be a default under the related indentures and could cause a
default under agreements governing its other indebtedness. If such defaults
occur, the holders of the indebtedness would have enforcement rights, including
the right to accelerate payment of the entire amount of the debt and the right
to commence an involuntary bankruptcy proceeding against Covad Communications.
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COVAD COMMUNICATIONS' INTELLECTUAL PROPERTY PROTECTION MAY BE INADEQUATE TO
PROTECT ITS PROPRIETARY RIGHTS, AND COVAD COMMUNICATIONS MAY BE SUBJECT TO
INFRINGEMENT CLAIMS.
Covad Communications regards certain aspects of its products, services and
technology as proprietary. Covad Communications attempts to protect them with
patents, copyrights, trademarks, trade secret laws, restrictions on disclosure
and other methods. These methods may not be sufficient to protect its
technology. Covad Communications 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 its products, services or technology without
authorization, or to develop similar technology independently.
Currently, Covad Communications has been issued one patent and has a number
of additional patent applications pending. Covad Communications intends to
prepare additional applications and to seek patent protection for its systems
and services. These patents may not be issued to Covad Communications. If
issued, they may not protect its intellectual property from competition.
Competitors could seek to design around or invalidate these patents.
Effective patent, copyright, trademark and trade secret protection may be
unavailable or limited in certain foreign countries. The global nature of the
Internet makes it virtually impossible to control the ultimate destination of
Covad Communications' proprietary information. The steps that Covad
Communications has taken may not prevent misappropriation or infringement of its
technology. Litigation may be necessary in the future to enforce its
intellectual property rights, to protect its 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 harm Covad
Communications' business.
In addition, others may sue Covad Communications with respect to
infringement of their intellectual property rights. Last year Covad
Communications was sued by Bell Atlantic for an alleged infringement of a patent
issued to them in September 1998 entitled "Variable Rate and Variable Mode
Transmission System." Although a court recently held that Covad Communications
does not infringe Bell Atlantic's patent, Bell Atlantic has filed a notice of
appeal with respect to the court's ruling. As litigation is inherently
unpredictable, there can be no guarantee that Covad Communications will prevail
on an appeal of this ruling. An unfavorable outcome on appeal of this ruling, or
in any other lawsuit that may be brought against Covad Communications, could
limit its ability to provide all its services and require Covad Communications
to pay damages, which could significantly harm its business.
COVAD COMMUNICATIONS WILL NEED ADDITIONAL FUNDS IN THE FUTURE IN ORDER TO
CONTINUE TO GROW ITS BUSINESS.
Covad Communications believes its current capital resources will be
sufficient for its funding and working capital requirements for the deployment
and operation of its network into the second quarter of 2001. Thereafter, Covad
Communications will be required to raise additional capital through the issuance
of debt or equity financings. Covad Communications may choose to raise
additional capital sooner, depending on market conditions. The actual amount and
timing of its future capital requirements will depend upon a number of factors,
including:
o the number of geographic areas targeted and entered and the timing of
entry and services offered;
o network deployment schedules and associated costs;
o the rate at which customers and end-users purchase Covad
Communications' 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 each region Covad Communications
enters;
o the rate at which Covad Communications invests in engineering and
development and intellectual property with respect to existing and
future technology; and
o investment opportunities in complementary businesses, acquisitions or
other opportunities.
Covad Communications also may be unsuccessful in raising sufficient capital
at all or on terms that it considers acceptable. If this happens, its ability to
continue to expand its business or respond to competitive developments would be
impaired.
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In addition, indentures governing Covad Communications' existing
indebtedness contain covenants that may restrict its business activities and its
ability to raise additional funds. As a result, Covad Communications may not be
able to undertake certain activities which management believes are in its best
interest to develop its business. Covad Communications also may be unable to
raise as much additional funding through the issuance of debt securities as it
may need in the future. This could require Covad Communications to raise funding
through the issuance of equity securities or amend its indentures, which it may
be unable to do on acceptable terms.
THE SCALABILITY AND SPEED OF COVAD COMMUNICATIONS' NETWORK REMAIN LARGELY
UNPROVEN.
As of June 30, 2000, Covad Communications had deployed its network in a
total of 81 metropolitan statistical areas, many of which have been deployed
only in the last several months. As a result, the ability of its DSL networks
and operational support systems to connect and manage a substantial number of
online end-users at high speeds is still unknown. Consequently, there remains a
risk that Covad Communications may not be able to scale its network and
operational support systems up to its expected end-user numbers while achieving
superior performance. Peak digital data transmission speeds currently offered
across its DSL networks are 1.5 megabits per second downstream. However, the
actual data transmission speeds over its network could be significantly slower
and will depend on a variety of factors, including:
o the type of DSL technology deployed;
o the distance an end-user is located from a central office;
o the configuration of the telecommunications line being used;
o quality of the telephone wires provisioned by traditional telephone
companies; and
o Covad Communications' operational support systems which manage its
network.
As a result, Covad Communications' network may be unable to achieve and
maintain the highest possible digital transmission speed. Covad Communications'
failure to achieve or maintain high-speed digital transmissions would
significantly reduce customer and end-user demand for its services.
INTERFERENCE IN THE TRADITIONAL TELEPHONE COMPANIES' COPPER PLANT COULD
DEGRADE THE PERFORMANCE OF COVAD COMMUNICATIONS' SERVICES.
Certain tests indicate that some types of DSL technology may cause
interference with, and be interfered with by other signals present in a
traditional telephone company's copper plant, usually with lines in close
proximity. In addition, as Covad Communications continues to implement line
sharing with the traditional local telephone companies, its deployment of its
ADSL data services could interfere with the voice services of the traditional
local telephone companies carried over the same line or adjacent lines. If it
occurs, such interference could cause degradation of performance of its services
or the services of the traditional local telephone companies and render Covad
Communications unable to offer its services on selected lines. The amount and
extent of such interference will depend on the condition of the traditional
telephone company's copper plant and the number and distribution of DSL and
other signals in such plant, which cannot now be ascertained.
When interference occurs, it is difficult to detect. The procedures to
resolve interference issues between competitive telecommunications companies and
traditional telephone companies are still being developed and may not be
effective. In the past Covad Communications has agreed to interference
resolution procedures with certain traditional telephone companies. However,
Covad Communications may be unable to successfully negotiate similar procedures
with other traditional telephone companies in future interconnection agreements
or in renewals of existing interconnection agreements. In addition, the failure
of the traditional telephone companies to take timely action to resolve
interference issues could harm the provision of Covad Communications' services.
If its TeleSpeed(TM) and TeleSurfer services cause widespread network
degradation or are perceived to cause that type of interference, actions by the
traditional telephone companies or state or federal regulators could harm Covad
Communications' reputation, brand image, service quality, customer satisfaction
and retention, and overall business. Moreover, ostensible interference concerns
have in the past been, continue to currently, and may in the future be, used by
the traditional telephone companies as a pretext to delay the deployment of
Covad Communications' services and otherwise harm its business.
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A SYSTEM FAILURE COULD DELAY OR INTERRUPT SERVICE TO COVAD COMMUNICATIONS'
CUSTOMERS.
Covad Communications' operations depend 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 Covad Communications' network operations center or any of its
regional data centers could cause interruptions in its services. Additionally,
failure of a traditional telephone company or other service provider, such as
competitive telecommunications companies, to provide communications capacity
that Covad Communications requires, as a result of a natural disaster,
operational disruption any other reason, could cause interruptions in Covad
Communications' services. Any damage or failure that causes interruptions in
Covad Communications' operations could harm its business.
A BREACH OF NETWORK SECURITY COULD DELAY OR INTERRUPT SERVICE TO COVAD
COMMUNICATIONS' CUSTOMERS.
Covad Communications' network may be vulnerable to unauthorized access,
computer viruses and other disruptive problems. Internet service provider,
telecommunications carrier 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 Covad
Communications' customers and the customers' end-users. This might result in
liability to Covad Communications' customers and also might deter potential
customers. Covad Communications intends to implement security measures that are
standard within the telecommunications industry as well as newly developed
security measures. Covad Communications has not done so yet and may not
implement such measures in a timely manner. Moreover, if and when implemented,
such measures may be circumvented. Eliminating computer viruses and alleviating
other security problems may require interruptions, delays or cessation of
service to Covad Communications' customers and such customers' end-users, which
could harm Covad Communications' business.
COVAD COMMUNICATIONS DEPENDS ON A LIMITED NUMBER OF THIRD PARTIES FOR
EQUIPMENT SUPPLY SERVICE AND INSTALLATION.
Covad Communications relies on outside parties to manufacture its network
equipment and provide certain network services. These services and equipment
include:
o digital subscriber line access multiplexers;
o customer premise equipment modems;
o network routing and switching hardware;
o network management software;
o systems management software;
o database management software;
o collocation space; and
o Internet connectivity and Internet protocol services.
As Covad Communications signs additional service contracts, it will need to
increase significantly the amount of manufacturing and other services supplied
by third parties in order to meet its contractual commitments. For example,
Covad Communications has a service arrangement with Lucent Technologies Inc. to
assist Covad Communications in installing its central office facilities and
associated equipment.
Covad Communications has in the past experienced supply problems with
certain of its vendors. These vendors may not be able to meet Covad
Communications' needs in a satisfactory and timely manner in the future. In
addition, Covad Communications may not be able to obtain additional vendors when
needed. Covad Communications has identified alternative suppliers for
technologies that it considers critical. However, it could take Covad
Communications a significant period of time to establish relationships with
alternative suppliers for critical technologies and substitute their
technologies into its network.
Covad Communications' reliance on third-party vendors involves additional
risks, including:
o the absence of guaranteed capacity; and
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o reduced control over delivery schedules, quality assurance, production
yields and costs.
The loss of any of Covad Communications' relationships with these suppliers
could harm its business.
COVAD COMMUNICATIONS' SUCCESS DEPENDS ON ITS RETENTION OF CERTAIN KEY
PERSONNEL, ITS ABILITY TO HIRE ADDITIONAL KEY PERSONNEL AND THE MAINTENANCE OF
GOOD LABOR RELATIONS.
Covad Communications depends on the performance of its executive officers
and key employees. In particular, its senior management has significant
experience in the data communications, telecommunications and personal computer
industries, and the loss of any of them, in particular Robert Roblin, Tim Laehy
and Robert Grant, could negatively affect its ability to execute its business
strategy. Additionally, Covad Communications does not have "key person" life
insurance policies on any of its employees.
Covad Communications' future success also depends on its continuing ability
to identify, hire, train and retain other highly qualified technical, sales,
marketing, legal 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. This
is particularly the case in software development, network engineering and
product management. Covad Communications also may be unable to attract,
assimilate or retain other highly qualified technical, operations, sales,
marketing and managerial personnel, which could hurt its business. In addition,
in the event that Covad Communications' employees unionize, it could incur
higher ongoing labor costs and disruptions in its operations in the event of a
strike or other work stoppage.
COVAD COMMUNICATIONS HAS MADE AND MAY MAKE ACQUISITIONS OF COMPLEMENTARY
TECHNOLOGIES OR BUSINESSES IN THE FUTURE, WHICH MAY DISRUPT ITS BUSINESS AND BE
DILUTIVE TO ITS EXISTING STOCKHOLDERS.
In addition to its acquisition of Laser Link.Net, Inc. and its agreement to
acquire BlueStar, Covad Communications intends to consider acquisitions of
businesses and technologies in the future on an opportunistic basis.
Acquisitions of businesses and technologies involve numerous risks, including
the diversion of management attention, difficulties in assimilating the acquired
operations, loss of key employees from the acquired company, and difficulties in
transitioning key customer relationships. In addition, these acquisitions may
result in dilutive issuances of equity securities, the incurrence of additional
debt, large one-time expenses and the creation of goodwill or other intangible
assets that result in significant amortization expense. Any of these factors
could materially harm Covad Communications' business or its operating results in
a given period.
AN ECONOMIC DOWNTURN COULD ADVERSELY IMPACT DEMAND FOR COVAD
COMMUNICATIONS' SERVICES.
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 Covad Communications' services. Any such
decline or concern about an imminent decline could delay decisions among certain
of Covad Communications' customers to roll out Covad Communications' services or
could delay decisions by prospective customers to make initial evaluations of
Covad Communications' services. Such delays would have a material adverse effect
on Covad Communications' business, prospects, operating results and financial
condition.
COVAD COMMUNICATIONS' STOCK PRICE HAS BEEN AND IS LIKELY TO CONTINUE TO BE
VOLATILE.
The trading price of Covad Communications' common stock has been and is
likely to continue to be highly volatile. Covad Communications' stock price
could fluctuate widely in response to factors such as the following:
o actual or anticipated variations in quarterly operating results,
including the pace of the expansion of its business;
o announcements of new products or services by Covad Communications or
its competitors or new competing technologies;
o the addition or loss of ISP or enterprise customers or subscribers;
o changes in financial estimates or recommendations by securities
analysts;
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o the adoption of new, or changes in existing, accounting rules,
guidelines and practices, which may materially impact Covad
Communications' financial statements and may materially alter the
expectations of securities analysts or investors;
o conditions or trends in the telecommunications industry, including
regulatory developments;
o growth of the Internet and online commerce industries;
o announcements by Covad Communications of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
o additions or departures of key personnel;
o future equity or debt offerings or Covad Communications' announcements
of such offerings;
o general market and general economic conditions; and
o other events or factors, many of which are beyond Covad
Communications' control.
Covad Communications is currently aware of a Staff Accounting Bulletin
entitled SAB 101 "Revenue Recognition in Financial Statements", which was issued
in December 1999 by the SEC. 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 Covad
Communications' fiscal year. The SEC intends to issue further definitive
guidance on the implementation of SAB 101. When and if that guidance is
received, Covad Communications will fully evaluate this guidance and respond and
comply accordingly. If SAB 101 is implemented and its implementation is contrary
to Covad Communications' current practice, it may have an adverse effect on
Covad Communications' financial statements.
FUTURE SALES OF COVAD COMMUNICATIONS COMMON STOCK MAY DEPRESS ITS STOCK
PRICE.
Sales of a substantial number of shares of Covad Communications common
stock in the public market, or the appearance that such shares will be available
for sale, could adversely affect the market price for Covad Communications
common stock. As of August 1, 2000, Covad Communications had 154,770,567 shares
of common stock outstanding.
A significant number of these shares are not currently publicly traded but
are available for immediate resale to the public, subject to certain volume
limitations under the securities laws and lock-up arrangements. Covad
Communications also has 32,383,377 shares of its common stock reserved for
issuance pursuant to options under its 1997 Stock Plan, of which 25,700,808
shares were subject to outstanding options at August 1, 2000. Covad
Communications has reserved 1,006,050 shares of its common stock for issuance
pursuant to options it assumed in connection with its acquisition of Laser
Link.Net. Covad Communications has also reserved 1,732,716 shares of common
stock for issuance under its 1998 Employee Stock Purchase Plan as of August 1,
2000. Shares underlying vested options are generally eligible for immediate
resale in the public market. In addition, a significant portion of Covad
Communications' stockholders have registration rights with respect to their
shares.
ANTITAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS, DELAWARE LAW,
COVAD COMMUNICATIONS' INDENTURES AND STOCKHOLDER PROTECTION RIGHTS PLAN COULD
LIMIT COVAD COMMUNICATIONS' ABILITY TO BE ACQUIRED.
Covad Communications' 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 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 Covad
Communications' outstanding voting stock. Covad Communications' charter and
bylaws provide for a classified board of directors, limitations on the ability
of stockholders to call special meetings and act by written consent, the lack of
cumulative voting for directors and procedures for advance notification of
stockholder nominations and proposals. These provisions, as well as Section 203
under the Delaware General Corporation Law to which Covad Communications is
subject, could discourage potential acquisition proposals and could delay or
prevent a change of control.
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The indentures relating to the 1998 notes, 1999 notes and 2000 notes
provide that, in the event of certain changes in control, each holder of the
notes will have the right to require Covad Communications to repurchase such
holder's notes at a premium over the aggregate principal amount or the accreted
value, as the case may be, of such debt. In addition, Covad Communications'
Stockholder Protection Rights Plan contains provisions that make a hostile
takeover prohibitively expensive and, in effect, requires interested suitors to
cooperate with the board of directors prior to acquiring more than 15% of Covad
Communications. There can be no guarantee that the Stockholder Protection Rights
Plan will not discourage takeover attempts which would otherwise result in a
premium to Covad Communications' stockholders.
The provisions in the charter, bylaws, indentures and Stockholder
Protection Rights Plan could have the effect of discouraging others from making
tender offers for Covad Communications' shares and, as a consequence, they also
may inhibit increases in the market price of Covad Communications' shares that
could result from actual or rumored takeover attempts. Such provisions also may
have the effect of preventing changes in Covad Communications' management.
COVAD COMMUNICATIONS' FAILURE AND THE FAILURE OF THIRD PARTIES TO BE YEAR
2000 COMPLIANT COULD NEGATIVELY IMPACT ITS BUSINESS.
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.
Covad Communications has reviewed its internally developed information
technology systems and programs and believes that its systems are Year 2000
compliant and that there are not significant Year 2000 issues within its systems
or services. Covad Communications 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. Covad Communications 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, Covad
Communications utilizes third-party equipment and software and interacts with
traditional telephone companies that have equipment and software that may not be
Year 2000 compliant. Failure of such third-party or traditional telephone
company equipment or software to operate properly with regard to the year 2000
and thereafter could require Covad Communications to incur unanticipated
expenses to remedy any problems, which could have a material adverse effect on
its business, prospects, operating results and financial condition.
To date, Covad Communications has not experienced any problems in complying
with Year 2000 requirements, nor has it experienced any operational difficulties
related to Year 2000 issues.
THE BROADBAND COMMUNICATIONS INDUSTRY IS UNDERGOING RAPID TECHNOLOGICAL
CHANGES, AND NEW TECHNOLOGIES MAY BE SUPERIOR TO THE TECHNOLOGY COVAD
COMMUNICATIONS USES.
The broadband communications industry is subject to rapid and significant
technological change, including continuing developments in DSL technology, which
does not presently have widely accepted standards, and alternative technologies
for providing broadband communications, such as cable modem technology. As a
consequence:
o Covad Communications will rely on third parties, including some of its
competitors and potential competitors, to develop and provide it with
access to communications and networking technology;
o Covad Communications' success will depend on its ability to anticipate
or adapt to new technology on a timely basis; and
o Covad Communications expects that new products and technologies will
emerge that may be superior to, or may not be compatible with, its
products and technologies.
If Covad Communications fails to adapt successfully to technological
changes or fails to obtain access to important technologies, its business will
suffer.
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COVAD COMMUNICATIONS' STRATEGY DEPENDS ON GROWTH IN DEMAND FOR DSL-BASED
SERVICES.
The market for high-speed Internet and RLAN access is in the early stages
of development. As a result, Covad Communications cannot predict the rate at
which demand will grow, if at all, or whether new or increased competition will
result in satisfying all demand. Various providers of high-speed digital
communications services are testing products from various suppliers for various
applications. Covad Communications does not know whether DSL will offer the same
or more attractive price-performance characteristics. 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 demand for Covad
Communications' services grows more slowly than Covad Communications anticipates
or is satisfied by competitors, its ability to achieve revenue growth and
positive cash flow will be harmed.
COVAD COMMUNICATIONS MUST COMPLY WITH FEDERAL AND STATE TAX AND OTHER
SURCHARGES ON ITS SERVICE THE LEVELS OF WHICH ARE UNCERTAIN.
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 Covad Communications' 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. The FCC is currently considering the jurisdictional
nature of ISP-bound traffic as a result of a March 24, 2000 decision by the U.S.
Court of Appeals for the D.C. Circuit related to the jurisdictional nature of
analog, dial-up traffic to the Internet. A change in the characterization of
their jurisdictions could cause Covad Communications' payment obligations,
pursuant to the relevant surcharges, to increase. In addition, pursuant to
periodic revisions by state and federal regulators of the applicable surcharges,
Covad Communications may be subject to increases in the surcharges and fees
currently paid. Also, a determination of the jurisdictional nature of Covad
Communications' DSL services may require it to commit additional resources to
regulatory compliance, such as tariff filings.
COVAD COMMUNICATIONS' SERVICES ARE SUBJECT TO GOVERNMENT REGULATION, AND
CHANGES IN CURRENT OR FUTURE LAWS OR REGULATIONS COULD ADVERSELY AFFECT ITS
BUSINESS.
Covad Communications' services are subject to federal, state and local
government regulations. The 1996 Telecommunications 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 Covad Communications operates. The 1996 Telecommunications 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 Telecommunications act removes barriers to
entry in the local telecommunications markets by preempting state and local laws
that restrict competition by providing competitors interconnection, access to
unbundled network elements, collocation and retail services at wholesale rates.
The FCC's primary rules interpreting the 1996 Telecommunications Act were issued
on August 8, 1996. These rules have been reviewed by the U.S. Court of Appeals
for the Eighth Circuit, the U.S. Court of Appeals for the D.C. Circuit, and the
U.S. Supreme Court. The U.S. Supreme Court overruled the Eighth Circuit in
January 1999 and upheld most of the FCC rules. On November 5, 1999, the FCC
implemented unbundling rules that responded to the Supreme Court's January 1999
decision. Currently pending before the Eighth Circuit is the legality of the
FCC's decision to require traditional telephone companies to sell unbundled
network elements to companies like Covad Communications at total element,
long-run incremental cost. An adverse decision in that proceeding could increase
the amount Covad Communications must pay for copper wires, transport links and
collocation.
Since August 1996, the FCC has proposed and adopted further rules related
to Covad Communications' ability to obtain access to unbundled network elements
and other services.
In August 1998, the FCC stated that its rules required traditional local
telephone companies to provide Covad Communications' access to copper wires in
order to provide "advanced services", such as its DSL services. In that same
proceeding, the FCC proposed new rules that would allow traditional telephone
companies to provide their own DSL services free from traditional telephone
company regulation through a separate affiliate. The provision of DSL services
by an affiliate of a traditional telephone company not subject to such
regulation could harm Covad Communications' business. The FCC has not
implemented such separate affiliate rules as of this date. However, the
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FCC, in approving the merger of SBC and Ameritech in October 1999, required
SBC/Ameritech to create such an affiliate throughout the SBC/Ameritech service
territory. In June 2000, Bell Atlantic and GTE were ordered by the FCC to create
such an affiliate in the context of their merger. The FCC requires SBC/Ameritech
and Bell Atlantic/GTE to provide all of their in-region DSL services through
this "separate affiliate".
In March 1999, the FCC revised its collocation and unbundled network
element rules, in order to facilitate the deployment of advanced services by
companies like Covad Communications. In March 2000, the U.S. Circuit Court for
the D.C. Circuit struck portions of the FCC's new collocation rules and has
required the FCC to reconsider and review those rules. In particular, the D.C.
Circuit required the FCC to revise its rules concerning the types of equipment
that Covad Communications may collocate on the traditional telephone company
premises, the method in which Covad Communications may be permitted to connect
that equipment to other new entrants, and the steps that traditional telephone
companies may take to separate their equipment from Covad Communications'
equipment. The traditional telephone companies may implement the court's ruling
and any subsequent FCC rules in a manner that impairs Covad Communications'
ability to obtain collocation space and collocate the equipment of Covad's
choice on their premises. Such actions by the traditional telephone companies
could adversely affect Covad Communications' business and disrupt its existing
network design, configuration and services.
In November 1999, the FCC ruled that traditional local telephone companies
must provide access to "line-sharing" on an unbundled basis. Line-sharing
permits Covad Communications to provide a DSL service on the same telephone wire
in which an end-user has analog, local telephone service. Only certain DSL
technologies, such as asymmetrical DSL, or ADSL, are designed to work on the
same line as analog telephone service. Most traditional telephone companies
provide ADSL service exclusively over line-sharing. Without access to
line-sharing, Covad Communications has to have the traditional telephone company
install an additional telephone line to an end-user's premises. Without
line-sharing, Covad Communications may not be able to provide a product that is
competitive with the traditional telephone company's offering. A group of
traditional telephone companies has appealed this decision, and an adverse
result in that court proceeding could harm Covad Communications' business.
Covad Communications has not entered into interconnection agreements that
take full advantage of these new federal rules. Covad Communications anticipates
that traditional telephone companies will challenge these new rules in
regulatory proceedings and in court. In addition, Covad Communications
anticipates that traditional telephone companies will resist full implementation
of these federal and state rules. Any unfavorable decisions by the courts, the
FCC or state telecommunications regulatory commissions could harm Covad
Communications' business. In addition, a failure to enforce these rules by the
appropriate court, FCC or state authority in a timely basis could slow down
Covad Communications' deployment of services or could otherwise harm its
business.
Changes to current regulations, the adoption of new regulations by the FCC
or state regulatory authorities, court decisions, or legislation, such as
changes to the 1996 Telecommunications Act, could harm Covad Communications'
business. In particular, several bills pending before the 106th Congress,
including H.R. 2420, H.R. 1686 and S. 877, would directly harm Covad
Communications business by taking away some of the legal rights Covad
Communications has to unbundled network elements and collocation, or by
diminishing the incentive the traditional telephone companies have to provide
Covad Communications the elements, collocation and services Covad Communications
needs to provide its services. Passage of any of these bills or similar
legislation would adversely and significantly harm Covad Communications'
business, and may cause it to eliminate or even disconnect certain services to
particular end-users. In addition, passage of any of these bills may cause Covad
Communications to disrupt and change its existing network design and
configuration.
SPECIAL NOTE REGARDING 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. Examples of such forward-looking
statements include but are not limited to:
o its plans to expand its existing networks or to commence service in
new metropolitan statistical areas;
o estimates regarding the timing of launching its service in new
metropolitan statistical areas;
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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 its service;
o expectations regarding its relationships with its strategic partners
and other potential third parties;
o expectations as to pricing for its services in the future;
o expectations as to the impact of its TeleSurfer service offerings on
its margins;
o the possibility that Covad Communications may obtain significantly
increased sales volumes;
o the impact of its national advertising campaign on brand recognition
and operating results;
o 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 its anticipated capital expenditures;
o plans to enter into business arrangements with broadband-related
service providers;
o expectations regarding the commencement of its voice service;
o the effect of regulatory reform and regulatory litigation; and
o other statements contained in this prospectus regarding matters that
are not historical facts.
These statements are only estimates or predictions and cannot be relied
upon. Covad Communications can give you no assurance that future results will be
achieved. Actual events or results may differ materially as a result of risks
facing Covad Communications 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 Covad Communications' ability
to:
o successfully market its services to current and new customers;
o generate customer demand for its services in the particular regions
where Covad Communications plans to market services;
o achieve favorable pricing for its services;
o respond to increasing competition;
o manage growth of its operations; and
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.
All written and oral forward-looking statements made in connection with
this prospectus which are attributable to Covad Communications or persons acting
on its behalf are expressly qualified in their entirety by the "Risk Factors"
and other cautionary statements included in this prospectus. Covad
Communications disclaims any obligation to update information contained in any
forward-looking statement.
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ACTION TO BE TAKEN BY WRITTEN CONSENT
TIMING
All written consents must be received at Five Corporate Centre, Suite 600,
801 Crescent Centre Drive, Franklin, Tennessee by September 11, 2000 to be
counted toward approval of the merger.
MATTERS TO BE APPROVED BY WRITTEN CONSENT
In the action to be taken by written consent, stockholders of BlueStar will
be asked to approve:
o the merger, the merger agreement and the form of escrow agreement and
the appointment of Christopher Lord as the BlueStar stockholders'
agent under the merger agreement and the escrow agreement.
EXCEPT FOR RICHARD A. SHAPERO AND CHARLES J. MCMINN (WHO RECUSED THEMSELVES
FROM THE BOARD OF DIRECTORS' DELIBERATIONS AND VOTE DUE TO THEIR AFFILIATION
WITH COVAD COMMUNICATIONS), THE BLUESTAR BOARD OF DIRECTORS HAS, BY UNANIMOUS
VOTE, APPROVED THE MERGER AGREEMENT, THE FORM OF ESCROW AGREEMENT, THE MERGER
AND THE TRANSACTIONS COMPLETED THEREBY, AND THE APPOINTMENT OF CHRISTOPHER LORD
AS THE BLUESTAR STOCKHOLDERS' AGENT UNDER THE MERGER AGREEMENT AND THE ESCROW
AGREEMENT, AND RECOMMENDS A VOTE FOR APPROVAL OF THE MERGER, THE MERGER
AGREEMENT, THE FORM OF ESCROW AGREEMENT AND THE APPOINTMENT OF CHRISTOPHER LORD
AS THE BLUESTAR STOCKHOLDERS' AGENT UNDER THE MERGER AGREEMENT AND THE ESCROW
AGREEMENT.
RECORD DATE; STOCKHOLDERS ENTITLED TO PARTICIPATE
Only stockholders of record of BlueStar at the close of business on August
22, 2000 are entitled to participate in the written consent. As of the close of
business on the record date, there were 13,183,046 shares of BlueStar common
stock outstanding and entitled to vote, held of record by 54 stockholders,
12,345,003 shares of BlueStar Series A Preferred Stock outstanding and entitled
to vote, held of record by five stockholders, 8,177,040 shares of BlueStar
Series B Preferred Stock outstanding and entitled to vote, held of record by 20
stockholders and 2,165,603 shares of BlueStar Series C Preferred Stock
outstanding and entitled to vote, held of record by four stockholders. Each
BlueStar stockholder is entitled to one vote for each share of BlueStar stock
held as of the record date.
CONSENT REQUIRED
Adoption of the merger agreement by BlueStar's stockholders is required by
the General Corporation Law of the State of Delaware. The proposal to approve
and adopt the merger and the associated transactions, the merger agreement, the
form of escrow agreement, and the appointment of Christopher Lord as the
BlueStar stockholders' agent under the merger agreement and the escrow
agreement, requires the affirmative vote or consent of
o 90% of the holders of outstanding shares of BlueStar common stock and
BlueStar preferred stock, voting together as a single class; and
o a majority of the holders of outstanding BlueStar preferred stock,
voting separately as a single class.
SHARE OWNERSHIP OF MANAGEMENT
As of the record date, the executive officers and directors of BlueStar and
their affiliates collectively owned 22,587,819 shares of BlueStar common stock
and BlueStar preferred stock, together representing approximately 63% of the
total outstanding BlueStar stock, and 15,856,043 shares of BlueStar preferred
stock, representing approximately 69% of the total outstanding BlueStar
preferred stock.
It is anticipated that the shares of BlueStar stock held by management of
BlueStar will be voted in favor of the various matters to be approved by written
consent.
SHARES SUBJECT TO STOCKHOLDER AGREEMENTS
Pursuant to stockholder agreements among Covad Communications and certain
stockholders of BlueStar, Covad Communications holds proxies for 4,026,978
shares of BlueStar common stock and 18,166,844 shares of BlueStar preferred
stock, representing approximately 62% of the total shares of BlueStar stock
outstanding on the record date, and 80% of the shares of BlueStar preferred
stock outstanding on the record date.
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EXECUTION OF CONSENTS
Shares represented by all properly executed consents received by September
11, 2000 will be counted as votes in favor of the transactions described herein.
For purposes of the written consent, only shares represented by a consent
will be counted as favorable votes for approval and adoption of the transactions
described herein. The failure to submit a written consent will have the same
effect as a vote against approval and adoption of the merger agreement, the form
of escrow agreement, the merger, and the appointment of Christopher Lord as the
BlueStar stockholders' agent under the merger agreement and the escrow
agreement.
The written consent accompanying this prospectus is solicited on behalf of
BlueStar's board of directors. BlueStar stockholders are requested to complete,
date and sign the accompanying written consent and promptly return it in the
accompanying envelope or otherwise mail it to BlueStar.
REVOKING CONSENTS
BlueStar stockholders of record may revoke their consents at any time prior
to September 11, 2000. Consents may be revoked by written notice, including by
telegram or facsimile, to the General Counsel of BlueStar. Any written notice of
a revocation of a consent must be sent so as to be delivered before September
11, 2000 as follows:
BlueStar Communications Group, Inc. Five Corporate Centre, Suite 600 801
Crescent Centre Drive Franklin, TN 37067 Attention: General Counsel
Consents for shares held by stockholders who are party to the stockholder
agreements with Covad Communications may not be revoked at any time or under any
circumstances.
CONSENT SOLICITATION
BlueStar will bear the cost of the solicitation of consents from its
stockholders, except that Covad Communications and BlueStar will share equally
the cost of filing, printing and distributing the registration statement and
this prospectus. In addition to solicitation by mail, the directors, officers
and employees of BlueStar may solicit consents from stockholders of BlueStar by
telephone or telegram or by other means of communication. Such directors,
officers and employees will not be additionally compensated but may be
reimbursed for reasonable out-of-pocket expenses in connection with such
solicitation.
DO NOT SEND IN ANY STOCK CERTIFICATES WITH YOUR WRITTEN CONSENTS. COVAD
COMMUNICATIONS WILL INSTRUCT ITS EXCHANGE AGENT TO SEND TRANSMITTAL FORMS WITH
INSTRUCTIONS FOR THE SURRENDER OF CERTIFICATES REPRESENTING SHARES OF COVAD
COMMUNICATIONS COMMON STOCK TO FORMER BLUESTAR STOCKHOLDERS SHORTLY AFTER THE
MERGER IS COMPLETED.
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THE COMPANIES
COVAD COMMUNICATIONS GROUP, INC.
OVERVIEW
Covad Communications is a leading provider of broadband communications
services to Internet service provider, enterprise telecommunications carrier and
other customers. These services include a range of high-speed, high capacity
Internet and network access services using digital subscriber line (DSL)
technology, and related value-added services. Internet service providers
purchase these services in order to provide high-speed Internet access to their
business and consumer end-users. Enterprise customers purchase these services
directly or indirectly from Covad Communications to provide employees with
high-speed remote access to the enterprise's local area network (RLAN access),
which improves employee productivity and reduces network connection cost.
Telecommunications carrier customers purchase these services for resale to their
Internet service provider affiliates, Internet users and enterprise customers.
As of June 30, 2000, Covad Communications believes it has the nation's
largest DSL network with 1,700 operational central offices passing over at least
42 million homes and businesses. As of June 30, 2000, it had installed 138,000
DSL based high-speed access lines and received orders for its services from more
than 295 Internet service provider, enterprise and telecommunications carrier
customers, including AT&T, Concentric Network, Flashcom, MindSpring Enterprises
Inc. (now Earthlink, Inc.), Oracle Corporation, Prodigy Communications
Corporation, PSINet, Qwest Communications International Inc., Stanford
University, Sun Microsystems, UUNET Technologies (an MCI WorldCom Company) and
Verio.
By June 30, 2000, Covad Communications had deployed its network in a total
of 81 metropolitan statistical areas. When its 165 metropolitan statistical area
(MSA) build-out is completed, which is expected to be by the end of 2000, its
network will pass more than 45% of homes and 50% of businesses in the United
States.
Covad Communications plans to continue to pursue rapid network expansion
and installation of high-speed access lines, and to develop a variety of
services that are enhanced or enabled by its expanding network, by entering into
business arrangements with broadband-related service providers in order to bring
a variety of value-added service offerings to its customers and their end-users.
INDUSTRY BACKGROUND
GROWING MARKET DEMAND FOR BROADBAND COMMUNICATIONS BANDWIDTH SERVICES.
High-speed connectivity has become important to small- and medium-sized
businesses and consumers due to the dramatic increase in Internet usage.
According to International Data Corporation, the number of Internet users
worldwide reached approximately 196 million in 1999 and is forecasted to grow to
approximately 502 million by 2003. The popularity of the Internet with consumers
has driven the rapid proliferation of the Internet as a commercial medium.
Businesses are increasingly establishing Web sites and corporate intranets and
extranets to expand their customer reach and improve their communications
efficiency. Consumers are increasingly using the Internet to carry out
commercial transactions. International Data Corporation estimates that the value
of goods and services sold world wide via the Internet will increase from $111
billion in 1999 to over $1.3 trillion in 2003. 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 more effectively with employees, customers and
business partners. Broadband connections are also becoming increasingly
important to businesses and consumers as rich Internet content--such as
multi-media advertising, news and entertainment--and on-line consumer
transactions and e-commerce become more widely available and widely used.
The demand for broadband communications services for RLAN access is also
growing rapidly. Over the past ten years, high-speed local area networks have
become increasingly important to enterprises to enable employees to share
information, send e-mail, search databases and conduct business. Covad
Communications believes that a large majority of personal computers used in
enterprises are connected to local area networks. Enterprises are now seeking to
extend this same high-speed connectivity to employees accessing the local area
networks from home to improve employee productivity and reduce operating costs.
The number of home office households on the Internet grew from 12.0 million at
the end of 1997 to an estimated 27 million by the end of 1999, and is expected
to grow to
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30.2 million households by 2002. Only 3.7% of these users currently access the
Internet through a broadband connection of any type.
As use of the Internet, intranets and extranets increases, Covad
Communications expects the market size for both small- and medium-sized business
and consumer Internet and RLAN access to continue to grow rapidly, causing the
demand for broadband communications services to also grow rapidly. However, the
full potential of Internet and local area network 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 kilobits per
second to 56.6 kilobits per second, 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 local area
network by low-speed analog lines. Higher speed connections are available,
including:
o INTEGRATED SERVICES DIGITAL NETWORKS--An ISDN line 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 compatible PBX systems.
o T1 LINE AND FRACTIONAL T1--These are telephone industry terms for a
digital transmission link with a capacity of 1.544 megabits per second
or portions thereof.
o FRAME-RELAY--A high-speed packet-switched data communications
protocol.
o CABLE MODEM--Internet access over hybrid fiber coaxial cable.
While these services have recently experienced dramatic growth in the
United States, they are frequently expensive, complex to order, install and
maintain, and in some cases are not as widely available as DSL technology.
EMERGENCE OF DSL TECHNOLOGY. DSL technology first emerged in the 1990s and
is commercially available today to address 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 copper telephone
lines from analog modem speeds of 56.6 kilobits per second, for the fastest
consumer modems, and ISDN speeds of 128 kilobits per second, to DSL speeds of up
to 6 megabits per second depending on the length and condition of the copper
line. Recent advances in semiconductor technology and digital signal processing
algorithms and falling equipment prices have made the widespread deployment of
DSL technology more economical over time. Covad Communications 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 alternative
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, requiring a comparatively lower initial fixed investment.
Subsequent variable investments in DSL technology are directly related to the
number of paying customers.
IMPACT OF REGULATORY DEVELOPMENTS. The passage of the 1996
Telecommunications Act created a legal framework for competitive
telecommunications companies to provide local analog and digital communications
services in competition with the traditional telephone companies. The 1996
Telecommunications Act eliminated a substantial barrier to entry for competitive
telecommunications companies by enabling them to leverage the existing
infrastructure built by the traditional telephone companies, which required a
$200 billion investment by these telephone companies and their ratepayers,
rather than constructing a competing infrastructure at significant cost. The
1996 Telecommunications Act requires traditional telephone companies, among
other things:
o to allow competitive telecommunications companies to lease telephone
wires on a line by line basis;
o to provide central office space for the competitive telecommunications
companies' DSL and other equipment required to connect to the leased
telephone wires;
o to lease access on their inter-central office fiber backbone to link
the competitive telecommunications companies'equipment; and
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o to allow competitive telecommunications companies to electronically
connect into their operational support systems to place orders and
access their databases.
The 1996 Telecommunications Act, as interpreted by the Federal
Communications Commissions, in particular emphasized the need for
competition-driven innovations in the deployment of advanced telecommunications
services, such as DSL services.
COMPETITIVE STRENGTHS OF COVAD COMMUNICATIONS
Covad Communications was formed to capitalize on the substantial business
opportunity created by the growing demand for broadband Internet and network
access, the commercial availability of low-cost DSL technology and the passage
of the 1996 Telecommunications Act. Key aspects of its solution to provide
broadband communications services include:
o an attractive value proposition that provides high-speed connections
at similar or lower prices than alternative high-speed technologies
currently available to customers;
o a rapid network deployment and service rollout with significant
increases in line installations to date;
o a widely available, continuously connected, secure network that
facilitates deployment of Internet and intranet applications; and
o a management team experienced in the data communications,
telecommunications and personal computer industries.
ATTRACTIVE VALUE PROPOSITION. Covad Communications offers higher bandwidth
digital connections than alternative services at similar or lower prices that do
not vary with usage. For business Internet users, its high-end services offer
bandwidth comparable to that offered by T1 and frame-relay circuits at
approximately 25% of the cost. For the RLAN market, its mid-range services are
three to six times the speed of ISDN lines and up to ten times the speed of
analog modems at monthly rates similar to or lower than those for heavily used
ISDN lines. Covad Communications believes that many of its enterprise customers
can justify deploying lines to their employees if their 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, consumer services are comparably priced to current cable modem
services. Unlike cable modems, the speed of its service does not decrease when
more users are added.
COVAD COMMUNICATIONS HAS LEVERAGED ITS FIRST-MOVER ADVANTAGE TO RAPIDLY
EXPAND ITS NETWORK AND GROW ITS NUMBER OF LINES INSTALLED. Covad Communications
was the first to widely roll out DSL services on a commercial basis, making DSL
service available for purchase in the San Francisco Bay Area in December 1997.
Covad Communications believes that it has leveraged its first-mover advantage to
rapidly expand its network into its targeted metropolitan regions and grow its
number of line installations. Covad Communications believes it has the nation's
largest DSL network with more than 1,700 operational central offices passing
over more than 42 million homes and businesses. As of June 30, 2000, Covad
Communications had installed a total of 138,000 lines nationwide.
WIDELY AVAILABLE, ALWAYS-CONNECTED SECURE NETWORK. Covad Communications'
strategy of providing blanket coverage in each region Covad Communications
serves is designed to ensure that its services are available to the vast
majority of its customers' end-users. Its network provides 24-hour, always-on
connectivity, unlike ISDN lines and analog modems which require customers to
dial-up each time for Internet or RLAN access. Also, because Covad
Communications uses dedicated connections from each end-user to the Internet
service provider or enterprise network, its customers can reduce the risk of
unauthorized access. These factors are important to customers because any
Internet service they market to their end-users must actually be available for
them to purchase and be secure enough to not risk their own reputation or
business with any security lapses.
EXPERIENCED MANAGEMENT TEAM. Covad Communications' management team includes
individuals with extensive experience in the data communications,
telecommunications and personal computer industries, including Robert Knowling,
Jr., Chairman of the Board, President and Chief Executive Officer (former
Executive Vice President of Operations and Technology at U S WEST
Communications, Inc.), Catherine Hemmer, Executive Vice President and Chief
Operations Officer (former Vice President, Network Reliability and Operations at
U S WEST Communications, Inc., former General Manager, Network Provisioning at
Ameritech Corporation and former Vice
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President, Network Services at MFS), John McDevitt, Executive Vice President,
Sales and Marketing (former Vice President of Sales and Marketing at Danly IEM
and former Business Director at Praxair, Inc.), Mark Perry, Executive Vice
President and Chief Financial Officer (former Vice President and Corporate
Officer, Finance & Administration of US West Communications), Robert Davenport,
III, Executive Vice President, Business Development (former Senior Vice
President and Chief Operating Officer of Tele-Communication, Inc.'s Internet
Services subsidiary TCI.NET), Joseph Devich, Executive Vice President, Corporate
Services (former Vice President, Operations and Technologies Staff of U S WEST
Communications, Inc.), Dhruv Khanna, Executive Vice President, General Counsel
and Secretary, Jane Marvin, Executive Vice President of Human Resources (former
Vice President of Human Resources for the General Business Services unit of
Ameritech Corporation), Terry Moya, Executive Vice President, External Affairs
(former Vice President & Chief Financial Officer, Capital Management, Network
Operations and Technologies at U S WEST Communications, Inc), Michael Lach,
Executive Vice President, Corporate Services and Business Integration (former
Vice President, Customer Provisioning and Maintenance of Ameritech Corporation);
and Jimmy La Valley, Executive Vice President, Community Relations (former Vice
President, Human Resources at US WEST Communications, Inc.).
BUSINESS STRATEGY
Covad Communications' objective is to become the leading nationwide
provider of broadband services and a critical element in the proliferation of
e-commerce and other applications that are enabled or enhanced by broadband
communications. The key elements of its strategy to achieve this objective are
as follows:
EXPAND ITS NETWORK AND ROLL OUT SERVICE RAPIDLY IN TARGETED METROPOLITAN
STATISTICAL AREAS. As of June 30, 2000, Covad Communications had introduced
services in 81 of the top metropolitan statistical areas nationwide. Covad
Communications plans to expand services to a total of 165 metropolitan
statistical areas by the end of 2000. In the aggregate, these 165 metropolitan
statistical areas cover more than 45% of homes and 50% of businesses in the
United States. In addition, Covad Communications has recently begun to assess
the regulatory and competitive environments in other countries.
PROVIDE PERVASIVE COVERAGE IN EACH METROPOLITAN STATISTICAL AREA. Covad
Communications is pursuing a blanket coverage strategy of providing service in a
substantial majority of the central offices in each region that it enters, since
its Internet service provider customers desire to market their Internet access
services on a region-wide basis. Blanket coverage is also important to Covad
Communications' enterprise customers since most of them desire to offer RLAN
access to all employees regardless of where they reside. In addition, Covad
Communications believes its presence in 165 metropolitan statistical areas will
allow it to better serve its Internet service provider, enterprise,
telecommunications carrier and other customers. These customers are increasingly
seeking a single supplier in multiple metropolitan areas.
ESTABLISH AND MAINTAIN SALES AND MARKETING RELATIONSHIPS WITH LEADING
INTERNET SERVICE PROVIDERS, TELECOMMUNICATIONS CARRIERS AND OTHER DSL RESELLERS.
Covad Communications principally targets Internet service providers,
telecommunications carriers and other DSL resellers that can offer their
end-users cost and performance advantages for Internet access using its
services. Covad Communications primarily provides connections to Internet
service providers, which in turn offer high-speed Internet access using its
network. In other cases, Covad Communications provides wholesale DSL and
Internet access services for resale by its customers such as Prodigy
Communications Corporation and Juno Online Services. In this way, Covad
Communications:
o carries the traffic of multiple Internet service providers,
telecommunications carriers and other customers in any region,
increasing its volume and reducing its costs;
o leverages its selling efforts through the sales and support staff of
these Internet service providers, telecommunications carriers and
other customers;
o offers Internet service providers, telecommunications carriers and
other customers an alternative, since the traditional telephone
company typically provides its own retail Internet access services in
competition with Covad Communications' customers; and
o provides Internet service providers, telecommunications carriers and
other customers a high-speed service offering to compete with
cable-based Internet access.
DEVELOP A NATIONAL BRAND. Covad Communications believes that it can enhance
its competitive position and increase demand for its services by actively
developing a positive brand and image for the company and its services
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through a combination of television, print and radio advertisements on both a
national and local basis. In October 1999, Covad Communications commenced a
significant national advertising campaign in pursuit of this strategy. This
branding strategy has created the opportunity for Covad Communications to
provide end-user leads to its existing customers.
DEVELOP AND COMMERCIALIZE VALUE-ADDED SERVICES. Covad Communications
intends to introduce value-added services to its customers and leverage the
value of the network access it offers today. Offering services such as voice
over DSL, DSL plus Internet Protocol (DSL + IP), and its Virtual Broadband
Service Provider (VBSP) offering will allow it to bundle service offerings to
its customers and improve the quality of content delivery to their end-users as
well as reduce costs. Covad Communications believes this is an important part of
its strategy and will allow it to build upon its success to date in adding and
retaining subscribers.
ACQUIRE AND ENTER INTO BUSINESS ARRANGEMENTS WITH NETWORK AND
BROADBAND-RELATED SERVICE PROVIDERS. Covad Communications believes that the pace
of deployment of its network can be increased by acquiring and entering into
business arrangements with other network service providers, some of which may be
located outside of the United States. Covad Communications also believes its
network deployment will enable the delivery of a variety of broadband-related
services and content that are desired by its customers. Covad Communications
expects to make these services available to its customers through acquiring and
entering into business arrangements with leading providers of broadband-related
services or content. For example, Covad Communications recently acquired Laser
Link.Net, Inc. This acquisition will allow Covad Communications to better
provide DSL and IP services on a wholesale basis and better enable it to serve
customers who do not wish to maintain any network facilities. Its agreement to
acquire BlueStar will expand Covad Communications' selling capabilities in
smaller cities and rural areas, increase distribution methods and will enhance
its ability to deliver enhanced broadband solutions to small businesses.
TAKE ADVANTAGE OF NEW REGULATORY DEVELOPMENTS. In late 1999, the FCC
required the major local phone companies to provide Covad Communications and
other competitive local carriers with "line sharing." This allows Covad
Communications to provide its services over the same telephone wire used by the
traditional telephone companies to provide analog voice services. In addition,
some of the Ameritech/SBC merger conditions adopted by the FCC in October 1999
also contain provisions on line sharing and provide for reductions in costs for
telephone wires in certain circumstances. In many cases, line sharing would
allow Covad Communications to provision its asymmetric DSL services on the same
telephone wire as the existing local phone companies' voice service. Currently,
Covad Communications provides almost all of its DSL services over a separate
additional telephone wire. Asymmetric DSL and standard telephone service can
exist on a single line and most, if not all, of the traditional telephone
companies provision their own asymmetric services on the same line as existing
voice services.
Covad Communications sees line sharing as an extremely important
opportunity for three primary reasons. First, line sharing should significantly
reduce the monthly recurring charges Covad Communications incurs for telephone
wires. Second, line sharing should reduce the time it takes traditional
telephone companies to deliver telephone wires because the telephone wire will
already exist. Third, line sharing should resolve lack of telephone wire
problems that Covad Communications has encountered when ordering telephone wires
in some areas of the country. Covad Communications has signed interim
line-sharing agreements with Bell South, Bell Atlantic and U S WEST. It has also
entered into interim line sharing agreements with SBC in California and is
negotiating agreements for the remaining states in SBC's territory. Covad
Communications has entered into an interim line sharing agreement with GTE for
all of its major markets other than Texas. It recently received a decision from
the Texas Public Utilities Commission implementing line sharing in Texas. Covad
Communications has implemented line sharing in nine states. Covad Communications
expects all of the major traditional local phone companies to implement line
sharing on a wide scale later this year.
COVAD COMMUNICATIONS' SERVICE OFFERINGS
Covad Communications offers six business-grade services under the
TeleSpeed(TM) brand to connect its customers' end-users to regional data centers
and two consumer-grade service offerings called TeleSurfer and TeleSurfer Pro.
In March 2000, Covad Communications introduced two new services--DSL+IP and
VBSP. It also offers business consumers Virtual Private Network (VPN) technology
over DSL. In addition, Internet service provider and enterprise customers may
purchase backhaul services to connect their facilities to Covad Communications'
regional data centers.
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TELESPEED SERVICES
Covad Communications' TeleSpeed(TM) services connect individual end-users
on conventional telephone wires to Covad Communications' DSL equipment in their
serving central office and from there to Covad Communications' network serving
that metropolitan statistical area. A traditional telephone company's
infrastructure consists of numerous central offices which are connected by a
fiber optic backbone to a regional office that routes local and long distance
traffic. Each central office collects the individual telephone wires from
end-users' premises in the neighborhood.
The particular TeleSpeed(TM) service available to an end-user depends in
large part on the user's distance to the central office. Covad Communications
believes that substantially all, if not all, of its potential end-users in its
target markets generally can be served with one of its services. Covad
Communications estimates that approximately 70% of end-users are within 18,000
feet of a central office and can be served by at least its TeleSpeed(TM) 384
service. However, the specific number of potential end-users for the higher
speeds will vary by central office and by region and will be affected by line
quality. The chart below compares the performance and markets for each of Covad
Communications' intraregional end-user services as of July 1, 2000:
<TABLE>
<CAPTION>
MAXIMUM MAXIMUM
SPEED TO SPEED FROM RANGE*
INTRAREGIONAL SERVICES END-USER END-USER (FEET) MARKET USAGE
----------------------- ----------- ----------- -------- ---------------------------
<S> <C> <C> <C> <C>
TeleSpeed(TM)144................... 144 Kbps 144 Kbps 35,000 ISDN replacement
TeleSpeed(TM)192................... 192 Kbps 192 Kbps 18,000 Business Internet, RLAN
TeleSpeed(TM)384................... 384 Kbps 384 Kbps 18,000 Business Internet, RLAN
TeleSpeed(TM)768................... 768 Kbps 768 Kbps 13,500 Business Internet
TeleSpeed(TM)1.1................... 1.1 Mbps 1.1 Mbps 12,000 Business Internet
TeleSpeed(TM)1.5S.................. 1.5 Mbps 1.5 Kbps 15,000 High-speed Web access
</TABLE>
-------------
* Estimated maximum distance from the end-user to the central office.
Prices for its end-user services may vary depending upon the performance
level of the service. For example, TeleSpeed(TM) 144 and 192 services are Covad
Communications' lowest priced end-user services and TeleSpeed(TM) 1.1 and 1.5
services are its highest priced end-user services. Covad Communications' prices
also vary across regions and for high volume customers that are eligible for
volume discounts.
TELESPEED(TM) 144. Covad Communications' TeleSpeed(TM) 144 service operates
at speeds up to 144 kilobits per second 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
the TeleSpeed(TM) service per month flat rate can compare favorably to ISDN
services from the traditional telephone company when per-minute usage charges
apply. It is also the service that Covad Communications offers on telephone
wires that are either too long to carry its higher speed services or are served
by digital loop carrier systems or similar equipment where a continuous copper
connection is not available from the end-user site to a central office.
TELESPEED(TM) 192. This service provides one and a half to three times the
performance of ISDN lines at similar or lower prices than heavily-used ISDN
lines.
TELESPEED(TM) 384. This service provides three to six times the performance
of ISDN lines at similar prices to heavily-used ISDN lines
TELESPEED(TM) 768. This service provides one-half the bandwidth of a T1
data circuit at substantially less than one-half of the monthly price that Covad
Communications' estimates is typical for T1 service. The target market for the
TeleSpeed(TM) 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.
TELESPEED(TM) 1.1. This service provides over two-thirds the bandwidth of a
T1 data circuit at less than one-half of the monthly price that Covad
Communications' estimates is typical for T1 service. The target market for the
TeleSpeed(TM) 1.1 service is small businesses needing T1-level 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(TM) 1.5S. This service provides bandwidth comparable to a T1 data
circuit at less than one-half of the monthly price that Covad Communications
estimates is typical for T1 service. The service also provides the highest
performance of any TeleSpeed(TM) service to stream video or other multimedia
content to end-user locations.
TELESPEED(TM) REMOTE. TELESPEED(TM) provides high-speed network access for
end-users located in remote regions to their corporate networks. This service is
targeted at businesses that want high-speed remote office connections at a lower
cost than ISDN or frame-relay services. For example, this service can provide a
corporation's employees located in Boston high-speed access to their corporate
network located in San Francisco.
TELESURFER SERVICES
MAXIMUM MAXIMUM
SPEED TO SPEED FROM RANGE*
INTRAREGIONAL SERVICES END-USER END-USER (FEET) MARKET USAGE
----------- ------------ -------- ---------------
Telesurfer ADSL.......... 608 Kbps 128 Kbps 12,000 Consumer
TeleSurfer Pro ADSL...... 1.5 Mbps 384 Kbps 12,000 Consumer
--------------
* Estimated maximum distance from the end-user to the central office.
TELESURFER ADSL. This consumer-grade service is an asymmetric service,
offering up to 608 kilobits per second downstream and up to 128 kilobits per
second upstream. This service is the base consumer service. The target market
for this service is consumers using either dial-up analog or ISDN connections
for web browsers.
TELESURFER PRO ADSL. This is a premium consumer-grade asymmetric service,
offering up to 1.5 megabits per second downstream and up to 384 kilobits per
second upstream. The target market for this service is consumers using analog or
ISDN connections for web browsers.
DSL + IP
This service currently bundles Internet protocol services with Covad
Communications' existing TeleSurfer services. Covad Communications also plans to
offer it with Covad Communications' TeleSpeed(TM) services. The additional
Internet protocol services include end-user authentication, authorization and
accounting, Internet protocol address assignment and management, domain name
service and Internet protocol routing and connectivity.
VBSP
Covad Communications plans to offer this additional service which provides
a complete solution for organizations and businesses that want to offer
broadband Internet services to their customers without having to develop their
own Internet capabilities. Covad Communications will provide Internet services
to end-users under the brand name of its customer. Its Internet services will be
a turnkey solution that includes registration, connection and Internet software,
web sites, network authentication, electronic mail, billing and reporting, news
and personal web-space for end-users and end-user service and technical support.
VPN OVER DSL
In August 1999, Covad Communications introduced its VPN over DSL service.
This service uses the public Internet backbone or a private data network,
combined with DSL connections, as a channel for sharing information and
applications within a closed circle of users in different locations. Covad
Communications offers two levels of VPN over DSL service.
COVAD BRANCH OFFICE. This service is available for remote or branch offices
that require high-speed inter-office connectivity across multiple locations.
COVAD TELEWORKER. This service is available for telecommuters and other
remote users who secure access to their corporate network and the Internet from
home.
OTHER SERVICES
Covad Communications also provides a DS3 backhaul service from its regional
network to an Internet service provider or enterprise customer site. This
service aggregates all individual end-users in a metropolitan statistical area
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<PAGE>
and transmits the packet information to the customer on a single high-speed
line. The service utilizes an asynchronous transfer mode (ATM) protocol that
efficiently handles the high data rates involved and operates at up to 45
megabits per second. In addition to monthly service charges, Covad
Communications imposes nonrecurring order set-up charges for Internet service
provider and RLAN end-users for its DS3 backhaul service. Customers must also
purchase a DSL modem from Covad Communications or a third party for each
end-user of its services.
CUSTOMERS
Covad Communications offers its services to Internet service providers,
enterprises, telecommunications carriers and other DSL resellers. As of June 30,
2000, it had installed 138,000 DSL lines and received orders for its services
from more than 295 Internet service provider, enterprise and telecommunications
carrier customers. The following is a list of selected customers:
<TABLE>
<CAPTION>
SELECTED INTERNET SERVICE PROVIDER SELECTED ENTERPRISE SELECTED TELECOMMUNICATIONS
CUSTOMERS CUSTOMERS CARRIERS
---------------------------------------- --------------------------- ---------------------------
<S> <C> <C>
Concentric Network Corporation Apple Computer AT&T
Flashcom Inktomi e.spire
Juno Intel IGC
Earthlink Oracle Corporation Qwest
PSINet Stanford University RCN Corporation
Prodigy Sun Microsystems
UUNET WebTV
Verio
</TABLE>
Covad Communications' agreements with Internet service providers and other
DSL resellers generally have terms of one year and are nonexclusive. Covad
Communications does not require Internet service providers to generate a minimum
number of end-users and generally grants volume discounts based on order volume.
Covad Communications serves Internet service providers who provide their own
Internet access service and has started serving Internet service providers who
choose to obtain access to the Internet through Covad Communications. In both
cases, the Internet service providers purchase Covad Communications' services on
a wholesale basis and sell such services under their own brand.
Covad Communications' practice with respect to its enterprise customers has
been to enter into an arrangement or a negotiated price to install the service
initially to a small number of end-users. An enterprise customer decides whether
to implement abroad, rollout of its services after evaluating the results of
this initial phase of deployment. To date, a typical enterprise customer's
initial phase of deployment and its decision to roll out its service to
additional end-users has taken at least six months and has generally taken
longer than Covad Communications originally expected. As of June 30, 2000, a
substantial majority of its enterprise customers had not yet rolled out their
services broadly to their employees.
Covad Communications will not receive significant revenue from an
enterprise customer until and unless these rollouts occur. During the lengthy
sales cycle for an enterprise customer, Covad Communications incurs significant
expenses in advance of the receipt of revenues. Covad Communications also enters
into customer agreements with telecommunications carriers, including competitive
telecommunications companies and interexchange carriers. Under these agreements
its telecommunication carrier customers typically resell its services to their
new and existing customers. These carriers currently market Covad
Communications' Internet and RLAN services primarily to small, medium and
enterprise businesses that purchase voice services from them.
SALES AND MARKETING
BUSINESS AND CONSUMER INTERNET. For the business and consumer Internet
access markets, Covad Communications sells its service to Internet service
providers, telecommunications carriers and others. These customers can either
combine Covad's lines with their Internet access services, or purchase wholesale
Internet access services from Covad Communications, and resell the combination
to their existing and new end-users. Covad Communications addresses these
markets through sales and marketing personnel dedicated to the Internet service
provider sales channel. Covad Communications supplements its sales efforts to
Internet service providers through training programs and marketing programs that
include promotions and sales incentives designed to encourage the Internet
service providers to sell Covad Communications' services instead of those of its
competitors.
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<PAGE>
REMOTE LOCAL AREA NETWORK. Covad Communications markets its RLAN services
to businesses through a direct sales force, augmented by marketing programs with
value-added resellers and interexchange carriers. The sales force is directed to
deal directly with the chief information officer and the telecommunications
manager responsible for remote access within an enterprise. Covad Communications
augments its sales efforts to RLAN customers through partnerships with
value-added resellers, including systems integrators that can offer Covad
Communications' TeleSpeed(TM) service as part of a complete work-at-home
solution to businesses.
THIRD-PARTY RELATIONSHIPS. A key element of Covad Communications' strategy
is to enter into relationships with leading telecommunications companies,
including competitive telecommunications carriers and interexchange carriers,
pursuant to which those companies resell Covad Communications' TeleSpeed(TM) and
TeleSurfer services to their customers. For example, Covad Communications has
entered into a commercial agreement with AT&T providing for the purchase and
resale of Covad Communications' services, primarily to AT&T's small business and
enterprise customers. Covad Communications believes that these indirect sales
channels will enable it to penetrate its target markets more rapidly and
eventually will generate the majority of sales of its services.
BRANDING AND MARKETING PROGRAMS. In October 1999, Covad Communications
commenced a branding and advertising effort to educate the market about its
broadband service offerings and increase recognition of its brand. This program,
which uses television, print and radio advertising on both a national and
regional basis, is intended to inform the market about the availability of Covad
Communications' service, differentiate the products and services offered by it
and simplify the process through which these products and services are ordered.
Covad Communications is also pursuing several types of joint marketing
arrangements with its Internet service provider, telecommunications carrier
customers and other DSL resellers. In addition, certain of Covad Communications'
equipment suppliers have promoted its services through seminars to corporate
information technology managers in the San Francisco Bay Area. Covad
Communications 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
Internet service providers, telecommunications carriers and corporate
information technology managers typically have had to assemble their digital
communications connections using multiple service and equipment suppliers,
leading to additional work, cost and coordination problems. With its services,
Covad Communications emphasizes a one-stop service solution for its customers.
This service solution includes:
o extending Covad Communications' network to customers and end-users
with various needs and configuration requirements;
o end-user premise wiring and DSL modem configuration;
o ongoing network monitoring and customer reporting;
o customer service and technical support; and
o operational system support.
EXTENDING COVAD COMMUNICATIONS' NETWORK TO CUSTOMERS AND END-USERS. Covad
Communications works with its Internet service provider, enterprise,
telecommunications carrier and other customers to extend its network to each
customer premise and each end-user premise by ordering circuits from the
traditional telephone company or a competitive telecommunications company,
interconnecting the customers and end-users to its network, testing the
circuits, configuring customer routers or switches and end-user routers and
monitoring the circuits from the network operations center.
END-USER PREMISES WIRING AND DSL MODEM CONFIGURATION. Covad Communications
uses its own and subcontracted field service crews and trucks to perform any
required inside wiring and to configure DSL modems at each end-user site.
NETWORK MONITORING. Covad Communications monitors its network from its
network operations center, which helps it to identify and correct network
problems. Covad Communications has also developed network capability to provide
Internet service provider, enterprise and telecommunications carrier customers
direct monitoring access of their end-users for more efficient monitoring of
their own network performance.
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<PAGE>
CUSTOMER REPORTING. Covad Communications communicates regularly with its
customers about the status of their end-users. Covad Communications also
operates a toll-free customer care help line. Additionally, it provides
Web-based tools to allow individual Internet service providers and enterprise
information technology managers and telecommunications carriers 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 Covad Communications on an ongoing
basis.
CUSTOMER SERVICE AND TECHNICAL SUPPORT. Covad Communications provides 24x7
on-line support to its Internet service provider customers and enterprise
information technology managers. The Internet service provider and information
technology manager and telecommunications carriers serve as the initial contact
for service and technical support, and Covad Communications provides the second
level of support. For customers using its VBSP offering, Covad Communications
will provide the first level of support for their end-users.
OPERATIONAL SUPPORT SYSTEM. Covad Communications has developed what it
believes to be the industry-leading operational support system for DSL networks.
Covad Communications' operational support system is based on web interfaces and
is highly automated. These features are intended to and should allow Covad
Communications to scale its businesses rapidly because they eliminate many
manual processes such as line testing, network path configuration, equipment
configuration, order taking and verification, billing and telephone wire
supplier management.
NETWORK ARCHITECTURE AND TECHNOLOGY
The key design principles of Covad Communications' network attempt to
provide the following attributes which Covad Communications believes are
important requirements of its existing and potential customers:
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. Covad Communications' network is designed to ensure
secure availability of all internal applications and information for remote
locations. Its 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 its customers to transmit
sensitive information and applications over Covad Communications' TeleSpeed(TM)
lines.
CONSISTENT AND SCALABLE PERFORMANCE. Covad Communications believes that
eventually public packet networks will evolve to replace the over 40 million
modems currently connected to circuit switched networks that have been deployed
in the United States. As such, it designed its network for scalability and
consistent performance to all users as the networks grow.
Covad Communications has designed a "star topology" network similar to the
most popular local area network architecture currently used in high-performance
enterprise networks. In this model, new capacity is added automatically as each
new user receives a new line. Covad Communications also uses asynchronous
transfer mode equipment in its network that implements 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 continuously connected, they can also always be monitored.
Covad Communications has visibility from the Internet service provider or
enterprise site across the network and into the end-user's home or business.
Because its network is centrally managed, it can identify and dynamically
enhance network quality, service and performance and address network problems
promptly.
FLEXIBILITY. Covad Communications has designed its network to be flexible
in handling various types of network traffic, starting with data, but able to
accommodate voice and video. This flexibility will allow it to directly offer,
or enter into arrangements with other entities to offer, not only value-added
services such as voice over DSL, but also control the prioritization of content
delivery within its national network.
The primary components of Covad Communications' network is the network
operations center, high-speed private metropolitan networks, central office
spaces, including digital subscriber line access multiplexers (DSLAMs), copper
telephone lines and DSL modems.
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<PAGE>
NETWORK OPERATIONS CENTERS. Covad Communications' entire network is managed
from two network operations centers. Covad Communications 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 network operations centers, Covad
Communications can monitor the equipment and circuits in each metropolitan
network (including the asynchronous transfer mode equipment), each central
office (including DSLAMs) and potentially individual end-user lines (including
the DSL modems). Presently, one network operations center is located in the San
Francisco Bay Area and the second network operations center is on the East
Coast.
PRIVATE METROPOLITAN NETWORK. Covad Communications operates its own private
metropolitan network in each region that it enters. The network consists of
high-speed asynchronous transfer mode communications circuits that it leases to
connect its asynchronous transfer mode hubs, equipment in individual central
offices and its Internet service provider, enterprise and telecommunications
carrier customers. This network operates at a speed of 45 to 155 megabits per
second.
CENTRAL OFFICE SPACES. Through its interconnection agreements with the
traditional telephone companies, Covad Communications seeks to secure space in
every central office where it intends to offer service. These central office
spaces are designed to offer the same high reliability and availability
standards as the traditional telephone company's other central office space.
Covad Communications requires access to these spaces for its equipment and for
persons employed by, or under contract with, it. Covad Communications place
DSLAMs in its central office spaces to provide the high-speed DSL signals on
each copper line to its end-users. As of June 30, 2000, Covad Communications had
1,700 central office spaces operational. In addition, it has a significant
number of additional spaces under construction as well as other spaces on order
from various traditional telephone companies. In December 1998, it entered into
a professional service arrangement with Lucent Technologies to augment and
accelerate its ability to deploy its central office facilities.
TELEPHONE WIRES. Covad Communications leases the telephone wires running to
end-users from the traditional telephone companies under terms specified in its
interconnection agreements. Covad Communications leases lines that, in numerous
cases, must be specially conditioned by the traditional telephone companies to
carry digital signals, usually at an additional charge relative to that for
voice grade telephone wires. The price it is obligated to pay for these lines
currently varies from $4 to $70 per month per line with additional one-time
charges in some cases for installation, modification or removal of lines.
DSL MODEMS AND ON-SITE CONNECTION. Covad Communications buys its DSL modems
from its suppliers for resale to its Internet service provider or enterprise
customers for use by their end-users. Covad Communications configures and
installs these modems along with any required on-site wiring needed to connect
the modem to the copper line leased from the traditional telephone company. For
the most part, the DSL modem and DSLAM equipment used have come from the same
vendor for all services, since there are not yet interoperability standards for
the equipment used in higher-speed services. Covad Communications is also
pursuing a program of ongoing network development. Its 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 its
network and to facilitate the development of network applications by third
parties that will increase the use of its network.
COMPETITION
The markets for business and consumer Internet access and network access
services are intensely competitive. Covad Communications expects that these
markets will become increasingly competitive in the future. The principal bases
of competition in Covad Communications' markets include:
o price/performance;
o breadth of service availability;
o reliability of service;
o network security;
o ease of access and use;
o content bundling;
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<PAGE>
o customer support;
o brand recognition;
o operating experience;
o relationships with Internet service providers and other third parties;
and
o capital resources.
Covad Communications faces competition from traditional telephone
companies, cable modem service providers, competitive telecommunications
companies, traditional and new national long distance carriers, Internet service
providers, on-line service providers and wireless and satellite service
providers.
TRADITIONAL TELEPHONE COMPANIES. All of the largest traditional telephone
companies in Covad Communications' target markets have begun offering DSL
services. As a result, the traditional telephone companies represent strong
competition in all of Covad Communications' target service areas, and Covad
Communications expects this competition to intensify. The traditional telephone
companies have an established brand name and reputation for high quality in
their service areas, possess sufficient capital to deploy DSL equipment rapidly,
own the telephone wires themselves and can bundle digital data services with
their existing voice services to achieve economies of scale in serving their
customers. Certain of the traditional telephone companies have aggressively
priced their consumer DSL services as low as $19-$29 per month, placing pricing
pressure on Covad Communications' TeleSurfer services. The traditional telephone
companies are also in a position to offer service from central offices where
Covad Communications is unable to secure space and offer service because of
asserted or actual space restrictions.
CABLE MODEM SERVICE PROVIDERS. Cable modem service providers such as AT&T,
Excite@Home, Cox, Time Warner, Road Runner and MediaOne (and their respective
cable partners) are deploying high-speed Internet access services over hybrid
fiber coaxial cable networks. Hybrid fiber coaxial cable is a combination of
fiber optic and coaxial cable, and has become the primary architecture utilized
by cable operators in recent and ongoing upgrades of their systems. Where
deployed, these networks provide similar and in some cases higher-speed Internet
access than Covad Communications' provides. They also offer these services at
lower price points than Covad Communications' TeleSurfer services. Covad
Communications believes the cable modem service providers face a number of
challenges that providers of DSL services do not face. For example, different
regions within a metropolitan statistical area may be served by different cable
modem service providers, making it more difficult to offer the blanket coverage
required by potential business customers. Also, much of the current cable
infrastructure in the United States must be upgraded to support cable modems, a
process which Covad Communications believes is significantly more expensive and
time-consuming than the deployment of DSL-based networks.
COMPETITIVE TELECOMMUNICATIONS COMPANIES. Many competitive
telecommunications companies such as NorthPoint Communications, Rhythms
NetConnections and Network Access Solutions offer high-speed digital services
using a business strategy similar to Covad Communications. Some of these
competitors have begun offering DSL-based access services and others are likely
to do so in the future. Companies such as NEXTLINK Communications 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 traditional telephone companies pursuant to which they have
acquired central office space in many markets targeted by Covad Communications.
Further, certain of Covad Communications' customers have made investments in its
competitors.
NATIONAL INTEREXCHANGE CARRIERS. Interexchange carriers, such as AT&T,
Sprint, MCI WorldCom, Qwest, Level 3 and Global Crossing have deployed
large-scale Internet access networks and ATM networks, sell connectivity to
businesses and residential customers and have high brand recognition. They also
have interconnection agreements with many of the traditional telephone companies
and a number of spaces in central offices from which they are currently offering
or could begin to offer competitive DSL services.
INTERNET SERVICE PROVIDERS. Internet service providers such as Genuity,
UUNET Technologies (acquired by MCI WorldCom), EarthLink Network, Concentric
Network Corporation (acquired by NEXTLINK), and PSINet provide Internet access
to residential and business customers, generally using the existing public
switched telephone network at integrated services digital network speeds or
below. Some Internet service providers such as UCNET Technologies in California
and New York, HarvardNet Inc. and InterAccess have begun offering DSL-based
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<PAGE>
services. To the extent Covad Communications is not able to recruit Internet
service providers as customers for Covad Communications' service, Internet
service providers could become competitive DSL service providers.
ON-LINE SERVICE PROVIDERS. On-line service providers include companies such
as AOL, Yahoo!, CompuServe (acquired by AOL), MSN (a subsidiary of Microsoft
Corp.) and Web TV (a subsidiary of 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
on-line service providers have developed their own access networks for modem
connections. If these on-line service providers were to extend their access
networks to DSL or other high-speed service technologies, they would become
Covad Communications' competitors.
WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Wireless and satellite data
service providers are developing wireless and satellite-based Internet
connectivity. Covad Communications may face competition from terrestrial
wireless services including future third-generation wireless networks, 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.
Covad Communications also may face competition from satellite-based
systems. Motorola Satellite Systems, Inc., Hughes Communications (a subsidiary
of General Motors Corporation), Globalstar, Lockheed, 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.
INTERCONNECTION AGREEMENTS WITH TRADITIONAL TELEPHONE COMPANIES
A critical aspect of Covad Communications' business is its interconnection
agreements with the traditional telephone companies. These agreements cover a
number of aspects including:
o the price Covad Communications pays to lease access to the traditional
telephone company's telephone wires;
o the special conditioning the traditional telephone company provides on
certain of these lines to enable the transmission of digital signals;
o the price and terms of central office space for Covad Communications'
equipment in the traditional telephone company's central offices and
remote terminals;
o the price Covad Communications pays and access it has to the
traditional telephone company's transport facilities;
o the operational support systems and interfaces that Covad
Communications can use to place orders, report network problems and
monitor the traditional telephone company's response to its requests;
o the dispute resolution process that Covad Communications uses to
resolve disagreements on the terms of the interconnection contract;
and
o the term of the interconnection agreement, its transferability to
successors, its liability limits and other general aspects of the
traditional telephone company relationship.
As of June 30, 2000, Covad Communications had entered into interconnection
agreements with or otherwise obtained interconnection rights from the major
traditional telephone companies in all the states covering its metropolitan
statistical areas. Traditional telephone companies do not in many cases agree to
Covad Communications' requested provisions in interconnection agreements, and
Covad Communications has not consistently prevailed in obtaining all of its
desired provisions in such agreements either voluntarily or through the
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<PAGE>
interconnection arbitration process. Covad Communications cannot be sure that it
will be able to continue to sign interconnection agreements with existing or
other traditional telephone companies. Covad Communications is currently
negotiating agreements with several traditional telephone companies in order to
expand its services into 165 targeted metropolitan statistical areas. The
traditional telephone companies are also permitting competitive
telecommunications companies to adopt previously signed interconnection
agreements. In certain instances, Covad Communications has adopted the
interconnection agreement of another competitive telecommunications company.
Other competitive telecommunications companies have also adopted the same or
modified versions of Covad Communications' interconnection agreements, and may
continue to do so in the future.
Many of Covad Communications' interconnection agreements have a term of
three years. Covad Communications will have to renegotiate these agreements when
they expire. Although Covad Communications expects to renew the interconnection
agreements that require renewal and believes the 1996 Telecommunications Act and
the agreements themselves limit the ability of traditional telephone companies
not to renew such agreements, Covad Communications may not succeed in extending
or renegotiating its interconnection agreements on favorable terms.
Additionally, disputes have arisen and will likely arise in the future as a
result of differences in interpretations of the interconnection agreements. For
example, Covad Communications is in litigation proceedings with some of the
traditional telephone companies. These disputes have delayed Covad
Communications' deployment of its network. They have also adversely affected
Covad Communications' service to its customers and its ability to enter into
additional interconnection agreements with the traditional telephone companies
in other states. Finally, the interconnection agreements are subject to state
commission, FCC and judicial oversight. These government authorities may modify
the terms of the interconnection agreements in a way that hurts Covad
Communications' business.
GOVERNMENT REGULATION
OVERVIEW. Covad Communications' services are subject to a variety of
federal regulations. With respect to certain activities and for certain
purposes, Covad Communications has submitted its operations to the jurisdiction
of state and local authorities who may also assert more extensive jurisdiction
over its facilities and services. The FCC has jurisdiction over all of Covad
Communications' services and facilities to the extent that Covad Communications
provides interstate and international services. To the extent it provides
identifiable intrastate services, Covad Communications' services and facilities
are subject to state regulations. Rates for the services and network elements it
purchases from the traditional local telephone companies are generally
determined by the states consistent with federal law. In addition, local
municipal government authorities also assert jurisdiction over Covad
Communications' facilities and operations. The jurisdictional reach of the
various federal, state and local authorities is subject to ongoing controversy
and judicial review, and Covad Communications cannot predict the outcome of such
review.
FEDERAL REGULATION. Covad Communications must comply with the requirements
of the Communications Act of 1934, as amended by the 1996 Telecommunications
Act, as well as the FCC's regulations under the statute. The 1996
Telecommunications 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 Telecommunications
Act.
Among other things, the 1996 Telecommunications Act removes barriers to
entry in the local telecommunications market. It does this by preempting certain
state and local laws that are barriers to competition and by requiring
traditional telephone companies to provide nondiscriminatory access and
interconnection to potential competitors, such as cable operators, wireless
telecommunications providers, interexchange carriers and competitive
telecommunications companies such as Covad Communications.
Regulations promulgated by the FCC under the 1996 Telecommunications Act
specify in greater detail the requirements of the 1996 Telecommunications Act
imposed on the traditional telephone companies to open their networks to
competition by providing competitors interconnection, central office and remote
terminal space, access to unbundled network elements, retail services at
wholesale rates and nondiscriminatory access to telephone poles, ducts, conduits
and rights-of-way. The requirements enable companies such as Covad
Communications to interconnect with the traditional telephone companies in order
to provide local telephone exchange services and to use portions of the
traditional telephone companies' existing networks to offer new and innovative
services such as
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its TeleSpeed(TM) and TeleSurfer services. In January 1999, the U.S. Supreme
Court ruled on challenges to the FCC regulations. Although the U.S. Supreme
Court upheld most of the FCC's authority and its regulations, it required the
FCC to reexamine and redefine which unbundled network elements the traditional
telephone companies must offer. The FCC issued its revised list of unbundled
network elements in September 1999. The 1996 Telecommunications Act also allows
the Regional Bell Operating Companies (RBOCs), which are the traditional
telephone companies created by AT&T's divestiture of its local exchange
business, to enter the long distance market within their own local service
regions upon meeting specified requirements. The remaining RBOCs include
BellSouth, Verizon (formerly Bell Atlantic Corporation), Ameritech Corporation,
U S WEST Communications, Inc. (recently acquired by Qwest) and SBC
Communications, Inc. The timing of the various RBOCs' entry into their
respective in-region long distance service businesses is extremely uncertain. In
December 1999, Bell Atlantic's (now Verizon) application to provide in-region
long distance services in New York state was granted by the FCC. The FCC
recently granted Southwestern Bell Telephone Company's application to provide
in-region long distance service in Texas. Given the FCC's grant of the New York
and Texas applications, the FCC is likely to thereafter grant similar
applications by Verizon and the other RBOCs in other states. The timing of the
various RBOCs' in-region long distance entry will likely affect the level of
cooperation Covad Communications receives from each of the RBOCs. The approval
of such entry will likely adversely affect the level of cooperation.
In addition, the 1996 Telecommunications Act provides relief from the
earnings restrictions and price controls that have governed the local telephone
business for many years. Traditional telephone company tariff filings at the FCC
have been subjected to increasingly less regulatory review. However, precisely
when and to what extent the traditional telephone companies will secure pricing
flexibility or other regulatory freedom for their services is uncertain. For
example, under the 1996 Telecommunications Act, the FCC is considering
eliminating certain regulations that apply to the traditional telephone
companies' provision of services that are competitive with Covad Communications.
The timing and the extent of regulatory freedom and pricing flexibility and
regulatory freedom granted to the traditional telephone companies will affect
the competition Covad Communications faces from the traditional telephone
companies' competitive services. Pursuant to recent merger conditions, SBL and
Verizon have established in-region separate affiliates to provide DSL services.
Those affiliates will be subject to less regulation than if the services were
provided on an integrated basis.
Further, the 1996 Telecommunications Act provides the FCC with the
authority to forbear from regulating entities such as Covad Communications who
are classified as "non-dominant" carriers. The FCC has exercised its forbearance
authority. As a result, Covad Communications is not obligated to obtain prior
certificate approval from the FCC for Covad Communications' interstate services
or file tariffs for such services. Covad Communications has determined not to
file tariffs for its interstate services. Covad Communications provides its
interstate services to its customers on the basis of contracts rather than
tariffs. Covad Communications believes that it is unlikely that the FCC will
require it to file tariffs for its interstate services in the future.
On March 18, 1999, the FCC adopted rules to make it easier and less
expensive for competitive telecommunications companies to obtain central office
space and to require traditional telephone companies to make new alternative
arrangements for obtaining central office space. However, in March 2000, the
U.S. Court of Appeals for the D.C. Circuit issued a decision casting doubt on
whether new entrants will be able to locate certain kinds of equipment in the
traditional local telephone companies' central offices. The FCC's rules on
location of new entrant's equipment in central offices remain somewhat
uncertain, and have not been uniformly implemented. In the March 1999
announcement, the FCC also provided notice of proposed rule-making to determine
whether carriers should be able to provide asymmetric DSL over the same line
over which traditional telephone companies provide voice service. On November
18, 1999, the FCC required the traditional local phone companies to provide
Covad Communications and other competitive local carriers with line sharing
access. If implemented by the traditional local phone companies these rules
could materially lower the price Covad Communications pays to lease access to
the traditional telephone company's telephone wires. While Covad Communications
believes that these rules are advantageous to it, the traditional telephone
companies may balk at, delay, or thwart the implementation of such rules.
In its March 2000 ruling, the federal appeals court struck portions of the
FCC's new rules concerning the location of new entrants' equipment in
traditional local telephone companies' central offices and has required the FCC
to reconsider and review those rules. In particular, the appeals court has
required the FCC to revise its rules concerning the types of equipment that
Covad Communications may collocate on the traditional telephone company premises
and the steps that traditional telephone companies may take to separate their
equipment from its equipment. The traditional telephone companies may implement
the court's ruling and any subsequent FCC rules in
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a manner that impairs Covad Communications' ability to obtain collocation space
and collocate the equipment of its choice on their premises. Such actions by the
traditional telephone companies could adversely affect Covad Communications'
business and disrupt its existing network design, configuration and services.
On July 18, 2000, the United States Court of Appeals for the Eighth Circuit
struck down the FCC's total element long run incremental cost methodology, which
the FCC previously required state commissions to use in setting the prices for
collocation and for unbundled network elements purchased from the traditional
telephone companies. The Court also rejected an alternative cost methodology
based on "historical costs," which was advocated by the traditional telephone
companies. In rejecting the FCC's cost methodology, the court held that it is
permissible for the FCC to prescribe a forward-looking incremental cost
methodology that is based on actual incremental costs under the 1996
Telecommunications Act.
The Eighth Circuit's decision creates some additional uncertainty
concerning the prices that Covad Communications is obligated to pay the
traditional telephone companies for collocation and unbundled network elements.
While the FCC may appeal the Eighth Circuit's decision, it may also adopt new
rules to reflect the cost methodology that was approved by the Eighth Circuit.
If the decision is appealed, it is uncertain whether the Eighth Circuit's
decision will be affirmed by the United States Supreme Court. It is also
uncertain whether the FCC and state commissions will implement a new cost
methodology as a result of this decision.
The impact of these judicial and regulatory decisions on the prices Covad
Communications pays to the traditional telephone companies for collocation and
unbundled network elements is highly uncertain. There is a risk that any new
prices set by the regulators could be materially higher than current or
currently expected prices. If Covad Communications is required to pay higher
prices to the local telephone companies for collocation and unbundled network
elements, it could have a material adverse effect on their business.
Any changes in applicable federal law and regulations, in particular,
changes in its interconnection agreements with traditional telephone companies,
the prospective entry of the RBOCs into the in-region long distance business and
grant of regulatory freedom and pricing flexibility to the traditional telephone
companies, could harm Covad Communications' business.
STATE REGULATION. To the extent Covad Communications provides identifiable
intrastate services or has otherwise submitted itself to the jurisdiction of the
relevant state telecommunications regulatory commissions, it is subject to such
jurisdiction. In addition, some states have required prior state certification
as a prerequisite for processing and deciding an arbitration petition for
interconnection under the 1996 Telecommunications Act. As of August 1, 2000,
Covad Communications was authorized under state law to operate as a competitive
local exchange carrier in 45 states and intends to obtain authorization in the
other states necessary to cover its 165 targeted metropolitan statistical areas.
Covad Communications has pending arbitration proceedings in different states for
interconnection arrangements with the relevant traditional telephone companies.
Covad Communications has concluded arbitration proceedings in a number of states
by entering into interconnection agreements with the relevant traditional
telephone companies. Covad Communications has filed tariffs in certain states
for intrastate services as required by state law or regulation. It 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 unbundled network elements
(unbundled network elements are the various portions of a traditional telephone
company's network that a competitive telecommunications company can lease for
purposes of building a facilities-based competitive network, including telephone
wires, central office collocation space, inter-office transport, operational
support systems, local switching and rights of way), as well as the discount for
wholesale services that Covad Communications purchases from the relevant
traditional telephone company. The rates set forth in many of its
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 unbundled network elements as unbundled loops and
interoffice transport. Covad Communications has participated in unbundled
network element rate proceedings in several states in an effort to reduce these
rates. If any state commission decides to increase unbundled network element
rates, Covad Communications' operating results could suffer. The applicability
of the various state regulations on Covad Communications' business and
compliance requirements will be further affected by the extent to which its
services are determined to be intrastate services. Jurisdictional determinations
of Covad Communications' services as intrastate services could harm its
business.
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LOCAL GOVERNMENT REGULATION. Covad Communications may be required to obtain
various permits and authorizations from municipalities in which it operates its
own facilities. The issue of whether actions of local governments over the
activities of telecommunications carriers, including requiring payment of
franchise fees or other surcharges, pose barriers to entry for competitive
telecommunications companies which may be preempted by the FCC is the subject of
litigation. Although Covad Communications relies primarily on the unbundled
network elements of the traditional telephone companies, in certain instances it
deploys its own facilities, including fiber optic cables and, therefore, may
need to obtain 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 harm Covad Communications' business.
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 United States. In particular, several
bills pending in the 106th Congress would significantly alter or repeal
pro-competitive FCC rules and portions of the 1996 Telecommunications Act.
Passage of any these bills could adversely affect Covad Communications'
business. The ultimate outcome of these proceedings and the ultimate impact of
the 1996 Telecommunications Act or any final regulations adopted pursuant to the
1996 Telecommunications Act on Covad Communications' business cannot be
determined at this time but may well be adverse to its interests. Covad
Communications cannot predict the impact, if any, that future regulation or
regulatory changes may have on its business, and Covad Communications can give
you no assurance that such future regulation or regulatory changes will not harm
its business.
INTELLECTUAL PROPERTY
Covad Communications regards certain aspects of its products, services and
technology as proprietary and attempts to protect them with patents, copyrights,
trademarks, trade secret laws, restrictions on disclosure and other methods.
These methods may not be sufficient to protect its technology. Covad
Communications 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 Covad Communications' products, services or technology without
authorization or to develop similar technology independently.
Currently, Covad Communications has one patent and a number of patent
applications pending and intends to prepare additional applications and to seek
additional patent protection for its systems and services to the extent
possible. The pending and any future patents may not be issued to Covad
Communications, and if issued, they may not protect Covad Communications'
intellectual property from competition which could seek to design around or
invalidate these patents.
Further, effective patent, copyright, trademark and trade secret protection
may be unavailable or limited in certain foreign countries. The global nature of
the Internet makes it virtually impossible to control the ultimate destination
of Covad Communications' proprietary information. Steps taken by Covad
Communications may not prevent misappropriation or infringement of its
intellectual property rights, and litigation may be necessary in the future to
enforce its intellectual property rights to protect its 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.
In addition, others may sue Covad Communications with respect to
infringement of their intellectual property rights. Covad Communications was
recently sued by Bell Atlantic for an alleged infringement of a patent issued to
them in September 1998 entitled "Variable Rate and Variable Mode Transmission
System." On February 18, 2000, Covad Communications was granted a summary
judgment ruling in the Bell Atlantic lawsuit. The court ruled that Covad
Communications had not infringed on Bell Atlantic's patent. Bell Atlantic has
filed a notice of appeal of this decision and, while Covad Communications
expects that it will prevail on appeal, the outcome of such an appeal is
inherently uncertain. Similar lawsuits, including the appeal in the Bell
Atlantic lawsuit, could significantly harm Covad Communications' business.
EMPLOYEES
As of June 30, 2000, Covad Communications had approximately 1,700
employees, excluding temporary personnel and consultants. None of its employees
are represented by a labor union, and Covad Communications
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considers its relations with its employees to be good. Covad Communications'
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, legal and managerial personnel, and its continuing ability to
attract and retain highly qualified technical, sales, marketing, legal and
managerial personnel. Competition for such qualified personnel is intense,
particularly in software development, network engineering and product
management. In addition, in the event that its employees unionize, Covad
Communications could incur higher ongoing labor costs and disruptions in its
operations in the event of a strike or other work stoppage.
PROPERTIES
Covad Communications leases its headquarter facilities in Santa Clara,
California. These leases will expire beginning on or before July 14, 2002. Covad
Communications also leases office space in many of the metropolitan statistical
areas in which it conducts operations.
Covad Communications has recently expanded its headquarters space in Santa
Clara by leasing additional office space, and has expanded its operational space
with a new facility lease in Denver, Colorado. Through a subsidiary, Covad
Communications has also acquired land and has built a 100,000 square foot
network operations center in Prince William County, Virginia.
Covad Communications also leases central office space from the traditional
telephone company 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 its central office space is subject to the
terms of its interconnection agreements which expire on or before March 2001.
Covad Communications will increase its central office space as it expands its
network geographically.
LEGAL PROCEEDINGS
Covad Communications 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
Covad Communications 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. Covad Communications has
also filed a lawsuit against Pacific Bell and certain of its affiliates,
including SBC Communications, in federal court. Covad Communications is pursuing
a variety of contract, tort, and antitrust and other claims, such as violations
of the 1996 Telecommunications Act, in these proceedings. In November 1998,
Covad Communications prevailed in its commercial arbitration proceeding against
Pacific Bell. The arbitration panel found that Pacific Bell breached its
interconnection agreement with Covad Communications and failed to act in good
faith on multiple counts. The arbitration panel ruled in favor of awarding Covad
Communications direct damages, as well as attorneys' fees and costs of the
arbitration. Pacific Bell is currently attempting to have the decision vacated.
On May 15, 2000, the arbitration panel stated its intention to grant an award of
partial damages to Covad Communications in the amount of $27.5 million,
including $257,166 previously awarded to them by the panel. The panel also ruled
that Pacific Bell must pay reasonable attorneys' fees and costs.
Covad Communications has also filed a lawsuit against Bell Atlantic and its
affiliates in federal court. Covad Communications is pursuing antitrust and
other claims in this lawsuit. In addition, Bell Atlantic has separately filed
suit against Covad Communications 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 Covad Communications had not infringed Bell Atlantic's
patent. Bell Atlantic has filed a notice of appeal and, while Covad
Communications expects that it will prevail on an appeal, the outcome of such an
appeal is inherently uncertain.
One of Covad Communications' former employees has filed a complaint against
Covad Communications in California Superior Court, alleging that he was
terminated wrongfully and is entitled to commissions and other amounts arising
from his employment with Covad Communications. Covad Communications contends
that this employee resigned and that Covad Communications does not owe him any
money, but litigation is unpredictable and there is no guarantee Covad
Communications will prevail. Another group of its former employees has filed a
complaint against Covad Communications in California Superior Court, alleging
that they were terminated wrongfully and are entitled to various amounts arising
from their employment with Covad Communications. Covad
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Communications believes that it does not owe these employees any money, but
litigation is unpredictable and Covad Communications cannot guarantee that it
will prevail in this matter. A third employee has filed a complaint against
Covad Communications in California Superior Court, alleging that he was
terminated wrongfully based on his age. Covad Communications also believes that
they do not owe this employee any money. Failure to resolve these various legal
disputes and controversies without excessive delay and cost and in a manner that
is favorable to Covad Communications could significantly harm its business.
Covad Communications is not currently engaged in any other legal
proceedings that it believes could have a material adverse effect on its
business, prospects, operating results and financial condition. It is, however,
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 Covad Communications' interconnection agreements in
particular. In some cases, Covad Communications 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 Covad Communications'
agreements. The results of any of these proceedings could harm its business.
BLUESTAR COMMUNICATIONS GROUP, INC.
BlueStar is a provider of broadband communications and Internet services to
small- and medium-sized businesses in Tier 2 and Tier 3 markets. BlueStar's
Internet access services, which are packaged with Web hosting and e-mail, and
its high-speed real private networking services are provided primarily using
digital subscriber line, or DSL, technology. BlueStar has deployed an
asynchronous transfer mode, or ATM, and Internet protocol backbone network that
links all of its central offices and markets. This network allows it to lower
its Internet access costs, control speed and quality of its broadband services
and provides it with a superior platform for the delivery of additional enhanced
services.
BlueStar's strategy has been to be among the first competitive broadband
communications providers to small- and medium-sized businesses in the markets it
enters, creating an early mover advantage and allowing it to establish strong
relationships with targeted customers and network professionals. In each of
these markets, BlueStar has a locally based, dedicated and experienced team that
builds personalized customer relationships through direct selling. BlueStar also
ensures a high standard of service quality by providing its own customer premise
equipment installation and customer care services. BlueStar collocates its
equipment in central offices that serve a high density of its target customers,
which allows it to service more potential customers within a market and to
provide a more attractive service offering to businesses with multiple locations
or telecommuters.
BlueStar began deploying its network in the Southeast. As of June 30,
2000, BlueStar was offering its services in 38 markets, representing 131 cities.
As of June 30, 2000, BlueStar had sold 9,067 high-speed access lines, of which
3,694 were installed in the customer's business. Of the 9,067 lines sold, 2,217
lines were sold as part of its real private network service and 665 of these
lines were in service. As of June 30, 2000, BlueStar had collocated its network
equipment in 309 central offices.
BlueStar has obtained permission to provide DSL in 26 states. In addition,
BlueStar has successfully negotiated interconnection agreements with Ameritech,
BellSouth, GTE, SBC, Sprint and U S West.
COVAD ACQUISITION CORPORATION
Covad Acquisition Corporation is a wholly owned subsidiary of Covad
Communications that was organized solely for the purpose of completing the
merger. It has no other operations.
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MANAGEMENT OF COVAD COMMUNICATIONS
DIRECTORS AND EXECUTIVE OFFICERS
Covad Communications' directors and executive officers, and their
respective ages as of March 15, 2000, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Robert Knowling, Jr................. 44 Chairman of the Board, President and Chief Executive Officer
Mark Perry.......................... 50 Executive Vice President and Chief Financial Officer
Robert Davenport, III............... 40 President and Chief Executive Officer, Covad Communications
International, B.V.
Catherine Hemmer.................... 41 Executive Vice President and Chief Operating Officer
John McDevitt....................... 48 Executive Vice President, Sales and Marketing
Joseph Devich....................... 42 Executive Vice President, Corporate Services
Dhruv Khanna........................ 40 Executive Vice President, General Counsel and Secretary
Jane Marvin......................... 40 Executive Vice President, Human Resources
Terry Moya.......................... 41 Executive Vice President, External Affairs
Michael Lach........................ 38 Executive Vice President, Corporate Development and Business
Integration
Jimmy LaValley...................... 46 Executive Vice President, Community Relations
Rich Wong........................... 31 Executive Vice President, Broadband Services
Robert Hawk......................... 60 Director
Hellene Runtagh..................... 51 Director
Daniel Lynch........................ 58 Director
Frank Marshall...................... 53 Director
Rich Shapero........................ 51 Director
Larry Irving........................ 43 Director
Debra Dunn ......................... 44 Director
</TABLE>
ROBERT KNOWLING, JR. has been Covad Communications' President, Chief
Executive Officer and a member of its board of directors since July 1998. As of
September 1999, he also became Chairman of the board of directors. From October
1997 through July 1998, Mr. Knowling served as the Executive Vice President of
Operations and Technologies at U S WEST Communications, Inc., a regional
telecommunications service provider. 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
where he 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. As lead
architect of the Ameritech Corporation transformation, Mr. Knowling reported
directly to the Chairman. In July 2000, Mr. Knowling was appointed to the board
of directors for Ariba, Inc. a business-to-business eCommerce platform provider,
and Hewlett-Packard Company, a leading global provider of computing and imaging
solutions and services.
MARK PERRY joined Covad Communications in August 2000 as Chief Financial
Officer and Executive Vice President, Finance. Prior to joining Covad
Communications, he was with U S WEST Communications, where he began in 1996 as
its Vice President and Corporate Officer, Finance & Administration and
subsequently became its Vice President, Operations and Merger Integration. From
1995 to 1996, he was U S WEST Communications' Managing Director with Cable Plus,
a cable television/telecommunications joint venture that consisted of ten
operating companies. From 1994 to 1995, he was the Vice President, Finance of
Comcast International. From 1988 to 1994 he served in a variety of management
roles with U S WEST Communications, including Assistant Corporate Controller and
Chief Auditor, Vice President and Chief Financial Officer of the Cable
Communications Division. From 1976 to 1988, he was with RCA Corporation, where
he served as its Controller and as a Director, Billing and Receivables.
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ROBERT DAVENPORT, III joined Covad Communications in January 1999 He served
as its Vice President, Business Development until February 1999 and has served
as its Executive Vice President, Business Development since that date Prior to
joining Covad Communications, Mr. Davenport was Senior Vice President and Chief
Operating Officer at Tele-Communications, Inc's Internet Services subsidiary,
TCINET from 1997 to 1999 Between 1995 and 1997, Mr. Davenport was with
Tele-Communications, Inc, as Vice President, Finance and Development for the
Telephony Services subsidiary From 1992 to 1995, he was Managing Partner of RD
Partners, LLC, a private investment firm focused on leveraged equity
investments.
CATHERINE HEMMER joined Covad Communications in August 1998. She served as
its Vice President, Operations until February 1999 and served as its President,
Network Services from February 1999 to September 1999, and currently serves as
its Executive Vice President and Chief Operating Officer. From 1996 to August
1998, she was Vice President, Network Reliability and Operations at U S WEST
Communications, Inc. 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 1981 to 1987, she served in various
management roles at MCI Communications Inc. (now MCI Worldcom, Inc.), providing
management information systems support for the network operations organization.
JOHN MCDEVITT has served as Covad Communications' Executive Vice President,
Sales and Marketing since July 2000. Prior to joining Covad Communications, he
was Vice President of Sales and Marketing for Danly IEM from 1998 to June 2000.
From 1996 to 1998, Mr. McDevitt served as Business Director with Praxair, Inc.
Between 1978 and 1996, Mr. McDevitt was with Liquid Carbonic Corporation, where
he served as Vice President of Sales and Marketing, General Manager and as a
National and Regional Manager.
JOSEPH DEVICH joined Covad Communications in August 1998. He served as Vice
President and General Manager of its Western Region until February 1999, and
served as President and General Manager of the Western Region from February 1999
to September 1999. Since September 1999, he has served as Executive Vice
President, Corporate Services. Prior to joining Covad Communications, from
November 1996 to August 1998, Mr. Devich was Vice President, Operations and
Technologies Staff of U S WEST Communications, Inc., where he served on the
strategic leadership council and was responsible for leading staff support
functions, methodical and procedural process support, results reporting and
analysis, systems planning and integration, customer value analysis, disaster
recovery/business continuity planning, network security, supplier management and
operations strategy planning. From August 1986 to November 1996, Mr. Devich
worked in several capacities at Ameritech Corporation, including Manager of
Product Management--Technical Support, and Director in the areas of customer
support in the large business market, service reliability within custom business
services, process improvement of network operations and network provisioning.
DHRUV KHANNA is one of Covad Communications' founders. He served as its
Vice President, General Counsel and Secretary from October 1996 until February
1999 and has served as its Executive Vice President, General Counsel and
Secretary since that date. He was an in-house counsel for Intel Corporation'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, LLP, where his clients included Teleport Communications
Group (now AT&T Corp.), McCaw Cellular Communications, Inc. (now AT&T Wireless),
and Southern Pacific Telecom (now Qwest Communications International, Inc.). 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 act.
JANE MARVIN joined Covad Communications in April 1999 as its Senior Vice
President, Human Resources. Prior to joining Covad Communications, from August
1995 to April 1999, Ms. Marvin was Vice President, Human Resources for the
General Business, Small Business and Enhanced Business Services units and
Director, Leadership and Executive Development of Ameritech Corporation. In
these capacities, she re-engineered and streamlined multiple HR processes and
drove corporate-wide change initiatives. From 1991 to 1995, Ms. Marvin was Human
Resources Director with the Pepsi Cola Company, a division of Pepsico Inc.,
where she improved business processes in the areas of recruitment, selection,
training and compensation. From 1984 to 1991, Ms. Marvin worked in progressively
broader HR leadership roles at Data General Corporation, a provider of
enterprise hardware and software solutions.
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TERRY MOYA joined Covad Communications in July 1999 as its Senior Vice
President, External Affairs. Prior to joining Covad Communications, from January
1999 to July 1999, Mr. Moya served as Vice President & Chief Financial Officer,
Capital Management, Network/Operations and Technologies at U S WEST
Communications, Inc. From August 1998 to January 1999, Terry served as Vice
President, Operations for U S WEST Communications, Inc., where he managed over
$2 billion in capital expenditures and over $320 million in engineering and
construction transaction costs. From February 1997 to August 1998, Mr. Moya
served as Vice President, Construction, Operations and Technologies and led the
outside plant construction contracting organization for U S WEST Communications,
Inc. From August 1992 to February 1997, Mr. Moya spent time in over a half dozen
foreign countries establishing and improving several different lines of business
for U S WEST Communications, Inc. These countries include Poland, Russia, the
Czech Republic, Hungary, Brazil and the United Kingdom. Prior to August 1992,
Mr. Moya was at KPMG Peat Marwick, LLP in New Orleans.
MICHAEL LACH joined Covad Communications in January 2000 as its Executive
Vice President, Corporate Development and Business Integration. Prior to joining
Covad Communications, from May 1997 to December 1999, Mr. Lach was Vice
President, Customer Provisioning and Maintenance of Ameritech Corporation, where
he was responsible for the installation and repair of residential phone lines
across a five-state region. From October 1995 to May 1997, Mr. Lach was General
Manager, Network Operations West of Ameritech Corporation, where he was
responsible for provisioning and maintaining central offices and the transport
network in a three state region. From September 1994 to October 1995, Mr. Lach
was Division Manager, Technical Support of Ameritech Corporation, where he
supported the development and implementation of new product for residential and
business customers. From March 1993 to August 1994, Mr. Lach was Director,
Business Development for Siemens Stromberg-Carlson, Inc. From January 1984 to
February 1993, Mr. Lach served in various management roles with Ameritech
Corporation relating to its network.
JIMMY LAVALLEY joined Covad Communications in April 2000 as Executive Vice
President of Community Relations. Prior to joining the Company, from June 1979
to April 2000, Mr. LaValley was with U S WEST Communications, Inc. Most
recently, from February 1999 to April 2000, Mr. LaValley was Vice President,
Human Resources, responsible for Strategic Staffing Services and Management
Development for U S WEST's 58,000 employees. From October 1997 to February 1999,
Mr. LaValley was Vice President Human Resources supporting Network Services, the
largest U S WEST business unit. In this role, all aspects of Human Resources
support were provided to 28,000 employees. Prior to these assignments, Mr.
LaValley held leadership positions in all aspects of the Human Resources
disciplines at U S WEST.
RICH WONG joined Covad Communications in January 1999 as our Director of
Product Marketing and Vice President of Marketing and, in July 2000, became
Executive Vice President, Broadband Services. From January 1996 to January 1999,
he was an Associate and an Engagement Manager with McKinsey & Company. From June
1991 to December 1995 he was a Brand Manager in the Brand Management Group with
Proctor & Gamble.
ROBERT HAWK has served as a member of Covad Communications' 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, a regional telecommunications service provider, 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, Inc.,
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 PairGain Technologies,
Inc., COM21, Inc., Concord Communications, Inc., Radcom, Ltd., Efficient
Networks, Inc. and several privately held companies.
DANIEL LYNCH has served as a member of Covad Communications' board of
directors since April 1997. Mr. Lynch is also a founder of CyberCash, Inc. and
has served on 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 member of the
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board of directors of Exodus Communications since January 1998. Mr. Lynch
previously served as a member of the board of directors at UUNET Technologies,
Inc., from April 1994 until August 1996.
FRANK MARSHALL has served as a member of Covad Communications' 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 Covad Communications' 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, Inc., Senior Director of Marketing at AST Research, Inc., 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 Sagent Technology, Inc., a provider of real-time eBusiness
intelligence, and several privately held companies.
HELLENE RUNTAGH has served as a member of Covad Communications' board of
directors since November 3, 1999. Ms. Runtagh has served as Executive Vice
President of Universal Studios since January 1999. In this capacity, she is
responsible for overseeing the activities of the Universal Studios Operations
Group, Universal Studios Consumer Products Group, Universal Studios Corporate
Marketing and Sponsorships, the Spencer Gift retail operations, Universal
Studios' worldwide information technology, and Seagram's global sourcing and
real estate operations. From February 1997 to January 1999, she held the
position of Senior Vice President of Reengineering Effort at Universal.
Previously, Ms. Runtagh spent 25 years at General Electric, where she served as
President and Chief Executive Officer of GE Information Services from 1989 to
1996 and held general management roles with GE's capital and software
businesses.
LARRY IRVING has served as a member of Covad Communications' board of
directors since April 2000. Mr. Irving is the President and CEO of
UrbanMagic.com, an Internet portal for the African American community scheduled
to be launched later this year. Prior to joining UrbanMagic.com, Mr. Irving
served for almost seven years as Assistant Secretary of Commerce for
Communications and Information, where he was a principal advisor to the
President, Vice President and Secretary of Commerce on domestic and
international communications and information policy issues, including the
development of policies related to the Internet and Electronic Commerce. He was
a point person in the Administration's successful efforts to reform the United
States' telecommunications law, which resulted in the passage of the
Telecommunications Act of 1996. Mr. Irving is widely credited with popularizing
the term "Digital Divide" and was the principal author of the landmark Federal
survey, FALLING THROUGH THE NET which tracked access to telecommunications and
information technologies, including computers and the Internet, across racial,
economic and geographic lines. In recognition of his work to promote policies
and develop programs to ensure equitable access to advanced telecommunication
and information technologies, Irving was named one of the fifty most influential
persons in the "Year of the Internet" by Newsweek Magazine. Prior to joining the
Clinton-Gore Administration, Mr. Irving served ten years on Capitol Hill, most
recently as Senior Counsel to the U.S. House of Representatives Subcommittee on
Telecommunications and Finance. He also served as Legislative Director, Counsel
and Chief of Staff (acting) to the late Congressman Mickey Leland (D-Texas).
During the previous three years, Mr. Irving was associated with the Washington,
D.C. law firm of Hogan & Hartson, specializing in communications law, antitrust
law and commercial litigation.
DEBRA DUNN has served as a member of Covad Communications' board of
directors since April 2000. Since late 1999, Ms. Dunn has been the vice
president of Strategy and Corporate Operations for Hewlett-Packard Company and
has global responsibility for driving the broad range of efforts required to
reposition Hewlett-Packard. She is responsible for corporate-wide functions
including corporate strategy, development, communications, philanthropy and
government affairs. Ms. Dunn joined Hewlett-Packard in 1983 as an executive
development manager in Hewlett-Packard's Corporate Training division in Palo
Alto. She held a wide range of development and marketing management positions
from 1986 to 1992, and was promoted to manufacturing manager for
Hewlett-Packard's Video Communication division in 1992, marketing manager in
1993 and was named general manager of the division in 1996. Ms. Dunn was
promoted to general manager of Hewlett-Packard's executive
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committee in 1998 and led the Hewlett-Packard/Agilent split process and
Hewlett-Packard's new business creation function.
CLASSIFIED BOARD
The Covad Communications' board of directors is divided into three classes.
The term of office and directors for each class is as follows:
<TABLE>
<CAPTION>
CLASS DIRECTORS TERM OF OFFICE
-------- ------------ ------------------
<S> <C> <C>
Class I Daniel Lynch o expires at the annual meeting of stockholders in 2003 and
Rich Shapero at each third stockholders in 2003 and at each third
Larry Irving succeeding annual meeting thereafter
Class II Frank Marshall o expires at the annual meeting of stockholders in 2001 and
Hellene Runtagh at each third succeeding annual meeting thereafter
Class III Robert Hawk o expires at the annual meeting of stockholders in 2002 and
Robert Knowling, Jr. at each third succeeding annual meeting thereafter
Debra Dunn
</TABLE>
The classification of directors has the effect of making it more difficult
to change the composition of the board of directors.
BOARD COMMITTEES
In April 1998, Covad Communications' board of directors established an
audit committee and a compensation committee. The audit committee consists of
three of Covad Communications' outside directors, Mr. Lynch, Mr. Hawk and Ms.
Runtagh. The audit committee's primary responsibilities include:
o conducting a post-audit review of the financial statements and audit
findings;
o reviewing Covad Communications' independent auditors, proposed audit
scope and approach; and
o reviewing on a continuous basis the adequacy of Covad Communications'
system of internal accounting controls.
The compensation committee also consists of three of Covad Communications'
outside directors, Ms. Runtagh, Ms. Dunn and Mr. Shapero. Mr. Marshall, also an
outside director, serves as an alternate on the committee. The primary
responsibilities of the compensation committee include:
o reviewing and determining the compensation policy for Covad
Communications' executive officers and directors, and other employees
as directed by the board of directors;
o reviewing and determining all forms of compensation to be provided to
Covad Communications' executive officers; and
o reviewing and making recommendations to Covad Communications' board of
directors regarding general compensation goals and guidelines for its
employees and the criteria by which bonuses to its employees are
determined.
Covad Communications also has a pricing committee and management
compensation committee. The pricing committee currently consists of three
outside directors, Messrs. Shapero, Irving and Marshall, and one inside
director, Mr. Knowling. The function of the pricing committee is to set the
price for the sale of Covad Communications common stock to third parties. The
function of the management compensation committee, which consists solely of one
inside director, Mr. Knowling, is to review and determine the compensation
policy for employees other than executive officers and directors and to review
and determine all forms of compensation for such employees.
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DIRECTOR COMPENSATION
Except for grants of stock options subject to vesting and restricted stock
subject to repurchase, directors generally do not receive compensation for
services as a director or committee member. New directors will receive a stock
option grant to purchase 60,000 shares of Covad Communications common stock
which will vest over four years. Covad Communications does not pay additional
amounts for committee participation or special assignments of the board of
directors, except for reimbursement of expenses in attending board and committee
meetings.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the board of directors 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. Mr. Shapero is affiliated with Crosspoint Venture Partners L.P., which was
a party, along with Covad Communications, to a Series C Preferred Stock and
Warrant Subscription Agreement dated February 23, 1998.
EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to
compensation awarded to, earned by or paid to each person who served as Covad
Communications' Chief Executive Officer or was one of Covad Communications' four
other most highly compensated executive officers during the fiscal year ended
December 31, 1999. All share numbers have been adjusted in light of the 3-for-2
stock split, effected in the form of a stock dividend, effective March 31, 2000.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
------------------------------
ANNUAL COMPENSATION RESTRICTED SECURITIES
FISCAL --------------------- STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS AWARDS($) OPTIONS/SARS(#) COMPENSATION
-------------------------- -------- ----------- ----------- ------------ ---------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Robert Knowling, Jr............ 1999 $ 399,996 $ 500,000 -- -- $ 750,420 (8)
Chairman, Board of Directors, 1998 180,768(2) 250,000 -- 4,725,000 750,343 (9)
President and Chief Executive 1997 -- -- -- -- --
Officer (1)
Robert Roblin.................. 1999 $ 232,692 $ 140,250 $ 882,500(7) -- $ 405(10)
Executive Vice President, 1998 21,154(3) 9,493 -- 562,500 74(10)
Sales and Marketing (13) 1997 -- -- -- -- --
Catherine Hemmer............... 1999 $ 180,769 $ 109,500 $ 882,500(7) -- $ 240(10)
Chief Operating Officer 1998 58,359(4) 56,000 -- 437,713 84,363(11)
1997 -- -- -- -- --
Joseph Devich.................. 1999 $ 167,308 $ 101,250 $ 882,500(7) -- $ 210(10)
Executive Vice President, 1998 52,981(5) 20,137 -- 380,622 76,961(12)
Corporate Services 1997 -- -- -- -- --
Robert Davenport, III.......... 1999 $ 183,077(6) $ 91,667 -- 450,001 $ 171(10)
Executive Vice President, 1998 -- -- -- -- --
Business Development 1997 -- -- -- -- --
</TABLE>
--------------
<TABLE>
<CAPTION>
<S><C>
(1) In September 1999, Mr. Knowling became Chairman of Covad Communications' Board of Directors.
(2) Prorated based on an annual salary of $400,000 from hiring date of July 8, 1998.
(3) Prorated based on an annual salary of $220,000 from hiring date of November 16,1998.
(4) Prorated based on an annual salary of $150,000 from hiring date of August 10,1998.
(5) Prorated based on an annual salary of $150,000 from hiring date of August 13,1998.
(6) Prorated based on an annual salary of $200,000 from hiring date of January 20, 1999.
(7) This value is based upon the split-adjusted closing price of $29.416 for 30,000 post-split shares granted
on November 3, 1999 to Mr. Roblin, Ms. Hemmer and Mr. Devich. As of December 31, 1999, all of these shares
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
<S><C>
were unvested and valued at $1,118,750 based on a split-adjusted closing price of $37.29. Twenty-five
percent of these shares will vest on the four consecutive anniversaries of the grant date.
(8) Includes $750,000 for the final installment of Mr. Knowling's sign-on
bonus as well as $420 for term life insurance premium.
(9) Includes $750,000 for the first installment of Mr. Knowling's sign-on
bonus as well as $343 for term life insurance premium.
(10) The dollar amount in this column represents premium payments Covad Communications
made for term life insurance policies.
(11) Includes a payment of $84,275 as a sign-on bonus as well as $88 for term life insurance premium.
(12) Includes a payment of $76,883 as a sign-on bonus as well as $78 for term life insurance premium.
(13) On May 12, 2000, Covad Communications announced the resignation of Robert Roblin. John McDevitt has been appointed to
replace Mr. Roblin.
</TABLE>
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THE MERGER
THIS SECTION OF THE PROSPECTUS DESCRIBES CERTAIN ASPECTS OF THE PROPOSED
MERGER, INCLUDING THE MATERIAL ASPECTS OF THE MERGER AGREEMENT AND ASSOCIATED
DOCUMENTS. TO THE EXTENT IT RELATES TO THE MERGER AGREEMENT, THE FOLLOWING
DESCRIPTION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MERGER AGREEMENT
AND ITS EXHIBITS WHICH ARE ATTACHED AS APPENDIX A, AND ARE INCORPORATED HEREIN
BY REFERENCE. YOU ARE URGED TO READ THE MERGER AGREEMENT AND THE EXHIBITS.
BACKGROUND OF THE MERGER
In early January 2000, BlueStar began to explore alternatives for funding
the expansion of its network and business operations. In late January 2000,
BlueStar filed with the SEC to register for an initial public offering of its
common stock. In April 2000, before BlueStar could complete the public offering
of its stock, the public markets for new equity issuances, which up to that
point had been favorable for telecommunications companies, suffered a
substantial reversal, and BlueStar was unable to raise the capital necessary to
fund its expansion through a public offering of its stock.
At a regularly scheduled meeting of BlueStar's board of directors in early
May 2000, the directors discussed the impact of the stock market downturn and
the effect on providers of DSL. The board of directors discussed the financial
condition of BlueStar and the funding alternatives available to BlueStar. The
board of directors reviewed and discussed funding proposals from two investment
banks for a private equity financing. After reviewing the proposals, the board
of directors authorized Robert E. Dupuis, as chief executive officer of
BlueStar, to pursue the funding proposal from one of the investment banks.
On May 18, 2000, BlueStar's board of directors held a special meeting to
discuss the financial condition of BlueStar. After a discussion of the financial
condition and funding alternatives available to BlueStar and the likelihood that
the capital markets would not be available to start-up companies in BlueStar's
stage of development, the directors agreed that an acquisition of BlueStar was a
viable alternative for BlueStar that should be pursued.
On May 19, 2000, at the suggestion of the board of directors, Mr. Dupuis
traveled to Atlanta, Georgia, to meet with Robert E. Knowling, the chief
executive officer, president, and chairman of the board of Covad Communications,
to discuss a possible business combination involving the two companies. Messrs.
Dupuis and Knowling discussed the benefits of an acquisition of BlueStar. The
talks included a discussion of the impact BlueStar's business model would have
on the business operations of Covad Communications. At this meeting, Messrs.
Dupuis and Knowling established the framework for a possible acquisition of
BlueStar by Covad Communications, including structuring the merger as a
stock-for-stock transaction.
On May 22, 2000, BlueStar's board of directors held another special meeting
to discuss Mr. Dupuis' meeting with Mr. Knowling and the preliminary framework
established for the proposed merger. The board encouraged Mr. Dupuis to continue
negotiations with Covad Communications and to obtain bridge financing for
BlueStar to fund the company until a merger could be consummated or alternative
funding could be secured.
Following the meeting, the companies began consulting with their financial
and legal advisors. Covad Communications retained Bear Stearns & Co. Inc. as its
financial advisor and Simpson Thacher & Bartlett as its legal counsel. BlueStar
retained Donaldson, Lufkin & Jenrette Securities Corporation Inc. as its
financial advisor and Brobeck, Phleger & Harrison LLP as its legal counsel.
Working with their advisors, Covad Communications began conducting its due
diligence investigations using publicly available materials and began analyses
of a possible combination. These consultations continued throughout the
remaining merger discussions.
Soon after the meeting of the executives in Atlanta, Mr. Dupuis, at the
request of Mr. Knowling, contacted Ray Hernandez of Covad Communications.
Messrs. Dupuis and Hernandez, along with their advisors, conducted several
telephonic conversations over several days to establish the structure of the
acquisition and a time frame for completing the acquisition.
Over the next two weeks, Messrs. Dupuis and Hernandez had periodic
telephonic conversations to discuss the proposed merger and the possibility of
Covad Communications providing interim financing to BlueStar following execution
of the merger agreement. In addition to the telephonic conversations with Mr.
Hernandez, Messrs. Dupuis and Knowling continued to have telephonic discussions
and in-person meetings regarding the merger and the consideration to be received
by BlueStar Stockholders.
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In late May 2000, the investment bank with whom BlueStar had been
discussing proposed private equity financing withdrew its financing proposal
after conducting due diligence and reconsidering investor demand for stocks of
DSL providers.
On June 8, 2000, BlueStar received a term sheet for an equity investment
from a venture capital firm. BlueStar's board of directors called a special
meeting to discuss the proposal. The board of directors authorized the managers
of BlueStar to pursue the equity investment in the event the merger agreement
with Covad Communications was not executed.
In early June 2000, in telephonic conversations between Messrs. Dupuis and
Hernandez, Mr. Hernandez proposed that the merger consideration be issued in two
tranches rather than in one payment at the merger closing. Mr. Hernandez
suggested that Covad Communications issue up to 8,000,000 shares of Covad
Communications common stock upon the closing of the merger and up to an
additional 5,000,000 shares of Covad Communications common stock if BlueStar
achieves certain performance targets in calendar year 2001.
On June 13 and 14, 2000, BlueStar, Covad Communications and their
respective advisors intensified due diligence activities and preparation of
definitive documentation. During this time period, representatives of Covad
Communications and BlueStar held telephonic discussions to plan and to prepare
for the announcement of the acquisition. These activities continued throughout
the next two days.
Meanwhile, representatives of BlueStar continued to negotiate the sale of
an equity interest in BlueStar with the venture capital firm. The firm
eventually offered financing of up to $200 million. Representatives of BlueStar
and their legal counsel drafted documents and delivered them to the legal
counsel for the venture capital firm.
On June 14, 2000, BlueStar's board of directors held a telephonic meeting
to consider the proposed merger with Covad Communications and the proposed
purchase of BlueStar preferred stock by the venture capital firm. At this
meeting, Mr. Dupuis reviewed the financial condition of BlueStar. Mr. Dupuis
also reviewed the two transactions with the board of directors, including the
strategic reasons for the proposed transactions, the principal terms of the
proposed transactions (including the interim financing), a financial review of
the proposed transactions, and a review of Covad Communications' financial
condition and business operations.
BlueStar's internal legal counsel and representatives of Brobeck, Phleger &
Harrison discussed with the directors their fiduciary duty under Delaware law in
considering a strategic business combination. Mr. Dupuis then asked if any
director had any conflicts of interest due to the transactions. Messrs. McMinn
and Shapero abstained from participating in the discussions related to the
acquisition due to their past and present affiliations with Covad
Communications. Representatives of Brobeck, Phleger & Harrison then discussed
the terms of the merger agreement and related documents. Representatives of
Donaldson Lufkin & Jenrette presented to BlueStar's board of directors a summary
of its analyses on the strategic rationale for, and financial analyses related
to, the acquisition. In addition, Donaldson Lufkin & Jenrette delivered a draft
of a form of opinion it would be prepared to deliver to the BlueStar board,
upon payment of the fee under its engagement letter with BlueStar, to the
effect that the aggregate consideration to be paid to the BlueStar stockholders
pursuant to the merger agreement was fair, from a financial point of view, to
holders of BlueStar's stock.
The board of directors:
o determined that the terms of the merger agreement and related
agreements, as then in effect, and the transactions contemplated
thereby were advisable and fair to and in the best interests of
BlueStar and its stockholders,
o approved and adopted the merger agreement and the related agreements,
o directed that the merger agreement and the related agreements be
submitted for consideration by the BlueStar stockholders, and
o recommended that the BlueStar stockholders vote for the adoption of
the merger agreement.
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In reaching this conclusion, the board of directors of BlueStar, with the
assistance of its financial and legal advisors, considered and analyzed a number
of factors, including, without limitation, the following:
o the presentation of Donaldson Lufkin & Jenrette Securities
Corporation, Inc. and its draft of a form of opinion it would be
prepared to deliver to the BlueStar board, upon payment of the fees
under its engagement letter with BlueStar, to the effect that the
aggregate issuance of Covad Communications common stock to
stockholders of BlueStar in the transactions contemplated by the
merger agreement and the related agreements was fair, from a financial
point of view to the holders of BlueStar stock. Such opinion was
substantially in the form of the opinion subsequently delivered by DLJ
on August 4, 2000 and attached as Appendix E to this prospectus.
o reports from BlueStar's management and legal and financial advisors on
specific terms of the merger agreement and related agreements;
o the current financial position of BlueStar;
o information concerning the financial performance, business operations
and prospects of Covad Communications presented at meetings of
BlueStar's board of directors, including, among other things, Covad
Communications' recent and historical stock and revenue performance;
o the need of BlueStar to enter into a strategic relationship to compete
more effectively in the broadband DSL market;
o the registration of the Covad Communications common stock to be
exchanged for BlueStar stock in the merger;
o the provision of interim financing in order to permit BlueStar to
operate as a going concern between the time of the execution of the
merger agreement and the closing of the merger;
o the fact that the provisions of the merger agreement would permit
BlueStar's board of directors, in accordance with their fiduciary
duties and the provisions of the contribution agreement, to obtain
additional financing for BlueStar's operations in the event the
financing provided in connection with the merger was terminated or
became fully utilized;
o the unfavorable terms of the equity investment by the venture capital
firm, including the liquidation preference and dilution of current
ownership interests;
o the risk that BlueStar might not achieve its goals in an increasingly
competitive DSL market, even with the sale of additional equity; and
o the eventual need for additional capital beyond the offered private
equity and the possible difficulty of raising that capital.
Based on information with respect to the financial condition, results of
operations, cash flow, business and prospects of BlueStar on both a stand-alone
basis and as compared with those available in combination with Covad
Communications, the board of directors of BlueStar determined that the BlueStar
stockholders would benefit substantially from the merger transactions. Such
benefits would consist of:
o the ability of the BlueStar stockholders to own an interest in Covad
Communications and thereby benefit from the enhanced prospects of
Covad Communications in terms of financial and operational resources
and flexibility and its position as one of the leading DSL providers;
o the combination of BlueStar's and Covad Communications' businesses
resulting in a larger company, with more sales channels, users,
products and services and geographic coverage, which should enable
Covad Communications to compete more effectively in the DSL market
where geographic coverage is an important competitive factor;
o Covad Communications' enhanced ability to take advantage of future
strategic opportunities;
o the value of Covad Communications' name, trademarks and brand;
o the belief that the merger should allow BlueStar to meet the
challenges of the increasingly competitive environment in the Internet
market more effectively than BlueStar could on its own; and
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o the expected tax treatment of the merger.
BlueStar's board of directors also considered a number of potentially
negative factors in its deliberations concerning the merger transactions,
including:
o the possibility that the shares of Covad Communications common stock
placed in escrow may not be distributed to the BlueStar stockholders;
o the risks associated with obtaining necessary regulatory and
stockholder approvals of the merger transactions;
o the risk that the potential benefits of the merger transactions might
not be realized;
o the relative complexity of the several transactions contemplated by
the merger agreement and the related agreements, specifically the
interim financing to be provided by Bear Stearns; and
o the other risks described under "Risk Factors."
The BlueStar board of directors concluded, however, that the potential
benefits of the merger transactions to BlueStar and its stockholders outweighed
the risks associated with the foregoing factors.
The foregoing discussion of the information and factors considered by the
BlueStar board of directors in connection with its evaluation of the
transactions contemplated by the merger agreement and the related agreements is
not intended to be exhaustive but is intended to include the material factors
considered by the directors.
Upon completing its deliberations, the disinterested directors of BlueStar
unanimously approved the merger agreement and the related agreements and the
transactions contemplated by those agreements, declared them advisable and
resolved to recommend that BlueStar's stockholders adopt the merger agreement.
On June 16, 2000, the merger agreement was executed and Covad
Communications issued a press release announcing its execution.
REASONS FOR THE MERGER
The companies are merging in order to accelerate their network deployment
and expand their presence as broadband services providers using DSL technology.
The companies believe that together the companies will have greater visibility
and market penetration and will increase revenues from small- and medium-sized
businesses located in Tier 2 and Tier 3 cities.
The companies expect to realize the following benefits as a result of the
merger:
o additional distribution channels for their services and products;
o speed to market in implementing a nationwide direct sales strategy in
smaller markets;
o increased ability to provide enhanced broadband services to small- and
medium-sized businesses;
o greater visibility and market penetration in Tier 2 and Tier 3 cities;
o a large sales force with extensive experience selling broadband
services to end users; and
o higher margins for each end user.
RECOMMENDATION OF THE BLUESTAR BOARD OF DIRECTORS
THE BOARD OF DIRECTORS OF BLUESTAR BELIEVES THAT THE MERGER AGREEMENT, THE
FORM OF ESCROW AGREEMENT, THE MERGER, AND THE APPOINTMENT OF CHRISTOPHER LORD AS
THE BLUESTAR STOCKHOLDERS' AGENT UNDER THE MERGER AGREEMENT AND THE ESCROW
AGREEMENT ARE FAIR TO AND IN THE BEST INTERESTS OF BLUESTAR AND ITS STOCKHOLDERS
AND HAS APPROVED AND DECLARED ADVISABLE THE MERGER AGREEMENT, THE FORM OF ESCROW
AGREEMENT, THE MERGER, AND THE APPOINTMENT OF CHRISTOPHER LORD AS THE BLUESTAR
STOCKHOLDERS' AGENT UNDER THE MERGER AGREEMENT AND THE ESCROW AGREEMENT. THE
BLUESTAR BOARD OF DIRECTORS RECOMMENDS THAT BLUESTAR STOCKHOLDERS GIVE THEIR
CONSENT TO THE PROPOSAL TO APPROVE THE MERGER AGREEMENT, THE FORM OF ESCROW
AGREEMENT, THE MERGER, AND THE
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APPOINTMENT OF CHRISTOPHER LORD AS THE BLUESTAR STOCKHOLDERS' AGENT UNDER THE
MERGER AGREEMENT AND THE ESCROW AGREEMENT.
BOARD PRESENTATION AND OPINION OF FINANCIAL ADVISOR TO BLUESTAR
BlueStar asked Donaldson, Lufkin & Jenrette Securities Corporation, Inc.,
or DLJ, in its role as financial advisor to BlueStar, to make a presentation to
the BlueStar board on certain financial background and analyses regarding the
consideration to be received by the holders of BlueStar stock in the merger. On
June 14, 2000, DLJ delivered its presentation to the BlueStar board. In
conjunction with the presentation, DLJ supplied each of BlueStar's directors a
draft of a form of opinion DLJ would be prepared to deliver to the BlueStar
board upon payment of DLJ's fee under its engagement letter with BlueStar. Such
opinion was substantially in the form of the DLJ opinion subsequently delivered
on August 4, 2000 and described below.
At the June 14, 2000 meeting, DLJ was not requested to, nor did it, deliver
to the BlueStar board an opinion. However, DLJ did indicate that if it were
requested by BlueStar to deliver a formal opinion, it would be prepared to
render an opinion in the form previously delivered, to the effect that the
consideration to be received by the holders of BlueStar stock in the merger was
fair to such holders from a financial point of view based on the assumptions,
limitations and qualifications set forth in the draft opinion.
On August 4, 2000, after receipt of payment from BlueStar for its opinion,
DLJ delivered to the BlueStar board its written opinion, dated August 4, 2000,
to the effect that, as of June 14, 2000, based on and subject to the
assumptions, limitations and qualifications set forth in its written opinion,
the consideration to be received by the holders of BlueStar stock in the merger
was fair to such holders from a financial point of view.
THE FULL TEXT OF DLJ'S OPINION IS ATTACHED AS APPENDIX E TO THIS
PROSPECTUS. THE SUMMARY OF DLJ'S OPINION SET FORTH IN THIS PROSPECTUS IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF DLJ'S OPINION.
BLUESTAR STOCKHOLDERS ARE URGED TO READ DLJ'S OPINION CAREFULLY AND IN ITS
ENTIRETY FOR THE PROCEDURES FOLLOWED, ASSUMPTIONS MADE, OTHER MATTERS CONSIDERED
AND LIMITS OF THE REVIEW BY DLJ IN CONNECTION WITH ITS OPINION.
DLJ prepared its opinion for the BlueStar board, and the opinion addresses
only the fairness to the holders of BlueStar stock from a financial point of
view, as of June 14, 2000, of the consideration to be received by such holders.
DLJ expressed no opinion as to the price at which Covad Communications common
stock would actually trade at any time. DLJ's opinion did not address the
relative merits of the merger and the other business strategies considered by
the BlueStar board, as of June 14, 2000, nor did it address the BlueStar board's
decision to proceed with the merger. DLJ's opinion did not constitute a
recommendation to any BlueStar stockholder as to how such stockholder should
vote on the merger.
The consideration to be received by the holders of BlueStar stock was
determined in arm's length negotiations between BlueStar and Covad
Communications, in which DLJ advised BlueStar.
BlueStar selected DLJ as its financial advisor because DLJ is an
internationally recognized investment banking firm that has substantial
experience providing strategic advisory services. DLJ was not retained as an
advisor or agent to the stockholders of BlueStar or any other person. As part of
its investment banking business, DLJ is regularly engaged in the valuation of
businesses and securities in connection with mergers, acquisitions,
underwritings, sales and distributions of listed and unlisted securities,
private placements and valuations for corporate and other purposes. BlueStar did
not impose any restrictions or limitations upon DLJ with respect to the
investigations made or the procedures followed by DLJ in rendering its opinion.
In preparing its opinion, DLJ:
o reviewed the Third Amended and Restated Certificate of Incorporation
of BlueStar and the merger agreement and the exhibits thereto;
o reviewed financial and other information that was publicly available
or furnished to it by BlueStar as of June 14, 2000, including
information provided during discussions with the management of
BlueStar. Included in the information provided during discussions with
the BlueStar's management were certain financial projections of
BlueStar, as of June 14, 2000, for the period beginning January 1,
2000 and ending December 31, 2004, prepared by the management of
BlueStar and certain financial projections of Covad Communications, as
of June 14, 2000, for the period beginning January 1, 2000 and ending
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December 31, 2002, prepared by a nationally recognized research
analyst identified by the management of BlueStar;
o was informed by the management of BlueStar that, as of June 14, 2000,
BlueStar expected to exhaust its liquidity in the near term unless it
entered into a dilutive private equity financing to fund its
anticipated operating and capital needs over the following 12 months;
o compared certain financial and securities data of BlueStar and Covad
Communications with various other companies whose securities are
traded in public markets;
o reviewed the historical stock prices and trading volumes of Covad
Communications common stock;
o reviewed prices and premiums paid in certain other business
combinations; and
o conducted such other financial studies, analyses and investigations as
DLJ deemed appropriate for purposes of preparing its opinion.
In rendering its opinion, DLJ relied upon and assumed the accuracy and
completeness of all of the financial and other information that was available to
it from public sources, that was provided to it by BlueStar, or its
representatives, or that was otherwise reviewed by DLJ, as of June 14, 2000, and
assumed that BlueStar was not aware of any information prepared by it or its
advisors that might be material to DLJ's opinion that had not been made
available to DLJ, as of June 14, 2000. With respect to the financial projections
of BlueStar, as of June 14, 2000, supplied to DLJ, DLJ relied on representations
that the projections were reasonably prepared on the basis reflecting the best
available estimates and judgments of the management of BlueStar, as of June 14,
2000, as to the future operating and financial performance of BlueStar. With
respect to the financial projections prepared by the research analyst referred
to above, DLJ assumed, with BlueStar's consent, the reasonableness thereof and
that they do not materially differ from the best available estimates and
judgments of the management of Covad Communications, as of June 14, 2000, as to
the future operating and financial performance of Covad Communications. DLJ
expressed no opinion with respect to these projections or the assumptions upon
which they were based. DLJ did not assume responsibility for making any
independent evaluation of the assets or liabilities or for making any
independent verification of any of the information reviewed by DLJ. DLJ relied
as to certain legal matters, including that the merger will be free of federal
tax to BlueStar and its stockholders, on advice of counsel to BlueStar.
DLJ's opinion was necessarily based on economic, market, financial and
other conditions as they existed on, and on the information made available to
DLJ as of, June 14, 2000. DLJ states in its opinion that, although developments
subsequent to June 14, 2000 may affect DLJ's ability to reach the conclusion set
forth in its opinion as of a later date, DLJ does not have any obligation to
update, revise or reaffirm its opinion.
SUMMARY OF FINANCIAL ANALYSES PERFORMED BY DLJ
The following is a summary of the financial analyses presented by DLJ to
the BlueStar board on June 14, 2000. In conjunction with the presentation, DLJ
supplied each of BlueStar's directors with a printed version of its financial
presentation. No company or transaction used in the analyses described below is
directly comparable to BlueStar or the contemplated transaction. In addition,
mathematical analysis such as determining the mean or median is not in itself a
meaningful method of using selected company or transaction data. The analyses
performed by DLJ are not necessarily indicative of actual values or future
results, which may be significantly more or less favorable than suggested by
these analyses. The information summarized in the tables which follow should be
read in conjunction with the accompanying text.
COMPARABLE PUBLICLY TRADED COMPANY ANALYSIS/PRIVATE EQUITY TRANSACTION
ANALYSIS. DLJ noted that although the analysis set forth below analyzed the
market values and trading multiples of selected publicly traded DSL industry
companies that were comparable to BlueStar, these companies were not directly
comparable to BlueStar because (1) each of these companies had funding through
2000 and BlueStar would be required to significantly curtail operations and
terminate a large portion of its employees if it did not achieve funding
immediately and (2) BlueStar required $482,000,000 to fund its business plan and
had no ability to raise such funds in the public debt or equity markets at that
time. As a result, DLJ suggested that the most appropriate valuation methodology
to look at is multiples that can be achieved in a private equity financing.
Based on the market conditions as they were on June 14, 2000, DLJ stated that a
private equity investment in BlueStar involving a convertible preferred security
would likely value the equity of BlueStar (prior to any infusion of funds)
between
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$125,000,000 and $250,000,000, representing an enterprise value range between
1.0x and 2.0x projected 2001 revenue. If $125,000,000 of such a convertible
preferred security were assumed to be issued, it would (1) provide BlueStar,
based on BlueStar's business plan, with a comparable amount of funding to the
companies set forth below, and (2) result in the dilution of existing BlueStar
stockholders' equity interest by approximately 33.3% (on a fully diluted basis).
Subject to these qualifications, DLJ analyzed the market values and trading
multiples of selected publicly traded DSL industry companies that DLJ believed
would be reasonably comparable to BlueStar assuming that BlueStar had the
financing to effect its business plan. These comparable companies consisted of:
o Covad Communications Group, Inc.
o DSL.net Inc.
o Network Access Solutions Corp.
o NorthPoint Communications Group Inc.
o Rhythms NetConnections Inc.
In examining these comparable companies, DLJ calculated the enterprise
value of each company as a multiple of its respective: (i) 1999 revenue, LQA
revenue and projected revenues for calendar years 2000 and 2001 and (ii) net
PP&E. The enterprise value of a company is equal to the value of its
fully-diluted common equity plus debt and the liquidation value of outstanding
preferred stock, if any, minus cash and the value of certain other assets,
including minority interests in other entities. LQA means the annualized revenue
for the last quarter for which financial data for the company at issue has been
reported. Net PP&E means the book value of any plant, property and equipment
minus accumulated depreciation. All historical data was derived from publicly
available sources and all projected data was obtained from DLJ Equity Research,
in the case of DSL.net Inc. and Network Access Solutions Corp., Merrill Lynch
Research, in the case of Covad Communications Group, Inc. and NorthPoint
Communications Group Inc., and Deutsche Bank Equity Research, in the case of
Rhythms NetConnections Inc. DLJ's analysis of the comparable companies yielded
the following multiple ranges:
<TABLE>
<CAPTION>
1999 LQA 2000 2001 NET
REVENUES REVENUES REVENUES REVENUES PP&E
------------ ------------ ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
High............................. 407.5x 77.0x 26.5x 8.2x 12.1x
Low.............................. 36.5x 23.9x 14.3x 4.7x 6.9x
Average.......................... 149.8x 40.3x 19.8x 6.6x 9.2x
Median........................... 100.8x 26.8x 18.2x 6.6x 9.2x
</TABLE>
Based on an analysis of this data and BlueStar's projected results for
comparable periods, DLJ derived an implied equity value of BlueStar ranging from
$186,000,000 to $310,800,000, compared to an estimated stockholder consideration
of $189,400,000 excluding the earn-out and $295,600,000 including the earn-out
in the merger based on a Covad Communications common stock price of $26.56 as of
June 13, 2000.
PRECEDENT MERGER AND ACQUISITION TRANSACTION ANALYSIS. DLJ reviewed
selected acquisitions involving companies in the DSL and/or CLEC industry that
DLJ believed were reasonably comparable to the merger. These transactions
consisted of:
o Voyager.net Inc./CoreComm Limited
o Splitrock Services Inc./McLeod USA Inc.
o Concentric Network Corp./Nextlink Communications Inc.
In examining these acquisitions, DLJ calculated the enterprise value of the
acquired company implied by each of these transactions as a multiple of LTM
revenue and gross PP&E. LTM means the last twelve month period for which
financial data for the company at issue has been reported. Gross PP&E means the
book value of any plant, property and equipment including accumulated
depreciation. DLJ's analysis of these comparable acquisitions yielded the
following multiple ranges:
LTM ROSS
REVENUE GPP&E
--------- --------
High....................................... 25.4x 29.0x
Low........................................ 11.4x 19.6x
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Based on an analysis of this data and BlueStar's historical and projected
operating results, DLJ derived an implied equity value of BlueStar ranging from
$220,000,000 to $320,000,000, compared to an estimated stockholder consideration
of $189,400,000 excluding the earn-out and $295,600,000 including the earn-out
based on a Covad Communications common stock price of $26.56 as of June 13,
2000.
DISCOUNTED CASH FLOW ANALYSIS. DLJ performed a DCF analysis of the
projected cash flows of BlueStar for the fiscal years ending December 31, 2000
through December 31, 2009, using projections and assumptions provided by the
management of BlueStar. DCF means discounted cash flow. The DCFs for BlueStar
were estimated using discount rates ranging from 30.0% to 40.0% and 14.0% to
16.0%, based on estimates related to the weighted average costs of capital of
BlueStar, and focused on terminal multiples of estimated EBITDA for BlueStar's
fiscal year ending December 31, 2009 ranging from 9.0x to 11.0x. EBITDA means
earnings before interest expense, taxes, depreciation and amortization. The
30.0% to 40.0% discount rate range reflected DLJ's judgment as to the requisite
weighted average cost of capital for BlueStar in any funding through the private
equity market. The 14.0% to 16.0% discount rate range reflected DLJ's judgment
as to the requisite weighted average cost of capital for BlueStar in any funding
through the public equity market, assuming that BlueStar had previously secured
funding through 2000, thereby having comparable funding amounts to the
comparable public companies. Based on this analysis, DLJ estimated an equity
value of BlueStar, using discount rates ranging from 30.0% to 40.0%, ranging
from $70,200,000 to $260,400,000, and, using discount rates ranging from 14.0%
to 16.0%, ranging from $1,350,900,000 to $1,789,400,000, compared to an
estimated stockholder consideration of $189,400,000 excluding the earn-out and
$295,600,000 including the earn-out based on a Covad Communications common stock
price of $26.56 as of June 13, 2000. As noted above, DLJ estimated that a
$125,000,000 private equity market funding at such time (an amount to fund
BlueStar through 2000) would have resulted in approximately a 33.3% dilution to
existing BlueStar stockholders. DLJ also noted that BlueStar required
approximately $482,000,000 in total to fund its business plan.
CONTRIBUTION ANALYSIS. DLJ analyzed the relative contributions of BlueStar
and Covad Communications to the pro forma combined company for the years 1999
through 2004 on selected financial data, assuming no anticipated cost savings or
related expenses. DLJ analyzed the respective contributions of each company's
projected revenues and net PP&E for each of the years 1999 through 2004 based on
estimates provided by the management of BlueStar, in the case of BlueStar, and
Merrill Lynch Equity Research, in the case of Covad Communications. The implied
percent of contribution in the table below denotes each respective company's
share of the combined company's total revenue and net PP&E:
BLUESTAR IMPLIED % COVAD IMPLIED % OF
OF CONTRIBUTION CONTRIBUTION
-------------------- ------------------
REVENUES
----------
1999.............................. 1.1% 98.9%
2000.............................. 7.9% 92.1%
2001.............................. 18.2% 81.8%
2002.............................. 20.9% 79.1%
2003.............................. 24.9% 75.1%
2004.............................. 28.3% 71.7%
NET PP&E
----------
1999.............................. 2.1% 97.9%
2000.............................. 2.3% 97.7%
2001.............................. 3.1% 96.9%
2002.............................. 2.5% 97.5%
2003.............................. 2.9% 97.1%
2004.............................. 2.3% 97.7%
DLJ compared the above implied percentages of contribution to the combined
company's total revenue and net PP&E to the percentages of the combined company
that BlueStar and Covad Communications would own upon consummation of the
merger. BlueStar stockholders would own approximately 4.2% and Covad
Communications stockholders would own approximately 95.8% of the combined
company under the scenario excluding the earn-out, and BlueStar stockholders
would own approximately 6.4% and Covad Communications stockholders would own
approximately 93.6% of the combined company under the scenario including the
earn-out.
DLJ noted that there was one common director on the board of directors of
BlueStar and Covad Communications, respectively.
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The summary set forth above does not purport to be a complete description
of the analyses performed by DLJ but describes, in summary form, the material
elements of the presentation made by DLJ to the BlueStar board on June 14, 2000
and that it used in reaching its conclusion as to fairness. The preparation of a
fairness opinion involves various determinations as to the most appropriate and
relevant methods of financial analysis and the application of these methods to
the particular circumstances and, therefore, such an opinion is not readily
susceptible to summary description. Each of the analyses conducted by DLJ was
carried out in order to provide a different perspective on the transaction and
to add to the total mix of information available. DLJ did not form a conclusion
as to whether any individual analysis, considered in isolation, supported or
failed to support an opinion as to fairness from a financial point of view.
Rather, in reaching its conclusion, DLJ considered the results of the analyses
in light of each other and ultimately reached its opinion based on the results
of all analyses taken as a whole. DLJ did not place any particular reliance or
weight on any individual analysis, but instead concluded that its analyses,
taken as a whole, supported its determination. Accordingly, notwithstanding the
separate factors summarized above, DLJ has indicated to BlueStar that it
believes that its analyses must be considered as a whole and that selecting
portions of its analyses and the factors considered by it, without considering
all analyses and factors, could create an incomplete view of the evaluation
process underlying its opinion. The analyses performed by DLJ are not
necessarily indicative of actual values or future results, which may be
significantly more or less favorable than suggested by these analyses.
ENGAGEMENT LETTER
Pursuant to the terms of an engagement agreement dated May 22, 2000,
BlueStar has agreed to pay a fee that is customary in transactions of this
nature, a substantial portion of which is contingent upon the consummation of
the merger. In addition, BlueStar agreed to reimburse DLJ, upon request by DLJ
from time to time, for all out-of-pocket expenses (including the reasonable fees
and expenses of counsel) incurred by DLJ in connection with its engagement
thereunder and to indemnify DLJ and certain related persons against certain
liabilities in connection with its engagement, including liabilities under U.S.
federal securities laws. DLJ and BlueStar negotiated the terms of the fee
arrangement.
OTHER RELATIONSHIPS
DLJ, as part of its investment banking services, is regularly engaged in
the valuation of businesses and securities in connection with mergers,
acquisitions, underwritings, sales and distributions of listed and unlisted
securities, private placements and valuations for corporate and other purposes.
DLJ has performed investment banking and other services for Covad Communications
in the past and has been compensated for such services, including (i) acting as
co-manager for Covad Communications' initial public offering completed in
January 1999, (ii) acting as co-manager for Covad Communications' $215 million
offering of senior notes completed in February 1999, (iii) acting as co-manager
for Covad Communications' $285 million offering of Covad Communications common
stock completed in June 1999, and (iv) acting as co-manager for Covad
Communications' $559 million offering of Covad Communications common stock
completed in November 1999.
STRUCTURE OF THE MERGER
The merger agreement provides for the acquisition of BlueStar by Covad
Communications. If the merger agreement and related matters are approved by the
BlueStar stockholders, Covad Acquisition Corporation will merge into BlueStar.
All of BlueStar's outstanding stock will be canceled, and BlueStar will become a
wholly owned subsidiary of Covad Communications.
The merger agreement is attached as Appendix A to this prospectus. We
encourage you to read the merger agreement carefully because it is the legal
document that governs the merger.
CLOSING MATTERS
CLOSING. The closing of the merger will take place as soon as practicable
following the satisfaction or waiver of the closing conditions, unless the
merger agreement is terminated or the parties agree to a different time for
closing. See "--Conditions to the Merger," below.
EFFECTIVE TIME. In connection with the closing, the parties will file a
certificate of merger with the Secretary of State of the State of Delaware. The
merger shall become effective at the time the certificate is duly filed with the
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Secretary of State of the State of Delaware, or at a later time if specified in
the certificate and agreed to by the parties.
CONSIDERATION TO BE RECEIVED IN THE MERGER
INITIAL CONSIDERATION. Under the merger agreement, Covad Communications
will issue 8,000,000 shares of common stock, minus shares (priced at the closing
price for Covad Communications common stock on the NASDAQ National Market on the
third business day prior to closing) with a value that reflects (1) BlueStar's
transaction costs and (2) the principal, interest and expenses associated with
the interim financing extended to BlueStar prior to the merger. This
consideration will be provided at the closing of the merger, and will be divided
among BlueStar stockholders, option holders and warrant holders according to an
exchange ratio as follows:
o First, for the purpose of satisfying the liquidation preferences of
BlueStar preferred stockholders, shares of Covad Communications common
stock (priced at the average closing price for Covad Communications
common stock on the NASDAQ National Market over a 30 day period
ending three days prior to closing) will be set aside with a value
equal to $71,121,770.57, the total amount of those preferences, and
divided among the BlueStar preferred stockholders pro rata according
to their share ownership; and
o Second, each share of BlueStar stock, including the BlueStar preferred
stock, will be converted into a number of shares of Covad
Communications common stock to be calculated by dividing the remaining
shares of Covad Communications common stock to be issued in the
merger, by the total number of BlueStar shares (calculated on a fully
diluted basis, excluding certain options that have been forfeited by
their owners and are incapable of exercise).
EARN-OUT SHARES. Following the conclusion of BlueStar's 2001 fiscal year,
Covad Communications will issue up to 5,000,000 additional "earn-out" shares of
Covad Communications common stock to BlueStar's stockholders. The exact number
of the earn-out shares will depend upon the performance of BlueStar in fiscal
year 2001 against pre-established income and earnings benchmarks described in
the merger agreement.
The number of earn-out shares will be calculated by comparing BlueStar's
fiscal year 2001 (1) revenue and (2) earnings before interest, taxes,
depreciation and amortization ("EBITDA"). BOTH THE REVENUE AND THE EBITDA
THRESHOLD TARGETS MUST BE MET BEFORE ANY EARN-OUT SHARES ARE EARNED. If BlueStar
meets the revenue and EBITDA thresholds, Covad Communications will prepare a
calculation of the earn-out shares to present to the stockholders' agent soon
after the availability of audited financial statements for fiscal year 2001. The
earn-out shares will be calculated in accordance with the following table:
REVENUE EBITDA
ACTUAL 2001 EARN-OUT ACTUAL 2001 EARN-OUT
REVENUE SHARES EBITDA (LOSS) SHARES
------------------- ---------------- -------------------- ---------------
($ MILLIONS) ($ MILLIONS)
less than $112.2 0 lower than $(190.7) 0
112.2 100,000 (190.7) 100,000
113.5 200,000 (189.0) 200,000
114.7 300,000 (187.3) 300,000
116.0 450,000 (185.5) 450,000
117.2 600,000 (183.8) 600,000
118.5 800,000 (182.1) 800,000
119.7 1,000,000 (180.3) 1,000,000
121.0 1,200,000 (178.6) 1,200,000
122.2 1,400,000 (176.9) 1,400,000
123.5 1,700,000 (175.1) 1,700,000
124.7 2,000,000 (173.4) 2,000,000
130.9 2,250,000 (164.7) 2,250,000
137.2 2,500,000 (156.1) 2,500,000
The number of earn-out shares received will also be reduced by any of
BlueStar's outstanding transaction costs from the merger.
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The earn-out shares, if any, will be divided according to an earn-out
exchange ratio. Each share of BlueStar stock outstanding as of the effective
time of the merger will represent the right to receive additional shares of
Covad Communications common stock to be calculated by dividing the total number
of earn-out shares by the total number of BlueStar shares outstanding at the
effective time of the merger (calculated on a fully diluted basis, excluding
certain options that have been forfeited by their owners and are incapable of
exercise). See "--Exchange Ratios" for more detail as to how the earn-out
exchange ratio is calculated.
INTERIM FINANCING. In connection with the merger, Bear Stearns Corporate
Lending, Inc. provided BlueStar with a $40 million financing commitment 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 commitment from Bear Stearns in exchange for
shares of Covad Communications common stock. Bear Stearns also has the right to
put the loan to Covad Communications in exchange for Covad Communications common
stock in certain other circumstances.
All of the interest, principal and expenses of this interim financing will
be subtracted from the merger consideration to be received by the BlueStar
stockholders in the merger. BlueStar has currently borrowed $15.9 million for
its continued operations to the date of this prospectus, and currently expects
to borrow up to $32.0 million to the effective time of the merger.
EXCHANGE RATIOS. The full formulas for the exchange ratios for both the
initial consideration and the earn-out shares are set out in Exhibits B and C to
the merger agreement included as Appendix A to this prospectus.
FRACTIONAL SHARES. Covad Communications will not issue fractional shares in
the merger. Instead, the total number of shares of Covad Communications common
stock to be received by each BlueStar stockholder in the merger will be rounded
down to the nearest whole number, and the stockholder will receive a cash
payment for the value of the fraction of a share of Covad Communications common
stock they would otherwise have received. For the purpose of calculating the
amount of any payment for a fractional share, the Covad Communications common
stock will be valued at its closing price on the NASDAQ National Market on the
third business day prior to the closing of the merger.
TREATMENT OF STOCK OPTIONS AND BENEFIT PLANS
Pursuant to the merger agreement, all outstanding stock options granted
under BlueStar's 2000 Stock Incentive Plan or a predecessor plan, will, upon the
closing of the merger, be assumed by Covad Communications, subject to the same
terms and conditions immediately prior to the closing, except that the number of
shares subject to the option and the exercise price will be adjusted to reflect
the exchange ratio in effect at the closing. Soon after the merger becomes
effective, a document evidencing the terms of the assumption by Covad
Communications of the options will be distributed to option holders.
Under the BlueStar option plan, the vesting of the options of certain
managerial employees is accelerated upon a change of control of BlueStar such as
the merger. For these employees, each outstanding option will, at the effective
time of the merger, become vested with respect to 50% of the unvested portion of
the option. As of July 31, 2000, the merger transactions will result in the
accelerated vesting of 1,860,006 options, of which 1,275,943 options are held by
executive officers of BlueStar.
As a condition to closing, certain BlueStar officers and employees whose
options were granted under the BlueStar option plan have agreed to conditions
and restrictions on the sale of shares of Covad Communications common stock
issued in the merger and have agreed that if within 12 months of the merger they
depart Covad Communications voluntarily or are dismissed for cause, the portion
of their options that received accelerated vesting will be forfeited. See
"--Stock Restriction Agreements," below.
Covad Communications has agreed that the employees of BlueStar who continue
their employment with BlueStar after the merger will be entitled to participate
in the employee benefit and equity programs maintained by BlueStar and Covad
Communications after the merger on a basis, in the aggregate, no less favorable
than for similarly situated employees at Covad Communications or its other
subsidiaries, including for these purposes credit for length of service with
BlueStar.
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CONDITIONS TO THE MERGER
Each party's obligation to effect the transactions contemplated by the
merger agreement is subject to the satisfaction or waiver of the following
conditions on or before the closing:
o the adoption of the merger agreement by holders of 90% of all
outstanding shares of BlueStar stock;
o the absence of an injunction, restraining order or other decree that
restrains or prohibits the consummation of any of the transactions
contemplated by the merger agreement;
o the absence of a statute, rule, regulation or order that will make the
consummation of the transactions contemplated by the merger agreement
illegal; and
o the receipt of all orders, consents and approvals of any governmental
authorities legally required for the consummation of the transactions
contemplated by the merger agreement and the expiration or termination
of the waiting periods applicable under the Hart-Scott-Rodino Act and
other applicable antitrust or merger control or competition laws or
regulations, except as would not cause a material adverse effect to
BlueStar.
In addition, BlueStar's obligation to consummate the merger agreement is
further subject to the satisfaction or waiver of the following additional
conditions:
o appropriate representations and warranties of Covad Communications
contained in the merger agreement being true and correct in all
material respects as of the date of the merger agreement and as of the
closing date as though made on and as of such time, and Covad
Communications delivering to BlueStar a certificate to that effect;
o Covad Communications having performed in all material respects all
obligations required to be performed by it under the merger agreement
and BlueStar having received from Covad Communications a certificate
to that effect;
o the nonoccurrence of a material adverse effect on Covad
Communications; and
o the receipt of a tax opinion stating that the merger will be treated
as a tax-free reorganization.
In addition, the obligation of Covad Communications to consummate the
merger agreement is further subject to the satisfaction or waiver of the
following additional conditions:
o appropriate representations and warranties of BlueStar contained in
the merger agreement being true and correct in all material respects
as of the date of the merger agreement and as of the closing date as
though made on and as of such time, and BlueStar delivering to Covad
Communications a certificate to that effect;
o BlueStar having performed in all material respects all obligations
required to be performed by it under the merger agreement, and Covad
Communications having received from BlueStar a certificate to that
effect;
o BlueStar's having obtained consents from all necessary third parties;
o absence of any injunctions or restraints on the conduct of BlueStar's
business;
o nonoccurrence of a material adverse effect with respect to BlueStar;
o receipt by Covad Communications of a properly executed FIRPTA
notification letter from BlueStar;
o resignation of the directors and officers of BlueStar;
o execution of the escrow agreement;
o termination of all agreements concerning BlueStar stock;
o receipt of a tax opinion stating that the merger will be treated as a
tax-free reorganization;
o execution of stock restriction agreements by 85% of a selected group
of BlueStar's managers, 80% of its employees holding vested options
and holders of 75% of the stock held by the remaining stockholders;
and
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o certification of transaction fees and expenses.
TERMINATION OF THE MERGER AGREEMENT
The merger agreement may be terminated at any time before the closing of
the merger, whether before or after adoption of the merger agreement by BlueStar
stockholders:
o by mutual consent of Covad Communications and BlueStar;
o by Covad Communications or BlueStar by written notice to the other
party if the closing has not occurred by December 31, 2000; provided,
that this termination right will not be available to a party whose
action or failure to act has been the cause or resulted in the failure
of the merger;
o by Covad Communications if:
(1) BlueStar breaches in any material respect any representation,
warranty, obligation or agreement and does not cure it within
five business days upon written notice from Covad Communications;
or
(2) BlueStar's board of directors withdraws or modifies its
recommendation of the merger agreement or the merger in a manner
adverse to Covad Communications;
o by BlueStar if Covad Communications breaches in any material respect
any representation, warranty, obligation or agreement and does not
cure it within five business days upon written notice from BlueStar;
and
o by Covad Communications or BlueStar if any permanent injunction or
other order preventing the merger becomes final and nonappealable.
CONDUCT OF BUSINESS PENDING THE CLOSING OF THE MERGER
Under the merger agreement, BlueStar has agreed that prior to the closing
of the merger agreement, except where Covad Communications has consented to such
action, BlueStar will operate its businesses only in the ordinary course of
business, consistent with past practice. Moreover, except as expressly permitted
in the merger agreement, BlueStar will not:
o amend its certificate of incorporation or bylaws;
o issue, purchase or redeem, or declare or pay any dividend with respect
to, any shares of BlueStar stock or any class of securities
convertible into, or any rights, warrants or options to acquire, any
of these securities, other than issuances of BlueStar common stock
upon the exercise of stock options outstanding on the date of the
merger agreement in accordance with its terms and limited issuances of
new BlueStar options in accordance with the merger agreement;
o adopt any stock option plans (provided that it may complete grants
that it is already committed to grant);
o enter into, violate, amend or modify any material contracts;
o issue, deliver or sell or authorize or propose the issuance, delivery
or sale of, any shares of its stock or securities convertible into
such stock, or subscriptions, rights, warrants or options to acquire,
or other agreements or commitments of any character obligating it to
issue any such stock or other convertible securities, other than the
issuance of stock pursuant to the exercise of outstanding stock
options or warrants;
o transfer to any person or entity any intellectual property other than
pursuant to non-exclusive non-source code licenses in the ordinary
course of business consistent with past practice;
o enter into or amend any agreements granting exclusive marketing or
other exclusive rights with respect to any of its products, services
or technologies;
o sell, lease, license or otherwise dispose of or encumber any of its
properties or assets which are material, individually or in the
aggregate, to its business;
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o incur any indebtedness for borrowed money in excess of $60,000 or
guarantee any such indebtedness or issue or sell any debt securities
or guarantee any debt securities of others, other than indebtedness to
Covad Communications;
o enter into any operating lease involving payments in excess of $60,000
annually or $5,000 monthly;
o pay, discharge or satisfy in an amount in excess of $20,000 in any one
case or $60,000 in the aggregate, any claim, liability or obligation
arising other than in the ordinary course of business, except as
already reserved in the financial statements;
o make any capital expenditures, capital additions or capital
improvements, except in the ordinary course of business and consistent
with past practice;
o materially reduce the amount of any material insurance coverage
provided by existing insurance policies;
o terminate or waive any right or rights which individually or in the
aggregate would reasonably be expected to be material in value, other
than in the ordinary course of business;
o increase or accelerate the compensation or fringe benefits of any
current or former director or employee or adopt or amend any employee
benefit or stock purchase or option plan or pay any special bonus or
special remuneration to any employee or director, except in the
ordinary course of business consistent with past practice;
o grant, pay or agree to any provisions regarding severance or
termination pay to any director, officer or other employee except as
agreed to with Covad Communications;
o commence a lawsuit or take any action in connection with any existing
or threatened lawsuit, administrative proceeding, mediation,
arbitration or other similar proceeding other than routine exceptions;
o acquire, merge or consolidate with any business or any corporation,
partnership, association or other business organization or division
thereof, or otherwise acquire any assets which are material,
individually or in the aggregate, to its business;
o other than in the ordinary course of business, make or change any
material policies in respect of taxes;
o revalue any of its assets, other than in the ordinary course of
business;
o fail to give all notices and other information required to be given to
the employees or any other labor group;
o delay or otherwise change the manner of payment of accounts payable or
other liabilities; or
o take or agree to take any action which would make any of its
representations or warranties contained in the merger agreement untrue
or incorrect or prevent it from performing any of its covenants
thereunder.
ADDITIONAL COVENANTS AND AGREEMENTS
In addition to the above covenants related to the conduct of BlueStar's
business prior to the closing, BlueStar has agreed:
o not to solicit, initiate or encourage any other takeover proposal or
to engage in negotiations with, or grant confidential information or
access to BlueStar's properties, records or books to any other person
who has advised BlueStar that it may be considering making, or who has
made, a takeover proposal;
o to keep Covad Communications fully informed as to negotiations for any
additional bridge financing BlueStar may require, and not to enter
into an agreement for any such financing without Covad Communications'
consent unless BlueStar will not incur any expenses or financial or
other material obligations in relation thereto prior to the
termination of the merger agreement; and
o to grant Covad Communications access to BlueStar's financial and other
records.
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Covad Communications has agreed to take all necessary actions to obtain an
amendment to its certificate of incorporation to permit the issuance of the
Covad Communications common stock to be issued in the merger. It has since
obtained approval for this amendment.
Both parties have agreed to cooperate on steps to be taken toward
registering the stock to be issued in the merger and to preparing this
prospectus.
REPRESENTATIONS AND WARRANTIES
The merger agreement contains customary representations and warranties
relating to, among other things:
o corporate organization and similar corporate matters concerning Covad
Communications and BlueStar;
o authorization, execution, delivery, performance and enforceability of,
conflicts and defaults created by, and required consents, approvals
and authorizations of governmental authorities relating to, the merger
agreement and related matters;
o engagement and payment of fees of brokers, investment bankers, finders
and financial advisors by both Covad Communications and BlueStar;
o the capital structure of both Covad Communications and BlueStar;
o stock options of BlueStar;
o financial information of BlueStar being presented fairly and the
absence of undisclosed liabilities of BlueStar, the accuracy of
information contained in those financial statements and the absence of
undisclosed liabilities of BlueStar;
o the absence of material changes or events concerning BlueStar;
o the validity and enforceability of contracts and other agreements of
BlueStar;
o the absence of legal proceedings relating to BlueStar;
o the absence of labor controversies of BlueStar;
o intellectual property of BlueStar;
o governmental licenses and permits of BlueStar;
o compliance with applicable laws;
o employee benefit matters of BlueStar;
o filing of tax returns and payment of taxes by BlueStar; and
o Year 2000 compliance of BlueStar.
AMENDMENT
The merger agreement may not be amended or modified except in a writing
signed by all parties thereto. However, after the adoption of the merger
agreement by the stockholders of BlueStar, the merger agreement may only be
amended, without the further approval of such stockholders, as permitted by law.
REGULATORY APPROVALS REQUIRED
Under the Hart-Scott-Rodino Act, and the rules promulgated thereunder by
the FTC, the transactions contemplated by the merger agreement cannot be
consummated until notifications have been given to the FTC and the Antitrust
Division of the Department of Justice and the specified waiting periods have
expired or terminated. The notifications required under the Hart-Scott-Rodino
Act were furnished to the FTC and the Antitrust Division by Covad Communications
and BlueStar with respect to the transactions contemplated by the merger
agreement on July 7, 2000. Additional materials were provided in relation to
Crosspoint Venture Partners LS 1997, the holder of a substantial amount of
BlueStar stock on July 12, 2000. The waiting period under the Hart-Scott-Rodino
Act expired at 11:59 p.m., eastern time, on August 4, 2000. Notwithstanding the
termination of the waiting periods under the
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Hart-Scott-Rodino Act, the Antitrust Division, the FTC or any state or foreign
governmental authority could take such action under the antitrust laws as it
deems necessary or desirable in the public interest. Such action could include
seeking to enjoin the consummation of the transactions contemplated by the
merger agreement or seeking divestiture of portions of the businesses intended
to be part of Covad Communications. Private parties may also seek to take legal
action under the antitrust laws under specific circumstances. Pursuant to the
merger agreement, any filing fees required by the Hart-Scott-Rodino Act will be
paid by the stockholders of BlueStar as transaction costs if the merger is
consummated.
There can be no assurance that a challenge to the consummation of the
transactions on antitrust grounds will not be made or that, if such a challenge
were made, the parties to the merger agreement would prevail.
To the extent that BlueStar and Covad Communications provide identifiable
intrastate services or have otherwise submitted themselves to the jurisdiction
of the relevant state telecommunications regulatory commissions, they are
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 Telecommunications Act.
In addition, Covad Communications and BlueStar must receive authorization
from or make filings with the appropriate governmental authorities for the
transfer of control of BlueStar's CLEC authority (required for the operation of
BlueStar's business). BlueStar has received all of the approvals from the
appropriate government authorities that it believes are necessary for the
consummation of the merger.
EXPENSES
The parties to the merger agreement have agreed that all costs and expenses
incurred in connection with the merger shall be borne by the party incurring
such expenses, except that if the merger closes then BlueStar's investment
banking, legal and other related merger fees and expenses shall be deducted from
the merger consideration received by BlueStar stockholders.
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion describes the material federal income tax
consequences of the exchange of shares of BlueStar stock for Covad
Communications common stock, pursuant to the merger that are generally
applicable to holders of BlueStar stock. This discussion is based on currently
existing provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), existing and proposed Treasury regulations thereunder and current
administrative rulings and court decisions, all of which are subject to change.
Any such change, which may or may not be retroactive, could alter the tax
consequences to BlueStar stockholders as described herein.
BlueStar stockholders should be aware that this discussion does not deal
with all federal income tax considerations that may be relevant to particular
BlueStar stockholders in light of their particular circumstances, such as
stockholders who are dealers in securities, who are subject to the alternative
minimum tax provisions of the Code, who are foreign persons, who do not hold
their BlueStar stock as capital assets, or who acquired their shares in
connection with stock option or stock purchase plans or in other compensatory
transactions. In addition, the following discussion does not address the tax
consequences of the merger under foreign, state or local tax laws, the tax
consequences of transactions effectuated prior or subsequent to, or concurrently
with, the merger (whether or not any such transactions are undertaken in
connection with the merger), including without limitation any transaction in
which shares of BlueStar stock are acquired or shares of Covad Communications
common stock are disposed of, or the tax consequences of any receipt of rights
to acquire Covad Communications common stock. ACCORDINGLY, BLUESTAR STOCKHOLDERS
ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES
TO THEM OF THE MERGER, INCLUDING THE APPLICABLE FEDERAL, STATE, LOCAL AND
FOREIGN TAX CONSEQUENCES AND THE EFFECT OF POSSIBLE CHANGES IN APPLICABLE TAX
LAWS.
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The merger is intended to constitute a reorganization within the meaning of
the Code. Provided that the merger does so qualify as a reorganization, then,
subject to the limitations and qualifications referred to herein, the merger
will generally result in the following federal income tax consequences to the
BlueStar stockholders:
o No gain or loss will be recognized by holders of BlueStar stock solely
upon their receipt of Covad Communications common stock in exchange
for BlueStar stock in the merger (except to the extent of cash
received in lieu of a fractional share of Covad Communications common
stock).
o The aggregate tax basis of the Covad Communications common stock
received by BlueStar stockholders in the merger (including any tax
basis attributable to fractional shares deemed to be disposed of) will
be the same as the aggregate tax basis of the BlueStar stock
surrendered in exchange therefor.
o The holding period of the Covad Communications common stock received
by BlueStar stockholders in the merger will include the period for
which the BlueStar stock surrendered in exchange therefor was
considered to be held, provided that BlueStar stock so surrendered is
held as a capital asset at the time of the merger.
o Cash payments received by holders of BlueStar stock in lieu of a
fractional share will be treated as if such fractional share of Covad
Communications common stock had been issued in the merger and then
redeemed by Covad Communications. A BlueStar stockholder receiving
such cash will recognize gain or loss, upon such payment, measured by
the difference, if any, between the amount of cash received and the
basis in such fractional share.
The parties have not and will not request a ruling from the Internal
Revenue Service as to the tax consequences of the merger or any related
transaction. The Internal Revenue Service may adopt positions contrary to that
discussed below and such positions could be sustained.
A successful Internal Revenue Service challenge to the reorganization
status of the merger would result in BlueStar stockholders recognizing taxable
gain or loss with respect to each share of BlueStar stock surrendered equal to
the difference between the stockholder's basis in such share and the fair market
value, as of the effective time of the merger, of the Covad Communications
common stock received in exchange therefor. In such event, a stockholder's
aggregate basis in the Covad Communications common stock so received would equal
its fair market value, and the stockholder's holding period for such stock would
begin the day after the merger.
The obligations of BlueStar and Covad Communications to complete the
merger are conditioned upon the receipt by BlueStar of an opinion of its
counsel, Brobeck, Phleger & Harrison LLP, and the receipt by Covad
Communications of an opinion of its counsel, Simpson Thacher & Bartlett, that
the merger will, for federal income tax purposes, constitute a "reorganization"
within the meaning of Section 368(a) of the Code. The tax opinions will be based
upon facts, representations and assumptions set forth or referred to in the
opinion and the continued accuracy and completeness of representations made by
Covad Communications and BlueStar, including representations in certificates to
be delivered to counsel by the management of each of Covad Communications and
BlueStar which if incorrect in any material respect could change the conclusions
in the opinion. If BlueStar's counsel or Covad Communications' counsel does not
give such a tax opinion, then the opinion may instead be supplied by Covad
Communications' or BlueStar's counsel, as the case may be.
The parties to the merger intend that the merger qualify as a tax free
reorganization pursuant to Section 368 of the Code. Therefore, you should report
the transaction in your tax returns as a reorganization pursuant to Section 368
of the Code. To do so, you must include with your federal income tax return for
the year of the merger the statements required by the applicable U.S. Treasury
regulations.
ANTICIPATED ACCOUNTING TREATMENT
Covad Communications intends to account for the transactions with BlueStar
as the accounting acquiror in a purchase business combination for financial
reporting and accounting purposes, under generally accepted accounting
principles.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Some members of the BlueStar board of directors and management have
interests in the merger in addition to their interests generally as stockholders
of BlueStar. These include, among other things, provisions in the merger
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agreement relating to indemnification and the acceleration and/or payout of
benefits under specified agreements and employee stock option agreements. In
addition, two of BlueStar's directors have a financial interest in Covad
Communications. The BlueStar board of directors was aware of these interests and
considered them, among other matters, in approving the merger agreement and the
transactions contemplated thereby.
EMPLOYMENT AND OTHER AGREEMENTS. Two officers of BlueStar, one of whom also
is a director, have agreements with BlueStar that provide for compensation in
the event of a change in control of BlueStar. Pursuant to an employment
agreement with Robert E. Dupuis, BlueStar's chief executive officer and the
chairman of the board of directors, 50% of Mr. Dupuis' unvested options shall
automatically vest upon a change in control. In the event Mr. Dupuis
involuntarily loses his job within six months following a change in control, the
balance of his unvested options will vest. BlueStar also is required to pay Mr.
Dupuis a sum equal to twelve months' salary in the event Mr. Dupuis is
terminated without cause at any time.
Richard L. Burtner, BlueStar's Chief Financial Officer, is a party to a
stock restriction and special payment agreement. Pursuant to this agreement, Mr.
Burtner was required to place 65% of his shares in escrow. Upon a change in
control, Mr. Burtner is entitled to receive from escrow 50% of his escrowed
shares upon a change in control. In the event Mr. Burtner is terminated without
cause (as defined in the agreements), he is entitled to receive from escrow a
number of shares equal to 25% of the shares remaining in escrow and is also
entitled to be paid a sum equal to six months' salary. BlueStar may repurchase
any shares remaining in escrow, if any, at a price of $0.049 per share.
INDEMNIFICATION AND DIRECTORS' AND OFFICERS' INSURANCE. The merger
agreement provides that Covad Communications will cause the surviving
corporation to indemnify each present and former director and officer of
BlueStar or any of its subsidiaries, to the fullest extent permitted under
BlueStar's certificate of incorporation, bylaws or applicable law, for
liabilities for acts or omissions occurring at or prior to the date of the
BlueStar merger. The indemnification obligations include the payment of any
costs, judgments, settlements or attorneys' fees and providing advances of
expenses. The merger agreement also provides that Covad Communications shall
cause the surviving corporation to maintain BlueStar's current directors' and
officers' liability insurance coverage on terms no less favorable than the
policy currently in effect for six years after the date of the BlueStar merger,
but the surviving corporation is not obligated to pay for any annual premium
more than 200% of the amount paid for premiums by BlueStar as of the date of the
merger agreement.
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.
INTERESTED DIRECTORS. Two of BlueStar's directors, Richard A. Shapero and
Charles J. McMinn, have interests in Covad Communications. Mr. Shapero is a
director of Covad Communications and holds options to acquire shares of Covad
Communications common stock. Mr. McMinn is a founder and former chief executive
officer of Covad Communications. Mr. McMinn owns a substantial number of shares
of Covad Communications common stock. As a result of these relationships,
Messrs. Shapero and McMinn abstained from deliberations and voting on the merger
transactions at BlueStar's board of directors meetings.
STOCK OPTION PLANS. Pursuant to the merger agreement, all outstanding stock
options granted under BlueStar's 2000 Stock Incentive Plan or a predecessor
plan, and each option granted under these plans, will, upon the closing of the
merger, be assumed by Covad Communications, subject to the same terms and
conditions immediately prior to the closing, except that the number of shares
subject to the option and the exercise price will be adjusted to reflect the
conversion ratio in effect at the closing.
Upon a change of control of BlueStar, the vesting of the options of
certain managerial employees is accelerated. For each of these employees, 50% of
their respective unvested options held as of the date of the merger will become
fully vested. Accordingly, as of July 31, 2000 the merger will result in the
accelerated vesting of
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1,860,006 options, of which 1,275,943 options are held by executive officers of
BlueStar. As a condition to closing, certain BlueStar officers and employees
have agreed to conditions and restrictions on the sale of shares of Covad
Communications common stock issued in the merger and have agreed that, if within
12 months of the merger they depart Covad Communications voluntarily or are
dismissed for cause, the portion of their options that received accelerated
vesting will be forfeited. See "--Stock Restriction Agreements," below.
Covad Communications has agreed that the employees of BlueStar who continue
their employment with BlueStar after the merger will be entitled to participate
in the employee benefit and equity programs maintained by BlueStar and Covad
Communications after the merger on a basis, in the aggregate, no less favorable
than for similarly situated employees at Covad Communications or its other
subsidiaries, including for these purposes credit for length of service with
BlueStar.
RESALE OF COVAD COMMUNICATIONS COMMON STOCK
The shares of Covad Communications common stock to be issued to
stockholders of BlueStar pursuant to the merger have been registered under the
Securities Act, so these shares may generally be freely traded without
restriction by people who will not be "affiliates" of Covad Communications after
the merger and who were not "affiliates" of BlueStar on the date of the BlueStar
action by written consent for purposes of Rule 145 under the Securities Act. All
directors and certain officers of BlueStar may be deemed to have been
"affiliates" of BlueStar within the meaning of such rule. Those people may
resell the Covad Communications common stock received by them in the merger only
if the shares are registered for resale under the Securities Act or an exemption
from such registration under the Securities Act is available. Those people may
be permitted to effect resales under the volume limitation safe harbor
provisions of Rule 145 under the Securities Act (or Rule 144 in the case of such
persons who become "affiliates" of Covad Communications) or as otherwise
permitted under the Securities Act. People who may be deemed to be affiliates of
BlueStar or Covad Communications generally include individuals or entities that
control, are controlled by, or are under common control with, BlueStar or Covad
Communications, as applicable, and may include certain officers and directors of
such party as well as principal stockholders of BlueStar or Covad
Communications, as applicable. It is recommended that any such person obtain
advice of securities counsel prior to effecting any resales.
The merger agreement provides that prior to the closing of the merger,
BlueStar will use all reasonable efforts to cause each of its affiliates to
deliver a written agreement to Covad Communications prior to the closing of the
merger, to the effect that such person will not offer or sell or otherwise
dispose of any of the Covad Communications common stock received in the merger
in violation of the Securities Act or the rules and regulations thereunder.
This prospectus does not cover resales of Covad Communications common stock
received by any person who may be deemed to be an affiliate of Covad
Communications or BlueStar.
DISSENTERS' RIGHTS
The following summary of the provisions of Section 262 of the Delaware
General Corporation Law is not intended to be a complete statement of the
provisions and is qualified in its entirety by reference to the full text of
Section 262 of the Delaware General Corporation Law, which is included as
Appendix F to this prospectus.
Under Delaware law, BlueStar stockholders are entitled to appraisal rights.
If the transaction is consummated, each holder of BlueStar stock who
(1) files a written demand with BlueStar of an intention to exercise
rights to appraisal of his, her or its shares within 20 days of
the mailing of notice of the approval of the merger and the
exercise of appraisal rights,
(2) does not vote in favor of the merger or consent thereto in
writing, and
(3) follows the procedure set forth in Section 262 of the DGCL,
will be entitled to be paid the fair value for his, her or its common or
preferred stock, as the case may be. The fair value of shares of BlueStar stock
will be determined without giving effect to any value arising out of the merger.
The shares of BlueStar stock with respect to which holders have perfected their
appraisal rights in accordance with
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Section 262 and have not effectively withdrawn or lost their appraisal rights
are referred to as the "dissenting shares."
Within 10 days after the effective date of the merger, BlueStar, as the
surviving corporation in the merger, must mail a notice to all stockholders who
have complied with (1) and (2) above notifying such stockholder of the effective
date of the merger. Within 120 days after the effective date of the merger,
holders of BlueStar stock may file a petition in the Delaware Court of Chancery
for the appraisal of their shares, although they may, within 60 days of the
effective date, withdraw their demand for appraisal. Within 120 days of the
effective date of the merger, the holders of dissenting shares may also, upon
written request, receive from BlueStar a statement setting forth the aggregate
number of shares with respect to which demands for appraisal have been received.
A demand for appraisal should be signed by or on behalf of the stockholder
exactly as the stockholder's name appears on the stockholder's stock
certificate(s). If the shares are owned of record in a fiduciary capacity, such
as a trustee, guardian or custodian, the demand should be executed in that
capacity, and if the shares are owned of record by more than one person, as in a
joint tenancy or tenancy in common, the demand should be executed by or on
behalf of all joint owners. An authorized agent, including one or more joint
owners, may exercise a demand for appraisal on behalf of a record holder;
however, in the demand the agent must identify the record owner or owners. A
record holder such as a broker who holds shares as nominee for several
beneficial owners may exercise appraisal rights for shares held for one or more
beneficial owners and not exercise rights for the shares held for other
beneficial owners. In this case, the written demand should state the number of
shares for which appraisal rights are being demanded. When no number of shares
is stated, the demand will be presumed to cover all shares held of record by the
broker or nominee.
If any BlueStar stockholder who demands appraisal of his, her or its shares
under Section 262 of the DGCL fails to perfect, or effectively withdraws or
loses, the right to appraisal, his, her or its shares will be converted into a
right to receive a number of shares of Covad Communications common stock in
accordance with the terms of the merger agreement. Dissenting shares lose their
status as dissenting shares if:
o the merger is abandoned,
o the dissenting stockholder fails to make a timely written demand for
appraisal,
o the dissenting shares are voted, or a written consent given, in favor
of the merger,
o neither BlueStar nor the stockholder files a complaint or intervenes
in a pending action within 120 days of the effective date of the
merger, or
o the stockholder delivers to BlueStar as the surviving corporation,
within 60 days of the effective date of the merger, or thereafter with
BlueStar's approval, a written withdrawal of the stockholder's demand
for appraisal of the dissenting shares, although no appraisal
proceeding in the Court of Chancery may be dismissed as to any
stockholder without the approval of the court.
FAILURE TO FOLLOW THE STEPS REQUIRED BY SECTION 262 OF THE DELAWARE GENERAL
CORPORATION LAW FOR PERFECTING APPRAISAL RIGHTS MAY RESULT IN THE LOSS OF
APPRAISAL RIGHTS, IN WHICH EVENT A BLUESTAR STOCKHOLDER WILL BE ENTITLED TO
RECEIVE THE CONSIDERATION WITH RESPECT TO THE HOLDER'S DISSENTING SHARES IN
ACCORDANCE WITH THE MERGER AGREEMENT. IN VIEW OF THE COMPLEXITY OF THE
PROVISIONS OF SECTION 262, BLUESTAR STOCKHOLDERS WHO ARE CONSIDERING OBJECTING
TO THE MERGER SHOULD CONSULT THEIR OWN LEGAL ADVISORS.
PROCEDURES FOR EXCHANGING BLUESTAR STOCK CERTIFICATES
THE EXCHANGE AGENT. Promptly after the effective time of the merger, Covad
Communications is required to deposit with a bank or trust company certificates
representing the shares of Covad Communications common stock to be exchanged for
shares of BlueStar stock and any dividends or distributions to which holders of
BlueStar stock may be entitled to receive under the merger agreement.
PROCEDURES FOR EXCHANGING STOCK CERTIFICATES. Promptly after the effective
time of the merger, Covad Communications will cause the exchange agent to mail
to the holders of record of BlueStar stock certificates,
(1) a letter of transmittal and
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(2) instructions on how to surrender BlueStar stock certificates in
exchange for certificates representing shares of common stock of Covad
Communications and any dividends or other distributions that they may be
entitled to receive under the merger agreement. HOLDERS OF BLUESTAR STOCK
SHOULD NOT SURRENDER THEIR BLUESTAR STOCK CERTIFICATES UNTIL THEY RECEIVE
THE LETTER OF TRANSMITTAL FROM THE EXCHANGE AGENT.
Upon surrendering their BlueStar stock certificates to the exchange agent
for cancellation, together with the letter of transmittal and any other
documents required by the exchange agent, the holders of BlueStar stock
certificates will be entitled to receive a certificate representing that number
of shares of Covad Communications common stock which that holder has the right
to receive (less escrow shares) and any dividends or other distributions to
which the holder is entitled. Until surrendered to the exchange agent, from and
after the effective time, outstanding BlueStar stock certificates will be deemed
to evidence
(1) only the right to receive the number of full shares of Covad
Communications common stock into which the shares of BlueStar stock
formerly represented thereby have been converted and
(2) the right to receive any dividends or distributions payable under
the merger agreement.
DISTRIBUTIONS WITH RESPECT TO UNEXCHANGED SHARES. Until each BlueStar
stockholder surrenders his or her BlueStar stock certificate in exchange for
Covad Communications common stock, that stockholder will not receive any
dividends or other distributions declared or made by Covad Communications after
the effective time of the merger. However, once that stockholder surrenders his
or her BlueStar stock certificate to the exchange agent, he or she will receive
cash, without interest, as payment for any dividends or other distributions
previously made by Covad Communications after the effective time of the merger.
STOCKHOLDER AGREEMENTS
In connection with the merger agreement, Covad Communications and certain
stockholders of BlueStar entered into stockholders agreements on June 15, 2000
as a condition to the signing of the merger agreement. Under the stockholders
agreements, the BlueStar stockholders have agreed to retain ownership of their
BlueStar stock prior to the merger and to vote all of their shares of BlueStar
stock in favor of the adoption of the merger agreement. The stockholders have
also agreed to give Covad Communications an irrevocable proxy over their stock
in relation to proposals relating to the approval of the merger and the merger
agreement and other matters that would facilitate their approval. They have also
agreed, subject to any fiduciary duties as directors and officers of BlueStar,
not to initiate, solicit or negotiate other acquisition proposals prior to the
expiration of the stockholder agreement.
The stockholder agreement expires on the earlier of the date of the
happening of the merger or date of the termination of the merger agreement.
Stockholders, including Robert E. Dupuis, Chairman and CEO of BlueStar,
holding a majority of the voting stock and a majority of the preferred stock,
have entered into such agreements. In total, stockholders representing
18,166,844 of 22,687,646 total outstanding shares of BlueStar preferred stock
(approximately 80% of such stock), and shares of 22,193,822 total outstanding
shares of BlueStar stock (approximately 62% of such stock) have signed
stockholder agreements and each is an affiliate of BlueStar.
STOCK RESTRICTION AGREEMENTS
BlueStar has agreed as a condition to closing that it will obtain stock
restriction agreements from 85% of a selected group of BlueStar's managers, 80%
of its employees holding vested stock options, and holders of 75% of the stock
held by the remaining stockholders.
The stock restriction agreements restrict the ability of the signatories
to transfer the Covad Communications stock they receive in the merger, or any
interest in it, for a period of 12 months (in the case of the managers) or
six months (in the case of other signatories).
The agreements also provide that, if an option holder has received an
accelerated vesting of options due to a change of control brought about by the
merger, as will be the case for some managers, then the accelerated options will
be subject to forfeiture if the option holder leaves the employment of BlueStar
or is dismissed for cause within 12 months.
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ESCROW AGREEMENT
Before the effective time of the merger, Covad Communications, Christopher
Lord, as agent for the BlueStar stockholders, and an escrow agent will enter
into an escrow agreement providing for 800,000 of the shares of Covad
Communications common stock to be issued upon the closing of the merger to be
delivered to the escrow agent upon the closing of the merger. This fund will be
used to indemnify Covad Communications in the event that BlueStar is found to
have breached the merger agreement. Covad Communications will be entitled to
make claims against the escrow fund in the event of certain breaches or other
circumstances. In most cases of breach by BlueStar, the escrow fund will be
Covad Communications' exclusive source of indemnification. The escrow agreement
is an integral part of the merger agreement.
You will be asked to approve the appointment of Christopher Lord as the
stockholders' agent by executing a written consent.
After the escrow period expires 12 months after the merger becomes
effective, shares in escrow that are not required to meet pending claims will be
released to the BlueStar stockholders.
If there are still claims pending against the escrow fund when the earn-out
shares are calculated, and there are inadequate shares remaining in escrow to
cover these claims, then sufficient earn-out shares to cover the pending claims
will be deposited in escrow, to a maximum of 10% of the earn-out shares.
STOCKHOLDERS' AGENT
Christopher Lord has been recommended by the BlueStar board of directors to
serve as the stockholders' agent under the escrow agreement and the merger
agreement.
As stockholders' agent, Mr. Lord would act on behalf of the BlueStar
stockholders on matters under the merger agreement and the escrow agreement.
These matters include the power to:
o settle and/or arbitrate all claims against the escrow fund;
o waive any conditions of the escrow agreement;
o accept negotiate or arbitrate the earn-out share calculations;
o receive notices or other communications;
o delivery any notices, certificates or other documents required; and
o retain professional advisors in connection with the performance of his
duties.
The stockholder representative will not have the power to vote on behalf of
the BlueStar stockholders on matters that require a vote of the stockholders of
Covad Communications, and the stockholder agents' powers will be limited to
those necessary for the purposes of administering the escrow agreement.
Covad Communications and the escrow agent will have the right to rely upon
the acts taken or omitted to be taken by the stockholders' agent on behalf of
the BlueStar stockholders. By voting in favor of the merger agreement, the
merger and the appointment of Mr. Lord as stockholders' agent, each of the
stockholders of BlueStar is agreeing that any act or omission by the
stockholders' agent will be deemed an act or omission by such stockholders, and
final, conclusive and binding on such stockholders.
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
OF COVAD COMMUNICATIONS GROUP, INC.
THE FOLLOWING SELECTED HISTORICAL CONSOLIDATED BALANCE SHEET DATA AS OF
DECEMBER 31, 1997 WAS DERIVED FROM COVAD COMMUNICATIONS' AUDITED CONSOLIDATED
FINANCIAL STATEMENTS, WHICH ARE NOT INCLUDED IN THIS PROSPECTUS AND ARE
QUALIFIED BY REFERENCE TO THOSE FINANCIAL STATEMENTS AND THE RELATED NOTES. THE
FOLLOWING SELECTED HISTORICAL CONSOLIDATED STATEMENT OF OPERATIONS AND BALANCE
SHEET DATA AS OF DECEMBER 31, 1998 AND 1999 AND FOR EACH OF THE THREE YEARS IN
THE PERIOD ENDED DECEMBER 31, 1999 HAVE BEEN DERIVED FROM COVAD COMMUNICATIONS'
AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES, WHICH ARE
INCLUDED ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING SELECTED HISTORICAL
CONSOLIDATED STATEMENT OF OPERATIONS AND BALANCE SHEET DATA AS OF JUNE 30, 2000
AND FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 HAVE BEEN DERIVED FROM COVAD
COMMUNICATIONS' UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THE
RELATED NOTES, WHICH ARE ALSO INCLUDED ELSEWHERE IN THIS PROSPECTUS. YOU SHOULD
READ THE FOLLOWING SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA TOGETHER WITH
"COVAD COMMUNICATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" AND THE CONSOLIDATED FINANCIAL STATEMENTS
AND THE RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS.
IN MARCH 2000, COVAD COMMUNICATIONS ACQUIRED LASER LINK.NET, INC. IN A
TRANSACTION ACCOUNTED FOR AS A PURCHASE. ACCORDINGLY, THE SELECTED HISTORICAL
CONSOLIDATED STATEMENT OF OPERATIONS DATA FOR THE SIX MONTHS ENDED JUNE 30, 2000
INCLUDE THE RESULTS OF OPERATIONS OF LASER LINK FROM THE DATE OF ACQUISITION
THROUGH JUNE 30, 2000 AND THE SELECTED HISTORICAL CONSOLIDATED BALANCE SHEET
DATA AS OF JUNE 30, 2000 INCLUDE LASER LINK'S FINANCIAL POSITION AS OF THAT
DATE. THE SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA FOR THE SIX MONTHS
ENDED JUNE 30, 2000 ARE NOT NECESSARILY INDICATIVE OF THE RESULTS THAT MAY BE
EXPECTED FOR THE ENTIRE FISCAL YEAR OR FUTURE PERIODS.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ----------------------------
1997 1998 1999 1999 2000
----------- ------------ -------------- ------------ --------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 26 $ 5,326 $ 66,488 $ 16,429 $ 99,967
Operating expenses:
Network and product costs.............. 54 4,562 55,347 15,525 74,963
Sales, marketing, general and
administrative....................... 2,374 31,043 140,372 43,089 187,907
Depreciation and
amortization......................... 70 3,406 37,602 13,318 41,717
Amortization of goodwill
and other intangible assets.......... -- -- -- -- 23,453
Amortization of deferred
compensation......................... 295 3,997 4,768 2,887 1,911
Write-off of in-process technology..... -- -- -- -- 3,726
----------- ------------ -------------- ------------ --------------
Total operating expenses............. 2,793 43,008 238,089 74,819 333,677
----------- ------------ -------------- ------------ --------------
Loss from operations...................... (2,767) (37,682) (171,601) (58,390) (233,710)
Net interest expense................... 155 (10,439) (23,796) (12,366) (19,780)
Other income........................... -- -- -- -- 14,787
----------- ------------ -------------- ------------ --------------
Net loss.................................. (2,612) (48,121) (195,397) (70,756) (238,703)
Preferred dividends....................... -- -- (1,146) (1,146) --
----------- ------------ -------------- ------------ --------------
Net loss attributable to common
stockholders........................... $ (2,612) $ (48,121) $ (196,543) $ (71,902) $ (238,703)
=========== ============ ============== ============ ==============
Net loss per share--basic and diluted...... $ (0.35) $ (3.75) $ (1.83) $ (0.79) $ (1.59)
=========== ============ ============== ============ ==============
Weighted average shares used in
computing net loss per share--basic
and diluted.......................... 7,360,978 12,844,203 107,647,812 91,396,284 150,060,418
=========== ============ ============== ============ ==============
</TABLE>
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL
DATA OF COVAD COMMUNICATIONS GROUP, INC.-(Continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ----------------------------
1997 1998 1999 1999 2000
----------- ------------ -------------- ------------ --------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
EBITDA(1)................................. $ (2,402) $ (30,154) $ (129,486) $ (42,185) $ (162,903)
Capital expenditures...................... 2,253 59,503 208,186 93,748 262,914
Net cash provided by (used in) operating
activities............................. (1,895) (9,054) (102,767) (27,721) (105,643)
Net cash provided by (used in) investing
activities............................. (2,494) (61,252) (736,096) (194,446) (115,205)
Net cash provided by (used in) financing
activities............................. 8,767 130,378 990,451 415,188 427,630
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
---------- ----------- -------------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents and short-term investments.. $ 4,378 $ 64,450 $ 767,357 $ 763,154
Net property and equipment............................ 3,014 59,145 237,542 466,137
Total assets.......................................... 8,074 139,419 1,147,606 1,783,880
Long-term obligations, including current portion...... 783 142,879 375,049 828,910
Total stockholders' equity (net capital deficiency)... 6,498 (24,706) 690,291 794,319
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------- AS OF JUNE 30,
1997 1998 1999 2000
---------- ----------- -------------- ----------------
<S> <C> <C> <C> <C>
OTHER OPERATING DATA:
Homes and businesses passed........................... 278,000 6,023,217 29,000,000 42,000,000
Lines installed....................................... 26 3,922 57,000 138,000
</TABLE>
--------------
(1) EBITDA consists of net loss excluding net interest, taxes, depreciation and
amortization, non-cash stock-based compensation expense and other
non-operating income or expenses. Covad Communications has provided EBITDA
because it is a measure of financial performance commonly used in the
telecommunications industry as well as to enhance an understanding of its
operating results. EBITDA should not be construed as either:
o an alternative to operating income (as determined in accordance with
generally accepted accounting principles) as an indicator of our
operating performance, or
o an alternative to cash flows from operating activities (as determined
in accordance with generally accepted accounting principles) as a
measure of liquidity.
EBITDA as calculated by Covad Communications may be calculated differently
than EBITDA for other companies. See the consolidated financial statements
and the related notes thereto contained elsewhere in this prospectus.
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COVAD COMMUNICATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF COVAD COMMUNICATIONS' FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 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 THE ACCURACY OF
WHICH INVOLVES RISKS AND UNCERTAINTIES. COVAD COMMUNICATIONS' ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS
FOR MANY REASONS INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN "RISK
FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. COVAD COMMUNICATIONS DISCLAIMS ANY
OBLIGATION TO UPDATE INFORMATION CONTAINED IN ANY FORWARD-LOOKING STATEMENT. SEE
"SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS."
OVERVIEW
Covad Communications is a leading provider of broadband communications
services to Internet service provider, enterprise and telecommunications
carrier, and other customers. Since March 1998, Covad Communications has raised
$1,537.2 million of gross proceeds from debt and equity financings to fund the
deployment and expansion of its network. By June 30, 2000, Covad Communications
had deployed its services in 81 metropolitan statistical areas. Covad
Communications plans to build its network and offer its services in a total of
165 metropolitan statistical areas nationwide. As of June 30, 2000, its network
passed 42 million homes and businesses, and Covad Communications had installed
138,000 end-user lines.
In connection with its expansion within existing metropolitan statistical
areas and into new metropolitan statistical areas, Covad Communications expects
to significantly increase its capital expenditures, as well as its sales and
marketing expenditures, to deploy its network and support additional end-users
in those regions. Accordingly, Covad Communications expects to incur substantial
and increasing net losses for at least the next several years.
Covad Communications derives revenue from:
o monthly recurring service charges for connections from the end-user to
its facilities and for backhaul services from its facilities to the
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 Covad Communications
provides to its customers due to the general unavailability of
customer premise equipment through retail channels.
Covad Communications expects 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. Covad Communications
believes its revenues from the sale of customer premise equipment will decline
over time, as customer premise equipment becomes more generally available. Covad
Communications expects that the prices Covad Communications charges to customers
for customer premise equipment will decrease each year.
The following costs comprise its network and service costs:
o MONTHLY NON-RECURRING AND RECURRING CIRCUIT FEES. Covad Communications
pays traditional telephone companies and other competitive
telecommunications companies non-recurring and recurring fees for
services including installation, activation, monthly line costs,
maintenance and repair circuits between and among its digital
subscriber line access multiplexers and its regional data centers,
customer backhaul, and end-user lines. As its end-user base grows,
Covad Communications expects that the largest element of network and
product cost will be the traditional telephone companies' charges for
its leased telephone wires.
o OTHER COSTS. Other costs that Covad Communications incurs include
those for materials in installation and the servicing of customers and
end-users, and the cost of customer premise equipment.
The development and expansion of Covad Communications' 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 its central office cages, end-user DSL
line cards, and expenditures for other elements of its network design.
Currently, the average capital cost to deploy its 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
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due to the quantity and type of equipment Covad Communications initially deploys
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 build-out of its central
office space, the major portion of its capital expenditures is the purchase of
DSL line cards to support incremental end-users. Covad Communications 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 its network, Covad
Communications will use its capital for marketing its services, acquiring
Internet service provider, enterprise and telecommunication carrier customers,
and funding its customer care and field service operations.
In connection with rolling out service on a national basis, Covad
Communications has commenced a branding campaign to differentiate its service
offerings in the marketplace. As a result, Covad Communications expects its
selling, general and administrative expenses to increase significantly in future
periods as Covad Communications implements increased marketing efforts as part
of the campaign.
RECENT DEVELOPMENTS
On May 16, 2000, Covad Communications announced that the American
Arbitration Association issued its Intended Award of Damages to it in its
arbitration hearings against Pacific Bell for violations of the
Telecommunications Act of 1996. The arbitrators awarded Covad Communications
$27.2 million plus attorneys' fees and costs which is in addition to the panel's
January 1999 interim decision to award Covad Communications $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 Covad Communications by failing to timely deliver
collocation space and operable loops.
On June 16, 2000, Covad Communications announced the signing of an
agreement to acquire BlueStar, a provider of broadband and Internet services for
small- and medium-sized businesses throughout the Southeastern United States.
Under the acquisition agreement, Covad Communications will issue up to 8 million
shares of its common stock 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 Covad Communications
common stock may be issued to the BlueStar stockholders if certain performance
targets are met by BlueStar over the 2001 fiscal year. Covad Communications
anticipates that this acquisition will accelerate the national expansion of its
network. Covad Communications anticipates the acquisition of BlueStar will
provide the following benefits:
o Speed to market in implementing its direct sales strategy in Tier 3
markets;
o A large, experienced direct sales force;
o BlueStar's customer base; and
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 commitment 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 commitment from Bear Stearns in exchange for shares
of Covad Communications common stock. Bear Stearns also has the right to put the
loan to Covad Communications in exchange for Covad Communications common stock
in certain other circumstances.
In addition, Covad Communications' acquisition of BlueStar will provide it
with 135 new central offices that were built out by BlueStar and had not been
built out by Covad Communications. Covad Communications believes that it
acquired these new central offices at a cost savings in comparison with what it
would have cost Covad Communications to build, operate and support those central
offices and the underlying businesses associated with the markets they serve.
In connection with its announcement of the BlueStar acquisition, Covad
Communications reduced the number of end-user lines that it expected to be in
service on June 30, 2000. At the same time, Covad Communications reduced
expectations for 2000, primarily because of the channel conflict with its
customers that may result from its acquisition of BlueStar, which sells directly
to end-users.
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On July 18, 2000, the United States Court of Appeals for the Eighth Circuit
struck down the FCC's total element long run incremental cost methodology, which
the FCC previously required state commissions to use in setting the prices for
collocation and for unbundled network elements we purchase from the traditional
telephone companies. The court also rejected an alternative cost methodology
based on "historical costs," which was advocated by the traditional telephone
companies. In rejecting the FCC's cost methodology, the court held that it is
permissible for the FCC to prescribe a forward-looking incremental cost
methodology that is based on actual incremental costs under the 1996
Telecommunications Act. The Eight Circuit's decision creates some additional
uncertainty concerning the prices that Covad Communications is obligated to pay
the traditional telephone companies for collocation and unbundled network
elements. While the FCC may appeal the Eighth Circuit's decision, it may also
adopt new rules to reflect the cost methodology that was approved by the Eighth
Circuit. If the decision is appealed, it is uncertain whether the Eighth
Circuit's decision will be affirmed by the United States Supreme Court. It is
also uncertain whether the FCC and the state commissions will implement a new
cost methodology as a result of this decision.
On August 2, 2000, Covad Communications announced the appointment of
Mark H. Perry as executive vice president and chief financial officer. Mr. Perry
succeeds the current executive vice president and chief financial officer,
Timothy Laehy, who is retiring.
On August 10, 2000, Covad Communications 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. Covad Communications 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 their balance sheet. The
agreement requires no additional financial commitments, and no additional
expenses to be incurred. Covad Communications will also hold two seats on ACCA's
board of directors.
Covad Communications is currently aware of a Staff Accounting Bulletin
entitled SAB 101 "Revenue Recognition in Financial Statements," which was issued
in December 1999 by the SEC. 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 Covad
Communications' fiscal year. The SEC intends to issue further definitive
guidance on the implementation of SAB 101. When and if that guidance is
received, Covad Communications will fully evaluate this guidance and respond and
reply accordingly. If SAB 101 were implemented and its implementation is
contrary to Covad Communications' current practices, it may have an adverse
effect on financial statements.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
REVENUES
Covad Communications recorded revenues of $100.0 million for the six months
ended June 30, 2000 compared to $16.4 million for the six months ended June 30,
1999. This increase is attributable to growth in the number of customers and
end-users resulting from Covad Communications' increased sales and marketing
efforts and the expansion of its national network. Covad Communications
expects revenues to increase in future periods as it expands its network
within its existing regions, deploy networks in new regions and increase its
sales and marketing efforts in all of its regions.
NETWORK AND PRODUCT COSTS
Covad Communications recorded network and product costs of $75.0 million
for the six months ended June 30, 2000 and $15.5 million for the six months
ended June 30, 1999. This increase is attributable to the expansion of its
networks and increased orders resulting from its sales and marketing efforts.
Covad Communications expects network and product costs to increase significantly
in future periods due to increased sales activity and expected revenue growth.
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SALES MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Sales, marketing, general and administrative expenses consist primarily of
salaries, expenses for the development of business, the development of corporate
identification, promotional and advertising materials, expenses for the
establishment of its management team and sales commissions. 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. This
increase is attributable to growth in headcount in all areas of Covad
Communications' continued expansion of its sales and marketing efforts,
deployment of its networks and building of its operating infrastructure. Sales,
marketing, general and administrative expenses are expected to increase
significantly as Covad Communications continues to expand its business.
DEFERRED COMPENSATION
Through June 30, 2000, Covad Communications recorded a total of
approximately $19.3 million of deferred compensation, with an unamortized
balance of approximately $8.4 million on its June 30, 2000 consolidated balance
sheet. Deferred compensation is a result of Covad Communications granting stock
options to its employees, certain of its directors and certain contractors with
exercise prices per share below the fair values per share for accounting
purposes of its common stock at the dates of grant. Covad Communications is
amortizing the deferred compensation over the vesting period of the applicable
option using a graded vesting method. 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.
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;
o amortization of capitalized software costs; and
o amortization of intangible assets.
In January 1999, Covad Communications 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 $4.2 and $4.0 million during the six
months ended June 30, 2000 and 1999, respectively, and is included in
depreciation and 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 $41.7 million for the six
months ended June 30, 2000, and $13.3 million for the six months ended June 30,
1999. This increase was due to the increase in equipment and facilities placed
in service throughout the period as well as amortization of intangible assets.
Covad Communications expects depreciation and amortization to increase
significantly as Covad Communications increases its capital expenditures to
expand its networks.
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 Covad Communications' Unaudited
Condensed Consolidated Financial Statements), Covad Communications recorded on
its 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. Covad Communications is amortizing
goodwill and other intangible assets on a straight line basis over its estimated
useful life of five years. For the six months ended June 30, 2000, amortization
of goodwill and other intangible assets was $23.5 million.
NET INTEREST INCOME AND EXPENSE
Net interest income and expense consists primarily of interest income on
Covad Communications' cash balance and interest expense associated with Covad
Communications' debt. Net interest expense for the six months ended June 30,
2000 was $19.8 million. 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 the initial public
offering and Covad Communications' issuance of preferred stock to AT&T Ventures,
NEXTLINK and Qwest. Net interest expense for the six months ended June 30, 1999
was $12.4 million. 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
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proceeds raised from the issuance of the 1998 notes. Covad Communications
expects interest expense to increase significantly over time.
INCOME TAXES
Covad Communications made no provision for taxes because it operated at a
loss for the years ended December 31, 1997, 1998 and 1999 and the six months
ended June 30, 2000.
THREE YEARS ENDED DECEMBER 31, 1999
REVENUES
Covad Communications recorded revenues of $66.5 million for the year ended
December 31, 1999, $5.3 million for the year ended December 31, 1998, and
$26,000 for the year ended December 31, 1997. The increase in revenues in all
periods is attributable to growth in the number of customers and end-users
resulting from its increased sales and marketing efforts and the expansion of
its national network. Covad Communications expects revenues to increase in
future periods as it expands its network within its existing regions, deploys
networks in new regions and increases its sales and marketing efforts in all of
its regions.
NETWORK AND PRODUCT COSTS
Covad Communications recorded network and product costs of $55.3 million
for the year ended December 31, 1999, $4.6 million for the year ended December
31, 1998, and $54,000 for the year ended December 31, 1997. The increase in
network costs in all periods is attributable to the expansion of its network and
increased orders resulting from sales and marketing efforts. Covad
Communications expects 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 were $140.4 million
for the year ended December 31, 1999, $31.0 million for the year ended December
31, 1998, and $2.4 million for the year ended December 31, 1997. The increase in
sales, marketing, general and administrative expense for all years is
attributable to growth in headcount in all areas of Covad Communications'
continued expansion of its sales and marketing efforts, deployment of its
network, expansion of its facilities and building of its operating
infrastructure. In addition, in 1999, sales, marketing, general and
administrative increased over 1998 due to its advertising campaign initiated in
1999. Sales, marketing, general and administrative expenses are expected to
increase significantly as Covad Communications continues to expand its business.
DEFERRED COMPENSATION
Through December 31, 1999, Covad Communications recorded a total of
approximately $15.6 million of deferred compensation, with an unamortized
balance of approximately $6.5 million remaining on its December 31, 1999
consolidated balance sheet. Deferred compensation is a result of Covad
Communications' granting stock options to its employees, certain of its
directors, and certain contractors with exercise prices per share below the fair
values per share for accounting purposes of its common stock at the dates of
grant. Covad Communications is amortizing the deferred compensation over the
vesting period of the applicable option using a graded vesting method.
Amortization of deferred compensation was $4.8 million for the year ended
December 31, 1999, $4.0 million for the year ended December 31, 1998, and
$295,000 for the year ended December 31, 1997.
DEPRECIATION AND AMORTIZATION
In January 1999, Covad Communications 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 $8.2 million during the year ended
December 31, 1999, and is included in depreciation and 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 two-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.
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Depreciation and amortization was approximately $37.6 million for the year
ended December 31, 1999, $3.4 million for the year ended December 31, 1998, and
$70,000 for the year ended December 31, 1997. The increase for both years was
due to the addition of equipment and facilities placed in service throughout the
year as well as amortization of intangible assets recorded in 1999. Covad
Communications expects depreciation and amortization to increase significantly
as it increases its capital expenditures to expand its network.
NET INTEREST INCOME AND EXPENSE
Net interest expense for the years ended December 31, 1999, 1998 and 1997
was $23.8 million, $10.4 million and ($155,000), respectively. Net interest
expense during these periods consisted primarily of interest expense on its 13
1/2% senior discount notes due 2008 issued in March 1998 and its 12 1/2% senior
notes due 2009 issued in February 1999 and capital lease obligations. Net
interest expense was partially offset by interest income earned primarily from
the investment of the proceeds raised from the issuance of the 1998 notes and
the 1999 notes as well as its initial public offering and its issuance of
preferred stock to AT&T Ventures, NEXTLINK and Qwest. Covad Communications
expects interest expense to increase significantly over time, primarily because
the 1998 notes and 1999 notes mature in 2008 and 2009, respectively, and because
Covad Communications issued $425.0 million of new long-term debt in January
2000.
INCOME TAXES
Covad Communications made no provision for taxes because it operated at a
loss for the years ended December 31, 1999, 1998 and 1997.
QUARTERLY FINANCIAL INFORMATION
The following table presents certain unaudited consolidated statements of
operations data for Covad Communications' most recent eight quarters. This
information has been derived from its unaudited consolidated financial
statements. In its 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 included elsewhere in this prospectus. The
operating results for any quarter are not necessarily indicative of results for
any future period.
<TABLE>
<CAPTION>
SEPT 30, DEC 31, MAR 31, JUNE 30, SEPT 30, DEC 31, MAR 31, JUNE 30,
1998 1998 1999 1999 1999 1999 1999 1999
-------- -------- -------- -------- --------- --------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues........................ $ 1,565 $ 2,766 $ 5,596 $ 10,833 $ 19,141 $ 30,918 $ 41,807 $ 58,160
Operating expenses:
Network and product costs....... 1,355 2,246 4,960 10,565 16,694 23,128 31,349 43,614
Sales, marketing, general and
administrative............... 10,681 13,812 18,113 24,976 37,697 59,586 85,445 102,462
Depreciation and amortization... 738 2,058 4,647 8,671 10,593 13,691 17,432 24,285
Amortization of goodwill
and other intangible assets.. -- -- -- -- -- -- 3,350 20,103
Amortization of deferred
compensation................. 1,837 1,302 1,653 1,234 1,008 873 1,186 725
Write-off of in-process
technology................... -- -- -- -- -- -- 3,726 --
-------- --------- --------- --------- --------- --------- ---------- ----------
Total operating expenses........ 14,611 19,418 29,373 45,446 65,992 97,278 142,488 191,189
-------- --------- --------- --------- --------- --------- ---------- ----------
Loss from operations............ (13,046) (16,652) (23,777) (34,613) (46,851) (66,360) (100,681) (133,029)
Net interest income (expense)... (3,511) (3,208) (5,127) (7,239) (7,254) (4,176) (7,543) (12,237)
Other income ................... -- -- -- -- -- -- 999 13,788
-------- --------- --------- --------- --------- --------- ---------- ----------
Net loss........................ (16,557) (19,860) (28,904) (41,852) (54,105) (70,536) (107,225) (131,478)
Preferred dividends............. -- -- (1,146) -- -- -- -- --
-------- --------- --------- --------- --------- --------- ---------- ----------
Net loss attributable to
common stockholders.......... $(16,557) $(19,860) $(30,050) $(41,852) $(54,105) $(70,536) $(107,225) $(131,478)
========= ========= ========= ========= ========= ========= ========== ==========
Net loss per share.............. $ (1.23) $ (1.22) $ (0.37) $ (0.41) $ (0.47) $ (0.53) $ (0.73) $ (0.86)
========= ========= ========= ========= ========= ========= ========== ==========
</TABLE>
Covad Communications has generated increasing revenues in each of the last
eight quarters, reflecting increases in the number of customers and end-users.
Its network and product costs have increased in every quarter,
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reflecting costs associated with customer and end-user growth and the deployment
of its network in existing and new regions. Its selling, marketing, general and
administrative expenses have increased in every quarter and reflect sales and
marketing costs associated with the acquisition of customers and end-users,
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
its networks. Covad Communications has experienced increasing net losses on a
quarterly basis as it increased operating expenses and increased depreciation as
a result of increased capital expenditures, and it expects to sustain increasing
quarterly losses for at least the next several years. See "Risk Factors--Risks
Related to Covad Communications." Its annual and quarterly operating results may
fluctuate significantly in the future as a result of numerous factors. Factors
that may affect its operating results include:
o the willingness, timing and ability of traditional telephone companies
to provide Covad Communications with central office space;
o the rate at which traditional telephone companies can provide Covad
Communications telephone wires over which it sells its service;
o the rate at which customers subscribe to its services;
o decreases in the prices for its services due to competition,
volume-based pricing and other factors;
o its ability to retain Internet service provider, enterprise and
telecommunications carrier customers and limit end-user churn rates;
o the success of its relationships with strategic partners and other
potential third parties in generating significant subscriber demand;
o the ability to order or deploy its services on a timely basis to
adequately satisfy end-user demand;
o delays in the commencement of operations in new regions and the
generation of revenue because certain network elements have lead times
that are controlled by traditional telephone companies and other third
parties;
o the mix of line orders between consumer end-users and business
end-users (which typically have higher margins);
o the amount and timing of capital expenditures and other costs relating
to the expansion of its network;
o the ability to develop and commercialize new services by it or its
competitors;
o the impact of regulatory developments, including interpretations of
the 1996 Telecommunications Act; and
o its ability to successfully operate its network.
Many of these factors are outside of its control. In addition, Covad
Communications plans to increase operating expenses to fund operations, sales,
marketing, general and administrative activities and infrastructure, including
increased expenses associated with its relationships with strategic partners. If
these expenses are not accompanied by an increase in revenues, Covad
Communications could experience a material adverse effect on its business,
prospects, operating results and financial condition and its ability to service
and repay its indebtedness.
LIQUIDITY AND CAPITAL RESOURCES
Covad Communications' operations have required substantial capital
investment for the procurement, design and construction of its central office
cages, the purchase of telecommunications equipment and the design and
development of its networks. Capital expenditures were approximately $262.9
million for the six months ended June 30, 2000. Covad Communications expects
that its capital expenditures will be higher in future periods in connection
with the purchase of infrastructure equipment necessary for the development and
expansion of its networks and the development of new regions.
From its inception through June 30, 2000, Covad Communications financed its
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 its initial public offering,
$60.0 million in net proceeds
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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 its
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, Covad Communications had an
accumulated deficit of $484.8 million, and cash, cash equivalents and short-term
investments of $763.2 million.
Net cash used in its 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 its 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.net, 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.
Covad Communications believes that its current cash, cash equivalents and
short-term investments, including the proceeds received from its recently
completed issuance of the 2000 senior notes, will be sufficient to meet its
anticipated cash needs for working capital and capital expenditures into the
second quarter of 2001.
Covad Communications expects to experience substantial negative cash flow
from operating activities and negative cash flow from financing activities for
at least the next several years due to continued development, commercial
deployment and expansion of its networks. Covad Communications may also make
investments in and acquisitions of businesses that are complementary to or
support the growth of its business. Its future cash requirements for developing,
deploying and enhancing its networks and operating its business, as well as its
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 its 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 Covad Communications invests in engineering and
development and intellectual property with respect to existing and
future technology;
o existing and future technology; and
o unanticipated opportunities.
Covad Communications will be required to raise additional capital, the
timing and amount of which it cannot predict. Covad Communications expects to
raise additional capital through debt or equity financings, depending on market
conditions, to finance the continued development, commercial deployment and
expansion of its networks and for funding operating losses or to take advantage
of unanticipated opportunities. If Covad Communications is unable to obtain
required additional capital or is required to obtain it on terms less
satisfactory than it desires, Covad Communications may be required to delay the
expansion of its business or take or forego actions, any or all of which could
harm its business.
In addition, Covad Communications may wish to selectively pursue possible
acquisitions of or investments in businesses, technologies or products
complementary to it in the future in order to expand its geographic presence and
achieve operating efficiencies. Covad Communications may not have sufficient
liquidity, or it 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.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Covad Communications' exposure to financial market risk, including changes
in interest rates and marketable equity security prices, relates primarily to
its investment portfolio and outstanding debt obligations. Covad Communications
typically does not attempt to reduce or eliminate its market exposure on its
investment securities because a substantial majority of its investments are in
fixed-rate, short-term securities. Covad Communications does not have any
derivative instruments. The fair value of its investments portfolio or related
income would not be significantly affected 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 its investment portfolio. In addition, substantially
all of its outstanding indebtedness at June 30, 2000, including its 1998 notes,
its 1999 notes and its 2000 notes, is fixed-rate debt.
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
OF BLUESTAR COMMUNICATIONS GROUP, INC.
The selected financial data should be read in conjunction with
"BlueStar Management's Discussion and Analysis of Financial Condition and
Results of Operations" and BlueStar's consolidated financial statements and the
notes to those statements included in this prospectus. The consolidated balance
sheet data at December 31, 1998 and 1999 and the consolidated statements of
operations data for the years ended December 31, 1998 and 1999 have been derived
from audited consolidated financial statements included in this prospectus. The
consolidated balance sheet data at June 30, 2000 and the consolidated statements
of operations data for the six months ended June 30, 1999 and 2000 have been
derived from BlueStar's unaudited consolidated financial statements that are
included elsewhere in this prospectus. The unaudited consolidated 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. BlueStar has not presented any financial information
prior to January 1, 1998, due to its limited revenues, expenses and cash flow
for the period from inception (March 7, 1997) to December 31, 1997. See notes to
the audited and unaudited consolidated financial statements for additional
information.
EBITDA consists of net loss excluding net interest, taxes, depreciation and
amortization, including amortization of deferred compensation. BlueStar has
presented data related to EBITDA because it is a measure of performance commonly
used in the telecommunications industry to enhance an understanding of operating
results. BlueStar believes that EBITDA may be used by investors as supplemental
information to evaluate a company's financial performance, including its ability
to incur and/or service debt. However, EBITDA may be needed to make other
payments prior to servicing debt. Negative EBITDA implies that a company is not
currently generating sufficient income to fund its operations or service its
debt. BlueStar's calculation of EBITDA may not be comparable to that of other
companies.
EBITDA is not a measure of performance under generally accepted accounting
principles and should not be used as a substitute for net income, net cash
provided by operating activities or other operating or cash flow statement data
prepared in accordance with generally accepted accounting principles.
EBITDA and cash flows from operating activities reflected in the statement
of cash flows differ significantly. Cash from operating activities is net of
interest and taxes paid and is a more comprehensive determination of periodic
income on a cash (rather than accrual) basis, exclusive of non-cash items of
income and expenses such as depreciation and amortization. In contrast, EBITDA
is derived from accrual basis income and is not reduced by cash invested in
working capital. Consequently, EBITDA is not affected by the timing of
receivable collections or when accrued expenses are paid.
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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
OF BLUESTAR COMMUNICATIONS GROUP, INC. (Continued)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------------ -----------------------------
1998 1999 1999 2000
------------- ---------------- ------------- ---------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue $ 12,101 $ 771,108 $ 136,211 $ 3,625,031
Operating Expenses:
Network and product costs........................ 199,973 8,082,759 950,659 20,612,551
Selling and marketing ........................... 76,572 4,809,590 323,581 17,349,024
General and administrative ...................... 426,250 6,949,442 863,145 12,235,957
Amortization of deferred compensation............ -- 425,840 3,976 1,095,963
Depreciation & amortization ..................... 28,402 263,972 24,493 1,934,852
------------- ---------------- ------------- ---------------
Total Operating Expenses ...................... 730,197 20,531,603 2,165,854 53,228,347
------------- ---------------- ------------- ---------------
Loss from Operations................................ (718,096) (19,760,494) (2,029,643) (49,603,316)
Net Interest Income (expense) ...................... 467 541,714 40,010 403,319
One time changes & debt fees........................ -- -- -- (1,454,244)
------------- ---------------- ------------- ---------------
Net Loss............................................ $ (717,629) $ (19,218,780) $ (1,989,633) $ (50,654,241)
============= ================ ============= ===============
Net loss per share:
Basic and diluted................................ $ (0.07) $ (2.15) $ (0.19) $ (5.31)
============= ================ ============= ===============
Weighted average shares ......................... 10,154,010 8,959,153 10,425,501 9,539,643
============= ================ ============= ===============
Other Data:
EBITDA........................................... $ (689,694) $ (19,070,682) $ (2,001,074) $ (48,026,745)
Net cash used in operating activities............ (496,606) (12,842,434) (1,277,479) (36,611,549)
Net cash used by investing activities ........... (89,556) (12,023,658) (1,236,441) (15,503,185)
Net cash provided by financing activities........ 1,087,773 37,266,188 6,182,071 40,133,696
Balance Sheet Data:
Cash and cash equivalents........................ $ 501,611 $ 12,901,707 $ 920,669
Working capital (deficit), excluding cash and
cash equivalents............................... (347,621) (7,294,784) (25,600,888)
Total assets..................................... 671,246 26,506,367 31,649,660
Redeemable convertible preferred stock .......... -- 37,016,697 70,991,697
Total stockholders' deficit...................... (29,048) (18,882,097) (68,073,505)
</TABLE>
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BLUESTAR MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF BLUESTAR'S FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 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 THE ACCURACY OF WHICH
INVOLVES RISKS AND UNCERTAINTIES. BLUESTAR'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS FOR MANY
REASONS INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" AND
ELSEWHERE IN THIS PROSPECTUS. BLUESTAR DISCLAIMS ANY OBLIGATION TO UPDATE
INFORMATION CONTAINED IN ANY FORWARD-LOOKING STATEMENT. SEE "SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS."
OVERVIEW
BlueStar provides broadband communications and Internet access services to
small- and medium-sized businesses in Tier 2 and Tier 3 markets. It initiated
its service in September 1998 and rapidly began to deploy its network in the
fourth quarter of 1999. As of June 30, 2000, BlueStar provided services in 38
markets, representing 131 cities.
When BlueStar enters a new market, it establishes a local market presence,
incurring significant selling and marketing and general and administrative
expenses. As part of entering a new market, BlueStar leases equipment from
Lucent and contracts with it or another third party to install the equipment
into targeted central offices. These operating leases and central office
installation expenses are expensed as network and product costs. Once BlueStar
has deployed its network in a market, additional expenditures primarily include
leasing costs associated with DSL line cards and customer premise equipment.
BlueStar derives a majority of its revenues from Internet access and
broadband communications services, including real private networking (RPN)
services. BlueStar offers its services directly to customers at retail prices.
BlueStar bills its customers monthly for recurring charges based on the data
transfer speeds selected by the customer. BlueStar currently offers flat rate
plans at prices that include its fully bundled Internet services and its
high-speed access and connectivity services on contracts with terms generally
ranging from one to three years. In addition to monthly service fees, BlueStar
bills customers for nonrecurring service activation, equipment and installation
charges. On occasion, BlueStar reduces or waives equipment or installation
charges to encourage potential customers to enter into multi-year contracts.
BlueStar expects that prices for its services will decline over time as a result
of competition and changes in its product mix.
BlueStar's expenses are recognized as incurred and consist of the following
principal categories:
o network and product costs, which consist primarily of equipment costs,
access charges and technical salaries;
o selling and marketing expenses, which consist primarily of advertising
costs, compensation and related expenses;
o general and administrative expenses, which consist primarily of
corporate, management and administrative salaries and corporate office
expenses; and
o depreciation and amortization expenses, which include non-cash charges
related to property and equipment and collocation fees.
BlueStar incurred operating losses, net losses and negative earnings before
interest, taxes, depreciation and amortization, including amortization of
deferred compensation, or EBITDA. As of June 30, 2000, BlueStar had total
stockholders' deficit of $68.1 million.
BlueStar incurred stock compensation expense as a result of the granting of
stock options to employees and others with exercise prices per share
subsequently determined to be below the fair values per share of its common
stock for financial reporting purposes at the dates of grant. The stock
compensation is being charged immediately or is being amortized over the vesting
period of the applicable options, which is generally 48 months.
BlueStar's consolidated financial statements include the activity of
BlueStar Communications, LLC and BlueStar Properties, Inc., a Tennessee
corporation, as predecessor entities. Revenue, expense and cash flow
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information for the period from its inception on March 7, 1997 to December 31,
1997 were all less than $6,700, and, as a result, BlueStar has not included a
full set of consolidated financial statements for 1997.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
REVENUES
BlueStar recorded revenues of $3.6 million for the six months ended June
30, 2000, and $136,211 for the six months ended June 30, 1999. This increase is
attributable to growth in the number of BlueStar customers resulting from its
increased sales and marketing efforts and the expansion of BlueStar's network in
the Southeast. As of June 30, 2000 and June 30, 1999, BlueStar had sold 9,067
and 87 high-speed access lines, respectively. BlueStar had installed 3,694 and
58 lines at June 30, 2000 and June 30, 1999, respectively. Average recurring
revenues per installed line for the six months ended June 30, 2000 were
approximately $230 per month.
BlueStar earns revenues from recurring monthly service and non-recurring
equipment sales and installation charges. During 1999 and the six months ended
June 30, 2000, approximately 45% and 32% of total revenues was non-recurring,
respectively. BlueStar recognizes expenses related to non-recurring revenues in
the same period as it recognizes the revenue.
NETWORK AND PRODUCT EXPENSES
Network and product expenses were $20.6 million for the six months ended
June 30, 2000, and $1.0 million for the six months ended June 30, 1999. This
increase is attributable to the increased operational needs of BlueStar's
network and increased orders resulting from sales and marketing efforts.
Operating lease expenses for network equipment increased to $3.1 million for the
six months ended June 30, 2000, from $0.5 million for the six months ended June
30, 1999. The remainder of the increase is primarily attributable to network
circuit backhaul, Internet access costs and salaries and wage expense.
SELLING AND MARKETING EXPENSES
BlueStar recorded selling and marketing expenses of $17.3 million for the
six months ended June 30, 2000, and $0.3 million for the six months ended June
30, 1999. This increase is attributable to a $9.9 million increase in salaries,
wage and sales commission expense, a $2.4 million increase in advertising
expense, and a $1.6 million increase in employee benefit expense.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased to $12.2 million for the six
months ended June 30, 2000, from $0.9 million for the six months ended June 30,
1999. This increase is primarily attributable to a $3.6 million increase in
salaries, wages and consulting expense, a $1.2 million increase in recruiting
and relocation expense, a $1.5 million increase in office rent and equipment
expense, and a $0.8 million increase in phone expenses.
AMORTIZATION OF DEFERRED COMPENSATION
Amortization of deferred compensation increased to $1.1 million during the
six months ended June 30, 2000 from $3,967 for the six months ended June 30,
1999.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses were $1.9 million for the six months
ended June 30, 2000, and $24,493 for the six months ended June 30, 1999. The
increase was due to an increase in equipment and facilities placed in service
throughout the period and the installation of BlueStar's internal hardware and
software systems.
INCOME TAXES
For the six months ended June 30, 2000, and June 30, 1999, BlueStar
recognized no tax benefits with regard to operating losses due to the
uncertainty of future taxable income sufficient to utilize the losses during the
periods.
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TWO YEARS ENDED DECEMBER 31, 1998 AND 1999
REVENUES
BlueStar recorded revenues of $0.8 million for the year ended December 31,
1999, and $12,101 for the year ended December 31, 1998. This increase is
attributable to growth in the number of BlueStar customers resulting from its
increased sales and marketing efforts and the expansion of its networks in the
Southeast. As of December 31, 1999 and December 31, 1998, BlueStar had sold
1,224 and five lines, respectively. BlueStar had installed 428 and five lines at
December 31, 1999 and December 31, 1998, respectively. Average recurring
revenues per installed line for 1999 were approximately $330 per month. During
1999, approximately 45% of total revenues was non-recurring.
NETWORK AND PRODUCT EXPENSES
Network and product expenses were $8.1 million for the year ended December
31, 1999, and $0.2 million for the year ended December 31, 1998. This increase
is attributable to the increased operational needs of the network and increased
orders resulting from sales and marketing efforts. Operating lease expenses for
network equipment were $2.9 million for 1999, and $128,896 for 1998. The
remainder of the increase is primarily attributable to network circuit backhaul
and Internet access costs and salaries and wage expense.
SELLING AND MARKETING EXPENSES
BlueStar recorded selling and marketing expenses of $4.8 million for the
year ended December 31, 1999, and $76,572 for the year ended December 31, 1998.
This increase is attributable to a $2.3 million increase in salaries and wage
expense, a $0.9 million increase in advertising expense, a $0.6 million increase
in recruiting expense and a $0.5 million increase in sales commission expense.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased to $6.9 million for the year
ended December 31, 1999, from $0.4 million for the year ended December 31, 1998.
This increase is attributable to a $2.4 million increase in salaries, wages and
consulting expense, a $1.1 million increase in recruiting and relocation expense
and a $0.4 million increase in office rent.
AMORTIZATION OF DEFERRED COMPENSATION
Amortization of deferred compensation was $0.4 million during the year
ended December 31, 1999. BlueStar did not incur any deferred compensation for
the year ended December 31, 1998. Through December 31, 1999, BlueStar recorded
$3.6 million of deferred compensation, with an unamortized balance of
approximately $3.2 million as of December 31, 1999.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses were $0.3 million for the year ended
December 31, 1999, and $28,402 for the year ended December 31, 1998. The
increase was due to an increase in equipment and facilities placed in service
throughout the period and the installation of internal hardware and software
systems.
INCOME TAXES
For the years ended December 31, 1999 and December 31, 1998, BlueStar
recognized no tax benefits with regard to operating losses due to the
uncertainty of future taxable income sufficient to utilize the losses during the
periods.
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LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, BlueStar had a stockholders' deficit of $68.1 million
and cash and cash equivalents of approximately $0.9 million. For the six months
ended June 30, 2000 and June 30, 1999, the net cash used in BlueStar's operating
activities was approximately $39.7 million and $1.3 million, respectively.
During 1999 and 1998, the net cash used in BlueStar's operating activities was
approximately $12.8 million and $0.5 million, respectively. This cash was used
for a variety of operating purposes, including personnel costs, consulting and
legal expenses, network operations and other administrative expenses.
The net cash used in investing activities for the six months ended June 30,
2000 and June 30, 1999 was approximately $13.2 million and $1.2 million
respectively. During 1999 and 1998, net cash used in investing activities was
$12.0 million and $89,556, respectively. Net cash used in investing activities
primarily resulted from collocation costs and the purchase of networking and
other equipment.
Net cash provided by financing activities for the six months ended June 30,
2000 and June 30, 1999 was approximately $40.9 million and $6.1 million,
respectively. During 1999 and 1998, net cash provided by financing activities
was approximately $37.3 million and $1.1 million, respectively. Net cash
provided by financing activities primarily resulted from the sale of common and
preferred stock and borrowings against the Lucent working capital line of
credit.
During the year ended December 31, 1998, BlueStar sold 1,725,000 shares of
common stock to an initial round of investors at a price of $0.33 per share,
resulting in net proceeds to it of $575,000.
In March 1999, BlueStar issued 12,345,003 shares of redeemable,
convertible, voting preferred stock designated as Series A preferred stock for
$0.49 per share. In August 1999, BlueStar issued 8,177,040 shares of redeemable,
convertible, voting preferred stock designated as Series B preferred stock for
$3.80 per share. BlueStar received $37,149,060 in total net proceeds from the
sale of Series A and Series B preferred stock.
During 1999, BlueStar repurchased 2,020,971 shares of common stock from one
of its founders at a cost of $99,030. In January 2000, BlueStar repurchased
1,784,935 shares of common stock from one of its founders for $0.049 per share
at a cost of $87,462.
In January and February 2000, BlueStar issued 2,165,603 shares of
redeemable, convertible, voting preferred stock designated as Series C preferred
stock for $15.70 per share. BlueStar received $33,975,000 in net proceeds from
the sale of the Series C preferred stock.
In 1998 and 1999, BlueStar borrowed a total of $1.0 million from Lucent
under a credit agreement, which bears interest at 8.5% for the first $500,000
and 7.75% for the second $500,000, and which amounts mature in August 2001 and
February 2002, respectively. The credit agreement provides for maximum borrowing
of $1.0 million.
In December 1999, BlueStar issued a short-term note in the amount of
$541,526 to Oracle Corporation to finance software. The note bears interest at
an annual rate of 15% with equal monthly principal and interest payments of
$58,704 through October 2000.
In May 1999, BlueStar entered into an equipment operating lease facility
with Ascend, which later merged with Lucent, that provides up to $109.0 million
of equipment and network services provided by Lucent and other third party
vendors for equipment utilized in BlueStar's central office and multi-tenant
building installations. Under the terms of the Lucent facility, BlueStar is
required to use Lucent as a vendor if its equipment meets competitive price and
performance standards. If BlueStar fails to make required payments under the
facility, Lucent may terminate the facility and take back its equipment. The
first tranche of $30.0 million is available to BlueStar through July 2001.
BlueStar may utilize up to $30.0 million under the equipment lease facility
without restriction, and may utilize up to $50.0 million under this facility
upon meeting certain equity requirements, which BlueStar has satisfied.
Utilization of amounts in excess of $50.0 million requires that BlueStar
maintain a minimum of $10.0 million of unrestricted cash. As of June 30, 2000,
BlueStar had utilized $50.5 million of the facility and had $124.5 million
available under the Lucent equipment lease facility. The lease payments are due
through 2002.
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<PAGE>
In April 2000, BlueStar renegotiated the Lucent equipment operating lease
facility to provide an additional $66.0 million of equipment and network service
financing. At June 30, 2000, BlueStar had utilized $50.5 million of the facility
and had $124.5 million available.
In April 2000, BlueStar entered into an equipment operating lease facility
with Cisco Systems Capital that provides up to $50.0 million of equipment and
network services provided by Cisco. BlueStar may utilize up to $10.0 million of
the facility provided it maintains an average minimum cash balance of not less
than $2.0 million. Utilization of amounts in excess of $10.0 million require
that BlueStar maintain an average minimum cash balance of not less than $7.0
million.
In June 2000, BlueStar entered into a $40.0 million demand loan agreement
with Bear Stearns Corporate Lending Inc. Under the terms of the loan agreement,
BlueStar may request up to $5.0 million every two weeks, not to exceed an
aggregate of $40.0 million. Bear Stearns, however, is not obligated to provide
any portion of the requested amount. Any amounts borrowed under the loan
agreement bear interest, at BlueStar's discretion, at either (1) the prime rate
publicly announced by Citibank, N.A. plus 600 basis points or (2) the interest
rate which eurodollar deposits for one month are offered in the interbank
eurodollar market plus 700 basis points. Under either interest rate election,
the minimum interest rate is 13.0%. The loan agreement matures at the earliest
of (1) demand by Bear Stearns, (2) the date of commencement by or against
BlueStar or any of its subsidiaries of any bankruptcy proceeding, (3)
termination of the merger agreement in accordance with its terms, (4)
consummation of the merger with Covad Communications or any other change in
control of BlueStar or (5) December 15, 2000.
During 2000, BlueStar entered into additional operating leases for
equipment with a market value of approximately $34.4 million under the Lucent
equipment lease facility, primarily for equipment and network services. In
addition, BlueStar expects to make capital expenditures of approximately $12.0
million during 2000 that will be used primarily for software, furniture and
fixtures for its corporate and regional offices.
The development and expansion of BlueStar's business requires significant
capital expenditures. The principal capital expenditures incurred to enter each
market include the procurement, design and construction of collocation space. In
addition, BlueStar enters into significant operating lease obligations with
Lucent to acquire and install necessary telecommunications equipment. The number
of central offices that BlueStar expects to target in a given market will vary,
as will the average capital cost to enter a market.
If the merger with Covad Communications does not occur, BlueStar believes
that cash generated from operations and amounts available under its commercial
credit facilities will not be sufficient to meet its expected working capital
and capital expenditure requirements for the next 12 months. BlueStar will be
required to raise additional funds through private or public sales of
securities, bank debt, financing under leasing arrangements or otherwise, the
availability of which cannot be assessed.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
Due to the nature of its short-term investments, BlueStar has concluded
that it has no material market risk exposure.
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BLUESTAR SECURITY OWNERSHIP OF MANAGEMENT
AND PRINCIPAL STOCKHOLDERS
SET FORTH BELOW IS INFORMATION REGARDING BENEFICIAL OWNERSHIP OF BLUESTAR'S
CAPITAL STOCK AS OF JULY 31, 2000 BY (1) EACH PERSON OR ENTITY WHO IS KNOWN TO
BLUESTAR TO OWN BENEFICIALLY 5% OR MORE OF THE OUTSTANDING SHARES OF COMMON
STOCK, SERIES A PREFERRED STOCK, SERIES B PREFERRED STOCK AND SERIES C PREFERRED
STOCK, (2) EACH PRESENT DIRECTOR AND EXECUTIVE OFFICER OF BLUESTAR AND (3) ALL
BLUESTAR DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP.
<TABLE>
<CAPTION>
AMOUNT AND NATURE
OF BENEFICIAL CLASS OF PERCENT
NAME AND ADDRESS OWNERSHIP STOCK OF CLASS
------------------- --------------------- -------------------- -----------
<S> <C> <C> <C>
EXECUTIVE OFFICERS AND DIRECTORS:
Robert E. Dupuis...................................... 980,000 Common Stock 6.4
Richard A. Shapero.................................... 15,537,572 Common Stock 43.9
11,020,410 Series A Preferred 89.3
3,943,914 Series B Preferred 48.2
573,248 Series C Preferred 26.5
John W. Gerdelman..................................... 20,000 Common Stock *
Charles J. McMinn..................................... 338,471 Common Stock *
318,471 Series C Preferred 14.7
Fredjoseph Goldner.................................... 3,026,978 Common Stock 8.6
Richard L. Burtner.................................... 2,019,798 Common Stock 5.7
22,500 Series A Preferred *
Norton Cutler......................................... 300,000 Common Stock *
J. Chad Grier......................................... 150,000 Common Stock *
Tye Schriever......................................... 150,000 Common Stock *
Cliff Duffey.......................................... 300,000 Common Stock *
All Officers and Directors as a Group
(10 persons)....................................... 23,822,819 Common Stock 64.9
5% STOCKHOLDERS:
Crosspoint Venture Partners........................... 15,537,572 Common Stock 43.9
11,020,410 Series A Preferred 89.3
3,943,914 Series B Preferred 48.2
573,248 Series C Preferred 26.5
Gramercy BlueStar, L.P................................ 2,629,272 Common Stock 7.4
2,629,272 Series B Preferred 32.2
Scott E. Kozicki...................................... 2,668,527 Common Stock 7.5
</TABLE>
--------------
* Indicates less than 1% ownership.
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<PAGE>
EXECUTIVE OFFICERS AND DIRECTORS. Additional information regarding the
beneficial ownership of shares of common stock held by BlueStar's executive
officers and directors is contained below. Except as indicated below, the
address for each executive officer and director is Five Corporate Centre, 801
Crescent Drive, Franklin, Tennessee 37067.
o ROBERT E. DUPUIS. Includes 980,000 shares issuable upon exercise of
immediately exercisable stock options. Of the 1,000,000 shares held by
Mr. Dupuis, 381,260 are subject to right of repurchase.
o RICHARD E. SHAPERO. All shares indicated as owned by Mr. Shapero are
included due to his affiliation with funds affiliated with Crosspoint
Venture Partners. Mr. Shapero's address is c/o Crosspoint Venture
Partners, The Pioneer Hotel, 2925 Woodside Road, Woodside, California
94062.
o JOHN W. GERDELMAN. Includes 20,000 shares of common stock subject to
right of repurchase.
o CHARLES J. MCMINN. Includes 20,000 shares of common stock subject to
right of repurchase and 318,471 shares of common stock subject to
issuance upon conversion of 318,471 shares of Series C Preferred
Stock.
o FREDJOSEPH GOLDNER. Excludes 12,987 shares of common stock, of which
Mr. Goldner disclaims beneficial ownership, held directly by or in an
irrevocable trusts for his child.
o RICHARD L. BURTNER. Includes 869,822 shares of common stock that are
subject to BlueStar's right to repurchase if Mr. Burtner's services
are terminated with cause prior to vesting, or 324,561 shares of
common stock if Mr. Burtner's services are terminated without cause
prior to vesting, 40,000 shares of common stock owned by Mr. Burtner's
spouse, 22,500 shares of common stock subject to issuance upon
conversion of 22,500 shares of Series A Preferred Stock held in Mr.
Burtner's profit sharing (Keogh) plan and 50,000 shares of common
stock held in an irrevocable trust. Includes 140,000 shares of common
stock, of which Mr. Burtner disclaims beneficial ownership, held in
irrevocable trusts for his children.
o NORTON CUTLER. Includes 225,000 shares of common stock held by Mr.
Cutler, all of which are subject to BlueStar's right of repurchase,
and 75,000 shares of common stock issuable upon exercise of
immediately exercisable options.
o J. CHAD GRIER. Of the 150,000 share of common stock held by Mr. Grier,
112,500 are subject to right of repurchase.
o TYE SHRIEVER. Of the 150,000 share of common stock held by Mr.
Schriever, 121,875 are subject to right of repurchase.
o CLIFF DUFFEY. Of the 300,000 shares of common stock held by Mr.
Duffey, 231,250 are subject to right of repurchase.
OTHER 5% STOCKHOLDERS. Information regarding the beneficial ownership of 5%
or more of BlueStar's common stock is set forth below.
o CROSSPOINT VENTURE PARTNERS. Includes 15,537,572 shares of common
stock subject to issuance upon conversion of (a) 11,020,410 shares of
Series A Preferred Stock and 1,551,273 shares of Series B Preferred
Stock held by Crosspoint Venture Partners 1997; (b) 1,078,005 shares
of Series B Preferred Stock held by Crosspoint Venture Partners LS
1997; and (c) 1,314,636 shares of Series B Preferred Stock and 573,248
shares of Series C Preferred Stock held by Crosspoint Venture Partners
LS 1999. The general partner of Crosspoint Venture Partners 1997 and
Crosspoint Venture Partners LS 1997 is Crosspoint Associates 1997. The
general partner of Crosspoint Venture Partners LS 1999 is Crosspoint
Associates 1999. The general partners of Crosspoint Associates 1997
and Crosspoint Associates 1999 are John Mumford, Rich Shapero, one of
BlueStar's directors, Robert Hoff, Don Milder and Seth Neiman. Each of
the general partners of Crosspoint Associates 1997 and Crosspoint
Associates 1999 disclaim beneficial ownership of the shares held by
Crosspoint Venture Partners 1997 and Crosspoint Venture Partners LS
1999, except to the extent of his pecuniary interest in these shares.
The address of the investment funds affiliated with Crosspoint Venture
Partners is The Pioneer Hotel, 2925 Woodside Road, Woodside,
California 94062.
o GRAMERCY BLUESTAR, L.P. Includes 2,629,272 shares of common stock
subject to issuance upon conversion of 2,629,272 shares of Series B
Preferred Stock. The address of Gramercy BlueStar, L.P. is 712 Fifth
Avenue, 43rd Floor, New York, New York 10019.
o SCOTT E. KOZICKI. Mr. Kozicki's address is 2601 Belmont Blvd.,
Nashville, Tennessee 37212.
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<PAGE>
COMPARATIVE PER SHARE DATA
THE FOLLOWING TABLE PRESENTS CERTAIN HISTORICAL PER SHARE DATA OF COVAD
COMMUNICATIONS GROUP, INC., LASER LINK.NET, INC. AND BLUESTAR COMMUNICATIONS
GROUP, INC. AND CERTAIN UNAUDITED PRO FORMA PER SHARE DATA THAT REFLECT THE
COMBINATION OF COVAD COMMUNICATIONS, LASER LINK AND BLUESTAR USING THE PURCHASE
METHOD OF ACCOUNTING. THIS DATA SHOULD BE READ IN CONJUNCTION WITH COVAD
COMMUNICATIONS' AUDITED AND UNAUDITED FINANCIAL STATEMENTS, LASER LINK'S AUDITED
FINANCIAL STATEMENTS, BLUESTAR'S AUDITED AND UNAUDITED FINANCIAL STATEMENTS AND
THE COVAD COMMUNICATIONS' UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL
STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS. THE UNAUDITED PRO FORMA
COMBINED PER SHARE DATA DO NOT NECESSARILY INDICATE THE OPERATING RESULTS THAT
WOULD HAVE BEEN ACHIEVED HAD THE COMBINATION OF COVAD COMMUNICATIONS, LASER LINK
AND BLUESTAR ACTUALLY OCCURRED AT THE BEGINNING OF THE PERIODS PRESENTED NOR DO
THEY INDICATE FUTURE RESULTS OF OPERATIONS OR FINANCIAL POSITION.
<TABLE>
<CAPTION>
SIX
MONTHS
YEAR ENDED ENDED
AS OF AS OF
DECEMBER JUNE 30,
HISTORICAL 31, 1999 2000
-------------- ------------- -----------
<S>
Covad Communications: <C> <C>
Net income (loss) per share--basic................................................... $ (1.83) $ (1.59)
Net income (loss) per share--diluted................................................. (1.83) $ (1.59)
Book value per common share (1) ..................................................... 4.71 $ 5.14
Laser Link:
Net income (loss) per share--basic................................................... $ (0.16) n/a
Net income (loss) per share--diluted................................................. (0.16) n/a
Book value per common share (1) ..................................................... (0.01) n/a
BlueStar:
Net income (loss) per share--basic................................................... $ (2.15) $ (5.31)
Net income (loss) per share--diluted................................................. (2.15) $ (5.31)
Book value per common share (1) ..................................................... (1.61) $ (5.17)
Pro Forma:
Net income (loss) per share--basic................................................... $ (2.74) $ (1.99)
Net income (loss) per share--diluted................................................. (2.74) $ (1.99)
Book value per common share (2) ..................................................... 7.52 $ 5.63
Equivalent pro forma net income (loss) per Laser Link
share--basic and diluted (3)...................................................... (0.48) n/a
Equivalent pro forma book value per Laser
Link share (3) ................................................................... 1.31 n/a
Equivalent pro forma net income (loss) per BlueStar
share--basic and diluted (3)...................................................... (0.20) (0.14)
Equivalent pro forma book value per BlueStar share (3) .............................. 0.54 $ 0.41
</TABLE>
--------------
(1) The historical book value per share is computed by dividing total
stockholders' equity as of the end of each period for which such
computation is made by the number of common shares outstanding at the end
of each period.
(2) The pro forma book value per share is computed by dividing pro forma
stockholders' equity by the pro forma number of shares outstanding at the
end of each period for which such computation is made.
(3) The Laser Link and BlueStar pro forma equivalent per share amounts are
computed by multiplying the Covad Communications pro forma combined per
share amounts by the exchange ratio of 0.174 and 0.0722 of a Covad
Communications common share for each Laser Link and BlueStar common
share, respectively. Pro forma diluted earnings per share excludes the
effect of dilutive securities for the year ended December 31, 1999 and
the six months ended June 30, 2000, respectively, as they are
antidilutive.
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DESCRIPTION OF COVAD COMMUNICATIONS CAPITAL STOCK
THE FOLLOWING SUMMARY DESCRIBES THE MATERIAL TERMS OF COVAD COMMUNICATIONS'
CAPITAL STOCK. HOWEVER, IT DOES NOT PURPORT TO BE COMPLETE AND IS QUALIFIED IN
ITS ENTIRETY BY THE ACTUAL TERMS OF COVAD COMMUNICATIONS' CAPITAL STOCK
CONTAINED IN ITS AMENDED AND RESTATED CERTIFICATE OF INCORPORATION AND OTHER
AGREEMENTS REFERENCED BELOW.
As of August 1, 2000 Covad Communications' authorized capital stock
consisted of 600,000,000 shares of common stock, 10,000,000 shares of Class B
common stock and 5,000,000 shares of preferred stock. As of July 1, 2000, there
were 613 holders of record of common stock and no holders of Class B common
stock or preferred stock. The common stock and preferred stock each have a par
value of $0.001 per share. As of August 1, 2000, there were 154,770,567 shares
of common stock outstanding. As of August 1, 2000, options to purchase
25,700,808 shares of common stock at a weighted average exercise price of $21.41
per share were outstanding.
COMMON STOCK
The holders of Covad Communications common stock are entitled to one vote
per share on all matters submitted to a vote of the stockholders. Subject to
preferential rights of 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. In the event of liquidation, dissolution or winding
up, the holders of common stock are entitled to share ratably in all Covad
Communications' remaining assets after payment of liabilities and satisfaction
of preferential rights of any outstanding series of preferred stock. 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.
CLASS B COMMON STOCK
Although there are 10,000,000 shares of Class B common stock authorized,
there is, currently, no Class B common stock 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 without any further action or vote by the
stockholders. In addition, the board of directors is authorized, without
stockholder approval, to fix the rights, preferences, privileges and
restrictions granted to or imposed upon such preferred stock, including:
o dividend rights;
o conversion rights;
o terms of redemption;
o liquidation preferences;
o voting rights;
o sinking fund terms; and
o the number of shares constituting any series or the designation of
such series.
As a result, the board of directors could issue additional preferred stock
with voting and conversion rights which could adversely affect the voting power
of the holders of common stock. Issuing preferred stock could also have the
effect of delaying, deferring or preventing a change in control or the removal
of Covad Communications' board of directors. Covad Communications has no present
plan to issue any shares of preferred stock.
WARRANTS
In connection with the issuance of Covad Communications' senior discount
notes in March 1998, Covad Communications issued warrants to purchase an
aggregate of 11,370,969 shares of its common stock with exercise prices of
$0.0015 per share. Covad also issued to a consultant a five-year warrant to
purchase 303,750 split-adjusted
103
<PAGE>
shares of common stock with an exercise price of $0.4445 per share. This warrant
is immediately exercisable. In April 1999, Covad Communications issued a warrant
to purchase 450,000 shares of common stock to a customer. This warrant vested
with respect to 225,000 shares on April 1, 2000 and will vest with respect to
the remaining 225,000 shares on April 1, 2001, subject to the customer achieving
certain performance goals. The exercise price for 225,000 of the shares is
$48.4375. The exercise price for the remaining 225,000 shares will be the fair
market value of the common stock on the ten trading days preceding the second
vesting date.
REGISTRATION RIGHTS
Certain holders of Covad Communications common stock are entitled to
registration rights. Pursuant to the stockholder rights agreement holders of
29,859,175 shares of common stock and the former holders of 6,379,177 shares of
Class B common stock are entitled to certain rights with respect to the
registration under the Securities Act of the shares of common stock held by them
or issued as a result of the conversion of the Class B common stock. The
6,379,177 shares of Class B common stock have been converted into 14,353,147
shares of common stock. 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 managing underwriter advises 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) January 21, 2002 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,
between Covad Communications and Bear, Stearns & Co. Inc. and BT Alex. Brown
Incorporated, holders of warrants that remain outstanding after Covad
Communications' current S-1 offering are entitled to certain registration rights
with respect to the shares of common stock issuable upon exercise of such
warrants. Like the rights holders, the number of securities that a warrant
holder may request to be included in any registration is subject to a pro rata
reduction. Such a reduction will be 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 managing underwriter advises Covad
Communications 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 THE CHARTER, BYLAWS, DELAWARE LAW AND THE STOCKHOLDER
PROTECTION RIGHTS PLAN.
As noted above, Covad Communications' board of directors, without
stockholder approval, has the authority under Covad Communications' charter 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 the common stock holders and could be
issued with terms calculated to delay or prevent a change of control of Covad
Communications or make removal of management more difficult.
ELECTION AND REMOVAL OF DIRECTORS. Covad Communications' charter and bylaws
provide for the division of its board of directors into three classes with the
directors in each class serving for a three-year term, and one class being
elected each year by the stockholders. The 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 Covad Communications and may maintain the incumbency of the board of
directors, as it generally makes it more difficult for stockholders to replace a
majority of the directors.
STOCKHOLDER MEETINGS AND WRITTEN CONSENT. Under Covad Communications'
bylaws, the stockholders may not call a special meeting of the stockholders of
Covad Communications. Rather, only the board of directors, the chairman of the
board of directors and the President or Chief Executive Officer may call special
meetings of stockholders. Covad Communications' charter provides that
stockholders may not act by written consent. As a result, stockholders can only
act at a meeting.
REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS. Covad Communications' bylaws establish advanced notice procedures
with respect to stockholder proposals and the nomination of candidates for
election as directors, other than nominations made by or at the direction of the
board of directors or a committee thereof.
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SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW. Covad Communications
is subject to Section 203 of the Delaware General Corporation Law. Section 203
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
o 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;
o 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
o 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. An "interested stockholder" is generally
a person who, together with affiliates and associates of such person,
o owns 15% or more of the corporation's voting stock or
o 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 Covad
Communications.
STOCKHOLDER PROTECTION RIGHTS PLAN. In addition, Covad Communications' has
adopted a stockholder protection rights plan under which stockholders received
one right for each share of common stock owned by them. The rights become
exercisable, in most circumstances, upon the accumulation by a person or group
of 15% or more of the outstanding shares of common stock. Each right entitles
the holder to purchase from Covad Communications, as provided by the stockholder
protection rights agreement, one one-thousandth of a share of participating
preferred stock, par value $.001 per share, for $400.00 subject to adjustment.
The rights plan is not intended to, and will not, prevent a takeover of Covad
Communications at a full and fair price. However, the rights may cause
substantial dilution to a person or group acquiring 15% or more of the common
stock unless the rights are first redeemed by the board of directors.
105
<PAGE>
COMPARISON OF STOCKHOLDER RIGHTS
IF THE MERGER IS COMPLETED, ALL HOLDERS OF BLUESTAR STOCK WILL BECOME
HOLDERS OF SHARES OF COVAD COMMUNICATIONS COMMON STOCK. THE RIGHTS OF A HOLDER
OF COVAD COMMUNICATIONS COMMON STOCK ARE SIMILAR IN SOME RESPECTS AND DIFFERENT
IN OTHER RESPECTS FROM THE RIGHTS OF A HOLDER OF BLUESTAR STOCK. THE RIGHTS OF
BLUESTAR STOCKHOLDERS ARE CURRENTLY GOVERNED BY THE DELAWARE GENERAL CORPORATION
LAW AND THE CERTIFICATE OF INCORPORATION AND BYLAWS OF BLUESTAR. THE RIGHTS OF
COVAD COMMUNICATIONS STOCKHOLDERS ARE CURRENTLY GOVERNED BY THE DELAWARE GENERAL
CORPORATION LAW AND THE CERTIFICATE OF INCORPORATION AND BYLAWS OF COVAD
COMMUNICATIONS. THE FOLLOWING ARE SUMMARIES OF THE MATERIAL DIFFERENCES BETWEEN
THE CURRENT RIGHTS OF BLUESTAR STOCKHOLDERS AND THE RIGHTS THEY WILL HAVE AS
HOLDERS OF COVAD COMMUNICATIONS COMMON STOCK FOLLOWING THE MERGER.
THE FOLLOWING COMPARISON OF STOCKHOLDERS' RIGHTS IS NECESSARILY A SUMMARY,
IS NOT INTENDED TO BE COMPLETE OR TO IDENTIFY ALL DIFFERENCES THAT MAY, UNDER
GIVEN SITUATIONS, BE MATERIAL TO STOCKHOLDERS OF BLUESTAR AND IS SUBJECT, IN ALL
RESPECTS, AND IS QUALIFIED BY REFERENCE TO, THE DELAWARE GENERAL CORPORATION
LAW, THE COVAD COMMUNICATIONS CERTIFICATE OF INCORPORATION, THE COVAD
COMMUNICATIONS BYLAWS, THE BLUESTAR CERTIFICATE OF INCORPORATION AND THE
BLUESTAR BYLAWS.
AUTHORIZED SHARES
BLUESTAR. The total number of authorized shares of stock of BlueStar is
82,689,584, consisting of 60,000,000 shares of common stock, 12,345,003 shares
of series A preferred stock, 8,177,040 shares of series B preferred stock, and
2,165,603 shares of series C preferred stock, each having a par value of $.01
per share.
COVAD COMMUNICATIONS. The total number of authorized shares of stock of
Covad Communications is 615,000,000, consisting of 600,000,000 shares of common
stock, 10,000,000 shares of Class B common stock and 5,000,000 shares of
preferred stock, each having $.001 par value. The board of directors has the
authority to issue up to 5,000,000 shares of preferred stock in one or more
series without any further action or vote by the stockholders. In addition, the
board of directors is authorized, without stockholder approval, to fix the
rights, preferences, privileges and restrictions granted to or imposed upon such
preferred stock.
DIRECTORS
NUMBER OF DIRECTORS. The BlueStar bylaws provides that the number of
directors on the BlueStar board will be fixed by the board of directors but will
not be less than one. BlueStar currently has five directors. The Covad
Communications bylaws provide that the number of directors on the Covad
Communications board will not be less than five and not more than nine, and
Covad Communications' currently has eight directors.
CLASSIFICATION OF BOARD OF DIRECTORS. The BlueStar board of directors is
not divided into separate classes but consists of a single class elected
annually. The Covad Communications board of directors is divided into three
classes. The term of office and directors consisting of each class is as
follows:
<TABLE>
<CAPTION>
TERM OF
CLASS DIRECTORS OFFICE
------ ---------- --------------
<S> <C> <C>
Class I Daniel Lynch o expires at the annual meeting of
Rich Shapero stockholders in 2003 and at each third
Larry Irving succeeding annual meeting thereafter
Class II Frank Marshall o expires at the annual meeting of
stockholders in 2001 and at each third
succeeding annual meeting thereafter
Hellene Runtagh
o expires at the annual meeting of
Class III Robert Hawk stockholders in 2002 and at each third
Robert Knowling, Jr. succeeding annual meeting thereafter
Debra Dunn
</TABLE>
The classification of directors has the effect of making it more difficult
to change the composition of the Covad Communications board of directors.
NUMBER OF DIRECTORS NECESSARY TO CONSTITUTE A QUORUM. Under the BlueStar
bylaws, a majority of the entire board of directors then in office constitutes a
quorum for the transaction of business by the BlueStar board. Under
106
<PAGE>
the Covad Communications bylaws, the presence of a majority of the authorized
number of directors constitutes a quorum for the transaction of business by the
Covad Communications board.
REMOVAL OF DIRECTORS. Under the BlueStar bylaws, a member of the board of
directors may only be removed for cause. Under Delaware law and the Covad
Communications bylaws, any and all directors may be removed if the removal is
approved by the affirmative vote of a majority of the stockholders entitled to
vote.
CUMULATIVE VOTING. Cumulative voting rights in the election of directors
entitle a stockholder to give one nominee as many votes as are equal to the
number of directors to be elected multiplied by the number of shares owned by
the stockholder, or to distribute such votes among two or more nominees, as the
stockholder sees fit. In the absence of cumulative voting, the holder or holders
of a majority of the shares present or represented at a meeting has the power to
elect each director to be elected at such meeting.
Delaware law provides that a corporation's certificate of incorporation may
provide for cumulative voting. However, neither BlueStar nor Covad
Communications, stockholders may cumulatively vote their shares for the election
of directors, because neither BlueStar nor Covad Communications' certificates of
incorporation provides for cumulative voting.
BYLAW AMENDMENTS
AMENDMENT OF BYLAWS. Under Delaware law and the BlueStar certificate of
incorporation and bylaws, the BlueStar bylaws can be amended or repealed by the
affirmative vote of either:
o holders of a majority of the outstanding voting shares, or
o a majority of the BlueStar board of directors.
Under Delaware law and the Covad Communications certificate of
incorporation and bylaws, the Covad Communications bylaws can be adopted,
amended or repealed by the affirmative vote of a majority of either:
o the stockholders entitled to vote, or
o the board of directors.
STOCKHOLDER MEETING PROCEDURES
SPECIAL MEETINGS OF STOCKHOLDERS. Under Delaware law, special meetings of
stockholders may be called by the board of directors or by such person or
persons as may be authorized by the certificate of incorporation or bylaws.
Under the BlueStar certificate of incorporation and bylaws, special meetings may
only be called by the board of directors. Under the Covad Communications
certificate of incorporation and bylaws, special meetings may be called at any
time by the board of directors, 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 one or more shareholders holding
shares in the aggregate entitled to cast not less than 10% of the votes cast at
that meeting, but such special meetings may not be called by any other person or
persons.
PROVISIONS FOR NOTICES. Under the BlueStar bylaws, BlueStar is not required
to give notice of a meeting. Any and all notices of a meeting may be waived by a
stockholder by submitting a signed waiver either before or after the meeting.
The attendance of any stockholder at a meeting, in person or by proxy, without
protesting prior to the conclusion of the meeting the lack of notice of such
meeting, will constitute a waiver of notice.
Under the Covad Communications bylaws, Covad Communications must give
personally or by mail, not less than ten and not more than sixty days before the
date of any meeting of stockholders, to each stockholder entitled to vote at
such meeting, written notice stating the place, date, hour and purpose or
purposes of the meeting. Any and all notices of a meeting may be waived by a
stockholder by submitting a signed waiver of notice or a consent to the holding
of the meeting or an approval of the minutes thereof, either before or after the
meeting. The attendance of any stockholder at a meeting, in person or by proxy,
without protesting at the beginning of the meeting the lack of notice of such
meeting, will constitute a waiver of notice.
STOCKHOLDERS NECESSARY TO CONSTITUTE A QUORUM. Under the BlueStar and Covad
Communications's bylaws, the holders of record of a majority of the outstanding
shares of stock entitled to vote shall constitute a quorum for the purposes of
transacting business at any stockholder meeting.
107
<PAGE>
LEGAL OPINIONS
The legality of the shares of Covad Communications common stock to be
issued to holders of shares of BlueStar stock pursuant to the merger will be
passed upon for Covad Communications by Simpson Thacher & Bartlett, New York,
New York.
Certain federal income tax matters related to the merger will be passed
upon by Brobeck, Phleger & Harrison LLP, Austin, Texas.
EXPERTS
The consolidated financial statements of Covad Communications Group, Inc.
at December 31, 1998 and 1999 and for each of the three years in the period
ended December 31, 1999, included in this prospectus, have been audited by Ernst
& Young LLP, independent auditors, as set forth in their report appearing
elsewhere herein, and are included in reliance upon such report given on the
authority of such firm as experts in accounting and auditing.
The consolidated financial statements of the BlueStar Communications Group,
Inc. as of December 31, 1998 and 1999 and for the years ended December 31, 1998
and December 31, 1999 included in this prospectus have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their report with
respect thereto, and are included herein in reliance upon the authority of said
firm as experts in giving said reports.
The consolidated financial statements of Laser Link.Net, Inc. as of
December 31, 1998 and 1999 and for each of the three years in the period ended
December 31, 1999, appearing in this prospectus, have been audited by
PricewaterhouseCoopers LLP, independent auditors, as set forth in their report
thereon appearing elsewhere herein, and are included in reliance upon such
report given on the authority of such firm as experts in accounting and
auditing.
108
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
Covad Communications has filed with the SEC a registration statement on
Form S-4 to register the Covad Communications common stock to be issued to
BlueStar stockholders in the merger. As allowed by SEC rules, this prospectus
does not contain all of the information included in the Form S-4 registration
statement and its exhibits. You should refer to the copy of those documents
filed as exhibits to the registration statement with the SEC for a more complete
understanding.
Covad Communications files annual, quarterly and special reports, proxy
statements and other information with the SEC. The registration statement,
including the attached exhibits and schedules, may be inspected and copied at
the public reference facilities maintained by the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional
offices of the SEC located at Seven World Trade Center, New York, New York
10048, and 500 West Madison Street, Chicago, Illinois 60661. Please call the SEC
at 1-800-SEC-0330 for further information about the public reference rooms. The
SEC maintains a web site that contains reports, proxy statements and
prospectuses and other information regarding registrants that file
electronically with the SEC. Copies of the registration statement and the
reports, proxy statements and prospectuses and other information that Covad
Communications files with the SEC may be obtained from the SEC's Internet
address at http://www.sec.gov.
THE DOCUMENTS INCORPORATED BY REFERENCE IN THIS DOCUMENT ARE AVAILABLE TO
STOCKHOLDERS OF BLUESTAR WITHOUT CHARGE UPON WRITTEN REQUEST TO COVAD
COMMUNICATIONS AT THE FOLLOWING ADDRESS AND TELEPHONE NUMBER:
COVAD COMMUNICATIONS GROUP, INC.
ATTENTION: INVESTOR RELATIONS
4250 BURTON DRIVE
SANTA CLARA, CALIFORNIA 95054
(408) 987-1000
TO OBTAIN TIMELY DELIVERY, STOCKHOLDERS MUST REQUEST THIS INFORMATION NO
LATER THAN SEPTEMBER 5, 2000, FIVE BUSINESS DAYS PRIOR TO THE DEADLINE FOR THE
SUBMISSION OF WRITTEN CONSENTS PURSUANT TO WHICH BLUESTAR STOCKHOLDERS WILL
APPROVE THE MERGER.
COVAD COMMUNICATIONS HAS NOT AUTHORIZED ANYONE TO GIVE ANY INFORMATION OR
MAKE ANY REPRESENTATION ABOUT THE MERGER, COVAD COMMUNICATIONS OR BLUESTAR THAT
DIFFERS FROM OR ADDS TO THE INFORMATION IN THIS PROSPECTUS OR IN COVAD
COMMUNICATIONS' DOCUMENTS THAT ARE PUBLICLY FILED WITH THE SEC. THEREFORE, IF
ANYONE DOES GIVE YOU DIFFERENT OR ADDITIONAL INFORMATION, YOU SHOULD NOT RELY ON
IT.
THE INFORMATION CONTAINED IN THIS PROSPECTUS SPEAKS ONLY AS OF ITS DATE
UNLESS THE INFORMATION SPECIFICALLY INDICATES THAT ANOTHER DATE APPLIES.
109
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S><C>
PAGE
----
COVAD COMMUNICATIONS GROUP, INC
ANNUAL FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1999........................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1997, 1998 and 1999.......... F-4
Consolidated Statements of Stockholders' Equity (Net Capital Deficiency) for the years ended
December 31, 1997, 1998 and 1999.................................................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999.......... F-6
Notes to Consolidated Financial Statements.......................................................... F-7
INTERIM FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheet at June 30, 2000............................................... F-19
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 1999 and
2000.............................................................................................. F-20
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 2000..... F-21
Notes to Condensed Consolidated Financial Statements................................................ F-22
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
Overview............................................................................................ F-28
Unaudited Pro Forma Condensed Combined Consolidated Balance Sheets at June 30, 2000................. F-29
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the year ended
December 31, 1999................................................................................. F-30
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the six months
ended June 30, 2000............................................................................... F-31
Notes to Unaudited Pro Forma Condensed Combined Consolidated Financial Information.................. F-32
LASER LINK.NET, INC
ANNUAL FINANCIAL STATEMENTS
Report of Independent Accountants................................................................... F-38
Balance Sheets at December 31, 1999 and 1998........................................................ F-39
Statements of Operations for the years ended December 31, 1997, 1998 and 1999....................... F-40
Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999............. F-41
Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999....................... F-42
Notes to Financial Statements....................................................................... F-43
BLUESTAR COMMUNICATIONS GROUP, INC
ANNUAL FINANCIAL STATEMENTS
Report of Independent Public Accountants............................................................ F-50
Consolidated Balance Sheets at December 31, 1998 and December 31, 1999.............................. F-51
Consolidated Statements of Operations for the years ended December 31, 1998 and 1999................ F-52
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998 and 1999...... F-53
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1999................ F-54
Notes to Consolidated Financial Statements.......................................................... F-55
INTERIM FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets at June 30, 2000.............................................. F-65
Condensed Consolidated Statements of Operations for six months ended June 30, 1999 and 2000......... F-66
Condensed Consolidated Statements of Stockholders' Equity for the six months ended June 30, 2000.... F-67
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 2000..... F-68
Notes to Condensed Consolidated Financial Statements................................................ F-69
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, 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, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity (net capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial statements referred to herein
present fairly, in all material respects, the consolidated financial position of
Covad Communications Group, Inc. as of December 31, 1998 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1999 in conformity with accounting
principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Walnut Creek, California
January 21, 2000, except for Note 9,
as to which the date is April 3, 2000
F-2
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
ASSETS 1998 1999
---------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents......................................................... $ 64,450 $ 216,038
Accounts receivable, net of allowances for uncollectibles of $220 and $2,857 at
December 31, 1998 and 1999...................................................... 1,933 15,393
Short-term investments............................................................ -- 551,319
Unbilled revenue.................................................................. 663 5,419
Inventories....................................................................... 946 8,547
Prepaid expenses.................................................................. 1,183 6,048
Other current assets.............................................................. 514 1,219
---------- -------------
Total current assets ........................................................... 69,689 803,983
PROPERTY AND EQUIPMENT:
Networks and communication equipment.............................................. 55,189 233,260
Computer equipment................................................................ 4,426 24,057
Furniture and fixtures............................................................ 1,119 4,383
Leasehold improvements............................................................ 1,887 6,884
Land.............................................................................. -- 1,120
---------- -------------
62,621 269,704
Less accumulated depreciation and amortization....................................... (3,476) (32,162)
---------- -------------
Net property and equipment...................................................... 59,145 237,542
OTHER ASSETS:
Restricted cash................................................................... 225 63,308
Deposits ......................................................................... 337 1,131
Deferred debt issuance costs, net ................................................ 8,112 12,369
Deferred charge, net.............................................................. -- 20,529
Other long term assets............................................................ 1,911 8,744
---------- -------------
10,585 106,081
---------- -------------
Total Assets.................................................................... $ 139,419 $ 1,147,606
========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 14,975 $ 41,126
Unearned revenue.................................................................. 551 5,238
Accrued network costs............................................................. 1,866 8,798
Other accrued liabilities......................................................... 3,854 27,104
Current portion of capital lease obligations...................................... 263 268
---------- -------------
Total current liabilities....................................................... 21,509 82,534
Long-term debt, net of discount...................................................... 142,300 374,737
Long-term capital lease obligations.................................................. 316 44
---------- -------------
Total liabilities............................................................... 164,125 457,315
Commitments and contingencies (see notes 4 and 8)
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY):
Preferred stock ($0.001 par value):
Authorized shares--30,000,000 at December 1998 and 5,000,000 at December 31,1999.. -- --
Issued and outstanding shares--27,369,243 at December 31, 1998 and 0 at
December 31, 1999............................................................... 18 --
Common Stock ($0.001 par value):
Authorized shares--65,000,000 at December 31, 1998 and 190,000,000 at December 31,
1999 ........................................................................... -- --
Issued and outstanding shares--26,491,494 at December 31, 1998 and
132,331,316 at December 31, 1999................................................ 12 82
Common Stock--Class B ($0.001 par value)
Authorized shares--0 at December 31, 1998 and 10,000,000 at December 31, 1999 ..... -- --
Issued and outstanding shares--0 at December 31, 1998 and 6,379,177 at December 31,
1999............................................................................ -- 6
Additional paid-in capital........................................................... 30,685 851,589
Deferred compensation................................................................ (4,688) (6,513)
Accumulated other comprehensive income, net of tax effect............................ -- 91,257
Accumulated deficit ................................................................. (50,733) (246,130)
---------- -------------
Total stockholders' equity (net capital deficiency)............................. (24,706) 690,291
---------- -------------
Total liabilities and stockholders' equity (net capital deficiency)............. $ 139,419 $ 1,147,606
========== =============
</TABLE>
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>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
------------ ------------- -------------
<S> <C> <C> <C>
Revenues............................................................. $ 26 $ 5,326 $ 66,488
Operating expenses:
Network and product costs......................................... 54 4,562 55,347
Sales, marketing, general and administrative...................... 2,374 31,043 140,372
Amortization of deferred compensation............................. 295 3,997 4,768
Depreciation and amortization..................................... 70 3,406 37,602
------------ ------------- -------------
Total operating expenses........................................ 2,793 43,008 238,089
------------ ------------- -------------
Loss from operations................................................. (2,767) (37,682) (171,601)
Interest income (expense):
Interest income................................................... 167 4,778 20,676
Interest expense.................................................. (12) (15,217) (44,472)
------------ ------------- -------------
Net interest income (expense)..................................... 155 (10,439) (23,796)
------------ ------------- -------------
Net loss............................................................. (2,612) (48,121) (195,397)
Preferred dividends.................................................. -- -- (1,146)
------------ ------------- -------------
Net loss attributable to Common Stockholders......................... $ (2,612) $ (48,121) $ (196,543)
============ ============= =============
Net loss per share--basic and diluted................................ $ (0.35) $ (3.75) $ (1.83)
============ ============= =============
Weighted average shares used in computing net loss per
share--basic and diluted........................................ 7,360,978 12,844,203 107,647,812
============ ============= =============
</TABLE>
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)
(AMOUNTS IN 000'S, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------------------- ------------------------- PAID-IN DEFERRED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION
----------- ---------- ----------- ---------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Initial issuance of Common Stock..... -- $ -- 27,000,000 $ 12 $ 38 $ --
Repurchase of Common Stock........... -- -- (5,423,166) (3) (7) --
Issuance of Common Stock............. -- -- 3,985,875 2 66 --
Issuance of Series A Preferred Stock 1,125,000 1 -- -- 249 --
Issuance of Series B Preferred Stock
(net of $43 of financing costs)... 25,500,002 17 -- -- 8,440 --
Deferred compensation ............... -- -- -- -- 906 (906)
Amortization of deferred............. -- -- -- -- -- 295
Net loss............................. -- -- -- -- -- --
----------- ---------- ----------- ---------- --------- ------------
Balances at December 31, 1997 ....... 26,625,002 18 25,562,709 11 9,692 (611)
Issuance of Common Stock............. -- -- 928,785 1 570 --
Issuance of Series B Preferred Stock. 150,003 -- -- -- 100 --
Issuance of Series C Preferred Stock. 594,238 -- -- -- 1,100 --
Issuance of Common Stock warrants as
part of debt offering issuance
costs............................. -- -- -- -- 2,928 --
Issuance of Common Stock warrants
Pursuant to debt offering......... -- -- -- -- 8,221 --
Deferred compensation ............... -- -- -- -- 8,074 (8,074)
Amortization of deferred compensation -- -- -- -- -- 3,997
Net loss............................. -- -- -- -- -- --
----------- ---------- ----------- ---------- --------- ------------
Balances at December 31, 1998........ (27,369,243) 18 26,491,494 12 30,685 (4,688)
Issuance of Common Stock ............ -- -- 48,999,989 33 725,708 --
Issuance of Common Stock upon
exercise of warrants.............. -- -- 15,652,382 10 (5) --
Issuance of Series C and D Preferred
Stock............................. 9,568,766 6 -- -- 59,994 --
Deferred charge related to issuance of
Series C and D Preferred Stock ... -- -- -- -- 28,700 --
Conversion of Series A, Series B and
Series C Preferred Stock to
Common Stock...................... (27,369,243) (18) 41,053,864 27 (9) --
Conversion of Series C1 and D1
Preferred stock................... (9,568,766) (6) 6,379,177 6 -- --
Preferred dividends ................. -- -- 133,587 -- (77) --
Conversion of convertible Preferred
Stock............................. -- -- -- -- -- --
Deferred compensation................ -- -- -- -- 6,593 (6,593)
Amortization of deferred compensation -- -- -- -- -- 4,768
Unrealized gains (losses) on
investments....................... -- -- -- -- -- --
Net loss............................. -- -- -- -- -- --
----------- ---------- ----------- ---------- --------- ------------
Balances at December 31, 1999........ -- -- 138,710,493 $ 88 $851,589 $ (6,513)
=========== ========== =========== ========== ========= ============
<CAPTION>
ACCUMULATED OTHER TOTAL STOCKHOLDERS'
COMPREHENSIVE ACCUMULATED EQUITY (NET CAPITAL
INCOME DEFICIT DEFICIENCY)
---------------- ----------- ---------------
<S> <C> <C> <C>
Initial issuance of Common Stock..... $ -- $ -- $ 50
Repurchase of Common Stock........... -- -- (10)
Issuance of Common Stock............. -- -- 68
Issuance of Series A Preferred Stock -- -- 250
Issuance of Series B Preferred Stock
(net of $43 of financing costs)... -- 8,457
Deferred compensation ............... -- --
Amortization of deferred............. -- (295)
Net loss............................. -- (2,612) (2,612)
---------------- ----------- ---------------
Balances at December 31, 1997 ....... -- (2,612) 6,498
Issuance of Common Stock............. -- -- 571
Issuance of Series B Preferred Stock. -- -- 100
Issuance of Series C Preferred Stock. -- -- 1,100
Issuance of Common Stock warrants as
part of debt offering issuance
costs............................. -- -- 2,928
Issuance of Common Stock warrants
Pursuant to debt offering......... -- -- 8,221
Deferred compensation ............... -- -- --
Amortization of deferred compensation -- -- 3,997
Net loss............................. -- (48,121) (48,121)
---------------- ----------- ---------------
Balances at December 31, 1998........ -- (50,733) (24,706)
Issuance of Common Stock ............ -- -- 725,741
Issuance of Common Stock upon
exercise of warrants.............. -- -- 5
Issuance of Series C and D Preferred
Stock............................. -- -- 60,000
Deferred charge related to issuance of
Series C and D Preferred Stock ... -- -- 28,700
Conversion of Series A, Series B and
Series C Preferred Stock to
Common Stock...................... -- -- --
Conversion of Series C1 and D1
Preferred stock................... -- -- --
Preferred dividends ................. -- -- (77)
Conversion of convertible Preferred
Stock............................. -- -- --
Deferred compensation................ -- -- --
Amortization of deferred compensation -- -- 4,768
Unrealized gains (losses) on
investments....................... 91,257 -- 91,257
Net loss............................. -- (195,397) (195,397)
---------------- ----------- -----------
----------------
Balances at December 31, 1999........ $ 91,257 $ (246,130) $ 690,291
================ =========== ================
</TABLE>
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>
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1998 1999
---------- ----------- -----------
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net loss........................................................................ $ (2,612)$ (48,121) $ (195,397)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 70 3,406 37,602
Loss on disposition of equipment............................................. -- -- 358
Amortization of deferred compensation........................................ 295 3,997 4,768
Accreted interest and amortization of debt discount and deferred debt
issuance costs............................................................. -- 16,009 20,269
Net changes in operating assets and liabilities:
Accounts receivable........................................................ (25) (1,908) (13,460)
Unbilled revenue........................................................... (4) (659) (4,756)
Inventories................................................................ (43) (903) (7,601)
Prepaid expenses and other current assets.................................. (369) (1,328) (5,570)
Accounts payable........................................................... 651 14,324 26,151
Unearned revenue........................................................... 7 544 4,687
Other current liabilities.................................................. 135 5,585 30,182
---------- ----------- -----------
Net cash used in operating activities.................................... (1,895) (9,054) (102,767)
INVESTING ACTIVITIES:
Purchase of restricted investment............................................... (210) (15) (73,435)
Redemption of restricted investments............................................ -- -- 13,214
Purchase of investments......................................................... -- (460,062)
Deposits........................................................................ (31) (306) (794)
Long-term assets................................................................ -- (1,428) (6,833)
Purchase of property and equipment.............................................. (2,253) (59,503) (208,186)
---------- ----------- -----------
Net cash used in investing activities.................................... (2,494) (61,252) (736,096)
---------- ----------- -----------
FINANCING ACTIVITIES:
Net proceeds from issuance of long-term debt and warrants....................... -- 129,328 205,049
Principal payments under capital lease obligations.............................. (48) (238) (267)
Proceeds from Common Stock issuance, net of repurchase.......................... 108 571 725,746
Proceeds from preferred stock issuance.......................................... 8,707 1,200 60,000
Offering costs related to Common Stock offering................................. -- (483) (77)
---------- ----------- -----------
Net cash provided by financing activities................................ 8,767 130,378 990,451
---------- ----------- -----------
Net increase in cash and cash equivalents................................ 4,378 60,072 151,588
Cash and cash equivalents at beginning of year.................................. -- 4,378 64,450
---------- ----------- -----------
Cash and cash equivalents at end of year........................................ $ 4,378 $ 64,450 $ 216,038
========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest.......................................... $ 9 $ 99 $ 13,257
========== =========== ===========
SUPPLEMENTAL SCHEDULE ON NON-CASH INVESTING AND FINANCING ACTIVITIES:
Equipment purchased through capital lease....................................... $ 831 $ 34 $ --
========== =========== ===========
Warrants issued for equity commitment........................................... $ -- $ 2,928 $ --
========== =========== ===========
</TABLE>
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 Group, Inc. (the "Company") is a high-speed Internet
and network access provider offering digital subscriber line ("DSL") services to
Internet Service Provider ("ISP") and enterprise customers. ISPs purchase the
Company's services in order to provide high-speed Internet access to their
business and consumer end-users. Enterprise customers purchase the Company's
services to provide employees with remote access to their Local Area Networks to
improve employee productivity and reduce operating costs. 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
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.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results may differ materially from
those estimates.
INITIAL PUBLIC OFFERING
In January 1999, the Company completed an initial public offering of
20,182,500 shares of Common Stock at a purchase price of $8 per share. Net
proceeds to the Company aggregated approximately $150.2 million. In connection
with the offering, all of the preferred stock outstanding automatically
converted into 41,053,864 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). The
Company's Board of Directors and stockholders also approved an amendment to the
Company's Articles of Incorporation to increase the total number of shares which
the Company is authorized to issue to 205,000,000 shares, of which 200,000,000
is Common Stock and 5,000,000 is preferred stock.
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. Revenue recognized for which the customer has not been
billed is recorded as unbilled revenue until the period such billings are made.
Amounts billed in advance of providing services are recorded as unearned revenue
until the period such services are provided. For the year ended December 31,
1998, one customer accounted for approximately 17% of the Company's revenue. For
the year ended December 31, 1999, two customers accounted for 15% and 14%
percent of the Company's revenues.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments, with a maturity of
three months or less from the date of original issuance, to be cash equivalents.
F-7
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RESTRICTED CASH
As of December 31, 1998, the Company had $225,000, in commercial deposits
held in the Company's name but restricted as security for certain of the
Company's capital lease financing arrangements. As of December 31, 1999, the
Company had $63,308,000 (net of an unrealized loss of $918,000) in U.S. Treasury
investments and commercial deposits for the payment of interest on the Company's
1999 notes and as security for certain lease financing arrangements.
CONCENTRATION OF CREDIT RISK AND CREDIT RISK EVALUATIONS
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents,
restricted cash, short-term investments and accounts receivable. The Company's
cash and investment policies limit cash equivalents, restricted cash and
short-term investments to short-term, investment grade instruments. Cash and
cash equivalents, restricted cash and short-term investments are held with
various domestic financial institutions with high credit standing. The Company
has not experienced any significant losses on its cash and cash equivalents,
restricted cash or short-term investments. The company conducts business with
companies in various industries, primarily in the United States. Concentrations
of credit risk with respect to accounts receivable are limited due to the large
number of customers comprising the Company's customer base. In addition, 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. Allowances are maintained for potential credit
issues and such losses to date have been within management's expectations.
INVENTORIES
Inventories are stated at the lower of cost or market and consist primarily
of customer premise equipment. Costs are based on the "first-in, first-out"
method.
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............................... 3 to 7 years
Computer equipment................................... 3 years
Office equipment..................................... 2 to 5 years
Computer software.................................... 2 to 7 years
</TABLE>
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes costs associated with the design, deployment and
expansion of the Company's network including internally and externally developed
software in accordance with Financial Accounting Standard Board No. 86 "Software
Development Costs" ("FAS 86") and Statement of Position 98-1 "Accounting for
Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"),
respectively. Costs incurred subsequent to the establishment of technological
feasibility are capitalized and amortized over the estimated lives of the
related products. Technological feasibility is established upon completion of a
working model. Capitalized external software costs include the actual costs to
purchase software from vendors. Capitalized internal software costs generally
include personnel and related costs incurred in the enhancement and
implementation of purchased software packages. Capitalized internal labor costs
for the years ending December 31, 1997, 1998 and 1999 were $139,000, $3,063,000
and $15,733,000, respectively. Capitalized interest cost for the years ending
December 31, 1997, 1998 and 1999 were none, $908,000 and $2,756,000,
respectively.
F-8
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options using the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25")
and makes the pro forma disclosures required by Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("FAS123").
ADVERTISING COSTS
The Company expenses the costs of advertising as incurred. Advertising
expense for the years ended December 31, 1997, 1998 and 1999 was $120,000,
$1,500,000 and $25,798,000, respectively.
INCOME TAXES
Due to the Company's overall loss position, there is no provision for
income taxes for 1997, 1998 or 1999.
The reconciliation of income tax computed at the US federal statutory rate
to income tax expense is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1997 1998 1999
--------------- --------------- ---------------
<S> <C> <C> <C>
Federal at 34%, statutory...................... $ (757,000) $ (16,363,000) $ (66,435,000)
Nondeductible interest......................... -- 911,000 2,050,000
Losses with no current benefits................ 757,000 15,436,000 64,306,000
Other.......................................... -- 16,000 79,000
--------------- --------------- ---------------
Provision...................................... $ -- $ -- $ --
=============== =============== ===============
</TABLE>
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities for federal and state income taxes
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1998 1999
--------------- ---------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................... $ 16,000,000 45,462,000
Accrued interest........................................... -- 15,977,000
Other...................................................... 2,500,000 1,846,000
------------- ---------------
Total Net deferred tax assets............................ 18,500,000 63,285,000
Valuation allowance........................................... (18,500,000) (26,782,000)
------------- ---------------
Total tax deferred assets................................ -- 36,503,000
Unrealized gain on investments................................ -- (36,503,000)
------------- ---------------
Net deferred tax assets.................................. $ -- --
============= ===============
</TABLE>
Realization of the Company's deferred tax assets is dependent upon future
earnings, if any, the timing and amount of which are uncertain. Accordingly, the
net deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by $8,282,000 during 1999.
As of December 31, 1999, the Company had federal net operating loss
carryforwards for federal tax purposes of approximately $219.5 million which
expire in the years 2012 through 2019, if not utilized. The Company also had
F-9
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
net operating losses carryforwards for state income tax purposes of
approximately $122.3 million expiring in year 2004, if not utilized.
The tax benefits associated with employee stock options provide a deferred
tax benefit of $14.5 million for the year-ended December 31, 1999. The deferred
tax benefit has been offset by a valuation allowance and will be credited to
additional paid-in capital when realized.
The utilization of the net operating loss is subject to a substantial
annual limitation due to the "change in ownership" provisions of the Internal
Revenue Code of 1986, as amended, and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
for financial instruments:
CASH, CASH EQUIVALENTS AND RESTRICTED CASH. The carrying amount
approximates fair value.
SHORT TERM INVESTMENT. The fair values of short-term investments were
estimated based on quoted market prices.
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, 1998 and 1999, fair value approximates
recorded value.
LOSS PER SHARE
Basic loss 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, after giving consideration to shares subject to repurchase,
outstanding during the period.
Diluted loss per share is determined in the same manner as basic loss per
share except that the number of shares is increased assuming exercise of
dilutive stock options and warrants using the treasury stock method. The diluted
loss per share amount is the same as basic 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 and the assumed is not dilutive.
The consolidated financial statements applicable to the prior periods have
been restated to reflect a three-for-two stock split effective May 1999.
F-10
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table presents the calculation of basic and diluted net
income (loss) per share (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1997 1998 1999
-------------- -------------- --------------
(IN 000'S, EXCEPT SHARE AND PER SHARE
AMOUNTS)
<S> <C> <C> <C>
Net loss......................................... $ (2,612) $ (48,121) $ (195,397)
Preferred dividends.............................. -- -- (1,146)
-------------- -------------- --------------
Net loss attributable to common stockholders..... $ (2,612) $ (48,121) $ (196,543)
============== ============== ==============
Basic and diluted:
Weighted average shares of Common Stock
outstanding................................. 24,797,854 25,886,940 115,675,656
Less: Weighted average shares subject to
repurchase.................................. 17,436,876 13,042,737 8,027,844
-------------- -------------- --------------
Weighted average shares used in computing basic
and diluted net loss per share................ 7,360,978 12,844,203 107,647,812
============== ============== ==============
Basic and diluted net loss per share............. $ (0.35) $ (3.75) $ (1.83)
============== ============== ==============
</TABLE>
If the Company had reported net income, the calculation of historical
diluted earnings per share would have included an additional 8,574,189,
43,282,296 and 26,517,674 common equivalent shares related to the outstanding
stock options and warrants not included above (determined using the treasury
stock method) for the years ended December 31, 1997, 1998 and 1999,
respectively.
KEY SUPPLIERS
The Company is dependent on limited source suppliers for certain equipment
used to provide its services. The Company has generally been able to obtain an
adequate supply of equipment. In addition, the Company believes that there are
alternative suppliers for the equipment used to provide its services. However,
an extended interruption in the supply of equipment currently obtained from
limited source suppliers could adversely affect the Company's business and
results of operations.
ACCOUNTS RECEIVABLE ALLOWANCE
The Company's reserve for uncollectible accounts receivable was $220,000
and $2,857,000 at December 31, 1998 and 1999, respectively. No significant
charges were made against this reserve as of December 31, 1999.
BUSINESS SEGMENTS
For management purposes, the Company is viewed as one entity with a Chief
Executive Officer ("CEO"), who is the Chief Operating Decision Maker. Financial
position and results of operations for the entity are provided to the CEO in a
format similar to the accompanying financial statements. The Company's
management makes financial decisions and allocates resources based on these
financial statements.
SHORT-TERM INVESTMENTS
At December 31, 1999, all of the Company's investments were classified as
available for sale. Investments were also classified as short-term, as their
maturing date was less than one year from the balance sheet date. Management
determines the appropriate classification of investments at the time of purchase
and reevaluates such designation at the end of each period. Unrealized gains and
losses on short-term investments as of December 31, 1999, are included as a
separate component of stockholders' equity, net of any related tax effect. The
amount of realized gains or losses for the years ended December 31, 1997, 1998
and 1999 was not significant.
F-11
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes the Company's investments:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
----------- ------------- ------------ ------------
(AMOUNT 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 also had a net unrealized loss of $168,000 on cash and cash
equivalents and an unrealized loss of $920,000 on long term U.S. Treasury
investments, classified as Restricted Cash on the Company's balance sheet.
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 "1998 notes") and one warrant, initially
exercisable to purchase 43.7346 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.
The principal amount of the 1998 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 1998 notes are unsecured senior
obligations of the Company that will mature on March 15, 2008. The 1998 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 1998 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 1998 notes. Debt issuance
costs were incurred through the issuance of additional warrants associated with
the commitment of equity by certain investors. The debt issuance costs are also
being amortized over the life of the 1998 notes. For the years ended December
31, 1998 and 1999, the accretion of the 1998 notes and the amortization of debt
discount and debt issuance costs was $16.0 million and $22.3 million,
respectively, of which $15.1 million and $21.0 million, respectively, is
included in interest expense and $900,000 and $1.3 million, respectively, is
capitalized in property, plant and equipment.
The Unit Warrants have ten year terms, have exercise prices of $0.0022 per
share (subject to adjustment in certain events), contain net exercise provisions
and are currently exercisable.
On February 18, 1999, the Company completed the issuance of $215.0 million
senior debt notes (the "1999 notes"). Net proceeds from the 1999 notes were
approximately $205.0 million after transaction costs of approximately $9.9
million, which are being amortized over the life of the notes. Amortization
expense related to the transaction cost was $827,000 for year ended December
31,1999. The principal amount of the 1999 notes bears interest at the rate of 12
1/2% per annum through February 15, 2009, compounded semi-annually, and
thereafter bears interest at the rate of 12 1/2% per annum, payable
semi-annually, in arrears on February 15 and August 15 of each year, commencing
on August 15, 1999. The 1999 notes are unsecured senior obligations of the
Company that will mature on February 15, 2009. The notes will be redeemable at
the option of the Company at any time after February 15, 2004 at stated
redemption prices plus accrued and unpaid interest thereon.
The Company purchased approximately $74.1 million of government securities
from the net proceeds, representing sufficient funds to pay the first six
scheduled interest payments on the 1999 notes. These government securities are
pledged as security for repayment of interest on the 1999 notes.
F-12
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On June 1, 1999, the Company completed an offer to exchange all outstanding
12 1/2% senior notes due February 15, 2009 for 12 1/2% senior notes due February
15, 2009, which have been registered under the Securities Act of 1933.
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 original principal value of these leases totaled $865,000 as of
December 31, 1999, and was equivalent to the fair value of the assets leased.
Future minimum lease payments under capital leases are as follows:
YEAR ENDING DECEMBER 31,
-------------------------
2000................................................. $ 294,000
2001................................................. 44,000
2002................................................. 4,000
Thereafter........................................... --
--------------
342,000
Less amount representing interest....................... (30,000)
Less current portion.................................... (268,000)
--------------
Total long-term portion............................ $ 44,000
==============
Accumulated amortization for equipment under capital leases is reflected in
accumulated depreciation and amortization for property and equipment.
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:
YEAR ENDING DECEMBER 31,
-------------------------
2000................................................. 5,852,000
2001................................................. 5,713,000
2002................................................. 5,023,000
2003................................................. 3,875,000
2004................................................. 3,292,000
Thereafter........................................... 2,326,000
------------
Total............................................. $ 26,081,000
============
Rental expense on operating leases totaled $131,000, $1,507,000 and
$4,302,000 for the years ended December 31, 1997, 1998, and 1999, respectively.
5. STOCKHOLDERS' EQUITY
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. For the
year ended December 31, 1999, amortization expense totaled $8.2 million.
F-13
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INITIAL PUBLIC OFFERING
On January 27, 1999, the Company completed the 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 offering were
$150.2 million after deducting underwriting discounts and commissions and
offering expenses payable by the Company. As a result of the offering,
41,053,864 shares of the Common Stock and 6,379,177 shares of the 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 4,049,439 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.
SECOND PUBLIC OFFERING
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 $568.8 million
after deducting underwriting discounts and commissions and offering expenses.
COMMON STOCK
Shares of Common Stock outstanding at December 31, 1998 and December
31,1999 were 26,491,494 and 132,331,316 shares, respectively, of which
10,739,437 and 6,679,313 shares, respectively, remain subject to repurchase
provisions which generally lapse over a four-year period from the date of
issuance. Shares of Class B Common Stock outstanding at December 31, 1998 and
December 31, 1999 were 0 and 6,379,177, respectively, of which no shares remain
subject to repurchase.
Common Stock reserved for future issuance as of December 31, 1999 is as
follows:
Outstanding options............................................... 24,522,633
Options available for grant....................................... 1,905,080
Employee stock purchase plan...................................... 2,872,836
Warrants outstanding.............................................. 1,995,041
------------
Total...................................................... 31,295,590
============
PREFERRED STOCK DIVIDENDS
The holders of Series A, Series B and Series C were entitled to receive in
any fiscal year, dividends at the rate of $0.0111 per share, $0.0267 per share
and $0.1487 per share, respectively, payable in preference and priority to any
payment of dividends on Common Stock. The rights to such dividends were
cumulative and accrue to the holders to the extent they were not declared or
paid and were 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, 1998 and December 31,1999 for Preferred Stock were approximately
$1,085,000 and $ 1,146,000, respectively, which were converted into 133,587
shares of Common Stock in connection with the IPO.
F-14
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. EMPLOYEE BENEFIT PLANS
DEFINED CONTRIBUTION PLAN
Effective September 1, 1997, the Company adopted a defined contribution
retirement plan under Section 401(k) of the Internal Revenue Code which covers
substantially all employees. Eligible employees may contribute amounts to the
plan, via payroll withholding, subject to certain limitations. The Company does
not match contributions by plan participants.
1998 EMPLOYEE STOCK PURCHASE PLAN
In January 1999, the Company adopted the 1998 Employee Stock Purchase Plan.
The Company has reserved a total of 3,375,000 shares of Common Stock for
issuance under the plan. Eligible employees may purchase Common Stock at 85% of
the lesser of the fair market value of the Company's Common Stock on the first
day of the applicable twenty-four month offering period or the last day of the
applicable six month purchase period.
STOCK OPTION PLANS
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 December
31, 1999 the Plan has reserved 34,920,770 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 table summarizes stock option activity for the year ended
December 31, 1997, 1998 and December 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF OPTION PRICE
COMMON STOCK PER SHARE
---------------- --------------------
<S> <C> <C> <C>
Granted.................................................... 8,648,438 $ 0.022 - $ 0.03
Exercised.................................................. (13,500) -- - $ 0.02
Cancelled.................................................. (60,750) $ 0.022 - $ 0.03
---------------- --------------------
Balance as of December 31, 1997............................ 8,574,188 $ 0.022 - $ 0.03
Granted.................................................... 21,077,955 $ 0.067 - $ 5.44
Exercised.................................................. (466,863) $ 0.022 - $ 0.45
Cancelled.................................................. (1,627,730) $ 0.022 - $ 5.29
---------------- --------------------
Balance as of December 31, 1998............................ 27,557,550 $ 0.022 - $ 5.44
Granted.................................................... 8,774,658 $ 0.007 - $44.67
Exercised.................................................. (8,012,683) $ 0.007 - $38.17
Cancelled.................................................. (3,796,892) $ 0.147 - $43.42
---------------- --------------------
Balance as of December 31, 1999............................ 24,522,633 $ 0.0007 - $44.67
================ ====================
</TABLE>
F-15
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following is a summary of the status of stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- -------------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
EXERCISE NUMBER OF AVERAGE LIFE AVERAGE NUMBER OF AVERAGE
PRICE RANGE SHARES REMAINING EXERCISE PRICE SHARES EXERCISE PRICE
------------------------ -------------- ------------- ----------------- -------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$ .007 - $ 6.33 16,509,627 6.1 $ 1.14 3,592,692 $ 1.05
$ 1.33 - $12.67 1,704,315 7.0 $ 7.55 326,487 $ 7.55
$12.67 - $19.00 25,614 7.1 $ 18.61 2,757 $ 18.61
$19.00 - $25.33 34,500 7.1 $ 20.96 5,502 $ 20.91
$25.33 - $31.67 2,944,256 7.4 $ 28.41 166,840 $ 28.38
$31.67 - $38.00 1,754,922 7.5 $ 34.50 65,499 $ 36.21
$38.00 - $44.33 1,534,774 7.3 $ 40.69 151,818 $ 40.23
$44.33 - $50.67 14,625 5.6 $ 44.67 2,432 $ 44.67
-------------- ------------- ----------------- -------------- ----------------
24,522,633 6.5 $ 9.79 4,314,027 $ 4.57
============== ============= ================= ============== ================
</TABLE>
During the year ended December 31, 1997, the Company recorded 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 using a graded vesting method. Such amortization was $295,000 for the
year ended December 31, 1997. During the year ended December 31, 1998, the
company recorded additional deferred compensation of approximately $8.1 million.
Amortization of deferred compensation during this same period was approximately
$4.0 million. During the year ended December 31, 1999, the Company recorded
additional deferred compensation of approximately $6.6 million. Amortization of
deferred compensation during this same period was approximately $4.8 million.
STOCK-BASED COMPENSATION
Pro forma information regarding the results of operations and net loss per
share is required by FAS 123, which also requires that the information be
determined as if the Company had accounted for its employee stock options using
the fair value method of FAS 123. The fair value of each option granted is
estimated on the date of grant using the Black Scholes valuation model.
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FAS 123 requires the use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercised price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
The option valuation models were developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value of the estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
F-16
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
For the years ended December 31, 1997, 1998 and 1999, the fair value of the
Company's stock-based awards to employees was estimated using the following
weighted average assumptions:
1997 1998 1999
------- -------- --------
Expected life of options in years........... 4.0 4.0 4.0
Volatility.................................. 123.5% 123.5% 123.5%
Risk-free interest rate..................... 7.0% 7.0% 7.0%
Expected dividend yield..................... 0.00% 0.00% 0.00%
The weighted average fair value of stock options granted during the years
ended December 31, 1997, 1998 and 1999 was $0.11, $0.91 and $9.79 per share,
respectively. For pro forma purposes, 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, $1.7
million and $35.2 million for the years ended December 31, 1997, 1998 and 1999,
respectively. The result of applying FAS 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 $0.13 per
share and $0.33 per share for the year ended December 31, 1998 and 1999,
respectively.
The pro forma impact of options on the net loss for the years ended
December 31, 1997, 1998, and 1999 is not representative of the effects on net
loss for future years, as future years will include the effects of additional
years of stock option grants.
7. RELATED PARTY TRANSACTIONS
The Company purchases equipment from a supplier which is partially owned by
an investor in the Company. Purchases from this supplier totaled $85,000,
$5,844,000 and $45,695,000 for the years ending December 31, 1997, 1998 and
1999, respectively. During 1999, an unrelated party acquired this supplier, as
such, the Company had no financial interest in them by year end December
31,1999. In addition, the Company acquired an interest in a new supplier.
Purchases from this new supplier totaled $3,401,000 for the year ended December
31, 1999.
8. 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 decisions vacated. Meanwhile, the
arbitration panel is evaluating the Company's claim.
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
with respect to the court's ruling. While the Company expects that it would
prevail on an 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 that this employee resigned and that it does not owe him any
money, but
F-17
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
litigation is unpredictable and there is no guarantee the Company
will prevail. Another group of former employees of the Company have filed a
Complaint against the Company in California Superior Court alleging that they
were terminated wrongfully and are entitled to other amounts arising from their
employment. The Company believes it has valid defenses and does not own them any
money. Another employee has filed a complaint against the Company in California
Superior Court, alleging that he was terminated wrongfully based on his age. The
Company also believes that it does not owe this employee any money. Litigation
is unpredictable and 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's 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'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 our agreements. The results of any of these proceedings could
harm the business.
9. SUBSEQUENT EVENTS
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. The 2000 notes are unsecured senior obligations of the Company
maturing on February 15, 2010 and 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. These notes were sold in a private
placement under Rule 144A and Regulation S under the Securities Act of 1933, as
amended.
The Company has filed a registration statement covering an offer to
exchange new registered 12% senior notes due February 15, 2010 for all
outstanding 12% senior notes due February 15, 2010.
On February 15, 2000 the Company's Board of Directors adopted a Stockholder
Protection Rights Plan under which stockholders received one right for each
share of the Company's Common Stock or Class B Common Stock owned by them. The
rights become exercisable, in most circumstances, upon the accumulation by a
person or group of 15% or more of the Company's outstanding shares of Common
Stock. Each right entitles the holder to purchase from the Company, as provided
by the Stockholder protection Rights Agreement, one one-thousandth of a share of
Participating Preferred Stock, par value $.001 per share, for $400.00, subject
to adjustment.
On March 7, 2000, the Company announced a 3-for-2 stock split, which was
effectuated through a stock dividend. The Company's Common Stock began trading
on a split adjusted basis on April 3, 2000. All share and per share numbers in
the accompanying consolidated financial statements have been retroactively
adjusted to reflect this split.
On March 20, 2000 the Company completed the acquisition of Laser Link.Net,
a leading provider of branded internet access, based in Media, Pennsylvania in a
transaction to be accounted for as a purchase. Under the acquisition agreement,
the Company issued 6.45 million shares of common stock and stock options for all
Laser Link.Net outstanding, common shares and stock options, plus assumption of
all outstanding debt. The Company anticipates that this acquisition will allow
the Company to provide a turnkey broadband access solution to companies and
affinity groups who want to offer broadband internet services to their
customers, members, or affiliates. Laser Link.Net currently provides a similar
service using dial-up access. The total consideration related to the
acquisition, was approximately $411.1 million.
F-18
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)
JUNE 30,
2000
------------
Current assets:
Cash and cash equivalents..................................... $ 422,820
Accounts receivable, net...................................... 32,054
Short-term investments........................................ 340,334
Unbilled revenue.............................................. 7,555
Inventories................................................... 18,362
Prepaid expenses and other current assets..................... 19,500
------------
Total current assets...................................... 840,625
Property and equipment, net...................................... 466,137
Restricted cash.................................................. 52,078
Goodwill and other intangible assets, net........................ 375,172
Other assets, net................................................ 49,868
------------
Total assets.............................................. $ 1,783,880
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 70,188
Unearned revenue.............................................. 11,253
Accrued network costs......................................... 10,190
Other accrued liabilities..................................... 69,020
Current portion of capital lease obligations.................. 146
------------
Total current liabilities................................. 160,797
Long-term debt, net.............................................. 811,820
Long-term capital lease obligations.............................. 25
Other long-term liabilities...................................... 16,919
------------
Total liabilities......................................... 989,561
Stockholders' equity:
Common stock.................................................. 138
Common stock--Class B.......................................... 6
Additional paid-in capital.................................... 1,260,089
Deferred compensation......................................... (8,361)
Accumulated other comprehensive income........................ 27,280
Accumulated deficit........................................... (484,833)
------------
Total stockholders' equity................................ 794,319
------------
Total liabilities and stockholders' equity................ $ 1,783,880
============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-19
<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
Write-off of in-process technology..................... -- -- 3,726 --
------------ ---------- ------------ -----------
Total operating expenses........................... 191,189 45,446 333,677 74,819
------------ ---------- ------------ -----------
Income (loss) from operations............................. (133,029) (34,613) (233,710) (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 -- 14,787 --
------------ ---------- ------------ -----------
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.
F-20
<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.
F-21
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO 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 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.
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
------------------------- --------------------------
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 153,403 102,235 150,060 91,396
net loss per share.......................................
============ ============ ============ ============
Basic and diluted net loss per share........................ $ (0.86) $ (0.41) $ (1.59) $ (0.79)
============ ============ ============ ============
</TABLE>
F-22
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
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 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.
The following table summarizes the Company's short-term investments.
<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ----------- -----------
(AMOUNT 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>
The Company had a net unrealized loss of $576,000 on long term U.S.
Treasury investments at June 30, 2000 classified as restricted cash on the
accompanying unaudited condensed consolidated balance sheet. The Company also
had a net unrealized gain of $626,000 on cash and cash equivalents at June 30,
2000.
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 an average 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.
F-23
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
The Unaudited Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 2000 include the results for Laser Link subsequent
to the March 20, 2000 acquisition date, which were not significant to the
Company's consolidated results of operations.
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):
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
============
LIFE ANNUAL
(YRS) AMORTIZATION
------ -------------
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
============ =============
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 will be 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
F-24
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
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.
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.
Under the terms of the of the merger agreement, Covad will issue to the
BlueStar stockholders and other equity owners of BlueStar at the effective time
of the merger, 8 million shares of Covad common stock minus shares (priced at
the closing market price of Covad common stock on the third business day prior
to closing) with a value equal to:
o BlueStar's transaction costs for the merger; and
o the principal, interest and expenses associated with the interim
financing extended to BlueStar prior to the merger.
This consideration will be divided among BlueStar stockholders and other
equity owners of BlueStar at the effective time of the merger according to an
exchange ratio calculated as follows:
o First, for the purpose of satisfying the liquidation preferences of
BlueStar preferred stockholders, shares of Covad common stock (priced
at the average closing market price for Covad common stock over the 20
days ending on the fourth business day prior to closing) will be set
aside with a value equal to $71,121,771, the total amount of those
preferences, and divided among the BlueStar preferred stockholders pro
rata according to their share ownership; and
o Second, each share of BlueStar stock, including the BlueStar preferred
stock, will be converted into a number of shares of Covad common stock
to be calculated by dividing the remaining shares of Covad common
stock to be issued in the merger, by the total number of BlueStar
shares (calculated on a fully diluted basis, excluding certain options
that have been forfeited by their owners and are incapable of
exercise.)
In addition, up to 5 million additional Covad common shares will be issued
which depends on BlueStar reaching certain specified levels of revenue and
earnings before interest, taxes, depreciation and amortization (EBITDA) in
fiscal 2001.
F-25
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
The table below assumes 7,140,411 Covad common shares would be issued for
the BlueStar common and preferred shares outstanding at June 30, 2000. For
purposes of the table below, the Covad common shares have been valued at the
closing market price on August 18, 2000 of $15 5/8 per share. The actual value
will be determined based on the average closing price of Covad common shares for
a few days before and after the actual closing date. As of June 30, 2000, Blue
Star's outstanding options and warrants would be converted into options and
warrants to purchase 633,669 shares of Covad common stock and have an average
fair value of $9.59 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 table below does not give effect to the potential
issuance of the additional 5 million
shares which depends on results in fiscal 2001. Since any outstanding loans at
the closing date will become a part of the purchase cost, the reduction in
shares to be issued for any outstanding loans will not have a significant effect
on Covad's total purchase cost.
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):
Estimated purchase cost
Value of common shares issued................................ $ 111,569
Assumption of BlueStar Inc. options and warrants............. 6,075
-----------
117,644
Estimated acquisition costs..................................... 9,346
-----------
Total estimated purchase costs.................................. $ 126,990
===========
LIFE ANNUAL
(YRS) AMORTIZATION
-------- ------------
Purchase price allocation:
Tangible net assets at June 30, 2000..... $ 2,919
Intangible assets acquired:
Customer base.......................... 10,500 3 3,500
Acquired workforce..................... 11,300 3 3,767
Deferred stock compensation............ 2,293 2.5 917
Goodwill.................................... 99,978 5 19,996
---------- ------------
Total estimated purchase price allocation... $ 126,990 $ 28,180
========== ============
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 will be amortized on a straight line basis over
its estimated useful life of three 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 will be
amortized on a straight line basis over its estimated useful life of three
years.
Deferred stock compensation represents the excess intrinsic value of the
outstanding unvested common stock options on the date the acquisition is
finalized versus the weighted average intrinsic value on the date the shares
were originally granted. The price of the Company's common stock on August 18,
2000 of 15 5/8 was used as the
F-26
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
acquisition price for purposes of calculating the
purchase consideration. Deferred stock compensation will be amortized over the
weighted average remaining vesting period of the options or 2.5 years.
Goodwill is determined based on the residual difference between the amount
paid and the values assigned to identified tangible and intangible assets.
Goodwill will be 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.
SECOND PUBLIC OFFERING:
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.
F-27
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements give effect to the combination of Covad
Communications Group, Inc., Laser Link.Net Inc., and BlueStar Communications
Group, Inc. through the issuance of Covad common shares and stock options for
the outstanding Laser Link.Net and BlueStar Communications Group, Inc. common
shares and stock options and, in the case of BlueStar, the outstanding preferred
shares and warrants. The combination with Laser Link was completed on March 20,
2000, and the combination with BlueStar Communications Group, Inc. is expected
to be completed in the third quarter of 2000.
The Unaudited Pro Forma Condensed Combined Consolidated Statements of
Operations for the year ended December 31, 1999 and for the six months ended
June 30, 2000 reflect the combinations as if they had taken place on January 1,
1999 and January 1, 2000, respectively. The Unaudited Pro Forma Condensed
Combined Consolidated Balance Sheets give effect to the combination with
BlueStar as if it had taken place on June 30, 2000. Covad's historical balance
sheet as of June 30, 2000 includes the financial position of Laser Link. The
Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations
combine Covad's historical results of operations for the year ended December 31,
1999 and the six months ended June 30, 2000 with BlueStar's historical results
of operations for those same periods and Laser Link's historical results of
operations for the year ended December 31, 1999 and the period from January 1,
2000 to March 20, 2000 (the closing date of the transaction), respectively.
The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements reflect the combinations using the purchase
method of accounting and have been prepared on the basis of assumptions
described in the notes thereto, including assumptions relating to the allocation
of the total purchase cost to the assets and liabilities of Laser Link and
BlueStar based upon estimates of their fair value. The allocation of the total
purchase cost for BlueStar is preliminary. The actual BlueStar allocation may
differ from those assumptions after the transaction is closed and the valuation
is finalized.
The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements should be read in conjunction with the Covad
audited and unaudited financial statements, the Laser Link audited financial
statements, and the BlueStar audited and unaudited financial statements,
included elsewhere in this document. The Covad Communications Group, Inc.
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements are not
necessarily indicative of what the actual operating results would have been had
the combinations actually taken place on January 1, 1999 or January 1, 2000 or
what the financial position would have been had the combination with BlueStar
taken place as of June 30, 2000 and do not purport to indicate Covad's future
results of operations or financial position.
F-28
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S)
<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------------------
PRO FORMA
BUSINESS
COMBINATIONS PRO FORMA
COVAD BLUESTAR TOTAL ADJUSTMENTS COMBINED
---------- --------- ----------- ------------- ----------
ASSETS
Current Assets
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents..................... $ 422,820 921 423,741 $ (9,346) $ 414,395
Accounts receivable, net...................... 32,054 1,304 33,358 -- 33,358
Short-term investments........................ 340,334 -- 340,334 -- 340,334
Unbilled revenue.............................. 7,555 -- 7,555 -- 7,555
Inventories................................... 18,362 18 18,380 -- 18,380
Prepaid expenses and other current assets..... 19,500 1,476 20,976 -- 20,976
---------- --------- ----------- ------------- ----------
Total current assets........................ 840,625 3,719 844,344 (9,346) 834,998
Property and equipment, net................... 466,137 23,775 489,912 489,912
Other Assets:
Restricted cash............................... 52,078 -- 52,078 -- 52,078
Goodwill and other intangible assets, net..... 375,172 -- 375,172 121,778 496,950
Other assets, net............................. 49,868 4,156 54,024 -- 54,024
---------- --------- ----------- ------------- ----------
Total other assets.......................... 477,118 4,156 481,274 121,778 603,052
---------- --------- ----------- ------------- ----------
Total assets..................................... $1,783,880 $ 31,650 $1,815,530 $ 112,432 $1,927,962
========== ========= =========== ============= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.............................. $ 70,188 $ 8,171 $ 78,359 $ -- $ 78,359
Unearned revenue.............................. 11,253 -- 11,253 -- 11,253
Accrued network costs......................... 10,190 -- 10,190 -- 10,190
Other accrued liabilities..................... 69,020 12,623 81,643 -- 81,643
Current portion of long term obligations...... 146 334 480 -- 480
Note payable.................................. -- 7,271 7,271 -- 7,271
---------- --------- ----------- ------------- ----------
Total current liabilities................... 160,797 28,399 189,196 -- 189,196
Long-term debt, net.............................. 811,820 332 812,152 -- 812,152
Long-term capital lease obligations.............. 25 -- 25 -- 25
Other long-term liabilities...................... 16,919 -- 16,919 -- 16,919
---------- --------- ----------- ------------- ----------
Total liabilities........................... 989,561 28,731 1,018,292 -- 1,018,292
Stockholders' Equity:
Preferred stock............................... -- 70,992 70,992 (70,992) --
Common stock and additional paid-in capital... 1,260,233 6,234 1,266,467 117,644 1,377,877
(6,234)
Restricted stock loan receivable.............. -- (728) (728) 728 --
Deferred stock compensation................... (8,361) (3,077) (11,438) (2,293) (10,654)
3,077
Accumulated other comprehensive income ....... 27,280 -- 27,280 -- 27,280
Accumulated deficit .......................... (484,833) (70,502) 555,335 70,502 (484,833)
---------- --------- ----------- ------------- ----------
Total stockholders' equity ................. 794,319 2,919 797,238 112,432 909,670
---------- --------- ----------- ------------- ----------
Total liabilities and stockholders' equity....... $1,783,880 $ 31,650 $1,815,530 $ 112,432 $1,927,962
========== ========= =========== ============= ==========
</TABLE>
SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.
F-29
<PAGE>
COVAD COMMUNCATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
----------------------------------------------------------------------------
PRO FORMA
BUSINESS
COMBINATION PRO FORMA
COVAD LASER LINK BLUESTAR TOTAL ADJUSTMENTS COMBINED
------------ ----------- ---------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................ $ 66,488 $ 6,044 $ 771 $ 73,303 $ -- $ 73,303
Operating expenses:
Network and product costs........ 55,347 5,451 8,083 68,881 2,605 71,486
Sales, marketing, general and
administrative................. 140,372 2,855 11,759 154,986 -- 154,986
Depreciation and amortization.... 37,602 1,313 264 39,179 -- 39,179
Amortization of goodwill and
other intangible assets........ -- -- -- -- 104,377 104,377
Amortization of deferred
compensation................... 4,768 -- 426 5,194 917 6,111
------------ ----------- ---------- ---------- ------------ ------------
Total operating expenses....... 238,089 9,619 20,532 268,240 107,899 376,139
------------ ----------- ---------- ---------- ------------ ------------
Loss from operations................ (171,601) (3,575) (19,761) (194,937) (107,899) (302,836)
Interest income (expense):
Interest income.................. 20,676 14 607 21,297 -- 21,297
Interest expense................. (44,472) (181) (65) (44,718) -- (44,718)
------------ ----------- ---------- ---------- ------------ ------------
Net interest income (expense).... (23,796) (167) 542 (23,421) -- (23,421)
------------ ----------- ---------- ---------- ------------ ------------
Net loss............................ (195,397) (3,742) (19,219) (218,358) (107,899) (326,257)
Preferred dividends................. (1,146) (490) -- (1,636) -- (1,636)
------------ ----------- ---------- ---------- ------------ ------------
Net loss attributable to common
stockholders..................... $ (196,543) $ (4,232) $ (19,219) $(219,994) $ (107,899) $ (327,893)
============ =========== ========== ========== ============ ============
Basic and diluted net loss per share $ (1.83) $ (0.16) $ (2.15) $ (2.74)
============ =========== ========== ============
Weighted average shares outstanding
used in computing basic and
diluted net loss per share....... 107,647,812 26,074,860 8,953,153 119,792,282
============ =========== ========== ============
</TABLE>
SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED FINANCIAL STATEMENTS.
F-30
<PAGE>
COVAD COMMUNCATIONS GROUP, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 2000
-----------------------------------------------------
PRO FORMA
LASER LINK BUSINESS
(1/1/00- COMBINATIONS PRO FORMA
COVAD 3/20/00) BLUESTAR TOTAL ADJUSTMENTS COMBINED
-------------- ----------- ------------ ------------ ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................ $ 99,967 $ 5,440 $ 3,625 $ 109,032 $ -- $ 109,032
Operating expenses:
Network and product costs......... 74,963 2,823 20,612 98,398 651 99,049
Sales, marketing, general and
administrative.................. 187,907 2,745 29,585 220,237 -- 220,237
Depreciation and amortization.... 41,717 353 1,935 44,005 -- 44,005
Amortization of goodwill and
other intangible assets......... 23,453 -- -- 23,453 29,560 53,013
Amortization of deferred
compensation.................... 1,911 -- 1,096 3,007 459 3,466
Write-off of in-process
technology...................... 3,726 -- -- 3,726 (3,726) --
-------------- ----------- ------------ ------------ ------------- --------------
Total operating expenses........ 333,677 5,921 53,228 392,826 26,944 419,770
-------------- ----------- ------------ ------------ ------------- --------------
Loss from operations................ (233,710) (481) (49,603) (283,794) (26,944) (310,738)
Interest income (expense):
Interest income................... 27,180 -- 499 27,679 -- 27,679
Interest expense.................. (46,960) (137) (96) (47,193) -- (47,193)
-------------- ----------- ------------ ------------ ------------- --------------
Net interest income (expense).... (19,780) (137) 403 (19,514) -- (19,514)
Other income (expense).............. 14,787 -- (1,454) 13,333 -- 13,333
-------------- ----------- ------------ ------------ ------------- --------------
Net loss............................ $ (238,703) $ (618) $ (50,654) $ (289,975) $ (26,944) $ (316,919)
============== =========== ============ ============ ============= ==============
Basic and diluted net loss per
share.............................. $ (1.59) $ (5.31) $ (1.99)
============== ============ ==============
Weighted average shares outstanding
used in computing basic and
diluted net loss per share....... 150,060,418 9,539,643 159,400,415
============== ============ ==============
</TABLE>
SEE ACCOMPANYING NOTES TO THE UNAUDITED PRO
FORMA CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS.
F-31
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRO FORMA PRESENTATION
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. The Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated Statements of Operations for the six months ended June 30,
2000 and for the year ended December 31, 1999, reflect the issuance of these
shares as if the transaction had closed on January 1, 2000 and January 1, 1999,
respectively. In addition, the outstanding Laser Link stock options were
converted into approximately 1.4 million options to purchase Covad common shares
at an average 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 Covad Communications Group, Inc. Unaudited Pro Forma Financial
Statements 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):
<TABLE>
<CAPTION>
<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.
F-32
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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. Such amount has, therefore, been reflected in Covad's historical
financial statements for the six months ended June 30, 2000 but has been
excluded from the Unaudited Pro Forma Condensed Combined Consolidated Statements
of Operations since such amount is non-recurring in nature.
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.
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.
Under the terms of the of the merger agreement, Covad will issue to the
BlueStar stockholders and other equity owners of BlueStar at the effective time
of the merger, 8 million shares of Covad common stock minus shares (priced at
the closing market price of Covad common stock on the third business day prior
to closing) with a value equal to:
o BlueStar's transaction costs for the merger; and
o the principal, interest and expenses associated with the interim
financing extended to BlueStar prior to the merger.
F-33
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
This consideration will be divided among BlueStar stockholders and other
equity owners of BlueStar at the effective time of the merger according to an
exchange ratio calculated as follows:
o First, for the purpose of satisfying the liquidation preferences of
BlueStar preferred stockholders, shares of Covad common stock (priced
at the average closing market price for Covad common stock over the 20
days ending on the fourth business day prior to closing) will be set
aside with a value equal to $71,121,771, the total amount of those
preferences, and divided among the BlueStar preferred stockholders pro
rata according to their share liquidation preference; and
o Second, each share of BlueStar stock, including the BlueStar preferred
stock, will be converted into a number of shares of Covad common stock
to be calculated by dividing the remaining shares of Covad common
stock to be issued in the merger, by the total number of BlueStar
shares (calculated on a fully diluted basis, excluding certain options
that have been forfeited by their owners and are incapable of
exercise.)
In addition, up to 5 million additional Covad common shares will be issued
which depends on BlueStar reaching certain specified levels of revenue and
earnings before interest, taxes, depreciation and amortization (EBITDA) in
fiscal 2001.
The following table calculates the exchange ratio under three sets of
assumptions described further below. For each calculation, the closing market
price of Covad's common stock on August 18, 2000 of $15? per share and the
outstanding common and preferred shares, options and warrants of BlueStar at
June 30, 2000 were used. The actual shares to be issued will depend on the
closing market price of Covad common stock for the periods preceding the closing
date as described above and the actual shares of BlueStar common and preferred
shares and options and warrants outstanding at the closing date.
The calculation below as of June 30, 2000 was used for purposes of
preparing the Covad Communications Group, Inc. Unaudited Pro Forma Condensed
Combined Consolidated Financial Statements. There were no amounts outstanding or
costs incurred under the interim financing arrangements at that date. The
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements assume
7,140,411 of Covad common shares would be issued for the outstanding BlueStar
common and preferred shares outstanding at June 30, 2000. For purposes of the
Unaudited Pro Forma Condensed Combined Consolidated Financial Statements, the
Covad common shares have been valued at the closing market price on August 18,
2000 of $15 5/8 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. As of June 30, 2000, BlueStar's outstanding
options and warrants would be converted into options and warrants to purchase
633,669 shares of Covad common stock and have an average fair value of $9.59 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 Unaudited Pro Forma Condensed Combined Consolidated Financial
Statements do not give effect to the potential issuance of the additional 5
million shares which depends on results in fiscal 2001.
The calculation as of August 18, 2000 is based on the balance outstanding
under the interim financing arrangement of $20.9 million at that date and the
related interest and financing costs of $700,000 incurred to that date. The
actual shares to be issued will depend on the balance outstanding and the costs
incurred under the interim financing arrangement at the closing date. Since any
outstanding loans at the closing date will become a part of the purchase cost,
the reduction in shares to be issued for any outstanding loans will not have a
significant effect on Covad's total purchase cost.
F-34
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The calculation as of September 30, 2000 assumes that September 30, 2000 is
the closing date and reflects the amount which BlueStar expects to be
outstanding under the interim financing arrangement at the closing date of $27.9
million. If BlueStar's borrowings at the closing date exceed $27.9 million or
the closing date occurs subsequent to September 30, 2000, the shares available
to the stockholders and other equity owners will be reduced.
<TABLE>
<CAPTION>
JUNE 30, 2000 AUGUST 18, 2000 SEPTEMBER 30, 2000
------------------------- -------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Maximum Covad common shares
to be issued............... 8,000,000 8,000,000 8,000,000
Estimated transaction costs
for BlueStar............... $3,530,000 (225,920) $ 3,530,000 (225,920) $ 3,530,000 (225,920)
Interim financing and related
costs...................... -- -- $ 21,600,000 (1,382,400) $29,138,000 (1,864,832)
----------- ------------ -----------
Net shares to be issued to
BlueStar stockholders and
other equity holders....... 7,774,080 6,391,680 5,909,248
Shares to be issued to
preferred stockholders for
liquidation preferences.... $71,121,771 (4,551,793) $71,121,771 (4,551,793) $71,121,771 (4,551,793)
----------- ------------ -----------
Net shares remaining for
BlueStar stockholders and
other equity holders....... 3,222,287 1,839,887 1,357,455
=========== ============ ===========
BLUESTAR SHS COVAD SHS BLUESTAR SHS COVAD SHS BLUESTAR COVAD SHS
------------ ----------- ------------- ------------ ------------ -----------
Number of common and
preferred shares of
BlueStar outstanding at
June 30, 2000 and
allocation of Covad common
shares..................... 35,864,420 2,588,618 35,864,420 1,478,069 35,864,420 1,090,509
BlueStar options and warrants
outstanding at June 30,
2000 and Covad common
shares reserved for
issuance................... 8,779,273 633,669 8,779,273 361,818 8,779,273 266,946
------------ ----------- ------------- ------------ ------------ -----------
44,643,693 3,222,287 44,643,693 1,839,887 44,643,693 1,357,455
============ =========== ============= ============ ============ ===========
Exchange ratio................ 0.0722 0.0412 0.0304
============ ============= ============
</TABLE>
F-35
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Covad Communications Group, Inc. Unaudited Pro Forma Financial
Condensed Combined Consolidated Statements have 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. Following is a table of the
estimated total purchase cost and annual amortization of the intangible assets
acquired (in thousands):
Estimated purchase cost
Value of common shares issued ...................... $ 111,569
Assumption of BlueStar Inc options and warrants..... 6,075
--------------
117,644
Estimated acquisition costs......................... 9,346
--------------
Total estimated purchase costs.................. $ 126,990
==============
<TABLE>
<CAPTION>
LIFE ANNUAL
(YRS) AMORTIZATION
---------- ------------
<S> <C> <C> <C>
Purchase price allocation:
Tangible net assets at June 30, 2000............... $ 2,919
Intangible assets acquired:........................
Customer base.................................... 10,500 3 3,500
Acquired workforce............................... 11,300 3 3,767
Deferred stock compensation...................... 2,293 2.5 917
Goodwill......................................... 99,978 5 19,996
------------ ------------
Total estimated purchase price allocation...... $ 126,990 $ 28,180
============ ============
</TABLE>
Tangible net assets of BlueStar principally include 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 will be amortized on a straight line basis over
its estimated useful life of three 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 will be
amortized on a straight line basis over its estimated useful life of three
years.
Deferred stock compensation represents the excess intrinsic value of the
outstanding unvested common stock options on the date the acquisition is
finalized versus the weighted average intrinsic value on the date the shares
were originally granted. The price of the Company's common stock on August 18,
2000 of 15 5/8 was used as the acquisition price for purposes of calculating the
purchase consideration. Deferred stock compensation will be amortized over the
weighted average remaining vesting period of the options or 2.5 years.
Goodwill is determined based on the residual difference between the amount
paid and the values assigned to identified tangible and intangible assets.
Goodwill will be amortized on a straight line basis over its estimated useful
life of five years.
2. PRO FORMA NET LOSS PER SHARE
The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Statements of Operations have been prepared as if the combination
of Covad, Laser Link and BlueStar had occurred on January 1, 1999 for the year
ended December 31, 1999 and January 1, 2000 for the six months ended June 30,
2000. The pro forma basic and diluted net loss per share are based on the
weighted average number of Covad common shares outstanding during each period,
the actual number of Covad shares issued to acquire the
F-36
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
outstanding Laser Link common shares and the assumed 7.1 million shares to
acquire the outstanding preferred andcommon shares of BlueStar. Outstanding
stock options for Covad, Laser Link and BlueStar are not included in the
computation of pro forma diluted net loss per share as their effect would be
antidilutive.
3. PRO FORMA ADJUSTMENTS
The Covad Communications Group, Inc. Unaudited Pro Forma Condensed Combined
Consolidated Financial Statements give effect to the allocation of the total
purchase cost to the assets and liabilities of Laser Link and BlueStar based on
their relative fair values and to the amortization over the respective useful
lives of amounts allocated to intangible assets. The allocation of the total
purchase cost for BlueStar is preliminary. The actual BlueStar allocation may
differ after the transaction is closed and the valuation is finalized.
Intercompany transactions between Covad, Laser Link, and BlueStar were
insignificant.
No pro forma adjustments were required to conform the accounting principles
used by Laser Link and BlueStar to the accounting principles used by Covad.
F-37
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders of
Laser Link.Net, Inc.:
In our opinion, the accompanying balance sheets and the related statements
of operations, stockholders' equity and redeemable preferred stock and of cash
flows present fairly, in all material respects, the financial position of Laser
Link.Net, Inc. at December 31, 1999 and 1998, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States. 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 of these statements in
accordance with auditing standards generally accepted in the United States,
which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
------------------------------
January 21, 2000, except for Note 9 as
to which the date is March 8, 2000
F-38
<PAGE>
LASER LINK.NET, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
--------- --------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents............................................................... $ 4,586 $ 3,514
--------- --------
Accounts receivable, net of allowance for doubtful accounts of $339 at December 31, 1999 12 2,588
Prepaid expenses and other current assets............................................... -- 230
--------- --------
Total current assets.................................................................... 4,598 6,332
Property and equipment, at cost............................................................ 759 4,516
Less accumulated depreciation and amortization............................................. (157) (1,470)
--------- --------
Property and equipment, net............................................................. 602 3,046
--------- --------
Total assets............................................................................ $ 5,200 $ 9,378
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit.......................................................................... $ -- $ 3,750
--------- --------
Accounts payable........................................................................ 447 3,974
Accrued payroll and other expenses...................................................... 65 776
Deferred revenue........................................................................ -- 349
Loans from officers..................................................................... 417 --
--------- --------
Total liabilities..................................................................... 929 8,849
--------- --------
Commitments and contingent liabilities:
Class A Redeemable Preferred Stock, no par value, 20,000 shares authorized, issued and
outstanding at December 31, 1999 and 1998, respectively Liquidation value: $2,000 at
December 31, 1999 and 1998............................................................ 352 842
Stockholders' (deficit) equity:
Preferred Stock, no par value, 10,000,000 shares authorized, 20,000 issued and
outstanding as redeemable preferred stock.............................................
Class A Common Stock, no par value, 200,000,000 shares authorized, 7,474,860
and 7,562,480 shares issued and outstanding at December 31,
1998 and 1999, respectively........................................................... 4,253 4,255
Class B Common Stock, no par value, 200,000,000 shares authorized, 18,600,000 and
18,512,380 shares issued and outstanding at December 31,
1998 and 1999, respectively........................................................... 350 348
Additional paid-in capital.............................................................. 1,672 1,182
Accumulated deficit..................................................................... (2,356) (6,098)
--------- --------
Total stockholders' (deficit) equity.................................................. 3,919 (313)
--------- --------
Total liabilities and stockholders' (deficit) equity.................................. $ 5,200 $ 9,378
========= ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
F-39
<PAGE>
LASER LINK.NET, INC.
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1998 1999
------------- -------------- --------------
<S> <C> <C> <C>
Revenues........................................................... $ 138 $ 30 $ 14,288
Cost of services provided.......................................... -- -- 8,244
------------- -------------- --------------
Net revenues ...................................................... 138 30 6,044
Costs and expenses:
Cost of internet services ...................................... 263 1,109 5,451
Sales and marketing ............................................ 7 120 807
General and administrative...................................... 74 520 2,048
Depreciation and amortization................................... 26 130 1,313
------------- -------------- --------------
Total costs and expenses ..................................... 370 1,879 9,619
------------- -------------- --------------
Loss from operations............................................ (232) (1,849) (3,575)
Interest income.................................................... -- 2 14
Interest expense................................................... 14 68 181
------------- -------------- --------------
Net loss ..................................................... (246) (1,915) (3,742)
Preferred stock dividends and accretion of preferred stock to
redemption value ............................................... -- -- (490)
------------- -------------- --------------
Net loss attributable to common shareholders........................ $ (246) $ (1,915) $ (4,232)
============= ============== ==============
Basic and diluted net loss per common share........................ $ (0.01) $ (0.09) $ (0.16)
============= ============== ==============
Basic and diluted weighted average shares outstanding.............. 18,629,918 21,335,443 26,074,860
============= ============== ==============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
F-40
<PAGE>
LASER LINK.NET, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
REDEEMABLE CLASS A
PREFERRED STOCK COMMON STOCK
--------------------------- -----------------------------
SHARES AMOUNT SHARES AMOUNT
------------- ------------ --------------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1996.....................................
Sale of Class A Common Stock..................................... 1,640,000 $ 410
Redemption of Class B Common stock...............................
Purchase of Class B Common Stock.................................
Net loss for the year............................................
------------- ------------ --------------- -----------
Balance at December 31, 1997..................................... 1,640,000 410
------------- ------------ --------------- -----------
Sale of Class A Common Stock..................................... 5,834,860 3,843
Non-employee stock option compensation expense...................
Warrants issued for Class B Common stock.........................
Sale of Class A Preferred Stock, net of expenses................. 20,000 352
Net loss for the year............................................
------------- ------------ --------------- -----------
Balance at December 31,1998 ..................................... 20,000 352 7,474,860 4,253
------------- ------------ --------------- -----------
Amortization of discount on Class A Preferred Stock.............. 330
Accretion of dividends on Class A Preferred Stock................ 160
Exchange of stock................................................ 87,620 2
Net loss for the year............................................
------------- ------------ --------------- -----------
Balance at December 31, 1999..................................... 20,000 $ 842 7,562,480 $ 4,255
============= ============ =============== ===========
<CAPTION>
ADDITIONAL
PAID-IN
CLASS B COMMON STOCK CAPITAL
-------------------------------
SHARES AMOUNT
----------------- ----------- --------------
<S> <C> <C> <C>
Balance at December 31, 1996..................................... 4,020
Sale of Class A Common Stock.....................................
Redemption of Class B Common stock............................... (4,020)
Purchase of Class B Common Stock................................. 18,600,000 $ 350
Net loss for the year............................................
----------------- ----------- --------------
Balance at December 31, 1997..................................... 18,600,000 350
----------------- ----------- --------------
Sale of Class A Common Stock.....................................
Non-employee stock option compensation expense................... $ 13
Warrants issued for Class B Common stock......................... 59
Sale of Class A Preferred Stock, net of expenses................. 1,600
Net loss for the year............................................
----------------- ----------- --------------
Balance at December 31,1998 ..................................... 18,600,000 350 1,672
----------------- ----------- --------------
Amortization of discount on Class A Preferred Stock.............. (330)
Accretion of dividends on Class A Preferred Stock................ (160)
Exchange of stock................................................ (87,620) (2)
Net loss for the year............................................
----------------- ----------- --------------
Balance at December 31, 1999..................................... 18,512,380 $ 348 $ 1,182
================= =========== ==============
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT DEFICIT
----------------- -----------------
<S> <C> <C>
Balance at December 31, 1996..................................... $ (195) $ (195)
Sale of Class A Common Stock..................................... 410
Redemption of Class B Common stock............................... --
Purchase of Class B Common Stock................................. 350
Net loss for the year............................................ (246) (246)
----------------- -----------------
Balance at December 31, 1997..................................... (441) 319
----------------- -----------------
Sale of Class A Common Stock..................................... 3,843
Non-employee stock option compensation expense................... 13
Warrants issued for Class B Common stock......................... 59
Sale of Class A Preferred Stock, net of expenses................. 1,600
Net loss for the year............................................ (1,915) (1,915)
----------------- -----------------
Balance at December 31,1998 ..................................... (2,356) 3,919
----------------- -----------------
Amortization of discount on Class A Preferred Stock.............. (330)
Accretion of dividends on Class A Preferred Stock................ (160)
Exchange of stock................................................ --
Net loss for the year............................................ (3,742) (3,742)
----------------- -----------------
Balance at December 31, 1999..................................... $ (6,098) $ (313)
================= =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-41
<PAGE>
LASER LINK.NET, INC.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $ (246) $ (1,915) $ (3,742)
Adjustments to reconcile net loss to cash used in operating
activities:
Depreciation and amortization.................................... 26 130 1,313
Amortization of debt discount.................................... -- 59 --
Allowance for doubtful accounts.................................. -- -- 339
Non-employee stock option compensation expense................... -- 13 --
Changes in operating assets and liabilities:
Accounts receivable............................................ (150) 150 (2,915)
Other assets................................................... (8) -- (230)
Accounts payable............................................... 24 409 3,527
Accrued payroll and other expenses............................. -- 57 711
Deferred revenues.............................................. -- -- 349
----------- ----------- ------------
Net cash used in operating activities........................ (354) (1,097) (648)
----------- ----------- ------------
Cash flows from investing activities:
Capital expenditures............................................... (275) (475) (3,757)
----------- ----------- ------------
Net cash used in investing activities........................ (275) (475) (3,757)
----------- ----------- ------------
Cash flows from financing activities:
Proceeds from borrowings under line of credit...................... -- -- 3,750
Proceeds from issuance of common stock............................. 760 3,843 --
Proceeds from issuance of preferred stock.......................... -- 2,000 --
Stock issuance costs............................................... -- (48) --
(Repayments of) proceeds from loans from officers.................. (85) 317 (417)
----------- ----------- ------------
Net cash provided by financing activities.................... 675 6,112 3,333
----------- ----------- ------------
Net (decrease) increase in cash and cash equivalents......... 46 4,540 (1,072)
Cash and cash equivalents, beginning
of period.......................................................... -- 46 4,586
----------- ----------- ------------
Cash and cash equivalents, end of period.............................. $ 46 $ 4,586 $ 3,514
=========== =========== ============
Supplemental disclosure of cash flow:
Cash paid for interest............................................. 14 9 181
=========== =========== ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-42
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND LIQUIDITY:
Laser Link.Net, Inc. ("Laser Link" or the "Company") which was incorporated
in Pennsylvania on February 22, 1996 is engaged in the business of providing a
full-service dial-up based Internet access service to corporations and other
organizations. The Company has incurred losses since its inception as it has
devoted substantially all of its efforts toward building network infrastructure
and internal staffing, developing systems, expanding into new markets, and
raising capital.
The Company has funded its operations since inception through contributions
from shareholders and the sale of common and preferred stock to investors.
Effective August 13, 1999, the Company changed its name from Laser Link
Communications, Inc. to Laser Link.Net, Inc.
The Company operates in a single segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Cash and cash
equivalents are stated at cost, which approximates fair value.
PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost. Depreciation and amortization
are provided for using the straight-line method over the estimated useful lives
of the related assets, which is generally three years for computers, computer
related equipment, and purchased software and five years for furniture and other
equipment. Leasehold improvements are amortized over the life of the lease.
LONG-LIVED ASSETS:
In accordance with Statement of Financial Accounting Standard No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of", the Company reviews assets for impairment
whenever events or changes in circumstances indicate the carrying value of the
asset may not be recoverable. A determination of impairment (if any) is made
based on estimates of undiscounted future cash flows. The Company believes that
no such impairment existed at December 31, 1999.
REVENUE RECOGNITION:
The Company recognizes revenue when services are provided. Certain services
are generally billed one month in advance while others are billed one month in
arrears. Advance billings including prepaid services and collections relating to
future access services are recorded as deferred revenue and recognized as
revenue when earned.
COSTS OF SERVICES PROVIDED:
Costs of revenues include costs related to the production of software as
well as costs incurred for Internet services provided to the Company.
RESEARCH AND DEVELOPMENT COSTS:
Research and development costs incurred to develop software products are
charged to operations as incurred.
F-43
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
ADVERTISING COSTS:
Advertising costs, included in sales and marketing expenses, are expensed
as incurred. Advertising expenses were $51,000 and $10,000 for the years ended
December 31, 1998 and 1999, respectively.
INCOME TAXES:
From inception through December 28, 1998, the Company, with consent of its
stockholders, elected to have its income taxed under the S Corporation
provisions of the Internal Revenue Code (the "Code"), which provide that, in
lieu of corporate income taxes, the stockholder is taxed on the Company's
taxable income. Accordingly, there was no provision for federal or state income
taxes in the Company's statement of operations. Effective December 29, 1998, the
Company terminated its S Corporation status and began operation as a C
Corporation. The Company has incurred losses from operations in the period from
December 29, 1998 through December 31, 1999; therefore, there was no provision
for income taxes in the Company's statement of operations at December 31, 1999.
The Company uses the liability method of accounting for income taxes. Under
this method, deferred income tax assets and liabilities are recorded based on
the differences between the tax bases of assets and liabilities and their
carrying amounts for financial reporting purposes. Deferred tax liabilities or
assets at the end of each period are determined using the tax rate enacted under
the current tax law. The measurement of net deferred tax assets is reduced by
the amount of any tax benefits that, based on available evidence, are not
expected to be realized, and a corresponding valuation allowance is established.
CONCENTRATION OF CREDIT RISK:
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and short-term investments. Short-term investments are stated at cost, which
approximates fair market value. The Company has its cash and cash equivalents
placed with high quality, creditworthy financial institutions. The balances at
such institutions at December 31, 1999 and periodically throughout the year are
in excess of federally insured limits. As part of its cash management process,
the Company performs periodic evaluations of the relative credit standings of
these institutions.
The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. For certain customers, the
Company's risk of loss is limited due to advance billings for services, the use
of preapproved charges to customer credit cards, and the ability to terminate
access on delinquent accounts. In addition, the concentration of credit risk to
these customers is mitigated by the large number of customers comprising the
customer base. Where services are billed in arrears, the Company performs
ongoing credit evaluations of its customers' financial condition. The carrying
amount of the Company's receivables approximates their fair value.
VULNERABILITY DUE TO CERTAIN CONCENTRATIONS:
The Company's growth and future success is substantially dependent upon its
ability to convince corporations and other organizations to adopt the Laser Link
service for their constituents. Although a number of corporations and
organizations have entered into discussions regarding the service, only two have
entered into written agreements with the Company obligating them to offer the
service to their subscribers.
The Company has signed a Virtual Internet Provider agreement with UUNet
Technologies, Inc. ("UUNet") that provides the Company with access to UUNet's
points of presence capacity.
The Company continues to seek additional capital resources to complete the
development of its service and expand and improve its product line.
F-44
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 reported amount of assets and liabilities,
disclosure of contingent assets and liabilities at the dates of the financial
statements, and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
STOCK-BASED COMPENSATION:
Stock based compensation is recognized using the intrinsic value method
prescribed in Accounting Principles Board Option No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the fair market
value of the Company's stock at the date of grant over the amount an individual
must pay to acquire the stock and amortized over the vesting period. All
transactions in which goods and services are the consideration received for the
issuance of equity instruments, such as stock options, are expensed based on the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. The Company has adopted
the disclosure only provisions of Statements of Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123) (see Note 5).
HISTORICAL NET LOSS PER SHARE:
The Company calculates net loss per common share in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share." Basic Earnings Per Share ("EPS") is a per share measure of an entity's
performance computed by dividing net income (loss) available to common
shareholders (the numerator) by the weighted-average number of shares of common
stock outstanding during the period (the denominator). Diluted EPS measures the
entity's performance taking into consideration common shares outstanding (as
computed under basic EPS) and dilutive potential common shares, such as stock
options. However, entities with a net loss do not include common stock
equivalents in the computation of diluted EPS as the effect would be
anti-dilutive. Therefore, the Company's basic and diluted EPS are equal as
common stock equivalents are not included as inclusion of such shares would have
an anti-dilutive effect.
3. PROPERTY AND EQUIPMENT:
A summary of property and equipment at December 31, 1999 is as follows:
<TABLE>
<CAPTION>
1998 1999
---------- -------------
<S> <C> <C>
Computer equipment..................................................... $ 681,000 $ 2,410,000
Purchased software..................................................... 78,000 1,658,000
Furniture.............................................................. -- 324,000
Leasehold improvements................................................. -- 124,000
---------- -------------
Less: accumulated depreciation and amortization........................ 759,000 4,516,000
(157,000) (1,470,000)
---------- -------------
Property and equipment, net............................................ $ 602,000 $ 3,046,000
========== =============
Depreciation expense was approximately $21,000, $109,000, and $791,000 in
1997, 1998 and 1999, respectively. Amortization expense was approximately
$5,000, $21,000 and $522,000,in 1997, 1998 and 1999, respectively.
</TABLE>
F-45
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. INCOME TAXES:
The significant components of deferred tax assets at December 31, 1999 are
as follows:
<TABLE>
<CAPTION>
1999
------------
<S> <C>
Loss carryforwards.............................................................. $ 1,410,000
Bad debt expense................................................................ 132,000
------------
Total deferred tax assets.................................................... 1,542,000
Less: valuation allowance....................................................... (1,542,000)
------------
Net deferred tax assets...................................................... $ --
============
</TABLE>
As of December 31, 1999, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $3,526,000. The federal loss
carryforwards, which expire between 2018 and 2019, are available to offset
future federal taxable income, if any. The Company also had state net operating
loss carryforwards as of December 31, 1999 of $3,526,000. The state loss
carryforwards, which expire between 2008 and 2009, are limited to a maximum
utilization of $1,000,000 per year.
Management has determined that realization of these tax benefits is
uncertain and therefore has provided a full valuation allowance. The utilization
of tax credit carryforwards may be limited by changes in ownership under Section
382 of the Internal Revenue Code and similar statutes.
5. STOCKHOLDERS' EQUITY:
COMMON STOCK:
Class A Common stockholders have the right to one vote for each share of
Class A Common Stock held. Class B Common stockholders have the right to one
vote for each share of Class B Common Stock held. Class B Common stockholders
have the right to elect a majority of the Board of Directors.
On April 1, 1999 the Company effected a twenty-for-one stock split of the
outstanding shares of common stock in the form of a stock dividend. Accordingly,
all common stock data shown in the accompanying financial statements and notes
have been retroactively adjusted to reflect the stock split.
PREFERRED STOCK:
The Board of Directors has the authority to issue shares and to fix voting
privileges, dividend rates, conversion privileges and any other rights of the
preferred stock.
REDEEMABLE PREFERRED STOCK:
On December 29, 1998, the Company issued 20,000 shares of its Class A
Redeemable Preferred Stock to an investor for $2,000,000. Stock issuance costs
of $48,000 have been charged to the redeemable preferred stock. The Class A
Redeemable Preferred Stock has no voting privileges and accrues quarterly
dividends at 8% of the liquidation preference (defined by the agreement to be $5
per share) per annum. The Class A Redeemable Preferred stockholders are entitled
to distribution of $5 per share in preference to holders of Common Stock plus
all accrued and unpaid dividends on December 31, 2003 or earlier upon the
occurrence of certain events such as an initial public offering. Upon
liquidation, dissolution or winding up of the Company, Class A Redeemable
Preferred stockholders are entitled to a distribution equal to the liquidation
preference amount. This offering included a warrant to purchase 2,099,900
additional shares of Class A Common Stock at less than $.01 per share. The
warrant expires on December 29, 2008.
F-46
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
STOCK OPTION PLAN:
The Company established the 1997 Stock Option Plan (the "Plan") that
provides for the grant of stock options and warrants to officers, directors and
other key employees of the Company to purchase a maximum of 10,000,000 shares of
Class A Common Stock. The Plan provides for granting of both incentive stock
options, as defined in Section 422 of the Code, and options that do not qualify
under Section 422 of the Code ("nonqualified options"). The Plan expires ten
years from the date of adoption of the Plan, subject to the right of the Board
of Directors to terminate the Plan at any time prior thereto. Grants under the
Plan expire five or ten years from the date of the grant and generally vest over
a four year period. The exercise price of all options granted under the Plan
must be at least 100% of the fair market value on the date of grant. As of
December 31, 1999, no options have been exercised, and 1,885,500 options remain
available for issuance under the Plan.
NON-QUALIFIED OPTION GRANTS:
In addition to the options granted under the Plan, the Company granted
20,000 nonqualified stock options to a consultant during 1998. Nonqualified
options generally have a maximum term of 10 years and generally vest in equal
annual increments over a three- year period.
If compensation cost had been determined based on the fair value of the
options at the grant dates for those options for which no compensation cost has
been recognized, consistent with the method of SFAS 123, the Company's net loss
and loss per share would have been:
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------- --------------
<S> <C> <C> <C>
Net loss:
As reported......................................... $ (246,000) $ (1,915,000) $ (3,742,000)
Pro forma........................................... (248,000) (1,961,000) (4,204,000)
Net loss:
As reported......................................... (0.01) (0.09) (0.14)
Pro forma........................................... (0.01) (0.09) (0.16)
</TABLE>
Such pro forma disclosures may not be representative of future compensation
expense because options vest over several years and additional grants are made
each year.
The weighted-average fair value of stock options granted was $0.02 per
option in 1997, $0.05 in 1998 and $0.25 in 1999. The fair value of each option
grant was estimated at the date of grant using the Black-Scholes option-pricing
model. The following weighted average assumptions were used for grants in 1997,
1998 and 1999, respectively: risk-free interest rates of 5.8%, 5.6% and 5.3%;
dividend yields and volatility factors of 0%; and expected lives of three years.
The following table summarizes stock option activity in 1998 and 1999:
<TABLE>
<CAPTION>
EXERCISE WEIGHTED-AVERAGE
NUMBER OF PRICE RANGE WEIGHTED-AVERAGE REMAINING
SHARES PER SHARE EXERCISE PRICE CONTRACTUAL LIFE
------------ --------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Outstanding as of December 31, 1997...... 2,000,000 $ 0.05-$0.25 $0.11 7.95 years
Granted............................... 1,870,000 $ 0.05-$0.50 $0.31 8.32 years
Exercised............................. -- -- -- --
Cancelled/forfeited................... (80,000) $ 0.25 $0.25 8.94 years
------------ --------------- ------------------- -------------------
Outstanding as of December 31, 1998 3,790,000 $ 0.05-$0.50 $0.20 8.13 years
Granted............................... 4,499,500 $ 0.76-$3.38 $1.39 9.39 years
Exercised............................. -- -- -- --
Canceled/forfeited.................... (75,000) $ 0.76 $0.76 9.75 years
------------ --------------- ------------------- -------------------
Outstanding as of December 31, 1999...... 8,214,500 $ 0.05-$3.38 $0.84 8.80 years
============ =============== =================== ===================
</TABLE>
F-47
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes the number of options outstanding by year of
grant:
<TABLE>
<CAPTION>
NUMBER OF EXERCISE
YEAR OF GRANT SHARES PRICE RANGE
-------------- ------------- ----------------
<S> <C> <C>
1997............................................................. 2,000,000 $ 0.05 - $0.25
1998............................................................. 1,790,000 $ 0.05 - $0.50
1999............................................................. 4,424,500 $ 0.76 - $3.38
</TABLE>
As of December 31, 1998, 549,800 shares were exercisable at a
weighted-average price per share of $0.12. As of December 31, 1999 1,994,300
shares were exercisable at a weighted average price per share of $0.29. No
options were exercised during 1997, 1998 or 1999.
6. RELATED PARTY TRANSACTIONS:
Each nonmanagement member of the Board of Directors received an option to
purchase 300,000 shares of common stock at exercise prices ranging from $0.05 to
$0.50 per share (estimated fair market value at date of grant). These options
(totaling 1,500,000 shares) expire on April 20, 2003 and vest over a period of
three years, except that the options may vest immediately upon the occurrence of
certain events.
An officer of the Company has made advances to the Company for working
capital and equipment purchases. These loans had a term of one year and included
interest at the prime rate. These advances were repaid in full during 1999. In
connection with these loans, this officer was issued warrants to purchase
146,000 and 570,660 shares of Class B Common Stock at $0.38 and $0.76 per share,
respectively. These warrants expire five years from the date of issuance on
April 27, 2003 and December 9, 2003, respectively.
The Company may borrow up to $5,000,000 under a revolving credit agreement
with an investor group. The credit agreement will expire on June 30, 2000.
Borrowings under the agreement bear interest at prime plus 2% (10.5% at December
31, 1999) and are collateralized by substantially all of the assets of the
Company. The credit facility contains certain quarterly financial covenants. The
Company had borrowings outstanding under the credit facility of $0 and
$3,750,000 as of December 31, 1998 and 1999, respectively. As of December 31,
1999, the Company was in violation of certain financial covenants of the credit
facility.
7. COMMITMENTS AND CONTINGENCIES:
LEASES:
The Company leases three facilities for its operations and equipment
network. The equipment network facility is under a noncancelable operating lease
expiring November 15, 2003. One operations facility is leased on a
month-to-month basis with no formal agreement. The other facility agreement is a
noncancelable lease expiring March 15, 2004.
At December 31, 1999, the Company's minimum rental commitments under
non-cancelable operating leases for each fiscal year ended December 31 are as
follows:
<TABLE>
<CAPTION>
FISCAL OPERATING
YEAR LEASES
----------- -------------
<S> <C>
2000............................................................................. $ 278,000
2001............................................................................. 282,000
2002............................................................................. 210,000
2003............................................................................. 210,000
2004 and thereafter.............................................................. 53,000
-------------
Total minimum lease payments................................................... $ 1,033,000
=============
</TABLE>
Total rent expense for operating leases for the years ended December 31,
1997, 1998 and 1999 amounted to approximately $22,000, $39,000 and $184,000,
respectively.
F-48
<PAGE>
LASER LINK.NET, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
EMPLOYMENT CONTRACTS:
The Company has entered into various employment contracts with key
employees. These agreements are consecutive one-year terms and entitle the
employees to a total of 1,320,000 options to purchase Class A common stock.
SIGNIFICANT AGREEMENTS:
Access to the Internet for subscribers is provided through points of
presence capacity leased from UUNet. The agreement with UUNet expires June 1,
2001 and automatically renews for consecutive one- year terms, unless terminated
prior to or at the end of its current term.
UUNet is also a competitor of the Company. UUNet's availability may be
limited in the future if other significant UUNet users increase capacity. The
Company pays UUNet a fee per network hour used.
The Company has licensed Netscape Communicator software ("Netscape") from
Netscape Communications Corporation, and Microsoft Internet Explorer Software
("Explorer") from Microsoft Corporation. These licenses permit the Company to
distribute Netscape and Explorer in the Company's Network Operations Center
access packages. Management believes that contract renewal of both of the
licenses under conditions acceptable to the Company is probable.
The Company has entered into an agreement with a company to provide
customer service and technical support to the Company's customer base. The
Company is subject to charges by the service provider on a fixed fee basis per
subscriber.
LEGAL PROCEEDINGS:
The Company is subject to legal proceedings and claims that arise in the
ordinary course of business. As of December 31, 1999, management is not aware of
any asserted or pending litigation or claims against the Company that would have
a material adverse effect on the Company's financial condition, results of
operations or liquidity.
8. EMPLOYEE BENEFIT PLAN:
In 1999, the Company established a defined contribution 401(k) retirement
plan covering substantially all its employees. Under this plan, eligible
employees may contribute a portion of their salary until retirement and the
Company, at its discretion, may match a portion of the employee's contribution
up to 15% of an employee's annual compensation. The Company contributed $31,000
in 1999.
9. SUBSEQUENT EVENTS:
On March 8, 2000, the Company signed an Agreement and Plan of Merger (the
"Agreement") with Covad Communications Group, Inc. ("Covad"). Under the terms of
the Agreement, Covad will exchange approximately 4,300,000 shares (6,450,000
split-adjusted shares) of its common stock for all outstanding Company common
stock and all unexpired and unexercised outstanding Company options and
warrants.
F-49
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To BlueStar Communications Group, Inc.:
We have audited the accompanying consolidated balance sheets of BlueStar
Communications Group, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1998 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows each of the two years in the
period ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of BlueStar
Communications Group, Inc. and subsidiaries as of December 31, 1998 and 1999,
and the consolidated results of their operations and their cash flows for each
of the two years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
-----------------------
Nashville, Tennessee
January 14, 2000, except for the fifth
and eighth paragraphs of Note 9, as to
which the date is July 14, 2000
F-50
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
------------- ---------------
ASSETS
Current Assets:
<S> <C> <C>
Cash and cash equivalents..................................................... $ 501,611 $ 12,901,707
Accounts receivable........................................................... 1,142 140,115
Inventories................................................................... -- 108,051
Prepaid expenses and other current assets..................................... 6,531 325,643
------------- ---------------
Total current assets........................................................ 509,284 13,475,516
------------- ---------------
------------- ---------------
Property and equipment, net...................................................... 142,712 5,017,500
Collocation fees, net............................................................ 19,250 7,445,674
Other assets..................................................................... -- 567,677
------------- ---------------
Total assets................................................................ $ 671,246 $ 26,506,367
============= ===============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable.............................................................. $ 30,978 $ 2,360,369
Accrued liabilities........................................................... 169,316 4,645,776
Note payable.................................................................. --- 541,526
Current portion of long-term debt............................................. 155,000 320,922
------------- ---------------
Total current liabilities................................................... 355,294 7,868,593
------------- ---------------
Long-term debt, net of current portion........................................... 345,000 503,174
------------- ---------------
Total liabilities........................................................... 700,294 8,371,767
Commitments and Contingencies:
Redeemable Convertible Preferred Stock, $01 par value;
25,000,000 shares authorized
Series A, 12,345,003 shares outstanding....................................... -- 5,936,688
Series B, 8,177,040 shares outstanding........................................ -- 31,080,009
Stockholders' Deficit:
Common stock, $0025 and $01 par value at December 31, 1998 and 1999,
respectively; 50,000,000 and 60,000,000 shares authorized at December 31,
1998 and 1999, respectively; 12,145,593 and 11,712,900 shares issued and
outstanding at December 31, 1998 and 1999, respectively..................... 30,364 117,128
Additional paid-in capital.................................................... 421,463 4,018,372
Deferred compensation......................................................... -- (3,239,122)
Accumulated deficit........................................................... (480,875) (19,778,475)
------------- ---------------
Total stockholders' deficit................................................. (29,048) (18,882,097)
------------- ---------------
Total liabilities, redeemable convertible preferred stock and
stockholders' deficit.....................................................
$ 671,246 $ 26,506,367
============= ===============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
F-51
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
-------------- -----------------
<S> <C> <C>
Revenues.................................................................... $ 12,101 $ 771,109
Operating Expenses:
Network and product costs................................................ 199,973 8,082,759
Selling and marketing.................................................... 75,572 4,809,590
General and administrative............................................... 426,250 6,949,442
Amortization of deferred compensation.................................... -- 425,840
Depreciation and amortization............................................ 28,402 263,972
-------------- -----------------
Total Operating Expenses............................................... 730,197 20,531,603
-------------- -----------------
Loss from Operations........................................................ (718,096) (19,760,494)
Interest Income (Expense):
Interest income.......................................................... 14,633 607,200
Interest expense......................................................... (14,166) (65,486)
-------------- -----------------
Net interest income.................................................... 467 541,714
Net loss.................................................................... $ (717,629) $ (19,218,780)
============== =================
Net loss per common share, basic and diluted................................ $ (0.07) $ (2.15)
============== =================
Weighted average number of common shares outstanding........................ 10,154,010 8,953,153
============== =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
F-52
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN DEFERRED MEMBER ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION CAPITAL DEFICIT TOTAL
----------- ---------- ---------- -------------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998 . -- $ -- $ -- $ -- $ 100,808 $ -- $ 100,808
Member contributions .... -- -- -- -- 20,314 -- 20,314
Net loss of LLC.......... -- -- -- -- -- (236,754) (236,754)
Issuance of common stock
and reorganization
from LLC
to Corporation......... 9,855,000 24,637 (140,269) -- (121,122) 236,754 --
Common stock issued...... 2,332,281 5,831 575,524 -- -- -- 581,355
Common stock redemption.. (41,688) (104) (13,792) -- -- -- (13,896)
Net loss since
reorganization ........ -- -- -- -- -- (480,875) (480,875)
----------- ----------- ---------- -------------- ---------- ------------- -------------
Balance at December 31, 12,145,593 30,364 421,463 -- -- (480,875) (29,048)
1998
Change of par value of
common stock from
$.0025
to $.01 per share ..... -- 91,091 (91,091) -- -- -- --
Shares issued to
employee (1,298,244
shares restricted and
deferred compensation
at $.049 per share).... 1,390,017 13,900 54,211 (63,615) -- -- 4,496
Deferred compensation on
stock option grants ... -- -- 3,601,347 (3,601,347) -- -- --
Amortization of deferred
compensation .......... -- -- -- 425,840 -- -- 425,840
Compensation expense
related to
non-employee warrant
and stock
options granted ....... -- -- 10,000 -- -- -- 10,000
Exercise of common stock
options................ 198,315 1,983 22,442 -- -- -- 24,425
Repurchase of common stock . (2,021,025) (20,210) -- -- -- (78,820) (99,030)
Net loss.................... -- -- -- -- -- (19,218,780) (19,218,780)
----------- ----------- ---------- -------------- ---------- ------------- -------------
Balance at December 31,
1999 ....................... 11,712,900 $ 117,128 $4,018,372 $ (3,239,122 ) $ -- $(19,778,475) $(18,882,097)
=========== =========== ========== ============== ========== ============= =============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-53
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss....................................................................... $ (717,629) $ (19,218,780)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment....................................... 28,402 224,548
Amortization of collocation fees............................................. -- 39,424
Amortization of deferred compensation........................................ -- 425,840
Non-cash compensation expense................................................ 6,073 14,496
Changes in operating assets and liabilities:
Accounts receivable........................................................ (1,142) (138,973)
Inventories................................................................ -- (108,051)
Prepaid expenses and other current assets.................................. (6,531) (319,112)
Other assets............................................................... -- (567,677)
Accounts payable........................................................... 30,978 2,329,391
Accrued liabilities........................................................ 163,243 4,476,460
------------- --------------
Net cash used in operating activities.................................... (496,606) (12,842,434)
------------- --------------
Cash Flows From Investing Activities:
Purchase of property and equipment............................................. (70,306) (4,557,810)
Payments of collocation fees................................................... (19,250) (7,465,848)
------------- --------------
Net cash used in investing activities.................................... (89,556) (12,023,658)
------------- --------------
Cash Flows From Financing Activities:
Proceeds from issuance of common stock......................................... 575,000 24,425
Repurchase of common stock..................................................... -- (99,030)
Proceeds from issuance of preferred stock...................................... -- 37,016,697
Proceeds from long-term debt................................................... 500,000 500,000
Repayments on long-term debt (175,904)
Other equity transactions, net................................................. 12,773 --
------------- --------------
Net cash provided by financing activities................................ 1,087,773 37,266,188
------------- --------------
Net Increase in Cash and Cash Equivalents......................................... 501,611 12,400,096
Cash and Cash Equivalents, beginning of year...................................... -- 501,611
------------- --------------
Cash and Cash Equivalents, end of year............................................ $ 501,611 $ 12,901,707
============= ==============
Supplemental Cash Flow Information:
Interest paid.................................................................. $ 14,166 $ 65,486
============= ==============
Supplemental Non-Cash Financing Activities:
Software purchased through short-term note payable............................. $ -- $ 541,526
============= ==============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
F-54
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BlueStar Properties, Inc., a Tennessee corporation, was incorporated on
September 28, 1998. On the same date, subsequent to incorporation, all assets
and liabilities of BlueStar Communications, LLC, which was organized on March 7,
1997, were merged with and into BlueStar Properties, Inc., a Tennessee
corporation, in a common control reorganization. On June 21, 1999, we
reincorporated in Delaware by merging BlueStar Properties, Inc., a Tennessee
corporation, into BlueStar Properties, Inc., a Delaware corporation, with
BlueStar Properties, Inc., a Delaware corporation, surviving. The Delaware
corporation subsequently changed its name to BlueStar Communications Group, Inc.
(collectively, including all predecessors, the Company).
The Company has four wholly owned subsidiaries, BlueStar Communications,
Inc., the operating business, BlueStar Networks, Inc. and BlueStar Networks of
Virginia, Inc., both of which maintain certain regulatory licenses, and BlueStar
Communications of the Southeast, Inc.
The Company is a provider of broadband communications and Internet services
to small- and medium-sized businesses in Tier II and Tier III cities. Our
Internet services, which are packaged with Web hosting and e-mail, and our
high-speed real private networking services are primarily provided using DSL
technology. In addition to DSL technology, the Company also offers other
low-cost broadband solutions, including unbundled network element T1, or UNE T1,
in order to meet its customers' needs and maximize its network footprint.
The consolidated financial statements include the activity of BlueStar
Communications, LLC and BlueStar Properties, Inc., a Tennessee corporation, as
the predecessors to the Company. Revenue, expense and cash flow information for
the period from inception (March 7, 1997) to December 31, 1997 were all less
than $6,700, and, as a result, a full set of consolidated financial statements
for 1997 have not been included.
To date, the Company has incurred cash losses from operations and projects
that it will continue to incur losses in the near future, resulting in the need
for additional cash. The Company could incur additional losses as it continues
to expand its operating network. The Company intends to obtain cash from
strategic partners, existing and/or new stockholders or other resources. If such
resources are not obtained by the Company, then it could adversely affect the
Company's ability to operate at its current level.
(A) BASIS OF PRESENTATION
The consolidated financial statements of the Company include the accounts
of its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
(B) REVENUE RECOGNITION
Revenue related to service, installation 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. Although not material at December 31, 1998 or December 31,
1999, payments received in advance of providing services are recorded as
unearned revenue until such services are provided.
Selling costs in connection with lines that have been sold but not yet
installed are expensed as incurred. These selling costs are the only expenses
incurred prior to installation.
(C) CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with initial maturities of
less than three months to be cash equivalents. The Company had $8,994 in cash
balance subject to withdrawal restrictions as a condition of its $75,000
equipment leasing line of credit with its bank at December 31, 1998 and no
restrictions at December 31, 1999.
F-55
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(D) INVENTORIES
Inventories consist of telecommunications equipment that will be installed
at customer locations. Inventory is accounted for on a FIFO basis at the lower
of cost or market.
(E) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated using the
straight-line method over the following estimated useful lives:
Furniture and fixtures .......................... 7 years
Network equipment ............................... 5 years
Software ........................................ 3 years
Leasehold improvements .......................... Life of the lease
Expenditures for maintenance and repairs are charged to expense as
incurred, whereas expenditures for renewals and betterments are capitalized. The
Company accounts for software costs in accordance with the American Institute of
Certified Public Accountants' Statement of Position 98- 1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." The
statement requires capitalization of certain costs incurred in the development
of internal-use software, including external direct material and service costs.
(F) COLLOCATION FEES
Collocation fees represent non-recurring (one-time) fees paid to
traditional telephone companies. Non-recurring fees are an investment paid to
the telephone carriers to make space in the phone carriers central office
available and ready for use and placement of certain Company equipment.
Non-recurring collocation fees are amortized over their estimated useful lives
of five years.
The Company also incurs recurring monthly fees to traditional telephone
companies. Recurring collocation fees compensate the traditional telephone
carrier for maintenance of the facilities and variable costs such as power.
These fees also provide Company employees unlimited access to collocation space
and enable local loops between the central office and the customer as well as
broadband transport facilities to transmit data among the Company's
collocations. These recurring fees are cancelable by the Company when it ceases
to occupy the space. However, should the Company move to another collocation
space in the same area in order to over our service, monthly fees would be
payable at approximately the same levels ($500 average per month per collocation
facility).
(G) LONG-LIVED ASSETS
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of "
requires that companies consider whether indicators of impairment of long-lived
assets held for use are present. If such indicators are present, companies
determine whether the sum of the estimated undiscounted future cash flows
attributable to such assets are less than their carrying amount, and if so,
companies recognize an impairment loss based on the excess of the carrying
amount of the assets over fair value. Accordingly, management periodically
evaluates the ongoing value of property and equipment and has determined that
there were no indications of impairment as of December 31, 1998 and 1999.
(H) ADVERTISING
The Company expenses the cost of advertising as incurred. Advertising
expense was approximately $30,192 and $898,653 for the years ended December 31,
1998 and 1999, respectively.
(I) INCOME TAXES
Prior to becoming BlueStar Properties, Inc., a Tennessee C corporation, on
September 28, 1998, the Company operated as a limited liability company under
the provisions of the Internal Revenue Code. Under these provisions,
F-56
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
income or losses of BlueStar Communications, LLC were reported by the members on
their individual federal and state income tax returns, and BlueStar
Communications, LLC did not pay income taxes or receive income tax benefits. The
year-to-date loss of the LLC through September 28, 1998, of $236,754 was netted
against paid-in capital upon the dissolution of the LLC on that date.
The Company accounts for income taxes under Statements of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). Under
the asset and liability method of SFAS 109, deferred tax assets and liabilities
are determined based on differences between financial reporting and tax basis of
assets and liabilities and are measured using the enacted tax rates and laws
that are expected to be in effect when the differences are expected to reverse.
Under SFAS 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
(J) STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations, as permitted under Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation"(SFAS 123).
(K) NET LOSS PER SHARE
Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128). SFAS 128 requires the presentation of basic and diluted earnings per share
(EPS). Under the provisions of SFAS 128, basic net loss per share is computed by
dividing the net loss for the period by the weighted average number of shares of
common stock outstanding during the period.
Shares issued to employees subject to repurchase by the Company are not
included in the weighted average number of common shares outstanding for the
period.
Diluted EPS is the same as basic EPS as all potentially dilutive securities
are antidilutive Potential dilutive securities at December 31, 1999 include
common stock that would be issued for the exercise of stock options and warrants
6,854,450 shares the expiration of restrictions on shares 3,657,157 shares and
the conversion of preferred shares 20,522,043 common shares
(L) USE OF ESTIMATES
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and such differences may be
material to the financial statements.
(M) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheet for cash and cash
equivalents, restricted cash, accounts receivable, accounts payable, and debt
approximate fair value.
(N) START-UP COSTS
In accordance with Statement of Position 98-5, "Reporting on the Costs of
Start-up Activities" (SOP 98-5), the Company has expensed all start-up costs to
date.
(O) COMPREHENSIVE LOSS
The Company's comprehensive loss as defined by Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" has been the same
as reported losses since inception.
F-57
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(P) SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131). SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a
Business Enterprise", replacing the "industry segment" approach with the
"management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. The
Company operates in one segment: high-speed Internet access and data
communications services.
(Q) NEWLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133). SFAS 133 establishes accounting and reporting standards requiring that
every derivative instrument be recorded in the balance sheet as either an asset
or liability measured at its fair value. SFAS 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. SFAS 133 is effective for fiscal quarters
beginning after June 15, 2000. The impact of the adoption of SFAS 133 is not
expected to have a material impact on the Company's results of operations or
financial position.
Staff Accounting Bulletin 101 "Revenue Recognition in Financial
Statements," ("SAB 101") was issued in December 31, 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 complications surrounding the implementation of SAB 101, the SEC has
deferred the implementation date of certain provisions of SAB 101 until no later
than the quarter ended December 31, 2000, with retroactive application to
transactions entered into during the quarter ended March 31, 2000. This
extension will allow the Company and other companies impacted by this Bulletin
adequate time to fully understand the broader implications of SAB 101 and to
respond accordingly.
(R) CONCENTRATION OF RISK
Under a master operating lease agreement with Ascend Communications, now
Lucent, the Company had leased equipment valued at $16,213,932 as of December
31, 1999. Lucent is the primary supplier of the Company's network equipment.
Lucent also provided the Company with a $1,000,000 line of working capital in a
transaction separate from the lease agreements.
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash, cash equivalents and accounts
receivable. Concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers comprising the Company's customer
base.
2. PROPERTY AND EQUIPMENT
Property and equipment, at cost, as of December 31, consisted of the
following:
1998 1999
----------- --------------
Furniture and Fixtures.................... $ 2,815 $ 375,094
Network equipment......................... 166,493 2,358,357
Software.................................. -- 2,434,854
Leasehold improvements.................... 1,806 102,145
Less accumulated depreciation............. (28,402) (252,950)
----------- --------------
Property and equipment, net............... $ 142,712 $ 5,017,500
=========== ==============
F-58
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENT--(CONTINUED)
3. LEASE COMMITMENTS
The Company leases its office facilities and certain equipment from various
sources and leases its DSL equipment from Lucent as part of its $109.0 million
equipment lease line. The payment terms for each of the individual leases under
the Lucent Master Lease Agreement escalate during the first year and then remain
constant over the remaining life of the lease. Under the Lucent Master Lease
Agreement, the Company may lease equipment with a fair market value up to $30.0
million immediately. The Company may lease additional equipment up to the full
$109.0 million value so long as it maintains certain financial ratios and
covenants defined in the Lucent Master Lease Agreement. Once the Company has
leased equipment with a fair market value greater than $50.0 million, it must
maintain $10.0 million of restricted cash or cash equivalents on hand at all
times. The total amount of the base rent for all leases and subleases is being
charged to expense on the straight-line method over the terms of the leases.
Rental expense for all operating leases and subleases was $128,896 and
$3,566,838 for the years ended December 31, 1998 and 1999, respectively. Future
minimum commitments under noncancellable operating lease agreements and building
office space lease agreements outstanding at December 31, 1999 are as follows:
OPERATING
LEASE PAYMENTS
---------------
2000............................................. $ 9,219,241
2001............................................. 9,689,065
2002............................................. 5,427,773
2003............................................. 490,726
2004............................................. 205,572
---------------
Total minimum lease payments.................. $ 25,032,377
===============
4. ACCRUED LIABILITIES
At December 31, 1998 and 1999, accrued liabilities consisted of the
following:
1998 1999
------------- --------------
Accrued software payments................ $ -- $ 995,537
Accrued compensation expenses............ -- 764,482
Deferred lease payments.................. 80,251 1,824,962
Other accruals........................... 89,065 1,060,795
------------- --------------
Accrued liabilities...................... $ 169,316 $ 4,645,776
============= ==============
Deferred lease payments, within accrued liabilities, are caused by the
difference between the recognition of lease expense under generally accepted
accounting principles and the payment terms required by the Lucent Master Lease
Agreement. The payment terms for each of the individual leases under the Lucent
Master Lease Agreement escalates during the first year and then remains constant
over the remaining life of the lease. Accordingly, the base rent for the lease
is being charged to expense using the straight line method over the life of the
lease (36 months).
5. NOTE PAYABLE
In December 1999, the Company entered into a short-term note payable to an
equipment vendor in the amount of $541,526. Interest accrues at an annual rate
of 15%. Principal and interest payments of $58,704 are due monthly for the first
10 months of the year ended December 31, 2000.
F-59
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. LONG-TERM DEBT
At December 31, 1998 and 1999, long-term debt consists of:
<TABLE>
<CAPTION>
INTEREST
RATE 1998 1999
-------- ------------ ------------
<S> <C> <C> <C>
Lucent loan dated August 1998.............................. 8.50% $ 500,000 $ 373,891
Lucent loan dated February 1999............................ 7.75 -- 450,205
Less current portion....................................... (155,000) (320,922)
------------ ------------
Long-term debt............................................. $ 345,000 $ 503,174
============ ============
</TABLE>
The Company has a working capital line of credit agreement (Credit Line)
with Lucent allowing for borrowings up to $1,000,000. The balance is secured by
all of the assets of the Company. The line of credit is available in two
tranches of $500,000 each. Each tranche is payable over thirty-six months with
interest only payments for the first six months and principal and interest due
over the remaining thirty months. The August 1998 tranche matures in August 2001
and the February 1999 tranche matures in February 2002. Amounts charged to
interest expense for both loans was $14,166 and $65,486 during the years ended
December 31, 1998 and 1999, respectively.
7. REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Company's certificate of incorporation, as amended, authorizes the
issuance of up to 25,000,000 shares of Redeemable Convertible Preferred Stock
(Preferred Stock), of which 12,345,003 and 8,177,040 shares are designated
Series A and Series B, respectively. In March 1999, the Company issued
12,345,003 shares of redeemable convertible voting preferred stock designated as
Series A Preferred Stock at $0.49 per share. In August 1999 the Company issued
8,177,040 shares of redeemable convertible voting Preferred Stock designated as
Series B Preferred Stock at $3.80 per share.
The rights with respect to voting, dividends, liquidation and conversion of
the Preferred Stock are as follows:
Each share of Series A and B Preferred Stock has the same number of votes
as the number of shares of Common Stock into which that Series of Preferred
Stock is convertible.
Holders of Series A and B Preferred Stock are entitled to receive dividends
at the annual rate of $0.04 and $0.30 per share, respectively, when, as and if
declared by the Board of Directors. Such dividends are non-cumulative and are
payable prior and in preference to any dividends payable for Common Stock
declared by the Board of Directors. There have been no dividends declared to
date. As of December 31, 1999, the preferred stock holders have a priority right
on dividends of $1,296,000.
In the event of any liquidation or winding up of the Company, including a
merger or sale of significant assets, the holders of Series A and B Preferred
Stock shall be entitled to receive prior and in preference to any distribution
of any of the assets of the Company to the holders of Common Stock an amount of
$0.49, the original Series A liquidation amount, and $3.80, the original Series
B liquidation amount, per share for each share of Series A and B Preferred
Stock, respectively, plus all declared but unpaid dividends, if any. If assets
are insufficient to permit payment in full of a particular series, then
distribution would occur in proportion to the original issue price of the
respective series of Preferred Stock held by such holders.
After paying the amounts due the holders of shares of Preferred Stock, the
remaining assets available for distribution shall be distributed pro rata among
the holders of Common Stock and all Preferred Stock.
Each share of Preferred Stock is convertible into Common Stock at the
option of the holder or upon the consent of a majority of the aggregate votes of
the number of preferred shares then outstanding. The number of fully paid and
nonassessable shares of common stock into which each share of Series A and
Series B Preferred Stock may be converted shall be determined by dividing the
gross issue proceeds plus any declared but unpaid dividends by the
F-60
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
original issue price, adjusted for the effect of any stock splits, dividends or
other distribution payable that entitles aholder of Common Stock to receive
additional shares without payment of any consideration for the additional
shares. The conversion price was $0.49 and $3.80 for each share of Series A and
Series B Preferred Stock, respectfully, at December 31, 1999.
Such conversion is automatic upon the effective date of an initial public
offering of Common Stock for which the gross proceeds to the Company are at
least $20,000,000 and the offering price per share is at least $3.80 per share.
A total of 20,522,043 shares of Common Stock have been reserved for issuance
upon the conversion of the Series A and Series B Preferred Stock.
Each holder of Series A or Series B Preferred Stock may require the Company
to redeem on the dates specified below, by giving not less than 60 days written
notice, up to a cumulative total of that percentage of the shares held by such
requesting holder as set forth below.
<TABLE>
<CAPTION>
CUMULATIVE
PERCENTAGE
OF SHARES
WHICH MAY BE
REDEMPTION DATE REDEEMED
--------------
<S> <C>
March 17, 2006................................................................. 25%
March 17, 2007................................................................. 50
March 17, 2008................................................................. 75
March 17, 2009................................................................. 100
</TABLE>
8. STOCKHOLDERS' DEFICIT
On October 29, 1999, the Company effected a 3-for-1 stock split in the form
of a stock dividend. The accompanying consolidated financial statements and all
references to Common Stock shares and per share amounts including options and
warrants to purchase Common Stock have been retroactively restated to reflect
the stock split. Membership units in the LLC were not effected by the stock
split as it was not an organized entity at the time of the stock dividend.
During 1999 the Company enacted a change in the par value of its common stock
from $0.0025 to $.01 per share.
As a condition of the Series A Preferred Stock agreement entered into on
March 17, 1999, three employees of the Company entered into Stock Restriction
and Special Payment Agreements with the Company. The agreements require tenure
conditions for the respective employees in order to fully vest in a portion of
their shares owned as of the date of the funding of the Series A Preferred
Stock. Restricted shares are subject to a right of repurchase by the Company, at
a price of $0.049 per share, if the employee leaves the Company or is terminated
prior to vesting. This right of repurchase lapses ratably over a 48-month period
and an additional 25% of the original amount of restricted shares automatically
accelerates vesting for termination without cause. In addition, the agreements
also include provisions which accelerate vesting upon a change in control of the
Company. In connection with the termination of employment of one of these
employees subject to such agreements, the Company exercised its right of
repurchase of 2,021,025 shares of Common Stock at a price of $.049 per share and
immediately retired these shares.
On September 22, 1998, the Company entered into a Personal Services
Agreement (PSA) with a consultant for the Company. Under the terms of the
agreement, the consultant was granted 3.5% stock ownership in the Company and
ultimately received additional ownership interest under the agreement. As of
December 31, 1998, the consultant had received ownership in 5% of the
outstanding Common Stock. Compensation expense was recorded based on the 5%
ownership for the year ending December 31, 1998. On March 18, 1999, the
consultant received 1,390,017 additional shares per the terms of the PSA.
Immediately subsequent to receipt of the shares, the consultant became an
officer and employee of the Company and the PSA was terminated. As a condition
of the Series A Preferred Stock Purchase Agreement, a portion of his shares of
Common Stock are restricted and subject to repurchase by the Company.
Compensation expense related to the unrestricted shares was recognized upon
issuance.
F-61
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The value related to the 1,298,244 restricted shares was recorded as deferred
compensation and is being amortized over the 48-month vesting period.
On August 8, 1998, the Company entered into a Warrant Agreement with Lucent
in relation to the working capital note payable. In consideration of this
commitment with a ten-year term, a warrant was issued to purchase shares of
Common Stock at an exercise price of $0.33 per share. The number of shares
available to be exercised per the terms of the note equaled the total principal
amount advanced to the Company divided by ten, adjusted for any stock splits. At
December 31, 1998, the Company had borrowed $500,000 and thus 150,000 shares
were available to be issued under the warrant. In February 1999, the Company
borrowed an additional $500,000 on the note and the number of shares available
to be issued under the warrant was increased to 300,000. As of December 31,
1999, there have been no exercises under the warrant.
In July 1999, the Company entered into a Warrant Agreement with Boyle
Consolidated Communications, LLC (Boyle) as consideration for an exclusivity
license to install access equipment in certain Boyle properties. The Company
issued to Boyle a warrant to purchase 60,000 shares of Common Stock with an
exercise price of $1.67 per share. This warrant is immediately exercisable and
expires on the earlier of July 2004 or a breach of the agreement. The Company
may exercise the option to repurchase any unvested shares at a price of $1.67
per share. The shares vest ratably over a 36-month period. As of December 31,
1999, there have been no exercises under the warrant. The Company accounted for
the warrants based on their fair value at the grant date utilizing the Black
Scholes economic model. The value of the warrants was expensed.
9. STOCK OPTION PLAN
During 1998, the Company issued 360,000 non-qualified stock options to
certain initial employees and consultants of the Company From January 1999 to
March 1999, the Company issued an additional 366,000 non-qualified stock options
to certain employees and three consultants of the Company All initial employee
or consultant options were issued at exercise prices greater than market value
as determined by the Board of Directors of the Company The options expire in
2006 The Company recognized compensation expense for the value of the 360,000
options issued to non-employees.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
----------- -----------
<S> <C> <C>
Outstanding at January 1, 1998.......................................... -- --
Granted.............................................................. 360,000 0.33
Exercised............................................................ -- --
Cancelled............................................................ -- --
----------- -----------
Outstanding at December 31, 1998........................................ 360,000 0.33
Granted.............................................................. 366,000 0.38
Exercised............................................................ (45,000) 0.33
Cancelled............................................................ (135,000) 0.33
----------- -----------
Outstanding at December 31, 1999........................................ 546,000 $ 0.37
=========== ===========
Exercisable at December 31, 1999........................................ 306,000 $ 0.36
=========== ===========
</TABLE>
In March 1999, the Company's Board of Directors (Board) adopted the 1999
Incentive Stock Option Plan (Plan). The Plan provides for the granting of stock
options to employees, directors or consultants of the Company. The Plan is
administered by the Board and allows for the granting of non-qualified (NQOs)
and incentive stock options (ISOs) for purchase up to an aggregate of 3,259,500
shares of Common Stock. The options are exercisable at the discretion of the
plan administrator, but generally are exercisable upon vesting. Options
generally vest over a four year period at a rate of 25% after the first year of
service, then ratably over the next thirty-six months. Certain employees of the
Company have been granted ISOs which vest at a rate of 12.5% after the first six
months of
F-62
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
service and then ratably over the next forty-two months. Options expire within
10 years after the date of grant. In the event of a change of control of the
Company, the Plan provides for accelerated vesting based upon the terms
evidenced in the Option grant, generally 50.0% of the unvested options of the
employee. All options under the Plan have a ten year term.
In October 1999, the Board approved and adopted the 1999 Stock Option/Stock
Issuance Plan (New Plan). The New Plan provides for the granting of stock
options and stock purchase rights to employees, non-employee members of the
Board and consultants who provide services to the Company. At December 31, 1999,
7,615,500 shares of Common Stock were reserved for issuance under the Plan. The
Plan is administered by the Board and allows for the granting of non-statutory
options (NSOs) and incentive stock options (ISOs). The plan administrator
establishes exercise provisions for options, but generally options are
immediately exercisable upon grant. In the event that options are exercised
prior to vesting, the shares issued pursuant to unvested options will be subject
to repurchase by the Company. Options generally vest over a four year period at
a rate of 25% after the first year of service, then ratably over the next
thirty-six months. Certain employees of the Company have been granted options
which vest at a rate of 12.5% after the first six months of service and then
ratably over the next forty-two months. Options expire within 10 years after the
date of grant.
All grants under the Plan will be issued new certificates under the New
Plan. Grants issued above the amount authorized by the Plan have been approved
by the Board and are considered issued under the New Plan.
The Company accounts for options issued to employees under APB Opinion 25.
For the period ended December 31, 1999, the Company granted options with
exercise prices greater than, equal to and less than the market value of the
common stock as determined by the Board of Directors of the Company. As a result
of the Company's reassessment during 2000 of the fair value per share of its
common stock, the Company has restated its financial statements for the year
ended December 31, 1999 to recognize deferred compensation of $3,601,347 related
to options granted with exercise prices less than the market value of the common
stock. Stock compensation expense is recognized over the four year vesting
period and totaled $425,840 for the year ended December 31, 1999. The Company
recognized compensation expense related to non-qualified options issued to
consultants under the Plan.
Plan and New Plan activity is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
------------ -----------
<S> <C> <C>
Outstanding at January 1, 1999............................................. -- --
Granted................................................................. 6,134,265 $ 0.37
Exercised............................................................... (153,315) 0.06
Cancelled............................................................... (32,500) 0.57
------------ -----------
Outstanding at December 31, 1999........................................... 5,948,450 $ 0.38
============ ===========
Exercisable at December 31, 1999........................................... 308,543 $ 0.07
============ ===========
</TABLE>
The following table summarizes information about initial employee, Plan and
New Plan options outstanding at December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED
OPTIONS REMAINING WEIGHTED OPTIONS AVERAGE
OUTSTANDING CONTRACTUAL AVERAGE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/99 LIFE IN YEARS EXERCISE PRICE AT 12/31/99 PRICE
----------------------- -------------- -------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C> <C>
$ 0.05-0.10 2,939,250 4.50 $ 0.07 299,043 $ 0.05
0.20-0.49 1,008,000 3.71 0.29 306,000 0.36
0.77 2,547,200 5.00 0.77 9,000 0.77
-------------- -------------- --------------- --------------- --------------
6,494,450 4.60 $ 0.38 614,043 $ 0.22
============== ============== =============== =============== ==============
</TABLE>
F-63
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SFAS 123 established new financial and reporting standards for stock-based
compensation plans. As the Company has adopted the disclosure-only provision of
SFAS 123, no compensation cost has been recognized for the Company's option plan
based on the fair value method. If the Company had recognized compensation cost
for the option grants based on the fair value method prescribed by SFAS 123, the
effects for the year ended December 31, 1998 would have been immaterial and the
Company's net loss would have increased by approximately $44,000 or less than
$0.01 per share for the year ended December 31, 1999. The weighted average fair
value of options granted during 1999 was $0.61. The above tables include 37,500
non-qualified options issued under the plan that are subject to repurchase by
the Company. The Company did not repurchase any of these shares as of December
31, 1999.
The fair value for these options was estimated at the date of grant using
the minimum value method allowed under SFAS 123. Under this method, the expected
life of the options used in this calculation was 2, 3, 5 and 6 years for options
vesting in 1, 2, 3 and 4 years, respectively, from the date of grant; the risk
free interest rate used ranged from 4.62% to 6.38%; and a volatility factor of
nil.
10. INCOME TAXES
The components of the net deferred income tax asset (liability), at an
effective rate of 39%, as of December 31, 1998 and 1999 are as follows:
<TABLE>
<CAPTION>
1998 1999
------------ --------------
<S> <C> <C>
Non-current asset (liability):
Net operating loss carryforward............................... $ 186,811 $ 7,906,389
Tax over book depreciation.................................... (9,008) (265,253)
Compensation accrual.......................................... -- 77,728
Other nondeductible accruals.................................. -- 143,500
Capitalized start-up costs.................................... 9,576 7,912
Long-term accrued liability................................... 34,735 --
------------ --------------
Total non-current asset..................................... 222,114 7,870,276
Less valuation allowance...................................... (222,114) (7,870,276)
------------ --------------
Net deferred tax asset...................................... $ -- $ --
============ ==============
</TABLE>
SFAS 109 requires the Company to record a valuation allowance when it is
"more likely than not that some portion or all of the deferred tax assets will
not be realized." It further states that "forming a conclusion that a valuation
allowance is not needed is difficult when there is negative evidence such as
cumulative losses in recent years." The ultimate realization of the deferred
income tax assets depends on the Company's ability to generate sufficient
taxable income in the future. The Company has provided a valuation allowance at
December 31, 1998 and December 31, 1999. If the Company achieves sufficient
profitability in future years to use all of the deferred income tax asset, the
valuation allowance will be reduced through a credit to expense (increasing
retained earnings).
As of December 31, 1999, the Company had federal net operating loss
carryforwards of approximately $479,002 which expire in 2013 and $18,804,874
which expire in 2014.
11. COMMITMENTS AND CONTINGENCIES
The Company is involved in various litigation that arise through the normal
course of business. Management believes that the resolution of these matters
will not have a material adverse effect on the Company's financial position or
results of operations.
On April 5, 1999, the Company entered into an agreement with the Chief
Executive Officer. The agreement provides for a monthly base salary and 12
months' salary and additional vesting of options if terminated.
F-64
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND JUNE 30, 2000
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
--------------- ---------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................................... $ 12,901,707 $ 920,669
Accounts receivable......................................................... 140,115 1,303,684
Inventories................................................................. 108,051 18,010
Prepaid expenses and other current assets................................... 325,643 1,476,466
--------------- ---------------
Total current assets...................................................... 13,475,516 3,718,829
--------------- ---------------
Property and equipment, net.................................................... 5,017,500 12,195,324
Collocation fees, net.......................................................... 7,445,674 11,579,176
Other assets................................................................... 567,677 4,156,331
--------------- ---------------
Total assets.............................................................. $ 26,506,367 $ 31,649,660
=============== ===============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable............................................................ $ 2,360,369 $ 8,170,872
Accrued liabilities......................................................... 4,645,776 12,622,889
Note payable................................................................ 541,526 7,270,767
Current portion of long-term debt........................................... 320,922 334,520
--------------- ---------------
Total current liabilities................................................. 7,868,593 28,399,048
--------------- ---------------
Long-term debt, net of current portion......................................... 503,174 332,420
Total liabilities......................................................... 8,371,767 28,731,468
Commitments and contingencies:
Redeemable convertible preferred stock, $01 par value;
25,000,000 shares authorized
Series A, 12,345,003 shares outstanding .................................... 5,936,688 5,936,688
Series B, 8,177,040 shares outstanding ..................................... 31,080,009 31,080,009
Series C, 2,165,603 shares outstanding...................................... -- 33,975,000
Stockholders' Deficit:
Common stock, $01 par value at December 31, 1999 and June 30, 2000;
60,000,000 shares authorized at December 31, 1999 and June 30, 2000,
11,712,900 and 13,176,774 shares issued and outstanding at December 31,
1999 and June 30, 2000, respectively ..................................... 117,128 131,767
Additional paid-in capital ................................................. 4,018,372 6,101,976
Restricted stock loan receivable............................................ -- (728,150)
Deferred compensation ...................................................... (3,239,122) (3,076,769)
Accumulated deficit......................................................... (19,778,475) (70,502,329)
--------------- ---------------
Total stockholders' deficit .............................................. (18,882,097) (68,073,505)
--------------- ---------------
Total liabilities, redeemable convertible preferred stock and
stockholders' deficit................................................... $ 26,506,367 $ 31,649,660
=============== ===============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
F-65
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(UNAUDITED)
<TABLE>
<CAPTION>
1999 2000
-------------- ----------------
<S> <C> <C>
Revenues.................................................................... $ 136,211 $ 3,625,031
Operating Expenses:
Network and product costs ............................................... 950,659 20,612,551
Selling and marketing.................................................... 323,581 17,349,024
General and administrative............................................... 863,145 12,235,957
Amortization of deferred compensation.................................... 3,976 1,095,963
Depreciation and amortization ........................................... 24,493 1,934,852
-------------- ----------------
Total operating expenses ............................................ 2,165,854 53,228,347
-------------- ----------------
Loss From Operations ....................................................... (2,029,643) (49,603,316)
Interest Income (Expense):
Interest income ......................................................... 40,197 499,709
Interest expense ........................................................ (187) (96,390)
-------------- ----------------
Net interest income (expense)........................................ 40,010 403,319
-------------- ----------------
One time charges and debt fees........................................... -- (1,454,244)
============== ================
Net loss ................................................................... $ (1,989,633) $ (50,654,241)
============== ================
Net loss per common share, basic and diluted ............................... $ (0.19) $ (5.31)
============== ================
Weighted average number of common shares outstanding........................ 10,425,501 9,539,643
============== ================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-66
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
<TABLE>
<CAPTION>
RESTRICTED
COMMON STOCK ADDITIONAL STOCK
--------------------------- PAID-IN LOAN DEFERRED
SHARES AMOUNT CAPITAL RECEIVABLE COMPENSATION
------------- ------------ --------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999................ 11,712,900 $ 117,128 $ 4,018,372 $ -- $ (3,239,122)
Exercise of common stock options......... 3,248,809 32,488 1,149,994 -- --
Repurchase of common stock............... (1,784,935) (17,849) -- -- --
Deferred compensation on
stock option grants.................... -- -- 933,610 -- (933,610)
Amortization of deferred compensation.... -- -- -- -- 1,095,963
Restricted stock loan receivable......... -- -- -- (728,150) --
Net loss................................. -- -- -- -- --
------------- ------------ --------------- -------------- ----------------
Balance at June 30, 2000.................... 13,176,774 131,767 6,101,976 (728,150) $ (3,076,769)
============= ============ =============== ============== ================
<CAPTION>
ACCUMULATED
DEFICIT TOTAL
--------------- -----------------
<S> <C> <C>
Balance at December 31, 1999................ $ (19,778,475) $ (18,882,097)
Exercise of common stock options......... -- 1,182,482
Repurchase of common stock............... (69,613) (87,462)
Deferred compensation on
stock option grants.................... -- --
Amortization of deferred compensation.... -- 1,095,963
Restricted stock loan receivable......... -- (728,150)
Net loss................................. (50,654,241) (50,654,241)
--------------- -----------------
Balance at June 30, 2000.................... $ (70,502,329) $ (68,073,505)
=============== =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-67
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(UNAUDITED)
<TABLE>
<CAPTION>
1999 2000
--------------- ---------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss................................................................... $ (1,989,623) $ (50,654,241)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment................................... 24,493 1,412,374
Amortization of collocation fees......................................... -- 522,478
Amortization of deferred compensation.................................... -- 1,095,963
Interest on restricted stock receivable.................................. -- (22,580)
Changes in operating assets and liabilities:
Accounts receivable.................................................... (38,964) (1,163,569)
Inventories............................................................ -- 90,041
Prepaid expenses and other current assets.............................. (72,622) (1,150,823)
Other assets........................................................... -- (3,588,654)
Accounts payable....................................................... 268,330 5,810,503
Accrued liabilities.................................................... 337,151 7,977,113
--------------- ---------------
Short-term note payable................................................ 193,756 13,598
--------------- ---------------
Net cash used in operating activities................................ (1,277,479) (39,657,797)
--------------- ---------------
Cash Flows From Investing Activities:
Purchase of property and equipment......................................... (297,941) (8,590,198)
Payments of collocation fees............................................... (938,500) (4,655,980)
--------------- ---------------
Net cash used in investing activities................................ (1,236,441) (13,246,178)
--------------- ---------------
Cash Flows From Financing Activities:
Proceeds from issuance of common stock..................................... -- 476,912
Repurchase of common stock................................................. -- (87,462)
Proceeds from issuance of preferred stock.................................. 5,936,688 33,975,000
Proceeds from long-term debt............................................... 245,383 6,729,241
Repayments on long-term debt............................................... -- (170,754)
Other equity transactions, net............................................. 0 --
--------------- ---------------
Net cash provided by financing activities............................ 6,182,071 40,922,937
--------------- ---------------
Net Increase in Cash and Cash Equivalents..................................... 3,668,151 (11,981,038)
Cash and Cash Equivalents, beginning of period................................ 501,611 12,901,707
--------------- ---------------
Cash and Cash Equivalents, end of period...................................... $ 4,169,762 $ 920,669
=============== ===============
Supplemental Cash Flow Information:
Interest paid.............................................................. $ 33,663 $ 96,390
=============== ===============
Supplemental Non-Cash Investing Activities:
Restricted Stock Receivable................................................ $ -- $ 705,570
=============== ===============
Supplemental Non-Cash Financing Activities:
Software purchased through short-term note payable......................... $ -- $ 29,555
=============== ===============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
F-68
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated balance sheet as of June 30, 2000 and the
condensed consolidated statements of operations and cash flows for the periods
ended June 30, 1999 and June 30, 2000 have been prepared by the Company in
accordance with the accounting policies described in its annual financial
statements for the year ended December 31, 1999 and should be read in
conjunction with the notes thereto.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position at
June 30, 2000 and results of operations and changes in cash flows for all
periods presented have been made. The results of operations for the periods
ended June 30, 1999 and 2000 are not necessarily indicative of the operating
results for the full years.
2. NET LOSS PER SHARE
Net loss per share is presented in accordance with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128). SFAS 128 requires the presentation of basic and diluted earnings per share
(EPS). Under the provisions of SFAS 128, basic net loss per share is computed by
dividing the net loss for the period by the weighted average number of shares of
common stock outstanding during the period.
Shares issued to employees subject to repurchase by the Company are not
included in the weighted average number of common shares outstanding for the
period.
Diluted EPS is the same as basic EPS as all potentially dilutive securities
are antidilutive. Potential dilutive securities include common stock that would
be issued for the exercise of stock options and warrants 4,581,700 shares the
expiration of restrictions on shares 3,456,018 shares and the conversion of
preferred shares (22,687,641 common shares).
3. LEASE COMMITMENTS
In April of 2000, the Master Lease Agreement with Lucent was amended to
increase the maximum lease line from $109 million to $175 million. As of June
30, 2000, the Company has drawn a total of $50.5 million from the lease line.
In April, 2000, the Company executed an equipment leasing line with Cisco
Systems Capital, which allows the Company to lease equipment with a fair market
value up to $50.0 million.
4. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On January 28, 2000, the Company issued 318,471 shares of Series C
Preferred Stock for a total consideration of $5,000,000. On February 14, 2000,
the Company issued an additional 1,847,132 shares of Series C Preferred Stock
for net proceeds of $28,984,968. The rights and preferences of the Series C
preferred stock are similar to Series A and B preferred stock, except that
Series C preferred stock contains antidilution provisions.
5. STOCKHOLDERS DEFICIT
In January 2000, one of the employees subject to a Stock Restriction and
Special Payment Agreement resigned. The Company exercised its right to
repurchase the related outstanding restricted shares of 1,784,935 at a purchase
price of $0.049 per share. The total cost of repurchased options and severance
to the Company under the resignation agreement was approximately $231,000.
F-69
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. STOCK OPTION PLAN
During 2000, the Company's Board of Directors (Board) adopted the 2000
Stock Incentive Plan (2000 Plan). The 2000 Plan provides for five separate
equity incentive programs for eligible employees, directors and consultants of
the Company, which are the Discretionary Option Grant Program, Salary Investment
Option Grant Program, Stock Issuance Program, Automatic Option Grant Program and
Director Fee Option Grant Program. A total of 8,538,500 shares of common stock
have been reserved for issuance under the 2000 Plan, which includes all option
grants under the predecessor option plans (i.e. the initial employee Plan and
New Plan, and shares available for issuance under the predecessor plans) and
4,200,315 additional shares approved by the Board for issuance.
The Salary Investment Option Grant Program is restricted to certain highly
compensated employees and other insiders as defined in the 2000 Plan. The
Automatic Option Grant and Director Fee Option Grant programs are restricted to
non-employee Board members. All employees, non-employee members of the Board and
consultants and the independent advisors who provide services to the Company are
eligible under the Discretionary Option Grant and Stock Issuance Programs.
The Company granted an additional 2,265,000 incentive stock options under
the 2000 Plan to certain employees of the Company at exercise prices ranging
from $0.77 to $7.85 per share in the period from January 5, to June 30, 2000.
These option grants generally vest over a four year period at a rate of 25%
after the first year of service, then ratably over the next thirty-six months.
From January 1, 2000 to June 30, 2000, certain employees of the Company
exercised options for 3,248,809 shares at a weighted average exercise price of
$0.27 per share. Some of these employees were issued recourse loans by the
Company valued at $705,570 in order for the employees to purchase their
respective shares. The loans accrue interest at an annual rate of 7%. The loans
are also secured by a pledge of the Common Stock purchased by the loan proceeds.
Of the shares exercised through June 30, 2000, 1,544,375 shares have not vested
and are subject to repurchase by the Company at a weighted average exercise
price of $0.36 per share.
7. STOCK PURCHASE PLAN
On March 30, 2000, the Company's Board of Directors approved the BlueStar
Communications Group, Inc. Employee Stock Purchase Plans (the "ESPP"). As part
of the ESPP, 600,000 of common shares have been reserved for issuance under the
plan. The ESPP's adoption is subject to the Company's completion of its initial
public offering.
The ESPP, which is intended to qualify under Section 423 of the IRS Code,
will be implemented by a series of overlapping offering periods of 24 months'
duration, with new offering periods, other than the first offering period,
commencing on the first business day in February and August of each year.
The purchase price per share at which shares will be sold in an offering
under the ESPP will be the lower of 85% of the fair market value of a share of
the Company's common stock on the first day of an offering period or 85% of the
fair market value of a share of the Company's common stock on the semi-annual
purchase date. The fair market value of the Company's common stock on a given
date will be equal to the closing price of the Company's common stock on such
date as such price is reported by the National Association of Securities Dealers
on the Nasdaq national market.
8. SUBSEQUENT EVENTS
On June 16, 2000 an agreement was reached to merge with Covad
Communications, Group, Inc. ("Covad"), a provider of broadband and Internet
services. Under the merger agreement, the Company will receive 8 million shares
of Covad common stock for all of the Company's outstanding shares, plus
assumption of $55 million in debt and operating leases in a transaction
currently scheduled to close in the third quarter of 2000. Up to five million
additional shares of Covad common stock may be issued to the BlueStar
shareholders if certain performance targets are met by BlueStar over the 2001
fiscal year.
In June 2000, BlueStar entered into a $40.0 million demand loan agreement
with Bear Stearns Corporate Lending Inc. Under the terms of the loan agreement,
BlueStar may request up to $5.0 million every two weeks, not
F-70
<PAGE>
BLUESTAR COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
to exceed an aggregate of $40.0 million. Bear Stearns, however, is not obligated
to provide any portion of therequested amount. Any amounts borrowed under the
loan agreement bear interest, at BlueStar's discretion, at either (1) the prime
rate publicly announced by Citibank, N.A., plus 600 basis points or (2) the
interest rate which eurodollar deposits for one month are offered in the
interbank eurodollar market plus 700 basis points. Under either interest rate
election, the minimum interest rate is 13.0%. The loan agreement matures at the
earliest of (1) demand by Bear Stearns, (2) the date of commencement by or
against BlueStar or any of its subsidiaries of any bankruptcy proceeding, (3)
termination of the merger agreement in accordance with its terms (4)
consummation of the merger with Covad Communications or any other change in
control of BlueStar or (5) December 15, 2000.
F-71
<PAGE>
COVAD COMMUNICATIONS GROUP, INC.
AND
BLUESTAR COMMUNICATIONS GROUP, INC.
Appendices to the Prospectus
A. Agreement and Plan of Merger and Reorganization
B. Form of Stockholder Agreement
C. Form of Stock Restriction Agreement
D. Form of Escrow Agreement
E. Opinion of Donaldson, Lufkin & Jenrette Securities Corporation
F. Section 262 of the Delaware General Corporation Law
<PAGE>
APPENDIX A
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION
BY AND AMONG
COVAD COMMUNICATIONS GROUP, INC.,
COVAD ACQUISITION CORPORATION
AND
BLUESTAR COMMUNICATIONS GROUP, INC.
DATED AS OF
JUNE 15, 2000
A-1
<PAGE>
TABLE OF CONTENTS
Page
TABLE OF CONTENTS............................................................2
INDEX OF EXHIBITS............................................................5
ARTICLE I THE MERGER.....................................................6
1.1 The Merger.....................................................6
1.2 Closing; Effective Time........................................6
1.3 Effect of the Merger...........................................7
1.4 Certificate of Incorporation; By-laws..........................7
1.5 Directors and Officers.........................................7
1.6 Taking of Necessary Action; Further Action.....................7
ARTICLE II CONVERSION OF SECURITIES; EXCHANGE OF CERTIFICATES.............7
2.1 Total Consideration............................................7
2.2 Effect on Capital Stock; Conversion of Securities..............7
2.3 Exchange of Certificates.......................................9
2.4 Form S-4......................................................11
2.5 Dissenters' Rights............................................11
2.6 Alternate Transaction Structures..............................12
2.7 Rights to Receive Additional Shares of Parent Common Stock....12
ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................13
3.1 Organization, Standing and Power; Subsidiaries................14
3.2 Capital Structure.............................................14
3.3 Authority.....................................................15
3.4 Financial Statements..........................................16
3.5 Absence of Certain Changes....................................16
3.6 Absence of Undisclosed Liabilities............................17
3.7 Litigation....................................................18
3.8 Restrictions on Business Activities...........................18
3.9 Governmental Authorization....................................18
3.10 Title to Property.............................................18
3.11 Intellectual Property.........................................19
3.12 Environmental Matters.........................................20
3.13 Taxes.........................................................20
3.14 Employee Benefit Plans........................................21
3.15 Employee Matters..............................................22
3.16 Transactions with Affiliates..................................23
3.17 Insurance.....................................................23
3.18 Compliance With Laws..........................................23
3.19 Minute Books..................................................23
3.20 Brokers' and Finders' Fees....................................24
3.21 Stockholder Agreement; Irrevocable Proxies....................24
3.22 Vote Required.................................................24
3.23 Board Approval................................................24
A-2
<PAGE>
3.24 Accounts Receivable...........................................24
3.25 Customers and Suppliers.......................................24
3.26 Material Contracts............................................24
3.27 No Breach of Material Contracts...............................25
3.28 Third Party Consents..........................................26
3.29 Year 2000.....................................................26
3.30 Affiliates....................................................26
3.31 Outstanding Stock Options.....................................26
3.32 Prospectus and Proxy Statement and S-4........................26
3.33 Representations Complete......................................26
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PARENT......................27
4.1 Organization, Standing and Power..............................27
4.2 Capital Structure.............................................27
4.3 Authority.....................................................27
4.4 SEC Documents; Financial Statements...........................28
4.5 Broker's and Finders' Fees....................................28
4.6 No Prior Activities...........................................28
4.7 Prospectus and Proxy Statement and S-4........................28
ARTICLE V CONDUCT PRIOR TO THE EFFECTIVE TIME...........................28
5.1 Conduct of Business of the Company............................28
5.2 Restricted Conduct of the Company.............................29
5.3 No Solicitation...............................................31
5.4 Additional Bridge Financing...................................31
ARTICLE VI ADDITIONAL AGREEMENTS.........................................31
6.1 Prospectus and Proxy Statement................................31
6.2 Meeting of Stockholders.......................................31
6.3 Access to Information.........................................32
6.4 Public Disclosure.............................................32
6.5 Consents; Cooperation.........................................32
6.6 Company Affiliate Agreements..................................33
6.7 Stock Restriction Agreement...................................33
6.8 Legal Requirements............................................33
6.9 Blue Sky Laws.................................................33
6.10 Escrow Agreement..............................................34
6.11 Form S-8......................................................34
6.12 Listing of Additional Shares..................................34
6.13 Confidentiality...............................................34
6.14 Expenses......................................................34
6.15 Further Assurances............................................34
6.16 Indemnification of Directors, Officers, etc...................35
6.17 Reorganization for Federal Income Tax Purposes................35
6.18 Funding To Be Arranged By Parent..............................35
6.19 Non-solicitation of Employees.................................35
6.20 Loan Acceleration.............................................35
6.21 Employee Benefits.........................................35
A-3
<PAGE>
ARTICLE VII CONDITIONS TO THE MERGER......................................36
7.1 Conditions to Obligations of Each Party to Effect
the Merger....................................................36
7.2 Additional Conditions to Obligations of the Company...........36
7.3 Additional Conditions to the Obligations of Parent
and Merger Sub................................................37
ARTICLE VIII TERMINATION, AMENDMENT AND WAIVER.............................38
8.1 Termination...................................................38
8.2 Effect of Termination.........................................39
8.3 Amendment.....................................................39
8.4 Extension; Waiver.............................................39
ARTICLE IX ESCROW AND INDEMNIFICATION....................................39
9.1 Escrow Fund...................................................39
9.2 Indemnification...............................................39
9.3 Damage Threshold..............................................40
9.4 Escrow Period.................................................40
9.5 Claims upon Escrow Fund.......................................40
9.6 Objections to Claims..........................................41
9.7 Resolution of Conflicts; Arbitration..........................41
9.8 Stockholders' Agent...........................................42
9.9 Actions of the Stockholders' Agent............................42
9.10 Third-Party Claims. ..........................................42
9.11 Earn-Out Fund. ...............................................43
ARTICLE X GENERAL PROVISIONS............................................43
10.1 Survival of Representations, Warranties and Agreements........43
10.2 Notices.......................................................43
10.3 Interpretation................................................44
10.4 Counterparts..................................................44
10.5 Entire Agreement; Nonassignability; Parties in Interest.......44
10.6 Severability..................................................44
10.7 Remedies Cumulative...........................................44
10.8 Governing Law.................................................44
10.9 Rules of Construction.........................................45
A-4
<PAGE>
EXHIBITS
Exhibit A Form of Stockholder Agreement
Exhibit B Exchange Ratios
Exhibit C Earn-Out Calculations
Exhibit D Form of Stock Restriction Agreement
Exhibit E Form of Escrow Agreement
Exhibit F Interim Financing
Exhibit G FIRPTA Notice
Exhibit H Treasury Notice
Exhibit I Form of Company Affiliate Agreement
A-5
<PAGE>
AGREEMENT AND PLAN OF MERGER AND REORGANIZATION
THIS AGREEMENT AND PLAN OF MERGER AND REORGANIZATION (this
"AGREEMENT") is made and entered into as of June 15, 2000, by and among Covad
Communications Group, Inc., a Delaware corporation ("PARENT"), Covad Acquisition
Corporation, a Delaware corporation and a direct, wholly owned subsidiary of
Parent ("MERGER SUB"), and Big Sur, a Delaware corporation (the "COMPANY").
R E C I T A L S :
WHEREAS, the boards of directors of Parent, Merger Sub and the Company
have determined that it is advisable and in the best interests of their
respective companies and stockholders to enter into a business combination by
means of the merger of Merger Sub with and into the Company (the "MERGER") and,
in furtherance thereof, have approved this Agreement and the transactions
contemplated hereby, including the Merger;
WHEREAS, pursuant to the Merger, among other things, each outstanding
share of capital stock of the Company ("COMPANY CAPITAL STOCK") shall be
converted into shares of Parent Common Stock (as defined in Section 4.2 below),
in the manner set forth herein;
WHEREAS, for United States Federal income tax purposes, it is intended
that the Merger shall qualify as a "reorganization" within the meaning of
Section 368(a) of the Internal Revenue Code of 1986, as amended (together with
the rules and regulations promulgated thereunder, the "CODE"), and that this
Agreement shall be, and hereby is, adopted as a plan of reorganization for
purposes of Section 368 of the Code; and
WHEREAS, concurrently with the execution of this Agreement and as an
inducement to Parent to enter into this Agreement, certain stockholders of the
Company have entered into an agreement in the form attached hereto as EXHIBIT A
(the "STOCKHOLDER AGREEMENT") to vote the shares of the Company Capital Stock
owned by such person or entity to approve this Agreement and the Merger.
A G R E E M E N T :
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth in this
Agreement, and intending to be legally bound hereby, the parties hereto agree as
follows:
ARTICLE I THE MERGER
I.1 THE MERGER. Upon the terms and subject to the conditions set forth
in this Agreement, and in accordance with the General Corporation Law of the
State of Delaware (the "DELAWARE LAW"), at the Effective Time (as defined in
Section 1.2), Merger Sub shall be merged with and into the Company. As a result
of the Merger, the separate corporate existence of Merger Sub shall cease and
the Company shall continue as the surviving corporation of the Merger (the
"SURVIVING CORPORATION").
I.2 CLOSING; EFFECTIVE TIME. The closing of the transactions
contemplated hereby (the "CLOSING") shall take place as soon as practicable
following the satisfaction or waiver of each of the conditions set forth in
Article VII hereof, or at such other time as the parties hereto agree (the
"CLOSING DATE"). The Closing shall take place at the offices of Simpson Thacher
& Bartlett, 425 Lexington Avenue, New York, New York, or at such other location
as the parties hereto agree. In connection with the Closing, the parties hereto
shall cause the Merger to be consummated by filing a certificate of merger (the
"CERTIFICATE OF MERGER") with the Secretary of State of the State of Delaware
and shall make all other filings or recordings required under Delaware Law. The
Merger shall become effective at such time as the Certificate of Merger shall
have been duly filed with the Secretary of State of the State of Delaware, or at
such later time as is agreed by Parent and the Company and specified in the
Certificate of Merger (the time the Merger becomes effective under the Delaware
Law being the "EFFECTIVE TIME").
A-6
<PAGE>
I.3 EFFECT OF THE MERGER. At the Effective Time, the effect of the
Merger shall be as provided in this Agreement, the Certificate of Merger and the
applicable provisions of the Delaware Law. Without limiting the generality of
the foregoing, and subject thereto, at the Effective Time, all the property,
rights, privileges, powers and franchises of Merger Sub and the Company shall
vest in the Surviving Corporation, and all debts, liabilities and duties of
Merger Sub and the Company shall become the debts, liabilities and duties of the
Surviving Corporation.
I.4 CERTIFICATE OF INCORPORATION; BY-LAWS. At the Effective Time, the
Certificate of Incorporation of the Company, as in effect immediately prior to
the Effective Time and as may be amended by the Certificate of Merger, shall be
the Certificate of Incorporation of the Surviving Corporation until thereafter
amended. The By-laws of Merger Sub, as in effect immediately prior to the
Effective Time, shall be the By-laws of the Surviving Corporation until
thereafter amended as provided by the Delaware Law.
I.5 DIRECTORS AND OFFICERS. The directors of Merger Sub immediately
prior to the Effective Time shall be the directors of the Surviving Corporation,
and the officers of Merger Sub immediately prior to the Effective Time shall be
the officers of the Surviving Corporation, in each case until their respective
successors are duly elected or appointed and qualified.
I.6 TAKING OF NECESSARY ACTION; FURTHER ACTION. If, at any time after
the Effective Time, the Surviving Corporation shall consider or be advised that
any deeds, bills of sale, assignments, assurances, or any other actions or
things are necessary or desirable to vest, perfect or confirm, of record or
otherwise, in the Surviving Corporation its rights, title or interest in, to or
under any of the rights, properties or assets of either Merger Sub or the
Company or their subsidiaries acquired or to be acquired by the Surviving
Corporation as a result of, or in connection with, the Merger or otherwise to
carry out this Agreement, the officers and directors of the Surviving
Corporation shall be authorized to execute and deliver, in the name and on
behalf of each of Merger Sub and the Company, all such deeds, bills of sale,
assignments and assurances and to take and do, in the name and on behalf of each
of Merger Sub and the Company or otherwise, all such other actions and things as
may be necessary or desirable to vest, perfect or confirm any and all right,
title and interest in, to and under such rights, properties or assets of the
Surviving Corporation or otherwise to carry out this Agreement in accordance
with its terms.
ARTICLE II
CONVERSION OF SECURITIES; EXCHANGE OF CERTIFICATES
II.1 TOTAL CONSIDERATION. The number of shares of Parent Common
Stock (as defined in Section 4.2) to be issued (including Parent Common Stock to
be reserved for future issuance upon exercise of all outstanding Company Options
(as hereafter defined) and Company Warrants (as hereafter defined) assumed by
Parent) in exchange for the acquisition by Parent by virtue of the Merger of all
outstanding Company Capital Stock and all unexpired and unexercised Company
Options and Company Warrants shall be eight million (8,000,000) shares of Parent
Common Stock (the "CLOSING SHARES"), reduced as a result of any Dissenting
Shares (as hereafter defined), Interim Funding Shares (as defined in Section
6.18) and Closing Fee Shares (as defined in Section 6.14) and subject to
reduction for fractional shares, the disposition of which shall be governed by
Sections 2.2, 2.3 and 2.5. In addition, a further five million (5,000,000)
shares of Parent Common Stock (the "ADDITIONAL SHARES") shall be issued and
distributed in accordance with Section 2.7.
II.2 EFFECT ON CAPITAL STOCK; CONVERSION OF SECURITIES.
(a) CONVERSION RATIOS. At the Effective Time, by virtue of the Merger
and without any action on the part of Merger Sub or the Company or the holders
of any of the Company's Capital Stock:
(i) Each share of Series A Preferred (as defined in Section 3.2)
of the Company issued and outstanding immediately prior to the
Effective Time, other than any shares to be canceled pursuant to
Section 2.2(c) and any Dissenting Shares, shall be converted into the
right to receive such number of shares of Parent Common Stock as shall
be determined in accordance with EXHIBIT B hereto (the "SERIES A
CONVERSION RATIO").
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(ii) Each share of Series B Preferred (as defined in Section 3.2)
of the Company issued and outstanding immediately prior to the
Effective Time, other than any shares to be canceled pursuant to
Section 2.2(c) and any Dissenting Shares, shall be converted into the
right to receive such number of shares of Parent Common Stock as shall
be determined in accordance with EXHIBIT B hereto (the "SERIES B
CONVERSION RATIO").
(iii) Each share of Series C Preferred (as defined in Section
3.2) of the Company issued and outstanding immediately prior to the
Effective Time, other than any shares to be canceled pursuant to
Section 2.2(c) and any Dissenting Shares, shall be converted into the
right to receive such number of shares of Parent Common Stock as shall
be determined in accordance with EXHIBIT B hereto (the "SERIES C
CONVERSION RATIO").
(iv) Each share of Company Common Stock (as defined in Section
3.2) issued and outstanding immediately prior to the Effective Time,
other than any shares to be canceled pursuant to Section 2.2(c) and
any Dissenting Shares, shall be converted into the right to receive
such number of shares of Parent Common Stock as shall be determined in
accordance with EXHIBIT B hereto (the "COMMON STOCK CONVERSION
RATIO").
(b) ADJUSTMENT TO EXCHANGE RATIOS. Each of the Series A Conversion
Ratio, the Series B Conversion Ratio, the Series C Conversion Ratio and the
Common Stock Conversion Ratio shall be adjusted to reflect fully the effect of
any stock split, reverse split, stock dividend (including any dividend or
distribution of securities convertible or exchangeable into Parent Common Stock
or Company Capital Stock), reorganization, recapitalization or other like change
with respect to Parent Common Stock or Company Capital Stock occurring after the
date hereof and prior to the Effective Time.
(c) CANCELLATION OF COMPANY CAPITAL STOCK OWNED BY THE COMPANY. At the
Effective Time, all shares of Company Capital Stock that are owned by the
Company as treasury stock shall be canceled and extinguished without any
conversion thereof.
(d) OPTIONS. At the Effective Time, the Company Stock Plans (as
defined herein), and each outstanding option to purchase shares of Company
Capital Stock, whether granted pursuant to a Company Stock Plan or otherwise,
whether vested or unvested ("COMPANY OPTION") and each outstanding grant of
restricted shares of Company Common Stock ("RESTRICTED STOCK") (all such Company
Options and Restricted Stock being set forth on SCHEDULE 3.2 and SCHEDULE 3.31)
will be assumed by Parent, pursuant to the terms of the applicable Company Stock
Option Plan. Each such Company Option and grant of Restricted Stock so assumed
by Parent under this Agreement shall continue to have, and be subject to, the
same terms and conditions set forth in the Company Stock Plans and the
applicable stock option agreement or stock purchase agreement immediately prior
to the Effective Time (but giving effect to changes in such terms and conditions
resulting from the consummation of the Merger), except that (x) such Company
Option will be exercisable for that number of whole shares of Parent Common
Stock equal to the product of the number of shares of the Company Common Stock
underlying such assumed Company Option immediately prior to the Effective Time,
multiplied by the Common Stock Conversion Ratio and rounded down to the nearest
whole number of shares of Parent Common Stock, (y) the per share exercise price
for the shares of Parent Common Stock issuable upon exercise of such assumed
Company Option will be equal to the quotient determined by dividing the exercise
price per share of the Company Common Stock at which such Option was exercisable
immediately prior to the Effective Time by the Common Stock Conversion Ratio,
rounded up to the nearest whole cent, and (z) each share of Restricted Stock
shall be converted into shares of Parent Common Stock pursuant to Section
2.2(a)(iv). Within five (5) business days after the Effective Time, Parent will
distribute to each person who appears as a holder of a Company Option listed on
SCHEDULE 3.31 and the Record Schedule (as defined in Section 2.3(b)) a document
evidencing the assumption of such Company Option by Parent pursuant to this
Section 2.2(d). For purposes of the Agreement, "COMPANY STOCK PLANS" shall mean
the Company 1999 Stock Option/Stock Issuance Plan, Company 1999 Incentive Stock
Option Plan, and Company 2000 Stock Incentive Plan.
(e) WARRANTS. At the Effective Time, all outstanding warrants exercisable
for shares of Company Capital Stock (as set forth on SCHEDULE 3.2) ("COMPANY
WARRANTS") shall be assumed by Parent and shall be exchangeable for a new
warrant to purchase Parent Common Stock having the same terms and subject to the
same conditions set forth in the agreement providing for the terms and
conditions of the Company Warrant immediately prior to the Effective Time,
except that (i) each such Company Warrant will be exercisable for that number of
whole shares of Parent Common Stock equal to the product of the number of shares
of
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Company Common Stock that were issuable upon exercise of such Company Warrant
immediately prior to the Effective Time multiplied by the Common Stock
Conversion Ratio and rounded down to the nearest whole number of shares of
Parent Common Stock, and (ii) the per share exercise price for the shares of
Parent Common Stock issuable upon exercise of such assumed Company Warrant will
be equal to the quotient determined by dividing the exercise price per share of
Company Common Stock at which such Company Warrant was exercisable immediately
prior to the Effective Time by the Common Stock Conversion Ratio, rounded up to
the nearest whole cent. Within five (5) business days after the Effective Time,
Parent will issue to each person who, immediately prior to the Effective Time,
was a holder of an outstanding Company Warrant a document evidencing the
assumption of such Company Warrant by Parent pursuant to this Section 2.2(e).
(f) REPURCHASE RIGHTS. All rights which the Company may hold
immediately prior to the Effective Time with respect to the repurchase of any
Company Warrant or Company Capital Stock (the "REPURCHASE RIGHTS") shall be
assigned to Parent in the Merger and shall thereafter be exercisable by Parent,
with respect to the Parent Common Stock issued in exchange for such Company
Capital Stock, upon the same terms and conditions in effect immediately prior to
the Effective Time, except as shall be adjusted to reflect the Common Stock
Conversion Ratio and except as such terms and conditions may be changed as a
result of the consummation of the Merger.
(g) CAPITAL STOCK OF MERGER SUB. At the Effective Time, each share of
common stock of Merger Sub issued and outstanding immediately prior to the
Effective Time shall be converted into and exchanged for one validly issued,
fully paid and nonassessable share of common stock of the Surviving Corporation.
Each stock certificate of Merger Sub evidencing ownership of any such shares
shall continue to evidence ownership of such shares of common stock of the
Surviving Corporation.
II.3 EXCHANGE OF CERTIFICATES.
(a) EXCHANGE AGENT. Parent's transfer agent shall act as exchange
agent (the "EXCHANGE AGENT") in the Merger, at Parent's expense. Promptly after
the Effective Time, Parent shall deposit with, or cause to be deposited with,
the Exchange Agent for the benefit of the holders of shares of the Company's
Capital Stock, for exchange in accordance with this ARTICLE II through the
Exchange Agent, (i) certificates evidencing such number of shares of Parent
Common Stock issuable pursuant to Section 2.2 in exchange for shares of Company
Capital Stock outstanding immediately prior to the Effective Time less the
number of shares of Parent Common Stock to be deposited in an escrow fund (the
"ESCROW FUND") pursuant to the requirements of ARTICLE IX and (ii) cash in the
amount sufficient to permit payment of cash in lieu of fractional shares
pursuant to Section 2.3(h) (such certificates for shares of Parent Common Stock
together with any dividends or distributions with respect thereto and such cash,
being hereinafter referred to as the "EXCHANGE FUND").
(b) EXCHANGE PROCEDURES. At or prior to the Closing, the Company shall
provide to Parent a schedule of all holders of Company Capital Stock, Company
Warrants and Company Options as of the date of the Closing, containing such
information in such format as shall be reasonably requested by Parent or the
Exchange Agent (the "RECORD SCHEDULE"), and such schedule shall be certified as
complete and correct by an authorized officer of the Company. Promptly after the
Effective Time, the Surviving Corporation shall cause to be mailed to each
holder of record of a certificate or certificates (the "CERTIFICATES") which
immediately prior to the Effective Time represented outstanding shares of
Company Capital Stock, whose shares were converted into the right to receive
shares of Parent Common Stock (and cash in lieu of fractional shares) pursuant
to Section 2.2, (i) a letter of transmittal (which shall specify that delivery
shall be effected, and risk of loss and title to the Certificates shall pass,
only upon receipt of the certificates by the Exchange Agent, and shall be in
such form and have such other provisions as Parent and the Company shall agree)
and (ii) instructions for use in effecting the surrender of the Certificates in
exchange for certificates representing shares of Parent Common Stock (and cash
in lieu of fractional shares). Upon surrender of a Certificate for cancellation
to the Exchange Agent or to such other agent or agents as may be appointed by
Parent, together with such letter of transmittal, duly completed and validly
executed in accordance with the instructions thereto, the holder of such
Certificate shall be entitled to receive in exchange therefor (x) a certificate
representing the number of whole shares of Parent Common Stock to which that
holder is entitled pursuant to Section 2.2, less the number of shares of Parent
Common Stock to be deposited in the Escrow Fund on such holder's behalf pursuant
to Article IX hereof, and (y) payment in lieu of fractional shares which such
holder has the right to receive pursuant to Section 2.3(h), and (z) any payments
to which such holder may be entitled pursuant to Section 2.3(c), and the
Certificate so surrendered shall forthwith be canceled. Until so
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surrendered, each outstanding Certificate that, prior to the Effective Time,
represented shares of Company Capital Stock will be deemed from and after the
Effective Time, for all corporate purposes, other than the payment of dividends
(which shall be governed by Section 2.3(c)), to evidence the ownership of the
number of full shares of Parent Common Stock into which such shares of Company
Capital Stock shall have been so converted and the right to receive an amount in
cash in lieu of the issuance of any fractional shares in accordance with Section
2.3(h). As soon as practicable after the Effective Time, and subject to and in
accordance with the provisions of Article IX hereof, Parent shall cause to be
deposited with the Escrow Agent (as defined in Section 9.1 hereto) a certificate
or certificates representing 800,000 shares (which number shall be adjusted in
the same manner as provided for in Section 2.2(b)) of Parent Common Stock
issuable in the Merger pursuant to Section 2.2 (the "ESCROW SHARES") which shall
be registered in the name of the Escrow Agent as nominee for the holders of
Certificates canceled pursuant to this Section 2.3(b). The Escrow Shares shall
be vested shares not subject to any repurchase rights, shall be beneficially
owned by such holders and shall be held in escrow and shall be available to
compensate Parent for certain damages as provided in Article IX. To the extent
not used for such purposes, such shares shall be released, all as provided in
Article IX hereof.
(c) DISTRIBUTIONS WITH RESPECT TO UNEXCHANGED SHARES OF PARENT COMMON
STOCK. No dividends or other distributions declared or made with respect to
Parent Common Stock with a record date on or after the Effective Time shall be
paid to the holder of any unsurrendered Certificate with respect to the shares
of Parent Common Stock represented thereby, and no other part of the merger
consideration shall be paid to any such holder, until the holder of such
Certificate shall surrender such Certificate. Subject to applicable law,
following surrender of any such Certificate, there shall be paid promptly to the
holder, whole shares of Parent Common Stock issued in exchange therefor, the
amount of any cash payable with respect to a fractional share of Parent Common
Stock to which such holder is entitled pursuant to Section 2.3(h) and the amount
of dividends or other distributions with a record date on or after the Effective
Time theretofore paid with respect to such whole shares of Parent Common Stock,
and at the appropriate payment date, the amount of dividends or other
distributions, with a record date after the Effective Time but prior to
surrender and a payment date occurring after surrender, payable with respect to
such whole shares of Parent Common Stock. No interest shall be paid on the
merger consideration.
(d) TRANSFERS OF OWNERSHIP. If any certificate for shares of Parent
Common Stock is to be issued in a name other than that in which the Certificate
surrendered in exchange therefor is registered, it will be a condition of the
issuance thereof that the Certificate so surrendered will be properly endorsed
and otherwise in proper form for transfer and that the person requesting such
exchange will have paid to Parent or any agent designated by it any transfer or
other taxes required by reason of the issuance of a certificate for shares of
Parent Common Stock in any name other than that of the registered holder of the
Certificate surrendered, or will have established to the reasonable satisfaction
of Parent or any agent designated by it that such tax has been paid or is not
payable.
(e) NO LIABILITY. None of the Exchange Agent, Parent, Merger Sub or
the Surviving Corporation shall be liable to any holder of shares of Company
Capital Stock for any such shares of Parent Common Stock (or dividends or
distributions with respect thereto) or cash delivered to a public official
pursuant to any applicable abandoned property, escheat or similar law.
(f) DISSENTING SHARES. The provisions of this Section 2.3 shall also
apply to Dissenting Shares that lose their status as such, except that the
obligations of Parent under this Section 2.3 shall commence on the date of loss
of such status and the holder of such shares shall be entitled to receive in
exchange for such shares the number of shares of Parent Common Stock to which
such holder is entitled pursuant to Section 2.2 hereof and the amount of cash,
if any, to which such holder is entitled pursuant to Sections 2.3(c) and 2.3(h)
hereof.
(g) NO FURTHER OWNERSHIP RIGHTS IN THE COMPANY CAPITAL STOCK. All
shares of Parent Common Stock issued upon the surrender for exchange of shares
of Company Capital Stock in accordance with the terms hereof (including any cash
paid in lieu of fractional shares) and pursuant to the rights granted in Section
2.7, shall be deemed to have been issued in full satisfaction of all rights
pertaining to such shares of Company Capital Stock, and following the Effective
Time there shall be no further registration of transfers on the records of the
Surviving Corporation of shares of Company Capital Stock which were outstanding
immediately prior to the Effective Time. If, after the Effective Time,
Certificates are presented to the Surviving Corporation for any reason, they
shall be canceled and exchanged as provided in this Article II.
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(h) NO FRACTIONAL SHARES. No certificates or scrip evidencing a
fraction of a share of Parent Common Stock shall be issued upon the surrender
for exchange of Certificates, and such fractional share interests will not
entitle the owner thereof to vote or to any rights of a stockholder of Parent.
In lieu of any fractional shares remaining after aggregating all such fractional
shares of a holder, each holder of Company Capital Stock upon surrender of a
Certificate for exchange pursuant to this Section 2.3 shall be paid an amount in
cash (without interest), rounded up to the nearest whole cent, equal to the
product of (i) such fraction, multiplied by (ii) the closing price of one share
of Parent Common Stock on the Nasdaq National Market on the third business day
prior to the Closing Date.
(i) LOST, STOLEN OR DESTROYED CERTIFICATES. In the event any
Certificates shall have been lost, stolen or destroyed, the Exchange Agent shall
issue and pay, as appropriate, in exchange for such lost, stolen or destroyed
Certificates, upon the making of an affidavit of that fact by the holder
thereof, such shares of Parent Common Stock and cash in lieu of fractional
shares as may be required pursuant to Sections 2.2, 2.3(c) and 2.3(h); PROVIDED,
HOWEVER, that Parent may, in its discretion and as a condition precedent to the
issuance thereof, require the owner of such lost, stolen or destroyed
Certificates to deliver a bond in such sum as it may reasonably direct as
indemnity against any claim that may be made against Parent, the Surviving
Corporation or the Exchange Agent with respect to the Certificates alleged to
have been lost, stolen or destroyed.
(j) TERMINATION OF EXCHANGE FUND. Any portion of the Exchange Fund
which remains undistributed to the holders of Company Capital Stock twelve (12)
months after the deposit thereof by Parent with the Exchange Agent shall be
delivered to Parent, upon demand, and any holders of Company Capital Stock who
have not theretofore complied with this ARTICLE II shall thereafter look only to
Parent for the Merger Consideration to which they are entitled.
(k) WITHHOLDING RIGHTS. Parent shall be entitled to deduct and
withhold from the consideration otherwise payable pursuant to this Agreement to
any holder of shares of Company Capital Stock such amounts as Parent is required
to deduct and withhold with respect to the making of such payment under the
Code, or any provision of state, local or foreign tax law. To the extent that
amounts are so withheld by Parent, such withheld amounts shall be treated for
all purposes of this Agreement as having been paid to the holder of the shares
of Company Capital Stock in respect of which such deduction and withholding was
made by Parent.
II.4 FORM S-4. Parent and the Company shall cooperate in preparing and
filing with the SEC, as soon as is reasonably practicable after the date hereof,
a registration statement on Form S-4 (the "S-4") and they shall cooperate using
commercially reasonable efforts to have the S-4 declared effective by the SEC
promptly thereafter. The S-4 shall include a disclosure document for the offer
and issuance of the shares of Parent Common Stock issued in respect of the
Merger (including the Earn-Out Shares, as defined below) and for the
stockholders of the Company to approve the Merger (the "PROSPECTUS AND PROXY
STATEMENT") and shall be prepared in accordance with this Section 2.4 and
Section 6.1. Parent and the Company shall use their respective best efforts to
cause the S-4 to comply with applicable federal and state securities laws
requirements. Each of Parent and the Company shall provide promptly to the other
such information concerning its business and financial statements and affairs
as, in the reasonable judgment of the providing party, may be required or
appropriate for inclusion in the S-4, or in any amendments or supplements
thereto, and cause its counsel and auditors to cooperate with the other's
counsel and auditors in the preparation of the S-4. The Company will promptly
advise Parent, and Parent will promptly advise the Company, in writing if at any
time prior to the Effective Time either Target or the Company shall obtain
knowledge of any facts that might make it necessary or appropriate to amend or
supplement the S-4 in order to make statements contained or incorporated by
reference therein not misleading or to comply with applicable law. The Company
shall cause Brobeck, Phleger & Harrison LLP to deliver an opinion supporting the
disclosure of the tax matters and tax consequences to the stockholders of the
Company as set forth in the S-4. Parent and the Company shall furnish each other
with all information concerning themselves, their subsidiaries, directors,
officers and stockholders and such other matters as may be necessary or
advisable (as determined by the providing party's counsel) for the S-4, the
proxy or information statement which forms a part thereof, filings under the
Blue Sky laws of any pertinent states, and any other statement or application
made by or on behalf of Parent or the Company with respect to such filings.
II.5 DISSENTERS' RIGHTS. Notwithstanding any other provisions of this
Agreement to the contrary, shares of Company Capital Stock that are outstanding
immediately prior to the Effective Time and which are held by stockholders who
shall have not
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voted in favor of the Merger or consented thereto in writing and who shall have
demanded properly in writing appraisal for such shares in accordance with
Section 262 of the Delaware Law (collectively, the "DISSENTING SHARES") shall
not be converted into or represent the right to receive the merger consideration
otherwise applicable to such shares pursuant to Sections 2.2(a), 2.3(b) and 2.7.
Such stockholders shall be entitled to receive payment of the appraised value of
such shares of Company Capital Stock held by them in accordance with the
provisions of such Section 262, except that all Dissenting Shares held by
stockholders who shall have failed to perfect or who effectively shall have
withdrawn or lost their rights to appraisal of such shares of Company Capital
Stock under such Section 262 shall thereupon be deemed to have been converted
into and to have become exchangeable, as of the Effective Time, for the right to
receive, without any interest thereon, the merger consideration applicable to
such shares pursuant to Sections 2.2(a) and 2.3(b), upon surrender, in the
manner provided in Section 2.3, of the certificate or certificates that formerly
evidenced such shares of Company Capital Stock, and the right to receive
Earn-Out Shares pursuant to Section 2.7.
II.6 ALTERNATE TRANSACTION STRUCTURES. Parent may at any time
change the method of effecting the Merger, including by merging the Company with
and into Parent or by merging the Company with and into a direct or indirect
wholly owned subsidiary of Parent, and the Company shall cooperate in such
efforts, including by entering into an appropriate amendment to this Agreement;
PROVIDED, HOWEVER, that such actions shall not (a) alter or change the amount or
kind of consideration to be issued to holders of Company Capital Stock as
provided for in this Agreement, (b) adversely affect the tax treatment to the
Company's stockholders as a result of receiving Parent Common Stock pursuant to
Section 2.2, (c) materially delay the consummation of the transactions
contemplated by this Agreement or (d) otherwise materially adversely affect the
stockholders of the Company.
II.7 RIGHTS TO RECEIVE ADDITIONAL SHARES OF PARENT COMMON STOCK.
(a) ADDITIONAL SHARES. At the Effective Time, Parent shall issue the
Additional Shares and shall, as soon as practicable, deliver a certificate or
certificates in respect of such shares to the Escrow Agent to be held in a
separate and distinct fund (the "EARN-OUT FUND"). The Additional Shares shall be
held in the Earn-Out Fund until distributed in accordance with this Section 2.7.
(b) CALCULATION OF EARN-OUT SHARES. For the Surviving Corporation's
fiscal year 2001, Parent shall, no later than 15 days following the availability
of audited financial statements for such period, prepare and deliver to the
Stockholders' Agent (pursuant to Section 2.7(e)) a report (the "REPORT")
containing a calculation, in accordance with EXHIBIT C hereto and giving
reasonable detail, of the Earn-Out Share Number (as defined in EXHIBIT C
hereto), together with a copy of the financial statements from which such
calculation is derived. As set forth in EXHIBIT C, the Earn-Out Share Number
shall be determined based on the Surviving Corporation's (i) fiscal Year 2001
Revenues, and (ii) its fiscal Year 2001 EBITDA, PROVIDED that (as set forth in
EXHIBIT C) if the Surviving Corporation fails to meet the minimum threshold for
either Year 2001 Revenues or Year 2001 EBITDA then the Earn-Out Share Number
shall be zero (0). Within 30 days after its receipt of the Report, the
Stockholder's Agent shall notify Parent in writing whether it disputes the
accuracy of the calculation in the Report, setting forth in reasonable detail
the reason for such dispute. If the Stockholders' Agent does not so notify
Parent, then he shall be deemed to have accepted the Report on behalf of all of
the former holders of Company Capital Stock, and the Earn-Out Share Number
calculation shall be deemed to be final and binding for purposes of this
Agreement. The parties shall use their best efforts to resolve any disagreement
within 30 days after the Stockholders' Agent has notified Parent of its dispute
of the Earn-Out Share Number calculation. If the parties fail to resolve their
dispute following such efforts, the dispute shall be resolved in accordance with
Section 9.7(b) and (c), below.
(c) DISTRIBUTION PROCEDURES. On the date (the "EARN-OUT DISTRIBUTION
DATE") seven days after the date that the Report and the Earn-Out Share Number
calculation become final and binding, the Escrow Agent shall distribute in the
manner provided in Section 2.7(d) below, a number of Additional Shares (the
"EARN-OUT SHARES") equal to: (i) the Earn-Out Share Number, LESS (ii) the
Earn-Out Transaction Fee Shares (as defined in Section 6.14), LESS (iii) any
fractional shares, PLUS (iv) any Recovered Shares (as defined in Section
2.7(f)); PROVIDED that, if there is any pending claim against the Escrow Fund
pursuant to Section 9.5 at the Earn Out Distribution Date, a number of Earn-Out
Shares of adequate value (in combination with any amount remaining in the Escrow
Fund, and as calculated pursuant to Section 9.5(b)) to satisfy all such pending
claims, to a maximum of ten percent (10%) of the Earn-Out Shares, shall be
deposited into the Escrow Fund with the Escrow Agent and made available for the
satisfaction of any such claim until all such claims are finally satisfied or
resolved, and PROVIDED FURTHER that such Earn-Out Shares shall be deemed to
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have been part of the Escrow Fund from the Effective Time. The Additional Shares
remaining after the subtraction of the Earn-Out Shares shall be transferred to
Parent. Any fractional shares shall be dealt with in accordance with Section
2.3(h), except that the price of Parent Common Stock pertinent to that section
shall be determined as of the third business day preceding the Earn-Out
Distribution Date.
(d) DISTRIBUTION OF EARN-OUT SHARES.
(i) At the Effective Time, each share of Company Capital Stock held
immediately prior to the Effective Time shall represent the right to receive
from the Earn-Out Fund (at the Earn-Out Distribution Date, and subject to
reduction for fractional shares and deposit in the Escrow Fund in accordance
with Section 2.7(c)) a number of Earn-Out Shares calculated in accordance with
Section B of EXHIBIT C hereto.
(ii) At the Effective Time, each Company Option shall represent the
right to receive upon the later of (x) the Earn-Out Distribution Date and (y)
the date of exercise of the Option, a number of Earn-Out Shares determined
according to Section C of EXHIBIT C hereto. After the Earn-Out Distribution
Date, if the Option has not yet been exercised, such shares shall be transferred
from the Earn-Out Fund to Parent.
(iii) At the Effective Time, each Company Warrant shall represent the
right to receive upon the later of (x) the Earn-Out Distribution Date and (y)
the date of exercise of the Warrant, a number of Earn-Out Shares determined
according to Section D of EXHIBIT C hereto. After the Earn-Out Distribution
Date, if the Warrant has not yet been exercised, such shares shall be
transferred from the Earn-Out Fund to Parent.
(iv) The rights created hereby to receive any number of the Additional
Shares (if any) are not assignable, and any purported assignment of any such
right is void.
(e) STOCKHOLDER'S AGENT. The Stockholders' Agent (as defined in
Section 9.8) shall be the same Stockholders' Agent as appointed pursuant to
Article IX of this Agreement, and shall be constituted and appointed as agent
for and on behalf of the Company stockholders, option holders and warrant
holders to give and receive notices and communications, to agree to, negotiate,
enter into settlements and compromises of, and demand arbitration and comply
with orders of courts and awards of arbitrators with respect to, the Earn-Out
Shares, and to take all actions necessary or appropriate in the judgment of the
Stockholders' Agent for the accomplishment of the foregoing. Such agency may be
changed by holders of a majority of the shares of Parent Common Stock received
pursuant to Section 2.2 of this Agreement, from time to time upon not less than
ten (10) days' prior written notice to Parent. No bond shall be required of the
Stockholders' Agent, and the Stockholders' Agent shall receive no compensation
for services rendered. Notices or communications to or from the Stockholders'
Agent shall constitute notice to or from each of the Company stockholders. The
Stockholders' Agent shall not be liable for any act done or omitted hereunder as
Stockholders' Agent except to the extent it has acted with gross negligence or
willful misconduct, and any act done or omitted pursuant to the advice of
counsel shall be conclusive evidence that it did not act with gross negligence
or willful misconduct. The Company stockholders shall severally indemnify the
Stockholders' Agent and hold him harmless against any loss, liability or expense
incurred without gross negligence or bad faith on the part of the Stockholders'
Agent and arising out of or in connection with the acceptance or administration
of the duties hereunder. The Stockholders' Agent shall be a third party
beneficiary of the terms of this Section 2.7(e).
(f) RECOVERED SHARES. Prior to the Earn-Out Distribution Date, the
Chief Financial Officer of Parent shall certify to the Escrow Agent the number
of shares of Parent Common Stock underlying all Company Options assumed at the
Effective Time by Parent, which Company Options are unvested and have, since the
Effective Time, become incapable of exercise due to their holder leaving the
employ of the Surviving Corporation after the Effective Time ("THE RECOVERED
SHARES"). This number of Additional Shares shall be added to the Earn-Out Shares
pursuant to Section 2.7(c), and, if there are not sufficient Additional Shares
to satisfy this requirement, Parent shall transfer such shares to the Earn-Out
Fund prior to on or the Earn-Out Distribution Date.
ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY
In this Agreement, any reference to any event, change, condition or
effect being "MATERIAL" with respect to any entity or group of entities means
any material event, change, condition or effect related to the condition
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(financial or otherwise), properties, assets (including intangible assets),
liabilities, business, prospects, operations or results of operations of such
entity or group of entities. In this Agreement, any reference to a "MATERIAL
ADVERSE EFFECT" with respect to any entity or group of entities means any event,
change or effect that is materially adverse to the condition (financial or
otherwise), properties, assets, liabilities, business, prospects, operations or
results of operations of such entity and its subsidiaries, taken as a whole.
In this Agreement, any reference to a party's "knowledge" means actual
knowledge of such party's officers and directors, PROVIDED that such persons
shall have made reasonable inquiry of those employees of such party and its
subsidiaries whom such officers and directors reasonably believe would have
actual knowledge of the matters represented.
The Company represents and warrants to each of Parent and Merger Sub
as follows:
III.1 ORGANIZATION, STANDING AND POWER; SUBSIDIARIES. The Company and
each of its subsidiaries is a corporation duly organized, validly existing and
in good standing under the laws of its jurisdiction of organization. SCHEDULE
3.1 contains a list of each direct or indirect subsidiary of the Company, the
jurisdiction of organization of such subsidiary and such subsidiary's authorized
and issued capital stock or other ownership interests. The Company and each of
its subsidiaries has the corporate power to own its properties and to carry on
its business as now being conducted and as currently proposed to be conducted
and is duly qualified to do business and is in good standing in each
jurisdiction in which the failure to be so qualified and in good standing would
have a Material Adverse Effect on the Company. The Company has delivered or made
available to Parent a true and correct copy of the Certificate or Articles of
Incorporation and By-laws or equivalent organizational documents, as applicable,
of the Company and each of its subsidiaries, each as amended to date. The
Company is the owner of all outstanding shares of capital stock or other
ownership interests of each of its subsidiaries and all such shares and other
ownership interests are duly authorized, validly issued, fully paid and
nonassessable. All of the outstanding shares of capital stock or other ownership
interests of each subsidiary are owned by the Company free and clear of all
liens, charges, claims, security interests or encumbrances or rights of others.
There are no outstanding subscriptions, options, warrants, puts, calls, rights,
exchangeable or convertible securities or other commitments or agreements of any
character relating to the issued or unissued capital stock or other ownership
interests of any such subsidiary, or otherwise obligating the Company or any
such subsidiary to issue, transfer, sell, purchase or redeem or otherwise
acquire any such securities. The Company does not directly or indirectly own any
equity or similar interest in, or any interest convertible or exchangeable or
exercisable for, any equity or similar interest in, any corporation,
partnership, joint venture or other business association or entity.
III.2 CAPITAL STRUCTURE.
(a) The authorized capital stock of the Company consists of (i)
22,689,584 shares of Preferred Stock, par value $0.01 per share (the "COMPANY
PREFERRED STOCK") consisting of 12,346,941 shares of Series A Preferred Stock
(the "SERIES A PREFERRED"), 8,177,040 shares of Series B Preferred Stock (the
"SERIES B PREFERRED"), 2,165,603 shares of Series C Preferred Stock (the "SERIES
C PREFERRED"), and (ii) 60,000,000 shares of Common Stock, par value $0.01 per
share (the "COMPANY COMMON STOCK"). Except for shares of Company Common Stock
issued upon the exercise of Company Options or Company Warrants, there are
issued and outstanding 12,345,003 shares of Series A Preferred that are
convertible into 12,345,003 shares of Company Common Stock, 8,177,040 shares of
Series B Preferred that are convertible into 8,177,040 shares of Company Common
Stock, 2,165,603 shares of Series C Preferred that are convertible into
2,165,603 shares of Company Common Stock, and 13,173,525 shares of Company
Common Stock.
(b) Except as set forth on SCHEDULE 3.2, there are no other authorized
or outstanding shares of Company Capital Stock or voting securities and no
outstanding commitments to issue any shares of capital stock or voting
securities of Company other than (i) pursuant to the exercise of Company
Warrants listed on SCHEDULE 3.2, which are exercisable for the number of shares
of Company Capital Stock at the exercise prices set forth on SCHEDULE 3.2, and
(ii) pursuant to the exercise of Company Options outstanding under the Company
Stock Option Plans (as defined in Section 2.2(d)) and listed on SCHEDULE 3.31.
SCHEDULE 3.2 lists the name, address and stock and warrant holdings of each
record holder of Company Capital Stock and Company Warrants.
(c) Except as set forth on SCHEDULE 3.2, all outstanding shares of
Company Capital Stock are duly authorized, validly issued, fully paid and
non-assessable and are free of any liens, charges, claims, security interests or
encumbrances, other than liens, charges, claims, security interests and
encumbrances created by or
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imposed upon the holders thereof, and are not subject to preemptive rights or
rights of first refusal created by statute, the Certificate of Incorporation or
By-laws of the Company or any agreement to which Company is a party or by which
it is bound. The Company has reserved 22,687,646 shares of Company Common Stock
for issuance upon conversion of the shares of Company Preferred Stock. The
Company has reserved 360,000 shares of Company Common Stock for issuance to
holders of Company Warrants, of which no shares have been issued pursuant to
warrant exercises, and 360,000 shares are subject to outstanding, unexercised
Company Warrants (43,340 of which would be subject to repurchase rights of the
Company if exercised at the date hereof). The Company has reserved 11,815,815
shares of Company Common stock for issuance to holders of options pursuant to
the Company Stock Option Plan, of which 3,443,875 shares have been issued
pursuant to option exercises (of which 2,248,792 shares are subject to
repurchase rights of the Company) and 5,220,640 shares are subject to
outstanding, unexercised Company Options.
(d) Except for (i) the rights created pursuant to this Agreement, and
(ii) as described on SCHEDULE 3.2 and SCHEDULE 3.31, there are no options,
warrants, calls, rights, commitments or agreements of any character 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 capital stock of the Company or
obligating the Company to grant, extend, accelerate the vesting of, change the
price of, or otherwise amend or enter into any such option, warrant, call,
right, commitment or agreement. Except as stated on SCHEDULE 3.2 there are no
other contracts, commitments or agreements relating to voting, purchase or sale
of Company Capital Stock (i) between or among the Company and any of its
stockholders and (ii) to the Company's knowledge, between or among any of the
Company's stockholders. The terms of the Company Warrants and the Company Stock
Option Plan permit the assumption or substitution of warrants or options, as the
case may be, to purchase Parent Common Stock as provided in this Agreement,
without the consent or approval of the holders of such securities, the Company
stockholders, or otherwise. True and complete copies of all agreements and
instruments to which the Company is a party relating to the Company Warrants and
the Company Stock Plans, the Company Options and Restricted Stock issued
thereunder have been delivered to Parent, and such agreements and instruments as
so delivered have not been amended, modified or supplemented, and there are no
agreements to amend, modify or supplement such agreements or instruments in any
case from the forms made available to Parent. All outstanding shares of Company
Capital Stock and all Company Warrants and Company Options were issued in
compliance with all applicable securities laws.
III.3 AUTHORITY. The Company has all requisite corporate power and
authority to enter into this Agreement and to consummate the transactions
contemplated hereby. The execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby have been duly authorized
by all necessary corporate action on the part of the Company, subject only to
the approval of the Merger by the Company's stockholders as contemplated by
Sections 3.22, 7.1(a) and 7.3(a). This Agreement has been duly executed and
delivered by the Company and constitutes the valid and binding obligation of the
Company enforceable against the Company in accordance with its terms. Except for
(i) limitations by applicable bankruptcy, insolvency, reorganization, moratorium
and other laws of general application affecting enforcement of creditors' rights
generally, (ii) limitations relating to the availability of specific
performance, injunctive relief or other equitable remedies and (iii)
indemnification provisions contained herein that may be limited by applicable
federal or state securities laws, the execution and delivery of this Agreement
by the Company does 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 or acceleration of any obligation or loss of any
benefit under (i) any provision of the Certificate of Incorporation or By-laws
of the Company, as amended, (ii) any Material Contract (as defined in Section
3.26), or (iii) any lease, license or other agreement or instrument, or any
permit, concession, franchise, judgment, order, decree, statute, law, ordinance,
rule or regulation applicable to the Company or any of its properties or assets,
except, as to clauses (ii) and (iii) only, where such conflicts, violations,
defaults, terminations, cancellations, accelerations or losses would not,
individually or in the aggregate, cause a Material Adverse Effect on the
Company. Except as set forth on SCHEDULE 3.3, no consent, approval, order or
authorization of, or registration, declaration or filing with, any court,
administrative agency or commission or other governmental authority or
instrumentality (each, a "GOVERNMENTAL ENTITY") is required by or with respect
to the Company in connection with the execution and delivery of this Agreement
by the Company or the consummation by the Company of the transactions
contemplated hereby, except for (i) the filing of the Certificate of Merger as
provided in Section 1.2; (ii) such consents, approvals, orders, authorizations,
registrations, declarations and filings as may be required under
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the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
ACT") and applicable federal and state securities laws and the securities laws
of any foreign country; and (iii) such other consents, authorizations, filings,
approvals and registrations which, if not obtained or made by the Company, would
not have a Material Adverse Effect on the Company or its subsidiaries and would
not prevent, materially alter or delay any of the transactions contemplated by
this Agreement.
III.4 FINANCIAL STATEMENTS. The Company has delivered to Parent its
audited financial statements (balance sheet, statement of operations and
statement of cash flows) on a consolidated basis for the fiscal years ended
December 31, 1998 and 1999, and its unaudited financial statements (balance
sheet, statement of operations and statement of cash flows) as at, and for the
three-month period ended, March 31, 2000 (collectively, and together with the
notes thereto, the "FINANCIAL STATEMENTS"). The Financial Statements have been
prepared from the books and records of accounts of the Company and its
subsidiaries and in accordance with United States Generally Accepted Accounting
Principles ("U.S. GAAP") (except that the unaudited financial statements do not
have notes thereto and are subject to normal year-end audit adjustments) applied
on a consistent basis throughout the periods indicated and with each other.
Except as may be set forth in the notes to the Financial Statements or on
SCHEDULE 3.4, the Financial Statements fairly present in all material respects
the consolidated financial condition and operating results of the Company and
its subsidiaries as of the dates, and for the periods, indicated therein,
subject in the case of the unaudited financial statements to normal year-end
audit adjustments. The Company and its subsidiaries maintain and will continue
to maintain an adequate system of internal controls established and administered
in accordance with generally accepted accounting principles.
III.5 ABSENCE OF CERTAIN CHANGES. (a) Since March 31, 2000 (the
"COMPANY BALANCE SHEET DATE"), the Company and its subsidiaries have conducted
their business in the ordinary course consistent with past practice and, except
as expressly contemplated by this Agreement or as set forth in SCHEDULE 3.5,
there has not occurred:
(i) as of the date hereof, any change, event or condition
(whether or not covered by insurance) that has resulted in, or would
reasonably be expected to result in, a Material Adverse Effect to the
Company;
(ii) any acquisition, sale or transfer of any material asset of
the Company or its subsid
(iii) any change in accounting methods or practices by the
Company or any revaluation by the Company of any of its, or its
subsidiaries' assets;
(iv) any issuance or sale by the Company of any shares of its
capital stock (or any option or right to acquire same, other than
Company Options listed on SCHEDULE 3.31 or stock issued upon the
exercise of Company Options) or of any other equity securities
(including, without limitation, any warrants, options or other rights
to acquire its capital stock or other equity securities) or any
declaration, setting aside, or payment of a dividend or other
distribution with respect to the shares of the Company, or any direct
or indirect redemption, purchase or other acquisition by the Company
of any of its shares of capital stock (other than the repurchase of
unvested shares of Company Common Stock issued under the Company Stock
Option Plan);
(v) except as disclosed in SCHEDULE 3.26, any Material Contract
entered into by the Company or any of its subsidiaries,
or any material amendment or termination of, or default by any of
them, or, to the Company's knowledge, any other party thereto, under
any Material Contract to which the Company is a party or by which it
is bound;
(vi) any amendment or change to the Certificate of Incorporation
or By-laws of the Company or any of its subsidiaries;
(vii) any (x) increase in or modification of the compensation or
benefits payable or to become payable by the Company or any of its
subsidiaries to any current or former directors or employees in excess
of $10,000 individually or $100,000 in the aggregate, (y) grant of
severance or termination pay to any current or former director or
employee of the Company or any of its subsidiaries or (z)
establishment, adoption, entrance into, amendment or termination of
any Company Plan;
(viii) any issuance of notes, bonds or other debt securities;
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(ix) any borrowing of any amount or the incurrence of any
liabilities, except current liabilities incurred in the ordinary
course of business and liabilities under contracts entered into in the
ordinary course of business;
(x) any discharge or satisfaction of any mortgage, pledge,
security interest, encumbrance, lien or charge of any kind (including,
without limitation, any conditional sale or other title retention
agreement or lease in the nature thereof), any sale of receivables
with recourse against the Company or any of its Affiliates, any filing
or agreement to file a financing statement as debtor under the Uniform
Commercial Code or any similar statute other than to reflect ownership
by a third party of property leased to the Company or any of its
subsidiaries under a lease which is not in the nature of a conditional
sale or title retention agreement, or any subordination arrangement in
favor of another Person (collectively, a "LIEN") or paid any
obligation or liability, other than current liabilities paid in the
ordinary course of business;
(xi) any mortgage or pledge of any of its, or its subsidiaries',
properties or assets or the incurrence of any Lien, except Liens for
current property taxes not yet due and payable;
(xii) any sale, assignment or transfer of any of its, or its
subsidiaries', tangible assets, except in the ordinary course of
business, or cancellation of any debts or claims;
(xiii) any sale, assignment, transfer, license or other
disposition, in whole or in part, of its, or its subsidiaries',
Intellectual Property except nonmaterial ones in the ordinary course
of business;
(xiv) any extraordinary losses or any waiver of any material
rights of value, whether or not in the ordinary course of business or
consistent with past practice;
(xv) any capital expenditures or commitments therefor by the
Company or its subsidiaries that aggregate in excess of $500,000,
which have not been paid for in cash;
(xvi) any loans or advances to, guarantees for the benefit of,
any direct or indirect investments in, or any capital contributions by
the Company or its subsidiaries to any persons in excess of $10,000 in
the aggregate, except for loans or advances to officers or employees
listed in SCHEDULE 3.16;
(xvii) any charitable contributions or pledges;
(xviii) any damage, destruction or casualty loss exceeding in the
aggregate $50,000 and not covered by insurance;
(xix) any direct or indirect investment in or taken steps to
incorporate any subsidiary;
(xxi) any agreement to do any of the things described in the
preceding clauses (i) through (xix) other than negotiations with
Parent and its representatives regarding the transactions contemplated
by this Agreement;
(xxii) delay or other change in the manner of payment of accounts
payable or other liabilities; or
(xxiii) any other transaction other than in the ordinary course
of business or entered into any other material transaction, whether or
not in the ordinary course of business.
(b) The Company has not at any time made any payments for political
contributions or made any bribes, kickback payments or other illegal payments.
III.6 ABSENCE OF UNDISCLOSED LIABILITIES. Except as set forth in
SCHEDULE 3.6, the Company has no material obligations or liabilities of any
nature (matured or unmatured, fixed or contingent) other than (i) those set
forth or adequately provided for in the Consolidated Balance Sheet dated as of
March 31, 2000 (the "COMPANY BALANCE SHEET") included in the Financial
Statements, (ii) those incurred in the ordinary course of business and not
required to be set forth in the Company Balance Sheet under U.S. GAAP, (iii)
those incurred in the ordinary course of business since the Company Balance
Sheet Date and consistent with past practice, and (iv) those incurred in
connection with the execution and performance of this Agreement.
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III.7 LITIGATION. Except as set forth in SCHEDULE 3.7, there is no
private or governmental action, suit, proceeding, claim, arbitration or
investigation (each an "ACTION") pending or, to the knowledge of the Company,
threatened before any agency, court or tribunal, foreign or domestic, against
the Company or any of its subsidiaries or any of their respective properties or
any of their respective officers or directors (in their capacities as such) or
any Company Plan (as defined in Section 3.14(a) hereof) or any fiduciary
thereof, that could prevent, enjoin, or materially alter or delay any of the
transactions contemplated by this Agreement, or that could reasonably be
expected to have a Material Adverse Effect on the Company or any of its
subsidiaries. Except as set forth in SCHEDULE 3.7, there is no judicial,
administrative or governmental order (each, an "ORDER") against the Company, or,
to the knowledge of the Company or any of its subsidiaries, any of their
respective directors or officers (in their capacities as such), that could
prevent, enjoin, or materially alter or delay any of the transactions
contemplated by this Agreement, or that could reasonably be expected to have a
Material Adverse Effect on the Company or any of its subsidiaries. SCHEDULE 3.7
also lists all litigation that the Company or any of its subsidiaries has
pending against other parties.
III.8 RESTRICTIONS ON BUSINESS ACTIVITIES. Except as set forth on
SCHEDULE 3.8, there is no agreement, judgment, injunction, order or decree
binding upon the Company or any of or its subsidiaries which has or could
reasonably be expected to have the effect of prohibiting or impairing any
current or future business practice of the Company any of or its subsidiaries,
any acquisition of property by the Company or any of its subsidiaries or the
conduct of business by the Company or any of its subsidiaries as currently
conducted or as proposed to be conducted by any of them.
III.9 GOVERNMENTAL AUTHORIZATION. Except as set forth in Schedule 3.9,
the Company and each of its subsidiaries has obtained each federal, state,
county, local or foreign governmental consent, license, permit, grant, or other
authorization of a Governmental Entity (i) pursuant to which the Company or any
of its subsidiaries currently operates or holds any interest in any of its
properties or (ii) that is required for the operation of the Company's or any of
its subsidiaries' business or the holding of any such interest in their
properties (the items referenced in clauses (i) and (ii) herein collectively
referred to as "COMPANY AUTHORIZATIONS"), and all of such Company Authorizations
are in full force and effect, except where the failure to obtain or have any
such authorizations could not reasonably be expected to have a Material Adverse
Effect on the Company.
III.10 TITLE TO PROPERTY. Except as set forth in Schedule 3.10, the
Company and each of its subsidiaries has good and marketable title to (or, with
respect to leased properties and assets, to its knowledge, valid leasehold
interests in) all of its owned properties, interests in properties and assets,
real and personal, reflected in the Company Balance Sheet or acquired after the
Company Balance Sheet Date (except properties, interests in properties and
assets sold or otherwise disposed of since the Company Balance Sheet Date in the
ordinary course of business), free and clear of all mortgages, liens, pledges,
charges or encumbrances of any kind or character, except (i) as reflected in the
Financial Statements, (ii) the lien of current taxes not yet due and payable,
and (iii) such imperfections of title, liens and easements as do not and will
not materially detract from or interfere with the use of the properties subject
thereto or affected thereby, or otherwise materially impair business operations
involving such properties. All material plants, property and equipment of the
Company and each of its subsidiaries that are used in the operations of its
business are in good operating condition and repair subject to normal wear and
tear. All properties used in the operations of the Company and its subsidiaries
are reflected in the Company Balance Sheet to the extent U.S. GAAP require them
to be so reflected. SCHEDULE 3.10 also identifies each parcel of real property
owned or leased by the Company or any of its subsidiaries.
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III.11 INTELLECTUAL PROPERTY.
(a) To the Company's knowledge, the Company or its subsidiaries own,
license or have other enforceable contractual rights to use all intellectual
property, including without limitation, patents, trademarks, trade names,
service marks, domain names, trade dress, copyrights, copyrightable works, mask
works, hardware, discoveries, databases, systems, networks, documentation,
drawings, research and development, schematics, technology, know-how, trade
secrets, inventions, ideas, algorithms, processes, computer software programs or
applications (in source code and/or object code form), and proprietary
information or material ("INTELLECTUAL PROPERTY") that are used in the business
of the Company and its subsidiaries as currently conducted.
(b) SCHEDULE 3.11 lists (i) all issued or registered Intellectual
Property and any applications therefor, (ii) all licenses,
sublicenses, royalty, consent and other agreements as to which the Company or
its subsidiaries is a party or is otherwise bound and which concern Intellectual
Property, including any Intellectual Property incorporated or included in any
the Company products or services, but excluding Commercial Software. "COMMERCIAL
SOFTWARE" means packaged commercially available software which has been licensed
to the Company pursuant to standard end-user licenses but is in no way a
component of, incorporated in or specifically required to develop or support any
of the Company's services, products and business.
(c) To the Company's knowledge, or that of its subsidiaries, there is
no unauthorized use, disclosure, infringement or misappropriation (each an
"INFRINGEMENT") of any Intellectual Property rights of the Company or its
subsidiaries by any third party, including any of their employees or former
employees of the Company. Neither Company nor any of its subsidiaries has agreed
to indemnify any other person against any charge of Infringement of any
Intellectual Property, other than indemnification provisions contained in
end-user purchase orders or sales contracts arising in the ordinary course of
business.
(d) To the Company's knowledge, all material Intellectual Property
owned or used by the Company and its subsidiaries is valid and subsisting.
Neither Company nor any of its subsidiaries has been sued in any Action which
involves a claim of Infringement of any third party. To the Company's knowledge,
the manufacturing, marketing, licensing or sale of the Company's products and
services and operation of its business does not infringe any patent, trademark,
service mark, copyright, trade secret or other proprietary right of any third
party. The Company has not brought any Action for Infringement of Intellectual
Property or breach of any agreement involving Intellectual Property against any
third party. There are no outstanding or, to the Company's knowledge, imminent
Actions or Orders nor, to the Company's knowledge, threatened Actions or Orders
that seek to limit or challenge the use, ownership, validity, enforceability or
value of any Intellectual Property of the Company, nor, to the Company's
knowledge, is there a valid basis for any such Action or Order.
(e) The Company or its subsidiaries secured valid written assignments
from all consultants and employees who contributed to the creation or
development of the Company's Intellectual Property of the rights to such
contributions that the Company does not already own by operation of law.
(f) The Company has used commercially reasonable efforts to protect
and preserve the confidentiality of all of its Intellectual Property that is
confidential in nature ("CONFIDENTIAL INFORMATION"). All use, disclosure or
appropriation of material Confidential Information owned by the Company by or to
a third party has been pursuant to the terms of a written agreement between the
Company and such third party. All use, disclosure or appropriation by the
Company of material Confidential Information not owned by the Company has been
pursuant to the terms of a written agreement between the Company and the owner
of such Confidential Information, or is otherwise lawful. The Company has used
commercially reasonable efforts to protect and preserve the integrity and
security of its software, systems and networks and the information thereon from
any unauthorized use, access or appropriation.
(g) There are no actions that must be taken by the Company or its
subsidiaries within sixty (60) days of the Closing Date that, if not taken, will
result in the loss of any Intellectual Property right, including the payment of
any fees or the filing of any responses or documents needed to obtain, maintain,
perfect, preserve or renew any Intellectual Property.
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III.12 ENVIRONMENTAL MATTERS. (a) (i) The Company and its subsidiaries
comply and have complied in all material respects with all applicable
Environmental Laws, and possess and comply with and have possessed and complied
in all material respects with all Environmental Permits; (ii) there are and have
been no Materials of Environmental Concern, or other conditions, at any property
owned, operated, or otherwise used by the Company or its subsidiaries now or in
the past (to the Company's knowledge), or at any other location, in
circumstances that would reasonably be expected to result in liability to the
Company or its subsidiaries under any Environmental Law or result in costs to
the Company or its subsidiaries arising out of any Environmental Law; (iii) no
judicial, administrative, or arbitral proceeding (including any notice of
violation or alleged violation) under any Environmental Law to which the Company
or its subsidiaries are, or to their knowledge of the Company will be, named as
a party is pending, or to their knowledge are threatened, nor are they the
subject of any investigation or the recipient of any request for information in
connection with any such proceeding or potential proceeding; (iv) to the
knowledge of the Company and its subsidiaries, the foregoing representations and
warranties are also true and correct with respect to any entity for which the
Company may be liable; and (v) the Company has provided to Parent true and
complete copies of all material Environmental Reports in the possession or
control of the Company and its subsidiaries.
(b) For purposes of this Agreement, the terms below shall be defined
as follows:
(i) "ENVIRONMENTAL LAWS" shall mean any and all laws, rules,
orders, regulations, statutes, ordinances, guidelines, codes, decrees,
or other legally enforceable requirement (including, without
limitation, common law) of any foreign government, the United States,
or any state, local, municipal or other governmental authority,
regulating, relating to or imposing liability or standards of conduct
concerning protection of the environment or of human health, or
employee health and safety.
(ii) "ENVIRONMENTAL PERMITS" shall mean any and all permits,
licenses, registrations, notifications, exemptions and any other
authorization required under any applicable Environmental Law.
(iii) "ENVIRONMENTAL REPORT" shall mean any report, study,
assessment, audit, or other similar document that addresses any issue
of actual or potential noncompliance with, actual or potential
liability under or cost arising out of, or actual or potential impact
on business in connection with, any Environmental Law or any proposed
or anticipated change in or addition to Environmental Law, that may in
any way affect the Company, or any entity for which it may be liable.
(iv) "MATERIALS OF ENVIRONMENTAL CONCERN" shall mean any gasoline
or petroleum (including crude oil or any fraction thereof) or
petroleum products, polychlorinated biphenyls, urea-formaldehyde
insulation, asbestos, pollutants, contaminants, radioactivity, and any
other substances of any kind, whether or not any such substance is
defined as hazardous or toxic under any Environmental Law, that is
regulated pursuant to or could give rise to liability under any
Environmental Law.
III.13 TAXES. The Company and its subsidiaries and any consolidated,
combined, unitary or aggregate group for Tax (as defined below) purposes of
which Company is or has been a member, have properly completed and timely filed
all Tax Returns (as defined below) required to be filed by them and have paid
all Taxes shown thereon to be due, other than any Taxes for which adequate
reserves in accordance with generally accepted accounting principles have been
reflected in the Financial Statements. The Company's Financial Statements
reflect any Taxes of the Company and its subsidiaries that have not been paid,
whether or not shown as being due on any Tax Returns other than Taxes arising in
the ordinary course of business after the date of the Financial Statements. The
Company and its subsidiaries have not, or will not have at the Effective Time,
any material liability for unpaid Taxes accruing after the date of their latest
Financial Statements except for Taxes incurred in the ordinary course subsequent
to March 31, 2000. There is (i) no material claim for Taxes that is a lien
against the property of the Company (or any of its subsidiaries) or is being
asserted against the Company or any of its subsidiaries other than liens for
Taxes not yet due and payable, (ii) no audit of any Tax Return of the Company or
any of its subsidiaries being conducted by a Tax Authority (as defined below),
(iii) no extension of the statute of limitations on the assessment of any Taxes
granted by the Company or any of its subsidiaries and currently in effect, and
(iv) no agreement, contract or arrangement to which the Company or any of its
subsidiaries is a party that may result in the payment of any amount that would
not be deductible by reason of Section 280G or Section 404 of the Code. Neither
the Company nor any of its
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subsidiaries has been or will be required to include any material adjustment in
Taxable income for any Tax period (or portion thereof) pursuant to Section 481
or 263A of the Code or any comparable provision under state or foreign Tax laws
as a result of transactions, events or accounting methods employed prior to the
Merger. Neither the Company nor any of its subsidiaries has filed nor will file
any consent to have the provisions of paragraph 341(f)(2) of the Code (or
comparable provisions of any state Tax laws) apply to the Company. Neither the
Company nor any of its subsidiaries is a party to any Tax sharing or Tax
allocation agreement nor does the Company or any of its subsidiaries have any
liability or potential liability to another party under any such agreement.
Neither the Company nor any of its subsidiaries has filed any disclosures under
Section 6662 or comparable provisions of state, local or foreign law to prevent
the imposition of penalties with respect to any Tax reporting position taken on
any Tax Return. Neither the Company nor any of its subsidiaries has ever been a
member of a consolidated, combined or unitary group of which the Company was not
the ultimate parent corporation. The Company and its subsidiaries have in their
possession receipts for any Taxes paid to foreign Tax authorities. The Company
has never been a "United States Real Property Holding Corporation" within the
meaning of Section 897 of the Code. For purposes of this Agreement, the
following terms have the following meanings: "TAX" (and, with correlative
meaning, "TAXES" and "TAXABLE") means (i) any net income, alternative or add-on
minimum tax, gross income, gross receipts, sales, use, ad valorem, transfer,
franchise, profits, license, withholding, payroll, employment, excise,
severance, stamp, occupation, premium, property, environmental or windfall
profit tax, custom, duty or other tax, governmental fee or other like assessment
or charge of any kind whatsoever, together with any interest or any penalty,
addition to tax or additional amount imposed by any governmental entity (a "TAX
AUTHORITY") responsible for the imposition of any such tax (domestic or
foreign), (ii) any liability for the payment of any amounts of the type
described in (i) as a result of being a member of an affiliated, consolidated,
combined or unitary group for any Taxable period, and (iii) any liability for
the payment of any amounts of the type described in (i) or (ii) as a result of
being a transferee of or successor to any person or as a result of any express
or implied obligation to indemnify any other person. As used herein, "TAX
RETURN" shall mean any return, statement, report or form (including, without
limitation, estimated tax returns and reports, withholding tax returns and
reports and information reports and returns) required to be filed with respect
to Taxes.
III.14 EMPLOYEE BENEFIT PLANS.
(a SCHEDULE 3.14 contains a true and complete list of each "employee
benefit plan" (within the meaning of section 3(3) of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"), including, without
limitation, multiemployer plans within the meaning of ERISA section 3(37)), and
each stock purchase, stock option, severance, employment, change-in-control,
fringe benefit, collective bargaining, bonus, incentive, deferred compensation
and all other employee benefit plans, agreements, programs, policies or other
arrangements, whether or not subject to ERISA (including any funding mechanism
therefor now in effect or required in the future as a result of the transaction
contemplated by this Agreement or otherwise), whether oral or written, under
which any current or former employee or director of the Company or its
subsidiaries ("COMPANY EMPLOYEES") has any current or future right to benefits
or under which the Company or its subsidiaries have any current or future
liability. All such plans, agreements, programs, policies and arrangements shall
be collectively referred to as the "COMPANY PLANS".
(b With respect to each Company Plan, the Company has delivered or
made available to Parent a current, accurate and complete copy (or, to the
extent no such copy exists, an accurate description) thereof and, to the extent
applicable: (i) any related trust agreement or other funding instrument; (ii)
the most recent determination letter; (iii) any summary plan description and
other written communications (or a description of any oral communications) by
the Company or its subsidiaries to Company Employees concerning the extent of
the benefits provided under the Company Plans; and (iv) for the two most recent
years (A) the Form 5500 and attached schedules and (B) audited financial
statements.
(c (i) Each Company Plan has been established and administered in
accordance with its terms, and in compliance with the applicable provisions of
ERISA, the Code and other applicable laws, rules and regulations; (ii) each
Company Plan which is intended to be qualified within the meaning of Code
section 401(a) is so qualified, has received a favorable determination opinion,
notification or advisory letter as to its qualification, or has a period of time
remaining under applicable Treasury regulations or Internal Revenue Service
pronouncements in which to apply for such letter and to make any amendments
necessary to so qualify, and nothing has occurred, whether by action or failure
to act, that could reasonably be expected to cause the loss of such
qualification; (iii) no event has occurred and no condition exists that would
subject the Company, either directly or by reason of its affiliation with any
member of its "Controlled Group" (within the meaning of Section 414(b), (c), (m)
or (o) of the Code), to any tax, fine, lien, penalty or other liability
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imposed by ERISA, the Code or other applicable laws, rules and regulations,
except as would not be reasonably expected to have a Material Adverse Effect;
and (iv) no "reportable event" (as defined in Section 4043 of ERISA) or
"prohibited transaction" (as defined in Section 406 of ERISA and Section 4975 of
the Code) has occurred with respect to any Company Plan that would result in
liability to the Company or its subsidiaries; and (v) except as required by
Section 4980B of the Code or any similar state statute, no Company Plan provides
retiree welfare benefits and the Company has no obligations to provide any
retiree welfare benefits.
(d No Company Plan is subject to Title IV of ERISA or Section 412 of
the Code, and the Company could not have, directly or indirectly, any current or
future liability under Title IV of ERISA or Section 412 of the Code (including,
without limitation, an obligation to indemnify any person or entity for
liability related to a plan subject to Title IV of ERISA or Section 412 of the
Code). No Company Plan is a "multiemployer plan" (as defined in Section
4001(a)(3) of ERISA), and neither the Company nor any member of its Controlled
Group (within the meaning of Section 414(b), (c), (m) or (o) of the Code) has
any liability or contributes (or has at any time contributed or had an
obligation to contribute) to any multiemployer plan.
(e Except with respect to each Company Employee and each such
employee's right or benefit set forth in SCHEDULE 3.14(E), no Company Plan
exists that, as a result of the execution of this Agreement or the transaction
contemplated by this Agreement, could result in the payment to any Company
Employee of any money or other property or could result in the increase,
acceleration or provision of any other rights or benefits to any Company
Employee, including without limitation any partial acceleration of the vesting
and exercisability of any Company Option or the partial lapse of any
restrictions imposed on any Restricted Stock.
III.15 EMPLOYEE MATTERS. Except as set forth in SCHEDULE 3.15, (1) the
Company and its subsidiaries are in compliance in all material respects with all
applicable laws, regulations, agreements, contracts and policies relating to
employment, discrimination in employment, terms and conditions of employment,
wages, hours and occupational safety and health and employment practices; (2)
the Company and its subsidiaries have withheld all amounts required by law or by
agreement to be withheld from the wages, salaries, and other payments to
employees, and the Company and its subsidiaries are not liable for any arrears
of wages or any taxes or any penalty for failure to comply with any of the
foregoing; (3) the Company and its subsidiaries are not liable for any payment
to any trust or other fund or to any governmental or administrative authority,
with respect to any unpaid unemployment compensation benefits, social security
or other benefits or obligations for employees (other than routine payments to
be made in the normal course of business and consistent with past practice); (4)
as of the date hereof, there are no pending claims against the Company or its
subsidiaries under any workers compensation plan or policy or for long-term
disability; (5) there are no controversies pending or, to the knowledge of the
Company, threatened, between the Company or its subsidiaries and any of their
respective employees, which controversies have resulted, or could reasonably be
expected to result, in an action, suit, complaint, proceeding, claim,
arbitration or investigation before or by any governmental agency,
administrative agency, court, commission or tribunal, foreign or domestic by or
on behalf of any employee, prospective employee, former employee, retiree, labor
organization or other representative of the Company's or its subsidiaries
employees; (6) neither the Company nor any of its subsidiaries is a party to any
collective bargaining agreement or other labor union contract, and the Company
does not know of any activities or proceedings of any labor union in connection
with an attempt to organize any such employees; (7) to the Company's knowledge,
no employees of the Company or its subsidiaries are in violation of any term of
any employment contract, patent disclosure agreement, noncompetition agreement,
or any restrictive covenant to a former employer relating to the right of any
such employee to be employed by the Company or its subsidiaries because of the
nature of the business conducted by the Company or its subsidiaries or to the
use of trade secrets or proprietary information of others; (8) since March 31,
2000, no employee of the Company or its subsidiaries has given notice to the
Company or its subsidiaries, and the Company and its subsidiaries are not
otherwise aware, that any such employee intends to terminate his or her
employment with the Company or its subsidiaries; (9) the Company or its
subsidiaries are not party to any employment agreement or consulting agreement
with any person or entity, nor is any such contract or agreement presently being
negotiated; (10) there is no unfair labor practice charge or complaint pending
or, to the best knowledge of the Company or any subsidiary, threatened against
or otherwise affecting the Company or any subsidiary; (11) there is no labor
strike, slowdown, work stoppage, dispute, lockout or other labor controversy in
effect, threatened against or otherwise affecting the Company or any subsidiary,
and the Company and its subsidiaries have not experienced any such labor
controversy within the past five years; (12) no grievance is pending or, to the
best knowledge of the Company or any subsidiary, threatened which, if adversely
decided, could have a material adverse effect on the Company or any subsidiary;
(13) neither the Company nor any subsidiary is a party
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to, or otherwise bound by, any consent decree with, or citation by, any
Government agency relating to employees or employment practices; (14) the
Company and its subsidiaries have paid in full to all employees of the Company
and its subsidiaries all wages, salaries, commissions, bonuses, benefits and
other compensation due to such employees or otherwise arising under any policy,
practice, agreement, plan, program, statute or law; (15) neither the Company nor
any subsidiary is liable for any severance pay or other payments to any employee
or former employee arising from the termination of employment, nor will the
Company or any subsidiary have any liability under any benefit or severance
policy, practice, agreement, plan, or program which exists or arises, or may be
deemed to exist or arise, under any applicable law or otherwise, as a result of
or in connection with the transactions contemplated hereunder or as a result of
the termination by the Company or any subsidiary of any persons employed by the
Company or any subsidiary on or prior to the Closing Date; (16) neither the
Company nor any subsidiary have closed any plant or facility, effectuated any
layoffs of employees or implemented any early retirement, separation or window
program within the past five years, nor has the Company or any subsidiary
planned or announced any such action or program for the future; (17) neither the
Company nor any subsidiary will, at any time within the 90-day period prior to
the Closing Date, effectuate a "plant closing" or "mass layoff", as those terms
are defined in the Worker Adjustment and Retraining Notification Act of 1988, as
amended ("WARN") or any state law, affecting in whole of in part any site of
employment, facility, operating unit or employee; and (18) the Company and its
subsidiaries are in compliance with their obligations pursuant to WARN, and all
other notification and bargaining obligations arising under any collective
bargaining agreement, statute or otherwise.
III.16 TRANSACTIONS WITH AFFILIATES. Except as set forth on SCHEDULE
3.16, no officer, director, employee, stockholder of five percent (5%) or more
of the Company's common stock or "AFFILIATES" of the Company (within the meaning
of Rule 144 of the Securities Act) or any immediate family member of any such
individual or any entity in which any such person or individual owns at least a
five percent (5%) interest, is a party to any agreement, contract, commitment or
transaction with the Company or any subsidiary or has any material interest in
any material property used by the Company or any subsidiary; PROVIDED that the
following events need not be disclosed: (a) dividends, redemptions, stock
purchases and other distributions otherwise permitted under this Agreement, (b)
the payment of reasonable fees to directors of the Company who are employees of
the Company, (c) any transaction with an officer or member of the board of
directors of the Company in the ordinary course of business involving
compensation, indemnity, employee benefit arrangements or expense reimbursement,
(d) loans or advances to employees otherwise permitted under this Agreement and
(e) customary employment arrangements and benefit programs on reasonable terms
as approved by the board of directors of the Company or a committee thereof.
III.17 INSURANCE. The Company and its subsidiaries have policies of
insurance and bonds of the type and in amounts customarily carried by persons
conducting businesses or owning assets similar to those of the Company and its
subsidiaries. There are no material claims pending under any of such policies or
bonds as to which coverage has been questioned, denied or disputed by the
underwriters of such policies or bonds. All premiums due and payable under all
such policies and bonds have been paid and the Company or its subsidiary, as
applicable, is otherwise in compliance with the terms of such policies and
bonds. Neither the Company nor any of its subsidiaries have any knowledge of any
threatened termination of, or material premium increase with respect to, any of
such policies.
III.18 COMPLIANCE WITH LAWS. The Company and its subsidiary have
complied with, are not in violation of, and have not received any notices of
violation with respect to, any federal, state, local or foreign statute, law or
regulation with respect to the conduct of their business, or the ownership or
operation of its business, except for such violations or failures to comply as
would not be reasonably expected to have a Material Adverse Effect on the
Company and its subsidiaries.
III.19 MINUTE BOOKS. The minute books of the Company and its
subsidiaries made available to Parent contain a complete and accurate summary of
all meetings or actions by written consent of directors or stockholders since
the time of incorporation of the Company and its subsidiaries.
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III.20 BROKERS' AND FINDERS' FEES. The Company has not incurred, nor
will it incur, directly or indirectly, any liability for brokerage or finders'
fees or agents' commissions or investment bankers' fees or any similar charges
in connection with this Agreement or any transaction contemplated hereby, except
as set forth in SCHEDULE 3.20.
III.21 STOCKHOLDER AGREEMENT; IRREVOCABLE PROXIES. Holders of more
than 51% of the outstanding shares of Company Capital Stock and more than 51% of
all such series of the Company Preferred Stock have agreed in writing to vote
for approval of the Merger pursuant to voting agreements substantially in the
form attached hereto as EXHIBIT A.
III.22 VOTE REQUIRED. The affirmative vote of the holders of at least
(i) a majority of the outstanding shares of all series of Company Preferred
Stock, with each series voting together as a single class and (ii) a majority of
the outstanding shares of Company Capital Stock, in each case outstanding on the
record date set for the special meeting of the Company stockholders called for
the purpose of approving the Merger and related matters (the "COMPANY
STOCKHOLDERS' MEETING") (or any written consent in lieu thereof) is the only
vote (or consent) of the holders of any Company Capital Stock necessary to
approve this Agreement and the transactions contemplated hereby.
III.23 BOARD APPROVAL. The Board of Directors of the Company has (i)
approved and declared the advisability of this Agreement and the Merger, (ii)
determined that the Merger is in the best interests of the Company and its
stockholders and is on terms that are fair to such stockholders and (iii)
recommended that the stockholders of the Company approve this Agreement and the
Merger.
III.24 ACCOUNTS RECEIVABLE. Subject to any reserves set forth in the
Financial Statements, the accounts receivable shown on the Financial Statements
represent and will represent on the Effective Date bona fide claims against
debtors for sales and other charges, and are not subject to discount except for
normal cash and immaterial trade discounts. The amount carried for doubtful
accounts and allowances disclosed in the Financial Statements was calculated in
accordance with U.S. GAAP and in a manner consistent with prior periods.
III.25 CUSTOMERS AND SUPPLIERS. Except as provided in SCHEDULE 3.25,
no customer which individually accounted for more than 5% of the Company's
consolidated gross revenues during the three month period preceding the date
hereof, and no supplier of the Company or any subsidiary during the three month
period preceding the date hereof has canceled or otherwise terminated, or made
any written threat to the Company or any subsidiary to cancel or otherwise
terminate its relationship with the Company or any subsidiary, or has decreased
materially its services or supplies to the Company or any subsidiary in the case
of any such supplier, or its usage of the services or products of the Company or
any subsidiary in the case of such customer, and to the Company's knowledge, no
such supplier or customer intends or has threatened to cancel or otherwise
terminate its relationship with the Company or any subsidiary or to decrease
materially its services or supplies to the Company or any subsidiary or its
usage of the services or products of the Company or any subsidiary, as the case
may be. Neither the Company nor any subsidiary has knowingly breached, so as to
provide a benefit to the Company or any subsidiary that was not intended by the
parties thereto, any agreement with, or engaged in any fraudulent conduct with
respect to, any customer or supplier of the Company or any of its subsidiaries.
III.26 MATERIAL CONTRACTS. Except for the contracts described in
SCHEDULE 3.26, (collectively, the "MATERIAL CONTRACTS"), the Company and its
subsidiaries are not a party to or bound by any material contract, including
without limitation:
(a any distributor (other than the standard form), sales,
advertising, franchise, agency or manufacturer's representative
agreement involving payments or receipts of more than $5,000 per
month;
(b any continuing contract for the purchase of materials,
supplies, equipment or services involving payments or receipts of more
than $5,000 per month;
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(c any trust indenture, mortgage, promissory note, loan
agreement or other contract for the borrowing of money, any currency
exchange, commodities or other hedging arrangement or any leasing
transaction of the type required to be capitalized in accordance with
U.S. GAAP, except for capital leases of equipment as set forth in the
Financial Statements;
(d any contract for capital expenditure in excess of $50,000 in
the aggregate;
(e any contract limiting the ability of the Company or
any of its subsidiaries to engage in any line of business or to
compete with any other person or entity or within any geographical
area or pursuant to which the Company or any of its subsidiaries is
restricted from selling, licensing or otherwise distributing any of
its products to, or providing services to, customers, potential
customers or any class of customers;
(f any confidentiality, secrecy or non-disclosure
contract, other than non-disclosure agreements entered into in the
normal course of business or in connection with efforts to obtain
financing;
(g any contract with any person with whom the Company or any of
its subsidiaries does not deal at arm's length;
(h any material agreement of guarantee, support,
indemnification, assumption or endorsement of, or any similar
commitment with respect to, the obligations, liabilities (whether
accrued, absolute, contingent or otherwise) or indebtedness of any
other person or entity;
(i any contract for the employment of any officer,
individual employee or other person on a full-time, part-time,
consulting or other basis providing annual compensation in excess of
$50,000 or contract relating to loans to officers, directors or
Affiliates;
(j any contract providing for the advance to any other Person
amounts in the aggregate exceeding $25,000;
(k any lease or agreement under which the Company or any
of its subsidiaries is lessee of or holds or operates any property,
real or personal, owned by any other party, except for any lease of
real or personal property under which the aggregate monthly rental
payments do not exceed $5,000;
(l any lease or agreement under which the Company or any
subsidiary is lessor of or permits any third party to hold or operate
any property, real or personal, owned or controlled by the Company or
any of its subsidiaries, under which the aggregate monthly payments do
not exceed $5,000 or $60,000 per year;
(m any contract or group of related contracts with the
same party or group of affiliated parties the performance of which
involves consideration in excess of $5,000 per month or $60,000 per
year;
(n except as set forth in SCHEDULE 3.11, any assignment,
license, indemnification or agreement with respect to any intangible
property (including, without limitation, any Intellectual Property);
(o any warranty agreement (other than on the standard form) with
respect to its services rendered or its products sold or leased;
(p any agreement under which it has granted any person any
registration rights (including, without limitation, demand and
piggyback registration rights);
(q any material agreement with a term of more than
eighteen months which is not terminable by the Company or any
subsidiary upon less than 30 days notice without penalty;
(r any agreement under which the Company or any of its
subsidiaries receives or provides Internet access, telecommunications
services or technical or other support services, involving
consideration in excess of $5,000 per month or $60,000 annually; or
(s any other agreement which is material to its
operations and business prospects or involves a consideration in
excess of $5,000 per month or $60,000 annually.
True, correct and complete copies of all Material Contracts have been made
available to Parent.
III.27 NO BREACH OF MATERIAL CONTRACTS. The Company and its
subsidiaries have performed in all material respects all of the obligations
required to be performed by it and is entitled to all benefits under, and is not
alleged to be in default in respect of any Material Contract. Except as provided
in SCHEDULE 3.27, each of the Material Contracts is in full force and effect,
unamended,
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and there exists no default or event of default or event, occurrence, condition
or act, with respect to the Company or to the Company's knowledge with respect
to the other contracting party, which, with the giving of notice, the lapse of
time or the happening of any other event or conditions, would become a default
or event of default under any Material Contract.
III.28 THIRD PARTY CONSENTS. SCHEDULE 3.28 sets forth every contract
of the Company and its subsidiary which, if no consent to the transactions
contemplated by this Agreement were obtained, would have a Material Adverse
Effect on Parent's ability to operate the business of the Company and its
subsidiary in the same manner as such business was operated prior to the
Effective Time.
III.29 YEAR 2000. Except as set forth on SCHEDULE 3.29, there have
been no Year 2000 Compliance problems with any of computer hardware, software,
databases, automated systems and other computer and telecommunications equipment
owned or used by the Company ("SYSTEMS") or any products or services designed,
manufactured, distributed or sold by the Company ("PRODUCTS OR SERVICES") that
would result in a Material Adverse Effect to the Company. "YEAR 2000 COMPLIANCE"
means, with respect to the Systems, Products or Services or other equipment or
materials in question, that they can be used before, during and after the
calendar year 2000 A.D., and will operate during each such time period, either
on a stand-alone basis or by interacting or interoperating with third-party
software (provided that such third-party software is Year 2000 Compliant),
without error relating to the processing, calculating, comparing, sequencing or
other use of date-related data.
III.30 AFFILIATES. SCHEDULE 3.30 to the Company Disclosure Statement
sets forth those persons who are, in the Company's reasonable judgment,
"AFFILIATES" of the Company within the meaning of Rule 144 of the Securities
Act.
III.31 OUTSTANDING STOCK OPTIONS. SCHEDULE 3.31 sets forth a true and
complete list as of the date hereof of all holders of outstanding Company
Options under all Company Stock Plans, including the number of shares of Company
Capital Stock subject to each such Company Option, the exercise or vesting
schedule, the exercise price per share and the term of each such Company Option.
III.32 PROSPECTUS AND PROXY STATEMENT AND S-4. The information with
respect to the Company, its officers, directors and affiliates in the proxy
statement or consent solicitation to be furnished to the stockholders of the
Company that will form part of the S-4 (the "PROSPECTUS AND PROXY STATEMENT") or
in the S-4 will not, (i) in the case of the Prospectus and Proxy Statement, on
the date the Prospectus and Proxy Statement is first mailed to the stockholders
of the Company or on the date of the stockholders' meeting or effective date of
the stockholders' consent in lieu thereof, or (ii) in the case of the S-4, at
the time the S-4 becomes effective and at the Effective Time, or as the
Prospectus and Proxy Statement and S-4 are then amended and supplemented,
contain any untrue statement of material fact, or 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.
III.33 REPRESENTATIONS COMPLETE. None of the representations or
warranties made by the Company herein or in any Schedule hereto, or in any
certificate furnished by the Company pursuant to this Agreement, when all such
documents are read together in their entirety, or with respect to the Company in
the Company's Amendment No.2 to Form S-1 Registration Statement provided to
Parent (taken as of the date of that Amendment, and except as to the extent that
the statements in that Amendment have been superseded by disclosures contained
in Schedules to this Agreement), contains any untrue statement of a material
fact, or omits to state any material fact necessary in order to make the
statements contained herein or therein, in the light of the circumstances under
which made, not misleading.
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ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PARENT
Parent and Merger Sub represent and warrant to the Company as follows:
IV.1 ORGANIZATION, STANDING AND POWER. Parent and Merger Sub are
corporations duly organized, validly existing and in good standing under the
laws of the State of Delaware. Each of Parent and Merger Sub has the corporate
power to own its properties and to carry on its business as now being conducted
and as proposed to be conducted and is duly qualified to do business and is in
good standing in each jurisdiction in which the failure to be so qualified and
in good standing would have a Material Adverse Effect on Parent. Parent has
delivered or made available to the Company true and complete copies of the
Certificate of Incorporation and By-laws of each of Parent and Merger Sub.
Neither Parent nor Merger Sub is in violation of any of the provisions of its
Certificate of Incorporation or By-laws.
IV.2 CAPITAL STRUCTURE. The authorized capital stock of Parent
consists of 190,000,000 shares of Common Stock ("PARENT COMMON STOCK"), $0.001
par value per share, 10,000,000 shares of Class B Common Stock, $0.001 par value
per share, and 5,000,000 shares of Preferred Stock, $0.001 par value per share,
of which there were issued and outstanding as of the close of business on March
31, 2000, 148,028,308 shares of Parent Common Stock, 1,594,794 shares of Class B
Common Stock and no shares of Preferred Stock. As of March 24, 2000, 17, 744,
288 Shares of Parent Common Stock were subject to outstanding options under the
Company's 1997 Stock Plan. As of March 24, 2000, Parent had also reserved
1,500,000 Shares of Parent Common Stock for issuance under its 1998 Stock
Purchase Plan. The shares of Parent Common Stock to be issued in the Merger in
exchange for Company Capital Stock and upon the exercise of assumed Company
Options and Company Warrants (including the Additional Shares) will be duly
authorized, validly issued, fully paid, and non-assessable, free of any liens,
charges, claims, security interests or encumbrances and free of preemptive
rights or rights of first refusal created by Parent's Certificate of
Incorporation or Bylaws or any agreement to which Parent is a party or by which
it is bound, other than Parent's right of repurchase with respect to unvested
options and restrictions under applicable state and federal securities laws or
as contemplated by this Agreement and its exhibits. The authorized capital stock
of Merger Sub consists of 1,000 shares of Common Stock, $0.01 par value, and
1,000 shares of common stock are issued and outstanding and held by Parent.
IV.3 AUTHORITY. Each of Parent and Merger Sub has all requisite
corporate power and authority to enter into this Agreement and to consummate the
transactions contemplated hereby, and the execution and delivery of this
Agreement and the consummation of the transactions contemplated hereby have been
duly authorized by all necessary corporate action on the part of Parent and
Merger Sub, other than the approval by Parent's stockholders of an amendment to
Parent's Certificate of Incorporation to provide for any increase in its
authorized capital stock made necessary or desirable by this Agreement. This
Agreement has been duly executed and delivered by Parent and Merger Sub and
constitutes the valid and binding obligation of each of Parent and Merger Sub,
enforceable against each of Parent and Merger Sub in accordance with its terms.
The execution and delivery of this Agreement 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 or acceleration of
any obligation or loss of a benefit under (i) any provision of the Certificate
of Incorporation or By-laws of Parent or Merger Sub or (ii) any material
mortgage, indenture, lease, contract or other agreement or instrument, permit,
concession, franchise, license, judgment, order, decree, statute, law,
ordinance, rule or regulation applicable to Parent or Merger Sub or their
properties or assets. No consent, approval, order or authorization of, or
registration, declaration or filing with, any Governmental Entity, is required
by or with respect to Parent or Merger Sub in connection with the execution and
delivery of this Agreement by Parent and Merger Sub or the consummation by
Parent and Merger Sub of the transactions contemplated hereby, except for: (i)
the filing of the Certificate of Merger as provided in Section 1.2; (ii) the
filing of the S-4 pursuant to Section 2.4, above; (iii) the filing of a Form 8-K
with the SEC and National Association of Securities dealers ("NASD") within
fifteen (15) days after the Closing Date; (iv) any consents, approvals, orders,
authorizations, registrations, declarations and filings as may be required under
the HSR Act and applicable federal and state securities laws and the securities
laws of any foreign country; and (v) such other consents, authorizations,
filings, approvals and registrations which, if not obtained or made by Parent or
Merger Sub, would not have a Material Adverse Effect on Parent or Merger Sub and
would not prevent, materially alter or delay any of the transactions
contemplated by this Agreement.
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IV.4 SEC DOCUMENTS; FINANCIAL STATEMENTS. Parent has made available to
the Company each statement, report, registration statement (with the prospectus
in the form filed pursuant to Rule 424(b) of the Securities Act), definitive
proxy statement, and other filing filed with the SEC by Parent since December
31, 1998 (collectively, the "PARENT SEC DOCUMENTS"). In addition, Parent has
made available to the Company all exhibits to the Parent SEC Documents filed
prior to the date hereof, and will promptly make available to the Company all
exhibits to any additional Parent SEC Documents filed prior to the Effective
Time. As of their respective filing dates, the Parent SEC Documents were filed
on a timely basis and complied in all material respects with the requirements of
the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), and the
Securities Act, and none of the Parent SEC Documents contained any untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements made therein, in light of the
circumstances in which they were made, not misleading, except to the extent
corrected by a subsequently filed Parent SEC Document. Parent has timely filed
with the SEC all required statements, reports and documents required to be filed
by it with the SEC on or since December 31, 1998, all of which complied as to
form when filed in all material respects with the applicable provisions of the
Securities Act or the Exchange Act, as the case may be. The financial statements
(including the notes thereto) contained in the Parent SEC Documents, have been
prepared in accordance with U.S. GAAP applied on a basis consistent throughout
the periods indicated. The Parent Financial Statements fairly present the
consolidated financial condition and operating results of Parent at the dates
and for the periods indicated therein (subject, in the case of any unaudited
statements, to normal, recurring year-end adjustments). Except as disclosed in
the Parent SEC Documents and any press releases by Parent issued up to and
including the date hereof, there has not occurred any event, change or effect
that would reasonably be expected to result in a Material Adverse Effect to
Parent.
IV.5 BROKER'S AND FINDERS' FEES. Except as listed on Schedule 4.5,
Parent and Merger Sub have not incurred, nor will they incur, directly or
indirectly, any liability for brokerage or finders' fees or agents' commissions
or investment bankers' fees or any similar charges in connection with this
Agreement or any transaction contemplated hereby.
IV.6 NO PRIOR ACTIVITIES. Except for the obligations incurred in
connection with its incorporation or organization or the negotiation and
consummation of this Agreement and the transactions contemplated hereby, Merger
Sub has neither incurred any obligation or liability nor engaged in any business
activity of any type or kind whatsoever or entered into any agreement or
arrangement with any person.
IV.7 PROSPECTUS AND PROXY STATEMENT AND S-4. The information with
respect to Parent, its officers, directors and affiliates contained in the
Prospectus and Proxy Statement and S-4 will not, (i) in the case of the
Prospectus and Proxy Statement, on the date the Prospectus and Proxy Statement
is first mailed to the stockholders of the Company or on the date of the
stockholders' meeting or effective date of the stockholders' consent in lieu
thereof, or (ii) in the case of the S-4, at the time the S-4 becomes effective
and at the Effective Time, or as the Prospectus and Proxy Statement and S-4 are
then amended and supplemented, contain any untrue statement of material fact, or
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.
ARTICLE V CONDUCT PRIOR TO THE EFFECTIVE TIME
V.1 CONDUCT OF BUSINESS OF THE COMPANY. During the period from the
date of this Agreement and continuing until the earlier of the termination of
this Agreement or the Effective Time, the Company agrees (except to the extent
expressly contemplated by this Agreement or as consented to in writing by
Parent), to carry on its business in the usual, regular and ordinary course in
substantially the same manner as heretofore conducted. Subject to the
limitations set forth in Section 5.2, the Company further agrees to pay debts
when commercially reasonable and pay Taxes when due subject (i) to good faith
disputes over such debts or Taxes and (ii) to Parent's consent to the filing of
material Tax Returns, if applicable, to pay or perform other obligations when
due, and to use all reasonable efforts consistent with past practice and
policies to preserve intact its present business organizations, and use
commercially reasonable efforts to keep available the services of its present
officers and key employees and preserve its relationships with customers,
suppliers, distributors, licensors, licensees, and others having business
dealings with it, to the end that its goodwill
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and ongoing businesses shall be unimpaired at the Effective Time. The Company
agrees promptly to notify Parent of any event or occurrence not in the ordinary
course of its business, and of any event that could have a Material Adverse
Effect on the Company.
V.2 RESTRICTED CONDUCT OF THE COMPANY. During the period from the date
of this Agreement and continuing until the earlier of the termination of this
Agreement or the Effective Time, except as expressly contemplated by this
Agreement, the Company shall not do, cause or permit any of the following, or
allow, cause or permit any of its subsidiaries to do, cause or permit any of the
following, without the prior written consent of Parent:
(a CHARTER DOCUMENTS. Cause or permit any amendments to its
Certificate of Incorporation or By-laws or other
equivalent organizational documents;
(b DIVIDENDS; CHANGES IN CAPITAL STOCK. Declare or pay
any dividends on or make any other distributions (whether in cash,
stock or property) in respect of any of its capital stock, or split,
combine or reclassify any of its capital stock or issue or authorize
the issuance of any other securities in respect of, in lieu of or in
substitution for shares of its capital stock (other than any issuance
of Company Common Stock upon exercise of outstanding Company Options
or Company Warrants) or repurchase or otherwise acquire, directly or
indirectly, any shares of its capital stock except from former
employees, directors and consultants in accordance with agreements
providing for the repurchase of shares in connection with any
termination of service to it;
(c STOCK OPTION PLANS, ETC. Grant any options or similar
rights (including grants of Restricted Stock) under its Company Stock
Plans or accelerate, amend or change the period of exercisability or
vesting of options or other rights granted under its Company Stock
Plans, or lower the exercise price of such options or authorize cash
payments in exchange for any options or other rights granted under any
of such plans; PROVIDED, HOWEVER, that, so long as the conditions set
forth in Section 7.3(o) are met, the Company shall be permitted to
complete the grants of the Company Options that have been committed to
be granted between January 1, 2000 and the date hereof but which, as of
the date hereof, have not yet been issued (each such Company Option
(including the date of grant, the name of the holder, the exercise
price, vesting schedule and term of such Option) being set forth on
SCHEDULE 5.2(C) (collectively, the "UNISSUED OPTIONS"));
(d MATERIAL CONTRACTS. Enter into any Material Contract or
commitment which would violate, amend or otherwise
modify or waive any of the terms of any of its material contracts,
without the reasonable consent of Parent;
(e ISSUANCE OF SECURITIES. Issue, deliver or sell or
authorize or propose the issuance, delivery or sale of, any shares of
its capital stock or securities convertible into, or subscriptions,
rights, warrants or options to acquire, or other agreements or
commitments of any character obligating it to issue any such shares or
other convertible securities, other than the issuance of shares of
Company Common Stock pursuant to the exercise of stock options
therefor outstanding as of the date of this Agreement or pursuant to
the exercise of warrants outstanding as of the date of this Agreement
and the issuance of options to purchase shares of the Company Common
Stock to employees hired after the date hereof or for additional
issuances to existing employees with exercise prices not less than the
fair market value for Company Common Stock on the date of the option
grant; PROVIDED, HOWEVER, that Company shall be permitted to secure a
financing commitment or similar arrangement (but not borrow
thereunder) in such amount as Company shall deem appropriate for
financing to be provided to Company in the event of termination of
this Agreement, so long as the costs of securing such financing
commitment or similar agreement are borne by the stockholders of the
Company in the event that the Merger is consummated.
(f INTELLECTUAL PROPERTY. Transfer to any person or entity any
rights to the Company Intellectual Property other than pursuant to
non-exclusive non-source code licenses in the ordinary course of
business consistent with past practice;
(g EXCLUSIVE RIGHTS. Enter into or amend any agreements
pursuant to which any other party is granted exclusive marketing or
other exclusive rights of any type or scope with respect to any of its
products, services or technologies;
(h DISPOSITIONS. Sell, lease, license or otherwise
dispose of or encumber any of its properties or assets which are
material, individually or in the aggregate, to its business, taken as
a whole, except for
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(i) sales, leases or licenses of products in the ordinary course of
business consistent with past practice and (ii) sales of obsolete or
unused equipment;
(i INDEBTEDNESS. Subject to Section 5.4, incur any
indebtedness for borrowed money in excess of $60,000 or guarantee any
such indebtedness or issue or sell any debt securities or guarantee
any debt securities of others, other than indebtedness to Parent;
PROVIDED, HOWEVER, that Company shall be permitted to secure a
financing commitment or similar arrangement (but not borrow
thereunder) in such amount as Company shall deem appropriate for
financing to be provided to Company in the event of termination of
this Agreement so long as the costs of securing such financing
commitment or similar agreement are borne by the stockholders of the
Company in the event that the Merger is consummated.
(j LEASES. Enter into any operating lease involving payments in
excess of $60,000 annually or $5,000 monthly;
(k PAYMENT OF OBLIGATIONS. Pay, discharge or satisfy in
an amount in excess of $20,000 in any one case or $60,000 in the
aggregate, any claim, liability or obligation (absolute, accrued,
asserted or unasserted, contingent or otherwise) arising other than in
the ordinary course of business, except for the payment, discharge or
satisfaction of liabilities reflected or reserved against in the
Company Financial Statements;
(l CAPITAL EXPENDITURES. Make any capital expenditures, capital
additions or capital improvements, except in the
ordinary course of business and consistent with past practice;
(m INSURANCE. Materially reduce the amount of any material
insurance coverage provided by existing insurance policies;
(n TERMINATION OR WAIVER. Terminate or waive any right or
rights which individually or in the aggregate would reasonably be
expected to be material in value to the Company, other than in the
ordinary course of business;
(o EMPLOYEE BENEFIT PLANS; PAY INCREASES. Increase or
accelerate the compensation, or fringe benefits of any current or
former director or employee of the Company or its subsidiaries (expect
for increases in salary or wages in the ordinary course of business
consistent with past practices, or adopt or amend any employee benefit
or stock purchase or option plan (except as expressly contemplated by
this Agreement) or pay any special bonus or special remuneration to
any employee or director;
(p SEVERANCE ARRANGEMENTS. Grant, pay or agree to any
provisions regarding severance or termination pay to any director,
officer or other employee except as provided on SCHEDULE 5.2;
(q LAWSUITS. Commence a lawsuit or take any action in
connection with any existing or threatened lawsuit, administrative
proceeding, mediation, arbitration or other similar proceeding other
than (i) for the routine collection of bills, (ii) in such cases where
it in good faith determines that failure to commence suit or take such
action would result in the material impairment of a valuable aspect of
its business, the waiver of any right or claim, and/or the violation
or lapse of any statute of limitations, statutory or judicial
deadline, PROVIDED that it consults with Parent prior to the filing of
such a suit or taking of such action, or (iii) for breach of this
Agreement or any other agreement between Parent and the Company;
(r ACQUISITIONS. Acquire or agree to acquire by merging or
consolidating with, or by purchasing a substantial portion of the
assets of, or by any other manner, any business or any corporation,
partnership, association or other business organization or division
thereof, or otherwise acquire or agree to acquire any assets which are
material, individually or in the aggregate, to its business;
(s TAXES. Other than in the ordinary course of business,
make or change any material election in respect of Taxes, adopt or
change any accounting method in respect of Taxes, file any material
Tax Return or any amendment to a material Tax Return, enter into any
closing agreement, settle any claim or assessment in respect of Taxes,
or consent to any extension or waiver of the limitation period
applicable to any claim or assessment in respect of Taxes;
(t REVALUATION. Revalue any of its assets, including without
limitation writing down the value of inventory or writing off notes or
accounts receivable other than in the ordinary course of business;
(u NOTICES. Fail to give all notices and other information
required to be given to the employees of the Company, any collective
bargaining unit representing any group of employees of the Company,
and any applicable government authority under the WARN Act, the
National Labor Relations Act, the Internal
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Revenue Code, the Consolidated Omnibus Budget Reconciliation Act, and
other applicable law in connection with the transactions provided for
in this Agreement;
(v PAYABLES. Delay or otherwise change the manner of payment of
accounts payable or other liabilities; or
(w OTHER. Take or agree in writing or otherwise to take,
any of the actions described in Sections 5.2(a) through (v) above, or
any action which would make any of its representations or warranties
contained in this Agreement untrue or incorrect or prevent it from
performing or cause it not to perform its covenants hereunder.
V.3 NO SOLICITATION. The Company will not permit its officers,
directors, employees or other agents to, directly or indirectly, (i) take any
action to solicit, initiate or encourage any Takeover Proposal (as defined
herein) or (ii) engage in negotiations with, or disclose any nonpublic
information relating to the Company, or afford access to the properties, books
or records of the Company, to any person that has advised the Company that it
may be considering making, or that has made, a Takeover Proposal. The Company
shall not, and shall not permit any of its officers, directors, employees or
other representatives to agree to or endorse any Takeover Proposal. The Company
will promptly notify Parent after receipt of any Takeover Proposal or any notice
that any person is considering making a Takeover Proposal or any request for
nonpublic information relating to the Company or for access to the properties,
books or records of the Company by any person that has advised the Company that
it may be considering making, or that has made, a Takeover Proposal and will
keep Parent fully informed of the status and details of any such Takeover
Proposal notice, request or any correspondence or communications related thereto
and shall provide Parent with a true and complete copy of such Takeover Proposal
notice or request or correspondence or communications related thereto, if it is
in writing, or a written summary thereof, if it is not in writing. As used
herein, "TAKEOVER PROPOSAL" shall mean any offer or proposal for, or any
indication of interest in, (i) a merger or other business combination involving
the Company (other than the Merger), (ii) the acquisition of outstanding shares
of the capital stock of the Company, or (iii) the acquisition of a substantial
portion of the assets of the Company (other than the sale or disposition of
inventory in the ordinary course of the Company's business).
V.4 ADDITIONAL BRIDGE FINANCING. The Company may seek to obtain
additional financing for the Company's operations that would become available in
the event that the financing referred to in Section 6.18 became no longer
available or became fully utilized prior to the Merger or termination of this
Agreement; PROVIDED THAT without the prior consent of Parent the Company may not
enter into any agreement with respect to such financing unless (i) no costs or
expenses related thereto are incurred by Parent, Merger Sub or the Company and
(ii) the Company incurs no financial or other material obligations prior to the
termination of this Agreement. The Company shall keep Parent fully informed
regarding any discussions or negotiations relating to such additional financing.
ARTICLE VI ADDITIONAL AGREEMENTS
VI.1 PROSPECTUS AND PROXY STATEMENT. The Company shall mail the
Prospectus and Proxy Statement to all holders of Company Capital Stock as soon
as practicable after the S-4 shall be declared effective by the SEC. Whenever
any event occurs with respect to the Company that is required to be set forth in
an amendment or supplement to the Prospectus and Proxy Statement, the Company
shall promptly inform Parent of such occurrence and cooperate in mailing to
stockholders of the Company such amendment or supplement. The Prospectus and
Proxy Statement shall include the recommendation of the Board of Directors of
the Company in favor of this Agreement and the Merger and the conclusion of the
Board of Directors that the terms and conditions of the Merger are fair and
reasonable to the stockholders of the Company. Anything to the contrary
contained herein notwithstanding, the Company shall not include in the
Prospectus and Proxy Statement any information with respect to Parent or its
affiliates or associates, the form and content of which information shall not
have been approved by Parent prior to such inclusion (such approval not to be
unreasonably withheld or delayed).
VI.2 MEETING OF STOCKHOLDERS. The Company shall take all action
necessary under the Delaware Law and its Certificate of Incorporation and
By-laws to convene a meeting of the stockholders of the Company for the purpose
of approving this Agreement and
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the transactions contemplated hereby or to secure the written consent of its
stockholders thereto (referred to as the "COMPANY STOCKHOLDERS MEETING") as soon
as practicable after the mailing of the Prospectus and Proxy Statement. The
Company shall consult with Parent regarding the date of the Company Stockholders
Meeting and shall not postpone or adjourn the Company Stockholders Meeting
without the consent of Parent. The Company shall use its best efforts to solicit
from stockholders of the Company proxies in favor of the Merger and shall take
all other action necessary or advisable to secure the vote or consent of
stockholders required to effect the Merger.
VI.3 ACCESS TO INFORMATION.
(a) The Company shall provide Parent and its accountants, counsel and
other representatives reasonable access during normal business hours during the
period prior to the Effective Time to (i) all of the Company's properties,
books, contracts, commitments and records, and (ii) all other information
concerning the business, properties, personnel of the Company as Parent may
reasonably request. The Company shall continue to generate internal financial
statements in accordance with past practice and shall provide to Parent and its
accountants, counsel and other representatives copies of such statements
promptly upon request.
(b) Subject to compliance with applicable law, from the date hereof
until the Effective Time, each of Parent and the Company shall confer on a
regular and frequent basis with one or more representatives of the other party
to report operational matters of materiality and the general status of the
Company's ongoing operations.
(c) No information or knowledge obtained in any investigation pursuant
to this Section 6.3 shall affect or be deemed to modify any representation or
warranty contained herein or the conditions to the obligations of the parties to
consummate the Merger.
(d) The Company shall provide Parent and its accountants, counsel and
other representatives reasonable access, during normal business hours, during
the period prior to the Effective Time, to all of the Company's Tax Returns and
other records and work papers relating to Taxes and shall provide to Parent and
its representatives, promptly upon request, the (i) the types of Tax Returns
being filed by the Company in each taxing jurisdiction, (ii) the year of the
commencement of the filing of each such type of Tax Return, (iii) all closed
years with respect to each such type of Tax Return filed in each jurisdiction,
(iv) all material Tax elections filed in each jurisdiction, (v) any deferred
intercompany gain with respect to transactions to which the Company has been a
party, and (vi) receipts for any Taxes paid to foreign Tax authorities.
VI.4 PUBLIC DISCLOSURE. Unless otherwise permitted by this Agreement,
each party shall consult with the other party before issuing any press release
or otherwise making any public statement or making any other public (or
non-confidential) disclosure (whether or not in response to an inquiry)
regarding the terms of this Agreement and the transactions contemplated hereby.
The Company shall not issue any such press release or make any such statement or
disclosure without the prior approval of Parent.
VI.5 CONSENTS; COOPERATION.
(a) Each of Parent and the Company shall promptly apply for or
otherwise seek, and use its best efforts to obtain, all consents and approvals
required to be obtained by it for the consummation of the Merger. The Company
shall use all commercially reasonable efforts to obtain all necessary consents,
waivers and approvals under any of its material contracts in connection with the
Merger for the assignment thereof or otherwise. The parties hereto will consult
and cooperate with one another, and consider in good faith the views of one
another, in connection with any analyses, appearances, presentations, memoranda,
briefs, arguments, opinions and proposals made or submitted by or on behalf of
any party hereto in connection with proceedings under or relating to federal or
state antitrust or fair trade law.
(b) Each of Parent and the Company shall use all commercially
reasonable efforts to resolve such objections, if any, as may be asserted by any
Governmental Entity with respect to the transactions contemplated by this
Agreement under the HSR Act, the Sherman Act, as amended, the Clayton Act, as
amended, the Federal Trade Commission Act, as amended, and any other Federal,
state or foreign statutes, rules, regulations, orders or decrees that are
designed to prohibit, restrict or regulate actions having the purpose or effect
of monopolization or restraint of trade (collectively, "ANTITRUST LAWS"). In
connection therewith, if any administrative or judicial action or proceeding is
instituted (or threatened to be instituted) challenging any transaction
contemplated by this Agreement as violative of any Antitrust Law, each of Parent
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and the Company shall cooperate and use all commercially reasonable efforts
vigorously to contest and resist any such action or proceeding and to have
vacated, lifted, reversed, or overturned any Order that is in effect and that
prohibits, prevents, or restricts consummation of the Merger or any such other
transactions, unless by mutual agreement Parent and the Company decide that
litigation is not in their respective best interests. Notwithstanding the
provisions of the immediately preceding sentence, neither party shall have any
obligation to litigate or contest any administrative or judicial action or
proceeding or any Order beyond the earlier of (i) sixty (60) days after the date
of this Agreement or (ii) the date of a ruling preliminarily enjoining the
Merger issued by a court of competent jurisdiction. Each of Parent and the
Company shall use all commercially reasonable efforts to take such action as may
be required to cause the expiration of the notice periods under the HSR Act or
other Antitrust Laws with respect to such transactions as promptly as possible
after the execution of this Agreement.
(c) Notwithstanding anything to the contrary in Section 6.6(a) or (b),
(i) Parent shall not be required to divest any of its or its subsidiaries'
businesses, product lines or assets, or to take or agree to take any other
action or agree to any limitation that could reasonably be expected to have a
Material Adverse Effect on Parent or of the Surviving Corporation after the
Effective Time and (ii) the Company may not agree to divest any of its
businesses, product lines or assets, or to take or agree to take any other
action or agree to any limitation without the consent of the Parent.
VI.6 COMPANY AFFILIATE AGREEMENTS. The Company shall cause to be
delivered prior to the Effective Time to Parent a Company Affiliate Agreement
(the "COMPANY AFFILIATE AGREEMENTS") in the form attached hereto as EXHIBIT I
from all affiliates of the Company listed on SCHEDULE 3.30 and any person who to
the knowledge of the Company, may be deemed to have become an affiliate of the
Company after the date of this Agreement and prior to the Effective Time. The
foregoing notwithstanding, Parent shall be entitled to place legends as
specified in the Company Affiliate Agreement on the certificates evidencing any
of the Parent Common Stock to be received by (i) any affiliate of the Company or
(ii) any person Parent reasonably identifies (by written notice to the Company)
as being a person who may be deemed an "affiliate" within the meaning of Rule
145 promulgated under the Securities Act, and to issue appropriate stop transfer
instructions to the transfer agent for such Parent Common Stock, consistent with
the terms of the Company Affiliate Agreement, regardless of whether such person
has executed a Company Affiliate Agreement and regardless of whether such
person's name and address appear on SCHEDULE 3.30 to the Company Disclosure
Statement.
VI.7 STOCK RESTRICTION AGREEMENT. The Company shall use its
commercially reasonable efforts to deliver or cause to be delivered to Parent at
or prior to the Closing from each of the stockholders of the Company an executed
Stock Restriction Agreement (the "STOCK RESTRICTION AGREEMENT") in the form
attached hereto as EXHIBIT D.
VI.8 LEGAL REQUIREMENTS. Each of Parent and the Company shall, and
Parent and the Company shall cause their respective subsidiaries to, (i) take
all reasonable actions necessary to comply promptly with all legal requirements
which may be imposed on them with respect to the consummation of the
transactions contemplated by this Agreement, (ii) promptly cooperate with and
furnish information to any party hereto necessary in connection with any such
requirements imposed upon such other party in connection with the consummation
of the transactions contemplated by this Agreement, and (iii) take all
reasonable actions necessary to obtain (and will cooperate with the other
parties hereto in obtaining) any consent, approval, order or authorization of,
or any registration, declaration or filing with, any Governmental Entity or
other person, required to be obtained or made in connection with the taking of
any action contemplated by this Agreement.
VI.9 BLUE SKY LAWS. Parent shall take such steps as may be necessary
to comply with the securities and blue sky laws of all jurisdictions that are
applicable to the issuance of the Parent Common Stock in connection with the
Merger and the assumption and exercise of the Company Options and Company
Warrants. The Company shall use its best efforts to assist Parent as may be
necessary to comply with the securities and blue sky laws of all jurisdictions
that are applicable in connection with the issuance of Parent Common Stock in
the Merger.
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VI.10 ESCROW AGREEMENT. On or before the Effective Time, the Escrow
Agent, the Stockholder' Agent (as defined in Section 9.8 hereto), the Company
and Parent shall execute the Escrow Agreement contemplated by Article IX in
substantially the form attached hereto as EXHIBIT E ("ESCROW AGREEMENT").
VI.11 FORM S-8. Parent agrees to file, no later than thirty (30)
business days after the Closing, a registration statement on Form S-8 covering
the shares of Parent Common Stock issuable pursuant to outstanding Company
Options under the Company Stock Plan assumed by Parent, PROVIDED that such
Company Options qualify for registration on such Form S-8. The Company agrees
that it shall cause to be delivered to Parent prior to the Closing all option
documentation relating to the outstanding Company Options, and, in the event
such delivery is delayed, Parent's obligation to file the registration statement
on Form S-8 shall be commensurately delayed.
VI.12 LISTING OF ADDITIONAL SHARES. Prior to the Effective Time,
Parent shall file with the NASDAQ Market a Notification Form for Listing of
Additional Shares with respect to the shares of Parent Common Stock to be issued
as provided in this Agreement.
VI.13 CONFIDENTIALITY. Each of Parent and the Company will hold and
will cause its officers, employees, auditors and other agents to hold in
confidence, unless compelled to disclose by judicial or administrative process
or, in the written opinion of its legal counsel, by other requirements of law,
all documents and information concerning the providing party or its subsidiaries
and furnished to the receiving party in connection with the transactions
contemplated in this Agreement. In addition, all such confidential documents and
information shall promptly be redelivered to the providing party (whether in the
possession of Parent, the Company or any other person permitted by this
Agreement to receive such documents and information) and any copies, extracts or
other reproductions, in whole or in part, of the same will not be retained.
VI.14 EXPENSES. (a) Whether or not the Merger is consummated, all
costs and expenses incurred by the Parent or the Company in connection with this
Agreement and the Merger and the transactions contemplated hereby and thereby
shall be paid by the party incurring such expense; PROVIDED that if the Merger
is consummated the merger consideration shall be reduced by the amount of any
investment banking, legal and other related merger fees and expenses incurred by
the Company ("TRANSACTION FEES").
(b) On the Closing Date, the Company's Chief Financial Officer shall
certify to Parent the amount of Transaction Fees that have been incurred by the
Company or become payable by the Company in respect of the consummation of the
Merger (including further investment banking fees that have become payable) (the
"CLOSING TRANSACTION FEES"). The "CLOSING FEE SHARES" shall be calculated by
dividing the Closing Transaction Fees by the closing price of one share of
Parent Common Stock on the National Nasdaq Market on the third business day
prior to the Closing Date, and deducted from the merger consideration in
accordance with Section 2.1 hereof.
(c) On the Earn-Out Distribution Date, Parent's Chief Financial
Officer shall certify to the Stockholders' Agent the amount of Transaction Fees
(together with appropriate invoices) that were incurred by the Company prior to
the Closing or have become payable by the Company since the Closing Date or are
payable in respect of the distribution of the Earn-Out Shares (if any) (the
"EARN-OUT TRANSACTION FEES"). The "EARN-OUT TRANSACTION FEE SHARES" shall be
calculated by dividing the Earn-Out Transaction Fees by the closing price of one
share of Parent Common Stock on the National Nasdaq Market on the third business
day prior to the Earn-Out Distribution Date, and deducted from the merger
consideration in accordance with Section 2.7 hereof.
VI.15 FURTHER ASSURANCES. Subject to the terms and conditions of this
Agreement, each of the parties to this Agreement shall use its best efforts to
effectuate the transactions contemplated hereby and to fulfill and cause to be
fulfilled the conditions to closing under this Agreement. Each party hereto, at
the reasonable request of another party hereto, shall execute and deliver such
other instruments and do and perform such other acts and things as may be
necessary or desirable for effecting completely the consummation of this
Agreement and the transactions contemplated hereby.
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VI.16 INDEMNIFICATION OF DIRECTORS, OFFICERS, ETC. (a) Parent and the
Surviving Corporation shall indemnify, defend and hold harmless the present and
former directors and officers of the Company and Parent shall cause the
Surviving Corporation to indemnify, defend and hold harmless the present and
former employees and agents of the Company (collectively, the "INDEMNIFIED
PARTIES"), in each case, against all losses, claims, damages, expenses or
liabilities arising out of actions or omissions or alleged actions or omissions
occurring at or prior to the Effective Time to the same extent and on the same
terms and conditions (including with respect to advancement of expenses)
permitted or required under applicable law and the Company's Articles of
Incorporation and By-Laws in effect at the date hereof. Parent or the Surviving
Corporation shall pay all reasonable expenses, including attorneys' fees, that
may be incurred by any Indemnified Party in enforcing the indemnity and other
obligations provided for in this Section.
(b) For a period of six years after the Effective Time, Parent shall
cause to be maintained in effect the current policies of directors' and
officers' liability insurance maintained by the Company (PROVIDED that Parent
may substitute therefor policies of at least the same coverage and amounts
containing terms and conditions which are no less advantageous); PROVIDED,
HOWEVER, that if the premiums with respect to such insurance exceed 200% of the
annual premiums paid as of the date hereof by the Company for such insurance,
Parent shall be obligated to purchase directors' and officers' liability
insurance with the maximum coverage as can be obtained at an annual premium
equal to 200% of the annual premiums paid by the Company as of the date hereof.
VI.17 REORGANIZATION FOR FEDERAL INCOME TAX PURPOSES. From and after
the date of this Agreement, each party hereto shall use its best efforts to
cause the Merger to qualify, and shall not knowingly take actions or cause
actions to be taken which could reasonably be expected to prevent the Merger
from qualifying, as a "reorganization" within the meaning of Section 368(a) of
the Code.
VI.18 FUNDING TO BE ARRANGED BY PARENT. Parent agrees until the
earlier of: (i) the Effective Time or (ii) the termination of this Agreement, to
arrange for loans to be made to the Company on the terms set forth in EXHIBIT F
hereto. A number of shares (the "INTERIM FUNDING SHARES") shall be deducted from
the merger consideration pursuant to Section 2.1, equal to the sum of (i) any
principal outstanding under such loans as at the Effective Time, (ii) any
interest paid or payable for the period from the time the loans were incurred
until the Effective Time, (iii) any fees or expenses paid or payable by the
Company in relation to such loans, divided by the closing price of one share of
Parent Common Stock on the National Nasdaq Market on the third business day
prior to the Closing Date.
VI.19 NON-SOLICITATION OF EMPLOYEES. Each of the Company and Parent
agrees that neither it nor its subsidiaries will, directly or indirectly, at any
time from the date this Agreement is terminated until the date six (6) months
from such termination, solicit for employment any employee of the other party
(other than as contemplated by this Agreement).
VI.20 LOAN ACCELERATION. The Company may enter into an agreement, on
terms acceptable to Parent, regarding the waiver of rights to accelerate payment
of loans made by the Company to employees of the Company in respect of, and
secured by, stock of the Company, payable to the Company upon a change of
control of the Company resulting from the Merger.
VI.21 EMPLOYEE BENEFITS. On and after the Closing Date, the employees
of the Company who continue their employment with the Surviving Corporation or
with Parent shall be entitled to participate in the employee benefit plans and
share purchase or other equity programs maintained by the Surviving Corporation
or Parent after the Closing Date on a basis, in the aggregate, no less favorable
for similarly situated employees at Parent or other subsidiaries owned by
Parent, and for the purposes thereof shall be entitled to credit for length of
service with the Company.
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ARTICLE VII CONDITIONS TO THE MERGER
VII.1 CONDITIONS TO OBLIGATIONS OF EACH PARTY TO EFFECT THE MERGER.
The respective obligations of each party to this Agreement to consummate and
effect the Merger and the transactions contemplated hereby shall be subject to
the satisfaction at or prior to the Effective Time of each of the following
conditions, any of which may be waived only in writing signed by all the parties
hereto:
(a) STOCKHOLDER APPROVAL. This Agreement and the Merger shall
have been approved -and adopted by the requisite vote of the Company
stockholders under the Delaware Law.
(b) NO INJUNCTIONS OR RESTRAINTS; ILLEGALITY. No temporary
restraining order, preliminary or permanent injunction or other order
issued by any court of competent jurisdiction or other legal or
regulatory restraint or prohibition preventing the consummation of the
Merger shall be in effect, nor shall any proceeding brought by an
administrative agency or commission or other governmental authority or
instrumentality, domestic or foreign, seeking any of the foregoing be
pending; nor shall there be any action taken, or any statute, rule,
regulation or order enacted, entered, enforced or deemed applicable to
the Merger, which makes the consummation of the Merger illegal under
applicable law. In the event an injunction or other order shall have
been issued, each party agrees to use its commercially reasonable
efforts to have such injunction or other order lifted.
(c) GOVERNMENTAL APPROVAL. Parent and the Company and their
respective subsidiaries shall have timely obtained from each
Governmental Entity all approvals, waivers and consents (including the
satisfaction of any applicable waiting period), if any, necessary for
consummation of or in connection with the Merger and the transactions
contemplated hereby, including such approvals, waivers, consents and
waiting periods as may be required under the Securities Act, under
state Blue Sky laws, and under the HSR Act.
(d) S-4. the S-4 shall have been declared effective by the SEC
under the Securities Act and no stop order suspending the
effectiveness of the S-4 shall have been issued by the SEC and no
proceeding for that purpose shall have been initiated by the SEC and
not concluded or withdrawn.
VII.2 ADDITIONAL CONDITIONS TO OBLIGATIONS OF THE COMPANY. The
obligations of the Company to consummate and effect this Agreement and the
transactions contemplated hereby shall be subject to the satisfaction at or
prior to the Closing Date of each of the following conditions, any of which may
be waived only in writing signed by the Company:
(a) REPRESENTATIONS, WARRANTIES AND COVENANTS. (i) The
representations and warranties of Parent in this Agreement shall be
true and correct in all material respects (except for such
representations and warranties that are qualified by their terms by a
reference to materiality which representations and warranties as so
qualified shall be true in all respects) on and as of the Closing Date
as though such representations and warranties were made on and as of
such date, except to the extent that any representations and
warranties expressly relate to an earlier date in which case such
representations and warranties shall be as of such date, and (ii)
Parent shall have performed and complied in all material respects with
all covenants, obligations and conditions of this Agreement required
to be performed and complied with by it as of the Closing Date.
(b) CERTIFICATE OF PARENT. The Company shall have been provided
with a certificate executed on behalf of Parent by its Executive
Vice-President and its Chief Financial Officer to the effect set forth
in Section 7.2(a).
(c) NO MATERIAL ADVERSE EFFECTS. There shall not have occurred
any Material Adverse Effect on Parent; PROVIDED, HOWEVER, that
fluctuations in the market value of the Parent Common Stock shall not
be deemed to constitute a Material Adverse Effect on Parent except to
the extent accompanied by other demonstrable material adverse effects
occurring with respect to Parent's and its subsidiaries' businesses,
taken as a whole.
(d) TAX OPINION. The Company shall have received the opinion of
Brobeck, Phleger & Harrison, LLP counsel to the Company to the effect
that the Merger will be treated for Federal income tax purposes as a
tax-free reorganization within the meaning of Section 368(a) of the
Code; PROVIDED that if Brobeck, Phleger & Harrison, LLP does not
render such opinion, this condition shall nonetheless be deemed
satisfied if Simpson Thacher & Bartlett renders such opinion to the
Company (it being agreed that Parent and the Company shall
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each provide reasonable cooperation to Brobeck, Phleger & Harrison,
LLP or Simpson Thacher & Bartlett as the case may be, to enable them
to render such opinion).
VII.3 ADDITIONAL CONDITIONS TO THE OBLIGATIONS OF PARENT AND MERGER
SUB. The obligations of Parent and Merger Sub to consummate and effect this
Agreement and the transactions contemplated hereby shall be subject to the
satisfaction at or prior to the Closing Date of each of the following
conditions, any of which may be waived, in writing, by Parent:
(a) COMPANY STOCKHOLDER APPROVAL. This Agreement and the Merger
shall have been approved and adopted (including by written consent) by
the holders of at least 90% of the outstanding shares of Company
Capital Stock, and holders of no more than 10% of the outstanding
shares of Company Capital Stock shall have voted against the Merger or
demanded appraisal rights under the Delaware Law (it being understood
that the period in which stockholders may demand appraisal rights may
not have expired prior to the Closing Date), PROVIDED, HOWEVER, that
Parent may not waive this requirement to the extent that it would
cause the Merger to fail to qualify as a reorganization under Section
368(a) of the Code.
(b) PARENT STOCKHOLDER APPROVAL. Parent shall have obtained the
approval of its stockholders of the increase of its authorized capital
stock as provided for in its Proxy Statement for the Annual Meeting to
be held on June 30, 2000.
(c) REPRESENTATIONS, WARRANTIES AND COVENANTS. (i) The
representations and warranties of the Company in this Agreement shall
be true and correct in all material respects (except for such
representations and warranties that are (x) qualified by their terms
by a reference to materiality which representations and warranties as
so qualified shall be true in all respects or (y) not then true and
correct solely as a result of the taking of actions permitted by this
Agreement, which representations and warranties shall be true and
correct (but for the taking of permitted actions) on and as of the
Closing Date as though such representations and warranties were made
on and as of such time, except to the extent that any representations
and warranties expressly relate to an earlier date in which case such
representations and warranties shall be as of such date, and (ii) the
Company shall have performed and complied in all material respects
with all covenants, obligations and conditions of this Agreement
required to be performed and complied with by it as of the Closing
Date.
(d) CERTIFICATE OF THE COMPANY. Parent shall have been provided
with a certificate executed on behalf of the Company by its Chief
Executive officer and its Chief Financial Officer to the effect set
forth in Section 7.3(c).
(e) THIRD PARTY CONSENTS. Parent shall have been furnished with
evidence satisfactory to it of the consent or approval of those
persons whose consent or approval shall be required in connection with
the Merger as set forth on SCHEDULE 3.28, which consent shall in the
case of Lucent Technologies include a waiver of any past defaults
(other than defaults in payment).
(f) INJUNCTIONS OR RESTRAINTS ON CONDUCT OF BUSINESS. No
temporary restraining order, preliminary or permanent injunction or
other order issued by any court of competent jurisdiction or other
Governmental Entity limiting or restricting Parent's conduct or
operation of the business of the Company following the Merger shall be
in effect, nor shall any proceeding brought by an administrative
agency or commission or other Governmental Entity, domestic or
foreign, seeking the foregoing be pending.
(g) NO MATERIAL ADVERSE CHANGES. After the date hereof, there
shall not have occurred any event which has a Material Adverse Effect
with respect to the Company, other than any Material Adverse Effect
resulting from Parent's failure to comply with Section 6.20.
(h) FIRPTA CERTIFICATE. The Company shall, prior to the
Closing Date, provide Parent with a properly executed FIRPTA
Notification Letter, substantially in the form of EXHIBIT G attached
hereto, which states that shares of capital stock of the Company do
not constitute "United States real property interests" under Section
897(c) of the Code, for purposes of satisfying Parent's obligations
under Treasury Regulation Section 1.1445-2(c)(3); and simultaneously
with delivery of such Notification Letter, the Company shall have
provided to Parent, as agent for the Company, a form of notice to the
Internal Revenue Service in accordance with the requirements of
Treasury Regulation Section 1.897-2(h)(2) and substantially in the
form of EXHIBIT H attached hereto along with written authorization for
Parent to deliver such notice form to the Internal Revenue Service on
behalf of the Company upon the Closing of the Merger.
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(i) RESIGNATION OF DIRECTORS AND OFFICERS. The directors and
officers of the Company in office immediately prior to the Effective
Time shall have resigned as directors and officers, as applicable, of
the Company effective as of the Effective Time, unless otherwise
provided in separate employment agreements between such individual and
Parent.
(j) ESCROW AGREEMENT. The Escrow Agreement substantially in the
form of EXHIBIT E attached hereto shall have been executed and
delivered by all parties other than Parent.
(k) CERTIFICATES OF GOOD STANDING. The Company shall, prior to
the Closing Date, provide Parent a certificate from the Secretary of
State of Delaware, and from each other jurisdiction in which the
Company or any subsidiary is qualified to do business, as to the
Company's or any subsidiary's good standing and payment of all
applicable taxes.
(l) TERMINATION OF STOCKHOLDER AGREEMENTS. All provisions of all
agreements among the Company and any of its securityholders or
optionholders, or among any Company securityholders or optionholders,
providing for registration rights, rights of first refusal, rights of
co-sale, relating to the voting of Company securities, requiring the
Company to obtain the consent or approval of any such securityholders
or optionholders prior to taking or failing to take any action (other
than the Stockholder Agreements executed pursuant to this Agreement
and the Company's Certificate of Incorporation), shall have been
terminated effective immediately prior to the Effective Time.
(m) AFFILIATES. Each person who is an "affiliate" of the Company
shall have executed and delivered to Parent an Affiliate Agreement in
accordance with Section 6.6 hereof.
(n) TAX OPINION. Parent shall have received the opinion of
Simpson Thacher & Bartlett, counsel to Parent, to the effect that the
Merger will be treated for Federal income tax purposes as a tax-free
reorganization within the meaning of Section 368(a) of the Code;
PROVIDED that if Simpson Thacher & Bartlett does not render such
opinion, this condition shall nonetheless be deemed satisfied if
Brobeck, Phleger & Harrison LLP renders such opinion to Parent (it
being agreed that the Company and Parent shall each provide reasonable
cooperation to Brobeck, Phleger & Harrison LLP or Simpson Thacher &
Bartlett as the case may be, to enable them to render such opinion).
(o) AGREEMENTS RESTRICTING DISPOSITION OF PARENT COMMON STOCK.
Stock Restriction Agreements shall have been executed and delivered by
(i) eighty-five percent (85%) of the persons listed on SCHEDULE
7.3(O), (ii) eighty percent (80%) of the employees of the Company who
hold vested stock options at the Closing Date who are listed on
SCHEDULE 3.31, other than persons listed on SCHEDULE 7.3(o), and (iii)
holders of ninety percent (90%) of all the Company Capital Stock held
by persons who are not included in either (i) or (ii), above.
(p) COMPLETION OF GRANT OF 2000 STOCK OPTIONS. The Company shall
have obtained executed copies of stock option agreements documenting
the Unissued Options from each holder set forth on Schedule 5.2(c),
which stock option agreements shall be in a form reasonably acceptable
to Parent.
(q) CERTIFICATION OF TRANSACTION FEES AND EXPENSES. The Chief
Financial Officer of the Company shall have certified the amount of
Closing Transaction Fees in accordance with Section 6.14.
ARTICLE VIII TERMINATION, AMENDMENT AND WAIVER
VIII.1 TERMINATION. At any time prior to the Effective Time, whether
before or after approval of the matters presented in connection with the Merger
by the stockholders of the Company, this Agreement may be terminated:
(a) by mutual consent duly authorized by the board of directors of
Parent and the Company;
(b) by either Parent or the Company, if the Closing shall not have
occurred on or before December 31, 2000 (the "DROP-DEAD DATE"); PROVIDED that
the right to terminate this Agreement under this Section 8.1(b) shall not be
available to a party whose action or failure to act has been the cause or
resulted in the failure of the Merger to occur on or before such date and such
action or failure to act constitutes a breach of this Agreement;
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(c) by Parent, if: (i) the Company shall breach in any material
respect any representation, warranty, obligation or agreement hereunder and such
breach shall not have been cured within five (5) business days of receipt by the
Company of written notice of such breach (PROVIDED that the right to terminate
this Agreement by Parent under this Section 8.1(c) shall not be available to
Parent if Parent is at that time in breach of this Agreement in any material
respect); or (ii) the Board of Directors of the Company shall have withdrawn or
modified its recommendation of this Agreement or the Merger in a manner adverse
to Parent or shall have resolved to do so;
(d) by the Company, if Parent shall breach in any material respect any
representation, warranty, obligation or agreement hereunder and such breach
shall not have been cured within five (5) business days following receipt by
Parent of written notice of such breach (PROVIDED that the right to terminate
this Agreement by the Company under this Section 8.1(d) shall not be available
to the Company if the Company is at that time in breach of this Agreement in any
material respect);
(e) by Parent if any permanent injunction or other order of a court or
other competent authority preventing the consummation of the Merger shall have
become final and nonappealable; or
(f) by the Company if any permanent injunction or other order of a
court or other competent authority preventing the consummation of the Merger
shall have become final and nonappealable.
VIII.2 EFFECT OF TERMINATION. In the event of termination of this
Agreement as provided in Section 8.1, this Agreement shall forthwith become void
and there shall be no liability or obligation on the part of Parent or the
Company or their respective officers, directors, stockholders or affiliates,
except to the extent such termination results from the breach by a party hereto
of any of its representations, warranties, covenants or other agreements set
forth in this Agreement; PROVIDED, HOWEVER, that the provisions of Section 6.4
(Public Disclosure), Section 6.13 (Confidentiality), this Section 8.2 and
Article X shall remain in full force and effect and survive any termination of
this Agreement.
VIII.3 AMENDMENT. The boards of directors of the parties hereto may
cause this Agreement to be amended at any time by execution of an instrument in
writing signed on behalf of each of the parties hereto; PROVIDED that an
amendment made subsequent to adoption of the Agreement by the stockholders of
the Company shall not (i) alter or change the amount or kind of consideration to
be received on conversion of the Company Capital Stock, or (ii) alter or change
any of the terms and conditions of this Agreement if such alteration or change
would materially adversely effect the holders of Company Capital Stock.
VIII.4 EXTENSION; WAIVER. At any time prior to the Effective Time any
party hereto may, to the extent legally allowed, (i) extend the time for the
performance of any of the obligations or other acts of the other parties hereto,
(ii) waive any inaccuracies in the representations and warranties made to such
party contained herein or in any document delivered pursuant hereto and (iii)
waive compliance with any of the agreements or conditions for the benefit of
such party contained herein. Any agreement on the part of a party hereto to any
such extension or waiver shall be valid only if set forth in an instrument in
writing signed on behalf of such party.
ARTICLE IX ESCROW AND INDEMNIFICATION
IX.1 ESCROW FUND. As soon as practicable after the Effective Time, the
Escrow Shares shall be registered in the name of, and be deposited with, an
institution selected by Parent with the reasonable consent of the Company, as
escrow agent in connection with this Agreement (the "ESCROW AGENT"), such
deposit (together with interest and other income thereon) to constitute the
Escrow Fund and to be governed by the terms set forth herein and in the Escrow
Agreement substantially in the form attached hereto as EXHIBIT E. The Escrow
Fund shall be available to compensate Parent solely pursuant to the
indemnification obligations of the stockholders of the Company.
IX.2 INDEMNIFICATION. (a) Subject to the limitations set forth in this
Article IX, subsequent to the Closing, the stockholders of the Company will
indemnify and hold harmless Parent and its officers, directors, agents and
employees,
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and each person, if any, who controls or may control Parent within the meaning
of the Securities Act (hereinafter referred to individually as an "INDEMNIFIED
PERSON" and collectively as "INDEMNIFIED PERSONS") from and against any and all
losses, costs, damages, liabilities and expenses arising from claims, demands,
actions or causes of action, including, without limitation, reasonable legal
fees, net of any recoveries by Parent under existing insurance policies or
indemnities from third parties (collectively, "DAMAGES"), arising out of (i) any
misrepresentation or breach of or default in connection with any of the
representations, warranties, covenants and agreements given or made by the
Company in this Agreement, the Company Disclosure Schedules or any exhibit or
schedule to this Agreement, (ii) any litigation claim described on SCHEDULE 3.7
to the extent such Damages exceed the amount recorded for that litigation as an
accrued expense or liability in the Company Balance Sheet as at March 31, 2000,
or (iii) any costs or expenses associated with the Company's proposed initial
public offering or preparation for such proposed initial public offering, to the
extent such costs or expenses exceed the amount recorded as an accrued expense
or liability in respect of that item in the Company Balance Sheet as at March
31, 2000. The Escrow Fund shall be security for this indemnity obligation
subject to the limitations in this Agreement. If the Merger is consummated,
recovery from the Escrow Fund in accordance with this Article IX shall be the
exclusive remedy under this Agreement for any breach or default in connection
with any of the representations, warranties, covenants or agreements set forth
in this Agreement or any exhibit or schedule hereto, except in the event of
fraud or intentional misrepresentation or in the event of a breach of any of the
representations and warranties set forth in Section 3.1 (Organization, Standing
and Power), Section 3.2 (Capital Structure) or Section 3.13 (Taxes), PROVIDED
that Parent shall first proceed against the Escrow Fund unless or until the
Escrow Fund is subject to pending claims in excess of the value of the remaining
Escrow Fund, and further that no stockholder of the Company shall be liable to
Parent hereunder in an amount in excess of the consideration received by such
stockholder pursuant to this Agreement.
(b) Nothing in this Agreement shall limit the liability (i) of the
Company for any breach of any representation, warranty or covenant if the Merger
does not close, or (ii) of any Company stockholder in connection with any breach
by such stockholder of the Voting Agreement.
IX.3 DAMAGE THRESHOLD. Notwithstanding the foregoing, Parent may not
receive any shares from the Escrow Fund unless and until one or more Officer's
Certificates (as defined in Section 9.5 below) identifying Damages the aggregate
amount of which exceeds $100,000 has been delivered to the Escrow Agent as
provided in Section 9.5 below and such amount is determined pursuant to this
Article IX to be payable, in which case Parent shall receive shares equal in
value to the full amount of Damages; PROVIDED, HOWEVER, (i) that Damages
resulting from any inaccuracy, breach or default under the representations and
warranties contained in Sections 3.1, 3.2 or 3.13 shall not be subject to the
recovery threshold set forth in this sentence, and (ii) that in no event shall
Parent receive more than the number of shares of Parent Common Stock originally
placed in the Escrow Fund, as adjusted to reflect fully the effect of any stock
split, reverse stock split, stock dividend (including any dividend or
distribution of securities convertible or exchangeable into Parent Common
Stock), reorganization, recapitalization or other like change with respect to
Parent Common Stock occurring after the date hereof. In determining the amount
of any Damages resulting from any misrepresentation, breach or default subject
to indemnity under this Article IX, any materiality standard contained in the
applicable representation, warranty, covenant or agreement shall be disregarded.
IX.4 ESCROW PERIOD. The Escrow Period shall terminate at the one (1)
year anniversary of the Effective Time; PROVIDED, HOWEVER, that such portion of
the Escrow Shares necessary to satisfy any unsatisfied claims specified in any
Officer's Certificate or Certificates theretofore delivered to the Escrow Agent
prior to the termination of the Escrow Period, with respect to facts and
circumstances existing prior to expiration of the Escrow Period, shall remain in
the Escrow Fund until such claims have been resolved. Parent shall deliver to
the Escrow Agent a certificate specifying the Effective Time. Any portion of the
Escrow Fund for which there is no claim pursuant to this Article IX (net of one
half of expenses) shall be distributed promptly by the Escrow Agent to the
stockholders of the Company in accordance with each stockholder's percentage of
the Escrow Fund as set forth in the Escrow Agreement.
IX.5 CLAIMS UPON ESCROW FUND.
(a) Upon receipt by the Escrow Agent on or before the last day of the
Escrow Period of a certificate signed by any officer of Parent (an "OFFICER'S
CERTIFICATE")
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(i) stating that, Damages exist in an aggregate amount greater
than $100,000; and
(ii) specifying in reasonable detail the individual items of such
Damages included in the amount so stated, the date each such item was
paid, or properly accrued or arose, and the nature of the
misrepresentation, breach of warranty or claim to which such item is
related,
the Escrow Agent shall, subject to the provisions of Section 9.6 and 9.7 below,
deliver to Parent out of the Escrow Fund, as promptly as practicable, Parent
Common Stock or other assets held in the Escrow Fund having a value equal to
such Damages.
(b) For the purpose of compensating Parent for its Damages pursuant to
this Agreement, the Parent Common Stock in the Escrow Fund shall be valued based
on the average closing price for Parent Common Stock for the 20 trading days
immediately prior to the date that an indemnification claim is made.
IX.6 OBJECTIONS TO CLAIMS. At the time of delivery of any Officer's
Certificate to the Escrow Agent, a duplicate copy of such Officer's Certificate
shall be delivered to the Stockholders' Agent (defined in Section 9.8 below),
and, for a period of thirty (30) days after such delivery to the Escrow Agent of
such Officer's Certificate, the Escrow Agent shall make no delivery of Parent
Common Stock or other property pursuant to Section 9.5 hereof unless the Escrow
Agent shall have received written authorization from the Stockholders' Agent to
make such delivery. After the expiration of such thirty (30) day period, the
Escrow Agent shall make delivery of the Parent Common Stock or other property in
the Escrow Fund in accordance with Section 9.5 hereof, PROVIDED that no such
payment or delivery may be made if the Stockholders' Agent shall object in a
written statement to the claim made in the Officer's Certificate and such
statement shall have been delivered to the Escrow Agent and to Parent prior to
the expiration of such thirty (30) day period.
IX.7 RESOLUTION OF CONFLICTS; ARBITRATION.
VI.9 BLUE SKY LAWS. Parent shall take such steps as may be necessary
to comply with the securities and blue sky laws of all jurisdictions that are
applicable to the issuance of the Parent Common Stock in connection with the
Merger and the assumption and exercise of the Company Options and Company
Warrants. The Company shall use its best efforts to assist Parent as may be
necessary to comply with the securities and blue sky laws of all jurisdictions
that are applicable in connection with the issuance of Parent Common Stock in
the Merger.
VI.10 ESCROW AGREEMENT. On or before the Effective Time, the Escrow
Agent, the Stockholder' Agent (as defined in Section 9.8 hereto), the Company
and Parent shall execute the Escrow Agreement contemplated by Article IX in
substantially the form attached hereto as EXHIBIT E ("ESCROW AGREEMENT").
VI.11 FORM S-8. Parent agrees to file, no later than thirty (30)
business days after the Closing, a registration statement on Form S-8 covering
the shares of Parent Common Stock issuable pursuant to outstanding Company
Options under the Company Stock Plan assumed by Parent, PROVIDED that such
Company Options qualify for registration on such Form S-8. The Company agrees
that it shall cause to be delivered to Parent prior to the Closing all option
documentation relating to the outstanding Company Options, and, in the event
such delivery is delayed, Parent's obligation to file the registration statement
on Form S-8 shall be commensurately delayed.
VI.12 LISTING OF ADDITIONAL SHARES. Prior to the Effective Time,
Parent shall file with the NASDAQ Market a Notification Form for Listing of
Additional Shares with respect to the shares of Parent Common Stock to be issued
as provided in this Agreement.
VI.13 CONFIDENTIALITY. Each of Parent and the Company will hold and
will cause its officers, employees, auditors and other agents to hold in
confidence, unless compelled to disclose by judicial or administrative process
or, in the written opinion of its legal counsel, by other requirements of law,
all documents and information concerning the providing party or its subsidiaries
and furnished to the receiving party in connection with the transactions
contemplated in this Agreement. In addition, all such confidential documents and
information shall promptly.
(a) In case the Stockholders' Agent shall so object in writing to any
claim or claims by Parent made in any Officer's Certificate, Parent shall have
twenty (20) days after receipt by the Escrow Agent of an objection by the
Stockholders' Agent to respond in a written statement to the objection of the
Stockholders' Agent. If after such twenty (20) day period there remains a
dispute as to any claims, the Stockholders' Agent and Parent shall attempt in
good faith for thirty (30) days to agree upon the rights of the respective
parties with respect to each of such claims. If the Stockholders' Agent and
Parent should so agree, a memorandum setting forth such agreement shall be
prepared and signed by both parties and shall be furnished to the Escrow Agent.
The Escrow Agent shall be entitled to rely on any such memorandum and shall
distribute the Parent Common Stock or other property from the Escrow Fund in
accordance with the terms of such memorandum.
(b) If no such agreement can be reached after good faith negotiation,
either Parent or the Stockholders' Agent may, by written notice to the other,
demand arbitration of the matter unless the amount of the damage or loss is at
issue in pending litigation with a third party, in which event arbitration shall
not be commenced until such amount is ascertained or both parties agree to
arbitration; and in either such event the matter shall be settled by arbitration
conducted by three (3) arbitrators. Within fifteen (15) days after such written
notice is sent, Parent and the Stockholders' Agent shall each select one
arbitrator, and the two arbitrators so selected shall select a third arbitrator.
The decision of the arbitrators as to the validity and amount of any claim in
such Officer's Certificate shall be binding and conclusive upon the parties to
this Agreement, and, notwithstanding anything in Section 9.6 hereof, the Escrow
Agent shall be entitled to act in accordance with such decision and make or
withhold payments out of the Escrow Fund in accordance therewith.
(c) Judgment upon any award rendered by the arbitrators may be entered
in any court having jurisdiction. Any such arbitration shall be held in San
Francisco, California under the commercial rules then in effect of the American
Arbitration Association. Each party shall bear its own expenses (including
attorneys' fees and expenses) incurred in connection with any such arbitration,
and the fees and expenses of each arbitrator and the administrative fee of the
American Arbitration Association shall be allocated by the arbitrator or
arbitrators, as the case may be (or, if not so allocated, shall be borne equally
by Parent, on the one hand, and the Company stockholders, on the other hand.
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IX.8 STOCKHOLDERS' AGENT.
(a) Prior to the approval and adoption of this Agreement and the
Merger by the requisite vote of the Company stockholders, the Company shall
nominate a person to be constituted and appointed as agent ("STOCKHOLDERS'
AGENT") for and on behalf of the Company stockholders to give and receive
notices and communications, to authorize delivery to Parent of the Parent Common
Stock or other property from the Escrow Fund in satisfaction of claims by
Parent, to object to such deliveries, to agree to, negotiate, enter into
settlements and compromises of, and demand arbitration and comply with orders of
courts and awards of arbitrators with respect to such claims, and to take all
actions necessary or appropriate in the judgment of the Stockholders' Agent for
the accomplishment of the foregoing. Such agency may be changed by the holders
of a majority in interest of the Escrow Fund from time to time upon not less
than ten (10) days' prior written notice to Parent. No bond shall be required of
the Stockholders' Agent, and the Stockholders' Agent shall receive no
compensation for services rendered. Notices or communications to or from the
Stockholders' Agent shall constitute notice to or from each of the Company
stockholders.
(b) The Stockholders' Agent shall not be liable for any act done or
omitted hereunder as Stockholders' except to the extent it has acted with gross
negligence or willful misconduct, and any act done or omitted pursuant to the
advice of counsel shall be conclusive evidence that it did not act with gross
negligence or willful misconduct. The Company stockholders shall severally
indemnify the Stockholders' Agent and hold him harmless against any loss,
liability or expense incurred without gross negligence or bad faith on the part
of the Stockholders' Agent and arising out of or in connection with the
acceptance or administration of the duties hereunder.
(c) The Stockholders' Agent shall have reasonable access to
information about the Company and the reasonable assistance of the Company's
officers and employees for purposes of performing its duties and exercising its
rights hereunder, PROVIDED that the Stockholders' Agent shall treat
confidentially and not disclose any nonpublic information from or about the
Company to anyone (except on a need to know basis to individuals who agree to
treat such information confidentially).
(d) The Stockholders' Agent shall be a third party beneficiary of the
terms of this Section 9.8.
IX.9 ACTIONS OF THE STOCKHOLDERS' AGENT. (a) A decision, act, consent
or instruction of the Stockholders' Agent shall constitute a decision of all
Company stockholders for whom shares of Parent Common Stock otherwise issuable
to them are deposited in the Escrow Fund and shall be final, binding and
conclusive upon each such Company stockholder, and the Escrow Agent and Parent
may rely upon any decision, act, consent or instruction of the Stockholders'
Agent as being the decision, act, consent or instruction of each and every such
Company stockholder. The Escrow Agent and Parent are hereby relieved from any
liability to any person for any acts done by them in accordance with such
decision, act, consent or instruction of the Stockholders' Agent.
(b) After the Effective Time, Parent shall make available to the
Stockholders' Agent those senior executives of the Company that continue as
employees of the Company or Parent to assist the Stockholders' Agent in
analyzing and defending against any claims made under this Article IX. Parent
shall cause the Company to waive any conflict of interest claim related to the
involvement in such analysis or defense by the general counsel or any other
lawyer employed at the Company prior to the Effective Time.
IX.10 THIRD-PARTY CLAIMS. In the event Parent becomes aware of a
third-party claim which Parent believes may result in a demand against the
Escrow Fund, Parent shall promptly notify the Stockholders' Agent of such claim,
and the Stockholders' Agent and the Company stockholders for whom shares of
Parent Common Stock otherwise issuable to them are deposited in the Escrow Fund
shall be entitled, at their expense, to participate in any defense of such
claim. Parent shall have the right to settle any such claim; PROVIDED, HOWEVER,
that Parent may not effect the settlement of any such claim without the consent
of the Stockholders' Agent, which consent shall not be unreasonably withheld. In
the event that the Stockholders' Agent has consented to any such settlement, the
Stockholders' Agent shall have no power or authority to object under Section 9.6
or any other provision of this Article IX to the amount of any claim by Parent
against the Escrow Fund for indemnity with respect to such settlement.
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IX.11 EARN-OUT FUND. On the deposit of Earn-Out Shares in the
Escrow Fund pursuant to section 2.7(c), the Escrow Agent shall administer the
Escrow Fund in relation to such shares according to this Article IX as though
the Earn-Out Shares deposited to escrow were deemed to be available for the
satisfaction of claims against the Escrow Fund from the Effective Time, PROVIDED
that the Escrow Fund in relation to such shares shall terminate in accordance
with Section 2.7 upon the final satisfaction or resolution of all pending
claims.
ARTICLE X GENERAL PROVISIONS
X.1 SURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS. The
representations, warranties and agreements of each party hereto shall remain
operative and in full force and effect regardless of any investigation made by
or on behalf of any other party hereto, any person controlling any such party or
any of their officers or directors, whether prior to or after the execution of
this Agreement. The representations, warranties and agreements of each party
hereto shall survive the execution and delivery of this Agreement until the
expiration of the Escrow Period, PROVIDED, HOWEVER, that any agreement or
covenant set forth in the Agreement which is to be performed after the Closing
Date shall survive until fully performed in accordance with this Agreement;
X.2 NOTICES. All notices and other communications hereunder shall be
in writing and shall be deemed given if delivered personally or by commercial
delivery service, or mailed by registered or certified mail (return receipt
requested) or sent via facsimile (with confirmation of receipt) to the parties
at the following address (or at such other address for a party as shall be
specified by like notice):
(a) if to Parent or Merger Sub, to:
Covad Communications Group, Inc.
4520 Burton Drive
Santa Clara, CA 95054
Attention: General Counsel
Facsimile: (408) 987-1111
with a copy to:
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017
Attention: John W. Carr, Esq.
Facsimile: (212) 455-2502
(b) if to the Company prior to the Closing, to:
BlueStar Communications Group, Inc.
41 Union Street, Suite 900
Nashville, TN 37219
Attention: Robert E. Dupuis
Facsimile: (615) 346-3875
if to the Stockholders' Agent, until otherwise advised:
c/ BlueStar Communications Group, Inc.
41 Union Street, Suite 900
Nashville, TN 37219
Attention: Robert E. Dupuis
Facsimile: (615) 346-3875
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in each case, with a copy to:
Brobeck, Phleger & Harrison LLP
301 Congress Avenue, Suite 1200
Austin, Texas 78701
Attention: Carmelo M. Gordian, Esq.
Facsimile: (512) 477-5813
By its inclusion herein as a recipient of copies of notices, the
parties acknowledge and agree that notwithstanding the fact that Brobeck,
Phleger & Harrison LLP represented the Company in connection with the
transactions provided for in this Agreement, Brobeck, Phleger & Harrison LLP
shall be permitted to represent the holders of Company Capital Stock, including
the Stockholders' Agent on their behalf, and their respective heirs, executors,
administrators, affiliates, successors and assigns, in connection with any and
all matters which may arise out of in connection with this Agreement, the Escrow
Agreement or any of the other related agreements.
X.3 INTERPRETATION. When a reference is made in this Agreement to
Exhibits, such reference shall be to an Exhibit to this Agreement unless
otherwise indicated. The words "include," "includes" and "including" when used
herein shall be deemed in each case to be followed by the words "without
limitation." The phrase "made available" in this Agreement shall mean that the
information referred to has been made available or in the case of the Parent SEC
Documents, that such documents were furnished or available on the SEC's website.
The phrases "the date of this Agreement," "the date hereof," and terms of
similar import, unless the context otherwise requires, shall be deemed to refer
to the date first written above. The table of contents and headings contained in
this Agreement are for reference purposes only and shall not affect in any way
the meaning or interpretation of this Agreement.
X.4 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
shall become effective when one or more counterparts have been signed by each of
the parties and delivered to the other parties, it being understood that all
parties need not sign the same counterpart.
X.5 ENTIRE AGREEMENT; NONASSIGNABILITY; PARTIES IN INTEREST. This
Agreement and the documents and instruments and other agreements specifically
referred to herein or delivered pursuant hereto, including the Exhibits and the
Schedules, including the Company Disclosure Statement: (a) constitute the entire
agreement among the parties with respect to the subject matter hereof and
supersede all prior agreements and understandings, both written and oral, among
the parties with respect to the subject matter hereof; (b) are not intended to
confer upon any other person any rights or remedies hereunder except for the
stockholders of the Company and as set forth in sections 2.2(a) (Effect on
Capital Stock; Conversion of Securities), 2.3(a)-(c) and (e)-(f) and (h)-(i)
(Exchange of Certificates), 2.4 (Form S-4), 2.7(a)-(e) (Rights to Receive
Additional Shares of Parent Common Stock), 6.16 (Indemnification of Directors,
Officers Etc.) and 9.8 (Stockholders Agent); and (c) shall not be assigned by
operation of law or otherwise except as otherwise specifically provided.
X.6 SEVERABILITY. In the event that any provision of this Agreement,
or the application thereof, becomes or is declared by a court of competent
jurisdiction to be illegal, void or unenforceable, the remainder of this
Agreement will continue in full force and effect and the application of such
provision to other persons or circumstances will be interpreted so as reasonably
to effect the intent of the parties hereto. The parties further agree to replace
such void or unenforceable provision of this Agreement with a valid and
enforceable provision that will achieve, to the extent possible, the economic,
business and other purposes of such void or unenforceable provision.
X.7 REMEDIES CUMULATIVE. Except as otherwise provided herein, any and
all remedies herein expressly conferred upon a party will be deemed cumulative
with and not exclusive of any other remedy conferred hereby, or by law or equity
upon such party, and the exercise by a party of any one remedy will not preclude
the exercise of any other remedy.
X.8 GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Delaware without reference to such
state's principles of conflicts of law. Each of the parties hereto irrevocably
consents to the exclusive jurisdiction of any court located within the State of
California, in connection with any matter based upon or arising out of this
Agreement or the matters contemplated herein (other than as provided by Section
9.7), agrees that process may be served upon them in any manner authorized by
the laws of the State of California for such
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persons and waives and covenants not to assert or plead any objection which they
might otherwise have to such jurisdiction and such process.
X.9 RULES OF CONSTRUCTION. The parties hereto agree that they have
been represented by counsel during the negotiation, preparation and execution of
this Agreement and, therefore, waive the application of any law, regulation,
holding or rule of construction providing that ambiguities in an agreement or
other document will be construed against the party drafting such agreement or
document.
[SIGNATURE PAGE FOLLOWS]
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<PAGE>
IN WITNESS WHEREOF, Parent, Merger Sub and the Company have caused
this Agreement and Plan of Merger and Reorganization to be executed and
delivered by their respective officers thereunto duly authorized, all as of the
date first written above.
COVAD COMMUNICATIONS GROUP, INC.
By:/s/ Robert E. Knowling, Jr.
--------------------------------------
Robert E. Knowling, Jr.
President and Chief Executive Officer
COVAD ACQUISITION CORPORATION
By:/s/ Robert E. Knowling, Jr.
---------------------------------------
Robert E. Knowling, Jr.
President and Chief Executive Officer
BLUESTAR COMMUNICATIONS GROUP, INC.
By:/s/ Robert E. Dupuis
--------------------------------------
Robert E. Dupuis
Chief Executive Officer
A-46
<PAGE>
EXHIBIT A
FORM OF STOCKHOLDER AGREEMENT
[SEE APPENDIX B TO THE PROSPECTUS]
A-47
<PAGE>
EXHIBIT B
EXCHANGE RATIOS
A. CONVERSION RATIOS.
COMMON STOCK CONVERSION RATIO: Each share of Company Common Stock
issued and outstanding immediately prior to the Effective Time shall be
exchanged for a number of shares of Parent Common Stock equal to the Stock
Exchange Ratio.
SERIES A CONVERSION RATIO: Each share of Series A Preferred Stock issued
and outstanding immediately prior to the Effective Time shall be exchanged for a
number of shares of Parent Common Stock equal to the sum of (i) the Series A
Liquidation Number, and (ii) the product of the Series A Conversion Number and
the Stock Exchange Ratio.
SERIES B CONVERSION RATIO: Each share of Series B Preferred Stock issued
and outstanding immediately prior to the Effective Time shall be exchanged for a
number of shares of Parent Common Stock equal to the sum of (i) the Series B
Liquidation Number, and (ii) the product of the Series B Conversion Number and
the Stock Exchange Ratio.
SERIES C CONVERSION RATIO: Each share of Series C Preferred Stock issued
and outstanding immediately prior to the Effective Time shall be exchanged for a
number of shares of Parent Common Stock equal to the sum of (i) the Series C
Liquidation Number, and (ii) the product of the Series C Conversion Number and
the Stock Exchange Ratio.
B. DEFINITIONS. For purposes of this Exhibit, all capitalized terms not
otherwise defined shall have their meanings as defined in the Agreement and Plan
of Merger and Reorganization ("THE AGREEMENT") of which this Exhibit C is a
part, and further:
"CLOSING FEE SHARES" shall be as defined in Section 6.14 of the
Agreement.
"CONVERSION NUMBER" for each series of Preferred Stock shall mean the
number of shares of Company Common Stock into which a single share of that
series of Preferred Stock may be converted.
"INTERIM FUNDING SHARES" is as defined in Section 6.18 of the Agreement.
"LIQUIDATION NUMBER" for each series of Preferred Stock shall be a number
of shares of Parent Common Stock equal to the fraction the numerator of which is
the liquidation price of a share of that series of Preferred Stock, and the
denominator of which is the Parent Average Stock Price.
"PARENT AVERAGE STOCK PRICE" shall mean the average of the closing
prices of one share of Parent Common Stock on the NASDAQ National Market over
the 30 days ending on three days prior to the Closing.
"STOCK EXCHANGE RATIO" shall mean the fraction, the numerator of which is
the number of Closing Shares (as defined in Section 2.1 of the Agreement), minus
the sum of (i) the Closing Fee Shares, (ii) the Interim Funding Shares, and
(iii) the Total Liquidation Shares, and the denominator of which is Total
Outstanding Company Stock.
"TOTAL LIQUIDATION SHARES" shall mean the number of shares of Parent
Common Stock equal to the sum of (i) the product of the total number of shares
of Series A Preferred Stock outstanding immediately prior to the Effective Time
and the Series A Liquidation Number, (ii) the product of the total number of
shares of Series B Preferred Stock outstanding immediately prior to the
Effective Time and the Series B Liquidation Number, and (iii) the product of the
total number of shares of Series C Preferred Stock outstanding immediately prior
to the Effective Time and the Series C Liquidation Number.
"TOTAL OUTSTANDING COMPANY STOCK" shall mean the number of shares of
Company Common Stock on a fully diluted basis immediately prior to the Effective
Time, namely, the sum of (i) the number of shares of outstanding Company Common
Stock, (ii) the number of shares of Company Stock issuable upon conversion of
all outstanding Company Preferred Stock, (iii) the number of shares of Company
Stock issuable upon exercise of all outstanding Company Options, whether or not
then exercisable (other than Company Options that are unvested and
* Reflects amendment to the merger agreement on August 28, 2000
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<PAGE>
incapable of exercise due to the holder of that option leaving the employ of the
Company), and (iv) the number of shares of Company Common Stock issuable upon
exercise of all outstanding Company Warrants.
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<PAGE>
EXHIBIT C
EARN-OUT CALCULATIONS
Unless otherwise defined, all capitalized terms have the meanings
accorded to them in the Agreement and Plan of Merger and Reorganization ("THE
AGREEMENT") to which this document is an Exhibit.
A. EARN-OUT SHARE NUMBER. The Earn-Out Share Number shall be the sum of
the Revenue Earn-Out Share Number and the EBITDA Earn-Out Share Number, in each
case calculated with respect to the 2001 fiscal year of the Surviving
Corporation, PROVIDED that the Earn-Out Share Number shall be zero (0) if either
of the Revenue Earn-Out Share Number or the EBITDA Earn-Out Share Number is zero
(0).
The Revenue Earn-Out Share Number shall be the number set forth below
opposite the highest Actual 2001 Revenue of the Company achieved in the 2001
fiscal year:
ACTUAL 2001 REVENUE REVENUE EARN-OUT
($ MILLIONS) SHARE NUMBER
----------- ------------
less than $112.2 0
112.2 100,000
113.5 200,000
114.7 300,000
116.0 450,000
117.2 600,000
118.5 800,000
119.7 1,000,000
121.0 1,200,000
122.2 1,400,000
123.5 1,700,000
124.7 2,000,000
130.9 2,250,000
137.2 2,500,000
The EBITDA Earn-Out Share Number shall be the number set forth below
opposite the highest Actual 2000 EBITDA (or lowest loss) achieved in the 2001
fiscal year:
ACTUAL 2001 EBITDA (LOSS) EBITDA EARN-OUT
($ MILLIONS) SHARE NUMBER
------------ ------------
lower than $(190.7) 0
(190.7) 100,000
(189.0) 200,000
(187.3) 300,000
(185.5) 450,000
(183.8) 600,000
(182.1) 800,000
(180.3) 1,000,000
(178.6) 1,200,000
(176.9) 1,400,000
(175.1) 1,700,000
(173.4) 2,000,000
(164.7) 2,250,000
(156.1) 2,500,000
B. COMPANY CAPITAL STOCK. Subject to deposit in the Escrow Fund pursuant
to Section 2.7(c), each share of Company Capital Stock outstanding immediately
prior to the Effective Time shall represent the right to receive on the Earn-Out
Distribution Date, a number of Earn-Out Shares equal to the product of (i) the
Conversion Number for that class and series of share, and (ii) the Earn-Out
Exchange Ratio, that product being rounded down to the nearest whole number.
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<PAGE>
C. COMPANY OPTIONS. Each Company Option outstanding immediately prior to
the Effective Time shall represent the right to receive, on the later of (a) the
Earn-Out Distribution Date, and (b) the date of exercise of such Option, subject
to Section 2.7 of the Merger Agreement, a number of Additional Shares equal to
the product of (i) the number of shares of Company Common Stock that were
issuable upon exercise of such Company Option immediately prior to the Effective
Time, and (ii) the Earn-Out Exchange Ratio, that product being rounded down to
the nearest whole number.
D. COMPANY WARRANTS. Each Company Warrant outstanding immediately prior
to the Effective Time shall represent the right to receive, on the later of (a)
the Earn-Out Distribution Date, and (b) the date of exercise of such Warrant,
subject to Section 2.7 of the Merger Agreement, a number of shares of Parent
Common Stock equal to the product of (i) the number of shares of Company Common
Stock that were issuable upon exercise of such Company Warrant immediately prior
to the Effective Time, and (ii) the Earn-Out Exchange Ratio, that product being
rounded down to the nearest whole number.
E. DEFINITIONS.
"CONVERSION NUMBER" means, (i) for each series of Company Preferred
Stock, the number of shares of Company Common Stock into which each share of
that class of stock is convertible at the Effective Time, or (ii) for Company
Common Stock, the number one (1).
"EARN-OUT EXCHANGE RATIO" means the fraction the numerator of which is
the Earn-Out Shares (as defined in Section 2.7(c) of the Agreement), the
denominator of which is the sum of (i) the number of shares of outstanding
Company Common Stock at the Effective Time, (ii) the number of shares of Company
Stock issuable upon conversion of all outstanding Company Preferred Stock at the
Effective Time (excluding any shares reflecting liquidation preferences), (iii)
the number of shares of Company Stock issuable upon exercise of all outstanding
Company Options at the Effective Time (less those Company Options assumed by
Parent at the Effective Time that at the Earn-Out Distribution Date are unvested
and incapable of exercise due to their holder leaving the employ of the Company
prior to the Earn-Out Distribution Date) and (iv) the number of shares of
Company Common Stock issuable upon exercise of all outstanding Company Warrants
at the Effective Time.
"EARN-OUT TRANSACTION FEE SHARES" has the meaning set forth in Section
6.14 of the Agreement.
"EBITDA" means the Revenue of the Company and its subsidiaries for the
2001 fiscal year from continuing operations, minus associated expenses for
interest, income taxes, unallocated depreciation and amortization, determined in
each case on a consolidated basis in accordance with United States Generally
Accepted Accounting Principals and consistent with the Company's Financial
Statements.
"REVENUE" has the meaning of such term in accordance with United States
Generally Accepted Accounting Principles and consistent with the Company's
Financial Statements.
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<PAGE>
EXHIBIT D
FORM OF STOCK RESTRICTION AGREEMENT
[SEE APPENDIX C TO THE PROSPECTUS]
A-52
<PAGE>
EXHIBIT E
FORM OF EXCROW AGREEMENT
[SEE APPENDIX D TO THE PROSPECTUS]
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<PAGE>
EXHIBIT F
INTERIM FINANCING
The Interim Financing to be arranged by Parent shall be on terms set
forth in:
1. The Demand Loan Agreement, dated as of June 15, 2000 among BlueStar
Communications Group, Inc. and Bear Stearns Corporate Lending Inc.;
2. Guarantee and Collateral Agreement, dated as of June 15, 2000, made
by each of the grantor signatories thereto in favor of Bear Stearns
Corporte Lending Inc.; and
3. Put/Call Option Agreement, dated as of June 15, 2000 between Covad
Communications Group, Inc. and Bear Stearns Corporte Lending Inc.
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<PAGE>
EXHIBIT G
STATEMENT OF NON-U.S. REAL PROPERTY HOLDING CORPORATION STATUS
PURSUANT TO TREASURY REGULATION SECTION 1.897-2(h)
Pursuant to an Agreement and Plan of Merger among Covad Communications
Group, Inc., a Delaware corporation ("Acquirer"), Covad Acquisition Corporation,
a Delaware corporation and a wholly-owned subsidiary of Acquirer ("Merger Sub")
and BlueStar Communications Group, Inc., a Delaware corporation (the "Company"),
dated as of June 15, 2000, Merger Sub shall be merged with and into the
Company.
Section 1445 of The Internal Revenue Code of 1986, as amended (the "Code"),
provides that a transferee of a U.S. Real Property Interest must withhold tax if
the transferor is a foreign person. In order to confirm that neither Merger Sub
nor Acquirer, as transferee, is required to withhold tax from amounts paid to
any stockholder upon the Merger, the undersigned, in his capacity as President
of the Company, hereby certifies as follows.
1. The stock of the Company does not constitute a U.S. Real Property
Interest as that term is defined in Section 897(c)(1)(A)(ii) of the Code;
2. The determination in Paragraph 1, above, is based on a determination by
the Company that the Company is not and has not been a U.S. Real Property
Holding Corporation as that term is defined in Section 897(c)(2) of the Code
during the five-year period preceding the date of this Statement and
Certification, as indicated below;
3. The Company's U.S. employer identification number is 62-1757987;
4. The Company's office address is 414 Union Street, Suite 900, Nashville,
Tennessee 37219; and
5. The Company hereby authorizes Acquirer to deliver a Notice to the
Internal Revenue Service pursuant to the requirements of Treasury Regulation
Section l.897-2(h)(2) (which Notice is being provided to Acquirer by the
Company) at any time after the closing of the Merger.
This Statement is made in accordance with the requirements of Treasury
Regulation Sections 1.897-2(h) and 1.1445-2(c)(3). The Company understands that
any false statement contained herein could be punished by fine, imprisonment or
both.
Under penalties of perjury I declare that I have examined this Statement
and to the best of my knowledge and belief it is true, correct and complete, and
I further declare that I have authority to sign this document on behalf of the
Company.
BlueStar Communications Group, Inc.
Dated: [______], 2000 ____________________________________
By
Title:
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<PAGE>
EXHIBIT H
NOTICE TO THE INTERNAL REVENUE SERVICE
PURSUANT TO REQUIREMENTS OF TREASURY
REGULATION SECTION 1.897-2(H)(2)
This Notice is being provided by BlueStar Communications Group, Inc., a
Delaware corporation (the "Company") pursuant to the requirements of Treasury
Regulation Section 1.897-2(h)(2).
The Company is located at 414 Union Street, Suite 900, Nashville,
Tennessee 37219. The Company's Taxpayer Identification Number is 62-1757987.
The attached Certificate of Non-U.S. Real Property Holding Corporation
Status was not requested by a foreign interest holder. Such Certificate was
requested by Covad Communications Group, Inc., a Delaware corporation
("Acquirer"). Acquirer is located at 4250 Burton Drive, Santa Clara, CA 95054.
Acquirer's Taxpayer Identification Number is _____________________________.
The interests in question, shares of Company common stock to be exchanged
pursuant to an Agreement and Plan of Merger, dated as of June 15, 2000, are
not U.S. Real Property Interests.
Under penalties of perjury I declare that I have examined this Notice and
the attachment hereto and to the best of my knowledge and belief they are true,
correct and complete, and I further declare that I have authority to sign this
document on behalf of the Company.
BlueStar Communications Group, Inc.
-----------------------------------
Dated: ____________________, 2000 By:
Title:
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<PAGE>
EXHIBIT I
June _____, 2000
FORM OF COMPANY AFFILIATE AGREEMENT
[Affiliate]
[Address]
Ladies and Gentlemen:
The undersigned, a holder of shares of preferred or common stock
("COMPANY CAPITAL STOCK"), of BlueStar Communications Group, Inc., a Delaware
corporation (the "COMPANY"), is entitled to receive in connection with the
merger (the "MERGER") of the Company with Covad Acquisition Corporation, a
Delaware corporation, common stock, par value $0.001 per share (the "MERGER
STOCK"), of Covad Communications Group, Inc., a Delaware corporation ("ISSUER").
The undersigned has been advised that, at the effective time of the Merger, the
undersigned may be deemed an "affiliate" of the Company within the meaning of
Rule 145 ("RULE 145") of the Securities and Exchange Commission (the "SEC")
promulgated under the Securities Act of 1933, as amended (the "ACT"), although
nothing contained herein should be construed as an admission of such fact.
The undersigned has been advised that the issuance of shares of Merger
Stock pursuant to the Merger will be registered under the Act pursuant to a
registration statement on Form S-4. The undersigned has also been advised that,
if the undersigned is in fact an "affiliate" of the Company at the time the
Merger is submitted to a vote of the stockholders of the Company, Rule 145 will
restrict the undersigned's sales of shares of Merger Stock, if any, received in
the Merger. The undersigned hereby represents to and covenants with the Company
that the undersigned will not sell, assign, transfer or otherwise dispose of any
of the Merger Stock received by the undersigned in exchange for shares of
Company Common Stock pursuant to the Merger except (i) pursuant to an effective
registration statement under the Act, (ii) in conformity with the volume and
other limitations of Rule 145 or (iii) in a transaction which, in the opinion of
independent counsel reasonably satisfactory to Issuer or as described in a
"no-action" or interpretive letter from the Staff of the SEC, is not required to
be registered under the Act.
In the event of a sale or other disposition by the undersigned of Merger
Stock pursuant to Rule 145, the undersigned will supply Issuer with evidence of
compliance with such Rule, in the form of a letter in the form of Annex I
hereto. The undersigned understands that Issuer may instruct its transfer agent
to withhold the transfer of any Merger Stock disposed of by the undersigned, but
that upon receipt of such evidence of compliance the transfer agent shall
effectuate the transfer of the Merger Stock sold as indicated in the letter.
The undersigned understands and agrees that:
(i) Issuer is under no obligation to register the sale, transfer or
other disposition of the shares of Merger Stock to be received by the
undersigned in the Merger except as set forth in written agreements, if
any, with the undersigned that have been entered into by Issuer or that
have been specifically assumed by Issuer.
(ii) Stop transfer instructions will be given to the transfer agent
of Issuer with respect to the shares of Merger Stock to be received by
the undersigned in the Merger, and there will be placed on the
certificate representing such stock, or any certificates delivered in
substitution therefor, a legend stating in substance:
"THE SECURITIES REPRESENTED BY THIS CERTIFICATE WERE ISSUED IN A
TRANSACTION TO WHICH RULE 145 UNDER THE SECURITIES ACT OF 1933, AS
AMENDED (THE "ACT") APPLIES. THE SECURITIES REPRESENTED BY THIS
CERTIFICATE MAY BE TRANSFERRED ONLY IN ACCORDANCE WITH RULE 145(d) OR
PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT OR EXEMPTION FROM
REGISTRATION UNDER THE ACT."
(iii)Unless the transfer by the undersigned of the shares of Merger
Stock is a sale made in conformity with the provisions of Rule 145(d), or
is made pursuant to a registration statement under the Act, Issuer
reserves the right to put an appropriate legend on the certificate issued
to a transferee.
A-57
<PAGE>
In connection with the foregoing, Issuer agrees as follows:
(i) For so long as and to the extent necessary to permit the
undersigned to sell the shares of Merger Stock pursuant to Rule 145 and,
to the extent applicable, Rule 144 under the Act, Issuer shall use
reasonable best efforts to file, on a timely basis, all reports required
to be filed with the SEC by it pursuant to Section 13 of the Exchange Act
of 1934, as amended (the "EXCHANGE ACT"), so long as it is subject to
such requirement.
(ii) Issuer agrees that the stop transfer instructions and legends
referred to above shall be terminated or removed if the undersigned shall
have delivered to Issuer a copy of a letter from the staff of the SEC or
an opinion of counsel with recognized expertise in securities law
matters, in form and substance satisfactory to Issuer, to the effect that
such instructions and legends are not required for the purposes of the
Act.
The undersigned acknowledges that (i) the undersigned has carefully read
this letter and understands the requirements hereof and the limitations imposed
upon the distribution, sale, transfer or other disposition of Merger Stock and
(ii) the receipt by Issuer of this letter is an inducement and a condition to
Issuer's obligations to consummate the Merger. This letter agreement shall be
governed by and construed in accordance with the laws of the State of Delaware.
This letter agreement shall terminate if and when the Merger Agreement is
terminated according to its terms.
Please indicate your agreement with the foregoing by signing the
acknowledgment below on the enclosed copies of this letter, and returning the
same to the undersigned, whereupon this letter agreement shall become an
effective agreement between Issuer and the undersigned.
Very truly yours,
------------------------------------
[Name]
Acknowledged and agreed
as of this ____ day of
______, 2000 by:
Covad Communications Group, Inc.
By:
---------------------------------
Name:
Title:
A-58
<PAGE>
Annex I
[Name] [Date]
On ________________________ , the undersigned sold the shares of common
stock (the "COMMON STOCK") of Covad Communications Group, Inc. described below
in the space provided for that purpose. The Common Stock sold by the undersigned
was received by the undersigned in connection with the merger of BlueStar
Communications Group, Inc. with Covad Acquisition Corp.
Based upon the most recent report or statement filed by the Company with
the Securities and Exchange Commission, the Common Stock sold by the undersigned
was within the proscribed limitations set forth in paragraph (e) of Rule 144
promulgated under the Securities Act of 1933, as amended (the "ACT").
The undersigned hereby represents that the Common Stock was sold in
"brokers' transactions" within the meaning of Section 4(4) of the Act or in
transactions directly with a "market maker" as that term is defined in Section
3(a)(38) of the Securities Exchange Act of 1934, as amended. The undersigned
further represents that the undersigned has not solicited or arranged for the
solicitation of orders to buy the Common Stock, and that the undersigned has not
made any payment in connection with the offer or sale of the Common Stock to any
person other than to the broker who executed the order in respect of such sale.
Very truly yours,
[Space to be provided for number of shares of Common Stock sold]
A-59
<PAGE>
APPENDIX B
FORM OF STOCKHOLDER AGREEMENT
THIS STOCKHOLDER AGREEMENT (this "AGREEMENT") is entered into as of
the 15th day of June, 2000 between Covad Communications Group, Inc., a Delaware
corporation ("PARENT"), and the undersigned stockholder (the "STOCKHOLDER") of
BlueStar Communications Group, Inc., a Delaware corporation (the "COMPANY").
Capitalized terms used herein but not otherwise defined herein shall have their
respective meanings as set forth in the Merger Agreement (as defined below).
RECITALS
WHEREAS, the Company and Parent have entered into an Agreement and
Plan of Merger and Reorganization, dated as of June 15, 2000 (the "MERGER
AGREEMENT"), pursuant to which Covad Acquisition Co., a Delaware corporation and
a direct and wholly owned subsidiary of Parent ("MERGER SUB") will be merged
with and into the Company (the "MERGER");
WHEREAS, upon the consummation of the Merger and in connection
therewith, the undersigned Stockholder will become the owner of shares of Common
Stock of Parent (the "PARENT SHARES");
WHEREAS, as a condition to the execution and delivery of the Merger
Agreement, Parent requires that Stockholder execute and deliver this Stockholder
Agreement containing the terms and conditions set forth herein;
WHEREAS, in order to induce Parent to enter into the Merger Agreement,
the Company has agreed to use its best efforts to solicit the proxy of certain
stockholders of the Company on behalf of Parent, and to cause certain
stockholders of the Company to execute and deliver stockholder agreements to
Parent;
WHEREAS, pursuant to the Merger Agreement, an Escrow Agreement
attached thereto as Exhibit E (the "ESCROW AGREEMENT") shall be entered into
between the Parent, an escrow agent and an agent ("STOCKHOLDERS' AGENT") of the
former stockholders of the Company; and
WHEREAS, the undersigned Stockholder understands and acknowledges that
the Company, Parent and their respective stockholders are entitled to rely on
(x) the truth and accuracy of the undersigned Stockholder's representations
contained herein and (y) the undersigned Stockholder's performance of the
obligations set forth herein.
NOW, THEREFORE, in consideration of the promises and the mutual
agreements, provisions and covenants set forth in the Merger Agreement and in
this Agreement, it is hereby agreed as follows:
1. SHARE OWNERSHIP AND AGREEMENT TO RETAIN SHARES.
1.1 TRANSFER AND ENCUMBRANCE.
(a) Stockholder is the beneficial owner of that number of shares of
Company Capital Stock set forth on the signature page hereto (the "SHARES") and,
except as otherwise set forth on the signature page hereto, (A) has held such
Company Capital Stock at all times since the date set forth on such signature
page, and (B) did not acquire any shares of Company Capital Stock in
contemplation of the Merger. These Shares constitute the Stockholder's entire
interest in the outstanding capital stock of the Company. No other person or
entity not a signatory to this Agreement has a beneficial interest in or a right
to acquire such Shares of Company Capital Stock or any portion of such Shares of
Company Capital Stock (except, with respect to stockholders which are (i)
partnerships, partners of such stockholders, (ii) limited liability companies,
the members of such stockholders and (iii) trusts, the beneficiaries of such
stockholders). The Shares are and will be at all times until the Expiration Date
(as defined below) free and clear of any liens, claims, options, charges or
other encumbrances. The Stockholder's principal residence or place of business
is set forth on the signature page hereto.
(b) Stockholder agrees not to transfer (except as may be specifically
required by court order or by operation of law), sell, exchange, pledge or
otherwise dispose of or encumber the Shares or any New Shares (as defined
below), or to make any offer or agreement relating thereto, at any time prior to
the Expiration Date, unless the transferee agrees in writing to be bound by the
terms hereof. As used herein, the term "EXPIRATION DATE" shall mean the earlier
to occur of (i) the Effective Time of the Merger, and (ii) termination of the
Merger Agreement.
B-1
<PAGE>
1.2 NEW SHARES. Stockholder agrees that any shares of capital stock of
the Company that Stockholder purchases or with respect to which Stockholder
otherwise acquires beneficial ownership after the date of this Agreement and
prior to the Expiration Date ("NEW SHARES") shall be subject to the terms and
conditions of this Agreement to the same extent as if they constituted Shares.
2. AGREEMENT TO VOTE SHARES. Prior to the Expiration Date, at every
meeting of the stockholders of the Company called with respect to any of the
following, and at every adjournment thereof, and on every action or approval by
written resolution of the stockholders of the Company with respect to any of the
following, Stockholder shall vote the Shares and any New Shares in favor of
approval of the Merger and any matter that could reasonably be expected to
facilitate the Merger.
3. IRREVOCABLE PROXY. Stockholder has delivered to Parent a duly
executed proxy in the form attached hereto as ANNEX A (the "PROXY") with respect
to each and every meeting of stockholders of the Company prior to the Expiration
Date or action or approval by written resolution of stockholders of the Company,
such Proxy to cover the total number of Shares and New Shares in respect of
which Stockholder is entitled to vote at any such meeting or in connection with
any such written consent. Upon the execution of this Agreement by the
Stockholder, the Stockholder hereby revokes any and all prior proxies given by
the Stockholder with respect to the subject matter contemplated by Section 2 and
agrees not to grant any subsequent proxies with respect to such subject matter
until after the Expiration Date.
4. REPRESENTATIONS, WARRANTIES AND COVENANTS OF STOCKHOLDER.
Stockholder hereby represents, warrants and covenants to Parent as follows:
(a) The undersigned Stockholder will observe and comply with the
Securities Act and the General Rules and Regulations thereunder, as now in
effect and as from time to time amended and including those hereafter enacted or
promulgated, in connection with any offer, sale, exchange, transfer, pledge or
other disposition of the Parent Shares or any part thereof.
(b) Until the Expiration Date, the Stockholder will not (and will use
such Stockholder's reasonable best efforts (subject to any fiduciary duties as
an officer or director of the Company, if any) to cause the Company, its
affiliates, officers, directors and employees and any investment banker,
attorney, accountant or other agent retained by such Stockholder or them, not
to): (i) initiate or solicit, directly or indirectly, any proposal, plan of
offer to acquire all or any substantial part of the business or properties or
capital stock of the Company, whether by merger, purchase of assets, tender
offer or otherwise, or to liquidate the Company or otherwise distribute to the
Stockholders of the Company all or any substantial part of the business,
properties or capital stock of the Company (each, an "ACQUISITION PROPOSAL");
(ii) initiate, directly or indirectly, any contact with any person in an effort
to or with a view towards soliciting any Acquisition Proposal; (iii) furnish
information concerning the Company's business, properties or assets to any
corporation, partnership, person or other entity or group (other than Parent, or
any associate, agent or representative of Parent) under any circumstances that
could reasonably be expected to relate to an actual or potential Acquisition
Proposal; or (iv) negotiate or enter into discussions or an agreement, directly
or indirectly, with any entity or group with respect of any potential
Acquisition Proposal. In the event the Stockholder shall receive or become aware
of any Acquisition Proposal subsequent to the date hereof, such Stockholder
shall promptly inform Parent as to any such matter and the details thereof to
the extent possible without breaching any other agreement to which such
Stockholder is a party or violating its fiduciary duties.
(c) Stockholder understands that pursuant to the Merger Agreement,
Parent and Stockholder's Agent shall enter into the Escrow Agreement and that
Stockholder shall be bound by the provisions of the Escrow Agreement in the form
attached as an exhibit to the Merger Agreement and Article IX of the Merger
Agreement ("ARTICLE IX"); and as such, Stockholder agrees to appoint a
Stockholder's Agent prior to the closing and further agrees to be bound by the
terms of the Escrow Agreement and Article IX.
(d) Stockholder agrees that for a period of one year after the date
hereof, Stockholder will not encourage or solicit any employee of the Company as
of the date of this Agreement to leave the Company (or Parent after consummation
of the Merger) for any reason or to accept employment with any other company.
B-2
<PAGE>
As part of this restriction, Stockholder will not interview or provide any input
to any third party regarding any such person during the period in question.
5. TAX COVENANTS.
5.1 The Stockholder and Parent agree as follows: to the extent any
payment or benefit to which such Stockholder becomes entitled in connection with
the Merger is determined by Parent's independent auditors within ninety (90)
days of the event that triggers an excess parachute payment to constitute an
excess parachute payment under Section 280G of the Internal Revenue Code, such
Stockholder shall pay to the Internal Revenue Service on or before April 15th of
the year following the year in which such excess parachute payment occurred the
excise tax imposed under Section 4999 of the Internal Revenue Code upon that
excess parachute payment and shall provide to Parent appropriate proof of such
payment. If Stockholder submits in writing at least 45 (forty-five) days prior
to April 15 an excess parachute payment calculation prepared by one of the "Big
Five" accounting firms, at Stockholder's expense, which indicates an excess
parachute payment that is at least 5% less than the excess parachute payment
determined by Parent's independent auditors, then the two accounting firms shall
select a third of the "Big Five" accounting firms to make a final determination
of the excess parachute payment, and such determination shall be binding on all
parties. Stockholder and Parent shall share equally in the costs of the third
accounting firm. Parent shall issue a Form W-2 for the amount of such excess
parachute payment no later than January 31st of the year following the year in
which such excess parachute payment occurred.
6. ADDITIONAL DOCUMENTS; PRIOR AGREEMENTS. Stockholder hereby
covenants and agrees to execute and deliver any additional documents necessary
or desirable, in the reasonable opinion of Parent, to carry out the purpose and
intent of this Agreement. Stockholder also agrees that all the shares of Parent
Common Stock issued in the Merger shall be deemed to satisfy all rights
pertaining to Company Capital Stock and any other rights or agreements relating
thereto shall be of no further force or effect, except as expressly provided for
in the Merger Agreement.
7. CONSENT AND WAIVER; TERMINATION OF EXISTING REGISTRATION RIGHTS
AGREEMENT. Stockholder hereby gives any consents or waivers that are reasonably
required for the consummation of the Merger under the terms of any agreement to
which Stockholder is a party or pursuant to any rights Stockholder may have.
Effective immediately upon the Effective Time of the Merger, any registration
rights that the Stockholder may have prior to the Effective Time will be waived
and terminated.
8. CONFIDENTIALITY. Stockholder agrees (i) to hold any information
regarding this Agreement and the Merger in strict confidence, and (ii) not to
divulge any such information to any third person, until such time as the Merger
has been publicly disclosed by Parent.
9. MISCELLANEOUS.
9.1 SEVERABILITY. If any term, provision, covenant or restriction of
this Agreement is held by a court of competent jurisdiction to be invalid, void
or unenforceable, then the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
9.2 BINDING EFFECT AND ASSIGNMENT. This Agreement and all of the
provisions hereof shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and permitted assigns, but, except as
otherwise specifically provided herein, neither this Agreement nor any of the
rights, interests or obligations of the parties hereto may be assigned by either
of the parties without the prior written consent of the other. This Agreement is
intended to bind Stockholder as a stockholder of the Company only with respect
to the specific matters set forth herein.
9.3 AMENDMENT AND MODIFICATION. This Agreement may not be modified,
amended, altered or supplemented except by the execution and delivery of a
written agreement executed by the parties hereto.
B-3
<PAGE>
9.4 SPECIFIC PERFORMANCE; INJUNCTIVE RELIEF. The parties hereto
acknowledge that Parent will be irreparably harmed and that there will be no
adequate remedy at law for a violation of any of the covenants or agreements of
Stockholder set forth herein. Therefore, it is agreed that, in addition to any
other remedies that may be available to Parent upon any such violation, Parent
shall have the right to enforce such covenants and agreements by specific
performance, injunctive relief or by any other means available to Parent at law
or in equity and the Stockholder hereby waives any and all defenses which could
exist in its favor in connection with such enforcement and waives any
requirement for the security or posting of any bond in connection with such
enforcement.
9.5 NOTICES. All notices, requests, demands or other communications
that are required or may be given pursuant to the terms of this Voting Agreement
shall be in writing and shall be deemed to have been duly given if delivered by
hand or mailed by registered or certified mail, postage prepaid, as follows:
(a) If to the Stockholder, at the address set forth below the
Stockholder's signature at the end hereof.
(b) If to Parent:
Covad Communications Group, Inc.
4520 Burton Drive
Santa Clara, CA 95054
Attention: General Counsel
STOCKHOLDER AGREEMENT
Facsimile No.: (408) 844-7680
WITH A COPY TO:
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017
Attention: John W. Carr, Esq.
Facsimile No.: (212) 455-2502
or to such other address as any party hereto may designate for itself by notice
given as herein provided.
9.6 GOVERNING LAW. This Amendment shall be governed by, construed and
enforced in accordance with the laws of the State of Delaware
applicable to contracts made and to be performed in the State of Delaware.
9.7 ENTIRE AGREEMENT. This Agreement and the Proxy contain the entire
understanding of the parties in respect of the subject matter hereof, and
supersede all prior negotiations and understandings between the parties with
respect to such subject matter.
9.8 COUNTERPART. This Agreement may be executed in several
counterparts, each of which shall be an original, but all of which together
shall constitute one and the same agreement.
9.9 EFFECT OF HEADINGS. The section headings herein are for
convenience only and shall not affect the construction or interpretation of this
Agreement.
B-4
<PAGE>
STOCKHOLDER AGREEMENT
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the date first above written.
COVAD COMMUNICATIONS GROUP, INC. STOCKHOLDER
By: /s/ STEVEN F. FOSTER
---------------------------- -----------------------------------
(Signature)
Name: Crosspoint Venture Partners LS 1999
------------------------- -----------------------------------
(Print Name)
Title:
------------------------ -----------------------------------
(Print Address)
-----------------------------------
(Print Address)
-----------------------------------
(Print Telephone Number)
-----------------------------------
(Social Security or Tax I.D. Number)
Total Number of Shares of Company Capital Stock owned on the date hereof:
Class A Preferred Stock:
--------------------------
Class B Preferred Stock: 1,314,636
--------------------------
Class C Preferred Stock: 573,248
--------------------------
Company Common Stock:
--------------------------
State of Residence:
--------------------------
[SIGNATURE PAGE TO STOCKHOLDER AGREEMENT]
B-5
<PAGE>
STOCKHOLDER AGREEMENT
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the date first above written.
COVAD COMMUNICATIONS GROUP, INC. STOCKHOLDER
By: /s/ ROBERT E. DUPUIS
---------------------------- -----------------------------------
(Signature)
Name: Robert E. Dupuis
------------------------- -----------------------------------
(Print Name)
Title:
------------------------ -----------------------------------
(Print Address)
-----------------------------------
(Print Address)
-----------------------------------
(Print Telephone Number)
-----------------------------------
(Social Security or Tax I.D. Number)
Total Number of Shares of Company Capital Stock owned on the date hereof:
Class A Preferred Stock:
--------------------------
Class B Preferred Stock:
--------------------------
Class C Preferred Stock:
--------------------------
Company Common Stock: 1,000,000
--------------------------
State of Residence:
--------------------------
[SIGNATURE PAGE TO STOCKHOLDER AGREEMENT]
B-6
<PAGE>
STOCKHOLDER AGREEMENT
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the date first above written.
COVAD COMMUNICATIONS GROUP, INC. STOCKHOLDER
By: /s/ LARRY GRAFSTEIN
---------------------------- -----------------------------------
(Signature)
Name: Laurence Grafstein, Managing Director
------------------------- -----------------------------------
(Print Name)
Title:
------------------------ -----------------------------------
(Print Address)
-----------------------------------
(Print Address)
-----------------------------------
(Print Telephone Number)
-----------------------------------
(Social Security or Tax I.D. Number)
Total Number of Shares of Company Capital Stock owned on the date hereof:
Class A Preferred Stock:
--------------------------
Class B Preferred Stock: 2,629,272
--------------------------
Class C Preferred Stock:
--------------------------
Company Common Stock:
--------------------------
State of Residence:
--------------------------
[SIGNATURE PAGE TO STOCKHOLDER AGREEMENT]
B-7
<PAGE>
STOCKHOLDER AGREEMENT
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the date first above written.
COVAD COMMUNICATIONS GROUP, INC. STOCKHOLDER
By: /s/ STEVEN F. FOSTER
---------------------------- -----------------------------------
(Signature)
Name: Crosspoint Venture Partners 1997
------------------------- -----------------------------------
(Print Name)
Title:
------------------------ -----------------------------------
(Print Address)
-----------------------------------
(Print Address)
-----------------------------------
(Print Telephone Number)
-----------------------------------
(Social Security or Tax I.D. Number)
Total Number of Shares of Company Capital Stock owned on the date hereof:
Class A Preferred Stock: 11,020,410
--------------------------
Class B Preferred Stock: 1,552,273
--------------------------
Class C Preferred Stock:
--------------------------
Company Common Stock:
--------------------------
State of Residence:
--------------------------
[SIGNATURE PAGE TO STOCKHOLDER AGREEMENT]
B-8
<PAGE>
STOCKHOLDER AGREEMENT
IN WITNESS WHEREOF, the parties have caused this Agreement to be
executed as of the date first above written.
COVAD COMMUNICATIONS GROUP, INC. STOCKHOLDER
By: /s/ FREDJOSEPH GOLDNER
---------------------------- -----------------------------------
(Signature)
Name: Fredjoseph Goldner
------------------------- -----------------------------------
(Print Name)
Title:
------------------------ -----------------------------------
(Print Address)
-----------------------------------
(Print Address)
-----------------------------------
(Print Telephone Number)
-----------------------------------
(Social Security or Tax I.D. Number)
Total Number of Shares of Company Capital Stock owned on the date hereof:
Class A Preferred Stock:
--------------------------
Class B Preferred Stock:
--------------------------
Class C Preferred Stock:
--------------------------
Company Common Stock: 3,026,978
--------------------------
State of Residence:
--------------------------
[SIGNATURE PAGE TO STOCKHOLDER AGREEMENT]
B-9
<PAGE>
ANNEX A TO STOCKHOLDER AGREEMENT
IRREVOCABLE PROXY
TO VOTE STOCK OF
BLUESTAR COMMUNICATIONS GROUP, INC.
Capitalized terms used herein but not otherwise defined herein shall have
their respective meanings as set forth in the Merger Agreement (as defined
below).
The undersigned stockholder of BlueStar Communications Group, Inc., a
Delaware corporation (the "COMPANY"), hereby irrevocably (to the fullest extent
permitted by Delaware Law) appoints the members of the Board of Directors of
Covad Communications Group, Inc., a Delaware corporation ("PARENT"), and each of
them, or any other designee of Parent, as the sole and exclusive attorneys and
proxies of the undersigned, with full power of substitution and resubstitution,
to vote and exercise all voting rights (to the fullest extent that the
undersigned is entitled to do so) with respect to all the shares of capital
stock of the Company that now are or hereafter may be owned of record by the
undersigned, and any and all other shares or securities of the Company issued or
issuable in respect thereof on or after the date hereof (collectively, the
"SHARES") in accordance with the terms of this Irrevocable Proxy. The Shares
beneficially owned by the undersigned stockholder of Company as of the date of
this Irrevocable Proxy are listed on the final page of this Irrevocable Proxy.
Upon the undersigned's execution of this Irrevocable Proxy, any and all prior
proxies given by the undersigned with respect to any Shares are hereby revoked
and the undersigned agrees not to grant any subsequent proxies with respect to
the Shares until after the Expiration Date (as defined below).
This Irrevocable Proxy is irrevocable (to the extent permitted by Delaware
Law), is coupled with an interest, and is granted in consideration of Parent
entering into that certain Agreement and Plan of Merger and Reorganization
between the Company and Parent (the "MERGER AGREEMENT"), which agreement
provides for the merger of Covad Acquisition Corporation, a Delaware corporation
and a direct and wholly owned subsidiary of Parent ("MERGER SUB") with and into
the Company (the "MERGER"). As used herein, the term "EXPIRATION DATE" shall
mean the earlier to occur of (i) such date and time as the Merger shall become
effective in accordance with the terms and provisions of the Merger Agreement,
and (ii) the date of termination of the Merger Agreement.
The attorneys and proxies named above, and each of them are hereby
authorized and empowered by the undersigned, at any time prior to the Expiration
Date, to act as the undersigned's attorney and proxy to vote the Shares, and to
exercise all voting and other rights of the undersigned with respect to the
Shares (including, without limitation, the power to execute and deliver written
consents pursuant to Delaware Law), at every annual, special or adjourned
meeting of the stockholders of the Company and in every written consent in lieu
of such meeting as follows: (a) in favor of approval of the Merger and the
Merger Agreement and (b) in favor of any matter that could reasonably be
expected to facilitate the Merger.
The attorneys and proxies named above may not exercise this Irrevocable
Proxy on any other matter except as provided above. The undersigned stockholder
may vote the Shares on all other matters.
All authority herein conferred shall survive the death or incapacity of the
undersigned and any obligation of the undersigned hereunder shall be binding
upon the heirs, personal representatives, successors and assigns of the
undersigned.
B-10
<PAGE>
The Irrevocable Proxy is coupled with an interest as aforesaid and is
irrevocable.
Dated:________________, 2000
------------------------------------------
(Signature of Stockholder)
------------------------------------------
(Print Name of Stockholder)
Shares owned of record:
______ shares of Class A Preferred Stock
______ shares of Class B Preferred Stock
______ shares of Class C Preferred Stock
______ shares of Common Stock
[SIGNATURE PAGE TO IRREVOCABLE PROXY]
B-11
<PAGE>
APPENDIX C
FORM OF STOCK RESTRICTION AGREEMENT
AGREEMENT dated as of ________________, among Covad
Communications Group, Inc. a Delaware corporation ("PARENT") and the parties
listed on Schedule A hereto (collectively, the "STOCKHOLDERS").
BACKGROUND
WHEREAS, Parent, Covad Acquisition Corp., a Delaware
corporation and a direct, wholly owned subsidiary of Parent ("MERGER SUB") and
BlueStar Communications Group, Inc., a Delaware corporation (the "COMPANY") have
entered into an Agreement and Plan of Merger and Reorganization (the "MERGER
AGREEMENT"), dated as of June 15, 2000, pursuant to which Merger Sub will be
merged into the Company and shares of capital stock of the Company will be
converted into the right to receive shares of the Common Stock, par value $0.001
per share, of Parent ("PARENT COMMON STOCK");
WHEREAS, pursuant to the Merger Agreement Parent has agreed to
assume certain options to purchase shares in the Company ("COMPANY OPTIONS");
WHEREAS, Parent and the Stockholders desire to establish in
this Agreement certain terms and conditions concerning, among other things, the
disposition of Parent Common Stock.
In consideration of the mutual covenants and agreements herein
contained, the parties to this Agreement hereby agree as follows:
AGREEMENT
ARTICLE 1: REPRESENTATIONS AND WARRANTIES
1.1 REPRESENTATIONS AND WARRANTIES OF THE STOCKHOLDERS.
Each Stockholder, severally and not jointly, represents and warrants to Parent
and Merger Sub as follows:
(1) AUTHORITY; ENFORCEABILITY. Such Stockholder has the legal
capacity (in the case of Stockholders that are natural persons) and all
requisite power and authority to enter into this Agreement, to perform its
obligations hereunder and to consummate the transactions contemplated hereby.
This Agreement has been duly authorized, executed and delivered by such
Stockholder and constitutes a valid and binding obligation of such Stockholder
enforceable against it in accordance with its terms.
(2) NO CONFLICTS. Except for filings required under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 as amended (the "HSR ACT"),
the applicable requirements of the Securities Act and the Exchange Act, and the
applicable requirements of state securities, blue sky or takeover or other
corporate laws, (A) no filing with, and no permit, authorization, consent or
approval of, any court, administrative agency or commission or other
governmental authority or instrumentality or any other person is necessary for
the execution of this Agreement by such Stockholder and the consummation by it
of the transactions contemplated hereby, and (B) the execution and delivery of
this Agreement by such Stockholder, the consummation of the transactions
contemplated hereby and compliance with the terms hereof by such Stockholder
will not conflict with, or result in any violation of, or default (with or
without notice or lapse of time or both) under any provision of, the certificate
of incorporation, by-laws or analogous documents of such Stockholder (if the
Stockholder is not a natural person) or any other agreement to which such
Stockholder is a party, including any voting agreement, Stockholders agreement,
voting trust, trust agreement, pledge agreement, loan or credit agreement, note,
bond, mortgage, indenture, lease or other agreement, instrument, permit,
concession, franchise or license, or violate any judgment, order, notice,
decree, statute, law, ordinance, rule or regulation applicable to such
Stockholder or to its property or assets.
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(3) OWNERSHIP, ETC. OF SHARES. Such Stockholder is the
beneficial owner of the number of shares of Company Common Stock set forth
opposite such Stockholder's name under the Column "Owned Shares" on Schedule A
(collectively, the "OWNED SHARES"). Such Stockholder has good and marketable
title to its Owned Shares, free and clear of any encumbrances, agreements,
adverse claims, liens or other arrangements with respect to the ownership of or
the right to vote or dispose of its Owned Shares (other than under this
Agreement). On the date hereof, the Owned Shares constitute all of the
outstanding shares of Company Common Stock owned of record or beneficially by
such Stockholder. Such Stockholder does not have record or beneficial ownership
of any Shares not set forth on Schedule A, as applicable. Such Stockholder has
sole power of disposition with respect to all of its Owned Shares and sole
voting power with respect to the matters set forth in Section 1.1(a) and sole
power to demand dissenter's or appraisal rights, in each case with respect to
all of its Owned Shares, with no restrictions on such rights, subject to
applicable federal securities laws and the terms of this Agreement. None of such
Owned Shares is subject to any voting trust, stockholders agreement or other
agreement, arrangement or restriction with respect to the voting or transfer of
any of the Owned Shares, except as contemplated by this Agreement and the Merger
Agreement.
ARTICLE 2: TRANSFER RESTRICTIONS
2.1 TRANSFER RESTRICTIONS. (a) Each Stockholder hereby agrees
during the Restricted Period (as herein defined) not to (i) directly or
indirectly sell, transfer, pledge, encumber, assign or otherwise dispose of
(including by gift) (collectively, "TRANSFER"), or enter into any contract,
option or other arrangement or understanding (including any profit sharing
arrangement) with respect to the Transfer of, any of its Restricted Securities
(as herein defined) to any person other than pursuant to the terms of the Merger
Agreement or this Agreement, (ii) enter into any voting arrangement or
understanding other than under this Agreement or pursuant to the Merger
Agreement, whether by proxy, voting agreement or otherwise, with respect to any
of its Restricted Securities, or (iii) take any action that would make any of
its representations or warranties contained herein untrue or incorrect or have
the effect of preventing or impeding such Stockholder from performing any of its
obligations under this Agreement.
(b) For the purposes of this Section 2.1, (i) the
"RESTRICTED PERIOD" shall mean (x) for those persons listed on Schedule B
hereto, a period of 12 months from the Effective Time, or (y) for all other
Stockholders, a period of 6 months from the Effective Time, PROVIDED that the
Restricted Period shall terminate upon any Change in Control; (ii) "RESTRICTED
SECURITIES" shall include (w) each Owned Share, (x) each share of Parent Common
Stock into which such Owned Shares may be converted pursuant to the Merger
Agreement, (y) each Company Option, and (z) each share of Parent Common Stock
obtained on the exercise of a Company Option, held by the Stockholder (each, an
"OPTION SHARE").
2.2 LEGEND. If, at any time prior to the termination of
this Agreement, shares of Parent Common Stock are issued in certificate form to
Stockholders in respect of Restricted Securities or, if applicable, issued upon
the exercise of the Accelerated Portion (as defined below) of Company Options,
then each certificate representing such securities shall bear the following
legend on the face thereof:
"THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO A STOCK
RESTRICTION AGREEMENT DATED AS OF __________, 2000 AMONG COVAD
COMMUNICATIONS GROUP, INC. AND THE LISTED STOCKHOLDERS THEREIN, A COPY
OF WHICH IS ON FILE WITH THE SECRETARY OF COVAD COMMUNICATIONS GROUP,
INC. NO TRANSFER, SALE, ASSIGNMENT, PLEDGE, HYPOTHECATION OR OTHER
DISPOSITION OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY BE
MADE EXCEPT IN ACCORDANCE WITH THE PROVISIONS OF SUCH STOCK RESTRICTION
AGREEMENT. THE HOLDER OF THIS CERTIFICATE, BY ACCEPTANCE OF THIS
CERTIFICATE, AGREES TO BE BOUND BY ALL OF THE PROVISIONS OF SUCH STOCK
RESTRICTION AGREEMENT."
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ARTICLE 3: OPTIONS
3.1 PARENT'S OPTION TO REPURCHASE SHARES AND OPTIONS OF
MANAGEMENT STOCKHOLDER. (a) If, during the term of this Agreement, (x) Parent,
the Company or the Surviving Corporation, or any of their subsidiaries, as
applicable, terminate an Employee's (as herein defined) employment for
Misconduct (as herein defined), or (y) an Employee voluntarily terminates his or
her employment for any reason, then Parent (or its designated assignee) shall
have the right, for a period of 90 days after termination of the Employee's
employment, to purchase:
(i) all or any portion of the Accelerated
Options (as hereinafter defined), at a purchase price equal
to $0.01 for each share of Parent Common Stock subject to
the Accelerated Options; and
(ii) all or any portion of the Accelerated
Option Shares (as hereinafter defined) then held by the
Employee, at a per share purchase price equal to the per share
purchase price paid by the Employee upon exercise of the
applicable Accelerated Option.
(b) The completion of the purchases pursuant to this Article
3 shall take place at the principal office of Parent on the tenth business day
after the giving of notice.
(c) In determining the purchase price, appropriate
adjustments shall be made for any share dividends, splits, combinations,
recapitalizations or any other adjustment in the number of outstanding Parent
Common Stock shares in order to maintain, as nearly as practicable, the intended
operation of the provisions of this Article 3.
(d) Notwithstanding anything in Section 3.1(a) to the
contrary, if there exists and is continuing a default or an event of default on
the part of Parent under any loan, guarantee or other agreement under which
Parent has borrowed money or if the repurchase referred to in Section 3.1(a)
would result in a default or an event of default on the part of Parent under any
such agreement or if a repurchase would not be permitted under the Delaware
General Corporation Law (the "DGCL") or would otherwise violate the DGCL (or if
Parent reincorporates in another state, the business corporation law of such
state) (each such occurrence being an "EVENT"), Parent shall not be obligated to
repurchase any of the Accelerated Portion from the Employee, until the first
business day which is 10 calendar days after all of the foregoing Events have
ceased to exist; PROVIDED, HOWEVER, that (i) the number of shares of Stock
subject to repurchase under this Section 3.1(c) shall be that number of
Accelerated Option Shares, and (ii) in the case of a repurchase pursuant to
Section 3.1(a)(i), the number of Accelerated Options shall be the number of
Accelerated Options, specified in the notice given by Parent to the Employee of
its intent to exercise its rights pursuant to Section 3.1(a) (the "NOTICE"), and
held by the Employee, at the time of delivery of such Notice. All Accelerated
Options exercisable as of the date Parent provides the Notice shall continue to
be exercisable until the repurchase of such Options pursuant to such Notice,
provided that to the extent any Accelerated Options are exercised after the date
of such Notice, the number of Accelerated Option Shares, for purposes of
calculating the purchase price pursuant to Section 3.1(a)(ii) shall be reduced
accordingly.
3.2 VESTING OF OPTIONS OR RELEASE OF SHARES NOT ACCELERATED
DUE TO DISMISSAL FOR MISCONDUCT OR VOLUNTARY DEPARTURE. If, during the term of
this Agreement, (x) Parent, the Company or the Surviving Corporation (as
applicable) terminates an Employee for Misconduct (as herein defined), or (y) an
Employee voluntarily terminates his or her employment for any reason, (i) there
shall be no accelerated vesting of any of that Employee's Company Options,
notwithstanding any other option or employment agreement or stock option plan
which would otherwise entitle the Employee to such accelerated vesting, and each
Employee hereby waives any right to any such acceleration in any such
circumstances, and (ii) there shall be no accelerated release of, or release
from repurchase rights in respect of, any of that Employee's Parent Common Stock
or any other equity of the Company or the Surviving Corporation or any of their
subsidiaries held by the Employee, pursuant to any stock purchase or employment
agreement or Company Stock Plan which would otherwise entitle the Employee to
such an accelerated release, and each Employee hereby waives any right to any
such acceleration in any such circumstances.
3.3 TERMINATION ON CHANGE IN CONTROL. Sections 3.1 and 3.2
shall terminate in the event of a Change in Control.
3.4 DEFINITIONS. For the purposes of this Article 3,
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"ACCELERATED OPTIONS" shall mean, with respect to any Company
Option, the portion of such Option that shall have become exercisable,
as of the Effective Date, as a result of the consummation of the Merger
pursuant to the terms of the Company Stock Plan, but which, as of the
date Parent exercises its rights pursuant to Section 3.1 of this
Agreement, the Management Stockholder has not yet exercised.
"ACCELERATED OPTION SHARES" shall mean any Option Shares
acquired by the Management Stockholder pursuant to the exercise of an
Accelerated Option.
"ACCELERATED PORTION" shall mean, collectively, the
Accelerated Options and the Accelerated Option Shares.
"MANAGEMENT STOCKHOLDER" shall mean each of the persons
designated as such in Schedule B hereto who are also listed on Schedule
A hereto.
"MISCONDUCT" shall mean, with respect to any Stockholder who
is an employee of Parent, the Company or the Surviving Corporation
(each, an "EMPLOYEE"), (i) the commission of any act of fraud,
embezzlement or dishonesty by the Employee, (ii) any unauthorized use
or disclosure by such person of confidential information or trade
secrets of Parent, the Company or the Surviving Corporation (or any
parent or subsidiary thereof), (iii) any intentional wrongdoing by such
person, whether by omission or commission, which adversely affects the
business or affairs of Parent, the Company or the Surviving Corporation
(or any parent or subsidiary thereof) in a material manner, or (iv) the
failure of the Employee to substantially perform his or her duties and
responsibilities, after Notice and the Cure Period, in the good faith
determination of the Employee's Supervisor. Reasons for such
termination shall be set forth in the Termination Notice. For purposes
of this definition, "NOTICE" shall mean thirty (30) days' prior written
notice to the Employee from the Employee's Supervisor of such
Supervisor's determination of the Employee's failure to substantially
perform his or her duties, specifying the basis for such determination
and the particulars thereof, "CURE PERIOD" means the thirty (30) day
period immediately following the date the Employee receives the Notice,
during which time the Employee shall have the opportunity to cure or
otherwise resolve the behavior in question, "SUPERVISOR" means the
person or committee directly responsible, pursuant to the Corporation's
rules, by-laws, policies, practices and/or procedures, for supervising,
providing orders and directions to the Employee, and for making all
related decisions regarding the termination of the employment of the
Employee, and "TERMINATION NOTICE" shall mean written notice, delivered
to the Employee following the Cure Period, which sets forth the basis
on which the Supervisor is, in his, her or its good faith
determination, terminating the employment of the Employee. The
foregoing shall not in any way limit the grounds for the dismissal or
discharge of any person in the service of Parent, the Company or the
Surviving Corporation (or any parent or subsidiary thereof).
ARTICLE 4: COVENANTS
4.1 FURTHER ASSURANCES. Each of the parties hereto agrees that
it will, from time to time, execute and deliver, or cause to be executed and
delivered, such additional or further consents, documents and other instruments
as any of the other parties to this Agreement may reasonably request for the
purpose of effectively carrying out the transactions contemplated by this
Agreement.
ARTICLE 5: MISCELLANEOUS
5.1 ASSIGNMENT. Neither this Agreement nor any of the rights,
interests or obligations hereunder may be assigned by any of the parties hereto
without the prior written consent of the other parties hereto. Subject to the
preceding sentence, this Agreement will be binding upon, inure to the benefit of
and be enforceable by the parties hereto and their respective successors and
permitted assigns.
5.2 TERMINATION. This Agreement will terminate, and no party
hereto shall have any rights or obligations hereunder, upon the first to occur
of (a) the first anniversary of the Effective Time of the Merger, or (b) the
termination of the Merger Agreement in accordance with its terms.
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5.3 ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes all other prior agreements and understandings, including any written
or oral agreement or understanding, among or between the parties with respect to
the subject matter hereof.
5.4 AMENDMENTS. This Agreement may not be amended except by an
instrument in writing signed by each of the parties hereto whose rights or
obligations are affected by such amendment. Without limiting the generality of
the foregoing, this Agreement may be amended to add to or subtract from the list
of Stockholders and/or to modify the treatment of Stockholders' holdings as set
forth on Schedule A, and such amendment need only be executed by Parent and
those Stockholders who are being added to or subtracted from the list of
Stockholders or the treatment of whose holdings is being modified as set forth
on Schedule A.
5.5 NOTICES. All notices, requests, claims, demands and other
communications hereunder shall be in writing and shall be given (and shall be
deemed to have been duly given upon receipt) by delivery in person, by telecopy
or by registered or certified mail (postage prepaid, return receipt requested)
to the respective parties at the following addresses (or at such other address
for a party as shall be specified by like notice):
STOCK RESTRICTION AGREEMENT
if to Parent or Merger Sub:
Covad Communications Group, Inc.
4520 Burton Drive
Santa Clara, CA 95054
Attention: General Counsel
Facsimile: (408) 987
WITH A COPY TO:
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, New York 10017
Attention: John W. Carr, Esq.
Facsimile: (212) 455-2502
if to the Company:
BlueStar Communications Group, Inc.
41 Union Street, Suite 900
Nashville, TN 37219
Attention: Robert E. Dupuis
Facsimile: (615) 346 - 3875
WITH A COPY TO:
Brobeck, Phleger & Harrison LLP
301 Congress Avenue, Suite 1200
Austin, Texas 78701
Attention: Carmelo M. Gordian, Esq.
Facsimile: (512) 477-5813
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if to the Stockholders:
c/o BlueStar Communications Group, Inc.
BlueStar Communications Group, Inc.
41 Union Street, Suite 900
Nashville, TN 37219
Attention: Robert E. Dupuis
Facsimile: (615) 346-3875
WITH A COPY TO:
Brobeck, Phleger & Harrison LLP
301 Congress Avenue, Suite 1200
Austin, Texas 78701
Attention: Carmelo M. Gordian, Esq.
Facsimile: (512) 477-5813
5.6 INTERPRETATION. (a) When a reference is made in this
Agreement to Sections, such reference shall be to a Section of this Agreement
unless otherwise indicated. The headings contained in this Agreement are for
reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement. Wherever the words "include", "includes" or
"including" are used in this Agreement, they shall be deemed to be followed by
the words "without limitation."
(b) Unless otherwise defined, all capitalized terms used
herein are to be interpreted as defined in the Merger Agreement.
5.7 COUNTERPARTS. This Agreement may be executed in one or
more counterparts, all of which shall be considered one and the same agreement.
5.8 GOVERNING LAW. This Agreement shall be governed by, and
construed in accordance with, the laws of the State of Delaware.
5.9 ENFORCEMENT. The parties agree that irreparable damage
would occur in the event that any of the provisions of this Agreement were not
performed in accordance with their specific terms or were otherwise breached. It
is accordingly agreed that, in addition to any other remedy to which it may be
entitled, at law or in equity, the parties shall be entitled to the remedy of
specific performance of the covenants and agreements contained herein and
injunctive and other equitable relief.
5.10 NO TERMINATION OR CLOSURE OF TRUSTS. Unless, in
connection therewith, the Shares held by any trust which are presently subject
to the terms of this Agreement are transferred upon termination to one or more
Stockholders and remain subject in all respects to the terms of this Agreement,
the Stockholders who are trustees shall not take any action to terminate, close
or liquidate any such trust and shall take all steps necessary to maintain the
existence thereof at least until the termination of this Agreement.
5.11 PARTIES IN INTEREST. This Agreement shall be
binding upon and inure solely to the benefit of each party hereto. Except as
provided in the preceding sentence, nothing in this Agreement, express or
implied, is intended to or shall confer upon any other person any rights,
benefits or remedies or any nature whatsoever under or by reason of this
Agreement.
5.12 DESCRIPTIVE HEADINGS. The descriptive headings used
herein are inserted for convenience of reference only and are not intended to be
part of or to affect the meaning or interpretation of this Agreement.
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5.13 SEVERABILITY. Whenever possible, each provision or
portion of any provision of this Agreement will be interpreted in such manner as
to be effective and valid under applicable law, but if any provision or portion
of any provision of this Agreement is held to be invalid, illegal or
unenforceable in any respect under any applicable law or rule in any
jurisdiction, such invalidity, illegality or unenforceability will not affect
any other provision or portion of any provision in such jurisdiction, and this
Agreement will be reformed, construed and enforced in such jurisdiction as if
such invalid, illegal or unenforceable provision or portion of any provision had
never been contained herein.
5.14 DEFINITIONS; CONSTRUCTION. For purposes of this Agreement:
(1) "BENEFICIALLY OWN" or "BENEFICIAL OWNERSHIP" with
respect to any securities shall mean having "beneficial ownership" of
such securities (as determined pursuant to Rule 13d-3 under the
Exchange Act), including pursuant to any agreement, arrangement or
understanding, whether or not in writing. Without duplicative counting
of the same securities by the same holder, securities Beneficially
Owned by a Person shall include securities Beneficially Owned by all
other Persons with whom such Person would constitute a "group" as
described in Section 13(d)(3) of the Exchange Act.
(b) "CHANGE IN CONTROL," shall mean any of the
following: (i) a merger, consolidation or other business combination
or transaction to which Parent is a party if the stockholders of
Parent immediately prior to the effective date of such merger,
consolidation or other business combination or transaction, as a
result of such merger, consolidation or other business combination or
transaction, do not have Beneficial Ownership of voting securities
representing 50% or more of the total current voting power of the
resulting corporation (or its parent corporation) following such
merger, consolidation or other business combination or transaction;
(ii) an acquisition by any Person of Beneficial Ownership of voting
stock of Parent representing 50% or more of the total current voting
power of Parent; (iii) a sale of all or substantially all the
consolidated assets of Parent to any Person or Persons (other than
Parent or its subsidiaries); or (iv) a liquidation or dissolution of
Parent.
(c) "PERSON" shall mean an individual, corporation,
partnership, joint venture, association, trust, unincorporated
organization or other entity.
(e) In the event of a stock dividend or distribution,
or any change in the Company Common Stock by reason of any stock
dividend, split-up, recapitalization, combination, exchange of shares
or the like, the term "RESTRICTED SECURITIES" shall be deemed to refer
to and include the restricted Securities as well as all such stock
dividends and distributions and any shares into which or for which any
or all of the shares may be changed or exchanged.
5.15 STOCKHOLDER CAPACITY. Notwithstanding anything herein to
the contrary, no person executing this Agreement who is, or becomes during the
term hereof, a director of the Company makes any agreement or understanding
herein in his capacity as such a director, and the agreements set forth herein
shall in no way restrict any director in the exercise of his fiduciary duties as
a director of the Company. Each Stockholder has executed this Agreement solely
in his capacity as the record or beneficial holder of such Stockholder's Owned
Shares and/or Company Options or as the trustee of a trust whose beneficiaries
are the beneficial owners of such Stockholder's Owned Shares and/or Company
Options.
IN WITNESS WHEREOF, Parent and the Stockholders listed below
have caused this Agreement to be duly executed, as of the date first written
above.
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STOCK RESTRICTION AGREEMENT
SIGNATURE PAGE TO STOCK RESTRICTION AGREEMENT
COVAD COMMUNICATIONS GROUP, INC.
By:_____________________________
Name:
Title:
AGREED AND ACCEPTED AS OF
THE DATE FIRST SET FORTH ABOVE
By:
Name:
Total Number of Owned Shares:
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SCHEDULE A: STOCKHOLDERS
Name of Total Number of
Stockholder Owned Shares
------------------------------ ---------------------------------
Total......................... =================================
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SCHEDULE B: MANAGEMENT STOCKHOLDERS
Name of Stockholder Name of Stockholder
------------------------------ ---------------------------------
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APPENDIX D
FORM OF ESCROW AGREEMENT
THIS ESCROW AGREEMENT is made as of _____, 2000, by and among
____________ ("ESCROW AGENT"), Covad Communications Group, Inc.
a Delaware corporation ("PARENT"), and Christopher Lord, as agent
("STOCKHOLDERS' AGENT") of the former stockholders of BlueStar Communications
Group, Inc., a Delaware corporation (the "COMPANY"). Capitalized terms not
otherwise defined herein shall have the meaning set forth in the Merger
Agreement (as defined below).
WITNESSETH
WHEREAS, Parent and the Company have entered into an Agreement and Plan of
Merger and Reorganization (the "MERGER AGREEMENT"), dated as of June 15, 2000,
providing for the merger of Covad Acquisition Corporation, a Delaware
corporation and a direct, wholly owned subsidiary of Parent ("MERGER SUB"), with
and into the Company (the "MERGER"); and
WHEREAS, pursuant to Article IX of the Merger Agreement, a copy of which is
attached hereto as Annex A (" ARTICLE IX"), an escrow fund (the "ESCROW FUND")
will be established to compensate Parent for certain Damages (as defined in
Article IX) arising out of any misrepresentation or breach of or default in
connection with any of the representations, warranties, covenants and agreements
given or made by the Company in the Merger Agreement, the Company Disclosure
Schedules or any exhibit or schedule to the Merger Agreement; and
WHEREAS, the Stockholders' Agent has been constituted as agent for and on
behalf of the former stockholders of the Company (individually a "STOCKHOLDER"
and collectively the "STOCKHOLDERS") to undertake certain obligations specified
in Article IX;
WHEREAS, the Merger Agreement provides for an Escrow Fund of 800,000 shares
(which number shall be adjusted in the manner as provided for in Section 2.2(b)
of the Merger Agreement), such escrow to be held by the Escrow Agent; and
WHEREAS, pursuant to the Merger Agreement, an earn-out escrow fund (the
"EARN-OUT FUND") will be established to hold certain Additional Shares (as
defined in the Merger Agreement) until their distribution in accordance with
Section 2.7 of the Merger Agreement, including the distribution of a portion of
such Additional Shares into the Escrow Fund;
WHEREAS, the parties hereto desire to set forth further terms and
conditions in addition to those set forth in Article IX relating to the
operation of the Escrow Fund and the Earn-Out Fund.
NOW, THEREFORE, the parties hereto, in consideration of the mutual
covenants contained herein, and intending to be legally bound, hereby agree as
follows:
1. ESCROW AND ESCROW SHARES.
Pursuant to Article IX, Parent shall deposit in escrow with the Escrow
Agent, as escrow agent, within five (5) business days of the Effective Time (as
defined in the Merger Agreement) of the Merger, a stock certificate or
certificates representing 800,000 shares (which number shall be adjusted in the
manner as provided for in Section 2.2(b) of the Merger Agreement) (the "ESCROW
SHARES") which shall be registered in the name of the Escrow Agent as nominee
for the beneficial owners of such shares and constitute the Escrow Fund. The
Escrow Shares shall be held and distributed by the Escrow Agent in accordance
with the terms and conditions of Article IX and this Agreement. The number of
Escrow Shares beneficially owned by each Stockholder, the percentage interest of
each Stockholder in the Escrow Fund, the address of each Stockholder and the
taxpayer identification of each stockholder are set forth in Annex B attached
hereto, as amended from time to time.
2. EARN-OUT ESCROW SHARES.
Pursuant to Section 2.7, Parent shall deposit in escrow with the Escrow
Agent, as escrow agent, within five (5) business days of the Effective Time (as
defined in the Merger Agreement) of the Merger, a stock certificate or
certificates representing 5,000,000 shares (which number shall be adjusted in
the manner as provided for in Section 2.2(b) of the Merger Agreement) (the
"EARN-OUT ESCROW SHARES") which shall represent the Additional Shares issued
pursuant to the Merger Agreement, be registered in the name of the Escrow Agent
as nominee for
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Parent and constitute the Earn-Out Fund. The Earn-Out Escrow Shares shall be
held until the Earn-Out Distribution Date and thereupon distributed by the
Escrow Agent in accordance with the terms and conditions of the Merger Agreement
and this Agreement.
3. RIGHTS AND OBLIGATIONS OF THE PARTIES.
The Escrow Agent shall be entitled to such rights and shall perform such
duties of the escrow agent as set forth herein and in Article IX (collectively,
the "DUTIES") in relation to each Fund in accordance with the terms and
conditions of this Agreement, Article IX and the Earn-Out Provisions. Parent,
the Company and the Stockholders' Agent shall be entitled to their respective
rights and shall perform their respective duties and obligations as set forth
herein and in Article IX and the Earn-Out Provisions, in accordance with the
terms hereof and thereof. In the event that the terms of this Agreement conflict
in any way with the provisions of Article IX or the Earn-Out Provisions, Article
IX or the Earn-Out Provisions, as the case may be, shall control.
4. ESCROW PERIOD.
The Escrow Period for the Escrow Fund shall terminate on the one-year
anniversary of the Effective Time; PROVIDED, HOWEVER, that a portion of the
Escrow Shares, which (as set forth in a Certificate of Parent) are necessary to
satisfy any unsatisfied claims specified in any Officer's Certificate delivered
to the Escrow Agent prior to termination of the Escrow Period with respect to
facts and circumstances existing prior to expiration of the Escrow Period, shall
remain in the Escrow Fund until such claims have been resolved, and PROVIDED
that if there is any pending claim against the Escrow Fund pursuant to Section
9.5 at the Earn Out Distribution Date, a number of shares from the Earn-Out Fund
of adequate value (in combination with any amount remaining in the Escrow Fund)
to satisfy all such pending claims, to a maximum of ten percent (10%) of the
Earn-Out Shares, shall be deposited into the Escrow Fund with the Escrow Agent
and made available for the satisfaction of any such claim until all such claims
are finally satisfied or resolved.
5. DUTIES OF ESCROW AGENT IN RELATION TO ESCROW FUND.
In addition to the Duties set forth in Article IX, the Duties of the Escrow
Agent in relation to the Escrow Fund shall include the following:
(a) The Escrow Agent shall hold and safeguard the Escrow Shares
during the Escrow Period, shall treat such Escrow Fund as a trust fund in
accordance with the terms of this Agreement and Article IX and not as the
property of Parent, and shall hold and dispose of the Escrow Shares only
in accordance with the terms hereof.
(b) The Escrow Shares shall be voted by the Escrow Agent in
accordance with the instructions received by the Escrow Agent from the
beneficial owners of such shares. In the absence of such instructions,
the Escrow Agent shall be under no obligation to vote such shares. The
Escrow Agent need not forward proxy information, annual or other reports
or other information received from Parent with respect to the Escrow
Shares.
(c) Promptly following termination of the Escrow Period as set
forth in Section 3 hereof, the Escrow Agent (i) shall deposit with the
Parent's stock transfer agent (which is currently Boston EquiServe L.P.)
the number of Escrow Shares and other property in the Escrow Fund in
excess of the amount of such Escrow Shares or other property (as set
forth in a certificate of the Parent) as being sufficient to satisfy any
unsatisfied claims specified in any Officer's Certificate theretofore
delivered to the Escrow Agent prior to termination of the Escrow Period
with respect to facts and circumstances existing prior to expiration of
the Escrow Period and (ii) shall cause such transfer agent to transfer
such Escrow Shares and other property to the Stockholders. As soon as all
those claims referenced in clause (i) above have been resolved, the
Escrow Agent shall cause such transfer agent to deliver to such
Stockholders all of the Escrow Shares and other property remaining in the
Escrow Fund and not required to satisfy such claims and expenses. Each
Stockholder shall receive that number of Escrow Shares equivalent to such
Stockholder's percentage interest in the Escrow Fund as set forth in
Annex A hereto, as amended from time to time.
(d) Pursuant to Section 9.5(b) of the Merger Agreement, for the
purpose of compensating Parent for its Damages pursuant to this
Agreement, the Parent Common Stock in the Escrow Fund shall be valued
based on the average closing price for Parent Common Stock for the 20
trading days immediately prior to the date that an indemnification claim
is made (the "PARENT STOCK PRICE"). Parent shall set forth the Parent
Stock Price in a Certificate delivered to the Escrow Agent. If the value
to be distributed to Parent (or to any Stockholder
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<PAGE>
upon a termination of the escrow) is not evenly divisiblse by the Parent
Stock Price, the Escrow Agent shall round down the number of shares to be
distributed to the next highest number of shares and shall cause the
transfer agent of the Escrow Shares to distribute that number. In lieu of
the fractional interest not distributed, Parent shall furnish to the
Escrow Agent, and the Escrow Agent (or such stock transfer agent) in turn
will distribute to Parent (or to any stockholder), cash equal to such
fractional interest times the Parent Stock Price. Parent shall be deemed
to have purchased such fractional interests with respect to which it has
furnished funds to the Escrow Agent. Accordingly, the Escrow Agent, upon
receipt of such funds, shall deliver the corresponding number of shares
to Parent. In all events, Parent shall so purchase only a whole number of
shares. Any cash so received from Parent and not so immediately
distributed by the Escrow Agent shall be retained by the Escrow Agent as
part of the Escrow Fund, but need not be invested.
6. DUTIES OF ESCROW AGENT IN RELATION TO EARN-OUT FUND.
In addition to the Duties set forth in Article IX, the Duties of the Escrow
Agent in relation to the Earn-Out Fund shall include the following:
(a) The Escrow Agent shall hold and safeguard the Earn-Out Escrow
Shares until distributed pursuant to the Merger Agreement, shall treat
such Earn-Out Fund as a trust fund in accordance with the terms of this
Agreement and Article IX with Parent as the beneficial owner, and shall
hold and dispose of the Earn-Out Escrow Shares only in accordance with
the terms hereof.
(b) The Earn-Out Escrow Shares shall be voted by the Escrow Agent
in accordance with the instructions received by the Escrow Agent from
Parent. In the absence of such instructions, the Escrow Agent shall be
under no obligation to vote such shares.
(c) At the Earn-Out Distribution Date, the Escrow Agent (i) shall
deposit with the Parent's stock transfer agent (which is currently Boston
EquiServe L.P.) the number of Earn-Out Shares calculated according to the
Earn-Out Provisions, less any shares to be deposited in the Escrow Fund
to satisfy pending claims specified in any Officer's Certificate
theretofore delivered to the Escrow Agent prior to the termination of the
Escrow Period, (ii) shall cause such transfer agent to transfer such
Earn-Out Shares to the Stockholders, (iii) shall transfer to the Escrow
Fund the shares reserved against pending claims pursuant to the Earn-Out
Provisions, and (iv) return to Parent any remaining shares or property in
the Earn-Out Fund. Each Stockholder shall receive that number of Earn-Out
Shares calculated in accordance with Exhibit C of the Merger Agreement
and certified to the Escrow Agent by the Chief Financial Officer of
Parent.
7. DISTRIBUTION.
Any cash dividends, dividends payable in securities or other
distributions of any kind (but excluding any shares of Parent capital stock
received upon a stock split or stock dividend) shall be promptly distributed by
the Escrow Agent to the beneficial holder of the Escrow Shares to which such
distribution relates, by check mailed via first class mail, to the Stockholders
at their addresses, and in the percentage interests, set forth in Annex A. Any
shares of Parent Common Stock received by the Escrow Agent upon a stock split
made in respect of any securities in the Escrow Fund shall be added to the
Escrow Fund and become a part thereof. Any provision hereof or of Article IX or
the Earn-Out Provisions shall be adjusted to appropriately reflect any stock
split or reverse stock split.
8. EXCULPATORY PROVISIONS.
(a) The Escrow Agent shall be obligated only for the performance of
such Duties as are specifically set forth herein and in Article IX and
may rely and shall be protected in relying or refraining from acting on
any instrument reasonably believed to be genuine and to have been signed
or presented by the proper party or parties. The Escrow Agent shall not
be liable for forgeries or false impersonations. The Escrow Agent shall
not be liable for any act done or omitted hereunder as escrow agent
except for gross negligence or willful misconduct. The Escrow Agent
shall, in no case or event be liable for any representations or
warranties of the Company or Parent or for punitive, incidental or
consequential damages. Any act done or omitted pursuant to the advice or
opinion of counsel shall be conclusive evidence of the good faith of the
Escrow Agent.
(b) The Escrow Agent is hereby expressly authorized to comply with
and obey orders, judgments or decrees of any court or rulings of any
arbitrators. In case the Escrow Agent obeys or complies with any such
order, judgment or decree of any court or such ruling of any arbitrator,
the Escrow Agent shall not be liable to any of the parties hereto or to
any other person by reason of such compliance, notwithstanding any such
order,
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judgment, decree or arbitrators' ruling being subsequently reversed,
modified, annulled, set aside, vacated or found to have been entered
without jurisdiction.
(c) The Escrow Agent shall not be liable in any respect on account
of the identity, authority or rights of the parties executing or
delivering or purporting to execute or deliver the Agreement or any
documents or papers deposited or called for thereunder,
(d) The Escrow Agent shall not be liable for the outlawing of any
rights under any statute of limitations with respect to the Agreement or
any documents deposited with the Escrow Agent.
9. ALTERATION OF DUTIES.
The Duties may be altered, amended, modified or revoked only by a writing
signed by all of the parties hereto.
10. RESIGNATION AND REMOVAL OF THE ESCROW AGENT.
The Escrow Agent may resign as Escrow Agent at any time with or without
cause by giving at least thirty (30) days' prior written notice to each of
Parent and the Stockholders' Agent. Such resignation shall be effective thirty
(30) days following the date such notice is given. In addition, Parent and the
Stockholders' Agent may jointly remove the Escrow Agent as escrow agent at any
time with or without cause, by an instrument executed by Parent and the
Stockholders' Agent (which may be executed in counterparts) given to the Escrow
Agent, which instrument shall designate the effective date of such removal. In
the event of any such resignation or removal, a successor escrow agent which
shall be a bank or trust company organized under the laws of the United States
of America or of the State of New York having (or if such bank or trust company
is a member of a bank company, its bank holding company has) a combined capital
and surplus of not less than $50,000,000, shall be appointed by the
Stockholders' Agent with the approval of Parent, which approval shall not be
unreasonably withheld. Any such successor escrow agent shall deliver to Parent
and the Stockholders' Agent a written instrument accepting such appointment, and
thereupon it shall succeed to all the rights and duties of the escrow agent
hereunder and shall be entitled to receive the Escrow Fund and the Earn-Out
Fund.
11. FURTHER INSTRUMENTS.
If the Escrow Agent reasonably requires other or further instruments in
connection with performance of the Duties, the necessary parties hereto shall
join in furnishing such instruments.
12. DUTIES.
It is understood and agreed that should any dispute arise with respect to
the delivery and/or ownership or right of possession of the securities held by
the Escrow Agent hereunder, the Escrow Agent is authorized and directed to act
in accordance with, and in reliance upon, the terms hereof and of Article IX.
13. ESCROW FEES AND EXPENSES.
Parent shall pay the Escrow Agent such fees, as are established by the Fee
Schedule attached hereto as Annex C.
14. STOCKHOLDER'S AGENT EXPENSES.
Upon the termination of the Escrow Period in accordance with Section 3
hereof and in the event the Stockholder's Agent incurs any expenses (including
fees) in connection with his duties pursuant to this Agreement and the Merger
Agreement, to the extent any proceeds remain in the Escrow Fund upon
distributions, if any, to Parent required hereunder, upon delivery of a
certificate to the Escrow Agent by the Stockholder's Agent detailing such
expenses, the Escrow Agent shall distribute that number of Escrow Shares as
being sufficient to satisfy such expenses.
15. INDEMNIFICATION.
In consideration of the Escrow Agent's acceptance of this appointment,
the Escrow Agent shall be indemnified and held harmless by Parent, as to any
liability incurred by the Escrow Agent to any person, firm or corporation by
reason of its having accepted such appointment or in carrying out the terms
hereof and of Article IX, and to reimburse it for all its costs and expenses,
including, among other things, counsel fees and expenses,
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<PAGE>
reasonably incurred by reason of any matter as to which an indemnity is paid;
provided, however, that no indemnity shall be paid in case of the Escrow Agent's
negligence, willful misconduct or breach of this Agreement.
16. GENERAL.
(a) Any notice given hereunder shall be in writing and shall be
deemed effective upon the earlier of personal delivery or the third day
after mailing by certified or registered mail, postage prepaid as
follows:
To Parent:
Covad Communications Group, Inc.
4520 Burton Drive
Santa Clara, CA 95054
Attention: General Counsel
Facsimile No.: (408) 844-7680
With a copy to:
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017
Attention: John W. Carr, Esq.
Facsimile No.: (212) 455-2502
To Stockholders' Agent:
--------------------------
--------------------------
--------------------------
With a copy to:
--------------------------
--------------------------
--------------------------
To the Escrow Agent:
--------------------------
--------------------------
--------------------------
or to such other address as any party may have furnished in writing to
the other parties in the manner provided above. Any notice addressed to
the Escrow Agent shall be effective only upon receipt.
(b) The Officer's Certificate as defined in Article IX may be
signed by the President, Vice President or Chief Financial Officer of
Parent.
(c) The captions in this Escrow Agreement are for convenience only
and shall not be considered a part of or affect the construction or
interpretation of any provision of this Escrow Agreement.
(d) This Escrow Agreement may be executed in any number of
counterparts, each of which when so executed shall constitute an original
copy hereof, but all of which together shall constitute one agreement.
(e) No party may, without the prior express written consent of each
other party, assign this Escrow Agreement in whole or in part. This
Escrow Agreement shall be binding upon and inure to the benefit of the
respective successors and assigns of the parties hereto.
(f) This Escrow Agreement shall be governed by and construed in
accordance with the laws of the State of New York applicable to contracts
made and to be performed in the State of New York. The parties to this
Escrow Agreement hereby agree to submit to personal jurisdiction in the
State of New York.
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<PAGE>
17. INVESTMENT OF ESCROW CASH.
The Escrow Agent shall invest cash dividends or other cash it may receive
with respect to the Escrow Fund or the Earn-Out Fund in the SsgA U.S. Treasury
Money Market Fund or, with the prior written consent of the Stockholders' Agent,
in another money market mutual fund registered under the Investment Company Act
of 1940, the principal of which is invested solely in obligations issued or
guaranteed by the United States government. All interest or any other income
earned with respect to shares shall be retained by the Escrow Agent as part of
Escrow Fund or the Earn-Out Fund, as the case may be, until distributed in
accordance with other provisions of this Agreement. For tax reporting purposes,
all income to the Escrow Fund shall be allocated to the Stockholders in
accordance with their pro rata percentage interests set forth in Annex B and all
income to the Earn-Out Fund shall be allocated to Parent.
18. TAX REPORTING MATTERS.
The Parent and the Stockholders' Agent on behalf of the Stockholders agree
to provide the Escrow Agent with certified tax identification numbers for each
of them by furnishing appropriate forms W-9 (or Forms W-8, in the case of
non-U.S. persons) and other forms and documents that the Escrow Agent may
reasonably request (collectively, "Tax Reporting Documentation") to the Escrow
Agent within 30 days, after the date hereof. The parties hereto understand that,
if such Tax Reporting Documentation is not so certified to the Escrow Agent, the
Escrow Agent may be required by the Internal Revenue Code, as it may be amended
from time to time, to withhold a portion of any interest or other income earned
on the investment of monies or other property held by the Escrow Agent pursuant
to this Agreement. The Escrow Agent need not make any distribution of all or any
portion of the Escrow Fund to any person until such person has furnished to the
Escrow Agent such Tax Reporting Documentation as the Escrow Agent may reasonably
require.
[Signature pages follow]
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<PAGE>
IN WITNESS WHEREOF, the undersigned have caused this Agreement to be
executed and delivered by their respective officers thereunto duly authorized,
all as of the date first written above.
COVAD COMMUNICATIONS GROUP, INC.
By:
---------------------------
Name:
Title: Executive Vice President
[Escrow Agent]
By:
---------------------------
Name:
Title:
--------------------------------
Christopher Lord
--------------------------------
[Stockholder]
--------------------------------
[Stockholder]
--------------------------------
[Stockholder]
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<PAGE>
ANNEX A
[SEE APPENDIX A TO THE PROSPECTUS.]
D-8
<PAGE>
ANNEX B--STOCKHOLDERS
STOCKHOLDER INTEREST IN ESCROW FUND
[Name of Stockholder]
[Address] [___]%
[Taxpayer identification number]
Beneficial ownership: [__] shares of Parent Common Stock
[Name of Stockholder]
[Address] [___]%
[Taxpayer identification number]
Beneficial ownership: [__] shares of Parent Common Stock
[Name of Stockholder]
[Address] [___]%
[Taxpayer identification number]
Beneficial ownership: [__] shares of Parent Common Stock
[Name of Stockholder]
[Address] [___]%
[Taxpayer identification number]
Beneficial ownership: [__] shares of Parent Common Stock
D-9
<PAGE>
ANNEX C--FEE SCHEDULE
[TO BE INSERTED AT SIGNING]
D-10
<PAGE>
APPENDIX E
[Donaldson, Lufkin & Jenrette Securities Corporation Letterhead]
August 4, 2000
Board of Directors
BlueStar Communications Group, Inc.
414 Union Street
Suite 900
Nashville Tennessee 37219
Dear Sirs:
You have requested our opinion as to the fairness, as of June 14, 2000,
from a financial point of view to the holders of common stock, par value $0.01
per share, of BlueStar Communications Group, Inc. (the "Company Common Stock")
of the consideration to be received by such stockholders pursuant to the terms
of the Agreement and Plan of Merger, dated as of June 15, 2000 (the
"Agreement"), by and among BlueStar Communications Group, Inc. (the "Company"),
Covad Communications Group, Inc. ("Parent"), and Covad Acquisition Corporation,
a wholly owned subsidiary of Parent ("Merger Sub"), pursuant to which Merger Sub
will be merged (the "Merger") with and into the Company.
Pursuant to the Agreement, Parent has agreed to issue an aggregate of 7.1
million shares of its common stock, par value $0.001 per share ("Parent Common
Stock") in connection with the Merger (the "Aggregate Consideration"). In
addition, Parent has agreed to issue up to 5 million additional shares of Parent
Common Stock based on the operating performance of the Company as set forth in
the Agreement. Specifically, pursuant to the Agreement, each share of Series A
Preferred, Series B Preferred and Series C Preferred (each as defined below)
will receive the respective liquidation preference payment entitled to be paid
to each such share as set forth in the Third Amended and Restated Certificate of
Incorporation of the Company ("Certificate of Incorporation") and will share
ratably on an as converted basis in accordance with the Certificate of
Incorporation the remaining merger consideration with each share of Company
Common Stock, whereby (i) each share of Series A Preferred Stock, par value
$0.01 per share, of the Company ("Series A Preferred"), other than shares held
in treasury by the Company, will be converted into the right to receive that
number of shares of Parent Common Stock as shall be determined in accordance
with the Agreement, (ii) each share of Series B Preferred Stock, par value $0.01
per share, of the Company ("Series B Preferred"), other than shares held in
treasury by the Company, will be converted into the right to receive that number
of shares of Parent Common Stock as shall be determined in accordance with the
Agreement, (iii) each share of Series C Preferred Stock, par value $0.01 per
share, of the Company ("Series C Preferred"), other than shares held in treasury
by the Company, will be converted into the right to receive that number of
shares of Parent Common Stock as shall be determined in accordance with the
Agreement, and (iv) each share of Company Common Stock, other than shares held
in treasury by the Company, will be converted into the right to receive that
number of shares of Parent Common Stock as shall be determined in accordance
with the Agreement.
In arriving at our opinion, we have reviewed the Certificate of
Incorporation and the Agreement and the exhibits thereto. We also have reviewed
financial and other information that was publicly available or furnished to us
by the Company, as of June 14, 2000, including information provided during
discussions with its management. Included in the information provided during
discussions with the management of the Company were certain financial
projections of the Company, as of June 14, 2000, for the period beginning
January 1, 2000 and ending December 31, 2004 prepared by the management of the
Company and certain financial projections of Parent, as of June 14, 2000, for
the period beginning January 1, 2000 and ending December 31, 2002 prepared by a
nationally recognized research analyst identified by the management of the
Company. The management of the Company had also informed us that the Company, as
of June 14, 2000, expected to exhaust its liquidity in the near term and did not
have a financing source for funding its anticipated operating and capital needs
over the following 12 months. In addition, we have compared certain financial
and securities data of the Company and Parent with various other companies whose
securities are traded in public markets, reviewed the historical stock prices
and trading volumes of Parent Common Stock, reviewed prices and premiums paid in
certain other business combinations and conducted such other financial studies,
analyses and investigations as we deemed appropriate for purposes of this
opinion.
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In rendering our opinion, we have relied upon and assumed the accuracy and
completeness of all of the financial and other information that was available to
us from public sources, that was provided to us by the Company or its
representatives, or that was otherwise reviewed by us, as of June 14, 2000, and
have assumed that the Company is not aware of any information prepared by it or
its advisors that might be material to our opinion that had not been made
available to us, as of June 14, 2000. With respect to the financial projections
supplied to us, we have relied on representations that they have been reasonably
prepared on bases reflecting the best available estimates and judgments of the
management of the Company, as of June 14, 2000, as to the future operating and
financial performance of the Company. With respect to the financial projections
prepared by the research analyst referred to above, we have assumed with your
consent the reasonableness thereof and that they do not materially differ from
the best available estimates and judgements of the management of Parent, as of
June 14, 2000, as to the future operating and financial performance of Parent.
We have not assumed any responsibility for making an independent evaluation of
any assets or liabilities or for making any independent verification of any of
the information reviewed by us. We have relied as to certain legal matters,
including that the Merger will be free of federal tax to the Company and its
stockholders, on advice of counsel to the Company.
Our opinion is necessarily based on economic, market, financial and other
conditions as they existed on, and on the information made available to us as
of, June 14, 2000. It should be understood that, although developments
subsequent to June 14, 2000 may affect our ability to reach the conclusion set
forth in this opinion as of a later date, we do not have any obligation to
update, revise or reaffirm this opinion. We are expressing no opinion herein as
to the price at which the Parent Common Stock will actually trade at any time.
Our opinion does not address the relative merits of the Merger and the other
business strategies that were being considered by the Company's Board of
Directors, as of June 14, 2000, nor does it address the Board's decision to
proceed with the Merger. Our opinion does not constitute a recommendation to any
stockholder as to how such stockholder should vote on the proposed transaction.
Our opinion does not address the allocation of the Aggregate Consideration among
classes of stockholders of the Company. Our analysis was based on the total
outstanding shares of the Company calculated by assuming the conversion of all
outstanding preferred stock into Company Common Stock and the inclusion of all
options granted (whether or not currently exercisable) and all outstanding
warrants of the Company.
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), as part of its
investment banking services, is regularly engaged in the valuation of businesses
and securities in connection with mergers, acquisitions, underwritings, sales
and distributions of listed and unlisted securities, private placements and
valuations for corporate and other purposes. DLJ has performed investment
banking and other services for Parent in the past and has been compensated for
such services, including (i) acting as co-manager for Parent's initial public
offering completed in January 1999, (ii) acting as co-manager for Parent's $215
million offering of Senior Notes completed in February 1999, (iii) acting as
co-manager for Parent's $285 million offering of Parent Common Stock completed
in June 1999, and (iv) acting as co-manager for Parent's $559 million offering
of Parent Common Stock completed in November 1999.
Based upon the foregoing and such other factors as we deem relevant, we are
of the opinion that, as of June 14, 2000, the Aggregate Consideration to be
received by the holders of the Company Common Stock pursuant to the Agreement is
fair to such stockholders from a financial point of view.
Very truly yours,
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
By: /s/ James M. Broner
----------------------------
James M. Broner
Senior Vice President
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APPENDIX F
Section 262 of the Delaware General Corporation Law
(a) Any stockholder of a corporation of this State who holds shares of stock on
the date of the making of a demand pursuant to subsection (d) of this section
with respect to such shares, who continuously holds such shares through the
effective date of the merger or consolidation, who has otherwise complied with
subsection (d) of this section and who has neither voted in favor of the merger
or consolidation nor consented thereto in writing pursuant to S 228 of this
title shall be entitled to an appraisal by the Court of Chancery of the fair
value of the stockholder's shares of stock under the circumstances described in
subsections (b) and (c) of this section. As used in this section, the word
"stockholder" means a holder of record of stock in a stock corporation and also
a member of record of a nonstock corporation; the words "stock" and "share" mean
and include what is ordinarily meant by those words and also membership or
membership interest of a member of a nonstock corporation; and the words
"depository receipt" mean a receipt or other instrument issued by a depository
representing an interest in one or more shares, or fractions thereof, solely of
stock of a corporation, which stock is deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or series of
stock of a constituent corporation in a merger or consolidation to be effected
pursuant to S 251 (other than a merger effected pursuant to S 251(g) of this
title), S 252, S 254, S 257, S 258, S 263 or S 264 of this title:
(1) Provided, however, that no appraisal rights under this section
shall be available for the shares of any class or series of stock,
which stock, or depository receipts in respect thereof, at the record
date fixed to determine the stockholders entitled to receive notice of
and to vote at the meeting of stockholders to act upon the agreement of
merger or consolidation, were either (i) listed on a national
securities exchange or designated as a national market system security
on an interdealer quotation system by the National Association of
Securities Dealers, Inc. or (ii) held of record by more than 2,000
holders; and further provided that no appraisal rights shall be
available for any shares of stock of the constituent corporation
surviving a merger if the merger did not require for its approval the
vote of the stockholders of the surviving corporation as provided in
subsection (f) of S 251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal rights
under this section shall be available for the shares of any class or
series of stock of a constituent corporation if the holders thereof are
required by the terms of an agreement of merger or consolidation
pursuant to SS 251, 252, 254, 257, 258, 263 and 264 of this title to
accept for such stock anything except:
a. Shares of stock of the corporation surviving or resulting
from such merger or consolidation, or depository receipts
in respect thereof;
b. Shares of stock of any other corporation, or depository
receipts in respect thereof, which shares of stock (or
depository receipts in respect thereof) or depository receipts
at the effective date of the merger or consolidation will be
either listed on a national securities exchange or designated
as a national market system security on an interdealer
quotation system by the National Association of Securities
Dealers, Inc. or held of record by more than 2,000 holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a. and
b. of this paragraph; or
d. Any combination of the shares of stock, depository
receipts and cash in lieu of fractional shares or fractional
depository receipts described in the foregoing subparagraphs
a., b. and c. of this paragraph.
F-1
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(3) In the event all of the stock of a subsidiary Delaware corporation
party to a merger effected under S 253 of this title is not owned by
the parent corporation immediately prior to the merger, appraisal
rights shall be available for the shares of the subsidiary Delaware
corporation.
(c) Any corporation may provide in its certificate of incorporation that
appraisal rights under this section shall be available for the shares of any
class or series of its stock as a result of an amendment to its certificate of
incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets of
the corporation. If the certificate of incorporation contains such a provision,
the procedures of this section, including those set forth in subsections (d) and
(e) of this section, shall apply as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal rights
are provided under this section is to be submitted for approval at a
meeting of stockholders, the corporation, not less than 20 days prior
to the meeting, shall notify each of its stockholders who was such on
the record date for such meeting with respect to shares for which
appraisal rights are available pursuant to subsection (b) or (c) hereof
that appraisal rights are available for any or all of the shares of the
constituent corporations, and shall include in such notice a copy of
this section. Each stockholder electing to demand the appraisal of such
stockholder's shares shall deliver to the corporation, before the
taking of the vote on the merger or consolidation, a written demand for
appraisal of such stockholder's shares. Such demand will be sufficient
if it reasonably informs the corporation of the identity of the
stockholder and that the stockholder intends thereby to demand the
appraisal of such stockholder's shares. A proxy or vote against the
merger or consolidation shall not constitute such a demand. A
stockholder electing to take such action must do so by a separate
written demand as herein provided. Within 10 days after the effective
date of such merger or consolidation, the surviving or resulting
corporation shall notify each stockholder of each constituent
corporation who has complied with this subsection and has not voted in
favor of or consented to the merger or consolidation of the date that
the merger or consolidation has become effective; or
(2) If the merger or consolidation was approved pursuant to S 228 or S
253 of this title, each consitutent corporation, either before the
effective date of the merger or consolidation or within ten days
thereafter, shall notify each of the holders of any class or series of
stock of such constitutent corporation who are entitled to appraisal
rights of the approval of the merger or consolidation and that
appraisal rights are available for any or all shares of such class or
series of stock of such constituent corporation, and shall include in
such notice a copy of this section; provided that, if the notice is
given on or after the effective date of the merger or consolidation,
such notice shall be given by the surviving or resulting corporation to
all such holders of any class or series of stock of a constituent
corporation that are entitled to appraisal rights. Such notice may,
and, if given on or after the effective date of the merger or
consolidation, shall, also notify such stockholders of the effective
date of the merger or consolidation. Any stockholder entitled to
appraisal rights may, within 20 days after the date of mailing of such
notice, demand in writing from the surviving or resulting corporation
the appraisal of such holder's shares. Such demand will be sufficient
if it reasonably informs the corporation of the identity of the
stockholder and that the stockholder intends thereby to demand the
appraisal of such holder's shares. If such notice did not notify
stockholders of the effective date of the merger or consolidation,
either (i) each such constitutent corporation shall send a second
notice before the effective date of the merger or consolidation
notifying each of the holders of any class or series of stock of such
constitutent corporation that are entitled to appraisal rights of the
effective date of the merger or
<PAGE>
consolidation or (ii) the surviving or resulting corporation shall
send such a second notice to all such holders on or within 10 days
after such effective date; provided, however, that if such second
notice is sent more than 20 days following the sending of the first
notice, such second notice need only be sent to each stockholder who
is entitled to appraisal rights and who has demanded appraisal of such
holder's shares in accordance with this subsection. An affidavit of
the secretary or assistant secretary or of the transfer agent of the
corporation that is required to give either notice that such notice
has been given shall, in the absence of fraud, be prima facie evidence
of the facts stated
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therein. For purposes of determining the stockholders entitled to
receive either notice, each constitutent corporation may fix, in
advance, a record date that shall be not more than 10 days prior to
the date the notice is given, provided, that if the notice is given on
or after the effective date of the merger or consolidation, the record
date shall be such effective date. If no record date is fixed and the
notice is given prior to the effective date, the record date shall be
the close of business on the day next preceding the day on which the
notice is given.
(e) Within 120 days after the effective date of the merger or consolidation, the
surviving or resulting corporation or any stockholder who has complied with
subsections (a) and (d) hereof and who is otherwise entitled to appraisal
rights, may file a petition in the Court of Chancery demanding a determination
of the value of the stock of all such stockholders. Notwithstanding the
foregoing, at any time within 60 days after the effective date of the merger or
consolidation, any stockholder shall have the right to withdraw such
stockholder's demand for appraisal and to accept the terms offered upon the
merger or consolidation. Within 120 days after the effective date of the merger
or consolidation, any stockholder who has complied with the requirements of
subsections (a) and (d) hereof, upon written request, shall be entitled to
receive from the corporation surviving the merger or resulting from the
consolidation a statement setting forth the aggregate number of shares not voted
in favor of the merger or consolidation and with respect to which demands for
appraisal have been received and the aggregate number of holders of such shares.
Such written statement shall be mailed to the stockholder within 10 days after
such stockholder's written request for such a statement is received by the
surviving or resulting corporation or within 10 days after expiration of the
period for delivery of demands for appraisal under subsection (d) hereof,
whichever is later.
(f) Upon the filing of any such petition by a stockholder, service of a copy
thereof shall be made upon the surviving or resulting corporation, which shall
within 20 days after such service file in the office of the Register in Chancery
in which the petition was filed a duly verified list containing the names and
addresses of all stockholders who have demanded payment for their shares and
with whom agreements as to the value of their shares have not been reached by
the surviving or resulting corporation. If the petition shall be filed by the
surviving or resulting corporation, the petition shall be accompanied by such a
duly verified list. The Register in Chancery, if so ordered by the Court, shall
give notice of the time and place fixed for the hearing of such petition by
registered or certified mail to the surviving or resulting corporation and to
the stockholders shown on the list at the addresses therein stated. Such notice
shall also be given by 1 or more publications at least 1 week before the day of
the hearing, in a newspaper of general circulation published in the City of
Wilmington, Delaware or such publication as the Court deems advisable. The forms
of the notices by mail and by publication shall be approved by the Court, and
the costs thereof shall be borne by the surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the stockholders
who have complied with this section and who have become entitled to appraisal
rights. The Court may require the stockholders who have demanded an appraisal
for their shares and who hold stock represented by certificates to submit their
certificates of stock to the Register in Chancery for notation thereon of the
pendency of the appraisal proceedings; and if any stockholder fails to comply
with such direction, the Court may dismiss the proceedings as to such
stockholder.
F-3
<PAGE>
(h) After determining the stockholders entitled to an appraisal, the Court shall
appraise the shares, determining their fair value exclusive of any element of
value arising from the accomplishment or expectation of the merger or
consolidation, together with a fair rate of interest, if any, to be paid upon
the amount determined to be the fair value. In determining such fair value, the
Court shall take into account all relevant factors. In determining the fair rate
of interest, the Court may consider all relevant factors, including the rate of
interest which the surviving or resulting corporation would have had to pay to
borrow money during the pendency of the proceeding. Upon application by the
surviving or resulting corporation or by any stockholder entitled to participate
in the appraisal proceeding, the Court may, in its discretion, permit discovery
or other pretrial proceedings and may proceed to trial upon the appraisal prior
to the final determination of the stockholder entitled to an appraisal. Any
stockholder whose name appears on the list filed by the surviving or resulting
corporation pursuant to subsection (f) of this section and who has submitted
such stockholder's certificates of stock to the Register in Chancery, if such is
required, may participate fully in all proceedings until it is finally
determined that such stockholder is not entitled to appraisal rights under this
section.
(i) The Court shall direct the payment of the fair value of the shares, together
with interest, if any, by the surviving or resulting corporation to the
stockholders entitled thereto. Interest may be simple or compound, as the Court
may direct. Payment shall be so made to each such stockholder, in the case of
holders of uncertificated stock forthwith, and the case of holders of shares
represented by certificates upon the surrender to the corporation of the
certificates representing such stock. The Court's decree may be enforced as
other decrees in the Court of Chancery may be enforced, whether such surviving
or resulting corporation be a corporation of this State or of any state.
(j) The costs of the proceeding may be determined by the Court and taxed upon
the parties as the Court deems equitable in the circumstances. Upon application
of a stockholder, the Court may order all or a portion of the expenses incurred
by any stockholder in connection with the appraisal proceeding, including,
without limitation, reasonable attorney's fees and the fees and expenses of
experts, to be charged pro rata against the value of all the shares entitled to
an appraisal.
(k) From and after the effective date of the merger or consolidation, no
stockholder who has demanded appraisal rights as provided in subsection (d) of
this section shall be entitled to vote such stock for any purpose or to receive
payment of dividends or other distributions on the stock (except dividends or
other distributions payable to stockholders of record at a date which is prior
to the effective date of the merger or consolidation); provided, however, that
if no petition for an appraisal shall be filed within the time provided in
subsection (e) of this section, or if such stockholder shall deliver to the
surviving or resulting corporation a written withdrawal of such stockholder's
demand for an appraisal and an acceptance of the merger or consolidation, either
within 60 days after the effective date of the merger or consolidation as
provided in subsection (e) of this section or thereafter with the written
approval of the corporation, then the right of such stockholder to an appraisal
shall cease. No twithstanding the foregoing, no appraisal proceeding in the
Court of Chancery shall be dismissed as to any stockholder without the approval
of the Court, and such approval may be conditioned upon such terms as the Court
deems just.
(l) The shares of the surviving or resulting corporation to which the shares of
such objecting stockholders would have been converted had they assented to the
merger or consolidation shall have the status of authorized and unissued shares
of the surviving or resulting corporation.
F-4
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify such person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that such person is or was a director, officer, employee or agent of the
corporation or is or was serving at its request in such capacity in another
corporation or business association, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if such
person acted in good faith and in a manner such person reasonably believed to be
in or not opposed to the best interests of the corporation, and, with respect to
any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful.
Section 102(b)(7) of the DGCL permits a corporation to provide in its
certificate of incorporation that 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, except for liability (i) for any
breach of the director's duty of loyalty to the corporation or its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL,
or (iv) for any transaction from which the director derived an improper personal
benefit.
As permitted by Section 102(b)(7) of the DGCL, Covad Communications'
amended and restated certificate of incorporation includes a provision that
limits a director's personal liability to Covad Communications or its
stockholders for monetary damages for breaches of his or her fiduciary duty as a
director. Article X of Covad Communications' amended and restated certificate of
incorporation provides that no director of Covad Communications shall be
personally liable to Covad Communications or its stockholders for monetary
damages for breach of fiduciary duty to the fullest extent permitted by the
DGCL.
As permitted by Section 145 of the DGCL, Covad Communications' bylaws
provide that, to the fullest extent permitted by the DGCL, directors, officers
and certain other persons who are made, or are threatened to be made, parties
to, or are involved in, any action, suit or proceeding will be indemnified by
Covad Communications with respect thereto. Article VI of Covad Communications'
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.
Covad Communications maintains insurance policies under which its directors
and officers are insured, within the limits and subject to the limitations of
the policies, against expenses in connection with the defense of actions, suits
or proceedings, and certain liabilities that might be imposed as a result of
such actions, suits or proceedings, to which they are parties by reason of being
or having been directors or officers of Covad Communications. Covad
Communications also entered into agreements to indemnify Covad Communications'
directors and executive officers, in addition to the indemnification provided
for in Covad Communications' amended and restated certificate of incorporation
and bylaws.
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<PAGE>
ITEM 21. (A) EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Merger and Reorganization among
Covad Communications Group, Inc., Covad Acquisition
Corporation and BlueStar Communications Group, Inc. dated
as of June 15, 2000, and amended as of August 28, 2000
(included as Appendix A to the Prospectus).
2.2 Form of Stockholder Agreement between Covad Communications
Group, Inc. and certain stockholders of BlueStar
Communications Group, Inc. dated as of June 15, 2000
(included as Appendix B to the Prospectus).
2.3 Form of Stock Restriction Agreement among Covad
Communications Group, Inc. and certain stockholders of
BlueStar Communications Group, Inc. (included as Appendix
C to the Prospectus).
2.4 Form of Escrow Agreement among Covad Communications Group,
Inc., Christopher Lord, as Agent of the former
stockholders of BlueStar Communications Group, Inc., and
the escrow agent thereto (included as Appendix D to the
Prospectus).
3.1(2) Amended and Restated Certificate of Incorporation of Covad
Communications Group, Inc.
3.2(4) Bylaws of Covad Communications Group, Inc., as currently
in effect.
3.3(7) Certificate of Amendment of Certificate of Incorporation
of Covad Communications Group, Inc. filed on July 14,
2000.
4.1(1) Indenture dated as of March 11, 1998 between Covad
Communications Group, Inc. and The Bank of New York.
4.4(1) Warrant Registration Rights Agreement dated as of March
11, 1998 among Covad Communications Group, Inc. and Bear,
Stearns & Co., Inc. and BT Alex. Brown Incorporated.
4.5(1) Specimen 13 1/2% Senior Note Due 2008.
4.6(1) Amended and Restated Stockholders Rights Agreement dated
January 19, 1999 among Covad Communications Group, Inc.
and certain of its stockholders.
4.7(2) Indenture dated as of February 18, 1999 among Covad
Communications Group, Inc. and The Bank of New York.
4.8(2) Registration Rights Agreement dated as of February 18,
1999 among Covad Communications Group, Inc. and the
Initial Purchasers.
4.9(2) Specimen 12 1/2% Senior Note Due 2009.
4.10(6) Indenture dated as of January 28, 2000, between Covad
Communications Group, Inc. and United States Trust Company
of New York.
4.11(6) Registration Rights Agreement dated as of January 28,
2000, between Covad Communications Group, Inc. and Bear,
Stearns & Co., Inc.
4.12(6) Specimen 12% Senior Note Due 2010.
4.13(3) Stockholder Protection Rights Agreement of Covad
Communications Group, Inc. dated February 15, 2000.
5 Opinion of Simpson Thacher & Bartlett as to the legality
of the Securities.
8 Tax opinion of Brobeck, Phleger & Harrison LLP.
10.1(2) Form of Indemnification Agreement entered into between
Covad Communications Group, Inc. and each of its
executive officers and directors.
10.2 Demand Loan Agreement dated as of June 15, 2000 among
BlueStar Communications Group, Inc. and Bear Stearns
Corporate Lending Inc. (filed previously).
10.3 Put/Call Option Agreement dated as of June 15, 2000 among
Covad Communications Group, Inc. and Bear Stearns
Corporate Lending Inc. (filed previously).
10.5(2) Series C Preferred Stock and Warrant Subscription
Agreement dated as of February 20, 1998 among Covad
Communications Group, Inc., Warburg, Pincus Ventures,
L.P.,Crosspoint
II-2
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
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 Covad Communications Group, Inc. Warburg,
Crosspoint and Robert Hawk.
10.6(2) Employment Agreement dated June 21, 1999 between Covad
Communications Group, Inc. and Robert E. Knowling, Jr.
10.7(2) Sublease Agreement dated July 6, 1998 between Auspex
Systems, Inc. and Covad Communications Group, Inc. with
respect to Registrant's facilities in Santa Clara,
California.
10.8(2) 1998 Employee Stock Purchase Plan of Covad Communications
Group, Inc. and related agreements, as currently in
effect.
10.10(2) Form of Warrant to purchase Common Stock issued by Covad
Communications Group, Inc. on February 20, 1998 to
Warburg, PincusVentures, L.P., Crosspoint Ventures
Partners 1996 and Intel Corporation.
10.11(4) Note Secured by Deed of Trust dated October 7, 1998
issued by Catherine A. Hemmer and John J. Hemmer in favor
of Covad Communications Group, Inc.
10.12(4) 1997 Stock Plan of Covad Communications Group, Inc. and
related option agreement, as currently in effect.
10.13(4) Series C-1 Preferred Stock Purchase Agreement dated as of
December 30, 1998 among Covad Communications Group, Inc.,
AT&T Venture Fund II, LP and two affiliated funds.
10.14(4) Series D-1 Preferred Stock Purchase Agreement dated as of
December 30, 1998 among Covad Communications Group, Inc.,
AT&T Venture Fund II, LP and two affiliated funds.
10.15(4) Series C-1 Preferred Stock Purchase Agreement dated as of
December 30, 1998 between Covad Communications Group, Inc.
and NEXTLINK Communications, Inc.
10.16(4) Series D-1 Preferred Stock Purchase Agreement dated as of
December 30, 1998 between Covad Communications Group, Inc.
and NEXTLINK Communications, Inc.
10.17(4) Series C-1 Preferred Stock Purchase Agreement dated as of
January 19, 1998 between Covad Communications Group, Inc.
and U.S. Telesource, Inc.
10.18(4) Series D-1 Preferred Stock Purchase Agreement dated as of
January 19, 1998 between Covad Communications Group, Inc.
and U.S. Telesource, Inc.
11.1(5) Statement of Computation of Per Share Earnings.
12.1 Statement of Computation of Ratios (filed previously).
21.1(5) Subsidiaries of Covad Communications Group, Inc.
23.1 Consent of Donaldson, Lufkin & Jenrette, Securities
Corporation.
23.2 Consent of Simpson Thacher & Bartlett (included in
Exhibit 5).
23.3 Consent of Brobeck, Phleger & Harrison LLP (included in
Exhibit 8).
23.4 Consent of Ernst & Young LLP, independent auditors.
23.5 Consent of Pricewaterhouse Coopers LLP, independent
auditors.
23.6 Consent of Arthur Anderson LLP, independent auditors.
24.1 Power of Attorney (filed previously).
27.1(5) Financial Data Schedules.
99.1 Opinion of Donaldson, Lufkin & Jenrette Securities
Corporation (included as Appendix E to the Prospectus).
99.2 Form of Written Consent of Stockholders of BlueStar
Communications Group, Inc.
--------------
(1) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s Registration Statement on Form
S-4 (No. 333-51097) as originally filed on April 27, 1998 and as
subsequently amended.
(2) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s Registration Statement on Form
S-4 (No. 333-75955) as originally filed on April 4, 1999 and as
subsequently amended.
(3) Incorporated by reference to Exhibit 4.1 filed with Covad Communications
Group, Inc.'s Registration Statement on Form 8-A as originally filed on
February 22, 2000 and as subsequently amended.
(4) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s Registration Statement on Form
S-1 (No. 333-63899) asoriginally filed on September 21, 1998 and as
subsequently amended.
(5) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s report on Form 10-K as originally
filed on March 30, 2000 and as subsequently amended.
(6) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s Registration Statement on Form
S-4 (No. 333-30360) as originally filed on February 14, 2000 and as
subsequently amended.
II-3
<PAGE>
(7) Incorporated by reference to the exhibit of corresponding number filed
with Covad Communications Group, Inc.'s Registration Statement on Form
S-4 (No. 333-43494) as originally filed on August 10, 2000 and as
subsequently amended.
(B) FINANCIAL STATEMENTS
None.
ITEM 22. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement will be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time will be deemed to be the initial BONA FIDE offering thereof.
(b) Insofar as indemnification for liabilities arising under the
securities act of 1933 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 Securities and
Exchange Commission that such indemnification is 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
nation, 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 Act and
will be governed by the final adjudication of such issue.
(c) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registrant 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 will be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus will
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time will be
deemed to be the initial bona fide offering therefor.
(d) The undersigned registrant hereby undertakes to respond to
requests for information that is incorporated by reference into the
prospectus pursuant to Item 4, 10(b), 11, or 13 of this form, within one
business day of receipt of such request, and to send the incorporated
documents by first class mail or other equally prompt means. This included
information contained in documents filed subsequent to the effective date
of the registration statement through the date of responding to the
request.
(e) The undersigned registrant hereby undertakes to supply by means of
a post-effective amendment all information concerning a transaction, and
the company being acquired involved therein, that was not the subject of
and included in the registration statement when it became effective.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, Covad Communications
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of Santa Clara, state of
California, on the 29th day of August 2000.
Covad Communications Group, Inc.
By: /s/ MARK PERRY
------------------------------------------------
Mark Perry
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the Securities Act, this registration
statement has been signed by the following persons on August 29, 2000 in the
capacities indicated.
SIGNATURE TITLE
--------- -----
*
-------------------------- Chairman of the Board, President and Chief
(Robert E. Knowling, Jr.) Executive Officer (Principal Executive Officer)
/s/ MARK PERRY
--------------------------- Executive Vice President and Chief Financial
(Mark Perry) Officer(Principal Financial and Accounting
Officer)
*
--------------------------- Director
(Robert Hawk)
*
--------------------------- Director
(Hellene Runtagh)
*
--------------------------- Director
(Larry Irving)
*
---------------------------- Director
(Daniel Lynch)
*
---------------------------- Director
(Frank Marshall)
*
-------------------------- Director
(Debra Dunn)
*
-------------------------- Director
(Rich Shapero)
*By: /s/ MARK PERRY
----------------------
Mark Perry, attorney-in-fact
II-5
